Earnings Call Transcript - NTES Q4 2023

Brandi Piacente, President of Piacente Financial Communications

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 in this discussion. A general discussion of the risk factors that could affect NetEase's 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 announcements and 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 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 2023 fourth quarter and full year earnings news release issued earlier today. Please note that certain financial information regarding Cloud Music we will be discussing on this call has been prepared in accordance with IFRS. For additional information including a definition of non-IFRS measures and a reconciliation of IFRS measure and a reconciliation of IFRS to non-IFRS financial results, please refer to Cloud Music’s annual results announcement for 2023. 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 the NetEase corporate website at ir.netease.com.

Bill Pang, Vice-President of Corporate Development

Thank you, Brandi and thank you everyone for participating in today’s call. Before we begin, I would like to remind everyone that all percentages we're talking about here today are in RMB. 2023 marks another year of innovation for NetEase. We drove momentum across our businesses, expanding our top and bottom lines year-over-year for both 2023 and the fourth quarter. Continuous cross-category innovation at NetEase Games is actively expanding and diversifying our ever-growing game portfolio. On top of our inherent strengths in MMO and Chinese culture-derived titles, in 2023, we have landmark success and breakthroughs in diversified genres. This powerful combination is driving our game business with healthy fourth quarter performance from both our new and time-honored titles. Looking first at some of our MMO performance for the period, we remain highly committed to supporting and growing the robust appeal of our esteemed legacy franchises, such as Fantasy Westworld Journey and Westworld Journey Online, with fresh content and exciting in-game events like our annual celebration for Fantasy Westworld Journey. In the fourth quarter, we held a series of carnival-themed events that re-invigorated players, reaffirming the importance of Fantasy Westworld Journey's IP and its stature as one of the most influential MMORPGs in China. The longevity of these flagship titles also underscores our commitment and ability to elevate traditional game standards through ongoing in-game innovation. Adding to our conventional MMO titles, our new MMOs are pushing the boundary of what MMOs can be. The revolutionary advancements we have introduced with games like Justice are evolving the genre as a whole and continue to gain player momentum. In the fourth quarter, the Justice Lishuihan franchise reached a new milestone of 100 million active users, encompassing a broad and diverse user base. In our experience, these are telltale signs of games' potential for robust operating longevity. The innovative Renovation Seasonal Magazine, which both introduced new pursuits and reduced entry barriers, continues to captivate and inspire current users and new users alike. These are bolstered by rich challenges and achievements where everyone can develop individual interests and be rewarded equally, whether playing in PvP instances, combat-focused PvP sessions, or casual gameplay modes. The steps we are taking to strengthen our brand and engage players are also bearing fruit. By integrating players' other interests with our games and giving them more in-game autonomy and choices, we create deeper connections between our games and player communities. For example, in the fourth quarter, players got to weigh in on the selection of collaboration planners for the Justice franchise. In response to players' popular choices, we established a collaboration with the Chinese fan sensation, Finnish Legend, providing players a voice in shaping their gaming experience has proved highly resonant with our community. The event was a huge success, led by players' world of marketing, with friends' recommendations driving the bulk of newcomers to the game. In addition to our MMOs, we made headway across a diverse set of genres in 2023, broadening our reach across more casual game players and entering new genres, such as sports and simulation games. These extend and enrich our broader NetEase community, but also highlight our ability to bring highly successful games to players in more diverse game categories. Touching on a few of our successes in genres that are new to us, Dunk City Dynasty has emerged as a groundbreaking basketball game. Here we have successfully attracted a large user base to a genre that was previously considered relatively small in China. To build on the game's initial success, we are providing more for our players, adding further diversified gameplay and exciting player-to-team rosters. We have been expanding the player lineup since the fourth quarter, introducing MVP stars like James Harden, Russell Westbrook, Joel Embiid, Jamal Murray, and Aaron Gordon, as well as CBA legends, including Yi Jianlian and Guo Ailun. Beyond the game itself, we are committed to spreading basketball game culture. To foster broader basketball game community growth, we are launching a foundation valued at more than RMB10 million this year to support the sport's development, including sponsoring university basketball games and facilitating event promotions. We expect this initiative to extend the reach of our game and the sport itself across a broader audience. Racing Master is another new hit for us, offering top-tier content for all racing fans. During the fourth quarter, we enriched the player experience with an extended selection of international professional racetracks and aspirational supercars, catering to our robust demand from our player community. Following its official launch in China in June, Racing Master is now available in Hong Kong, Macau, and, most recently, Taiwan. We're atop the local iOS download and browsing chart in the first week of its launch. As we extend our reach across a growing range of genres, we are also capturing the attention of more female players with innovative games like Shijie zhi wai. With this ACG-style women's romance game, we have once again defied conventions, introducing an infinite school backdrop and bringing players more storytelling and gameplay innovation. We released Shijie zhi wai in January this year, and the players continue to embrace it, having topped China's iOS download gaming chart during its first week on the market. For our blockbuster Eggy party, we continue to cultivate our EGC ecosystem. Building on players' enduring enthusiasm, in December, we introduced a new feature, Eggy Code, unleashing even more content creation potential by offering an engaging and easy coding tool for our players. Coding lines can now be translated into user-friendly toy blocks to control events, actions, and conditions more readily, allowing creators to further unleash their creativity. This newest innovation pushes our game coding limits, greatly increasing creation flexibility for the game's more than 26 million creators. To further expand our rich catalog of diverse games, we have a number of new titles under development. Today, I'd like to mention a couple of our new upcoming games that will be rolling out this year. First is She Diao Condor Hero. Based on one of China's most popular martial arts novels, She Diao is an open-world RPG that will be launching across PC, mobile, and cloud gaming platforms. We have established a highly immersive martial arts world for the game, featuring open explorations and rich storytelling. All players will embark on their journey within a single server that can accommodate over 10 million players for simultaneous online interaction. Multiple rounds of tests have shown excellent performance so far. We are on course for She Diao's soft launch on March 28th this year. Next comes Where Winds Meet, which is designed to bring players an open world gaming experience comparable to console gameplay. The game features realistic martial arts combat experience and an inclusive art style with a unique historical backdrop. We successfully concluded testing on the PC side in December, and we are currently gearing up for the game's launch later this year. Additionally, we are thrilled to announce that we have received license approval for Naraka Breakpoint and Onmyoji on mobile earlier this week. We are excited to extend the immersive combat experience enjoyed by players on PC and console platforms to the mobile world. On the global stage, we continue to add studios around the world that demonstrate our ability to draw on local talent and extend our international appeal. We are thrilled to announce the latest addition to our game studio portfolio, World Untold in Vancouver, Canada, and our newest U.S. addition, BulletFarm, headquartered in Los Angeles. World Untold is led by industry veteran Mac Walters, who has over two decades of experience in game and writing, well-known for his contribution to the acclaimed Mass Effect series. We welcome Mac and his team, who will be dedicated to creating new IP with their debut product already underway. The remote first studio, BulletFarm, is led by David Vanderhaar and his team of industry veterans. David is an award-winning and experienced game developer, best known for his leadership on the Call of Duty franchise. They are currently working on an ambitious new AAA game set in an original universe, with an emphasis on collaborative gameplay. We're looking forward to his contribution in creating more highly anticipated titles for our portfolio. As we have always said, people are most valuable, and talent development is one of our top priorities. The tailored course we offer our employees across various career development stages and professions ensures that native culture fosters sustainable talent incubation. I'm pleased to announce that in the first quarter of 2024, we were the sole Chinese internet company to be awarded the ATD Excellence in Practice Award. This prestigious award and acknowledgment from the global talent development industry is an honor that further strengthens our commitment to cultivating a new wave of internet talent. Alongside our business momentum, we have assumed increasing social responsibility. This comes with a result for that minors in our internet endeavors. In addition to our existing anti-addiction system, we have started integrating several functions, including a minor mode across our China-based game lineup to protect minors. And we'll continue to steer the gaming ecosystem towards a healthier trajectory with our innovative products and technology. Now let's move to Youdao. In the fourth quarter, Youdao continued to propel technological innovation and product development, further improving profitability and cashflow. In our learning services, we have consistently raised the quality of our unique courses. Digital content services kept its healthy growth momentum in the fourth quarter. In addition, the retention rates were approximately 70% in the fourth quarter for both advanced level programming courses and Go courses. In 2023, 340 students from our programming courses received awards in the CSP programming competition held in China. Notably, 106 students won first prize, comprising over 20% of all the award recipients. We believe that our students' success highlights the high standard and effectiveness of our courses. Additionally, the utilization of our cutting-edge AI technology and the enhancement of our data infrastructure drove Youdao’s online marketing services revenue to reach a record-breaking RMB474.1 million in the fourth quarter. These AI-driven advancements have empowered us to enhance our real-time API technology capabilities, diversify our time base, and broaden the scope of our applications. Our smart devices saw an expected year-on-year decline in net revenue in the fourth quarter. This was due to the organizational initiative for our strategic channel structures, as mentioned last quarter. The steps we have taken are directed at reducing low ROI sales channels, which, in turn, affected China's channel inventory in the short term, but are expected to serve our long-term ROI-driven objectives. Encouragingly, we have observed signals indicating a recovery, including a return to healthy development in the fourth quarter compared to the previous quarter. The sales channel's optimization has been completed. Our commitment to technological innovation remains central to Youdao's business. We have consistently advanced our proprietary LLM unit and accelerated the development of large-language model applications since the fourth quarter. Expanding our capabilities in virtual human tutoring, we upgraded the digital human language coach Hi Echo in the fourth quarter, further enhancing its conversational capabilities. To augment students' learning experiences, we introduced the AI tutor into our recently launched Youdao Smart Learning Path X-20. The AI tutor adeptly responds to students' inquiries on the Path, simulating the interaction of a human tutor. Furthermore, we are observing the tangible impact of AI technology in truly improving performance. Our existing LLM features, particularly AI bots, continue to receive user acclaim, contributing to more than 100% year-on-year growth in the translation substitution fees for three consecutive quarters. Turning to NetEase Cloud Music, in the fourth quarter of 2023, Cloud Music continued to navigate quality development across our music-centric ecosystem while further extending robust monetization momentum in the core online music business and improving overall profitability. The revenue from substitution-based membership in the fourth quarter continued a solid upward trend. This growth was primarily driven by an increase in the number of subscribers, along with a moderate improvement in ARPU as a result of our diligence in strengthening our music-centric monetization capabilities. With the introduction of new premium offerings, including exciting content and innovative features, as well as broadening membership privileges and joint programs with external partners, we notably grew our subscriber base in the fourth quarter. Moreover, we considerably improved our profitability for Cloud Music throughout 2023, achieving full-year positive adjusted net profit under IFRS for the first time. We remain committed to fostering strong partnerships with music copyright holders and are actively working towards deepening this collaboration to expand our catalog of music label content, promote advantageous music genres, and increase album sales in collaboration with the top artists. In particular, popular music genres such as hip-hop and Chinese folk have been celebrated on our platform, and we continue to cultivate content in these advantageous genres. 2023 also marked our debut in the physical album market with our first co-published physical album, Hua Chenyu's new album, Xīwǎng Hòu, followed by the successful sales of Zhang Jie's physical album in the fourth quarter. We continue to enhance our support system for independent artists by actively investing in initiatives that bolster musicians, improving music creation tools, and expanding online and offline music exposure. We aim to help independent artists increase their influence and commercial income, ultimately strengthening the original music ecosystem on our platform. As of November 2023, our platform had over 684,000 registered independent artists who contributed around 3.1 million music tracks to our library. Drawing on our expertise in music, a wide and varied user base, and in-depth user insights, our in-house studios continue to enrich our content matrix, offering high quality and unique music content. Our studios are gaining increasing ground in advantageous music genres. For instance, we produced a number of popular tracks in the fourth quarter, including Sunshine Boy and Sunshine Girls, further solidifying our competitiveness in the hip-hop genre. Turning to our private label consumer brand, in 2023, Yanxuan continued to strengthen its brand presence with highly popular products in focus categories. With increasing consumer recognition of domestically made products in China, Yanxuan has established solid brand awareness across pet supplies and household cleaning, as well as office supplies and food, among others. Sales growth remains steady in 2023, with double-digit increases in specific e-commerce channels year-over-year. Simultaneously, we are continuously optimizing Yanxuan's supply chain to improve cost efficiency by integrating automated systems. In 2024, we will continue to provide Yanxuan customers with consistent, high-quality, original products. Across our business lines, the cornerstone of our competitive edge is our innovation. With our robust R&D capability, we have consistently produced unique products that drive our company and industry's research forward. In 2024, we remain committed to these principles, and we will bring more high-quality products to the market. By crafting outstanding products, we can simultaneously create value for both our user community and our stakeholders. This concludes William's comments.

Felix Liu, Analyst, UBS

Thank you, management, for taking my question. And congratulations on the mobile version of Naraka Bladepoint. My question is on the game. Can management share a bit more color on the R&D progress of the game? How would the mobile version differ from the PC version? And what is your expected launch time for this game? Thank you very much.

Bill Pang, Vice-President of Corporate Development

Yes. I will do the translation. For the mobile version of Naraka, we did a test. Everything is on track. We did a test in Chengdu back in December. The result was fairly good. Regarding your question on the experience between mobile and PC, what William said is that during the past two and a half years of operating on PC, we have accumulated time and experiences. And we're doing all the needed modifications and everything – optimization for the mobile version. Regarding the going live date, everything is on track, and now our best estimate is sometime in Q2.

Alex Poon, Analyst, Morgan Stanley

Congratulations management for very strong results and the game pipeline. My first question is regarding the overseas expansion of Eggy Party. We have launched in many countries already last year what our latest thought for the game in 2024. My second question is related to the progress of Project Mugen. Thank you very much.

Bill Pang, Vice-President of Corporate Development

Okay, I will do the translation. First of all, as everybody knows Eggy Party has achieved success in China and with tons of experience. Regarding the overseas market, we are in the exploration period now. We are taking that step by step, validating a lot of cost and thoughts to try different things out. Please stay tuned; we are going together for the overseas market of Eggy Party. Regarding the status of Project Mugen, it is under normal game development now and of course, it’s also in the process of trying for the publishing number as well. The product has a very specific, clear positioning and development target and we hope in the area of ACG Open World Game to make the game flagship enough to have this on the market. Thank you. Next question.

Lei Zhang, Analyst, Bank of America Securities

Thanks management for taking my question. My question is regarding the overseas business. Can you give us some updates on the overseas game plan and do we have any plan to expand or acquire more overseas studios? Thank you.

Bill Pang, Vice-President of Corporate Development

So now we have studios in the U.S., Japan, U.K., and other countries. This is quite normal when we are going global. We have set up our studios around the globe; that’s quite normal. And we are going to, it's going to be a new norm for us in the future. Thank you. Next question.

Yang Bai, Analyst, CICC

Regarding our understanding of the year, first we would like to say ACG Game is now the EBITDA, looking globally now many companies successfully do that. And for NetEase we have our strengths, our experience, our unique experience and strength, but what we are doing is keep exploring.

Bill Pang, Vice-President of Corporate Development

What we can do is keep a humble and accretive attitude and keep exploring the new ways of doing creative, being creative in the year of game design. And regarding the synergy between domestic success and going overseas, the fun part of games is the same, regardless of where the game or the player stays. So what we can do is leverage what we learn on the fun part, how to design a fun game, and apply that to global products. Thank you, and next question please.

Jialong Shi, Analyst, Nomura

Thanks management for taking my question. I have a question on Eggy Party. We know that since the end of last year, many offline promotional activities have been held for your game Eggy Party. Just wonder what is the trend for your marketing spend this year and whether or not this promotional expense for Eggy Party was rather an acceleration in your marketing expense last year.

Bill Pang, Vice-President of Corporate Development

Yes, I will do the translation. Jialong, you are right. In Q4, if you look at our marketing spending, of course, as you are commenting, there is some factor of competition that we have to deal with in the market. But in the meantime, if you look at the recent performance, during the Chinese New Year 2024, Eggy Party achieved RMB40 million DAU achievement, which shows that the initiatives we spent are quite effective. The result is quite good and effective. Looking forward, we don’t see a big increase in marketing spending and we keep exploring the most effective marketing strategies while working closely with the spend. The increase in marketing spending shouldn’t be a concern. Year 2024 is actually a year of harvest for us. We are going to unleash the accumulation of experience we have gathered over the past 20 years and you will see more and more results from new games coming out. Thank you and next question please.

Lincoln Kong, Analyst, Goldman Sachs

So I will translate myself. My first question is about Where Winds Meet. So with our target to launch timeline for this game, it will be a cross-platform global launch for this time. And it seems, during the testing, it requires quite high equipment for the PC world. So would that affect the mobile world in terms of gameplay and the components? How would that fit in both PC and mobile? And the second question is around the overall market. We do see some uncertainty around the macro economy and consumption going forward into 2024. So in those longer-term legacy games like Westfall Journey, do we see any of the change in terms of the user spending behavior or paying willingness on those games? What's our outlook for this year's gaming industry?

Bill Pang, Vice-President of Corporate Development

Thank you. I will do the translation. First of all, regarding your question about Where Winds Meet, as we explained, it is a very high-quality martial arts-based open-world RPG game. Regarding the graphic concerns, that's something players don't need to worry about either. Our engine has the capability to adapt to different hardware platforms to push the limit of that specific hardware while ensuring it runs on different systems. In the meantime, for the game itself, it's indeed a high-graphic game on advanced hardware platforms. Also, from our experience, we see that people love the Wuxia culture, and we hope this game could be a vehicle that we could use to promote Wuxia culture globally. As for your second question regarding macroeconomic uncertainties, from our observation, gamers spend prudently, regardless of macroeconomic conditions. The spending behavior is more related to the quality of the game itself. Gamers, both in China and globally, are becoming increasingly selective regarding quality, which puts all developers, including ourselves, under pressure to ensure higher quality content. Yes, that's the macro situation of the gaming industry we're in. Thank you. Next question, please.

Ritchie Sun, Analyst, HSBC

So I will translate this question myself. So Where Winds Meet will be launched in March, and Naraka can be launched in the first half. So in terms of the user demographics, how big is the overlap between these games and our existing games? And how would NetEase coordinate the promotion and launch schedule to maximize the hit rate? And when will Naraka be launched? Thank you.

Bill Pang, Vice-President of Corporate Development

Regarding your question on the two different martial arts-based games, these two games have totally different IP attributes. One is very loved by Jin Yong fans. The other one is more like an Asian reality kind of setup. Both games are developed by different teams with different art styles and system setups. We don't anticipate significant overlap between the two games. Our view is the market is looking for high-quality martial arts open-world games. By offering two high-quality martial arts games with different positioning, we hope to push the market further. Everything is being prepared for the go-live date, and yes, everything is on track. Thank you.

Brandi Piacente, President of Piacente Financial Communications

Thank you once again for joining us today. If you have any further questions, please feel free to contact us and have a great day.

Bill Pang, Vice-President of Corporate Development

Thank you.

Operator, Operator

That does conclude our conference for today. Thank you for participating. You may now disconnect.