Youdao, Inc.
Q4 2020 Earnings Call Transcript

Published: 28 Feb 2021

[Operator:]

Good day and welcome to the Youdao 2020 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.

[Jeffrey Wang:]

Thank you, operator. Please note that discussion today will contain forward-looking statements relating 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 the 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.

[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 all numbers are based on renminbi. The importance of online education has never been as evident as it was in 2020. 2020 was a banner year for Youdao. Let me start by going over financial and operational highlights across our business. Total gross billings from our online courses reached RMB 1.1 billion in Q4 and RMB 3.1 billion in 2020, up to 22% and 33% year-over-year, respectively. Accordingly, the total revenue achieved was RMB 1.1 billion in Q4 2020 and RMB 3.2 billion in 2020 full year, up 169% and 142%, respectively, on a year-on-year basis. Our paid student enrollments from K-12 reached of 659,000 in Q4 2020 and 1.64 million in 2020, up 309% and 357%, respectively on a year-over-year basis. Overall gross margin reached 47.5% in Q4 2020, up over 17% year-over-year. We achieved positive operating cash flow of RMB 129 million in Q4 2020, marking our third quarter of positive operating cash flow in 2020. Our operating cash outflow for 2020 narrowed to RMB 322 million, compared with RMB 372 million in 2019. It means more than tripled of gross billings with RMB 50 million decrease in cash outflow. Quality of our courses and products also got more recognition in the industry. Four of our courses were recently granted 5A rating for online education service issued by China Quality Certification Center. We raised approximately US$232 million of net proceeds through a follow-on offering in February 2021. In addition, the Board of Directors of both NetEase and our company have recently approved a proposed revolving loan facility to be expanded by NetEase to us with a total commitment of US$300 million in to support our long-term growth.

[Peng Su:]

Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights from our 2020 fourth quarter and the full-year. We encourage you to read through our press release issued earlier today for further details. As Dr. Zhou mentioned, we have an exceptional year’s progress – of the progress we brought in terms of scale and our financial availability is sound. We made considerable strides, reaching more students, products and customers. With that, we have changed our segment reporting to more clearly delineate our offering, which better reflects the emergence of our products into three distinct categories. As we continue to grow in each area, we will not be reporting learning services, learning products, and online marketing services. In doing so, we can more readily see the performance from our courses versus our intelligence devices. Let's move to the financial and operating results of the fourth quarter. Total gross billing from our online courses reached RMB 1.12 billion for the first quarter, up 222.8% from 2019. And the gross billing from our premium courses rose to RMB 1.04 billion, up 268.8% and 18.2% year-over-year and quarter-over-quarter, respectively. Our K-12 segment continued to lead our growth, reaching a record RMB 767 million in gross billing in the fourth quarter, up 354.5% year-over-year and up 13.5% from the third quarter. Paid enrollments from our K-12 group reached 659,000 in Q4, up 309% year-over-year. Paid enrollment for premium courses were up by 208% year-over-year. 29% of all new enrolled students gross billing coming from our organic traffic for Q4, which grew 183% year-over-year. This growth shows not only our determination, but our ability to quickly expand our business and that our model is working. For the fourth quarter, total net revenue reached a record RMB 1.1 billion or US$169.6 million. This represents an increase of 169.7% from the fourth quarter of 2019. Looking at this growth by segment, net revenue from our learning services were RMB 731.6 million or US$112.1 million, up 198.8% from the same period in 2019. We attribute this growth to a substantial increase in both the pace building enrollments for K-12 courses of Youdao premium courses and the gross billing for paid student enrollments of Youdao premium courses.

[Operator:]

The first question comes from Brian Gong of Citigroup. Please go ahead.

[Brian Gong:]

Thanks management for taking my question. Congratulations on the decent results. So, I have a very quick question. So, can management share some information about student enrollment and the marketing cost for the winter session in the first quarter? And also, how does management see the competition or upcoming summer session? And what's our marketing budget for this year? Thank you.

[Feng Zhou:]

Thank you for the question. Brian, there's a little break in your background. So, my understanding is discuss of – share some color regarding the sales margin computation or the customer acquisition computation in this winter, and any color and any trend regarding the customer acquisition in the summer, right?

[Brian Gong:]

Yes, yes, and also some of the information about the student enrollment for the winter session.

[Feng Zhou:]

Okay. And yes, as we discussed over the call – yes. And as we mentioned in the script, we did achieve great tremendous achievements in the last year, especially in Q4 and all the student enrollments and also the retention and also the gross billing of the K-12 business reaching the peak in the – reaching the record numbers in the past. And we think, for this winters, right now, we didn't offer – give any official guidelines, but we can share some trend with you. For this winter, everything, because we are all dedicated on our content creation as well as we are – we believe that's the content, the quality of the content and the instructor's teaching behavior will be the core value given the growth of the business. So – also we'll be dedicated on the high-quality content creation. And also we are looking for the path involved with the deep involvement combined with the online courses content and learning devices. So, we think through that perspective, so before us, so we think the key metrics to drive growth of our business is now the sales and marketing because of the quality of the content. That's what we believe. So, right now, I think everything is in line. We didn't see too much liabilities in the – for the customer acquisition cost in the past. And we think that we'll be – that's strictly related to the content creation – to our quality of our content, as well as our product quality. That's the thing we spend a lot of effort and spend a lot of resource on the – to working on that. So, that's what we seem to care about. So, I think from our trend, also for the trend regarding on the summer campaign or the summer promotions, that's a little bit longer, far away from now, but I think we will – definitely we'll be focused. First, we'll be focused on the content. Secondly, we will definitely be – we will carry more healthy, as we mentioned a lot, and it's a healthy, fast growth. That's what we care about, the unit economics. That means we will care about what can we get the returns on our investment. So, I think that will be the other strategy we will deliver into the summer. We think we can share with more information when the summer season is coming, we expect.

[Lei Jin:]

And just to add to that. So yes, so customer acquisition recently has been relatively stable. Yes. So, I think part of that is – so ads that people – different players use has been – there has been a little bit more rules around those ads. And the ads has been more, kind of – the rules are strict, so the competition among the players has been a little bit low recently. So that means the price is relatively stable. The other is we are seeing more and more diversification of customer acquisition, ways to do customer acquisition. Yes. So, we're doing different ways to do that. And we also see other players doing that. Yes, so to add to that. I hope that answers your question.

[Brian Gong:]

Yes, thank you. Very helpful.

[Operator:]

The next question comes from Sheng Zhong of Morgan Stanley. Please go ahead.

[Sheng Zhong:]

Thank you for taking my question. I have a few questions. First one is, thanks for the update about the interacting technology. And I remember, in last quarter, management mentioned that when you were focused on differentiation, and then – so that your primary school courses can be differentiated with others. So would you mind to give some more updates on your primary school tutoring strategy? And the second one is, if we look at this full-year, I think for the segment, what do you think the major growth will be from in terms of maybe subjects or grades? Because you said you will be focused on – very focused on the core star courses. And lastly is, would you mind give some number breakdown about your revenue and the gross billing on – to the K-12 and adult learning services. Thank you very much.

[Feng Zhou:]

Yes. Thanks, Sheng. I'll take the first one. So, regarding primary school, yes, this is a very important segment for us. Right now, junior high school and the senior high school are bigger for us. And we talk about we want to have more innovation, more differentiated products for the primary school segment. And there have been a number of ongoing projects, and I can give you two updates. So, first is, we have extended our Chinese course, with which we have a very good reputation for junior high school to primary school. Yes. So to the fifth grade the sixth grade, we have basically extended the junior high school Chinese courses to these two grades. And we adapted the content accordingly. Yes, so added the content and also features, technical features for the small – for younger students. Yes, unlike the voice sensor I talked about, like also more and more stronger interactions. Yes, so it is – that project is going on well. The second update is basically for us – yes. So we think, for primary school segment, we are very interested in extracurricular courses, extracurricular courses. Yes, so the course, Go game course we talked about is a good example. Yes, so because we think it is the students in primary schools are – the students themselves and also the parents are all very interested in extracurricular courses to develop skills and talents in different areas. We think it's a very interesting area. And the course is doing good. So, you will see us working more in this area. Yes.

[Lei Jin:]

And before the second question, I have to take the third question first. And I think across fitting and the revenue for the 2021, firstly, we didn't – I'd just repeat, again, we didn't give any official guidance as in-line with our net group. But we think – and also, we just try to emphasize, again, all of our strategies across our business. First of all, we are focused on the healthy and fast growth. That's the first thing. And that means we care about the unit economics and, thus, we care about the quality of the content of products, which we deliver to the – to our customers, to student customers. And I think with that fundamental content, with that fundamental key factors, we think we can achieve our goals for the growth in our expectation. That's our view on our business growth in 2020 and 2021. And so for your second question regarding the star courses, and yes, such that the doctor mentioned, we will be focused – instead of focus on all the subjects for the special grade, we will be more dedicated. At the very beginning, we will be more dedicated on some star courses, although some courses, we believe, we have – this is the best quality – I think as well, the best quality, leading positions in the market. We will spend – we will evenly distribute our resources to – for all the subjects in the age group. We will definitely focus on the most value to that subject, which we are leading on the peers or the leading the sector. So that will be the long-term strategy for operating our bare fleet. That does not mean we didn't dedicate to upgrade all the content for all the subjects. We expect to – we will release the more high-quality content year-over-year, just like we mentioned in the summer – in this year and the math for our business, it will be – grow 8x in the Q3 earnings release in terms of the enrollment. We think that's kind of achievement can prove that we are on the right track to produce high-quality products for students and customers. That's our strategy on the star process or the star subjects. Thank you.

[Sheng Zhong:]

Regarding – sorry, if I may. Sorry for the confusion on the gross billing. Actually, I want to ask the fourth quarter gross billing and revenue breakdown to K-12 and adults, if I may. Thank you.

[Feng Zhou:]

Okay. So for the K-12, gross billing in the fourth quarter is CNY 767 million. And for the adults, for the adult number, it's about CNY 269 million, yes.

[Sheng Zhong:]

And can provide revenue as well?

[Feng Zhou:]

Yes. The total revenue from K-12 in fourth quarter is around CNY 400 million. Yes. And the total revenue for gas is CNY 214 million.

[Sheng Zhong:]

Thank you so much.

[Operator:]

The next question comes from Alex Xie of Credit Suisse.

[Alex Xie:]

Okay. Congratulations on very strong results and thank you for taking my questions. My first question will be about your growth target in 2021. I think for the second half of 2020, we are encouraged to see the acceleration of growth in the second half versus the first half of 2020. And would you care to show more color on, say, how – do you expect this kind of trend to continue? And since you have raised the funding recently and got a new revolving credit, that it's making you more comfortable and will you increase your targets. And secondly, I see very strong results from the – growth from the hardware learning products business. Would give us more color on, for example, the sales volume of your Youdao Dictionary Pen in 4Q and also in the last year? And how much percentage of the Dictionary Pen buyers will be K-12 students? And what is the factor that's caused a very strong sequential growth in Dictionary Pen. Is it the new generation of products or the new sales channels? Thank you.

[Feng Zhou:]

Yes, I'll take the first one. So yes, regarding 2021, so our teams are very bullish about 2021. So, as you said, for 2020, it's the first year that we seriously participated in the summer campaign for acquiring large number of students. Yes. So, in Q3, we had about 500,000 enrollments. In Q4, it's already up to 650,000. Yes. So, very quick growth. And if you look at our Q4, we have positive operating cash flow because – mostly because the retention in Q4 is above our expectation. Yes, so it's given all the information that our teams, I think, 2021 is going to be a good year for us. And the strategy remains the same. Yes, so we are focusing on different projects for each different age group because the age groups, as soon as they have very different requirements and needs for their courses. So high school, as we talked about, we're doing tiers or multi-level instruction because students really, they have – high school students have very, very limited time. Yes. So the quality, the learning efficiency, the quality of the courses really matter. So you have to have the good level of course for each different group of students. Yes. And also, for junior high school, we talked a lot about localized content because that's the key pain point for junior high school students. Yes, so different students from – have – they learn things in different orders. And their test exams have different content in each different city and province. So, we have prepared that and it's already launched, it's online, and the courses will start in the spring. Yes, so with these, we think we are very confident about 2021. And of course, there's the devices business, we also think we are leading in the industry. And there's, as we get to know more and more parents buying our devices, we have – the teams have a lot of new ideas. So, they are working on new products. Yes, so overall, we think we can maintain a relatively high-growth speed in 2021. And obviously, customer acquisition is available, right? Yes. So, every year, will be a little bit different. But I think our strategy works because as third markets become more and more mature, it's only the best products that can acquire customers. That's big. Yes, so maybe 2, 3 years ago, you can flood the market with capital, with money and you can get a lot of students. But now you have to have the best course for a certain subject that you have. It has to be innovative. It has to be kind of softer palm on the students to be able to kind of acquire students efficiently. And many of our courses currently do that. Some – they are still working on their UE. So, we will manage this process and be patient, and we think we can have a good 2021.

[Peng Su:]

We have some more information about the new product. Our learning products are growing very fast. The main channel of the learning products are maybe online. The official flagship store of Youdao Ranked Number 1 by the standard diffusion of sales. Our e-commerce platforms, such as Tmall and . The Dictionary Pen 3 released last December maintains the leading position in the market. We totally shipped over 390,000 units of Youdao Dictionary Pen in the fourth quarter, and about maybe 20% of this latest 3.0 version. In 2021, learning device sales are expected to keep sustainable growth. We believe the learning devices are not only a new channel for the customer acquisition, but also expanding awareness of the Youdao. We target to create more natural scenarios for the conversion. Thank you.

[Alex Xie:]

Got it. Just a very quick follow-up. So, for the buyers of the learning product devices, how much of them will be K-12 students? And how much will be adult students?

[Feng Zhou:]

About maybe 70% of the...

[Peng Su:]

Yes. As we disclosed in the Q3 in the numbers, we discussed, over 70% is in the K-12 age group of our Youdao Dictionary process. And we think – thinking of the features of the Youdao Dictionary Pen, that's specially designed for the English learnings. And so we believe that's the majority – in the long-run, the majority users will be the K-12 – in the K-12 group. That will be the trend for the long run. And for this, we expect that will be after – as the doctor mentioned in the – on the call, and we will also have the different learning devices in our pipeline to serve to the different demand for the learning scenario. So, we expect we kind of have more learners exactly for the fee. Those students below 18 to be our device buyers in the long-run. Thank you.

[Alex Xie:]

Got it. Very helpful

[Peng Su:]

Thank you.

[Operator:]

The next question comes from Jessie Xu of Nomura. Please go ahead.

[Jessie Xu:]

Thanks for taking my question. My first question is also on smart devices. The revenue and gross margin of the smart devices are both encouragingly strong in the fourth quarter. So, I want to understand how is the shipment of the Dictionary Pen in January and February? What's the trend? And secondly, how we should think about the gross margin outlook for smart devices for the next few quarters? And talking about gross margin, if you could also comment on the gross margin outlook for premium courses that would be great.

[Peng Su:]

Hi. Thank you for your question. For the gross margin for our Dictionary Pen, I think we're close to 40% in 2020. And it's a very good improvement, compared with last year due to the volume. We feel – we expect to have stable improvement on the gross margin of our learning products due to the large business scale and new SKUs with higher margins will be sold more in the future. For the gross margin of our learning services, I think we got sharp increase in 2020. Going forward, we still have improvement on our learning service on an annual basis, but because, firstly, we expect more steps for – from non-upskilled, we believe large class field teachers model will continue to gain more benefit as we achieved, more non-upskilled. We believe our gross margin will rise to an industry medium high level, say, 60% to 70% in the long run. Secondly, we expect we have more room to achieve higher ASPs, the average selling price for paid enrollment, from our opinion, because it was around RMB 1,343 in 2020, up 49% year-over-year. However, the ASPs were relatively cheaper when compared with some – our online and offline peers. We will continue to invest more in our content. So, we believe our users were willing to pay a higher price. Finally, we expect we will get a better compensation structure. If we achieve a large in scale, we have more room optimize our compensation structure, which also leads to a better GP margin as well, which is helpful.

[Jessie Xu:]

Thank you, management. If I may, I have another question regarding preschool learning products. It seems to be increasingly popular among parents. We know we have multiple online learning tools and courses. So, I want to understand what is your view and your strategy here. Thanks.

[Feng Zhou:]

You said preschool learning products? Services?

[Jessie Xu:]

Yes, preschool learning services.

[Feng Zhou:]

Yes, yes, of course. Yes. So this is an area where -- if you follow us for long time, you will know that we've been working on preschool courses for quite some time now. Yes. So we have Youdao Math. We also have , the Chinese reading app. And also also covers a lot of preschoolers. Yes, so as I said in the prepared remarks, yes, we think extracurricular learning and also before school time preschool learning is a very interesting area. And in the market, we have AI courses. We have small group courses, a lot of different fun factors of courses. For us, we think that you have to have a very good combination of actually be interactive so that the content is attractive to the kid and also not make this just to pass time. You have to have good learning results. Yes, so that's a balance we want to strike, and which is a very good example of our philosophy. We think that the kids really love the course and it is an area where the existing products on the market is not up to the standard, yes, I would say. Yes. So, we will keep looking for opportunities like this. And of course, we have multiple ongoing projects. We think we are investing in them because we think the directions are very promising. Yes. So we think we can have multiple successful products in this area. So in some sense, it's a little bit like the adult-oriented courses that we have. Yes. So we have a good model of incubation courses in these two areas. And for adult level, we already have multiple courses at scale. Yes. So for Logic English, for the extraordinary memory and a couple of others. Yes. So, we think we can also do that for preschool courses. Yes. I hope that answers your question.

[Peng Su:]

In addition to the comments regarding our preschool products, we think, for another part, as Youdao Dictionary Pen 3 is also another – it's a new generation of Youdao Dictionary Pen. It's also enables interactive reading functions for the – especially for the preschool kids. And we think that will be another new channel for us to convert our users into the products for the services. We think that will be the combined strategy for us to develop the market of the preschool business. Thank you.

[Jessie Xu:]

Thank you. That’s very helpful. Thanks.

[Operator:]

The next question comes from of CICC. Please go ahead.

[Unidentified Analyst:]

Hi. Can you hear me?

[Feng Zhou:]

Yes.

[Unidentified Analyst:]

Yes. Congratulations for the good results. Some of my questions has been answered, so I just have a quick following question about learning devices. So, as we see the learning project took up 20% of the revenue this quarter. So, what is our expectation of this proportion in the future, like, in the long-term? And the second question is, so we learned a lot about our strategy for the QTEL learnings services. And can you update more information about the left part, such as the online cases? And do we have any future plans to develop like to the business or like other strategic cooperation with the university part? Thanks.

[Feng Zhou:]

Yes, of course. Yes, so the Dictionary Pen is doing really great in Q4. And we just – we actually only released Dictionary Pen 3 at the end of Q4 of December. Yes. So, we think the products will have a long runway ahead of them, yes. So – and yes, regarding the future, yes, we want our courses and our learning devices to both be very successful. Yes. So, we don't want to put a percentage number on them, yes. But for the short to midterm, yes, I would say the courses, of course, will be a majority of the business going forward, yes, because it has really high growth and we have a lot of really exciting star courses coming up. Yes, so – and we also said that the devices, we will have new devices for this year, yes, more than one. Yes, so we feel good about both sides of the business. And of course, we want them to kind of strengthen each other, right? Yes. So, we have been talking about that for some time now. So, we will keep working on cross selling between the two categories, and we will report back when we have results. Yes. And regarding university products. Yes, so internally, we basically – we think – so you categorize it in this way. Basically, for all the products targeting learners over 18 years old, we try to put them in the same category. So – and we want to – we want the teams to work with each other to have a holistic strategy for adult oriented products. And we really like our product. China University MOOC and also NetEase Cloud Classroom. These two are, kind of one of the most – two of the most important successful online learning products for university-level learning. Yes. So, we really like them. We feel responsible to keep them in good hands for the future. Yes, so actually, we will have something to announce maybe in a month. Yes. So, we have been working on – we keep working on them for some time now. Yes. So, we will have something coming up. So yes, just follow us, yes, if you're interested. Yes. Thank you.

[Unidentified Analyst:]

Thank you.

[Operator:]

And the last question today will come from Binnie Wong of HSBC.

[Binnie Wong:]

Thank you management for talking my questions. So, I just wanted to understand that if we look into 2021, what are your investment priorities? And also, say, technology on user acquisitions, and also how is our strategy to compete will be different from last year, especially considering, as we talked about earlier, that we're – like regulatory scrutiny in terms of the heavy, aggressive subsidies or sales and marketing strategy? And do you expect that those will become rationalized among the players and should meet as favorable or unfavorable to Youdao? Thank you.

[Feng Zhou:]

Yes. So, regarding competition, yes, I would just say, yes, we prepare for Top 5. Yes, we don't assume the market will be friendly to us. Yes. So, that's always the good approach to take, yes. So we think, given that the adoption of online courses continue to rise, yes, we will expect, still, a large-scale kind of customer acquisition activities, kind of high-level of that in the marketplace. So – and our teams are good at this. Yes. So because we have good cost, good content, highly competitive courses, yes. So, we think our customer acquisition cost is low. Yes, you can see that from us achieving three quarters of positive cash – operating cash flow in 2020. Yes. So we think we're good at this. We're competitive. And also, what you talked about is right. I think players will be more rational. And because of kind of restrictions and limits placed on the market by the regulators, I think it will be good for the benefit for the health of the industry in the long run, and because our kind of customer acquisition techniques has been always within the rules. Yes, so we think we will continue to do good.

[Binnie Wong:]

Okay. So, do you think that the marketing spend, in general, are the payers would spend less in terms of the subsidies or maybe less aggressive sales and marketing strategy? Or you think that overall, and this is something that Youdao – how should we read in terms of directionally in the sales and marketing spend in tradition? Should we expect a deleverage, at least as a percentage of revenue?

[Feng Zhou:]

Yes. It's just the beginning of this year. It's this part. Yes. We had – everything was also mentioned about is as a trend and the strategies from our perspective. And we think that we should discuss all the, really, detailed number. Even the range is right, just the beginning of this year and very difficult to predict about this uncertainty. It's about the summer. We think that will be too early to discuss about these kind of results. So, probably we can share more info as this is probably close to the summer or after summer. It always will be the key season for quite new students for the online education business.

[Binnie Wong:]

Okay, great. Thank you so much. Appreciate it. Thank you.

[Operator:]

And that concludes the question-and-answer session. I would like to turn the conference back over to management for any additional or closing comments.

[Feng Zhou:]

Yes. 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:]

Thank you. The conference has ended. You may disconnect your lines.