New Oriental Education & Technology Group Inc. annual report, Q4 FY2013

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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, 2013. Although the request identifies “2012 Q4,” the filing is annual—not a standalone quarterly report—and does not provide a clear Q4-only set of financial results. Figures below compare FY2013 with FY2012 and are in U.S. dollars.

The company provides education and training in China, principally language training and test preparation. It operated 57 schools and 669 learning centers at year-end. Substantially all education operations are conducted through a variable interest entity (VIE) and contractual arrangements.

Financial performance and position

  • Revenue: $959.9 million, up 27.4% from $753.2 million. Educational programs and services generated $857.7 million; books and other revenue generated $102.2 million.
  • Profit: Operating income was $122.6 million versus $120.2 million, a 2.0% increase. Net income attributable to the company was $136.3 million versus $132.7 million, up 2.7%. Basic and diluted continuing-operations EPS were $0.88 and $0.87, respectively, unchanged from FY2012.
  • Margins: Operating margin declined to approximately 12.8% from 16.0%; net margin declined to approximately 14.2% from 17.6%. Cost of revenue was 40.0% of revenue, compared with 38.9%; general and administrative expense rose to 32.4% of revenue from 30.1%.
  • Cash flow: Operating cash flow was $283.6 million, up from $249.3 million. Investing activities used $237.9 million, primarily reflecting $168.0 million net purchases of short-term investments and $61.5 million of property and equipment. Financing activities used $70.8 million, including $28.5 million for share repurchases and $47.0 million for dividends.
  • Liquidity and debt: Cash and cash equivalents were $417.2 million; short-term investments were $505.0 million and term deposits were $50.0 million. Current assets were $1,070.8 million and current liabilities $489.8 million. The summarized balance sheet does not show borrowings; the filing does not provide a clear debt total. Total liabilities were $496.2 million, including $332.2 million of deferred revenue.
  • Equity and capital returns: Total equity was $857.3 million. The company had 156.7 million common shares outstanding at May 31, 2013. A special dividend of $0.30 per ADS was paid in 2012; a further $0.35 per ADS dividend was declared in July 2013, payable in October.

Material changes versus the prior comparable period

  • Revenue growth was driven by increased course enrollments and network expansion: enrollments rose from approximately 2.4 million to 2.5 million, while schools increased from 55 to 57 and learning centers from 609 to 669.
  • Profit growth lagged revenue growth as operating costs and expenses increased 32.3%, faster than revenue. General and administrative expense rose 37.4%, partly due to higher personnel costs, share-based compensation and expenses related to the SEC investigation.
  • Management reported average class size for short-term language training and test preparation fell to about 10 students from 13. The filing attributes margin pressure in part to demand for smaller classes.
  • Cash and cash equivalents decreased $11.1 million, despite higher operating cash flow, reflecting investment activity, repurchases and dividends. Short-term investments increased to $505.0 million from $321.2 million.
  • Elite English was transferred to its former head in July 2012 and is presented as discontinued operations. The stated $5.5 million consideration is payable in installments from May 2014 to May 2016; no receivable or disposal gain was recognized because collectability was not assured at year-end.

Outlook, commentary, risks and unusual items

  • Management expects to continue expanding schools and learning centers and states that cash and anticipated operating cash flow should cover foreseeable needs. No numerical revenue, earnings or margin guidance is provided.
  • Key business risks include competition, teacher recruitment and retention, student demand and pricing, seasonal enrollment patterns, smaller-class economics, and dependence on test-preparation demand. Four cities—Beijing, Shanghai, Wuhan and Guangzhou—accounted for 41.6% of FY2013 revenue.
  • SEC investigation and litigation: The SEC’s formal investigation, opened in July 2012, includes questions about consolidation of the VIE and allegations raised by Muddy Waters. The company says it is cooperating; timing and outcome are uncertain. Shareholder securities lawsuits were pending, and the company did not accrue a loss because it could not estimate the outcome.
  • VIE and regulatory exposure: The VIE accounted for approximately 99% of FY2013 revenue. The company warns that PRC authorities could challenge the contractual structure, potentially limiting control, economic benefits or consolidation. PRC counsel considered the arrangements valid under current rules but noted legal uncertainty.
  • Other exposures: Risks include changing PRC education and tax rules, potential loss of preferential tax treatment, currency controls and RMB movements, and restrictions on moving cash from China. Operating lease commitments totaled $465.1 million, including $113.4 million due in FY2014.
  • Deloitte issued unqualified opinions on the consolidated financial statements and internal controls as of May 31, 2013. Management also concluded disclosure controls and internal controls over financial reporting were effective.

Investor verification priorities

  1. Confirm the requested period: this filing reports FY2013, not standalone 2012 Q4.
  2. Review the SEC investigation’s subsequent developments, the VIE consolidation basis and the status and potential exposure of shareholder litigation.
  3. Assess whether expense growth, smaller classes and expansion costs are continuing to pressure operating and net margins.
  4. Verify the quality, liquidity and maturity profile of short-term investments and the accessibility of cash held within the VIE and PRC subsidiaries.
  5. Track enrollment growth, class sizes, teacher capacity, city concentration and the company’s ability to sustain pricing.
  6. Check the terms and collection of the deferred Elite English consideration, the CMSI acquisition obligations and the effect of PRC tax or regulatory changes.