Youdao(US:DAO)2024-04-25 10:38PART I Key Information This section details Youdao's corporate structure, including VIEs, and discusses associated risks, regulatory developments, and HFCAA implications - Youdao operates through a VIE structure due to PRC restrictions on foreign investment, with investors purchasing securities of a Cayman Islands holding company, not the PRC operating entities19 VIE Contribution to Total Net Revenues and Assets | Year/Date | VIE Revenues as % of Total Net Revenues | VIE Assets as % of Total Consolidated Assets | | :--- | :--- | :--- | | 2021 | 68.5% | N/A | | 2022 | 70.1% | 34.6% (as of Dec 31) | | 2023 | 77.0% | 49.3% (as of Dec 31) | - The PCAOB vacated its determination regarding auditor inspections in December 2022, mitigating immediate HFCAA trading prohibition risks, though future risks remain subject to annual review21221 - In 2023, VIEs transferred RMB 3,287.5 million (US$463.0 million) to PRC subsidiaries as service fees, though PRC restrictions may limit cash availability outside China2527 - Recent PRC regulations, including cybersecurity and overseas listing measures, introduce new filing requirements and potential reviews, creating uncertainty for future capital-raising activities3438169 Risk Factors This section details principal risks across business, VIE structure, PRC operations, and ADS holdings, including net losses, regulatory changes, and dual-class share limitations - The company recorded net losses of RMB 745.9 million in 2022 and RMB 550.1 million (US$77.5 million) in 2023, and may not achieve future profitability due to heavy investments82 - Compliance with PRC's "Alleviating Burden Opinion" materially affected the business, leading to cessation of K-9 Academic AST courses and ongoing regulatory uncertainty for non-academic tutoring7172 - The VIE structure faces substantial uncertainties under PRC laws, with potential severe penalties if contractual arrangements are deemed non-compliant, including forced relinquishment of VIE interests181185 - The PRC government may intervene in operations at any time, increasing oversight over overseas offerings, which could materially change the business and potentially devalue ADSs208211 - The dual-class share structure grants Class B shares three votes per share, with Class B shares representing 89.5% of total voting power as of March 31, 2024, limiting other shareholders' influence272273274 Information on the Company This section provides a comprehensive overview of Youdao's business, history, and organizational structure, detailing its evolution into a technology-focused intelligent learning company and its complex regulatory landscape - Following PRC regulatory changes, Youdao ceased its Academic AST Business in Q4 2021, completing its transition to a technology-focused intelligent learning company in 2022287 - In 2023, the company launched "Ziyue," China's first education-specific LLM, powering new AI-driven tools like 'Hi Echo' and 'Mr. P AI Tutor'287317 - The company's business is segmented into Learning Services, Smart Devices, Education Digitalization Solutions, and Online Marketing Services309 - As of March 31, 2024, Youdao holds 428 patents, 431 trademarks, and 328 copyrights in the PRC, forming its intellectual property base358 History and Development of the Company This section traces Youdao's key milestones, including its strategic shift to intelligent learning, recent AI product launches, corporate history, IPO, and a condensed consolidating financial schedule - The company completed its NYSE IPO on October 25, 2019, and raised approximately US$231.6 million in net proceeds from a February 2021 follow-on offering290 Condensed Consolidating Schedule - Total Assets (as of Dec 31, 2023) | Entity Group | Total Assets (RMB in thousands) | | :--- | :--- | | Youdao, Inc. | 2,943,626 | | Other Subsidiaries | 572,775 | | Primary beneficiaries of VIEs | 1,767,554 | | VIEs and their subsidiaries | 2,028,232 | Condensed Consolidating Schedule - Third-Party Net Revenues (FY 2023) | Entity Group | Third-Party Net Revenues (RMB in thousands) | | :--- | :--- | | Other Subsidiaries | 1,052,123 | | Primary beneficiaries of VIEs | 205,027 | | VIEs and their subsidiaries | 4,132,058 | Business Overview This section details Youdao's business as a technology-focused intelligent learning company, outlining its four main offerings, core technologies, revenue models, and the extensive PRC regulatory framework governing its operations - Youdao Dictionary, the company's flagship product, is China's leading language app with 45.8 million average MAUs in 2023304 - The company's core technologies include Optical Character Recognition (OCR), Neural Machine Translation (NMT), Automatic Speech Recognition (ASR), and its proprietary Large Language Model (LLM) "Ziyue"308 - Revenue is generated from sales of smart devices, learning service tuition, online marketing advertising, premium tool subscriptions, and technology licensing fees348349350352353 - The company is subject to extensive PRC regulations covering telecommunications, foreign investment, private education, data security, cybersecurity, and online content, significantly impacting its operations369376386430 Organizational Structure This section details Youdao's corporate structure, including its Cayman Islands holding company, PRC subsidiaries, and VIEs, outlining the contractual arrangements that enable control and financial consolidation, with VIEs contributing 77.0% of 2023 net revenues - The company's PRC subsidiaries, Youdao Information and Youdao Hangzhou, control the VIEs through contractual arrangements as foreign-invested enterprises510 - Contractual arrangements enable Youdao to be the primary beneficiary of the VIEs, allowing consolidation of their financial results under U.S. GAAP510 - Service fees charged by PRC subsidiaries to VIEs are a key mechanism for economic benefit transfer, amounting to RMB 2,881.0 million (US$405.8 million) in 2023510 Operating and Financial Review and Prospects This section provides management's discussion and analysis of Youdao's financial performance, covering results of operations, segment revenues, liquidity, capital resources, and critical accounting policies, with a focus on the strategic shift post-Academic AST Business disposal - The company disposed of its Academic AST Business in compliance with 2021 PRC regulatory changes, with historical results now reported as discontinued operations529596 Consolidated Results of Operations (Continuing Operations) | Metric (RMB in thousands) | 2022 | 2023 | % Change | | :--- | :--- | :--- | :--- | | Net Revenues | 5,013,182 | 5,389,208 | 7.5% | | Gross Profit | 2,586,416 | 2,767,462 | 7.0% | | Gross Margin | 51.6% | 51.4% | -0.2 p.p. | | Loss from Operations | (774,680) | (466,326) | 39.8% (Improvement) | | Net Loss from Continuing Operations | (739,778) | (550,117) | 25.6% (Improvement) | Net Revenues by Segment (RMB in thousands) | Segment | 2022 | 2023 | % Change | | :--- | :--- | :--- | | Learning services | 3,084,375 | 3,148,114 | 2.1% | | Smart devices | 1,256,446 | 909,192 | -27.6% | | Online marketing services | 672,361 | 1,331,902 | 98.1% | - The company had a working capital deficit of RMB 1,799.3 million as of December 31, 2023, relying on NetEase Group's financial support, including a revolving loan facility extended to March 2027612 Directors, Senior Management, and Employees This section details the company's leadership, compensation, board structure, and workforce, including director and executive officer information, share incentive plans, employee demographics, and major shareholder voting power - In 2023, aggregate cash compensation to directors and executive officers totaled RMB 17.5 million (US$2.5 million)650 - The company has two share incentive plans, with options to purchase 3,680,851 ordinary shares outstanding under the 2015 Plan as of March 31, 2024653659 - As of December 31, 2023, the company had 4,364 full-time employees, with 49.9% teaching staff and 23.0% in R&D677678 Major Shareholder Voting Power (as of March 31, 2024) | Shareholder | Total Voting Power % | | :--- | :--- | | NetEase, Inc. | 67.2% | | Peng Ke Holdings Inc. (Dr. Feng Zhou) | 20.6% | Major Shareholders and Related Party Transactions This section details major shareholders and related party transactions, primarily with NetEase Group, including services exchanged and significant outstanding loans as of year-end 2023 Key Related Party Transactions with NetEase Group (FY 2023) | Transaction Type | Amount (RMB in thousands) | | :--- | :--- | | Services and products provided to NetEase Group | 79,932 | | Services and products purchased from NetEase Group | 181,344 | | Interest expenses on loans from NetEase Group | 69,472 | Loans from NetEase Group (as of Dec 31, 2023) | Loan Type | Amount (RMB in thousands) | | :--- | :--- | | Short-term loans | 878,000 | | Long-term loans | 630,360 | Financial Information This section confirms the inclusion of consolidated financial statements, addresses legal proceedings, and outlines the company's dividend policy of retaining earnings for business expansion - The company plans no future dividends, intending to retain earnings for business operation and expansion695 Additional Information This section provides supplementary details on corporate governance, including the dual-class share structure, and outlines tax implications for holding ADSs or shares in the Cayman Islands, PRC, and United States, including PFIC risk - The company's dual-class share structure grants Class B ordinary shares three votes per share, while Class A ordinary shares receive one vote per share706 - The company believes it was not a PFIC for 2023, but its status is subject to annual determination and potential change based on asset composition and ADS market price283745 - If classified as a PRC resident enterprise, dividends to non-PRC enterprise shareholders and ADS sale gains could be subject to a 10% withholding tax727 Quantitative and Qualitative Disclosures About Market Risk This section discusses the company's exposure to market risks, primarily interest rate risk on cash holdings and foreign exchange risk due to currency mismatches, with inflation risk noted as a possibility - The company's primary market risks are interest rate risk on cash holdings and foreign exchange risk due to currency mismatch between RMB and USD755756 PART II Material Modifications to the Rights of Security Holders and Use of Proceeds This section details the full utilization of net proceeds from the 2019 IPO (US$213.2 million) and 2021 follow-on offering (US$231.6 million) for technology, marketing, and general corporate purposes - The net proceeds from the 2019 IPO (US$213.2 million) and 2021 follow-on offering (US$231.6 million) have been fully used for technology, product development, marketing, and general corporate purposes769772 Controls and Procedures This section confirms the effectiveness of the company's disclosure controls and internal control over financial reporting as of December 31, 2023, as concluded by management and attested by the independent auditor - Management concluded that as of December 31, 2023, the company's disclosure controls and procedures, and internal control over financial reporting, were effective774775 Other Information This section covers corporate governance, including audit committee expertise, accountant fees, share repurchase programs, foreign private issuer status, and the company's cybersecurity risk management program Principal Accountant Fees (RMB in thousands) | Service | 2022 | 2023 | | :--- | :--- | :--- | | Audit Fees | 8,200 | 8,200 | | Tax Fees | — | 90 | | Other Fees | 150 | 150 | | Total | 8,350 | 8,440 | - The company has a share repurchase program authorized for up to US$40.0 million, with approximately 6.6 million Class A ordinary shares purchased as of March 31, 2024785 - Controlling shareholder NetEase has a share purchase program for up to US$50.0 million of Youdao's ADSs, with approximately 2.7 million ADSs purchased as of March 31, 2024784 - The company's cybersecurity risk management program is overseen by a committee chaired by the CEO, reporting to the audit committee793 PART III Financial Statements This section presents the audited consolidated financial statements for Youdao, Inc. for fiscal years 2021-2023, prepared under U.S. GAAP, including the independent auditor's report confirming fair presentation and effective internal controls - The independent auditor, PricewaterhouseCoopers Zhong Tian LLP, issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting as of December 31, 2023807808 - A critical audit matter identified was the estimation of the average learning period for customer revenue recognition, due to significant management judgment814 Consolidated Balance Sheet Highlights (RMB in thousands) | Item | Dec 31, 2022 | Dec 31, 2023 | | :--- | :--- | :--- | | Total Assets | 2,276,156 | 1,666,195 | | Total Liabilities | 3,753,430 | 3,795,298 | | Total Shareholders' Deficit | (1,541,845) | (2,167,064) | Consolidated Cash Flow Highlights (RMB in thousands) | Item | 2022 | 2023 | | :--- | :--- | :--- | | Net cash used in operating activities | (603,123) | (438,145) | | Net cash provided by investing activities | 125,823 | 125,573 | | Net cash provided by/(used in) financing activities | 184,649 | (18,942) |