51Talk Online Education Group (COE) 2017 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 Fiscal Year 2017 Earnings Conference Call. (Operator Instructions) 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 fourth quarter and the full year 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 the 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 statements except as required on 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, everybody, and thank you for joining our quarterly earnings conference call today. We are pleased to report another strong quarter that capped off a solid year. This quarter was highlighted by continued strong results from our K-12 mass-market one-on-one offerings and encouraging early results of our recently launched K-12 small-class offering. As a result, the gross billings contributed by K-12 students reached over 80% for the quarter. Key operating metrics for the small-class offering were in line or even better than our expectation. And we are very excited about the growth prospects of this new program.

We made significant strides in 2017 to position our company for continued growth. In the third quarter of 2017, we announced our focus on the K-12 segments, including both our mass-market one-on-one format and our small-class offerings. This K-12 focus provides a more favorable margin proposition and significantly widens our target customer opportunities, allowing us to further penetrate the market down to second-, third- and fourth-tier cities in China in the future.

In conjunction with our K-12 focus, we unveiled our new brand positioning a few weeks ago. Our 51Talk brand now represents K-12 mass-market one-on-one products and will be the centerpiece of our marketing campaign this spring. Currently, we have about 12,000 Filipino teachers and along with our (inaudible) operations team of about 500 local staff based in the Philippines. We have created a high barrier to enter in the market for potential competitors. We will position our one-on-one adult English offering under the WuYouYingYu brand, as we believe this independent adult brand will help us better target the adult learners.

For our small-class offerings, we will use the Hawo brand, which we aim to fuel it into the leading online small group class brand in the market. Let me give small color on this recently launched product. We primarily use North American teachers for this program, and we will utilize the resources from our American Academy one-on-one program, including the new house in the North American teacher operations.

In the month of December 2017, gross billings of the small-class program reached over RMB 12 million, taking only 6 months growing from 0. We also found out there is a differentiation on the targeted student base compared to one-on-one format, as the small group format attracts students who prefer peer study environment and encourages more interactions among classmates.

In closing, we believe our refined strategic focus and more fully developed brand identity will increase national awareness of our offerings and positions us well for continued growth in the future.

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.

Thank you, Jack, and hello, everyone. We saw dynamic growth for both net revenue and gross billing for the full year 2017, which we view as indicative of our compelling model and our strong competitive position. We anticipate gross billing pressure in the first quarter of 2018, as we continue to deemphasize our low-margin American Academy one-on-one offering. We expect the percentage American Academy offering will reduce to about 10% of total gross billing in the first quarter compared to close to 20%, just 20% just a few quarters ago. But importantly, our billing mix is shifting to our higher-margin mass-market K-12 offering and our pipeline expected to yield solid results.

Following anticipated weakness in the first quarter of 2018, we expect gross billing trend to resume to past growth pattern starting in the second quarter of the year as our mass-market K-12 focus strategy takes effect and our small-class offering grows. In addition, our nationwide marketing and brand awareness campaign targeting the spring back-to-school season will likely pressure sales and marketing expense near-term, but those costs are expected to subside as those program gain traction through the year.

As we leverage our proven industry-leading technology, our refined strategy targets higher-margin revenue growth and a large and diverse customer base which build our confidence in the future. That said, for the fourth quarter of 2017, net revenue were RMB 260.6 million, a 103.3% increase from RMB 128.2 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 fourth quarter of 2017 was 175,200, 51.7% increase from 115,500 for the same quarter last year.

In the first -- fourth quarter of 2017, we include an out-of-period adjustment to record RMB 15.5 million of omitted revenue that should have been recognized in the prior periods, of which RMB 4.5 million, RMB 6.8 million and RMB 3 million and RMB 1.2 million were attributed to the third and the second and the first quarter of 2017 and the fourth quarter of 2016, respectively. If excluding this out-of-period adjustment, net revenue for the fourth quarter of 2017 would have been RMB 241.5 million, (sic) [RMB 245.1 million] representing an 89.4% increase from the fourth quarter of 2016.

Cost of revenue was RMB 98 million, a 115.8% increase from RMB 45.4 million for the same quarter last year. The increase was primarily driven by an increase in the total service fee paid to teachers, due to the delivery of increased number of paid lessons as well as the increased cost per lesson associated with the year-over-year increase use of the western teachers.

Gross profit was RMB 162.6 million, a 96.4% increase from RMB 82.8 million for the same quarter last year. Gross margin was 62.4% compared with 64.6% for the same quarter last year. The decrease was mainly attributed to the year-over-year increase penetration of American Academy program, which has a lower gross profit margin. If recording the revenue out-of-period adjustment in respective periods, gross margin for the fourth quarter, third and the second quarter and first quarter, fourth quarter of 2000 -- and first quarter of 2017 and fourth quarter of 2016, would have been 60%, 62.5%, 64.2%, 66.3% and 64.9%, respectively.

Total operating expense were RMB 315.5 million, a 35.2% increase from RMB 233.4 million for the same quarter last year. The increase was mainly due to the result of increase in the sales and marketing, product development and general and administrative expenses.

Before I continue, I would like to remind everyone that our non-GAAP financial measure exclude share-based compensation expenses. Total share-based compensation expenses were RMB 7.5 million for the quarter compared -- for the fourth quarter of 2017 compared to RMB 9.2 million in the year ago period. Non-GAAP sales and marketing expense were RMB 189 million, a 37.3% increase from RMB 137.6 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 increased marketing and branding promotional expenses. Non-GAAP product development expenses were RMB 58.1 million, a 37.3% increase from RMB 42.3 million for the same quarter last year. The increase was primarily the result of a 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 higher technical service fee.

Non-GAAP G&A expenses were RMB 61 million, a 37.5% increase from RMB 44.3 million for the same quarter last year. The increase was primarily due to additional expenses for the personnel necessary to support our expanded operation as well as higher recruiting costs and costs related to compliance and reporting obligation as a public company.

Loss small operation was RMB 152.9 million compared with RMB 150.6 million for the same period last year. Non-GAAP loss from the operation was RMB 145.5 million compared with RMB 141.5 million for the same quarter last year. Before -- because of the foregoing, net loss was RMB 159.7 million compared with RMB 154.2 million for the same quarter last year. Non-GAAP net loss was RMB 152.2 million compared with RMB 145 million for the same period -- same quarter last year.

Basic and diluted net loss for the ADS attributable to the ordinary shareholders was RMB 7.95 compared RMB 7.7 for the same quarter last year. Each ADS represent RMB 0.15 -- 15 Class A ordinary shares. Non-GAAP net basic and diluted net loss per ADS attributable to the ordinary shareholders was RMB 7.5 compared with RMB 7.24 for the same quarter last year.

As of December 31, 2017, the company had total cash, cash equivalents, time deposits and short-term investments of RMB 623.4 million compared with RMB 647 million as of December 31, 2016. The company had deferred revenue, current and noncurrent, of RMB 1.2 billion as of December 31, 2017, compared with RMB 687.1 million as of December 31, 2016. We recorded positive full year operating cash flow of RMB 55.1 million for the year 2017 compared with RMB 28.7 million for the year of 2016. For more of our 2017 full year financial results, please refer to our earnings press release for further detail.

For the first quarter of 2018, we currently expect net revenue to be between RMB 245 million to RMB 250 million, which would represent an increase of approximately 54% to 57% from RMB 159 million for the same quarter last year, and gross billing to be between RMB 340 million to RMB 350 million, which would represent an increase of approximately 5% to 8% from RMB 325 million for the same quarter last year.

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

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

(Operator Instructions) The first question comes from Roger Parodi of Silverhorn.

This is Roger. Let me ask you 2 questions. The first question is maybe you can explain a bit more about the reasons behind the weak Q1 guidance? Secondly, could you provide -- you seem to be very confident on the small-class offering. As you have explained already a bit about it, could you provide a bit more color on the launch of the small-class offering? These are my 2 questions.

Okay. Thanks very much. (foreign language)

Okay. Jack would answer your question in Chinese, and I'll do translation.

(foreign language)

As in my prepared remark, we made our strategic focus starting shift, starting from after 3Q last year. One is in focusing on the K-12 mass-market product, the other one is focusing on our small group class format.

(foreign language)

Okay. To give you a further insight into the Q1 guidance, when we look at the makeup of our gross billing component, in 2017 Q1, the K-12 mass market represents 52%, adult represents 32% and American Academy one-on-one represents 16% of our gross billing. This percentage in Q1 of 2018, we expect it, it will be -- mass market K-12 product now represents 70%, adult 18%, and the American Academy is down to about 11%. So that -- you can see that the mass-market K-12 component has grown from 52% to 72% -- 70%.

(foreign language)

Okay. For the most important business that we strategically focus, which is K-12 mass-market product, in Q1 2018 versus Q1 2017, actually, from the absolute dollar perspective, we project it going to have a 40% growth.

(foreign language)

Okay. Also, a lot of shifting happened in January and before Chinese New Year. So if we look at the most recent trend, the months of March, which is current month, we project it, actually, that K-12 mass-market product growth, year-on-year, we expect to have a 60% growth.

(foreign language)

Although that we experienced gross billing pressure from this adjustment, but we firmly believe our core business that we want to grow, which is K-12 mass market is going to have a healthy growth in that later foundation for our future candidates.

(foreign language)

Regarding the second question on the small group class, we have decided to use Hawo for the branding of this product. And like I said in the previous remark, in this past December, we have seen the gross billing for this format reach RMB 12 million in a single month.

(foreign language)

We further expect this format in the months of March could grow into RMB 20 million gross billing. That allows us to see a great potential for this product.

(foreign language)

Yes. So that's the basic foundation for our remark why we think the -- after the pressure in the Q1 and the Q2, we will resume to past growth.

Okay. Jimmy, just to be -- to make sure, for the first question, the answer was related to billings, not to revenues, right? The...

Right, to the gross billing.

Of the percentage of the business to billing. Okay.

Yes.

(Operator Instructions) Seeing that there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over 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 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.