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spk05: Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's third 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'll now turn the call over to your host, Ms. Judy Piao, Investor Relations for the company. Please go ahead, Judy.
spk02: Thank you. Hello, everyone, and welcome to the third quarter 2020 earnings conference call of China Online Education Group, also known as 5.1 Talk. The company's results were issued by 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.5.1talk.com. Mr. Jack Wong, our Chief Executive Officer, and Mr. Ming Xu, our CFO, will begin with some prepared remarks. Following the prepared remarks, Lingming Zhang, our COO, 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 Security Litigation Results 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 20F and other public filings as filed with the U.S. Securities and Executions Commission. The company does not assume any obligation to update any forward-looking statements, except as required under the applicable law. Please also note that Taiwan has earnings press release, and this conference call includes discussions of an audited GAAP's financial information as well as unaudited non-GAAP financial matters. File and Talk's press release contains a recognition of the unaudited non-GAAP matters to the unaudited directly comparable GAAP matters. I will now turn the call over to our CEO, Jack Huang. Please go ahead.
spk04: Hello, everyone. Thank you very much for joining our earnings conference call. We are pleased to report another robust quarter of solid financial and operating results. Our third quarter performance proves the merits of our strategy focused on the K-12 one-on-one mass market offering in non-tier one cities and showcases our ability to execute our initiatives. Highlights of the quarter included net revenues, reaching RMB 538.5 million, up 31.8 percent year-over-year, surpassing the top end of our guidance, with contribution from our K-12 one-on-one mass market offering growing by 46 percent year-over-year to hit RMB 471.8 million. Moreover, The number of active students on our platform in the third quarter grew to 338,000 at 30.9% compared to the third quarter in 2019. In the third quarter, our gross billings reached 728.4 million RMB, growing 33.1% year over year, of which Our K-12 one-on-one mass market growth spilling grew 37.2% to 692.2 million RMB. Clearly, families across China are gaining greater familiarity and comfort with online learning channels and recognizing the strong value we provide. As they do, they are sharing their positive experiences with their friends and our high-quality brand reputation is spreading. In October, we were honored to be invited as the only online education enterprise to join the 2020 China Annual Conference for International Education and provide key inputs for future guidelines and requirements for online foreign teachers in China. At the conference, we signed a framework agreement with the China Education Association for international exchange to jointly create recruiting and training standards for online foreign teachers. These standards will become part of China Ministry of Education's policies regulating online foreign teachers. We are excited to be part of this national-level working group. We look forward to sharing our experience working with thousands of online foreign teachers and helping shape the future of the industry. Also in October, we hosted our 2020 Sino-Philippines Educational Exchanges Seminar attended by education and government leaders, including the ambassador from China and the Philippines. Through live streaming, we engaged over 5,000 people from China and the Philippines to celebrate 45th anniversary of the establishment diplomatic relations between the two countries, showing mutual cooperation in our positive role in cross-border relations. This video receives the Guinness World Records Award for the largest online video album of people waving. In conclusion, our K-Strop 101 mass market non-tier-one city strategy is working. Our teams are executing, and the groundwork we've laid is allowing us to take advantage of more and more market opportunities. With these pieces in place, we will continue to contribute to sustained long-term growth and maintain the balanced bottom-line achievements. With that, I will now turn the call to our CFO, Ximing.
spk01: Thank you, Jack. We continued our growth momentum in Q3, achieving solid top-line increments, coupled with another quarter of profitability, our fourth consecutive profitable quarter. As the demand for online education continues to accelerate, our strategy to pursue balanced growth is delivering as planned. As an example of this can be seen in our decision during the quarter to increase non-GAAP sales and marketing expenses by 31% year-over-year to capture certain market opportunities. and increased non-GAAP product development expenses by 13% year-over-year to further improve our technology platform and the curriculum. Despite the increase in expense, we still recorded probability this quarter, with non-GAAP net income coming at 38.5 million RMB, excluding the 15 million RMB favorable impact of coronavirus relief policies in the third quarter, our non-GAAP net profit margin would have been 4.4%. Additionally, our operating cash flow reached 186.1 million RMB. Looking ahead, we will continue on our pathway of sustained growth and executing our strategies that bring to students in this rapidly developing market our strong value proposition for learning English. Now let me walk you through our third quarter financial details. Net revenues for third quarter were 538.5 million RMB, a 31.8% year-over-year growth. This increase was primarily attributable to the increases in the number of active students. Our number of active students in the third quarter was 338,000, a 30.9% year-over-year growth. Gross profit for the third quarter was 391.8 million RMB, a 33.9% year-over-year gross. Gross margin for the third quarter was 72.8%, compared with 71.6% for the same quarter last year. One-on-one offering gross margin for the third quarter was 73.2%, compared with 72.7%. for the same quarter last year. The margin increase was mainly attributable to improve of efficiency of American Academy lessons. Gross margin for 5.1 TOCS small class offering for the third quarter was 63.6% compared with 56% for the third quarter of 2019. The increase was mainly due to a favorable mix of higher margin products. Total operating expenses for third quarter were 379.6 million RMB, a 26.8% year-over-year increase. Sales and marketing expenses for third quarter were 282.8 million RMB, a 31.3% year-over-year increase. Excluding the share-based compensation expenses, non-GAAP sales and marketing expenses for third quarter was 280.6 million RMB, a 30.6 percent a year increase. Non-GAAP sales and marketing expenses, excluding branding expenses, were 31.8 percent of the gross billing for the third quarter, compared with 32.6 percent for the same quarter last year. Product development expenses for the third quarter were 43.8 million RMB, a 14% year-over-year increase. Excluding share-based compensation expenses, non-GAAP product development expenses for the third quarter were 42.1 million RMB, a 12.8% year-over-year increase. GMA expenses for the third quarter were 53 million RMB, a 16.2 million year-over-year increase. Excluding share-based compensation, non-GAAP G&A expenses for the third quarter were 50 million RMB, a 14.2% year-over-year increase. Since the first quarter of this year, we added another income line above the operating income in our income statement. Other income for the third quarter was 9.3 million RMB, which included 7.6 million RMB VAT exemption and 1.7 million RMB Super deduction. Operating income for third quarter was 21.4 million RMB compared with loss from operations of 6.7 million RMB for the same quarter last year. Non-GAAP operating income for the third quarter was 28.3 million RMB compared with non-GAAP loss from operations of 3.3 million RMB for the same quarter last year. The total favorable impact of coronavirus relief policies was 15 million RMB in the third quarter. Excluding this impact, non-GAAP operating income for the third quarter would have been 13.3 million RMB, representing a 2.5% non-GAAP operating margin. Net income for the third quarter was 31.6 million RMB compared with net loss of 5.8 million RMB for the same quarter last year. Non-GAAP net income for the third quarter was 38.5 million RMB compared with non-GAAP loss of 2.3 million RMB for the same quarter last year. Excluding the federal impact of coronavirus relief policies of 15 million RMB in the third quarter, non-GAAP net income for the third quarter would have been 23.5 million RMB representing net margin of 4.4%. Diluted EPS for the third quarter was 1.38 RMB compared with EPS of negative 0.28 RMB for the same quarter last year. Each ADS represents 15 Class A ordinary shares. Non-GAAP dilute EPS for the third quarter was 1.68 RMB compared with EPS negative 0.11 RMB for the same quarter last year. As of September 30, 2020, the company has total cash, cash equivalent, time deposits, and short-term investments of 1.6 billion RMB compared with 1.1 billion RMB RMB as of December 31, 2019. The company had advances from students of 2.6 billion RMB as of September 30, 2020, compared with 2.2 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 latest information available, we currently expect Q4 net revenues to be between 525 million to 530 million RMB, which would represent 32.2% to 33.4% year-over-year increase from 397.2 million RMB for the same quarter last year. The above outlook is based on the current market conditions. and reflects the company's current and preliminary estimates of the market and operating conditions and customer demand, which are all subject to change. On September 8, 2020, 5.1 Talk announced that its board of directors has authorized its share repurchase program of up to $20 million between September September 2020 and September 2021. As of November 19, the company had repurchased close to 70,000 ADSs for approximately $1.7 million under this program. This concludes our prepared remarks. We will now open the call to questions. Operator, please go ahead.
spk05: Thank you. 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. 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 keys. To withdraw your question, please press star, then 2. At this time, we'll pause momentarily to assemble our roster. Our first question is from Vincent Yu from Needham and Company. Please go ahead.
spk00: Thank you. Thank you, Benjamin, for taking my question. My first question is how should we think about the active student trends and the growth spending trends in the fourth quarter and the first quarter, things such as the tough comp and the potential year-over-year decreases? Second question is on the student behavior areas in terms of user time spent, number of classes taken per student compared to last year during the summer break. Third question is as we approach 2021, can we share some color on what will likely to drive 51Talks growth in next year? Thank you.
spk01: Okay. Thank you, Vincent.
spk04: Since the third quarter of this year, we have a very important strategic direction. We have started to reduce the price of our first orders. This will lead to a rapid growth of our new users. So, we have actually started to reduce the price of our first orders since the third quarter. 所以其实我们可以看到我们整个的第三季度的新增用户数 其实也是我们一个创纪录的数字 我们在第三季度我们的新增的K12用户数 对比去年同期其实已经基本上有一个百分之超过 大概是一个超过68%的年对年的新增用户数的增幅 这个应该也是一个非常快的增长 um um So we estimate that the cash income of the fourth quarter will be lower than that of the third quarter this year. Of course, compared to the same period last year, it is definitely a growth trend. Finally, I would like to answer your question about the growth of drivers in 2021. We believe that in the second half of this year, we will reduce our threshold and reduce the price of the first order. Of course, this is because we hope to further strengthen our market competitiveness in the market. In addition, we are still very confident in the long-term flow of users. So we also hope to increase the growth of users faster. to be a driving force for our growth in 2021 and next year. As you can see, we have more than 68% of new users in this quarter. When we have more users, we have more seed users. This will further accelerate our user growth. So Jack will talk about some trends. I'll fill in some of the details.
spk01: So number one, we're seeing, you know, we're doing quite well in, you know, in Q3 and Q4. We're, you know, 5.1 Talk as a company is well established and we have a very good brand and have very good reputation among our students and parents. And so in Q3, we started to take some measures. Actually, we mentioned this before. We started to cut our course package size in order to lower the total price in order to drive the user growth. So this is very important for us. For example, in Q3, the new paying students number for our K-12 business increased more than 68% year-over-year. This is a very significant growth. In Q4, we plan to continue to execute on this strategy. We will continue to cut our course package size. So in order to target our customers in Tier 2 and Tier 3 cities. So if you look at 2021 growth, and because we have confidence in our students' retention, So what we're continuing to do is that we will continue to execute our strategy to decrease the package size and to drive the user goals. As you know that in this quarter, in Q3, 68% of our new users are from referrals. So the bigger our user base is, the more students we're going to get from referral. We believe this is a great strategy for us. That kind of concluded Jack's comment. I'll give you some comments on the active students as well as the gross billing trend in Q4 and maybe in Q1. So basically, you know, if you see that, you know, our active students will continue to, you know, have very healthy growth in Q4 and Q1. And we believe that the trend will continue. And even in Q1, because we believe our engagement, our students' engagement, really helping us to improve their retention. And in addition, because we're driving user growth, so there are more and more new users coming onto our platform. And so naturally, they're gonna start with new active students. So we believe with our strategy to continue the user growth, our active students growth will continue to be very healthy. And in terms of the growth spilling, as Jack mentioned earlier, so we are actually looking at to decrease our average package size. So you're likely going to see that our average order size will decline maybe 20% year-over-year in Q4, which is a pretty steep decline. However, our net paying students number are likely going to grow more than 45% year-over-year. With that, we're still going to see our growth spilling to grow probably 20% year-over-year. This is definitely slower than previous quarters, but we believe this is a small price we can afford in order to drive user growth. You know, for us, we have very healthy cash flow, and we have a huge number of deferred revenue. So it actually helps for us to, you know, slow down the gross billing growth to kind of slow down the increase of deferred revenue. But an increasing user base is actually more important for us. um and uh And you also want to ask about the user behavior. So when we look at the user behavior, I think there is, you know, if we look at this summer, actually, you know, in China, you know, mostly the life has been back to normal. And the user behavior, you know, is quite similar to past summer. And, you know, what we can see is that, you know, the art pool of our students remain flat. And so that at the same time, we're seeing, you know, obviously... The lesson consumption, average lesson consumption for students is not going to be as active as in Q1 and Q4 this year. So you're likely going to see the lesson consumption decline in double digits. However, that's going to be more than compensated by increase in our active students. So I do not believe you're going to see year-over-year decline. So we're still going to see year-over-year growth, but obviously it's going to be much, much lower than current Q1s. year-over-year increase of 52%, you know, it's more than likely going to be, you know, below the normal 30% year-over-year growth we were normally seeing in the normal quarter. So I hope this answers your question.
spk00: Yes, very helpful. Thank you, Jack. Thank you, Ming.
spk01: Yeah, no problem. Thank you, Vince.
spk05: The next question comes from Fan Jiang from Benchmark. Please go ahead.
spk03: Yes, hello, President Jiang. My question is also about the growth of active students. Recently, the quarter has been very impressive. I would like to know about your new active users. Do they look different from your old users? I don't know if there is any difference. Another point is that I don't know if you have made certain adjustments and changes to your sales team and sales strategy. I don't know if the targeted cities are still Tier 2 and Tier 3, including your ideas for Tier 1. You also mentioned that your current growth strategy may come from the growth of new users. But in the case of so many new users, how do you maintain the retention of new users? Just quickly translate my questions. Still regarding your active student growth, it was very impressive growth in the past quarters. Just wonder what's the user profile for your new acquired active user, and particularly your strategy in terms of how you continue to drive the growth of new users as well as the retention of the new users.
spk04: Okay. Okay. Let me give a brief answer. First of all, regarding the active students who came in this year, it should be said that they are basically the same as the users we saw last year. There is no fundamental difference. For example, from the city line, more than 70% come from non-city lines. Then we can see a big change. This year, we can see that even in the first-tier cities, our user growth is also starting to increase very significantly. Of course, I think this is basically because even in the first-tier cities, their users There are also strong demands for these Philippine foreign trade businesses with high cost-effectiveness. Under the pandemic and the effects of our other products, we have shown a stronger reputation than our competing brands in the long term. We have seen a particularly good phenomenon in the first-tier cities. Although it is not the focus of our efforts, the growth of our first-tier cities this year This is also an obvious increase. You just mentioned sales teams. From the second half of this year, we will emphasize the assessment of the number of users compared to the income. This is also the price of our first class. user retention. So we hope to use better services to allow these users to have better fees in the future. Because in fact, according to the logic, the amount of the first order of the user will be reduced, and the amount of the second order will be increased. Because in general, we think that the LTV of the overall user will not be too high. So, but now we do have a problem because we are now due to this, this user growth is actually more than we expected. So, indeed, we are now seeing that the staff of the team is insufficient. I don't know. I don't know. So in terms of the student profile for the new students, there's no big difference compared to last year.
spk01: It's very similar. We're still seeing more than 70% of students coming from non-tier one cities. However, there is one change that is obvious that we're seeing Tier 1 market, we're seeing very nice user growth acceleration. And we believe it's for two reasons. Number one, there are few customers looking for good values in Tier 1 cities. And also number two reason is that it takes a while for the Tier 1 City customers to find out that some other products, they cannot deliver as good results as the 5.1 Talk product. So it takes a while for them to figure that out and switch to our platform. This is why we believe this Tier 1 user growth acceleration will continue as we continue to improve our product quality and service quality. So in terms of what we're doing in terms of sales to really drive the acceleration, so as we mentioned before, we're putting higher priority on user growth than the gross billing growth. So it's actually quite easy. In terms of KPI, we just give user growth a higher weight than the gross billing, and it naturally drives our sales to try to drive the user growth. In terms of user retention, we are actually starting an initiative to improve the service quality of our student success team. And it is very important for student success team will work very closely with parents and students to help them, you know, improve their learning experience to make sure they have good results. And as a result, we're expecting good renewal rate. We're expecting good referral rate. And as we continue to cut the size of our first order, you can actually see that the renewal order size should increase. And at the same time, the renewal rate should increase. So as a result, you actually should see our students' lifetime value should increase that way. However, we are facing a challenge that is when we continue to drive our new user growth, suddenly our student success team does not have the capacity to service a much bigger user base. So we are working very hard to help improve their efficiency and to add headphones in order to, you know, to make sure they can deliver very high, you know, service standard and service quality to our students. So this is a challenge we're going to tackle in the coming two quarters.
spk03: It is clear. Thanks for the call. Congrats for a strong quarter.
spk05: Thanks, Paul. As there are no further questions now, I'd like to turn the call back over to the company for closing remarks.
spk02: Thank you once again for joining us today. If you have further questions, please feel free to contact 5.1 Talks Investor Relations through our website, 5.1talks.ir.com, or the Pearson Group Investor Relations. Thank you.
spk05: This concludes this conference. You may now disconnect your line. Thank you.
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