NetEase, Inc.
Q2 2019 Earnings Call Transcript

Published: 8 Aug 2019

[Operator:]

Good day and welcome to the NetEase Second Quarter 2019 Earnings Conference Call. The conference is being recorded. At this time, I would like to turn the conference over to Margaret Shi, the 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 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. We are very pleased to report another quarter of financial and operational growth across our businesses with a 15% increase in revenue and 46% growth in our net income on a year-over-year basis. Online games remain a cornerstone of our business. Despite a seasonally slower period in the second quarter, the steady performance of our game portfolio marked the fifth consecutive quarter that we have exceeded CNY 10 billion in online game revenues. Our flagship titles continue to provide solid support to our online games business. Throughout the years, these titles have remained relevant to each generation of users as we diligently explore and create innovative new elements to our games, keeping our content fresh. Take Fantasy Westward Journey Online as an example. Over the course of the last 15 years since its initial launch, we have introduced close to 30 major expansion packs, averaging approximately two major expansion packs per year with many smaller-scale updates along the way. For FWJ’s mobile version, we have made even more frequent updates, with nearly 40 major updates since its initial launch four years ago. Beyond substantial game overhauls and additions, we consistently look for various ways to keep our users engaged. During the quarter, we held a number of FWJ e-sports tournaments, which helps boost our user stickiness and drive continued revenue contribution for future periods.

[Operator:]

We will take our first question from Hillman Chan from Citi.

[Hillman Chan:]

I have a question regarding the overseas expansion strategy for our games. So as we noticed, we recently launched a new game studio in Montreal and acquired stake in Behaviour Interactive. And our games are doing well in Japan and some overseas market, so going forward in the future, could management share more on the strategies? In particular, what are the key focus markets by geography, the target game genres and steps you will take to achieve the overseas growth either from organic growth or M&A? And also, some of the – updates on the latest partnership synergy with this overseas studio will be helpful.

[Charles Yang:]

[William Ding:]

[Charles Yang:]

Okay. Thank you, Hillman. I will provide a brief translation of William’s comments, for everyone’s benefit. So as you can see that we’ve been very active and open-minded for deeper collaboration with global premium game studios, it’s because for ourselves, NetEase, we have been cultivating in game content development R&D with almost two decades of expertise and experiences. So we are very, very open minded. And we will continue to explore deeper collaboration with peers, the best-in-class studios globally. In terms of the overseas expansion strategy, William has summarized from a few different aspects. First is about our games launched NetEase Games into global stage. Currently, we have achieved certain milestones in Japan. And we are hopeful and we are working hard to make also our popular content, popular games into a popular hit into mainstream Western market in North America and Europe. In terms of collaboration with global peers, we’ve always been focusing on joint R&D development as a priority because that is our know-how, and that is where we see a lot of supplementary capabilities that we can provide to each other. The goal is to jointly develop by leveraging each other’s competitive strengths to develop premium content for global gamers. As to the genres, there’s no fixed, rigid framework. We are very open minded to be more explorative in nature because, as everyone can witness, in the most recent years, game genre has been evolving very fast. And we are very glad that NetEase is always a pioneer in the forefront of keeping innovation in terms of gameplays and genre.

[Operator:]

We will take from – our next question from Alex Poon from Morgan Stanley.

[Alex Poon:]

I have a question regarding with the music business. It’s very glad to see the new module Cloud Village launch recently. Can you also talk about in the second half how your monetization strategy will change? And I also have seen some news regarding the timetable of profitability. Can you also share with us, how are you going to control the costs and achieve that profitability?

[William Ding:]

[Charles Yang:]

Okay, Alex. So for everyone’s benefits, let me quickly translate William’s remarks. So we are glad to see that you’ve noticed in our most recent version update of Cloud Music there is a prominent music community feature called Cloud Village. So everyone – a true music lover is now official villager of our app. As we’ve mentioned previously, a key focus of Cloud Music is to dedicate our platform and our user outreach to promote independent musicians and independent music here in China. And with these community features, I think this is more productive in us achieving this mission. In terms of your question on monetization, by and large, I think it can be categorized into, one, being the user subscription, which we’re now seeing a very robust growth in both the overall users as well as subscriber growth more than 135% year-over-year. Second is from advertising, which again come – grows hand-in-hand as we’re growing our user base and popularity amongst users. The third is broadcasting, which is not only in the format of video live streaming but also audio broadcasting. Fourth, now with the establishment of a community feature, we will also be more innovative and exploring a – deeper monetization opportunities around these community interactive features. In terms of your question on profitability, we’ve never officially commented on any timetable, but rest assured we feel very, very confident about the growth upside of China’s online music industry as a whole. And NetEase, as you can now witness for the past few records, we are very disciplined in controlling costs at a reasonable level; as well as be focusing on the return on the various investments, whether it’s selling, marketing or R&D, into our different business segments. So profitability is ultimately our target.

[Operator:]

We will take our next question from Natalie Wu from CICC.

[Natalie Wu:]

I actually have two here. First one is regarding the Cloud Music as well. You just mentioned about the Internet Cloud Village module. Actually, I tried this, that module, and it’s very innovative and interesting. Just wondering, can management share with us some further operating metrics regarding the user engagement recently for the Cloud Music? I just want to get a sense of how that new function has improved the user engagement, say, the daily active user or the daily time spent, as well some things relating with that. And secondly, about the Marvel IP. Just wondering, how should we anticipate the use of Marvel IP? Will there be some new brand – some brand-new games or genres launching under these IPs or just new update with these new features embedded in our existing games?

[Charles Yang:]

Thank you, Natalie. I will answer your first question, on operating metrics, and then William will further comment on the Marvel IP. Well, as you know, we’ve only launched this new updated version almost – I think it’s 29th of July, towards the very end of July, so it’s about 10 days. So there’s really not a lot of operating metrics that I can specifically share, but we’ve seen very, very encouraging signs of strong growth in both DAU and MAU since we launched the most updated version. And these data is exactly why we are confident that our innovation in bringing in this new interactive community feature will eventually be very well rewarded, because it is not only a way of changing people’s habit of experiencing music, but hand in hand, as this new feature is now not only encouraging users to listen but also to watch and interactive – interacting with other music lovers, it also creates possible opportunities for us to explore monetization potential. And I’ll leave the second question to William.

[William Ding:]

[Charles Yang:]

For the Marvel IP. Natalie, it’s a big area for – a deep route of collaboration is that we will, by – we will leverage Marvel’s global popularity of the IPs to develop games. And it’s not only one. It’s actually several games across different genres that we have different schedule and timetable to collaboratively develop with Marvel. And the partnership also goes beyond games. For all those details, it will be gradually announced as we further progress along this long-term strategic partnership.

[Operator:]

We will take our next question from Thomas Chong from Jefferies.

[Thomas Chong:]

Congratulations on solid cost control for this quarter. And my questions is mainly focusing on the costs side. I think, for the GP margin, the innovation and others achieved the first positive gross profit in the past 12 months. Can we basically assume that our cost control is very solid and we should expect innovation and others to maintain GP margin to be positive going forward? As well as for e-commerce, do we need to stay stable GP margin for e-commerce in 2019? And my second part of the question is about the OpEx. Can management comments about the headcounts that we have in Q2 versus Q1? And how should we think about 2019? In particular, for R&D expenses, is there any reason why we see a sequential decline? Should we expect the trend to go – to be continued in the following quarters?

[Charles Yang:]

Okay. Thank you, Thomas. I will take your questions. On the costs side, let me first begin by saying that NetEase has been listed since 2000, for 19 years. And we have gone through various cycles over the last 19 years of journey of being a listed company. So we’ve always been very, very disciplined in terms of making adaptive measures to – in corresponding to different macro environment. For 2019, as we commented in the previous quarter’s earnings call, one key focus is a more disciplined balance between growth and margin. So we are very happy that, at least for the last two quarters, we’ve been delivering on what we have promised to the market being very disciplined, but having said that, it doesn’t mean a scale back. In terms of headcount, by the end of the second quarter, the overall headcount is by and large stable versus a quarter ago or end of last year. So a lot of market rumors commenting on massive layoffs and all that, those are utterly just not facts. So relating to your other questions

[Operator:]

We will take our next question from Bill Liu, Goldman Sachs.

[Bill Liu:]

I have a follow-up question on costs, mainly about the sales and marketing line. I noticed that, for this quarter, it’s almost flattish quarter-on-quarter but a reduction from a year-on-year perspective. So I wonder for the sales and marketing expense, so how should we think for this line for the rest of the year given that for – on one side, we have a deceleration in e-commerce growth and, on the other hand, the new – the number of new products has been rather limited comparing to previous expectations?

[Charles Yang:]

Thanks, Bill. I’ll again take that question since it’s relates mostly to financials. For selling and marketing, majority of the selling and marketing is allocated to games. And as you mentioned and relatively speaking, there’s fewer new games that has been launched in the first half of this year. That explains why the selling and marketing on games is a relatively lower amount comparing to periods where we have major titles that we needs to promote. Now on e-commerce, as I mentioned for now at least two, three quarters, it’s always a balanced approach between how fast we wants to grow the top line as well as the profit profile of my e-commerce segment. And I think, coming into 2019, we are more disciplined in keeping that balance in a sense that we will not – it’s just never our philosophy that we are to pursue a faster top line growth at the expense of a bigger loss. So that is not our intention and it’s never in our corporate DNA. So these two factors accounts for mostly why in the first half, for the past two quarters, selling and marketing expense has been maintained at a very cautious and disciplined level. Well, that does not mean that we face resource constraint. In the second half, if there are new games that’s ready for marketing and promotion, we will do so. And if there are opportunities for us to see a re-acceleration of my e-commerce or other business segments top line growth, we will not hesitate to spend marketing dollars, but whatever marketing dollars we spend, it will be a very calculated investment focusing on returns and focusing on the results of my marketing dollar expenditure.

[Operator:]

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

[Eddie Leung:]

I have two quick questions. The first one is about e-sports. It seems like there is a – plans to invest in a stadium in Shanghai. So wondering how will that affect our capital expenditure going forward. And then secondly, just any update on game regulation, anything related to the young users time restriction? Anything on along that line would be helpful.

[Charles Yang:]

[William Ding:]

[Charles Yang:]

Okay. So Eddie, I will translate the first question. You – I think you noticed the recent news we made at ChinaJoy. Yes, we are going to invest in Shanghai on e-sports related. And Shanghai is very supportive of e-sports and overall new economy as a whole. As you may notice, that – our team dragons, which most recently won a championship in the Overwatch League, is a team that is based in Shanghai. And we’ve also had plan to invest – it’s not solely just for e-sports stadium, but it’s an e-sports and as well as R&D center that is more tilted towards developing e-sports-relevant game content. So that’s a longer-term strategic plan. And in terms of CapEx, because it’s going to be spend across next three, five years or even longer, so – from a financial statement, from a cash flow perspective, these are well within our resource capability and control. It is not going to impact our financial results materially at all.

[William Ding:]

[Charles Yang:]

And on your second question, game regulations, we don’t have any further update on how the regulation is progressing.

[Operator:]

We will take our next question from Jialong Shi from Nomura.

[Jialong Shi:]

I have two questions. First question is about your dividend payout. And as Charles mentioned in the prepared remark, you revised your dividend payout from a fixed 25% to the range of 20% to 30% going forward. So I still – I just wonder the rationale to make this change. Is it fair to think, going forward, you will be able to pay higher than previous 25% in dividends since your earnings outlook is getting better? And my second question is about Fantasy Westward Journey 3D. And this game will – based on the game’s website, this game will start a new round of testing today. So can you give us some colors on its revenue potential based on the performance during the past rounds of testing? And is there any potential cannibalization risk between the upcoming FWJ 3D and your existing 2D FWJ game? And finally, how long do you expect this latest round – how long this latest round of testing may last and when you expect to monetize this new game.

[Charles Yang:]

[William Ding:]

[Charles Yang:]

Okay. So to just translate, for everyone’s benefits. For FWJ 3D, yes, we started – we will start closed beta testing on Android today. As to the official launch and monetization time line, that will be subject to, first of all, obviously the approval when we can get the license; secondly, also based on the testing results of these closed beta testing rounds. On your concerns on internal cannibalization, as this FWJ 3D and the current FWJ PC version and the FWJ mobile version, they are targeting different user appeals, so see – we see very, very little concern, if any at all, in terms of user internal cannibalization. We are very, very confident and positive about the future outlook of FWJ 3D upon its official launch. For your first part of the question, on the dividend payout ratio, let me comment saying that NetEase is in fact one of the very, very few technology companies globally that has been consistently paying dividends, returning dividends to our shareholders on a quarterly basis. Every quarter, the exact dividend payout ratio is obviously subject to the Board approval. So now the Board has authorized the management, instead of a fixed 25% point, to a 20% to 30% range. And that’s not means that we are bound by this range. So every quarter, the exact dividend payout ratio will be dependent on the financial and operational performance of the company and ultimately subject to the Board’s reapproval. So that’s – it does not indicate that in the future we will always be paying 30%, but we are still pleased that, this quarter, we are paying more because we are confident about our sustainable profitability profile down the road. For the future quarters, it all depends on how the macro economy and our outlook of the company’s performance change.

[Operator:]

Thank you. This conclude today question-and-answer session. Margaret, at this time, I will turn the conference back to you for any additional or closing remarks.

[Margaret Shi:]

Thank you 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.

[Operator:]

This conclude today conference. Thank you for your participation.