Youdao, Inc.

Good day, and welcome to the UDAO 2024 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeffrey Wong, Investor Relations Director of UDAO. Please go ahead, sir.

Thank you, operator. Please note that 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 the risk factors that could affect UDAO's business and financial results is included in 13 company filings 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 recalculations of GAAP to non-GAAP financial results, please see the 2024 Third Quarter Financial Results News Release issued early today. As a reminder, this conference is being recorded. A webcast replay of this conference call will be also available on UDOT's corporate website at ir.udot.com. Joining us today on the call from UDOT's senior management are Dr. Feng Zhou, our chief executive officer, Mr. Lei Jin, our president, Mr. Peng Shu, our VP of strategy and capital markets, and Mr. Wayne Lee, our VP of finance. I will now turn the call over to Dr. Zhou to review some of our recent highlights and strategic directions.

Thank you, Jackson. And thank you all for participating in today's call. Before we begin, I would like to remind everyone that all numbers are based on RMB, unless otherwise specifically stated. We're thrilled to announce an outstanding third quarter. Revenues for the quarter reached RMB 1.57 billion, marking a 2.2% increase year over year. Our profitability improves remarkably. Income from operations reached RMB 107.3 million, compared with the loss of RMB 57.7 million in the same period last year. This represents our first profitable third quarter and sets a new quarterly record for income from operations. We are on track to achieve our first full-year operational profitability this year. Additionally, operating cash outflow narrowed to RMB $85.4 million, an improvement of 71% compared to the same period last year. Now let's review the major developments across our business lines. Revenues from learning services were RMB $767.9 million, down 19.2% year-over-year, primarily due to our proactive focus on high-demand services and a reduction in low return of investment customer acquisition operations during the summer. Notably, customer retention continued to improve. Therefore, the overall financial health of our learning services segment significantly improved in Q3. Within this segment, net revenues generated by digital content services, that is, online courses, were RMB 513.7 million. These revenues covered the costs and operating expenses, and yielded meaningful profit. Our team focused on improving the products of Youdao Lingshi. We expanded our knowledge video library to nearly 40,000, targeting students of different learning levels. Additionally, we doubled the question bank to around 100,000 questions. Leveraging our advanced large language model, our AI can now automatically collect and categorize users' mistakes, adding new questions to enhance personalized learning experience. We also released new small-class study experiences, including personalized monthly learning plans developed by our experienced learning counselors and AI-recommended quizzes. This provides students with a welcoming and motivating learning experience that delivers great results and high retention rates. In the meantime, UDAW literature continues to expand the use of AI writing refinements in Q3, leading to a 7 percentage point increase in conversion rates. We expect to sustain strong demand for online learning services in the coming years. The key to success lies in our ability to deliver high-quality service and learning outcomes at scale. While we have made significant progress in online learning innovations, as evidenced by quickly improving retention rates and positive customer feedback, there is still substantial room for further innovation. Fortunately, we now have new AI tools at our disposal, and customer demand remains robust. We look forward to serving learners and families in innovative online learning solutions in the years ahead. Sales of our AI-driven subscription services in the learning services segment continue to grow rapidly, approaching RMB 70 million in Q3, representing over 150% year-over-year growth. This marks the seventh consecutive quarter of more than 50% year-over-year growth. On the product front, we released new AI translation upgrades in UDAW Dictionary and UDAW Translation, These updates includes multilingual translation support, customized glossaries, and multi-modal input capabilities for images and documents. To date, our AI document translation service has processed over 100 million documents. Yuda Dictionary introduced an AI-powered voice simultaneous interpretation feature, powered by our large language model, Ziyue. This feature has seen over 4 million users in its first quarter and has become the most popular paid feature in the U.S. dictionary. High Echo also gained prestigious recognition this quarter and was prominently featured on the Apple App Store homepage. It also ranked in the top 10 for next-day retention on the renowned AI application ranking chart by AICPB.com. Following this launch, Mr. P, AI tutor, received an enthusiastic reception with nearly 20 million users in the third quarter and a monthly compound growth rate exceeding 100%. For online marketing services, net revenues reached RMB 489.4 million in Q3, representing an increase of 45.6% year-over-year. Gross margin increased to 36.3%, up 4.4 percentage points year-over-year. This growth was mainly driven by our expansion into new sectors and leveraging data applications and AI to optimize app performance, pushing RTA revenues to a historical high and an over 100% increase year-over-year. Additionally, we observed positive developments in overseas advertising, which accounted for approximately 20% of the ad revenue in the third quarter. Robust demand in games and related industries fueled growth, driving overseas KOL ad revenue up by over 50% year-over-year. We also upgraded our anti-fraud system for advertising in Q3. integrating real-time monitoring across multiple dimensions, optimizing quality control, and identifying potential audiences. We expect ongoing algorithm upgrades and enhanced service quality to support the long-term growth of our online marketing services. In the smart devices segment, net revenues reached RMB 315.3 million in Q3, up 25.2% year-over-year. and marking the highest revenues since 2023. Alongside this growth, this segment's overall health has significantly improved, with gross margin rose to 42.8%, also reaching its highest levels since 2023. In terms of product upgrades, we launched the latest generation of our flagship dictionary pen, the X7 Pro, This high-end device featured a comprehensive 78 million word database and an AI camera that supports advanced LRM functions such as Mr. P, AI tutor, and AI translation. Notably, the X7 series has become the first learning device in the industry to support offline large language model translation with accuracy surpassing online neural machine translation. The strong performance of our new products drove over 50% year-over-year net incomes growth for dictionary pens in Q3. Building on this success, I am pleased to announce that we will launch a new product in the fourth quarter. Please stay tuned for further details. So that is the summary of our progress in Q3. As discussed on this call earlier this year, We have two key objectives for 2024. Rapidly integrating generative AI technology across our businesses to enhance competitiveness both now and in the future. And operational focus on streamlining our business lines to achieve full-year operating profitability. With robust results from Q3, we are making significant strides towards meeting these goals. By the end of the third quarter, cumulative income from operations had reached RMB 64.6 million, a significant improvement compared with RMB 542.6 million loss from operations in the same period last year. I am confident that we will achieve four-year operational profitability this year. Looking ahead, we are committed to the continued implementation of our large language models. to enhance user experience and create a greater value through digital content services, AI-driven subscription services, and smart devices. In our online marketing services, we aim to explore new domestic opportunities while also expanding internationally to better support client success. Lastly, financially, we remain dedicated to prudent operations and strengthening our profitability. With that, I will turn the call over to Supong to provide you with more detailed insights into our financial performance. Thank you.

Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights from the third quarter of 2024. We encourage you to read through our press release issued earlier today for further details. For the third quarter, total net revenue, RMB 1.6 billion, or U.S. dollar, 224.1 million. representing a 2.2% increase from the same period of 2023. Net revenue from our learning services were RMB $767.9 million, or US dollar $109.4 million, representing a 19.2% decrease from the same period of 2023. The year-over-year decrease reflects our commitment to a more selective customer acquisition approach, prioritizing higher ROI, return on investment engagements, This strategy has helped enhance our overall resilience and efficiency of our business. Net revenue from our smart devices were RMB 315.3 million, or U.S. dollar, 44.9 million, up 25.2% from the same period of 2003, which was primarily driven by the popularity of the UDAO newly launched products in 2004. Net revenue from our online marketing services were RMB 489.4 million, or U.S. dollar, 69.7 million, representing a 45.6% increase from the same period of 2003. The increase was mainly attributable to the increased demands for performance-based advertisements through third-party internet properties, which was driven by our continuing investment in cutting-edge AI technology. For the third quarter, our total gross profit was RMB $789.5 million, U.S. dollar $112.5 million, representing a 8.2% decrease from the third quarter of 2003. Gross margin for learning services was 62.1% for the third quarter of 2004, compared with 67.8% for the same period of 2003. Gross margin for smart devices was 42.8% for the quarter of 2004, compared with 42.6% for the same period of 2003. First margin for online marketing services was 36.3% for the third quarter of 2024, compared with 31.9% for the same period of 2023. For the third quarter, we reduced our total operating distance to RMB 682.2 million, or US dollar 97.2 million, compared with RMB 917.3 million for the same period of last year. Looking at our expense in more details. Sales and marketing expense declined to RMB 519.6 million, compared with RMB 674.2 million in the third quarter of 2023. Research and development expense were decreased to RMB 119.6 million, compared with RMB 187.3 million in the third quarter of 2023. Our operating income margin was 6.8% in the third quarter of 2024, compared with operating loss margin of 3.7% for the same period of last year. For the third quarter of 2024, our net income attributable to ordinary shareholders was RMB 86.3 million, or U.S. dollar 12.3 million, compared with net loss attributable to the ordinary shareholders of RMB 102.9 million for the same period of last year. Non-cap net income attributable to the ordinary shareholders for the third quarter was RMB 88.7 million, or U.S. dollar 12.6 million, Compared with non-GAAP net loss attributable to the ordinary shareholders of the RMB 67.3 million for the same period of last year. Basic and dilute net income per ADS attributable to the ordinary shareholders for the third quarter of 2004 were RMB 0.74 or US dollar 0.11. Non-GAAP basic and dilute net income per ADS attributable to the ordinary shareholders for the third quarter was RMB 0.76. or US dollar 0.11. Our net cash used in operating activities was RMB 85.4 million, or US dollar 12.2 million for this quarter. Looking at our balance sheets, as of September 30, 2004, our contract liabilities, which mainly consists of the deferred revenue generated from our lending services, were RMB 839.7 million, or US dollar 119.7 million. compared with RMB $1.1 billion as of December 31, 2023. At the end of the period, our cash, cash equivalents, current and non-current interest rate cash, time deposit, and short-term investment totaled RMB $489.4 million, or US dollar $69.7 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.

Thank you very much. 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 star keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then 2. Again, if you would like to ask a question, please press star and then 1. The first question that we have comes from Brian Gong of Citigroup. Please go ahead.

Yeah, thanks, management, for taking my question. I have a very clear question, and we have noticed that many of our peers have been increasing investment in the cost-relief business line. So, can management share our strategies on this, and are we planning to increase our investment in the learning service sector in the future? Thank you.

Thank you, Brian. This is Supong. I will handle the question first. I think aligned with our strategy of achieving the positive fear of breaking profit in the near future, we focus on strong demand services, which is getting back on the low returns customer acquisition efforts during the last summer, during the summer. And we believe that the healthy and sustainable development is more essential for the long-term success. and as you may notice without insurance staffing is the strategic priority for our business although there are sometimes some short-term headwinds we remain optimistic about this medium and the long-term growth we expect the sustained strong demands for the online learning services in the coming years ensuring the financial health of our business we will facilitate the development of the learning service particularly in long-term strategies. We believe that increasing our market shares over the mid-term to the long-term will primarily come from providing the differentiated and high-quality products and services to the users and improving their learning outcomes. We think our flagship products offer unique combinations of AI, tiered learnings, videos, and comprehensive learning consulting services. Through the AI enhancements and ongoing product upgrade, we enabled the users to achieve the personalized education, improve learning efficiency and outcome. The comprehensive services including the learning diagnostics, learning path planning, paired learning video, AI quiz recommendations, and the AI collection, and the categorizations of the students' mistakes, learning consulting services, one-class study experience, and also the AI college admissions advisors. I think that's kind of the full services generated and driven by our AI. We will definitely continue to invest in our products and services, which has strengthened our users' loyalty, evidenced in the upgrade in retention rates for the first quarter. The current retention rate, we'll just give you a little bit of colors, for the Lingxu, has already hit about 70% by now, although the retention period has not finished yet. It's almost over, rests up about over 5% compared with the same period of last year. Looking ahead, I think I'm confident in LinkShare development for the next year. On one hand, we will continue to focus on our personalizations, pre-recorded video learnings, leveraging our AI capabilities and upgrade and enhance our users' learning experience On the other hand, we will explore more offline opportunities, offering offers and service to our customers. I think that's our priority. And in the long term, the last point is we expect to increase the investment on the products upgrade and also the customer acquisitions following the strategy of the total companies. Thank you.

This is Zhoufeng. Let me add one point. Yeah, for Ye Da Ling Shi, so marketing and customer acquisition, particularly in the summer, is very important for its growth and performance. So there were some challenges on this front this summer. So on the other hand, we always believe that customer acquisition satisfaction and retention are more important and more fundamental. So as long as our retention is leading, our satisfaction is leading, I believe we will always find ways to grow the business and grow the students. If you look at the number that we just, Supong just shared, so recent retention period, we've already reached 70%. retention, that's very good and already competitive. So I think that is the key thing, and we are building future growth on solid foundations. Yeah, thank you.

Thank you, Sal. The next question we have comes from Brenda Zhao of CICC. Please go ahead. Apologies. The next question we have comes from Thomas Chong of Jefferies. Please go ahead.

Hi, good evening. Thanks, management, for taking my question. We are pleased to see that the smart devices sector has resumed year-on-year growth in the first quarter. Can we expect this growth to be sustainable? Thank you.

Hi, Thomas. Yeah, so net revenue from smart devices reached RMB 315 million in the third quarter, up 25% year-over-year. I believe several factors contributed to the rebound of device revenue. The first one is positive outcomes from our strategic focus and channel reorganization. So earlier this year, had a review of our device business, and we decided that we need to focus the team's work. We want to do fewer things and do really well. So since then, I think increased the focus of our operations, in particular, more focus on the dictionary pen products really paid off well in Q3. The new X7 and X7 Pro are one of our most successful launches ever. The high-end product, X7 Pro, equipped with the new AI camera and a suite of exciting AI features like HiACO, Mr. PAI Tutor, has received widespread acclaim from users. This positive reception, in turn, Drill net revenues and gross margin and the gross margin of smart devices and revenue have reached highest levels since 2023. So during the recent W11, I also want to share, W11 shopping festival, Audition Japan has Again, secured the top spot in terms of sales volumes in its category on both Tmall and JD.com. That is for five consecutive years in a row. Furthermore, our newly launched dictionary pen X7 Pro achieved the highest single product sales in its category on both Tmall and JD.com. So these accomplishments, I think, reflect our continued dominance in the market with that outstanding performance. So revenues of smart devices, we expect them to continue to perform in the fourth quarter, continue to grow in the fourth quarter. The second factor is kind of enhanced team capabilities. The team, I think it's much more important than the product or the strategy. So our device team has seen ups and downs. In particular, we faced much pressure since last year leading to A lot of reflections, replanning and changes in our security. So I'm pleased to see that in such a challenging environment, our team has shown remarkable resilience. They asked the right tough questions and executed on the new focusing strategy. So I think the team executed really well across functions. including product design, R&D, supply chain, sales and marketing. So leading to a significant recovery of the business. I believe any team that was able to go through Dunton's and reemerge stronger is more likely to succeed in the future. So looking ahead, from a product pipeline perspective, we expect to launch a new product in Q4 with more new products scheduled in Q1 as well. So in terms of product strategy for dictionary pens, we emphasize cost effectiveness for range products, including our A and S series. High quality and differentiation for high-end products, that is the X series. And The whole product line will employ more large language model features to greatly enhance user experiences. We're more convinced that LLM has a lot more to offer for education products for years to come. So the team will be busy integrating more such features into the products in the coming quarters. So we are on the right track, I believe, to more leading products, better financial health and profitability for the device segment. Thank you. Thank you.

Thank you. The next question we have comes from Brenda Zhao of CICC. Please go ahead.

Good evening, Jozo and Suzong. Thanks for taking my questions. I noticed your online marketing service continued to see strong growth momentum. However, as the business had a high base in the fourth quarter of last year, where should we anticipate the future growth potential of this advertising business? Thank you.

Thank you. This is Simei. Navigating from online marketing services has recorded rapid growth for eight quarters, primarily driven by advancement in AI. including outgoing algorithm optimization and enhanced data applications. Additionally, our team's execution is steadily improved. Looking ahead, I believe that there is significant growth potential for both domestic and international advertising in the medium to long term. In the domestic market, we anticipate substantial opportunities in following sectors. First, the online entertainment industry, such as gaming and social media. In this summer vacation, we drove gaming AD revenues to a historical high in Q3. In addition, enhanced data analysis and optimized algorithm models have improved monetization rates by over 90%. Second, AI tools. Since the rapid development of the domestic large language models in the later half of the last year, major tech companies had a significantly increased marketing budget for their AI tools. A trend we captured onto a drive rapid growth during the last several quarters. Future demand for AI tools advertising is excited to raise future. Third, the automotive industry. The consumption stimulating policies anticipate to benefit the automotive and related services sectors, likely driving an increase in advertising demand. In the international market, we became a primary agent for TikTok in the first half of this year. Recently, we have established the initial intention for cooperation with several global tech giants. This formal partnership is expected in the near future, being a solid foundation for our future global expansion. In the meantime, growth in our advertising business also faces certain short-term challenges. For example, as you mentioned, AD Reminio set a very high base in the fourth quarter of the last year, And the e-commerce advertising has not been so robust during the recent double 11 shopping festival. In addition, recent updates on our international market factors have added uncertainty to oversee advertising. However, from a financial health perspective, the probability of the AD advertising is expected to maintain a solid level in the first quarter. The focus aligns with our broader aesthetic objective for the year and the main key metric under the current condition. Thank you.

Thank you. The last question we have comes from Boson of Houtai Securities. Please go ahead.

Thanks for taking my question. This is . is about what is the management outlook for the source culture.

Thank you, Dan Bo. This is Wayne. As we mentioned before, we have focused on the digital content services, online marketing services, and AI-driven subscription services this year. With a particular emphasis on advancing generative AI to achieve full-year bidding probability in the near future. For the past three quarters of this year, we have seen significant improvement from our financial side. Our revenue for the first three quarters of this year reached RMB 4.3 billion, representing an increase of around 10% year-over-year. We achieved a positive cumulative income from operations around RMB 65 million compared with around RMB 543 million loss from operations in the same period of last year. Very significant improvement. The strong financial performance fully demonstrates that our strategy around AI technology plus education is on the right path. And we are very confident that we will achieve the profitable objective of this year. Looking forward, we will continue to facilitate the integration of generative AI technology around our business to enhance competitiveness. First, learning services. The robust demand for online learning services is expected to persist well into the coming years. and we are confident in the medium to long-term growth potential of our learning services. Our success will hinge on our ability to deliver high-quality services and learning outcomes at school. As mentioned in previous questions, high school business remains our top priority. The demand for high school business is robust, which is likely to sustain in the coming years. We've been building the best instructor team and incorporating AI function in our learning services for years. The strong AI technology advantages give us confidence in the challenging competitive advantages in high school buildings. In the 10 of AI-driven subscription services, we are committed to advancing our current offering while exploring new avenues to enhance user experience in learning, work, and daily life. For the fourth quarter, we still expect the total sales in AI-driven subscription services to maintain rapid year-over-year growth. Second, online marketing services. We have witnessed rapid growth and a continued improvement of online marketing services for executive quarters. In the near term, the advertising business serves as a cash cow and crucial profit center. Over the long term, we will continue to explore strategy growth area both in the domestic and the international market. We will provide updates on significant developments as they arise. Third, smart devices. We treat AI-integrated smart devices as one of the most exciting opportunities of recent years. While smartphones and tablets continue to dominate many usage scenarios, the market for traditional smart devices is shrinking. Integration of AI into smart devices paves the way for innovation, including the creation of devices either smaller than smartphones or larger than tablets to meet user demand. In addition, edge-based AI apps unlock new opportunities for smart devices. As discussed in today's prepared remarks, our Dictionary 10 X7 series have become the first learning devices in the industry to support offline LIM translation with accuracy, surpassing online mutual machine translation. As we are further tackling the potential of the integration of edge-based LIM into our smart devices to better serve users. In the long run, our extensive experience in edge reasons Supply chain management and the sales channels provide a strong foundation for sustainable growth in our smart devices segment. Additionally, our planning for next year is underway. We are looking forward to share more insights in next earnings call. Thank you.

Yeah, let me add a little bit more information. Yeah, this is Zhoufeng. If you look at our financial performance this year and last year, you can see that we improved the overall financials a lot this year. We are growing the business and operationally profitable two and three quarters this year so far and on the right track for Q4 and full year. In addition to that, we have created new products and high growth revenue streams like new online courses, RTA ads, international KOL ads, AI-driven subscription services, that's a highlight, and also high-end dictionary pens, the X7 series. These will drive our growth in the immediate future, and we will have more to discuss in a future course. Putting these together, It means our focusing strategy this year and also our bet on large language model applications since last year. These two strategies have really been working. AI plus education is an exciting opportunity and is already having a great positive impact on our business. So Yodawi is aiming to lead in AI plus education in China. Yeah, thank you.

Thank you, sir. That concludes our question and answer session. I would now like to turn the conference back to Jeffrey Wong for any additional or closing comments. Please go ahead.

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

Thank you, Sal. Ladies and gentlemen, that then concludes today's conference. Thank you for joining us. You may now disconnect your lines.