Earnings Call Transcript - GOTU Q2 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Gaotu Techedu Inc. Second Quarter 2021 Earnings Conference Call. Please note, this event is being recorded on Wednesday, September 22, 2021. I would now like to hand the conference over to your first speaker today, Ms. Sandy Qin, IR Director of GOTU. Thank you. Please go ahead.

Sandy Qin, IR Director

Thank you, Operator. Hello, everyone, and thank you for joining us today. GOTU's earnings release was distributed earlier and is available on the company's IR website at ir.gotu.com. On the call with me are Mr. Larry Chen, GOTU's Founder, Chairman, and Chief Executive Officer; and Ms. Shannon Shen, Chief Financial Officer. Larry will give a general overview, and Shannon will discuss the financials. Following the prepared remarks, Larry and Shannon will be available to answer your questions. I will translate for Larry. Before we begin, I would like to remind you that the conference call contains 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 expectations and current market and operating conditions, and related events that 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. Further information regarding these and other risks, uncertainties or factors is included in the company's filings with the SEC. The company does not undertake any obligation to update any forward-looking statements, 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 GOTU's new Investor Relations website at ir.gotu.cn. It is now my pleasure to introduce Larry. Larry, please go ahead.

Larry Chen, CEO

Thank you, Sandy. Good evening, and good morning to you all. Thank you for joining us today on our second quarter 2021 earnings conference call. In the second quarter of 2021, our revenue has reached a record high of RMB2.232 billion. Selling expenses margin in the quarter has also substantially dropped and has reverted to a similar low level that we recorded a year ago, and we have entirely stopped new fee advertising spending since mid-May this year. As you all know, the education industry has experienced some changes over the past few months. However, as the saying goes, we will begin with the end in mind when setting our strategy. We will always remain committed to our original aspiration of quality education, and we will seek to provide authentic educational services. In the meantime, we have actively shouldered our social responsibility at our education company. Ever since May, we have successfully collaborated with multiple nonprofit organizations, including the China Charity’s Aid Foundation for Children, the China Youth Development Foundation and the China Next Generation Education Foundation and Henan Normal University by donating cash or free courses to aid the revitalization of rural area education and supporting the goal of providing equal access to education for all. To actively respond to the nation's call, we have recently and rapidly adopted the organizational structure of our company to focus on professional education and STEAM education. And we are further exploring opportunities related to digital products and vocational education. First, we will continue to expand our investments in our existing professional education segments, such as financial certificate and public office exam preparation, while constantly exploring more professional education portfolio opportunities, including post-graduate exam preparation and overseas studies preparation, among which Some have already achieved a better-than-industry average online. We aim to establish a diversified professional education portfolio with multiple segments. Secondly, we have also increased our investments in our STEAM education segment, which is developing rapidly. Take programming as an example. Just in July 2021, the conversion rate from trial classes to regular price for courses exceeded 30%. Thirdly, we are simultaneously exploring new opportunities in various products and vocational education, continuing to reinforce the positive effect technology has on educational content and tools while expanding our footprint across the education sector. We firmly believe that the education market in China will continue to grow steadily. We also firmly believe that the current education firm will play a very important role in education. We are confident that our company will live up to our responsibilities and mission. Since spring, we have made numerous breakthroughs in the K-12 area, including streamlining the higher industry supply chain, refining the standard procedures, training experts, and improving operational efficiencies, all of which helped us accumulate a great deal of insight and expertise. We now plan to replicate this insight and expertise in STEAM education, professional education, and vocational education. We sincerely hope that we can soon return to the profitable growth trajectory that we saw back in 2019. As many of you know, our company experienced a severe cash shortage in 2016 and 2017 and almost went bankrupt. We call it our darkest moment internally. But it was exactly that pressure that we came together as a united and effective team with coherent and exemplary execution to build a miraculous business that generated rapid revenue growth and growing profitability over seven consecutive quarters. If 2014 was our first time as a start-up and 2015 was our second start, then we can say that 2021 is our third start. As someone who has worked in the education industry for 33 years, I believe we should always have love for our families and our country, always keep the end goal of education in mind, always firmly believe that education is a noble profession, and always have faith that the future ahead is bright, both for our industry and our society. Now I will pass the call over to our CFO, Shannon, to walk you through our financial and operational details.

Shannon Shen, CFO

Thanks, Larry, and thank you, everyone, for joining the call. Now I will walk you through our operating and financial results. Please note that all financial data that I mention later is in RMB terms unless otherwise noted. First, allow me to share with you some details about the compliance status post-policy changes. On July 24, 2021, China's official state media, including Xinhua News Agency and China Central Television, announced the opinions on further alleviating the burden of homework and after-school tutoring for students in compulsory education, which was issued by the General Office of the CPC Central Committee and the General Office of the State Council. We later issued an announcement informing that the policy will have a material impact on our operations. Since the new policy announcement, we are dedicated to respond within the shortest time possible and to adjust our business and strategy accordingly with high compliance standards. This can be seen from the following aspects. Regarding advertising, we stopped acquiring traffic from online social platforms since the second quarter. Regarding class hour adjustments, we strictly abide by the new rule that after-school tutoring institutions shall not organize any classes on national festivals, weekends, or summer and winter holidays. We have adjusted our full class schedule for compulsory education classes from weekends and national festivals to the legal time from Monday to Friday as required by the new policy. Based on the data we have, the retention rate after schedule adjustment is in single digits. Regarding the standardization of content, we strictly tracked and reviewed our content to make sure no content is out of regulatory limits. Regarding the requirement on tuition prepayments, according to the requirement by the Beijing government regarding the management of upfront tuitions for after-school tutoring institutions, we have technologically collaborated with custodian banks to monitor upfront tuition, return the required funds properly, and ensure our clients' right to refund is protected. Moving on, we will continue to focus on the following two aspects. First, regarding fee standards on tuitions. On September 6, the National Development and Reform Commission, the MOE, and the State Administration for Market Regulation jointly issued an announcement on adopting a government-guided pricing mechanism for curriculum-based after-school tutoring courses for students in the stage of compulsory education. Online and offline subject tutoring institutions for students at this stage must adopt government-instructed price limits, with the upper limit set by local governments no higher than 10% and no lower limits. Up until now, we have not yet received any price list guidance on the price control for online education. We will adjust our pricing once we have received specific government instructions. Second, in terms of turning academic AST institutions for students at the stage of compulsory education into not-for-profit organizations, we will continue to communicate with the government. Gaotu will strictly abide by all the laws and regulations and communicate with all of our stakeholders promptly. Now let's review our financial and operational status for this quarter. For the second quarter of 2021, net revenues increased 35.3% year-over-year to CNY 2.23 billion, driven by our continuously expanding paid course enrollment growth, thanks to our enhanced teaching quality and brand recognition. Gross billings, the leading indicator for net revenue, was CNY 2.7 billion, increasing by 12.2% year-over-year from CNY 2.4 billion last year. Paid course enrollments, which refers to enrollments priced at or above CNY 99, increased to a record high of CNY 1.63 million for the quarter, a 4.1% year-over-year increase. Now let's break down our operations and financials by business lines. Net revenue from our K-12 courses, including STEAM courses, increased by 51% year-over-year to CNY 2.09 billion, accounting for 94% of net revenues. Gross billings contributed by K-12 courses increased by 17.2% year-over-year to CNY 2.58 billion. Paid course enrollments for K-12 grew by 4.5% year-over-year to CNY 1.56 million. Average enrollments processed were 1,700 in the second quarter of 2021 compared to 2,300 in the previous quarter. For the above quarter, the number slipped slightly because we offered shorter-term courses with smaller class sizes to cater to various students' needs. Net revenues from our foreign language, professional, admission, and other vocational education services grew to CNY 141 million and accounted for 6% of net revenues. Gross billings contributed by foreign language, professional, admission, and other services reached CNY 120.2 million. Paid course enrollments for foreign language, professional, admission, and other services hit 68,000. Moving over to our selected financial metrics summary. Our cost of revenues increased by 100.8% year-over-year to CNY 724 million. The year-over-year growth rate was mainly due to increases in compensation for instructors and tutors, learning materials, rental expenses, as well as salary and other costs. GAAP gross profit margin decreased to 67.6%, down from 78.1% in the same period of 2020. Non-GAAP gross profit margin, which excludes share-based compensation, decreased to 69.1%, down from 79.1% in the same period of 2020. The decrease was primarily due to an increase in the number of tutors to enhance our service level and the personalized experience that our students receive, as well as an increase in compensation for such staff. Selling expenses increased to about CNY 1.64 billion in the second quarter of 2021. Within that, expenses for traffic acquisition were approximately CNY 0.9 billion. Expenses for branding activities were approximately CNY 95.1 million, hence the remaining expenses covered labor, servers, etc. The selling expenses margin decreased year-over-year to 74%. We have seen continued improvement of margins, which have fallen back to their original level a year ago since we stopped news feed and online advertising spending in May. Research and development expenses increased by 204.9% year-over-year to CNY 427 million. The increase was primarily due to an increase in the number of course professionals and technology development personnel, as well as an increase in compensation for such staff. G&A expenses increased by 128.9% to CNY 242 million, mainly due to an increase in G&A headcount and related compensation. Non-GAAP net loss was CNY 763.9 million compared to net income of CNY 72.7 million in the first quarter of 2020. GAAP net loss margin was 41.2%. As of June 30, 2021, we had CNY 1.02 billion of cash and cash equivalents, restricted cash; CNY 3.95 billion of short-term investments, and CNY 518.5 million of long-term investments, combining to be CNY 5.49 billion. As of June 30, 2021, our deferred revenue balance was CNY 1.98 billion. Deferred revenue primarily consists of the tuition collected in advance. Net operating cash outflow for the second quarter of 2021 was CNY 318.6 million. Considering the uncertainty that the government policy brings to the following financial conditions, we will not provide the next quarter's performance guidance for now. That concludes my prepared remarks. Operator, we are now ready to take questions. Thanks.

Operator, Operator

The first question comes from Stephen Yang with Goldman Sachs.

Stephen Yang, Analyst

So we've got two questions. First is on the plans and priorities for the next 12 months. For example, on professional and STEAM. And more details on how the company has reorganized so far accordingly. For example, what percentage of the organization can be tied to the future plans?

Larry Chen, CEO

Thank you. So we believe under the current policy guidelines, we are the first online education company to formally adopt online teaching services for 3- to 6-year-old children. We are the first education company to fully stop all traffic acquisition spending on free channels. I believe we might also be the first among the top players to have a comprehensive and very rapid reorganization through further classes on our courses given. So in the next couple of months, we will focus on two assets. First of all, we will focus on our organization, focus on talent, and focus on delivering the best product. In the past seven years, I think the previous wealth we have accumulated across the organization, our brand and the recognition we have realized that it is time. So we will continuously position our organization to grow in a healthy and more powerful way. We will continuously train our talent, so our people can have better growth. We will continuously improve and optimize our products. We will develop the product that our customers really like, so that we can use our products to represent our organization service plans. According to the current policy, the double reduction policy mainly focuses on child free education and after-school tutoring. I believe, despite the uncertainty brought by certain policy monitoring, we will focus on three business lines. First, professional education. As you know, we have started this assessment since 2016, and we have accumulated a lot of experience, and we have made some trial and errors. As we adjust our operating model, we will definitely make breakthroughs in STEAM courses. As I spoke earlier, we have tried programs, and we have seen a lot of great data. Going forward, we will further explore the STEAM courses. Lastly, we will try vocational education and also digital products. We are exploring some opportunities, and according to our long-term development plan and the position of the company, I believe we will achieve great results.

Stephen Yang, Analyst

Got it. The second question is regarding not-for-profit organization. So the MOE has published a document specifying the measures of online education re-registration. Would you mind sharing the company's registration progress so far? If registered as a not-for-profit organization, how will that impact shareholders, for example, the onshore and offshore assets?

Shannon Shen, CFO

Thanks, Stephen. On September 16, the MOE and other six government ministries jointly announced guidance stating that online education institutions need to change from a registration-based regime to an approval-based regime. For compulsory education service providers, all service providers need to be approved as not-for-profit institutions by the end of this year. This is like a high-level instruction. According to the announcement, the requirement for being approved is that the organization must have been registered with the government in the past, which Gaotu has already done in 2020. We were already on the list issued by the Beijing Education Bureau. Other requirements to be approved also include having qualified offline training centers, having secured data, and privacy. We will strictly follow the notice to ensure full compliance and maintain frequent communications with the regulators. Besides the announcement, we are talking to the regulators weekly to get more detailed instructions about how to proceed in the coming months. So this status is ongoing. We will update you once we have clear and specific instructions.

Operator, Operator

The next question comes from Mark Li with Citi.

Mark Li, Analyst

May I ask a question on the staff optimization given the significant change of our focus from subject-based tutoring to other areas? How large would the staff optimization be? When do you think it would last? And what would be the cash impact on the over RMB5.5 billion of cash we have on hand?

Shannon Shen, CFO

Thanks, Mark. We reacted immediately after the double reduction policy was released. The restructuring was completed back in July and August. We closed certain operating centers outside of Beijing, and we also paid severance costs for some of the employee layoffs. It was a tough decision, but making it quickly allowed us precious time to think about our future and make the right decisions. We expect our company size and employee scale to be stable in the short term as we explore our new businesses. From the cash perspective, we have around CNY 5.5 billion of cash and cash equivalents, as well as short-term and long-term investments on hand. Even after paying cancellation penalties for lease agreements or severance costs, we still have sufficient cash to continue to develop and explore new business and support our future endeavors. The key for us is how to provide high-quality learning products that meet the demand for vocational education, professional education, and STEAM courses. As Larry mentioned, we are also developing our digital products to provide more efficient learning methodologies for our customers. This is our third time exploring new business, and we are committed to assuring you that the team still holds faith in the future of the education industry and the company.

Mark Li, Analyst

May I know the number of tutors we currently have?

Shannon Shen, CFO

After all the restructuring for our employees, we still maintain sufficient tutors to support the learning service for our first-semester students. The current number fits that of our company size. We will adjust the employee scale and skill to fit the future development of our company.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Ms. Sandy Qin for any closing remarks.

Sandy Qin, IR Director

Okay. Thank you, operator, and thank you, everyone, for joining the call today. If you have any further questions, please don't hesitate to contact the company or reach out to us via e-mail at [email protected] directly. Please feel free to subscribe to our news alert for quarterly investor newsletters on the company IR website. Thank you very much.

Operator, Operator

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