The Zhitong Finance App learned that on February 29, educational technology company NetEase Youdao (DAO.US) announced unaudited financial reports for the fourth quarter of 2023 and fiscal year 2023. Financial reports show that in the fourth quarter of 2023, Youdao's net revenue reached 1.48 billion yuan. Operating profit achieved a single quarter profit of 80 million yuan, an increase of 209.2% over the previous year, and a net operating cash flow inflow of 160 million yuan, an increase of 91.0% over the previous year. In the fourth quarter, net profit attributable to Youdao's common shareholders was 69.3 million yuan under non-US GAAP, compared to 31.1 million yuan for the same period last year.

After the financial report was released, NetEase Youdao CEO Zhou Feng, NetEase Youdao President Jin Lei, Vice President of Strategy and Capital Markets Su Peng, and Vice President of Finance Li Yongwei attended the subsequent analyst earnings conference call to interpret the highlights of the financial report and answer questions from analysts.

Here's a transcript of the conference call:

1. What are the main channels for monetization according to the Dao Dao Big Language Model?

Zhou Feng: First, there is a consensus in the artificial intelligence industry that education is one of the most important fields for large model applications. Sam Altman talked about this, and Bill Gates talked about education and health care being the big model's most important areas. So the overall focus is to seize important use cases in education and then commercialize them.

We are basically focusing on two directions: one is improving existing businesses and products, and the other is launching new products.

(1) Improvement of existing products: The Ziyuedai model has promoted many of the key features of our products, leading to an increase in product sales or subscription revenue.

First, through smart hardware. Our direction is becoming increasingly clear. Some of the features of the big models have become the main selling points of hardware products. For example, grammar explanation and vocabulary explanation have become the most commonly used features and selling points of Youdao Dictionary pens since last year. It reminds me of how YouDao Dictionary won the dictionary market. At the time, there were two key features: online interpretation and machine translation. I'd like to point out that since we launched the dictionary pen, these features based on the big model have become the most differentiated selling point in our products. Another key application is our AI tutor, Mr. Xiao P.. On our AI learning board X20, the usage rate of Mr. Xiao P reached nearly 40%, making it the most popular application on X20.

Second, through the app-side subscription service. For example, AIBox has become a key feature of YouDao Dictionary and has led to an overall subscription fee increase of more than 100% over three quarters. Recently, AI translation has also become popular.

Third, online marketing services. Large models are used in the advertising business to assist in material generation, save costs, and improve efficiency. This is also the main reason for the steady growth of the advertising business over the past five quarters. Currently, about 20% of advertising materials use AI technology.

Perhaps more important in the long run are our new or upcoming standalone apps — such as Mr. P and Hi Echo. I think they cover a wide range of usage scenarios, such as oral English learning, AI home tutoring, etc.

Looking at the performance of the language learning product Speak in the Korean market, they have achieved annual revenue of about 20 million dollars. I believe our language learning products also have broad prospects for development.

Also, take Mr. P as an example. It covers a very wide range of topics. When students encounter problems while studying at home, the tutoring provided by Mr. P can think more clearly than the parents or students themselves, and can solve all kinds of problems in all subjects and classes. Not only are the answers high quality, but they can also guide children to study independently. I think having AI provide guidance and answer questions is a far-reaching change.

In summary, I am optimistic that the big model will drive medium- to long-term development.

2. What are the key areas of learning services in 2024?

Zhou Feng: In 2023, digital content services will become an important source of net revenue and cash flow in the learning services sector. We have classified these services as new types of services launched after policy adjustments, including courses such as YouDao Master, YouDao Bofeng, etc., excluding adult courses. In 2023, the net revenue from digital content services reached RMB 2 billion, an increase of 11.7% over the previous year. Operating cash inflows exceeded 150 million yuan. Furthermore, the gross margin is approximately 70%.

In 2024, digital content services will be the focus of learning services.

First, consumer demand is quite strong, and we are improving services to meet the needs of different users. Our advanced courses are already leading in the industry, and our blog post courses are also very popular. As the user base continues to grow, their needs are becoming more diverse. As a result, our commitment to providing more personalized services has become a key point in our work. Lingshi recently launched a new small class course for students with advanced learning needs. This new form of small class teaching is different from the past; it combines recorded course content with experienced teacher resources. At the same time, Dao Bowen made major updates to the course, expanded the applicable age group, and provided users with more flexibility in choosing course time. As these products establish a leading position in the market, we can tailor the products according to the needs of users in different cities, different age groups and different consumption plans.

Next, we'll launch a new SKU. Over the past two years, due to trends such as the macro environment, policies, and artificial intelligence, the learning needs of families have changed very rapidly, so it is natural for our team to see opportunities for new SKUs. We focus on literacy learning for K-12 users. These services aim to provide quality learning content and services to expand learners' horizons, cultivate their interest in important STEM and humanities fields, and enhance their lifelong abilities. We take an agile and lean approach to these projects, starting small and growing organically. These are some projects that are being incubated, and we'll see the results of these projects over the next few quarters.

Third, we use artificial intelligence as the key to product differentiation. Relying on our big model technology, we are capable of implementing a variety of applications, including but not limited to AI diagnosis, AI coaching, and personalized exercises. Integrating artificial intelligence into the curriculum is at the core of two aspects: improving learning effectiveness and enhancing production efficiency. In addition to the motivation to learn, we believe that the main challenge in the learning process is that it is a labor-intensive service. That's why we focus on providing services that are critical to learning outcomes, but often require a great deal of effort from teachers. Using AI, we have achieved very good results. For example, in our YouDao Bowen AI writing precision review service, we have carefully revised and improved 25,000 student essays in just one quarter. If everyone could save half an hour, the overall savings would be over 12,000 hours. At the same time, students' writing skills will also be significantly improved. As a result, this has created a win-win situation: on the one hand, it provides unique value to users, and on the other hand, it also improves production efficiency. Currently, many similar projects are underway, and they will have an increasingly profound impact on student learning outcomes and key business performance indicators.

Su Peng added: I would like to add some information on the recent college entrance examination policy update. Eight provinces have confirmed that they will implement the college entrance examination mathematics examination reform starting this year. The reforms include reducing the number of topics, adjusting topic scores, and innovating ways to solve problems.

After the policy was updated, we found high school students were in high demand. To this end, we have upgraded digital content services, including intelligent learning services such as diagnosis, personalized learning path recommendations, and AI test recommendations to better serve users.

In addition, we also provide consulting services for strong foundation programs. We have extensive experience in consulting services and have established a good reputation in top universities and high schools in the country.

3. Following the rapid growth of online marketing services in 2023, what are the new growth drivers in 2024?

Jin Lei: In 2023, the advertising market showed a rapid growth trend. The advertising business of major Chinese companies such as Tencent, ByteDance, Baidu, and iQiyi achieved 20% to 25% growth. Among them, the rise of performance advertising has become a key factor driving this growing trend.

In this development process of the advertising market, you have achieved a growth rate that exceeds the industry average by integrating artificial intelligence technology into the advertising business.

Net revenue from online marketing services reached 1.3 billion yuan, an increase of 98.1% over the same period last year, and has achieved year-on-year growth of more than 50% for five consecutive quarters. This growth is mainly due to the widespread application of artificial intelligence in the advertising industry. Specifically, in 2023, the net revenue from real-time ad delivery (RTA) was over RMB 100 million. Additionally, around 20% of ad creatives are created using artificial intelligence technology.

Looking ahead to 2024, we will focus on developing the digital advertising business and improving advertising effectiveness. We will continue to strengthen the previously mentioned strengths and seek new growth opportunities in the following two areas:

First, we will focus on developing overseas markets. Youdao Online Marketing Service is committed to providing Chinese companies with digital marketing solutions such as brand promotion, global key opinion leader (KOL) marketing, and overseas advertising. With deep experience and resources in the field of translation, our translation services can cover 108 languages around the world. Furthermore, relying on self-developed artificial intelligence technology, recommendation algorithms, and neural network translation, we have successfully connected more than 1 million high-quality influencers in vertical fields around the world, and directly reached more than 2 billion users in more than 75 countries or regions, effectively promoting the globalization process of Chinese brands. Recently, Youdao Ads has become an authorized advertising agency for TikTok for Business, which will further help Chinese brands expand overseas markets.

Second, tap the potential of vertical industries such as gaming. We have many advantages in serving gaming customers, including material production capabilities, a deep understanding of games, and expertise in content marketing. In the second half of last year, we began a closer collaboration with NetEase Games. Looking ahead, we will continue to use our strong artificial intelligence capabilities and these advantages to provide customers in specific industries with more comprehensive and customized services to further explore the growth potential of the advertising business.

Zhou Feng: I'd like to add one more point. A lot of people have asked us recently why and how we are achieving this growth. The key to our success in advertising has always been the combination of operational excellence and deep advertising technology expertise. Youdao advertising's business model is unique: we're not a team to monetize our own traffic, nor a brand advertising agency. We are a performance advertising platform business with technology as the core driving force. We not only monetize our own traffic, but also provide traffic monetization services for third parties. Every page view (PV) and click brings a small amount of revenue, and efficiency is at the core of our success. Therefore, our artificial intelligence and big data capabilities play a critical role in improving advertising efficiency, etc. Many advertising agencies may be good at business operations, but lack strong technical support; many advertising technology teams may not fully master strong business operation skills. After years of practice and accumulation, we have successfully integrated these two competencies. That's why we've been able to achieve significant growth, and we believe this will help us continue to be successful in the future.

4. Smart hardware has faced certain challenges in 2023. How will smart hardware revenue resume growth this year?

Zhou Feng: I'll provide some more details about the latest product launch and some thoughts on the future direction of development.

The A6 Pro dictionary pen went on sale far beyond our expectations, with sales reaching 50,000 units in the first week. In terms of product definition, the A6 Pro dictionary pen is equipped with the best display and content at the same price, and supports high-quality offline translation, grammar teaching, and vocabulary teaching models. At the same time, our supply chain management has also done an excellent job, providing excellent quality and value at a relatively reasonable price. The Douyin live broadcast further boosted the product's sales momentum.

It's worth noting that although the A6 Pro is more cost-effective for consumers, the gross margin is actually not much different from expensive products, and we won't sacrifice profits to increase sales. Thanks to our strong in-house design capabilities and close collaboration with IC and other supply chain partners, we are able to maintain the product's competitive gross margin. The Hearing Bao E6 also met our expectations. This is a great start for the smart hardware team, and I hope the team continues to launch great products over the next few months.

Looking ahead, we plan to launch a series of new products in Q1 and Q2. If you look back at our past products, you'll find that we mainly focus on producing products whose prices are higher than the market average. However, our future plans are to expand our product range to cover different price ranges from high-end to mid-range. We have adopted this strategy because our team has accumulated extensive experience and our supply chain is mature enough to ensure superior quality and user experience even for low-cost products. As a result, we are now at the best time to use our diverse product portfolio to attract a wider user base.

For future higher-end products, the combination of artificial intelligence and hardware has created a lot of value for users. For example, integrating big model functionality into hardware is very appealing because as big model features (such as grammar teaching) become more popular, users naturally want to be able to use these features on hardware because it is more convenient and has a faster response time. One question we often get asked is whether the dictionary pen supports offline translation, and the answer is yes. The ability to translate offline is a key consideration for users when purchasing. Therefore, artificial intelligence and language processing capabilities on hardware are very interesting aspects in the field of high-end products, and we have extensive experience in these areas.

Finally, we have restructured our sales channels and have now moved to a more online and flexible sales and supply chain structure. The recently released new products prove our sales team's ability. Thanks to recommendations from Douyin Live and Dabao, the new product received significant momentum after its launch. But our team still has a lot of work to do as we plan to create more new sales and marketing channels and optimize them. Despite this, the success of the new product launch proved that we are on the right track.

5. As cash flow improves in 2023, can management provide an outlook for 2024 cash flow?

Operating cash flow has always been viewed as a key indicator of the company's health, and we are pleased to note that our operating cash flow in 2023 has improved significantly compared to the past. Operating cash outflows in 2023 narrowed by nearly 20% year over year. Notably, operating cash inflows in the fourth quarter reached a record level of approximately RMB 161 million, an increase of 91% over the previous year. This indicates that the business is moving in a healthier direction. Looking at market segments, both learning services and online marketing services have achieved positive operating cash inflows, which makes us more confident about further improvements in operating cash flow in 2024.

We expect our operating cash flow to maintain this positive trend through 2024. First, we will continue to improve our ability to generate cash inflows in 2024 by utilizing artificial intelligence technology and optimizing business operations. Additionally, for the smart hardware segment, improvements in product performance and sales channel management are expected to increase the cash generation capacity of this segment. It is also worth noting that cash flow showed quarterly changes, and the second and fourth quarters were more seasonal, mainly due to user acquisition and retention reasons for the learning services business during this period.

Furthermore, in the long run, NetEase has been providing financial support to Youdao. For example, NetEase's $300 million revolving loan amount was disclosed in our ER, with an expiration date of March 31, 2027, which will help the development of our business, particularly our long-term investment in core technology.