Good day, and welcome to the NetEase 2022 Second 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, 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 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’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 in 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 and a reconciliation of GAAP to non-GAAP financial results, please see the 2022 second quarter earnings news release issued earlier today. As a reminder, this conference is being recorded.

In addition, the 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.

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

Magic Awakened and other exciting games such as Fantasy Westward Journey Online. Net revenues from our mobile games accounted for approximately 66% of net revenue from the operation of online games. Youdao’s net revenues were RMB956 million, compared with RMB1.3 billion in the same quarter last year.

The decline was mainly due to the conclusion of Youdao's after-school tutoring services for academic subjects on the China's compulsory K9 education system, which were previously included in its learning services back in 2021. Net revenues from Cloud Music were RMB2.2 billion, up nearly 30% year-over-year.

The increase was mainly due to the increased revenues from membership subscription, as well as social entertainment services. Net revenues for innovative businesses and others were nearly RMB2 billion, up 14% quarter-over-quarter, mainly due to increased contribution from Yanxuan in the second quarter.

Our total gross profit margin rose to 55.9% in the second quarter, up slightly compared with 54.5% in the second quarter of last year. GP margin for the games and related value-added services was 64.9%. The majority of our gross profit in this segment is contributed by online games revenue.

The contribution from related VAS is relatively much smaller, which carries a lower margin than online games. Therefore, even with adjustments to our line items, our games and related VAS margin is generally stable with some narrow fluctuations based on the revenue mix of mobile and PC titles, self-developed, co-developed, as well as licensed games.

GP margin for Youdao was 42.8%, compared with 52.3% in the same period of last year. The decline was mainly due to the lower revenue proportion from Youdao's learning services, resulting from the conclusion of the after-school tutoring businesses for K9 academic subjects.

Gross profit margin for Cloud Music continues to improve in the second quarter, climbing to 13% versus 4.1% a year ago. The significant margin improvement primarily resulted from strong top line growth, as well as the improved efficiency of our content investment. GP margin for innovative businesses and others was 25.8% compared with 27.3% last year.

The decline was mainly due to the result of decreased revenue from higher-margin advertising services. Total operating expense for the second quarter were RMB8 billion, or 35% of our total net revenues.

If we look at our cost composition in more details, our selling and marketing expenses, as a percentage of net revenue were 14%, compared with 15% for the same period last year. The change was mainly due to less marketing spend related to Youdao.

If we exclude Youdao, our selling and marketing expenses as a percentage of net revenue were 12%, compared with 11% in the same period last year, mainly due to increased spending on certain games promotion during the second quarter.

Our R&D expense were RMB3.6 billion or 15% as a percentage of total net revenue, compared with 17% for the same period last year. We remain committed to investing in content creation and product development. We are also seeing leverage in our R&D investment.

Our other income was RMB785 million for the second quarter compared with RMB28 million last quarter. The quarter-over-quarter increase was mainly due to the exchange rate of the US dollar against RMB fluctuating over the last couple of periods. Our effective tax rate for this quarter was 22%.

As a general reminder, the effective tax rate is presented on an accrual basis and the tax credit deferred from each of our legal entities at different time periods depending on applicable policies and our operations.

Our non-GAAP net income from continuing operations attributable to shareholders for the second quarter totaled RMB5.4 billion or US$808 million. Non-GAAP basic earnings per ADS from continuing operations for the quarter was US$1.23 or US$0.25 per share.

This quarter, we also had RMB625 million of net income from discontinued operations, which was related to the disposal of the Kaola business. Additionally, our cash position remains strong. As of the quarter end, our net cash position was about RMB88 billion, compared with RMB86 billion as of the year-end last year.

In accordance with our dividend policy, we are pleased to report that our Board of Directors has approved a dividend of US$0.072 per share or US$0.36 per ADS. Lastly, we continued to buy back shares during the period.

Under our share repurchase program for up to US$3 billion, approximately 24 million ADS has been repurchased as of June 30 year for a total cost of approximately US$3 billion. Meanwhile, under NetEase Youdao purchase program for up to US$50 million, approximately 1.7 million ADS has been purchased for a total cost of about 18 million as of June 30.

In addition, NetEase purchased about 0.8 million ordinary shares of Cloud Music for a total cost of US$8 million during the second quarter. Thank you for your attention. We would like now to open the call to your questions. Operator, let's go to Q&A..

Thank you. [Operator Instructions] We will take our first question from the line of Yang Bai from CICC..

[Foreign Language] Okay. Thank you, management. NetEase has continuously made efforts in the overseas market in recent years and has established several game developers overseas. What is our take on the pace of overseas investments in the future? Also, could you perhaps share some colors on the products in development? Thank you..

Overseas market is upgrade important for NetEase. And as everybody knows that in the past year, we've not received any license approval of [indiscernible] in China. So we have to make the strategic choice to shift some of our R&D resources to the global market, the European markets to the Japanese -- or the Asian markets.

So everybody knows that we have a very strong track record in game production. We have very high R&D efficiencies, and we are now working very closely with many overseas developers to find a product that will be welcomed by the global game players. We actually do have a lot of products under development.

And hopefully, you will see some of them being introduced to the market very soon. On June 2, everybody saw the success of Diablo that we – Blizzard, and I think it's been a very positive -- very, very strong release of that game. Thank you..

Our next questions from the line of Thomas Chong from Jefferies..

[Foreign Language] Thanks management for taking my questions. We have seen Internet companies highlighting about cost efficiencies, such as staff costs and marketing spending on the back of global macro heaviness these days. Can management share the thought about the outlook about the operating expenses in sales and marketing, R&D and G&A? Thanks..

[Foreign Language].

So it's not -- the question is about cutting costs. So the question is about optimization of cost. Sometimes it throughout of development operation of our business, sometimes we do have -- we do cut costs in certain areas, but we'll also increase our investment spend in other areas.

So NetEase, we will continue to optimize the way we spend the cost structure of the company. Only just because there is weakness in the macro, it doesn't necessarily mean that we have to take certain actions to address that. NetEase, we think very long-term, and we care about the sustainable long-term growth of the company. Thank you..

And Thomas, it's Charles. Just to add a bit more.

As you can see, we've always been very committed in R&D spending over the past couple of years, our had strong headcount, total headcount also remained relatively stable because for us, we think investing into talent, investing into technology is the key competence in us creating the world-class content..

Thank you, Thomas. Next question please..

Okay. Thank you. We will take our next question from the line of Kenneth Fong from Credit Suisse..

[Foreign Language] Thank you management for taking my question. What's management view on the domestic regulatory landscape and expectation on the Banhao approval? With a likely lower number of Banhao approved in the future, how will this change our game strategy, including Jar app, IP investment, et cetera? Thank you..

[Foreign Language].

So, I kind, of mentioned that in the earlier question, one of the reasons we have to look abroad and be more active in expanding our -- against our user base overseas because of lack of know-how in China.

And secondly, it kind of tells you -- tells us that we have to value or cherish the domestic market even more, because know-how the precious resources now. So everybody how we get, we have to work, we’re putting more effort to make sure every game we develop -- launch to the market will be popular, will be welcomed by the game players in China.

Thank you..

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

Bladepoint mobile.

So from a longer term perspective, how do we see the potential for the mobile game version? What's our differentiated strategy to penetrate those large DAU based for battle royale game type and especially acquiring the market share from those competitors?.

[Foreign language].

Sure. Thanks. The first question is on Infinite Lagrange. So our team actually has strong expertise in voting game for a very long period of time.

So Infinite Lagrange has actually in operation for quite a while, we introduced a new version this year and the game player seems to have loved this new version, which means that the content was strong enough to attract a whole new – whole brand-new set of game players and that gives us confidence that we will be able to continue to expand this category.

Thank you..

[Foreign Language].

BLADEPOINT has been so successful is because the user experience it creates is very unique experience such as combat experience, free movement in the game.

And the reason why in the past that in our competitors or other developers have not been able to create a game like NARAKA is because this game requires very hardcore and cutting-edge technology to deliver that type of user experience. So again, we are – so – we will continue to explore various ways to give our users a continued good user experience.

Thank you..

Okay. Thank you. We will take our next question from the line of Alicia Yap from Citigroup. The line is open. Please go ahead..

Okay. Hi. Good evening. [Foreign Language] Good evening, management. Thanks for taking my questions. My question is related to the US ADR delisting risk.

So, whether management has any comments on your plans for the primary Hong Kong leasing? And if so, what is the rough time frame that we should expect that to happen? And then if management have any latest update that you could share with us regarding discussion status between China and US and whether the ADR will indeed be delisted from the US exchange? Thank you.

.

Thank you, Alicia, it's Charles. Let me answer your question directly in English. So firstly, we are very closely monitoring the situation. As everyone knows, this is a topic or rather this is a question that's beyond the control of an individual company.

It is more of a job political issue, but we remain cautiously optimistic that US and China, the two largest countries in the world and the senior leadership, will find the common ground of interest. So, we think a kind of a hard landing or decoupling between entirely the Chinese companies. There are over 200 Chinese companies listed in the US market.

We really don't think a hard landing or decoupling would take place or rather be accelerated. What we could control though, is that we are making very proactive preparation in the event or in a hypothetical scenario, if that extreme situation happened then NetEase will be prepared to continue being a listed a liquid asset.

As many of you know, we are in fact, the second Chinese ADR that is being dual listed in Hong Kong back in 2020, although we were -- we are currently a secondarily listed status on the Hong Kong Stock Exchange.

The conversion between secondary listing to primary listing is more of a technical paperwork or in a joking way, it's more of a lawyer's work. There's no barrier or there's no roadblocks per se and the preparation work, some of them has been undergoing for a while by us.

We think if the situation requires the conversion will be a very swift and smooth process..

Thank you, Charles..

Okay, thank you. We will take our next question from the line of Natalie Wu from Haitong International..

[Foreign Language] Let me take in my first question. Thanks, management, for taking my question and congratulations for very strong quarter. My question is related with the recent World of Warcraft, mobile game rumor. Just heard that collaboration has been halted.

So, I just wanted to make sure, if this is an independent effect, or should we be concerned regarding company's future relationship with Blizzard, especially after the Microsoft deal next year? And secondly, very quickly follow up with the Infinite Lagrange mobile game.

I was just wondering, if the majority of the recent incremental user of booking is generated through the [indiscernible] game publisher plan initiatives? And if yes, how should we think of the related margin profile? Thank you..

[Foreign Language].

Just translate the -- for the first question. So lastly -- like you said, the case on World of Warcraft is the independent one. So our relationship with Blizzard has been very good. And as you’ve seen recently, we codeveloped and copublished Diablo on well stage and achieved very positive results. Thank you..

Yes. Natalie, for your second question on Infinite Lagrange, the answer is -- the short answer is that, we -- from time to time, we continuously monitor and explore what we think are effective ways of user acquisition and marketing doing amongst many others is a conducive marketing channel for certain type of games, maybe not all.

For Infinite Lagrange, it works for certain types of marketing spending. But all in all, when we look at overall margin profile of a game, obviously, we factor in a lot of considerations, marketing channels, marketing expense being one.

But the success or rather the increasing popularity and success of Infinite Lagrange, I don't think it's only dependent on one single source of marketing channel.

It played a role, but I think more importantly, the success is underscored by the continuous expansion packs in particular, the expansion pack that we released in the second quarter was particularly effective..

Got it, very clear. Thank you..

Okay. Thank you. We will take our next question from the line of Charlene Liu from HSBC..

Thank you. [Foreign Language] Thank you, management for giving me the opportunity to ask the question. We understand that app is off to an excellent start, recording amazing download and growth billing figures.

How would the management evaluate the app performance so far? And what are your expectations on the longevity of the game? Also what are the key KPIs would you be tracking mainly? Thank you very much..

[Foreign Language].

Diablo has achieved very prominent results on a worldwide stage. And it's a very strong MMO game, and like we've done with our -- many of our legacy games. We will continue to issue strong content, good expansion packs to serve our global game players as well. Thank you. Thank you, next question please..

We will take our next question from the line of Alex Poon from Morgan Stanley..

BLADEPOINT on Xbox after its release in June and the timeline for PS5 and other platforms in the future? Thank you..

[Foreign Language].

So our product is designed to provide strong user experience for all players. We are not targeting only those who pay a lot of money in the game. We want to serve all of our players of all levels, equally well. So there are many of my friends globally, who have hosted. They've had a great time, playing Diablo without having to spend much money.

And it is true, there are many cultural differences, player differences in different regions around the globe, and we will endeavor to provide great experience to players in every country, every region of the world. Thank you..

[Foreign Language].

Bladepoint was launched Xbox and we joined Xbox Live, which brought us a lot of incremental users, particularly console game players. And in terms of PlayStation 5, we're looking at a launch around end of this year or early next year. Thank you. Thank you very much.

Thank you that end our call, Operator?.

Thank you. Okay. Due to time constraint that concludes today's question-and-answer session. I will turn the conference back to Margaret Shi for any additional or closing remarks..

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 participation..