Business Context and Reporting Period
New Oriental Education & Technology Group Inc. (NYSE: EDU), the largest provider of private educational services in China, reported unaudited financial results for its second fiscal quarter ended November 30, 2011. The filing, submitted on January 18, 2012, covers the period from September 1, 2011, to November 30, 2011, which is the seasonally slowest quarter for the company.
Key Financial Metrics
Quarter Ended November 30, 2011
- Net Revenues: US$132.0 million (up 38.0% year-over-year).
- Net Income (GAAP): US$3.3 million (up 80.5% year-over-year).
- Net Income (Non-GAAP): US$7.5 million (up 46.0% year-over-year), excluding share-based compensation.
- Operating Loss (GAAP): US$4.0 million (loss increased 94.6% year-over-year).
- Operating Income (Non-GAAP): US$0.2 million (down 81.2% year-over-year).
- Earnings Per ADS (GAAP): US$0.02 (Basic and Diluted).
- Earnings Per ADS (Non-GAAP): US$0.05 (Basic and Diluted).
- Student Enrollments: Approximately 471,600 (up 16.2% year-over-year).
- Liquidity: Cash and cash equivalents totaled US$379.2 million as of November 30, 2011. Deferred revenue was US$201.8 million.
- Capital Expenditures: US$13.1 million, primarily for new learning centers.
Six Months Ended November 30, 2011
- Net Revenues: US$404.0 million (up 40.3% year-over-year).
- Net Income (GAAP): US$94.0 million (up 46.5% year-over-year).
- Operating Income (GAAP): US$90.8 million (up 42.1% year-over-year).
- Operating Margin (GAAP): 22.5% (compared to 22.2% in the prior year).
Material Changes vs. Prior Period
Revenue growth was driven by a 16.2% increase in student enrollments and higher average selling prices due to price increases and a shift toward smaller, more expensive class options. While GAAP net income surged 80.5%, the GAAP operating loss widened to US$4.0 million due to a 27.0% increase in share-based compensation expenses to US$4.2 million. Excluding these non-cash expenses, Non-GAAP operating income declined 81.2% to US$0.2 million, reflecting higher operating costs relative to revenue in this seasonally weak quarter.
Cost of revenues increased 37.2% to US$61.2 million, and General and Administrative expenses rose 45.4% to US$50.3 million, largely due to headcount expansion and the opening of 39 net new learning centers.
Guidance, Outlook, and Risks
Outlook for Q3 Fiscal 2012
Management expects total net revenues for the third fiscal quarter (ending February 29, 2012) to range between US$168.3 million and US$176.2 million, representing year-over-year growth of 27.0% to 33.0%.
Management Commentary
CEO Michael Yu noted that the early timing of the Chinese New Year (January 23, 2012) will shorten the winter holiday for students, negatively impacting Q3 revenues and profits. However, management anticipates a strong rebound in the fourth fiscal quarter as students return to prepare for entrance exams in June, similar to the pattern observed in 2009.
Risks and Contingencies
- Seasonality: The early Chinese New Year is expected to reduce Q3 performance.
- Regulatory and Economic: Risks include changes in Chinese government policies regarding private education and general economic conditions in China.
- Competition: Intense competition in the private education sector and the ability to retain qualified teachers.
Investor Verification Checklist
- Verify the impact of the early Chinese New Year on Q3 revenue guidance versus historical Q3 performance.
- Monitor the reconciliation between GAAP and Non-GAAP metrics, specifically the US$4.2 million share-based compensation expense impacting Q2 operating loss.
- Assess the sustainability of the 16.2% enrollment growth rate in the context of a slowing Chinese economy.
- Review the deferred revenue balance of US$201.8 million as an indicator of future revenue recognition.
- Confirm the execution of the "fill-in" strategy with small learning centers (approx. 500 sq meters) to drive K-12 growth.