New and old games are launching together, overseas expansion is accelerating (CLOUD MUSIC 23Q1 financial report conference call summary)

The following is a summary of the Q1 2023 earnings call for NetEase.US. For a financial analysis, please refer to "NetEase: The 'Pig' Cycle is Back".

I. Management Remarks

Our game portfolio had an impressive start to 2023, with total revenue reaching RMB 25 billion, a YoY increase of 6%, and net profit attributable to shareholders increasing by 54% YoY to RMB 6.8 billion.

"Fantasy Westward Journey"

Thanks to various immersive holiday events and captivating new expansion packs, this series continues to attract domestic players and delivered another strong performance this quarter. Our flagship product has remained popular for nearly 20 years due to the user connections within the game and our regular updates to maintain user engagement and satisfaction.

"Egg Party"

This game further solidified its leading position in the casual gaming market. The success of "Egg Party" demonstrates NetEase's ability to innovate and operate games, by continuously adding new content updates, gameplay, and cross-industry collaborations to maintain player engagement.

We have taken a series of measures to strengthen the unique game ecosystem of "Egg Party," including upgrading our creator incentive program and game editor. We view AIGC as an important tool that allows users to create content more easily, and we will develop and provide more such features in the game editor to encourage more people to participate in creation. With our comprehensive UGC ecosystem, our user community creates over 1 billion maps every week, providing players with fresh and enjoyable content.

Following the successful launch of "Egg Party" in China, we have tested its potential on the global stage and received valuable feedback. We are working hard to bring "Egg Party" to global users in the near future, and we believe players worldwide will choose the captivating gameplay and unique UGC experience that "Egg Party" offers.

"Identity V"

This is an asymmetric competitive game that we launched five years ago, and it has benefited greatly from its successful cross-industry collaboration with the famous Japanese anime "Bungo Stray Dogs."

"Nishuihan Mobile Game"

As our next-generation MMORPG mobile game, this game is committed to creating a unique gaming experience and setting a new industry standard for MMORPG games, distinguishing it from traditional MMO games. It caters to the preferences of younger players, providing a variety of decorative props and a more fair and balanced gaming environment and experience. It is one of the earliest products to apply AI technology to game creation and development, which further enhances our development capabilities and greatly enriches the open world experience. Including new gameplay, storylines, and maps. Through technological innovation, such as AI-supported NPCs, players can interact with them in unique ways, and these interactions will also affect the game's storyline, providing players with more personalized gaming experiences and increasing user enjoyment.

"Extraordinary Pioneer" -

In our recent rounds of testing, "Extraordinary Pioneer" has shown strong appeal to players and is an important member of NetEase's shooting game products. We hope that "Extraordinary Pioneer" can help us enter new fields with its new mechanisms and exciting combat experience.

"Pinnacle Speed" -

"Pinnacle Speed" has 3A-level quality and the most realistic racing simulation gaming experience, dynamic racing handling and performance, allowing players to fully immerse themselves in the world of racing.

"Harry Potter: Magic Awakening" -

We are pleased to announce that "Harry Potter: Magic Awakening" will be launched globally. Our professional team has been working hard to improve and perfect the gameplay of this game on mobile and PC, ensuring that players around the world can experience the most realistic and exciting magical world. "Harry Potter: Magic Awakening" will be launched in most parts of the world this summer.

Global Gaming Strategy

Our globalization strategy continues to steadily advance. The studio is led by Paul Enreth, who has over 20 years of experience in PC and console game development. Anchor Point Studio will mainly focus on developing action-adventure games.

In addition, Bad Brain is an emerging game studio located in Canada, led by Sean Crooks, an experienced producer who has also assembled an experienced team. The studio is currently developing a new story-driven action-adventure game, which will be made using Unreal Engine 5 and is an open-world game.

After years of strategic planning, we have acquired/established game studios in overseas regions such as Spain, Japan, the United States, Canada, and Europe, which have prepared us for the next international development stage. Looking to the future, we will continue to attract, invest in, and support our international talents, giving them full autonomy in game creation and development. We hope that NetEase's games will not only be well-known domestically but also be connected to fresh, attractive, and long-term operating game products worldwide.

Youdao

Despite the impact of the epidemic in January 2023, Youdao's STEAM education courses and other business lines have returned to growth. With the further improvement and enrichment of STEAM courses, our STEAM business continues to steadily grow. Our Go Champion Class, launched in the fourth quarter of last year, achieved good results, and its participants won the championship in the UK Youth Group in January. In addition, the total sales of "Youdao Everyday Reading," a picture book reading platform specially designed for children, increased by nearly 40% year-on-year in the first quarter, which uses advanced natural language processing capabilities to provide tailored reading content and personalized reading experiences based on user age and reading behavior. We are committed to continuously improving our intelligent hardware devices to provide users with a better experience. In the first batch of product standard tests conducted by the China Academy of Information and Communications Technology, our Youdao Dictionary Pen X5 and P5 achieved 100% accuracy in 12 complex online and offline application scenarios. In addition, the applications available on the Youdao Dictionary Pen operating system are constantly expanding, providing users with a variety of choices. Our intelligent learning machine has also been upgraded to provide professional vocabulary training using computer technology, helping students plan their learning strategies more effectively. Looking to the future, we will continue to focus on technological innovation and use our cutting-edge technology to ensure the long-term success of our intelligent devices and learning services.

Cloud Music

In the first quarter of 2023, Cloud Music continued to work hard to enrich its music-centered ecosystem and expand its unique content products, forming a thriving community with high user engagement.

Cloud Music's total revenue in the first quarter was RMB 2 billion, a year-on-year decrease of 5%. We continue to actively promote profit margin growth and have already achieved returns. The gross profit margin has reached around 20%, further strengthening our profit performance, which was achieved by continuously optimizing our copyright cost structure and improving our revenue sharing strategy. We continue to expand our content supply and ensure that important music copyrights are available. We continue to cooperate with music labels to expand our music library. Following our digital music copyright authorization agreement, we renewed our agreement with Rolling Stones Records, deepening our strategic partnership. Looking to the future, we will continue to cultivate a music-centered ecosystem, further develop our community, and promote the long-term healthy profitability of Cloud Music.

Innovative Business

On April 11th, NetEase Yanxuan celebrated its seventh anniversary, dedicated to providing users with high-quality products and further deepening its supply chain model, especially in top categories such as pet supplies and home cleaning. We have taken a comprehensive approach to ensure the best user experience. For example, we have established independent production lines to help maintain product quality consistency, and we have worked with suppliers and sellers to enhance our innovation capabilities through joint laboratories.

The best-selling products this quarter include cat food, bathroom perfume, coffee, biscuits, and suitcases. Our mission is to provide consumers with more high-quality, original design products and promote a relaxed and enjoyable lifestyle.

ESG

We attach great importance to sustainable development and continuously improve our ESG regulatory framework. Our efforts in ESG have been widely recognized and have achieved leading scores in multiple authoritative ESG assessments, with scores continuously improving.

We recently released the 2022 ESG Annual Report, which showcases our achievements in ESG last year. In terms of corporate governance, we optimized the composition of the board of directors, promoted diversity, and currently have a female representation of 40%, leading the international average. We are also committed to reducing carbon emissions and implementing energy-saving and emission-reduction measures. In 2022, our greenhouse gas emissions per unit of net income decreased by 5%. We have also started our own IDC construction and incorporated low-carbon concepts into our designs.

Talent development is crucial to our success, and we are proud to have been named one of Forbes' Best Employers for the fifth consecutive year. We actively promote diversity, fairness, and inclusiveness, and are proud of the high proportion of female employees. We also attach great importance to career development, providing comprehensive employee development plans and a wide range of opportunities to support employee growth and maximize their potential.

In short, Netease's next stage of growth will be driven by content innovation across all of our business lines, which has always been our core value and driving force. We will continue to bring more diverse product experiences to users in the gaming field. Our goal is to create value for the company and stakeholders while enhancing our influence in domestic and foreign markets.

II. Analyst Q&A

Q1: Regarding the game market and macroeconomics, have you observed a situation where China's macro consumption is weak and game player consumption is decreasing? Will the gaming industry be affected by macroeconomics? What is the outlook for game revenue in the next few quarters?

A1: Netease not only focuses on the domestic market, but also on the development of future overseas markets. In the future, the team is very confident in producing excellent high-quality works to meet consumer needs in the gaming industry.

Q2: What is the latest progress on the Nishuihan mobile game? Netease Games has used AI technology in gameplays such as character creation, NPC, and player dialogue. In which other areas do you expect AI to be applied in the future?

A2: We just finished the latest round of testing for Nishuihan mobile game. After expanding the testing scale, it attracted many players and met the needs of different types of players. Everyone had fun in the game. We have collected a lot of player feedback, and the team will continue to adjust and optimize in the coming time (until the game is launched). We believe that it will bring a stunning experience after it is launched on June 30.

There are many areas in games where AI technology can be applied, and it has brought many new experiences. Nishuihan was widely welcomed by players during the testing period, and the most important thing is that the gameplay of the entire game is based on deep learning. Under this condition, many imaginative and unprecedented gameplay can be launched when the time is ripe.

Q3: How has the trend of the Egg Party game been so far in the second quarter? What is the outlook for future Egg Party users and monetization? How is the overseas game layout?

A3: Egg Party has performed very well since its launch. We are confident in continuous innovation to meet user needs. We believe that there will be more refreshing and high-quality works launched this summer. Egg Party also has plans to expand overseas, and Netease has a good grasp of the future product roadmap.

Q4: What are the specific situations regarding overseas studio game strategies, R&D, and product positioning? A4: We are delighted to share our creative experience with many outstanding teams, serving both overseas and Chinese markets. We believe that working with experienced teams is mutually beneficial. We are willing to share our 20 years of creative experience with them and help them create more impressive games.

Q5: What is the impact of AI models on the company's financial situation?

A5: AI development can be described as a hundred flowers blooming, a hundred birds singing, and dazzling. Every day, there are various applications based on large models in different scenarios. In this field, NetEase is currently more concerned about how AI can be applied in different product scenarios. The basic large models are similar, and we believe that the real winner in AI is to successfully choose the appropriate scenario and create AI products that provide users with high-quality experiences.

Q6: How do you view the competition pattern of the new game market this year, incremental or stock competition? How does NetEase's flagship game strengthen its long-term operational capabilities?

A6: There have been many emerging new games in the past 4-5 months, but consumers tend to choose high-quality works. NetEase can maintain its uniqueness in innovation and meet user needs in both gameplay and new technology applications in past and future products. We are confident in continuing to maintain our unique advantages in future development.

NetEase is very good at MMORPG game categories, and there are few competitors in the market. We believe that NetEase can leverage this category advantage.

In addition to continuous innovation and launching new games, long-term game operation capabilities also need to be emphasized. The mobile version of "Fantasy Westward Journey" set a new record for the highest revenue in this quarter; "Identity V" also set a new revenue high in the first quarter after five years of operation. The persistence of these flagship games is impressive and constitutes our main source of further investment and commitment to innovation to produce better new games.

Q7: What are the driving factors for the new high gross profit of games? Is there a chance for dividend yield to increase in the future?

A7: The reasons for the increase in game gross profit margin are as follows:

1. Continuous growth in scale, with the expansion of scale, the operating leverage effect has increased. We have been launching new games and achieved sustained and stable growth;
2. Changes in revenue composition since January 2023;
3. Continuous optimization of channel costs.

Therefore, through the continuous efforts and the impact of some one-time income, the gross profit margin has reached a historical high.

The current company dividend payout ratio is 30%, making us one of the few technology companies worldwide that regularly pay dividends. We use dividend payments and share buybacks as a tool to share the company's sustained growth and feedback to shareholders. At the same time, we will also review and expand our share buyback plan from the initial $500 million to the current $5 billion share buyback plan and increase the dividend payout ratio to 30%. Looking ahead, as we continue to achieve stable growth, we will continue to review and examine the best and optimal ways to share the joy of sustained growth and value creation with long-term shareholders. Q8: What is the consideration behind the reduction of revenue sharing by Cloud Music? How is the YoY growth rate of Cloud Music's revenue, and when can it achieve YoY positive growth?

A8: Cloud Music's revenue mainly consists of two parts:

Online music services, which maintain stable growth driven by the continuous expansion of paid users;

Social entertainment business, which has experienced a YoY decline. We have begun to pay more attention to the health and sustainable profitability of business growth, rather than just focusing on top-line growth.

We have been consciously transferring resources to exclusive live services for music fans rather than guilds with high revenue sharing, in order to make the business more sustainable. Although Cloud Music's quarterly revenue has declined YoY, the gross profit margin has significantly increased from 12% last year to 22.4% this quarter. We believe that we are moving towards a profit margin that can achieve sustainable and healthy development, and this roadmap can lead us to achieve cash flow balance and eventually achieve a balance of profits and losses in the future.

Risk disclosure and statement of this article: Dolphin Analyst Disclaimer and General Disclosure