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

Good day, ladies and gentlemen. Thank you for standing by, and welcome to the Gaotu Techedu, Inc. Third Quarter 2022 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Sherry Liu, IR Manager for Gaotu. Please go ahead.

Thank you very much, operator. Good evening, ladies and gentlemen, and thank you all for joining us tonight for Gaotu's Third Quarter 2022 Earnings Conference Call. Gaotu's third quarter earnings release was published earlier today and is available on the company's IR website at ir.gaotu.cn. On the call with me tonight are Mr. Larry Chen, Gaotu's Founder, Chairman and Chief Executive Officer; and Ms. Shannon Shen, Gaotu's Chief Financial Officer. Larry will give a general business overview for the quarter, and then Shannon will discuss the financials in more detail. Following their prepared remarks, Larry and Shannon will be available for the Q&A session. I will translate for Larry. Before we begin, I'd like to remind you that this conference call will contain forward-looking statements as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current beliefs and expectations as well as the current market and operating conditions, and they involve known or unknown risks, uncertainties and other factors, all of which are difficult to predict and many of which are beyond the company's control and may cause the company's actual results, performance or achievements to differ materially from those contained in any forward-looking statements. Further information regarding these and other risks is included in the company's filings with the U.S. SEC. The company does not undertake any obligation to update any forward-looking statement, except as required under applicable law. As a reminder, this conference is being recorded. In addition, a live and archived webcast of this conference call will be available on Gaotu's IR website. It is now my pleasure to introduce Larry. Larry, please go ahead.

Thank you, Sherry. Good evening, and good morning, everyone. Thank you for joining us on Gaotu's Third Quarter 2022 Earnings Conference Call. I would like to take this opportunity to convey my gratitude for your continued interest in and support for us and the education industry. Before I start, I would like to remind everyone that all financial information that I mention later is based on RMB unless otherwise noted. In 2022, through gradually deepening our understanding of customer needs, we have been actively exploring new business models and expanding their limits. Undeniably, business transformation is a very challenging process as we have overcome numerous difficulties thanks to our outstanding operational skills and the extensive educational experience we have accumulated in the past 8 years, we have united a more powerful organization with a deep passion for education. At the same time, our capital and talent reserves remain strong. These assets have given us a strong edge when confronting unknown external risks. We are confident that as long as we remain patient and persevere, while remaining true to our original aspirations, we will eventually achieve significant breakthroughs on our businesses and evolve into a greater organization. In this quarter, we divided our business into 2 categories. One is learning services and the other is educational content and digitalized learning products. The new strategic directions within our learning services include educational services for college students and adults, overseas study-related services, nonacademic tutoring services and others. With our new businesses continuing their steady development post restructuring, we are glad to report that during the quarter, our net revenue has increased 12.7% quarter-over-quarter to CNY 606.2 million, and our net loss has significantly narrowed year-over-year. As we are still in the process of business transformation, the gradual and stable increase of our net revenue is solid evidence that these new businesses are growing continuously and sustainably, which boosts our confidence in our future, and indicates that our strategic choices are right, our organization is resilient and our operations are efficient. Due to differences in testing seasons, market demand and the course scheduling, our new businesses exhibit different seasonality patterns. Guided by the strategy of profitable growth, we expect that the growth momentum of our business is to continue, and we expect to see a sizable positive net operating cash flow in the next quarters. Amidst the complex macroeconomic environment, we firmly believe that it's essential to persistently seek progress and sharpen our skills while maintaining a steady pace of direct development. After a year of exploration, we have accumulated a fair amount of insight into our new businesses, which have made decent advances in this quarter, and we will continue to propel our long-term effective growth. Now I will present the progress we made during the quarter from 3 aspects. First, we will continue to place a fundamental emphasis on good teachers. Good teachers are at the core of education and the service and professionalism are the prerequisites with teachers. Our recruitment efforts have always followed the principle that good teachers should not only be able to improve students' academic performances and learning capabilities, but should also serve as an inspiring role model and the mentors who provide emotional support. Take our post-graduate entrance exam preparation business, for example. More than 50% of our tutors in this business line have graduate degrees, a high ratio relative to our peers, and we are aiming to further increase the ratio. In our opinion, teachers who have successfully passed those exams can be more compassionate to students who are going through the same experience. We can better understand the students' needs and therefore, can offer more constructive service and achieve better results. During the quarter, our post-graduate entrance exam prep business recorded a roughly 76% quarter-over-quarter increase in net revenues and over 46% quarter-over-quarter increase in gross billings, which was partly driven by the good branding gradually established by our top-notch teaching talents and their high-quality services. Second, we will continue to focus on improving our operational efficiency. In the quarter, our gross margin reached 72.2%, higher than that of the last quarter of the same period of last year. Our efficiency for customer acquisition also improved, with our ROI for customer acquisition achieved quarter-over-quarter increase. Considering that, in terms of seasonality, the third quarter is the peak season for drawing new enrollments. We seized the market opportunity to increase in size by slightly raising marketing expenses that result in small-scale losses. However, as our customer acquisition efficiency improved and our business expands, we expect to see higher brand exposure and a greater market share and ultimately, more profitability in the mid to long term. Third, we will continue to fulfill our corporate social responsibilities as we strive for effective growth. During the quarter, we co-organized the third Gaotu Rural Education Support Program with China Youth Development Foundation. Through the program, we provided financial subsidies and training classes to principals of rural primary school to help improve their teaching quality, provide assistance for more needed children in these areas and in this way, aid rural revitalization. Further, our Board of Directors today authorized a new share repurchase program under which we may repurchase up to USD 30 million worth of our ADS in 3 years. Our cash position remains strong. As of September 30, 2022, our cash, cash equivalents, restricted cash and short-term investments totaled approximately CNY 3.3 billion. I also intend to purchase up to USD 20 million worth of our shares to demonstrate our management’s unwavering confidence in the future development of our company. Finally, I'm very happy and proud to share with you that on October 19, 2022, we received a closing letter from the SEC regarding its investigation related to a number of short-seller reports from approximately early to mid-2020, and that we had previously disclosed in our annual report for the fiscal year of '20 and '21. In the letter, the SEC notified us that it had concluded its investigation into our company and that, based on the information that it had as of the date of the letter, the SEC did not intend to recommend an enforcement action against us. Integrity is our core corporate value. As a public company, we are fully dedicated to value creation for shareholders and have always ensured timely and truthful disclosure of financial and operational information. Going forward, we will continue to stay true to our original aspiration to educate, continue to nurture talents for our society and to continue to contribute to the educational development of China. Thank you very much for listening. I have concluded my prepared remarks. Now I will pass the call over to our CFO, Shannon, to walk you through our financial and operational details of the quarter.

Thank you, Larry, and thank you, everyone for joining our call today. I will now walk you through our operating and financial performance for the third quarter of 2022. Please note that all financial data that I mention later is based on RMB unless otherwise noted. As we continued to explore new businesses post restructuring against the backdrop of external challenges and uncertainties, we are pleased to report that our business sustained its continuous and healthy growth as we expected, driven by our deepening understanding of the new vertical markets, relentless efforts to optimize our operational efficiency and constant investment in teaching quality. During the third quarter, net revenues increased 12.7% quarter-over-quarter to CNY 606.2 million. Gross billings more than doubled compared to that of last year, with a sharp year-over-year increase of 101.3%, and a slight quarter-over-quarter decrease of 0.8% to CNY 607 million. This solid performance, while in part due to favorable seasonality, was driven by the decent progress of our businesses, which consist of learning services as well as educational content and digitalized learning products. Within learning services, our new business, mainly include: educational services for college students and adults; overseas study-related services; nonacademic tutoring services; and others. Now I will elaborate the progress we made in each of these business lines during the quarter. First, learning services, which accounted for about 90% of net revenues in the quarter, is still the biggest contributor of our revenues. Of the 90%, approximately 30% of the net revenues were contributed by educational services for college students and adults. School holidays are typically high-demand seasons for our businesses related to college students and students from junior to high school, including our post-graduate entrance exam preparation business and overseas study related services, as the holiday coincides with the test-preparation period. Correspondingly, we are glad to see our related businesses achieved high double-digit quarter-over-quarter growth in revenue during the quarter. Further, we have noticed that as the overall number of exam registrants goes up, students’ willingness to participate in preparation courses escalates. And as a result, the market for services related to college students’ further education and job searching is booming. Take the post-graduate entrance exam prep business, for example. According to multiple market research, the number of applicants for China's 2023 post-graduate admission exam is predicted to exceed a record 5 million, representing a year-over-year increase of at least 10%. Additionally, more and more students are starting their preparation as early as their freshman years. We will continue to serve students preparing for such exams with dedicated teachers and comprehensive application planning. At the same time, we have also witnessed cross-registration by these students for other career enhancement courses, such as financial certificate preparation courses or civil services examination preparation courses, which could reduce our customer acquisition costs and improve operational efficiency. Our financial certificate preparation business has achieved profitability for 2 consecutive quarters. Apart from our educational services for college students and adults, the rest of the roughly 60% of our learning services revenues came from services targeting the group of students from primary to high school, including nonacademic tutoring services and others. This sector exhibits a more salient seasonality as course retention and the corresponding sharp increase in gross billings normally happen in the second and fourth quarter. However, the third quarter is the season for acquiring new students. And as a result, during the quarter, we strategically increased our investment in sales and marketing to improve our market penetration rate. As you may have noticed, even though the third quarter is not a peak season for course retention, our gross billings for the quarter remained at the same level as that of last quarter, indicating that the gross billings contributed by new students are taking up a higher percentage due to our effective new customer acquisition strategies. This increase, in effect, will snowball and provide more leverage to next quarter's gross billings. Thus, we expect to see a sizable positive net operating cash flow in the fourth quarter. The remaining 10% of the quarter's net revenues came from educational content and digitalized learning products. This segment mainly includes smart textbooks, learning devices and other digital products for students. These products serve as supplements to our courses, satisfying students' diversified learning needs and will boost user retention on our platform through better user engagement. Next, I will present our financials of the quarter in more detail. Our cost of revenues this quarter decreased by 76.4% year-over-year to CNY 168.8 million. Our gross profit increased 9.4% year-over-year to CNY 437.4 million. Gross profit margin was 72.2%, a 190 basis point increase compared to that of last quarter and a significant year-over-year improvement. Non-GAAP gross profit was CNY 439.3 million, and non-GAAP gross margin was 72.5%. The increase in gross profit margin is largely due to higher service delivery efficiency as well as an increase in the average number of students served by each tutor for our businesses related to college students and adults. Operating expenses decreased by 65.8% year-over-year to CNY 506.9 million. Now let's break down our OpEx. Selling expenses decreased 59.2% year-over-year and slightly increased quarter-over-quarter to CNY 336.8 million. The quarter-over-quarter increase in selling expenses was mainly due to seasonality. The summer vacation is usually the peak new-customer enrollment season for most of our learning service businesses. We allocated marketing investments proportionate to the soaring demand we observed in the market. Through improving operational efficiency and ROI of our marketing expenses, we can gradually increase our brand exposure and market share. We are also exploring various new and cost-effective customer acquisition channels, including but not limited to live-streaming classes, test banks and other exam-practice applications to attract high-intent customers at a lower cost. As a company with a long-term orientation, we will continue to focus on brand building and recognition, to reduce our customer acquisition costs by heavier reliance on word-of-mouth referrals and to enhance user conversion rate and selling expenses ROI through better using targeting and, in this way, achieving sustainable growth. Moving on, research and development expenses decreased 68.3% year-over-year to CNY 106.5 million, accounting for 17.6% of net revenues, which was 1.7% lower than last quarter's R&D margin. This was mainly due to the greater economies of scale as the increase in net revenues outpaced the growth in R&D expenses. We allocated most of the incremental R&D budget to course content development, including recording curriculum design experts with significant experience and influence in their respective fields. General and administrative expenses decreased 61.4% year-over-year to CNY 63.6 million, accounting for 10.5% of net revenues. Loss from operations for the quarter was reduced by 93.6% year-over-year to CNY 63.6 million. Non-GAAP loss from operations was CNY 53 million. Net loss for the quarter was significantly reduced by 94.1% year-over-year to CNY 61.4 million. Non-GAAP net loss was CNY 44.8 million. If we exclude the CNY 17.5 million losses on our offshore RMB reserves caused by exchange rate fluctuations during the quarter from our net loss, the actual net loss margin would be 7.2%. Our net operating cash flow this quarter was CNY 34.7 million. We expect net operating cash flow to turn significantly positive in the next quarter. Turning to our balance sheet. As of September 30, 2022, we had CNY 909.5 million cash, cash equivalents and restricted cash and CNY 2.4 billion short-term investments, which totaled approximately CNY 3.3 billion, providing ample resources for continued business development. Further, as of September 30, 2022, our deferred revenue balance was CNY 638.4 million, which primarily consists of tuition collected in advance. As my speech comes to an end, I would like to take this opportunity to exercise our management's unceasing efforts in fulfilling our responsibilities to shareholders. Our Board today has authorized a 3-year share repurchase program up to USD 30 million. Our Founder and CEO, Larry, has also promised to increase his shareholding by purchasing up to USD 20 million worth of our shares personally. Our management would like to demonstrate our faith and firm confidence in the long-term development of our company. Moreover, the closing letter we received from the U.S. SEC, eliminated potential external negative effects, and is a perfect testament to the high standard in corporate governance, information disclosure and compliance that we have always abided by. Going forward, we will focus more on satisfying customers' needs and continue to create value for our shareholders. Before I provide our business outlook for the next quarter, please allow me to remind everyone that this contains forward-looking statements, which involve risks and uncertainties, which are beyond our control and could cause the actual results to differ materially from our predictions. Based on our current estimates, total net revenues for the fourth quarter of 2022 are expected to be between CNY 608 million and CNY 628 million, representing a decrease of 50.7% to 52.3% on a year-over-year basis. This concludes my prepared remarks. Operator, we are now ready for the Q&A session. Thank you, everyone, for listening.

[Operator Instructions] Our first question comes from Mark Li of Citi.

Management, congratulations on the results, and thanks for the share repurchase and the increased efforts. This is Mark Li from Citi. May I ask for our nonacademic education, could you share about our recent key developments and perhaps outlook for the next year?

Thanks, Mark. Thanks for your question. Our nonacademic tutoring services is one of the new businesses we focused on after our restructure. And this business line is still in the process of optimizing our course products and gradually winning recognition among students and parents. So after the double deduction policy, students have more spare time during their weekends and holidays, which has spurred a huge demand for nonacademic tutoring services, especially among first- and second-tier cities. So we currently offer a variety of nonacademic tutoring services, including programming, chess, international chess, humanity and also science courses, et cetera, that our students like for online education and interaction. These courses are very constructive in sparking children's interest and intellectual curiosity. Our nonacademic courses could enhance students' learning skills and, at some level, can indirectly improve students’ performance back in school. So it has won the trust and support among parents. And also the nonacademic tutoring services follow a progressive and systematic curriculum design. This sector exhibits seasonality as well. Our course retention normally happens in the second quarter and the fourth quarter. So in the second and fourth quarter, it usually has a large increase in the gross billings. We just finished the Q4 retention in November, and the retention rate was as high as 78%, which actually exceeded our expectation and also inspired us. And also the ASP for nonacademic tutoring services is proportionate to the market demand, so its unit economics is more healthy with a high gross profit margin. And as you may have noticed that our gross profit margin also increased this quarter. So based on what we see now, the development of this sector measures our expectations. As this sector is still in the early development stage, we will disclose more information on enrollments and revenues as it matures. But going forward, we will continue to focus on optimizing the product and enhancing our learning experience and continuously improving our course curriculum. But as for the expectations, we're more preferred to provide a more short-term instruction. So we do foresee like the gross billings in the fourth quarter to increase meaningfully, and also, will be having a sizeable positive net operating cash flow in the fourth quarter. And that majority was contributed by our nonacademic education, learning services and others that may serve the students from junior school to high school. Hope that addressed your questions. Thanks, Mark.

Shannon, may I have a quick follow-up? You mentioned about increasing gross billing and positive cash flow in Q4. May I know for our profitability, is it likely to see also a better margin or perhaps like a break-even performance in the Q4?

Yes. So yes, so we foresee Q4, we will be profitable. So the net profit margin will be higher than breakeven, maybe still in the range of a single digit, but it should be a meaningful net profit margin. Thanks.

Thank you, Mark.

This concludes our question-and-answer session. I would like to turn the conference back over to Sherry Liu for closing remarks.

Thank you very much, operator, and thank you, everyone, for joining the call today. If you have any further questions, please don't hesitate to contact our Investor Relations Department or our management via e-mail at [email protected] directly. You are also welcomed to subscribe to our news alert on company's IR website. Thank you very much again for your time. Have a great night.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.