NetEase, Inc.

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 Shee, IR Director of NetEase. Please go ahead.

Thank you, Operator. Please note that the discussion today will contain forward-looking statements relating to future performance of the company and are intended to qualify for a 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 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 the 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 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 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 NETGEAR's COPPA website. Joining us today on the call from NetEase Senior Management is Mr. William Ding, Chief Executive Officer, and Mr. Charles Yan, 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 22.2 billion RMB. For online games, Our flagship titles continues to demonstrate strong growth after nearly two 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 two legacy sagas showed resilient year over year growth as well. Adding to our strong portfolio of PC games, our new hit games Naraka Blade Point 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 Blade Point has taken the PC games market by storm, reinvigorating the stable battle royale genre with exciting novel ideas. Its global success showcased our ability to bring first-rate games to the world stage. By November the 10th, we have already sold more than 6 million copies of Naraka Bladepoint worldwide in just four months' time, making it one of the top sellers ever on Steam platform. Players in both China and global market 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 other NetEase 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 around the clock to extend 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 Blade Points deal, 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 on 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 top download charts and top grossing charts in China following its launch in September. Harry Potter Magic Awakened conjures a charming wizardry world touching the hearts of millions. The game has attracted a large crowd from young generations. Across the gamer community, its elaborate designs are gaining great acclaim, including iconic European retro picture books and interesting card-based combat. Infused with abundant competitive gameplay, we hope Harry Potter Magic Awakens will continue to gain adoration from players in China maintaining its popularity over the longer term, as many of our other 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 formally launch Harry Potter Magic Awakens 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 US, 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 a 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, with revenue ramping up gradually and showing an upward trend over time with a long-lasting lifecycle. 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 Catholic 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 blockbuster for players worldwide. In addition, we have launched a few game 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 Awakens in more overseas regions, as well as bringing players console and mobile versions of Naraka's Blade Forms. 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, players get 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 stand the test of time in China and worldwide. Turning to Youdao, we have made solid progress with our transition to better align your Daoist 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 digitization 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 accounts for around 25% of Youdao's total net revenues. In the third quarter, we continue to grow our STEAM course offerings. For Youdao Go, Youdao Weiqi, its growth billions 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 iCode, 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, Fei Chang Ji Yi, course retained its leading position with gross billions 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 Platform. Learning devices remain robust with record high revenues of RMB 255 million, a 56% increase year over year. Yodal 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 textbooks published by the press. We also rolled out our Youdao listening part in September, which helps improve students' English skills in listening, speaking, and reading through real-time intelligence scoring and pronunciation correction functions. In addition, we are working with local schools, experimenting with different digitization solutions, which gives 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 drives solid margins in the third quarter representing our second consecutive quarter of positive growth margins. Some of our innovations include 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 personalized 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 Baxter 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 the 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 investment 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 groups 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 on to Yanshan, as Medi's private label consumer brand, Yanshan 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 now have seen strong momentum from short video platforms such as Douyin and Kuaishou with some popular products like bathroom flavorings and coffee practice. Our advanced and differentiated original design products are being very well received by the users and the market. In Q3, we successfully 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 two prestigious Red Dot Awards for our Dear John Bedding Design and Yanshan Dunhuang Museum tea packaging design, competing among thousands of design submissions that came from more than 60 countries and regions. These accolades add to NetEase Yanshan's increasing number of awards and honors, which includes 2021 German IF Design Award, along with many other international awards and recognitions from the design industry. During the Double 11 promotion, we recorded over 100 million GMV through Taobao and Timor channels. And on JD, we were also the number one 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 towards social responsibility has also been heightened by the immediate need of those who have fallen victim to natural disasters and public health crisis. 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 $50 million to Henan and RMB $20 million to Shanxi to support much-needed relief efforts and post-disaster reconstruction. The mounting natural disasters tell us that we all must become better custodians of the Earth. As a corporate citizen, NetEase's commitment to environmentally responsible action In addition to our financial contributions toward natural disaster alleviation and restoration, we are leveraging our strengths 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, live after one of our flagship titles, joined the second annual Green Game Jam, organized by the UN-facilitated Playing for the Planet Alliance. Players need to go to the forest in the game to put out the forest fire during the activation. Our participation in this alliance represents NAGI'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 capability 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 strengths 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 third quarter were RMB 22.2 billion, or US dollar 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 Narrative Late Point and Harry Potter Magic Awakens, as well as from existing games such as Fantasy Westward Journey Online and Westward Journey Online 2. Net revenues from our mobile games accounted for approximately 69% of the total net revenues from online game 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% of that relates to academic subject courses in China's compulsory education system. Net revenues from innovative businesses and others while 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 maintain 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 Yodal was 56.6% compared with 45.9% in the same period of last year Significant growth was primarily attributable to the improved learning services growth 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 Yodao Dictionary Pen 3.0, also contributed to these gains, as this line carries a higher growth margin than other product lines. Gross profit margin for innovative businesses and others was 15.6% compared with 16.8% last year. The decrease was mainly due to decreased gross profit margin from the games streaming business, CC Live Streaming. NetEase Cloud Music, however, enjoyed its second consecutive quarter of positive GDP margin. 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 your dollar. 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 US dollars 599 million. Our non-GAAP basic earnings per ADS were US dollars 0.9 or 0.18 per share. Our cash position remains strong. As of September 30th, our total cash and cash equivalents, current and non-current time deposit, and short-term investment 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 US$0.045 per share or US$0.225 per ADS. Lastly, under the current two-year share repurchase program, approximately 13.5 million ADS has been repurchased as of September 3rd for a total cost of approximately US$1.3 billion. Meanwhile, On the NetEase Youdao share purchase program, approximately 0.1 million ADS had been purchased for a total cost of US dollar 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.