Youdao, Inc.

Good day and welcome to UDAO third quarter 2025 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 UDAO. Please go ahead.

Thank you, operator. Please note the discussion today will contain four roles. related to the future performance of the company, which are intended to qualify for the safe harbor fund 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, and substance 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 UDAO'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 reconciliations of GAAP to non-GAAP financial results, please see the 2025 Third Quarter Financial Results Release issued earlier today. As a reminder, this conference is being recorded. A webcast replay of this conference call will also be available on UDAO's corporate website at ir.udao.com. Joining us today on the call from UDAO's Senior Management are Dr. Feng Zhou, our Chief Executive Officer, Mr. Lei Jin, our President, Mr. Peng Su, our Senior VP, and Mr. Wayne Lee, our VP of Finance. I will now turn the call over to Dr. Zhou to review some of our recent highlights and strategic direction.

Thank you, Jeffrey. Thank you all for participating in today's call. Before we begin, I would like to remind everyone that all is based on RMB, unless otherwise stated. In the third quarter, our strategically prioritized businesses, and online marketing services delivered a strong momentum, supporting our long-term growth trajectory. Net revenues reached RMB 1.6 billion, up 3.6% every year. Operating profit was RMB 28.3 million, a decline of 73.7% year-over-year, primarily due to two factors. First, following the significant operating profit improvements in the first half of the year, we increased investments in new dollars and our online marketing services in Q3 to accelerate medium to long-term expansion. Second, We faced a high comparison base from the same period last year due to a one-off impact from the STEAM courses. Our restructuring of the learning services segment is now complete. For the first nine months of the year, operating profit reached IMB 161.1 million, representing a substantial 149.2% year-over-year increase and highlighting the meaningful progress we have made in enhancing our profitability. Notably, we have now achieved operating profits for five consecutive quarters, the first in our history. From a cash flow perspective, operating cash outflow for the quarter was RMB 58.6 million, an improvement of 31.4% year-over-year. Next, I will delve into the major developments across our businesses. The revenues from the learning services segment were RMB 643.6 million, 1 million, down 16.2% year-over-year, reflecting our disciplined and strategic approach to customer acquisition as we focus on growing the LingXu business. Within the learning services segment, net revenues from digital content services were RMB $425.9 million during the quarter, and our achievements in digital learning have gained international recognition. Youdao was included in the 2026 GSV150, a list that highlights the world's most transformational growth companies in digital learning and workforce skills, selected from more than 3,000 global companies. Turning to Youdao Lingshi, one of our key strategic businesses. We made solid progress during the quarter by diversifying its customer acquisition channels. Lingshi accelerated, achieved over 40% year-over-year growth in gross billions. More recently, retention rate has exceeded 75%, up from over 70% in the fourth quarter of last year. In addition, as part of our broader commitment to cultivate innovative talent, we collaborated with the Yao Mathematical Science Center at Tsinghua University, Tsinghua University's Qiu Chengtong Mathematical Science Center. providing technical support to a platform designed to identify and support mathematically gifted students. The system is currently being piloted in top-tier schools, with a national rollout planned following further refinements. In terms of our programming courses, we introduced an AI tutor for live programming classes in the third quarter, featuring a lifelike avatar and supporting both text and voice interactions. The AI Tutor helps answer students' questions in real time, significantly enhancing the overall learning experience. With ongoing product upgrades, gross billings for our programming courses increased by more than 30% year-over-year in Q3. Additionally, we continued our deep collaboration with the China Computer Federation, CCF, and are honored to have become a golden partner. On the app side, Total sales of our AI-driven subscription services reached a new record of approximately RMB 100 million in the third quarter, representing over 40% year-over-year growth. We launched our Confucius 3 translation model, which supports real-time bidirectional translation across 38 languages and offers advanced multi-model capabilities. Despite its compact parameter size, Confucius 3 translation delivers translation quality that surpasses some larger general-purpose models. In August, our Confucius 3 series LRM was among the first to receive the highest-level trusted AI education large language model certification from the China Academy of Information and Communications Technology. Regarding product development, we introduced a major upgrade to our flagship Youdao dictionary app UDAW Dictionary 11, delivering a truly AI-native experience that has been met with widespread user acclaim. A key highlight is the fully redesigned AI simultaneous interpretation feature. Powered by industry-leading noise reduction technology in our proprietary turn detection algorithm, it achieves top-tier voice translation accuracy with exceptionally low latency. The feature also received one-click summarization of translated content and automatically generates mind maps, significantly improving user efficiency across both learning and the work scenarios. These enhancements have been well received, driving over 200% year-over-year growth in sales of the AI simultaneous interpretation feature during the third quarter. To date, more than 20 million users have engaged with this capability. We have launched a new AI audio and video translation product, UDAO AnyDump, in the third quarter to automate multilingual production of content such as TV shows, marketing videos, and more. It leverages our proprietary adaptive voice cloning technology to learn a speaker's vocal characteristics and generates a natural, fluent, and emotionally rich tone. The system delivers optimal translation results by holistically considering key factors, including voice, speaker identity, and even video scene transitions, to produce dubbing that is more accurate, contextually aligned, and precisely suited the creator's intended purpose. Turning to our online marketing services segment, growth accelerated in the third quarter. Net revenues reached RMB $739.7 million, a new record and an increase of 51 year-over-year. The strong performance was primarily driven by increased demand from the NetEase group and overseas markets, which was driven by our continued investments in AI technology. Gross margin for the segment was 25.4% in Q3, moderated roughly 10 percentage points year-over-year, but largely stable sequentially. remaining within our long-term target range of 25% to 35%. We continue to rapidly expand our new client base during the quarter to support future growth. Advertising revenues from the gaming industry, mainly contributed from NetEase, grew by over 50% year-over-year. We assisted NetEase Games with a growing number of programmatic advertising and influencer marketing campaigns. For example, in promoting the blockbuster title, Where Winds Meet, we executed comprehensive integrated marketing strategy that generated over 500 million video views and more than 21.4 million live streaming exposures. Looking ahead, we plan to further deepen our collaboration with the NetEase Group and other game clients to unlock additional synergies. Our overseas advertising business also delivered strong momentum, with revenues growing by more than 100% year-over-year. We are pleased that our BYD WonderLife Global Influencers co-creation campaign received the Brands and Creators Award at the YouTube Works Awards China. Looking ahead, we plan to further deepen our collaboration with Google and with global advertisers to better support Chinese companies in expanding their global presence. We continue to drive improved advertising performance by our AI Ad Placement Optimizer. It is an end-to-end AI-powered agentic solution covering demand analysis, strategy formulation, data analytics, and iterative optimization. In addition, I am thrilled to share that we will launch AI Ad Placement Optimizer version 2 by the end of this year. Please stay tuned. Moving to our smart devices segment, net revenues were RMB 245.8 million during the quarter, down 22.1% year-over-year. This reflects our strategic decision to exercise greater discipline in marketing expenditures. Focusing on strengthening the segment's operational health, As a result, we saw year-over-year improvement in the segment's fundamentals during the third quarter. Product-wise, we launched a new tutoring plan, UDAO Space X, which offers precise scanning for long-form and multi-graphic problems, AI-powered video explanations for academic problems, and an AI-based mistake ledger. These features empower students to learn and review subjects more effectively and efficiently. Our dictionary pane and tutoring panes were also featured at the World AI Conference, receiving strong exposure to new audiences and coverage from multiple media outlets. Looking ahead, we will continue executing on our AI-native strategy with a focus on deepening the application of and innovating with our large language model, Confucius. across both our learning and advertising businesses to consistently create value for our customers. Financially, we will maintain disciplined operations and remain confident in achieving the four-year targets set at the beginning of the year, including robust year-over-year operating profits growth and reaching annual operational cash flow break-even for the first time. 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 third quarter of 2025. We encourage you to read through our press release issued earlier today for further details. For the third quarter, total net revenue will be 1.6 billion. All U.S. dollar, 228.8 million. representing a 3.6% increase from the same period of 2024. Net revenue from our learning services, RMB $643.1 million, or U.S. dollar, $19.3 million, representing a 16.2% decrease from the same period of 2024. The year-over-year decrease was primarily attributable to our decisions to take a disciplined, strategic approach to customer acquisitions, which plays a greater emphasis to a high ROI . We believe this strategy has enhanced the overall resilience and operational efficiency of our business, despite the short-term revenue decline. Net revenue from our smart devices were RMB $245.8 million, or USD $34.5 million, representing a 22.1% decrease from the same period of 2024. Our net revenue from our online marketing services were RMB $739.7 million. For U.S. dollar, $103.9 million, representing a 51.1% increase from the same period of 2014. The year-over-year increase was primarily driven by the increased demand from the net-ease group and the overseas markets, which was driven by our continuing investment in AI technology. For third quarter, our total gross profit was RMB $687.9 million, or US$96.6 million, representing a 12.9% decrease from the same period of 2004. Gross margin for learning services was 58.5% for the quarter of 2025, compared with 62.1% for the same period of 2004. Gross margin for smart devices was 50.3% for the quarter of 2025, compared with 42.8% for the same period of 2004. Gross margin for online marketing services was 25.4% for the third quarter of 2025, compared with 36.3% for the same period of 2024. For the third quarter, we reduced our total operating expense to RMB $659.6 million, for US dollar, $92.7 million, compared with RMB $682.2 million for the same period of the last year. Looking at our expense in more detail, Sales and marketing expense declined to RMB 487.7 million, compared with RMB 519.6 million in the third quarter of 2024. Research and development expense were RMB 127.8 million, compared with RMB 119.6 million in the third quarter of 2024. Our operating income margin was 1.7% in the third quarter of 2025, compared with 6.8% for the same period of last year. For the third quarter of 2025, our net income attributable to ordinary shareholders was RMB $0.1 million, or US dollar near to zero, compared with RMB $86.3 million for the same period of last year. Non-GAAP net income attributable to the ordinary shareholder for the third quarter was RMB $9.2 million, or US dollar $1.3 million, compared with RMB $88.7 million for the same period of last year. Basically, I dilute the net income per ADS attributable to the ordinary shareholder for the quarter of 2025 was near zero. Non-GAAP basic and net income per EDS attributable to the ordinary shareholder for the quarter was RMB 0.08, or US dollar 0.01. Our net cash used in the operating activity was RMB 58.6 million, or US dollar 8.2 million for the sub-quarter. Looking at our balance sheet of the September 30, 2025, Our contract liabilities, which mainly consist of the deferred revenue generated from our loan services, were RMB $751.1 million, or U.S. dollar $105.5 million, compared with RMB $661 million as of December 31, 2024. At the end of the period, our cash equivalents, current and uncurrent restricted cash, and short-term investment totaled RMB $557.7 million, or U.S. dollar $78.3 million. This concludes our prepared remarks. Thank you for your attention. We would now like to open the call to your questions. Operator, please go ahead.

Thank you. This is the Coral School Conference operator. We will now begin the question and answer session. Anyone who wishes to ask a question may press star and one on the touchtone telephone. From the question queue, please press star and two. Please pick up the receiver when asking questions. Anyone who has a question may press star and one at this time. First question is from Brian Gong City.

Thanks, Madison, for taking the question. A very good question for our strategists ahead. So our marketing services are growing rapidly, kind of showing a different trend versus no new services. From strategy perspective, will online market services become more important than learning services in the future?

Thank you. Hi, Brian. So right now we are experiencing a higher growth for ads compared with learning services. In the long term, we actually see great opportunities on both areas. So let me explain that for you. So the strong expansion of our Marketing services over the past three years have been mostly driven by, first, our advanced ad tech and AI capabilities, then customers trained to transition from traditional ads to performance ads, and finally, opportunity of overseas ads. Since the advertising revenue first exceeded RMB 200 million in a single quarter in Q4 2022, It has reached a record high of over 700 million this quarter, so representing a year-over-year increase of more than 50%. So as we've discussed several times on this call, we believe our advertising business is doing the early days. The application of generative AI and agentic AI in online advertising is only just beginning. we see 2025 as the first year when generative VM agent tech AI will be put to work on ads at scale. So we launched our iMagicBox ads creative platform in Q1 and our AI ad placement optimizer and ad automation agent in Q2. These AI-driven improvements in delivering the ads have strengthened the customer satisfaction already, which in turn encourages advertisers to allocate larger budgets to our platform, accelerating our growth from a customer expansion perspective. We continue to see substantial opportunities across online games, e-commerce, overseas online games, overseas electronics and through our deepening collaboration with partners such as Google and TikTok. So with all these reasons, we believe these will all drive strong app revenue growth for the coming years, hopefully. So on the other side, We also see a very good growth opportunities in our learning services business. This part of our business, as you probably know, has undergone quite significant changes over the past two years, largely because we actually believe there is tremendous long-term potential to see AI-driven online services. So AI is a decade-long growth trajectory, and cap chain rates require us to build and scale truly AI-native services and application, and that's what we've been doing. So on AI-driven subscription services, so this part, we began sharing our progress since last year, and the trajectory is very promising. So total sales of AI-driven subscription services amounted to approximately RMB 50 million in the first quarter of last year, if you remember. So it took us only six quarters to double that figure, reaching approximately RMB 100 million this quarter. So we are actively developing new features, applications, and agents to support future expansion. A lot of agents are running inside our companies to improve our business efficiency. So we see ample product optimization opportunities ahead and expect the growth to continue. In the digital content segment, the learning content, we have fully completed the restructuring and have sharpened our focus on the Lingxi business. In Q3, UDarling should deliver over 40% year-over-year growth in growth billions and demonstrated strong user stickiness and retention rate exceed 75%. So adding all that up, in the near term, we expect, actually we expect net revenues from the entire learning services segment to return to year-over-year growth. So in summary, we remain firmly committed to driving growth across both our marketing and advertising businesses by continuing to serve our customers better and also leveraging AI technologies better. Yeah, thank you. Thank you.

Next question is from Linda Huang, MechWire.

Hello, can you hear me?

Hello? Yes, yes, we can hear you.

Yes, yeah, so thank you very much for this opportunity. So my question is regarding for the online advertisement. Because it seems the second quarter this year, we noticed that the gross margin below 20, I think below 30%, maybe around like a 25%. So I just want to know that does the manager have any plan or like a timeline we can return back to the above 30% and what we need to do to make sure that our margin can recover. So that's for online marketing. Thank you.

I'll answer this briefly before Jinlei provides more details. We always operate with a long-term view and aim to increase the value we create for advertisers. We think that's most important. So in Q3, we saw strong opportunities to grow the customer base. So we chose to engage and onboard more customers. And that is reflected in the revenue growth. You can see very, very quick revenue growth. On the flip side of that, we basically gave up some short-term growth margin as new customers are less profitable. And sometimes even we operate at a loss for particular important customers. So that is actually also true, I believe, for the learning side of the business. I just want to mention in Q3. So we invested in hiring more personnel for expanding our Lingshi across business in Q3, also for future growth. We believe this kind of investment are very good investments, and we have solid and profitable unit economics. We ensure we have that. And we think investments like these are going to translate to growth and profitability in the coming quarters.

Hi, this is Zimek. Regarding the gross margin of our online marketing services business, The major parts are adopting the performance-based advertising pricing model and the growth method revenue recognition, which necessitates a balance between delivery value to our clients and sustain our own healthy long-term development. Against this backdrop, we consider a growth margin within the range from 25% to 35% to be a reasonable target. Our current objective is to drive an improvement in gross margin, which we aim to achieve through several key initiatives. First, we plan to burden the application of the iMagicBox creative production platform throughout the AD creation process. Compared to manual creation production, and Magicbox reduced production costs by approximately 70% while improving production efficiency. By leveraging our end-to-end data chain to identify and analyze high-performing creatives, we can scale the application, better serve our clients, and enhance overall delivery efficiency. Second, we will continue to optimize and upgrade our data management platform, BMP, and the programmatic delivery system. This includes expanding data dimensions and mining underlying data characteristics to improve audience and traffic insights. Those enhancements will enable more systematic and process identification of targeting audiences, leading to a higher advertising delivery effectiveness. Third, we will capitalize our robust AI capabilities to further integrate AI-driven creative production with the advertising delivery process. By closely linking those functions with the data capabilities of our BMP, we aim to establish an automated closed-loop system that boosts the overall operational efficiency of our online services. Thank you.

Thank you very much.

Next question is from Brenda Zao, CICC.

Good evening, Zhou Zong and Su Zong. Thanks for taking my question. My question is also related to the profit margin because we see the operating profit experience the year-over-year decline in the third quarter. What is the potential for rebound to year-over-year growth in fourth quarter. Thank you.

Thank you, Brenda. This is Supong. I will handle the question first. And I think at the beginning of this year, we set the two full-year financial goals. The first is to achieve the rapid year-over-year improvement in operating profit. And secondly, to achieve the break-even in full-year operating cash flow. And if you see the performance of the user in the first half of this year, especially in the operating profit. The operating profit in this year, in the first half of 2025, I mean, it's much better than that in the last year at the same time. Improving from the 40 million RMB loss to the 130 million RMB gain So I think that has provided more flexibility for us to make more investments in the second quarter of the 2095. With that investment in advertising the customer acquisition, we are maintaining the profitability. And also, we start to spend a lot of dollars to acquire the potential clients for the advertisement business. from the third quarters, as the doctor mentioned before, in our earnings call. And Eudaldium should deliver over 40% year-over-year GMV growth and increase the retention rate to the 75%, over the 75%. And also, we achieved about the revenue of the advertisements growth over 50% in the Q3, in the 2025, and also the new clients, account for over 30% of the total clients. So I think that will create a great momentum and fundamentals for our business in Q4 and next year. And for our first quarter's priorities, and at the same time, I'll just try to explain in more detail regarding the value impacts of our, we call it the the learning service business and in the, as Dr. mentioned before. And in the last year, STEAM courses still account for the meaningful percentage of our revenue for our learning services. And at the same time, in summer, we shrink a lot significantly for the investments and for the STEAM courses and for the customer acquisitions, but still deliver significant revenues in the Q3, that's definitely have the impact of our profitability in the last year. That means the kind of high base we mentioned before. So I think that's the impact only for this year. So our first quarter's priority is to secure the rapid operating profit improvement from the full year perspective online at the start of the year. In the meantime, we will continue to invest in our core business, resulting through AI apps and as well as the online marketing services. As we access the macro environment and our growth opportunities, through this focus approach, we aim to deliver the greater values to an expanding user space. Our medium to long-term focus is on executing AI-native strategies accelerating the deployment of our large-language model computers in learning and advertising scenarios. Central to this effort is enhancing our sustained profitability while also constantly evaluating the quality of our users' services. Since its launching three years ago, our AI interactive services of Yu Daolin Shi has integrated AI across the multi-scenarios, including the users' learning assessments, personalized learning path recommendations, QA sessions, assignment grading, and as well as the college application consultancy. This has enhanced the learning efficiency and outcome for users, gathering widespread positive feedback. As the highest gross margin business within our learning services segment, and following the recent restructuring of this segment, U.S. dollar increase is expected to account for the growing share of segment revenue. This, in turn, is expected to continue to improve the versatility of the learning services segment in the long run. Regarding the online marketing services, as noted previously, AI contributed to enhance the delivery and the operational efficiency in area, including the ad creative production, data mining, programmatic delivery, and also attribution analysis. These advancements deliver in midterm and long term the possibility improvement of these segments. I think, I hope that answers your question. Thank you.

That's very helpful. Thank you.

Next question is from Bolsan Hotai.

Hello. Thanks for taking my question. My question is, given the cumulative net operating cash outflow recorded in the first three quarters, So this is back and change to the four-year break-even target. Thank you.

Thank you, Istanbul, for your question. This is Wen. Our team has such great importance on the performance of our operating cash flow, and we already got a remarkable improvement in optimizing our operating cash flow performance in recent years. For 2025, we set a target to achieve four years cash flow breakeven, and we remain very confident to achieve this target. At the same time, I would like to emphasize that reaching this breakeven point is only a near-term milestone. Our long-term objective definitely is to deliver even healthy performance in our cash flow through standard profitability enhancement to simplify the credit management and optimize working capital practice. As you mentioned, for the first nine months this year, cumulative net operating cash flow amounted to 129 million. However, it reflects over 40% of significant improvements on a year-over-year basis. In addition, our quarter cash flow performance obvious seasonal features which are driven by certain seasonal factors. For example, Q1 is typically annual bonus payment period due to the Lunar New Year, and the Q3 is traditionally peak user acquisition period during which operating cash flow typically register net outflow due to the marketing investment In contrast, Q2 and Q4 are retention-driven seasons and generally demonstrate stronger cash flow performance. So we expect the fourth quarter usually generates good operating cash inflow. To provide context, as you know, we achieved operating cash inflow of RMB 158 million in Q4 last year. As previously highlighted, our restrictions in learning services have been completed. Youdao Lingshi in particular has demanded robust retention momentum in Q4, maintaining a retention rate of about 75%. Additionally, another pre-paid service, our AI-driven subscription services, Q3 sales from these businesses have accelerated growth to over 40% year-over-year, which also positively supports our cash flow position. On the other hand, the expansion of our advertising business potentially brings certain collection dynamics, which potentially slows down the cash inflow from our customers. For example, Online marketing services typically provide a certain curtain to our premium clients. Zero results from the pre-quarters. We are satisfied for the performance of cash collections and the curtain are well managed. Taking into account the distinct seasonality of our operations, the significant year-over-year cash flow improvements in the first three quarters and the potential strong retention performance from Youdao Lingshi in Q4. We maintain the confidence in achieving our full-year operating cash flow with even targets. Thank you.

Thank you, Tasha.

That concludes our question and answer session. I would like to turn the conference back over to management for any additional or closing remarks.

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

Ladies and gentlemen, thank you for joining. The conference is now over. You may disconnect your telephone.