NetEase, Inc.

Good day and welcome to the NetEase 2023 First Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Marjorie Couture, Senior 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 a company and are intended to qualify 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 risks are beyond 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 the filing from the company with the Securities Exchange Commission, including its annual report on Form 20S, and the announcement in the filing from 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 2023 First Quarter Earnings news release issued earlier today. As a reminder, this conference has been 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, 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. We kicked off 2023 with an impressive performance from our game portfolios that drove our total net revenues to RMB 25 billion in the first quarter, up 6% year-over-year. Our net income, attributable to NetEase shareholders, increased 54% year-over-year to RMB 6.8 billion. Revenue from our Fantasy Westward Journey Online Series flagship titles once again grew steadily in the first quarter. This franchise continues to captivate Chinese audiences and enjoyed another quarter of impressive performance thanks to a variety of immersive festive activities and engaging new expansion packs, particularly during the Spring Festival period. Our flagship games have remained incredibly popular with users for almost two decades now due to the sustained in-game user connections and continuous iterations we release every few months to keep our users engaged and content. Our newer titles are also showing impressive results. Aggie Party became China's most downloaded game on iOS in the first quarter, further solidifying its leading position in the casual game arena. Aggie Party's accomplishment is a testament to NetEase content innovation and operational know-how that keeps players engaged through the consistent addition of fresh and exciting content updates, new gameplay features, tournaments, and crossover events. Following its successful launch, we've been taking significant steps to solidify Aggie Party's distinct game ecosystem, including upgrading our creator incentive schemes and game editor. Our users can now design more sophisticated minigames with more flexibility and versatility, making the game more engaging and self-sustaining. We see new generative technology as a great tool for users to create content more easily, and we will develop and offer more of these features in our game editor to encourage more people to participate in this creative process. Aggie Party is approaching its first year anniversary this weekend. With our comprehensive UGC ecosystem, our user community has been creating more than one million apps per week, providing players with continued fresh and enjoyable content. As a key focus of our Aggie Party operational strategy, we will be further strengthening our UGC offerings to help ensure the longevity for Aggie Party that we see in many of our other games. Following its success in China, we are testing its potential on the global stage as well. We've already soft-launched Aggie Party in Southeast Asia and received valuable feedback. We are working to bring Aggie Party to global audiences in the near future and believe that players worldwide will enjoy the engaging gameplay and unique UGC experience that Aggie Party has to offer. Another good example of our casual games showing longevity is Identity V, our five-year-old asymmetrical battle arena game. In the first quarter, Identity V achieved record high net revenues driven by a successful crossover campaign with Bongo Stray Dogs, a famous Japanese anime series. Moving on to our game pipeline, we have a very busy summer planned ahead for this year, with Justice Mobile Game set for launch on June the 30th, and many other titles such as Badlander and Racing Master ready for the Chinese mainland market. We are also planning for Harry Potter Magic Awakens to make its international market debut. As our next generation MMORPG, Justice Mobile Game is dedicated to creating a unique gaming experience that will set a new bar for the MMO market. Differentiating itself from traditional MMOs, Justice Mobile Game caters to the preferences of younger generations offering a wide variety of cosmetic items. The game also provides players with a fairer playing ground, ensuring a sense of equality and fostering a more balanced game experience. Justice Mobile Game is one of the first pioneers to apply machine learning technology in the game's creation and development. Such technologies have further enhanced our development process. and enabled us to greatly enrich the open world experience in Justice Mobile Game, including new gameplay, storyline, and maps. In addition, through innovations like computer-driven non-player characters that allow players to chat and have them interact in unique ways that impact game storylines, Justice Mobile Game provides players with more personalized gaming experiences that add to users' enjoyment of the game. Badlander, our next-generation looter shooting mobile game, is scheduled for launch on June the 8th with close to 20 million pre-registered users. In our recent round of testing, Badlander has shown strong player traction. As an exciting addition to NetEase's roster of shooting games, We are hopeful that Badlanders will help us tap into new territory with its brand new space mechanism and exciting battle experience. Next in the pipeline is Racing Master, a new car racing game that we will be bringing to players on June 20th, which has also had over 20 million pre-registered users. Racing Master boasts AAA quality and the most authentic experience possible for a racing simulation game with dynamic car handling and performance that allows players to fully immerse themselves in the thrilling world of racing cars. We are happy to announce that the highly anticipated global launch of Harry Potter Magic Awakens is nearly here. Our dedicated team has been working hard to enhance and refine the gameplay of this long-awaited game for both mobile and PC, ensuring that players around the world get the most authentic and thrilling experience of the Wizarding World. This summer, Harry Potter Magic Awakened will be distributed in most regions across the globe. NetEase is primarily responsible for the Asian market, while Warner Bros. Games will handle distribution in other geographies including Europe, the Americas, Africa, and Oceania. We believe that our efforts will pay off and that this addition to the beloved Harry Potter IP will be worth the wait. We are excited to release this game to a global audience and hope that players will enjoy it as much as we do. We continue to make solid progress in our globalization strategy. During the podcast, we were pleased to announce the establishment of Anchor Point Studios, which is led by Paul Ehres. With over 20 years of experience in game design and direction for PC and console, PC, Paul has an impressive track record that includes making essential development contributions to hit titles such as Control and Halo. Anchor Point Studios is dedicated to developing action-adventure games that push the boundaries of entertainment and offer players unique and surprising gameplay experiences. We are also excited to welcome Bad Brain Game Studios to the NetEase game family, which we announced earlier this week. Bad Brain Game Studios is a new game studio located in Canada led by Sean Crooks, an experienced producer who has worked on the Watch Dogs franchise and Driver San Francisco. In addition to his own franchise experiences, Sean Crooks assembled a veteran team who also worked on many other major franchises such as Army of Two and Splinter Cell. the studio is developing an ambitious new game franchise based on the story-driven action-adventure theme built with Unreal Engine 5. After years of strategic planning, we now have over 10 proprietary NetEase game studios overseas, spanning Japan, the US, Canada, and Europe, which prepare us for our next stage of international growth. Moving forward, we remain committed to attracting, investing, and supporting our international talent, giving them full autonomy over game creation and development. We hope that soon these games will not just be a household name in China, but also globally associated with fresh, engaging, and long-lasting gaming franchises. Now let's move on to Yeodao. Yodao resumed its growth trajectory of STEAM courses and other key business lines despite a challenging environment in January due to the pandemic. Our STEAM courses continued to show solid growth as we further improved and enriched their content. The recent launch of our champion class in the fourth quarter of last year yielded exceptional results which we saw as our course participants won the youth group championship at the British Youth Go Open in January. Additionally, the gross billings of Youdaofang Reading, our digital online reading service for children, powered by advanced natural language processing capabilities, increased by nearly 40% year-over-year in the first quarter. Youdaofang Reading provides tailored reading content based on users' age and reading behavior, enabling a personalized experience for each user. We are dedicated to continuously improving our smart devices and providing users with better experiences. As an industry pioneer, in the first batch of product standard tests conducted by the Chinese Academy of Information and Communications Technology, our Youdao Dictionary 10 X5 and P5 achieved a 100% accuracy rate in 12 complex online and offline application scenarios. Moreover, the applications available on our Youdao Dictionary 10 operating system are continuously expanding to provide users with a diverse range of options. Our Smart Learning Pad has also been upgraded utilizing computer-powered technology to offer specialized word training and help students plan their learning strategies more effectively. Looking ahead, we will continue to focus on technological innovation and leverage our cutting-edge technology to ensure the long-term success of our smart devices and learning services. Turning to our cloud music business, In the first quarter of 2023, Cloud Music continued its ongoing efforts to enrich its music-centric ecosystem and expand its unique content offerings, resulting in a thriving community with high user engagement. Our online music MAUs continued to show steady growth, while our membership paying ratio remained solid at around 20%. Our online music has continued to show solid growth momentum on a year-over-year basis, while our social entertainment revenue has declined as we enhanced the listening experience of more dedicated music fans and adjusted our focus to improve profitability in a sustainable manner. In the first quarter, total net revenue declined 5% year-over-year to RMB $2 billion, reflecting these mixed results. However, we continued our initiative to drive margin expansion. They have paid off with gross margin reaching about 20% for the first time and further reinforcing our bottom line performance. This has been achieved through the ongoing optimization of our copyright cost structure and improved revenue sharing strategy. to extend our content offerings and ensure access to important copyrighted music. We continue to work with music labels that help us grow our music library. Following our licensing agreement for rights to digital music from Being Music's rich library of CPOP stars, we renewed our agreement with Rock Records, deepening our strategic partnership. We also broadened our music content with the addition of music licensing contracts with Comix Wave Films, an anime film studio known for its critically acclaimed Makato Shinkai movies. Support for independent artists remains a top function of our cloud music platform. By the end of March, NetEase Cloud Music was home to a cumulative 630,000 registered independent artists and we continue to foster new talent with an environment founded upon creativity and the increasing suite of supportive tools. We have recently launched several support programs such as the new voice power project and project cloud ladder 2023 with the aim of of discovering and nurturing music talent. We offer a range of valuable resources to independent artists, including professional training, traffic referrals, and enhanced incentives and assistance for promoting independent artists' music. With these offerings, we are seeing more independent artists joining our cloud music platform, leveraging our services and realizing their commercial value. Going forward, we will continue to foster our music-centric ecosystem, further grow our community, and drive healthy long-term monetization for NetEase Cloud Music. Now on to NetEase Yanshan, our private label consumer brand. On April 11, Yanshan celebrated its seventh anniversary, committed to delivering quality products to our users Yanshan has further deepened the supply chain model, particularly in top categories, such as pet food and supplies, and home cleaning. Furthermore, we have taken a comprehensive approach to ensure the best possible user experience. For instance, we have established independent production lines to help maintain consistent product quality, and we have partnered with suppliers and vendors to enhance our innovative capabilities through joint laboratories. In the first quarter, Yanshan realized significant year-over-year sales growth from categories including pet supplies as well as home cleaning, home furnishing, bedding and mattresses. Top selling products during the quarter also include cat food, bathroom fragrance, coffee cookies, suitcases, and jelly blankets. It remains our mission to provide consumers with more high-quality original designed products that promote a relaxed and enjoyable lifestyle. Lastly, we would like to touch upon our ESG initiatives and achievements. We place significant emphasis on the ongoing development of our ESG practices and the continual improvement of our ESG regulatory framework. Our assets have been widely recognized, and we have achieved leading scores in authoritative ESG evaluations, such as MSCI, DJSI-CSA, and Sustainalytics, with scores that consistently improved. In late April, we released our 2022 ESG Annual Report, which showcased our ESG accomplishments for the last year. In terms of corporate governance, we have optimized the composition of our Board of Directors to promote diversity with female representation comprising 40% of our board right now, leading the average international level. We are also committed to reducing our carbon footprint and implementing energy saving and emission reduction measures. In 2022, we decreased our greenhouse gas emissions per unit of net revenue by 5%. We have also started our own IDC construction and incorporated low-carbon concepts into our designs. Furthermore, talent development is critical for our success, and we are proud to have been recognized by Forbes as one of the world's best employers for the fifth consecutive year. We actively promote diversity, equity, and inclusion, and are also proud to have a high percentage of female employees, again, leading the industry average. We also place great importance on career development, offering comprehensive employee development programs that provide a wide range of opportunities to support employee growth, training, and maximizing our employees' potential. In summary, NetEase's next wave of growth will be driven by content innovation across all of our business lines. This has always been a core value and driving force at NetEase, and we will continue to bring more diverse product experiences to our users in gaming, Yorda, cloud music, and Yen Chef. Our goal is to delight and elevate our community, both domestically and abroad, while creating value for our company and stakeholders. This concludes William's comments. I will next provide a brief review of our 2023 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 revenue for the first quarter were RMB $25 billion, or US dollar $3.6 billion, representing a 6% increase year-over-year. Total net revenues from our games and related value-added services were RMB 20.1 billion, up 8% year-over-year. Growth was primarily due to increased revenue contribution from mobile games, including our strong legacy titles, such as the Fantasy Westworld Journey series, and our newly launched games, such as Aggie Parties. Net revenues from our mobile games accounted for approximately 72% of our total net revenues from online games operation. The adult net revenue were RMB 1.2 billion, a year-over-year decrease of 3%. The primary reason for the decrease in net revenues was the challenging environment due to the pandemic in China, particularly in January. Net revenues from Cloud Music were RMB 2 billion, which represented a 5% decline compared to the same period last year. In the first quarter, Cloud Music introduced a number of measures to its live streaming services to enhance the listening experience of more dedicated music fans and reinforce its risk controls by reducing the in-app exposure of certain live streaming functions and lowering the revenue sharing ratio to broadcasters and agencies. These measures led to a decrease in net revenues from Cloud Music's social entertainment services, but improvement in its margin profile. Net revenues for innovative businesses and others were RMB 1.9 billion, up nearly 13% year-over-year, mainly due to increased contribution from Yansheng. Our total gross profit margin was 59.5% in the first quarter, compared with 54.5% in the first quarter of last year. Looking at our first quarter margins in more detail, gross profit margin was 66.7% for our gains and related value-added services segment, compared with 62.2% in the same period of last year. The growth was primarily driven by the termination of certain licensed gains with comparatively lower growth margins as well as more revenue contribution from our organic channels. Our GP margin for Youdao was 51.7% compared with 53.1% in the same period of last year. The year-over-year decline mainly resulted from the reduction in net revenues. Gross profit margin for cloud music continues to improve in the first quarter, climbing to 22.4% versus 12.2% in the same period a year ago. Margin improvement mainly resulted from our optimized revenue sharing strategy as well as continuous improvement in cost control measures. Our innovative businesses and others line GP margin was 25.4% compared with 21.7% last year. The increase was mainly due to the result of increased revenues from the ancient. Total operating expenses for the first quarter were RMB 7.7 billion, or 31% of our total net revenues. Taking a closer look at our expense composition, our selling and marketing expenses as a percentage of total net revenues were 11.6% in the first quarter and remained relatively stable year over year. Our R&D expenses as a percentage of total net revenues also remained stable year over year at 15% in the first quarter. As an innovative content and technology-driven company, our commitment to investing in content creation and product development is ongoing. we are also seeing leverage in our R&D investments in the longer term. Other income was R&D 1.1 billion for the first quarter, which is up quarter over quarter and year over year, mainly due to the market value appreciation of certain publicly traded securities in our investment portfolio during the first quarter. As per applicable accounting standards, we are required to reflect these fair value changes in our P&L. The effective tax rate was 19.5% for the first 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 operational results. Our non-GAAP net income attributable to our shareholders for the first quarter totaled to RMB 7.6 billion or US dollar 1.1 billion. Non-GAAP basic earnings per ADS for the quarter was US dollar 1.71 or US dollar 0.34 per share. Additionally, our cash position remains strong with net cash of approximately RMB 95.1 billion as of March end 2023 which is approximately the same level as that at the end of last year. In accordance with our dividend policy, we are very pleased to report that our Board of Directors have approved a dividend of U.S. dollar 0.093 per share, or U.S. dollar 0.465 per ADS. Lastly, under our current U.S. dollar 5 billion share repurchase program, starting mid-January this year, Approximately 3.1 million ADS have been repurchased as of the first quarter end for a total cost of approximately US dollar 267 million. Thank you for your attention. We would like now to open the call to your questions. Operator, let's go to the Q&A.