Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Sisi Zhao - Senior Investor Relations Manager

Louis Hsieh - President &CFO

Analysts

Philip Wan - Morgan Stanley

Chenyi Lu - Cowen &Company

Catherine Leung - Goldman Sachs

Brandon Dobell - William Blair

Ruby Zhang - Nomura

Jeff Mueller – Robert W. Baird & Company Inc

Janice Chen - Piper Jaffray

Eric Wen - Mirae Asset

Jennifer Kao - Credit Suisse

Paul Ginocchio - Deutsche Bank

Chao Wang – Merrill Lynch

Ella Ji - Oppenheimer

Ming Zhao - Susquehanna Financial Group

Leonie Foong - Janchor Partners

Charles Cartledge - Sloane Robinson

New Oriental Education & Technology Group Inc. (EDU) F2Q2012 Earnings Call January 17, 2012 8:00 AM ET

Operator

Good evening and thank you for standing by for New Oriental’s Second Quarter of Fiscal Year 2012 earnings conference call. At this time all participants are in a listen-only mode. After management’s prepared remarks, there will be a question-and-answer session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I’d now like to turn the meeting over to your host for today’s conference, Ms. Sisi Zhao. Thank you. Please go ahead.

Sisi Zhao

Hello everyone, and welcome to New Oriental’s second quarter of fiscal year 2012 earnings conference call. Our financial results for the period were released earlier today and are available on the company’s website as well as on Newswire services.

Today, you will hear from Louis Hsieh, New Oriental’s President and Chief Financial Officer. After his prepared remarks, 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 laws.

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 President and CFO, Louis Hsieh. Louis, please.

Louis Hsieh

Thank you, Sisi. Hello everyone and thanks for joining us. The second quarter is seasonally the slowest quarter for New Oriental. But I’m very pleased that we’re presenting a very healthy set of financial results today.

Total student enrollments grew by 16.2%, revenue grew by 38% and profit rose by 80.5%. This is despite some very tough comparisons in the same period a year-ago when revenues were up about 56% and enrollments up over 32%.

First, you recall that in the second quarter 2011 we benefited from a strong rebound in enrollments after the World Expo in Shanghai closed. Second, certain low performing businesses which we discontinued over the past 12 months contributed approximately $3 million in revenue in Q2 of 2011 that are not accounted in this year’s second fiscal quarter results.

The driving force behind the solid performance is simple. New Oriental remains the most trusted brand in private education services in China. We see huge unmet demand for our services and we continue to execute successful strategy to take advantage of this demand. Across our business lines we recorded sustained growth in the second fiscal quarter. Our overseas test preparation program recorded year-over-year enrollment growth of about 1% to over 74,200. The moderate growth is still pleasing given that we experience such a huge spike in enrollments in the second quarter of last year, when enrollments were up 39%.

As you remember a lot of students chose to defer their studies from the summer quarter in the – to the autumn quarter last year in part because of the Shanghai World Expo. In addition, gross revenues this quarter is up more than 52% year-over-year to over $43 million in part because more students are choosing to register for smaller more expensive classes.

The K-12 all subjects after school tutoring business continues to impress. The segment recorded year-over-year enrollment growth of more than 33% to over 233,900 and year-over-year gross revenue growth of over 45% to over $44 million.

Once again, this quarter we’re seeing the most rapid growth in our VIP personalized classes with year-over-year enrollment growth of about 42% to 20,100 and year-over-year revenue growth of over 52% to over $45 million. This particularly encouraged by our success in the segment because it really illustrates New Oriental’s position as the premium provider – private education provider in China.

We were gaining market share much more quickly than our competitors in the VIP small class segment because our students recognize the unquestioned premium quality unanimous with the New Oriental brand.

On a related note, we wanted to mention that our new intensive English training program, Maxen, which we introduced last quarter. Maxen is a very high end after school tutoring program that aims to provide students with a U.S standard English education in U.S standard English learning environment.

Over the past few quarters, we’ve opened five Maxen centers around China and already we were getting traction. Enrollments have reached 330 students in total in the first half of the fiscal year and ASP of approximately $2300 for one year course. Again, I want to emphasize that New Oriental is uniquely positioned to offer a product like this in the Chinese market. It is only New Oriental has established that premium brand cache entrust with parents of students to justify this premium position.

Finally, our Vision Overseas Study Consulting business continues to outperform with year-over-year revenue growth of over 90% to about $3.8 million. Despite the challenging economic conditions in the U.S and Europe and the slowing Chinese economy, increasing numbers of Chinese students – despite that increasing numbers of Chinese students attempt – to attend degree granting programs in those regions as well as in places like Australia and Canada because they believe such qualifications are for better long-term prospects.

To take advantage of the growing demand in our services, in the last quarter, we’ve opened up a net of 39 new learning centers in 20 cities. However, we continue to emphasize operational efficiency in network optimizations. So our approach to expansion is considered in high – highly strategic.

Of the 39 new learning centers we opened in the last quarter, more than half are small centers of approximately 500 square meters or less, which are used primarily for K-12 after school tutoring in VIP classes. These facilities obviously require lower initial investment in terms of CapEx, marketing, and headcount. Being smaller they can get up to speed – they can get an optimal utilization much more quickly than our larger centers.

While I talk about network growth, I do want to highlight that our rapid expansion into second-tier cities beyond Beijing and Shanghai result in our blended ASP growth right appearing deceptively low. In the second fiscal quarter, we maintained a healthy ASP growth of 11%. But it is important to understand that lower tier cities which were we charge lower prices are now accounting for a growing percentage of the revenue mix.

Naturally in places like (indiscernible) – Nantong, we price our training programs at a lower rate than we do in Beijing or Shanghai or Guangzhou. We’re still able to charge the premium rate – that our premium brand justifies, but we adapt our pricing structure to suit local market conditions. So as we expand our business in the markets beyond Tier-1, you need to bear in mind that the shifting revenues mix will dampen the overall ASP growth rate.

Over time we expect that ASPs in these lower tier markets will trend upwards. But the important point here is that we’re expanding our footprint quickly in these new high growth markets and we’re able to maintain healthy ASP increases.

As you know from past quarters, our emphasis right now is on achieving better efficiency across our network. We’re determined to focus our energy on the parts of our business that are more lucrative. So when we need – when we see areas of our business that aren’t working, we aim to make immediate changes. To that end, in the second quarter, we decided to close our North Star Occupational Test Prep school based in Beijing. This is a decision that allows regional management to refocus their attention on more productive core business line.

Last quarter I also mentioned that we had identified some issues in our Northeast region and had intervened to make some senior management changes in the cities of Harbin, Dalian, Shenyang and Chongqing.

Although revenue from these cities is up 22% year-over-year, enrollment is down 19% for the quarter. Clearly there is some work to be -- to turn things around, but we've new school heads in place and we're already seeing some signs of improvement. This is a long term effort, but we're confident that we will rectify this situation.

I’m also pleased to let you know that legal action against new way of education has been successful. New Oriental has been awarded the entire initial acquisition consideration of $2 million plus interest. We expect to receive the repayment at the end of February and report it in our fiscal third quarter.

Along with Mingshitang and Beijing Tomorrow Oriental Technologies, these four discontinued businesses entities did not contribute to revenue in the second quarter of 2012, whereas combined they generated about $3 million in revenue in Q2, 2011. Our strong Q2 performance just adds up well for the coming quarters. Looking ahead we're confident about the growth potential, but I do want to flag a couple of factors that we expect will have an influence on our Q3 results.

In the immediate term, we expect that the timing of the Chinese New Year festival this year will have a negative impact on our Q3 revenues and margins. This year the festival falls on January 23, which is a couple of weeks earlier than usual. So in most provinces the winter school holiday is shorter than usual by up to a week, because the schools will need to finish their four terms before the break.

This means that many students who would normally signup for our test prep training courses during the winter holiday break don’t have time to do so. So we expect that this will have some impact on enrollments and revenues for the third quarter. You may remember that we saw a similar trend in the third quarter of 2009, where the Chinese New Year festival occurred on January 26.

Having said that, students still need to take test prep classes before they sit for high-school and college entrance examinations in June, so we anticipate the suppressed demand for courses during the winter break will spill over into the fourth fiscal quarter and those students who didn’t take courses during the winter break will signup for after school or weekend courses in Q4. Again you remember that we saw this effect in the fourth quarter of 2009 when revenues grew by 48% and in income by 50%.

Another short-term speed bump that I wanted to address is the decision by the Shanghai Government to cancel the Shanghai star-level English test. This was an English proficiency exam that primary and junior high-school students in Shanghai were required to sit.

The municipal government announced in December that it had decided to abolish this exam. But Shanghai training centers had been offering some dedicated test prep courses for the exam, so we expect that this decision will have an impact on our Q3 earnings of about RMB3 million to RMB4 million, a negative impact.

But while the government has cancelled this specific testing requirement, school kids in Shanghai still have to reach a level of English proficiency for the other English exams they need to take. So over time we expect that parents who would have sent their kids to a dedicated star-level English test prep course will sign their kids up for other English training programs instead.

Looking longer term like everyone else, we’re closely monitoring the impact of the ongoing global financial crisis and China’s own economic slowdown. New Oriental is of course not immune to these macro effects. But we're confident that the education sector is much better insulated than other sectors and that New Oriental is in a much stronger position than our competitors we’re fighting for a share at the lower-end of the market.

Harbin again, we've seen that when China faces economic turbulence, education spending remains incredibly resilient, because Chinese families pay such a high priority on securing good education for their children. In our fiscal year of 2009 when China’s economy stumbled in the phase of the global financial crisis before the government stepped in with its stimulus package. New Oriental actually grew revenues up approximately 46%.

At such times, New Oriental is the industry leader enjoyed a particularly advantage because there is inevitable fight to quality. People look for a better return for their education investment and they know that they can rely on our premium brand to provide that. So despite the macroeconomic headwinds we remain confident that New Oriental will continue to see rapid growth in the years to come. We see demand for New Oriental services increasing quickly both in the established markets like Beijing and Shanghai and in newer markets in second and third tier cities across China, and we believe that we have the right strategy in place to take advantage of that trend.

Before we open the discussion up for your questions, let me quickly go through our financial highlights. The full details are available in our press release. I just want to focus on some important indicators.

Net revenues from education programs and services for the second fiscal quarter were $120.1 million, which is 42.1% year-over-year. We want to remind you however that the year-over-year comparison is not exactly apples-to-apples.

For example, in Q2 of 2011, we experienced a spike in enrollments after the impact of the World Expo in earlier quarters. Also, Mingshitang gaokao re-taker schools, Beijing Tomorrow Technologies, a new way of education, and North Star occupational test prep facility in Beijing accounted for about $3 million of revenue in Q2, 2011, but did not contribute to revenue in Q2 this year.

So, again, comparing growth rates for the quarter to the rates from the same period a year-ago is not particularly illustrative of New Oriental’s organic growth.

Selling and marketing expenses for the quarter increased by 32.3% year-over-year to $24.5 million. We’re continuing to keep a tight hand on sales and marketing spending. As we mentioned earlier, a lot of our new learning centers are being opened in areas where New Oriental is already well established, which reduces the need for marketing spending.

General and administrative expenses for the quarter increased by 45.4% year-over-year to $50.3 million, and on a non-GAAP basis, G&A expense were $46 million, which is 46.4% higher than last year. This is primarily due to expansion of our network by net of 39 facilities compared to a net increase of only 24 facilities in the same period last year, which actually means that we increased our headcount. We’ve also been investing in developing new programs and content as well as in teacher training to ensure that we continue to offer the best services in the market.

Operating margin for the quarter was negative 3% compared to negative 2.1% in the same period of the prior fiscal year. Non-GAAP operating margin, which excludes share-based compensation expenses for the quarter was 0.2% compared to 1.3% in the same period of the prior fiscal year.

Net income attributed to New Oriental for the quarter was $3.3 million, representing 80.5% increase from the same period of the prior fiscal year. Non-GAAP net income attributed to New Oriental for the quarter was $7.5 million, representing a 46% increase from the same period last year. The net income line benefits from an interest income effective over $6 million. Thanks to our very strong cash balance.

New Oriental’s deferred revenue balance, which is cash collected from students for courses and recognized proportionally as revenue as the instructions are delivered. As of November 30, 2011, it was $201.8 million, an increase of 46.3% as compared to $137.9 million as of November 30, 2010.

Turning now to our outlook for the third fiscal quarter of 2012, we currently expect total revenues in the third quarter of fiscal year 2012 to be in the range of $168.3 million to $176.2 million, representing year-over-year growth in the range of 27% to 33%. This forecast takes into account the negative impact of the timing of the Chinese New Year, which we discussed earlier, and it reflects New Oriental’s current and primary review, which is subject to change.

At this point, I will take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Philip Wan from Morgan Stanley. Please ask your question.

Philip Wan - Morgan Stanley

Hi, Louis and Sisi, thanks for taking my question. My question is about your overseas test preparation. You mentioned early about the self enrollment growth for this quarter was due to a difficult (indiscernible), but would you be able to share with us the trend going into December or maybe going into January? Thank you.

Louis Hsieh

Thanks, Philip. Yeah, I mean the trend is Q3 is not trending as high as normal because of the shortened Q3 break. As you know, the Chinese school kids just got out of their full terms typically around January 13th, this year, and so they don’t have much time to enroll in a full winter term period.

So, the trend is it’s still up over Q3, but it’s not as strong as the 22% we saw in the summer quarter. I think the overall trend is on track for what we had forecast, which is about 12% enrollment growth and about 40% revenue growth.

So, I think those are still on track. I’d expect Q3 to be above last year, but not at 22% and I think Q4 should be quite good.

Philip Wan - Morgan Stanley

Okay. And slightly related to that, I’m just curious that what kind of enrollment growth rate for the VIP, specifically for overseas test prep?

Louis Hsieh

I don’t have this, the breakout on hand for just overseas test prep. Overall, VIP is growing obviously very rapidly with enrollments up about over 40%, year-over-year revenue up 55% year-over-year.

So, VIP tends to be actually one of the stronger performing businesses, especially given that this year if Q3 is going to be a little bit light on revenues then what’s going to happen we believe is that in Q4, the students will be running out of time. So, they will be cramming for their courses, which is actually a very good sign for VIP.

Philip Wan - Morgan Stanley

Thanks, Louis. I’ll get back to the queue.

Louis Hsieh

Yeah.

Operator

Thank you. The next question comes from the line of Chenyi Lu from Cowen & Company. Please ask your question.

Chenyi Lu - Cowen &Company

Okay, thank you. I’ve a question regarding your operating expense trend given that this quarter you spent really heavy on the sales and marketing. North Star acquired spending on the G&A especially for the increased headcount and the investment in new content and the new program. So, can you give us the operating margin trend in 2012? That would be great, thank you.

Louis Hsieh

Thank you, Chenyi. I think we want to sort of suspend that until the operating margin -- until we see the Q3 results. And like I said because of the early timing of Chinese New Year, it tends to have a disproportionate negative impact on our profit number. So -- because our revenues will come in a little bit lighter than we had originally forecast, therefore I’d like to wait until next quarter to give you sort of the operating margin trend.

So far in the first two quarters of the year, we’re up about 500 basis points versus last year. So, we’re half a percentage point up. I’d expect Q4 to be stronger than trend and Q3 to be lower than trend. So, let’s see how those play out. So, I like to defer that question until next quarter. I’m sorry.

Chenyi Lu - Cowen &Company

Okay, great. Thank you.

Operator

Thank you. Your next question comes from the line of Catherine Leung from Goldman Sachs. Please ask your question.

Catherine Leung - Goldman Sachs

Hi, my question is you highlighted the growing mix of lower tier cities in your prepared remarks, will see effective dampening ASP, can you comment on whether these lower tier cities necessarily are lower margin in terms of the intensity of competition as well that you’re encountering in some of these lower tier cities as well? Thanks.

Louis Hsieh

That’s a great question, Catherine. I think the lower tier cities today are lower margin because they’re not as established as Beijing and Shanghai. Obviously the -- because the ASP is lower, the costs are also much very lower, but I think the overall fact is that it will be a long time before they have the margins that Beijing have or the Shanghai have. So, I’d expect them to be lower margin, but they are still, you know, the operating margin in these cities will still usually be 15% when they hit a level maturity of seven or eight years.

So, I think they’re still great lucrative markets to go into, but we believe over time, we’ll be able to take up prices more. The competition is from very strong local and tranche competitors. And so, it will take us time also to beat them out. So, it’s just a -- we typically will win in almost every market we enter, but it takes sometime. So, I think it is competition plus the fact that the cities are as economically developed as Beijing and Shanghai will mean these will have lower margins for a while. But we believe long-term, these are very lucrative markets to be in and they are part of our growth strategy.

Catherine Leung - Goldman Sachs

Okay, thank you.

Operator

Thank you. The next question comes from the line of Brandon Dobell from William Blair. Please ask your question.

Brandon Dobell - William Blair

Hi, Louis, I wonder if you could give us some color on how the pricing looks in some of the smaller cities that you’re either opening new centers up or growing, are you seeing the same kind of pricing increases or same kind of pricing trends as you’re in the tier 1 cities? And then I also want to get a feel for how many other smaller initiatives you’ve going on, you’ve Maxen, you closed down North Star, how much else do you’ve going on kind of behind the scene and maybe something turn into a bigger product set for you? Thanks.

Louis Hsieh

Okay, thank you, Brandon. I think the second tier cities are typically priced 25% to 30% below Beijing and Shanghai from most of the programs. However, for the VIP programs, they’re probably priced at about a 40 -- from 40% to 50% discount. So, it varies across the board.

Our ASP increases in those smaller cities are actually quite high. So, we’re increasing it at a very comfortable level at Beijing and Shanghai. That’s why I said that the ASP can be looked effectively low because the more and more students are enrolling in the second tier cities. It brings down the blended ASP for the whole company even though in those cities the ASPs are actually quite healthy at probably 12% to 15% increase year-over-year. So, that’s why it’s effective. So, the ASP grows as the business moves towards second and tier two cities will look like it’s not growing much even though it is.

The second issue on the new initiative, we don’t have that much in the pipeline. So, I think we’re kind of focused on basically K-12 education, VIP, overseas study consulting and our overseas test prep businesses. Those obviously still have very, very long legs and a very long runway. And so, we continue to focus on those initiatives. We’ll look at new markets. I mean we made an investment in dajie.com, the occupational site that helps college students find jobs, but it’s a small investment, so it’s something we’re dipping our toes into. There’s no large scale investment initiative’s in the pipeline currently.

Brandon Dobell - William Blair

And one final question for you, if you look across the tier-1 cities right now, how many -- or what proportion of the enrollments do you think are coming or class centers are coming, be online or technology as opposed to people going into learning centers and signing up there?

Louis Hsieh

As far as Beijing and Shanghai, very close to half, if not more than half of our enrollments are actually coming online, beyond the online registration system. Yeah, obviously they attend to learning centers, but they are registering online. And so, I think if that trend will continue, which is great for us, because obviously with online registration we don’t have to spend a lot of money on representatives and registration facilities. So I think if the trend will follow across China, that probably in three or four years we would expect that probably half or more of the students will actually register online, but they’ll still be attending physical classes.

Brandon Dobell - William Blair

Okay, great. Thanks, Louis.

Operator

Thank you. The next question comes from the line of Jin Yoon from Nomura. Please ask your question.

Ruby Zhang - Nomura

Hi, this is Ruby Zhang sitting in for Jin Yoon. Am just wondering if you can comment a little bit more on your staffing cost as well as rent in the quarter?

Louis Hsieh

Yeah, we usually typically raise salaries once a year and we do that just before Chinese New Year. And this year we -- our staffing cost did not go up as much as in past years. In the last couple of years they went up about 10% or 11% year-over-year. This year we raised salaries about 8% to 10%, so it’s down a couple of percentage points which obviously helps our margin, similarly we can keep up the ASP trend. So overall staffing cost, I think we’re pretty happy with it, its lower this year as an increased number than it was in the past two years.

Ruby Zhang - Nomura

I see. Is that a result of kind of the general economic trend or is that just …

Louis Hsieh

I think that’s (ph) price – well, I think the last two years have been normally high, because China has been going through a phase of very high inflation. And so, I think as inflation cools off it has a slight benefit for us, there’s not as much wage pressure. And so, yeah, I think it is a direct result of the, so a slow economy in China.

Ruby Zhang - Nomura

I see. And do you see the same trend for your rent expenses as well?

Louis Hsieh

Rent expense is a little bit slower to follow. Rent is not going up as much as it has in the past as well, especially as we move to second tier third cities, the rent increase is not as high as it has been in Beijing and Shanghai. So, we would expect that trend to continue on the rent side as well. And everything still goes up, but not as much as in the last couple of years.

Ruby Zhang - Nomura

I see -- I see. Thanks.

Louis Hsieh

Yes.

Operator

Thank you. Your next question comes from the line of Jeff Mueller from Baird. Please as your question.

Jeff Mueller – Robert W. Baird & Company Inc

Hi, Louis. I was wondering if you could give any sort of quantification about what type of, -- what the guidance is assuming from the impact from Chinese New Year being earlier this year, and then how much of that do you think is delayed into Q4 versus how much of it do you think is potentially lost. And then, I understand that you’re suspending the margin guidance, but can you just talk conceptually about, of the shortfall in revenue from the, you know that revenue being pushed back or not capturing it this year. How much of that are you able to offset in terms of lower cost?

Louis Hsieh

Yeah, that’s a great question. I don’t have -- I didn’t put a hard number in our prepared remarks obviously because its -- it’s a moving target. If I had to estimate today and I said don’t hold me to this. If I had to estimate today I would expect the negative impact on Q3 to be between $5 million and $7 million, maybe $8 million on the revenue line. And that’s why you saw us take the revenue guidance down a few percentage points. But that translates into a disproportionate impact on profit. So, I would expect it to hit the net profit number in Q3 by probably about $3 million to $4 million, so it has a larger impact on the margins, that’s why I suspended the guidance until, I really did not suspend it just because I want to see how good we're at cost control to offset some of the revenue shortfall.

I think we will get more than half of it back in Q4, above. So I would expect -- I expect us to lose some revenue and some profit permanently as we’ve seen in past years for that experience, but we expect a nice bounce back in Q4, there’s a lot of factors pushing Q4 up higher, but June is the deadline for students to prepare for the end of the year exams. I think because Q3 is compressed this year it benefits Q4 anyway. And I think it also have an outsized impact because as students are forced to cram in the last quarter, they tend to opt for smaller classes and for VIP classes, which helps our -- obviously our top and bottom line.

Jeff Mueller – Robert W. Baird & Company Inc

Okay, thanks for that. And then just a follow-up on the overseas test prep, I understand the slower enrollment growth with the tough comp, but revenue growth was still quite good there. Anything that you can say in terms of – was there a larger price increase that you went through or was it mixed with more culture (indiscernible) Shanghai or …

Louis Hsieh

Yeah, it was the pre-enrollments from the summer. So if you look at Q2 our enrollments were up 22%, so remember that -- those are usually pre signups in that quarter, but most of the revenue is recognized in the subsequent quarter.

Jeff Mueller – Robert W. Baird & Company Inc

Okay. Thank you.

Louis Hsieh

Yeah, and the prices are going up, I mean the prices they’re healthy, they’re still over 20%. So like, that’s why I said you can't just look at the enrollment number, the enrollment numbers you see actually an indicator of future demand, not past demand.

Jeff Mueller – Robert W. Baird & Company Inc

Okay. Thanks, Louis.

Louis Hsieh

Thank you.

Operator

Thank you. Your next question comes from the line of Janice Chen from Piper Jaffray. Please ask your question.

Janice Chen - Piper Jaffray

Hi, Louis, this is Janice Chen asking questions on behalf of Mark Marostica, my question is about Maxen. So what's the brand new contribution from Maxen in 2Q, and out of that 39 learning centers you added in a quarter, how many are related to Maxen? Thanks.

Louis Hsieh

Yeah, Maxen we've a total of five now, usually one or two is added in the quarter. Maxen we had 330 students, you just times up by $2300 just about $600,000 and you just divide it by 4, right or 3. So, it’s quit a couple of $100,000 is the contribution on the revenue side. But Maxen is just getting started. So we probably won't open more than eight centers before now and the end of the year and then we’ll see how those progress before we decide on the next strategic move with Maxen. So its progressing well, I mean the demand, the take up is good so far, but it’s very early.

Janice Chen - Piper Jaffray

Are you planning to tap into more cities, other than the existing four cities?

Louis Hsieh

Yes, that would be -- that would be our plan, is to take it to probably the top -- the top 12 or 14 largest cities in China, in the next few years. So I mean the initial pilot cities do well.

Janice Chen - Piper Jaffray

All right. Just one more question. How much did G&A spend in the quarter incremental relate to the cost development and the teacher training in the quarter. Thanks.

Louis Hsieh

I don’t have that specifically broken out. There was an earlier question about marketing and I think in marketing we had, the actual market promotional expenses didn’t go up that up, it went from $7.7 million to $10.7 million, up 38%. G&A itself on R&D expense was flat, $2.1 million at that period last year, $2.1 million this year.

Janice Chen - Piper Jaffray

Okay.

Louis Hsieh

HR expense for G&A went up a lot. It went up from $18.5 million to $27.4 million, up 54% and that’s because of the learning centers actually. So it’s because we added 39 learning centers this year -- this quarter, the staffing had to be ramped up, so we increased headcount by about -- let me check the final number. We increased headcount in the quarter overall from Q1 by about 1400 people which about 600 or so were teachers. So it was the headcount increase that drill out the G&A primarily because of the new learning center.

Janice Chen - Piper Jaffray

Okay, thanks very much, Louis.

Louis Hsieh

Yeah, and that is definitely a strategic move because we expect Q3 and Q4 to be stronger. So, we’ve to prepare in Q2 on the learning center side.

Janice Chen - Piper Jaffray

Okay, thanks.

Operator

Thank you. And your next question comes from the line of Eric Wen from Mirae Asset. Please ask your question.

Eric Wen - Mirae Asset

Hi, Louis, thanks for taking my questions. I just have some housekeeping questions, the first one is about your tax weight, can you give us some color on the tax weight outlook for the next two years, given I think your tax weight for this quarter is little bit on the high side? Thanks.

Louis Hsieh

Yeah, like we’ve been saying taxes are going up in China. So, we expect this calendar year, taxes to be probably somewhere between 10% and 11%, overall blended and then probably go up one percentage point next year, so, probably 11% to 12%. We’re training toward 15% in the next few years.

Eric Wen - Mirae Asset

Okay, a quick follow-up on the -- and the follow-up question is your other income, what is the nature of this part of -- I saw an increase during the quarter?

Louis Hsieh

Yeah, the increase is from interest income, Eric, as you know, we’ve US$700 million in cash. And so, it’s the interest income from that -- from those funds.

Eric Wen - Mirae Asset

Okay, thanks.

Louis Hsieh

Yeah. It’s about $6 million this last quarter.

Operator

Thank you. And your next question comes from the line of Jennifer Kao from Credit Suisse. Please ask your question.

Jennifer Kao - Credit Suisse

Hi, Louis, my question is about actually on the interest in those business units. Can you please tell me a little bit more about the breakdown in terms of the enrollment like the age group, it’s targeted at age 4 to 17, and like how -- what percentage is from like primary and really small, younger kids and how much is from like the high school students? Thanks.

Louis Hsieh

Okay, yeah. I don’t have the specific breakdown, I apologize, Jennifer. I think most of the students are going to be middle and high school you know, sort of middle aged kids. So, probably not as many grammar school kids, but that’s kind of just early. I think our target -- our long-term target is to get students in the grade school level. So, somewhere between first or second grade and sixth grade is longer term, but as we rollout these programs, the initial adaptors are the ones who are -- the parents who are already trying to pay catch up, trying to get their kids into these programs now versus what they were offered in the past.

So, I think this -- we will begin to track it more closely in the quarters ahead for you. I don’t have a specific age-by-age breakdown, but we’ll begin to track that going forward.

Jennifer Kao - Credit Suisse

Okay, thank you.

Louis Hsieh

Yeah.

Operator

Thank you.

Louis Hsieh

I was always happy to see 330 units.

Operator

Thank you. Our next question comes from the line of Paul Ginocchio from Deutsche Bank. Please ask your question.

Paul Ginocchio - Deutsche Bank

Thanks for taking my questions. First, just on the -- you’ve added 94 centers year-to-date up 22%, that’s better than your entire growth last year, I just want you to talk about maybe capacity of your centers? And then also maybe talk about margins that you’re -- centers you add in fiscal ’09 versus fiscal ’10 versus fiscal ’11, are they ramping to your target margins as quickly as maybe some of the over cohorts of learning centers? Thanks.

Louis Hsieh

Yeah, I think the centers are actually ramping up quite well. As you know, Paul, there is a kind of position effect, as you open up a new center in a new city, actually counterpart is from the older cities, but because we are opening up smaller learning centers, we’re actually ramping up quite quickly. So, their payback is typically in the first year. They are breakeven in the first year and then they begin to be profitable in year two. And so, they are ramping sort of on schedule.

I don’t have a specific margin breakdown by cohort, by 2008-2009-2010 because as you know, our finances are setup in a city-by-city mode. And so they are not specifically broken out margin by learning center, they are broken out margin by school. And so, but they’re ramping up quite rapidly.

Their typically long-term margin will not be as high as our existing learning centers because those existing learning centers typically are much larger, and because of that they’ll have longer -- they will have higher longer term margins, but they take longer to ramp. So, the newer centers the typically smaller. They’re typically kids and VIP, our K-12 and VIP. And so they’ll -- but they’ll fill up quicker. So, there should be sort of a maturity between two and three years, which is about 65% above.

As far as utilization for the quarter, as you know, Q2 is our lowest quarter. So, utilization is typically in the 35% to 40% range, and it should ramp up in this quarter in Q4, and the highest utilization is in Q1 during December quarter.

Paul Ginocchio - Deutsche Bank

Okay, thanks very much.

Louis Hsieh

Thank you.

Operator

Thank you. Our next question comes from the line of Chao Wang from Merrill Lynch. Please ask your question.

Chao Wang – Merrill Lynch

Hi, thanks for taking my question. I’ve a follow-up question on the Chinese New Year impact, is the impact mainly on the overseas test preparation segment or also on the domestic segments? Thank you.

Louis Hsieh

It’s on all the segments, but it has a bigger impact on overseas test prep. That’s a good observation, because students got out of school, finished on January 13th, the New Year holiday is less than a week and half away. So, most students -- so, there is not enough time for them to take a really meaningful class. And for us, the issue really relates to -- we make revenue the longer the winter break is because we make revenue as the students are actually in class by the hour. So, if the nearest holiday is going to cost three to five days, that’s a big impact on us for 90-day period especially when the students are not ready themselves, but typically we’ll make it back in Q4 and Q1 together, we will get probably more than half of it back of this shortfall. That’s based on what we saw in the summer of 2009 when this happened as well. So, three years ago, this sort of phenomenon happened as well.

Chao Wang – Merrill Lynch

And I also have a follow-up question on Maxen, why -- it seems that profit is not receipted in non-controlling interest item probably for (indiscernible)?

Louis Hsieh

Oh, yeah because it will – that give you a close this quarter.

Chao Wang – Merrill Lynch

Oh, okay. I see.

Louis Hsieh

It is being restructured. So, it will begin -- it will be showing that way as 65/35 in our favor going forward, but it takes some time to structure everything and get the legal entity going.

Chao Wang – Merrill Lynch

Okay. And also in a sense of the Maxen’s margin level reach a mature stage?

Louis Hsieh

We’ve internal forecasts of 15% to 20%, but like I said, it’s a forecast and mature stage means a long time, probably three to five years. So, a lot of things can happen between now and then, but we expect it to be 15% or 20% margin.

Chao Wang – Merrill Lynch

In line with the (indiscernible)?

Louis Hsieh

Yeah, it should be in line, and like I said, it takes time and so those are based on a lot of assumptions that may or not happen in the next three or five years.

Chao Wang – Merrill Lynch

Okay, fair enough. Thanks very much.

Louis Hsieh

Okay, thank you.

Operator

Thank you. Our next question comes from the line of Ella Ji from Oppenheimer. Please ask your question.

Ella Ji - Oppenheimer

Hi, thank you. I’ve two questions. First is, as the inflation rates picks off, how does that impact your like-for-like ASP growth in the next year? And my second question is regarding your operating expenditure, if we continue to see general softness in your top line growth, will you consider increase your operating expenditure towards sales and marketing or in other promotional expenses where you’ll continue to be in this cost control mode? Thanks.

Louis Hsieh

It was a good question. For us the inflation rate, typically if inflation is high we will typically raise prices to compensate for that. If inflation is low we will still raise prices but probably not quite as much. We actually obviously prefer a low inflation environment for our business since it is sort of headcount intensive as well as facility is intensive, so we do prefer a low inflation rate. So I think the trend of lower inflation helps us.

If inflation does go up again, then well of course we’ll have to raise prices as well as raise salaries similar to the last couple of years, where it went up about 10% to 11%, which is not ideal for us. So I think as far as if the business slows we will typically spend more money on promotion expenses and then we’ll also probably slowdown the learning center growth and cut other expenses, but we’ll typically, yeah, increase promotional expense to try to compensate and get the revenue dollars up.

Ella Ji - Oppenheimer

Again, just a quick follow-up for the like-for-like ASP, should we expect it will go back to your normal range which is 8% to 12%?

Louis Hsieh

It is -- it is in that range now. And like I said is that, don’t be deceived by the fact it shows like 11% overall, it’s because as the enrollments increase in the lower tier cities, it actually brings down the blended ASP. So the actual real ASP is our historical trend of 10% to 12% up.

Ella Ji - Oppenheimer

Thank you.

Operator

Thank you. Your next question comes from the line of Ming Zhao from SFG. Please ask your question.

Ming Zhao - Susquehanna Financial Group

Thanks for taking my question. Just a question on the books and other revenue line, it seems like its a little bit light for the second quarter and whether it’s from quarter-over-quarter or year-over-year perspective. Just want to understand what's the reason behind that? Thank you.

Louis Hsieh

Yeah, I mean the books in other lines have been slow growers for a while, Xunkao school don’t forget it’s full. So our private school at Xunkao it’s full, so it’s just going to grow at whatever the tuition increase is per year. Books is typically been a slow grower for few years; it’s a very mature business. And so those typically are going to be slow growers. And that’s why we don’t spend a lot of time on discussing those businesses, because they kind of grow at 10% to 15% a year.

Ming Zhao - Susquehanna Financial Group

So it’s just books not the overseas consulting?

Louis Hsieh

Overseas consulting is taking off, as you saw in our prepared remarks the revenue is up 90% year-over-year and so, I mean, this is a business that – that’s gone from almost nowhere and this year we will do probably very close to $40 million. So it’s been a rocket shift. I think Overseas Study Consulting is the – is probably the fastest growing business in New Oriental right now.

Ming Zhao - Susquehanna Financial Group

Okay. Thank you.

Louis Hsieh

Thank you.

Operator

Thank you. Your next question comes from the line of Leonie Foong from Janchor. Please ask your question.

Leonie Foong - Janchor Partners

Hi, Louis. Another question on the Chinese New Year effect, when you were originally making your forecast and making your hiring plans, have you not anticipated this early Chinese New Year effect? And if so, that the reason for the revise, -- slower guidance, is it because the trends you’re seeing is slower than you had originally expected? Thanks.

Louis Hsieh

It is slower than we originally expected. We just taught a couple of – few years ago, it was over a week, it was the difference. This time it’s like three to five days. We thought it will have a negative impact, but not as much as it is. It’s because of the timing were students get out of school – eight or nine days before the holiday itself.

So don’t forget typically we try to run two sessions, one session before Chinese New Year, one session after. The demand for the session before Chinese New Year is been the part, that’s been disappointing because of the compressed schedule, students decided to opt for the session afterwards or not to sign up at all during winter break because seven days or eight days, its just not enough for a full course. So its – I mean, we didn’t expect it to be as bigger impact as it has become to date. Like I said as I don’t want to be chicken little, till the sky is falling.

We’re still going to have a good quarter, we believe, I mean – revenue growth of over 30% or so is nothing to sneeze at. So it’s still going to be within the typical range that we guide of 30% to 35%. It’s just that because the analysts – that you guys had basically taken up the numbers in Q3 and Q4 because we’ve been typically outperforming in those quarters. So you guys are very astute and you figured out that we used to do very well in Q3 and Q4. I want to – we always had 30% to 35%. So this guidance is only 2% lower. And as you know we typically will beat the guidance by a little bit.

So it’s really a quarter in line, but because of the consensus had gotten way up there, like 37%, 38%. And also the profit number had gotten quite high at about 20 – $27 million, $28 million for the quarter. When we saw that the enrollments weren’t picking up as much as we wanted in the first – in the last couple of – that’s actually in the last couple of weeks since – when the student start to signing up and we heard from the parents that they’re not going to (ph) send for classes, there were only seven or eight days.

Leonie Foong - Janchor Partners

Thank you.

Operator

Thank you. And next question comes from the line of Charles Cartledge from Sloane Robinson. Please ask your question.

Charles Cartledge - Sloane Robinson

Hi, Louis.

Louis Hsieh

Hi, Charles.

Charles Cartledge - Sloane Robinson

Could you tell us – hi. Could you tell us what your thinking is or the Board’s thinking is on the $700 million and what you’re going to do with that? Because it’s going to start acting as real cash drive on your balance sheet and the more it goes on, more it will spread on your stock price?

Louis Hsieh

Yeah, I mean, it’s obviously a question we deal with at every Board of meeting as you know. I think you said we’re still kind of in a hold mode, we had that discussion yesterday. The $700 million is little bit deceptive as you know Charles. We’re $200 million isn’t ours, it belongs to the students because its deferred revenue. So that means we’ve about $500 million and because of the nature of our business, one of the biggest risks to our business is pandemics and other things that we were forced to shutdown our schools for long periods of time.

In that respect we need a cash balance of about 12 to 18 months of operating expense, which means we need a whole about $253,000 million. In our pocketing case, there is a pandemic event, like similar to SARS, but much bigger where we’ve to shut down our schools. We don’t want to – have to close the company because of that.

The other – so that leads about $200 million. We need about $50 million in the network as sort of working capital degrees, the wheels as we go into – we’ve 49 cities, each city needs a certain bank balance. So like I said, as we have a balance of about – probably about $150 million to $200 million, we could potentially pay out. The issue is that, that money is not in U.S dollars. As you guys know, our revenues are in RMB than our expenses are in RMB. And so the money that we had in U.S dollars, we used already to purchase shares. So we spend $94 million of our IPO proceeds and bought back $1.4 million EDSS at about $73 a share a few years ago.

So our U.S dollar balance is not high. So we study it each time, but there is no movement on that right now. And as you know there is also withholding tax in China that looks like its 10%, but when the company is going through the process there is being a lot other taxes and the amount goes up into the 20s. And so the cost of dividends or repurchase – stock repurchases becomes overwhelming high, unless you have a lot of U.S dollars and which we don’t.

Charles Cartledge - Sloane Robinson

Understood. Thank you.

Louis Hsieh

Thank you.

Operator

Thank you. Ladies and gentlemen, we’re now approaching the end of the conference call. I will now turn the call over to New Oriental’s President and CFO, Mr. Louis Hsieh, for his closing remarks.

Louis Hsieh

Again, thank you everyone for joining us today. If you have any further questions, please do not hesitate to get in touch with me or any of our investor relations representatives. Have a good day. Have good evening. Thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: New Oriental Education & Technology Group Inc. F2Q2012 - Earnings Call Transcript
This Transcript
All Transcripts