NetEase Inc (NTES) 2009 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the NetEase fourth quarter and full year 2009 earnings conference call. During today's presentation, all participants will be in a listen only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). The conference is being recorded today, February 24, 2010 and at this time, I would like to turn the conference over to Brandi Piacente, Investor Relations. Please go ahead, ma'am.

Thank you, operator. Please note that 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 US 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 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 20-F. 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 call 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, and hello, everyone. Before I begin, please note that for the purposes of this discussion, all percentages are based on renminbi.

We concluded 2009 with a strong fourth quarter. Total revenues for the fourth quarter of 2009 increased to CNY1.3b or $189m compared to CNY879.4m in the prior quarter and CNY801.7m in the fourth quarter of 2008. For the full year, total revenues increased 28% to CNY3.8b or $560.1m compared to CNY3b for the preceding year.

Revenues for our online game business total CNY1.1b or $159.4m for the fourth quarter compared to CNY775.1m in the third quarter and CNY672.5m for the fourth quarter of 2008. For the full year, revenues from online games were up 35% to CNY3.4b or $493.5m compared to CNY2.5b for the preceding fiscal year.

Tianxia II has performed very well since its open beta testing launch last September and we continue to garner steady growth in new user registrations. We launched a new expansion pack called Flying Dragon for this game in December to a positive play response.

Ancient Runes, the ninth expansion pack for Fantasy Westward Journey was launched in October. Fantasy Westward Journey delivered peak concurrent users of 1.3m and daily ACUs of 490,000 for the fourth quarter. While user activities declined in 2009 compared to 2008 overall, we were exceptionally pleased to reach a record PCU number during August and have great confidence that this game will continue to preserve it popularity as an iconic MMORPG game.

Our second web based game Storm of Empires was commercialized on December 15. This game format gives players easy accessibility without downloading and installing software.

Additionally, we launched a final closed beta testing for Legend of Westward Journey on December 12. We rescheduled plans for new Fly for Fun and TF Online and now target new expansion packs in the second quarter of 2010 and the third quarter of 2010 respectively.

We recently concluded several large scale product specific and Spring Festival related promotional campaign for a number of our games which were developed over the course of the fourth quarter. In the new game pipeline, we are continuing with closed beta testing of Ghost and limited closed beta testing of Legend of Datang and plan to commercialize this game midyear.

We are committed to the continued success of World of Warcraft, a game licensed from Blizzard Entertainment which is evidenced by the highly positive response from players since the game was relaunched in Mainland China on September 19, 2009. As of December 31, 2009, our game development team totals 1,100. We plan to continue to increase this number through 2010 commensurate with the growth of our game portfolio and user activity.

Overall, as we proceed through 2010, we will continue to follow our pragmatic approach to game strategy execution in order to build MMORPG game market share in China.

Now, turning to advertising. Brand advertising revenue has show positive signs of recovery. Revenues from advertising services were CNY183.7m or $26.9m for the fourth quarter of 2009, up 113% compared to CNY86m in the prior quarter and up 64% compared to CNY111.8m for the fourth quarter of 2008 respectively. For the fiscal year 2009, revenues from advertising services were CNY383.6m or $56.2m compared to CNY405.9m for the fiscal year 2008.

The outstanding sequential improvement we experienced in the fourth quarter was due in part to the successful outcome of restructuring our portal business operations and implementing other new portal marketing strategies early this year -- in last year. Our best performing advertising sectors in the fourth quarter of 2009 were automobile, internet services and apparel. A trend which we expect will continue this year.

Our newest enhancement to content and channels are as follows. On November 2, we launched our game channel. In January, we launched a video channel and we also expanded our realty channel to cover Beijing, Shanghai and Tianjin. In 2010, we will gradually expand our realty channel to cover other cities in China and also, we plan to launch our new microblog service. We look forward to our added coverage of major international events such as Expo 2010 in Shanghai, the 16th Asian Games in Guangzhou, and the 2010 FIFA World Cup in South Africa which will provide great opportunities for our advertisers to reach our diverse user base.

Based on the business plans I just discussed, we are cautiously optimistic about the cost of our advertising business this year.

That concludes William's remarks on games, advertising and portal. Now, I will provide a review of our fourth quarter and full year 2009 financial results. In order to avoid repetitions with the press release, I will primarily focus on the discussions of margin and expense fluctuations along with net profit.

Starting with the fourth quarter results, gross profit for the fourth quarter of 2009 was CNY844.1m or $123.7m compared to CNY627m and CNY639m for the third quarter of 2009 and fourth quarter of 2008 respectively. The quarter-over-quarter and year-over-year increases in gross profit were primarily attributable to increased revenues from both the online games and advertising businesses, partially offset by increased cost of revenues such as royalties and consultancy fees related to World of Warcraft operations and increased staff-related costs resulting from increased headcount in the current quarter.

Gross profit margin for the online game business for the fourth quarter of 2009 was 70.8% compared to 79.9% and 88% for the preceding quarter and the fourth quarter of 2008 respectively. The quarter-over-quarter and year-over-year decreases in gross profit margin were primarily due to the reporting of a full quarter of operating results for World of Warcraft operations in the fourth quarter of 2009.

Gross profit margins for the advertising business for the fourth quarter of 2009 was 58.4% compared to gross profit margins of 23.1% and 51.1% for the preceding quarter and the fourth quarter of 2008 respectively. The quarter-over-quarter increase in gross profit margin was mainly attributable to the significant increase in advertising revenues for the quarter partially offset by increased staff-related costs and content costs. The year-over-year increase in gross profit margin was primarily driven by higher advertising revenue in the fourth quarter of 2009.

Gross loss margin for the wireless value added services and other business for the fourth quarter of 2009 was 38.5%, compared to 45% for the preceding quarter and 24.9% for the fourth quarter of 2008. The quarter-over-quarter decrease in gross loss margin was mainly due to reduced depreciation charge in the fourth quarter of 2009 as servers associated with wireless value added services operations became fully depreciated.

The year-over-year increase was mainly due to the 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 and high staff-related costs from increased headcount, partially offset by reduced depreciation charge in the fourth quarter of 2009 as assets became fully depreciated.

Total operating expenses for the fourth quarter of 2009 were CNY237m or $34.7m, compared to CNY218.9m and CNY168.5m for the preceding quarter and the fourth quarter of 2008 respectively. The quarter-over-quarter increase in operating expenses was mainly due to increased selling and marketing expenses. The year-over-year increase was mainly due to increased staff-related costs.

Net profit for the fourth quarter of 2009 was CNY571.8m or $83.8m, compared to CNY393.8m and CNY575.9m for the preceding quarter and the fourth quarter of 2008 respectively.

During the fourth quarter, we reported a net foreign exchange loss of CNY15.3m or $2.2m under other net, compared to a net foreign exchange gain of CNY25.3m for the preceding quarter and a net foreign exchange loss of CNY22m for the fourth quarter of 2008. The quarter-over-quarter and year-over-year changes in foreign exchange gain and losses were mainly due to the translation gains and losses arising from the Company's euro denominated bank deposit balances as of December 31, 2009 as the exchange rate of the euro against the RMB fluctuated over the periods.

We reported basic and diluted earnings per ADS of $0.65 and $0.64 respectively for the fourth quarter of 2009. This compares to basic and diluted earnings per ADS $0.45 and $0.44 respectively for the preceding quarter and $0.66 and $0.65 respectively for the fourth quarter of 2008.

We recorded an income tax charge of CNY71.2million or $10.4 million and CNY65.5 million for the fourth quarter and the preceding quarter respectively, compared with a net tax benefit of CNY79.9m for the fourth quarter of 2008.

The effective tax rate for the fourth quarter of 2009 was 11.3% as compared to 14.3% for the preceding quarter and a net tax benefit rate of 16.1% for the fourth quarter of 2008. During the fourth quarter of 2009, certain subsidiaries of the Company became subject to preferred tax rate as they qualified for key software enterprise or high and new technology enterprise status at 10% and 15% respectively for fiscal year 2009.

The year-over-year change in the effective tax rate was primarily due to the reversal recorded in December 2008 for the excess tax charge related to the first three quarters of 2008 as the Company's various subsidiaries did not receive approval for the preferred tax status of high and new technology enterprise until December 2008.

Cash flow generated from operating activities was CNY712.4m or $104.4m for the fourth quarter of 2009, compared to CNY270m and CNY514m for the preceding quarter and the fourth quarter of 2008 respectively.

I would now like to take a few moments to review full year fiscal 2009 results. Gross profit for fiscal year 2009 was CNY2.8b or $410.9m compared to CNY2.5b for the preceding fiscal year. The increased gross profit for fiscal year 2009 was primarily due to increased online game revenue from our various flagship games such Fantasy Westward Journey and Westward Journey Online II, as well as the relaunch of World of Warcraft on September 19, 2009.

Furthermore, we also recognized approximately CNY101.6m or $14.9m of revenue from dormant accounts of online games for fiscal year 2009 resulting from a change in the user agreement with online game players in May 2009. The increase in revenues was partially offset by increased cost of revenues resulting mainly from increased staff-related costs due to headcount increases and royalties, amortizations of license fees and technical consultancy fees associated with the operations of World of Warcraft. In addition, in June 2008, we recorded a one-time business tax refund of CNY133.9m for online games.

Total operating expenses for fiscal year 2009 were CNY781.3m or $114.5m compared to CNY610.4m for the preceding fiscal year. Higher operating expenses for fiscal year 2009 were primarily due to increased staff-related costs resulting from increases in headcount and performance related bonus accruals across the selling and marketing, general and administrative, and research and development areas in 2009. In addition, increased selling and marketing costs were also incurred for brand building and markets promotion activities for certain self-developed games and the relaunch of World of Warcraft in 2009.

Net profit for fiscal year 2009 totaled CNY1.9b or $271.1m compared to $1.6b CNY for the preceding fiscal year. For fiscal year 2009, we reported a net foreign exchange gain of CNY9.6m or $1.4m under other net compared to a net foreign exchange loss of CNY167.1m for the preceding fiscal year.

The change to a net foreign exchange gain for 2009 from a net foreign exchange loss for 2008 was mainly due to the translation gains arising from our euro-denominated bank deposit bank balances as of December 31, 2009 as the exchange rate of the euro against the RMB fluctuated over the period.

We reported basic and diluted earnings per ADS of $2.11 and $2.09 for the fiscal year 2009 respectively, compared with basic and diluted earnings per ADS of $1.88 and $1.81 for the preceding fiscal year respectively.

We recorded a net income tax charge of CNY313.9m or $46m and an effective tax rate of 14.6% for the fiscal year 2009 compared with a net income tax charge of CNY300.7m and an effective tax rate of 15.8% for the fiscal year 2008.

The relatively higher effective tax rate for fiscal year 2008 was primarily due to the remeasurement of deferred tax assets previously recorded at the new statutory range of 25% effective January 1, 2008 to the 15% tax rate applicable to high and new technology enterprise as certain of our subsidiaries in China were granted the HNTE status for fiscal year 2008 in December 2008.

As of December 31, 2009, cash and time deposits total CNY7b or $1b, compared to CNY5.6b as of December 31, 2008.

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

Operator, please go ahead.

(Operator Instructions) And our question comes from the line of Richard Ji with Morgan Stanley. Please go ahead.

Thank you. William and Onward, congratulations on a very strong quarter. I have two questions and the first starting with online games business. Obviously, World of Warcraft and the Tianxia II have become your new catalysts for growth and can you give us some color on the operating metrics of these two games including PCU and ideally, a revenue contribution.

And a related question is when do you expect the new expansion pack for World of Warcraft, namely the Wrath of the Lich King be approved? Thank you.

Okay, thank you, Richard. Maybe I will translate the questions, first of all for William to answer.

(Spoken in Chinese)

Maybe I just do a quick translation on what William has just talked about, our online game business. For the first one, regarding the operations metrics, pointing the fact that the Company has a wide array of game titles putting forward to the China markets and it is the Company's intentions that going forward and in the upcoming quarters, we decided that we wouldn't go too much to disclose respective product titles, PCU numbers or the revenue contributions because as all of you may well aware of, the products that we are not currently launched to the market including the time based games and also the item based games and using the PCU numbers or the ACU numbers wouldn't be a very good reference point to assess the exact performance of our games.

And so, this is what we are thinking about and we would decide not to disclose this kind of metrics going forward. But having said that, it is always the Company's intent to make sure that we have a very good product quality and content quality to ensure and enhance the player's gaming experiences and their recognitions to our gaming products and this is what is more important that we would strive to do.

On the second question, regarding the launch of the new expansion packs for the World of Warcraft, namely the Wrath of the Lich King, the Company would do according to the relevant government authorities' requirements and we would update all the interested parties including our investors and everybody as it comes to an appropriate timing. Thank you.

Thank you, William and Onward. And my second question is regarding your online game recovery. And let me ask you this question in both Chinese and English for the benefit of William and also our investors.

Okay.

Obviously, you delivered a very robust advertising performance in the past quarter and your growth rate is substantially above the levels for your closest competitor and other than the sector-wide rebound and what have your company done particularly to boost the advertising sales? And also, what is your advertising outlook for 2010 especially based on the budget commitments of your advertisers and also the initial feedback from you advertising customer?

(Spoken in Chinese).

Okay, just to recap on the main points on William's remarks. Regarding the growth in the fourth quarter for our advertising business, I think one of the points is that we have a very strong team. They have been performing very exceptionally good, especially in the 2009.

And by looking at the competitive landscape, although NetEase was currently, as compared with our peers, in a less competitive position, but given that we have a very strong pipeline of other products just like our email and blog search and things like that, going forward we also would have a very strong and enhanced service delivery in terms of the communications, contents and also from the social kind of products. And we believe that going forward we would have a very good room to position ourselves in this part of the business. Thank you.

Thank you, William and Onward, and congrats again.

Thank you, Richard.

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

Hi. Good morning, William and Onward and Brandi. Just quickly on the -- two questions. One is, first of all, it's again on the advertising business. How much of the incremental of the advertising revenue, generates from the new game channel and also what is the percentage of revenue coming from the email service?

And the second question would be on the search engine part. It's actually on Yodao. Do you have any new strategies given the fact that we recently had the Google China incident and are you going to be more aggressive in 2010?

(Spoken in Chinese).

Regarding the first part of William's remarks, regarding the incremental revenue contributions from our game channels, because this channel is just newly launched, not long ago and so the revenue contributions will not be very significant at this stage.

And at the same time regarding the email revenue contributions, I think we still need to get back to do some more analysis before giving out further details. But definitely we hold a very positive view about the advertising business in general. And in the upcoming period, we will still focus more on building up our revenues through our SMS products, our email products as such.

(Spoken in Chinese).

Regarding William's remarks, at this stage we don't have much to share about the operational metrics regarding the Yodao business. But we will try our very best efforts to make sure that we have a very good technical capabilities to fit in the needs of the markets.

Thank you. Just one quick follow up question. (Spoken in Chinese). So I just want to ask a question related to the email products. How can NetEase maintain its long term leading position? Thank you.

(Spoken in Chinese).

Regarding William's remarks, regarding how the Company can maintain our leading positions in the email business competitions, basically we can consider it from two perspectives. First of all, regarding the product itself, we have full confidence regarding the quality of our products that we are currently putting for use in the market. And on the other hand, regarding our efforts to do more investment, we would continue to add in more funding to ensure that the email users would have very good user experiences. And especially in this year, both the free emails and also the corporate emails would be our major development focus and we would make sure that we continue to increase our market share in this respect. Thank you.

Thank you.

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

Hi, thanks for taking my questions. I have two questions. The first one is can you discuss more about the NetEase video channel strategy. (Spoken in Chinese).

And the second question is regarding the margin trends going forward particularly on the game gross margin. If the game mix between licensed games and in-house games are the same, should we expect much of the variation from the current gross margin? And also if you can give some -- shed some light on the full year sales and marketing and G&A expense, that would be great. Thanks.

(Spoken in Chinese).

First of all, regarding our video channel's strategies, I think our main focus point will still be to use this as a tool to supplement our servicing kind of products just like a communications channel service. And say for example, we are going to have the Asian Games in this year and we will also focus on doing this strategy in Beijing such that we would have the firsthand information to deliver the very timely and quality content deliveries to our interested users. And this would be the basic core theme on our video strategies. And we also believe that by so doing we will have a very good development in this respect.

And regarding the trend, perhaps on the -- or the margin's performance in general for the online game business, because we will see that especially for this quarter, the composite gross margin would be a little bit lower as compared with previous ones, mainly because of the fact that we have also taken into account the operations of the World of Warcraft in general. But we still believe that the current margin levels would be the kind of levels that we would be looking for in the upcoming quarters.

And for the third question regarding the selling and marketing expenses trends, perhaps for the 2010 I think basically just as what the Company has remarked in the third quarter, the Company has decided to put in more efforts to do more selling and marketing, promotional, that kind of stuff so as to increase the awareness of our products and services to our targeted users and customers, players as such. And also -- we would also like to make sure that through the various brand building campaigns and kind of stuff, this would help to increase the recognition of NetEase as a very good and premium label in the China market.

And so in terms of the -- of our investment in the selling and marketing activities, we still believe that for 2010, we will also still make very good efforts as such. And perhaps the current levels in terms of the dollar amounts would be a good reference point for you to consider how serious we are in order to doing this part of the promotion and marketing events. Thank you.

Okay.

Thank you. Our next question comes from the line of Ming Zhao with SIG. Please go ahead.

Thank you for taking my question. Good morning. I have two questions. My first question is about your game pipeline. Do you have a specific quarter that you can tell us about launching the Ghost and the Legend of Datang? Also is there any progress on Starcraft II and Battle.net that you can share with us? (Spoken in Chinese).

Sure, of course, Ming. Regarding the game pipeline kind of questions for the Ghost and also the Legend of Datang, I think basically the Company would also expect that we will try to commercialize it hopefully by the middle of this year, perhaps in the second quarter.

And with regard to the launch of the Starcraft II, I think at this stage the Company does not have any further updates. But as soon as we have got any further updated news, we would let you know as soon as possible.

Okay, thank you.

(Spoken in Chinese).

And also -- William has also given some supplemental remarks regarding the launch of our Ghost product in the market. In this month, in fact, we would also do another round of the technical testing of the product. And if everything is very satisfactory and up to our expectations, then it wouldn't -- the actual launch of the games we wouldn't need to wait too long.

Okay, thank you.

Thank you. Our next question comes from the line of Doug Creutz with Cowen & Company. Please go ahead.

Thank you. I was wondering if you could some guidance as to what you expect your tax rate to be in 2010?

Regarding the tax rate for the 2010, I think basically -- I think basically we don't have a very exact number that can be given out for the time being. But basically I think from the Company's perspective we would and always be doing to find out all the tax incentive policies that we can enjoy, say for example the high and new technology enterprises tax status and the key software enterprise. And all this kind of stuff we'd consider altogether and we will try to maintain our tax rate at a reasonable level.

Okay, thank you.

Thank you. Our next question comes from the line of Alicia Yap with Citigroup. Please go ahead.

Hi. Thanks for taking my question. I have a couple of questions. First of all, since you are the official sponsor for the Guangzhou Asian Games, have you started to see some increased demand from the advertisers? Will there be any additional costs of content associated with the sponsorship?

My second question is to follow up on the Starcraft question. Since Blizzard announced that it will be launched around mid-2010, do you think China will be able to do a simultaneous global launch?

And then lastly, will there be any remaining old game points from The9's game card that will still need to be honored in the first quarter '10?

(Spoken in Chinese).

Regarding the first question regarding our sponsorship on the Asian Games, basically at this stage I think there's no specific comment that we can add on regarding how far and how good it is, for the time being regarding the potential or the advertisers' response. But we would have full confidence that our sales team on the advertising business will try their very best efforts in actively seeking every possible (inaudible) opportunities to build an exceptional and a very good performance in this respect.

Because as you all may well aware of we are also a company that has been established in Guangzhou for quite a long period. And so we do have a very strong confidence and belief that we will do a very good job in this front, especially on supporting this Asian Games in Guangzhou this year.

And regarding the second questions, regarding the potential launch of the Starcraft II, from the Company's perspective, we would work closely together with our partners, which is the Blizzard side, to make sure that the games would launch and come into the China market in the shortest possible time frame.

And with regard to the third question that Alicia has bring up regarding the old game points that are brought forward from the previous operator, I think basically substantially all those points has been consumed or have been utilized in the fourth quarter of 2009. And hopefully starting from the 2010, the full quarter results would be basically the reflections of the operations solely by NetEase.

Thank you.

Thank you.

(Operator Instructions).

Operator, that concludes our call for today. I'd like to thank everyone for joining us. And if you have any further questions please feel free to contact us. Thank you so much and Happy New Year.