Welcome to the NetEase 2019 Third Quarter Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Margaret Shee, IR Director of NetEase. Please go ahead.
Thank you, operator. Please note the discussion today will contain forward looking statements relating to the 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 with 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 2019 Q3 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 NetEase corporate website atir.netease.com. Joining us today on the call from NetEase Senior Management is Mr. William Ding, Chief Executive Officer and Mr. Charles Liang, Chief Financial Officer.
I will now turn the call over to Charles, who will read the prepared remarks on behalf of William.
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. Firstly, to assist better understanding and analysis of our quarterly results, I would like to remind everyone that based on the changes in this quarter, including the sale of Kalab and the NYSE listing of Youdao, we will now be reporting segmented part as online games, Youdao and interact Businesses and others, which include now Yanxuan, NetEase Cloud Music, Internet Media, CC Live Streaming and others. Kaola's financial results have been deconsolidated and listed as discontinued operations. This applies to the current quarter as well as the historical comparative period.
This quarter, our total net revenue represents both year over year and quarter over quarter growth. You can also refer to Youdao's earnings release for more details about its quarterly results. I will now read the prepared remarks on behalf of William. We have had quite an eventful Q3 with a number of strategic moves made across our business lines. Those moves allow us to realign our resources and sharpen our strengths in areas where we see the most potential for our sustainable long term growth.
During this quarter, we continued to grow our online games business with steady performances from existing titles and further expanded our overseas presence. We are pleased to have achieved another quarter of strong financial performance with total net revenues increasing by 11% and non GAAP net income from continuing operations increased by 74% year over year. For games, our online games revenue continues to exceed RMB10 1,000,000,000 for the 6th consecutive quarter, driven primarily by the steady performance of the long running titles in our game portfolio. Our flagship Fantasy Westward Journey series and Westward Journey series continue to perform strongly as 2 of the longest and largest running game IPs in China. Those games continue to attract a loyal crowd.
Fantasy Westward Journey Online achieved another record high quarter of gross billing since its debut in 2003, 16 years ago, while the mobile version also reached its highest quarter of gross billing in the last 2 years. For the Westwood Journey series, we introduced a brand new dragon character in conjunction with an expansion pack in August for both the PC and mobile games, which quickly gained popularity within fans. Westwood Journey Online also peaked in gross billings this quarter, reaching the highest level we've seen since 2015. Other games launched in more recent years are also enjoying impressive popularity with highly active core user bases. InvinciBull had another quarter of record revenue with continued growth in active users.
In October, with its 4th year anniversary, the InvinciBull reached number 2 on China's iOS top grossing chart. Onmyoji also celebrated its 3rd anniversary this quarter and topped China's iOS grossing chart for the 3rd time this year in September. In addition, other games in our portfolio, including our new ghost series, Identity 5, all about Jianghu, which previously known as CLX, and LifeAfter, are also enjoying a sizable and steady run rate with their respective large bases of royal fans. 2 weeks ago, we launched an updated version of LifeAfter. The update came with an overhaul of the game, introducing a series of new themes and innovative gameplay, leading to a strong growth in the number of active users and gross billings.
These games span different genres, target different user profiles and last a long time horizon. This is how we achieve sustainable revenue base for our existing portfolio of games and continuously add more and more game titles to this expanding game portfolio. The fans that these games have accumulated over the years and the reach of their influence have turned each of them into valuable IP, giving rise to the possibility of more renditions of these popular characters and storylines. Most recently in October, we launched Shenzhen Dragon Upon the Cloud, a Chinese style turn based MMORPG, which topped the iOS downloads chart soon after its launch. And for Bloom and Blade, a new MMORPG we just launched last Friday is also trending well.
This game is designed to target female game players and was featured by the iOS App Store. Our joint venture with Blizzard Entertainment has also had a good quarter. In line with our successful 10 year partnership operating with World of Warcraft in Mainland China, the popular franchise continues to provide new thrilling game experiences to players across the world. August 27 marks the official launch in China of Blizzard World of Warcraft Classic, an inventive revitalization of Wow as a world renowned MMORPG, calling on the nostalgia of a generation of old players and intriguing new players alike. This latest release increased both revenue contribution and total number of subscribers for the game.
In terms of overseas revenues, we delivered a record quarter. We now have 2 blockbuster games in Japan, Knives Out and Identity V, both of which gained top position on Japan's iOS growth in chart. Live faster, our newer release, is also ramping up well in Japan. With the success of Knives Out, we gained a better and deeper understanding of users in Japan in terms of their interests, social behavior and preferences in style, aesthetics and gameplay. We pass this successful experience and knowledge onto the design of other NetEase games, enhancing our ability to deliver popular titles to Japanese users.
IDENTITY V topped Japan's iOS top growth in chart for the first time in September, while Nai's Out remains a household name in Japan amongst the gamers. To further support our game's growth in Japan and stimulate player enthusiasm, we hosted Knives Out Championship, our first ever e sports championship tournament in Japan from May to August with more than 500,000 players participating. In terms of our pipeline of games, we are pleased to have received the license for SWJ3D, which is currently undergoing the final round of beta testing and is scheduled for launch in December. In addition, we are excited to announce plans to release Harry Potter: Magic Awakened, a card game featuring a blend of strategic role play elements that invites players to experience the magical wizarding world. Other games included in our lineup include: Onmyoji: The Card Game, Marvel Super War, Onmyoji: Yokoi Polia, EVE Echoes, Ghost World Chronicle, Diablo Immortal and Pokemon Quest.
While our existing games are expected to sustain our online games revenue at a high level, the abundant pipeline titles represent opportunities to further fuel the revenue growth for our online games. Now turning to our Education business. We have completed Youdao's public listing on the New York Stock Exchange in October. This marks our first ever carve out IPO under the NetEase umbrella and the beginning of a new journey for Youdao to lead our efforts in revolutionizing the way that people learn and receive education. Following the IPO, NetEase remains Youdao's majority shareholder and will continue to support Youdao's future growth that propels their mission to empower the people of China on their lifelong learning journey.
Over the past 13 years, Youdao has become a strong contender in the online education space with clear advantages in Internet native path driven content offerings. The Internet has disrupted many industries in the world, but so far it has had a minimum impact on the education space in China. This offers tremendous opportunity for Youdao. Led by Doctor. Zhou, Youdao's senior management team is comprised mostly of computer science graduates and doctorates from top universities who are best suited to lead the transformation in the online learning space enabled by the application of technologies.
Both Youdao and NetEase are fully committed to investing in technology and content creation in order to bring to our users more effective and technology driven education experience. Moving on to Innovative Businesses and Others. For NetEase Cloud Music, we continue to deliver a highly differentiated music product with the mission to help tens of thousands of talented Chinese independent musicians create indigenous content that resonates with Chinese listeners. We strive to provide our users with the most intimate, interactive and high quality music experience. As we continue to amass more and more of what we call cloud villagers, we know we are on track.
NetEase Cloud Music continues to ramp up its monetization efforts, reaching new record high revenues in the Q3. Revenue growth has been strong across the board in subscription, advertising and live streaming, leading to continued improvement in our financials. We entered into a definitive agreement with Alibaba and Yunfeng for approximately US700 $1,000,000 in September. With our new strategic partners, we are able to explore more innovative forms of monetization for this highly engaging music platform. For Yanxuan, the focus continues to be about operating efficiency.
During the Q3, we continued to optimize our supply chain management to reduce our inventory and to deepen our relationships with Choice Manufacturing Partners. We help our manufacturing partners better understand the consumer metrics and provide them with better visibility and ultimately better sales figures. Further ahead, Yanxuan will continue to focus more on quality control and bring high quality products to our consumers. In September, we completed the sale of our cross border e commerce business, Kaola, and we are pleased to have found a strategic fit for Kaola within Alibaba's extensive ecosystem. In summary, we had a busy quarter being more focused and realizing value for each of our core business areas.
We are very confident in the future prospects of the sectors we choose to be in, and we have developed and will continue to strengthen our distinct product offerings in each of these markets. We will persist in our pursuit of excellence across all of our business lines and the needs of our users always remain at the heart of our business strategy. As we advance each of our businesses and create value, we are always looking for ways to increase returns to our shareholders. This quarter, in addition to our regular dividend representing a 30% payout ratio, we will also be distributing a special dividend of US3.45 dollars per ADS this quarter in consideration of the sale of Kaola Business. As always, we appreciate and value the long term support from our shareholders, and we are always devoted to maximizing the interest of our shareholders.
This concludes William's comments. I will now provide a brief review of our Q3 2019 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. Our total net revenues for the 3rd quarter were RMB14.6 1,000,000,000 or US2 $1,000,000,000 representing a year over year increase of approximately 11%.
And again, let me remind everyone that the revenue has taken into the consideration that we have deconsolidated Caola results in the current quarter as well as the historical comparative period. Net revenues from online game services were RMB11.5 billion, up 11% year over year. The year over year increase was primarily driven by LifeAfter, which was launched at the end of last year as well as continued strong performances from Invisible and Identify. Mobile games accounted for approximately 71% of net revenues from our online games in the 3rd quarter. Net revenues from Youdao nearly doubled year over year to RMB346 1,000,000, primarily due to increased net revenues from Youdao premium courses driven by higher paid student enrollment and average selling price.
Net revenues from innovative businesses and others were RMB2.8 billion, up 4% year over year due to mainly the increased monetization from cloud music, partially offset by decreased revenue from online advertising businesses due to macro environment. Overall gross margin was 53.8% in the 3rd quarter. Gross margin for our online game services for this quarter was 63.8%. Our gross margin for online games is generally stable, fluctuating quarter to quarter within a narrow band based on the revenue mix of mobile PC as well as self developed and licensed games. Youdao's gross margin was 25.8%, an improvement from 23.3% in the prior year period due to increased net revenues from Youdao premium courses and down from 32.9% in the previous quarter.
Gross margin for Innovative Businesses and Others for the quarter was 15.2% compared to 15.5% 17% for the previous quarter and prior year period, respectively. The year over year decrease was primarily due to decreased net revenues from advertising services. For the Q3, total operating expenses were RMB4.5 billion. Our selling and marketing expenses as a percentage of our net revenue were 11.1% compared with 8.9% in the 2nd quarter. The quarter over quarter increase was mainly due to increased marketing expenditures related to online game services as well as the summer promotion of Youdao, which is typical in the online education space.
R and D expenses remain steady at around RMB2.2 billion. We remain committed to investing in content creation and product development, which is what defines us as a technology company. Non GAAP net income from continuing operations attributable to our shareholders for the Q3 of 2019 totaled RMB4.7 billion or $661,000,000 representing an increase of 21% quarter over quarter and 74% year over year. Our non GAAP diluted earnings per ADS from continuing operations were RMB36.31 or US5.08 dollars for the Q3. Our cash position remains strong.
As of September 3, our total cash and cash equivalents, current and non current time deposits and short term investment balance totaled RMB61.4 billion compared with RMB49.7 billion as of the year end last year. As William mentioned in his remarks, we are pleased to report that our Board of Directors have approved a dividend of US7.59 dollars per ADS. This includes a regular quarterly dividend of US4.14 dollars per ADS, equivalent to approximately 30% of our net income attributable to the shareholder plus a special dividend of US3.45 dollars per ADS. Thank you for your attention. We would like now to open the call to your questions.
Operator, please go ahead to the Q and A.
Thank if you wish to ask your questions in Chinese, please immediately repeat your question in English. Please ask one question each time. We'll take our first question from Natalie Wu from CIBC. Your line is open. Please go ahead.
Hi, good morning. Thanks for taking my question. I have a question on the upcoming FWJ3D. Just wondering if management can give us some color on your expectation for that game. And do we need to worry that game could have the possibility of cannibalizing your current FwJ Mobile crossing if that FwG3D could be the next hit game?
Thank you.
Okay. Thank you, Natalie. I will translate that question for William. I'll provide a brief translation of William's response. SWJ3D is currently scheduled to launch in the first half of December, And we are quite excited about this game because this game represents accumulation of over a decade long of R and D experience, both from the PC version as well as the mobile version of SWJ.
And we can assure to the users and the investor community that you're going to see a lot of innovative innovation in this game. So this game is we are hoping that this game can attract many enthusiastic fans about the Westwood Journey franchise. And we given all these games are in house developed by NetEase, we are not overly concerned about any internal cannibalization to our existing FWJ PC and FWJ Mobile.
Next up, we have Alex Un from Morgan Stanley. Your line is open. Please go ahead.
Thank you, Alex. I'll provide a brief translation of William's comments for the audience. Firstly, on music, so in short, yes, we are very actively exploring different opportunities in terms of monetization that will be reflected in the upcoming quarters as we continue to explore strengthening existing monetization channels as well as to apply some innovative brainstorming on new features, for instance, social aspect, etcetera, that we mentioned previously. In terms of cost control, NetEase as a whole, not only as NetEase Music, we are very prudent and practical in terms of cost control. We think that in order to differentiate our music business from the competition, we are going to further strengthen sales production, UGC, independent musicians as a differentiated content.
As a result, we do not see any material increase in terms of music content acquisition cost. Overall, we are very confident about the prospect of monetization, which will lead the path to profitability. We do not have any definitive timetable for breakeven or IPO, but I think as long as we progress on track towards the mission and those are those both will come just naturally. To your second question on the overseas game strategy, so as you have mentioned, we've been also quite active in exploring overseas opportunities. The various overseas investments that we made in those studios are mostly valuing their R and D expertise, which we think can supplement to our in house R and D capability.
Equally, our NetEase R and D expertise is something that attracts those business partners to collaborate with us. Today, we have achieved a small milestone in Japanese market and we are hopeful that with more new game launches on the global stage, step by step, we are also going to have a more promising future in terms of the U. S. And European Western market.
Next up, we have Hillman Chan from Citi. Your line is open. Please go ahead.
Hello, William, Charles and Margaret. Thank you very much for taking my question. My first question is to follow-up on the F. 2 d Mobile. During the final beta testing for Android, do we have a sense of the percentage of participants coming from those currently playing mobile FJ?
And also could you share more observation from the beta testing as well? And then my another question is on the Marvel Super War. Could you share more on the development status and launch timetable and what other game genres for the Marvel IP under development and the status please? Thank you very much.
Okay. Okay. Thank you, Hillman. For your first question on SWJ3D, as you know, we've started beta testing as early as in the summer. So far, the testing results have been very promising, which leads to our confidence in launching this game in the first half of next month.
For your second question on Marvel IP, as we have reviewed the overall partnership with Marvel on our main 20th game day, there will be multiple games that's going to be developed by NetEase for Marvel IP and Marvel Super War is one of them. I think Marvel Super War is well on track from a development perspective. So this game could be expected in the near term. Obviously, for Chinese market, this is after all subject to the license approval. But several of these Marvel games are targeting both the Chinese market as well as international market.
Next up we have Kenneth Fung from Credit Suisse. Your line is open. Please go ahead.
I have a couple of questions related to the overseas business. First, what is overseas game revenue as a percentage of our total game revenue? 2nd, among our game pipeline, which one of you, you see great potential for the overseas market next year? 3rd is how do you see the competitive landscapes for the overseas game development, especially I noticed that there's a lot of Chinese game developer also very active in in publishing overseas? Thank you.
So Kenneth, to translate William's response and also to add a few more color. In terms of the overseas game revenue, and consistently above 10% of our overall game revenues. We see great potential in terms of further enhancing both the absolute dollar of my overseas game revenue as well as this percentage ratio. To your second question, in terms of game specific product lineups for the various international markets, apologies for your understanding that we would not be able to elaborate the details here. But there is a solid plan where we say that we are confident to increase the overseas game revenue as well as the percentage, it is actually bottom up.
It is supported by a very extensive study of the overseas market as well as our product lineup. For your third part of the question, in terms of the competitive landscapes of the overseas market, I think that's a good question because when we are launching our products to the overseas market, we realize that in more developed markets like Japan and U. S, users are actually a lot more sophisticated. The only way to impress, to retain, to attract these users is through product innovation and game quality. That is something that Medit is proud of our competitiveness.
And with that confidence, I think it represents actually a very, very optimistic upside of the overall NetEase gains in the market beyond China.
Next we have Jialong Shi from Nomura. Your line is open. Please go ahead.
Good morning, management. Thanks for taking my call and congratulations on a solid quarter. Let me first ask my questions in Chinese. The first question is about the online gaming business. So I was just wondering when company will officially launch the upcoming new mobile game Harry Potter.
And also I was wondering what company did to in Q3 to have helped the 2 legacy titles, FWAJ and WWJ to achieve a record high growth in Q3, respectively? My second question is about the online music business. We heard from some media that China's regulator is likely launching investigation into the licensing practice between record labels and the music streaming companies. So I was wondering if management can provide some colors on this ongoing investigation and specifically what potential changes this investigation may bring to the music streaming industry? And related to that, what potential impacts these changes may have on NetEase Cloud Music Business?
Thank you.
Thank you, Jialong. I will translate the William's response for the audience. Firstly, given that we have a daunting lineup for the game pipeline, William is actually encouraging people, trying not to us to focus too much on individual titles, whether it is existing SWJ, WWJ or the upcoming SWJ three d or Harry Potter. All of these are high quality games that we self develop, and we are very confident about their performance, longevity. And so and we have a lot more than just those couple of names that we quoted.
For the past summer, yes, FWJ and WWJ both have delivered a record quarter, stimulated mostly by expansion plans in the summer. Harry Potter is also scheduled for launch. We don't have a concrete timetable yet, but it should be planned for next year. On your second question, Jiayo, on the music, we've also learned from the media about potential regulatory investigations and queries into that. Our general attitude is that for any sort of industry growth, a conducive environment from the players and from the regulator are ultimately longer term beneficial to serious and long term players.
Our mission ultimately is to ensure that the industry as well as the passionate Chinese online music users benefit from a healthy and diversified growth of the industry. Overall, we think an appropriate and conducive environment is going to be long term beneficial to all the players in this sector.
Next up, we have Daniel Chen from JPMorgan. Your line is open. Please go ahead.
I will translate myself. I'm asking on behalf of Alex Yao. So my question is, first one is related to PC games. We noticed some of our top PC games such as World of Warcraft Classic and the Finalcy: Westward Journey actually performance is very resilient. So could management talk about the PC game market outlook in next few years and what are the key growth areas?
The second question is related to some of the new innovative trends. Could management talk about naive strategy in these new innovative trends such as 5 gs and cloud gaming? Thank you.
Okay. Thank you. Daniel, I will translate William's response and also add on to your first question. Your second question, William commented that's a great question that the industry has been noticing these new features. First of all, William thinks that the user recognition of game titles or any sort of content is ultimately attractive to the content, less so on the different screens or media.
So ultimately, it is best quality content for the different factor of users that dictate who is the winner. Cloud gaming as well as 5 gs, all these are great features to supplement to this content creation industry, whether they are going to be a mainstream feature or whether that's going to be disruptive to the overall user experiences, those are all good questions to fund and to be further observed. Overall, we think as long as it's a content industry, whether it's education, whether it's music, whether it's games, ultimately, content is the king. The one who has the capability of developing the highest quality content would always be the ultimate winner. For your first question on the PC games, we have recorded a great quarter in terms of PC games of our portfolio with symbols, FWJ, WWJ PC as well as our Wow Classic delivering quite strong quality results.
Overall, we think obviously, we can't speak for the entire industry, But as for us, we are fairly confident about the steady performance of our PC games into 2020.
Next up we have Thomas Chong from Jefferies. Your line is open. Please go ahead.
Thanks management for taking my questions. I have two questions. The first question is about our cloud music business. Given that we are going to include more features such as live streaming to the music side, how should we think about the impact of short form video to live streaming? And my second question is about the OpEx trend.
Given the fact that we are innovating a lot of new business as well as we are also expanding to overseas. How should we think about our R and D headcounts going forward? Are we going to expand our headcounts in overseas? Thank you.
Thank you, Thomas. I'll translate William's remarks. Firstly, he thinks that the short video industry in general is actually a positive catalyst to China's online media industry because as you can see, all the presentation of short format video as well as live streaming require some sort of a music element, which actually helps to promote music popularity. For NetEase Cloud Music specifically, we now have over 80,000 Chinese independent musicians that's been nurturing on our platform, and this figure is growing. We think short format video is a very conducive way to promote good music.
Based on our data and user statistics, we are not seeing short format video as a distraction or a competition for users' screen time and others, we think ultimately user traffic is attracted by good music, Chinese and global alike. Currently, on cloud music, we now have almost all the good music of the last couple of decades. Those are the core assets that attract users. And quickly before we wrap up this call, to your second question on the OpEx trend, our R and D headcount is steadily increasing. In fact, overall, by the end of the Q3, especially after the summer recruiting season, our headcount has represented a slight increase comparing to last quarter as well as to the last year end.
I think this is a strong factual evidence to dismiss many ungrounded rumors of so called massive layoffs about NetEase.
Thank you.
Thank you. I would now like to turn back the conference to our management
Thank you once again for joining us today. If you have any further questions, please feel free to contact us directly or TDG Maturation. Have a great day.
That concludes today's conference. Thank you everyone for your participation.