Gaotu Techedu Inc.

Ladies and gentlemen, thank you for standing by and welcome to the GAL 2 Techadoo Incorporated Second Quarter 2021 Earnings Conference Call. All participants will be in a 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 1 on your touchtone phone. To withdraw your question, please press star, then 2. Please note, this event is being recorded on Wednesday, September 22, 2021. I would now like to hand the conference over to your first speaker today, Ms. Sandy Chin, IR Director of GALTU. Thank you. Please go ahead.

Thank you, operator. Hello, everyone, and thank you for joining us today. GoTo's earnings release was distributed earlier and is available on the company's IR website at ir.cultool.cn. On the call with me are Mr. Larry Chen, GoTo founder, chairman, and chief executive officer, and Mr. 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 would like to remind you that the 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 and 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 with CFPB. The company does not undertake any obligations to update any forward-looking statement except as required and applicable now. As a reminder, this company... Thank you, Sandy. Good evening and good morning to you all. Thank you for joining us today on our second quarter 2021 earnings conference call. In the second quarter of 2021,

our revenue has reached a record high of 2.232 billion RMB. Setting expenses margin this quarter has also substantially dropped and has reverted a similar low level that we recorded a year ago, as we have entirely stopped new fees advertising spending since mid-May this year. As you all know, the education industry has experienced some changes over the past few months. However, as the saying goes, we will begin with the end in mind when setting our strategy. We will always remain committed to our original aspiration of quality education and we will seek to provide authentic educational services. In the meantime, we have actively shouldered our social responsibility as an education company. Ever since May, we have successfully collaborated with multiple nonprofit organizations, including the China Charities Aid Foundation for Children, the China Youth Development Foundation, and the China Next Generation Education Foundation, and the Henan Normal University by donating cash or free courses to aid the revitalization of rural area education and supporting the goal of providing equal access to education for all. To actively respond to the nation's call, we have recently and rapidly adopted the organizational structure of our company to focus on professional education and STEAM education. And we are further exploring opportunities related to digital products and vocational education. First, we will continue to expand our investments in our existing professional education segments, such as financial certificates and the public office exam preparation, while constantly exploring more professional education portfolio opportunities, such as postgraduate exam preparation and overseas study preparation among which some have already achieved a better than industry average ROI. We aim to establish a diversified professional education portfolio with multiple segments. Secondly, we have also increased our investment in our theme education segment, which is developing rapidly. Take programming as an example. Just in July 2001, the conversion rate from trial classes to regular class 4 courses exceeded 30%. Thirdly, we are simultaneously exploring new opportunities in digital products and vocational education, continuing to reinforce the positive effects technology has on education content and education tools, and expanding our footprint across the education sector. We firmly believe that the education market in China will continue to grow steadily. We also firmly believe that the tech education firm will play a very important role in this. We are confident that our company will live up to our responsibilities and mission. Since founding, we have made numerous breakthroughs in the K-12 area, including streamlining an entire industry supply chain, refining standard procedures, training expert teachers at scale, constructing effective service systems, and improving operational efficiencies. all of which helped us accumulate a great deal of insight and expertise. We now plan to replicate the insights and expertise to theme education, professional education, and vocational education, and we sincerely hope that we can soon return to the profitable growth trajectory that we saw back in 2019. As many of you know, Our company experienced a severe cash shortage back in 2016 and 2017 and almost went bankrupt. We call it the darkest moment internally. But it was exactly under that pressure that we came together as a united and effective team with tremendous cohesion and the best execution to build a miraculous business that generates rapid revenue growth and growing profitability over seven consecutive quarters. If 2014 was our first attempt as a startup and 2015 was our second start, then we can say that 2021 is our third start. As someone who has worked in the education industry for 33 years, I believe we should always have love for our family and our country. Always keep the end goal of education in mind. Always firmly believe that education is a noble profession and always have faith that the future ahead is bright, both for our industry and our society. 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 our operating and financial results. Please note that all financial data that I mention later is in RMD terms, unless otherwise noted. Allow me to share with you some details about the compliance status post-policy changes. On July 24, 2021, China's official state media, including Xinhua News Agency and China Central Television, announced the opinions on further alleviating the burden of homework and after-school tutoring for students in compulsory education. which was issued by the General Office of the CPC Central Committee and the General Office of the State Council. We later issued an announcement informing that the policy will have a material impact on our operations. Since the new policy announcement, we are dedicated to respond within the shortest time of period and to adjust our business and strategy accordingly with high compliance standards. which can be seen from the following aspects. Regarding adult housing, we stopped acquiring traffic from online social platforms since the second quarter. Regarding class hour adjustments, we strictly abide by the new rule that after-school tutoring institutions shall not organize any classes on national festivals, weekends, or summer and winter holidays. We have adjusted full class schedule for compulsory education classes from weekends and national festivals to legal time from Monday to Friday, required by the new policy. Based on the data we have, the refund rate after schedule adjustment is in single digits. Regarding the standardization of the content, we strictly checked and reviewed our content to make sure no content is out of the regulatory limits. Regarding the requirement on tuition prepayment, according to the requirement by the Beijing government on the management of upfront tuitions at after-school subject tutoring institutions, we have technologically collaborated with custody banks to monitor upfront tuitions, return the required funds properly, and make sure our clients' right to refund is protected. Moving on, we will continue to focus on the following two aspects, First, regarding fee standard on tuition, on September 6, the National Development and Reform Commission, the MOE, and the State Administration for Market Regulation jointly issued an announcement on adopting a government-guided pricing mechanism for curriculum-based after-school tutoring courses for students at the stage of compulsory education. Online and offline subject tutoring institutions for students at the stage of compulsory education must adopt government-instructed price limits, with the upper limit of the price range set by local government no higher than 10% and no lower limit. Up until now, we have not yet received any process guidance on the price control on online education. We will adjust our pricing after we have received specific government instructions. Second, in terms of turning academic ASG institutions for students at the stage of compulsory education into non-for-profit organizations, we will continue to communicate with the government. GAL2 will strictly abide by all the laws and regulations and communicate with all of our stakeholders remotely. Now, let's review our financial and operational status of this quarter. For the second quarter of 2021, net revenues increased 35.3% year-over-year to $2.23 billion, driven by our continuously expanding paid course enrollment growth, thanks to our enhanced teaching quality and brand recognition. Class buildings, the leading indicator for net revenues was $2.7 billion, increasing by 12.2% year-over-year from 2.4 billion last year. Paid course enrollment, which referred to enrollment price at or above 99 yuan, increased to a record high of 1.63 million for the quarter, a 4.1% year-over-year increase. Now, let's break down our operations and financials by business line. Net revenue from our K-12 courses including student courses, increased by 51% year-over-year to $2.09 billion and accounted for 94% of net revenues. Gross earnings contributed by K-12 courses increased by 17.2% year-over-year to $2.58 billion. Paid course enrollment for K-12 grew by 4.5% year-over-year to $1.56 million. Average enrollment per class was 1,700 in the second quarter in 2021, compared to 2,300 in the previous quarter. Quarter over quarter, the numbers linked slightly because we offered shorter-term courses with smaller class sizes to cater to various students' needs. Net revenues from our foreign language, professional, admission, and other vocational education services go to 100 and 41 million and accounted for 6% of net revenues. Those billions contributed by foreign language, professional, admission, and other services reached 120.2 million. The paid course enrollment for foreign language, professional, admission, and other services is 68,000. Moving over to our selected financial metrics summary, Our cost of revenues increased by 100.8% year-over-year to $724 million. The year-over-year growth rate was mainly due to increases in compensation for instructors and tutors, learning materials, rental expenses, as well as service and service costs. Gap gross profit margins decreased to 67.6%, down from 78.1% in the same period of 2020. And then GAAP cross-profit margin, which excludes share-based compensation, decreased to 69.1%, down from 79.1% 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 that our students receive, as well as an increase in compensation for such staff. Selling expenses increased to about $1.64 billion in the second quarter of 2021. Within that, expenses for traffic acquisition were approximately $0.9 billion. Expenses for branding activities were approximately $95.1 million. The remaining expenses cover labor, server, etc. The selling expenses margin decreased year-over-year to 74%. We have seen continued improvement of margin, which falls back to its original level a year ago, since we stopped new feed and online advertising spending in May. Research and development expenses increased by 204%, 4.9% year-over-year to $427 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. G&A expenses increased by 128.9% to $232 million, mainly due to an increase in G&A headcount and related compensation. Nangat net loss was $763.9 million, compared to the net income of $72.7 million in the first quarter of 2020. gap net loss margin was 1.2%. As of June 30, 2021, we had $1.02 billion of cash and cash equivalent, restricted cash, $3.95 billion of short-term investments, and $518.5 million of long-term investments, combining to be $5.49 billion. As of June 30, 2021. Our deferred revenue balance was $1.98 billion. Deferred revenue primarily consists of the tuition collected in Iran. Net operating cash outflow for the second quarter of 2021 was $318.6 million. Considering the uncertainty that the government policy brings to the following financial conditions, We will now provide the next quarter's performance guidance for now. That concludes my prepared remarks. Operator, we are now ready to take questions. Thanks.

Thank you. 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. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Steven Young with Goldman Sachs. Please go ahead.

Hi. Thanks very much for your time and sharing. It's very clear. So we've got two questions. First is on the plans and priorities in the next 12 months. For example, on professional esteem and more details on how the company has reorganized so far accordingly. For example, how many percentage of the organization can be tied to the future plans.

Thank you. Thank you. We are the first company in the industry to stop online training for children aged 3 to 6. We are also the first company to stop online training for children aged 3 to 6. We are also the first company to stop online training for children aged 3 to 6. We are also the first company to stop online training for children aged 3 to 6. We are also the first company to stop online training for children aged 3 to 6.

Thank you. So we believe under the current policy environment, we are the first online education company to formally stop the online training services for three to six-year-old children. And we are the first education company to fully stop all the traffic acquisition settings. I believe we might also be the first one among the top players to have a comprehensive and a very valid reorganization to further focus on our core dividends.

We focus on delivering the final product. I think if we have the biggest wealth in the past seven years, I think it is our high-end organization, high-end brand, and high-end. It has received a lot of recognition in the whole society. So we will continue to make the high-end organization grow better and more powerful. We will continue to train our talents, so that our talents can grow and grow better and faster. We will also continue to polish our products and really achieve the products that our customers love, so that the products can become the endorsement of this high-end organization.

So in the next couple months, we will focus on two aspects. Firstly, we will focus on our organization, focus on talent, and focus on delivering the best product. In the past seven years, I think the biggest wealth we have accumulated is gathered from organizations, our brands, and investmentization we have realized by the society. So we will continuously to let our world's vision to grow in a healthy and more powerful way. We will continuously to train our talent so that our people can have a better growth. And then we will continuously to improve and optimize our products. We will develop the products that our customers really like so that we can use our products to represent our organization's service quality.

According to the current policy, the two points of the country are mainly aimed at the obligation-based stage. I think in addition to the policy and the management of these areas, we are facing a lot of setbacks. I think our next focus is to break through in three areas. The first is to recognize the business We know that we started doing adult business in 2016. We still have a lot of knowledge. Of course, we have made a lot of mistakes. I believe that with the adjustment of our current model, we should be able to make some breakthroughs in the adult business aspect. Secondly, we will pay more attention to quality education. We tried programming before. At present, many data are still good. We will further to expand our business exploration in the field of quality education. The third aspect is that we will explore vocational education as well as some smart digital products. We are thinking about this, but I think based on our long-term development and based on the positioning of our entire company, I also believe that we can do something in this regard.

So, according to current policy, the double reduction policy mainly focuses on compulsory education for active school children. I believe, in spite of the uncertainty brought by the regulatory monitoring, we will focus on three business lines. First, professional education. As you know, we have started this segment since 2016, and we have accumulated a lot of We have definitely also made some trial and errors. And I believe as we adjust our operating model, we will make some breakthroughs. Definitely, theme courses, as I spoke earlier, we have tried programming and we have seen a lot of great data. So going forward, we will further explore the same projects. Lastly, we will try the vocational education and also digital products. We are having some explorations, and according to our long-term development plan and the position of the company, I believe we will do something great. Thank you.

Thank you. The second question is regarding not-for-profit organization. So the MOE has published a document specifying the measures of online AAC re-registration. So would you mind sharing the company's registration progress so far? And if registered as not-for-profit organization, how will that impact shareholders, for example, the onshore or offshore assets? Thank you.

On September the 16th, the MOE and other state government ministries jointly announced a guidance stating the online education institutions need to change from the registration-based region to an approval-based region. And for compulsory education service providers, all the service providers need to be approved as not-for-profit institutions by the end of this year. So this is like a high-level instruction. And according to the announcement, the prerequisite of being approved is that the organization has to be registered with the government in the past, which GoTo has already done in 2020. We were already on the red list issued by the Beijing Education Bureau. So other requirements to be approved also include having qualified offline training centers, having secure data and privacies and so on, So we will strictly follow the notice to ensure full compliance and maintain frequent communications with the regulators. But besides the announcement, we are talking to the regulators on a weekly basis, just try to get a more detailed instructions about how we should do for the following month. So it's still in ongoing status. We will update you once we have a clear and specific instruction.

Thank you, Sharon. That's very clear.

The next question comes from Mark Lee with Citi. Please go ahead.

Hi, management. May I ask a question on the Staff optimization, given the big change of our focus from the subject-based tutoring to the other area, how big would the staff optimization and when would you think it would last? And what would be the cash impact to the, you know, over 5.5 billion R&D of cash that we have on hand? Thank you.

Thanks, Mark. So we reacted in the shortest time right after the double deduction policy was released. So the restructuring was already done back in July and August. We closed certain operating centers outside of Beijing, and we also paid for the severance cost for some of the employee layoffs. So it's a tough decision to make, but making that decision quickly also left us a precious time and room to think about our future and make the right decisions. So we expect our company size and employee scale to be stable in the short term to support us to explore our new businesses. And also from the cash perspective, like I just mentioned, we have around $5.5 billion cash and cash equivalents in short-term and long-term investments on hand. Even like we paid for the cancellation penalties for leasing agreement or the severance cost for our employees, that still left us sufficient cash to continue to develop and explore new business in support our business in the future. So I think the key for us to think about is how to provide a high level, a high quality of learning product that can meet the demand for vocational education, for professional education, for seeing courses. And like Larry just mentioned, we are also developing our digitalization product to provide more efficient learning methodology for our customers. So we will try our best. Like I just mentioned, this is the third time for us to kind of like explore for the new business. We will try our best to to show you that the team still holds the faith in the future of the education industry and also in the company. Thanks.

Thanks. May I know what's the number of TA we have at this moment? Thank you.

After all the research for our employees, we still maintain sufficient of our tutors to support the learning service for our fall semester students. So the number fits our current company size, and we will adjust the employee skill and let the skill to fit the future development of our company.

Understood. Thank you.

Thanks. This concludes our question and answer session. I would like to turn the conference back over to Ms. Sandy Chin for any 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.go2.cn directly. Please feel free to subscribe to our news alert or follow us through 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.