Welcome to the NetEase First Quarter 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Margaret Shi, Investor Relations for NetEase. 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 subject to certain risks and uncertainties, assumptions and other factors.
Some of these risks are beyond 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 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 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 2020 Q1 earnings 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 NetEase corporate website at ir.netease.com. Joining us today on the call from NetEase's senior management is Mr. William Ding, Chief Executive Officer Mr. Charles Yang, Chief Financial Officer and Mr.
Hilton Hui, Co President of NetEase Games. I will now turn the call over to Charles, who will read the prepared remarks on behalf of Williams.
Thank you, Margaret, and thank you, everyone, for participating in today's call. Before we begin, I would like to remind everyone that all percentages are based on renminbi. Like every company around the globe, we started the year with a great deal of uncertainty amidst one of the world's worst health crisis. I am pleased to say that we have worked very hard to address the effects of the pandemic, providing health where we can and making the appropriate adjustments to our businesses to ensure the safety of our NetEase family. We believe many companies inside and outside of China will overcome this pandemic and come out strong.
We had a good quarter, increasing our net revenues by 18% to rmb17.1 billion, and our net income from continuing operations attributable to our shareholders was up by 30% to RMB3.6 billion, both on a year over year basis. For our online games, net revenues reached RMB13.5 billion in the first quarter on the back of our existing titles' stellar performances, growing 14% year over year even though 1Q 2019 was itself a very strong quarter for our game services a year ago. Our legacy PC titles such as The Fantasy Westward Journey and New Westward Journey Online 2 continued their strong performances in the Q1 with new expansion packs launched for the Chinese New Year holidays, introducing a series of new content. Quarterly revenues for these games broke new records, hitting another all time high since their debut almost 2 decades ago. Momentum for legacy mobile games was also strong as we continued to supply this large and sustainable user base with continual content updates.
Take our fantasy westward journey mobile game as an example, where we introduced a brand new character, which quickly gained popularity and was a strong driver for gross billings. While we continue to dominate the MMO genre, many of our recent titles in categories that are relatively new for us have also shown remarkable success and sustainability, providing us with steady revenue streams in what is now a very diverse game portfolio. Invincible, Amiogi, Identify and LifeAfter launched in 2015, 'sixteen, 'eighteen and 'eighteen, respectively, serve as good examples of our superior game longevity within different game genres. Invincible, our 2015 launch, hit another pot recordquarterhighgross billing and active users. We are pleased to see the game's strong traction in the SLG market.
After more than 5 years of successful operations with InvinciBull, we have accumulated a solid SLG fan base and extensive expertise in this field. We look forward to developing more innovative games to delight our users in this engaging and thought provoking genre. Amiogen continues to show remarkable longevity as we consistently introduce new characters. These additions are resonating well with new game players, further solidifying the reach of ARMYOG as a leading ACG game. As the first of our younger IPs that we have created in house, our goal for ARMYOGI is to have an even larger and deeper impact on the vibrant community of young users.
In addition to Amyouji, the card game, the collectible card game we launched last year and the upcoming simulation game, Onmyoji Yohai Koya planned for later this year, we have more exciting new games in store based on the Onmyoji IP. Later today, this evening, Beijing time, at our May 20th Game Day event, we will introduce 2 new Onmyoji spin off games in brand new genres. Launched in 2018, Identity V and LifeAfter are also a few of our newer titles, attracting a large base of young fans and starting to demonstrate sustained longevity. Celebrating its 2nd anniversary in April with a series of content updates, Identity V reached a milestone of 200,000,000 registered users, attracting players with its characteristic art style and innovative gameplay. With LifeAfter, since its initial phase of stabilization, gross billings have been picking up steadily over the past few months as we launched a couple of highly popular expansion packs, introducing a series of new themes and innovative gameplay.
We believe that LifeAfter will be another one of our titles that resonates with fans for many years to come. In terms of new titles, Fantasy Westwood Journey 3 d was launched at the end of 2019 and delivered a stable performance in the Q1, further expanding the reach of the FWJ franchise as a whole and captivating both returning fans as well as a new audience. In April, we launched Donna Vios in China, previously known as Asia Vio. As our newest MMORPG featuring sandbox gameplay, the game topped the iOS download chart soon after its launch and was featured by the iOS App Store. In overseas markets, we continue to gain market share in Japan.
NICE Out and Identity V remain at the forefront of Japan's top growth in games chart, and the user bases for both games are growing at a strong pace. The success of these games has helped us to gain a much better understanding of Japanese users and their preferences, allowing us to better tailor our games for the Japanese market. We have integrated this successful experience and know how into the design of other NetEase games, enhancing our ability to deliver popular titles to global audience. At the end of 2019, we began operating invincible in Japan ourselves With our proficiency in operating this game domestically, along with our newly acquired understanding of Japanese user preferences, we saw a steady increase in InvinciBull's revenues in the Q1. Now turning to our game pipelines.
Many of the games under development have the potential to achieve mass audience appeal, transcending geographies and spanning multiple genres. We have a number of these exciting new releases planned for 2020, which we expect to help us gain more brand recognition in the broader global markets, particularly in the U. S. And European market. As announced 2 days ago, EVE Echos is ready for its global launch in August.
Additionally, other exciting upcoming titles include Fantasy Westward Journey H5 Version, Kingdom Hunters, PES Club Managers, Amiyoji Yokaikoya, Ghost World Chronicle, Revelation Mobile Game, Harry Potter: Magic Awakened, Diablo Immortal, Pokemon Quest and Marvel Duo. Now for our education business, Youdao started the year off on a strong note with healthy gains across many of its primary financial metrics. Total net revenues accelerated by 140% year over year to RMB541 1,000,000 and operating cash flow turned positive for the first time. We are seeing an increasing adoption rate of online education, doing large part to the structural effects of the pandemic. Online courses generated gross billions of RMB519 1,000,000, up 2.87% year over year, primarily due to continued enhancements to our cost content and product.
To match the needs of newly enrolled students during the pandemic, Youdao quickly developed and refined new products, helping students receive the most effective teaching online, especially for those taking entrance exams this year. In line with the growing enrollment, we carefully crafted a few more products, including junior high school math, high school English courses, which received wide popularity. We also expanded our education team to over 1,000 instructors and teaching assistants who are well trained and incentivized to give our students the most tailored and personal support they need. During the quarter, we further enhanced our technology offering with the launch of AI Essay Assessment in our dictionary app, a feature that automatically grades and offers suggestions to improve English writing. Going forward, Youdao will continue to build up its largely scalable business model and provide users with effective educational experiences empowered by great content and technology.
For our cloud music business, we are also growing and proud to have celebrated NetEase Cloud Music's 7th anniversary in April. Revenue from our Cloud Music platform continued to accelerate with high speed, achieving triple digit growth year over year in the Q1 and record high membership revenue. Live streaming revenue is also growing at a rapid pace. In the Q1, we released several online live events that were particularly appointments during the pandemic outbreak and helped to support our independent musicians and their ability to distribute. These include the Bedroom Live Music Festival, where well known musicians performed at home via live streaming and the indie live, a high quality broadcast of independent brands, band live shows.
While we maintain a competitive edge in original music with now over 160,000 independent musicians on our platform, We are also looking to provide music from all over the globe to expand our music library. In March, we added popular Japanese music to our platform through our distribution agreement with Studio Ghibli, one of the most acclaimed animation studios in the world. Further adding to our catalog of songs, we recently signed a strategic partnership with Rock Records, one of the largest record labels in China, all with all. As with all of our businesses, innovation is key. Along these lines, our music platform's largest progression includes a newly launched karaoke offering for our young people.
Moving ahead, we will continue to make sensible investments in content and innovation to remain relevant and competitive in the exciting world of music. Turning our focus to Yanxuan. After a short 4 years, we have developed a distinct and recognizable brand with a number of notable self developed products that appeal to a wide range of consumers. In particular, Yanxuan has made a name for itself with distinctive offerings in housing, personal care and food categories. During the Q1, we upgraded our membership offering to a pro membership to include more benefits, attracting a considerable new constituency.
New memberships rose by 138 percent year over year, owing to our innovative marketing approaches, such as collaborating with top live streaming celebrities. Meanwhile, our inventory has been managed to a healthy level as we continuously optimize our procurement and reduce obsolete inventory. Overall, we had a strong start to 2020. Our primary business lines grew during the Q1, and we are pleased to have advanced our mission to bring inspiring, leading products and services to our growing community of followers. We will press forward as we have done for the past 2 decades with our eyes on the long term and plans to reach incremental gains along the way.
This concludes William's prepared remarks. I will now provide a brief review of our 20 20 Q1 financial results. Given the limited time on today's call, I will be presenting some abbreviated financial highlights. We encourage you to read through our press release issued earlier today for further details. Total net revenues for the Q1 were RMB17.1 billion or US2.4 billion dollars representing an 18% increase year over year.
Net revenue from online game services were RMB13.5 billion, up 14% year over year. This increase was primarily driven by the strong performance of our flagship titles in SWJ franchises, New Westwood Journey 2 as well as Blizzard's World of Warcraft. Mobile games accounted for approximately 70% of net revenues from our online games in the Q1. Net revenues from Youdao also increased 140% year over year in the Q1, reaching RMB541 1,000,000, primarily due to the increased net revenues from online courses with a rapid increase in K-twelve, paid enrollment and sales of intelligence learning devices. Net revenues from innovative businesses and others were RMB3 1,000,000,000 for the Q1, up 28% year over year, mainly due to increased contribution from NetEase Cloud Music and CC Live Streaming.
Overall gross margin was 55% in the Q1. GP margin for our online game services for the Q1 was 1st quarter was 64.1%. Our gross margin for online games is generally stable, fluctuating quarter to quarter within a narrow bandwidth based on the revenue mix of mobile and PC as well as self developed and licensed games. Youdao's gross margin expanded sharply to 43.5% in the 1st quarter, a vast improvement from 29.8% in the last quarter. This was primarily driven by the achievement of economies of scale and better faculty compensation structure.
Gross margin for Innovative Businesses and Others for the Q1 was 15.8%, up from 5.7% year over year. Improvement comes primarily from significantly increased revenue from our NetEase Cloud Music business. For the Q1, total operating expenses were RMB4.9 billion. Our selling and marketing expenses as a percentage of net revenue was 10.9% compared with 13.7% in the prior quarter. The quarter over quarter decrease was a result of less spending in online game promotion and cloud music during this quarter.
R and D expenses were RMB2.1 billion, up 5% year over year. We remain committed to investing in innovative content creation and product development, which is what's defining us as a technology company. Effective tax rate was 22% for the Q1, relatively flat with the prior period and down from 31% in the Q1 of 2019. Non GAAP net income from continuing operations attributable to our shareholders for the Q1 was RMB4.2 billion or US595 1,000,000, representing increase of 15% quarter over quarter and nearly 26% year over year. Our non GAAP diluted earnings per ADS from continuing operations were RMB32.17 or US4.54 dollars for the Q1 of 2020.
Our cash position remains strong. As of 31 as of March 31, 2020, our total cash and cash equivalents, current and non current time deposits and short term investment balance totaled RMB79.3 billion compared with rmb74.4 billion as of the end of last year. In accordance with our dividend policy, we are pleased to report that our Board of Directors has approved a dividend of US1.16 dollars per ADS for this quarter. This represents a regular dividend paying stream since 2013. On February 26, 2020, we announced the Board approval for a new share repurchase program for up to US1 $1,000,000,000 of our outstanding ADS, and we announced an amendment to such program earlier today to increase the total authorized repurchase amount from the original US1 $1,000,000,000 to US2 $1,000,000,000 As of March 31, 2020, approximately CAD 1,100,000,000 ADS have been repurchased for a total consideration of USD 342,000,000.
Thank you for your attention. We would like now to open the call to your questions. Operator, please go ahead with Q and A. Thank
We will take our first question from the line of Alex Poonce from Morgan Stanley.
I'll translate my questions. First question is regarding the lessons learned from COVID-nineteen. Regarding the game business, many game genres have become very popular during this period, no matter it is mobile or shooting games and also casual games as well. So in terms of user acquisition, retention, game genre, development strategy, do we have some new source new ideas after this COVID-nineteen? And my second question is regarding the music business.
Top line growth is very strong. How should we think about the product development and margin trend in 2020? Thanks very much.
I would like to provide a
brief translation of William's remarks. Firstly, on games, during the pandemic, we have seen games becoming a sense event for family members staying together in house, so they have more time spent together as a family, as a whole, to get joy and excitement and some relief from game as a broad entertainment. It is also a boost to new game users during the past quarter. And these will be obviously translated into our thinking of how to focus more on R and D, self development of games that can create a bonding opportunity for family members as a whole going forward. For the music, William emphasized, in fact, reemphasized from his prior remarks that the ambition, the mission of NetEase cloud music platform is we want to create a best environment to support development of China's independent musicians, people with talent who can express themselves and distribute their product to a group of music enthusiasts with passion, with an exploration of new diversified different genres of songs.
And I think for the foreseeable future, that is our key focus of development. You also asked about the margin trend. I think that as we continue to grow the scale and diversification of our music revenue stream possibilities, we will naturally benefit a lot from economies of scale with enhancement of margin trend. And I think on the margin trend, we are also quite optimistic. Hope that answers your question, Alex.
Thank you very much.
We will take our next question from Alicia Yap from Citigroup.
Hello.
Alicia Yap. Your line is open. Please go ahead.
Okay. Hi. Thank you. Good morning, William and Charles. Congrats on the results.
Thanks for taking my questions. My question is on your gaming business. As many other company are seeing the normalizing trend of the gamers traffic and activity post the lockdown lift off? How does that trend looking for NetEase games? And how should we think about the offsetting factor with your deferred revenue for the Q2 and also the lockdown in overseas that might benefit the overseas gaming closing?
Thank you.
Alicia, do you want to translate your question yourself?
Sure.
I will provide a brief translation of William's remarks. So he commented, Alicia, I think your observation is right. However, that is a short term volatility. I think across the board, as you mentioned, other game companies and us might be seeing. However, William emphasized that the growth engine of NetEase games is our ability to continuously launch, produce in house and launch new game titles as well as our ambition of becoming a more globalized game company with more exciting titles launched into overseas market, such as Japan and hopefully very soon in the mainstream Western market.
We saw that we are not overly concerned about these short term volatilities and we are very, very optimistic about the outlook of NetEase Games' growth driven by the diversification of new titles as well as diversification of new geographies.
We will take our next question from the line of Natalie Wu from China International Capital Corporation. Your line is open.
Hi, good morning. Hi, good morning. Thanks for taking my question and congratulations on a very solid quarter. I will translate myself. So I have two questions.
First one is regarding the PC games. So your PC game outperformed industry despite a hard off operation of the Net Cafe, which is quite encouraging. It would be great if management can share with us some thoughts of the future outlook for that segment? And second one is regarding Harry Potter. So just wondering if the game is ready, but still need time to get approval in domestic China market.
Will you decide to wait for the license? Or will you launch it firstly in overseas regions? Thank you.
Okay. Yes, naturally, I'll translate William's comments for everyone's broader benefit for the question, and I will answer the question on Harry Potter. So firstly, we what we observed is that during the global pandemic, PC and console games, in general, has seen an increasing trend as more people are spending time at home. And it is not so much correlated to the Internet Cafe's operation as you can see from our game results because our PC games are legacy titles running for over a decade. In case of FWJ, we see a record quarter since it's debuted almost 17 years ago, and we are very confident about the sustained gross billing popularity of our flagship PC games.
For the time being, our main concentration focus of new game development is tilted towards mobile games. So launch of new PC games will be opportunistic. We do not have a regular agenda like we regularly launch new mobile games. So that's to your first question. 2nd question, Harry Potter.
We are very excited about Harry Potter. It is a strong IP globally, and we are confident in our R and D ability to convert this IP into an exciting game title. I think it's too early to predict about the situation on regulatory approval in China. And when it comes to the stage when the game is ready for launch, whether we will do a global simultaneous launch or whether we will do overseas launch first, followed by domestic upon the approval. Both are possibilities and we will decide that later when the game is more advanced.
Got it. Thank you.
We will take our next question from Sijia Wang from Nomura. Your line is open. Please proceed.
Yes. Good morning, management. Thanks for taking my questions. First of all, congratulations on a very solid quarter. I have two questions.
First question is about NetEase online gaming business. Just wondering how much of native online gaming revenue was contributed by overseas market in 1Q? My second question is about NetEase Music Business. According to various media reports, it seems to me NetEase Music has accelerated the purchase of licensed content since this year, including the recent licensing agreement with top global record labels as well as the exclusive purchase of some of the highly rated music shows. I was just wondering why it seems NetEase Music became more aggressive on content purchase.
Thank you.
Xiaolong's first question, overseas, 1st quarter, our overseas revenue accounts for slightly more than 10% of our total game revenue, consistent with our level of last year. But we are very confident to continue to grow and even very strongly to grow this revenue contribution from the overseas game market in the next 3 to 5 years. I'll provide a quick translation of William's remarks. So first of all, our dedication to support and promote independent musicians and native IPs are not mutually exclusive with our deep respect and open minded strong collaboration with music label companies. In fact, in the past, there are obstacles in the industry preventing us from purchasing music content and music IP directly from label companies.
We are very, very active and in deep collaboration with all these highly regarded label companies in an effort to acquire music IPs, content, copyright and utilize our efficiency and our massive user scale of NetEase Cloud Music to distribute their music content to a group of music enthusiast lovers. And we also want to reiterate that we hope that the whole industry in China and all the players in China can spend more focus, efforts and resources into promoting native IP, organic music from independent musicians because I think it is going to be a much bigger ambition for the entire industry to see the rising of Chinese music, Chinese musicians as a whole to play a much bigger role on the global audience on the global stage.
Okay. We will take our next question from the line of Eddie Leung from Bank of America Merrill Lynch. So my question is about the new game launch. Historically, when we have a big year of a lot of new games to be launched, typically the marketing spending ratio would go up. So just wondering what could be the pattern this year and whether there would be different ways to promote new games?
Thank you.
Okay. Yes. Eddie, your question is on our outlook of marketing expenses. I want to reemphasize one point. NetEase Games focuses a lot on self developed, in house developed games.
As such, we are always excited about our lineups of new games. Whenever we consider promoting a new game, it is always a return driven exercise internally, depending on our projections of the game's performance and expectations of the gross billion, then we allocate marketing resources in a very sensible way. That is why I think in the prior quarters, I also made remarks that trying not to look too much into the quarter over quarter fluctuations of the marketing spending dollars. In fact, if you look at my marketing dollars as a percentage of the overall revenue on the full year trend, Last year, we controlled it at around 10%, a significant decrease from the prior 2 years. However, absolute dollars is not shrinking.
That is because we are more sensible, we are more conscious about the return generation on marketing dollars with more new game titles, yes, we are going to spend more marketing dollars, but we are even more optimistic that with effective promotion, the new games are going to generate even faster return for us at the top line. So on the financial planning aspect, NetEase remains prudent and sensible.
Got it. Thank you, Charles. We will take our next question from the line of Alex Liu from China Renaissance.
I'll translate myself. My first question is on the cash allocation. We have very good cash flow on our core business and also very solid cash balance. Just wondering, should we think about the enlarged stock repurchase program and perhaps further stock repurchase program as a more occurring practice down the road? And the second question is on deferred revenue.
Deferred revenue balance was very strong this quarter. And I was wondering if the management could give some color on this growth and whether it's due to the mix change between PC and mobile games? Thank you.
Okay. Alex, for your first question, our treasury policy is always very prudent. We are one of the very, very few tech companies globally that pays a regular dividend. In fact, we've been paying a regular dividend since 2013, and we will continue to do so, returning value to our shareholders, especially long term shareholders who has been supporting us in the journey of the growth over the last 2 decades. The stock buyback programs is also a regular exercise for a couple of years.
And when the situation requires and then within our ability, we can go back to the Board, just like this time seeking for their authorization of enhanced dollar amount for the overall stock buyback. So that is on the treasury cash management aspect. For your deferred revenue, we don't further break down exactly on the composition, but I think you're right. Q1, if I remember correctly, it is probably another record quarter for both my recognized revenue as well as deferred revenue. And again, largely, it's underpinned by the gross billion and the growth of both my PC lines as well as mobile lines of games, largely consistent with what you are seeing in the year over year growth for the recognized revenue.
Youdao also contributed to certain extent, of course, but then you can refer to Youdao's public filings for the deferred revenue incremental portion.
Understood. Thank you very much.
We will take our next question from the line of Binnie Wong from HSBC.
Hi. Good morning,
William, Charles and Margaret. I'll quickly translate myself. Post the COVID-nineteen, do you think that it actually changes in terms of how we view our overseas games expansion plan? What are the new opportunities that we also see? And how do we see our target in the next 3 to 5 years?
How does that change or that remain the same? And then in terms of your upcoming game launches, which one do you think because these are all
very highly anticipated, which one do you think that
we probably will see if you see the significance of those? Thank you.
So I will provide a brief translation of William's remarks. So firstly, how the pandemic situation globally would affect our thinking of game promotions, particularly in the overseas market. William's comment is that, generally speaking, the pandemic situation requires people to spend more time in house. So it is a structural tailwind for overall activities that happen at home, playing video games, watching drama, etcetera. And that, we think, is going to also benefit in our game promotions because this content is having more user time, so to speak, on a global scale.
And we are not particularly concerned about the pandemic situation disrupting our plan, our original plan of game launches, especially for these mature overseas market, users are more attractive and emphasizing a lot on game quality. I think that is our biggest selling point. It is the quality of the NetEase games. And second, you asked on the approval process and our expectation on the overseas games, it's really difficult for us to do a false ranking, which one is number 1, which one is number 2, because for all these projects since the inception of the project business planning, we think they are all great products representing highest quality in the respective genre to target and attract to a very different segment of target users. So we are very excited.
Some of the games can be launched as early as the middle of this year and some might have to wait until the second half later part of this year. And William draws also a closing remark that he himself personally throughout and given the pandemic situation, he's actually been thinking and giving a lot of more thoughts in terms of how game content can be designed and developed and how game content can be distributed to fulfill a better social responsibility and value to families, to people around the globe.
Thank you, William and Charles. That's very helpful.
We will take our next question from the line of Thomas Chong from Jefferies. Your line is open. Please go ahead.
Hi, good morning. Thanks, William, Charles and Margaret for taking the questions. I have a question back to the music business. Given the fact that we have been also monetizing for the live streaming business models. Can you comment about how we should think about the competition in the live streaming space as well as the competition with short form video.
So in the interest of time, I'll provide a brief translation of William's remarks just now. So broadcasting is just one way of us thinking how we can monetize on our NetEase Cloud Music platform. It is not the only way, and we will continue to explore different and innovative and diversified ways of monetization in a sensible and user appealing way. But the essence of us, the biggest ambition and the mission of us doing the NetEase Cloud Music platform is that we want to contribute whenever we can within our ability to help promote and better enhance the Chinese music industry as a whole. It might look very different from mature market in the Western world, but we think Chinese music market is huge with huge upside potential and it could allow multiple players to develop its respective differentiated competitiveness, advantage and edge in collectively making China's online music industry a better and a more promising industry.
Thank you. Due to time limit, that concludes today's question and answer session. At this time, I will turn the conference back to Margaret Shi for any additional or closing remarks.
Thank you once again for joining us today. If you