On February 29th, educational technology company NetEase Youdao released its unaudited financial reports for the fourth quarter and fiscal year of 2023. According to the financial report, in the fourth quarter of 2023, Youdao's net income reached 1.48 billion yuan, and its operating profit achieved a single quarter profit of 80 million yuan, a year-on-year increase of 209.2%. The net inflow of operating cash flow was 160 million yuan, a year-on-year increase of 91.0%. In the fourth quarter, the net profit attributable to common shareholders of Youdao under non US GAAP accounting standards was 69.3 million yuan, compared to 31.1 million yuan in the same period last year.
After the financial report was released, executives such as Zhou Feng, CEO of NetEase Youdao, Jin Lei, CEO of NetEase Youdao, Su Peng, Vice President of Strategy and Capital Markets, and Li Yongwei, Vice President of Finance, attended the subsequent analyst financial report conference call to interpret the key points of the report and answer analyst questions.
Here is the transcript of the conference call:
What are the main channels for monetization in the Youdao language model?
Zhou Feng: Firstly, there is a consensus in the artificial intelligence industry that education is one of the most important areas for applying big models. Sam Altman talked about this, and Bill Gates also mentioned that education and healthcare are the most important areas of the big model. So the overall focus is to capture important usage scenarios in education and then commercialize them.
We basically focus on two directions: one is the improvement of existing businesses and products, and the other is the launch of brand new products.
(1) Improvements to existing products: The Confucius model has driven many key features of our product, resulting in an increase in product sales or subscription revenue.
Firstly, through intelligent hardware. Our direction is becoming increasingly clear. Some features of large models have become the main selling points of hardware products. For example, grammar and vocabulary have become the most commonly used functions and selling points of Youdao dictionary pens since last year. This reminds me of the way Youdao Dictionary won the dictionary market, with two key features at that time: online interpretation and machine translation. I would like to point out that since we launched the dictionary pen, these large model based features have become the most differentiated selling points in our products. Another key application is our AI tutor Teacher Xiao P. On our AI learning board X20, Teacher Xiao P's usage rate has reached nearly 40%, making it the most popular application on X20.
Secondly, through the subscription service on the APP side. For example, AIBox has become a key feature of Youdao Dictionary and has driven an overall subscription fee growth of over 100% for three quarters. Recently, AI translation has also become popular.
Thirdly, online marketing services. The application of large models in advertising business can assist in material generation, save costs, and improve efficiency. This is also the main reason for the steady growth of advertising business in the past five quarters. Currently, about 20% of advertising materials use AI technology.
In the long run, perhaps more important are our newly launched or upcoming independent applications, such as Teacher P and Hi Echo. I think their coverage is very extensive, such as in English speaking learning, AI home tutoring, and other usage scenarios.
Observing the performance of language learning product Speak in the Korean market, they have achieved an annual revenue of approximately $20 million. I believe that our language learning products also have broad development prospects.
Taking Teacher Xiao P as an example, its coverage is very extensive. When students encounter problems while studying at home, the guidance provided by Teacher P can provide clearer thinking than parents or students themselves, and can solve various problems in all subjects and stages of learning. Not only does it provide high-quality answers, but it can also guide children to learn independently. I believe that having AI provide coaching and Q&A is a profound change.
In summary, I am optimistic about the driving force of the big model for the medium to long-term development of Youdao.
What are the key areas of learning services in 2024?
Zhou Feng: In 2023, digital content services will become an important source of net income and cash flow in the field of learning services. We classify these services as new types of services launched after policy adjustments, including courses such as Youdao Lingshi and Youdao Bowen, excluding adult courses. In 2023, the net revenue of digital content services reached 2 billion yuan, a year-on-year increase of 11.7%. The operating cash inflow exceeded 150 million yuan. In addition, the gross profit margin is approximately 70%.
In 2024, digital content services will become a focus of learning services.
Firstly, there is a strong demand from consumers, and we are improving our services to meet the needs of different users. Our Lingshi courses are already in a leading position in the industry, and our erudition courses are also very popular. With the continuous growth of user base, their needs are becoming increasingly diverse. Therefore, dedicating ourselves to providing more personalized services has become a key point in our work. Lingshi has recently launched new small class courses for students with advanced learning needs. This new form of small class teaching is different from the past, as it combines recorded course content with experienced teacher resources. At the same time, Youdao Bowen has made significant updates to the course, expanding its age range and providing users with more flexibility in course time selection. As these products establish a leading market position, we can customize our products according to the needs of users in different cities, age groups, and consumption plans.
Secondly, we will launch new SKUs. In the past two years, due to the influence of macro environment, policies, and artificial intelligence trends, the learning needs of families have changed very quickly, so our team will naturally see opportunities for new SKUs. We will focus on the literacy learning of K-12 users, which aims to provide high-quality learning content and services to broaden learners' horizons, cultivate their interest in important STEM and humanistic literacy areas, and enhance their lifelong abilities. We adopt an agile and lean approach to these projects, starting from small projects and then developing them organically. These are some ongoing incubation projects, and we will see the results of these projects in the coming quarters.
Thirdly, we utilize artificial intelligence as the key to product differentiation. Relying on our big model technology, we have the ability to achieve various applications, including but not limited to artificial intelligence diagnosis, artificial intelligence tutoring, and personalized practice. The core of integrating artificial intelligence into the curriculum lies in two aspects: improving learning effectiveness and enhancing production efficiency. We believe that besides learning motivation, the main challenge in the learning process is that it is a labor-intensive service. Therefore, we focus on providing services that are crucial to learning outcomes but often require a significant investment of effort from teachers. We have achieved very good results using AI. For example, in our Youdao Bowen AI writing refinement service, we have meticulously corrected and improved 25000 student essays in just one quarter. If everyone could save half an hour, then overall it would save over 12000 hours. At the same time, students' writing skills will also be significantly improved. Therefore, this creates 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 being advanced, which will have an increasingly profound impact on student learning outcomes and key performance indicators of the business.
Su Peng added: I would like to add some content to the recent update of the college entrance examination policy. Eight provinces have confirmed that they will implement the reform of the mathematics exam for the college entrance examination starting from this year. Reform includes reducing the number of questions, adjusting question scores, and innovating problem-solving methods.
After the policy update, we found that there is a high demand for high school students. To this end, we have upgraded our 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 the Strong Foundation Program. Our consulting services are experienced and have established a good reputation in top universities and high schools in China.
3. After the rapid growth of online marketing services in 2023, what are the new growth drivers for 2024?
Jin Lei: In 2023, the advertising market will show a rapid growth trend. The advertising business of major Chinese enterprises such as Tencent, ByteDance, Baidu and iQIYI will grow by 20% to 25%. The rise of effect advertising has become a key factor driving this growth trend.
In the development process of the advertising market, Youdao has achieved a growth rate that exceeds the industry average by integrating artificial intelligence technology into the advertising business.
The net revenue of online marketing services reached 1.3 billion yuan, an increase of 98.1% compared to the same period last year, and has achieved over 50% year-on-year growth 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 advertising (RTA) exceeded RMB 100 million. In addition, approximately 20% of advertising materials are created through artificial intelligence technology.
Looking ahead to 2024, we will focus on developing digital advertising business and improving advertising effectiveness. We will continue to strengthen the previously mentioned advantages and seek new growth opportunities in the following two areas:
Firstly, we will be committed to exploring overseas markets. Youdao Online Marketing Services is committed to providing digital marketing solutions for Chinese enterprises, including brand promotion, Global Key Opinion Leaders (KOLs) marketing, and overseas advertising placement. With profound experience and resource accumulation in the field of translation, our translation services can cover 108 languages worldwide. In addition, relying on independently developed artificial intelligence technology, recommendation algorithms, and neural network translation, we have successfully connected over 1 million high-quality internet celebrities in vertical fields worldwide, and directly reached over 75 countries or regions with over 2 billion users, effectively promoting the globalization process of Chinese brands. Recently, Youdao Ads has become an authorized advertising agent for TikTok for Business, which will further assist Chinese brands in expanding overseas markets.
Secondly, tap into the potential of vertical industries such as gaming. We have many advantages in serving game customers, including material production capabilities, deep understanding of games, and professional knowledge in content marketing. Last year in the second half, we began a closer cooperation with NetEase Games. Looking ahead, we will continue to leverage our strong artificial intelligence capabilities and aforementioned advantages to provide more comprehensive and customized services to customers in specific industries, in order to further explore the growth potential of our advertising business.
Zhou Feng: I would like to add one more point. Recently, many people have asked us why and how to achieve this growth. The key to our success in the advertising field has always been the integration of excellent business operations capabilities and profound advertising technology expertise. Youdao Advertising has a unique business model: we are not a team that monetizes our own traffic, nor are we brand advertising agents. We are a technology driven effect advertising platform business, which not only monetizes our own traffic but also provides traffic monetization services to third parties. Every page view (PV) and click can bring a small profit, and efficiency is the core of our success. Therefore, our artificial intelligence and big data capabilities play a crucial role in improving advertising efficiency and other aspects. Many advertising companies may excel in business operations, but lack strong technical support; Many advertising technology teams may not have fully mastered strong business operation skills. After years of practice and accumulation, we have successfully integrated these two abilities. This is precisely why we are able to achieve significant growth, and we firmly believe that this will help us achieve sustained success in the future.
In 2023, intelligent hardware encountered certain challenges. How will the revenue of smart hardware recover and grow this year?
Zhou Feng: I will provide more details about the latest product release and some ideas for future development direction.
The release of Dictionary Pen A6 Pro far exceeded our expectations, with sales reaching 50000 units in the first week. In terms of product definition, the Dictionary Pen A6 Pro is equipped with the best display screen and content in the same price range, and supports high-quality offline translation, grammar teaching, word teaching and other large models. At the same time, our supply chain management is also very excellent, providing excellent quality and value at relatively reasonable prices. Tiktok live broadcast further promoted the sales momentum of the product.
It is worth noting that although A6 Pro is more cost-effective for consumers, its gross profit margin is almost the same as that of expensive products, and we will not sacrifice profits to increase sales. Due to our strong internal design capabilities and close collaboration with IC and other supply chain partners, we are able to maintain a competitive gross profit margin for this product. The Listening Treasure E6 has also achieved our expectations. This is a good start for the intelligent hardware team, and I hope the team will continue to launch excellent products in the coming months.
Looking ahead, we plan to launch a series of new products in Q1 and Q2. Looking back at our past products, we will find that we mainly focus on producing products with prices higher than the market average. However, our future plan is to expand our product range, covering different price ranges from high-end to mid to low end. We adopt this strategy because our team has accumulated rich experience and our supply chain has matured to ensure excellent quality and user experience even for low-cost products. Therefore, we are currently in the optimal period of utilizing a diverse product portfolio to attract a wider user base.
For more high-end products in the future, the combination of artificial intelligence and hardware has created a lot of value for users. For example, integrating large model functionalities into hardware is very attractive because as large model functionalities (such as grammar teaching) become increasingly popular, users naturally want to be able to use these functionalities on hardware because it is more convenient and response time is faster. A common question we are often asked is whether dictionary pens support offline translation, and the answer is yes. Offline translation ability is a key consideration for users when making purchases. Therefore, artificial intelligence and language processing capabilities in hardware are very interesting aspects in the high-end product field, and we have rich experience in these areas.
Finally, we restructured our sales channels and have now shifted towards a more online and flexible sales and supply chain structure. The recently released new products demonstrate the capabilities of our sales team. Thanks to the recommendation of Tiktok Live and Dabao, the new product has gained significant impetus after its launch. But our team still has a lot of work to do, as we plan to establish more new sales and marketing channels and optimize them. Nevertheless, the successful launch of the new product proves that our development direction is correct.
5. With the improvement of cash flow in 2023, can the management provide an outlook for cash flow in 2024?
Operating cash flow has always been regarded as a key indicator of a company's health, and we are pleased to note that our operating cash flow in 2023 has significantly improved compared to the past. The operating cash outflow in 2023 narrowed by nearly 20% year-on-year. It is worth noting that in the fourth quarter, the operating cash inflow reached a record high of approximately 161 million yuan, a year-on-year increase of 91%. This indicates that the business is moving towards a healthier direction. From the perspective of segmented markets, both learning services and online marketing services have achieved positive operating cash inflows, which gives us more confidence in further improving operating cash flows in 2024.
We expect that our operating cash flow will maintain this positive momentum by 2024. Firstly, we will continue to enhance our ability to generate cash inflows in 2024 by utilizing artificial intelligence technology and optimizing business operations. In addition, improvements in product performance and sales channel management are expected to enhance the cash generation capacity of the intelligent hardware segment market. It is also worth noting that cash flow shows quarterly changes, with stronger seasonality in the second and fourth quarters, mainly due to the acquisition and retention of users in the learning service business during that period.
In addition, in the long run, NetEase has been providing financial support for Youdao. For example, in our ER, we have disclosed NetEase's $300 million revolving loan line with a maturity date of March 31, 2027, which will contribute to the development of Youdao's business, especially in our long-term investment in core technologies.