NetEase: No need to worry about the short-term fluctuations caused by the adjustment of Treasure Trove (1Q24 conference call minutes)

The following is a summary of NetEase's 1Q24 performance conference call. For a review of the financial report, please refer to " NetEase: Returning to "Three Good Students" will take a little more time 》

I. Financial Performance Indicators

II. Management Report

1. Key Points from Management:

1. Financial Data: Net revenue for 1Q24 was RMB 26.9 billion, a year-on-year increase of 7.2%. Net revenue from games and related businesses was RMB 21.5 billion, a 7% increase year-on-year. Revenue from mobile games accounted for approximately 79% of total online game revenue. Net revenue from Youdao was RMB 1.4 billion, a 19.7% increase year-on-year, mainly driven by the growth in revenue from Youdao's online marketing services. Net revenue from NetEase Cloud Music was RMB 2 billion, a 3.6% increase year-on-year, primarily due to the growth in subscription revenue. Net revenue from innovative and other businesses was RMB 2 billion, a 6.1% increase year-on-year, mainly driven by the increased revenue contribution from Yanxuan and other innovative businesses.

The overall gross profit margin for 1Q24 was 63.4%, compared to 59.5% in the same period last year. The gross profit margin for games and related businesses was 69.5%, up from 66.7% in the previous year, mainly due to changes in revenue contribution from different platforms and an increased proportion of net revenue from self-developed games by NetEase. Youdao's gross profit margin was 49%, down from 51.7% in the previous year, mainly due to the higher contribution of online marketing services with lower gross profit margins compared to other products and services. NetEase Cloud Music achieved a gross profit margin of 38%, up from 22.4% in the previous year, primarily driven by the increase in subscription revenue, cost optimization, and adjustments in copyright costs, where the adjustment in copyright costs led to an increase in gross profit margin by approximately 5 percentage points. The gross profit margin for innovative and other businesses was 33.4%, compared to 25.4% in the first quarter of 2023, mainly due to the improved profit margins of Yanxuan and several other businesses in that department.

Total operating expenses for 1Q24 were RMB 9.4 billion, accounting for 35% of net revenue. Sales and marketing expenses accounted for 15% of total revenue, up from 11.6% in the previous year, mainly due to increased game marketing expenses in this quarter. Research and development expenses accounted for 15.5% of total net revenue, compared to 15% in the previous year. The effective tax rate for 1Q24 was 16%; non-GAAP net profit attributable to shareholders was RMB 8.5 billion, a 12.5% increase year-on-year, with earnings per ADS of $1.84 and earnings per share of $0.37. As of March 31, 2024, net cash was approximately RMB 113.4 billion, compared to RMB 110.9 billion at the end of 2023Dividend Policy: The board has approved a dividend of $0.99 per share or $0.495 per ADS. Additionally, as part of the $5 billion share repurchase plan initiated in mid-January last year, approximately 8.9 million ADS have been repurchased as of March 31, 2024, at a total cost of around $811 million.

1. Gaming: Quarterly revenue for the mobile game "Journey to the West" hit a new high; with the latest season update of "Eternal Oblivion," it broke its live streaming record, attracting over 370,000 concurrent players. Following a successful initial test in April, "Eternal Oblivion" saw another 10 million players pre-register within two weeks, bringing the total pre-registration count to over 25 million. The game "Egg Party" has exceeded 40 million DAU; "Slam Dunk" ranked high on the iOS download charts in Taiwan, Hong Kong, and Macau, topping the iOS total revenue chart in Taiwan and ranking second in Hong Kong. The otome game "Beyond the World" topped the charts after its January release and reached the third position in the Chinese iOS total revenue chart after a March content update. Plans to launch "Yanyun Sixteen Sounds" in July and updated the release schedule for "Assault: Shadow Legends" on May 20.

2. Youdao: In terms of learning services, net revenue from digital content services grew strongly by 11% year-on-year. Online marketing service net revenue grew by over 120% year-on-year, reaching a historical high. In the smart devices segment, Youdao Dictionary Pen X6 Pro will be launched this quarter.

3. Cloud Music: Subscription member revenue growth accelerated in the first quarter, attributed to the expansion of user base. Net advertising revenue hit a two-year high for the quarter, with ARPU remaining stable. Continuously enhancing music product strength by enriching the music library through licensed and original music, expanding music genres to key categories like hip-hop and rock. Recently signed agreements with record companies in South Korea, including JYP Entertainment and Kakao Entertainment, to expand product offerings with K-pop content.

Furthermore, many internally produced and promoted music works have been very successful, appearing on TV shows and gala evenings. In terms of marketing innovation, a joint brand plan was reached with the toy brand Farmer Ball to provide a stylish IP music player; social features were also launched to enhance user interaction and social engagement, attracting new members and increasing user activity and stickiness.

1. NetEase Yanxuan: Sales of adhesive products, household cleaning products, office furniture, and other product categories have shown strong growth. Notably, the recently launched ergonomic chair has been well-received, ranking first on the sales charts of major domestic e-commerce platforms.

2. Q&A Analyst Questions

Q: The mobile game "Eternal Oblivion" completed testing in April. Could you share the main results of the test? Additionally, when do you expect this game to be officially released?A: First of all, the test actually reflects the high expectations of the player community, and we can feel the enthusiasm of the players. During the testing process, we actually validated our game strategy. We have collected enough data to prepare for the next round of continuous operations for the game. Overall, this time has actually boosted the team's confidence level and resolved issues before the game's release, which is scheduled for this summer.

Q: Regarding your newly launched game "The Legend of the Condor Heroes," our recent upgrades and how should we view the game's future development?

A: The results of the first phase of "The Legend of the Condor Heroes" did not meet our expectations. Now, with a new leader and core team in place, we are actively making modifications, focusing on aspects such as fun factors to make the game enjoyable, social elements, and our unique style. We are making various modifications and believe that with our experience and expertise in MMORPGs, we can make it fun. The expected release time for the updated version is during the summer vacation.

Q: The first question is about "The Sixteen Songs of the Swallows." We have seen that the PC version has completed final testing and is planned to be launched in July. How should we view the expected revenue? How is the development stage of the mobile version of "The Sixteen Songs of the Swallows," and what is the target release time?

The second question is about our future game pipeline, especially after 2025. What areas are we currently preparing for? Is there any additional information available? What about the overseas market?

A: First of all, thank you for your questions. As you know, we have announced the release time for the PC version of "The Sixteen Songs of the Swallows," and everything is ready, with the team busy preparing for the release. As for the mobile version, all development work has actually been completed, and we are conducting some testing and optimization. It can be imagined that this game is a bit heavy to run on mobile devices, requiring a lot of optimization work, and we are busy with this task. The release time for the mobile version will be slightly later than the PC version. This is an open-world game, and we believe it has potential in overseas markets, where we will also do marketing and promotion. As for your next question about products after 2025, we will disclose our products at the appropriate time through our regular news releases and events. Thank you for your attention.

Q: First, regarding "Fantasy Westward Journey" for PC, it is a relatively mature and stable game series for NetEase, but recent adjustments in the game have received mixed feedback from users. I also noticed some adjustments after May 20, can management discuss the strategy for handling user backlash? When do you expect the game performance to stabilize? Additionally, I noticed more games ("Justice" and "Westward Journey") have made adjustments to the Treasure Pavilion, can management explain the reasons behind this?

A: Yes, as you know, for over 20 years, "Fantasy Westward Journey" has been one of our classic MMORPG games. And over the 20 years of operation, it has been loved by a large user base. One of the reasons we have always been loved is that we have always focused on the long term, ensuring that the game is long-lasting and that players enjoy staying in the gameRecently, we are making some adjustments, but for the same reason, we have adjusted some systems and logic to make long-term play more interesting and meet the needs of users. These adjustments are still ongoing, and we expect to complete them in the first half of this year. One thing to note is that you don't need to worry too much about the short-term fluctuations caused by these short-term adjustments, as our goal is completely aligned with that of our game player community. This is for the long-term vitality of the game. We hope the game will be loved by players for a long time and continue to be loved by players.

At the same time, our development team actually maintains a very humble attitude and is willing to listen to all feedback from our game community. Therefore, in order to make the game more creative and fun to play, please focus more on the interesting aspects of the game. One thing you don't need to worry about is that the entire company and development team take this very seriously. This is our focus, and we hope to have a more interesting version to play after this adjustment period.

Q: My first question is about shooting games. We noticed that the company has always focused on shooting games. How do you view the competition in this genre and what is our strategy? My second question is about your overseas studios. Could management share the latest developments of the overseas game studios and when do you expect the overseas studios to start releasing games?

A: First, regarding your question about the shooting game genre, you are right that shooting is actually a major genre in the entire gaming industry, both domestically and globally. In the past, shooting was not our strong suit, but we are very focused on how to conquer this genre. That's why starting a few years ago, we began deploying product development into this genre, and that's why you see us launching products from this year. We hope to achieve a certain level of success in this major genre. At the same time, shooting is also a very popular field, very popular in the overseas gaming market as well. We hope to achieve a certain level of success there too. By launching a series of high-quality shooting games, we are determined to expand our genre base and enter more genres and global markets.

Regarding the second question about overseas studios:

The fact is, many products are currently busy in development. However, developing a new game takes many years, 2 years, 3 years, or even longer. Currently, we do not have plans or release dates to share with you regarding products from overseas studios, but we are actively developing products there. At the same time, another point about the global market is that for our domestic studios, we are also actively developing games for the global market. As you have seen, "Speed Drifters" has achieved a certain level of success in the Greater China region, and "Identity V" has been successful in Japan. "Rules of Survival" has been successful in Japan. We hope you can feel that we have enough resources, determination, and attitude to explore overseas markets.

Q: My question is about operating expenses. Can management comment on the changes in operating expenses, especially the operating expenses related to social media marketing?A: There is no need to overly focus on the significant increase in sales and marketing expenses. In fact, we are already very mature and have a lot of experience in marketing operations. And we are actually gaining more and more experience in this field. Our customer acquisition costs are now decreasing. In the future, you will not see a significant increase in sales and marketing expenses.

Q: My question is about the spending of game players in NetEase games. There is a lot of news about consumption downgrading in China now. So, against this macro background, I would like to know if the management has noticed any changes in the in-game spending patterns of game players? What are the trends in MMO games?

A: We have not observed any downgrading in the in-game spending of game players because the value we provide to consumers through games is more like emotional value. Players spend a certain amount of money to have fun, enjoy some relaxing time here. It is very different from the consumer patterns of data users' daily shopping or other physical products. We believe that consumers will recognize the emotional value we provide. Again, we have not seen any downgrading.

Q: My question is related to our capital return. Last year, we paid about $2.3 billion in 2023. What will 2024 look like?

A: For buybacks and dividends, we actually do it at our own pace. You may have noticed that in the past quarter, we have been gradually buying back shares as planned, and we will continue to buy back shares in the future and pay dividends as before.

Q: My question is, we recently obtained the copyright for the new game "Egg Party" series game "Egg Slippery". So, can any information or updates about this game be shared? Also, how should we view the long-term strategic prospects of the entire "Egg Party" ecosystem?

A: You are right, this match-three game based on the "Egg Party" IP, we have spent some time developing it and will be launching it soon. Regarding "Egg Party" as an ecosystem, yes, "Egg Party" is a very cute and lovely IP, and players feel relaxed and casual when interacting with the IP. We sincerely hope to do more creative things with this IP, create more fun experiences, and make everyone enjoy this party game type. We still have a lot of work to do, and we are very excited about it.

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