Youdao, Inc. (NYSE:DAO) Q3 2022 Earnings Call Transcript

Youdao, Inc. (NYSE:DAO) Q3 2022 Earnings Call Transcript November 17, 2022

Youdao, Inc. misses on earnings expectations. Reported EPS is $-1.33 EPS, expectations were $-0.86.

Operator: Good day and welcome to the Youdao 2022 Third Quarter Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeffrey Wang, investor relations Director of Investor Relations of Youdao. Please go ahead.

Photo by Gabrielle Henderson on Unsplash

Jeffrey Wang: Thank you, operator. Please note the discussion today will contain forward-looking statements, related to future performance of the Company, which are intended to qualify for the Safe Harbor from liability, as established by the U.S. Private Securities Litigation Reform Act. Such statements are not guarantees of the future performance and are subject to certain risks and uncertainties, assumptions and other factors. Some of these risks are beyond the Company’s control, and could cause actual results to differ materially from those mentioned in today’s press release and this discussion. A general discussion of the risk factors that could affect Youdao’s business and financial results is included in certain filings of the Company with the U.S. Securities and Exchange Commission.

The Company does not undertake any obligation to update this forward-looking information, except as required by law. During today’s call, management will also discuss certain non-GAAP financial measures, for comparison purposes only. For the definitions of non-GAAP financial measures, and reconciliations of GAAP to non-GAAP financial results, please see the 2022 third quarter financial results news release issued earlier today. As a reminder, the conference is being recorded. Besides, a webcast replay of this conference call will be available on Youdao’s corporate website at ir.youdao.com. Joining us today on the call from Youdao’s senior management is Dr. Feng Zhou, our Chief Executive Officer, Mr. Lei Jin, our President, Mr. Peng Su, our VP of Strategy and Capital Markets and Mr. Wayne Li, our VP of Finance.

I will now turn the call over to Dr. Zhou to review some of our recent highlights and strategic direction.

Dr. Feng Zhou: Thank you, Jeffrey. And thank you all for participating in today’s call. Before we begin, I would like to remind everyone that the financial information and non-GAAP financial information mentioned in this release is presented on a continuing operations basis, and all numbers are based on Renminbi, unless otherwise specifically stated. We had a strong third quarter with solid financial and operating results. Our net revenues reached a record-high of RMB 1.4 billion, up 35.0% year-over-year. Total gross margin climbed to a record-high of 54.2%, improving 1.6% year-over-year. These results were attributable to the strong performances of our new services and smart devices. Sales of digital content services reached over RMB 400 million with gross margin ratio exceeding 60%.

For smart devices, the first 100,000 units of the newly launched Youdao Dictionary Pen X5 have been sold out, propelling net revenues from smart devices to RMB 356.5 million in Q3, a new record. In fact, net revenues from Youdao Dictionary Pen series in Q3 this year have grown tenfold compared with Q3 2019 after Youdao Dictionary Pen 2 was launched. The first 10,000 units of Youdao Smart Learning Pad Y10 released in August have also been sold out, reflecting strong demand for this new category. In terms of our operating loss, it narrowed to RMB 219 million with operating loss margin narrowing by 6.1% year-over-year to 15.6%. We have improved the margin structures of our business lines while growing their top line at the same time. For example in Q3, for digital content services, Youdao Dictionary Pen and Youdao Listening Pod, their net revenues could cover their costs and operating expenses, respectively.

Today we announced that the board of directors has authorized the Company to adopt a share repurchase program in the near future in accordance with applicable laws and regulations for up to USA 20 million of its Class A ordinary shares including in the form of ADS during a period of up to 36 months. We are bullish about the future growth of the business. With that overview, I would like to share more color on our business lines in Q3. Smart devices revenue reached RMB 356.5 million in Q3, a new record for the sector and up 40.1% year-over-year. Gross margin of smart devices reached 40.4%, up 6.7% year-over-year, mainly due to the launch of new products. The application of advanced AI technology and unique learning content make us confident that the gross margin of smart devices will be around 40% in the long run.

Our new flagship Dictionary Pen, Youdao Dictionary Pen X5, is a great showcase of our strength in R&D and product innovation. In fact, in September we cannot make enough X5s due to strong demand. Not only did X5 feature even better translation precision, support for over 100 languages and a whole-new design, it also includes the world’s first smart dictionary pen operating system. It allows users to download apps to customize the dictionary pen to their liking with endless possibilities. Many top content providers were already on-board, including Ximalaya FM, RAZ English, NetEase Cloud Music and Kaishu Storytelling. They all created apps using our easy-to-use Software Development Kit and offered them on Youdao Dictionary Pens, creating a unique ecosystem that will grow stronger when more consumers and developers join in.

Recently, we launched Youdao Smart Learning Pad X10, our 2nd learning pad product, with significantly improved AI precision learning, larger screen, more storage and other improvements. In the long-term, the learning pad has significant market potential. According to Frost & Sullivan, expected volume of education tablets are likely to reach 7.26 million units in 2025, with total sales of RMB 25.4 billion. Our AI adaptive learning feature provides high-quality personalized learning for students and has received very positive feedback from consumers. Over time, we expect the Youdao Smart Learning Pad to become as popular as our Youdao Dictionary Pen. Then let’s turn to learning services. Net revenues from learning services reached a record-high of RMB 888.5 million in Q3, up 37.2% year-over-year, with a relatively flat gross margin of 64.5%.

Breaking this down a bit further, net revenues from STEAM courses increased by more than 200% year-over-year and accounted for over 25% of the net revenues of this segment. We continued to make progress on the Youdao Go course. In collaboration with the Chinese Weiqi Association and the Jiangsu Chess Sports Association, we held the National Children’s Weiqi Open Championship in Q3, which was highly recognized by the General Administration of Sport of China. As for adult courses, we see a downward trend in gross margins year-over-year, mainly due to the macro environment. We are actively realigning our resources to focus on growth areas in this segment. Graduate school entrance exams and vocational courses are two bright spots. Their gross billings increased by over 150% and over 200% year-over-year respectively.

Looking forward, we are confident in our operations in Q4. The transition from regulatory changes last year is mostly finished. For the last four quarters, we have maintained our investment level for our business, kept innovating in challenging times, and this allowed us to gain share in the market. It was made possible by the long-term investment in AI technology and a diversified product portfolio, and also by firm support from our parent NetEase group. Going forward, we believe we are in a good position today to achieve sustainable growth and drive towards profitability with a portfolio of strong products and businesses. Our team continues to capitalize on tailwinds including the quick adoption of smart learning devices, digital content services and STEAM courses.

We look forward to bringing our products and services to more and more consumers. With that, I will turn the call over to Su Peng to give you more details on our financial performance. Su Peng?

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Peng Su: Thank you, Dr. Zhou, and hello everyone. Today I will be presenting some financial highlights for the third quarter of 2022. We encourage you to read through our press release issued earlier today for further details. For the third quarter, total net revenues were RMB 1.4 billion, or USA 197.2 million. This represents an increase of 35% from the third quarter of 2021. Net revenues from our learning services were RMB 888.5 million, or USA 124.9 million, representing a 37.2% increase from the same period in 2021. We attribute this growth to the strong sales performance from the new services initiated after the implementation of the â€Å“Double Reductionâ€Â Policy. Net revenues from our smart devices were RMB 356.5 million, or USA 50.1 million, up 40.1% from the same period in 2021, driven by the popularity of the newly launched products in 2022.

Net revenues from our online marketing services were RMB 157.5 million, or USA 22.1 million, representing a 14.9% increase from the same period in 2021. The increase was mainly attributable to the increase in performance-based advertisements through third parties’ internet properties. For the third quarter, our total gross profit was RMB 760.2 million, or USA 106.9 million, representing a 39% increase from the third quarter of 2021. Gross margin for learning services was 64.5% for the third quarter of 2022, compared with 65% for the same period in 2021. Gross margin for smart devices was 40.4% for the third quarter of 2022, compared with 33.7% for the same period in 2021. Gross margin for online marketing services was 27.1% for the third quarter of 2022, compared with 29.2% for the same period in 2021.

For the third quarter, total operating expenses were RMB 979.2 million, or USA 137.7 million, compared with RMB 772.6 million for the same period of last year. With that, for the third quarter, our sales and marketing expenses were RMB 709.8 million, compared with RMB 553.4 million in the third quarter of 2021. Research and development expenses were RMB 212.9 million, compared with RMB 163.6 million in the third quarter of 2021. Our operating loss margin was 15.6% in the third quarter of 2022, compared with 21.7% for the same period of last year. For the third quarter of 2022, our net loss from continuing operations attributable to ordinary shareholders was RMB 183.9 million, or USA 25.9 million, compared with RMB 225.3 million for the same period of last year.

Non-GAAP net loss from our continuing operations attributable to ordinary shareholders for the third quarter was RMB 164.4 million, or USA 23.1 million, compared with RMB 200.2 million for the same period of last year. Basic and diluted net loss per ADS from continuing operations attributable to ordinary shareholders for the third quarter of 2022 was RMB 1.49, or USA 0.21. Non-GAAP basic and diluted net loss from continuing operations per ADS for the third quarter was RMB 1.33, or USA 0.19. Our net cash used in continuing operating activities was RMB 294.1 million, or USA 41.3 million, for the third quarter. Looking at our balance sheet, as of September 30, 2022, our contract liabilities, which mainly consist of deferred revenue generated from our learning services, were RMB 996.5 million, or USA 140.1 million, compared with RMB 1.1 billion as of December 31, 2021.

At the end of the period, our cash, cash equivalents, restricted cash, time deposits, and short-term investments totaled RMB 953.1 million, or USA 134 million. This concludes our prepared remarks. Thank you for your attention. We would now like to open the call to your questions. Operator, please go ahead.

Q&A Session

Operator: Our first question comes from Brian Gong with Citigroup.

Brian Gong: Congratulations on the solid results. So I saw the revenue increased roughly in the third quarter and may I know what’s the main contributors to our rapid transition? And how should we look at the growth trend in the future?

Dr. Feng Zhou: So as for Q3 growth, so data content services and smart devices are 2 main drivers for this quarter for our growth. And both are — based on our strength in technology R&D, as you know. So digital content service are doing well. So compared with the online services that we offer before, they — the difference is they are mostly — they’re mostly contains prerecorded video content or interactive learning or STEAM content STEAM courses. As with our courses before, they are live courses mainly. So the form is different. So it’s a new product after last year. So in Q3, digital content services have maintained strong momentum. So sales reached over RMB 400 million compared with over RMB 200 million in Q2. So basically doubled quarter-to-quarter.

So while gross margin also rose from over 50% in Q2 to over 60% in Q3. So more over net revenues from digital on services can cover their costs and operating expenses in Q3. So this supports our bottom line improvements in this quarter. So second, Smart Devices revenues are at, as you can see, a record high of RMB M356 million, up 40% year-over-year in Q3. Moreover, this growth also comes with a healthy operating metrics. So net revenue from Youdao Dictionary Pen and Youdao Listening Pod, for these 2 products, they can also cover their own costs and expenses in Q3. So one product that’s pretty important is Dictionary Pen X5 launched in August. So this new generation of Dictionary Pen supports online translation of over 100 languages and is equipped with the world’s first Dictionary Pen operating system, smart operating system.

So after its release, it’s already the top seller of Dictionary Pens or electronic dictionaries on both JD.com and Tmall, selling out the first batch of 100,000 units quickly. So the launch of another product is the launch of Youdao Smart Learning Pad Y10 and also more recently, X10. So this marked our entry into the learning tablet market and also the first batch of 10,000 Y10 units sold out in about 2 months. So that gives our teams more confident in this category. So our plan is to have a steady flow of new product — new learning smart devices products to drive sustainable growth in this category. So recently after Q3. So we launched 3 more new products. That is Youdao Dictionary Pen P5 for more advanced learners and professionals. And also, Youdao Smart Learning Pad X10, I just mentioned.

So with the learning dashboard that further improves the AI precision learning experience and lastly, an upgraded version of Youdao Listening Pod with new English and Chinese content in line with textbooks. Also with more advanced AI technology helps users improve listening and speaking skills in both English and Chinese. So given the strong pipelines we sold more than 100,000 units of Youdao Dictionary Pens in the Singles Day on November 11 shopping festival this year, so over 100,000 is Youdao Dictionary Pens. Yes. So that’s an overview of drivers of growth for Q3.

Operator: Our next question comes from Hongyi Cao with CICC.

Hongyi Cao: Congratulations on the good performance. We can see the strong growth of net revenue, but Youdao still face the operating loss. So my question is, what are our strategies for improving the loss-making factors?