Good day, and welcome to the Youdao 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 Youdao. Thank you, and over to you.

Thank you, operator. Please note the discussion today will contain forward-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 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 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 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 Youdao's corporate website at ir.youdao.com. Joining us today on the call from Youdao'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 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.

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 renminbi, 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 billings. 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, driven 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, Youdao Lingshi 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 generate 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 Olympiads 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, and an open-sourced 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 DeepSeek-R1 at just USD 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. P AI Tutor received the Gold Me Award, the highest honor granted to developers on the Xiaomi App Store. Additionally, Youdao Dictionary was named 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. Gross 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 gross margin to stabilize in the 25% to 35% range over the medium to long term. Gaming was a highlight this quarter. We deepened 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 ad placement optimizer in Q2, an end-to-end AI-driven solution covering demand analysis, strategy formation, data analytics, and iterative optimizations. We also significantly upgraded our anti-fraud 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 GenAI-powered ad technology space, delivering 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 RMB 126.8 million, primarily attributable to two factors. First, certain high-end Dictionary Pen models approached the end of their product life cycles during the quarter. Second, we reduced the marketing expenditure in hardware to prioritize business health at this stage. Within this segment, we focused on Youdao Dictionary Pen, which maintained its market leadership, securing the #1 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 Youdao Dictionary Pen 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 highs 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 relationships with key accounts, and deployed more GenAI 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 our learner productivity and deliver a higher return on advertising. With industry-leading AI technology and operational expertise, we remain committed to sustainably creating customer value while further strengthening our financial performance. With that, I will hand over to Su Peng 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 net revenue was RMB 1.4 billion or USD 197.9 million, representing a 7.2% increase from the same period of 2024. Net revenue from our learning services was RMB 657.8 million or USD 91.8 million, representing a 2.2% increase from the same period of 2024. Net revenue from our smart devices was RMB 126.8 million or USD 17.7 million, representing a 23.9% decrease from the same period of 2024. Net revenue from our online marketing services was RMB 632.9 million or USD 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 or USD 85.1 million, representing a 4.3% decrease from the same period of 2024. Gross margin for learning services was 59.8% for the second quarter of 2025 compared with 60% for the same period of 2024. Gross margin for smart devices was 41.5% for the second quarter of 2025 compared with 30.3% for the second quarter of 2024. Gross margin for online marketing services was 25.8% for the second quarter of 2025 compared with 39.1% for the second quarter of 2024. For the second quarter, we reduced our total operating expense to RMB 580.6 million or USD 81 million compared with RMB 709.3 million for the same period of last year. Looking at our expenses in more detail, sales and marketing expense declined to RMB 401.8 million compared with RMB 515.7 million in the same quarter of 2024. Research and development expense was decreased to 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 an 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 USD 2.5 million compared with RMB 99.5 million for the same period of last year. Non-GAAP net income attributable to ordinary shareholders for the quarter was RMB 12.5 million or USD 1.7 million compared with non-GAAP net loss attributable to the ordinary shareholders of RMB 96 million for the same period of last year. Basic and diluted net loss per ADS attributable to the ordinary shareholders for the second quarter of 2025 were RMB 0.15 or USD 0.02. Non-GAAP basic and diluted net income per ADS attributable to the ordinary shareholders for the second quarter was RMB 0.11 or USD 0.02 and RMB 0.1 or USD 0.01, respectively. Our net cash provided by operating activities was RMB 185 million or USD 25.8 million for the same quarter. Looking at our balance sheet as of June 30, 2025, our contract liabilities, which mainly consist of deferred revenue generated from our online learning services, were RMB 856.7 million or USD 119.6 million compared with RMB 961 million as of December 31, 2024. At the end of the period, our cash, cash equivalents, current and noncurrent restricted cash and short-term investments totaled RMB 617 million or USD 86.1 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.

Our first question comes from Vicky Wei from Citi.

Could management provide an update on the third quarter outlook for Youdao Lingshi?

Thank you for the question. This is Peng Su. I will handle the question first. In Q2, Youdao Lingshi kept growing year-over-year with revenue increasing by roughly 30%. The retention rate exceeded about 75%, reaching a record high. It indicates that user satisfaction for our products also reached a record high level. It is a solid foundation for the subsequent development, we believe. Youdao Lingshi, we think is a key initiative of the application education scenarios by our large language models. In the second half of this year, we will continue to leverage the robust capability of the Confucius Large Language Model to further enhance the products and services quality and expand our user space. Regarding the product updates, the two major developments are planned for the second half of this year. First is the AI Essay Grading features rolled out in Q2 this year, which provides users with professional Chinese essay feedback. Its specialized targets and timely grading have received best grades and positive feedback from our users. In the second half of this year, we will expand the AI Essay Grading to cover English essays as well, enabling users to more efficiently improve their English writing skills. Second, we will launch AI tutoring. Powered by Confucius 3.0, it offers more timely, tailor-made, and precise assistance to users, helping them to resolve their questions and improve learning efficiency and outcomes. In terms of user acquisition, since our AI interactive courses format was introduced in 2022, users' learning outcomes have shown sustained and rapid improvement. Youdao Lingshi's reputation among users continues 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 feel very comfortable about the products of Youdao Lingshi right now, and we will definitely keep investing in technology as well as updates about the quality of all the products. And we are confident that Youdao Lingshi will maintain momentum in the second half of this year and in the future. I hope that answers your question.

Our next question comes from the line of Jing Qiang from China International.

My question is about the smart device segment. I wonder whether the smart device segment's year-over-year revenue decline in this quarter will see some improvement in the second half of this year?

I will address this question. For the full year of 2025, our main goal for the smart devices segment is to enhance business health. Even though we saw a revenue decline in Q2, it's encouraging that in both Q1 and Q2, our hardware business's health improved compared to the same quarter last year. From a product strategy and growth perspective, we will continue to prioritize Dictionary Pens and our new category, Tutoring Pens. We believe both of these categories offer significant growth opportunities. In the Dictionary Pen market, we are both pioneers and the clear market leader, having ranked #1 in sales for five consecutive years. The Tutoring Pen, which we launched earlier this year, benefits from our large language model, Confucius, allowing it to tackle key challenges in math and other K-12 subjects, particularly for middle and high school students. This market segment is critical, and the product has received positive feedback from students and parents. We are planning to launch a new Tutoring Pen product next week, and we anticipate that its enhanced user experience will lead to better metrics for the segment in the latter half of this year. I'd also like to highlight two aspects of our device business's long-term development. First, I am optimistic about the medium- to long-term prospects of AI-powered hardware. Market research indicates that China's AI hardware market, excluding smartphones and cars, is projected to exceed 1 trillion RMB for the first time in 2025, with an annual growth rate of 18% over the next five years. While this includes various categories, the educational smart devices segment alone is expected to reach 34 billion RMB in 2025, indicating a substantial market that is likely to expand further. By leveraging our strong AI capabilities, we plan to continue broadening the applications of our smart hardware to enhance users' learning and work efficiency. Second, we see great potential in deepening the synergy between hardware and our learning services. For instance, our Tutoring Pen can accurately determine users' learning profiles, such as their educational level and specific learning needs. This precision will allow us to enhance the integration of hardware and our learning services, unlocking more cross-selling opportunities while also helping to lower our overall sales and marketing expenses and improving operational efficiency. In Q2, our sales and marketing to revenue ratio was 28%, which is a decrease of roughly 11 percentage points year-over-year. We believe there is further potential for improvement, particularly as we focus on integrating our hardware with our learning services.

Our next question comes from the line of Thomas Chong from Jefferies.

My question is about advertising.

We apologize for the interruption, Mr. Chong. We're having difficulty hearing you clearly. If you're using an external headset, could you please switch to handset mode?

My question is about advertising. What are the specific applications of the AI ad placement optimizer in advertising, as well as the potential impact on future financial metrics?

This is Jin Lei. Thank you for your questions. The application scenario of the 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 delivery data through our DMP. It automatically explores target audiences and traffic streams while intelligently generating audience targeting strategies. Post-ad delivery, leveraging campaign data and our large language models, AI Ad Placement Optimizer intelligently generates delivery diagnostics and attribution analysis reports. Those outputs drive utility optimization for subsequent audience targeting and strategy deployment, making advertising simpler and smarter. AI Ad Placement Optimizer enables 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 iMagicBox, which launched earlier this year, we delivered comprehensive AI-powered support across the full advertising life cycle from creative development and material production to delivery attribution and optimization iteration, leveraging our robust AI capabilities. Medium- to long-term, the AI Ad Placement Optimizer will support both advertising revenue growth and profitability improvement for us. It will enhance advertisers' return on investment, driving increased budget allocation from existing clients on our platform. Concurrently, broader adoption will expand our advertiser base. Those factors collectively will accelerate our advertising revenue growth. Secondly, the solution identifies cost-efficient, high-quality traffic while maximizing data utilization from our DMP, thereby strengthening profitability from our online marketing services segment.

Our next question comes from the line of Bo Zhan from Huatai Securities.

This is Bo Zhan from Huatai. Given the year-over-year decline in operating cash inflow during Q2, do we have any revision on the target for achieving operating cash flow breakeven this year?

Thank you for your question. This is Wayne. I will take your question. As you have noticed, we generated operating cash flow of RMB 185 million in Q2. 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 breakeven. This is primarily related to the following factors. First, our profitability has been improving, indicating sustained long-term cash flow enhancement. From a profitability perspective, we achieved an operating profit of around RMB 133 million in the first half of this year, a significant improvement in financial health compared to a loss of RMB 42.6 million in the same period of last year. This profit improvement stems from our continuous enhancement of our 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 costs and expenses. We are confident in achieving accelerated operating profit growth for the full year of 2025. Second, our operating cash flow demonstrated improvement on a year-over-year 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 received approximately RMB 70 million in the first half of this year, representing an improvement of around 50%. Thirdly, our operating cash flow exhibits seasonality. Q1 is typically the weakest quarter within a year due to the payment for the annual bonus from the previous year. Excluding additional investments in our key initiatives such as AI technology and Youdao Lingshi, the cash flow performance in the second half of this year is expected to be stronger than the first half. Fourthly, the relatively slower pace of cash flow improvement compared with 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, typically resulting 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. The advertising business usually involves granting advertisers an acquired period, which typically brings a one- or two-quarter lag when comparing profit results with cash flow performance. While developing the business, we always strictly control our credit policy to improve our cash flow position. In summary, despite the uncertainty of competition and the macro conditions, we are confident in achieving the target of operating cash flow breakeven this year.

Our next question comes from the line of Linda from Macquarie.

I have two questions. The first one is regarding advertisement. In the announcement, you also mentioned strong growth coming from gaming and overseas markets. Can you elaborate more about the growth drivers behind these two segments? And what is your outlook for 2026? The second one is about the buyback. We noticed that the $40 million buyback authorization has almost moved up. And do we have any new buyback scheme?

Linda, it seems there is some connection issue. Would you please kindly repeat your questions again?

Okay. The first one is about advertisement. I just want to know whether you can give us some details regarding gaming and the overseas market? And what is the outlook for 2026? The second one is about the share buyback because we used $33.8 million. So do we have any new scheme because it's close to the $40 million arrangement?

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

Linda, this is Su Peng. I think I will handle the second question first. Regarding the share buyback, yes, we announced a $40 million share buyback plan several quarters ago. Right now, we still have several million remaining, and obviously, we will process the rest of our budget for the share buyback in the next few quarters. Secondly, as my colleague mentioned in the call, we feel very confident that we can definitely achieve full-year operating profit this year. This means we can have more capability on our financial balance sheet to present a new plan maybe in the next few quarters. That depends on the market as well as on investment in technology, especially. We think that we will spend more money, and that will be more meaningful investment in the long run. We will definitely take care to clearly manage our balance sheet and look for the best strategies to balance this investment with the share buyback plan in the future. I hope that answers your second question. And for the first question, I would just add a little more color to Dr. Zhou's comments. Because in our press announcement, we mentioned the growth of advertisement in Q2 due to the growth of business in the gaming industry and overseas market. If you see the trend of the gaming market, the peak season is roughly in the second and third quarters, especially in the third quarter. For the trend in the second half of this year, we expect to accelerate our growth for advertisement in both domestically for gaming and the overseas market. So I think that is the trend we'll be following.

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

Yes. Thank you once again for joining us today. If you have any further questions, please feel free to contact us at Youdao 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.