New Oriental Education & Technology Group Inc (EDU) 2010 Q1 法說會逐字稿

Good evening, and thank you for standing by for the New Oriental first fiscal quarter 2010 earnings conference call.

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

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

After management's prepared remarks, there will be a question and answer session.

Today's conference is being recorded.

If you have any objections, you may disconnect at this time.

(Operator Instructions).

I would now like to turn the meeting over to your host for today's conference, Ms.

Courtney Shike, of Brunswick Group.

Please proceed.

Thank you, Katie.

Hello, everyone, and welcome to New Oriental's first fiscal quarter 2010 earnings conference call.

The Company's first fiscal quarter earnings results were released earlier today and are available on New Oriental's website, as well as on newswire services.

Today you will hear from Michael Yu, New Oriental's Chairman and CEO, and Louis Hsieh, New Oriental's President and Chief Financial Officer.

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

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve inherent risks and uncertainties.

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

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

New Oriental does not undertake any 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 Chairman and CEO, Michael Yu.

Michael?

Thank you, Courtney.

Hello, everyone, and thanks for joining us today.

It's hard to believe that the end of the first fiscal quarter 2010 marks the close of our third year as a publicly listed company.

It is a milestone we are very proud to reach.

On behalf of Louis and the rest of the management team, I want to thank those of you who have been with us through these years.

We owe much of our success to your support.

Today, as usual, I will spend a few minutes discussing developments and highlights from the quarter, before turning the call over to Louis Hsieh to discuss the financials.

As you all know, the first fiscal quarter is seasonally our strongest, as students are on summer holiday and often sign up for multiple New Oriental courses during the two-month break.

True to form, strong total enrollment growth in the first fiscal quarter of 18.7% drove revenue growth up to 26.3%, bringing total net revenue to approximately $149.4m.

In particular, our three key growth segments performed well, with Kids English up to 34.1%, Middle and High School English and all subjects training up to 18.2% and overseas test preparation 14% in enrollment.

This is especially impressive, given that enrollments in June and July 2008, the first fiscal quarter of fiscal year 2009 were very strong, making year-over-year comparisons more difficult than usual.

Also, during the quarter, we opened a net of 17 new learning centers in 10 existing cities, bringing the total number of schools and learning centers to 287 across our nationwide network.

While we are pleased with our first fiscal quarter results, we estimate that the H1N1 flu pandemic negatively impacted our top-line growth this quarter by 2% to 4%.

As a result of the recent high level of alarm in China over H1N1, we received tens of thousands of inquiries this summer from concerned parents and students across China.

A large percentage of these inquiries decided not to re-enroll themselves or their children as a safeguard against coming down with the flu.

You must remember that due to the one-child policy in China, most of the Chinese families take extreme precautions when it comes to the health and the wellbeing of their often only one child.

Of course, this resulted in lower-than-expected enrollments, especially in our larger classes.

We also saw a record number of cancellations and deferments from registered students this summer, as applicable local health regulations required us to temporarily close or cancel classes and summer camps whenever an enrolled student contracted the flu, at which point we would refund or defer students' course fees, as well.

While the overall impact from H1N1 was greater than we initially expected, we believe this caution is par for the course in a country where families prioritize the health and the wellbeing of their only child.

This, of course, is one of the reasons why New Oriental continues to be so successful.

We are able to meet the needs of the family as they strive to provide their children with the best possible education and skills for a successful future.

I should note that we believe the impact from H1N1 is temporary and will not have a long-term impact on our business, especially after the vaccine is widely rolled out throughout the country.

To date, nine pharmaceutical companies in China have been granted the license to produce the H1N1 vaccine in China, and with over 60m doses scheduled for release in the coming months, the government expects to have a reserve of 100m doses by the end of this year.

School-aged children and teachers, along with health care providers, should receive proper priority in vaccine distribution.

In Beijing, the local government announces that primary and middle school students should have the option to receive the vaccine at their schools starting tomorrow, October 21st, in most cases at a low cost for students' families.

So we expect that as the availability of the vaccine widens throughout the larger population centers in China, the impact we have seen on our business will subside accordingly.

We were very pleased this quarter to officially launch our customized learning program for school-aged students from age six to 18.

The new program offers one-on-one or small-size class -- like up to five students tutoring class in all subjects classes required for both the gaokao and the zhongkao middle school entrance examination and the high school entrance examination.

China's national college and high school examinations -- as you all know, we launched our very successful U-Can all subjects training program back in January 2008, which to date has had over 90,000 enrollments and is one of our strongest-performing segments.

This new customized learning program is designed to complement U-Can, creating a two-pronged strategy of both larger, more affordable classes and smaller, more targeted classes for school-aged students.

With over 190m children aged six to 18, China's after-school training market is now a multi-billion dollar industry.

We are very excited about the opportunities that lay ahead in after-school children and we believe that with New Oriental's leading brand name and excellent reputation, we are very well positioned to gain momentum in this market.

As such, we are targeting over $25m in revenue in fiscal year 2010 from this newly expanded offering of all-subjects training, including U-Can, our new customized learning programs.

Our costs.

The costs associated with the rollout of this new program in Q1 impacted our bottom line this year, with increased expenses for marketing, remodeling older learning centers, opening new learning centers and hiring and training new teachers and staff.

We have front loaded these expenses in Q1 this year, ending August -- ending August 31, 2009, and Q2, ending November 30, 2009, and obviously this 2010 fiscal year.

We expect to be ready for the peak season for this market, which occurs from January to June, since gaokao is given in June and the zhongkao is in July each year.

As those of you who have been following private education in China know, this sector has seen increasing competition due in part to the ready availability of funding from venture capital and the private equity funds.

Since New Oriental's IPO in 2006, to illustrate, in the four years period from 2002 to 2005, less than -- only less than $80m was invested in the private education sector in China, including private -- [privacy] about more than $20m invested into New Oriental in 2004.

In the subsequent four years, from 2006 to 2009, however, total investment in the sector rose to approximately $600m, primarily going to the education companies in the larger cities, such as Beijing, Shanghai, Guangzhou, Chongqing and Shenzhen.

While we are seeing more resilience from certain competitors in these cities as they seek to build a brand through larger marketing spending programs and establishing learning centers rapidly, we remain confident in the competitive advantages of New Oriental's leading franchise, leading brand, national scale, experienced teachers and management and a suite of high-quality content and course offerings covering the educational needs of Chinese students throughout their lifetimes.

We will, however, not take these formidable competitors lightly and will continue to spend on marketing, especially in our newer programs, like POP Kids, U-Can, in order to stay in the front line -- in the forefront of parents' and students' mind.

We look forward to continuing our leadership in China's private education sector and to delivering strong results in the quarters and the years to come.

With that, I will turn it over to Louis Hsieh to go over our financial highlights for the first quarter 2010.

Louis, it's your turn now.

Thank you, Michael, and welcome to all of you on the call today.

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

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

For the first fiscal quarter of 2010, we reported net revenue of $149.4m, representing a 26.3% increase year-over-year.

Net revenue from educational programs and services in the first fiscal quarter were $142.4m, representing a 28.1% increase year-over-year.

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

GAAP operating cost and expenses for the quarter was $88.4m, a 27.4% increase year-over-year.

Non-GAAP operating cost and expenses for the quarter were $84.7m, a 29.3% increase year-over-year.

Cost of revenues increased by 23.8% year-over-year to $47.7m, 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 57.3% year-over-year to $15.5m, primarily due to expanded headcount in the selling and marketing department and increased brand promotion expenses, in part due to the marketing activities around the launch of our new customized all-subjects training program.

GAAP general and administrative expenses for the quarter increased by 20% year-over-year to $25.3m.

Non-GAAP general and administrative expenses were $21.8m, a 25% increase year-over-year, primarily due to increased headcount as the Company expanded its network of schools and learning centers and remodeled older learning centers in select locations throughout China.

Total share-based compensation expense, which were allocated to related operating costs and expenses, decreased to $3.7m in the first quarter of fiscal 2010 from $3.9m in the same period of the year-ago period.

GAAP income from operations was $60.9m for the quarter, a 24.7% increase from $48.9m in the same period of fiscal year 2009 and non-GAAP income from operations for the quarter was $64.6m, compared to $52.7m in the same period of the prior fiscal year.

GAAP operating margin for the quarter was 40.8%, compared to 41.3% in the same period of the prior fiscal year.

Non-GAAP operating margin for the quarter was 43.3%, compared to 44.6% in the same period of the prior fiscal year.

This decline in operating margin was primarily due to increased marketing expenses related to POP Kids English, U-Can and the launch of New Oriental's customized learning program for middle and high school kids.

GAAP net income for the quarter was $57.1m, representing a 27.1% increase from the same of the prior fiscal year.

Basic and diluted earnings per ADS was $1.52 and $1.47, respectively.

Non-GAAP net income was $60.8m, representing a 24.6% increase from the same period of the prior fiscal year.

Basic and diluted earnings per ADS, excluding share-based compensation expense, non-GAAP, was $1.61 and $1.57, respectively.

Capital expenditures for the quarter were $5.2m, which was primarily used to add a net 17 new learning centers during the quarter.

As of August 31, 2009, New Oriental had cash and cash equivalents of $238.7m, as compared to $254.8m as of May 31, 2009.

In addition, the Company has $129m in term deposits at the end of the quarter.

Net operating cash flow for the first quarter of fiscal year 2010 was approximately $61.2m.

The deferred revenue balance at the end of the first quarter of fiscal year 2010 was $57.9m, an increase of 36.2%, as compared to the $42.6m at the end of the first quarter of fiscal year 2009.

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.

Moving to the revenue guidance, we expect our total net revenue -- excuse me -- in second quarter of fiscal year 2010, September 1, 2009, to November 30, 2009, to be in the range of $60.8m to $62.8m, representing year-over-year growth in the range of 23% to 27%, respectively.

We expect our student enrollment to continue to be negatively impacted by the fear of the H1N1 flu during the second fiscal quarter.

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

Since our reporting currency is US dollars and our operating currency is RMB, we have benefited from currency translation gains during periods when the renminbi appreciates against the US dollar.

In the last several quarters, when the renminbi consistently appreciated against the US dollar 5% to 10%, our revenue growth for financial reporting purposes benefited from such appreciation.

But, given the current trend for the past 12 months, the RMB/US dollar exchange rate has stabilized.

Our currency transaction gains have shrunk accordingly.

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

At this point, Michael and I will be happy to take your questions.

(Operator Instructions).

Your first question comes from the line of Catherine Leung from Citigroup.

Please proceed.

Hi, Michael and Louis.

Hi, Catherine.

Hi, Michael.

My question is on swine flu.

When you discuss in your press release that the swine flu had a more significant negative impact on the bottom line, is this mainly an effect of your having a fixed-cost business model, or were there some other factors?

And, actually -- sorry, I have a follow-up question related to swine flu.

Were there any cities where parents were particularly concerned about the swine flu?

And has this impacted your expansion plans in the quarter or for the rest of the year.

Okay.

Actually, Catherine, we didn't expect swine flu to have so great an influence before, but during the summertime, a third of our school classes were stopped because students get swine flu and some of the parents, they canceled their classes, like from New Oriental's school.

(inaudible) They're still in registration to the wintertime.

We didn't expect the swine flu to have great influence in the wintertime.

There were two reasons.

One is that the vaccine has been already spread out in China, so everybody can get a vaccine almost, especially school students.

The other is that usually during the wintertime the swine flu is not active.

Catherine, to follow up on Michael's answer as well is that we -- the swine flu impact on our business really had to do -- in the cities where swine flu was detected, we saw very, very noticeable drop-offs in enrollments and in revenues.

So, for instance, Guangzhou, Shenzhen, other cities like Shenyang, Harbin, [Chongqing], all these cities where the health authorities asked schools to shut down whenever there was cases of swine flu, we saw very, very noticeable decreases in revenue for the whole summer quarter.

So any city that was heavily impacted, including Shanghai, as well, would suffer from this.

We also saw the epidemic really grow over the time.

Because, as you remember, the swine flu started in Mexico and the United States back in March/April.

It didn't really hit Hong Kong and China until May and June, and it's gotten progressively worse.

As you report, every week, every month, it's exponentially growing in the number of cases.

So, as Michael said, is we're hopeful that tomorrow the vaccine becomes available in Beijing.

In the next week or two, it becomes released in most major cities in China, with school-aged kids being vaccinated in most cases for free.

So health officials are going around in each of the primary schools and secondary schools and give free vaccinations to those who wish to have it.

So we expect, as Michael said, not to have it impact our business starting in the winter as much, if all goes well.

We do not expect the swine flu, if the vaccinations go through, to have any material impact on our calendar year 2010 numbers.

So we would expect -- I think some of the analysts have us about $2.60 to $2.80 in EPS for calendar year 2010.

We do not expect at this time that that will be impacted by the swine flu.

And far as it changing our plans, it won't change our rollout plans as far as learning centers.

What will change is that because of the customized learning program that Michael discussed in his speech, we will be adding more smaller learning centers.

So the learning centers will go from -- we were planning to [have] 60 last year -- I mean, two quarters ago in the guidance.

We'll probably move that up to 70 to 80 learning centers for the year, to customize this new launch.

Sorry.

It's a long answer to your question.

Did we get it, Catherine, your question?

That's very helpful.

Thank you.

Actually, from the deferred revenue, we can see that the deferred revenue has increased up to $36.2m.

That means some of the students, when they are facing H1N1, they are deferring their registration to the wintertime.

Right.

And it also had a significant impact on our summer camps.

If you think about it, last year was already a bad year for summer camps, because of the Beijing Olympics in August.

So this year we expected at least a 50% increase in the number of students who would attend summer camp in North America and Europe, in the [New Oriental].

These are high-ticket items.

Each student pays between $1,000 and $3,000 to attend these summer camps.

Not only did we not get -- last year, we had 1,500.

This year, we only had 800.

600 students canceled their registrations and another 100 more who were planning to register chose not to, because they didn't want to go into North America, where the swine flu was even more widespread.

Okay, okay.

I see.

Okay?

Thank you.

Thank you.

Thank you.

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

Please proceed.

Thanks for taking my question.

When we look at the sharp increase in sales and marketing spend in the quarter, how much of it is to publicize new courses versus the need to invest against existing courses?

And is it fair to assume sales and marketing spend will grow faster than revenue in the second quarter and then slower than revenue in the quarters beyond then?

Actually, we spent an extra of about RMB20m in POP Kids and U-Can and the customized one-on-one tutoring for the first quarter of this year.

That's right, yes.

So last year we spent $9.5m in marketing during the summer.

This year, we spent $15.5m.

The original budget was for about $12m, so we exceeded that budget by over $3m (multiple speakers).

And that [excession] was because of marketing to offset the impact of swine flu or because of marketing around new courses?

Yes, it's marketing around new courses.

Because if we do not step our speed to go into this new market, then other competitors will occupy the market and it will be more difficult for us to go in.

So I decided to ask the marketing department to spend extra monies on that, without noticing of the investors.

Yes.

I didn't learn about it until later in the summer, unfortunately, James.

Okay.

But you're right, though.

Your second part of your question is that that spending will continue for the next quarter.

Because, if you think about it, right, the peak season for students who prepare -- middle and high school students to prepare for examinations is January through June, so it's just like we are premarketing now in Q1 and Q2 in the fall and in the summer in order to prepare for the winter and in the spring.

James, we are not only spending money on the marketing.

We are spending it on remodeling the learning centers, so opening the new learning centers for this kind of trend, and we are pretty confident that for the next two quarters, I mean, quarter three and quarter four, the busier season for students who take examinations, we will see that the numbers go up.

Thank you.

Thank you.

Thank you, James.

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

Please proceed.

Hi, thanks.

Louis, last quarter you said you thought you could get 200 to 300 basis points of margin improvement in the year, and I'm assuming that maybe that's not possible now, given your seasonally strongest quarter was down 50 basis points.

But can you just touch on kind of where pricing's been trending and how that impacts your margins and where you expect you could come in for the year at this point?

Yes.

That's a great question, Amy, and you are right.

We expected to get 200 basis points on the bottom line primarily due to some gross margin expansion from last year.

That obviously will not occur because of H1N1 effect on revenues and on marketing.

The second thing that's going to impact that is the decision we made three, four months ago to go into this customized learning program, so that the spending on that also will change that scenario.

As far as our pricing goes, one of the things is we didn't raise prices much in big classes this summer.

So the overall price increases ended up being 9.1% in RMB terms, 9.5% in US dollar terms for the summer, but that's mostly because students signed up for small classes.

It wasn't so much -- because they wanted to avoid the big classes because of H1N1, and also because the market is moving toward small classes.

So we have to move into smaller classes.

The market is trending that way.

I think of it as, as China develops, parents have more money and they're going to spend it on higher-quality offerings, which means smaller classes and more attention for their kids.

And so just your expectations now on margin expansion for the year, is it -- can we still see some margin expansion, you think, this year?

Will it be --?

Well, what I want to do is, I want to wait for Q2 to see when the H1N1 effect begins to wear off, because we are still in the midst of being affected by the H1 -- the number of infections is escalating in China, so I want to see when that stabilizes.

Then I'll have a better answer for you.

Okay, and then just a quick follow up.

Do you have there -- if you said it, I missed it, but what the currency translation rate you used for the quarter?

I think it's 6.83-something, and I'll get that for you in a minute.

Okay, thank you.

(multiple speakers)

Yes.

It's almost [been] flat --

Yes.

But it's been almost flat for the whole year.

Almost full year.

Okay, great.

I'll pass it on.

Thanks.

I'll state it on the call.

(Operator Instructions).

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

Please proceed.

Hey, Jeff.

Jeff, before you ask your question, I want to get Amy her answer.

On the P&L, we used 6.8325 as the RMB exchange rate to the US dollar.

For the balance sheet, we used 6.8299 for Q1.

Okay, great.

Jeff, go ahead, sorry.

I wanted to hear more about the new gaokao tutoring program.

Maybe talk about the impetus behind it, how the margins compare for it?

And then of the expected revenue, the $25m you talked about for U-Can, what portion is expected from the new tutoring offer?

(inaudible).

The impetus for the program is that that's where the market's going.

I kind of -- I was talking to Michael about this a couple of months ago.

I kind of compare it to Chinese families several years ago, five or six years ago, when they started buying cars in large numbers, they bought cheaper, domestic-made cars in mass numbers, and I equate that to large classes.

As families got more and more wealthy and had more money to spend, they're able to afford cars like Buicks and Toyotas and Hondas.

And so those are the five or six person per class offerings.

And now, as Chinese families have more and more disposable income, they're buying Mercedes and BMWs, so the one-on-one and one-on-three, one-on-four offerings, so that's where the market's headed.

There are still people who want to be in the big classes, who can't afford the small classes.

So our impetus for opening the small classes is we're following the market and we're reading ahead of the market.

We know that the market is going to follow other countries like Korea and Taiwan, or other regions like -- and Hong Kong and other places.

And it's a move toward smaller classes, so we want to get ahead of that curve, so that's the impetus for it.

As far as the margins go, the margins are quite good.

It's going to have lower gross margins than one-on-one tutoring.

It will be somewhere around 50% gross margins, but the net margins are quite high.

When learning centers are relatively full, it's going to be about 30% profit margins.

And, to us, it's we're not going to have much pricing power in this area for the first two or three years until we build a brand name, so we're going to price at the market.

But I think over time we'll do to it as we did in the other sectors, which is, once we establish a brand, we'll have more -- the margins will begin to go up.

Also, in the first year, we'll be investing.

So Michael and I, we've already hired -- we have 300 teachers in this space already, another 130 staff covering this area, and that will continue to grow, because this is obviously a teacher-intensive endeavor.

Now, as far as the revenue side, last year U-Can, the non-English subjects, we had about 57,000 enrollments in that area.

It contributed about $7m in revenue.

U-Can should almost double this year to about 80,000 to 90,000 enrollments, so it should contribute about $10m or $11m, which means that we expect this one-on-one tutoring business to also contribute another $10m or $12m, to reach the $25m target.

Okay, great.

Thank you very much.

Thank you.

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

Please proceed.

It's actually Mark Skitovich for Marostica.

Just a follow-up on the H1N1.

Could you just give us a rough idea of how the cancellation rate, or if you look at just the number of cancellations trended during Q1 and strictly on a month-to-month basis, and then how it has trended in September and October, as well?

Thanks.

Good question, Mark.

We don't have the rates, but we know that the cancellations started -- it's gotten progressively worse during the summer, and most of our summer camps are in August.

And we saw almost half the signed people for summer camps cancel.

In Guangzhou school, all the summer camps got canceled.

Yes.

They were canceled by order of the government.

The government.

By the government, we had no choice.

It has trended -- it was actually not good in September, as well, and during the National Day holiday, October 1 through 8th, some of the cities actually prevented their students from leaving the campus.

They didn't want them to travel, for fear of spreading the H1N1 flu virus.

So it has had a significant impact on Q2, which is why we lowered our guidance to 23% to 27%.

Now, we believe that since the vaccine is now available in Beijing, the students -- the parents of the students who were most afraid of contracting it will get vaccinated, so they will then sign up for classes.

Also, I think as it becomes widely available throughout the cities in China, it will become less of an effect.

And I think the timing couldn't be better for New Oriental, because the timing for us is Q3 and Q4 for this U-Can and the middle and high school and the Kids business, it really takes off.

So -- go ahead.

I'm sorry, Louis.

Does your guidance for Q2 imply that the cancellation rate, if you want to call it, will sort of subside in November?

Or can you provide a little more clarity?

If the flu vaccine is rolled out as scheduled, it should subside in November.

And this is similar to -- except SARS never had a vaccine.

This is similar to what happened to us in SARS in 2003, right?

So remember the two big risks to New Oriental's business in the last [six] years has always been government policy and pandemics.

So this is just the second, the latter of the two, but luckily there is a vaccine for this one.

And so as it becomes available, like in Beijing tomorrow, primary and secondary students are getting vaccinated starting tomorrow, across the city.

Once that happens in other cities, we believe this -- logically, this issue should subside on its own.

And then we believe there's going to be pent-up demand for New Oriental's services, because some students have held off for one or two quarters for fear of contracting the virus, so we should see a bounce-back, and that's what we're hoping for.

That's what we're hoping for.

Okay, very good.

Thank you.

Thank you.

Your next question comes from the line of Richard Ji from Morgan Stanley.

Please proceed.

Hi, Michael, Louis.

Thank you for taking my call.

Hey, Richard.

Thank you.

Hi, sure.

And, obviously, this quarter, one of the big initiatives is, again, the small class.

And can you shed a little more light on the profitability profile for the small class, relative to your big class, and especially -- and, as you point that out, these small classes tend to be teacher intensive, and also you probably need more classroom space for these smaller-size classes.

But, on the other hand, obviously, you can charge a high price.

That's right.

So, going forward, how should we look at it?

Right?

Actually, like you said, Chinese parents are choosing more smaller classes, even one-on-one classes, because they wanted their kids to have more intensive attention so that their kids can get a high score, to pass the examinations, to go to better universities, to go to better high schools.

So that's why we are remodeling our existing learning centers already.

Usually, before our existing learning center is the 100 students classroom or even 200 students classroom.

Now we are remodeling our classrooms into from five students classroom to 40 students classroom, even one-on-one classroom.

So while remodeling these classrooms we can have a still -- students if they want to study in smaller classrooms, then they pay much higher, usually 10 times higher than in big classrooms.

So, the margin will be pretty good actually on these customized learning centers, so our smaller-sized classroom learning centers.

Yes.

Richard, to give you an idea, a typical class of 20 students to 50 students, they'll pay about $200 per enrollment, $150, $200.

If the student -- if the class has five to 10 students, the fee may be $1,000 for a 30/40-hour course.

A one-on-one tutoring will cost about $2,000 on average, for the same amount of time.

So, if you take -- the worst margin should be one-on-one, and one-on-one should have -- the student will pay about $50 per hour, $40 to $50 per hour.

The teacher will probably get paid about $20 and the room is probably $5 to $10 so the rest is all profit.

Yes, as you mentioned the teacher problem.

Actually, the teachers are not a problem because in big classrooms, like 200 and more, the classrooms still sitting there, we need a speaker, a really powerful speaker who'll become a teacher, like Obama, speaking to the audience here, now.

But in a small classroom the teacher only needs their skills and their patience because they only take care of five students, 10 students or 20 students.

So the teachers don't have to be powerful, humorous or like a public speaker, he only has to be -- or she only has to have patience and pay a lot of attention to students and answer students' questions, correct students' homework and get connected (inaudible) with parents and have good relations with parents.

So these teachers are already in China because most of the primary school teachers, high school, middle school teachers are already these kind of teachers, so we only have to train them to have some bit of New Oriental culture in their mind before they go into the classroom.

And also university students when they graduate from university after three months' training they can be pretty good teachers in smaller classrooms.

We have already done that and we have already in this area have more than 300 teachers trained and it's much easier to train the big classroom teachers.

Right.

That is very interesting.

And my related question is regarding the ASP trends and, obviously, during the quarter you did not raise the price too much for the large class.

Going forward, how should we think about that?

And especially for your small class, which has been just rolled out and should we expect higher price increase?

Very interesting question.

For larger classes, because -- then our class model was divided into three; larger classrooms and small-sized classrooms, like 15 students to 10 -- to 40 students, and then the one-on-one classrooms only one student to five students.

For this remodel, for larger classrooms like our traditional classrooms, we're not going to increase much every year for the price yet.

In my mind it's only like around the 5%.

So, for this is -- we only have our [influence] to have more students coming to New Oriental and take care of those students who -- some are a poor family, they don't have enough money to pay for New Oriental smaller classes.

So this will be like a 5% increase every year for the prices of -- for bigger classes.

But for smaller-sized classes and for one-on-one classes, there is no limit for increasing prices.

It's just catering to the parents and the students' need.

Some students would like to pay more to have long hours or even they want to -- if, for example, if they want a better teacher, they will pay double money.

It's interesting that we can -- that's why we can keep -- still keep a good margin in these smaller-sized classroom or our one-on-one classes.

It's only because when students -- when parents want to choose to study in the small classrooms, they don't care about money.

Just like if they want to buy a Mercedes-Benz or buy a BMW, they don't care about the money, that's the same comparison, I think.

Yes.

(multiple speakers) thing is that why we call it a customized, individual customized learning program.

You think about in the gaokao, as you know, there is many subjects in the zhongkao.

So the students can pick four subjects now, they can come in on a -- over a two-day period on Saturday and Sunday, they can go to one class in the morning of five students or 10 students, one class [in the afternoon], so they may pick Math in the morning, they may pick English in the afternoon.

They may pick Physics the next day and then they may pick Chinese language for the fourth class.

They can customize the study program according to wishes but if it is all picks four small classes, they'll pay us $1,000, $1,000, $1,000, $1,000, that's $4,000 for that one student.

So that's why it's customized for whatever the individual needs are.

As Michael says, if you think about it, right now there's 190m Chinese students between six and 18 going to school.

Half of them live in -- more than half of them live in big cities, that's over 90m.

But most of the research we've seen says that 40% to 60% of Chinese students in large cities pay for after-school tutoring classes.

That's about 40m, 50m Chinese kids.

Most of them will take, on average, four classes a year, that's 200m enrollments.

Yes, that's the problem in New Oriental is that when our students finish the English class in New Oriental, they walk away to other schools, to other training centers -- other school training centers to attend their Mathematics or Chinese classes, so we have to retain them here.

But for Mathematic Chinese classes, especially students want to choose smaller-sized or one-on-one classes, because you cannot have the students of same ability of Mathematics together for 400 students or 200 students in one classroom.

But English it is the same because students start English at the same time and if their level is at the same so we can have big classes.

But for Mathematics, for Physics, Chemistry, students' level is not the same, so we have to have smaller classes for students' needs.

Yes, makes sense, very enlightening.

Thank you.

Thank you.

Once again, ladies and gentlemen, please limit your questions to one, with one follow-up if you need to.

Please get back in the queue with your follow-up questions.

Your next question comes from the line of Ming Zhao from SIG.

Please proceed.

Thanks.

Good evening.

I want to ask a question about the books and others revenue this quarter.

You show the different seasonal trend, basically it's down quarter over quarter versus up in a year-ago quarter so can you give us some color on that?

Yes, sure.

The reason the other revenues is down is because of the summer camps.

So it's what we discussed that the online revenue was up about 50%.

Books has been slowing because books isn't that important a business for us anyway, but it was up about 15% or so.

But the one that really slowed down was the Overseas Study Consulting and that's exactly the summer camps we hit on.

Last year we had, I think, it's RMB15m in revenue, this year we had RMB15m, we expected RMB30m.

It was -- that was part of the hit from the summer camps because students didn't want to travel overseas, to go to North America or Europe, where the -- there was actually more cases of H1N1 than in China.

So the main culprit, there, is the Overseas Consulting business.

Okay.

So just to -- but if we look out to the second quarter where there is -- supposedly there's no summer camp there, so we should expect that normal trend to resume, is that correct?

Well, no.

In the -- as I said, in the cities that have had the most number of cases of H1N1, cities like Guangzhou, Shenzhen, Shanghai, Shenyang and others, the number of enrollments in middle and Kids English is much slower than past trend, much, much slower, single digits, and that's not normal.

So we attribute that mostly to the H1N1 effect.

As the vaccine becomes available this month and next month, we believe that will subside and we believe that the opposite will happen, which is the pent-up demand from the summer and Q2 -- Q1 and Q2, will flow into Q3 and Q4 because, at the end of the day, just like the SARS year, students have to take the test preps.

The reason is that before the National Day of China, like the October 1, the government warned all the students to not go outside to public places, or to training schools because they were afraid that if the students have more H1N1, they will affect the National Day celebration, that's the reason.

So after the National Day, the government seemed to relax the situation.

They allow students to come out but it's only like two weeks.

And so the government is trying to vaccinate the students from tomorrow, so by doing that they allow students to walk to anywhere because it's already after National Day and the celebration is over so even if the students have the more H1N1 it will not influence the image of China in the world.

I just want to clarify.

Would you say that the swine flu had a bigger impact on the other revenue or the education services?

It had in both because the other revenue has the Overseas Consulting, which is the summer camps.

Summer camps happen in August.

That's the one where we saw half -- almost half cancellations and we expected double the revenue than we got from that.

So, the second half is that it also affects the most vulnerable group which is in the most precious group for Chinese families, young kids and middle school students.

So it's going to affect our Kids English.

Even though we grew POP Kids with 34% this year, it grew 50% last year in enrollments.

Yes, we have targeted POP Kids to grow 50% also this year but in the summer we only grew 30 --.

-- 4%.

34% this year.

But we were expecting, actually, to grow at least 45% in the summer.

Yes.

But in summer because of the H1N1, most of the -- some of the parents stopped their kids from going to training schools including our (multiple speakers).

And you can see it.

As the swine flu moves from south to north, we see the gradual trend in the summer were that enrollments began to decline in every city where swine flu became a problem.

So, as it reverses and the vaccine becomes available, we believe that trend will go the opposite way.

Okay.

Just a follow-up to the new customized program.

We -- obviously, we saw $3m plus expenses coming in as selling and marketing expense this quarter.

Do you see more expense hitting the G&A line, or cost line, because you need -- supposedly you need to hire more teachers?

Yes, I think it will be more on the marketing line but we will have to hire more teachers, you're absolutely correct.

So we expect to fully spend for the whole year in adding teachers for both U-Can and for the customized learning platform as well as some of them overlap with POP Kids and others, as well.

Yes.

But, overall, we would expect marketing to be -- probably be about $6m, $7m and G&A expenses about $3m, for the whole year.

Yes.

Teachers is not a problem because we have begun to use more than half of the teachers as a -- on part-time basis.

That means if we have classes, teachers are working if we don't, teachers are home, so we do not pay them fixed income each month.

But the marketing fee will still have to be spent because we have to occupy the market and we have to have more students coming.

And also the training piece will be increased because we have the training teachers to become New Oriental teachers.

Louis Hsieh.

Yes.

You need to think of it as -- we're trying to be greedy here.

We're trying to capture the whole market.

We're offering you a Toyota Corolla if you want a big class.

We're offering you a Toyota Camry if you want a small/medium-sized class.

We're offering you a Lexus if you want a high end one-on-one tutoring.

We're trying to capture the whole market, here.

Actually we are targeting to become a Walmart model in New Oriental not like an expert model.

Yes.

Your next question comes from the line of Paul Keung from Oppenheimer.

Please proceed.

Hi, Michael.

Hi, Louis.

Hi, Paul.

Hi.

Good.

Listen, we do a lot of work on this non-English U-Can type category like [Olympic] Math and Physics and my question is specifically focused on this category.

We looked at about dozen schools in Beijing and Shanghai and I can tell you they don't see any swine flu impact; these schools are actually quite packed on the weekends and the weeknights.

And when I take apart your numbers, it's also one of the fastest growing categories in your -- in enrollment sample in your business although it's a quite -- off a small base.

My question is how fast can you grow that non-English component of the business from an enrollment perspective?

Is the pricing discount in a way that you'll see decent price increases in that category to drive the brand and trust for those non-English categories?

And lastly, again related, is do you think you need acquisitions to really jump-start that business even further?

That's a good question, Paul.

I'll be honest with you, I think -- well, we grew it from scratch to 55,000 enrollments in non-English last year.

We expect that to grow about 80% to 90,000 plus this year.

So we are growing at the market, if not faster.

Not too many of our competitors are growing 90% in a category.

This -- the classes are packed in the summer but they're not as packed as they normally are arguably.

You're also -- you're looking at Beijing and Shanghai.

Beijing wasn't affected by the swine flu even in our business, Beijing grew like crazy.

Shanghai was and so was Guangzhou and Shenzhen and other cities.

So, it depends on which city you're looking at.

And, as far as our competitors go, we have strong competitors in every city and we did look at acquisitions and that's probably why we waited a while to get into this business.

We were looking to acquire some companies in this space, it didn't work out so Michael made the decision to go it on our own, for now.

Yes, but the problem is that those targets wanted to make acquisitions and they also decided to get the investment and they're trying to go IPO by themselves.

Yes.

There is just so much money flowing through China so everybody's busy getting money, so they don't think like acquisition is a good way for them to get money, anyway.

Yes.

So that's why we decided that this year -- we really seriously decided we will go into this business by ourselves.

Yes, since you've done the research, Paul, you know who we're talking about, right?

So we have -- when you look at the number of private equity investments in China, as Michael highlighted in his talk, between 2002 and 2005, those four years, $80m flowed into the China's private education sector from PE funds and venture capital funds.

In the four years since then and with New Oriental's IPO in 2006, that number has gone to $600m.

More than a 10 times increase if you strip out the Tiger funding in New Oriental, in just -- in the same amount -- number of years.

We -- actually, we created in large the training market in China and then so much money coming into China so we created lots of competitors, and especially they are spending money like crazy because they think -- before IPOs they don't have to consider about their net income.

That's right.

They just want to occupy the market and opening more learning centers, much learning centers, more [learning] centers than New Oriental do.

So that's why actually, at first, at the beginning, about six months ago, we only decided to open around 60 new learning centers this year.

But we see that one of our competitors, they open 60 learning center in a month's time.

So, we have to reconsider opening more learning centers, otherwise the parents will choose the learning centers near their home to study because they don't want to spend the time in a traffic jam.

Yes, yes.

Not to alarm you guys, but these learning centers are small, they're not very (multiple speakers).

They're very small, yes.

About $50,000 so they're not -- our capital expenditure budget will not increase, it's still about $15m.

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

Please proceed.

Hi.

I want to get better sense of your marketing spending into the remainder of the year.

You mentioned for the first fiscal quarter you overspent by roughly about $3.5m and you'll continue to spend into the second quarter, so how much of a structural increase in marketing spending can we expect for the full year?

And, of that number, are you also trying to reallocate your spending to specific quarters or are we basically looking at a [naked] increase for the entire year?

Yes, your call.

Yes.

Last year, Marisa, we spend $38.7m in marketing.

This year we were expecting marketing to go up a little bit as a percentage of revenue.

So revenue went up 25% or 30% and marketing will go up probably 32%, 33%.

Last year it was about 13% of revenue, this year we expect to go to about 14%.

Because of the customized learning platform, we're going to front-load it into the first two quarters but it'll probably be higher than 14% of revenue so it will go up.

But it will subside in Q3 and Q4.

Most of the marketing will be done in Q1/Q2 and then there'll be some left over in Q3 and Q4 but we need to roll out these programs early.

This is the very crucial year that we roll out these programs.

If we are not too successful, then our competitors become bigger or become more competitive than us.

So, that way, if we spend even more money, we cannot occupy the market, we cannot.

So that's why we have to spend the marketing fee early and recruit new teachers early so that we can have a standing point in this area.

So, if we did $38.7m last year, Marisa, we did $15.5m in the first quarter of this year, you can expect us to be somewhere between $50m and $54m in marketing spending for the year.

Does that answer your question?

Yes, thanks.

But on the margin expansion question earlier, so was there some increase in marketing spending for the remainder of the year, we're probably going to be looking at flat margin for the full year as a result (multiple speakers).

Yes, like you said, I always try to get away from gross margin and I look at even margin, you're right, it would probably be somewhere flat.

We didn't expect the heavy impact from H1N1, we just didn't.

So, I -- things will -- I'll be better positioned to give you clarity once this issue subsides, probably early next quarter.

I think as we're trying to maximize the bottom line, EPS.

As I said earlier in the call, we expect calendar year 2010 EPS to remain the same, about $2.60, $2.80.

$2.60 to $2.80 per share for calendar year 2010.

That has not changed.

I think that the impact will be -- most hopefully will be just this quarter and in Q2 which will end in November 30.

And we've accounted for that, hopefully, the worst of it in the forecast we already gave, which is 23% to 27% revenue increase.

Right.

So, would it be correct to interpret this as such the H1N1 impact as primarily shifting revenue towards your winter quarter and --

Wintertime, mostly for wintertime.

(multiple speakers) -- in marketing right now should be recouping in the form of high ASP and also high enrollment coming from the customized product, would that be a right interpretation?

I think that's correct, Marisa, but we do lose some revenue permanently, which is the summer camp revenue.

Right.

And also, because students have a certain amount of time.

They would have taken classes every quarter but they lost one quarter, we lost one quarter from them.

So, you're right, most -- some -- most of it will flow back into Q3 or at least a substantial percentage, but we'll lose some permanently.

We've lost the summer camp revenue permanently.

They'll never get that summer back.

That's great.

Thanks.

Thank you.

Your next question comes from the line of Adele Mao from OLP Global.

Please proceed.

Hello.

Hey, Adele.

We cannot hear you.

Hi.

Sorry.

Hi, guys.

My question is also related to EDU school and learning center expansion strategy, going forward.

Michael mentioned earlier that your competitors are basically opening learning centers left and right, so you may be opening more but you may be opening 70 to 80 smaller centers in fiscal year 2010, is this 70 to 80 net addition or it has excluded any center closings?

They'll be net additions, 70 to 80 net additions.

Okay.

But they'll be smaller, on average.

So the net capital expense that it will still be about $15m is what we're projecting.

I see.

Now, if we take a look at what New Oriental has done in the fiscal year 2009, you had net addition of 22 schools and learning centers but with 40 openings, new openings, but 18 closings in 15 different cities.

Correct me if I'm wrong, it seems that the Company's adding more centers to major revenue driver cities such as Beijing, Shanghai and Guangzhou, but selectively closing learning centers in some second tier cities where you may have penetrated within the last couple of years.

Could you just help me understand the rationale behind center closings and openings?

Actually, we didn't close learning centers in the second tier cities, actually.

When we close the learning centers in second tier cities, it's because the location of the centers is not good so we open another new learning center in other parts of the city instead, we do not close them.

So we have never closed -- we have never decreased any learning centers in any city, actually, if New Oriental is there.

We open -- we are opening more learning centers in Beijing, Shanghai, Guangzhou, these big cities, because there are more needs in here.

This is where the customized learning platform is being rolled out, first in Beijing, then Shanghai, then Guangzhou.

So in this first year it's not going to all 30 cities, these customized learning center -- these customized learning programs will be targeted at the larger cities.

We actually only close a learning center in any city is because our lease time is up.

Yes.

That means the landlord does not want to lend us anymore, they want to get the property back.

Or we think that this is not a good location, so want to find a better location for that learning center.

Okay.

So, if we see a number of learning centers dropping in fiscal year 2009, for example like city of Dalian, I think there is one less learning center in fiscal year 2009 versus 2008, is it you guys were consolidating the centers?

Yes, that's mostly the case (multiple speakers).

Okay.

And I guess, going forward, your learning center opening strategy should basically better -- to make sure that you are able to better expand offering of small-sized customized subject classes, is that correct?

Yes, that's right.

We are targeting to 350 learning centers at the end of this fiscal year because, now, we have 287 learning centers.

I see.

Okay, that's very helpful.

Thank you.

Thank you.

Thank you.

We are now approaching the end of the conference call.

I will now turn the call over to New Oriental's Chairman and CEO, Michael Yu, for closing remarks.

Over to you, Mr.

Yu.

Again, thank you very much for joining us today.

Even though our numbers does not look so excellent, but we are pretty confident that later for the whole fiscal year we are confident that we can do pretty good things in new business, I mean the customized learning centers and other things.

I'm also pretty much appreciate your patience to listen to us explain so many things here.

If you have any further questions, please do not hesitate to contact us or any of our Investor Relations representatives.

Thank you for your time and for your patience.

Bye-bye.

Thank you for your participation in today's conference call.

This concludes the presentation.

You may now disconnect.

Have a wonderful day.