NetEase, Inc. (NASDAQ:NTES) Q4 2023 Earnings Call Transcript February 29, 2024

NetEase, Inc. misses on earnings expectations. Reported EPS is $1.6 EPS, expectations were $1.8. NTES isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the NetEase 2023 Fourth Quarter and Full Year Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Brandi Piacente, President of Piacente Financial Communications. Please go ahead, ma'am.

Brandi Piacente: 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. Joining us today on the call from NetEase Senior Management is Mr. William Ding, Chief Executive Officer; and Mr. Bill Pang, Vice-President of Corporate Development. I will now turn the call over to Bill, who will read the prepared remark on William’s.

Bill Pang: 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 underscore 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 [ph] 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 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 are not only 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 successes in genres that are new to us, Dunk City Dynasty, [Indiscernible] 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 the team rosters.

We have been expanding the player lineup since the fourth quarter, introducing MVPA stars like James Harden, Russell Westbrook, Joel Emmett, Jamal Murray, and Aaron Gordon, as well as CBA legends, including Yi Jianlian and Guo Ai Lun. Beyond the game itself, we are committed to spread 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 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, Dian Feng Ji Su, is another new hit for us, offering top-tier content for all the 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 a top 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 womens romance game, we have once again defied conventions, introducing an infinite school backdrop and bringing players more storytelling and gameplay innovation.

We released the 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, Danzai Pai Dui [ph] 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 be now 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 coming 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 art 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 simultaneous online interaction. Multiple rounds of tasks has shown an excellent performance so far. And we are on course for She Diao soft launch on March 28th this year.

Next comes Where Winds Meet, [Indiscernible], 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, Onmyoji [ph] on mobile earlier this week. We are excited to extend the immersive combat experience enjoyed by players on PC and console platforms to 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 in the acclaimed Mass Effect series. We welcome Mac and his team, who will be dedicated in 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 leadership on the Call of Duty franchise. They are currently working on an ambitious new AAA game set in the 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 stage and professions ensure that native culture foster 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 acknowledgement from the global talent development industry is an honor that further strengthens our commitment to cultivating the new wave of internet talent. Alongside with our business momentum, we have assumed increasing social responsibility.

This comes with a result for that minors [ph] 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 continue 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, comparison 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 the 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 expensive 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, music genres such as hip-hop and Chinese folk have been asserted in popularity on our platform and we continue to cultivate content in these advantageous genres. 2023 also marked our debut of the physical album market with our first co-published physical album, Hua Chenyu's new album, Xīwǎng Hòu [ph], followed by the successful sales of Zhang Jie's physical album, [Indiscernible] in the fourth quarter. We continue to enhance our support system for independent artists by actively investing to initiatives that bolster musicians, improving music creation tools, and expand 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, 2023, [Indiscernible], 2023, and Shengshan, 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 domestic made products in China, Yanxuan has established a 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 digits increase 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. I will now provide a brief review of our 2023 annual results with focus on the fourth quarter. Given the limited time on today's call, I'll be presenting some abbreviated financial highlights. We encourage you to read through our press release issued earlier today for further details. Our total net revenue for 2023 for RMB103.5 billion, or US$14.6 billion, representing a 7% increase year-over-year. For the fourth quarter, total revenue was RMB27.1 billion, or US$3.8 billion, up 7% year-over-year.

For 2023, our net revenue from games and related BES were RMB81.6 billion, or 9% from 2022. Revenue accelerated even faster in Q4 to RMB20.9 billion, up 10% year-over-year. The additional growth was primarily due to increased revenue contribution from launch of new games, such as Justice Mobile, and sustainable development titles like Eggy Party. Revenues from mobile games continue to make up the lion's share of our game business, accounting to 77% of our total net revenue from online game operations in the fourth quarter, and 75% for the year. Youdao's net revenue for 2023 reached RMB5.4 billion, and were up 2% year-over-year in the fourth quarter, in the fourth quarter reaching RMB1.5 billion, primarily due to increased revenue contribution from Youdao's online marketing services.

Net e-commerce music net revenue will RMB7.9 billion for the full year, and RMB2 billion in the fourth quarter a 13% and 16% decline respectively compared to the same period last year. As we have previously discussed, the decline reflects lower revenue from social entertainment services as we adjust our focus to improve profitability in a sustainable manner. Net revenue for innovative business and others were RMB8.6 billion for the year, up 9% year-over-year. In Q4, total revenue were RMB2.8 billion up 12.9% year-over-year mainly due to increased revenue contribution from Yanxuan and some of our innovative business. The total gross profit margin was 62% in the fourth quarter compared with 52.2% for the same period in 2022. Looking at our fourth quarter margin in more detail, gross profit margin was 69.5% for games and related BAS compared with 59.1% in the same period last year.

The increase will primarily attribute to a higher proportion of net revenues contributed by netting self-developed games. Our gross profit margin for Youdao was 49.9% compared with 53.3% in the same period of last year. The decrease was mainly due to reduced revenue contribution from smart devices, which was partially offset by increased revenue contribution from online marketing services, which carry relatively lower margins. Gross profit for cloud music improved in the fourth quarter reaching 30.3% versus 17.8% in the same period a year ago. The margin improvement primarily resulted from increased revenue scale from membership subscriptions and continued improvement to our cost management measures. For our innovative business and others, gross profit margin was 34.4% compared with 31.5% in the fourth quarter of 2022.

The increase was primarily the result of margin improvement in Yanxuan and our advertising services. Total operating expenses for the fourth quarter was RMB10 billion, or 37% of total net revenue. Taking a closer look at our cost composition, our selling and marketing expenses as a percentage of total revenue was 15.6% compared with 13.5% for the same period last year, mainly due to increased spending on gaming promotions we support. On a full year basis, selling and marketing expenses accounted for 13.5% of net revenue, which remained relatively stable compared with 2022 when it was 13.9%. Our R&D expenses as a percentage of total net revenue also remained stable year-over-year at 16.5% in the fourth quarter compared with 16.1% for the same period last year.

On a full year basis, R&D expenses accounted for 15.9% of net revenue, which remained relatively stable compared to 2022 when it was 15.6%. We remain committed in investing to cost integration and product development. We are also seeing leverage in our R&D investment longer term. Our other income was RMB876 million for the fourth quarter compared with RMB1.5 billion last quarter. The decrease was mainly due to exchange rate of US dollars against RMB fluctuating over the period and mark-to-market value of certain publicly traded securities in our investment portfolio witnessed decrease during the fourth quarter. As per equitable accounting standard, we are required to reflect this fair value changes. The effective tax rate was 13.8% for the full year and the fourth quarter.

As a reminder, the effective tax rate is presented on a accrual basis depending on our people policies and our operations. On a non-GAAP net income from continued operations attributes to shareholders for the fourth quarter totaled RMB7.4 billion or US$1 billion up 53% over a year. Non-GAAP basic earning for ADS from a continuous operation for the quarter was US$1.62 or US$0.32 per share. Additionally our cash position remains strong. As of year-end Our net cash position was about RMB110.9 billion compared with RMB95.6 billion at the end of 2022. In accordance with our dividend policy, we're pleased to report that our board of directors has approved a dividend of US$0.21597 per share were US$1.07985 per ADS. Lastly under our current US$5 billion share repurchase program starting in mid-January last year we have repurchased approximately 7.2 million ADSs at December 31st of 2023 for total cost of approximately US$644 million.

Thank you for your attention. We would not like to open the call to your questions.

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