Youdao, Inc. (DAO) Earnings Call Transcript & Summary

Good day, and welcome to the Youdao 2024 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.

Thank you, operator. Please note 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 the future performance and are subject to certain risks and uncertainties, inceptions, 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 the 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 purpose only. For the definition of non-GAAP financial measures and reconciliations of GAAP to non-GAAP financial results, please see the 2024 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 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 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.

Okay, Jeffrey, and thank you all for participating in today's call. Before we begin, I would like to remind everyone that all numbers are based on renminbi, unless otherwise specifically stated. In the second quarter of 2024, net revenues reached RMB 1.3 billion, growing 9.5% year-over-year. Operating cash inflow reached a record level of RMB 250.2 million, an increase of 18.2% year-over-year. Loss from operations was RMB 72.6 million as Q2 is typically seasonally weak in the bottom line and it narrowed by 74.9% year-over-year. In the first half of 2024, net revenues reached RMB 2.7 billion, marking an increase of 14.5% year-over-year. Loss from operations was RMB 42.6 million, narrowing 91.2% year-over-year. Operating cash outflow was reduced to RMB 148.8 million, reflecting an improvement of 53.7% year-over-year. The financial performance was in line with our end. Now, let's review the major development across our business lines in the second quarter. Net revenues from learning services were RMB 643.8 million, slightly down by 5.5% compared with the same period of last year. Digital content services maintained a healthy growth trajectory, achieving net revenues of RMB 403.3 million, up 6.8% year-over-year. Operating cash inflows generated by digital content services exceeded RMB 200 million. Youdao Lingshi continued to drive product upgrades and customer satisfaction. Firstly, in Q2, we released over 400 newly helpfully calibrated tiered learning videos for students at different levels. We also significantly upgraded the class-based study experience for better motivation and context. As we discussed before, Lingshi pioneered the approach of personalized prerecorded video learning. Building upon this vast library of thousands of high-quality videos, we offer a set of important services, including automatic diagnosis of students' current learning levels, class-based digital learning, personalized quiz generation, and weekend live consultation with our experienced staff members. These are all key to the high effectiveness of our products, and we keep improving them every year. Second, in terms of applications of AI and growth initiatives, we upgraded our College Admission and Consultation Services to the all-new AI College Admission Advisers in Q2. Using large language models, the AI Adviser effectively discusses and guides students in their college application process, helping them in choosing universities and majors. Since the new release, the service saw nearly 3 million Patriots rising by 30% year-over-year, making it a key asset in attracting new students and parents. Continuous product and service upgrades significantly boosted the retention ratio of Youdao Lingshi, reaching over 70% in the second quarter, a record high, and an increase of more than 10% points year-over-year. In addition, as for Youdao Literature, we offer nearly 40,000 high-quality AI writing refinements in the second quarter, improving our retention rate by approximately 10 percentage points on a year-over-year basis. Next is Learning Services segment, is our AI-driven subscription services. In the second quarter, our AI-driven subscription services maintained rapid growth with total sales surpassing RMB 60 million, marking a nearly 200% year-over-year increase and over 30% quarter-over-quarter of growth. Moreover, this represents the sixth consecutive quarter of over 50% year-over-year growth. [indiscernible], in June, we launched a major new mobile app, Mr. P AI Tutor, the first on subject AI tutor in China, and it received positive feedback from users after its initial integration into the Dictionary Pen earlier this year. Second, AI translation in Youdao Desktop Translation now supports languages other than English and Chinese. There is also new support from term databases and multi-model document input. These upgrades pushed the AI translation usage to exceed 30 million times in Q2. Third, in collaboration with NetEase Cloud Music, Youdao Dictionary introduced a music sentence feature in the second quarter, helping users learn vocabulary while listening to music. Last but not least, Hi-Echo introduced the children Mode offering tailored topics for children, child-friendly digital avatars and generating exclusive post conversation reports to aid children in improving their English-speaking skills. We are also delighted to observe that the average usage time of children mode is nearly twice that of other modes, highlighting its effectiveness in engaging and retaining users as well as enhancing their English proficiency. Our Online Marketing Services segment maintained a strong growth trajectory in Q2 with net revenues reaching RMB 511.2 million, hitting a record high and representing an increase of 68.4% year-over-year. This marks the seventh consecutive quarter of over 50% year-over-year growth, driven primarily by RTA, Real-Time API, and domestic KOL's ongoing robust performance, with RTA revenue more than doubling year-over-year in Q2. Furthermore, as large language models rapidly advance in the market, the demand for promoting these models and their applications among tech companies has searched. Our team sees this opportunity and is helping leading players like [indiscernible] in Tianjin, in this area to grow their products. In Q2, net revenues from AI tools and advertisement grew by more than 100% quarter-over-quarter. Additionally, our advertising collaboration with NetEase Group has been advancing smoothly and demonstrating synergy. On one hand, Youdao's data applications significantly enhances the traffic monetization rate on a number of NetEase assets by over 100% in Q2. On the other hand, our improved advertising performance has attracted more NetEase product teams to use our service. In the second quarter, the percentage of our total advertising revenue for NetEase as our clients increased around 3 percentage points quarter-over-quarter. It is still less than 10% of our total ad revenue, indicating significant future growth potential. Regarding the Smart Devices segment, the net revenues were RMB 166.7 million in Q2, down 25% year-over-year. The decline was in large part due to unfavorable product mix. In Q1, we updated our entry-level Dictionary Pen. So, these reached record unit sales in Q2. In the meantime, our high-end products were from last year and reached the latter part of their life cycle in Q2. So, high-end products had relatively lower sales. These factors negatively impacted total device revenue and also average unit price for Q2. We expect Q2 to be the low point operationally for the device business this year as we are currently ramping up high-end products for the new school. In fact, Youdao Dictionary Pen was again the category top seller on JD.com during the June 18 Shopping Festival for the fifth consecutive year. And Q2 unit sales showed a year-over-year increase of over 50%, broadening our brand's reach. More recently, we launched the new high-end Youdao Dictionary Pen X7, large language model functions like AI translation, and Mr. P AI Tutor has already been quietly welcomed by users. First month sales units doubled those of X6 Pro from the high-end product released. This week, we just released our top-of-the-line X7 Pro with the premium screen and the more advanced AI features, it is gaining a lot of interest. Looking at our business as a whole. In the first half of this year, we executed on our overall strategy of AI plus education and made significant progress in our journey. We focused our resources on 3 core businesses: digital content services, especially Youdao Lingshi, online marketing services and AI-driven subscription services. All 3 areas show good growth, healthy economics, our unique competitiveness, and long future run rates. And more importantly, they are key assets in our mission of helping every person learn more effectively. In the meantime, financially, we worked hard to drive toward sustainable profitability, which we believe is the foundation for our next phase of growth. I am pleased with the team's progress and solid execution. Our operational and financial metrics showed increased competitiveness of our business. For example, in addition to the numbers I shared at the beginning, the ratio of sales and marketing expenses to net revenues was 35.8% in the first half of this year, down by approximately 13 percentage points year-over-year, a very good improvement. Looking ahead, barring unexpected market changes, we expect the business to achieve full-year positive operating income in the near future. Youdao's strength lies in our unique ability to advance AI environments across business lines, combining technical strength with operational excellence. The rapid development of our online marketing and AI subscription services proves this and will continue to drive our growth. Our online courses underpinned by high-quality content, differentiated services and unique ways of leveraging AI are another pillar of our future growth. In the long term, the future of AI+ education looks incredibly bright, and we will strive to lead the charge. With that, I will turn the call over to Su Peng to provide you with more detailed insights into our financial performance. Thank you.

Thank you, Dr. Zhou, and hello, everyone. Today, we will be presenting some financial highlights from the second quarter of 2024. We encourage you to read through our press release issued earlier today for further details. For second quarter, total net revenue were RMB 1.3 billion or USD 181.9 million, representing a 9.5% increase from the same period of 2023. Net revenue from our learning services were RMB 643.8 million or USD 88.6 million, representing a 5.5% decrease from the same period of 2023. Net revenue from our smart devices were RMB 166.7 million or USD 22.9 million, down 25% from the same period of 2023, which was mainly attributable to the decreased unit price due to the change of the product mix. Net revenue from our online marketing services were RMB 511.2 million or USD 70.3 million, representing a 68.4% increase from the same period of 2023. The increase was primarily due to the increased sales of the performance-based advertisement to the third parties' internet properties, which were driven by our continued investment in the cutting-edge AI technology. For the second quarter, our total gross profit was RMB 636.8 million, or USD 87.6 million, representing a 12.3% increase from the second quarter of 2023. Gross margin for learning services was 60% for second quarter of 2024 compared with 57.4% for the same period of 2023. Gross margin for smart devices was 30.3% for the same quarter of 2024 compared with 35.8% for the same period of 2023. Gross margin for online marketing services was 39.1% for the second quarter of 2024 compared with 31.9% for the same period of 2023. For the second quarter, we reduced our total operating expense to RMB 609.3 million or USD 97.6 million compared with RMB 656.3 million for the same period of last year. Looking at our expenses in more detail. Sales and marketing expense declined to RMB 515.7 million compared with RMB 587.7 million in the second quarter of 2023. Research and development expense were decreased to RMB 153 million compared with RMB 205.1 million in the second quarter of 2023. Our operating loss margin also significantly narrowed to 5.5% in the second quarter of 2024 compared with 24% for the same period last year. For the second quarter of 2024, we narrowed our net loss attributable to ordinary shareholders to RMB 99.5 million or USD 13.7 million compared with RMB 299.2 million for the same period of last year. Non-GAAP net loss attributable to the ordinary shareholders for the second quarter was RMB 96 million or USD 13.2 million compared with RMB 283.6 million for the same period of last year. Basic and diluted net loss per ADS attributable to the ordinary shareholders for the second quarter of 2024 was RMB 0.85 or USD 0.12. Non-GAAP basic and diluted net loss per ADS attributable to the ordinary shareholders for the same quarter was RMB 0.82 or USD 0.11. Our net cash provided by the operating activity was RMB 250.2 million or USD 34.4 million for the same quarter. Looking at our balance sheet. As of the June 30, 2024, our contract liabilities, which mainly consist of the deferred revenue generated from our learning services, were RMB 1.0 billion, or USD 142.9 million compared with RMB 1.1 billion as of December 31, 2023. At the end of the period, our cash, cash equivalents, current and noncurrent restricted cash, time deposit, and short-term investment totaled RMB 568.5 million, or USD 78.2 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 Instructions] Our first question today will come from Brian Gong of Citi.

I have a question regarding our strategy on education sector. So, as we observed, competitors are working out on their investment in the whole sector, education sector, given the intensified competition, what is our strategy?

Thank you, Brian. This is Peng. I will handle the question first. And before I answer your question, I will give a very quick background regarding the education scenario in China. And if you see the numbers of the candidates registered for the College Entrance Exam, it has been increased from roughly 10 million since 2019 to over 30 million in this year. It's likely to keep increasing in the next decades as well. Also, the exam is getting more competitive. The overall College Entrance Exam score line has been shown as the upward trend. Taking the example as in Tianjin, it has been increased by more than 70 points compared to the 2019. So, we think about the demand for the College Entrance Exam preparations will continue to rise. If you go back to questions, we do see the competition intensified moderately for the prequal learning services in this year. As understandable given the current market conditions, I believe we have the necessary means to continue to invest to be still keeping to the leading player here and the benefit from the more dynamic market. The first thing we will do is, we will still continue to drive the customer satisfaction and retention. We have at least has the industry-leading satisfaction and retention rates. During the first half of this year, our retention rate reached our history quota in Q2, exceeding about 70% and representing a year-over-year increase of over 10%. As interest metrics is a testament to the user's recognizations of our products and services. Secondly, we think we will continue to produce outstanding learning results as long as we have already helped the students get the good results and get into their dream university and school. Most students will come to us and if you look at our results from the last year and this year, we are almost or more than doubled the number of students getting to the top schools and universities in this year. I think that is an important thing that can help us to build up our reputation in the market. I think that this is possible because I think you do it 10 years format of our classes, the AIBox content and comprehensive service model. I think that's pretty innovative and creative and prove a learning methodologies for the College Entrance Exam preparation and the others. So, do we think we are applying more technology in our business, such as the segment we have been mentioned previously like the AI recommendation and AI-based College Admissions Advice services? In Q2, our AI College Application Advisers generate nearly 60,000 application form, roughly 30% increase year-over-year, positioning, I think we believe that will be the leading one in the market in this year. I think that shows what AI can bring us the privilege over the market. The first one, we think we will keep innovating and investing in the market as well. We will continue to strengthen our market channels and branding development, providing a better-integrated experience for the users through our online and off-line coordination. This year, suites such as WeChat video accounts, the Vision Shipping [ Ho ], we have enhanced the localized live broadcast and operate to provide the user with a range of localization services and highly customer services in the different cities. We will fully leverage our teaching strength and IT operational experience to enhance our online customer acquisitions, competitive, and reduce customer acquisition costs. I think as well, we will persist in exploring the offline service and opportunities and looking for the better chance to invest into that market. Above all, we think that we are confident about future [indiscernible] business and service. We're thinking the long run, that means our high-quality products always will be the answer for the competitive market.

Yes. Let me add a point. I think what's the most important thing is the product. In the end, it's about how well you understand the customers and how to best satisfy the customers' needs. So, we think our teams are very good at this because Lingshi and its previous predecessor have been a long-running business at your top, they have been doing it for 8 years already, yes. And within the process, we actually innovated several times. So, the current AI plus prerecorded video plus comprehensive service model, it was introduced in 2021. It was a big change. But if you think about it, it really makes a lot of sense because for students preparing for college entrance exam, what they really lack is, they lack a lot of free time. So, the traditional life cost format is not such a good fit. So, the team had actually been preparing for the change for a year at that time. And the market condition in 2021 pushed the team to make the leap. And that's why we've been able to grow the business several times since then. So, I think that proves the innovation capability of our teams. And I expect the Lingshi team to keep innovating and keep loving what they do. That is the reason Youdao culture is and what makes us good at making high-quality content. So, I think that's the most important thing. We'll keep improving the product and serve the customer better.

The next question will come from Liping Zhao of CICC.

Your online marketing business saw very strong revenue growth in the first half of the year. Could you please tell what's the outlook of this business in second half of the year?

Hi, this is Lei Jin. For the second half of the year, our outlook for online marketing services remains positive. We have seen net revenue growth significantly from around RMB 200 million per quarter to over RMB 500 million in Q2 of this year. This marks 7 consecutive quarters of year-over-year net revenue growth exceeding 50%, alongside the continuous improvement in profitability. We expect year-over-year revenue growth to continue through the second half of this year. Several key factors are driving this sustainable growth. First, our ramp up data accumulation, advanced AI evidence, and deep understanding of customer demand from the [indiscernible] response of our long-term competitive needs. As we continuously collect and speed data into our data management platform, DMT, we achieved more accurate predictions, better decision-making, and more refined online marketing services tailored to user needs. Second, our expansion to overseas advertising has been a significant growth driver. We offer the client comprehensive and personalized international advertising services, including brand communication, global KR marketing, overseas AD placement, and live-streaming commerce. Leveraging our divesting of client needs, we have accelerated the development of international advertising infrastructure. By the end of the Q2, our international KOL database has exceeded 7 million, a year-over-year increase of over 200%. This drove Q2 net revenue from international performance-based advertising to nearly RMB 100 million, a growth rate of about 30 percentage points higher than in Q1. In this second half, we will continue to capitalize on the growing demand from Chinese companies looking to expand internationally, first in the sustainable development of our international advertising efforts. Third, our collaboration with NetEase Group has been mutually beneficial. In Q2, Youdao's data application significantly improved the monetization rate by over 100% of NetEase boost traffic. In return, NetEase provides us with more consumable and predictable traffic resources. Moving forward, we will keep upgrading our demand the DMP platform to enhance our AI-driven data capabilities, improved advertising efficiency, and boost revenues, while we are mindful of the increasing risk of traffic competition. We are committed to see the opportunities to assist Chinese companies in their global expansion, at the same time, leveraging our strength in customer relations, AI, and the data. We are gradually establishing our own exclusive AV network. This will help to the sustainable and healthy development of our AV business.

Our next question today will come from Thomas Chong of Jefferies.

May I ask about our AI subscription services? We're actually seeing the construction services continue to expand. What is the commercialization part for Mr. P AI Tutor?

Hi, Thomas, yes, this is Feng. The key thing here is the user scenario. I thought we focused a lot on user scenarios. And Mr. P serves the home learning scenario, which we believe is the #1 or #2 of all consumer learning scenarios for students. So, it is a very important and not served well by current products. So, we think Mr. P fits this scenario very well. In terms of the product and our learnings and also the commercialization pass, as you asked, I have several points to share. The first one is the initial feedback for the app is very positive. The recent release of Mr. P is what we call a broad release for us. So, in the [ app ] factor and in the X7 and X7 Pro Dictionary Pens, in its first month on the market, users engage with Mr. P AI Tutor for nearly 2 million times, ranking it actually as the second most used feature of the X7 Dictionary Pen only after word lookup and translation, which is kind of the basic function of the device. So, it is already #2. So, as surpassed previous favorite features like Wayne and Xinjiang, I think that proves its popularity. The second point I want to share is Mr. P is quite unique and leading product in the market in terms of functionality. It is the first all subject, that's 9 in total, K-12 AI learning companion app with high-quality results. Some of our peer companies focused on 1 or 2 subjects. Others, their product doesn't yet deliver high-quality results. So, our engineering and research team has developed a key set of technologies that make Mr. P possible and are now working hard to keep improving it. Obviously, we're still in the early days. So, we expect the experience to become much better over time. And we believe this technology holds a lot of promise. So, I would think every family in China with students need this AI companion. So, yes, think about it. So, either in apps form or in highway devices or other phones, actually, not only in China but in other countries as well. So, that's how we look at it. Third point is that regarding monetization and commercialization, we think subscription fees are a very scalable way of monetizing generative AI technology. And obviously, we also look at other ways like Smart Devices, B2B licensing, and also international markets. So, I do not want to talk too much about our concrete plans, but you can look at our existing products to get some ideas. For example, Hi Echo is already a significant contributor to our overall AI subscription sales, which in total, we just shared, reached over RMB 60 million in Q2 and grew nearly 200% year-over-year. And the growth for Hi Echo comes from several things, continuous product improvements positive word of mouth, and a lot of the users to use the referrals. So, we expect Mr. P to follow a similar path. So, we also did some projects for Hi Echo on the B2B front. Hi Echo has entered over 100 schools nationwide. We also focused on partnerships. Hi Echo became an official partner of the British consoles IELTS test. So, I believe this is also our strength. It has a long history of working effectively with international companies and institutions. Hi Echo was also recently featured on the App Store, Apple App Store homepage, which is a testimony of its quality and popularity. So, overall, we find that AI apps are popular online users, and we have a lot of ideas. Our team has a lot of ideas how to commercialize them. And we expect this year and next year to be a very good time period, time window to grow and monetize these AI apps. Yes. So. we will focus on them. Yes, thank you.

Our next question today will come from Howard Ton of Macquarie.

My question is about the nonacademic tutoring market. So, I'd like to know more about your company's progress in STEAM courses and whether you will accelerate investments in the future?

Thank you. This is Peng. I will handle the questions. And in the second quarter, we made some progress in our nonacademic process. Although our language screening and logic thinking courses are in their early stage. But in terms of the gross billings, both have experienced year-over-year growth over 100%. As in English, our communication and the other skills-based training has always been the strength of as you know, and empowered by the AI, we can now provide the users with very comprehensive services and highly customer services during, before, and after classes. On the other hand, we have already had very strong faculties and high-quality content to provide excellent in-class services to the users. With the rapid development of our AI-driven subscription services, and we can also exist in the users in personalization and post-class scenario to their listening and speaking capabilities. For example, as we mentioned in the last several quarters, the higher cost allow users to engage in oral communication anytime and anywhere and generate personalized analysis report to correct the issues related to speech and grammar during the conversations. For logic thinking courses, it is highly demanded by the users. Clients always hope to that kind of through the course, I think they are children thinking abilities will continuously improved. Our products meets the needs of the parents. And additionally, when the students encounter problem after classes, as Dr. Zhou mentioned, Mr. P AI Tutors can help them to answer the questions and I think it's a different way. And we didn't just like a mentioned, semester is not directly give them the answers, but just to try to lead them to think about all the path. We think that will be the kind of innovation, and that will be really need from the family education scenario. Looking ahead, we will continue to emphasize the high-quality development of the nonacademic process. If we identify the clear opportunities, we are encoding the health and of our business. We will consider increasing the investments in the [indiscernible] courses.

I think you need to choose which causes to provide very carefully to be successful. So, it is particularly important for nonacademic learning because they can be very wide in terms of topic. So, you can choose from a very wide set of topics. But you have to choose very, very carefully because parents, they may initially be interested in different topics. They may want to try it. But in the end, they choose the courses that's really helpful for their kids in the long term. Only those courses will become popular for the long term. So, you need to choose comfortably. So, that's what we focus on for nonacademic courses. Yes. For example, we believe Chinese literature abilities are very, very important for kids. Being able to grasp the power of language is one of the key abilities that benefits our persons of life. So, that cost has proven successful with [indiscernible] in the last several years. So, we will keep improving. And also, one other thing we think that's really important is computing skills. Everyone knows that it's key for future careers. So, our competitive program, of course, Youdao Little Tooling has been running for 6 years. We had our first national NOI gold medalist for this year. Yes. So, the key thing is that if we start some course, some nonacademic course, we will make sure that we choose carefully and we want it to be successful for many years to come. Yes. So, I think that's important.

Our next question today will come from [indiscernible] of Huatai Securities.

Congratulations on the strong performance this quarter. I have a question regarding Smart Life. We saw the revenue from the smart device is still decreasing. Could you share some color on strategy for your entire document plan for the second half of the year and average offers?

For the last few quarters, we've reorganized our sales channels as we communicated in the last several quarters. We also focused our products to be, again, around our core fixed are paying category. This year, we've released 4 Dictionary Pens from the mid-tier X6 Pro, to flagships, X7 and X7 Pro. So, the good thing is, users have told us that they really like these new products. So, the Youdao Dictionary Pens is ranked the #1 seller in the category during the June 18th Shopping Festival on JD.com for 5 years consecutively, reflecting their users' preference for our brand. X7 in its first month on the market, generated twice the revenue of last year's flagship X6 Pro as I just talked about during the prepared remarks. So, this good news tell us that our overall strategy of focusing on core products and channel efficiency are correct. What we need to do now is we need to continue to focus on our key products, mainly Dictionary Pens and strong sales capability and efficient channels at the same time. Another good thing is that the device business and the financial performance has improved after the refocusing. So, that set up a good foundation for the business to build on. So, here are a few more kind of points about the Dictionary Pen. The first one is about high-end products. These are our strengths. And our first large language model applications were on our high-end products. So, in July, we launched the Dictionary Pen X7 and last week, X7 Pro, both of them carry life language model features, including Mr. P and the AI translation. So, as we just shared, Mr. P is the #2 most popular function. And the AI translation is also very popular. So, that's really encouraging for us because only our products have these features right now. Second point I want to share is regarding price point. Last year, we expanded into the midrange market with the launch of the SNA series, aiming to serve a broader audience and meet diverse user needs. In Q2, one of the results is Dictionary Pen unit sales grew by over 50% year-over-year. And in addition, net revenue from Dictionary Pens increased nearly 10% year-over-year. So, unit growth, 50%, revenue growth, 10%. That means the strategy of not going for a very low price is correct. We didn't go for a price war. So, our cheapest product, X6 Pro still RMB 50 or RMB 100 higher, more expensive than our peers. So, we believe that's a good balance to strike. So, it allowed us to achieve both unit growth and revenue growth. I think that's a good trend. Yes. The third point is regarding gross margin ratio because this is something that people look at carefully. So, in Q2, our gross margin ratio for Smart Devices was a bit low at 30%. Again, that was mostly due to the product mix as we just discussed. So, more mid-tier product, fewer high-end products. However, as we ramp up on higher-end product in Q3 and Q4, we are still targeting 40% gross margin ratio as before. So, we have a good feature differentiation, a lot of AI features. And the hardware is much stronger with AI cameras the first time this year and with much better screens that users really like. And we also improved our supply chain a lot over the last year. So, that lowered our supply cost. We think 40% gross margin ratio is a reasonable and feasible growth target to shoot for. I think, all in all, as we said, we expect Q2 to be the low point operationally for the hardware business. So, we're looking forward to its future performance. Yes.

Our next question today will come from [indiscernible].

My question is about the profit. Will we achieve profitability this year? And if so, will we be able to sustain profitability in the future?

Thank you for your question. This is Wayne. I will take your question. We have fully committed to improving the overall health and achieving full-year positive operating income in the near future. Over the past year, we have successfully reduced operating loss on a year-over-year basis, especially in the first half of this year, where operating loss were reduced by over 90% year-over-year to approximately RMB 40 million. Historical data indicates that due to seasonal factors typically higher operating income in the second half year compared to the first half year, giving us confidence in achieving positive operating income for the full year of 2024 despite intense competition and various uncertainties. We believe that this profitability is expected to be sustainable on a full-year basis in the future due to the following reasons. First, strong profitability in 3 core areas. Digital content services, online marketing services, and AI-driven region services have been identified as our key strategic focus areas. We allocate more resources to these areas, which has resulted in profitability, and we will continue to do so. Our online marketing services fueled by our RTA technology, data capability, and precise understanding of user needs have achieved over 50% year-over-year net revenue growth for 7 consecutive quarters driving profitability. Through leveraging AI technology and high-quality content, our digital content services actually have improved learning efficiency and effectiveness for our users. Lingshi is a leading products and services have been pivotal in driving revenue and profit growth. AI-driven subscription services, a key aspect of our AI commercialization efforts have experienced the strong sales growth, and we have confidence in the future profitability. Second, enhanced financial performance in non-core business. For non-core business, such as smart devices and nondigital content services, we have implemented stricter health requirements, focusing on higher ROI metrics and the labor efficiency. This has resulted in a temporary decline in overall business scale but has significantly improved the health of this business and reduce the losses. Third, operational efficiency improvement through AI technology and content innovation. To achieve profitability, we are continuously striving to improve marketing efficiency through innovation and enhanced user experience through the creation of our premium learning content. We explore various innovations, such as diversified marketing channels and deleveraging advanced AI technology to optimize marketing efficiency and mitigate challenges like rising acquisition costs due to intense computation. By innovating premium content, such as our transition from traditional living stream online classes to provide content embedded with AI technology, like adaptive Question Bank, we address user concerns such as influx schedules and provide personal life learning experience. This premium content has exited strong user engagement with over 70% retention rate in Q2. In summary, our strategic focus and the innovative approaches have resulted in continued improvement in our operating margins, giving us confidence in sustained profitability of our business in the future. Thank you.

Our next question today will come from Crystal Li of China Merchants Securities.

Congratulations on the strong results. I just want to know how should we interpret the recent opinions on promoting the high-quality development of service consumption, and particularly regarding the education and training consumption?

Thank you .Yes, we have noted that earlier this month, the state counselors issue opinions and promoting the high-quality development of services consumptions, which emphasize the meetings of diverse and personalized learning needs of the general public and the promoting the social training institutions to enhance service quality in response to the public demands. First, I think I’ll just to make it clear, Youdao has always consistently to embrace the policy and adhere to operating within the scope of the permitted by policies. And by now, it's still in the very early stage, and we don't know any further on the detailed information like scope and the category of the policy. First, definitely we will wait the following information related with the public regarding the detailed information. And what we can say now is about the strategy of Youdao is to consist to invest into the education sector within the AI features. And if you see the dynamic of our products, we always be innovative and have creative to create a new format of our products following the policies. We think we will keep the update on the existing product and provide new services following the instruction of the existing policy and our [indiscernible]. Everything that will be the consistent thing so we deliver to deliver the message regarding the policies. And we can discuss more in detail so that after we receive more information from regarding on the special policies.

At this time, we will conclude the question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.

Thank you 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, and you may now disconnect.