51Talk Online Education Group (COE) 2017 Q3 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's Third Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Ms. Hanyu Liu, Investor Relations Manager for the company. Please go ahead, Hanyu.

Hello, everyone, and welcome to the Third 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.

Mr. Jack Huang, our Chief Executive Officer; and Mr. Jimmy Lai, our Chief Financial Officer, will start with the prepared remarks. Our Chief Operating Officer, Mr. Liming Zhang, will also join for the Q&A session later.

Before we continue, please note that today's discussion will contain forward-looking statements made under safe harbor provision of the U.S. 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 Form 20-F and other public filings as filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statement except as required under applicable law.

Please also note that 51Talk's earnings press release and this conference call include discussions of the 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 our CEO, Jack Huang. Please go ahead.

Hello, everyone, and thank you very much for joining our quarterly earnings conference call today.

During the third quarter of 2017, we've decided to focus attention going forward on our K-12 one-on-one mass-market product offering, which has a better margin proposition and we believe is better suited to reach the large market potential before us.

Our premium American Academy one-on-one program, which has a lower margin profile, will be positioned as a complementary product in our K-12 offerings. We believe this focus on the mass-market product offering will provide us a clear path to profitability for our one-on-one business.

The K-12 small-class offering is also an important strategic product for us. As reported in our last quarterly earnings call, we've piloted our K-12 small-class offering in late June. We are at the forefront of the market with this offering. The peer-study format, the competitive environment within the class, as well as the interactive curriculum of the small-class offering are all highly appreciated by our K-12 students in the program and their parents.

We are encouraged to see an increase in the number of students enrolled in the program and the improvement in the key operating metrics. We will continue to refine our small-class offering with further improvements in technology, curriculum and teacher training methodologies, which will require ongoing investments in the coming quarters. We believe our investments will be rewarded and this product will become a key part of our product portfolio in the longer term.

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. We are pleased to report that the net revenue continued a strong growth in the quarter as students booked record number of lessons on our platform during the period.

We are also pleased to report that the number of active students reached 176,600 in the quarter while the number of foreign teachers on our platform hit 14,800, up from 12,600 at the end of second quarter. These metrics are further proof of the wide market appeal of our 51Talk brand.

Owing to -- owing in large part of the aforementioned strategic shift Jack was just mentioning, during the third quarter, our gross billings were flat on a sequential basis as growth from our K-12 one-on-one mass-market program was offset by decrease in the American Academy and adult program. The gross billing contributed by K-12 students represent a record-high 76.3% of our total gross billing in the quarter and remained our growth driver.

As we are ramping up of our small-class offering, our operating expense increased from the previous quarter. Net operating cash flow were soft in the quarter primarily due to the flat gross billing, higher teacher service fees as a result of more lessons delivered and increased operating expenses, as I just discussed.

We are confident that our strategy to focus on the K-12 one-on-one mass-market program and develop our K-12 small-class offering bode well with our operational and financial goal and will provide better visibility for our future profitability.

With that said, for the third quarter of 2017, net revenue were RMB 236.1 million, a 95.1% increase from RMB 121 million for the same quarter last year. 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 in the quarter was 176,600, a 74.5% increase from 101,200 for the same quarter last year.

Cost of revenue were RMB 90.2 million, a 118% increase from RMB 41.4 million for the same quarter last year. The increase was primarily driven by increase in the total service fee paid to the teachers because of the increased number of paid lessons delivered as well as an increase in our cost per lesson with increased use of Western teachers.

Gross profit was RMB 145.9 million, an 83.3% increase from RMB 79.6 million for the same quarter last year. Gross margin was 61.8% compared with 65.8% for the same quarter last year. The decrease was mainly attributed to the year-over-year expansion of our American Academy program, which has a lower gross profit margin.

Total operating expenses were RMB 285.7 million, a 40.3% increase from RMB 203.6 million for the same quarter last year. The increase was mainly the result of a higher sales and marketing, product development and the general and administrative expenses.

Before I continue, I would like to remind everyone that our non-GAAP financial measure exclude share-based compensation expense. Total share-based compensation expense were RMB 8.4 million for the third quarter 2017 compared to RMB 10.2 million in the year-ago period.

Non-GAAP sales and marketing expense were RMB 165.8 million, a 38.8% increase from RMB 119.5 million for the same quarter last year. The increase was mainly due to the higher expenses related to an increase in the number of sales and marketing personnel as well as increase in marketing and branding promotional expenses.

Non-GAAP product development expenses were RMB 58.7 million, a 56.3% increase from RMB 37.5 million for the same quarter last year. The increase was primarily the result of newly added technology and course development-related personnel, who we have hired to further strengthen our technology platform and expand our curriculum offering, as well as a higher technical service fee.

Non-GAAP G&A expenses were RMB 52.8 million, a 45.2% increase from RMB 36.4 million for the same quarter last year. The increase was primarily due to the additional expenses for personnel necessary to support our expanded operation as well as higher recruitment expenses and costs related to compliance and reporting obligation as a public company.

Loss from operation was RMB 139.8 million compared with RMB 124 million for the same quarter last year. Non-GAAP loss from operation was RMB 131.4 million compared with RMB 113.8 million for the same quarter last year. Because of the foregoing, net loss was RMB 141.8 million compared with RMB 123 million for the same quarter last year. Non-GAAP net loss was RMB 133.5 million compared with RMB 113.3 million for the same quarter last year.

Basic and diluted net loss per ADS attributable to ordinary shareholder was RMB 7.05 compared with RMB 6.17 for the same quarter last year. Each ADS represented 15 Class A ordinary shares. Non-GAAP basic and diluted net loss per ADS attributable to the ordinary shareholder was RMB 6.6 compared with RMB 5.66 for the same quarter last year.

As of December -- as of September 30, 2017, the company had a total cash, cash equivalent, time deposits and short-term deposit of RMB 656.6 million compared with RMB 647 million as of December 31, 2016.

The company had a deferred revenue, current and noncurrent, of RMB 1.0891 million -- billion as of September 30, 2017, compared with RMB 687 million as of December 31, 2016.

For the fourth quarter of 2017, we currently expect net revenue to be between RMB 253 million to RMB 260 million, which will represent an increase of approximately 97% to 103% from RMB 128.2 million for the same quarter last year; and gross billing to be between RMB 382 million to RMB 390 million, which will represent an increase of approximately 34% to 37% from RMB 285.5 million for the same quarter last year.

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

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

(Operator Instructions) The first question comes from Greg Zhu of Crédit Suisse.

I have 3 questions. The first, can management explain the relationship between the [grossing] growth and the revenue growth in this quarter? And that this link seems to be widening compared to last quarter. And how should we think about this in the future? And the second question is, can management shed more color on the development of the K-12 small-class business? Any metrics or targets from this business that can be shared? And the third question is about the margins. In terms of -- we noticed that the sales and marketing expenses as a percentage of the gross is actually increasing this quarter versus the reduction target management mentioned last quarter. How should we think about this going forward? And also, we noticed similar trend in product investment and G&A expenses as well. So would this affect the breakeven point management mentioned earlier? And how should we think about this in terms of margin and breakeven in -- maybe next year and the year after?

Thank you, Greg. I will take the #1 question and #3 questions, and I'll ask our CEO, Jack, to talk a little bit more about small-class offering. Regarding the first question, gross billing -- relationship of gross billing and the net revenue, you have to look at that way -- I mean, on the gross billing side, as Jack mentioned, we are shifting our focus from American Academy and adult to put more resources in our mass-market one-on-one K-12 product, which are taught by our Filipino teachers. And with that, I think we've been talking about the mass-market product actually has a better gross margin. And this quarter, we have decided to put more focus on this product and just use American Academy taught by American -- North American teacher as a complementary product for our premium-need parents and the students. So that's why there's a -- when we're doing the shifting, there's a reallocation of resources, and that's a primary reason that our gross billings were flat. The net revenue growth is due to the previous engaged students that are taking more and more lesson on our platform. So there's actually a delayed effect from our gross billing side. So we -- as you can tell from the outlook we posted, it looks like -- next quarter, we are looking -- our estimate right now is probably doubling again on our revenue side -- on our net revenue, and we will resume the growth on the gross billing side as we are -- not completing, as we are getting more into the process of shifting the focus to the mass-market K-12 product. And so that is the reply on your question #1. I'll let Jack talk a little bit more about the -- our small-class program.

(foreign language)

Okay. Okay, thank you.

Okay. (foreign language)

Okay. I'll just give some of the key number Jack just threw out. Very quickly, the product, we pilot end of June, and we -- during the third quarter, we have -- we've been doing the expansion of this program. And so right now, the expansion is still in a controlled environment as we are working toward further refining the product. Even though the product initially wasn't perfect, but the response from the students and the parents are very favorable, that give us confidence to move ahead. For example, in the month of October alone, we have more than 1,000 students -- regular program students, coming to this program. So we are very confident about this program, and we -- as time goes by, as the product's getting more refined, we will start promoting this in the larger scale. Okay. Regarding the question #3, the sales and marketing efficiency, as we stated in our remark, the -- this quarter, as we are shifting our strategy on focusing more on the mass-market product, so that being reason #1. Reason #2 is, as we are expanding this small-class program, we are adding sales and marketing expenses to promote this product. So that is now the reason that our sales and marketing efficiency in this quarter, it doesn't seem like it's improving but actually, although the gross margin number were flat, but the component of this gross margin -- now we have a more higher-margin Filipino -- this mass-market product, K-12 product, less on a lower-margin American Academy product, so the composition is actually better.

(Operator Instructions) The next question comes from Ivy Luo of Macquarie.

So I just have one question to clarify a bit on the American Academy program. So we are seeing gross margin actually decline slightly quarter-over-quarter, and this is because an expansion of the American Academy program? So I just want to confirm that. Is that like, on the revenue side, we are still seeing the percentage of AA course increasing, but when it comes to gross billing, as we are shifting our focus to the mass-market K-12 one-on-one, gross billing as a percentage of the total -- the AA gross billing have already been coming down? And I just want to get a sense of what's the AA program's revenue contribution and gross billing contribution at the moment. And where shall we expect it to be in the future?

Okay. Very good question. Thank you, Ivy. Actually, as you know, the shifting from the gross billing to the net revenue, there's a time delay. So what you're seeing in Q3, in terms of revenue on the American Academy side, is actually probably the gross billing from a couple of quarters ago, okay? So what I can tell you is the revenue composition of the American Academy for this quarter, it's around 17%, and the gross billing from the American Academy this quarter is around 18%. But I think, this quarter -- or the Q4, you're going to see that trend cross paths. So probably in another quarter or 2, you're going to see less of American Academy component in the net revenue side. We are confident, with that, we can bring back the gross -- bring up the gross margin again.

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

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