Youdao, Inc. Q1 FY2025 earnings call

• Executed AI native strategy through product development, with operating income reaching a Q1 record and profitability boosted. - Learning Services segment: Net revenues declined but rate of decline narrowed; digital content services had RMB 410.8 million in Q1; Youdao Lingshi saw over 25% year-over-year gross billing growth; STEAM courses' programming courses had over 40% year-over-year gross billing growth; AI-driven subscription services had nearly RMB 70 million in Q1 sales, growing over 40% year-over-year. - Model development: Open-sourced Confucius-o1; enhanced translation model; started self-hosting DeepSeek-R1 inference. - Applications: Upgraded Mr. P AI Tutor with multi-model visual system; launched Youdao AI podcast assistant and academic paper plagiarism detection system. - Online Marketing Services: Q1 net revenues rose 2.6% year-over-year; performance-based advertising client base grew by 20% year-over-year; secured Official Google Partner Certification and complemented TikTok partnership; launched Youdao MagicBox; deepened collaboration with NetEase Group.

In the first quarter, net revenues were RMB 1.3 billion, declining 6.7%, primarily due to decreased learning services revenue. Operating income reached a Q1 record of RMB 104.0 million, surging 247.7% year-over-year. Net revenue from Learning Services segment was RMB 602.4 million, a 16.1% year-over-year decrease. Net revenue from Smart Devices segment was RMB 190.5 million, up 5.1% from the same period of 2024. Net revenue from Online Marketing Services segment was RMB 505.4 million, a 2.6% increase year-over-year. Gross margin for Learning Services was 59.8% in Q1 2025 compared with 63.1% in the same period of 2024. Gross margin for Smart Devices was 52.3% in Q1 2025 compared with 32.6% in the same period of 2024. Gross margin for Online Marketing Services was 3.5% in Q1 2025 compared with 34.3% in the same period of 2024. Operating cash outflow narrowed by 34.7% to RMB 255.5 million.

• Target to achieve operating cash flow breakeven for full year 2025. - Expect to reduce Q2's operation losses year-over-year while noting potential macroeconomic uncertainty may affect results.

Q: A quick question on AI. I noticed our AI thinker integrated ahead of our peers in the first quarter. So, from a medium- to longer perspective, how does management view the differentiation between your large language model fusions and other large language models in educational scenarios?

A: Brian, so let me take the question. From day 1 of the large language model development back in early 2023, we've emphasized the importance of embracing open technologies. So that is why we are the first in the ad tech industry to integrate it into our LLM stack and Mr. P AI Tutor in Q1, giving users options of models to solve K-12 problems. So at the same time, our proprietary model, Confucius, has been evolving since 2023. In January, we released a major leap with Confucius-o1, actually before the DeepSeek R1 release. So Confucius-o1 was the first open-source educational reasoning model capable of step-by-step exposition while being far more GPU-efficient than general-purpose models. So this next-generation Confucius is now also deeply integrated across our learning services. So AI-driven subscriptions and also smart devices, solidifying our leadership in deploying large language models for education in China. So let me highlight 3 key advantages of combining open and proprietary technologies for you. The first, we believe is this dual approach enhances the user experiences. Confucius delivers faster responses while DeepSeek R1 often provides more comprehensive answers. We've observed that users very naturally adopt to Confucius for quick checks and DeepSeek for in-depth explanation. So currently, actual usage is split roughly evenly. Second, we believe open technologies accelerate our teams and technology growth. Just as Google Android leverages the Linux kernel, we benefit from the broader ecosystem while contributing back. This dynamic environment pushes our teams to iterate faster, keep us at the forefront of innovation. Thirdly, Confucius excels in education-specific scenarios. So, thanks to the continuous refinements, it outperforms general purpose models in a few very important areas. First is translation quality. Confucius leads the industry in translation accuracy, a core capability for our platforms while operating at a fraction of the cost of general-purpose models. As noted earlier, we've completed our year-long transition from NMT to LLM translation, now processing over 1.5 billion tokens every day. The second strength of Confucius models is Q&A accuracy. So, with recent multimodal upgrades, Mr. P AI Tutor achieves over 92% accuracy in K-12 problem solving. So that is a 7-point year-over-year improvement over last year, significantly surpassing stand-alone DeepSeek performance in these scenarios. So we're also optimizing our use of DeepSeek by migrating DeepSeek R1 inference to our fully-internal deployment. We've achieved 99.9% availability, lower latency and also greater cost with further optimization still ongoing. So our progress has gained a lot of recognition. Actually, the Time Magazine recently ranked Youdao as the world's #2 ad tech companies among over 7,000 firms, underscoring our leadership in LLM deployment and operational excellence. So moving forward, we will deepen our focus on educational verticals, enhancing Mr. P's accuracy while also expanding Confucius into more areas, including lesson planning, grading and assessments. So exciting products and model updates are coming this summer, and we look forward to sharing them soon. Thank you.

Q: My question is about your learning service. So, I noticed that the net revenue from the learning service segment remained year-over-year decline during the first quarter. When do you project the segment's revenue to return to growth?

A: Thank you, Brenda. This is Su Peng. I will handle the question first. And I think our adjustment for the learning services segment initiated last year remains ongoing right now. And we have intensified our focus on service with robust demand and significant growth potentials such as the Youdao Lingshi while scaling back nonessential offerings. And as we mentioned in the last 2 quarters, it will be accomplished in this year. And although the net revenue from the learning services segment still declined from a year-over-year basis in Q1, the rate of decline narrowed by roughly 5% compared to the previous quarters. This improvement was primarily driven by the resilient performance of the Youdao Lingshi during this quarter. And we believe there are several points to support the sustainable growth of Youdao Lingshi's business. The first is about China's paid college entrance exam advisory service market has demonstrated significant growth potential in recent years, driven by the evolving college and school selection rules under the new Youdao policies and at the same time, the family's urgent needs to bridge the information gaps. In Q1, we launched an upgraded AI college admission advisers powered by our large language models, offering the user professional, efficient and tailor-made one-stop services. This service gained immediate users' recognition and drove the Youdao interest Q1's gross billing to grow by over 25% year-over-year. And looking forward, we expect a sustained rapid growth for our AI college admission advisers. Our computer model in continuous advancements will further refine the recommendation accuracy of our pricing, which at least -- at less than 10% of the traditional advisory fee and make quality guidance accessible to more families. At the same time, we just noticed that the recent education construction plan online has been released, which emphasizes cultivating the top tiers innovative talents and including the outstanding talent program for exceptional high school students. We will definitely actively monitor policy development and leverage our premium resources and product expertise to capitalize on these emerging opportunities. And in summary, we anticipate completing our segment restructuring in the second half of this year with revenue stabilization expected thereafter. For our flagship Youdao Lingshi services, we project both revenue and profit to achieve year-over-year growth in this year. Thank you, Brenda.

Q: My question is about online marketing services. As we see, revenue from online marketing services has remained at around RMB 500 million for 6 consecutive quarters. When does management anticipate a reacceleration in revenue growth?

A: This is Lei Jin. Assuming the stable market conditions and the execution of our business plan, we expect online marketing services revenue will show stronger growth momentum in the second half of this year compared to the first half, driven by 3 key factors. First, accelerated overseas advertising expansion. After obtaining Google's official partnership status in Q1 and completing certification, we are now implementing collaborative initiatives that should contribute meaningful to H2 revenue. Additionally, our TikTok advertising revenue maintained a strong growth in Q1, a trend we expect to continue through the year-end. Second, updated AI-powered advertising solutions. Our Q1 launch of Youdao MagicBox and AI-driven one-click AD Creator tool marked the first step to our enhanced capabilities. We are currently developing our AI advertising optimizer with a beta version launching in Q2 and a full release planned for H2. This system will automatically generate comp strategies, including targeting scenarios and budget allocation aligned with advertiser objectives while continuously optimizing through real-time RLM insights and adaptive recommendation models. Third, deepen the collaboration with NetEase School. In Q1, we leveraged our algorithmic and data analytics expertise to enhance the efficiency of NetEase's gaming promotions. In particular, for global promotions, our overseas influencer network now encompass 15 million creators across 75 countries, reaching over 2 billion users directly. NetEase advertising with us grew steadily in Q1 with this positive trajectory is expected to continue. Regarding tariff impact, while the uncertainty duties may present challenges for acquiring overseas e-commerce clients. This segment currently represents a minimal portion of total AD revenue, making the overall effect notably stable. We should note that H2 performance remains subject to macroeconomic conditions in domestic and international markets, which could introduce operational variabilities. Thank you.

Q: My question is, last year was Youdao's first full year of profitability. Among the 4 quarters, the second quarter reported an operating loss. Is there a possibility of the profitability in the second quarter this year?

A: This is Wayne Li. I will take your question. Our financial performance throughout 2024 and Q1 2025 demonstrates significant and sustained profitability improvement. This progress validates the success of our strategic initiatives across 3 critical areas: first, sharpen focus on high-margin digital content, advertising and AI-powered subscriptions; second, comprehensive AI native transformation boosting operational efficiency. The last one is the simplified cost optimization. By concentrating resources on Youdao online marketing services and other key initiatives, we've successfully contained the losses from non-core operations. Our AI integration has revolutionized multiple business functions from cost operations to AD production and R&D, delivering higher efficiency and profitability levels compared to our historical performance. Historically, Q2 has remained unprofitable mainly due to 2 seasonality reasons. First, Q2 is traditionally the weakest quarter for revenue generation from learning services and smart devices. Second, substantial sales and marketing campaign for summer enrollment, which typically begin in June. For Q2 this year, we will maintain our strategic priorities like large language model deployment and cost development while further optimizing our cost structure in line with our full year profitability goals. Our ongoing investments in core offerings --like you may temporarily-- competitive position and drive full fiscal profitability. In summary, we expect to reduce Q2's operation losses year-over-year while acknowledging potential macroeconomic uncertainty that may affect results. Wish it is helpful. Thank you.