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NetEase Q4 2014 Results


NetEase (NASDAQ:NTES) released financial results for Q4 FY2014 which included accelerating revenue growth and stable profit margins compared to earlier quarters. Performance across different businesses was relatively robust, with online game revenues rising +36% YoY and the email, E-commerce and others segments growing +228% YoY, combining to offset softer growth in advertising of about +22% YoY.

Compared to consensus expectations, fourth-quarter revenue and earnings per ADS both exceeded estimates (revenue 3.5 billion RMB vs. 3.2 billion RMB est.; EPADS of 10.62 RMB vs. 9.64 RMB est.).

A key highlight for full-year performance was progress in mobile. NetEase launched several mobile games during FY2014, which contributed about 14% of Q4 game revenues, helping drive that segment, but also began monetizing some mobile apps, helping to boost the advertising business. Looking ahead to FY2015, management was very constructive not only of established initiatives in mobile, but also new areas of growth such as its new cross-border e-commerce initiative, Kaola, which was launched in January 2015.

Recent Quarterly Performance FY2014
(000) RMB Q4 Q1 Q2 Q3 Q4
Revenue 2,422,422 2,365,512 2,767,590 3,116,739 3,462,993
Gross profit 1,727,208 1,707,736 1,999,685 2,258,441 2,485,428
Operating profit 1,078,928 1,144,087 1,176,029 1,199,233 1,245,776
Net income 1,246,252 1,126,050 1,221,633 1,170,726 1,277,296
Earnings per share (RMB, GAAP) 9.48 8.60 9.18 8.83 9.67
Comparison YoY
Revenue 7% 10% 22% 32% 43%
Gross profit 7% 10% 18% 29% 44%
Operating profit 5% 5% 10% 8% 15%
Net income 23% 5% 13% 12% 2%
Earnings per share 23% 5% 9% 10% 2%
Comparison QoQ
Revenue 3% -2% 17% 13% 11%
Gross profit -1% -1% 17% 13% 10%
Operating profit -3% 6% 3% 2% 4%
Net income 19% -10% 8% -4% 9%
Earnings per share 18% -9% 7% -4% 9%
Margin analysis
GPM 71% 72% 72% 72% 72%
OPM 45% 48% 42% 38% 36%
NPM 51% 48% 44% 38% 37%
EBITDA 49% 51% 44% 40% 40%

NetEase generated approximately 1.9 billion RMB of operating cash flow during Q4, higher than 1.6 billion RMB a year ago and 1.1 billion RMB last quarter. The increase in Q4 operating cash flow was due to higher net income during the quarter as well as a reduction in working capital needs.

The fourth-quarter balance sheet included ample liquidity to satisfy the company’s cash needs. Total liquid cash assets (cash and cash equivalents, time deposits, and short-term investments) at the end of Q4 were about 23 billion RMB, up from 19 billion RMB a year ago and 21 billion RMB in Q3.

Outlook

Management did not provide specific performance guidance going forward, but instead offered some qualitative discussion of its near-term (FY2015) prospects. Initiatives on the agenda for FY2015 included an increase in mobile game launches during the year, and further success with its PC games business (its view ahead was for a “fruitful” year in this regard).

When discussing the strategy for mobile game development, management seemed to emphasize its priority to achieve well-received games, hinting that monetization was not the most paramount concern. For the types of games the company is focusing on, that approach seems prudent – irrespective of the game monetization model (freemium, item-based, etc.) achieving a critical mass of players is critical, something made much easier if gamers respond well to the title. When pushed, management did concede that the business has inherently lumpy revenues (consistently producing hit games has been the veritable white rabbit in the industry), and commented further that their entire process includes feedback considering what was successful as well as learning from missteps.

The recently announced cross-border e-commerce business, Kaola, seems to be in the very early stages of development and management did not offer much in the way of detail. Two tidbits which were provided were that the company would sell only authentic products on the platform and would also tap cooperation agreements to broaden the customer offering. In terms of “what” Kaola would be selling, the only clues provided were SKUs which were the “highest value for money” to the target audience.

Key Business Developments during Q4 FY2014

Game launches – During the fourth quarter, the company launched several new games both for PC and mobile users. NetEase released World of Warcraft, Warlords of Draenor expansion pack in November, which was met with a positive player response, and also reported success with its mobile battle arena game Battle to the West and 3-D action adventure title The World HD. The company also released expansion packs for existing titles, including Fantasy Westward Journey II, Tianxia III, Ghost II and Heroes of Tang Dynasty Zero, which management remarked delivered solid performance during Q4.

Mobile messaging – The company launched a new version of its YiChat mobile messaging mobile app in Q4, and commented that it was “well received” by users. Plans going forward include a version targeting SME users, something in the development pipeline for FY2015.

Financial Performance

Income Statement FY2014
(000) RMB Q4 Q1 Q2 Q3 Q4
Revenue
Online games 2,109,456 2,155,626 2,336,498 2,459,596 2,863,299
Advertising 358,153 244,713 389,102 478,330 439,507
E-mail, e-commerce, others 117,473 118,638 226,348 387,987 380,800
Sales taxes -162,660 -153,465 -184,358 -209,174 -220,613
Total revenue 2,422,422 2,365,512 2,767,590 3,116,739 3,462,993
YoY 7% 10% 22% 32% 43%
Cost of revenues -695,214 -657,776 -767,905 -858,298 -977,565
Gross profit 1,727,208 1,707,736 1,999,685 2,258,441 2,485,428
YoY 7% 10% 18% 29% 44%
Gross profit margin 71% 72% 72% 72% 72%
Selling and marketing expenses -328,152 -223,455 -433,494 -533,838 -704,211
General and administrative expenses -82,168 -96,837 -98,054 -128,928 -143,850
Research and development expenses -237,960 -243,357 -292,108 -396,442 -391,591
Operating profit 1,078,928 1,144,087 1,176,029 1,199,233 1,245,776
YoY 5% 5% 10% 8% 15%
Operating profit margin 45% 48% 42% 38% 36%
Investment income 4,890 10,690 10,482 8,693 -2,492
Interest income 139,082 142,215 146,456 156,084 156,747
Exchange gain/loss -17,568 7,123 -20,181 2,184 -7,124
Other, net 90,341 1,501 6,783 1,872 72,282
Pretax income 1,295,673 1,305,616 1,319,569 1,368,066 1,465,189
Income tax expense -49,421 -179,566 -97,936 -197,340 -187,893
Net income 1,246,252 1,126,050 1,221,633 1,170,726 1,277,296
YoY 23% 5% 13% 12% 2%
Net profit margin 51% 48% 44% 38% 37%
Net income (loss) due noncontrolling interests -9,227 -2,190 -19,284 -11,581 -6,027
Net income due common shareholders 1,237,025 1,123,860 1,202,349 1,159,145 1,271,269

Revenue growth during Q4 was driven by positive momentum in the core online games business. Management noted that not only were new launches contributing, but existing titles were performing well thanks to expansion packs. Performance in the advertising business also helped, pushed higher due to progress monetizing some of mobile apps, which saw solid interest from customers in multiple industries.

Although total gross margins were flat QoQ, there were some changes at the segment level. Online games gross margin softened slightly to 76% (vs. 78% Q4 last year, 77% in Q3), advertising margins improved to 67% (vs. 58% Q4 last year, 66% in Q3) due to scale effects, and the email, E-commerce, and other segment swung to a gross profit margin of 46% vs. -4% Q4 last year, which was lower than the 50% in Q3 due to softer E-commerce sales.

Operating profit was higher due to revenue growth, but increases in fixed costs, mainly related to new game launch/promotion expenses, pressured operating margins.

Net profit margin fell QoQ due to tighter operating margins, and was lower YoY due to the one-time tax benefit in Q4 FY2013.

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