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Netease Q1 financials show hefty expenses, reduced profits

Management remains confident in sturdy existing portfolio and recent releases such as Knives Out will pay off

Netease hasn't yet begun to harvest the fruits of its recent mobile releases, despite hefty spending to create and market them. In yesterday's Q1 financial report and earnings call, the company posted a 75 per cent increase in operating expenses for the quarter and a 20.4 per cent decrease in gross profit.

Netease showed earned net revenue for Q1 2018 of $2.3 billion, a 3.9 per cent increase year over year. Gross profit, on the other hand, was down 20.4 per cent year over year at $949.1 million.

Of this, online game services accounted for $1.4 billion in net revenue, a decrease of 18.4 per cent from Q1 2017. 71.8 per cent of this came from mobile games, while the rest came from PC titles.

Speaking on behalf of Netease CEO William Ding, CFO Charles Yung attributed the decrease in gross profit to lower revenue from self-developed mobile games, specifically mentioning Onmyoji and New Ghost. That said, the company saw a quarter over quarter increase in online game gross profit due to the release of both Knives Out and Chu Liu Xiang.

Knives Out and Chu Liu Xiang's release last quarter contribute to a broader strategy, according to Netease. The company wants to diversify its game portfolio using both internally-developed titles and by continuing to bring in licensed games from overseas.

Netease has already seen success with its Chinese releases of popular Blizzard games such as Hearthstone and Overwatch, as well as Minecraft (which has 60 million registered users now in China). Not mentioned in the report was Netease's upcoming Pokémon GO localization, which is anticipated for the second half of 2018.

"PC and mobile games remain as two duel engines for our games segment," Ding said. "We will continue to invest in the PC segment because we think PC games still carry their own unique features and appeal to the users. For instance, toward the end of June, we are going to introduce a new PC game Justice to the market, and also for Knives Out, even though we self-developed it as a mobile game, we also introduced a highly-attractive PC version of that game."

That said, those diversification efforts resulted in a 75 per cent year over year operating expense increase for Netease to $756.7 million. When asked for details on what the large increase in expenses entailed, Yung indicated that investors should expect a turnaround in the coming quarters:

"This is indeed an upfront investment to promote new genres in new geographies," Yung said. "They will result in an increased contribution from these new games in the following quarter, and we're very happy to see Knives Out and Terminator 2 are contributing significantly to our revenue. We remain highly positive about the continued and sustained contributions from these games."

The financial report also mentioned "higher staff-related costs" as contributing to the jump in operating expenses.

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