Noah Education Holdings, Ltd. F3Q10 (Qtr End 03/31/2010) Earnings Call Transcript

| About: Noah Education (NED)

Noah Education Holdings, Ltd. (NYSE:NED)

F3Q10 (Qtr End 03/31/2010) Earnings Call

May 13, 2010 8:00 a.m. ET


Dong Xu - Chairman and CEO

Jerry He - EVP and CFO

Dora Li - VP of Finance, Controller


Ella Ji - Oppenheimer

Ingrid Yin - Brean Murray


Welcome to the Noah Education third quarter fiscal year 2010 financial results conference call. (Operator Instructions)

Joining the conference today are Mr. Dong Xu, Chairman and CEO; Mr. Jerry He, CFO and Executive Vice President; and Ms. Dora Li, Vice President of Finance, Controller.

After the U.S. markets closed yesterday, Noah issued a press release announcing its third quarter fiscal year 2010 financial results. The release is available on the company's IR homepage at along with the presentation for today's call. This call is also being broadcast live over the Internet.

Before management's presentation, I would like to refer to the Safe Harbor statement in connection with today's conference call. This call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including certain expectations and goals, which are subject to numerous assumptions and risks. Forward-looking statements involve known and unknown risks and uncertainties, many of which are beyond our control, which may cause actual results to differ materially from any future results or achievements implied by such forward-looking statements.

The company's actual results may differ materially from those contained in the Risk Factors section of the company's final prospectus or recent filings filed with the Securities and Exchange Commission. Unless required by law, the company undertakes no obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

I would now like to turn the call over to Noah's Chairman and CEO, Mr. Dong Xu.

Dong Xu

[Interpreted] Good morning, and to some, good evening. Thank you for joining us today for our third quarter 2010 results conference call.

As you would have seen from our earnings release, we delivered another quarter of healthy growth, with revenues increasing 18.3% year-over-year, gross profit up 9.5% and net income climbing 4.9%. This growth was mainly supported by more than 100% growth in our kids learning device sales and a strong performance by our Little New Star school system.

Although total net revenue for the quarter did not reach our initially guided range, our business remains very healthy and we are pleased to have expanded our track record of delivering consistent growth. We remain confident in our long-term opportunities and potential and believe our ongoing strategic initiative will help us maintain our growth trajectory.

As we approach the end of our 2010 fiscal year, I am pleased with our progress on both the operational and the financial front. In recent quarters, we have taken clear steps to expand our business both organically and equivocally.

Within our ELP business, we have introduced a customer-focused product development and marketing strategy through which we remain arduously focused on developing products that will successfully meet the design, functionality and content needs of our customers. We are confident this strategy will allow us to remain competitive and maintain ELP revenue growth.

In addition to our focus on maintaining growth in our ELP business, we remain committed to accelerating acquisitive growth within China's education services space as evidenced this quarter by the acquisition of Wentai Education. We view education services as our main growth driver going forward, and will continue to actively pursue accretive acquisitions within this segment.

These assets have aided us in growing both our top and bottom lines, and I am confident in our ability to deliver continued growth going forward.

With that, I will now turn the call over to Dora to walk you through our financial performance for the quarter.

Dora Li

Thank you, Chairman. We continue to see healthy growth in the third quarter, supported largely by an impressive rise in KLD sales and complemented by growth in our education service segment.

As noted on slide 3, net revenue totaled RMB253.7 million, up 18.3% from the third quarter of fiscal 2009. As our chairman just mentioned, although revenue was below our initial guidance, we are still encouraged by the year-over-year growth rate we attained across our top and bottom line.

Jerry will share with you in just a few minutes our unique strategy and the opportunities we are faced with, that will support future growth.

Our ELP business maintained stable growth during the quarter. Taking a closer look at our ELP business, as shown on slide 4, the 27% year-over-year decline in DLD revenues was more than offset by a 100.7% increase in KLD sales and to a lesser extent a 5.4% increase in E-dictionaries.

Our Kid Learning Devices remain a primary catalyst for growth, and our recently launched device has perfectly captured customers across a range of spending habits. We believe there remain ample opportunities to further expand our presence in this space. To help further expand KLD sales and to stabilize DLD revenue, our R&D efforts going forward will be heavily focused on developing products based on our customers' needs and requests.

This customer-focused approach will help ensure the success of each new product launch.

Slide 5 offers a breakdown of our revenues for this quarter. Our ELP business contributed RMB243 million, up 13.3% from last year. Little New Star contributed RMB10.7 million, which was at the top end of our guidance range, demonstrating how Little New Star is complementing our ELP revenue growth.

From the table on slide 5, we can see that we have achieved constant growth during the past few quarters, with a weighted average growth rate for the last 12 months of 17.8% for revenue and 53.6% for operating income.

Moving to slide 6, our gross profit grew 9.5% year-over-year to RMB124.3 million, representing a gross margin of 49%, compared to 52.9% the year before. This margin pressure continues to be a result of our product mix (shipping) more heavily towards lower priced KLDs, a trend which will continue in the coming quarters.

Moving to slide 7, our ongoing efforts on streamlining costs successfully led to a revenue growth, outpacing growth in expenses. Operating expenses as a percentage of revenue fell to 42.9% compared to 44.7% in the third quarter of fiscal 2009 due to improved efficiencies. This is especially impressive as R&D and sales and marketing expenses also increased.

R&D expenses grew 19.6% as we strive to strengthen our content development capabilities and stay at the forefront of China's interactive education market. Sales and marketing expenses also grew 12% from the same period last year as we increased marketing content surrounding new product launches.

On slide 8, we have extrapolated some key items from our income statement. The company reported net income of RMB36 million, or $5.3 million for the first quarter of fiscal 2010. Basic earnings per share and diluted earnings per share were RMB0.94 and RMB0.92 respectively for the quarter. This compares with net income in the third quarter of fiscal 2009 of RMB34.1 million and basic and diluted earnings per share of RMB0.96 and RMB0.95respectively.

As slide 9 shows, we remain well-funded and fundamentally strong with cash, cash equivalents, short-term bank deposits and short-term investments of RMB714 million as of March 31, 2010. This compares with cash and cash equivalents, short-term bank deposits and investments of RMB800.3 million as of December 31, 2009.

This capitalization provides us with sufficient resources to accomplish our objectives to gain back organic growth and strength (vide) strategic acquisitions.

Now I will turn the call over to Jerry, who will talk about our strategy and operational programs in a bit more detail.

Jerry He

Thank you. As Dora and the Chairman mentioned, this quarter growth we seen our ELP business continue to stem from our rapidly growing KLD products, which more than doubled in value over the third quarter of fiscal 2009.

It is important to note that while revenue grew more than 100%, our volume of KLD products increased 70.9%, indicating that our higher priced devices, including the device just introduced to the market in the third quarter are successfully gaining traction in the market.

These new premium products are a result of our customer-focused product development and marketing strategy, which is summarized on slide 10, as well as strong interactive content.

While our KLDs continued to progress nicely, DLD revenue fell 27% year-over-year, and the sales volumes declined 26.3% due mainly to some softness in market demand. To help stabilize DLD revenue levels going forward, the company will employ a heavily customer-focused development approach in order to introduce products that are aligned with the preference of its target customer base.

Our ELP business was boosted by a 5.4% increase in E-dictionary sales, which stem from original design manufacturing request from our partners. The growth in our E-dictionary business was (aided) not only by the launch of a high-end model, but also from increased volume of ODM contracts.

In addition to growth within the year of good business, our partnership that was strengthening that (content to) publishers, which we completed in March, will provide us with several other distinct advantages over our 21% of stake not only gives us the potential to earn substantial investment income that's added into this quarter, but also serves as a base for ongoing collaborative efforts.

We are looking forward to having exclusive sponsorship of Franklin's SpellEvent, utilizing their extensive distribution channels and joining force on the R&D front. We are confident our relationship with this globally recognized brand will increase Noah's brand recognition and would be the source of renewable opportunities in the future.

Within our education services business, we are continuing to see a solid contribution from Little New Star. As slide 11 shows, our efforts to enhance the Little New Star brand name resulted in the number of franchised schools growing from 700 last quarter to 724 as of March 31, 2010. And we plan to continue proactively to expand this Little New Star network by addition of franchise schools.

During the third fiscal quarter, we made sound progress on our Dudu Happy Reading Program, which is a premium English language training program for kids aged three to six. We plan to roll-out this program to additional kindergartens in the coming quarters.

I'm pleased to say that we remain on track to deliver 30% growth in top-line for Little New Star. However, looking further ahead, we will remain focused on maintaining growth in our ELP business, while accelerating acquisitive growth within education services space.

We recently took another important step along our path to expanding our position within China's education services space. In March, we reached a definitive agreement to purchase 70% of interest in Wentai Education, and manage and operate of schools for students aged three to 18 for RMB126 million.

Wentai currently manages and operates six kindergartens and four schools in China, and its reputation for academic excellence and rigorous curriculums make it an attractive offering for many families in China that have placed top priority on giving their children the best education available.

There are robust growth prospects for Wentai's unique business model, and this acquisition will provide the company with the funds necessary to accelerate its expansion plans and to capitalize on its market demand and opportunity, in addition to the immediate earnings accretion.

This acquisition will provide us with additional means to tap our interactive content services, further strengthening our R&D approach. This deal is also finished (inaudible) is evidence of our execution ability and a proactive approach to expanding our education services business.

The acquisition is on track to close by June 1, and I look forward to providing you with more details about the deal and our integration plan at that time. We have a strong acquisition pipeline for fiscal year 2011.

Slide 12 shows our guidance for the next quarter and the remainder of the fiscal year. For the fourth fiscal quarter of 2010, we anticipate the total revenues to be in the range of RMB129 million to RMB135 million, representing 8.3% to 13.4% of year-over-year growth. Within this range, the ELP portion of our business should contribute approximately RMB121 million to RMB126 million, with Little New Star making up the remaining RMB8 million to RMB9 million.

This guidance reflects our visibility into current market demand for our ELP product within the industry. We also expect basic earnings per share in the fourth fiscal quarter to be about RMB0.1 to RMB0.17.

In light of this outlook for the fourth quarter, we have updated our full fiscal year revenue guidance to RMB776 million to RMB782 million and our basic earnings per share guidance to RMB2.43 to RMB2.50. Although this range is lower than our original guidance, it still represents a healthy growth rate. And furthermore, our long-term outlook and the confidence remains unchanged.

It also affords us the opportunity to drive value for our shareholders, as we announced yesterday that our Board had authorized a share repurchase program for up to US$10 million of ADS over in that year. This program reflects our confidence in our long-term outlook and the valuation potential.

In summary, as the Chairman mentioned, we view education services as our main growth driver going forward, and we remain committed to accelerating of our accretive growth within this segment of our business. We also are committed to assembling a strong portfolio of products to meet the evolving preference of ELP customers. With a solid strategy and a sufficient funding to keep investing in our growth, I believe we are well positioned to capitalize on market opportunities.

Dora and I, we're now happy to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Ella Ji with Oppenheimer.

Ella Ji - Oppenheimer

I have a few questions about your margins. Your 4Q guidance suggests a mid to low net income margins. And I guess you have set the interchange of your distributing channels. How much have you set in your guidance and will that impact your cash production from your (progressive) sales channel or is there any difference in your agreement with the new distributors?

Jerry He

Actually we lowered our Q4 guidance mostly because based on whatever we have now from Q3, even though the new product we introduced performed well, but below our original expectation. So we think it is prudent to be conservative around the guidance for the fourth quarter; therefore, we lowered our forecast.

We would start to realign our distribution channel; however, it should be positive in the long run, but the magnitude of the impact for this quarter, we have not had very precise estimate of that. But we expect that to be minimal or modest.

Ella Ji - Oppenheimer

Okay. So you cannot give us the percentage of the impact, like how much of the percentage impact there will be in the fourth quarter?

Jerry He

No, not at this point, because we are still in the process of talking to the existing distributors and the potential new distributors. Is really a case by case process; it's very hard to gauge how big of an impact it will be. And if we (implement) our plans, there should be very little impact.

Ella Ji - Oppenheimer

Just another follow-up question; you said maybe conservative about 4Q's guidance, and is there any changes on the market you foresee, the demand for business? Is that part of the reason?

Jerry He

If you look at our guidance, compared to last year, we still (our share) have a growth. Just take a moment to look at our Q3 numbers; yes, we missed our guidance, but we still grew our revenue by 18.3%. The fourth quarter is a slow season. We don't continue to sell what we have been selling in the last quarter.

So based on what we know for Q3, our original target for our products were too high. As we think, given we are selling pretty much the same (price) in Q4, it's (prudently) lower than expectation as well.

Ella Ji - Oppenheimer

So you said next quarter is the slow season, but in my understanding summer is the peak season.

Jerry He

If you look at our history, Q1 and Q3, which are the two quarters when the school start their semesters, has to be the hard season. So if you talk about our June quarter, historically has been a slow season. Say July to September quarter will be our high season.

Ella Ji - Oppenheimer

Talking about the summer peak season, and in addition to the new distributor channels is there anything you're prepared for the season, or what's your expectation for the competition on the market, and do you remain comfortable with your 15% organic growth?

Jerry He

So now you're alluding to the first quarter of fiscal 2011, which we haven't given our guidance yet. We will give our guidance for the full year on next quarterly earnings call that means approximately three months from now. So at this point of time, we are not able to give out numbers yet. But in terms of strategy going forward, our strategy is to maintain (inaudible) growth in ELP business, but the focus would be accelerating the pace of acquisition in education services business.

Ella Ji - Oppenheimer

Just regarding for ELP business, I understand you introduced another higher priced for KLD device. What's your thought the average price for each category will be; trend down or lower for the next quarter in 2011?

Jerry He

Again, for 2011 we haven't given out the guidance yet, which we will talk about next quarter. But for Q4, we expect overall our DLD is going to remain relatively flat. Dictionary is also going to remain relatively flat. KLD, which we experienced a huge growth year-over-year this quarter, we don't think we're going to repeat that next quarter just like we did in Q2 during slow seasons. Growth for DLDs in not going to be as high. Your question was about ASP, our expectation is not going to change dramatically from Q3.

Ella Ji - Oppenheimer

And I will switch to the services. How much growth do you expect for the Little New Star and Wentai for the next quarter or the next year?

Jerry He

For the next quarter, Little New Star, we gave out guidance eight million to nine million. Because we haven't given out the number before the acquisition yet, but we gave out the revenue number for the whole year, before the acquisition, that was approximately RMB 29 million.

For fiscal 2010, I think Little New Star is on track to achieve 30% of revenue growth. That's going to be at least within the 38 million to 39 million range for next quarter, from what we can see right now, because we have relatively higher visibility on the education services business. We are on track to achieve that. Wentai, the deal has not closed yet; even for Q4, is on track to close by June 1. So for Q4, we're really talking about a one month.

So for sure, we don't get some revenue and net income for that one month, but it's not going to be material.

Ella Ji - Oppenheimer

And how about Wentai for the next year?

Jerry He

It seems the deal has not closed, so we are not at liberty to talk about that yet, and we will definitely update you once the deal has closed, and for sure next earnings call.

Ella Ji - Oppenheimer

What’s your projection for R&D expenses as percentage of revenue? I understand you’re putting in a lot of effort on the new product development. The percentage of revenue will be going up?

Jerry He

Percentage of revenue would not go up. Going forward, for our ELP business, we want to maintain healthy growth. That also means we do not expect that business to grow aggressively. So our focus is going to be on optimizing efficiency and making sure that all the products we introduced, have done enough homework and have done enough market research to meet market demand.

So instead of necessarily investing more money, we are increase the efficiency of those R&D efforts. So to that end, potentially we will reduce the number of products we are going to introduce to the market, while making sure those products are better received in the marketplace.

So in short, overall we do not expect R&D as a percentage of revenue would go up.

Ella Ji - Oppenheimer

My last question; could you give us a little bit more color about your M&A pipeline?

Jerry He

As you know, we can’t really talk about specific deals, but I can tell you that our pipeline is very strong, and we hope we will have more deal to complete in fiscal 2011 and exceeding our original 10% target. We will update you while the timing is more appropriate.


(Operator Instructions) Your next question comes from the line of Ingrid Yin with Brean Murray.

Ingrid Yin - Brean Murray

I have a question on Little New Star. You mentioned the q-over-q growth rate for this segment is 30%. Do you expect that growth rate to continue, and what is the margin for this business?

Jerry He

Actually the 30% is not q-over-q; it's fiscal year-over-fiscal year as a whole, not q-over-q. Going forward, I think 30%, in our view, is not a sustainable growth for a long period of time. The growth margin you ask is about 50% to 60% for this business.

Ingrid Yin - Brean Murray

What about the net margin?

Jerry He

Net margin is about 25% or so. That's after-tax and everything.

Ingrid Yin - Brean Murray

So just to follow up, if you think 30% is not sustainable, what is the more realistic sustainable growth rate for this?

Jerry He

That I probably would leave to next quarter earnings call, when we will give out the full guidance for fiscal '11.

Ingrid Yin - Brean Murray

Okay. So you mentioned earlier that KLD business will increase, although it's probably not going to be a 100%; DLD will be flat. So if that's the case, should we expect like a margin for the ELP business going down in the future quarters and future coming years?

Jerry He

For the coming years, I don't think that would be the case. But for the coming quarter, we'll have higher visibility. If you look at our margin over the last few quarters, it has been stabilizing, since the percentage of revenue for our KLD increasing over time, therefore our margin declined year-over-year.

For example, for Q3, we went from 72.9% last year to 49% this year because of the mix. However, you can only go as low as what's the lower end would be. In our case, the DLD typically is about 55% of sales gross margin. And for KLD, it's somewhere around the 45% or so.

If you put those together, it's very hard to get it below 45%, because the lower end is 45%. So we think the overall gross margin for ELP business would stabilize around where it is today; however, if you add in education service business, which has a higher growth margin, as a percentage of education service business, revenue will go up. Overall gross margin for the company, we expect actually might slightly go up.

Ingrid Yin - Brean Murray

I also noticed for the quarter, the operating efficiency has been improved and the operating expense actually comes down. Do you expect that kind of trend going forward?

Jerry He

Yes, actually that's a bigger part of our strategy going forward. I mentioned earlier that our goal is to maintain healthy growth in ELP by accelerating the pace in the acquisition.

So for an ELP business, we are trying to make that part of the business lean and mean. So one part of that strategy will be to actually reduce the costs to make it more efficient. So we should expect the operating efficiency higher going forward as the expense part of it would actually go down going forward.


(Operator instructions) And there are no further questions in the queue at this time. I would now like to turn the call over to Mr. Jerry He, CFO and Executive Vice President, for closing remarks.

Jerry He

All right, thank you very much for joining us. We look forward to seeing you again next time. Have a great day. Bye.


Ladies and gentlemen, this concludes the presentation. Thank you for your participation and you may now disconnect. Have a great day.

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