Next year's game reserves remain abundant (NetEase 3Q23 conference call minutes)

Summary of the 3Q23 Earnings Call of NetEase.US (NTES.US), for reference, please see the analysis report "NetEase: Is the "Money Printing Machine" Going Downhill? Is the Pig Farm Not Scary?"

I. Management Remarks

1. Gaming

(1) Legacy Games

• "Fantasy Westward Journey" series: Introduced new storylines and activities in 3Q23 to inject new vitality into the classic game and drive revenue growth.

(2) New Games

The company actively expanded its product portfolio and further strengthened its leading position in the MMO gaming sector. At the same time, it expanded its influence in a broader range of game categories and player groups through innovative content, gameplay, and monetization models.

• "Justice" mobile game: Launched in June 2023, with over 50 million registered users by October, it has become one of the largest games in the company's history.

In addition to "Justice" mobile game, NetEase achieved success in other game categories in the third quarter.

"Top Speed Racing": Ranked in the top three in terms of downloads and revenue rankings after its launch, it has high appeal to racing enthusiasts. As China's first 3A-level racing simulation mobile game, "Top Speed Racing" brings the racing experience into the mainstream gaming field in China, meeting the demand for casual games and leveraging the company's rich R&D capabilities.

"Egg Party": In August, it created over 100 million UGC maps and attracted 100 million users. The company is committed to cultivating a UGC ecosystem. In 3Q23, it enhanced its self-developed editor by introducing more advanced interactive features and added collaborative map creation functionality, allowing players to create and share maps online with friends, enhancing creativity.

"Endless Journey" PC game: After transitioning to a free-to-play model in July, the game reached the milestone of 40 million users. In 3Q23, a new hero was introduced, attracting a large number of new users to join the game.

(3) Games in Development

"Yanyun Sixteen Tones": A martial arts action game that creates an immersive open world and adopts an interactive sandbox adventure mode. Users can explore the world flexibly and engage in solo or cooperative activities, choosing between single-player or MMO modes. The game is about to launch its second round of testing, with longer testing time and richer content. It is expected to be released in 2024.

"Code: Great World": An open-world ACG game that leverages the company's innovative capabilities and experience in the anime and manga gaming sector to inject new vitality into the game.

Other games: "Mission Zero," "The Legend of the Condor Heroes," "Endless Journey" mobile game.

New studio: Fantastic Pixel Castle, led by former chief designer of "World of Warcraft" and "League of Legends," Greg Street. The team is developing a fantasy MMO game codenamed "Ghost." 2. Youdao

Driven by leading learning services and online marketing, Youdao achieved operating revenue of 1.5 billion yuan in 3Q23, a YoY increase of 10%. Operating losses narrowed by 74% YoY to 58 million yuan.

3. Cloud Music

The company has developed a core ecosystem centered around music to improve overall profitability. The user base remains stable, with approximately 200 million MAU in 3Q23. Operating revenue in 3Q23 reached 2 billion yuan, with a relatively stable MoM growth. After adjusting its live streaming strategy, the social entertainment business gradually stabilized in the latter half of 3Q23.

4. Netease Yanxuan

The sales volume of self-branded products, such as pet supplies, robots, and household cleaning products, continued to grow through diversified channels.

II. Financial Data

(1) Revenue

Total revenue in 3Q23 was 27.3 billion yuan, a YoY increase of 12%.

Games: Due to the increased contribution of new games such as "Nishuihan," revenue in 3Q23 reached 21.8 billion yuan, a YoY increase of 16%.

Youdao: Due to the increased contribution of learning services and online marketing services, revenue in 3Q23 was 1.5 billion yuan, a YoY increase of 10%.

Cloud Music: Net revenue in 3Q23 was 2 billion yuan, a YoY decrease of 16%. This was due to the company's adjustment of its development focus to improve profitability in a sustainable manner, resulting in a decrease in revenue from social entertainment services.

Innovation and other businesses: Net revenue in 3Q23 was 2 billion yuan.

(2) Gross Margin

The overall gross margin in 3Q23 increased from 56% in the same period last year to 62%.

Games: The gross margin increased from 65% in the same period last year to 69%, mainly due to changes in revenue structure.

Youdao: The gross margin decreased from 54.2% in the same period last year to 55.9%, mainly due to the increased contribution of learning services and online marketing services.

Cloud Music: The gross margin increased from 14.2% in the same period last year to 27.2%, mainly due to the increase in revenue from member subscriptions.

Innovation and other businesses: The gross margin increased from 25.5% in the same period last year to 27.3%, mainly due to improved cost management measures and the growth of innovative businesses such as Netease Yanxuan.

(3) Expense Structure

Operating expenses in 3Q23 totaled 9.4 billion yuan, accounting for 35% of total revenue.

Sales expenses: The expense ratio was 13%, compared to 15.4% in the same period last year, reflecting the company's continuous improvement in marketing efficiency.

R&D expenses: The expense ratio was 16%, relatively stable MoM, while continuing to invest in content and product development.

Administrative expenses: The expense ratio was 5.5%, with the increase mainly due to one-time impacts. (4) Net Profit

In 3Q23, other income was 1.5 billion yuan, compared to 2.8 billion yuan in the same period last year, mainly due to exchange rate fluctuations.

The effective tax rate in 3Q23 was 14.2%. However, it should be noted that the company's deferred taxes may vary with changes in tax policies in different periods and operating entities.

Non-GAAP net profit attributable to shareholders was 8.6 billion yuan, and Non-GAAP earnings per ADS were $1.85/$0.37.

(5) Cash and Dividends

The company's cash flow is approximately 104.4 billion yuan.

Dividends: The board of directors has approved a dividend of $0.099 per share, or $0.495 per ADS.

Share repurchase: Under the $5 billion stock repurchase plan, starting from mid-January 2023, as of September 30, the company has repurchased approximately 7 million shares, with a total investment of $588 million.

III. Analyst Q&A

Q1: How does the company view the competitive landscape of party games? Is it a winner-takes-all situation or can there be multiple game products? How will the company respond to competition and maintain its leading position?

A1: Competition is normal, and NetEase will continue to innovate and provide high-quality services to attract players and steadily advance in the market. The company is confident in its efforts and appeal in party games.

Q2: How does the company maintain the strong vitality of long-running games like the "Fantasy Westward Journey" series? What is the current revenue and internal ecosystem of these games?

A2: In games, innovation comes first, followed by providing high-quality and segmented content to meet user needs, thereby maintaining the long-term vitality of the games. NetEase has adhered to a long-term philosophy in game operation for over 20 years and will not engage in short-term behaviors for the sake of short-term profits.

Q3: What is the status of the company's upcoming reserve products? For the three games with approved licenses, "The Legend of the Condor Heroes," "Yan Yun Sixteen Tones," and "Project Zero," can you provide updates on their development progress and when they will be launched in the market? Are there any updates on games awaiting licenses, such as the mobile game "Endless Journey" and "Code: Infinite"?

A3: Every game product launched by NetEase undergoes careful polishing and is only provided to users when its quality is guaranteed. Games like "The Legend of the Condor Heroes" and "Project Zero" are in the final stages of preparation for launch, and "Yan Yun Sixteen Tones" is expected to be launched no later than 2Q24.

Q4: Can the management share the future strategy and plans for the company's overseas business?

A4: In the global market, the company will adhere to the principle of focusing on high-quality content and actively seek cooperation with partners who share the same research and operation concepts worldwide. NetEase will continue to support outstanding overseas teams and strive to create high-quality products for global users.

Q5: This year, both the mobile games "Nishuihan" and "Egg Party" by the company have a larger user base compared to previous games. For future games developed and launched by NetEase, especially "Yan Yun Sixteen Tones" and "The Legend of the Condor Heroes," can we expect more innovative gameplay and references to previous successful experiences? A5: Products with a large DAU (Daily Active Users) will be an important direction for the company's future development. The company is continuously summarizing the experience of successful games with a large DAU and will continue to launch more high-quality games in this direction.

At the same time, the company will create high-quality niche game products to meet the needs of players with different interests. For example, this year's releases of "All-Star Street Basketball Party" and "Peak Speed" represent the company's ability to achieve breakthroughs in different categories. NetEase has teams that can develop games with a large DAU as well as teams specializing in unique games. The company encourages teams to leverage their respective strengths and continuously launch high-quality products for the market and users.

Q6: "All-Star Street Basketball Party" is not available on the Android app store. Although the cost of the Android channel is high, it can attract potential customers and extend the product's lifecycle. How does the management evaluate the return on investment of not launching the game on the Android channel? Which games will adopt a similar strategy in the future?

A6: The company believes that games with a large DAU that are suitable for all age groups and family-friendly are better suited to leverage the advantages of all channels. In the future, the company does not exclude maintaining a cooperative relationship with the Android channel under appropriate conditions.

However, "All-Star Street Basketball Party" needs to accurately target players who have a passion for basketball. In this case, the company prefers to maintain game users and build a long-term operation community for basketball enthusiasts, allowing for more direct communication with users and better promotion of game product iterations. In addition, although "All-Star Street Basketball Party" is not available on the Android channel, Android phone users can still download the game through the official website and channels such as TapTap. Therefore, the game can still attract a considerable number of users on the Android platform.

Q7: How has AIGC improved the efficiency of content updates for new and old games? Can the update speed of expansion packs be faster, with a higher frequency, such as monthly or weekly updates, to increase user stickiness and monetization?

A7: AIGC has been very helpful in the company's research and development. In the planning process, AIGC technology has been applied in level design, story writing, art creative design, code, and other aspects, improving the efficiency of the entire development team.

Although AIGC promotes capacity improvement, the release rhythm of game expansion packs still depends on operational rhythm and player preferences. It is not about being faster but about giving players enough time to experience and immerse themselves in the game. The company will adhere to long-term operation and, with improved efficiency, produce more and higher-quality content in the same amount of time.

Q8: Is there a chance for "Code: Infinity" and "Endless Journey Mobile Game" to be launched in 2024?

A8: - "Endless Journey Mobile Game" has been in development for a long time and has undergone multiple player invitation tests. The company has made sufficient preparations for its development and launch. Currently, it is mainly waiting for the issuance of the license, and it is believed that the product will be ready for launch once the license is approved.

• "Code: Infinity" is the next-generation premium game that the company and players are eagerly anticipating. The company hopes that this game can achieve further breakthroughs and will invest more resources in its development to create a product of epoch-making quality. Therefore, a specific timeline for the launch of this game cannot be provided at the moment. A9: About the users of "Nishuihan" (also known as "Justice"), about one-third of them had not played any other games by NetEase before playing the mobile game version of "Nishuihan". These users mainly come from other large-scale games in the current market, which proves that "Nishuihan" is a game that is friendly to a wide range of users. Other games, such as the outstanding performance of "Peak Speed" and "All-Star Streetball Party" in 3Q23, have also attracted many new players who had not played NetEase games before.

In terms of payment for "Nishuihan" mobile game, the game adopts a more user-friendly payment model that does not force players to pay for in-game values. Because the game focuses on small payments, the proportion of paying users is relatively high compared to other products, while the average revenue per user (ARPU) is relatively low. The company is committed to creating a healthier and less stressful emerging service model for players to ensure the long-term healthy operation of the product.

Risk Disclosure and Statement in this article: Dolphin Research Disclaimer and General Disclosure