China Online Education Group (COE) CEO Jack Huang on Q4 2020 Results - Earnings Call Transcript

China Online Education Group (NYSE:COE) Q4 2020 Results Conference Call March 5, 2021 8:00 AM ET

Company Participants

Judy Piao - Investor Relations

Jack Huang - Chief Executive Officer

Min Xu - Chief Financial Officer

Liming Zhang - Chief Operating Officer

Conference Call Participants

Vincent Yu - Needham & Company

Fawne Jiang - Benchmark

Operator

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 like to turn the call over to your host, Ms. Judy Piao, Investor Relations for the Company. Please go ahead, Judy.

Judy Piao

Thank you. Hello, everyone, and welcome to the fourth quarter and full year 2020 earnings conference call of China Online Education Group, also known 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.

Jack Huang

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 to 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 the 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 those.

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 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 Xu Min.

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 our 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 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 offering 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. And small class gross margin was 59.5%, up from 52.7% for Q4 2020.

Total operating -- I'm sorry, 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 same quarter last year. Excluding share-based compensation expenses, non-GAAP G&A expenses for 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 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 releasing of valuation allowance for deferred tax asset of RMB9.7 million.

Basic EPS for 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 total cash balance of RMB1.73 billion, compared with RMB1.05 billion last year advances from students was 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.

Operator, please go ahead.

Question-and-Answer Session

Operator

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

Vincent Yu

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 start-ups. So are we seeing any new growth initiatives launched by these companies in real-time that may pose to our core business? And what's our strategy to address these new entries? Second question is about, in 2021, what we expect to see investment to be made in different online tutoring area 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.

Jack Huang

Yes. So I appreciate the question. And so 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 the players in this space are putting up a huge loss. However, we are actually one of the very few profitable company -- online education company.

And 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 actually -- the competition in these two sectors are extremely intense. And we're actually in a different sector, which is the K-12 online English education sector, which is -- which we kind of -- is one of the earlier sector to really see a strong growth.

So our sector is already -- is more mature than other sectors. There's already a very small number of players in our market, and we're one of the market leader. And obviously, if you look at the Q4 user growth in 2020, we're seeing user growth -- new user -- new paying user growth of more than 60%. And this is obviously the fastest-growing company in our sector. So we're very confident that we're going to do well in 2021.

Jack Huang

Okay. So for the second question, so basically, we -- in 2021, our strategy is going to be focusing -- continue to focus on our core business of K-12 English education. And we want to continue our momentum of user growth in 2020. And we target to be the absolute leader in our sector in 2021. And so there are two areas we will put our investment and to achieve that goal.

So number one is we're target to make sure to drive our user growth with better user experience in both products and services. So in order to do that, so we are going to invest more in R&D. And we have to say that our investment in R&D was not sufficient in early years. So we're going to fix this and put more into the development of our products and curriculum.

And this will allow us to drive our user growth through user referral, but not just blindly putting in more marketing dollars. So as one of the example, we recently acquired GKid's product line and their industry-leading AI technology, so we will integrate the AI technology together with our one-on-one products to provide a holistic experience for our users and students.

We're expecting to come up with a new product, which is a 5-minute AI pre-session before our 25-minute one-on-one foreign teacher session. We believe this is a very complementary product, which can really help our students to better enjoy their learning experience. So -- and the second area we plan to invest in is actually the branding

And we target to elevate the brand awareness by putting more branding investment in different channels. And we believe this is a very important area when you have a very satisfying consumer product and having a good brand is a must.

And in summary, we are going to continue to invest in our product, service and user experience as well as the branding to make sure our user growth will continue in our core business area.

Jack Huang

So for third question, we do see our current sector is a big market and still have a lot of room to grow. And so our top priority will still be in our current core market. However -- and also, we're quite confident that we can provide better products and services than our peers. Now however, we always look for opportunity to continue to expand our target market. Just for an example, our recent acquisition of GKid product is just an effort to kind of expand that market.

We will -- based on GKid product, we will continue to develop AI product for pre-K students. And this is a pretty efficient way to expand our market. And we are also -- last year, we also kind of started our -- started exploring using off-line experience store as a new channel to reach to our target customers in lower-tier cities. And we've already set up more than 100 experienced stores throughout the country.

And this is a very major initiative for online merge off-line effort -- strategy. And our COO, Liming Zhang, will elaborate more on our OMO strategy a little later. And as we continue to expand our active students from 350,000 to maybe someday we can reach more than 1 million students.

And with that huge student base, we will always look for ways to explore their demand, and we will provide whatever they need, and we will just follow our students' demand. So I'll hand the call to Liming to offer you some more lights on OMO strategy.

Liming Zhang

Sure. So since last year, we've already expanded our off-line experience store to more than 100 stores in roughly 20 provinces. So this is an experiment to find a way to better reach our potential customers in the lower-tier cities. So there are four ways we can make ourselves closer to our customers in the lower-tier cities. One is the customer acquisition is closer to our target market.

And second, the brand awareness, it is with a physical store. You significantly increase your brand awareness in your target TAM. And then also the sales effort is kind of more closer to our customer with local people face to face instead of on the phone or on WeChat and the sales effort is closer to our customers and also the service and with a place to go to, to do child lessons or maybe even paid lessons and ask questions.

And the service we can provide is closer to our customers. So this is a very meaningful effort for us to explore the off-line master to kind of expand our customer acquisition channels and exposures. And so we will continue to put more effort in our off-line experience store and look forward to having more impact and help 51Talk to reach more of the mass market customers.

Operator

The next question comes from Fawne Jiang of Benchmark.

Fawne Jiang

Congrats on solid quarter and a very strong finish of the year. Just want to follow up and dig a little bit more on your user behavior against curve. We're roughly one year after COVID. Just wonder, with the current online adoption curve among your students, I also noticed that your active students continue to accelerate. Just wonder what's the driver behind it. But in particular, what's the source of your future growth? Are we looking for more students from lower-tier cities? Or we are moving up into the higher-tier cities? And how you're planning to allocate your resources going forward?

Jack Huang

Okay. So let's first talk about the customer behavior change after pandemic. So what we see, as you expected, the online adoption significantly increased for two reasons. One is because of COVID-19 impact. People have to go online. And the other one is actually the heavy investment of many test prep, large class education peers. They put in a lot of marketing dollars to really raise the awareness of online education.

So this is a good thing because people are -- online education are turning from a new fancy way to do education and become a very familiar way, actually probably the preferred way, to learn and to take lessons. And many people just -- a lot of the parents are from just hearing online education through friends by -- and try it by curiosity, now many of the parents are becoming very mature shoppers of online education.

Many of them are expert in comparison shopping, so they know a lot about every company. So this is a good thing, and the market is becoming more mature, which means that a lot of times may be advertising is not enough. And you have to meet your customers' demand you have to provide great product and great services.

And that's the only way to generate customer loyalty and to guarantee the long-term customer satisfaction. So that's why we're putting a lot of -- we are going to put a lot of money in product development and services and to drive customer satisfaction and, in turn, drive user growth.

Jack Huang

So now let's talk about the user growth. So we are seeing very strong user growth and accelerating user growth in second half 2020. And we believe there are three major drivers. Number one is the customers' satisfaction. So we mostly drive our user growth through referral.

And one of the key reason is that our students' lesson consumption is roughly 13 to 15 per month, which is the highest in industry because the students are very actively taking the lesson, making progress, leading to better results and then leading to better customer satisfaction. So we believe it is one of the key.

And second is the brand. And our brand is gaining momentum throughout the year. As you guys probably know, in the past few years, we've had a strong competition from many peers focusing on North American teachers. And in the past year, many of them stopped those very aggressive or excessive advertising, which is leading to our brand is actually -- our brand awareness is accelerating, and now we're becoming the biggest brand in our sector.

And the third one is the operation strategy. And one of the operating strategy I want to point out is that, in the past year, we actively lowered the average package size. And by lowering the average package size, we lowered the barrier for many of our customers to buy our product. And one exciting thing we find out is that, after we lowered average package size, not only the lower-tier city markets are seeing very strong growth.

We're seeing actually accelerate growth in the Tier 1 cities, which means like it doesn't matter what the market is. As long you have great product, great service and a reasonable price, you're going to see very strong long-term growth. Okay. So yes, so I'm not sure if we answered all your questions.

Fawne Jiang

Yes, that's very helpful.

Min Xu

Excellent.

Operator

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

Judy Piao

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 or The Piacente Group's Investor Relations. This concludes the conference call. You may now disconnect your line.

Thank you.

Operator

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