Youdao Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 22, 2024

There are 9 speakers on the call.

Operator

Good day, and welcome to the Yodao 20 24 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 Yadao. Please go ahead.

Speaker 1

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 the future performance and are subject to certain risks and uncertainties, assumptions and other factors.

Speaker 1

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 Yudao's business and financial results is included in the certain company filings with the U. S. Securities and Exchange Commission. The company does not undertake any obligation to update these forward looking information, except as required by law.

Speaker 1

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 2024 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 be available on Yudao's corporate website at ir. Yudao.com.

Speaker 1

Joining us today on the call from Yudao's senior management are Doctor. Feng Zhou, our Chief Executive Officer Mr. Lei Jun, our President Mr. Peng Shu, our VP of Strategy and Capital Markets and Mr. Wayne Li, our VP of Finance.

Speaker 1

I will now turn the call over to Doctor. Zhou to review some of our recent highlights and strategic direction.

Speaker 2

Thank you, Jeff, 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. In the Q2 of 2024, net revenues reached RMB 1,300,000,000, growing 9.5 percent year over year. Operating cash inflow reached a record level of RMB 250,200,000, an increase of 88.2 percent year over year. Loss from operations was RMB72,600,000 as Q2 is typically seasonally weak in the bottom line and it narrowed by 74.9 percent year over year.

Speaker 2

In the first half of twenty twenty four, net revenues reached RMB2.7 billion, marking an increase of 14.5 percent year over year. Loss from operations was RMB42.6 million, narrowing 91.2 percent year over year. Operating cash outflow was reduced to RMB103.8 million, reflecting an improvement of 53.7 percent year over year. The financial performance was in line with our guidance. Now, let's review the major developments across our business lines in the 2nd quarter.

Speaker 2

Net revenues from learning services were RMB643,800,000, slightly down by 5.5% compared with the same period of last year. Digital content services maintained a healthy growth trajectory, achieving net revenues of RMB 403,300,000, up 6.8% year over year. Operating cash inflows generated by digital content services exceeded RMB 200,000,000. Yoda Ling Shi continued to drive product upgrades and customer satisfaction. Firstly, in Q2, we released over 400 newly healthily calibrated tiered learning videos for students of different levels.

Speaker 2

We also significantly upgraded the class based study experience for better motivation and context. As we discussed before, Ling Shi pioneered the approach of personalized pre recorded video learning. Building upon this vast library of thousands of high quality videos, we offer a set of important services, including automatic diagnosis of students' current learning levels, class based digital learning, personalized quiz generation, and weekend live consultation with our experienced staff members. These are all key to the high effectiveness of our products and we keep improving them every year. 2nd, in terms of applications of AI and growth initiatives, we upgraded our college admission consultation service to the all new AI College admission advisors, AI in Q2.

Speaker 2

Using large language models, the AI advisor effectively discusses and guides students in their college application process, helping them in choosing universities and majors. Since the new release, the service saw nearly 3,000,000 page views, rising by 30% year over year, making it a key asset in attracting new students and parents. Continuous product and service upgrades significantly boosted the retention ratio of Yudao Lingshi, reaching over 70% in the Q2, a record high and an increase of more than 10% points year over year. In addition, as for Yudao Literature, we offered nearly 40,000 high quality AI writing refinements in the Q2, improving our retention rate by approximately 10 percentage points on a year over year basis. Next is Learning Services segment, is our AI driven subscription services.

Speaker 2

In the Q2, our AI driven subscription services maintained rapid growth, with total sales surpassing RMB 60,000,000, marking a nearly 200% year over year increase and over 30% quarter over quarter growth. Moreover, this represents the 6 consecutive quarters of over 50% year over year growth. Order wise, in June, we launched a major new mobile app, Mr. P AI Tutor, the first ARM subject AI tutor in China, and it received positive feedback from users after its initial integration into the Yudao dictionary pen earlier this year. 2nd, AI translation in Yudao desktop translation now supports languages other than English and Chinese.

Speaker 2

There is also new support for unturned databases and multimodel document input. These upgrades pushed AI translation usage to exceed 30,000,000 times in Q2. 3rd, in collaboration with NetEase Cloud Music, Yudao Dictionary introduced a music sentence feature in the 2nd quarter, helping users learn vocabulary while listening to music. Last but not least, HiEcho introduced the children mode, offering tailored topics for children, child friendly digital avatars and generating exclusive post conversation reports to 8 children in improving their English speaking skills. We are also delighted to observe that the average usage time of Children Mode is nearly twice that of other modes, highlighting its effectiveness in engaging and retaining users, as well as enhancing their English proficiency.

Speaker 2

Our online marketing services segment maintained a strong growth trajectory in Q2, with net revenues reaching RMB511.2 million, hitting a record high and representing an increase of 68.4% year over year. This marks the 7th consecutive quarter of over 50% year over year growth, driven primarily by RTA, our real time API, and domestic KOL's ongoing robust performance, with RTA revenue more than doubling over year in Q2. Furthermore, as large language models rapidly advance in the market, the demand for promoting these models and their applications among tech companies has surged. Our team sees this opportunity and is helping leading players like Baidan's Doubo, Zhipu and Baidu Ernie in this area to grow their products. In Q2, net revenues from AI tools and advertisement grew by more than 100% quarter over quarter.

Speaker 2

Additionally, our advertising collaboration with Medis Group has been advancing smoothly and demonstrating synergy. On one hand, Youdao's data application significantly enhances the traffic monetization rates on a number of NetEase assets by over 100% in Q2. On the other hand, our improved advertising performance has attracted more NetEase product teams to use our service. In the Q2, the percentage of our total advertising revenue from NetEase as our clients increased around 3 percentage points quarter over quarter. It is still less than 10% of our total ad revenue, indicating significant future growth potential.

Speaker 2

Regarding the smart devices segment, the net revenues were RMB166.7 million in Q2, down 25% year over year. The decline was in large part due to unfavorable product mix. In Q1, we updated our entry level dictionary plans. So these reached record unit sales in Q2. In the meantime, our high end products were from last year and reached the latter part of their lifecycle in Q2.

Speaker 2

So high end products had relatively lower sales. These factors negatively impacted total device revenue and also average unit price for Q2. We expect Q2 to be the low point operationally for the device business this year as we are currently ramping up high end products for the new school year. In fact, Yudao Dictionary PAM was again the category top seller on jd.com during the June 18th shopping festival for the 5th consecutive year. And Q2 unit sales showed a year over year increase of over 50%, broadening our brand's reach.

Speaker 2

More recently, we launched the new high end U. S. X7. Large language model functions like AI translation and MSP AI tutor has already been widely welcomed by users. 1st month sales units doubled those of X6 Pro, the high end product released.

Speaker 2

This week, we just released our top of the line X7 Pro with a premium screen and a more advanced AI features. It is gaining a lot of interest. Looking at our business as a whole, in the first half of this year, we executed on our overall strategy of AI plus education and made significant progress in our journey. We focused our resources on 3 core businesses, digital content services, especially Vali Shi, online marketing services and AI driven subscription services. All three areas show good growth, healthy economics, our unique competitiveness and long future runways.

Speaker 2

And more importantly, they are key assets in our mission of helping every person learn more effectively. In the meantime, financially, we worked hard to drive towards sustainable profitability, which we believe is the foundation for our next phase of growth. I am pleased with the team's progress and solid execution. Our operational and financial metrics showed increased competitiveness of our business. For example, in addition to the numbers I shared at the beginning, the ratio of sales and marketing expenses to net revenues was 35.8% in the first half of this year, down by approximately 13 percentage points year over year, a very good improvement.

Speaker 2

Looking ahead, borrowing the unexpected market changes, we expect the business to achieve full year positive operating income in the near future. Yudao's strength lies in our unique ability to advance AI empowerment across business lines, combining technical strength with operational excellence. The rapid development of our online marketing and AI subscription services prove this and will continue to drive our growth. Our online courses underpinned by high quality content, differentiated services and unique ways of leveraging AI are another pillar of our future growth. In the long term, the future of AI plus education looks incredibly bright and we will strive to lead the charge.

Speaker 2

With that, I will turn the call over to Su Kong to provide you with more detailed insights into our financial performance. Thank you.

Speaker 3

Thank you, Doctor. Sho, and hello everyone. Today I will be presenting some financial highlights from the Q2 of 2024. We encourage you to read through our press release issued earlier today for further details. For the Q2, total net revenue of RMB1.3 billion or US181.9 million dollars representing a 9.5 percent increase from the same period of 2023.

Speaker 3

Net revenue from our learning services were RMB643.8 million or US88.6 million dollars representing a 5.5 percent decrease from the same period of 2023. Net revenue from our smart devices were RMB166.7 million or US22.9 million dollars US22.9 million dollars down 25 percent from the same period of 2023, which was mainly attributable to the decreased unit price due to the change of the product mix. Net revenue from our online marketing services were RMB511.2 million or US70.3 million dollars representing a 68.4% increase from the same period of 20 93. The increase was primarily due to the increased sales of the performance based advertisement to the 3rd party's internet properties, which were driven by our continuing investment in the cutting edge AI technology. For the 2nd quarter, our total gross profit was RMB636.8 million or US87.6 million dollars representing a 12.3% increase from the Q2 of 2023.

Speaker 3

Gross margin for learning services was 60% for Q2 of 2024, compared with 57.4 percent for the same period of 2023. Gross margin for smart devices was 30.3% for the Q2 of 2024, compared with 35.8% for the same period of 2023. Gross margin for online marketing services was 39.1 percent for the Q2 of 2024 compared with 31.9% for the same period of 2023. For the 2nd quarter, we reduced our total operating expense to RMB RMB609.3 million or US97.6 million dollars compared with RMB856.3 million for the same period of last year. Looking at our expense in more detail, sales and marketing expense declined to the RMB515.7 million compared with RMB587.7 million in the Q2 of 2023.

Speaker 3

Research and development expense were decreased to RMB153 1,000,000 compared with RMB205.1 million in the Q2 of 2023. Our operating loss margin also significantly narrowed to 5.5 percent in the Q2 of 2024 compared with 24% for the same period of last year. For the Q2 of 2024, we narrowed our net loss attributable to ordinary shareholders to RMB99.5 million or US13.7 million dollars compared with RMB299.2 million for the same period of last year. Non GAAP net loss attributable to the ordinary shareholders for the 2nd quarter was RMB96 1,000,000 or US13.2 million dollars compared with RMB283.6 million dollars for the same period of last year. Basic and diluted net loss per ADS attributable to the ordinary shareholders for the Q2 of 2024 was RMB0.85 or US0.12 dollars Non GAAP basic and diluted net loss per ADS attributable to the ordinary shareholders for the same quarter was RMB0.82 or US0.11 dollars Our net cash provided by the operating activity was RMB250.2 million or US34.4 million dollars for the same quarter.

Speaker 3

Looking at our balance sheet, as of June 30, 2024, our contract liabilities which mainly consists of the deferred revenue generated from our lending services, were RMB1 1,000,000,000, compared with RMB1.1 billion as of December 31, 2023. At the end of the period, our cash, cash equivalents, current and non current restricted cash, time deposit and short term investment totaled RMB568.5 million or US78.2 million dollars 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.

Operator

Thank you. We will now begin the question and answer session. Our first question today will come from Brian Gung of Citi. Please go ahead.

Speaker 4

Thanks management for taking the question. I have a question regarding our strategy on education sector. So as we observed, competitors are ramping up their investment in the whole sector, right, education sector. Given the intensified competition, what is our strategy? Thank you.

Speaker 3

Thank you, Brian. This is Tong. I will handle the question first. And before I answer your question, I will give a very quick background regarding on the education scenario in China. And if you see the numbers of the candidates register for the college entrance exam has been increased from roughly 10,000,000 in 2019 to the over 30,000,000 in this year.

Speaker 3

It's likely to keep increasing in the next decades as well. Also the exam is getting more competitive. So overall college entrance exam score line has been shown as the upward trend. Taking the example as the in Tianjin, it has been increased by more than 70 points compared to the 2019. So we think about the demand for the polygynyxin exam preparations will continue to rise.

Speaker 3

If you go back to questions, we do see the competition intensify moderately for the pre quality learning services in this year. That's understandable given the current market conditions. I believe we have the necessary means to continue to invest to be keeping to the speed leading player here and benefit from the more dynamic markets. The first thing we do is we will still continue to drive the customer satisfaction and retentions. We have already have the industry leading satisfaction and retention rates.

Speaker 3

During the first half of this year, our retention rates reached record high in Q2 exceeding about 70% and representing a year over year increase of over 10%. I think the debt metrics is a testament to the users' recognitions of our products and services. Secondly, we think we will continue to produce outstanding learning results as long as we had already helped the students get good results and get into the upcoming university and school. Most students will come to us and if you look at our results from the last year and this year, we almost more than doubled the number of the students getting to the top school and universities in this year. I think that is important thing that can help us to build our reputations in the market.

Speaker 3

I think that's this is possible because I think the U. S. Insurer pioneers format of our classes, the AI plus content and the comprehensive services models. I think that's pretty innovative and creative and the proven learning methodologies for the college entrance exam preparation and the others. 3rd, we think we are applying more AI technology in our business, such as the segments we have been mentioned in the previously like the AI quiz recommendation and the AI based college admissions advice services.

Speaker 3

In Q2, our AI college application advisors generated nearly 60,000 application form, roughly 30% increase year over year, Positioning, I think we believe that this will be the leading one in the market in this year. I think that shows the AI can bring us the privilege over the market. The first one we think we will keep innovating and investing in the market as well. We will continue to strengthen our market channels and branding developments, providing a better integrated experience for the users through our online and offline coordination. This year through the months of such as WeChat video accounts, the vision shipping hall, we have enhanced the localized live broadcast and operate the software to provide the users with a range of the localization services and the highly customer services in the different cities.

Speaker 3

We will fully leverage our teaching strengths and IT operational experience to enhance our online customer acquisitions, competitive and reduce customer acquisition cost. I think as well, we will persist in exploring the offline service and the opportunities and looking for the better chance to invest into that market. I think above all, we think that's what we are confident about future development of the Intelligent Business and Service. We think in the long run definitely the high quality products always will be the answer for the competitive market.

Speaker 2

Yes, Brian.

Speaker 4

Thank you.

Speaker 2

Yes. Let me add a point. So, I think what's the most important thing is the product. In the end, it's about how well you understand the customers and how to best satisfy the customers' needs. So, we think we are our teams are very good at this, because Lingxi and its predecessor have been a long running business at Quedao.

Speaker 2

We've been doing it for 8 years already. And within the process, we actually innovated several times. So, the current AI plus pre recorded video plus comprehensive service model, it was introduced in 2021. So, it was a big change. But if you think about it, it really makes a lot of sense, because for students preparing for college entrance exam, what they really lack is they lack a lot of free time.

Speaker 2

So the traditional live course format is not such a good fit. So the team has actually been preparing for the change for a year at that time and the market condition in 2021 pushed the team to make the leap and that's why we've been able to grow the business several times since then. So, I think that proves the innovation capability of our teams and I expect the Lingxi team to keep innovating and keep loving what they do. That is what NetEase and Youdao culture is and makes us good at making high quality content. So, I think that's the most important thing.

Speaker 2

We'll keep improving the product and serve the customer better.

Speaker 5

Thank you.

Speaker 2

Thank you,

Operator

Xiaobo. The next question will come from Liping Zhao of CICC. Please go ahead. Good evening, Doctor. Zhou Fuzhou.

Operator

Thanks for taking my questions. Your online marketing business saw very strong revenue growth in the first half of the year. Can we could you please tell what's the outlook of this business in second half of the year? Thank you.

Speaker 6

Hi, this is Leijing. For the second half of the year, our outlook for online marketing services remains positive. We have seen net revenue growth significantly from around RMB200 1,000,000 per quarter to over RMB500 1,000,000 in Q2 of this year. This marks 7 consecutive quarters of year over year net revenue growth exceeding 50% alongside the continuous improvement in profitability. We expect year over year revenue growth to continue through the second half of this year.

Speaker 6

Several key factors are driving this sustainable growth. First, our robust data accumulation, advanced AI algorithms and a deep understanding of customer demand, forms a cornerstone of our long term competitiveness. As we continuously collect and feed data into our data management platform, CMP, we achieved more accurate prediction, better decision making and more refined online marketing services tailored to user needs. 2nd, our expansion in overseas advertising has been a significant growth driver. We offer to clients comprehensive and personalized international advertising services, including brand communication, global KOL marketing, overseas AD placement and live streaming commerce.

Speaker 6

Leveraging our deep understanding of our client needs, we have accelerated development of international advertising infrastructure. By the end of the Q2, our international KOL database exceeded 7,000,000, a year over year increase of over 200%. This drove Q2 net revenue from international performance based advertising to nearly RMB100 1,000,000, a growth rate of about 30 percentage points higher than in Q1. In this second half, we will continue to capitalize on the growing demand from Chinese companies looking to expand internationally. First thing, the sustainable development of our international advertising efforts.

Speaker 6

3rd, our collaboration with NetEase Group has been mostly beneficial. In Q2, EuDA's data application significantly improved the monetization rate by over 100% of NetEase Group's traffic. In return, NetEase Group provides us with more comfortable and predictable traffic resources. Moving forward, we will keep upgrading our algorithm and the DMP platform to enhance our AI driven data capabilities, improve advertising efficiency and boost revenue. While we are mindful of the increasing risk of traffic competition.

Speaker 6

We are committed to see the opportunities to assist Chinese companies in their global expansion, at the same time leveraging our strength in customer relations, AI and the data. We are gradually establishing our own exclusive AD network. This will help for the sustainable and the health development of our AD business. Thank you.

Operator

Our next question today will come from Thomas Chong of Jefferies. Please go ahead.

Speaker 7

Hi, good evening. Thanks management for taking my question. May I ask about our AI driven subscription services? We are actually seeing the subscription services continue to expand. What is the commercialization part for Mr.

Speaker 7

P AI tutor? Thank you.

Speaker 2

Hi, Thomas. Yes, this is Feng. The key thing here is the user scenario. You know we focus a lot on the scenarios. And Mr.

Speaker 2

P serves the home learning scenario, which we believe is the number 1 or number 2 of all consumer learning scenarios for students. So it is very important and not served well by current products. So we think Mr. P fits this scenario very well. In terms of the product and our learnings and also the commercialization path as you asked, I have several points to share.

Speaker 2

The first one is the initial feedback for the app is very positive. The recent release of Mr. P is our what we call broad release for us. So in the App form factor and in the X7 and X7 Pro Dictionary Pins, in its 1st month on the market, users engage with MSPE of AI tutor for nearly 2,000,000 times, ranking it actually as the 2nd most used feature of the X7 Dictionary PIN, only after word lookup and translation, which is kind of the basic function of the device. So it is already number 2.

Speaker 2

So it surpassed previous favorite features like VM and Jing Zhang. So I think that proves its popularity. The second point I want to share is Mr. P is quite unique and leading product in the market in terms of functionality. It is the 1st all subject, that's 9 in total, K-twelve AI learning companion app with high quality results.

Speaker 2

Some of our peer companies focused on 1 or 2 subjects. Others, their product doesn't yet deliver high quality results. So our engineering and research team has developed a key set of technologies that make Mr. P possible and are now working hard to keep on improving it. So obviously, we're still in the early days.

Speaker 2

So we expect the experience to become much better over time. And we believe this technology holds a lot of promise. So I think I would think every family in China with students needs this AI companion. So yes, think about it. So, either in apps form or in hardware devices or other forms, actually not only in China, but in other countries as well.

Speaker 2

So, that's how we look at it. 3rd point is that regarding monetization and commercialization, we think subscription fees are a very scalable way of monetizing generative AI technology. And obviously, we also look at other ways like smart devices, B2B licensing and also international markets. So I do not want to talk too much about our concrete plans, but you can look at our existing products to get some ideas. For example, HEICO is already a significant contributor to our overall AI subscription sales, which in total we just shared reached over RMB60 1,000,000 in Q2 and grew nearly 200% year over year.

Speaker 2

And the growth for Hayako comes from several things, continuous product improvements, positive word-of-mouth and a lot of user to user referrals. So we expect that Mr. P to follow a similar path. So we also did some projects for Hayako on the B2B front. Hayako has entered over 100 schools nationwide.

Speaker 2

We also focused on partnerships. Hayako became an official partner of the British Council's IELTS test. So I believe this is also our strength. NetEase has a long history of working effectively with international companies and institutions. Hayako was also recently featured on the App Store, Apple App Store homepage, which is a testimony of its quality and popularity.

Speaker 2

So overall, we found that AI apps are popular online users and we have a lot of ideas. Our team has a lot of ideas to how to commercialize them. And we expect this year and next year to be a very good time period, time window to grow and monetize these AI apps. Yes, so we will focus on them. Yes, thank you.

Speaker 7

Thank you.

Operator

Our next question today will come from Howard Tung of Macquarie. Please go ahead.

Speaker 8

Hi, good evening and thank you for taking my question. My question is about the non academic tutoring market. So I'd like to know more about your company's progress in STEAM courses and whether you will accelerate investments in the future? Thank you.

Speaker 3

You. This is Peng. I will handle the questions. And in the 2nd quarters, we made some progress in our non academic courses, although our language training and logic thinking courses are in their early stage, but in terms of the gross billings both have experienced a year over year growth over 100%. As in English, the other skill based training has always been the strength of Liudao.

Speaker 3

As you know and empowered by the AI, we can now provide the users with very comprehensive services and highly customer services during, before and after classes. On the other hand, we have already have very strong faculty and high quality content to provide excellent in class services to the users. This is rapid development of our e vapor subscription services and we can also access the users in personalization and the post class scenario between their listening and speaking capabilities. For example, as we mentioned in the last several quarters, the higher calls allow users to engage in oral communication anytime and anywhere and generate a personalized analysis report to correct the issues related to speech and grammar during the conversations. For logic thinking courses, it is highly demanded by the users.

Speaker 3

Parents always hope to the that kind of through the courses I think their children's thinking abilities will continuously improved. Our products meets the needs of the parents. And additionally, when the students encounter the problem after classes, as Doctor. Fu mentioned, Mr. P, AI tutors can help them to answer the questions and with the I think with a different way.

Speaker 3

And we didn't just like Doctor. Tu mentioned, the method is not directly give them the answers, but just try to lead in them to think about all the path. We think that will be the kind of the innovation and that will be really need from the family education scenarios. Looking ahead, we will continue to emphasize the high quality development of the non academic courses. If we identify the clear opportunities, we are ensuring the health end of our business.

Speaker 3

We will consider increasing the investments in the non academic courses. Thank you.

Speaker 2

I think you need to choose which courses to provide very carefully to be successful. So, it is particularly important for non academic learning because they can be very wide in terms of topic. So, you can choose from a very wide set of topics, but you have to choose very, very carefully, because parents, they may initially be interested in different topics. They may want to try it, but in the end, they are they choose the courses that's really helpful for their kids in the long term. Only those courses will become popular for the long term.

Speaker 2

So you need to choose carefully. So that's what we focus on for non academic courses. For example, we believe Chinese literature abilities are very, very important for kids. Being able to grasp the power of language is one of the key abilities that benefits a person's whole life. So that course has proven successful in the last several years.

Speaker 2

So we will keep improving. And also one other thing we think that's really important is computing skills. Everyone knows that it's key for future careers. So our competitive programming course, Yudao Little Turing has been running for 6 years. So, we had our 1st national NOI gold medalist for this year.

Speaker 2

So, the key thing is that if we start some course, some non academic course, we will make sure that we choose carefully and we want it to be successful for many years to come. Yes, so I think that's important.

Operator

Our next question today will come from Bao Zhang of Haitai Securities. Please go ahead. Hello, John. Bo Zhang, your line is open.

Speaker 2

Hello. Can you

Speaker 5

hear me?

Operator

Your line is live. Yes. Thank you.

Speaker 5

Thank you, manager, for taking my question and congratulations on the strong performance this quarter. I have a question regarding smart device. We saw the revenue from the smart device is still decreasing. Could you share some color on strategy for Youdao DRM for the second half of the year and the average

Speaker 3

half of the year?

Speaker 5

Thank you.

Speaker 2

For the last few quarters, we've reorganized our device sales channels as we communicated in the last several calls. We also focused our products to be again around our core dictionary pen category. This year we've released the 4 dictionary pens from the mid tier A6 Pro, S6 Pro to flagships X7 and X7 Pro. So the good thing is users have told us that they really like these new products. So, the Yoda dictionary pen is ranked the number one seller in the category during the June 18th shopping festival on jd.com for 5 years consecutively, so reflecting their users' preference for our brand.

Speaker 2

X7 in its 1st month on the market generated twice the revenue of last year's flagship X6 Pro as we just as I just talked about during the prepared remarks. So this good news tell us that our overall strategy of focusing on core products and channel efficiency are correct. So what we need to do now is we need to continue to focus on our key products, mainly dictionary pins and use strong sales capability and efficient channels. At the same time, another good thing is that the device business and the financial performance has improved after the refocusing. So that set up a good foundation for the business to build on.

Speaker 2

So here are a few to build on. So here are a few more kind of points about the dictionary pens. So the first one is about the high end products. So these are our strengths and our first large language model application were on our high end products. So in July, we launched the Dictionary PEN X7 and last week X7 Pro, both carry large language model features, including Mr.

Speaker 2

P and AI translation. So, as we just shared, Mr. P is the number 2 most popular function and AI translation is also very popular. So, that's really encouraging for us because only our products have these features right now. 2nd point I want to share is regarding price point.

Speaker 2

So last year, we expanded into the mid range market with the launch of the S and A Series aiming to serve a broader audience and meet diverse user needs. In Q2, so one of the result is addiction repaying unit sales grew by over 50% year over year. And in addition, net revenue from the exchange rate plans increased nearly 10% year over year. So, unit growth 50%, revenue growth 10%. So that means the strategy of not going for a very low price is correct.

Speaker 2

We didn't go for a price war. So our Chipy's product, the A6 Pro is still 50 or 100 to yen higher, more expensive than our peers. So we believe that's a good balance to strike. So achieving allowed us to achieve both unit growth and revenue growth. I think that's a good trend.

Speaker 2

Yes. The third point is driving gross margin ratio because this is something that people look at carefully. So in Q2, our gross margin ratio for smart devices was a bit low at 30%. Again, that was mostly due to the product mix as we just discussed. So more mid tier product, fewer high end product.

Speaker 2

However, as we ramp up on the higher end product in Q3 and Q4, So we are still targeting 40% gross margin ratio as before. So we have good feature differentiation, a lot of AI features and the hardware is much stronger with AI cameras the first time this year and with much better screens that users really like. So and we also improved our supply chain a lot over the last year. So that lowered our supply cost. So we think 40% gross margin ratio is a reasonable and feasible growth target to shoot for.

Speaker 2

So, I think only more as we said, we expect Q2 to be the low point operationally for the hardware business. So, we're looking forward to its future performance.

Operator

Our next question today will come from Yikon Zhang of Citix. Please go ahead with your question.

Speaker 2

Good evening, management. Thank you for taking my question. My question is about profit. Will we achieve profitability this year? And if so, will we be able to sustain profitability in the future?

Speaker 2

Thank you.

Speaker 5

Thank you for your question. This is Wayne. I will take your question. We are fully committed to improving the overall health and achieving full year positive operating income near future. Over the past year, we have successfully reduced operating loss on a year over year basis, especially in the first half of this year, where operating loss were reduced by over 90% year over year to approximately RMB40 1,000,000.

Speaker 5

It's always the data indicates that due to seasonal factors, typically higher operating income in the second half year compared to the first half year. Given us confidence in achieving positive operating income for the full year of 2024, despite intense competition and various uncertainties, We believe that this profitability is expected to be sustainable on a full year basis in the future due to the following reasons. 1st, strong profitability in 3 core areas, Digital content services, online marketing services and AI driven subscription services have been identified as our key strategic focus area. We allocate more resources to these areas, which has resulted in profitability and we will continue to do so. Our online marketing services fueled by our RTA technology, data capability and the precise understanding of user needs have achieved over 50% year over year net revenue growth for 7 consecutive quarters driving profitability.

Speaker 5

Through leveraging AI technology and high quality content, our digital content services, especially Lingxi, have improved the learning efficiency and effectiveness for our users. The leading products and services have been pivotal in driving revenue and the profit growth. AI driven subscription services, a key aspect of our AI commercialization efforts, have experienced a strong sales growth and we have confidence in their future profitability. 2nd, enhance the financial performance in non core business. For non core business such as smart devices and non digital content services, we have implemented the stricter health requirements focusing on higher ROI metrics and the label efficiency.

Speaker 5

This has resulted in a temporary decline in overall business skill, but has significantly improved the health of this business and reduced the losses. 3rd, operational efficiency improvement through AI technology and the content innovation. To achieve profitability, we are continuously striving to improve marketing efficiency through innovation and enhance the user experience through the creation of premium learning content. We explore various innovations such as diversifying marketing channels and leveraging advanced AI technology to optimize marketing efficiency and mitigate challenges like rising acquisition costs due to intense competition. By innovating premium content, such as our transition from traditional living stream online classes to prerecorded content embedded with AI technology, like adaptive question bank, we address user concerns such as inflex both schedules and provide personalized learning experience.

Speaker 5

This premium content has exhibited strong user engagement with over 70% retention rate in Q2. In summary, our strategic focus and innovative approaches have resulted in a continued improvement in our operating margins, giving us confidence in sustained profitability of our business in the future. Thank you.

Operator

Our next question today will come from Crystal Lee of China Merchant Securities. Please go ahead. Hi. Thanks management for taking my question. Congratulations on the strong results.

Operator

I just want to know how should we interpret the recent opinions on promoting the high quality development of service consumption and particularly regarding the education and training consumption? Thank you.

Speaker 3

Thank you. Yes, we have noted that earlier this month, the state councilors issued opinions on promoting the high quality development of services consumptions, which emphasize the meeting of the diverse and the personalized learning needs of the general public and promoting the social training institutions to enhance service quality in response to the public demands. First, I think just to make it clear, you'd always consistently to embrace the policy and adhere to operating within the scope of the permitted by policies. And by now, it's still in the very early stage And we don't know any further and the detailed information like scope and the category of the policy. First of the definitely, we will wait on this, the following information related with the public regarding of the detailed information.

Speaker 3

And what we can say now is about the strategy of Yodao is to consistently invest into the education sector, within the AI features. And if you see the dynamic of our products, we always be innovative and creative to create a new format of our products following the policies. We think we will keep the updates and the existing product and provide the new services following the instruction of the existing policy and upcoming ones. And we think that will be the consistent thing to deliver the message regarding on the policies and we can discuss more in details right after we receive the more information from regarding on this detailed policy. Thank you.

Operator

Thank you. At this time, we will conclude the question and answer session. I'd like to turn the conference back over to management for any closing remarks.

Speaker 1

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

Operator

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

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Earnings Conference Call
Youdao Q2 2024
00:00 / 00:00
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