The9 Limited
Q1 2007 Earnings Call Transcript

Published: 22 May 2007

[Operator:]

Good day, ladies and gentlemen, and welcome to The9 Limited’s First Quarter 2007 Earnings Conference Call. My name is Camay, and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference call. As a reminder, this conference is being recorded for replay purposes (Operator Instructions). I would now like to turn the presentation over to your host for today's conference, Ms. Dahlia Wei, Senior Investor Relations Manager of The9 Limited. Please proceed, ma'am.

[Dahlia Wei:]

Thank you operator. Hello, everyone, and thank you for joining us today for The9’s first quarter 2007 financial results conference call. The management with me today are Mr. Jun Zhu, Chairman and CEO and Ms. Hannah Lee, Vice President and Chief Financial Officer. Before we start, I would like to read you the Safe Harbor statement. During the course of today’s call, certain projections or forward-looking statements may be made regarding The9’s future financial performance or future events. We wish to caution you that such statements or predictions are based on our current information and expectations, and actual results may differ materially from those projected in the forward-looking statements. We would also like to refer you to documents that the company files with the U.S. Securities and Exchange Commission. Those documents contain additional information concerning factors that could cause actual results to differ materially from those contained in management’s projections or forward-looking statements. Let me now turn the call over to Mr. Zhu, our CEO, who will provide you with an overview of our business for the quarter.

[Jun Zhu:]

Good morning and good evening ladies and gentlemen. I would like to thank you for participating in our discussion of The9's first quarter 2007 earnings. First, I would like to present a quick overview of the key financial highlights for the first quarter of 2007. Net revenues for the first quarter of 2007 were US$35 million. Net income was US$8.6 million or earnings of US$0.34 per ADS for the quarter. Now let me discuss some highlights of our game operations. First of all, World of Warcraft, in the first quarter of 2007, although we experienced some seasonality impact from Chinese New Year and the winter holiday, we maintained the concurrent users for WoW at a relatively stable level. In the first quarter of 2007, WoW PCU was over 680,000 and ACU was approximately 330,000. As of March 31, 2007, over 7.5 million accounts have been registered and activated for the WoW game in Mainland China. With respect to the much-anticipated expansion pack, The Burning Crusade, we will first launch the upgrade version 2.0 Before The Storm. The last upgrade version for the expansion pack in late June, and soon after in the third quarter we will launch The Burning Crusade Expansion Pack, so far the version is on schedule. This late April, we have started upgrading the existing WoW server sites. In addition, we are also appealing the eighth WoW server sites to accompany the launch of The Burning Crusade, which standalone with the existing server sites. Seven server sites will provide a full total capacity of close to 1 million peak concurrent users, paving a way for the user growth anticipated based on market responses in other parts of the world. With respect to Soul of The Ultimate Nation, SUN, we commenced All-access Open Beta Testing for the game on April 18th. Within one week of open beta testing, SUN PCU have exceeded 400,000. Subsequently, we opened sixth server site and top of the state server sites to allow more users to experience the exciting SUN game. In addition, we will soon announce a strategic co-marketing partnership with a renowned fast-moving consumer goods brand to promote SUN through China. We've recently announced that SUN will adopt the free play plus item sales model and have just started selling SUN game points through The9 physical and the virtual card distribution network, as well as direct through online transaction. So far, we have seen strong demand from users. We will launch SUN’s online shopping mall on May 24th, allowing players to purchase virtual items and various value added services within a game. The encouraging performance SUN has achieved during its All-access Open Beta Testing, once again demonstrated The9's strong operational capabilities. We view it as an important milestone for The9 as we transit from one game operation to many game operations and diversify the revenue sources for the company. We will continuously work with the game developer to upgrade our game content and analyze players behavior to better meet user demand and driving the virtual in-game items add-in cards, as well as other value added services within a game. For Guild Wars, we started All-access Open Beta Testing on March 7th and have opened all available content from chapter one to chapter three to players. We will further monitor the progress of the Guild Wars open beta testing to decide our operation plan for the next phase. Some upgrades on our licensed MMORPG in our pipeline. With respect to Granado Espada, we are continuously localizing new content of the game based on developers' latest upgrade version. We currently plan to start beta testing of the game by the end of 2007. For Hellgate

[Hannah Lee:]

Thank you Zhu and Dahlia, and hello everyone. For the first quarter of 2007, the non-reported net revenues of $35.0 million, a decrease of 4% from the fourth quarter of 2006 and a 27% increase compared to the first quarter of 2006. The sequential revenue decrease was mainly due to the seasonal impact of World of Warcraft usage during the Chinese New Year and winter holiday. Net revenues attributable to World of Warcraft, which included revenues from game playing times, merchandise and installation package sales were $34.5 million in the first quarter of 2007. This represents quarter-over-quarter decrease of 5% due to the holiday impact I just mentioned and a 27% increase from the same period of last year. ARPU

[Operator:]

(Operator Instructions) And your first question comes from the line of Wallace Cheung with Credit Suisse. Please proceed.

[Wallace Cheung:]

Hello? Hi, Jun Zhu, Hannah.

[Hannah Lee:]

Hi, Wallace.

[Wallace Cheung:]

Okay, mainly two questions. First of all can you explain what are the key strategic value from the Electronic Arts investments? And second question also regarding same issues, it’s actually how do you expect the pleasant more response to this year investment, would it relationship between the non-implicit be changed afterwards? Thank you.

[Jun Zhu:]

First, to answer your first question. We believe the casual game is picking up in China, as that on last year Q2 conference call, as that we believe the 3D online games these are future direction for online game industries. I compare the 2D game versus 3D game to the back and white TV versus color TV. And similarly at this point, we think the casual game is picking up, because of material opportunity in China, and also if you’re looking further beyond we believe console game, we will have big potential in China too. We think the success of World of Warcraft and the SUN had proved our anticipation of 3D game success in China. Our vision for the future game development is actually on the casual games area is our key strategy behind actual investment from that of EA. We believe EA have a rich portfolio of sports games and casual online games and also EA is one of the most leading publisher in the console game area. So, we believe the equity investment from EA will be beneficial to us in the long-term especially on casual game and the console game area. Okay, the rest now we hand our license of FIFA Online is at, I believe with the upcoming Beijing Olympics next year. We believe the sports illustrative casual games will draw a lot of attention and interest among Chinese player. So we believe FIFA online will be our very popular game we’ll launch in China. For your second question, I don’t think the actual enhancements from here will have any impact on our relationship with Blizzard, because EA's franchise, the portfolio is mainly on the casual game and the sports stream area, but to Blizzard to be our focus is on the 3D, MMORPG areas so I think it’s no complex here. And the second item in the line is our comprehensive platform for all kinds of games, whether its in MMORPG or casual game, we are open to operate all kinds of games and bring them to China and make a very successful story in China. So for the above-mentioned two reasons I believe the partnership with EA and our relationship with Blizzard will be no complex. Thank you.

[Operator:]

Your next question comes from the line of Jason Brueschke with Citigroup. Please proceed.

[Jason Brueschke:]

Thank you, good morning everyone. Let me add my congratulations also on the EA partnership. A quick follow to Wallace's question, did you issue new or existing shares for the EA stake and when do you plan to actually launch FIFA in China? And then my second question is WoW 2.0 upgrade that you’re doing in June, can you help us to understand the importance of this in relationship to Burning Crusade. And I’m wondering is it necessary to do this upgrade to the Burning Crusade or is that optional that you would do this ahead of Burning Crusade? And then could you comment whether you expect to see a similar type of revenue boost from this upgrade as we saw with the last upgrade that happened last fall? Thanks.

[Operator:]

Hello, Ms. Wei.

[Jason Brueschke:]

Hello.

[Operator:]

This is the operator, hello.

[Jason Brueschke:]

Hello. Yes.

[Operator:]

One moment, I think we’ve lost. And please standby ladies and gentlemen. Ladies and gentlemen please standby. (Technical Difficulty)

[Operator:]

Please go ahead Ms. Wei.

[Dahlia Wei:]

Sorry, we got some technical problems. We will continue with the call. So, just now Jason will ask three questions.

[Jason Brueschke:]

(Foreign language)

[Hannah Lee:]

Hi, Jason. It’s Hannah. I will answer your three questions. With respect to your first question, the approximately 15% on equity interest of EA will be obtained. They will obtain that through issuing us new shares of The9 Limited. And there are no old shares as existing shareholders are selling their shares. And for your second question for FIFA timetable, we have just signed the agreement with EA and right now we’re still working with them to finalize the timetable. Currently, we do not have an exact timetable for it. As soon as we have any idea of the exact timetable we’ll make an announcement. For your first third question about the upgrade of, the necessity of upgrading the service prior to the launch of Burning Crusade, we are launching an upgrade prior to Burning Crusade, which is version 2.0 as mentioned in our early presentation. That the upgrade is necessary to facilitate the new version upgrade prior to Burning Crusade that will include the experience of the players as we said on the call, and not only the hard work that are going to be upgraded, the network facilities are also going to be upgraded with higher broadband connections and etcetera and things like that. And hence this movement of play by the players and for us the main reason why we want to launch an upgrade prior to Burning Crusade, is we want to mere what’s the other parts of the world has done about Blizzard by launching an upgrade prior to the actual launch of Burning Crusade introducing some of the key features to the player who to them down, have a taste of what Burning Crusade is like prior to the actual launch. Regarding your question about the outlook for Q3, after Burning Crusade because we do not provide financial projection. I cannot, we cannot specifically tell what our internal estimate is. But from an operational perspective we are building the eight server sites service in conjunction with the launch of Burning Crusade and we will closely monitor the demand of the players with respect to the 2.0 launch and Burning Crusade’s launch and we will timely add additional service sides when we see there is necessary, when we see there is demand from the players. Does that answer your question? Hello.

[Jason Brueschke:]

Perfect.

[Operator:]

We can go ahead with the next question.

[Hannah Lee:]

Okay.

[Operator:]

The next question comes from the line of Lin Chi with Lehman Brothers. Please proceed.

[Lin Chi:]

Hi, Jun Zhu, Hannah and Dahlia, good morning.

[Hannah Lee:]

Hi.

[Lin Chi:]

Congrats on the investment. I have some questions regarding the financials. Number one is for the pre-launch costs for SUN and Guild Wars where, in which line did you book it during the quarter and what’s the magnitude for both titles? And number two is that, can you tell us today sales and marketing spending for GE, for SUN and World of Warcraft this during the quarter? And as I noticed there is some decline in both prepaid royalty, as well as their prepayment in other current asset. It will be great if you give the reasons behind? Thanks.

[Hannah Lee:]

Hi, Lin, can you actually repeat the second and third question, I got your fist one? I can’t quite hear your second and third question.

[Lin Chi:]

Sure. And my second question is about the sales and marketing. I wonder whether you can breakdown the sales and marketing spending for Guild Wars, for SUN and World of Warcraft during the quarter? And the third question is there has been a decline in both the prepaid royalty, as well as the prepayments and other current assets line and what’s the reason behind.

[Hannah Lee:]

The first question regarding the pre launch cause and of Soul of The Ultimate Nation and Guild Wars these are all fortified under private development as I’ve said in the presentation. This is consistent with our previous treatment of similar cause that we incurred for World of Warcraft. Your second question with respect to sales and marketing. The sales and marketing for Guild Wars and SUN were classified under sales and marketing during the pre launch stage both due imposed and Open Beta Testing on a combined basis there are about $1 to $1.5 million. Sorry they are about $1.5 million for World of Warcraft it's about $1 million. For royalties your third question, these are booked in current assets because these are treated as prepayments that we made to the licensor of World of Warcraft because we need to order the prepaid power we are actually selling them to the distributors that’s why we’ve classified under current assets. And we will expense it to match the revenue that we bring in when the players consume their game points. This is consistent treatment that we did before.

[Lin Chi:]

Okay. Understood I will go back to the queue. Thank you.

[Hannah Lee:]

Thank you.

[Operator:]

Your next question comes from the line of Dick Wei with JP Morgan. Please proceed.

[Dick Wei:]

Hi, these are secondary questions. My question is on the marketing expense and G&A expense for the next quarter. Just wonder want kind of level, do you expect to see? And how much is it related to each new games events or old games as well?

[Hannah Lee:]

We do not provide specific financial outlook as I said before, but looking at what we've had launch for over WoW old path (ph) the content that we are going to launch. We have said on the call, as Mr. Zhu has said, we are planning to launch the 2.0 upgrade before the end of the second quarter. And we are planning to launch, when if you say in the third quarter. So with respect to these upgrades we expect to incur additional sales and marketing expenses just like what we did before. We always time our sales and marketing expenses to in conjunction with the launches to maximize the effect. For SUN of course we are commercializing i.e. introducing the shopping mall feature on Thursday, two days from now on May 24th. So around that time and even now and for last few days we have started marketing one of the fact that we are going to set items two days from now, and almost a week ago we started the process of allowing players to trust the value, to add value to the game and casual, that would expedites their process and to allowing them to start buying items when the shopping mall features are introduced on Thursday. I think that will give you a flavor as to how you should project your sales and marketing income. We do not disclose what exactly, how we much we are budgeting for each game. As Mr. Zhu has said for GE and Guild Wars, and Hellgate

[Dick Wei:]

Great, thanks.

[Hannah Lee:]

Thank you.

[Operator:]

Your next question comes from the line of Ming Zhao with SIG. Please proceed.

[Ming Zhao:]

Thank you good morning. Thanks for taking my question. Several question on the new game. Very quick question one, for Guild Wars can you give us some metric in the open beta testing such PCU data? Second on the SUN, what kind of trend you do see, after you get that 400,000 PCU? Is it going up or is it flat or it’s trailing down? And finally on the Audition 2, can you help us understand what happens to JEO after Audition 1 licensing term and will you be able to get the users of Audition 1 or you have to acquire new users for Audition 2? Thank you.

[Jun Zhu:]

For Guild Wars, as I mentioned previously we are still monitoring the programs of open beta testing and that we will determine on our next phase, operation phase. For SUN, our PCU remains stable at 400,000 PCU level and we are satisfied with that and we basically have launched six server sites for SUN. Sorry, let me add a point, we basically add part of the six server sites for SUN. I remember last year lot of analyst asked me what's our strategy on the casual game area, I remember I said we will wait, the casual game in this market to become more mature and we will take the similar approach on the MMORPG side. We will use our best quality games strategy to enter a casual game too. We actually licensed Audition 2. When we consider it we didn’t impacted on our standalone basis. We basically consider which type of casual game can be successful. We basically have belief in the Tensing (ph) music related games and also the spot related casual games. And some analysts also ask me what's our strategy or what's our criteria, where’s lacking games? I basically have two criteria's, one is I actually see whether this game have a view, where you likely have a very huge user base in China. And second, our look at that developer or that studio whether they have successful experience or track record on the online game development. We licensed Audition 2 and FIFA Online because these two games meet our two criteria as very well. As I said just now, we will further look into the Caribbean area using our two key criteria in casual games and we are very open to more proactively enter the casual game areas.

[Hannah Lee:]

For 9-use contract with Audition, it’s not appropriate for us to comment at this stage. Thank you?

[Operator:]

Next question comes from the line of Paul Keung with CIBC. Please proceed.

[Paul Keung:]

Yes. I have one question that has to deal with your marketing outlook for The Burning Crusade, you mentioned earlier a lot of your forecast is looking how it’s doing in other parts of the world; it appears at this point that The Burning Crusade, probably to be a lot incremental marketing promotional cost, I was wondering if you think that phenomenon holds true in China or is it different in China where you actually spend more than other parts of the world?

[Hannah Lee:]

Hi Paul it’s Hannah. For the marketing around Burning Crusade it will definitely be higher than the smaller upgrade that we’ve pushed out before as to whether it is exactly the same or at similar level compared to the launches in other regions. We don’t have the exact numbers of how much they spent in the other region, but we are definitely allocating sufficient resources that we think are required to make sure the Burning Crusade launch is going to be successful. And people that have already played the game will have a registered account with the9 for the World of Warcraft will continue to spend a lot of time playing the game will come back to play the game and if they have moved on before. So, from a magnitude perspective it will definitely be higher than what we have spent in the smaller upgrades that we have launched to date.

[Paul Keung:]

Okay, great thank you.

[Hannah Lee:]

Thank you.

[Operator:]

Your next question comes from the line of James Rhee with Bear Stearns. Please proceed.

[James Rhee:]

Hi, good morning and congrats on the recent developments.

[Hannah Lee:]

Thank you.

[James Rhee:]

Related to the EA investment just two quick questions. Did you receive any rights of first refusal on future EA games beyond FIFA? And if you can comment were there any restrictive covenants preventing EA from taking equity takes and other Chinese operators? Thank you.

[Jun Zhu:]

For original details about the EA agreement with us, we cannot comment. But overall, I think the EA's equity investment in the9 is very positive in the long run. Thank you.

[Operator:]

Your next question is a follow up question from the line of Lin Chi with Lehman Brothers. Please proceed.

[Lin Chi:]

Hi, thanks for taking my follow up this is the question about World of Warcraft license is this still quite early to talk about it, but the license will expire in ’09, which is not that far away? I just want to -- based on your accounted discussion with Vivendi, how do you see the possibility of expanding the license? Thanks.

[Jun Zhu:]

Blizzard and I have been very focusing on and on the upcoming launch of the Burning Crusade straight away both exactly to the success in China.

[Hannah Lee:]

And the relationship between the two parties are very good.

[Jun Zhu:]

But currently we haven’t talk about the same beyond ’09.

[Hannah Lee:]

Thank you.

[Lin Chi:]

Thank you.

[Operator:]

And at this time we have no more questions in queue. I will now like to turn the call back over to Ms. Wei for closing remarks.

[Dahlia Wei:]

Okay. Thank you everyone for participating in today’s call. If you have any additional questions please feel free to contact us. Thank you.

[Hannah Lee:]

Thank you.

[Operator:]

Thank you for participating in today’s call. This concludes the presentation. You may now disconnect and have a great day.