NetEase's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: NetEase, Inc (NTES)

NetEase, Inc (NASDAQ:NTES)

Q4 2012 Earnings Call

February 6, 2013 8:00 PM ET


Brandi Piacente – IR

Onward Choi – Acting CFO

William Ding – CEO


Richard Ji – Morgan Stanley

Wallace Cheung – Credit Suisse

Dick Wei – JP Morgan

Alicia Yap – Barclays Capital

Eddie Leung – Merrill Lynch


Ladies and gentlemen, thank you for standing by and welcome to the NetEase, Incorporated Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. During today’s presentation, all parties will be in a listen only mode. Following the presentation, the conference will be opened for questions.

(Operator Instructions) This conference is being recorded today.

And I would now like to turn the conference over to Brandi Piacente. Please go ahead.

Brandi Piacente

Thank you, operator. Please note the discussion today will contain forward-looking statements relating to future performance of the company and are intended to qualify for the Safe Harbor from liability as established by the U.S. Private Securities Litigation Reform Act.

Such statements are not guarantees of future performance and are subject to certain risks and uncertainties, assumptions and other factors. Some of these risks are beyond the company’s control and could cause actual results to differ materially from those mentioned in today’s press release and in this discussion.

A general discussion of the risk factors that could affect NetEase’s business and financial results is included in certain filings of the company with the SEC, Securities and Exchange Commission, including its annual report on Form 20-F. The company does not undertake any obligation to update its forward-looking information, except as required by law.

As a reminder, this conference is being recorded. In addition, a webcast replay of this conference call will be available on the NetEase corporate website at

I will now turn the conference over to Mr. Onward Choi, Acting Chief Financial Officer, who will read the prepared remarks on behalf of Mr. William Ding, Chief Executive Officer of NetEase.

Onward Choi

Thank you, Brandi. Before I begin, please note that for the purposes of this discussion, all percentages are based on renminbi.

2012 was another strong year for our company with growth across our online games, portal and e-mail businesses. Throughout the year, we introduced enhancements to our online services and game offerings. That’s why as deliver newer services, content and games to the markets that build on our successful online platforms. Our popular services and games continued to gain favor with the online community, and our business continues to price.

In 2012, we increased our total revenues by 12.1% to RMB8.4 billion led by the outstanding performance of our self-developed games and growth from our advertising services business. We would like to note that, we are very pleased with our year-over-year growth and financial results from our self-developed games business in 2012.

Remarkable growth from our self-developed games drove 11.2% increase in online game revenues during 2012. Our flagship games continued to demonstrate encouraging performance and growth. Some of our highest performing games for the year included Fantasy Westward Journey, and Westward Journey Online II which both reached record high PCU level in August, with Westward Journey Online II celebrating its 10 year anniversary in 2012.

Ghost and Tianxia III also delivered solid performances during the year. Our newest games, Kung fu Master and Heroes of Tang Dynasty II also received positive feedback and contributed to our increase in annual online game revenues. We’ve finished the year with solid fourth quarter total revenues of RMB2.3 billion representing 8.3% growth year-over-year and a 13.8% increase quarter-over-quarter.

Online game revenues for the fourth quarter increased 13.6% quarter-over-quarter driven primarily by our self-developed games, including our three newest games Kung Fu Master, Soul of the Fighter and Heroes of Tang Dynasty II as well as the launch of Blizzard Entertainment’s World of Warcraft: Mists of Pandaria in October. Kung Fu Master, and Soul of the Fighter were released in October and September of 2012 respectively. While both games are still relatively new we are pleased with their performance so far. The games being well received by players and we will continue to enhance user experience for these games. Heroes of Tang Dynasty II has also performed well since its introduction on November 16. This gain is a comprehensive upgrade of Heroes of Tang Dynasty that builds on the strong user base offers already popular and long running.

As we look to 2013, we plan to continue our growth power by introducing expansion packs and new contents for our popular self-developed games and bring new games to China’s online market. Robust game expansions and pipeline development continues to be a core theme for our online game services in 2013.

By introducing exciting and high quality content, supported by well time promotional activities. We expect to further advance our growing portfolio of self-developed gains that address revolving trends and user demands.

Our current release come in the course for new expansion packs for Westward Journey Online III and New Fly for Fun in the first quarter, followed by expansion packs for Westward Journey Online II, Tianxia III, Heroes of Tang Dynasty II, Kung Fu Master and Soul of the Fighter, rest of them as the new version of Ghost in the second quarter.

In additions to our schedules for expansion packs, we are actively developing new games to extend and diversify our portfolio. Our development asset are progressing well and we expect to commercialize the new games in the second half of the year. Including Heroes of Three Kingdoms, our 3D action real-time strategy game, Dragon Sword, our next-generation 3D MMORPG and Legend of Tibet, a 2.5D MMORPG, that follows a unique story based on Tibetan mythology.

Turning to our advertising services, we increased the revenues by 6.8% quarter-over-quarter, led by the automobile, financial services and internet services sectors. We continue to build on this business with the focus on further enhancements to our offerings. In particular, our mobile strategy is broadening our reach across an even larger audience. Our mobile initiatives are proving to be highly popular with users and we have had great success with our mobile applications.

As of December 31, 2012, we had over 50 million installations for our Mobile News application with over 22 million active users on a daily basis, 8.5 million installations for Youdao Cloudnote and 128 million installations for Youdao Dictionary on mobile devices. As we move through 2013, we are working to increase traffic to our portals with a focus on both traditional and mobile Internet and we are cautiously optimistic that we will see continued spending and growth from our advertising.

In addition, NetEase continues to be one of China’s leading e-mail service providers. 2012 marked the 15th anniversary of our mailbox services. And in August we launched our new e-mail 5.0 services. The enhancements helped to drive a number of new users and substantially increased user activity for the year. As of December 31, 2012, we had approximately 530 million registered e-mail users. As we continue to optimize these services, we expect to further improve user appeal.

We steal the opportunities to provide enhanced services across our business and continue to bring to online markets the quality and innovation that is anonymous with NetEase brand. In 2013, we will work to achieve continued growth through our strategic initiatives that underscore our commitments to driving content, community, communications and commerce in China’s rapidly growing online market.

This concludes William’s updates. Now, I will provide a review of our fourth quarter and full year 2012 financial results. I will primarily focus on the discussions of margins and expand fluctuations along with net profits.

Beginning with the fourth quarter 2012 results, gross profit for the fourth quarter of 2012 was RMB1.6 billion or $258.1 million. This compares to RMB1.4 billion and RMB1.5 billion for the preceding quarter and the fourth quarter of 2011 respectively.

The quarter-over-quarter increase in gross profit was primarily attributable to increase the revenues from both the online games and advertising service businesses. Revenues from our self-developed games increased during the period mainly attributable to Tianxia III, Heroes of Tang Dynasty II, and our two new games Kung Fu Master and Soul of the Fighter.

The performances of Fantasy Westward Journey, Westward Journey Online II and Ghost were steady in the fourth quarter of 2012. The increased revenues from licensed games were mainly due to the October 2012 launch in Mainland China of Mists of Pandaria, the fourth expansion for Blizzard Entertainment’s World of Warcraft.

The quarter-over-quarter increase in gross profit from advertising services was primarily attributable to seasonality and reduced content costs due to higher content costs incurred in the third quarter for the 2012 London Olympics.

The year-over-year increase in gross profit was primarily attributable to increased revenues from our self-developed games, mainly Fantasy Westward Journey, Kung Fu Master and Soul of the Fighter. This increase was partially offset by decrease of revenues from advertising services.

Gross profit margins for our online games business for the fourth quarter of 2012 was 75.3% compared to 74.2% and 72.6% for the preceding quarter and the fourth quarter of 2011 respectively.

Gross profit margins for our advertising business for the fourth quarter of 2012 was 54.3% compared to 36.2% and 54.5% for the preceding quarter and the fourth quarter of 2011 respectively. The quarter-over-quarter increase in gross profit margins was primarily due to increased revenues and reduced content costs resulting from higher content cost incurred in third quarter for the 2012 London Olympics.

Gross profit margins for the e-mail, WVAS and other business for the fourth quarter of 2012 was 13%, compared to 6% and 2.2% for the preceding quarter and the fourth quarter of 2011 respectively. The improvement in gross profit margins were mainly due to increase of revenues from our e-commerce and mailbox businesses as well as the sale game related accessories such as the limited edition package of World of Warcraft.

Total operating expenses for the fourth quarter of 2012 were RMB580.4 million or US$93.2 million compared to RMB537.5 million, and RMB529 million for the preceding quarter, and the fourth quarter’s of 2011 of respectively. The quarter over quarter increase in operating expenses was primarily due to increased selling and marketing expenses mainly resulting from increased promotional activities for Kung Fu Master, World of Warcraft and Heroes of Tang Dynasty II, which was partially offset by decreased research and development costs as we have recently commercially launched a number of new products.

The year-over-year increase in operating expenses was primarily due to increased selling and marketing expenses and research and development staff related costs, which was partially offset by an impairment provision of RMB50.3 million made in 2011 on the initial online game license fees of Blizzard Entertainment’s StarCraft II.

Net profit for the fourth quarter of 2012 totaled RMB1 billion or US$161.9 million compared to RMB811.9 million, and RMB898.6 million for the preceding quarter and the fourth quarter of 2011 respectively. During the fourth quarter of 2012, we reported a net foreign exchange loss of RMB5.8 million or US$0.9 million, compared to a net foreign exchange gain of RMB23.7 million and a net foreign exchange loss of RMB36.4 million for the preceding quarter and the fourth quarter of 2011 respectively.

The quarter over quarter, and year-over-year foreign exchange gains and losses were mainly due to the exchange gains and losses arising from our foreign exchange – foreign currency denominated bank deposit balances as of December 31, 2012, as the exchange rate of the Euro and U.S. dollars against the RMB fluctuated over the periods.

We reported basic and diluted earnings per ADS of $1.23 each for the fourth quarters of 2012. This compares with basic and diluted earnings per ADS of $0.99 each for the preceding quarters and basic and diluted earnings per ADS of $1 and $0.10 each for the fourth quarters of 2011.

We recorded a net income tax charge of RMB184.2 million or $29.6 million for the fourth quarters of 2012, compared to RMB194.8 million and RMB122.6 million for the preceding quarter and the fourth quarters of 2011, respectively.

The effective tax rate for the fourth quarters of 2012 was 15.4%, compared to 19.9% for the preceding quarter and 11.8% for the fourth quarters of 2011. The quarter-over-quarter decrease in effected tax rates was due to the occurrence in the preceding quarter of a onetime accrued withholding tax of RMB40 million associated with the offshore remittance of cash from China in connections with the declarations of our special cash dividend.

Our various principal subsidiaries renewed their qualifications as High and New Technology Enterprises in 2011 and received a preferential enterprise income tax rate of 15% from 2011 to 2013, subject to annual review by the relevant tax authorities in China.

Now, turning to the fiscal year 2012 financial results. Gross profit for fiscal year 2012 was RMB5.6 billion or US$902.5 million, compared to RMB4.9 billion for the preceding fiscal year. The growth in revenues primarily drove the increase in gross profit for fiscal year 2012, which was partially offset by higher cost of revenues.

Total operating expenses for fiscal year 2012 were RMB1.9 billion or US$306.8 million, compared to RMB1.6 billion for the preceding fiscal year. The increase in operating expenses in 2012 was primarily due to increased selling and marketing expenses, resulting from increased marketing and promotional activities for various games including Kung Fu Master, Soul of the Fighter, and Blizzard Entertainment’s World of Warcraft, and increased staff related costs, resulting from greater headcounts in general and administration and research and development areas. These increases were partially offset by the impairment provisions of an initial online game license fees in 2011, as I previously noted.

Net profit for fiscal year 2012 totaled RMB3.6 billion or US$583.9 million, compared to RMB3.2 billion for the preceding fiscal year. For fiscal year 2012, we reported a net foreign exchange loss of RMB0.6 million or US$0.1 million. This compares to a net foreign exchange loss of RMB79.1 million for the preceding fiscal year. The net foreign exchange losses for 2012 and 2011 were mainly due to exchange losses arising from our euro denominated and deposit benefits as the exchange rate of the euro against the RMB fluctuating over this period.

We reported basic and diluted earnings per ADS of US$4.45 and US$4.44 for fiscal year 2012 respectively. This compares to basic and diluted earnings per ADS of US$3.97 and US$3.96 for the preceding fiscal year respectively.

We recorded a net income tax charge of RMB691.6 million or US$111 million and RMB392.8 million at an effective tax rate of 16.2% and 10.9% for fiscal year 2012 and 2011 respectively. The change in the effective tax rate was mainly due to the explorations of the tax exemption period for certain subsidiaries in 2012. The one-time accrual recording tax of RMB40 million in 2012 as I previously mentioned and a tax refund of RMB47.1 million that was received in 2011.

As of December 31, 2012, our total cash and time deposit balance was RMB15.2 billion or US$2.4 billion, compared to RMB11.9 billion as of December 31, 2011. Total held-to-maturity investments and other short-term investments balance was RMB1.1 billion or US$172.3 million as of December 31, 2012. This compared to RMB993.6 million as of December 31, 2011.

Cash flow generated from operating activities was RMB4.2 billion or US$678 million for fiscal year 2012, compared to RMB4.1 billion for the fiscal year 2011.

Finally, before we open the call to your questions, I would like to provide an update on the special cash dividend and share repurchase program, both of which were authorized by our board of directors in November 2012. The special cash dividend of US$0.04 per ordinary share, which is equivalent to US$1 per ADS amounted to approximately US$131 million and was paid to shareholders on record as of January 15, 2013.

Under out US$100 million share repurchase program, as of December 31, 2012, we had cumulatively purchased approximately 1.66 million ADS in the open market for total consideration of approximately US$67.2 million.

The share repurchase program expires on November 20, 2013.

Thank you for your attention. We will now be happy to take your questions. Operator, please go ahead.

Question-and-Answer Session


Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Our first question comes from the line of Richard Ji from Morgan Stanley. Please go ahead.

Richard Ji – Morgan Stanley

Hi, William, Onward. Good morning, and happy Chinese New Year in advance and also congrats on the solid quarter. I have two questions. And first of all, let me start with English then I will translate. And your new games have been performing well and including Ghost, Kung Fu Master and Soul of the Fighter and we understand that you usually you don’t disclose the revenue breakdown of those games. But can help us to understand a little better about their growth rate relative to the levels for that your legacy games. And also, can you comment on the performance of these new games relative to your own expectation?

William Ding

(Interpreted) So, basically we have highlighted with respect to Richard’s question is that from the company’s perspective we are quite satisfied with the new games growth and developments and in particular for games like the Kung Fu Master, which has been developed in the markets by the companies for six years to seven years. The performance of the game so far in the market has been encouraging and the companies would be more than willing to invest more resources to further develop the games into the market as well.

And as for the other games like Ghost, it has also been performing well and we are also very satisfied with its performance so far. And stepping into 2013, the company would also rollout more new games initiatives into new game areas and some of the games that we will be using will be taking a new theme, like the 2.5D MMORPG to Tibetan mythologies game that we are going to roll out, which is called the Legend of Tibet. And so, I think we are looking forward to the new game development in this year. Thank you.

Richard Ji – Morgan Stanley

Thank you. My second question is regarding your mobile Internet initiative and you have deployed some very popular mobile apps, such as NetEase Mobile News and Youdao et cetera. And so, for 2013, can you comment on your money titration plan as well as your mobile gaming strategy?

William Ding

(Interpreted). Okay. So, basically with regards to the company’s treasuries in terms of the mobile internet area, the companies will focus very much on this treasuries in exploding our mobile internet businesses. And in 2013, we will also increase our efforts to rollout full array of our mobile applications in different areas. And so far, I think other than the Mobile News, the Youdao Dictionary applications that has been in the markets for some time, we have also been able to rollout some other popular applications like the Youdao Cloudnote, the News Read and also the Cloud Music. And other than those applications kinds of stop, we would also look forward into the both of these areas and we believe that everyone would got a better sense on how NetEase would position ourself in this area especially in 2013. Thank you.

Richard Ji – Morgan Stanley

Thank you.


Thank you. And our next question comes from the line of Wallace Cheung with Credit Suisse. Please go ahead.

Wallace Cheung – Credit Suisse

Hi. Thank you. Congratulations on very good results William and Onward. Let me just quickly ask a question in Chinese and then I’ll translate back in English. My questions firstly, what is the growth of the existing two – major two games in 2013 and the other question is in terms of revenue contribution from the non-portal business of NetEase. Thank you.

Onward Choi

(Interpreted). So with regard to one of the first questions, I think with regards to the online game business growth and performance for NetEase, I think the focus should not be permanently on our legacy games like the Fantasy of Westward Journey, or Westward Journey Online II. In fact for the companies in the last five years, we have also made other achievements or rollout some of the new initiatives in by rolling out some of the new game channels in the markets like Tianxia III, Ghost, Heroes of Tang Dynasty II, Kung Fu Master and all of those new games has also been experienced some very successful launch, a good user receptions and perceptions and we also see that those new games has also contributed a good result that can be reflected in our financials.

And with regards of our Wallace’s questions on the revenue contributions on our other non-portal businesses. I think for NetEase we are very focused on our user experiences and especially into mobile Internet areas, we have also rollout some new initiatives, like the News the news reader that they user rate the movie tickets applications and many other things. We also see that those initiatives would mainly to improve the user experiences and to also able to establish a platform to enable to people to get the information more timely.

And in terms of revenue contribution, we do see that in the soft time, it would not be contributing too much revenue to our overall businesses, but the more important point is that, we’ll try to improve the user experiences and also to fill a good user base from there. And then, we will see how we further develop the businesses going forward.

Wallace Cheung – Credit Suisse

(Interpreted) So, what is the plan for the new expansion pack launch for the Fantasy Westward Journey and Westward Journey Online II? Thank you.

Onward Choi

(Interpreted). Maybe I can also have some rough estimations based on the company’s current expectations, because usually for those legacy games, the rollout of the new expansion packs would be somewhere around in the second half – the second quarter to fourth quarters of the year. But usually we would some announcements before the rollouts of those expansion packs. And so, you can do these kind of estimations for now.

Wallace Cheung – Credit Suisse

(Interpreted). Thank you.


Thank you. And our next question comes from the line of Dick Wei from JP Morgan. Please go ahead.

Dick Wei – JP Morgan

Hi. Congratulations for another strong quarter. So, I have two questions. First question is I think the last quarter World of Warcraft and Tianxia III has very good growth. I wonder if you can comment on this quarter and the first quarter what is the momentum for the two games. And other second question is on gross margin. What are the key reasons for gross margin increase or what’s the main reason if the gain mix moving more towards the in-house developed games?

William Ding

(Interpreted). This is William. Well, with regard to this first question. First of all for Tianxia III, this one is NetEase self-developed 3D MMORPG games adopting guide in base model and from all the time we have enhanced its contents and user experiences with lots of advancement in cost, in terms of R&D. And we will upkeep those efforts in order to improve the product itself in order to make it going well in the market and excel in the industry.

And for the World of Warcraft, I think basically the launch of the portal with some China elements was in October and the initial feedback has been very good though and we do looking forward that in the upcoming periods, there would be more regular launch of new elements or expansion packs or new game play in order to enrich the user experiences for the World of Warcraft.

And with regard to Dick’s second question about the gross margins increase for the game businesses, I think it is quite rightly in saying that it is mainly a result of the change in the game mix that we have got a higher portion of the revenues coming from self-developed games.

Dick Wei – JP Morgan

Great. Thank you, Onward sharing your view.

Onward Choi



Thank you. And our next question comes from the line of Alicia Yap from Barclays Capital. Please go ahead.

Alicia Yap – Barclays Capital

Good morning William, Onward and Brandi. Thanks for taking my questions. My first question is regarding mobile games market. So wonder that if William can share his view on the mobile games market potential in China. And if this year whether we will see the inflection points for mobile games to take off more meaningfully for many games company. And for your own mobile game strategy just can you comment whether it will be more on those like charge per download or on the original item selling model? Thank you.

William Ding

(Interpreted). So, basically William says about the mobile game markets potential is that we also holds a positive view about this part of the game market and we also advertise the importance of further expanding into this area. And for this year we will also put in more efforts in terms of researching and developing new initiatives. But of course, it would also take some time and but we would look forward to it.

Alicia Yap – Barclays Capital

Thank you. And my second question

William Ding

(Interpreted). Okay. So – and thanks. Also one supplement that William would also like to share about his will on the mobile game market developments. Basically we’ll also see quite a lot of successful experiences in countries like the Korea, Japan, U.S. and also Europe. And basically for the mobile games development in terms of the development requirement, it is must easier to do so. And given the path for NetEase, we have been cumulated quite a lot of valuable experience in the game development areas. And so, we’ll look forward that we will be able to work out something meaningful in the upcoming future.

Alicia Yap – Barclays Capital

I see. Thank you for the very detailed answer. Can I just follow-up on and can William share his view that whether on the mobile games take off, will there be any cannibalizations on the user traffic or how the revenue performance for the existing MMO games in the future?

William Ding

(Interpreted). Okay. So basically, we do not view that the roll out of any mobile games would have cannibalization issues on our user base for the client base games.

Alicia Yap – Barclays Capital

Great. Thank you so much.


Thank you. And our next question comes from the line of Eddie Leung from Merrill Lynch. Please go ahead.

Eddie Leung – Merrill Lynch

Good morning, William and Onward. Thank you for taking my questions. Two questions. The first one is about your game releases. Could you share with us, your plans on licensing fees for this year? And then, secondly about your portal business. Do you expect desktop traffic growth would be fairly slow or even stopped this year and if so, what’s the plan to handle this change? Thank you.

William Ding

(Interpreted). So with regard to Eddie’s first question about the company’s plan for licensing games in this year. I think basically, the companies would be up holding an over that it deals with and if we could actually identify some good products in any markets with the good contest and good and reasonable price. I think we will actively considering all this kind of initiatives and to consider licensing those new games.

And for the second question about the potential impact on the desktop traffic growth. I think basically, I think so we will use that, there wouldn’t be any big changes to the desktop traffic even though we have made much more efforts in rolling out more mobile initiatives, say for example, for our desktop initiatives we have very good products, which is sustainable to the users and through so many periods of time, we have also enhanced and increased our user experiences by rolling out some new products and the latest one like the user rate is also one of those that can also enhance the user experiences.

And at the same time, while the – what we view about the mobile Internet development is that it is not replacing what we apparently doing on the desktop – on our existing portal, but rather we would consider it as an extension and supplement to our existing portal business strategies. And maybe the initial roll out of the mobile initiatives would cause some impact to the desktop profit or so, but in the long-term, we do see that those two platforms or those two initiatives would be quite complimentary product and replacing one to the other.

So, basically other things that William would like to supplement is that in this year I think for NetEase we would further increase our investments in terms of the content delivery and one of the initiatives that we have likely rollout is the music, the Cloud Music and we do see that we would try to make this available to both the users on the mobile platforms as well as on the PC platforms. And this is also a very good application by itself to share some good music with the users on this applications. And at the same time we would also do more meaningful stuff on our news reading products by having more independent writers to contribute stuff on this platforms in order to enhance the reading or the user experiences as such.

And in fact for this year for NetEase, we would also upkeep our commitments to invest more to buy and more good qualities content like the both, the online videos and things like that. And one more points that we would like to supplement is that we also got our open educations applications which is available on both the PC and also the mobile platforms.

Eddie Leung – Merrill Lynch

Got it. Thank you.


Thank you. And that’s all the time we have for questions. I would now like to turn the conference back over to the speaker for closing comments.

Brandi Piacente

Thank you, once again for joining us today. Please feel free to contact Cassia Curran, NetEase’s IR Manager, based in Hangzhou or the Piacente Group Investor Relations if you have further questions. Have a wonderful day, and Happy New Year.


Ladies and gentlemen, this does conclude our conference for today. This conference will be available for replay until February 21, 2013 until – at midnight. You may access the replay system at any time by dialing 1-800-406-7325, or international participants for 303-590-3030, enter the access code of 4588210#. We thank you for your participation. And at this time, you may now disconnect.

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