NetEase Inc (NTES) 2023 Q3 法說會逐字稿

Good day, and welcome to the NetEase 2023 Third Quarter Earnings Conference Call.

Today's conference is being recorded.

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

Thank you, operator. Please note the discussion today will contain forward-looking statements relating to the 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 company's control and it could cause actual results to differ materially from those mentioned in today's press release and in today's discussion.

A general discussion of the risk factors that could affect NetEase's business and the financial result is included in certain filings of the company with the Securities and Exchange Commission, including in its Annual Report on Form 20-F and the announcements of the filings on the website of the Hong Kong Stock Exchange. The company does not undertake any obligation to update forward-looking information except as required by law. During today's call, management will 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 2023 third quarter 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's senior management are Mr. William Ding, Chief Executive Officer; and Mr. Charles Yang, Chief Financial Officer. 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 based on RMB.

The third quarter was another period marked by outstanding results. Our beloved legacy titles and new hit games are strengthening our reach throughout the gaming world. Our total net revenues were RMB 27.3 billion for the third quarter, up nearly 12% year-over-year, and our net income attributable to shareholders rose to RMB 7.8 billion, increasing by 17% year-over-year.

Our time-honored legacy franchises have maintained robust popularity. Notably, we brought players updates for the Fantasy Westward Journey saga in the third quarter, with a brand-new storyline and captivating activities, which once again breathed new life into the saga and drove year-over-year revenue growth for more than 20-year-old epic title.

In addition to our well-established games, we are actively expanding our portfolio by consistently launching and cultivating long-lasting franchises across more genres. We have strengthened our leadership in MMOs by pushing the boundaries of industry standards. We have also expanded our presence in broader game categories and demographics with innovative content, gameplay, and monetization models.

We can see this in the enduring popularity of the games that we have introduced in recent years, such as Eggy Party and Naraka: Bladepoint. Furthermore, our recently launched titles, including Justice mobile game, Racing Master, and Dunk City Dynasty, have quickly climbed to the top of the iOS grossing chart after its release.

Looking at our newest hit titles, Justice mobile game, launched just in June, impressively surpassed 50 million registered users in October, establishing itself as one of the largest MMOs in NetEase's company history in terms of user base size. Notably, a significant portion of its player community comprises Generation Z players who were previously unfamiliar with the MMO genre, becoming the gateway of MMO games for the younger generation in China. As a trendsetter in the MMO industry, NetEase has once again brought key innovations to the genre with the launch of Justice mobile game and reshaped the MMO landscape. It offers players a vast array of high-quality content for free, revamping the conventional paying model for MMOs. The shift to a more balanced spending approach gives players more freedom to enjoy the game's rich features and gameplay, with optional purchases focused on avatars' cosmetics and accessories.

This model was very well received by the game's player base, solidifying its stability. In late October, we introduced Justice mobile game's first seasonal update, which significantly enhanced player engagement with captivating storylines, new gameplay, and additional professional-role options. It swiftly propelled Justice mobile game to the No.2 position on China's iOS grossing chart shortly after its release. The innovative seasonal mechanism we've introduced to the MMO genre gives all players a fresh start with a focus on fair and balanced gameplay. It also reduces the gap between experienced and new players, ensuring that everyone can enjoy and engage in this game.

In addition to the success of this new blockbuster MMO title, we also achieved success across other game genres in the third quarter. Our new racing simulation game Racing Master consistently ranked among the top three most downloaded and highest-grossing games on the iOS charts in China following each new game update, proving its broad appeal to racing enthusiasts. Notably, as China's very first triple-A standard racing simulator mobile game, Racing Master has introduced an authentic racing experience into China's mainstream gaming sphere. With the plan for Racing Master's global market expansion, we will soon commence overseas testing to bring this exciting racing simulation experience to players worldwide.

We also achieved a significant milestone with our foray into sports games, a historically less popular category in China. We've broken new ground with Dunk City Dynasty, a street basketball game that provides various modes to deliver a casual basketball gameplay experience. Dunk City Dynasty quickly rose to the No.2 position on the iOS grossing chart in China just a few weeks after its release. Following our latest seasonal updates, with the introduction of new basketball superstars to the team roster,like James Harden, the game rose to the No.1 position on the iOS grossing chart in China. The innovative gameplay and balanced gaming experience we've infused in Dunk City Dynasty are important differentiators for our game. By integrating players authorized by the NBPA with street basketball, we provide players with higher gameplay freedom,along with expanded cosmetic options. The game also includes a fair court for fair play, meaning increased player spending doesn't dictate who wins. This facilitates more inclusive gameplay and even more potential for the game's long-term success.

Player enthusiasm for Racing Master and Dunk City Dynasty underscores the significant demand in China for top-tier games in the casual game genre. Along with our rich R&D capabilities, we are leveraging the inroads we've already made across a broader spectrum of genre verticals to fill these gaps in the market with new hit game that players love.

Games we've introduced in recent years continue to resonate with players, demonstrating enduring popularity and long-term operating potential. Eggy Party, for example, continues to achieve remarkable milestones. In August, Eggy Party set new records by amassing over 100 million UGC maps and attracting 100 million MAUs. We have been committed to fostering and nurturing our UGC ecosystem, which is a cornerstone of Eggy Party's success. We enhanced our self-developed editor in the third quarter by introducing more advanced and interactive functions. We also added collaborative map-crafting functionality that lets users create with friends online on a shared canvas. To help foster even more creativity, we've introduced tutoring systems and a range of incentives to reward and motivate creators through various activities. To build on the game's notoriety in domestic markets, we are actively pursuing global expansion plan for Eggy Party. In the third quarter, we launched Eggy Party in Southeast Asia, where it consistently secured dominating positions on Google Play download charts for multiple weeks, particularly in Indonesia and Thailand. These early overseas releases also gave us valuable feedback and insights that guide our efforts as we optimize the game for a global audience.

We are also proud to announce that Naraka: Bladepoint recently reached a remarkable milestone of 40 million users. Following the transition to a free-to-play mode in July, we also introduced new heroes to the game in the third quarter, igniting greater player enthusiasm and attracting a massive influx of additional users to the game.

To bolster our robust portfolio of games, we have a number of new games under development. As we get closer to some of these introductions, we are particularly excited about Where Winds Meet, our new triple-A martial arts-themed action-adventure game. Where Winds Meet infuses an immersive open-world experience with an exciting historical backdrop that's relatively untouched in Chinese gaming.

This interactive sandbox-style adventure features an extensive map, a diverse array of weaponry, and captivating martial arts techniques. Players have the flexibility to explore this interactive world both individually and in groups, with two gameplay options. Players can freely roam in the ancient Chinese landscape in single-player mode, enjoying a highly personalized combat experience. In multiplayer mode, players can work closely with friends to complete tasks, engaging in exciting and heartwarming social interactions. We will soon launch the second round of testing,where players will be able to see more of the game with a longer play-time. Early feedback fuels our excitement as we get closer to officially launching this brand-new open-world experience to our players in 2024.

As the developer of China's first ACG hit title, Onmyoji, NetEase has made ongoing investments in the animation genre, accumulating valuable industry expertise, and we hope to impress the ACG community once again. The promotional video release of our upcoming ACG title under development set in the metropolitan-themed open-world genre, Project Mugen has garnered significant attention from players, both domestically and internationally. We are committed to infusing new vitality into the ACG arena, drawing upon our renowned innovation capabilities and experience in the realms of animated games.

Beyond these titles, we also have a number of other games in the making including Mission Zero, Once Human,She Diao, and Naraka: Bladepoint mobile game.

On the global stage, our game development is progressing smoothly in Japan, North America, and Europe. This month, we are excited to welcome Fantastic Pixel Castle as our newest additions to the NetEase family. Fantastic Pixel Castle is led by Greg Street, who is well-known for his contributions to massively successful games around the world including World of Warcraft and League of Legends. Greg and his experienced founding teams are currently developing a top-tier MMO game codenamed "Ghost", to provide players with a fresh and immersive fantasy MMO experience.

We are thrilled to collaborate with so many talented industry producers, leveraging their creativity in synergy with our deep research and operational capabilities. Together, we aim to deliver even more captivating games to players worldwide.

Now let's move on to Youdao. In the third quarter, Youdao achieved record-high revenue of RMB 1.5 billion, growing 10% year-over-year, driven by the growth in learning services and online marketing. Additionally, as part of our continued efforts to improve profitability, our operating loss for Youdao narrowed by a significant 74% year-over-year to RMB 58 million.

The solid growth in our learning services was due to our consistent ability to launch unique and high-quality courses. Notably, in the third quarter, our coding course introduced a specialized program aimed at preparing students for the CSP informatics competition, one of the most popular competitive programming event in China. Our program features all-encompassing services that include learning, contest practice and an evaluation system. The evaluation system is supported by our in-house developed scoring model, allowing students to estimate their scores and assess their probability of progressing into the next round of the contest.

Youdao's online marketing services have consistently grown at an impressive rate of approximately 100% for the second consecutive quarter. This underscores our expertise in proprietary algorithms and the effectiveness of our customized solutions that are precisely crafted for diverse industry sectors.

Revenues from our smart devices declined in the third quarter as we strategically optimized our channel mix by reducing sales through less cost-effective channels. Although this may have a temporary impact on Youdao's revenue, we believe it will lay a solid foundation for sustained long-term growth and enhance Youdao's profitability potential over the long term.

Our focus on technological innovation remains our driving force. In addition to Youdao's tech-boosted performance, we upgraded AIBox on Youdao's translation products in the third quarter, which enables more accurate and natural translation across various types of documents. With the support of our machine-generated functions, third-quarter revenue from subscription fees for translation increased by over 160% year-over-year. Furthermore, following the August introduction of our digital human language coach, Hi Echo through Youdao Dictionary Pen X6 pro, we expanded our reach to a broader user base through an independent app in October, attracting over 100,000 user registrations within just a month. We will continue to iterate Hi Echo with a new update coming soon.

Looking forward, we will look to drive more technological innovation and introduce more products that genuinely meet our users' needs by harnessing our expertise in machine learning technology.

Next, turning on to NetEase Cloud Music. In the third quarter of 2023, Cloud Music continued to navigate quality development across our core music-centric ecosystem while further extending the robust monetization momentum in the core online music sphere and improving overall profitability. Total online music MAUs remained largely steady, staying above 200 million in the third quarter. Total revenues for the quarter were RMB 2 billion, on par with last quarter. Growth in our music-centric memberships accelerated, demonstrating our ability to introduce premium offerings, including expansive content and innovative features. Additionally, our social entertainment services started to stabilize on a monthly basis during the latter part of the third quarter, following our strategic positioning refinements in livestreaming, which resulted in short-term setbacks. With solid monetization momentum in the core online music businesses and continued cost structure optimization, Cloud Music maintained steady margin improvement for the period.

We are constantly expanding our music library to provide a comprehensive selection of music for our diverse audience base. During the third quarter, we broadened our extensive music collection by adding songs from popular C-pop artists like Karen Mok, ZHENG Jun, and ZHANG Jie. In addition, we were delighted to release albums by pop stars, including G.E.M., KeyNG,and SHEN Yicheng.

As part of our ongoing commitment to enriching our music-centered ecosystem, we remain dedicated to empowering and assisting independent artists. As of the end of September, we proudly served a thriving community of over 660,000 registered independent artists, showing strong growth of 16% compared with the same period last year. We've also broadened our support for emerging music talent. Our new programs are tailored to regional roots and distinctive styles in different areas, including programs like Localized Sound and Project Stone Season 5 to unearth and promote more diverse artists. At the same time, we hosted offline music festivals such as 65PARK Camp Music Festival, providing more exposure for our independent musicians.

In addition to broadening our content selections, we continued our product innovation initiatives, aiming to elevate users' music listening experience and foster our music-centric community. We recently officially launched the "Private DJ" feature,incorporating music recommendations with an intelligent and personalized music introduction and explanatory experience. This feature allows users to recall old-fashioned radio DJ, while enjoying a more personalized music accompaniment as part of their listening experience. Building on our iconic Comments section, our "Comment Square" has emerged as a vibrant gathering place for users to express and find connections with others.

Moving on to Yanxuan. In the third quarter, our private-label consumer brand launched more popular products through diversified channels. We saw robust sales growth in selected categories like pet supplies and home cleaning products. Bestsellers like ergonomic chairs, bathroom fragrances, and cat food consistently outperformed competitors across various platforms. Our strategic efforts, including efficient warehouse and distribution management and personalized packaging,have also proven successful. Thanks to the innovative marketing campaign, our down jacket series, which is highly acclaimed for its exceptional quality at affordable price, gained immense popularity during this year's "Double Eleven" online shopping event, driving the collection to hit top positions on multiple best-selling charts on several e-commerce platforms.

In summary, innovation is at the core of all of our businesses, driving our growth and our competitive edge. We believe that great content, products, and services stem from new and creative ideas. This principle lies at the heart of NetEase. Whether it's games, Cloud Music, Youdao or Yanxuan, we consistently strive to reach new heights. In doing so, we help drive the industries we serve forward while delivering value to our growing global community, our partners, our team members, and our stakeholders.

This concludes William's comments.

I will now provide a brief review of our 2023 third quarter 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.

Total net revenues for the third quarter were RMB 27.3 billion, or USD 3.7 billion, representing an increase of approximately 12% year-over-year.

Total net revenues from our games and related value-added services were RMB 21.8 billion, up 16% year-over-year. The growth was primarily due to increased revenue contribution from newly launched games, such as Justice mobile game, Racing Master and Eggy Party. Net revenues from our mobile game accounted for nearly 78% of our total net revenues from online games' operations.

Youdao's net revenues were RMB 1.5 billion, a year-over-year increase of nearly 10%, primarily due to increased revenue contribution from learning services and online marketing services.

Net revenues from Cloud Music were RMB 2 billion, a 16% decline compared to the same period last year. As we explained earlier, this result reflects declining revenue of social entertainment services as we adjusted our focus to improve profitability in a sustainable manner.

Net revenues for innovative businesses and others were relatively flat in the third quarter at RMB 2 billion.

Our total gross profit margin continues to grow, exceeding 62% in the third quarter, compared with 56% in the third quarter of 2022. Looking at our third quarter margin in more details.

Gross profit margin was 69% for our games and related VAS, compared with 65% in the same period of last year. The increases were primarily attributable to changes in the revenue mix of the NetEase's self-developed,co-developed and licensed games.

Our gross profit margin for Youdao was 55.9%, compared with 54.2% in the same period of last year. The increase mainly resulted from increased revenue contribution from its learning services and online marketing services segments.

Gross profit margin for Cloud Music improved in the third quarter, reaching 27.2% versus 14.2% in the same period a year ago. The margin improvement primarily resulted from increased revenues scale from membership subscriptions and continued improvement to our cost management measures.

For innovative businesses and others, gross profit margin was 27.3%, compared with 25.5% in the third quarter of last year. The increase was primarily the result of margin improvement in Yanxuan and some of our innovative businesses.

Total operating expenses for the third quarter were RMB 9.4 billion, or 35% of our total net revenues.

Taking a closer look at our expense composition:

Our selling and marketing expenses as a percentage of total net revenues were 13% in the third quarter, compared with 15.4% for the same period last year. This reflects our ongoing efforts to consistently enhance marketing efficiency.

Our R&D expenses as a percentage of total net revenues also remained stable quarter-over-quarter at 16% in the third quarter. As always, we are committed to ongoing investments in content creation and product development. We are also seeing leverage in our R&D investments longer term.

Our G&A expenses as a percentage of total net revenues was 5.5%, the slight increase from the previous quarter was primarily due to certain one-off items.

Our other income was RMB 1.5 billion for the third quarter of 2023 versus RMB 2.8 billion in previous quarter. The decrease was mainly due to the exchange rate of the U.S. dollar against the RMB fluctuating over the period. As per applicable accounting standards, we are required to reflect these fair value changes.

The effective tax rate was 14.2% for the third quarter. As a reminder, the effective tax rate is presented on an accrual basis and the tax credit differ for each of our entities at different time periods, depending on applicable policies and our operations.

Our non-GAAP net income from continuing operations attributable to our shareholders for the third quarter totaled RMB 8.6 billion, or USD 1.2 billion. Non-GAAP basic earnings from continuing operations per ADS for the quarter was USD 1.84, or USD 0.37 per share.

Additionally, our cash position remains robust with net cash of approximately RMB 104.4 billion as of the end of September, compared with RMB 95.6 billion as of the end of last year.

In accordance with our dividend policy, we are pleased to report that our Board of Directors has approved a dividend of USD 0.099 per share, or USD 0.495 per ADS.

Lastly, under our current USD 5 billion share repurchase program starting in mid-January this year, we had repurchased approximately 7 million ADSs as of September 30, 2023, for a total cost of approximately USD 588 million.

Thank you for your attention. We would like now to open the call to your questions.

(Operator Instructions) Our first question comes from Ritchie Sun with HSBC.

(foreign language) I will translate this questions myself. I have a question about the competitive landscape for party games. Does management think it's a winner-take-all market or can you have two players? And we noticed that Eggy Party has strong user base and UGC content already. Given that there are more potential competition from other platforms, what would NetEase do to sustain the leadership?

(foreign language)

[Interpreted] I'll just do the translation for William. So we think it's absolutely normal to have a competition. And so far, from NetEase's perspective, we'll continue to drive innovation, and provide good services to our users and that's how we lead the market. So we have full confidence in keep pleasing our users in the party game genre. Thank you.

Our next question comes from Shiqi Ge with CICC.

(foreign language) My question is about the flagship games. Can management share more details with us how do the flagship games such as Fantasy Westward Journey series maintain their strong vitality? And what is the cash flow trend of this game?

(foreign language)

[Interpreted] So I want to say, the most important thing for a game is innovation and need to provide high-quality content for our users. And it's important for us to focus on the long-term longevity of our games and never make any short-term decisions. So based on our 20 years' operation experience, we think that long-term goal is the key.

Our next question comes from Felix Liu with UBS.

(foreign language) Let me translate myself. Congratulations on the strong third quarter results. My question is on the pipeline. Among the 3 of your games that already have banhao, including Shediao, Where Winds Meet and Mission Zero, how is the R&D progress for these games? And when do you think these things can come to market? And for the other games that are still waiting for banhao such as NARAKA Mobile and Project Mugen, does management have any color on their R&D progress?

(foreign language)

[Interpreted] Thank you. I'll do a quick translation for William. For each of our games, it's always after very careful adjustments, moderations before we are ready to release them to the market. And so games such as Shediao, Mission Zero, we're still waiting for the final stage of preparation. And hopefully, we'll get them released to the market no later than the second quarter of next year. Thank you.

Our next question comes from Thomas Chong with Jefferies.

(foreign language) My question is about our overseas strategies. Given that we have demonstrated very good set of results in the domestic market with a very solid pipeline, how should we think about our overseas expansion in the coming years as well as our investment strategies?

(foreign language)

[Interpreted] So on the global market, we will continue our strategy of high-quality focused direction. And we'll continue to look for partners who share the same mentality, share the same passion for games as we do, and continue to invest in good teams to produce and create great content for users all around the globe.

Our next question comes from Lincoln Kong with Goldman Sachs.

(foreign language) We have seen this year a very successful title from Eggy Party and Justice mobile, which is a bit different from traditional legacy game, and have a very big user base and DAU. So when we think about the future upcoming launch in games, especially for next year, Where Wind Meets and Shediao, should we expect some of the similar type of features? And anything we can sort of copy from the past success? When should we expect the next success of Justice mobile?

(foreign language)

[Interpreted] Let me do a translation. So the large DAU games is definitely a very important direction for us. And we'll continue to find the key takeaways from the games that have succeeded in order for us to produce more games of this type. But at the same time, it's also very important to create high-quality games of a particular niche category to meet the different requirement and preference of different type of users. For example, this year, we launched a basketball game, racing car games. So these are good examples of top-performing games of each of their respective categories. So within NetEase, we have a lot of teams who specialize in large DAU games. And there are teams that focus on particular niche. So that we have various different teams with NetEase. And we encourage them apply their unique edges and unique experience.

Our next question comes from Ritchie Sun with HSBC.

(foreign language) So the Dunk City Dynasty has been quite successful despite launching without Android App Store. Although it could have higher channel costs, Android can also bring in more users potentially, which can sustain the game longevity. So how does management assess the ROI of not using Android Store? And what type of titles would adopt a similar launch strategy in the future?

(foreign language)

[Interpreted] For games that are targeting towards a very massive user base like party games, games that are targeted for all ages, for these type of games, the distribution platforms are more effective in reaching out more users. But for games such as the basketball game, it requires a specific group, a specific community of game players. And we can find these players through various different platforms and channels. So in order for us to bring them on to NetEase platform and to operate this game for a long period of time, in order to get to know these users a little bit better and then to continue to perform different iterations, to give better and better service and experience to our users. We also want to add that for the Android platform users, they can also download our game through our own website and TapTap and various other channels.

Our next question comes from Alex Poon with Morgan Stanley.

(foreign language) Congratulations on a very strong quarter. My question is related to AIGC. And can AIGC for our future game updates, expansion packs be much more frequent than the current 3 to 6 months, becoming on a monthly basis or even a weekly basis? And such that the longevity and gaining user stickiness monetization can get better?

(foreign language)

[Interpreted] Yes, we agree that AI is extremely helpful in increasing and enhancing the R&D efficiency, particularly in areas of game design, storyline design, mission design and arts scenes, et cetera. So every month, we can see another upgrade in terms of R&D efficiency. But while the productivity is increasing, the pace of pushing our expansion packs is not completely dependent on that. We need our users to enjoy our content fully. So the pace and frequency of rolling out expansion packs is still very much dependent on the presence of our gamers. So we want to run each of our games for a long period of time. With the increase in efficiency, we can provide higher-quality content within the same amount of time frame.

(foreign language) My second question is about NARAKA: BLADEPOINT mobile and Project Mugen. Are they likely to be released in 2024?

(foreign language)

[Interpreted] Okay. So for NARAKA: BLADEPOINT mobile game, as you know, the game has been under preparation for a while now. I think we are fully prepared. The only thing we are waiting for is a license approval. So once we receive license approval, the product should be ready to go. In terms of the Project Mugen, it's one of the games that's highly anticipated by both us and the gaming community. We want to keep surprise our players with great content. So we're going to continue to invest in more resources in developing that game in order to create next-generation quality content. For now, we do not have a timetable to share. The last question, please.

Our last question comes from Alicia Yap with Citigroup.

(foreign language) My question is related on Justice mobile. So in addition to the new users, for those existing NetEase gamers, where do these gamers come from? Which NetEase games that they were playing before and which non-NetEase games that these players used to pay before Justice? Is the paying ratio and also the ARPU for Justice is much higher than the other NetEase games?

(foreign language)

[Interpreted] For Justice mobile, based on our stats, about roughly 1/3 of our users have never played NetEase games before. And these gamers mostly come from other large DAU products around the market, which means that this is actually a very friendly among many other users. In fact, this year, some of the other games that we launched, such as the basketball game and the Racing Master, a large proportion of gamers who've never played NetEase games before.In terms of the paying ratio, monetization of Justice mobile, we opted a more lighter monetization model. Because of that, the ARPU is relatively lower with much higher paying ratio. We purposely chose this monetization model so that we can create a more healthy balanced in-game environment giving our game players less pressure in terms of paying to give them a long-term enjoyable environment in which they can enjoy their games.

That's all the questions we have for today.

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

Thank you once again for joining us today. If you have any further questions, please feel free to contact us directly or Piacente Financial Communication. Have a great day. Thank you.