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

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

Thank you, Zafar. Hello, everyone. Welcome to China Online Education Group's presentation. My name is Min Xu, I'm the CFO of the company. While you read the safe harbor statement, I will give you a brief introduction of China Online Education Group. We are a leading player in China's K-12 online education market. In China, we're commonly known by our main brand name 51Talk, which means I want to talk. We bring together more than 350 -- hold on one second, looks like -- one more slide. Yes. So we bring together more than 350,000 students and roughly 30,000 teachers to our online platform to provide one-on-one and small group live English lessons. Our mission is to empower everyone to talk to the world. 51Talk provides the best live online lessons to improve student's spoken English. Our K-12 [ one-on-one mass market ] offers a 25-minute lesson taught by our Filipino teachers for roughly RMB 40, which is about $7. Our core business was roughly 90% of our Q4 net revenue. The gross margin of our core business is more than 70%, and our core business is growing at roughly 50% year-over-year in Q4. And we also have other complementary businesses. Our Hawo K-12 small group class offers one-on-six English lessons. The lesson is roughly 45 minutes and priced at RMB 60. And our Hawo business accounted for roughly 4% of our Q4 net revenue. Our adult one-on-one lessons are taught also by Filipino teachers. Similar to our K-12 one-on-one mass market offering, the lesson is 25 minutes, same price, RMB 40, and gross margin is also more than 70%. So this slide shows the net gross billing breakdown by product line. So I'll just skip this one. And so in the past few years, we have been focusing on our core business, the K-12 one-on-one mass market business. Our core business net revenue was growing at a really fast speed. And you can see that in order for students to get good spoken language training, it is -- one-on-one format is the best format for them to improve their spoken English. And in China, it is really hard to find offline foreign teachers. So online is the best way to find a kind of native speaker foreign teacher to really help you with your spoken English. And majority of our teachers are Filipino teachers, and this is one of the best places you can find very qualified English teachers. And it is also interesting to see that the Philippines has no time difference with China. So the productivity of the English teacher is also high in the Philippines. So another kind of a strategy we focused on in the past few years is that we really focus on the non-Tier 1 city market. And you can see that the K-12 student population in China's Tier 1 city was -- is roughly 6 million. And in the Tier 2 city, there are roughly 33 million K-12 students. However, in the Tier 3 and lower cities, there are 170 million, much more than Tier 1 and the Tier 2 combined together. And so this is a huge market with great potential. And because of the per capita kind of disposal income in the Tier 3 cities, much lower than Tier 1 and Tier 2. So it is very important for us to provide an affordable product offering with very good results. And because of the 51Talk's product quality and affordable price, we really have very strong and recognizable brand in the lower-tier city. And so it is natural to see that we have -- majority of our students or businesses are in the non-Tier 1 city. And another thing we really focus on is our strong brand and user engagement. We believe our students practice English is the -- actually the key driver for the progress in their spoken English capability. And so our students takes roughly 13 to 15 lessons per month, which is more than double the number of our peers. And because of the high-frequency study, the students -- the results are obviously -- and the students, the progress in their spoken English is much faster than those students studying in our peers' platform. And as a result, our student -- our customer satisfaction is high, and the retention rate as well as the referral rates are high. And in Q4, our retention rate is roughly 77% and our referral rate is roughly 65%. The 2 kids we show here, they are one of the top -- or 2 of the top 51Talk students, and they will recommend to do an English presentation at United Nations Climate Change Conference, which is a -- makes them on top of the news in most of Chinese media last year. So with a strong brand and engagement with our students, we achieved quite strong growth for our business. So in Q4, we were growing at 35% year-over-year. And in terms of students number, it's growing even faster. If we look at our core business, the K-12 one-on-one mass market net new paying students number, it was growing at more than 90% year-over-year in Q4. So not only we were growing at an impressive speed, we are also profitable. So because we're targeting for sustainable growth, profitable growth. So if you look at our margin, it is at 72.7%. So our non-GAAP operating expenses as a percentage of net revenue for the sales and marketing, it was roughly 53%; for G&A, 8.5%; and product development, roughly 8%. That leaves us at a non-GAAP operating margin of 3%. However, this does really represent how profitable [ our business is ]. You know that the sales and marketing expenses for the most of education company are actually used to generate gross billing instead of net revenue. So if we take our operating expenses and divide it by our gross billing, you can see that our sales marketing is actually 39% of our gross billing; and G&A, 7%; and the product development, 6%. So as a result, we say that the gross billing contribution margin for Q4 was 20%. What does this mean? It means that if we finish all the lessons we taught during the quarter, then we would have the 20% operating margin. In other word, over the lifetime of our students, we are generating 20% operating income. So that really shows how profitable our business is. So in the past 5 quarters, we're profitable. And 2019 Q4 was the first quarter we achieved profitability. And first half of 2020, because of the help of the government subsidies and very strong lesson consumption, we were quite profitable at roughly 12% and 8% non-GAAP net margin. And in the second half, the COVID-19 positive impact start to really disappear. And so our margin came down to 7%. And as we indicated in our previous earnings calls that we are actually targeting non-GAAP net margin of low single digit because we believe, for all excess profit, we really should take those profit and spend it on the product development as well as brand marketing or branding in order to achieve long-term growth. And not only we are profitable, we also generate very strong operating cash flow. You can see that in the past 5 quarters, we have generated roughly 1.7 -- roughly $170 million to $180 million operating cash flow every quarter. However, there is some seasonality. For Q1, it's normally -- there will be low cash flow. If you look at our 2019 cash flow, you can see that it's really low. And so 2020 Q1 was really an exception because of the COVID-19 impact. And we also have a quite strong cash balance on our balance sheet. We have roughly RMB 1.7 billion on our balance sheet. So the strong operating cash flow, together with the strong cash balance, really provide us a lot of the operational flexibility. So let's talk about our competitive advantage in the next few slides. We believe 51Talk has full competitive advantages. We have a really exceptional, very effective teacher operation expertise. And we have the proprietary curriculum offering, and we have the proprietary technology platform. Also, we have a very strong brand. 51Talk was established in 2011. And right next year, in 2012, we established our Filipino headquarter in Manila. And so today, we have -- we established more than -- we established 7 training centers besides the headquarter in Manila. And so we also, instead of the -- in addition to managing the roughly 29,000 Filipino teachers in the Philippines, we also manage roughly 1,000 global teachers all around the world. So we have really a very heavy operation in the Philippines. We have roughly 450 full-time staff working on operation. We also have more than 800 full-time teachers. So it is very difficult to maintain more than 29,000 -- actually close to 30,000 teachers all around the world. We are very strict on selecting teachers. Right now, we have roughly 3% acceptance rate, and we continue to raise the bar of selecting the best teachers. And more than -- 100% of our teachers are TESOL-certified. Also, all the new teachers who will take more than 100 hours of training in order to do a good job. And so here are some pictures of our Filipino office. And 51Talk used to be an adult English training company. And we worked very hard to be a K-12 company. And you can see that the working environment in the Philippines is very much [ cutified ]. And our Filipino teacher is the most enthusiastic and entertaining teacher, which can really keep kids very interested. Because most of our Filipino teachers work from home, so we actually established more than 1,000 51Talk teacher clubs all across the Philippines in order to make them -- have a sense of community. And by engaging our home-based teachers, they feel more like a part of a big 51Talk family. And normally, they actually -- we actually established a stronger brand awareness. And all the teachers -- happy teachers, they would love to introduce their friends to teach at 51Talk. So we have our proprietary curriculum. And so because we have our proprietary curriculum, we have the ability to really quickly upgrade and make our curriculum more interactive. It also helps that -- this is an example of our Level-K course, and now we changed the name to Level-S, stands for starter. And in Q4 2020, we acquired the leading AI education company, GKid. So GKid actually has one of the most -- the industry-leading AI technology and one of the best early education in English courses. And so with GKid working with us, we can really increase AI capability of our company, and we can offer more interactive and more interesting courses for our students. I mentioned earlier that we have proprietary curriculum, and it also helps to have a proprietary technology platform. When you have both curriculum and the platform under control, it is much easier for you to upgrade and add a lot of the new technologies, for example, the AI technology as well as the big data technology into your curriculum and to make the work -- make the teaching experience and learning experience much better for our teachers and students. So in order to showcase the spoken English capability of our students, we hold English speech contest every year. In the past 2 years, we have been working with China Youth League on this competition, and it really increased the exposure of the competition. In the past year, we have more than 1 million students participating in our speech contest. We also take our best students to all those very popular TV shows in China to showcase their English. And it really, really shows everybody that -- how good their English is and also increase the awareness of a 51Talk brand. So in the past few quarters, there's one thing we see is that our growth rate in the Tier 1 city is coming back, so which means we are gaining market share in the Tier 1 cities. So as a result, we decided to put more marketing in the Tier 1 cities. So this is -- normally, we don't do offline branding investment. But this time, in order to gain more market share in Tier 1 cities, we put landmark -- we put 51Talk advertisements in landmark buildings in the top 5 cities in China. So we also -- we're also one of the [ Guinness ] -- because we're helping a lot of Filipino teachers and we're kind of a symbol of good relationship between the 2 countries, the China and the Philippines, last year, we actually did a -- celebrated the 45th anniversary of the establishment of a diplomatic relation between the 2 countries, and we created the Guinness World Record by creating the largest online video album for people high-fiving. And you can see that the ambassadors from China and the Philippines, both participated in this activity. So we also celebrated the milestone that we delivered 150 million one-on-one online English lessons. So in December 2019, we cumulatively delivered 100 million lessons. And in the past year, we actually delivered roughly 50 -- more than 50 million, so which means the growth of the company is really accelerating. So I think I'll stop right here, so -- and take any questions because there are there only 5 minutes left.

So I'll read the question and try to answer it. So the first question is, how do you plan to incorporate AI expertise from the GKid acquisition? So yes, so number one, the AI technology for the -- from GKid is really industry-leading. And what we plan to do is that we plan to incorporate that technology into our main course. And in addition, we will probably provide -- we will continue to run GKid kind of early education English courses for young kids. And so for the main course, what we're going to do is that in front of the 25-minute live lesson, we plan to add 5-minute AI lesson. And the purpose of that AI lesson is to kind of help students to warm up and learn some of the concepts or maybe some of the vocabulary, maybe some of the grammar. So with the 5-minute AI lesson, the kids are better prepared for the following 25-minute live lesson with Filipino teachers. So the next question, any plans to return your strong cash flow to investors through dividends or share buybacks? So we have a share buyback program. So we are doing that. And I do not believe the dividend is going to happen anytime soon because, as I mentioned, that we plan to keep our non-GAAP net margin to be at low single digit. And we will take the excess profit to put it back into product development and branding. And so what you're going to see is that you're probably going to see higher product development expenses as a percentage of gross billing as well as higher sales marketing expenses as a percentage of gross billing. Next question is, how do you acquire new students? And what's the average subscription period? So typically, we -- there are many channels we acquire new students. And so the largest channel for us actually is referral. There are roughly 2/3 of the new students are coming from the referral. And so the average subscription period is roughly 2 to 3 years. So okay, so I'll answer the last question. Do you expect your Q4 paying student growth rate to continue? What are the expectations for 2021? So number one, I think the Q4 paying students growth rate is really high, so it is hard to repeat that. It's hard to repeat that for 2 reasons: one -- number one, it was comparing with a pre-COVID-19 number; and number two, for the Q4, we have really kind of a 20% lower order size, which will help the paying students growth. So in 2021, we do not have -- so paying student growth rate will come down to a more reasonable level or kind of a more -- kind of it is still going to be more than 40%, but it's not going to be as high as kind of the number we're showing in our presentation. And so this is the last question, and so appreciate everyone participating. And if you have any questions, feel free to reach out to us, and we look forward to talk to you. We can set up another call to answer your questions. All right. Thank you very much.