Hello, ladies and gentlemen. Thank you for standing by for China Online Education Group's third quarter 2019 earnings conference call. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded.I will now turn the call over to your host, Ms. Judy Piao, Investor Relations for the company. Please go ahead, Judy.

Hello, everyone. And welcome to the third quarter earnings conference call of China Online Education Group, also known as 51Talk. The company's results were issued via newswire services earlier today and are posted online. You can download the earnings press release and sign up for the company's distribution list by visiting the IR section of its website at ir.51talk.com.Mr. Jack Huang, our Chief Executive Officer, and Mr. Min Xu, our CFO, will begin with some prepared remarks. Following the prepared remarks, Mr. Liming Zhang, our Chief Operating Officer, will also join the call for our Q&A session.Before we continue, please note that today's 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 these 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 51Talk's earnings press release and this conference call include discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. 51Talk's press release contains 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.

Hello, everyone. Thank you for joining our conference call.The third quarter is a seasonally strong quarter for us, and our results for Q3 reflected consistent execution of our focused strategy. Our net revenues and gross billings results exceeded the high end of our guidance ranges by 2.3%and 5.7%, respectively. We also recorded robust active student growth in the quarter, up 23% year-over-year.Unquestionably, our primary growth driver remains our K-12 mass market one-on-one offering in non-tier one cities. K-12 mass market one-on-one gross billings grew 52% year-over-year to reach RMB 504.6 million and represented 92.2% of our total gross billings. The improvement in our fundamentals reflected our consistent strategy of focusing on K-12 mass market in non-tier-one cities.In the third quarter, we launched our mobile-friendly, interactive curriculum for levels 0 to 2 for our flagship course, Classic English Junior. The enhanced curriculum improves learning effectiveness and leads to better learning outcomes through several new features including interactive games, virtual teaching aids, improved facial emotional recognition and engaging role-play scenarios. As with all our curriculum, the goal is to maximize enjoyment and engagement through capturing the interests of our students and inspiring them to continue learning.We also improved our proprietary Magic Mirror System by incorporating advanced elements of big data and analytics. Drawing our vast data sets from our large student base, we use these analytics to generate deeper insights into our students' learning behavior, tailor individual learning paths and suggest more effective study techniques that will allow our students to make more efficient progress.On a separate note, I am very proud to share that two of our students were selected from a national pool of applicants to represent Chinese youth and present speeches in English on the topic of environmental protection at the recent United Nations Climate Change Conference held in Madrid, Spain, on December 5th.Our emphasis at 51Talk has always been the improvement of English communication skills and we are proud to have been instrumental through our teachers, curriculum and program in enabling two of our students to participate in such a noteworthy event.I am also happy that we successfully provided over 100 million one-on-one online English lessons from our inception in 2011 through the end of November this year. This is a nice milestone to mark as we work toward our vision to empower everyone to talk to the world.As 51Talk continues to grow, we are confident that our balanced growth strategy and operational focus on non-tier-one cities will continue to yield solid value for our stakeholders.With that, I will turn now the call over to our CFO, Xu Min.

Thank you, Jack. Our momentum from the first half continued into the third quarter as we achieved record high top line, gross billings, gross margins, as well as the smallest non-GAAP net loss in our history at RMB 1.8 million.Non-GAAP net margin improved to negative 0.4% from negative 7.6% in the previous quarter.Q3 operating cash flow was also historical high at RMB 123.2 million. These results reflected the wide market appeal of our offerings and our ongoing effort to improve operation efficiencies.Now I would like to walk through our third quarter financial details. Net revenues for the third quarter were RMB 409.2 million, a 35% increase from RMB 303.2 million for the same quarter last year. The increase was primarily attributed to an increase in the number of active students and, to a lesser extent, an increase in average revenue per active student. The number of active students in the third quarter was 258,000, a 23% increase from 210,000 for the same quarter last year.Net revenues from one-on-one offerings for the third quarter were RMB 383.4 million, a 37.6% increase from RMB 278.6 million for the same quarter last year. Net revenues from small class offering for the third quarter were RMB 25.8 million, a 4.9% increase from RMB 24.6 million for the same quarter last year.Cost of revenues for the third quarter was RMB 116 million, a 5.8% increase from RMB 109.6 million for the same quarter last year. Cost of revenues for one-on-one offerings for the third quarter was RMB 104.6 million, representing a 12.6% year-over-year increase. Cost of revenues of small class offering for the third quarter was RMB 11.4 million, representing a 32% year-over-year decrease.Gross profit for the third quarter was RMB 293.2 million, a 51.5% increase from RMB 193.5 million for the same quarter last…

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

Hi. Good evening. Congratulations on your first one-on-one business non-GAAP breakeven. Can management give us some color on the drivers behind it?

Yeah, sure. Thank you, Long, for the question. Yes, our one-on-one business non-gap net margin did improve to – we did improve to a positive 0.7% from negative 7.3% earlier. So, basically, from a financial point of view, there are three key drivers. One is revenue scalability really contributed about 5 percentage points improvement and the gross margin improvement actually contributed 1.6 percentage point improvement. And also, the sales and marketing efficiency improvements contributed about 1 percentage point.So, however, we do want to remind everybody that due to the seasonality, the non-GAAP net margins for our one-on-one business for the next two quarters are likely to be negative.

[Foreign Language]So, since 2018, we have been focusing on our Filipino teachers and also the K-12 market. And what we find out that after two years of great execution, our product is really gaining a lot of traction in the lower-tier cities. And as I mentioned earlier, the core business has been growing at 52% year-over-year. And so, not only our business is growing fast, it also has a profitable economic model. So, we're glad that we can do a sustainable and profitable growth.

Thank you. That's very helpful. My second question is regarding your guidance. So, you did not provide – management did not provide gross billings guidance for Q4. Can management give us – can you give us some reason behind that?

Yeah, sure. So, the reason we did not provide gross billings number is because it is really complicated to forecast the gross billings numbers, which is the main reason that leads to relatively late earnings report date. So, without gross billings guidance, hopefully, we can report our quarterly results earlier, which will allow more time to attend conference, communicate with investors.So, I just want to add more color. So, number one, we still expect a very solid Q4 gross billings and we do expect that the sequential growth should be in the low-single-digit percentage. And the second is that we will continue to provide gross billing numbers in our earnings releases.And I also want to point out that we haven't seen – although we've done a lot of things to be compliant to the current government regulations, which people might think it could impact the gross billings, but we haven't seen any impact on our gross billing numbers.

Great, thanks. My third question is regarding the overall outlook. Can management talk about the overall outlook and the key trends for online education in 2020? Do you see any changing, like industry dynamics, like in regulation environment and competitive landscape, especially for the competition in lower-tier cities? How would that impact COE see and what is management's outlook for the company's revenue growth and margin trend in year 2020, particularly for the lower-tier cities? Thank you.

[Foreign Language]So, for 2020, we believe the online education market, after few years of fast development, is becoming a more mature market. And we see that the competitive environment is kind of stable and should be very similar to 2019.[Foreign Language]So, in 2018 and 2019, 51Talk has been focusing on developing the market in lower-tier cities and we're glad to see that our products provide good value and good results for our students and it's quite competitive. So, we're very confident that we can continue to do well in 2020.[Foreign Language]So, we also have been focusing on operational efficiencies. And with our business continue to grow and we continue to increase our scale, we see our financials continue to improve and it's getting more healthy. And we're also seeing that our operating cash flow continues to grow and reach the RMB 123 million this quarter, and we believe this trend will continue.

Thank you. That's very helpful. So, just follow-up, so you have been talking about improving operational efficiency. Just wondering what are some of the key measures you have been taking to improve the operating efficiency.

So, let's talk about it in several different aspects. Number one is the gross margin. You can see that we achieved record high gross margin. And one of the reason is that some of the lower margin business is having smaller percentage in the quarter.[Foreign Language]And also, the sales and marketing is the largest portion of our expenses. And you can see that, in the first three quarters this year, our sales and marketing expenses as a percentage of our gross billing continued to decline.[Foreign Language]And our G&A and R&D expenses have been relatively flat. And as we continue to expand our revenue, the percentage of G&A and R&D expenses as a percentage of our revenue continues to decline.

So, on the gross margin part, your gross margin improved nicely. Just wondering – so you're saying, it's because of the reduction of lower-margin products. Just wondering, is it more because of the – also, I think you mentioned in your earnings report that it's also because a contributor to the price increase. Just wondering, is it more because of your price increase or is it because of more of your reduction of your lower-margin product? And what's your pricing strategy going forward?

Yeah. So, I'll take the question. So, if you look at year-over-year margin improvement, it was roughly 780 bps. So, 70% of this improvement came from one-on-one business. And the rest is actually from the small class business. So, for one-on-one business, our margin improved from 66.6% to 72.7%. That was mostly due to price increase, and so, to a lesser extent, due to more efficient teacher operations. And for the small class business side, we actually improved our margin from 32% to 56%. This was mostly due to kind of fewer lower margin trial lessons and better margin for regular lessons too.

Thank you. That's very helpful. So, are you planning further increase your price going forward? What's your pricing strategy?

So, our price will probably – it's hard to say what we're going to do in 2020. But in the past few years, we typically hiked our price once every year, but we haven't decided what to do in 2020 yet.

Okay, good. Thank you. So, my last question is regarding your lower-tier city penetration strategy. Actually, I was trying to ask if management can share some operating metrics in lower-tier cities, such as retention rate and some of the user acquisition strategy and key marketing channels? And what does the management see the user acquisition cost trend going forward? Also, the contribution – the revenue contributions from lower-tier cities. Thanks. That's my question. Thank you.

[Foreign Language]So, the growth in the non-tier-one city is actually the key driver of our growth. And so, for our core business, the gross billing from the non-tier-one city is getting close to 75% of our total – of our total core business gross billings.[Foreign Language]So, we do expect this percentage to continue to grow. And we see a lot of potential in the lower-tier cities. That's why we're quite confident that we've got a lot of room for future growth.[Foreign Language]So, when we look at the customer acquisition in the lower-tier cities, we find out that people there believing more their close friends and referrals. So, that's why we're seeing that the referral rate, namely referral gross billing as a percentage of total new user number, is going to be more than 60%.[Foreign Language]So, in order to target lower-tier city customers, we're actually making a lot of changes and adjustments to our products and services. Just for one example, we believe the lower-tier city parents and students not only want good spoken English, they also want to have good grades in school. So, what we're doing in our services that we're providing a Chinese teacher reviewing session for the students, and so not only we can have good spoken English, through the Chinese teacher tutoring, they can get good grades in school.Thank you

[Operator Instructions]. The next question comes from Roger Parodi with Silverhorn. Please go ahead.

Hello, Jack. Hello, Xu Min.

Hey, Roger.

I have one question. Hi. I have one question. First of all, congratulations to the very good results.

Thank you.

Quite impressive. Then one question. You generate substantial positive operating cash flow. It's a lot, right? When you extrapolate that to 12 months, you really generate a lot of cash. At the same time, you are still slightly, but it's still small cap profit negative. And how do these two numbers fit together as there is not much CapEx? How is the relationship between that? I would expect to with this cash-generating capability to be much more profitable. That is one question.The other question I have is regarding – I would like to follow-up on the previous question from the previous caller. It's around the pricing strategy [Technical Difficulty] new competitors coming up. They might even offer classes at a lower price than you have. And they target as well lower-tier cities. How do you differentiate yourself from competitors that mainly compete on price?

Right. So, I'll take the first question first. Yeah, so we did have very strong operating cash flow. However, our total company's non-GAAP income is still negative. So, I'll explain a little bit. So, number one, the operating cash flow is actually very closely linked to our gross billing P&L contribution. So, namely, our gross billing is same as cash revenue in some other companies' terms.So, let me define the gross billing P&L contribution first. So, basically, it is the gross billing times the gross margin and minus the non-GAAP operating expenses. So, this number really reflects the lifetime profit for this period's gross billing. So, for example, if you calculate using this formula, you will find out this quarter our gross billing P&L contribution margin is 17.6%. And it's roughly like RMB 100 million, which is very close to the RMB 123 million operating cash flow. And if you compare this to a year ago, in Q3 2018, the gross billing P&L contribution margin was negative 1%. And a year ago, the operating cash flow for Q3 2018 was only RMB 1.7 million. So, you can see that they're very closely related.And the reason why the GAAP profitability lagging gross billing P&L is also quite straightforward. The main reason is that the customer acquisition cost is realized in the current period, right? However, the lessons will be taken in the future periods. Thus, the recognized revenue and profits all coming in future periods. Just because of this mismatch, when a company is growing, the GAAP profitability will naturally lag gross billing profit. So, that's kind of a long-winded explanation on why there is a big difference. And I know it's complicated and I'll be happy to discuss this with any investors if anyone is interesting to find out more.

[Foreign Language]So, in terms of competing with some of the low-priced competitors, we always believe we are an education company. The essence of education is actually we provide better teacher and better learning experience, better effectiveness and good results. And then, in turn, good reputation and good brand. So, we will not compete with anyone in pricing because we do not want to sacrifice the product quality and the service quality. And we believe, in the long run, only those education companies provide the best learning experience and the best result can survive and can have a good brand.Thank you.

As there are no further questions, I'd like to turn the call back over to the company for closing remarks.

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 at ir.51talk.com or The Piacente Group investor relations.This concludes this conference call. You may now disconnect your lines. Thank you.

This conference has concluded. You may now disconnect your line. Thank you for attending.