Participants

Feng Zhou; Chief Executive Officer and Director; Youdao, Inc.

Peng Su; Vice President; Youdao, Inc.

Jeffrey Wang; Investor Relations Director; Youdao, Inc.

Brian Gong; Analyst; CITI Group

Thomas Chong; Analyst; Jefferies

Brenda Zhao; Analyst; CICC

Presentation

Feng Zhou

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From operations in the same period of last year. I am confident that we will achieve full year operational profit profitability this year.
Looking ahead, we are committed to the continued implementation of our large language models. We have to enhance user experience and create a greater value through digital content services, AI driven subscription services and smart devices. In our online marketing services. We aim to explore new domestic opportunities while also expanding internationally to better support client success. Lastly, financially, we remain dedicated to prudent operations and strengthening our profitability.
With that. I will turn the call over to Su Peng to provide you with more detailed insights into our financial performance. Thank you.

Peng Su

Thank you, Mr. Zhou and hello everyone. Today, I will be presenting some financial highlights from the third quarter of 2024. We encourage you to read our press release issued earlier today for further details.
For the third quarter, total net revenue RMB1.6 billion or $224.1 million, representing a 2.2% increase from the same period of 2023. Net revenue from our learning services were RMB767.9 million or $109.4 million, representing a 19.2% decrease from the same period of 2023.
The year over year decrease reflects our commitment to a more selective customer acquisition approach, prioritizing higher ROI- return on investments engagements. This strategy has helped enhance our overall resilience and efficiency of our business.
Net revenue from our smart devices where RMB315.3 million or $44.9 million, up 25.2% from the same period about 2023, which was primarily driven by the popularity of Youdao’s newly launched products in 2024.
The net revenue from our online marketing services were RMB489.4 million or $69.7 million representing a 45.6% increase from the same period of 2023. The increase was mainly attributable to the increased demand for performance-based advertisements through the third party's internet properties, which was driven by our continuing investment in cutting edge AI technology.
For the third quarter, our total gross profit was RMB789.5 million or $112.5 million representing an 8.2% decrease from the third quarter of 2023.
Gross margin for learning services was 62.1% for the third quarter of 2024, compared with 67.8% for the same period of 2023. Gross margin for smart devices was 42.8% for the third quarter of 2024, compared with 42.6% for the same period of 2023. Gross margin for online marketing services was 36.3% for the third quarter of 2024, compared with 31.9% for the same period of 2023.
The third quarter, we reduced our total operating funds to RMB$682.2 million or $ 97.2 million compared with RMB917.3 million for the same period of last year.
Looking at our expenses in more detail: Sales and marketing expenses declined to RMB519.6 million, compared with RMB674.2 million in the third quarter of 2023. Research and development expenses were decreased to RMB119.6 million, compared with RMB187.3 million in the third quarter of 2023.
Our operating income margin was 6.8% in the third quarter of 2024, compared with operating loss margin of 3.7% for the same period of last year. For the third quarter of 2024, our net income attributable to ordinary shareholders was RMB86.3 million, or $12.3 million, compared with net loss attributable to ordinary shareholders of RMB102.9 million for the same period of last year. Non-GAAP net income attributable to ordinary shareholders for the third quarter was RMB88.7 million, or $12.6 million, compared with non-GAAP net loss attributable to ordinary shareholders of RMB67.3 million for the same period of last year.
Basic and diluted net income per ADS attributable to ordinary shareholders for the third quarter of 2024 were RMB0.74 or $0.11. Non-GAAP basic and diluted net income per ADS attributable to ordinary shareholders for the third quarter was RMB0.76 or $0.11. Our net cash used in operating activities was RMB85.4 million or $12.2 million for the third quarter.
Looking at our balance sheet as of September 30, 2024, our contract liabilities which mainly consist consists of deferred revenue generated from our learning services, were RMB839.7 million or $119.7 million, 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 deposits, and short-term investments totalled RMB489.4 million or $69.7 million.
This concludes our prepared remarks. Thank you for your attention. We would not like to open the call to your questions. Operator, please go ahead.

Question and Answer Session

Operator

(Operator Instructions) Brian Gong of CITI Group.

Brian Gong

Yeah, thanks management for taking my question. I have a very good question, and we have noticed that many of our peers have been increasing investment in the cost business, right? So commencement share our strategies on this. And are we planning to increase our investment in the learning service sector in the future? Thank you.

Peng Su

Thank you, Brian. This is Su Peng; I will handle the question first. I think aligned with our strategy of achieving the positive we of breaking profit in the near future, we focus on strong demand services which scaling back on the low returns customer acquisition efforts during the summer. And we believe that the healthy and sustainable development is more essential for the long-term success.
And as you may notice without insurance, that is the strategic priority for our business. Although there are some short-term headwinds, we remain optimistic about the medium and the long-term growth. We expect the strong demand for the online learning services in the coming years. Ensuring the financial health of the business, we will facilitate the development of the learning service particularly (inaudible).
We believe that is our long-term strategies. We believe that the increasing our market shares in over the midterm to the long term, we primarily come from the providing the differentiated and high-quality products and services to the users and the improving their learning outcomes. We think our flagship products offers a unique combination of AI, tiered learning videos and the comprehensive learning consulting services.
Through the AI enhanced enhancements and ongoing product upgrade. We enabled the users to achieve the personalized education, improve learning efficiency and outcome. The comprehensive services including the learning diagnostics, learning path planning, paired learning video, AI create recommendations and AI collection and (inaudible) categorizations of the students' mistakes, learning consulting services, one class study experience and also the AI college admissions advisors. I think that's the kind of the full services generator and drive AI.
We will definitely do continue to invest in our products and services which has strength our user loyalty evidence in the upgrade in [intension rates] for the first quarter. The current retention rate, we just give you a little bit colour for the [ined]has already hit 70% by now. Although the retention period has not finished yet, it's almost over rest up over 5% compared with the same period of last year.
Looking ahead, I think I'm confident in the development for next year. On one hand, we will continue to focus on our personalization, prerecorded video learning, severing our AI capabilities and upgrade and enhance our user learning experience. On the other hand, we will explore more offline opportunities, offering and service offers and service to our customers with. I think that's our right. And in the long term, as the last point is we, we expect to increase the investment on the products upgrade and also a customer acquisition following the strategy of the total company. Thank you.

Feng Zhou

This is Zhou Feng. Yeah, let me add one point. Yeah, for your darling.
So marketing and customer acquisition particularly in the summer is very important for its growth and performance. So there were some challenges on this front this this summer. So on the other hand, we always believe that customer satisfaction and retention are more important and more fundamental. Yeah. So as long as our retention is leading, our satisfaction is leading, I believe we will always find ways to grow the business and grow the students.
If you look at the number that we just shared. So recent retention period that we've already reached 70% retention, that's very good and already competitive with the.
So I think that is the key and the key thing and we are building future growth on solid foundations. Yeah. Thank you.

Operator

(Operator Instructions) Brenda Zhao of CICC. Please go ahead, apologies.
(Operator Instructions) Thomas Chong of Jefferies.

Thomas Chong

Hi, good evening. Thanks, management, for taking my question. We are pleased to see that the smart devices sector has resumed a year-on-year growth in the first quarter. Now, can we expect this growth to be sustainable? Thank you.

Feng Zhou

Hi Thomas, yeah. So the revenue from smart devices reached RMB315 million in the third quarter, up 25% year over year. I believe several factors contributed to the rebound of device revenue. The first one is a positive outcomes from our strategic focus and the channel reorganization. So earlier this year, we had a review of our device business and we decided that we need to focus the team's work and we want to do fewer things and do really well.
So but since then, I think increased the focus of our operations in particular, more focused on the dictionary pen products really paid off well in Q3, the new X7 and X7 Pro are one of our most successful launches ever that the high end product X7 equipped with the new AI camera and a suite of exciting AI features like higher Mr. P AI Tutor has received the widespread acclaim from users. This positive reception turns net revenues and gross margin and the gross margin of smart devices and revenue have reached the highest levels since 2023.
So during the recent Double 11, I also want to share Double 11 shopping festival audition pen has again secured the top spot in terms of sales volumes in its category on both Tmall and JD.com. That is for five consecutive years in a row. Furthermore, our newly launched dictionary pen X7 Pro achieved the highest single product sales in its category on both Tmall and JD.com.
So these accomplishments, I think reflect our continued dominance in the market with that outstanding performance. So revenues of smart devices, we expect them to continue to perform in the fourth quarter, continue to grow in the fourth quarter.
The second factor is kind of enhanced team capabilities. The team I think it's much more, it's more important than the product or the strategy. So our device team has seen ups and downs in particular, we faced so much pressure since last year, leading to all of the reflections, replanning and changes in our (inaudible).
So I'm pleased to see that in such a challenging environment, our team has shown remarkable resilience. They asked the right tough questions and executed on the new focusing strategy. So I think the team executed really well across functions including product design, R&D, supply chain, sales and marketing.
So leading to a significant recovery of the business. I believe any team that was able to go through [D] and reemerge stronger is more likely to succeed in the future.
So looking ahead from a product pipeline perspective, we expect to launch a new product in Q4 with more new products scheduled in Q1 as well. So in terms of product strategy for dictionary pens, we emphasized cost effectiveness for products including our A&S series, high quality and differentiation for high end products, that is the X series and the whole product line will employ more large language model features to greatly enhance user experiences.
We are more convinced that LLM has a lot more to offer for education products for years to come. So the team will be busy integrating more of such features into the products in the coming quarters. So we are on the right track. I believe to more leading products, better financial health and profitability for the device segment. Thank you.

Operator

(Operator Instructions) Brenda Zhao of CICC.

Brenda Zhao

Good evening, Zhou Feng and Su Peng. Thanks for taking my questions.
I noticed your online marketing service continued to see strong growth momentum. However, as the business had a high base in the fourth quarter of last year, where should we anticipate the future growth potential of this advertising business? Thank you.

Feng Zhou

Thank you. The net revenue from online marketing services has recorded rapid growth for eight quarters, primarily driven by advancement in AI including ongoing algorithm optimization and enhanced data applications. Additionally, our team's execution is steadily improved.
Looking ahead, I believe that there is a significant growth potential for both domestic and international advertising in the medium to long term. In the domestic market we anticipate the substantial opportunities in following sectors. First, the online entertainment industry such as gaming and social media. In this summer vacation, we drove the gaming ad revenues to a historical high in Q3. In in addition, enhanced data analysis and optimized algorithm models have improved marketization rates by over 90%.
Second, AI tools, since the development of the domestic large language models. In the later half of the last year, major tech companies had a significantly increased marketing budget for their AI tools. A trend we captured onto a drive rapid growth. During the last several quarters, future demand for a two advertising is excited for this future.
Third, the automotive industry, the consumption stimulating policies are anticipated to benefit the automotive and the related services sectors like in likely driving an increase in advertising demand in the international market. We became a pre agent for TikTok in the first half of this year. Recently, we have established the initial intention for cooperation with several global techs (inaudible).
This formal partnership expanded in the near future, being in a solid condition for our future global expansion. In the meantime, growth in our advertising business also face a certain short-term challenges. For example, as you mentioned, ad revenue set a very high base in the fourth quarter of the last year. And the e-commerce advertising has not been so robust during the recent Double 11 shopping festival.
In addition, recent update on our international market factors have added uncertainty to oversee advertising. However, from a financial health perspective, the probability of the advertising is expected to maintain a third level in the fourth quarter, the focus aligns with our broader aesthetic objective for the year and remain a key metric under the current conditions.
Thank you.

Operator

(Operator Instructions) Bozon of (inaudible) Securities. Please go ahead.

Thanks for taking my question. This is Janbu. My question is, is about what is the management outlook for the source culture?

Jeffrey Wang

Thank you Janbu. And this is we, as we mentioned before, we have focused on the digital content services, online marketing services and AI driven subscription services this year with a particular emphasis on advancing generative AI to achieve full year possibility in the near future. For the past three quarters of this year, we have seen significant improvements from our financial side.
The revenue for the first three quarters of this year reached RMB4.3 billion, representing an increase of around 10% year over year. We achieved a positive cumulative income from operations around RMB65 million compared with around RMB $543 million from operations in the same period of last year. Very significant improvement.
The strong financial performance fully demonstrates that our strategy around AI technology plus education is on the right path and we are very confident that we will achieve the profitable objective of this year.
Looking forward, we will continue to facilitate the integration of generative AI technology around our business to enhance competitiveness first learning services. The robust demand for online learning service is expected to well into the coming years and we are confident in the medium to long term growth, potential of our learning services.
I was upset will hinge on our ability to deliver high quality services and then learning outcome at scale. As mentioned in previous questions, high school businessmen remain our top priority. The demand for high school business is robust which is likely to sustain in the coming years, we will be building the best instructor team and incorporating AI function in our learning services for years. The strong AI technology advantages give us confidence in the strength and competitive advantages in the high school business.
In the 10 of AI driven subscription services, we are committed to advancing our current offering while exploring new avenues to enhance user experience in learning, work and daily life.
For the fourth quarter, we still expect the total sales in AI driven subscription services to maintain rapid year over year growth. Second, online marketing services, we have witnessed rapid growth and continue to improve ability of online marketing services for eight consecutive quarters.
In the near term, the [Thai] business serves as a cash flow and crucial profit centre. Over the long term, we will continue to explore strategic growth area both in the domestic and the international market (inaudible). We will provide updates on significant developments as they arrive.
Third, smart devices, we treat AI integrated smart devices as one of the most exciting, exciting opportunity of recent years. While smartphone and the tablets continue to dominate many usage scenarios, the market for traditional smart devices is shrinking. However, the integration of AI into smart devices paved the way for innovation including the creation of devices either smaller than smartphones or larger than tablet to meet user demand.
In addition, (inaudible) and unlock new opportunity for smart devices as discussed in today to prepare the remark, our dictionary pen X7 series have become the first learning device in the industry to support offline a translation with accuracy, surpassing online mutual machine translation.
As we are further attacking the potential of the integration of edge based LLM into our smart devices to better serve users in the long run. Our exact our extensive experience in reasons, supply chain management and the sales channels provide a strong foundation for sustainable growth in our smart device segment.
Additionally, our planning for next year is we are looking forward to share more insights in next earnings call.
Thank you.

Feng Zhou

Yeah, let me add a little bit more information. Yeah, this is Zhou Feng.
If you look at our financial performance this year and last year, you can see that we improved the overall financials a lot this year. We are growing the business and operationally profitable for two or three quarters this year so far and on the right track for people and the full year. In addition to that, we have created new products and high growth revenue streams like new online courses, RTA ads, international [kol] ads, AI driven subscription services, that's a highlight and also high-end dictionary pens the X7 series.
These will drive our growth in the immediate future, and we will have more to discuss in future course. Yeah, putting this together it means our focusing strategy this year and also our bet on large language model applications. Since last year, these two strategies have really been working. AI plus education is an exciting opportunity and is already having a great positive impact on the business. So Youdao is aiming to lead in AI plus education in China. Yeah, thank you.

Operator

Thank you, sir. That concludes our question-and-answer session. I would now like to turn the conference back to Jeffrey Wang for any additional or closing comments. Please go ahead.

Jeffrey Wang

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 US. Have a great day.

Operator

Thank you. So, ladies and gentlemen, that then concludes today's conference. Thank you for joining us. You may now disconnect your lines.

Portions of this transcript marked (technical difficulty) indicate audio problems. The missing text will be supplied if a replay becomes available.