Good day, and welcome to the Youdao 2023 Second Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeffrey Wang, Investor Relations Director of Youdao. Please go ahead.

Thank you, operator. Please note the discussion today will contain forward-looking statements related to 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. 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 filings of the company 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 2023 third quarter -- 2023 second quarter financial results news release issued earlier today. As a reminder, this conference is being recorded. Besides, a webcast replay of this conference call will be available on Youdao's corporate Web site at ir.youdao.com. Joining us today on the call from Youdao's senior management is Dr. Feng Zhou, our Chief Executive Officer; Mr. Lei Jin, our President; Mr. Peng Su, our VP of Strategy and Capital Markets; and Mr. Wayne Li, our VP of Finance. I will now turn the call over to Dr. Zhou to review some of our recent highlights and strategic direction.

Thank you, Jeffrey, and thank you all for participating in today's call. Before we begin, I would like to remind everyone that the financial information and non-GAAP financial information mentioned in this release is presented on a continuing operations basis and all numbers are based on Renminbi, unless otherwise specifically stated. In Q2 2023, our net revenues came in strong and reached RMB1.2 billion, representing a year-over-year increase of 26.2%. Loss from operations narrowed to RMB289.1 million, marking a year-over-year improvement of 36.5%. Net cash provided by continuing operating activities stood at RMB133 million, reflecting growth of 27.6% year-over-year. We are on a clear path to achieving profitability. As for our business segments, learning services and online marketing services continue to be our current main driver of growth, both reaching record levels of sales. In the meantime, we're making solid progress in learning service -- learning devices, R&D, and we are leading the charge to apply AIGC in education by rapidly releasing applications of generative AI. In the first half of the year, we see an overall positive trend in key financial indicators. Net revenues amounted to RMB2.4 billion, indicating an increase of 9.9% year-over-year. Loss from operations in the first half reduced to RMB484.9 million, improving by 16.4% year-over-year. Net cash used in continuing operating activities reached RMB304 million, marking a 5%. year-over-year improvement. For our learning services segment. Q2 sales of digital content exceeded RMB800 million, reaching a record high. Customer retention rates across the services was over 60% leading to over RMB200 million in operating cash inflow for this area. In addition to our learning content, we launched an AI University Application Adviser AI Zhìyuàn Tiánbào Xìtǒng [ph] in Q2 to support students in their college selection process. Users were quick to adopt this tool, leading to…

Thank you, Dr. Zhou, and hello, everyone. Today I will be presenting some financial highlights from the second quarter of 2023. We encourage you to read through our press release issued earlier today for further details. For the second quarter, total net revenues were RMB1.2 billion, or US$166.4 million, representing a 26.2% increase from the same period in 2022. Net revenues from our learning services were RMB680.9 million, or US$93.9 million, representing a 20.8% increase from the same period in 2022, primarily driven by the strong sales performance of digital content services compared with the same period of 2022. Net revenues from our smart devices were RMB222.2 million, or US$30.6 million, down 7.4% from the same period in 2022, primarily due to the decreased demands for the intelligent learning products in the second quarter of 2023. Net revenues from our online marketing services were RMB303.6 million, or US$41.9 million, representing a 98.7% increase from the same period in 2022. The increase was mainly attributable to the increased demands for performance based advertisements through third parties’ internet properties. For the second quarter, our total gross profit was RMB567.2 million, or US$78.2 million, representing a 38.4% increase from the second quarter of 2022. Gross margin for learning services was 57.4% for the second quarter of 2023, compared with 52.2% for the same period in 2022. Gross margin for smart devices was 35.8% for the second quarter of 2023, compared with 30.6% for the same period in 2022. Gross margin for online marketing services was 31.9% for the second quarter of 2023, compared with 27.7% for the same period in 2022. For the second quarter, total operating expenses were RMB856.3 million, or US$118.1 million, compared with RMB864.9 million for the same period of last year. With that, for the second quarter, our sales…

[Operator Instructions] And our first question today will come from Brian Gong with Citi. Please go ahead.

Good evening management. Thanks for taking my questions. I have a very quick one on our plan on AIGC technology. What AI applications will be launched in the second half of this year, and what impact will they have on our business in your view? Thank you.

Hi, Brian. Yes, this is Feng Zhou. Yes, we announced our proprietary large language model Ziyue, for education in July. We are looking to leverage this breakthrough technology to drive both short-term and future growth. So we have plans for both the coming months and also for the longer term. So in the short-term, we've already launched six applications for the year, including our digital human language coach named Echo. AIBox 2.0, and AI Translation, et cetera. So the first line of work for us is to deploy these applications to more of our services, apps and devices and start to drive business growth with these new capabilities. So in fact, it is already driving growth as early as in Q2. For example, AIBox 1.0 already drove nearly 100% year-over-year growth of translation subscriptions. And over 200% year-over-year growth of subscription fees in Q2 as we just discussed in March [ph]. We've also launched Echo, our digital human language coach and English grammar instruction feature in the latest Youdao Dictionary Pen X6 Pro, launched earlier this month. Echo is the first large language model base with zero human language coach in China. So this is a groundbreaking product. It is liked a lot by our customers from our feedback. In our AI Grammar instruction feature is also the first of its kind in learning devices. Our users tell us that they really like these two new features because they are really helpful and engaging. We will continue to upgrade these features over the coming months. And we plan to launch and monetize them on other platforms, for example, on phones. So Echo and other features will be on phones too. One of the strengths of AIGC's products from our observation is that consumers are willing to pay for them, because…

Thank you. That's very helpful.

Our next question today will come from Kelly Wang [ph] of CICC. Please go ahead.

Good evening, management. This is Caini Wang from CICC. Thank you for taking my questions. So in terms of the smart devices, things we have released the Youdao Dictionary Pen X6 Pro, and listening Pod Pro earlier this month. So would you mind provide an update on the user feedback for this new smart devices? And also, as we saw a slight decline in revenue in the smart devices sector this quarter, does management still maintain a confidence in the long-term prospects of this business which might give us more color on this? Thank you.

Yes, this is thank you. This is Feng Zhou, again. As you mentioned that we launched the Dictionary Pen X6 Pro and Youdao Listening Pod Pro earlier this month. So let me provide a quick update. For the X6 Pro Dictionary Pen, this is our flagship product. And the most popular features were the 100 day, ultra long standby time, English grammar instruction, video, human language coach and test and lab analysis from the popular five three series. So these are the four most popular features we got from user feedback. The users liked these features very much. So what's exciting for us is that the AIGC language coach is actually among the most popular features. It's the number three feature. So it's the one of the most popular features. So we're happy to share that -- for the first 30 days of August, driven by the popularity of X6 Pro and X6, our new Dictionary Pen activations were up by more than 20% year over year. So that's for the new dictionary pen product. As for Youdao Listening Pod Pro the most popular features from user feedback is the AI player and AI dialogue, these two features are the most popular as some kind of new product sales activation, so we've observed that year-over-year increase in new activations of our listening pod line. So this year is higher in activation than the same period last year. That's also for the first 20 days in August. And as I discussed in prepared remarks, we will have new devices to be released in Q4. So we are looking forward to bringing more new products to our customers in Q4 this year. So that's a quick update on new product. Now let's discuss our thinking regarding the current market environment. Recently the…

Yes. And Caini, this is Peng. I'll address only one point added after Dr. Zhou's comments. And we think the X6 Pro is totally different or the innovative, the most innovative Dictionary Pen compared with all the Dictionary Pen released in the past year. It's because it used to be the hardware of students to learn English more efficient -- efficiently. And right now we think we will not only just Enhance the features of the dictionary functions and same time we also added about a service contract like the Echo, the interactive language training program as well as the grammar instructing program. That's the most useful function -- features for the student when they learned and learn the language. So we believe after the added test purposes, they can create more interactive between the users and our hardware test we can help us to know more about their demands for the -- in the long run. So we think about [indiscernible] will be totally different products compared with the pathway. So we are still confident about absolute [indiscernible] in the mid-term. And the lack of automation we expect to in our future products, we can enable more features of large language models into our hardware. Thank you.

Yes, more exciting products, I mean, yes, later Q4. Yes.

Got it. Thank you. That's very clear. And we look forward to them.

Our next question is from Thomas Chong of Jefferies. Please go ahead.

Hi, good evening. Thanks, management for taking my questions. My question is regarding the online marketing side. What was the driving practice behind the rapid growth in revenue from online marketing services over the past three quarters. Furthermore, what are the key direction for the later half of this year? Thank you.

Hi. This is Lei Jin. The online marketing services has already have robust growth for the three quarters in a row with a surge of nearly 100% for Q2. And Q2 is the fourth quarter, which online marketing revenue exceeded RMB300 million. Internally, there are mainly two factors that drive the growth. Firstly, the advancement of AI technology has improved the margin of accuracy and our ad platform. [Indiscernible] can effectively reach the users across various major platforms. Our use of AI technology allow us to accurately identify the relevant streams associated with the QL [ph], achieving accurate rate of nearly 90%. This enable us to deliver highly processed advertising and help our clients reach their target audience faster and more accurate. Secondly, we upgraded the data and analytics abilities of our ad platform. This more and more convincing that we can enhance and optimize the traffic under advertisement materials based on our effectiveness and resulting in improved advertising performance. Externally, despite a sluggish consumer environment, there is still a strong consumption wellness [ph] among the young people aged between 18 and 35 in gaming, cosmetics and fast moving consumer goods. Our ad clients would like to capitalize the purchasing intent of young people. As for Youdao, a lot of young people are using our products, and we have a deep understanding of them. In the second half year, we will focus on two key directions with ad. Firstly, we will focus on oversee ad marketing. This is a strong demand. We have advantage in terms of resources, language capabilities and experience in this field. With our in-house AI technology recommendation [indiscernible] and the intra network translation, we can connect with over 1 million [indiscernible] worldwide, directly reaching more than 2 billion users in our 55 countries and regions. Those are reaching Chinese brand to overseas expansion. Secondly, we will further enhance our data capabilities. Since the upgrade of ad platform in Q4 last year, we have seen a huge benefit of the real time and accurate data in helping our user decision making and posting on the ad revenue. By the end of this year, we will strive to further enhance our ad platform to give our client better marketing performance. Thank you.

Our next question today will come from Candis Chan of Daiwa. Please go ahead.

Great. Thank you for taking my question. I have a question regarding this learning services. Can management talk about our coming focus where the learning services in the second half of this year, both on the K-12 and also the education -- sorry, the [indiscernible] segment? Thank you.

Digital content services are the largest part of our learning service business segment. As we mentioned in the prepared remarks, digital content services are actually a bright spot. Its sales reached RMB800 million in Q2. It's the first time, it's the record high, and retention is also at a high-level of around the 60%. So within the digital content category, in Q2, we launched AI University Application Adviser to support students in their college selection process. So this is -- we think going forward, this is going to be important because it allows us to touch many users. So in this -- since its launch its already gained over 2 million page views as we mentioned in prepared remarks. So if you look at digital content service over the last five quarters, so it's actually been growing very healthily over the course over the last five quarters as our learners keep adopting this new form of interactive online learning. So it's different from online learning before. So it's a new form with video materials, personalized practice and also AI feedback. So it's great for us to see that users -- more and more users adopt this new form, and the business is growing, growing very quickly, yes. So we're happy to see that. So we expect the digital learning content and learning services as a whole to continue to perform well in the second half. So we will enhance our learning further by investing in educational R&D to create high-quality content, and also improve our personalized assessment and feedback system, which is a strong feature of our systems. Furthermore, our collaboration with Shaanxi History Museum for immersive learning on Youdao Literature, that project was a great success. So we have more IP collaboration plans for this year, offering users more…

Great. Thank you very much.

The next question will come from Lian Duan of Huatai Securities. Please go ahead.

Good evening management. Duan Lian from Huatai Securities. Thanks for taking my questions. Just a quick one. With the ongoing investments in AI result in a significant increase in R&D expenses in the second half of this year.

This is Wayne. Thank you for your question. I will take your question. In terms of R&D investment, we are prudent on it and we believe our investment is continue and more focused education is not widespread for all scenarios. As just mentioned about Dr. Zhou, our recent AI investment mainly focused on fixed applications such as large language based in translation in English grammar from an instruction and AIGC [ph]. Just a reminder that this is not our first time we invested in AI area. Youdao is planning in implementing AI technology, and such technologies has been widely applied in our learning services and smart devices. At the same time, we have received the benefit from adopting more effective methods, which enhance our R&D efficiency. For example, in the first half of this year, although we deployed our proprietary large language model in certain education scenarios. We still experienced around 6% year-over-year decline in R&D expenses when compared to the same period last year, which mainly contributed from our efficiency improvements with more comprehensive experiences in AI investment, and saving costs through applying AIGC technology. The introduction of AIGC has resulted in a notable enhancement in work efficiency. For instance, the incremental implementation of AIGC has led to a 50% increase in the efficient production of content for our courses' teaching materials. We anticipate that such improvements will be continued in the future. Both cost saving in AI investments and the application of AIGC technology enable us to accumulate potential technological [indiscernible] the knowledge for further advancement. By the end of this year, we plan to launch more AI application as we will continuously balance our investment in large language models and applications. We believe our team will gain more experience on it and will develop a clear understanding on investment yield with great -- greater effectiveness. We expect the effectiveness of the application side will continue to improve. Going forward, we are continuously on the clear path to achieving profitability, and we will continue to optimize the structure of our R&D investments. For example, eliminating R&D expenditure on those unclear perspective projects, so that we can allocate the savings to our preferred AI project. Above all we will enhance investment in AI. But we do not expect a significant year-over-year increase in overall R&D expense in the second half year, which is helpful. Thank you.

Thank you.

And that concludes the question-and-answer session. I would like to turn the conference back over to management for any additional or closing comments.

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.

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