Gaotu Techedu Inc.

Good day, ladies and gentlemen. Thank you for standing by. And welcome to the GAL2 Tech EDU Inc. Third Quarter 2022 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 touch-tone phone. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Sherry Liu, IR Manager for GAL2. Please go ahead.

Thank you very much, Aubrey. Good evening, ladies and gentlemen, and thank you all for joining us tonight for GAL2's third quarter 2022 earnings conference call. GAL2's third quarter earnings release was published earlier today, and it's available on the company's IR website at ir.gal2.cn. On the call with me tonight are Mr. Larry Chen, Gautu's founder, chairman, and chief executive officer, and Ms. Shannon Shen, Gautu's chief financial officer. Larry will give a general business overview for the quarter, and then 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 defined 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 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 from those contained in any forward-looking statement. Further information regarding these and other is included in the company's filing with the U.S. 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 GAL2's IR website. It is now my pleasure to introduce Larry. Larry, please go ahead.

Thank you, Sherry. Good evening and good morning, everyone. Thank you for joining us on GoTo's third quarter 2022 earnings conference call. I would like to take this opportunity to convey my gratitude for your continued interest in and support for us and the education industry. Before I start, I would like to remind everyone that all financial information, as I mentioned later, is based on RMB and is otherwise noted. In 2022, through gradually deepening our understanding of customer needs, we have been actively exploring new business models and expanding their limits. Undeniably, business transformation is a very challenging process as we have overcome numerous difficulties Thanks to our outstanding operational skills and the extensive educational experience we have accumulated in the past eight years, we have united a more powerful organization with a deep passion for education. At the same time, our capital and talent reserves remain strong. These assets have given us a strong edge when confronting unknown external risks. We are confident that as long as we remain patient and persevere, while remaining true to our original aspiration, we will eventually achieve significant breakthroughs on our businesses and evolve into a greater organization. In this quarter, we divided our business into two categories. One is learning services. and the other is educational content and digitalized 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 post-restructuring, we are glad to report that during the quarter, our net revenues increased 12.7% quarter-over-quarter to $606.2 million, and our net loss has 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 right, our organization is resilient, and our operations are efficient. Due to differences in testing seasons, market demand, and the cost scheduling, our new business exhibits different seasonality patterns. Guided by the strategy of profitable growth, we expect the growth momentum of our business to continue, and we expect to see 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 skill while maintaining a steady pace of development. After a year of exploration, we have accumulated a fair amount of insight into our new businesses. We have made decent advances in this quarter, and we 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 place a fundamental emphasis on good teachers. Good teachers are at the core of education and the service and the professionalism are the prerequisites for good teachers. Our recruitment efforts have always followed the principle that good teachers should not only be able to improve students' academic performances and learning capabilities, but should also serve as an inspiring role model and mentors who provide emotional support. Take our postgraduate 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 are aiming to further increase the ratio. In our opinion, teachers who have successfully passed the exam can be more compassionate to students who are going through the same experience. They can better understand the students' needs and therefore can offer more constructive service and achieve better results. During the quarter, our postgraduate entrance exam prep recorded a roughly 76% quarter-over-quarter increase in net revenues and an over 46% quarter-over-quarter increase in gross variance. which was partly driven by the good branding gradually established by our top-notch teaching talent and their high-quality services. Second, we will continue to focus on improving our operational efficiency. In the quarter, our growth margin reached 72.2%, higher than that of last quarter of the same period of last year. Our efficiency for customer acquisition also improved with our ROI for customer acquisition achieved quarter-over-quarter increase. Considering that, in terms of seasonality, the third quarter is the peak season for growing new enrollments. We see that the market opportunity to increase in size by slightly raising marketing expenses that result in small-scale losses. However, as our customer acquisition efficiency improves and our business expands, we expect to see higher brand exposure and a 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 Go to Rural Education Support Program with the China Youth Development Foundation. Through the program, we provided financial subsidies and training courses to principals of rural primary schools to help improve their teaching quality, provide assistance for more needy children in these areas, and in this way, aid rural revitalization. Further, our board of directors today authorized a new share repurchase program under which we may repurchase up to $30 million worth of our EDS in three years. Our cash position remains strong as of September 30th. 2022, our cash, cash equivalents, restrictive cash, and short-term investments totaled approximately $3.3 billion. I also intend to purchase up to $20 million U.S. dollars worth of shares to demonstrate our management and weavering 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 a number of short-term reports from approximately early to May 2020, and that we had previously disclosed in our annual report for the fiscal year of 20 and 21. In the letter, the SEC notified us that It had concluded its investigation into our company and that based on the information that it had as of the date of the 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, continue to nurture parents for our society, and to continue 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 you through our financial and operational details of the quarter.

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 that I mention later is based on RMB unless otherwise noted. As we continue 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 sub-quarter, net revenues increased 12.7% quarter-over-quarter to $606.2 million. Gross buildings 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 $607 million. This solid performance, well 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. Within learning services, our new business mainly includes educational services for college students and adults, overseas data-related services, non-academic tutoring services, and others. Now, I will elaborate the progress we made in each of these business lines during the quarter. First, learning services, which accounted for about 90% of net revenues in the quarter, is still the biggest contributor of our revenues. Of the 90%, Approximately 30% of the 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 test preparation period. Correspondingly, we are glad to see our related businesses achieved high double-digit quarter-over-quarter growth in revenue during the quarter. Further, we have noticed that as the overall number of exam registrants goes up, students' willingness to participate in preparation courses escalates, and as a result, The market for services related to college students, further education, and job searching is booming. Take the postgraduate entrance exam prep business for example. According to multiple market research, the number of applicants for China's 2023 postgraduate admission exam is predicted to exceed a record 5 million, representing a year-over-year increase. of at least 10%. Additionally, more and more students are starting their preparation as early as their freshman years. We will continue to serve students preparing for such exams with dedicated teachers and comprehensive application planning. At the same time, we have also witnessed cross-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 rest of the roughly 60% of our learning services revenues came from services targeting the group of students from primary to high school, including non-academic tutoring services and others. This factor exhibits a more silent seasonality, as course retention and the corresponding sharp increase in gross billing normally happen in the second and fourth quarter. However, the third quarter is the season for acquiring new students. And as a result, during the 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 cost retention, our gross earnings for the quarter remained at the same level as that of last quarter. indicating that the gross earnings contributed by new students are taking up a higher percentage due to our effective new customer acquisition strategies. This increasing effect will snowball and provide more leverage to next quarter's gross earnings. Thus, we expect to see a sizable positive net operating cash flow in the fourth quarter. The remaining 10% of the quarter's net revenues came from educational content and digitalized learning products. This segment mainly includes smart textbooks, learning devices, and other digital products for students. These products serve as supplements to our courses, satisfying students' diversified learning needs and will boost user retention on our platform through better user engagement. Next. I will present our financials of the quarter in more detail. Our cost of revenues this quarter decreased by 76.4% year-over-year to $168.8 million. Our gross profit increased 9.4% year-over-year to $437.4 million. Gross profit margin was 72.2%. a 190 basis point increase compared to that of last quarter, and a significant year-over-year improvement. Non-GAAP gross profit was $439.3 million, and non-GAAP gross margin was 72.5%. The increase in gross profit margin 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 businesses related to college students and adults. Operating expenses decreased by 65.8% year-over-year to $506.9 million. Now, let's break down our OPEX. Selling expenses decreased 59.2% year-over-year and slightly increased quarter-over-quarter to $300 and $36.8 million. The quarter-over-quarter increase in selling expenses was mainly due to seasonality. The summer vacation is usually the peak new customer enrollment for most of our learning service businesses. We allocated marketing investments proportionate to the soaring demand we observed in the market. Through improving operational efficiency and ROI of our marketing expenses, we can gradually increase our brand exposure and market share. 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 to focus on brand building and recognition to reduce our customer acquisition costs by heavier reliance on word-of-mouth referrals and to enhance user conversion rate and selling expenses ROI through better using targeting and in this way, achieving sustainable growth. Moving on, research and development expenses decreased 68.3 percent year-over-year to $106.5 million, accounting for 17.6 percent of net revenues, which was 1.7 percent lower than last quarter's R&D margin. This was mainly due to the greater economics of GAIL 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, including recruiting curriculum design experts with significant experience and influence in their respective fields. General and administrative expenses decreased 61.4% year-over-year to 63.6 million, accounting for 10.5% of net revenues. Loss from operations for the quarter was reduced by 93.6% year-over-year to $69.6 million. Net gap loss from operations was $53 million. Net loss for the quarter was significantly reduced by 94.1% year-over-year to $61.4 million. Net gap net loss was $44.8 million. If we exclude the 17.5 million losses on our offshore RMB reserves, up 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 34.7 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 $909.5 million cash, cash equivalents and restricted cash, and $2.4 billion short-term investments, which totaled approximately $3.3 billion, providing ample resources for continued business development. Further, as of September 30, 2022, Our default revenue balance was $638.4 million, which primarily consists of tuition collected in allowance. As my speech comes to an end, I would like to take this opportunity to emphasize our management's unceasing efforts in fulfilling our responsibilities to shareholders. Our board today has authorized a three-year share repurchase program up to 30 million US dollars. Our founder and CEO, Larry, has also promised to increase his shareholding by purchasing up to 20 million US dollars worth of our shares personally. Our management would like to demonstrate our faith and firm confidence in the long-term development of our company. Moreover, the closing letter we received from the US SEC eliminated potential external negative effects, and it's a perfect testament to the high standard in corporate governance, information disclosure, and compliance that we have always abided by. Going forward, we will focus more on satisfying customers' needs and continue to create value for all shareholders. Before I provided our business outlook for the next quarter, please allow me to remind everyone that this contains forward-looking statements, which involve risks and uncertainties, which 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 fourth quarter of 2022 are expected to be between $608 million and $628 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 the Q&A session. Thank you, everyone, for listening.

We will now begin the question-and-answer session. To ask a question, you may press star then 1 on your touch-tone 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, management. Congratulations on the result and thanks for the share repurchase and the increased efforts. This is Mark Lee from Citi. May I ask for our non-academic education, could you share about our recent key development and perhaps outlook for the next year?

Thanks, Mark. Thanks for your question. Our academic student services is one of the new businesses we focused on after our restructure. And this business line is still in the process of optimizing course products and gradually winning recognition among students and parents. So after the double deduction policy, students have more spare time during their weekends and holidays, which has spurred a huge demand for non-academic children's services, especially among first- and second-tier cities. So we currently offer a variety of non-academic children's services, including programming tests, international tests, humanity, and also science courses, etc. That are students for online education and interaction. These courses are very constructive in sparking children's interest and intellectual curiosity. Our academic courses could enhance students' learning skills and at some level can directly improve students' performance back in school. So it had won the trust and support among parents. And also, the non-academic children's services follow a progressive and systematic curriculum design. This sector exhibits seasonality as well, with cost retention normally happen in the second quarter and the fourth quarter. So in the second and fourth quarter, it usually has a large increase in the gross billings. We just finished the Q4 retention in November, and the retention rate was as high as 78%, which actually exceeded our expectation and also inspired us. And also the ASP for non-academic children's services is proportionate to the market demand, so its unit economy is more healthy with a high growth profit margin as you may have noticed that our gross profit margin also increased in this quarter. So based on what we see now, the development of this sector matches our expectations. As this sector is still in the early development stage, we will disclose more information on enrollments and revenues as it matures. But going forward, we will continue to focus on optimizing the products and enhancing our learning experience and continuously improving our course curriculum. As for the expectations, we are more preferred to provide a more short-term instruction. So we do foresee, like the in the fourth quarter, increase meaningfully, and also we will be having a flexible, positive net operating cash flow in the fourth quarter, and that majority was contributed by our academic education, learning services, and others that we serve the students from junior school to high school. Hope that address your questions. Thanks, Mark.

Thank you. Shannon, may I have a quick follow-up? You mentioned about increasing gross billing and positive cash flow in Q4. May I know for our profitability, is it likely to see also a better margin or perhaps like a break-even performance in Q4? Thank you.

Yes, so we foresee Q4 will be profitable. So the net profit margin will be higher than work-even, maybe still in the range of a single digit, but it should be a meaningful net profit margin. Thanks.

Very helpful. Thank you.

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

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 our management via email at ir.cultu.cn directly. You're also welcome to subscribe to our news alert on companies' IR website. Thank you very much again for your time. Have a great night.

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