Hello, ladies and gentlemen, thank you for standing by for China Online Education Group's Fourth Quarter 2021 Earnings Conference Call. At this time, all participants are in listen-only mode. Today's conference is being recorded.

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

Ni Yan - Investor Relations

Hello everyone, and welcome to the fourth 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 financials of Company's distribution list within the IR section of our website at ir.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, Mr. Liming Zhang, our Chief Operating Officer will also try to come for our Q&A session.

Before we continue, please note that today's discussion will contain forward-looking statements made under the Safe Harbor Provision of the US 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 accepted with US 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 51Talk's earnings press release and its conference call include discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. 51Talk's press release consist of 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. Hello, everyone. Thank you for joining our conference call. In response to the changes in the government regulations related to After-School Tutoring, we have taken measures to restructure our business, so that the Company's 2022 strategy were clearly focused on overseas business. In the fourth quarter, overseas business net gross billings have reached $2.9 million, more than triple Q3 net gross billings. As the overseas business momentum continues to build, we have extended our product offerings to students in more than 50 countries and regions outside Mainland China. We have been able to leverage our strength for high quality teacher resources, interactive curriculum and advanced technology platform to quickly establish our presence in the new markets.

We will stick with our proven business model which balances growth with profitability and were proven in Mainland China market. We are excited for exploring opportunities in overseas markets which allow our Filipino teachers to help more students in the world to be able to talk to the world. In order to comply with applicable laws and regulations and allow our listing company to focus on the overseas business, I have sent a proposal to our board to acquire the Company's Mainland China business. Meanwhile, I will continue to lead our listing company as the Chairman of the Board and the CEO to drive the growth in the overseas markets. And the Board has formed a special committee to evaluate my proposal.

With that, I will now turn the call to our CFO, Xu Min.

Min Xu - Chief Financial Officer

Thank you, Jack. Hello everyone. We concluded 2021 with RMB2.2 billion revenue, a 5.5% increase from last year. Non-GAAP net income for 2021 was RMB133 million, representing a non-GAAP net margin of 6.1%. We have streamlined our operations to meet our smaller scale. As a result, the fourth quarter operating expenses were RMB321 million, representing 30% decrease from the second quarter. Net revenues for Q3 and Q4 of 2021 were RMB574 million and RMB413 million respectively, representing a sequential decline of 1% and 28%. The number of active students with attended lesson consumption in Q4 was 299,000, a 20% sequential decline from 376,000 for Q3. Gross margin for Q3 and Q4 was 73.5% and 78.6% respectively.

Non-GAAP operating expenses as a percentage of net revenue was 63% in Q3 and 77% in Q4. Non-GAAP sales and marketing expenses for Q3 were RMB191 million, down 39% sequentially. Non-GAAP sales and marketing expenses for Q4 were RMB235 million, among which RMB124 million were due to deferred sales and marketing expenses write-off. Excluding the write-off, Q4 non-GAAP sales and marketing expenses would have been RMB111 million, down 42% sequentially. Non-GAAP product development expenses for Q3 were RMB39 million, down 38% sequentially. Non-GAAP product development expenses for Q4 were RMB16 million, down 60% sequentially. Non-GAAP G&A expenses for Q3 were RMB101 million, among which RMB51 million was restructuring cost. Excluding the restructuring cost, Q3 G&A expenses would have been RMB50 million, down 34% sequentially. Non-GAAP G&A expenses for Q4 were RMB67 million, among which RMB22 million was restructuring cost. Excluding the restructuring costs, Q4 G&A expenses would have been RMB45 million, down 10% sequentially.

Q3 impairment loss of RMB31.8 million was due to goodwill and intangible asset write-off related to acquisitions. Other income for Q3 was due to RMB6.0 million super deduction credit. Q4 impairment loss of RMB0.4 million was due to intangible asset write-off related to employee performance evaluation system. Other income for Q4 was due to RMB0.6 million super deduction of credit. Non-GAAP operating income was RMB64 million in Q3 and RMB7 million in Q4, representing 11% and 2% operating margin, respectively. Interest income for the third quarter of 2021 was negative RMB7 million due to RMB15 million reversal of interest income accrual from the time deposit early withdrawal, partially offset by interest income of RMB8 million. Other income for Q4 was RMB8 million, mainly due to government subsidy. Non-GAAP net income was RMB79 million in Q3 and RMB55 million in Q4, representing 14% and 13% net margin respectively. Non-GAAP diluted EPS was RMB0.23 in Q3 and RMB0.16 in Q4.

Company's total cash, cash equivalents, time deposits and the short-term investments were RMB1.3 billion at the end of Q3 and there was no restricted cash. The company's total cash, cash equivalents, time deposits, short-term investments and restricted cash were RMB0.99 billion at the end of Q4 and among which RMB50.6 million were restricted cash, which was advances from students under the government supervision. Advances from students were RMB2.3 billion at the end of Q3 and RMB1.8 billion at the end of Q4. The gap between advances from students and the cash balance has decreased from RMB1,052 million in Q2 to RMB997 million in Q3 and then to RMB775 million in Q4.

For more of our 2021 full year and Q3, Q4 results, please refer to our earnings press release.

Looking forward to the first quarter of 2022, we currently expect the net gross billing of overseas business to be between $4.4 million and $4.6 million, representing sequential growth between 52% to 59%. The above outlook is based on our current market condition and reflects the company's current and preliminary estimate 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 & Answers

Operator

[Operator Instructions] And we will take the first question from Long Lin from the Benchmark Company.

Min Xu - Chief Financial Officer

Hello Long. We cannot hear you. You might be muted.

Long Lin - Benchmark Company - Analyst

Hi, sorry. Can you hear me now?

Operator

Yeah.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

Yes.

Long Lin - Benchmark Company - Analyst

Hi, thank you for taking my questions. So my question is about your overseas business. Just wanted to get a sense of the growth potential for the overseas expansion and where do you see your key markets and how conduct is these markets for your services.

Min Xu - Chief Financial Officer

So I'll take this question. Hey Jack, you want to take this question?

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

Okay.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

Okay. Yeah. Thank you for the questions. So we are very positive on the potential of our overseas market. We've done a lot of work and we see this market size is huge. And in addition, the overseas market is actually very similar to Chinese market and we look at the global market - in 2022, our focus will be in Southeast Asia and in this country are actually very, very similar to China in terms of English education demand, especially K12 English education demand.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

So there is another very crucial factor that the COVID-19 continue to drive the demand for online education in Southeast Asia, very similar to what was happening in China in 2020 and we see the penetration of online education increase dramatically and we started our overseas spin in Q3 2021 and already we are able to achieve $2.9 million gross billing in Q4, which more than tripled the gross billing in Q3 and we also gave the guidance for Q1, which represent a more than 50% sequential increase.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

And we see online English education to be probably the largest segment in terms of our online language learning and we see very limited competition in this target market in Southeast Asia. This also give us a lot of confidence that we can quickly drive our overseas market.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

And also our business model has been well proven in the Chinese market in the past few years. We were able to achieve very balanced sustainable growth in the past few years and with that expertise and know-how, we believe we can transfer that knowledge to overseas market and to be one of the leading brand in terms of online English education.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

I hope this answers your question. Thank you.

Long Lin - Benchmark Company - Analyst

Okay, thank you. So just a follow-up. So for your key markets, what are the competition regulation risk like in those markets and how do you [Indecipherable] in those markets.

Min Xu - Chief Financial Officer

So I'll take the first question, I'll let Jack take the second part. So, so far we have not yet identified any regulatory risk in the markets where we're active. Right now, we have paying students actually from more than 50 countries and regions outside of Mainland China. So this kind of a geographic diversification also helps to mitigate the impact from any potential regulatory risk in any specific region.

So Jack, can you talk about brand building?

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

Yeah. In terms of branding, we always believe that good product and good service is actually the key driver for good reputation. Luckily, we have already tested our product and service in Chinese market for the past decade and we have the most interactive curriculum that needs our customers demand and our curriculum is also designed according to the European standard, CFR. And with this kind of very advanced technology platform, interactive curriculum as well as high quality service, we have been very successful in China in the past decade and we believe in terms of customer demand in English learning as a second language, the demand is very similar in Southeast Asia markets versus in China. And so we're very confident that as we continue to improve our product, service and we will have an advantage in those markets.

And the second part of the brand building is actually localization and we understand it is very important to a good localization job in our key market and we are putting resources on this, try to to drive our branding in our initial key markets.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

Thank you.

Long Lin - Benchmark Company - Analyst

Okay, thank you. So my second question is about the cost structure for the international business compared with China business. So can management also provide an outlook for the Company's profitability this year. Also you just mentioned about localization, which is a key part of your [Indecipherable] how will that impact your cost going forward.

Min Xu - Chief Financial Officer

Sure. I'll take the question. So actually if you look at in terms of business model, the steady state cost structure of overseas business is very similar to our current business in Mainland China. So we believe the gross margins are both above 70% and also the target ratio as a percentage of gross billings is also 50% for sales and marketing and below 10% for G&A and R&D. Obviously, we need to reach a certain scale to reach that kind of cost structure target. So if we can grow at a moderate pace, we are likely that we can achieve positive cash flow [Technical Issues] for us is that we do not make major localization work on our core product, which is the part of teaching English and we do not need to make major work on curriculum nor technology platform. The only localization work we need to do is the sales and marketing part. So any customer interfaces that related to sales and marketing, we need to do that. And in terms of core product curriculum and technology firm, there are some localization work, but it is very light. So we do not expect this to change our target for the research and development expense ratio.

Jack Jiajia Huang - Founder, Chairman and Chief Executive Officer

[Foreign Speech]

Min Xu - Chief Financial Officer

Yeah. So just want to add one more point is that English learning is our core product and we are actually having a good advantage is that we have more than 30,000 Filipino teachers and the Filipino teachers is the reason that students have very good learning experience and very good learning experience and also we can achieve very good margin. And so in terms of - because of our advantages in the teacher resources and also because Filipino teachers, we are actually more international than many other Chinese companies and that's the reason why we are able to make good progress in terms of the transition and to quickly move our strategy and the focus from domestic business to overseas markets.

Long Lin - Benchmark Company - Analyst

Thank you. That's all my questions for now. I will get back to queue.

Min Xu - Chief Financial Officer

Thank you, Long.

Operator

[Operator Instructions] We will now take the next question from Boris Suvorov from Bova. Please go ahead, your line is open.

Boris Suvorov - Bova LLC - Analyst

Hello and thanks for taking my question. My question is about distribution of assets and liabilities between Mainland China and Non-Mainland China students. I see that as of last report is about $151 million in current assets. What percentage of those current assets are for Mainland China.

Min Xu - Chief Financial Officer

I'll take this question. Yes. So I'll take this question. So right now, there is just no clear-cut of liability and assets between the Mainland China part and overseas market part. So once the Board has made evaluation and in terms of the value of both business, we still need to split the overhead. So however, this, one principal we will look at in terms of splitting these two part of business is that we will always make sure the overseas business, we have positive net equities, which means in principal, we will keep more cash than the gross billings or deferred revenues from the overseas students.

And in terms of domestic business, as I mentioned earlier that there always has been a huge gap between the advance from students versus the cash. And so after that we believe once we split these two businesses, our domestic domestic business will keep that way. However, going forward all these advances from students will be consumed and turned into profit. So this is why we are confident that by splitting domestic business and overseas business, we allow a very clean balance sheet for overseas business, allow it to grow on its own trajectory, and at the same time for the domestic business, we can focus on our students to make sure all these lesson credits will be consumed and our students will learn and improve.

Boris Suvorov - Bova LLC - Analyst

Thank you very much. And as a follow-up, similar question. If the company will be split and Non-Mainland China and Mainland China, what about product development expense and general and admin. In terms of staffing, do you see any deduction of costs, split of cost between two companies or most of engineers and general admin staff team is Non-Mainland China company.

Min Xu - Chief Financial Officer

Yes. So we will split our staff in terms of G&A and R&D. And so obviously anything related to public company will stay with the public company and most of the pattern and IP will go to the public company and we believe like [Indecipherable] have a very, very small G&A and R&D team. So roughly, it will be probably 50-50, half of the staff will stay with the domestic business and half of the staff will stay with the public company, focusing on overseas market.

Boris Suvorov - Bova LLC - Analyst

Thank you.

Min Xu - Chief Financial Officer

All right.

Operator

There are no further questions at the moment. [Operator Instructions] And we have a follow-up question from Long Lin from The Benchmark Company. Please go ahead, your line is open.

Long Lin - Benchmark Company - Analyst

Hi, yes. Yeah, I have a follow-up on your overseas business. So just want to see the company need any additional capital to fund the overseas expansion.

Min Xu - Chief Financial Officer

I'll take this question. Currently, we do not need additional capital to fund overseas business growth. So the cash balance on our overseas bank accounts are sufficient to drive our growth by the time we turn cash flow positive, which I said earlier, we believe this could happen in 2023.

Long Lin - Benchmark Company - Analyst

Okay, got it. Thank you.

Operator

And we have no further questions. So I would like to turn the call back to the Company for closing remarks. Mrs. 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 Investor Relations through the contact information provided on our website.

Min Xu - Chief Financial Officer

Thank you, everyone.

Operator

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51TALK ONLINE EDUCATION GROUP

Q4 2021

Earnings Transcript

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