China Online Education Group (COE) Q2 2022 Earnings Call Transcript

China Online Education Group  (NYSE: COE) Q2 2022 earnings call dated Aug. 30, 2022

Corporate Participants:

Ni Yan — Investor Relations

Jack Jiajia Huang — Founder, Chairman and Chief Executive Officer

Min Xu — Chief Financial Officer

Analysts:

Long Lin — The Benchmark Company — Analyst

Presentation:

Operator

Hello ladies and gentlemen. Thank you for standing by for China Online Education Group’s Second Quarter 2022 Earnings Conference Call. [Operator Instructions]

I will now turn the call over to your host, Ms. Ni Yan, Investor Relations for the company. Please go ahead, Ni.

Ni Yan — Investor Relations

Hello, everyone, and welcome to the second quarter 2022 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 signup for the company’s distribution list by visiting the IR section of our website at 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, there will be a Q&A session.

Before we continue, please note that 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 the applicable law.

Please also note that earnings press release and this conference call includes discussion of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. 51Talk’s press release contain 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 Jiajia Huang — Founder, Chairman and Chief Executive Officer

Okay. Thank you, Ni. Hello, everyone. Thank you for joining our conference call today. In the second quarter of 2022, we successfully completed the divestiture of our China Mainland Business, and we are solely focused on our overseas business going forward.

Starting from the third quarter, 100% of the company’s revenues will be derived from overseas markets. Furthermore, to reflect our overseas focus, we will hold an Annual General Meeting on September 30th to vote on the proposal of changing our legal name from China Online Education Group to 51Talk Online Education Group.

We are very excited to report another quarter marked by continuing top line growth of our overseas business. In the second quarter, our overseas business continued to see healthy and sustainable development. Our second quarter overseas business net gross billings reached $7.8 million, representing 46.5% sequential growth. The number of our paying students reached 8,100, representing 25% sequential growth. And the number of our active students with attended lesson consumption reached 14,900, representing a 60% sequential growth in the second quarter.

In addition, our overseas business achieved breakeven in cash flow during the two months of May and June. This reflects our strong execution of healthy growth strategy in overseas business, and we are looking forward to the future performance of cash flow.

We are sorry to announce that our CFO, Mr. Min Xu submitted his resignation today for personal reasons and his last day will be September 30, 2022. Our VP of Finance, Ms. Cindy [Phonetic] Chun Tang will assume the role of CFO on October 1, 2022. On behalf of the board of directors and myself, I would like to thank Min for his service over the past four years, leading our company to profitability by focusing on sustainable growth. We wish him the best in his future endeavors.

With that I will now turn the call over to you.

Min Xu — Chief Financial Officer

Thank you, Jack, for your nice words. I want to thank every 51Talk investor, employee, teacher, student, parent, and partner for your support in the past four years, making my every moment at 51Talk a memorable one. Jack has led us through the most difficult time in 51Talk history, and I trust 51Talk under his leadership is only going to grow stronger, fulfilling our dream of helping everyone talk to the world.

My successor Cindy [Phonetic], current VP-Finance, has been with the company for eight years and played an instrumental role in the company’s IPO in 2016 and in turning mainland China business profitable in Q4 2019. I’m confident that she will leverage her leadership and experiences and work with the team to reproduce the success in the overseas market.

Now let’s take a look at Q2 numbers. The momentum of our overseas business continued into Q2 with gross billing reaching $7.8 million, surpassing the top end of our guidance of $7.5 million. We will continue on our pathway of sustainable growth and focus on delivering strong value proposition to our students in this rapid developing overseas market.

Please note that we completed divestiture of our China Mainland business on June 30, and we’ll focus on overseas market going forward. Since we started our overseas business in July last year, there is no comparable figure for Q2 last year.

Net revenues for Q2 of continuing business were $3.5 million, representing 87.7% sequential gross. Gross margin for the second quarter was 79.2%, Q2 operating expenses of continuing business were $6.9 million, a 38.3% sequential increase from $5.0 million last quarter.

Q2 sales and marketing expenses of continuing business were $3.6 million, a 79.3% sequential increase from $2 million for last quarter. Q2 product development expenses of continuing business were $0.7 million, a 36.4% sequential decrease from $1.1 million for last quarter.

Q2 G&A expenses of continuing business were $2.6 million, among which $0.5 million were one-time fee related to the divesture of our China Mainland Business. Excluding this one-time cost, Q2 G&A expenses would have been $2.1 million. G&A expenses for the overseas business were $1.9 million in the first quarter of 2022.

Q2 operating loss of continuing business was $4.1 million. Q2 net loss was $15.0 million. Net loss from continuing overseas business and the discontinued Mainland China Business were $4.6 million and $10.4 million, respectively.

Q2 GAAP and non-GAAP EPS were both negative $0.67. The company’s total cash, cash equivalents, and restricted cash were $22.1 million at the end of the second quarter. Advances from students of continuing business were $10.2 million at the end of the second quarter.

Looking forward to the third quarter of 2022, we currently expect the net gross billing to be between $8.0 million and $8.2 million. The above outlook is based on our current market conditions and reflect the company’s current and preliminary estimate of the market and operating conditions and the customer demand, which are all subject to change.

This concludes our prepared remarks. We will now open the line for questions. Operator, please go ahead.

Questions and Answers:

Operator

[Operator Instructions] The first question comes from Long Lin with The Benchmark Company. Please go ahead.

Long Lin — The Benchmark Company — Analyst

Hi, good evening. Thanks for taking my questions. So the company delivered better-than-expected revenue growth for the second quarter. Just wondering what are some of the key drivers behind that and the can management give a breakdown of your key market performance for the quarter? Thank you. [Foreign Speech]

Min Xu — Chief Financial Officer

Jack you want to take the question.

Jack Jiajia Huang — Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu — Chief Financial Officer

Yes, so we believe the overseas market is still in a very early stage and the strong growth we see in the past quarter or a few quarters really leveraged our success factors in our existing China markets. And we believe the English training market is very different from other education products because the demand for English learning is a common demand for many countries and markets in the world, and we see a very strong demand in the overseas market. Yeah, Jack, continue.

Jack Jiajia Huang — Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu — Chief Financial Officer

So, we do see very strong growth since we started our overseas business in July last year. And so, the strong growth of the past year is actually a result a result of our expertise and experience in China market in the past decades. In the past decade we already accumulated a lot of knowledge in terms of technology, product development, in terms of Filipino teacher operation, and K-12 curriculum. And so, as a result, we do have a very solid, very competitive product in our overseas market from the very from the very beginning.

Jack Jiajia Huang — Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu — Chief Financial Officer

So in terms of a market breakdown, majority of our gross billings, roughly 90% of our gross billings are from Southeast Asia and only 10% from outside of Southeast Asia.

Jack Jiajia Huang — Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu — Chief Financial Officer

Thanks.

Long Lin — The Benchmark Company — Analyst

Thank you. It’s very helpful. My second question is about the company’s outlook. Can you provide like a outlook for the company’s revenue growth and profitability in the second half 2022 and next year? Does the company expect any macro impact on the overseas market?

Min Xu — Chief Financial Officer

I’ll take this question. So we provide Q3 gross billing guidance which is $8.0 million to $8.2 million. And if you look at Q4, it’s likely going to be flat sequentially given historical seasonality. But again, we’re not giving our guidance right now. Just giving you some color on how to estimate the Q4. And we do see many positive macro impact in our target market. For example, COVID-19 continues to boost online education needs over the world. And the digitization process in Southeast Asia continued to have a very positive impact on the online education demand in our target market. And we’re very confident that the overseas market is going to be very, very attractive for us.

And in addition, in terms of the online English training, we have a very — we kind of have a niche product, and we have very limited competition in many of our target markets. So our strategy is to continue to focus on our customer needs and satisfaction, which will in turn continue to drive the retention and referral, which are in — we believe are the key factors to drive our success in China market, and we believe it will do the same magic in the overseas market. Hopefully, this answers your question, Long.

Long Lin — The Benchmark Company — Analyst

Definitely. Thanks.

Jack Jiajia Huang — Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu — Chief Financial Officer

Okay. So, Jack will add a little bit information on the possibility. And if we look at the student advance, we know that we’re getting the cash first and then the revenue gets recognized after the lessons are consumed. So as a result, our business has a very unique pattern. If you look at our historical data, the company was established in 2011 and first achieved cash flow breakeven in 2016. That’s a five-year period. And then in 2018, we achieved gross billings contribution positive, that’s under two year. Then in 2019 Q4 we achieved GAAP profitability, and that’s about a year and a half. However, our pace of getting from the start of the business, going to cash flow breakeven, then go to gross billing contribution positive, then to GAAP probability will be much accelerated in overseas market compared to the China market. One of the key reasons is that because we’ve done this once, and we have the experience, we have the expertise, we know how to do it.

So, if you look at, even though we did our spinoff at the end of June, our reference date is end of April. So, from end of April to end of June, we’ve already seen that the overseas market cash flow has achieved breakeven. And it is very likely that Q3 — we’re going to target cash flow breakeven for Q3, too. So basically, right out of the gate, after only one year starting our overseas business, we already achieved cash flow breakeven. And we do see the timeline for achieving gross billing contribution positive and GAAP profitability will be much more accelerated compared to the China market.

Long Lin — The Benchmark Company — Analyst

Thank you. That’s very helpful. I will jump back in the queue. Thanks.

Min Xu — Chief Financial Officer

All right. Thank you.

Operator

[Operator Instructions] As we are reaching the end of our conference call, I’d like to turn the call back over to the company for closing remarks. Ms. Ni Yan, please go ahead.

Ni Yan — Investor Relations

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.

Operator

[Operator Closing Remarks]