New Oriental Education F2Q08 (Qtr End 11/30/07) Earnings Call Transcript

New Oriental Education & Tech. Group Inc. (EDU)

F2Q08 Earnings Call

January 15, 2008 8:00 am ET

Executives

Sisi Zhao - Manager, Investor Relations

Louis T. Hsieh - Chief Financial Officer, Director

Analysts

Mark M. Marostica - Piper Jaffray

Adele L. Mao - Susquehanna Financial Group

Scott Schneiber - Oppenheimer

Trace Urdan - Signal Hill Group

James Mitchell - Goldman Sachs

Brandon Dobell - William Blair

Alex Xu - Brean Murray Carret

Catherine Leung - Citigroup

Anindya Chatterjee - Jefferies & Co.

Marisa Ho - Credit Suisse

Presentation

Operator

Good evening and thank you for standing by for the New Oriental second fiscal quarter 2008 earnings conference call. (Operator Instructions) I would like to now turn the meeting over to your host for today, Miss Sisi Zhao, New Oriental Investor Relations Manager. Please proceed.

Sisi Zhao

Hello, everyone and welcome to New Oriental's second fiscal quarter 2008 earnings conference call. Our second 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 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 obligations 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 New Oriental's CGO, Louis Hsieh. Louis, please.

Louis T. Hsieh

Hello to all of you on the call and on the webcast and thank you for joining us today. I am pleased to report that New Oriental posted solid results for the second fiscal quarter of 2008, with strong top and bottom line growth. I would like to take you through some of the highlights in the quarter before moving to the second quarter and six-month financials.

As you may know, our second fiscal quarter corresponds with the beginning of the Chinese school year and as a result is typically characterized by a sharp drop in enrolment from the summer quarter.

We are pleased to report that despite seasonality, we experienced healthy revenue growth in all our key segments, which led to a 42.4% year-over-year net revenue increase and our net profits this quarter grew 77% over the same period a year ago.

During our second fiscal quarter, we continued our strategy of foregoing short-term profits in favor of rapidly expanding our leading nationwide network by establishing a net of 34 new schools and learning centers in the first half of our fiscal year 2008. That’s compared to 19 schools and learning centers for the entire fiscal year 2007.

In order to staff our rapidly growing physical network, we added over 900 teachers and staff in the first half of our fiscal year 2008. In addition to increasing our G&A spending, primarily due to headcount increases, we also continued to rapidly increase our marketing spending, which during the second quarter grew by approximately 50% year over year, in order to drive strong student enrolment and revenue growth. We expect to continue benefiting from this rapid expansion strategy in the quarters and years to come.

In the second quarter, we were able to beat top line guidance and the main drivers behind our revenue growth was the strong rise in student enrolment for our leading language training and test prep and overseas test prep courses for the year-over-year increase from 217,000 students to over 257,000 students this year second quarter.

Also driving revenue growth this quarter was enrolment in our overseas test prep program and POP kids English program, which increased more than 30% and 50% respectively over the same period last year.

We continued our pilot program in mathematics in a half a dozen cities and are pleased to report we had over 3,800 enrolments in the fall quarter, usually a slow period when students go back to school.

As the private education trade in China expands to students at younger ages, we are recognizing -- we recognize the potential in providing families with full-time enrolment options for pre-school aged students. In the first fiscal quarter, we began our kindergarten business and I am pleased to report that our first operational kindergarten opened officially during the second quarter in Beijing.

Looking forward, we expect the trend to continue with families beginning their children’s education at younger ages and we plan to leverage our leading brand name in English language to provide competitive options to this highly fragmented area.

In general, Chinese parents are name brand buyers and the education of their child or children is the top priority in their lives. When selecting pre-schools for their one child, parents will typically consider the following criteria: known brand name, clean and safe environment, quality programs with English language training a definite plus -- kids learn Mandarin at home, typically -- convenience, and price.

We believe that our New Oriental Star branded kindergartens will be an attractive offering in this competitive fragmented market.

As our enrolment continues to rise, we realize the importance of providing our growing number of students with course content that meets the highest standards. Aside from developing content in-house, we constantly seek out collaborations with leading domestic and international content providers.

During the second quarter, we announced two new strategic agreements with premier content providers, ETS and Heinle ELT, a part of Cengage Learning, formerly Thomson Learning.

Our agreement with ETS, students enrolled in New Oriental's TOEFL preparation course will now have access to ETS’ online program which further solidifies our dominant position in TOEFL test preparation.

And under our agreement with Hienle ELT, Hienle ELT will work with New Oriental's instructors to develop a line of localized English language training materials, including text book and video programs and Internet based content for use in New Oriental's iEnglish brand courses and by New Oriental's [inaudible] online platform.

Also, we continue making good progress in upgrading our Beijing elite learning centers with a DynEd software model. As we announced last year, the upgrade to DynEd’s international state-of-the-art English language training software in elite English courses will provide teachers with a platform by which they can track the progress of each student. The software will also help reduce operating costs as students will spend the first stages of the courses using the software and only at a later stage will teachers be needed for in-class instruction. We expect to expand our elite English with DynEd software in other cities in 2008.

Now I will walk you through the contributions to our second fiscal 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 the press release.

Our second fiscal quarter 2008 total revenues were RMB240.6 million, equivalent to $32.6 million, an increase of 42.4% over the second fiscal quarter of 2007. Revenues from our educational programs and services comprising our language training and test preparation courses and primary and secondary education programs, rose 37.9% year over year, driven by an increase in new student enrolments in language training and test preparation courses.

Overall, operating costs and expenses for the quarter were up 43.3% year over year. Of these, costs of revenue increased by 35.5% year over year, mainly due to the increased number of courses offered to a larger student base and a greater number of schools and learning centers in operation.

Selling and marketing expenses increased 49.9% year over year, due to the brand promotion expenses and headcount increases. In addition, as you are aware, China’s inflation rate has been rising for the last year and we are feeling the stress of wage inflation for teachers and staff as we continue to compete for the best personnel.

G&A expenses increased 52.6% year over year, primarily due to increased headcount as the company expands its network of schools and learning centers.

Operating margins for the quarter was negative 0.5%, compared to positive 0.2% in the corresponding period of the previous year. Excluding share-based compensation expenses, operating margins for the quarter was 5.8% compared to 4.5% in the corresponding period of the prior year. This increase was primarily due to the improved operating efficiency as revenue growth outpaced the growth of operating costs and expenses.

Total share-based compensation expenses for the quarter was RMB15.3 million, equivalent of $2.1 million. Of this amount, approximately RMB2.4 million was recognized as cost of revenue, RMB0.5 million was recognized as selling and marketing expense, and RMB12.3 million is general and administrative expenses.

Net income for the quarter increased to RMB14.5 million, equivalent of $2 million, an increase of 77% from the second fiscal quarter of 2007. Net income excluding share-based compensation expenses increased to RMB29.8 million, equivalent of $4.0 million, an increase of 83.6% from the second fiscal quarter of 2007.

Basic and diluted earnings per ADS were RMB0.39, equivalent of $0.05, and RMB0.37, equivalent of $0.05 respectively. Excluding share-based compensation expenses, or non-GAAP, basic and diluted earnings per ADS were RMB0.79, equivalent of $0.11, and RMB0.76, equivalent of $0.10 respectively. Each ADS represents four common shares.

Moving to our balance sheet, our total cash and cash equivalents as of November 30, 2007 were RMB1.8248 billion, equivalent to $247.1 million, an increase of 4.6% from August 31.

Capital expenditures for the quarter was RMB12.3 million, the equivalent of $1.7 million.

Net operating cash flow for the quarter was RMB63.9 million, or equivalent of $8.6 million.

Financial results for the six months ended November 30, 2007 -- before I give guidance, I would like to take a brief look at the comparison between the first six months of fiscal 2008 and the first six months of fiscal 2007.

Student enrolments in language training and test prep courses grew 25.8% year over year to 698,200 approximately. Net revenues were up 42.5% year over year to RMB852.6 million, equivalent of $115.4 million. Net income was up 56.1% year over year to RMB270.5 million, the equivalent of $36.6 million. Non-GAAP net income was up 59.6% year over year to RMB298.5 million, equivalent of $40.4 million. And our operating margins went from 30.2% in the six months ended November 30 2006 to 31.4% in the six months November 30 2007.

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

Total net revenue in the third fiscal quarter 2008 that runs from December 1, 2007 to February 29, 2008, are expected to be in the range of RMB311.2 million, equivalent of $42.1 million, to RMB326.5 million, equivalent of $44.2 million, representing year-over-year growth in the range of 22% to 28%.

Please note that New Oriental's third fiscal quarter 2008 revenue growth will be especially challenging when compared to the third fiscal quarter of 2007, which showed year-over-year net revenue growth of 51.3%. The company’s third fiscal quarter 2007 benefited from the late timing of Chinese New Year in 2007, which fell in the third week of February 2007, allowing Chinese students an extended winter break and a longer period of time to study in language training and test prep courses. This will not be the case in 2008, as the Chinese New Year falls on the first week of February, a more typical date for the Lunar New Year celebration.

In addition, many schools throughout China, including those in Beijing, have decided to shorten the 2008 winter break for students by one week or more, in return for extending the 2008 summer break by a corresponding length of time. This is in order to allow Chinese students time to study and enjoy the Olympic Games that will be in Beijing this summer.

Furthermore, we expect to see continuing margin pressure from wage inflation as we continue to rapidly grow our business. We also expect stock-based compensation expenses to increase significantly beginning next quarter as we grant options and restricted shares to retain our talented teachers, school heads, and management.

New Oriental typically grants options and restricted shares twice a year, in February and in August, and this year’s grants are expected to be significantly larger than 2007 because the large batch of incentive shares were granted in early 2006 before our IPO, and those shares are subject to three-year vesting which will conclude in the next year or so. The grants in 2008 will in part replace the 2006 grants to retain our top management and teachers.

Notwithstanding these numerous challenges and factors, we continue to see surging demand for educational programs and services in the current quarter, and we expect to continue to execute on our strategy and continue to deliver strong growth in top and bottom line financial results for our shareholders, particularly on a non-GAAP basis.

As of Q2 2008, our deferred revenue balance is RMB278.8 million, representing a 52.6% increase compared to the same fiscal quarter last year. Deferred revenue balance, which appears on the current liabilities portion of our balance sheet, represents the course fees and school fees collected from students who will take the classes in subsequent quarters, essentially a measure of backlog and a good indicator of current demand.

Before moving on to your questions, I also want to mention that as far as we know, we have not as yet been negatively impacted by the economic slow down and related events in the United States given that virtually all of our revenues are derived from the China market. Moreover, we continue to benefit from the strengthening RMB, given that virtually all of our revenue are in RMB and are translated into U.S. dollars for financial market reporting convenience. In addition, the strengthening RMB helps our students who wish to study abroad as it makes it less expensive for them.

Once again, thank you for participating in our earnings call for the second fiscal quarter of 2008. At this point, I am happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Mark Marostica from Piper Jaffray. Please proceed.

Mark M. Marostica - Piper Jaffray

Thank you and good evening, Louis and Sisi. I wanted to ask you a question about the big jump in revenue per enrolment this quarter. I think it was up a little over 20% year over year. What drove that jump? And perhaps if you could delineate between test prep and English language instruction it would be helpful.

Louis T. Hsieh

I think overall, ASP increases were north of 15% this last quarter and in overseas test prep, it was higher than 15%, so it was the highest driver. And also, as you know, Mark, we have continually been moving to smaller size classes, which means the ASP will naturally be higher because there’s fewer students in the class and they are priced that way. So those two factors together made ASP increases north of 15% for the current quarter.

Mark M. Marostica - Piper Jaffray

As a follow-up, would you expect that rate of ASP increase to affect the other quarters of the fiscal year?

Louis T. Hsieh

We have always sort of guided around 10%, 10% to 13% ASP growth, so we will continue to say probably conservatively 10% to 13%, although it seems that we have exceeded those numbers the last few quarters.

Mark M. Marostica - Piper Jaffray

Great. I’ll turn it over and hop back in the queue.

Operator

Your next question comes from the line of Adele Mao from SIG. Please proceed.

Adele L. Mao - Susquehanna Financial Group

Louis, could you discuss a little more in detail related to your marketing expense ramp-up, given intensified competition out there? What are the new marketing initiatives that you have put in place and would you expect further ramp-up in marketing expenses in the quarter as they come particularly before Olympic Games and when the high season, the summer vacation season for students comes around?

Louis T. Hsieh

That’s a good question, Adele. Thank you. For New Oriental, the marketing expenses are several -- the increase is about 50% year over year and that’s really a result of adding personnel and also advertising in more cities. Because at this time last year, we were in about seven or eight fewer cities, as I recall, so we have to advertise in more cities.

The second thing is the advertising actually costs more this year because of all the companies in China that are competing for the advertising space and you’ve seen a lot of companies IPO-ing in the advertising space in China, from China. Actually, the ad rates have gone up so that has naturally increased our marketing spend. And then the factor that we’ve mentioned in the past has been that private equity has injected a lot of money in education companies and several of them have listed in the United States as well. And they are also spending aggressively using those funds to market.

So we need to meet those challenges by spending a lot of marketing ourselves, and so you saw it increase. You wouldn’t just -- just advertising spend is also in headcount increases in the marketing team.

In addition, we are -- this quarter we don’t expect as big a ramp-up in marketing spend versus last year. Last year we spent about 30, 38 million in Q3. We will spend more than that but it won’t be the same 50% increase.

Q4 traditionally for us is a very heavy marketing spend and we’d expect it to be another ramp-up in marketing because Q4, as you’ll recall, is the March/April/May quarter, and that sets up our summer quarter, June/July/August, which is our key, our most important quarter. So we will probably curb a little bit of the advertising spending in Q3 and ramp it up in Q4.

Now remember, part of the 50% increase in Q2 was because we were trying to drive the strong student growth for Q3, which is what we are in now. So all that spending for Q2 is really meant to set up Q3, which is our second-strongest quarter. And you saw some of the benefits of that in our backlog in the deferred revenue side where it was up to RMB278.8 million, up 52% year over year. Remember last year was record year for us, so it is paying off in student enrolments.

Adele L. Mao - Susquehanna Financial Group

Great. That’s very helpful. Thank you.

Operator

Your next question comes from the line of Paul Keung from Oppenheimer.

Scott Schneiber - Oppenheimer

It’s Scott Schneiber from Oppenheimer. Just following up on looking ahead to the spend lines, you’ve mentioned that there’s been wage inflation so the cost of new hires, and you had a lot of new hires in the first half, I think 900, was putting some pressure on and then obviously you just mentioned that advertising spend is creeping up. And thanks for the second half discussion, but are we going to see you creeping to new levels longer term, or do you think that you can drive the scale and compensate for these inflations?

Louis T. Hsieh

I think we’ve been quite successful in raising prices higher than our costs are going up, so we would expect to do that in the near-term. We don’t know, of course, about the long-term but in near-term, we would expect, given that we do have some pricing power to increase ASPs at a higher rate than wage -- wage inflation is between 6% and 10% a year and as you know, we’ve been able to increase prices between 10% and 15% year over year. So we’d expect to continue to do that in the short term.

Scott Schneiber - Oppenheimer

Thanks.

Operator

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

Trace Urdan - Signal Hill Group

Louis, I’m wondering if you could speak a little bit about the announcement you made regarding the introduction of Chinese language courses and I presume now you have all of the pieces necessary for the Chinese entrance exam test prep and I wondered if you could maybe talk about your plans in that market a little bit.

Louis T. Hsieh

That’s a great question. The Chinese language program that we have now is on our [inaudible] side and it’s mostly directed actually at foreigners who want to learn Chinese or -- it’s not as much the Chinese grammar yet, so we expect to roll out Chinese grammar classes targeted at the national entrance exam over the next year.

In that market, Trace, we would hope to be more aggressive in entering that market in the next year. I would prefer to do it through acquisitions but we will also go it alone if we can’t find suitable acquisition targets who are willing to be acquired by New Oriental.

We believe that’s a very lucrative market going forward. We already trained 200,000 plus high school students in the English portion of that and we just began to offer mathematics, as you know, the last couple of quarters, and we’re beginning to see good traction there.

We will offer Chinese language next year but we are still missing some of the other subjects, such as Chinese politics and history, some of the specialized subjects like in chemistry or physics or other subjects, so the ideal way for us would be to acquire our way into that business.

Trace Urdan - Signal Hill Group

Are there any well-scaled businesses in that market right now?

Louis T. Hsieh

No, they are mostly local businesses. Because of the way that the Chinese national entrance exam is set up, each province has a slight variation on that exam, so there is strong local players. It is just like most of the education markets in China, they are highly fragmented and very local. So our ideal would be to acquire a leading player in several of the large markets and then [certainly consolidate] that and build a brand around that to grow that business.

Trace Urdan - Signal Hill Group

Thank you.

Operator

Your next question comes from the line of James Mitchell from Goldman Sachs. Please proceed.

James Mitchell - Goldman Sachs

Could you just talk a little bit about the February stock grant and perhaps a very rough quantification in terms of the P&L impact, and also in terms of the share count?

Louis T. Hsieh

As you know, James, I’m not good with [inaudible], so I don’t know the P&L impact yet. But I think what this stems from is that in January and February of 2006, before our IPO, we had 8 million shares, so about 2 million ADS, shares -- sort of a massive grant to the employees, to about 350 people within New Oriental -- you know, the top management on down to the teachers and school heads. And then what happened was that they are three-year grants, so they expired at the end of this year. So what we need to do is in order to keep the people, we need to have another -- not quite as large a grant as in 2006 but a large enough grant.

And as you know, because of the performance of our stock price and the volatility, the stock-based comp charge is much higher now than when we were a private company. So we would expect the stock-based comp over the next quarter -- it will hit us in Q3. we’ll be probably double, if a little bit not higher than what it is today and today it is about $2 million a quarter. So we expect that to double and then the effect will be felt for a couple of years, because we are layering two years of stock grants together. And then they will begin to subside a little bit in about 18 months from now.

I don’t know the exact quantification, James, but it will probably be well over -- it will probably double what the stock-based comp charge is today.

James Mitchell - Goldman Sachs

That’s exactly what I needed. No need to break out the --

Louis T. Hsieh

But we are also moving to a combination of restricted shares and options, which will actually -- short-term, it will hit the P&L harder because restricted shares take the full value of the shares. But they also -- they have a minimum impact on dilution, and so the board has decided to go with a combination of restricted shares and options.

James Mitchell - Goldman Sachs

Great. Thank you.

Operator

Your next question comes from the line of Brandon Dobell from William Blair. Please proceed.

Brandon Dobell - William Blair

Thanks. Louis, maybe going back to the ASP question, you mentioned overseas test prep up a little bit more than 15% in ASPs. If you could maybe disaggregate the benefits you guys saw from reducing the class sizes, how much of the year-over-year ASP increase in total was driven by that?

And the same kind of question -- on the gross margin these days, or on the rest of the operating expenses, how do I think about what the class size reductions are doing to other gross margins or operating expenses and how far along are you in that process of getting those class sizes down into more manageable levels?

Louis T. Hsieh

Good question. Thanks, Brandon. To be perfectly honest, the price impact of year-over-year classes is about 10% on average. So it’s exactly the same class, so the fact that we -- our ASPs went up over 15% this quarter year over year, much of it is driven by the overseas test prep side, which was up well north of 15%, very close to 20%. And then the remaining impact is due to the smaller class sizes.

We are going to begin to get data on the actual number of progress -- we’re collecting it now, Brandon -- on the number of classes that are of certain sizes. So I don’t have the exact reduction but I know that overall, it’s about 8% or 9% per year of classes are going to the smaller size format of basically 20 or 30 students versus 50 to 70 students.

Brandon Dobell - William Blair

Thank you.

Louis T. Hsieh

Okay. And on the gross margin impact, we would expect it to be slightly -- probably slightly negative to the gross margin but not materially.

Operator

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

Alex Xu - Brean Murray Carret

Thank you. Good evening, Louis. I have a quick question on your learning center -- it looks like so far in this fiscal year, you are already at 34 learning centers, already exceeding the total number of last year. Do you have some sort of updated target in terms of how many learning centers you want to get by the end of this fiscal year, and as well as the schools? And also, in terms of those learning centers, what kind of learning centers are they? I mean, in the old -- a year ago, probably your learning centers were more focused on the test preparation. But are these new learning centers different in terms of their configuration, or maybe they are more focused on the other side of business, like high school kids English or something like that?

Louis T. Hsieh

That’s a great question. We have added 34 schools and learning centers this year. I think 31 learning centers in three schools versus 19 -- in the first half versus 19 for all of last year, so you are right, we accelerated that.

Our target, at the beginning of this year we challenged the school heads to open between 40 and 50 learning centers and of course, we guided conservatively as we didn’t think they’d be able to do it. So we guided 20 to 25 learning centers for the year.

Now that we’ve already opened 31 in the first two quarters, and I think we’ll continue to open aggressively, we will probably raise that target to the original 40 to 50 for the fiscal years over the next -- so another 15 or 16 schools and learning centers over the next two quarters.

And the school count remains the same. We would expect to open four to six new schools. We’ve opened three already in the first half, so one to three more in the second half of the year.

Now, on the composition of learning centers, it’s a mix. Some of the learning centers, four of the learning centers in this quarter went into Shanghai, so it now has 25. And those are typically large learning centers with a multiple purpose.

But the fastest growing number of learning centers going forward will be kids, and probably next year beginning will be elite learning centers, which are smaller. So you are absolutely right that the configuration is smaller and they are meant to be located closer to areas where our students would be, particularly in the kids and high school area. And these will typically be learning centers that are about two to three stories and will have room for about 20 class rooms, with a couple of large class rooms and the other ones smaller to accommodate 20 or 30 students.

Alex Xu - Brean Murray Carret

Just a follow-up then; if this new configuration of the learning centers, do these new ones cost more or less compared to your old ones?

Louis T. Hsieh

They cost less because they are smaller but they are also being offset because as you know, the price of rent -- I mean, the rent cost, lease costs in China are going up, especially in places like Shanghai and Beijing and others. So even though they should cost less because of rent inflation, they do cost a little bit less but not as much as we’d like. They are still going to cost $80,000 to $120,000 to set up.

Alex Xu - Brean Murray Carret

Okay. Thank you.

Operator

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

Catherine Leung - Citigroup

Good evening. Thank you for taking my question. Could you maybe discuss the impact of the Olympics and what you are doing -- I know you mentioned earlier your marketing spend in relation to the ramp up to the Olympics, but in terms of structuring your classes, maybe we could see some kind of shift of students taking the classes earlier rather than during the Olympics month? And if so, would you see -- have more student volume concentrated in those two months of the first quarter of fiscal year ’09 and hence would you need to increase your staff headcount or your teacher headcounts to accommodate that type of capacity increase or volume increase?

Louis T. Hsieh

That’s a good question and we are addressing it. The way it turns out is that the Beijing Government helped us a little bit with this by lengthening the summer recess, so the kids in Beijing will actually get out earlier by a week or so in June than they normally do. And so we are accommodating that by doing exactly what you said, Catherine, and offering more classes earlier in the quarter so that we will have more classes in June and July than normal, and we’ll have fewer classes in August for the reason that the Olympics are in August. So that’s exactly what we plan to do.

The other thing that we got some good news from the Beijing Government is that it appears that the traffic patterns, you know, the streets won’t be shut down and our classes will be allowed to continue to operate in Beijing during that time. We are planning also to move our summer camp and our classrooms to areas that are not the high traffic patterns of the Olympic Games, so we’ll move it to learning centers outside, on the outskirts of Beijing or in areas away from the Olympic Stadium area.

Thirdly, we are going to shift some of our summer camps to other cities like Shanghai and others to stay out of the way, especially in August, of the Olympic tourists and the traffic. So we are doing -- we are taking a number of measures to address the Beijing Olympics and we are -- at this point, we are not -- we don’t see a material negative impact for the Olympics but it is still a little bit early to tell.

Catherine Leung - Citigroup

Okay. Thank you.

Operator

You have a follow-up question from Adele Mao from SIG. Please proceed.

Adele L. Mao - Susquehanna Financial Group

Louis, could you update us what your thoughts are with respect to acquisitions, particularly whether you continue to view the acquisition of a degree program a priority? And what type of multiples can we expect right now out there in the market?

Louis T. Hsieh

M&A is an area that we’ve been telling investors and Wall Street that we’d like to pursue. And we haven’t, to be perfectly honest, we haven’t been as successful with it as we would hope, and there’s a number of factors we’ve talked about in the past calls, private equity funding, prices, et cetera.

And also, to be perfectly fair, there is a -- in New Oriental we do seem to be able to have a mentality to try to do it ourselves. So we are still aggressively looking at M&A targets and I think the focus has moved to more in the Gao Kao area or the national entrance exam that we believe is a market we’d like to address.

And also, it continues to be in the four-year college area where we would still like to buy one college in Beijing or Shanghai, so those are our two immediate focuses and we are still looking at acquiring sort of our competitors in many of the large cities as well.

But you know, it sounds like we’ve been saying this for several quarters now. We have not yet closed a significant M&A transaction.

Adele L. Mao - Susquehanna Financial Group

I see. Could you just share with us -- you know, you are looking at one college or university in Shanghai or Beijing. Will this be general college, university programs or something more related to specialized vocational training -- something with a --

Louis T. Hsieh

It’s not a vocational -- it’s the -- the couple that we are looking at are four-year colleges but they are smaller ones, so they haven’t -- they have capacity to grow probably 20%, 25% in student enrolment each of the next three to five years and they are growing and they are profitable. So those -- the ideal one for us is to buy a four-year degree college that is focused more on business degrees and others but is a full four-year program that is accredited by the government. But one that isn’t at full capacity yet, so therefore we have the flexibility to grow the business and so it is not dilutive to our shareholders. So ideally, that’s what we are looking at and we have a couple of targets.

But the valuations -- it always comes down to valuation and we haven’t agreed because remember, when we buy a college, it’s much more expensive than buying a school because we need to buy the land and the buildings, and so the price tag becomes quite high day one. And those land and those buildings don’t really generate any revenue, right? It’s the -- so just like in our learning center model, we always prefer to lease than to buy. So if we buy a school, we actually have to buy the buildings and the land, so it’s going to be -- it makes it much less attractive.

Adele L. Mao - Susquehanna Financial Group

Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Anindya Chatterjee from Jefferies & Co.

Anindya Chatterjee - Jefferies & Co.

Good evening. The question is the number of new hires that you’ve done for your teaching staff, how many of those are for non-English training courses?

Louis T. Hsieh

I don’t have the breakdown, to be perfectly honest. I know that we added a net of 100 or so teachers this quarter and 350 or so in personnel total for the quarter. Many of those people were actually on the teacher side. Our sales and marketing is growing significantly and so is G&A as well, to staff the learning centers and the schools. And we are also having growing teachers in other languages as well.

But the net is I think of the 300 and something we added the last quarter, 124 or so were teachers, net teachers.

Anindya Chatterjee - Jefferies & Co.

Okay, thanks. Another -- actually, a different question, follow-up question is on the Beijing Olympics, what is the best case and worst case scenario in terms of your costs and enrolment in terms of impact of the Olympics? Do you think that advertisement costs would actually come down after the Olympics are over? Or which specials would start [inaudible] after the Olympics? And on the other hand, do you think actually enrolment, despite the resetting of the summer base, the school base, do you think enrolments will actually suffer because of the Olympics?

Louis T. Hsieh

We don’t know, to be perfectly honest, right now. I think the -- well, we are hopeful that it won’t because if you think about it, the students need to take the classes, so we don’t think -- we believe that the Beijing Olympics will obviously not be a positive for our business but we don’t think at this point -- and the information we get from the government is quite positive that it won’t be as big a disruption to our business and the government is actually helping us by moving the summer holiday this year earlier by one week.

So the Olympics is only two weeks, so it is two weeks in August and we are getting one week back in June, so there is a net difference of one week, if you think of it that way.

As far as advertising and other disruptions, I don’t know what advertising dollars will do after the Olympics. Obviously our colleagues at Focus Media and others will tell you that they are not going down after the Olympics, but I don’t know. I’m not -- I don’t set the price.

I do think that our cost structure is not necessarily driven by the Beijing Olympics. It’s really the wage pressures are coming from the inflation in China. If you remember, the last reported TPI increase in China was 6.9%, which I think is like a 10-year high. So we are suffering from the exact same inflation pressures that everyone else in China is, from materials to personnel to food, et cetera. But we’ve been very lucky in being able to cope with it by having some pricing power to increase our ASPs at a rate higher than our cost of salaries.

Anindya Chatterjee - Jefferies & Co.

Thank you.

Operator

Your next question comes from the line of Brandon Dobell from William Blair. Please proceed.

Brandon Dobell - William Blair

A quick follow-up for you, Louis; you mentioned deferred revenue up about -- I think about 53%. I just want to make sure I understand that in the context of the revenue guidance. I know there was some timing issues this quarter that skewed that a little bit but how do I think about that deferred revenue guidance and how that revenue on the balance sheet will flow through the income statement the next couple of quarters?

Louis T. Hsieh

I think most of it will show up in Q3, so we are really encouraged because of the amount of money we spend -- as you know, Brandon, we increased sales and marketing spending by 50% in Q2, the quarter we just reported. And you see the benefits again in Q3 where deferred revenue was up from 169 million a year ago or so -- sorry, 170 to -- almost a 53% increase year over year, so we are very encouraged by that number because most of that revenue will be recognized in the current quarter, which is our Q3.

And even last year we were saying that given that last year the Chinese New Year had an extra week-and-a-half or two weeks, it was in the third week in February, we were expecting a very challenging quarter this year for Q3, because last year was such a good quarter. And then the government also decided to shorten the -- in Beijing and other cities, shorten the winter quarter by about a week and add it to the summer.

So all those things working against us, you know, we were very pleased with the deferred revenue number that shows even higher growth than we’ve ever seen in this particular quarter.

So we are quite encouraged and we guided at 22% to 28%, which is about 3% lower than we normally would guide but that’s only because last year was so strong.

Brandon Dobell - William Blair

Thank you.

Operator

Your next question comes from the line of Marisa Ho from Credit Suisse. Please proceed.

Marisa Ho - Credit Suisse

Can I get a quick word on the composition of the other income item on your P&L, please? Is there any particular reason that caused the item to increase quite a bit on a year-on-year basis?

Louis T. Hsieh

It’s interest income from the $247 million we have.

Marisa Ho - Credit Suisse

All right, excellent. And apart from that, there’s no other item like government subsidies or any unusual items?

Louis T. Hsieh

No, no, nothing unusual.

Marisa Ho - Credit Suisse

Great. Thank you.

Louis T. Hsieh

We just have a lot of cash, which I think will lead to the same question -- we want to buy companies and if we can’t, we need to return it at some point to the shareholders in the form of a share buy-back or some other form.

Marisa Ho - Credit Suisse

Thanks.

Operator

At this time, I am showing you have no further questions. I would like to now turn the call back over to Louis.

Louis T. Hsieh

Thank you very much. I just want to thank everyone again for joining us today on the call. If you have any further questions, please do not hesitate to contact myself or any of our investor relations representatives listed on the press release. Thank you.

Operator

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

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