NetEase Inc (NTES) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the NetEase fourth quarter and fiscal year 2008 conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Wednesday, February 25, 2009. I would now like to turn the conference over to Brandi Piacente, of Investor Relations. Please go ahead.

Thank you, operator. Please note the discussions 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 US Private Securities Litigation Reform Act. Such statements are not guarantees of future performance and are subject to risks -- 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 this discussion.

A general discussion of the risk factors that could affect NetEase's business and financial results are included in certain filings of the Company with the Securities and Exchange Commission, including its annual report on Form 20F. The Company does not undertake any obligation to update this 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 corp.NetEase.com.

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

Thank you Brandi. Thanks to everyone for joining us.

As fiscal 2008 drew to a close amid the global economic downturn, we are pleased with the solid performance of our online game business due to the broad reach and lasting appeal of our flagship game, Fantasy Westward Journey, our investment in game development and our intensified focus on item-based games.

Total revenues for the fourth quarter of 2008 were $117.5m compared to $118.2m in the prior quarter and $91.2m in the fourth quarter of 2007. In the fourth quarter revenues for our online game business totaled $98.6m compared to $99m in the previous quarter and $74.3m for the fourth quarter of 2007.

Our online games continue to perform well due to our ability to maintain gamer interest through the release of expansion packs and periodic updates even in the current economic environment. We believe that online games offer an economical and affordable form of entertainment and do not expect to see a slowdown in user interest or game demand.

The performance of Fantasy Westward Journey in the fourth quarter again demonstrated the strong popularity and extensive community of users among online gamers in China.

In the current quarter Fantasy Westward Journey's PCUs and ACUs were 1.8m and 625,000 respectively compared with 2.3m and 675,000 in the third quarter respectively. PCUs and ACUs were higher in the third quarter due to the summer holiday season and marketing campaigns trying to coincidence with the summer season. Fantasy Westward Journey has been in operation for five years and is still one of the most popular games in China.

Westward Journey II performed very well this quarter. Fourth quarter's PCUs and ACUs for Westward Journey II were 897,000 and 197,000 respectively compared with 430,000 and 170,000 in the third quarter respectively.

Tianxia II, our first 3D item based game, achieved positive growth during the fourth quarter in terms of both the number of game players and consumption level following the launch of a new expansion pack on September 24, 2008. We are very enthusiastic about the appeal of this game in attracting new users.

The open beta testing of Legend of Westward Journey, an item-based version of our popular Westward game journey series, is going smoothly. And we made further enhancements to the game based on game player feedback, including increasing the quality and the variety of items.

We are also working diligently on the development of Heroes of Tang Dynasty, a Chinese history based and adventure role playing game, and TF Online based on war based role playing games which are in closed beta testing.

We believe we are well positioned to attract new players to our games to further solidify our leading positions in the Chinese online game market in 2009 and beyond due to our strong development capabilities. And we will continue to focus on the development of appealing and innovative games for our large, loyal and growing community of game players in China.

During the quarter we continued to execute well on our strategy to diversify our game product offerings, including an intensified focus on item based games. We are also exploring strategic licensing opportunities to further penetrate the game market. Our partnership with Blizzard is progressing well although there is no fixed timetable yet for the launch of StarCraft II or Battle.net in China.

Turning to advertising, overall we are pleased with our advertising services performance this quarter. Revenues from advertising services were $16.4m for the fourth quarter of 2008 compared to $16.6m and $14.4m for the preceding quarter and the fourth quarter of 2007 respectively.

Our top performing (inaudible) this quarter were automobiles and related products, information technologies and the Internet.

We continue to focus on strengthening the qualities of the contents on our portal to attract and retain new users and advertisers to our sites. We are always looking for ways to raise awareness with advertisers of the great potential marketing value of our renowned and broad advertising space which is a premium advertising tool for many advertisers who want to reach our audience of consumers.

With our ongoing strength in delivering integrated strategies and informations to both users and advertisers on our portal, we believe we will further capitalize on the opportunities brought about by the shift from traditional advertising media to online advertising platforms.

Looking ahead we plan to continue focusing on the development of appealing and innovative games and enhancement of our portal services for both users and advertisers.

Finally I'm sad to say that earlier today we announced the resignations of Mr. Michael Tong, our Co-Chief Operating Officer, effective March 12, 2009 for personal reasons. I, meaning William, will assume responsibility for our online advertising business after March 12. Michael has served as NetEase's Co-Chief Operating Officer since July 2004 and has also been a member of our Board since December 1999. He will remain on our Board of Directors after his resignation becomes effective.

Michael has been a valuable member of our management team and I am personally grateful to him for his leadership, loyalty and dedication. Michael has made many significant contributions to our business over the years and he will be greatly missed. I have now completed the reading of William's prepared remarks.

Now I will provide a review of our fourth quarter and fiscal year 2008 financial results, using numbers and percentages based on US dollars. In order to avoid any repetitions with the press release, my remarks will be focused on a discussion of margin and expense fluctuations along with net profit.

Starting with the fourth quarter results our gross profit was $93.7m, compared to $92.5m in the preceding quarter and $71.5m for the fourth quarter of 2007. The quarter-over-quarter increase in gross profit was primarily attributable to a reduction of Olympics related content cost recorded in the preceding quarter, which was partially offset by increases in staff related costs resulting from increases in headcount and performance related bonus accrual, as well as slightly lower total revenue in the current quarter.

The quarter-over-quarter decrease in online game revenue was mainly due to lower revenue from Fantasy Westward Journey in the current quarter compared to higher revenue in the preceding quarter as a result of the summer holiday season.

The year-over-year increase in gross profit was primarily driven by increased online game and advertising revenue, partially offset by higher staff related costs resulting from increases in headcount and performance related bonus accrual in the current quarter.

The year-over-year increase in online game revenue was primarily attributable to Fantasy Westward Journey related marketing activities in 2008 and the successful launch of an expansion pack for Fantasy Westward Journey in early October, 2008.

Our advertising revenue for the current quarter remained relatively stable compared to the preceding quarter. The year-over-year increase in advertising revenue was primarily due to increased revenue contributed from the Company's email ad space during the fourth quarter of 2008.

Gross profit margin for the online game business for the fourth quarter of 2008 was 88%, compared to 89.7% and 90.7% for the preceding quarter and the fourth quarter of 2007 respectively. The quarter-over-quarter and year-over-year decreases in gross profit margin were primarily due to higher staff related costs resulting from increases in headcount and performance related bonus accrual in the current quarter.

Gross profit margin for the advertising business for the fourth quarter of 2008 was 51.1%, compared to 26.9% and 52% for the preceding quarter and the fourth quarter of 2007 respectively. The quarter-over-quarter increase in gross profit margin was primarily due to a reduction of Olympic-related content costs recorded in the preceding quarter. The year-over-year gross profit margin remained relatively stable.

Gross loss margin for the Wireless Value Added Services and others business for the fourth quarter of 2008 was 24.9%, compared to 6.4% and 19.5% for the preceding quarter and the fourth quarter of 2007 respectively. The quarter-over-quarter and year-over-year decreases in gross profit margin were primarily due to increased bandwidth charges and server custody usage fees in the current quarter resulting from volume increases associated with our free email and photo blog services.

Total operating expenses for the fourth quarter of 2008 were $24.7m compared to $24.1m and $22.4m for the preceding quarter and the fourth quarter of 2007 respectively.

The quarter-over-quarter increase in selling and marketing expenses was primarily due to increased staff related costs resulting from an increase in headcount and performance related bonus accrual and increased temporary marketing promotion staff costs, partially offset by a reduction of Olympic related marketing expenses of $0.5m which had been recorded in the preceding quarter.

The quarter-over-quarter decrease in general and administrative expenses was mainly due to a decrease in bad debt provision.

The quarter-over-quarter increase in research and development expenses was mainly due to increased depreciation expenses related to additional fixed assets purchased to support increased research and development activities of our online game, search engine and free email services in this quarter.

The year-over-year increase in operating expenses was primarily due to increased staff related costs associated with our selling and marketing efforts, as well as research and development activities, primarily resulting from increases in headcount and performance related bonus accrual in the current quarter.

Net profit for the fourth quarter of 2008 totaled $84.4m compared to $45.9m and $57.1m for the preceding quarter and the fourth quarter of 2007, respectively.

During the fourth quarter of 2008, we reported a net foreign exchange loss of $3.2m under Other net, compared to $10m and $4.4m for the preceding quarter and the fourth quarter of 2007 respectively. The quarter-over-quarter and year-over-year decreases in net foreign exchange loss were primarily due to the reductions in translation loss related to our bank deposits denominated in US dollars and euros, resulting from improved stability in the exchange rates of US dollar and euro against renminbi at the end of the current quarter.

NetEase reported basic and diluted earnings per ADS of $0.66 and $0.65 respectively for the fourth quarter of 2008. NetEase reported basic and diluted earnings per ADS of $0.36 and $0.35, and $0.47 and $0.44 for the preceding quarter and the fourth quarter of 2007 respectively.

Effective as of January 1, 2008, the Chinese government adopted a new income tax law which unified the enterprise income tax payable by domestic and foreign invested enterprises at a tax rate of 25%. For the first three quarters of 2008, we followed the applicable accounting standards and adopted the statutory rate of 25% in making tax provisions, except for those entities still enjoying unexpired tax holidays under the 2008 tax laws.

By December 31, 2008, our applications for the High and New Technology Enterprises status by certain subsidiaries have been duly assessed and included in the relevant Chinese government authority's published list of approved High and New Technology Enterprises, with the over-paid income taxes for the first three quarters of fiscal year 2008 duly refunded.

Accordingly, we recorded a net tax benefit of $11.7m for the current quarter compared to a tax charge of $18.4m and a tax benefit of $7.7m for the preceding quarter and the fourth quarter of 2007 respectively.

The quarter-over-quarter decrease in tax charge was primarily attributable to the refund of the over-paid amount of income taxes for the first three quarters of 2008, as explained above, partially offset by the increase in tax charge resulting from the adjustment to recognize the deferred tax assets as of December 31, 2008 at the preferential tax rate for High and New Technology Enterprises.

The year-over-year increase in the tax benefit was mainly due to the tax refund and adjustment to deferred tax assets in the current quarter, as explained above. Whereas the tax benefit reported in the fourth quarter of 2007 primarily resulted from the adjustment to recognize the deferred tax assets at the new statutory tax rate of 25% under the post 2008 tax laws, except for entities still enjoying unexpired tax holidays.

I would now like to take a few moments to review full year fiscal 2008 results.

Total revenues for fiscal year 2008 were $436.2m compared to $338m for the preceding year.

Revenues from online games were $366.2m for fiscal year 2008 compared to $283.3m for the preceding fiscal year. Revenues from advertising services were $59.5m for fiscal year 2008 compared to $44.7m for the preceding fiscal year. Revenues from Wireless and Value Added Services and others were $10.5m for fiscal year 2008 compared to $10m for the preceding fiscal year.

Gross profit for fiscal year 2008 was $370.1m compared to $263.5m for the preceding fiscal year. The increased gross profit for fiscal year 2008 was primarily due to increased online game revenue from our various flagship games, as well as the receipt of a business tax refund of $21.5m in June, 2008 related to certain excess taxes paid in previous years, which was determined as a result of changes in certain rules in connection with business tax deductions.

The foregoing increases in gross profit were partially offset by increased staff related costs resulting from increased headcount and increased performance related bonus accrual.

Total operating expenses for fiscal year 2008 were $89.5m compared to $86.8m for the preceding fiscal year. Higher operating expenses for fiscal year 2008 were primarily due to increased research and development staff related costs resulting from higher headcount, partially offset by reduced selling and marketing expenses on games as a result of the implementation of certain cost savings measures.

Net profit for fiscal year 2008 totaled $234m compared to $185.3m for the preceding fiscal year.

For fiscal year 2008, we reported a net foreign exchange loss of $24.5m under Other net compared to $7.5m for the preceding fiscal year respectively. The increase in net foreign exchange loss was primarily due to the increase in translation loss related to our bank deposits denominated in US dollar and euros, resulting from the depreciation in the exchange rate of US dollar and euro against renminbi at the end of the current quarter.

NetEase reported basic and diluted earnings per ADS of $1.88 and $1.81 for fiscal year 2008 respectively. NetEase reported basic and diluted earnings per ADS of $1.50 and $1.40 for the preceding fiscal year respectively.

As a result of the new income tax laws in China and the successful application for the High and New Technology Enterprises status in the current quarter, as explained above, and the expiration of the tax holidays of certain subsidiaries, we reported a net income tax charge of $44.1m for fiscal year 2008.

For fiscal year 2007, we reported a net income tax charge of $0.4m primarily attributable to the receipt of reinvestment incentive tax refunds of $8m and a net adjustment to the deferred tax assets of approximately $6.1m, resulting from the adoptions of the new statutory income tax rate of 25% at December 31, 2007 except for those entities still enjoying unexpired tax holidays.

As of December 31, 2008 our total cash and time deposit balance was $822.8m compared to $609.5m as of December 31, 2007.

Cash flow generated from operating activities was approximately $75.3m for the fourth quarter of 2008, compared to $72.7m and $62.5m for the preceding quarter and the fourth quarter of 2007 respectively.

On September 12, 2008, our Board authorized a share repurchase program of up to $100m of our outstanding ADS for a period not to exceed one year. As of December 31, 2008 we have spent in aggregate a total purchase consideration of approximately $13.1m which includes transaction costs.

Thank you for your attention. We will now be happy to take your questions.

Operator, please go ahead.

Thank you, sir. We will now begin the question and answer session. (Operator Instructions).

Our first question comes from the line of Richard Ji with Morgan Stanley. Please go ahead.

Hi, Onward and Michael. Good morning. I have two questions. Let me start with the first one.

We understand Fantasy Westward Journey saw some gamer volume decline in 4Q '08 and possibly due to the absence of some holidays as well as the marketing promotion activities. And have you seen any sign of re-acceleration for the gamer volume for Fantasy Westward Journey in 1Q '09?

Sorry Richard, are you talking about whether the macro environment would be affecting our online game business in general?

No. I'm talking about Fantasy Westward Journey in particular. And we saw some gamer volume decline in 4Q '08. Have we seen some recovery in terms of gamer volume in first quarter '09?

I think in '09, I think the users has become more stable because as you know in the third quarter we had some holiday seasons, which is traditionally will be a peak quarter for our game performance. And for the fourth quarter there would be a slight decline because all the students or all the people who are attending schools has already go back to school and so they would -- the usage would be a little bit drop.

But basically we can still refer back to our performance of the Westward Journey II. In fact there would be still a popularity based on what we have done so far, including the expansion packs and so forth.

Richard? (Spoken in Chinese).

William -- so maybe I do a quick translation from what William has highlighted just now.

Fantasy Westward Journey is a major revenue contributor to our game revenues. And we have been doing very -- trying our very best efforts to think of new things to attract the users to play our games.

And from the technological perspective, we still believe that we have many new ideas to come through. And in the coming one to two years, we are still having confidence of growing this game.

Thank you. My second question is regarding the online game pipeline. And we are quite eager to understand a little better about the commercialization schedule for Tianxia II as well as your plan for StarCraft. And if you can also help us -- help to shed a little light on your other game developments in your pipeline that will be much appreciated.

(Spoken in Chinese).

First of all, just as what William has just mentioned, in 2009 we will have a couple of new game titles coming out. But for the time being we would still like to keep it as a secret because we are still working on them. But as soon as it comes to the appropriate timing then we will make more announcements to you guys.

And regarding the Tianxia II development, since we have -- do the open betas on June last year, the progress has been very well. And we have been seeing that the users' numbers as well as the consumption level has been growing. So we still believe that we have a very positive expectation on this game.

And apart from this, for the new Fly for Fun, this has also been -- comes into the beta testing phase. And we are also getting the feedback from gamers to further enhance the games and also try to develop the games going forward. And basically this is about what we'll be doing about the game pipeline.

Thank you.

You're welcome.

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

Hi. Good morning William and Onward.

Good morning.

Well, first of all it's very sad to hear Michael's departure and we appreciate his help in the last few years time.

I've got two questions.

Number one is I wanted to hear -- actually two questions also directed to William. Actually one is after Michael's departure, how do you see the growth of your advertising business as we can see that NetEase has been hiring quite a lot of new talent into the portals team both on the content side as well as the sales team side. Can you explain a little bit your expectation and strategy for the portal business going forward?

And secondly is, regarding I think there's some news talk about I think maybe either NetEase or William, yourself have some incentive in terms of some pig farming going forward. Can you disclose more details about what you intended?

(Spoken in Chinese).

Okay, first of all, maybe I'll just reply the first question regarding the ad business growth following Michael's departure and the strategy of the Company.

William is very grateful for the contributions that Michael has brought to the Company in the past couple of years through his leadership and also his contributions. There are many achievements that have been achieved. And this is what the Company has very appreciated.

Regarding the developments of the advertising business, in the upcoming two to three years, the Company would increase our investment in this respect because we still have confidence on the business growth in this sector of the business. And we also would like to increase the presence of NetEase portal in competition with our other peers.

Regarding the second question on the pig farming, William has mentioned that there are quite -- a couple of media reporting already done. And this could be easily referred back on the Internet and you would be recommended to refer those reports for more details.

But in a nutshell I think basically the pig farming activities is just something to enhance the welfare of the society and the environmental protection, all these things to do with the social responsibility.

And this in fact would not affect our main business that we are currently doing because this activity is just of a very small scale and using just a small amount of money. And so I think this is all that we would like to do in order to promote the people's awareness in this respect.

Okay, thank you. May I have just one quick follow up question? (Spoken in Chinese).

(Spoken in Chinese).

Okay. Regarding Wallace's follow up question on our Company's development on the Yodao business, the search engine, William still believes that we are still in the stage of further enhancing the product qualities. And we will still put up sufficient support and resources to make sure the research and development would further enhance the product itself.

Okay, thank you.

Thank you. Our next question comes from the line of Dick Wei with JP Morgan.

Hi, thanks for taking my questions.

I wonder what are you guys seeing in terms of the macro impact on games. I guess, how much were they impacted in the fourth quarter. And if you can also comment on any changes in user behavior, I guess in terms of average spending or the churn rate for the user, that would be great.

(Spoken in Chinese).

Okay. Regarding to Dick's questions about our game developments going forward, I think even though in the fourth quarter there seems to be a small slip in the revenues, but we still have a very strong confidence on the development on the game business.

There is not much change in the user trends or their preference in playing the games. And what NetEase would be doing is that we would still deploy very much our resources to make sure that our product qualities are very high and we would provide a very customer service to service our players and to meet their game demands.

And on an ongoing basis of course we will still be doing everything to make sure that it would be a success. And we have a positive view on the game business going forward.

(Spoken in Chinese).

(Spoken in Chinese).

And just now Dick's follow up question is about whether the macroeconomic environment will have any significant impact on NetEase game business. And William said that there's not much of an impact on our game business.

Thank you.

Thank you.

Thank you. We have no more time for further questions. I would like to turn the call back over to Ms Brandi Piacente for closing remarks. Please continue.

Thanks everyone for joining us today. If you have any further questions that didn't get answered, please feel free to contact us. Thank you.

Ladies and gentlemen that does conclude our conference for today. We thank you for your participation and at this time you may now disconnect.