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Youdao, Inc. (DAO)

Q2 2021 Earnings Call· Tue, Aug 31, 2021

$11.25

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Transcript

Operator

Operator

Good day and welcome to the Youdao 2021 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 for Youdao. Please go ahead.

Jeffrey Wang

Management

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

Management

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. Q2 was another solid quarter for us. Total net revenues were RMB1.3 billion, representing a 107% increase from the same period in 2020. Revenue from our three segments: learning services, learning products and online marketing services, grew by 112%, 138% and 60% year-over-year, respectively. Loss from operations for the second quarter of 2021 was RMB544 million. That translates to margin of loss from operations improvement of 330 basis points from the same period in 2020. As you all know, significant regulatory changes regarding after-school tutoring were introduced recently in China after our fiscal Q2 concluded. Our remarks will be two parts. I will first talk about the double reduction policy, it's impact on us and our plans. Then, we will go over our Q2 results in more detail. Regarding the double reduction policy, we saw four major points most relevant to us: First, publishing of AST advertising is banned on most media platforms; second, access to capital markets is severely limited. For example, ASTs are not allowed to pursue IPOs; third, tutoring timing limitations. For example, no school subject academic tutoring on weekends or holidays; fourth, academic ASTs are required to register as nonprofit going forward. We have been exploring strategic and operational changes to our tutoring business and setting new priorities for the whole company since the regulation was published on July 24. First, as always, we are committed to embrace and fully comply with these laws and government policies. We have already made changes to our business like stopping academic classes during the summer holidays and we are actively communicating with regulators on further changes like the nonprofit requirements as…

Peng Su

Management

Thank you, Dr. Zhou and hello everyone. Today, I will be presenting some operational and financial highlights from our 2021 second quarter. We encourage you to read through our press release issued earlier today for further details. Dr. Zhou introduced the strategic and operational change to our tutoring business and our new priority just now. Then I will add more color on the operating side in Q2. First of all, in terms of the adult segment of premium courses, the revenue account for 21.5% of the total net revenue in Q2. The Extraordinary Memory, Feifan de jiyi, course was the biggest one from the gross billing perspective in Q2. In the meantime, an upgraded version of the practical English course has been launched recently; English for All Enjoyment Camp [ph] offers immersive teaching from the first person view, it's optimized the education and training model based on the learning characteristics and the learning habits of the adult. Furthermore, the upgraded course presents language learning scenario by using AI technology and integrate learning, practice and test to improve the concentration of students. The Intelligent Assessment System tracks the students' learning conditions to help them customize their learning course accurately from the five major dimensions. In short, enhancing service by AI technology has made education and the training easier. As for China University MOOC, means massive open online course, the leading MOOC platform in China and also the major online courses platform for Chinese University students. 137 courses has been certified as the national level premium online courses for vocational education by Ministry of Education. Looking at our Youdao Dictionary, we added a new function named High Reading in Q2. It is the first learning app that supports real-time assessment of oral English and the professional sound monitoring in China, making oral…

Operator

Operator

[Operator Instructions] And our first question comes from Sheng Zhong of Morgan Stanley. Please go ahead.

Sheng Zhong

Analyst

Thank you for taking my question. My question is, actually, you mentioned that in current regulatory environment, you will focus more on the non-K-12 space. But my question is, wondering what this means for K-12 tutoring business? Will you keep it or gradually exit this market? And if you have any operation adjustment plan you can share with us, that will be great. Thank you.

Feng Zhou

Management

Thanks, Sheng Zhong. Yes, right now, we are following guidance from government at a working level. So for example, we stopped summer courses. We removed any courses scheduled on weekends and things like that. So going forward, we will see more changes like this. And we basically -- the way we offer our service for K-12 will be different. And in the process, we will follow guidance from the government. One thing is that we see that the national policy, Beijing policy and other local policies regarding AST, they are actually quite consistent in their content. So our current thinking is, we expect the measures in these policies, some are already implemented, some are not implemented yet. But we expect them to be executed, implemented in the coming months. So, we're still in the process; so some of the timing is not clear yet. And the schedules -- the government schedules could be moved around but basically, we will follow the government's instructions. And -- so this is our current view. And so I think it's still earlier for a very clear to tell adjustment plan from us. Again, as we said, we do expect the measures to have significant impact on our existing K-12 cost business and these impacts will come in the coming quarters. Let me take this opportunity to talk a bit more about where we are from a more macro perspective. So first, I think the policies are designed for the long-term development of China's education. So let kids have more free time, let them develop more extracurricular interests and put more resources into schools. These are all designed for the long term. Therefore, we fully embrace these changes, these policies and will be compliant, as our original intention to do education business is actually very…

Sheng Zhong

Analyst

Thank you very much.

Operator

Operator

The next question comes from Brian Gong of Citi. Please go ahead.

Brian Gong

Analyst

Yes, thanks management for taking my question. My question is about the competition on learning devices, adult education and STEAM education. So do you think the competition of those areas will become more intensified since after the new regulation, new policy, other AST names? There are also -- some of them are also looking to come into this area to find new growth drivers. Yes, that's my question. Thank you.

Peng Su

Management

Thank you, Brian. This is Su Peng. Yes, we -- the first is, we always believe that the intelligent learning devices will provide huge opportunities for the ed-tech companies. And in China, there's nearly about 200 million K-12 students as well as even more backlog learners aspire to improve their learning efficacy. Also parents right now are ready to invest in education. Yes, indeed, with growing demand, probably many of the other companies have already entered the segment. However, what we think about these for the intelligent learning products, there are some really technical barrier to the entire process, including the development, production and sales, where we think that Youdao has made substantial improvement in the area for the long time and achieved exceptional results. If you go back to two years ago and about -- we released our Dictionary Pen Series 2 in August 2019. With this resource, we had established a good market reputation and recognition and we think we have pushed the barriers, made impressive message to the parents -- in parents' mind. So we think we are in the leading -- we are -- definitely we will be the leading one. At least, we are the leading one in the learning device sector. So we are thinking about -- we are really confident to face about the competition in these sectors. The second thing is about the adult education product. Yes, if you see about the numbers, net revenue from our adult education business is up about over 100% year-over-year in Q2. And also, we are successfully operating the two different SKU or the content or the product in our pipeline. First is what we call practical English, English product. It's a language learning product. Second is called the Extraordinary Memory. That's kind of to help…

Feng Zhou

Management

Brian, this is Feng Zhou. Yes, let me add a few words. So yes -- so the question is about competition in these new areas. Of course, we will see a lot of competition and we already see companies coming up with new products and services already. So the way we think about it is that we view ourselves as a product company. So that's the -- and we think we have product-focused companies and service-focused companies in education and both models are good but I think for some products, for some things, so this is -- this will lead to different ways of doing things and different competitiveness. And for hardware for devices, it's obviously product because you actually hold the product. So we think for devices, we absolutely have advantage here because we've been doing it for a couple of years and we have very strong teams -- very strong product teams. So defining [indiscernible] refining and selling these products. And also for STEAM, we think we are stronger online. So that's why we've always been focusing on the online side of tutoring education. And for STEAM courses, we will also focus on online. And it's a bit different from the academic courses in the sense that STEAM courses at least should be more attractive and more friendly to the students because it's extracurricular, right? Yes. So we think we have good experience and a good track record in creating really attractive STEAM courses like the Weiqi, the Go game courses. So we think we will be able to create more of these really successful SKUs. And -- yes -- so I hope that's helpful. Thank you.

Brian Gong

Analyst

Yes, thank you very much. That's very helpful.

Operator

Operator

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

Alex Xie

Analyst

Hi, management. Thank you for taking my questions. My first question is about your customer acquisition strategy and customer acquisition costs. I think you will shift your being focused to the non-K-12 segments. How should we think about them in the future? And my second question is about the profitability of your non-K-12 business lines. Would you please share with us some of your ideas about what kind of margins could your non-K-12 business achieve in your business plan? Thank you.

Peng Su

Management

Alex, this is Su Peng. I will take the first question first and I think before I go to question, it's about adult. It's committed to fully complying with Beijing after-school tutoring measures and similar measures to be adopted by the other local governments and if I need to implement the requirements of the central government's opinions. And for the customer acquisition strategy for the non-K-12 after-school tutoring business and first of all, for the STEAM and adult education, we definitely will leverage the existing user traffic and attach more importance to the conversions and contribute by our organic traffic to boost the conversion rate and expand our users, too. As for the WOW Community, we recall the WOW Community launched in Youdao Dictionary in Q1, grew fast with MAUs of more than 10 million in Q2. And I think that will show our capabilities to boost our organic traffic volumes in our Dictionary apps. So, I think for the adult business, I think, first of all, you have to create the high-quality content and products before you're spending on the marketing dollar to sort of customer acquisitions. And so, we think about all the strategies for the customer acquisition. We -- internally, we try to -- always try to provide high-quality process and create the high-quality content to our customer first. And then, we just -- before we release to the public, we always will take it through several rounds about internal taps for the auto content and we will just refine the content and -- again and again to make sure we provide the high-quality content to our customers. We think that will be the strategy for us ongoing for adult education. And for the STEAM products, definitely, we will also build up several different new content in…

Alex Xie

Analyst

Got it. Thank you very much.

Operator

Operator

The next question comes from Thomas Shen of Nomura. Please go ahead.

Thomas Shen

Analyst

Thank you, management, for taking my questions. I have one question about how should we forecast the impact from the recent regulations for after-school tutoring? Any colors on the top line or margins will be very helpful. Thank you.

Lei Jin

Analyst

Hi Thomas, this Lei Jin. Firstly, Youdao is committed to fully complying with the Beijing AST measures and the similar measures given by other local governments. Youdao needs to implement the requirements of the central government opinion. In compliance with Beijing AST measures, we stopped offering the extended AST classes on weekend, national holidays and the current high school breaking period in Beijing. Such measures are expected to have a material impact on our existing K-12 academic cost business. In the first quarter of this year, the revenue from K-12 AST classes accounted for less than 50% of our total revenue. Youdao is an intelligent learning company, not just a totalitarian company. So we will double reduction as external process. This does not change our long-term reversion and we are truly optimistic about the long-term development. In the medium term, I think this is maybe 12 months [indiscernible] we will exclude a few quarters for transition. The whole K-12 AST makes up about 41% of our Q2 total revenue. And computer education, grade 1-9, subject to make up about 24% of Q2 total revenue. At the same time, we run a diversified business with other significant segments that are not impacted by the regulation. Our non-AST business is already quite big at over 50% of our revenue and growing about 100%. So we think we are in a good shape. We will manage the process carefully and prudently. We, Youdao management team, has a long-term vision and commitment and we are confident to navigate the challenges and have a better position in the market. In addition, NetEase is supporting us in the long run.

Thomas Shen

Analyst

Thank you. It was helpful.

Operator

Operator

The next question comes from Thomas Chong of Jefferies. Please go ahead.

Thomas Chong

Analyst

Hi, good evening. Thanks management for taking my questions. May I ask about the outlook in terms of the operating expenses like R&D, sales and marketing and G&A in the next couple of quarters? In particular, about the sales and marketing side, should we expect it will materially slowing down in the next couple of quarters? And on the head count, any color about what we should expect the head count by the end of this year? Thank you.

Yongwei Li

Analyst

Hi Thomas, thank you for your question. This is Wayne. As just mentioned by Dr. Zhou, we are stepping on the brakes on the AST side. At the same time, we are driving more growth on the non-AST side, our businesses such as smart devices, education digitalization solutions. Therefore, I think it is not easy to have a clear direction for the change of the operating expense at the whole financial level. As just mentioned, Youdao is an ed-tech company and we have multiple businesses. K-12 AST is not our sole business. And the non-K-12 businesses revenues for second quarter this year was about 60% which -- there is no direct negative impact from the double reduction policy. I'm willing to share two points on the channel of operating expenses for our K-12 AST which represents part of our financial outlook. First, according to the government policy, publishing AST advertising on most media platform is banned. We stopped AST advertising for K-12 such as [indiscernible] and the branding activity for our causes which resulted in a sharp decrease in marketing expenses we spend. Second, we will downsize the K-12 AST business scale. As we mentioned, the head count, considering the limited tutoring time, the salesperson and the tutoring classes on K-12 will be reduced accordingly. For the R&D investment, I think we are an AI technology company, we will continue to invest a lot in our other business. So there's a chance it will be continuing to increase for R&D. Finally, I'd like to emphasize, the diversification is our -- one of our advantages. We will try to take any chance to grow our business but the precondition is to fully embrace and comply with the law and the government policy. Thank you.

Thomas Chong

Analyst

Thank you.

Operator

Operator

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

Liping Zhao

Analyst

Good evening, management. Thanks for taking my questions. I have two questions here. First, this recent policy encourage students to study at home or at school, will this stimulate the demand for our educational smart devices? And any plan for the new product launch of our smart devices? And secondly, related -- second question related to the share purchase program. We noticed that NetEase announced the share purchase program of US$50 million of Youdao's ADR. Could management elaborate a little bit more on the reason behind it? Thank you.

Feng Zhou

Management

Yes, thanks. So regarding the first question about learning devices, you asked about any plans for new products in this area. Yes, so we actually do have new products very recent time. So tomorrow, yes -- so yes, I'll just -- you guys will be the first to know. Tomorrow, we will launch a new version of the Dictionary Pen in collaboration with People's Education Press. They've been in charge for that. So tomorrow, September 1, we will launch this new Dictionary Pen that has features that work directly with the students' textbooks. So this is one of the most asked about feature that the parents and students need and we have finally been able to work out all the details and it launches tomorrow and we are very looking forward to; you guys will like it. And I think a couple of days after that, yes, we will have another product that's related to language learning -- also language learning. But the other -- another side of language learning. Yes, not the reading part. So you can guess what it's about. How do you learn a language, right? So you read or you do what? So, we also like that product very much. And we think we will know -- so we will know how the students react to it. But as we talked about, September is a start of school, so it's a very important period for any products related to learning. So we think that the two new products, along with the existing Dictionary Pen that are selling very well; so we think that we have a very good product lineup for this school year. Yes, thanks.

Operator

Operator

The next question comes from Candis Chan of Daiwa. Please go ahead.

Feng Zhou

Management

Sorry, operator. I think we have the second question, right. Yes, so this question regarding the share repurchase -- share purchase program for -- from NetEase. So I introduced in my prepared remarks that NetEase today announced that there's a share purchase program approved for up to US$50 million of Youdao's shares. And it starts two days from now, lasting at most three years. So it's -- so NetEase will purchase Youdao's shares on the open market. So the -- NetEase announced the share purchase program. And I think on one hand, it demonstrates the strong support for Youdao's business for our long-term development. So, as you all know, so NetEase has supported us on multiple occasions. For example, providing us with the credit line a couple of quarters back. And this shows again their support. I think that's very important in this market scenario. And on the other hand, I think NetEase certainly hope -- would hope NetEase -- Youdao has as a good performance in the capital market in the long run. So I think that's for the share purchase program and we will provide you with more updates when we -- if we have more in the future. Yes, thank you.

Operator

Operator

The next question will now come from Candis Chan of Daiwa. Please go ahead.

Candis Chan

Analyst

Hi, management. Thank you for taking my question. I just want to quickly follow-up on your comments about the downsizing of the K-12 business. Can you just quantify the restructuring costs for this K-12 AST business? And how would that impact your cash flow position?

Peng Su

Management

Candis, thank you for your question. For K-12 restructuring costs, we believe each player will incur additional costs such as compensation cost for dismissed staff, cancelation costs for the rental office and certain impairment loss for prepaid office materials. However, I think different players might face different situations. As just mentioned by Dr. Zhou, Youdao already has a good basis for non-K-12 business. And in the future, we expect to be driving more growth on the non-AST side of our business. Part of K-12 talents will join the non-K-12 business, such as STEAM classes and adult education. They will continue to create valuation for us. Let's say, compared with other tutoring companies, we have relatively low additional cost on the compensation side and we will offer more opportunity to our talent. Second, as an online company, there are fewer fixed costs such as rental fee to be considered during the restructuring. Finally, we believe the restructuring cost is closely linked to the final policy of non-for-profit organization for K-12. Currently, we are actively communicating with the regulators on the detailed policy and -- for non-for-profit organization but the policy is still underway. So we will fully compliant with the government policy and we still need to wait for the final policy. Wish it is helpful for your questions.

Candis Chan

Analyst

Yes. Thank you very much.

Operator

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.

Jeffrey Wang

Management

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

The conference is now concluded. Thank you for attending today's presentation and you may now disconnect.