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Executives

Vivien Wang – IR Officer

Michael Chi – Founder, Chairman and CEO

Kelvin Lau – CFO

Analysts

Jason Brueschke – Citigroup

Andrey Glukhov – Brean Murray

Wallace Cheung – Credit Suisse

Thomas [ph] – Banc of America

Paul Keung – Oppenheimer

Ying [ph] – Susquehanna

Lisa [ph] – Morgan Stanley

Adam Krejcik – Roth Capital Partners

Tian Hou – Pali Capital

Atul Bagga – ThinkEquity

James Lee – Sterne Agee Capital

Jin Yoon – Nomura International Limited

Perfect World Co., Ltd. (PWRD) Q4 2008 Earnings Call Transcript March 2, 2009 8:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Perfect World fourth-quarter and full-year 2008 earnings conference call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session (Operator instructions). I must advise you that this conference is being recorded today, 2nd March, 2009.

I would now like to hand the conference over to Ms. Vivien Wang, Investor Relations Officer of Perfect World. Please go ahead, Ms. Wang.

Vivien Wang

Thank you, operator, and thank you, everyone, for joining us today for Perfect World’s fourth quarter and fiscal year 2008 earnings release conference call. We distributed our unaudited fourth quarter and fiscal year 2008 earnings release earlier today. You may find a copy of the press release on our official website or through the newswire.

Today, you will hear from Mr. Michael Chi, our Chairman and CEO, who will give us a brief introduction and overview. Mr. Kelvin Lau, our CFO, will then discuss some of our latest developments and operational developments and take us through our financial performance in the fourth quarter and fiscal year 2008. Following the prepared marks, Mr. Chi, Mr. Lau and I will be available to answer your questions.

Before I continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US Private Securities Litigation Reform Act of 1995. Perfect World does not undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under applicable law. For more information about the risks involved, please visit our filings with the SEC.

I would now like to turn the call over to Michael.

Michael Chi

Thank you, Vivien, and thanks everyone for joining us today for our fourth quarter and fiscal year 2008 earnings call.

We are proud of the growth we achieved over the past year despite the global economic slowdown. During the year, we successfully launched three new games, including Chi Bi, Pocketpet Journey West, and our first 3D online casual game, Hot Dance Party. Online game players have responded positively to the games in the various active launches. And moving forward, we will continue to leverage our strong R&D to further enhance players gaming experience.

Our positive results during the period continue to be driven by our execution of our strategy. We continue to develop and launch new games to the market in a very timely manner. We are also maintaining game players' interest in our existing game portfolio. Our strong pipeline now contains seven MMORPGs, one of which, Battle of the Immortals is currently under small-scale closed beta testing and is targeted to launch for large scale closed beta testing on March 5, 2009.

Given our solid pipeline and the existing portfolio of games, we have decided to fine-tune our strategy. We will continue to quickly produce new games in the short and medium-term. In the meanwhile, we will also focus on enhancing the sustainability of our business by devoting more resources to longer-term potential blockbuster projects and launch expansion packs for our existing games.

We have also seen many great achievements in our overseas expansion efforts during 2008. We successfully broadened our geographic coverage in Asia and Europe through overseas licensing and we established a wholly owned subsidiary in the United States that operates our own games throughout North America. Following the launch of open beta testing for Perfect World II in September, we have seen a positive response for game players in the North America region. We also launched closed beta testing for Pocketpet Journey West in North America under the name Ether Saga Online in February 2009 and are looking forward to the launch of open beta testing soon.

Pursuing strategic acquisitions is also one of our strategy to drive business growth. We successfully completed our deals with InterServ, which has not only strengthened our pipeline by adding XiaoAoJiangHu and Meteor Online, but has also enhanced the level of our already strong research and development capabilities.

We are currently integrating the newly acquired Shanghai and Chengdu subsidiaries with the team to further expand our business there. For 2009, we remain confident that our strong management team and rich experience in developing and releasing online games will continue to enhance value for our shareholders. By implementing a longer-term view and expanding the resources needed for developing these games, we are positioning ourselves to further strengthen our global presence and drive sustainable business growth.

With that, I would like to pass the call to Kelvin.

Kelvin Lau

Thank you, Michael. We are very pleased to announce our strong fourth quarter and year-end results. In terms of the development of our existing games, we successfully rolled out a number of expansion packs during the fourth quarter, including Horseback Fighters for Chi Bi, You Are My Destiny for Hot Dance Party and a Special Year-End Edition for Zhu Xian. The variety of new features these expansion packs provide and enhance the game content and graphics has been well received by the market since their respective release.

Our marketing effort during the period included 2008 Gratitude To Gamers campaign. The campaign effectively enhanced our brand by reaching out to gamers in 26 provinces and 166 cities holding notable gaming events. We have continued to make progress on our overseas development efforts during the past quarter. We successfully signed agreements with various overseas operators to license Chi Bi in Japan and Korea and Zhu Xian in Korea.

Also during the quarter, we launched Legend of Martial Arts in Thailand and Vietnam, Zhu Xian in Japan, Malaysia, Singapore and the Philippines, and an English version of Perfect World II in Europe through various overseas operators. More recently, following the quarter end, we entered into a new overseas licensing agreement to license Pocketpet Journey West in Korea and we launched Zhu Xian in Thailand and Vietnam through respective overseas operators. We also launched closed beta testing for Pocketpet Journey West in North America under the name of Ether Saga Online through our US subsidiary in February and are looking forward to the launch of open beta testing soon.

Before I take you through our fourth quarter and full year 2008 financial highlights, I would like to provide a quick update on our ADS and share repurchases. In October 2008, the Board authorized an ADS repurchase program of up to $100 million worth of ADS from October 2008 to October 2009. As of March 1, 2009, we had repurchased an aggregate of 977,492 ADS from the open market. In addition to and separate from the aforementioned ADS repurchase program, in December 2008, we entered into an agreement to repurchase a total of 18,750,000 shares of the company's class A ordinary shares for approximately $56.6 million from SB Asia Investment Fund or SAIF, an affiliate of SAIF. This transaction was closed in January 2009 and will be recorded in our first quarter 2009 financial statements.

Now I would like to take you through our fourth quarter and full year 2008 financial highlights. Our total revenue were RMB 417.8 million in 4Q08 an increase of 9.4% from 3Q08 and an increase of 61.7% from 4Q07. Our online game operation revenue were RMB 362.6 million, an increase of 11.7% from 3Q08 and an increase of 57.5% for 4Q07. The sequential increase in online game operation revenue was primarily attributable to the successful launch of open beta testing for Pocketpet Journey West, the success launch of expansion packs for a number of our existing games and the positive market response from recent marketing campaigns.

Our ACU for games under operation in Mainland China must approximately 690,000 in 4Q08 as compared to 717,000 in 3Q08 and 624,000 in 4Q07. The APC of games operated in Mainland China under the item based revenue model was approximately 1,546,000 in 4Q08 as compared to 1,610,000 in 3Q08 and 1,565,000 in 4Q07. The ARPU of games operated in Mainland China under the item based revenue model was RMB 225 in 4Q08, an increase of 14.8% from 3Q08 and an increase of 59.6% from 4Q07. The increase in ARPU from 3Q08 was mainly due to a series of successful promotions and the launch of new expansion packs. The slight increase in ACU and APC from 3Q08 was mainly due to more aggressive anti-cheating efforts.

Our overseas licensing revenues were RMB 55.2 million in 4Q08, a decrease of 3.7% from 3Q08 and an increase of 98.8% from 4Q07. The slight decrease from 3Q08 was mainly due to a decrease in initial license fee, partially offset by an increase in usage-based royalty fees. Our gross profit was RMB 368.5 million in 4Q08, an increase of 10.1% from 3Q08 and an increase of 67.7% from 4Q07. Gross margin was 88.2% in 4Q08 as compared to 87.6% in 3Q08 and 85.1% in 4Q07.

Our operating expenses were RMB 218.9 million in 4Q08, an increase of 62.7% from 3Q08, and an increase of 165.7% from 4Q07. The increase in operating expenses from 3Q08 was mainly attributed to the following factors. Number one, an RMB 78.8 million increase in R&D expenses, this was primarily due to the non-recurring charge of approximately RMB 78.4 million resulting from the InterServ acquisition which was related to two online games under development i.e. Meteor Online, an online game developed based on famous book XiaoAoJiangHu authored by Louis Cha.

Based upon certain recognized valuation principles, the two games under development were valued at approximately RMB 78.4 million and were expensed as in process research and development status under US GAAP. Number two, an RMB 8.3 million increase in general and administrative expenses due to an increase in staff costs and professional fees. Number three, an RMB 2.7 million decrease in sales and marketing expenses which was primarily attributable to a reduction in advertising and promotion expenses associated with a more effective marketing campaign strategy.

Our income tax expenses was RMB 33.6 million in 4Q08, an increase of 283.3% from 3Q08 and an increase of 688.1% from 4Q07. The board decided to distribute RMB 520 million earnings of the Beijing Perfect World Software Ltd or PW Software, our wholly owned subsidiary in Beijing to its direct parent Perfect Online Holding Ltd or PW Hong Kong, which is holding only subsidiary in Hong Kong. As such a withholding cash of RMB 26 million was accrued and recorded as deferred cash liabilities as of December 31, 2008. Such US dollar distribution will enabled us to fund the share repurchase program under US GAAP or distribute the earnings are facilitated to be translated to the parent company and are subject to withholding tax, therefore you accrue 5% withholding tax for the earnings made from PW Software going forward.

Given the aforementioned factors, net income was RMB 124.8 million in 4Q08 a decrease of 27.2% from 3Q08 and a decrease of 14.7% from 4Q07. Excluding share-based compensation charge and non-recurring charge related to the InterServ acquisition in October 2008, non-GAAP net income was RMB 220 million in 4Q08 an increase of 3.7% from 3Q08 and an increase of 46.4% from 4Q07. This in diluted earnings per ADS were RMB 2.21 and RMB 2.12 respectively in 4Q08. This compares to RMB 3.53 and RMB 3.34 in 3Q08 and RMB 2.62 and RMB 2.48 in 4Q07. Excluded our share-based compensation charge, and a non-recurring charge related to the InterServ acquisition in October 2008, non-GAAP basic and diluted earnings per ADS were RMB 3.9 and RMB 3.74 respectively in 4Q08 as compared to RMB 3.77 and RMB 3.56 in 3Q08 and RMB 2.69 and RMB 2.55 in 4Q07.

For our full fiscal year 2008 results, our total revenues were RMB 1437.2 million in 2008, an increase of 108.6% from 2007, primarily due to the expansion of our game portfolio, the launch of a series of expansion packs and marketing campaigns, and a significant expansion in overseas licensing business. Our online game operations revenue were RMB 1251 million in 2008, an increase of 103.2% from 2007. Overseas licensing revenue were RMB 186.2 million in 2008, an increase of 153.8% from 2007.

Our gross profit was RMB 1261.9 million in 2008 an increase of 121.3% from 2007. Our gross margin was 87.8% in 2008, which increased from 82.7% in 2007. The year over year increase in gross margin was primarily due to a high level of economies of scale generated from significant revenue growth. Our operating profit was RMB 677.1 million in 2008, an increase of 93.3% from 2007, excluding share-based compensation charge and a non-recurring charge related to the InterServ acquisition in October 2008. Non-GAAP operating profit was RMB 805.4 million in 2008, an increase of 124.6% from 2007.

Net income was RMB 646.5 million in 2008, an increase of 78.6% from 2007. Excluding share-based compensation charge and a non-recurring charge related to the InterServ acquisition in October 2008, non-GAAP net income was RMB 774.8 million in 2008, an increase of 109.2% from 2007. Basic and diluted earnings per ADS were RMB 11.5 and RMB 10.91 in 2008 as compared to RMB 8.63 and RMB 6.77 in 2007. Exclude share-based compensation charges and a non-recurring charge related to the InterServ acquisition in October 2008, non-GAAP basic and diluted earnings per ADS were RMB 13.78 and RMB 13.07 in 2008 as compared to RMB 8.83 and RMB 6.93 in 2007.

In terms of financial guidance, based on our current operation, total revenues for the first quarter of 2009 I expect it to be between RMB 376 million and RMB 397 million is by percent a decrease of 5% to 10% on a sequential basis and a decrease of 24% to 31% on a year-on-year basis. The sequential decline mainly reflects the seasonal factors and takes into consideration we have been devoting more resources to upcoming new games and big expansion packs for existing games.

With that now, I would like to turn the call back to Vivian.

Vivien Wang

Thank you Kelvin. This concludes the prepared marks for today. We are happy to take your questions now. Operator, we're ready for questions.

Question-and-Answer-Session

Operator

Thank you. We will now begin the Q&A session. (Operator instructions). The first question comes from Jason Brueschke of Citigroup. Please ask a question.

Jason Brueschke – Citigroup

Thank you and good evening everyone. Kelvin, if I may start with the guidance, could you maybe give us a little bit of more color about the seasonal factors, because when we think about the number of expansion packs that were released in the fourth quarter, generally we would expect to kind of have a positive carryover effect into the fourth quarter for us against the subsequent quarter and we seem to have more of a sequential decline there than I think we had expected. And then could you also may be comment on how the devoting of more resources internally to some of your longer term efforts which I understand the strategy of doing so, but how does that end up causing a great seasonal impact on the revenue that we are going to see in the first quarter? Thanks. And then I have a follow-up question.

Michael Chi

[Interpreted] Okay. We’ve seen time about three some, and you know we are always producing some singles and doubles but not a home run or a blockbuster type of game, we don’t know when we are going to do so. And the answer is given that we already have a solid portfolio and a very strong pipeline we decided to fine tune our strategy and we believe that a lot of our future growth actually will come from big projects with potential to be a blockbuster title and we’ve been putting a lot of resources into those new titles or longer-term projects and this caused a little bit of resources shifting from existing games to our new game. And also on the existing game side, historically, we have seen operating – putting a lot of small upgrades to our existing games on monthly or even weekly basis and now we have decided to fine tune the strategy a little bit as well. We're working on some of the large or big extension packs for the second half of the year and this also cost a lot of that of resources and the near-term pressure. Hope this answers your question.

Jason Brueschke – Citigroup

It does, thank you. And maybe a follow-up, when I look at your ARPU, the ARPU has had fantastic growth in 2008 as well, but if I heard you correctly, the 225 RMB, I'm wondering in light of the maybe the more challenging economic conditions in China, do you think – or I guess how should we be thinking about your ability to continue to grow ARPU into 2009? Are we kind of reaching the high end of what is likely to be expected or do think there is continued ability to deliver strong growth throughout the year? Thanks.

Michael Chi

[Interpreted] First of all, the reason for the growth of ARPU, you noticed that the longer the game exists, typically or naturally the higher the ARPU, because gamers are getting stickier with the game. And secondly in line with the global economic slowdown, we actually have not seen a significant impact of this on our business. But having said that we want to highlight our ARPU growth typically comes from two sides. One is the upgrades or expansion packs, the other is the some seasonal promotion. And in line with the global economic slowdown and in consideration of the gamers disposable income, we actually decided to do less promotion into Q1 but put more resources on the content upgrade tariff for the longer-term benefit of our games’ growth.

Jason Brueschke – Citigroup

Right, thank you.

Operator

Thank you. Your next question comes from Andrey Glukhov of Brean Murray. Please ask a question.

Andrey Glukhov – Brean Murray

Thank you. If I may follow-up on Jason's question a little bit, can you guys give us an little bit more granularity on the timeline of some of the large expansion pack that are planning this year as well as new game launches so that we can think about sort of writing new patterns through the year as a function of that? Thanks.

Kelvin Lau

In fact we already mentioned in our press release that right now we have seven MMORPGs under development and also we will – I think we also announced that our first game (inaudible) is going to be launched in Q2. We expect according to our current schedule we expect to have about three to four games, new games to be launched this year for sure, we want it to be launched in Q2. But I think for the remaining two to three or three to four games I think we still haven't fixed the time. We hope to launch one new game each quarter.

Andrey Glukhov – Brean Murray

Okay. And as far as the expansion packs are concerned since you're concentrating on the large expansion pack, is any of the games within your current portfolio going to get a new expansion pack in the second quarter or are all the expansion packs pretty much concentrated on the back half of the year?

Michael Chi

[Interpreted] We plan to have some in later Q2 but most of them will come from the second half of the year.

Andrey Glukhov – Brean Murray

Great. Thank you.

Operator

Thank you very much. Your next question comes from Wallace Cheung of Credit Suisse. Please ask a question.

Wallace Cheung – Credit Suisse

Hi. Good evening. Hi Michael, Kelvin and Vivien. Just a very quick question, can you give us an update about your operation west, is it now profitable and how’s the ramp going? And also when we talk about your InterServ acquisition, can you describe more like how’s the integration going forward and how the (inaudible) work of the team and the two games that are under development? Thank you.

Kelvin Lau

Wallace, thank you for the question. Number one is regarding the US subsidiary operation. Right now our US operation is pretty good. As we noted the first game in the national version has been launched since September last year right. Right now the performance is quite good. We also expect we are going to launch maybe two to three new games in North America this year. We expect North American subsidiary will be profitable this year. So it is not that bad.

Regarding the InterServ acquisition I think assuming InterServ has I think they have two major business lines, one is consulting and the other one is the game testing and the final one is game development. In terms of outsourcing, yes, I think as I mentioned before, we continue to operate our outsourcing business and also the game testing business. We are going to do some restructuring for our outsourcing team and game development team and then the game testing team. Regarding the InterServ game development team, I think their developers will integrate with our Shanghai office R&D team. We have set up a separate team for this InterServ R&D people, they will work together with our Shanghai people and Beijing people.

So I think we are in a position process, so far so good, I think is the question. Regarding the two games we have acquired from InterServ, I think XiaoAoJiangHu ,we almost started the game development now and is expected to launch this game in 2010. Meteor Online continues to develop. I think as I mentioned in last earnings call, Meteor Online is about 50% percent complete, so we continue to work on the scheme.

Michael Chi

[Interpreted] One more comment on our US operation, the operation is actually quite satisfactory and we are kind of ahead of our schedules. And also in the future we are open to operate our studios game in the US as well.

Andrey Glukhov – Brean Murray

All right, just a quick follow-up on the US operation site, so just want to characterize it today, is it already breakeven either on a P&L level or cash flow level? And also when you talk about some of the operating matrix, Ken described like positive growth trend or ARPU how does it compare with the China situation? Thank you.

Kelvin Lau

All right. First of all, I will just apologize, we're not going to disclose the (inaudible) in the US. But I can tell you I think in terms of the cash flow, cash flow is positive right now in US. In 2008 because we are cutting some set up cost, establishment costs, the operating expenses, so in 2008 our US operations still at a loss position, but I think according to our – but I think we are confident that US operation this year can breakeven or even profit this year.

Andrey Glukhov – Brean Murray

Okay, thank you.

Kelvin Lau

Welcome.

Operator

Thank you very much. The next question comes from Eddie Leung of Banc of America. Please ask a question.

Thomas – Banc of America

Hi. I'm Thomas [ph] asking questions on behalf of Eddy. Two questions. Would you give us some color of how Pocketpet Journey West in US going since the first two months of 2009? And my second question is can you give us some guidance on 2009 share-based compensation expenses? Thanks.

Michael Chi

[Interpreted] Since the launch of Pocketpet Journey West in October 2008 performances is very good and we keep operating the game. However we have got to admit that some of the adjustments that we did was a little bit more aggressive causing some of the gamers left. And also the other reason is we have been stepping out in terms of anti-cheating efforts were more aggressive than ever in this game because we strongly believe that only if we can make sure Q4 08 and maintain a fairness environment for the game we are doing something that is beneficial for the long-term of the game like cycle. We are working on doing some adjustments to fix some of the issues and with those expansion packs or upgrades, launches in the future we hope to ramp up the user level. And but we’ve got to emphasize that this game, even though after the adjustment now, it’s still performing pretty good and still profit-making. On more comment, for the expansion pack for this month for Pocketpet Journey West, we are launching soon in the first half of the year and we remain very confident of this games performance.

Kelvin Lau

Regarding the share-based compensation expenses, estimation in 2009, I think we strongly believe that the share options one of the most effective and efficient tools to retain or attract good talent especially R&D people in this industry. So going forward, yes, we're still very emphasized on our R&D and also we will continue to grant options to all those key, especially all the key people, especially all those R&D people. So I would say we are going to expand our operations, we are going to expand our game portfolio and also our – so I would expect the share-based compensation will increase in 2009 but I think we have a policy on hand it seems that the new acquired options will be about 1 to 2% of the equities. That is what I mentioned I think in the previous earnings call.

Thomas – Banc of America

Okay, thank you.

Kelvin Lau

You are welcome.

Operator

Thank you very much. Your next question comes from Paul Keung of Oppenheimer. Please ask the question.

Paul Keung – Oppenheimer

Just a question on casual games, given that we have (inaudible) strategy on the casual game development?

Vivien Wang

You mean the strategy on the casual game side?

Paul Keung – Oppenheimer

Yes.

Michael Chi

In terms of Hot Dance Party which is our first casual game, although the performance at the very beginning is not as exciting as we expected, but we are happy to seem that this game is going very good lately. It has already become a medium size game in terms of the revenue contribution to it, and also in the following months, we are preparing for a big marketing activity for the game in order to ramp up users. We remain very confident of the success of this game. As for other casual games, we currently don't have plans to develop more causal games pipeline. We want to focus more on products more concentrated onto this games worth.

Paul Keung – Oppenheimer

Thanks. And my next question is on the Battle of the Mortals, how should we expect its ARPU level, for example should it perform– over the long run should it perform similar to Zhu Xian, or is it going to be a higher ARPU game such as Chi Bi?

Michael Chi

[Interpreted] To be honest, our internal estimate of ARPU for Battle of the Immortals is on average level because before the launch of any game it is actually very hard to predict exactly what the ARPU level of the game is, especially given that this is a new type of game. But because this is a 2.5G game, we have quite a lot of confidence in the long-term potential of this game and hope begin the be a better answer in Q2.

Paul Keung – Oppenheimer

Okay, thank you.

Operator

Our next question comes from Ming Zhao of Susquehanna. Please ask your question.

Ying – Susquehanna

Ying [ph] for Ming, can you talk about the feedback of US players regarding the item based model, are they getting used to it quickly or slowly? Thank you.

Michael Chi

[Interpreted] To be honest, our game in the US hasn’t become mainstream as of now. But in the past few months our all of our operating metrics, ACU, APC and ARPU have been gradually increasing and we have no doubt about the acceptance of item-based models in the US or even in the world because after all it is free to play, it is easier to drive adoption. And coming back to specific to our games performance, Perfect World II or Perfect World International is more Chinese cultured themes. So in the future we are planning to launch more games in the US that are Western themed and hopefully can get even greater success with those teams.

Unidentified – Susquehanna

Thank You.

Operator

Thank you. Your next question comes from Lisa [ph] of Morgan Stanley. Please ask your question.

Lisa – Morgan Stanley

Hi, good evening, Michael, Kelvin and Vivien. I'm calling on behalf of Richard. My first question is regarding your tax rate, do you see a hike in tax percent for the quarter, is that reflecting the 5% tax on the (inaudible) to the Hong Kong-based entity?

Kelvin Lau

Lisa, I think you're right. I think the increase in income tax expenses in Q4 is solely because of the withholding tax related to the dividend distributed from our Chinese entity to Hong Kong company. I think as I mentioned in the earnings call, the sole purpose of this type of distribution for the share buyback program. So according to US GAAP, if you distribute the dividend to the parent company (inaudible) withholding tax. This is according to the new tax law implemented by the Chinese Tax Bureau with effect from first of January 2008. So as long as we have this type of intention to buy back shares and distribute dividend to our parent company, we’ve got accrue 5% before tax

Lisa – Morgan Stanley

So, going forward, how would you model your effective tax rate for 2009?

Kelvin Lau

Okay. We will stick to the marketing front. If once we stopped the share buyback program and also I think the court decided we're nothing to distribute any dividend to the current company at Hong Kong, we can stop the accrual of this type of withholding tax. I will keep everybody informed.

Lisa – Morgan Stanley

thank you. My second question is about the acquisition of InterServ, what is the R&D headcount of the addition? And also regarding the total US$38 million on the acquisition, what is the (inaudible) for the rest of the month?

Kelvin Lau

Yes, quite about 250 R&D people from InterServ, about 250 R&D people. Okay, for the InterServ transaction, just regarding the two transactions, on is, the first one is acquisition of assets, it cost about 15 millions as I mentioned on earnings call, about 78 million RMB has been written off as non recurring expense in Q4. Regarding the second transaction, the second transaction is the acquisition of business transaction. So most of the conservation 23 million will be booked as a goodwill in our books. According to US GAAP the equal will not be advertised. But I think on an annual basis we’ve got have an parallel assessment on this million 23 million. So as long as we continue this business and this business goal fine and book profit, there is no need for us to do any impairment on this goodwill.

Lisa – Morgan Stanley

Thank you.

Operator

Thank you. Your next question comes from Adam Krejcik of Roth Capital Partners. Please ask your question.

Adam Krejcik – Roth Capital Partners

Thanks for taking my call. Two questions, number one, in terms of the guidance, could you perhaps break down how much of that sequential decline minus 5% to 10%, how much of that is based on the decline in ACU and APA versus decline in ARPU or perhaps ARPU stays flat?

Michael Chi

[Interpreted] It actually may come from both sides because on the one hand we decided to do less promotion in Q1. On the other hand because of the Chinese New Year, there will be pressure on the ACU and APC as well.

Adam Krejcik – Roth Capital Partners

Okay, that is helpful. In terms of operating margins in the past I think you have guided for or hope that you could reach 50% this quarter backing up in the InterServ charge I guess 54 1/2% operating margin, I guess going forward can you provide any internal expectation or goals in terms of operating margins for the next couple of quarters?

Kelvin Lau

Adam, first of all (inaudible) the guidance for the margin, I think on a quarter on quarter basis. But as we’ve mentioned in the previous earnings call, in the short run, yes, we’ll have some pressure on the margin, why because we are continuously investing in R&D. InterServ we have close to 250 R&D people and it is tough – probably this season we will be involved in other outsourcing and game testing but part of the people will be mostly in the game development. As I said, we need people for game development. We have not come up with any (inaudible) so I get to bear the cost, but in the long run, these people, I mean these are physically relevant in the form new games next year. So my R&D spending is being increased this year but as I mentioned before we tried on a yearly basis, I think our target is trying to maintain the margin above 45 to 50% as I mentioned before.

Adam Krejcik – Roth Capital Partners

Okay great. And just really quickly on Battle Of The Immortals, the large-scale closed beta, is that similar to the unlimited closed beta testing you did for Pocketpet Journey West or we should expect some revenue beginning in March?

Kelvin Lau

No, Adam. I think this time is a formal closed beta testing. I think as we mentioned before, Pocketpet Journey West, we have a limited closed beta testers, a very special case because of right before the Olympic games we cannot do a lot of promotions, so even though we have commercially launched the game, we just unlimited close beta testing, but we started to charge, we started to channel revenue, but I think for Battle Of The Immortals, just wanted to do the formal closed beta testing, we're not going to charge any money from our gamers in the close beta attesting.

Adam Krejcik – Roth Capital Partners

Okay, thank you very much.

Kelvin Lau

You are welcome.

Operator

Thank you. Your next question comes from Tian Hou of Pali Capital. Please ask a question.

Tian Hou – Pali Capital

game and my understanding is not all the new games are (inaudible) original Perfect World team, developed by the team. You acquired Norwich was just newly recruited. So there will be operating in a decent system. So my understanding is that would be some impact on the gross margin, so Kelvin could you please give us a little color on the potential impact on the margin ?

Kelvin Lau

Tian, you are right. The team assembled for Shanghai team, they are a new team. I think (inaudible) product or company. They are working a lot, I think our Beijing R&D people, we’ve worked together with this new team, and this newly acquired team. This is what we call equation. So normally for new teams, are Shanghai team took a longer time to develop a game, so as well people saying, okay for those new teams, normally they would incur more times on developing the games, so you can start well, more possibly being credit for these new games but I think we wanted two games to be launched I think, we can continue the margin, we can improve the margin.

Tian Hou – Pali Capital

Okay. Thank you, that is it.

Operator

Thank you. And your next question comes from Atul Bagga of ThinkEquity. Please ask your question.

Atul Bagga – ThinkEquity

Hi guys. Thanks were taking my call. So can you give us some clarity on Q4 APA and ACU performance, you mentioned that some of the impact was because of the anti-cheating efforts, so if you exclude those impacts, what was the growth in APA and ACU for Q4?

Michael Chi

If there were no anti-cheating effort, ACU would have been higher and ACC would have been somewhat higher. But there was no hypothetical because we keep operating our anti-cheating technique and also we decided that even if cheating becomes charged (inaudible) about the cheating account, this actually impacted on the ACC.

Atul Bagga – ThinkEquity

Got you. And the second question on 2009 performance, do you guys expect most of the growth in 2009 coming from the new games or do you expect the existing game performance also to rebound after Q1? Thank you.

Michael Chi

[Interpreted] We think it is actually both, half half.

Atul Bagga – ThinkEquity

Got you. Thank you. And maybe one last quick question if I may, can give us some sense on the impact of InterServ acquisitions on top line and bottom line, you mentioned that you will continue to operate their outsourcing business, what can we expect, what can be modeled from contribution from top line from InterServ and also on the bottom line, is there going to be an impact from this acquisition?

Kelvin Lau

(inaudible) if you compare our outsourcing revenue to our online game operation, I think our outsourcing is just very, very portion of our total revenue. So the contribution to the top line, this very, very insignificant, this is number one. Number two as had mentioned, as I mentioned in this earnings call, I would say InterServ people are very good R&D people but I think we cannot expect it that (inaudible) new games I think this year. So this is our further investment for us. We have got to incur R&D expenses to bear the cost until the coming of new games in 2010. So that is why I said there will be some pressure in R&D expenses in this year.

Atul Bagga – ThinkEquity

Thank you.

Operator

thank you. In our next question comes from James Lee of Sterne Agee Capital. Please ask you question.

James Lee – Sterne Agee Capital

Hi. Can you give us more color about BOI expectation for 2009, maybe we can start talking about the large-scale open data in March, can you give us a sense of how large that scale of beta testing is and I'm curious in your first round of beta testing what kind of feedback are you getting from users in general and what kind of adjustments have we made? And also Kelvin, any maybe talk about this, can you give some color about the cost of acquisition and especially in Cox, I just want a great of greater number on intangible assets? I remember last time we talk about 4 million to been attacked over the next three years, is that still the case? Thanks.

Michael Chi

[Interpreted] Regarding the first question about the Battle of the Immortals, the small-scale closed beta, the feedback from the small group closed beta is actually positive. And given that we decided to do a large scale close- beta testing. This is – we think this is the month for this game because this game is a new type, new type of game, so we need a very large goal post to test before the official launch.

Kelvin Lau

Regarding (inaudible) games, in the first transaction of acquisitions of InterServ, the total contribution is 15 million. Of this 15 million, about 11.5 million has been written off as nonrecurring charges in Q4. And then the remaining $3.5 million, this $3.5 million is all related to the usage rate of the illustrator engine and some IP, so this $3.5 million cost has been moved in our intangible assets. So, if you look at our balance sheet, the intangible assets increased by about 25 million RMB, so this type of intangible assets will be amortized over five years.

James Lee – Sterne Agee Capital

Got it, thank you. And just follow question on BOI again, can Chi maybe give a little more color, he had said the feedback was very good, I was wondering what kind of adjustments having you gone back, maybe more on the improvement side of the business, what kind of adjustments have you made to make this game better in anticipation of the larger scale closed end beta?

Michael Chi

[Interpreted] So we see that from the small scale testing, it’s actually pretty good in terms of the design of the game and this large-scale close beta testing is more on the technical testing site i.e. testing the server crashes (inaudible) players and et cetera.

James Lee – Sterne Agee Capital

I guess my last question is an easier one for Kevin, what is the share count expectation for 1Q?

Vivien Wang

Can you repeat your question again?

James Lee – Sterne Agee Capital

What is the share count expectation for 1Q?

Vivien Wang

For 1Q?

James Lee – Sterne Agee Capital

Yes.

Kelvin Lau

(inaudible) on the share buyback program, right. All the shares we bought back in the open market will be cancelled out, so it is hard to say because it is still one month to go before the end of this quarter. I think I already reported in the earnings call up to March 1, we have already acquired – we’ve already bought back about 1 million ADS already and of these shares will be cancelled out.

James Lee – Sterne Agee Capital

Okay, great. Thank you.

Kelvin Lau

You are welcome.

Operator

Thank you. Your next question comes from Jin Yoon of Nomura International. Please ask your question. Thank you.

Jin Yoon – Nomura International Limited

Yes, hi guys. Just a couple of questions throughout the call here, on your overseas revenues, how much exposure or the decline in Q4 I was real surprised in the decline, how much of that is due to the actual slowdown or seasonality, and how much of that is due to FX slide in the Southeast Asian countries? And Q1 guidance going forward, the overseas business, how much of that, again the same thing, how much of the 5% to 10% decline is due to possibly FX exposures to foreign exchange currencies? Thanks.

Kelvin Lau

First of all in Q4, the decline in overseas (inaudible) revenues mainly because as I mentioned in earnings call there is some decline in recognition of the license fee, why because in Q3 we have Zhu Xian and Chi Bi are launched in most of the Asian countries. So in Q4 by the time we had already recognized quite a lot in (inaudible). In Q4 that is not so many big titles launched in all those major Asian countries, but we still have Legend of Martial Arts and Zhu Xian I as a mentioned and this got launched in Thailand and some countries. But in Q4 in fact, the usage based on (inaudible) increased. That means we did not expect a very significant impact of the economies – coming from the economic slowdown in Asian countries because usage based royalty fees increased in Q4. Yes, I think some of the foreign currency, Korean Won, some foreign currency are depreciating. I guess some things on the income of the overseas (inaudible) but I think your foreign exchange impact on that has actually worsened because (inaudible) 10 to 15% of total revenues, so the foreign exchange difference would not be very big deal for us. In Q1 I would expect that that will be also some (inaudible) we just signed a license in Korea. We expect that the game will be launched in Q2 or Q3, so I don’t expect there will be many new – many of our games will be launched in all those new countries in overseas markets.

Jin Yoon – Nomura International Limited

Okay. Thanks guys.

Operator

Thank you very much. Due to time constraints, we have to end our question-and-answer session at this time. Ms. Vivien Wang, please continue. Thank you.

Vivien Wang

Thank you. This is the end of the conference call. The web cast replay will be available at Perfect World's official website www.pwrd.com under IR section. If you have any additional questions, please feel free to contact us. Thank you.

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Source: Perfect World Co., Ltd. Q4 2008 Earnings Call Transcript
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