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Edited Transcript of NTES earnings conference call or presentation 10-Aug-17 1:00am GMT

Beijing Aug 10, 2017 (Thomson StreetEvents) -- Edited Transcript of NetEase Inc earnings conference call or presentation Thursday, August 10, 2017 at 1:00:00am GMT

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The Piacente Group, Inc. - Founder and President

* Lei Ding

NetEase, Inc. - Founder, CEO and Director

* Hilton Hui

NetEase, Inc. - Co-President of NetEase Games

* Zhaoxuan Yang

NetEase, Inc. - CFO

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* Alicia Yap

Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research

* Angela Xu

* Eddie Leung

BofA Merrill Lynch, Research Division - MD in Equity Research and Analyst

* Han Joon Kim

* Jialong Shi

Nomura Securities Co. Ltd., Research Division - Head of China Internet and Media Research and VP

* Karen Chan

* Yue Wu

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Operator [1]

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Good day, and welcome to the NetEase Second Quarter 2017 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Ms. Brandi Piacente. Please go ahead, ma'am.

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Brandi Piacente, The Piacente Group, Inc. - Founder and President [2]

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Thank you, operator. Please note, the discussion today will contain forward-looking statements relating to 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 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. The Company does not undertake any obligation to update these forward-looking information, except as required by law.

During today's call, management will also discuss certain non-GAAP financial measures for comparison purposes only. For a definition of a non-GAAP financial measure and reconciliation of GAAP to non-GAAP financial results, please see the 2017 second quarter financial results 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.

I will now turn the call over to Mr. Charles Yang, Chief Financial Officer, who will read the prepared remarks on behalf of Mr. William Ding, Chief Executive Officer of NetEase.

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Zhaoxuan Yang, NetEase, Inc. - CFO [3]

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Thank you, Brandi, and thank you, everyone, for participating in today's call. I would like to start by saying that I'm very, very excited to join NetEase. For the past decade, my career has been dedicated to corporate finance and investment banking with a focus on China's TMT sector. Like many of you, I have followed NetEase for some time, both personally and professionally, and it is a great honor to join a great company and becoming a part of this reputable management team.

Before we begin, I would like to remind everyone that all percentages are based on renminbi. With that said, I'm pleased to deliver opening remarks on William's behalf.

Providing people with outstanding services and products is the heart of our business. With each piece of new content that we introduce, we are keeping our community connected and engaged, and our business is thriving.

During the second quarter, our net revenues grew almost 50% compared with the same period last year. Our net revenue for our online game services grew 46.5% year-over-year, led by our self-developed mobile games. These remain our primary growth engine, accounting for 72.4% of our online game services net revenue in the second quarter.

Looking at our game portfolio, the popularity of many legacy titles continues to be strong. During the second quarter, our PC-client game, Fantasy Westward Journey Online, and mobile game, Invincible, reached record-high quarterly revenues. We also saw positive momentum from Fantasy Westward Journey and Westward Journey mobile games as well as the mobile version of New Ghost. In addition to new content for our legacy titles, we launched a number of new mobile games to enthusiastic audiences during the second quarter, including Land of Glory and Treasure Hunter, both of which were very well received.

In mid-July, we also brought Crusaders of Light to the U.S., that's the international version of Land of Glory, and we are pleased with the initial reception.

While we saw some pullbacks from Onmyoji, this is within the management's expectation given the title's huge success with players since its launch late last year. We see this as part of the natural ebb and flow while our players still crave for new content. The latest content update "Fireworks Festival", was well received once released at the end of July. We plan to frequently launch high-quality content update to meet players' growing appetite. Additionally, to leverage its strong IP, we've launched a media strategy to expand the brand influences, and Onmyoji continues to increase in popularity among players internationally.

During the second quarter, Onmyoji reached record-high downloads in Japan and Southeast Asia. We are continuing to expand its reach and plan to bring this popular mobile RPG to players in Korea, Canada, Europe and the U.S. later this year. Onmyoji has already reached record-high preregistration levels with our licensing partner in Korea, and the release on Facebook's Gameroom platform is further fortifying this game's overseas presence.

While we bring our community new exciting content and games, we are simultaneously exploring creative market segments where we see complementary growth opportunities. Producing games for additional platforms and adding new gameplay capabilities such as VR and AR enables us to leverage our strong and innovative R&D competencies and employ our pioneering spirit.

At the end of the second quarter, we released Twilight Spirits, our first title for the Steam platform. Initial feedback has been positive, and we will look for other opportunities where we can expand our reach. We also continue to invest in VR- and AR-related projects and are exploring investment opportunities in both hardware manufacturers and content developers.

Our mobile portfolio currently stands as one of the most robust in China. We intend to grow this business, with current plans to introduce new titles and content that support our position. We have an exciting pipeline of upcoming games for the third quarter. We have already released a handful of titles, and on July 21, we began closed beta testing for PC-client game Open Range. We are also moving forward with the highly anticipated sandbox game Minecraft. We initiated open beta testing for the PC version on August 8 and plan to roll out our initial beta testing for Minecraft mobile version soon. Our primary focus during this initial stage will be to attract users and development partners.

Other new upcoming games include Index and Forever 7, 2 exciting Japanese themed RPGs; and the stunning 3D PC-client game, Conqueror's Blade, which was formerly known as War Rage.

In addition to our leading position in China's online games market, we are expanding our global footprint as we see ample opportunity to grow our brand and bring more of our games to overseas markets.

Now turning on to our other business segments. Our net revenues from advertising services increased by 12.1% compared to the same period last year, supported by our award-winning NetEase News App. Automobile, Internet services and real estate services segment were the top performing verticals. Mobile advertising continues to rise as the preferred means of advertising, which bodes well for us, as we hold considerable mobile reach with our users.

Our e-mail, e-commerce and others business segment also increased in the second quarter, growing by 68.9% compared to the same period last year. E-commerce, in particular, is becoming an increasingly important revenue contributor. Kaola and Yanxuan are flourishing among a market ripe for high-quality products, and both of them did quite well during the June 18 sales event.

We continue to invest in our future development. We are introducing exciting new games and services that continue to strengthen and diversify our portfolio, support our ability to broaden our reach within our expanding community worldwide and continue to grow each of our business lines.

I will now provide a review of our second quarter 2017 financial results. As in past quarters, the discussion will primarily focus on margins, expense fluctuations and net profit.

Our gross margin for the second quarter was CNY 6.7 billion or USD 993.7 million compared with CNY 7.5 billion and CNY 5.3 billion for the preceding quarter and the second quarter of 2016, respectively. The year-over-year increase in online game gross profit was primarily driven by increased revenue contribution from mobile games such as Onmyoji and the mobile version of New Ghost. The quarter-over-quarter decrease in online game gross profit was primarily due to decreased revenue contribution from mobile games.

The year-over-year increase in advertising services gross profit was primarily due to our enhanced monetization efforts. The quarter-over-quarter increase in advertising services gross profit was primarily due to seasonality. The year-over-year decrease in e-mail, e-commerce and others gross profit was primarily due to decreased revenue contribution from certain e-commerce businesses with relatively higher gross profit margins.

Gross profit margin for our online game business for the second quarter of 2017 was 63.1%. This compares with 63.9% and 66.2% for the preceding quarter and the second quarter of 2016, respectively. The year-over-year decrease in gross profit margin was mainly due to increased revenue contribution from mobile games, which have relatively lower gross profit margins as a percentage of our total online game services net revenues.

Gross profit margin for our advertising services business for the second quarter of 2017 was 67.6%. This compares with 57.3% and 65.5% for the preceding quarter and the second quarter of 2016, respectively. The year-over-year increase in gross profit margin was mainly due to our enhanced monetization efforts. The quarter-over-quarter increase in gross profit margin was mainly due to seasonality.

Gross profit margin for our e-mail, e-commerce and others businesses for the second quarter of 2017 was 11.3%. This compares with 14.8% and 33.8% for the preceding quarter and the second quarter of 2016, respectively. The year-over-year and quarter-over-quarter changes in gross profit margin were primarily attributable to changes in our e-commerce business mix.

Total operating expenses for the second quarter of 2017 were CNY 3.3 billion or USD 491.4 million compared with CNY 2.7 billion and CNY 2.2 billion for the preceding quarter and the second quarter of 2016, respectively. The year-over-year and quarter-over-quarter increases in operating expenses were mainly due to higher...


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