Youdao Inc (DAO) 2022 Q4 法說會逐字稿

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.

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 state 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 data to differ materially from those mentioned in today's press release in 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 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 definition 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.

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 RMB 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 sold 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.

The total gross margin climbed to 53.3%, rising by 11% 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 2 consecutive quarters. Personal Smart Devices. Strong new product sales drove approaching 100% year-over-year growth on November 11 shopping festival and facilitated the 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. Our net revenues reached RMB 2.9 billion in the 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. Our gross margin was 51.6%, improving 2 percentage points year-over-year. Loss from operations was RMB 774.7 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 with an rated AI-supported learning dashboard for better personalized learning experiences. After we entered the field of education [publets] in Q3, the compound monthly growth rate of sales units exceeded 100% and moreover, for the first 3 months after we launched the Learning Pad X10, its compound mentally growth rates of sales units was nearly twice that of the Y10 for the same period. 

As for 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 percentage 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 codeveloped by Youdao and Minecraft Education addition. 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 the teaching team led by World Champion, Ke Jie. The Youdao Go courses create 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 post-graduate entrance exams. It offers comprehensive solutions from target consultation to hybrid tutoring by AI and humans. Students are thrilled with these new features and 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 a customer-oriented philosophy and enhanced customer experiences with upgraded services and smart devices facilitated by technology and innovation in 2022.

We released the world's first veterinary pain OS and launched digital content services that enhanced learning efficiency and effectiveness, which was supported by customers that 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 our cutting-edge technology and innovation to promote the sustainable development of smart devices, digital content services and steam costs, further improving our business healthiness and financial performance. With that, I will turn the call over to Su Peng to give you more details in our financials.

Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights from our 2022 first quarter and the full year. We encourage you to read through our press release issued earlier today for further details. For the fourth quarter, total net revenue of RMB 1.5 billion or USD 210.8 million. This will represent an increase of 38.6% from the fourth quarter of 2021. Net revenue from our learning services were RMB 86.3 million or USD 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 revenue from our smart devices were RMB 407 million or USD 59 million, up 28.1% from the same period in 2021, driven by the popularity of the Youdao-newly launched products such as Youdao Dictionary Pen X5. Net revenue from our online marketing services were RMB 240.8 million or USD 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 advertisement through third parties internet property. 

For the first quarter, our total gross profit was RMB 774.7 million or USD 112.3 million, representing a 74% increase from the fourth quarter of 2021. Gross margin for learning services was 64.1% for the first quarter of 2022 compared with 51.4% for the same period in 2021. Gross margin for smart devices was 46.2% for the first quarter of 2022 compared with 30.8% for the same period in 2021. Gross margin for online marketing services was 29.2% for the first quarter of 2022 compared with 32.6% for the same period in 2021. For the fourth quarter, total operating expense were RMB 750 million or USD 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 expense were RMB 515.9 million compared with $420.4 million in the first quarter of 2021. Research and development expense were RMB 179.5 million compared with $170.2 million in the fourth quarter of 2021. Our operating income margin was 1.7% in the first quarter of 2022 compared with operating loss margin of 23.7% for the same period of the last year. For the fourth quarter of 2022, our net income from continuing operations attributable to ordinary shareholders was RMB 12.3 million or USD 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 first quarter was RMB 31.1 million or USD 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 USD 0.01. Non-GAAP basic and diluted net income from continuing operations per ADS attributable to ordinary shareholders for the first quarter was RMB 0.25 or USD 0.04.

Our net cash provided by the continuing operating activity was RMB 34.1 million or USD 12.2 million for the first quarter. Turning to our full year results. Our total revenue for 2022 increased by 24.8% to RMB 5 billion or USD 726.8 million. Net revenue from our learning services for 2022 were RMB 3.1 billion or USD 447.2 million, up 26.3% from the 2021. Net revenue from our smart devices for 2022 grew by 28.2% year-over-year to RMB 1.3 billion or USD 182.2 million. Net revenue from our online marketing services for 2022 were up 13.2% year-over-year to RMB 672.4 million or USD 97.5 million. Total gross profit for 2022 was RMB 2.6 billion or USD 375 million compared with RMB 2 billion in 2021.

The Total operating expense for 2022 increased to RMB 3.4 billion or USD 487.63 million compared with RMB 2.9 billion in 2021. Net loss from continuing operations attributable to Youdao ordinary shareholder for 2022 was RMB 72.9 million or USD 145 million and the basic and diluted net loss per ADS from continuing operation attributable to ordinary shareholders for 2022 was RMB 5.3 or USD 0.85. Looking at our balance sheet. As of the December 31, 2022, our contract liabilities, which mainly consists of the deferred revenue generated from our learning services was RMB 1.1 billion or USD 154.7 million compared with RMB 1.1 billion as of the December 31, 2021. At the end of the period, our cash, cash equivalents, restricted cash, time deposits and short-term investment totaled RMB 1 billion or USD 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.

(Operator Instructions)

Our first question today will come from Brian Gong of Citigroup.

So my question is about the outlook for this year. What's our wealth management's expectation for the revenue for 2023? And what are the key drivers of learning services this year?

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 good position to both grow the impact of our business and also improve our financial metrics, including top and bottom line and cash flow for this year. So you asked about the drivers for Learning Services. So this is our largest sector, yes. So I see several things that works in our favor, but I'll talk about 2 major drivers. So one is data 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 Go.

So in 2022, it has proven that interactive content instead of live classes, live courses based 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 these new content. Whatever works for that particular area and also the 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 team. So engineering, math and arts so extracurricular kind of content. So we've talked about this trend before. So as children's learning in China evolves. So families are more and more willing to invest in steam learning like auto engineering and other extracurricular activities. So we offer a very good computer programming courses, and that will be a focus area for us in 2023. We already have a leading and healthy go game and CES course business. So it grew by over 50% in Q4. Yes. So -- it is also a very special service.

It's a very, I would say, a type of service as its employees and excellent teaching staff, leading AI learning technology and has thriving learning community. 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 users are satisfied. So we were able to basically double the size of the business in 2022. So it is a testimony of family's preference and need for this kind of extracurricular 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 great teachers 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 growth 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 as netizens of Youdao, we've always been doing this. And we believe this will lead to -- will have a bright future for us in this year and beyond. I hope that answers your question.

I think you asked about the trend of the business growth in the 2023, and they feel -- yes, I think Dr. Zhou has already explained about the drivers as well as the key numbers we have reviewed in our earnings -- and -- but the -- I think there is a more point I just want to add here is just if you go back and look first half second half of 2022, the number is a little bit different. And you can see about the -- if you look at the revenue in the first half of 2022, is grew about 12% compared with the first half of '21. But in the second half, the revenue growth, growth rate reached almost -- it's over almost 40%, is 37% in the second half of 2022 compared with second half of 2021.

If you review all the numbers, including the revenue of learning services, smart devices or the market service is also more faster, much faster or much higher than 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 -- but if you look at the second half is below the -- it's narrowed down to the even below the RMB 200, RMB 200 million. And we also decreased our cash outflow of over RMB 100 million in the second half compared to the first half. So I think we view a more strong trends or strong momentum in the second half, and we expect to keep that momentum in the 2023. And I think that's to control how we build up like doctor in the last mention about how did we focus on the healthy operation and healthy financial performance. That's the point I added. I hope that answers your question, Brian.

Our next question today will come from Liping Zhao of CICC.

So my question is about your AI R&D. According to recent media reports, your company has invested in AIGC in education scenario. Could you please share more color on that topic?

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 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 would 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 the technology foundations, and we will pay a lot of attention to it. And it's a very diverse and a wide area of technology. So if you really look at the details, there are several important pillar technologies in this wave of what I would call modern language model technology innovation. So there are several ones. So one is what we call a transformer models, yes. And another is a huge language data sets. Also faster training and influence of these large models, a lot of technologies in that front. So to name a few of these are kind of pillar technology. 

So our teams actually have experience and have done work in most of these areas through our work in translation and 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. But it's very, very promising. So we will keep a close eye on it. And it's -- the fundamental difference about this wave of technology is, I would say, the versatility and generality. So basically, you can use one or several models to tackle dozens or even hundreds of different usage areas, 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 yes, so that's what I -- we can say right now. And we believe that this will have a big impact on education technology-related businesses in the coming years. And when the opportunity when the kind of very concrete opportunity actually comes, we will be prepared, we will be in a very good position.

Our next question today will come from Thomas Chong of Jefferies.

My question is that will there be any new smart devices introduced in 2023 and which SKU will be the key for to investment Device segment for this year. Thank you.

Thomas, let me take this question. As you can see, edition learning pads and listening parts were doing quite well in Q4. Yes, we reached record revenue for the devices sector. So given the challenging macro environment where I believe that speaks to the effectiveness of our strategy. So basically, we focused on a few key products yes, we didn't -- 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 iteration. So that -- 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, then our product will do best in the market. And 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 3 really well. So of course, you talked about new products. So new products will always contribute to growth. 

But yes, yes, so -- but I want to first talk about something else. So that is our new generation hardware and the 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 use different chips. We make sure the platform had features, 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 partner with our computer chip partner, SoC partner rupture to enhance the NPU, the neuroprocessing unit for better efficiency in running the 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 design 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 rate 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 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 Raz-Kids and like NetEase Cloud Music. So our Dictionary Pen users will be able to enjoy this great content on devices, while these contents are not available on our peers' devices. 

So -- and lastly, and not as -- 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's 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. Yes. So applying these new hardware platforms to more products is a priority for us in 2023. Yes. So maybe also talk a little bit about the learning path. We expect the Learning Pad to be an important growth contributor in 2023. Our key advantage here is that we have both the product 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 the white 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.

And Thomas, just to add an extra point, this is Dr. Zhou. And if you go back to see our learning products development process and we released our Dictionary Pen 2.0 in fact in the middle of 2019. And for the language learning, there are always for capabilities, including listening, reading and writing and speaking. And we start from the Dictionary Pen, which helps the students and users to reading and writings. Right after it, we released about listening part to cover the listening and speaking to the users, including the potential users as well as the existing users. And right now, we just moved to the learning path and beyond the language of learnings.

So we start from -- I think you can understood our strategy of our development of new products or learning products of you do through -- through the process of from Dictionary Pen to the Learning Pad. We started from the language learning. It's because we can leverage the strength of our Dictionary Act and right now, we think we do more than the learning is -- like we're learning is because right now, we have all existing branding and in users for the learning products 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 to answer your questions. Thank you.

Our next question today will come from Linda Huang of Macquarie.

Mine is regarding from the online marketing business because we see that the Q4 number is 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 will go into 2023. And so it would be great if you can give us some more color for this year.

Thank you, Linda. This is Lei Jin. Our advertisement segment is more segment for us. It is relatively smaller than our learning service and modern devices segment. So -- but we're still likely 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. This has reached RMB 240 million in Q4. We have always been focused on the customer value and the technology approach to the digital marketing. It's paying off when more and more customers pay more attention to the return of the investment of their marketing.

For the internal perspective, we upgraded our advertising system with a more timely and accurate conversion data. So the result to our performance-based advertisement was improved and we brought better to our clients. From the internal perspective, we saw marketing demand from the online entertainment industry increased in the fourth quarter, which is mainly driven by our AD revenue. The number of clients increased around 20% and they spend more money on the advertisement. In terms of outlook for the online marketing service 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 with the macro environment is still very challenging, but the good news is that our many several economic policy has been out since the Chinese New Year. Besides one entertainment clients, we are also seeing more AD budgets in the financial and transportation industry with the performance-based advertisement. This is a very good start. Thank you. Hoping it helpful to you.

Our next question will come from Candis Chan of Daiwa.

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 a great improvement in terms of the gross margin this year. Can you share about the trend going forward?

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 going forward basis. To begin with our learning services, we achieved healthy sales in our digital content services in 2022. We expect even higher 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 in percentage of revenue share with our instructors was noted on 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 9%, 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 the new version is 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 on our margin of lenses and smart devices. While our advertising business margin will be flat compared with last year. That's which it is helpful. Thank you.

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.

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 the TS Financial Communications in China or the U.S. Have a great day.

The conference has now concluded. We thank you for attending today's presentation, and you may now disconnect your lines.