New Oriental Education & Technology Group Inc (EDU) 2008 Q3 法說會逐字稿

Good evening and thank you for standing by for the New Oriental third [fiscal] quarter 2008 earnings conference call.

At this time, all participants are in a listen-only mode.

After management 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 like to now turn the meeting over to your host for today's conference, Miss Sisi Zhao, New Oriental Senior Investor Relations Manager.

Please proceed.

Hello, everyone, and welcome to New Oriental's third fiscal quarter 2008 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 Chief Executive Officer; and Louis Hsieh, our Chief Financial Officer.

After their prepared remarks, both Michael and Louis will be available to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S.

Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve inherent risks and uncertainties.

As such, our results may be materially different from the 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 obligation to update any forward-looking statement, except as required under applicable law.

As a reminder, this conference is being recorded.

In addition, a webcast of this conference call will be available on New Oriental's investor relations' website at http://investor.neworiental.org.

I will now turn the call over to New Oriental's CEO, Michael Yu.

Michael, please.

Hello, everybody.

Long time no see.

Actually, last time, I didn't attend the quarter meeting because I was on a business trip.

And this time, I quit my business trip to be here.

Very like to be here, very much happy.

And hello, everybody, and thank you for joining us today.

I would like to begin the call by taking you through some highlights from this quarter before handing the call over to my CFO, Louis, to discuss our third quarter financial results.

I'm pleased to report that we delivered good results for the third fiscal quarter of 2008, despite the winter storms in Southern and Central China, as strong growth in our key business segments allow us to exceed the high end of our revenue guidance by more than [$3.9m].

Driving results in the third quarter was the strong growth in our language training and our overseas test preparation enrollments, which rose from 199,000 in same period of last year to about 268,000 at the end of the third quarter.

Programs that did especially well this quarter was our POP Kids English and overseas test preparation, with both growing their enrollments more than 60% over the third quarter of 2007.

During the third quarter, we also opened, net, 17 new learning centers.

As we have discussed in previous quarters, the test preparation market for the college entrance examination in China, or gaokao, is large and very fragmented.

We are excited to be moving into this market with the third quarter launch of our first all-subject middle school high school training program, which we are calling New Oriental U-Can.

U-Can is targeted at middle and high school Chinese students from age 13 to 18 who are preparing for the gaokao, which is required for admission to bachelor degree programs and most associated degree programs at Chinese colleges and universities.

Out of the 9.5m students who took the gaokao in 2007, over 70% were first-time takers.

U-Can is designed for those preparing to take the gaokao for the first time, and also for younger students who seek after-school, weekend or holiday programs to help them to improve their grades in Chinese, English, Mathematics, Physics, Biology, Chemistry, History and the Politics subject areas.

In its initial launch this quarter, more than 8,000 of students enrolled in U-Can non-English subject classes in New Oriental.

In future quarters, we expect the business to grow, leveraging New Oriental's substantial middle and high school English business, which enrolled over 220,000 students in the last 12 months alone.

In addition to the launch of our U-Can program, we would like to announce our additional foray into the gaokao market with our agreement to acquire 60% equity stake in Mingshitang, a Beijing-based private school that specializes in tutoring students who need to retake the gaokao.

The remaining 40% of the equity stake will be subject to a multi-year earn-out structure.

We signed the definitive agreement for this on April 14, 2008 and the transaction is scheduled to close in June 2008, pending further due diligence.

This acquisition is highly strategic for New Oriental.

We are very happy and we expect it will benefit the Company in several ways.

First, it will extend the New Oriental brand to a large non-English test preparation market.

Gaokao re-takers occupy over 25% of the 9.5m students who took the examination in 2007, and the demand for training services in this area is strong.

Second, it will moderate the seasonality of our business, as the re-takers' training market is largely counter-seasonal to our core businesses, which may allow us to further utilize our existing facilities.

Third, this deal should offer additional opportunities for consolidation in a highly fragmented market.

Mingshitang gives New Oriental a Beijing foothold to leverage as we roll out our re-takers' training business to other select high-potential cities nationwide.

Lastly, the deal offers many synergies with New Oriental U-Can, as both businesses address similar subject areas like Chinese, English, Mathematics, Physics, Biology, Chemistry, History and Politics.

We expect to modify and use a portion of the content to be developed by Mingshitang in our U-Can business.

And the Mingshitang teaching team, with their experience in the gaokao subject areas, will be a valuable resource for our U-Can instructors.

Before handing the call over to Louis, who's the guy sitting beside me, I want to speak on the strategy behind the New Oriental accelerated expansion in fiscal year 2008 to date.

We plan to open approximately 60 schools and learning centers for the fiscal year ending May 2008.

This is in comparison to the only 19 schools and learning centers we opened for the whole of last fiscal year.

This ramp-up is a result of the very strong demand we are seeking -- we are seeing in our [high end] market, especially in the [trip] education area.

The accelerated expansion requires upfront costs, both in physical facilities and equipment and in personnel, both teachers and staff.

In fact, we have added almost 1,700 employees in the first three quarters of fiscal year 2008 and over 750 in the third quarter alone.

While these upfront investments are impacting G&A and sales and marketing expenses, we are confident that the revenues to support this substantial investment will come in the future quarters and years.

We believe an accelerated growth strategy will pay off handsomely for New Oriental's long-term shareholders, given we are spending money shareholders [nowadays].

In addition to following an accelerated schedule of opening new schools and learning centers, we are also constantly adding new programs and entering new businesses in education areas, especially related in training areas.

These too require substantial upfront investment.

Key examples are our recently-announced gaokao training programs with our U-Can brand, the CPA and the bar examination with our North Star brand, high-end [Wild Call] English with our Elite brand, our kindergarten education business with New Oriental Star brand and targetchinese.com, our online Chinese language course that targets non-native speakers and which we offer on the Koolearn online platform.

These businesses are mainly in the investment phase and, thus, have a temporary effect on our operating and net margins, but they are strategically very important to New Oriental's future growth and the market position as the leading private education provider in China.

We will continue our best effort to invest in new areas of private education in China in a strategic and value-creating manner that delivers substantial shareholder value later on.

We strive to balance long-term investment in our business with delivering strong financial performance for current shareholders, and we are pleased with the results of this effort thus far.

With our present investment in physical facilities, [such as] (inaudible) and marketing, we continue to show expanding top and bottom line growth, as reflected in our strong financial performance.

Well, after talking all about that, I will now turn the call over to CFO, Louis, to discuss the quarter's financial performance.

Louis, it's your turn.

Thank you, Michael, and hello to everyone on the call.

Thank you for joining us today.

At the end of January, we affirmed our net revenue guidance for the third quarter of 2008 at 22% to 28% year-over-year growth, notwithstanding the detrimental impact on our business as a result of the severe winter storms in China in late January and early February; the worst in over 50 years.

We are now pleased to announce that we beat our top line guidance by delivering 46.9% top line growth.

The severe winter storms in Southern and Central China forced us to close dozens of schools and learning centers in affected areas, due to power outages and road closures caused by the freezing temperatures, strong winds and record snowfall amounts across China.

We would like to take the opportunity to thank our students for their determination and dedication to learning, and to our teachers and staff for their commitment to teaching and hard work and perseverance in overcoming this natural disaster, in keeping many New Oriental schools and learning centers operational for as long as possible during this period.

The vast majority of the students in the affected areas where schools were closed elected to defer their enrollments to future quarters rather than cancel them -- their registrations.

As a result, we enjoyed a record 268,400 student enrollments for the quarter, an increase of 34.8% over the year-ago period, and record deferred revenue balance.

Deferred revenue is money collected from students for classes in future quarters; essentially, a measure of demand backlog.

At the end of the quarter, our deferred revenue showed a balance of $35.8m; an increase of 105.2% from the year-ago period.

However, not all the $35.8m deferred revenue will be recognized in the current quarter, Q4 '08.

Rather, about $23m of the $35.8m is scheduled to be recognized as revenue in the fourth quarter, with the remaining amount recognized in subsequent quarters.

I would also like to comment on third quarter seasonality.

As many of you know, our third fiscal quarter corresponds to Chinese school age children's long winter holiday.

During this time, we seasonally expect a sharp increase in enrollments due to our additional full-time winter course offerings.

Now, I'll turn to the financials.

I'll walk you through the contributors to our third quarter fiscal results and some financial highlights.

Please note that certain figures I will talk about are non-GAAP, including measures that are given excluding share-based compensation expense.

You can find a reconciliation of these figures in the financial tables at the end of the Press Release.

Our third fiscal quarter 2008 net revenues were $48.1m; an increase of 46.9% from the third fiscal quarter 2007.

Revenues from educational programs and services, comprising our language training and test preparation courses, and primary and secondary education programs, were up 44.4% year over year, driven by an increase in new student enrollments in language training and test preparation courses.

Student enrollments in language training and test preparation for the third quarter of fiscal 2008 grew 34.8% year over year to 268,400, from 199,000 in the third fiscal quarter 2007.

Overall, operating costs and expenses for the quarter were up 47.1% year over year.

Of those costs, cost of revenue increased by 33.5% year over year, mainly due to the increased number of courses offered to a larger student base and the greater number of schools and learning centers in operation.

Selling and marketing expenses increased 90.8% year over year, mainly due to brand promotion expenses and headcount expenses -- increases.

Additional expenses of over $1.3m in the quarter were incurred by the Company in launching its U-Can gaokao test preparation and middle school training brands, and also promoting our IELTS program, which led to an over 55% increase in IELTS enrollments for the quarter.

In addition, the headcount for our sales and marketing department increased by 364 over the year-ago period.

The marketing staff includes registration verification personnel and receptionists needed at each of our Company's 181 schools and learning centers, which increased by 53 [in count] over the year-ago period.

General and administrative expenses increased 50.5% year over year, primarily due to increased headcount as the Company expands its network of schools and learning centers.

Excluding share-based compensation expense (non-GAAP), operating income for the quarter was $12.5m; a 62.6% increase from $7.7m in the year-ago period.

Non-GAAP income -- sorry, non -- GAAP -- excuse me.

GAAP operating income for the quarter was $10.2m; a 46.1% increase from $7m in the year-ago period.

Excluding share-based compensation expense, operating margin for the quarter was 25.9%, compared to 23.4% in the corresponding period of the prior year.

GAAP operating margin for the quarter was 21.2%, compared to 21.3% in the corresponding period of the previous year.

This increase was primarily due to the improved operating efficiency, as revenue growth outpaced the growth in operating costs and expenses.

Capital expenditures for the quarter were $4.2m, which was primarily used to add, net, 17 new learning centers and in maintenance expenses for a much greater number of schools and learning centers in operation, 181 versus 128 in the year-ago period, and also for remodeling of a larger number of older schools.

Total share-based compensation expense for this quarter was $2.3m.

Excluding share-based compensation expenses, non-GAAP, net income increased to $13.9m; an increase of 52.7% from the fiscal year of 2007 third quarter.

GAAP net income for the quarter increased to $11.6m; an increase of 38.1% from the third fiscal quarter of 2007.

Excluding share-based compensation expenses, non-GAAP basic and diluted earnings per ADS were $0.37 and $0.35 respectively.

GAAP basic and diluted earnings per ADS were $0.31 and $0.29 respectively.

Each ADS represents four common shares.

Moving on to our balance sheet, our total cash and cash equivalents as of February 29, 2008 were $230.1m, with an additional $30m in term deposits, as compared to $246.8m as of November 30, 2007.

Net operating cash flow for the quarter was $16.3m.

Before I give guidance, I would like to take a brief look at the comparison between the first nine months of fiscal 2008 and the first nine months of fiscal year 2007.

Student enrollments in language training and test prep grew 28.1% year over year to 966,500, from approximately 754,300 in the nine months ended February 28, 2007.

Net revenues were up 49.1% year over year to $160.8m.

Excluding share-based compensation expense, non-GAAP operating income was up 60.7% year over year, to $51.4m.

GAAP operating income was up 53.3% year over year, to $45.4m.

Non-GAAP operating margin went from 29.8% (sic - see Press Release) for the nine months ended February 28, 2007, to 32% for the nine months ended February 29, 2008.

GAAP operating margin went from 27.4% for the nine months ended February 28, 2007 to 28.2% for the nine months ended February 29, 2008.

Non-GAAP net income was up 63.8% year over year, to $53.2m.

GAAP net income was up 56.8% year over year, to $47.3m.

I will now read you New Oriental's financial guidance for the fourth fiscal quarter 2008.

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 revenues in the fourth fiscal quarter 2008, that runs from March 1, 2008 to May 31, 2008, are expected to be in the range of $32.1m to $33.4m, representing year-over-year growth in the range of 29% to 34% respectively.

Now, let me hand the call back to Michael for his closing remarks.

Michael?

Once again, everybody, thank you for participating in our earnings call for the third fiscal quarter 2008.

At this point, we're happy to take your questions, if you have any questions.

If you don't have questions, we are happy.

(OPERATOR INSTRUCTIONS).

Your first question comes from the line of James Mitchell from Goldman Sachs.

Please proceed.

Hello.

(Inaudible) James.

Nice to hear from you.

Well, I have two questions, so you may be less happy.

But anyway, the first question is just with regard to stock-based compensation.

I think last quarter you guided it would be around CNY30m per quarter going forward.

It looks like it was in the mid-teens.

Is that just a temporary effect, or would you expect stock-based compensation to be lower than initially guided?

And then I have a second question.

Yes.

In answer to the first question, James, it's $2.3m this quarter.

It will go up in the next quarter because some of the incentive stock grants were granted in Q4, not Q3.

So the total amount will be about $3m to $3.5m [this] quarter.

Okay.

Okay, so it will go up in this quarter that we're in now, probably about $1m to $1.2m.

Right.

And then, on the revenue guidance, if I look at easy comparables, growth in deferred revenue, growth in reported enrollments, then it feels that the guidance for the fourth quarter revenue growth is a little, or a lot, conservative, especially given that the renminbi appreciation -- should I just look at that number and say, directionally, you're forecasting a faster percentage year-on-year revenue growth rate for the fourth quarter than you were for the third quarter, and I should ignore the change in reporting currency and that's all I should take away?

I think, as you know, James, and I think most of the people on the call know, we tend to guide relatively conservatively, right?

So our guidance is probably -- it already takes into account a 5% to 8% appreciation in the renminbi, which is why the guidance last quarter was 22% to 28%.

This quarter, it's 29% to 34% growth.

And you are right that we have easier comparisons over last year.

So as you know, we've always guided conservatively and that's our pattern

Also, James, there is another reason.

In Beijing all the university students will -- are going to take their final examinations early this semester because of the Olympic Games.

So, since they are going to take the final examinations early, there isn't much time to take New Oriental courses.

So that's one reason that we are trying to guide a little more conservatively.

Okay.

Thank you very much.

Thank you.

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

Please proceed.

Thank you.

Louis, I wonder if you could take a minute, now that you've changed the basis for reporting, and talk a little bit about the methodology that you're employing in terms of making the conversion from renminbi to U.S.

dollars, how frequently that happens.

At what point do you use the conversion?

And then, I note that our numbers for conversion differ on the prior-year basis.

I'm wondering what the philosophy is with respect to how you're going to report the prior-year numbers with respect to currency.

Okay.

Good question.

The currency we use for this reporting quarter, which is Q3 of '08, is CNY7.2613 to US$1, and that was the average rate of the renminbi versus the U.S.

dollar throughout the quarter.

So that's the basis we're going to employ going forward.

We will leave historical numbers at their historical rates.

Okay.

So at the end of the quarter you'll take the renminbi number and use that average, which is gathered from a daily average?

Correct.

Okay, very good.

That's the methodology that our account -- our auditors have told us to use.

That's the methodology employed by most Chinese companies who report in U.S.

dollars.

Okay, fair enough.

I appreciate that.

And then, could you speak a little bit to the -- just give us a little bit of a [premer] on the gaokao test, how frequently it's taken and what the option is for the re-takers once they've missed it.

Are they waiting a full calendar year to take it again?

Yes, everybody -- we only have one gaokao every year for all the Chinese high school students to have the chance to go into universities and colleges.

So if those people fail the examinations, they have to wait for another whole year to take the next year's examinations -- gaokao examinations.

So that gives us a chance for a whole year to have these re-takers come into New Oriental to study again, to train them for a whole year.

If they take every two months, then we don't have the chance to train them.

Also, for those students who want to take the gaokao for once and then go into universities, they have to put a lot of extra hours, like during their holidays and the weekends, to study, to find best teachers to teach them.

New Oriental is experienced at finding better teachers and trains these teachers to get them prepared to teach and then get the students prepared for gaokao.

So, actually, it's on the same line with our [old] customers, our -- those students who have registered for English courses from middle school or high school, so we are fully confident that this year we will get some students from gaokao areas and that we will grow somehow quickly in this area.

Yes.

And Trace, it shouldn't be underestimated that we are -- the gaokao test prep is part of our new U-Can business.

Don't forget, between 13 and 18, there are six grade levels -- grades seven, eight, nine, 10, 11 and 12.

We are actually tailoring programs for each grade level.

So grades seven and eight have one set of programs in Math, History, Politics, Chemistry, Physics, Biology, and then grade nine has a separate set of programs.

And grades 10 and 11 have a separate set of programs.

And grade 12 is for the gaokao exam.

So we're not getting those students just in their twelfth grade.

We're hoping to get them much earlier.

There are six years all together.

Yes.

So that's why -- so it's not just the 9.5m who actually took the gaokao that we're targeting.

Yes.

We're actually targeting much younger than that and, eventually, we'll move the programs into five to 12-year-olds as well.

Not the Physics, obviously, and Chemistry, but the Chinese, Mathematics and English parts.

And in terms of the re-taker market, what's the pattern that these students exhibit?

Are they typically there ready the next week to go, or do you -- do they -- do you have to go out and find them?

Are they familiar with the re-taker market?

No, we have to wait until students, after taking the examinations and as that they get to know they are not up to the standards and that they fail, then we are going to have these re-takers come into New Oriental usually around the beginning of August, or the beginning of September, for the whole 10 months to stay here until the next year June, because it's June 7, 8, 9 is the dates that people take gaokao examinations.

So Trace, what happens is that they take the exam in early June, they get their scores in early July or late June, so it isn't right away.

And then, our [pootoo], or our re-takers pool, the Mingshitang acquisition that we announced, is dedicated to that re-taker market.

And of the 9.5m students who took it last year, more than a quarter were re-takers.

So that's over 2m students a year who re-take the gaokao, and that's growing rapidly.

So they will actually spend a full boarding school year studying for that gaokao exam.

So it means two semesters and they'll pay -- usually in Beijing, it's -- with boarding fees, it's about CNY17,000, so it's $2,500.

So (multiple speakers) and it's full boarding school.

Right.

So that population turns over for you guys every year and the enrollment period starts in the summer for fall admissions?

Exactly.

So they have two terms; one in the fall and then one in the spring.

So it's exactly counter-seasonal to our current business, where fall and spring are slow for us.

Right, but it's kind of a fire drill to grab those students and get them locked into place.

That's not a --

(Inaudible) know they're going to fail.

They know they're going to fail.

Okay.

So they're already prepared to take that.

Also, there's another group, Trace, of students who actually passed the gaokao, but didn't get into the school of their choice.

And so some -- there's actually a growing number that actually elect to take it again the next year, so actually sit out a year and they take it again with the chance to get into a better college.

I see.

And my last --

Out of the 9.5m who take it, only 2.5m get into four-year colleges and universities.

Right.

Another 2.5m to 3m get into associate degree programs, so not full year or four-year bachelor degree programs.

(multiple speakers)

Last question from me.

I'll let you move on.

Do you -- will this now be a brand that you're going to grow, this acquired school, or is it likely that you might acquire additional schools and fold them in together?

Initially, we are going to merge this brand into our private school and the learning center so that will save money, because we already have physical facilities there and the personnel there.

We only have to train the new teachers and to put our students into those empty classrooms sometimes during the spring and the fall.

Then, if it is necessary for us to open new schools and learning centers just for gaokao, then we will do it at [proper] time.

Okay.

Thanks guys.

Thank you.

Your next question comes from the line of Scott Schneeberger from Oppenheimer.

Please proceed.

Thank you and congratulations on the strong revenue growth.

Just following up on the gaokao topic, how fast would you say the test taker market is growing there?

9.5 you mentioned this year, is that going to be growing at a double-digit clip?

It has been, Scott.

It's been growing about 16% CAGR in the total number of takers in the last six years.

Now, we believe, actually, that that understates the market growth rate because there's several things that have happened in the gaokao space which is why we're excited about it.

Number one is that the Chinese Government passed a new policy last year that prohibits students and their teachers who are in the public school system now from taking fees and studying on school premises, extra training for the gaokao after school.

So that means that there's more and more students who are looking for a place, and teachers looking for a place, to teach outside of school premises.

So that's a very -- that's a big benefit for New Oriental, because we have facilities in most of these cities.

The second trend is that Chinese consumers are getting wealthier.

So we believe, and the anecdotal evidence is such, that there's more and more students actually taking test prep.

So even though the market's growing 16%, the number of students actually taking test prep outside of their physical school is actually growing much faster than that.

Okay.

Thanks.

That's helpful.

And then, it sounds like a great acquisition, could you -- I don't know how open you're doing it, but could you discuss the acquisition multiple that you paid, what you're seeing out there in the acquisition environment, what your plans are going forward, how aggressive you're going to be, just addressing the general topic?

Thanks.

Yes.

I can -- the target company has asked us not to disclose the purchase price, so we won't disclose that.

But you can -- from discussions with me in the past you know that it will -- it is set to be accretive to New Oriental shareholders.

So we didn't pay a very large -- we didn't pay a multiple even close to ours, but it will be accretive.

Okay.

Thanks very much.

The next question comes from the line of [Richard Jae] from [Confusion Capital].

Please proceed.

I have three questions.

The first question is, Louis, can you tell about the growth rate on renminbi basis for [next] year to year?

The growth rate, I think, last year was around, I'm not positive, between 7.4 and 7.5 that we used, and now we're using 7.26.

So I think it appreciates.

The difference is about 8% overall.

So the actual growth rate is 20% year-to-year growth on a renminbi basis?

The renminbi appreciation, I'm not exactly positive, but I think it's either 7.5 or 7.7 a year ago.

It's now -- we used 7.26 in the last reported quarter.

Okay.

And then, can you talk about maybe the marketing expenses that you need to do for the competition, because are you going to spend more marketing money because the competition?

You mentioned before that VC funding for other competitors are strong.

So how does that affect your Q4 expenses and EPS?

Actually, we have already expanded marketing fee expenses and we are expanding marketing fees because, just let you know that there are a lot of our competitors that got VC, venture capital, from people, and they are doing bigger marketing activities actually all over China.

Even though our brand name is the biggest in China, but if all the people still often see our competitors still advertising, people don't see ours, then the [field] will be kind of disadvantaged [here].

So we have already expanded marketing -- increased our marketing fees from actually the second quarter of this year and then for this quarter.

And also we are continuing to spend some more marketing fees next quarter.

But we (inaudible) the marketing expands at a reasonable pace.

And also we think that it's very important for New Oriental because we -- whilst we spend marketing fees so we can find more schemes like for IELTS .

IELTS is a program which is -- a test which is done by English, British Council in China.

And last year we only increased about 20% last fiscal year.

But this year we increased more than 50% by doing -- and we had about like $1m marketing fee into these areas, then we are winning back the market in these areas.

So I think we are having -- still continue spending reasonable marketing expenses next quarter and next year, but we have [some trade] into very reasonable

Is there a way of figuring out how effective it is, because you spend more and more money on the marketing, but the revenue growth rate is slowing only -- it's only 20% year on year compared to next quarter guidance.

Richard, what happens -- Michael said we spent about a little over 800,000 on the IELTS test which is an English proficiency exam for Commonwealth countries.

Last year we had 8,200 enrollments during the third quarter 2007.

This year, because of that extra spending, we had almost 13,000.

The increased revenue just from those 4,700 students, or 55% increase, is already over $1.3m, so it more than pays for itself.

Okay.

We're not just spending money just to get a 20%.

We're spending money -- if you had a 55% increase in revenue -- I mean in enrollments, plus the 20% price increase, it's 75% increase in revenues on the IELTS side.

It pays for itself in one quarter.

Okay.

And last question on the Olympic impact.

Can you maybe quantify, because your first quarter, it seems like 65% of EPS is coming from that last quarter?

Very important quarter, but anyone who went to visit your school knows that you're right near the Olympic stadium.

And not just the Olympics itself for the two weeks, but before that, the clearing out Beijing for security reasons, would that affect traffic to your school?

Well, we're somewhat affected, but not serious.

I think that we are negotiating or talking with the government to allow us to open classes here in Beijing and we have some (inaudible) agreements on that.

And of course we are going to move, I think, some of our classes outside Beijing, maybe particular regions or for because -- if you have a big group of students here, it's also like security troubles for your school.

But mainly we are going to keep our students here in Beijing.

And it's a good time for us to enroll students from other local areas because lots of students want to come to watch the games and, at the same time, start studying English actually.

Okay.

Can you remind us how much from Beijing is your revenues?

Beijing for -- revenues for Beijing is about 35%, 37% a year.

It's a declining percentage.

It will probably be lower next year because we will lose some of the students.

Because they can't stay in the Beijing dormitories in their schools after July 8, many of them will go back to Shanghai or other cities.

And so we'll pick them up in other cities.

So -- but if you have to move from Beijing, and that's 35% of your revenue, can you quantify --?

We are not moving from Beijing.

We only move some of our classes.

Mostly, we are going to stay in Beijing also.

Yes, we have 29 learning centers in Beijing.

Only a couple of them are near the Olympic stadium.

So, you say there's no impact at all to Q1 EPS?

I think you're twisting our words.

We never said there's no impact.

We said that it's limited impact.

What is limited?

Well, we don't know yet because the quarter [hasn't been].

The truth is, you probably won't see it.

As I've been saying, that our growth rate is quite rapid so we grew 30% this summer, or 33%.

I don't know how much would have been attributed to the Olympics.

We'll pick it up in other cities.

That's also no impact?

Well, no, we didn't say no impact.

We don't know the impact.

No one knows the impact right now.

We believe today that it will be limited.

And we believe it will be a negative impact.

It will be limited.

But we believe that, because students still need to take the test prep and the courses, and study for the courses, that our growth rate is so rapid it will overcome that negative impact.

What is limited, like 5% or --?

To me, I don't know.

My best guess would probably be between 2% and 5%, but you probably won't see it because the growth numbers are quite good.

Thank you very much.

Okay.

(OPERATOR INSTRUCTIONS).

Your next question comes from the line of Mark Chang from Merrill Lynch.

Please proceed.

Hello, Louis and Michael.

Well, I want to check with you on the ASP trend in this quarter because, if I calculate the number, it seems like ASP year on year we do not see too much increase here.

And what's going on, and what would be the trend in the next few quarters?

The ASP, Mark, for the quarter went up 12% year over year.

Up 12%?

Because don't forget, what you're calculating is a lot of students -- our enrollment system is such that you're picking up students that signed up but did not -- we didn't recognize the revenue yet.

Right?

So remember we have that lag period.

So the overall ASP on a year-over-year blended basis went up 12%.

And what's driving this 12%?

Is it the class format changes, or you are raising the price?

It's both.

As you know, it's typically both.

So overseas test prep prices, language training prices have all gone up year over year, as well as the fact that we are shifting to -- there's more and more [smaller] classes is also having probably a 2% or 3% effect on the price structure as well.

Okay.

Thank you.

Your next question comes from the line of Alex Xu from Brean Murray.

Please proceed.

Thank you.

Hello, Louis.

Hello, (inaudible).

Can I have, first of all, clarification regarding the guidance?

I remembered in the quarter, last quarter, you mentioned the snowstorm impact and said some of the revenue will push back into the May quarter.

Can you just quantify a little bit, is the guidance including any of those pushback revenue from the February quarter?

It is including it.

Of the -- we have about $20m, over $21m that's backlog revenue from the deferred revenue line that will be recognized this quarter, we believe, in the fourth quarter.

Then there's also revenue from Koolearn bookstores, and our Yangzhou School.

So that's why we put in the -- of the $35.8m, probably at least $23m to $25m will be recognized this quarter, of the revenue.

And then, as you know, Alex, and I think most the people on the call know, we typically guide conservative.

So we will typically beat the top of our guidance.

Also, another reason is that those winter students who have paid their fees for study, they will -- they delay their classes maybe into summer time, not into spring time.

Of the $35m, we know that about $21m have indicated will come in this fourth quarter.

And then with the Yangzhou School deferred revenue, that's the boarding school, and also the Koolearn and other deferred revenue, we have a backlog that we believe we've recognized of between $23m and $25m already which is very strong for us, yes.

Yes.

That's helpful.

And my question is on your gaokao expansion again.

My understanding is that the gaokao exam in China are -- right now, at least, are pretty much localized at a provincial level, meaning each province probably have different kind of a test question, has different kind of focus on those contents, even though the curriculum is probably similar.

How -- I guess how when you expand your gaokao offering are you going to localize your content and localize your tutors?

And what's your plan to do that kind of expansion in this kind of (multiple speakers)

We are dividing our (inaudible) into two parts.

One part can be generally used all over China.

[But basically our idea was] basic testing techniques and those things that are used commonly by all the provinces.

Then we are going to localize the local content, training our local teachers for teaching each school.

So those things that are in almost every province we have in the Oriental schools there.

So it's easy for us to find local teachers who's expert in gaokao areas and are training new teachers in that area.

So [the investment] -- we can do some training all over China with the basic knowledge of gaokao, basic contents of gaokao, and then we still can localize our content, so we have the advantage here.

Okay.

And then 8,100 students you already have.

Where are they right now?

Mostly in Beijing and some in Shian and other provinces.

Alex, you understand this is the tip of the iceberg, right?

We are just starting in gaokao.

And -- so this, eventually, over the next several years will become probably one of our two or three biggest growth drivers.

Yes.

Okay.

Thank you.

Thank you.

Your next question comes from the line of Marisa Ho from Credit Suisse.

Please proceed.

Hello, Michael.

Hello, Louis.

I have a further question on the Mingshitang acquisition.

Although you don't want to discuss the valuation pay, can we actually have some idea about how big the revenue impact is going to be, and also the earnings impact is going to be, coming from this particular new school that you bought?

Yes, I think, Marisa, we expect Mingshitang to generate about $2m in revenue in the first 12 months after the deal closes, between $2m and $3m.

And it should grow about 50% to 70% over the next couple of years, each year.

And the profit impact, I believe they actually forecasted profits for this calendar year of about 500,000 -- almost $500,000, and doubling next year.

That's their own forecast.

But we need to do the due diligence on it.

So it has marginal impact.

But the thing is, it only has about 800 students currently but they each pay about $2,500 a year.

Mingshitang suffers from a lack of space.

So we are going to help them find a second building with a dorm in it, and if we double it, we'll double the revenue, right?

And also the 72 teachers that they currently have are leverageable, whether it's 700 students or 1,500 students.

So I think we'll begin to see more scale economies as we add locations for Mingshitang throughout Beijing.

Yes.

Mainly this acquisition was strategic.

It's very important for us to go into other areas in a very short period of time.

When you mentioned the Mingshitang internal forecast for 100% growth in net profit by the second year, is that also the type of assumption you've built into your earn-out assumptions?

The earn-out assumption is -- the group that will stay on as management of Mingshitang will get earn-out based on different levels.

So they'll get paid out based on the earnings they generate.

There's like four or five different levels, so there's not just one, Marisa.

Right.

So it's built on anywhere from 50% growth in earnings up to a cap, and I don't want to go into the exact detail on the cap.

Although the acquisition valuation will be fairly consistent with what you discussed with us before, things like, for example, looking for a certain amount of internal return and also the previous key indication that you talk about before.

Yes.

It's very consistent and it's probably better than I indicated to you.

Okay.

Great, thank you.

We didn't -- I don't believe -- based on numbers we've seen from them, I don't believe we overpaid.

It'll be accretive to our shareholders within the first year.

Right.

Excellent, thanks a lot.

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

Please proceed.

Thank you and nice job on the quarter, Michael and Louis.

A question following up on gaokao and the Mingshitang acquisition.

I'm curious, with the 2m plus re-takers every year of the gaokao, what percentage of those individuals are in the Beijing area?

In other words, I'm trying to get a sense of your addressable market with the Mingshitang acquisition in terms of the percentage of total re-takers.

[100,000] maybe?

30,000 re-takers if it's from the same area.

28,000 if Beijing has the same percentage.

Mark, what we understand is there was 110,000 gaokao takers in Beijing last year -- approximately last year.

And let's say probably, conservatively, 20%, 25% of them will re-take.

So it means we have 20,000 to 25,000 re-takers in Beijing alone.

So Mingshitang is one of the largest players, but is not the largest player.

And we will continue to look for opportunities to acquire these kind of players in the re-taker market in other large cities, because it's a highly fragmented market.

Yes, great.

And then just one other question and I'll turn it over.

On the U-Can rollout, can you give us a sense today how many subjects and how many schools are currently up and running on U-Can?

I know it's early days but -- and a sense also for how rapid the rollout will be and, perhaps, the cost of -- incremental cost of the rollout?

I think the total number of cities that have any kind of non-English class is 18 cities today, but most of them only have math.

And some of them only have like one class.

So it's just beginning.

The biggest enrollment is in Beijing, Mark.

So once we roll out Beijing, then we'll begin to aggressively roll it out into the other cities, so we're aggressively adding teachers and beginning to leverage our resources in each city.

Michael would like to roll out in about 30 cities in the next two years?

Yes.

That's it, yes.

Okay.

And then on the cost side, can you talk to what type of incremental costs you think you'll absorb in this roll out?

We believe that we can -- the program will pay for itself, it will be more than self funding, because we already have a lot of the physical infrastructure and the learnings centers in the city.

That's why we've been growing so fast, in anticipation with U-Can as well as Kids English.

So much of the infrastructure's in place.

The only incremental cost really relates to content development and to teacher training and marketing, so those three.

But we believe that the demand that it will generate will be profitable within the first year.

And, Louis, any stock buyback in the quarter?

Yes.

We started the program on, I believe, February 25.

So in only in a month and 20 days we bought back over 0.25m shares of our own stock.

So we're well ahead of schedule.

Thanks.

Your next question comes from the line of Brandon Dobell from William Blair.

Please proceed.

Hello, guys.

Good evening.

Just a quick one.

If you could maybe bring the gaokao classes in the context with which we're familiar, for example, the size of the classes, the number of students, the price points, how many classes they take a week?

Just trying to get it in a context relative to, let's say, the ELITE English or the Pop Kids just trying to frame what the impact of that business could be as you ramp the number of students.

Yes, we're in the development phase of that, Brandon.

But what I can tell you is what we're thinking about now is that we will charge between $90 to $400 for a full set of courses.

So what happens is if you take one class, like in physics, you may pay $600 for a three-month class, just like a couple of times a week and maybe one day in a weekend; typical of our New Oriental classes.

If you bundle it and you take a group of classes, let's say, Chinese, English, Math and Chinese History, which is one group for liberal art majors, you may pay $400 for that bundled package.

So these are -- this is a big market, right, because you're talking about kids 13 to 18.

There's 20m kids at each of these age groups.

That's 120m potential students.

And half of them are going to take the gaokao exam.

So they're motivated to prepare aggressively for that exam.

And we've set up modules for each grade level.

So it's not like they only come to us when they're in twelfth grade.

We're hoping they'll come to us starting in seventh grade abd take each module as they move up.

And as you know English, we have many, many layers in English.

So they can keep (multiple speakers) one quarter, they pay $100.

And then they pay (inaudible), yes, they take smaller classes, they'll pay $200.

Okay.

So we can assume that you're going to have different sized classes to (inaudible).

We usually have three levels of class.

There is one we call the big class, which is 40 or more students to 100, 200 students.

We have a very small, we call ELITE class, kind of like around 10 to 20 students that pay much double, or three times higher, the price than those students who pay in big classes.

And then we also have one-on-one classes we call the individualized training center or tutoring center.

Sometimes one teacher teaching one student, that's a very high price.

So usually we have these three levels of teaching nowadays.

So I gave you the numbers for the cheapest class, right, which is a 40 to 100 person class.

It starts off at about $100 and it moves up in bundles to $400 -- $400 to $500 per group.

Okay.

And then, one quick one on ELITE English.

Are you guys satisfied with how the rollout of the revamped curriculum in new centers are going and what's the growth outlook for that part of the business?

Thanks.

For ELITE English this year we have established eight centers by the end of last semester -- by the end of March.

And we are now doing a lot of advertising.

And the student studying time is very flexible, so they can come to any time some days, they can install studying software into their own computers and they can use [telephones to] study by our teachers.

So we have -- we are pretty sure that this year the ELITE student numbers will go up and the revenues will go up a lot, actually.

Okay.

So, Brandon, we got a slow start to the Dynamics Education software, took us a little while to get it installed.

But now we believe it's going to begin to hit the ramp up.

Also because of the half -- almost the three months of redecorating the old learning centers.

To accommodate the computer facilities.

Right.

Okay.

Thanks, guys.

We're expecting good things from ELITE in the next four quarters.

The next question comes from the line of Catherine Leung from Citigroup.

Please proceed.

Hello.

Good evening, Michael, Louis.

Evening.

Hello, and congratulations on a great result.

My question is the Company's new U-Can business is clearly following the strategic expansion of the New Oriental brand.

Considering that these non-English subjects are not the Company's traditional core strengths, can you help us understand the driver behind your ramping to 8,000 students in such a relatively short period of time?

So is it mainly the strength of the New Oriental brand, meaning that we can expect the Company to achieve a certain degree of market share pretty much in any education segment between elementary to high school that you choose to enter?

We are very happy.

Actually, for the first -- in the quarter we are very happy we have more than 8,000 students studying other subjects because, traditionally speaking, New Oriental is only English training system.

There are two reasons that we got students and we are pretty sure we will have more students later in the future; one of these is our brand name.

Students believe that in any training areas we can do somehow, meet up the expectations, and we have a way of training our teachers so they believe in our teachers.

And most of our English teachers, they can teach other subjects at this time.

So actually, for these [8] students, most of their teachers actually originally are English teachers because these English teachers they study other subjects in universities, so it's easy for them to shift from English teaching, use the same teaching style, teach other subjects.

And another reason that we find students is that our teachers in English class, they help students at the same time we are training Chinese, mathematics at the same time.

So actually, for these students, and for some of them, when they finish their English studies, they just shift from English classroom to Mathematics classroom to continue studying here.

We've currently become a one-stop-shop.

So what Michael's referring to is that many of our teachers are college graduate students.

So they're actually the best and brightest in China who have taken all these tests and subjects themselves and passed the gaokao and are very good teachers.

So all -- and they already know the subject matter.

So just them learning the New Oriental content and the style.

And we've partnered with some of the best content providers in China in these gaokao areas to get the best content, and we've developed it ourselves.

And that's part of the strategic benefit of Mingshitang as well, is they have 72 teachers and some very experienced gaokao content that they've used for many years.

So all these things we're trying to put together and we begin to leverage the same teachers, many of the same teachers, we have in our current classes to teach new ones and we're also recruiting more and more teachers at the same time.

So that's why we don't think incremental cost is that much relative to the amount of revenues we will generate from increased students.

Right.

And my second question is on the expansion strategy.

So this quarter again we saw that the expansion was pretty widespread geographically.

Can you elaborate on whether these additions -- are they mainly centers to soak up the excess demand of your existing classes offered, or are these new types of centers, such as the Kids or the ELITE English centers?

And also for expansion plan, could you give us the split between new schools, i.e., new cities and the new learning centers?

Thanks.

In the [first] time we are going to open several new schools in the big cities we haven't (inaudible) like [Qingdao], [Chamei], (inaudible).

And we are still going to open up new learning centers in our existing cities because there are several reasons for that.

One is that with the increase of the traffic jam in each city, parents choose to send their kids to study in the nearby areas, like within 20 minutes of traveling or walking the (inaudible) distance, you know.

Otherwise they will not come to Oriental because it will take them one hour or two hours to come to the studying center and then they go back, take one hour, two hours.

It spends much of their time.

So there are more reasons that we expand so many learning centers to meet the needs of the parents and the students.

Of course, there's also demand for studying (inaudible) learning centers.

You can see that our revenue is going up because, even though -- the nearest (inaudible) facilities have students studying in it.

The second reason is that some of our competitors, they build up learning centers actually sometimes faster than we do, [so they are turning] into the community centers that it's easier for students to have access to.

So with this we have to build up learning centers in the same areas so that students will come to our places to study.

I think, Catherine, we are doing it for convenience for students.

We're not capacity constrained, because you're still going to see leverage in our business model as the existing 181 facilities still have a lot of capacity left.

So what we're doing, as Michael says, we're building new centers.

And this is part of -- this is synergistic with our U-Can strategy.

So we're going to have -- usually where you find our elementary schools, you find high schools and junior highs as well.

So we're trying to locate centers nearby there where we can leverage three sets of classes in one.

All right, understood.

Thank you.

Your next question comes from the line of Adele Mao from Susquehanna Financial.

Please proceed.

Hello.

It's Adele Mao from Susquehanna.

I may have missed some of your earlier comments on Mingshitang.

Could you just share with us some details on several things?

Number one, does Mingshitang own their current boarding school infrastructure in Beijing?

I believe they lease it.

They lease it, okay.

Yes.

So they have capacity for about 800 something students.

And they have -- it's almost full, as I said.

They already have 780 students or so.

But we're looking for a second location to hopefully double or triple the capacity of Mingshitang.

And we already have the content and the teachers in place.

We have 72 teachers.

I see, because there seems to be some construction going on.

Is it on -- for their current infrastructure or it's part of the expansion?

We would plan to lease a second building and we would then fit it out and have it, hopefully, ready to pick up students in the fall.

I see.

Okay.

So if it's generating approximately $2m this year, if we double the student base, we can hopefully double -- more than double -- I mean double the revenue and more than double the net profit from that.

Right, exactly.

With several VCs have previously contacted Mingshitang, what makes New Oriental stand out from possibly even higher valuation from private equity money?

Why don't I answer that since Michael's too modest?

I believe the CEO of Mingshitang believes that he wanted to be acquired by, and work with, Michael Yu.

So it's more Michael's celebrity status and his prominence in the education space in Beijing.

You're absolutely right, Adele.

Many of our competitors actually also went after Mingshitang.

But I think the deciding factor was that the CEO has known about Michael for many years and --.

He was my student, actually.

Yes, so this is --.

And also he thinks that we have synergies in it.

If he just get a VC, then he has to find it by himself.

But at New Oriental we have so many student spaces behind and (inaudible) so he thinks that he can find more students as quickly as possible.

So that's why.

Actually a lot of people talked to him about an acquisition, about an investment, because that guy is a real exciting guy.

He wants to make things big, you know.

I love his fighting spirit and I love that he loves me, you know.

That's great.

It's good to hear that.

Lastly, if I could, is there any historical statistics in terms of Mingshitang's college admission rate after re-takers actually go through their program?

Yes, this has a very good record of students going into universities including (inaudible).

Actually, their success rate is actually very high.

But with New Oriental going into that, I think we can make things better.

I think they have a direct (inaudible), a growing history and also a good management team there and also the [direct] of students going to university.

So we are happy that we can continue that growing for the next several years, I think.

Adele, Mingshitang is one of the top re-takers, gaokao schools in Beijing, one of the top three or four.

And I think with New Oriental's brand we will hopefully make it the best one in Beijing.

There are a number of other reasons that we acquire Mingshitang.

The policy regulations in China is not at all, middle school, high schools, are not allowed to train re-takers from this year.

So all those students who took classes in middle -- high schools don't have to find another training center for their re-taking preparations.

So this is a good time that we acquire Mingshitang.

Immediately we can find new students from the high school re-takers to come into Mingshitang to study.

So we are pretty sure that in this area we are in a growing area in New Oriental even though, totally speaking, this cost very little this year or next year about the driving up [now].

But don't forget, even though the number of students is now high, the ASP per student is about $2,500, including board.

Board is several thousand, RMB4,000 or RMB5,000.

So they're basic items, and the school's already profitable.

And so we believe that we can leverage a lot of resources from the school.

And as we grow the student base, there won't be much cost associated with it, other than leasing the new building.

Great.

Can I just go back to your fiscal fourth quarter revenue guidance a little bit?

We have seen many class offerings in recent months in gaokao prep area.

And I would imagine students will be taking these classes leading all the way up to the entrance exam in early June.

Did you factor in any of this gaokao prep business into your guidance?

The dollar amount will be relatively small, but I would think the impact from this revenue driver should be pretty meaningful in a seasonally slow quarter.

We have virtually no revenue forecasted from this business in our forecast.

Yes, let me tell you that all the students who will take the gaokao examination they have actually, from last year, they have found their schools to study Chinese [state] studies.

So Chinese students, typically, they are going to find new training centers to study from July, after they take the gaokao examination.

So actually from -- for this quarter, for the fourth quarter out of the fiscal year, it's difficult for us, even though we have (inaudible), it's difficult for us to find new students for the final several months of this gaokao enrollment.

So I think our big increase in -- our increase in revenue and in student number will be from July to next June.

Yes.

Now, Adele, there's two things.

One is the Mingshitang acquisition closes in June, so none of the numbers will be counted in Q4, right?

Second thing is we've taken zero for our U-Can business in Q4 to date.

So you know we'll do better.

And, as you know from us historically, we are conservative with our guidance.

Right, understood.

Thank you very much.

So yes, there's a lot of upside that haven't counted in.

And your final question comes from the line of Marisa Ho from Credit Suisse.

Please proceed.

Hello, it's me again.

I just have a quick question on your fourth quarter of the financial year about the cost outlook because, traditionally, it is the quarter where you ramp up spending ahead of the summer quarter.

But, on the other hand, you also have very easy comparison with last year because you spent a lot on your marketing activities a year ago as well.

So what should we expect in terms of the Y-on-Y OpEx outlook going into the fourth quarter of the financial year?

I think for the fourth quarter, you're right, Marisa, because we do spend a lot of money in the fourth quarter with the Dream Tour and all the other marketing expenses to drive our student growth for the first quarter dip, with our biggest quarter.

So we'll continue to do that.

And we also have additional marketing expenses because of U-Can and because of elite English and kindergarten and targetchinese.com and all these other -- and [Norstar].

So all these initiatives we are going into, we will have -- our market spending will go up.

But because our revenue is increasing rapidly, we're getting leverage in our business model.

And, as you mentioned very astutely, we have very easy comparisons into the fourth quarter.

So you'll see us ramp up spending.

But we will -- we are very comfortable that we will -- we're very comfortable with the guidance on the revenue side that we will at least meet, it if not exceed it.

And we will control our cost accordingly to the revenues that we can generate from that.

But, basically, I don't expect a loss-making quarter.

Yes.

Sorry, I didn't actually catch that.

You don't expect a loss-making quarter?

No, I don't.

We expect a profitable quarter, and the number -- because it's easy comparisons, the numbers should look very good compared to last year.

Excellent, thanks.

At this time, I would like to now turn the call back over to management for closing remarks.

Louis?

We just want to thank everyone for attending this call.

And we look forward to seeing -- and for all the excellent questions.

We look forward to talking to you in future conferences and on the road show.

Thank you.

Ladies and gentlemen, thank you for your participation in today's conference.

This concludes the presentation and you may now disconnect.

Have a wonderful day.