New Oriental Education & Technology Group Inc (EDU) 2009 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2009 New Oriental Education & Technology Group earnings conference call.

My name is Josh and I'll be your coordinator for today.

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

We will be facilitating a question and answer session towards the end of this conference.

(Operator Instructions).

I'd now like to turn the presentation over to our host for today's call, the New Oriental Senior Investor Relations Manager Sisi Zhao.

You may proceed.

Hello, everyone, and welcome to New Oriental's third fiscal quarter 2009 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 Louis Hsieh, New Oriental's Chief Financial Officer.

After his prepared remarks, Louis will be available to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1994.

Forward-looking statements involve inherent risks and uncertainties.

As such our results may be materially different from the views expressed today.

A number of potential risks and uncertainties are outlined in our public filings with the SEC.

New Oriental does not undertake any obligation to update any forward-looking 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 investor.neworiental.org.

I will now turn the call over to New Oriental's CFO, Louis Hsieh.

Louis, please.

Thank you, Sisi.

Good morning or good evening to everyone on the call and thank you for taking the time to join us today.

I will begin by discussing some of the highlights from the quarter before taking you through the financials in greater detail.

As most of you know, the third quarter is typically New Oriental's second strongest quarter with school age children taking advantage of their winter holidays to attend New Oriental courses in English, all subjects training and test preparation.

This year we saw a revenue increase of 36.1% year-over-year even as the business was negatively impacted by two main factors.

First, as we discussed in our press release in mid-February when we adjusted the revenue guidance downwards for the quarter, due to the weak macroeconomy and that led to lower anticipated enrollments in our adult English courses, even as we continue to grow slightly year-over-year these enrollments -- sorry, these enrollments grew slightly year-over-year reaching 50,300 for the quarter, up from approximately 50,100 in the year ago period.

Second, our third quarter results were impacted by the early timing of the Chinese New Year holiday which began on January 26 this year, almost two weeks earlier than in 2008.

As a result of the compressed timeframe between when students completed their regular school sessions and the beginning of the early Chinese New Year holiday, our schools in Shanghai, Nanjing and several other cities experienced scheduling problems with students' regular school sessions leading to a dramatic slowdown in enrollments in the second half of January.

This said, we did see a strong pickup in enrollments in February as total enrollments for the third quarter increased by 31% reaching 351,700 students from 268,400 in the same period last year, totaling so far this year 1.189m enrollments in our first three quarters.

We are confident that we will reach the high end of our fiscal year 2009 enrollment target of 1.475m to 1.5m student enrollments.

This solid enrollment growth helped to achieve year-over-year net revenue growth of 36.1% exceeding the high end of our revised guidance.

And this is keeping in mind the difficult year-over-year comparison, given our exceptional performance in Q3 2008 when we saw revenue growth of 46.9%, enrollment growth of -- student enrollment growth of 34.8% and an income growth of 38.1% compared to Q3 2007.

If you've followed New Oriental since our IPO you know that the cornerstone of our business is the strong cultural emphasis Chinese families place on early education for their children combined with New Oriental's leading brand and reputation as the best provider of supplemental education.

This continues to be the case with demand for our kids and middle and high school English course offerings seeing strong growth, helping us offset weaker demand for adult courses.

Turning now to look at these business lines in more detail.

New Oriental's POP Kids English program remains one of our most popular offerings with children from ages five to 12 taking courses that blend humor and learning and encourage students to engage making learning fun.

In the third quarter, Kids' English experienced enrollment growth of 48% year-over-year bringing total enrollment up to about 86,000 for the quarter.

And for the first nine months of 2009, enrollments in Kid's English reached 240,400, an increase of over 50% over the first nine months of fiscal year 2008.

To capitalize upon the successful and growing Kid's English offering, during the third quarter we continued to expand our nationwide network of schools and learning centers, opening a net of nine new learning centers in various cities throughout China.

We also opened a new kindergarten in Nanjing.

As of February 28, 2009 our total number of schools and learning centers was 257, up from 247 at the end of the second quarter of 2009.

Another strong driver of growth is our all-subject middle and high school training programs, U-Can.

During the third fiscal quarter we continued to roll out U-Can in new cities throughout China.

And as of February 28, 2009 it was available in over 30 cities with total enrollments for the third quarter exceeding 18,600.

In addition to this, the two acquired gaokao training schools Mingshitang and Tongwen also offered short term training courses for students preparing to take the gaokao this June, helping them achieve short term enrollments of over 5,100 for the third quarter.

For the first nine months of 2009, enrollments in middle and high school non-English courses surpassed 45,000 enrollments, bringing us into the range of 40,000 to 50,000 that we had previously targeted for the entire 2009 fiscal year.

So we are pleased to have reached this goal with one quarter of fiscal year 2009 still to go.

We expect to see continued synergies between all-subjects training and our traditional language and test preparation offerings.

And in order to capitalize on this trend we will continue expanding our U-Can offerings to exciting cities while rolling out -- programs out in new cities -- sorry to existing cities, while rolling out new programs in new cities.

Looking ahead we see much to be optimistic about.

Education of their child or children will continue to be the top priority for Chinese parents.

And as we expand our offerings to meet a wide range of educational needs, we are confident that families will continue to turn to New Oriental as their children's lifelong education partner.

Now I'll take you through the financials for the quarter.

Please note that certain figures I will refer that exclude share based compensation expense are non-GAAP.

You can find the reconciliation of these figures to GAAP in the financial tables at the end of the earnings press release.

For the third fiscal quarter of 2009 we reported net revenue of $65.4m representing a 36.1% increase year-over-year.

Net revenues from educational programs and services for the third fiscal quarter were $60m, representing a 34.7% increase year-over-year.

The growth was mainly driven by an increase in the number of student enrollments in language and test preparation courses.

Excluding share based compensation expenses, non-GAAP operating costs and expenses for the quarter was $52.7m, a 47.9% increase year-over-year.

GAAP operating costs and expenses for the quarter were US$56.8m, a 49.7% increase year-over-year.

Cost of revenues increased by 40.9% year-over-year to $26m, primarily due to the increased number of courses and the greater number of schools and learning centers in operation.

Selling and marketing expenses increased by 51.9% year-over-year to $10.5m, primarily due to brand promotion expenses.

Non-GAAP general and administrative expenses were $16m, a 55% increase year-over-year.

GAAP general and administrative expenses for the quarter increased by 61.4% year-over-year to $20.2m, primarily due to increased headcount as the Company expanded its network of schools and learning centers.

Total share-based compensation expenses, which is allocated to related operating costs and expenses, increased by $4.1m -- sorry, increased to $4.1m in the [third] fiscal quarter of 2009 from $2.3m in the same period of the prior fiscal year.

Share based compensation expense should drop below $4m in the fourth quarter of 2009 -- fiscal quarter, so next quarter.

Non-GAAP income from operations for the quarter was $12.8m, a 2.4% increase from $12.5m in the same period of the prior fiscal year.

Non-GAAP operating margin for the quarter was 19.5%, compared to 25.9% in the same period of the prior fiscal year.

GAAP operating margin for the quarter was 13.3% compared to 21.3% (sic -- see press release) in the same period of the prior fiscal year.

The drop in operating margin was primarily due to decreased operating efficiency as the growth in operating costs and expenses outpaced revenue growth.

We also accrued a large amount for staff bonus payments -- a larger amount for staff bonus payments in 2003 -- I'm sorry, in Q3, 2009 which negatively impacted operating margins.

Going forward, we expect to see a positive margin trend as the average class size is not decreasing as fast as previous quarters.

The non -- if you strip out VIP, the average class size in the third quarter 2009 was about 35 students to a class as compared to around 38 students in the year ago period.

Additionally ASP for the third fiscal quarter 2009 grew approximately 11.8% in RMB terms and approximately 18% in US dollar terms to $169, up from $143 in the year ago period.

Both of these factors should lead to higher margins in future quarters.

Non-GAAP net income was $14.5m, representing a 4.3% increase from the same period of the prior fiscal year.

Basic and diluted earnings per ADS excluding share-based compensation expenses or non-GAAP was $0.39 and $0.38 respectively.

GAAP net income for the quarter was $10.4m, representing a 10.3% decrease from the same period in the prior fiscal year.

This decrease was due in part to the increased bonus accrual in the quarter as compared to last year, and the approximately $1.8m increase in stock based compensation expense as compared to last year to $4.41m in this quarter.

Basic and diluted earnings per ADS was $0.28 and $0.27 respectively.

Capital expenditures for the quarter were $4.4m, which was primarily used to add one new school and a net of nine new learning centers during the quarter.

As of February 28, 2009, New Oriental had cash and cash equivalents of $224m as compared to $182.8m as of November 30, 2008.

In addition, the Company had $62.5m in short term deposits at the end of the quarter.

Net operating cash flow for the third quarter of fiscal year 2009 was $21.7m.

The deferred revenue balance at the end of the third quarter of fiscal year 2009 was $55.4m, an increase of 54.8% compared to $35.8m at the end of the third quarter of fiscal year 2008.

Deferred revenue, where students enroll and pay for courses to be completed in future quarters, as most of you know, is essentially a measure of backlog for New Oriental.

Before I give guidance, I would like to take a brief look at the comparison between the first nine months of fiscal year 2009 and the first nine months of fiscal year 2008.

Student enrollments in language training and test preparation grew 23.1% year-over-year to [1.189m, 300,000] (sic - see press release) from approximately 966,500 in the nine months ended February 29, 2008.

Net revenues were up 45% year-over-year to $233.1m.

Excluding share based compensation expense, non-GAAP operating income was up 37.6% to $70.7m.

GAAP operating income was up 28.7% year-over-year to $58.4m.

Non-GAAP operating margin went from 32% for the first nine months ended February 29, 2008 to 30.3% for the nine months ended February 28, 2009.

GAAP operating margin went from 28.2% for the first nine months ending February 2008 to 25.1% for the nine months ended February 28, 2009.

Non-GAAP net income was up 32.7% year-over-year to $70.6m.

Non-GAAP basic and diluted earnings per ADS for the nine months ended February 28, 2009 was $1.90 and $1.84 respectively.

GAAP net income was up 23.5% year-over-year to $58.4m.

GAAP basic and diluted earnings per ADS for the nine months ended February 28, 2009 were $1.57 and $1.52, respectively.

Moving on to revenue guidance, we expect our total net revenues in the fourth fiscal quarter of 2009 from March 1, 2009 to May 31, 2009 to be in the range of $50.5m to $53.5m, representing year-over-year growth in the range of 25.7% to 33.2% respectively.

This forecast reflects New Oriental's current and preliminary view, which is subject to change.

Since our reporting currency is the US dollar, and our operating currency is renminbi, we have benefited from currency translation gains during the periods when the renminbi appreciated against the US dollar, which has been the case in the last several quarters when the renminbi consistently appreciated against the US dollar by 8% to 10% year-over-year.

Our revenue growth for financial reporting purposes benefited from such appreciation.

But given the current trend in the third and fourth fiscal quarters 2009, as the CNY/USD exchange rate has stabilized, our currency translation gains will shrink accordingly.

Once again, thank you for participating in our quarterly conference call.

At this time I would like to take questions.

Thank you very much, sir.

(Operator Instructions).

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

James, you may proceed.

Hi, Louis.

Hi (inaudible).

Glad to hear you're opening U-Can in more exciting cities going forward.

A couple of small questions.

One was about the amount of the staff bonus accrual.

Could you give us some sizing around that and just confirm, I think last year you took that in the first quarter of the fiscal year whereas this year you spread it more evenly between the first and third quarter?

And then the second question was around the tax rate.

Okay.

Thank you, James.

On the bonus issue is that last year, in fiscal year 2008 we had a phenomenal summer, Q1 summer quarter.

So we took a larger percentage of our bonus accrual.

We've also since then changed our bonus policy to pay bonuses basically twice a year, once in February to the staff and teachers for Chinese New Year which is traditional in China.

The second, for executive bonuses, are now paid in the summer during July/August timeframe.

So we basically begin to accrue bonuses accordingly.

And as you pointed out correctly, James, we did take more bonus accrual this quarter than we did last year at this time.

The difference is between $600,000 and $800,000 which was bonus payments made this quarter that was not made in the same period of last year for teachers and staff.

So that's one issue.

On the tax rate, the tax rate is quite low this quarter because we had over-accrued for taxes in Q1 and Q2.

Don't forget we were applying for the emerging market status for several of our entities.

And until we got that, we basically accrued at a higher rate of over 12%.

Our tax rate for fiscal year -- or accounting year 2009 should be somewhere between 11% and 12%.

So we did get a slight income tax benefit from the taking back the accruals that we had over-accrued for in the last two quarters.

Great.

And the bonus went into the G&A principally?

Yes.

Principally G&A.

A little bit in marketing, but most of it in G&A.

Okay.

Thank you.

Yes.

And our next question comes from the line of Catherine Leung.

Catherine, you may proceed.

Hi.

Thanks for taking my questions.

I have two questions.

The first one is in terms of the margin.

So if we were to add back the approximately $3m to the revenues, which is about the amount that the guidance had been lowered in February, and even if we assume that all this goes to the bottom line, we're still looking at non-GAAP net margin of about 25%.

And then if we add back the $600,000 to $800,000 one-off -- the difference in the staff cost accrual treatment, it still looks like the net margin is down slightly on a year-on-year basis.

Would you be able to help us quantify any other one-time reasons for this?

And I know that you had already said it on the conference call earlier that you were still going to expect margin expansion in the next fiscal year.

Would you be able to quantify as well the magnitude of the expansion?

And secondly, in terms of your network expansion, in the press release you had stated that you added nine learning centers.

Are all these POP Kids English centers?

And can you share with us more detail on these schools, for example, where these are located, capacity and how fast these schools have been filling up in the past quarter.

Thank you.

Thank you, Catherine.

The second question is easier for me.

We added a net of seven new POP Kids learning centers out of the nine learning centers that we added.

They were added in various large and medium sized cities.

I don't have the exact breakdown.

POP Kids English schools -- centers aren't that big.

They're about 15 to 20 classrooms.

They typically fill up about 30% or 40% in the first year and about 60% or so in the second year.

And they probably top out around 70% to 80% full in the third year.

But they are profitable within the first year.

So it is one of our fastest growing businesses.

On the margin question, we are going through budgeting currently for 2010 fiscal year as we're already into our last fiscal quarter.

We do expect margin expansion, especially in the gross margin line, as the class size begins to abate.

We went from 38 to 35 students per class this quarter, which means the class size is not falling as fast, whereas ASPs were up 11.8% in renminbi terms year-over-year.

So we do expect some margin expansion in the gross margin area.

We are going through a debate now within the management team with regard to how much to spend on marketing.

And it looks like we will probably begin to accelerate marketing spending.

I think we've been in the 12% to 13% range.

And we may move that up to the 13% to 15% range which would not be, obviously, favorable for net margins, for operating margins.

However, we've done calculations where when we spend money on marketing it actually accelerates our topline growth many times-fold what we spend on marketing.

So if we do increase the marketing spending, likely we will increase our revenue growth beyond the 25% to 30% that we've been guiding.

So we do expect some operating margin improvement, probably in the 100 to 200 basis points for fiscal year 2010.

And I believe you'll see some margin improvement in the fourth quarter of 2009 as well.

Does that answer your questions, Catherine?

Yes, thank you.

And can I also ask as a follow up, what type of courses, or are there specific cities that you'll be concentrating your marketing spend on?

Yes.

We're going to be concentrating our marketing spending on two areas.

One is POP Kids English centers.

So as we roll into more and more cities with more and more centers, we'll continue to spend on marketing for that.

And the second of course is our U-Can program.

We're very delighted to see that our enrollments have exceeded our expectations and that we're getting a lot of traction especially in, obviously, the non-English subject areas.

So those two programs are the fastest growing lines, Kids' English and middle and high school English including gaokao and after school tutoring.

And so those two areas are where we're spending most of our marketing dollars.

They have the highest payback.

Okay.

Thank you.

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

Mark, you may proceed.

Yes, thank you.

My first question relates to your overseas test prep business.

And I'm wondering if you could give us a sense of what type of enrollment growth and ASP growth you saw in that line of business in the quarter.

Good morning, Mark.

For the quarter we saw enrollment growth of a little bit over 13% to 51,100 students in overseas test prep.

And ASPs were up approximately -- I'm looking here -- was up approximately 20%.

Okay.

Thank you for that.

And as you look into the fourth quarter, the May quarter, can you give us a sense of what your plans are for new school and center openings?

And prospectively or looking forward into fiscal 2010, how you're thinking about new center -- new learning center and school openings.

That's a great question.

I think we're going to probably open more learning centers, maybe one more school.

We've already opened more than our four to five that we typically would open, and we'll probably open another 10 learning centers.

So we'll finish the year with approximately 60 to 65 new facilities versus last year.

I believe in 2010 fiscal year we're planning to open fewer schools, probably two to three new schools, so new cities or through acquisition.

And we'll probably open about 45 to 50 new learning centers, primarily in the kids and middle school area.

So the ages five to 18 year olds in China, the students there are our fastest growing businesses.

Okay, great.

And then a question on deferred revenue.

Noticing past trends, I think this is the first quarter that I recall that your deferred revenues into Q3 exceeds your guidance for revenue in the subsequent quarter, Q4.

And I'm wondering why is that this time around.

And perhaps you can talk about how deferred revenue in Q3 flows into the upcoming quarters.

That's another very good question.

We currently have deferred revenue of $55.4m of which we believe approximately $35m will come into this quarter Q3 -- Q4, sorry.

The other $20m will flow into the summer quarter.

And this is a little bit higher than normal primarily because of, as you recall, that we had the scheduling issues in Shanghai and Nanjing and other cities where, because of the early timing of Chinese New Year, many students didn't get out of class until -- from their regular schools until after New Oriental's classes already started.

So we had basically mistimed the opening for those classes before Chinese New Year.

Because of that many of the students deferred their enrollments until the summer.

So they already paid for classes.

Instead of canceling their classes they just deferred their enrollments into the summer quarter.

And we also saw that in February.

So even though we had very strong enrollment growth and a lot of enrollments in February, most of that revenue will flow into Q4, which is why we have such a high deferred revenue balance.

So this year was a little bit unusual.

Got it.

And a last question, Louis, regarding the adult business, understanding you've had some challenges there.

Can you give us a sense for how the adult enrollment growth behaved on a year-over-year basis throughout the quarter just as you look at the various months, December, January, February?

And as you look at the month of March, now that's behind you and presumably April as well, you've got some sense, how is that behaving on a sequential basis?

Adult enrollments are relatively flat.

They were down in January primarily because, I think, of the timing of Chinese New Year this year.

So they were way down in January.

They were up in December because they had -- they were minus 3% in the prior fiscal quarter.

So adult enrollments for the whole quarter was 50,300, it was up 200 from last year.

In March and April, I don't have the April numbers.

In March, they were relatively flat year-over-year.

So this is, we believe, primarily due to the financial crisis.

And we can see it because the slowdown is primarily in the cities that are most export related, meaning Shanghai, Guangzhou, Shenzhen.

Most of the Eastern coastal cities, large cities are the most impacted by the slowdown in adult.

So even though adult is not growing, at least it's not declining year-over-year now.

And we've been benefiting from the adults who are signing up for New Oriental classes are signing up for smaller classes, which means they're paying us more.

So ASP increases in adult English is up about -- over 15% year-over-year because of this trend.

So there's fewer students coming.

There's a slower growth rate, but they're paying more.

Okay.

Thank you.

I'll turn it over.

Thank you.

And our next question comes from the line of Paul Keung from Oppenheimer.

Paul, you may proceed.

Yes, thank you.

Two questions, first was a follow up to what Mark just asked about the deferred revenue.

You mentioned about $20m of that as of the end of the February quarter, is really for the summer quarter.

Now that we're [towards] the end of April I am just curious if [you're] actually giving the same sort of guidance at all.

Just how strong does that really suggest to you because -- are those comparing [from] numbers a year ago, suggest that even the first quarter of 2010 you have pretty strong bookings and some part may be the very [deep] (inaudible) would be for last year.

So, maybe tell us a little bit more about that.

Second question has to do with the competitive landscape.

We recently saw the acquisition of Wall Street English by Pearson, and then there was some other smaller deals as well.

What kind of multiples are these private companies going for, and then what does it suggest to you?

Do you think multiples are coming down to a point that you actually might see some opportunities again or do you think it's still a frenzy, overpriced multiples today in the marketplace?

Thank you, Paul, good questions.

On Q1 we are very hopeful for a good Q1 obviously, because Q1 is our most important quarter during the summer when Chinese students get two months off.

I think the early indicators are that the summer will be good, given especially since we don't have the Beijing Olympics to contend with as we did last year, so -- but it's still early.

We had a rapid February, we had a more normal -- every time we have a rapid increase we usually have a slower next month, so March was -- we saw growth, but not at the torrid pace of February where enrollments were up over 40%.

So we are -- we typically -- I always ask investors and analysts alike to evaluate New Oriental on a rolling 12 month basis, because we have fluctuation -- monthly fluctuations in enrollments and revenues.

And so if we have a very strong quarter we typically have a weaker one the next one, and it all evens out over 12 months to show nice growth patterns.

So for the summer we are -- it's early.

The reason, Michael, is not on this call is because he is on the Dream Tour.

So he is traveling around to 25 to 30 cities giving a lot of speeches and marketing to basically drum up business for the summer.

And as far as the competitive landscape we did see that Pearson acquired Wall Street Institute.

And we don't see much change in the competitive landscape.

It depends on what Pearson does with Wall Street.

We've always been competing against Wall Street at the very high end.

So with our Elite English offering and our VIP offerings -- don't forget we came after them in the market, they've been established in the high-end white collar market in Shanghai and Beijing before we went into this business at the high end.

So we will still compete -- we will still continue to compete against them.

We don't see any change there.

As far as our own M&A strategy, we continued to be very disciplined on the multiples we paid.

Because we signed a confidentiality agreement I am not allowed to disclose the multiples that Pearson paid for Wall Street based on their projections for 2009.

But New Oriental has been making acquisitions at single digit multiples, based on forward 12 month GAAP net incomes.

And so we continue to be disciplined in that.

We do see a number of opportunities in the areas that we discussed which is primarily, number one, competitors in large cities.

Number two is domain knowledge we don't have.

And number three is gaokao retaker schools.

So we are basically in the process of integrating Tongwen and Mingshitang.

And they are going quite smoothly, so we'll begin to look at acquiring additional gaokao retaker schools.

Does that answer your question, Paul?

Thank you.

It does, it does, thank you.

And our next question comes from the line of Adele Mao from SIG.

Adele, you may proceed.

Adele, your line is open you may proceed.

Thanks.

Hi, Louis.

Given that you plan to -- you are planning on accelerated marketing budget for fiscal year 2010, what level of enrollment growth you will be targeting for the year, and if you could also discuss your plan on tuition increases that would be very helpful.

I think that's a good question, Adele, I think they go hand in hand.

So what happens is if we increase prices more we'll get lower enrollments.

If we market more we'll get higher enrollment.

So it's interplay between marketing dollars and also price increases.

And so I think as we'll begin we'll kind of monitor this over the quarter.

We are basically targeting 15% enrollment growth and probably 10% ASP increases on a blended basis.

That includes the -- because students are picking smaller class sizes.

So we expect revenue growth in the range of 25% to 30% next year.

Now, obviously if we don't increase prices as much we will probably get higher enrollment growth.

So it's one of those things that we are constantly fiddling with to see what the maximum amount of sort of marketing spend versus return, and price increases versus enrollment growth.

I see, okay that's helpful.

My other question is related to teacher salary.

Could you just give out the numbers of part-time versus full-time teachers in the quarter?

And how many new teachers did you add in the quarter?

Okay.

I will -- give me one second, I have to pull that information out, I don't have it handy, give me one second.

We ended up with 4,900 and so teachers by the end of the quarter as I recall.

I'm looking at, pulling it now.

And for the quarter -- let me look here, for the quarter we added a net of 530 new teachers.

And we have a total now of 10,450 employees within New Oriental.

Okay.

And I remember you mentioned last quarter that 3% to 5% salary increase was approved for current employees.

When are we going to see that salary increase hitting the -- (Multiple speakers)?

-- this quarter, it was approved just before Chinese New Year.

Okay, so it's already been reflected?

Yes, so it took effect February 1, and so you saw it partly in this quarter and partly -- you'll see it in Q4.

I see, okay.

For the new teachers that you have hired are you able to recruit for less because of availability of college graduates out there in China, or do you feel that the labor cost is actually increasing perhaps with the shortage of qualified teachers?

Well, we increased staff salaries and teacher salaries approximately 4% for 2009, for this year.

And we haven't decreased our salaries and they've gone up 4%.

So we don't -- we probably could find teachers for less, but we want to make sure we hire the best quality teachers and we train them.

So we have not reduced teacher salaries.

Thank you.

Even though the market is softer, the employment market.

Okay, that's very helpful.

Thank you.

Thank you.

And our next question comes from the line of Amy Junker from Robert Baird.

Amy, you may proceed.

Good morning, Louis.

I had a quick question to follow up on the competitive landscape.

In addition to Wall Street English we came across a story said that Disney is going to start to open some schools to teach children English.

Are you familiar with that?

How would you expect them to compete with you?

And given kind of the recognizable brand name do you have any idea if they are going to compete with you on price or any comments you would have on that?

I think Disney has opened some centers in Shanghai.

And it's ironic because we had the discussion with them before IPO, so three or four years ago to open up high-end English schools throughout China with New Oriental running them and with Disney's brand name.

So they took the idea obviously and ran with it.

There we don't compete directly with them because they are priced well above us, they are priced more than double or triple what we charge for Kids.

So we are after the mass market, middle and up, and they target the very high end.

I believe they are still using the content that was developed by Pearson, which is what New Oriental uses.

So the content is very similar, but Disney customized it with their characters and with their brand on it.

And so I believe that the English -- the Kids English market is huge in China is huge and still growing.

And so I think there is -- we compete with 30,000 other language training schools and test prep schools.

Disney obviously, given its great brand name and its well run company, is going to be a competitor.

But I think they are typically priced well above what most of our POP Kids offerings are.

Great, that's helpful.

Thank you.

And just given the macro environment that you've seen have you noticed any material difference in the enrollment ramp of any of your new schools as you've been opening those up this year?

Are they behaving similar to what you've seen in years past?

The new schools are behaving similar to years past.

But we believe that we get much more bang for our buck by opening learning centers in existing cities, because as many of you have heard we haven't really penetrated any city to maturity yet.

And so we are going to aggressively roll out U-Can and Kids over the next year.

That's our primary strategy in existing cities, because they are -- the Kids Program is only six or seven years old, it's growing 50% a year and U-Can is brand new.

And so if you think about it we will probably have enrollments of close or over 1.5m enrollments this year.

600,000 of them will come from ages five to 18, and so the five to 18 year old group will have doubled in less than three years.

So that is -- that's where we are going to focus our attention.

And as you also know, Amy, it's a lifelong value of that student.

The younger we get them into the New Oriental system the longer they typically stay with us and the more they'll pay us over their lifetimes.

Great thanks.

That's all I had, thank you.

And our next question comes from the line of Hao Hong from Brean Murray.

Hao, you may proceed.

Thank you.

Louis, just quickly, what is the currency assumptions built into your forward guidance?

Our currency assumptions are basically the same as they are now, which is CNY6.8395 is what we use for the income statement for fiscal year -- for this last quarter.

Okay.

So if I take out your currency from your guidance and also the currency appreciation from this quarter as well, for some reason I am actually seeing a decelerating top line growth trend even though your marketing spending is increasing.

Could you give us some color on that?

Yes, I think our RMB growth rate for the quarter was 28.2%.

And it is slightly lower, and that's primarily because of the slowdown in adult English as we mentioned.

Number two, it's because of the scheduling problems we had in Shanghai, Nanjing and several other cities.

As Catherine mentioned earlier, those two issues account for about $3m, $2m to $3m.

So if you add that back then you'll see that our growth rate hasn't really decelerated.

And you'll see that.

But I think as overall our long term growth rate of course would decelerate because of the law of large numbers.

But if you think about it for last year we added 200,000 net new enrollments for fiscal year 2008.

For fiscal year 2009 we should be very close to 2.

-- for 250,000.

So actually our business is actually growing very healthily, it's just that we are going to get hit with the law of large numbers where the denominator of what we are comparing against is getting bigger and bigger.

Right.

And also just looking at your top line growth conceptually, if I take out enrollment growth and currency growth for some reason I am seeing a negative year on year ASP growth number here, did I [see it] right?

No, no, ASP growth is up 12% to 14% year over year in RMB terms.

Right.

Constant dollars, so constant RMB terms our ASP is way up.

Okay, thank you.

And our next question comes from the line of Jeff Lee from Signal Hill.

Jeff, you may proceed.

Thanks.

Louis, can you talk more about the impact of the economic softness, obviously it's seen on the adult English market.

Is there anywhere else where you are sort of seeing that?

Well, we are primarily seeing it right now, Jeff, in the adult segment.

We haven't seen -- I am sure that it is probably impacting us at the margin at the middle and high school as well as the Kids level.

So by example a family may send their child to two or three New Oriental classes a year, and because of financial constraints they may reduce the number to one or two.

But it's unlikely they'll go to zero.

And so we may see that in the margin.

But right is we are seeing it primarily in the adult sector.

Okay.

And then can you talk about rent and personnel expense?

How much did they grow in the quarter, and then how do you expect them to trend going forward?

We expect -- well, personnel expense is easier for us because we set -- we kind of set salaries once a year and we increased salaries by 4% in February.

As far as the rent expense, for new learning centers and others we aren't seeing a double digit increase as we had in past years.

So 2007 fiscal year -- calendar year, we saw double digit increases, now they are low single digits.

So that's why we were -- we believe that we should get some margin expansion is because our teachers cost and rent, which are the two biggest components of cost, are going up low single digits.

And we are still able to raise prices on apples to apples classes between 8% and 10%, which gives us a 400, 500 basis point improvement in margin.

Okay, great.

And then last question, the ASP increases, how variable are they across different programs?

And then how sustainable do you think these increases are given the economic softness?

Well, I think as -- obviously we get this question hundreds of times a quarter.

So far we have been able to increase in the ASPs for overseas test prep in the range of 15% to 20% a year.

And for Kids English it's much lower it's around 8% or 9%.

And for middle and high school it's about 10% to 12%.

And so those are our three fastest growing lines.

Adult sector has been -- we've been increasing prices over 15%, but that's only because adults are picking more expensive options, they are picking smaller class options in large numbers.

And finally, we are seeing a trend where almost 4,000 students signed up this quarter for VIP meaning one on one instruction.

And the average ticket there is over $1,100.

And so we are seeing -- and so that kind of obviously affects the ASP as well.

So we are seeing the wide range.

On an apples to apples comparison we are still increasing prices around 8% to 9%, and that's been the case for the last four or five years since I've been at New Oriental.

So you are not seeing really any pushback from the economic softness?

No, I think our competitors are doing about the same thing.

So we are -- remember price usually typically factors third in a family's decision where brand name is the first consideration, location is the second consideration, how far are we from their home or their school, and price is usually the third consideration.

Okay.

Thank you.

Thank you.

And our next question comes from the line of James Mitchell from Goldman Sachs.

James, you may proceed.

Hi, great.

Thanks for taking a couple more follow up questions.

One [customers] -- with regards to the possible increase in marketing spending of 13% to 15% of revenue, is that a response to the competitive environment or is that just more a desire to grab land while it's available?

It's really the second, James.

It's really that we have just seen that when we spend $1 on marketing and in Kids in middle school we get $3 to $5 in revenue.

Whereas we spend $1 in marketing in adults we don't get much [for it].

Right.

And also because we are trying to roll out U-Can, it's a brand new program for us, and because we saw -- we've seen extremely -- we've been extremely successful in the first year, we are beginning to feel very confident that this program has a lot of legs and has a long --.

And if you think about it if you combine the ages five to 18 market, this market dwarfs English Language training and overseas test prep.

The market is three or four times larger.

And so you can imagine that it's such a large market, and we are in the essentially the first inning of this trend that we are going to go after it as hard as we can to get market share.

Because if we get a child when they are six to 12 they typically stay with us for many, many years.

Okay.

And then second question, I am probably over-analyzing this but I think you said that you are confident you should be around the high end of your enrollment target of, I think, 1.5m at the high end.

Right.

For fiscal '09, and that would imply about 310,000 enrollments in the fourth quarter, which would be kind of flat year on year against 301,000 in the fourth quarter last year.

Is there any reason why enrollment growth might be slower year on year in the fourth quarter of this year?

It would only be because enrollment growth was so strong in Q3.

So, it's like I said, that's why I made the comment that we wish that investors and analysts would track us over a six month or 12 month basis.

Because if we took -- if you recall in Q1 we had a very strong enrollment growth as well in the 20 -- well over 20% for the summer, and then we had a slow Q2 where enrollment growth was only 13%.

But all that meant was there was pent up demand and we had enrollment growth of 31% in Q3.

Well, 31% is double what our normal growth rate is, so we would expect that to fall in Q4.

But at the end of the day if you look at 12 month rolling basis we typically grow about 18% to 20% in enrollments, and about 35% in revenue.

Right.

And this quarter last year that we are now in the impact of the earthquake was to --

It was to the May month, so it was the last three weeks of the quarter.

So, yes, I think we have easy comparisons this quarter.

But -- so we -- that's why I think we are confident that we'll be above that 1.5m rate -- we'll exceed that number.

Okay, fantastic.

Thank you, James.

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

Marisa, you may proceed.

Hello, Louis.

Could you remind us of the actual ASP [achieved] for the [Q] -- [full] product areas, please?

Let me -- get all that out.

You mean the actual US dollar numbers?

The US or RMB either or.

Okay, if I look here our US dollar number I am sorry I don't have it right in front of me.

The average -- I just have the growth numbers to be honest, Marisa, is that okay?

Right, going back to one of the earlier questions on the (inaudible) between the 28% local currency revenue growth and vis-a-vis the 31% enrollment growth, and obviously you are still looking at positive ASPs accretion on a year on year basis.

Are we looking at a relationship because you are looking at a mix shift towards the POP Kids English and [tends] on kind of biasing the actual ASP number downwards?

POP Kids does have a lower ASP on average.

But don't forget because we are raising prices across the board the ASP will still go up year over year.

And also even among POP Kids they have two choices, one is a smaller class, 15 person class and one is a 25 person student class, which is about 30%, 40% cheaper.

So even in POP Kids it's tiered.

I have the numbers now, Marisa, on overseas test prep our average ASP was about $350.

On high school, including U-Can the average price point was about $120, and for Kids it's about $125 per course.

Great.

And also on the tax rate in the third quarter, can you quantify the amount of overprovision that was written back during the third quarter?

I don't have that right in front of me.

We paid $200,000 something in taxes but it's -- you can figure out that our tax rate going forward is about 11.5%, 11.8%.

So we had accrued it at 12.2% rate in the first two quarters.

Right.

So we got a little bit back.

It's in the range of a little bit over $0.5m.

Right, thank you.

I don't know the exact number.

You can contact Sisi for the exact number.

(technical difficulty) thank you.

Thank you.

And our next question comes from the line of Chris Shutler from William Blair.

Chris, you may proceed.

Hi, Louis.

It's Brandon for Chris.

Hi, Brandon.

Just two quick ones here.

The margin expansion number you talked about 100 to 200 basis points, is that a GAAP number or is that excluding stock based comp?

How should we think about how you do that (Multiple speakers)?

Stock based comp is going to decrease in the quarters ahead as you know, so it's going to go below $4m this quarter.

It will go up a little bit in Q1 as the August -- it won't go up, it should stay relatively flat, and it will drop significantly in Q3 of next year when the '07 options go away.

The '07 options represent about $9m a year.

And so the -- we will have new grants but they won't be to that level.

So I would expect margin expansion on a GAAP basis will actually exceed non-GAAP.

So we are at that tipping point now, where the reason -- the reason is our stock based compensation was the highest this year, it was about $17m.

It will drop to between $12m and $14m next year and then hopefully would drop again, excluding any acquisitions or any very expensive hires.

Okay.

Okay.

So I think that we would expect 100 to 200 basis point improvement from the '08 -- '09 numbers in gross margin, and we would expect probably something even better than that on the bottom line, on the operating margin and on the net margin.

But don't forget 2009 we were basically hurt by two main events.

We started off in the hole 250 basis points after Q1 because of the Beijing Olympics.

And then we didn't execute well in Q3 in Shanghai School and Nanjing School in the scheduling.

And so we were never going to dig ourselves out of that hole.

Okay.

And then if you look at the Kids business, if you could talk about the gross margin profile and the operating margin profile in the context of, one of your competitors saying they hadn't made any money in Kids in, I don't know, five, 10, 15 years something like that.

Just trying to get a feel for your level of confidence around your ability to make money on the operating line, how do you get to a decent operating margin number in Kids?

Is it just there is lower expense associated with the lower gross margin, or is it --

I think you are talking about English First and they have a different model than we do.

They are trying to feed in the high end.

They -- them and us are the biggest competitors to Wall Street at the very high end in white collar English.

And they use Kids as a loss leader.

So they have a different model.

We use Kids as bread and butter, because we don't plan to just offer Kids English, we plan to offer Kids math and Chinese and other classes as well.

And also I think EF is priced at a price point above New Oriental as well.

Okay.

Okay, so that's why.

As far as your question on margins if you take a standalone Kid center we should get over 60% gross margin from them -- from that center within the first year, year and half operation.

When the center is mature after three years it should generate gross margin in excess of 65% and operating margin in excess of 30%.

Okay.

It's still a very, very good business when it's well run, but it takes about three years to mature to that level.

And as you know we've been expanding so fast that we don't have that many Kids centers that are three years old.

Got it.

Okay, thanks a lot.

And our next question comes from the line of Adele Mao from SIG.

Adele, you may proceed.

Hi, Louis, I have a follow up question regarding Kids English growth.

The enrollment growth this quarter is 48% year over year.

I believe this is partially driven by an increase in your school count, given that 77 new centers were added in fiscal year 2008, and I think so far 50 new centers were added in fiscal year 2009.

Many of these centers are for POP Kids English.

How much of that growth is from new centers that opened during the past year?

Is there more of an organic growth number that we can look at, just -- not on an aggregate basis but rather growth on per school basis for the schools that -- (Multiple speakers)?

I think that the schools tend to track very closely to a 30% to 40% number in year one and then a 50% to 70% year number in year two, and then it tops out at 80% in year three.

But you're absolutely right is that as we open up Kids learning centers near schools and near large residential areas, we are seeing a very rapid ramp up in Kids enrollments.

So I don't have the exact breakdown but the Kids pattern is very simple.

I think typically if you build them in the right locations the Kids will come, and you -- you market correctly.

Hello?

Yes, I am here.

Okay.

Yes, so I don't have the exact breakdown.

But I think that a lot of the growth in the Kids area -- if a school -- if a learning center is three years old it's probably not growing much, it's not contributing growth.

But a new center is probably -- obviously in the first year it's going to add 1,000 plus students, and in the second year it would double.

Okay.

So for the POP English centers that have been there for the past, let's say, three, four years, would you be opening new Kids learning centers around that center -- (multiple speakers).

We will probably open in other locations near other schools.

Okay, but in the same city?

Yes, in the same city.

So that's exactly right.

So we are opening up most of the Kids centers in existing cities.

We are not opening in new cities.

Okay.

It's just that we are -- it's a convenient -- remember convenience is more important to families typically than price.

Right.

Right, so we need to be close to your elementary schools and elsewhere.

If you think about it if we have 127 schools and learning centers opened in the last two years.

Probably 50% of them or more are Kids centers.

And so you can just do the math that they are going to contribute significantly.

It will be 60,000 or so, or 120,000 enrollments just from those new centers in the last two years.

Okay.

All right, that's helpful, thank you.

And our next question.

(Operator Instructions).

And our next question comes from the line of [Katie Wong], Katie you may proceed.

I think most of my questions have been answered.

Thank you, Katie.

And at this time we are showing no further questions.

Mr.

Hsieh, you may proceed.

Well, thank you everyone for attending New Oriental's Q3 2009 conference call.

We look forward to seeing you soon.

Thank you for your participation in today's conference.

This concludes the presentation you may now disconnect.

Have a wonderful day.