51Talk Online Education Group (COE) 2018 Q1 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's 2018 First Quarter 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 2018 first quarter 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 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 our CEO, Jack Huang. Please go ahead.

Hello, everyone, and thank you for joining our quarterly earnings conference call. 2018 is off to good start as we exceeded the top end of our guidance in both net revenues and gross billings. Our first quarter results reflect the successful implementation of our strategic initiatives to focus our company on the driving 51Talk market, which represented 84% of our Q1 gross billings. We see a clear pathway to leverage our core competencies and grow our company. Because of our successful strategy in our K-12 mass market one-on-one program, which represented 53% of total gross billings in the first quarter, and it continues to grow. Our Hawo small-class offering is also attracting an increasing number of students, and this early-stage program is gaining traction. The advantage we have made in each of our programs are designed to emphasize higher quality and improve our margin profile as we continued to wind down our American Academy one-on-one offering. With our strategic initiatives squarely aligned in the K-12 market, we are able to more greatly reach our target market, not only in Tier 1 cities but also in lower tier cities where we see tremendous growth opportunity. Our model and the strategy are resonating well within this segment of the market with steadily increasing gross billings from non-tier 1 cities. For our K-12 mass-market one-on-one program, gross billings from non-tier 1 cities accounted for 63% in the first quarter of 2018 versus 52% a year ago.

In summary, our top priority for the remainder of 2018 will be K-12 mass-market one-on-one program, which will lead our penetration in non-tier 1 cities. We will also expand Hawo small class program, utilizing resources from our American Academy one-on-one program. In addition, we plan to rejuvenate our adult program, which we expect to stabilize.

Before turning the call over to our CFO, I would like to take this opportunity to welcome Mr. Min Xu, who has been appointed as Co-CFO to work alongside Jim. With that, I will now turn the call over to Jimmy, who will discuss our key operating metrics and financial results.

Thank you, Jack, and hello, everyone. We see positive impact on our financials following the alignment of our strategy to dedicate our resources to K-12 mass-market. Our strategy to streamline our business and deemphasize our American Academy one-on-one program lead to sequential gross margin expansion from 62.4% in the first quarter of 2017 to 64.6% in the first quarter of 2018 as well as sequential reduction of RMB 47 million in net loss. This is despite our RMB 37 million investment in the largest marketing campaign in our company history, to support our branding effort during the first quarter of 2018.

Furthermore, we expect our non-tier 1 cities expansion strategy will support our future growth and improve our financial performances. I will now like to walk through our first quarter 2018 financial highlights. Net revenue were RMB 262.6 million, a 64.6% increase from RMB 159.5 million for the same quarter last year. The increase was primarily attributed to an increase in the number of active student, and to a lesser extent, an increase

(technical difficulty)

The number of active student in the first quarter of 2018 was 190,800, a 41.8% increase from 134,000 -- 134,500 for the same quarter last year. Cost of revenue was RMB 92.9 million, a 69.7% increase from RMB 54.8 million for the same quarter last year. The increase was primarily driven by increase in the total service fees paid to teachers, mainly due to the delivery of an increased number of paid lesson. Gross profit was RMB 169.6 million, a 61.9% increase from RMB 104.8 million for the same quarter last year. Gross margin was 64.6% compared to 65.7% for the same quarter last year. Total operating expenses were RMB 280.2 million, a 14.3% increase from RMB 245 million for the same quarter last year. The increase was mainly the result of the increase in the sales and marketing product development and general and administrative expenses.

As a reminder, our non-GAAP financial measures exclude share-based compensation expenses. Total share-based compensation expenses were RMB 6.6 million for the first quarter of 2018. This compares with RMB 13.1 million for the year-ago period. Non-GAAP sales and marketing expenses were RMB 170.4 million, a 17.6% increase from RMB 144.9 million for the same quarter last year. This increase was mainly due to higher branding and marketing expenses and was partially offset by capitalized sales and personnel expenses of RMB 6.7 million in relation to the new accounting standard, FASB ASC Topic 606, adopted by the company since January 1, 2018. For further clarification, under the new accounting standard, among other things, certain sales commission to the sales personnel and the sales agent are considered incremental costs of obtaining project and therefore will be recognized as an asset, given that the company expected to recover those costs. Upon deduction of the new standard, RMB 82.7 million of contract cost asset was recognized in the pre-paid expenses, in other current asset account on March 31, 2018. Including the cumulative adjustment of RMB 76 million, which was recorded as a reduction to the accumulated deficit and the reduction of a sales personnel expense of RMB 6.7 million recorded in the sales and marketing expenses for the first quarter of 2018.

Non-GAAP product and development expenses were RMB 50.7 million, an 11.5% increase from RMB 45.5 million for the same quarter last year. The increase was primarily due to the high expenses-related technology and course development-related personnel to further strengthen technology platform and expand curriculum offering as well as higher technical service fee.

Non-GAAP general and administrative expenses were RMB 52.6 million, a 26.4% increase from RMB 41.6 million for the same quarter last year. The increase was primarily the result of additional expenses for personnel necessary to support expanded operation as well as higher cost related to compliance and reporting obligation as a public company.

Loss from operation was RMB 110.5 million compared with RMB 140.3 million for the same quarter last year. Non-GAAP loss from operation was RMB 104 million compared with RMB 127.2 million for the same quarter last year. Before the foregoing -- because of the foregoing, net loss was RMB 112.7 million compared with RMB 140 million for the same quarter last year. Non-GAAP net loss was RMB 106.1 million compared with RMB 126.9 million for the same quarter last year.

Basic and diluted net loss per ADS attributable to ordinary shareholder was RMB 5.55 compared with RMB 7.05 for the same quarter last year. Each ADS represent 15 Class A ordinary share. Non-GAAP basic and diluted net loss per ADS attributable to ordinary shareholder was RMB 5.25 compared with RMB 6.3 for the same quarter last year.

As of March 31, 2018, company had total cash, cash equivalent, time deposit and short-term investment of RMB 549 million compared with RMB 623.4 million as of December 31, 2018. The company had current and a noncurrent deferred revenue of RMB 1.3 billion as of March 31, 2018, compared to -- compared with RMB 1.2 billion as of December 31, 2018.

Now, for the second quarter of 2018, we currently expect net revenue to be between RMB 265 million to -- and RMB 275 million, which would represent an increase of approximately 38% to 43% from RMB 191.8 million for the same quarter last year. And we are also projecting gross billing to be between RMB 385 million and RMB 395 million, which would represent an increase of approximately 8% to 11% from RMB 355.1 million for the same quarter last year. Of course, the above outlook is based on the current market condition and reflect company's 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) The first question comes from [Wang Hi Hui] of CICC.

(foreign language) I have 2 questions. The first one is the guidance. We noticed that our guidance for the second quarter, especially in gross billing, is a lot more higher than the first quarter. So I'm just wondering, which part of our business will the main growth driver? My second question is about competitive landscape. We noticed that a lot of players are going into this market, including (inaudible). So I was just wondering how will this impact our business?

(foreign language) Jimmy.

Okay. Okay.

Okay. (foreign language)

Okay. The -- Yes, the guidance sequentially increased between 8% to 11%, and the main -- the key driver came from our K-12 mass-market, one-on-one product. This product in Q1, in term of gross billing, it was 63% of total gross billing. And we expect, in the second quarter, this percentage will increase. In the meantime, the K-12 mass-market product, year-on-year growth in Q1 was 34%. And again, in Q2, we believe this percentage will also further increase.

(foreign language)

The reason for the increase of extension, actually, it started in Q4. The penetration -- our K-12 mass-market product penetration down to the second and third-tier city because our product is the -- has the best value for the price in this area. So very suitable for the second and third-tier city.

(foreign language)

Also, in term of the K-12 mass-market product, the second and third-tier city percentage, as a percentage of total gross billing in Q1 was 63%. This number last year, same time, was 52%. We expect in Q2, it would further increase from 63% and above.

(foreign language)

Of course, if you drill down to further information, it's not just the price. We modify our product a little bit, we -- in order to make it more suitable for the student in the second and third-tier city.

Okay. (foreign language)

Okay. Of course, the Hawo small-class product, we'll also see a sequential increase, but it's not going to be as big as the K-12 mass-market, one-on-one product.

(foreign language)

The last part is adult business. The last couple of quarters, we've been focusing on some of the adjustment, so it has not been increasing. But starting in Q2 2018, you will see this product to stabilize or increase.

(foreign language)

Of course. The potential competition you bring up in question like [Total], they are still focusing on the premium market North American teacher one-on-one product. And this product has now been -- we deemphasized it a couple of quarters ago. So it probably is not going to have much -- too much impact on us.

The next question comes from Sheng Zhong of Morgan Stanley.

(foreign language) So my question is, can you share some observations of the student acquisition cost and retention in Q1 and in our Tier 1 cities?

Okay. (foreign language)

Thank you for your question. Of course, the traffic and acquisition cost in the Tier 1 city has become expensive. As a result, this second and third-tier city -- because the traffic cost is the lower. So as a result, the customer acquisition cost is lower. But that's not the main driver. The main driver is actually from the second and third-tier city, is the referral rate. We see a higher referral rate in the second- and third-tier city versus a first-tier city. The Q1 referral rate was 59%. And of course, the lower-tier city referral rate is higher than that.

(foreign language)

Okay. If we take a closer look for the reason why the lower-tier city referral rate is higher. First is, our product is, like we said, is a better product price -- value for price. So lower-tier cities' parents are more willing to refer our product. When you compare our product with the premium North American product, RMB 40 per lesson versus RMB 120, RMB 130 per lesson, it's much easier for those parents to refer our product. Number two is the social openness for lack of better translation. In the lower-tier city, there are less social openness when you refer the -- our product to the peers.

(foreign language)

As far as the retention rate, we see no difference between Tier 1 city and lower-tier cities.

(foreign language)

So we're very happy to see the online education product. It's penetrating in a major way into low-tier cities.

The next question comes from [Francisco Rodriguez Prada] of (inaudible) Capital.

This is Francisco from Spain. (technical difficulty) I'm sorry, is it any better?

Yes.

Okay. The company you guys have built has been a remarkable history. I'd like to ask a few questions. Can you please help us understand how this largest marketing campaign you guys have done recently translate into revenues, growth and especially more importantly free cash flow and margins going forward, please?

Okay. Actually in direct -- if you look at the marketing campaign, this is more of a long-term branding awareness that's probably not a direct correlation between the Q1 marketing campaign and the Q2 revenue. So that's to answer your question, it's more for longer-term brand awareness campaign. Number two, the gross margin...

(inaudible)

Sorry, Francisco, can you repeat your second question?

(inaudible)

Okay, sorry.

(foreign language)

My second question was regarding how do you do -- how do you allocate your resources for your marketing spending? Is it more depending on how the gross billing is going to be, do you just allocate a percentage of it to your -- to the marketing, or do you allocate marketing resources as the opportunities arise?

There are 2 type of sales, marketing spend. One, of course, is the branding. Branding is, when we see fit, we will invest in the branding. The marketing expense is more related to the student acquisition, giving reward to the referral. So [it's] -- second part is more directly to the gross billing. I don't know if that answered your question.

Okay. Thank you very much. I'm not going to ask you to us -- to give us more guidance than 1 quarter ahead. But will you please tell us what kind of growth of gross billings will you be comfortable with in the future?

No, we just -- our practice is to give guidance for the next quarter. That's -- sorry, that's been our practice.

Okay. And I don't know if I understood the retention rate that somebody before asked, but could you please say again the retention rate of the students, please?

Okay. Question was the, do we see difference between Tier 1 city student retention rate and the lower-tier city student retention rate, and our reply was there's no difference between Tier 1 and Tier -- lower-tier cities.

And what's more or less the range of the retention rate? Do you guys disclose that?

No. But it's complicated question because student can be coming by various package, and each package come with a -- depend on duration, it probably have a different retention rate.

Okay. May I -- can I ask a few more questions?

I probably need to say, probably one more because we still have analysts in the back that want to ask questions.

I can jump in the line and come back later if that's fine.

Okay.

Okay, yes, all right.

And that next question will come from [Alexander] (inaudible) of TR Capital.

Good evening. My question is about K-12 small-class offering. So basically during the last earnings call, it was mentioned that gross billing for K-12's small-class offering was about RMB 12 million in December last year. Considering that gross billing for Q1, for that particular product, was RMB 36.9 million. It seems that small-class offering hasn't gained much traction so far. So I'm curious to know what's your view on that? Are you satisfied with the progress made? And is this a product that you will be pushing further in the future?

Sure. A very good question. We did mention that, in the month of December, gross billing was CNY 12 million. The small-class offering, it's more similar to the offline small-class, where there is a window of adding new student, of a window for the student to renew. So it's not a monthly linear type of projection, okay? So if you compare apple-to-apple, the -- for example, the Q4 last 2017, the quarterly gross billing for small-class was CNY 20 million, and this quarter was CNY 36 million. So that is actually a -- quite a big event in term of increase.

We are very optimistic about the Hawo small-class, but the strategy is not to expand it very aggressively. While we're expanding it, we're very cautious about fine-tuning all the operating metrics, including the utilization rate, renewal rate, student satisfaction. That's what we -- at this stage, that's what we are more focusing on rather than the gross -- income of the gross billing number.

(Operator Instructions) .

Thank you, once again, for joining us today. (inaudible).

Excuse me, I do see that there is a follow up from [Francisco Rodriguez Prada]. Please go ahead.

Just a quick one. I would like to ask a question to Mr. Min Xu. What are your first impressions about the team 51Talk and also more in general, what's the rationale for having a CFO and a Co-CFO?

Francisco, we'd be more than happy to have Min Xu [chat with you person] one-to-one -- one-on-one occasion instead of doing this on the conference call. Yes. We can arrange a time to check, okay?

Okay, fantastic. (inaudible) the roadshow in the U.S. plan, are you guys still thinking about that?

We will discuss with you on personal one-on-one situation, okay? Thanks.

And we have a question from [Erica Lung] of Silverhorn Investment Advisors.

So my question is more on the certain marketing expense. So we see that certain marketing expense improve much quarter-on-quarter. But if we consider the branding campaign in Q1, which caused around RMB 37 million. It actually improved [significantly]. So can you give us more guidance to help us to understand the trend of the [COD] self-efficiency, for example, on the development of conversion rates or cost per newly acquired student? And also, what do you see for certain marketing expenses as a percentage for gross billings [in the future]? And also one more questions on the small-class offering. I see that lot of private and public company are entering the market. They are more -- they are larger and strongly funded. So what's your [least] competitive edge, and how can you maintain your leading position in this highly anticipated market as the competition start to intensify?

Thank you. I'll take the first question, and Jack would take the second question. Our sales and marketing expenses percentage gross billing was 48% in Q1 2018, which is [quiet] compared with our last quarter, Q4 2017. However, in Q1, we invest in the largest branding campaign in the company history, where we invested RMB 37 million. So if you take out the branding investment and other adjustment, take an apple-to-apple comparison, our sales and marketing expense as a percentage gross billing reduced from 44% in Q4 2017 to 39% in Q1 2018. There's about 5 points improvement. The largest contributor for this marketing efficiency improvement is actually in the increase of referral rate. As indicated before, our K-12 referral rate increased from 53% in Q4 2017 to 59% in Q1 2018. In non-tier city, where our primary focus market, the K-12 referral rate has actually reached 60%. Our strategy and our goal is that we continue to drive up the referral rate, which -- with a goal of reducing our sales and marketing percentage, just percentage to gross billing. However, it's hard to give you -- this is the forward-looking statement. It's hard to give you a percentage. But our goal is to continue to drive it down. And I'll let Jack take the second question on the small-class, and I'll do the translation.

Okay. (foreign language)

When we do this small group class, compare with some of the startup company in the industry, our advantage primarily in the 3 area: one -- number one is our proprietary technology platform, which we'll be investing for 5, 6 years; our curriculum development team, we have 160 people dedicate to developing curriculum internally; number three is we -- when we did the American Academy, there is a lot of know-how in term of the North American's teacher recruiting and training, which we'd leverage on this -- how will we leverage our American Academy one-on-one. So this give us a better foundation for developing this product.

(foreign language)

Our -- the whole cost format is based on the -- what we call 3 fix: fixed classroom, fixed teacher and fixed schedule. This was combined with 3 lesson per week, 2 conducted by foreign teachers and 1 conducted by Chinese teacher. So as a result, we can have a higher renewal rate compared with other players in the industry, and this give us distinct advantage.

(foreign language)

Of course, this still early stage product. It represent only a small portion of our total gross billing and net revenue. And really don't expect to see a profit though from this business in the near-term.

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 Investor Relations through the contact information provided on our website or The Piacente Group Investor Relations. Thank you.

Thank you, [everyone].

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