Earnings Call Transcript - GOTU Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Gaotu Techedu Inc. Second Quarter 2022 Earnings Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Ms. Sherry Liu, IR Manager of Gaotu. Please go ahead.

Sherry Liu, IR Manager

Thank you very much, operator. Good evening, everyone, and thank you all for joining us tonight for Gaotu's Second Quarter 2022 Earnings Conference Call. Gaotu's second quarter earnings release was published earlier today and is available on the company's IR website at ir.gaotu.ca. On the call with me tonight are Mr. Larry Chen, Gaotu's Founder, Chairman, and Chief Executive Officer; and Ms. Nan Shen, Gaotu's Chief Financial Officer. Larry will give the general business overview for the quarter, and Nan Shen will discuss the financials. After the prepared remarks, Larry and Nan Shen 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 we filed 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 will involve known or unknown risks, uncertainties, and other factors, all of which are difficult to predict, 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 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 Gaotu's IR website. It is now my pleasure to introduce Larry. Larry, please go ahead.

Larry Chen, CEO

Thank you, Sherry. Thank you for joining us on Gaotu's Second Quarter 2022 Earnings Conference Call. Before I start, I would like to remind everyone that all financial information that I mention later is based on RMB unless otherwise noted. During the second quarter of this year, our STEAM sales sustained a healthy and stable growth. Our growth billing nearly doubled compared with that of last quarter, and we successfully generated positive net operating cash flow. Moreover, our net loss substantially narrowed year-over-year, and this is the third consecutive quarter that we realized non-GAAP profitability after our business restructuring. Going forward, we will continue to focus on educational services for college students and adult non-academic tutoring services as well as educational content and digitalized learning products. We will continue to uphold our strategy of profitable growth and strive for effective growth through improving operational efficiency and optimizing cost structure. During this quarter, our net revenue reached RMB 537.8 million, and our gross billing increased 92.3% quarter-over-quarter to RMB 611.7 million. To provide a consistent basis of comparison, if we compare continuing businesses, the net revenues of our comparable business sales increased over 30% quarter-over-quarter, and the gross billings of comparable businesses have achieved quarter-over-quarter growth for 4 consecutive quarters. Further, our gross margin this quarter was 70.2%, slightly higher than that of the same period of last year. Additionally, we generated a net operating cash flow of RMB 93.8 million, demonstrating that we have achieved effective growth. In the second quarter, we upgraded our user products and made solid progress in our main businesses. Additionally, we saw decent improvement in some of our key operational metrics, including ROI for selling expenses and employee efficiency. I will now briefly talk about the progress we made in each of these areas during the quarter. First, in terms of product upgrades, we have repositioned and transformed the Gaotu APP from a cross delivery tool into a comprehensive learning content and service platform. To better serve our students, we have equipped our APP with additional tools, including independent mini-programs for key business lines, delivery of live streaming announcements and exam guides as well as new features such as mock examinations, test banks, teacher-student interactions, and exam reminders. After the upgrade, daily active users, student retention rate, and the number of newly registered users for our APP all showed gradual increases. The improvement in the level of user engagement demonstrates that our APP fulfills students' multilevel and highly diversified needs and solidifies our corporate mission as a learner-centric, lifelong learning and service platform. By reaching out to a larger and broader customer base, our APP has delivered better performance in customer retention and generated more synergies among our business lines, thereby expanding our customer acquisition channels while reducing marketing costs. Going forward, we will continue to enhance our products with dedication to make learning a better and more convenient experience through technology and innovation. Second, we saw stable development for our key product lines during the quarter. In May, we released the Gaotu college students' postgraduate entrance examination white paper, which presents detailed guidance and a new medical analysis that we summarized based on numerous surveys and studies, intended to help students better prepare for their exams. According to our survey results, the success rate was more than double that of the national average for our 2022 class for the national graduate school entrance exam. Additionally, our non-academic tutoring services also delivered a solid performance this quarter. It not only achieved quarterly operating profit but also contributed positive net operating cash flow. With a continuous effort to refine and optimize our products, we are pleased to see a higher user satisfaction. For instance, the retention rate of our programming tutoring business was almost 8% during this quarter, and its gross billings increased significantly quarter-over-quarter. We believe that a high retention rate is the best indicator of user satisfaction. Going forward, we will continue to optimize our products and services to further increase retention rates and customer satisfaction. Third, ROI for selling expenses and employee efficiency both increased during the quarter. ROI for selling expenses doubled compared with that of the last quarter and employee efficiency also nearly doubled quarter-over-quarter. Going forward, guided by our effective growth strategy, we will continue to implement controls on marketing expenses and further improve ROI for selling expenses and operational efficiency. Lastly, I would like to say that we celebrated Gaotu's 8th anniversary on June 16 of this year. In this area of challenges as well as opportunities, we are well prepared to leverage our strong organizational capability to properly respond and adjust to the ever-changing environment. Although we have restructured our businesses and our organization, we remain true to our original aspiration to educate. Our starting point has never changed, nor have our hopes for the future of our confidence in the education industry. With an emphasis on long-term value, we will continue to explore the education industry, practice corporate social responsibility as an education company, and actively play a role as advocates, practitioners, and leaders in the core education sector in China. Over the next 18 and even 28 years, we will continue to offer exceptional services, create better products, provide superior content, empower more students, and build a better Gaotu. Thank you very much. Now I will pass the call over to our CFO, Nan Shen, to walk you through our financial and operational details for this quarter.

Nan 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 2022. Please note that our financial data that I mention later is based on RMB terms unless otherwise noted. The education industry highly relies on employees' operational efficiency and the synergies among the workforce. During the second quarter, by optimizing costs and enhancing operational efficiency, we continued to achieve effective growth under this challenging economic environment. Net revenues generated by comparable businesses showed quarter-over-quarter growth for 3 consecutive quarters, and gross billings showed a quarter-over-quarter growth for 4 consecutive quarters. We expect this momentum to continue in the next quarter. Additionally, net loss was significantly narrowed by 94.6% year-over-year to RMB 49.8 million on a GAAP basis. We remained profitable this quarter on a non-GAAP basis with an amount of RMB 645,400. We are also seeing a positive net operating cash flow of RMB 93.8 million, and with that, our capital position remains strong. As of June 30, 2022, we had a total of approximately RMB 3.4 billion in cash, cash equivalents, restricted cash, and short-term investments on our balance sheet, providing ample resources for continued business development. Going forward, we will continue to focus on our 3 core businesses: educational services for college students and adults, non-academic tutoring services, and educational content and digital learning products, guided by our strategy of sustainable growth. Now I will go through our key financial data for the second quarter. As the new businesses we initiated after our business restructuring are still in their early development phases, we will compare our financial performance on a quarter-over-quarter basis, alongside year-over-year comparisons to better present the development of our comparable businesses. In the second quarter of 2022, our net revenues decreased 75.9% year-over-year to RMB 537.8 million. To provide a consistent basis of comparison, if we compare our comparable businesses, our net revenues achieved healthy growth with a higher than 270% increase year-over-year and over 30% increase quarter-over-quarter. We would like to point out that from the second quarter onwards, our net revenues and gross billings come from continuing businesses. Gross billings decreased 77.3% year-over-year and increased 92.3% quarter-over-quarter to RMB 611.7 million. The gross billings of our comparable businesses showed quarter-over-quarter increases for 4 consecutive quarters. Among that, gross billings for non-academic tutoring services showed substantial quarter-over-quarter increases. The performance for non-academic tutoring services displayed seasonality as customer retention normally happens during the second and fourth quarters of the year, during which income from these services will be collected, and therefore, gross billings will increase. We expect the same increasing trend to appear in the following fourth quarter of this year. Our cost of revenues this quarter decreased by 77.9% year-over-year to RMB 106 million. Our gross profit decreased 74.9% year-over-year to RMB 377.8 million, which gives us a gross profit margin of 70.2%, 269 basis points higher than that of the same period of last year. Non-GAAP gross profit was RMB 396.4 million, and the non-GAAP gross profit margin was 73.7%. The increase in gross profit margin is because compensation for instructors and tutors in new businesses took up a smaller proportion of net revenues. Operating expenses decreased by 81.4% year-over-year to RMB 438.3 million. To break down the operating expenses, selling expenses decreased by 83.6% year-over-year and 5.3% quarter-over-quarter to RMB 269 million. Selling expenses have shown quarter-over-quarter decreases for 5 consecutive quarters since the first quarter of last year. Selling expenses margin for the first quarter was 50%, a solid decrease compared to the same period of last year. ROI for sales and marketing expenses has also increased over the last quarter. The improvement in selling expenses efficiency is due to lower costs and diversified customer acquisition channels and constantly increased operational efficiency. Since different customer acquisition strategies are suited for different business lines, after our restructuring, we prefer to acquire new customers more vertically, and we have upgraded our model for private traffic operations to better identify potential customers with high conversion rates. We have also upgraded our APP, which is not only a learning tool but also an application for customer acquisition and retention through enriched content. Further, we will continue to establish our branding in the education industry through exceptional service, superior quality, and better learning results, gradually becoming more reliant on customer acquisition through referrals and, in this way, lowering our customer acquisition cost and selling expenses margin to pursue shareholder value and sustainable growth. Research and development expenses decreased by 75.6% year-over-year to RMB 103.9 million. To provide superior quality education and to offer content and products that exceed users' expectations, we will invest in R&D according to the development of each specific business line. Meanwhile, we will adjust the R&D employee structure to continuously enhance ROI for R&D expenses and realize R&D efficiency improvement. General and administrative expenses decreased by 73% year-over-year to RMB 65.4 million. Since our new businesses are still in the early development stage, initial fixed costs, including R&D expenses, take up a relatively high proportion of net revenues. We expect some R&D and G&A expenses to start showing economies of scale as the size of new businesses grows larger. Going forward, we will continue to improve our operational efficiency and optimize our cost structure to achieve greater value for our stakeholders. Our loss from operations for the second quarter was reduced by 92.9% to RMB 60.5 million. Our net loss was reduced by 94.6% to RMB 49.8 million. Non-GAAP net income was RMB 645,000. Our net loss margin was 9.3%, and non-GAAP net income margin was 0.1%. Due to the effect of restricted stock units offered to employees in the past years, the share-based compensation expenses are still being recognized towards costs and expenses, thus, taking a high proportion of net revenue causing a relatively wide gap between GAAP and non-GAAP bottom lines. With the end of this acceleration and the increase in our revenue, we expect share-based compensation expenses to gradually account for a lesser and lesser proportion of revenues in the following quarters. Additionally, our net operating cash flow turned positive this quarter, reaching RMB 93.8 million and representing an improvement in efficiency compared with the same period of last year and last quarter. The large increase in cash flow was primarily due to an increase in gross billings. We are pleased to be able to continue to achieve effective growth this quarter, and we will strive to maintain this momentum. Turning to our balance sheet, as of June 30, 2022, we had RMB 591.5 million cash, cash equivalents, and restricted cash, and RMB 2.8 billion in short-term investments, totaling approximately RMB 3.4 billion, providing ample resources for continued business development. Further, as of June 30, 2022, our deferred revenue balance was RMB 647.9 million, which primarily consists of tuition collected in advance. 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 beyond our control and could cause the actual results to differ materially from our predictions. Based on our current estimates, net revenues for the third quarter of 2022 are expected to be between RMB 576 million and RMB 596 million, representing a decrease of 46.5% to 48.3% on a year-over-year basis. This concludes my prepared remarks. Operator, we are now ready for the Q&A section. Thank you, everyone.

Mark Li, Analyst

Thanks for your presentation and congrats on breaking even in this quarter in the non-GAAP net profit. My first question is about Q3 revenue outlook. We see the quarter-on-quarter revenue improvement. Could you share a bit on the breakdown of the major segments? Or could you comment on the quarter-on-quarter growth drivers for the major segments?

Nan Shen, CFO

Thanks, Mark. We are gradually becoming more focused on our businesses and products to target a more vertical student population, thereby creating synergies between our users and enhancing our branding and market penetration rate. During this quarter, we focused on the 3 main businesses: educational services for college students and adults, non-academic tutoring services, and educational content and digitalized learning products. Our new businesses are still in their early development stages, and the revenue contributed by each of the business lines will be affected by different seasonalities and different stages of development. Currently, we did not disclose our revenue breakdown in detail because our current revenue structure is not a perfect indication of what's going on, and we expect it to change in the following quarters as our revenues grow larger. But I can give you a high-level picture. In the second quarter, our academic tutoring services and educational content and digitalized learning products combined contributed roughly 60% of our revenues and constantly contributed operating profit and sizable net operating cash flow. The remaining 40% of our revenue was contributed by educational services for college students and adults, which include categories such as entrance exam preparation, civil servant exam preparation, financial and accounting qualification test preparations, and other exam preparation categories. Different business lines are still at different stages of maturity, so we will disclose more information as these businesses mature. For the third quarter outlook, we foresee all these 3 categories of revenue to grow, but it still depends on seasonality and the different stages. Hope that helps.

Mark Li, Analyst

Got it. May I have a quick follow-up on the education service for the college students? Looking into Q3, what are the major drivers for the courses or any new courses you could highlight?

Nan Shen, CFO

Yes. Thanks for your question, Mark. In this third quarter, we're transforming and restructuring our business. Currently, we've categorized our core businesses according to the groups of clients that we want to target. College students and working adults are energetic learners, and their demand is very strong. Historically speaking, we have achieved decent progress with these new businesses. If we look back at the last quarter, this business achieved over 200% year-over-year growth, and gross billings also achieved over 68% year-over-year growth. We are happy to see that momentum continue. Gross billing serves as an important indicator, establishing a strong foundation for future development. Some of our business lines targeting this group have achieved quarterly operating profit, such as the financial qualification prep businesses. The graduate school entrance exam preparation businesses also achieved around 30% quarter-over-quarter growth in revenue. Additionally, we offer courses for overseas tax preparation and other subjects with similar quarterly growth. Given our investments in these categories, we expect our education services for college students and working adults to continue to grow in a sustainable manner. In terms of seasonality, for instance, with the graduate school entrance exam preparation, Q1 and Q3 usually see high enrollment as tuition fees are collected, leading to increased gross billings. Conversely, the second and fourth quarters are when students started to take courses, so we will see revenue growth during those periods. Both categories are poised for fair growth.

Operator, Operator

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

Sherry Liu, IR Manager

Thank you, operator, and thank you everyone for joining the call tonight. If you have any further questions, please don't hesitate to contact our Investor Relations department or our management. You are also welcome to subscribe to our newsletters on the company's IR website. Thank you very much again for your time. Have a great night.

Operator, Operator

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