NetEase, Inc. FY2012 Form 20-F Summary
Business context and reporting period
NetEase, Inc. filed an audited annual report on Form 20-F for the fiscal year ended December 31, 2012. The filing presents consolidated results for 2010–2012 under U.S. GAAP. It does not provide a separate Q4 2012 income statement; the requested period is therefore covered by the full-year FY2012 filing.
NetEase operates primarily in China through subsidiaries and variable interest entities, providing online games, Internet advertising, e-mail, wireless value-added services and e-commerce-related services. Approximately 87.8% of FY2012 net revenue came from online games.
Key financial metrics
| Metric | FY2012 | FY2011 | Change |
|---|---|---|---|
| Net revenue | RMB8,201.0 million | RMB7,290.7 million | +12.5% |
| Online game net revenue | RMB7,200.6 million | RMB6,448.6 million | +11.7% |
| Advertising net revenue | RMB767.5 million | RMB720.1 million | +6.6% |
| E-mail, wireless and other net revenue | RMB232.9 million | RMB122.0 million | +90.9% |
| Gross profit | RMB5,622.9 million | RMB4,918.4 million | +14.3% |
| Gross margin | 68.6% | 67.5% | +1.1 percentage points |
| Operating profit | RMB3,711.6 million | RMB3,323.4 million | +11.7% |
| Net income attributable to shareholders | RMB3,637.5 million | RMB3,234.3 million | +12.5% |
| Net margin attributable to shareholders | 44.4% | 44.4% | Approximately stable |
| Basic EPS | RMB1.11 | RMB0.99 | +12.1% |
| Basic EPS per ADS | RMB27.70 | RMB24.76 | +11.9% |
| Operating cash flow | RMB4,224.3 million | RMB4,072.9 million | +3.7% |
| Capital expenditures | RMB178.7 million | RMB410.1 million | -56.4% |
FY2012 revenue was approximately US$1.316 billion and net income attributable to shareholders was approximately US$583.9 million using the filing’s translation rate. Share-based compensation expense increased to RMB203.0 million from RMB122.0 million.
Liquidity, capital structure and cash flows
- Cash and cash equivalents were RMB1,590.8 million at December 31, 2012, compared with RMB2,214.6 million at year-end 2011.
- Short- and long-term time deposits totaled RMB13,588.7 million, and short-term investments totaled RMB1,073.5 million. Cash, cash equivalents and time deposits totaled approximately RMB15.2 billion.
- Total assets were RMB19,278.0 million; total liabilities were RMB3,676.5 million; and shareholders’ equity was RMB15,601.5 million.
- The filing reports no interest-bearing debt and no interest expense in 2011 or 2012. Long-term liabilities consisted primarily of other long-term payables.
- Net cash used in investing activities was RMB4,454.0 million, principally reflecting time-deposit placements and purchases of short-term investments. Financing activities used RMB390.2 million, primarily for share repurchases.
- NetEase repurchased 1.66 million ADSs, equivalent to 41.50 million ordinary shares, for approximately US$67.2 million during 2012.
- Management stated that existing cash, operating cash flow and short-term investments were sufficient to meet anticipated cash needs for at least the next 12 months.
Material changes versus the prior comparable period
- Self-developed games, including Fantasy Westward Journey, Ghost, Tianxia III, Kung Fu Master and Westward Journey Online II, drove online-game growth. World of Warcraft revenue declined as its expansion-pack life cycle matured.
- Online-game gross margin increased to 74.0% from 71.2%, partly because lower World of Warcraft royalties and amortization offset higher staff and sales-tax costs.
- Advertising gross margin declined sharply to 38.2% from 47.2% because of higher headcount and content costs, including costs associated with Euro Cup 2012 and the London Olympics.
- Research and development expense increased 54.3% to RMB718.3 million as NetEase expanded game development personnel and content-design spending.
- Income tax expense increased 76.1% to RMB691.6 million. The effective tax rate rose to 16.2% from 10.9%, primarily because certain tax exemptions expired, a RMB40.0 million withholding-tax accrual was recorded, and FY2011 included a RMB47.1 million tax refund.
- FY2011 included a one-time RMB50.3 million impairment charge for the StarCraft II license; no comparable charge was recorded in 2012.
- NetEase declared a special cash dividend of US$130.8 million, or US$1.00 per ADS, payable in January 2013. The company also changed its name from NetEase.com, Inc. to NetEase, Inc. in March 2012.
Guidance, outlook, risks and unusual items
The filing does not provide numerical revenue or earnings guidance. Management expects online games to remain the primary revenue source, while continuing to invest in new games, mobile products, advertising, e-mail and e-commerce services.
- Revenue concentration remains high: several internally developed games and Blizzard-licensed games generated 93.7% of total game revenue in 2012, and online games represented 87.8% of total net revenue.
- Blizzard-related commitments were significant. Outstanding commitments for StarCraft II and World of Warcraft totaled RMB1,123.9 million at December 31, 2012, including RMB636.7 million due in 2013. NetEase guaranteed these obligations if Shanghai EaseNet lacked sufficient funds. A further commitment of approximately RMB375.9 million was expected after the commercial launch of Blizzard All-Stars, which had not yet launched in China.
- NetEase also disclosed up to approximately RMB218.0 million of potential hardware obligations related to Blizzard-licensed games.
- The company relies on VIE contractual arrangements because foreign ownership of certain Chinese Internet and online-game businesses is restricted. Substantially all revenue is generated directly or indirectly through VIEs. Adverse regulatory action could restrict operations, revenue collection or consolidation of the VIEs.
- Regulatory risks include online-game content and licensing approvals, real-name and anti-addiction requirements, virtual-currency rules, advertising and payment regulations, data protection and censorship requirements.
- Other material risks include dependence on key games and employees, intense competition, rapid technology changes and mobile migration, cybersecurity and service interruptions, Renminbi and foreign-currency fluctuations, restrictions on transferring funds from China, and possible changes to preferential tax treatments.
- The company reported no material pending legal proceedings and stated that its disclosure controls and internal control over financial reporting were effective as of December 31, 2012. The auditor noted that its China-based firm was not subject to regular PCAOB inspection at that time.
Most important facts for investors to verify
- Confirm that FY2012 annual figures, rather than standalone Q4 figures, meet the intended reporting-period requirement.
- Reconcile the high concentration of revenue in a limited number of online games and assess performance after major expansion-pack life cycles.
- Review Blizzard license commitments, guarantees, minimum marketing obligations and the commercial launch prospects of Blizzard All-Stars.
- Assess the legal enforceability and regulatory status of the VIE structure and the company’s ability to access cash held by PRC subsidiaries and VIEs.
- Evaluate the sustainability of the 16.2% effective tax rate, preferential tax statuses and potential withholding taxes.
- Verify cash availability after the special dividend, share repurchases, restricted cash and contractual commitments.
- Monitor R&D and share-based compensation growth, advertising-margin pressure and the company’s ability to diversify toward mobile and non-game services.