Gaotu(US:GOTU)2023-04-17 16:00PART I KEY INFORMATION This section details Gaotu's VIE-reliant corporate structure, significant financial shifts, and key regulatory and delisting risks Holding Company Structure, Cash Flows, and PRC Permissions Gaotu operates through a VIE structure in China, with the VIE contributing 100% of revenues, facing risks from contractual control, PRC cash flow regulations, and past PCAOB inspection uncertainties now mitigated - Gaotu operates through a VIE structure in mainland China, with the VIE contributing 100% of the company's total revenues for the fiscal years 2020, 2021, and 202217 - The company's ability to pay dividends is dependent on payments from its PRC subsidiaries, which are subject to PRC laws requiring them to set aside at least 10% of after-tax profits into a statutory reserve until it reaches 50% of registered capital26 - In December 2022, the PCAOB vacated its determination that it was unable to inspect auditors in mainland China and Hong Kong, reducing the immediate risk of delisting24 - Under the CSRC's new Trial Measures effective March 31, 2023, the company is not required to file for its previous NYSE listing but will be subject to filing and reporting requirements for future offerings and certain material events37 Selected Consolidated Financial Data This section presents key financial data, highlighting a significant revenue decline, a shift from net loss to net income, and changes in assets and cash flows Selected Consolidated Statements of Operations (in thousands RMB) | Indicator | 2020 | 2021 | 2022 | | :--- | :--- | :--- | :--- | | Net revenues | 7,124,744 | 6,561,747 | 2,498,214 | | Gross profit | 5,362,196 | 4,164,143 | 1,797,164 | | (Loss)/income from operations | (1,755,033) | (3,180,343) | (118,052) | | Net (loss)/income | (1,392,930) | (3,103,465) | 13,172 | | Net (loss)/income per ordinary share - Basic | (8.72) | (18.17) | 0.08 | Selected Consolidated Balance Sheet Data (in thousands RMB) | Indicator | As of Dec 31, 2020 | As of Dec 31, 2021 | As of Dec 31, 2022 | | :--- | :--- | :--- | :--- | | Total current assets | 8,457,248 | 3,936,786 | 4,166,477 | | Total assets | 10,685,792 | 5,024,666 | 4,876,175 | | Total liabilities | 4,955,937 | 2,143,724 | 1,780,346 | | Total shareholders' equity | 5,729,855 | 2,880,942 | 3,095,829 | Selected Consolidated Cash Flow Data (in thousands RMB) | Indicator | 2020 | 2021 | 2022 | | :--- | :--- | :--- | :--- | | Net cash from/(used in) operating activities | 603,273 | (4,185,807) | 54,545 | | Net cash (used in)/from investing activities | (5,596,304) | 4,812,502 | (158,385) | | Net cash from/(used in) financing activities | 5,272,100 | (100,614) | — | Risk Factors This section outlines significant risks, including the impact of China's education regulations, reliance on the VIE structure, and potential delisting under the HFCAA - The company's business has been materially and adversely affected by China's "Opinions on Further Alleviating the Burden of Homework and After-School Tutoring for Students in Compulsory Education," which led to the cessation of its K-9 academic tutoring services576365 - The company relies on contractual arrangements with its VIE for business operations, which may not be as effective as direct ownership and poses risks if the PRC government deems these arrangements non-compliant5860169 - There is a risk that the company's ADSs may be prohibited from trading in the U.S. under the HFCAA in the future if the PCAOB is unable to inspect auditors in China for two consecutive years, which could materially affect the investment's value61196199 - The company's dual-class share structure gives its founder, chairman, and CEO, Mr. Larry Xiangdong Chen, 88.6% of the aggregate voting power, limiting the influence of other shareholders on corporate matters257 INFORMATION ON THE COMPANY This section provides a comprehensive overview of Gaotu's history, business model, and organizational structure, highlighting its pivot from K-9 tutoring and reliance on a VIE structure History and Development of the Company This section details Gaotu's history, including its NYSE listing, name change, strategic pivot from K-9 tutoring due to regulations, and share repurchase programs - The company commenced trading on the NYSE on June 6, 2019, under the symbol "GSX" and later changed it to "GOTU" on May 6, 2021291 - From the end of 2021, the company ceased offering compulsory education academic subject tutoring services and pivoted its business focus to college and adult education, overseas study services, and non-academic tutoring294 - The board authorized a share repurchase program of up to US$150 million in May 2020 and another for up to US$30 million in November 2022292294 Business Overview This section describes Gaotu's online live large-class business model, its pivot to college and adult education, and the extensive PRC regulatory framework it operates under - The company's business model is based on online live large-classes using a dual-teacher system, which includes a main instructor and multiple tutors for smaller student groups298318 - After ceasing compulsory education academic tutoring services by the end of 2021, the company's main offerings are now learning services (for college students, adults, overseas study, and non-academic tutoring) and educational content & digitalized learning products302312 - As of December 31, 2022, Gaotu had 1,152 instructors (203 full-time, 949 contract) and 583 tutors298 - The company is subject to extensive PRC regulations, including the "Alleviating Burden Opinion" which fundamentally reshaped the after-school tutoring industry, as well as rules governing internet services, data security, and foreign investment374389422 Organizational Structure This section details Gaotu's Cayman Islands holding company structure, its reliance on a VIE in China, and the contractual arrangements used to maintain control over the VIE's operations - The company operates in China through a VIE structure to comply with PRC restrictions on foreign investment in the telecommunications sector492 - Control over the VIE is established through a series of contractual arrangements, which include: Powers of Attorney, Equity Interest Pledge Agreement, Exclusive Management Services and Business Cooperation Agreement, and Exclusive Call Option Agreement494495498499 - The contractual arrangements effectively assign all voting rights of the VIE's shareholders to the WFOEs, enable the WFOEs to receive the VIE's economic benefits, and provide an exclusive option to purchase the VIE's equity when permitted by PRC law493 Property, Plants and Equipment This section outlines the company's property holdings, including leased office spaces in Beijing and other Chinese cities, and owned office buildings in Zhengzhou - The company leases a total of 28,642 square meters for its operations in Beijing and other Chinese cities504 - Gaotu owns three office buildings in Zhengzhou with a combined gross floor area of 64,687 square meters505 OPERATING AND FINANCIAL REVIEW AND PROSPECTS This section analyzes Gaotu's financial performance, highlighting a sharp revenue decline but a significant turnaround to net income in 2022, alongside strong liquidity and key operational factors Operating Results This section details the company's operating results, showing a significant revenue decrease but a shift to net income in 2022, driven by substantial cost reductions and improved gross margin Comparison of Operating Results (in thousands RMB) | Indicator | 2021 | 2022 | | :--- | :--- | :--- | | Net Revenues | 6,561,747 | 2,498,214 | | Gross Profit | 4,164,143 | 1,797,164 | | Total Operating Expenses | 7,344,486 | 1,915,216 | | Loss from Operations | (3,180,343) | (118,052) | | Net (Loss)/Income | (3,103,465) | 13,172 | - Net revenues decreased by 61.9% in 2022, primarily due to business restructuring and the cessation of compulsory education academic subject tutoring services to comply with government regulations544 - Total operating expenses decreased by 73.9% in 2022, with significant reductions in selling expenses (-76.9%), R&D expenses (-64.5%), and general & administrative expenses (-59.7%) due to cost-cutting measures545543547 Liquidity and Capital Resources This section details Gaotu's liquidity and capital resources, highlighting strong cash and short-term investments, a significant improvement in operating cash flow, and the geographic distribution of its cash holdings Summary of Cash Flows (in thousands RMB) | Indicator | 2020 | 2021 | 2022 | | :--- | :--- | :--- | :--- | | Net cash from/(used in) operating activities | 603,273 | (4,185,807) | 54,545 | | Net cash (used in)/from investing activities | (5,596,304) | 4,812,502 | (158,385) | | Net cash from/(used in) financing activities | 5,272,100 | (100,614) | — | - As of December 31, 2022, the company had cash and cash equivalents of RMB 819.9 million and short-term investments of RMB 2,923.9 million564 - As of December 31, 2022, 99.3% of cash and cash equivalents were held in mainland China and Hong Kong, with 38.1% held by the VIE and its subsidiaries567 Critical Accounting Estimates This section outlines critical accounting estimates, including income taxes, impairment assessments of long-lived assets and goodwill, and the valuation of share-based compensation - Key critical accounting estimates include income taxes and the valuation allowance for deferred tax assets, requiring significant judgment in assessing the realizability of these assets587 - The company performs impairment assessments of long-lived assets and goodwill, which involves estimating future cash flows and making assumptions that could materially affect the determination of fair value588589 - Valuation of share-based compensation requires subjective assumptions regarding stock price volatility, expected term, and forfeiture rates, which can significantly impact compensation expense590 DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES This section details the company's leadership, compensation, board structure, and employee base, highlighting the significant reduction in headcount and the founder's controlling voting power Compensation of Directors and Executive Officers This section details cash compensation for directors and executive officers in FY2022 and outlines the company's Share Incentive Plan for equity awards FY2022 Cash Compensation (in thousands) | Recipient Group | Compensation (RMB) | Compensation (USD) | | :--- | :--- | :--- | | Executive Officers | 3,200 | 470 | | Non-Executive Directors | 2,500 | 360 | - The company has a Share Incentive Plan adopted in March 2019, with a maximum of 28,400,000 ordinary shares authorized for issuance607 Employees This section provides employee headcount data, highlighting a dramatic reduction from 22,570 in 2020 to 4,002 in 2022, with key functions identified Employee Headcount by Function as of Dec 31, 2022 | Function | Number of Employees | | :--- | :--- | | Instructors | 203 | | Tutors | 583 | | Technology and content R&D | 984 | | User growth | 740 | | Sales | 949 | | General and administrative | 543 | | Total | 4,002 | - The total number of employees decreased dramatically from 22,570 at the end of 2020 to 4,002 at the end of 2022627 Share Ownership This section details the company's dual-class share structure, highlighting the founder's significant voting power of 88.6% as of February 28, 2023 - The company has a dual-class share structure: Class A shares have one vote per share, while Class B shares have ten votes per share256662 - As of February 28, 2023, founder and CEO Larry Xiangdong Chen beneficially owns shares representing 88.6% of the aggregate voting power257635636 MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS This section covers major shareholder information, primarily focusing on related party transactions with the VIE and granted registration rights to certain shareholders - The company's primary related party transactions are the contractual arrangements with its VIE, which are fundamental to its operational structure in China639 - The company has granted demand, piggyback, and Form F-3 registration rights to certain shareholders, allowing them to have their shares registered for public sale under specific conditions642643644 FINANCIAL INFORMATION This section details the conclusion of an SEC investigation, ongoing shareholder class action lawsuits, and the company's current dividend policy of retaining earnings - An SEC investigation that began after short-seller reports in 2020 was concluded in October 2022, with the SEC stating it did not intend to recommend an enforcement action against the company650 - The company is currently a defendant in two putative shareholder class action lawsuits, one filed in April 2020 and another in December 2022, alleging material misstatements or omissions in public filings651652 - The company does not have any present plan to pay cash dividends and intends to retain earnings for business operations and expansion657 ADDITIONAL INFORMATION This section covers corporate governance, including the dual-class share structure, and taxation, noting the company's likely PFIC status for 2022 and its implications for U.S. holders Memorandum and Articles of Association This section details the company's memorandum and articles of association, highlighting the dual-class share structure, board's share issuance authority, and differences from U.S. corporate law - The company's ordinary shares are divided into Class A (one vote per share) and Class B (ten votes per share); Class B shares are convertible into Class A shares, but not the reverse662663665 - The board of directors has the authority to issue additional shares, including series of preference shares with designated rights, without further shareholder approval675676 - Cayman Islands law provides for mergers and consolidations, which require director approval and a special resolution from shareholders, but generally not court approval683 Taxation This section outlines the company's taxation across the Cayman Islands, PRC (including preferential rates and resident enterprise risk), and U.S. federal income tax, noting its likely PFIC status for 2022 - The company is not subject to profits, income, or capital gains taxes in its jurisdiction of incorporation, the Cayman Islands713 - Certain PRC subsidiaries are eligible for preferential enterprise income tax rates of 15% (as HNTEs) or 12.5% (as Software Enterprises), below the statutory 25% rate10461049 - The company believes it was a Passive Foreign Investment Company (PFIC) for the 2022 taxable year, which could lead to significant adverse U.S. federal income tax consequences for U.S. holders of its ADSs or ordinary shares286729740 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This section details the company's primary market risks, focusing on foreign exchange risk due to RMB-denominated operations and interest rate risk from cash and investments - The company's primary market risk is foreign exchange risk, as its business is denominated in RMB while its ADSs are traded in U.S. dollars752 - As of December 31, 2022, the company held RMB 2.95 billion in RMB-denominated cash, restricted cash, and short-term investments, and US$114.4 million in U.S. dollar-denominated cash and short-term investments754 - Interest rate risk is mainly associated with interest income from cash and investments, and the company has not used derivative instruments to manage this exposure755 CONTROLS AND PROCEDURES This section confirms the effectiveness of the company's disclosure controls and internal control over financial reporting as of December 31, 2022, as concluded by management and the independent auditor - Management concluded that the company's disclosure controls and procedures were effective as of December 31, 2022767 - Based on the COSO framework, management concluded that the company's internal control over financial reporting was effective as of December 31, 2022770 - The independent registered public accounting firm issued an unqualified opinion, stating that the company maintained effective internal control over financial reporting as of December 31, 2022773 CORPORATE GOVERNANCE AND OTHER ITEMS This section covers corporate governance, including the audit committee financial expert, accountant fees, share repurchase programs, and the mitigated delisting risk under the HFCAA - The board of directors has determined that Jin Cui is an audit committee financial expert781 Principal Accountant Fees (in thousands RMB) | Fee Type | 2021 | 2022 | | :--- | :--- | :--- | | Audit fees | 13,800 | 10,350 | | Audit related fees | 27,454 | — | | Tax fees | 1,380 | 270 | - In November 2022, the board authorized a share repurchase program for up to US$30 million of its common shares, effective until November 2025788 - Following the PCAOB's removal of mainland China and Hong Kong from its list of non-inspection jurisdictions in December 2022, the company does not expect to be identified as a Commission-Identified Issuer under the HFCAA793 PART III FINANCIAL STATEMENTS This section presents the audited consolidated financial statements for 2020-2022, prepared under U.S. GAAP, including balance sheets, income statements, cash flows, and detailed notes on key accounting policies and the VIE structure Consolidated Financial Statements This section presents the consolidated financial statements, highlighting the balance sheet, income statement, and cash flow performance for the three years ended December 31, 2022 Consolidated Balance Sheet Highlights (As of Dec 31, 2022, in thousands RMB) | Account | Amount | | :--- | :--- | | Cash and cash equivalents | 819,911 | | Short-term investments | 2,923,864 | | Total Assets | 4,876,175 | | Total current liabilities | 1,609,222 | | Total Liabilities | 1,780,346 | | Total Shareholders' Equity | 3,095,829 | Consolidated Statement of Operations Highlights (Year ended Dec 31, 2022, in thousands RMB) | Account | Amount | | :--- | :--- | | Net revenues | 2,498,214 | | Gross profit | 1,797,164 | | Loss from operations | (118,052) | | Net income | 13,172 | Notes to Consolidated Financial Statements This section provides detailed notes to the financial statements, covering the VIE structure, regulatory impact, revenue recognition, share-based compensation, and income tax policies - The company's VIE and its subsidiaries accounted for 49.00% of the Group's consolidated total assets and 80.89% of its consolidated total liabilities as of December 31, 2022875 - Revenue from live interactive tutoring services is recognized proportionately as classes are delivered, while revenue from content playback access is recognized proportionally over the playback period936937938 - As of December 31, 2022, the company had RMB 101.9 million in unrecognized compensation costs related to RSUs, expected to be recognized over a weighted average period of 3.08 years1034 - As of December 31, 2022, the Group had net operating loss carryforwards of RMB 2.72 billion from its mainland China entities, which will expire on various dates between 2023 and 20321056