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

F1Q08 (Qtr End 8/31/07) Earnings Call

October 15, 2007 8:00 am ET

Executives

Sisi Zhao - Investor Relations Manager

Louis Hsieh - CFO

Analysts

Catherine Leung - Citigroup

Paul Keung - CIBC

Mark Marostica - Piper Jaffray

Adele Mao - Susquehanna Financial Group

Alex Xu - Brean Murray

Trace Urdan - Signal Hill

Chris Schutler - William Blair & Company

Art Bascomb - Oppenheimer

Mark Chang - Merrill Lynch

Anindya Chatterjee - Jefferies & Co

Marisa Ho - Credit Suisse

Leah Hao - Goldman Sachs

Zhou Wu - Deutsche Bank

Operator

Good evening and thank you for standing by for New Oriental's First Fiscal Quarter 2008 Earnings Call. At this time all participants are in 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 would now like to turn the meeting over to your host for today's conference Ms. Sisi Zhao, New Oriental's Investor Relations Manager. Please proceed.

Sisi Zhao

Hello, everyone and welcome to New Oriental's first fiscal quarter 2008 earnings conference call. Our first fiscal quarter earnings results 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 our CFO. 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 SafeHarbor provisions of the US 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 SEC. New Oriental does not undertake any obligation to update any forward-looking statements except as required under applicable law.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call will be available on New Oriental's Investor Relations website at http://investor.neworiental.org.

I will now turn the call over to the New Oriental's CFO, Louis Hsieh. Louis please.

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Louis Hsieh

Thank you, Sisi. And thank you for everyone who's joining today's call. I am pleased to begin by mentioning that the end of New Oriental's first fiscal quarter of 2008 also marks the close of very successful first year as a public company. On behalf of our Chairman and CEO, Michael Yu, and everyone at New Oriental, we want to thank all of our investors, research analysts, partners, supporters and especially our students for the tremendous success we've enjoyed in our first year as a public company.

It is typical for New Oriental to see its strongest results in terms of student enrollment and revenue generation in our first fiscal quarter, as many Chinese students take advantage of the summer vacation to enroll in our classes.

This year's Q1 was no different, with strong growth in student enrollment in our leading language training and test preparation courses, POP Kids and middle and high school English courses, driving healthy revenue growth in all of our key segments, substantially exceeding our own forecast.

Looking forward, we expect that enrollments in our test preparation courses will continue to be a major driver of our earnings growth. We will continue to leverage our leadership in this area to expand our offerings with courses that prepare students for an even greater range of domestic and international, academic and professional tests.

We are very optimistic about the potential we see for growth in China's primary and secondary school, private sector market, which is just emerging in China. And we are already building upon our strong reputation to take a leading position. We expect to use continued growth in the POP Kids English and middle and high school English enrollment in the quarters ahead.

We are pleased with increase in student enrollments we are seeing at our existing schools and learning centers and we are also expanding our leading nationwide network as demand for private education in China continues to grow.

During the first fiscal quarter, we opened two new schools, one in Jingzhou, which is Hubei Province and one in Dalian in [Liaoning] 06, 1.41 province and 17 additional learning centers and one bookstore, mostly in large cities throughout China.

Our hub and spoke business model allows us to recognize the value of leveraging on the ground school management network to assist in the development of new schools and learning centers, as we increased our presence in large Chinese cities.

Our other business lines, notably online, book sales, and international consulting also grew from the same period last year, largely because of increased course offerings and the fact that our first fiscal quarter is peak season for book sales and enrollments in our international summer camps.

We will continue to develop these areas and explore opportunities for value creating partnerships with international content providers.

Before moving into our first quarter financials, I would like to add that as the Chinese economy continues to develop rapidly, private education providers are increasing their efforts to meet the surging demand for English language education and test preparation services. We are confident in New Oriental's continued role, as the industry leader, as the largest private education provider in China, with a well-recognized brand and a proven business model. We feel we are in an excellent position to continue benefiting from the market opportunities before us.

Recently, many of our competitors have successfully raised capital from private equity funds, and other sources, and are aggressively spending on marketing programs. To respond to this challenge, New Oriental plans to increase their marketing spending in order to continue gaining market share and to add and to grow more rapidly than the overall language training market in China.

Now, I will walk you through the contributions to our first quarter results and some financial highlights. Please note that certain figures I will talk about are non-GAAP, including all measures that are given, excluding share-based compensation expense. You can find a reconciliation of these figures in the financial tables at the end of our press release.

Our first fiscal quarter 2008 total net revenues increased by 42.5% year-over-year to RMB612 million, US equivalent to $81.1 million, from RMB429.3 million in the first quarter of fiscal year 2007.

Revenue from our educational programs and services, comprising our language training and test preparation courses, and primary and secondary education programs, rose 40.4% year-over-year, driven by increases in new student enrollments in language training and test preparation courses. We also saw increased revenue from books and other education materials and services, which rose 93.8% to RMB33.8 million, equivalent of US$4.5 million, from the year ago period.

Total operating costs and expenses for the quarter were RMB343.2 million, equivalent of US$45.5 million, a 37.7% increase year-over-year. Of these, selling and marketing expenses increased 29.5% year-over-year to RMB46.3 million, mainly due to higher expenses to promote the brand in our expanded network of schools and learning centers, which extends to 35 cities at the end of the quarter.

General and administration expenses were RMB102.8 million, equivalent to US$13.6 million, a 37.5% increase from the same period last year, mainly as a result of expansion of our school network.

Operating margin for the quarter was 43.9% compared to 42.0% in the year ago period. Excluding share-based compensation expenses, or non-GAAP, operating margin for the quarter was 46.0% compared to 43.3% in the corresponding period of prior year. This increase was primarily due to the improved operating efficiency as revenue growth outpaced the growth in operating costs and expenses.

Total share-based compensation expenses for the quarter were RMB12.7 million, equivalent to US$1.7 million. Of this amount, approximately RMB872,000 was recognized as cost of revenue, RMB446,000 was recognized as selling and marketing expense and RMB11.4 million as G&A expense.

Net income for the quarter increased by 55.1% year-over-year to RMB256.0 million, equivalent to US$33.9 million, up from RMB165.1 million in the first quarter of fiscal year 2007 and net income, excluding share-based compensation expenses, non-GAAP, increased by 57.4% year-over-year to RMB268.7 million, equivalent to US$35.6 million.

Basic and diluted earnings per ADS were RMB6.86, equivalent to US$0.91, and RMB6.56, equivalent to US$0.87, respectively. Excluding share-based compensation expenses, non-GAAP, basic and diluted earnings per ADS were RMB7.20, equivalent to US$0.95, and RMB6.89, equivalent to US$0.91, respectively. Each ADS represents four common shares.

Common shares used in calculating basic and diluted earnings per ADS in the first quarter of fiscal year 2008, as compared to the first quarter of 2007, were increased due to 34.5 million common shares equivalent or 8.625 million ADSs issued and sold by the company's initial public offering in September 2006, and approximately 2.4 million new common shares equivalent to equivalent the 600,000 ADS's issued and sold by the company, in spite of our offering in February of 2007.

Net operating cash flow for the first quarter of fiscal year 2008 was RMB212.4 million, equivalent to $28.2 million.

Moving to our balance sheet, our total cash and cash equivalents as of August 31, 2007 was RMB1,743.9 million, equivalent to $231.1 million, an increase of 11.5% from the end of fiscal year 2007 as in the May 31 quarter.

I will now read you New Oriental's financial guidance for the second fiscal quarter 2008. Please note that the following outlook statements are based on our current expectations. These statements are forward-looking and the actual results may differ materially.

New Oriental expects its total net revenues in the second quarter of fiscal 2008 September 1, 2007 to November 30, 2007, to be in the range of RMB211.2 million, equivalent of $28 million or RMB224 to RMB224.8 million, equivalent of $29.8 million, representing year-over-year growth in the range of 25% to 33% respectively. This forecast reflects New Oriental's current and preliminary views, which is subject to change.

Once again I want to thank you for participating in our quarterly earnings conference call. At this point I am glad to take questions.

Question-and-Answer Session

Operator

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

Catherine Leung - Citigroup

Hi, good evening Louis and Sisi, and congratulations on a very strong quarter. My first question is, we continue to see revenue and student enrolment growth accelerate. Could you please elaborate on where we are seeing this accelerating growth come from? Is it from the more established tier-1 cities or from the geographic expansion in to the tier-2 and tier-3 cities? Thanks, I have a follow-up question probably will jump back in to the queue, thanks.

Louis Hsieh

Okay, thank you Catherine, a very good question. We are seeing strong demand across all our major program and services, so both in tier-1 and what you call tier-2 cities, what we call all large cities in China. We are seeing a very strong growth and that goes all the way from overseas test preparation to POP Kids English to middle school to Elite and even adult comprehensive English, which was laggard last year, has begun to pickup. So, you can see as we expand our network, we added 17 new learning centers and two schools, we added 19 facilities in one quarter. We are seeing very strong demand across all our major products. So you can see the other business services also are growing at almost 90%, the other revenue category. And you can see that in our student growth which serves 30.5% year-over-year which is I think the highest quarter we've ever had.

Catherine Leung - Citigroup

Okay. Thank you.

Operator

Your next question comes from the line Paul Keung from CIBC. Please proceed.

Paul Keung - CIBC

Hi, Michael, hi Louis.

Louis Hsieh

Hi, Paul.

Paul Keung - CIBC

I hear some comments earlier about the increased competition and the number of the private players being well-funded? [I'll hang] in and your response has been more marketing spend? This clears us to two folds; one is that we all suggest that you'll see a little less efficiency from a marketing standpoint, and two, given at some point would have been their pricing ability to sustain price increases?

Louis Hsieh

Okay. That's a good question. I don't know with in effect it is of the marketing campaign, what you are seeing is we're still spending, like last quarter we spent less on sales and marketing as a percent of revenue than we did in the prior year. But what we are seeing is in the major cities, because of the competitors are coming in, because of private equity money and other sources. They are spending a lot of money on marketing, so we feel to maintain our market share and to increase the share we are taking in these cities we would like to respond by spending on large marketing campaigns as well.

It has not so far diminished our capacity to raise prices that you've seeing by our revenue growth and our student increases. So, in that sense, it is not, we have not felt those effects yet, but I don't know what will happen in the quarters and years to come.

Operator

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

Mark Marostica - Piper Jaffray

Yeah, nice job on the quarter, Louis.

Louis Hsieh

Thanks Mark.

Mark Marostica - Piper Jaffray

Question regarding, actually, a follow-up to the last questionnaire, as you look out to the remaining quarters of the fiscal year, should we expect the same type of leverage on selling and promotion, G&A and cost of revenue as we saw in the first quarter, in another words, year-over-year improvement on a quarterly basis?

Louis Hsieh

Yes, I think, what we expect to see is basically, it should improve year-over-year, expect for Q3. So, don't forget Q3 last year we had an exceptional quarter because Chinese New Year was late that year, we had an extra 10 days of classes, a week or 10 days of classes. So except for that we would expect that we will continue to get operating leverage in our cost structure even though sales and marketing expenses are going to be higher. They should still hold as the guidance we gave, which is around 10% to 12% of total revenues. So, we would expect, as you can see this quarter we trended up marginally. We are higher in gross margins than last year's overall and we are beginning to see some leverage effect.

So you can see us on an apples-to-apples, which means year-over-year comparison, the number should still begin to trend up, except for Q3, which is the December, January, February quarter, because Chinese New Year this year I think will come earlier, so we won't have the benefit of last year.

Mark Marostica - Piper Jaffray

Thanks. I will hop back in the queue.

Louis Hsieh

Thanks Mark.

Operator

Your next question comes from the line of Adele Mao from Susquehanna Financial Group. Please proceed.

Adele Mao - Susquehanna Financial Group

Thank you. Louis, given your brand awareness in test prep and English language training you are able to raise prices year-over-year. Have you seen a pricing pressure in new growth areas such as Kids English where you or Elite English where your competitors have been early entrants in those areas.

Louis Hsieh

Yeah. I think in general, that's a good question though. In general, we have the most leverage on price increases in overseas test prep. I think in the Kids area it is more competitive because there are so many schools, so we do feel that. And Elite is the same thing. We were not the first entrant in this space, but we continue to grow the business very nicely. So, yeah, we do face more price pressures in those two areas. But overall, we are seeing surging demand and we are still able to increase price at a level that we're very comfortable with.

Adele Mao - Susquehanna Financial Group

Okay. Thank you.

Operator

Your next question comes from the line of Alex Xu from Brean Murray. Please proceed.

Alex Xu - Brean Murray

Sure. Thanks. Hi, Louis. Congratulations on the quarter.

Louis Hsieh

Yes.

Alex Xu - Brean Murray

Just a quick one on the student enrollment, this quarter obviously very strong both year-over-year and sequentially. Number one, what's the driver behind that on the year-over-year basis?

And secondly, has this strong number changed your view in terms of long-term student growth on year-over-year basis. I think really in the past you are talking about 10% to 15%, but in the past two quarters you basically brought up the numbers on the growth. So, anything changed on the long-term outlook on that? Thanks.

Louis Hsieh

Yeah. I think we are getting more confident in our growth on the student count. So, I think I originally guided for this year 15% to 18%, about 15% in student actual enrollment growth. I think given that we grew it 30.5% in Q1 alone and that's probably 40% of our revenue, we would expect we should be able to grow students probably in the low 20% range, similar to last year. Because, if you look at the deferred revenues, you will see that Q2 was actually only 11% up from the same level last year. So, basically we allow the students enroll this summer. So, that's why we saw the exceptional growth.

Q2 is trending fine. As you saw we increased our guidance, but the student count, many of the students in Q2 actually enrolled in Q1. So, that's why you saw the surge to 30.5%, which is the highest ever for our first fiscal quarter which is June, July, August.

Alex Xu - Brean Murray

Thank you.

Louis Hsieh

Did I answer your question Alex?

Alex Xu - Brean Murray

Yeah. Thank you.

Louis Hsieh

Yeah.

Operator

Your next question comes from the line of Trace Urdan from Signal Hill. Please proceed.

Trace Urdan - Signal Hill

Hey, good morning or good evening again for you.

Louis Hsieh

Hey, Trace.

Trace Urdan - Signal Hill

Hey. I noticed that you entered the math market, and I wondered if you could tell us a little bit more about that. And sort of specifically how large you see this market being, and whether this sort of is the first step towards putting you more in to the test prep business for the Chinese University entrance exam?

Louis Hsieh

Absolutely yes. And so math is the next logical one. For English language, math and Chinese language are the three key subjects for the Gau Cau or the Chinese equivalent of the SAT or the ACT exam. So, we have also begun to develop Chinese language programs directed for Chinese students to help them prepare for those tests. So, it absolutely is correct.

As far as the math market, we've only rolled this out in only a few cities. So, the 4,800 enrollment you saw this summer is only about I think six or seven cities and only in limited learning centers, because we don't have the teachers yet to teach math across our network. In fact, math wasn't even rolled out in Shanghai this summer because they were just too busy with English.

So, we think it is a problem. It will never be as big a market as English language, but it's a nice incremental revenue source for the same students. If they come to our school for English they might also take math and Chinese and other course while they are here. It saves them time in enrollment, of going to other schools. And don't forget the Gau Cau market is huge, the other Chinese SAT. There is two million...

Trace Urdan - Signal Hill

And that's what I wanted ask about.

Louis Hsieh

Chinese students per year.

Trace Urdan - Signal Hill

Are Chinese students accustomed to spending money out of pocket to prepare for that exam?

Louis Hsieh

Well, many of them are. It is prepared for in the senior high schools in China. But as you know just like in any other country students are looking for an edge. So, they are willing to pay for supplemental training in this area, it's such an important test to their future. That's the sole determinant of which school or which college they get into. And given how competitive the landscape is, there are 10 million kids who take the Gau Cau every year for only 3 million spaces. They only have 30% chance to get in. And don't forget, Trace, those 7 million who don't get in, many of them will spend one more year full-time studying for the SAT or the ACT exam for the next year. So, that's another huge market.

Trace Urdan - Signal Hill

Got it. Thank you.

Operator

You next question comes from the line of Chris [Schutler] from William Blair & Company. Please proceed.

Chris Schutler - William Blair & Company

Hi, Louis, how are you?

Louis Hsieh

Hey, good, Chris. Thanks.

Chris Schutler - William Blair & Company

May be you could talk just for a second about the recent Ministry of Education mandate that graduate enrollments only grew by 5%. Just wondering what kind of impact do you expect that to have on your business? Thanks.

Louis Hsieh

Well, I think, right now, the only graduate exam that we -- you would have a graduate school, right Chris. Okay. Chris, I believe, it's…

Chris Schutler - William Blair & Company

Yeah, that's correct.

Louis Hsieh

Yeah. The only graduate exam that we wouldn't prepare to so far is the CET 6 exam right now, because the Chinese English level thinks it is a very small part of our business. And if that's the case, I actually believe that means the more Chinese students, if they want a graduate degree, will have to go overseas, which is exactly our bread and butter right, that's a most profitable product line which is overseas test preparation.

Chris Schutler - William Blair & Company

Okay.

Louis Hsieh

So, I don't think it should have much impact on our current business.

Chris Schutler - William Blair & Company

Okay, fair enough. And then just one question on M&A if you don't mind, I know you talked a lot in the past about [bunches of] opportunities there, but one area -- I mean is their one area, in particular, that you might be looking at particularly cards right now, and what are your current thoughts on the vocational school markets?

Louis Hsieh

Vocational, we are looking to go into that area in the next 12 months to 18 months. We have been doing a lot of work on the BD side of that area. As far as M&A target, the primary focus will be buying up competitors in large cities, and that goes across our product groups, from kids English to other language training in other areas. So that will be our number one focus, is buying competitors that we can pick up in large markets. Second, will be looking at complementary businesses, so, like, it maybe vocational or other areas that we don't currently have the domain expertise.

And then we are also -- one thing that's not in here, but in Q1, we actually bought a kindergarten. So, in Beijing, the very small kindergarten is immaterial to our earnings. But it's a first step to get a license, because private kindergarten is a very profitable business in China. And because of our English brand name, it's a great synergies, parents will send it to New Oriental just for the brand name. So, we think that ended. ASPs are much higher between anywhere from RMB15,000 to RMB40,000 a year for private kindergartens. So, that's an area that we would like to get into. And as you recall, it's an area that's not as heavily regulated, it's grades one through nine and also colleges.

Chris Schutler - William Blair & Company

Right, okay. How quickly do you anticipate actually being able to ramp up in that market?

Louis Hsieh

I think this will take a while, because you require a separate license in each city you operate, just like our schools. So sometimes in each district you operate, you need a separate license, and they usually take sometime to get. So, that's why we have bought a school that has a very small one as 50 to 100 students right now. And we are now launching the name, New Oriental Star, as our brand name for sort of nursery school and kindergarten age kids. So, you think about it, the thing that parents care about it is that those kids are in a prestigious kindergarten and they are learning English and they are in a very clean environment and that's what we hope to provide.

Chris Schutler - William Blair & Company

Okay. I will turn it over. Thanks.

Louis Hsieh

Thank you.

Operator

Your next question comes from the line of Art Bascomb from Oppenheimer. Please proceed.

Art Bascomb - Oppenheimer

Hi, Louis, just two quick questions, just regarding competitors, you alluded to more spending that you are seeing from private equity-related competitors. I am wondering if you could talk about, who they are and how aggressive they are?

And then secondly, as you talk about the greater degree to which they're advertising and marketing, what are the things that you are specifically doing where they are most active with regard to your marketing and advertising?

Louis Hsieh

Okay. Thank you, Art. I'll give you a couple of examples, I mean Carlyle who owns Wall Street English is I think is a rumor in the market as they're probably eyeing some kind of offering. And so you can see that their advertising spend is very high-end side, is accelerating in large cities, in particularly in Shanghai and Beijing, where they faced a lots of stiff competition in the high-end side and also from our Elite English. So, we are doing the same thing, we are beginning to roll out, we have been advertised more aggressively to get a piece of that very competitive market, that's what we're talking about. Your second question related to market strategy, is that right, Art?

Art Bascomb - Oppenheimer

Yes.

Louis Hsieh

On the marketing strategy, I mean, we would like to sort of market to all levels. But, I think well there is more competition, is going to be in the English language for kids and in very high-end side. So, the marketing dollars we targeted mostly to kids and Elite English segment. I think in the test preparation, we're very comfortable with our market position.

Art Bascomb - Oppenheimer

Great, thank you.

Louis Hsieh

Thank you.

Operator

Your next question comes from the line of Mark Chang from Merrill Lynch. Please proceed.

Mark Chang - Merrill Lynch

Hi, Louis.

Louis Hsieh

Hi, Mark. How are you?

Mark Chang - Merrill Lynch

Good. Well, one question -- I think on your balance sheet, you've not got about RMB1.7 billion and you just mentioned that you did a small acquisition and you've been talking about looking for acquisition in the past, and is there any update on that, and will you be considering paying out any dividends, if you keep generating such a big amount of money on your balance sheet?

Louis Hsieh

Yes. I think right now, we have several specific targets that we are aggressively pursuing in the M&A side. And as I mentioned earlier they really relate to competitors in large cities and also in domain knowledge like kindergarten. We didn't have that license for that domain knowledge when we bought it. So wasn't very expensive but it's a first step for us and then in areas like Gau Cau we want to go into the Chinese SAT, it’s a highly fragmented market. So those are areas that we don't have the full domain knowledge yet, but we'd like to make some acquisitions there.

As far as the cash goes we've got 230 million on our balance sheet. I don't want to pay a dividend, if I did any I'd probably, my suggestion would be to buyback shares, but we get a lot of resistance as you know from our large investors who think our float is not -- we don't have enough liquidity as it is in our float. So we are looking to deploy that money and buy acquisitions where we could probably use more cash than shares if any shares at all.

Mark Chang - Merrill Lynch

Okay. Thank you.

Operator

Your next question comes from the line of Anindya Chatterjee from Jefferies & Co. Please proceed.

Anindya Chatterjee - Jefferies & Co

Hi Louis. Congrats, for the good numbers. Wanted to know more about your acquisition strategy particularly when it comes to four year colleges that you had talked earlier, [break in] amount of four year colleges, and also on the Gau Cau provider? It will be too -- where do think you are going to be if you take the one year view?

Louis Hsieh

What is the second question? Sorry.

Anindya Chatterjee - Jefferies & Co

Yeah, asking about your acquisition strategy on expansion on complimentary businesses and particularly four year colleges have been Gau Cau providers?

Louis Hsieh

Okay, I think many of the analysts know my view on, what you call as -- I've never been a big -- I have only one voice so let me say that upfront of the board and of the management. So I'm just one of five board members and one of -- Michael is the key decision maker as the CEO and Chairman. But I personally don't like the four year of private college business in China, because of the current regulatory stream and the sort of the system that's in place for revenue. The degrees are controlled basically by the government, which is in the system where they dole out the degree. So it's a very competitive market and I don't believe it is as profitable like some of the other businesses that we are in today. So that's just my opinion, it's not necessarily the view of the whole company.

As far as acquisitions, as I said we have a lot of cash and most of the targets we are looking at are much smaller than we are. So they take time to digest because, these are companies that don't necessarily -- the most sophisticated don't have ordered books -- you are not getting lined up it as a public company we need to do the particular financials for these companies in order to report then to you guys. So, the due diligence process in this area takes much longer than for a company that has a good set of books and it will takes time. So we are aggressively pursuing targets like I said to be competitive again and with the domain knowledge like Gau Cau, like kindergarten, like areas that we don't have our own, like vocational.

Anindya Chatterjee - Jefferies & Co

Thanks.

Louis Hsieh

Okay

Operator

(Operator Instructions) Your next question comes from the line of Marisa Ho from Credit Suisse. Please proceed.

Marisa Ho - Credit Suisse

Just wanted to wish on the great quarter, congratulations.

Louis Hsieh

Thank you.

Marisa Ho - Credit Suisse

Looking at enrollment, I mean they have actually been tracking very much ahead of your original expectations. And you also mentioned that competition could be heating up and you want to make sure that you are maintaining or increasing your market share. What are these actually doing to your organic growth plans for the rest of the year?

Louis Hsieh

I think we were pleasantly surprised by the surge in enrollment, but 30.5% is way too high. And so, like as I said, I think some of the students that enrolled during the summer will actually go into Q2. So, you'll see a slowdown in Q2 enrollment, but that doesn't mean -- you see our revenue guidance for Q2, actually is well above what we normally would guide. So, you can see that we are pretty confident on Q2, than the quarter we're in now. But I think as 30% revenue -- student growth is too high, we think we are more comfortable with the low 20%.

As far as organic growth you can see that we opened 17 learning centers, which is an all time high for us. We opened two new cities. So, we're seeing surging demand across our major product lines, especially in overseas test drive, and especially in POP Kids English. And now where some of those learning centers are opening are in the high end side, Elite and VIP English, as well as in Adult comprehensive English. This was the strongest quarter of growth for Adult compressive English. Student enrollments were up over 18%, which is very-very good for that sector, which last year has grown about 5%. So, we're seeing strong demand across our major product groups.

Operator

Your next question comes from the line Leah Hao from Goldman Sachs, please proceed.

Leah Hao - Goldman Sachs

Hi good morning, can you hear me.

Louis Hsieh

Yes, I can here you Leah, thank you.

Leah Hao - Goldman Sachs

Yeah, hi Louis, how are you? Just a quick question. Since you have given your continued geographic expansion, can you give us an idea of the utilization rate of your facility right now, breakdown by tier-1 versus tier-2, and what's your outlook for the remainder of the quarter?

Louis Hsieh

Okay. I think as you know, we don't really track utilization, but during the summer for most of our Tier 1, the larger cities were very full. So, I don't know their full capacity, but they were very full. The quarter we are in now, and the rest of the year they will not be fully utilized, because students don't have the two months off as they did in summer. So, Q3 will see a nice bump up normally because the one month Chinese New Year holiday. Q2, they were in as usually slow and Q4 is slow. But at the beginning of the year we had guided revenue growth of about 20% to 25% that we are comfortable with. I think we are very comfortable to take that up well over 25% probably closer to 30% as you see in the numbers. If our first quarter grew 42.5% in revenue, it's 40% of our revenue. It didn't take a genius to figure out that our growth assuming the rest of the quarters are reasonable will be probably high 20s or low 30s.

Leah Hao - Goldman Sachs

Great. Thank you.

Operator

Your next question comes from the line of [Zhou Wu] from Deutsche Bank. Please proceed.

Zhou Wu - Deutsche Bank

Hi Louis. Congratulations on this first quarter.

Louis Hsieh

Thank you, Zhou.

Zhou Wu - Deutsche Bank

Okay. I know one of your biggest competitors Global IELTS is actively implementing its franchised schools plan. So do you have any plan in the near future about implementing the franchise schools?

Louis Hsieh

We've never franchised in the big cities and we did that on purpose, because one of our core competitive strengths is our brand and the ability to have a similar experience across different cities. When you franchise you loose control of the quality of teachers and teachers are key to student's educational experience. So, we believe that if you lose that control you can't really manage your brand. This is not like the McDonalds or Starbucks where everything looks exactly alike, and the key to teaching is the content, the brand and the teachers. And we believe when you franchise you loose control of the teachers and also you loose control to some degree of the look and feel of the school.

Our New Oriental Schools, many of them look very similar. They have the same high quality and we believe that franchising is not optimal model if you want to build a very strong brand name.

Zhou Wu - Deutsche Bank

Okay. Thank you.

Operator

Your next question comes from the line Catherine Leung from Citigroup. Please proceed.

Catherine Leung - Citigroup

Hello, hi. Could you please update us on your geographic expansion plans? I know that the last time we talked we talked about scaling back your geographic expansion and focusing more on the Tier 1 kind of the larger cities, increasing the numbers of learning centers there. And what type of impact on margins do you foresee this strategy to have? Thank you.

Louis Hsieh

I think we still aren't going to grow that many new cities. Cathy, as you know, we grew 19 facilities, but only two new cities, right. So, the bulk of it is exactly what we told you, which is that we are going basically add learning centers in existing cities, because the demand is there.

During the quarter we added basically learning centers in many of the big cities, both Tier 1 and Tier 2 cities and that is how that breaks down. But we ended up with about 70 new learning centers across probably 15 or 16 cities. But every big city of the top eight cities, I think let me count here, 1, 2, 3, about five or six of the top cities all had a new learning centers this summer.

The strategy has only changed. We would like to focus more on adding learning centers in existing cities than to just grow out in to new cities. So we grew two cities we will probably, as we had originally forecasted four to six cities for the year. But, the learning center count would probably expand, will probably take that number up, because the success of the first quarter to probably well over 30 learning center this year up from the 25 we had originally guided.

Catherine Leung - Citigroup

Okay. Thanks.

Operator

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

Mark Marostica - Piper Jaffray

Louis, in regards to your expansion of the learning center footprint, I am curious if you could give us a sense of the economic value of the learning center model? Again, time to break even an operating margin profile and that sort of thing? Thanks.

Louis Hsieh

I think in general in an established city a learning center is very profitable. It will cost us typically between, probably, if the cost is going to go up a little bit, let's say $80,000 to $130,000 to lease the building or several floors of a large building. We'll hire some staff and put in the desk and the TVs. The model is such that, that investment will be paid for and return the full invested capital probably in three to six months. So, it is a highly profitable model, the learning center model for us and that's part of the reason we get operating leverage. Because we don't get as much operating leverage in the school level as we do in the learning center model. So, within the learning center we don't have to hire another school head. We don't have to hire a marketing team. There is no registration system there, and there are no bookstores or any kind of cost there. They are just typically empty classrooms that the teachers travel from the schools to teach at, and so they are much more profitable for us than opening a new school.

Mark Marostica - Piper Jaffray

And in regards to the…

Louis Hsieh

I don't exactly have one for each school, it depends on the cities operating in. But, they're all typically when they are a year or two in, they should easily be 25% operating margin, if not much higher.

Mark Marostica - Piper Jaffray

Okay. Thank you.

Louis Hsieh

Probably north of 30%.

Operator

Your next question comes from the line of Adele Mao from Susquehanna Financial Group. Please proceed.

Adele Mao - Susquehanna Financial Group

Louis, we've seen some new initiatives from New Oriental recently, for example, a rollout of ELT Advantage courses that offer English Teacher Certification. Could you discuss how fast programs like this may ramp up and whether this initiative could be a meaningful revenue driver for fiscal 2008?

Louis Hsieh

Good question, Adele. We launched ELT Advantage with Thomson Learning. What ELT does is that it gives the TESOL certificate to English teacher, so absolutely international standard from what I guess by. I think its Cambridge University for English teachers across the world. China hasn't really adopted TESOL yet, so New Oriental being the largest English teaching school -- I tell you it's only in China. Thomson wanted to partner with us to build that standard, that certification for English teachers. So, we are trying to, at this point, looking on a pilot with Thomson to get many of our teachers TESOL certified. We believe that's a marketing advantage in the market today if our teachers to say that they have the TESOL certification, in objective international standard for English teachers.

If that catches on, we will be the exclusive provider of the ELT Advantage in China for several years. So, it will not have a meaningful impact on '08 earnings, but we are optimistic that '09-'10, it will begin to have more impact and it will give us that marketing advantage as we recruit students into our classes, because our teachers -- many of them will be TESOL certified, if not all of them at some point.

Adele Mao - Susquehanna Financial Group

That's great. You envisioned sort of a nationwide rollout into '09 and '08, and I assume programs like this should help smooth out your seasonality, correct?

Louis Hsieh

Right, this is what it is there is -- I think I believe there is six or eight, I can't remember, different modules and teachers can study them online, so this is sort of our co-learn site, this is one of our online program. They take the course and they pass the test, every test they pass, they get a certificate if they pass this module. And that certificate gives them a marketing advantage in other countries outside of China; that says this teacher is proficient in English and has been certified by TESOL, the international standard for English teachers. So, we believe if we get us a marketing management, we believe we will get some revenue and we believe it will help us recruit more students.

Adele Mao - Susquehanna Financial Group

Great, thanks a lot.

Louis Hsieh

Sure

Operator

(Operator Instructions) Your last question will come from Trace Urdan from Signal Hill. Please proceed.

Trace Urdan - Signal Hill

Hi, Louis, I just wanted to come back and make sure that I understood something that you had said earlier when you were talking about acquisition strategy. Does it now you suggested that sort of four-year degree granting schools that are heavily regulated are less attractive business and less interesting to you now?

Louis Hsieh

I said that's my view, but at the same time, we would like to buy one. So, Michael was always telling, post 12/31 he would like to acquire one policy to give us the degree granting ability and also if it's in Beijing or Shanghai, we can get a lot of benefits from it because we can use that campus for our summer camp. Again, this summer, we spent millions of US dollars on temporary space in Beijing and Shanghai for our summer camps. So, we would like to get a campus, and also we would like to get the degree granting ability to help with our vocational training in our online program. It helps us with do either more partnerships with international renowned-educational institutions.

Trace Urdan - Signal Hill

Is there a minimum size or something associated with what kind of property you would acquire?

Louis Hsieh

Well, I think we would -- it doesn't make sense to acquire anything that has fewer than probably 2000 or 3000 students at a minimum and I think anything over -- there is not that many private colleges that are over 10,000 or 15,000 students. So in the 3000 to 10,000 student range, it's probably the right size.

Trace Urdan - Signal Hill

I was asking because I was very surprised when I learned that China Cast had kind of successfully got an MOI on the Wuhan Media and Communications College. And it struck me that you guys would probably be a much more likely acquirer of choice and I sort of wondered if that was because that asset was too small for you or too regional or too vocationally specific or maybe you could comment on that?

Louis Hsieh

I mean we had the target to make the more sense to me right now. We have obviously limited staff on business development as acquiring competitors and acquiring sort of vocational knowledge versus the full-year college. If we bought a full-year college, we wouldn't be interested in Wuhan, but only be interested most likely, this is Michael on the Board thinking in Beijing or Shanghai where we can really use that physical facility as well as the fact that probably the tuition and the revenue is a little bit higher in those cities.

Trace Urdan - Signal Hill

Got it. Okay, thanks.

Louis Hsieh

The Wuhan for college would probably not be the most desirable target for us.

Operator

Your next question comes from the line of Anindya Chatterjee from Jefferies & Co. Please proceed.

Anindya Chatterjee - Jefferies & Co.

Hi, Louis, I just wanted to get some more clarity on the guidance, this time your actuals have turned out to be significantly better than your initial guidance. What caused this, was it enrollments that picked up later, just to throw a light on future guidance and decisions in that process?

Louis Hsieh

Yeah, I think, if you recall, our deferred revenue number was calling for about a 35% growth this summer. The deferred revenue number on our balance sheet at the end of Q4 was about 35% higher than the year ago period. So, we thought if things are well, we can go about 35%. It turned out that we had surging demand this summer for overseas test prep and kids in middle school just across the spectrum. So, it was unanticipated, therefore again last year our Q1 was a record quarter for us, its the best ever in New Oriental's history. And then it did exceed that by 42% and 55% in profits; I just couldn't -- in good conscious try to forecast that. Okay, so -- going forward though because given that as 40% of revenue and use the 60% to 70% of our profits in a year it makes sense then just the law of numbers will tell you that we should be able to grow students in the low 20s on a conservative basis and revenues in the high 20s to low 30s without having to stretch or it won't be a stretched target for us basically. So it's a very surprising quarter, it really surprised the whole management team.

Anindya Chatterjee - Jefferies & Co.

Right, thank you.

Operator

We are now approaching the end of the conference call. I will now turn the call over to New Oriental's Chief Financial Officer, Louis Hsieh for his closing remarks.

Louis Hsieh

Well, I think I just want to thank everyone for the opportunity to give our Q1 guidance. Like I said we are very pleased with our results this quarter. We see very strong demand across our major programs and services and we are quite optimistic about our outlook. And we want thank you all for your support and like that we are very pleased with our performance in our first year as a public company. Thank you very much and we look forward to seeing you in person in conferences as we travel. Thank you.

Operator

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

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Source: New Oriental Education & Technology F1Q08 (Qtr End 8/31/07) Earnings Call Transcript
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