Gaotu Techedu Inc. (GOTU) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the GSX Techedu Investor Conference Call. [Operator Instructions] Please note, this event is being recorded. On today's call, we have with us, Mr. Larry Chen, Chairman and CEO of GSX; Ms. Shannon Shen, Chief Financial Officer; and Ms. Sandy Qin, IR Senior Manager. Shannon will give -- will first give her prepared remarks. I would now like to turn the conference over to your first speaker today, Ms. Shannon Shen. Thank you. Please go ahead.

Thank you all for joining us in such a short notice. This is Shannon, GSX' CFO. Recently, we have noticed that certain ADR companies listed in U.S. disclosed internal fraud and some stocks were frequently attacked by short sellers. We believe every company is an independent entity with its unique culture, value, strategy and operations. As a public company, we are accountable to deliver the value we created to investors when the faith in the market is weak. We hereby voluntarily share more concrete information to help investors understand GSX better. Let's start with cash. As of December 31, 2019, our cash and cash equivalents were RMB 74 million, short-term investments were RMB 1.17 billion -- sorry, RMB 1.47 billion, and long-term wealth management investments were RMB 1.19 billion. Our RMB-denominated cash and cash equivalents and short-term and long-term investments are jointly held by 7 onshore entities, while the USD-denominated assets are mainly held by our offshore entity in the Cayman Islands. U.S. dollar assets mainly came from IPO proceeds in June 2019. And as of now, not a single penny has been transferred back onshore. Our cash and cash equivalents are mainly held at the following branch banks: China Merchants Bank, Beijing [indiscernible]; China Merchants Bank, Beijing [indiscernible]; China Merchants Bank, Beijing [indiscernible]; China Construction Bank, Shanghai [indiscernible]; China Construction Bank [indiscernible]; Bank of Beijing [indiscernible]. Our cash savings totals RMB 7.106 million in China Merchants Bank; RMB 4.062 million in China Construction Bank; RMB 494,000 in Bank of Beijing; and USD 8.853 million in Citibank in Hong Kong. Our short-term and long-term wealth management investments consist of USD 189 million from Citibank; RMB 637 million from China Merchants Bank; RMB 692 million from Industry Bank as well as unrealized gains of USD 289,000 and RMB 5.868 million. The unrealized gains or loss are recorded in other comprehensive income on the balance sheet until redemption. Then those will be finally recorded as interest income on the income statement. If you combine our Q4 interest income and realized gains of RMB 10 million together with the nice increased unrealized gains from investments of RMB 3.5 million recorded in other comprehensive income and divide the number by the weighted average cash balance between our Q3 and Q4 end of RMB 1.3 billion, you will get an annualized interest rate of around 4.15% for our short-term investment, which roughly matches general market rates in China. Our USD-denominated long-term wealth management investments are affected by interest rates, credit price and durations, which drags down our overall average interest rate today. I would like to reiterate, as of now, our IPO proceeds remained offshore and has not been transferred back onshore. We got at hand all of the supporting materials, including stamp-hold bank statements, payment receipts and third-party appraisal reports for the balances I just mentioned. Secondly, in terms of financial results, we had a positive operating cash flow of $1.28 billion for 2019. By the end of 2019, our cash and cash equivalents, short-term and long-term wealth management investments increased by RMB 2.498 billion from the beginning of the year. Our full year non-GAAP net profit reached RMB 286.9 million. Overall, our net operating cash flow, cash balances and net profit, all grew at the same direction, which clearly separates us from company that has negative net operating cash flows, continuously declining cash balances and continued net losses. The third, generally speaking, the service cycle for education industry is relatively long. From traffic acquisition, promotional trial courses, conversion to regular courses, material delivery and receipt to live course participation, homework submission and collection, study reports, test taking, retention and cross-selling, every single piece of data is recorded and tracked by back-office database and online system. Any abnormalities in the data can cause a big mismatch. In 2019, we've generated RMB 3.358 billion in gross billings. It is a fairly large amount that we believe only true data can survive from extremely strict inspection and analysis performed by both internal and external audit procedures. I will just take the delivery of textbooks as an example. There is a rumor who claims to have tracked our textbook logistics. He believes that one logistics vendor, which accounted for over 90% of our package deliveries showed a significant lower number of packages compared with the relevant numbers we reported. The allegation is simply untrue. Firstly, among all the 4 logistics vendors we used in 2019, [indiscernible], none accounted for over 90% of our package deliveries. Secondly, they do not exactly match the timing of payment. For instance, for Q4 2019, we reported 1.1 million paid enrollments, a lot were actually signed up for winter or spring semester in 2020. So their textbooks will wait until 2020 to be delivered. Even if so according to the stamped written confirmation from our logistics vendors, in 2019, we have mailed out around 3 million packages. Considering we combined deliveries when the same students signed up for multiple enrollments and the above-mentioned factors, the package delivery number was far exceeding the enrollments we reported in 2019, partially due to our promotion costs. From this case, we highly suspect the rumor maker did not pay a real visit to the vendor or did not monitor the logistics for a reasonable time. In conclusion, majority of these riding rumors about GSX are false allegations. Last major point is the download data of our apps. According to QuestMobile, one of the most frequently used third-party data providers shows the total monthly new users for GSX and Gaotu Ketang apps were 2.21 million for the second half in 2019, ranking up the third among education peers. Given the fact that we still have over half of the students using excel pages and PC terminals, the excel data actually verifies our faster growth and student enrollments. Now let's take a look at the store seller report issued in February. A majority of the data sourced by Grizzly are not accurate, reliable or applicable to our business model, adding that the outfit's methodology in reading the data is extremely flawed. Any rational investor familiar with the China Internet landscape will easily figure out the outfit's unprofessionalism. First, they use Alexa to estimate wide browser traffic. The accuracy here depends on size of the samples of users who use Alexa web browser plug-in. However, the accuracy of data traffic statistics in China is low, because very few people in China use Alexa web browser plug-in. Alexa statistics are not relevant. Second, the report position of Qimai as a professional mobile Internet analysis platform. We acknowledge that the industry recognizes Qimai's experience in app store ranking and ASO monitoring, but not download estimates because its download estimates are mainly based on rankings, which are not accurate, or sometimes, significantly inaccurate. The short seller solely referring to Qimai for downloaded estimates is simply not professional or reliable. Furthermore, the short seller tries to prove our low brand recognition and choose to quote ranking published via suspicious advertising websites. It not only did not conduct an independent sample survey but also failed to rely on data published by a credible research institute. There are also some other straightforward claims that we would like to share with you. First, tax. The RMB 17 million income tax expenses, as disclosed in our 20-F include not only current tax -- current income expense -- current tax income expenses but also deferred tax expenses. The reconciliation could be found in 20-F clearly. During 2019, we paid RMB 340,000 for current income tax expenses. According to China's Enterprise Income Tax Law, any taxable entity can carry its net operating losses forward to 5 years to help with tax deduction purpose. We began to make profit starting FY 2018, which partially offset the losses carrying forward. Secondly, about 2B business. All of our K-12 businesses fall in the 2C business, which means we provide courses to students directly through no middleman. Besides our 2B business Chengxi business school contributed RMB 26 million revenue, accounting for 1.22% of the entire group's revenue. Chengxi business school provides professional training to presidents, management and teachers of education institutions to help them improve operation efficiency and management capability. Chengxi business school's customers are individuals from educational industry and the business does not involve distributors or agencies. So in a sense, it's also 2C business. Thirdly, about related party transactions, Baijia Yuntu and BaiJiaHuLian mentioned in the short seller report do not have any related party transactions with GSX in 2018 and 2019. The other company mentioned in the short seller report, Beijing Youlian Jiazhang Jia is GSX related party and we actually paid a nice RMB 3 million for service provided by Beijing Youlian Jiazhang Jia in 2019, which takes 0.16% of GSX total cost and operating expenses of the year. Please note, the direction is that we paid Beijing Youlian Jiazhang Jia rather than Beijing Youlian Jiazhang Jia transferred its profit to us as wrongly alleged in the report. Fourth, about the property acquisition in Zhengzhou. The consideration was RMB 330 million, which, if divided by the 68,000 square meters building resulted in a unit square meter cost of RMB 4,850, significantly lower than the average price of neighborhood building at around RMB 8,000 per square meter. We believe the suspected actual purchase price of RMB 75 million raised by the short seller report shows that they also lack basic common sense because the number will get us to a surprisingly low unit SQM cost of only RMB 1,000 in Zhengzhou, the provincial capital of Henan. Fifth, the gap between the company's credit report and SAIC filing was actually GAAP difference between China and U.S. after the groups restructured to spin-off 2B business in 2017. The difference is totally reasonable and legitimate and has nothing to do with operational numbers. Based on a decision made by management, with the support of our Board of Directors and the lawyers, we decided not to respond to Grizzly's short report. The report is full of irrelevant and false allegations and a lack of basic accounting knowledge. For example, the report illogically compares our gross spend margins to offline education companies. In another instance, it speculated about the prior employer of myself as CFO, even though I never worked for the company it mentioned. We generally do not respond to low-quality short report like this except for the special situation like today. As early as April 3, we have filed a 20-F with standard and qualified audit opinion. I now quote the sentence on the independent auditor report that: In our opinion, the financial statements present fairly in all material respects the financial position of the group. To our investors, we are a young company and one that has been public for less than a year but have demonstrated strong performance so far. As we are growing so fast, we also encountered all in -- kinds of difficulties and challenges. However, in our circumstances, we always take to our core value of integrity. Our business model is validated, our strategy is solid, and our execution is highly efficient. Going forward, we will keep delivering our promise and work hard to outperform. On the way to become a greater company, we are always open to feedback and suggestions from investors, media and our partners to help us improve. However, to those who look to maliciously attack us through groundless, misleading and deceptive labels, we have marked down all the evidence and we reserve the right to legal action. We always believe, time will tell. The temporary negative impact will ultimately disappear, and only the companies who provide real values to customers, employees and shareholders will remain. We also want to use the most open and transparent way to demonstrate our credibility. There are several due diligence measures adopted by the grassroots. Some apply to our current business model where others won't. However, the most effective approach will always be visiting the company physically and in person to fully understand the company, the management and the people. If you may, visit GSX to know those GSX people who devoted their full hearts to our parents and students, those who work late night and still could jam the traffic and those young men and girls who fight for their beautiful lives and serve each parents and students to their satisfaction. That concludes my prepared remarks. Thank you, everyone. Now let's enter the Q&A section. Larry and I will jointly host the Q&A session, and we are an extremely open and transparent company so that we welcome all investors to raise questions. Operator, please.

[Operator Instructions] Today's first question comes from Gregory Zhao at Barclays.

So I have 3 questions. So the first one is just want to understand, so after you recognize an enrollment from students, normally, how long can you receive the enrollment fees, I mean the cash? So the second one is, we know because of the business size, so you are categorized as an emerging growth company, and we will also see several other medium-sized Internet companies, like they also use this definition. So as such kind of company, I know you are exceptional from the SOX 404. So I just wanted to understand, so what extra or incremental auditing works are required under the SOX 404? And I know next year, you will also -- using this kind of auditing the rule. And the last one is, we know with -- the COVID-19 is largely contained in China and students coming back to school. So would you please give us an update of your business and also with the market, the competitive landscape post the COVID-19?

Okay, sure. Your first question was how long like after we receive cash of the enrollment. Usually, the enrollment happens spontaneously when we receive the cash. It basically happens at the same time. And the second question is about our SOX adoption. So actually, we got a lot of the inquiries upon our audit opinion, which is quite unusual. But for -- we call it FTI, which means our foreign private issuers, we usually have 5 years based on the Jobs Act that we called emerging growth companies that we can enjoy SOX exemptions. So -- but if a company's top line, I mean net revenue exceed $1.07 billion during the year or the market flow exceeds USD 700 million, the company needs to finish the stock's internal control framework buildup and subject to integral audit by the end of the year. So which means by the end of 2020, we will complete all of our SOX compliance and deliver an integral audit report in 2021. Actually, we already adopt a couple of measures to build up our internal control system. We had PricewaterhouseCoopers as external consultants last year. They already joined us for a couple of months, helped us to kind of like inspect like business operating process internally and help us to build up the internal control system. And also we get a independent public auditor like Deloitte, they will be inspecting how our internal control framework is building up, and they will give the final opinion by the end of the year.

[Foreign Language]

[Interpreted] So as for the third question, I'm going to give you the answers.

[Foreign Language]

[Interpreted] So what we are observing is a lot more and more promises, we are seeing grade -- not only grade 12 are resuming their school openings. And also what we are seeing is after May 10, a lot of the primary and middle school students also going back to school.

[Foreign Language]

[Interpreted] The most uncertainty lies in the cities of Beijing and Wuhan.

[Foreign Language]

[Interpreted] So while we were doing these education businesses, we always remind ourselves to provide the best quality teachers and the best quality services and bring the students better learning results. So regardless of the coronavirus or not, whether the students study at home or go back-to-school, actually, what the students and parents in China, they are pursuing, is always the best quality. So this need will not change. So what I am thinking is, even if students are going back-to-school, actually, there are not any essential changes to the online learning businesses.

[Foreign Language]

[Interpreted] Just as I mentioned in many different occasions, we always believe that any company, you should focus more on the students and parents instead of your competitors. So that's why in the past several years, we spent a lot of effort in picking the best talents. We train them and we motivate them. And we spend a lot of effort to upgrade our organizational capabilities.

[Foreign Language]

[Interpreted] And we actually received a lot of data from everyone. And just if you -- including the public online education companies and also the private online education companies, if you look at outcome, in 2019, the full year, we are actually the only one that realized a positive net profit. And also our net operating cash flow exceeds CNY 1.2 billion. But if you look at other peers, like say, #2 or #3, their net operating cash flow actually are negative CNY 800 million or negative CNY 1 billion. So -- and, obviously, you can see last year, our revenue actually has a growth rate -- year-over-year growth rate of over 400%. That is also #1 across the sector. So after this coronavirus broke out, thanks to our training of organizational capabilities for the past several years, we actually direct the opportunity of this pandemic. And throughout this pandemic, we not only strengthened our organizational capability training, but also we improved our operational efficiency, and that will help with our future growth. And we are very confident.

[Foreign Language]

[Interpreted] Since the operator dropped off from the line, so I'll just give you some extra color.

[Foreign Language]

[Interpreted] As many investors -- many of you already know, I had made a promise before that we'll not participate in any external public activities, and we will not take any interviews, except in some emergencies. And yesterday, I still gave a media conference call. Why I decided to do the media conference call is because I observed the U.S. listed Chinese stock are facing some credit crisis, which is worrying me. And as a firm that really wants to contribute to the society and whose mission is the technology, we will make the education better, I think we should stand out and say something. So that's why I did the media conference call. And today, on a short notice, we decided to do investor conference call. We always believe any questions can be resolved through communication. And as a very -- as a relatively young company, there are some voices questioning us and don't believe our numbers. Actually, it's a great opportunity for us to review ourselves and always, obviously, where we can improve ourselves.

And pardon me, ma'am, this is the operator. I do apologize for the difficulties earlier. Our next question today comes from Felix Liu from UBS. It looks like we will proceed to our next question, which is from Tian Hou at T.H. Capital.

[Foreign Language]

[Interpreted] Okay. Thank you, Tian Hou. So the question is, according to this rule, a lot of the grade 12 students when they graduated from high school and they go to the colleges, will the company see a significant drop of their enrollments?

[Foreign Language]

[Interpreted] Thanks for your question. Thank you. Your question is very interesting. So number one, if you look at breakdown of all of our enrollments, actually, the primary school contributed a much larger -- contributed a larger and larger proportion. And the growing speed of primary school enrollment is actually faster than the ones in middle school and high school. And secondly, actually, we have a really high teaching quality and great brand awareness for our high school courses. So that we actually have overwhelming advantages in the high school education. And the students from our grade 12, after they left the high school courses, they can still go to our advanced courses to take other courses. In addition, the grade 12 teachers of our company can still use their reputations to attract some more new students. And our grade 11 students, after they graduate from grade 11, they will also go to grade 12. And the expenses, I always believe, for any education company, that ultimately you have to provide the best teachers and services. So as long as we can achieve the highest operational efficiency, we will get the best benefit, and we are able to pay our teachers the highest salary, so that our tutors are able to provide the best quality of services. So it's a positive cycle. And a lot of external people -- it's not clear for them to -- it's not easy for them to be clear. So I believe now is the time I get a lot of the questions through.

Our next question comes from Alex Xie at Crédit Suisse.

[Foreign Language] So let me translate by myself. My first question will be about the share pledge financing. We are glad that management promised not to decrease the shareholdings for now. But I think investor is also worried that some other companies management, they did share pledge financing and caused a significant drop of the share price. And what's the situation for GSX management? My second question will be about our pricing strategy because we have seen across the industry some key players, including say TAL, Yuan Fu Dao and Zuoyebang, all increased their prices significantly for the summer and autumn courses and then get much closer to the premium prices of GSX. So what will be the pricing strategy of GSX for the next year?

[Foreign Language]

[Interpreted] Thank you for your 2 questions. Well, as far as now, the core management team, none of them have reduced their positions. And even myself, I'm even considering to increase my position if it's allowed by the legal.

[Foreign Language]

[Interpreted] So I wanted to explore the possibilities to increase my position. And there are some investment banks that get in touch with me and offered me some margin loan options, but I am very conservative. Based on my knowledge, the maximum amount of loans that I can take is no more than USD 50 million, and I have a new benefit. So throughout the entire process that I am working in GSX, there are many touching moments. And people cannot imagine how much faith that our core management team have in this company. And in March, during the trading window period, many of our employees, they don't want to sell their stocks. Instead they pledged their stocks to get some money to restock their emergency needs. So the more you get in touch with our core management team, the more you will see our faith in our company.

[Foreign Language]

[Interpreted] As far as of now, I have like $50 million of cost that I can use and I just got that this week, but I haven't used any of it. And in addition to this, there is no -- any loans or pledges from me. You know that before I worked in New Oriental for so many years. So actually, my assets is enough for me to spend my -- this life -- entire life. And I understand why you want to ask the question like this because ever after what happened to Luckin Coffee, the trust between people actually crushed, which I feel is pretty sad about it.

[Foreign Language]

[Interpreted] Your second question is about how we think about our pricing for the classes. And as of now, I actually didn't pay attention to the average pricing of our peers for the summer or fall. How we determine our pricing is that is the price that we can survive. And we are very happy to see that as our scalability of economics begin to show up and we are also testing some low-priced courses. In the future, we don't rule out the possibilities of providing some low-priced courses or some customized courses for different regions. There are many investors tell us that we actually -- GSX defines the live large class from the pricing to the tutors, the business model we define it. When we hear these words, we actually feel encouraged. And what I want to tell you is, we will continue to make changes according to our own unit economics model. We don't like follow others in our strategy making.

Our next question comes from Felix Liu with UBS.

[Foreign Language] Let me translate myself. First of all, thank you very much for the time. And thank you very much for the very transparent conference call today. My question is mostly on the customer acquisition cost, which has been a key important factor between the high GSX profitability. What are management's thoughts on this as we head into the spring and especially summer promotion season? On the one hand, we know that the COVID-19 outbreak has driven substantial traffic to online. But on the other hand, we also see competitors getting new rounds of financing, which could intensify the competition for advertising resources. So what are management's thoughts on this area?

[Foreign Language]

[Interpreted] This is a great question. Before we went public, actually we only rose one round of raising of worth USD 50 million. And if you look at Yuan Fu Dao or Zuoyebang, the funds they have rose actually are more than 10x or 20x of us. And if we look back at the performance with us in 2019, we are actually pretty satisfied.

[Foreign Language]

[Interpreted] In February and March, actually, our stock performed pretty good in the market. So that many investors came to us telling us, do you want to do another follow-on or so. Telling us our peers, they're actually raising more fund and the competition is getting more fierce. But just as what I tell you last time, my core belief is, as long as we serve our students and parents to their satisfaction, the money will come -- the cash will come themselves. Education, this industry, we all receive prepaid tuitions, so that feels like the pre-fund raising. In 2019, our net operating cash flow actually exceeded CNY 1.2 billion. But if you look at our peers, their net operating cash flow are like negative CNY 1 billion.

[Foreign Language]

[Interpreted] So as -- when I saw a lot of our peers, they rose a significant size of money, I actually feel pretty happy for them. Number one is because more fund raising for online education means this sector can attract many more top level talents. And number two is more capital will help push the popularity of online education among students and parents. And number three, we saw many great peers. They have a lot of good actions that can give us more pressure to work harder. So one line on top of my employees the most is, this is once in a lifetime opportunity, and we do see that the investors across the globe are happy and they come to invest their money in this online education sector.

[Foreign Language]

[Interpreted] So the last thing I want to mention is, anything that you can buy with money will not be the ultimate threshold of your business.

[Foreign Language]

[Interpreted] Even for talent, talent is not the core competitive advantages. Instead, how you can organize and manage and motivate them that is the core competitive advantages.

[Foreign Language]

[Interpreted] So what I see is the pure traffic acquisition cost to bring new enrollment, actually, this cost -- every player will see this cost converge in the future because everyone can just buy this through money. But what differs us is how we can have the best itself and services and the teacher teaching quality, so that our conversion rate, retention rate, cross-selling and word of mouth outperform others. Those factors actually represent the long-term competitive advantages of an organization.

[Foreign Language]

[Interpreted] So last I want to emphasize that in this industry, you see someone spend $2 to get $1 back. But GSX, we spend $0.90 and we can get $1 back. So my opinion is, it's 1 firm, it still has a net loss margin of like 70% to 90%. If you want to turn it to positive, you need at least 2 years. And in fact, in 2018 and 2019, we actually -- when we do the market spending, we see great pressure because the money we can afford is very little. But if you look at our quarterly growth data, you will actually get an estimate of what our quarterly performance in 2020 will be like. So we are very proud to say that in 2020, when we can guarantee the profitable growth, the money that we can spend in marketing actually is far more than what we are able to do in 2019. And the market spending this year in some perspective, actually, the money we can spend will not be too less than our peers or sometimes might be even the same.

[Foreign Language]

[Interpreted] Okay. So actually our team has -- did research on the most successful companies in the world. And our conclusion is that there's not a few -- there's not 1 great company can raise -- achieve their brand high recognition through burning cash, especially burning cash for long term. Someone might ask, what about Amazon? It has been moving money for years. But if you look at it, actually it's operating cash flow has been positive for many years. And today, we do see many companies that burn a lot of cash, but their operating cash flow is negative. So time will tell, and giving it some more time, we will see a clearer picture. It's not difficult for GSX to raise another big round of funds. But why we stick to our own rules so hard is we always ask our team. So we like money. Actually, what we want to improve more is our respect to our customers and our employees and what we believe starts day 1. Thank you, Rocco. I think we'll conclude our call.

Right. I need to just give a quick conclusion here. [Foreign Language]

[Interpreted] So GSX, we -- as a newly listed company for the past year, we actually went through a lot. And the challenge we are facing today, actually, we feel we are lucky too because this challenge gives us the opportunity to show our confidence, to show our faith and courage to openly disclose the data with the capital market. And we have the opportunity to prove that our data is true and solid. Well, after what happened to Luckin Coffee, me and my team actually received a lot of questions. We actually understand your concerns a lot. But many other investors questions are partial, and you didn't look at our company from a very comprehensive standpoint. Look at our business, strategy and execution, combine them together, so that some investors, they might got their confidence pressed down. And today, we voluntarily to disclose all our data and also all support information actually got stable proof and the confirmation from the third-party vendors. So if any investor is interested, please feel free to sign up with Sandy, which is me, for a Zoom meeting, so that we can show you all the proof we have. And in April, we actually filed our 20-F with the SEC, which received standard, unqualified opinion. And behind this report, actually, there are a lot of efforts that our team and our independent auditors have been paid. So during this coronavirus period, we actually tried our best to open all the accesses to our independent auditors, allow them to do all the interviews with each of our teams and third-party vendors. So at the moment, right now, the market is fragile, but our company -- we really want to be very frank and open and transparent. In the future, we will still face a lot of challenges, but we are also very lucky to have so many investors that support us and contemplate, provide feedback to us, so that we can have a better chance to resolve all the concerns you have. And all your concerns will get our feedback and solutions. And in the future, our team will continue to focus on internal business and keep improving our internal control and help us to grow into a great company.

Thanks.

Thank you, Rocco. You can conclude the call.

Yes, ma'am. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day. Thank you.