NetEase, Inc.

We are counting on hope for this next first quarter 2022 Unlinked Conference call. At this time, we are assembling today's audience and plan to be underway shortly. We appreciate your patience and please remain on the line. Thank you. Good day and welcome to the NetEase first quarter 2022 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 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 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 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 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 2022 First 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 NetEase corporate website at ir.netease.com. Joining us today on the call from NetEase Senior Management is Mr. William Ding, Chief Executive Officer, Mrs. Charles Yang, Chief Financial Officer, and other members of Senior Management. 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. We kicked off 2022 with a solid quarter, advancing each of our business lines with total revenues coming in at RMB 23.6 billion, up nearly 15% year-over-year, and our net operating profit increased 29% year-over-year to RMB 5.5 billion. Online games revenues were RMB 17.3 billion, growing by 15% year-over-year. Our flagship titles continue to impress with their remarkable longevity and strength. In the first quarter, revenue from Fantasy Westward Journey Online and New Westward Journey Online 2 continued to grow steadily, demonstrating NetEase's core competence in operating franchise IPs over an impressive duration and longevity of about 20 years. With immersive festive activities and engaging new expansion packs during the Chinese New Year period, we are thrilled that these epic games remain as attractive and appealing to the players as ever. We are actively growing many other long-lasting franchises in addition to these legacy titles, keeping our content fresh with years of perseverance and dedicated craftsmanship. Take LifeAfter as an example. Our open world Doomsday survival game, first introduced in 2018, continues to lead its category with its distinctive survival gameplay. Since its operation of more than three years ago, we've been frequently rolling out big updates for LifeAfter on an almost quarterly basis. refreshing players' appetites with numerous content updates. In the first quarter, the Spring Festival version of LiveAfter brought the game to the forefront once again on China's iOS top-grossing chart. In terms of newly launched titles, nearly one year since its launch, Naraka BladePoint maintains strong engagement levels with fast-paced content updates. including new gameplay, heroes, and weapons. Adding to our regular update schedule, we are prepping for a significant update, including the first new map, to bring new excitement to the whole player community in the second half of this year. Featuring unchained melee combat, Naraka Blade Point was a huge breakthrough for us in esports, and has become one of the most popular games on live streaming platforms in China. To round out the game's ecosystem, we established a multi-tiered tournament system consisting of scrimmages, regional tournaments, and the World Championship, catering to different player groups, including the general public, as well as professional teams across different regions. In January, we concluded the first World Championship tournament, the game's highest level of competition, which attracted considerable attention from esports fans worldwide and brought global players an exciting visual feast. We are also seeing growing momentum with Infinite Lagrange. Similar to our original SLG game, Invincible, this next-generation SLG title has begun to show healthy, sustainable growth trend in the first quarter. As the game advances, we are steadily gaining more confidence in our ability to extend the success of SLG games to an even broader demographic. In April, we launched Dead by Daylight Mobile in Asia, co-developed with Behaviour and published by us. Dead by Daylight Mobile is the mobile version of the famous asymmetrical battle arena game, bringing players unrivaled asymmetrical competitive experiences on mobile platforms. Soon after its debut, Dead by Daylight Mobile tops the iOS download chart in both Japan and Thailand with very strong user engagement. In the second half of the year, we plan to bring to the world more exciting titles, which we hope to thrill our growing global community. In particular, we are extremely excited to have Diablo Immortal slated for release on the 2nd of June in most global markets. And last Friday, at our annual Game Day event, we announced that the China launch of Diablo Immortal is now confirmed for June the 23rd. As one of the gamer community's most anticipated titles this year, Diablo Immortal marks one of the most ambitious game release in the Diablo franchise's 25-year history and will bring fans and new players an uncompromised AAA gaming experience. Pre-registration has been exceptional with more than 35 million people preparing for the battles to come worldwide including 15 million in China and counting. Diablo Immortal supports both cross-play and cross-progression, allowing global players to join the fight with each other, regardless of platform, while being able to seamlessly transition between mobile and PC gameplay. We consider the debut of Diablo Immortal a huge opportunity to show the world particularly Western gamer community, about NetEase's strong R&D capability. We take a very global view of our online game business, and Diablo Immortal truly embodies the sort of worldwide appeal that we hope to possess. Next in the pipeline, we will be introducing Naraka BladePoint on console. The development is well on track, and we are definitely excited about its prospects. and to welcome console players to our global Naraka BladePoint community. Equally exciting is our planned global market launch of Harry Potter Magic Awakened, which captivated the Chinese market since last September. While we are putting great effort into the global version, we are also simultaneously working intensively to update the game in China, regularly rolling out new cards costumes, and gameplay to add even more fun. Our rich pipeline goes far beyond these titles, and we continue to initiate new projects on schedule. As usual, we held our 2022 annual game product launch event last Friday on May 20th, revealing the latest information about other exciting titles in the pipeline, including the mobile versions of Justice, and Naraka Playpoint, Aggie Party, A Casual Game, Raw of War, Vive le Football, and Mission Zero. We encourage you to read through our press release about this event or watch last Friday's event replay to get more comprehensive information. In 2022, we have made more solid progress in globalization We have always been relentless in our drive to invest in and empower our people, and we are incredibly excited to have more global talents joining us. After years of strategic planning, we now have a number of first-party overseas studios across Japan and North America, each of them being led by top industry veterans. who are using their creativity to forge their best titles on NetEase platform. For example, our three Japanese studios aim to build great console games for both the Japanese and the global audience. Earlier this month, we also launched our first U.S. studio, Jack Club Games, led by industry veteran Jack Emmert. who has decades of experience in MMO game development. Our idea is to persistently unleash talent potential by enabling them to focus on core mechanics and storylines with creative autonomy while offering them solid technical support in areas such as coding and art design. Going forward, we hope the world will see more of Natty's relevance on AAA releases in the global market, either through self-development, investment, or publishing. Now turning to our education business, NetEase Yodao achieved a solid and sustainable performance in the first quarter after disposing of its academic after-school tutoring businesses. With total net revenues of RMB 1.2 billion and gross margin of 53.1%, Smart learning devices remain the key driver of Yodao's future growth. In the first quarter, Yodao continued to extend its technology offering by launching improved content, features, and new products. Net revenues from Yodao's smart devices segment reached RMB 253 million, representing an increase of 25% year-over-year. Through partnership with education presses in 11 additional regions, we have added original sounds to the Youdao listening pod based on various versions of the English learning textbooks. In early April, we introduced a new product named Youdao Smart Light, Youdao Zhimen Taiden, which integrates AI learning features into a desk lamp. Powered by our robust AI algorithms, It allows users to schedule a plan before they study, look up meanings and translations of words and sentences in Chinese and English during their study time, and inspect and review their homework after they finish studying. By clicking the screen to conduct research, the device helps students develop more independent learning habits and significantly improves their learning efficiency while protecting their eyes Looking towards growth opportunities in the STEAM education sector, we have worked hard to optimize the functions and user experience for different courses. As a result, for example, growth billions from Youdao chess class increased over 170% quarter over quarter. In addition to content upgrades, we have also built a learning community on the Youdao Board Game Academy app On this platform, students of Go, chess, and Chinese chess courses can interact and compete with AI or their peers of similar levels in a fun and engaging way. To complete the cycle of learning, testing, and grading, Yeodao has applied to become an official online testing and certification site for various board game associations in China to make the skill certification process easier for our students. Looking ahead to the remainder of 2022, Yodao will remain focused on upgrading its diversified portfolio of products and services, and we have confidence in its future development, powered by its sophisticated R&D capabilities and persistent drive to empower education with our technology. With NetEase Cloud Music, we maintain steady momentum in the first quarter. MAU for our online services were 182 million, largely stable both year over year and quarter over quarter. We also continue to improve our monetization capabilities, growing our net revenues by 39% year over year to RMB 2.1 billion, driven by healthy membership growth and robust social and payment services. Our membership paying ratio reached 20% compared with 13% in the same period last year. We made enhancements to our content and introduced more product feature innovations to improve the user experience, which helped us drive paying user growth. Additionally, growth margins more than doubled quarter over quarter in the first quarter, reaching over 12% as we continue to optimize our content cost structure. On the new features front, we introduced our innovative Harry Potter Magic Radio, a joint collaboration with NetEase Games team, which allows users and gamers to enjoy Harry Potter themed podcast content within the game. While we continue to add unique products and capabilities that help redefine our community's music experience, we are also improving our brand awareness and influence with content-oriented and event-driven campaigns. We offer a full spectrum of varied content as the demands of our useful user base are increasingly diverse and personalized. By the end of March 2022, Our content library consists of more than 90 million music tracks, including music from established labels, as well as independent artists. We are attracting independent music talent at a notable rate, and by the end of the first quarter, we have more than 450,000 registered independent artists on our platform. To help independent artists create and promote their music, as well as realize commercial value, we continue to nurture music talent with invaluable tools such as support programs, traffic referrals, fan interactions, and multiple monetization methods. Moving on to Yanshan, April marked its sixth year anniversary. Over the course of the last six years, we have built Yanshan into an exciting private label consumer lifestyle brand. We have an established and strong supply chain system and can accurately profile user preferences with our leading algorithms. Through diversified channels, Yanshan has launched a number of popular products such as cat foods, bathroom fragrance, and ergonomic chairs. As we move ahead, Yansheng will continue to focus on pets, home cleaning, bedding, and other categories that we excel in while we continue to launch original design products and bring consumers products that facilitate more chilled and pleasant lifestyle. Above all else, NetEase is always a content company with deep-rooted internet DNA. Our ability to innovate, create, and leverage our proprietary technology forms a cohesive layer across our different business lines, whether it be games, education, or music. Within each of these areas of robust content, we are step first in our mission. Dedicated to improve our content competitiveness, we will continue to invest and innovate to provide users with excellent products and services full of fun, technology, and surprises. At the forefront of each of our business lines is our commitment to social responsibility and charitable endeavors. With the recent pandemic cases in China, each of our businesses have utilized their resources to help the community we are serving. In March, NetEase Group, distributed one million copies of anti-pandemic gift packages to cater to people's entertainment, work, and consumption needs. More recently, leveraging the advantage of our supply chain, Yanshan mobilized 50 tons of fresh vegetables from our fresh food suppliers for people in COVID-affected Shanghai areas. Additionally, leveraging the power of music As an inspiring and uniting force, we distributed another 5 million cloud music Vimeo memberships for free to the people in Shanghai and Jilin province with a goal of using music to comfort and inspire those impacted by the pandemic. This concludes William's comments. I will now provide a brief review of our 2022 first quarter 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 $23.6 billion or US $3.7 billion, representing a 15% increase year-over-year. Net revenues from online game services were RMB $17.3 billion, up 15% year-over-year. The additional growth was primarily due to the increased revenue contribution from the launch of new games such as Naraka Bladepoint and Harry Potter Magic Awakens. Net revenues from our mobile games accounted for approximately 67% of total games revenue. Youdao's net revenues were RMB 1.2 billion, compared with 1.3 billion last year, same quarter. Youdao discontinued its after-school tutoring services for academic subjects under China's compulsory education system K9 since the fourth quarter of last year, per regulatory requirement. If we exclude this continued business, Q1's Apple-to-Apple revenue stayed relatively stable compared with last year. On the other hand, the smart devices business maintained steady growth trajectory with net revenues up 25% year over year. Net revenues from cloud music were RMB 2.1 billion, up 39% year over year. The increase was primarily due to increased revenues from membership subscription and social entertainment services. Net revenues for innovative businesses and others were RMB $3 billion, up nearly 12% year-over-year due to business development and seasonality impact of various lines. Our total gross profit margin was 54.5% in the first quarter, up slightly compared with 53.9% in the first quarter of last year. GP margin for our online game services remained stable at 65.1%. 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. GP margin for Youdao was 53.1%, compared with 57.3% in the same period of the last year. The decline was mainly due to the lower revenue proportion from Youdao's learning services, which carry a relatively higher margin. GP margin for cloud music excelled in this quarter, climbing to 12.2% versus 4.1% in the preceding quarter and a negative margin of 3.1% in the same period last year. The significant margin improvement primarily resulted from strong top-line growth, as well as improved content cost control. Additionally, this marks our fourth consecutive quarter of positive growth GP margin for cloud music. Growth profit margin for innovative businesses and others was 23.3%, flattish compared with 24.1% in the first quarter of last year. Total operating expenses for the first quarter were RMB 7.3 billion or 31% of our total net revenues. If we look at our costs in more details, our selling marketing expenses as a percentage of net revenues were 12% compared with 13% last year. The change was mainly due to less marketing spending related to Youdao. If we exclude Youdao, our selling and marketing expenses as a percentage of net revenue were 11% compared with 10% last year, mainly due to increased spending on certain games promotions in the first quarter. Our R&D expenses were RMB 3.4 billion, or 14% as a percentage of net revenues. We remain committed to investing in content creation and product development, which is core to our revenue growth. Other income was RMB 28 million for the first quarter. The quarter-over-quarter and year-over-year decrease resulted from the fact that we had certain publicly traded securities in our current investments, and the prices of such securities declined meaningfully in the first quarter. We are required on the U.S. GAAP to reflect for these fair value changes. The effective tax rate was 22% for the first quarter. As a reminder, the effective tax rate is presented on an accrual basis, and the tax rates differ from each of our entities, depending on the applicable policies and our operational results. Our non-GAAP net income attributable to our shareholders for the first quarter of 2022 totaled RMB $5.1 billion or U.S. dollars, 807 million. Non-GAAP basic earnings per ADS was 1.23 U.S. dollars, or 0.25 per share. Our cash position remained strong. As of the quarter end, our total cash, cash equivalents, current and non-current time deposits, and short-term investments balance totaled RMB 107 billion, compared with $103 billion as of the end of last year. In accordance with our latest revised dividend policy, our Board of Directors have approved a dividend of US$0.0644 per share or US$0.322 per ADS. Lastly, under our share repurchase program, approximately 20.1 million ADS had been repurchased as of the first quarter end for a total cost of approximately US dollar 1.9 billion. Thank you for your attention. We would like now to open the call to your questions. Operator, please go ahead to the Q&A.