17 Education & Technology Group Inc. (YQ) Q3 2021 Earnings Call Transcript

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17 Education & Technology Group Inc. (YQ 7.27%)
Q3 2021 Earnings Call
Jan 17, 2022, 8:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good evening and good morning, ladies and gentlemen. Thank you for standing by for 17EdTech's third quarter 2021 earnings conference call. [Operator instructions] As a reminder, today's conference call is being recorded. I'll 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 -- Director of Investor Relations

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 the chief financial officer. Andy will walk you through our latest business performance and strategies, followed by Michael, who will discuss our financial performance. 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 20(e) of the Securities Exchange Act of 1934 and the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations and the 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 management's control.

These risks may cause the company's actual results, performance, or achievements to differ materially. Further information regarding these and other risks, uncertainties or 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 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 earnings call today. I would like to start with some updates of the company.

The company has ceased offering tutoring services related to academic subjects to students from kindergarten through the last year of senior high school in Mainland China by the end of 2021 to comply with the "Opinions on Further Alleviating the Burden of Homework and After-School Tutoring on Students in Compulsory Education," also known as the Double Reduction Policy, and applicable rules, regulations and measures. At the same time, we have quickly formed new business strategies in response to the new regulatory environment. Leveraging our extensive knowledge and expertise accumulated through serving China's education authorities, schools, teachers, and students over the past decade, we have adapted our business and organizations to focus on two key business areas. First, for our in-school business, we launched our new teaching and learning -- teaching and -- first, for our in-school business, we launched our new teaching and learning SaaS offerings as an upgrade to our previous in-school products and services.

The new offerings are aimed at facilitating the digital transformation and upgrade of Chinese schools with a focus on improving the efficiency and the effectiveness of core teaching and learning scenarios such as homework assignment and in-school teaching. Second, for our after-school business, we have started to offer a personalized self-directed learning product to Chinese families as a substitute for the original after-school tutoring services that we offered historically. The product utilizes our technology and data insights to provide personalized and targeted learning and exercise content that is aimed at improving students' learning efficiency. This is not a tutoring services and is consistent with some of the key concepts and philosophies of one of the 10 case studies selected by the Ministry of Education's General Office for the implementation of the Opinion.

Now let me explain in detail the logic and the progress for our business transformation and how the two businesses fit the new era of China's education market and user needs both in in-school and after-school segments. On the in-school side, we are seeing three main themes driving the development of the industry. First, China's education informatization kicked off in 2012 when the government published the blueprint of the three accesses and two platforms. Under the initiative, the government took a lead to improve Internet infrastructure and build multimedia classrooms for schools.

By 2018, school network infrastructures for online or digital teaching were mostly in place. In the same year, the government released the work plan version 2.0 for education digitalization, which aims to achieve three full coverages, two improvements, and one platform. Since then, the focus of the education informatization market has shifted from education infrastructure to digital tools for teaching and school management as well as digital teaching resources to build an "Internet plus education" platform that is aimed at improving teaching result and efficiency. According to estimates based on numbers from National Bureau of Statistics of China, the annual budget for education digitalization reached RMB 340 billion in 2020.

Under the backdrop of education digitalization version 2.0, we believe the growth trajectory will continue in the next few years as China's GDP expands. Second, education informatization investments generally fall into two categories: one teaching and learning-related; and the other not. The first category includes hardware and software, which are directly used in teaching and learning processes, including teaching and learning management systems. A typical example is our homework management system that allows schools and teachers to evaluate and track students' mastery of different knowledge points through homework and assign personalized homework accordingly with the support of both hardware and software.

One of the two categories, investments in teaching and learning-related education informatization, are steadily taking up an increasing share in the annual budget. In earlier years, the purchase of nonteaching and learning hardware was the biggest component. Third, in recent years, we have also observed that teaching and learning-related digital products shifted away from smart classrooms and exam, marching toward homework-focused teaching and learning products. This was a result of a few key changes in the education philosophy and guidelines from the Ministry of Education.

First, the discouragement restriction on using exams and promotion of homework as the main tool to evaluate student's academic performance. Second, the need for an advanced information-based system to achieve the personalized and the tiered homework promoted under the Double Reduction Policy. Third, China's latest curriculum standard -- standards published in 2021, which is refreshed every 10 years, put more emphasis on students' comprehensive academic competency and the more proactive participation by students during class in the form of in-school -- in-class exercises. All of these would not have been possible with the historical manual approach and created a surge in demands for dedicated and comprehensive teaching and learning management systems centered around homework and exercises that integrate both hardware and software.

Homework has thus become an ideal scenario for evaluating students' learning progress and a core to connect all other teaching and learning scenarios and teaching management. Our teaching and learning products focus on homework assignments and can generate data that enables comparison between classes and schools for a selected time period. This makes it a very powerful tool for school principals to manage the teaching progress at school, and for education officials to check on the teaching management on district level. It also reduces the burden of both teachers and students as it is designed to improve the efficiency of homework assignments as related to teaching and learning scenarios.

This has opened up enormous business opportunities for us. For the technology, data insights, content and brand power we have gained through the past 10 years invested in homework development, we have been chosen by a number of regional education authorities to become a partner of choice of homework-focused teaching and learning management systems. There is one difference this time. In the past 10 years, we have provided more basic services on a free-of-charge basis.

Now on the new teaching and learning, SaaS offerings are paid products which integrates both software and hardware in one package and also feature data-driven recommendations and other value-added functions and cater to the needs of schools and education authorities. Purchases are mostly made by the district education authority on behalf of a group of schools. Our product offerings are based on tailored combination of a number of standardized modules covering classrooms, question bank, homework assignments, self-directed learning, and multi-role reporting to suit the needs of different users. We are also seeing increasing acceptance of the SaaS subscription model by governments instead of the more prominent onetime software construction projects, which was more common in nonteaching and learning-related investments.

To date, we have successfully entered in-depth cooperations with a number of regional education authorities across multiple districts in China, including Shanghai Minhang District and Beijing Xicheng District, which are among the 10 case studies selected by the Ministry of Education's General Office for the implementation of the Opinion. Projects of different scales are already being implemented using our teaching and learning SaaS products across more than 50 cities. Turning to our new business model for the after-school business. As we all know, Chinese families put strong emphasis on students' education.

Before the Double Reduction Policy, such emphasis and needs were mostly satisfied by after-school tutoring services, which created a huge market, some estimate it to be as large as RMB 1 trillion. The New Regulations have dramatically changed the supply and the nature of products in the education industry. Marginal demand in the market previously provoked by massive promotion campaigns were indeed discouraged by some degree. But we see needs from core user groups remain intact and deeply underserved with the highly affected tutoring services.

The good news is that such user needs tend to be more resilient. Due to the Double Reduction Policy, school vocations and weekends, which used to be the major battlefields for the after-school tutoring services, will, for the first time in decades, become family time in a vacuum of tutoring services. During this two-month break and all subsequent holiday and weekend periods, Chinese parents will be in urgent need for high-quality self-directed learning content to keep their children occupied. To address these needs, we started offering a personalized self-directed learning product to Chinese families.

This product is based on our premium contents and insights into students' learning progress and difficulties. It is designed with a core aim to be compliant with new regulatory environment. In a nutshell, it is a self-directed learning, Qiaohu-like product that supplements the in-school studies of primary and middle school students. Each month, our users will receive a material package consisting of customized exercises based on their personal academic profile, diversified learning tools, expanded learning videos, family education magazines.

The monthly package provides the basic materials and elements for parents to guide their children's learning program. The core component of our self-directed learning product is a personalized and targeted exercise book, formulated every month based on last month's learning progress and weakness. Which -- with our in-school business over the last decade, we have accumulated huge educational content and the school and district-level data insights across China, which give us a deep understanding about our users and the content of local exams so that we can develop personalized exercise books to meet their needs. In addition, we have designed a set of effective systems to motivate children to develop through self-directed learning habits.

In the meanwhile, we also allocate a personal learning partner to each of our users and provide them with learning customization and guiding services. Personal learning partners customize the learning materials and plans for our users on a monthly basis and follow-up with the implementation of their learning plans. Our self-directed learning product is charged for each subject. And the subscription fee for one subject is in the range of RMB 2,500 to RMB 3,000 per year.

We expect that it will take some time for the market to get familiar with this new product format. But we are happy to see more than 30,000 paid subscriptions in the product since we launched this product around a month ago. We believe that we have a strong competitive advantage with our new business models. This advantage comes from the millions of paid users who trust us, from the localized teaching content, massive data, brand recognition and the reputation we have built up over the past 10 years, providing free in-school homework services.

It is with the decade-long accumulation that's on the in-school side, we quickly launched the new teaching and learning SaaS offerings to provide personalized teaching assistance and the personalized self-directed learning products in the after-school business. This is our transformation strategy, which is based on what we believe can best leverage our decade-long experience and expertise in the in-school business. As the industry is undergoing tremendous transformation, the companies that comply with New Regulations and meet the changing user needs will emerge strong. 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. But before I begin, there's one number I would like to correct in the remarks from Andy is that the new paid subscription to our new after-school self-learning products over the last month is more than 300,000 new users instead of 30,000 users. So now I continue with our financial performance.

So please note that all the financial data I talk about will be presented in RMB terms. However, I would like to note that the publication and enforcement of the Opinion and applicable rules have significantly impacted our business, both in terms of slowing down our revenue growth as well as enlarging our losses. But subsequently, we have adopted a significant changes to our business model as shared by Andy earlier, and the online after-school tutoring services, which generated the vast majority of our revenue were ceased by the end of December 2021. Therefore, I would like to remind everyone that the quarterly results we presented here should be taken with great care, if you would like to use it as a reference for our potential future performance.

And the quarterly results are subject to significant impacts from one-off events due to the series of regulations introduced in the third quarter 2021 and corresponding adjustments to our business model, our organization and our workforce. Andy has shared that we have formed a clear, new business strategy for future growth and have made prompt adjustments to our organization to accommodate this strategy. The vast majority of the adjustment that's needed to our operations and workforce and the associated one-off expenses have taken place in the third quarter of 2021. We will be operating with a clear aim of quickly turning profitable in the near term.

As of September 30, 2021, our cash and cash equivalents were RMB 1.4 billion, or equivalent to USD 221 million. We believe we have sufficient capital to support the transformation of our business and to grow our new businesses. For the results of the third quarter of 2021, we achieved continuous top line growth despite the regulatory impact. Net revenue increased by 62% year over year to RMB 497 million in the third quarter of 2021 and increased by 103% year over year to RMB 1,642 million in the first nine months of 2021.

Net revenues from online K-12 tutoring services increased by 66% year over year to RMB 478 million in the third quarter of 2021 and increased by 113% year over year to around RMB 1.6 billion in the first nine months. The gross billing of online K-12 tutoring services, which is a non-GAAP measure, decreased by 35% year over year to RMB 302 million in the third quarter of 2021 and increased by 56% year over year to RMB 1.675 billion in the first nine months of 2021. The slowdown was primarily due to the impact of Double Reduction Policy during the summer vacations during the third quarter. Paid course enrollments decreased by 42% year over year to 226,000 in the third quarter of 2021 and increased by 67% year over year to the -- to 1,952,000 in the first nine months of 2021.

The decrease in the gross billings and paid course enrollments in the third quarter was primarily as a result of the adverse impact of the Double Reduction Policy introduced in July on new student acquisition. Average MAUs of in-school applications for students decreased by 30% year over year to 11.7 million in the third quarter of 2021 and decreased by 90% to 15.7 million in the first nine months of 2021. The year-over-year decrease in MAU was attributable to the publication and enforcement of the regulations. In addition to revenue growth, our operational efficiency continued to improve in the third quarter and the first nine months September of 2021.

Non-GAAP adjusted net loss, which excludes share-based compensation expenses, was RMB 457 million in the third quarter of 2021, compared with adjusted net loss of RMB 521 million in the third quarter of 2020. And it was RMB 1.26 billion in the first nine months of 2021, compared with RMB 849 million in the first nine months of 2020. Non-GAAP adjusted net loss as a percentage of net revenue was negative 91.9% in the third quarter of 2021, narrowed from negative 169.6% in the first -- in the third quarter of 2020, or was negative 77% for the first nine months of 2021, compared with negative 105.2% in the first nine months of 2020. Next, I will go through our third quarter financials in greater detail.

Net revenues were RMB 497 million, which represented a year-over-year increase of 62% from RMB 307 million in the third quarter 2020. The increase was primarily driven by an increase in the net revenues from online K-12 tutoring services. Net revenues from online K-12 tutoring services were RMB 478 million, up 66% year over year from RMB 288 million in the third quarter of 2020 and accounted for 96.1% of our total net revenues. The increase was primarily driven by an increase in paid course enrollments in the second quarter of 2021, as the corresponding revenues were recognized in the third quarter of 2021.

Paid course enrollments were 226,000, representing a decrease of 42% year over year from approximately 393,000 in the third quarter of 2020. Cost of revenue was RMB 251 million, which included severance costs for instructors and tutor workforce due to the impact of the New Regulations and representing an increase of 77% year over year from RMB 142 million in the third quarter of 2020. The increase was primarily due to the increases in compensation costs for instructors, tutors as well as -- which was largely in line with the growth of net revenues from our online K-12 tutoring services as we provided services to more students. Gross profit was RMB 245 million, representing a year-over-year increase of 49% from RMB 165 million in the third quarter of 2020.

The increase was primarily driven by the increase in net revenues. Gross margin was 49.4% compared with 53.8% in the third quarter of 2020. The decrease was attributable to the severance costs for reduction in staffing, which was recognized in the third quarter of 2021 as a result of the impact of the New Regulations. Moving over to the expenses side.

Total operating expenses were RMB 744 million, including RMB 33 million of share-based compensation expenses. This represents a year-over-year increase of 0.8% from RMB 738 million in the third quarter of 2020. Total operating expense as a percentage of revenue was 150%, significantly decreased from the 240% in the third quarter of 2020. Sales and marketing expenses were RMB 389 million, including RMB 7 million of share-based compensation expenses.

This represents a year-over-year decrease of 22% from RMB 496 million in the third quarter of 2020. The decrease was primarily due to the decrease in brand advertisement and promotional course expenses, which were partially offset by an increase in salary and welfare for sales and marketing personnel, including the severance costs for reduction of such personnel in the third quarter of 2021 due to the impact of New Regulations. R&D expenses were RMB 201 million, representing a year-over-year increase of 31% from RMB 154 million in the third quarter of 2020. The increase was primarily due to an increase in the severance costs for reduction in research and development personnel in the third quarter 2021 due to the impact of New Regulations.

The R&D expenses also included RMB 12 million of share-based compensation expenses. Our G&A expenses were RMB 123 million, which includes RMB 14 million of share-based compensation expenses. This represents a year-over-year increase of 38% from RMB 89 million in the third quarter of 2020. Again, the increase was primarily driven by the severance costs for a reduction of general and administrative personnel in the third quarter of 2021 due to the impact of the New Regulations.

There's an additional line in the report that impairments for property and equipment, right-of-use assets and rental deposits for the third quarter of 2021 were RMB 30.8 million compared with zero in the third quarter of 2020. As a result of the change in regulatory environment in the online education industry, combined with financial performance, we performed an impairment assessment on the long-term asset and recognized impairment losses in these items in the third quarter of 2021 as a result that we have vacated some of our tenancy. Loss from operations were RMB 498 million, compared with RMB 573 million in the third quarter of 2020. Loss from operations as a percentage of net revenues was negative 100.3%, compared with negative 186.5% in the third quarter of 2020.

This significant improvement on narrowing of losses was due to the improvement in the overall operational efficiencies despite the regulation change. Net loss was RMB 490 million, narrowing from RMB 581 million in the third quarter of 2020. Non-GAAP adjusted net loss was RMB 459 million, compared with RMB 521 million in the third quarter of last year. Non-GAAP adjusted net loss as a percentage of net revenues was negative 91.9%, narrowed from negative 169.6% in the third quarter of 2020.

As of September 30, 2021, cash and cash equivalents were RMB 1,422 million, compared with RMB 2,835 million as of December 31, 2020. We believe we have sufficient capital to support the transformation of our business and to grow our new business. And finally, deferred revenue was RMB 543 million as of September 30, 2021, representing a decrease of 9.3% from RMB 598 million as of December 31, 2020. The decrease was primarily attributed to the enforcement of Double Reduction Policy affecting the new student acquisition.

With that, it concludes our prepared remarks. Thank you. Operator, we are now ready to begin the Q&A session. Thanks.

Questions & Answers:

Operator

Thank you very much. [Operator instructions] We have questions from the line of Anthony Riera from Riera Holdings. Please ask your question.

Anthony Riera -- Riera Holdings -- Analyst

What are projected subscriptions year to date?

Michael Chao Du -- Director and Chief Financial Officer

Excuse me. Would you mind repeating your initial question? You mean what subscription year to date?

Anthony Riera -- Riera Holdings -- Analyst

Yes. What are the projected subscriptions year to date with the new software that's implemented? You mentioned you had 300,000 new subscriptions due to the new software that was launched?

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

Yes. We have 300,000. Michael, please answer the question, and I will explain it in detail.

Michael Chao Du -- Director and Chief Financial Officer

Yes. As we are still in the process of actually acquiring additional new users, we don't actually, at this stage -- we won't, at this stage, provide accurate annual forecast for the total number of subscribers. But we do have the confidence that this 300,000 actually came only through a one-month period during the winter vacation session. We do see the additional sessions such as during the summer vacation part where we will see other chances of acquiring new students.

So we do have the confidence that this number will continue to increase. However, it might be difficult for us to provide an accurate estimate for the whole year, especially this business is still in its early stage, but we do see a relatively high potential. 

Anthony Riera -- Riera Holdings -- Analyst

Excellent. Are those month to month? Or are those subscriptions with the year contract, the 300,000?

Michael Chao Du -- Director and Chief Financial Officer

That 300,000 is actually a combination of subscription of different lengths. Some of them -- the shortest are the quarter, but some are half years, and a small percentage of them are annual ones.

Anthony Riera -- Riera Holdings -- Analyst

Excellent. Thank you. 

Operator

[Operator instructions] We have a new question from the line of Barry Blank of J H Darbie & Co. Please go ahead.

Barry Blank -- JH Darbie and Company -- Analyst

OK. Thank you. I have several questions. The first question is when the price of the stock dropped precipitously low last time, you did a reverse split effectively by changing the number of ADRs.

Stock is approaching that level again. And I was wondering, are you planning to do that again because it was very detrimental to the price of the stock?

Michael Chao Du -- Director and Chief Financial Officer

We currently have no plan to do further reverse stock split.

Barry Blank -- JH Darbie and Company -- Analyst

OK. My next question is, with the transferring of a lot of Chinese equities to Hong Kong, do you believe that you'll be able to keep the equity listed in the United States? Or do you believe it will be transferred only to Hong Kong in the near future?

Michael Chao Du -- Director and Chief Financial Officer

We have been keeping a very close eye on the policy and also the regulatory environments in relation to SEC as well as U.S. listed environments. It's our current plan to continue to remain listed and be compliant with relevant rules and regulations from SEC. At this stage, we don't have any plan to migrate our listings from U.S.

to Hong Kong or have dual listing plan.

Barry Blank -- JH Darbie and Company -- Analyst

My next question is do you plan on doing any -- I guess they're called road shows. I mean any coming to the United States and talking to investors and meeting with them?

Michael Chao Du -- Director and Chief Financial Officer

We are trying our best trying to meet investors through webcast or online or video conferences. Physical traveling might be difficult given the COVID-19 scenarios around the world. Apologies for that.

Barry Blank -- JH Darbie and Company -- Analyst

OK. And my last question is, are you planning to have to sell any additional equity? Or do you have cash that will hold you for the foreseeable future?

Michael Chao Du -- Director and Chief Financial Officer

Yes. As we've shared earlier, by the -- as of September 30, 2021, our cash and cash equivalents were around RMB 1.4 billion or around USD 220 million. And as we also shared earlier that we have tried to -- we have completed the vast majority of our adjustment to our business model, our organization, our workforce, including large one-off expenses in the third quarter, which is this quarter, this financial results. And we do have a plan to significantly increase the health, financial health, and profitability of our business, aiming to quickly turning profitable or breaking even in the near future.

So with that amount of cash and a more -- a higher -- a more stringent control over our financial health, we do have confidence that the existing cash balance will be sufficient for the transformation of our business. And therefore, at this stage, we don't have any plan to raise additional equity.

Operator

[Operator signoff]

Duration: 38 minutes

Call participants:

Raymond Huang -- Director of Investor Relations

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

Michael Chao Du -- Director and Chief Financial Officer

Anthony Riera -- Riera Holdings -- Analyst

Barry Blank -- JH Darbie and Company -- Analyst

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