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

Youdao, Inc. (NYSE:DAO) Q4 2023 Earnings Call Transcript February 29, 2024

Youdao, Inc. beats earnings expectations. Reported EPS is $0.58, expectations were $0.04.
Youdao, Inc.  isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Youdao 2023 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 that discussion today will contain forward-looking statements related to future company performance, 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 these forward-looking information, except as required by law. During today’s call, management will also discuss certain non-GAAP financial measures for comparison purpose only. For the definitions of non-GAAP financial measures and reconciliations of GAAP to non-GAAP financial results, please see the 2023 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, and thank you all for participating in today’s call. Before we begin, I would like to remind everyone that the financial information, 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 solid financial performance in Q4, producing an all-time high income from operations and operating cash inflow. Net revenues reached RMB 1.5 billion in Q4, up 1.8% year-over-year. Income from operations reached RMB 76.3 million, increasing 209.2% year-over-year. In terms of cash flow, we achieved an operating cash inflow of RMB 160.6 million, rising by 91% year-over-year. For the full year 2023, our key financial indicators improved significantly.

Net revenues reached RMB 5.4 billion, up 7.5% year-over-year. Loss from operations was RMB 466.3 million, narrowed by 39.8% year-over-year. Operating cash outflow amounted to RMB 438.1 million, improving 17.6% year-over-year. We executed on our strategy of growing our businesses in key growth areas, including digital content services and online marketing services, while at the same time, building product leadership and future growth through AI technology. We continue to drive towards profitability and have already delivered two major versions of our large language models, a solid foundations for both 2024 and an AI-driven future. Now I would like to share more color on our progress in the fourth quarter. First of all, our large language model projects.

Last month, we released our second language model for education, Ziyue 2, with major upgrades to conversational abilities, knowledge-based question-answering capabilities and text processing capabilities. Utilizing this new model, we launched Hi Echo 2 with extensive upgrades to digital human characters, scenarios, conversational abilities and the all-new teaching mode. We also introduced a major new LLM application, Mr. P AI Tutor, a conversation and camera-based tutoring app for all K-12 subjects. The AI tool extends the application of Ziyue from language learning to real-time and multi-modality tutoring and covers one of the largest scenarios in K-12 learning. We are thrilled to be the first in China to deliver an all subject AI tutor and look forward to serving more and more users with this technology.

Additionally, we have open sourced two technologies, EmotiVoice and QAnything since Q4, which have so far garnered over 10,000 stars on GitHub, showcasing our technology ability. LLM technology is already driving concrete business growth. For example, our translation subscription fees have grown quickly since we launched LLM features, with over 100% year-over-year growth for three consecutive quarters. Most of the growth comes from the LLM-driven AIBox and recently launched LLM translation features. As for the Learning Services segment, net revenues reached RMB 784 million, largely stable on a year-over-year basis. Momentum from our data content services is strong with net revenues of RMB 508.3 million, an increase of 13.4% year-over-year in Q4.

The gross profit margin was above 70%. Furthermore, the net operating cash inflow of digital content services reached over RMB 200 million. Additionally, net revenue in Q4 could cover the cost and operating expenses. Departments primarily including — includes Lingshi and Youdao Literature continue to improve their products and services for users. In terms of business updates, I’m glad to share that the retention rate of our consultation service for the plan for strengthening basic academic disciplines [Changi Chuan] was around 75% in Q4. Moreover, since the introduction of AI writing refinement in the third quarter, we have efficiently provided over 25,000 high-quality refinements, gathering widespread praise from our users. For 2023, net revenues from digital content services reached RMB 2 billion, up 11.7% year-over-year, also covering the full year cost and operating expenses.

Regarding STEAM courses, our CSP score prediction system for competitive programming had 200% year-over-year user growth. The retention rates for advanced level programming courses and Go courses reached approximately 70%. In 2023, 340 students of our programming courses received awards in the CSP competition. Among them, 106 students won the first prize. This achievement highlights the quality of our courses and services. In addition, Youdao Zongheng was rewarded the second prize in the China new information consumption competition of 2023. As for our online marketing services, in the fourth quarter, the net revenues surged through a historic peak of RMB 474.1 million, an extraordinary year-over-year growth of 96.9%. Online marketing services have recorded over 50% year-over-year revenue growth for 5 consecutive quarters.

This was primarily attributed to our cutting-edge AI technology and enhance the data infrastructure, empowering us to provide — to upgrade our RTA technology capabilities, broadening our client base and expand the range of applications. AI is playing a larger and larger role in our advertisement service. In fact, about 20% of our current advertising materials have already incorporated AI workflow. In addition, net revenues from online marketing services of gaming, entertainment, sports and O2O industries in Q4 rose by over 200% year-over-year. With regard to the Smart Devices segment, net revenues amounted to RMB 222.4 million, declining 45.3% year-over-year. Our efforts to optimize low return of investment sales channels continued to reduce overall channel inventory, impacting the fourth quarter revenue.

At the same time, the overall financial health of this segment has improved on a quarter-over-quarter basis. We have finished our sales channel reshuffling, so that is behind us. Product-wise, we recently launched the Youdao Smart Learning Pad X20, featuring Mr. P AI Tutor powered by our LLM Ziyue. This is the industry’s first learning pad within LLM-based all subject AI tutor. We believe the headwinds of the Devices segment are temporary. In fact, on February 21, we launched Youdao Dictionary Pen X6 Pro. With more AI and LLM features, I’m happy to report that A6 Pro sold over 50,000 units in the first week, making it our #1 launch with the most units in the first week in our history. As you can see, we are accelerating our product launches.

In past years, our new products were mostly launched in the summer. This year, we started the year strong A6 Pro and E6. And our work on AI is paying off. Our devices have more attractive features and differentiations than any time before because of AI technology. Exclusive features like AI grammar instruction, AI word instruction and Mr. P AI Tutor are liked by more and more users and only Youdao products have them. These features are driving high user satisfaction and growth. This is why the new products are selling well. So we remain confident in the future of learning devices. For education digitalization solutions, we reached a major milestone in 2024 of over RMB 100 million contract sales. Additionally, since the launch of Youdao Fun Sports, it has been adopted by over 100 schools with the current utilization rate of over 95%.

Looking ahead, let’s take a high-level view of the business. First, we see that users demand for digital learning content and services across subjects and across age groups are increasingly — are increasing steadily since last year after COVID. Youdao is in a good position to capture this opportunity. With our experienced teams and established content, our digital learnings contents business is already on a multi-quarter growth trajectory. This year, we continue to drive growth by focusing on key strong content areas, mainly including Lingshi and literature and developing new content. Another important factor at a high level is our unique strengths in AI technology. We continue to build on our leadership in educational LLM in 2024 for a technological tidal wave like the LLM.

First movers enjoy significant leverage and its impact on business shows in an accelerating fashion over time. We are a first mover here and had a quick ramp up in 2023 for our LLM technology and products. We released our own model and multiple industry-first products quickly. As we gain more understanding of the technology, this year, we believe LLM will contribute more to product leadership of our products, including learning devices, online marketing services and learning apps. From this high-level view, we believe we are in a good position to lead in building a new generation of AI-powered, high-quality content-based learning and other experiences for people around the country and over the world. Thank you and now is Su Peng to give you an update on our financials.

Peng Su: Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights from the fourth quarter and the full year of 2023. We encourage you to listen to our press release issued earlier today for further details. As Dr. Zhou mentioned, for the fourth quarter, total net revenue was RMB 1.5 billion or USD 208.5 million, representing a 1.8% increase from the same period of 2022. Net revenue from our learning services were RMB 784 million or USD 110.4 million, representing a 2.8% decrease from the same period of 2022. Net revenue from our smart devices were RMB 222.4 million or USD 31.3 million, down 45.3% from the same period of 2022, primarily due to our continuous efforts to streamline marketing channel with low return on investment for the intelligence learning products in the first quarter of 2023.

Net revenue from our online marketing services were RMB 474.1 million or USD 66.8 million, representing a 96.9% increase from the same period of 2022. The year-over-year increase in revenue from the online marketing services were mainly attributable to the increased demand for the performance-based advertisement through the third-party Internet properties. For the fourth quarter, our total gross profit was RMB 738.8 million or USD 104.1 million, representing a 4.6% decrease from the first quarter of 2022. Gross margin for learning services was 63.6% for the first quarter of 2023 compared with 64.1% for the same period of 2022. Gross margin for smart devices was 38.3% for the first quarter of 2023 compared with 46.2% for the same period of 2022.

Gross margin for online marketing services was 32.7% for the first quarter of 2023 compared with 29.2% for the same period of 2022. For the fourth quarter, total operating expense for RMB 662.5 million or USD 93.3 million compared with RMB 750 million for the same period of last year. Looking at our expense in more detail. Our sales and marketing expense were RMB 441.4 million compared with RMB 515.9 million in the first quarter of 2022. Research and the development expense were RMB 168.1 million compared with RMB 179.5 million in the first quarter of 2022. Our operating income, income margin was 5.2% in the first quarter of 2023 compared with 1.7% for the same period of last year. For the first quarter of 2023, our net income from continuing operations attributable to ordinary shareholder was RMB 56.5 million or USD 8 million compared with RMB 12.3 million for the same period of last year.

Non-GAAP net income from continuing operations attributable to ordinary shareholders for the first quarter was RMB 69.3 million or USD 9.8 million compared with RMB 31.1 million for the same period of last year. Basic and diluted net income from continuing operations per ADS attributable to ordinary shareholders for the first quarter of 2023 was RMB 0.47 or USD 0.07. Non-GAAP basic and diluted net loss, net income from continuing operation per ADS attributable to ordinary shareholders for the first quarter was RMB 0.58 or USD 0.08. Our net cash provided by the continuing operating activities was RMB 160.6 million or USD 22.6 million for the first quarter. Turning to our full year results. Our total revenue for 2023 increased by 7.5% to RMB 5.4 billion or USD 759.1 million.

Net revenue from our learning services for 2023 were RMB 3.1 billion or USD 443.4 million, keeping flat for the 2022. Net revenue from our smart devices for 2023 down by 27.6% year-over-year to RMB 909.2 million or USD 128.1 million. Net revenue from our online marketing services for 2023 were up 98.1% year-over-year to RMB 1.3 billion or USD 187.6 million. Total gross profit for 2023 was RMB 2.8 billion or USD 389.8 million, compared with RMB 2.6 billion into 2022. Total operating expense for 2023 decreased to RMB 3.2 billion or USD 455.5 million compared with RMB 3.4 billion in 2022. Net loss from continuing operations attributable to ordinary shareholders for 2023 was RMB 549.9 million or USD 77.5 million and basic and diluted net loss per ADS from continuing operation attributable to ordinary shareholders for the 2023 was RMB 4.53 or USD 0.64.

Looking at our balance sheet. As of December 31, 2023, our contract liabilities, which mainly consists of the deferred revenue generated from our learning services were RMB 1.1 billion or USD 148.3 million compared with RMB 1.1 billion as of December 31, 2022. At the end of the period, our cash, cash equivalent, reserved cash, time deposits and short-term investments totaled RMB 527.1 million or USD 74.2 million. This concludes our prepared remarks. Thank you for your attention. We would now like to open the floor to your questions. Operator, please go ahead.

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question is from Brian Gong with Citi Group.

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Q&A Session

Brian Gong: I have a question on our large language model. Youdao is pretty committed to AI and we also launched our own large language model to the year. Can management share our NIM monetization channels for the year? Thank you.

Feng Zhou: I’ll take this question. Yes. first, there is a consensus in the AI industry that education is one of the most important areas for large language model applications. Sam Altman talks about it. Bill Gates also talks about education and health care are the most important areas. So the overall focus is I think, to capture kind of really important use scenarios in education and then monetize that. We basically think about this in two ways, two kinds of LLM projects. One is value-adding projects to our existing businesses. One is completely new things. So for the first category, we have a couple of channels. So obviously, one of the very important one is smart devices. I think one trend is quite clear. So LLM features are quickly becoming kind of major selling points for our devices.

So for example, AI features like AI grammar instruction, [Iva Jinja] for explaining sentences and word instruction, that’s the [indiscernible] for explaining separate words or phrases. These features have become the most used features and major selling points for Youdao Dictionary Pen since last year. I compare this to Youdao Dictionary, not the Dictionary Pen, the app, Youdao Dictionary, how we won the dictionary market. So that was done with the two features. One is a web interpretation on [indiscernible]. The other is machine translation. So when you have something that really works for specific learning scenario that users really care. And also, we only you have that and the other players don’t. Then it is a very good way to gain more market share and also monetize the technology.

Of course, we also have the [Molson] [indiscernible] Mr. P AI Tutor [Foreign Language] We think that will also be popular. So this is one way we monetize the technology through smart devices. Of course, we also monetize though app subscriptions. We talked about for our dictionary and translation, AIBox has become a key feature to driving over 100% growth in subscription year-over-year for the last three quarters and it also contributed to our growth of online marketing significantly. So yes, right now, over 20% of our advertising materials, they go through — somewhere in the process, they go through a generative AI workflows. So that’s already pretty significant. One out of five ad materials are generated from using AI technology or it’s processed using AI technology.

So that’s the first category, how we apply AI to our existing businesses. The other one, maybe more important for the longer term is completely new products. So of course, we have Hi Echo, the English learning app. So — and also yes, we will have Mr. P AI Tutor as a stand-alone product, too. Yes. So Mr. P AI Tutor as a stand-alone product is upcoming. It’s a future product. If we look at these apps, these products, I think they cover large use scenarios. For example, the English language learning, spoken English language learning scenario is a pretty significant business in itself. And in fact, if we look at our peers, the Korean app, [Speak] has, I think, around USD 20 million annual revenue already, yes. So I think there’s a bright future for AI-powered language learning there.

And if you look at Mr. P AI Tutor, it covers an even larger scenario. Yes, that is the home tutoring scenario. If the student is learning at home and doing drills and exercises and have a question, then the AI tutor can answer that question much better than parents or the students herself. So I think it is a profound idea, I would say. It’s a profound idea because this is one of the most important scenarios in home education. So if we can have an AI tutor answer questions for all the subjects that the students learn and if the AI can answer that question in a really instructional and high-quality fashion, then I think that will create a lot of value. So in summary, I think the two channels, the two categories are the ones that we are looking at.

One has an immediate impact on the business. The other one, longer term, but probably larger in scope, yes. So I’m very optimistic about this — the impact LLM will have on the — our business going forward.

Operator: The next question is from Caini Wang with CICC.

Caini Wang: [Foreign Language] So my question is, we can see that our learning services revenue in 2023 is kind of flat compared to 2022. So I’m just wondering, what is the focus for the — our Learning Services segment in 2024? Thank you.

Feng Zhou: Yes. So I’ll take this, too. So in 2023, yes, if you look at data content services, so this is the major contributor of net revenue in our learning services content. So we redefine digital content services within the learning services sector by any new service that’s launched after and according to the policy change. So these primarily include Lingshi and Youdao Literature and some other smaller courses, not including things like adult courses. So in 2023, net revenues from [indiscernible] content services reached RMB 2 billion. So it is up 11.7% year-over-year, yes. So — and the gross margin was around 70%. So we — so this part of the business met our expectations. So in 2024, we think Digital Content services will be the focus of our Learning services.

So let me give you a few points regarding our priorities. So first is consumer needs are quite strong in this area and we are improving the services to satisfy different user needs. So our Youdao Lingshi is already leading in the industry. Our Youdao Literature course is also quite popular. As we gain more and more users so one of the key areas is we will provide more personalized services to users. So Lingshi recently introduced a small class course format for students with more advanced learning needs. So this is actually different from the past small class experiences. The new format is offered with mostly prerecorded video content and our experienced tutors to provide the service. So feedback is very good for this new format. Youdao Literature, Youdao [indiscernible] also launched a new major revision of the course, broadening to more age groups and provide more choices with how much the user wants to — how much time the user wants to spend on the course.