NetEase.com Reports Fourth Quarter and Fiscal Year 2010 Unaudited Financial Results

BEIJING, Feb. 24, 2011 /PRNewswire-Asia/ -- 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, 2010.

William Ding, Chief Executive Officer and Director of NetEase, stated, "We ended 2010 with strong fourth quarter results in both online games and advertising services, delivering solid sequential and year-over-year revenue growth.  Fourth quarter online game revenues increased 13% quarter-over-quarter and 31% year-over-year, driven primarily by the Wrath of the Lich King(TM) expansion pack launched on August 31, 2010 for World of Warcraft(R), a game licensed from Blizzard Entertainment, and the outstanding performances from our fastest growing self-developed games, Tianxia II, Heroes of Tang Dynasty and Westward Journey Online II. The combination of the first full year of operation of World of Warcraft and the impact of successful large scale promotions for Fantasy Westward Journey, Tianxia II and Westward Journey Online II, as well as the launch of Heroes of Tang Dynasty in April 2010 and its first expansion pack in August 2010, drove annual online game services revenue growth up by 47% for 2010. During the fourth quarter of 2010, we were pleased to see that revenue from Westward Journey Online II reached a new high.

"Game expansion and pipeline development is proceeding well in the new year beginning with the release of the tenth expansion pack for Fantasy Westward Journey in January 2011. The latest expansion features a new story line and setting and adds new characters that enhance the game's visual appeal and challenge for players. We have on schedule numerous other expansion packs in process for release in 2011. These will include updates for Tianxia II, Heroes of Tang Dynasty, Westward Journey Online II and III, Legend of Westward Journey, Ghost and Westward Journey: Genesis, among others. Overall, our top strategic priorities in online games this year include accelerating our product development time-to-market and further enhancing our highly competitive and innovative technology and commercial appeal.

"In advertising services, revenue growth was consistently strong throughout 2010, underscored by quarter-over-quarter and year-over-year increases of 44% and 27% for the fourth quarter, respectively, and an increase of 65% for the full year," Mr. Ding continued. "Our improved internal organizational structure supported excellent sales execution and customer relationship development in 2010.  We integrated a number of new products, services and channels into our portal that have drawn a substantial number of new users and improved user traffic statistics. In 2010, our large investments in promotional activities through sponsorship and support of major Chinese national events and programs paid off well, which we believe successfully raised our portal's standing and delivered outstanding value-for-money advertising services to our advertisers."

Mr. Ding concluded, "In conjunction with our online games strategy for 2011, for our portal business, we will focus on new product applications in mobile phones and will explore new advertising formats and marketing models to attract premier advertisers and stimulate ad spending. We are working to achieve healthy growth across our business in 2011 in line with anticipated market expansion in order to maintain our leading position in China's burgeoning Internet community."

Fourth Quarter 2010 Financial Results

Revenues

Total revenues for the fourth quarter of 2010 were RMB1.7 billion (US$254.5 million), compared to RMB1.4 billion and RMB1.3 billion for the preceding quarter and the fourth quarter of 2009, respectively.

Revenues from online games were RMB1.4 billion (US$215.5 million) for the fourth quarter of 2010, compared to RMB1.3 billion and RMB1.1 billion for the preceding quarter and the fourth quarter of 2009, respectively.

Revenues from advertising services were RMB233.7 million (US$35.4 million) for the fourth quarter of 2010, compared to RMB162.0 million and RMB183.7 million for the preceding quarter and the fourth quarter of 2009, respectively.

Revenues from wireless value-added services and others ("WVAS and others") were RMB23.3 million (US$3.5 million) for the fourth quarter of 2010, compared to RMB20.9 million and RMB18.5 million for the preceding quarter and the fourth quarter of 2009, respectively.

Gross Profit

Gross profit for the fourth quarter of 2010 was RMB1.1 billion (US$168.7 million), compared to RMB952.0 million and RMB838.4 million for the preceding quarter and the fourth quarter of 2009, respectively. The quarter-over-quarter and year-over-year increases in gross profit were primarily attributable to increased revenues from both the online games and advertising businesses, partially offset by increased cost of revenues, such as royalties and consultancy fees related to World of Warcraft operations and increased staff-related costs, resulting from increased headcount in the current quarter.

The quarter-over-quarter and year-over-year increases in game revenue were primarily attributable to World of Warcraft, Tianxia II and Heroes of Tang Dynasty, as a result of the launch of expansion packs for these games, and Westward Journey Online II, which benefited from large scale promotional activities in the third quarter and improved game designs implemented in the fourth quarter of 2010. In addition, Fantasy Westward Journey contributed to the year-over-year revenue increase, resulting mainly from increased promotional activities held in the second quarter of 2010.

The quarter-over-quarter and year-over-year increases in advertising services revenue were attributable to a combination of factors, including primarily increased advertising related to the 2010 Asian Games and improved portal and search traffic on the NetEase websites. In addition, seasonality contributed to the quarter-over-quarter increase in advertising services revenue in the fourth quarter of 2010.

Gross Profit (Loss) Margin

Gross profit margin for the online game business for the fourth quarter of 2010 was 71.8%, compared to 71.8% and 70.5% for the preceding quarter and the fourth quarter of 2009, respectively.

Gross profit margin for the advertising business for the fourth quarter of 2010 was 53.5%, compared to 51.5% and 56.6% for the preceding quarter and the fourth quarter of 2009, respectively.  The quarter-over-quarter gross profit margin remained relatively stable.   The year-over-year decrease in gross profit margin was primarily due to increased staff-related costs and content costs in the fourth quarter of 2010.

Gross loss margin for the WVAS and others business for the fourth quarter of 2010 was 19.7%, compared to 42.4% and 40.4% for the preceding quarter and the fourth quarter of 2009, respectively.

Operating Expenses

Total operating expenses for the fourth quarter of 2010 were RMB320.7 million (US$48.6 million), compared to RMB365.0 million and RMB231.3 million for the preceding quarter and the fourth quarter of 2009, respectively. The quarter-over-quarter decrease in operating expenses was primarily due to reduced selling and marketing expenses, partially offset by a change in bad debt provision. The decrease in selling and marketing expenses was primarily due to the non-recurrence of marketing promotional expenses associated with the celebration of the first anniversary of Tianxia II in the preceding quarter.  The year-over-year increase in operating expenses was mainly due to increased selling and marketing expenses, mainly comprising the amortization of certain contractual costs for product spokespersons related to Fantasy Westward Journey, Heroes of Tang Dynasty and Tianxia II launched in the third quarter of 2010. In addition, increases in staff-related costs in the current quarter, resulting from headcount increases in the areas of general and administration and research and development, also contributed to the year-over-year increase in operating expenses.

Net Profit

Net profit for the fourth quarter of 2010 totaled RMB712.5 million (US$108.0 million), compared to RMB585.3 million and RMB571.8 million for the preceding quarter and the fourth quarter of 2009, respectively. During the fourth quarter of 2010, the Company reported a net foreign exchange loss of RMB36.4 million (US$5.5 million) under Other, net, compared to a net foreign exchange gain of RMB54.3 million for the preceding quarter, and a net foreign exchange loss of RMB15.3 million for the fourth quarter of 2009. The quarter-over-quarter and year-over-year foreign exchange gains/losses were mainly due to the translation gains/losses arising from the Company's Euro-denominated bank deposit balances as of December 31, 2010 as the exchange rate of the Euro against the RMB fluctuated over the periods. NetEase reported basic and diluted earnings per American depositary share ("ADS") of US$0.83 each for the fourth quarter of 2010. The Company reported basic and diluted earnings per ADS of US$0.68 each and US$0.67 each for the preceding quarter and the fourth quarter of 2009, respectively.

Income Taxes

The Company recorded a net income tax charge of RMB83.2 million (US$12.6 million) for the fourth quarter of 2010, compared to RMB91.3 million and RMB71.2 million for the preceding quarter and for the fourth quarter of 2009, respectively.  The effective tax rate for the fourth quarter of 2010 was 10.3% as compared to 13.7% for the preceding quarter and 11.3% for the fourth quarter of 2009.  The quarter-over-quarter effective tax rate decreased mainly due to a reversal of tax provision for the first three quarters of 2010 by a certain subsidiary of the Company when it became tax-exempted for fiscal year 2010 during the fourth quarter of 2010.  The year-over-year effective tax rate remained relatively stable.

Fiscal Year 2010 Financial Results

Revenues

Total revenues for fiscal year 2010 were RMB5.7 billion (US$857.5 million), compared to RMB3.8 billion for the preceding fiscal year. Revenues from online games were RMB4.9 billion (US$749.2 million) for fiscal year 2010, compared to RMB3.4 billion for the preceding fiscal year. Revenues from advertising services were RMB633.2 million (US$95.9 million) for fiscal year 2010, compared to RMB383.6 million for the preceding fiscal year.  Revenues from WVAS and others were RMB82.1 million (US$12.4 million) for fiscal year 2010, compared to RMB71.2 million for the preceding fiscal year.

Gross Profit

Gross profit for fiscal year 2010 was RMB3.7 billion (US$561.9 million), compared to RMB2.8 billion for the preceding fiscal year. The increase in gross profit for fiscal year 2010 was primarily driven by increased revenue partially offset by increased cost of revenue from the online game and advertising service businesses.

The significant increase in online game revenue in 2010 was principally attributable to the full year operation of World of Warcraft as well as the Company's self-developed flagship games such as Tianxia II, Heroes of Tang Dynasty, Westward Journey Online II and Fantasy Westward Journey for the reasons explained above.  Furthermore, the Company also recognized approximately RMB42.1 million (US$6.4 million) of revenue from dormant accounts of online games for fiscal year 2010, as compared with RMB101.6 million in 2009.  The increase in revenue was partially offset by increased cost of revenues, principally due to royalties, technical consultancy service fees, custody fees and depreciation charges related to servers and amortization of license fees associated with the operation of World of Warcraft, as well as increased staff-related costs, mainly driven by increases in headcount and performance-based compensation relating to the operation of the Company's self-developed games.

The increase in advertising services revenue in 2010 was attributable to a combination of factors, including primarily improved Chinese economy, increased advertising related to major events such as the 2010 FIFA World Cup, Expo 2010 in Shanghai, the 2010 Asian Games and improved portal and search traffic on the NetEase websites, partially offset by increased staff-related costs resulting from increased headcount and performance-based compensation, as well as increased content costs related to the World Cup, Asian Games and the Shanghai Expo in 2010.

Operating Expenses

Total operating expenses for fiscal year 2010 were RMB1.2 billion (US$176.4 million), compared to RMB761.1 million for the preceding fiscal year. The increase in operating expenses in 2010 was primarily due to increased sales and marketing expenses comprising marketing and promotional activities for Fantasy Westward Journey, Tianxia II and Heroes of Tang Dynasty, and increased commission and other performance-based compensation, as well as increased staff-related costs resulting from increased headcount in general and administration and research and development areas.

Net Profit

Net profit for fiscal year 2010 totaled RMB2.2 billion (US$338.8 million), compared to RMB1.9 billion for the preceding fiscal year. For fiscal year 2010, the Company reported a net foreign exchange loss of RMB89.5 million (US$13.6 million) under Other, net, compared to a net foreign exchange gain of RMB9.6 million for the preceding fiscal year. The change to a net foreign exchange loss for 2010 as compared to 2009 was mainly due to the translation loss arising from the Company's Euro-denominated bank deposit balances as of December 31, 2010 as the exchange rate of the Euro against the RMB fluctuated over the periods. NetEase reported basic and diluted earnings per ADS of US$2.61 and US$2.60 for fiscal year 2010, respectively.  The Company reported basic and diluted earnings per ADS of US$2.17 and US$2.16 for the preceding fiscal year, respectively.

Income Taxes

The Company recorded a net income tax charge of RMB344.4 million (US$52.2 million) and RMB313.9 million at an effective tax rate of 13.4% and 14.6% for fiscal years 2010 and 2009, respectively.

Other Information

As of December 31, 2010, the Company's total cash and time deposit balance was RMB9.5 billion (US$1.4 billion), compared to RMB7.0 billion, as of December 31, 2009.  Cash flow generated from operating activities was RMB901.5 million (US$136.6 million) for the fourth quarter of 2010, compared to RMB532.6 million and RMB712.4 million for the preceding quarter and the fourth quarter of 2009, respectively.

** 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$1.00 = RMB6.6000 on December 31, 2010 as set forth in the H.10 statistical release of the U.S. Federal Reserve Board. No representation is made that the RMB amounts could have been, or could be, converted into US$ at that rate on December 31, 2010, or at any other certain date. The percentages stated are calculated based on RMB.

Notes to Unaudited Financial Information

The unaudited financial information disclosed in this press release is preliminary. The audit of the financial statements and related notes to be included in the Company's annual report on Form 20-F for the year ended December 31, 2010 is still in progress.  In addition, because an audit of the Company's internal controls over financial reporting in connection with section 404 of the Sarbanes-Oxley Act of 2002 has not yet been completed, the Company makes no representation as to the effectiveness of those internal controls as of the end of fiscal year 2010.

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

Conference Call

NetEase's management team will host a conference call at 8:00 p.m. Eastern Time on Wednesday, February 23, 2011 (Beijing/Hong Kong Time: 9:00 a.m., Thursday, February 24, 2011). NetEase's management will be on the call to discuss the quarterly and full year results and answer questions.

Interested parties may participate in the conference call by dialing 1-877-941-2069 (international: 1-480-629-9713), 10-15 minutes prior to the initiation of the call. A replay of the call will be available by dialing 800-406-7325 (international 303-590-3030), and entering passcode 4406810#. The replay will be available through March 9, 2011.

This call is being webcast live and the replay will be available for 12 months. Both will be available on NetEase's corporate web site at http://corp.netease.com, Investor Info: Earnings Call.

About NetEase

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. NetEase's online communities and personalized premium services have established a large and stable user base for the NetEase websites which are operated by its affiliates. In particular, NetEase provides online game services to Internet users through the in-house development or licensing of massively multi-player online role-playing games, including Fantasy Westward Journey, Westward Journey Online II, Westward Journey Online III, Tianxia II, Heroes of Tang Dynasty and Datang, as well as the licensed game, Blizzard Entertainment's World of Warcraft.

NetEase also offers online advertising on its websites which enables advertisers to reach its substantial user base. In addition, NetEase has paid listings on its search engine and web directory and classified advertising 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 advertisements, matchmaking, alumni clubs and community forums. NetEase is also the largest provider of free email 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.

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, including its recent expansion pack for Fantasy Westward Journey and planned expansion packs for Tianxia II, Heroes of Tang Dynasty, Westward Journey Online II and III and Legend of Westward Journey, do not become as popular as management anticipates; the ability of NetEase to effectively market its games and other services and achieve a positive return on its marketing expenditures; the risk that Shanghai EaseNet will not be able to continue operating World of Warcraft or other games licensed by it for a period of time or permanently due to possible governmental actions; the risk that Shanghai EaseNet or NetEase will be subject to penalties or operating restrictions imposed by governmental authorities in the PRC resulting from the operations of their online games, including suspension of their Internet service or other penalties; the risk that changes in Chinese government regulation of the online game market may limit future growth of NetEase's revenue or cause revenue to decline; uncertainty regarding the effectiveness of marketing programs for NetEase's online advertising business and online games business in China; the risk that NetEase may not be able to continuously develop new and creative online services; 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 and general competition and price pressures in the marketplace); 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.

NETEASE.COM, 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 = RMB6.6000 on December 31, 2010 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 operations is set out as follows (in thousands):

Note 3:  In the fourth quarter of 2010, management of the Company decided to allocate facility costs comprising of office and staff quarter rentals and management fees, building amortization and miscellaneous utility costs previously recorded under general and administration based on headcount in the respective functions under cost of revenue, selling and marketing, research and development and general and administration.  The change was implemented to better reflect staff-related operating cost.  Reclassifications have been made to cost of revenue and operating expense amounts in the condensed consolidated statements of operations and segment information for prior periods in order to conform to the current period's presentation.  There is no change to the condensed consolidated balance sheets and condensed consolidated cash flows statements.