>EDUCOMP SOLUTIONS LIMITED: 1QFY11 results weaker than expected; SmartClass, K-12 schools traction continues to be strong - ALERT

■ 1QFY11 results came in lower than expected: Revenues of Rs.2,279m came in 6% below our estimates, driven by lower ICT and preschools business revenues missing our estimates. EBIT margins of 20.4% were below our estimate of 24% mainly driven by lower margins in the SLS (SmartClass and ICT) businesses. However, sharp reduction in tax rates led to net profit (Rs. 366m) coming in just 5% below our estimates.

■ SmartClass segment: Educomp implemented SmartClass solutions in 6,750 classrooms in 1QFY11 - on track to achieve the high end of its FY11 guidance of 25,000-30,000 implementations. However, margins were hit by 1) induction of 160 additional sales & marketing personnel taking the sales team size to 380 people; 2) Increase in COGS due to hardware costs for partial SmartClass deployments where revenue has not been recognized – we believe this should reverse in 2QFY11.

■ ICT segment: Surprisingly, Educomp did not implement any new schools in ICT segment – leading to 27% Q/Q decline in ICT revenues. EBIT margins also declined to 17.7% vs. our expectation of 30% and 4QFY10 levels of 37.7%.

■ K-12 segment: Schools revenues came in at Rs. 205m (up 37% Q/Q, 71% Y/Y). Revenue decline in pre-schools segment (Eurokids and R2W) led to flat revenues Q/Q for the overall K-12 segment at Rs. 305m. EBIT margins were strong at 38% driven by better margins in the schools
business.

■ Other segments: Investments in Raffles JV, Pearson JV (IndiaCan) and online ventures (Savvica, Authorgen, LearningHour etc.) amounting to Rs. 104.3m in the quarter.

• Tax rate change: 1QFY11 tax rate was lower than expected (MAT rate) - the company attributed this to tax benefits arising from higher tax paid in FY10 on the school contracts transferred from BOOT to EduSmart model. As a result, management expects effective tax rate to come down to 18% in FY11 and return to corporate tax rate (30%) in FY12. We would seek further clarity on this from the management.

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