Youdao, Inc.

Good day and welcome to the YoDAF 2025 Second 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 YoDAF. Thank you and over to you.

Thank you, operator. Please note the discussion today will continue for 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 UDAH'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 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 recalculations of GAAP to non-GAAP financial results, please see the 2025 Second Quarter Financial Results News Release issued earlier today. As a reminder, this conference is being recorded. A webcast replay of this conference call will also be available on UDOT's corporate website at ir.udot.com. Join us today on the call from UDOT's senior management, Dr. Feng Zhou, our chief executive officer, Mr. Lei Jin, our president, Mr. Peng Su, our senior VP, and Mr. Wen Li, our VP of finance. I will now turn the call over to Dr. Zhou to review some of our recent highlights in a strategic direction.

Thank you, Jeffrey, 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 RMB, unless otherwise specifically stated. Strong execution of our AI-native strategy drove robust financial results in the second quarter, highlighted by our first profitable second quarter. Operating income was RMB 28.8 million, compared with an operating loss of RMB 72.6 million in the same period last year. Net revenues reached RMB 1.4 billion, an increase of 7.2% year-over-year. Operating cash inflow was RMB 185 million, down 26.1% year-over-year, primarily due to the strategic scaling back of certain STEAM and adult courses, which reduced the gross billions. Next, let's review our progress by business lines. Net revenues from learning services rose 2.2% year over year to RMB 657.8 million in Q2, given primarily by the strong performance of Youdao Lingshi. Within the learning services segment, net revenues from digital content services reached RMB 447.4 million. As a strategically focused initiative, achieved exceptional results, with net revenues growing approximately 30% year-over-year. On the product front, our large language model, Confucius, continued to power innovation. In Q2, we introduced the AI essay grading feature, designed in line with exam grading standards to provide comprehensive personalized evaluation and generates tailored feedback reports. The feature received widespread acclaim upon launch, driving Q2 retention rate above 75%, a historical high. We also leveraged LLM Confucius' capabilities to create personalized learning plans, further enhancing learning efficiency and outcomes. For our STEAM courses, we broadened enrollment channels, driving a year-over-year increase of roughly 15% in gross billings for programming courses. User satisfaction continues to rise, with Q2 retention rates hitting a record high of over 75%. Additionally, we signed 12 gold medalists from the National Olympics in Informatics to strengthen our top-tier teaching and R&D team, laying a strong foundation for future student services. On the app side, total sales of AI-driven subscription services rose approximately 30% year-over-year, to nearly RMB 80 million in Q2, setting a record high. During the quarter, we released Confucius 3, our latest education LLM powering our education and translation services. An open source Confucius 3 math, China's first reasoning model dedicated to math education. Combining large scale reinforcement learning with algorithmic innovations, Confucius 3 math delivers State-of-the-art accuracy with exceptional cost efficiency, 15 times the inference performance of DeepSeq R1 at just US dollar 0.15 per million tokens, well below typical LLM costs, enabling the low-cost deployment of professional-grade math AI applications. One notable milestone is Scholar AI launched in May, which has already attracted over 1 million cumulative users. Designed to support students and scholars in research paper writing, it offers AI-powered plagiarism detection, proofreading, and other tools to improve academic work. Powered by Confucius 3 math, we also upgraded our Mr. P AI tutor to achieve over 95% accuracy for K-12 math problem solving and tutoring. Mr. PAI Tutor received the Gold Me Award, the highest honor granted to developers on the Xiaomi App Store. Additionally, Yu Dao Dictionary was named the China's top 50 most valuable AGI innovators in 2025. Moving to our online marketing services segment, Q2 net revenues reached a record RMB 632.9 million, up 23.8% year-over-year. driven by strong demand from the gaming industry and Chinese clients expanding overseas. The growth margin was 25.8%, down 13 percentage points from a year ago, primarily due to the initial onboarding of new clients. We continue to expect this segment's growth margin to stabilize in the 25% to 35% range over the medium to long term. Gaming was a highlight this quarter. We deepened the collaboration with NetEase Games and other gaming advertisers on both domestic and overseas campaigns, driving gaming ad revenue growth of more than 50% year-over-year, a trend we expect to sustain under stable macroeconomic conditions. On the product front, we continue to invest in GenAI-powered advertising technologies, we launched the AI App Placement Optimizer in Q2, an end-to-end AI-driven agentic solution covering demand analysis, strategy formation, data analytics, and iterative optimizations. We also significantly upgraded our antifraud system to enable real-time diagnosis and automated monitoring of ad delivery, including traffic requests, clicks, and conversions, improving service quality and strengthening our risk control framework. These advances build on iMagicBox, our AI creative generation product introduced in Q1. Our team continues to move quickly in the J&AI powered ad technology space, delivery fully integrated services from creative production and placement to post campaign analytics We believe we are still in the early stages of a new cycle in which GenAI will create substantial value for advertisers and fuel our long-term growth. We see significant growth potential in the advertising business, in gaming, e-commerce, overseas markets, and GenAI applications, and remain focused on capturing these opportunities to build a strong foundation for sustained growth. Next, in our Smart Devices segment, business health improved in Q2, while net revenues declined 23.9% year-over-year to IMB 126.8 million, primarily attributable to two factors. First, certain high-end dictionary pain models approached the end of their product life cycles during the quarter. Second, we reduced the marketing expenditure in hardware prioritize business health at this stage. Within this segment, we focused on Udall Dictionary PAN, which maintained its market leadership, securing the number one spot in sales on JD.com and Tmall during the 618 Shopping Festival for the sixth consecutive year. We also expanded our mid-range coverage with the launch of Udall Dictionary PAN S7 Pro and A7 in Q2. Looking ahead, I remain confident in the long-term potential of AI-powered devices. I'm excited to share that we will be unveiling a new AI-powered smart device next week. Please stay tuned. Before I conclude, let me quickly recap a strong first half. We significantly enhanced our large language model portfolio, launching Confucius 3 and open sourcing both Confucius 01, and Confucius 3 Math. Our learning services hit new heights, with Lingshi achieving a 75% retention rate and the launch of successful new AI apps like Scholar AI. In advertising, we expanded our customer base, deepened the relationships with key accounts, and deployed more Gen AI capabilities, fueling strong Q2 growth. Financially, H1 total net revenue reached RMB 2.7 billion, up slightly year-over-year, while operating income surged to a record RMB 132.8 million from a loss of RMB 42.6 million a year ago. Looking ahead, we will continue to advance our AI-native strategy, driving scenario-based optimizations of our large language models and agents to serve both learning and advertising customers. Our goal is clear. Enhance learner productivity and deliver higher return on advertising with industry-leading AI technology and operational expertise. We remain committed to sustainably create customer values while further strengthening our financial performance. With that, I will hand over to Supong for a deeper dive into our financial results. Thank you.

Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights from the second quarter of 2025. We encourage you to read through our press release issued earlier today for further details. For the second quarter, total narrow annual RMB 1.4 billion, or US dollar, 197.9 million. representing a 7.2% increase from the same period of 2024. Net revenue from our learning services were RMB 657.8 million, or US dollar 91.8 million, representing a 2.2% increase from the same period of 2024. Net revenue from our smart devices were RMB 126.8 million, or US dollar 17.7 million, representing a 23.9% decrease from the same period of 2024. Net revenue from our online marketing services were RMB 632.9 million, or US dollar, 88.3 million, representing a 23.8% increase from the same period of 2024. The year-over-year increase was mainly attributable to the increased demand from the gaming industry and overseas markets, which was driven by our continued investment in AI technology. For the second quarter, our total gross profit was RMB 609.4 million, For U.S. dollar, $85.1 million, representing a 4.3% decrease from the same period of 2024. World's margin for learning services was 59.8% for the second quarter of 2025, compared with 60% for the same period of 2024. World's margin for smart devices was 41.5% for the same quarter of 2025, compared with 30.3% for the same period of 2024. Gross margin for online marketing services was 25.8% for the second quarter of 2025, compared with 39.1% for the same period of 2024. For the second quarter, we reduced our total operating expense to RMB 580.6 million, or US dollar 81 million, compared with RMB 709.3 million for the same period of last year. Looking at our expense in more details, Sales and marketing expense declined to the RMB 401.8 million, compared with RMB 515.7 million in the second quarter of 2024. Research and development expense was decreased to the RMB 128.3 million, compared with RMB 153 million in the second quarter of 2024. Our operating income margin was 2% in the second quarter of 2025, compared with operating loss margin of 5.5% for the same period of last year. For the second quarter of 2025, our net loss attributable to the ordinary shareholders was RMB 17.8 million, or US dollar 2.5 million, compared with RMB 99.5 million for the same period of last year. Non-GAAP net income attributable to the ordinary shareholders for the second quarter was RMB 12.5 million, or US dollar 1.7 million, compared with non-GAAP net loss attributable to the ordinary shareholders of the RMB 96 million for the same period of last year. Basic and dilute net loss per ADS attributable to the ordinary shareholders for second quarter of 2005 were RMB 0.15 or US dollar 0.02. Non-GAAP basic and dilute net income per ADS attributable to the ordinary shareholder for second quarter was RMB 0.11 or US dollar 0.02 and RMB 0.1 and or US dollar 0.01, respectively. On net cash provided by the operating activities, was RMB $185 million, or $25.8 million for the same quarter. Looking at our balance sheet as of June 30, 2025, our contract liabilities, which mainly consists of deferred revenue generated from our online learning services, were RMB $856.7 million, or $119.6 million, compared with RMB $961 million as of December 31, 2024. At the end of the period, our cash, cash recurrence, current and non-current risk-free cash, and short-term investment, total NB 670 million, OUS dollar 86.1 million. This concludes our prepared remarks. Thank you for your attention. We would now like to open the call to our questions. Operator, please go ahead.

Thank you. We will now begin with the question and answer session. To ask a question, you may press star and then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and then 1, sorry 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from the line of Vicky Wei from Citi. Please go ahead.

Thanks, management, for taking my question. Could management provide an update on the third quarter outlook for Yudao Lingshi? Thank you.

Thank you. Thank you for your question. This is Pengsu. I will handle the question first. And in Q2, Yudao Lingshi keeps growing year over year, with revenue increasing by roughly 30%. The retention rate exceeds about 75%, reaching a record high. It indicates that the users' satisfaction for our products also reaches a record high level. It is a solid foundation for the subsequent development, we believe. With Allure, we think it's a key initiative of the application education scenarios by our large library model computers. In the second half of this year, we will continue to leverage the robust capability of the computer's large library model to further enhance the products and services quality and expand our user space. Regarding on the product updates, the two major developments are planned for the second half of this year. First is the AI assay grading features rolled out in the Q2 this year, which provides the users with professional Chinese assay feedback. It's specialized targets and timely grading has received positive feedback from our users. In the second half of this year, we will expand the AI's ASCII grading to cover the English AS well, enabling the users to more efficiently improve their English writing skill. Second, we will launch the AI tutoring powered by Confucius as well. It offers a more timely and tailor-made and precise assistance to the users, helping them to resolve the questions and improves the learning efficiency and outcomes. In terms of the user acquisitions, since our AI interactive courses format was introduced in 2022, users' learning outcome has been shown as sustained and rapid improvements. This all ensures reputations among the users continue to strengthen, which will help us to serve more users in the future. Additionally, we are actively expanding the acquisition channels and have achieved positive results in exploring localized user acquisition strategies. In summary, we think we feel very comfortable about the products of the UDAO Linkshu right now. And we will definitely keep investing for the technology as well as the updates about the quality of all the products. And we are confident that the UDAO Linkshu will maintain the momentum in the second half of this year and in the future. I hope that answers your question. Thank you.

Miss Vicky, does that answer your question?

Thank you.

Thank you. Our next question comes from the line of Jing Yuan from China International. Please go ahead.

Hello, thanks for taking that question. My question is about the smart device segment. I wonder will the smart device segment deal with your revenue decline in this quarter, see some improvement in the second half of this year?

Thanks. Yeah, I'll take this question. So for the full year of 2020, the main focus or objective for the smart device segment is to further improve business health So although the revenue declined in Q2, but encouraging in both Q1 and Q2, the health of our hardware business improved compared with the same periods last year. So from a product strategy and also growth standpoint, so we will continue to focus on dictionary pens and also our new category this year, tutoring pens. We think both these categories present a lot of opportunities for growth in the future. So the dictionary pen market, we are both the pioneer and also the clear market leader, ranking number one. So in sales for five consecutive years. So the tutoring pen, That's a new category we introduced earlier this year. So what's interesting about Deuterium PENs is that because of the use of our large language model, Confucius, so it is able to address key pain points in math and other subjects, basically all subjects in K-12 learning. And in particularly for middle school and high school students. So I think that's a very important segment of market. And the product, what we see is that it already resonates strongly with both students and parents. So we think this is a market with significant growth potential. Next week, as I just said, we will launch a new tutoring, new product. I can say it's a new tutoring product. So we expect its enhanced user experience to drive improvements in the segment metrics in the second half of this year. So I'd also like to share two points regarding the the long-term development of our device business. First, I remain optimistic about the medium to long-term prospects of AI-powered hardware. According to RU&TO Rentalkeji, China's AI hardware market, excluding smartphones and cars, is projected to exceed RMB 1 trillion for the first time in 2025, and is expected to maintain a compound annual growth rate of 18% for the next five years. Of course, that contains a lot of categories, but for educational smart device specifically, the report predicts the market size to be expected to be RMB $34 billion in 2025. So that's a sizable market, and it's expected to grow further. So leveraging our strong AI capabilities, we will continue to broaden the application scenarios of our smart hardware and work to improve users' learning and work efficiency and outcomes. So that's one. The second point I want to make is that we see great potential for deepening the synergy between hardware and our learning services. So for example, our tutoring plan can accurately identify users' learning profile, such as whether he's in elementary, middle, or high school, or all his actual learning needs, specific needs. So with that level of precision, we can expand the hardware and our learning services integration to unlock more cross-selling opportunities. So this approach also helps reduce our overall sales and marketing expenses and improving operational efficiency. If you look at our overall sales and marketing to revenue ratio in Q2, it was 28%. It's already done roughly 11 percentage points year over year. So we see further room for improvements and partly so when we work on the integration of hardware and our learning services. Yeah, thank you.

Got it, thanks.

Thank you. Our next question comes from the line of Thomas Chong from Jefferies. Please go ahead. Really sorry to interrupt Mrs. Thomas Chong. Really sorry to interrupt. We are not able to hear you clearly. If you're using any external headset, may we request to use the speaker mode please? Sorry, the handset mode.

Hi, good evening. Thanks, management, for taking my question. My question is about app pricing. What are the specific applications of AI app placement optimizer in app pricing, as well as the potential impact on future financial metrics? Thank you.

Hi, this is Jinlei. Thank you for your question. The application scenario of AI AD placement optimizer covers the entire advertising delivery process. Prior to AD delivery, AI AD placement optimizer can conduct intelligent 24-7 Q&A with customers by analyzing protocol delivery data through our DMP. It automatically explores target audience and traffickers' dreams. while intelligently generating sufficient audience targeting strategies. Post-AD delivery. Leveraging company data and our large language model, Confucius. AI AD placement optimizer intelligently generates, delivers diagnostics and attribution analysis reports. Those output drivers iteratively Optimization for subsequent audience targeting and strategy deployment, making advertising simpler and smarter. AI AD placement optimizer enable end-to-end AI decision making throughout the advertising workflow. Demand analysis, strategy formulation, intelligent delivery, data analytics and attribution, and optimization iteration. The data processing capacity significantly exceeds human capabilities, operating 24-7 with faster iteration cycles. The solution launched at the end of Q2 and has been deployed to several advertisers in programmatic advertising campaigns, receiving positive feedback. Furthermore, integrated with Magic Box that's launched earlier this year. We delivered a comprehensive AI-powered support across the full advertising lifecycle. From creative development and material production to deliver attribution and optimization iteration, leveraging our Rambus AI capabilities. Medium to long-term, AI AD placement optimizer will support both advertising revenue growth and profitability improvement for us. Firstly, it will enhance advertisers' return on investment, driving increased budget allocation from existing clients on our platform. Concurrently, border adoption will expand our advertiser base, Those factors collectively accelerated our advertising revenue growth. Secondly, the solution identified cost-efficient, high-quality traffic while maximizing data utilization from our DMP, thereby strengthening the profitability from our online marketing services segment. Thank you. Thanks.

Thank you. Our next question comes from the line of Bosan from Huatai Securities. Please go ahead.

Thanks for the management. This is Shandor from Huatai. During the year of your decline in operating cash inflow during Q2, do we have any revision on the target for achieving operating cash flow break-even this year? Thank you.

As you have noticed, we generated operating cash flow of RMB 185 million. Although this represents a decrease compared to the same period of last year, it does not alter our annual target of achieving operating cash flow even. This is primarily related to the following factors. First, our profitability has been improving, indicating sustained long-term cash flow enhancement. From the profitability perspective, we achieved operating profit of around $133 million in the first half of this year, a significant improvement in financial health compared to the loss of RMB 42.6 million in the same period of last year. This profit improvement stems from our continuous enhancement of product and service capabilities through AI technology and the reduction in operating expenses, which will inevitably lead to cash flow improvement over the long term. In the second half of this year, we will continue leveraging our AI advantages to enhance operational efficiency and optimize cost and expenses. We are confident in achieving accelerated operating profit growth for the full year of 2025. Second, our operating cash flow demonstrates improvement from the year-over-year base basis in the first half of this year, compared to operating cash outflow of RMB 140.8 million in the first half of 2024. We saved approximately RMB 70 million in the first half of this year, representing an improvement of around 50%. Thirdly, our operating cash flow exhibit Q1 is typically the weakness quarter within a year due to the payment for last year's annual bonus, excluding additional investments in our key initiatives, such as AI technology and the Youda Lusheng. The cash flow performance in the second half of this year is expected to be stronger than the first half. The relatively slower pace of cash flow improvement compared with the operating profit growth is mainly linked to the change in our business mix. Previously, our faster growing segment was learning services, which operates on a prepayment model which typically results in cash flow improvement preceding profit improvement in our income statement. In the recent quarters, the learning services segment is in a proactive transition, while the faster-growing segment is our online marketing services. Advertising business usually involves granting advertisers a correct period, which typically brings one or two quarters back when comparing the profit results with the cash flow performance. While developing the business, We always strictly control our credit policy in order to improve our cash flow position. In summary, despite the uncertainty of competition and the macro condition, we are confident in achieving the target of operating cash flow breaking even this year. Thank you.

Thank you.

Thank you. Our next question comes from the line of Linda from Macquarie. Please go ahead.

Hi, management. I have two questions. The first one is regarding for as an advisor. In the announcement, you also mentioned about the strong growth coming from M&E and coming from overseas markets. Can you elaborate more about the growth driver behind these two recommendations and what is your outlook for 2026? The second one is for the buyback. We noticed that the 14 million buyback of our region, we almost used up. And do we have any, like, a new buyback scheme? Thank you.

Hi, Linda. It seems there is some connecting issue. Would you please kindly repeat your questions again? Thank you.

Okay. The first one is about enterprise loans. So I just want to know that whether you can give us some detail regarding for a gaming and overseas market and where is the outlook for 2026? The second one is about the share buyback because we used 33.8 million. And so do we have any new schemes because it's close to all 14 million of our arrangement? Thank you.

Sure, I'll take the question first. So you're asking about the gaming advertisement and overseas. So gaming is doing really well in Q2. So we talked about the revenue from gaming actually increased 50% year over year. And so we serve the top game providers in China, both in the domestic market and also overseas. And NetEase Games, and along with several other game providers, are both growing quickly as our client. And for games, we do both brand-oriented KOL marketing and also the more performance-oriented advertising. So both are growing nicely. So that's a very quick update on games. Overseas market, as you know, we signed partnerships with TikTok last year and with Google this year. And both partnerships are going on well. And we are also working. So one update I can provide regarding Google is that revenue with Google has increased triple digit percentage wise. So overseas it also contributes to our growth significantly. So that's for overseas. Regarding the buyback, Do you have anything?

Yeah, hi. This is Supong. I think I will handle the second question first. And for the share buyback, yes, we do announce about 40 million share buyback plans about several quarters ago. And right now we still, you can base on my findings, you know, we still have several million still left. And we still will process the rest of our budget for the share buyback next few quarters. And secondly, as my colleague mentioned about in the call, and we feel very confident about, we can definitely receive the full year operating profit in this year. So that means we can have more capability on our financial balance sheet to process a new plan maybe in the next few quarters. But that depends on the market as well as depends on the investment in technology especially. We think that will be spent more money and that will be more meaningful investment in the long run. So we definitely will take care clearly of our CEO balance sheet and looking for the best strategies to balance the investment as well as the share buyback plan in the future. I think I hope to answer your second question. And for the first question, I just added some more colors, a little bit more colors for Dr. Zhou's comments. And, you know, because in our announcement, press announcement, we mentioned about the growth of the advertising in Q2 is because of the growth of the business in the gaming industry and overseas market. And if you see the trend of the gaming markets, the peak season roughly is in the second quarter and third quarters. and especially in the third quarters. So for the trend of second half of this year, we expect we can just accelerate about growth for the advertisement. So I think that will be domestically for the gaming as well as the market in the overseas. So I think that is the trend, share a little bit of trend, all the colors of the advertisement business for the ODA. Thank you.

Thank you very much.

Thank you. This concludes our question and answer session. I would like to turn the conference back over to the management for closing comments.

Thank you once again for joining us today. If you have any further questions, please feel free to contact us directly or reach out to Pearson Financial Communications in China or the U.S. Have a nice day.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.