Good day, and welcome to the NetEase 2023 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Margaret Shi, Senior IR Director of NetEase. Please go ahead, ma'am..

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 third 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 a 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 remark on behalf of William..

Bladepoint mobile game. On the global stage, our game development is progressing smoothly in Japan, North America, and Europe. This month we are excited to welcome Fantastic Pixel Castle as our newest additions to the NetEase family.

Fantastic Pixel Castle is led by Greg Street who is well-known for his contribution to massively successful games around the world including World of Warcraft and League of Legends.

Greg and his experienced founding teams are currently developing a top-tier MMO game code named Ghost to provide players with a fresh and immersive fantasy MMO experience. We are thrilled to collaborate with so many talented industry producers leveraging their creativity in synergy with our deep research and operational capabilities.

Together, we aim to deliver even more captivating games to players worldwide. Now let's move on to Youdao. In the third quarter, Youdao achieved record-high revenue of RMB1.5 billion growing 10% year-over-year, driven by the growth in learning services and online marketing.

Additionally, as part of our continued efforts to improve profitability, our operating loss for Youdao narrowed by a significant 74% year-over-year to RMB58 million. A solid growth in our learning services was due to our consistent ability to launch unique and high-quality courses.

Notably in the third quarter, our coding courses introduced a specialized program aimed at preparing students for the CSP Informatics competition, one of the most popular competitive programming events in China. Our program features all-encompassing services that include learning, context practice, and an evaluation system.

The evaluation system is supported by our in-house developed scoring model allowing students to estimate their scores and assess their probability of progressing into the next round of the contest. Youdao's online marketing services have consistently grown at an impressive rate of approximately 100% for the second consecutive quarter.

This underscores our expertise in proprietary algorithms and the effectiveness of our customized solutions that are precisely crafted for diverse industry sectors. Revenues from our smart devices declined in the third quarter as we strategically optimized our channel mix by reducing sales through less the cost-effective channels.

Although this may have a temporary impact on Youdao's revenue, we believe it will lay a solid foundation for sustained long-term growth and enhance Youdao's profitability potential over the long run. Our focus on technological innovation remains our driving force.

In addition to Youdao's tech-boosted performance, we upgraded AI Box on Youdao translation product in the third quarter, which enables more accurate and natural translation across various types of documents.

With the support of our machine-generated functions, third quarter revenue from subscription fees for translation increased by over 160% year-over-year.

Furthermore, following the August introduction of our digital human language coach Hi Echo through Youdao Dictionary Pen X6 Pro, we expanded our reach to a broader user base through an independent app in October attracting over 100,000 user registrations within just a month. We will continue to iterate Hi Echo with a new update coming soon.

Looking forward, we will look to drive more technological innovation and introduce more products that genuinely meet our users' needs by harnessing our expertise in machine learning technology. Next turning on to NetEase Cloud Music.

In the third quarter of 2023, Cloud Music continues to navigate quality development across our core music-centric ecosystem while further extending the robust monetization momentum in the core online music sphere and improving overall profitability.

Total online music MAUs remained largely steady staying above RMB200 million in the Q3, total revenues for the quarter were RMB2 billion on par with late last quarter. Growth in our music-centric memberships accelerated demonstrating our ability to introduce premium offerings including expensive content and innovative features.

Additionally, our social entertainment services started to stabilize on a monthly basis during the latter part of third quarter following our strategic positioning refinements in live streaming which resulted in short-term setbacks with solid monetization momentum in the core online music businesses and continued cost structure optimization, Cloud Music maintained steady margin improvement for the period.

We are constantly expanding our music library to provide a comprehensive selection of music for our diverse audience base. During the third quarter, we broadened our extensive music collection by adding songs from popular Chinese pop artists like Karen Mok, ZHENG Jun, and ZHANG Jie.

In addition, we were delighted to release albums by pop stars including JAM, KeyNG, and Shen Yichen [ph]. As part of our ongoing commitment to enriching our music-centered ecosystem, we remain dedicated to empowering and assisting independent artists.

As of the end of September, we proudly serve a thriving community of over 660,000 registered independent artists showing strong growth of 16% compared with the same period last year. We have also broadened our support for emerging music talent.

Our new programs are tailored to regional routes and distinctive styles in different areas, including programs like Localized Sound and Project Sound Season Five to honor and promote more diverse artists. At the same time, we hosted offline music festivals such as 65PARK Camp Music Festival, providing more exposure for our independent musicians.

In addition to broadening our content selections, we continued our product innovation initiatives, aiming to elevate users' music listening experience and foster our music-centric community.

We have recently officially launched the Private DJ feature incorporating music recommendations with an intelligent and personalized music introduction and explanatory experience. This feature allows users to record old-fashioned radio DJ, while enjoying a more personalized music accompaniment, as part of their listening experience.

Building on our iconic comments section, our Comments Square has emerged as a vibrant gathering place for users to express and find connections with one another. Moving on to Yanxuan, in the third quarter, our private-label consumer brand launched more popular products through diversified channels.

We saw robust sales growth in selected categories like pet supplies and home cleaning products and sellers like ergonomic chairs, bathroom fragrances, and cat food, consistently outperformed competitors across various platforms.

Our strategic efforts including efficient warehouse and distribution management and personalized packaging have also proven successful.

Thanks to the innovative marketing campaign, our Down Jacket series, which is highly acclaimed for its exceptional quality at affordable price, gained immense popularity during this year's Double Eleven online shopping event, driving the collection to hit top positions on multiple bestselling charts on several e-commerce platforms.

In summary, innovation is at the core of all of our businesses, driving our growth and our competitive edge. We believe that great content, product, and services, stem from new and creative ideas. This principle lies at the heart of NetEase, whether it is games, Cloud Music, Youdao or Yanxuan, we consistently strive to reach new heights.

In doing so, we help to drive the industries we serve forward, while delivering value to our growing global community, our partners, our team members, and our stakeholders. This concludes William's comments. I will now provide a brief review of our 2023 third quarter financial results.

Given the limited time on today's call, I will be presenting some abbreviated financial highlights. We encourage you to read through our press release, issued earlier today for further details. Total net revenues for the third quarter were RMB27.3 billion or US$3.7 billion, representing an increase of approximately 12% year-over-year.

Total net revenues from our games and value-added services were RMB21.8 billion, up 16% year-over-year. The growth was primarily due to increased revenue contribution from newly launched games such as Justice Mobile Game, Racing Master, and Eggy Party.

Net revenues from our mobile games accounted for nearly 78% of our total net revenues from online games operations. Youdao's net revenues were RMB1.5 billion, a year-over-year increase of nearly 10%, primarily due to increased revenue contribution from learning services and online marketing services.

Net revenues from Cloud Music were RMB2 billion, a 16% decline compared to the same period last year. As we explained earlier, this result reflects declining revenue of social entertainment services as we adjust our focus to improve profitability in a sustainable manner.

Net revenues for innovative businesses and others were relatively flat in the third quarter at RMB2 billion. Our total gross profit margin continues to grow exceeding 62% in the third quarter, compared with 56% in the third quarter of 2022.

Looking at our third quarter margin in more details, gross profit margin was 69% for our games and related value-added services compared with 65% in the same period of last year. The increases were primarily attributable to changes in the revenue mix of the NetEase self-developed and co-developed and license gains.

GP margin for Youdao was 55.9% compared with 54.2% in the same period of last year. The increase mainly resulted from increased revenue contribution from its learning services and online marketing services segment. Gross profit margin for cloud music improved in the third quarter reaching 27.2% versus 14.2% in the same period a year ago.

The margin improvement primarily resulted from increased revenues, scale from membership subscription, and continued improvement to our cost management measures. For innovative businesses and others, gross profit margin was 27.3% compared with 25.5% in the third quarter of last year.

The increase was primarily the result of margin improvement in Yanxuan and some of our innovative businesses. Total operating expenses for the third quarter were RMB9.4 billion or 35% of our total net revenues.

Taking a closer look at our expense composition, our selling and marketing expenses as a percentage of total net revenues were 13% in the third quarter compared with 15.4% for the same period of last year. This reflects our ongoing efforts to consistently enhancing marketing efficiency.

Our R&D expenses as a percentage of total net revenues also remained stable quarter over quarter at 16%. As always, we are committed to ongoing investments in content creation and product development. We are also seeing leverage in our R&D investments longer term. Our G&A expenses as a percentage of total net revenues was 5.5%.

The slight increase from the previous quarter was primarily due to certain one-off items. Our other income was RMB1.5 billion for the third quarter of 2023 versus RMB2.8 billion in previous quarter. The decrease was mainly due to the exchange rate of the U.S. Dollar against the RMB is fluctuating over the period.

As per applicable accounting standards, we are required to reflect these fair value changes. The effective tax rate was 14.2% for the third quarter. As a reminder the effective tax rate is presented on an accrual basis and the tax credits differ for each of our entities at different time periods depending on applicable policies and our operations.

Our non-GAAP net income from continuing operations attributable to our shareholders for the third quarter totaled RMB8.6 billion or US$1.2 billion. Non-GAAP basic earnings from continuing operations per ADS for the quarter was US$1.84 or US$0.37 per share.

Additionally, our cash position remains robust with net cash of approximately RMB104.4 billion as of September end compared with RMB95.6 billion as of the end of last year. In accordance with our dividend policy, we are pleased to report that our Board of Directors has approved a dividend of US$0.0990 per share or US$0.4950 per ADS.

Lastly, under our current US$5 billion share repurchase program starting in mid-January this year, we had repurchased approximately 7 million ADS as of September 30, 2023, for a total cost of approximately US$588 million. Thank you for your attention. We would like now to open the call to your questions. .

[Operator Instructions]. Our first question comes from Ritchie Sun with HSBC. Please go ahead..

[Foreign Language]. I will translate these questions myself. Thank you, management, for taking my questions. I have a question about the competitive landscape for Party games.

Does management think it's a winner takes all market or can you have two players? And we noticed that Eggy Party has strong user base and UGC content already, given that there are more potential competition from other platforms, what would NetEase further do to sustain the leadership? Thank you..

[Foreign Language]. Just a translation for William. So, we think it's absolutely normal to have a competition. So, from that perspective, we will continue to drive innovation and provide good services to our users, and that's how we lead the market. So, we have full confidence in keep placing our users in the Party game genre. Thank you.

Next question, please..

Our next question comes from Yang Bai with CICC. Please go ahead..

[Foreign Language]. My question is about the flagship games. Could management share more details with us about how do the flagship game such as [indiscernible] and Racing Master game? Thank you..

[Foreign Language]. So, I want to say, that the most important thing for a game is innovation and continue to provide high-quality content for our users and it is important for us to focus on the long-term longevity of our games and never make any short-term decisions.

So, based on our 20 years of operational experience, we think that a long-term goal is key. Thank you. Next question, please..

Our next question comes from Felix Liu with UBS. Please go ahead..

[Foreign Language]. Let me translate myself. Thank you, management, for taking my question, and congratulations on the strong third quarter results. My question is on the pipeline.

In among the three your games already have done how including Studio, Where Winds Meet, and Project Zero? How's the R&D progress for these games? And when do you think these games can come to market? And for the other games that are still waiting for Banhao, such as Naraka Mobile and Project Mugen.

Does management have any color on their R&D progress? Thank you..

[Foreign Language]. Thank you. Just a quick translate for William. Yes, so for each of our games, it's always after very careful adjustments, moderation before we are ready to release them to the market.

And so, games such as studio, we are still, we're in the final stage of preparation and hopefully we'll get them released to the market no later than the second quarter of next year. Thank you. Next question, please..

Our next question comes from Thomas Chong with Jefferies. Please go ahead..

[Foreign Language]. Thanks, management for taking my questions. My question is about overseas strategies. Given that we have demonstrate very good sets of result in the domestic market with a very solid pipeline. How should we think about our overseas expansion in the coming years as well as our investment strategies? Thank you..

[Foreign Language]. So, on the global market, we will continue our strategy of high-quality focused direction, and we'll continue to look for partners who share the same mentality, share the same passion for games as we do and continue to invest in good teams to produce and create great content for users all around the globe. Thank you.

Next question, please. .

Our next question comes from Lincoln Kong with Goldman Sachs. Please go ahead..

[Foreign Language]. So, thank you, Mitchell, for taking my questions. So, we have seen this year our successful title from Eggy Party and Justice Mobile, which is a bit different from traditional legacy games, have a very big user base and DAU.

So, when we think about the future upcoming launching games, especially for next year where Weemings and Xiaodao [ph], should we expect some of the similar type of features and anything we can sort of copy from past success? When should we expect the next success of Justice Mobile?.

[Foreign Language]. Thank you. Let me do the translation. So, the large DAU games is definitely a very important direction for us. We'll continue to find the key takeaways from the games that have succeeded in order for us to produce more games of this type.

But at the same time, it's also very important to create high-quality games of a particular niche category to meet the different requirements and preference of different type of users. For example, this year, we launched a basketball game, racing car games. So, these are good examples of top-performing games of each of their respective categories.

So, within that ease, we have lot games who teams who specialize in large DAU games and our teams that focus on particular niche. So that we have various different teams with NetEase and we encourage them to show do to apply their unique edges and unique experience. Thank you. Next question, please. .

Our next question comes from Ritchie Sun with HSBC. Please go ahead..

[Foreign Language]. So, the Dunk City Dynasty has quite successful despite launching without Android App Store. Although it could have higher channel costs, Android can also bringing more users potentially, which can sustain the game longevity.

So how does management assess the ROI of not using Android store? And what type of titles would absorb a single launch strategy in the future? Thank you..

[Foreign Language]. Thank you. So, for games that we are targeting towards a massive user base, the Party games, games that are targeted for all ages, for these types of games, the distribution platforms are more effective in reaching out more users.

But for games such as Basketball game, it requires a specific group, a specific community of game players. So, we can find these players through various different platforms and channels.

So, in order for us to bring them onto to NetEase platform and to operate this game for a long period of time, in order for us to get to know these users a little bit better and then to continue to perform different situations to give better service and experience to our platform users.

We also want to add that, for Android platform users, they can also download our games through our own website and TapTap and various other channels. Thank you. Next question, please..

Our next question comes from Alex Poon with Morgan Stanley. Please go ahead..

[Foreign Language]. Congratulations on a very strong quarter. My question is related to AIGC.

And can AIGC for our future game updates, and expansion packs be much more frequent than the current three months to six months, becoming on a monthly basis or even weekly basis, and such that the longevity and gaming user stickiness monetization can go, can get better? Thank you, very much..

[Foreign Language]. Yes. We agree that AI is extremely helpful in increasing, enhancing the R&D efficiency, particularly in areas of game designs, storyline design, mission designs, and art et cetera. So almost every year, we can, every month, we can see another upgrade in terms of R&D efficiency.

But while the productivity is increasing, but the pace of us pushing out expansion packs is not completely dependent on that. We need our users to enjoy our content fully. So, the pace and frequency has already now expansion packs is still very much dependent on the preference of our gamers.

So, we want to run each of our game for a long period of time. So, with the increased efficiency, we can provide higher quality content within the same amount of time frame. Thank you. Next question, please..

Bladepoint mobile and Project Mugen. Are they likely will be released in 2024? Thank you very much..

Bladepoint mobile game, as you know, the game has been under translation for a little, for a while now, and I think we are fully prepared. The only thing we are waiting for is the license approval. So, once we receive license approval, the product should be ready to go.

In terms of project medium, it's one of the games that's highly anticipated by both us and the gaming community. So, we want to keep surprise our players with great content, so we're going to continue to invest in more resources in developing that game in order to create next-generation quality content.

So, for now, we do not have a timetable to share. Thank you. The last question, please. .

Our last question comes from Alicia Yap with Citigroup. Please go ahead..

[Foreign Language]. My question is related on Justice Mobile.

So, in addition to the new user for those existing NetEase gamers, where do these gamers come from? Which NetEase game had they were playing before and which non-NetEase game that these players used to play before Justice? Is the paying ratio and also, the ARPU for Justice much higher than the other NetEase game? Thank you..

[Foreign Language]. So, for Justice Mobile, based on our stats about roughly a third of our users have never played NetEase games before and this game has mostly come from other large DAU products around the market, which means that this is actually a very friendly among many other types of users.

In fact, I mean, this year, some of the other games that we launched, such as the Basketball game and the Racing Master, they also enjoyed many a large portion of gamers who have never played NetEase games before. So, in terms of the paying ratio, and monetization of Justice Mobile.

So, for Justice Mobile, we have actually we opted a more a lighter monetization model. And because of that, the ARPU is relatively lower with a much higher pay-in ratio.

So, we purposely chose this monetization model so that we can create a more healthy, and balanced in-game environment, giving our game players less pressure in terms of paying to give them a long-term enjoyable environment in which they can enjoy their games. Thank you. Yes. So, I think that's all the questions we have for today.

Operator?.

Thank you. That concludes the question-and-answer session. I would like to turn the conference back over to management for any additional or closing comments..

Thank you once again for joining us today. If you have any further questions, please feel free to contact us directly at Piacente Financial Communications. Have a great day. Thank you..