iHuman Inc.

Good day and welcome to the iHuman Inc. third quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Ms. Jung Chang, Investor Relations Manager for iHuman Inc. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. iHuman's earnings release was distributed earlier today and is available on the company's IR website. On the call with me today are Dr. Michael Chi, founder and chairman of iHuman, Dr. Peng Dai, director and chief executive officer, and Mr. Vivian Wen, director and chief financial officer.

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operations, and financials.

They will all be available to answer your questions during the QA session that follows. Before we begin, I'd like to remind you that this conference call contains forward-looking statements as defined in the U.S. Private Security Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and current market and operations conditions and relate to events that involve known or unknown risks uncertainties, and other factors, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance, and achievements to differ materially. Further information regarding this and other risks, uncertainties, or factors is included in the company's filing with the SEC. The company does not undertake any obligation to update any forward-looking statements except as required under applicable law. It is now my pleasure to introduce our chairman, Michael. Michael, please go ahead.

Thank you all for joining our first earnings call as a public company. It has been a great journey and we are very happy to be here today. In this quarter, we are pleased to report that we recorded another quarter of strong growth. Our total revenues more than doubled year on year, with these revenues from online learning services quadrupled. Our net income for the quarter reached RMB 10.6 million. I'd like to take a moment to talk a bit more about our company and our industry. For those who may be new to our story, We are a leading player in the online childhood edutainment sector in China. We deliver highly effective, interactive, and engaging edutainment products for children, such as online learning apps, offline learning materials, and smart learning devices. Our online apps cover multiple subjects, such as Chinese, English, Pinyin, math, reading and many others. Our management team is very experienced in not just education but also technology and entertainment. We have dedicated more than two decades of work to the childhood education space and we are still very committed. The childhood entertainment market in which we operate presents tremendous opportunities. The market has been growing rapidly. According to Frost-Solomon's report, total sales are expected to increase six times by 2024. As the industry leader, we are confident that our superior product quality will help us gain more market share. Our unique business model is driven by our superior capabilities in educational content development and technology innovation, which has set us apart from our peers and has allowed us to build such fast organic growth. One of the things we really try to do is to create products from a child's point of view and to balance fun and learning. We create tailor-made content that is designed for each knowledge point within our apps, which helps to encourage children to learn. Our products are full of creative elements and the interactive designs that greatly help to cultivate creativity in children, which cramming can never do. Our work so far has not only created our unique positioning, but has also produced very high entry barriers. I also believe our products play a more important role than just learning tools. We often see that native English speaking kids can typically start reading books at three or four, as English is more like a phonetic language and the kids can easily pick up and start reading. On the other hand, children in China usually don't start until they are six, after they have started an official school curriculum.

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This is because Chinese is a pictorial language and it's harder for kids to connect pronunciation and the meaning of words. And I'm very pleased to see that the entertainment nature of inhuman Chinese actually allow children to start reading Chinese easier, earlier in their development because of and product design help simplify the learning of complex Chinese characters. Going forward, we will remain focused on developing the very best educational content and committed to transforming learning into a fun journey for every child. We think there's no greater reward than hearing great feedback from parents. And it pleases us to no end when they tell us that their kids have become much more motivated with their own learning and how quickly they start to develop when using our apps. This is something we hear a lot. Even for children in less developed areas who don't have access to premium teaching resources, as long as they have an internet connection and a mobile device, our self-directed learning products can help them achieve better learning results. This inspires us to constantly innovate and launch new products that deliver truly unique, interactive, and massive learning experience that are both fun and educational. Now, I will hand the call over to Dr. Peng, our CEO, to walk you through our business development and operating results.

Thank you. Thanks, Michael, and thank you, everyone, for joining the call. In Q3, We capitalized on our superior educational content and technologies while riding on the rising consumer acceptance of online childhood education to quickly expand our online services business. As mentioned by Michael earlier, revenues from our online services quadrupled and reached RMB 120.7 million. This growth was backed by the highly interactive and immersive learning experience that our online products deliver and our in-depth understanding of childhood education. In Q3, we continued to be a leading player in the online childhood edutainment sector in China in terms of both monthly active users and paying users. Our online products achieved 11.1 million MAUs. representing 187% year-on-year growth. And our paying users reached 1.4 million in Q3, which represents 160% year-on-year growth. We are particularly proud to have developed a great reputation for our superior product quality. The majority of our content is educational. and we have incorporated phone features and interactive designs as a new way to incentivize children to progress with their learning. On top of this, we use big data analysis to further optimize our products to enhance the user experience and help parents manage their children's learning progress, which is something very hard to replicate. We continued to optimize and update our key products on a weekly or biweekly basis to further enrich their major curriculums. We added a large amount of interactive learning and practice sections to both iHuman Chinese app and iHuman Math app. We added an alphabet course to iHuman English app, as well as a dinosaur reader and a pinyin practice section to our iHuman pinyin app. iHuman Chinese our flagship app continued to be the number one best-selling app in both education and children category of Apple's App Store in China for Q3. Very often, three or four out of the top five on the list are all our products. Although we are already number one in this market, given that the market is still very fragmented, we think there is a great opportunity to leverage our competitive advantages and grow our market share. We are confident in the sustainability of our growth as we continue to expand our product portfolio, extend our demographic and geographical coverage, enhance our user engagement, and enrich the content and curriculum of our existing products. With that, I would now like to hand the call over to our CFO Vivian to talk about our financial results.

Thank you, Peng. And thank you everyone for joining the call. I will now walk you through our operating and financial results. Please note that all financial data that I talk about will be presented in RMB. We have seen robust growth so far this year, and I'm thrilled to announce that the momentum has continued in this quarter. We saw strong revenue growth, increasing operating efficiency, profitability, and strong cash liquidity. Fuller revenues in Q3 more than doubled from the same quarter last year to 156.9 million. This was mainly due to the rapid revenue growth of our learning services, which more than quadrupled to reach 120.7 million as our superior services and products continue to drive significant organic user growth. MAU of our online business reached a record high of 11.1 million in Q3. The number of paying users was 1.4 million in Q3, which more than doubled from the same quarter last year. Our efforts to enhance the current educational content and further expand our product portfolio continue to help boost our user growth. Our revenues from learning materials and devices were 36.2 million, a slight increase from 35.5 million in the same quarter last year. We saw a strong rebound from second quarter, which was driven by a recovery in demand from kindergarten and after-school learning centers as they reopened after COVID-19 closures. Thanks to our scalable business model, our profitability and operating efficiency are also steadily improving. Along with the rapid growth of our online business, which accounts for a higher percentage of our total revenues, our gross profit and gross margins significantly improved. In particular, our gross margin further improved to 68.5% in Q3 from 63.9% in the same quarter last year. I will move on to our operating expenses now. As an R&B-driven company, we have always focused on research and development to maintain our core competitive advantages. We have built up a unique position that has enjoyed strong user loyalty in the entertainment space because content quality is the dominant factor. Our R&D expenses were 55.9 million, an increase of 112% from 26.4 million in the same quarter last year. Currently, our R&D expenses are around 36% of our total revenue. Our sales and marketing expenses were 22.7 million, compared with 7.6 million in the same quarter last year. This was primarily due to our increases in advertising and promotional activities, which was in line with our revenue growth. Even though we accelerated our marketing efforts this quarter, which was an effective supplement, the vast majority of our user growth still came from word of mouth referrals. We always carefully decide when and how many resources to dedicate to marketing or any new business opportunities. As a percentage of total revenues, Our sales and marketing expenses maintained at a relative low level. Our G&A expenses were $15.4 million compared with $5.2 million in the same quarter last year. This was mainly due to an increase in professional fees. And the increase in G&A was in line with the total revenue growth. Operating income was $13.5 million which was over 4.6 times higher than 2.4 million in the same quarter last year. Income tax expense were 6.7 million compared with 0.8 million in the same quarter last year. Net income was 10.6 million, which was over three times higher than 2.6 million in the same quarter last year. Writing out the momentum we achieved in the first half remains profitable in Q3, which is now often seen for an online education company that just started to commercialize major products two years ago. Basic and devoted net income per ADS were both 15 cents, compared with 7 cents each in the same quarter last year. Each ADS represents five Class A ordinary shares of the company. Cash and cash equivalents or 215.8 million as of September 30th, 2020, compared with 104.9 million as of December 31st, 2019. As a result, we have a healthy balance sheet with a strong cash balance and no debt. The majority of our current liabilities is deferred revenue, which actually gave us a great visibility on our future revenue growth. With that, I will now provide our business outlook. Based on our current estimates, total revenues for the fourth quarter of 2020 are expected to be between 165 million and 173 million, representing an increase of 167% to 180% year over year. This takes into consideration the expected growth from the strong and continued expansion of our business as well as the fact that Q4 is usually a slower season for us. These estimates represent management's current and preliminary view, which are subject to change. That concludes our prepared remarks. Operator, we're now ready to take questions. Thanks.

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we'll pause momentarily to assemble our roster. The first question today comes from Alex Xu with Credit Suisse. Please go ahead.

Hi. I mentioned this is Alex Xu from Credit Suisse. Thank you for taking my questions. My first question would be about your pipeline. Would you please share more about the progress of your new products including your content packages and new versions of apps as well as the online courses development? And secondly, I'd like to ask about your view on the overall market trends in the online entertainment market as well as the border online education for junior kid market. Thank you.

Thank you, Alex. This is Phuong. I will take the first question and I will leave the second question for our chairman, Michael. About the product pipeline, actually our first priority is still to continue to upgrade and expand our current apps product portfolio because we believe the childhood entertainment apps market still presents very tremendous growth opportunities. Our iHuman Pinyin app and iHuman English app are still very young, and we will keep enhancing their educational content with more interactive designs to build comprehensive curriculums. We will launch a new traditional Chinese literature course package to iQman Chinese app, which is already five times bigger after its launch. iHuman English app will continue its expansion to cover multiple levels of curriculum, which will be more systematic. iHuman Math app will also add more interactive designs to connect children, you know, the learning of the math with real-world experiences. And for our upcoming new apps, we are actually cooperating with a leading global publisher to develop a comprehensive English-level reading app for children at the age of 3 to 12 with a very highly effective and friendly assessment module and interactive reading features, which are expected to be at an industry-leading level. We are also developing a new STEM app, which is expected to expand our coverage to science topics that are essential to children's education. Moving beyond the apps category, we will also extend our offerings such as AI courses, which is a natural extension for us. The design of our AI courses will be totally unique and differentiated. They are expected to stay true to our edutainment nature with a lot of interactive designs, animations, as well as fun features to motivate children, which we believe they will be a very differentiating factor. And with our strong content and technology capabilities, we have built a strong foundation of a dynamic product pyramid. The bottom of this pyramid, which includes all of our current and upcoming apps, will provide us with a large number of user base and valuable insights. And we can then leverage this user base to build our AI courses on top. We will leverage the organic user growth to direct users to AI courses, which makes us very flexible in sales and marketing efforts. And of course, in the near term, X category will still be our major focus, and we believe they have a stronger growth potential. This is about our product pipeline. And then for the next question.

For the next question, it's better for me to answer in Chinese, and John will help me to translate in English. Thank you. We focus on the online child education market. According to Sullivan's report, in 2024, it will be a market of 46 billion. As online education becomes more and more accessible, people's learning habits, the development of online learning habits, and the increase in parents' payment wishes, in the next few years, According to Foster and Sullivan's report, the online childhood education market we focus on is expected to reach $460 billion market size in 2024.

But online education is more relevant today than ever before, and it is profoundly transforming how people learn. Parents are more willing to pay for online entertainment products. We expect the market to remain on a growth trend, and we're positive about its future development.

Currently, the market competition is scattered. At this stage, we have a lot of room for improvement in the online app market. Clearly, the market is still very fragmented, and I believe our online apps have lots of room to grow.

On one hand, reflecting the huge market size, and on the other hand, demonstrating our significant competitive advantages, given our superior product quality.

Also, parents are always looking for better products and learning results. So we believe that the quality of the product will lead to the development of the market. Unlike social platforms, the conversion cost is relatively high. In online education, high-quality educational products can easily get users to convert from other platforms. For example, the red cross. Our product has been in the same category for many years before it was launched. But as soon as we launched it, it became the first in the market, and there was no advertising fee. Our deep accumulation in education, technology, and creative fields will help us to grasp some future development opportunities and promote business growth.

But parents are constantly pursuing better products and learning results. We believe product quality is the dominant factor in this market. Unlike social platforms, which has a high tuition cost, high quality education products can always easily attract users to reach from other platforms. Taking iHuman Chinese as example, it become number one in the market soon after its launch, while its competition has been out for years, and we didn't really see any marketing dollars on that. with a market leader with strong education, technology, and innovation backgrounds. We are always in a position to capture such opportunities and further grow our business.

Thank you. Thank you.

Thank you, Benjamin. It's very clear.

The next question comes from Mark Lee with Citi. Please go ahead.

Hi, management. Congratulations on the results since you're listening, and thanks for the presentation. I want to ask, firstly, how do we think about our R pool trend going forward, considering the new apps and AI calls and contributions you mentioned? And secondly, it's a more long-term question. If you take a two to three-year view, how would you think the company would transform to capture more entertainment opportunities? Thank you.

Thank you, Mark. This is Vivian. I'll take the first question, and I'll leave the second question for Michael. So in terms of our pool, it actually keeps improving quite a lot for the past few quarters. We believe that our portfolio has a lot of room to grow, given that, first of all, we continue to expand our product portfolio, continue to enhance a lot of content, that to keep our users engaged, and continue to optimize our product to deliver better user experience. And secondly, we're also stepping up with a crowd-selling initiative, whereas parents or children, if they like one of our apps, they can easily download and play or learn with our other apps. And also, with the upcoming new apps, and online courses in our pipeline. We believe that there is a lot of room for us to continue to grow our R pool. And then I'll leave the second question for Michael.

Okay. We are very optimistic about the online education industry. We are also optimistic about our company. We focus on creating the best products and providing the best services.

We have strong confidence in the industry and our company. We are devoted to create back-in-class products and services.

We will remain committed to childhood education and solidify our leading position. We will also provide more superior products and services. I believe the market is big enough I believe we can utilize our core competencies in educational content

creativity, and technology to further amplify our influential power and risk as an important participant of the industry. We aim to become one of the most important online education companies.

Thank you. Thank you.

Thank you. Thank you very much. Thank you.

Thank you. The next question comes from Z Wang with Essence Securities. Please go ahead.

Hi. Thank you, management, for taking my questions. Congratulations on the very solid growth and the very strong guidance. So two questions from me. The first one is about your marketing or user acquisition strategy in Q4 and 2021. So could you share what are the main metrics to measure the ROI? Also, the second question is about the offline business, which is the revenue from learning materials and devices. We see the percentage of offline revenue, of total revenue decreased from 50% last year to currently above 20%. And beyond seasonality, how should we expect revenue from this segment to grow in the future two to three years? and what synergy we could expect between the two revenue segments. Thank you.

Well, about, yeah, thanks Xin.

About your first question, customer acquisition, actually we have very unique model because we mainly focus on the word of mouth referrals and organic growth. So with our deep understanding of children's psychology, solid pedagogy, and technology innovations, we can create self-motivated products for children, and we can deliver very strong learning results for parents. So we can enjoy strong word-of-mouth referrals leading to a massive organic growth. Before the end of 2019, we never spent marketing dollars, and we already ranked number one in this segment. And with our organic growth strategy, we can make it very flexible in terms of customer acquisition. We are not burning cash, and our level of investments will depend on the performance of each product and the responses from the market. So we will strategically determine when and how much to invest in customer acquisition. And our ROI will be evaluated based upon the user lifetime value and their contribution to our apps. And while we have been stepping up with our marketing efforts earlier this year, actually this is an effective supplement for us. While the majority of our user growth still comes from word of mouth referrals, So this makes our business model very healthy and sustainable. We have been profitable since this year, and this is not often seen from an online education company. And we believe product quality is still the dominant factor in this market, even moving forward. We will keep focused on what we do best with educational content and technology development. and providing truly unique and immersive learning experience for children and keep our sustainable and healthy business model. As for your second question about our offline business, our offline business rebounded strongly in Q3, which was mainly driven by the recovered demand from kindergartens and after-school learning centers as they reopened after COVID-19 closures. And moving forward, we have very strong synergies between online and offline businesses. They complement each other in a lot of areas, including R&D, sales marketing, etc. For family users, when we have enjoyed strong growth in our apps, parents still have concern about the children's eyes protection or restrict the amount of time they can spend with the electronic devices. While we have built very specific tools that allow parents to manage screen time within our apps, we also offer a strong lineup of offline reading plans, reading books, and other reading materials that match perfectly with our online apps in terms of artistic style, content, IP, and so on. And this will help us to extend the learning scenario And we will be able to elevate the user's stickiness by improving both the overall learning experience and the diversity of the learning materials. For kindergartens and educational organizations, traditionally, they use paper-based tools for teaching. But after the integration of our online and offline businesses in late 2019, we began to provide more online digital resources to those organizations, such as animations, interactive features, and a lot of foreign teaching videos, and so on. So we can help these organizations to achieve more effective learning results and making their classes more interactive and improve children's learning. This has also helped us discover a new growth driver moving forward for our offline business. So in summary, the integration of our online and offline businesses created significant synergies for us and formed a closed loop for both family users and educational organization. And we do see very huge growth potential for both our online and offline businesses moving forward. Thank you.

Yeah, thank you for the very detailed answers.

Just a reminder, please limit yourself to one question and one follow-up. The next question comes from Edmund Long with CLSA. Please go ahead.

Thank you for taking my question. I just got two questions here. We understand that the industry is still highly fragmented. Could you share with us approximately how much market share is in the top five players like they're sharing and what's the market share iHuman is looking at per se in like three to five year horizon? Thank you.

Hi, thank you. This is Vivian. As we mentioned earlier, you know, the market is very fragmented. And because a lot of our peers are still, you know, private company, we don't have the exact data on hand. But we believe that, you know, the top five, the aggregate of the top five market share is less than 10%. But because of the superior product design and the differentiated user experience that we can provide, we are strongly confident that we can take market share in the future. Thank you.

Thank you.

Our last question today will come from Albert Yip with CMBI. Please go ahead.

Hi, management. Thank you for taking my question. My question is about the coming online course business. Who are the major competitors? And could you share with us your comparative advantages? Thank you.

Well, actually, we are pretty unique versus our competitors because, as we mentioned earlier, we're more focused on the product and content innovation, and we have very natural growth strategy. These make us very unique versus the competitors. The major competitors in this Online course area will be a lot of K-12 focused companies and some of the other internet companies. But compared to them, we are pretty different and unique. First of all, we have more expertise in understanding the psychology and learning patterns for younger children. We have a rich industry and operational know-how based on our experience in the children education industry. We also have a solid pedagogical approach and a strong team of educational experts who have expertise in children's psychology and real-world teaching for multi-years. And we have been actually continuously providing teaching courses and materials to over 10,000 kindergartens and after-school learning centers across the country, so which further speaks to the quality of our educational content. And the second point will be we are much more than a leading online childhood education company. We are also a creative company full of innovative ideas. Leveraging our advantages in educational content and technology, we are dedicated to nurturing children's creativity, lifting their creativities, as well as open their eyes through delivering knowledge with the most creative and interactive ways. So this creative company with a lot of innovations will be totally unique and different versus the other players. Number three, we have industry-leading technologies such as 3D AI. We also have a secret recipe for fun educational content. So when kids get access to our products, they can enjoy more interactive and immersive learning experience. and become more self-motivated and engaged. And number four, so with the combination of both childhood education and innovation capabilities and our commitment to continuously pursuing perfection in our products, we create a tailor-made content that is designed for every single knowledge point within our apps and within each category. So building a very high entry barrier. And number five, on top of these higher starting point, we continue to use big data analysis to further optimize our products on a weekly or biweekly basis, as we mentioned earlier. So these will also help us further enhance the user experience continuously. So these advantages not only give us a very unique positioning, we are also able to utilize them to create high quality products and well received by parents. And this makes our user growth more organic and based upon the word of mouth referrals. within the two years of fully commercializing our major products, we already turned profitable, which further proves our healthy and sustainable business model. And also, yeah, we are pretty unique in terms of these kind of competitive advantages, and we already achieved number one in this market. Yeah, thank you.

Thank you very much. I have no further questions.

Due to time limitations, we will be closing our question and answer session. We would also like to close the conference. Thank you for attending today's presentation. You may now disconnect.

Thank you, everyone. Thank you.