Gaotu Techedu Inc. (GOTU) Q1 2021 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the GSX Techedu Inc. First Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note, this event is being recorded on Wednesday, May 26, 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.

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.gaotu.cn. 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 then 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'd like to remind you that this conference call contains forward-looking statements as defined in 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 relate to 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 statement, 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. Today, we officially launched our new website at ir.gaotu.cn. The old website will no longer be in use within one week. It is now my pleasure to introduce Larry. Larry, please go ahead.

Thank you, Sandy. Good evening and good morning to you all. Thank you for joining us today on our first quarter 2021 earnings conference call. In the first quarter, to further improve our service quality, we further lowered our student-per tutor ratio to just over 100 for our promotional courses. Costs related to our promotional course tutors rose to account for 20% of our quarterly revenue, up by 5 percentage points sequentially. That, combined with miscellaneous expenses, totaled RMB503 million. Additionally, this quarter we spent RMB352 million on branding activities. Excluding these factors, our traffic acquisition costs were RMB1.37 billion. While first-time users contributed a majority of the RMB1.18 billion in gross billings, which implies that on a lifetime value basis, we are still profitable. Recently, all of our school segments, including primary, junior and senior high schools, have returned to profitability on a lifetime value basis, and we have witnessed rebounding trends in our conversion, class retention and student reactivation rates. Last year end, we implemented some cost control measures, and actively stayed away from the cash burning war for the winter semester student recruitment period. At the same time, we continuously upgraded our products, enhanced our education quality and services, and adjusted our operations to improve our long-term service quality and customer satisfaction. We have always believed that the core of online education is education, rather than online. Extensive traffic growth no longer works for this industry, while every player has to compete by refining operations. As a company that prioritizes efficiency, we have decided to return to the core of education and a quality-driven growth, so that we could return to a possible profitable growth in the upcoming months. We will adhere to our long-term philosophy, adhere to our focus on continually improving efficiency and quality, adhere to our highest priority of satisfying each student and parent we serve, and adhere to expansive investments in our technology and education quality. A major priority for our investments has been on technology and education quality. In the first quarter, our investments in research and development reached a historical high of RMB365 million. Over the past year, we have recruited a dozen technology experts at the director level or above to enhance our technology across learning scenarios, teaching content and education services. We believe these investments will bring us tremendous leverage in terms of bolstering our education quality over the long term. In addition, premium instructors are one of the most important strategic resources for an education company, so we have also been expanding our investments in our teachers and education quality. Since the beginning of this year, we have raised the base compensation for each of our over 15,000 tutors by RMB500 per month. We have also established a RMB5,000 annual travel fund for each of our instructors, tutors and course development professionals so that they can have a better work-life balance. Our core strength has always been our instructors, and this quarter, we ramped up our efforts to recruit and develop talented instructors at the local level. Moreover, we continued to increase our spending to train tutors, and have helped them improve their academic knowledge and serving capabilities through routine subject training and lecturing contests. Education is one of the biggest factors that affect a person’s well-being, it is a social responsibility, and in the end, it is about enlightening one life with another life. In the first quarter, third tier cities and below contributed 59% of our K-12 enrollments. During the pandemic last year, we donated RMB20 million worth of winter semester regular-priced courses to Wuhan. We also founded a charity project to support poor families in Hezhang County of Guizhou and the left-behind children in Shenyang City of Liaoning by donating numerous courses. In addition, we established the Pillars of the State scholarship in Shanxi Province, and have provided approximately RMB15 million worth of regular-priced courses to more than 220 outstanding students from 8 local high schools. The social impact of online education is significant, profound, and essential to society. We will uphold our original aspiration and belief about education, shoulder our responsibility in advancing social progress and promoting equal access to education, and dedicate ourselves to bringing quality education resources to more and more families. Now, I will pass the call over to our CFO, Shannon to walk you through our financial and operational details.

Thanks, Larry, and thank you, everyone, for joining the call. Now, I will walk you through some thoughts about this past quarter, our operating and financial results, and conclude with our outlook for the coming quarter. Please note all financial data is in RMB terms. Since the second half of last year, we have continued to focus on building up our brand. Last September, we integrated all of our K12 businesses under the Gaotu brand. This April, we further integrated all of our services under the Gaotu brand, including Gaotu K12 for our K12 business, and Gaotu Professional for our foreign language, professional, admission and other services. We believe that by bringing all of our services under just one brand, Gaotu, we will be able to strengthen the recognition of our company in the market. Over the past few months, we continued to strengthen our investments in improving the quality of teaching services, developing localized teaching, expanding our teaching products portfolio, and upgrading research and development to secure our long-term competitive strength. The logic of burning money for traffic and scale does not work. Instead, we will focus our strategy on caring for our students, continually improving our education quality, and developing more personalized and engaging teaching products. Going forward, we will maintain our focus on a healthy growth, and pay more attention on metrics including product healthiness, cash flow and overall profitability. For the K12 spring retention period that just finished, our performance exceeded our expectations. In the first quarter of 2021, our net revenues increased 50% year-over-year to 1.9 billion, and net revenues from our K-12 courses increased by 62% year-over-year. This was driven by the continued growth in our student numbers, thanks to our enhanced education quality and brand recognition. Our gross billings were 1.18 billion. The year-over-year decrease was due to a few factors. On the one hand, the base last year was quite high due to the COVID19 pandemic period when a lot of students signed up for our classes. On the other hand, this winter we partially adjusted our operations. Paid enrollments, which refer to enrollments priced at or above 99 yuan, decreased 0.9% year-over-year to 767,000. Consistent with the seasonality shown in the first quarter of last year, our enrollments this quarter were still mostly first-time users. Breaking down our net revenues by business line: For Gaotu K12, net revenues increased by 62% year-over-year to 1.8 billion, and accounted for 94% of Group net revenues. I’d like to highlight our junior high school segment, which actually had a particularly strong quarter. Revenue grew by as high as 118% year-over-year, thanks to our good quality instructors, a competitive advantage that we have established. For this winter and spring course products, our interactive scenario design covers over [98%] of the curriculum, so that our courses are both interesting and effective. Gross billings contributed by Gaotu K12 was 1 billion. Paid course enrollments for Gaotu K12 reached 632,000. Average enrollments per class were 2,300 in the first quarter in 2021, compared with 2,600 in the fourth quarter last year. Quarter-over-quarter, the number slipped slightly because we have a wider range of class levels and localized classes to cater to various student needs. Meanwhile, new instructors are giving courses, and gradually growing their class size from a smaller size to bigger later. Net revenues from Gaotu Professional grew to 123 million, and accounted for 6% of Group net revenues. Gross billings contributed by Gaotu Professional were 181 million. Paid course enrollments for Gaotu Professional hit 135,000. Among them, finance-related classes performed well, with its paid enrollments growing 70% year-over-year. Our cost of revenues increased by 102% year-over-year to 572 million. The year-over-year growth was mainly due to increases in compensation for instructors and tutors, learning materials, and rental expenses et cetera. GAAP gross profit margin decreased to 71%, down from 78% in the same period of 2020. Non-GAAP gross profit margin, which excludes share-based compensation, decreased to 72%, down from 79% in the same period of 2020. The decrease was primarily due to an increase in the number of instructors and tutors to enhance our service level and the personalized experience, as well as an increase in compensation for such staff. To better localize our services, we recruited and trained over 50 experienced instructors and content development professionals with local experiences. This summer, we will launch localized courses for junior and senior high school students in Beijing, Jiangsu, Zhejiang, Henan, Shanxi, Shandong et cetera, and recruit students on provincial levels. In terms of tutoring, we further optimized the quality of our services, and fine-tuned our services for pre-class tutoring in boutique groups of 30 students each. At the same time, students can be classified according to whether they are first-time users, whether they live on campus, and their relative learning level. Therefore, we can better manage our classes and make sure the student experience is even better. Selling expenses increased to about 2.3 billion. Within that, expenses for traffic acquisition were approximately 1.37 billion, expenses for branding activities were approximately 352 million, and the remaining expenses cover labor, servers, bandwidth, et cetera. R&D expenses increased by 267% year-over-year to 365 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. We expanded our investments to recruit R&D talent as we look to enhance our overall education quality, especially across learning scenarios, teaching content and education services. Firstly, based on the massive amount of data that we collect from our courses, through in-class quizzes, periodic exams, homework correction and Q&A sessions, we can provide instant feedback to our instructors to help them upgrade the pace, difficulty and content of their courses. Secondly, with low latency 5G networks and AI/VR technology, we aim to create a real-time interactive classroom to provide our students with an immersive learning experience. We believe these steady investments in technology will benefit our company, and will be something we can leverage for many years to come. G&A expenses increased by 231% to 218 million, mainly due to an increase in G&A headcount and related compensation. GAAP net loss was 1,426 million, compared with net income of 148 million in the first quarter of 2020. The loss was mainly due to the continued increases in investments in our brand, instructors, research and technology, which are all essential to the long-term competitiveness of our business. As of March 31, 2021, we had 2.9 billion of cash and cash equivalents, 2.4 billion of short-term investments and 527 million of long-term investments. Those summed up to be 5.9 billion. As of March 31, 2021, our deferred revenue balance was 1.9 billion. Deferred revenue primarily consists of tuition that is collected in advance. Net operating cash flow for the first quarter of 2021 was 2.1 billion. The outflow was primarily due to higher branding activity expenses related to improving our market share and brand awareness, and an increase in compensation, which includes an annual bonus for 2020. The cash outflow to purchase long-term assets totaled 197 million, including around 101 million for Zhengzhou property. Before I provide our business outlook, please allow me to update. To ensure our growth is sustainable and healthy on our own unit and current level, and ensure our advertisements are in full compliance with regulations, in the second quarter, we gradually reduced and later completely terminated traffic acquisition on feeds performance channels. Meanwhile, we’ve also terminated ongoing branding contracts. Taking into consideration the possible impact of all these short-term operation adjustments on sales lead, we estimate our net revenues for the second quarter of 2021 to be between 2.14 billion and 2.16 billion, representing an increase of 30% to 31% on a year-over-year basis. That concludes my prepared remarks. Operator, we are now ready to take questions. Thanks.

[Operator Instructions]. Our first question comes from Mark Li of Citi. Please go ahead.

Hi Larry, Hi management, thanks for the presentation. This is Mark Li from Citi. May I ask given the recent update in our regulation from the government, what do we see is the potential impact on our operations for the rest of the quarter or for the next year? Could you share a bit more color? And also my second question is for our advertising ROI. Could you just share a little bit more color on the ROI for Q1? And what do we think going forward? Thank you.

Thanks, Mark. For the first question about the regulation impact. So we have been following the opinions on regulating after-school tutoring institutions in 2018 and further an opinion on regulating after-school -- online after-school institutions issued in 2019 in the past years. And recently, the government has issued regulatory guidance on several aspects of online education, including, first, prepaid tuition fee management. On May 21, 4 departments in Beijing jointly released a guideline, listing out specific requirement on the tuition fee collected in advance, including tuition fee coverage period, advance tuition fee collection timing and tuition fee monitoring. They provided very detailed guidelines. And second, about advertisement. All companies should follow the law of advertising and the law of -- against unfair competition. The department also provided a list about what a company should not do in commercials. It's a very detailed list. Also, regulators provided guidelines on teaching content, course format, course scheduling, teacher qualifications, homework and student rest time, et cetera. So to better implement these regulations, we have proactively established a cross-department compliance team within the company. This team consists of all senior management teams, and we have organized several rounds of meetings, initiated rounds of study on the new regulations. We've taken down non-compliant advertisement and adjusted our homework procedures and adjusted the class schedule to meet the requirement from all of those regulators. And with regard to instructor qualifications, except for check the paper, the certificate of the teachers' qualifications, we also cross checked the teacher qualifications online and from other channels. So on May 21, the same day of the prepaid tuition fee management rule, the Central Commission of Comprehensively Deepening Reform launched its 19th meeting. Eventually also approved the opinion on reducing burden from homework and after-school tutoring for compulsory education students. That is called [Zhōngyāng]. So we haven't received the specific content yet. Once the opinion is published, we will immediately take measures to comply in all levels. So after-school tutoring is part of the education industry and education, especially for K-12 education should focus on the social impact and core values. The regulations provided timely and clearly directions for the industry. We will proactively embrace the policy and take solid actions and closely monitor the following execution. We believe only when all the companies comply with the government policy at the highest level, the whole industry can achieve a lasting, healthy and sustainable development.

I want to add several more points. So firstly, the demand for premium education, for customized education from students and parents is eternal, always exist. Secondly, the benefits brought by online education at very affordable price will provide a secure for equal access to the education. Thirdly, the online education is able to collect data with all aspects from the students. So it's easier for online education to provide more customized solutions for each student. So in short, for me personally, I am very optimistic about the future of online education. And I believe that as far as we do education with our true heart, with our consciousness, I believe this sector will have a very long-term and sustainable development.

And your second question is about the ROI in Q1. So the ROI in Q1 is actually lower than normal. And if we can recall during our last earnings call, we mentioned that we would like to spend less of our customer acquisition budget on traffic acquisition from social platforms and invest more on innovation channels such as live streaming platforms, MCN, et cetera, and even offline channels. So one of the reasons like our observation is -- and it's actually the traffic acquisition on social platforms actually dragged down the ROI level. So this quarter, we gradually reduced the spending. And now, we have completely stopped traffic acquisition on social platform. So we expect students to come from other channels in the future. For instance, through our past branding activities, promotional courses and free courses, we have accumulated a fairly large student pool. Gaotu K12 brand has improved the brand awareness and reputation over the past quarters so -- which we expect it can draw up the organic traffic that flow to our APP and the website. Second, as for one of most referrals, we are ramping up our explorations such as adding key referral campaign or providing more coupon or benefits to encourage these referrals. In the future, we will focus more on education content to help our students and parents to actually resolve their questions in order to increase trust and visibility of our brand. We are also starting in localized student recruitment. We will provide more differentiated personalized services and content to further attract the students to join us. Thanks, Mark.

The next question is from D.S. Kim of JPMorgan. Please go ahead.

Hi, good evening, Mr. Chen and Shannon. Thanks for taking my question. Well, can I check out why and how we saw such a drastic deterioration in building enrollments in this quarter? I mean it's particularly surprising because the sales and marketing, as you mentioned, went up quite a lot to be twice the gross billing. And this quarter, wasn't even hurt materially by the regulatory pressure yet. And following question is for the second quarter guidance, could you break down the growth in the first half of second quarter versus second half to gauge the impact from the change in marketing that you just mentioned, say, like -- and do you think that this termination in traffic costs is temporary or more lingering change, say, into the summer promotional period?

Okay. So I will break down the reasons for the several points. Firstly, the net revenues of Q1 and Q2 of this year on a very large level relies on how much we spend in the second half of 2020, especially last Q4. And also the gross billings of the first quarter of 2021, part of it is also relying on December of last year, how much sales and marketing we spent. And as you can see in last Q4, our sales marketing margin is relatively low. And last December, we actually actively implemented some cost control on the sales and marketing spending. And that is why if we look in all the aspects, this Q1, the gross billings goes down slightly. The second reason is, in the first quarter, within all our sales and marketing channels, the traffic acquisitions from performance channel still account for a pretty high proportion. And because of this fierce market competition, the customer acquisition cost of the performance channels this quarter is up by several times compared to the same period of last year. That somehow also caused the change of our gross billings. Thirdly, this Q1, for the first time, we started a scaled branding activity spending. We believe our spending for this branding activities for this quarter might not produce immediate significant impact, however in the long-term, it will be some investments in assets. Secondly, for the first quarter, our R&D expenses also have reached its historical high. We believe that will also create a long-term average. Lastly, for the first quarter, we also expanded our recruitment and training for instructors and tutors. Those will also create value for our long-term. Lastly, in March, we have very significantly reduced our spending in this traffic acquisition on performance channels. And at this moment, we have completely stopped our spending in traffic acquisitions from the performance channel. On the one hand, we want to be in full compliance with regulations. On the other hand, we really want to return to the essence of education, return to a quality-driven growth. We believe in the next several months we will see some benefits. Also, internally, we are not satisfied with our operating efficiency in the first quarter. Internally, we have done a very comprehensive review and reflection. As of today, with our current size and current brand recognition and the way our gathering of so many talents, I believe in the following days, we will be able to make use of whatever we have learned and whatever we have observed and whatever we have thought about into our operations and will bring us better efficiency and effect. As for the sales and marketing budget for the second quarter, sales and marketing in Q2 that also relates to the student recruitment size for spring and the summer semesters in the second quarter. And it also will affect the revenues of Q3 and Q4. Based on the data we have collected so far, we see operating efficiencies in the second quarter have improved significantly, especially for conversion rate and retention rate. We've seen some significantly positive movement. So we’re confident about our future and I believe we definitely want to return to our original beliefs about operation, and we hope in some time, in quite a few period, we will return to this profitable growth.

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

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 contact us via email ir@gaotu.cn directly. The old email address will continue to be available. Please feel free to subscribe to our news alert or quarterly investor newsletters on the company IR website. Thank you very much.

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