NetEase Inc (NTES) 2011 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the NetEase Fourth Quarter and Fiscal Year 2011 Earnings Conference call. (Operator Instructions) At this time I'd like to turn the conference over to Brandi Piacente, Investor Relations. Please go ahead, ma'am.

(technical difficulty) -- 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 risk 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 discussion.

A general discussion of the risk factors that could affect many of the business and financial results is 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. Before I begin, please note that for the purposes of this discussion all percentages are based on Renminbi. 2011 was a year marked by considerable growth for NetEase. Our commitment to providing the highest quality content to our disparate and growing community accelerated our leadership in China's expanding Internet market. We achieved dynamic growth across our business segments and increased the total revenues for 2011 by 32% RMB7.5 billion or $1.2 billion.

Online gaming revenues grew 32.5% to RMB6.6 billion or $1 billion. Advertising services revenue increased 25.6% to RMB795.4 million or $126.4 million. For the fourth quarter of 2011 total revenues increased 28% year over year and 7% quarter over quarter to RMB2.1 billion or $341.4 million. Revenues from online games increased to 28.9% year over year and 4.4% quarter over quarter to RMB1.8 billion or $291.3 million for the fourth quarter of 2011.

During the fourth quarter our fast growing new self-developed games Tianxia III and Ghost grew dramatically. Building on the substantial user base from Tianxia II, Tianxia III generated record revenues and user statistics in the fourth quarter. Similarly Ghost became one of the most popular 2.5D MMORPGs of 2011 in China, and reached record user statistics in the fourth quarter. Fantasy Westward Journey and Westward Journey Online II also performed well benefiting from expansion packs launched early in the year and our successful large scale promotion activities for these games. Both Fantasy Westward Journey and Westward Journey Online II reached record revenues in 2011.

Heroes of Tang Dynasty also delivered a solid performance during the 2011 fourth quarter. Outstanding performances from our self-developed game Ghost, Fantasy Westward Journey, Tianxia III, Westward Journey Online II and Heroes of Tang Dynasty as well as increased earned revenues from Blizzard Entertainment's licensed game, World of Warcraft led our growth among games' revenues for the 2011 fiscal year.

The increasing popularity of our self-developed online games supports our growth momentum. Our strategy is to continue to diversify and enhance our game content and top line to bring our players the highest degree of innovation with new features that enhance their playing experiences. In 2012 we plan to enhance our portfolio of popular games with a variety of expansion packs. We will also introduce new games to further diversify our extensive portfolio.

Various updates planned for the first half of 2012 include expansion packs for Heroes of Tang Dynasty, Westward Journey Online II, Warsong of Westward Journey, New Fly For Fun and Legend of Fairy. We also plan to begin open beta testing for Ghost and Tianxia III. Two of our new self-developed games are well under development and we plan to begin beta testing for these new additions in mid-2012.

Turning to our advertising services and portal activities. In 2011 revenue growth from our advertising services segment was consistently strong, led by the financial services, food and beverage products, and internet services sectors. For the fourth quarter advertising services revenues increased 26.3% sequentially and 19.2% year-over-year with automobiles, internet services and financial services as our top performing revenue growth.

Our e-mail user base grew rapidly in 2011 both newly registered and active e-mail users reached record high user numbers in the fourth quarter further solidifying our position as the number 1 free e-mail provider in China. At the end of 2011 our registered e-mail user statistics had grown to 450 million users an increase of 4.7% over the third quarter. Similarly the number of micro-blogging users grew to 97.6 million an increase of 10.3% over the third quarter. We continue to evaluate the market and introduce new products and service offerings that meets the requirements of the dynamic internet industry.

During the year our innovation was recognized by PC Magazine as our technologically advanced photo-based products were named in the publication as the best products of 2011. This year we will be focusing on enhancing our product applications and introducing new mobile services and contents that further demonstrate our focus on quality and innovation.

We have a long history of cultivating loyal and receptive communities of internet users in China. Integrating new products and services that drive strong user traffic are central to our continued expansion. Our main priority for 2012 is to continue to satisfy China's internet users by providing unique and high demand products and services to the market. This concludes William's update on the games, advertising and portal.

Now I will provide a review of our fourth quarter and full year 2011 financial results. I will primarily focus on the discussions of margins and expense fluctuations along with net profit. Beginning with the fourth quarter 2011 results, gross profit for the fourth quarter of 2011 was RMB1.5 billion or $230.9 million. This compares to RMB1.3 billion and RMB1.1 billion for the preceding quarter and the fourth quarter of 2010 respectively. The quarter over quarter and year over year increases in gross profit were primarily attributable to increased revenues from both our online games and advertising services businesses. Partially offset by increased cost of revenues, such as royalties and consultancy fees related to licensed games operations and increased staff-related costs.

Our highest performing games in the fourth quarter were Tianxia III, Ghost, Fantasy Westward Journey and Westward Journey Online II. The quarter over quarter and year over year increases in games revenues were primarily attributable to increased revenues from our self-developed games, which were partially offset by a decline in revenues from Blizzard Entertainment's World of Warcraft in the fourth quarter. The quarter over quarter and year over year increases in advertising services revenues were primarily attributable to seasonality and the increasing appeal of our portal to users and advertisers, and improved portal and search traffic on our NetEase websites.

Gross profit margins for the online games business for the fourth quarter of 2011 was 72.6%, compared to 71.5% and 71.8% for the preceding quarter and the fourth quarter of 2010 respectively. For the fourth quarter of 2011, gross profit margin for the advertising business was 54.5%, compared to 48.4% and 53.5% for the preceding quarter and the fourth quarter of 2010 respectively. The quarter over quarter increase in gross profit margins was mainly due to economies of scale as advertising revenue increased in the fourth quarter without a corresponding increase in advertising related costs.

Gross profit margin for our wireless value-added services and other business for the fourth quarter of 2011 was 2.2%, compared to gross loss margins of 13.2% and 19.7% for the preceding quarter and the fourth quarter of 2010, respectively. The quarter over quarter and year over year improvements in gross profit margin were mainly due to increased revenues from our e-commence business and mailbox services.

Total operating expenses for the fourth quarter of 2011 were RMB529.0 million or $84 million, compared to RMB408.2 million and RMB320.7 million for the preceding quarter and the fourth quarters of 2010 respectively. The quarter for quarter increase in operating expenses was primarily due to increased selling and marketing expenses, mainly resulting from increased marketing promotional activities for Tianxia III, World of Warcraft and Ghost, and increased research and development staff-related costs, as well as an impairment provision of RMB50.3 million or $8 million on the initial online game license fees of Blizzard Entertainment's StarCraft II. The year over year increase in operating expenses was primarily due to increased selling and marketing expenses, staff-related costs and the aforementioned impairment provision in general and administrative expenses.

Net profit for the fourth quarter of 2011 totaled RMB898.6 million or $142.8 million, compared to RMB825.8 million and RMB712.5 million for the preceding quarter and the fourth quarter of 2010 respectively. During the fourth quarter of 2011, we reported a net foreign exchange loss of RMB36.4 million or $5.8 million, compared to a net foreign exchange loss of RMB65.0 million and RMB36.4 million for the preceding quarter and the fourth quarter of 2010, respectively.

The quarter over quarter and year over year foreign exchange losses were mainly due to the exchange losses arising from our Euro-denominated bank deposit balances as of 31 December 2011 as the exchange rate of the Euro against the RMB fluctuated over the period.

We reported basic and diluted earnings per ADS of $1.09 each for the fourth quarter of 2011. This compares with basic and diluted earnings per ADS of $1 each for the preceding quarter and basic and diluted earnings per ADS of US$0.87 each for the fourth quarter of 2010.

We recorded a net income tax charge of RMB122.6 million or $19.5 million for the fourth quarter of 2011, compared to RMB140.5 million and RMB83.2 million for the preceding quarter and for the fourth quarter of 2010 respectively. The effective tax rate for the fourth quarter of 2011 was 11.8%, compared to 14.7% for the preceding quarter and 10.3% for the fourth quarter of 2010.

Our various principal subsidiaries enjoyed the preferential enterprise income tax rate of 15% as High and New Technology Enterprises from 2008 to 2010. As these subsidiaries have recently renewed their qualifications as New and High Technology Enterprises, the preferential enterprise income tax rate will remain in effect for 2011 through 2013, subject to annual review by the relevant tax authorities in China.

Now turning to the fiscal year 2011 financial results, gross profit for fiscal year 2011 was RMB4.9 billion or $781.4 million, compared to RMB3.7 billion for the preceding fiscal year. The increase in gross profit for fiscal year 2011 was primarily driven by increased revenue, partially offset by increased cost of revenue from the online games and advertising service businesses.

Total operating expenses for fiscal year 2011 were RMB1.6 billion or $253.4 million, compared to RMB1.2 billion for the preceding fiscal year. The increase in operating expenses in 2011 was primarily due to increased selling and marketing expenses. Comprising mainly marketing and promotional activities for Ghost, Heroes of Tang Dynasty, Blizzard Entertainment's World of Warcraft and StarCraft II. And increased staff-related costs resulting from increased headcount in general and administration and research and development areas, as well as the impairment provisions of the initial online game license fee as I previously mentioned above.

Net profit for fiscal year 2011 totaled RMB3.2 billion or $513.9 million, compared to RMB2.2 billion for the preceding fiscal year. For fiscal year 2011, we reported a net foreign exchange loss of RMB79.1 million $12.6 million, this compares to a net foreign exchange loss of RMB89.5 million for the preceding fiscal year. The net foreign exchange losses for 2011 and 2010 were mainly due to exchange losses arising from the Company's Euro-denominated bank deposit balances as the exchange rate of the Euro against the RMB fluctuated over these periods. We reported basic and diluted earnings per ADS of $3.93 and $3.92 for fiscal year 2011 respectively. This compares to basic and diluted earnings per ADS of $2.74 and $2.72 for the preceding fiscal year, respectively.

We recorded a net income tax charge of RMB392.8 million or $62.4 million and RMB344.4 million as an effective tax rate of 10.9% and 13.4% for fiscal years 2011 and 2010 respectively.

As of 31 December 2011, our total cash and time deposit balance was RMB11.9 billion or $1.9 billion, compared to RMB9.5 billion as of 31 December 2010. Total held-to-maturity investments balance was RMB993.6 million or $157.9 million as of 31 December 2011. There were no such investments as of 31 December 2010. Cashflow generated from operating activities was RMB1.2 billion or $197.6 million for the fourth quarter of 2011, compared to RMB864.9 million and RMB901.5 million for the preceding quarter and the fourth quarter of 2010, respectively.

On 1 December 2011, our Board authorized a share repurchase program of up to $50 million of net outstanding ADSs. No ADSs have been repurchased as of 31 December 2011. The share repurchase program will end on 29 February 2012.

Thank you, Onward. Due to the technical difficulties at the beginning of the call, I need to re-read the safe harbor statement that will cover the session for today. So please note the discussion today has contained forward-looking statements or may have contained 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 risk 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 is 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 has been recorded and is currently being recorded. You can also find the webcast replay of the call on the Company website at corp.netease.com.

So we'd now like to open the call up for questions, Operator.

(Operator Instructions) Our first question comes from the line of Richard Ji with Morgan Stanley, please go ahead.

Good morning, William, Onward, congratulations on a very strong quarter. I have two questions and first of all two of your new self-developed games including Tianxia II and the Ghost delivered record performance. Can you possibly give us a little more color on the statistics of these games and hopefully user volume and the Renminbi contribution? Can you also rank your games in terms of their total sales contribution?

(interpreted) So in terms of user information statistics, I think given the fact that the Company by now has quite a lot of game products in place, in operation. So we are considered (technical difficulties). Okay, just to recap on what William has just highlighted on Richard's questions. For the user information we consider that it is not appropriate to disclose given the fact that by now NetEase has got quite a lot of game products in place and in operations. So far as the performance of Tianxia III is concerned the Company has put in a very good effort to put forward a comprehensive upgrade of Tianxia II to Tianxia III. Revenue contributions from the Tianxia III product is much higher than the Ghost one given that the product itself is already in place and is in the market for some time. Also given the fact that Ghost has only been operated within a one year time span.

Given that we have also rolled out some new expansion packs to enrich the game's contents and game play, the features to Tianxia III we do look forward to see how the market will respond to this new comprehensively upgraded product. Thank you.

Thank you. That's helpful and my second question is about your partnership with Blizzard and for 4Q and World of Warcraft showed some weakness. Should we expect World of Warcraft's growth to re-accelerate in the coming quarter? Can you also comment on your plan to further your partnership with Blizzard and for Battle.net, StarCraft and any future, new games.

(interpreted) So in terms of the performance of World of Warcraft I think basically the responses of the product in the market will very much depend on the game play, the features and the content. And whether there will be sufficient and rich content to attract to keep the players. We do believe that World of Warcraft is a traditional and very reputable game product and we do have confidence on the futures of operating this product as well. Insofar as the cooperation with Blizzard is concerned, we do maintain a good and smooth cooperation with the Blizzard side. Blizzard is also a really respected partner on a worldwide scale. We do look forward and we do have further cooperation in this area.

Thank you.

Thank you.

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

Hi, thanks for taking my questions. I think my first question is on the operating expenses. It seems like the Company has increased quite a bit of expenses in the fourth quarter. How do we see the expenses grow in the first quarter this year? Which line will be growing stronger and in particular on the R&D side, are you going to be hiring more people in the first quarter? The second question will be on the new business as we are seeing NetEase in the last total month actually have been quite active in getting to new areas, i.e. the online video, the animation business and also the enterprise e-mail. Can William and Onward give us a bit more insight about how do we see the net implementation of new business and any kind of a financial impact? Do I have to translate it? (spoken in foreign language)

(spoken in foreign language)

So first of all maybe I will just do a quick recap on William's highlights on his perspectives in the new business in different areas. First of all for the online video developments. I think lately quite a lot of you would be aware that NetEase has been getting into cooperation with (inaudible) in order to broaden our online video service offerings. We do believe that through this cooperation this will also make sure that we can have much better users' experiences for our portal users by providing some high quality online video playing experiences. Also this will be another area for our value add services that we are currently offering to our users.

In terms of the animation software area, I think basically this will be quite aligned with what we are currently doing for our online game business. In fact we will continue to increase our efforts in the R&D area in order to roll out more new products to the market. We do feel that the new try outs in the animation's area will be another form of enriching our content delivery in order to diversify our overall service delivery to the market.

In terms of the enterprise e-mail, basically I think this would be a kind of service faze-in the enterprises and the small and medium-sized enterprises in public work. Up to now through the launch of these services last year, we've got very good feedback and responses from the market and the service is also well received by them. By now we have over 40,000-plus paying users using these services. We do hope that this will help out quite a lot to the SME, the small and medium enterprises. in terms of improving their communications to their business partners alike.

On the other hand, maybe I will just supplement Wallace's second question about the operating expenses. A lot of the companies in 2012 or so -- because you are well aware that in the fourth quarter of 2011 there has been a little bit of increase in terms of the operating expenses. But basically I think this was mainly attributed to an impairment loss or impairment provisions of RMB50.3 million for the initial license fees relating to the StarCraft II product. Other than that, I think in terms of the other lines of the operating expenses, so to call the selling and marketing expenses, G&A and also research and development expenses, I think that this will be quite basically growing to cope with the expansion of the Company's business. Thank you.

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

Hi and congratulations on a good quarter. I also have a question on the R&D front. Onward, can you explain where did the RMB50 million booked on the R&D line and also, if we can discuss about the headcount plan for R&D for 2012, that would be great.

(interpreted) In terms of the Company's wishes [the strength] is on building the head count of the Company, so I think, as an innovative and technologically strong Company, we do place an importance or the priorities on our R&D people. For our long term people development strategies, I think lately, some of our peers may slow down their recruitment program, but this is not the case for NetEase and for ourselves, we do still continue with our momentums to attract and retain the best talents in the market and we do also offer a very competitive and good package to achieve that goal. Yes, please, go ahead.

I want to ask you about the -- where was the RMB50 million booked?

(interpreted) RMB50 million. Are you relating to the impairment provisions of RMB50 million?

Right.

(interpreted) This has not been - gone through to the R&D line, but instead, it has gone through to the G&A line. G&A line and so you will see that for its fourth quarters, our G&A expenses has increased by almost RMB40 million to RMB50 million and basically, this would be the impact relating to the impairment provisions that we've made.

Okay, great. Then, the second question is on the plans for social and mobile games?

(interpreted) Okay. With regard to our strategies on the social and mobile game front, basically, we have rolled out a new product on both the iPhone and also the iPad. A little game called Magic Box and this will be a totally new experiences for -- or a new trial on this part of the market. In terms of the social game front, I think we were also finding a new and unique way of developing some new games in this area and we will -- more information as we see fit.

Thank you.

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

Good morning, William, Onward and Brandi. Congratulations on a strong result. I have two questions. Number 1, the -- can you guys share the reasons for the impairment provisions on the StarCraft licensing fee? Is that mean that the game has not met up to expectation? Then, any future impairment charge for the minimum guarantee portions?

I think, first of all, regarding your questions on the impairment provisions, I think this is just an ongoing review and assessment of the performers or the operations of the games and if it's also an accounting treatment to align with the required (inaudible) that we need to put into and to account for them, but in no way, we do still believe the game itself is operating well and given the fact that we have done quite a lot of marketing and promotional events and activities so far throughout the year to make the game more visible and more (inaudible) to the market, we also received some very good and positive responses from the market as well, for the StarCraft II.

In fact, if you - you might also have heard that on 23rd of this month, we will also roll out an unlimited edition of playing this game, by paying a fee for the StarCraft II, which we believed to be a very convenient and economical ways of putting forward the games for the potential and existing players and we do still believe that this kind of e-Sports games we've got a good presence in the China market.

I see. Great. Thank you and second question is that I understand that NetEase actually has a number of web games released or under development. And wanted to get management view on the overall web game markets and how fast do you think these markets can grow in the next few year, versus the traditional MMO market? Thank you.

(interpreted) So with regard to our strategies on the web game developments, currently, we do have a few games in development, and we would also push for in the markets later on and still at this point of time, we believe that the client base game got a much better presence than the web games, but having said that, we do still believe the roll out of the -- and the developments of the web games would create a supplement to the existing user experiences of our online game products. Thank you.

I see. Great, thank you.

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

Good morning William and Onward. Could you help us to understand what you have seen in the advertising market this year? Have we seen any slowdown in advertising growth from your advertisers?

(interpreted) So basically, with regards to our views on the advertising market, basically, I think the macro environment would definitely cause some impact to the advertising businesses, but having said that, we do still believe that there are much rooms to further explore and further develop in terms of main use portals. Say for example, we are the biggest free email service providers by the end of 2011. We have a registered users of 450 million registered users and in terms of the active and unique users, the number would be about 100 million plus.

At the same time, we do believe that the (inaudible) diversify content delivery would also cause another room of opportunities in the advertising business and you would also see that by way of cooperating with the (inaudible) in terms of providing a much more comprehensive and diversified online video contents, we do believe that this would - got a very good and positive potentials in the service usage. By now, we do also see that the users behavior or their habits would not solely just watching news or just sending emails and they are also expecting much more and we do believe that by taking the various new measures of the new products or new services that we are going to offer to the market, this would pose a positive opportunities to NetEase. Thank you.

Got that. Thank you.

Thank you. Our next question comes from the line of Martin Bao with CICC. Please go ahead.

Thank you for taking my question. My question is regarding to the...

Sorry. The line is not very clear and we can't hear you clearly.

Sorry. Okay, hear me?

Yes, much better. Thank you.

Thank you. Thank you for taking my question. My question is regarding to the wireless value add and the other services and we see that it recorded a positive growth margin in the fourth quarter. Could you kindly give us some color of your expectation of the -- this business in 2012?

(interpreted) In terms of our strategies or the views on the wireless, whether there is services and other business in 2012, basically, we have been putting a very high effort to trial some new businesses in this area. At all times we do want to deliver very good services to the market. The process is difficult, challenging, but yet exciting and we do feel that by putting out some new business or new product and services to the market we would also experience some positive impact on the internet arena. Thank you.

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

Thank you very much for taking my questions. There are two quick questions. First question is on the capital expenditure and second question is on your game path line in this year.

Okay. Maybe, I will answer the first questions regarding the CapEx one first and then I will request William to give you some supplement on the game path line in 2012. In terms of the CapEx in the fourth quarters, you will see that there has been a significant increase, as compared with the third quarter's. There has been some expenditure that we have spent in the purchasing a properties in - an office building in the Beijing area.

With regard to our new game path licensing in 2012, I think there -- are definitely are some new kinds of games that we are going to roll out in 2012. One of those that William would like to highlight is a game called (inaudible) and this game itself is not a pure MMO game, but rather, this game will focus more on some visual and operating experiences to the players and at the same time, we also got some other games, potentially, in development process and at the moment, we think we would not disclose the exact names of it for the time being, but definitely, we will give up more colors and details on the upcoming quarters. Thank you.

Thank you very much.

Thank you. And at this time I will to turn the conference back over to Brandi Piacente.

Thank you, everyone, for joining us today. Please feel free to contact us, if you have further questions and have a great day.

Thank you, ladies and gentlemen.

(Operator instructions)

This does conclude the NetEase fourth quarter and fiscal year 2011 earnings conference call. Thank you for your participation. You may now disconnect.

Statements in English on this transcript were spoken by an interpreter present on the live call. The interpreter was provided by the Company sponsoring this Event.