Prepared remarks
Good day, and welcome to Youdao's second quarter 2026 earnings conference call. Please note this event is being recorded. I would now like to turn the conference over to Mr. Jeffrey Wang, Investor Relations Director of Youdao. Please go ahead.
Thank you, operator. Please note that 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 2026 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 Vice President; and Mr. Yongwei Li, our Vice President 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 denominated in renminbi, unless otherwise stated. We maintained solid momentum in the second quarter, delivering robust results. Net revenues for the quarter reached RMB 1.5 billion, representing a 3.5% year-over-year increase. In terms of profitability, we achieved a record high in Q2, with operating profit reaching RMB 111.5 million, nearly fourfold year-over-year. This marks our eighth consecutive quarter of operating profitability, representing a critical step towards our goal of healthy and sustainable development. Meanwhile, net cash inflow from operating activities was RMB 334.2 million, up 80.7% compared with the same period last year. These strong quarterly results also drove strong first-half performance. In the first half of 2026, total net revenues reached RMB 2.8 billion, up 3.6% year-over-year, while operating profit increased 27.3% to a record RMB 169 million. We also generated RMB 241.1 million in net operating cash flow, compared with a net outflow of RMB 70.5 million in the same period last year, reflecting a substantial improvement in cash generation. Let me begin with an update on our progress in AI technology and Confucius, our proprietary Large Language Model. AI remains a key driver across our business. During the second quarter, we continued to translate advances in our LLM capabilities into practical products and applications across our business lines. First, we rolled out Confucius 4 in the second quarter, with significant upgrades in multimodal, voice and translation capabilities. The new model delivers stronger performance in visual math and physics reasoning, particularly on complex diagrams. We also improved its reasoning architecture and training data to significantly reduce inference costs. In translation, an optimized acceleration mechanism increased inference speed by approximately 80%. Second, our growing portfolio of AI agents was showcased at the 2026 World AI Conference. Products including LobsterAI, Hi Echo, Youdao Baoku, InfunEase and iMagicbox, together with Confucius 4, demonstrated how AI is moving beyond basic Q&A toward executing more complex tasks across learning, work and advertising scenarios. Beyond technological advances and user adoption, our AI capabilities also continued to gain recognition and support from authoritative bodies. In Q2, the Beijing Key Laboratory of Artificial Intelligence for Multilingual Translation co-founded by Youdao was officially launched. Going forward, we will continue advancing end-to-end multilingual translation models and accelerate their application across learning, international conferences and cross-border trade. I will now walk through the performance of each of our business lines during the second quarter. Net revenues from learning services were RMB 795.6 million, up 20.9% year-over-year, primarily driven by the strong performance of Youdao Lingshi, one of our strategic focused areas. AI continues to play an increasingly important role across our learning ecosystem. Following the strong reception of our AI English Essay Grading feature launched in the first quarter, grading volume more than doubled sequentially in Q2. Together with AI-powered quiz recommendations and college admission advisory services, these differentiated AI capabilities helped enhance the user experience and contributed to a retention rate of over 75% for Youdao Lingshi in the second quarter. For our programming courses, continued product upgrades and channel expansion helped broaden the user base, while improvements in the learning experience supported a retention rate of over 75% in the second quarter. Within learning services, our AI-driven subscription products generated approximately RMB 100 million in sales during the second quarter, up more than 20% year-over-year. Our AI Simultaneous Interpretation feature also maintained strong momentum, with user engagement increasing by approximately 100% year-over-year. We also launched what we believe is the world's first 14-language, cross-lingual, accent-free voice cloning technology, enabling rapid voice replication across languages while preserving the speaker's emotional characteristics. To support broader adoption, we open-sourced the model weights and tool chains for local deployment and commercial use, significantly lowering the barrier to multilingual content production. Meanwhile, Hi Echo continued to perform strongly, with second quarter gross billings increasing by more than 100% year-over-year. The product also received positive feedback from both domestic and international users at WAIC. Turning to online marketing services, net revenues were RMB 584.4 million in the second quarter, down 7.7% year-over-year. The decline reflects our deliberate focus on higher-quality, higher-margin opportunities as we continue to prioritize the long-term health and profitability of the business. As a result, gross margin improved to 28.7%, up approximately 3 percentage points year-over-year. At the same time, we continued to make progress in client acquisition and retention, adding more than 100 new clients during the quarter and increasing advertiser retention by approximately 5 percentage points sequentially. Our AI application and short-form drama advertising businesses also maintained strong momentum, with revenues growing more than 50% year-over-year for the second consecutive quarter. On the product side, we recently launched the second generation of our AI Ad Placement Optimizer, further improving advertising efficiency and quality. Unified Account Management provides centralized access across accounts, simplifying campaign operations. Automated Push Notifications delivers real-time data updates to help users respond more quickly. Intelligent Alerts provides 24/7 anomaly detection with second-level response times, helping reduce wasted ad spend and operational losses. Together, these upgrades further enhance advertiser value and strengthen the long-term health of our marketing ecosystem. Moving to smart devices, improving profitability remains our primary objective. Net revenues were RMB 86.8 million in the second quarter, down 31.5% year-over-year, while the overall operational health of the business continued to improve. Our market position remained strong. During the 618 Shopping Festival, Youdao Dictionary Pen ranked #1 in sales in its category on both JD.com and Tmall for the seventh consecutive year. Our Youdao Tutoring Pen also received recognition from several government authorities for its application of AI in education, including the Ministry of Education, the Cyberspace Administration of China, and the Ministry of Industry and Information Technology. We also recently launched the Youdao Dictionary Pen X8, featuring an expanded database of 80 million authoritative words and AI-powered, photo-based tutoring across multiple subjects. Initial market response has been positive. Looking ahead, we will continue to execute our AI-Native Strategy, leveraging our technical capabilities to deepen the application of vertical LLMs across learning and advertising. We will also continue expanding our portfolio of AI Agents to enhance user experience and satisfaction, supporting further improvements in our key financial metrics in the second half of the year. With that, I will hand the call over to Peng Su 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 2026. We encourage you to read through our press release issued earlier today for further details. For the second quarter, total net revenues were RMB 1.5 billion or USD 216.2 million, representing a 3.5% increase from the same period of 2025. Net revenues from our learning services were RMB 795.6 million or USD 117.3 million, representing a 20.9% increase from the same period of 2025. The year-over-year increase was primarily driven by the strong momentum of tutoring services compared with the same period of 2025. Net revenues from our smart devices were RMB 86.8 million or USD 12.8 million, representing a 31.5% decrease from the same period of 2025, primarily due to a decline in demand for smart learning devices. Net revenues from our online marketing services were RMB 584.4 million or USD 86.1 million, representing a 7.7% decrease from the same period of 2025. The year-over-year decrease reflects Youdao's disciplined, strategic approach to engagement acceptance, which places greater emphasis on higher ROI engagements. Youdao believes this strategy has enhanced the overall operational efficiency of its business. For the second quarter, our total gross profit was RMB 716.9 million or USD 105.7 million, representing a 17.6% increase from the same period of 2025. Gross margin for learning services was 65.5% for the second quarter of 2026, compared with 59.8% for the same period of 2025. Gross margin for smart devices was 32.8% for the second quarter of 2026, compared with 41.5% for the same period of 2025. Gross margin for online marketing services was 28.7% for the second quarter of 2026, compared with 25.8% for the same period of 2025. For the second quarter, our total operating expenses were RMB 605.3 million or USD 89.2 million, compared with RMB 580.6 million for the same period of last year. Looking at our expenses in more detail: sales and marketing expenses for the second quarter of 2026 were RMB 424.1 million, compared with RMB 401.8 million in the second quarter of 2025. Research and development expenses for the second quarter of 2026 were RMB 142 million, compared with RMB 128.3 million in the second quarter of 2025. Our operating income margin was 7.6% in the second quarter of 2026, compared with 2% for the same period of last year. For the second quarter of 2026, our net income attributable to ordinary shareholders was RMB 73.8 million or USD 10.9 million, compared with net loss attributable to Youdao's ordinary shareholders of RMB 17.8 million for the same period of last year. Non-GAAP net income attributable to ordinary shareholders for the second quarter was RMB 90.6 million or USD 13.4 million compared with RMB 12.5 million in the same period last year. Basic and diluted net income per ADS attributable to ordinary shareholders for the second quarter of 2026 were RMB 0.62 or USD 0.09 and RMB 0.61 or USD 0.09 respectively. Non-GAAP basic and diluted net income per ADS attributable to ordinary shareholders for the second quarter was RMB 0.76 or USD 0.11 and RMB 0.75 or USD 0.11 respectively. Our net cash provided by operating activities was RMB 334.2 million or USD 49.3 million for the second quarter. Looking at our balance sheet, as of June 30, 2026, our contract liabilities, which mainly consisted of deferred revenues generated from our learning services, were RMB 835.1 million or USD 123.1 million, compared with RMB 847.7 million as of December 31, 2025. At the end of the period, our cash, cash equivalents, current and non-current restricted cash, and short-term investments totaled RMB 849.3 million or USD 125.2 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.
Questions and answers
Our first question comes from Brian Gong with Citi.
I want to ask about the ongoing integration of the large language model across your business and financial performance. I would like to ask management: what is the core strength of this model? And are there new product launches in the pipeline targeting this capability?
Brian, I will take the question. For large language models, we focus on areas where we see strong user demand, significant potential for value creation and also differentiated strength for Youdao. In addition to translation, which has long been one of our core strengths, I'd like to highlight two areas today: advanced voice and audio, and mathematics learning. In both areas, we believe Youdao has significant strength. For voice, we have seen strong user adoption for several years already. The success of our products, Hi Echo and Youdao Simultaneous Interpretation, demonstrated clear demand for high-quality, low-latency voice interactions in both learning and communications. In Q2, user engagement with simultaneous interpretation increased by approximately 100% year-over-year. Hi Echo's gross billings also grew by more than 100%. One recent development I want to highlight is Confucius 4-TTS. As we discussed in our prepared remarks, this modern text-to-speech model supports cross-lingual, accent-free voice cloning across 14 languages while preserving speaker identity and emotional expressions. We see broad potential applications in areas such as cross-lingual learning, multilingual content creation, dubbing and international communications for this model. We plan to launch more voice-related models and products in the coming months. The second area I want to highlight is mathematics. Mathematics is another very important focus for us. AI-driven math learning is highly demanded by users and it's also an area where we have strong technology and learning expertise. Math is a challenging subject for many learners and is foundational to almost all STEM disciplines. Students' needs in math learning are highly personalized and often revolve around very specific problems and knowledge gaps. This makes math learning a significant opportunity for AI to provide personalized explanation, diagnosis, practice and tutoring at scale. Confucius 4 significantly improved reasoning for vision math and physics prompts, particularly those involving complex diagrams. Going forward, we plan to introduce additional model capabilities and also AI agents for math learning, with similar opportunities across other STEM subjects. I'm also pleased to share that we plan to launch multiple new AI agent and model products in September next month. We will continue expanding our models and agent capabilities around these key areas. We look forward to sharing more very soon. Thank you.
Our next question comes from Jing Wang with CICC.
My question is also about AI, but it's more about Lingshi's AI Essay Grading. Lingshi's AI Essay Grading feature has earned wide user recognition. Do you plan to further expand its AI-powered features in the future?
Thank you. This is Peng Su. I will handle the question. Yes. For Lingshi, we see AI creating value in two important ways: improving the learning experience and expanding what we can offer to users, and improving the scalability and operational efficiency of our services. Over the past four years, powered by our continued investments in our large language model infrastructure, Youdao Lingshi has focused on resolving core pain points across learning and college application scenarios. Through continuous product refinements and exploration of the latest use cases, we have built a comprehensive AI interactive coursework and service platform. This platform empowers students to enhance their learning quality and efficiency, winning broad acclaim from our users. At the core learning features level, Youdao Lingshi has crafted granular and personalized intelligent learning solutions. First is personalized learning path recommendations. Centered around specific knowledge points, this function identifies students' weak areas to generate a tailor-made learning plan by targeting shortfalls directly and eliminating redundant practice. It boosts learning efficiency. Second is AI-based recommendations, leveraging individual learning profiles within the Youdao Lingshi Intelligent Learning system. This feature dynamically recommends adaptive exercises to help students master core concepts through application and variation. Third is AI Essay Grading for Chinese and English. Based on explicit evaluation rubrics, this feature diagnoses writing flaws with high precision and provides targeted optimization suggestions, helping students polish their writing skills efficiently. Last is AI-based college admission advisers. Expanding beyond academic learning, Youdao Lingshi leverages its massive user base and extensive industry data to offer professional AI-based college application advisory services. By assessing a user's performance, strengths, interests and risk preferences, it intelligently generates multiple well-balanced application strategies to guide candidates in their decision-making process. Our retention metrics serve as strong proof of our service capabilities. In the second quarter of this year, Youdao Lingshi achieved a retention rate exceeding 75%, maintaining an industry-leading level and demonstrating high user satisfaction with our AI-driven courses. For us, AI is not a simple additional feature for Lingshi. It has become an important driver of both user value and business efficiency, helping us improve the quality, scalability and long-term economics of our business. I hope I answered your question.
That's very clear.
The next question comes from Thomas Chong with Jefferies.
Could management share the outlook for online marketing services in the third quarter?
This is Lei Jin. Thank you for your question. In the second quarter, our advertising business became more profitable with gross margin improving by about 3 percentage points. We expect gross margin to continue improving year-over-year in the third quarter. Our online marketing revenue grew from about RMB 100 million in the first quarter of 2022 to about RMB 600 million per quarter in the first half of this year. This growth was driven by our continued investment in AI and data capabilities, which has helped us expand into new business opportunities. Whenever we capture key opportunities, revenue experiences a rapid acceleration in subsequent quarters. In the third quarter, we will focus on three areas. First, strengthening our AI-plus-advertising capabilities. We are integrating AI into all parts of our advertising business through our priority vertical LLM for KOL marketing. After upgrades in the first quarter, we plan to launch an overseas KOL marketing agent in the third quarter to help Chinese companies reach global markets more efficiently. Second, programmatic advertising matching. Our second-generation AI Ad Placement Optimizer improved traffic matching and helps increase targeting accuracy and operating efficiency. Third, expanding our advertiser base. With the support of our team and AI capabilities, we added more than 100 new advertisers in the second quarter. In the third quarter, we will focus on fast-growing sectors such as AI applications and short-form dramas, both in China and overseas. Finally, we are improving profitability. We will continue to improve gross margin through two initiatives: using Youdao devices to reduce the cost of producing advertising creatives and using the AI Ad Placement Optimizer to identify more cost-effective traffic. In summary, over the medium to long term, we will continue to apply AI to programmatic advertising and KOL marketing. This will help improve advertisers' ROI while supporting our growth in both revenue and profitability. In the short term, we will prioritize profitable and sustainable growth over rapid expansion. We will also keep upgrading our advertising and KOL marketing tools to support future growth. Thank you.
Our last question comes from Bo Zhan with Huatai Securities.
This is Zhan Bo from Huatai. Could management share the outlook for gross margin in the third quarter?
Thank you, Zhan Bo. This is Yongwei Li. I will take your question. As reflected in our financial results, we delivered an impressive performance in gross margin, reaching 47% in the first half of this year, representing a year-over-year improvement of around 2 percentage points. Gross margin for online marketing services and learning services expanded by about 1 percentage point and 3 percentage points year-over-year, respectively. I will give more details on the reasons for the improvement in profitability and its outlook by segment. First, online marketing services: the margin expansion stems from the execution of our AI-native strategy and profitability-priority discipline. Agents such as the AI Ad Placement Optimizer and iMagicBox have significantly boosted productivity across ad planning, user profiling and creative asset production. Under the profitability-priority approach, we proactively avoid certain ad opportunities with relatively low ROI, focusing our resources instead on campaigns that deliver higher value to users. Second, learning services: the improvement in learning services' gross margin was primarily driven by AI-enhanced learning efficiency and scaling benefits. AI features such as AI Essay Grading for Chinese and English and AI quiz recommendations have been widely adopted. These tools have elevated the efficiency of our teaching assistance, which in turn boosted both student retention rate and gross margin. On the economies-of-scale side, cost per revenue has steadily declined since the second half of 2025, and we expect economies of scale in learning services to become even more pronounced throughout 2026, driving further gross margin expansion. Third, smart devices: similar to the broader consumer electronics industry, our smart devices segment has faced cost pressure from rising memory costs alongside a reduction in hardware economies of scale. Consequently, gross margin for smart devices stood at around 37% in the first half of this year, down roughly 11 percentage points year-over-year. Although memory costs are likely to remain elevated in the near term, architecture and engineering improvements designed to reduce memory reliance will meaningfully mitigate margin compression with a new product launch planned for the third quarter. We anticipate the gross margin of smart devices to recover to over 40% in the second half of the year, narrowing the year-over-year decline. Looking ahead, we will further deepen the AI-native strategy and broaden LLM integration across all product lines while maintaining rigorous cost and operational efficiency optimization. This strategy will remain central throughout 2026, giving us confidence in delivering strong gross margin performance and achieving meaningful breakthroughs at the operating profit level in the second half of 2026. I hope the information is helpful. Thank you.
Ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.
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 Piacente Financial Communications in China or the U.S. Have a great day.
Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Goodbye.