New Oriental Education F1Q10 (Qtr End 8/31/09) Earnings Call Transcript

Oct.20.09 | About: New Oriental (EDU)

New Oriental Education & Tech. Group Inc (NYSE:EDU)

F1Q10 Earnings Call

October 20, 2009 8:00 am ET

Executives

Courtney Shike - Brunswick Group

Michael Yu - Chairman, Chief Executive Officer

Louis T. Hsieh - President, Chief Financial Officer, Director

Analysts

Catherine Leung - Citigroup

James Mitchell - Goldman Sachs

Amy Junker - Robert W. Baird

Jeff Lee - Signal Hill

Mark M. Marostica - Piper Jaffray

Richard Ji - Morgan Stanley

Ming Zhao - SIG

Paul Keung - Oppenheimer

Mariso Ho - Credit Suisse

Adele L. Mao - OLP Global

Operator

Good evening and thank you for standing by for New Oriental's first fiscal quarter 2010 earnings conference call. (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.

Courtney Shike

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 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 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 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 investor.neworiental.org.

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

Michael Yu

Thank you, Courtney. Hello, everyone and thanks for joining us today. It is hard to believe that at the end of the first fiscal quarter 2010 marked 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 a multitude of New Oriental courses during the two-month break. True to form, strong total enrolment growth in the first fiscal quarter of 18.7% drove revenue growth up to 26.3%, bringing total net revenue to approximately $149.4 million. In particular, our three key growth segments performed well, with kid’s English up to 34.1%, middle and high school English and all subject training up to 18.2%, and overseas test preparation, 14% enrolment. This is especially impressive given that enrolments 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 school and learning centers to 287 across our nationwide network.

While we are pleased with our first fiscal quarter results, we estimate that the H1N1 flue pandemic negatively impacted our top line growth [to 24%]. That’s 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-enrol themselves or their children as a safeguard against them 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 enrolments, especially in our larger classes. We also saw a record number of cancellations and a deferments from registered students this summer as applicable local health regulations required us to temporarily close or cancel classes and summer camps whenever an enrolment student contacted 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, set up 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, many pharmaceutical companies in China have been granted the license to produce the H1N1 vaccine in China, and with over 60 million [inaudible] scheduled for release in the coming months, the government expects to have a reserve of 100 million doses by the end of this year.

School-aged children and teachers, along with healthcare providers, should receive top priority in vaccine distribution. In Beijing, the local government announces that primary and middle school students should have the option to receive the vaccine out of their schools starting tomorrow, October 21st -- in most cases at a low cost to 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 aged 6 to 18. The new program offers one-on-one or small sized classes, like up to five students tutoring class in all subject classes, required for both the [inaudible] and [inaudible] middle school entrance examination and high school entrance examination, China’s national college and high school examinations.

As you all know, we launched our very successful [You Can] all subjects training program back in January 2008, which to date has had over 90,000 enrolments and is one of our strongest performing segments. This new customized learning program is designed to complement You Can, creating a two-pronged strategy of both larger, more affordable classes and smaller, more targeted classes for school-aged students. With over 190 million children aged 6 to 18, China’s after-school training market is now a multi-billion dollar industry. We are very excited about the opportunity that [inaudible] has in after-school tutoring 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 $25 million in revenue in fiscal year 2010 from this newly expanded offering of all subjects training, including You Can, our new customized learning programs.

Of course, the costs associated with the rollout of this new program in Q1 impacted our bottom line this year, with increased expenses for marketing, remodeling, all the 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 31, 2009 and Q2 ending November 30, 2009 of this 2010 fiscal year.

We expect to be ready for the peak season for this market, which occurs from January to June, since [inaudible] is given in June and the [inaudible] 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 private equity funds since New Oriental’s IPO in 2006. To illustrate, in the four-year period from 2002 and 2005, less than $80 million was invested in private education sector in China, including private [inaudible], about more than $20 million invested into New Oriental in 2004.

In the subsequent four years from 2006 to 2009, however, total investment in the sector rose to approximately $600 million, primarily going to the education companies in the larger cities such as Beijing, Shanghai, Guangzhou, [inaudible], and Shenzhen. While we are seeing more resilience from certain competitors in these cities as they seek to build a brand through large 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 offer for high quality content and course offerings covering the educational needs of China’s students throughout their lifetime. We will, however, not take these formidable competitors lightly and will continue to spend on marketing, especially for the newer programs like POP kids, You Can, in order to stay in the forefront of parents’ and students’ minds.

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

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

Louis T. Hsieh

Thank you, Michael and welcome to all of you on the call today. Please note that certain figures I will refer to 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 $149.4 million, representing a 26.3% increase year over year. Net revenue from educational programs and services in the first fiscal quarter were $142.4 million, representing a 28.1% increase year over year. The growth was mainly driven by the increase in the number of student enrolments in language training and test preparation courses.

GAAP operating costs and expenses for the quarter was $88.4 million, a 27.4% increase year over year. Non-GAAP operating costs and expenses for the quarter were $84.7 million, a 29.3% increase year over year. Costs of revenues increased by 23.8% year over year to $47.7 million, primarily due to the increased number of courses and a greater number of schools and learning centers in operation.

Selling and marketing expenses increased by 57.3% year over year to $15.5 million, 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 $25.3 million. Non-GAAP general and administrative expenses were $21.8 million, a 25% decrease year over year, primarily due to increased headcount as the company expanded the 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 $3.7 million through the first quarter of fiscal year 2010 from $2.9 million in the same period of the year-ago period.

GAAP income from operations was $60.9 million for the quarter, a 24.7% increase from $48.9 million in the same period of fiscal year 2009 and non-GAAP income from operations throughout the quarter was $64.6 million compared to $52.7 million 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, You Can, and the launch of New Oriental’s customized learning program for middle and high school kids.

GAAP net income for the quarter was $57.1 million, representing a 27.1% increase from the same period in the prior fiscal year. Basic and diluted earnings per ADS was $1.52 and $1.47 respectively.

Non-GAAP net income was $60.8 million, representing a 24.6% increase from the same period in 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 $5.2 million, which was primarily used to add a net of 17 new learning centers during the quarter.

As of August 31, 2009, New Oriental had cash and cash equivalents of $238.7 million, as compared to $254.8 million as of May 31, 2009. In addition, the company has $129 million in term deposits at the end of the quarter. Net operating cash flow for the first quarter of fiscal year 2010 was approximately $61.2 million.

The deferred revenue balance at the end of the first quarter of fiscal year 2010 was $57.9 million, an increase of 36.2%, as compared to the $42.6 million at the end of first quarter of fiscal year 2009. Deferred revenue, where students enroll in April 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 in the second quarter of fiscal year 2010, September 1 2009 to November 30 2009, to be in the range of $60.8 million to $62.8 million, representing year-over-year growth in the range of 23% to 27% respectively. We expect our student enrolment 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 U.S. dollars and our operating currency is RMB, we have benefited from currency translation gains during periods when the RMB appreciates against the U.S. dollar. In the last several quarters, when the RMB consistently appreciated against the U.S. dollar [inaudible], our revenue growth for financial reporting purposes benefited from such appreciation. But given the current trend for the past 12 months, the RMB/U.S. 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.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Catherine Leung from Citigroup.

Catherine Leung - Citigroup

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 because of your having a fixed cost business model or were there some other factors? And sorry, I have a follow-up question related to the 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? Thank you.

Michael Yu

Actually, Catherine, we didn’t expect swine flu to have so great an influence before but during the summer time, some of our school classes were stopped because students got the swine flu and some of the parents, they cancelled the classes from New Oriental schools, or deferred their students’ registration to the winter time.

We didn’t expect the swine flu to have a great influence in the winter time for two reasons -- one is that the vaccine has been already spread out in China, so everybody can get a vaccine, especially school students. The other is that usually during the winter time, the swine flu is not active.

Louis T. Hsieh

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 enrolment and in revenues. So for instance, Guangzhou, Shenzhen, other cities like [inaudible], [Harping], [inaudible], all these cities where the health authorities asked schools to shut down whenever there was a case 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 if 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, we are 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 in -- starting 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 as far as changing our plans, it won't change our rollout plans as far as learning centers. What will change is because of the customized learning program that Michael discussed in his speech, we will be adding more smaller learnings centers. So the learning centers will go from -- we were planning to have 60 last year -- two quarters ago in the guidance. We will 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 but did we get it, Catherine?

Catherine Leung - Citigroup

-- very helpful, thank you.

Michael Yu

Yeah, actually from the deferred revenue, we can see that the deferred revenue has increased 36.2. That means some of the students who [inaudible] deferring their registration to the winter time.

Louis T. Hsieh

Right. And it also had a significant impact on our summer camps, right? Because 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, you know, the [inaudible]. 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 cancelled their registration and another 100 more who were planning to register chose not to because they didn’t want to go into North America, because the swine flu was even -- it was more widespread.

Catherine Leung - Citigroup

Okay, I see. Thank you.

Operator

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

James Mitchell - Goldman Sachs

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?

Michael Yu

Actually, we spent an extra of about RMB20 million in POP kids and You Can and customized one-on-one tutoring for the first quarter of this year.

Louis T. Hsieh

That’s right, yeah, so last year we spent $9.5 million in marketing in the summer -- this year we spent $15.5 million. The original budget was for about $12 million, so we exceeded that budget by over $3 million.

James Mitchell - Goldman Sachs

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

Michael Yu

It’s marketing around new courses because we do not step our speed to go into this new market and other competitors who occupy the market and this 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] the investors.

Louis T. Hsieh

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

James Mitchell - Goldman Sachs

Okay.

Louis T. Hsieh

But you are right thought -- 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 pre-marketing now in Q1 and Q2 in the fall and in the summer in order to prepare for the winter and in the spring.

Michael Yu

James, we are not only spending money on the marketing -- we are spending -- remodeling the learning centers, so opening the 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 to take examinations, we will see that the numbers go up.

James Mitchell - Goldman Sachs

Thank you.

Operator

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

Amy Junker - Robert W. Baird

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 has been trending and how that impacts your margins and where you expect you can come in for the year at this point?

Louis T. Hsieh

Yeah, 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 with the -- because of the 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 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, but -- so the overall price increases ended up being 9.1% in RMB terms, 9.5% in U.S. 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 towards small classes. So we have to move into smaller classes. The market is trending that way.

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

Amy Junker - Robert W. Baird

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

Louis T. Hsieh

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 having -- being affected by the -- you know, the number of infections is escalating in China, so I want to see when that stabilizes and then I’ll have a better answer for you.

Amy Junker - Robert W. Baird

Okay, and then just a quick follow-up -- do you have -- if you said it, I missed it but what the currency translation rate you used for the quarter?

Louis T. Hsieh

It’s 6.83-something and I’ll get that for you in a minute.

Amy Junker - Robert W. Baird

Okay. Thank you.

Michael Yu

It’s almost keeping flat for the --

Michael Yu

Yeah, it’s almost flat for the whole year.

Amy Junker - Robert W. Baird

Okay, great. I’ll pass it on. Thanks.

Operator

(Operator Instructions) Your next question comes from the line of Jeff Lee from Signal Hill.

Louis T. Hsieh

Jeff, before you ask your question, I want to give Amy her answer -- on the P&L, we used 6.8325 as the RMB exchange rate to the U.S. dollar. For the balance sheet, we used 6.8299 for Q1.

Jeff Lee - Signal Hill

I wanted to hear more about the new [inaudible] tutoring program, maybe talk about the impetus behind it, how the margins compare for it, and then of the expected revenue in the $25 million you talked about for You Can, what portion is expected for the new tutoring offering?

Louis T. Hsieh

The impetus for the program is that that’s where the market is going, so 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 were 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 are buying Mercedes and BMWs, so the one-on-one and one-on-three, one-on-four offerings. So that’s where the market is headed.

There’s still people who want to be in the big classes because they can’t afford the small classes, so our impetus for opening the small classes is we are following the market and we are leading 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 towards 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, the one-on-one tutoring. It will be somewhere around 50% gross margins, but the net margins are quite high. When learning centers [inaudible], 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 are going to price at the market. But I think over time, we will 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 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 You Can, the non-English subjects, we had about 57,000 enrolments in that area. It contributed about $7 million in revenue. You Can should almost double this year to about 80,000 to 90,000 enrolments and so it should contribute about $10 million or $11 million, which means that we expect this one-on-one tutoring business to also contribute another $10 million or $12 million to reach the $25 million target.

Jeff Lee - Signal Hill

Okay, great. Thank you very much.

Operator

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

Mark M. Marostica - Piper Jaffray

It’s actually Mark [inaudible] Marostica -- just to 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.

Louis T. Hsieh

Good question, Mark. We don’t have the rates but we know that the cancellation started, they’ve 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.

Michael Yu

At the Guangzhou school, all the summer camps got cancelled.

Louis T. Hsieh

Yeah, they were cancelled by order of the --

Michael Yu

Of the government.

Louis T. Hsieh

By the government, so 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 8, 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 You Can and the middle and high school and the kids business.

Mark M. Marostica - Piper Jaffray

Okay, so -- so does your guidance for Q1 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 on that?

Louis T. Hsieh

If the flu vaccine is rolled out as scheduled, it should subside in November and this is similar to what -- except SARS never had a vaccine. This is similar to what happened to us with Sars in 2003, right? So the two big risks to New Oriental business the last 16 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 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 are hoping for.

Michael Yu

That’s what we are hoping for, yes.

Mark M. Marostica - Piper Jaffray

Okay, very good. Thank you.

Operator

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

Richard Ji - Morgan Stanley

Obviously this quarter, one of the big initiatives is again the small class -- can you shed a little more light on the profitability profile for the small class relative to your big class, and especially as you pointed out, the small class tends to be teacher intensive and also you probably need more classroom space for these smaller sized classes. But on the other hand, you can charge -- on the other hand, obviously you can charge a high price and so going forward, how should we look at it?

Michael Yu

Actually like you said, Chinese parents are choosing more smaller classes, even one-on-one classes because they want the kids to have more intensive attention so that their kids can get a high score in order to pass the examinations to go to better universities or to go to better high school. So that’s why we are remodeling our existing learning centers already because usually, before our existing learning centers is a 100-student classroom, or even 200-student classroom. Now we are remodeling our classrooms into like from five student classrooms to 40 student classrooms, even one-on-one classrooms. So while remodeling the classrooms, we can have students, if they want to study in smaller classrooms, then they pay much higher, even 10 times higher than in big classrooms.

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

Louis T. Hsieh

Richard, to give you an idea, a typical class of 20 to 50 students, they will pay about 200 U.S. dollars per enrolment, $150 to $200. 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.

Michael Yu

Yeah, as you mentioned, the teacher problem -- actually, the teacher is another problem because in big classrooms, like 200 or more classrooms, students sitting there, we need a speaker, a really powerful speaker to become a teacher, like an Obama speaking to the audience, you know? But in a small classroom, the teacher only needs their skills and 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 or she only has to pay enough attention to students and answer student questions, correct the students home work, and get connected, you know, relation 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 kinds 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 we have more than 300 teachers trained and it’s much easier to train the big classroom teachers.

Richard Ji - Morgan Stanley

That is very interesting. My related question is regarding the ASP trend and obviously during the quarter, you did not raise price too much for the large class. Going forward, how should we think about that and especially for your small class, which had been just rolled out? Should we expect a higher price increase?

Michael Yu

For the larger classes, because they are -- in our class model, we divide into three; larger classrooms and small-sized classrooms, like 15 students to 40 students, and then the one-on-one classrooms, only one student to five students. For these three models, for larger classrooms like our traditional classrooms, we are not going to increase much every year for the prices. But in my mind, it’s only around 5%, so for this, we only have our influence to have more students coming to New Oriental and take care of those students who are -- some have poor families, they don’t have enough money to pay for New Oriental's smaller classes. So this will be like a 5% increase every year for the -- for bigger classes. But for smaller sized classes and for one-on-one classes, there is no limits for increasing price yet. There is just catering to the parents’ and students’ needs.

Some students would like to pay more to have long hours or even they want to -- if, for example, they want to have a better teacher, they will pay double the money. So it’s interesting that we can -- that’s why we can still keep good margin in these smaller sized classrooms or our one-on-one classes. It’s only because 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 money. That’s the same comparison, I think.

Louis T. Hsieh

Yeah, every -- I mean, the ideal thing is that why we call it a customized, individual sort of customized learning program, if you think about in the [Gaucau], as you know, there’s many subjects, or the [inaudible], right? So the students can pick four subjects. Now, they can come in on -- over a two-day period, Saturday and Sunday. They can go to one class in the morning of five or 10 students, one class in -- they pick math in the morning and they pick English in the afternoon and they pick physics the next day and they may pick Chinese language for the fourth class. They can customize the study program by coordinating their wishes. But if they all pick four small classes, they will us $1,000, $1,000, $1,000, $1,000 -- $4,000 for that one student. So that’s why it’s customized for whatever their individual needs are.

As Michael says, if you think about it, right now there’s 190 million Chinese students between 6 and 18 going to school. Half of them live in -- more than half of them live I big cities -- that’s over 90 million. Most of the research we’ve seen said that 40% to 60% of Chinese students in large cities pay for after-school tutoring classes. That’s about 40 million, 50 million Chinese kids. Most of them will take on average four classes a year. That’s 200 million enrolments.

Michael Yu

Yeah, that’s the problem like at New Oriental -- 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 many Chinese classes, especially the students want to choose smaller size or one-on-one classes, because you cannot have the students with the same ability of mathematics together, 400 and 200 students in one classroom. But English, it’s the same because students start English at the same time and their level is the same, so we can have big classes. But for mathematics, for like physics, chemistry, the students’ level is not the same so we have to have smaller classes to suit the students’ needs.

Richard Ji - Morgan Stanley

That makes sense, very enlightening. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Ming Zhao from SIG.

Ming Zhao - SIG

I wanted to ask a question about the books and others revenue. This quarter it showed a different seasonal trend -- basically it is down quarter over quarter, but it is up in the year-ago quarter, so can you give us some color on that?

Michael Yu

Sure. The reason the other revenue is down is because of the summer camps, so what we discussed is online revenue is up about 50%. Books has been slowing because books isn’t that important to business anyway, but it is up about 15% or so. But the one that really slowed down was the overseas specialty consulting and that’s exactly the summer camps we hit on. Last year we had I think RMB15 million in revenue; this year we had RMB15 million. We expected 30 million, so 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 there is actually more cases of H1N1 than in China. So the main culprit there is the overseas consulting business.

Ming Zhao - SIG

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

Louis T. Hsieh

Well, no -- as I said, in the cities that had the most number of cases of H1N1, cities like Guangzhou, Shenzhen, Shanghai, [inaudible] and others, the number of enrolments 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 affect.

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.

Michael Yu

The reason is that before that national day of China, like the October 1, the government warns all those students do not go outside to public places or to like 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 seems to have relaxed the situation. I mean, they -- a lot of students will 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 lost students who went to anywhere because it’s already after the national day and the celebration is over so even the students have more H1N1 are influenced, recall the image of China in the world, you know?

Ming Zhao - SIG

I just want to clarify -- would you say that the swine flu had a bigger impact on the other revenue or the education services?

Louis T. Hsieh

It had on 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 the -- almost half cancellations and we expected double the revenue that we got from that, so the second half is 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 is going to affect our kids’ English, even though we grew POP kids with 34% this year, it grew 50% last year in enrolment.

Michael Yu

Yeah, we are targeting POP kids to grow 50% also this year but in the summer, we only grew 34% this year but we were expecting actually to grow at least the 45% in the summer. But in the summer because of the H1N1, some of the parents stopped their kids from going to training schools, including New Oriental.

Louis T. Hsieh

And you can see it, right? As the swine flu moves from south to north, we see the gradual trend in the summer where the enrolments begin 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.

Ming Zhao - SIG

Okay, just a follow-up to the new customized program, obviously we saw 3 million plus expenses coming in as the selling and marketing expense this quarter. Do you see more expense hitting the G&A line or cost line because you supposedly need to hire more teachers?

Louis T. Hsieh

Yeah, I think it will be more on the marketing line but we will have to hire more teachers, you are absolutely correct. So we expect to fully spend for the whole year in adding teachers for both the You Can and for the customized learning platform, as well as some of them also overlap with POP kids and others as well, but overall we would expect marketing to probably be about $6 million, $7 million and G&A expenses about $3 million for the whole year.

Michael Yu

Teachers is a large problem because we are going to use more than half of the teachers as our -- on a part-time basis. That means if we have classes, teachers are working. If we don’t have teachers [inaudible]. 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 fees will be increased because we have the training teachers to become New Oriental teachers.

Louis T. Hsieh

You need to think of it as we are trying to be greedy here. We are trying to capture the whole market so we are 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, you know, one-on-one in tutoring. We are trying to capture the whole market here.

Michael Yu

Actually, we are targeting to become a Walmart model in New Oriental, actually -- not like an [expert model].

Operator

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

Paul Keung - Oppenheimer

Listen, we did a lot of work on this non-English You Can type category, like [inaudible], math, and physics and my question is specifically focused on this category. Now we looked at about a dozen schools in Beijing and Shanghai and I can tell you we don’t see any swine flu impact -- I mean, these schools are actually quite packed on the weekends and the week nights, so -- and when I take apart your numbers, it’s also one of the fastest growing categories in your enrolment standpoint in your business, although it is off a small base. My question is how fast can you grow that non-English component of the business from the enrolment perspective? Is the pricing just kind of in the way that you will 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 further?

Paul Keung - Oppenheimer

That’s a good question, Paul. I’ll be honest with you -- well, we grew it from scratch to 55,000 enrolments 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 the category.

The classes are packed in the summer but you know, they are not as packed as they normally are, if that’s hard to believe. You are 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 are 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 the space, it didn’t work out. So Michael made the decision to go it on our own for now.

Michael Yu

Yeah, but the problem is if those [inaudible] want to make acquisitions and they also decided to get the investment and they are trying to go IPO by themselves, because there is so much money flowing into China so everybody is busy getting money, so they don’t think like acquisition is a good way for them to get the money anyway. But that’s why we decided that this year, we really seriously decided we are going to this business by ourselves.

Michael Yu

Yeah, because you’ve done the research, Paul, you know who we are talking about, right? So we have -- I mean, look at the number of private equity investments in China, as Michael highlighted in his talk, right? Between 2002 and 2005, those four years, $80 million flowed into the China private education sector from PE funds and venture capital funds. In the four years since then, with New Oriental's IPO in 2006, that number has gone to $600 million, more than 10 times increase if you strip out the [inaudible] funding in New Oriental in the same number of years.

Michael Yu

We actually -- we created [in large] the training market here in China and so much money coming into China, so we created lots of competitors and especially they are spending money like crazy because before the IPO, they don’t have to consider about their net income. They just want to occupy the market and opening more learning centers, more learnings centers than New Oriental has, so that’s why actually at first, at the beginning, about six months, we only decided to open around 60 new learning centers this year but we see that one of our competitors, they opened like 60 learning centers in a month’s time, so we have to reconsider opening more leaning 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.

Louis T. Hsieh

Not to alarm you guys, but these learning centers are small. They are not very --

Michael Yu

They are very small, yeah.

Louis T. Hsieh

Yeah, they are about $50,000, so they are not -- our capital expenditure budget will not increase. It’s still about $15 million.

Operator

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

Mariso Ho - Credit Suisse

I want to get a better sense of your marketing spending into the remainder of the year. You mentioned for the first fiscal quarter, you over-spent by roughly about $3.5 million and you 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, I mean, are you also trying to reallocate your spending to specific quarters or are we basically looking at kind of like a naked increase for the entire year?

Louis T. Hsieh

Last year we spent $38.7 million 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%, marketing will go up probably 32%, 33% -- last year was about 13% of revenue. This year we expect to go to about 14%. Because of the customized learning platform, we are going to front-load it into the first two quarters but it will 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 will be some left over in Q3 and Q4 but we need to roll out these programs early.

Michael Yu

This is a very crucial year that we roll out these programs. If we are not successful, then our competitor will become bigger, become more competitive than us so that way, if we spend even more money, we can occupy the market, we cannot -- so that is why we have to spend the marketing fee earlier and recruit new teachers early so that we can have a standpoint in this area.

Louis T. Hsieh

So if we did $38.7 million last year, we did $15.5 million in the first quarter this year, you can expect us to be somewhere between $50 million and $54 million in marketing spend for the year. Does that answer your question?

Mariso Ho - Credit Suisse

Yes, thanks but on the margin expansion question earlier, so with the increase in marketing spending for the remainder of the year, we are probably going to be looking at like flat margin for the full year, as a result?

Louis T. Hsieh

Like I said, I always try to get away from gross margin and I look at EBIT margin and you are right, it would probably be somewhere flat. We didn’t expect the heavy impact from H1N1 -- we just didn’t. So things will -- I will be better positioned to give you clarity once this issue subsides, probably early next quarter.

So I think we are trying to maximize the bottom line, right, EPS -- as I said earlier in the call, we expect calendar year 2010 EPS to remain the same, about $2.60 to $2.80 per share for calendar year 2010. That has not changed. The impact will be most -- hopefully will be just this quarter and in Q2, which will end in November 30th. And we’ve accounted for that, hopefully the worst of it, in the forecast we already gave, which is 23% to 27% revenue increase.

Mariso Ho - Credit Suisse

Right, so would it be correct to interpret [inaudible] H1N1 impact as primarily shifting revenue towards your winter quarter and the increased spending in marketing right now should be recouped in the form of higher ASP and also higher enrolment coming from the customized product. Would that be a right interpretation?

Louis T. Hsieh

I think that’s correct but we do lose some revenue permanently, right, which is the summer camp revenue. And also because students have a certain amount of time, right? They would have taken classes every quarter but they lost one quarter, we lost one quarter from them. So you’re right, most of it will flow back into Q3, or at least a substantial percentage but we will lose some permanently. We’ve lost the summer camp revenue permanently. They will never get that summer back.

Mariso Ho - Credit Suisse

That’s great, thanks.

Operator

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

Adele L. Mao - OLP Global

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 additions or it has excluded any center closings?

Louis T. Hsieh

They will be net additions -- 70 to 80 net additions -- they will be smaller, on average, so the net capital expense then will still be about $15 million is what we are projecting.

Adele L. Mao - OLP Global

I see. Now if we take a look at what New Oriental has done in the fiscal year 2009, you guys had net additional 22 schools and learning centers but with 40 openings, new openings, 18 closings in 15 difference cities. Correct me if I’m wrong, it seems that the company is 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 guys may have penetrated within the last couple of years. Could you just help me understand the rational behind center closings and openings?

Michael Yu

Actually, we didn’t close learning centers in second-tier cities, actually. When we close the learning centers in second-tier cities, it is because the location of the centers is not good, so we are opening another new learning center in other parts of the city instead, we don’t close them. So we have never closed -- we have never decreased any learning centers in any city, actually, if New Oriental is there. But we are opening more learning centers in Beijing, Shanghai, Guangzhou, these big cities because there are more needs in here.

Louis T. Hsieh

This is where the customized learning platform is being rolled out, first in Beijing, then Shanghai, then Guangzhou. So in the first year, it’s not going to all 30 cities. The customized learning center, these customized learning programs will be targeted at the larger cities.

Michael Yu

[inaudible] we only close a learning center in any city is because our lease time is up. That means the landlord does not want to lend us anymore, or they want to get their property back or we think that this is not a good location, so we want to find a better location for that learning center.

Adele L. Mao - OLP Global

Okay, so if we see a number of learning centers dropping in fiscal year 2009 -- I mean, for example, like a city of [inaudible], I think there is one less learning center in fiscal year 2009 versus 2008. Is it you guys were consolidating the centers?

Michael Yu

Yeah, that’s mostly the case. [inaudible] consolidated in two.

Adele L. Mao - OLP Global

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

Michael Yu

Yeah, that’s right -- we are targeting to 350 learning centers at the end of this fiscal year because now we have 287 learning centers.

Adele L. Mao - OLP Global

I see. Okay, that’s very helpful. Thank you.

Operator

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.

Michael Yu

Again, thank you very much for joining us today. Even though our numbers do not look so excellent, but we are pretty confident that later for the whole fiscal year, we are confident that we can do a pretty good [inaudible] in new business, I mean the customized learning centers and other things. And I am 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.

Operator

Thank you for your participation in today’s conference call. This concludes the presentation. You may now disconnect. Have a wonderful day.

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