NetEase Inc (NTES) 2021 Q3 法說會逐字稿

Good day, and welcome to the NetEase 2021 Third Quarter 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 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 in this discussion. A general discussion of the risk factors that could affect that is to 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, and the announcement and filings on the website of Hong Kong Stock Exchange.

The company does not undertake any obligation to update this 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 as a reconciliation of GAAP to non-GAAP financial results, please see the 2021 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 NetEase corporate website at ir.netease.com.

Joining us today on the call from NetEase senior management is 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 an exciting one for NetEase. We launched a number of top ranking games, bringing our game revenues to a new record of RMB 15.9 billion. Our other business segments also grew robustly, supporting our total net revenues growth of around 19% year-over-year, reaching RMB 22.2 billion. For online games, our flagship titles continue to demonstrate strong growth after nearly 2 decades of operation. Revenues from Fantasy Westward Journey Online and Westward Journey Online, both grew at double-digit rates year-over-year in the third quarter. The mobile versions of these 2 legacy sagas showed resilient year-over-year growth as well.

Adding to our strong portfolio of PC games, our new hit games Naraka: Bladepoint and Nightmare Breaker took our PC games revenue to a new record high in the third quarter, growing by 30% year-over-year, far outpacing industry growth.

Featuring. unchained melee combat Naraka: Bladepoint has taken the PC games market by storm, reinvigorating the stable battle royale genre with exciting novel ideas. Its global success showcases our ability to bring first-rate games to the world stage.

By November 10th, we had already sold more than 6 million copies of Naraka: Bladepoint worldwide in just 4 months, making it one of the top sellers ever on Steam. Players in both China and global markets are hailing Naraka: Bladepoint for its thrilling combat experience.

So far, Naraka: Bladepoint has retained an 80% positive review rate on Steam, which naturally leads to excellent user retention and continued user growth. We believe Naraka: Bladepoint will experience the same level of longevity as many of NetEase's flagship titles. We work hard to keep our games fresh and plan to continuously introduce more exciting new content, including new modes, heroes and maps. To add to the enthusiasm, we are also currently working round the clock to expand the game offering to console and mobile platforms. We expect to bring players these exciting versions in the next year.

On the heels of the Naraka: Bladepoint zeal, we launched another PC game, Nightmare Breaker in September. It is an action-based competitive fighting game taking place in a fantasy setting. Players can choose from a variety of roles with unique abilities to battle against dark forces and save the world. As a game with unique gameplay, Nightmare Breaker further expands our base of PC players.

Turning to the mobile side, our new hit game Harry Potter: Magic Awakened has enchanted millions of players going viral across China, it instantly dominated both the top download charts and top growth in China following its launch in September. Harry Potter: Magic Awakened conjures charming wizardry world, touching the heart of millions. The game has attracted a large crowd from young generations across the gamer community, its elaborate designs are gaining greater acclaim, including iconic European retro picture books and interesting card-based combat. Infused with abundant competitive gameplay, we hope Harry Potter: Magic Awakened will continue to gain adoration from players in China maintaining its popularity over the long term as many of our titles do. We are equally excited for its global launch. Calling on the nostalgia of generations of Harry Potter fans, we believe this game has great potential for extensive popularity across the globe.

Currently, we are working hard on its localization for other geographies with plans to properly launch Harry Potter: Magic Awakened in some of the major overseas markets next year.

As another title we launched in the domestic market, our space-themed SLG game Infinite Lagrange also had a strong start in China in the third quarter. Sci-fi fans were captivated by the game's intense and exciting travel through time and space. In time, we believe Infinite Lagrange will continue to earn respect from even more players, extending our strength in the SLG market through its super-immersive space experience.

On the international front, we introduced The Lord of the Rings: Rise to War to the U.S., Europe and several other overseas markets, making a strong debut at the end of the third quarter. The Lord of the Rings: Rise to War has amassed a huge user base across the globe. With engaging and thought provoking gameplay as well as the strong appeal of the Lord of the Rings IP, we see great potential for the growth of its users. We expect The Lord of the Rings: Rise to War to behave similarly to our other time-proven SLG title Invincible visible with revenue ramping up gradually and showing an upward trend over time with a long-lasting life cycle.

Complementary to our in-house R&D capabilities, we have also been deepening our overseas footprint through strategic investments and partnerships. We are looking for talent and teams that complement our R&D skills on a global scale. Over the past few years, we've invested in top teams, including Bungie, Quantic Dream, Second Dinner and Theorycraft,as well as the recently announced strategic funding in Kepler and acquisition of Grasshopper in Japan. With these partnerships, we plan to share our know-how in R&D and operations while gaining new inspiration from the creative minds of these overseas studios as well as a deeper understanding of overseas users and their preferences. Together, we share the same passion and vision to build the next sensational blockbusters for players worldwide.

In addition, we have launched a few gaming studios in places such as Montreal, Tokyo and LA with an aim to attract the best international talent to further broaden our R&D capabilities.

Moving to our game pipeline, as I mentioned earlier, in the next year, we plan to launch Harry Potter: Magic Awakened in more overseas regions as well as bring players, console and mobile versions of Naraka: Bladepoint. Very soon, we will be introducing another highly anticipated game, The Showbiz: Dream Chaser, our self-developed showbiz simulation game. Catering mainly to emerging female users, this game provides players with a new role playing experience as an actor or actress in the world of showbiz. Here, player gets to live their dreams of fame and explore the exciting life of a performer in the entertainment industry, highly acclaimed for its distinctive setting, immersive experience and art design. We believe The Showbiz: Dream Chaser could open up a new genre with great market potential for NetEase. Our pipeline also includes Diablo Immortal and Ghost World Chronicle.

Moving ahead, we will continue to bring players inspiring new games that stands the test of time in China and worldwide.

Turning to Youdao. We have made solid progress with our transition to better align Youdao's business with the latest regulatory guidelines which aim to alleviate excessive academic pressure on Chinese youth. While we are in the process of disposing of our academic after-school tutoring business, we are making excellent progress with our other pillars of future growth, including STEAM courses, adult learning, smart devices and education digitalization solutions.

Total net revenues for Youdao in the third quarter were RMB 1.4 billion representing a 55% growth year-over-year. Revenues from the after-school academic tutoring classes in China's compulsory education system accounted for around 25% of Youdao's total net revenues.

In the third quarter, we continued to grow our STEAM course offerings. For Youdao Go, Youdao Weiqi, its gross billings and user engagement has been growing rapidly since its launch last year. During the quarter, we upgraded its current AI system during the period, giving our students a more efficient platform for practices.

Youdao Icon, Youdao Xiaotuling which prepares children for programming education launched Python courses in this quarter and became a member of China Computer Federation Programming Trainer Accreditation.

Our reach in the adult education space is also expanding as encouraged by the authorities. For example, our extraordinary memory course retained its leading position with gross billings approaching RMB 100 million in a single quarter. We also recently announced a collaboration with Amazon Web Services(AWS) to bring its free digital training courses to Chinese users on NetEase Cloud Classroom.

Learning devices remain robust with record high revenues of RMB 255 million, a 56% increase year-over-year. Youdao continuously upgrades and enriches its product offerings to facilitate efficient learning under different scenarios.

In the third quarter, collaborating with the People's Education Electronic and Audiovisual Press, we launched a new version of our award-winning Dictionary Pen containing over 4,000 original sounds from tax books published by the Press. We also rolled out our Youdao Listening Pod in September, which helps improve students' English skills in listening, speaking and reading through real-time intelligent scoring and pronunciation correction functions.

In addition, we are working with local schools experimenting with different digitization solutions which give school teachers more automated teaching and grading tools and facilities, enabling more efficient teaching.

Now looking at our Cloud Music business. We continue to improve our differentiated music community ecosystem via product and content enhancements to keep us ahead of the curve. We are now better positioned amid a healthier industry development. Our top line growth drove solid margins in the third quarter representing our second consecutive quarter of positive gross margins. Some of our innovations included upgrading our main Cloud Music homepage in August, adding new community features. Users are also enjoying our newly launched Music Gift Box function, which opens the video creation capacity to individual users allowing them to distribute customized content to friends.

In addition, we launched Village Citizenship Card, giving each of our users a personal ID in Cloud Village allowing them to feel a fresh sense of belonging. This created a lot of buzz on the social media, further extending our brand influence. In combination with other industry players, we are actively working to secure more high-quality content with better ROI, especially following the recent favorable industry changes.

In the third quarter, we completed a direct agreement with Warner Music Group, which means we now have direct digital distribution contracts with all three of the world's largest recording label groups. We are also pleased to see such favorable collaborations with big labels at a more reasonable cost structure, providing us with the flexibility to optimize our content investments using a more disciplined and predictable approach. Meanwhile, we are also actively completing our major Chinese music library recently adding several new copyrights, including Modern Sky, one of China's largest independent record labels and Emperor Entertainment Group one of the largest entertainment group in Hong Kong. Our negotiations with some major music labels are close to being finalized, and we expect more to come, further complementing our song library offering.

Turning to Yanxuan. As NetEase's private label consumer brand, Yanxuan continues to build its brand awareness by regularly launching highly popular products via diversified channels. Apart from solid sales growth from external e-commerce channels, we have seen strong momentum from short video platforms such as Douyin and Kuaishou with some popular products like bathroom fragrances and coffee crackers.

Our advanced and differentiated original design products are being very well received by the users and the market. In Q3, we successively launched several original design series across categories including clothing, dining and kitchen, home furnishing and personal hygiene and maternity.

We are gaining increasing recognition for excellent design and creative style. In August, we won 2 prestigious Red Dot Awards for our Dear John Bedding Design Yanxuan Dunhuang Museum Tea Packaging Design, competing against thousands of design submissions that came from more than 60 countries and regions. These accolades add to NetEase Yanxuan's increasing number of awards and honor, which included the 2021 German IF Design Award, along with many other international awards and recognition from the design industry.

During the Double 11 promotion, we recorded over 100 million GMV through Taobao and Tmall channels, and on JD, we were also the #1 brand for daily goods and products. Commensurate with our extensive growth across our businesses, our capacity to give back has grown as well, enabling us to amplify our ability to help our communities. Our resolve toward social responsibility has also been heightened by the immediate needs of those who have fallen victim to natural disasters and public health crises.

Most recently, we were deeply saddened by the destruction and loss felt by those in Shanxi and Henan provinces. To help these flood ridden areas ravaged by natural disaster, NetEase has donated over RMB 50 million to Henan and RMB 20 million to Shanxi to support much-needed relief effort and post disaster reconstruction. The mounting natural disasters tell us that we all must become better custodian of the earth. As a corporate citizen, NetEase is committed to environmentally responsible action. In addition to our financial contributions toward natural disaster alleviation and restoration, we are leveraging our strength and resources for environmental protection. We believe games have the power to raise awareness among billions of people across the globe about environmental conservation and restoration.

In the third quarter, Life-After one of our flagship titles joined the second annual Green Game Jam organized by the UN facilitated Playing for the Planet Alliance. Player needs to go to the forest in the game to put out the forest fire during the activation. Our participation in this alliance represents NetEase's increased social responsibility using games as a tool to create environmental awareness to help protect our planet.

As we continue to advance our environmental and social pursuits, we are thankful for our growing business that allows us the financial capacity and social influence to support these efforts.

Moving ahead, we will continue to cultivate our business by exploring more creative practices to enrich our broad content, increase our product exposure and bring even more diverse and engaging experiences to our users while leveraging our strength to enact positive social and environmental change.

This concludes William's comments. I will now provide a brief review of our third quarter 2021 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 22.2 billion or USD 3.4 billion, representing a 19% increase year-over-year.

Our net revenues from online game services were RMB 15.9 billion, up 15% year-over-year. The year-over-year increase was primarily due to our newly launched games such as Naraka: Bladepoint and Harry Potter: Magic Awakened as well as from existing games such as Fantasy Westward Journey Online and Westward Journey Online II. Net revenues from our mobile games accounted for approximately 69% of the total net revenues from online games services in the third quarter.

Youdao's net revenues reached RMB 1.4 billion, up 55% year-over-year, driven by fast growth of both Youdao tutoring services as well as increased sales of intelligent learning devices. Of the Q3 total revenues, about 25% relates to academic subject courses in China's compulsory education system. Net revenues from innovative businesses and others were RMB 4.9 billion for the third quarter of 2021, up 26% year-over-year mainly due to increased contribution from NetEase Cloud Music. For Cloud Music, both membership and live streaming revenues maintained solid growth momentum driven by robust paying user expansion.

Our total gross profit margin was 53.2% in this quarter with a breakdown as follows: gross profit margin for our online game services was 64.5%. As a reminder, this number is generally stable with some narrow fluctuations based on the revenue mix of mobile and PC titles as well as self-developed and licensed games.

Gross profit margin for Youdao was 56.6% compared with 45.9% in the same period of last year. The significant growth was primarily attributable to the improved learning services gross margin due to improved economies of scale and continuous optimization of our faculty compensation structure.

Substantial sales growth of the smart learning hardware such as our Youdao Dictionary Pen 3.0 also contributed to these gains, as this line carries a higher gross margin than other product lines. Gross profit margin for innovative businesses and others was 15.6% compared with 16.8% [in 3Q 2020] (corrected by company after the call). The decrease was mainly due to decreased gross profit margin from the games streaming business [NetEase CC] (corrected by company after the call). NetEase Cloud Music however, enjoyed its second consecutive quarter of positive margins.

For the third quarter, total operating expenses were RMB 8 billion or 36% of our total net revenues. Our selling and marketing expenses as a percentage of net revenues were 14.1% compared with 14.7% in the prior quarter. The quarter-over-quarter decrease was mainly due to decreased marketing spending related to Youdao. R&D expenses were RMB 3.8 billion. The third quarter is our seasonally high quarter for R&D as our new campus hires graduate and commence their career with us. We remain committed to investing in content creation and product development, which is core to our sustainable future growth.

The effective tax rate was 19.6% for the third quarter. As a reminder, the effective tax rate is presented on an accrual basis and the tax credits differ from each of our entities at different time periods depending on applicable policies and our operation. Non-GAAP net income attributable to our shareholders for the third quarter totaled RMB 3.9 billion or USD 599 million.

Our non-GAAP basic earnings per ADS were USD 0.9 or USD 0.18 per share. Our cash position remains strong. As of September 30, 2021, our total cash and cash equivalents, current and non-current time deposits and short-term investments balance totaled RMB 98 billion, compared with RMB 100 billion as of end of last year.

In accordance with our dividend policy, we are very pleased to report that our Board of Directors has approved a dividend of USD 0.045 per share or USD 0.225 per ADS. Lastly, under the current 2-year share repurchase program, approximately 13.5 million ADSs has been repurchased as of September 30 for a total cost of approximately USD 1.3 billion. Meanwhile, under NetEase Youdao's share purchase program, approximately 0.1 million ADSs had been purchased for a total cost of USD 1.8 million as of September end.

Thank you for your attention. We would like to open the call to your questions. Operator, please go to Q&A.

(Operator Instructions) We will now take our question from Alex Poon from Morgan Stanley.

William, Charles, Margaret (foreign language)

My question is -- first of all, congratulations on very strong results and game pipeline. My question is regarding Harry Potter overseas release schedule. Do we have more specific timeline for different regions for release next year? How is the progress of content and localization and community localization, et cetera? How -- do we have a revenue expectation for overseas? How is it compared with China revenue?

Well, thank you, Alex. Let me answer your question directly in English. We have a strong pipeline and Harry Potter is one of them. And right now, subject to obviously the progress of localization, we intend to launch Harry Potter to some overseas markets as early as first half of next year. And given the huge fan base of the Harry Potter IP worldwide and particularly encouraged by the very strong performance of Harry Potter in China, we are hopeful that this game would become a worldwide sensation. The publishing right is a commercial arrangement between NetEase and Time Warner. For some of the markets, NetEase will be in charge of publishing whereby majority of the overseas market publishing will belong to Time Warner.

We will now take our next question from Alicia Yap from Citi.

William, Charles, Margaret (foreign language)

My question is related to NetEase Cloud Music. So how do you see the overall competitive landscape and also the time spend dilution from the short video platform? Do you worry if the leading short video platform like Douyin that could enter more aggressively in the online music content that could actually put some threat to Cloud Music over time and also affect the user time spend on Cloud Music?

(foreign language)

[Interpreted]

Alicia, so yes, we do observe that, at least in short term, short format videos or other general video format has taken some of the user time spent. That not only in music, but also in games in other forms of entertainment. But what's the major difference between music and the video is that music creates a resonance between users. It creates that immersive experience for users. So video, if you got one with on video, you probably don't want to watch it again. But for music, you tend to want to listen to it over and over again if it's a kind of music that you love.

For your second question on potential new competitors, new entrants to the market. Our view is that this is a very open market and we will very much welcome others to join and help those independent musicians in China to realize their dream.

We will now take our next question from Natalie Wu from Haitong International.

(foreign language)

So my question is regarding Naraka: Bladepoint. Just want to get an update of the copy based discount revenue contribution versus in-game purchase revenue contribution at a point of 6 million copies worldwide. And also for each part, how should we understand the deferral treatment in terms of the revenue recognition? Also, if management can share with us some thoughts on the longevity of this game. That will be great.

Okay. actually, in the interest of time, I'll answer that question directly in English. So firstly, on your question on revenue recognition. So both for the copy sales as well as the in-app purchase, we adopt the revenue deferral treatment over an expected lifespan. So this is consistent with our revenue recognition treatment of other PC and mobile games. Obviously, with the games being launched a few months back, now the more -- the gross billings will come more and more from the in-app purchases, which we are very confident that Naraka: Bladepoint just like many of our other NetEase flagship titles will have a very time-proven longevity. We think a combination of stellar global sales record for copies as well as our longevity through operations through content update, this will create a unique model for the global PC games in terms of proving the longevity and sustainability of the gross billion over the longer term. Hopefully, that answers your question.

We will now take our next question from Kenneth Fong from Credit Suisse.

Ding, Charles, Margaret. (foreign language)

I have a question on NetEase Cloud Music. Note that we have obtained the copyright authorization from Emperor Entertainment recently, and also The Big 3. So how should we think about the pace of signing up new copyrights and impact and benefit on our content cost and the margin going forward?

(foreign language)

[Interpreted] Over the last few years, the messages in China has not been perfect, which is why the industry players in music industry has been paying a much more expensive price to the label companies than anywhere else in the world. As everybody has seen on July 24, the authorities have given guidelines to certain companies, asked them to give up exclusive rights. So I think overall, we'd like to see to be able to pay a fair price to the label companies across the world. And we are confident under the right direction. from authorities, China music industry will continue to converge in the right direction.

And secondly, we think that every music company in China should really be focusing on helping independent musicians to create good music, to create, to relay positive messages. As a socially responsible company, NetEase Cloud Music has been making those preparation and that is our agenda, and that is our goal.

We will now take our next question from Thomas Chong from Jefferies.

(foreign language)

Congratulations on a very strong set of result. My question is about our M&A strategies as well as the use of cash. In addition, can management share about the cost in terms of the trend in operating expenses?

Thank you, Thomas. I'll answer your question directly in English. So firstly, for our M&A strategy, we are always very focused in our core pillars of businesses: games, online music, online education, private label brand, Yanxuan. So our business development will be concentrated in our major verticals. And we obviously prefer and for the past 2 decades or so, we've been growing organically. But we also remain highly active to explore opportunistic opportunities to deploy M&A to further supplement our growth. So that's always been our consistent approach towards M&A.

In terms of the cash proceeds used, again, we invest most of the cash into ourselves, into our talent acquisition and retention, into our content creation and it takes patience, and it takes commitment. For instance, a major title of next blockbuster game can easily take a few years with big budgets to develop. I think this is also one of our competitive edge that as a major game -- a powerhouse that we can afford and we can be determined to focus on what we are really good at and what we really want to create.

OpEx trend is, I think NetEase has been listed for over 21 years and we've always had a very consistent approach into expense management. We focus greatly on ROI return. Given our strong cash balance sheet, we are not shy to spend money. However, we never burn cash for the sake of spending money. Whenever we spend money in terms of selling & marketing into R&D, it is ultimately ROI driven that we want to make sure that the money we spend today may not necessarily give us the topline return within the same quarter, but we will be handsomely rewarded. As such, we expect that we maintain a prudent yet healthy level of selling & marketing on the R&D front. We are committed to spending more. That is also encouraged by the authorities. And I think that is also what a long-term sustainable technology company should do. Thomas, that's the answer to your question.

And congratulations on a strong quarter again.

We will now take our next question from Eddie Leung from Bank of America.

William, Charles, Margaret (foreign language)

I should do the translation myself. I have a follow-up question on your pipeline for the overseas game market. We understand that a good game should be public across different regions, but there are also cultural and regulatory differences. So just wondering besides working with overseas studios, if your Chinese studios will also be involved in game projects defined specifically for the overseas markets?

(foreign language)

[Interpreted]

This answer comes from Zhipeng. So our China-based team, their main focus is on the Chinese themed games that they know well for the Chinese-speaking countries. But secondly, we have been putting a lot of energy and resources in games that targeted for the global launch. So for those games, we think about gameplay, the world view and all the details in a global manner. And for those types of games is typically joint developed by our China-based team and some of our overseas games, for example, Montreal. And certainly, we also have games that have been developed solely by the overseas team, who will be working on games that buy them and have targeted in the markets that they know the most well in. So altogether, we hope to introduce to the global audience, more and more exciting games to play.

We will now take our next question from Jialong Shi from Nomura Securities.

William, Charles, Margaret. (foreign language)

I will translate myself. So my question is about metaverse, which is a very hot new area this day. A lot of companies are planning to invest heavily in this field. Can management share with us your vision on metaverse? And what are the potential growth opportunities it may bring to the online gaming industry? And what are your strategies to tap this opportunity?

(foreign language)

[Interpreted] Metaverse is indeed the new buzz word everywhere today. But on the other hand, I think nobody has actually had first-time experience in what it is. But at NetEase, we are technologically ready. We know how to accumulate the relevant know-how, the relevant skill sets when that day comes. So I think when that day eventually comes, we'll probably be one of the fastest runners in the metaverse space.

At this time, I would like to turn the conference back to Margaret Shi for any additional or closing remarks.

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

[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present live on the call.]