China Online Education Group (COE) on Q1 2021 Results - Earnings Call Transcript
Operator: 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.
Unidentified Company Representative: 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.
Jack Huang: 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 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 in providing the best learning experience to our students.
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.
Operator: Thank you. The first question today comes from Roger Duan with Needham & Company. Please go ahead.
Roger Duan: Good morning. Thank you management for taking my question. I have two questions. First is, can management discuss briefly about the recently introduced private education sector development guidelines issued by the State Department? Is there any positive or negative implication for COE's business model that we should pay attention to? And my second question has two parts. First is about the Koala Reading acquisition we just made, can management share with us the strategy that COE has for this new platform? Will it be built into a new English-reading learning platform or will it be continued to operate as a Chinese-reading training platform? If the second -- if it's the second case, does that signal that we're officially entering into a non-English product offering? Thank you.
Min Xu: Sure. Hey, Roger. Thanks for the question. So I'll answer the first question and Jack will comment on the second. So our read to 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?
Jack Huang: Okay.
Min Xu: All right. So thank you and we would like to share our thoughts on the Koala acquisition. So, actually, we would do both what you mentioned in your question. So in 2021, our first priority is to utilize -- leverage Koala's industry-leading assessment and reading rating system and add English component onto that system, in order to improve our current English-learning product and help our existing students. So, obviously, Koala has very nice 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.
Roger Duan: Thanks.
Min Xu: Thank you, Roger.
Operator: The next question comes from Fawne Jiang with Benchmark. Please go ahead.
Fawne Jiang: Thanks for taking my question. The first question is actually just want to get a bit better understanding of your 2Q guidance as well as the potential outlook for the rest of the year. It seems like the 2Q 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.
Min Xu: Sure. Hey, Fawne. So, thank you for the question. So first of all, in our Q4 earnings call we actually indicated the -- both Q1 and Q2 revenue growth is going to be -- was going to be soft. The main reason is because the ARPU is going to be lower comparing to a very strong first half in 2020. And for Q2 guidance of RMB 597 million to RMB 603 million revenue and 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 trend. And so the logic behind our Q2 revenue guidance is like 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, hope that answers your question.
Fawne Jiang: 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?
Min Xu: Yes. So -- yes. So, it's -- like we're not giving an official guidance, but it makes sense if you look at the 2021 active student growth rate. It is going to be between those of 2019 and 2020, because as I mentioned, 2020 is very strong due to COVID-19 positive impact. But we should be doing better than 2019. And in terms of ARPU, as I mentioned before, the ARPU is going to decline, kind of roughly 10% for both Q1 and Q2, and ARPU should stay flat for Q3 and Q4. So, putting together, you can probably get the big picture for 2021 growth.
Fawne Jiang: 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 independent brand or it will be fully emerged with 51Talk? And also, what's the resource commitment you're going to allocate into the new components of this new pilot was it 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 year?
Jack Huang: Okay. So, let's first talk about Koala acquisition. So, as I mentioned before our first priority for this year is going to be on the assessment system. And 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 a English assessment system which can really improve the learning experience of our existing students. And we also plan to find ways to help our customer acquisition.
Fawne Jiang: 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 of expansion to your ARPU as part of your product offering? Or you see that as independent, I think revenue source down the road? Just wonder is there any color on the incremental revenue opportunity here?
Min Xu: Yeah. So our first step is to provide the Koala product to our existing 51Talk students. This can potentially increase our ARPU. However, it is relatively insignificant, because the ASP of Koala product is relatively small compared to 51Talk current ASP. And after that, then we potentially could run, Koala's Chinese product as a, independent product and trying to do customer acquisition for that. But again, it's -- right now, it is still on the paper. And so in the near-term this is not going to be a major revenue contributor.
Fawne Jiang: Got it. Thank you.
Operator: The next question is a follow-up from Roger Duan with Needham. Please go ahead.
Roger Duan: 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.
Min Xu: So as I mentioned earlier, Koala's ASP is relatively small, compared to our current ASP. So it is not going to be a significant impact. And like in terms of modeling like you can -- you don't have to -- and we do not -- because it's insignificant. And we do not intend to disclose that number in the near future, either. So what we're trying to do is that, we believe, the value of Koala is actually in its industry-leading assessment system. And if we can make, -- we can combine our English training expertise with this industry-leading system then, it can really improve our students' learning experience. And it can also help our customer acquisition. That's where the Koala acquisition will add value to 51Talk.
Roger Duan: Very helpful. Thank you.
Min Xu: Thank you.
Operator: The next question comes from Roger Parodi with Silverhorn. Please go ahead.
Roger Parodi: Hi, Jack. Hi, Xu Min. Congratulations for a solid quarter. I have two questions. The first question is about the cash flow, the operating cash flow that you mentioned in the release. Are there some one-off effects? Or how should we -- how should I understand the cash flow? And the second question is regarding the Q2 guidance, is there already something -- is there something in the guidance included potential impact from regulatory changes? Or could regulatory changes have a further -- do you expect that regulatory changes that come within one month could have an impact on your Q2 guidance?
Min Xu: 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 a typically kind of a soft season for operating cash flow, and you can see that in 2019 and even before like before we have -- probably have negative cash flow for Q1. And so 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's going to happen in Q1. So that's the reason that it is going to be relatively low compared to other quarters. Also, we have a slight impact from 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 and so 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. So -- but we do not -- right now, we do not expect a big surprise and we will see how things go after. We do expect the regulation coming out in a month or so.
Operator: We have a follow-up from Roger. Hold on. Roger, please go ahead.
Roger Parodi: Yes, sorry. I just fell out of the call. Sorry to say to confirm and thank you for the explanation Xu Min.
Min Xu: No problem at all, yeah.
Operator: 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.
Unidentified Company Representative: 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 Investor Relations.
Operator: This concludes this conference call. You may now disconnect your lines. Thank you for…
Min Xu: Thank you everyone.
