Earnings Call Transcript - GOTU Q2 2023

Katherine Chen, Head of Investor Relations

Thank you, operator. Good evening, everyone. Thank you for joining Gaotu's second quarter 2023 earnings conference call. My name is Katherine, 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 at ir.gaotu.cn, as well as through PR Newswire Services. Joining the call with me tonight from Gaotu's 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 business highlights for the quarter, and then afterwards, Shannon will discuss our financial performance in more detail. Following their prepared remarks, we will open the floor to questions from analysts. Before we begin, I would like to remind you that this conference call will contain forward-looking statements made under the safe harbor provision of the U.S. Private Security 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 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 reconciliations 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.

Larry Chen, Founder, Chairman and CEO

Thank you, Katherine. Good evening and good morning, everyone. Thank you for joining us on Gaotu's second quarter 2023 earnings conference call. I would like to take this opportunity to express my gratitude to all of you for your interest in and support for Gaotu and the education industry. Before I start, I would like to remind everyone that all financial figures discussed today are quoted in RMB unless stated otherwise. During the second quarter of 2023, we continued to execute our effective growth strategy. We grew gross billings substantially on both an annual and sequential basis, while also recording our third consecutive quarter of profitability and generating a sizable positive net operating cash flow. Our net revenue grew 30.7% year-over-year to RMB703.1 million, and our gross billings reached RMB882.3 million up by 63.7% quarter-over-quarter and 44.2% year-over-year. Thanks to ongoing improvements in our organizational and operational efficiency, which delivered a triple-digit year-over-year increase in both income from operations and net income. Our non-GAAP net income margin for the quarter reached 9% and we generated a positive net operating cash flow of RMB288.5 million. Backed by ample cash reserves, we have been steadily ramping up our investments in talent, continuously refining our educational content and services, and persistently improving teaching quality and learning efficiency through artificial intelligence, technological innovation, and organizational upgrades. These efforts have strengthened our competitive edge in terms of content-driven customer acquisition and teaching quality, creating a flywheel effect. As the flywheel started to turn, our customer acquisition experience ongoing improvements in efficiency, and operating leverage began to grow, resulting in increasing clarity for our growth trajectory. Our focus remains on two major business lines, learning services and educational content and digitalized learning products. Learning services continue to serve as the core pillar of our business as the predominant revenue contributor. It mainly includes non-academic tutoring services and other traditional learning services, educational services for college students and adults, and overseas study-related services. We will now discuss business highlights of the quarter from three aspects. First, propelled by the dual engines of product growth and organizational capability, we remained laser-focused on enhancing our products and services. While all of our core business segments continued on our healthy development trajectory, our cost delivery, quality, and operational efficiency also improved during the quarter. With a strong focus on building organizational capacity, we not only cultivated a large pool of highly talented instructors and tutors internally, but also forged a long-term partnership with prominent universities to continuously source passionate teaching professionals. By fostering an innovative and cohesive workforce, we aimed to internally drive business breakthroughs. Meanwhile, our relentless pursuit of excellence in educational products, teaching quality and learning services is best represented by the compelling results our students are able to achieve. I will now share some of the progress and accomplishments we have achieved in this aspect during the second quarter. To start, our non-academic tutoring services booked roughly a 75% year-over-year increase in revenue and generated a positive net cash flow during the quarter. We continuously optimized the product value and service quality and diversified the delivery format to cater to customer needs. As a result, the business delivered a double-digit increase in gross billings on both an annual and sequential basis in the second quarter, operationally, we are glad to see increased user satisfaction as well. In particular, non-academic tutoring services' core offerings saw remarkable improvements in retention rates compared to the same period last year. Educational services for college students and adults, another key component of our learning services, also delivered a solid performance. Within the segment, the post-graduate entrance exam prep business saw a nearly 40% year-over-year increase in net revenue. According to our survey results, the success rate was more than twice that of the national average for the national graduate school entrance exam class of 2023. In addition, some of our overseas test prep and overseas study consulting businesses such as the IELTS prep business achieved nearly triple-digit revenue growth quarter-over-quarter. Finally, our well-established traditional learning services business also delivered a robust performance. According to our preliminary data, more than 210 Gaotu students were admitted to the top two universities in 2023. Going forward, we expect all of our main business lines to sustain high growth momentum while maintaining a high standard of instruction and delivering improved learning outcomes. Second, we are constantly pushing the boundaries through business innovation, expanding into a diverse range of new channels to acquire customers and improve conversion efficiency. Since the beginning of this year, we have been actively exploring innovative customer acquisition channels, including short-form videos and live streaming platforms, aiming to reinforce our competitive advantage by delivering premium content, boosting user engagement and reducing acquisition costs. We are happy to share that the contribution ratio from our self-operated traffic channels increased significantly within certain business segments this quarter. Meanwhile, certain key business lines also achieved breakthroughs in scaling customer acquisition through short video and live streaming. In June, the number of monthly transactional users of the IELTS business acquired through live streaming platforms surged by more than 300% compared to six months prior. The improved efficiency of customer acquisition further contributed to our overseas test prep business's positive monthly net operating cash flow and operating profit. Furthermore, there has been a significant surge in domestic demand for studying abroad as the pandemic's impact gradually recedes and countries around the world ease entry restrictions. It's worth mentioning that in terms of specific efficiency indicators, our selling expenses ROI for this quarter saw nearly a 20% improvement compared to the same period last year. Looking ahead, we will continue to build upon our experience and know-how to further optimize our diverse channel layout. Moreover, we will continue to leverage our lean operations management model to elevate overall operational efficiency. Third, by cultivating talents and investing in emerging technologies, we are able to amplify the impact and value our exceptional instructors and tutors have. This, in turn, unlocks greater front-end productivity and strengthens our organizational capabilities. Recent developments in artificial intelligence undeniably present significant opportunities and raise expectations for the education industry. We have applied artificial intelligence technologies into numerous user case scenarios for our products and services to continuously improve the efficiency of our teams across front-end teaching, back-end research, customer service and design, ultimately enhancing the overall learning experience for our students. I would like to emphasize that making learning better will always be a goal of our endeavoring mission, and we are willing to embrace all opportunities and challenges that lie ahead. Our dedication to addressing customer needs, prioritizing teaching quality and enhancing learning outcomes will remain unchanged. Our continued investment in technological innovation and organizational capability will remain unchanged. Our commitment to our original aspiration to educate will remain unchanged. Guided by our effective growth strategy, we are confident in our ability to create long-term value for our shareholders, customers, and society at large while contributing to the educational development of China. Thank you very much. This is the end of 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.

Shannon Shen, CFO

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 2023. Please note that all financial figures discussed today are quoted in RMB unless stated otherwise. During the second quarter of 2023, our business continued to grow in a healthy manner, achieving profitability while maintaining robust top-line growth momentum. Our net revenues increased by 30.7% year-over-year to more than RMB703.1 million. Our gross billings, a leading indicator of net revenues, increased considerably by 44.2% year-over-year and 63.7% quarter-over-quarter to RMB882.3 million, laying a solid foundation for future revenue growth. Additionally, as net revenues continued to scale, the impact of operating leverage became more evident. During the quarter, operating expenses as a percentage of revenue decreased by roughly 14 percentage points year-over-year and nine percentage points compared to the full-year figure for 2022. Furthermore, key profit metrics improved significantly compared to the same period last year due to greater operating leverage, together with our ongoing efforts to streamline operations and boost efficiency. Our net income experienced triple-digit year-over-year growth, and net income margin improved by approximately 17 percentage points to 8% on an annual basis. Non-GAAP net income increased to RMB63.2 million, with a non-GAAP net income margin of 9%, marking our third consecutive quarter of positive outcomes. Apart from sustaining profitable growth, it is worth mentioning that during this quarter, we also generated a sizable positive net operating cash flow of RMB288.5 million. Our solid financial performance stands as the ultimate testament to our resilient business model, strong organizational cohesion, and continuous endeavors in customer acquisition and operational efficiency. In terms of gross billings, which is a leading indicator of revenue, we attained a 44.2% year-over-year increase in this measure. To align with the school schedule, we designate the second and fourth quarters as our main customer retention season, during which gross billings do not typically rise as high compared to the first and third quarters. On the operational front, we have firmly adhered to the principle of growth and efficiency going hand-in-hand. During the quarter, we achieved healthy year-over-year revenue growth while enhancing customer acquisition efficiency. Our selling expenses in the quarter increased by only 20.5%, compared to the same period last year, but there was an impressive 44.2% year-over-year increase in gross billings, implying roughly 20% growth in our selling expenses ROI. In particular, our new user acquisition efficiency improved by more than 30% year-over-year. This was mainly attained through our continued efforts to explore more innovative channels to target and acquire high-intent students at lower costs with higher returns. Since the first quarter, we have enhanced our autonomy over customer acquisition by exploring proprietary channels. These channels have effectively lowered our customer acquisition costs and enabled us to boost user engagement across our platform through creating premium content. As of the end of the second quarter, some of our key business lines have made promising progress on live streaming and short video platforms, and we will fully leverage the accumulated insights and know-how in other businesses to add value to the company as a whole. Take our overseas test prep as an example. In June, the number of monthly enrollments acquired through live streaming platforms surged by more than 300% compared to six months ago. Additionally, we have already seen the contribution ratio from our self-operated traffic channels surge significantly within certain business segments in the second quarter. Lastly, we also adopted a targeted approach to acquire customers and serve students through localized and personalized operations. Going forward, we will continue to improve customer acquisition efficiency to drive effective growth and create long-term value for our stakeholders. Now, I will walk you through the progress we have made during the quarter. Learning services contributed over 75% of net revenue. Breaking it down, more than 70% of total revenues came from non-academic tutoring services and other traditional learning services, making it a key contributor to our business. For the education industry, non-academic tutoring services represent an emerging vertical with booming market demand and high growth potential, and we expect this segment to be one of our core growth drivers. During the quarter, in addition to turning a profit, this segment achieved a roughly 75% year-over-year growth in net revenue. Our near-term focus for this business line will still be to enhance and upgrade our curriculum design and product development to deliver offerings that exceed customer expectations and to explore some customer acquisition channels that drive continued growth. Leaning on our competitive strengths in traditional learning services, we will further refine our products and services and diversify our delivery formats to cater to customer needs, through which we aim to improve enrollment and retention to promote the sustainable growth of our non-academic tutoring business. The other crucial component of our learning services is educational services for college students and adults, which accounted for more than 20% of the quarter's total revenue. We optimized our product categories and overall metrics to better align with market demand and improve customer acquisition efficiency and profitability by prioritizing acquisition efforts through content-driven proprietary channels. It's worth mentioning that in the second quarter, our overseas test prep business achieved positive monthly net operating cash flow and operating profit as a result of improved customer acquisition efficiency. Now, I will present our financials in detailed numbers. Our cost of revenues this quarter was RMB184.4 million. Gross profit increased 37.3% year-over-year to RMB518.7 million and gross profit margin was 73.8%. Total operating expenses during the quarter increased 8.5% year-over-year and 5.1% quarter-over-quarter to RMB475.4 million. Operating expenses as a percentage of revenue equated roughly 14 percentage points year-over-year, falling from 81.5% in the same period last year to 67.6%. This was approximately nine percentage points lower than in the full year 2022. Similarly, in operating leverage, that resulted in an increase in operating profit margin. Breaking it down, selling expenses increased 20.5% year-over-year and 17% quarter-over-quarter to RMB324.1 million. Selling expenses margin increased roughly seven percentage points to 46.1% quarter-over-quarter, reflecting our increased marketing investment to address the robust demand during the summer season. Moving on, research and development expenses decreased 5.3% year-over-year and increased 1.4% quarter-over-quarter to RMB98.4 million, accounting for 14% of net revenue, which was 0.3 percentage points higher than that of last quarter. General and administrative expenses decreased 19.1% year-over-year and 32.4% quarter-over-quarter to RMB52.9 million, accounting for 7.5% of net revenue, which was 3.5 percentage points lower than that of last quarter. This was primarily attributable to a substantial sequential reduction in share-based compensation expenses. Income from operations increased 171.6% year-over-year to RMB43.3 million and the operating margin was 6.2%. Non-GAAP income from operations was RMB58.3 million and non-GAAP operating margin was 7.2%. Net income increased 212.8% year-over-year to RMB56.2 million, and net income margin was 8%. Non-GAAP net income was RMB63.2 million and non-GAAP net income margin was 9%. Our net operating cash inflow increased 207.6% year-over-year to RMB288.5 million. Turning to our balance sheet. As of June 30, 2023, we held RMB768.2 million in cash, cash equivalents, and restricted cash along with RMB2.9 billion in short-term investments and RMB114.5 million in long-term investments. This total reached approximately RMB3.7 billion, marking RMB388.9 million higher than the same period last year, ensuring ample cash resources for continued business development. As of June 30, 2023, our deferred revenue balance was RMB922.6 million, which primarily consists of tuition received in advance. Based on our current estimate, total net revenues for the third quarter of 2023 are expected to be between RMB728 million and RMB748 million, representing an increase of 20.1% to 23.4% 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.

Operator, Operator

Thank you. We will now begin the question-and-answer session. The first question today comes from Yiwen Zhang with China Renaissance. Please go ahead.

Yiwen Zhang, Analyst

Thanks for taking my question. So my question is actually about Q3 revenue guidance. If you look at on Q2 basis, it's roughly through by a mid-single digit. Such growth rate if compared with normal seasonality, it seems a bit softer. So it would be great if you can elaborate on what is driving that. Thank you.

Shannon Shen, CFO

Thank you, Yiwen, for your question. I believe it's quite representative of our situation. We are projecting revenue for the upcoming third quarter to be between RMB728 million and RMB748 million, reflecting a year-over-year growth of 20.1% to 23.4%. This guidance is based on two main factors. First, we are shifting our focus within learning services for college students and adults, transitioning from scaling operations to prioritizing profitability. Consequently, we have gradually adjusted and phased out some unprofitable units in this area. We expect the revenue from this segment to remain relatively stable in Q3 compared to the same period last year, where it contributed over 30% of our overall revenue, affecting our growth rate for Q3 2023. However, if we focus solely on the K12 related business, we can expect a reasonable middle double-digit growth year-over-year in the next quarter. Secondly, we introduced some lower-priced courses during the summer to increase enrollment, particularly among entrance-level K12 students, which has had a moderate impact on this quarter’s revenue. These enrollments are expected to generate more revenue in the fourth quarter. I hope this answers your question, Yiwen.

Yiwen Zhang, Analyst

Yes, sure. That's very clear. Thank you.

Shannon Shen, CFO

Thanks.

Operator, Operator

The next question comes from Crystal Lee with CMS. Please go ahead.

Crystal Lee, Analyst

Thanks management and congratulations on a strong result. Could you give us some insight on your enrollment growth during the summer season? And what's your marketing strategy going forward? Thank you.

Shannon Shen, CFO

Thanks, Crystal for your question. Yes. So, for the enrollment growth, based on the situation during the summer vacation we have indeed observed some different patterns compared to prior years. On one hand, there has been a concentrated surge in students' learning needs. The overall timing in the summer has leaned towards consistency, resulting in a tighter operational schedule, which is quite different from the vacations influenced by COVID. On the other hand, this summer, parents have allocated a substantial amount of time for their children to travel and go out. This factor also led to a more concentrated study period. Based on these factors, we will be able to manage our organization to fit the parents' demand and the student's time schedules, providing enough capacity to provide the learning services they need. If we look at the summer vacation operations as a management team, we could always have done better. This year, during our reflections, we feel there are aspects that we can improve in the future. For instance, we were a bit conservative in the early stages of teacher recruitment. Facing the boosting demand in summer, early recruitment can reserve sufficient time for teachers to train and therefore guarantee service capacity and quality. On the brighter side, there is huge potential in the education space for us to grow. In summary, the performance during the summer vacation is basically aligned with our expectations, and we will see enrollment start to grow at a more scalable rate; the performance is basically within our expectations. However, going forward, we will refine our operations to achieve a better output income. In terms of the marketing strategy, as we mentioned in our prepared remarks, we will be exploring more innovative channels like live streaming channels and short video platforms. We also want to leverage proprietary content and host some events back in schools to interact with students face-to-face. This way, we can have a clearer picture of our students and customers, which will enable us to acquire new leads and students at a lower cost. In this quarter, we have recognized that, compared to the same period of last year, our sales and marketing ROI has improved almost 20%. We will continue to explore such channels and work to lower customer acquisition costs and build up our competitive advantage across all our channels. I hope that addresses your questions, Crystal.

Crystal Lee, Analyst

Thank you. That's very helpful.

Shannon Shen, CFO

Thanks.

Operator, Operator

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

Katherine Chen, Head of Investor Relations

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 at ir.gaotu.cn directly. 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.

Shannon Shen, CFO

Thank you.

Operator, Operator

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