NetEase, Inc.
Q3 2019 Earnings Call Transcript

Published: 21 Nov 2019

[Operator:]

Good day and welcome to the NetEase 2019 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 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 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. Firstly, to assist better understanding and analysis of our quarterly results, I would like to remind everyone that based on the changes in this quarter, including the sale of Kaola and the NYSE listing of Youdao, we will now be reporting segment reports as online games, Youdao, and interactive businesses and others which include now Yanxuan, NetEase Cloud Music, Internet media, CC live streaming, and others. Kaola’s financial results has been deconsolidated and listed as discontinued operations. This applies to the current quarter as well as the historical comparative period. This quarter, our total net revenue represents both year-over-year and quarter-over-quarter growth. You can also refer to Youdao’s earning release for more details about its quarterly results. I will now read the prepared remarks on behalf of William. We have had quite an eventful third quarter with a number of strategic moves made across our business lines. Those moves allow us to realign our resources and sharpen our strength in areas where we see the most potential for our sustainable long-term growth. During this quarter, we continued to grow our online games business with steady performances from existing titles and further expanded our overseas presence. We are pleased to have achieved another quarter of strong financial performance with total net revenues increasing by 11% and non-GAAP net income from continuing operations increased by 74% year-over-year.

[Operator:]

Thank you. . We will take our first question from Natalie Wu from CICC. Your line is open. Please go ahead.

[Natalie Wu:]

Hi. Good morning. Thanks for taking my question. I have a question on the upcoming FWJ 3D. Just wondering if management can give us some color on your expectations for that game? And do we need to worry if that game could have the possibility of cannibalizing your current FWJ mobile grossing, if that FWJ 3D could be the next hit game? Thank you.

[Charles Yang:]

Okay. Thank you, Natalie. I’ll translate that question for William.

[William Ding:]

[Charles Yang:]

I’ll provide a brief translation of William’s response. FWJ 3D is currently scheduled to launch in the first half of December and we are quite excited about this game because this game represents accumulation of over a decade long of R&D experience both from the PC version as well as the mobile version of FWJ, and we can adhere to the users and the investor community that we’re going to see a lot of innovation in this game. So, this game is – we are hoping that this game can attract many enthusiastic fans about the Westward Journey franchise, and given all these games are in-house developed by NetEase, we are not overly concerned about any cannibalization to our existing FWJ PC and FWJ mobile.

[Operator:]

Next up, we have Alex Poon from Morgan Stanley. Your line is open. Please go ahead.

[Alex Poon:]

[William Ding:]

[Charles Yang:]

Thank you, Alex. I’ll provide a brief translation of William’s comments for the audience. Firstly, on music. So in short, yes, we are very actively exploring different opportunities in terms of monetization that will be reflected in the upcoming quarters as we continue to explore, strengthening existing monetization channels, as well as to apply some innovative brainstorming new features, for instance social aspect, et cetera, that we mentioned previously. In terms of cost control, NetEase as a whole not only as NetEase Music, we are very prudent and practical in terms of cost control. We think that in order to differentiate our music business from the competition, we are going to further strengthen sales production UGC independent musicians as a differentiated content. As a result, we do not see any material increase in terms of music content acquisition cost. Overall, we are very confident about the prospect of monetization which will lead the path to profitability. We do not have any definitive timetable for breaking even or IPO, but I think as long as we progress on track towards the mission, and those will come just naturally. To your second question on the overseas games strategy, so as you have mentioned, we’ve been also quite active in exploring overseas opportunities. The various overseas investments that we made in those studios are mostly valuing their R&D expertise, which we think can supplement to our in-house R&D capability. Equally, our NetEase R&D expertise is something that attracts those business partners to collaborate with us. Today, we have achieved a small milestone in Japanese market, and we are hopeful that with more new game launches on the global stage, step by step we are also going to have a more promising future in terms of the U.S. and European Western market.

[Operator:]

Next up, we have Hillman Chan from Citi. Your line is open. Please go ahead.

[Hillman Chan:]

Hello, William, Charles, and Margaret. Thank you very much for taking my question. My first question is to follow up on the FWJ 3D mobile. During the final beta testing for Android, do we have a sense of the percentage of participants coming from those currently playing mobile FWJ? And also could you share more observation from the beta testing as well? And then another question is on the Marvel Super War. Could you share more on the development status and launch timetable? And what other game genres for the Marvel IP under development and the status please? Thank you very much.

[William Ding:]

[Charles Yang:]

Okay. Thank you, Hillman. For your first question on FWJ 3D, as you know we’ve started beta testing as early as in the summer. So far, the testing results has been very promising which leads to our confidence in launching this game in the first half of next month. For your second question on Marvel IP, as we have reviewed the overall partnership with Marvel on our May 20th Game Day, there will be multiple games that’s going to developed by NetEase for Marvel IP, and Marvel Super War is one of them. I think Marvel Super War is well on track from a development perspective. So, this game could be expected in the near term. Obviously, for Chinese market, this is also subject to the license approval, but several of these Marvel games are targeting both the Chinese market as well as international markets.

[Operator:]

Next up, we have Kenneth Fong from Credit Suisse. Your line is open. Please go ahead.

[Kenneth Fong:]

I have a couple of questions related to the overseas business. First, what is the overseas game revenue as a percentage of our total game revenue? Second, among our game pipeline, which one of you, you see great potential for the overseas market next year? Third is how do you see the competitive landscapes for the overseas game development? Especially I noticed that there’s a lot of Chinese game developers also very active in publishing overseas. Thank you.

[William Ding:]

[Charles Yang:]

Kenneth, to translate William’s response and also to add a few more color, in terms of the overseas game revenue above 10% of our overall game revenues. We see great potential in terms of further enhancing both the absolute dollar by overseas game revenue as well as this percentage ratio. To your second question in terms of game-specific product lineups for the various international markets, apologies for your understanding that we would not be able to elaborate the details here, but there is a solid plan where we say that we are confident to increase the overseas game revenue as well as the percentage. It is actually bottom up. It is supported by a very extensive study of the overseas market as well as our product lineups. For your third part of the question in terms of the competitive landscapes of the overseas market, I think that’s a good question because when we are launching our products to the overseas market, we realize that in more developed markets like Japan and U.S., users are actually a lot more sophisticated. The only way to impress, to retain, to attract these users is through product innovation and game quality. That is something that NetEase is proud of our competitiveness. And with that confidence, I think it represents actually a very, very optimistic upside of the overall NetEase games in the markets beyond China.

[Kenneth Fong:]

Thank you.

[Operator:]

Up next, we have Jialong Shi from Nomura. Your line is open. Please go ahead.

[Jialong Shi:]

Good morning, management. Thanks for taking my call and congratulations on a solid quarter. Let me first ask my questions in Chinese. I have two questions. The first question is about the online gaming business. So I was just wondering when company will officially launch the upcoming new mobile game, Harry Potter. And also I was wondering what company did in Q3 to have helped the two legacy titles, FWJ and WWJ2 to achieve record high growth in Q3, respectively. My second question is about the online music business. We heard from some media that China’s regulator is likely launching investigation into the license and practice between record labels and the music streaming companies. So I was wondering if management can provide some colors on this ongoing investigation and – or specifically what potential changes this investigation may bring to the music streaming industry? And related to that, what potential impacts these changes may have on NetEase Cloud Music business? Thank you.

[William Ding:]

[Charles Yang:]

Thank you, Jialong. I’ll translate William’s response for the audience. Firstly, given that we have abundant lineups for the game pipeline, William is actually encouraging people to try not to focus too much on individual titles, whether it is existing FWJ, WWJ or the upcoming FWJ 3D or Harry Potter. All of these are high-quality games that we self-develop and we are very confident about their performance, longevity and we have a lot more than just those couple of names that we quoted. For the past summer, yes, FWJ and WWJ both have delivered a record quarter stimulated mostly by expansion packs in the summer. Harry Potter is also scheduled for launch. We don’t have a concrete timetable yet, but it should be planned for next year. On your second question, Jialong, on the music, we’ve also learned from the media about potential regulatory investigations and queries into that. Our general attitude is that for any sort of industry growth, a conducive environment from the players and from the regulators are ultimately longer-term beneficial to serious and long-term players. Our mission ultimately is to ensure that the industry as well as the passionate Chinese online music users benefit from a healthy and diversified growth of the industry. Overall, we think an appropriate and conducive environment is going to be long-term beneficial to all the players in this sector.

[Operator:]

Next up, we have Daniel Chen from JPMorgan. Your line is open. Please go ahead.

[Daniel Chen:]

I will translate myself. I’m asking on behalf of Alex Yao. So my question is, first one is related to PC games. We noticed some of our top PC games such as World of Warcraft Classic and Fantasy Westward Journey actually performance is very resilient. So could management talk about the PC game market outlook in next few years? And what are the key growth areas? Second question is related to some of the new innovative trends. Could management talk about NetEase strategy in these new innovative trends, such as 5G and cloud gaming? Thank you.

[William Ding:]

[Charles Yang:]

Okay. Thank you, Daniel. I will translate William’s response and also add on to your first question. Your second question, William commented that’s a great question, that the industry has been noticing these new features. First of all, William thinks that the user recognition of game titles, so any sort of content is ultimately attracted to the content, less so on the different screens or media. So ultimately, it is the best quality content for the different sector of users that dictates who is the winner. Cloud gaming as well as 5G, all these are great features to supplement to this content creation industry, whether they are going to be a mainstream feature or whether that’s going to be disruptive to the overall user experiences, those are all good questions to ponder and to be further observed. Overall, we think as long as it’s content industry, whether it’s education, whether it’s music, whether it’s games, ultimately content is the king. The one who has the capability of developing the highest quality content would always be the ultimate winner. For your first question on the PC games, we have recorded a great quarter in terms of PC games of our portfolio. We’ve seen both FWJ, WWJPC as well as WoW Classic delivering quite strong quarterly results. Overall, we think – obviously we can’t speak for the entire industry but as for us, we are fairly confident about the steady performance of our PC games into 2020.

[Daniel Chen:]

Thank you.

[Operator:]

Next up, we have Thomas Chong from Jefferies. Your line is open. Please go ahead.

[Thomas Chong:]

Thanks management for taking my questions. I have two questions. The first question is about our Cloud Music business. Given that we are going to include more features such as live streaming to the music side, how should we think about the impact of our short-format video to live streaming? And my second question is about the OpEx trend. Given the fact that we are innovating a lot of new business as well as we are also expanding to overseas, how should we think about our R&D headcount going forward? Are we going to expand our headcount in overseas? Thank you.

[William Ding:]

[Charles Yang:]

Okay. Thank you, Thomas. I’ll translate William’s remarks. Firstly, he thinks that the short video industry in general is actually a positive catalyst to China’s online music industry because as you can see, all the presentation of short format video as well as live streaming requires some sort of a music element, which actually helps to promote music popularity. For NetEase Cloud Music specifically, we now have over 80,000 Chinese independent musicians that’s been nurturing on our platform and this figure is growing. We think short-format video is a very conducive way to promote good music. Based on our data and user statistics, we are not seeing short-format video as a distraction or a competition for users screen time and others. We think ultimately user traffic is attracted by good music, Chinese and global alike. Currently, on Cloud Music we now have almost all the good music of the last couple of decades, those are the core assets that attracts users. And quickly before we wrap up this call, for your second question on the OpEx trend, our R&D headcount is steadily increasing. In fact, overall by the end of the third quarter, especially after the summer recruiting season, our headcount has represented a slight increase comparing to last quarter as well as to the last year-end. I think this is a strong factual evidence dismiss many ungrounded market rumors of so-called massive layoffs about NetEase.

[Thomas Chong:]

Thank you.

[Operator:]

Thank you. I would now like to turn the conference to our management 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 directly or TPG Investor Relations. Have a great day.

[Operator:]

That concludes today conference. Thank you everyone for your participation.