New Oriental Education and Technology Group Inc. F1Q09 (Qtr End 08/31/08) Earnings Call Transcript

Oct.20.08 | About: New Oriental (EDU)

New Oriental Education and Technology Group Inc. (NYSE:EDU)

F1Q09 Earnings Call

October 20, 2008 8:00 am ET

Executives

Sisi Zhao – Senior Investor Relations Manager

Michael Yu – Chief Executive Officer

Louis Hsieh – Chief Financial Officer

Analysts

Adele Mao – Susquehanna Financial Group

Catherine Leung – Citigroup

Scott Schneeberger – Oppenheimer & Co.

Brandon Dobell – William Blair & Company, LLC

Mark Marostica – Piper Jaffray

James Mitchell – Goldman Sachs

Chenyi Lu – Brean Murray Carret & Co.

Marisa Ho – Credit Suisse

Traer Urdan – Signal Hill

Operator

Good evening and thank you for standing by for New Oriental’s first fiscal quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the meeting over to your host for today’s conference Ms. Sisi Zhao, New Oriental’s Senior Investor Relations Manager.

Sisi Zhao

Hello everyone and welcome to New Oriental’s first fiscal quarter 2009 earnings conference call. Our first fiscal quarter earnings results were released earlier today and are available on the company’s website as well as on newswire services. Today you will hear from Michael Yu, our Chief Executive Officer and Louis Hsieh, our Chief Financial Officer. After prepared remarks, management 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 provision of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, our results may be materially different from the view expressed today. A number of potential risks and uncertainties are outlined in our public filings with the SEC. New Oriental does not undertake any obligation to update any forward-looking statements, except as required under applicable law.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on New Oriental’s investor relations website at http://investor.neworiental.org. I will now turn the call over to New Oriental’s CEO, Michael Yu. Michael, please.

Michael Yu

All right. Thank you Sisi. Good morning and good evening to everyone on the call. Nice to have you guys here again and thank you for joining us today.

As you have seen, we delivered strongly during our first fiscal quarter of 2009, exceeding the high end of our revenue guidance by over $8.7 million. These results were driven by high gross along with training and overseas test preparation enrollment, in particular our POP Kids English and overseas test preparations programs performed well, with enrollments increasing by over 55% and 24% respectively.

As many of you know, the first quarter is seasonably our strongest with the school age students taking advantage of the two month summer holiday to enroll in New Oriental classes. This year, even with the Beijing Olympics in August, our business results were strong as our Beijing school was able to remain open during the Games and the most of students who were attending the Games or who left Beijing during the Olympic period chose to defer course starting date instead of foregoing classes.

As a result, the event did not have a materialistically significant impact on our enrollment. We believe that this phenomenon demonstrates the importance placed on education in China and the effectiveness of the courses we offer.

During the first quarter we continued to expand our physical network. The total number of schools and the learning centers increased by 15 to 222 in first quarter, up from 207 as of

May 31, 2008. We opened two new schools this quarter, one in Qingdao and one in Xiamen to bring the total number of schools to 43 up from 41 as of May 31, 2008.

Also in this quarter, the number of learning centers increased by 13 to 179, up from 166 as of May 31, 2009. We closed with the acquisition of Mingshitang gaokao, an issue I will discuss further. I know we consolidated our two private boarding schools in Yangzhou and Taixing to one campus in Yangzhou. In summary, adding two new schools to the net of 13 new learning centers in several large cities, we now have a total of 222 number of schools and the learning centers spreading to 38 cities.

I am also happy to announce that of the U-Can all subject training program, which we launched in the third quarter of 2008, had approximately 15,000 enrollments in this quarter. Demand for all subjects training trend is high, as kids are under tremendous pressure to obtain high scores on the gaokao, China’s college entrance examination.

Our U-Can program, which helps students begin preparing for this examination at a young age, offers an attractive proposition. We believe enrollments in the U-Can program will continue to rise as students who are familiar with our culture and the teaching style and parents who trust our strong brand name come to us and stay with us year after year. We have already rolled out the U-Can program in 25 cities in China and our target is over 30 cities by the end of our fiscal year next May.

I’m pleased to tell you that during the first quarter we completed the acquisition of Mingshitang, a private school specializing children gaokao re-takers. During this quarter the school had more than 2,500 enrollment for this year’s class, almost 1,100 boarding students and another 1,600 for short term training, up from 800 in the third quarter when we announced our plans to acquire a stake in the school.

Our other traditional business lines, such as online education through Koolearn.com, bookstores and the international consulting also contributed to growth in the first quarter, driven by high summer enrollments during our peak season. We continue to see tremendous growth opportunities ahead in China’s private education market. Our having a smart business model allows us to leverage our underground and natural teachers and administrators as we expand our natural throughout China.

This scale abilities especially evident to us as we diversify our offerings and the movings all subject training at the domestic test preparations. I’ve asked New Oriental to provide an even more diverse and the comprehensive cross offerings. We will continue to build on our position as the destination of choice for supplemental education in China.

As New Oriental prepares to celebrate the 15th anniversary of our founding on

November 12, 2009, we have a lot of people to thank including the over 6 million students who have enrolled in our courses, the thousands of current and the former New Oriental teachers and the stuff and the supportive community of analysts and investors. We are pleased and grateful for all past success and we believe the future of New Oriental will be even brighter.

With that I will hand the call over to Louis Hsieh, our CFO who will take you through the financial results for the quarter. Hi Louis.

Louis Hsieh

Thank you Michael. Hello to everyone and thank you for joining us today. Before I begin I want to elaborate on the point Michael made about the 2008 Beijing Olympics. As we reported last quarter, we expected that the games, which took place between August 8 and August 24, would negatively impact our business. This was due to transportation and security logistics arrangements in Beijing, the potential distraction from classes as the nation tuned in to the games.

Despite the strong growth we achieved in the quarter, we estimate that the Beijing Olympics negatively impacted our net revenue growth by approximately $4 million, with the largest impact in Beijing where revenues for the summer quarter grew only 12.4% year-over-year in RMB terms as compared to 25.4% in the previous annual growth rate. In addition, because of enhanced security controls around the Beijing Olympics, our Shijiazhuang school closed for about two months from July 28 to September 20, resulting in a negative revenue impact of $0.4 million for the quarter.

Furthermore, we incurred significant additional marketing and logistics expense related to the Olympic Games. Despite the adverse impact to our business from the Olympic Games, we are pleased to report strong top line year-over-year growth of 46.8% to over $118 million. We expect to recoup a significant portion of the estimated $4 million in lost revenue attributable to the Beijing Olympics in subsequent quarters.

Now I will walk you through the contributors to our first fiscal quarter results and some financial highlights. Please note that certain figures I will talk about are non-GAAP, including all measures that are given share based compensation expense. You can find a reconciliation to these figures in the finance tables at the end of the press release.

Those of you who follow our company closely understand that growth is best evaluated by monitoring growth in four key measures. First, student enrollment growth; second, net revenue which encompasses ASP increases; third, non-GAAP operating income growth; and fourth, our free cash flow growth. Today I will focus on some of the factors affecting these key metrics.

As you have seen in the first fiscal quarter of 2009, our total net revenues increased by 46.8% year-over-year to $118.3 million from $80.6 million in the first quarter of fiscal 2008. Revenues from our education programs and services comprising our language training and test preparation courses, as well as primary and secondary education programs, grossed 46.1% year-over-year as new student enrollments in the language training and test preparation courses continued to surge.

Total student enrollments in language training and test preparation courses in the first quarter fiscal 2009 increased by 23.8% year-over-year to approximately 545,400 from approximately 440,500 in the first quarter of fiscal year 2008. We also saw increased revenue from books and other education materials and services which rose 58.4% from the year ago period to $7 million.

Excluding share based compensation expense, or non-GAAP, operating cost expenses for the quarter was $65.5 million, a 50.6% increase year-over-year. Total operating cost expenses for the quarter were $69.4 million, a 53.6% increase year-over-year. Costs of revenues increased by 50.6% year-over-year to $38.5 million, primarily due to the enhanced course offering and the greater number of schools and learning centers in operation.

Selling and marketing expenses increased by 61.8% year-over-year to $9.9 million, primarily due to additional brand promotion expenses during the Olympic Games. General administrative expenses were $21.1 million, a 55.6% increase from the same period last year, mainly as a result of increased headcount as the company expanded its network of schools and learning centers.

Total share based compensation expense for the quarter rose to $3.9 million from $1.7 million in the year ago period. Of this amount approximately $230,000 was recognized as a cost of revenue, $62,000 was recognized as sales and marketing expense, and $3.6 million in general administrative expenses.

Income from operations, excluding share based compensation expense or non-GAAP for the quarter of $52.7 million, a 42.3% increase from $37.1 million in the year ago period. And income from operations for the quarter rose $48.9 million, a 38% increase from $35.4 million in the year ago period. Excluding share based compensation expense, a non-GAAP measure, operating margin for the quarter would have been 44.6% compared to 46% in the corresponding period of the prior year.

Operating margin for the quarter was 41.3% compared to 43.9% in the year ago period. This decrease is primarily due to several factors. First, as we have discussed in previous quarters, the short term language training and test prep markets are moving to smaller class sizes, especially kids programs. This is because as discretionary income increases in Chinese households, students are willing to pay higher course fees for the individualized attention the smaller classes can offer.

This market trend was especially pronounced in our Q1 ’09 where average class size for short term language training and test prep courses was approximately 40 students per class, down from approximately 60 students per class in the year ago period. Smaller classes are marginally less profitable on average than larger classes, but they still remain very profitable overall. While we expect the trend to continue toward smaller class sizes, we also believe the rate of decrease in class sizes will abate in the quarters ahead.

The second factor affecting our operating margin in the first quarter is the Beijing Olympic Games which have already been discussed.

The third factor affecting margins this quarter was investment in new businesses, particularly in the U-Can all subjects training, Mingshitang and other gaokao retaker schools, New Oriental star kindergarten, a bilingual kindergarten business, and North Star, our CPA, bar and civil service exam prep school. Although these new business units were unprofitable in the quarter, we expect these businesses to grow rapidly and contribute meaningfully to New Oriental’s profitability in the years to come.

The fourth factor affecting our Q1 margins was an increase in share based compensation expense, which rose to $3.9 million from $1.7 million in the year ago period. We expect share based compensation expense to remain high in the coming two fiscal quarters before abating in subsequent quarters. Share based competition should be slightly over $4 million in the second quarter for fiscal year 2009.

And the fifth and final factor is provision for income taxes which increased to $6.2 million from

$3.3 million in the year ago period, due to increased tax rates in some of our locations as mandated by current PRC tax law.

Net operating cash flow for the first fiscal quarter 2009 was $41.8 million. On the bottom line, net income excluding share based compensation expense, non-GAAP, increased by 37.9% year-over-year to $48.8 million. And net income for the quarter increased by 33.2% year-over-year to

$44.9 million from $33.7 million in the first quarter of fiscal year 2008.

Excluding share based compensation expense, basic and diluted earnings per EDS were $1.31 and $1.27 respectively. Basic and diluted earnings per EDS were $1.21 and $1.17 respectively for GAAP measures. Each EDS represents four common shares. Basic and diluted earnings per common share amounted to $0.30 and $0.29 respectively.

Capital expenditures for the quarter were $5.5 million U.S. dollars which is primarily used to add two new schools and 13 new learning centers during the quarter, and for the remodeling and maintenance costs per existing facilities.

Moving to our balance sheet, our total cash and cash equivalence as of August 31, 2008 were

$196.9 million. In addition we had $68.9 million in term deposits at the end of the quarter. A deferred revenue balance made up of cash collected from registered students to be recognized proportionately as revenues and instructions are delivered, at the end of the quarter was

$42.6 million, an increase of 59.7% as compared to $26.6 million at the end of the first quarter of 2008.

I will now read you New Oriental’s financial guidance for the second fiscal quarter of 2009. Please note that the following outlook statements are based on the current expectations. These statements are forward-looking. Actual results may materially differ.

New Oriental expects its total net revenues at the second quarter of fiscal 2009,

September 1, 2008 to November 30, 2008, to be in the range of $46 million to $48 million, representing year-over-year growth in the range of 43.1% to 49.3% respectively. This forecast reflects New Oriental’s current and preliminary view which is subject to change. In contrast to the first fiscal quarter, the second fiscal quarter is typically New Oriental’s slowest quarter in terms of student enrollment and revenues as Chinese students go back to full time school, thus leaving less time for supplemental studies and test preparation.

Now I’ll hand the call back to Michael for his final thoughts. Michael.

Michael Yu

Thank you Louis. Well, I would like to conclude with the results on the macro environment. New Oriental has not yet been materially adversely impacted by the global credit crisis, the global economic slowdown or the economic slowdown in China. Considering that food, housing and education are the top three categories for disposable consumer spending in China, and is a parmount priority that Chinese families place on the education of their often only one child, we believe that education Saturday is one of the last areas to be affected when people begin to conserve their discretionary income in an economic downturn.

In view of our leading reputation in China’s education market, families will continue to recognize that as a value their children gain from education far exceeds the dollars spent on the New Oriental courses. So with our strong positioning as the first choice for helping students get ahead in life, we are confident that New Oriental will continue to see strong growth in the months and the years ahead.

Once again, thank you for participating in our quarterly earnings conference call. And at this point, we are glad to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Adele Mao – Susquehanna Financial Group.

Adele Mao – Susquehanna Financial Group

My question is related to the gaokao retake business. Obviously Mingshitang enrollment has ramped up very well over the past quarter. There appear to be some changes related to gaokao coming in China over the next couple years. How do you view these changes will impact the gaokao retake trend in light of the policy changes over the next couple years, whether you see this as an opportunity to further get into acquisitions in different areas?

Michael Yu

There are many to changes [in] gaokao over the next several years, so whether that is the evaluation system is having to change, people are – I want to say that up for the next several years they are not being told to take only one gaokao as their evaluation system. Also they have to take the student’s average scores in their schools and other factors into account. But this change will not affect the business because mainly the gaokao examination, that is the college entrance [examination] will still take I think 80% of the account like in the enrollment.

So the gaokao, that is college entrance examination, will be still very important to these students new enrollment into the universities. The offer is good for us, actually, that the policy is, that the government has repeatedly said that all the public high schools, they cannot use student’s leisure time or weekend to ask a student to stay in school to take more courses. That means students their time will be freed out in the evening or during the weekend. But students are free to take all the private training schools.

So like in Central Province this year, we can see there are more and more high school students coming to our school because the provincial government strictly doing that policy there. They tell the school I’m not allowed to give students lectures or courses during the weekend, so during the weekend they still come to New Oriental.

So my idea is to make changes here. I think the first change is not better, although it’s not so advantageous to New Oriental, but the second is really good for New Oriental. So I look upon gaokao as good business like in future time.

But still there are so many still, like at least around 50 students of high school students who were not to have any chance to go to university to study every year. And the strange thing is that some of the four also getting enrolled by universities. But a university, not an important university that we say a famous university in China, that they quit going to university. And they stay in gaokao school to study for another year so that they will have a good chance to go to famous universities.

Adele Mao – Susquehanna Financial Group

Just related to that was 2,700 student enrollment in gakao retake right now, what’s your revenue expectation for this year? And if there’s a goal you want to reach over the next 12 months? I guess in next school year, fiscal 2010?

Louis Hsieh

Yes Adele of the 2,700, approximately 1,100 are really full time boarding students. The other 1,600 are [inaudible] or short term students, just like U-Can students. So really our total enrollments for U-Can are about 16,500 for the quarter. As far as revenue from Mingshitang we haven’t disclosed that separately yet because we only own 60% of the company. So we haven’t disclosed that publicly yet.

Michael Yu

Yes, we have three places have gaokao school now. One is in Beijing, the other is in [Tauchen] province, the other is in [Chenan] province. And so all these schools are running pretty good these days. And there are still students coming to the school. And mostly we enroll students at the gaokao school and they stay here for almost a year until next year, when after they take the final college entrance examination.

In these three cities we are – I think we are doing pretty well. And in the encounter school, we also have them in with other students there, right?

Louis Hsieh

Well we will in the spring, because the art students don’t come in until the spring.

Michael Yu

Almost nearly that, plus nowadays it’s almost 1,500 now, over 1,500 now. One year students and the half a year students combined. So we are doing pretty good. But, well, just like Louis said we have a lot of exposure on the radio. Because they’re obviously staying there.

Louis Hsieh

The other thing is, Adele, they’re also going to be recruiting students in short term training, just like U-Can does. And so the revenue is changing every quarter.

Michael Yu

Week by week actually.

Louis Hsieh

There’s a lot about Mingshitang, because it’s a private company and we only own 60%, we’re not authorized to disclose yet.

Operator

Your next question comes from Catherine Leung – Citigroup.

Catherine Leung – Citigroup

My question is on the margins. Can you please update us on the margin outlook for the remainder of the year? And related to this, could you please quantify for us the impact from the incremental costs related to the Olympics and the investments and the new initiatives?

Louis Hsieh

I think on the margin question, even the class size, the dramatic fall in class size on average even surprised us. So I think our gross margins were down about 0.8% to 67.5%. I think at this point we are going to revise our margin guidance to probably flat gross margin year-over-year. We’re still going to shoot for 100 basis points improvement in gross margins. And we are hoping to hold or slightly improve the non-GAAP EBIT margins.

The margins below that are going to be impacted by a higher tax rate and also by the fact of the stock based compensation, as well as lower interest income from the deposits we have as interest rates have started to fall, as about a year ago at this time. So I think those margins then distort but they negatively impact our net margins. So that’s why we asked the analysts and investors to look at the true measure which will be non-GAAP operating margins for us, if that’s a more realistic indication of our profitability.

As far as quantifying the effects of the summer, the revenue impact you have at about $4 million. The cost impact – it’s hard to break out separately the cost items. But it’s safe to say that the additional costs of the Beijing Olympics is probably north of $10 million RMB in additional expenses.

Catherine Leung – Citigroup

And I know you can’t disclose the Mingshitang but the incremental costs for the new initiatives? The investments? For example, headcount or marketing costs for U-Can?

Louis Hsieh

Yes. The U-Can is not broken out separately but U-Can also will be over $1 million U.S. dollars. U-Can has about 340 teachers now and the average class size is about 30. So it’s losing money. But because it’s part of the integral schools, all the costs can’t be broken out separately because there’s the classroom rentals, etc. So we don’t have that. But in general, U-Can is losing money. The bilingual kindergartens are still losing money. Mingshitang actually lost money for the quarter.

But it will make money the next three quarters because it incurred a large marketing expense during the summer to recruit students. And the students will start classes in September, so it actually come into revenue and profitability in Q2, Q3 and Q4. This is very counter-seasonal to our current business. And so Mingshitang had a negative impact on net income of over

$0.5 million U.S. dollars for the quarter, but it will make it up in the next few quarters.

The other ones we don’t break them out separately as far as the kindergarten and North Star and the kindergartens have also lost money for the quarter.

Operator

Your next question comes from Scott Schneeberger – Oppenheimer & Co.

Scott Schneeberger – Oppenheimer & Co.

What type of robustness do you anticipate in pricing? Obviously we’ve seen a little bit of slowdown in the economy, somewhat insulated environment, though, that you operate in with education. Do you see any pressure from that with regard to pricing? And do you think that you’ll be able to continue to outpace it? With the margin guidance it sounds like you think you should, but just a little more color on pricing. Thanks.

Louis Hsieh

I think pricing for the quarter, the average day is P&RB terms, was up over 18%. So it seems like we have been able to hold our pricing. But part of that 18% is really due to the shift to smaller classes as we have been disclosing each quarter. So in U.S. dollar terms, prices were up about 30% year-over-year. We evaluate price every quarter, so we don’t expect the prices to fall and we evaluate price increases each quarter.

But at this point, as Michael mentioned earlier, we don’t expect any dramatic changes in our current pricing policy, for sure on the down side and most likely we’ll continue to raise prices. For like to like, about 10 to 12% a year.

Scott Schneeberger – Oppenheimer & Co.

Your capacity utilization of your new school build-outs, could you elaborate a little bit on that and your opportunity there?

Louis Hsieh

Our new schools are doing quite well. I mean the capacity – it takes about three years to sort of fill up a school, three to four years. So we have plenty of capacity, certainly in the new schools. And the learning centers usually take at least two years to fill up. So right now is we’re not capacity constrained at all. The reason we keep opening up learning centers is to get incremental revenue from families who don’t want to travel too far to take their students to class. So that’s the main reason that we’re opening up more learning centers.

Capacity has never been an issue. It only becomes an issue is really during the summer time. And it’s mostly in Beijing and Shanghai.

Michael Yu

Yes, that’s why we committed this year to actually open up many new learning centers, more than 60 actually for the whole year. We have to get prepared for the future. Where we made that is the parents don’t want to send the kids too far away places. They drive there and as the traffic jams, it takes too much time. And another reason other language schools are opening up and that they have lots of different schools in different areas. That will help with a lot of the day to day. These schools will become the pocket for parents to choose.

Even as their teaching qualities not as high as New Oriental’s but their location is convenient, so that’s why we have to open up so many new learning centers even though we have to spend ahead of time lots of money. We’ve got to prepare for the next two to three years so that we will have a strong competitive position.

Scott Schneeberger – Oppenheimer & Co.

And 40 to 50 is still the plan for the year of New Oriental learning centers in schools?

Michael Yu

Yes. Well for the next year maybe another 40. And the good thing is that every new learning center is opening and the students are coming and we actually need new teachers and new employees there. That’s why also we spend lots on human resources here at New Oriental, but also training people to get experience to open the learning centers actually. That’s why we have to – in China we have what’s called the basic plan that is in 3-D, you know. Something like that. You have a place there, then people will come. If you don’t have a place there, people will not come.

Louis Hsieh

It’s a U.S. expression, “If you build it, they’ll come.”

Operator

Your next question comes from Brandon Dobell – William Blair & Company, LLC.

Brandon Dobell – William Blair & Company, LLC

If you look at the smaller class size trends, does that give you an opportunity to do and kind of reconfigure some of the learning centers in some of the schools and do more classes at the same time? Or is it just you’re still kind of stuck with the same physical class sizes, physical class layouts, those kinds of things at your facilities?

Louis Hsieh

Well one thing Brandon is that the number of big classes has not decreased. It’s actually increased. It’s just that the number of small classes is increasing faster. And that’s primarily due actually to kids English. So you know kids enrollment as you saw in the quarter increased 55% year-over-year. So we had 97,000 pop kids enrollment this quarter versus I think it was like 62,000 from the year before. And you know kids classes have a maximum of 25 students. So it’s not like we’re reconfiguring old schools. We still need the big classrooms.

But overseas enrollment and English enrollment still were way up. So those classes remain intact. But the newer learning centers are having more smaller classes as you would expect as you follow the market trend.

Brandon Dobell – William Blair & Company, LLC

On the teacher side of the business, a couple of quarters ago we talked a lot about teacher’s salaries and the costs going up. I would imagine you don’t see those kind of pressures now with the economy. As you go towards either more kids classes or having a greater portion of smaller class sizes, is it a different kind of teacher? Do you have a different opportunity? Or a different risk there with finding those teachers? Or how do you think about the impact on your teacher training, all those kind of things as those smaller class sizes ramp up?

Michael Yu

Traditionally we have two kinds of teachers. One is the teacher for big classes and their salaries relative to compare is higher than those teachers who are teaching smaller classes, like the kids English classes. This is the New Oriental system here, that these two cannot teach if they do not compare with each other. Like our kids English classes, the teachers they get them up to a salary, plus they are hourly salary, which is very low. But in the big class teachers they only get hourly salary, they don’t get monthly salary. So that’s different.

We don’t have – we don’t want to have great pressure on the teacher training side of it, because we have a very good system of training teachers nowadays. And also even though there’s a financial crunch, it makes people have lower expectations. But our teachers still expect they can at least maintain the same salary going forward. So normally speaking we are pretty normal here in teachers training.

Louis Hsieh

Yes, if you think of the smaller class sizes in terms of kids English driving it, then the price you have to pay in salary to kids English teachers is significantly lower than to the rest of our teachers. I think that’s the key point. Yes, I think overall, Brandon, kids English teachers are easier to find and train than the test prep teachers. And so I think it actually bodes well for us that the kids business is doing well. And I want to make a point that the kids English business is highly profitable. It still has gross margins of 52 and it’s a full class over 67% with 25 students.

So we will continue to do this business. It’s highly profitable. It’s just not as profitable as the one teacher with 100 students in the overseas test prep class.

I think for the quarter we added a net of 900 teachers in Q1 in our seasonally biggest quarter. And so we’re still having success hiring teachers. As Michael said they actually get paid less than the overseas [inaudible], therefore teaching costs have not been under pressure as they were in the February quarter last year.

Brandon Dobell – William Blair & Company, LLC

As you look out the next six to 12 months, maybe give us a sense of some of the milestones within gaokao that you are looking for. We talked a little bit about the changes in the test going forward. But as you try and measure your own progress, is there – working with the different centers to get those programs implemented, perhaps rolling out new subjects, how should we think about that landscape, that horizon the next six or 12 months for you?

Louis Hsieh

Well I think as we have an internal target of about 40 to 50,000 U-Can enrollments in the first fiscal year, so starting June 1. So we’re very well on our way with 15,000 enrollments. We have another 1,600 from Mingshitang alone. And they’ll also contribute in the fourth quarter with additional short term programs. So I think we’re well on our way.

As Michael mentioned earlier, where we plan to be in over 30 cities by the year end and over the next nine months or so, and so progress remains good but we will still lose money in that business the first year. It takes us three years to sort of build business where it’s scaling and highly profitable.

Michael Yu

Yes, the program will become mature while we are gaining experience over this year and the students are actually bringing new interest into it, because we have never opened like Math class or a Physics class before. But over this summer we have 15,000 students coming to our school. And then we hired some of our experienced high school teachers and also we trained some of our own teachers. So the teachers training system is becoming mature. So looking ahead I think at the end of this fiscal year, this program will become one of the strong points in New Oriental, one of the strong business leaders in New Oriental’s sharp training business.

Brandon Dobell – William Blair & Company, LLC

Final one for you, Louis, the foreign exchange rate that you guys used for the first quarter and Q2 guidance as well as the balance sheet for this quarter?

Louis Hsieh

The one for the Q2 guidance as well as the income statement was 6.8594 RMB for the U.S. dollar. For the balance sheet it was 6.8252 RMB for the U.S. dollar.

Operator

Your next question comes from Mark Marostica – Piper Jaffray.

Mark Marostica – Piper Jaffray

Going back to the comment, Michael, that you made in regards to the economic sensitivity of the business which given the demand for education in China should be modest, I would think. But you know looking at the overall business from a geographic perspective, are there any regions or cities within China that you perhaps might argue are more economically sensitive than others? And give us a sense of your exposure there.

Michael Yu

Not really I can calculate for geographic because it is special for vacation areas. I know we are going to actually another two new provinces next quarter, like in [Qingdao] province and Chengdu province New Oriental is going to open two new schools there actually. Because even though, while there is some negative impact on Chinese economy wholly speaking, Chinese people have their tradition of saving for 20 years times 30 years salary as deposit for their kids education.

So most of the families in China if they have kids then they have saved enough money to readily to spend it for their kids, even though they are not making any new money here. So they have enough money for their kids, usually speaking. So it’s the middle classes.

Louis Hsieh

And Mark as Michael mentioned we have not seen the slowdown yet. The two worst performing schools in the last quarter was Beijing school and Shijiazhuang school which happened to be in the same location as the Beijing Olympics. The rest of the country performed exceptionally well.

Michael Yu

Our Shijiazhuang school was closed for a whole month because for the security reason. We complying with government policy.

Louis Hsieh

Other than that, if we looked across the regions New Oriental is in, all regions report very strong growth in all the schools with the exception of those two. And those have a good reason.

Mark Marostica – Piper Jaffray

And then in regards to the tax rate, did you also give us some color on how the tax rate should behave in the quarters to come? And then tied to that, an update on your high tech status application would be helpful. Thanks.

Louis Hsieh

Our tax rate we withheld at 12.3% for the quarter and we’ll do that for the rest of the year. The high tech or emerging market thing, we have several entities that have that and the new regulations have come out. We will apply for them next year. They run out in October of next year for now. So I have no comment on whether we will or will not get it.

Mark Marostica – Piper Jaffray

So from the standpoint of modeling purposes, we should be looking at a 12.3% tax rate for the duration of this year, and into next year when we think about fiscal 2010 can you give us an idea if you didn’t get the high tech approval, what the tax rate would be?

Louis Hsieh

It would be in the high teens.

Mark Marostica – Piper Jaffray

And do you know when you’ll find out?

Louis Hsieh

We should find out at the end of this fiscal year. So hopefully by May or June.

Operator

Your next question comes from James Mitchell – Goldman Sachs.

James Mitchell – Goldman Sachs

When I look at the guidance revenue growth for next quarter, you seem to be guiding for slightly faster rate of growth than you historically guided for. Should I read that as the $4 million of foregone revenue around the Olympics as being delayed three months?

Louis Hsieh

I think most of that will actually come, James, in Q3 during the winter quarter. The reason we’re guiding higher is because we have been criticized for guiding low in the past, so this is a – we’re really not holding back this time. This is what we think we’re going to do. I just think in this kind of environment we should just guide what we think we’re going to do. We got tired of the headlines saying “New Oriental Beat the Street, but Guides Too Low Consensus”.

Michael Yu

Most of that I think we can do during this quarter so that’s a good number, I think.

Louis Hsieh

And this is sort of no holding back.

Operator

Your next question comes from Chenyi Lu – Brean Murray Carret & Co.

Chenyi Lu – Brean Murray Carret & Co.

I have a question regarding your acquisition strategy going forward. Do you still focus on the gaokao area?

Louis Hsieh

We’ll continue to look at gaokao. I think that we’ve made two acquisitions in this phase now and there are a lot of other sectors that are quite attractive. So we’ll continue to integrate and learn from the gaokao area, use it as a springboard to grow our U-Can business. But then also looking at other sectors.

I think we’ll continue to look at gaokao schools but we want to see how those two integrate first. We’re also looking at the same sort of large competitors in large cities and also we will continue to look at business lines that we’re not in yet that we think are lucrative and will position New Oriental better for the future. So at the same time we’ll look at domain knowledge we don’t have. We’ll look at large competitors in large cities. And we’ll continue to look at the gaokao area as a specific focus.

Michael Yu

Yes, we are getting an amount of knowledge from these two acquisitions and actually we are opening gaokao classes in our own schools which costs us less money actually.

Chenyi Lu – Brean Murray Carret & Co.

And then regarding the marketing expense, I know this quarter during the summer you spent a lot of money to promote the schools in Beijing. I just want to get a feeling of what’s going forward? Do you still going to spend a higher level in the way that you also want to promote gaokao area?

Louis Hsieh

Yes I think the marketing expense in the future will be more focused on the newer businesses so will be mostly in gaokao. And also in some tests that we want to gain market share in, so like the [gialto] or other exams that we’re being aggressive on currently. But we don’t spend a lot of money in marketing our current programs.You know, the older programs.

Michael Yu

Yes, we don’t have to actually. Thinking school is in a very special period you know because of the Olympic Games. We have to spend money all over China to tell people that we are still opening classes in Beijing because everybody think that we have closed down school in Beijing during Olympic time.

So we bought almost $8 million RMB to tell people all over China, having advertising in newspaper telling them that we are opening schools here. So that’s a very special period. Mostly for the next quarter and the winter quarter we are going to spend money on new businesses, to attract business here.

Chenyi Lu – Brean Murray Carret & Co.

So that means we’ll go back to a normal level that your guidance costs paid in the past, right?

Michael Yu

Yes, somehow we expect that.

Louis Hsieh

Also some of our new businesses spent a lot. I mean, Mingshitang spent a lot in advertising along with us, that they’re part of New Oriental now. And that’s why you saw the direct benefit of enrollment in the boarding school growing from 790 a year ago to 1,100. And also 1,600 short term training students they never got before.

Chenyi Lu – Brean Murray Carret & Co.

And then one last question is during your last conference call you said that you expect for you can to achieve $5 million revenue in 2009? Is that still the case?

Louis Hsieh

Yes that’s the case because the 15,000 enrollment that came in this first quarter the average ASP’s $122 U.S. So we’re already well on our way. If we hit 50,000 at $122 we’ll be over

$6 million revenue.

Operator

Your next question comes from Marisa Ho – Credit Suisse.

Marisa Ho – Credit Suisse

Looking at the deferred revenue you had at the end of the first quarter, the $42.6 million U.S. dollars, it looks like it’s proportionately high in number compared to what we’ve seen in previous years. Is it mainly because that’s some of the parents in Shijiazhuang that decided not to put the kids through the summer school and now deferring to the winter term? Or is it because of any disruption from the Olympics and similar type of deferral?

And when you say that you’re expecting to launch the recaptured $4 million loss of revenue in Beijing, have you actually collected these in terms of enrollment or are you just expecting that these parents will come back at some future point?

Louis Hsieh

The first question on deferred revenue, Marisa, revenue will grow each year at this time because Yangzhou school is increasing their enrollment so we collect a lot of money because the students will pay for four months in advance. So that’s part of the build up.

The second part is also as you said, due to the Olympic Games and the Shijiazhuang school closing some of those students have deferred into Q2 and into Q3. And as far as the Beijing issue regarding the $4 million we have seen a pick up in Beijing in this quarter and we believe that will continue into Q3.

If you look at our growth rate for the quarter, it’s impressive at 47% almost. But it’s down from the last two quarters where we grew I think it’s 52% and 62% respectively. So the trend actually went down and there’s no reason it should of, other than the Olympic Games itself.

Marisa Ho – Credit Suisse

Also have you issued any new guidance on your share-based compensation for the remainder of FY 2009?

Louis Hsieh

I can give it now I think as we expect the share-based compensation to be $4.1 million in Q2 of ’09, probably $4.2 or $4.3 million in Q3 of ’09. That’s partially due to the expected RMB appreciation versus a year ago. And then in Q4 it should drop. So it should drop to around

$4 million, $3.9 to $4 million. And then the rest of it will depend on any share options that are granted next year, the next 12 months. But we don’t expect that amount to go up too much. It should be around $3.5 to $4 million going forward.

The ’06 options will expire in January into Q3 so they’ll fall in the fourth quarter. And then the ’07 options will expire next year. We will grab some options but they won’t be to the level that they have been in the past. So it’s share-based compensation is percent of revenue it’s percent of profit will begin to decline starting in Q4 of this year.

Operator

Your next question comes from [Traer Urdan] – Signal Hill.

Traer Urdan – Signal Hill

Louis I know you mentioned that you’ve not seen any effective economic slowdown. I’m wondering how you think about each of the different lines of business and whether you think any one area might be more or less sensitive to any kind of economic slowdown? And then maybe just as a follow up I’m wondering if you all know what percentage of your revenue comes directly from parents savings versus from their sort of current income, if you have a sense of that?

Louis Hsieh

We don’t have a sense of the second one but I think as far as the first one we have not seen a slowdown in our business. I think if there is a strong economic slowdown in China where we’ll first see it will be in the adult education area. So adults English. I don’t believe families, unless they absolutely have to, will skimp on their children’s education and saving for their children’s education.

You can see that in the numbers, right? I mean kids enrollment still grew 55% and revenue grew 80%, over 80% again in the quarter. And overseas test prep which is what you would expect to decline in historically hard times. Those are big ticket items. And the children, if they’re successful, they’re going to pay a lot. Actually enrollments went up 24% and revenue up 56% year-over-year.

So in the areas that you would expect, especially overseas test prep, we saw not a decrease at all. And that’s despite Beijing being slow. Beijing enrollment for overseas test prep was actually down year-over-year. And that was unusual. But the overall enrollment was around 24%. That’s why we have confidence that Beijing will bounce back in Q3 especially during the winter.

Michael Yu

I was afraid that the overseas study and preparation tests will go because of the financial crisis. But actually this number is coming up. The last two weekends there was exhibition international exhibition here in Beijing and the more than 20,000 students who go there and applied for American and the great schools there. More than 600 universities all over the world coming to China to enroll students, to find qualified students. So actually there are more students that are trying to go abroad to because of the financial crisis.

I think it’s time to get best opportunity to study is they don’t have any job here for them to work. But there are different areas I know – my friend was working in financial training area, he said the students is coming down because of financial crisis because he perceives that there’s not much job opportunity in the financial areas for the next two or three years.

Louis Hsieh

The enrollments in overseas test prep for the quarter were over 65,600. And that’s up from 52,000 a year before. So in the most sort of high ticket area, we are still seeing significant growth.

Operator

We are now approaching the end of the conference call. I will now turn the call over to New Oriental’s Chief Executive Officer, Michael Yu for his closing remarks.

Michael Yu

Thanks everybody for your nice questions. And anyway we will try our best to make New Oriental a better company and make New Oriental a trustable company and if you have any further questions please do not hesitate to contact Louis or me or our Senior Investor Relations Manager, Sisi Zhao. Thank you. Thanks a lot.

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