Good day, and welcome to the Youdao 2023 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.

Thank you, operator. Please note that discussion today will contain forward-looking statements related to future company performance, which are intended to qualify for the Safe Harbor from liability as established by the U.S. Private Securities Litigation Reform Act. Such statements are not guarantees of the future performance and are subject to certain risks and uncertainties, assumptions and other factors. Some of these risks are beyond the company's control and could cause actual results to differ materially from those mentioned in today's press release and this discussion. A general discussion of the risk factors that could affect Youdao's business and financial results is included in certain filings of the company with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update 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 2023 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 at ir.youdao.com. Joining us today on the call from Youdao's senior management is Dr. Feng Zhou, our Chief Executive Officer; Mr. Lei Jin, our President; Mr. Peng Su, our VP of Strategy and Capital Markets; and Mr. Wayne Li, our VP of Finance. I will now turn the call over to Dr. Zhou to review some of our recent highlights and strategic direction.

Thank you, Jeffrey, and thank you all for participating in today's call. Before we begin, I would like to remind everyone that the financial information, 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 had a solid financial performance in Q4, producing an all-time high income from operations and operating cash inflow. Net revenues reached RMB 1.5 billion in Q4, up 1.8% year-over-year. Income from operations reached RMB 76.3 million, increasing 209.2% year-over-year. In terms of cash flow, we achieved an operating cash inflow of RMB 160.6 million, rising by 91% year-over-year. For the full year 2023, our key financial indicators improved significantly. Net revenues reached RMB 5.4 billion, up 7.5% year-over-year. Loss from operations was RMB 466.3 million, narrowed by 39.8% year-over-year. Operating cash outflow amounted to RMB 438.1 million, improving 17.6% year-over-year. We executed on our strategy of growing our businesses in key growth areas, including digital content services and online marketing services, while at the same time, building product leadership and future growth through AI technology. We continue to drive towards profitability and have already delivered two major versions of our large language models, a solid foundations for both 2024 and an AI-driven future. Now I would like to share more color on our progress in the fourth quarter. First of all, our large language model projects. Last month, we released our second language model for education, Ziyue 2, with major upgrades to conversational abilities, knowledge-based question-answering capabilities and text processing capabilities. Utilizing this new model, we launched Hi Echo 2 with extensive upgrades to digital human characters, scenarios, conversational abilities and the all-new teaching mode. We also introduced a major new LLM application, Mr. P AI Tutor, a conversation…

Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights from the fourth quarter and the full year of 2023. We encourage you to listen to our press release issued earlier today for further details. As Dr. Zhou mentioned, for the fourth quarter, total net revenue was RMB 1.5 billion or USD 208.5 million, representing a 1.8% increase from the same period of 2022. Net revenue from our learning services were RMB 784 million or USD 110.4 million, representing a 2.8% decrease from the same period of 2022. Net revenue from our smart devices were RMB 222.4 million or USD 31.3 million, down 45.3% from the same period of 2022, primarily due to our continuous efforts to streamline marketing channel with low return on investment for the intelligence learning products in the first quarter of 2023. Net revenue from our online marketing services were RMB 474.1 million or USD 66.8 million, representing a 96.9% increase from the same period of 2022. The year-over-year increase in revenue from the online marketing services were mainly attributable to the increased demand for the performance-based advertisement through the third-party Internet properties. For the fourth quarter, our total gross profit was RMB 738.8 million or USD 104.1 million, representing a 4.6% decrease from the first quarter of 2022. Gross margin for learning services was 63.6% for the first quarter of 2023 compared with 64.1% for the same period of 2022. Gross margin for smart devices was 38.3% for the first quarter of 2023 compared with 46.2% for the same period of 2022. Gross margin for online marketing services was 32.7% for the first quarter of 2023 compared with 29.2% for the same period of 2022. For the fourth quarter, total operating expense for RMB 662.5 million or USD 93.3 million…

We will now begin the question-and-answer session. [Operator Instructions] The first question is from Brian Gong with Citi Group.

I have a question on our large language model. Youdao is pretty committed to AI and we also launched our own large language model to the year. Can management share our NIM monetization channels for the year? Thank you.

I'll take this question. Yes. first, there is a consensus in the AI industry that education is one of the most important areas for large language model applications. Sam Altman talks about it. Bill Gates also talks about education and health care are the most important areas. So the overall focus is I think, to capture kind of really important use scenarios in education and then monetize that. We basically think about this in two ways, two kinds of LLM projects. One is value-adding projects to our existing businesses. One is completely new things. So for the first category, we have a couple of channels. So obviously, one of the very important one is smart devices. I think one trend is quite clear. So LLM features are quickly becoming kind of major selling points for our devices. So for example, AI features like AI grammar instruction, [Iva Jinja] for explaining sentences and word instruction, that's the [indiscernible] for explaining separate words or phrases. These features have become the most used features and major selling points for Youdao Dictionary Pen since last year. I compare this to Youdao Dictionary, not the Dictionary Pen, the app, Youdao Dictionary, how we won the dictionary market. So that was done with the two features. One is a web interpretation on [indiscernible]. The other is machine translation. So when you have something that really works for specific learning scenario that users really care. And also, we only you have that and the other players don't. Then it is a very good way to gain more market share and also monetize the technology. Of course, we also have the [Molson] [indiscernible] Mr. P AI Tutor [Foreign Language] We think that will also be popular. So this is one way we monetize the technology through smart devices.…

The next question is from Caini Wang with CICC.

[Foreign Language] So my question is, we can see that our learning services revenue in 2023 is kind of flat compared to 2022. So I'm just wondering, what is the focus for the -- our Learning Services segment in 2024? Thank you.

Yes. So I'll take this, too. So in 2023, yes, if you look at data content services, so this is the major contributor of net revenue in our learning services content. So we redefine digital content services within the learning services sector by any new service that's launched after and according to the policy change. So these primarily include Lingshi and Youdao Literature and some other smaller courses, not including things like adult courses. So in 2023, net revenues from [indiscernible] content services reached RMB 2 billion. So it is up 11.7% year-over-year, yes. So -- and the gross margin was around 70%. So we -- so this part of the business met our expectations. So in 2024, we think Digital Content services will be the focus of our Learning services. So let me give you a few points regarding our priorities. So first is consumer needs are quite strong in this area and we are improving the services to satisfy different user needs. So our Youdao Lingshi is already leading in the industry. Our Youdao Literature course is also quite popular. As we gain more and more users so one of the key areas is we will provide more personalized services to users. So Lingshi recently introduced a small class course format for students with more advanced learning needs. So this is actually different from the past small class experiences. The new format is offered with mostly prerecorded video content and our experienced tutors to provide the service. So feedback is very good for this new format. Youdao Literature, Youdao [indiscernible] also launched a new major revision of the course, broadening to more age groups and provide more choices with how much the user wants to -- how much time the user wants to spend on the course. So…

Yes, I can add more color after Dr. Zhou's comments and on the digital content services. And I believe most of people knows a news about in province has been confirmed -- has confirmed the implementation of the reform in [indiscernible] exam -- for the college entrance exam in this year. And the reform, including a reduction in the number of questions, adjustments in the question scored and other innovative approach in the problem solving. So I think if you see the trend of the -- in the past and every single time when the college entrance exam has been updated for the new format of the test. And we expect about the demand for the consulting for the -- how to deal with the new test formats will go up in the whole year. And internally, we have been -- we have upgraded our digital content -- digital content services, including the consultings and otherwise and teach them how to prepare and in the family scenarios and for this update for the college entrance exam. In addition, we think that's also the further opportunities for the plan for the strengthening basic academic discipline, [Foreign Language], they are sophisticated in this consultation services, and we think we have built a very strong reputations in domestic [indiscernible] and high school. And we think that will be the kind of the driving of the growth of digital services in 2024.

The next question is from Thomas Chong with Jefferies.

Following the rapid growth for online marketing services in 2023, what are the new growth drivers that we should expect in 2024?

This is Lei Jin. In 2023, the advertising market is across the product range, this is a major domestic player like Tencent, [indiscernible] and Baidu. They are all growing maybe 20% or 25% in their AD business. The life of the performance space [indiscernible] is the significant driver of this trend. As we scale up the development of the AD market, we are -- we have integrated AI into our AD business, resulting in much higher growth compared with the [ regular level ] in the market. We achieved the continuous quarter-over-quarter growth in every quarter in 2023 and net revenue were RMB 1.3 billion for the whole year and an increase of nearly 100% growth year-over-year. Besides the AI capabilities, we have a deep understanding of client demand, effective utilization of the data and our strong focus on AD performance. Those internal capabilities are the key drivers to gather a great result. In 2024, we will focus on digital advertising, paying attention to the AD performance, continue to strengthen our advantage just mentioned above and explore the new growth in the following two areas. First is the overseas market. Youdao ADS provides a digital marketing solutions for the brand promotion of the Chinese enterprises, global influencer marketing and the overseas AD placement. This is our extensive business and expertise in the translation field, Youdao ADS excels in providing translation services for 108 languages. Moreover, our self-developed AI technology, recommendation algorithm and the neural network translation enabled us to connect with over 1 million high-quality influencers in various industries worldwide. This allows us to directly reach more than 2 billion users in over 25 countries or regions translating the global growth of the Chinese brand. Notably, we have recently become an authorized advertising agency for the TikTok, which will further support our expansion in the international market in the future. Secondly, we explore the potential of the vertical industry, just like online games. We have several advantages in the serving game class including capabilities in AD material production, deep understanding of gaming and [indiscernible] in content marketing. In the latter half of the last year, we began to collaborate more closely with NetEase Games. Moving forward, we will continue to leverage our robust AI capabilities and aforementioned plans to provide more comprehensive and tailored service to the client in vertical industries, aiming for a further tap into the growth of the advertisement business. Thank you.

Yes, this is Feng Zhou. I'd like to add a point. We got asked a lot recently about why and how we achieve this significant growth in the advertisement business, yes. Let me try to answer the question here. I believe the key to our past and future success in ads is our ability to combine strong business operations and deep advertisement technology. Youdao's ad business is unique. We are not a monetization team of our on traffic nor a brand advancement agency. We are a technology-based performance ad platform business. So in addition to our own and upgraded assets and traffic, we also deliver performance ads for third-party traffic. So every page view and every click contributes a tiny bit of revenue. So in this kind of business, efficiency is key to business. That's why our AI and large language model capability is a good fit for this. And it is very useful in learning and adapting the ad delivery process to maximize the efficiency and value creation. So a lot of ad companies on the market, they have a strong business ability, good sales and acquiring customers. But not necessarily good at technology. A lot of -- on the other hand, a lot of ad tech teams do not really have strong business operations. So through their years of experience our team have, so I think we have acquired both skills. So business operations and deep understanding of ad technology. So that is why we have seen such growth in the past year. And I believe also whether if we can do those skills better, that also will determine whether we can continue to be successful in the future. I hope this is helpful in understanding how we think about the ad business, yes.

The next question is from [Bo Zhang] with Huatai Securities.

Hello. Good evening, management. This is [indiscernible]. Thanks for taking my questions. In 2023, Smart Device business faced a challenge. In 2024, how to return to growth?

I've discussed the recent progress on Devices in the prepared remarks. So let me provide some more details on the most recent product launch and some thoughts on the future directions. The A6 Pro Dictionary Pen, the launch exceeded our expectations as we talked about with over 50,000 units sold in the first week. In terms of the product itself, the A6 Pro Pen has the best screen and best content within the price range and support high-quality off-line translation and AI features like grammar instruction and word instruction. So moreover, our supply chain team did a really good job of delivering very good quality and a good value for a relatively affordable price, yes. So also live video selling on Douyin contributed to the launch momentum. So that's kind of a rough breakdown of the A6 Pro launch. It is worth pointing out that although the A6 Pro is more affordable for consumers than our higher-end products, it actually has a similar gross margin ratio for us compared to our higher-priced products. So we are not sacrificing margin for selling more units. We are able to maintain a competitive gross margin ratio for this product because of our strong in-house design abilities and also our close collaboration with our IC supplier with our other supply chain partners. The other product, the listening part, E6 also met our expectations. It is the #1 selling product in its category right now. This is a good start for the Devices team this year, and I expect the team to keep delivering good launches in the coming months. Going forward, we have more device launches in Q1 and Q2 planned, yes. If you look at our products last year and before, we have been mostly focused on higher-priced products compared to our peers.…

The next question is from [indiscernible] with Citi.

Well, I have only one question. With the improved cash flow observed in 2023, could management provide outlook for the cash flow in 2024? Thank you.

Thank you for your question. This is Wayne. I will take your question. Operating cash flow is always treated as a key healthy indicator for our company, and we are pleased to note a remarkable improvement in our operating cash flow of 2023 compared with prior period. The operating cash outflow in 2023 was narrowed by near 20% year-over-year. Notably, in the fourth quarter, the operating cash inflow reached a record of around RMB 161 million, rising by net 1% year-over-year. This indicates that the business is progressing towards a healthy direction. On a settlement basis, both the Learning services and Online Marketing services helped achieve positive operating cash inflow, which makes us more confident in the further improved operating cash flow in 2024. We expect to maintain such good momentum for our operating cash flow in 2024. Firstly, we will continue to enhance our ability to generate cash inflow through leveraging AI technology and optimizing business operations. In addition, as to the Smart Devices segment, improvements in product performance and the sales channel management are expected to boost the cash generation capability from this segment. It is also worth noting that the cash flow exhibit quarterly, but varying with a stronger seasonality in the second and the fourth quarter, preliminary due to user acquisition and retention activity in the Learning Services segment during this period. Furthermore, from a long-term perspective, NetEase has been providing financial support to us. For instance, three years revolving loan facility amounting to $300 million as disclosed in our earnings release with maturity dated on March 31, 2027, we should facilitate the development of Youdao's business, especially in the area of our long-term investment in core technologies and resources. In sum, we are very confident in our cash flow for 2024. Thanks.

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

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 Pearson Financial Communications in China or the U.S. Have a great day.

Ladies and gentlemen, thank you for joining the conference is now over. You may disconnect your telephones. Thank you.