Earnings Call Transcript - DAO Q4 2021

Operator, Operator

Good day, and welcome to the Youdao 2021 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, sir.

Jeffrey Wang, Investor Relations Director

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 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 Securities and Exchange Commission. The company does not undertake any obligations 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 purposes only. For the definitions of non-GAAP financial measures and reconciliations of GAAP to non-GAAP financial results, please see the 2021 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.

Feng Zhou, CEO

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 finished the fourth quarter and the whole fiscal year 2021 with strong financial results. Total net revenue reached RMB1.0 billion in Q4 2021, and RMB4 billion in 2021 for the whole year, representing an increase of 22.6% and 58.9% year-over-year, respectively. In Q4, we achieved positive net income on a non-GAAP basis for the first time since our IPO, at RMB 31.1 million. Operating cash inflow from continuing operations was RMB142.2 million, mainly due to strong revenue and lower sales and marketing expenses incurred. To be fair, achieving non-GAAP profitability was helped by favorable seasonality in Q4, including the year-end shopping season. Nonetheless, the year-over-year trend is clear. The results demonstrated that our financials are steadily improving, and our business is on the right track to sustained profitability, even under the challenging regulatory environment. Moreover, Q4 results showed that our strategy of doubling down on new growth opportunities is working. We continue to make good progress on multiple fronts, including the smart devices segment, B2B business, and STEAM education business. In Q4, Youdao has also been added to the MSCI China All Shares Small Cap Index as of market close on November 30, 2021. We are pleased to be part of this widely recognized global benchmark and recognized for our business performance and growth potential. We continue to comply with the updated laws and government policies. We have ceased offering the after-school tutoring services on academic subjects in China’s compulsory education system and completed the disposal of this business. As a result, the K-9 academic AST Business met the criteria of discontinued operation and retrospective adjustments to the historical statement of operations have been made for the previous periods, which provides a consistent basis of comparison for the financial results of the continuing operations. I would like to thank all former teaching and operations staff for their contribution to the K-9 academic AST business in the last several years. Now, let me walk you through some of the details of our fourth quarter. Firstly, our smart devices segment kept strong momentum. It generated revenues of RMB317 million in Q4, up 24.8% quarter-over-quarter and 33.9% year-over-year from Q4 2020’s high base. Dictionary Pen sales exceeded 500,000, a new record. For the full year of 2021, revenue from the smart devices segment reached RMB980.4 million, representing an 81.6% increase from 2020. In Q4, we entered into a strategic partnership with the Commercial Press, with the exclusive inclusion of the Xinhua Dictionary in Youdao Dictionary Pens. In addition, many of the well-known dictionaries published by the Commercial Press will also be included in Youdao’s smart devices. The integration of smart AI and classic content makes the Dictionary Pen a truly indispensable tool for language learning and usage. We also kept improving our core technologies. A new feature called Writing Guide was introduced for the pro version of Youdao Dictionary Pen. Powered by our proprietary Natural Language Processing technology, the Writing Guide feature provides personalized assessment for students’ English writing, evaluates vocabulary usage, grammar correctness, and then offers suggestions for improvements. This is another novel application of Youdao’s AI learning technology. Our new-category product, Youdao Listening Pod was released at the end of Q3. So, Q4 was the first full quarter of sales. We are happy to say it is off to a strong start. The units of Youdao Listening Pod sold in Q4 was double that of the Youdao Dictionary Pen 1 in the same period. In Q4, we introduced more licensed textbooks and added AI listening comprehension mock tests to the device. We believe Youdao Dictionary Pod is a stronger product compared with its peers from other companies and will gain further popularity in the coming quarters. Then let’s turn to STEAM courses. The gross billings of Youdao Weiqi or Youdao Go increased by around 130% year-over-year and over 30% quarter-over-quarter, reflecting the sustainable growth and retaining the leading position in the Go course markets. We recently launched the Youdao Boardgame Academy app, for our learners to play Go and Chess matches online with fellow learners. It matches players with similar skill levels, supports both human-to-human and AI matches, and provides high-quality quizzes for improving skills. Our STEAM courses are also gaining more recognition in the sector. We received two excellent-course awards for our STEAM courses from the Beijing Association for Science and Technology. In terms of adult and vocational courses, our current strategy is to drive growth in areas that have a large addressable market and fit our expertise. Examples include graduate school entrance exam preparation and digital skills training courses. In 2021, the Ministry of Human Resources and Social Security released a working plan on enhancing digital skills focused on digital skills training such as artificial intelligence, big data, and cloud computing. This is a good fit for us. Gross billings of vocational education courses grew approximately 170% quarter-over-quarter in Q4. Besides, Youdao was included in the new base of adult education by the Zhejiang Province Human Resources and Social Security Department. We believe adult and vocational training has a bright future and we are patient in this area. As for education digitalization solutions, we kept rolling out new features for our solutions and signing up new customers and partnerships. In Q4, we signed a strategic partnership with the Suzhou municipal government to build smart education solutions in the city. Suzhou is a large and prosperous city, whose GDP is No. 6 among all Chinese cities, right after Chongqing. So, Suzhou’s endorsement is a milestone for our education digitization business. We are also dedicated to fulfilling our social responsibilities. Youdao Foreign Language Reading Corner, a public welfare project, benefited over 30,000 people. Besides, Youdao was awarded as the Annual Model Enterprise of CSR for its special contribution to helping the disabled and CSR CHINA TOP100 Best Brand of Fulfilling CSR of the Year. As we close our books on 2021, we had an eventful year, which I believe will still be special when we look back a couple of years from now. Despite the challenges, our teams were able to drive significant growth of our business at 58.9% of revenue growth. And likely more importantly, our diversified investment in smart devices, STEAM courses, and others in the last couple of years, and long-term support from our parent company NetEase, have allowed us to navigate the changing environment relatively smoothly and build a stronger position for us in the market. Looking ahead, we are committed to compliance and focusing on our growth areas, including smart devices, STEAM courses, adult and vocational courses, and education digitalization solutions. Education technology is still in its early days, and we firmly believe it has a bright future. I’d like to thank our investors for your continued support. And we look forward to a fruitful FY2022.

Peng Su, VP of Finance

Thank you, Dr. Zhou, and hello everyone. Today, I will be presenting some financial highlights from our 2021 fourth quarter and the full year. We encourage you to read through our press release issued earlier today for further details. Gross billings increased by 37.3% year-over-year to RMB854.5 million, or US$134.1 million in Q4. 18.9% of our gross billings came from adult and vocational courses. Given the current regulatory environment and the completion of the disposal of the K-9 academic AST business, more focus will be concentrated on AI and technology-driven businesses, such as smart devices and education digitalization solutions. Revenue is a key metric that could reflect the business performance. Therefore, we would not treat the gross billings of our tutoring services as our key financial measures on a going-forward basis. For the fourth quarter, total net revenues were RMB1 billion, or US$164.6 million. This represents an increase of 22.6% from the fourth quarter of 2020. Looking at this growth by segment: Net revenues from our learning services were RMB579.3 million, or US$90.9 million, up 20.6% from the same period in 2020. We attribute this growth to the increased revenue generated from our learning services, which were further driven by the growth in paid student enrollments during the period in 2021. Net revenues from our smart devices were RMB317.7 million, or US$49.9 million, up 33.9% from the same period in 2020, driven by the substantial increase in sales volume of Youdao Dictionary Pen in the fourth quarter of 2021. Net revenue from our online marketing services was RMB151.8 million, or US$23.8 million, representing a 10.2% increase from the same period in 2020. For the fourth quarter, our total gross profit reached RMB445.3 million, or US$69.9 million, up 11.5% compared with the fourth quarter of 2020. Gross margin for learning services was 51.4% for the fourth quarter of 2021, compared with 55.9% for the same period in 2020. Gross margin for smart devices was 30.8% for the fourth quarter of 2021, compared with 39.5% for the same period in 2020. Gross margin for online marketing services was 32.6% for the fourth quarter of 2021, compared with 26.9% for the same period in 2020. For the fourth quarter, total operating expenses were RMB693.6 million, or US$108.8 million, up 5.8% from RMB655.7 million for the same period last year. With that, for the fourth quarter, our sales and marketing expenses were RMB420.4 million, compared with RMB511.1 million in the fourth quarter of 2020. Research and development expenses were RMB170.2 million, compared with RMB109 million in the fourth quarter of 2020. Our operating loss margin was 23.7% in the fourth quarter of 2021, compared with 30% for the same period of last year. For the fourth quarter of 2021, our net loss from our continuing operations attributable to ordinary shareholders was RMB215.9 million, or US$33.9 million, compared with RMB251.2 million for the same period of last year. Non-GAAP net loss from continuing operations attributable to ordinary shareholders for the fourth quarter was RMB168.2 million, or US$26.4 million, compared with RMB238.1 million for the same period of last year. Basic and diluted net loss per ADS from continuing operations attributable to ordinary shareholders for the fourth quarter of 2021 was RMB1.75, or US$0.27. Non-GAAP basic and diluted net loss from continuing operations per ADS for the fourth quarter was RMB1.37, or US$0.21. Our net cash provided by the continuing operating activities was RMB142.2 million, or US$22.3 million, for the fourth quarter. Turning to our full-year results, our total revenues for 2021 increased by 58.9% to RMB4 billion, or US$630.2 million. Net revenues from our learning services for 2021 were RMB2.4 billion, or US$383.1 million, up 61.3% from 2020. Net revenue from our smart devices for 2021 grew by 81.6% year-over-year to RMB980.4 million, or US$153.9 million. Net revenues from online marketing services for 2021 were up 25.6% year-over-year to RMB593.9 million or US$93.2 million. Total gross profit for 2021 was RMB2 billion, compared with RMB1.1 billion in 2020. Total operating expenses for 2021 increased to RMB2.9 billion or US$460.1 million, compared with RMB2 billion in 2020. Net loss from continuing operations attributable to Youdao’s ordinary shareholders for 2021 was RMB895.4 million, or US$140.5 million, and basic and diluted net loss per ADS from continuing operations attributable to ordinary shareholders for 2021 was RMB7.36, or US$1.15. Looking at our balance sheet, as of December 31, 2021, our contract liabilities, which mainly consist of deferred revenue for our tutoring courses, were RMB1.1 billion, or US$167.2 million, compared with RMB894.2 million as of December 31, 2020. At the end of the period, our cash, cash equivalents, restricted cash, time deposits, and short-term investments totaled RMB1.6 billion, or US$247.4 million. This concludes our prepared remarks. Thank you for your attention. We would now like to open the call to your questions.

Operator, Operator

Thank you very much. Our first question is from Sheng Zhong of Morgan Stanley. Please go ahead.

Sheng Zhong, Analyst

Thank you. Thank you for taking my question. So, could you please provide an outlook on your learning devices growth in 2022? And if you can break down to your current products and the new product pipeline that's really great. Thank you.

Feng Zhou, CEO

Thank you, Sheng. Yes, this is Zhou Feng. I believe this is going to be an inflection year for us in terms of smart devices. We have a lot of exciting work underway and we not only drive growth, but also lay the foundation for next year and the year after. First, we are going to release new generations of our Dictionary Pen and Listening Pod products in 2022. There’s a lot to do there. For example, we have just added English writing related features to the Dictionary Pen. So, it was made possible by years of R&D and users really like them. You can expect us to add more hardware capabilities and more advanced AI technologies to help users in new scenarios and new learning cases in the new Dictionary Pens and Listening Pods this year. Second, we expect to release more new categories of devices this year. We're going to bring to these new products our strengths like attention to detail, great design, seamless AI, and that really works. Yes. So, all the strength that we have built in the Dictionary Pen to be a really popular learning product, we will bring them to our new categories of devices. Actually, there's one that's pretty close to launch. Yes, next month, we will launch the Youdao smart learning lamp. We think a smart tabletop device like the learning lamp is a very intriguing device. So, it's a very interesting device to help learners in multiple ways. And we have quite a few new ideas there, and we really like the ideas and we want to introduce them to our users. In general, what fascinates me is the fact that we have only really scratched the surface in using AI to help learners learn better. So, with new sensors, more computing power, more data, yes we see a future where AI really understands the learner and makes learning orders of magnitude better. So smart devices, or we like to call them AIoT devices, AI plus IoT, internet of things, are the best vehicle we believe for helping us to get the AI to the user because they allow us to really deploy these sensors, piece industry designs and the exact user interface that we want. That works best for any particular learning scenario. I want to share with you that we think the trend is becoming more and more clear. Regarding the 2021 China education smart devices trends report by Tencent Research Institute, the education smart devices market is expected to be close to RMB100 million in 2024. So, we intend to be a leading player in this market. Since 2019 we have already achieved three consecutive years of triple digits or high double-digit growth for smart devices. In 2021, the growth was 82%, with revenue reaching about RMB1 billion. So, I believe we have demonstrated our fast growth in this area and sustainable growth. As I talked about in earlier calls, compared to our peers, Youdao has deep knowledge in both the technologies and content required for the success of the smart devices. And compared to many of our peers, we have also a head start in terms of supply chain build-up and sales channel construction. So, we are in a very good position here as we compete for customers. So far, I believe the results have agreed with our view, and we believe we could achieve good growth in 2022 as well.

Sheng Zhong, Analyst

Thank you very much, Dr. Zhou. May I follow-up with a quick question? The emissions – I remember in the learning devices, sorry, the listening devices had a very good sales momentum. Can you please quickly comment on what the momentum is recently for this new product?

Feng Zhou, CEO

I didn't get your last sentence. Can you repeat it?

Sheng Zhong, Analyst

Yes, sure. About the learning device, I remember the sales were pretty good. So, could you comment about the recent momentum of this learning device, which is actually a new product for you?

Feng Zhou, CEO

Right. Yes. So, our recent trend, yes, as you know the seasonality of the hardware products, learning devices. So, we have actually multiple months in the year that are key drivers of sales. The Double 11 is one of those, and also December, the shopping festival in December is also pretty good. And the sales there was also good for us. The one after that would be the beginning of the semester, which is basically this month and next month. February and March are normally the strong months. So, after Q2, we expect it's doing pretty well for us right now and you can expect that the beginning of the new semester is the one that we are looking at right now, and it's not finished yet. Let me say a few words about the general whole-year trend. Normally the sales are strong in February and March. Also, one of the key months is the beginning of the whole school year, that will be August and September. That's normally stronger than February and March, because our products are sold more online. So, the e-commerce shopping festivals are very important. Q4 tends to also be pretty strong.

Sheng Zhong, Analyst

Thank you very much.

Operator, Operator

Thank you. The next question is from Brian Gong of Citigroup. Please go ahead.

Brian Gong, Analyst

Good evening, Dr. Zhou, Su Peng, and Jeffrey. Thanks for taking my question. My question is regarding our latest strategy and investment plan on STEAM courses, especially considering the latest regulatory environment and deposits from the Ministry of Education in late January. Thank you.

Peng Su, VP of Finance

Thank you, Brian. This is Su Peng. Yes, I will take this question. As for the regulatory environment, right now, there is currently no flow of the regulations that impact us to develop the STEAM programs. We will smoothly enhance the investment in the STEAM sector in our business segments. Youdao insists on empowering the STEAM programs with innovative technology and is always committed to offering high-quality courses to our users. The purpose for us to produce high-quality courses is, for example, let's talk to imagine the Go and Chess programs. It’s not only to teach something to students, but also we expect our students to understand the history and culture behind the games as well as how to play the game. In further detail, we hope they can make new friends through playing the games with others. We think that's really something related to the fundamentals of innovation in education. As Dr. mentioned, we have also introduced Go apps to organize online games, player versus player for students and others. We believe this will help build an online community for our students to play with others. We will continue to pay close attention to the latest regulatory requirements and ensure we run our business within the scope of relevant rules and regulations.

Brian Gong, Analyst

Thank you. That's very helpful.

Operator, Operator

Thank you. The next question is from Thomas Chong of Jefferies. Please go ahead.

Thomas Chong, Analyst

Hi, good evening. Thanks, management. May I ask about how we should think about the competitive environment for our adult education courses such as adult education and STEAM courses going forward? Will we expect the competition to intensify? Thank you.

Feng Zhou, CEO

Yes. Thank you, Thomas. This is Zhou Feng. Regarding the competitive landscape for adult and vocational courses, you may have already read the news from public channels regarding several peers announcing their plans to enter this area. This will be good news for the sector because it is also supported by the Central Government releasing several policies to foster the growth and development of vocational education. When we think about the competition in this new business, we will focus on the quality of our products, which we believe is fundamentally important for providing value to our users and students. We believe that with our user experience, we can leverage our existing relationships to promote our products more effectively. Additionally, the support of separate policies on training elevates the number of people engaged in this growth area. Thus, we think about the total number of users for the vocational training, and we have witnessed growth year-over-year, positioning us as one of the top players in this area. I hope that answers your question. Thank you, Thomas.

Thomas Chong, Analyst

Thank you.

Operator, Operator

Thank you very much. The next question is from Linda Huang of Macquarie. Please go ahead.

Linda Huang, Analyst

Hi, management. Thank you very much for taking my question. I have one regarding our normalized business. Can you share with us how we should expect your normalized growth? And how should we look at the profit margin for the remaining business, especially for 2022 and 2023? Thank you.

Wayne Li, VP of Finance

Hi Linda, this is Wayne. I would like to address your question. As I mentioned, key dynamics in 2021 have already been disclosed in our earnings regarding the performance of our remaining operational businesses. They continue to operate with a growth rate close to 50%. Overall gross profit margin for continuing operations is around 50%. Going forward, we will concentrate more on our segments, including smart devices, education digitalization solutions, STEAM, and adult education. Although we will not provide specific guidance on the revenue rates and profit margin for 2022 or 2023, I want to add some insight regarding our business respectively. First, for smart devices, we have a strong business with branding, technology, and channel advantages compared to our peers. We are committed to investing more in new categories and pipelines. As mentioned by Dr. Zhou, new pipelines are expected to be launched in the near future. We believe we can maintain a great year-over-year growth rate of our revenues. However, although our revenue business is already at a higher level, we expect a better profit margin primarily due to the achievement of economies of scale. Second, for STEAM and educational digitalization solutions, we have reached certain milestones in 2021, such as partnerships with entities to provide teachers and schools with our Youdao learning terminals and solutions, which aid them in tracking students' learning progress efficiently. We expect this business will grow significantly. We strive to achieve over 100% growth relative to previous low business figures in 2021. We also plan to invest more in R&D and marketing expenses to enhance our product versions. Therefore, we expect great growth rates alongside potential losses as we invest more in this segment. Additionally, we will follow regulatory guidance thoroughly, and there is strong demand for multiple products across our STEAM segment as we expect to launch more competitive SKUs for faster growth. Considering the increase in user demand and significant economies of scale, we are optimistic about achieving enhanced profit margins in the remaining business going forward. We hope this is helpful. Thank you.

Linda Huang, Analyst

Thank you very much. Very clear.

Operator, Operator

Thank you. The next question is from Yuzhong Gao of CICC. Please go ahead.

Yuzhong Gao, Analyst

Thanks for taking my questions. First, congratulations on the great financial performance. My question is, can you give us more clarity on the gross strategy for vocational service in the future? For example, currently there is a policy encouraging vocational education. Is there any chance to operate Government vocational students? Thank you.

Feng Zhou, CEO

Yes, this is Feng Zhou. Of course, we all know that the government encourages vocational training services. It is a very interesting area. Therefore, Youdao will combine this with adult courses like English training courses into a new segment. We have traditionally been strong in this area, with successful quarters, such as the logic English courses in the last couple of years. We have substantial experience here. The business landscape is changing due to COVID and other factors, and while we faced challenges in the past quarters, we are focusing on several growth areas now. One important area is still along the lines of our successful courses, specifically graduate school entrance exam tutoring. This is significant as over 4 million students are expected to take this exam this year, up from 3.7 million last year. Since it’s becoming increasingly popular, we believe that with our expertise in course design and AI, we can really make a difference. Other areas of interest involve digital skills training, such as big data and AI applications. We will invest significantly in these areas as we believe they are helpful for adults and can potentially lead to better financial outcomes. We are also collaborating with local governments to enhance our vocational training services. Recently, we partnered with the Beijing Municipal Human Resources and Social Security Department, which is intended to bolster vocational training for adults and workers. Overall, we believe this area holds strong potential, and we will focus primarily on online platforms for delivering this training, leveraging our software and AI capabilities to optimize the learning experience.

Yuzhong Gao, Analyst

Thank you.

Feng Zhou, CEO

Thank you.

Operator, Operator

Thank you. The next question is from Candis Chan of Daiwa. Please go ahead.

Candis Chan, Analyst

Thank you for taking my question. My question is about your customer acquisition strategy for various business segments, and also your key investment areas in 2022. How will that customer acquisition strategy differ from what we've seen in prior years, and are we further expanding our studios or hiring more teachers this year? Thank you.

Lei Jin, VP of Operations

This is Lei Jin. I will answer your question. In terms of our customer acquisition strategy in 2022, let me address it from two perspectives. Starting with smart devices, our customer business strategy will focus on multi-channel approaches. Online channels such as e-commerce platforms and short-video platforms accounted for around two-thirds of sales of our smart devices. We have intensified our marketing efforts in Q4 and achieved good results. Additionally, we have been recovering business through offline channels for products such as the Dictionary Pen and the Listening Pod. Our strategy includes enhancing brand visibility through social media and other platforms. We sold over 500,000 Dictionary Pens in Q4. For the STEAM courses, we decided to open more offline STEAM centers; our Beijing center established in Q4 has performed well. These centers focus on integral development which includes coding programs and various STEAM-related classes. Most STEAM courses will be conducted at our offline centers to foster comprehensive interactions for students. In terms of business outlook, we will continue to invest and focus on smart devices, STEAM courses, adult and vocational education, and education digitalization solutions in 2022.

Candis Chan, Analyst

Thank you.

Operator, Operator

Thank you very much. Ladies and gentlemen, that concludes the question-and-answer session. I would now like to turn the conference back to management for any additional or closing comments.

Feng Zhou, CEO

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 TPG Investor Relations in China or the U.S. Have a great day.

Operator, Operator

Thank you very much. Ladies and gentlemen, that concludes this event, and you may now disconnect.