Business Context and Reporting Period
Company: NetEase, Inc. (NASDAQ: NTES)
Filing Type: Form 6-K (Press Release)
Reporting Period: Second Quarter ended June 30, 2007
Business Overview: A leading China-based Internet technology company providing online game services, advertising, and wireless value-added services.
Key Financial Metrics
| Metric | Q2 2007 (RMB) | Q2 2007 (USD) |
|---|---|---|
| Total Revenues | 558.0 million | $73.3 million |
| Gross Profit | 437.8 million | $57.5 million |
| Net Profit | 312.6 million | $41.1 million |
| Operating Cash Flow | 331.0 million | $43.5 million |
| Cash & Time Deposits | 3.0 billion | $391.5 million |
| Restricted Cash | 761.6 million | $100.1 million |
| Long-Term Debt | 675.4 million | $88.7 million |
Segment Margins (Gross Profit Margin):
- Online Games: 90.2%
- Advertising Services: 47.2%
- Wireless Value-Added Services: (28.1%)
Material Changes vs. Prior Periods
- Revenue: Total revenue increased slightly quarter-over-quarter (QoQ) from RMB554.6 million to RMB558.0 million but decreased year-over-year (YoY) from RMB575.3 million. Online game revenue declined QoQ and YoY, while advertising revenue increased QoQ but decreased YoY.
- Profitability: Net profit increased QoQ to RMB312.6 million from RMB301.5 million, driven by a RMB24.4 million reinvestment incentive tax refund. YoY net profit was relatively flat (RMB314.1 million in Q2 2006).
- Operating Expenses: Increased QoQ to RMB142.8 million due to a RMB2.0 million provision for doubtful debts (reversing a prior quarter benefit), increased marketing for new games, and higher R&D staffing costs.
- Liquidity: Total cash and time deposits decreased QoQ from RMB3.9 billion to RMB3.0 billion, largely due to share repurchases and the transfer of RMB761.6 million to restricted cash for convertible note redemption facilities.
Guidance, Outlook, and Risks
Management Commentary & Outlook:
- Games: Management is diversifying the portfolio. Open beta for Westward Journey Online III is scheduled for August 2007. An expansion pack for Fantasy Westward Journey is planned for Q4 2007. Progress is being made on Tianxia II.
- Portal: Expanded content in news, sports, and entertainment channels is driving traffic growth.
Share Repurchases:
- Completed a $100 million program in June 2007, spending approximately $95.7 million.
- Active on a new $120 million program authorized July 2, 2007; spent approximately $5.6 million as of July 31, 2007.
Risks and Contingencies:
- Intense competition in the PRC internet industry affecting revenue.
- Risks related to the success of new game titles and expansion packs.
- Potential changes in Chinese government regulation of the online game market.
- Fluctuations in the Renminbi exchange rate.
Investor Verification Checklist
- Verify the sustainability of the Q2 net profit increase, noting the one-time RMB24.4 million tax refund impact.
- Monitor the performance of Westward Journey Online III and Tianxia II following their scheduled releases to offset declining revenue from legacy titles.
- Review the utilization of the $120 million share repurchase program and its impact on share count.
- Assess the trend in advertising revenue and margins given the YoY decline attributed to market competition.
- Confirm the status of the restricted cash balance (RMB761.6 million) and its relation to the zero-coupon convertible subordinated notes.