17 Education & Technology Group Inc. (YQ) Q1 2021 Earnings Call Transcript

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17 Education & Technology Group Inc. (YQ 5.36%)
Q1 2021 Earnings Call
May 24, 2021, 9:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good evening and good morning, ladies and gentlemen, and thank you for standing by for 17EdTech's first-quarter 2021 earnings conference call. At this time, all participants are in listen-only mode. After the management's prepared remarks, there will be a question-and-answer session. As a reminder, this conference call is being recorded.

I will now turn the meeting over to your host for today's call, Mr. Raymond Huang, 17EdTech's investor relations director. Please proceed, Raymond.

Raymond Huang -- Investor Relations Director

Thank you, operator. Hello, everyone, and thank you for joining us today. Our earnings release was distributed earlier today and is available on our IR website. On the call with me today are Mr.

Andy Chang Liu, founder, chairman, and the chief executive officer; and Mr. Michael Chao Du, director and chief financial officer. Andy will walk you through our latest business performance and strategies, followed by Michael, who will discuss our financial performance and guidance. They will be available to answer your questions during the Q&A session after their prepared remarks.

Before we begin, I'd like to remind you that this conference call contains forward-looking statements as defined in Section 20E of the Securities Exchange Act of 1934 and the U.S. Private Security Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and current market and operating conditions and relate 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. This risk may cause the company's actual results, performance, or achievements to differ materially.

Further information regarding this and other risks, uncertainties, and factors is included in the company's filings with the U.S. SEC. The company does not undertake any obligation to update any forward-looking statements as a result of new information, future events, or otherwise, except as required under applicable law. It is now my pleasure to introduce our chairman and the chief executive officer, Andy.

Please go ahead.

Andy Chang Liu -- Founder, Chairman, and Chief Executive Officer

Thank you, Raymond. Hello, everyone. Thank you for joining us for our first-quarter earnings call. We had another quarter of robust top-line growth.

Net revenues increased by 107% year over year to RMB 474.2 million, which exceeded the high end of our guidance by RMB 2.2 million – 274.2 million. For the past quarter, our MAUs of in-school applications for students demonstrated strong resilience among the latest changes in regular environment. Average MAUs of in-school applications for students for the first quarter only decreased by 5.5% year over year to 18.9 million. MAUs of in-school applications for students in March decreased by 21.3% year over year to 18.6 million.

If you compare student MAUs in March 2021, which was the first month of the 2021 spring semester, with student MAUs in semester 2020, which was the first month of the 2024 semester, it only decreased by 8%. The decline in March was partially a result of high-level student MAUs in March 2020 as a result of COVID-19 pandemic. While the students were encouraged to use more tools like ours to continue the study at home, there were concerns in the market about the regular environment since the start of the year. We are closely monitoring the policy changes very carefully.

From in-school perspective, we saw policies regulating digital homework moderating over the last few months from the initial notice on strengthening cellphone management in primary and the secondary schools published on January 18th that strictly limits cellphone use and prohibits assigning homework on cellphone to a more gentle five-year working plan published on April 28 step test not to rely on digital products to assign homework. We also see further notices promoting using various information technology measures to diagnose student's homework in the notice on student's homework management published on April 8th. We clearly see there are still strong demand for schools and government to use technology, to improve in-school learning experience and efficiency in various areas, including homework. We are still confident that the room for growth of our in-school applications for students remain strong in the next few years.

2021 marks the 10th anniversary of our company. We reflected on what we set out to do, have thus updated our vision based on the latest trends in education. Over the past decade, driven by our mission to make learning beautiful, we started helping primary school students to practice their English listening and speaking skills with technology. We rapidly expanded our services to a full range of education scenario across subjects and grades, including class preparation, class delivery, homework-related activities, and academic assessment.

Three years ago, we launched our online after-school tutoring business to further enhance up the learning experience for our users. As our business continues to grow, our vision crystallized that it's through integrating in-school and after-school scenarios we become a platform that delivers high-quality education driven by technology and artisan spirit. We believe that with our technology and insight into students' in-school learning progress, we are well-positioned to help Chinese hundreds of thousands of public schools to improve the learning experience efficiency for their students. We believe these only improvements within the public schools can finally bring about industrywide reform that can truly alleviate the burden on students and parents.

So what defines a beautiful learning experience? What should ideal education look like? Our understanding of this improved as our business and understanding of our user group, true high-quality education should satisfy through three keywords: equality, personalization, and the ability-oriented. From 1977 to 2021, China's education system has made tremendous achievements. Three key factors remain to be improved after past 45 years: equality, personalization, and ability-oriented education. First, equality.

Generally speaking, China has achieved a lot in delivering basic education to almost all Chinese citizens, a first step in equality. For the next few decades, the focus will be on how to provide equal access to quality education. In the past, and likely over the next decade ago, lower-tier cities will still strive for improvement in the equality education resources, especially content and teachers. Based on the current status in Chinese education system, the most feasible solution to the equal distribution of educational resources is by leveraging high-quality educational content and technology rather than just relying on teachers.

There are needs for companies to enter China's hundreds and thousands of schools to provide tailor-made, high-quality educational content for every teacher so that teachers can teach, and students can learn more effectively and efficiently. I believe that this would probably be the most practical way to narrow the resource gap in education between lower city and top-tier cities. With the clearly world high-quality content can bring to educational equality, we have been and will continue to invest in our in-school business, content, and technology. This is not limited to content related to homework assignments -- homework activity but also covers areas like class preparation, class delivery, and academic assessment.

The second keyword is personalization. Public schools will still continue to play a dominant role in China's education system. Large classes with more than 40 or even 50 students will remain the cases at most public schools. There is still a long way to go before the class size of public schools in China will be reduced to around 20 students.

Personalized education for more effective and efficient students will be difficult on this such a situation without the health of technology. Evaluation is one of the most important stepping stone to achieve higher levels of personalized education. Last year, tens of million students in China completed academic assessment on our platform. Please note that what I referred to was not homework, but academic assessment.

In the future, more and more formative data will increasingly replace summative data to generate a more comprehensive profile of the learning progress of each student where the evaluation of a students' academic performance will be less reliant on a single exam, but all his or her performance along the way. With these profiles, public school teachers, as well as instructors and tutors on our online large classes can better serve students in a personalized way. The provision of targeted learning recommendations and tutoring-based on thorough and accurate understanding of each student's learning progress and weakness are the key to personalized education. This is also what we are striving for to achieve with our investment in technology and products under our integrated model.

Ability-oriented education is the third thing that will help make learning beautiful. Despite limitations exist, we are pleased to see that the Zhongkao and Gaokao reforms have made a lot of progress over the years as modules designed to measure the capability and personal development of students were introduced. For example, listening tests were introduced as a new session for English test across China. Oral tests were introduced at a lot of other settings.

Reading has become more and more important in Chinese tests and problem-solving and application of math formulas in daily life scenarios have become more and more important in math test. Going forward, tests designed to access students' real-world capabilities will for sure take up greater weight of the Zhongkao and Gaokao exams. China will, for sure, make major progress in its basic education system over the next 10 years with the assistance of Internet, technology, content, and data. Over the next decade, our company will have huge growth opportunity if we can: first, leverage technology and precisely recommend content tailored to the needs of teachers and students in both in-school and after-school sectors, and help narrow the gap for educational resources; second, facilitate personalized education through comprehensive and educate -- accurate student assessment; third, meet the underlying need for ability-oriented education and all-around personal development, which are the emerging trends in modern education.

Next, I would like to talk about how I can see the education industry in the longer run. There have been a lot of attention around potential regulatory policies on the education sector. The online classroom and online education measured in the 14th five-year plan are not limited to online school, but also include the digitalization of various in-school education scenario. The education authorities also rolled out a series of supporting policies on online education, online homework, and personalized homework.

For example, in the Opinions on Strengthening the Construction and Application of Online Education Resources in Primary and Secondary Schools, [Foreign language], and the Notice of Strengthening Homework Management in Schools and Compulsory Education [Foreign language], the government introduced new requirements to leverage technology to make in-school teachings more efficient and tailored to the needs of students. In the Guideline on Curbing Myopia among School Children [Foreign language] issued on April 28, the authorities also take an approach to allow our teaching time using digital products, which should be less than 30% of total teaching time. We believe these policies will benefit the industry in the long run and support orderly, healthy, and sustainable growth. It is also clear that the education authorities now have a clear vision about the current situation and the future direction of the education system.

China has also included in its 14th five-year plan a long-term goal of becoming a strong country in education by 2035. Guided by our vision, we believe that we can support the government's efforts to improve education. We aim to improve the learning experience for students, address the challenges of education inequality, tailor education to meet students' individual educational needs, and stimulate students to pursue all-around development through ability-oriented education. Ultimately, education is to serve students, whether it's done in-school or after-school, whether it's delivered by teachers, instructors, or by tutors after school, and whether it is conducted online or offline.

Only by improving the learning efficiency and truly alleviating the burden on students and parents, can we maximize the effectiveness and efficiency of education. We believe that the best approach is to truly connect in-school and after-school learning, identify the problems that arise in school, and solve them in-school and after-school in a more personalized manner. Our tutors nowadays are able to see the in-school learning data of students, understand their weak points and access premium localized educational content in various regions in China. The premium localized content and unique insights into the learning progress of students are a huge value brought to students by the in-school and after-school integrated model.

Our next priority is to deepen these functions and to cover more students and regions. This is the rationale behind our integrated model. The essence of integrated model is not just the low customer acquisition cost, but to leverage our integration of in-school and after-school operations technology and data in after-school tutoring to address the issues identified in school in a more personalized way so that eventually, we can help students improve their academic performance in an effective way, efficiently, and alleviate their burden. No matter it's in-school and after-school products and services, we will always focus on creating value for our users.

This is the only way for us to develop the leading products and maintain our leading position in both in-school and after-school market and become a great company. Now, I will turn the call over to Michael, our CFO, to walk you through our latest financial performance. Thank you.

Michael Chao Du -- Director and Chief Financial Officer

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'm going to talk about will be presented in RMB terms. I'm here to report strong results for the first quarter of 2021.

We have achieved strong top-line growth. Net revenues increased by 107% year over year to RMB 474 million in the first quarter of 2021, exceeding the high end of our guidance by around RMB 4.2 million. Net revenues from online K-12 tutoring services increased by 118% to RMB 463 million in the first quarter of 2021. Before I review our first-quarter financials in details, I would like to remind everyone about our seasonality in our quarterly financial performance that we have shared in early quarters.

The first and third quarters tend to incur higher amount of sales and marketing expenses as these two quarters include summer and winter holidays, where large scale of promotional deposits take place and thus associated with promotional -- associate promotional cost expenses are accounted. The corresponding major increase in revenue, however, will only be primarily reflected in the second and fourth quarter. Thus, we typically record relatively lower quarter-to-quarter revenue growth rates with higher selling and marketing expenses in the first and third quarter, leading to larger losses in such quarters. And in the second and fourth quarters, the quarter-over-quarter revenue growth is much higher while incurring lower sales and marketing expenses, leading to lower loss ratios in such quarters.

Thus, internally, we typically compare consecutive first and third quarter together, while second and fourth quarter versus each other to see the trends given the seasonality. During this past winter vacation, we have successfully managed our promotional course strategy and efficiency. We saw our operations achieving high growth while controlling -- while the new student acquisition expense were controlled relatively well. Our overall operational efficiency continued to improve as we scaled up after taking into consideration seasonality.

The number of full-priced students converted during the winter conversion cycle increased significantly, which was more than double the number in the winter 2020 and around 30% more than the summer 2020 despite industry competition. This was reflected in our paid course enrollments, which were primarily new paid course enrollments converted during the winter 2021 conversion cycle. Our paid course enrollment in the first quarter increased year over year to 543,000. This was all achieved while our new enrollment CAC remained relatively stable and increased only by around 10% when compared to December 2020, our rate significantly lower than the industry average.

We believe this demonstrates the significant benefit and the edge of our integrated model. The gross billing of our online K-12 tutoring services in the first-quarter 2021 were RMB 603 million, representing a year-over-year increase of 126% from RMB 267 million in the first quarter of 2020. From a revenue recognition perspective, we would like to point out that net revenues from the online K-12 tutoring services in the first quarter of 2021 would have been slightly higher, but the revenue recognition schedule was delayed by late Chinese New Year in 2021, which led to a one-week delay in the company's spring semester course starting date. And there's a whole week less of revenue recognized in March 2021 as compared with year 2020.

But such revenue will be recognized in the second quarter in 2021. The company would also like to note that such variation in course starting dates and a recognition schedule are likely to happen over the years. Now, we go through our first-quarter financials in greater detail. In addition to the revenue and paid course enrollment information I shared earlier, our cost of revenue were RMB 188 million, representing an increase of 128% year-over-year increase from the first-quarter 2020.

The increase was primarily due to the increase in compensation costs for instructors and tutors, and teaching material costs, which increase was largely in line with the growth of our net revenue from online K-12 tutoring services during the same period as we will provide services to more students. The increase in the compensation costs for instructors in tutors was also partially increased because we hired more tutors to prepare for the expected increase in enrollments in 2020 -- sorry, 2021 spring semester. Gross profit was RMB 283 million, representing a year-over-year increase of 95% from the first quarter of 2020. The increase was primarily driven by the increase in net revenue.

Our gross margin was 60.4%, compared to 64.1% in the first quarter of 2020, and the decrease was attributed to us hiring more tutors to prepare for the spring semesters. Moving on to the expense side. Our total operating expenses were RMB 953 million, including RMB 71 million of share-based compensation expenses. And this represents a year-over-year increase of 154% from RMB 375 million in the first quarter of 2020.

Total operating expenses as a percentage of net revenue increased to 201% from 164% in the first quarter of 2020. Selling and marketing expenses were RMB 614 million, including RMB 5 million of share-based compensation expenses. This represents a year-over-year increase of 218% from RMB 193 million in the first quarter of 2020. This increase was primarily due to the increase in promotional course expenses and salaries and welfare for sales and marketing personnel, as well as branding-related activities.

This was consistent with the fact that the number of new students converted in winter 2021 more than doubled what was converted in the winter 2020. R&D expenses were RMB 210 million, representing a year-over-year increase of 58%. This was primarily due to an increase in salary for research and development personnel. Our R&D expenses included an RMB 11 million of share-based compensation.

Our G&A expenses were RMB 130 million, representing a year-over-year increase of 165% from the first quarter of 2020 primarily due to an increase in salaries and welfare for G&A personnel and also including increases in share-based compensation expenses. Our loss of our operations was RMB 667 million, compared with RMB 228 million in the first quarter of 2020. The loss ratios as a percentage of net revenues was negative 148% -- 141%. Our net loss was RMB 660 million in the first quarter of 2020.

Our non-GAAP adjusted net loss was RMB 589 million in the first quarter of 2021. Our non-GAAP adjusted net percentage of net revenue was negative 124%, compared with negative 78% in the first quarter in 2020. As of March 31, 2021, our cash and cash equivalents were RMB 2.2 billion. And finally, deferred revenue was RMB 723 million, representing an increase of 21% from RMB 598 million as of December 31, 2020.

The increase was primarily attributable to our rapid business growth. We generally -- and thus, our deferred revenue continued to grow as we convert more students. With that, I will now provide our business outlook. Based on current estimates, total revenue for the second quarter of 2021 are expected to be between RMB 640 million and RMB 660 million, representing a year-over-year increase of 136% to 143% from the second quarter of 2020.

These estimates represent our current and preliminary view which are subject to change. With that, we conclude our prepared remarks. Thank you. Operator, we are now ready to begin the Q&A session.

Thanks.

Questions & Answers:

Operator

[Operator instructions] Your first question comes from the line of Sheng Zhong from Morgan Stanley. Please ask your question.

Sheng Zhong -- Morgan Stanley -- Analyst

Hey, good morning. Thank you for taking the question. So we understand that your after-school tutoring students, meaning from your in-school service MAU conversion and also your offline operation, I mean, on the student acquisition perspective. While we see some regulatory -- regulation that is tightening the advertisement, customer acquisition for online companies.

And also, we see many online companies, online education companies are doing the offline customer acquisition exploration. So I want to -- can you please share your insight or share some color of your current customer acquisition efficiency from the MAU conversion from the offline? And do you see any TAC change recently? And you also mentioned that MAU was largely flat because of high base last year, so what's your outlook for the MAU in next one to two years?

Michael Chao Du -- Director and Chief Financial Officer

I'll try to answer your question by question. So first, in terms of your overall question about latest efficiency, both be it as a result of the regulatory environment change or other institutions attempting to do off-line explorations, I think overall, we usually have larger conversion cycles in winter and the summer, but much smaller cycles during the spring and for semesters. So during the spring conversion cycles, so far, we don't see any major change in terms of efficiencies, or as you said, how we are able to get as sign-ups from MAUs. We don't see major change in those trends and as well as in CAC when you are talking about immediate impact from the regulatory change or others are participating in offline exploration.

But the one thing we are happy to see is actually, the latest trend is basically proving the benefits of integral model where we believe more and more people will actually be leveraging. We'll be trying to recognize and to improve the teaching, as well as conversion efficiencies through our off-line presence.

Andy Chang Liu -- Founder, Chairman, and Chief Executive Officer

In addition, first, the integrated model that you have to have the good product, just with the good product to serve the teachers and students and parents. That means you have the opportunity to serve the parents. And with serving the parents, you can get the user for paid for enrollment. So I don't think it's easy for the competitor to build up the content, data, and the product because it took almost 10 years do that.

So that means for our CAC for this semester will not change and maybe even lower than before just because our efficiency has become higher and higher. And third, just because the Chinese government wants to improve the in-school teaching, in-school learning, and with that, we can persuade all the parents to reduce their burden for up to school tutoring. That means we will more and more rely on our in-school product to improve the teaching efficiency. They will more and more use our former assessment to make the tasks to finish for in school.

So that means I still think we have a bit opportunity to improve the MAUs in the future.

Operator

Your next question comes from the line of Timothy Zhao from Goldman Sachs. Please ask your question.

Timothy Zhao -- Goldman Sachs -- Analyst

Hi, Michael. Thanks for the presentation and taking my questions. I have two questions here. One is you shared a lot of good reason about utilization of the in-school education scenario.

Could you provide some provide up with some color on your potential monetization model in the in-school business? And could you give us some update on the progress of your content localization? And secondly, regarding the regulatory requirements from the Beijing government on creation, collection, and security. Could you share us what is the latest requirements that you have so far? And how will this requirement impact your operating cash flow, if any?

Andy Chang Liu -- Founder, Chairman, and Chief Executive Officer

Yeah. Timothy, I just want to clarify your first question. You were asking about any monetization plan for in-school operation.

Timothy Zhao -- Goldman Sachs -- Analyst

Right.

Andy Chang Liu -- Founder, Chairman, and Chief Executive Officer

Yes. OK. Yes, I think our strategy in terms of China fees for in-school operations still remain the same that we will largely remain free within schools. I think that would be for our basic functions.

[Foreign language]

Michael Chao Du -- Director and Chief Financial Officer

Yes. We've seen that for the basic function within schools we have been free, but we've also seen multiple districts like the Xichuan district or Minhang -- Beijing and or Minhang district in Shanghai. They were paying for premium services and integrated projects for us at a price around RMB 10 million per year for each district, and we do see some of the districts will become the models for other subsequent cities as we roll out, and the demand for educational services within the schools will continue to rise. I hope this answers your first question.

The second question, yes, you're right. We've seen the notice from the Beijing government in terms of tuition collection, as well as deposit the relative funds and custodian bank. We are closely monitoring this. And we were also monitoring what's being likely to happen in Shanghai because you know we are registered in Shanghai and all the actual cash flow impact and all other impacts will be directly dependent on what's the actual policy is in Shanghai.

So far, we can only share that we will be preparing for any potential policies coming out in Shanghai. But at this stage, it will be difficult for us to speculate on what the actual policy will be in Shanghai.

Timothy Zhao -- Goldman Sachs -- Analyst

Thank you. That's very helpful.

Operator

[Operator instructions] There are no further questions at this time. I would like to hand the conference back to these presenters. Please continue.

Raymond Huang -- Investor Relations Director

Thank you, operator. In closing, on behalf of 17EdTech's management team, we'd like to thank you for your participation on today's call. If you require any further information, feel free to reach out to us directly. Thank you for joining us today.

That concludes the call.

Operator

[Operator signoff]

Duration: 38 minutes

Call participants:

Raymond Huang -- Investor Relations Director

Andy Chang Liu -- Founder, Chairman, and Chief Executive Officer

Michael Chao Du -- Director and Chief Financial Officer

Sheng Zhong -- Morgan Stanley -- Analyst

Timothy Zhao -- Goldman Sachs -- Analyst

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