NetEase, Inc. 2015 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, 2015, prepared under U.S. GAAP. The filing covers the full year rather than providing a standalone fourth-quarter report; therefore, quarterly 2015 Q4 metrics are not separately presented in the supplied text.
NetEase operates primarily in China through subsidiaries and variable interest entities, with three reportable segments: online games, advertising services, and e-mail, e-commerce and other services. Its ADSs trade on NASDAQ, with each ADS representing 25 ordinary shares.
Key financial metrics
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Total net revenue | RMB22,802.9 million | RMB11,712.8 million | +94.7% |
| Online game revenue | RMB17,314.1 million | RMB9,266.2 million | +86.9% |
| Advertising revenue | RMB1,789.4 million | RMB1,344.8 million | +33.1% |
| E-mail, e-commerce and other revenue | RMB3,699.4 million | RMB1,101.8 million | +235.7% |
| Gross profit | RMB13,403.6 million | RMB8,451.3 million | +58.6% |
| Gross margin | 58.8% | 72.2% | Down 13.4 percentage points |
| Operating profit | RMB7,272.1 million | RMB4,765.1 million | +52.6% |
| Operating margin | 31.9% | 40.7% | Down 8.8 percentage points |
| Net income attributable to shareholders | RMB6,735.1 million | RMB4,756.6 million | +41.6% |
| Net margin attributable to shareholders | 29.5% | 40.6% | Down 11.1 percentage points |
| Diluted earnings per ADS | RMB50.94 | RMB36.29 | +40.4% |
All amounts are in RMB unless stated otherwise. The filing translates 2015 amounts at US$1.00 = RMB6.4778.
Cash flow, liquidity and capital structure
- Operating cash flow was RMB8,076.9 million, up from RMB5,873.0 million in 2014.
- Investing cash outflow was RMB2,536.5 million, compared with RMB4,520.2 million in 2014.
- Financing cash outflow was RMB1,632.7 million, including RMB1,468.0 million of dividends, RMB5,741.6 million of short-term loan repayments, and RMB132.2 million of share repurchases.
- Year-end cash and cash equivalents were RMB6,071.5 million. Time deposits totaled RMB15,703.3 million, including current and non-current deposits, and short-term investments totaled RMB5,013.5 million.
- Short-term borrowings were RMB2,272.8 million, all at fixed rates. The filing reports no material long-term debt balance.
- Working capital was RMB22,741.5 million, compared with RMB20,976.1 million in 2014. Total assets were RMB41,157.4 million and total shareholders’ equity was RMB29,323.6 million.
- Capital expenditures were RMB866.3 million, primarily for offices, warehouses, servers and infrastructure. Capital commitments totaled RMB1,192.3 million as of year-end.
- Management stated that cash, operating cash flow and short-term investments should be sufficient to meet anticipated cash needs for at least the next 12 months.
Material changes versus the prior comparable period
- Growth was led by mobile games, including Fantasy Westward Journey and Westward Journey Online, as well as licensed Blizzard titles and the self-developed PC game Revelation. Mobile games represented 45.7% of net game revenue in 2015, compared with 8.0% in 2014.
- Online game gross margin fell to 68.8% from 77.2%, primarily because mobile games carry lower margins due to revenue sharing with app stores, developers and other platforms.
- E-mail, e-commerce and other revenue grew sharply, but its gross margin fell to 7.9% from 42.7%. The decline reflected the suspension of higher-margin online lottery services and the expansion of lower-margin merchandise-based cross-border e-commerce.
- Net inventories increased from RMB28.3 million to RMB817.8 million, principally reflecting the Kaola cross-border e-commerce business.
- Cost of revenues increased 188.2%, substantially faster than revenue, while operating expenses rose 66.3%. Research and development expense increased 63.1% to RMB2,158.9 million.
- Share-based compensation increased to RMB684.5 million from RMB349.3 million. Unrecognized compensation cost for unvested awards was RMB1,777.5 million at year-end.
- The effective tax rate increased to 15.7% from 12.1%, primarily because certain subsidiaries moved from a 10% preferential rate in 2014 to a 15% rate in 2015.
- The company began quarterly dividends in 2015 under a policy targeting approximately 25% of anticipated quarterly after-tax income. Dividends declared for the four quarters were US$0.39, US$0.44, US$0.56 and US$0.64 per ADS, respectively.
- NetEase repurchased approximately 185,141 ADSs for US$20.7 million under a US$500 million repurchase authorization.
- Certain 2014 segment figures were reclassified between advertising and e-mail, e-commerce and other services; total revenue and consolidated cash flows were unchanged.
Guidance, outlook, risks and unusual items
The filing does not provide numerical 2016 revenue or earnings guidance. Management expects continued investment in mobile games, new game releases and expansion packs, advertising, e-commerce infrastructure and research and development.
- Online game concentration remains material: online games represented 76.0% of total revenue, and several key internally developed and licensed titles generated approximately 91.1% of total game revenue.
- Mobile games may produce lower margins because app stores generally retain approximately 30% of iOS revenue and 30% to 50% of Android app-store revenue.
- The government suspension of online lottery sales began in February 2015 and continued through the filing date, adversely affecting Caipiao revenue and segment profitability.
- NetEase guaranteed certain Blizzard-related license, royalty, marketing and hardware obligations if Shanghai EaseNet lacks sufficient funds. Outstanding commitments under specified Blizzard licenses were RMB903.0 million, with an additional expected Overwatch commitment of approximately RMB666.8 million and potential hardware commitments of up to RMB203.5 million.
- NetEase relies on contractual arrangements with VIEs because of Chinese restrictions on foreign ownership in Internet, online gaming, advertising and related businesses. Changes in Chinese law, enforcement, or the proposed Foreign Investment Law could restrict operations or prevent continued consolidation of the VIEs.
- Other major risks include dependence on key games and Blizzard, intense competition, changing consumer preferences, platform dependence, cybersecurity and data-protection exposure, Renminbi volatility, limits on fund transfers from China, preferential-tax status changes, inventory write-downs, and regulatory approval requirements.
- 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, 2015.
Most important facts for investors to verify
- Confirm whether the intended analysis requires annual FY2015 results or separate 2015 fourth-quarter results, because this 20-F does not provide a standalone Q4 income statement.
- Assess the sustainability of mobile-game growth and the resulting effect on online-game gross margins and revenue-sharing costs.
- Review Kaola inventory growth, working-capital requirements, inventory aging and potential write-down exposure.
- Track the status of the online-lottery suspension and its effect on e-commerce revenue and margins.
- Review Blizzard license renewals, guaranteed commitments, royalty economics and the timing of Overwatch commercialization.
- Evaluate the legal and regulatory durability of the VIE structure and the ability to transfer cash from PRC subsidiaries and VIEs to the Cayman Islands parent.
- Reconcile reported liquidity with restricted cash, pledged deposits, short-term borrowings, capital commitments and Blizzard guarantees.
- Monitor preferential tax qualifications, the 15.7% effective tax rate and potential withholding taxes on distributions from China.
- Consider dilution from approximately RMB1,777.5 million of unrecognized share-based compensation and the outstanding RSU balance.