17 Education & Technology Group Inc. Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to the 17h Education & Technology Group Incorporated Fourth Quarter and Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. There'll be a presentation followed by a question-and-answer session. I might advise you that this conference is being recorded today, Tuesday, 9 March 2021. I would now like to hand the conference over to the first speaker today, Mr. Raymond Huang, Investor Relations Director of the Company. Please go ahead.

Thank you, operator. Hello, everyone. And thank you for joining us today. 17's tax earnings release was earlier today and it's available on the company's IR website. On the call with me today are Mr. Andy Chang Liu, Founder, Chairman and the Chief Executive Officer of 17EdTech and Mr. Michael Chao Du, Director and the Chief Financial Officer of 17EdTech. Andy will walk you through our latest business performance and strategies, followed by Michael who will discuss our financial performance and the guidance. They will be available to answer your questions during the Q&A session after their prepared remarks.

Thank you, Raymond. Hello, everyone. Thank you all for joining us for our earnings call. This is our first call as a public company since we successfully listed on NASDAQ in early December 2020. We are grateful for the support from the investor community. And we believe our IPO helped further strengthen our brand image among parents, students, and public school teachers, as well as help us attract more great talent to join our team. Please allow me to start with some very quick background for those who might be new to our story. We have successfully developed our differentiated in-school plus after-school integrated model that coherently brings together our smart in-school classroom solutions and online after school tutoring operations. Our smart in-school classroom solution operation started in 2011 and provides school teachers with industry-leading tools and content libraries in a wide range of in-school teaching and learning scenarios including class preparation, class delivery, homework assignment, and grading and academic assessments. To allow a smoother and more efficient data-driven teaching, learning, and tracking experience for teachers and students at over 70,000 K-12 schools across China. We are now the largest in-school classroom solution provider in China in terms of MAU. Under our in-school plus after-school integrated model, we also offer online K-12 large class after-school tutoring services that complement students' in-school learning, leveraging our insights into students' localized education needs and personal learning profiles gained from our in-school operation powered by our integrated model and technology. Our online K-12 large class after school tutoring courses send out unique approaches to personalization based on what data-driven insights of individual students' in-school performance as well as our district-level localized insights.

Thanks, Andy, and thank you everyone for joining the call. I will now walk you through our financial and operating results. Please note that all financial data I talk about will be presented in RMB terms. I'm pleased to report our strong results for the fourth quarter and for the full year of 2020. We achieved strong top-line growth, net revenues increased by 153% year-over-year to RMB 487 million in the fourth quarter of 2020 and increased by 218.6% to RMB 1,294.4 million in 2020. The net revenues from online K-12 tutoring services increased by 164% to RMB 468 million in the fourth quarter of 2020 and increased by 239% to RMB 1,219 million in 2020. Gross billings of online K-12 tutoring services, which is in GAAP measure, increased by 166% year-over-year to RMB 579 million in the fourth quarter of 2020 and increased by 203% year-over-year to RMB 1,655 million for the full year. Pay course enrollments increased by 165% year-over-year to 849,000 in the fourth quarter of 2020 and increased by 178% year-over-year to 2.02 million. In addition to robust revenue growth, our operational efficiency continued to improve in the fourth quarter and the year of 2020. Our gross margin was 64.3% in the fourth quarter of 2020, improving from 62.9% in the fourth quarter of 2019. It was also 61.7% for the full year 2020 compared with 57.3% in 2019. Our adjusted net loss, also in GAAP measure which excludes share-based compensation expenses, was RMB 134.6 million loss in the fourth quarter of 2020, decreased from RMB 163 million in the fourth quarter of 2019.

Our first telephone question comes from Sheng Zhong from Morgan Stanley.

My first question is on your next quarter revenue guidance. How much impact do you see from the late Chinese New Year? And can you also provide the revenue guidance for the full year next year? And second question is about the regulation. We see the government disallow electronic homework and especially for primary school students. The government now requires the homework to be done in school. Do you think this will impact your in-school business, the MAU growth? And do you have plans to do more external student acquisition if there is impact from the regulation?

I'll answer the first question. And then, I will pass to Andy for the second question. So, on the question regarding next quarter's revenue guidance and how much it was affected by the late Chinese New Year, it is actually indeed affected by that. We actually have already completed our winter conversion cycle and we do see strong growth during that period. However, as the Chinese New Year is actually relatively late, it means that for the spring revenues, there is actually one whole week less of revenue that is being recognized in the first quarter. In our initial estimation, it probably decreased the overall revenue by around 10%, assuming all cycles were similar to the previous year. In terms of annual revenue guidance, we actually do not provide revenue guidance for the full year. With that, I will pass to Andy for the second question.

I will speak in Chinese and Michael will translate in English. Even considering the regulatory environment we have seen, we are still very confident in our overall annual growth in terms of revenues, especially we are confident that we can achieve that without relying on external staff acquisitions. Then, I will further elaborate on the reasons behind that. So first, in terms of our in-school ecosystem, essentially it's not only about homework, it actually includes class preparation, class delivery, homework assignments, as well as term assessments, which is comprehensive interactions with the teachers, students, and parents. Secondly, even in terms of homework, it can be completed by students on multiple types of devices, including PCs, tablets, and mobile phones at home. Also, in terms of completing homework at home on different devices, it is actually activities controlled by the parents and students themselves. So we don't see much impact on that. Lastly, I think starting from last year, we have been exploring domains where we are able to backup and duplicate the reach to parents and various students through our numerous social networks which further allow us to be less impacted in terms of the app itself. Therefore, in terms of the near term and the longer term of our integrated model, we are fairly confident because we believe if you look at things over three or five years or even longer horizons, the informatization and modernization of China's education system is irreversible. This is actually the only way to achieve or to improve education equality in China. So we are very confident as long as we can provide high value to the teachers, students, and parents in class preparations, deliveries, homework, assessments, and various learning and teaching scenarios. We are confident this is a model that has long-term prospects. If some of you may be interested, you're encouraged to see the 14th five-year plan, its interpretation, and discussion about informatization of China's education over the next few years. We see very strong needs and willingness to prepare this from China’s government.

May I follow up with your MAU outlook for next year?

So Sheng Zhong, we don't actually provide an outlook for a particular one year, but I think despite the policy environment, we are still confident that the MAU of our apps is likely to double over the next two to three years.

Yes, to clarify the remarks in the edit, it will probably be unique IDs for both apps and potentially a PC.

The next telephone question in queue is from Lucy Yu from BoFA Securities.

So I have two questions here. One is also on the policy side, but more on the after-school tutoring. So we have seen the government requiring all instructors to have the teacher qualification. So may I know how many of your current instructors who are teaching right now are without the qualification? If they don’t have the qualification, does it mean that they cannot teach the classes for the upcoming semester? And also how should we think about the competition in the after-school part going forward? So that's question number one. Number two is, could you elaborate a bit more about our winter promotion strategies? I have seen that the conversion rates from in-school to after-school went up quite nicely in the fourth quarter of last year, with MAU being largely flat q-on-q but the paid enrollment actually surged a lot. So how should we think about the conversion rates from in-school to after-school in 2021? Thank you.

Thanks Lucy. Let me quickly translate the questions to Andy. Thanks Lucy. So basically, in terms of instructor qualifications, as I recall, we have more than around two-thirds of our instructors actually are properly qualified or have already, and only around 10% of them have passed all the tests but do not yet have their qualifications. We don't see this having a major impact on us, as the vast majority of the revenues generated from instructors are with those who have qualifications. We actually are among the leading players with a higher percentage of teachers or instructors having such qualification. On your second question in terms of after-school tutoring, competition and how we see our fourth quarter paid course enrollments, I think the paid course enrollments in the first quarter were a combination of our improvements in terms of the students we can convert from our in-school traffic as well as existing students renewing and signing up for their courses. That's why you can see the numbers have continued increasing in the fourth quarter. In terms of our winter strategy, or actually our expectations for winter 2020, as you know, the winter conversion season has already completed. We have some preliminary statistics from that and we see them as very promising, and we are happy to see the trend. In summary, we see, first, in terms of the number of full-price students that get converted from our winter actually has increased significantly, which is more than double compared to the same number of last winter. Secondly, in terms of unique customer acquisition expenses, it also remains highly stable, only increasing by around 10% compared to the last conversion cycle, which is significantly slower than the industry increase. We believe this is a significant benefit and edge of our integrated models. That's why, as you mentioned earlier, the paid course enrollments that took place in the fourth quarter and also what we've seen in the winter cycle — we actually see us approaching what we believe is major milestones for our business where the number of concurrent students getting very close to 1 million enrollments after the winter cycle. So for 2021, I think as Andy had mentioned earlier, we are very confident to continuously grow in the sector despite the competition and we are confident of delivering a very strong overall year.

So the numbers we have seen in the first quarter and also the initial statistics we have seen in the winter are very stable with CAC around only a 10% increase. Additionally, the number of students getting converted was actually doubling what we saw in last winter 2019, and our overall app score tutoring business is getting very close to 1 million concurrent full-price student enrollments. This is all behind the long-term advantage of our integrated models. Over the last few years, our accumulation of presence in-school scenarios of more than 70,000 schools has actually been a long-term strength and a benefit that we will gradually play out in the next few quarters and years. We are confident that we will be growing on very healthy, unique customer acquisition expenses and in relatively solid growth rates without relying on external traffic.

Our next telephone question is from Sheng Zhong from Morgan Stanley.

Actually, I asked my questions already. But if I may, I want to ask one more question. Since you mentioned that your retention is seeing very strong improvement, could you add some color on this perspective? What is the retention rate for the students who you have in their academic performance record compared with the normal ones? Thank you.

As we have shared earlier and also as some investors have been communicating with us, we do experience customer acquisition expenses that are significantly lower than the industry average and also have similar retention rates among the leading players. Therefore, we have enjoyed significantly better unit economics with much higher LTV versus CAC structures. We also want to share that we see stronger potential for our renewal rates to improve further. As we shared earlier, we have utilized the in-school students' learning and localized learning data and integrated this with our after-school tutoring services. We believe the vast majority of our potential students or current students actually want to improve their grades in their in-school learning scenarios. That's why our in-school learning scenarios accumulate a lot of data in terms of academic assessments, homework data, what the student mistakes are, and what the local exam focus is. Such insights allow us to be much more efficient in helping the students to improve their learning results, and to be more targeted. While people may view the integrated model as significant for lowering customer acquisition expenses, what’s even more valuable, especially in the longer term, is the localized content and data that it provides, allowing us to offer stronger and more efficient after-school tutoring learning products to the students.

Our next telephone question is from Christine Xu from Goldman Sachs.

Thank you so much for the comprehensive update, Andy and Michael. I think we start to notice a lot more of your competitors actually starting to talk about localization as well as potentially exploring some offline customer acquisition channels. Can you highlight any product or R&D developments on that side over the last few months that you can highlight? Thank you.

So the question was about more and more players talking about localizations as well as trying to acquire students from offline channels, and what was our investments, especially in R&D product in these aspects. I think this has indeed been a trend where we have pioneered. If people recall during last year's investor meetings and roadshows, we had already mentioned that we have become among the leading players in having the most number of localized textbook versions in terms of school tutoring courses, as well as multiple levels of difficulties for our large classes. And this is what we have always focused on, to provide more targeted services. However, we believe that having multiple localized course versions and multiple difficulties is only the first step; it offers some value to the parents but may not be as great because, from a parent's perspective, they are more concerned about having courses and services that are more targeted to help them solve the problems that their students have encountered in school, and to prepare them for the exams within the schools. This, from our perspective, has the highest value. The first key data set comes from the school level, understanding the district's focuses, its exam focuses, teaching focuses, and what’s most likely to be tested. The second set of data comes from the individual level, understanding each student's own learning problems, strengths, and weaknesses, allowing us to deliver more targeted tutoring services. We are particularly strong in our integrated model with this. More than 10 million students actually took our academic assessments in 2020. This is consistent with the trend in the Chinese government trying to use progress data instead of final exams to evaluate how students are learning. This product and service adaptation requires high demand for both technology and expertise that we have accumulated over the years. Such a large number of students attending academic assessments on our platform, more than 10 million, gives us a significant knowledge advantage in understanding what schools are likely testing and what the exam focus is. This knowledge will aid our tutors in providing services to students that are accurately targeted and organized, complemented by the overall general large classes. In terms of offline customer acquisitions, we noticed this trend fairly early. As we've shared earlier, we believe all players will have a matrix of customer acquisition channels both online and offline as the social platform customer acquisition expenses are becoming increasingly more expensive. However, when you look at offline, we can aggregate this into multiple segments. The first is the offline versus outside the schools. This is not that difficult and doesn't have many barriers, and it’s been done in the offline industry for multiple years. The challenge is that it's not easily scalable. While you can maintain low customer acquisition expenses, it's more challenging for players to build such offline structures within a short time frame to achieve significant growth. The second segment involves in-school scenarios, which is divided again. The first label is product-driven in-school systems similar to ours, which requires longer-term investments in products, content, trust, and relationships within the schools and students. We believe this will be a challenge for others to replicate within a short period. The others we have seen are more focused on optimizing timing and one-off approaches, like holding seminars within schools, similar to what offline institutes have done for years. This has cost advantages but has scalability issues.

Next telephone question is from Manik Mahajan from Fremont Capital.

Thanks a lot for the detailed insights on the results. I just have one question and that's around ASP trend. How should we think about the average selling price for the after-school tutoring courses going forward? I encourage you to share how it has been trending per your expectations.

Let me share my view on our results first. In terms of ASP, I believe it is likely to grow around 15% annually over the next few years. The reasons behind that are, if you look at the average price of online large classes, it is around RMB 3,000 for the whole year. This price is highly acceptable and comfortable for students in Tier-3 and Tier-4 cities. This would account for around up to 10% of the annual income even in those cities. We have also conducted several surveys and believe this is a fairly comfortable level where they can accept. Moreover, the emphasis and focus on education overall and the continuous product improvements in the industry will drive demand, even from lower-tier cities. Additionally, since the online large classes represent an alternative to other formats, they offer significant price advantages compared to several other forms. So, even with a 15% annual price increase over the next two to three years, their prices will still remain competitive.

There are no more further questions at this time. I'd like to hand the call back to the speakers for closing remarks. Please continue.

Thank you, operator. In closing, on behalf of the 17EdTech management team, we would 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.