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Noah Education Holdings, Ltd. (NYSE:NED)

Q1 2011 Earnings Call

November 16, 2010 7:30 AM ET

Executives

Dong Xu – Chairman and CEO

Jerry He – CFO and Executive Vice President

Dora Li – VP, Finance and Controller

Analysts

Ella Ji – Oppenheimer

Operator

Welcome to Noah Education First Quarter Fiscal 2011 Financial Results Conference Call. At this time all participants are in listen-only mode. Following management's prepared remarks there will be a Q&A session. As a reminder, this conference is being recorded.

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

After the U.S. markets closed yesterday afternoon, Noah issued a press release announcing its first quarter fiscal year 2011 financial results. The release is available on the company's IR Web page at www.ir.noahedu.com.cn, 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 the connection with today's conference call. This call may contain forward-looking statements within the meaning of the Private Securities Litigation and 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 could 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. Sir, please go ahead.

Dong Xu

Good morning and to some good evening. Thank you for joining us today for our first quarter fiscal 2011 results conference call. We also reached a significant milestone within our educations services business. At the end of July, as we finalized our acquisition of a 70% stake in Wentai Education and further extended our footprint into this very attractive industry in China.

Our newly acquired interest in Wentai, not only demonstrates our ability to execute on our objective for accretive growth, but is an important strategic move as Wentai unique business model and reputation for academic excellence of a robust growth prospect. As we see a growing demand in China for top quality private education, this niche market is largely untapped, thus providing Wentai with an ideal setting for rapid expansion.

At the Little New Star, we will continue to add franchises in each quarter and this business remains untracked to meet our growth targets for 2011. With Little New Star and Wentai, we already have two very reputable and rapidly expanding education services brands under a Noah umbrella. So we are dedicated to pursuing additional targets for strategic acquisitions that will complement our existing entities and create additional [endurance] to the very attractive education services space in China.

We are complacent of the challenges we face in our ELP business and we believe we have implemented the appropriate remedial measures to recover our business. We are building strong relationships with our distributors, particularly those with the most timely payment record, releasing our inventory levels and executing on our cost savings initiatives to more effectively compete in an increasingly material and penetrated industry. We continue to employ a customer-focused approach to maximizing returns from our ELP product portfolio.

Overall, we initiated our fiscal year 2011 by proactively addressing the challenges we think. The initiatives and strategic imperatives we have implemented, firmly places on the road to recovery. Though there remains much work to do, we are focused on rebuilding our health channels, maintaining healthy inventory levels and accounts receivables and streamlining our cost-based and optimizing resources deployment in higher growth segments. Our management team is committed to accelerating organic and accretive growth within our educations services base.

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. As you’ve seen from release, net revenue in the first quarter declined 46.5% year-over-year to RMB127.3 million, in line with our initial guidance, as we rebut our distribution network and recover sales in our core business, ELP sales or RMB107.6 million down 52.2% from the first quarter of fiscal 2010.

DLD revenue declined 25.8% to RMB62.6 million and the KLD revenue was down 73.7% year-over-year to RMB27.9 million. Both of these segments were impacted by pressing pressure and declining sales volume in light of the toughening competitive landscape and ongoing disruption from our channel realignment initiatives.

As we continue to actively stabilized and restore growth to our ELP business, we are also focused on building up our education service offering, which we will as a more profitable and sustainable long-term business. As you can see on slide 5, revenues from education services grew by more than 51.5% year-over-year to about RMB20 million during the quarter, in line with our strategic decisions to accelerate the growth from this segment.

Little New Star accounted for RMB 11.6 million of education services revenue this quarter, with the remaining RMB8.1 million coming from two-month contribution from Wentai Education since the completion of acquisition on July 29, 2010.

Little New Star revenue was down year-over-year due to the increase in VAT, coupled with a decline in supply changing material. However, the franchise continues to expand and we believe this business remains healthy and will positioned for future growth.

Turning to next slide. Our gross profit in the first quarter was RMB47.6 million, compared to RMB117.5 million in first quarter of fiscal 2010. Gross margins for the quarter was 37.3%, compared to 49.3% in the first quarter of fiscal 2010.

With the decline driven by lower averaging selling price, across the ELP business as well as our decisions to offload old inventory at discounted prices in order to maintain appropriate inventory levels. We anticipate a similar level of gross margin next quarter as we continue to execute our risk decision.

Total operating percentage in the quarter decreased 13% to around RMB[85.4] million as we continue to streamline our cost structure, rationalize our sales and the marketing spending and optimize efficiency of resources to investment critical to maintain our competitiveness in the market.

Our sales and marketing expenses decreased by 14.7% but partially offset by increase in R&D and G&A expenses. R&D expenses were up 21.1% due to -- rises in recruitment costs, outsourced software development and content development contracts though we did benefit from reduced rental and the travel expenses.

G&A expenses were up more than 76% year-over-year as we wrote off RMD 6.9 million in bad debt. We are committed and remain on track to deliver our anticipated RMD 20 million in cost savings over the course of fiscal 2011 and Jerry will update you on the progress of this initiative in a few minutes. Nett loss for the quarter was RMD 21.9 million or RMB[3.58] per basic under diluted share compared to net income of RMD 37.8 million in year ago period.

As we continue along the recovery of [Prozac] we remain fundamentally sound with a solid balance sheet, ample cash (inaudible) cash and cash equivalent, short term bank deposits and investment of RMD 538.3 million as of September 30, 2010. This compares with cash and cash equivalent, short tem bank deposits and an investment of RMD 572.2 million as of June 30, 2010. This capital affords the financial flexibility to execute our strategic imperative of driving organic and acquisitive growth in the education service base well ensuring ongoing stabilization and restoration of ELP business.

That completes our financial review. I will now turn the call over to Jerry who will talk about our strategy and operational progress in a bit more detail.

Jerry He

Thank you, Dora. On slide 9, as Dora as our chairman mentioned, this quarter we made a progress in recovering our ELP business and that we continue to adhere to our strategy of making -- of taking a very customer-focus approach to R&D and sales and marketing. We believe this approach will allow us to operate relevant features, content and services at appropriate price points through our various targeted demographics leveraging our deep market knowledge.

We are also strategically optimizing our number of models in order to minimize cannibalization and to maximize revenue and profit for each design. In response to users revolving preferences for sleek modern designs this quarter we introduced the NP2300, a high-end DLD featuring a flat touch screen. This product was launched in late August and has been well received thus far.

Given our history of NE50 continues to perform well within the KLD segment we have made a strategic decision not to introduce any new products in this segment in the first half of this fiscal year. The goal of this decision is to optimize the performance the NE350 and not apply any further pricing pressure on an already competitive market. As we work to optimize our portfolio of devices and reduce inventory levels, we are also committed to strengthening our sales channels and in developing strong relationships with our distributors.

We are making progress on this front. And the ELP sales showed a marked improvement on a substantial basis as we strengthened this channels we are placing particular importance on cultivating the closest relationships with the distributors that have a strong track record for on-time payments. So we are still in the initial phase of recovering process. We are pleased with our progress and are confident in our ability to stabilize our ELP business.

On slide 10 (inaudible) the recovery of our ELP business one of our main strategic imperatives is the expansion of our footprint in the educations services space. This resilient and highly visible industry is rapidly growing and yet largely fragment in China, and therefore we see a significant opportunity to capitalize on this favorable dynamics. This quarter we further built our Little New Star Network with the addition of 14 newly franchise schools. There are now a total of 739 franchise in the (inaudible) schools and to the Little New Star brand and we will continue to expand each of these schools going forward.

Our Dudu Happy Reading Program is performing very well, and again in traction. As you can see despite the impact from VAT and a decline in supply of (inaudible) that Dora mentioned that this business remains fundamentally strong with robust growth prospects.

On slide 11, adding to our educational services revenue Wentai Education made a solid year contribution in the final two months of the first quarter following the closing of the deal in which we acquired a 70% interest in a entity. Wentai Education now possesses the capital necessary to accelerate its growth and expanding its number of managed and operated schools.

Wentai focuses on collaborating with real estate developers and local authorities to built schools that are -- for a integrated part of residential planning and developments. Wentai opened a new kindergarten this past September and revenue contributions from this school will be recognized in the next quarter.

In addition, there are two other kindergartens currently under conversion. This locations are slated to open in the first half of calendar 2011 meaning we will see accelerated growth of Wentai’s topline in the second half of our fiscal year. As you can see, the Wentai education has only been a part of new offers for several months.

The company has to be a robust pipeline and it’s were on its way to accelerating growth and to providing and increase in a meaningful contribution to our revenue base. We remain confident that Wentai’s vigorous curriculum and reputation for educational excellence will give rise to significant demand that will fuel business propulsion and drive long-term growth. In addition the Wentai acquisition enriches (inaudible) management experience in the education services segment.

Turning to slide 12, in addition to our efforts to drive revenue growth we are diligently focused on executing on cost of savings initiative that we outlined last quarter. We were to achieve our target of RMB20 million in cost savings this fiscal year.

The sales will be reached by streamlining costs under tighter cost control as well as making selective headcount reductions across various departments within the organization.

We will commence this headcount reductions in the second quarter which will result in a one-time (inaudible) however following this past we will beginning realizing cost savings from this action starting in the second half of this fiscal year as work to streamline our spending we also aim to optimize our cost structure and ensure resources appropriately aligned (inaudible) within the area of business that were the highest gross going forward. As we work to strengthen and to restore the business we are now nevertheless committed to our shareholders and continue to repurchase shares in the open market through our share buyback program. As of September 30, 2010 we had repurchase 936,677 ADS under open market at an average price of $3.38 (inaudible) a total consideration of $3.4 million.

On slide 13 based on our current estimate and market conditions we expect to generate net revenues in the range of RMB73.5 millions or $11 million through RMB80.5 million or $12 million for the second quarter of fiscal 2011 which includes RMB55 million to RMB61 million funded legacy ELP business, RMB18.5 million to 19.5 million from Education Services. Basic loss per share in the second quarter of fiscal 2011 are expected to be in the range of RMB0.59 to RMB0.67 or U.S. $0.009 to U.S. $0.10.

This concludes our presentation. Now, Mr. Xu, Dora and I will now be happy to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Ella Ji from Oppenheimer. Please proceed.

Ella Ji – Oppenheimer

Thank you, and good evening. My first question is, with -- for your ELP business. How long do you think it will take you to return the business back to normal? And could you comment on call where are your risk that you will continue to focus on?

Jerry He

Hi, Ella. This is Jerry. How are you?

Ella Ji – Oppenheimer

Hi. How are you?

Jerry He

Your first question, when we expect to stabilize the ELP business. The fact is, I guess, normal level. We expect the business to be stabilized by the end of this calendar year which means the end of second fiscal quarter. However, the normal may be a new normal, which means it would be lower than where we were before our channel realignment, not just because of the impact of the China realignment but also because the overall our industry trend.

The second question is about our focus. It’s actually two fourth, the first one is on the ELP side. Our priorities changed. The number one priority, actually in the ELP business is reduction in cash burn or conserving our cash and also at the same time, manage the account receivable and inventory to a more healthy level.

And overall, our focus has been shifted to Education Service business with the acquisition of one-time closing of deal, we see the contribution in revenue and profit contribution from the education service business and also for both Little New Star and Wentai, they are on track to growth for the bottom-line for the next fiscal year.

We are also actively working on new -- seeking new acquisition targets. We are -- again, we are pleased to report we have a very strong pipeline in Education Service business.

Ella Ji – Oppenheimer

Okay. Just a follow up on, so you said the ELP business will be at a lower level than you know, than before. So you know, how much percentage should we expect? And I know that you also owe the manufacturers but do you need to cut down your R&D and staff and also, you know, other related staff are relating to this business.

Jerry He

The first part of your question, the new normal is lower than where we were. It’s really hard to give you exact number, but we plan to for the industry go down by about 30%. So the second part…

Ella Ji – Oppenheimer

Sorry. So are they are in volume or in total revenue.

Jerry He

In revenue.

Ella Ji – Oppenheimer

Okay.

Jerry He

The second part is about the cost of reduction that’s actually across the entire organization other than, I guess, other than Little New Star and the Wentai Education because it runs separately. For our ELP business, we are going to have head accounts in R&D, in sales, in back office and pretty much in all departments.

Ella Ji – Oppenheimer

Got it. Okay. And for (inaudible) your Little New Star business, I noticed, I got -- actually its revenue is lower year-over-year in this quarter. Could you explain on that?

Jerry He

Sure. I think, I have probably explained a little bit about that and there are two major factors, one is the VAT tax. It was about 3% last year and this year, it’s 17%. So it’s a 14% increase in tax. Therefore, a 14% decrease in net revenue, that’s one contributor if you could add it back compare apples-to-apples. We should add it that 14% of that.

And second factor, the major factor is the -- is actually (inaudible) related to the ELP business. Because the last year, we sold about RMB700,000 KLD in Little New Star and this year, I think, we recognized it about a little bit over 100,000 or so. So that’s down about RMB600,000 or so. And if you take those two factors down, it’s very close to what we were last year.

Ella Ji – Oppenheimer

Okay. Just on the VAT tax upfront, I saw this is a tax, on top of your price, in Chinese, we say (inaudible). So I thought it wouldn’t really impact much of your revenue on the book because as you said, the revenue on the book will be your net revenue?

Jerry He

I’ll give you an example. Because last year we have this small enterprise VAT tax rate which means 3%, if we have sales of $117, we take $3 out, we would keep $114 as net revenue and this year we only keep $100 as net revenue because we are going to pay $17 in VAT tax. So if you have the same amount sales before tax we are going to have $14 less in net revenue this year.

Ella Ji – Oppenheimer

Got it. Then going forward will you consider transfer this higher tax rate to your sales amount?

Jerry He

We will do reasonable tax management but I think some this because the size of the business is different. So small enterprise tax we are not going to be no longer enjoy that but we can manage tax so that we have higher profit and lower tax units.

Ella Ji – Oppenheimer

Okay. And so, within your guidance for the education services sector for next quarter, could you break down Little New Star and Wentai?

Jerry He

Sure. For Little New Star we are looking at about RMB6.5 million to RMB7, for Wentai its RMB12 to RMB12.5 in Wentai.

Ella Ji – Oppenheimer

Okay. Great. And within Wentai, could you provide us some colors in terms of the tuition rates you are able to enjoy and also what type of organic growth shall we expect to going forward?

Jerry He

For Wentai the tuition right now because of different components of the cash receivable we have. We only recognize – for example, we – given a combination, the first part would be, what we call tuition we charge somewhere from RMB10,000 to RMB12,000 per year varies by different schools and also for Wentai kindergarten I think the high rates we charge is about close to RMB3,000 per month per student, so its very dramatic about our average somewhere between RMB10 to RMB12,000 per year.

That’s tuition. But there are other cash we receive from the students. For example, like the food, we don’t recognize those as revenue, we just take them but we expenses as we buy – prepare food for the students. So majority of our revenue in the school are tuition and there is a small component of boarding expenses.

Ella Ji – Oppenheimer

Got it. And then will you able to raise your tuition price or?

Jerry He

We are able to – if you look at a lifecycle of a school is actually have different phases and the first phase is maximizes (inaudible) or meaning you just need all as many student as possible, let’s say, you have the capacity of 300 students of a kindergarten, the first goal is actually to reach full capacity. So in that case we normally do not raise tuition actually on other hand we typically have a discount price to attract students.

Once you reach full capacity then and typically after two or three years, we work on the quality and the – and that time because long waiting list for the student getting our course and then that present us and are going to raise prices.

Typically we do that but in this case we should be able to do that, we are upon to do some price increase to second half of the fiscal year and also the next fiscal.

Ella Ji – Oppenheimer

Okay. And for those kindergartens that in the pipeline could you just give us some colors in terms of their revenue side?

Jerry He

So revenue side when they reach full capacity typically it’s about RMB3 million per unit. But it depends on the location and the surrounding communities it may take one to three years, depends.

Ella Ji – Oppenheimer

Okay. And then switching gears to the margins, will there be anymore bad debt write-off or inventory and inventory write-down going forward or do you seeing you already cleaned your balance sheet?

Jerry He

We do expect additional bad debt write-offs next quarter, which we factored in our guidance. And for inventory because if you look at our inventories, its level is not very high, so the re-inventory write-off may not be listed.

Ella Ji – Oppenheimer

Okay. And for the RMB20 million costs receiving when should we expect them to benefit your margins, in which quarter?

Jerry He

We should expect that in the third fiscal quarter.

Ella Ji – Oppenheimer

Okay. Okay. Great. Thank you very much for taking my questions.

Jerry He

Thank you.

Operator

(Operator Instructions) At this time, there are no further questions. I would now like to turn the conference over to Mr. Jerry He for closing remarks.

Jerry He

Thank you very much for joining us today. I look forward to meeting you next time. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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