Youdao, Inc. (NYSE:DAO) Q2 2023 Earnings Call Transcript

Youdao, Inc. (NYSE:DAO) Q2 2023 Earnings Call Transcript August 24, 2023

Youdao, Inc. misses on earnings expectations. Reported EPS is $2.32 EPS, expectations were $2.67.

Operator: Good day, and welcome to the Youdao 2023 Second Quarter Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeffrey Wang, Investor Relations Director of Youdao. Please go ahead.

Jeffrey Wang: Thank you, operator. Please note the discussion today will contain forward-looking statements related to 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 Youdao’s business and financial results is included in certain filings of the company with the U.S. Securities and Exchange Commission.

The company does not undertake any obligation to update this forward-looking information, except as required by law. During today’s call, management will also discuss certain non-GAAP financial measures for comparison purposes only. For the definitions of non-GAAP financial measures and reconciliations of GAAP to non-GAAP financial results, please see the 2023 third quarter — 2023 second 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 Youdao’s corporate Web site 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 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. In Q2 2023, our net revenues came in strong and reached RMB1.2 billion, representing a year-over-year increase of 26.2%. Loss from operations narrowed to RMB289.1 million, marking a year-over-year improvement of 36.5%. Net cash provided by continuing operating activities stood at RMB133 million, reflecting growth of 27.6% year-over-year. We are on a clear path to achieving profitability.

As for our business segments, learning services and online marketing services continue to be our current main driver of growth, both reaching record levels of sales. In the meantime, we’re making solid progress in learning service — learning devices, R&D, and we are leading the charge to apply AIGC in education by rapidly releasing applications of generative AI. In the first half of the year, we see an overall positive trend in key financial indicators. Net revenues amounted to RMB2.4 billion, indicating an increase of 9.9% year-over-year. Loss from operations in the first half reduced to RMB484.9 million, improving by 16.4% year-over-year. Net cash used in continuing operating activities reached RMB304 million, marking a 5%. year-over-year improvement.

For our learning services segment. Q2 sales of digital content exceeded RMB800 million, reaching a record high. Customer retention rates across the services was over 60% leading to over RMB200 million in operating cash inflow for this area. In addition to our learning content, we launched an AI University Application Adviser AI Zhìyuàn Tiánbào Xìtǒng [ph] in Q2 to support students in their college selection process. Users were quick to adopt this tool, leading to over 2 million page views. Online marketing services maintained the rapid growth momentum from the last two quarters. Net revenues reached RMB303.6 million in Q2, a historical high, representing an increase of 98.7% year-over-year. Moreover, gross profit margin improved by 4.2 percentage points year- over-year.

These achievements were primarily due to advancements to our ad platform driven by AI algorithms. First, we used proprietary AI technology to effectively identify and track the topics and products matching the audiences of specific key opinion leaders, with accuracy rates approaching 90%, resulting in more precise ad placement. Second, AIGC not only reduced the time for producing ad materials by more than 80%, which drove better user satisfaction, but also reduced production costs for certain ad materials by over 90%, driving the improvement in gross margin. The positive trend in digital content services and online marketing services in Q2 is expected to continue in the second half. Regarding our STEAM courses, on the policy front, the Ministry of Education announced that starting from June 20th this year, primary and secondary schools will add new programming courses to their curriculum.

This new policy is expected to further expand the demand for programming content and services from families. Youdao recently hosted the 7th “Wisdom Cup” Computer Programming Contest for primary and secondary school students in Beijing’s Haidian District in Q2, which showcased Youdao’s influence in the field of programming. In addition, both programming and Go courses performed well with retention in Q2, with the retention rate for the advanced classes approaching 70%. Besides, a student from the champion class won the Go Championship at Jiangsu Mind Sports Games. In terms of smart devices, total revenues of smart devices were down by 7.4% in Q2 year-over- year. We are still in a transitional period for device business, mostly due to sluggish consumer spending in recent months and our stricter sales & marketing budget control.

Both Youdao Dictionary Pen and Youdao Listening Pod performed well during the June 18th Shopping Festival, topping the chart for four consecutive years and two consecutive years respectively on JD.com for both sales volume and number of units sold in this category. In addition, Youdao Listening Pod was updated to support Youdao Learning OS, featuring additional apps such as “Chinese Children’s Encyclopedia” “Collins Big Cat Reading” and “Youdao AI Listening,” further enriching users’ experience. More recently, in August, we released Youdao Dictionary Pen X6 Pro and Youdao Listening Pod Pro. We believe in the long-term prospect of learning devices as they are convenient, helpful and affordable for consumers. We are focusing on two things to drive growth and profitability.

One is new products, which we will have more to be released in Q4. And second is optimization to our marketing and sales, which is under way. Then let’s discuss our progress with AI. As a leading education technology provider in China, we have always been proud of our capabilities in technological innovations. We believe large language models and AIGC presented a great innovation and growth opportunity for us. In July we announced our proprietary large language model Ziyue optimized for education applications, and have successfully deployed it in six applications starting from the second quarter. We believe we are among the fastest in adopting LLM and making the most solid business progress in this area in China. I am happy to report that one of Ziyue’s applications, the AIBox feature in Youdao Translation, has already driven nearly 100% year-over-year growth of translation subscription, and over 200% year-over-year growth of subscription fees.

AIBox provides very convenient, in-application AI features like sentence refinement, grammar correction, writing suggestion, and summarization. In July, we also launched the first digital human language coach in China named Echo. Echo teaches spoken English one-on-one. And thanks to large language model technology, she understands the learner very well, is fun to talk to, and provides high-quality feedback and really helps the learners improve their language acquisition. Echo made its debut at the World Artificial Intelligence Conference in Shanghai, receiving great enthusiasm from the audience and media. 2 weeks later — 2 weeks ago, Echo became generally available in Youdao Dictionary Pen X6 Pro. The reviews so far are great and we expect Echo to — and more AIGC launches to drive our business growth in the coming months.

Looking ahead, we believe education could be among the top verticals for large language models. This technology provides great potential for personalization of the learning experience, effective guidance throughout the learning process, and integration of knowledge across subjects. That summarizes our business operations in Q2. At a high level, our strategy this year is two-fold. Firstly, we prioritize driving healthy growth by offering high-quality digital content services. Secondly, we dedicate efforts to accelerate the integration of generative AI into our products and services. In Q2 our teams made significant progress in both areas. The user demand for high-quality learning products and services remains consistently high. Leveraging our strengths in content creation, user understanding, and technological capabilities, we are committed to continuously delivering exceptional products that address the needs of our users.

Finally, I would like to share Youdao and the NetEase Group have both approved a proposed amendment to the aforementioned US$300 million revolving loan facility to extend the maturity date of the facility, including the loans already drawn from it, until March 31, 2027. In addition, we announced that the Board of Directors has approved an amendment to the foregoing program to increase the total authorized repurchase amount by an additional US$20 million. These demonstrate the long-term support from NetEase and the confidence from Youdao’s management. Thank you. And now is Peng Su 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 second quarter of 2023. We encourage you to read through our press release issued earlier today for further details. For the second quarter, total net revenues were RMB1.2 billion, or US$166.4 million, representing a 26.2% increase from the same period in 2022. Net revenues from our learning services were RMB680.9 million, or US$93.9 million, representing a 20.8% increase from the same period in 2022, primarily driven by the strong sales performance of digital content services compared with the same period of 2022. Net revenues from our smart devices were RMB222.2 million, or US$30.6 million, down 7.4% from the same period in 2022, primarily due to the decreased demands for the intelligent learning products in the second quarter of 2023.

Net revenues from our online marketing services were RMB303.6 million, or US$41.9 million, representing a 98.7% increase from the same period in 2022. The increase was mainly attributable to the increased demands for performance based advertisements through third parties’ internet properties. For the second quarter, our total gross profit was RMB567.2 million, or US$78.2 million, representing a 38.4% increase from the second quarter of 2022. Gross margin for learning services was 57.4% for the second quarter of 2023, compared with 52.2% for the same period in 2022. Gross margin for smart devices was 35.8% for the second quarter of 2023, compared with 30.6% for the same period in 2022. Gross margin for online marketing services was 31.9% for the second quarter of 2023, compared with 27.7% for the same period in 2022.

For the second quarter, total operating expenses were RMB856.3 million, or US$118.1 million, compared with RMB864.9 million for the same period of last year. With that, for the second quarter, our sales and marketing expenses were RMB587.7 million, compared with RMB596 million in the second quarter of 2022. Research and development expenses were RMB205.1 million, compared with RMB208.4 million in the second quarter of 2022. Our operating loss margin was 24% in the second quarter of 2023, compared with 47.6% for the same period of last year. For the second quarter of 2023, our net loss from continuing operations attributable to ordinary shareholders was RMB299.2 million, or US$41.3 million, compared with RMB453.9 million for the same period of last year.

Non-GAAP net loss from continuing operations attributable to ordinary shareholders for the second quarter was RMB283.6 million, or US$39.1 million, compared with RMB435.8 million for the same period of last year. Basic and diluted net loss from continuing operations per ADS attributable to ordinary shareholders for the second quarter of 2023 was RMB2.45, or US$0.34. Non-GAAP basic and diluted net loss from continuing operations per ADS attributable to ordinary shareholders for the second quarter was RMB2.32, or US$0.32. Our net cash provided by continuing operating activities was RMB133 million, or US$18.3 million, for the second quarter. Looking at our balance sheet, as of June 30, 2023, our contract liabilities, which mainly consist of the deferred revenues generated from our learning services, were RMB1.2 billion, or US$167.3 million, compared with RMB1.1 billion as of December 31, 2022.

At the end of the period, our cash, cash equivalents, restricted cash, time deposits, and short-term investments totaled RMB680 million, or US$93.8 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.

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Q&A Session

Operator: [Operator Instructions] And our first question today will come from Brian Gong with Citi. Please go ahead.

Brian Gong: Good evening management. Thanks for taking my questions. I have a very quick one on our plan on AIGC technology. What AI applications will be launched in the second half of this year, and what impact will they have on our business in your view? Thank you.

Feng Zhou: Hi, Brian. Yes, this is Feng Zhou. Yes, we announced our proprietary large language model Ziyue, for education in July. We are looking to leverage this breakthrough technology to drive both short-term and future growth. So we have plans for both the coming months and also for the longer term. So in the short-term, we’ve already launched six applications for the year, including our digital human language coach named Echo. AIBox 2.0, and AI Translation, et cetera. So the first line of work for us is to deploy these applications to more of our services, apps and devices and start to drive business growth with these new capabilities. So in fact, it is already driving growth as early as in Q2. For example, AIBox 1.0 already drove nearly 100% year-over-year growth of translation subscriptions.

And over 200% year-over-year growth of subscription fees in Q2 as we just discussed in March [ph]. We’ve also launched Echo, our digital human language coach and English grammar instruction feature in the latest Youdao Dictionary Pen X6 Pro, launched earlier this month. Echo is the first large language model base with zero human language coach in China. So this is a groundbreaking product. It is liked a lot by our customers from our feedback. In our AI Grammar instruction feature is also the first of its kind in learning devices. Our users tell us that they really like these two new features because they are really helpful and engaging. We will continue to upgrade these features over the coming months. And we plan to launch and monetize them on other platforms, for example, on phones.

So Echo and other features will be on phones too. One of the strengths of AIGC’s products from our observation is that consumers are willing to pay for them, because they’re really useful and helpful. This has been shown to be true by the tremendous growth of products like Midjourney and ChatGPT. So we do not need to go through the feature use model to kind of indirectly monetize these products, instead they could be monetized directly from day one. So, this shortens the investment cycle of these products. We’re running entirely new applications. I am also happy to share that we plan to launch more our M based applications in Q4 this year. There are other aspects of the English language learning that AIGC can really help with, not only grammar, and there are other subjects that we should provide AIGC products for.

Our teams are now more familiar with the — how these language models work and have accumulated substantial experience in their applications. So we are able to quickly iterate and build more applications. So more applications will come in Q4 this year. So in short, we are off to a good start of the project. So we entered the market early and it is already driving close, and it has great long-term potential. So looking further ahead, our generative AI represents a transformative opportunity for the education technology sector, as well as a lot of other industries, as we all know, it has the potential to allow much more personalized learning and to increase the productivity of the overall education process. So we are also studying early in our — with the aim to drive long-term future growth.

So for that purpose, the basic LM technology is important. And we believe what’s more important is the application scenarios. As we are looking at a lot of the different scenarios in education and because we’re early into the game, our teams have more experience. So we believe we can maintain the early lead that we already have enjoying in this area. So overall, we are bullish about combining large language models in education. And we will keep innovating in this era. Yes, thank you.