Good day and welcome to the Youdao 2019 Fourth Quarter and Fiscal Year Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Pei Du, Investor Relations Director of Youdao. Please go ahead.

Thank you, operator. Please note this discussion today will contain forward-looking statements relating to future performance of the company and 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 – on assumptions and other factors. Some of the 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 of Exchange Committee, including its prospectus and associated amendment on the Form 424(b)(4) filed in conjunction with our recent IPO. The company doesn't undertake any obligation 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 definition of non-GAAP financial measures and the reconciliation of GAAP to non-GAAP financial results, please see the 2019 fourth quarter and fiscal year financial results news release issued earlier today. As a reminder, this conference is being recorded. Besides, a webcast replay of this conference will be available on Youdao's corporate website 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, VP of Operations; Mr. Peng Su, our VP of Strategy and Capital Markets; and Mr. Wei 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.

Thank you, Du Pei, 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. We are happy to report Youdao's best quarter as we finish 2019. We generated revenue of RMB 410 million in Q4, up 78% year-over-year. And for the full year 2019, revenues were RMB 1.3 billion, also up 78% year-over-year. With six consecutive quarters of growth, Q4 gross billings for our online courses were up 211% year-over-year, accelerating faster than our growth in Q3 of 140% year-over-year. Yearly gross billings of online courses reached RMB 940 million, up 125% year-over-year. We continue to build up a strong instructor and tutor team, reaching 151 instructors and 520 tutors by the end of 2019. Sales of our intelligent learning devices also continued to do well in Q4 after the launch of Youdao Dictionary Pen in August, reaching RMB 67 million of revenue in Q4, a 396% growth year-over-year. When we became a public company in October, we told people we are an intelligent learning company. What I mean is that, first and foremost, technology is in our corporate DNA. We have deeply integrated our proprietary technology across our offerings to create a unique online learning experience. For example, in 2019, we distributed over 60,000 Youdao Smart Pens to our students. This gives our students seamless real-time student-teacher interactions that mimic a physical classroom environment and personalized feedback. Second, the strength of our organic user base is another element that differentiates us. By the end of 2019, the number of our total monthly average users have reached 108 million and it keeps on growing. This is a testament to the engagement of our users. And moreover, it's driving growth across our online courses and learning…

Thank you. Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights for the 2019 fiscal year and the fourth quarter. We encourage you to read through our press release issued earlier today for the further details. We saw excellent gains across many of our primary metrics while we are building our business scale and offering. We are simultaneously working to balance our investment in our operations to best position us for sustainable growth over the long term. For the fourth quarter, we had a total net revenue of RMB 410.4 million or the US$59 million. This represents an increase of 78.4% from the fourth quarter of 2018. If we look at this growth by segment, net revenue from our learning services and products grew by 128.6% year-over-year to RMB 311.9 million or US$44.8 million. We attribute this growth to strong growth in the K-12 paid student enrollment. Net revenue for the online marketing services were RMB 98.5 million or US$14.2 million, flat compared with the prior year period. For the fourth quarter of 2019, our total gross profit was RMB 122.4 million or US$17.6 million compared with RMB 68.3 million for the fourth quarter of 2018. Gross margin for learning services and products improved to 29.3% for the fourth quarter of 2019, up from 21.6% for the fourth quarter of 2018. The large margin growth was primarily attributable to the effects of the economics of scale and the further optimization of our business and the faculty compensation structure. Gross margin for online marketing services was 31.6% for the fourth quarter of 2019 compared with the 41.4% of the – for the fourth quarter of 2018. The decrease was mainly the result of the more revenue generated from advertisement through the third-party Internet properties and…

Certainly, we will now begin the question-and-answer session. [Operator Instructions] The first question comes from Mark Li of Citi. Please go ahead.

Thank you management for the time. I have two questions. One is, I want to know more, given the unfortunate virus incident, could you share more about the online operating metric? We have seen like a bit color on the online students, we – or the traffic that we get. Or any plan for the servicing and retention? And the second question is, I would like to know our promotion or retention plan for the upcoming spring semester for both K-12 and adults segments. Thank you.

Thank you, Mark. Yes, so the first – regarding the virus, so our first priority is always the health of our employees and customers. So – and with that said, the outbreak significantly raises the awareness of online education. So business-wise, it's very positive for our courses. So we are doing several things. So first is, as we talked about, we are offering free courses to our users. And the – most of the results for the free course is actually branding awareness. So a lot of users are – through these free courses, they get to know Youdao and get to know online education for the first time. So actually, there's one number I can share with you, there are – there have been over 10 million free student – free course enrollments since we launched the campaign on January 24, so over 10 million enrollments there. So the second thing we're doing is, at the same time with the free courses, we are also offering low-cost trial courses. Most of these courses are the same with the before, but we do a little bit of an adjustment to some of them. And so that low cost to trial courses, so what we are seeing is, of course, much lower user acquisition costs over the period of time and also better conversion rates. So that's the second thing. The third thing is that, overall, we are spending more on – actually on our marketing budget. So most of that is actually around the low-cost trial courses. So this enables us to ramp up the business faster. And the coronavirus situation has negative impact for our other businesses, for advertising and smart devices business. For the smart devices business, this mostly impacts our off-line sales. However, these are currently smaller…

Yes, thank you Feng Zhou and management.

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

Hey, good morning management. Thank you for taking my questions. So I have two questions here. The first one is about the student acquisition cost. Can you please break down your sales and marketing costs to the adult business and the K-12 business? And regarding the – yes, a lot of things happened, coronavirus. So regarding the – your outlook about the competition of the online education, what's your plan or strategy for the student acquisition in this year? And the second one is, can you please share some color about your top five teacher revenue contribution of your K-12 and college business? Thank you.

Thank you, Sheng. This is Su Peng. I believe for the first question, for acquisition cost for the adult and kid whole business in the Q4 last year, in 2019, maybe compared with the Q3, we see the cost fully decreased in the cost that we've guided for new student acquisition. It's decreased season over season. That's because – firstly, that's because of seasonality issues. And for the – all the education business, always the summertime is, so they will be the most expensive seasons for the – to acquire new users. And secondly, we believe for the adult and the K-12 student acquisitions, we expect that in the future, so we do see the decreased trend. But we – right now, we don't know if it's a long-term trend or mid or short term. It's only the short-term performance of the market. So we will keep our eye to the market, and we expect to see more and – the results from the market, and again, get back to you to give you more information about the customer acquisition cost, it's trend in the future. And for your second question about how to – our teacher contributions. We believe our faculty and the kind of business structure, first, has been significantly optimized to better reflect the industry standards. We also maintain a highly competitive planning risk we believe, therefore, we retained the top talents. So that's definitely the most important thing for everyone. And also in the Q4, our top 20 instructors contribute about 73% of our revenues from the Youdao Premium courses. And first, it's not only the teachers – individual teachers because they all have the teams, so that shows the team's effort. It's not only the – only one teacher. So as we expect to hire more instructors, we expect the concentration will be come down in the longer term. So currently, we only have the two instructors as doing the revenue share models. And most of the – some teachers, their – the service contract will be ended in the December 31 – as of December 31, 2019. So we – all of them have renewed a new contract with us. We expect it will drag down our gross margin in the future. And we also in the – we also standardized and protected our content of the many performance structure. So we believe in the future, we will provide standardized – more standardized and content and product to our students. I hope that will be helpful. Thank you.

Yes, let me add some points to – thanks, Sheng Zhong. Let me add some to the plan for this year. I believe you asked how we are going to grow for this year. So the near-term focus is focusing on where we are doing great. So – because, overall, the growth of the business is doing well. And we will focus on expanding those courses that we are doing great. So this is mainly courses in junior high and high school. So Chinese, Physics and also recently, Math. So we've historically been strong in Chinese and Physics. And for the last in maybe 2 quarters, Math has improved a lot. So – and I believe junior high and high school are good segments because students here are under more pressure from exams and there are kind of urgent needs to get a successful training. And the other focus, at least for the first half of this year, is building up the service capacity. So we now have a 520 tutors. That's not enough. And we have – the good thing is that we already have very experienced leaders in these teams. So hiring is their number one priority now. And we also have good – already have good operating procedures and IT systems already, so that's good. And so the team's are doing teams. And these will grow quickly. We expect to have at least a few thousands of them of service employees, of tutors, at the end of 2020. Yes, I hope that answers your question.

Yes, thank you for the color. Thank you very much.

The next question comes from Alex Xie of Crédit Suisse. Please go ahead.

Hi, management. Thank you for taking my questions. So my first question will be about our GP margin outlook. I have seen the learning services, GP margin have been in the improving trend. What will be the outlook for 2020 and the key initiatives to lift the GP margin? And secondly, I think you also mentioned – Dr. Zhou also mentioned, the conversion rates improved in the last quarter. So what about the quarter-over-quarter retention rate for your K-12 normal-priced students from the autumn classes to the winter classes? That – what is the level? Or what is the improvement year-over-year? And do you think you still have some more room to go? And what can you do to improve it? And thirdly, I would like to ask about the Practical English business. I think it's performing quite strong. But I would like to ask you to share a little more about the tutor structure and the user profile of this business. I think they – is it just Chong Ting alone or a group of teachers led by Chong Ting. And is the customer group mainly college students or white collar employees? Thank you.

Thank you for your question, Alex. This is Wei. I will take your first question on the gross margin. The gross margin improvement is one of our focus areas, and we expect our gross margin learning segment to be improved with more benefit received from math upscales and better cost out efficiency. The largest drivers in our gross margin improvement was somewhat below. Firstly, a reduced around the sharing with our instructors due to the reduced reliance for our teachers. More instructors are rewarded by performance-based bonus. Secondly, the better cost efficiency that's started is the back of our investment in teacher training and technology under our belt. We can continue to expand our business without significant amounts of additional investment at this time. Finally, I think more benefit from the achievements of economics of scale. The online large class model seems accepted by more and more users and the stability was expected to continue. This is my answer for the first question. I hope this is helpful.

Yes. So we were very confident about GP margin. So we already see a little bit of results in Q4, and we'll have more improvements in 2020. So let me answer the second question. So regarding the conversion rates and retention rates. So basically, we are seeing high single-digit, percentage-wise, improvements year-over-year for both these numbers. So for conversion number, with – the key number we're looking at is our 48 3 trial courses. So we've been able to do high single-digit percentage improvement to the conversion number over the same period in 2018. And for retention, in Q4, we are looking at, actually retention users from the fall semester to spring semester this year. So it is done – this is done in Q4 as the fall courses were going on. So – and most of that conversion is done Q4. There is still a little bit left in Q1. But we can already see that retention from the fall semester to spring semester this year is much improved than before. It's high single digits, as I said, percentage-wise improvements over the same period in 2018. And we believe we are competitive in terms of conversion. And it is, of course, due to better service. We have many more tutors than before, and they are better trained. And also, it's due to high-quality content. The iterated approach we used in developing the content kind of having the teachers go back and forth with our operational staff and keep improving the course. They have been able to do it for maybe 2 years, 3 years now, and we've been good at that. So – yes, so I hope that answers your question. So Su Peng, can you take the third one? No, the third one is actually about Practical English,…

Thank you Feng Zhou for detailed answers. That’s very helpful.

[Operator Instructions] The next question comes from Thomas Chong of Jefferies. Please go ahead.

Hi, good morning. Thank you management for taking my questions. Given our solid set of results, with GP market improvement as well as efficiency in sales and marketing expenses and a number of – huge base of free traffic will be converted in coming quarters. Is there any change in terms of the time line for profitability? Any color would be great. And my second question is about the regulatory environment in China. How we should think about the trend going forward?

Thank you for your question. I would like to address your first question. We do not provide the detailed qualitative guidance on the timing of profitability. With that said, we are unchanged in our business plan, and I'd like to give you some additional information. On the top line, as to learning segment, in 2019, we have a strong growth, 75% year-over-year increase in learning services and nearly 400% year-over-year increase in learning products. We will replicate the experience to produce good courses to drive further growth in the top line. In terms of gross margin, with the achievements of economics of scale and the faculty compensation structure optimization, we expect the gross margin will improve continuously, as just said, and to get closer to the industry level over time. On the other side, we will continue to invest more in our servicing capability, such as recruiting more teaching assistants and building AI technology to enhance students' learning experience. We also believe this is a good time to do more marketing and branding activity to acquire more users, which helps to accelerate our stability. Wish this is helpful for your first question. Thanks.

Lei Jin, it's okay, you take the second question of – regarding the regulatory environment?

Yes. It's – with the regulation, we work heavily on the regulation movement. And it's important that they are incumbent in this regulation. And all of our – 9 Youdao act in the first they will call and approve the lease, which is published by the Ministry of Education in this Q4. Our free courses are now to come back at the same pace as public school classes. But other – our gear towards our view of the key concepts from previous semester to help students to prepare for the new semester. Therefore, we are carefully – we are fully confident not exceeding the pace of the public schools. We remain alert to public school curriculum schedules across different regions in China. Our team has carried out several [indiscernible] regarding the course content, curriculum scheduling and support the operating service. That's my answer. Thank you.

Thank you.

The next question comes from Natalie Wu of Youdao. Please go ahead.

[Indiscernible] Thank you for taking my questions. I have a couple of questions here. First 2 are regarding to your K-12 business. Just firstly, this run rate in 2019, what percentage of the new enrollment converted from your organic traffic? And what's your expectation for this year? And secondly, you mentioned that – Dr. Zhou, you mentioned that you have accumulated over 10 million free course enrollments during this outbreak. Just wondering how much of them to be converted into the full-priced course enrollment? We'd love to hear management's thoughts on that. And last question is regarding the smart devices. You have a very robust shipment of smart devices in the second half of last year, especially the Dictionary Pen. I'm just wondering how much revenue is contributed by that single product in the fourth quarter? And I'm also wondering if there would be any chance that we could see some synergies between the Dictionary Pen and your K-12 online courses this year. Any thoughts would be helpful.

Yes, thank you. Thank you, Natalie, for joining our company. I was joking. Okay. Yes, so regarding the K-12 organic traffic, so this is a very important work for us. So we have a dedicated team doing this. So we keep improving. So in 2019, so as I talked about, 40% of new paid students – to paid students enrollments actually came from our organic traffic. So mostly Dictionary, some from Translation app. And we actually have close to 20 apps now. So quite a few of them are very popular. So gross – another number is that gross billing of our K-12 course attributable to our organic traffic actually increased 92% year-over-year in 2019. So we almost doubled the amount of conversions from organic traffic. And – so 2020, so we think we – in 2020, we still have a lot to do. And I talked about the new version of Dictionary, so it is an important version. So if you look at it, it's quite different from the versions before. So we are basically transitioning from a – kind of a tool, a dictionary tool to an app that's tailoring to people's many different needs in terms of learning. So not only dictionary look-up, also kind of all-English practice, listening comprehension of English practice, and also some non-English learning activities. And this provides a much better approach for us to – much better platform for us to embed our courses within the Dictionary. So be sure to take a look. And we are using a lot of data, and this is natural if you look at where we're coming from. So we had good AI technology and good big data technology. So it's only natural that we apply those technologies to get better user conversions. So we're collecting…

Yes, that’s very helpful. Thank you much Feng.

[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to management for any additional or closing remarks.

Thanks 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 in the U.S. Have a good day. Thank you.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.