51Talk Online Education Group (COE) Earnings Call Transcript & Summary

Welcome to the Deutsche Bank Depositary Receipts Virtual Investor Conference, dbVIC. I'm pleased to announce that our next presentation is from China Online Education Group. Before I introduce our speaker, a few points to note. Please submit your questions in the ask a question box below the slides. Once the Q&A session has ended, don't log out. You will automatically be transferred into the China Online Education booth where you can continue to questions via the chat facility and access shareholder materials. On a final note, all of today's presentations will be recorded and can be accessed via the Deutsche Bank website, adr.db.com. At this point, I'm very pleased to welcome Min Xu, Chief Financial Officer at China Online Education, which trades on the NYSE under the symbol, COE. Welcome, Min, and over to you.

Thank you very much. Hello, everyone. This is Min Xu from 51Talk, ticker COE. So for those who are not familiar with 51Talk, we're one of the earliest online education company. The company was established in 2011, and we went public in 2016. So we were the earliest -- the K-12 education -- online education company in China that went public in the U.S. So 51Talk focuses on one-on-one English training online. And currently, on our platform, we have close to 300,000 students and 26,000 foreign teachers. So the product we offer is actually the 25-minute one-on-one session with -- for our K-12 mass-market product, this is mainly with our Filipino teachers. And you can see that our main product is roughly 85% of our total revenue in Q2, and this part of business was growing 61% year-over-year, and it's under our main brand, 51Talk. We also have some other complementary businesses. One is our small class business. It offers 45-minute lessons at a price of RMB 60. It is about 6% of our total revenue. And we also offer the one-on-one lesson to adult students, and that's the same price as the K-12 lesson, which is a 25-minute lesson for RMB 40. Our adult business is about 7% of our total revenue. So if you look at the distribution by product line, you can see that our core business is about 91% of our gross billing and 85% of our total revenue. And so if you look at our operations, so the company recently -- last year, Q4 last year, we achieved our first breakeven, and we were one of the first company to achieve breakeven in one-on-one online education. And the reason we're able to do that is because of we are focusing on 2 things: number one, we focus on our core product, which is K-12 mass-market one-on-one product. And why we're doing this? So because we're in English training, and we believe one-on-one format is the most effective format. And obviously, it will be best if we can have a foreign teacher -- and because there -- because of the availability and obviously, the online format will be much more efficient compared to the off-line model. So why -- like about 24,000 out of our 28,000 -- 26,000 supporting teachers are based in the Philippines. So why we love the Filipino teachers? And obviously, in the Philippines, we have a large quantity of very qualified English teacher. And in addition, the Philippines and China, we have no time difference. So the teacher -- the Filipino teacher productivity is much higher than any other teachers from any other regions. So for that reason, we focus on our Filipino teacher online one-on-one product. And our second focus is actually on the non-tier-one cities. So if you look at the K-12 student population in different tiers of Chinese cities, you can see that in the Tier 1 city, there are about 6 million K-12 students. And in Tier 2, 33 million. And Tier 3, we have 170 million. So that's -- if you add this up, it's about 5 to 6x of Tier 1 and Tier 2 add together. So it's a huge market. And in addition, you can see that the per capita disposable income for the Tier 3 city is only -- it's less than half of that in Tier 1. So when we charge like RMB 40 for 25-minute lesson, we -- our price is very affordable and very attractive compared to those products offered by our peers who are using North American teachers. They charge about RMB 130 to RMB 150. So with our price, it's definitely -- our products much better fit for the mass market in Tier 3 and Tier 2 cities. And so if you look at our gross billing, roughly 71% our gross billings are from the non-tier-one cities. And what we -- people will ask, okay, what do you think you can do while your peers and your competitors cannot do? And we have our core competencies in teacher operations, and the proprietary curriculum as well as in the proprietary technology platform. And we're going to go into details in the later slides. And another thing we focus on is student engagement. And so we always encourage our students to take more lessons, because we believe the frequency is the key for language development. And so for our students, the average lessons they take per month is anywhere between 11 and 15 lessons, which is more than twice the average numbers the students taken when they take our peers' lessons. So because of the high-frequency study, the result for our students is much better. And if you look at the left lower corner, and because of the frequency and because of the good results, we're getting very good retention rate as well as the very good referral rate. A good retention rate is the key to increase lifetime value, what we call LTV. And a very good referral rate is the key to lower the customer acquisition cost or what we call CAC. And so this is how we achieve our profitable business model and be the first profitable company in the one-on-one education company. So we -- because of our focus, we also achieved great growth in this market. If you look at our Q2 revenue, we did about RMB 494 million, which is 40% year-on-year growth. And however, if you look at the user number, if you look at the net new paying students number, it is growing much faster of our revenue. In Q2, we were growing more than 60%. Compared to a year ago, we were only growing at 26%. And another thing is that what I mentioned earlier that because our focus on user engagement, we have much better economics than our peers. So however, it is -- for education company, the model is a little bit different. So I want to explain this to you. So if you look at the left-hand side, you can see our non-GAAP operating model. So the 70.9% is our gross margin. And so if you look at our sales and marketing, G&A and product development as a percentage of revenues, and you can see it's 48%, 10% and roughly 6%. So if you subtract all these expenses from the gross margin, you get our non-GAAP operating margin of roughly 7%. However, the sales and marketing are mostly used to achieve our gross billing, which is also prepaid tuition, instead of net revenues. And because we're growing quite fast, our gross billings are much larger than the net revenue. So there's a mismatch between the net revenue versus the sales and marketing expenses. So the right way -- we believe the right way to look at this is that we should put the expenses as a percentage of gross billing. So if we do that, you can see that we still got the same gross margin, but now our sales, marketing, G&A and product development is a smaller percentage of our gross billing. And if you subtract those expenses, certainly, we have a 23% gross billing contribution, which means over the life time of the new students, we are getting 23% of operating margin. So this is just a different view. So -- in another word that the education companies are much more profitable than you can imagine if you only look at the non-GAAP P&L. All right. So one second. I don't think that -- it freeze a little bit. Hold on. Let me refresh this page. All right. All right. So now we are on Page 12. So because of the nice gross billing contribution margin, this is a key for us to achieve great profitability. So in Q3 last year, it was the first quarter we achieved the one-on-one business breakeven. And in Q4 last year, it's the first quarter we achieved a consolidated breakeven. And in Q1 and Q2, we did a non-GAAP net margin of 12% and 8%. So in addition to the great profitability, we also had great operating cash flow. So in 2018, we did about RMB 30 million -- RMB 30 million operating cash flow. In 2019, we did close to RMB 400 million operating cash flow. So for the first half of this year, we already did more than RMB 340 million operating cash flow. And as a result, you can see that right now, we have a cash balance of about RMB 1.4 billion. So with the strong operating cash flow and the sufficient cash balance, it provides a lot of operational flexibility for the company. And so I mentioned earlier that our core competencies are in teacher operations, proprietary curriculum and also the proprietary technology platform. So we just got to talk a little bit more about it. So the company, after -- 1 year after the company was established, we immediately established a headquarter in Manila, the Philippines. So today, besides the headquarter in Manila, we also have 7 other training centers across the Philippines. So with that, we also have more than 1,000 full-time local employees working on the recruiting, the training and the quality control features. So this is a very heavy operation. It will be -- it actually hard to imagine an online education company have this kind of a heavy operation, because we believe this is the key to provide a quality service and a quality product. So right now, we have about 24,000 teachers in the Philippines and 2,000 teachers all over the globe. And so the operation in the operations center in the Philippines manage all these teachers. And right now, we have a very low acceptance rate at around 5%. Before the COVID-19, our acceptance rate was at 7%. But after the COVID-19, there are a lot more candidates pouring in, trying to be -- trying to teach online. So we're making this process more selective. So -- and in terms of our curriculum, and we have a very strong team with very strong background, working -- developing our own curriculum instead of using the third-party textbook. This is very crucial, because the kids in China, they need a textbook that's more suitable to their level and kind of showing content they're more familiar with in order to achieve good results. And we also develop our own technology platform. At the beginning of the time, we also use the third-party platforms like QQ, like YY and also some other platforms. But over time, we realized we have to develop our own platform to increase reliability. And right now, at the peak time, we kind of deliver roughly 150,000 lessons per day. So you need to really optimize your system to be able to handle that kind of a load. So we also use a lot of the AI technology as well as the big data technology to really improve the teaching experience as well as the learning experience. And you can see that we're also trying to find ways to allow the teachers and students to be able to showcase their progress. So one way to do is that we hold our English speech contest every year. So this year is our second year actually partnering with China Youth League to deliver this contest. And so this year, there are more than 500,000 students participating. And it's really a very good platform to showcase how effective 51Talk's teaching is and allows all students to have a chance to show that how much they improved using our platform. And we're also putting -- invest in a lot of the branding. And so these are all very popular TV programs in China and we allow our students to really get on the stage and interact with the host and the guest to showcase their English. And so here are some financial numbers. I'll quickly go through it, so that you can have some opportunity to ask some questions. So you can see that the gross billing in Q2 is RMB 676 million. We're growing at roughly 36%. And while our core business actually is growing at a much faster rate and more than 45%. And I mentioned that our revenue is roughly RMB 494 million growing 40%, while our core business is growing at 61%. And our margin has been able to be -- stay above 70%. And obviously, in 2018 and early 2019, it was at around 60%, but we were able to optimize our operations and really increased the margin to be above 70%. And our strategy is to keep that margin at above 70%, and we're not chasing higher margin, because we believe as a mass market product that it's very important to offer an affordable price to our students so that more students will have a chance to have access to the great teachers in the Philippines. And so this shows our -- in Q4 last year, we have crossed the breakeven point, and we're able to achieve nice net margins. But going forward, again, it is not our goal to expand our net margin. So we have mentioned in our Q2 conference call that our intention is to keep our net margin at the low single digits, so that we will take the excess profit and put it back into our product [ development ], put it back into our branding and put it back into our marketing, so that we can offer a better product to more students. And as you can see, the sales and marketing is the largest portion of our expenses. And -- but we were able to optimize our marketing cost and continue to optimize the expenses so that the percentage -- the expenses as a percentage of gross billing continued to decline over the years. So that pretty much covers the presentation, and I'll be happy to take any questions.

All right. So here's the question from [ Guotong ]. So in terms of scalability of your business and growth, one, is teacher or recruiting students the bottleneck? And two, why not to a larger class format outside of English class? So number one, teacher is not a bottleneck. And there are plenty of great Filipino teachers in the country. And this is -- Filipino is kind of the BPO industry for the world, and a lot of calls will be routed to the Philippines, and we will be -- it will be very easy to find good English teachers there. So the bottleneck is actually student acquisition. So that's why you see the customer acquisition cost actually is the highest cost for this business. And this is what we have been trying to optimize. So -- and -hold on, one second. The second question is why not to do larger class format or other languages. So the answer for that is that, so large class format actually is a very crowded market. And there are many large players in that space. And it is -- and the economic model is not proven. So it will be a very difficult space to compete in. Right now, we have no intention to get into that space. And in terms of other languages, right now, English is the largest market for China's K-12 market. And so our intention is that we do not believe that going into other language will have better returns than getting into the lower-tier cities. We believe the largest potential growth will be coming from the lower tier city. And as you can see, lower tier city is a very big market and right now have very low penetration rate. And so it will be much easier to invest in lower tier city and get great return there, right? So next question from Ms. Furman. Can you speak to your customers' acquisition strategy and cost of customer acquisition? So I mentioned earlier that the large class format acquisition that in their market, the customer acquisition cost is fairly high. And for a RMB 1,000 class -- for a RMB 1,000 package class -- package customer, you'll probably have to spend RMB 3,000 to acquire that customer, and you will never get back the customer acquisition cost even throughout the lifetime of the students. But for us, we roughly have about RMB 15,000 lifetime value, and our customer acquisition cost is roughly RMB 3,500. So it's a much better LTV-to-CAC ratio compared to the large format class. And what is your retention rate for the teachers? So after 3 months, our attrition rate for our teacher is roughly 3% to 5% per month. And how do you plan to utilize your growing cash balance? So number one, even though we have a great cash balance, about RMB 1.4 billion, however, we have a bigger deferred revenue balance of about RMB 2.4 billion. So it is nice to have a good cash balance to make sure to strengthen our balance. But going forward, if we continue to have strong operating cash flow and a strong cash balance, obviously, we can utilize the cash balance as well as our stock to make acquisitions into other areas. However, as I mentioned earlier, our top priority will be getting into the lower-tier cities. So right now, we are only kind of looking at different options, but we're not going to do anything right now. And so can you please elaborate on how you calculate China's K-12 after-school education market size versus your average package size on Slide 7? So let me go back to Slide 7. I guess you're probably talking about Slide 6. Yes. So basically, the market size is from some market research we report. And so for our average package size, right now is about RMB 9,000. And it is actually declining because we're trying to attract students from the lower-tier cities, and we want to make that package smaller. So it is going towards RMB 8,000 or even RMB 7,000 right now. Okay. So we're kind of out of time. I'll take one more question and then we will move to the Q&A room. So the question is that how is your share repurchase program progressing? Yes. So it is progressing well. I think we've purchased more than USD 1 million now, and we will disclose this number on our Q3 earnings call. I think I will take one more question. Can you provide your strategy with targeting different Tier 2 to 3? Have you noticed different user behavior during COVID-19 between different tier cities? Actually, our strategy is -- actually, we're focusing on lower-tier cities. Our product actually suits all the students. But for lower-tier cities, we are making some little improvements. For example, lower-tier cities students, they don't have large screen devices like PC or pad. So we're improving the learning experience from small screen devices like cell phone. And we're -- another thing we're doing is that we're adding Chinese teacher review lessons, so that for those students who feel frustrated talking to foreign teachers will at least have some help from the Chinese teacher. So these are some of the works we do trying to make the lower-tier city students feel more comfortable doing our lessons. And in terms of the behavior, I believe in the lower-tier cities, they are -- because the penetration of online education is lower. And so as when COVID-19 hit, there are actually more students trying the online education. So we're seeing a lot more new users in the lower-tier cities than in other tiers. Okay. So I'll -- I think I'll wrap up this call and we can move to the Q&A room.