NetEase, Inc.
Q3 2022 Earnings Call Transcript

Published: 17 Nov 2022

[Operator:]

Good day and welcome to the NetEase 2022 Third Quarter 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.

[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 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 the 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 of the 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 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 third quarter earnings news release issued earlier today. As a reminder, the conference is being recorded. In addition, on the 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 team is Mr. William Ding, Chief Executive Officer; and Mr. Charles Yang, Chief Financial Officer. 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 saw healthy growth across our businesses in the third quarter with solid gains in each of our core business segments. Our total net revenues for the period were RMB24.4 billion, an increase of over 10% year-over-year despite a high base effect in the third quarter of last year. This demonstrates the resilience and improving operational efficiency of NetEase through different macro cycles. Our online games continues to be our primary growth driver with net revenues from our games and related value-added services coming in at RMB18.7 billion for the third quarter, up 9% year-over-year. Our flagship titles delivered another quarter of solid growth. In the third quarter, with new expansion packs launched for the summer holidays, our legacy PC side [indiscernible], including Fantasy Westward Journey Online and New Westward Journey Online 2 continues to attract players. Even with 2 decades of operations, we are constantly exploring, creating and introducing innovative new elements to our games, keeping our content fresh, boost engagement levels and naturally spirits players continuous willingness to spend. This further proves our long-term operational know-how on franchise titles, a unique strength of NetEase games that we are hoping to replicate to our other self-developed proprietary titles. For our new titles, Diablo Immortal was launched in China in July, topping China's iOS download chart shortly after its release. Following its launch, Diablo Immortal has enjoyed similar popularity in Western markets. players are enjoying the exciting adventure in the authentic Diablo world and the thrilling MMO RPG social experience. Diablo Immortal is a great strategic importance to us. It showcases our game development expertise on the international stage and further demonstrates that NetEase has the right capabilities to produce AAA games for worldwide audiences. As with all of our other games, our team works very hard to regularly and rapidly introduce exciting new game content to invigorate our players and ensure the longevity of our games. In September, we issued our first major update Forgotten Nightmares after Diablo Immortal's official launch, introducing a new Dungen [ph], an exploration system and battle pass and players love it. Naraka

[Operator:]

[Operator Instructions] Our first question today will come from Kenneth Fong of Credit Suisse.

[Kenneth Fong:]

On today's announcement about not renewing certain license related in China, that is still to expire next year. Can you please share with us the rationale behind and the subsequent arrangement that we should expect?

[William Ding:]

[Foreign Language] Thank you. We had very much hoped to continue operating activation liters games in the 2s Mainland and we have put in a great deal of effort achieved this. However, negotiations have been much more challenging than we had originally expected and we were unable to accept certain key terms requested by Activision Blizzard. We regret to see the early announcement from Activision Blizzard. And despite our best efforts to prevent the deal from falling through, we accept the division. In the meantime, we'll try our very best to fulfill our responsibility to serve our players until the last minute, ensuring the safety of their data and other assets.

[Operator:]

Our next question today will come from [indiscernible] of CICC.

[Unidentified Analyst:]

[Foreign Language] And congrats. In the third quarter, Infinity obtained approval of multi-devices version, we also know that a car also post multiterminal. So could management as [indiscernible] games in the future? And my second question with regards to game IP franchise. NetEase has created some overseas IP games such as Harry Potter, Lord of the Rings and -- so what's the progress of -- approval for the domestic version, except Harry Potter local IPs such as [indiscernible]. How can they help the company's business in the longer term?

[William Ding:]

[Foreign Language] Let me just translate answer to this question. So over the years of operation, we realized many of our mobile games players also want to be able to play our games in other formats in [ph] PC, right? They want to be able to experience a more immersive gaming world through a much larger screen. This is why you've seen us providing a PC simulator for many of our mobile games or creating a stand-alone PC version for them and this is to provide our users a much better gaming experience. At the same time, we noticed that in certain regions, many of our users actually own PC and mobile and console all at the same time and they play games on all 3 platforms. But for these players, they would also -- they would like to be able to switch seamlessly between these platforms which is why we are also looking into developing games -- developing cross-platform games. For us, there's no real technical barrier for developing an operating cross-platform games. Therefore, we take into consideration of users' needs, product features, market feedback and other factors before deciding whether we should do a multi-platform version for each of our games. [Foreign Language] So we do not actually have that many foreign IP commenting being submitted. But for those submitted, we are currently going through the relevant procedures as required. So for these following IPs and our self-developed IP, the ultimate difference is that in a virtual world, we can -- the virtual world we can bring to gamers are different. In the past, we sold a lot of games based on our rental culture, such as FWJ, WJ, Justice and Naraka. But by introducing IPs like Harry Potter, Lord of the Rings, [indiscernible], we can actually diversify and enrich the different world that we can create for our users, allowing them to experience different things. And of course, because of these IPs are different, the world's views are different. So the type of games we can create on the different IPs are different. For example, in the oriental world, you have cold wars such as swords and knives. And in the Western world, you have firearm. So this will actually lead to a very different game experience like an MMO for our rental base versus FPS game in a Western setting. So therefore, the reason for having all those IPs is to further enrich our game pipeline and create different gaming experience for our gamers. Thank you.

[Operator:]

Our next question today will come from Lincoln Kong of Goldman Sachs.

[Lincoln Kong:]

[Foreign Language] So the question is about overseas expansion. So we can find that NetEase has been investing in the overseas markets since the beginning of the year, especially including investing or acquiring a studios. So when we think about 2023, how should we expect our growth plan and the growth catalyst in -- particularly in the PC and the mobile game market?

[William Ding:]

[Foreign Language] So in short, there were basically 2 core strategies for overseas market. One is through sales development and another is through investment. So in the past few years, you've actually seen a number of very successful titles from -- that we've self-developed in innovative regions, such as Identity 5, Knives Out in Japan. And also, we've seen some very successful PC titles in the global market as well, like Naraka

[Operator:]

Our next question today will come from Charlene Liu of HSBC.

[Charlene Liu:]

[Foreign Language] I would like to ask about the gaming market outlook. So we observed that both the domestic and overseas mobile game market revenues declined further year-on-year in the third quarter. Obviously, there are some short-term headwinds of weaker consumption but we -- also the latest backdrop on how came through. With that positive development, how should we think about the timing and magnitude of recovery of the market as well as the long-term outlook for the domestic market?

[William Ding:]

[Foreign Language] Our [indiscernible] that the gaming market is driven by content. So whether in particular time whether the market is driving, it depends on whether the -- it depends on the game quality themselves. In a certain time, we will have a number of high-quality games available for games to play that will be the market driving. At the same time, if the gaming content available, it's not interesting, is mediocre, is a duplication of previous games then the market is slow. So in our view, is right now, we not about mortgage situation but rather that's been black high-quality games.

[Operator:]

Our next question today will come from Alex Poon of Morgan Stanley.

[Alex Poon:]

[Foreign Language] My first question is related to overseas games. In the last 1 to 2 years, we have launched many new games overseas. Can management share the gamers' feedback and longevity of these new games? And secondly, about the developments, we're developing more cash flow genres to fit the ties of overseas games about our cost structure. Can we talk about our head count trends and other OpEx trend in the future?

[William Ding:]

[Foreign Language] Since we launched Naraka last year and to Xbox in June this year, we've been very closely monitoring the reactions and feedback from the game of community. So from what we've seen, we think the players overall is very satisfied with this -- with our game with this -- it’s very unique mainly combat user experience. Some games value is about hundreds of hours a day and still feel good. One of the things we noted that there are a lot of statements the gamers who are on the lower spec platform, such as X one, they are also craving for this game. So we are now working on adapting this game on to different levels of devices, different level of platforms. And at the same time, also optimizing the beginners guide. So, if the game is harder to kind of get into -- so we're looking -- we are optimizing finding ways for beginners to kind of get into the game more quickly. And this is a task that we are working on with our Montreal office. So every day, we are having discussions on how to make our users happier within the game. So hopefully, we'll be able to bring at point to more game players on more platforms.

[Charles Yang:]

And Alex, for your second question about the overall trend of head count and operating expenses over the last 5, 6 quarters, our overall total head count stays relatively steady at above 30,000 overall head count. More specifically in the last quarter, by the quarter end, we have north of 31,000 [ph] overall head count, representing quarter-over-quarter about incremental 1,000 head count which is consistent with our summer recruiting season of campus recruiting. I think in terms of the overall operating expenses -- for many of you who have been tracking NetEase for long enough. We are very, very cost conscious and effective in expanding our investment, organic investment into ourselves in a very I would say, our oriented manner. Oftentimes, when you see an increase in R&D, in selling and marketing, that is actually an indication that we are developing a strong pipeline or we are about to launch an exciting new games -- and if we are patient enough, you will see the huge reward that we are planting the seeds today. So for the future outlook, I think we are continuing to grow. We will continue to invest. Absolute dollars of operating expenses will continue to increase but we will be hugely rewarded by operating leverage when we see the next cycle of product launched in both domestic and international markets.

[Operator:]

Our next question today will come from Felix Liu of UBS.

[Felix Liu:]

[Foreign Language] My question is on the overseas market. We noticed that we had updated publishing time for Harry Porter. So could you share more color on the market -- overseas market to focus on for Harry Potter power and any pipeline to share after Harry Potter's launch? And more on the longer-term question is on the overseas position in terms of genre and market position. What are these genres in markets you'll be focusing on with your extensive investments right now?

[William Ding:]

[Foreign Language] Okay. Firstly, Harry Potter will hopefully be launched very soon. As we mentioned in the call earlier, we're scheduled for launch in 2023. And currently, we will for -- we actually have a pretty -- plentiful of games to be launched over this market. We have our 3 games in Japan market that include [indiscernible] like PCG, racing and [indiscernible] And we have a cool games in Europe and North American market, in PPS, PCG and combat -- competitive games. So our focus now is basically the Asia Pacific region and European and American -- North America market.

[Operator:]

Our next question today will come from Natalie Wu of Haitong International.

[Natalie Wu:]

[Foreign Language] Let me calculate myself. So my question is regarding the Diablo model. degree that it measurable latest cash revenue and user activeness of Diablo Immortal so that we can better understand the game longevity and contribution. Also, you've mentioned before that Diablo Immortal is covered by a separate long-term agreement with Blizzard. It would be great to know exactly how many years does the long-term mean? And will there be uncertainties regarding the future collaboration, especially in overseas market for that title under the backdrop of the latest change with [indiscernible].

[William Ding:]

[Foreign Language] So Diablo Immortal has actually done a really good job across the world since launch. It's been online. It's being launched for almost 6 months now in overseas market. And the China version came about a month later. And so right now, if we look at the revenue contribution, the China part and [indiscernible] part, it's pretty much on par with each other. And going forward, we are going to launch more expansion pack, more content to keep the users engaged. And I think we're going to continue to balance the needs of both the Chinese users and overseas users. I noticed that the Chinese users, a lot of them are people in their 30s or 40s, it's mostly [indiscernible] and tier cities. For the North American users a lot of them come from the original PC game background. Going forward, we're going to explore -- discover more game users and promote game to a greater range of audience.

[Charles Yang:]

And Natalie, for your second question, we can follow-up off the line.

[Operator:]

This concludes the question-and-answer session. At this time, I would like to turn the conference back over to management for any closing remarks.

[Margaret Shi:]

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.

[Charles Yang:]

Thank you, everyone.

[William Ding:]

Thank you.

[Operator:]

The conference has now concluded. We thank you for attending today's presentation. You may now disconnect your lines.