Earnings Call Transcript - DAO Q3 2025

Operator, Operator

Good day and welcome to Youdao 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 Youdao. Please go ahead.

Jeffrey Wang, Investor Relations Director

Thank you, operator. Please note the discussion today will contain forward-looking statements regarding 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 which 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 these forward-looking statements, 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 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.

Feng Zhou, CEO

Thank you, Jeffrey. 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 stated. In the third quarter, our strategically prioritized businesses Youdao Lingshi and online marketing services delivered strong momentum, supporting our long-term growth trajectory. Net revenues reached RMB 1.6 billion, up 3.6% year-over-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 improvement in the first half of the year, we increased investments in Youdao Lingshi, 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 RMB 161.1 million, representing a substantial 149.2% year-over-year increase, highlighting the meaningful progress we have made in enhancing our profitability. Notably, we have now achieved operating profit 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. Revenues from the Learning Services segment were RMB 643.1 million, down 16.2% year-over-year, reflecting our disciplined and strategic approach to customer acquisition as we focus on growing the Lingshi business. Within the Learning Services segment, net revenues from digital content services were RMB 425.9 million during the quarter. Our achievements in digital learning have gained international recognition; Youdao was included in the 2026 GSV 150, 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, achieving over 40% year-over-year growth in gross billings. More recently, the 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 Yau Mathematical Sciences Center at Tsinghua University, 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 life-like 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 apps 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-modal 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 LLM 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, Youdao 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 and our proprietary turn detection algorithm. It achieves top-tier voice translation accuracy with exceptionally low latency. The feature also received a one-click summarization of translated content and automatically generates mind maps, significantly improving user efficiency across both learning and 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, Youdao Anydub. In the third quarter, to automate the 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 local characteristics and generate natural, fluent, and emotionally rich dubbing. 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 to 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 51.1% 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 by 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 a 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 & 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 with our AI Ad Placement Optimizer. It is an end-to-end AI-powered agentic solution covering demand analysis, strategy formulation, data analytics, and innovative 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 fundamentals during the third quarter. Product-wise, we launched a new tutoring pen, Youdao Space X, which offers precise scanning for long-form and multi-graphic prompts, 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 pen and tutoring pens 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 strategy, focusing 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 the sensible operations and remain confident in achieving the full year targets set at the beginning of the year, including robust year-over-year operating profit growth and reaching annual operational cash flow breakeven for the first time. With that, I will hand over to Su Peng for a deeper dive into our financial results. Thank you.

Peng Su, Senior VP

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 was RMB 1.6 billion or USD 228.8 million, representing a 3.6% increase from the same period of 2024. Net revenue from our learning services was RMB 643.1 million or USD 90.3 million, representing a 16.2% decrease from the same period of 2024. The year-over-year decrease was primarily attributable to our decision to take a disciplined, strategic approach to customer acquisitions, which places a greater emphasis on high ROI, return on investment engagements. 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 was 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 was RMB 739.7 million, or USD 103.9 million, representing a 51.1% increase from the same period of 2024. The year-over-year increase was primarily driven by the increased demand from the NetEase Group and overseas markets, which was driven by our continued investment in AI technology. For the third quarter, our total gross profit was RMB 687.9 million or USD 96.6 million, representing a 12.9% decrease from the same period of 2024. Gross margin for learning services was 58.5% in the third quarter of 2025 compared with 62.1% for the same period of 2024. Gross margin for smart devices was 50.3% for the third quarter of 2025 compared with 42.8% for the same period of 2024. 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 or USD 92.7 million compared with RMB 682.2 million for the same period last year. Looking at our expenses in more detail, sales and marketing expenses declined to RMB 487.7 million, compared with RMB 519.6 million in the third quarter of 2024. Research and development expenses 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 USD nearly 0, compared with RMB 86.3 million for the same period of last year. Non-GAAP net income attributable to the ordinary shareholders for the third quarter was RMB 9.2 million or USD 1.3 million compared with RMB 88.7 million for the same period of last year. Basic and diluted net income per ADS attributable to ordinary shareholders for the third quarter of 2025 was nearly 0. Non-GAAP basic net income per ADS attributable to the ordinary shareholders for the third quarter was RMB 0.08 or USD 0.01. Our net cash used in operating activities was RMB 58.6 million or USD 8.2 million for the third quarter. Looking at our balance sheet as of September 30, 2025, our contract liabilities, which mainly consist of the deferred revenue generated from our learning services, were RMB 751.1 million or USD 105.5 million compared with RMB 961 million as of December 31, 2024. At the end of the period, our cash, cash equivalents, current and non-current restricted cash, and short-term investment totaled RMB 557.7 million or USD 78.3 million. This concludes our prepared remarks. Thank you for your attention. We will now like to open to your questions. Operator, please go ahead.

Operator, Operator

The first question is from Brian Gong, Citi.

Brian Gong, Analyst

A very quick question for our strategies ahead. So our online marketing services are growing rapidly, showing a different trend versus learning services. From a strategic perspective, do online marketing services become more important than learning services in the future?

Feng Zhou, CEO

Brian, so right now, we are experiencing higher growth for ads compared with learning services. In the long term, we actually see great opportunities in both areas. So let me explain that to you. The strong expansion of our marketing services over the past three years has been mostly driven by, first, our advanced ad tech and AI capabilities; then, customers transition from traditional ads to performance ads; and finally, the opportunity of overseas ads. Since advertising revenue first exceeded RMB 200 million in a single quarter in Q4 2022, it has reached a record high of over RMB 700 million this quarter, 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 still in 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 and agentic AI will be put to work on ads at scale. So we launched our Youdao Magic Box ad creative platform in Q1 and our AI Ad Placement Optimizer and ad automation agents in Q2. These AI-driven improvements in delivering the ads have strengthened 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 revenue growth for the coming years, hopefully. On the other side, we also see 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 capturing it requires us to build and scale truly AI native services and applications, and that's what we've been doing. On AI-driven subscription services, this part, we began sharing our progress since last year, and the trajectory is very promising. 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 Lingshi business. In Q3, Youdao Lingshi delivered over 40% year-over-year growth in gross billings and demonstrated strong user stickiness and a retention rate that exceeds 75%. So adding all that up, in the near term, 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 learning and advertising businesses by continuing to serve our customers better and also leveraging AI technologies better. Yes.

Operator, Operator

Next question is from Linda Huang, Macquarie.

Linda Huang, Analyst

Can you hear me?

Feng Zhou, CEO

Yes, yes. We can hear you.

Linda Huang, Analyst

So my question is regarding the online advertisement, because since the second quarter this year, we noticed that the gross margin is below 30%, maybe around 25%. I just want to know, does the manager have any plan or timeline on when we can return above 30%? And what will we need to do to make sure that the margin can recover? So that's for online marketing.

Feng Zhou, CEO

I'll answer this briefly before Jin Lei provides more details. We always operate with a long-term perspective and aim to enhance the value we create for advertisers, which we consider most important. In the third quarter, we identified strong opportunities to grow our customer base, so we decided to engage and onboard more customers, which is reflected in our revenue growth. You can observe significant revenue increase. However, we did sacrifice some short-term gross margin because new customers tend to be less profitable, and for particularly important customers, we sometimes operate at a loss. This also applies to the learning side of the business. Additionally, in the third quarter, we invested in hiring more personnel to expand our audience across our businesses for future growth. We believe these investments are very beneficial, and we maintain solid and profitable unit economics. We are confident that such investments will lead to growth and profitability in the upcoming quarters.

Lei Jin, President

This is Jin Lei. Regarding the gross margin of our online marketing services business, the major parts are adopting the performance-based advertising pricing model and the gross method of revenue recognition, which necessitate balance between delivering value to our clients and sustaining our own healthy long-term development. Against this backdrop, we consider gross 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 broaden the application of the Magic Box creative production platform throughout the ad creation process. Compared to menu creation production, Magic Box 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, DMP, 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 processed identification of targeted audiences, leading to higher advertising delivery effectiveness. Third, we will capitalize on our robust AI capabilities to further integrate the AI-driven creative production with the advertising delivery process by closely linking those functions with the data capabilities of our DMP. We aim to establish an automatic closed-loop system that boosts overall operational efficiency of our online marketing services.

Operator, Operator

Next question is from Brenda Zhao, CICC.

Brenda Zhao, Analyst

My question is also related to the profit margin because we see the operating profit experienced a year-over-year decline in the third quarter. What is the potential for rebound to year-over-year growth in the fourth quarter?

Peng Su, Senior VP

Thank you, Brenda. This is Peng. I will handle the question first. At the beginning of this year, we set two full-year financial goals. The first is to achieve rapid year-over-year improvement in operating profit. The second is to achieve breakeven in full year operating cash flow. If you see the performance of Youdao in the first half of this year, especially in operating profit, it's much better than that in the last year's same time, improving from a RMB 40 million loss to a RMB 130 million gain. So I think that provides more flexibility for us to make more investments. In the second quarter of 2025, we started the investments in Youdao Lingshi in advertising and customer acquisition. We are maintaining profitability. And we also began to spend marketing dollars to acquire potential clients for the advertisement business. From the third quarter, as Dr. Zhou mentioned before in our earnings call, Youdao Lingshi delivered over 40% year-over-year GMV growth and increased the retention rate to over 75%. We achieved a revenue growth of over 50% in Q3 2025, and the new clients account for over 30% of the total clients. So I think that will create great momentum and fundamentals for our business in Q4 and next year. For our fourth quarter's priorities, the same time, I just want to explain in more detail regarding the one-off impacts of our learning services business. Dr. Zhou mentioned before that last year, STEAM courses still accounted for a meaningful percentage of our revenue from our learning services. At the same time, since summer, we shrank significantly our investment in STEAM courses for customer acquisitions, but still delivered significant revenues in Q3. That definitely had an impact on our profitability last year. That means the kind of high-base we mentioned before. I think that is a one-off impact only for this year. Our fourth quarter's priority is to secure rapid operating profit improvement from a full-year perspective online at the start of the year. In the meantime, we will continue to invest in our core businesses: Youdao Lingshi AI apps and online marketing services as we assess the macro environment and our growth opportunities. Through this focused approach, we aim to deliver greater value to our expanding user base. Our medium to long-term focus is on executing our AI native strategy and excelling in the deployment of our large language model computers in learning and advertising scenarios. Central to these efforts is enhancing our sustained profitability. We are also constantly evaluating the quality of our user services. Since its launch three years ago, our AI interactive services of Youdao Lingshi has integrated AI across multiple scenarios, including users' learning assessments, personalized learning path recommendations, QA sessions, assignment granting, and college application consulting. This has enhanced the learning efficiency and outcome for users, gathering the best positive feedback as the highest gross margin business within our Learning Services segment, and following the recent restructuring of this segment, Youdao Lingshi is expected to account for a growing share of segment revenue. This, in turn, is expected to continue improving the profitability of the learning services segment in the long run. Regarding online marketing services, as noted previously, AI contributed to enhancing delivery and operational efficiency in areas including ad creative production, data mining, programmatic delivery, and attribution analysis. These advancements are expected to deliver mid-term and long-term profitability improvements for the segments. I hope that answers your question?

Liping Zhao, Analyst

That's very helpful.

Operator, Operator

Next question is from Bo Zhan, Huatai.

Bo Zhan, Analyst

My question is, given the cumulative net operating cash outflow recorded in the first three quarters, should we expect any change to the full-year breakeven target?

Wayne Li, VP of Finance

Thank you for the questions. This is Wayne. Our team places great importance on the performance of our operating cash flow, and we already saw remarkable improvements in optimizing our operating cash flow performance in recent years. For 2025, we set a target to achieve full-year cash flow breakeven, and we remain very confident in achieving this target. At the same time, I would like to emphasize that reaching the breakeven point is only a near-term milestone. Our long-term objective is to deliver even healthier performance in operating cash flow through profitability enhancement, disciplined credit management, and optimized working capital practices. As you mentioned, the cumulative net operating cash flow for the first nine months this year amounted to RMB 129 million. However, it reflects over 40% significant improvement on a year-over-year basis. In addition, our quarterly cash flow performance helps obvious seasonal features driven by certain seasonal factors. For example, Q1 is typically the annual bonus payment period due to the Lunar New Year, and Q3 is traditionally the peak user acquisition period during which operating cash flow typically registers net outflow due to marketing investment. In contrast, Q2 and Q4 are retention-driven seasons and generally demonstrate stronger cash flow performance. So we expect the fourth quarter to usually generate good operating cash inflow. To provide context, as you know, we achieved an operating cash inflow of RMB 158 million in Q4 last year. As previously highlighted, our restructuring in learning services has been completed. Youdao Lingshi particularly has robust retention momentum in Q4, maintaining a retention rate above 75%. Additionally, another prepaid service, our AI-driven subscription services, saw sales growth from this business accelerate to over 40% year-over-year in Q3, which also positively supports our cash flow position. On the other hand, the expansion of our advertising business potentially brings certain collection dynamics, which can potentially slow down the cash inflow from our customers. For example, online marketing services typically provide a certain credit to our premium clients. Through results from the three quarters, we are satisfied with the performance of our cash collections and the collections are well managed. Taking into account the distinct seasonality of our operations, the significant year-over-year cash flow improvement in the first three quarters, and the potential strong retention performance of Youdao Lingshi in Q4, we maintain confidence in achieving our full-year operating cash flow breakeven target. Thank you.

Operator, Operator

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

Jeffrey Wang, Investor Relations Director

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 financial communications in China or the U.S. Have a nice day.

Operator, Operator

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