The9 Limited
Q4 2005 Earnings Call Transcript

Published: 23 Feb 2006

[Operator:]

Our first question comes from Jason Brueschke of Citigroup. Jason Brueschke. Thank you. Good morning and congratulations on really a fantastic quarter everyone. I have a couple of questions. May I start with maybe a general question about the competitive landscape that you’re going to look at in 2006? There’s a number of new games that are going to be coming from competitors such as NetEase and Shanda that will be 3D games and could you maybe comment on how you think (inaudible) is positioned as well as Sun and GE? Thanks.

[Jun Zhu:]

Well, let me first comment on WOW. As you remember, back in the year 2004, I said that thinking about the future trends of online games in China, at that time starting from the year 2005, 3D MMORPG games will be an obvious new trend in the China market. Now we see overwhelming success of WOW here. We can see that many companies have been convinced and are now moving their focus to 3D MMORPG, which shows that that forecast I said in 2004 was very correct. And during the IPO, I talked to the analysts, I explained there were 2 reasons why I believed that WOW would definitely be a very big success. The 2 reasons were first, WOW consumers in Korea, Europe and the US and the second reason is that the PC-based version had 6 million users, so that was also a foundation for the future success of WOW. And in the statement I made just now, according to the Q4 numbers, WOW has 3.3 million users, which is still far below the 6 million of the PC version users number. So those do have a far way to go. And I would like to draw your attention to the fact that a few months ago when WOW’s number of users was at 1.5 million. At that time the peak component user number was 460,000. Now the total number of users is at 3.3 million, you have the PCU number is a little bit higher, but still at 530,000. So that shows that in 2nd tier cities, we still have a lot of potential to grow. And also another issue comes to our attention. We realize that many users are spending relatively little time on WOW. But this year, (inaudible) is launching a new video or sample video of WOW, so I believe that many old users and the new users will be very attracted and the time they spend on WOW will increase. (Inaudible) registration for way of calculating the potential of WOW. Now let me comment on Sun and GE. And also, during my initial statement I said that in 2003 MU user was 300,000 and MU2 user was 1.2 million. So, the total number of users for these two Korean games, back in 2003, reached 1.5 million users. These numbers show that there is a big group of fans fro Korean games at the moment in the Chinese market there is no Korean developed game for these users. So we believe that as we launch Sun and GE, which ostensibly ranked #1 and #2 in Korea, so they were very successful in Korea, we believe that Sun and GE will attract a lot of Korean game fans in the Chinese market. And The9 is pretty strong in marketing and in channel management. So this year we will be very much focused on WOW, Sun and GE. These three games will be our main focus and we will do our best job to make them very successful. Jason Brueschke. Two other questions quickly

[Operator:]

Your next question will comes from the line of Wallace Cheung of Credit Suisse. Wallace Cheung. Thank you. A couple of questions. First of all, can you give us guidance of the trend of first for the fourth quarter and secondly in the first quarter ’06? Do you see a sequential growth trend, especially after . And the second question is, I think regarding on the subsidy, should we expect…is it a recurring income that we should expect in 2006? Jun Zhu, Chairman and CEO. We try to answer your question, but the second question, could you repeat. Wallace Cheung. Basically, you have received around $12 million from a subsidy from the government. Hannah Lie. I’ll answer after Mr. Zhu answers your first question. Jun Zhu, Chairman and CEO. In Q4 2005, the number of WOW users showed very steady growth. But you know, during the Chinese New Year, during that two weeks we observed some unsteadiness and slowdown of the growth from jobs, because many game players will go back to their hometown. But, just one week after Chinese New Year, the PCCU of WOW started to grow significantly and now we have recorded the highest number of PCCU of the WOW. Hannah will answer your second question. Hannah Lee. Wallace, we received $1.7 million US financial subsidy in Q4 with respect to the business tax that we paid in Q2 and Q3, basically from 2 onward because we commercialized World of Warcraft in June. As I said, in the earlier part of the earnings call, we recorded the financial subsidy as revenue upon receipt. Usually we receive the financial subsidy at least 2-3 quarters behind when we actually pay them. So, although we record it when we receive it, we don’t expect that in Q1 we will have such kind of subsidy. It’s all depending on the when the government pays us the cash and when they’re received in our account and that’s when we report the revenue. Wallace Cheung. I just have a quick follow up. PCU is doing quite well. Do we have the figures that and also about the ACU figures, say after the Chinese New Year, we see the ACU figures bounce back to normal. Jun Zhu, Chairman and CEO. I’d like to add that if you ask me about the ratio between ACU and PCCU, the trends that we experienced after Chinese New year, both ACU and PCCU have increased over what we experienced in Q4 of 2005. Hannah Lee. And after Chinese New Year, our PCCU has reached a new high, it’s also growing after the Chinese New year. Currently, it’s 560,000. Operator

[Hannah Lee.:]

I’m sorry, which upgrade are you referring to? Antonio Tambunan. She just mentioned that the new map rollout would bring in more new users. Were you referring to Burning Crusade or were you referring to another miniature map that’s coming in before Burning Crusade? Hannah Lee. There are going to be small upgrades along the way. As you know, now we’re up to 1.9. But, what our Chairman was just referring to was specifically relating to Burning Crusade. Antonio Tambunan. Okay, got you. My only other question then is on…do we have any statistics on how WOW is doing in Taiwan? What trends have you seen since it went commercial and what numbers are out there? Jun Zhu, Chairman and CEO. Well, the statistics released by technology company unlimited, which his a company that we have equity investment in, according to their information, which was released in December 12th, 2005, at that time the peak user number of WOW in Taiwan was 120,000 and in the first day of its launch, the packages were sold at the number of 18,000. Antonio Tambunan. Okay, thank you.

[Operator:]

Your next question will come from Lynn Sheet of Lehman Brothers. Lu Sun. Hi, this is actually Lu Sun calling from Lehman. We’re very happy to see the good results in the 4th quarter. Just a couple of follow up questions. How is the penetration into the 2nd tier and 3rd tier cities going? And can you give us some statistics like how many of your subscribers are actually coming from these places and whether you encounter more competition in these places. And secondly I want to ask more about the cost structure. There seems to be a pretty big decrease in the sales and marketing spending, but an increase in T&A. We want to know what you think will happen in the 2nd half of this year when you introduce more titles. Thank you. Jun Zhu, Chairman and CEO. You asked about the percentage of users coming from 2nd tier and 3rd tier cities; I’m afraid we cannot disclose this number. I can answer your question about competition in these markets. We know that whether a game is successful in this market of China, it depends very much on the content of the game. So, only with good content plus good marketing and good distribution channel can we get good results of operations. So if the content is average, even if marketing and distribution channel is excellent, I’m afraid the result will not be very good. Now with WOW we are very lucky that this game in terms of content is a very excellent game. And we have seen that our marketing efforts have been effective and our control of distribution channel is pretty strong. So I believe that leading forward to 2007, the next few years will all be very successful years for WOW. Hannah Lee. Lu, with respect to you question about cost structure in relation to the launching of new games, for Q4, we did spending about in marketing expense, which was comparable to what we spent in Q3, considering Q3 was actually the first quarter after we launched World of Warcraft. Q2’s marketing was , Q3’s was about $1.2 million and Q4’s was about $2.9 million. Those are in respect to the stages of when the game is. Q2 of course we spent more because we have open beta, closed beta and commercial launch all in one quarter. With respect to increase in general and administrative expenses and also marketing expenses, depending on when we will launch Sun and GE there will be a corresponding increase in marketing. Of course in the premarketing stage, before commercialization of the game – just like World of Warcraft – there will be single-sided expenses without any revenue coming in, but that is for long term purposes whereby we increase the awareness of the gamers and it will on a long-term basis bring profitability to the company and also increase the revenue on the long run. For G&A expenses, we are not expecting a significant increase in general and administrative expenses for this year, 2006. Lu Sun. On the headcount side, what is the current status and how many people do you envision to add in 2006 to handle the new game launches? Hannah Lee. We currently have about 900 staff. Of course that’s comprised mainly about 600 are in the customer service department. As we launch new games we will definitely add more customer service staff. Depending on what the ratio is required as to how many customer service staff is required for the currency levels of players, we will be adding customers service staff accordingly. But other staff, other than customer service staff, we will not have significant increase in those areas. Lu Sun. Okay, thank you very much.

[Operator:]

And your next question will come from the line of Steven Ng of Cazenov. Steven Ng. Good morning. I’ve got 2 questions. Number one can just update on the Satik system and number 2, can you tell us about the capacity of your sixth server and when are you likely to open up the 7th server? Thank you. Jun Zhu, Chairman and CEO. During our Q3 earnings call conference I commented on the Satik system. At that time I said it was too early to analyze an impact of the Satik system. I said that the actual impact of the Satik system will depend on how the CEO and CFO and how they manage and drive their policies. Now, if you ask me this question I would say that according to our observation the impact of that Satik system on WOW so far is very limited and maybe it’s too early to analyze the long term impact of that policy on the game. And to answer your second question, our sixth site was only a half launch. So that half, which is now being used, is doing pretty well. And we don’t have a finalized schedule for launching the 7th site. Steven Ng. Thank you and congratulations on a good quarter. Hannah Lee. Thank you Steven.

[Operator:]

Your next question will come from the line of Dick Wei of JP Morgan. Dick Wei. Hi, congratulations on a good quarter. I have 2 questions. The first question is that your (inaudible) expense was slightly up for the 4th quarter. I wonder what is your R&D (inaudible) and also what’s the R&D expectation going down to ’06 and ’07? And my second question is relating to The9 website joint venture. I wonder if The9 website joint venture were going to launch new games. Can you ensure you get the new game operating support fee for the new game as well? Hannah Lee. Thanks Dick for your question. With respect to your first question for R&D expenses, we currently still have around 40 in-house R&D staff which mainly developed our first in-house developed game The new games that we mentioned in the earlier part of the call, which is a 3D analog PG that we’re developing, we are actually using the outsourcing route for development instead of increasing our in house development staff headcount, we opted to use the outsourcing route that minimizes our costs and we think that is the best way to carry our R&D development strategy. We are, with respect to 2006 expectations for R&D expenses, we are going to keep it quite similar to what we spent in Q4, around $1-$1.5 million for the quarter. We’re not going to significantly increase that. And the game that we’re developing, the 3D MRPG is actually in time for the 2007 pipeline. With respect to your 2nd question relating to Websend, we did reduce our interest from 51% to 30%. Potentially in the future it will be operated through this joint venture, but currently we are not at liberty to comment to that respect. Dick Wei. I guess for The9's new games operation, if there were any games to be operated, would you still be able to generate the game operating support revenue or that’s only for (inaudible)? Hannah Lee. Right now I think you’re referring to the 10.5% of game operating support piece that we get for (inaudible). For new games, if another game is going to be operated by MU and our assistance is required, then we will discuss the management and we will definitely get reasonable compensation for it. Dick Wei. Great. Thank a lot. Operator

[Operator:]

Your next question will come from William Bean of Deutsche Bank. William Bean. I just wanted to understand the impact of the promotion on your ARPU in Q1 and Q2. Hannah Lee. Thanks for your question. ARPU, I want to clarify that. ARPU is a mixture of a few factors. It is effected by distributor discount, the amount of free hours or the promotions we give. So, the distributor discount is always negotiable with the distributors. With the significant demand from the players for game cards, we are gradually being able to decrease our distributor discount gradually and we are experiencing more sales with respect to the sales channel of direct sales, where the commissions that we need to give are relatively lower compared to the traditional channels of virtual cards and physical cards. The amount of free hours that we give on a short term basis might have a negative impact on the ARPU, but depending on what type marketing campaign we launch. For example, if you’re looking at our member-gets-member program whereby we only give 33 hours free for the old players that bring a new player in, the amount new revenue that was brought in by the new players is actually higher than what we had to give out. Because the net expense to us is actually the 22% royalties that we have to give. So I think with respect to increasing our ARPU or keeping our ARPU stable, it’s a mixture of the two factors that I just mentioned. William Bean. Okay, and can you give us a sense of guidance on option expense going forward? Hannah Lee. Option expenses, I cannot give you specific number with respect to the option expenses we will record in 2006. but based on the latest calculation, because our options are all at market price, we will be recording approximately $500,000 a quarter. William Bean. Thanks and just one last quick one following up on the other guys’ questions. When do you expect, did you mention when you expect to launch Burning Crusade as well as the new games? Jun Zhu, Chairman and CEO. In talking about the Burning Crusade, we are working closely with Blizzard. You can refer to the official . We’re working with the Korean developers of GE and Sun to finalize the schedule for launches. William Bean. Okay, thanks guys. Operator