NetEase, Inc.
Q1 2022 Earnings Call Transcript

Published: 24 May 2022

[Operator:]

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.

[Margaret Shi:]

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 US 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 20-F, and the announcement and 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 as 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 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 Yang, Chief Financial Officer and other members of the senior management. I will now turn the call over to Charles, who will read the prepared remarks 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. We kicked off 2022 with a solid quarter, advancing each of our business lines, with total revenues coming in at RMB23.6 billion, up nearly 15% year-over-year and our net operating profit increased 29% year-over-year to RMB5.5 billion. Online games revenues were RMB17.3 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 Westwood Journey Online II continued to grow steadily, demonstrating NetEase's 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 game play, since its operation of more than three years ago, we've been frequently rolling out big updates for LifeAfter on almost quarterly basis, refreshing players' appetite with numerous content updates. In the first quarter, the Spring Festival version of LifeAfter 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

[Operator:]

Okay. Thank you. [Operator Instructions] We will take our first question from the line of Alicia Yap from Citigroup.

[Alicia Yap:]

Hello. Hi. Yes. Thank you. Can you hear me? Okay.

[Charles Yang:]

Hi, Alicia. Yes, Alicia.

[Alicia Yap:]

Yes. Hi. Thank you. Yes. [Foreign Language] My question is on your overseas studio. So given your recent establishment of the overseas studio in the US and Japan, could you share some color with us regarding your hiring plans, your games development plans and also how you are viewing the overseas talent and future games growth and growth outlook? Thank you.

[William Ding:]

[Foreign Language] Okay. Thank you. So we -- the overseas market and the overseas market development is of utter importance to us. So right now, about 80% of our R&D resources is in China and some something between 10% to 20% is in overseas market. And going forward, we think that we want to probably see a 40% to 60% split, having 40% of the R&D resources in overseas markets. We are working very diligently and actively with overseas development teams to codevelop some games content. Internally, we have a plan -- we have a clear goal of how we want to achieve the revenue split between overseas market and the China market. And then hopefully, both the China market and overseas markets will account for a meaningful portion of our revenue. Thank you.

[Alicia Yap:]

Thank you.

[Operator:]

Okay. We will take our next question from the line of Yan Bai from CICC. Your line is open, please go ahead.

[Unidentified Analyst:]

[Foreign Language] Thanks for taking my question. [Technical Difficulty]

[Operator:]

Are you on speaker phone because your line is breaking?

[Unidentified Analyst:]

Hello, can you hear me now?

[Margaret Shi:]

[Foreign Language] So, his first question is about the impact of overseas games market, how that would affect our profitability for games business? And the second question was in terms of -- in addition to Japanese market, where other regions we're thinking of publishing ourselves?

[William Ding:]

Okay. So, for convenience, I will answer these questions directly in English. When we think of our overseas games increased contribution, obviously, we are in a ramp-up phase. But as we grow more diversified titles across different geographies, like I mentioned in previous quarters, the margin profile shouldn't be very different between domestic game and overseas game in a steady state. But rather, it is more correlated to the gross billing. So, we are very confident in the next three to five years' time as we continue to expand the scale and presence in the overseas market when we have multiple hit titles that universally are appealing to the users, those games are going to demonstrate very, very strong and similar margin profiles as what we have been experiencing with some of our very long lasting legacy titles here in China. Now, your second question regarding our publishing capability. As you may have noticed that NetEase remains very determined in major markets such as Japan and for some titles, even in the West market, we strive to learn and control our own publishing capability. That is something we have to gradually build up and learn as we become a truly global game company, you may have noticed that we've successfully self-published games like Knives Out, Identity V in Japan, we are going to publish Harry Potter

[Operator:]

Okay. We will take our next question from the line of Jialong Shi from Nomura. Your line is open. Please go ahead.

[Jialong Shi:]

[Foreign Language] Thanks for taking my question. [Foreign Language] Your game deferred revenue rose by 1% sequentially in 1Q, even though you did not launch any new titles in the first quarter. Could you give us some color what were the factors that have contributed to this recovery in your deferred game revenue? I just wonder if this recovery has anything -- had anything to do with the lockdown?

[William Ding:]

Thank you, Jialong. I'll answer this financial question directly in English. So by the way, we rephrased deferred revenue into contract liabilities just to be more precise and accurate under the accounting literature. So, yes, as you may have noticed, our contract liabilities increased slightly for games, if you exclude Youdao from that. It's largely attributable to our strong Q1 growth, Q1 performance of PC games. As you may know, Chinese New Year period is typically a seasonality peak for PC games and Fantasy Westward Journey, by the way, after almost two decades of operation have recorded a new record high quarterly gross billing and quarterly revenue in the first quarter. World of Warcraft also performed fairly strong in the first quarter, contributing to our strong game contract liabilities that's been recorded in the first quarter. That's the main reason. Operator, next question, please.

[Operator:]

Okay. Thank you. We will take our next question from the line from Felix Liu from UBS. Your line is open. Please go ahead.

[Felix Liu:]

Thank you. [Foreign Language] Thank you management for taking my questions. Let me translate myself. My first question is on Diablo Immortal. First, congratulations on the launch. Could you share any expectations on revenue or user metrics for this game? And which overseas markets will NetEase be responsible for distribution? And any thoughts or color on the long-term collaboration with Microsoft and Activision, Blizzard post the game launch? My second question is on Yanxuan, more specifically about the COV19 impact to the Yanxuan business in the second quarter and potential turning point? Thank you.

[William Ding:]

Okay. Thank you, Felix. I'll answer your question directly in English. So first of all, Diablo Immortal, while under the partnership agreement, we are a co-developer. So we got a co-developer share of pie from its global revenue. In terms of publishing, NetEase is responsible for the games publishing in Mainland China, whereby Blizzard is responsible for its publishing rest of the world. You may have noticed that we also have very close partnership -- business partnership with Microsoft because we've been the exclusive partner for Minecraft for multiple years. With the announced acquisition of Activision, Blizzard by Microsoft, we are very, very looking forward to a future strengthened partnership between NetEase and the broad Microsoft franchise, because we are a premium content provider. They obviously have very, very excellent first-party studios as well as Xbox distribution platform. So there are multiple areas that we can explore potential partnership down the road. To your second question on Yanxuan, we will have Yanxuan's CEO, [indiscernible] to answer your question.

[Unidentified Company Representative:]

[Foreign Language] So it's trading certain regions. And so we do think that our fulfillment and the logistics system has impacted somewhat by the pandemic. And since the end of March, the fulfillment time has been a lot longer than before. But the good news is that, since May, we've seen a much more meaningful improvement and progress. And we think that progress is still ongoing. Thank you.

[Charles Yang:]

Operator, next question please.

[Operator:]

We will take our next question from the line of Lincoln Kong from Goldman Sachs. Your line is open. Please, go ahead.

[Lincoln Kong:]

Hi. [Foreign Language] So thanks for taking my question. The question is about the overseas game market and our monetization strategy for international games. As we noted, strong engagement of DBT Mobile in Japan, but relatively small grossing. So we think that those international games monetization measure is evenly distributed within their product life cycle. If so, how should we think about those future high-profile international titles in the second half, especially higher, broader Japan? And related to that, how do we view the outlook for the Japanese mobile game market this year, especially year-to-date grossing seems to be a little weaker than expected? Thank you.

[William Ding:]

[Foreign Language] Yes, it's true that overseas markets are completely different from the China market. In China, majority of the revenue -- games revenue comes from mobile games, whereas for overseas, we have console, we have PC and we have mobile. So, it's a different type of games, there's very different amortization pattern and for different countries, amortization is different as well. But all of that, it shouldn't be a big challenge for NetEase. We have decades of experience in gaming R&D, so we should quickly find a way to satisfy users and players in different countries, on different types of devices. Thank you. Next question please.

[Operator:]

Okay. We will take our next question from the line of Natalie Wu from Haitong International. Your line is open, please go ahead.

[Natalie Wu:]

[Foreign Language] Thanks management for taking my question and congratulations for a very strong quarter. My question is regarding the pandemic impact on our game business. Just wondering, can you comment on the impact of pandemic opening up in overseas markets on your games business? Because some of your peers noted that the weakness coming due to that fact. Just wondering if you also experienced that kind of -- the situation. And in the meanwhile, in terms of the domestic market, did you see increasing time and value spend on your games during the domestic lockdowns? Thank you.

[Charles Yang:]

Hi Natalie, it's Charles. In the interest of time, let me answer your question directly in English. So, the COVID situation has been lasting since -- it's been more than two years. Frankly speaking, I think everyone is a victim of this COVID situation. Game industry or broadly speaking, entertainment industry is probably a little bit more fortunate that we are less severely impacted by the COVID than many of the other businesses. When -- frankly speaking, we do not observe any weakness from our overseas market right now because we are fairly, fairly new. And in our early stage of executing our ambitious global strategy, as we continue to launch more games, we feel pretty confident about our growth, particularly in the second half of this year when many of our exciting highly anticipated games will be unveiled to the international game audience. Now, speaking of the domestic market, for the past quarter, Chinese New Year period is, like I said, a strong seasonality for PC games, but we are not seeing really any meaningful so-called enhanced ARPU or timing spend on mobile. Mobile stayed relatively, I would say, stable. So you are not really seeing any highs and lows of obvious seasonality’s or one-off implications caused by the lockdown. I think our game development philosophy is fairly consistent and straightforward. We -- there's a lot of these macro situations that's beyond anyone's control. What we could do is that try to observe the shifting user experience preferences and try to cater to their shifting references by diligently and regularly rollout content update through innovation, through fresh gameplays, et cetera. I think that is kind of an open secret we've been adopting and operating for the last two decades. From PC screens to mobile screens, through good economies and bad economies, I think that's something -- if anything that we have learned from the COVID or from our past two decades of experience is that the main user-focused and content focused, then we won't go too round off the track. Operator? Maybe we have time for one last question.

[Operator:]

Okay. Thank you. We will take our next question from the line of Thomas Chong from Jefferies. Your line is open. Please go ahead.

[Thomas Chong:]

[Foreign Language] Thanks management for taking my questions. May I ask a question about the regulatory environment for the online gaming sector to the resumption of the ban [ph] on approval? Should we expect any new regulations or anything that may be released in the future? And on that front, how should we think about the outlook for the domestic gaming sector in coming years in terms of the growth momentum? Thank you.

[William Ding:]

[Foreign Language] So we're quite optimistic with the growth of the Chinese gaming market. It's a popular form of entertainment among the younger generation. So as you've seen, you see in April, there's been a batch of new license approval. And I think that going forward, the policy will remain that it supports game content that could be beneficial and educational to the gamers and game players. Thank you.

[Margaret Shi:]

Thank you. Thank you very much. I think that, that will end our call. Operator?

[Operator:]

Okay thank you.

[Margaret Shi:]

Thank you once again. Okay. Thank you once again for joining us today. If you have any further questions, please feel free to contact us directly or TPG Investor Relations. Have a great day. Thank you.

[Operator:]

That concludes today's conference. Thank you, everyone, for your participations.