Good day, and welcome to the NetEase First Quarter 2022 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, ma’am..

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 the US 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 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 the website of Hong Kong Stock Exchange.

The company does not undertake any obligation to update this 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 as a reconciliation of GAAP to non-GAAP financial results, please see the 2022 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 NetEase corporate website at ir.netease.com. Joining us today on the call from NetEase senior management is Mr. William Ding, Chief Executive Officer; and Mr. Charles Yang, Chief Financial Officer and other members of the senior management.

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

Magic Awakened. Net revenues from our mobile games accounted for approximately 67% of total games revenue. Youdao's net revenues were RMB1.2 billion, compared with RMB1.3 billion last year same quarter.

Youdao discontinued its after-school tutoring services for academic subjects under China's compulsory education system, K-9 since the fourth quarter of last year per regulatory requirement. If we exclude discontinued business, Q1's apple-to-apple revenue stayed relatively stable compared with last year.

On the other hand, the smart devices business maintained steady growth trajectory, with net revenues up 25% year-over-year. Net revenues from Cloud Music were RMB2.1 billion, up 39% year-over-year. The increase was primarily due to increased revenues from membership subscription and social entertainment services.

Net revenues for innovative businesses and others were RMB3 billion, up nearly 12% year-over-year due to business development and seasonality impact of various lines. Our total gross profit margin was 54.5% in the first quarter, up slightly compared with 53.9% in the first quarter of last year.

GP margin for our online game services remained stable at 65.1%. As a reminder, this number is generally stable with some narrow fluctuations based on the revenue mix of mobile and PC titles, as well as self-developed and licensed games. GP margin for Youdao was 53.1% compared with 57.3% in the same period of the last year.

The decline was mainly due to the lower revenue proportion from Youdao's learning services which carry a relatively higher margin. GP margin for Cloud Music excel in this quarter, climbing to 12.2% versus 4.1% in the preceding quarter and a negative margin of 3.1% in the same period last year.

The significant margin improvement primarily resulted from strong top line growth, as well as improved content cost control. Additionally, this marks our fourth consecutive quarter of positive growth GP margin for Cloud Music.

Gross profit margin for innovative businesses and others was 23.3%, flattish compared with 24.1% in the first quarter of last year. Total operating expenses for the first quarter were RMB7.3 billion or 31% of our total net revenues.

If you look at our costs in more detail, our selling and marketing expenses as a percentage of net revenues were 12% compared with 13% last year. The change was mainly due to less marketing spending related to Youdao.

If we exclude Youdao, our selling and marketing expenses as a percentage of net revenue were 11% compared with 10% last year, mainly due to increased spending on certain games' promotions in the first quarter. Our R&D expenses were RMB3.4 billion or 14% as a percentage of net revenues.

We remain committed to investing in content creation and product development, which is core to our revenue growth. Other income was RMB28 million for the first quarter.

The quarter-over-quarter and year-over-year decrease resulted from the fact that we had certain publicly traded securities in our current investments and the prices of such securities declined meaningfully in the first quarter. We are required under US GAAP to reflect for these fair value changes. The effective tax rate was 22% for the first quarter.

As a reminder, the effective tax rate is presented on an accrual basis and the tax rate differ from each of our entities depending on the applicable policies and our operational results. Our non-GAAP net income attributable to our shareholders for the first quarter of 2022 totaled RMB5.1 billion or US$807 million.

Non-GAAP basic earnings per ADS was US$1.23 or $0.25 per share. Our cash position remains strong. As of the quarter end, our total cash, cash equivalents, current and non-current time deposits and short-term investment balance totaled RMB107 billion compared with RMB103 billion as of the year-end of last year.

In accordance with our latest revised dividend policy, our Board of Directors have approved a dividend of US$0.0644 per share or US$0.322 per ADS. Lastly, under our share repurchase program, approximately 20.1 million ADS have been repurchased as of the first quarter end for a total cost of approximately US$ 1.9 billion. Thank you for your attention.

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

Okay. Thank you. [Operator Instructions] We will take our first question from the line of Alicia Yap from Citigroup..

Hello. Hi. Yes. Thank you. Can you hear me? Okay..

Hi, Alicia. Yes, Alicia..

Yes. Hi. Thank you. Yes. [Foreign Language] My question is on your overseas studio.

So given your recent establishment of the overseas studio in the US and Japan, could you share some color with us regarding your hiring plans, your games development plans and also how you are viewing the overseas talent and future games growth and growth outlook? Thank you..

[Foreign Language] Okay. Thank you. So we -- the overseas market and the overseas market development is of utter importance to us. So right now, about 80% of our R&D resources is in China and some something between 10% to 20% is in overseas market.

And going forward, we think that we want to probably see a 40% to 60% split, having 40% of the R&D resources in overseas markets. We are working very diligently and actively with overseas development teams to codevelop some games content.

Internally, we have a plan -- we have a clear goal of how we want to achieve the revenue split between overseas market and the China market. And then hopefully, both the China market and overseas markets will account for a meaningful portion of our revenue. Thank you..

Thank you..

Okay. We will take our next question from the line of Yan Bai from CICC. Your line is open, please go ahead..

[Foreign Language] Thanks for taking my question. [Technical Difficulty].

Are you on speaker phone because your line is breaking?.

Hello, can you hear me now?.

[Foreign Language] So, his first question is about the impact of overseas games market, how that would affect our profitability for games business? And the second question was in terms of -- in addition to Japanese market, where other regions we're thinking of publishing ourselves?.

Magic Awakened in Japan, we are globally publishing Lord of the Rings. I think, going forward, with more content partners, with more IP partners and with more self-developed or co-developed titles, our global publishing capability, particularly in major markets will be further strengthened. Operator, next question, please..

Okay. We will take our next question from the line of Jialong Shi from Nomura. Your line is open. Please go ahead..

[Foreign Language] Thanks for taking my question. [Foreign Language] Your game deferred revenue rose by 1% sequentially in 1Q, even though you did not launch any new titles in the first quarter.

Could you give us some color what were the factors that have contributed to this recovery in your deferred game revenue? I just wonder if this recovery has anything -- had anything to do with the lockdown?.

Thank you, Jialong. I'll answer this financial question directly in English. So by the way, we rephrased deferred revenue into contract liabilities just to be more precise and accurate under the accounting literature. So, yes, as you may have noticed, our contract liabilities increased slightly for games, if you exclude Youdao from that.

It's largely attributable to our strong Q1 growth, Q1 performance of PC games. As you may know, Chinese New Year period is typically a seasonality peak for PC games and Fantasy Westward Journey, by the way, after almost two decades of operation have recorded a new record high quarterly gross billing and quarterly revenue in the first quarter.

World of Warcraft also performed fairly strong in the first quarter, contributing to our strong game contract liabilities that's been recorded in the first quarter. That's the main reason. Operator, next question, please..

Okay. Thank you. We will take our next question from the line from Felix Liu from UBS. Your line is open. Please go ahead..

Thank you. [Foreign Language] Thank you management for taking my questions. Let me translate myself. My first question is on Diablo Immortal. First, congratulations on the launch.

Could you share any expectations on revenue or user metrics for this game? And which overseas markets will NetEase be responsible for distribution? And any thoughts or color on the long-term collaboration with Microsoft and Activision, Blizzard post the game launch? My second question is on Yanxuan, more specifically about the COV19 impact to the Yanxuan business in the second quarter and potential turning point? Thank you..

Okay. Thank you, Felix. I'll answer your question directly in English. So first of all, Diablo Immortal, while under the partnership agreement, we are a co-developer. So we got a co-developer share of pie from its global revenue.

In terms of publishing, NetEase is responsible for the games publishing in Mainland China, whereby Blizzard is responsible for its publishing rest of the world. You may have noticed that we also have very close partnership -- business partnership with Microsoft because we've been the exclusive partner for Minecraft for multiple years.

With the announced acquisition of Activision, Blizzard by Microsoft, we are very, very looking forward to a future strengthened partnership between NetEase and the broad Microsoft franchise, because we are a premium content provider. They obviously have very, very excellent first-party studios as well as Xbox distribution platform.

So there are multiple areas that we can explore potential partnership down the road. To your second question on Yanxuan, we will have Yanxuan's CEO, [indiscernible] to answer your question..

[Foreign Language] So it's trading certain regions. And so we do think that our fulfillment and the logistics system has impacted somewhat by the pandemic. And since the end of March, the fulfillment time has been a lot longer than before. But the good news is that, since May, we've seen a much more meaningful improvement and progress.

And we think that progress is still ongoing. Thank you..

Operator, next question please..

We will take our next question from the line of Lincoln Kong from Goldman Sachs. Your line is open. Please, go ahead..

Hi. [Foreign Language] So thanks for taking my question. The question is about the overseas game market and our monetization strategy for international games. As we noted, strong engagement of DBT Mobile in Japan, but relatively small grossing.

So we think that those international games monetization measure is evenly distributed within their product life cycle.

If so, how should we think about those future high-profile international titles in the second half, especially higher, broader Japan? And related to that, how do we view the outlook for the Japanese mobile game market this year, especially year-to-date grossing seems to be a little weaker than expected? Thank you..

[Foreign Language] Yes, it's true that overseas markets are completely different from the China market. In China, majority of the revenue -- games revenue comes from mobile games, whereas for overseas, we have console, we have PC and we have mobile.

So, it's a different type of games, there's very different amortization pattern and for different countries, amortization is different as well. But all of that, it shouldn't be a big challenge for NetEase.

We have decades of experience in gaming R&D, so we should quickly find a way to satisfy users and players in different countries, on different types of devices. Thank you. Next question please..

Okay. We will take our next question from the line of Natalie Wu from Haitong International. Your line is open, please go ahead..

[Foreign Language] Thanks management for taking my question and congratulations for a very strong quarter. My question is regarding the pandemic impact on our game business.

Just wondering, can you comment on the impact of pandemic opening up in overseas markets on your games business? Because some of your peers noted that the weakness coming due to that fact. Just wondering if you also experienced that kind of -- the situation.

And in the meanwhile, in terms of the domestic market, did you see increasing time and value spend on your games during the domestic lockdowns? Thank you..

Hi Natalie, it's Charles. In the interest of time, let me answer your question directly in English. So, the COVID situation has been lasting since -- it's been more than two years. Frankly speaking, I think everyone is a victim of this COVID situation.

Game industry or broadly speaking, entertainment industry is probably a little bit more fortunate that we are less severely impacted by the COVID than many of the other businesses. When -- frankly speaking, we do not observe any weakness from our overseas market right now because we are fairly, fairly new.

And in our early stage of executing our ambitious global strategy, as we continue to launch more games, we feel pretty confident about our growth, particularly in the second half of this year when many of our exciting highly anticipated games will be unveiled to the international game audience.

Now, speaking of the domestic market, for the past quarter, Chinese New Year period is, like I said, a strong seasonality for PC games, but we are not seeing really any meaningful so-called enhanced ARPU or timing spend on mobile. Mobile stayed relatively, I would say, stable.

So you are not really seeing any highs and lows of obvious seasonality’s or one-off implications caused by the lockdown. I think our game development philosophy is fairly consistent and straightforward. We -- there's a lot of these macro situations that's beyond anyone's control.

What we could do is that try to observe the shifting user experience preferences and try to cater to their shifting references by diligently and regularly rollout content update through innovation, through fresh gameplays, et cetera. I think that is kind of an open secret we've been adopting and operating for the last two decades.

From PC screens to mobile screens, through good economies and bad economies, I think that's something -- if anything that we have learned from the COVID or from our past two decades of experience is that the main user-focused and content focused, then we won't go too round off the track. Operator? Maybe we have time for one last question..

Okay. Thank you. We will take our next question from the line of Thomas Chong from Jefferies. Your line is open. Please go ahead..

[Foreign Language] Thanks management for taking my questions.

May I ask a question about the regulatory environment for the online gaming sector to the resumption of the ban [ph] on approval? Should we expect any new regulations or anything that may be released in the future? And on that front, how should we think about the outlook for the domestic gaming sector in coming years in terms of the growth momentum? Thank you..

[Foreign Language] So we're quite optimistic with the growth of the Chinese gaming market. It's a popular form of entertainment among the younger generation. So as you've seen, you see in April, there's been a batch of new license approval.

And I think that going forward, the policy will remain that it supports game content that could be beneficial and educational to the gamers and game players. Thank you..

Thank you. Thank you very much. I think that, that will end our call.

Operator?.

Okay thank you..

Thank you once again. Okay. 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. Thank you..

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