51Talk Online Education Group (COE) 2016 Q4 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's fourth quarter and full-year 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, Miss Hanyu Liu, Investor Relations Manager for the Company. Please go ahead, Hanyu.

Hello, everyone, and welcome to the fourth quarter and full-year 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 the earnings press release and sign up for the Company's distribution list by visiting the IR section of the website at ir.51talk.com.

On today's call is Mr. Liming Zhang, 51Talk's Chief Operating Officer, who will provide operational highlights for the Company; Mr. Jack Huang, 51Talk's Founder, Director and Chief Executive Officer, who will provide an update on the Company's business strategy; and Mr. Jimmy Lai, 51Talk's Chief Financial Officer, who will then review our Company's fourth quarter and full-year 2016 financial results, and provide our first quarter 2017 outlook.

Before we continue, please note that today's discussions 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 inherent 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 earnings press release, and this conference call, include discussions of unaudited GAAP financial information, as well as unaudited non-GAAP financial measures. 51Talk's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures.

I will now turn the call over to 51Talk's Co-founder and COO, Liming Zhang, to address our operational highlights. Please go ahead.

Thanks, Hanyu. Hi, everyone. Thank you for joining our quarterly conference call. We are pleased to deliver robust fourth quarter and full-year 2016 financial and operating results.

For the fourth quarter, our gross billings increased by 126%, and net revenues grew by 132%; both year over year. For the full year 2016, gross billings increased by 146%, and net revenues grew by a robust 170%; again, both year over year.

Our active student base in 2016 grew to over 160,000, an 89% increase from last year. Our tremendous growth in 2016 was primarily propelled by our growing K-12 student base, which accounted for 55% of gross billings in 2016, up from 30% in 2015, and reached over 64% in the fourth quarter 2016.

I'm also happy to say that we achieved those annual results with a positive operating cash flow of RMB29 million. We expect to see continued strong demand for online English learning for both K-12 and adult students in 2017, and our goal remains to rapidly grow our business to meet this demand. We are leveraging our industry-leading technologies, curriculum development capabilities, teacher training, and enhanced student services, to further increase student satisfaction and learning effectiveness. Along with a greater focus on word-of-mouth referrals, we aim to further improve our sales and marketing efficiency.

I will now turn over to our founder and CEO, Jack Huang, to address our key strategies for 2017. Jack.

Thank you, Liming, and hello, everybody. In 2017, we aim to maintain our leadership position in the mass market, as well as further grow our premium level American Academy program. Our American Academy program, a premium program for our K-12 students that we launched in the middle of 2016, has been very well received, and is starting to make meaningful contribution to 51Talk.

Our key strategies to drive these goals include significantly upgrading student services, and improving learning results through increased interaction with Chinese English teachers. The role of Chinese English teachers is to conduct periodic group lessons to help students preview and review before and after their foreign teacher lessons.

Chinese English teachers also provide various teaching services via the social apps, such as WeChat, including assigning and reviewing students' homework. We have noticed that the parents of our K-12 students really appreciate this added attention and service and, as a result, are more willing to renew their packages.

Additionally, our R&D team is currently developing our proprietary next generation audio and video learning technologies. Leveraging this proprietary technology, we plan to roll out exciting new product portfolio during the year.

With the rapid adoption of online education in China, we are confident about our continuous growth in 2017. We are committed to provide our students the best learning experience and results. We are also committed to growing the Company with optimal financial model. We believe that 2017 will be another exciting year for 51Talk.

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

Thank you, Jack, and hello, everyone. I would like to begin with a couple of highlights of the fourth quarter and the full year. As Liming mentioned, we finished the fourth quarter and the full year 2016 with strong results. In addition to closing the fourth quarter and the full year with a record high net revenue and gross billings, we also recorded a fourth quarter gross margin of 64.6%, up from 62% for the same quarter in 2015. For the year of 2016, gross margin was 64.8%, compared with 61.4% for FY15.

I'm also very pleased to report that we are continuing to see improvement in our operating leverage through increasing operational efficiency, especially in our sales efficiency. For the fourth quarter, non-GAAP sales and marketing expenses, as a percentage of gross billing, fell to 48.2%, down from 78.3% for the fourth quarter of 2015.

Non-GAAP sales and marketing expenses only increased by 38.8%, year over year, while our gross billing increased by 125.5%, year over year. Clearly, we are getting more efficient in our sales operation.

Finally, the full year 2016 we recorded (technical difficulty) compared with a negative RMB104 million operating cash flow for 2015. Our goal remain to continuously improve our operating efficiency while, at the same time, capturing the exponential market growth opportunities.

As our K-12 student enrolment has increased significantly in the past year and become a majority of our student base in the fourth quarter, we started to see slight seasonality in lesson taking patterns. K-12 students tend to take fewer lessons in the fourth quarter, corresponding with the fall school semester. This compared to the third quarter, which is seasonally high, and overlap with the summer break.

This type of minor fluctuation is normal and characteristic of a K-12 student base. We will closely monitor seasonality patterns as our K-12 student base continuing to grow.

Now, before walking through our detailed financial result for the fourth quarter of 2016, I would like to remind everyone about our non-cash, stock-based compensation expenses. There were no share-based compensation expenses recorded prior to our IPO in second quarter of 2016. All options granted prior to the completion of IPO were only exercisable subject to grantees' continuous service and the listing of the Company stock on a public stock exchange market.

Upon the completion of the IPO, the cumulative stock-based compensation expenses for all those options were recorded. As a result, share-based compensation expenses were RMB9.2 million for fourth quarter of 2016, compared to zero in the year-ago period. This is a unique set of circumstances to bear in mind in the comparative year-to-year analysis of certain financial metrics.

With that said, for the fourth quarter of 2016, net revenue were RMB128.2 million, a 131.8% increase from RMB55.3 million for the same quarter in 2015. The increase was primarily attributed 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 115,500, a 92.2% increase from 60,100 for the same quarter in 2015.

Cost of revenue was RMB45.4 million, a 115.9% increase from RMB21 million for the same quarter in 2015. The increase was primarily driven by an increase in total service fees paid to teachers, mainly due to the delivery of an increased number of paid lessons and, to a lesser extent, due to the increased cost per lesson with the expansion of western teachers.

Gross profit was RMB82.8 million, a 141.6% increase from RMB34.3 million for the same quarter in 2015. Gross margin was 64.6%, compared with 62% for the same quarter in 2015. The increase was mainly the result of increased price and a stable teacher cost base.

Total operating expenses were RMB233.4 million, a 60.4% increase from RMB145.5 million for the same quarter last year. The increase was mainly the result of the increased sales and marketing, product development, and the G&A expenses.

Excluding share-based compensation expenses, our non-GAAP sales and marketing expenses was RMB137.6 million, a 38.8% increase from RMB99.1 million for the same quarter in 2015. The increase was mainly due to the higher expenses related to the increase in the number of sales and marketing personnel, and increased expense associated with publicity effort.

Non-GAAP product development expenses were RMB42.3 million, a 98.3% increase from RMB21.4 million for the same quarter in 2015. The increase was primarily the result of the newly added technology and course development-related personnel to further strengthen technology platform and expand the curriculum offerings and technical services fees.

Non-GAAP G&A expenses were RMB44.3 million, a 77.1% increase from RMB25 million for the same quarter in 2015. The increase was primarily due to the additional personnel necessary to support expanded operations, North American teacher recruitment costs [incurred] for the American Academy program, and costs related to the compliance and reporting obligations as a public listed Company.

Loss from operations was RMB150.6 million, compared with RMB111.2 million for the same quarter in 2015. Non-GAAP loss from operations was RMB141.5 million, compared with RMB111.2 million for the same quarter in 2015. Because of the foregoing, our net loss was RMB154.2 million, compared with RMB114.3 million for the same quarter in 2015. Non-GAAP net loss was RMB145 million, compared with RMB114.3 million for the same quarter in 2015.

Basic and diluted net loss per ADS attributable to the ordinary shareholders was RMB7.7, compared with RMB29.62 for the same quarter in 2015. Each ADS represents 15 Class A ordinary shares. Non-GAAP basic and diluted net loss per ADS attributable to the ordinary shareholders was RMB7.24, compared with RMB29.62 for the same quarter in 2015.

As of December 31, 2016, the Company had total cash, cash equivalents and time deposits of RMB647 million, compared with RMB214 million as of December 31, 2015. The Company also had deferred revenues, current plus the non-current, of RMB687 million as of December 31, 2016, compared with RMB272.2 million as of December 31, 2015.

For our 2016 full-year financial results, please refer to our earnings press release for further detail.

Now, our business outlook. For the first quarter of 2017, we currently expect net revenue to be between RMB148 million to RMB153 million, which would represent an increase of approximately 105% to 112% from RMB72.2 million for the same quarter last year. And our gross billing to be between RMB310 million to RMB315 million, which would represent an increase of approximately 100% to 104% from RMB154.8 million for the same quarter last year.

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

This concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead.

(Operator Instructions). [Angela Zhou, Credit Suisse].

This is Zoe. I have three questions. The first question is on the 1Q 2017 guidance. I think that the gross billing growth is pretty good, but revenue guidance is relatively soft; could management please elaborate and provide more color on the full-year outlook for 2017?

And the second question is, can management give us more color on the profitability in this year?

I actually have a third question which is regarding the customer acquisition strategy. As we expand our product lines and customer coverage, what is our user acquisition strategy, going forward? Thank you.

Okay, all right. Zoe, thanks for the question. I'll take the first question and Jack would articulate an answer on the second and third questions. As we explained in our press release, more than 64% of our students base are K-12. This scenario is very much different than a year ago when about half of that percentage was K-12. So the learning behavior and the user, when they take a lesson and how fast they take a lesson, it's a new dynamic to us and we are learning every day on this new dynamic.

So what I can say is our outlook was based on this new dimension, this new scenario. Again, this is simply our outlook to give our investors a better view into what we expect. So I think that's probably as much as I can say only. Then I'll let Jack take the second and the third questions.

(interpreted) The market opportunity is still very huge and we're doing everything we can to capture this market opportunity. However, this year, the growth is not just the single goal. We are also growing with the strategy to optimize our user acquisition, optimize our sales and marketing expenses. As you can tell from our report this quarter, when we went public, at that time our sales and marketing, as a percentage to our gross billing, was 61% or 62% and now has come down to 48%. And our goal is to continue to optimize it to reach for the eventual best profitability goal. If you compare with year on year, that reduction is more obvious; in the fourth quarter 2015, that percentage was 78% and now it's 48%.

As second half the online education, this business [is still] education. Education, especially in China, the word of mouth is ultra-critical. So this year, our strategy is focus more and more on word-of-mouth effect to acquiring user, to increase the efficiency. Especially, the K-12 percentages are north of 60% and the characteristic of the K-12 parents is they're more than willing to spread the word, so we are very confident about this trend.

Okay. Thanks a lot.

[Ivy Luo, Macquarie].

I also have a question on the sales and marketing expense and also the user acquisition. For sales and marketing, could management break it down into the sales online, mobile marketing and the branding, like, what's the percentage that you were spending on those three categories? And also, we're seeing the sales and marketing expense as a percent of revenue decreasing to 48%, so do management have a target or a goal what percentage we're trying to control it to in 2017? So that's my first question.

And my second question on the user acquisition. So what is the percentage of students that we're getting through word of mouth and so referrals, and what's the percentage that's coming from referral? And also, management mentioned that as we add new features like the WeChat service, we're seeing retention rate increase so I'm wondering what the retention rates are in the fourth quarter or the full year 2016, and also what's the number of paying students in the 2016. Thanks.

Ivy, let me take the first question and Jack will take the second question. In Q4, approximately 65% of spending are in the sales side, mostly the telesales, we have pretty huge telesales team, and the rest is 35% in the marketing and branding. So that is a rough breakdown of how we spent that money in the fourth quarter.

Our goal is to continuously reduce that sales and marketing as a percentage to the gross billing. As you can see, in third quarter that percentage was 51.2%; in the fourth quarter, that was 48.2%. And we are hopeful we can follow a similar pattern going down the road.

And then I'll let Jack answer the second question.

(interpreted) Regarding the word of mouth, the news didn't come from word of mouth. We believe that that number has been pretty steady. About half of our new students come from word-of-mouth referral.

And the number of paying students and retention rate?

(interpreted) Regarding the retention rate, we typically do not disclose that information due to the competitive reason, sorry.

(Operator Instructions). Paul Strigler, Esplanade.

Can you just talk about gross margin for a second? Looks like you guys made some pretty good progress since the IPO, but maybe took a step back in Q4. How should we think about gross margin for Q1 2017 and full year?

Okay, two reasons that gross margin declined a little bit between Q3 and Q4. Number one is our American Academy program is making progress. Initially, that product portfolio have lower gross margin than our Filipino teacher program. But we are very confident this gross margin would enhance because, as any education product in China, when we establish ourself we will increase the price for this quality product. So that's the primary reason.

And then, it looks like your revenue for gross billings per student increased about a little over 7% sequentially; how should we think about your ability to increase prices into 2017? (multiple speakers)

Okay. The increase was, to a great extent, because introduction of American Academy. Typical American Academy the package is larger, compared with Filipino program. In the meantime, we are continuing increase the price at the range of 3% to 4% quarter on quarter, sequentially. So in the near term, we will continue to increase the price.

Great. Thanks, guys.

I would now 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 provided on our website, or the Piacente Group Investor Relations. Thank you.

Thank you, everyone.

Thank you.

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.