Earnings Call Transcript - IH Q1 2021

Operator, Operator

Good morning, and good evening, ladies and gentlemen. Thank you for standing by for iHuman's First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. Now, I will turn the call over to your speaker host today, Ms. Cynthia Tan, Senior IR Director of the Company. Please go ahead, ma'am.

Cynthia Tan, Senior IR Director

Thank you, operator. Hello, everyone, and welcome to iHuman's first quarter 2021 earnings conference call. Our earnings release was distributed earlier today and is available on the Company's IR website as well as our PR Newswire. Before we begin, I would like to remind you that this conference call contains forward-looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and current market and operating conditions and related 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 or achievements to differ materially. Further information regarding this and other risks, uncertainties or factors is included in our filing with the SEC. The Company does not undertake any obligation to update any forward-looking statements except as required under applicable law. Today, you'll hear from Dr. Peng Dai, Director and Chief Executive Officer, who will provide a general overview of the business and our operations, who will be followed by Ms. Vivian Wang, Director and Chief Financial Officer, who will provide additional details on the Company's financial results and outlook. Following management's prepared remarks, we'll open up the call to questions. With that said, I would now like to turn the call over to our CEO. Dr. Dai, please go ahead.

Dr. Peng Dai, CEO

Thank you, Cynthia. Hello, everyone. Thank you all for joining us on the call today. We are pleased to report another strong quarter as we reported a strong top line growth and further strengthened our leading position in the childhood edutainment sector. Over the past quarter, China's online education market has continued to grow rapidly as parents and kids have become increasingly receptive to online learning as a result of the ease of use, flexibility, and a variety of educational offerings that are available. Online learning apps have grown in popularity, especially among millennial and Gen-Z parents. As digital natives, they tend to view technology favorably and are more willing to use tech solutions to help their kids learn. Meanwhile, we are also seeing increasing demand among Chinese parents for high-quality edutainment content that inspires their kids' natural learning interest while having fun. Looking ahead, we continue to believe that the use of a variety of online tools for education is not a short-lived phenomenon; it will be a long-lasting and essential component of education that effectively serves the broader population. During this quarter, we continued to expand our brand awareness and user base in the online childhood edutainment market. We have always been committed to transforming learning into a fun journey for every child while lightening the burden for parents. One of the things we really tried to do is to create products from a child's point of view. We create tailor-made content that is designed for each knowledge point within our apps. We saw all of the creative elements and interactive designs that greatly help to cultivate creativity in children, which cramming courses and rote memorization can never do. We constantly look to inspire their curiosity by promoting the natural stages of their physical, intellectual, social, emotional, and moral development. Our self-directed and interactive learning products create opportunities for kids to support the joy of learning and nurture their curiosity and passion for knowledge. This business model is at a unique position in the market, and our work so far has produced very high entry barriers. At the end of the day, our favorite moment is when parents give us great feedback about their children's progress. We often hear that their kids become more motivated to learn and that they develop faster because of our apps. Our products are also very useful for kids who live in less developed areas and don't have access to high-quality educational resources that one might find in the big city. As long as they have a mobile device and access to the internet, they can enjoy a great educational experience with our self-directed product. This inspires us to constantly roll out product enhancements, expand our content offerings, improve our edutainment technologies, innovate, and launch new products that deliver truly unique, interactive, and immersive learning experiences that are both fun and educational, and achieve our goal of long-term sustainable growth. So now, I'd like to walk you through our business development and operation results. We are pleased to see continued growth across the board. In the first quarter of this year, revenues from our learning services increased by 233% year-over-year to RMB192 million, and our average total MAUs rose by 97% year-over-year to 16.12 million, both of which were new record highs. The solid growth was driven by our unrivaled educational content and the best-in-class technology. In terms of key recent business development, we continue to optimize and diversify our offerings by enriching the interactive content in our self-directed learning apps and expanding our content verticals. Our dedicated focus and relentless efforts to refine our products enabled us to provide a superior user experience and to further expand our competitive moat. In terms of new products in our pipeline, last quarter, we announced a strategic partnership with Oxford University Press on which we co-develop and co-promote a comprehensive level reading app called iHuman Readers, which combines Oxford University Press's world-class content with our advanced edutainment technologies. Currently, we are working diligently to co-develop features for an interactive library containing Oxford's most comprehensive level reading series of over 1,000 books, including world-renowned Oxford Reading Trees, TreeTops, and Project X CODE programs. We are also working as the first industry partner to co-develop and digitally publish over 100 exclusive and highly interactive level reading books called the Fantastic Friends series and a customized AI-powered assessment module. Development is on track, and we expect to officially launch this product around the middle of this year, which we believe will further enhance our brand recognition and expand our demographic coverage. Even though the product hasn't been officially launched yet, we are particularly proud to have received Oxford's Best Innovative and Empowering Partner of the Year award for all of the work we have done so far on this innovative collaboration. We are also making solid progress in developing our next generation AI content for different subjects. Notably, our iHuman Chinese Reading, which is currently at the child stage, has been designed based on our belief that learning is most effective when kids have fun by combining creative educational content with AI technologies. The product will provide children with an immersive and interactive experience to learn about classical Chinese literature and culture; hone their reading skills and boost their confidence with public speaking. Coupled with high-quality in-app content, our Chinese AI offering also provides responsive offline materials such as picture books, flashcards, and mind maps, which can be read aloud with a simple piece of reading paper. This not only creates a closed-loop learning journey that seamlessly connects the online and offline world, but also addresses parents' concerns about excessive screen time when kids learn online. In addition, we are also rolling out new products and services to further expand our comprehensive portfolio that better supports the around development of kids. In particular, this summer, we will launch iHumanpedia, which will help to illustrate hard-to-understand STEM-related material with short and captivating cartoons and videos. Kids can interact with animated characters who are ready to answer various questions with vividly illustrated videos and learn while dynamically interacting with the characters. The AI-based testimonial can track their progress and boost their motivation. To ramp up, we are encouraged by our strong performance in the first quarter and believe it provides a firm footing for our development throughout the rest of this year. Moving forward, we will continue to follow our guiding principle of helping kids to enjoy their childhood and inspire their natural interest in learning. We will focus on developing the best edutainment content while driving industry-leading technological innovation by constantly refining and expanding our product offerings and enhancing our technical capabilities through further investments in R&D. We believe this will ensure a great user experience and sustainable business growth over the long term. With that, I will now hand the call over to our CFO Vivian to talk about our financial results.

Vivian Wang, CFO

Thank you, Peng, and thank you everyone for joining the call. I will now walk you through our financial results. With no doubt, all the financial data that I discussed will be presented in RMB. First, I will briefly recap our financial performance for the first quarter of 2021 with robust growth. Quarterly revenues in Q1 came ahead of expectations, increasing 191% year-over-year to 227 million. This was mainly due to rapid growth in revenues from our learning services, which increased 233% to hit a record high of 192 million. The robust growth was powered by our user base expansion and enhanced user engagement as we continue to build on our unrivaled reputation for superior product quality. During the quarter, we further strengthened our leading position in the childhood edutainment sector and saw increased attraction for our products among millennial and Gen-Z parents who appreciate the curiosity that our products promote. Average total MAUs of our online business reached a record high of 16.5 million in Q1, an increase of 97% from the same quarter last year. The number of paying users also reached a record high of 1.68 million. We have delivered four consecutive quarters of triple-digit top line growth year-over-year, which speaks to our proven educational products and constant innovation capabilities and industry-leading edutainment technologies. Revenues from learning materials and devices were 35 million, an increase of 71% year-over-year, primarily due to the resumption of offline business activities as a result of the alleviation of the COVID-19 pandemic. Along with the rapid growth of our online business which has higher gross margins, our gross profit and gross margin remained solid. Gross profit was 161 million, an increase of 212% year-over-year. Our gross margin reached 71% in Q1 compared with 66% in the same period last year. I'll move on to our operating expenses now. Total operating expenses were 158 million, which increased 191% year-over-year. Excluding SBC, our total operating expenses were 151 million, an increase of 178% year-over-year. As an R&D and product-driven company, we have always focused on R&D to maintain our core competitive advantages. Our R&D expenses were 82 million, an increase of 149% year-over-year. Excluding SBC, R&D expenses were 78 million, an increase of 138% year-over-year, primarily due to rises in payroll-related and outsourcing expenses, as we continue to expand our R&D capabilities and enhance and develop our educational products and services. Our sales and marketing expenses were 53 million, an increase of 237% year-over-year. Excluding SBC, sales and marketing expenses were 52 million, an increase of 230% year-over-year. This was primarily due to an increase in advertising and promotion expenses as we specifically strengthened our brand recognition as a publicly listed company and marketing efforts to supplement organic user growth, as well as an increase in payroll-related expenses. Even though we accelerated our marketing efforts in recent quarters, which were an effective supplement to our organic user growth, the vast majority of our user growth came from word-of-mouth referrals. And as a percentage of total revenues, our sales and marketing expenses stayed at relative low levels. Our G&A expenses were 23 million, an increase of 303% year-over-year. Excluding SBC, G&A expenses were 21 million, an increase of 269% year-over-year, primarily due to an increase in payroll-related expenses and professional fees. Operating income was 3.6 million compared with an operating loss of 2.5 million in the same period last year. Adjusted operating income was at 10.7 million compared with an adjusted operating loss of 2.5 million in the same period last year. Net income was 7.1 million compared with a net loss of 1.6 million in the same quarter last year. Adjusted net income was 14.2 million compared with an adjusted net loss of 1.6 million in the same quarter last year. Basic and diluted net income for ADS were both $0.13 compared with basic and diluted loss of $0.11 in the same period last year. Adjusted diluted net income for ADS was $0.26 compared with an adjusted diluted net loss for ADS of $0.11 in the same quarter last year. Deferred revenue and customer advances were 318 million as of March 31, 2021, compared with 269 million as of December 31, 2020, primarily driven by our user expansion and enhanced user engagement. Cash and cash equivalents were 841 million as of March 31, 2021, compared with 862 million as of December 31, 2020. 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 provides us visibility on our future revenue growth. With that, I'll now provide our business outlook. Based on our current estimates, total revenues for the second quarter of this year are expected to be between 217 million and 227 million, representing an increase of 102% to 111% year-over-year. This reflects the expected and continued expansion of the Company's learning services and also takes into consideration that the second quarter is normally a slow season for the Company. These estimates represent management's current and preliminary view, which is subject to change. That concludes our prepared remarks. Operator, we're now ready to take questions. Thanks.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Mark Li from Citi. Please go ahead.

Mark Li, Analyst

Hi, management. Congratulations on the results, and thanks for the presentation. I have two questions. Number one, may I ask how the development for our AI course preparation, and can you share a bit more on the outlook update? And secondly, would you share any view on the potential regulations and our initiatives to work around that? Thank you.

Dr. Peng Dai, CEO

Thanks, Mark. I will answer the first question. So about our first AI course, which is iHuman Chinese Reading, we have done a few trial runs starting from April, and up to now, the conversion rate is better than our expectations. Based on our current data, the first month completion rate was as high as 90%, which already outweighed the performance of other similar products available in the market. And also, from the first couple of weeks, we also received a lot of positive feedback from kids and their parents who recognize that our product innovation helps kids learn while having fun. The young kids like to play with our content and learn using our products almost every day, which naturally improves their reading skills and enhances their comprehensive Chinese literacy through our design, fun, and interactive activities. And going forward, we will continue to build out more capabilities and functions within this product and further optimize the performance, adding more content going forward.

Vivian Wang, CFO

And, Mark, this is Vivian. I will answer the second question about the regulations. So based on our understanding of policies currently in place, recent supervision of after-school tutoring is basically reinforcing our government's previous focus on a few key areas of concern. So, the first one is the prime courses ahead of the syllabus, which adds significant pressure to students. The second one would be the regulations related to advance payments for tuitions and fees, as well as high pricing of the courses, some of which are too high and place extra burden on parents and also raise public concerns about the fairness or equality of education. And third, there would be false and excessive advertising, which causes heightened anxiety for parents and kids, and so on. So while the recent, more detailed policies give us further guidance in those areas, we believe what we offer to parents and children is in line with the healthy online education that the policies aim to address. So on the content side for our current products and business lines, also in self-directed learning apps, we mostly operate in the edutainment segment, which combines both education and entertainment elements. Our core value of offering innovative edutainment content echoes with the government's call for a fun learning experience. We creatively made content that is designed for each knowledge point within our app, which is full of creative elements and interactive designs that help to cultivate creativity in children, help them to explore the joy of learning, and nurture their curiosity and passion for knowledge. This is something that those memorizing and priming courses for exams or competitions can never do. In addition, our apps also allow parents to effectively manage their children's screen time to help protect their eyes and ensure that the kids are learning at a desired proportionate pace. Even for kids who live in less developed areas and don't have access to high-quality educational resources, as long as they have a mobile device and access to the internet, they can enjoy a great educational experience with our products. So in essence, our products support general education, foster a love of learning, and care for children's mental and physical health, which is the direction we believe the current policies and regulations are heading. And on the advertising side, we have been a content-and-product-focused company and have always aimed to build a healthy business model. We have mostly relied on our superior product quality and word-of-mouth referrals to grow our user base. Our products keep ranking No. 1 in the Apple attached app store education category almost every day since the end of 2018 and we also get recommended by our third-party channels. So although we've been a bit more active in terms of branding and marketing as a sophisticated supplement recently, the majority of our user growth still came from organic growth. We're not blindly burning cash for customer acquisition but rather focus on R&D to constantly optimize our products to keep our differentiation and sustain our long-term growth. So, we believe regulations on promotional apps and several of these other areas will help the industry become more rational and sustainable going forward. So to summarize, our potential regulations could help to bring the industry back to a healthier and more sustainable state. And as proven repeatedly by historical experience, it could also accelerate consolidation, and in the longer term, potentially benefit leading companies like us who are always aiming to be compliant with all the regulations and bring the best-in-class product to our customers. I hope this answered your question, Mark. Thanks.

Mark Li, Analyst

Thank you, Peng and Vivian.

Operator, Operator

Our next question comes from Lauren Zuo from Credit Suisse. Please go ahead.

Lauren Zuo, Analyst

Hi. Thanks, management, for taking my question. Congrats on the strong results. So I have two questions regarding your product. First, would you share more color on the new product and how would you differentiate your product content or quality with competitors? The second is about the R&D expenses. What would be your expectation for R&D spending this year and next year, and would you share more color on the magnitude of R&D? Thank you.

Dr. Peng Dai, CEO

Thanks, Lauren. This is Peng. So about the first question, our new product, actually, as we mentioned earlier, we do have several new products in sight. As we mentioned earlier, we just launched our first-generation AI product, iHuman Chinese Reading in April. And as I introduced earlier, we do see a lot of promising early results from our trial runs. For these products, we believe it helps children to learn about classical Chinese literature and culture and improves their reading skills and boosts their confidence with public speaking. Our key feature, our major difference versus competing products is that we create a more immersive and interactive way of learning with our products, so that children can enjoy a lot of fun with our enhanced animations and more diversified interactions during the learning process. The second new product is iHuman Readers, which I also introduced earlier. It's a collaboration with Oxford University Press. In general, it will be an interactive library containing Oxford's most comprehensive reading series of over 1,000 books. There will also be a customized AI-powered assessment module. So these two parts will both be very differentiating factors compared to all the other English-level reading products available in the market because the Oxford Reading Tree is a very well-known brand among the English-level reading brands. Also, this is the first time we co-create a children-focused English reading assessment tool. I believe this will be a very important innovation for the whole industry. Additionally, we are creating a new series of 100-level reading books, which is called the Fantastic Friends. For these new intellectual property, we will create a lot of interactions and animations so we can provide an even more engaging reading experience for children. So with that part, we have received a lot of good feedback and we even got the Best Innovation Award from Oxford this year. Additionally, as we mentioned earlier, we are building a more comprehensive portfolio that better supports the all-around development of children. As the first step, this summer, we will launch a new app, iHumanpedia, which will help to illustrate hard-to-understand STEM topics with short cartoons and a lot of aim gamified innovation. Kids can interact with animated characters and learn about STEM-related topics by watching those fun animations and exploring dynamic interactions. At the same time, we are also planning and working on other apps about coding and other topics, which will be released later this year or next year.

Vivian Wang, CFO

And regarding your second question, Lauren, about R&D expenses, so currently, in Q1, R&D expenses were around 82 million, and we do plan to further increase our investment into R&D going forward. As an R&D-centric company, we will keep reinvesting significantly into R&D because by doing so, we can sustain our long-term growth by providing differentiated products and keeping ahead of our technology advantages. We believe this devotion to high-quality content and advanced edutainment products should differentiate us from our competitors. So we'll keep investing aggressively into R&D going forward. Thanks.

Operator, Operator

Our next question is from Betty Zhou from Essence Securities. Please go ahead.

Betty Zhou, Analyst

Hi, management. Thank you for taking my question. I have two questions. The first one is about the staff situation. Can management elaborate on the staff profile of our company now? Also, it would be better if you give us more color about the personnel plan this year. My second question is related to the flagship product, GoPlay Chinese. Can management assure the operational traction of this product this year? Thank you.

Vivian Wang, CFO

Thanks, Betty. Regarding the personnel or headcount plan, we do plan to add pretty aggressively in terms of headcount. Currently, we have roughly 1,200 people, the majority of whom are R&D personnel. I said earlier, we will invest pretty aggressively into R&D. We do plan to increase our headcount significantly because we have many new products in our pipeline. We also want to continue to enhance and optimize our existing products and continue to provide a better experience for our customers. Yes, so we do plan to increase our headcount pretty aggressively.

Dr. Peng Dai, CEO

Thanks, Betty, for your second question about our plan for our flagship app, iHuman Chinese. Yes, we have many initiatives to further drive this app. First, we will continue to update the new content within the newly introduced package, which is the traditional Chinese medium package. We are still working on some new content and new products in that part. Second, we will also introduce another new package, which is the traditional Chinese coding package. This will also expand our content offerings for children. Third, we will add more reading and practicing functions within these apps because we believe that while they learn, kids will need more opportunities for practice and reading exercises. Fourth, we will continue to refresh the previous character learning units based on big data analysis because, as we mentioned earlier, we continuously optimize and update those in our course elements based on user feedback and our data analysis so that we can keep this whole app feeling fresh. Lastly, we will create more physical learning materials and companion products for iHuman Chinese because we observe a lot of good momentum with our bundle-selling strategies. Parents often need more companion and physical learning products for their children beyond the online offerings. Yes, these are our major initiatives for the iHuman Chinese app moving forward. Thanks.

Operator, Operator

Our next question comes from an unidentified analyst. Please go ahead.

Unidentified Analyst, Analyst

Hi, management. Could you please add some color about the traffic acquisition? Yes. Thank you.

Vivian Wang, CFO

I'm sorry. I didn't quite hear your question.

Dr. Peng Dai, CEO

For our customer acquisition, we believe we have our own principles. The first one is that we always believe that product quality is the dominant driver of our business. Good products and high-quality content bring us strong word-of-mouth referrals and further drive our massive organic user growth. This is the foundation of our business model. The second principle is we have a lot of strength in our channels. Our app has been ranking very high on the Apple App Store and other major Android stores. This gives us more exposure to users in those different channels. Third, we are also exploring new growth channels, for example, like OTT, smart devices, and social communities. We will leverage our online-offline channel synergies because we have a huge offline network that includes kindergartens and educational organizations all around China. This will also help us access a more extensive user base. Going forward, we will follow the same user growth principles and continue to expand and roll out high-quality products to fulfill their demands so that this organic growth model will be sustainable. Yes, thanks.

Operator, Operator

This concludes our question-and-answer session. I'd like to turn the conference back over to Ms. Cynthia Tan for any closing remarks.

Cynthia Tan, Senior IR Director

Thank you, operator. In closing, on behalf of iHuman management team, we'd like to thank you for your participation in today's call. If you require any further information, feel free to reach out to us directly. Thank you for joining us today. This concludes the call.

Vivian Wang, CFO

Thank you, everybody.

Dr. Peng Dai, CEO

Thank you.

Cynthia Tan, Senior IR Director

Bye-bye.

Dr. Peng Dai, CEO

Bye-bye.

Vivian Wang, CFO

Bye.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.