Business Context and Reporting Period
Company: NetEase, Inc. (NASDAQ: NTES)
Filing Type: Form 6-K (Press Release)
Reporting Period: Second Quarter ended June 30, 2009
Release Date: August 13, 2009
NetEase is a leading Chinese Internet and online game services provider. The quarter was characterized by the strategic preparation for the relaunch of World of Warcraft (licensed from Blizzard Entertainment), which entered closed beta testing in late July 2009 pending final government approval. The company also expanded its in-house game portfolio with the commercial launch of Buibui and TF Online.
Key Financial Metrics
| Metric | Q2 2009 (RMB) | Q2 2009 (USD) | Q1 2009 (RMB) | Q2 2008 (RMB) |
|---|---|---|---|---|
| Total Revenues | 872.1 million | 127.7 million | 781.7 million | 715.9 million |
| Gross Profit | 691.9 million | 101.3 million | 641.7 million | 722.8 million |
| Net Profit | 468.1 million | 68.5 million | 416.7 million | 438.2 million |
| EPS (ADS, Basic & Diluted) | US$0.53 | |||
| Operating Cash Flow | 544.4 million | 79.7 million | 567.8 million | 513.3 million |
| Cash & Time Deposits | 6.2 billion | 909.4 million | 5.6 billion (as of Dec 31, 2008) |
Segment Performance
- Online Games: Revenue of RMB781.5 million (US$114.4 million), up 8.0% QoQ and 31.3% YoY. Gross margin was 88.3%.
- Advertising Services: Revenue of RMB72.8 million (US$10.7 million), up 77.6% QoQ but down 30.0% YoY. Gross margin improved to 16.6% from a loss of 13.1% in Q1.
- WVAS & Others: Revenue of RMB17.8 million (US$2.6 million). The segment reported a gross loss margin of 43.0%.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 11.6% QoQ and 21.8% YoY, driven primarily by online game services.
- One-Time Revenue Recognition: Gross profit increased QoQ largely due to the recognition of RMB83.3 million in revenue from the clean-up of dormant online game accounts (points removed after 540 days of inactivity).
- Operating Expenses: Increased to RMB174.8 million (up 16.1% QoQ) due to marketing costs for New Fly for Fun and increased R&D headcount.
- Foreign Exchange: The company recorded a net foreign exchange gain of RMB47.2 million, a reversal from losses in the prior two quarters, attributed to fluctuations in the Euro against the RMB.
- Tax Adjustments: Income tax charges increased QoQ due to an extra tax charge of RMB38.5 million related to a reassessment of a subsidiary's tax status for 2008 and Q1 2009.
Guidance, Outlook, and Risks
Management Commentary & Outlook
Management expects solid performance in the second half of 2009 as new licensed and in-house games come to market. Advertising revenue is expected to grow over the next six months due to expanded sales forces and new content channels (education, travel, real estate, and book search). The company is prepared to commercially launch World of Warcraft immediately upon receiving approval from the General Administration of Press and Publication (GAPP).
Risks and Contingencies
- Regulatory Approval: The commercial launch of World of Warcraft is contingent on GAPP approval, which is currently pending.
- Tax Uncertainty: A subsidiary faced a tax reassessment requiring payment at a 12.5% rate instead of the anticipated 7.5% preferential rate, impacting Q2 tax charges.
- Legal Proceedings: The company has restricted cash of RMB82.0 million held as a security deposit for arbitration proceedings against a property developer in Guangzhou regarding title transfer issues.
- Market Risks: Risks include the success of product diversification, competition in the online game market, and potential adverse effects from the global economic slowdown on advertising demand.
Investor Verification Checklist
- World of Warcraft Status: Verify the timeline for GAPP approval and the commercial launch date of World of Warcraft.
- Dormant Account Revenue: Confirm the sustainability of the RMB83.3 million revenue boost from dormant account clean-ups and whether this is a recurring quarterly event.
- Tax Rate Stability: Monitor the final resolution of the subsidiary's tax rate dispute and its impact on future effective tax rates.
- Advertising Recovery: Assess the trajectory of advertising revenue recovery given the 30% YoY decline and the impact of economic stimulus measures.
- Share Repurchases: Track progress on the US$100 million share repurchase program (US$13.1 million spent as of June 30, 2009).