Earnings Call Transcript - GOTU Q3 2022

Operator, Operator

Good day ladies and gentlemen, thank you for standing by, and welcome to the Gaotu Techedu Inc., Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Sherry Liu, IR Manager of Gaotu. Please go ahead.

Sherry Liu, IR Manager

Thank you very much, operator. Good evening, ladies and gentlemen, and thank you all for joining us tonight for Gaotu's third quarter 2020 earnings conference call. Gaotu's third quarter earnings release was published earlier today and is available on the Company's IR website at ir.gaotu.ca. On the call with me tonight are Mr. Larry Chen, Gaotu's Founder, Chairman and Chief Executive Officer; and Ms. Shannon Shen, Gaotu's Chief Financial Officer. Larry will give the general business overview for the quarter, and Shannon will discuss the financials in more detail. Following their prepared remarks, Larry and Shannon will be available for the Q&A session. I will translate for Larry. Before we begin, I'd like to remind you that this conference call will contain forward-looking statements as we file 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. Good evening and good morning everyone. Thank you for joining us on Gaotu's third quarter 2022 earnings conference call. I would like to take this opportunity to convey my gratitude for your continued interest in the education industry. Before I start, I would like to remind everyone that all financial information that I mention later is based on RMB unless otherwise noted. In 2022, we have been gradually deepening our understanding of customer needs, actively exploring new business models and expanding our offerings. Undeniably, business transformation is a very challenging process, as we have overcome numerous obstacles. Thanks to our outstanding operational skills and the extensive educational experience we have accumulated over the past 20 years, we have united to create a more powerful organization with a deep passion for education. At the same time, our capital reserves will remain strong. These assets have given us a strong edge when confronting external risks. We're confident that as long as we remain patient and persevere, while staying true to our original aspirations, we will eventually achieve a significant breakthrough in our business and evolve into a greater organization. In this quarter, we divided our business into two categories. One is renewal services and the other is educational content and digital learning products. The new strategic directions within our learning services include educational services for college students and adults, overseas study related services, non-academic tutoring services, and others. With our new businesses continuing their steady development supporting the restructuring, we are glad to report that during the quarter, our net revenue increased 12.7% quarter-over-quarter to RMB606.2 million and our net loss significantly narrowed year-over-year. As we are still in the process of business transformation, the gradual and stable increase of our net revenue is solid evidence that these new businesses are growing continuously and sustainably, which boosts our confidence in our future and indicates that our strategic choices are correct, our organization is resilient and our operations are efficient. Due to differentiating and testing seasons, market demand and the cost scheduling, our new businesses exhibit different seasonal patterns. Guided by the strategy of profitable growth, we expect this growth momentum of our business data to continue and we anticipate seeing a sizable positive net operating cash flow in the next quarter. Amidst the complex macroeconomic environment, we firmly believe that it's essential to persistently seek progress and sharpen our scale while maintaining a steady pace of development. After a year of exploration, we have accumulated valuable insights into our new businesses. We have made decent advances this quarter and will continue to propel our long-term effective growth. Now, I will present the progress we made during the quarter from three aspects. First, we will continue to play a fundamental role as good teachers. Good teachers are at the core of education, and service and professionalism are prerequisites for good teachers. Our recruitment efforts have always focused on the principle that a good teacher should not only be able to improve a student's academic performance and learning capabilities but should also serve as inspiring role models and mentors who provide emotional support. Take our post-graduate entrance exam preparation business for example. More than 50% of our tutors in this business line have graduate degrees, a high ratio relative to our peers, and we aim to further increase this ratio. In our opinion, teachers who have successfully passed the exam can better empathize with students going through the same experience. They can better understand business needs and therefore can offer more constructive services and achieve better results. During the quarter, our post-graduate entrance exam prep business recorded roughly 76% quarter-over-quarter increase in net revenues and over 46% quarter-over-quarter increase in gross billings, which was partly driven by the strong branding gradually established by our top-notch teaching guidance and high-quality services. Second, we will continue to focus on improving our operational efficiency. In the quarter, our gross margins reached 72.2%, higher than that of the last quarter and the same period last year. Our efficiency for customer acquisition also improved, with our ROI for customer acquisition experiencing a quarter-over-quarter increase. Considering that in terms of seasonality, the third quarter is a peak season for drawing new enrollments, we see the market opportunity to increase in size by slightly raising marketing expenses, which may result in small scale losses. However, as our customer acquisition efficiency improves and our business expands, we expect to see higher brand exposure, greater market share, and ultimately more profitability in the mid to long term. Third, we will continue to fulfill our corporate social responsibilities as we strive for effective growth. During the quarter, we co-organized the third Gaotu rural education support program with the China Youth Development Foundation. Through the program, we provided financial services and training courses to principals of rural primary schools to help improve their teaching quality, assist more needy children in these areas, and aid rural revitalization. Furthermore, our Board of Directors has authorized a new share repurchase program under which we may repurchase up to US$30 million worth of our ADS over three years. Our cash positions remain strong. As of September 30, 2022, our cash, cash equivalents, restricted cash, and short-term investments total approximately RMB3.3 billion. I also intend to purchase up to US$20 million worth of our shares, demonstrating our management's unwavering confidence in the future development of our company. Finally, I am very happy and proud to share with you that on October 19, 2022, we received a closing letter from the SEC regarding its investigation related to several short sellers' reports from approximately early to mid-2020, and about our previous disclosures in our annual report for the fiscal year of 2020 and 2021. In the letter, the SEC notified us that it had concluded its investigation into our company and that based on the information it had as of the date of its letter, the SEC did not intend to recommend an enforcement action against us. Integrity is our core corporate value. As a public company, we are fully dedicated to value creation for shareholders and have always ensured the timely and truthful disclosure of financial and operational information. Going forward, we will continue to stay true to our original aspiration to educate, to continue nurturing talents for our society, and to contribute to the educational development of China. Thank you very much for listening. I have concluded my prepared remarks. Now, I will pass the call over to our CFO, Shannon, to walk us through the financial and operational details of this 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 third quarter of 2022. Please note that all financial data mentioned later is based on RMB unless otherwise noted. As we continued to explore new businesses post-restructuring against the backdrop of external challenges and uncertainties, we are pleased to report that our business sustained its continuous and healthy growth as we expected, driven by our deepening understanding of the new vertical markets, relentless efforts to optimize our operational efficiency and constant investment in teaching quality. During the third quarter, net revenues increased by 12.7% quarter-over-quarter to RMB606.2 million. Gross billings more than doubled compared to that of last year, with a sharp year-over-year increase of 101.3% and a slight quarter-over-quarter decrease of 0.8% to RMB607 million. This solid performance, in part due to favorable seasonality, was driven by the decent progress of our businesses, which consists of learning services as well as educational content and digitalized learning products. In terms of learning services, our new business mainly includes educational services for college students and adults, overseas study-related services, non-academic tutoring services, and others. Learning services accounted for about 90% of net revenues in the quarter and remain the biggest contributor. Of the 90%, approximately 30% of net revenues were contributed by educational services for college students and adults. School holidays are typically high demand seasons for our businesses related to college students and students from junior to high school, including our postgraduate entrance exam preparation business and overseas study-related services, as the holiday coincides with the tax preparation period. As a result, we are glad to see our related businesses achieved high double-digit quarter-over-quarter growth in revenue during the quarter. Furthermore, we have noticed that as the overall number of exam registrants increases, students' willingness to participate in preparation courses escalates. Consequently, the market for services related to college students' further education and job searching is booming. For instance, according to multiple market research, the number of applicants for China's 2023 postgraduate admission exams is predicted to exceed a record of 5 million, representing a year-over-year increase of at least 10%. Additionally, more students are starting their preparations as early as their freshman years. We will continue to serve students preparing for such exams with dedicated teachers and comprehensive application planning. Simultaneously, we have also witnessed course registration by students for other career enhancement courses such as financial certificate preparation courses or civil services examination preparation courses, which could reduce our customer acquisition costs and improve operational efficiency. Our financial certificate preparation business has achieved profitability for two consecutive quarters. Apart from our educational services for college students and adults, the remaining 60% of our learning services revenues came from services targeting primary to high school students, including non-academic tutoring services and others. This sector exhibits a different seasonality as course retention and the corresponding sharp increase in gross billing typically happens in the second and fourth quarters. However, the third quarter is prime for acquiring new students and as a result, during this quarter, we strategically increased our investment in sales and marketing to improve our market penetration rate. As you may have noticed, even though the third quarter is not a peak season for customer retention, our gross billing for the quarter remained at the same level as that of the last quarter, indicating that the gross billings contributed by new students are taking a higher percentage due to our effective customer acquisition strategies. This increasing effect will snowball and provide more leverage for next quarter's gross billings. Thus, we expect to see sizable positive net operating cash flows in the fourth quarter. The remaining 10% of the quarter's net revenues came from educational content and digitalized learning products, which mainly include smart textbooks, learning devices, and other digital products for students. These products serve as supplements to our courses, satisfying students' diverse learning needs and boosting user retention on our platform through better user engagement. Next, I will present our financials for the quarter in more detail. Our cost of revenue this quarter decreased by 76.4% year-over-year to RMB168.8 million. Our gross profit increased 9.4% year-over-year to RMB437.4 million. Gross profit margin was 72.2%, a 190 basis point increase compared to that of the last quarter and a significant year-over-year improvement. Non-GAAP gross profit was RMB439.3 million, and the non-GAAP gross margin was 52.5%. The increase in gross profit margins is largely due to higher service delivery efficiency as well as an increase in the average number of students served by each tutor for our college student-related businesses. Operating expenses decreased by 65.8% year-over-year to RMB506.9 million. Now let’s break down our OpEx. Selling expenses decreased 59.2% year-over-year and slightly increased quarter-over-quarter to RMB336.8 million. The quarter-over-quarter increase in selling expenses was mainly due to seasonality. The third quarter typically sees peak new customer enrollments due to growth in our learning service businesses, prompting us to allocate marketing investments proportionate to the soaring demand we observed in the market. By improving operational efficiency and ROI of our marketing expenses, we can gradually increase our brand exposure and market share as well. We are also exploring various new and cost-effective customer acquisition channels including, but not limited to, live streaming classes, test banks, and other exam practice applications to attract high intent customers at a lower cost. As a company with a long-term orientation, we will continue focusing on brand building and recognition to reduce our customer acquisition costs through word-of-mouth referrals and enhance our user conversion rate and selling expenses ROI through better targeting, thus achieving sustainable growth. Moving on, research and development expenses decreased 68.3% year-over-year to RMB106.5 million, accounting for 17.6% of net revenues, which was 1.7% lower than last quarter’s R&D margin. This was mainly due to the greater economies of scale, as the increase in net revenues outpaced the growth in R&D expenses. We allocated most of the incremental R&D budget to course content development with recording curriculum design experts who have significant experience and influence in their respective fields. General and administrative expenses decreased 61.4% year-over-year to RMB63.6 million, accounting for 10.5% of net revenues. Loss from operations for the quarter was reduced by 93.6% year-over-year to RMB69.6 million. Non-GAAP loss from operations was RMB53 million. Net loss for the quarter was significantly reduced by 94.1% year-over-year to RMB61.4 million. Non-GAAP net loss was RMB44.8 million. If we exclude the RMB17.5 million losses on our offshore R&D reserves amplified by exchange rate fluctuations during the quarter from our net loss, the actual net loss margin would be 7.2%. Our net operating cash flow this quarter was RMB34.7 million. We expect net operating cash flow to turn significantly positive in the next quarter. Turning to our balance sheet, as of September 30, 2022, we had RMB909.5 million in cash, cash equivalents, and restricted cash, along with RMB2.4 billion in short-term investments, which totaled approximately RMB3.3 billion, providing ample resources for continued business development. Furthermore, as of September 30, 2022, our deferred revenue balance was RMB638.4 million, which primarily consists of tuition collected in advance. As my speech comes to an end, I would like to take this opportunity to emphasize our management's commitment to our responsibilities to shareholders. Our Board has authorized a three-year share repurchase program of up to US$30 million. Our founder and CEO, Larry, has also pledged to increase his shareholding by purchasing up to US$20 million worth of our shares personally. Our management would like to demonstrate our faith and firm confidence in the long-term development of our companies. Moreover, the closing letter we received from the U.S. SEC has alleviated potential external negative effects and stands as a strong testament to the high standards in corporate governance, information disclosure, and compliance that we uphold. Going forward, we will focus more on satisfying customers' needs and continue to provide value for our shareholders. Before I provide our business outlook for the next quarter, please allow me to remind everyone that this contains forward-looking statements, which involve risks and uncertainties 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 first quarter of 2022 are expected to be between RMB608 million and RMB628 million, representing a decrease of 50.7% to 52.3% on a year-over-year basis. This concludes my prepared remarks. Operator, we are now ready for a Q&A session. Thank you everyone for listening.

Operator, Operator

We will now begin the question-and-answer session. Our first question comes from Mark Li of Citi. Please go ahead.

Mark Li, Analyst

Hi management, congratulations on the results and thanks for the share repurchase and the increased efforts. This is Mark Li from Citi. May I ask about our non-academic education? Could you share our recent key developments and perhaps the outlook for next year?

Shannon Shen, CFO

Thanks, Mark. Thanks for your question. Our non-academic tutoring services is one of the new businesses we focus on after our restructure, and this business line is still in the process of optimizing our course products and gradually winning recognition among students and parents. After the double deduction policy, students have more spare time during their weekends and holidays, which has spurred a huge demand for academic tutoring services especially among first and second-tier cities. Therefore, we currently offer a variety of non-academic tutoring services including programming, chess, humanities, and science courses designed to engage students through online education and interaction. These courses are constructive in sparking children's interest and intellectual curiosity. Our non-academic courses can enhance students' learning skills and can indirectly improve students' performance at school. This approach has gained the trust and support from parents. Additionally, the non-academic tutoring services follow a progressive and systematic curriculum design. The sector exhibits seasonality as our course retention typically occurs in the second and fourth quarters. We just finished the fourth quarter retention in November, achieving a retention rate as high as 78%, which exceeded our expectations and also inspired us. The ASP for non-academic tutoring services aligns with market demand. Consequently, its unit economics exhibit healthier gross profit margins, and as you may have noticed, our gross profit margin also increased this quarter. Based on what we see now, the development of this sector matches our expectations as it is still in the early development stage. We will disclose more information on enrollments and revenues as it matures. So going forward, we will continue optimizing the products, enhancing our learning experience, and continuously improving our course curriculum. Regarding our expectations, we believe the gross billings in the first quarter will see meaningful increases, and we anticipate a sizable positive net operating cash flow in the fourth quarter, primarily driven by our academic education, learning service offerings, and other services for students from junior school to high school. Hope that addresses all your questions. Thanks, Mark.

Mark Li, Analyst

Thank you, Shannon. I have a quick follow-up. You mentioned the increasing gross billing and positive cash flow in Q4. May I know if we are likely to see better margins or improved performance in Q4?

Shannon Shen, CFO

Yes. We foresee that Q4 will be profitable, and the net profit margins will be higher than breakeven, potentially still in the range of single digits, but it should reflect meaningful net profit margins. Thank you.

Operator, Operator

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

Sherry Liu, IR Manager

Thank you very much, operator. And thank you everyone for joining the call today. If you have any further questions, please don't hesitate to contact our Investor Relations department or management via email at ir@gaotu.cn directly. You're 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 day.

Operator, Operator

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