NetEase Inc (NTES) 2015 Q1 法說會逐字稿

Good day, and welcome to the NetEase First Quarter 2015 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brandi Piacente. Please go ahead.

Thank you, operator. Please note that the discussion today will contain forward-looking statements relating to future performance of the Company and are intended to qualify for the Safe Harbor from liability as established by the U.S. Private Securities Litigation Reform Act. Such statements are not guarantees of future performance and are subject to certain risks and uncertainties, assumptions and other factors. Some of these risks are beyond the Company's control and could cause actual results to differ materially from those mentioned in today's press release and this discussion.

A general discussion of the risk factors that could affect NetEase's business and financial results is included in certain filings of the Company with the Securities and Exchange Commission, including its annual report on Form 20-F. The Company does not undertake any obligation to update this forward-looking information except as required by law.

During today's call, management will also discuss certain non-GAAP financial measures for comparison purposes only. For a definition of non-GAAP financial measures and the reconciliation of GAAP to non-GAAP financial results, please see the first quarter financial results news release issued earlier today.

As a reminder, this conference is being recorded. In addition, a webcast replay of this conference call will be available on the NetEase corporate website at ir.netease.com.

I will now turn the conference over to Mr. Onward Choi, Acting Chief Financial Officer, who will read the prepared remarks on behalf of Mr. William Ding, Chief Executive Officer of NetEase.

Thank you, Brandi. Before I begin, please note that for the purposes of this discussion, all percentages are based on Renminbi.

Our first quarter was driven by advancement in our online PC-client and mobile games and other segments as we introduced new content and services. Total revenues increased by 54.2% year-over-year with growth from each of our business segments. Our online games business continues to thrive with revenues from this segment increasing by 44% in the first quarter.

Mobile games have become a major driving force in China's online games market and we see substantial opportunities to diversify our gaming user base. We have seen remarkable interest in our self-developed mobile games, particularly for our Battle to the West and The World HD, both of which we introduced in the fourth quarter. Moreover, our flagship game, Fantasy Westward Journey, continued to gain in popularity, with the mobile versions of this game reaching Number 1 in the iOS China app store, and setting a record peak concurrent user count of 1.6 million after its introduction in late March. We now offer over 20 mobile games across over a variety of channels and we plan to build on this positive momentum as we deploy more new self-developed and licensed mobile titles in the coming months.

Our self-developed online PC-client games also continued to be well received and there remains a satiable appetite for new games and updated content. During the first quarter, users gave a warm welcome to the beta tests for one of our games under development, Hegemon-King of Western Chu, our 3D warfare MMORPG. We also saw solid performances from Fantasy Westward Journey II and New Westward Journey Online II.

In 2015, we plan to expand our portfolio with an exciting pipeline that includes a number of new online PC-client and mobile games, as well as new content for our existing games. We are already making progress towards this goal. In April, we commercially launched Demon Seals, a 2.5D MMORPG, and introduced expansion packs for New Westward Journey Online II and Ghost II. We have also received positive feedback from users in the closed beta testings of Revelation, our 3D oriental fantasy MMORPG, which began in January, with open beta testing to follow. We also continue to work closely with Blizzard Entertainment and have been delighted by the success of the open beta testing for the Chinese version of Diablo III: Reaper of Souls. That game sold over 1 million copies within 10 days of its launch in late April, setting the record for fastest-selling PC game in China. We plan to begin open beta testing for Blizzard's Heroes of the Storm in late May.

We are excited to bring our successful games to overseas markets and to expand our global footprints. Later this year, we plan to work with local partners to launch our games in other countries in Asia and North America so that users can enjoy the NetEase gaming experience.

Looking at our advertising services business, this segment remains strong. Our Mobile News Application and the growing online advertising market in China, supported our growth in advertising services revenues which increased by 35.9% compared with the same period last year. Automobile, Internet services, and food and beverage were the top performing advertising verticals in the first quarter. E-commerce in particular is an area where we see significant growth opportunities. While it is still in the early stages of operation, our self-operated cross border e-commerce platform, Kaola, has performed well so far. We are actively expanding our range of product offerings to service our growing customer base.

Throughout the year, we expect to see continued momentum across our businesses with high demand from the mobile market and stable growth from our PC-client games and services. Our model is designed to build on our strength and lead new trends in China's evolving online market.

Throughout these changes, our strategy will remain focused on diversity, excellence and international expansion to achieve healthy growth across all of our Internet businesses where we can continue to serve our community and our shareholders.

This concludes William's comments. I will now provide a review of our first quarter 2015 financial results. I will primarily focus on the discussions of margins and expense fluctuations along with net profit. Before I begin, I would like to note that beginning in the first quarter of 2015, we made a reclassification of certain revenue and cost of revenue from our advertising services segment to our e-mail, e-commerce and others business segment. The reclassification of these segments reflects changes in the way we evaluate our business performance and manage our operations. Reclassification of certain fourth quarter 2014 comparative figures in these segments has been changed to conform to the current period presentations.

Total sales taxes for the first quarter of 2015 were CNY225 million or $36.3 million compared to CNY220.6 million and CNY153.5 million for the preceding quarter and the first quarter of 2014 respectively. The year-over-year and quarter-over-quarter increases in sales tax were mainly due to the increase in our total revenues.

Gross profit for the first quarter of 2015 was CNY2.5 billion or $401.5 million compared to CNY2.5 billion and CNY1.7 billion for the preceding quarter and the first quarter of 2014 respectively.

The year-over-year increase in online games gross profit was primarily driven by the revenue contributions from our self-developed online games, such as New Westward Journey Online II and Fantasy Westward Journey II and licensed games such as Blizzard's World of Warcraft as well as mobile games including Battle to the West, The World HD and the mobile versions of Fantasy Westward Journey. The quarter-over-quarter increase in online games gross profit was primarily driven by increased revenue contributions from our mobile games, Battle to the West, The World HD and mobile versions of Fantasy Westward Journey.

The year-over-year increase in advertising services gross profit was primarily due to strong demand from the automobile, Internet services and food and beverage sectors, and the monetizations of our mobile applications such as our Mobile News Application. The quarter-over-quarter decrease in advertising services revenues and gross profit were primarily due to seasonality.

The year-over-year increase in e-mail, e-commerce and others gross profit was primarily attributable to an increase from e-commerce services related to third-party lottery products. The quarter-over-quarter decrease in e-commerce, e-mail and others gross profit was primarily attributable to the temporary suspension of e-commerce services related to third-party lottery products since late February 2015, which was partially offset by an increase in revenues from our e-mail and others businesses in this segment.

As expected, we saw some gross margin contractions in our online game businesses during the first quarter as we experienced increased revenue contributions from our mobile games which carry a relatively lower gross profit margins. Gross profit margin for our online games business for the first quarter of 2015 was 73.1%, compared to 76% and 78.5% for the preceding quarter and the first quarter of 2014, respectively.

Gross profit margin for our advertising services business for the first quarter of 2015 was 59.2%, compared to 65.9% and 47.8% for the preceding quarter and the first quarter of 2014, respectively. The year-over-year increase in gross profit margin was mainly due to enhanced economies of scale driven by revenue growth. The quarter-over-quarter decrease in gross profit margin was mainly due to the decrease of advertising services revenues due to seasonality.

Gross profit margin for our e-mail, e-commerce and others business for the first quarter of 2015 was 38.9%, compared to 48.2% and 6.7% for the preceding quarter and the first quarter of 2014, respectively. The year-over-year increase in gross profit margin was mainly due to increased revenue from e-commerce services related to third-party lottery products, which has a relatively higher gross profit margin. The quarter-over-quarter decrease in gross profit margin was primarily attributable to the fact that revenue from third-party lottery products decreased as a percentage of total revenues for this segment due to the temporary suspension I previously mentioned.

Total operating expenses for the first quarter of 2015 were CNY1.2 billion or $189.3 million compared to CNY1.2 billion and CNY0.6 billion for the preceding quarter and the first quarter of 2014, respectively. The year-over-year increase in operating expenses was mainly due to increased selling and marketing expenses for online PC-client and mobile games, promotions for our e-mail, e-commerce and others business, as well as the advertising services business, and increased staff-related research and development costs resulting from an increase in the number of employees and average compensation. The quarter-over-quarter decrease in operating expenses was mainly due to decreased promotional costs for our online games and advertising services.

We recorded a net income tax charge of CNY214.5 million or $34.6 million for the first quarter of 2015, compared to CNY187.9 million and CNY179.6 million for the preceding quarter and the first quarter of 2014, respectively.

The effective tax rate for the first quarter of 2015 was 14.1%, compared to 12.8% and 13.8% for the preceding quarter and the first quarter of 2014, respectively.

We also had a net foreign exchange gain of CNY22.7 million or $3.7 million compared to a net foreign exchange loss of CNY7.1 million and a net foreign exchange gain of CNY7.1 million for the preceding quarter and the first quarter of 2014, respectively. The quarter-over-quarter and year-over-year changes in foreign exchange gains and losses were mainly due to unrealized exchange gains and losses arising from our foreign currency-denominated bank deposits and short-term loan balances as the exchange rate of the U.S. dollar against the RMB fluctuated over the periods.

Our net income attributable to shareholders for the first quarter of 2015 totaled CNY1.3 billion or $204 million compared to CNY1.3 billion and CNY1.1 billion for the preceding quarter and the first quarter of 2014 respectively. Non-GAAP net income attributable to shareholders which excludes share-based compensation totaled CNY1.4 billion or [$229.9 million], compared to CNY1.4 billion and CNY1.2 billion for the preceding quarter and the first quarter of 2014, respectively.

Our basic and diluted earnings per ADS were $1.56 and $1.55, respectively, for the first quarter of 2015. We reported basic and diluted earnings per ADS of $1.57 and $1.56, respectively, for the preceding quarter, and the basic and diluted earnings per ADS of $1.39 each for the first quarter of 2014. Non-GAAP basic and diluted earnings per ADS was $1.76 and $1.74, respectively, for the first quarter of 2015, compared to non-GAAP basic and diluted earnings per ADS of $1.72 and $1.71, respectively, for the preceding quarter, and $1.46 each for the first quarter of 2014.

As of March 31, 2015, our total cash and time deposits balance was CNY22.1 billion or $3.6 billion, compared to CNY21.2 billion as of December 31, 2014. Cash flow generated from operating activities was CNY1.9 billion or $310.6 million for the first quarter of 2015, compared to CNY1.9 billion and CNY1.7 billion for the preceding quarter and the first quarter of 2014, respectively.

We continued to return value to our shareholders and are pleased to announce that in line with our quarterly dividend policy, the Board of Directors has approved a dividend of $0.39 per ADS for the first quarter of 2015. We expect to pay this on June 5, 2015 to shareholders of record as of the close of business on May 27, 2015.

Thank you for your attention. We would now like to open the call to your questions. Operator, please go ahead.

Thank you. (Operator Instructions) Jialong Shi, Credit Suisse.

And I have a few questions. The first question is about your advertising business and your Guangzhou advertising revenue growth was much faster than your total peers. So I just wonder how much your ads revenue was contributed by mobile apps and also the same question for your online gaming business and just wonder how much of your gaming revenue was from mobile games in 1Q?

(spoken in foreign language)

Jialong, first of all regarding the mobile apps contributions for our advertising businesses, just as what we have mentioned in previous calls, we haven't disclosed exact percentage of this but it has also been come to a double-digit levels and on a quarter-over-quarter basis, we have also seen -- there has been a good growth in terms of this contributions from the mobile front for our advertising businesses.

As for our mobile game revenue contributions, in the last quarter as we mentioned, it has come up to a [level of about 1%] and for this quarter, it has come up to 20% about.

With a percent of your total gaming revenue?

Yes.

So in terms of mobile games, I know you guys have launched mobile blockbuster title Fantasy Westward Journey in Q1, so how much of your mobile game revenue was contributed by mobile Fantasy Westward Journey?

(spoken in foreign language)

So far as the launch of the mobile versions of Fantasy Westward Journey is concerned because it has been just launched by late of March and we have also seen -- there has been some contributions there, but we haven't been disclosed the percentages of it so far, but -- and so far, if you look back to our performances on the ranking board on the China iOS app store, it has been upkeep as a -- ranked as Number 1 on that chart for already over months and so you will see that its performance has been very encouraging.

My second question is about how large that cross border e-commerce business and I just wonder what's the (inaudible) you guys have started in Q1, so maybe in Q1 the change was still small, so I just wonder what the (inaudible) and what do you think are your competitive edges in this first quarter e-commerce business?

(spoken in foreign language)

With regard to your questions about our cross-border e-commerce businesses, so far that -- this would be our newly introduced business initiatives and we are still in the early stage of implementing these new business strategies. We are still seeing how it goes down the roads. And so far, we are still quite happy and satisfied with its performance so far and perhaps we will give you more colors to it at a later stage.

Alicia Yap, Barclays.

I have two questions. Number one is regarding the Fantasy mobile, Fantasy Westward Journey mobile. So what makes Fantasy mobile so successful, how long do you think the strong franchise interaction to continue? And then given typically mobile games usually have a relatively short life cycle, should we be worried for Fantasy or will this be an exception?

(spoken in foreign language)

So with regard to your questions about the critical success factors attributing to our business launch on the Fantasy Westward Journey mobile versions, first of all on the IPs of this game itself has already been surpassed 10 years -- more than 10 years in the market. And so far as the project teams is concerned, they have been working very diligently and work hard in order to enrich the game content and the game play and stuff like that in order to make it to be a very good product to our targeted audiences or the players in the market.

And that's why for this mobile version of the Fantasy Westward Journey game, we have do quite a lot of inspirations and new innovations in the way to attract our targeted audiences in this new space. And we have also taken the previous success experiences that we've earned or developed so far in executing or running our own PC-client Fantasy Westward Journey games in the market. And so that's why we believe that we have do a very good job in order to shape a very competitive and good quality products in the marketplace.

And so far as its performance is concerned, we are still quite happy and satisfied with its performance so far, and we are looking forward that we would be working more game titles along these lines to put forward to the market.

Second question very quickly on the impacts on the lottery suspension, so when do you think the suspension to be lift and after it is lift, how should we think about the revenue trends compared to previously?

In terms of the temporary suspension is concerned, I think the companies will not be in the most suitable positions to comment on when this would release or the suspension would be over. But we would consider that and so far as this revenue contribution is concerned, it is still a relatively small part to the overall businesses that we have been doing. And I think this would be the updates that we can share with you for now. And in case we do got more updates about the developments, we'll keep you posted as soon as possible.

Thomas Chong, Citigroup.

I have two questions. The first question is about the mobile games market as well as Fantasy Westward Journey. Given we have seen the lifecycle of mobile games in China is somewhat like a year or so, so how should we think about the life cycle for mobile Fantasy Westward Journey? Then I have a follow up.

(spoken in foreign language)

So with regard to our expectations on the life cycle for the mobile games or perhaps the Fantasy Westward Journey game titles in particular, basically we have full confidence about developing a long list of mobile games like the Fantasy Westward Journey that was launched recently. And if you look to the market so far, there would be a couple hundred of thousands mobile games in the market and not many of them would be very successful. But given the fact that possibly for NetEase that we are pursuing the highest qualities and the best user experiences in launching and upgrading our various products and sources, we believe that and coupled with our continuing innovation to adding some creative stuffs to our games, we do look upon that and we would be able to run out something that would be of a much longer life cycle.

And my second question is about the cash, given [Prologis had such a high cash LIFO] management consider increasing the dividend payout ratio or any other areas you would consider doing M&A etcetera?

So basically the Company will still be upkeep with our three main directions on the potential utilizations of the cash. First of all, the dividend payout which we already have a very clear quarterly dividend policy that we will be giving about 20% to 25% of the quarterly net income by returning value to our shareholders.

And secondly, hopefully if the conditions or the criteria would be suitable then we would also be considering some potential buyback or stuff like that. And you would also be aware that we have one last program that we announced in last year but unfortunately we haven't been brought out -- bought back any shares upon its expiry in February this year.

And thirdly, of course the Company has also been actively pursuing some investing opportunities in the market and we believe that those will be the three main ways that we will be considering utilizing the cash going forward.

Vivian Hao, Deutsche Bank.

I had two questions. First of all, we've seen that the mobile Fantasy Westward Journey has been a great success so far, just trying to understand how cannibalistic is our mobile games to our legacy PC online portfolio under the same IP. For example, like we still have -- we have FWJ and also probably incoming we have the Westward Journey this fall, this is my first question? And second question is regarding can we get a sense to roughly like how much lower is the margins for our mobile games versus PC games that will be very helpful?

(spoken in foreign language)

So basically William's comments is that and so far as the game is concerned, we do not see that would be a very obvious or significant kind of realization coming up from the launch of the mobile games to our existing PC-client games.

And with regard to your second question about the mobile games gross margins, basically we have previously also highlighted that we are expecting that overall gross margins would be lower than what our existing PC games will be doing, the most obvious fact is that there would be some revenue sharing cost that we will be paying out to the third-party distribution channels. But having said that and so far as the distribution of the mobile games is concerned, we would be implementing an overall strategy by considering what's best in order to put forward to the market. Of course, while we would be using some third-party resources but at the same time we would also be making good use of our own internal resources to distribute our own games titles.

Nick Ning, 86 Research.

So my question is with the success of Fantasy Westward Journey mobile, are we confident that we can obtain a bigger market share of mobile than PC in the next two years even though we were a bit late in mobile gaming? And how do we see the overall mobile game market despite a relatively short history. Will this become much bigger by size than PC gaming?

(spoken in foreign language)

So basically with regard to your first question about the -- our win about the market share in the mobile games market, first of all, we have a very strong confidence about making good market share in this part of the new business and a very clear sign that you can make reference to [RS wrecking ball] about the top grossing applications, the Fantasy Westward Journey has been ranking as Number 1 for a very long time and at the same time for the top pay chart. You would also see that our latest launch of mobile games like the [Monthan] has also been ranked as Number 1.

And so far as the overall gaming market is concerned, both the mobile and also the PC-client games markets is concerned, we still believe that the success factors would be attributing to companies that will be able to deliver some highest quality stuff to the market in order to secure their positions in the marketplace.

And at the same time, we do see that with the various new initiatives in terms of the PC-client games that we have been doing, we are also in a very confident position to saying that we will be doing good in the gaming market.

My second question is judging by the current trend of Diablo III, do you see it's possible to become as big or even bigger than World of Warcraft China?

(spoken in foreign language)

So far as the launch of Diablo III is concerned with the relatively short launch history of it, it has just launched on the 23rd of April, not a very long time, so far we are still quite happy with its performance. And for PC games like these, which is adopting to a one-time payment model, we do see the upcoming performances would be depending on how the contents will be developing or evolving whether or not we would have richer contents within the games and how the game play would be evolved to make it more attractive to our targeted audiences.

And while we wouldn't be making any specific expectations on how good the game will be doing but we still believe that this would be a very successful PC game in the marketplace.

Tian Hou, T.H. Capital.

So I have a question related to mobile game. So what's the major channel of your mobile distribution besides the app stores? And how much of the traffic actually comes from your YiChat and do you also take -- use this payment from overseas, it is also in iOS app store? (spoken in foreign language)

(spoken in foreign language)

With regard on to the distribution of our mobile games, basically we would be emphasizing and also placing much effort to make good use of our own internal resources to promote our various game titles. And just now you mentioned about the YiChat and this is not the only way that we will be distributing our own game titles. In fact, we would have also got some other very popular and content-rich mobile applications available on hand including the Mobile news Application and our dictionary. And definitely this would be -- interactions we would be doing going forward.

And so far as the overseas payments is concerned, this option is already available in the U.S. markets for games like the Fantasy Westward Journey and for players in the overseas market like U.S., the players can make the payments with their credit card. And basically, we are also setting aside our work of -- of working, expanding our footprint outside the China market and with the concurrently doing the localizations of our various games titles, we would be looking for that more and more games would be made available or distributed in overseas markets via the Apple stores or the Google Play.

And for other game title distribution just like Battle to the West, we have also been into operations with a Korean company and also in Taiwan and also Thailand and a company called the [The Lon]. And so you will see that in terms of the overall distribution strategies for NetEase, we would be embracing a very wide and extensive and comprehensive solutions in order to put through our various game titles to our targeted audiences in different parts of the world.

This is very helpful. May I ask one more question, this is related to your mobile, BOBO is like a mobile entertainment, so I wonder if you could give you some color on the progress of that? And also in terms of your e-commerce program, so what is your plan for your overseas direct title program, so do you plan to make it a major part of your business or it's just a side business? (spoken in foreign language)

(spoken in foreign language)

So with regard to your first question about BOBO, basically this would be our online video entertainment services that have been offered to our targeted users. And in fact -- or so called the Internet interactive communication services. We have two services in particular, one is called the BOBO and the other one is called the CC. The BOBO one is targeted more to the public entertainment needs and the CC is more targeted to the game broadcasting to explain how the games would be doing and to show some of the tournaments or the performances of various games on these channels or the so-called platforms.

And so far we, have also accumulated quite a good user base there, a traffic reach and with our new innovations there and we also see that our targeted users has been expressed a very positive effect to us of using these two different platforms.

And in so far (multiple speakers) -- and one more thing and so far as the cross border e-commerce is concerned, basically we are still looking forward with the launch of our Kaola, cross border e-commerce since the [Generic X]. We have been using this brand name to source good values or value for money products over the world in different parts of the world. And you will appreciate that for NetEase. We have been doing very well in particular to on the information services and we are looking upon that as we are entering to new and emerging areas like the cross border e-commerce. We will also be doing a very good on the merchandise service to our targeted customers in China.

And what we have said as our vision is that for the self-operated cross boarder e-commerce platforms, we would like to become one of the Top 3 operators in the marketplace and we also look upon that with this kind of platform services. We would be working out something more meaningful perhaps in a year's time.

Charanjit Singh, HSBC.

I was wondering if you can just give us an update on YiChat. I read in the press that you are sort of launching more features and functionalities, so if you can just give us an update on maybe users, habits, I assume any type of operational update on YiChat would be very helpful. Thanks so much.

(spoken in foreign language)

So basically in terms of the newly introduced or implemented functionalities for the YiChat services data pack in the Chinese New Year holidays, we have been launched the free call functions on the YiChat platforms which also prove to be very popular to our targeted users. And we have also seen both the traffic and the activity levels has been rising since then. And we are also quite happy and satisfied with this performance so far and we will update our momentum on our innovative capabilities to roll out something more interesting to the market.

And we do see that what the market or the users has been expecting is a more efficient and easy to use tools to facilitate their communication needs or interaction needs. This is also our long term vision to operate this kind of communication services in the long term with a more successful win.

Natalie Wu, CICC.

I have two questions. First, William, you mentioned that you have overseas expansion later this year. Can you give us some extra color on this plan? And you denoted to a mobile game or client base game on this aspect and what's specifically kind of game will it involve? You already have overseas version of Battle to the West. Are you just planning to raise the overseas portfolio in addition to that or you've done it -- take more significant steps and will you recruit more people and open overseas rep office to facilitate better expansion? (spoken in foreign language)

(spoken in foreign language)

Basically (technical difficulty) on the terms that you have just used, basically rather than saying that we are doing expansions some expansion on the gaming business. To be more specific, we are referring to our overseas distribution of the games and basically our targeted products would be focusing on the mobile games.

And so far as the game titles are concerned, so far other than Battle to the West, we have also got other games like The World HD and also the Speedy Ninja that soon go to the overseas market. And basically we would like to further enrich the different types of mobile games that we are going to roll out into overseas market and one way of doing it is that we would be distributing it by ourselves and we would also be considering to get into co-operation with some other parties in the overseas markets.

So I noticed that Hearthstone iOS and Android version has already been released last month, wondering can we get some revenue sharing from this game and if yes, how much could we get and how much should we allocate to Qihoo 360 as it claims to be the operator on the Android version? (spoken in foreign language)

(spoken in foreign language)

So basically you are right in saying that we are distributing the Hearthstone on both the Android and also the iOS platforms and there will be certain stipulated rules on how the revenues will be sharing out on different platforms.

That concludes today's question-and-answer session. I will turn the conference back to management for any additional or closing remarks.

Thank you, operator, and thanks everyone for joining us today. If you have any further questions, please feel free to contact Cassia Curran, NetEase's IR Manager based in Hangzhou or the Piacente Group Investor Relations. Have a wonderful day. Thank you.

This concludes today's conference and thank you for your participation.