51Talk Online Education Group Q4 FY2020 Earnings Call

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's Fourth Quarter and Full Year 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 Piao, Investor Relations for the Company. Please go ahead, Judy.

Thank you. Hello, everyone, and welcome to the fourth quarter and full year 2020 earnings conference call of China Online Education Group, also known as 51Talk. The Company's results were issued by our 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 laws. Please also note that 51Talk's 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.

Hello, everyone. Thank you for joining our conference call. The growth momentum from the beginning of 2020 continued into the fourth quarter, reflecting solid strategic execution in our online K-12 English mass market offerings. Fourth quarter net revenues grew 34.7% year-over-year to reach RMB535.1 million. We also recorded historically high operating cash flow of RMB188.5 million. In addition, the number of new paying students grew over 70% year-over-year, boosted by our effective curriculum and improving service quality, while our active students reached 353,800, up 37.6% compared with the same period in 2019. Although 2020 presented an array of unforeseen challenges, our strong pre-established foundational groundwork allowed us to not only manage this period but, in fact, benefit from the shifting environment as we took advantage of new opportunities. Full year net revenues grew 38.9% to RMB2.1 billion. 2020 operating cash flow rose 80.8% to reach a historical high of RMB719.3 million, compared with RMB397.9 million in 2019, further strengthening our financial position for future growth. We also witnessed remarkable growth in new paying students, which increased 60% year-over-year. We are also very excited about our recent acquisition of GKid's product portfolio and industry-leading AI technologies. GKid offers innovative AI-driven online English courses through highly interactive animation and picture books for children, with product offerings intended for those between the ages of three and eight. This acquisition both extends our addressable market and broadens our product and curriculum portfolio. We foresee many potential collaboration and integration opportunities between our platform and GKid's products and industry-leading AI technologies, leading to both new products and product improvements, which will better serve our customers. As we head further into 2021, we are focusing on user growth and enhanced brand promotions to advance market share expansion. To better attract and retain users, we will continue optimizing our learning experiences through upgraded product offerings and an enriched curriculum mix. We are launching innovative AI-powered robotic tutors to help students learn core knowledge points with the aim of enhancing overall learning efficiency. To make our courses more interesting and engaging to young children, we are also integrating more interactive features into our textbooks. Additionally, we are expanding our curriculum portfolio in order to provide a holistic learning experience through investing in R&D, upgrading our services to students, and expanding our teacher operations. Finally, we target to further increase our branding and marketing efforts to heighten brand awareness as we enter the next phase of growth. We are also pleased to have successfully provided over 50 million one-on-one online English lessons, including free trials, between November 2019 and December 2020, a rapid increase that took our cumulative offerings since our inception in 2011 to more than 150 million and is a strong testament to our accelerating growth trajectory. As 51Talk continues to grow, we are confident our balanced growth strategy will continue to yield solid value for our stakeholders. With that, I will now turn the call over to Min Xu.

Thank you, Jack. We concluded a turbulent 2020 with solid operating and financial results, evidenced by sustained revenue growth and the first profitable year in our company history. We recorded non-GAAP net income of RMB173.7 million for 2020 compared to a non-GAAP net loss of RMB87.7 million in 2019. In 2021, our investment will be channeled toward the development of our curriculum, technology platform, and brand as we look to capitalize on market dynamics, drive user growth, and achieve a leading market position. Now let me walk you through our fourth quarter financial results. Net revenues for the fourth quarter were RMB535 million, a 35% increase from RMB397 million for the same quarter last year. The increase was primarily attributable to an increase in the number of active students. The number of active students in the fourth quarter was 354,000, a 38% increase from 257,000 for the same quarter last year. Net revenues from one-on-one offerings were RMB515 million, a 39% increase from last year. Net revenues from small class offerings were RMB20 million, a 23% decline from last year. Gross margin for the fourth quarter was 72.7%, compared with 72.1% for the same quarter last year. One-on-one gross margin for the quarter was 73.2% compared with 73.5% for the same quarter last year. Small class gross margin was 59.5%, up from 52.7% for Q4 2019. Total operating expenses for the fourth quarter were RMB386 million, up 34% year-over-year. Sales and marketing expenses for the fourth quarter were RMB285 million, 39.5% of Q4 gross billings. Excluding share-based compensation expenses, non-GAAP sales and marketing expenses for the quarter were RMB283 million, 39.2% of Q4 gross billings. Non-GAAP sales and marketing expenses, excluding branding expenses, were 33.6% of the gross billing for the fourth quarter compared with 30.4% a year ago. The increase of sales and marketing expenses as a percentage of gross billing was mostly due to a decrease in order size. Product development expenses for the fourth quarter were RMB44.6 million, a 20% increase year-over-year. Excluding share-based compensation, non-GAAP product development expenses for the fourth quarter were RMB43.3 million, an 18% increase from last year. G&A expenses for the fourth quarter were RMB56.6 million, a 16% increase from the same quarter last year. Excluding share-based compensation expenses, non-GAAP G&A expenses for the fourth quarter were RMB53 million, a 14% increase from last year. Other income for the fourth quarter was RMB7.8 million, which included RMB7.5 million VAT exemption and RMB0.3 million super deduction. Operating income for the fourth quarter was RMB11 million, compared with an operating loss of RMB1.9 million for the same quarter last year. Non-GAAP operating income for the fourth quarter was RMB17.8 million, compared with operating profit of RMB1.8 million a year ago. Net income for the fourth quarter was RMB31.8 million compared with net income of RMB0.8 million for the same quarter last year. Non-GAAP net income for the fourth quarter was RMB38.6 million, compared with a non-GAAP net income of RMB4.5 million for the same quarter last year. Income tax benefit for the fourth quarter of 2020 was RMB8.9 million, including release of valuation allowance for deferred tax asset of RMB9.7 million. Basic EPS for the fourth quarter was RMB1.48, compared with RMB0.04 for the same quarter last year. Diluted EPS for the quarter was RMB1.39, compared with RMB0.04 for the same quarter last year. Each ADS represents 15 Class A ordinary shares. Non-GAAP EPS for the quarter was RMB1.79 compared with EPS of RMB0.20 for the same quarter last year. Non-GAAP EPS for the fourth quarter was -- the diluted non-GAAP EPS for the fourth quarter was RMB1.68, compared with RMB0.20 last year. Gross billings for the fourth quarter were RMB721 million, a 24% year-over-year increase. This is driven by more than 50% year-over-year growth of order number, partially offset by close to 20% order size year-over-year decline. At the end of 2020, the Company had a total cash balance of RMB1.73 billion, compared with RMB1.05 billion last year. Advances from students totaled RMB2.7 billion at the end of 2020, compared with RMB2.2 billion last year. Our GAAP and non-GAAP bottom line for the year of 2020 turned positive for the first time in our company history. For more of our 2020 full year financial results, please refer to our earnings press release for further details. Looking forward to the first quarter of 2021, we currently expect net revenues to be between RMB595 million to RMB600 million, which could represent an increase of approximately 22.2% to 23.2% from RMB487 million for Q1 last year. The above outlook is based on current market conditions and reflects the Company's current and preliminary estimates of market 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.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Vincent Yu with Needham & Company.

Congrats on another profitable quarter. So I have three questions. One -- the first one is that we are seeing a large amount of capital being invested in the online education space, in particular by these unicorn startups. So are we seeing any new growth initiatives launched by these companies in real-time that may pose a threat to our core business? And what's our strategy to address these new entries? Second question is about 2021. What do we expect to see in terms of investment being made in different online tutoring areas by COE? And how should we think about the net margin for COE in 2021 versus last year? And third question is about -- tied to the second one. What are some of the areas we think should be a natural market for COE to enter, in addition to areas such as pre-K English learning?

Yes. I appreciate the question. For the first question, we do see very intense competition in the online education space, and this is why you're seeing a lot of players in this space putting up huge losses. However, we are actually one of the very few profitable online education companies. If you look at the K-12 test preparation focus, the large-class online education space, as well as the pre-K AI-based early education sector, a lot of companies are experiencing extremely intense competition. We are actually in a different sector, which is the K-12 online English education sector, and it's one of the earlier sectors to really see strong growth. Our sector is more mature than other sectors, and there are already a very small number of players in our market. We're one of the market leaders. Moreover, if you look at the Q4 user growth in 2020, we're experiencing new paying user growth of more than 60%. This is clearly the fastest-growing company in our sector, so we are very confident that we're going to do well in 2021. Regarding the second question, in 2021, our strategy will continue to focus on our core business of K-12 English education. We want to continue the momentum of user growth we established in 2020 and aim to be the absolute leader in our sector in 2021. We will invest in two main areas to achieve this goal. First, we will focus on driving user growth through better user experience in both products and services. We will invest more in R&D since we recognize our investment in R&D was not sufficient in the early years. This will drive our user growth through user referrals rather than just increasing our marketing budget. For example, we recently acquired GKid's product line and their industry-leading AI technology, and we will integrate the AI technology with our one-on-one products to provide a holistic experience for our users and students. We expect to launch a new product, which is a 5-minute AI pre-session before our 25-minute one-on-one teacher session. This will significantly enhance our students' learning experience. The second area of investment will be branding. We aim to elevate brand awareness by increasing branding investments across different channels, as having a strong brand is essential when offering a satisfying consumer product. For the third question, we recognize our current sector is a large market with plenty of growth potential, so our top priority will still be in our existing core market. However, we are quite confident that we can provide superior products and services compared to our peers. We will also look for opportunities to further expand our target market. For example, our recent acquisition of GKid products is a step towards market expansion. We will continue to develop AI products for pre-K students based on GKid products. Additionally, we started exploring offline experience stores as a new channel to reach target customers in lower-tier cities. Currently, we have set up over 100 experience stores throughout the country, which is a major initiative for our online merge offline strategy. Our COO, Liming Zhang, will elaborate more on our OMO strategy shortly. As we continue to grow from 350,000 active students to potentially over 1 million, we will always seek ways to meet our students' demands.

Sure. Since last year, we've already expanded our offline experience store to more than 100 stores in roughly 20 provinces. This is an experiment to find a way to better reach our potential customers in the lower-tier cities. There are four ways we can make ourselves closer to our customers in these areas. First is customer acquisition, which brings us closer to our target market. Second, brand awareness; having a physical store significantly enhances brand recognition in our target addressable market. Third, our sales efforts are localized, meaning they are more face-to-face interactions with customers rather than just on the phone or through messaging apps. Finally, our services can be better tailored to our customers, providing a place for child lessons or even paid lessons and the opportunity to ask questions. This effort accounts for a significant step towards expanding our customer acquisition channels and growing our market exposure.

The next question comes from Fawne Jiang of Benchmark.

Congrats on a solid quarter and a very strong finish of the year. I want to follow up and dig a little bit more into your user behavior against the curve. We're roughly one year after COVID. I wonder, with the current online adoption curve among your students, I also noticed that your active students continue to accelerate. What's driving this? Are we seeing more students from lower-tier cities, or are we moving into higher-tier cities? How are you planning to allocate your resources going forward?

Let's first talk about the changes in customer behavior after the pandemic. As you expected, online adoption has increased significantly for two reasons: one is the impact of COVID-19, which forced people online, while the other is the heavy investments made by many test preparation and large-class education peers who are raising awareness about online education. This is a positive development because online education is transitioning from a new trend to a familiar and preferred method of learning for many parents. They are now becoming more discerning shoppers when it comes to online education options. Therefore, advertising alone may not suffice; it's essential to meet customer demands through exceptional products and services to generate loyalty and long-term satisfaction. Hence, we will focus heavily on product development and service enhancement to foster customer satisfaction, which in turn will drive user growth. Now regarding user growth, we're experiencing very strong and accelerating user growth in the latter half of 2020. We believe there are three main drivers: first is customer satisfaction, through which we primarily drive user growth via referrals. Our students average 13 to 15 lessons per month, which is the highest in the industry. Their high engagement leads to better results and increased satisfaction. Secondly, our brand is gaining momentum; over the past year, we have seen our brand awareness accelerate as many aggressive competitors have scaled back their advertising, allowing us to become the biggest brand in our sector. Lastly, our operational strategy has played a role; by lowering the average package size, we've diminished the barrier for customers to purchase our products, which has resulted in robust growth in both lower-tier cities and Tier 1 markets. With high-quality products and services at reasonable prices, we anticipate continued strong long-term growth.

Excellent.

[Operator Instructions] As there are no further questions now, I'd like to turn the call back over to the Company for closing remarks.

Thank you once again for joining us today. If you have further questions, please feel free to contact 51Talk's Investor Relations through the contact information provided on our website. This concludes the conference call. You may now disconnect your line. Thank you.

Again, this concludes this conference call. You may now disconnect your line. Thank you.