Youdao : Third Quarter 2020 Earnings Conference Call (Transcript)

YOUDAO 3Q 2020 CONFERENCE CALL SCRIPT

Speaker dial in numbers:

China: 4001-201203

Toll free (US): 1-866-250-8117

Conference ID: 10149588

Operator introduction

Good day and welcome to the Youdao 2020 third quarter earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Regina. Please go ahead.

Regina Wang

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 US 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, including our annual report filed on Form 20-F. The Company does not undertake any obligation to update this forward- looking information, except as required by law.

During today's call, management will also discuss certain non-GAAP financial measures, for comparison purposes only. For the definitions of non-GAAP financial measures, and reconciliations of GAAP to non- GAAP financial results, please see the 2020 third quarter financial results news release issued earlier today.

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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.

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Feng Zhou

Thank you, Regina. 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.

Online education is more relevant today than ever before and it is profoundly transforming how people are learning. We accelerated our rapid growth momentum in the third quarter and generated total revenues of RMB896 million.

Gross billings from online courses reached RMB 955 million, up 228% year-over-year and 76% quarter- over-quarter, supported by our large-scale marketing and branding campaign. Growth in our K-12 segment was particularly strong reaching a record high. Gross billings from this group were RMB 676 million, up 369% and 120% year-over-year and quarter-over-quarter, respectively. K-12 paid enrollments reached 499K, up 52% quarter-over-quarter. The K12 gross billings' proportion of Youdao Premium courses increased to 77% from 67% in the same period last year. ASP for the K-12 segment was slightly down, primarily due to the increased proportion of primary school enrollments, which have relatively lower ASPs than our high and junior high school courses. Also, 22% of all newly enrolled students' gross billings came from organic traffic for Q3, which grew 188% year-over-year.

Gross margins also continue to improve with product improvements and larger scale. Overall gross margin was 45.9%, and the gross margin for our learning services was 53.9%, up 220 basis points from Q2. We expect to maintain the growth momentum of our GP margin, mainly due to further improvement on economy of scale.

We continue to strengthen our star instructor and TA teams. More than 70% of our current instructors come from Tsinghua University, Peking University, or a top 50 university in the world. This year, we hired only about 0.3% of all instructor candidates. We are committed to continue hiring elite instructors and to offer high-quality courses. Regarding TA teams, we continue to expand our capacity. Total TAs reached 3,368 at the end of Q3, at operation centers around the country.

Our K12 Math courses made significant progress in Q3. The number of paid enrollments for Math students in grade 1-12 increased in the third quarter by over 800% year-over-year. For primary school, we added more interactions in classes for key knowledge points. For junior high school, we started offering region- and-text-book-specific courses. For high school, several newly recruited star teachers are available for students to meet diverse demands.

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We released a new set of Kids' programming courses, including Python programming, and a custom hardware programming kit in Q3. Student retention exceeded 85% for our programming courses. We have two new videos available on our IR website about recent course development and our Interactive Large- Class model. I invite you to take a look if you are interested.

Q3 is the main quarter for our summer marketing campaign targeting the K-12 audience. In respect to our user acquisition strategy, our K-12 paid enrollments increased by over 400% on a year-over-year basis during our heightened summer campaign. The campaign included online performance advertisement, TV sponsorship and ads, and etc. In particular, we were the exclusive sponsor for a Hunan TV show named "Dingdong, Hello Teacher," (叮咚上线 老师好). The show was the most-watched show in its time slot across satellite channels. More recently in October, some of you may have seen our advertisement around the blockbuster movie Leap (夺冠 ).

We expect this marketing campaign to be the largest for FY 2020. In Q3, brand and performance advertisement spending on courses amounted to RMB 881 million. Although increased spending led to more short-term losses, it helped drive scale more quickly, and was done under strict unit economics requirements. We looked at front-loaded marketing spending in this quarter, and the total of expected returns over the next several quarters for each project to make sure it is healthy.

Turning to our adult segment, gross billings increased to RMB 201 million, up 185% YoY, and 34% QoQ. We continue our 2-fold strategy here. One, we focus on high-value courses, such as skill-learning and interest-oriented courses, and shift away from low-value courses such as college English. Second, we leverage our expertise in content development in this area to launch and quickly iterate new course offerings. Our staple courses continue to do well. For example, Logical English(逻辑英语) grew over 100% in gross billings YoY. Practical English Courses released this year including English Recitation Camp (背诵营) and Oral English Training (口语教练) have ramped quickly, which become the major component of our adult with over 7 times growth YoY in gross billings.

Our intelligent learning devices also grew at an accelerated clip in Q3, with revenues reaching RMB 163 million, up 289% YoY, and 89% QoQ. We shipped about 250K units of our Dictionary Pen 2.0, up 59% from Q2. Over 70% of our dictionary pens were purchased by or for a K-12 user. We continue to integrate software and hardware here to deliver even more seamless experiences. For example, you can now scan

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