Earnings Transcript for NTES - Q2 Fiscal Year 2023

Operator: Good day, and welcome to the NetEase 2023 Second 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.

Margaret Shi: 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 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 20-F and the announcements and filings on the website of the Hong Kong Stock Exchange. The company does not undertake any obligation to update its forward-looking 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 second quarter earnings news release issued earlier today. Please note that certain financial information regarding Cloud Music we'll be discussing on this call have been prepared in accordance with IFRS. For additional information, please refer to Cloud Music's interim report for the first half of 2023. 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 NetEase's 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 Yang, Chief Financial Officer. We will now turn the call over to Charles, who will read the prepared remark on behalf of William.

Charles Yang: 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. Our total net revenues came in at RMB24 billion, an increase of nearly 4% year-over-year, and our net income attributable to shareholders increased by 56% year-over-year to RMB8.2 billion. Our long-standing franchises are still resonating well with our users. In the second quarter, revenues from our Fantasy Westward Journey Saga continues to grow year-over-year, further impressing the industry with this IP's longevity and sustainable popularity. Westward Journey franchise recently celebrated its 21st anniversary since its commercial launch. Games from our flagship series, crafted on solid foundations and continual iterations every few months maintain their top-tier positions and a luring charm in today's market, even after nearly two decades of operation. In addition to these legacy titles, we are proactively cultivating an expanding array of long-lasting franchises. We believe our recent portfolio additions, such as Eggy Party and Naraka

Operator: Thank you. [Operator Instructions] Your first question comes from Alex Poon with Morgan Stanley. Please go ahead.

Alex Poon: [Foreign Language] Congratulations management and risk development team. We have got blockbuster title one after another launching this year. Can management elaborate how the Justice Mobile leverage AI to boost revenue and user engagement? And how did Justice Mobile became the first one of this kind in China to adopt AI? And can management also share some of the difficulties and expectations of this game into the future? Thank you very much.

William Ding: [Foreign Language] Thank you. I will do a quick translation. This is -- the AI -- we applied -- AI has an effect on us in two ways. Firstly is on the -- it has greatly enhanced our R&D efficiency and secondly, it enhanced our user experience. From the R&D efficiency perspective, we've adopted AI technology in programming, in graphic designing, and most importantly, we changed the way we think about designing games from just game plus AI to AI plus games, which means that when we -- at the very beginning of designing the game, we start thinking AI, we build the whole -- the world view based on AI world, which gives our users very immersive strong open-world experience. So for what we'll be seeing, our users have been highly attracted to this game. And then -- we feel very strong stickiness and engagement of users of the game and it has -- I think the enjoyment that users are getting from the game has caused voluntary stress or promotion of our game within the gamer community and will be able to attract many gamers who were traditionally non-MMO game players. And obviously how we want to add on here is that, apply AI technology into our game development is not something that can be achieved overnight. We started thinking about AI as far as back in 2016, 2017 when we saw AlphaGo and that's when we realized AI will have a profound impact on gaming. So that's one. So I think what the result seen today is the accumulation of all the investments and dedication we have put into AI research and AI development in games. Thank you.

Margaret Shi: Our next question, please.

Operator: Your next question comes from Yang Bai with CICC. Please go ahead.

Yang Bai: [Foreign Language] Okay. I will translate that myself. After the success of Eggy Party, Racing Master, Justice Mobile, we noticed that the company has recently launched Dunk City Dynasty which ranks number eight on China's iOS top-grossing chart soon after its launch. Could the management share more color on the operation strategy of this game and how should we think of the opportunity of esports games? Besides, we can also see that the company released the PV of urban open-world game of Project Mugen which seems to be another big title. Could management tell us more about this game? Thank you.

William Ding: [Foreign Language] Yes, to answer the first question on Dunk City Dynasty. So this game is actually our first attempt in sports game runway, specifically in basketball. After researching this market, we think there's potential innovation we can do in this particular genre. So we actually, when we started to put together the team of developers and then designers, we asked all the team members -- we chose all the team members who are hardcore basketball players, personally. So all of them have a passion about basketball and they want to play the best basketball game ever in the market. So yes, actually taking another few years of development and dedication optimization, we want to -- we feel like we only launched the game when we feel like we've mastered great graphics, and a maneuver and style in that game. So going forward, we hope to continue to expand the user base for this game and hopefully become the dominant player in this category. Thank you. And -- so the second question is on Internet. So this is actually our attempt on innovation in the anime-style game genre. So ACG game. This is our attempt to bringing the open-world experience and AI technology into the ACG genre. And so, this is our attempt to further solidify our development capabilities in AI and also give our ACG game lovers a true experience of open-world city lifestyle game experience. And hopefully, we'll be able to do -- will be able to introduce the game to our gamers in a not too far future. Thank you.

Margaret Shi: Thank you. Next, please.

Operator: Your next question comes from Ritchie Sun with HSBC. Please go ahead.

Ritchie Sun: [Foreign Language] Good evening, management. Thank you for taking my question. What's the rationale behind the change of Naraka

William Ding: [Foreign Language] Okay. So when office returned this game to a free -- to free, we were able to bring in more users. So after this transition, we actually saw a great improvement in terms of both our active users and also our revenues. So we think that was the right decision to make. Thank you.

Margaret Shi: Thank you. Next question, please.

Operator: Your next question comes from Felix Liu with UBS. Please go ahead.

Felix Liu: [Foreign Language] Let me translate myself. On the domestic pipeline, congratulations on the [Badlanders] win on Where Winds Meet. We look forward to more color on the game in Gamescom. Can management share more color on the status -- R&D status of the game? What are the potential launch time that we're looking at? And what is the game's differentiated marketing positioning comparable with Justice Mobile given both seems to be open-world and martial arts-based RPG game? Thank you.

William Ding: [Foreign Language] So Where Winds Meet is actually a very important game for us. It actually has a very different worldview to our Justice. So when we develop -- when we were developing Where Winds Meet, we are actually learning about different things with open world experience and hopefully, we'll be able to launch it by the second half next year.

Charles Yang: Second quarter.

William Ding: Second quarter next year. So for NetEase, we believe we have a lot of experience in open-world games. So -- and then we -- every game we launch, we try to bring our users to a different user experience. Thank you.

Operator: The next question comes from Lincoln Kong with Goldman Sachs. Please go ahead.

Lincoln Kong: [Foreign Language] So thank you management for taking my question. My question is about the new game title offer a NetEase. So in the past 12 months, we have seen a very successful launch of Eggy Party, Racing Master, and also recently the Dunk City Dynasty. Those are relatively less exposed game from NetEase in the past. So how should we conclude and understand the success experience -- learning from these games? And after the breakthrough for all these different type, what company's R&D development or operational strategy have any change or priorities in the future, especially for those leisure party, car racing or even like a shooting type of games.

William Ding: [Foreign Language] So as the -- as the Internet company, as a content provider, we keep our innovations really at heart and we continue to invest very heavily in R&D. So the success you've seen in the past 12 months are some positive results from the past effort with fully in R&D and in developing game. But these are successive, but there have been failures too, but we will continue to work hard, never give up, and we want to bring our game users continues great game content through our innovation and dedication analogy. Thank you.

Operator: Your next question comes from Kenneth Fong with Credit Suisse. Please go ahead.

Kenneth Fong: [Foreign Language] Thank you for taking my question and congrats for the very strong set of results. I have a question about the gross profit margin. What's the game business and overall business gross profit margin outlook for second half and 2024 as we see strong performance of self-developed titles and continuous channel optimization? Thank you.

Charles Yang: Okay. Thank you, Kenneth. It's Charles. In the interest of time, let me answer this question directly in English. As you have rightfully put, NetEase prioritizes our R&D resources and attention to self-developed proprietary games, which would yield, relatively speaking, much higher margin vis-a-vis licensed games. In the first half of this year, we continue to enhance our game services-related GP margins largely because the termination of certain licensed games as well as very strong performance of our self-developed legacy games such as FWJ, WWJ, as well as new games such as Eggy Party. In the second half, as you can already tell, that we launched multiple new exciting very, very strong-performing games in June. So the trajectory of more self-developed games contributing to higher margins is somewhat sustainable.

Margaret Shi: Thank you, Kenneth. Next question, please.

Kenneth Fong: Thank you.

Operator: Next question comes from Natalie Wu with Haitong International. Please go ahead.

Natalie Wu: [Foreign Language] Thanks for taking my question. My question is related with the games overseas expansion plan. Just want to get an update both in short term and the long term, which market and regions will be the focus for your game expansion? And wondering if you can give us an update of your overseas expansion plan and target, both in short term and long term. And Charles, you've mentioned that Naraka's transition and other party in your prepared remarks. So just wondering if your -- if NetEase get any expiration on license lessons or learns from these kind of recent initiatives. And lastly, just one housekeeping, what's the overseas wrapping contribution for game in last quarter? Thank You.

William Ding: [Foreign Language] So in terms of geographical focus, both North America and Europe, Japan and Korea. So in terms of -- and the markets are very different in the sense that in the China market, mobile game is a mainstream and console game second place. Whereas in overseas market, console and PC games are still the mainstream. And thirdly, in terms of genres a lot of the games that's popular -- a lot of genres are popular in China probably do not apply for overseas market. So what are the genres that will attract overseas audiences is a topic that we are studying. I was -- we have spent a lot of time evaluating and I'm sure that very soon, we'll be able to introduce to the world the right genre, the right answer. Thank you.

Charles Yang: And, Natalie, for your second part of the question. Overseas games revenue, well, since the strong performance of Eggy Party from Q4, the year-end of last year, the overseas revenue percentage has slightly declined to a single-digit from previously around 10-ish. So -- but again the primary reason of that percentage mix to change is mainly due to the strong performance of certain of our new games launched mostly in domestic market. Now with Justice Mobile and Racing Master's strong debut launch in June, we would expect my domestic games -- particularly domestic mobile games in the second half to continue to grow -- outgrow fast -- at a faster rate than my overseas game revenue.

Margaret Shi: Thank you.

Natalie Wu: Thank you.

Operator: Your next question comes from -

Margaret Shi: Thank you, operator. No, I think this -- that's what the time we got for today. I think that's all the questions -- all the time we've got for today, so maybe this concludes the question-and-answer session. So thank you once again for joining us today. If any further questions, please feel free to contact us directly or Piacente Financial Communications. Thank you. Have a good day.

Operator: Thank you. The conference has ended. You may now disconnect your line. Thank you.