New Oriental Education & Technology Group Inc. annual report, Q4 FY2022

Business context and reporting period

New Oriental Education & Technology Group Inc. filed this Form 20-F annual report for the fiscal year ended May 31, 2022, with audited U.S. GAAP financial statements. The request metadata says “2021 Q4,” but the filing is an annual report for FY2022 and does not provide a separate 2021 Q4 results summary.

The Cayman Islands holding company conducts substantially all of its China education operations through PRC subsidiaries and variable interest entities (VIEs) controlled by contractual arrangements. VIEs contributed 99.6% of FY2022 revenue. The business includes test preparation, non-academic tutoring, online education, overseas study consulting, and educational materials and distribution.

Financial results and liquidity

Amounts below are in U.S. dollars; figures are for fiscal years ended May 31. Percentages are year-over-year unless noted.

FY2022 investing cash flow was positive $1.169 billion, primarily reflecting $2.041 billion of short-term investment maturities, partly offset by purchases of investments and $150.7 million of property and equipment. Financing cash flow was negative $230.9 million, principally from the note repurchase. Current assets were $4.474 billion and current liabilities $1.710 billion at year-end.

Material changes versus the prior comparable period

• The principal driver of the revenue decline and operating loss was cessation of K-9 academic after-school tutoring services in China by the end of 2021, following the 2021 regulatory changes. The company said the former K-9 revenue contribution was significant but could not be quantified because it did not maintain discrete financial information for those services.
• General and administrative expenses rose 25.3% to $1.867 billion, including a reported $435.7 million impairment loss related to downsizing learning centers and higher personnel costs associated with the cessation. Separately, the filing identifies $368.6 million of impairment on property and equipment and leasehold improvements; these disclosures describe related but differently scoped impairment amounts.
• Closure and restructuring materially reduced the footprint: schools and learning centers declined from 122 and 1,547 at May 31, 2021 to 107 and 637 at May 31, 2022. Teachers declined from approximately 54,200 to 26,300.
• Online education revenue fell 35.1% to $136.7 million, while overseas study consulting revenue rose 17.0% to $325.9 million. Books and other services revenue increased overall, largely due to overseas study consulting.
• The company deconsolidated two compulsory-education schools in September 2021, recording a $79.6 million loss. It also derecognized $781.3 million of right-of-use assets and corresponding lease liabilities upon early lease terminations.

Outlook, risks, contingencies and unusual items

• Outlook: No numerical revenue, earnings or cash-flow guidance is provided. Management expects the cessation of K-9 academic tutoring to negatively affect FY2023 and subsequent periods. It is shifting toward test preparation, non-academic tutoring, intelligent learning systems and devices, study tours, educational materials and other initiatives; profitability and cash generation from new businesses remain uncertain.
• Regulatory and operating risk: The filing describes substantial uncertainty in implementation of China’s education rules, including restrictions on academic tutoring, foreign involvement and VIE arrangements. The regulatory status of some digital learning products and the application of rules to non-academic services were not settled.
• VIE and China exposure: Investors own shares in a Cayman Islands holding company, not equity in the China VIEs. Contractual control may be less effective than direct ownership, and PRC authorities could challenge the structure. Cash transfers from China are subject to legal, reserve, tax and foreign-exchange restrictions.
• Audit access and listing: The filing states the PCAOB was unable to inspect the company’s auditor and warned of possible U.S. trading prohibition under the HFCAA if inspection restrictions persisted. The company also noted substantial uncertainty about future PRC approvals or filings for overseas offerings.
• Other financial and legal items: The company recorded $129.4 million of long-term investment impairment, $14.9 million of fair-value losses and $51.5 million of equity-method investment losses. A U.S. securities class action filed in 2022 was in a preliminary stage; the company said it could not estimate a possible loss. It also disclosed $40.2 million of loans to an equity-method investee that were fully impaired.
• Other disclosures: Management said it had sufficient cash and anticipated operating cash flow for foreseeable needs, although FY2022 operating cash flow was materially negative. Operating lease commitments totaled $686.1 million undiscounted. The company has no current dividend policy. It believed it was a PFIC for U.S. tax purposes for FY2022.

Most important facts an investor should verify

1. Confirm the regulatory treatment and continuing financial impact of the K-9 tutoring cessation, including the revenue and cost base of replacement businesses.
2. Review the audited cash-flow statement and liquidity composition, especially the operating cash outflow, deferred-revenue decline, investment maturities, and the location and accessibility of cash held in China and VIE entities.
3. Reconcile the $435.7 million general and administrative impairment disclosure with the $368.6 million property and equipment impairment and the filing’s other long-lived asset impairment disclosures.
4. Assess the enforceability and regulatory standing of VIE arrangements, required licenses, and any future CSRC, CAC or other PRC approvals or filings.
5. Track PCAOB inspection access and HFCAA developments, as well as the status and potential exposure of the pending securities class action.