51Talk Online Education Group (COE) 2017 Q1 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's First Quarter 2017 Earnings Conference call. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. (Operator Instructions)

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

Hello, everyone, and welcome to the first quarter 2017 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 its website at ir.51talk.com. On today's call is Mr. Jack Huang, our Chief Executive Officer, Mr. Liming Zhang, our Chief Operating Officer, and Mr. Jimmy Lai, our Chief Financial Officer.

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 Form 20-F and other public filings 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 this 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 to the unaudited most directly comparable GAAP measures.

I will now turn the call over to our CEO, Jack Huang. Please go ahead.

Hello, everyone, and thank you for joining our quarterly earnings conference call. We are pleased to have kicked off 2017 with another quarter of solid progress after we executed on our initiatives and reported net revenues and gross billings surpassing the high-end of our guidance. Our rapidly expanding K-12 student enrollment remains our growth driver and contributed 69% to gross billings in the quarter, up from 42% in the year ago quarter. These factors are a testament to our platform's strong market appeal.

I would like to speak very clearly now about our overall strategy. As we continue to see strong demand for online English learning, we are committed to rapidly growing the company and maintaining our leadership position in the market. At the same time, we are also committed to enhancing our students' satisfaction and better optimizing the operating efficiencies of the company as we grow. Especially in the areas of students acquisition costs and the sales and marketing expenses. In this way, our organization will be stronger, more agile and in an enhanced position to better capitalize on the enormous growth opportunities that we see in our space. Ultimately, we know that to maintain our market leadership position, we must pursue a multi-faceted strategy that plays to our existing strength, including leveraging our industry leading proprietary technology, relentless enhancing our curriculum development capabilities, continuously upgrading our teacher training programs and bringing outstanding learning experiences for our students that produce the highest possible learning outcomes. Our results show us that we are on the right track and that we are confident in our ability to continue to execute and create long-term value for our shareholders. I will now turn the call over to our COO, Liming Zhang.

Thank you, Jack. In the first quarter, many of our strategic growth and operating initiatives that we put in place gained traction. We are particularly pleased how our investment in industry-leading technologies is paying off. Our superior quality audio and video technology is clearly distinguishing us in the market. It not only provides the underpinning for our teachers to deliver effective lessons, so students can make the highest possible learning outcomes. It also forms the bedrock of our best-in-class online learning experience. We are very proud that now more than half of our [adult] students use our proprietary technology as part of their lessons and we expect the number to keep rising. Looking ahead, we're excited to see how our commitment to developing proprietary technologies can deliver even greater benefits to our students and it will be a key differentiator for us among our peers. Upgrading student services is another key initiative that gained traction.

As mentioned in the last quarter, we are upgrading services and improving learning results through increased student interactions with Chinese English teachers. By March 31, 2017, we had 188 Chinese English teachers serving supportive teaching roles, helping students preview and review before and after they are following [teacher] lessons. These teachers also provide various administrative functions, interacting with students and parents through social media apps. Since the launch of Chinese English teacher initiative, we have received extremely positive feedback from parents of our K-12 students, which bodes well to inference word-of-mouth referrals and our marketplace reputation.

Going forward, we are placing greater emphasis on word-of-mouth referrals as part of students acquisition effort. We know that word-of-mouth referrals are especially influential in a purchase decision of K-12 parents more than in the purchase decision for adult students. Towards this end, we have actively developed several incentive programs to drive referrals and have no plan to materially increase our telemarketing personnel from its current level while we continue to expect exponentially growing demand of the market. With that I will now turn the call over to our CFO, Jimmy Lai, who will discuss our key operating metrics and the financial results. Jimmy?

Thank you, Liming, and hello, everyone. As Jack mentioned earlier in the call, our goal for the Company is to grow rapidly so as to capitalize on the enormous growth opportunity that lay before us, while at the same time improving the operating leverage of our operation. I'm happy to report on our first quarter result clearly demonstrates that we made meaningful progress on both of these [plans]. Our net revenue and gross billing result both exceeded the high-end of our guidance, by reporting 121% and 110% year-over-year growth, respectively. We also saw market improvement in our operating efficiency in the quarter. Notably, non-GAAP sales and marketing expense as a percentage of gross billing fell to 44.6% from 60.9% in the year-ago period quarter. This is a key operating leverage metrics for us and we are very pleased to see this result and are working diligently to see further reduction. Gross margin also improved in the quarter to 65.7% from 63.6% in the same period last year, largely attributed to price increase. I'm also very pleased to report that net operating cash flow from the first quarter reached RMB30.5 million surpassing the total amount for the entire fiscal year 2016. With a healthy positive operating cash flow, we can continue to meet the strong demand for online English learning. And our ongoing goal is to improve efficiencies, to better capitalize opportunities in the expanding market. Before we walk through the detailed financial results for the first quarter of 2017, I would like to remind everyone again about our non-cash stock-based compensation expenses. There were no share-based compensation expenses recognized prior to our IPO in the second quarter of 2016. All options granted prior to the completion of IPO were only exercisable subject to the grantee's continuous service and the listing of company stock on 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 expense were RMB13.1 million for the first quarter of 2017 compared to zero in the year-ago period. This unique set of circumstances to bear in mind in comparative year-over-year analysis of certain financial metrics. That said, for the first quarter of 2017 net revenue were RMB159.5 million, a 121% increase from RMB72.2 million for the same quarter in 2016. The increase was primarily attributed to an increase in the number of active student and to a lesser extent an increase in the average revenue per active student. The number of active students was 134.5 thousand, an 87.1% increase from 71.9 thousand for the same quarter in 2016. Cost of revenue was RMB54.8 million, a 108% increase from RMB26.3 million for the same quarter in 2016. The increase was primarily driven by an increase in the total service fee paid to teacher 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 expansion of Western teachers. Gross profit was RMB104.8 million, a 128.3% increase from RMB45.9 million for the same quarter in 2016.

Gross margin was 65.7% compared with 63.6% for the same quarter in 2016. The increase was mainly the result of increased price and a stable teacher cost base. Total operating expenses were RMB245 million, a 67.3% increase from RMB146.4 million for the same quarter last year. The increase was mainly the result of the increase in sales and marketing, product development and the G&A expenses. Excluding share-based compensation expenses, our non-GAAP sales and marketing expenses were RMB144.9 million, a 53.7% increase from RMB94.2 million for the same period in 2016. The increase was mainly due to the high expenses related to an increase in the number of sales and marketing personnel and an increase in the expenses associated with marketing and branding. Non-GAAP product development expenses were RMB45.5 million, a 71.3% increase from RMB26.5 million for the same quarter in 2016. 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 offering and the technical service fees. Non-GAAP G&A expenses were RMB41.6 million, a 62.1% increase from RMB25.7 million for the same quarter in 2016. The increase was primarily due to the additional personnel necessary to support expanded operation, recruitment costs related to North American teacher recruitment for the American Academy program and costs related to compliance and reporting obligations as a public listed company. Loss from operation was RMB140.3 million compared with RMB100.6 million for the same quarter in 2016. Non-GAAP loss from operations was RMB127.2 million compared with RMB100.6 million for the same quarter in 2016. Because of foregoing, net loss was RMB140 million compared with RMB99.3 million for the same quarter in 2016. Non-GAAP net loss was RMB126.9 million compared with RMB99.3 million for the same quarter in 2016. Basic and diluted net loss per ADS attributable to ordinary shareholder was RMB7.05 compared with RMB30.9 for the same quarter in 2016; each ADS represents 15 Class A ordinary shares. Non-GAAP basic and diluted net loss per ADS attributable to ordinary shareholders was RMB6.3 compared with RMB30.9 for the same quarter in 2016. As of March, 31, 2017, the Company had total cash, cash equivalents and time deposits of RMB663 million compared with RMB647 million as of December 31, 2016. The Company had a deferred revenue, current and non-current, of RMB839 million as of March, 31, 2017 compared with [RMB687 million] as of December 31, 2016. For the second quarter of 2017, we now currently expect net revenue to be between RMB179 million to RMB184 million, which will represent an increase of approximately 85% to 90% from RMB96.9 million for the same quarter last year. And our gross billings to be between RMB352 million to RMB359 million, which will represent an increase of approximately 80% to 84% from RMB195.2 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 customer demand, all which are subject to change. This concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead.

We will now begin the question-and-answer session. (Operator Instructions) Zoe Zhao, Credit Suisse.

Hi, management, thank you for taking my question. I've got three questions here; first of all could management give us an updated expectation on our gross billing growth for the coming two years. And the second question is regarding any update on the American Academy program and third question is just like accounting question like when we said that we have like 188 Chinese English teachers for service, so are those [COGS] like the cost related to these teachers booked under cost of goods sold or G&A expenses. Thank you.

All right, I'll take the question on the first one and third one and I'll let Jack talk a bit more about the status of the American Academy program. Regarding the first question, of course, you know that we don't give out the annual guidance per se, but like what we've been saying on the script and what we talk about is while the Company is surely not just looking for growth, we're looking for what we call quality growth, which we're balancing the growth along with optimizing our efficiency, our operating expenses, as well as maximizing the student satisfaction. So what is seen in the Q2 although probably represent an annual kind of growth rate that we are looking at. Give or take an 85% level for this year over last year in term of gross billing. So that's question number one. Question number three regarding the accounting treatment for the 188 Chinese English teachers. There are two component, the two service that this Chinese English teacher are conducting. When they are actually conducting a group lesson their cost or their salary component will be classified as cost of sales. When they are conducting using the social media app to help a student with homework, to help parents with the question and reviewing students' homework, then that part is treated as sales and marketing expenses. And now, I'll let Jack to talk about the American Academy program.

(interpreted) American Academy, as you know, we started the program mid of last year that actually is growing pretty fast. In Q1 2017, the gross billing contribution from American Academy represent about 16% of our total gross billings. Of course, this is a premium product and we are reaching to a new users group, this premium users group, and this is one of our key strategy to tap into the new market, to tap into new untapped customers compared with our Filipino program. So that's pretty much our comment.

Sure, that's very helpful. Thank you.

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to the company for 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 everyone.

Operator, can you just take the -- there's a guy that just queued, can you please take Jason Yuan?

Of course, sure.

Yes, thank you.

Jason Yuan, Indus Capital.

Hi management, thanks for taking my call. So I would like to know why gross margin [again] improved [2.1%] year-on-year in first Q?

Okay, Jason, let me take on this question. As we, our product, this product, we've been increasing the price we charge the customer because it's such a mass market product and actually in the mass market, we [hardly have] any competition. So what we've been doing is gradually increase our price quarter-on-quarter. And that's a key contributor for enhancement of gross margin while the teacher cost has been pretty stable.

Okay, thank you. So just as Jack mentioned, the revenue from American Academy [came from] for 16% of total gross billings. So what's your expectation for next few quarters about this ratio?

I will answer the question in Chinese and Jimmy will translate for me. (Spoken in Foreign Language)

Because the American Academy, as stated earlier, is a premium product and our key focus is still in a mass market product. So we think this probably will enhance from 16% to a 20% level, that's our current view right now.

(Spoken in Foreign Language)

Thanks for your question. Actually, if you look, gross billing is increasing, in the meantime, our sales and marketing expense is increasing as well and the lesson, the book this quarter is greater than last quarter. So we had to pay our teacher a little bit more money. So mainly that's where the money is going to. Although, we have a loss situation, but thanks for our prepaid [month] business model, we are able to actually have a positive operating cash flow as a result.

(Spoken in Foreign Language)

Yeah. As you can see the RMB30.5 million positive cash flow that amount exceeded 2016 full year total.

Ivy Luo, Macquarie.

Thank you management for taking my question. Just a very quick question on [not the sales] and marketing. So, we mentioned that we are going to focus more on word of mouth, since we think that's more effective. So, just want to know what's the percentage of new customers coming from word of mouth referral at the current point and what's our expectation or our target in like one to two years? Thank you.

(Spoken in Foreign Language)

(interpreted) Currently, what we see from our K-12 students, the students who came from word of mouth is approximately 48%. We do think that with this K-12 student base' continuous increase, this percentage can go even higher down the road.

(Spoken in Foreign Language)

(interpreted) And this is also can be seen from the result of sales and marketing expense efficiency improvement. A year ago, it was 60. -- sales and marketing expense as a percentage [of] gross billings was 60.9% and now this quarter it's improved to [66.6%] another angle is we do see the individual sales person's output increasing, this quarter if you look at our telesales personnel compared with the last year same quarter, we will only increased by 10%, but our gross billing now is about double the size, so this all the evidence of what referral can bring to the Company.

Thank you management, this is very helpful. I Just have a quick follow-up, so for the non-GAAP sales and marketing expenses as a percent of gross billing, yes, we have been seeing it coming down like over the past two years, like 90% and now it's 45%, so what do we expect it to like keep trending down to what kind of level in the next one year or two?

Okay. Of course, we're going to continue to - our goal is to continue to bring that down. Internally, we set a target of about [three percentage point] per quarter to bring it down. So that's our internal target.

(Operator Instructions) Again, as there are no further questions now, I'd like to turn the call back over to the Company for 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.

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

Statements in English on this transcript were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.