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NetEase.com Reports Fourth Quarter and Fiscal Year 2006 Unaudited Financial Results

Beijing - February 27, 2007
2007/02/27 09:44:35

(Beijing -February 27, 2007) -NetEase.com, Inc. (NASDAQ: NTES), one of China's leading Internet and online game services providers, today announced its unaudited financial results for the fourth quarter and fiscal year ended December 31, 2006.

Highlights for the Fourth Quarter 2006

. Online game revenues were better than the Company's guidance and decreased 3.5% to RMB451.6 million (US$57.9 million) compared to the preceding quarter;

. U.S. GAAP net profit for the quarter increased 1.7% to RMB320.2 million (US$41.0 million), equivalent to US$0.32 (basic) and US$0.30 (diluted) earnings per American Depositary Share (ADS) compared to the preceding quarter;

. Fantasy Westward Journey and Westward Journey Online II reported record peak concurrent user numbers of approximately 1,335,000 and 603,000, respectively;

. Westward Journey III, which is the upgraded version of Westward Journey Online II, has come to the final stage of its development phase, and is scheduled to launch its internal close beta testing in the second quarter of 2007;

. The Phase II unlimited open beta testing for the Company's next generation online 3D game, Tianxia II, will be launched on March 1, 2007;

. The Company's new proprietary search engine entered beta testing in December 2006 and is expected to enter open beta testing during the second quarter of 2007; and 

. As of December 31, 2006, approximately 3.6 million of the Company's issued and outstanding ADSs had been repurchased for an aggregate purchase consideration of US$60.1 million (including transaction costs) pursuant to the share repurchase program announced on August 29, 2006.

Highlights for Fiscal Year 2006

. Total revenues grew 30.9% year-over-year to RMB2,217.2 million (US$284.1 million);

. Online game revenues grew 34.5% year-over-year to RMB1,856.1 million (US$237.8 million); 

. U.S. GAAP net profit for the year grew 33.3% to RMB1,242.8 million (US$159.2 million), equivalent to US$1.23 (basic) and US$1.14 (diluted) earnings per ADS, compared to RMB932.0 million (US$115.5 million, equivalent to US$0.90 (basic) and US$0.82 (diluted) per ADS in fiscal 2005 and

. Total cash and time deposit balance was RMB3.9 billion (US$504.6 million) at December 31, 2006, compared to RMB3.4 billion (US$418.5 million) at December 31, 2005.

William Ding, Chief Executive Officer and Director of NetEase stated, "Overall, we were satisfied with the results of the fourth quarter, and pleased with the strong growth rates in total revenues, online game revenues and net profit achieved for fiscal year 2006. We also made significant progress during the year with regard to our games and game upgrades under development. Tianxia II is on schedule for open beta testing beginning March 1, which we expect will be followed closely by its commercial launch. The testing process for Tianxia II has proceeded smoothly and without interruption, and we are confident in the market potential and player appeal of this next generation online 3D game. During the fourth quarter in 2006, we also made substantial progress with Westward Journey III which will enter internal closed beta testing during the second quarter of this year followed by open beta testing in the third quarter. In addition, the latest expansion pack for Fantasy Westward Journey was released late last month."

"We are equally enthusiastic about our portal strategy in 2006," Mr. Ding continued. "Our online communities on our portals, 30-plus million active email users, number one free email ranking in China, and growing blog community are all highly valuable assets."

Fourth Quarter Financial Results

Total revenues for the fourth quarter ended December 31, 2006 were RMB540.3 million (US$69.2 million) compared with RMB571.9 million (US$72.4 million) for the third quarter of 2006, representing a decrease of 5.5%. Total revenues increased 10.9% from RMB487.3 million (US$60.4 million) for the fourth quarter of 2005.

Revenues from online games were RMB451.6 million (US$57.9 million) for the fourth quarter of 2006, representing a decrease of 3.5% from RMB467.9 million (US$59.2 million) for the third quarter of 2006 and an increase of 12.6% over RMB400.9 million (US$49.7 million) for the fourth quarter of 2005. 

Revenues from advertising services were RMB72.1 million (US$9.2 million) for the fourth quarter of 2006, representing a decrease of 13.5% from RMB83.4 million (US$10.5 million) for the third quarter of 2006 and an increase of 4.3% over RMB69.1 million (US$8.6 million) for the fourth quarter of 2005. 

Revenues from wireless value-added services and others were RMB16.6 million (US$2.1 million) for the fourth quarter of 2006, representing a decrease of 19.4% from RMB20.6 million (US$2.6 million) for the third quarter of 2006 and a decrease of 3.5% from RMB17.2 million (US$2.1 million) for the fourth quarter of 2005.

GAAP gross profit for the fourth quarter of 2006 was RMB456.7 million (US$58.5 million), compared to RMB448.1 million (US$56.7 million) for the third quarter of 2006 and RMB386.2 million (US$47.9 million) for the same period last year. The Company's non-GAAP gross profit in the fourth quarter was RMB460.4 million (US$59.0 million), representing an increase of 1.8% over the previous quarter's non-GAAP gross profit of RMB452.3 million (US$57.2 million), and an increase of 19.2% over non-GAAP gross profit of RMB386.2 million (US$47.9 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 fourth quarter of 2006 was 82.4%, compared to 81.7% for the third quarter of 2006 and 82.6% for the same period last year. Total non-GAAP gross margin for the fourth quarter was 83.1% compared with non-GAAP gross margin of 82.5% for the preceding quarter and 82.6% for the same period last year. The increase was primarily attributable to the increase in the gross margin for online games for the reason explained below. 

GAAP gross margin for the online game business for the fourth quarter of 2006 was 90.3%, compared to 89.4% for the third quarter of 2006 and 89.4% for the same period last year. Non-GAAP gross margin for the online game business for the fourth quarter of 2006 was 90.6% compared with non-GAAP gross margin of 89.7% for the preceding quarter and 89.4% for the fourth quarter of 2005. The increase was primarily due to a one-time business tax refund of RMB35.5 million (US$4.5 million) which was approved by the relevant local tax bureau in the fourth quarter of 2006.

GAAP gross margin for the advertising business for the fourth quarter of 2006 was 50.5%, compared to 56.1% for the third quarter of 2006 and 62.9% for the same period last year. Non-GAAP gross margin for the online advertising business for the fourth quarter of 2006 was 53.1% compared to non-GAAP gross margin of 58.9% for the preceding quarter and 62.9% for the fourth quarter of 2005. The quarter-over-quarter decrease was primarily due to the seasonal decline in advertising services revenue in the fourth quarter while costs remained relatively stable. The year-over-year decrease was primarily due to the increase in salaries and other benefits paid to content editors and the increased costs associated with the Company's online advertising business so as to enhance the content and attractiveness of the NetEase websites.

GAAP gross loss margin for the wireless value-added services and others business for the fourth quarter of 2006 was 18.9%, compared to gross profit margin of 3.4% for the third quarter of 2006 and gross loss margin of 1.3% for the same period last year. Non-GAAP gross loss margin for the wireless value-added services and others business for the fourth quarter of 2006 was 14.6% compared with non-GAAP gross profit margin of 7.6% for the preceding quarter and gross loss margin of 1.3% for the fourth quarter of 2005. The decline in gross margin was mainly due to the full quarter impact of the implementation of a new requirement from mobile operators that customers provide double confirmations to order SMS monthly subscriptions and the further strengthening of billing policies and procedures of certain provincial mobile network operators. The year-over-year decrease was primarily due to increased server depreciation costs associated with the Company's free email services and redundancy costs paid to staff in rationalizing the wireless value-added services business.

Total GAAP operating expenses for the fourth quarter of 2006 were RMB123.9 million (US$15.9 million), compared to RMB131.5 million (US$16.6 million) for the third quarter of 2006 and RMB94.9 million (US$11.8 million) for the same period last year. Total non-GAAP operating expenses for the fourth quarter of 2006 were RMB104.5 million (US$13.4 million), compared with RMB109.7 million (US$13.9 million) for the preceding quarter and RMB94.9 million (US$11.8 million) for the same period last year. The decrease in non-GAAP operating expenses in comparison to the preceding quarter was primarily due to lower marketing expenses resulting from the completion of a substantial marketing campaign launched in the third quarter. The decrease was partially off-set by a higher provision for doubtful debts of RMB1.6 million (US$0.2 million). The year-over-year increase 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, and increased research and development expenses associated with increased staffing for the enhancement of existing products and for the development of new products.

As a result of the translation of foreign currency denominated assets and liabilities into Renminbi in accordance with applicable accounting standards, the Company recorded a foreign exchange gain of RMB1.3 million (US$172,000) in the fourth quarter of 2006, compared to a foreign exchange gain of RMB219,000 (US$28,000) in the preceding quarter. The Company recorded RMB1.9 million (US$0.2 million) in foreign exchange loss in the fourth quarter of 2005.

GAAP net profit for the fourth quarter totaled RMB320.2 million (US$41.0 million), compared to RMB314.8 million (US$39.8 million) for the third quarter of 2006 and RMB276.7 million (US$34.3 million) for the same period last year. Non-GAAP net profit for the fourth quarter totaled RMB343.3 million (US$44.0 million), a 0.7% increase over the previous quarter’s non-GAAP net profit of RMB340.8 million (US$43.1 million) and a 24.1% increase over non-GAAP net profit of RMB276.7 million (US$34.3 million) for the fourth quarter of 2005. NetEase reported GAAP basic and diluted earnings per ADS of US$0.32 and US$0.30 for the fourth quarter of 2006, respectively, which includes the impact of approximately US$3.0 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$0.31 and US$0.29 for the third quarter of 2006, and US$0.27 and US$0.25 for the fourth quarter of 2005, respectively.

Fiscal Year 2006 Financial Results

Total revenues for fiscal year 2006 totaled RMB2,217.2 million (US$284.1 million), a 30.9% increase over fiscal 2005 revenues of RMB1,694.4 million (US$210.0 million). Online game revenues for fiscal 2006 totaled RMB1,856.1 million (US$237.8 million), up 34.5% from RMB1,379.5 million (US$170.9 million) in fiscal 2005, which was primarily attributable to the continued growth in the popularity of Fantasy Westward Journey. Advertising revenues grew 18.5%, due primarily to an overall expansion of China’s robust online advertising market, whereas wireless value-added services and others revenues grew 2.3% year-over-year.

Gross margin was 82.4% in fiscal 2006, remained relatively stable in comparison to 82.9% in fiscal 2005. Non-GAAP gross margin was 83.2% in fiscal 2006, up from 82.9% in fiscal 2005.

GAAP net profit for fiscal 2006 was RMB1,242.8 million (US$159.2 million) or basic and diluted earnings per ADS of US$1.23 and US$1.14, respectively, compared to RMB932.0 million (US$115.5 million) or basic and diluted earnings per ADS of US$0.90 and US$0.82, respectively, for fiscal 2005. Non-GAAP net profit in fiscal 2006 was RMB1,344.1 million (US$172.2 million) or basic and diluted earnings per ADS of US$1.23 and US$1.14, respectively, compared to RMB932.0 million (US$115.5 million) or basic and diluted earnings per ADS of US$0.90 and US$0.82, respectively, for fiscal 2005.

Other Information

As of December 31, 2006, the Company's total cash and time deposit balance was RMB3.9 billion (US$504.6 million), compared to RMB3.8 billion (US$478.7 million) and RMB3.4 billion (US$418.5 million) as of September 30, 2006 and December 31, 2005, respectively. Cash flow generated from operating activities was approximately RMB531.5 million (US$68.1 million), compared to RMB344.5 million (US$43.6 million) for the preceding quarter and RMB220.3 million (US$27.3 million) for the fourth 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 December 31, 2006, the Company had effected transactions in the open market purchasing approximately 3.6 million ADSs for an aggregate purchase amount of approximately US$60.1 million (including transaction costs), representing 60.1% of the total authorized share repurchase amount. The share repurchase program will end on March 4, 2007.

Non-GAAP Disclosure
To supplement the unaudited consolidated financial statements presented in accordance with the U.S. GAAP , NetEase's management uses non-GAAP measures of gross margin, gross profit, operating expenses, net profit and net profit per ADS, 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 Condensed 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’s 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=RMB7.8041. The percentages stated are calculated based on RMB.**

Notes to Unaudited Financial Information

The unaudited financial information disclosed in this release is preliminary. The audit of the financial statements and related notes to be included in our annual report on Form 20-F for the year ended December 31, 2006 is still in progress. In addition, because an audit of our internal controls over financial reporting in connection with section 404 of the Sarbanes-Oxley Act of 2002 has not yet been completed, we make no representation as to the effectiveness of those internal controls as of the end of fiscal 2006.

Adjustments to the financial statements may be identified when the audit work is completed, which could result in significant differences between our audited financial statements and this preliminary unaudited financial information.

Conference Call

NetEase's management team will host a conference call at 9:00 pm Eastern Time on February 26, 2007 (Beijing/Hong Kong Time: 10:00 am, February 27, 2007). 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 800-289-0485 (international: 913-981-5518), 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 6425478. The replay will be available through March 12, 2007 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.

About NetEase.com,Inc. 

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 December 2006, the NetEase websites had more than 710 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.

Fourth Quarter and Fiscal year 2006 Financial Statement





Contact:

Grace Zhao
NetEase.com, Inc.
IR@service.netease.com
8610-8518-0163x8208