Gaotu Techedu Inc. Q2 FY2024 Earnings Call

Thank you, operator. Good evening, everyone. Thank you for joining Gaotu's second quarter 2024 earnings conference call. My name is Catherine, and I'll help host the earnings call today. Gaotu's earnings release for the quarter was distributed earlier and is available on the company's IR website, as well as through PR newswire services. Joining the call with me tonight from Gaotu senior management is Mr. Larry Chen, Gaotu's Founder, Chairman and Chief Executive Officer, and Ms. Shannon Shen, Gaotu's Chief Financial Officer. Larry will first provide the business highlights for the quarter, and then afterwards, Shannon will discuss our financial performance in more detail. Following their prepared remarks, we'll open the floor to questions from analysts. Before we begin, I'd like to remind you that this conference call will contain forward-looking statements made under the safe harbor provisions of 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 this and other risks is included in the company's public filings with the U.S. SEC. The company does not undertake any obligation to update any forward-looking statements, except as required under applicable law. During today's call, management will also discuss certain non-GAAP measures for comparison purposes only. For a definition of non-GAAP financial measures and reconciliation of GAAP to non-GAAP financial results, please refer to our second quarter earnings release published earlier today. 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 our Founder, Chairman and Chief Executive Officer, Larry. Larry, please.

Good evening and good morning, everyone. Thank you for joining us on Gaotu's second quarter of fiscal year 2024 earnings conference call. I would like to take this opportunity to express my gratitude to all of you for your interest and support of Gaotu. Before I start, I would like to remind everyone that all financial figures discussed today are quoted in RMB, unless stated otherwise. We achieved encouraging results in the second quarter with net revenues increasing 43.6% year-over-year to RMB1.0 billion, reflecting strong accelerating growth momentum. Our gross billings grew by a substantial 87.4% year-over-year to RMB1.7 billion, which not only exceeded market expectations, but also underscored our growth potential in the education sector. Thanks to our long-term investments in diversified and proprietary channels, we maintained industry-leading customer acquisition efficiency, while serving robust market demand. During the quarter, our net operating cash inflow reached RMB386.2 million. Our cash reserves remained strong, totaling RMB4.1 billion in cash, cash equivalents, restricted cash and short-term and long-term investments, which is RMB361.3 million higher than at the same point in time last year. This ongoing improvement in our operational efficiency is a result of our consistent focus on business health and commitment to our educational aspirations. As of June 30, 2024, our deferred revenue reached RMB1.6 billion, representing a 71.5% increase from the same point in time last year, ensuring robust support for our continued growth in the second half of the year. I will now provide an update on the progress we have achieved in the quarter. We've consistently recognized that learning services and teaching quality form the bedrock of our core competencies. Over the past few months, we have significantly enhanced learning experience and outcomes for students through the continuous optimization and refinement of course content alongside the strategic strengthening of our instructors and tutors' expertise and qualification. For instance, within our educational services for college students, we have increased the proportion of our tutors and content development team holding master's degrees, thereby elevating our overall professional acumen and teaching quality. In our non-academic tutoring services, we have not only fostered our team by raising the percentage of tutors from top-ranked universities, but also diligently refined classroom activities and course design based on student feedback and industry insights. This has boosted greater student engagement, fostering their comprehensive capability in innovation, problem-solving, and self-directed learning. To address individualized learning needs, we have introduced innovative teaching models and flexible course structures that have significantly boosted student engagement and satisfaction. This approach has, in turn, contributed to the overall health of our business. During the quarter, we observed a steady increase in retention rates for our traditional learning services with a particularly notable uptick among new enrollments. These efforts have reinforced our competitive edge within the industry and laid a solid foundation for the effective growth of our business. Looking forward, our strategic priorities will remain focused on refining our educational offerings, improving our teaching quality, and optimizing the learning experience. Top-tier talent is a core driving force behind the long-term growth of our company and the education industry at large. At Gaotu, we have enhanced the professional expertise and stability of our leading instructors and tutors by refining our incentive and valuation framework, strengthening our organizational culture, and expanding our training and feedback mechanism. We have also established a robust recruitment system and made substantial investments in cultivating new teachers. In the first half of 2024, we formed strategic partnerships with over 60 leading universities across China, engaging in collaborative initiatives, such as joint programs and on-campus lecture series. To support new hires, we have implemented programs like mentor orientation and newcomer camp to facilitate their seamless integration into our culture, smooth team integration, and effective transition into teaching roles. These initiatives equip them with the skills and knowledge needed to succeed in their roles. Moreover, we are actively onboarding seasoned industry professionals with extensive industry experience and management capabilities. Their proven methodologies and strategic insights are infusing our rapidly expanding business with invaluable expertise and comprehensive perspective. Going forward, we remain dedicated to cultivating our talent pool to ensure a solid foundation for sustained and effective growth. While rapidly expanding our business, we have maintained an unwavering focus on operational efficiency in terms of customer acquisition. We have proactively increased investment in talent and resources, developed a diverse range of acquisition channels, with a particular focus on building proprietary channels. This strategy not only established a competitive market position for us, but also effectively mitigated risks by fostering closer cross-team collaboration and streamlining operations. We have consistently maintained user conversion rates at a high level. Looking ahead, as our enrollments grow and brand recognition expands, we will continue to leverage the power of positive word-of-mouth to further strengthen our brand and drive effective business growth. June 16 marked the 10th anniversary of Gaotu's founding. Over the past decade, we have stayed true to our educational aspirations of striving for excellence by harnessing the power of artificial intelligence. We are advancing our mission to make learning better and working diligently towards our operational goal of fostering student growth through exceptional teachers and realizing meaningful social value. In response to China's evolving demand for talent cultivation, we co-hosted the second top-notch innovative talent collaborative cultivating academic forum in collaboration with esteemed official organizations, including the Chinese Society of Educational Development Strategy. This initiative underscores our dedication to advancing the framework and practices essential for nurturing innovative talent in the education sector. According to our internal data, the number of Gaotu students admitted to the top two Chinese universities in 2024 has seen an increase from last year, a strong testament to our excellence in cultivating outstanding innovative talent. Our success is fundamentally rooted in the trust and support of our shareholders. We remain steadfastly committed to enhancing shareholder value. As of August 26, 2024, the company had repurchased around 7.9 million ADS in total for approximately US$27 million under the existing share repurchase program. Moving forward, we remain committed to prioritizing customer needs and creating lasting value for our shareholders. Thank you very much. This concludes my prepared remarks. Now, I will pass the call over to our CFO, Shannon, to walk you through the 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 second quarter of fiscal year 2024. We kicked off the year with robust growth and successfully carried this momentum into the second quarter, further scaling our operations while delivering results that exceeded our expectations in both revenues and gross billings. Specifically, net revenues grew 43.6% year-over-year to RMB1.0 billion, outpacing the growth rate we set in the first quarter by approximately 10 percentage points. Gross billings for the first half of the year increased 67.7% to RMB2.4 billion, laying a solid foundation for further revenue growth in the second half of the year. These results reflect our ongoing efforts to boost operational efficiency, address market demand, and enhance teaching quality. Moving forward, we will maintain our focus on core education business, expand our product offerings, attract top talent, and refine operations to capitalize on market opportunities and drive long-term sustainable growth. Before diving into the results this quarter, I would like to first address the seasonality and the volatility inherent in our online education business. To effectively manage the summer surge in demand, we strategically planned and allocated resources ahead of time, particularly for teacher recruitment, team training, and customer acquisition channels. Since there is typically a three to six months lag between these investments and revenue recognition, we recommend using the ratio of gross billings to market expenditure as a key metric to more accurately gauge customer acquisition efficiency for our online business. During the quarter, we dynamically adjusted our investments in marketing activities and customer acquisition channels, which led to better-than-expected gross billings while ensuring acquisition efficiency, thereby successfully delivering on our goal of effective growth. Additionally, since our fiscal quarters do not fully align with the school calendar, the extensive investments made during the summer would span substantially both in the second and third fiscal quarters, impacting our near-term operating profit. We are confident that our strategic investments in summer will drive meaningful growth in student enrollments, further solidifying our market position and boosting brand recognition. Next, I will walk you through the progress we've made during the quarter. Learning services contributed over 95% of net revenues. Breaking it down, more than 75% of total revenues came from non-academic tutoring services and other traditional learning services, representing an increase of nearly 55% year-over-year. Our new initiatives centered around non-academic tutoring services experienced remarkable growth in this quarter. Net revenues and gross billings both surged by more than triple digits year-over-year. Notably, gross billings from new student enrollments soared by more than 200% compared to the same period last year. These results speak volumes about the strong market recognition our educational products and learning services have received. For the first time, this segment contributed more than 20% of total revenues, making it one of our key revenue drivers. This success is the result of our key insights into market trends and deep understanding of user needs, which have enabled us to continually optimize curriculums and learning services, making them more engaging and interactive while better integrating the underlying transferable knowledge and skills. Additionally, the average number of enrolled courses per student also improved on a year-over-year basis, further demonstrating the effectiveness of our courses and services in addressing user needs. Our educational learning services maintained a healthy growth trajectory. During the quarter, this segment saw a high double-digit year-over-year increase in gross billings, with revenue growth exceeding 40% compared to the same period last year. Our ongoing efforts to optimize and refine learning services significantly boosted student retention, especially for new enrollments. Moreover, the notable enrollments in our overall student structure and a more diverse student base further bolstered the health of this segment. The other crucial component of our learning services is educational services for college students and adults. During the quarter, this segment contributed just under 20% of total revenues, growing roughly 10% year-over-year. To better address the diverse learning needs of users from various backgrounds, we have rebranded our postgraduate entrance exam prep services into educational services for college students and expanded our offerings to include services such as CET4 and CET6, examination prep and career consulting. Additionally, we have partnered with prestigious institutions to provide high-quality educational content and resources to college students, servicing their need for academic support, career planning, and quality job opportunities. During the quarter, gross billings from our educational services for college students increased by high double digits year-over-year, while revenues from our overseas study-related services rose by high double digits. I will now present our financials in more detail. Our cost of revenue this quarter was RMB313.4 million. Gross profit increased 34.3% year-over-year to RMB696.4 million, with a gross margin of 69.0%. The year-over-year decrease in gross margin was predominantly a result of changes to our product mix. Total operating expenses during the quarter increased 144.2% year-over-year to about RMB1.2 billion. Breaking it down, selling expenses increased 157.8% year-over-year to RMB835.4 million, accounting for 82.7% of net revenues. This was partially attributable to our proactive recruitment of short-term tutors at the beginning of the quarter to ensure operational efficiency during the peak summer season. The increase also reflected a rise in our marketing expenses in response to heightened market demand over the period, while maintaining solid unit economics. Research and development expenses increased 64.7% year-over-year to RMB162.1 million, accounting for 16.1% of net revenues. General and administrative expenses increased 209.3% year-over-year to RMB169.6 million, accounting for 16.2% of net revenues. The increase was largely driven by the recruitment of seasoned management professionals and operational staff to support and scale the growth of our online business and the expansion of our offline operations, ensuring the smooth development of our business. Loss from operations was RMB464.8 million and operating margin was negative 46.0%. Non-GAAP loss from operations was RMB453.2 million and non-GAAP operating margin was negative 44.9%. Net loss was RMB429.6 million and net income margin was negative 42.5%. Non-GAAP net loss was RMB418.0 million and non-GAAP net income margin was negative 41.2%. Our net operating cash inflow was RMB386.2 million. Now, turning to our balance sheet. As of June 30, 2024, we held RMB1.4 billion in cash, cash equivalents, and restricted cash, along with RMB1.8 billion in short-term investments and RMB905.8 million in long-term investments. This comes to a total of over RMB4.1 billion, approximately RMB301 million higher than at the same point in time last year. As of June 30, 2024, our deferred revenue balance was RMB1.6 billion, which primarily consists of tuition received in advance. As of August 26, 2024, we had repurchased an aggregate of around 7.9 million ADS on the open market for approximately US$27 million under the existing share repurchase program. We will continue to execute stock buybacks in accordance with the guidance of the Board of Directors and create long-term 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 include risks and uncertainties that 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 third quarter of 2024 are expected to be between RMB1.188 billion and RMB1.208 billion, representing an increase of 50.5% to 53.0% on a year-over-year basis. This concludes my prepared remarks. Operator, we are now ready for the Q&A section. Thank you, everyone, for listening.

We will now begin the question-and-answer session. Please note that the first question today comes from Alice Cai with Citibank. Please go ahead.

Good evening, Larry and Shannon. I have a question about the offline expansion, because we've noticed the increase of losses, probably related to offline expansion, I guess. Could you please share some insights on the progress of offline expansion? For instance, how many cities have you entered? How many learning centers have you opened so far? And how is the student enrollment in the city? Any color will be appreciated. Thank you.

Thanks, Alice. You were asking about our offline business expansion progress and the numbers of learning centers, right? And we are very glad to share the progress we have made on our offline business. Relying on the brand recognition and the industry influence of our Founder, Larry, a highly efficient and professional team was rapidly assembled in the first half of 2024, providing a strong foundation for our offline operations. And therefore, the expansion of learning centers, both in terms of city coverage and the number of learning centers, has significantly exceeded our expectations at the beginning of the year. At the same time, the business is progressing steadily and rapidly with notable achievements across many tasks. On the journey of exploring our offline business, we found several key parts where offline and online business can work synergistically. Firstly, in teacher recruitment, we have a strong capability in recruiting top-tier talent from prestigious domestic universities like Beijing, Fuzhou, and also other top-notch universities. Our headquarters recruitment team has been able to cross these institutions combined with the abilities to share excellent teaching resources to our offline operations, providing critical faculty support for our offline operations in their early stages, which is very important for an offline learning center. This will greatly enhance the quality of our offline education, offering students superior educational resources, because we all know that teachers are the most significant factors in all offline learning centers. Secondly, in terms of educational products and content, the meticulously refined online teaching materials, particularly those overlapping with offline education, can be shared. This could significantly increase the efficiency of our offline education product process. This is only conservative resources, but also ensures that offline teaching is supported by high-quality content. Furthermore, the most importantly is our brand awareness. Compared to other brand new offline education brands, our brand holds significant value in demand of parents and students, providing a strong boost to our offline business. However, there are notable differences between offline and online operations that have been identified in the past half of the year. Offline education products place a greater emphasis on localization and personalization. Given our simultaneous expansion into multiple cities and multiple learning centers, current education research efforts are being paid to meet the specific needs of students in different regions. That means we need to invest in localized content at this stage, which partially explains the increase in our R&D expenses. Additionally, the operation is quite different if we compare the online business to the offline business. We need to develop an operational support system distinct from our online business, requiring investment in product research and development. For example, systems to support site selection and renovation of campus as well as systems for student check-ins and class rescheduling, etc. These significant differences in operational details between online and offline business make a comprehensive operational support system crucial for our multiple locations and multiple campus expansion. Such a system will significantly enhance operational efficiency and ensure that our offline business operations will be successful. At the same time, we fully recognize that the entry barriers for offline business are very high and the moat is deep. Building systems for teacher recruitment and training, principal cultivation, educational products, and operational support requires a long cycle. We do not underestimate the challenges of accessibility, recognition, and reputation among students and parents as a new entrant, nor do we overlook the time and cost of team integration and development. However, we are deeply committed to our offline business strategy with a high level of patience and determination. The current investment is of great importance for our long-term growth. Finally, when the time is right and when our offline revenue contribution reaches a significant level, we will begin disclosing relevant operation metrics, including the cities we entered and also the numbers of our learning centers. That can help us gain a more comprehensive understanding of the progress of our offline business in the future. Thanks, Alice.

Thank you, Shannon.

Great. Thank you, management, for taking my question. I think in your prepared remarks, you mentioned AI. So, my question is regarding the AI empowerment in education. Just wondering what is management's view and what is your strategy in this field for different business segments? And how much potential operating efficiency gains do you think AI will bring to your business? Thank you.

Yeah. Thanks, Timothy. This is a very good question, and the whole management team is paying a lot of attention to the most recent developments in artificial intelligence. With the rapid development of AI technology and the continuous evolution and development of AI firms in various industries recently, we have a more profound and clear understanding of the application of artificial intelligence. Larry personally visited the United States and met several entrepreneurs in Silicon Valley to gain the most recent knowledge about artificial intelligence. So, currently, AI has been widely used in quite a few aspects of our business, and the current applications are mainly focused on internal cost reduction and efficiency improvement. Firstly, in the field of teaching product design and research and development, artificial intelligence can help our designers improve efficiencies by automatically correcting the students' homework and AI oral language practice that the students can engage with on our application for their daily oral practice. Furthermore, the design of more interactive AI teaching products are being used to assist all of our tutors and teachers to provide more personalized learning for our existing students. However, currently, the majority of our products are directed towards our existing students instead of promoting them to new students because we want them polished and ensure they create incremental value for our students before introducing them to the market. Secondly, in the area of Internet product research and development, AI has significantly improved the efficiency in front-end research and development, including our internal instant message system and other internal efficiency tools; we have applied AI technology to enhance our office productivity. Finally, in other operational links such as customer service and automatic responses, AI is also playing an important role in reducing costs and improving efficiency across different links. We believe in the future, as the technology develops, artificial intelligence can create tremendous value for our company. But right now, we prefer a conservative investment strategy in this field. Currently, we only use it to improve our internal efficiency at this stage. Thanks, Timothy.

Thank you, Shannon.

Thank you for taking my question and congratulations on a strong quarter. My question is that we see the guidance that quarter three will be a faster growth quarter. Can you share more color about the revenue growth breakdown for quarter three, like, say, online or offline, and in fact, business segment? Thank you.

Thanks, Summer. We wouldn't be able to hear clearly, but I guess you were asking about the revenue guidance for the next quarter. I do think the guidance should be diving into the numbers deeply. As of now, our gross billings in the first half of the year is approximately RMB2.4 billion, with a year-over-year growth rate of about 67.7%, and the deferred revenue balance increased over 30% year-over-year. That all indicates a higher revenue growth rate in the third quarter, right? The upper limit of revenue guidance we provided in the earnings release is RMB1.208 billion with a year-over-year growth rate of 53%. It appears that the growth rate of gross billings is much higher than that of revenue. There are mainly two reasons for this. First, the class schedule in September, which is the last month in Q3, has one less weekend compared to 2023, which negatively impacts the year-over-year growth rate by approximately 5 percentage points and the related revenue will be recognized in Q4. Secondly, we conducted some special price class operations for entrance-level grades during the summer course, seizing the strategic window to increase the student scale. For these students, the main contribution in Q3 is gross billings instead of revenues; the revenue contribution will be present in Q4. We can continuously predict the revenue growth rate in Q4 by referring to our Q3 gross billings growth rates along with Q1 and Q2 gross billings. This is also typical seasonality of the online large live class business model. The combined effect of these reasons causes our revenue guidance to fall within the currently indicated range. As for your second question regarding the breakdown of our offline revenue contribution and online revenue contribution, as of this year, the offline revenue contribution is not significant enough to be disclosed separately. So, the majority of the contribution of revenue and gross billings were derived from our online business. Thanks, Summer. Hope that addresses your question.

It's very clear. Thank you.

Thanks management for taking my question. So, I see you have exceptional new enrollment in this summer reflected by your gross billings growth. Could you elaborate more on the main driver behind this? And how about the retention of these new enrollments? And my second question regarding your marketing strategy going forward. Thank you.

Sure. Thanks a lot. Right, actually, Q2 is a critical quarter for our business every year because there were two significant events happening in the second quarter. The first is the retention that usually happens at the end of April or the early May. In the past few years, we have continually invested in our teachers' recruitment and training and have been perfecting our educational product. As I mentioned in my prepared remarks, we see our retention rate continues to increase, especially for our newly joined students. That's something we really have confidence in for our future business. The second important part is the preparation for the summer campaign that has usually started in mid-May. This summer, the education market has shown a vibrant landscape, and we've felt the strong demand firsthand. To ensure we fully meet the diverse learning needs of students and parents during the summer, we proactively planned operations to better seize this valuable opportunity. In terms of our teacher recruitment training, we understand that excellent teachers are the key to the success of our summer operation. Outstanding teachers and tutors provide high-quality educational services, greatly enhancing the learning experience. Thus, we initiated the recruitment of tutors early this year, followed by comprehensive and systematic training immediately thereafter. Most teachers began their training four to six weeks in advance, focusing on professional skills, teaching mastery, and improving their communication skills. This thorough preparation allowed them to approach their summer teaching assignments with greater passion and professionalism. Additionally, regarding your second question about our customer acquisition channels, we have characterized ourselves by a highly diversified approach, particularly in the live streaming sector, where we've already achieved scalable customer acquisition and also contributed a majority of the customer acquisition this summer. We intensified our investment during the summer and successfully attracted attention from both students and parents. During the summer enrollment period, we fully capitalized on the benefits of this diversified channel strategy. Furthermore, we actively expanded other channels such as social media and some offline channels to comprehensively reach potential customer groups, thereby increasing brand awareness and influence. Through these strategic and operational measures, we successfully achieved the expected growth in student enrollments, and we've maintained a favorable level of return on investment of our sales and marketing expenses. Based on the information from third parties, we've conducted channel tracking during the summer vacation, and we found our customer acquisition cost remained relatively low within the industry. This reflects the effectiveness of our operational strategies and gives us a competitive edge in the market. We will continue to optimize our operations to provide even better educational services to students and parents. For our customer acquisition channels, we will further optimize the structure of the channels and ensure that low-cost channels and more private-type channels contribute more to student enrollments in the future. Thanks, Crystal.

Thanks, Shannon. That's very helpful.

Thank you, 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 email. You are also welcome to subscribe to our news alert on the 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.