Youdao (NYSE:DAO) reported second-quarter financial results on Thursday. The transcript from the company's second-quarter earnings call has been provided below.

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Summary

Net revenues for the second quarter reached RMB 1.5 billion, a 3.5% year-over-year increase, with a record operating profit of RMB 111.5 million, marking the eighth consecutive quarter of operating profitability.

The company rolled out Confucius 4, a significant upgrade to its large language model, enhancing multimodal capabilities and reducing translation costs, and demonstrated its AI products at the 2026 World AI Conference.

Learning services revenue increased by 20.9% to RMB 795.6 million, driven by the success of DAO Lingshi, while AI-powered subscription products and simultaneous interpretation features showed strong growth.

Online marketing services revenue declined by 7.7% to RMB 584.4 million due to a strategic focus on higher-margin opportunities, improving gross margin to 28.7%.

Smart Devices revenue decreased by 31.5% year over year, but the company maintained a strong market position with the DAO Dictionary Pen ranking number one in sales during the 618 shopping festival.

The company plans to continue executing its AI-native strategy, focusing on expanding AI agent capabilities and enhancing user satisfaction to support financial metric improvements.

Gross margin for learning services improved to 65.5%, while the smart devices segment faced cost pressures, with a gross margin of 32.8%.

Net income attributable to ordinary shareholders for Q2 was RMB 73.8 million, compared to a net loss in the same period last year, reflecting significant financial improvement.

Full Transcript

OPERATOR

Good day, and welcome to DAO's second quarter 2026 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your telephone keypad. To withdraw your question, please press star then 2. Please note this event is being recorded.

I would now like to turn the conference over to Mr. Jeffrey Wong, Investor Relations Director of DAO. Please go ahead.

Jeffrey Wong, Investor Relations Director

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 DAO'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 DAO's corporate website at ir.dao.com. Joining us today on the call from DAO senior management are Dr. Feng Zhou, our Chief Executive Officer, Mr. Lei Jin, our President, Mr. Peng Su, our Senior VP, and Mr. Wayne Li, our VP of Finance. I will now turn the call over to Dr. Zhou to review some of our recent highlights and strategic direction.

Feng Zhou, CEO

Thank you, Jeffrey, 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 RMB 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 continue 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 Lobster AI, HighEcho, DAO Baku, Infini's, and ImagicBox, together with Confucius 4, demonstrated how AI is moving beyond basic Q&A towards executing more complex tasks across learning, work, and advertising scenarios. Beyond technological advances and user adoption, our AI capabilities also continue to gain recognition and support from authoritative bodies. In Q2, the Beijing Key Laboratory of Artificial Intelligence for Multilingual Translation, co‑funded by DAO, 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 DAO Lingshi, one of our strategic focus areas.

AI continued 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 CRIs, recommendation, and college admission advisory services, these differentiated AI capabilities helped enhance the user experience and contributed to a retention rate of over 75% for DAO Lingshi in the second quarter.

For our programming courses, continued product upgrades and channel expansion helped to 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 up 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 broad adoption, we open‑sourced the model weights and toolchains for local deployment and commercial use, significantly lowering the barrier to multilingual content production. Meanwhile, HighEcho 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. 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 continue 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 app placement optimizer, further improving advertising efficiency and quality.

Unified Account Management provides centralized access across accounts, simplifying campaign operations. Automated push notifications deliver real‑time data updates to help users respond more quickly. Intelligent alerts provide 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 80.6 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 remains strong. During the 618 shopping festival, DAO Dictionary Pen ranked number one in sales in its category on both JD.com and Tmall for the seventh consecutive year. Our DAO 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 DAO 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.

Peng Su, CFO

Thank you, Dr. Tu, and hello everyone. Today I will be presenting some financial highlights for 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 revenue was RMB 1.5 billion, or US$216.2 million, representing a 3.5% increase from the same period of 2025. Net revenue from our learning services was RMB 795.6 million, or US$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 revenue from our smart devices was RMB 86.8 million, or US$12.8 million, representing a 31.5% decrease from the same period of 2025, primarily due to the decline in demand for smart learning devices. Net revenue from our online marketing services was RMB 584.4 million, or US$86.1 million, representing a 7.7% decrease from the same period of 2025.

The year-over-year decrease reflects DAO's disciplined strategic approach to engagements, which places a greater emphasis on higher ROI (return on investment) engagements. DAO believes this strategy has enhanced the overall operational efficiency of its business. For the same quarter, our total gross profit was RMB 716.9 million, or US$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 US$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 US$10.9 million, compared with a net loss attributable to 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 19.6 million, or US$13.4 million, compared with RMB 12.5 million in the same period of last year. Basic and diluted net income per ADS attributable to ordinary shareholders for the second quarter of 2026 were RMB 0.62, or US$0.09, and RMB 0.61, or US$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 US$0.11, and RMB 0.75, or US$0.11, respectively.

Our net cash provided by operating activities was RMB 334.2 million, or US$49.3 million, for the second quarter. Looking at our balance sheet as of June 30, 2026, our contract liabilities, which mainly consist of revenue generated from our learning services, were RMB 835.1 million, or US$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 restricted cash, and short-term investments totaled RMB 849.3 million, or US$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.

OPERATOR

We will now begin the question-and-answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Our first question comes from Brian Kong with Citi. Please go ahead.

Brian Kong, Analyst at Citi

Good evening, management. Thanks for taking my question. I want to ask about the ongoing integration of the Confucius large language model that has built positive momentum across your business and financial performance. I would like to ask management what is the progress of this model, and are there new product launches in the pipeline targeting this capability? Thank you.

Feng Zhou, CEO

Hello, Brian. Yeah, 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 DAO. 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 DAO has significant strengths. For voice, we have seen strong user adoption for several years already.

The success of our products Hi Echo and DAO Simultaneous Interpretation demonstrated clear demand for high-quality, low-latency voice interactions in both learning and communications. In Q2, user engagements with simultaneous interpretation increased by approximately 100% year over year, while 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, we all know, a challenging subject for many learners and is foundational to almost all STEM disciplines. At the same time, 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 multilingual reasoning for visual 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, so we will continue expanding our models and agent capabilities around these key areas. We look forward to sharing more very soon. Thank you.

OPERATOR

Our next question comes from Jing Wan with CICC. Please go ahead.

Jing Wan, Analyst at CICC

Good evening, management. Thank you for taking my question. My question is also about AI, but it's more about AI features of Lingshi AI essay grading. We all know that Lingshi AI essay grading has earned widespread user recognition. Do we plan to further expand its AI-powered features in Lingshi in the future? Thanks.

Sungsu

Thank you. This is Sungsu. I will handle the question first. For Lingshi, we see AI creating value in two important ways: by improving the learning experience and expanding what we can offer to users, and by improving the scalability and operational efficiency of our services. Over the past four years, powered by our continuing investment in our large language model, Confucius, DAO Lingshi has focused on resolving the core pain points across the learning and college application scenarios.

Through continuous product refinements and exploration of use cases, we have built a comprehensive AI interactive courses and service matrix. This platform empowers students to enhance their learning quality and efficiency, winning broad acclaim from our users. At the core learning features level, DAO Lingshi has crafted granular and personalized intelligent learning solutions. The first is personalized learning path recommendations centered around specific knowledge points.

This function pinpoints a student's weak areas to generate a tailor-made learning plan. By targeting shortfalls directly and eliminating redundant practice, it boosts learning efficiency a lot. Second is AI quiz recommendations. Leveraging individual learning profiles within the DAO intelligent learning system, this feature dynamically recommends adaptive exercises, helping students master core concepts through application and evaluations. 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. And last is the AI-based College Admission Advisor. Extending beyond academic learning, DAO Lingshi leverages its massive user base and extensive industry data to offer professional AI-based college application advisory services. By syncing users' 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 a strong proof of our service capabilities. In the second quarter of this year, DAO Lingshi achieved a retention rate exceeding 75%, maintaining an industry-leading level and demonstrating high user satisfaction with our AI interactive courses. So for us, AI is not a simple additional feature. We will ensure it becomes 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. Thank you.

Jing Wan, Analyst at CICC

Thanks. That's very clear.

OPERATOR

The next question comes from Thomas Strong with Jefferies. Please go ahead.

Thomas Strong, Analyst at Jefferies

Hi, good evening. Thanks, management, for taking my question. Could management share the outlook for online marketing services in the first quarter?

Lei Jin (President)

Hi, this is Lei Jin. Thank you for your questions. 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, revenues experience rapid acceleration in the subsequent quarters. In the third quarter we'll focus on three areas. The first: strengthen our AI plus advertising capabilities. We are integrating AI into all parts of our advertising business through our priority vertical LLM. One is KOL marketing. After upgrading Infinix 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.

The other is programmatic advertising. Launched in the second quarter, our second-generation AI ad placement optimizer improves traffic matching and helps increase targeting accuracy and operating efficiency. The second: expanding our advertiser base. With the support of our team and AI capabilities, we added more than 100 new advertisers in the second quarter, and in the third quarter we will focus on fast-growing sectors such as AI applications and short-form dramas, both in China and overseas.

The third: improving profitability. We will continue to improve gross margins through two initiatives: using Imagic Box 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 advertiser ROI while supporting our growth in both revenue and profitability.

In the short term, we will continue to 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.

OPERATOR

Our last question comes from the line of Zhang Bo with Huatai Securities. Please go ahead.

Zhang Bo, Analyst at Huatai Securities

Thanks for taking my question. This is Zhang Bo from Huatai. Could management share the outlook for gross margin in the third quarter?

Wen Ling

Please, thank you. Thank you. Zhang Bo, this is Wen Ling. I will take your question. As reflected in our financial results, we delivered 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. Especially, gross margin for online marketing services and learning services expanded by 1 percentage point and 3 percentage points year over year, respectively.

I will give more details on the reasons for the improvements in profitability and its outlook by segment. First, in terms of online marketing services, the margin expansion in our advertising business stems from the disciplined execution of our AI-native strategy and profitability-priority discipline. As for the AI-native strategy, the agents such as the AI ad placement optimizer and Imagic Box have significantly boosted productivity across ad planning, user profiling, and creative asset production.

As for the profitability-priority approach, we proactively withdrew from certain ad opportunities with relatively low ROI, focusing our resources instead on campaigns that deliver higher value to users. Second, learning services. The improvements in learning services gross margin were primarily driven by AI-enhanced learning efficiency and scaling benefits. On the AI empowerment side, features such as AI essay grading for Chinese and English and AI quiz recommendation have been widely adopted.

These tools effectively elevated the efficiency of our teaching assistants, which in turn boosted both student retention rate and gross margin. On the economies-of-scale side, as cost per revenue has steadily declined since the second half of 2025, we expect the economies of scale in learning services to become even more pronounced throughout 2026, which drives 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, the 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 new products planned for launch in 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 stronger gross margin performance and achieving meaningful breakthroughs at the operating profit level in the second half of 2026. Hope the information mentioned is helpful. Thank you.

OPERATOR

Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to the management for any closing remarks.

Jeffrey Wong, Investor Relations Director

Thank you once again for joining us today. If you have any further questions, please feel free to contact us at DAO directly or reach out to Piacente Financial Communications in China or the US. Have a great day.

OPERATOR

Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Goodbye.

Disclaimer: This transcript is provided for informational purposes only. While we strive for accuracy, there may be errors or omissions in this automated transcription. For official company statements and financial information, please refer to the company's SEC filings and official press releases. Corporate participants' and analysts' statements reflect their views as of the date of this call and are subject to change without notice.