51Talk Online Education Group

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's second quarter 2020 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. I will now turn the call over to your host, Ms. Judy Payal, 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 Fi1Talk. The company's results were issued by Newswire Services earlier today and are posted online. You can download the earnings price release and sign up for the company's distribution list by visiting the IR section of its website at ir.fi1talk.com. Mr. Jack Huang, our Chief Executive Officer, and Mr. Ming Xu, our CFO, will begin with some prepared remarks. Following the prepared remarks, Mr. Li Ming 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. Privilege Securities Litigation Reform Act of 1995. Forward booking 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 know that by one talk, earnings press release and this conference call include discussion of and audited gaps financial information as well as an audited non-gap financial measure. So on talks, press release contains a reconciliation of the audited non-gap measure to the audited more directly comparable gap measures. I will now turn the call over to our CEO, Jack Fong. 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 in the second quarter. These results were fueled by the continued optimization of our K-12 one-on-one mass market strategy in non-tier-one 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 493.5 million RMB, a figure 5% above the high end of our guidance. Net revenues from our core business catatroph one-on-one mass market offerings increased 61% year-over-year to reach 417.9 million RMB. Furthermore, our growth billings reached 676.4 million RMB, 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 growth spillings grew 46.4% year-over-year to 612.5 million RMB accounting for 90.6% of our total growth spillings. 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 age 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 and our continuous promotion efforts, we further strengthened our leadership position in online education and effectively promoted teaching careers at Five One Top for Filipinos with high English proficiency, passion for teaching, and familiarity with the Chinese culture. Additionally, on September the 2nd, 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 one 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, Shimin.

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 a non-GAAP net income of 39.6 million RMB as our net revenues and growth spending continue to expand. Excluding the 17.9 million RMB favorable impact of government-related COVID-19 relief benefits, received in the second quarter, our non-GAAP net profit margin would have been 4.4 percent, compared with a non-GAAP net margin of negative 7.8 percent for the second quarter of last year. In addition, we're pleased to record operating cash inflow, a key metric of our financial health, of 172.1 million RMB. 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 probability. So now let me walk you through our second quarter financial details. Net revenues for second quarter were 493.5 million RMB, a 40% increase from 352.6 million RMB 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 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 349.9 million RMB, a 42.8% increase from 245 million RMB for the same quarter last year. Gross margin for the second quarter was 70.9 percent, compared with 69.5 percent for the same quarter last year. One-on-one offering gross margin for the second quarter was 71.6 percent, compared with 71.1 percent for the same quarter last year. The margin expansion was mainly attributable to a favorable mix of higher margin products. Five One talked 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 332.4 million RMB, an 18.7% increase from 280.1 million RMB for the same quarter last year. Sales and marketing expenses for the second quarter were 239.9 million RMB, a 27.4% increase from 188.4 million RMB for the same quarter last year. Excluding share-based compensation expenses, non-GAAP sales and marketing expenses for second quarter were 237.4 million RMB, a 26.8% increase from 187.3 million RMB for the same quarter last year. Non-GAAP sales and marketing expenses, excluding branding expenses, were 30.7% of the gross billing for the second quarter, compared with 32.6% for the same quarter last year. Product development expenses for the second quarter were 38.6 million RMB, a 6.6 percent decrease from 41.4 million RMB for the same quarter last year, excluding share-based compensation expenses. Non-GAAP product development expenses for the second quarter were 37.0 million RMB, a 7.2 0% decrease from 39.7 million RMB for the same quarter last year. G&A expenses for the second quarter were 53.9 million RMB, a 7% increase from 54.4 million RMB 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 51.1 million RMB, a 7.7% increase from 47.5 million RMB for the same quarter last year. Since the first quarter of this year, we added another income, we added other income line above the operating income in our income statement. Other income for the Second quarter was 9.6 million RMB, which included 7.0 million RMB VAT exemption and 2.6 million RMB super deduction. Operating income for the second quarter was 27.1 million RMB compared with operating loss of 35.1 million RMB for the same quarter last year. Non-GAAP operating income for second quarter was 34.0 million RMB compared with non-GAAP operating loss of 29.4 million RMB for the same quarter last year. The total favorable impact of coronavirus relief policies was 17.9 million RMB in the second quarter, which included impact of exemption of employer obligation on Social Security contributions, operating income of 10.9 million RMB, In addition to coronavirus policy related VAT exemption of 7.0 million RMB, excluding this favorable impact, non-GAAP operating income for the quarter would have been 16.1 million RMB, representing 3.3% non-GAAP operating margin. Net income for the second quarter was 32.8 million RMB compared with a net loss of 33.2 million RMB for the same quarter last year. Non-GAAP net income for the second quarter was 39.6 million RMB compared with a non-GAAP net loss of 27.6 million RMB for the same quarter last year. Excluding the favorable impact of coronavirus relief policies of 17.9 million RMB in the second quarter. Non-GAAP net income for the second quarter would have been 21.7 million RMB, representing 4.4% net margin. Diluted EPS for the second quarter was 1.44 RMB, compared with EPS of negative 1.62 RMB for the same quarter last year. Each hour ADS represents 15 Class A ordinary shares. Non-GAAP diluted EPS for the second quarter was 1.75 RMB compared with EPS of negative 1.34 RMB 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 1.43 billion RMB compared with 1.05 billion RMB as of December 31, 2019. The company had advances from students of 2.41 billion RMB as of June 30, compared with 2.19 billion RMB 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 525 million to 532 million RMB, which would represent 28.5% to 30.2% year-over-year increase from 408.7 million RMB for the same quarter last year. The above outlook is based on the current market conditions and reflects the company's and preliminary estimates 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.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star then two. For the benefit of all participants on today's call, if you wish to ask your question to management in Chinese, please immediately repeat your question in English. At this time, we will pause momentarily to assemble the roster. The first question today comes from Vincent Yu of Needham & Company. Please go ahead.

Thank you, management. for taking my question, and congrats on the great quarter. I have three questions. The first question is, can you guys elaborate on the recently introduced level K courses? For 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, are we noticing more marketing efforts made by us as well as competitors how should we think about the sales and market expenses for second half 2020? The third question is for, as we are seeing great quarter for both FTE students and the growth buildings, has the reopening of schools has any impact on our operation, or should we expect to see steady growth for both metrics in second half 2020 and going forward? Thank you.

I'll answer that. The first question, Xu Ming will answer the second and third questions. First of all, let's talk about the new K-level course that we have developed. We see that there are more and more 3-6 year old students on our platform. This is a little bit difficult to use our previous zero-level courses. So we have developed a new level-K course for these children in the childhood stage. In these courses, we have added more games and animations. We have also trained these children specifically. foreign foreign Of course, most of our users are from non-one-line cities, so most of the potential users will also be from low-line cities. We also believe that the UR course will be very helpful for us to further develop low-line cities.

Jeff already answered question one and I will answer question two and question three. We developed this new level K course because we're seeing there are a lot of demand from the students from age three to six years old. And a lot of times the level zero courses we have already is actually too difficult for them. So that is why we invest a lot to develop this level K course. And in order to make the courses more suitable for the younger age kids, we added a lot of games, components and we added a lot of innovation. We increased a lot of the interaction between the teachers and the students. We also retrain our teachers so that they understand how to teach younger age kids. Right now, 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 attract many of the younger kids in the lower tier cities to be able to start early on English training. We believe this will help us further penetrate the lower tier cities. Talk about question two, and basically you're saying, I'll just repeat the question. So you're noticing more marketing efforts made by 5.1 Talk 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 who are 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 there are different demands, We're not exclusive, so it's not like someone bought an AI lesson or large class lesson. Most likely, they still will buy our courses. This is why we actually can maintain our current CAC level and we keep our sales 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 marketing to meet our customer demands. 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 bidding We're likely to be higher than Q2 level, which is around 35%. Actually, that percentage will be actually more close to the Q1 level. In Q1, our non-GAAP sales 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 growth buildings. How the reopening of schools had any impact on our operations and how should we see the growth trend in second half? With the school reopening, our student lesson consumption is starting to get back to normal. We, you know, like both in Q1 and Q2, the coronavirus lockdown really helped to increase the lesson consumptions for our students. So, you know, it was growing in double digits. But we expect the lesson consumption growth to be in the low single digits in second half instead of the double digit growth in first half. But this is not a concern because we do expect our net revenue growth will mainly come from the growth of our active students. And also, the demand remains solid, and our gross billing yearly growth will likely be in the high 20s percentage. With the paying students number, yearly growth will be above 40 percent. So, we're not worried about any demand, and we're actually very excited about the opportunities in the second half. So, yeah, I hope this answered your question. Got it.

Very clear. Thank you.

Thanks, Chris.

The next question comes from Fong Jung of Benchmark. Please go ahead. Yep.

Thanks for taking my question. Congrats on a very solid quarter. Jack, just want you to have an understanding about how you think about the long-term sustainable growth for the company. Clearly, 2010 would 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 will be a reasonable growth outlook we could assume for the company? Okay.

First of all, let me talk about the new users this year. You can see that compared to the growth of the same period last year, the new users this year are the fastest in recent years. And we can see that these new users not only have more users, but also are more active. is also the highest in recent years. So we can actually see that our K12 one-to-one users this year, each user in our average course consumption in July and August is probably more than 15 classes. So this is actually in the industry is this must be the most leading uh uh Okay. So in 2020, we see a very strong growth in new paint users, which actually has been the highest in the region.

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, you know, is above 15 lessons per month, which we believe is the highest level for the industry. And not only this, you know, we do expect, you know, we're seeing the year-on-year growth close to 5%. And so... So we're expecting, you know, 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, you know, elevate the brand awareness. And we do expect this will create a very, very strong momentum for the company.

Understood. That's very helpful. My second question is actually regarding your geographic penetration. As you point out, your non-tier one students account for 70% of your total active students. Let me just wonder, in terms of your geographic strategy, Are you targeting like a more like tier two or you think you have a better opportunity than much lower tier, tier three or like even lower? How are you allocating your resources? I think, you know, based on different tiers of the cities.

那么目前从增长速度来讲呢,就是三四线城,三四五线城市的增长速度比 The second-tier cities are a little faster. But the second-tier cities are the largest market for the city line. So we think that the second-tier and the third-tier cities have a lot of opportunities. Of course, from the maturity of the market, the maturity of the second-tier cities is more mature than the third, fourth and fifth-tier cities.

In terms of growth rate, our Tier 3 and lower cities have the highest growth rate. However, in terms of the size of the gross billing, right now tier two cities has the largest share of our gross billing. So if you look at in terms of the market size, You know, the Tier 2 market is actually much more mature than the Tier 3 or lower cities. So we will, you know, 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.

Understood. Thank you very much. I'll go back to Keith.

Thank you, Phuong.

Again, if you have a question, please press star, then one. The next question comes from Roger Perotti of Silverhorn. Please go ahead.

Hi, Chuck. Hi, Sweeney. Congratulations for the outstanding quarter. Hi. I have two questions. The first one, we have seen your active student year-on-year growth rate steadily accelerate in the past few quarters. Now it's at 28%. One 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 Qimong, this K-level English that you now started and how you compete with the existing ones who obviously spend a lot of money on this. like the Bama, AI, Guagalong, and so on. Does this affect your lead cost?

And has this an impact on your conversion rate? OK. First of all, we emphasize the growth of users, especially the growth of new users. So we look at the growth of new users compared to all these financial indicators, such as cash income. We hope to expand our market share and increase our brand's popularity. This is actually a very important thing. You can see that our user growth is accelerating this year. We believe that the trend of acceleration will continue. So I think this is a very important big operation strategy. In addition, because in the past three years, we have been adhering to one of the business of the Philippine diplomatic mass market, we are constantly improving our entire operation efficiency, our transfer rate is increasing, Yeah, so you know

In 2020, we actually put a lot of emphasis on growing the 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. We do believe as long as we continue to invest in user acquisition, this growth acceleration trend will continue. And second is that we also put a lot of focus 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, on our renewal rate, and all the basics. And with the improvement of all those fundamental metrics, and we naturally, you know, is able to improve our product as well as service qualities. And that really helps the, you know, kind of a... increase the student engagement and naturally bring a lot of the sleepy students back to action and increase the growth of our active students.

您刚刚问的第二个问题是关于我们的幼儿课程 versus 市场上目前比较多见的这些 And we provide a diplomatic service. So these are two completely different product types for different needs. As for now, there are indeed a lot of users who are buying this kind of AI-based product. So we think that they are not necessarily a threat, but maybe a good opportunity. Because in fact, in the English category, in the end, It's not enough to just rely on self-study. It's not enough to just have a start-up. You still need to have a foreign language service to be able to help you really solve the problems of listening, speaking, reading, and comprehensive English. So we think this is maybe, for us, we think in the future, we have a lot of room to grow.

Talking about the pre-K English market, we just launched our level K product to address this market. In this space, there are a lot of players offering AI products, and we believe we are two very different solutions. For the AI products, basically, they will have the younger kids to watch video and do a lot of self-study. Our solution, actually, we're using the live teachers to help them to improve their English through conversation. These are totally two different products. So we do believe this market will grow, will 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. It is actually an opportunity because a lot of AI products helped educate the market and help to stimulate the interest from students and parents. However, at certain stage, this kind of AI product you know, kind of self-study is not going to meet the parents' and students' demand, and they will naturally come to look for 5.1 tox products. So as soon as you have the need to kind of improve the 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.

I got that. Thanks a lot. It's actually assuming. Thank you, Roger.

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 5.1 Talks Investor Relations through the contact information provided on our website, at ir.51talk.com, all the PS and group investor relations. This concludes this conference call. You may now disconnect to the online. Thank you.