Youdao, Inc. (NYSE:DAO) Q4 2022 Earnings Call Transcript

Youdao, Inc. (NYSE:DAO) Q4 2022 Earnings Call Transcript February 23, 2023

Operator: Good day, and welcome to the Youdao 2022 Fourth Quarter and Full Year 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 Youdao. Please go ahead.

Jeffrey Wang: Thank you, operator. Please note the discussion today will contain forward-looking statements related to the 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 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 fourth quarter and full-year financial results news release issued earlier today. As a reminder, this 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.

Feng Zhou: Thank you, Jeffrey. 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. Our financial performance in Q4 was strong, producing record high net revenues and achieving our first-ever income from operations. Net revenues soared to a record RMB 1.5 billion in Q4, up 38.6% year-over-year. Income from operations reached RMB 24.6 million compared with the loss from operations of RMB 248.3 million in the same period of 2021. Total gross margin climbed to 53.3%, rising by 11 percentage year-over-year. In terms of cash flow, we achieved an operating cash inflow of RMB 84.1 million.

These results were primarily driven by the solid performance of our new services and smart devices. Sales of digital content services reached over RMB 600 million. Besides, the gross margin has been above 60% and net revenues have covered the cost and operating expenses for two consecutive quarters. As for smart devices, strong new product sales approaching 100% year-over-year growth on November 11 Shopping Festival, and facilitated growth of net revenues from this segment to the best level of RMB 407 million in Q4. Then let me walk through the key financial metrics for our second half 2022. Net revenues reached RMB 2.9 billion in second half of 2022, increasing 36.8% year-over-year. Gross margin was 53.7%, improving 6 percentage points year-over-year.

Loss from operations reached RMB 194.4 million, narrowing by 59% year-over-year. Operating cash outflow improved to RMB 210 million, a decline of 63.8% from the second half of 2021, which included discontinued operations. For the fiscal year of 2022, our key financial indicators improved significantly. Net revenues reached RMB 5 billion, up 24.8% year-over-year. Gross margin was 51.6%, improving 2 percentage points year-over-year. Loss from operations was RMB 74.7 million, narrowed by 17.9% year-over-year. Operating cash outflow improved to RMB 603.1 million, a decline of 55.2% from 2021, which included discontinued operations. Then I would like to add more color to our business progress in Q4. Net revenues from smart devices hit RMB 407 million, up 28.1% year-over-year.

Dictionary Pen sales exceeded 400,000 units, the majority of which were the new products launched in 2022. Product-wise, we launched Youdao Dictionary Pen P5 in Q4, especially, specifically designed for professionals, updated with 5 million professional terms in 16 professional fields. It provides translation into over 100 languages and enhances recognition accuracy by more advanced natural language processing. We also launched Youdao Smart Learning Pad X10 in Q4 we then created AI-supported Learning Dashboards for better-personalized learning experiences. As we enter the field of education tablets in Q3, the compound monthly growth rate of sales units exceeded 100%. Moreover, for the first three months after we launched the Learning Pad X10, its compound monthly growth rates of sales units was nearly twice that of the Y10 for the same period.

As for our learning services, net revenues reached RMB 806.3 million in Q4, up 39.2% year-over-year. Gross margin of learning services climbed to 64.1%, improving 13% points year-over-year. We have been exploring digitization of our learning services and have made significant progress. In Q4, we upgraded Youdao Literature-Creative Writing, which was co-developed by Youdao and Minecraft Education Edition. The digitized content effectively enhances learners’ interaction and engagement, making learning materials easier to understand and more attractive. I encourage you to view the video on our IR website. In addition, the Champion Class of Youdao Go was released in Q4 with a teaching team led by World Champion, Ke Jie. The Youdao Go courses create a learning path starting from entry-level to advanced level followed by champion-level classes.

The successful adaptation of these progressive courses drove the gross margins up by over 50% year-over-year in Q4. Besides, the retention rate of the advanced level class reached over 70%. In terms of adult courses, we released upgraded solutions to the postgraduate entrance exams. It offers comprehensive solutions from Target Consultation to Hybrid Tutoring by AI and humans. Students are thrilled with these new features, leading to gross margins up by nearly triple digits year-over-year in Q4. Meanwhile, gross billings from vocational courses such as IT and Internet and constructor courses increased over 100% year-over-year in Q4. Looking back, we stuck to customer-oriented philosophy and enhanced the customer experiences with upgraded services and smart devices facilitated by technology and innovation in 2022.

We released the world’s first Dictionary Pen OS and launched digital content services that enhanced learning efficiency and effectiveness, which was supported by customers and ultimately, reflected in our financials. Moreover, the share repurchase program demonstrated management’s confidence in future growth of the business. Looking ahead, we will continue to leverage cutting-edge technology and innovation to promote the sustainable development of smart devices, digital content services, and STEAM courses, further improving our business healthiness and financial performance. With that, I will turn the call over to Su Peng to give you more details on our financial performance. Su Peng?

Peng Su: Thank you, Dr. Zhou, and hello everyone. Today I will be presenting some financial highlights from our 2022 fourth quarter and full year. We encourage you to read through our press release issued earlier today for further details. For the fourth quarter, total net revenues were RMB 1.5 billion or $210.8 million. This represents an increase of 38.6% from the fourth quarter of 2021. Net revenues from our learning services were RMB 806.3 million or $116.9 million, representing a 39.2% 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 Double Reduction Policy. Net revenues from our smart devices were RMB 407 million or $59 million, up 28.1% from the same period in 2021, driven by the popularity of Youdao’s newly launched products, such as the Youdao Dictionary Pen X5.

Net revenues from our online marketing services were RMB 240.8 million, or $34.9 million, representing a 58.6% 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 fourth quarter, our total gross profit was RMB 774.7 million or $112.3 million, representing a 74% increase from the fourth quarter of 2021. Gross margin for learning services was 64.1% for the fourth quarter of 2022, compared with 51.4% for the same period in 2021. Gross margin for smart devices was 46.2% for the fourth quarter of 2022, compared with 30.8% for the same period in 2021. Gross margin for online marketing services was 29.2% for the fourth quarter of 2022, compared with 32.6% for the same period in 2021.

For the fourth quarter, total operating expenses were RMB 750 million, or $108.7 million, compared with RMB 693.6 million for the same period of last year. With that, for the fourth quarter, our sales and marketing expenses were RMB 515.9 million compared with RMB 420.4 million in the fourth quarter of 2021. Research and development expenses were RMB 179.5 million compared with RMB 170.2 million in the fourth quarter of 2021. Our operating income margin was 1.7% in the fourth quarter of 2022 compared with operating loss margin of 23.7% for the same period of last year. For the fourth quarter of 2022, our net income from continuing operations attributable to ordinary shareholders was RMB 12.3 million or $1.8 million, compared with net loss from continuing operations attributable to ordinary shareholders of RMB 215.9 million for the same period of last year.

Non-GAAP net income from continuing operations attributable to ordinary shareholders for the fourth quarter was RMB 31.1 million or $4.5 million compared with Non-GAAP net loss from continuing operations attributable to ordinary shareholders of RMB 168.2 million for the same period of last year. Basic and diluted net income per ADS from continuing operations attributable to ordinary shareholders for the fourth quarter of 2022 was RMB 0.1 or $0.01. Non-GAAP basic and diluted net income from continuing operations per ADS attributable to ordinary shareholders for the fourth quarter was RMB 0.25 or $0.04. Our net cash provided by continuing operating activities was RMB 84.1 million, or $12.2 million for the fourth quarter. Turning to our full-year results.

Our total revenues for 2022 increased by 24.8% to RMB 5 billion or $726.8 million. Net revenues from our learning services for 2022 were RMB 3.1 billion or $447.2 million, up 26.3% from 2021. Net revenues from our smart devices for 2022 grew by 28.2% year-over-year to RMB 1.3 billion or $182.2 million. Net revenues from our online marketing services for 2022 were up 13.2% year-over-year to RMB 672.4 million or $97.5 million. Total gross profit for 2022 was RMB 2.6 billion or $375 million, compared with RMB 2 billion in 2021. Total operating expenses for 2022 increased to RMB 3.4 billion or $487.3 million compared with RMB 2.9 billion in 2021. Net loss from continuing operations attributable to Youdao’s ordinary shareholders for 2022 was RMB 720.9 million or $104.5 million, and basic and diluted net loss per ADS from continuing operations attributable to ordinary shareholders for 2022 was RMB 5.83 or $0.84.

Looking at our balance sheet, as of December 31, 2022, our contract liabilities, which mainly consist of deferred revenues generated from our learning services, were RMB 1.1 billion or $154.7 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 1 billion or $147.4 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 today will come from Brian Gong of Citigroup. Please go ahead.

Brian Gong: Good morning. Good evening, gentlemen. Thanks for taking my question. Congratulations on the solid results. So my question is about the outlook for this year. What are management’s expectations for the revenue for 2023 and what are the key drivers of no new services this year? Thank you.

Feng Zhou: Hello, Brian. Yes. So, our mission is to make learning happen and we are doing that with the other business that we do, including our devices, our artificial intelligence-based learning services, and also our teaching staff. So we believe at this particular time, at this moment, we are in a good position to both grow the impact of our business and also improve our financial metrics, including top and bottom line cash flow so — for this year. So, you ask about the drivers for learning services. So this is our largest sector. Yes, so I see several thing that works in our favor, but I’ll talk about two major drivers. So, one is digital content services. So we’ve talked about this form of product for several quarters.

So, popular — we have popular products in this form, including Youdao Literature, Youdao . So in 2022, it has proven that interactive content instead of live classes like courses-learning are a great way of delivering learning services. These services have consistently expanded for us in 2022, so the customers really like them. We expect it to be the preferred way for us to offer new learning services in 2023. Our teams are constantly looking for new content opportunities and also using AI-assisted ways to do digital content, and also use things like immersive learning ways of offering this new content, whatever works for the particular area and also for the particular user need. So we will continue to scale our digital content services by both adding new content and iterating on existing ones.

So we are bullish on this area. It’s already proven and we have — our teams have many ideas and we will do a lot of work in this area. The second driver I see is STEAM. So engineering, math, and arts, so extra-curricular kind of content. So we’ve talked about this trend before. So, as students learning in China evolve. So families are more and more willing to invest in STEAM learning like art, engineering, and other extra-curricular activities. So we offer very good computer programing courses and that will be our focus for us in 2023. We already have a leading and healthy Go game and chess course business. So it grew by over 50% in Q4. So it is also a very special service. It’s a very, I would say, Youdao type of service, as its employees and excellent teaching staffs, leading AI learning technology, and has thriving learning community.

So that’s — so the kids can actually play each other on our platform. So you can imagine that we provide a very good user experience during the process because that’s what we are good at. And because the users are satisfied, so we were able to basically double the size of the business in 2022. So it is a testimony of families preference need for this kind of extra-curricular content. So we will continue to look for opportunities in this area and I believe it is our unique ability to combine technology and great content and the great features to — for us to be able to be leading in this area. And — so in Q4, we were able to achieve profitability and this speaks to the results of our focus on the healthy operation of our business. So this will also be — continue to be a focus for us for this year.

We focused on — not on kind of absolute gross numbers, we focused on unit economics of our various services. We also focused on user satisfaction. We put a lot of focus on that. And — because we — that’s how we operate. So at NetEase and Youdao, we’ve always been doing this and we believe this will lead to — we have a bright future for us in this year and beyond. I hope that answered your question.

Peng Su: Yes. I guess, Brian. So if you — I think you asked us also the trend of the business growth in the 2023. And if you — I think Dr. Zhou has already explained about the drivers as well as the key numbers we have reviewed in our earnings. And — but there — so I think there is one more point I just want to add here is just, if you go back and look at first half — second half of 2022 numbers, a little bit different. And you can see about — if you look at revenue in the first half of 2022, it grew about 12% compared with the first half of 2021. But in the second half, the revenue growth rate reached almost — is over 40%, it’s 37% in the second half of 2022 compared to the second half of 2021. If you review all the numbers, including the revenue of our learning services, smart devices, also online marketing services, it’s also growing more faster, much faster, much higher that the — in the second half over the first half.

And also the net loss. If you go back to the net loss numbers in the first half, we almost lost about RMB 600 million and probably, we will look at the second half as below the — is narrowed down to the — even below the RMB 200 million, and we also decreased our cash outflow over RMB 100 million in the second half compared to the first half. So I think we built a more strong hands — strong momentum in the second half and we expect to keep that momentum in 2023. And I think that’s the control how we build up like doctor in the last mentioned about, how can we — how did we focus on the healthy operation and healthy financial performance. Thank you. That’s only — that’s the point added. Hope that answers your question, Brian.

Brian Gong: Yes. That’s very helpful.

Operator: Our next question today will come from Liping Zhao of CICC. Please go ahead.

Liping Zhao: Good evening, Dr. Zhou and Su Peng. Thanks for taking my questions. So my question is about your AI R&D. Of reading two recent media reports, your company has invested in AIGC in education scenario. Could you please share more color on that topic? Thank you.

Feng Zhou: Thanks. It’s a hot topic. Yes. So everybody is talking about it. I believe AIGC and large language models are going to have a significant impact on our education technology, and maybe a lot of kind of technology and product areas, business areas. So it’s a very long-term thing. So this year, we will see new products. Next year, we will see some company come up with a lot of new ideas, but it’s also going to take it, I will say, a pretty long time to mature. So we are looking carefully at this area. And what I can say is that we are prepared and we have the related technology foundations. Not the specific technologies but technology foundations and we will pay a lot of attention to it. And it’s a very diverse and wide area of technology.

So if you really look at the details, there are several important pillar technologies in this wave of, what I will call, modern language module technology innovation. So there are several ones. So one is what we call transformer models. Yes. And another is huge language datasets. So fast training and influence of these large models technologies in that front so to name a few of these, kind of pillar technology. So our teams actually have the experience and have done work in most of these areas through our work in translation in AI learning devices and other areas like grammar correction, things like that. So it’s not mature yet. It’s not like that as a lot of media talked about, it’s going to change everything overnight. I don’t think so. Yes.

So — but it’s very promising. So we will keep a close eye on it. And it’s — the fundamental difference about this wave of technology is, I will say, the versatility and generality. So basically, you can use one or several models to tackle dozens or even hundreds of different usage scenarios, different problems before. So before we need to build separate models for one of — each one of them, now maybe one or a few models will be enough. So that’s very promising. So that’s what I — we can share right now. And we believe this will have — has a big impact on education technology-related businesses in the coming years. And the when — when the opportunity, when the kind of very concrete opportunity actually comes, we will be prepared, we’ll be in a very good position.

Yes. Thank you.

Liping Zhao: Thank you.

Operator: Our next question today will come from Thomas Chong of Jefferies. Please go ahead.

Thomas Chong: Hi. Good evening. Thanks management for taking my questions. My question is that will there be any new smart devices introduced in 2023? And which SKU will be the key contributor in the smart device segment for this year? Thank you.

Feng Zhou: Yes, Thomas. Let me take this question. As you can see, Youdao Dictionary Pen, Learning Pads, and Listening Pods were doing quite well in Q4. Yes, we reached record revenue for the devices sector. So given the challenging macro environment we are in, I believe that speaks to the effectiveness of our strategy. So basically, we focused on a few key products. We didn’t receive like a sea of different devices. We didn’t do that. We focused on a few key products and we tried our best to deliver meaningful innovation in each new product innovation. So that works because parents don’t need kind of white-label low-quality learning devices. They want the best product for their kids. So, we intend to offer that. If we can do that than our product will do best in the market.

And then our key strengths continues to be the unique ability to combine hardware, AI software abilities and also great learning content. So in the Chinese learning devices market, we believe we are the only one truly capable of doing all three really well. So — of course, you mentioned — you talked about new products. So new products will always contribute to our growth but I want to first talk about something else. So — that is our new generation hardware and software platform. So our latest X5 and P5 Dictionary Pen are based on a new generation hardware platform. So a lot of work went into the platform. We used different chips. We made sure the platform have the features, have the capabilities that we need for not only the last year’s products but also kind of this year, maybe more products.

And we make sure that we can achieve the competitiveness that we want to achieve in this platform. So for example, we cooperated very deeply with our chip partners — with our computer chip partner, associate partner, Rockchip to enhance the NPU, the neural processing unit, for better efficiency in running AI computation models that we are making a lot of improvements on. We want the chip to be able to execute larger models, to be able to execute them with better energy efficiency, and we want kind of specifically designed models that only we have to be able to run well on those chips. So the net result is that we are able to reduce already low translation error rates further by over 60% while improving the speed of the device by 50%. So I believe this new platform is very important to us, so it allows a lot of innovation to happen and it also allows kind of the sharing of work between our products.

And it runs our Youdao OS, operating system, shares common apps, and also brings in apps from high-quality content providers like Ximalaya, like like NetEase Cloud Music. So our dictionary paying users will be able to enjoy these great contents on devices allowed — these contracts are not available on our peer’s devices. Yes, so — and lastly — and not important, it’s probably, very important. So the new platform has a very good cost structure. So you can already see the results of the cost structure in Q4 results as X5 and P5 helped Q4’s device gross margin ratio. So the gross margin ratio in Q4 was 46%, a record high for us. So applying these new hardware platforms to more products is a priority for us in 2023. So maybe also talk a little bit about the learning pad.

We expect Youdao Learning Pad to be an important growth contributor in 2023. Our key advantage here is that we have both products, and also the selling expertise. And more importantly, we have our teaching staff, the very experienced teaching staff that we have contributed a lot to the development of these learning pads. And our X10 and Y10 SKUs, they currently cover the mid-market price points. We are planning to cover other price points with new products this year. So that will make a lot of customers more happy we believe. So lastly, we are also looking at a new category opportunity. So, we will share more information when we have them. Yes, thank you.

Thomas Chong: And Thomas, this is Peng and just one point to add here. And if you go back to see our learning products development process and we released our Dictionary Pen Version 2 in the — in the middle of 2019. And for the language learning, there are always four capabilities, including listening, reading and writing and speaking. And we start from the Dictionary Pen, which helps our students and users to reading and writings. released about Listening Pod to cover the listening and speaking to the users, including the potential users as well as the existing users. And right now, we just move to the learning pad and beyond the language learning. So we start from — I think you can understood our strategy of our — the new products, our learning products of Youdao through the process of the — from dictionary pad to the learning pad.

We started growing the language learning it’s because we can leverage the strengths of our Youdao Dictionary app. And right now, we are where we think we do more than learning — the English language learning is because right now, we have already existing branding and seeing users for the learning products average sectors. So we think about in the future, we will always leverage our strength of our products and branding to release more categories in the long run. So I think that’s — I hope that can help you answer your questions. Thank you.

Thomas Chong: Thank you.

Operator: Our next question today will come from Linda Huang from Macquarie. Please go ahead.

Linda Huang: Thank you very much for the opportunity to ask the question. Mine is regarding online marketing business because we see that Q4 number is, it’s quite impressive, especially for the year-on-year revenue growth. So can the management help us to walk through what is the key reason behind that? And then how sustainable is the business going into 2023? And — so it would be great if you can give us some more color for this year. Thank you very much.

Lei Jin: Thank you, Linda. This is Lei Jin. Our advertisement segment is a modest segment for us. It is relatively smaller than our linear service and smart devices segment. So — but we’re still lagging because it is stable and constantly growing. This quarter, the Ad business is doing very well. The net revenue from this segment increased almost 60% year-over-year, reached RMB 240 million in Q4. We have always been focused on the customer value and technology-driven approach to the digital marketing. It’s paying off. More and more customer is paying more attention to the return on investment of their marketing. From the internal perspective, we upgraded our advertising system with more timely and accurate commercial data. So the results to our performance-based advertisements improved and we brought better ROI to our clients.

From the external perspective, we saw marketing demand from the online entertainment industry increase in the fourth quarter. This is mainly driven by our Ad revenue. The number of clients increased around 20% and we spend more money on advertisements. In terms of outlook for the online marketing services this year, I’m cautiously optimistic. We expect the revenue from the online marketing services to continue to increase on a year-over-year basis this year although the macro environment is still very challenging. But the good news is that our many several economic policy has been rolled out since the Chinese New Year. Besides the online entertainment clients, they are also seeing more Ad budget in the financial and transportation industry.

These are performance-based advertisements. This is a very good start. Thank you. Hope it’s helpful to you.

Feng Zhou: Thank you.

Linda Huang: Thank you very much. Yes, thank you.

Operator: Our next question will come from Candis Chan of Daiwa. Please go ahead.

Candis Chan: Great. Hi, management. Thank you for taking my question and also congratulations on the strong set of results. So my question is related to the gross margin trend for each segment for 2023, because we have seen that for learning services and also smart devices have seen great improvement in terms of the gross margin this year. Can you share about the trend going forward? Thank you.

Feng Zhou: And thank you for your question. Yes, we achieved excellent performance on our overall gross margin in 2022, reaching around 52% this year, up from 50% last year. The increase in our gross margin was mainly driven both from our learning services and smart devices. So as you mentioned, I’d like to add some color on this on a going-forward basis. Let’s begin with our learning services, we achieved healthy sales in our digital content service in 2022. We expect even high revenue base to be achieved in 2023, which will bring us added benefit from a number of scale from our learning services. For example, decreasing trends in the percentage of revenue shared with our instructors was noted year-over-year basis, which lead us to believe our gross margin for learning services will also flatly increase over the long run.

Furthermore, for our smart devices segment, the average gross margin in 2022 was 39%, slightly up from 37% in 2021. We are pleased to note that in this quarter, gross margin for our smart devices reached 46% after we launched X5, updated generation of Dictionary Pen. We regularly update our smart devices and their new version. It’s usually with a higher gross margin level during its launch stage due to higher price, better platform, and well, popularity. This is the reason why we could achieve a better performance of gross margin in this quarter. And we expect the gross margin will gradually reach a stable level. In the long run, we believe the gross margin of smart devices will keep at or above 40%, which is very healthy and make us more competitive.

In closing, going forward on the annual basis, we still expect a reasonable improvement our margin of learning services and smart devices. Well, our advertising business margin will be flat compared with last year. That’s all. Wish it is helpful. Thank you.

Operator: Ladies and gentlemen, this will conclude our question and answer session. At this time, I would like to turn the conference back over to management for any closing remarks.

Jeffrey Wang: Thank you once again for joining us today. If you have any further questions, please feel free to contact us at Youdao directly or reach out to Piacente Financial Communications in China or the U.S. Have a great day.

Operator: The conference has now concluded. We thank you for attending today’s presentation and you may now disconnect your lines.