51Talk Online Education Group Q1 FY2021 Earnings Call

Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's First Quarter 2021 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. Joyce Lee, Investor Relations for the company. Please go ahead, Joyce.

Hello, everyone and welcome to the first quarter 2021 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 our website at ir.51Talk.com. Mr. Jack Huang, our Chief Executive Officer; and Mr. Min Xu, our Chief Financial Officer, 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 US 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 US Securities and Exchange 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 51Talk's earnings press release and its conference call include discussion 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.

Okay. Hello, everyone. Thank you for joining our conference call. We are happy to report another solid quarter as the first quarter net revenues exceeded RMB 600 million, a 23.3% year-over-year increase that once again beats the top end of our guidance. Remarkably, our net revenues from K-12 one-on-one mass market offerings grew 36% compared to the first quarter last year. This performance was mainly driven by an increase in active students, which rose 37% year-over-year. These results illustrate the massive opportunity that exists in K-12 mass market with the growing acceptance of online education. In addition to organic growth through our existing strategies, we have also been pursuing external opportunities with our recent acquisition of Koala Reading. We are leveraging its expertise in Chinese reading assessments and plan to further establish a trailblazing English reading skill evaluation system that allows us to improve our product offerings. Furthermore, this acquisition widens our course offerings with additional Chinese courses, which is in line with the long-term strategy of expanding our curriculum portfolio. Along with our efforts in enhancing teacher operations, optimizing curriculums, and advancing AI-powered robotic tutors, the acquisition of Koala Reading is a testament to our commitment to providing the best learning experience to our students. In order to solidify our leadership in K-12 mass market English education, we are focused on ramping our market efforts and improving student satisfaction, while also investing in research and upgrading course offerings. We are excited to announce the appointment of Ms. Maine Mendoza as our latest brand ambassador and 51Talk Guest Teacher. Maine Mendoza is a well-known Filipino actress and a social media influencer. Her appointment instantly became the most tweeted event in the Philippines, further strengthening our brand recognition in the country. I look forward to continuing to execute our mission to generate long-term benefits to all stakeholders. With that, I will now turn the call to our CFO, Min Xu.

Thank you, Jack. Hello, everyone. We started off 2021 with a solid financial and operating performance. In addition to 23% year-over-year growth in net revenues, we delivered another profitable quarter, with non-GAAP net income of RMB 17 million. In order to keep the company on track for healthy growth, we are proactively investing in our operations to drive students' growth and brand awareness. Now, let me walk you through our first quarter 2021 financial highlights. Net revenues for the first quarter were RMB 600 million, a 23% increase from RMB 487 million for the same quarter last year. The number of active students in the first quarter was 393,000, a 37% increase from 287,000 for the same quarter last year. Gross margin for the first quarter was 73%, compared with 70% for the same quarter last year. This increase was mainly attributable to slightly higher revenue per lesson. One-on-one gross margin for the first quarter was 74% and small class gross margin was 66%. Total operating expenses for the first quarter were RMB 446 million, up 42% year-over-year. Sales and marketing expenses for the first quarter were RMB 319 million, 47% of Q1 gross billings. Excluding share-based compensation or SBC, non-GAAP sales and marketing expenses for the first quarter were RMB 317 million, representing 46% of Q1 gross billings. Excluding branding expenses, non-GAAP sales and marketing expenses were 40% of the gross billing for the first quarter of 2021, compared with 32% a year ago. The increase was mostly due to a decrease in order size. Product development expenses for the first quarter were RMB 58 million, a 61% increase year-over-year. Excluding SBC, non-GAAP product development expenses for the first quarter were RMB56 million, a 56% increase from last year. G&A expenses for the first quarter were RMB69 million, a 37% increase from the same quarter last year. Excluding SBC, non-GAAP G&A expenses for the first quarter were RMB65 million, a 39% increase from last year. Other income for the first quarter was RMB11.1 million, which included RMB10.7 million VAT exemption and RMB 0.4 million super deduction credit. Operating income for the first quarter was RMB5.9 million compared with operating income of RMB44.9 million for the same quarter last year. Non-GAAP operating income for the first quarter was RMB14.6 million compared with non-GAAP operating income of RMB51.1 million a year ago. Net income for the first quarter was RMB8.0 million compared with net income of RMB50.8 million for the same quarter last year. Non-GAAP net income for the first quarter of 2021 was RMB16.8 million compared with non-GAAP net income of RMB57 million for the same quarter last year. Income tax expenses for the first quarter was RMB6.1 million. Basic EPS for the first quarter was RMB0.37 compared with RMB 2.43 for the same quarter last year. Diluted EPS for the first quarter was RMB0.35 compared with RMB2.26 for the same quarter last year. Each ADS represents 15 Class A ordinary shares. Non-GAAP EPS for the first quarter was RMB0.78 compared with EPS of RMB2.73 for the same quarter last year. The diluted non-GAAP EPS for the first quarter was RMB0.73 compared with RMB2.54 last year. Gross billings for the first quarter were RMB685 million, a 15% year-over-year increase. This is driven by a 43% year-over-year growth of order numbers, partially offset by 20% order size year-over-year decline. At the end of the first quarter 2021, the company had a total cash balance of RMB1.73 billion flat with cash balance on December 31st, 2020. Advances from students were RMB2.76 billion at the end of first quarter 2021, slightly up from RMB2.72 billion as of December 31st, 2020. Looking forward to the second quarter of 2021, we currently expect net revenues to be between RMB597 million to RMB603 million, which would represent an increase between 21% and 22% from RMB494 million for Q2 last year. The above outlook is based on the current market condition 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. Operator, please go ahead.

Thank you. The first question today comes from Roger Duan with Needham & Company. Please go ahead.

Good morning. Thank you, management, for addressing my questions. I have two inquiries. First, could management provide a brief overview of the recently introduced private education sector development guidelines from the State Department? Are there any implications, positive or negative, for COE's business model that we should be aware of? My second question has two parts. Regarding the Koala Reading acquisition, could management outline COE's strategy for this new platform? Will it be integrated into a new English-reading learning platform, or will it continue as a Chinese-reading training platform? If it’s the latter, does that indicate we are officially expanding into non-English product offerings? Thank you.

Sure. Hey, Roger. Thanks for the question. So, I'll answer the first question and Jack will comment on the second. So, our read on the guideline is that, number one, it is mostly focused on the private school section instead of after-school training. So we actually do expect detailed regulation to be issued for after-school training in the next month or so. Second, the guideline actually addressed some of the major concerns of private education sector investors and it's mostly expected. So, in general, it is positive to vocational education and training and slightly positive to private high school education. I hope this answers your question. Jack?

Okay.

All right. So thank you and we would like to share our thoughts on the Koala acquisition. Actually, we would do both what you mentioned in your question. So in 2021, our first priority is to utilize Koala's industry-leading assessment and reading rating system and add an English component onto that system in order to improve our current English-learning product and help our existing students. So, obviously, Koala has an award-winning Chinese-reading product and we intend to continue to support that, and we do expect to offer Koala's product to our existing students. But again, as I mentioned earlier, our first priority is still on the English assessment system and our priority is still in our core business of K-12 one-on-one mass market product in lower-tier cities, and that's not going to change. Thank you.

Thanks.

Thank you, Roger.

The next question comes from Fawne Jiang with Benchmark. Please go ahead.

Thanks for taking my question. The first question is actually just want to get a bit better understanding of your Q2 guidance as well as the potential outlook for the rest of the year. It seems like the Q2 guidance was a little bit on the softer side. I just wonder what has contributed to the weakness? In addition, for the Q2 guidance, what's the implied gross billing growth as well as the active student growth? And how should we think about the overall growth for 2021? That's my first question.

Sure. Hey, Fawne. So, thank you for the question. So first of all, in our Q4 earnings call, we actually indicated that both Q1 and Q2 revenue growth was going to be soft. The main reason is because the ARPU is going to be lower compared to a very strong first half in 2020. For Q2 guidance of RMB 597 million to RMB 603 million in revenue, the underlying active student year-over-year growth rate assumption is low 30s percentage. And so, we actually do not have good visibility in gross billing trends. The logic behind our Q2 revenue guidance is based on a couple of things. So, number one, roughly a 10% decline in ARPU, as I mentioned before; and second, we are comparing to an exceptionally strong base of 2020 in Q2, which had benefited from a positive COVID-19 impact. So, I hope that answers your question.

Yes. Min, just a quick follow-up there, how should we think about 2021 overall, I mean the second half? If you could give it a little bit?

Yes, we're not providing official guidance, but if you examine the active student growth rate from 2021, it will likely fall between that of 2019 and 2020, as 2020 saw substantial growth due to the positive effects of COVID-19. We expect to perform better than 2019. Regarding ARPU, it is anticipated to decline by roughly 10% in both Q1 and Q2, with ARPU expected to remain steady in Q3 and Q4. Together, this should give you a clear picture of growth for 2021.

Understood. That's very helpful. Second question is a combination of where you're going to spend your resources in the coming quarters as well as just some follow-up on the Koala acquisition? I guess the question here is, will Koala run as an independent brand or will it be fully merged with 51Talk? And also, what's the resource commitment you're going to allocate into the new components of this new pilot on the English side or on the Chinese side? I noticed that your R&D has essential uptake in the first quarter. Just wonder where you are spending your incremental resources? And how should we look at it for the rest of the year?

Okay. So, let's first talk about the Koala acquisition. As I mentioned before, our first priority for this year is going to be on the assessment system. We're going to leverage Koala's expertise in AI and machine learning combined with our expertise in English training, and we plan to come up with an English assessment system which can really improve the learning experience of our existing students. We also plan to find ways to help our customer acquisition. In terms of the Koala brand, we plan to continue to run the Koala brand this year and we will decide whether we will create a new brand or combine brands with Koala in the future.

Understood. Last question actually, so a quick follow-up on the Koala acquisition. In terms of the access systems, do you guys see that more as expansion to your ARPU as part of your product offering? Or do you see that as an independent revenue source down the road? Just wonder if there is any color on the incremental revenue opportunity here.

Our first step is to provide the Koala product to our existing 51Talk students. This could potentially increase our average revenue per user, but the impact is expected to be minor since the average selling price of the Koala product is relatively low compared to 51Talk's current average selling price. Afterward, we might consider promoting Koala's Chinese product as a standalone offering aimed at customer acquisition. However, this concept is still in the planning stage and won't contribute significantly to revenue in the near term.

Got it. Thank you.

The next question is a follow-up from Roger Duan with Needham. Please go ahead.

Hi management. Thank you for taking my question again. A quick follow-up on the Koala. I understand the acquisition has been closed. I'm just wondering, how much of revenue contribution will that have on our full-year result and which quarter will that start to hit, if there is any contribution? Thank you.

As I mentioned earlier, Koala's average selling price is relatively small compared to our current average selling price. Therefore, it will not have a significant impact. In terms of modeling, it is not necessary for us to include it because it is insignificant. Our focus is on the value of Koala, which lies in its industry-leading assessment system. By combining our expertise in English training with this advanced system, we can greatly enhance our students' learning experience and assist in customer acquisition. This is how the Koala acquisition will contribute value to 51Talk.

Very helpful. Thank you.

Thank you.

The next question comes from Roger Parodi with Silverhorn. Please go ahead.

Hi, Jack. Hi, Xu Min. Congratulations on a solid quarter. I have two questions. First, regarding the operating cash flow mentioned in the release, are there any one-off effects, or how should I interpret the cash flow? Second, concerning the Q2 guidance, is potential impact from regulatory changes already factored in, or do you anticipate that any regulatory changes occurring within the next month could affect your Q2 guidance?

Okay. So first question, the cash flow. Our Q1 cash flow is at RMB39 million. It is relatively low compared to the quarters in 2020. However, I want to point out that Q1 is typically a soft season for operating cash flow, and you can see that in 2019 and even before, we probably had negative cash flow for Q1. The reason is that in Q1, typically that’s the quarter we pay out our full-year bonuses, and there are some annual payments that are going to happen in Q1. So that's the reason that it is relatively low compared to other quarters. Also, we have a slight impact from the GKid acquisition; part of the cash payment is related to that acquisition. And for Q2 guidance, we took partially the regulation impact into our guidance. It is hard to predict, but from what we see, we did see a little bit slowing down due to the overhang of the potential government regulation. However, we do not expect a big surprise, and we will see how things go after. We do expect the regulation to come out in a month or so.

We have a follow-up from Roger. Hold on. Roger, please go ahead.

Yes, sorry. I just fell out of the call. Sorry to say to confirm and thank you for the explanation, Xu Min.

No problem at all, yeah.

As there's no one in the question queue and there are no further questions, 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 this conference call. You may now disconnect your lines. Thank you for…

Thank you, everyone.