NetEase, Inc.
Q1 2019 Earnings Call Transcript

Published: 16 May 2019

[Operator:]

Good day, and welcome to the NetEase First Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. 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 the future performance of the company and are intended to qualify for 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 this discussion.

[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 renminbi. 2019 began on a strong note with robust financial growth and our core businesses strategically aligned for future success. Our total net revenues grew by 30% year-over-year for the first quarter and we more than doubled our non-GAAP net income to CNY 3 billion on an annual basis. Our online games revenues grew by 35% as a result of continued strong performance from our flagship titles and our successful diversification initiatives. Beyond online games, we realigned our resources to be more focused on our e-commerce, music and online education divisions, which we believe will improve our profitability in the longer run. Over the last few years, we have been steadily amassing a portfolio of high-quality games that span a diverse universe of game types. This has allowed for exceptional stability within our online games segment and enabled us to better navigate the fluid market without having to rely solely on new game introductions. Combined with the time-proven longevity of our games, we delivered another quarter of sequential growth based on just our existing titles. This is the fourth consecutive quarter that we have exceeded CNY 10 billion in quarterly online games revenue. We delivered this result amid a challenging industry environment, with fewer new games being approved for a market release in China. With our promising pipeline of upcoming new titles in China and abroad, we are confident in our ability to sustain this growth trend in our online games division.

[Operator:]

We will take our first question from Eddie Leung from Bank of America Merrill Lynch.

[Eddie Leung:]

Just I have a question on an industry phenomenon. We have seen a group of Internet companies talking more and more about focusing on time spent of ad users. So just curious if NetEase thinks about these problems? Do you think time spent is the most important metric internally for a lot of your business unit? If not, why? Especially given your experience in running PC games, which you are, again, one of the first Internet applications facing the challenge of time spent diluting by other applications. So it would be great to hear from you guys in terms of these industry dynamics.

[Charles Yang:]

Thank you, Eddie. I will translate the question for William and the other management team. Okay. Eddie and everyone on the call, for the benefit of the broader population, I'll briefly translate William's comment that he made in Chinese. Well, first of all, we don't think this is a question can be answered by one generalized answer. Definitely time spend is an important factor, but this should not be the only or so important factor that is applicable to all the different verticals. For us, what we think are the most critical factors to our success is the -- back to the essence of a content, whether you are providing a unique and differentiated experience to the users that differentiates your products versus of a competitor. So to us, we really think that's the core, that's the essence that's been attracting users coming back with higher frequency of using our products and services. So if we were to summarize this broad macro question, it is the frequency of user revisiting and unique and differentiated experiences that we will prioritize when we think about the NetEase products and services.

[Operator:]

We'll take the next question from Natalie Wu from CICC.

[Natalie Wu:]

Congratulations on a very solid result. My question is related to the innovative business and others, including Youdao education, Cloud and others. Just wondering what the scale of the investment are you preparing for this business this year. And specifically for online education, even that it is actually quite difficult to reach a flexible level by simply utility app category direction for online K12 after tutoring -- after-school tutoring, especially those primary school costs is related, so just wondering what differentiation or unique positioning NetEase has in the competition with other industry leaders, say New Oriental and TAL et cetera. And what the resources NetEase would allocate on the group level to facilitate a better development of this business? And also, a housekeeping question. Can you update us about the overseas revenue contribution this quarter?

[Charles Yang:]

Okay. Let me translate again. So Natalie, in terms of specifically on Youdao, the one positioning that we would like to emphasize is that our core Youdao business is only focused on online teaching and learning, so we are not tapping into offline, and the primary focus is K12 segment of the population. One very unique advantage of NetEase as a technology company and Youdao that has been cultivating its online education resources for over a decade is that we have very, very strong technology-backed proprietary hardware AI technology such as our smart pen smart device. That's one thing that many other online education or offline educations do not have as strong as us. And also in terms of traffic support, at a group level, we are dedicating a lot of traffics from various business segments to contribute and support the growth of Youdao. Many of our users are now in the age of their parenthood, so it's not only them and it also extends beyond to their children that can be a potential beneficiary of our Youdao product and services. And last but not least, a very important factor around all these educational assets is NetEase brand appeal. That brand appeal itself is now being widely recognized as a household name in the teaching and learning space because we, again, like I commented earlier, we have over a decade of experience and a period cultivating our Youdao brand in multiple products. Natalie, to your second question, overseas gained in revenue this quarter. It's still approximately 10%.

[Natalie Wu:]

Just a very quick follow-up. Does that mean the focus of traffic acquisition or user acquisition for Youdao online K12 would be app traffic redirection rather than the traffic purchase to external channel?

[Charles Yang:]

Yes. So it's a mixture of both. I think we have a unique advantage of traffic. At the same time, we will also be acquiring users from external traffic channels. But ultimately, that is driven by the efficiency, whether or not the acquisition cost makes sense vis-à-vis, for instance, the lifetime value of that particular user that can contribute to our Youdao online courses.

[Operator:]

We will take our next question from Hillman Chan from Citibank.

[Hillman Chan:]

I've got two questions. First one is on the overseas expansion strategy for our games in Japan and international markets. Could you share more on our strategy on that regarding the game development and publishing capability? In addition, can management highlight a major update on our partnership and synergy with the game studios that we previously invested globally? And my second question is more a housekeeping one. We see some decrease in the marketing expenses for this quarter, which should be related to the e-commerce seasonality of game launches. Could you share more color behind that? And how should we think about the trend going forward, please, as a percentage of revenue relative to the revenue growth of respective business lines?

[Charles Yang:]

So for the overseas game expansion strategy, I think that is also a common question that we've been asked quarter-over-quarter. So as of today, we have achieved some small achievement in Japan, in particular with Knives Out. To continue on that momentum, we've introduced Night Falls

[Operator:]

We'll take our next question from Alex Poon from Morgan Stanley.

[Alex Poon:]

I'll translate myself. My first question is related to Fantasy Westward Journey 3D version. No doubt this will be a blockbuster title. How should we think about the user base and revenue potential cannibalization? And also, actually the synergy, some users may play 3D and go back to play the 2D version as well. And second is regarding the Diablo mobile development and licensing progress. And third is regarding music business. Selectively renewing some of the music label may be good for margin, but would that affect user experience? How should we balance between these two? And regarding your competitor, Tencent Music, they have been doing a lot of live streaming and karaoke to monetize. How do you position in this segment?

[Charles Yang:]

Let me translate the answer to the first question on FWJ 3D first. So in March, we just completed another testing run. Result is pretty satisfactory. In terms of the addressable user market, we do not have much concern about a potential internal cannibalization with existing FWJ titles because FWJ 3D is more missioned towards broadening a potential user outreach to both PC and mobile and hardcore users as well as users who play real time MMO. So when the FWJ 3D eventually launched we think that's going to bring incremental net gains to our overall user metrics. For Diablo Immortal, the mobile version, it's on track. We will be applying for the regulatory approval in accordance with overall, the latest guidance from the ministry. And I guess people do not need to worry too much about it. It's on track because Diablo, the PC version, was approved. It's long been launched and released in China. So for now, we think the approval process is well on track, but again, at this moment, we do not have a specific timetable for the launch of Diablo Immortal as yet. Alex, for your last question on music, William's answer is twofold. First of all, the current status of very high cost in renewing -- essentially, a renewing business is a rental business, right? We pay the price to rent the music content for a period of time. A very high cost of that is not healthy to the overall industry. And we fundamentally believe that the cost will come down and be more rationalized in the longer run, which then will be a more conducive environment for the overall healthy and sustainable growth of China's online music streaming industry. Secondly, from NetEase's perspective, we are also applying a lot of thought and innovation in thinking of how we can potentially change our NetEase Cloud Music from merely just listening to music into a very active forum for music enthusiasts together to facilitate their communication sharing. And if we achieve that, I think the potential for imagination of what NetEase Cloud Music can enable is more than just playing songs, a content IP-driven business.

[Operator:]

Next up, we have Alex Yao from JPMorgan.

[Alex Yao:]

My question is about the overall capital allocation strategy for 2019. You guys have touch based on some of the key strategies that you're going to implement this year, including a pretty sensitive focus on core business from gaming, to music, to e-commerce, et cetera, and also cost reduction in the noncore business, even within these core business we noticed from the media reports that there seem to be a pretty systematic cost reduction initiative across different business units. My question is about what is the trigger for such a philosophical change in capital deployments or allocation? And how long would this operational strategy last?

[Charles Yang:]

Alex, I'll briefly translate William's answer. So the guiding principle is really that we've been more selective in terms of what we are good at. For instance, for education, that is a broad sector that many players come and go. For us, we've been here for over a decade. We know what we are good at. We know how we are going to be differentiated and we continue to invest into our competitive edge. The same applies to e-commerce, whereby this is a relatively crowded vertical, but there are areas we think that we have a better understanding and it's probably more suitable for NetEase, whether it's from a user appeal or from a brand image perspective, that we can continue to cultivate that, creating something of a differentiation and with uniqueness. Businesses that we are relatively less familiar with -- or good at, for instance, comics business that we've divested that business to other players who are probably better positioned to operate. So that is really the guiding principle. From a financial perspective, NetEase, being listed for 19 years, we've always been financially very disciplined. When we think about investment, again, it is return-driven. We are not shy of making big investment into areas that's being highly selective in our focused areas but whatever investment amount that we make, or the scale, or magnitude that we make, ultimately, the purpose is to drive our unique and competitive positioning.

[Operator:]

Thank you, everyone, for participating in the Q&A session. Now, I would like to turn the conference back to Ms. Margaret Shi for any additional or closing remarks.

[Margaret Shi:]

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

[Charles Yang:]

Thank you, everyone.

[Operator:]

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