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On Tuesday, New Oriental Education & Technology Group Inc. ADR (NYSE:EDU) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Take a look.
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Grounded Enrollment and ASP Growth Expectations
Philip Wan – Morgan Stanley: My first question is about your first quarter guidance which appears soft. Could you please elaborate a little bit more on which business lines are slowing down and why and also could you share with us your full year expectation in terms of the enrollment and ASP growth for the year?
Louis Hsieh – President and CFO: For the first quarter there are several reasons why the guidance is a little bit lower than normal. One reason is that Beijing and Shanghai have begun to slowdown as we mentioned in there. In fact in RMB terms, Beijing and Shanghai only grew 24% and 20% last year, respectively. Well, (indiscernible) the U.S. dollar translation benefit the growth rate has really slowdown from 29 down to 20 or so. So that will take the slowdown. The reason for that is a lot of that – all the cities around Beijing and Shanghai are cannibalizing that because the quality of New Oriental Education in those cities is quite good, and so students are finding it no long necessary to travel to Beijing and Shanghai to take those classes. So that’s one factor. Our second factor is relating to the fact that our investment today is in cities outside Beijing and Shanghai because the growth rate is much higher, so we expect those to continue to grow rapidly. A third factor is last year we had a very strong Q1, remember our revenues were up 41%, profits were up 45%. So that makes it very challenging on year-over-year comps, so we just thought try to be a little bit more conservative, and so those are primary the reasons. Foreign currency translation, some slowdown in Beijing and Shanghai, as you know Beijing and Shanghai both have new school heads, so there is going to be a transition period, and then the issues with managing — with the cannibalization. The fourth factor obviously is a slowing Chinese economy. I think even though we seem very resilient, we’re still growing (37%) a year. It was not immune from a slowing Chinese economy, especially consumer discretionary spending. As far as guidance for the year, I think our revenue guidance will somewhere be – probably similar to our first quarter guidance 25% to 30% — 26% to 31%. I think the profit guidance is the one that’s difficult because we’re expanding so rapidly. In these lower margin businesses, we haven’t got the efficiencies down yet. We need another one or two quarters to fix the efficiencies and get the margins turning the right way, so I think we’ll get 25% to 30% probably on the top-line and somewhere between 22% and 25% on the bottom-line and as I said that’s our preliminary view. As far as enrollment increase, we increased the 2.4 million or 15% last year. I would expect that number to come down a little bit given the larger base and the slowdown in the general economy, so I would expect us to grow enrollment roman somewhere in the probably 10% to 13% range. So that takes us about 2.7 million enrollments.
Philip Wan – Morgan Stanley: You mentioned slowdown in Beijing Shanghai, is it mainly for the overseas test preparation?
Louis Hsieh – President and CFO: It’s partly overseas test preparation; it really is more the summer camps, the boarding schools. So, in the past we used to have thousands of students who would pays us like RMB 5,000, RMB 6,000 RMB 8,000 to come into Beijing for 10 days and study either CET 4 or CET 6 SAT, a whole bunch of test, but as we’ve been successful in growing like I said either in Shanghai, our Shanghai school is very good, but our Hangzhou school and our Suzhou schools are just as good. So students who used to come from Hangzhou and Suzhou to go to Shanghai to take this no longer are travelling there, so the margins for this business actually quite high. Instead of RMB 5,000 per student, if they stay home in Hangzhou or Suzhou the ASP is RMB 1,000 and so it’s we’re victim of our own success, but it’s a right thing to do. I showed you our quality is getting quite good across the country, same thing as we explain in Beijing, and so I think that’s just a – it’s a factor. I think Beijing and Shanghai truly without sounding too bad have been mismanaged the last couple years and so we’re hopeful of the new management teams in place there will also begin to drive growth, especially the K-12 and the overseas test prep business as well. So I think as Beijing and Shanghai still have long way, but they’re growing on a RMB terms in the low 20s, whereas the rest of network is growing in the high 30s, low 40s. So the emphasis has to be on the Tier 2 cities. We’re already so big in Beijing and Shanghai. We’re over $200 million a year in Beijing, over almost about $100 million in Shanghai. The base is getting so large. It’s getting more (indiscernible) ourselves out.
Philip Wan – Morgan Stanley: Then quickly on the VIP business, you’ve provided cash revenues for the year and I just wonder how does that compare to the revenues that you actually recognized during the year?
Louis Hsieh – President and CFO: Well, the cash revenue is when they sign up for the course. So a lot of the cash revenue gets put into deferred revenue as it gets paid out over the course of the year. Some of that cash revenue never gets recognized because of students who cancel just before the class starts. So it’s a good proxy for demand, but it’s not a one-to-one.
Philip Wan – Morgan Stanley: Do you have roughly the level of the cancellation as percentage of total?
Louis Hsieh – President and CFO: It’s pretty low. It’s like 1% or 2%.
Philip Wan – Morgan Stanley: Lastly, could you also provide the recognized revenue for the year, so I can get a comparison against your cash revenue?
Louis Hsieh – President and CFO: The recognized revenue for the year is $771 million. I don’t know what the total gross revenue was. Total gross revenue will be 4% higher (indiscernible) business tax.
Philip Wan – Morgan Stanley: No, I mean for your VIP business?
Louis Hsieh – President and CFO: I don’t have that breakdown sorry. Sisi can probably get that for you.
School Schedule Breakdown
Chenyi Lu – Cowen and Company: I have two questions. Regarding your school expansion in 2013 you’re talking about it’s going to be over 200 new learning centers. Can you give us a breakdown as to the schedule of the school expansion, are you going to be more focused on second half of fiscal year 2013 that will be my first question? Then after that I’ve got another question.
Louis Hsieh – President and CFO: I mean ideally if I could do it I would want expansion in Q2 and Q4. The reason is Q2 is a slow quarter if you add the learning centers then you can ramp them up by the way in Q3 during the winter and also in Q4 it’s always a busy quarter, and Q1 is busier so if ca ramp up the expansion in the Q4 and then do it in Q1. But it doesn’t work up that way. So, we end up expanding relatively the same all year around I think the total capacity add for this year will be much lower than last year even though the numbers look higher. That’s how we’ve quoted them in square meters. Last year we added net 177 learning synergies, when it was 1050 square meters on average that means we get to 2000 square meters. For this year even if we get 200 or something (lesser) they are higher number we’re unlikely to add more than 150,000, 160,000 square meters so the net add is actually much lower which means that I think it won’t be as negative to margins as last year. So, that’s how we’re trying to manage these so that they become profitable quickly and in that way the margin picture will turn relatively quickly. So, we didn’t need another quarter or two.
Chenyi Lu – Cowen and Company: So my next question also relates to the operating margins just to build the 100 what you said the answer. So can you give us the view on operating margin in 2013 without (indiscernible) in the fiscal year 2014?
Louis Hsieh – President and CFO: I think the difficulty is we will bottom sometime in 2013. Unfortunately it probably won’t be Q1. So if it’s not Q1, which is the current quarter we’re in, Q1 is 60% of profit, it will make a dent in the rest of it. So, we believe we will bottom sometime in Q2. But if you go to core year-over-year comparisons, it just start to get better, but Q1 will not because we added 177 learning centers and like 100 and something two quarters beforehand and those haven’t filled up yet. As we mentioned earlier, the pickup has been a little bit slower than we thought. The new enrolments are not as fast as in past years because of the economic slowdown in China.
Chenyi Lu – Cowen and Company: So, do you expect margin going to – on an annual basis to be flat or probably slightly down year-over-year in 2013?
Louis Hsieh – President and CFO: We’re going to fight like hell to get it flat or up but we haven’t been winning this one in the last year, year-and-a-half. We do our best, but like I said, we’re also fighting our own school heads because – and legitimate so. I think we’ve taken a different picture. We are focused on profit but in cities that are high profit margin and growing really fast, we’re not going to slow down the learning center growth. So, for example, the city like Hangzhou, Hangzhou we have like 30% profit margins and if you want to have learning centers, you can be as welcome as they would because I guess it’s a high profit number, not counting corporate overhead. The same is (Shenyang). So, there are all cities that are really well managed that are growing like crazy, I’m not going to slow them down. Some cities that are not as well managed and they still want to have learning centers, those are the ones we’re going to target to try to slow down the learning center growth.
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