Gaotu Techedu Inc.

Ladies and gentlemen, thank you for standing by and welcome to the GSX-Tekadu, Inc. first quarter 2021 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw from the question queue, please press star then two. 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 Chin, IR Director of GoTo. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. GoTools and its release was distributed earlier and is available on the company's IR website at ir.goTools.cn. On the call with me are Mr. Larry Chen, GoTools founder, chairman, and chief executive officer, and Ms. Shannon Schiff, 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 the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management's current expectations in current market and operating conditions and related events that involve known or unknown risks, uncertainties, and other factors, all of which are difficult to predict, and many of which are beyond a 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 filing for CFTC. The conference does not undertake any obligation to update any forward-looking statements except as required and are applicable now. As a reminder, this conference is being recorded. In addition, a live and archived webcast of this conference call will be available on GoTo's new investor relations website. Today, we officially launched our new website at ir.go2.cn. The old red spot 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 cost tutors rose to account for 20% of our quarterly revenue, up by 5 percentage points sequentially. That, combined with miscellaneous expenses, totaled RMB 503 million. Additionally, this quarter, we spent RMB 352 million on branding activities. Excluding these factors, our traffic acquisition costs were RMB 1.37 billion, while first-time users contributed a majority of the RMB $1.18 billion in gross billions, 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. Expensive 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 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 expensive investment in our technology and education quality. A major priority for our investment has been on technology and education quality. In the first quarter, our investment in research and development reached a historical high of RMB 365 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 been also expanding our investment in our teachers and education quality since the beginning of this year. We have raised the base compensation for each of our over 1,500 tutors by RMB 500 per month. We have also established a RMB 5,000 annual tribal fund for each of our instructors, tutors, and cross-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 apps to recruit and develop talented instructors at the local level. Moreover, we continue to increase our spending to train tutors and have helped them improve their academic knowledge and the certain capabilities through routine subject training and the lecturing context. Education is one of the biggest factors that affect a person's well-being. It's a social responsibility, and in the end, it's about enlightening one life with another life. In the first quarter, third-tier cities and below contributed 59% of our K-12 enrollment. During the pandemic last year, we donated 20 million worth of winter semester regular-priced courses to Wuhan. We also founded a charity project to support prayer 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 Payers of the State Scholarship in Shaanxi Province and have provided approximately RMB 15 million worth of regular-priced courses to more than 220 outstanding students from eight 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 bring 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 operation details.

Thanks, Larry, and thank you everyone for joining the call. Now, I will walk you through our operating and financial results for the past quarter and conclude with our outlook for the coming quarter. 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 K-12 businesses under GAL2 brand. This April, we further integrated all of our services under the GAL2 brand, including GAL2 K-12 for our K-12 business. and GoTo Professional for our foreign language, professional, admission, and other services. We believe that by bringing all of our services under just one brand, GoTo, we will be able to strengthen the recognition of our company in the market. Over the past few months, we've continued to strengthen our investment in improving the quality of teaching services. developing localized teaching, expanding our teaching product portfolio, and upgrading research and development to secure our long-term competitive strengths. The logic of burning cash for traffic and skill doesn't 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 our healthy growth and pay more attention on metrics, including product healthiness, cash flow, and overall profitability. For the K-12 screen 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 decreases was due to a few factors. On the one hand, The base last year was quite high due to the COVID-19 pandemic period when a lot of students signed up for our classes. On the other hand, this winter we partially adjusted our operations. Paid enrollment, which referred to enrollment 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 K-12, 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 segments. which actually had a particularly strong quarter. Revenue grew by as high as 180% year-over-year, thanks to our good quality instructors, a competitive advantage that we have established. For this winter and spring courses products, our interactive scenario design covers over 98% of the curriculum, so that our courses are both interesting and effective. Gross billings contributed by GAL2 K-12 was $1 billion. Paid course enrollments for GAL2 K-12 reached 632,000. Average enrollments per class were 2,300 in the first quarter in 2021, compared with 2,600 in the first quarter last year. Quarter over quarter, the numbers slightly because we have a wide range of class levels and localized classes to cater to various students' needs. Meanwhile, new instructors are giving courses and gradually growing their class from a smaller size to bigger later. Net revenues from go to professional grow to $123 million and accounted for 6% of group net revenues. Gross billings contributed by GAL2 professional were $181 million. Paid course enrollments for GAL2 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 costs, etc. Gap gross profit margin decreased to 71%, down from 78% in the same period of 2020. Non-gap 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, Shaanxi, Shandong, etc., 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 students' 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 covered labor, servers, etc. 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 QA 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 and VR technology, We aim to create a real-time interactive classroom to provide our students with an immersive learning experience. We believe these data investments in technology will benefit our company and will be something we can leverage for many years to come. G&A expenses increased by 207% to $218 million. mainly due to an increase in G&A headcount and related compensation. G&A 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 increase in investments in our brand, instructors, research, and technology. which are all essential to the long-term competitiveness of our business. As of March 31st, 2021, we had $2.9 billion of cash and cash equivalent, $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 31st, 2021, Our default 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 the 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 substantial and healthy on our own unit economic 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 fees performance channels. Meanwhile, we've also stopped engaging new branding contracts, taking into consideration the possible impact of all these short-term operation adjustments on sales leads. We estimate our net revenue 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.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then two. Our first question comes from Mark Lee of Citi. Please go ahead.

Hi, Larry. Hi, management. Thanks for the presentation. This is Mark Lee 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 quarters or for the next year? Could you share a bit more color? And also, my second question is for our advertising ROI. Could you share a little bit more color on the ROI in Q1? And what do we think going forward? Thank you.

Thanks, Mark. First question about the regulation impact. So we have been following the opinions on regulating after-school tutoring institutions in 2018 and further opinions on regulating 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, four departments in Beijing jointly released a guideline listing out specific requirements on the tuition fee collected in advance, including tuition fee coverage period, advanced tuition fee collection timing, a tuition fee monitoring. They provided very detailed guidelines. And second, about advertisement. All companies should follow the law of advertising and the law 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 formats, course scheduling, teacher qualifications, homework and student rest time, etc. 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 noncompliant 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 teacher's qualifications. We also cross-checked the teacher qualifications online and from other channels. So on May 21st, the same day with the prepaid tuition fee management rule, the Central Commission of Comprehensively Depending Reform launched its 19th meeting. It eventually also approved the opinion on reducing burdens from homework and after school tutoring for compulsory education students. That is called . 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 clear directions for the industry. We will proactively embrace the policy and take solid actions and closely monitor the following executions. 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 can add a few points. The first is that Students and parents have always had a need for personalized education. Second, the convenience of online education and the affordability of the price can ensure the fairness of education. Third, online education has a whole chain of data. And these data can be used to better understand students, so that we can provide students with personalized targeted learning solutions. So I personally think that we are very optimistic about the future of online education. And I also think that if we really pay attention to education, I want to add several more points. Firstly, the demand for premium education, for customized education from students and parents is eternal, always exists.

Secondly, the benefits brought by online education at very affordable price will provide a secure for equal access to the education. And thirdly, the online education is able to collect data with all assets from the students. So it's easier for online education to provide more customized solutions for each student. So in short, me personally, I am very optimistic about the future of online education. And I believe that as long as we do education with our true hearts, 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, MCNs, etc., 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 platforms. 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. GoToK12 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 word of mouth 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 learn 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.

Thank you.

The next question is from BS Kim of JP Morgan. Please go ahead.

Hi, good evening, Mr. Chen and Shannon. Thanks for taking my question. Well, can I check why and how we saw such a drastic deterioration in billing and enrollment this quarter? I mean, It's particularly surprising because sales and marketing, as you mentioned, went up quite a lot to be twice of gross building, 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 first half of second quarter versus second half to gauge the impact from the change in marketing that you just mentioned? And do you think that this termination in traffic cost is temporary or more lingering change, say, into the summer promotional period? Thank you.

Thank you. I would like to talk to you about the following aspects. The first aspect is that the sales income in the first and second quarter of 2021 is largely the same as in the third and fourth quarters of 2020. especially in the fourth quarter. The cash income in the first quarter of 2021 is partly due to the last month of the fourth quarter of 2020, which is December, which is the cost of market investment in December. In the fourth quarter of last year, our SM cost Okay, so I will break down the reasons for several points. First of all,

the net revenues of Q1 and Q2 of this year, on a very large level, relies on how much we spent in the second half of 2020, especially last Q4. And also, with growth feelings 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, last Q4, Our sales market 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 at all the assets, this Q1, the growth rate goes down quite a bit.

The second is that our first quarter's inflow rate is relatively high. The second reason is in the first quarter, within all our sales and marketing channels,

the traffic acquisition from performance channels do account for a pretty high proportion. And because of the 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 outlook feelings.

The third is that we started relatively large-scale wholesale in the first quarter of this year. This is the first time we have done a relatively large-scale wholesale. We believe that these wholesale will not have a significant impact in the current season, but it will become a real asset in the long term. In the first quarter of this year, the cost of our R&D has also reached a historical high. We believe that this is also a long-term value. In the first quarter of this year, we continue to increase the recruitment of instructors and tutors. These teachers' training will also become our important asset in the long term.

Thirdly, this Q1, for the first time, we started a scaled branding activities 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 investment in assets. Secondly, for the first quarter, our R&D expenses also have reached a historical high. We believe that will also create long-term leverage. 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 feeling growth, we believe in the next several months, we will see some benefits.

Yes, another thing is that we are not satisfied with the efficiency and efficiency of the first quarter. We have made deep reflections on it. I think as we have reached today's scale, the brand has reached the level of recognition today. 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 with 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.

Regarding the second quarter's sales, we all know that the second quarter's sales cost will be related to the second quarter's spring and summer salaries. At the same time, it will also have an impact on our third quarter and fourth quarter's income. In terms of current data, the operating efficiency and efficiency of the second quarter has been significantly improved, especially our low-cost and positive-cost performance, as well as our positive-cost performance. In comparison, I think there is still a lot of improvement. So we still have a lot of confidence in the future, and we still have to As for the sales and marketing budget for the second quarter, sales marketing too, that also relates to the student recruitment size for spring and the summer semester in the second quarter.

And it also relates will affect the revenues of Q3 and Q4. Based on the data we have collected so far, we see the operating efficiency in the second quarter has improved significantly, especially for conversion rate and retention rate. We see some significant positive movements. So we are positive about the future, and I believe we definitely want to return to our original beliefs about operations. And we hope in some time, in quite a period, we will continue this profitable growth.

Thank you very much, Mr. Chen. Very hopeful.

This concludes our question and answer session. I would like to turn the conference back over to Sandy Chen 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 at calltools.cn directly. The old email address will continue to be available. Please feel free to subscribe to our news alerts or portal 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.