New Oriental Education & Technology Group Inc (EDU) 2007 Q3 法說會逐字稿

Thank you for standing by for New Oriental third fiscal quarter 2007 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, New Oriental Investor Relations Manager. Please proceed.

Hello, everyone, and welcome to New Oriental's third fiscal quarter 2007 earnings conference call. Our third fiscal quarter earnings results were released earlier today and are available on the Company's website as well as on newswire services. Today you will hear from Michael Yu, our Founder, Chairman, and Chief Executive Officer, and Lou Hsieh had, our Chief Financial Officer. After their prepared remarks, Michael and Louis will be available to answer your questions.

Before we continue please note that the discussion today will contain forward-looking statements under the Safe Harbor provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statement involves inherent risks and uncertainties, as such our results may be materially different from the view 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 and 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 as http/investor.neworiental.org. I'll now turn the call over to New Oriental CEO, Michael Yu. Michael, please?

Thank you, good evening and good morning, and I'm happy to be here again for the third quarter of 2007 and I'm Michael Yu. Thank you for joining us today. We delivered good results for the third fiscal quarter of 2007 with strong growth in our key business segments allowed us to exceed at the high end of our revenue guidance. By more than RMB43 million or $5.5 million U.S.

In addition, the scalability of our business and the efficiency of our management systems were evident as we recorded net income of over $8 million U.S. Over 500% higher than the year ago period. Due to the holiday, the third fiscal quarter is traditionally our second strongest in terms of revenue as many students enroll in winter classes to prepare for domestic and overseas tests. During this third fiscal quarter, student enrollment for our leading language training and test preparation courses grew from approximately 184,000 a year ago to over 199,000 in the third quarter. In particular, our middle school and Top Kids English training programs continue to show strong enrollment growth. Please note that the percentage growth of the student enrollments appears relatively low because the late Chinese New Year Holiday pushes many students registrations from Spring Session, from February into March.

Our content distribution and other business lines also delivered strong results, growing over 90% from the year ago period, although this area of our business is starting from a lower revenue base, we have high expectations about the potential for growth. Along with our distribution network of over 5,000 third party bookstores we are consistently (Inaudible - highly accented language) New Oriental bookstore and we opened our 18th bookstore during the quarter. With tremendous demand of both quality Education in China and a highly fragmented Education environment, one of our key strategies is to rapidly extend our leading nationwide network and in the third fiscal quarter, we opened a new learning centers in six major cities. Our [HARP] and (Inaudible) business model is designed so that each new learning center can leverage both teaching and administrative resources of nearby schools. With wider spread awareness of the New Oriental brand, we are able to ramp up enrollment relatively quickly.

In addition to expanding our physical network, we are also focused on building forceful partnerships with international content providers to enhance our education offering and ensure that our students are receiving quality education. We plan to rollout programs based on our initiatives with Thomson Learning and Environmental Education International later this year and we are confident that they will be well received by students. Going forward we will continue to explore strategic relationships with leading education providers to help us leverage our nationwide distribution channels and online usage.

Despite our achievements to date, the (Inaudible) Education industry in China is still in its early stage. In order to help capture the opportunities ahead of us, we are strongly committed to investing in our growth. To this end, we expect to continue expanding our network of learning centers and of schools to broaden our brand recognition through marketing initiatives and the marketing activity to invest in technology systems and across to continue recruiting the best of teaching talents in China, especially for the first quarter of this year. We have to better prepare for the next year. Now, I will turn the call over to Louis Hsieh, our CFO, to take you through the financial numbers. Thank you.

Thank you, Michael. And welcome to everybody on this call. As Michael just mentioned earlier, we had a strong quarter with strong top and bottom line growth, a significant improvement in our operating margins. Today, I will walk you through the contribution to our third fiscal quarter results and some financial highlights. Please note that the certain figures I will talk about are non-GAAP, including all measures that are given excluding share based compensation expenses. You can find a reconciliation of these figures in the financial tables at the end of the press release.

Our third fiscal quarter 2007 total revenues were RMB255.1 million, equivalent to U.S. 33.0 million, an increase of 51.3% from the third fiscal quarter of 2006. Revenue from our education program and services comprising our language training and test preparation courses and primary and secondary education programs rose 49.3% year-over-year driven by an increase in new student enrollment and language training and test preparation courses. This quarter's results were especially strong because Chinese New Year holiday was later than usual in 2007, allowing Chinese students more time to attend supplemental education programs during their winter holiday, and we also saw increased revenue from books and other education materials and services which rose 93.4% to RMB14.8 million equivalent U.S. dollars, 1.9 million from the year ago period.

Overall, operating expenses for the quarter were up 26.5% year-over-year. Of these, costs of revenues increased by 44.0% year-over-year, mainly due to the increased number of courses offered to a larger student base and a greater number of schools and learning centers in operation. Selling and marketing expenses increased 37.7% year-over-year, mainly due to brand promotion expenses as well as one month impact of an accounting reclassification of some human resource expenses from G&A to sales and marketing. General and administrative expenses increased 2.3% year-over-year to RMB64.8 million, equivalent of $8.4 million U.S.

Operating margins for the quarter was 21.2% compared to 5.8% in the corresponding period of the previous year, excluding share based compensation expenses, operating margins for the quarter was 23.4% compared to 6.4% in the corresponding period of 2006. This increase was primarily due to the improved operating efficiency as revenue growth outpaced the growth in operating costs and expenses.

Total share based compensation expenses which were allocated to related operating cost and expenses increased to RMB5.6 million, equivalent of U.S. $700,000 in the third quarter of 2007. From RMB1 billion in the third quarter of fiscal year 2006. Net operating cash flow for the quarter was RMB49.1 million equivalent of U.S. $6.3 million. Net income for the quarter was RNB65.3 million equivalent of $8.4 million U.S., representing a 543.5 % increase from the third fiscal quarter of 2006. Net income attributable to holders of common shares excluding share based compensation expenses increased to RMB70.9 million. Equivalent of $9.2 million U.S.

Basic and diluted earnings per ADS were RMB$1.79 equivalent to U.S. $0.23, and RMB$1.72 equivalent to U.S. $0.22 respectively. Excluding share based compensation expenses or non-GAAP, basic and diluted earnings per ADS were RMB1.94 equivalent of U.S. $0.25 and RMB1.86 equivalent to U.S. $0.24 respectively. Each ADS represents 4 common shares. Common shares used in calculating basic and diluted earnings per ADS increased in the third quarter of fiscal year 2007 due to 34.5 million new common shares issued and sold by the Company in our initial offering in September of 2006 during the Company's second quarter and approximately 2.4 million new common shares issued and sold by the Company in our secondary offering in February of 2007 during the third fiscal quarter.

Moving to our balance sheet. Our total cash and cash equivalents as of February 28, 2007, were RMB3.432.6 billion, equivalent in U.S. Dollars , 443.4 million, an increase of 194.3%. From November 31, 2006. This jump was primarily due to the proceeds from the follow-on offering in the third fiscal quarter of 2007. In fact, approximately RMB2.667.7 billion, equivalent of U.S. $267.1 million of total cash was paid to selling shareholders in March, early March of 2007, at the beginning of the Company's fourth fiscal quarter.

Before I give guidance, I'd like to take a brief look at the comparisons between the first nine months of fiscal year 2007 and the first nine months of fiscal year 2006. Student enrollment in language, training, and test prep grew 19.0% year-over-year to 754,300 students from 633,600 in the year ago period. Net revenues are up 37.1% year-over-year to RMB853.4 million equivalent of U.S. $110.2 million from RMB622.6 million a year ago.

Net income was up 185.2% year-over-year to RMB238.6 million. U.S. equivalent $30.8 million. From RMB83.7 million in the year ago period, and our operating margins went from 15.3% in the nine months to February 28, 2006, up to 27.5% in the nine months from February 28, 2007. We are are very pleased with these results.

I will now read you New Oriental's financial guidance for the fourth fiscal quarter of 2007. Please note that the following outlook statements are based on our current expectations. These statements are forward-looking and actual results may differ materially. Total net revenue in the fiscal, fourth fiscal quarter of 2007 that runs from March 1, 2007 to May 31, 2007, are expected to be in the range of RMB177 million, U.S. Dollars equivalent 22.9 million to RMB185 million, U.S. equivalent 23.9 million, representing year-over-year growth in the range of 19.9% to 25.3%. Now, let me turn the call back to Michael for his closing remarks.

Thank you, Louis. Once again, thank you for participating in our earnings call for the third fiscal quarter 2007. Now, we will be happy to take your questions. Thank you.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Brandon Dobell with Credit Suisse. Please proceed.

Hi, guys, good morning.

Hi, Brandon, good morning.

Wondered if you could walk through how we should think about what the timing impact of the Chinese New Year was on enrollment but also on revenue per student. I think that came in a lot higher than we had looked for but enrollments came in lower than we had looked for. I'm sure there's some connection with how that works from an accounting perspective or from a longer length of core perspective so maybe Lou, if you could walk us through how we reconcile those two numbers that would be great.

Yes, that's a great question, and we're not surprised by it. Yes, what happened in this Q3 of '07 was an atypical quarter because Chinese New Year occurred around February 17, 18th time period, so basically students had a longer period to study in Q3 of '07, so what happened was last year in Q3 of '07, the amount of cash and student enrollments that were collected in that same quarter and actually recognized as revenue in Q3 of '06 was about 38% of the total cash collection. So last year, the revenue in Q3 was RMB147 million of which about 58 million of which was recognized in Q3 of '06.

Okay.

Now when we switched to Q3 of '07 that changed. We had 176 million in short-term True Language and test prep revenue, and this time, 61% of that revenue this year was actually recognized in the same quarter, so that difference is already RMB38 million so that's one big factor. And then the second issue which relates to your question on student enrollments was that because Chinese New Year was so late this year around February 17, what happened was when the students go back-to-school, they don't go back-to-school until February 26, or 27, and then about a week later they start signing up for Spring courses. So normally, Chinese New Year is at the end of January. Those students would have started signing up for courses in February, end of February, middle to end of February. This year they didn't start signing up for classes until March so much of the student enrollment that would have occurred in Q3 has actually been pushed to Q4.

Okay.

Does that make sense, Brandon?

Yes, it does make sense. The third factor was that of the RMB255 million in revenue in Q3 of this quarter, actually in the short-term we saw about 220 million of that revenue, half of it was actually revenue collected from Q1 and Q2 student enrollments. So it is recognized in Q3. So if you recall in Q1, our student growth rate was 25.9% increase year-over-year and in Q2 of '07 it was 20.3% increase. Those were unsustainable levels. They are just too high, so RMB110 million of that revenue from those students who paid in Q1 and Q2 was actually recognized in Q3. Okay. So it sounds like--? So it sounds like you've got both a front end impact where you had some recognition from prior quarters where courses were longer but you also had a back end impact which pushed out enrollments by a week or two which would have pushed people from Q3 into Q4?

Exactly right. Exactly right. And then so what the impact is, just so everybody is clear, that will actually slightly negatively impact our Q4 revenues because the first week or ten days of March, there won't be much cost from activity, so the classes won't start until the middle of March in this quarter.

Oh, okay.

Because of that, Q4 revenue will be slightly down from what it would have been but because the macroeconomic trends are quite favorable, we're still comfortable with the 20 to 25% revenue increase year-over-year. So the same guidance we gave in Q3.

Okay, I'll be mindful of the one question and I'll jump back into the queue. Thanks.

Thank you, Brandon.

Thank you.

Your next question comes from the line of [Tin Ho] with Unterberg. Please proceed.

Hi, Michael.

Hi.

I wasn't planning to ask a question on the call, but, you know, since, okay, nobody jumped on so I said, you know, I'll give it a shot. So how many total schools or learning centers did you open in this quarter? Six?

Yes, in this quarter, we didn't open any new schools. But we did add nine new learning centers and we closed two.

Oh.

So total 128 learning centers and schools and we added one bookstore.

Yes, because of the Chinese New Year, so we really only had the chance to register for new schools because the government office have closed for the New Year actually, for the quarter. We are opening the schools the fourth quarter and also we are opening more new learning centers to be prepared for the summer quarter, the first quarter of next year.

Do you have any plans in next quarter how many schools do you want to open, how many learning centers do you want to open or how many do you want to--?

You mean of '07?

Yes.

You mean until the end of May?

Correct.

Until the end of May, I think we are going to open like about ten new learning centers all over China and maybe two or three new schools.

Okay.

Thank you.

And the other question is, did you increase your price in last quarter?

Yes. Our ASP increases year-over-year were around 10 or 11%.

But did that happen in last quarter?

Yes, this is year-over-year comparison.

Yes, yes, okay.

Not a quarter by quarter, it's a year over year.

I got it, so compared with last year? Okay, got it.

Yes, but a caveat to that is a lot of this is that (Inaudible) the increase, a lot of it is attributable to the fact we are actually offering smaller classes with nicer environments so it's not exactly an apples to apples comparison.

Yes.

The big part is is the fees are approximately the same. It's because students are willing to pay more for a nicer environment and smaller classes than the ASP's are going up.

That's right.

I see, okay.

It's the price of (Inaudible) because it's sort of a different (Inaudible) study, but a different price.

And your next question comes from the line of Paul Keung with CIBC World Markets. Please proceed.

Hi, Paul.

Hello, can you hear me?

Hi, Paul.

How is it going? I just want to confirm that despite the Chinese New Year that the enrollment growth is back to the midteens next quarter and that pricing is around 10 to 12% again, that pace is still on track.

We haven't disclosed forward pricing, but it should be relatively comparable to Q3 and we would expect student enrollment to be higher than 8%, but probably lower than the 20% that we saw in Q2 and lower than, for sure lower than the 26% we saw in Q1.

Got it.

So I think it's a good ballpark to be in the low teens.

Okay, and then real quick question on the acquisition front, I'm curious what the environment is like now given you mentioned in the past that a lot of the potential sellers and opportunities out there are looking for much higher prices, environment changes on and on and I know it's only a quarter or so, but has it changed at all?

Actually, it has not changed. The environment is still quite typical for us to make an acquisition at this time, but we still have a number of acquisitions in the pipeline, so it did take longer than we would like, and there is still a lot of private equity money that is forging into the sector and still trying to create the next New Oriental.

Okay. I'll get back in the queue. Thank you.

Thank you.

Your next question comes from the line of Jason Kodig with NWD Investments. Please proceed.

Hi. My questions were mostly answered, but I think the deferred revenues on the balance sheet, was that the same impact as what happened with enrollments and the Chinese New Year impact?

Yes. That's exactly right, Jason. What happened was that last year at the end of Q3, we had 140.7 million in deferred revenue that went into Q4. This year, in '07 we only had 135 million in deferred revenue and that's because of two factors. One was because 61% of the revenues were actually already recognized in Q3 this year versus only 38% last year, it was less to defer. Second was what Michael mentioned earlier in his prepared remarks which is that the Chinese New Year holiday was late this year so students didn't start enrolling for Spring courses until March so you'll see them directly into the fourth quarter.

Okay, thank you.

Okay.

Your next question comes from the line of Trace Urdan with Signal Hill. Please proceed.

Hi, good morning. I'd just like to follow-up on the theme a little bit more precisely. So can you review the definition of the enrollments that you report exactly and might I suggest that maybe it's not, there's a disconnect here between how you define those enrollments and clearly how the revenue gets recognized. Maybe there needs to be a different measure that more closely reflects the number, I mean my understanding is that we're talking about the number of student days in class versus just the raw number of students that were enrolled. Is that a fair characterization?

That's a great question, Trace. We have -- the way, we have two systems. We report student enrollment to you folks on the line, by the actual number of students who come into our schools and learning centers that quarter and actually pay cash. That doesn't mean they complete their courses or even take their courses that quarter so they will get counted in that student enrollment because that's the way our systems are set up is it's a cash revenue as we get them from the students so that's how our student enrollment count is calculated.

Now, because of U.S. GAAP, our revenues are pro rated based on how long the class is so the class is three months, we'll recognize one-third of that cash revenue each month during the class and classes will overlap into quarters. So because of that, there is a slight disconnect between the number of student enrollment and the actual revenue versus the actual collected student enrollment cash revenue, and that's why we have the deferred revenue number in our balance sheet, but our systems aren't such that we could reconcile those easily, so we haven't, because of the U.S. GAAP and the pro rata revenue recognition, we have to live with this slight disconnect.

Okay, and then if I could sort of related to that, can you help me understand, I mean I understand the point about there being sort of fewer revenue days in the coming quarter as a function of Chinese New Year, but the sort of deceleration from the sort of 37% year-to-date rate of growth and the 20 to 25% rate that you're talking about next quarter, it seems like a more significant drop than just a week of classes being deferred, but maybe not?

But if you notice our past guidance, Trace, it's about that way. We guided Q3 in 20 to 25% range and we ended up at 51%. I don't think we can do that in Q4 but I think we're comfortable with 20, 25 in Q4 which is typically our second close quarter anyway so Q4 is really the set up for the summer.

Okay, fair enough and if I could sneak one more in, just the tax rate looked especially low this quarter. Was there something that went into that?

Yes, in Q1, we were extremely conservative, so we took a large tax reserve on the advice of our accountants, and we were comfortable that we wouldn't need that tax reserve so some of it is coming back in Q2 and Q3.

Okay, so when we look at a year-to-date number is that something, is that sort of more close to what we should think about modeling?

It should be about 7.5%.

Okay, thank you.

It should go up in the next, in the years to come by 0.5% or 1% a year.

Okay. Thanks, Louis.

Your next question comes from the line of Mark Marostica with Piper Jaffray. Please proceed.

Good evening, everyone.

Hi, Mark.

Hi, Mark.

My question relates to looking forward to the August quarter and to the degree that you have any sense of how the backlog is building or course interest is building as you look into the all-important Summer time frame, that will be helpful.

How is the summer building up.

The summer building up in Q1 of next year, right, our fiscal year. Yes, actually, Mark, we are trying our best to get it prepared for the first quarter of next fiscal year. We are doing great marketing these days and the person actually involved in it and also, we will open in the first quarter of this year and the first quarter of next year, we're going to open more learning centers, in my mind, we are going to open maybe somehow 20 learning centers mostly in Kids English and in high end at each learning centers and the VIP learning centers actually, and also we're trying to push up (inaudible) a little more quickly so that more people in China will recognize this as they think about long studies they come (inaudible) so I'm sure that we are trying to get prepared for the Summer.

And how many schools will you have up and running in Q1 of '08 versus Q1 of '07?

I mean, how many new schools we are going to open and running?

No, not new schools but just how many total campuses, how many total schools will you have in Q1 versus--?

We have 30, 34 schools, right? For the next two quarters we are going to have another five, four to five new schools opening in provincial cities.

Right so if you look back to Q1 of '07, so August a year ago, how many schools did you have at that point?

We had 20?

I think at the end of May which is where our filing was, it was 25 schools, 111 learning centers, Mark, and if you look at August I don't have the exact number for August, but it was, we had added seven new schools in Q1 so it was about 32 and I believe the number was about 115, 116 learning centers and you can expect us probably given Michael's numbers to be in the 140 to 150 learning center, total learning centers and about 38, 39 schools.

Very good.

Hi, Mark, also let me give a concept like looking forward, actually, we have -- we are going through most of the major cities in China, so even when we open new schools we open new schools in the middle size of the cities, that means that while we are opening new schools, it's very important for us to open new learning centers in big cities with the schools, that will mean we invest less, but you can attract more students with an easier strategy and you can save money and also it can make more money, like every time we open a new learning center we can also like generate revenue about 3 million to 5 million, but to open a new school, usually we have to do 5 million within almost three years in the middle size of the city. So, opening new learning centers are very important while we are still opening new schools all over China.

Great. One last question, and I'll jump back into the queue. And that is the ASP you mentioned, Louis was up 10 to 11% in February. You expected the same in May and again my question looking into the August quarter, would you expect ASP's to be up about the same in August as well?

We'll visit that question that question this quarter, so we haven't, traditionally we've increased prices between 6 and 8% but given the fact that the product mix is changing and we're going to smaller class sizes, you can expect the ASP overall to go up.

Great. Okay thanks I'll turn it over.

Thank you. So it's probably a pretty good guess or estimate.

Your next question comes from the line of Brandon Dobell with Credit Suisse. Please proceed.

Just a couple quick follow-ups.

Hi Brandon again.

I'm back in the queue again here. As you look out to the schools that you plan to open or learning centers you plan to open in the next two or three quarters, are you comfortable with where those are in the approval process with the government in terms of finding sites, getting the licenses, getting the people set up, just trying to gauge your comfort level or confidence level with the new school opening schedule.

Yes, we are comfortable with our new school opening schedule. I know we have better relations with the government and actually, the cities that we are going into, the several cities, actually we have connected with the government and have talked with the government and most of them are supporting us to go into their city as quickly as possible, actually.

Okay. Is there any potential impact that you see next year from the Olympics either in Beijing or just in generally in terms of how students are going to be enrolling or patterns in enrollment or what the government might be doing?

Actually, sorry. Actually, we're not very sure at this time, but the Beijing government has just gave out announcements and also the provincial government that people from outside of Beijing will not be stopped from coming to Beijing for Olympics or for other purposes because like about two months ago, people were, there was a rumor that the government will stop people from coming to Beijing for those four months and also will stop Beijing people from working for about two weeks, but now the government says everything will go as normal. People can come into Beijing any time they want and also those people who work in Beijing from other locals, from other places, can also stay in Beijing, continue their jobs or whatever, so my expectation is that the only thing affecting us during the Olympic Game period is that the hotel fees will be very much higher so we'll have to pay more for their hotel stays. They come to study during the Summertime. So our strategy is actually we're going to move some of our campuses down to some of the areas of Beijing so that we can avoid the congestion actually.

Okay. And then final question, Louis. You talked about the class sizes getting a bit smaller. I would assume that that's primarily in language training or are we going to see that happen in test preparation also?

It is mostly in language training but test prep also, it's happening where students just want a better environment because they can afford to pay for it and so they would prefer class size instead of 400 to maybe 50 to 100 or 30 to 50.

Okay.

They are willing to pay multiples of the large class fees. And language training is going down from 50 to 100 down to 25 to 50ish.

Okay.

Yes, let me explain further just for classroom size. Actually, from this year on, Brandon, we are dividing our classroom size into three parts. One is what we call the big classroom size from 50 students up to maybe 400 students, called a big classroom size. We are not really going to raise the ASP in this sector very much because in this sector, students would like to pay a reasonable money to study in the (inaudible) environment but we are going to do exactly from like 20 students to 40 students is what we call a small size classroom, we are going to raise the prices in this sector and somehow higher than the large classroom size because before, we do not do this kind of definition, and we have even offered the small size classroom still in better environment, better facility and even offer them like drinks and the fruit so that they enjoy our environment while studying but we charge them more and because in China, more and more parents and students would like to study in this environment and also, we are going to set up a VIP classroom and that means students maybe around 10 students, maybe from 5 students to 15 students, we are going to open up learning centers with this environment with very small classrooms but with better facilities and more teaching guidance, so that we can cater to the needs of the students, on different levels in China.

Okay, do you think you have enough teachers to do that, if you take a 400 person class environment and 850 group of classes?

Actually, it's even easier to find teachers to teach the VIP classroom. The teachers which are most difficult to find is the bigger classroom teachers because they are not only teachers, they are speakers and they have to give speeches and they should be charming and charismatic but for the small size classroom teachers and VIP classroom teachers the only thing teacher needs is their patience and their teaching skills in a detailed way actually so that's easier to find is teachers actually. And also, every day we get a lot of applications from teachers teaching in other institute, so I don't think teacher is a big problem where we divide the classroom into these three sizes.

Brandon, to give you the statistics, as of May 31, last year, we had 1744 teachers. As of February 28, so nine months later we have 2291 teachers so we have added more than 500 teachers including almost 200 in Q3 alone, so we are basically ramping up the teacher numbers.

Okay. Great. Thank you.

Your next question comes from the line of [David Degroth] with MSS. Please proceed.

Hi, Michael, hi, Louis.

Hi, David.

I had a question about the underlying G&A growth rate when I adjust for the accounting change it looks like the last couple of quarters it's been 3 to 4% growth year-over-year and I'm wondering if there's a change in the business model there and if that rate is sustainable in Q4 and beyond?

Yes, I think this time G&A was only up 2.3% because of the accounting change, there's only one month left in Q3, so it was only the December month, so that's why the G&A change was lower.

Right, and how are you able to sustain that low of a growth rate when enrollments are growing?

Because of the system. We basically built up a lot in '05, '06, all our systems, our headquarters doesn't require that many more people as we grow, so that leverages our business model. Our content is scalable across the whole network, so actually, if I look at the headcount, G&A headcount for the quarter actually went down 108 people, so for the quarter, went down from 1290 down to 1182, between Q2 and Q3, so we're getting efficiencies in the G&A sector. Now, Michael mentioned we will actually increase our sales and marketing spend in preparation to make sure that we have a strong Summer quarter. So, even though G&A is being held steady going down relative to revenue growth selling and marketing will probably make a big push in Q4 and early Q1.

My understanding was, Louis, that the part-time teachers were in that line as well? Which I would think would be--?

Yes. So I'll give you the break down of part-time teachers at the end of Q3 is 1309 and full-time teachers at 982 so more than half the teachers are part-time and that's part of our strategy because we don't want to pay them full-time when the classes are empty part of the day.

So that was the end of Q3 and do you have the numbers for the end of last fiscal year or last years Q3?

Yes. At the end of May 31, of '06, so basically last fiscal year, was 837 part-time teachers and 907 full-time teachers so the trend is definitely towards part-time teachers.

Okay, great. And then I was curious as to the two learning center closures this quarter, what was the reasoning behind that?

Let me see. The learning center closures, one was in Shanghai because we opened three new learning centers and Shanghai closed one so we just moved locations so we actually had a net add of two in Shanghai and the other learning center close was in Shijiazhuang and I don't know the exact reason?

I think maybe the reason is that the time was up.

Probably the lease expired.

Okay, did you relocate that one?

It was a shorter term lease.

It's a very small learning center. We're opening new learning centers this year for POP Kids English.

So it's just going to be a change. It will be a timing difference, a learning center will close this quarter but will open in a different location or be a larger one next quarter.

Okay. And then finally I was wondering if you could talk about revenue growth in POP Kids, Elite English and then how the professional certification business is going, I don't know if it's too early for that?

The professional certification business is too early because the revenues will actually start--.

Only 0.5 million revenue.

It will start this quarter.

Okay.

As far as the revenue growth from the key segment, the test prep grew 80% year-over-year in revenue but the student numbers didn't increase that much. It's only about 3.5% because of the enrollment difference only 8% total enrollment growth because the timing differences of Chinese New Year and then revenue from high school grew 49% and kids grew 53 year-over-year.

And Elite?

And Elite grew -- Elite didn't grow. It grew 3.9%. Elite is going through that transition in the Dynamic Education so we're in the process of that transition and adding learning centers to Elite.

Yes. The transition will be like for almost the whole year to change from our outpatient model to a dynamic education model so we are in data transition and by the way, I feel very comfortable with that because we know that later, when we finish the transition, this is a good area to go into a high end. We can do that much better.

Great. Thank you very much.

Thank you.

Your next question comes from the line of [Alberto Esterol] with [J-Hop Capital]. Please proceed.

Hi, Louis. How are you?

Hi, Alberto.

I have a follow-up question on the number of students on the enrollment and the definition I understand is that you recognize students as new students coming into the school for the specific quarter, and that this number for this quarter is 8% higher than same quarter 2006, which is I would say kind of lower than the year-over-year guidelines, so if the question is how is it that they are, how confident are you that for the fourth quarter you would go back into the high teens?

I don't know about high teens, but don't forget, we already have six weeks of data. So it's already the middle of April and we started the quarter March 1. We get weekly numbers on cash revenue and students.

Okay. Thank you.

Okay, so yes, so we're seeing starting in May, starting to see growth again.

Thank you.

Your next question comes from the line of Trace Urdan with Signal Hill. Please proceed.

Louis, I wanted to make sure that I really understood what's happening with the ASP's because I think I heard you ascribe all of the increase to this mix shift towards the more expensive classes and suggest that pricing really wasn't a factor in the quarter, but I wasn't sure that that was correct.

Yes, the makeshift accounts for about 38 million in RMB, the 61% of the revenue collected in Q2 was actually recognized in Q3 versus 38% a year ago, and then 8% is due to growth and 11% ASP growth gets you to the growth difference.

Right, but within that 11% what I'm interested in is it seems like the driver of the growth in ASP is the migration towards more expensive smaller classes versus simply--.

That's right.

Versus simply an increase in rates on existing classes, is that right?

That's correct, although typically overseas test prep will still be increased year-over-year by quarter.

Okay, and then I presume that the sort of smaller, higher end classes, I mean this takes the form of a different product offering, is that right?

It's pretty much the same courses, just the environment for a student to have more chance to interact with the teacher.

I get it but when the student is signing up, they are saying okay, do you want the regular or the super premium?

They can choose.

And how long have those sort of higher end options been available to the students? Is that something you've always done or is that something that you've introduced in the last year?

Actually, we had a little last year but this year, we have given all of the schools like clear definitions about our high end and the middle end and the lower end or we call big classroom size, small classroom size, and VIP classroom size.

Okay, just what I'm trying to get at I guess I heard you say that you're going to continue to offer even more premium classes but what I'm trying to understand is whether there's some kind of an anniversary that we're going to come up against with respect to this trend?

This has been ongoing for a couple years Trace.

That's fair. And then if I could ask one other question that I get asked and don't really have a good answer for and haven't seen articulated by you guys but I wondered if you could speak to what the average capacity is when you open up a new school and whether that has changed at all. Are the schools larger or smaller as you go forward and then what, if you could, speak to the system wide capacity that you're seeing right now, capacity utilization rather?

I think that we don't look at, we've answered this before, we don't look at capacity utilization as such because it's easy for us to say our learning centers are in the city so as we get any kind of capacity issue, we just open a learning center so it's never been an issue and don't forget our schools for nine months of the year are probably empty half a day within the school hour day, right? As far as capacity goes don't forget 19 of our schools have been open the last two years, so they haven't even hit 50% capacity, let's say, and it's never an issue because we just open learning centers so if we hit a capacity issue we just open another learning center but the truth is we have plenty of capacity in the system, so it's a step function issue, but it's just not a problem for us.

Is there some kind of minimum size, when you open up the new school, are the new schools that you open up sort of the same structures that they've always been? Do they need to be a certain size in order to sort of establish a brand presence in the market before you start opening up learning centers?

I think our newer schools are smaller than the older schools because the cities are smaller.

Another reason is actually we like to open more learning centers in the city because from a big school in one place, they don't have to travel a long time especially considering these days Chinese cities with lots of traffic jams, so that's why we are opening smaller schools with more learning centers. The model changed a little because we want to have access to our school more easily.

But even the smaller schools still have 100,000 to 200,000 square feet, so it will be basically a whole building.

Thanks for that color. I appreciate it.

Thank you.

Thank you.

Your next question comes from the line of Mark Marostica with Piper Jaffray. Please proceed.

Yes, hi, guys. Just a follow-up on your comments regarding ramping up marketing spend in advance of the summer again, and to that point, I'm curious as to whether or not you're drastically changing it all, your branding and marketing techniques this year for the summer versus last year, what's changing in your marketing mix in terms of how you try to generate interest?

Well, actually, not very much has changed for the marketing strategy. Mostly we are doing lectures all over China cities. Last year, we did maybe 50 cities last year, but this year, we go up to more than like 100 because I think more students actually want to know about the teaching style before they decided to come into the study so this year actually from much to the end of June, we have introduced like about more (inaudible) and lectures out of China with our famous teachers and (inaudible) speaking, and also, we are also going to do some marketing with like the like (inaudible) on the side of the road.

Billboards.

Yes, the kiosks and also we are going to do some branding marketing like maybe in the training station or in the airport, or on the campuses of Universities actually, so that should be spending more money than last year, but in addition more people will be for Summer will get more clear (inaudible), before they should push more student enrollment into (inaudible).

And just one last follow-up on the marketing. Should we expect that line item to still, like in terms of how you think about the spend on marketing, should we expect that line item to grow slower than revenue or should we expect it to grow faster than revenue going forward?

It was 11% this quarter versus 12% a year ago, so revenue should out pace marketing spend as a percent of revenue, so the total marketing dollars will go up.

Correct. So you expect that 11, 12% to be a good number as we kind of look into the out years?

Yes, Q1 it won't be even such a big number.

Right. I am thinking more on an annual basis.

I think the percentage of marketing of the total revenue will go up a little higher for the first quarter of this fiscal year because we are still preparing for the first crop next year, so for the first quarter of next year, the marketing fee will be lower because the total revenues will be higher.

Correct. Very good. Thank you.

Thank you. Your next question comes from the line of [Scott Shysler] with [Tiger Global]. Please proceed.

Hello, congratulations on a great quarter.

Thanks.

Just one quick follow-up question. You mentioned that the headcount, the G&A headcount went down by I think it was like about 60 or 70 or 80 or 100 people.

108.

During the quarter and I was just wondering if you can go through the nature of why those people or why headcount got reduced and then -- yes, that would be great.

What's that?

G&A headcount went down by 108 people. I think a lot of it has to do with people leaving the -- people leaving. We just aren't hiring as many people in G&A, so they leave.

Actually, it's really kind of an order and a system duty, because at the beginning of this year, I ordered all the heads of the school that tried to employ, to use the more efficient people, not to use more people. I asked them to use five people for a 10 people job, it was 8 peoples money actually. So that's why the number of people come in town but I also at the same time asked them to employ more talented teachers, that's why our teacher number is going up actually. That's the reason. It's kind of a strategy for the whole year.

That's great and then just to follow-up, has it impacted a marking, obviously it has a significant impact on margins. Do you guys have any, if you guys were to compare where you are at now versus where you were a year ago, what do you think the implication that has long term on the margins?

Well, it has obviously a very positive implication.

If you look at the first three quarters I don't have the total number yet, but G&A and sales and marketing together are significantly down from last year as a percent of revenue, so we're getting at least 600, 700 basis points difference. So it's having a huge impact and you see that in the bottom line.

And lastly, was there a portion of the increased margin this quarter that was non-recurring, like you essentially, you didn't like recognize too much revenue, but you recognized revenue in accordance with U.S. GAAP, but like were pro forma margins this quarter actually lower than reported margins and just because of the way that the timing works?

Gross margins were down, -- were up year-over-year 57, 58% but they are down from Q1 which is like 67% so that's normal but there's nothing, no odd one-time revenue recognition issue, so we do everything in accordance to U.S. GAAP.

Thank you very much.

Your next question comes from the line of Lin Shi with Lehman Brothers. Please proceed.

Hi, Michael and Louis. Thank you for taking my question.

Hi, Lin, how are you?

Hi. I still want to follow-up on the student enrollment question. I noticed that in the first three quarters of this fiscal year actually, the year on year growth of student enrollment has been slowing down from 26% in Q1, 20% in Q2 and 8% in Q3 and I know there's some particular reason for Q3, but I just wonder for Q1 and Q2 how should we look at the number? And also whether you can give me some color regarding the capacity utilization status of your existing learning centers? Thank you.

Well, I think the student number at 26% Q1 is unsustainable and 20% is still high, and 8% is too low so we've always guided around 10 to 14% student growth.

Yes.

It's reasonable, and so like I said in Q3, we actually recognized RMB17 million of revenue from Q1 enrollment, and RMB94 million of revenue from Q2 enrollment, so basically, a lot of students are enrolling early, one or two quarters in advance more so than they did in the past so that's one issue, but I think we're still guiding around 10 to 14% student enrollment growth is comfortable for us. So I don't think this 8%, this 8% is lower this quarter because Chinese New Year was late and so students didn't go back-to-school to register for classes until March and March, as you know, falls into our Q4. Last year, the Chinese New Year was earlier they were enrolling for classes in February which falls into Q3.

Okay.

Also, we're going to get caught at some point by the law of large numbers so as our student base will top over 1 million students this fiscal year is making it harder and harder to grow 20, 25% on those kind of numbers on a student count basis that's why we're guiding 10 to 14. As far as capacity utilization, Lin, we don't really have any constraint on capacity. 19 of our schools have been open the last two years so they aren't even close to being full and the ones that ar e sort of being relatively utilized we just open learning centers so in Shanghai, we opened three new learning centers this quarter so learning centers are great to put up. They don't cost very much and they make money within three months. So that's the way we look at the business because it's never been a problem other than during the summer.

Okay, thank you.

Thank you.

Your next question comes from the line of Art Bacomb with Oppenheimer Capital. Please proceed.

Hi, guys. Can you just quickly talk about the, I guess a couple initiatives, is the road show you were recently on kind of talking about your consulting services and what type of impact we want to think about to the P& L and timing and then also the potential impact from the computer based [Tofo] and what that might do for pricing?

Consulting business, it's just part of the business, it's very small, so it oversees consulting. It's growing but it's just a small part of our business. On the computer Tofo--? Actually it's good impact, also the pricing because we are using computers with key students so the price goes up higher, the students think it's very reasonable and also because we have (inaudible) also we published (inaudible) in our computer based only by (inaudible) so actually, it's just a track of more students come through in the study. Generally speaking in computer business, Tofo training we have kind of monopolized the market actually after today, not that there are many other institutes where training in Tofo, that they don't have the lab facilities (inaudible) but they don't have the books. If they are going to use the books then we have logos on the cover of the books actually, otherwise they have to pirate the books to be used in their classroom but that's another reason that we published all of the Tofo books in China, this kind of stops other incidents from opening the Tofo projects actually. So this area, I think we offer about 90% of the market in this area.

But both too small--?

So in general--.

Go ahead.

Go ahead.

But both too small at this point to start to think about in terms of an impact to the P&L?

Can you repeat the question, please?

Both of them are too small at this point to think about them having an impact on the P&L?

The Tofo has a huge impact on the P&L because Tofo is part of our overseas test prep.

Yes.

But I mean, I should say the move to the computer base? Is that anything significant?

Whenever there's a course change, in a new test, it kind of helps us because the students don't feel they can just buy books to do it because it's so new, they will come to New Oriental to get the latest in a transition time period.

Yes.

The dynamic education, the computer based learning is for Elite English only and that's too early, but that model we're comfortable with will be very profitable because it lets us use fewer teachers and more computer based training.

Got it. Thank you.

Okay.

You have a follow-up question from the line of Trace Urdan with Signal Hill. Please proceed.

I'm sorry to come back one more time and I don't mean to put you on the spot but I wanted to ask you, there's news on the tape this morning that Kaplan is partnering with Ace Education to enter a market for prepping students in China for entry into UK Universities and I wonder if you could just talk about what that -- do the UK Universities use the same standardized tests that the American Universities do to look at students? Do you know how your student body breaks down in terms of students who are looking to enter U.S. Universities versus UK Universities? If you could just give a little color on that specific market that might be helpful.

First, the tests that the University use is different from the tests that is used by American Universities. The UP Universities use (inaudible - highly accented language) to evaluate students English ability, and the American Universities use Tofo evaluate the English ability. We are not prominent, we occupy about like 55 to 60% of the market and then there are some other incidents where also they occupy like about a 45% to around 45% of the market, so that's why this year, we are doing a great marketing, (inaudible) so it comes to New Oriental systems study. Also what they are doing is they combined their teaching, studying, with applications together so it is easier to apply for European Universities and that is exactly what we are doing from actually three months ago, so I think I'm comfortable with our market (inaudible) that combines teaching, learning teaching, application for Universities and then for their learning services also, and again, Chinese students actually nowadays are looking more and more to go studying in the United States and Canada Universities actually. To my knowledge, more and more high school students actually are applying for United States Universities instead of UK Universities because of their (inaudible) or University recognizes that Chinese students really have money and it's also (inaudible) it's easier for Chinese students to get a Visa to study in that State. It's almost as easy as students can get a Visa in the UK University. The reason students go to UK is that several years ago, it was easy to get it from UK, and also the Universities idea to get to enroll students and nowadays this transition has been happening in the United States. So that's why yesterday, we got a news that Asia killed many American students and we were afraid that that was a Chinese student. That the fact that it was South Korean to our relief, actually.

Yes, it was a South Korean student who had been in the U.S. since he was eight years old.

It's not a Chinese student problem.

It was actually reported in China that he was a Chinese student.

Okay, well that's very helpful. Thank you.

Thank you.

We are now approaching the end of the conference call. I would now turn the call back over to the New Oriental Chief Executive Officer, Michael Yu for his closing remarks. Please proceed, sir.

Yes, thank you, everybody, thank you. You have given us a lot of good questions. I don't know whether we have given good answers, but anyway, we have done our best for the results, for revenue, for profit, and also for marketing for our future, so I'll comment to you in case you are investing money to our income. If you have any further questions please do not hesitate to contact Louis or any other of our Investor Relations representatives in case of emergency, you can contact me. Thank you. Okay, have a good night and good morning, bye-bye.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.