51Talk Online Education Group (COE) 2020 Q2 法說會逐字稿

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Today's conference call is being recorded.

I will now turn the call over to your host, Ms. Judy Piao, Investor Relations for the company. Please go ahead, Judy.

Hello, everyone, and welcome to the Second Quarter 2020 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. Min Xu, our CFO, will begin with some prepared remarks. Following the prepared remarks, Mr. Liming Zhang, our Chief Operating Officer, will also join the call for our Q&A session.

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 risks 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 discussion 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. Thank you for joining our conference call today.

We extended our outstanding performance by registering another quarter of robust, across-the-board results during the second quarter. These results were fueled by the continued optimization of our K-12 one-on-one mass market strategy in non-tier 1 cities as well as the overall growing market awareness and acceptance of online education brought about by the effect of COVID-19 pandemic.

Financial highlights of the second quarter include our net revenues increasing 40% year-over-year to reach RMB 493.5 million, a figure 5% above the high end of our guidance. Net revenues from our core K-12 one-on-one mass market offerings increased 61% year-over-year to reach RMB 417.9 million. Furthermore, our gross billings reached RMB 676.4 million, growing about 35.7% year-over-year and recording the highest growth rate since the first quarter of 2018. Our K-12 one-on-one mass market gross billings grew 46.4% year-over-year to RMB 612.5 million, accounting for 90.6% of our total gross billings.

Operationally, our team continued to execute well and capture the market opportunities. We grew our number of active students by 27.8% year-over-year in the second quarter. To augment our K-12 offerings, we recently launched brand new Level-K courses for kindergarten students aged from 3 years old to 5 years old, aiming to broaden our student base and build good study habits from a young age through our platform. We also held tournaments for our flagship China Youth Talk speech contest between April and August. This high-profile event attracted more than 500,000 K-12-aged contestants from across the country and showcased the achievements among some of the most talented youth.

In the second quarter, we embarked on a brand uplift efforts in the Philippines to further burnish our already strong appeal among existing and potential instructors. A highlight of this campaign is the appointment of Ms. Pia Wurtzbach as our brand ambassador in the Philippines. She is a former Miss Universe with strong popularity among our target instructor demographic. With her appointment in our continuous promotion efforts, we further strengthened our leadership position in online education and effectively promoted teaching careers at 51Talk for Filipinos with high English proficiency, passion for teaching and familiarity with the Chinese culture.

Additionally, on September 2, at the K-12 Online Education Service and Evaluation Standard conference, we presented the first enterprise standards for K-12 Online Education Industry, which we believe is an important step forward in the maturity of our industry and the standardization of the service scope and requirements for K-12 online education enterprises.

In summary, we are proud of our second quarter achievements, both financially and operationally. The firm's organizational foundation built over the years, coupled with our focus in the K-12 one-on-one mass market in non-tier 1 cities, has helped us emerge today in a stronger, better position as we move into the second half of 2020. I look forward to continuing to execute on our mission, bringing our strong value proposition to the market and the long-term benefits to all our stakeholders.

With that, I will now turn the call over to our CFO, Xu Min.

Thank you, Jack. Hello, everyone. I'm pleased to report another solid quarter marked by both continued top line growth and robust profitability, driven by our strategy to pursue healthy growth while keeping a close eye on operational efficiencies.

During the second quarter, we achieved non-GAAP net income of RMB 39.6 million as our net revenues and gross billings continued to expand. Excluding the RMB 17.9 million favorable impact of government-related COVID-19 relief benefits received in the second quarter, our non-GAAP net profit would have been -- profit margin would have been 4.4% compared with a non-GAAP net margin of negative 7.8% for the second quarter of last year. In addition, we are pleased to record operating cash inflow, a key metric of our financial health, of RMB 172.1 million. I should also highlight our successful follow-on public offering during the quarter, which further strengthened our balance sheet and stimulated investor interest. I'm confident that company is on the right track for continued growth and profitability.

So now let me walk you through our second quarter financial details. Net revenues for second quarter were RMB 493.5 million, a 40% increase from RMB 352.6 million for the same quarter last year. This increase was primarily attributed to an increase in the number of active students as well as an increase in average revenue per active student. The number of active students in the second quarter was 298,000, a 27.8% increase from 233,000 for the same quarter last year. The average revenue per active student in the quarter increased by 9.5% year-over-year.

Excluding the positive impact of coronavirus-related exemption of employer obligation on social security contributions, gross profit for second quarter was RMB 349.9 million, a 42.8% increase from RMB 245 million for the same quarter last year. Gross margins for the second quarter was 70.9% compared with 69.5% for the same quarter last year.

One-on-one offering gross margin for the second quarter was 71.6% compared with 71.1% for the same quarter last year. The margin expansion was mainly attributable to a favorable mix of higher-margin products. 51Talk's small class offering gross margin for the second quarter was 58.9% compared with 54.5% for the second quarter of 2019. The increase was mainly due to a favorable mix of higher-margin products.

Total operating expenses for the second quarter were RMB 332.4 million, an 18.7% increase from RMB 280.1 million for the same quarter last year. Sales and marketing expenses for the second quarter were RMB 239.9 million, a 27.4% increase from RMB 188.4 million for the same quarter last year. Excluding share-based compensation expenses, non-GAAP sales and marketing expenses for the second quarter were RMB 237.4 million, a 26.8% increase from RMB 187.3 million for the same quarter last year. Non-GAAP sales and marketing expenses, excluding branding expenses, were 30.7% for the gross billing -- of the gross billings for the second quarter compared with 32.6% for the same quarter last year.

Product development expenses for the second quarter were RMB 38.6 million, a 6.6% decrease from RMB 41.4 million for the same quarter last year. Excluding share-based compensation expenses, non-GAAP product development expenses for the second quarter were RMB 37.0 million, a 7.0% decrease from RMB 39.7 million for the same quarter last year. G&A expenses for the second quarter were RMB 53.9 million, a 7% increase from RMB 50.4 million for the same quarter last year. This increase was primarily due to the higher professional services fee in connection with the follow-on public offering. Excluding share-based compensation expenses, non-GAAP G&A expenses for the second quarter were RMB 51.1 million, a 7.7% increase from RMB 47.5 million for the same quarter last year.

Since the first quarter of this year, we added another income -- we added other income line above operating income in our income statement. Other income for the second quarter was RMB 9.6 million, which included RMB 7.0 million VAT exemption and RMB 2.6 million super deduction. Operating income for the second quarter was RMB 27.1 million compared with operating loss of RMB 35.1 million for the same quarter last year. Non-GAAP operating income for the second quarter was RMB 34.0 million compared with non-GAAP operating loss of RMB 29.4 million for the same quarter last year.

The total favorable impact of coronavirus relief policies was RMB 17.9 million in the second quarter, which included impact of exemption of employer obligation on social security contributions, operating income of RMB 10.9 million in addition to coronavirus policy VAT exemption of RMB 7.0 million. Excluding this favorable impact, non-GAAP operating income for the quarter would have been RMB 16.1 million, representing 3.3% non-GAAP operating margin.

Net income for the second quarter was RMB 32.8 million compared with a net loss of RMB 33.2 million for the same quarter last year. Non-GAAP net income for the second quarter was RMB 39.6 million compared with a non-GAAP net loss of RMB 27.6 million for the same quarter last year. Excluding the favorable impact of coronavirus relief policies of RMB 17.9 million in the second quarter, non-GAAP net income for the second quarter would have been RMB 21.7 million, representing 4.4% net margin.

Diluted EPS for the second quarter was RMB 1.44 compared with EPS of negative RMB 1.62 for the same quarter last year. Each of our ADS represents 15 Class A ordinary shares. Non-GAAP diluted EPS for the second quarter was RMB 1.75 compared with EPS of negative RMB 1.34 for the same quarter last year.

As of June 30, 2020, the company had total cash, cash equivalents, time deposits and short-term investments of RMB 1.43 billion compared with RMB 1.05 billion as of December 31, 2019. The company had advances from students of RMB 2.41 billion as of June 30 compared with RMB 2.19 billion as of December 31, 2019.

Now let's talk about outlook. While there are still uncertainties related to the coronavirus pandemic during the remainder of 2020, based on the latest information available, we currently expect Q3 net revenues to be between RMB 525 million to RMB 532 million, which would represent 28.5% to 30.2% year-over-year increase from RMB 408.7 million for the same quarter last year. The above outlook is based on the current market conditions and reflects the company's current and preliminary estimate of market and operating conditions and the customer demand, which are all subject to change.

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

(Operator Instructions) The first question today comes from Vincent Yu of Needham & Company.

Congrats on the great quarter. I have 3 questions. The first question is can you guys elaborate on the reintroduced Level-K courses, example, the course pricing compared to our K-12 offering. And will we also focus on targeting lower-tier cities as well?

The second question is we are noticing more marketing efforts made by us as well as competitors. How should we think about the sales and marketing expenses for second half 2020?

The third question is for -- as we are seeing great quarter for both active students and the gross billings, has the reopening of schools had any impact on our operation? Or should we expect to see steady growth for both metrics in second half 2020 and going forward?

(foreign language)

So Jack already answered question 1, and I will answer question 2 and question 3.

So what -- we developed this new Level-K courses because we're seeing there are a lot of demand from the students from age 3 to 6 years old. And a lot of times, the level 0 courses we have already is actually too difficult for them. So that is why we spend -- we invest a lot to develop this Level-K course. And in order to make the courses more suitable for the younger-aged kids, we added a lot of games components, and we added a lot of animation. We increased a lot of the interaction between the teachers and the students. And we also retrain our teachers so that they understand how to teach younger-aged kids.

So we -- right now, a majority of our students, actually, more than 70% of those are in the non-tier 1 cities. So obviously, naturally, we believe our new Level-K lesson will be -- will attract many of the younger kids in the lower-tier cities to be able to study -- start early on English training, and we believe this will help us further penetrate the lower-tier cities.

So as -- talk about question 2, and basically, you're saying -- I'll just repeat the question. So you're noticing more marketing efforts made by 51Talk as well as our competitors and how should we think about sales and marketing expenses for the second half. So first of all, I want to stress that we're not directly competitors to either AI players or large class players who are actually the major players for elevating their effort on sales and marketing. And because we focus mostly on spoken English, which is kind of a capability development instead of the test prep, and so we're -- our product actually is relatively high priced compared to the low-priced AI lessons or large class lessons. So we're actually targeting different demands. Even though it may come from the same customer group, but because they are different demands, we're not exclusive. So it's not like someone bought a AI lesson or large class lesson, they -- most likely, they still -- or will buy our courses. And this is why we actually can maintain our current CAC level, and we keep our sales and marketing quite efficient.

So that being said, we're still going to increase our investment in our sales and marketing because we're seeing a lot of opportunities, and the demand is there. And so we're trying to invest in the sales and marketing to meet our customer demand. And as we said before, we're investing excess profit back into the marketing and branding. So our second half non-GAAP sales and marketing expenses as a percentage of gross billing were likely to be higher than Q2 level, which is around 35%. Actually, that percentage will be actually more close to the Q1 level. We did -- our -- in Q1, our non-GAAP sales and marketing expenses was roughly 37.9% of the gross billing. So hopefully, that can give you some color.

And for the third question, so basically, you're saying because we're seeing very strong growth in both active students and gross billings, how the reopening of schools had any impact on our operations and how should we see the growth trend in second half. So with school reopening, our student lesson consumption is starting to get back to normal. So we -- like in -- both in Q1 and Q2, the coronavirus lockdown really helped to increase the lesson consumptions for our students. So it was growing in double digits. But we expect the lesson consumption growth to be in the low single digits in the second half instead of the double-digit growth in first half. So -- but this is not a concern because we do expect our active -- our net revenue growth will mainly come from the growth of our active students.

So -- and also, the demand remains solid, and our gross billing, year-over-year growth will likely be in the high 20s percentage with the paying students number year-over-year growth be above 40%. So we're not worried about any demand, and we're actually very excited about the opportunities in the second half. So yes, I hope this answered your question.

The next question comes from Fawne Jiang of Benchmark.

Yes. Congrats on a very solid quarter. Jack, I just want to have an understanding about how you think about the long-term sustainable growth for the company. Clearly, 2010 (sic) [2020], we benefit from the lockdown. I just wonder what's your observation on the user behavior you acquired during the lockdown, whether they are different from your past new users. And heading to 2021 or beyond, what would be, like, a reasonable growth outlook we could assume for the company?

Okay. (foreign language)

Okay. So in 2020, we see very strong growth in new paying users, which actually has been the highest in recent years. So not only the user increase is strong, we also see very high level of student engagement. And so we believe student engagement is very crucial in getting a good training result.

And so what we are seeing is that in the summer months and in July and August, we're seeing lessons per active student is above 15 lessons per month, which we believe is the highest level for the industry. And not only this, we do expect -- we're seeing the year-over-year growth close to 5%. And so we're expecting the trend to continue, and we do expect the high number of new paying users will bring actually more referrals and, at the same time, elevate the brand awareness, and we do expect that this will create very, very strong momentum for the company.

Understood. That's very helpful. My second question is actually regarding your, I guess, your geographic penetrations. As you point out, your non-tier 1 students account for 70% of the -- your total active students. I mean, I just wonder, in terms of your geographic strategy, are you targeting, like, a more, like, tier 2? Or do you think you have a better opportunity, the much lower tier 3 like -- or even lower? How are you allocating your resources, I think, based on different tiers of cities?

(foreign language)

So in terms of growth rate, our levels 3 and lower -- tier 3 and lower cities has the highest growth rate. However, in terms of the size of the gross billing, right now, tier 2 cities has the largest share of our gross billing.

So if you look at in terms of the market, the tier 2 market, actually, much more mature than the level -- the tier 3 or lower cities. So we will kind of -- right now, we will spend -- actually probably put more effort in the tier 3 and lower cities, but we will spend -- we will still allocate a very significant chunk of resources to tier 2 cities, too.

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

Congratulations for the outstanding quarter. I have 2 questions. The first one, we have seen your active students year-on-year growth rate steadily accelerate in the past few quarters. Now it's at 28%. 1 year ago, it was below 20%. It was around 19%. What is the driver behind this growth, active student growth?

The second one, you already touched in your first question, but maybe you can give a bit of more color there is regarding this [new mode], this K-Level (sic) [Level-K] English that you now started and how you compete with the existing ones who obviously spend a lot of money on this like the Banma AI, the GuaGuaLong and so on. Does this affect your lead cost? And has this an impact on your conversion rate?

Okay. (foreign language)

Yes. So in 2020, we actually put a lot of emphasis on the growing user numbers. So we actually believe the increase of new paying students is actually more important than other financial metrics. So that's why we put a lot of emphasis on operation to increase our market share as well as to elevate our brand awareness. And we do believe this -- as long as we continue to invest in user acquisition, our -- this growth acceleration trend will continue.

And second is that we also put a lot of focus on the -- on our core product. And so with that focus, we also significantly increased our efficiencies. And we -- in our operations, we focus a lot on our conversion rate, our renewal rate and all the basics. And with the improvement of all the fundamental metrics, and we naturally is able to improve our product as well as service qualities, and that really helps the kind of increased student engagement and naturally bring a lot of the sleepy students back to action and increase the growth of our active students.

(foreign language)

So talking about the pre-K English market, yes, so we just launched our Level-K product to address this market. And so in this space, there are a lot of players offering AI products, and we believe we have 2 very different solutions. So for the AI products, basically, they will have the younger kids to watch video and do a lot of self-study. And so our solution, actually, we're using the live teachers to help them to improve their English through conversation. So these are totally 2 different products.

So we do believe this market will grow. We'll have very fast growth in the next few years. But obviously, because AI products, they're not expensive. So a lot of the parents and students will start from their product. However, we do not view that as a threat. So it is actually an opportunity because a lot of AI products kind of help educate the market and help to stimulate the interest from the students and students -- from students and parents. And -- however, at certain stage, this kind of AI product, kind of self-study is not going to meet the parents' and students' demand, and they will naturally come to look for 51Talk's product. So as soon as you have the need to kind of improve comprehensive understanding or conversation on English language, you will find out the live online lesson will be the best option. So we actually believe this actually is a great opportunity for us.

As there are no further questions, now I'd like to turn the call 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's Investor Relations through the contact information provided on website at ir.51talk.com or the Piacente Group's Investor Relations.

This concludes this conference call. You may now disconnect your lines. Thank you.