NetEase Inc (NTES) 2022 Q4 法說會逐字稿

Good day, and welcome to the NetEase 2022 Fourth Quarter and Year-End Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Margaret Shi, IR Director of NetEase. Please go ahead.

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 Safe Harbor from liability as established by 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 in this discussion. A general discussion of the risk factors that could affect NetEase's business and financial results is included in certain filings for the company with the Securities and Exchange Commission, including its annual report on Form 20-F, and announcement and the filings on the website from Hong Kong Stock Exchange.

The company does not undertake any obligation to update its 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 the definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, please see the 2022 fourth quarter and full year earnings news release issued earlier today.

As a reminder, this conference is being recorded. In addition, an investor presentation and a webcast replay of this conference call will be available on the NetEase corporate website at ir.netease.com. Joining us today on the call from NetEase senior management is Mr. William Ding, Chief Executive Officer; Mr. Charles Yang, Chief Financial Officer; as well as other members of senior management team.

I will now turn the call over to Charles, who will read the prepared remarks on behalf of William.

Thank you Margaret, and thank you everyone, for participating in today's call. Before we begin, I would like to remind everyone that all percentages are calculated based on RMB. 2022 marked another year of solid growth for NetEase. Healthy development in each of our core businesses paves the way for meaningful financial gains. We achieved another record high net revenues of RMB 96.5 billion for the full year, up 10% year-over-year, with games and related value-added services coming in at RMB 74.6 billion for 2020, also up 10% year-over-year. This demonstrates NetEase's unique ability to deliver solid and sustainable growth throughout different macro cycles with time proven track record.

In the fourth quarter, players continues to show their strong passion for our legacy titles, including Fantasy Westward Journey Online and the Westwood Journey Online series. With our consistent rollout of content updates, these games have been staying at the forefront of the market for almost 2 decades. I claimed for their robust ecosystem and depth in game design. Adding to their success, we will soon introduce Westwood Journey Returns, a more casual and light version of the legacy IT. This game is designed to retain the essence of the franchise and has sparked a resurgence of interest amongst older fans, giving them an opportunity to relive cherished memories.

With this new addition, we anticipate a further expansion of our user base of the Westwood Journey Online franchise. Our new game, Eggy Party took the game market in China by storm in the fourth quarter. The game was initially launched in May of last year, and the number of daily active users has been continuously growing after a few months of operation and fine-tuning. During the Chinese New Year, Eggy Party further grew its user base exponentially through word-of-mouth and scaled new heights to the #3 position in China's iOS growth [in chat]. Its daily active users have now exceeded 30 million, making it the largest game in NetEase's history in terms of user scale. Adding to the dynamic and interactive gaming experiences that we produced in-house, Eggy Party distinguishes itself from other party games through the unique contribution of user-generated content. Players of Eggy Party are encouraged to take advantage of a diverse toolset available in editor mode to design and publish new levels on the platform. As a result, player engagement with user-generated content has further enriched the content spectrum on top of our in-house PGC content. This setup creates a virtuous cycle that continually add fresh content to the platform and enhances player engagement and loyalty. With a goal of cultivating a driving and self-sustaining ecosystem with long-lasting potential, we will continue to provide these players with tools and incentives to inspire and empower them to generate even more content.

While Eggy Party represents a huge breakthrough for us in terms of our efforts to expand into casual games, we have been steadily building up our capabilities through many great games over the past few years. For example, our award-winning adventure mobile game, Sky, which was launched in 2019, also delivered a strong performance in the fourth quarter. Sky offers players a heart warming gameplay experience and has established a dynamic and passionate fan community. With the cool Halloween update during the quarter, Sky also surged to the top position on China's iOS top growth in charts. While experiencing significant progress in casual games, we have also maintained our strong presence in the hardcore genre. This is evidenced by the sustained popularity of our key titles such as Invisible and mobile version of New Ghost.

Now let's move on to our pipeline. 2023 is exciting. We are set to expand our reach even further with a host of new titles. We have already received license approvals in China for a number of exciting titles such as Justice mobile game, Racing Master, and Badlanders, starting with the Justice mobile game. It complements the success of the PC version and aimed to be rolled out later this year. The mobile version will recreate the vivid world of the Tang Dynasty on mobile devices with cutting-edge game technologies such as real-time ray tracing for amazing graphics that bring in game things to life.

With the extensive support of a highly skilled and experienced development team, Justice mobile game boasts a wealth of exciting and engaging content that players can enjoy for a sustained life cycle. Equally importantly, as a next-generation MMO, this game represents a major evolution beyond the conventional norms of player interaction within the MMO genre, offering a truly unique gaming experience. We think the captivating and immersive open world experiences we have created with Justice mobile game will continue to raise the bar for both MMOs and the broader mobile game industry.

Second, the launch of Racing Master is also on track. As our second car racing game, Raising Master boasts a AAA quality rating stimulation. Players can expect an authentic racing experience with dynamic car handling and performance with a range of over 100 licensed vehicles from renowned car brands globally, players can fully emerge themselves in the thrilling world of racing and experiences like never before. As for Badlanders, it is our next-generation looter shooting mobile game, featuring a brand-new escape mechanism and exciting looting experience on the battlefield. We will go through rounds of testing and hope we can bring this game to life soon.

On the international front, we are preparing the highly anticipated global launch of our Harry Potter: Magic Awakened. Our team is making dedicated efforts to continue enhancing and refining its gameplay and user experience, ensuring that our global players will list amazing visage relife on both mobile and PC. At the same time, we are also working on a series of expansion packs that will be ready to go so that our global players will always have plenty of engaging content.

Looking beyond these launches, we continue to enhance our robust pipeline and are actively working on a variety of exciting new game titles, including Naraka: Bladepoint mobile version. These pipeline games are making solid progress and show great potential. In the fourth quarter, we have also made further progress in our global expansion assets. For example, we are thrilled to welcome Canadian-based SkyBox Labs to the NetEase game family. SkyBox Lab has an impressive track record in game development and have contributed to some of the industry's most renowned franchises such as Halo Infinite, Minecraft, and Fallout 76.

Earlier this month, we also announced the establishment of Spliced, a new global game studio. Spliced is driven by a talented group of passionate industry gurus from a variety of backgrounds, including participating in the development of major game franchises like GTA, Call of Duty, The Sims, Rocket League and Red Dead Redemption. We value their dedication and innovative approach and look forward to supporting the development of their latest project, which seeks to redefine gaming and how we engage with it. We are excited to see what's the real Spliced, we'll bring to the industry and the impact they will have on the gaming landscape.

After years of planning, we built a robust portfolio of NetEase Global Game Studios, spanning multiple continents and established strong connections with the best-in-class talent within the global developers communities. As we further expand our global ambition, we are unwavering in our commitment to providing the support and resources needed to unleash the full potential of games and more broadly speaking, interactive entertainment. In 2023, we will remain dedicated to fostering an environment where our talented developers can harness their full ability and bring their innovative ideas to life with the ultimate goal of creating uplifting experiences and next-generation blockbuster games franchises for our global players.

Moving on to Youdao. During the fourth quarter, Youdao achieved record-breaking net revenues of RMB 1.5 billion and for the first time ever, a positive income from operations, which totaled RMB 25 million. This impressive outcome is a testament to our constant effort to provide cutting-edge updates for our smart devices and enhance our learning services. Net revenues from smart devices hit RMB 407 million, up 28% year-over-year in Q4, thanks to the successful launch of new products. Our new product Youdao Dictionary Pen P5 now has translation capabilities across more than 100 languages and expand our Dictionary vocabulary in 16 professional fields such as economics, law, medicine and computer science. Its user experience is further improved with even greater recognition, accuracy, leveraging our natural language processing technology.

We also launched Youdao Smart Learning Pad X10 with an improved learning dashboard, supported by AI for better personalized learning experiences. These sharpened iterations of our smart devices have garnered robust demand from customers, translating directly to substantial growth in sales. Our STEAM courses delivered another quarter of strong growth. In Q4, we collaborated with Minecraft Education editions and successfully launched enriched updates to Youdao Literature. Youdao Literature is an online learning app that provide an immersive learning experience aimed at developing a comprehensive range of skills.

Using artificial intelligence technology, Youdao Literature delivers a wealth of engaging learning materials that combine literature, traditional culture and stories, as well as tools of iconic architectures globally. The highly positive reception from learners and parents is evidenced by the app's impressive subscription rate and renewal rate. In addition, we strengthened our Youdao golf course offerings by introducing the Champion class led by (inaudible), a world champion in golf tournament.

Our champion class is part of a comprehensive learning part that covers everything from entry level to advanced and culminates in the champions level classes. This new offering was met with great success, bolstering gross billings by more than 50% in Q4 year-over-year, along with a remarkable retention rate. Looking ahead, we will continue to focus on technological innovation and leverage our cutting-edge technology to ensure the long-term success of our smart devices and learning services amongst others.

Now let's look at our Cloud Music business. In 2022, we achieved record financial results while enhancing our music-inspired offerings and differentiated music ecosystem. Total net revenues for Cloud Music in 2022 were RMB 9 billion, representing 29% growth year-over-year. Due to steady sales growth rate and an optimized cost structure, we continue to see strong gross margin expansion, which reached 14.4% for the year and 17.8% in Q4, up from just 2% and 4.1%, respectively, from the previous year, with continued efforts to provide better user experiences and bring music lovers broader music listening scenarios, our total MAUs for 2022 was 189.4 million, up 4% year-over-year, and our paying ratio rose to 20.2% in 2022, up from 15.8% in 2021, underpinned by our high-quality and young user community, ongoing content enhancement initiatives and continued innovation to our unique features.

Recently, we signed several licensing agreements with major labels such as Being Music, which produces music for nationally renowned stars, including Mayday and top Japanese music label, Pony Canyon. Additionally, we renewed our cooperation with Avex, one of Japan's largest music labels. Throughout 2022, we also established partnerships with other leading Asian labels, including SM Entertainment, YG Entertainment, Emperor Entertainment Group, China Record Group, (foreign language), Modern Sky and VFY Entertainment by continuously expanding our music library, we are working to provide even broader selection of offerings to our community of music enthusiasts.

Digital Albums, particularly those from well-renowned artists such as (foreign language) witnessed impressive sales in Q4, demonstrating high-quality audience base, deep user engagement and users increasing willingness to pay for premium content on our cloud music platform. Meanwhile, the top 10 best-selling digital albums of 2022 on our platform, span diverse music categories, including Chinese-pop, K-pop, Western-pop, Chinese folks song and alternative rock showcasing the personalized music taste of our young and diversified user base with unwavering commitment to fostering an inspiring environment in which musicians are encouraged and empowered to create, we introduced several new forums to support this effort. We launched Music Talk, an online program that allows musicians to exchange ideas on professional topics that helps with creation.

We also rolled out the original music zone and the local zone to help music lovers explore new music content and expand independent artist exposure. By the end of 2022, the number of registered independent artists on our platform has surpassed 600,000. Our in-house music studios also made solid progress, popularizing a batch of hit songs, including Good Bye Monica, (foreign language) and demonstrating our ability to produce excellent music content organically. And it is one of the many reasons that sets our platform unique. Going forward, we will continue to prioritize product innovation and content creation to further grow our community.

Moving on to Yanxuan. In the fourth quarter, our private label consumer brand launched more popular products through diversified channels, adding to our concentrated categories like pet supply, home cleaning products and home furniture, we released popular items such as detergents, bathroom fragrances and Chinese New Year gift boxes. We will continue to focus on original design, facilitating pleasant lifestyle options for consumers. Looking at our business as a whole, we are honored to have been recognized for our contributions to society in terms of our environmental, social and governance practices. We were recently added to the 2022 Dow Jones Sustainability Indices and continue to obtain outstanding ESG scores on MSCI and Sustainalytics.

Furthermore, our dedication to diversity and the quality has led to our second year of inclusion in the Bloomberg Gender Equality Index. We remain committed to continuing the work of advancing equality, diversity and inclusion and building a company where people are treated with respect and dignity they deserve. We believe a truly inclusive workplace will be fueled with creativity, innovation and development, and this motivates us to push forward. During 2022, we continued strong performance in each of our business lines and made new progress in each major vertical we operate in. Our extensive portfolio of products and services are reaching audience on a broader scale as we move forward to our global aspirations. And with the solid ground we gained across our businesses, we believe that we are well positioned to achieve even more in 2023 and beyond.

Looking forward, we will continue to innovate, diversify and expand our reach to generate value to our users and the broader stakeholder community. This concludes William's comments.

I will now provide a very brief review of 2022 annual results with a focus on the fourth quarter. 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. Our total net revenues for 2022 were RMB 96.5 billion or USD14 billion, representing a 10% increase year-over-year. For the fourth quarter, total revenues were RMB 25.4 billion or USD3.7 billion, up 4% year-over-year.

For 2022, our net revenues from games and related value-added services were RMB 74.6 billion, up 10% from 2021. Despite a high base in 2021, total net revenues from our games and related VAS continued year-over-year growth in the fourth quarter, reaching RMB 19.1 billion, an increase of 2% year-over-year. The growth was primarily due to increased revenue contributions from both our existing games such as Fantasy Westwood Journey Online and sensitive Westwood Journey mobile game and our new blockbuster hit Diablo Immortal, which we introduced mid of the year last year.

Revenues from mobile games continue to make up a lion's share of our games businesses, accounting for 66% of our total net revenues in the fourth quarter and 67% for the full year. Youdao's net revenues for 2022 reached RMB 5 billion, and in the fourth quarter were up 9% year-over-year to reach RMB 1.5 billion, primarily due to increased sales of our new services and smart devices. NetEase Cloud Music's net revenues were RMB 9 billion for the full year, up 29% year-over-year and up 26% year-over-year in the fourth quarter to reach RMB 2.4 billion. The increase was mainly due to the contribution from membership subscriptions and digital album sales.

Total revenues for innovative businesses and others were RMB 7.9 billion for the year, up 7% year-over-year. And in Q4, this segment recorded RMB 2.4 billion net revenues, up 3% year-over-year, mainly due to increased revenue contribution from Yancheng. Our total gross profit margin was relatively flat in the fourth quarter at 52.2%, compared with 53% for the same period in 2021.

Looking at our fourth quarter margins in more details. GP margin was 59.1% for our games and related VAS compared with 60.9% in the same period of last year. The slight decrease was mainly due to the one-off recognition of royalty fees related to certain licensed games. Improved margins in our Smart Devices segment drove Youdao's GP margin expansion to 53.3% in the fourth quarter compared with 5.7% in the same period of last year. The year-over-year increase was mainly due to the robust sales of new smart devices, which carry higher GP margins.

Gross profit margin for Cloud Music continues to improve in the fourth quarter, climbing to 17.8% versus 4.1% in the same period a year ago. The significant margin improvement primarily resulted from strong top-line growth as well as improved efficiency in content investment. For our innovative businesses and others, GP margin was 31.5% in the fourth quarter, slightly improved from 30.5% in the same period of previous year.

Total operating expenses for the fourth quarter was RMB 8.8 billion or 35% of our total net revenues. Taking a closer look, our selling and marketing expenses as a percentage of total net revenues were largely stable year-over-year, both for the fourth quarter and for the full year at 3.5% and 13.9%, respectively. Our R&D expenses as a percentage of total net revenues also remained stable year-over-year at 16.1% in the fourth quarter compared with 15.8% for the same period last year.

On a full year basis, R&D expenses as a percentage of full year net revenue slightly improved to 15.6% compared with 16.1% in 2021. We remain committed to investing in content creation and product development. We are also seeing leverage in our R&D investments in the longer term. Our other income was RMB 343 million for the fourth quarter compared with 3 billion last quarter. The high base from last quarter was mainly due to one-off gain resulting from the disposal of investment, as well as financial gains resulting from fluctuations in exchange rates.

Effective tax rate was 20.7% for the full year and 20.2% for the fourth quarter. As a general reminder, our effective tax rate is presented on an accrual basis and the tax credit is deferred from each of our legal entities at different time periods, depending on applicable policies and our operations. Our non-GAAP net income from continuing operations attributable to shareholders for the fourth quarter totaled RMB 4.8 billion or USD698 million. Non-GAAP basic earnings per ADS from continuing operations for the fourth quarter was $1.08 or $0.22 per common share.

Additionally, our cash position remains strong. As of year-end, our net cash position was about RMB 95.6 billion compared with 85.6 billion at the end of 2021. In accordance with our dividend policy, we are very pleased to report that our Board of Directors has approved a dividend of $0.054 per common share or $0.27 per ADS.

Lastly, we continued to buy back shares during the period under our prior share repurchase program for up to $3 billion, which was completed on January 9, 2023, approximately 34 million ADS has been repurchased under this program. And our Board has announced a new share repurchase program of up to $5 billion of the company's ADS and ordinary shares in open market transactions for a period not to exceed 36 months commencing on January 10, 2023.

Meanwhile, under NetEase purchase programs were up to $50 million of Youdao's ADS, NetEase purchased approximately 2.7 million of Youdao's ADS for a total cost of about 22 million as of December 31, 2022.

Thank you for your attention. We would like now to open the call to your questions. Operator, let's go through the Q&A.

(Operator Instructions) For the benefit of all participants on today's call, if you wish to ask your question to the management in Chinese, please immediately repeat your question in English. (Operator Instructions) Your first question comes from Alicia Yap with Citigroup.

(foreign language) Can management comment on the domestic gaming landscape. So with domestic games approval process normalizing, will NetEase reallocate more resources to domestic in development or will put more resource in content that is targeted specifically towards Chinese gamers? Or will you actually still retain your strategy of putting more resource into the overseas games development?

(foreign language) Over the last few months, the process of license of (inaudible) has started to normalize, which is a very good news for us. So I think in the past, we've always had the same focus on both the China market and the global market. So there's no real change in direction. We'll continue to place equal emphasis on both the China market and the global market.

Thank you. Your next question comes from Yang Bai from CICC.

(foreign language) Okay. Can you comment on the competitive landscape in the overseas gaming market? What are the current advantages and the gaps between NetEase overseas games and other overseas leading game companies? And also, NetEase has continued to make much progress in overseas markets this years. What kind of synergies can be created between domestic and overseas? Are there any products under development to share with us?

(foreign language) So yes, from what we are observing currently is that overseas games are actually very different. For the Western game players, they prefer PC games and console game, for them, the mobile games are more of the casual type. For the Japanese market, we think the players will accept both PC games and mobile games. For China market, it's obviously, they are more inclined play mobile games. So in terms of content creation, PC games and mobile games are very different in design and in developing. So it is a challenge, but I'm very confident NetEase will find a solution to create games that appeal to both the China market and the international audience.

Thank you. Your next question comes from Lincoln Kong with Goldman Sachs.

(foreign language) So my question is about Justice mobile. So we have seen this game having gotten their approval. So can management provide some update in terms of the development progress and the launching time for Justice mobile and how does this game sort of compare with the PC version and we also have seen this can sort of impact us with so much BT buffer elements?

(foreign language) So yes, we got the license approval in January, and we're going through the final phase of testing now. And hopefully, we'll be able to introduce the game to you in the first half of this year. In terms of our mobile game version, I think we are more focused on the game experience in terms that we're trying to make a different -- trying to create games that appeal to different type of gamers, whether it's a RPG gamer, MMORPG gamer. And we think we've achieved lots of breakthroughs on top of the traditional MMORPG user experience through advanced technologies such as AI, and the aim is to create more personalized experience for our gaming users. And I think this is a game that we've built on our 20-year of experience in MMO. And on top of that, we have delivered a more innovative experience. So I think it's a very exciting game to -- for our gamers.

The next question is from Natalie Wu with Haitong International.

(foreign language) If you look at that Eggy Party recorded quite a successful deal. Just wondering how should we think about the success? As a matter of fact, we noticed that NetEase has been positive and often surprise us with successful launch of new games more frequently in the past several years, or should I say, that may show up, becomes higher this year for the company. That make us wondering if it is more suitable to you the Eggy Party most randomly single title success or it is as a result of our refined development and operational sale. Just wondering any kind of new games in your pipeline that could compel Eggy Party, yes that we can expect?

Another question for the games longevity. Actually, some of your games enjoy quite great longevity like (inaudible), but some good titles in the space in several months. So just curious, from a management point of view, if there is a good way for us to have a better judgment on the game longevity going forward? Let's say, how should we think about the longevity going for Eggy Party?

(foreign language) Yes. So Eggy Party is one of the very successful games we recently launched, and it is a tough game that you have done with, with your friends and family. So we think what you worry about probably won't happen because we learn from our mistakes. So we hope this is a game that will continue to bring enjoy to our gamers. We will dedicate more resources on to the game to ensure longevity of that game. When we talk about longevity, we mean at least 10 years, games like FWJ has been running for more than 2 decades. So we hope to replicate a similar type of longevity in all of our game.

Your next question comes from Alex Poon with Morgan Stanley.

(foreign language) My first question is related Naraka: Bladepoint, the console performance on Xbox, and our future plans with PS4, PS5 and mobile version and international launch? My second question is related to our overall margin trend in the next 1 to 2 years, considering we have Youdao Music, they are improving their margins. And gaming business, we are investing more R&D and G&A in overseas market?

(foreign language) So the -- so our Naraka: Bladepoint was launched last June on Xbox, and we are pleased to have joined the SEP program. And since then we have seen a huge number of gamers try now our game, and we have been optimizing user experience based on their feedback, and we've been working tirelessly with our Montreal office and to ensure we can deliver the back experience to our users. And based on those efforts we have -- even more improved version with our PS5 version. So we are going through testing for the PS5 version.

And in terms of mobile games, also we're going through -- we're going through testing stages for that game. And we hope that -- we were pretty confident that the mobile game will kind of do replicate the same level of user experience as one would on our original PC version.

Right. Alex, and to your second question on the margin outlook. In the next 2 to 3 years, our game margin will remain relatively stable. You are right that for our overseas studios, they are in the investment phase and likely the games developed by our overseas game studios will only come into the market in 2025 and beyond. However, we do have a very strong and sizable existing portfolio of games that provide a very, very strong support to cash flow, to profitability, to the margin.

And for our subsidiaries like Cloud Music, Youdao, they have already demonstrated a clear trend of narrowing down the losses. We are very confident, give them another 6 to 8 quarters, both businesses are very, very optimistic to be self-sustainable and breaking even. So all-in-all, I think in the next 2 to 3 years, our margins will be steady and slightly improving with positive surprises coming in in 2025 and beyond, which will then primarily be fueled by the commercial launch of our overseas game that's currently in the development phase.

Your next question comes from Felix Liu with UBS.

(foreign language) Let me translate myself. And you mentioned the improved regulation outlook in China about game license. We're definitely happy to see that. Outside of the licensed games that you already mentioned, if we look into second half this year, at maybe 2024, could you give us some color on the big titles, our big genres that you have a good pipeline for?

(foreign language) Okay. I'm sure this year and next year and then many years ahead, you will continue to see more games to be launched, these 5 new games we launched from NetEase. Okay, the subject innovation is perpetual, and we will continue to focus on innovating our gameplay and our game quality. And you've seen -- and we are confident we'll continue to be able to deliver strong blockbuster games to the market year after year. And last year, we had amazing blockbuster Naraka: Bladepoint. This year, we have Eggy Party. So those are breakthroughs that have been equally successful in the code weapon type of MMORPG games, and we are equally successful in the casual game that you play with family and friends. So I'm very confident you will continue to see new exciting innovative games coming from design run rate out of NetEase.

Thank you. And that concludes the question-and-answer session. I would like to turn the conference back over to the management for any additional or closing comments.

Thank you again for joining us today. If you have any further questions, please feel free to contact us directly or present it to financial communication. Have a great day. Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.