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Noah Education Holdings Ltd. (NYSE:NED)

F1Q2012 Earnings Conference Call

November 18, 2011 8:00 AM ET

Executives

Jerry He – Chief Executive Officer

Dora Li – Chief Financial Officer

Analysts

Ella Ji – Oppenheimer

Kun Tao – ROTH Capital Partners

Operator

Good morning and good evening, ladies and gentlemen. Welcome to Noah Education Holdings Limited First Quarter of Fiscal 2012 Financial Results Conference Call. At this time, all participants are in a 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. Jerry He, CEO; and Ms. Dora Li, CFO. After the U.S. markets closed yesterday afternoon, Noah issued a press release announcing its first quarter of fiscal 2012 financial results. The release is available on the Company's IR website at ir.noaheducation.com along with a 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 could differ materially from those contained in the Risk Factors section of the Company's final 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 conference over to Noah's CFO, Ms. Dora Li. Ms. Li, please go ahead.

Dora Li

Thank you for joining us today on our first quarter fiscal year 2012 earnings conference call. I hope you all have had a chance to read our earnings press release. We are very pleased to report that Noah started the fiscal year 2012 with a strong quarter and accomplished a number of key milestones as guided.

First, revenue, up 74% year-over-year, reached the upper end of our guidance. Second, we executed the expansion plan to open five schools and kindergartens in the quarter. Third, net income turned positive.

Turning to the detailed financial results for the first quarter of fiscal year 2012. As they are available in our earnings release, I would like to highlight a few key financial metrics with you. All numbers will be in RMB unless otherwise stated.

Net revenue for the quarter was up 74% year-over-year. The strong growth was mainly driven by the contribution from Wentai Education, the stable growth of Little New Star, and addition of Yuanbo Education which only started contributing to the top line in August.

For the quarter, Wentai accounted for 47% of net revenue, Little New Star accounted for 41%, and Yuanbo 12%. You can imagine that the ratio will be somewhat different going forward when Yuanbo started to have contribution for the whole quarter.

Gross profit was up 38% year-over-year and the gross margin was 48% compared to 60% during the first quarter of fiscal year 2011. The decline in margin was due to a couple of reasons. First, we added five new schools in Wentai Education, Little New Star, and Yuanbo Education. And second, five out of 17 Yuanbo kindergartens are currently in ramp-up stage with less than two years of operating history.

A kindergarten usually takes two years to break even and improve utilization for a certain level. Therefore, the gross margin during the quarter was impacted as new schools are not profitable yet. But in most cases, our kindergartens over-delivered. And as the new ones continue to ramp up, we are confident that gross margins will normalize at 50% level in the fiscal year.

Looking into detailed operating expenses, research and development expenses are up 26%. R&D accounted for 2% of net revenue compared to 3% during the same period in fiscal 2011.

Sales and marketing expenses for the quarter are up 49% year-over-year. Sales and marketing expenses accounted for 4% of net revenue compared to 5% during the same period in fiscal year 2011. The increase mainly reflected Little New Star's advertising spending used in promoting the brand. We expect the sales and marketing expenses, as a percentage to revenue, to maintain at a lower level in fiscal year 2012.

General and administrative expenses are up 57% year-over-year, mainly due to the incremental expenses from Yuanbo Education. There was also an RMB1.3 million one-time expenses for relocation of headquarters and the cost for stock attribution. As a percentage of revenue, general and administrative expenses were 60% compared to 67% in the same time in fiscal year 2011. The lower percentage reflected the improvement of operational leverage with the expansion of revenue scale.

Other operating income increased to RMB4.6 million from RMB0.05 million during the same quarter in fiscal year 2011. The increase was mainly attributable to rental income and the summer camp income.

Net income for the quarter was RMB1.8 million or basic and diluted earnings per share of RMB0.02. This compared to a net income of RMB8.4 million in the first quarter of fiscal 2011. There was a RMB9.4 million one-time foreign exchange gain as a result of U.S. dollar depreciation on intercompany loans leading to a much higher net income in the first quarter of fiscal 2011.

In the quarter, our balance sheet continued to strengthen. Cash and cash equivalents, short-term bank deposit, and short-term investments up to RMB500 million on September 30, 2011, compared to RMB487.9 million on June 30, 2011. Our operations have also generated positive cash flow of RMB52.4 million.

In terms of per share value, our cash per share at the end of September is $2.15. Cash plus real estate value at book is $2.66 per share and the net asset value per share is $3.30. If we add remaining receivables from disposal of ELP business to cash per share, cash per share value would be $2.28 per share. In addition, we had a deferred revenue of RMB41.9 million, which is the tuition fee collected and to be booked in the following quarters according to the course schedule.

To complete our financial review, I would now turn the call back to our CEO, Jerry. He will walk you through our operation updates, strategy, outlook, and guidance.

Jerry He

Thank you, Dora. We are very pleased to deliver a strong quarter and the return to a profit, which is an endorsement of the merits of our new business model and the solid execution of growth strategy to drive exciting business progress and opportunities.

Let me update you on our three education service units one by one. Please refer to Slide 10. Firstly, about Yuanbo Education. Let me recap a bit the background of Yuanbo as it is new to the Noah family. It is the third acquisition since our transition to education services business in 2009. We added two kindergartens as planned and now Yuanbo operates and manages 17 kindergartens in the economically prosperous Yangtze Delta region under the brand name Qingan as of the end of September.

Yuanbo kindergarten focuses on children at the age of two to six. It offers world class international courses to meet the growing demand for high quality pre-school education in China. It has a total enrollment of over 4,700. To drive further growth, Yuanbo will continue to expand its kindergarten network, focusing on the eastern part of China and improve efficiency and margin.

As the opening schedule of new kindergartens is tied with school terms, our opening schedules will mostly be in September and March quarter. Hence, there are no new kindergartens scheduled for opening in the second quarter. In general, it takes two years for a kindergarten to break even, but our kindergartens have continuously achieved breakeven in less than two years.

With the new ones continuing to ramp up, the utilization rates will gradually increase and we will gradually raise our ASP. There will be revenue growth and margin expansion opportunities.

Slide 11 shows Wentai in the first quarter. It added one kindergarten and one school as planned, making the total number grow to 17 schools and kindergartens. Total enrollment exceeded 6,700, representing a 44% year-over-year increase. Wentai continued to have strong performance, driven by two growth catalysts. First, continued expansion of the number of schools and kindergartens; and second, continued ramp-up of schools.

For the quarter, 12 out of 17 schools have opened for two years or more and have reached full utilization, with the remaining five schools and kindergartens operating for less than two years. In addition, we have signed a contract for two additional schools and six kindergartens, which are scheduled to open over the next two years.

Next slide. For Little New Star, revenue mainly comes from the sales of teaching material, tuition, and the franchise fees. We are pleased to report that the Dudu Happy Reading program, DHR, is gaining traction. We have already introduced DHR to nine kindergartens via our own school network. We will ramp up our marketing program to expand DHR's reach.

In addition, we also added one kindergarten as scheduled, making the total number of kindergartens under the Little New Star umbrella to four. Moreover, we have continued to expand the management capabilities at Little New Star to enhance operating efficiency and to better realize the potential of the business.

Next slide, to recap, our strategic direction is crystal clear. In the high growth education service industry in China, we will focus on three areas, namely, number one, pre-school education; number two, primary and secondary education; and number three, supplemental education.

On pre-schools, we will leverage on our existing platform to identify opportunities and broaden our offerings in addition to continued expansion of the kindergarten network. On primary and secondary education, we will emphasize on English training and explore opportunities in offering international programs. On supplemental education, we see a lot of opportunities in this business segment. At the moment, Little New Star's English training program is well placed to capture the potential in the segment. We have also expanded to offer summer camp to increase spending per enrollment.

While we are excited with the progress on our expansion and the prospects of our respective business segments, we remain focused on optimizing profitability through various operational initiatives. First, increase enrollment to optimize utilization; and second, broaden service offering to increase incremental revenue per student; and third, initiate internal integration and strengthen infrastructure to enhance business competitiveness and operating efficiency to maximize profitability and potential.

There won't be new school opening in the coming quarter as the opening schedule is tied with school terms, and is mostly in September and the March quarter. I am also pleased to report that our free cash flow from operations, cash position becomes even stronger with $78.3 million liquid asset as of the end of September, which does not include the $4.7 million received on October 12th from the sale of ELP business. We will certainly capitalize on our financial strength to further expand our presence in the pre-school education space and build a nationwide network to drive mid-to-long term growth.

Finally, looking into our financial outlook, for the second quarter of fiscal 2012, we expect net revenue to be in the range of RMB35 million to RMB37 million, representing 67% to 76% year-over-year growth. We reiterate our full fiscal 2012 guidance and expect net revenue to be in the range of RMB145 million to RMB155 million, representing a 55% to 66% year-over-year growth. This reflected current business plan of Little New Star, Wentai, and Yuanbo Education, without factoring any potential acquisitions or additional expansion plan of the three existing businesses.

This concludes our presentation and we would like to open the call for questions. Operator, please. Hello, operator?

Question-and-Answer Session

Operator

Yes. (Operator instructions) Your first question comes from the line of Ella Ji of Oppenheimer.

Ella Ji – Oppenheimer

Thanks. Good evening, Jerry and Dora. Jerry, I want to confirm that you said there's no schools – no new schools to open in the next quarter or for the remainder of the year?

Jerry He

For next quarter, which means the quarter of October to December, we don't have any plan to any – open any new schools. But it's likely that we may have additional schools or kindergartens to be opened in March quarter.

Ella Ji – Oppenheimer

In March quarter, okay. Can you share with us your targeted number of schools and kindergartens by end of this year?

Jerry He

Without factoring any acquisitions, we probably will open two to three kindergartens in March. But it's not for sure yet.

Ella Ji – Oppenheimer

Two to three kindergartens, okay. Schools, how about schools?

Jerry He

No schools in March.

Ella Ji – Oppenheimer

Okay, got it. Thanks. And then I want to ask about your margin, especially the operating margin level. I understand that you plan to improve your margins. What would be the main driver? Is it going to be the operational efficiency or do you think there are rooms that you can cut in some operating expenses in the absolute dollar amount?

Dora Li

Well, Ella, in this quarter, you can see from our press release, in our general and administrative expenses, there is a one time of RMB1.3 million expenses related to headquarter relocation and stock compensation. And we are expecting our R&D and sales and marketing expenses will remain at the lower level and our general and administrative expenses will be normalized within the expansion of our revenue level. So we are expecting our operating expenses will trend down in the next quarter and for the full fiscal year.

Ella Ji – Oppenheimer

Trend down, is it just because you wouldn't incur these one-time RMB1.3 million expenses or is there any other areas that you think you can cut?

Dora Li

Well, with the expansion of our total revenue and the percentage of our total operating expenses, as a percentage of our net revenue, will be lower.

Ella Ji – Oppenheimer

Okay. So, is it fair to say that most of the margin improvement would come from the operational leverage?

Dora Li

Yes.

Ella Ji – Oppenheimer

Okay, great. And then, when do you expect to break even on the operating margin level?

Dora Li

We are expecting our operating margins will be breakeven for the fiscal year 2012.

Jerry He

To add to that, we do expect our – we will have operating profit next quarter.

Ella Ji – Oppenheimer

Okay, great. Thank you. Thank you for taking my questions.

Jerry He

Thank you.

Operator

Your next question comes from the line of Kun Tao of ROTH Capital Partners.

Kun Tao – ROTH Capital Partners

Hi, thank you for taking my questions. First question, just to clarify, Jerry, you just mentioned you are going to – you plan to open two to three kindergartens in March quarter, but you don't have any plan so far in June quarter, right?

Jerry He

We typically open schools in – either in – basically at the beginning of the semester. That will be typically either in March or in September.

Kun Tao – ROTH Capital Partners

Okay. So just – in December quarter and June quarter, you don't have any plan. So for the remaining of this fiscal year, you plan to open two to three kindergartens, but no school plan yet. Is that correct?

Jerry He

No schools. That's correct.

Kun Tao – ROTH Capital Partners

Okay. And do you have a breakdown of your operating margin for three subsidiaries?

Jerry He

Yes.

Dora Li

Yes, the operating margin for our Little New Star is around – about 28% and for our Wentai Education Group, it's about 20%. And for Yuanbo, because it only has two months' revenue contribution, so for this quarter its operating margin is negative.

Kun Tao – ROTH Capital Partners

Okay. How about gross margin?

Jerry He

Gross margin.

Dora Li

Okay. The gross margin for this quarter at Little New Star is around 60% and Wentai is about 40%, while Yuanbo is at 29%.

Kun Tao – ROTH Capital Partners

Little New Star is about 60% or 50%?

Dora Li

60%.

Kun Tao – ROTH Capital Partners

60%.

Dora Li

60.

Kun Tao – ROTH Capital Partners

Okay. All right. The reason Yuanbo has negative operating margin, can you say again? I'm sorry.

Dora Li

First, Yuanbo only contributed two months' revenue and all the expenses have been factored in and also because Yuanbo opened two new kindergartens in this month and we have to expense the startup cost in this quarter, which is close to RMB800,000. So that makes – the margin for Yuanbo is relatively lower this quarter. And we believe next quarter, when Yuanbo contributes a whole three months and we hope its margin will be improved.

Kun Tao – ROTH Capital Partners

Okay. All right. Last question, I guess, is for Jerry and for the management group. Given the strong cash flow and your current cash position, do you have any plan to further utilize your cash? For instance, maybe paying dividend or anything like that?

Jerry He

Thanks for the question. We do intend to leverage our cash to grow our business through acquisition in the next year. But it's possible that – since we just turned to profit this quarter and we do expect a profitable [ph] fiscal year of 2012, it's possible we will consider a dividend at the end of the fiscal year.

Kun Tao – ROTH Capital Partners

Okay. For acquisition part you mentioned, do you have any clear targets or how many schools do you think you will add by this fiscal year?

Jerry He

As you know, the – when you talk about acquisitions, it's very fluid. Until a definitive agreement is signed, we typically do not disclose too much information about that. But we do have a very strong pipeline. We will report as we sign anything definitive.

Kun Tao – ROTH Capital Partners

All right. That's very helpful. Thank you for taking my questions.

Jerry He

Just keep in mind, the guidance for the fiscal 2012 did not factor in any acquisitions.

Kun Tao – ROTH Capital Partners

Right. Thanks.

Jerry He

Welcome.

Operator

(Operator instructions). We'll pause for a moment to compile the Q&A roster. At this time, there are no further questions in queue. So I would like to hand the call back over to Mr. He for closing remarks.

Jerry He

Thank you, operator. In summary, we will continue to see strong top line growth for the second quarter and the fiscal 2012, driven by continuous organic growth over the platform of Little New Star, Wentai, and Yuanbo.

In terms of profitability, gross margin will steadily increase with ramp-up of new schools, while G&A to revenue will be trending down with the expansion of revenue scale. We will continue to work on enhancing synergies and the efficiencies through integration and we expect continued improvement in profitability over the course of fiscal 2012 after a strong start in the first quarter.

To conclude the call, thank you for joining us today and we look forward to updating you on our progress at the next earnings call. Have a nice day.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference call. You may now disconnect. Have a nice day.

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