Youdao - Q3 2022

Transcript

Operator (participant)

Good day. Welcome to the Youdao 2022 Third Quarter Earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, we will have a question-and-answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeffrey Wang, Director of Investor Relations of Youdao. Please go ahead.

Jeffrey Wang (Director of Investor Relations)

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, 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 companies 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 definitions of non-GAAP financial measures and reconciliations of GAAP to non-GAAP financial results, please see the 2022 third quarter financial result news release issued earlier today. As a reminder, the conference is being recorded. Besides, 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 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.

Feng Zhou (CEO and Director)

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 RMB, unless otherwise specifically stated. We had a strong third quarter with solid financial and operating results. Our net revenue CNY 1.4 billion, up 35% year-over-year. Total gross margin climbed to a record high of 54.2%, improving 1.6% year-over-year. These results were attributable to strong performance of our new services and smart devices. Sales of the digital content services reached over CNY 400 million, with gross margin ratio exceeding 60%.

For smart devices, the first 100,000 units of the newly launched Youdao Dictionary Pen X5 have been sold out, propelling net revenues from smart devices to CNY 356.5 million in Q3, a new record. In fact, net revenues from Youdao Dictionary Pen series in Q3 this year have grown tenfold compared with Q3 2019 after Youdao Dictionary Pen 2 was launched. The first 10,000 units of Youdao Smart Learning Pad Y10 released in August have also been sold out, reflecting strong demand for this new category. In terms of our operating loss, it narrowed to CNY 219 million, with operating loss margin narrowing by 6.1% year-over-year to 15.6%.

We have improved the margin structure of business lines while growing their top lines at the same time. For example, in Q3, for digital content services, Youdao Dictionary Pen and Youdao Listening Pod, their net revenues could cover their costs and operating expenses respectively. Today, we announced that the board of directors has authorized the company to adopt a share repurchase program in the near future in accordance with applicable laws and regulations for up to $20 million of its Class A ordinary shares, including in the form of ADS, during a period of up to 36 months. We are bullish about the future growth of the business. With the overview, I would like to share more color on our business lines in Q3.

Smart devices revenue reached CNY 356.5 million in Q3, a new record for the sector and up 40.1% year-over-year. Gross margin of smart devices reached 40.4%, up 6.7% year-over-year, mainly due to the launch of new products. The application of advanced A.I. technology and unique learning content make us confident that the gross margin of smart devices will be around 40% in the long run. Our new flagship dictionary pen, Youdao Dictionary Pen X5, is a great showcase of our strength in R&D and product innovation. In fact, in September, we cannot make enough X5s due to the strong demand.

Not only did X5 feature even better translation precision, support for over 100 languages, and a whole new design, it also includes the world's first smart dictionary pen operating system. It allows users to download apps to customize the dictionary pen to their liking with endless possibilities. Many top content providers were already on board, including Himalaya FM, Raz-Plus, NetEase Cloud Music, and Kaishu Storytelling. They all created apps using our easy-to-use software development kit and offered them on Youdao dictionary pens, creating a unique ecosystem that will grow stronger when more consumers and developers join in. Recently, we launched the Youdao Smart Learning Pad X10, our second learning pad product with significantly improved AI Precision Learning, larger screen, more storage, and other improvements. In the long term, the learning pad has significant market potential.

According to Frost & Sullivan, expected volume of education tablets are likely to reach 7.26 million units in 2025, with total sales of CNY 25.4 billion. Our AI adaptive learning feature provides high-quality personalized learning for students and has received very positive feedback from consumers. Over time, we expect the Youdao Smart Learning Pad to become as popular as our Youdao Dictionary Pen. Let's turn to learning services. Net revenues from learning services reached a record high of CNY 888.5 million in Q3, up 37.2% year-over-year, with a relatively flat gross margin of 64.5%.

Breaking this down a bit further, net revenues from STEAM courses increased by more than 200% year-over-year and accounted for over 25% of the net revenues of this segment. We continue to make progress on the Youdao Go course. In collaboration with the Chinese Weiqi Association and the Jiangsu Chess Sports Association, we held the National Children's Weiqi Open Championship in Q3, which was highly recognized by the General Administration of Sport of China. As for adult courses, we see a downward trend in gross margins year-over-year, mainly due to the macro environment. We are actively realigning our resources to focus on growth areas in this segment. Graduate school entrance exams and vocational courses are two bright spots. Their gross billings increased by over 150% and over 200% year-over-year, respectively.

Looking forward, we are confident in our operations in Q4. The transition from regulatory changes last year is mostly finished. For the last four quarters, we have maintained our investment level for our business, kept innovating in challenging times, and this allowed us to gain share in the market. It was made possible by the long-term investment in AI technology and a diversified product portfolio, and also by firm support from our parent, NetEase Group. Going forward, we believe we are in a good position today to achieve sustainable growth and drive towards profitability with a portfolio of strong products and businesses. Our team continues to capitalize on tailwinds, including the quick adoption of smart learning devices, digital content services, and STEAM courses. We look forward to bringing our products and services to more and more consumers.

With that, I will turn the call over to Su Peng to give you more details on our financial performance. Su Peng?

Peng Su (VP of Strategy and Capital Markets)

Thank you, Dr. Zhou, and hello, everyone. Today, I will be presenting some financial highlights for the third quarter of 2022. We encourage you to read through our press release issued earlier today for further details. For the third quarter, total net revenue were CNY 1.4 billion, or $197.2 million. This represent an increase of 35% from the third quarter of 2021. Net revenue from our learning services were CNY 888.5 million, or $124.9 million, representing a 37.2% increase from the same period in 2021. We attribute this growth to the strong sales performance from the new services initiate after the implementation of the Double Reduction policy.

Net revenue from our smart devices were CNY 356.5 million, or $50.1 million, up 40.1% from the same period in 2021, driven by the popularity of the newly launched products in 2022. Net revenue from our online marketing services were CNY 157.5 million, or $22.5 million, representing a 14.9% increase from the same period in 2021. The increase was mainly attributable to the increase in performance-based advertisements through the third-party's internet properties. For the third quarter, our gross profits were CNY 760.2 million, or $106.9 million, representing a 39% increase from the third quarter of 2021.

Gross margin for learning services was 64.5% for the third quarter of 2022, compared with 65% for the same period in the 2021. Gross margin for smart devices was 40.4% for the third quarter of 2022, compared with 33.7% for the same period in the 2021. Gross margin for online marketing services was 27.1% for the third quarter of 2022, compared with 29.2% for the same period in 2021. For the third quarter, total operating expense were CNY 979.2 million, or U.S. dollar, $137.7 million, compared with CNY 772.6 million for the same period of last year.

With that, for the third quarter, our sales and marketing expense were CNY 709.8 million, compared with CNY 753.4 million in the third quarter of 2021. Research and development expense were CNY 212.9 million, compared with CNY 163.6 million in the third quarter of 2021. Our operating loss margin was 15.6% in the third quarter of 2022, compared with 21.7% for the same period of last year. For the third quarter of 2022, our net loss from continuing operation attributable to ordinary shareholders was CNY 183.9 million, or $25.9 million, compared with CNY 225.3 million for the same period of last year.

Non-GAAP net loss from our continuing operation attributable to ordinary shareholders for the third quarter was CNY 164.4 million, or $23.1 million, compared with CNY 200.2 million for the same period of last year. Basic and diluting net loss per ADS from continuing operations attributable to ordinary shareholders for the third quarter of 2022 was CNY 1.49 or $0.21. Non-GAAP basic and diluting net loss from continuing operations per ADS for the third quarter was CNY 1.33 or $0.19. Our net cash used in continuing operating activity was CNY 294.1 million or $41.3 million for the third quarter.

Looking at our balance sheet as of September 30, 2022, our contract liabilities, which mainly consist of the deferred revenue generated from our learning services, were CNY 996.5 million or $140.1 million, compared with CNY 1.1 billion as of December 31st, 2021. At the end of the period, our cash equivalent, restricted cash, term deposits and short-term investments totaled CNY 953.1 million or $134 million. This conclude our prepared remarks. Thank you for your attention. We would now like to open the call to your questions. Operator, please go ahead.

Operator (participant)

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Brian Gong with Citigroup. Please go ahead.

Brian Gong (Equity Research Analyst)

Good evening, management. Thanks for taking my questions, and congratulations on the solid results. I saw the revenue increased rapidly in the third quarter. May I know what's the main contributors to our rapid transition and how should we look at, you know, the growth trend in the future? Thank you.

Feng Zhou (CEO and Director)

Hello, Brian. As for Q3 growth, digital content services and smart devices are two main drivers for this quarter for our growth. Both are based on our strength in technology R&D, as you know. Digital content service are doing well. Compared with the online services that we offer before, the difference is they're mostly contains pre-recorded video content or interactive learning or STEAM content, STEAM courses. As with our courses before, they are live courses mainly. The form is different. It's a new product after last year. In Q3, digital content services have maintained strong momentum.

Sales reached over CNY 400 million, compared with over CNY 200 million in Q2. Basically doubled quarter-to-quarter, while gross margin also rose from over 50% in Q2 to over 60% in Q3.

Moreover, the revenues from the digital content services can cover their costs and operating expenses in Q3. This supports our bottom line improvements in this quarter. Second, smart devices revenues are at, as you can see, a record high of CNY 356 million, up 40% year-over-year in Q3. Moreover, this growth also comes with a healthy operating metrics. Net revenue from Youdao Dictionary Pen and Youdao Listening Pod, for these two products, they can also cover their own costs and expenses in Q3. One product that's pretty important is Dictionary Pen X5, launched in August.

This new generation of Dictionary Pen supports online translation of over 100 languages and is equipped with the world's first Dictionary Pen operating system, smart operating system. After its release, it's already the top seller of Dictionary Pens or electronic dictionaries on both JD.com and Tmall, selling out the first batch of 100,000 units quickly. The launch of another product is the launch of Youdao Smart Learning Pad Y10 and also more recently, X10. These marked our entry into the learning tablet market and also the first batch of 10,000 Y10 units sold out in about two months.

That gives our teams more confidence in this category. Our plan is to have a steady flow of new product, new learning smart devices products to drive sustainable growth in this category. Recently after Q3, we launched three more new products. That is Youdao Dictionary Pen P5 for more advanced learners and professionals. Also Youdao Smart Learning Pad X10, I just mentioned. With a learning dashboard that further improves the AI Precision Learning experience. Lastly, an upgraded version of big Youdao Listening Pod with new English and Chinese content in line with textbooks. Also with more advanced A.I. technology, helps users improve listening and speaking skills in both English and Chinese.

Given the strong pipelines, we sold more than 100,000 units of Youdao Dictionary Pens in the Singles' Day on November 11th shopping festival this year. Over 100,000 units of Youdao Dictionary Pens. Yeah. That's an overview of drivers of growth for Q3. Thank you.

Brian Gong (Equity Research Analyst)

Thank you.

Operator (participant)

Your next question comes from Hongyi Zhao with CICC. Please go ahead.

Hongyi Zhao (Equity Research Analyst)

Okay. Good evening, management. Thanks for taking my question and congratulations on the good performance. We can see the strong growth of that revenue, but Youdao still face the operating loss. My question is, what are our strategies for improving the loss-making factors? Thank you.

Feng Zhou (CEO and Director)

Yeah, thank you, Brenda. Yeah, that's a very natural question. First I wanna say that driving towards profitability is a priority for us. The operating loss in Q3 mainly came from our early stage products and businesses. These include STEAM courses, Youdao Smart Learning Pad, the new device, and education digitization solutions. These are the three significant loss makers. Yeah, we have plans for profitability for each product area here. Let me break that down a little bit. Our STEAM courses, they're growing fast and we believe they have a bright future.

For this segment, what we are doing is to optimize our product offerings and marketing tactics. We're seeing continuous improvements in return of investments every month. The Go courses are more mature over the STEAM courses. Our other STEAM courses such as chess, programming, science, music, and Chinese painting, they are mostly still in their early days. The investments we made in these areas, they are paying off. Youdao Go and its companion app has accumulated over 1.6 million users and is already the leader in online Go learning in China. That's for the STEAM courses.

For Smart Learning Pad, it is a strategic product for us, and it is in the early stages. The opportunity here is that the learning pad market is going through a generational transformation from a hardware and content-based business to a technology-centered AI adaptive learning-based business. We are taking advantage of this transformational opportunity, and it is a very good investment for us. Very importantly, the first two products, Y10 and X10, they are off to a good start. We believe they have a bright future. As for the third category, the education digitization solutions, we recently reduced our resources here. There are progress in our products and services here.

Our campus sports education digitization solution with vision analytics was re-released and started to enter schools and schools like them. However, due to macroeconomic challenges, the landscape has been different from our projections one or two years ago. Yeah, spending on digitization solutions has been slower than we expected. Our goal here is to find better product positions in this challenging environment with less resources and achieve profitable growth.

All in all, if we add all our business that's operating profitably and also these three loss makers together, we've been able to narrow our net operating cash outflow to CNY 294 million in Q3. Operating loss also improved to CNY 219 million, with operating loss margin improving 6.1% year-over-year. Going forward, the plan is to operate prudently, growing the business while at the same time drive towards profitability. Yeah, I hope that answers the question. Thank you.

Hongyi Zhao (Equity Research Analyst)

Thank you.

Operator (participant)

Our next question comes from Thomas Chong with Jefferies. Please go ahead.

Thomas Chong (Managing Director and Equity Research Analyst)

Hi. Good evening. Thanks management for taking my questions. In Q2, I think we mentioned that we are confident in the prospect of second half this year. Would you please share your Q4 expectations? Thank you.

Feng Zhou (CEO and Director)

Tha-thank you, Thomas. Um, yeah, I think, uh, yeah, you have seen our Q3 numbers and, uh, uh, the, uh, the solid Q3, uh, financials and, uh, operating results, uh, they give us, uh, confidence in, in Q4. So, um, uh, net revenue, uh, reached, uh, one point four billion in Q3, so, uh, up, uh, thirty-five percent year over year. So, uh, so one, one thing is, even if you compare the net revenue in Q3, um, to, uh, to Q3 last year and Q3 2020, without giving effects to the, uh, recent disposal of, uh, our academic, uh, AST business, revenues, uh, still increased by, uh, one point one percent and, uh, fifty-six point five percent respectively.

In Q4, we will keep focusing on the healthiness of our key financials and operating indicators, that's for sure. As for learning services, Q4 is the retention season for STEAM courses, which is expected to have a positive effect on the cash flow and other financial metrics. Besides, digital content services released in Q2 have performed well in sales and gross margin over the past two quarters. In terms of smart devices, Q4 is typically a peak season with the November 11th and December 12th shopping festivals.

Our smart devices sales performed well during the November 11th shopping festival with aggregated sales over CNY 100 million in Tmall, JD.com and Douyin, up over 80% year-over-year. In terms of Youdao Dictionary Pen, it has retained the leading position in sales in its category for three consecutive years in both Tmall and JD.com. Youdao Listening Pod also ranked number one in sales in this category in JD.com. I think these all bodes well for Q4. Today we announced that the board of directors have authorized us to adopt a share repurchase program in the near future for up to $20 million.

It basically reflects management's confidence in the business both in the short term and in the long term. Yeah, I think that's all for me. Su Peng, you have anything to add?

Peng Su (VP of Strategy and Capital Markets)

Yeah, yeah. This is Su Peng. Thank you, Thomas, for your questions. Just one more comment to add it after Dr. Zhou. We think about our expectation for the Q4. The business, we expect to maintain the momentum of the business growth and whatever in the digital content service, but also in the smart devices and the rest of the sector we are investing. We are feel confident about this growth, and we find the great potential of the market from the customer's demands. That's why we think about the confidence.

We still have enough capability to invest with our new categories in the learning products as well as the new service or initiate new service for after the policy change. If you look at our balance sheet, we still have almost CNY 1 billion cash in our balance sheet, as well as we still have about $230 million revolving loan from NetEase. That give us more capabilities we invest and to see the feedback from market. That's why we feel promising about market in the long run. I hope that answers your question. Thank you, Thomas.

Thomas Chong (Managing Director and Equity Research Analyst)

Thank you.

Operator (participant)

Our next question comes from Linda Huang with Macquarie. Please go ahead.

Linda Huang (Equity Research Analyst)

Hi, management. Thank you for taking my question. My question is regarding for the learning devices because we launched a very successful the learning tablets in the second quarter. Can you share with us how do you think about the future for this product? Especially management, you just mentioned about the very sizable addressable market. You know, what kind of the market size we can capture in the long term? We also hope that management can share with us what is the product strategy. Maybe you can explain with us regarding for your product spec and your pricing strategy. Thank you very much.

Peng Su (VP of Strategy and Capital Markets)

Thank you, Linda. This is Su Peng. Thank you for questions. For your questions. First of all, we are feel confident about our products of the Youdao Learning Pad. Because we see about the great demandings from the market, we expect, according to Frost & Sullivan, the volume of the education tablets is likely to reach about 7 million units in 2025, with total sales above the CNY 25 billion, as we mentioned.

As we mentioned in last call, we, as you remember, we said we feel confident about products. Last time we just released in August, we released about our new products of the Youdao AI Smart Learning Pad, and it's Y10. It's released in August and right now, I think has been sold out for the first batch of the 10,000 units. That's, I think, reflecting the strong demand from this new category. More recently, we just released about our next generation's Youdao Learning Pad is called the X10. We think that we have upgraded about definitely in the features and functions, and there will be more precision on the AI's diagnostics.

We think about that will be more adaptive, more suitable for the student learning's roadmaps. We think we try to build out kind of that roadmap for the each individual student and to provide a highly customized services for the different students based on the Youdao technology. That's why we feel confident about our products. Even right now, we still see the about productions of a lot of demanding from market. Right now it's still at the very early stage to see about the finally how much market we will account for this smart tablets market. Right now we see the fast growth of our product sales weeks by week.

We think that shows our product success, part of our successful product strategies. We will keep investing in this market, whatever we will operation or upgrade our products and upgrade the features and provide more diversified services to our customers. That's why I think about that's our strategy and what we expectation for this market.

Feng Zhou (CEO and Director)

Yeah. Let me add a few points. First, the addressable market of learning tablets are larger than, probably larger than Dictionary Pen. If you look at different numbers, it's either five times, six times or maybe 10x larger. Yeah. That's a very good market to be in if we can actually take shares from it. The reason we think we are at a very good position to get our tablets into the hands of a lot of consumers is that, as I said, it's AI-driven product.

From our experience for the last few years or so, whenever we can come up with really useful AI experiences, like for the Dictionary Pen, the very quick translation lookup of its Dictionary Pen and also for example for our recent Dictionary Pen P5, you can scan multiple lines with a single swipe of the pen. Whenever we can come up with experiences like this, we will be at a good position in the market. The product will have good reputation and we will have lower marketing costs and everything. Things work in our favor.

We are gonna just do that for the learning pad. Our first two products have already bring new experiences to our users. That's one. The other point I wanna make is that we will be using a pretty quick product cadence as you have seen. We have already released five different SKUs this year already. That's faster than last year. That's because our teams have been gaining more and more experience. We have gaining more know-how in the supply chain of learning hardware.

We're also getting more intellectual properties, more patents and everything. We have more of that already in place so we can innovate faster. We are also building a ecosystem of content providers as we have seen in the Dictionary Pen OS initiative. That's also going well. Yeah. With that, I think we are at a good position, with a lot of effort from the team, of course, to be able to achieve a leading position in the learning tablet market. Yeah. Thank you.

Peng Su (VP of Strategy and Capital Markets)

Yeah. Linda, just one more point to add here. Just if you go back to see our strategy of our Dictionary Pens, you can see that and what we spent almost two years to increase about 10x in term of the number of sales of units. I think we also think for the AI tablets market is, for us, it's a long-term strategic investment. We'll be patient. We expect to copy our successful strategy in our Dictionary Pen in our smart tablets. That's what we exactly expect for this special category.

Right now we are still in the investment stage. It's at an early stage. It's just beginning, and we expect we can receive a lot of very strong demand and see as a positive feedback from markets. That's our expectations from this new categories. Thank you.

Linda Huang (Equity Research Analyst)

Thank you. Thank you, management for your detailed explanation. Thank you.

Feng Zhou (CEO and Director)

Thank you, Linda.

Operator (participant)

Our next question comes from Lian Duan with Huatai Securities. Please go ahead.

Lian Duan (Equity Research Analyst)

Good evening, management, and thanks for taking our question. In recent quarters, we saw adult courses face some challenges. What is our strategy for improving the business? Thank you.

Lei Jin (President)

Thank you, Lian. This is Lei. Your question is, yes, the adult courses face the challenge. Given the macroeconomic factors and the pandemic, we adjust our strategy from the interest-related courses to the segment that give students a better chance to get a job. There are graduate school entrance exam preparation and vocational education such as digital skill improving. We have been seeing a booming demand from the graduate school entrance exam. There is a record high number of registrants of 4.5 million this year, and 21% growth year-over-year. The double the number from 2017. It is likely to grow further in the coming years because the higher education means a higher probability for a better job.

As our Youdao Campus Recruitment, postgraduates resumes have accounted for over 70% of total candidates for the five years. Our graduate school entrance exam courses focus on personalized service.

As we know, choosing a suitable college and a subject is a key factor. Our AI assistant application consulting service offer a tailor-made advice to students based on their own academic performance and the big data of the graduated college recruitment. Their OMO services, especially in the pandemic conditions, create a comprehensive experience in the online learning and offline summer camp. In terms of user acquisition, we have the most popular study apps for college students in China, including Youdao Dictionary and China University MOOC. In Q3, over 50% of the gross billing came from this organic traffic and increased over 150% year-over-year. Vocational education, especially digital skill improving, is the other focus. It is consistent with the government's policy direction of boosting employment. Our digital skill courses mainly include data analysis and user interface design.

Provide a virtual training system where learners could easily log in and practice with a web browser on any PC. With the virtual system, the training environment has already been set up, and all the operations by the learners can be recorded and replayed. Teacher could also have a guidance and a feedback in the online system conveniently. With the easy-to-use system, we can see approaching 100% year-over-year growth of the gross billing from these courses in Q3. Thank you.

Lian Duan (Equity Research Analyst)

Thank you for your detailed explanation. Thank you.

Operator (participant)

Our next question comes from Candice Chen with Daiwa. Please go ahead.

Candice Chen (Equity Research Analyst)

Great. Good evening, management. Congrats on the solid set of results. We actually see that for this quarter, the gross margin of learning services indeed has been very strong at close to like 65%. I wonder whether this margin level will be sustainable in the following quarters, and any colors on the margin trend of learning services for the next year? That would be great. Thank you.

Wayne Li (VP of Finance)

Thank you for your question, Candice. This is Wayne. As you see in our gross margin of course, quarter three arrived at around 65%, up 13% quarter-over-quarter, which mainly contributed to the benefit from economies of scale from the higher revenue base and the improved margin for the digital content services. We are pleased to see the gross margin return to the similar level as last year after we experienced a transitional period since the release of Double Reduction policy last year. In last quarter, we got a relatively low revenue base for our learning services due to the service transition, which directly resulted in decreased gross margin performance during the last quarter.

With the launch of our new services, the digital content service since quarter two, and the relevant sales increased very quickly and reached over CNY 400 million in this quarter, along with over 50% gross margin increase from 50% in Q2. With the further extension of our new services, we expect to enjoy great benefits on the economic scale and higher gross margin whatever for next year. Although seasonal fluctuation will be studied, but in the long run, we are very confident in our revenue growth of learning services as well as its gross margin. Yeah, that's for the learning service gross margin. Actually, I'd like to add some other color to our smart devices gross margin performance as well.

In this quarter, the gross margin of smart devices increased to around 40% from 34% for the same period of last year, which mainly contributed from the sales of X5, which carry with a higher gross margin. Youdao has the advanced AI technology, has rich learning content and good at technology innovation, which bring us the advantage in product and more premium price. Based on it, we also believe a higher gross margin will be achieved for our smart devices. That's all. Thank you for your question.

Candice Chen (Equity Research Analyst)

That's very clear. Thank you.

Operator (participant)

This concludes the question and answer session. I would like to turn the conference back over to the management for any closing comments.

Feng Zhou (CEO and Director)

Yeah. 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 TPG Investor Relations in China or the U.S. Have a great day.

Operator (participant)

The conference is now concluded.