NetEase, Inc.

Good day, and welcome to the NetEase 2023 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Margaret Shi, Senior IR Director of NetEase. Please go ahead, ma'am.

Thank you, Operator. Please note the discussion today will contain forward-looking statements relating to the 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 risks are beyond companies' control and could cause actual results to differ, particularly from those mentioned in today's press release and 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 20F and the announcement of the filings on the website of the Hong Kong Stock Exchange. The company does not undertake any obligation to update all the information except as required by law. During today's call, management will 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 third quarter earnings release 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 are 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 another period marked by outstanding results. Our beloved legacy titles and new hit games are strengthening our reach throughout the gaming world. Our total net revenues were RMB 27.3 billion for the third quarter, up nearly 12% year-over-year, and our net income attributable to shareholders rose to RMB 7.8 billion, increasing by 17% year-over-year. Our time-honored Lexi franchises have maintained robust popularity. Notably, we brought players updates for the Fantasy Westward Journey saga in the third quarter with a brand new storyline and captivating activities, which once again breathed new life into the saga and drove year-over-year revenue growth for the more than 20-year-old epic title. In addition to our well-established games, We are actively expanding our portfolio by consistently launching and cultivating long-lasting franchises across more genres. We have strengthened our leadership in MMOs by pushing the boundaries of industry standards. We have also expanded our presence in broader game categories and demographics with innovative content, gameplay, and monetization models We can see this in the enduring popularity of the games that we have introduced in recent years, such as Aggie Party, Naraka Blade Point. Furthermore, our recently launched titles, including Justice Mobile Game, Racing Master, and Stunk City Dynasty, have quickly climbed to the top of the iOS growth in charts after its release. Looking at our newest hit titles, Justice Mobile Game, launched just in June, impressively surpassed 50 million registered users in October, establishing itself as one of the largest MMOs in NetEase company history in terms of user-based size. Notably, a significant portion of its player community comprises Generation Z players who were previously unfamiliar with the MMO genre. becoming the gateway of MMO games for the younger generation in China. As a trendsetter in the MMO industry, NetEase has once again brought key innovations to the genre with the launch of Justice Mobile game and reshaped the MMO landscape. It offers players a vast array of high-quality content for free, revamping the conventional paying model for MMOs The shift to a more balanced spending approach gives players more freedom to enjoy the game's rich features and gameplay, with optional purchases focused on avatars, cosmetics, and accessories. This model was very well received by the game's player base, solidifying its stability. In late October, we introduced Justice Mobile Games' first seasonal update which significantly enhanced player engagement with captivating storylines, new gameplay, and additional professional role options. It swiftly propelled Justice Mobile Game to the number two position on China's iOS grossing chart shortly after its release. The innovative seasonal mechanism we've introduced to the MMO genre gives all players a fresh start with a focus on fair and balanced gameplay. It also reduces the gap between experienced and new players, ensuring that everyone can enjoy and engage in this game. In addition to the success of this new blockbuster MMO title, we also achieved success across other game genres in the third quarter. Our new racing simulation game, Racing Master, consistently ranked amongst the top three most downloaded and highest-grossing games on the iOS chart in China following each new game update, proving its broad appeal to racing enthusiasts. Notably, as China's very first AAA-standard racing-simulated mobile game, Racing Master has introduced an authentic racing experience into China's mainstream gaming sphere, with the plan for Racing Master's global market expansion, we will soon commence overseas testing to bring this exciting racing simulation experience to players worldwide. We also achieved a significant milestone with our foray into sports games, a historically less popular category in China. We've broken new ground with Dunk City Dynasty, a street basketball game that provides various modes to deliver a casual basketball gameplay experience. Dunk City Dynasty quickly rose to the number two position on the iOS growth chart in China just a few weeks after its release. Following our latest seasonal updates, with the introduction of new basketball superstars to the Team Rooster, like James Harden, the game rose to the number one position on the iOS grossing chart in China. The innovative gameplay and balanced gaming experience we've infused in Bank City Dynasty are important differentiators for our game. By integrating players authorized by the MBPA with Street Basketball, we provide players with higher gameplay freedom along with expanded cosmetic options The game also includes a fair card for fair play, meaning increased player spending doesn't dictate who wins. This facilitates more inclusive gameplay and even more potential for the game's long-term success. Player enthusiasm for Racing Master and Dunk City Dynasty underscores the significant demand in China for top-tier games in the casual game genre. Along with our rich R&D capabilities, we are leveraging the inroads we've already made across a broad section of genre verticals to fill these gaps in a market with new hit games that players love. Games we've introduced in recent years continue to resonate with players, demonstrating enduring popularity and long-term operating potential. Agipati, for example, continues to achieve remarkable milestones. In August, Agipati set new records by amassing over 100 million UGC maps and attracting 100 million MAUs. We have been committed to fostering and nurturing our UGC ecosystem, which is the cornerstone of Agipati's success. We enhanced our self-developed editor in the third quarter by introducing more advanced and interactive functions. We also added collaborative map crafting functionality that lets users create with friends online on a shared canvas. To help foster even more creativity, we've introduced tutoring systems and a range of incentives to reward and motivate creators through various activities. Building on the game's notoriety in domestic markets, we are actively pursuing global expansion plan for Aggie Party. In the third quarter, we launched Aggie Party in Southeast Asia, where it consistently secured dominating positions on Google Play download charts for multiple weeks, particularly in Indonesia and Thailand. These early overseas releases also gave us valuable feedback and insights that guide our efforts as we optimize the game for a global audience. We are also proud to announce that America's PlayPoint recently reached a remarkable milestone of 40 million users. Following the transition to a free-to-play mode in July, we also introduced new heroes to the game in the third quarter igniting greater player enthusiasm and attracting a massive influx of additional users to the game. To bolster our robust portfolio of games, we have a number of new games under development. As we get closer to some of these introductions, we are particularly excited about Where Winds Meet, our new AAA martial arts-themed action-adventure game, Whale Wings Meet infuses an immersive open world experience with an exciting historical backdrop that's relatively untouched in Chinese gaming. This interactive sandbox style adventure features an extensive map, a diverse array of weaponry, and captivating martial arts techniques. Players have the flexibility to explore this interactive world both individually and in groups, with two gameplay options. Players can freely roam in the ancient Chinese landscape in single-player mode, enjoying a highly personalized combat experience. In multiplayer mode, players can work closely with friends to complete tasks, engaging in exciting and heartwarming social interactions. We will soon launch the second round of testing, where players will be able to see more of the game with a longer play time. Early feedback fuels our excitement as we get closer to officially launching this brand new open world experience to our players in 2024. As the developer of China's first ACG hit title, NetEase has made ongoing investments in the animation genre, accumulating valuable industry expertise, and we hope to impress the ACG community once again. The promotional video release of our upcoming ACG title under development, set in the metropolitan-themed open-world genre, Project Moogan, has garnered significant attention from players both domestically and internationally. We are committed to infusing new vitality into the ACG arena, drawing upon our renowned innovation capabilities and experience in the realms of animated games. Beyond these titles, we also have a number of other games in the making, including Mission Zero, Once Human, She Diao, and Naraka Blade Point mobile game. On the global stage, our game development is progressing smoothly in Japan, North America, and Europe. This month, we are excited to welcome Fantastic Pixel Castle as our newest addition to the NetEase family. Fantastic Pixel Castle is led by Greg Street, who is well known for his contribution to massively successful games around the world, including World of Warcraft and League of Legends. Greg and his experienced founding teams are currently developing a top-tier MMO game codenamed Ghost to provide players with a fresh and immersive fantasy MMO experience. We are thrilled to collaborate with so many talented industry producers, leveraging their creativity in synergy with our deep research and operational capabilities. Together, we aim to deliver even more captivating games to players worldwide. Now let's move on to Youdao. In the third quarter, Youdao achieved record high revenue of RMB 1.5 billion. growing 10% year-over-year, driven by the growth in learning services and online marketing. Additionally, as part of our continued efforts to improve profitability, our operating loss for Youdao narrowed by a significant 74% year-over-year to RMB 58 million. The solid growth in our learning services was due to our consistent ability to launch unique and high-quality courses. Notably, in the third quarter, our coding courses introduced a specialized program aimed at preparing students for the CSP Informatics Competition, one of the most popular competitive programming events in China. Our program features all-encompassing services that include learning, contest practice, and an evaluation system. The evaluation system is supported by our in-house developed scoring model, allowing students to estimate their scores and assess their probability of progressing into the next round of the contest. Yeodao's online marketing services have consistently grown at an impressive rate of approximately 100% for the second consecutive quarter. This underscores our expertise in proprietary algorithms and the effectiveness of our customized solutions that are precisely crafted for diverse industry sectors. Revenues from our smart devices declined in the third quarter as we strategically optimized our channel mix by reducing sales through less cost-effective channels. Although this may have a temporary impact on Yodao's revenue, We believe it will lay a solid foundation for sustained long-term growth and enhance Yodao's profitability potential over the long run. Our focus on technological innovation remains our driving force. In addition to Yodao's tech-boosted performance, we upgraded AI Box on Yodao translation products in the third quarter which enables more accurate and natural translation across various types of documents. With the support of our machine-generated functions, third-quarter revenue from subscription fees for translation increased by over 160% year-over-year. Furthermore, following the August introduction of our digital human language coach, High Echo, through Yodao Dictionary Pen X6 Pro, we expanded our reach to a broader user base through an independent app in October, attracting over 100,000 user registrations within just a month. We will continue to iterate High Echo with a new update coming soon. Looking forward, we will look to drive more technological innovation and introduce more products that genuinely meet our users' needs by harnessing our expertise in machine learning technology. Next, turning on to NetEase Cloud Music. In the third quarter of 2023, Cloud Music continues to navigate quality development across our core music-centric ecosystem while further extending the robust monetization momentum in the core online music sphere and improving overall profitability. Total online music MAUs remained largely steady, staying above 200 million in the third quarter. Total revenues for the quarter were RMB 2 billion, on par with last quarter. Growth in our music-centric memberships accelerated, demonstrating our ability to introduce premium offerings, including expensive content and innovative features. Additionally, Our social entertainment services started to stabilize on a monthly basis during the latter part of the third quarter, following our strategic positioning refinements in live streaming, which resulted in short-term setbacks. With solid monetization momentum in the core online music businesses and continued cost structure optimization, Cloud Music maintained steady margin improvement for the period. we are constantly expanding our music library to provide a comprehensive selection of music for our diverse audience base. During the third quarter, we broadened our extensive music collection by adding songs from popular Chinese pop artists like Karen Mock, Zheng Jun, and Zhang Jie. In addition, we were delighted to release albums by pop stars including Jam, Key and Gee, and Shen Yichen. As part of our ongoing commitment to enriching our music-centered ecosystem, we remain dedicated to empowering and assisting independent artists. As of the end of September, we proudly served a thriving community of over 660,000 registered independent artists, showing strong growth of 16% compared with the same period last year. We've also broadened our support for emerging music talent. Our new programs are tailored to regional roots and distinctive styles in different areas, including programs like Localized Sound and Project Stone Season 5 to honor and promote more diverse artists. At the same time, We hosted offline music festivals, such as 65 Park Camp Music Festival, providing more exposure for our independent musicians. In addition to broadening our content selections, we continued our product innovation initiatives, aiming to elevate users' music listening experience and foster our music-centric community. We recently officially launched the private DJ feature, incorporating music recommendations with an intelligent and personalized music introduction and explanatory experience. This feature allows users to record old-fashioned radio DJ while enjoying a more personalized music accompaniment as part of their listening experience. Building on our iconic comments section, Our common square has emerged as a vibrant gathering place for users to express and find connections with one another. Moving on to Yanshan. In the third quarter, our private label consumer brand launched more popular products through diversified channels. We saw robust sales growth in selected categories like pet supplies and home cleaning products. that sellers like ergonomic chairs, bathroom fragrances, and cat food consistently outperformed competitors across various platforms. Our strategic efforts, including efficient warehouse and distribution management and personalized packaging, have also proven successful. Thanks to the innovative marketing campaign, our Down Jacket series which is highly acclaimed for its exceptional quality at affordable price, gained immense popularity during this year's W11 online shopping event, driving the collection to hit top positions on multiple best-selling charts on several e-commerce platforms. In summary, innovation is at the core of all of our businesses, driving our growth and our competitive edge. We believe that great content, products, and services stem from new and creative ideas. This principle lies at the heart of NetEase. Whether it's games, cloud music, Youdao, or Yanshan, we consistently strive to reach new heights. In doing so, we help drive the industries we serve forward while delivering value to our growing global community, our partners, our team members, and our stakeholders. This concludes William's comments. I will now provide a brief review of our 2023 third 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 third quarter were RMB 27.3 billion, or US dollars 3.7 billion, representing an increase of approximately 12% year over year. Total net revenues from our games and value added services were RMB 21.8 billion, up 16% year over year. The growth was primarily due to increased revenue contribution from newly launched games, such as Justice Mobile Game, Racing Master, and Aggie Party. Net revenues from our mobile game accounted for nearly 78% of our total net revenues from online games operation. Yeodao's net revenues were RMB 1.5 billion, a year-over-year increase of nearly 10%, primarily due to increased revenue contribution from learning services and online marketing services. Net revenues from cloud music were RMB 2 billion, a 16% decline compared to the same period last year. As we explained earlier, this result reflects declining revenue of social entertainment services as we adjust our focus to improve profitability in a sustainable manner. Net revenues for innovative businesses and others were relatively flat in the third quarter at RMB 2 billion. Our total gross profit margin continues to grow, exceeding 62% in the third quarter, compared with 56% in the third quarter of 2022. Looking at our third quarter margin in more details, gross profit margin was 69% for our games and related value-added services compared with 65% in the same period of last year. The increases were primarily attributable to changes in the revenue mix of the NetEase self-developed and co-developed and licensed games. GP margin for Youdao was 55.9% compared with 54.2% in the same period of last year. The increase mainly resulted from increased revenue contribution from its learning services and online marketing services segment. Gross profit margin for Cloud Music improved in the third quarter, reaching 27.2% versus 14.2% in the same period a year ago. The margin improvement primarily resulted from increased revenues scale from membership subscription and continued improvement to our cost management measures. For innovative businesses and others, gross profit margin was 27.3% compared with 25.5% in the third quarter of last year. The increase was primarily the result of margin improvement in Yanshan and some of our innovative businesses. Total operating expenses for the third quarter were RMB 9.4 billion, or 35% 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 13% in the third quarter, compared with 15.4% for the same period of last year. This reflects our ongoing efforts to consistently enhancing marketing efficiency. Our R&D expenses as a percentage of total net revenues also remain stable quarter over quarter at 16%. As always, we are committed to ongoing investments in content creation and product development. We are also seeing leverage in our R&D investments longer term. Our GNN expenses as a percentage of total net revenues was 5.5%. The slight increase from the previous quarter was primarily due to certain one-off items. Our other income was RMB 1.5 billion for the third quarter of 2023, versus RMB 2.8 billion in previous quarter. The decrease was mainly due to the exchange rate of the U.S. dollar against the RMB fluctuating over the period. As per applicable accounting standards, we are required to reflect these fair value changes. The effective tax rate was 14.2% for the third quarter. As a reminder, the effective tax rate is presented on an accrual basis. and the tax credits defer for each of our entities at different time periods, depending on applicable policies and our operations. Our non-GAAP net income from continuing operations attributable to our shareholders for the third quarter totaled RMB $8.6 billion, or US dollar $1.2 billion. Non-GAAP basic earnings from continuing operation per ADS for the quarter was US dollar 1.84 or US dollar 0.37 per share. Additionally, our cash position remains robust with net cash of approximately RMB 104.4 billion as of September end compared with 95.6 billion RMB as of the end of last year. In accordance with our dividend policy, we are pleased to report that our Board of Directors has approved a dividend of US$0.099 per share or US$0.0495 per ADS. Lastly, under our current US$5 billion share repurchase program starting in mid-January this year, we had repurchased approximately 7 million ADS as of September 30, 2023, for a total cost of approximately US dollar $588 million. Thank you for your attention. We would like now to open the call to your questions.