NetEase Announces Third Quarter 2006 Unaudited Financial Results
(Beijing -November 6, 2006) NetEase.com, Inc. (NASDAQ: NTES), one of China's leading Internet and online game services providers, today announced its unaudited financial results for the third quarter ended September 30, 2006.
Third Quarter 2006 Performance
-Total revenues for the quarter decreased 0.6% quarter-over-quarter and increased 23.6% year-over-year to RMB571.9 million (US$72.4 million);
-U.S. GAAP net profit for the quarter increased 0.2% quarter-over-quarter and 21.7% year-over-year to RMB314.8 million (US$39.8 million), equivalent to US$0.29 (diluted) earnings per American Depositary Share (ADS);
-Non-GAAP net profit for the quarter, which is exclusive of non-cash, share-based compensation costs, increased 0.1% quarter-over-quarter and 31.8% year-over-year to RMB340.8 million (US$43.1 million), equivalent to US$0.31 (diluted) earnings per ADS;
-The internal beta testing schedule for the Company's next generation online 3D game, Tianxia II, remains on track, and open beta testing is expected to commence by the end of 2006;
-Internal closed beta testing of the upgraded version of Westward Journey II (Westward Journey III) is on schedule to commence in the second quarter of 2007; and
-As of September 30, 2006, approximately 1.0 million of the Company's issued and outstanding ADSs had been repurchased for an aggregate purchase consideration of US$17.1 million (including transaction costs) pursuant to the share repurchase program announced on August 29, 2006.
William Ding, Chief Executive Officer and Director of NetEase stated, "Our online game revenues, which decreased 3.7% quarter-over-quarter, were impacted in part by expected seasonality in the last month of the quarter. In addition, our revenues from online games were affected by increased competition, particularly from free-to-play games offered by some of our competitors, and in-game protests by certain users of our Fantasy Westward Journey game who mistakenly identified an image in this game as being a Japanese flag. Our 21.2% quarter-over-quarter increase in advertising revenue for the third quarter reflected the improved content and optimization of new products and services. We are continuing to improve and expand our online user experience and drive traffic volume within our online communities by introducing new products such as our blog services and a new home page, both launched in October this year."
Mr. Ding added, We continued to make significant progress in the development of our online game pipeline during the quarter, and remain on track to initiate internal closed beta testing of Westward Journey III, which incorporates a new game engine and new features and content, in early to mid-2007. Tianxia II development is also progressing according to plan, and we expect to commence open beta testing by the end of this year. Datang contributed modestly in its first full quarter since commercialization, but we believe its popularity will grow as we add new content and playing features and increase our marketing of this game."
Total revenues for the third quarter ended September 30, 2006 were RMB571.9 million (US$72.4 million) compared with RMB575.3 million (US$72.0 million) for the second quarter of 2006. Total revenues increased 23.6% from RMB462.6 million (US$57.2 million) for the third quarter of 2005.
Online game revenues were RMB467.9 million (US$59.2 million) for the third quarter of 2006, representing a decrease of 3.7% from RMB486.0 million (US$60.8 million) for the second quarter of 2006 and an increase of 25.6% over RMB372.7 million (US$46.1 million) for the third quarter of 2005.
Revenues from advertising services increased 21.2% to RMB83.4 million (US$10.5 million) for the third quarter of 2006, from RMB68.8 million (US$8.6 million) for the second quarter of 2006. Advertising services revenues increased 13.6% over RMB73.4 million (US$9.1 million) for the third quarter of 2005.
Revenues from the Company's wireless value-added services and others were RMB20.6 million (US$2.6 million) for the third quarter of 2006, representing an increase of 0.6% from RMB20.5 million (US$2.6 million) for the second quarter of 2006 and an increase of 24.9% from RMB16.5 million (US$2.0 million) for the third quarter of 2005.
GAAP gross profit for the third quarter of 2006 was RMB448.1 million (US$56.7 million). The Company's non-GAAP gross profit in the third quarter was RMB452.3 million (US$57.2 million), representing a decrease of 2.0% over the previous quarter's non-GAAP gross profit of RMB461.7 million (US$57.8 million), and an increase of 21.9% over non-GAAP gross profit of RMB370.9 million (US$45.8 million) for the corresponding period a year ago. The non-GAAP financial measures included in this release exclude the effect of certain non-cash, share based compensation expenses. The reconciliation of GAAP measures with non-GAAP measures for gross profit, operating expenses, net profit and net profit per ADS is set forth in the Company's unaudited financial information below.
Total GAAP gross margin for the Company for the third quarter of 2006 was 81.7%. Total non-GAAP gross margin for the third quarter was 82.5% compared with non-GAAP gross margin of 83.5% for the preceding quarter and 83.6% for the same period last year. The decrease was primarily attributable to the decrease in the gross margin for online games for the reason explained below.
GAAP gross margin for the online game business for the third quarter of 2006 was 89.4%. Non-GAAP gross margin for the online game business for the third quarter of 2006 was 89.7% compared with non-GAAP gross margin of 91.0% for the preceding quarter and 89.7% for the third quarter of 2005. The decrease was primarily due to the increased costs associated with the open beta testing and initial commercial launch of Datang during the third quarter of 2006.
GAAP gross margin for the advertising business for the third quarter of 2006 was 56.1%. Non-GAAP gross margin for the online advertising business for the third quarter of 2006 was 58.9% compared to non-GAAP gross margin of 53.3% for the preceding quarter and 68.1% for the third quarter of 2005. The quarter-over-quarter increase was primarily due to the fact that advertising costs were relatively stable while advertising revenue grew.
GAAP gross margin for the wireless value-added services and others business for the third quarter of 2006 was 3.4%. Non-GAAP gross margin for the wireless value-added services and others business for the third quarter of 2006 was 7.6% compared with non-GAAP gross margin of 1.9% for the preceding quarter and 11.3% for the third quarter of 2005.
Total GAAP operating expenses for the third quarter of 2006 were RMB131.5 million (US$16.6 million). Total non-GAAP operating expenses for the third quarter of 2006 were RMB109.7 million (US$13.9 million), compared with RMB112.4 million (US$14.1 million) for the preceding quarter and RMB94.7 million (US$11.7 million) for the same period last year. The decrease in non-GAAP operating expenses in comparison to the preceding quarter was primarily due to a one-time write-off of RMB11.6 million (US$1.4 million) in software cost for the Company's licensed online 3D game, Fly for Fun, in the second quarter. The decrease was partially off-set by a higher provision for doubtful debts and increased research and development expense associated with increased staffing for enhancement of existing products and for development of new products in the third quarter.
As a result of foreign currency translation from currencies other than the Renminbi into Renminbi in accordance with applicable accounting standards, the Company reported a RMB219,000 (US$28,000) foreign exchange gain in the third quarter of 2006, compared to a foreign exchange loss of RMB45,000 (US$6,000) in the preceding quarter. The Company reported a RMB6.4 million (US$0.8 million) exchange loss in the third quarter of 2005.
GAAP net profit for the third quarter totaled RMB314.8 million (US$39.8 million). Non-GAAP net profit for the third quarter totaled RMB340.8 million (US$43.1 million), a 0.1% increase over the previous quarter抯 non-GAAP net profit of RMB340.4 million (US$42.6 million) and a 31.8% increase over non-GAAP net profit of RMB258.6 million (US$32.0 million) for the third quarter of 2005. NetEase reported GAAP basic and diluted earnings per ADS of US$0.31 and US$0.29 for the third quarter of 2006, respectively, which includes the impact of approximately US$3.3 million, or US$0.02 per ADS, in non-cash, share-based compensation costs. The Company reported GAAP basic and diluted earnings per ADS of US$0.30 and US$0.28 for the second quarter of 2006, and US$0.25 and US$0.22 for the third quarter of 2005, respectively.
As of September 30, 2006, the Company's total cash and time deposit balance was RMB3.8 billion (US$478.7 million), an increase of 4.8% from RMB3.6 billion (US$451.8 million) at June 30, 2006. Cash flow generated from operating activities was approximately RMB344.5 million (US$43.6 million), an increase of 16.2% from the previous quarter's RMB296.5 million (US$37.1 million) and an 18.9% decrease from RMB424.9 million (US$52.5 million) for the third quarter of 2005.
On August 29, 2006, NetEase announced that its board of directors had approved a share repurchase program of up to US$100 million of the Company's outstanding ADSs. As of September 30, 2006, the Company had effected transactions in the open market purchasing approximately one million ADSs for an aggregate purchase amount of approximately US$17.1 million (including transaction costs), representing 17.1% of the total authorized share repurchase amount.
Denny Lee, NetEase's Chief Financial Officer, added, Our new share repurchase program is double the size of our previous program completed in May 2006, which signals the confidence of our board and management in our long-term growth prospects and vision for the future. Our strong balance sheet and healthy cash flow enables us to strategically reinvest in the current business while continuing to repurchase our ADSs, both with the objective of enhancing shareholder value.
The Company separately announced today that it is currently negotiating the purchase of an office building in Guangzhou, PRC with total floor space of approximately 20,000 square meters. The Company has been occupying this building on a rent-free basis since its completion in July 2006, pending the completion of negotiations for such purchase. It is expected that the previously disclosed option held by William Ding to purchase the building from its developer will be terminated.
In addition, in July 2006 the Chinese Ministry of Information Industry (MII) issued a "Notice on Strengthening Management of Foreign Investment in and Operation of Value-added Telecommunication Services Business." The Notice states that domestic telecommunication companies shall not by any means lease, lend, transfer or sell their telecommunication service operation license to any foreign investor and shall not in any manner provide resources, premises, facilities, equipment or other features to any foreign investor that operates a telecommunication service business illegally in China. The Notice requires that, among other things, an operator of value-added telecommunication services must itself own the domain names and trademarks used by such operator. The Notice further requires that domestic companies which have already obtained value-added telecommunication services licenses evaluate their compliance with these requirements and take corrective action in accordance with these requirements. Local telecommunications authorities are required to monitor the process and inspect the results of such examination and self-correction and submit their inspection report to the MII before November 1, 2006. Companies which do not comply with these requirements must rectify their non-compliance within a specified time period or may have their value-added telecommunication service operation licenses revoked. NetEase conducts all of its Internet information services, advertising and wireless value-added services in China via Guangzhou NetEase and other domestic variable interest entities, or VIEs. Guangzhou NetEase submitted its compliance examination report to the Telecommunications Administration of Guangdong Province, or GDTA, and discussed with GDTA officials on its compliance with these requirements in October 2006 and is currently waiting for the feedback of GDTA. NetEase will continue to evaluate, on an on-going basis, its compliance (including the compliance of its VIEs) with these requirements, and it may take such actions as may be required to satisfy these requirements, including but not limited to modifying the current ownership structure in relation to its trademarks and domain names.
To supplement the unaudited consolidated financial statements presented in accordance with United States Generally Accepted Accounting Principles ("GAAP"), NetEase's management uses non-GAAP measures of gross margin, gross profit, operating expenses, net profit and net profit per American Depositary Share, which are adjusted from results based on GAAP to exclude the compensation cost of share-based awards granted to employees under Statement of Financial Accounting Standard 123R, effective from January 1, 2006. The non-GAAP financial measures, by excluding the non-cash, stock-based compensation costs, are provided to enhance the investors?overall understanding of NetEase's current financial performance and prospects for the future. These measures should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for, or superior to, GAAP results.
Reconciliations of NetEase's non-GAAP financial measures to unaudited Consolidated Statements of Operations are set forth at the end of this release.
NetEase's management believes that excluding the share-based compensation expense from its GAAP financial measures of gross margin, gross profit, operating expenses, net profit and net profit per American Depositary Share are useful for itself and investors, because it makes a more meaningful comparison of NetEase抯 current operating results to those periods prior to the adoption of Statement of Financial Accounting Standard 123R and improves readers' understanding of NetEase's performance.
**Note: The conversion of Renminbi (RMB) into U.S. dollars in this release is based on the exchange rate of US$1=RMB7.9040. The percentages stated are calculated based on RMB.**
NetEase's management team will host a conference call at 8:00 pm Eastern Time on November 6, 2006 (Beijing/Hong Kong Time: 9:00 am, November 7, 2006). Chief Executive Officer William Ding, Chief Financial Officer Denny Lee, and Co-Chief Operating Officer Michael Tong will be on the call to discuss the quarterly results and answer questions.
Interested parties may participate in the conference call by dialing 800-967-7184 (international: 719-457-2633), 10-15 minutes prior to the initiation of the call. A replay of the call will be available by dialing 888-203-1112 (international 719-457-0820), and entering passcode 4412175. The replay will be available through December 6, 2006 Eastern Time.
This call is being webcast live and archived, and will be available for 12 months on NetEase's corporate web site at http://corp.netease.com, Investor Info: Earnings Call.
NetEase.com, Inc. is a leading China-based Internet technology company that pioneered the development of applications, services and other technologies for the Internet in China. Our online communities and personalized premium services have established a large and stable user base for the NetEase websites which are operated by our affiliates. For the month of September 2006, the NetEase websites had more than 535 million average daily page views, making us one of the most popular destinations in China and on the World Wide Web. In particular, NetEase provides online game services to Internet users through the licensing or in-house development of massively multi-player online role-playing games, including Fantasy Westward Journey, Westward Journey Online II and Datang.
NetEase also offers online advertising on its websites which enables advertisers to reach our substantial user base. In addition, NetEase has paid listings on its search engine and web directory and classified ads services, as well as an online mall, which provides opportunities for e-commerce and traditional businesses to establish their own storefront on the Internet. NetEase also offers wireless value-added services such as news and information content, matchmaking services, music and photos from the Web which are sent over SMS, MMS, WAP, IVR and Color Ring-back Tone technologies.
Other community services which the NetEase websites offer include instant messaging, online personal ads, matchmaking, alumni clubs, personal home pages and community forums. NetEase is also the largest provider of free e-mail services in China. Furthermore, the NetEase websites provide various channels of content. NetEase aggregates news content on world events, sports, science and technology, and financial markets, as well as entertainment content such as cartoons, games, astrology and jokes, from over one hundred international and domestic content providers.
Third Quarter 2006 Financial Statement