Brandi Piacente - Investor Relations Charles Yang - CFO William Ding - Chief Executive Officer and Director Zhaoxuan Yang - Chief Financial Officer

Alicia Yap - Citi Eddie Leung - Merrill Lynch Jialong Shi - Nomura Securities Natalie Wu - China International Capital Corporation Karen Chan - Jefferies Han Joon Kim - Deutsche Bank Angelo Chu - UBS

Good day and welcome to the NetEase Second 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 segments 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 its 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 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.

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 game 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 striving. During the second quarter our net revenues grew almost 50% compared with the same period last year. Our net revenue for online game services grew 46.5% year-over-year less by our sales 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 in mobile game in Invincible reached record high quarterly revenues. We also saw positive momentum from Fantasy Westward Journey and Westward Journey mobile games as well as 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 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 reduction. Well we saw some pullbacks from Onmyoji this is within the management's expectation given the titles 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 once released at the end of July. We plan to frequently launch high quality content updates 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 high record high pre-registration levels with our licensing partner in Korea and release on Facebook's game room platform if you further fortifying these games overseas presence. While we bring our community in new exciting contents and games, we are simultaneously exploring creative market segments where we see complementary growth opportunities, producing games for additional platforms and adding new game play capabilities such as VR and AR enables us to leverage our strong and innovative R&D competencies and employ our time nearing spirit. At the end of the second quarter, we released Clear Lights, 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 portfolio currently stands as one of the most robust in China. We intend on growing this business with current plans to introduce new titles and content that supports 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, two exciting Japanese-themed RPGs and a stunning 3D PC-client game conquerors played 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 bringing more all of our games to overseas markets. Now turning to our other business segment. 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 at mobile, internet services, and real active services segments were the top performing verticals. Mobile advertising continues to rise as a preferred means of advertising, which both 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 increasingly important revenue contributor. Kaola and Yanxuan are flourishing among the market ride 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 how expanding community worldwide and continue to grow each of our business lines. This concludes Williams' comments. 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 RMB6.7 billion or US$993.7 million compared with RMB7.5 billion and RMB5.3 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, the mobile version of New Ghost. The quarter-over-quarter decrease in online games 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 RMB3.3 billion or US$491.4 million, compared to RMB2.7 billion and RMB2.2 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 staff-related costs resulting from an increase in headcount and average compensation, increased selling and marketing expenses mainly related to online games, and increased operating expenses related to our ecommerce businesses. For the second quarter of 2017 we incurred a net income tax charge of RMB703.5 million or US$103.8 million this compares with RMB943.0 million and RMB262.7 million for the preceding quarter and the second quarter of 2016, respectively. The effective tax rate for the second quarter of 2017 was 19.0%, compared with 19.0% and 8.6% for the preceding quarter and the second quarter of 2016, respectively. The year-over-year increase in the effective tax rate was mainly due to the fact that certain of our subsidiaries were recognized as Key Software Enterprises in the second quarter of 2016 and subject to a preferential tax rate of 10% for 2015, and we've recognized related tax credits in the second quarter of 2016. The effective tax rate represents our estimates as to the tax obligations and benefits applicable to us in each quarter. Net income attributable to the Company's shareholders for the second quarter of 2017 was RMB3.0 billion or US$438.4 million, this compares with RMB3.9 billion and RMB2.7 billion for the preceding quarter and the second quarter of 2016, respectively. Non-GAAP net income attributable to the Company's shareholders for the second quarter of 2017 was RMB3.5 billion or US$512.2 million, this compares with RMB4.3 billion and RMB3.2 billion for the preceding quarter and the second quarter of 2016, respectively. During the second quarter we had a net foreign exchange loss of RMB131.3 million or US$19.4 million this compares with a net foreign exchange loss of RMB48.5 million and a net foreign exchange gain of RMB77.3 million for the preceding quarter and the second quarter of 2016, respectively. The year-over-year and quarter-over-quarter changes in foreign exchange gains and losses were mainly due to unrealized exchange gains and losses arising from our U.S. dollar-denominated bank deposits and short-term loan balances as the exchange rate of the U.S. dollar against the RMB fluctuated over the periods. Our basic and diluted earnings per ADS were US$3.33 and US$3.31 respectively for the second quarter of 2017. This compares with basic and diluted earnings per ADS of US$4.40 and US$4.36, respectively, for the preceding quarter, and basic and diluted earnings per ADS of US$3.06 and US$3.04, respectively, for the second quarter of 2016. Our non-GAAP basic and diluted earnings per ADS were US$3.89 and US$3.86, respectively, for the second quarter of 2017 this compares with non-GAAP basic and diluted earnings per ADS of US$4.86 and US$4.82, respectively, in the preceding quarter, and non-GAAP basic and diluted earnings per ADS of US$3.62 and US$3.60 respectively for the second quarter of 2016. As of June 30, 2017, our total cash and cash equivalents, current and non-current time deposits and short-term investments balance totaled RMB41.2 billion or US$6.1 billion compared with RMB36.9 billion as of December 31, 2016. Cash flow generated from operating activities was RMB2.3 billion or US$342.4 million for the second quarter of 2017, compared to RMB4.0 billion and RMB3.3 billion for the preceding quarter and the second quarter of 2016, respectively. As part of our commitment to return value to our shareholders, our board of directors approved a dividends of US$0.83 per ADS for second quarter of 2017, which is expected to be paid of September 1, 2017 to shareholders of record as of the close of business on August 25, 2017. Additionally under our share repurchase program announced on November 15, 2016 we have repurchased approximately 366,000 ADS were approximately US$100.3 million by the end of the second quarter 2017. Thank you for your attention. We would like now to open the call to your question. Operator, please go ahead.

Thank you, sir. [Operator Instructions] We'll take our first question from Alicia Yap with Citi.

Hi, good morning William and Charles, thanks for taking my questions. Congratulations to Charles on your new role. I've two questions, the first one related to your sales and marketing expense line, so they'll grew quiet of - hello, yeah, can you hear me.

Yes.

Yeah, my first question is related to the sales and marketing expense, so because the line actually grew quite a bit on the sequential and year-over-year basis and from your prepared remarks seems to indicate that increased spending is more related to gain promotions. So wanted to know is that mainly related to overseas Onmyoji promotion, and I recall in the past, management actually has a disciplined approach in spending the sales promotion and tend not to allocate for example more than 10% of specific games revenue on marketing, has that target actually change. And then were you able to receive that effective promotion attractions with this step up spending during the quarter, how should we think about the spend for the second half of this year? Then second question is for your new games, can you share with us the expectations for the Forever 7 and Index will that be more similar to Onmyoji and how should that be different versus other assisting Japanese in the market? Thank you.

Okay, let me translate the questions. The second question is - the first question I will answer that, and then the second question I would translate for the management to answer. So Alicia, the first question on sales and marketing, number one, the 10% you mentioned the target, the target remains pretty much unchanged. For the second quarter of 2017 sales and marketing expense increase it's mainly a combination of continued spending on games, as well as some of the sales and marketing related promotion expenses are now at e-commerce businesses, which again largely in line with management budget and expectation. And going forward we are going to be still remain disciplined by our targets and we do see that sales and marketing expenses will continue to grow on a solid basis, but overall that principle and discipline would remain unchanged. So for the second question let me quickly translate for the management.

[Interpreted] Okay, so for these two games, they are Japanese team RPGs, our expectation is that this will further broaden our game portfolios and targeted to the ACG generation for these two mobile games.

Okay, thank you management.

Yeah, and this by the way these two games, we are now targeting for launch by end of this year.

Okay, great. Thank you.

We'll take our next question Eddie Leung with Merrill Lynch.

Hey, good morning guys. Thank you for taking my questions, quickly on two things. We know the Minecraft has been just launched it, so wondering if there is any user feedback and indication of the user engagement. And secondly about the e-commerce basis, we noticed that the gross margins coming down because of in the press release about the mix shift within the e-commerce business. So wondering if you could clarify a little bit on what's the mix shift within the e-commerce business? Thanks.

Okay, I will translate the first question first. [Interpreted]

[Interpreted] Okay so for Minecraft, Eddie for your first question, Minecraft the preliminary feedback from the PC version is positive, and within our management expectation and we're happy to see that and we continue to plan to launch the mobile version in Q3 of this year. Your second question is asking for the gross profit margin shift for the e-mail, e-commerce and other business segments, right, Eddie?

Yes.

Yeah, the GP margin change is mainly a reflection of the product mix change. As you know that the contribution from Yanxuan and Kaola continue to increase seeing that segment, so naturally it brings down the margin given the product the mix shift. Going forward the management is contemplating for potentially more disclosure on the e-commerce, so that analysts, audience and shareholders will gain more information on the performance of our e-commerce segment.

Understood, that would be great. Thank you very much.

Thank you, Eddie.

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

Hi. Good morning, William and Charles and Juliet, thanks for taking my question. I have two questions here. Firstly I heard management mentioned in the prepared remarks you were continue to invest in VR and AR games going forward. So I just wonder if management can provide any colors regarding how long you think before we can see these AR and VR game market to takeoff. And secondly about your e-commerce business and based on my calculation e-commerce revenue already represent 20% of our total revenue. So I just wonder at such a scale, is it time for management to consider improving the probability of your e-commerce business or you think it's still too early to consider probability and your focus remains on growing the market share at current stage? I would translate it into Chinese.

[Interpreted] So let me just say the benefits of the audience. Let me quickly translate the answers addressed by William. So first question on the AR VR games, William commented that the AR and VR slightly different here in China, so VR keep things it takes at least another two years or so to be ready in China again it's mainly restricted by the readiness of the equipment and hardware and that notes NetEase leave actually started early and we currently do have a VR games to like tiny that is distributed on the Google Daydream platform. For AR, we see more assets that's being put into a game plays. We haven't - we are yet to see a mature and successful AR game in the market to more of deploying AR as part of a game play. So we will be excited to see the development on the AR side. Second question on the e-commerce, the balance between growth and profitability as you all know we have Kaola, which is mainly focused on cross-border e-commerce and Yanxuan that is our private label e-commerce platform. And at this stage, our focus is still mainly to grow and market share we want these two platforms and our services and products to cover more families and users. In China, we see a huge upside consumers demanding for reliable high quality goods and value for goods. So profitability is not a near term focus, having said that we were not undermine the profitability by doing the subsidies and all other activities.

We'll take our next question from Chi Zhang with HSBC.

,:

[Interpreted] So for the question on the hotel, so first of all, William would like to clarify that NetEase, we actually do not own or upgrade any hotels in Yanxuan. The news mentioned about of a hotel that is business collaboration between Yanxuan and hotel and again we don't own or operate that hotel. We have ten rooms and the lobby in that hotel that we decorate and design with the products from our Yanxuan platform. So we view this as more of the off line marketing promotion event, because we want to give the users or the guest of the hotel firsthand experience and exposure to the Yanxuan products and they can feel and they can see, how the Yanxuan products can help lift out the experience of a home stay, so that's the intension of our corroboration with this hotel.

Thank you very much.

And we'll take our next question from Natalie Wu with China International Capital Corporation.

Hi good morning William and Charles and Juliet thanks for taking my question, so two questions here. The first one is what's the license to games revenue contribution this quarter and what do you expect that will be listed on future license game pipeline that would possibly impact on the license game revenue contribution and also can you touch a little bit on the future of this expansion plan? The second question is that for William, you've mentioned that about the five year target for your Kaola e-commerce business and earlier like 2016 in some media reports to grow Kaola's GMP to RMB100 billion. So just wondering if the target you host? Thank you.

[Interpreted] Little guesser could come out of his chair I'm going to go to the I.P.O. So you know almost a whole lot of you will get them done for you or have at the cost of other houses those house. She's in there was a lot of Lumia going to come like this one to our door that while it's over and the one seen the car wasn't all so well had all it gives you while you want to shove it I'm.

So let me let me quickly translate William's comment. First on the games. Obviously we are continuing our efforts for the collaborated games and that most anticipated title is Minecraft and we have high expectations of Minecraft into the future. And for the overseas game expansion plan again NetEase pushing many assets in actively exploring foreign titles bring that into China as well as to the opportunities of internationalization of our own ITs. Second question on Kaola, so as you all know that the policies and regulations shifted a little bit in China last year ASP the policy on the tariff rate as well as some annual spending caps on individual consumers across for the e-commerce purchase. But having said that, we think cross-border e-commerce has huge potential growth potential going into the future, as you all know a lot of Chinese tourists when they travel abroad they're spending can reach 1.6 trillion last year and that's physical spending overseas and that just represents a fraction of the cross-border e-commerce opportunity. And for Kaola we're very happy and proud that it is now the number one cross-border e-commerce platform in China and we are in a leading position in terms of the GMPs the revenues generated on our Kaola platform.

Great, very helpful, thank you, William and thank you Charles.

We'll take your next question from Karen Chan with Jefferies.

Thank you William, Charles and Juliet for taking my questions. Two questions here, the first question is, we saw some pretty good encouraging performance coming out of Onmyoji launch recently in South Korea, just wondering if management have a target on overseas revenue contribution to mobile game? And secondly just want to get your thoughts on any M&A plan strategy in the mobile gaming business? Thank you.

Okay, let me quickly translate the questions. [Interpreted] So let me translate the first question. Onmyoji in Korea we see good great feedbacks and it was ranked number seven in terms of growth grossing and number why in terms of the number of downloads and we are happy about the result and we will continue other internationalization plan for this game.

[Interpreted] For M&A William's comment is that again NetEase we are always very open minded, we are actively exploring potential opportunities, but at this stage we do not have anything that we would need to disclose or comment.

Thanks very much.

We'll take our next question from Han Joon Kim with Deutsche Bank.

Great. Thank you very much for the opportunity to ask questions. I have to as well. The first one is just your overall impressions as you continue to do overseas expansions so you've launched a few games in the U.S. Onmyoji into Japan you've had your trial with Kaola in Korea and so forth. What do you guys feel like you need to do more of or less of I mean it could be ranging from more R&D having more R&D overseas could be having just to more marketing or so forth, just kind of want to get your overall impression as if you like still an evolutionary process? And then the second question is just on the relative volatility that we're seeing for what Westward Journey mobile relative to FWJ and Ghost as far as the third quarter is concerned, so within the IOS ranking it seems to be showing a little more volatile to the others. Do you think there's a particular reason for that is it just kind of receptivity to the latest caught an update just kind of more seasonal? Thank you.

Okay. Let me translate these two questions for the management. [Interpreted]

[Interpreted] So let me translate the answers. First question on the overseas overall plan strategies, so we currently have our R&D offices in Korea and in the states and we will continue to invest in to resources overseas and in terms of our games, we prioritize the markets that may have higher reflectivity of our contents and products for the near term we're focusing on Japan, Korea and Southeast Asia. In addition, we are also developing games and content that's more payload for North America and European markets. For instance Crusaders of Light the U.S. version of Land of Glory was successfully launched into the U.S. market. On your second question, on the volatility around Westward Journey so as you know Westward Journey and Fantasy Westward both are MMORPG games they've been up and running for all that back head and it was actually very, very encouraging to see that a legacy titles like these was such a long operating history are still growing and the short term volatility performance that's very well within the management's operational expectation.

That's it. Thank you very much.

We'll take our next question from Angelo Chu with UBS.

Hi, good morning management. I have two questions. What is on the e-commerce margin and follow-up questions on the e-commerce margin? So other than the product mix change, but is the margin change is Kaola and Yanxuan respectively over the last quarters and also the change and also when can we expect Kaola to breakeven. And the second one is on international expansion, so I'm just wondering, how is the margin profile of international business compared to domestic business? Thank you.

Sorry. Just to clarify your second question, your second question is asking for international expansion for games?

Yeah, yeah, yeah for games, yeah.

For games, okay. Let me answer the first question first and then now I translate the second question for the management. For Yanxuan and Kaola the margins are relatively stable and as we continue to grow our scale, we do see the skill factor will benefit us and your part on the breakeven point for Kaola as Mr. William Ding mentioned previously our near term focus is still mainly to grow the market share and the user base grows and we the margin of breakeven profitability is not our near term focus and that were naturally come as we reach a critical mass in terms of upscale. And the second question I will translate. [Interpreted]

[Interpreted] So for your second question comes of the margin impact from our overseas games, so it really depends on the type of how we distribute our games overseas. Just for instance in Korea when Onmyoji's distribution is through local partnership with a Korean distributor then in under this mode, this will not affect our margins I generally speaking, but in other countries for instance Japan when we launched Onmyoji was operated by ourselves and we do see some impact in terms of overall margins, because we need to expand on the marketing and promotion aspects as well as the user acquisition profile in overseas market might be different from the Chinese market again depending on the target market.

Okay. Wonderful, thank you.

And ladies and gentlemen that's all the time we have tonight for questions. At this time I'd like to turn the call back over to management for closing remarks.

Thanks again everyone for joining us. If you have further questions, you are free to contact Juliet Yang, Senior IR Manager or Hangzhou or the IR group. Have a great day.

That does conclude today's conference. We appreciate your participation.