51Talk Online Education Group (COE) 2016 Q2 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's second quarter 2016 earnings conference call. (Operator Instructions). Today's conference call is being recorded. (Operator Instructions).

I will now turn the call over to your host for the call, [Hanyu Liu], Investor Relations Manager for the Company. Please go ahead, Hanyu.

Hello, everyone, and welcome to the second quarter 2016 earnings conference call of China Online Education Group, also known as 51Talk. The Company's results were issued via newswire services earlier today and are posted online. You can download a copy of the earnings press release, or sign up for the Company's distribution list by visiting the IR section of its website at ir.51talk.com.

Leading to this call is Mr. Jack Huang, 51Talk's Founder, Director, and Chief Executive Officer, who will provide operational highlights and update on the Company's business strategy. Mr. Jimmy Lai, 51Talk's Chief Financial Officer, will then review the Company's second quarter 2016 financial results.

Before we continue, please note that today's discussion will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. Forward-looking statements involve current risks and uncertainties. As such, the Company's results may be materially different from the views expressed today. Further information regarding this and other risks and uncertainties is included in the Company's prospectus as filed with the US Securities and Exchange Commission.

The Company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Please also note that 51Talk's earning press release and its conference call includes discussions of unaudited GAAP financial information, as well as our audited non-GAAP financial measures. 51Talk's press release contains a reconciliation of the unaudited non-GAAP measures through the unaudited most directly comparable GAAP measures.

I will now turn the call over to 51Talk's Founder, Director, and CEO, Mr. Jack Huang. Please go ahead.

Okay. Hello, everyone. Thank you very much for joining us for our first quarterly earnings conference call as a NYSE listed public company.

Our successful IPO on June 10 was a major milestone for us as we pursue our mission to make the high quality education resources accessible and affordable for millions of people in China. Our NYSE listing was also a powerful reinforcement for our 51Talk brand in the China online English education market.

We are very pleased to report robust second quarter financial and operating results, highlighted by the net revenues growing 204% year over year, and gross billings increasing 163% year over year. Both of these strong results were mainly driven by our rapidly expanding student base. In the second quarter, we recorded 87,000 active students representing a year-over-year increase of 119%.

We have also seen a significant increase in our brand awareness before and after the IPO. Our rapid growth is especially evident in K-12 student base, which accounted for 49% of our total gross billings in the second quarter, compared with just 25% for the prior year period. In the second quarter, K-12 gross billings reached RMB96.3 million, representing 423% year-over-year growth.

Going forward, we will continue to enhance our student learning experience, and better position us to capture the exponential growth opportunities in the online English education market, in both adult and K-12 market segments.

We are implementing a new and a comprehensive teacher training program, aiming to improve learning efficiencies for our students. We are investing in the technologies that can further engage students during the whole learning cycle; pre-class, in-class, and after-class with [simplification] features.

We are also expanding our product offerings; for example, in the second quarter we introduced our American academy program, mainly catering to kids from age five to age eight years old, which features teachers with previous elementary school and kindergarten teaching experience from North America.

As the largest online English education platform in China, with over 120,000 active students for the last 12 months, and over 8,000 foreign teachers, we are confident that we can further strengthen our leadership position in both the adult learner and the K-12 market segments. As I told our employees at the time of our listing that this is a small step for 51Talk, but a giant step for China Online Education. We are confident that this is just the beginning. We are on our way to achieving bigger and better things.

With that, I will now turn the call over to our CFO, Jimmy Lai, who will talk about our key operating metrics and the financial results. So, Jimmy, please go ahead.

Thank you, Jack, and hi, everyone. First, I would like to touch base on a couple of the highlights of the second quarter. Our business model is highly scalable and ideally suited to ride the wave of China's rapid acceptance of online education services.

A key emphasis, moving forward, will be improving our operating [efficiency] leverage by increasing efficiencies. We made strong strides in this effort in the second quarter as we improved our gross margin to 64.9%, compared with 62.3% for the same quarter last year.

As one of the key metrics to measure sales efficiency, our sales and marketing expenses, as percentage of gross billings, also continued to trend down. The non-GAAP sales and marketing expenses, as a percentage of gross billings, was 56%, compared with 61% in the previous quarter.

Most importantly, our operating cash flow turned into a positive RMB13.6 million, compared with a negative RMB3.7 million in the previous quarter, an improvement of about RMB17 million.

We plan to continue to build and strengthen our technology infrastructure, enhance our product portfolio, especially in the K-12 market segment, to enhance our student user experience and grabbing the K-12 market opportunities.

Now before walking through our detailed financial result in the second quarter of 2016, I would like to remind everyone about is our non-cash, stock-based, compensation expenses for this quarter.

All options granted prior to the completion of the IPO were only exercisable subject to the grantee's continuous service and the listing of the stock of the Company on the public stock exchange. Upon the completion of the IPO, cumulative stock-based compensation expenses for the option granted with IPO performance condition, for which the service condition has been satisfied as of such date, were recorded.

As a result, share-based compensation expenses were RMB28.8 million for the second quarter of 2016. Clearly, this is a unique set of circumstances and I just want to make sure everyone is aware of it at the start.

Net revenues were RMB96.9 million, a 203.5% increase from RMB31.9 million for the same quarter last year. The increase was primarily due to an increase in the number of active students and, to a lesser extent, an increase in the average revenue per active student. The number of active students was 86,600, a 118.7% increase from 39,600 for the same quarter last year.

Cost of revenues was RMB34 million, a 182.7% increase from RMB12 million for the same quarter last year. The increase was primarily driven by an increase in the total service fees paid to the teachers, mainly due to delivery of an increased number of paid lessons and, to a lesser extent, due to the increased cost per lesson with the introduction of western teachers.

Gross profit was RMB62.8 million, a 216.1% increase from RMB19.9 million for the same quarter last year. Gross margin was 64.9%, compared with 62.3% for the same quarter last year. The increase was mainly the result of increased prices and a stable teacher cost base.

Total operating expenses were RMB199.7 million, a 121.9% increase from RMB90 million for the same quarter last year. The increase was mainly the result of increases in the sales and marketing, general and administrative and product development costs.

Sales and marketing expenses were RMB111.3 million, a 66.2% increase from RMB67 million for the same quarter last year. The increase was mainly due to an increase in the number of sales and marketing personnel, increased marketing and promotion-related expense, and share-based compensation expenses.

There were no share-based compensation expenses recognized prior to the second quarter of 2016, as the initial public offering performance condition was not considered probable until the occurrence. Excluding share-based compensation expenses, non-GAAP sales and marketing expenses were RMB108.5 million, a 61.9% increase from RMB67 million for the same quarter last year.

Product development expenses were RMB38.5 million, a 262% increase from RMB10.6 million for the same quarter last year. The increase was primarily the result of newly added course development and technology-related personnel to further expand curriculum offerings and strengthen technology platforms, and recognized share-based compensation expenses.

There was no share-based compensation expenses recognized prior to the second quarter of 2016, as previously discussed. Excluding share-based compensation expenses, non-GAAP product development expenses were RMB30.1 million, a 183% increase from RMB10.6 million for the same quarter last year.

General and administrative expenses were RMB49.9 million, a 302.2% increase from RMB12.4 million for the same quarter last year. The increase was primarily due to the recognition of share-based compensation expenses, additional personnel necessary to support expanded operation, and increased costs related to compliance and reporting obligation as a public company.

There was no share-based compensation expenses recognized prior to the second quarter of 2016, as previous discussed. Excluding share-based compensation expenses, non-GAAP G&A expenses were RMB32.4 million, a 160.8% increase from RMB12.4 million for the same quarter last year.

Loss from operation was RMB136.9 million, compared with RMB70.1 million for the same quarter last year. Non-GAAP loss from the operation was RMB108.1 million, compared with RMB70.1 million for the same quarter last year.

Now because of the foregoing, net loss was RMB137.9 million, compared with RMB70.7 million for the same quarter last year. Non-GAAP net loss was RMB109 million, compared with RMB70.7 million for the same quarter last year.

Basic and diluted net loss per ADS attributable to ordinary shareholders was RMB21.97, compared with RMB17.79 for the same quarter last year. Each ADS represents 15 Class A ordinary shares. Non-GAAP basic and diluted net loss per ADS attributable to ordinary shareholders was RMB18.4, compared with RMB17.79 for the same quarter last year.

As of June 30, 2016, the Company had in total cash and cash equivalents, and time deposit of RMB656.2 million, compared with RMB214 million as of December 31, 2015. The increase was primarily due to net proceeds of RMB443.2 million raised in the Company's initial public offering and the concurrent private placement in June 2016.

The Company had deferred revenue, which is current plus non-current, of RMB439.3 million as of June 30, 2016, compared with RMB272.2 million as of December 31, 2015.

Now, let's turn to outlook. For the third quarter of 2016, we currently expect net revenue to be in between RMB116 million to RMB121 million, which would represent an increase of approximately 169% to 181% from RMB43.1 million for the same quarter last year. And gross billing to be between RMB220 million to RMB226 million, which would represent an increase of approximately 122% to 128% from RMB99.1 million for the same quarter last year.

This outlook is based on the current market condition and reflect the Company's current and preliminary estimate of the market and operating condition and customer demand, which are all subject to change.

Now this conclude our prepared remarks. We will now open the call to questions. Operator, please go ahead.

(Operator Instructions). Claire Cao, Morgan Stanley.

Can management give us some color on the recent trend of student retention rate for above K-12 and non-K-12 students?

And my second question is, we noticed the product development expense ratio increased a bit in the quarter. So can management provide us some color what's the detailed reason behind that?

(interpreted) The first question is regarding the retention rate. Regarding the K-12 retention rate, as we stated during the IPO roadshow in our prospectus, the retention rate after one years in the program for the K-12 in the Q1 was 63%. In the Q2, we continue to see this trend to improve.

On the RMB expenditure side, as you can see that our K-12 percentage, as a percentage of gross billing, has increased to 49%, and our K-12 gross billing Q2 versus Q2 last year has exceeded 400% growth. So we are investing heavily in the K-12 product, in the K-12 curriculum. We also investing heavily in the technology associated with K-12 in terms of the user experience.

Okay, one more comment regarding the R&D. We believe the R&D's one of the more important entry barriers we can create, so that's why we're investing in this area.

Okay. That's very helpful. Thanks.

(Operator Instructions). Zoe Zhao, Credit Suisse.

I have mainly three questions. First on the renewal rate; could management give us a rough sense of the gross billing breakdown by the new pay and the renewal paying gross billing?

And the second question is on the pricing and promotion strategy on the higher end market, especially with the competition of the American teaching model picking up.

And the third question is on the sales conversion rate; can management give us some color on the conversion rate from making a call to a registered user? I will translate my question.

Thank you for your question. As we consistently making a position, we do not disclose or break down our gross billing by new paying users versus renewal paying users. As you know, the so-called renewal, it's hard to distinguish because our students tend to upgrade their package throughout the learning process. So it's hard to distinguish which part is upgrade, which part is renewal and that's why we don't break down in these two categories.

(interpreted) What differs from us and compares with the offline trader is we don't particularly look at the business based on semester renewal between [and among] semesters. We more so look at the co-analysis one year post the student coming on the platform.

And as you can tell from our sales and marketing efficiency improves, sales and marketing expenses as a percentage of gross billing, that we do see that the students continue to study on our platform that is longer and longer.

We look at ourselves as an English training platform with a multiple product line, just like we have multiple SKUs on our platform. And we are the largest English training platform in China right now. As you can see the evidence in 2015 and in early 2016, our K-12 percentage continued to increase.

As this market increases, we see demand mainly from the first tier cities that the customer has a premium demand for American-type of teaching. That's why we are addressing this need and create this American academy program. As we saying, we look at ourselves as a platform not as a singular product Company. Because of the characteristics of the platform, we can quickly come out the products that adapt to the customers' needs.

The reason we can introduce this new product so quickly is because the foundation of our platform, which is our 51Talk brand name; our technology personnel, probably the largest pool of technology personnel in the industry; our proprietary curriculum development team; and our teacher recruiting training systems, which enable us to quickly come out with the product to address the market.

Regarding the third question on the conversion rate, although we do not disclose these operating metrics, however you can see from the improvement in the sales and marketing expense as a percentage of the gross billing that trend is improving.

Another thing that directly tied to the conversion rate is, actually, the referral rate. We did disclose, for example, the K-12 in Q1 the referral rate was 57% and that rate is continuing improving.

Was there a follow-up, Miss Zhao?

Thank you, management. Congrats on a good quarter.

(Operator Instructions). This concludes our question and answer question. I would like to turn the conference back over to management for any closing remarks.

Thank you, once again, for joining us today. If you have further questions, please feel free to contact 51Talk's Investor Relations through the contact information on our website or the 51Talk Group. Goodbye.

The conference has now concluded. Thank you for attending today's presentation, you may now disconnect.

Portions of this transcript that are marked (interpreted) were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.