NetEase, Inc.

And welcome to the NETI's 2021 Second Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Margaret Shee, IR Director of NETI. Please go ahead.

Thank you, Operator. Please note the discussion today will contain four 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 Security 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 lists are beyond the company's control and could cause the actual results to differ materially from those mentioned in today's press release and its discussion. A general discussion of the risk factor 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 20S and the announcements and filings on the website of the 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 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 2021 second 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 NETE corporate website at ir.nete.com. Joining us today on the call from NETE's senior management team is Mr. William Dean, our chief executive officer, and Mr. Charles Yan, 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 calculated based on renminbi. Our growth momentum continued in the second quarter with total net revenues of RMB 20.5 billion, representing an increase of 13% year over year. For our online games, in the second quarter, Total revenue was RMB 14.5 billion, up 5% year over year, despite a high comparable base in 2020. Our PC and mobile games remain our dual growth engines for online games. On the PC side, Naraka Blade Point, our next generation battle royale game, is one of the hottest games in the market. First launched in China in July, followed by the global launch on August the 12th, Narrator BladePoint quickly became the best weekly seller on Steam, winning the enthusiasm of Chinese and overseas players and marking a new breakthrough for us in the global market. With captivating gameplay and state-of-the-art graphics, Narrator BladePoint's debut was very well received among hardcore players in Western markets. We will continue this positive trend by introducing more content from different cultures around the world and start to work on other formats of the game, including console game and mobile versions, as we look to tap into these large market opportunities in China and abroad. Our legacy flagship PC titles, particularly FWJ, New Westward Journey Online, and Tianxia, continue to show remarkable longevity with strong year-over-year growth after nearly two decades of operation. We have created a strong and sophisticated social community within each game, and we continue to keep our users engaged with regular introductions of high-quality expansion packs. This type of longevity has also been extended to the mobile side. Fantasy Westward Journey mobile game Westward Journey online mobile game and their spin-offs continue to demonstrate strong performances during the second quarter. Touching on some highlights from a few other mobile games this quarter, Life After remains an iconic title, holding strong appeal with young users. We introduced a major annual expansion pack, The Revenant, in August, offering players a new category of characters new maps, and more gameplay options. These innovations allow our gamers to explore the doomsday world in an unprecedented and exciting way, bringing life after back to the top of China's iOS download chart. Omioji Arena, our mobile game based on our proprietary Omioji IP, has progressively built strong appeal among the young generation of players Leveraging our strength in art design, Omyoji Arena has impressed users with its widely acclaimed skin art across various themes, including Chinese traditional culture, cyberpunk, and Japanese anime. Some of the skin designs have even become high-trending topics, bringing us a continuous stream of new players. The original flagship game is another NetEase game that continues to shine and frequently leads China's iOS top growth chart. During the second quarter, we rolled out a new version that greatly enriched the Amioji world. The update features a fascinating new storyline and two popular new characters that thrilled our player community. again, fortifying Army OG's standing as a top AGC-themed game in China. During the second quarter and more recently, we have also expanded our offerings in new genres as we continue to diversify our game portfolio. We launched Ace Racer in July, our very first self-developed racing game, leveraging our industry-leading art and graphic capabilities Ace Racer features trap designs based on real urban landscapes of Chinese cities such as Hangzhou and Chongqing. Shortly after its release, Ace Racer topped the iOS download chart and reached the top 10 on China's iOS growth chart. Two weeks ago, Infinite Lagrange, our space-themed SLG game, made a strong debut in China. climbing up into a top 30 title on the iOS growth chart in less than a week. As a new game of this genre we introduced to the Chinese market after Invincible, we hope Infinite Lagrange will also earn the respect from game players and a good share of SLG market through its content innovation. Other new games that we recently launched in China include Pokemon Quest, Marvel Super War. These games further enrich our dynamic domestic game portfolio genres, and many of them quickly reached the top of the iOS download chart following their releases. Moving to overseas markets, we are very excited to see our games keep reaching new milestones outside of China. Over three years ago, Knives Out made its name in Japan and became one of the highest-grossing games ever made by a Chinese game developer to go overseas. Knives Out has held its leading position and continues to take its place in the upper echelons of Japan's iOS top-grossing charts, particularly when following various collaborations with well-known local Japanese IPs such as Eva and One Punch. Today, Naraka BladePoint has emerged as our next breakthrough on the international stage, which further boosts our global expansion efforts by opening the door to mainstream Western markets. On Steam alone, Naraka BladePoint has achieved the milestone of 100,000 peak concurrent users, and the number will be even higher when we include players who play the game on our official channels. As one of our global initiatives, Naraka Blade Point starts off with Chinese martial art culture and then substantially broadens its concept to Eastern fantasy by introducing universal elements more familiar to Western players, such as new characters like Persian warriors and new weapons such as muskets and cannons. These elaborate designs have greatly helped build strong mind share amongst hardcore player community in the Western market. Furthermore, for Harry Potter Magic Awakens, one of the market's most anticipated titles, we closed the final round of beta testing in June with very encouraging user feedback. It is now set for launch on September the 9th across Chinese mainland Hong Kong, Macau, and Taiwan, and will be successfully launched to various other regions globally. We look forward to seeing eager global players become Hogwarts freshmen, meet diversified wizard partners, learn spells, gain magic knowledge, and experience the amazing life of wizardry. The Lord of the Rings Rise to War is another exciting title coming soon. Pre-registration for this game has been available since August 25th. With engaging and thought-provoking gameplay, as well as a strong appeal of the Lord of the Rings IP, we see great potential for this release and look forward to impressing players with its global launch, which is now confirmed to be on September 23rd. For Diablo Immortal, In July, we had our first beta testing in China, and we are very excited with the strong feedback from the user community. We will keep working to bring our worldwide players engaging game experiences. The list goes on. We have a handful of other exciting titles in our pipeline as well. A few other pre-announced names include Nightmare Breaker, a PC game, and Ghost World Chronicle. Our mission to create world-class games for players has never wavered. We are relentlessly scaling new heights in terms of game development technology. Our game engine is one of the key assets within our R&D infrastructure. Recently, we've made a significant step forward with one of our flagship game engines, Messiah, in which we are proud to have implemented the world's first high-quality, real-time global illumination algorithm on mobile devices. This is a major breakthrough with our in-house engine technology, helping us to greatly speed up the pace of our artistic development and bringing world-class visual effects into our games. Turning to Youdao, our net revenues in the second quarter were RMB 1.3 billion, representing a 108% growth year-over-year. As an intelligent learning company, Youdao is and has always been committed to enhancing its competitiveness for the young generations through advanced technology. In line with evolving national guidelines, Our aim is to explore new strategic opportunities in non-academic businesses, such as STEAM courses, adult learning, and smart learning hardware devices. In the second quarter, we further expanded our STEAM course offerings. For example, net revenues from Youdao Go, Youdao Weiqi, increased by nearly 180% quarter over quarter, and we launched more advanced level courses to further meet our users' growing learning needs. Back in March, with an eye towards the growth opportunities in adult education sector, we established a dedicated division on adult education by integrating our Youdao premium courses for adults, China University MOOC, and NetEase Cloud Classroom. In terms of premium courses for adults, Its net revenues accounted for around 22% of total net revenues in the second quarter. Meanwhile, we launched an upgraded version of our Practical English course to provide adult users with more immersive and effective learning experiences. In addition, 137 courses on the China University MOOC platform have been certified by the Ministry of Education as recommended courses for academic studies and continued career development. Learning devices remain another major revenue source for Yodal with a mission to improve learning efficiency. This segment generated net revenues of RMB 206 million in the second quarter, increasing 139% year over year. We also introduced a new version of our dictionary pen, Youdao Dictionary Pen K3, designed to be more friendly to elementary school and pre-K kids, more affordable, and supportive of learning arithmetic in addition to English and Chinese. With that said, we expect Youdao to be somewhat less affected by the recent regulations as it has other high-growth businesses in addition to existing K-12 academic after-school tutoring classes, whose revenues accounted for around 41% of Yodao's total revenue in the second quarter. Looking ahead, Yodao will continue to strictly comply with national guidelines, and we are confident in Yodao's future development, as Yodao has one of the most talented R&D and teaching skill sets in the industry. Looking at our cloud music business, we have successfully maintained our user growth momentum over the past quarters, despite an industry-wide slowdown. While DAU over MAU ratio remained above 30% in the second quarter, owning to our advanced social networking functions and promotions like 88 VIP program in second quarter our membership paying ratio almost doubled year over year. In terms of margin, we continue to see improvement with our cloud music business as it increases its scale. In the past quarter, NetEase Cloud Music achieved positive gross margin for the first time ever, marking a new milestone with our music operations. We believe that our ongoing top-line growth in this segment will position us to continue driving margin expansion over time. We keep our users engaged through constant innovation and product improvement. Earlier this year, we gave our prize-winning function, Listen Together, another new touch, allowing users to listen to music together not only with friends but also with other users, providing additional social networking opportunities. Furthermore, our newly launched function Playlist Sharing has been very well received by our users, allowing multiple users to co-create and manage playlists at the same time. On the content side, we are pleased to see the changes that the music industry is currently undergoing which paves the way for strong and sustainable growth over the long term. We hope to work together with other industry players to ensure quality music is accessible to a wider audience at a more reasonable cost, which will ultimately benefit music lovers and the industry as a whole. Now turning to Yanshan, as our private label consumer brand, We continue to focus on building Yanshan's brand equity. Primarily, we are introducing highly popular products with proprietary award-winning product designs and strictly controlled product quality. In April, Yanshan Healthcare Series and Mooncake Gift Box won the German IF Design Award 2021. Working with major channels, including Taobao, Tmall, and JD, Our recognition from the broader public is actively growing. During the June 18 promotion period, Yanshan topped JD's household daily sales list, and our cat food category recorded the highest domestic cat food sales on both Tmall and JD for the first day of the June 18 promotion. In June of this year, we published our 2020 ESG report outlining our ESG policies, achievements, and improvements we made throughout the year. We started our ESG efforts as early as 2018 and issued our first ESG report last year. As a company deeply committed with social responsibilities, we will be keeping our efforts to being a responsible public company, and we will continue to pursue the ESG initiatives and will forge ahead with our strength to create greater value for our stakeholders and the community at large. Finally, during the quarter, we celebrated our 24th anniversary. As we review our past and look toward our future, we know innovation is key. Innovation has been at the heart of our journey and will continue to be the driver for our future growth. It empowers us to create amazing products and services that are adored by hundreds of millions of people. As we move forward, we will be dedicating even more time and resources to identifying and training talent and fostering innovation that creates a more promising and exciting future in each of the verticals we operate. This concludes William's comments. I will now provide a very brief review of our second quarter 2021 financial results. Given the limited time of 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 second quarter were RMB 20.5 billion, or USD 3.2 billion, representing a 13% increase year-over-year. Our net revenue from online game services were RMB 14.5 billion, up 5% year-over-year despite of last year's high base benchmark. The year-over-year increase was primarily due to newly launched games, revelation mobile games, and existing games such as Fantasy Westwood Journey Online. Net revenues from our mobile games accounted for roughly 72% of total revenue, and overseas revenue accounted for roughly 10% of total revenue in the second quarter. Yeodao's net revenues reached RMB 1.3 billion, up 108% year over year, driven by fast growth of both Yeodao online courses and the sale of intelligent learning devices. Net revenues from innovative businesses and others were RMB 4.7 billion for the second quarter, up 26% year-over-year, mainly due to the increased contribution from NetEase Cloud Music. For Cloud Music, both membership and streaming revenues maintained solid growth momentum, driven by robust paying user expansion. Overall total gross profit margin was 54.5%, with a breakdown as follows. Gross profit margin for game services was 66.1%. As a reminder, this number is generally stable, with some narrow fluctuations based on the revenue mix of PC versus mobile games, as well as self-developed and licensed games. Gross margin for Yeodao was 52.3%, compared with 45.2% in the same period of last year. The significant year-over-year growth was mainly attributable to the improved learning services growth margin, which was due to improved economies of scale and continuous optimization of its faculty compensation structure. Substantial sales growth of smart learning hardware, such as your DAO dictionary PAN 3.0, also contributed to these gains. as this line carries a higher GP margin than other product lines. Gross profit margin for innovative businesses and others was 19.3% compared with 18.5% last year. The improvement was mostly driven by NetEase Cloud Music as its gross margin turned positive for the first time during the quarter. For the second quarter, total operating expenses were RMB 7.4 billion, or 36 percent of our total net revenue. Our selling and marketing expenses as a percentage of net revenue were 14.7 percent. If we exclude Yodal, our selling and marketing expenses as a percentage of net revenue were 10.6 percent, compared with 10.7 percent in the second quarter of last year. R&D expenses were RMB 3.4 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 accounted for 16.6% compared with 14.9% in the previous quarter. The effective tax rate was 24.3% for the second 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 operations. Non-GAAP net income attributable to our shareholders for the second quarter totaled RMB 4.2 billion, or U.S. dollars 655 million. Our non-GAAP basic earnings for ADS were U.S. dollars 0.89 or 0.20 per share. Our cash position remains strong. As of June 30th, our total cash and cash equivalents, current and non-current time deposits, and short-term investment balance totaled RMB 1.8 billion, compared with RMB 100 billion as of the 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 U.S. dollar 0.048 per share, or U.S. dollar 0.24 per AES. Lastly, Under the share repurchase program approved by our board on February 25th, approximately 4.6 million ADS had been repurchased as of June 30th for a total cost of approximately $0.5 billion U.S. dollars. Today, our board announced the approval of an amendment to further increase the total authorized repurchase amount from the previously approved US dollar 2 billion to a new cap amount of 3 billion US dollars. Additionally, our board has also approved a share purchase program of up to US dollar 50 million of Yodao's outstanding ADS for a period not to exceed 36 months, beginning on the 2nd of September. Thank you for your attention. We would like now to open the call to your questions. Operator, please go to Q&A.