Youdao, Inc.

Good day and welcome to the YoDAO 2022 First Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeffrey Wong, Investor Relations Director for YoDAO. Please go ahead.

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 fund 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 the certain risks and uncertainties, assumptions, and other factors. Some of these risks are beyond the company's control, and could cause actual rebounds to differ materially from those mentioned in today's press release and this discussion. A general discussion of the risk factors that could affect UW's business and financial results is included in certain filings of the company with the Securities and Exchange Commission. The company does not undertake any obligation to update overlooking 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 2020 Fourth Quarter 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 UDOT's corporate website at ir.udot.com. Joining us today on the call from UDOT's senior management is Dr. Feng Zhou, our chief executive officer, Mr. Lei Jin, VP of operations, Mr. Peng Su, our VP of strategy and capital markets, and Mr. Wayne Lee, 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, 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're pleased to report solid performance in the first quarter of 2022, following the cessation of our K-9 academic AST business with record high revenues and overall gross margin, as well as a significant improvement in operating loss. Q1 net revenue was RMB 1.2 billion, up 26.6% year-over-year and 14.5% quarter-over-quarter. a new record high. We also achieved an overall gross margin of 53.5%, another record high. Given the disposal of canine academic AST business, retrospective adjustments to the historical statements of operations have also been made for the previous periods, which provides a consistent basis of comparison for the financial results of the continuing operations. Furthermore, We narrowed operating loss by 41.6% year over year to RMB 125.1 million from the loss of RMB 214.3 million in Q1 2021. These results amid a challenging macro environment clearly reflects our strengthening fundamentals as well as the effectiveness of our strategy. Liquidity-wise, we have adequate funding for long-term growth. First, as of March 31st, 2022, Yodao's cash, cash equivalents, restricted cash, time deposits, and short-term investments totaled RMB 1.2 billion. Secondly, our controlling shareholder, NetEase Group, has been supporting our long-term growth. And to the date of this release, Yodao has received various financial support from the NetEase Group. Among others, including RMB $878 million short-term loans and US dollar $300 million revolving loan facility. In support of UDAO's future business, NetEase Group has agreed to provide financial support for our continuing operations. Now I'd like to share more details on our first quarter progress. First, let's look at smart learning devices. Q1 device revenues was RMB 253.2 million, representing an increase of 25.4% year-over-year. This is a remarkable growth given the COVID-related supply chain and sales channel challenges. In total, we sold 430,000 devices in Q1. As we discussed in past quarters, devices are a key growth area for us. An important priority this year is to drive growth and synergy by scaling up R&D, updating existing product lines, and shipping new products. We strictly followed our strategy in Q1. We added new dictionary databases to Udall Dictionary PEN, while we already have the most comprehensive dictionary database. We added 11 new series of English textbooks to UDAO Listening Pod, with a total reaching 19. In terms of new products, more recently in early April, we launched UDAO Smart Light, a product in development for over a year. UDAO Smart Light is a smart desk lamp with integrated AI learning features, powered by our advanced AI algorithms. It automatically analyzes users' hand and body movements while sitting at the desk, allowing the user to seamlessly access a host of AI learning functionalities while they are reading, writing, or doing homework. You can point to an English word to look it up, or tap a sentence to have it read to you, or ask it to check your arithmetic worksheet for you. It even tracks the user's sitting posture and will alert the user when detecting unhealthy postures. After we launched the UW SmartLight, the initial feedback is very positive. We plan to grow its popularity over the coming months as we did with other products. We're also looking forward to introducing additional smart devices this year as planned. Now let's talk about learning services. Our strategy here is to transition from an academic AST center business to esteem and vocational courses center business at an accelerated pace. Since Q3 last year, Q1 is the third quarter in which our teams scaled up our growth products, like the Weichi courses and graduate school entrance exam courses, while at the same time closing down academic AST courses. That has been a challenging process, and we have continued to deliver steady progress in Q1. Our new courses are growing quickly, which partially offset loss of revenue from academic AST courses. Net revenue from learning services reached RMB $826 million in Q1 2022, up 36.1% year-over-year. If we were to compare with the learning service net revenue including K-9 academic AST business in Q1 2021, it declined by 17.3% year-over-year. Note that we were positively impacted by seasonality, because Q4 was a major renewal season, and a large part of gross billings generated in Q4 were recognized as net revenue in Q1. As for steam courses, Yeodao Chess expanded particularly fast, with its gross billings increasing 170% quarter-over-quarter. Besides, we established a strategic partnership with the Haidian Chess Association. In addition to courses, our Go and chess user community has been growing at a fast pace. Here we have the Yudao Board Game Academy app, where users can play against others or learn Go or chess with the help of our proprietary AI technology. Every day about 200,000 Go or chess games are played on the Youdao Ballgame Academy app and our other assets. This approach of combining courses and a community and AI-based app experience is a major competitive advantage for us. The courses and the app drive each other's growth. In addition, Youdao has become an official online testing and certification site for Weichi Academies in Beijing and Anhui province. Through the tests, users can receive certifications for their skill by the Chinese Weiqi Association or Beijing Weiqi Association. Let's turn to vocational and adult education courses. In Q1, we upgraded our graduate school entrance exam courses, trying to offer a one-stop service for our customers. We also explored online-merged offline courses. to increase the learning efficiency and effectiveness. With ongoing upgrade, the gross billings from the graduate school entrance exam courses grew by over 160% quarter over quarter. We also saw growing demand for other vocational courses, such as constructor certification courses and accounting courses, with gross billings increasing over seven times year over year in Q1. Our other endeavors, including education digitization business, dictionary and translation apps, and our charity initiatives are also progressing smoothly in Q1. Looking ahead, we continue to implement our strategy of four growth pillars. That is smart devices, STEAM courses, vocational education, and education digitization. The first two, devices and STEAM courses, are at a larger scale and already a significant part of our business. The latter two are making good progress in product development and business model validation. We expect to see challenges, including this new wave of COVID in China. We intend to overcome them through our diversity of businesses, large user bases, and deep technical roots for innovation. With that, I will turn the call over to Supong to give you more details on our financial performance. Supong.

Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights for the first quarter of 2022. We encourage you to read through our press release issued earlier today for further details. For the first quarter, total net revenue will be RMB $1.2 billion, or US$189.4 million. This represents an increase of 26.6% from the first quarter of 2021. Looking at this growth by segments, net revenue from our learning services were on the 826 million. For US dollar, 130.3 million, increased by the 36.1% from the same period in 2021. We attribute this growth to the increased revenue generated from our learning services, which were further driven by the growth in active users compared with the same period of 2021. Net revenue from our smart devices were on the 253.2 million, or U.S. dollar, 39.9 million, increased by 25.4% from the same period in 2021, driven by the increase in sales volume of Utah Dictionary Pen in the first quarter of 2022. Net revenue from our online marketing services were RMB 121.4 million, or U.S. dollar, 19.1 million, representing a 12.7% decrease from the same period in 2021. For the fourth quarter, Our total gross profit reached RMB $641.8 million, or US dollar $101.2 million, increased by 29.3% compared with the first quarter of 2021. Gross margin for learning services was 63.9% for the first quarter of 2022, compared with 63.4% for the same period in 2021. Gross margin for smart devices was 33.7% for the first quarter of 2022, compared with 44.1% for the same period in 2021. Gross margin for online marketing services was 23.7% for the first quarter of 2022, compared with 16.4% for the same period in 2021. For the first quarter, total operating expense were RMB 766.9 million, or US dollar 121 million, compared with RMB 710.8 million, for the same period of last year. With that, for the first quarter, our sales and marketing expense were RMB $506.4 million compared with RMB $548.7 million in the first quarter of 2021. Research and development expense were RMB $203 million compared with RMB $127.7 million in the first quarter of 2021. Our operating loss margin was 10.4% in the first quarter of 2022, compared with 22.6% for the same period of last year. For the first quarter of 2022, our net loss from our continuing operation attributable to ordinary shareholders was RMB $95.4 million, or $15.1 million, compared with RMB $219.3 million for the same period of last year. Non-GAAP net loss from continuing operation attributable to ordinary shareholder for the first quarter was RMB 70.9 million, or US dollar 11.2 million, compared with RMB 204.8 million for the same period of last year. Basic and diluted net loss for ADS from continuing operations attributable to ordinary shareholder for the first quarter of 2022 was RMB 0.77, or US dollar 0.12. Non-GAAP basic and diluted net loss from continuing operation per ADS for the first quarter was RMB 0.57 or US dollar 0.09. Our net cash used in continuing operation activity was RMB 425.6 million or US dollar 67.1 million for the first quarter. Looking at our balance sheet, as of the March 31, 2022, our contract liability, which mainly consists of the deferred revenue generated from our learning services were RMB $729.5 million, or US dollar, $115.1 million. Compare with RMB $1.1 billion as of December 31, 2021. At the end of the period, our cash, cash equivalents, restricted cash, time deposit, and short-term investments totaled RMB $1.2 billion, or US dollar, $183 million. This concludes our prepared remarks. Thank you for your attention. We would now like to open the call to our questions. Operator, please go ahead.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star then two. If you would like to ask your question in Chinese, we ask that you please repeat it in English for everyone on the call. Once again, that was star then one to ask a question. And at this time, we will pause momentarily to assemble the roster. And our first question will come from LC Shang from Morgan Stanley. Please go ahead.

Thank you, management, for taking my question. So I'd like to ask about the non-academic or the steam courses business. Could you give us more color in terms of the progress of this business and also the competitive landscape in this business? Thank you.

Yeah, hi Arcee. Yeah, this is Zhou Feng. Yeah, I'll take your question. As I discussed in our prepared remarks, we were making good progress here. Yeah, STEAM courses achieved rapid growth again in Q1. And as you probably know, Go and Chess are a strong area for us. Yeah, we've operated Go and Chess courses had it together for about two years now. So our teams are experienced, and we have a differentiated product strategy. So again, that is to combine excellent teaching staff with polished, interactive course materials, and also with AI tutoring and online community. In terms of progress in Q1, we are already a market leader for Go course, and we keep getting new customers every quarter. So chess was particularly a bright spot for Q1. As I said, growth feelings for chess in Q1 increased by over 170%, quarter over quarter. So chess caters to a smaller, probably smaller than gold, but more affluent population compared to gold. So we believe both are good businesses for us, so we will focus on both these courses. Again, our courses are very differentiated from our peers. We provide an integrated experience to our users. We made particular progress with the AI and the online community this quarter. So we upgraded the app experience so that the AI is more helpful when the students actually go review their chess games and their Go games. So this improves their learning. And we improved the matching between the players so that they have a better experience when when they go to the app and they get to match with the player with similar skill levels. And this improves their learning and experience a lot. So as always, our approach is to really pick good areas to work on and patiently produce the best product in that area. So we did that with our devices. We did that with the Weiqi and we are doing that with chess. So we believe that is the recipe for success. We don't intend to have too many courses, too many classes. We want to be focused. Apart from Go and chess, we actually plan to pick one or two other areas to also be our focus going forward in this non-academic course area. We will share more information with the new products when we have them. Thank you.

The next question comes from Hongji Kale with CICC. Please go ahead.

Thanks for taking my question and also congratulations for the good performance. My question is, can you give us more color on the new product, Yodao Smart Light, and how was the sales performance and what is the momentum for this new product compared to Yodao Dictionary Pen? Thank you.

Thank you. This is Supong. I will take these questions. The first is, I'll just try to emphasize again about the numbers of the Q1s with the performance of our smart devices. We catch our favorite windows of the new school semester opening and the generated revenue of the RMB 253.2 million, representing an increase of almost over 25% year-over-year from the smart devices segment in the first quarter. And for the Udall smart lights, go back to your questions. We scanned off the AI desk lamps and has been welcomed by the customer first. And we think the first we can share the performances about the first batch of the Udall smart lights has been sold out within the first month since its launch in early April, reflecting about the demand from the market. And we think about the reason behind about why we can see the very positive feedback from the market. It's about we think about this. We did create a lot of some different, all the innovative experience with our products. For example, we acquired the ratio of JD.com till now. Fingertip word search and the sentence intensive reading And we think we are the top two functions that we mentioned, as well as the price by our customers. We think about that's what we are. What we did is just try, we always insist on, we always try to provide high quality products to the market to meet the demands of the customers. And we think about we will keep moving on and try to upgrade more functions to our smart device. We think about this will be gets very positive feedback from the market. Although right now it's still in the very early stage, and we think we are still a long way to go, but we are confident about the performance of these new products in the long run. We expect we can share more information and numbers and data with you in the second quarter earnings, and we think about that we have enough time to analysis about the feedback from our customers, and we can provide more products to the market. Thank you.

The next question comes from Brian Gong of Citi. Please go ahead.

Good evening. Thanks, management, for taking my question. This is Katrina asking on behalf of Brian. So my question is, how should we look at the margin trend for the second quarter of 2022 and the full year? Have we done any cost optimization measures? And how should we think about the cost control going forward? Thank you.

Hi Katrina, thank you for your question. This is Wayne. I will add some color for the margin chain for 2022. As you're seeing in this quarter, we achieved a new high record in overall gross margin at 53%. Therefore, we are very confident about the improvement in our gross margin in the long run. For learning service segment, which is the largest segment from revenue perspective, and we have always seeking to optimize the cost structure and to achieve economic skills to get a better gross margin. On a full year basis, we expect the average gross margin of learning services for 2022 will keep stable when compared with last year. Meanwhile, we also noted that the seasonal fluctuation on the quarter-over-quarter basis in its gross margin is due to the seasonality of the recognized revenue. For the smart devices segment, which is another significant segment where we continue to invest in ANDI and other resources, and we expect to achieve sound growth on a year-over-year basis. However, the lockdown policy caused by the pandemic has been making a significant impact on the production and the delivery of our smart devices, which further results in more uncertainties on both sales and the chain of gross margin for this segment. We expect an improved gross margin of smart devices with realization of the greater economic field. However, we need to keep a close eye on the uncertainty around the margin of smart devices. Considering the margin of smart devices is relatively lower than the learning service segment at current stage, if a higher revenue portion from smart devices is achieved, the overall gross margin level is expected to be lower. As for operating margin, on one hand, we put efforts on improving the efficiency of sales and marketing, as well as staff costs. On the other hand, we continuously strengthen our technical and R&D investment to keep our technical advantages As you see, improved operating margin was achieved in this quarter, and we have tried to seek a better performance in operating margin in the long run, which is helpful. Thank you.

The next question comes from Linda Huang of Macquarie. Please go ahead.

Hi, management. Thank you for taking for my question. My question is regarding for the recent pandemic. We all know that this COVID-19 situation remains fluid. So how is the impact from the recent pandemic outbreak like the Shanghai and Beijing? And if the city lockdown or the social distance restriction remains, do we have any like contingency plan to mitigate the impact? So it would be great if the management, you can elaborate on learning devices and the learning services business. Thank you very much.

Thank you, Linda. This is Supeng. I will take these questions. And indeed, recently, COVID issues in some cities in China actually have some impact on our business. Yeah, we also come out with some contingency plan and try to mitigate about the impact. and we will divide it into that into two parts because uh with the different impact on this business and as for the learning service segments that's one of our majors uh we have new generation generator generated from and uh i think our first is our as our services primarily deliver via the internet so we don't need that really the physical contact with our customers most of our services have been offering via the online channels instead of the offline centers. So we think about we have very limited impact on the online learning services with business. And so that's the first part. And secondly, they do have some impact on our smart devices segment. And it's because of the smart devices. Whatever they purchase online or they purchase on the retail store, we have to deliver our products to our customer. That will be related to logistics, transportation issues. So we think about right now, in this part, we have some challenging things regarding logistics and transportation for our products to our customers. But we think about that will be the short-term impact. In the long run, we don't think. By now, we don't think about there's any impact on the demand from our customer regarding on the services provided by our smart devices from UW because we see a very strong momentum and a demand from customer in the last several quarters regarding you can see about the growth rate and the growth trend of our smart devices business in the last several quarters. So I think in the long run, that will go back to the normal. And indeed, by now, we are definitely doing something to mitigate the impact short term. And for example, we are setting up the new warehouse in Tianjin, Chengdu, Wuhan, and other areas in mainland China, and delivering the smart devices directly to the region distributors. So we think about that's what we did, and we hope we can just mitigate about the impact short-term, and we expect to see the business go back to normal right after the impact, the COVID has been closed. I think that's what we expect. Right now, we are still in the middle of the Q2, and we expect to share more information after we finish all of the Q2 seasons. Thank you.

Thank you very much. Just a very quick follow-up. Do you see the logistics disruption? Are the situations getting better off, or does it remain similar in April and May?

Yeah, we think about it. It's getting better and better with the times going. But that still depends on the regions. I think that's because in different regions, they have different policy regarding on the COVID impact issue. But in general, we see that it's getting better. And we expect that that trend will keep moving on and we can just deliver more products to our customers.

Okay, I got it. Thank you very much. Much appreciated. Thank you, Linda.

The next question comes from Thomas Chong of Jefferies. Please go ahead.

Hi. Good evening. Thanks, management, for taking my questions. May I ask about the updates on education digitization strategies and the adjustable market? Thanks.

I would like to highlight the education digitization advocated by national market policy in the recent years, including the new infrastructure for education. Fourteen five-year digital economy development plan, and the annual working plan of the Ministry of Education in 2022. Therefore, enhancing investment in education is clear from the national level. The central government hopes to improve the quality of each digitized approach. We would also use our own software, hardware, AI advantage, and rich teaching experience to help public schools and our customers to achieve it. A digitization business needs to focus on localized services, but due to the impact of the epidemic prevention and control, the opportunity to contact schools has been reduced. There are some partial delays in the progress of pollution implementation. I believe it is only a short-term impact. It will still come in this business in the long run. Although this is still an early stage and there are some pandemic impacts, we have received a lot of official recommendations in Cuba. First, the adult project on smart education quality systems and teaching plans was included in the first batch of 5G plus smart education pilot by the Ministry of Industry and Information Technology and the Ministry of Education. Secondly, we were also honored to be included in the new phase of adult education by the Beijing UNESCO Science and Technology Commission, the Administrative Commission of the Convention Science Park, and the Beijing Association for Science and Technology. Thursday, our Smart Living Terminal was selected as the recommended product in 2021 by People.in, as People quoted the myth for its innovation and improvement of uncomfortable teaching. According to the statistics from the Ministry of Education, there were more than 500,000 schools of all levels and types nationwide in 2021, with more than 290 million in-school students and 80 million full-time teachers. In terms of the potential market size of education digitization, it is expected to be over 1 billion. The next question comes from Candice Chan of DIWA. Please go ahead.

Great. Good evening, management. Thank you for taking my questions. And I would like to ask about your adult education business and how does the growth outlook look like in this year? And also, can you share a little bit more colors on our device pipeline for this year? Thank you.

Thank you, Candice. Yeah, this is Zhoufeng. Yeah, first regarding the vocational and adult courses. So current objectives for the teams are to basically upgrade our courses and focus on the growth products. As you probably know from the past few quarters, so the adult courses segment for us has seen some challenges for the past few quarters. So one of the key reasons is that demand for English courses, which were a large part of the business, was significantly impacted by COVID. So we are not out of the transitional period yet. Yeah, so with that said, we have actually several bright spots in Q1. So we saw good progress on graduate school entrance exam courses. So the gross billings from the graduate school entrance exam courses grew by over 160% quarter over quarter. Another bright spot is constructor certification courses. So it is a vocational course to help prepare for the exam to acquire a professional constructor certificate. The gross billings of this course increased actually over 10 times year-over-year in Q1, although from a low base. Given the current macro environment of the government actually very actively promoting vocational education and overall strong demand from the sector, So we think that the prospect is actually quite bright. So we will be patient here and spend time growing new products, perfecting the courses. So we believe vocational and adult courses have a bright future. So that's for vocational and adult courses. And regarding pipeline for our devices, so we we said we will have other other new products this year so um uh we already had one out so the uh yoda smart light it's uh in the early early april uh and we expect to launch uh another new category of smart device in the second half of uh of this year that that's our current plan yeah so Moreover, we will also continue to upgrade the smart devices portfolios in preparation for the sales season of the new school year. That's in September. Our lineup is basically, right now it's like this. We have the dictionary pen as our flagship product. we have the smart light and the listening pod as new upcoming products. And these two products are becoming more and more popular. So if we compare this with last year, last year we only have the dictionary pen. And we achieved good growth with one category of product. Yet this year we have a more comprehensive lineup This allows for a larger addressable market and also internally it allows more sharing of technology, expertise and personnel among the product lines. So we think this is a good strategy and lineup for us and the plan is to have another category of new product in the second half of the year. So, yeah, I hope that's helpful. Thank you.

Very clear. Thank you, Dr. Cho.

This concludes the question and answer session. I would like to turn the conference back over to Jeffrey Wong 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 UDAW directly or reach out to TPG Inventory Relations in China or the U.S. Have a great day.

The conference is now concluded. Thank you for attending today's presentation and you may now disconnect.