Business Context and Reporting Period
Company: NetEase, Inc. (NASDAQ: NTES)
Filing Type: Form 6-K (Press Release)
Reporting Period: Fourth Quarter and Fiscal Year ended December 31, 2007
Release Date: February 21, 2008
NetEase is a leading China-based Internet technology company specializing in online games, advertising, and wireless value-added services. The company reported record peak concurrent users for its flagship title, Fantasy Westward Journey, and continued diversification into item-based games and strategic licensing.
Key Financial Metrics
| Metric | Q4 2007 (RMB) | Q4 2007 (USD) | FY 2007 (RMB) | FY 2007 (USD) |
|---|---|---|---|---|
| Total Revenues | 622.1 million | 85.3 million | 2.31 billion | 316.1 million |
| Gross Profit | 488.0 million | 66.9 million | 1.80 billion | 246.5 million |
| Net Profit | 389.8 million | 53.4 million | 1.26 billion | 173.3 million |
| Operating Expenses | 152.8 million | 21.0 million | 592.2 million | 81.2 million |
| Operating Cash Flow (Q4) | 426.6 million | 58.5 million | N/A | N/A |
| Cash & Time Deposits (Dec 31, 2007) | 4.16 billion | 570.1 million | N/A | N/A |
| Earnings per ADS (Diluted) | N/A | $0.41 | N/A | $1.31 |
Segment Performance (Q4 2007)
- Online Games: RMB 507.0 million (Revenue); 90.7% Gross Margin.
- Advertising Services: RMB 98.1 million (Revenue); 52.0% Gross Margin.
- Wireless & Others: RMB 17.0 million (Revenue); 19.5% Gross Loss Margin.
Material Changes vs. Prior Period
- Revenue Growth: Q4 2007 revenue increased 9.0% quarter-over-quarter (QoQ) and 15.0% year-over-year (YoY). FY 2007 revenue grew 4.0% YoY.
- Profitability: Q4 Net Profit surged 49.8% QoQ and 21.7% YoY. FY 2007 Net Profit increased 1.7% YoY.
- Drivers:
- Games: Growth driven by the full-quarter contribution of Westward Journey Online III and peak usage during the National Holiday and Christmas seasons for Fantasy Westward Journey.
- Advertising: Increased traffic from integrated email and blog services boosted ad revenue.
- Expenses: Q4 operating expenses decreased QoQ due to reduced marketing spend compared to the heavy promotion in Q3, though they increased YoY due to higher R&D headcount.
- Tax Impact: Q4 results included a RMB 29.9 million reinvestment tax refund and a RMB 42.0 million tax benefit from reclassifying deferred tax assets to the new 25% statutory rate.
Outlook, Risks, and Unusual Items
Management Commentary & Outlook
Management expects to solidify its leading position in the Chinese MMORPG market through product diversification and strategic licensing. The company is focused on capturing domestic market share and capitalizing on marketing initiatives related to the 2008 Beijing Olympic Games.
Unusual Items & Contingencies
- Tax Rate Uncertainty: New corporate income tax laws effective Jan 1, 2008, unified rates to 25%. While the company recorded a benefit in Q4 2007, future quarters may see higher tax charges if preferential rates for high-tech enterprises are not confirmed by authorities.
- Convertible Notes: A revolving loan facility was cancelled in December 2007. Consequently, outstanding zero-coupon convertible subordinated notes (RMB 641.8 million) were reclassified from long-term to current liabilities.
- Share Repurchase: The company has spent approximately $35.7 million of its authorized $120 million share repurchase program as of Dec 31, 2007. The program ends July 1, 2008.
Risks
Key risks include the success of product diversification, competition in the online game market, changes in Chinese government regulations, and fluctuations in the Renminbi exchange rate.
Investor Verification Checklist
- Audit Status: Confirm that the unaudited financial information aligns with the final audited Form 20-F, as adjustments may occur.
- Tax Treatment: Monitor announcements regarding the confirmation of preferential tax rates for PRC subsidiaries under the new 2008 tax laws.
- Debt Classification: Verify the impact of the reclassified convertible notes on current liquidity ratios and covenant compliance.
- Game Lifecycle: Assess the sustainability of user growth for Fantasy Westward Journey and the adoption rates of new titles like Westward Journey Online III.
- Currency Exposure: Review the impact of RMB/USD exchange rate fluctuations on reported USD earnings.