Netease.com (NASDAQ: NTES) reported a 16.4% drop in net revenues from wireless value-added and other fee-based premium services for the three-month period ending September 30, 2004. However total net revenues rose by 15.4% over the preceding quarter to CNY238.6 million.

Gross margins for wireless value-added and other fee-based premium services declined from 69.0% in the preceding quarter to 53.2% in the third quarter mainly due to increased costs incurred in connection with various free services offered by Netease. In particular, the company incurred increased transmission costs in connection with increased usage of its free SMS service which is offered through its instant messaging application, POPO, and additional costs associated with its free email services, including server depreciation costs, bandwidth fees and increased staff costs arising from a rise in the number of staff working on these services.

As of September 30, 2004, the company's total cash and held-to-maturity investments balances were CNY1.8 billion (US$222.4 million) and CNY 248.5 million (US$30.0 million), respectively. Netease generated an operating cash flow of CNY148.8 million (US$18.0 million) for the quarter.

Acting Chief Executive Officer Ted Sun said, "The results of the third quarter emphasize once again that our diversified revenue streams provide us with a sound platform to benefit from the overall growth in the Internet market in China, with areas of strong performance mitigating areas of weaker performance. Thus, although the wireless value-added and other fee-based premium services have been operating under a challenging environment which led to a quarter-over-quarter drop in its revenues during the third quarter, we still manage to report a healthy growth in total net revenues which was driven by the continued growth of our two other business lines, online advertising and online games."

Gross margins for online advertising increased from 63.7% in the preceding quarter to 68.2% in the third quarter because the revenue growth in this area did not result in a proportional increase in costs.

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