U.S. Markets closed

Edited Transcript of COE earnings conference call or presentation 11-Sep-19 12:00pm GMT

Q2 2019 China Online Education Group Earnings Call

BEIJING Sep 17, 2019 (Thomson StreetEvents) -- Edited Transcript of China Online Education Group earnings conference call or presentation Wednesday, September 11, 2019 at 12:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Jiajia Huang

China Online Education Group - Founder, Chairman & CEO

* Judy Piao

China Online Education Group - Head of IR

* Min Xu

China Online Education Group - CFO

================================================================================

Conference Call Participants

================================================================================

* Roger Parodi;Silverhorn Group;Managing Partner

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Today's conference call is being recorded.

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

--------------------------------------------------------------------------------

Judy Piao, China Online Education Group - Head of IR [2]

--------------------------------------------------------------------------------

Hello, everyone, and welcome to the second quarter earnings conference call of China Online Education Group, also known as 51Talk. The company's results were issued via newswire services earlier today and are posted online. You can download the earnings press release and sign up for the company's distribution list by visiting the IR section of its website at ir. 51talk.com.

Mr. Jack Huang, our Chief Executive Officer; and Mr. 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 provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's results may be materially different from the views expressed today. Further information regarding this and other risks and uncertainties is included in the company's Form 20-F and other public filings as filed with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law.

Please also note that 51Talk earnings press release and this conference call include discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. 51Talk's press release contains a reconciliation of the unaudited non-GAAP measures to the unaudited most directly comparable GAAP measures.

I will now turn the call over to our CEO, Jack Huang. Please go ahead.

--------------------------------------------------------------------------------

Jiajia Huang, China Online Education Group - Founder, Chairman & CEO [3]

--------------------------------------------------------------------------------

Okay. Hello, everyone. Thank you very much for joining us for our second quarter earnings conference call. We are pleased to report that second quarter financial and operating results continued their strong performance, as we consistently implemented our strategy in K-12 mass-market one-on-one offerings, particularly in the non-Tier 1 cities. Both our net revenues and gross billings exceeded the high end of our second quarter guidance range. The strong results were firmly led by our K-12 mass-market one-on-one gross billings, which reached RMB 418.5 million, representing a 50.5% year-over-year increase and accounted for 84% of our total gross billings.

In addition to strong top line performance, our balanced approach to both growth and profitability continues to bear positive results. Our non-GAAP net loss for the second quarter narrowed further to RMB 26.7 million from a loss of RMB 59.5 million in the first quarter, representing an improvement in net margin to negative 7.6% from net negative 18.4%. This historically low non-GAAP net loss can be credited to our focus on teaching quality, student satisfaction and our continued pursuit to optimize operational efficiency and improve profitability.

In the second quarter, our gross billings from non-Tier 1 cities accounted for 72.4% of our K-12 mass-market one-on-one offerings, stabilizing from the elevated level we achieved in the first quarter. Going forward, we will continue to strengthen our core K-12 mass-market one-on-one business in non-Tier 1 cities by offering high-quality programs, coupled with best-in-class technology.

We aim to achieve better value, flexibility and alignment with our customers' needs and demands, all while boosting our profitability. I am very proud to share that we successfully provided over 90 million one-on-one online English lessons from our inception in 2011 to the end of August this year. This is a nice milestone to mark in our vision to empower everyone to talk to the world. Looking forward, we are committed to providing our teachers with additional training, which we believe will further perfect our pedagogy and strengthen learning outcomes and cost effectiveness for our customers.

As a leader in the online K-12 English education industry in China, we are proud to have organized the recently completed China youth talk national competition, with high-profile English language public speaking event, attracted over 100,000 students between 4 and 12 years old from all across the country. Students completed over a 8-month period in oral presentations centered around the China's intangible cultural heritage. Finalists in the senior and junior divisions were evaluated by a panel of education experts based on their English language presentation skills, overall communication abilities and culture education. The finalists also participated in a study tour of the U.K. We are very glad that we could be essential part of an event that helps to build cultural bridges through English language education, and we will seek additional opportunities that showcase our brand and our core competency in English education on a large scale.

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

--------------------------------------------------------------------------------

Min Xu, China Online Education Group - CFO [4]

--------------------------------------------------------------------------------

Thank you, Jack. During the second quarter, we continued to execute and made progress in improving operational efficiencies and profitability. We achieved historically high operating cash flow of RMB 99.2 million in the second quarter, exceeding previous high of RMB 67.3 million in the fourth quarter last year.

Consolidated gross margin expanded by 3.9 percentage points year-over-year to 69.6%, driven by improvement in both one-on-one and small class gross billing -- gross margins. With our focused growth strategy targeting non-Tier 1 cities and continued optimization of operating efficiencies, we are confident we can continue to deliver healthy growth and improve our profitability in second half of 2019.

Now I would like to walk through our second quarter 2019 financial highlights. Net revenues for the second quarter were RMB 353.4 million, a 25.4% increase from RMB 281.7 million for the same quarter last year. The increase was primarily attributed to an increase in the number of active students and, to a lesser extent, an increase in average revenue per active student. The number of active students in the second quarter was 233,400, a 19.4% increase from 195,500 for the same quarter last year.

Net revenues from one-on-one offerings for the second quarter was RMB 320.3 million, a 26.0% increase from RMB 254.2 million for the same quarter last year. Net revenues from small class offering for the second quarter were RMB 33.1 million, a 20.4% increase from RMB 27.5 million for the same quarter last year.

Cost of revenues for the second quarter was RMB 107.6 million, an 11.4% increase from RMB 96.5 million for the same quarter last year. The increase was primarily driven by an increase in total service fees paid to teachers, mainly due to the delivery of an increased number of paid lessons.

Cost of revenues for one-on-one offerings for the second quarter was RMB 92.5 million, a 15.8% increase from RMB 79.8 million for the same quarter last year. Cost of revenues of small class offering for the second quarter was RMB 15.1 million, a 9.5% decrease from RMB 16.7 million for the same quarter last year.

Gross profit for the second quarter was RMB 245.9 million, a 32.8% increase from RMB 185.2 million for the same quarter last year. Gross margin for the second quarter was 69.6% compared with 65.7% for the same quarter last year.

One-on-one offerings gross margin for the second quarter was 71.1% compared with 68.6% for the same quarter last year. The increase was mainly attributable to: first, price increases; and second, the inclusion of the company's audio picture book in course packages, which carries a high margin and recognized as revenues at the time of delivery. 51Talk's small class offering gross margin for the second quarter was 54.5% compared with 39.4% for the second quarter of 2018.

Total operating expenses for the second quarter were RMB 280.1 million, a 7.0% increase from RMB 261.7 million for the same quarter last year. The increase was mainly the result of an increase in sales and marketing expenses, partially offset by decreases of product development and G&A expenses.

Sales and marketing expenses for the second quarter were RMB 188.4 million, a 15.4% increase from RMB 163.3 million for the same quarter last year. The increase was mainly due to an increase in the number of sales and marketing personnel. Excluding share-based compensation, non-GAAP sales and marketing expenses for the second quarter were RMB 187.3 million, a 15.7 million -- 15.7% increase from RMB 161.9 million for the same quarter last year. Non-GAAP sales and marketing expenses, excluding branding expenses, were 32.6% of the gross billings for the second quarter compared with 33.0% for the same quarter last year.

Product development expenses for the second quarter were RMB 41.4 million, a 7.2% decrease from RMB 44.6 million for the same quarter last year. The decrease was primarily due to a decrease in the number of personnel. Excluding share-based compensation, non-GAAP product development expenses for the second quarter were RMB 39.7 million, a 7.2% decrease from RMB 42.8 million for the same quarter last year.

G&A expenses for the second quarter were RMB 50.4 million, a 6.5% decrease from RMB 53.9 million for the same quarter last year. Excluding share-based compensation, non-GAAP G&A expenses for the second quarter were RMB 47.5 million, a 5.8% decrease from RMB 50.4 million for the same quarter last year.

Loss from operations for the second quarter was RMB 34.3 million compared with the loss of RMB 76.5 million for the same quarter last year. Non-GAAP loss from operations for the second quarter was RMB 28.6 million compared with a loss of RMB 69.9 million for the same quarter last year.

Net loss for the second quarter was RMB 32.4 million compared with the loss of RMB 73.7 million for the same quarter last year.

Non-GAAP net loss for the second quarter was RMB 26.7 million compared with a loss of RMB 67.1 million for the same quarter last year.

Basic and diluted net loss per ADS for the second quarter was RMB 1.58 compared with 6 point -- RMB 3.60 for the same quarter last year. Each ADS represents 15 Class A ordinary shares. Non-GAAP basic and diluted net loss per ADS for the second quarter was RMB 1.30 compared with RMB 3.30 for the same quarter last year.

As of June 30, 2019, the company had total cash, cash equivalents, time deposits and short-term investments of RMB 785.6 million compared with RMB 712.1 million as of December 31, 2018. The company has deferred revenue of RMB 1.9 billion as of June 30, 2019, compared with RMB 1.7 billion as of December 31, 2018.

For the third quarter of 2019, the company currently expects net revenues to be between RMB 395 million to RMB 400 million, which would represent an increase of approximately 30.3% to 31.9% from RMB 303.2 million for same quarter last year.

Total gross billings to be between RMB 513 million to RMB 518 million, which would represent an increase of approximately 20.8% to 20.0% -- 22.0% from RMB 424.5 million for the same quarter last year.

Gross billings for the company's one-on-one business are expected to be between RMB 505 million to RMB 510 million, which would represent an increase of approximately 23.8% to 25.0% from RMB 407.9 million for the same quarter last year.

Gross billings for 51Talk's small class business are expected to be roughly RMB 8 million, which would represent a decrease of approximately 51.8% from RMB 16.6 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 estimates of marketing and operating conditions and customer demand, which are all subject to change.

This concludes our prepared remarks. We will now open the call to questions. Operator. Please go ahead.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And the first question comes from Roger Parodi from Silverhorn.

--------------------------------------------------------------------------------

Roger Parodi;Silverhorn Group;Managing Partner, [2]

--------------------------------------------------------------------------------

Do you hear me?

--------------------------------------------------------------------------------

Jiajia Huang, China Online Education Group - Founder, Chairman & CEO [3]

--------------------------------------------------------------------------------

Yes, Roger.

--------------------------------------------------------------------------------

Roger Parodi;Silverhorn Group;Managing Partner, [4]

--------------------------------------------------------------------------------

Congratulations for very strong results. First of all, I have 2 questions. You are able to keep your sales and marketing expenses at the very healthy level, that's actually, quarter-on-quarter, there was not even an increase. And how do you protect now going into the second half of the year? And how you will be able to maintain this operational efficiency that we can see -- clearly see here?

The second question is on the strong cash flow that you were able to generate, which is quite outstanding. How do you foresee that, that you will in order to -- are there any one-off events that were contributing to this? How do you see that in the second half? How will this further develop, just as a rough guideline? These are the 2 questions.

--------------------------------------------------------------------------------

Jiajia Huang, China Online Education Group - Founder, Chairman & CEO [5]

--------------------------------------------------------------------------------

Okay. (foreign language)

--------------------------------------------------------------------------------

Min Xu, China Online Education Group - CFO [6]

--------------------------------------------------------------------------------

[Interpreted] So thank you for the questions. So since last year, the company has been focusing on delivering healthy growth as well as operational efficiency. Of course, part of that is very significant portion of that is sales efficiency. So we did improve the -- our sales efficiency compared to last year. Of course, one reason that we see the efficiency improvement is because in Q2, we spend less on branding expenses versus in Q1.

--------------------------------------------------------------------------------

Jiajia Huang, China Online Education Group - Founder, Chairman & CEO [7]

--------------------------------------------------------------------------------

(foreign language)

--------------------------------------------------------------------------------

Min Xu, China Online Education Group - CFO [8]

--------------------------------------------------------------------------------

[Interpreted] For the second question, we're very glad you noticed our historical high operating cash flow. So we made a lot of adjustment to trying to achieve that. So one of the important adjustment we made in the past year is that we stopped the investment in the low-margin American Academy business, and we continued to focus on our core business K-12 one-on-one mass market and we spent a lot of time on non-Tier 1 cities. And we are glad to see the strategy is working, and we did see good results. And our core business percentage of -- as a percentage of total gross billings continued to increase in the past few quarters. And so if you -- so you can see that is upgrading both improvement in operating cash flow and narrow down of our net loss are the result of our consistent execution of our strategy.

And also, you can notice that the operating cash flow improvement has been happening in the past 3 quarters. So for both Q4 '18, Q1 '19 and Q2 2019, we are seeing significant year-over-year operating cash flow increase around CNY 70 million. And so as a result, we are seeing this quarter's operating cash flow is almost approaching CNY 100 million. So we're very glad that our strategy and good execution really reached this good result.

--------------------------------------------------------------------------------

Roger Parodi;Silverhorn Group;Managing Partner, [9]

--------------------------------------------------------------------------------

Understood. And maybe if you allow a follow-up question. In the last call, you explained how you -- your strategy is going towards lower-tier cities. If that -- are you still pursuing that strategy? And how does the competitive situation look like? And when you now go to the lower-tier cities, you maintain that for the next quarters? Or how do you -- are there any adjustments in that respect?

--------------------------------------------------------------------------------

Jiajia Huang, China Online Education Group - Founder, Chairman & CEO [10]

--------------------------------------------------------------------------------

(foreign language)

--------------------------------------------------------------------------------

Min Xu, China Online Education Group - CFO [11]

--------------------------------------------------------------------------------

[Interpreted] So we -- in the past few quarters, we continued to focus on the non-Tier 1 cities with our great Filipino teachers. And so we continue to deliver non-Tier 1 city gross billing percentage of more than 70%, which is significantly improved from year-over-year. And we're also putting a lot of resources and continue to improve our curriculum, improve our product and -- so that they are more suitable for the non-Tier 1 city students and parents. And we are seeing good results and we're seeing the referral rate in the non-Tier city continue to increase.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

(Operator Instructions) All right. As there are no further questions right now, I would like to turn the call back over to the company for any closing comments.

--------------------------------------------------------------------------------

Judy Piao, China Online Education Group - Head of IR [13]

--------------------------------------------------------------------------------

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 our 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.

--------------------------------------------------------------------------------

Operator [14]

--------------------------------------------------------------------------------

Thank you.

--------------------------------------------------------------------------------

Judy Piao, China Online Education Group - Head of IR [15]

--------------------------------------------------------------------------------

Thank you.

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]