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, 2018, not for 2017 Q4. The filing provides annual results and comparative data for fiscal years 2016 and 2017; it does not provide a distinct 2017 Q4 financial summary. Figures below are U.S. dollars unless noted.
The company provides education services in China, including K-12 tutoring, language training, test preparation, online education, schools, overseas study consulting and study tours. At May 31, 2018, it operated 87 schools and 994 learning centers, with approximately 28,100 teachers. It reported more than 6.3 million course enrollments for the year.
Financial results and liquidity
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Net revenue | $2,447.4 million | $1,799.5 million | +36.0% |
| Operating income | $263.0 million | $262.1 million | +0.3% |
| Net income attributable to New Oriental shareholders | $296.1 million | $274.5 million | +7.9% |
| Basic and diluted earnings per share | $1.87 | $1.74 | +7.5% |
| Operating cash flow | $781.1 million | $622.7 million | +25.4% |
| Capital expenditures | $214.3 million | $105.7 million | More than doubled |
- Operating margin was approximately 10.7%, down from 14.6% in FY2017. Gross margin, calculated as revenue less cost of revenue, was approximately 56.5%, versus 58.3%.
- Cost of revenue rose 42.2% to $1,065.7 million; selling and marketing rose 39.3% to $324.2 million; and general and administrative expenses rose 43.2% to $794.5 million. Share-based compensation increased to $57.4 million from $20.3 million and was included in G&A.
- Cash and cash equivalents were $983.3 million at May 31, 2018, up from $641.0 million. The company also reported $1,623.8 million of short-term investments and $107.7 million of term deposits. Current assets were $2,941.9 million against current liabilities of $1,750.9 million.
- Total assets were $3,977.7 million and total liabilities were $1,763.0 million. Deferred revenue, largely advance tuition payments, was $1,270.2 million. The balance-sheet disclosures provided do not identify a separate interest-bearing debt balance.
- Financing cash outflow was $74.9 million, including a $71.2 million special dividend paid in October 2017. Management said available cash and expected operating cash flow should meet anticipated needs for the foreseeable future.
Material changes and unusual items
- Growth was driven primarily by language training and test preparation revenue, which increased 33.9% to $2,023.0 million, alongside higher student enrollments and network expansion. Schools increased from 77 to 87 and learning centers from 778 to 994; the company opened 305 centers and closed 79 during FY2018.
- Books and other services revenue rose 48.1% to $282.3 million, including a substantial increase in overseas consulting revenue. The company acquired Hangzhou Shengshen for approximately $11.0 million and completed other smaller acquisitions.
- Other income, net rose to $94.1 million, primarily reflecting higher interest income. Net income growth was materially slower than revenue growth as operating expenses expanded rapidly.
- Comprehensive income attributable to shareholders was $501.9 million, well above net income, mainly reflecting unrealized investment gains and foreign-currency translation adjustments. These items were largely recorded outside net income.
- Koolearn issued redeemable preferred shares in May 2018, recorded as $206.6 million of mezzanine equity. The company held approximately 68% of Koolearn on a fully diluted basis at year-end.
Outlook, risks and contingencies
- Management planned further school and learning-center expansion, with an emphasis on fast-growing, high-margin cities; no quantified revenue or earnings guidance is provided. Management cited operating cash flow and existing cash as adequate for expected needs.
- Regulatory uncertainty is significant. The amended Private Education Law was in a transition period, with schools yet to complete re-registration as for-profit or non-profit entities. New after-school tutoring rules issued in 2018 impose requirements on course content, teacher qualifications, operating hours, enrollment fees, facilities and approvals; compliance may require costly operational changes.
- Substantially all education revenue depends on variable interest entity contractual arrangements: VIEs contributed 98.8% of FY2018 revenue. Changes in PRC interpretation or enforcement could impair control over these entities, access to their cash flows or the ability to consolidate their results.
- The filing reports a putative U.S. securities class action alleging misstatements in public filings; the company said its motion to dismiss remained pending and that it intended to defend the case. It could not estimate a possible loss range. Other ordinary-course lawsuits were not accrued because loss was not considered probable; the filing does not quantify potential exposure.
- Operating lease commitments totaled $1,257.5 million, including $296.6 million due within one year. Other risks include competition, teacher recruitment and retention, seasonal enrollment, reliance on major cities, tax-preference changes, currency controls and foreign-exchange movements.
- The auditor issued an unqualified opinion on the financial statements and internal controls. The company reported effective disclosure controls and internal control over financial reporting as of May 31, 2018.
Important facts for investors to verify
- Confirm the annual reporting period: this is FY2018, ended May 31, 2018, and does not supply standalone 2017 Q4 results.
- Track whether enrollment and revenue growth translate into improved margins, given the faster growth in costs and the increase in share-based compensation.
- Assess the quality and liquidity of the $1.62 billion short-term investment portfolio, alongside the concentration of cash flows and liabilities in VIEs.
- Monitor implementation of private-education and tutoring regulations, school re-registration, tax treatment and the enforceability of the VIE arrangements.
- Review the securities lawsuit, lease commitments, Koolearn preferred-share terms and the impact of future investment fair-value changes.