NetEase Reports First Quarter 2019 Unaudited Financial Results

BEIJING, May 15, 2019 /PRNewswire/ -- NetEase, Inc. (NASDAQ: NTES) ("NetEase" or the "Company"), one of China's leading internet and online game services providers, today announced its unaudited financial results for the first quarter ended March 31, 2019.

First Quarter 2019 Financial Highlights

• Net revenues were RMB18,356.2 million (US$2,735.2 million), an increase of 29.5% compared to the first quarter of 2018.
  - Online game services net revenues were RMB11,850.2 million (US$1,765.7 million), an increase of 35.3% compared to the first quarter of 2018.
  - E-commerce net revenues were RMB4,789.3 million (US$713.6 million), an increase of 28.3% compared to the first quarter of 2018.
  - Advertising services net revenues were RMB438.6 million (US$65.3 million), a decrease of 5.1% compared to the first quarter of 2018.
  - Innovative businesses and others net revenues were RMB1,278.1 million (US$190.4 million), an increase of 5.0% compared to the first quarter of 2018.
• Gross profit was RMB8,091.0 million (US$1,205.6 million), an increase of 35.9% compared to the first quarter of 2018.
• Total operating expenses were RMB4,681.6 million (US$697.6 million), a decrease of 1.4% compared to the first quarter of 2018.
• Net income attributable to the Company's shareholders was RMB2,382.1 million (US$354.9 million). Non-GAAP net income attributable to the Company's shareholders was RMB3,017.0 million (US$449.5 million).^[1]
• Diluted earnings per ADS were US$2.75; non-GAAP diluted earnings per ADS were US$3.48.^[1]

First Quarter 2019 and Recent Operational Highlights

• Sustained steady performances of flagship titles, such as Fantasy Westward Journey and New Westward Journey Online series with new expansion packs released.
• Delivered strong performances from top titles including Night Falls: Survival, Onmyoji and Invincible.
• Expanded the registered users of Minecraft in China to more than 200 million.
• Broadened footprint beyond Chinese mainland and deepened global reach:
  - Launched Night Falls: Survival and Cyber Hunter in Japan in April, both of which consecutively topped Japan's iOS download chart for several days.
  - Knives Out remained popular in Japan and topped the iOS grossing chart in March and May.
  - Identity V reached Japan's top 5 iOS grossing chart for the first time in April.
  - Furthered plans to launch Ancient Nocturne in Japan and Korea this year.
• Advanced pipeline with upcoming titles including BuildTopia, Sky, Love is Justice, Fantasy Westward Journey 3D, Xuan Yuan Sword:Dragon upon the Cloud and Ages of Isle.
• Improved efficiency in e-commerce business with operational restructuring, which included revamping warehouse logistics operations, product navigation and pricing.

"We are pleased to begin the year with a strong quarter. Our total net revenues grew robustly by 30% and our net income more than tripled year-over-year," said Mr. William Ding, Chief Executive Officer and Director of NetEase. "Online game services revenues continued to grow steadily with the support of a diversified portfolio and impressive performances from all of our leading titles. In the spirit of Chinese New Year and Lantern Festival, we rolled out a number of updates that celebrated our traditional culture and resonated strongly with our game players. We also made further progress on international fronts, with Night Falls: Survival and Cyber Hunter making strong debuts in Japan. After a few years of hard work, the NetEase brand is now widely recognized in not only MMORPG, but also in a broad range of non-MMORPG categories, both in China and internationally.

"Our heightened emphasis on online games, e-commerce, advertising, online education and music allows us to sharpen our focus on areas where we see the most potential for sustainable, long-term growth. During the first quarter, we made a series of structural optimizations to hone these core growth segments. Thanks to the effective execution of our teams, we are already seeing early success with this strategy, which directly resulted in a considerable increase in our profits in the first quarter. We remain focused on improving efficiency and increasing our return on investment across these primary business lines, where we can continue to create additional value for our stakeholders and partners," Mr. Ding concluded.

First Quarter 2019 Financial Results

Net Revenues

Net revenues for the first quarter of 2019 were RMB18,356.2 million (US$2,735.2 million), compared to RMB19,844.3 million and RMB14,173.0 million for the preceding quarter and the first quarter of 2018, respectively.

Net revenues from online game services were RMB11,850.2 million (US$1,765.7 million) for the first quarter of 2019, compared to RMB11,019.6 million and RMB8,761.2 million for the preceding quarter and the first quarter of 2018, respectively. Mobile games accounted for approximately 72.1% of net revenues from online game services for the first quarter of 2019, compared to 69.7% and 71.8% for the preceding quarter and the first quarter of 2018, respectively.

Net revenues from e-commerce were RMB4,789.3 million (US$713.6 million) for the first quarter of 2019, compared to RMB6,678.7 million and RMB3,732.5 million for the preceding quarter and the first quarter of 2018, respectively. 

Net revenues from advertising services were RMB438.6 million (US$65.3 million) for the first quarter of 2019, compared to RMB760.5 million and RMB462.0 million for the preceding quarter and the first quarter of 2018, respectively. The top performing advertising verticals in the first quarter of 2019 were real estate, automobile and internet services sectors.

Net revenues from innovative businesses and others were RMB1,278.1 million (US$190.4 million) for the first quarter of 2019, compared to RMB1,385.5 million and RMB1,217.3 million for the preceding quarter and the first quarter of 2018, respectively.

Gross Profit/(Loss)

Gross profit for the first quarter of 2019 was RMB8,091.0 million (US$1,205.6 million), compared to RMB7,657.5 million and RMB5,953.6 million for the preceding quarter and the first quarter of 2018, respectively.

The quarter-over-quarter increase in online game services gross profit was primarily due to increased revenues from mobile games such as Night Falls: Survival and Invincible. The year-over-year increase in online game services gross profit was primarily due to increased revenues from mobile games such as Night Falls: Survival, Knives Out and Identity V, as well as certain PC-client games such as Justice.

The quarter-over-quarter increase in e-commerce gross profit was primarily due to seasonality with larger-scale promotions and certain sales discounts in the fourth quarter of 2018. The year-over-year increase in e-commerce gross profit was primarily due to the increased sales volume of Kaola and Yanxuan as well as improved procurement and operation processes.

The quarter-over-quarter decrease in advertising services gross profit was primarily due to seasonality. The year-over-year decrease in advertising services gross profit was primarily due to decreased revenue contribution based on the evolving competitive macro-environment, and increased expenses related to staff and content purchases.

The quarter-over-quarter increase in innovative businesses and others gross loss was primarily due to seasonality with lower revenues generated from Cloud Music and NetEase CC, a live video streaming platform, as well as higher copyright costs. The year-over-year increase in innovative businesses and others gross loss was primarily due to decreased revenue contribution from certain online platform businesses, which have relatively higher gross margins, and partially offset by improving economies of scale of Cloud Music.

Gross Profit/ (Loss) Margin

Gross profit margin for online game services for the first quarter of 2019 was 63.7%, compared to 62.8% and 62.1% for the preceding quarter and the first quarter of 2018, respectively. The quarter-over-quarter and year-over-year increases in gross profit margin were mainly due to increased revenues while certain costs related to the Company's online game services were fixed.

Gross profit margin for e-commerce for the first quarter of 2019 was 10.2%, compared to 4.5% and 9.5% for the preceding quarter and the first quarter of 2018, respectively. The quarter-over-quarter increase in gross profit margin was primarily due to seasonality with larger-scale promotions and certain sales discounts in the fourth quarter of 2018. The year-over-year increase in e-commerce gross profit margin was primarily due to increased sales volume of Kaola and Yanxuan as well as improved procurement and operation processes.

Gross profit margin for advertising services for the first quarter of 2019 was 49.5%, compared to 66.3% and 59.0% for the preceding quarter and the first quarter of 2018, respectively. The quarter-over-quarter decrease in advertising services gross profit margin was primarily due to seasonality. The year-over-year decrease in advertising services gross profit margin was primarily due to decreased revenue contribution based on the evolving competitive macro-environment, and increased expenses related to staff and content purchases.

Gross loss margin for innovative businesses and others for the first quarter of 2019 was 13.1%, compared to 5.2% and 9.9% for the preceding quarter and the first quarter of 2018, respectively. The quarter-over-quarter increase in gross loss margin was primarily due to seasonality with lower revenues generated from Cloud Music and NetEase CC, as well as higher copyright costs. The year-over-year increase in gross loss margin was primarily due to decreased revenue contribution from certain online platform businesses, which have relatively higher gross profit margins, and partially offset by improving economies of scale of Cloud Music.

Operating Expenses

Total operating expenses for the first quarter of 2019 were RMB4,681.6 million (US$697.6 million), compared to RMB5,412.3 million and RMB4,746.6 million for the preceding quarter and the first quarter of 2018, respectively. The quarter-over-quarter decrease in operating expenses was mainly due to decreased marketing expenditures related to online game services and e-commerce, as well as decreased shipping and handling costs, and partially offset by increased staff related costs. The year-over-year decrease in operating expenses was mainly due to decreased marketing expenditures related to online game services, partially offset by increased staff related costs. Shipping and handling costs included in selling and marketing expenses for the first quarter of 2019 were RMB404.6 million (US$60.3 million), compared to RMB572.5 million and RMB325.8 million for the preceding quarter and the first quarter of 2018, respectively.  

Income Taxes

The Company recorded a net income tax charge of RMB1,269.0 million (US$189.1 million) for the first quarter of 2019, compared to RMB919.7 million and RMB282.7 million for the preceding quarter and the first quarter of 2018, respectively. The effective tax rate for the first quarter of 2019 was 34.0%, compared to 34.0% and 26.0% for the preceding quarter and the first quarter of 2018, respectively.

Net Income After Tax

Net income attributable to the Company's shareholders for the first quarter of 2019 totaled RMB2,382.1 million (US$354.9 million), compared to RMB1,697.7 million and RMB751.9 million for the preceding quarter and the first quarter of 2018, respectively. Non-GAAP net income attributable to the Company's shareholders for the first quarter of 2019 totaled RMB3,017.0 million (US$449.5 million), compared to RMB2,359.6 million and RMB1,337.2 million for the preceding quarter and the first quarter of 2018, respectively.

During the first quarter of 2019, the Company had a net foreign exchange loss of RMB45.4 million (US$6.8 million), compared to net foreign exchange losses of RMB27.1 million and RMB375.1 million for the preceding quarter and the first quarter of 2018, respectively. The changes in foreign exchange losses were mainly due to unrealized exchange gains and losses arising from the Company's U.S. dollar-denominated bank deposits and short-term loan balances as the exchange rate of the U.S. dollar against the RMB fluctuated over the periods, as well as certain foreign currency transactions.

NetEase reported basic and diluted earnings per ADS of US$2.77 and US$2.75, respectively, for the first quarter of 2019. The Company reported basic and diluted earnings per ADS of US$1.98 and US$1.96, respectively, for the preceding quarter, and basic and diluted earnings per ADS of US$0.85 each for the first quarter of 2018. Non-GAAP basic and diluted earnings per ADS were US$3.51 and US$3.48, respectively, for the first quarter of 2019, compared to non-GAAP basic and diluted earnings per ADS of US$2.75 and US$2.73, respectively, for the preceding quarter, and non-GAAP basic and diluted earnings per ADS of US$1.52 and US$1.51, respectively, for the first quarter of 2018.       

Quarterly Dividend

The board of directors has approved a dividend of US$0.69 per ADS for the first quarter of 2019, which is expected to be paid on June 7, 2019 to shareholders of record as of the close of business on May 31, 2019.

NetEase paid a dividend of US$0.48 per ADS for the fourth quarter of 2018 on March 15, 2019.

Under the Company's quarterly dividend policy announced on May 13, 2014, quarterly dividends will be set at an amount equivalent to approximately 25% of the Company's anticipated net income after tax in each fiscal quarter. The determination to make dividend distributions and the amount of such distributions in any particular quarter will be made at the discretion of the board of directors and will be based upon the Company's operations and earnings, cash flow, financial condition and other relevant factors.

Other Information

As of March 31, 2019, the Company's total cash and cash equivalents, current and non-current time deposits and short-term investments balance totaled RMB51,853.1 million (US$7,726.4 million), compared to RMB50,064.3 million as of December 31, 2018. Cash flow generated from operating activities was RMB3,386.6 million (US$504.6 million) for the first quarter of 2019, compared to RMB5,935.4 million and RMB1,905.0 million for the preceding quarter and the first quarter of 2018, respectively.

Share Repurchase Program

On November 15, 2017, the Company announced that its board of directors had approved a share repurchase program of up to US$1.0 billion of the Company's outstanding ADSs for a period not to exceed 12 months beginning on November 16, 2017. On June 11, 2018, the Company announced that its board of directors approved an amendment to expand the authorized repurchase amount to US$2.0 billion. As of November 15, 2018, the last day of such program, the Company had repurchased approximately 4.6 million ADSs for approximately US$1,178.5 million under this program.

On November 14, 2018, the Company also announced that its board of directors had approved a new share repurchase program of up to US$1.0 billion of the Company's outstanding ADSs for a period not to exceed 12 months beginning on November 16, 2018. As of March 31, 2019, no ADSs had been repurchased under this program.

Under the terms of the current approved program, NetEase may repurchase its issued and outstanding ADSs in open-market transactions on the NASDAQ Global Select Market. The timing and dollar amount of repurchase transactions will be subject to the Securities and Exchange Commission (SEC) Rule 10b-18 requirements. It is also expected that such repurchases will be effected pursuant to a plan in conformity with SEC Rule 10b5-1. The extent to which NetEase repurchases its ADSs will depend upon a variety of factors, including market conditions, regulatory requirements and other corporate considerations, as determined by NetEase's management team. The repurchase program may be suspended or discontinued at any time.

** The United States dollar (US$) amounts disclosed in this press release are presented solely for the convenience of the reader. Translations of amounts from RMB into United States dollars for the convenience of the reader were calculated at the noon buying rate of US$1.00 = RMB6.7112 on March 29, 2019 as set forth in the H.10 statistical release of the U.S. Federal Reserve Board. No representation is made that the RMB amounts could have been, or could be, converted into US$ at that rate on March 29, 2019, or at any other certain date. The percentages stated are calculated based on RMB.

Change in Segment Reporting

Effective as of December 31, 2018, the Company renamed its "e-mail and others" segment to "innovative businesses and others" to better articulate the businesses included in this segment, there's no change to the business mix included in this segment.  The Company now reports four reporting segments: online game services, e-commerce, advertising services and innovative businesses and others, and retrospectively revised prior period segment information to conform to current period presentation.

Impact of the Recently Adopted Major Accounting Pronouncement

In February 2016, the FASB issued ASU 2016-02 "Leases" as amended, which generally requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet and to provide enhanced disclosures surrounding the amount, timing and uncertainty of cash flows arising from leasing arrangements. The Company adopted the new standard effective January 1, 2019 on a modified retrospective basis and did not restate comparative periods. The Company recognized approximately RMB861.5 million as total right-of-use assets as well as total lease liabilities for the operating leases on its consolidated balance sheet as of January 1, 2019. The Company recognized RMB747.4 million and RMB763.2 million as total right-of-use assets and total lease liabilities, respectively, for the operating leases on its consolidated balance sheet as of March 31, 2019. Right-of-use assets are included in other long-term assets, and lease liabilities are included in accrual liabilities and other payables and other long-term payables respectively based on payment terms on the consolidated balance sheet. Other than the foregoing, the Company does not expect the new standard to have a material impact on the net assets of the Company's consolidated financial statements.

Conference Call

NetEase's management team will host a teleconference call with simultaneous webcast at 7:30 p.m. Eastern Time on Wednesday, May 15, 2019 (Beijing/Hong Kong Time: 7:30 a.m., Thursday, May 16, 2019). NetEase's management will be on the call to discuss the quarterly results and answer questions.

Interested parties may participate in the conference call by dialing 1-929-477-0448, 10-15 minutes prior to the initiation of the call. A replay of the call will be available by dialing 1-719-457-0820 and entering passcode 7691549#. The replay will be available through May 29, 2019. This call will be webcast live and the replay will be available for 12 months. Both will be available on NetEase's Investor Relations website at http://ir.netease.com.  

About NetEase, Inc.

NetEase, Inc. (NASDAQ: NTES) is a leading internet technology company in China. Dedicated to providing online services centered around content, community, communication and commerce, NetEase develops and operates some of China's most popular PC-client and mobile games, e-commerce businesses and advertising services, as well as a variety of other innovative businesses. In partnership with Blizzard Entertainment, Mojang AB (a Microsoft subsidiary) and other global game developers, NetEase also operates some of the most popular international online games in China. For more information, please visit: http://ir.netease.com/.

Forward Looking Statements

This press release contains statements of a forward-looking nature. These statements are made under the "safe harbor" provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terminology such as "will," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates" and similar statements. The accuracy of these statements may be impacted by a number of business risks and uncertainties that could cause actual results to differ materially from those projected or anticipated, including risks related to: the risk that the online game market will not continue to grow or that NetEase will not be able to maintain its leading position in that market, which could occur if, for example, its new online games or expansion packs and other improvements to its existing games do not become as popular as management anticipates; the ability of NetEase to successfully expand its mobile internet offerings; the ability of NetEase to effectively market its games and other services and achieve a positive return on its marketing expenditures; the risk that NetEase's affiliates will not be able to continue operating Minecraft or other games licensed by it for a period of time or permanently due to possible governmental actions or the risk that such games will not be popular with game players in China; the risk that changes in Chinese government regulation of the online game market and the market for NetEase's e-commerce businesses may limit future growth of NetEase's revenues or cause revenues to decline; competition in the online advertising business and the risk that investments by NetEase in its content and services may not increase the appeal of the NetEase websites among internet users or result in increased advertising revenues; the risk that NetEase may not be able to continuously develop new and creative online services, including its ability to maintain and enhance the popularity of its online game, e-commerce and other innovative businesses; the risk that NetEase will not be able to control its expenses in future periods; competition in NetEase's existing and potential markets; governmental uncertainties (including possible changes in the effective tax rates applicable to NetEase and its subsidiaries and affiliates and the ability of NetEase to receive and maintain approvals of the preferential tax treatments); the risk that fluctuations in the value of the Renminbi with respect to other currencies could adversely affect NetEase's business and financial results; and other risks outlined in NetEase's filings with the Securities and Exchange Commission. NetEase does not undertake any obligation to update this forward-looking information, except as required under the applicable law.

Non-GAAP Financial Measures

NetEase considers and uses non-GAAP financial measures, such as non-GAAP net income attributable to the Company's shareholders and non-GAAP basic and diluted earnings per ADS, as supplemental metrics in reviewing and assessing its operating performance and formulating its business plan. The presentation of non-GAAP financial measures is not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").

NetEase defines non-GAAP net income attributable to the Company's shareholders as net income attributable to the Company's shareholders excluding share-based compensation expenses. Non-GAAP net income attributable to the Company's shareholders enables NetEase's management to assess its operating results without considering the impact of share-based compensation expenses, which are non-cash charges. NetEase believes that these non-GAAP financial measures provide useful information to investors in understanding and evaluating the Company's current operating performance and future prospects in the same manner as management does, if they so choose. NetEase also believes that the use of this non-GAAP financial measure facilitates investors' assessment of its operating performance.

Non-GAAP financial measures are not defined under U.S. GAAP and are not presented in accordance with U.S. GAAP. Non-GAAP financial measures have limitations as analytical tools. One of the key limitations of using non-GAAP net income attributable to the Company's shareholders is that it does not reflect all items of expense that affect our operations. Share-based compensation expenses have been and may continue to be incurred in our business and are not reflected in the presentation of non-GAAP net income attributable to the Company's shareholders. In addition, the non-GAAP financial measures NetEase uses may differ from the non-GAAP measures used by other companies, including peer companies, and therefore their comparability may be limited.

NetEase compensates for these limitations by reconciling non-GAAP net income attributable to the Company's shareholders to the nearest U.S. GAAP performance measure, all of which should be considered when evaluating the Company's performance. See "Reconciliation of GAAP and Non-GAAP Results" at the end of this press release. NetEase encourages you to review its financial information in its entirety and not rely on a single financial measure. 

Contact for Media and Investors:

Margaret Shi
NetEase, Inc.
ir@service.netease.com 
Tel: (+86) 571-8985-3378

Brandi Piacente
Investor Relations
brandi@corp.netease.com
Tel: (+1) 212-481-2050

NETEASE, INC.

NOTES TO UNAUDITED FINANCIAL INFORMATION

Note 1: The conversion of Renminbi (RMB) into United States dollars (USD) is based on the noon buying rate of USD1.00 = RMB6.7112 on the last trading day of March 2019 (March 29, 2019) as set forth in the H.10 statistical release of the U.S. Federal Reserve Board.

Note 2: Share-based compensation cost reported in the Company's unaudited condensed consolidated statements of comprehensive income is set out as follows in RMB and USD (in thousands):

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SOURCE NetEase, Inc.