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NetEase Inc  (NASDAQ:NTES)
Q3 2018 Earnings Conference Call
Nov. 14, 2018, 8:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone and welcome to the NetEase Third Quarter 2018 Earnings Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Brandi Piacente. Please go ahead.

Brandi Piacente -- Investor Relations

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 US Private Securities Litigation Reform Act. Such statements are not guarantees of future performance and are subject to certain risks and uncertainties, assumptions and other factors. Some of these risks are beyond the company's control and could cause actual results to differ materially from those mentioned in today's press release and this discussion.

A general discussion of the risk factors that could affect NetEase's business and financial results is included in certain filings of the company with the Securities and Exchange Commission, including its Annual Report on Form 20-F. The company does not undertake any obligation to update this forward-looking information except as required by law. During today's call management will also discuss certain non-GAAP financial measures for comparison purposes only. For a definition of non-GAAP financial measures and a reconciliation of GAAP to non-GAAP financial results, please see the 2018 third quarter financial results news release issued earlier today.

As a reminder, this conference is being recorded, in addition an investor presentation and a webcast of this conference call will be available on the NetEase corporate website at ir.netease.com. Joining us today on the call from NetEase's Senior Management of Mr. William Ding, Chief Executive Officer; Mr. Charles Yang, Chief Financial Officer and Mr. Hudson Wang, Co-President of NetEase's Games.

I will now turn the call over to Mr. Yang who will read the prepared remarks on behalf of Mr. Ding.

Charles Yang -- Chief Financial Officer

Thank you, Brandi 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. With that said, I will deliver opening remarks on William's behalf. We are very pleased to report another strong quarter with total revenues up 35% year-over-year. Each of our primary business lines continues to grow, supported by our loyal community of users and our strong R&D team that strives to bring best-in-class games and Internet services to both users in China and internationally.

Total revenues for our online games in the third quarter stood at RMB10 billion for the second consecutive quarter and we are confident that this trend is sustainable. In addition to our growing catalog of games and world class R&D capabilities, our online games portfolio is more diversified than ever before. We now operate numerous games that span a wide variety of genres both domestically and internationally, as well as games that appeal to both PC and mobile players.

Through this diverse catalog, we can appeal to a multitude of players and interest levels worldwide. With the introduction of new games and our work in mobile has propelled our success in recent years. Our flagship titles remain remarkably steady. In the third quarter, Fantasy Westward Journey and Westward Journey series enjoyed another quarter of year-over-year growth, driven by the popularity of new expansion packs released over the summer.

Some of our newer titles released in recent years share this type of longevity, such as Invincible, Onmyoji, Knives Out and Identity V just to name a few. The remarkable longevity of these games is attachment to NetEase unique skill set and ability to operate games successfully over long periods of time. Very few companies globally kind of test this type of endurance in online games through different economic cycles and NetEase is proud to be among these prestigious ranks.

The value of our most popular games reaches far beyond the titles themselves. After years of operation, these games have accumulated huge fan bases, turning them into very powerful IP. Each self developed IP has the potential to become its own sustainable franchise with potential to diversify beyond just online games. One good example of this is with one of our most recognizable games Fantasy Westward Journey. This IP has been in successful operation for 16 years translating across PC and mobile platforms and sustaining interest with continuous expansion packs and new content. A cartoon series based on this IP has been airing on CCTV since October this year in a recent report published by a renowned domestic think tank, Liaowang Institute Fantasy Westward Journey is ranked the sixth most valuable IP in China's entertainment sector.

We are now looking to develop another iteration of this IP on mobile, Fantasy Westward Journey 3D, scheduled for launch in 2019. This pipeline game will be realized as a real time MMO in 3D format and reserve the classic game play and social system, while bringing in brand new experiences to mobile users in a 3D world. In addition to our ability to maintain a strong existing portfolio, NetEase is also one of the very few companies in the world that has consistently created distinct new game IP for both PC client and mobile platforms. A few recent titles that fit this profile are our PC client game, Justice, that we launched at the end of June, mobile game Ancient Nocturne which we launched at the beginning of September and mobile game Night Falls: Survival, which we launched in early November.

For Justice, we recently launched a new expansion pack, which contains a sophisticated set of social systems including faction systems, marriage systems, brotherhood, et cetera, all of which help to produce and solidify an active and deeply integrated user community. This in turn creates another powerful IP for NetEase. On the mobile side, Ancient Nocturne is a innovative mix of role playing and collectible card games. The story line was written by our in-house team of producers, with a dedicated effort toward promoting Chinese culture and Asians mythology. Ancient Nocturne was featured by the iOS app store and shortly after its release it climbed to the top of the iOS growth in charting China.

Night Falls: Survival was launched in early November and became an instant hit. The game is in original cooperative survival RPG setting a doomsday world. This game took us almost three years of in-house R&D effort. Upon release, this innovative game play immediately impressed the market and Night Falls: Survival quickly became the number one downloaded game on the iOS app store and monetization is also ramping up smoothly. Some of our other new titles launched in the third quarter include Butterfly Sword and Fever Basketball, both launches further diversify the genres we offer in our mobile game portfolio. These games also received positive feedback in their respective categories.

For Minecraft in just over a year, we now have attracted over 150 million registered users in China, most of them being K-12 students. Minecraft is great strategic importance to us as it gives us access to a much younger demographic that we never had before. We consider Minecraft an educational asset that stimulates children's creativity, promotes traditional culture and allow them to explore different types of Arts and Sciences. In many schools and universities, Minecraft is also used for teaching purposes. For example, students in 19 University of Aeronautics and Astronautics uses our game in their classes to explore the mysteries of the universe. More recently, Minecraft hosted a science fair in partnership with NASDAQ China using the game to raise public interesting in understanding outer space.

We continue to welcome talented and imaginative developers to create more interesting play modules that inspire our younger users. As of today we have more than 2,000 third party developers on our platform. For many of these kids, Minecraft is the first game that they were exposed to and we take a heightened approach to our social responsibility with new content for this target audience. As with all our games, we take very proactive measures to monitor the time spent and money spent by our users to ensure sustainable growth of our games business.

Moving onto our overseas expansion effort. We are taking a much more global approach to our online games business. We see axle and overseas opportunities to expand our brand and extend our games outreach to a global audience. In the third quarter we took this a step further and for the first time in our company's history, our overseas games revenue accounted for more than 10% of our total games net revenue.

Our success in Japan has been widely witnessed. Knives Out has consistently ranked among the top five games on Japan's iOS revenue grossing chart. We continue to add more localized content to broaden and deepen our geographic footprint in this important market. In August, we introduced some iconic content with Attack on Titan, a popular Japanese Anime/Manga series. This in game collaboration gained overwhelming popularity among users and in October Knives Out reached the People's Choice Award by Google Play in Japan and Taiwan.

Similarly, Identity V was ranked number one on the iOS downloads chart in Japan for 18 consecutive days and was featured by iOS app stores in 50 countries. Out of the three largest online games markets in the world, we now have reached critical claiming two being China and Japan. The United States market is the next frontier for Netease. Earlier this month, Blizzard Entertainment announced that we are collaborating to develop Diablo Immortal. We are very proud that Blizzard has chosen us to help bring one of their largest game franchise to mobile. We consider this is a huge opportunity to show the world and particularly Western gamers, Netease' strong R&D capabilities.

Turning to our e-commerce business. This continues to be our fastest growing business segment. In the third quarter, revenues from our e-commerce business grew 67% year-over-year, well outpacing the industry average. While this business is rapidly expanding, we are conscious of our margin profile. We maintained a disciplined approach to spending and our gross margins were capped at 10% in the third quarter. We continue to look for efficiency enhancement particularly with supply chain integration and fulfillment solution upgrade.

We recently signed a contract with global shipping giant Maersk to support and improve Kaola's global transportation and logistics services. With this agreement in place, we expect deliveries of overseas procurement to be more timely and for Kaola's cross border logistics to be more smoothly. Kaola and Yanxuan are complementary components of our e-commerce ambitions. Kaola is a platform and Yanxuan is our private label brand. We continue to focus on running a one key e-commerce business model built on our differentiated approach and strong consumer recognition. For Kaola, our goal is to bring the best brands across the world to Chinese consumers who are looking for quality and authenticity in their purchases.

At the very China International Import Expo that took place in Shanghai last week, the government shared its intention to encourage import's trade increase consumer confidence, reduce tariff and promote cross border e-commerce. Over the next 15 years, China is expected to import over USD400 trillion goods and services from overseas, which means a growing number of brands from all over the world will benefit from this trend. At the Expo, we connected with a great number of internationally renowned brand committing purchase agreements totaling approximately RMB20 billion.

Additionally, we signed strategic partnership upgrade agreements with Chem Brand including Xenon, Nestle, Swift and Sanofi which will give our users better access to their product and in turn further strengthen our competitive advantage as a global supply chain provider. Under the long-term strategic support of Kaola, some of our partners have achieved better than expected revenue growth in the third quarter, such as Rossmann, one of Germany's largest health and beauty chains and Woolworth, Australians grocery chain. On Yanxuan side, we pioneered innovative e-commerce business model in China. We are responsible for the designing of our products with dedication to the aesthetics, style, material and craftsmanship of each item that we offer. We work with carefully selected manufacturers to produce the product we design and offer these more affordable, yes, high quality items to our consumers.

On the design side, we are partnering with more art institutions that supply us with our regional ideas. We're also bringing products designed by independent designers from both China and overseas. On the manufacturing side, after two years of hard work, we now work with over 500 manufacturers, each of which is top ranked in their own field. Going forward, we plan to take a more concentrated approach and focus on working with the very best partners possible.

Moving onto our other steady businesses that help to put NetEase on the map and continue to support our growth. Our advertising services revenue in the third quarter increased by approximately 2% year-over-year to RMB644 million or USD94 million, with Internet services, automobile and real estate sectors as the top performing verticals. Net revenues from our email and others businesses were RMB1.4 billion or USD204 million in the third quarter, with a year-over-year increase of 32%. We see tremendous value in many of our incubated businesses. NetEase Cloud Music and Youdao are just a few of these business lines with initiatives under way that are yet to be fully realized. For Youdao, our K-12 online education initiatives continue to see robust growth.

We believe our strength in AI technology will give us an upper hand in further delivering best-in-class online learning experiences. For example, we have recently launched a new AI hardware, Youdao smartpen which will recommend personalized academic exercise questions, targeting students weak areas based on their historical study habits, pattern and results.

For music, we are pleased to have completed a new round of financing in NetEase Cloud Music. We believe this financing underscores the value of our proprietary platform and with more external shareholders in place, we are ready to take the business to the next level. We believe China's digital online music market has tremendous potential for continued growth, as younger generations embrace the convenience of streaming music services and online music becomes a way of lifestyle.

Focusing on delivering a differentiated and premium user experience, we now have created what is commonly perceived as China's most engaging music platform with market leading user retention rate and user time spend on the platform, as well as one of the largest catalogs of user generated content.

As of now, we have over 600 million registered users, adding 200 million alone over the last 12 months. To conclude, content creation and user experience differentiation is deeply embedded in our corporate DNA, a focus on quality and craftsmanship is prevalent in all of our product offerings, including online games, e-commerce, media, music, Youdao and others. We strive to further build our brand in China and overseas with content that entertains and gratifies our users and shareholders alike.

This concludes William's comment. I will now provide a very brief overview and review of our third quarter 2018 financial results, given the limited time on today's call, I will be presenting some abbreviated financial highlight. We encourage you to read through our press release issued earlier today for further details.

Net revenues for the third quarter of 2018 were RMB16.9 billion or UDS2.5 billion. This compares with RMB16.3 billion and RMB12.5 billion for the preceding quarter and third quarter of 2017 respectively. The year-over-year and quarter-over-quarter increases were driven by revenue growth across all business segments. Net revenues from online games increased by approximately 28% year-over-year, due to strong performance from both PC client games and mobile games, such as Justice, Fantasy Westward Journey Online, Chu Liu Xiang, Knives Out and Identify V. Mobile games accounted for approximately 68% of net revenues for this quarter, compared with 75% and 68% for the preceding quarter and the third quarter of last year.

Our gross profit for the third quarter of 2018 was RMB7.5 billion or USD1.1 billion, compared to RMB7.2 billion and USD5.9 billion for the preceding quarter and the third quarter of 2017 respectively. Our gross profit for online games segment increased year-over-year and quarter-over-quarter as a result of increase in revenue. Gross margin for our online games improved to 65% in the third quarter compared with 64% in the preceding quarter and 63% a year ago. The quarter-over-quarter increase in gross profit margin was mainly due to increased revenue contribution from PC client games, which have relatively higher gross profit margins, the mobile games.

The year-over-year increase was due to increasing revenue. During the third quarter, gross profit for our e-commerce business increased due to the expansion of both Kaola and Yanxuan. Gross profit margin for our e-commerce business was 10% in the third quarter compared with 10% and 11.5% for the preceding quarter and the third quarter of 2017 respectively.

We strive to keep a disciplined balance of rapid top line growth and steady gross profit margin for our e-commerce business. Gross profit margin for advertising services for the third quarter of 2018 was 64%, this compares with 67% and 68% for the preceding quarter and the third quarter of 2017 respectively. The decreases were mainly due to higher staff related cost and content purchase expenditures. Gross profit, gross loss margin for our email and others business for the third quarter was 3%. This compares to gross loss margin of 7% last quarter and gross profit margin of 13% for the third quarter of 2017 respectively.

The year-over-year decrease in gross margin was primarily due to decreased revenue contribution from certain online platform businesses which have relatively higher gross profit margins, as well as higher licensed music content costs related to our Cloud Music businesses in the third quarter. The quarter-over-quarter improvement was primarily due to higher revenue contribution from certain online platform businesses with relatively higher margins in this quarter.

As we have mentioned before, our other businesses include many promising inculpated businesses such as Youdao, Cloud Music and CC live broadcasting among others. Many of these businesses are undergoing an investment phase as they require up-front spending to acquire content and talent. We believe their upside potential in the long-term will more than justify our current investment. Gross margin will continue to improve as we further expand our scale. Total operating expenses for the third quarter of 2018 were RMB5.4 billion or USD792.1 million. This compares to RMB4.9 billion and USD3.4 billion for the preceding quarter and the third quarter of last year.

The year-over-year increase in operating expenses were mainly due to increased staff related cost, R&D investments and marketing expenditures. The quarter-over-quarter increase were mainly due to headcount expansion during the summer recruitment season and our GNN expense included a bad debt provisions relating to advertising business.

e-commerce related shipping and handling costs included in selling and marketing expenses for the third quarter were RMB385.5 million or USD56.1 million 8.6% of the net revenues from e-commerce businesses, which is an improvement from 8.9% in the preceding quarter and 11.1% in the third quarter of last year.

Effective tax rate for this quarter was 34.2%, compared to 15.7% and 8.1% for the preceding quarter and the third quarter of last year. The year-over-year and quarter-over-quarter changes in the effective tax rate were mainly due to certain subsidiaries of ours that received tax credits recognizing different period, as well as the expansion of some of our loss-making subsidiaries. As we have discussed on prior calls, we expect the effective tax rate for 2018 on an annual basis to be in the high 20's and the effective tax rate will grow higher in 2019. Our net income attributable to shareholders for the third quarter was RMB1.6 billion or USD232.4 million. This compares to RMB2.1 billion and USD2.5 billion for the preceding quarter and the third quarter of last year.

Non-GAAP net income attributable to our shareholders for this quarter totaled RMB2.3 billion or USD328.9 million. This compares to RMB2.7 billion and USD3.0 billion for the preceding quarter and the third quarter of last year. For this quarter, our diluted earnings per ADS were RMB12.43 or USD1.81. Our non-GAAP diluted earnings per ADS were RMB17.50 or USD2.55 respectively.

Our cash position remains strong. As of September 30th 2018, our total cash and cash equivalents current and noncurrent time deposit and short-term investment balance totaled RMB42.6 billion or USD6.2 billion. This compares with RMB43.2 billion as of the end of last year. Returning value to our shareholders remains a top priority.

For this quarter, we plan to pay a dividend of 45% per ADS, representing 25% of the net income attributable to our shareholders. Under our current share repurchase program, which began on November 16, 2017 and the amendment announced on June 11, 2018 authorizing a total repurchase amount up to USD2 billion. We had repurchased approximately 4.5 million ADS for approximately USD1.2 billion as of September 30. Immediately upon the expiration of the current plan, our Board has approved a new share repurchase program for up to USD1 billion of our outstanding ADS for the next 12 months, beginning November 16, 2018.

Thank you for your attention. We would like now to open the call to your questions. Operator. Please go ahead.

Questions and Answers:

Operator

Thank you. (Operator Instructions) We'll take our first question from Thomas Chong with Credit Suisse.

Thomas Chong -- Credit Suisse -- Analyst

Hi. Thanks, management for taking my questions and congratulations on the solid set of result. My first question is about the online gaming business, in particular recent cooperation with Blizzard, can you share a bit of -- more details about the timing of the launch of the new games, the revenue sharing ratio. And more importantly, do we expect to co-develop other new games in the future? And my second question is about, sorry, directly to the environment, how we should think about the online games outlook in 2019? Thank you.

Charles Yang -- Chief Financial Officer

(foreign language)

William Ding -- Founder, CEO & Director

(foreign language)

Charles Yang -- Chief Financial Officer

Okay. Let me translate the answers for William. So, on the Blizzard cooperation as you all know, our time proven collaboration is almost a decade long, with very, very pleasant partnership with Blizzard, bringing in great experiences to Chinese gamers their titles. And the collaboration on the Diablo mobile game is just another strong testament to the great partnership. We expect if everything goes on smoothly that the mobile game of Diablo Immortal will be launched globally next year.

And regarding your second question on regulatory environment, so first of all, we believe the government's intention to regulate and make that game segment overall as a healthy and sustainable segment and we fully understand and support the government intention. China is the fastest growing and is also now the largest game market in the world and throughout the fast development, there are also certain issues emerging for instance undesired impact on minors, inappropriate content, et cetera. But in the longer-term, the regulators intention is really to promote online game segment as a format of entertainment educational asset, as well as to promote creativity in cultural innovation. So in the longer term, the government is fully supportive of developing online games industry in healthy and sustainable manner.

Operator

Thank you, Thomas.

Charles Yang -- Chief Financial Officer

Operator, next question, please.

Operator

We will then take our next question from Eddie Leung with Merrill Lynch.

Eddie Leung -- Bank of America Merrill Lynch -- Analyst

Thank you for taking my questions. Management has mentioned that we have accumulated a large base of users. And there are more and more repetitions as far as content available to these users. So I'm just curious, how many of them actually are using multiple services or consuming multiple content on NetEase and how is that ration trending? And how management can encourage different business units to cooperate and hopefully get the users to have more NetEase, so this is.

And then just a separate question on regulation on games. Could you remind us how many of your games in your pipeline already obtained the ISBN approval. Thank you.

Charles Yang -- Chief Financial Officer

Eddie, can you translate your question in Mandarin, we didn't really get your question.

Eddie Leung -- Bank of America Merrill Lynch -- Analyst

(foreign language)

Charles Yang -- Chief Financial Officer

Okay, thank you. Eddie. So you've translated the first question and I will translate your second question to William. (foreign language) Eddie, I will answer your first question. So first of all, we do not disclose user specific metrics to our different lines of businesses. But having said that, as you know, NetEase now has evolved into a much more diversified franchise more than just game company. So definitely users of NetEase products and services are enjoying the more and more content, premium content and elevated user experiences from the NetEase overall brand.

We do not have the specific metrics to evaluate the overlap, but we think the overlap should be a significant ratio because after all users in different verticals they want to simply use the very best products and services they can find in the market. And as some of you may know, earlier this month, we have experimented a VIP membership program which upon purchase of the membership you will get a lot of membership benefit across different lines of our products, games, e-commerce music, et cetera. So that is also a measure to promote a kind of a cross experience of different product and services to our user base.

(foreign language)

William Ding -- Founder, CEO & Director

(foreign language)

Charles Yang -- Chief Financial Officer

(foreign language)

So, Eddie to answer your second question, Netease is never a name to compete based on quantity of games. As you know, the games that we launched the top priority to emphasis is always premium quality, best in class experiences we provide to the users. So for the next quarter -- for next year, we are very optimistic about the rich pipeline that we are going to bring differentiated contents to the users. So all in all, it is not a game about quantity, but rather it is the quality of the games and the user experience upon the release of our games. As you can see we've been quite active and bringing in newer games throughout 2018, we think the trend will continue into 2019.

Operator

We'll move next to Alicia Yap with Citi.

Alicia Yap -- Citigroup -- Analyst

Hi. Good morning, management. Thanks for taking my questions. I have two quick questions. Number one is that, with recent external funding for NetEase music, could you share with us the strategic thinking about this music business, does that mean we could try to use these funding to offset some of the cash need for the business and NetEase turn to separately spin-off the music business in the future, what is the competitive landscape given the dominant positions from Tencent music, will these be any special value proposition that NetEase music attract users to come over or do you think users actually will be using both NetEase and Tencent music platform?

So second question just very quickly that on the online games revenue, we have been keeping the promise that we're actually able to achieve the quarterly run rate of RMB10 billion, so should we actually expect these growth to maintain and that we will keep these quarterly run rate stable and gradually improving. Thank you.

Charles Yang -- Chief Financial Officer

(foreign language)

William Ding -- Founder, CEO & Director

(foreign language)

Charles Yang -- Chief Financial Officer

So Alicia, to answer your two questions, first on Cloud Music, first of all, we view the competition with TME as a very healthy competitive dynamics. As you know TME and NetEase Cloud Music are now probably the leading two camps of online music on differentiated value propositions. For us, we are going to continue invest into R&D, maintaining Cloud Music's strong reputation as a trend settler with emphasis on innovation. This round of financing is a strong testament of recognition and support from both strategic and financial investors. So, it is also -- this also provide a strong motivation for us to keep Cloud Music as independently operated business franchise, which will set a stage for its potential spin-off IPO in the future when the time is ready.

For your second question, short answer is, yes. We are very optimistic about maintaining sustainable and healthy growth trend of our online games revenue in the longer-term. This is underpinned by our continued R&D effort, investment and collaboration with multiple game studios. But aside from just financial metrics, William also wants to emphasize that a healthy and sustainable growth for games businesses is not only measured by financial metrics, but rather we care a lot more about user satisfaction and user recognition of our game quality, that applies to boast the gamer audience in China and in overseas. This would require NetEase to continuously invest to ensure that our competitive advantage in innovation, in localization, in understanding different geographies of the market are always ahead of the curve and we are confident to achieve that.

Operator

Next we'll move to Jialong Shi with Nomura Securities.

Jialong Shi -- Nomura Securities -- Analyst

William, Charles, Margaret, good morning and congratulations on a very solid quarter. I will first ask my questions in Chinese.

(foreign language)

I have two questions here. My first question is about the regulations and in particular the regulation M2 to protect or to restrict minors' game play time. And we noticed NetEase competitor Tencent recently has adoped measures to restrict minors' time spent on Tencent's games. So, I just wonder if NetEase may follow suit and if yes and what will be the potential impact on NetEase gain revenue going forward. My second question is about your strategies for toward NetEase's e-commerce business, we saw NetEase's music and also your dollar subsidiary were both spun-off within the past year by raising capital from external -- external investors. And now looking across NetEase incubated businesses, the e-commerce business is the only baby tiger, there has yet to be a spun-off. And so I just wonder if NetEase may consider inviting external strategic investors into your e-commerce business, so that you guys may leverage external resources brought by those investors. Thank you.

William Ding -- Founder, CEO & Director

Okay. (foreign language)

Charles Yang -- Chief Financial Officer

Thanks, Jialong. I will translate briefly the William's answers. First on your question on the anti-addiction measures. So, yes, we agree that our game operators share the responsibility to create a healthy online gaming environment for minors. In fact more than a decade ago when we were operating PC games, we already had measures in place to provide protection to minors to prevent addiction. For our logging system, we always encourage and require real name, with real personal age information for your logging.

So on that we are going to continue to improve and enhance our mechanism to ensure that we share the appropriate responsibility as a game operator. But beyond that, William also commented that for anti-addiction for minors probably this should not be only narrowly focused on online games. In fact, in this cyber world on this mobile Internet age, there are multiple parties who can contribute their asset and obligation in creating a more conducive and healthy Internet mobile Internet environment for the minors.

For your second question on e-commerce, so, as you know, Kaola and Yanxuan are two supplementary arms of our e-commerce businesses. In particular for Kaola, we've chosen it to focus on the cross-border e-commerce as a entry point, which we believe this is the right choice especially most recently President Xi saying that China Import Expo is being strongly encouraging imports -- China's imports in the coming years. We think there is huge upside to Kaola being a dedicated and leading operator in this cross border e-commerce.

We do not rule out the possibility that along the way of the development of both Kaola and Yanxuan in its growth phase when there is the right and strategic partners emerge. But for now, we do not have any plan or any disclosure to make.

Operator

And we'll take our next question from Natalie Wu with CICC.

Natalie Wu -- China International Capital Corporation -- Analyst

Hi. Thanks for taking my question. I have two here. First one about my -- about your e-commerce business. There is some concern on the market regarding the inventory issue of your e-commerce business. Just wondering, can you share some color on the SKU management, methodology of that business. Second question is about the overseas revenue contribution, you mentioned that, your overseas revenue contributed brand those hit games surpassed 10% for the first time, which is a very great number, last quarter, I remember the number was nearly 5%. So just wondering, can you help us understand about extra 5% contribution, how much is related with Knives Out and how much by Identity V. If they and also is there a blueprint for your overseas revenue contribution in the mid-term? And also the IP growth, how much is related about the overseas expansion endeavor. Thank you. I will translate myself.

(foreign language)

Charles Yang -- Chief Financial Officer

Thank you. Natalie. In the interest of time, I will take the questions and answer that directly in English. First of all for e-commerce, when you look at inventory of our e-commerce, I think the market needs to understand that it is not really apple-to-apple to many domestic e-commerce operators, because for cross border e-commerce, the inventory days will invariably be longer, it started when we make overseas procurement, including shipping et cetera. But we -- as we scale up, we are continuously optimizing our inventory management and we are confident that there is still a lot of space for us to improve and optimize here.

Secondly, for the overseas revenue contribution, well, in fact, this is the first time that we announced this split, it was a quite a milestone achievement for us to arrive at above 10%. In the past couple of quarters, while we do not provide specific ratio, but it is climbing up trend. As we communicated in prior calls, the overseas contribution today primarily comes from Knives Out strong performance in Japan.

Now with Identity V, with some other new games that we plan to bring to the international market, we are confident that the overseas revenue contribution will be more diversified going forward. But as to a percentage ratio, we really cannot give out any specific target, because you would understand that it is also dynamics right, it can be domestic games, growth is also very, very strong. So what I can say is that, the absolute dollar amount for sure, we are very, very confident that overseas games revenue is going to witness a strong growth. But as to the percentage, it is actually difficult for us to predict.

For your third question, R&D expenses is acting fast, it's less so affected by the overseas expansion, because majority -- super majority of our game studios are domestically situated in China. So whether the game is distributed in China or distributed in the overseas market, bulk of the R&D expenses they incur in China anyways. And with successful game that's being proven in China and by launching this game in a new geography outside of China, it does not necessarily incur a great amount of margin or additional R&D expense.

Natalie Wu -- China International Capital Corporation -- Analyst

Thank you.

Operator

And due to time constraints, we will take no further questions. I would like to turn the call back to management for closing remarks.

Brandi Piacente -- Investor Relations

Thank you once again for joining us today. If you have further questions, please contact, NetEase's IR Director, Margaret Shi, based in Hangzhou, or or TPG Investor Relations. Thank you and have a great day.

Charles Yang -- Chief Financial Officer

Thank you everyone.

Operator

Everyone, that does conclude our conference call. We do thank you all for your participation, you may now disconnect.

Duration: 62 minutes

Call participants:

Brandi Piacente -- Investor Relations

Charles Yang -- Chief Financial Officer

Thomas Chong -- Credit Suisse -- Analyst

William Ding -- Founder, CEO & Director

Eddie Leung -- Bank of America Merrill Lynch -- Analyst

Alicia Yap -- Citigroup -- Analyst

Jialong Shi -- Nomura Securities -- Analyst

Natalie Wu -- China International Capital Corporation -- Analyst

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