Brandi Piacente - IR Onward Choi - Acting CFO William Ding - CEO

Fan Liu - Goldman Sachs Alicia Yap - CitiGroup Natalie Wu - CICC Jialong Shi - Nomura Securities Eddie Leung - Merrill Lynch Hillman Chan - Macquarie

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

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 this 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 non-GAAP financial measures, and a reconciliation of GAAP to non-GAAP financial results, please see the first quarter 2017 financial results news 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 corporate NetEase website at ir.netease.com. I will now turn the call over to Mr. Onward Choi, Acting Chief Financial Officer, who will read the prepared remarks on behalf of Mr. William Ding, Chief Executive Officer of NetEase.

Thank you, Brandi. I would like to start by providing opening remarks on behalf of William. As a reminder all percentages are based on RMB. 2017 is off to a strong start and our ability to successfully develop and this should be in the weight of content continues to be the cornerstone for our growth. Mobile has taken hold as the dominant force in the online community and we are actively cultivating our mobile reach across our business to extend and then its brand to users not only in China but around the world. During the first quarter we advanced a number of strategic initiatives in each of our core divisions, increasing out total net revenues by approximately 72.3% year-over-year; and 12.7% quarter-over-quarter. Specifically we introduced multiple new mobile games and added new expansion packs to our popular PC client games. We also enhanced our monetization capabilities for our advertising services and expanded our e-commerce business. Led by our self-developed mobile games the year-over-year increase of net revenues from our online game services was 78.5%. Net revenues from our advertising services and email, e-commerce and all other segments were also up by 15.2% and 63.2% respectively or compared to the same period last year. Our mobile games continue to make greater contributions to our online games revenues. In the first quarter mobile games accounted for approximately 73% of our total online games net revenues, up from about 64% in the preceding quarter, as well as the first quarter of 2016. We released a number of new mobile titles in the first quarter including well received games such as Demon Seals Mobile, Westward Journey Rage, and Land of Glory [ph], an epic 3D Westward fantasy real-time MMORPG. Hit titles like Onmyoji continue to gain popularity with multiple content updates for us in the first quarter, and on February 20, 2017, it achieved 200 million global downloads. Other legacy mobile titles including Fantasy Westward Journey and Westward Journey online mobile games, Invincible, Heroes of Tang Dynasty Mobile and the mobile versions of New Ghost, as well as the PC-client games such as New Ghost and Fantasy Westward Journey online also maintained good user attractions during the period. We are also pleased to be expanding our global lattice [ph] when NetEase operated games are being widely embraced. In February, we released Onmyoji in Japan following a Southeast Asia release base last year. And we plan to continue our global rollout of this game this year with Korea, Canada, Europe, and the U.S. as the next destinations. We have the similar international aspirations with other self-developed games such as Land of Glory. Popular games that we operate in China are also enriching the domestic online games market. In particular, the closed beta tapping for my craft [ph] where it is launched in April is progressing well and we are on-track with the official launch planned for later this year. Additionally, for the first quarter Blizzard Entertainment's Hostel achieved record number of quarterly attributes and players are flocking to the games, U.S. expansion pack, journey to Ngoro [ph] launched last month. A central theme to our game strategy is glow where is market settlements while simultaneously attracting users to our legacy titles. We have to enrich pipeline lineup for 2017 with a number of mobile games under development. You shrink them and diversify our portfolio that includes more than 100 Titles. In April we released several new mobile titles to buzz reviewer as a feedback including Treasure Hunter, a catalyst style PPS game or third-party shooting games. We plenty to do more detailed pipeline information for the rest of the year as the latest game, New Press Conference on May 20, 2017 in Guangzhou. With our PC-Client Games, we launched new expansion packs for New Ghosts and Kung Fu Master II recently, and plan to introduce new expansion packs for several popular games in the coming months including Tianxia III, Heroes of Tang Dynasty Zero, Demon Seals, Revelations, and New Westward Journey Online II. The advertising and e-commerce markets are also core components of our growth. During the first quarter, the automobile, real estate and telecommunications strategies were our top performing verticals with our year-over-year gains driven by strong growth in mobile media supported by our top rank mobile news app. Additionally both Kaola.com and Yanxuan are rising with promising growth trajectories. Our focus remains on creating premium contents for and reaching the imaginations of our massive community in online games, media and e-commerce. It is this ideas and strategies that support our ability to maintain our commitments to our shareholders, increase our products and expand our company across its lines. This concludes Williams's comments. I will now provide a review of our first quarter 2017 financial results and primarily focus on margins, expense fluctuations and net profit. Our gross profit for the first quarter was RMB7.5 billion or $1.1 billion, compared to RMB6.5 billion and RMB4.6 billion for the preceding quarter and first quarter 2016, respectively. The year-over-year increase in online games gross profit was primarily driven by increased revenue contributions from mobile games such as Onmyoji, the mobile versions of New Ghost, and Demon Seals Mobile, as well as Blizzard Entertainment's Overwatch, and World of Warcraft. The quarter-over-quarter increase in online game gross profit was primarily driven by revenue contribution from mobile games such as Onmyoji, the mobile versions of New Ghost, and Demon Seals Mobile. Quarter-over-quarter we saw a decrease in advertising services gross profit which was primarily due to seasonality. The year-over-year increase in e-mail, e-commerce and other gross profit was primarily due to increased revenue contributions from our e-commerce business, such as Kaola.com. The quarter-over-quarter decrease was primarily due to lower revenue contributions from certain e-commerce businesses with relatively higher gross profit margins. First quarter gross profit margins for online games was 63.9% compared to 60.7%, and 67.1% for the preceding quarter and the first quarter 2016, respectively. The year-over-year decrease in gross profit margin was mainly due to increase in revenue contributions from mobile games, which have relatively lower gross profit margins as a percentage of our total online games net revenues. The quarter-over-quarter increase was mainly due to decreased revenue contributions from license games which have relatively lower gross profit margins and one-off recognitions of certain royalty expenses related to licensed games in the fourth quarter 2016 and possibly offset by the increase of revenue contributions from mobile games in the current quarter. First quarter gross profit margins for the advertising services business was 57.3%, compared to 66.5% and 62.4% for the preceding quarter and the first quarter of 2016 respectively. The year-over-year decrease in gross profit margin was mainly due to higher stock related and content purchase cost and the quarter-over-quarter decrease was mainly due to seasonality. First quarter gross profit margins for e-mail, e-commerce and others was 14.8% compared to 23.4% and 20.4% for the preceding quarter, and the first quarter 2016 respectively. The year-over-year and quarter-over-quarter decreases were primarily attributable to decreased of revenue contributions from certain e-commerce businesses with relatively higher gross profit margin. Total operating expenses for the first quarter were RMB2.7 million or $394 million compared to RMB2.6 billion and RMB1.7 billion for the preceding quarter, and the first quarter 2016 respectively. The year-over-year increase was mainly due to higher selling and marketing expenses related to online games, high R&D investments and higher stock related costs, as well as operating expenses related to kaola.com. The quarter-over-quarter increase was mainly due to higher stock related costs. During the first quarter we recorded in net tax charge of RMB943.0 million or US$137.0 million, compared to RMB882.0 million and RMB530.7 million for the preceding quarter and the first quarter of 2016, respectively. The effective tax rate for the first quarter of 2017 was 19.0%, compared to 19.2% and 17.5% for the preceding quarter and the first quarter of 2016, respectively. The change in effective tax rate represents the Company's estimate of the effective tax rate for the first quarter of 2017. The change in effective tax rate represents our estimates for the first quarter 2017. Net income attributable to the Company's shareholders for the first quarter totaled RMB3.9 billion or US$569.9 million, compared to RMB3.7 billion and RMB2.5 billion and RMB2.5 billion for the preceding quarter and the first quarter of 2016, respectively. Non-GAAP net income attributable to the Company's shareholders for the first quarter totaled RMB4.3 billion or US$630.0 million, compared to RMB4.0 billion and RMB2.7 billion for the preceding quarter and the first quarter of 2016, respectively. During the quarter, we had a net foreign exchange loss of RMB48.5 million or US$7.0 million, compared to a net foreign exchange gain of RMB90.5 million and a net foreign exchange loss of RMB36.0 million for the preceding quarter and the first quarter of 2016, respectively. Our first quarter, basic and diluted earnings per ADS were US$4.33 and US$4.29, respectively, this compares to basic and diluted earnings per ADS of US$4.08 and US$4.04, respectively, for the preceding quarter, and basic and diluted earnings per ADS of US$2.72 and US$2.70, respectively, for the first quarter of 2016. Our first quarter Non-GAAP basic and diluted earnings per ADS were US$4.79 and US$4.75, respectively, this compares to non-GAAP basic and diluted earnings per ADS of US$4.38 and US$4.34, respectively, in the preceding quarter, and non-GAAP basic and diluted earnings per ADS of US$2.94 and US$2.92, respectively, for the first quarter of 2016. As of March 31, 2017, our total cash and cash equivalents, current and non-current time deposits and short-term investments balance totaled RMB40.6 billion or US$5.9 billion, compared to RMB36.9 billion as of December 31, 2016. Cash flow generated from operating activities was RMB4.0 billion or US$585.7 million for the first quarter of 2017, compared to RMB5.4 billion and RMB3.1 billion for the preceding quarter and the first quarter of 2016, respectively. As part of our commitment to return values to our shareholders, our board of directors approved a dividends of US$1.08 per ADS for the first quarter of 2017, which is expected to be paid on June 2, 2017 to shareholders of record as of the close of business on May 26, 2017. On November 15, 2016, the Company announced that its board of directors approved a share repurchase program of up to US$1.0 billion of the Company's outstanding ADSs for a period not to exceed 12 months. As of March 31, 2017, the Company had repurchased approximately 83,000 ADSs for approximately US$23.7 million under this program. Thank you for your attentions, we would like now to open the call to your questions, operator please go ahead.

Thank you. [Operator Instructions] And our first question comes from Fan Liu with Goldman Sachs.

Hi management, thanks for taking my question. So your differed revenues this quarter has declined by 8% quarter-over-quarter, would you mind to guide the reason behind that and also do you mind to share with us, what is your company strategy to prolong a life longevity of the 16 titles this year, and what's your plan of the new product pipeline the second half? And also do you want to guide with us what's revenue a contribution on Kaola and Yanxuan this quarter? And also any color on the margin profile will be also appreciated. Thank you.

[Foreign Language]

So basically with regard to your questions about how the company's plans to maintain the longevities of the game products, it depends on the strategies that we are adopting, basically you can make reference to what we have been doing especially on the PC games front. I would like to see game titles such as FWJ and WJ, you see that we have accumulated quite a good experiences and the knowledge about how to maintain a long life cycles for various game titles that we have operated for long. And in a way you can also observe that through so many years, we have also been able to up keep a very stable and perhaps a growing performance for those like the legacy titles and a couple other game titles that we have put in place in the market. And we would definitely be making good use of those experiences that we have accumulated over the years as well as adopting similar strategies for moving on to our mobile price and we believe that those experiences would be very helpful to enabling us to make sure that the same thing what happens on our mobile price. And on the other hand, we are also looking upon the fact that NetEase is a company very strong in delivering high qualities and premium game products in the marketplace and we believe that by offering those good quality game products to the marketplace. This can also enhance the overall gaming experiences to our players or the gamers in general. And so we believe that this will also be another positive points that we would like to share with you. And on color of that we have also got very solid plans to roll out a couple of new quality and premium games to the market in the future periods. And so basically what Williams would like to share with you a bunch of how we think about and our strategies to ensure the continuity of the game products. And now getting back to your questions and more on the financial sides of the operations, I believe that in the first quarter and this is obvious that if you look at it different revenues, on a Q - on-Q comparison there has been this growth of about 8% but we do will that this is still a very understandable and yes and also not a way a significant decrease in terms of the program is because if you look back in especially in the last quarter because we already got it where high pace in the four quarters and in the first quarter of 2017 there's also been a quarter with not too many new games been go out. And so it's obvious, that's still quite within our expectations and we're still feeling that all of our game titles are still being good and most of them are still upkeeping, very stable performance at the same time as and when we are rolling out some more new contact updates on your special pack where we are also expecting that there would be a positive impact that brought about to the overall performances of our various other game titles in the marketplace. And so far to answer your third questions about the revenue contributions of Kaola businesses in our business segments which is the e-mail, e-Commerce and others. We'll start giving you to the exact percentage. I would say that in the first quarters of 2017 our e-commerce related businesses including both the Kaola and also our Yanxuan already accounts way race and the components of our overall revenue contributions in our first segments namely are the email commercial harvest.

Thank you. [Operator Instructions] And our next question comes from Alicia Yap of CitiGroup.

Hi. Thank you. Good morning, William and Onward. Thanks for taking my questions and congrats under strong quarter. My question is related to the recent fluctuations of - is it mainly due to more intensified competition from other new games or is that more related to MOG on operation effort and what would be the team currently are working on to improve and overturn the fluctuations of the game. And then second question is related to our activation recently on the conference call. They note that they saw about 30% year-over-year increase in the item sale for World of Warcraft and Overwatch. Do you see the similar type of growth rate for the China franchise for this year? Any color for that will be appreciated. Thank you.

[Foreign Language]

So basically first of all with regard to your first questions of - definitely we also see kind of some fluctuations in terms of the performance but after all we still believe that the game by itself is a very successful mobile games and we have a very strong teams and high quality products being roll out to the market. And at the same time we are holding a very confidence, performance going forward because in terms of both the depth and the breath of the context that we are offering for these particular games. This is also still a very good and we have lots to offer in the times to come. And so we believe that our this game will be still be performing well in the future. And on the other hand, with regards though to how we move about the lighter games performances in particular to all the games that we have in lightens from Blizzard Entertainments not only including the World of Warcraft, Overwatch but also extending to the upper three and also to cross stones and some other games as well. And one of the highlights that we would like to share with you is that the last week it happens on the strong net cash, all those games has also made another record high performances in terms of the matrix that has been very encouraging to us. And we are looking over the five offerings of some very quality products to the market. We still believe that this can also ensure a good experience has been conferred upon our players. And this can also ensure a long term performance of the games in the times to come.

Thank you. You are next question comes from Natalie Wu with CICC.

Hi, good morning, William, Onward and Juliet. Thanks for taking my question and congratulations on another solid quarter. And also thanks all for the support in the past years and financial apex wishes for you and for the future endeavor. So my question is about the. PC games. So I've noticed that there is some kind of the softness regarding the self-develop PC game last year. So just wondering is it an issue to be worried about because you know the PC game industry seems to be already sophisticated in China and cannibalization is taking place; if Natty is confident to maintain their healthy development of PC game business given your solid game operation experience. I just want to hear about management views on that. Thank you.

[Foreign Language]

So with regard to your questions about the company's will on busy game developments, basically we do believe that the user has been given to the PC games, players cannot be fully replaced by just playing the mobile games in some ways; and in particular, especially for our licensed games that we licensed from places like the Overwatch, we have also been offering this game free to play to all the users; and in fact, in the last week we have also been seeing that the games has also been averaging another record high that has been very encouraging to us. And in a much longer term, in terms of its market potentials we still believe that the PC game still got this opportunities in the future periods but of course, if you are talking about how we view about its growth potential, of course this would have been able to compare the rest of it with what the mobile games can be offered. But after all, we always believe that for some outstanding products, both in terms of its qualities of the gameplay that defines the content that we operate and of course how we are giving out the - where you need user experiences when playing the games to our pocket uses we believe that this would be the areas that can offer the opportunities to further develop, especially in the PC-client area. And after all we always believe that the innovations and their abilities to create some new stops would be also very crucial to ensure a much long-term success of the company, not only in the [indiscernible] but also companies in the whole gaming industry.

[Foreign Language]

Okay. Another supplements that William would like to add in this year we would also be planning to roll out two more new PC games in the market and in a way this can also reflecting in ways we are still looking good upon the potentials about the PC game developments going forward.

Thank you. We'll take our next question from [indiscernible].

Hi Onward and William, I have two questions. The first one is related to your game revenue like deferred revenue. Deferred revenue appears in the balance sheet pretty often, and a lot of investors and also I myself felt little bit confused about how you record your game revenue and how much of growth revenue will be recorded in the current quarter? How much - what percentage of that will be in the deferred; so that is one of the major questions. So I have a second question, in the seasonality Q1 is supposed to be the lower season for e-commerce but to your e-commerce - since it has an up-quarter - and I wonder what's the driver behind it? [Foreign Language]

[Foreign Language]

So first of all, maybe I just get back to your questions about how we view about the seasonality issues surrounding or you can respect in particular - in the first quarter. First of all, the main parts of it would be good things from the Kaola businesses; and as you may well aware of this would be focusing on the overseas market and also depends on the prototypes that we are being selected and being offered to our targeted customers in the China market. And of course, more of the products will be women focused and we believe that the relatively good performances are on our e-commerce business in the first quarters can be attributed to the fact that we have also been doing quite numbers of promotional stuff during the period and we have also been doing a little bit more acting campaigns to promote the overall business, that can also bring up a positive impact to the overall performance for the e-commerce in the first quarter. And with regard to your second questions about the deferred revenue and stuff like that. I believe that we have always been reiterating that we have a standard policy in order to amortize the revenues of our various gaming products for a period of not more than six months and we have been following it all the way through in a consistent manner. And basically we wouldn't be able to give you an exact percentages on how much of it will be recorded in the deferred revenues and how much would be in the revenues that we recognize but we have - would be doing it on an overall basis, and also whether it's from different game titles.

Thank you. We'll take our next question from Jialong Shi with Nomura Securities.

[Foreign Language] Actually I have three questions for the management. My first question is about Minecraft, I just wonder what is Minecraft potential monetization models in China and also I want to - I would like the management to share any colors on the revenue potential for this game in China. My second question is about Overwatch, management mentioned earlier, Overwatch was made of - was many free since May 1 this year; I just wonder if Overwatch may have some other revenue source such as from the sales of virtual items? And my last question is about the quarterly dividend; and the company has made natives as - you know, has 25% dividend payout ratio. Currently I just wonder if company - if management may consider raising the quarterly dividend payout ratio? Thank you.

[Foreign Language]

So getting back to your question, in general about the Minecraft, basically in China there wouldn't be any company sales as what the overseas markets has been doing. In fact the Minecraft that will be launched would adopting the free to play model and the current timelines that we're expecting to launch this game would be somewhere around the July timeframe. And on your second question about the Overwatch, basically we would be adopting a strategy as to offering free to play to the users during the period from May 1 till the end of May, which is May 31. But subject to the reveal after how the market would be reacting to this kind of arrangements [indiscernible] we would be extending it to a much longer period. And with regards to the monetization models or the business models that we are looking upon for the Overwatch product, basically this would still be adopting the sales software, virtual items within the games. And with regard to your third question about the dividend policies; I would say that for now the companies will still be quite happy with its current dividend payout ratios but of course the companies and the board would be regularly reviewing the overall situations and consider all potential changes whether we are talking about the further increases in terms of its dividend ratios in the future periods but for now we would still upkeep the current payout ratios at approximately 25%.

Thank you. Our next question comes from Eddie Leung with Merrill Lynch.

Thank you for taking my questions. Just a quick up follow-up question on Minecraft. I'm wondering if you could share your thoughts with us on the target user sentiment of Minecraft? How is it going to be different than the current Chinese user base? [Foreign Language]

[Foreign Language]

So with regard to your questions about how we look upon the Minecraft, especially the [indiscernible] it would happen in China. First of all, I will like to share with you about some statistics, some preferred track records in the past couple of years that the two of the most popular games in the markets; the number one would be Tetris and the second one would be Minecraft; and in some ways we also observed that in terms of this search index of searching the Minecraft games, this would got a - more than double search that the number one games. And so far as the game is concerned about its launch and the operations in the China market. Basically we would be adopting a different models from the rest of the world because in China we would be offering that game free of charge to play for the players and we are also looking upon that with the many new contests and features that we are offerings within these games, the rollout of the Minecraft in China would also be another successful one that we are expecting.

Thank you. We'll take our next question comes from Hillman Chan with Macquarie.

Good morning, management. Thank you for taking my questions. Regarding Minecraft, could you say more about the PC beta testing articulates from that? And also could you talk about a timeline for the mobile version of Minecraft in China? And my other question would be about the e-commerce business; I noticed that we have been being aggressive in Kaola, for example, going to Europe for big orders and also the Yanxuan is also very aggressive in China [ph] as well. Just wondering if you can share more on the growth, how long are the GMP target for this year in possible? In the longer term, mostly the margin poll that we should be expecting from the e-commerce business? Thank you.

[Foreign Language]

So basically with regard to the PC beta testing, we are feeling very happy with this performance so far and everything has been progressing well. And in terms of when we have reached to mobile versions of the Minecraft, the competitive stage would be somewhere around July of the year. [Foreign Language]

[Foreign Language]

So basically we would like to share with you about how we will about our strategies or the executions on our e-commerce businesses, especially on the Kaola and the Yanxuan front. For the Kaola, basically the reasons that are - that news would be getting into these new businesses is coming from three years before when the Chinese government has already opened the e-commerce businesses or in fact the cross body e-commerce businesses to all the entrepreneurs in the China market and we are making good use of this policy support in order to move into this new area. And in fact there has been a slogan stuff we have always been talking about when we are undertaking the current businesses because we are importing some of its products but the prices that we are offering would be just local price; meaning that we are targeting and aiming to giving a very good value for money to our targeting customers when they are buying some quantity products from the opposite market. And so far as the Europe market is concerned, of course we have our own merchandising departments out there and we are also in close partnership with some formerly [indiscernible] and in Japan, we are also in close collaborations with Karl [ph] in order to offer some of the more popular items to our targeted customers. And on the other hand, when we look upon to how we are moving to another area of doing the e-commerce businesses like the Yanxuan because we have been seeing that and there has been a very good demand from the local markets for some good quality products in the marketplace and - but many of the times, especially past, the people would be just doing it - the product is obvious been produced locally but when they just placed the brand name from some over the market spend, the price will be very expensive but what we have been doing is that we are doing it by collaborating with the manufacturers locally for some premium product or the brand names; and then we'll be just given the money to buy out certain defined because basically for Yanxuan, the models that we've been adopting would be ODI model. And there would be two things that we would like to offer as to our targeted customers. First of all, quality products and those would be something that they are actually - would like to have; and on the other hand, we are offering say very good price. And so far as the overall populations in China is concerned because by now China has already surpassed more than 1.3 billion people in China, and this definitely would be a very huge market. And we do believe that in the future periods that there would be a certain consumption upgrade and we are also confident and also feeling proud that we would be one of the leading players in the e-commerce area, especially on the Yanxuan fronts by offering a very good quality product but at a very cheap or very effective price to our targeted customers. And also in terms of the user experiences because we are also adopting a very renown and reputable logistic service provider like [indiscernible] and we have also been getting a very positive feedback from our customers so far.

So that concludes today's question answer session. At this time, I'll turn the conference back to management for any additional or closing remarks.

Thank you once again for joining us today. If you have any further questions, please feel free to contact Juliet Yang, Senior IR Manager based in Guangzhou [ph] or PB Investor Relations. Have a great day.

This concludes today's presentation. We thank you for your participation.