NetEase Inc (NTES) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the NetEase Fourth Quarter and Fiscal Year 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Brandi Piacente. Please go ahead, ma'am.

Thank you, operator. Please note, 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 a reconciliation of GAAP to non-GAAP financial results, please see the 2017 fourth quarter and full year fiscal year financial results news release issued earlier today.

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

Joining us on the call from NetEase's senior management is Mr. William Ding, Chief Executive Officer; Mr. Charles Yang, Chief Financial Officer; and Mr. Hilton Hui, Co-President of NetEase Games.

I will now turn the call over to Mr. Yang, who will read the prepared remarks on behalf of Mr. Ding.

Thank you, Brandi, and thank you, everyone, for participating in today's call. Before we begin, I would like to remind everyone again that all percentages are based on renminbi.

With that said, I'm pleased to deliver opening remarks on William's behalf. We are pleased with another year of strong performance, with a 42% increase in total net revenues.

During the year, we launched a number of popular new titles, including 2 global hits: Knives Out; and Terminator 2: Judgment Day. These games quickly became the best performers in their genre. This further strengthens and diversifies our high-quality game portfolio and also makes us a meaningful player in the international online games space.

As we continue to advance our international expansion strategy, many of our games have proven to have large universal appeal. With over 200 million players globally, Onmyoji is now available in 69 countries. Knives Out was also particularly well received internationally with Google Play Store recommending it in over 10 countries. Similarly, Terminator 2 has been ranked as one of the most popular games on iOS and Google Play platforms across multiple countries, including the U.S. market.

Also during the year, our e-commerce business more than doubled, achieving net revenues of CNY 11.7 billion. E-commerce is now our second-largest business segment, accounting for approximately 22% of our total net revenues in 2017.

For the fourth quarter, our total revenues came in at CNY 14.6 billion, representing an increase of approximately 21% year-over-year. Non-GAAP net income was CNY 1.9 billion compared to CNY 4 billion in the previous year. The year-over-year decrease to our bottom line reflects the strategic investments we made this year, particularly in mobile games and e-commerce. These investments offer us extended reach and momentum. They also support our diversification strategy as we build a solid foundation to our long-term growth.

Online game services continue to lead our business. On the PC side, we propelled the success of our flagship PC-client titles. During the fourth quarter, we introduced new expansion packs for long-time fan favorites, including Fantasy Westward Journey Online, Westward Journey Online II and Tianxia III. These compelling new expansion packs invigorate existing players as well as attract new players.

Mojang's Minecraft is now available across all platforms in China since October. We are currently on track to commence small-scale monetization for the mobile version of Minecraft in the first half of this year.

Total revenues from mobile games accounted for approximately 68% of our online games revenue in the fourth quarter. Our flagship mobile games such as Fantasy Westward Journey mobile and Westward Journey Online II mobile continue to impress the market with their strong and sustainable performance. For other popular titles such as Onmyoji and New Ghost mobile game, we released new content in the fourth quarter which revived our user interest. Onmyoji's November release in Thailand and December's expansion pack brought back earlier players and brought in brand-new players.

For New Ghost, players are also delighted by the new content, including new characters and promotions with other traditional Chinese animation IP.

In terms of new mobile games, Knives Out and Terminator 2, along with its global version, Rules of Survival, were launched in early November. Both games became immediate blockbusters. To date, Knives Out boasts over 100 million registered users, and Terminator 2 has accumulated a lofty 80 million registered users. We also started early monetization effort for these titles in December.

Moving on to e-commerce. This business segment has grown substantially with revenues in the fourth quarter increasing nearly 175% year-over-year to CNY 4.7 billion. By partnering with leading providers, Kaola.com and Yanxuan focus on providing customers with highest quality products and services. Our primary objective in this market is to create an elevated user experience that sets the standard for what online e-commerce should be. Our goal is to provide our growing user community with a best-in-class interface as well as broad purchase options. We plan to continue adding new product and premier services to further enhance our customer experience.

For advertising services, revenues in the fourth quarter increased by approximately 11% year-over-year to CNY 736.6 million, with automobile, Internet services and real estate as the top-performing verticals. The mobile advertising market, in particular, continued to expand. We hold considerable advantage in the mobile arena, proving to be a reliable partner to current and new clients.

E-mail and others net revenues were CNY 1.2 billion or USD 186.4 million in the fourth quarter, with a year-over-year increase of 55%.

2018 is off to a strong start. Our online games pipeline will focus on expanding and diversifying our portfolio as well as increasing our global footprint. January has been a busy month, as we have already begun executing on this strategy with a handful of thrilling new releases. We introduced the English language version of Onmyoji to Canada, Australia, New Zealand and Scandinavia. Additionally, players greeted the highly anticipated MOBA version of Onmyoji with great enthusiasm, and the game's early performance has exceeded our expectations.

We also launched MMORPG Chu Liuxiang, and the game is currently available for play on all major platforms. With an extremely receptive fan base and its innovative gameplay, Chu Liuxiang has been recognized as one of the top-grossing games on iOS since its launch. We plan to launch new mobile games across a variety of genres, strengthening our position by appealing to a broad range of players and user preferences. Our release schedule presently calls for an array of new genres, including the asymmetrical battle arena game Identity V, RPG Sky and 2.5D casual battle arena game Alive.

To further strengthen and diversify our product offering, we will continue to invest in self-developed games. We also plan to broaden our reach through partnerships with other industry leaders that help us bring games to users worldwide. Under our recently announced joint venture with Mattel and the formation of Mattel163, we are delighted to extend Mattel's popular IPs such as UNO, Barbie, Hot Wheels, Fisher-Price and Thomas & Friends to create mobile games and education apps that users everywhere can enjoy on an exciting new digital level.

As we move through the year, we will continue to make efforts toward our long-term growth objectives. Our strategy calls for diversification across our business lines. Our games pipeline is strong. Our e-commerce business is developing rapidly, and our advertising services and e-mail and others businesses are also growing. Each of these offers growth opportunities where we can generate value for our partners, shareholders and community. This concludes William's comments.

I will now provide a brief review of our fourth quarter 2017 financial results. Given the limited time on today's call, I will be presenting some abbreviated financial highlights. We encourage you to read through our press release issued earlier today for further details.

I would also like to remind our audience that effective beginning the fourth quarter of 2017, we moved from 3 to 4 reporting segments. We are now reporting financial results for our e-commerce business, which primarily includes Kaola.com and Yanxuan. All historical quarterly and year-end amounts for 2016 and '17 that we will be discussing today reflect this change.

Net revenues for the fourth quarter of 2017 were CNY 14.6 billion or USD 2.2 billion. This represents an increase of 17.1% and 20.7% compared with the preceding quarter and fourth quarter of 2016, respectively. The increase was mainly led by our e-commerce business and partially offset by a decline in revenue contribution from our online game services.

Our gross profit for the fourth quarter of 2017 was CNY 5.7 billion or USD 882.9 million compared to CNY 5.9 billion and CNY 6.5 billion for the preceding quarter and the fourth quarter of 2016, respectively. Our gross profit for our online games segment declined year-over-year and quarter-over-quarter in the fourth quarter as a result of decreased revenue contribution from some of our self-developed mobile games.

Margins for our online games segment was relatively stable at 61.4% in the fourth quarter compared to 60.7% a year ago and 62.5% in the preceding quarter.

With the rapid development and expansion of Kaola.com and Yanxuan, gross profit for our e-commerce business increased. Gross margin decreased to 7.4%, which was primarily impacted by larger scale promotions and certain sales discounts in the fourth quarter of 2017 such as Singles Day on November 11, 2017. This compares with gross margins of 11.5% and 12.5% for the preceding quarter and the fourth quarter of 2016, respectively.

Gross profit and margin for our advertising services business increased year-over-year and quarter-over-quarter in the fourth quarter of 2017. Gross margins were 71.2% compared to 68.0% and 66.5% for the preceding quarter and the fourth quarter of 2016, respectively.

Gross loss margin for our e-mail and others business was 3.3% compared to gross profit margin of 13.1% and 46.9% for the preceding quarter and the fourth quarter of 2016, respectively.

Total operating expenses for the fourth quarter of 2017 were CNY 4.3 billion or USD 663.6 million. This compares to CNY 3.4 billion and CNY 2.6 billion for the preceding quarter and the fourth quarter of 2016, respectively. The increase in operating expense was mainly due to increased selling and marketing expenses, research and development investments, staff-related costs and increased operating expenses due to our e-commerce businesses.

E-commerce-related shipping and handling costs included in selling and marketing expenses for the fourth quarter of 2017 were CNY 393.3 million or USD 60.4 million. This compares to CNY 294.8 million and CNY 177.2 million for the preceding quarter and the fourth quarter of 2016, respectively.

The effective tax rate for the fourth quarter of 2017 was 18.2% compared to 8.1% and 19.2% for the preceding quarter and the fourth quarter of 2016, respectively. The changes in the effective tax rate were mainly due to certain of our subsidiaries being recognized as Key Software Enterprises in the third quarter and fourth quarter of 2017 and subject to a preferential tax rate of 10% for 2016. We recognized related tax credits in the third quarter and fourth quarter of 2017 accordingly.

Our net income attributable to shareholders for the fourth quarter of 2017 was CNY 1.3 billion or USD 197.6 million. This compares to CNY 2.5 billion and CNY 3.7 billion for the preceding quarter and the fourth quarter of 2016, respectively.

Non-GAAP net income attributable to our shareholders for the fourth quarter of 2017 totaled CNY 1.9 billion or USD 288.8 million. This compares to CNY 3.0 billion and CNY 4.0 billion for the preceding quarter and the fourth quarter of 2016, respectively.

For the fourth quarter of 2017, our basic and diluted earnings per ADS were USD 1.50 and USD 1.49, respectively. Our non-GAAP basic and diluted earnings per ADS were USD 2.20 and USD 2.18, respectively, for the fourth quarter of 2017.

Turning to some highlights from the full year 2017 financials. Total net revenues for fiscal year 2017 were CNY 54.1 billion or USD 8.3 billion compares to CNY 38.2 billion for the preceding year. Gross profit for fiscal year 2017 was CNY 25.9 billion or USD 4.0 billion compares to CNY 21.7 billion for the preceding fiscal year. The increase was mainly due to: one, increased revenue contributions from our self-developed mobile games such as Onmyoji and the mobile version of New Ghost; two, the increased monetization efforts for mobile applications, primarily our Mobile News App; and three, the expansion of our e-commerce business.

Total operating expenses for fiscal year 2017 were CNY 13.8 billion or USD 2.1 billion compares to CNY 9.0 billion for the preceding fiscal year. The increase in operating expenses in 2017 was primarily due to increased selling and marketing expenses, research and development investments and higher staff-related costs as well as increased operating expenses related to our e-commerce businesses.

E-commerce-related shipping and handling costs included in selling and marketing expenses for fiscal year 2017 were CNY 1.2 billion or USD 181.8 million compares to CNY 503 million for the preceding fiscal year.

The effective tax rate was 16.6% for fiscal year 2017 compares to 15.1% for fiscal year 2016. The changes in the effective tax rate were mainly due to the higher withholding tax recorded in fiscal year 2017.

Net income attributable to our shareholders for fiscal year 2017 totaled CNY 10.7 billion or USD 1.6 billion compared to CNY 11.6 billion for the preceding fiscal year.

Non-GAAP net income attributable to our shareholders for fiscal year 2017 totaled CNY 12.7 billion or USD 2.0 billion compared to CNY 12.9 billion for fiscal year 2016. Our basic and diluted earnings per ADS were USD 12.50 and USD 12.41, respectively, for fiscal year 2017. Non-GAAP basic and diluted earnings per ADS were USD 14.85 and USD 14.73, respectively, for fiscal year 2017.

Our cash position remains strong. As of December 31, 2017, our total cash and cash equivalent, current and noncurrent time deposits and short-term investments balance totaled CNY 43.2 billion or USD 6.6 billion. This compares with CNY 36.9 billion as of December 31, 2016.

Our cash flow generated from operating activities was CNY 11.9 billion or USD 1.8 billion for fiscal year 2017 compared with CNY 15.5 billion for the preceding fiscal year.

Returning value to our shareholders remains a top priority. For the fourth quarter of 2017, we plan to pay a dividend of USD 0.38 per ADS in accordance with our 25% dividend distribution policy.

Under our current share repurchase program, which began November 16, 2017, we have not yet purchased any ADS as of December 31, 2017.

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

(Operator Instructions) We'll take our first question from Alicia Yap with Citi.

I actually have a couple of questions, if I may. Number one is related to the sales and marketing spend and overall margins. So can management share with us the step-up spending in the more aggressive to promote your e-commerce and your gaming business? What is the rationale behind the strategic decisions, and how should we be thinking and modeling in the upcoming spend for 2018? Should the fourth quarter level be the similar level that we should be thinking for 2018?

(foreign language) Thank you, Alicia. This is Charles. So first of all, sales and marketing expense is a format of our strategic investment to build a very solid foundation for NetEase's long-term growth objectives. Specific to Q4, there are certain seasonality impacts. For instance, in Q4 sales and marketing expenses, e-commerce is relatively higher due to the promotional season, Double 11, Double 12, Black Friday. For games, in Q4, as you all know, we have very successfully launched a couple of very promising titles, and related sales and marketing expenses on those titles are relatively higher comparing to the preceding quarters. Overall, I would say we remain very, very confident about the return of our investment in the format of sales and marketing. And also, as I've noted in the transcript just now, embedded in the sales and marketing are also the e-commerce-related shipping and handling costs, which you can get the numbers from our earnings release.

Next, we move to Eddie Leung with Merrill Lynch.

I have a question on the cross-border Kaola pieces. So we look at the very fast growth of your e-commerce revenues. I'm just curious, how much you think that's driven by industry growth? And how much that's driven by successful market share gain over some of your competitors? And then along the line, I'm just curious on your thought in terms of your longer-term strategy. How you can differentiate from a couple of the more general e-commerce platforms, which potentially have better economic scale in terms of the infrastructure?

(foreign language)

(foreign language)

So Eddie, to answer your questions, let me do a quick summary and translation. For Kaola, since the inception of our Kaola business, we have focused on the cross-border e-commerce segment, which over the past years, we have already built a leadership in terms of market share, and we are the fastest-growing player in this cross-border segment. Talking about competition, we do not think there's a head-to-head competition with the major players for this cross-border segment because there's a huge Chinese consumption demand when you see Chinese tourists spending overseas when they do a physical travel. So that we are talking about trillions of spendings. And that's obviously a very, very potential market, addressable market, for our cross-border e-commerce Kaola business. With respect to Yanxuan, again, our strategic position and rationale is that China is now already the largest manufacturing base for the world. A lot of made-in-China products represent very high quality, so we have close partnership with the select manufacturers in terms of designing and manufacturing product specific tailoring to the Chinese consumer user demand in this consumption upgrade trend. So longer term, we are very confident that we are going to sustain a very fast growth of our both Kaola and Yanxuan e-commerce business.

Next, we'll move to Thomas Chong with Credit Suisse.

I have a couple of questions. The first question is about survival games. Can management provide us some color about our expectations in terms of user and monetization by year-end in China and overseas market? And follow-up on that, how should we think about the competition of survival games in China and overseas? And my second question is about the e-commerce business. Can management provide us some additional color because we have the shipping expenses? But how should we think about on the operating profit level in terms of the operating profit and the timing of profitability? And my third question is about the trend in terms of the operating expenses in 2018. And my final one is about the online game broadcasting business that we recently see that NetEase wants to invest around RMB 1 billion in this area.

Okay. Thomas, that's 4 questions in total. Let me translate for William. (foreign language)

(foreign language)

Okay. So for our first question, we have already established early mover advantage in the survival genre, both domestically and globally. And we are also very glad to see that the games that we have launched has achieved its success in both domestic and overseas markets. The way we think about this genre is, this is a very, very exciting genre with very promising long-term sustainability by combining these survival battle arena sandbox elements into the new and innovative gameplays. So we are confident that this genre will be a very long-lasting genre that can create different innovative gameplays and apply that into different genres. And accordingly, we have also deployed our strategic resources in new games pipelines in this broader survival battle arena and sandbox genre. (foreign language)

(foreign language)

For our e-commerce, in terms of the trend for operating margins, comparatively speaking, we are relatively new entrant into e-commerce. So in the near term, our primary focus will be gaining broader user recognition and providing an elevated experience to the users. So margin profitability is not imminent near focus. However, given our continued growth and scale-up effect, margins will continue to improve, and we are very, very confident about the future profitability of our e-commerce business. (foreign language)

(foreign language)

Thomas, for your question on the trend, overall trend for the operating expense and margins. So as I explained earlier question, Q4 was a little bit unique with a couple of one-off impacts, e-commerce seasonality as well as the promotion of our newly launched games in Q4. For those strategic investments we made in Q4, based on the results that we continue to receive, we are very satisfactory with respect to the returns on those investments. For R&D throughout the year and going forward, we will continue to focus and invest because that is building our core confidence. And so overall, we think margin trend, we are confident. And William also commented that in Q4, there were certain copyright-related one-off expenses in relation to our online music business that is also one-off. (foreign language)

(foreign language)

So online broadcasting and e-sports are becoming increasingly more important elements of the overall game industry ecosystem. We observed that from the newest trend that players, they do not only play and experience the game, but they also enjoy watching and participating in the games from another format. So with that trend and also given that NetEase, we have very suitable and relevant IPs, both self-developed as well as licensed, that we are making very prudent and strategic deployment of our capital and resources in terms of online game broadcasting and e-sports, which we think will also bring positive value to our games ecosystem overall.

We'll move next to Natalie Wu with CICC.

This is Chao, speaking on behalf of Natalie. Actually, I have a follow-up question regarding our survival-type games. We noticed now you have launched a couple of new survival games recently. Could management share your thoughts on the positioning of these new games, and how they differentiated from previous ones, and how they differentiated from the Knives Out and Terminator 2, and how they differentiated from each other in terms of the positioning. And also, could management give us some color on your promotion plans for the survival games going forward, especially during Chinese New Year?

(foreign language)

(foreign language)

Okay. So in terms of the survival battle arena sandbox genre, we do have a very strong pipeline with differentiated games, differentiated from multiple aspects, some differentiated from the view angle, some differentiated from 2.5D, 3D, different highest qualities in their respective categories. Some are differentiated in terms of play mode, with some new and innovative concepts embedded into these games. We think those will be very strong supplements to our existing games. With respect to the upcoming Chinese New Year, for our existing games, Knives Out and Terminator 2, we will have a series of interesting new contents and new gameplays being introduced. At the end of January, Terminator 2 has introduced 8x8 biggest map that can accommodate 300 concurrent players, which again set a record for games in this genre. Knives Out very recently have introduced 50v50, a new concept of gameplay. Again, these are just some specific examples of a series of innovative actions we plan to bring exciting and creative concepts to the players.

We'll move next to Marcus Yang with Macquarie.

(foreign language) I've got 3 questions. So first of all, regarding Chu Liuxiang, which has been performing pretty well since launch last month. So can you share some, like, data or like DAU ARPU at the moment? And is this kind of mix genre, i.e. sandbox with MMORPG in this case, like high freedom become a key direction for manage to work on? And how does that compare to typical MMORPG or a sandbox game in terms of ARPU or user base? And my second question is about the survival genre. Can you share the customer acquisition cost out of Knives Out and Terminator 2? And my third question is regarding the overseas expansion. Can you share some monetization strategy comparison between the overseas market and domestic market, especially for Knives Out and Terminator 2?

(foreign language)

Okay. So I will do a very quick translation of the answers. So first question regarding Chu Liuxiang. This is a highly anticipated game we recently launched. We call this as MMO 2.0. It represents the highest quality. As you all know, MMORPG games is the most complicated genre with the highest entry barrier, and NetEase has a core competence in this genre. We think in terms of ARPU and overall performance of Chu Liuxiang, this will be in line with our other previous legacy games that has a very sustainable long-term growth. For the second question, for the user acquisition cost for Knives Out and Terminator 2, as William earlier commented, we incurred relatively higher selling and marketing expenses in Q4 when the games were initially launched. But longer term, we think the trend on the user acquisition on these survival battle arena games should be comparable and in line without our other games. With respect to overseas monetization, currently, the monetization efforts are more or less consistent with the monetization attempts we launched in domestic market. Going forward, we will also gradually introduce more tailor-made monetization offerings dedicated to differentiated overseas market for the global audience.

Next, we'll move to Jialong Shi with Nomura Securities.

I have 2 follow-up questions. I think management mentioned in previous question, in Q4, there were some expenses related to the royalty fee for your online music service. So I just wonder how big that expense was in Q4? And the second question regarding Chu Liuxiang. Just wonder if management can share some colors on the popularity spend of this game. I will do the translation myself. (foreign language)

Jialong, let me answer your first question in English directly. With respect to our copyright expenses for online music, there are 2 components. One is the natural ongoing accrual basis of the copyright. The one-off copyrights we talked about is with respect to certain additional copyrights that we expect to incur. So from accounting perspective, we will need to do an expense provision, and the magnitude is -- we don't disclose the specifics, but it is in line with the copyright expense increase as a general market trend. Your second question, I will defer to the rest of the management.

(foreign language)

As you all know, NetEase, we hold our core competence and track record in operating some of the most successful MMORPG games in the industry. So equally, we are highly confident about the ongoing sustainable performance of Chu Liuxiang, and this represents, like previously mentioned, elevated experience in the MMO. We call this the MMORPG 2.0 new generation.

And due to time constraints, we are not taking any more questions at this time. I'd like to turn the conference back over to management for any closing or additional remarks.

Thank you, once again, for joining us today. If you have further questions, please contact NetEase's IR Director, Margaret Shi, based in Hangzhou, or TPG Investor Relations. Have a great day.

Everyone, that does conclude our conference call. We do thank you all for your participation. You may now disconnect.