NetEase, Inc.

Good day and welcome to the NetEase 2021 First 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 US private securities litigation reform act. Such statements are not guarantees of future performance and are subject to certain risks and uncertainties, assumptions, and other factors. Some of these risks are beyond the company's control and could cause actual results to differ materially from those mentioned in today's press release and this discussion. A general discussion of the risks risk factors that could cause NetEase business and financial results is included in certain filings of the company with the Securities and Exchange Commission, including its annual report on Form 20S, and the announcements 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 also discuss certain non-GAAP financial measures with comparison purposes only. For a definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, please see the 2021 First Week Earnings News Release issued earlier today. As a reminder, this conference is being recorded. In addition, An in-depth 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, 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 Remedy. We began the year with a record quarter, exceeding RMB 20 billion in revenue for the first time. And net income attributable to the company's shareholders increased 25% year over year to RMB 4.4 billion. Our games business also reached a new record of RMB 15 billion in net revenues, up 11% year-over-year in the first quarter, despite a high comparable base last year. In Q1, our flagship titles continued to demonstrate strong growth after nearly two decades of operation, with revenues from Fantasy Westward Journey Online and Westward Journey Online Mobile all growing at double-digit rates year over year. 3 is another exemplary case. It is one of the rare instances where a legacy PC MMORPG game has regained growth after reaching maturity. Leveraging our growing knowledge and more recent successes in both MMO and non-MMO genres, we added some casual flavors to this legacy MMORPG giving our players a fresh feel and creating new content for users to consume and enjoy. We also crafted an in-game event at the end of last year, which quickly generated strong interest and discussions in the players' circle, leading to a large inflow of returning users who rejoined the game. Other games in the spotlight during the first quarter included Life After, Omioji, Identity V, and Invincible. Life After has remained an iconic title with strong appeal among young users. The new collaboration with the movie Godzilla vs. Kong in the first quarter was well-received by players as they fought off doomsday monsters. Tomioji also showed remarkable longevity, remaining at the forefront of China's iOS top-grossing charts. During the first quarter, we rolled out a highly anticipated IP collaboration with Diamond Slayer, a classic Japanese anime, further strengthening of Omioji's position as a top ACG game in China. Celebrating its third year anniversary in April, Identity V continues to draw the attention of young players, bringing them a thrilling competitive experience with a distinctive Gothic art style Between January to May, we hosted our annual global championship tournament, Call of the Abyss, with its finale being set in Hangzhou, attracting close to 2 million game players globally to participate in this event. Invincible remained steady in the first quarter with strong user engagement, holding unwavering loyalty from its fan community. Despite numerous Invincible-like games popping up in the market, Invincible has proven to be a trendsetting pioneer in this game genre. This also echoes well with our corporate DNA in product innovation. In terms of new games, we have launched a few new ones since the beginning of this year. We started with Revelation Mobile Game in January. As we discussed last quarter, This is our self-developed RPG game based on our flagship PC title, capturing both returning fans and brand new MMO players. We then launched Elysium of Legends in March, a self-developed card RPG game that brings together legendary figures in Chinese history. Shortly after these releases, both games reached the top of the iOS download chart in China. On the licensed front, In January, we introduced Yu-Gi-Oh! Duolink, a competitive card game based on the nostalgic IP that we licensed from Konami. And more recently in May, we brought the highly anticipated casual game Pokemon Quest to our domestic audience. Featuring cute-shaped Pokemon, the game invites players to be friends and create their Pokemon team to tap and battle through tumble cube islands Shortly after its release, Pokemon Quest quickly climbed to the top of the iOS download chart in China. In overseas market, we continued our efforts to expand our offerings while maintaining steady operation of our existing titles. Knives Out once again reached the number one spot on Japan's iOS top-grossing chart a couple of times during the first quarter Following a collaboration with well-known Japanese IP, The Promised Neverland, in February, Identity V was also crowned number two on Japan's iOS top pricing chart. The success of these games has helped us to gain a much better understanding of Japanese users and their preferences, allowing us to be more sophisticated in localization efforts. For instance, we found that Japanese users greatly value the sense of occasion. Users want to feel the grandness and ceremonial appeal in each game event. Take Knives Out as an example. Knives Out Day, the widely anticipated annual celebration officially recognized by the Japanese Anniversary Association since 2019, marks the start of the game's annual carnival on May the 5th. which includes the biggest esports championship tournament in Japan, as well as other exciting activities. We invited all of our users, brought millions of them online on that day, and the event has become one of the top trending topics on Krita in Japan for the past two years. With a couple of titles gaining popularity and recognition already in the overseas market today, we are hopeful that our upcoming releases will bring the next generation of games to the world stage and further expand our footprint in more regions, particularly in the US and Europe. In April, we launched Infinite Lagrange in Europe. Similar to Invincible, we expect Infinite Lagrange, our first globally targeted SLG game, to ramp up its revenue gradually and show a similar upward trend and longevity with time. This game will be next available in the US and other overseas markets over the coming months. As our very first next-gen SLG, we have been under development for a number of years. We hope that this title will extend our success in SLG into overseas markets. The highly anticipated Harry Potter Magic Awakens is also on track to meet eager audiences. We are thrilled to bring this game to Wizard fans soon, taking players around the world on a magical adventure. Earlier this month, we announced that we joined hands with our Polish partner, 11bit Studios, to develop and publish the mobile version of the world-renowned IP Frostpunk globally. Later this year, players will be able to access this elaborately crafted post-ecoclipse social survival game on mobile platforms. In addition, we have a handful of other exciting titles in our pipeline. Adding to those we just mentioned, our pipeline also includes The Lord of the Rings, Rise to War, Nightmare Breaker, Diablo Immortal, and Ghost World Chronicle. For more details on these titles, please join our annual product launch event on May 20, two days later, which will be hosted online this year and will have a dedicated English section for our global game players and business partners for the first time. We are proud of our world-class R&D infrastructure, which has been pivotal in maintaining a competitive edge in this market and delivering long-term value. The most important element is our people. With that in mind, we encourage our talents to share and exchange ideas with industry veterans worldwide. We just hosted the 2021 NetEase Game Developers Summit in April with a three-day forum covering topics like game design, art, and technology. The event brought together our internal developers as well as external industry partners including gurus in the Western game industry and developers community to share their in-depth game development philosophies and experiences, sparking wide attention from developers, game players, and many others in the industry. Now turning to our education business, Youdao achieved strong and sustainable growth in the first quarter, Total net revenues from Yodao increased by 147% year-over-year to RMB 1.3 billion, and overall gross margin significantly improved to 57%, reaching a new record since its IPO back in 2019. Gross billings from Yodao's K-12 segment was up 130% year-over-year, despite a high base last year due to the outbreak of COVID-19. K-12 paid student enrollment doubled year-over-year to 306,000. In order to match the growing scale and ensure the optimum teaching quality, we continued to strengthen our servicing team, which comprises 197 instructors and over 4,000 well-trained tutors by the end of the first quarter. Given that different syllabus is used in different parts of China, one of the most important agenda for us is to ensure localized content for courses we offer. We took our junior high school Chinese as the pilot case. During the past spring semester, we launched up to 31 versions of junior high school Chinese, meeting the needs of students in 31 different provinces. The localized courses has turned out to be very effective and very welcomed by our students. Net revenue of Yeodao's learning devices also continued a year-over-year growth of 280%. In March, we introduced the Dictionary 10 3.0 Pro version, further supporting bilingual translation of Chinese and Korean languages to meet the demand of a wider range of language learners. Yodao also further integrates the functions of our dictionary pen and the Yodao dictionary app, making the offline online transition even more efficient and effortless. Looking ahead into 2021, we are confident that Yodao will continue to grow its position as a leading provider of intelligent learning services and products, and our diversified business models products and technologies will give us the upper hand in the evolving after school tutoring and ad tech market. For our cloud music business, we have come a long way. Celebrating its eighth year anniversary last month, we are proud to say that we have sought and created new possibilities for music in this digital era. Our platform, which features a vast and highly interactive content community, has become a widely recognized household name that is seen as a cultural emblem amongst particularly the post-90s or younger generation. With a large base of young music lovers on our platform who are more willing to explore and discover music, we have been the creative outlet and a natural stage for independent musicians to shine. We strongly believe independent artists are a crucial driving force for the music industry, and our platform uniquely positioned us to nurture them in the modern era. In April, we held our annual signature event, the Indie Music Artist Ceremony, for the third time, celebrating the past year of their music and encouraging independent musicians to continue creating their remarkable work. In addition to our original music, We want to continue bringing together a library of new, unique, and influential music pieces from around the world and providing music fans with the ultimate audio experience. We have just announced a direct digital distribution partnership with Sony Music Entertainment, one of the world's three largest recording companies. Following UMG, this is the second direct licensing arrangement we have signed with the big three labels, and we are proud to see these positive changes happening in the music industry in China. Moving on to Yanshan, as a private label consumer brand, we further strengthened our brand appeal among the young middle class, developing products that revolve around their needs, centered around this notion, and along with Yanshan's fifth year anniversary, we developed a new value proposition, Live the Way You Like, through a promotion intended to express the voice of the new middle class. This campaign resonated strongly with its intended audience, sparking lively discussions. During the last year, we rolled out a range of highly popular Yanshan products, which have sold well since their introduction. Our strategy to incubate more hit products has paved a smooth path for us to strengthen Yanshan's product portfolio. We recently introduced a number of new style products, such as our proprietary laundry pods, wireless earbuds, bathroom fragrance, which quickly became top-selling products on multiple platforms, and some of the most recognized products in those emerging categories. We see potential in many of our proprietary products, and we are working to introduce a greater number of signature products this year. Additionally, we continue to optimize our operating efficiency in the first quarter. During the quarter, both our inventory turnover days and the fulfillment efficiency were improving. In summary, we are off to a strong start in 2021. Our game portfolio is getting ready for exciting new titles for both domestic and global players, while our existing games continue to hold strong. Our online education, music, and e-commerce businesses are each on solid footing as well. Premium and diverse content creation across our businesses continue to be our primary objective as we move forward, entering a new phase of growth and generating additional value for all of our users and stakeholders. This concludes William's comments. I will now provide a very brief overview of our first 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 first quarter were RMB 20.5 billion, or US dollar 3.1 billion, representing a 20% increase year-over-year. Our net revenues from online game services will remain be 15 billion, up 11% year-over-year. This year-over-year increase was primarily due to increased revenue contribution from newly launched Revelation mobile game, Fantasy Westward Journey H5, as well as PC games such as Fantasy Westward Journey Online. Net revenues from our mobile games accounted for approximately 73% of net revenues from online game services in the first quarter. Yeodao's net revenues reached RMB 1.3 billion, up 148% year-over-year, driven by fast growth of both its online courses and sales of intelligent learning devices. Net revenues from innovative businesses and others were RMB 4.2 billion for the first quarter, up 40% year-over-year, mainly due to increased contribution from NetEase Cloud Music, as well as Yanshan and CC live streaming. Our total gross profit margin was 53.9% in the first quarter, with a breakdown as follows. GP margin for our online game services was 64.6%. 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. Growth margin for Yodao was 57.3%, compared with 43.5% in the same period of last year. The significant growth was primarily attributable to the improved growth margin from learning services due to the economies of scale and the continuous optimization efforts of its cost structure. It is also due to the substantial sales growth of the smart learning hardware, such as Yodal Dictionary 10, which carries a higher growth margin than other hardware product lines. GP margin for innovative businesses and others was 14.4% compared with 15.8% in the first quarter of last year. While the margins for NetEase Cloud Music and Yanshan have improved year-over-year significantly, the impact was partially offset by the decrease in GP margin from the rest of the business segments in this line. For the first quarter, total operating expenses were remaining 6.8 billion, representing 33% of the total net revenues. Our selling and marketing expenses as a percentage of net revenue were 13.5% in the quarter. If excluding Yodao, our selling and marketing expenses as a percentage of net revenue were below 10%, lower than the previous quarter. As a reminder, fluctuation in selling and marketing as a percentage of revenue largely depends on the number of new games launches in a particular quarter, the genres they are in, and the most suitable marketing plans adopted for each new game launches. R&D expenses will remain 3.1 billion, largely stable from the previous quarter. We remain committed to investing in content creation and product development which is core to our revenue growth. As a percentage of net revenue, R&D expenses were 14.9% compared with 15.3% last quarter. Effective tax rate in this quarter was 22%. 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, attributable to our shareholders for the first quarter, totaled RMB $5.1 billion, or US$776 million. Our non-GAAP basic earnings per ADS were RMB $7.58, or US$1.16. Our cash position remains strong. As of the quarter end, our total cash and cash equivalents, current and non-current time deposits, and short-term investment balance totaled RMB $106 billion, compared with $100 billion as of the year end last year. In accordance with our dividend policy, we are very pleased to report that our Board of Directors has approved a dividend of U.S. $0.06 per share, or U.S. $0.03 per AVS. Lastly, under the Share Repurchase Program approved by our Board, Approximately 3 million ADS had been repurchased in the first quarter for a total cost of approximately US dollars 330 million. Thank you for your attention. We would like now to open the call to your questions. Operator, please go ahead to Q&A.