Good day, and welcome to the Youdao 2024 First 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 of Youdao. Please go ahead. .

Thank you, operator. Please note the discussion today will contain forward-looking statements related to the 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 company filings 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 2024 first quarter financial results news release issued earlier today.

As a reminder, this conference is being recorded. 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 are 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. .

the trend of tech-driven advertisement product innovations, including wide applications of RTA, DMP and particularly generative AI in the industry, as well as untapped customer acquisition opportunities as we achieve larger scale and product leadership.

Thirdly, our focus is on AI-driven subscription services, currently generating around RMB 50 million in quarterly total sales. Although relatively small at present, this segment is growing at a high speed, with over 100% year-over-year growth this quarter. It is a key conduit through which our investment in AI will pay off.

I'm pleased to share that we will be launching "Mr. P AI Tutor", the first all-subject AI tutor in China, as a free mobile app in June. We encourage you to try it out and provide us with feedback once it's available.

In conclusion, we are laser-focused on driving robust growth by offering premium online services -- online learning services, and spearheading AI innovations for consumers, while concurrently maintaining financial discipline. The future holds immense promise for AI-driven learning, advertisement and consumer services.

With that, I will turn the call over to Su Peng to provide you with more detailed insights into our financial performance. Thank you. .

Thank you, Dr. Zhou, and hello, everyone. Today I will be presenting some financial highlights from the first quarter of 2024. We encourage you to read through our press release issued earlier today for further details.

For the first quarter, total net revenues were RMB1.4 billion, or USD 192.8 million, representing a 19.7% increase from the same period of 2023. Net revenues from our learning services were RMB 718 million, or USD 99.4 million, representing a 2% decrease from the same period of 2023.

Net revenues from our smart devices were RMB 181.2 million, or USD 25.1 million, down 14.8% from the same period of 2023, primarily due to decreased demands for the learning products in the first quarter of 2024.

Net revenues from our online marketing services were RMB 492.7 million, or USD 68.2 million, representing a 125.9% increase from the same period of 2023.

The year-over-year increase in revenues from online marketing services was primarily due to the increase in the sales of performance-based advertisements through third parties' Internet properties, which was driven by our continued investments in cutting-edge AI technology.

For the first quarter, our total gross profit was RMB 681.5 million, or USD 94.4 million, representing a 13.2% increase from the first quarter of 2023. Gross margin for learning services was 63.1% for the first quarter of 2024, compared with 62% for the same period of 2023.

Gross margin for smart devices was 32.6% for the first quarter of 2024, compared with 39.6% for the same period of 2023. Gross margin for online marketing services was 34.3% for the first quarter of 2024, compared with 29.1% for the same period of 2023.

For the first quarter, total operating expenses were RMB 651.6 million, or USD 90.2 million, compared with RMB 797.6 million for the same period of last year. With that, for the first quarter, our sales and marketing expenses were RMB 455.4 million, compared with RMB 565.2 million in the first quarter of 2023.

Research and development expenses were RMB 146.7 million, compared with RMB 182.8 million in the first quarter of 2023. Our operating income margin was 2.1% in the first quarter of 2024, compared with operating loss margin of 16.8% for the same period of last year.

For the first quarter of 2024, our net income attributable to ordinary shareholders was RMB 12.4 million, or USD 1.7 million, compared with net loss attributable to the ordinary shareholders of RMB 204.4 million for the same period of last year.

Non-GAAP net income attributable to the ordinary shareholders for the first quarter was RMB 20.3 million, or USD 2.8 million, compared with non-GAAP net loss attributable to ordinary shareholders of RMB 193.9 million for the same period of last year.

Basic and diluted net income per ADS attributable to the ordinary shareholders for the first quarter of 2024 were RMB 0.11, or USD 0.02 and RMB 0.10, or USD 0.01. Non-GAAP basic and diluted net income per ADS attributable to ordinary shareholders for the first quarter was RMB 0.17, or USD 0.02.

Our net cash used in operating activities was RMB 391 million, or USD 54.1 million, for the first quarter.

Looking at our balance sheet, as of March 31, 2024, our contract liabilities, which mainly consist of deferred revenue generated from our learning services, were RMB 769.1 million, or USD 106.5 million, compared with RMB 1.1 billion as of December 31, 2023.

At the end of the period, our cash, cash equivalents, restricted cash, time deposits, and short-term investments totaled RMB 326 million, or USD 45.2 million. This concludes our prepared remarks. Thank you for your attention. We would now like to open the call to your questions. Operator, please go ahead. .

[Operator Instructions] Our first question comes from the line of Brian Gong with Citigroup. .

Yes. Congratulations on decent results. My question is regarding digital content services, which had affirmed -- demonstrated revenue growth over the past several quarters.

So the management share what are the primary factors driving future growth again?.

Thank you, Brian. This is Su Peng. We think this -- the first is about the digital content services, particularly Youdao Lingshi are the most in demand and financial robust parts with our learning services. In the last year, our net revenue from digital content services are for the -- it's around RMB 2 billion, up about 11% year-over-year.

Additionally, and digital content services generated profit for the full year last year. In the first quarter of this year, our net revenue from digital content services reached close to the RMB 500 million, reflecting around 11% year-over-year growth as well.

And we do not -- at the same time, we do not only keep the revenue growth at the same level but significantly improve the profitability at some time. We expect we can just expand out the profitabilities of the digital content services quickly in this year.

I think the factors which has driven the growth of the digital content services, definitely first is because we see the very strong demand from the market. That's the -- I think that's the best part of the -- from the -- that's what we see the signals from the market regarding our services.

And the second is about, definitely, we provided pretty unique values to our customers from our products.

And we think about our -- for example, with our AI capabilities, we can offer the users' academic diagnostics, personal learning test plan and recommend access following the video content consumption and also the AI based college admissions advisor, we call the [Foreign Language] provided comprehensive services such as college application assistance, core selection advice, as well as the college admissions policy guidance.

We think that's a pretty unique value we provide to our customers for these products. I think in the remaining 3 quarters of this year, we will continue to focus the profitability of each product. For the key products and services such as Lingshi, we will allocate more resources and efforts striving for the fast growth in this year.

And secondly, we find a significant potential for the off-line service as well. Through these initiatives, we aim to reach a broader range of students and provide more high-quality consulting services. While our digital content learnings is primarily delivered online, we believe that is the integration of online and off-line services.

We think that we will offer better services to all the students and customers as well. With that, we are confident -- pretty confident about the profitability of our digital content services is expected to see a rapid improvement in the full year of 2024.

In addition, Youdao Lingshi, our core product is expect to remain a rapid growth in the forecast in the foreseeable future. .

Brian, this is [ Zhou Feng ]. Yes, I just want to add one point. So as Su Peng just said, we are working on off-line services for Lingshi as of right now. Yes. So some -- we already have about 10 cities in service right now, yes. So this is an important initiative for the team.

So we think about online and offline a lot, so I want to -- just want to add a little bit of thinking about this. So we think online courses are really great. So fundamentally, they are more efficient. So -- and if we look at Lingshi, a lot of the course content is actually delivered with a pre-recorded video.

And this is a very good thing for the business because the users really like this format. It allows more freedom in how they schedule their time. So -- and it's good for the business because of high efficient nature of pre-recorded videos and AI content.

So however, we also recognize that to reach the students -- potential students and also to provide consultation for students. A lot of students and parents, they prefer offline face-to-face kind of service.

So we think the future is -- online is -- will be really great, and we will kind of complement that with offline and combining the 2 will actually bring a lot of values to the users and also kind of opening new avenues of growth for the business. .

Our next question comes from the line of Caini Wang, CICC. .

So I have just one question about our online marketing [Technical Difficulty] services. Our online marketing services have been experiencing rapid growth for 6 consecutive quarters.

So how could we achieve a sustainable growth in the future?.

This is Lei Jin. As we discussed during the call last quarter, Youdao's ad business is a performance-based ad platform. We aggregate traffic from the both -- from both within Youdao and outside of Youdao to serve the customers' marketing needs.

And our competitive strength lies is in the unique combination of the technology skills and the customer services and operation skills. In the first quarter of this year, our advertising business achieved a net revenue of nearly RMB 500 million and a gross margin of 34.3%. Both of these are record highs.

Additionally, this segment generates meaningful profit. Looking ahead, there are 3 key factors to drive the sustainable growth in the future. The first continued technological improvement.

In the first quarter, we expanded the real-time API RTA to cover it [ through ] include the industries such as entertainment, social media and automotive and e-commerce. Covering over 10 sectors now. The proportion of RTA ad revenue has increased to around 30% in Q1.

The implementation of RTA data strategy has improved conversion efficiency by over 50% for some clients. Looking ahead, RTA revenue is expected to further increase. By continuously optimizing AI algorithm and data analysis, we can better meet the diverse needs of our clients and [ improve ] advertising effectiveness.

In addition, our data management platform, DMP is a centralized application repository designed for collecting, storing and processing user data from multiple sources. This enable advertisers to gain a deep understanding of their target audience behaviors and the preference.

Our DMP enhances this by integrating user tags and audience package management functionalities with future guide target advertising development and optimization, thereby improving advertising efficiency and effectiveness.

And the second, the further expansion of customer acquisition opportunities, the proportion of the advertising traffic from -- and the revenue from the NetEase Group was relatively small, indicating significant growth potential in the future. Moving forward, we will better utilize the traffic resources within the NetEase Group.

Compared to the purely external traffic, the traffic from the NetEase is relatively more predictable and controllable. Furthermore, by strengthening our collaboration with the NetEase Group, we will gain deeper insight into the needs of the gaming industry users, which will help us expand our client base in the gaming sector.

The third, overseas marketing expansion. In terms of global Key Opinion Leader, KOL marketing, we have access to over 5 million global Internet celebrities, including more than 1,000 exclusive ones.

You can provide the client with a personalized KOL marketing solutions, including KOL selection, marketing strategy development, video content planning as well as mounting and optimization of KOL content performance.

Our leading AI technology to further empower global KOL marketing efforts to support the rapid international extension of Chinese enterprises. Youdao ADS launched China's first 5-star overseas marketing platform in Q1.

Youdao ADS have already assessed several Chinese companies overseas, including just like NetEase Games, BRD, [ Anker and Shein ] in their global expansion effort. Currently, the global KOL marketing business will still in the early stages, presenting substantial growth potential in the future. .

The next question comes from the line of Thomas Chong with Jefferies. .

My question is about what are the main products for our AI-driven subscription services?.

We apply AI and large language model heavily in multiple business lines, including advertising courses and subscriptions in apps. So AI subscriptions cover the last category. As we discussed in prepared remarks, AI subscription sales have been growing rapidly, up 140% this quarter year-over-year, reaching about RMB 50 million.

So to break it down a little bit for you, here are the major products that contributes to that. Yes. First is Youdao Dictionary and Youdao Desktop Translation. So Dictionary is our flagship mobile app and Desktop Translation is our most popular app for PCs and Macs.

According to Quest Mobile, they have over 100 million combined monthly active users and are the top translation apps in China. So last year, we introduced the AI translation feature, powered by our large language model to last year to web users.

In Q1, we significantly improved the translation quality, reaching 98% accuracy rate for English to Chinese, Chinese to English translation and they wrote it out to all users of Youdao Dictionary free of charge. So for more demanding scenarios, so paid subscription users enjoy more usage quotas.

So the user feedback has been overwhelmingly positive, leading to a lot of new subscriptions. Currently, these 2 apps are the largest contributors to our subscription sales, and we expect substantial growth as our large language model gained more capabilities and expand into new usage scenarios. Second, there's a Hi Echo. Yes.

It is the world's first digital human language coach, introduced last year. We recently launched a module tailored for IELTS preparation, IELTS, in collaboration with the British Council.

This module available through a separate subscription, assists users to better prepare for the IELTS exam through personalized exercises, customized feedback and simulated mock exams. So we expect the new offering to further boost the sales of Hi Echo.

So for international users, so it is the first time we shared that we have several apps that's popular. iRecord is the perfect app for those looking to capture high-quality voice recordings and transcribe them with high accuracy through automatic speech recognition.

Currently, iRecord ranks at the top 2 places in the voice recording apps category in North America. LectMate is an innovative app designed to help overseas college students, comprehend lectures more effectively by using the power of voice recognition and large language model technologies. It is the #2 in its category in North America.

So finally, there's Mr. P AI Tutor. As discussed in our prepared remarks, we will be launching the app version of Mr. P AI Tutor in June. Compared with the end of last year, we have further optimized our language model for K-12, achieving improved accuracy in problem solving.

Accuracy of problem solving has increased by 3%, and our serving cost has decreased by over 50%. So these 6 apps are our main offerings for AI subscription services. Subscription is a very natural monetization approach for AI and large language models.

So currently, subscriptions are experiencing rapid growth, and we have a pipeline of new features and new products under development. So for this year, we can already see a clear growth trajectory. Yes, I hope that answers your questions. .

The next question comes from the line of [ Bo Zhang ], Huatai Securities. .

This is [ Zhang Bo ] from Huatai. My question is the net revenue from smart devices continued to decline on a year-over-year basis.

How do we view the future development of this segment?.

the A6 Pro Dictionary Pen, the E6 Listening Pod and X20 Learning Pad. The result is that the year-over-year decline decreased to 14.8% over 30 percentage points less than Q4. The A6 Pro quickly became the top-selling dictionary pen on Douyin and JD.com.

More recently, after Q1, we launched the S6 Pro, which again surpassed the A6 Pro and that became the #1 dictionary pen. A6 Pro and S6 Pro are affordable and mid-priced dictionary pens at RMB 349 and RMB 599. The A6 Pro is actually are most of our affordable dictionary pen that launched.

However, it is more expensive than its peers in the market, which are priced at RMB 299 or even RMB 200. So we made a conscious choice here. We made the choice to build high-quality products even at affordable prices. So we do not intend to engage in a race to the bottom by undercutting each other with lower and lower prices.

So the result is that customers responded positively. And the A6 Pro and S6 Pro, as we just discussed swiftly became the #1 seller after their releases. So this is -- I believe this is excellent news. Now the A6 Pro is covering a price range that we were not serving before expanding our customer base.

And the S6 Pro is our top-selling mid-priced product. In the summer, we have some very innovative new products in the pipeline for the new school year. I'm optimistic about their outlook as there are several factors that are working in our favor.

One is our established product leadership positions in categories like dictionary pen best-selling products. Second is our ability to apply AI in the large language models to these devices. So parents tell us that they are very interested in these features, which have become increasingly mature and helpful.

Third, our sales and marketing channels are now more established and more efficient than before. So the device team obviously has a lot of work ahead of them. And we are we are eager to launch these new products. So yes, stay tuned for more updates. .

The next question comes from the line of [ Ya Jiang ], CITIC. .

My question is about the outlook.

Could the management share some insights into the outlook for 2024?.

Thank you. This is Su Peng. And I think for the outlook for this year, for the full year 2024, as Dr. Zhou discussed in the prepared speech, definitely will dedicate on the digital content services, online marketing services and AI-driven subscription services.

Firstly, for the digital content services, definitely is our top priorities for our business development. We will develop and ensure and seizing the increased demand by that continuously improve our products with our AI capabilities and expanding our presence in the offline market, as Dr. Zhou mentioned.

We have the confidence in the further improvement in profit from digital content services in this year. And secondly, as for the online marketing services, we think that it has made a significant strides since last year. We are focused on the long-term growth of our advertising business by deepen our RTA technology and generate AI applications.

In addition, we will definitely strengthen our partnership with NetEase Group in traffic, advertisement placements and as well as the other areas. Our investment in the AI is -- as you know, maybe as you knew, we have already invested in the AI for a long time.

And we expect we can generate more results from the AI subscription -- AI-driven subscription services in this year. We think we will keep -- we will continue to iterate about and develop new products, advancing the process of AI monetization as well.

Total sales of the AI subscription services are expect to be in a rapid growth momentum throughout this year. And finally, I think we will share some more color from the financial perspective. We have been making a great endeavors to achieve the full year profitabilities in the near future.

We expect since the last year, we have been diligently focusing on controlling the operating costs and expand while improving operational efficiency. This effort has already yielded significant results as evidenced by our achieved profitability for the 2 consecutive quarters for the first time.

And moving forward, we will maintain our costs as an expense management we are striving the increased revenue at [ same time ]. I think that's our outlook for the full year of 2024. .

The last question for today comes from the line of Linda Huang, Macquarie. .

Management, this is Macquarie, Linda Huang. I want to ask about operating expenses because I noticed that we have the decent decline for the sales and marketing and as well as the R&D.

So I just want to know about that for the rest of the year, how is the trend for this to the OpEx item? And how should we think about the expense to the revenue ratio?.

Thank you for the question. This is Wayne. I will take your question. Marketing efficiency is a crucial metric and a key indicator of our profitability. We are dedicated to improving the efficiency of online customer acquisition.

We continuously explore various innovations to optimize marketing efficiency, which includes not limited to diversified marketing channels to leverage our most advanced AI technology and to continuously enrich content to improve product experience.

Thereby, market creating the challenges such as rising acquisition costs due to the intense competition. I will add more color on these 3 areas mentioned above. First, diversification of user acquisition channel, take learning service as an example.

Online education companies have inherent advantages in channel innovation compared to offline education institutions. Online education allows us to reach customer beyond the geographic boundaries and actively capture traffic on high-traffic platforms.

In contract, customer acquisition for offline education institutions influenced by physical location constraints, limited their source of acquisition. In recent years, acquisition channel have become increasingly diversified, including KOL, Key Opinion Leader, lead streaming and integrated online versus off-line environment.

Such innovations enable us to reach a broader and more relevant audience, thereby reducing acquisition costs or improving conversion rates. Second, leverage AI capability into our products.

The application of AI technology can reduce the cost of material preparations and enhance product experience, thereby attracting user and increased conversion rates.

For instance, we employed an AISC refinement function to enhance user experience during trial lessons by providing timely feedback on lesson, thus improving the conversion efficiency of this lesson.

We believe that our advanced AI technology and large language models can help us to build a stronger product ecosystem, further enhancing marketing efficiency. Third, enhancing user experience through innovation of premium content. Each competitor pays a lot of attention and try to get an excellent conversion rate through certain forms of advertising.

Innovative premium content is the key to get good results by satisfying the needs of customers. Let me give you another example. Youdao Lingshi, one of our most important learning services has transitioned from traditional lead streaming online process to innovative pre-recorded content just mentioned by Dr.

Zhou, embedded with AI technology such as adaptive question bank, which results the concerns on the inflexible time schedule and offer personalized user experience. This transformation has proved successful in meeting user needs and enriching their user experience, gathering widespread clearance. Back to your question.

In 2022 and 2023, the sales and the marketing expense accounts for approximately 46% and 42% of our total revenue, respectively. And in the first quarter of 2024, further decreased to 33%. So we are very confident in maintaining this optimization trend in the long run. .

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. .

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..