Good day, and welcome to the NetEase 2021 First 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..

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 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 its discussion.

A general discussion of the risk factors that could cause NetEase 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 announcement and filings on our website of Hong Kong Stock Exchange.

The Company does not undertake any obligation to update these 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 2021 first quarter earnings news release issued earlier today. 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. Joining us today on the call from NetEase senior management is Mr. William Ding, our Chief Executive Officer; and Mr. Charles Yang, our Chief Financial Officer.

I will now turn the call over to Charles, who will read the prepared remarks on behalf of William..

GP margin for our online game services was 64.6%. As a reminder, this number is generally stable, with some narrow fluctuation based on the revenue mix of mobile and PC titles as well as self-developed and licensed games. Gross margin for Youdao was 57.3%, compared with 43.5% in the same period of last year.

The significant growth was primarily attributable to the improved gross margin from learning services due to the economies of scale and the continuous optimization effort of its cost structure.

It is also due to the substantial sales growth of the smart learning hardware such as Youdao Dictionary Pen, which carries a higher gross margin than other hardware product lines. GP margin for innovative businesses and others was 14.4%, compared with 15.8% in first quarter of last year.

While the margins for NetEase Cloud Music and Yanxuan has improved year-over-year significantly, the impact was partially offset by the decrease in GP margin from the rest of the business segments in this line. For the first quarter, total operating expenses were RMB6.8 billion, representing 33% of the total net revenues.

Our selling and marketing expenses as a percentage of net revenue, was 13.5% in the quarter. Excluding Youdao, our selling and marketing expenses as a percentage of net revenue were below 10%, lower than the previous quarter.

As a reminder, fluctuation in selling and marketing as a percentage of revenue largely depends on the number of new games launches in a particular quarter. The genres risk they are in and the most suitable marketing plan adopted for each new game launches. R&D expenses were RMB3.1 billion, largely stable from the previous quarter.

We remain committed to investing in content creation and product development, which is core to our revenue growth. As a percentage of net revenue, R&D expenses were 14.9%, compared with 15.3% last quarter. Effective tax rate in this quarter was 22%.

The effective tax rate represents certain estimates by the Company regarding the tax obligations and benefits applicable to it in each quarter. Non-GAAP net income attributable to our shareholders for the first quarter totaled RMB5.1 billion or $776 million. Our non-GAAP basic earnings per ADS were RMB7.58 or $1.16. Our cash position remains strong.

As of the quarter end, our total cash and cash equivalents, current and noncurrent time deposits and short-term investment balance totaled RMB106 billion, compared with RMB100 billion as of the year-end last year.

In accordance with our dividend policy, we are very pleased to report that our Board of Directors has approved a dividend of $0.06 per share or $0.3 per ADS. Lastly, under the share repurchase program approved by our Board, Approximately 3 million ADS has been repurchased in the first quarter for a total cost of approximately $330 million.

Thank you for your attention. We would like now to open the call to your questions. Operator, please go ahead to Q&A..

[Operator Instructions] We'll take our first question from Alex Poon with Morgan Stanley..

My question is regarding the press release. We have mentioned these big titles, Harry Potter, Lord of the Rings, Diablo Immortal will be coming in the next few months -- in the coming months. So, I'd like to understand about the launch schedule and details around these three big titles. Thank you very much..

Thank you, Alex. I'll answer your question directly in English. We do have very, very strong visibility and confidence for a rich pipeline, including highly anticipated games like Harry Potter, Lord of the Rings, Diablo Immortal, and a few others that I mentioned just now.

And many of these games have already obtained the license approvals already from the regulators. Most of these games will be launched in the second half of this year. In fact, two days later, on our annual gala game day, May 20 event, we will be disclosing more details on existing games as well as some of the exciting new titles.

I would encourage you and the investor community to join our event online to get more details just in two days' time, so a little bit more patience, please..

We'll take our next question from Jialong Shi with Nomura..

Thanks. Good evening management. Thanks for taking my questions. I will ask my question first in Chinese. I will translate myself later. [Foreign Language] So, I will translate my question. In recent years, there have been some independent game studios which were able to launch very successful self-developed titles.

Just like NetEase, these new game studios also published their games on their own instead of going through third-party publishers.

So, my question is do you think in China's mobile gaming space, the competition is becoming more intense? And if that is the case, how does NetEase plan to cope with the challenges from these small but quite competitive game studios?.

[Foreign Language] Okay..

You mean -- the companies that you mentioned have had great success in the recent years. It means that the overall environment for creativity, especially in games, is very good in China. At NetEase, we have been a business for over 20 years. We will continue to innovate to thrive.

And we are happy with -- for the success that the smaller gaming companies have achieved, and we will continue to rise and continue to exceed. Thank you..

We'll take our next question from Thomas Chong with Jefferies..

Hi, management thanks for taking my question.

Can you comment about our online user strategies, in particular, subscription and live streaming, and any thoughts on the long format audio strategies?.

Okay. Thomas, do you want to translate your question in English? Okay. Thomas, I will answer your question directly in English. Yes, there are -- as we've been mentioning in the past couple of quarters, there are plenty of possibilities in terms of product innovation, in terms of monetization streams that centered around this music vertical.

And we are very encouraged to see strong continued and robust growth in both subscription, live streaming, advertising, and new possibilities as we continue to innovate and try out. So right now, NetEase Cloud Music, despite the fact that it's been eight years old now, it is still in its relatively early nascent stage. So, lots of possibilities.

Revenue growth in the multiple formats that you mentioned have all been very strong. And specifically, you asked about long format audio. That's a very important vertical. In fact, we are a forerunner and the pioneer in this particular long format audio. Majority of our live streaming revenues actually come from long format audio.

And there are more players that's been following suit and coming into this vertical.

It has just proven one more time that how the potential upside of this vertical, and I think NetEase Cloud Music, just like many other product lines under the NetEase brand umbrella, will focus on unique product features powered by product innovations, targets specifically to this vibrant younger generation of music enthusiasts.

With that, we are actually very confident on multiple fronts both in terms of product features as well as monetization potential..

[Operator Instructions] We'll take our next question from Eddie Leung with Bank of America..

[Foreign Language] So my question is actually a bit of a follow-up on the game industry. So number one, congratulations on the continuous success of Fantasy Westward Journey and Westward Journey series.

But it seems to be interesting to observe that globally, no matter whether it's a successful PC, mobile, or console game developers, it seems to be relying to some extent, new versions or new games on some of the old IPs while actually some of the new companies are able to come up with big iconic IPs.

So, just wondering as a leading global game company, how we think about this kind of like issue? And is there any indication when we developed our game strategy? Thank you..

[Foreign Language].

BLADEPOINT, to name a few. So, we think we will continue to do what we're doing and to create new games as well as maintaining a long-term stability of our existing titles..

And Eddie, just to add one more point, as you can witness in the past couple of quarters, when there are fewer new game launch in a particular quarter or two, NetEase financial performance has been steady. It is, again, something we talked earlier in the past.

NetEase is a very, very unique combination of continuous innovation to come up with new titles as well as the operational know-how to extend the longevity and effective monetization of the old titles. It is because of this combination that we are able to deliver very steady and gradually improving financial profile for over two decades..

I guess that's very true..

[Operator Instructions] We'll take the next question from Alicia Yap with Citi..

My question is related to the Cloud Music.

So with NetEase now currently signing directly with all the three major music label, will that change the overall truck business of the content selection for user? And also will that help on driving the music subscription driving the music subscription growth, any material change on the gross margin impact? And also, can management elaborate the music strategy into the IoT partnership, any interest that you are extending the partnership with the OEM?.

[Foreign Language].

As the streaming platform or social community for music enthusiasts, NetEase Cloud Music is actively -- have always been actively seeking partnerships with content providers or label companies in order to help them promote their music in China. That's the answer to third question.

And in terms of IoT or furnishing or home furnishing, again, it's another important growth area for NetEase Cloud Music..

We'll take our next question from Elsie Cheng with Goldman Sachs..

My first question is about international games. We noticed that there are a lot of exciting titles for this year. And it seems for different international markets, we actually have different genres. That's the first of the key plan to touch base with the audiences over there.

So I just want to follow up a little bit more here that, when we're thinking about different international markets, do we actually have the sort of differentiated competitive strategy? And then if there are any further detailed color on how we're positioning ourselves, that would be great. And then the second question is on innovative businesses.

We noticed the seasonal fluctuation in contribution to the revenue of the innovative businesses. And fourth quarter could be -- sorry, the quarter where maybe e-commerce is contributing is contributing more in the first quarter is slow.

So I just wanted to understand a bit more so in terms of the growth curve of the two major lines, one is e-commerce, one is the Cloud Music, how would we describe the growth curve and where they are currently on that growth curve for these two? And in the long term, do you have any targets for them to sort of potentially become another major growth driver for the Company?.

[Foreign language].

BLADEPOINT on Steam, and that has been performing -- that has resonated very well with the users during the testing phase. It's a mainly combat type of game based on Chinese martial arts. And we are really -- we are very pleased to see that it has responded well by the global users..

And Elsie, for your second question, I'll answer that directly in English. Our newer businesses, whether it's online education, online music, NetEase Yanxuan, all of them are in relative younger pace comparing to our game businesses. So by and large, we think these younger business verticals have a very promising growth trajectory.

They should grow faster than my game BU in general. When you look at each quarter, however, different BUs might experience different seasonality. For instance, Q1 is a traditional peak season for game performance specifically because of the Chinese New Year where as it's a relatively low season, for instance, for e-commerce.

Likewise, education also witnessed strong seasonality in the different semester courses throughout the calendar year. So all in all, don't be overly concerned about a quarterly fluctuation.

But generally speaking, when you look at on the annual trend basis, for instance, innovative businesses and others line as well as -- in 2020, both lines has been growing very strong and much faster than my online game services.

What we want to achieve down the road eventually is that all of our deeply incubated and cultivated verticals will have a very robust and sustainable growth. And as they continue to grow and emerge, what we want to appeal to the users is what NetEase holding common a premium product and services offerings with elevated user experience.

That is the corporate DNA in common across the board. Operator, next question, please..

Thank you, sir. [Operator Instructions] It appears that there are no further questions at this time. I'd like to turn the call back to the management for closing remarks..

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

This concludes today's call. Thank you for your participation. You may now disconnect..