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, 2007. The filing was submitted on January 15, 2008. The company operates a nationwide network of schools and learning centers offering language training, test preparation, and primary/secondary education.
Key Financial Metrics
Quarter Ended November 30, 2007
- Net Revenues: RMB240.6 million (US$32.6 million), a 42.4% increase year-over-year.
- Net Income (GAAP): RMB14.5 million (US$2.0 million), a 77.0% increase year-over-year.
- Net Income (Non-GAAP): RMB29.8 million (US$4.0 million), excluding share-based compensation, an 83.6% increase year-over-year.
- Earnings Per ADS: RMB0.39 basic / RMB0.37 diluted (GAAP); RMB0.79 basic / RMB0.76 diluted (Non-GAAP).
- Operating Margin: Negative 0.5% (GAAP); 5.8% (Non-GAAP).
- Cash and Equivalents: RMB1,824.8 million (US$247.1 million) as of November 30, 2007.
- Operating Cash Flow: RMB63.9 million (US$8.6 million).
- Student Enrollments: Approximately 257,700 in language training and test prep, up 18.5% year-over-year.
Six Months Ended November 30, 2007
- Net Revenues: RMB852.6 million (US$115.4 million), a 42.5% increase year-over-year.
- Net Income (GAAP): RMB270.5 million (US$36.6 million), a 56.1% increase year-over-year.
- Operating Margin: 31.4%.
Material Changes vs. Prior Period
- Revenue Growth: Driven primarily by an 18.5% increase in student enrollments and a 37.9% increase in revenue from educational programs.
- Expense Increases: Total operating costs rose 43.3% year-over-year. Selling and marketing expenses increased 49.9%, and general and administrative expenses increased 52.6%, largely due to headcount increases (over 900 new employees in the first half of the fiscal year) and network expansion.
- Network Expansion: The company opened 1 new school (its first private kindergarten) and 14 new learning centers in the quarter, bringing the total to 38 schools and 164 learning centers.
- Share-Based Compensation: Increased to RMB15.3 million in the quarter, significantly impacting GAAP operating margins.
Guidance, Outlook, and Risks
Outlook for Third Quarter Fiscal 2008
Management expects total net revenues for the third quarter (December 1, 2007 to February 29, 2008) to range between RMB311.2 million and RMB326.5 million, representing year-over-year growth of 22.0% to 28.0%.
Management Commentary
- The company is executing a strategy of rapid expansion, foregoing short-term profit to build its network.
- Strategic partnerships were announced with ETS for TOEFL Practice Online and Heinle ELT for custom learning materials.
- Management noted that the company has not been adversely impacted by the US economic slowdown, as revenues are derived almost entirely from the China market.
Risks and Contingencies
- Seasonality: The third quarter growth rate is expected to be lower than the prior year's 51.3% due to the timing of the Chinese New Year (falling earlier in 2008) and shortened winter breaks in many schools to accommodate Olympic Games preparations.
- Operational Risks: Risks include the ability to attract students without fee decreases, retaining qualified teachers, and managing the rapid expansion of the school network.
- Regulatory Risks: Potential changes in Chinese governmental policies regarding private educational services.
Investor Verification Checklist
- Verify the sustainability of the 42% revenue growth rate given the anticipated slowdown in the third quarter due to holiday timing.
- Assess the impact of the aggressive expansion strategy (34 new locations in H1) on future operating margins and cash burn.
- Confirm the execution of new strategic partnerships (ETS, Heinle ELT) and their contribution to future revenue streams.
- Monitor the company's ability to maintain enrollment growth while managing the significant increase in headcount and associated G&A expenses.
- Review the reconciliation of Non-GAAP measures to understand the magnitude of share-based compensation expenses relative to net income.