NetEase, Inc.

Good day and welcome to the NetEase 2020 Fourth Quarter and Full Year's 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, ma'am.

Thank you, operator. Please note the discussion today will contain forward-looking statements relating to future performance of the company and are intended to qualify for the safe harbor from liability. as established by the U.S. Private Securities Education Reform Act. Such statements are not guarantees of future performance and are subject to certain risks and uncertainties, assumptions, and other factors. Some of these risks are beyond the company's control and could cause actual results to differ materially from those mentioned in today's press release and this discussion. A general discussion of the risk factors that could affect NetEase's business and financial results is included in certain filings of the company with the Securities and Exchange Commission, including its annual report on Form 20F and the announcement of the filings on the website of Hong Kong Stock Exchange. The company does not undertake any obligation to update with the forward-looking information, except as required by law. During today's call, management will discuss Thirdly, 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 2020 fourth quarter and the four-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 NetEase corporate website at ir.netease.com. Joining us today on the call from NetEase Senior Management is Mr. William Ding, our Chief Executive Officer, and Mr. Charles Yang, our 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 renminbi. We closed 2020 with a solid set of results in the fourth quarter, centered around content creation and user experience. Each of our key business segments showed impressive resilience and delivered sustainable growth during the year. We generated total net revenue of RMB $73.7 billion for the whole year, up 24% year-over-year, and RMB $19.8 billion in net revenues for the fourth quarter, up 26% year-over-year. 2020 was a challenging year for many businesses around the world. It was not a time to stand alone and survive, but a time to work together and thrive. While Collin's dictionary has declared the word lockdown as the word of the year, we believe the word breakthrough also defines the life and career of many in the past year. We are grateful for the initiatives our employees take to care for the impacted, to respond quickly and act responsibly to help both of our company and the broader community overcome these hurdles. In doing so, we are proud to have weathered the obstacles, growing each of our businesses in a meaningful way, supporting our business partners to stay safe and strong, and generating sustainable returns to our stakeholders. We are also proud to have achieved a few milestones in 2020 as we celebrated our 20th anniversary on NASDAQ, and completed our listing on the Hong Kong Stock Exchange. We are delighted to have seen a positive reaction from the market, especially after our dual listing in Hong Kong, a market that is closer to our roots. Turning to our Q4 results, during the quarter, the popularity of our online games business continued with steady performances from our existing titles, Net revenues from our online game services were up 15% year-over-year, reaching 13.4 billion RMB. Our legacy titles, such as Fantasy Westward Journey and Westward Journey Online series, continue to resonate with players. SWJ Online and New Westward Journey Online 2 once again reached record revenues in 2020, further strengthening their position as two of China's biggest MMO titles. On the mobile side, during various festive celebrations, SWJ Mobile Game and WWJ Mobile Game once again reached the number one and number two positions respectively on China's iOS games' top-grossing chart. Other games launched in more recent years are also enjoying impressive player traction with highly active core user bases. For example, LifeAfter and Invincible. Following its launch in 2018, LifeAfter has become an iconic title. Since reaching its initial phase of stabilization in 2019, Growth Billions of LifeAfter regained its growth momentum in 2020 as we launched a couple of highly popular expansion packs. bringing Avid players a series of new themes and innovative gameplay. Similarly, our SLG title Invincible remained steady in 2020 with strong user engagement in its own right amid increasing competitive marketing spend. Celebrating its fifth year anniversary in October, Invincible once again reached the number five position on China's iOS top game growth chart Based on OmniOG, one of our flagship titles, our IT strategy has paved a smooth road for creating various IT-based, 10 entertainment productions. As of today, the estimated value of OmniOG IT exceeds US dollar 10 billion, according to our research. Since its initial blockbuster launch in 2016, we have been seamlessly growing this important IT To date, we've introduced three Omioji spin-off games in MOBA, card, and simulation genre. We have two more new spin-off games in the making, Project WoW, an RPG game, and Omioji Idle Project, another simulation game. On the overseas front, we continue to make solid progress. For the past four consecutive years, revenue contribution from overseas markets has been growing continuously as a proportion of our overall game's revenue. Some of the key drivers include titles such as Knives Out, Life After, and Identity V, all of which had a record year in 2020. Japan is a key hub for the global games industry. We deeply value these creative minds, and our success in Japan has allowed us to work more closely with local partners. Initial momentum in this arena includes our established collaboration with the Pokemon Company and a series of IT collaborations between Naizout and other famous IT, such as EVA and Attack on Titan. We have also been more active in attracting and collaborating with local Japanese R&D talent, complementary to our own, as well as opened up our own Sakura Studio which focuses on building next-generation console games. 2021 is a super exciting year for us, with a number of strong titles ready for launch. We started this year with Revelation Mobile Game, the long-anticipated mobile adaptation of its PC version, capturing both returning fans and brand-new MMO players, including a large group of female and younger players Revelation Mobile Game quickly became a top-ranking title on China's iOS growth chart following its launch. Additionally, in January, we brought to market Yu-Gi-Oh! Dual Links, a competitive car game on mobile. Calling on the nostalgia of a generation of Yu-Gi-Oh! fans, the mobile game topped China's iOS download chart soon after its launch. Catering to the local preference, we optimize the range of items for the Chinese market, including a new mode, and select new designs which are proving quite popular among our players. Harry Potter The Magical Awakened marks another game that has been long anticipated by our player community. We hope the heart we pour into making this game will do it the justice that this global IP commands. featuring a blend of strategy RPG elements. Players will become a Hogwarts freshman, meet diversified wizard partners, learn spells, gain magic knowledge, and experience amazing wizardry life. We will also be bringing our next generation SLG title, Infinite Lagrange and the Lord of the Rings Rise to War to players around the globe. Infinite Lagrange is a space-themed SLG where players can explore an uncharted galaxy, command and build spacecraft, involve themselves in strategic battles, and plan the development of their own space station. The Lord of the Rings Rise to War is based on the famous trilogy. Set in a multi-layered fantasy world, the game will recreate a visually stunning and completely faithful rendition with iconic characters and locations from the original masterpiece. With these two games, we look forward to extending our success in SLGs from China to overseas markets where we see greater potential for this thought-provoking genre. In addition, we have a handful of other exciting titles in our pipeline, all have received license approval in China. These include Elysium of Legends, Nightmare Breaker, Ghost World Chronicle, Diablo Immortal, and Pokemon Quest. As we further enrich our game portfolio, we have been gradually broadening our skill sets in different areas of our R&D team, particularly over the past few years. Our sophisticated R&D infrastructure, user-centric corporate culture, and passion for games attract all kinds of talent to join us from both China and overseas. We believe our team's artistry and drive will bring to life even more great titles across diverse genres, extending our success beyond our MMORPG rules and newer successes in RPG and SLGs and so on. We are relentless in our drive to invest in and empower our people This year, we were once again the proud recipient of the ATD Excellence in Practice Award, one of the most recognized awards in the global talent development industry. To leverage the creativity of our young producers even more, we are working to further reform our game's project initiation and review mechanism to encourage more innovative ideas and give young producers more autonomy to bring their visions to fruition. In summary, 2020 has been a strong year for our online games business and for the industry. Despite its high base, we are excited to see what 2021 will bring. We look forward to introducing more titles to our users in the coming years in China and globally. Turning on to our education business, Youdao has witnessed the tremendous growth potential of China's online education industry over the past year. Faced with an influx of need across the country, we feel more responsible than ever to ensure our students receive the best quality teaching and the most effective learning possible. Youdao closed the year with an impressive quarter. Total net revenue for Youdao in the fourth quarter were RMB 1.1 billion, representing a 170% increase year over year. Growth billions from Yeodao's online courses in fourth quarter increased by 223% year-over-year to RMB 1.1 billion, driven by rapid growth across its segments. Growth from our K-12 segment continued to lead the way, reaching a record RMB 767 million in growth billions, up 355% year-over-year, with K-12 paid enrollment expanding to over 659,000. Despite intense market-wide competition for user acquisition during the summer, Yeodao's advertising strategy promoted healthy results and was eye-driven. We made sure that our unit economics and marketing spend were positive and our advertising content was conducted responsibly for our users and our investors. In the fourth quarter, we achieved another quarter of positive operating cash flow of RMB 129 million. To meet our growth needs and ensure our teaching quality, we continue to expand our high-quality servicing team, which now comprises 214 instructors and over 3,700 tutors. Learning devices is another component of Yodao that gives us a competitive edge with a mission to make learning more efficient. This has proven to be very popular among users, generating total net revenues from learning products of RMB 237 million in the fourth quarter, a significant increase of 254% year over year. In December, we released our new Dictionary Pen 3.0, which features two exclusive new experiences, the tap and chat function and the interactive reading function. Through the support of advanced AI technology and cooperation with multiple authority publishing houses, it keeps learning options fresh and progressive. Moving through 2021, We will continue in this vein and invest in content offerings and technology to bring our students optimal learning experiences and realize sustainable growth with compelling smart education products and services. In February, Youdao raised US dollar $232 million through a follow-on offering. We are determined to extend Youdao's competitive edge in this highly promising intelligent learning segment in China. On to our music capabilities. NetEase 12 Music has been in operation since 2013. Based on our passion for music and our understanding of music lovers, we created a unique product and community to give our users an unprecedented music experience. Seven years later, we now have more than 200,000 independent musicians and over 800 million registered users while over 90% of them are post-90s or even younger. In our newly launched version 8.0, we focus on bringing our young users elevated, personalized experiences to express themselves. It extends the playlist mode capabilities to videos and podcasts and offers new karaoke functions in the app. On the content side, we have witnessed some important changes in the industry, For the first time, we reached a direct, non-exclusive agreement with UMG. Under the new agreement framework, we can give our users a wider range of benefits and choices. We further enriched our content library during the year, reaching agreements with Studio Ghibli, Rock Records, and BMG, among others. Most importantly, we continued our efforts to invest in and cultivate independent musicians. In 2020, approximately 1 million original soundtrack music tracks were uploaded to our platform, and the total play time of all the music tracks on our platform exceeded 300 billion. As one of China's most influential music streaming platforms for original music, we continue to empower independent musicians giving them the tools and audience to help them create more hit songs. In terms of monetization, we have been stepping up these efforts since 2019 and continued this journey in last year. As a result, during the year, we saw strong growth in all three forms, membership, live broadcasting, and advertising. Given our somewhat fixed cost structure, we continue to see improvements in margins as we further scale up the music business. For Yanshan, we have firmly established this position as our private label consumer brand, targeting young professionals who are looking for trendy, high-quality, and at the same time, affordable living. Centered around this notion, we have increasingly built up our brand recognition among these target consumers. We are developing products that revolve around their needs, particularly in household products, personal care, food, and pet supplies. During the year, we launched a number of super popular products with annual sales exceeding 100 million RMB. These product popularity furthered our confidence in our design capabilities and understanding of the user needs. With the right content and product offerings, we were able to attract an increasing number of membership subscriptions in 2020. One of our main focuses moving forward is to continue improving the benefit shopping experience we offer to these loyal customers. All in all, despite the difficulties the world has faced in 2020, we are grateful to have achieved continued growth and are standing strong in the new year. With the solid ground we gained across our online games, online education, online music, and e-commerce businesses, we are poised to build on this growth in 2021. Our focus on content creation and elevating users' experiences with NetEase products and services remains at our core. We continue to innovate, diversify, and expand our reach to generate value for our user and investor communities. This concludes William's comments. I will now provide a brief overview of our 2020 full year and further 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 more details. Total net revenues for the year were RMB $73.7 billion, or US dollars $11.3 billion, representing a 24% increase year-over-year. Net revenues for the fourth quarter were $19.8 billion, or US dollars $3 billion, representing a 26% increase year-over-year. For 2020, our net revenues from online game services were RMB $64.6 billion, up 18% from 2019, and RMB $13.4 billion for the fourth quarter, up 15% year-over-year. Year-over-year increases were primarily due to the increased revenue contributions from Fantasy Westward Journey H5, Sky, Life After, and Invincible, as well as PC client games such as Fantasy Westward Journey Online in the fourth quarter. Net revenues from our mobile games accounted for approximately 72.4% of net revenues from online games in the fourth quarter. Yeodao's net revenues reached RMB 3.2 billion for 2020, up 143% year-over-year. On a quarterly basis, net revenue increased 170% to RMB 1.1 billion in the fourth quarter. driven by fast growth of post-year online courses and sales of intelligent learning devices. Net revenues from innovative businesses and others were RMB 15.9 billion for the full year, up 38% year-over-year, and up 41% year-over-year in the fourth quarter to reach RMB 5.3 billion. These mainly due to the increased contribution from NetEase Cloud Music that is, PC live streaming and YenGen. Our total gross profit margin in the fourth quarter was 50.2%, with a breakdown as follows. GC margin for our online game services was 63.1%. As a reminder, this number is generally stable, with some narrow fluctuations based on the revenue mix of mobile and PC, as well as self-developed and licensed games. Growth margin for Yodal for the fourth quarter was 47.5% compared to 29.8% in the same period of last year. The significant growth was primarily attributable to improved economies of scale, continuous optimization of our faculty compensation structure. Growth profit margin for innovative businesses and others was 18% compared with 20.6% the fourth quarter of 2019. While the margins for NetEase Cloud Music and Yansha have improved year over year, the impact was offset by the decrease in GP margin from NetEase CC live streaming, which covered a longer period of the annual celebration event in 2020 compared with 2019. Additionally, gross profit margin of innovative businesses and others also fluctuates. based on the revenue mix of this line item. For the fourth quarter, total operating expenses were RMB 6.9 billion, 35% of the total revenue. Our selling and marketing expenses as a percentage of net revenue was 15.6%, down from 18.5% in the prior quarter. The quarter-over-quarter decrease was mainly due to lower marketing costs related to your stock. Excluding Youdao, our selling and marketing expenses as a percentage of net revenues were 12.2%, compared with 12.9% in the prior quarter, which is relatively stable. R&D expenses were R&D $3 billion, up 9% from the previous quarter. We remain committed to investing in content creation and product development, which is core to our future revenue growth. On a full-year basis, R&D expenses as a percentage of full-year net revenue were 14.1% compared with 14.2% in 2019. Other income loss was R&D 1.5 billion for the fourth quarter, which included a net investment loss of R&D 272 million and a net foreign exchange loss of R&D 1.8 billion. due to the U.S. dollar's exchange rate continued depreciation against the RMB. The net investment loss and the net FX loss were both mainly books loss in nature, and most of them did not impact our cash flow. On a full year basis, total net foreign exchange loss for 2020 were RMB 3.1 billion, compared with the net gain of RMB 25 million in 2019. The effective tax rate was 37.2% for the fourth quarter and 19.8% for the full year of 2020. The effective tax rate represents certain estimates by the company regarding the tax obligations and benefits applicable to it in each quarter. Non-GAAP net income from continuing operations attributable to our shareholders for the fourth quarter of 2020 totaled RMB 1.6 billion, or US$244.9 million. Our non-GAAP diluted earnings per ABS from continuing operations were RMB 2.34 or US$0.36 for the fourth quarter of 2020. We would also like to point out, with the rapid growth of Yodal, it is having a much more material impact on our NetEase Group's financials. For 2020, Yodal generated total revenue of 3.1 billion RMB and a non-GAAP net loss attributable to Yodal's shareholders of 1.7 billion RMB, compared with net revenue of 1.3 billion RMB and non-GAAP net loss of 612 million RMB in 2019. Our cash position remains strong. As of end of 2020, our total cash and cash equivalent current and down-current time deposits, and short-term investment balance totaled RMB 100.1 billion, compared with RMB 74.4 billion as of the end of 2019. In accordance with our dividend policy, we are pleased to report that our Board of Directors has approved a dividend of U.S. dollar 0.012 per share, or U.S. dollar 0.06 per ADS, As a reminder, we changed our ADS ratio on October 1st from one ADS for every 25 ordinary shares to one ADS for every five ordinary shares. And finally, under our current share repurchase program for up to $2 billion, as of December 31st, 2020, approximately 21.1 million ADS have been repurchased under this program for a total cost of US dollar $1.6 billion. On February 25th, 2021, our board announced the approval of a new share repurchase program for up to US dollar 2.2 billion of our outstanding ADS and ordinary shares for the next 24 months, beginning on March 2nd, 2021. Thank you for your attention. We would like now to open the call to your questions. Operator, let's go to the Q&A session.