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Executives

Joanne Deng – IR Manager

Michael Chi – Founder, Chairman and Co-CEO

Robert Xiao – Co-CEO

Vivien Wang – VP, IR and Corporate Communications

Kelvin Lau – CFO

Analysts

Eddie Leung – Merrill Lynch

Timothy Chan – Morgan Stanley

Muzhi Li – Citigroup

Mark Marostica – Piper Jaffray

Andy Yeung – Oppenheimer

George Meng – Macquarie

William Huang – Barclays

Martin Bao – CICC

Jia Long Shi – CLSA

Nick Ning – 86 Research

Perfect World Company Limited (PWRD) Q4 2012 Earnings Call March 11, 2013 9:00 PM ET

Operator

Hello, ladies and gentlemen. This is Tara. I’ll be the operator for this conference call. I’d like to welcome everyone to the Perfect World Co., Limited Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. All lines have been placed on mute to prevent background noise. After the presentation, there will be a question-and-answer session. Please follow the instructions given at that time if you’d like to ask a question. In fairness to other callers, please keep your questions limited to one and then you are free to return to the queue.

Now, I would like to turn the call over to Ms. Joanne Deng, Investor Relations Manager at Perfect World. Ms. Deng, please proceed.

Joanne Deng

Thank you, operator and thank you, everyone for joining us today for Perfect World’s fourth quarter and fiscal year 2012 earnings release conference call. We distributed our unaudited earnings release earlier today. You may find a copy of the press release on our official website or through the newswires.

Today, you will hear from Mr. Michael Chi, our Chairman who would first give us a brief overview of the quarter and fiscal year 2012 and then make an important announcement of the company. Mr. Robert Xiao, our co-CEO, will then give us a brief overview of our business and cover strategy, and then provide an update on our dividend distribution plan.

After that, Ms. Vivien Wang, our Vice President of Investor Relations and Corporate Communications, would take us through some of our latest operational development. And then she will pass the call to Mr. Kelvin Lau, our CFO, who will talk through our financial performance in the fourth quarter and fiscal year 2012. Following the prepared remarks, Mr. Chi, Mr. Xiao, Mr. Lau and Ms. Wang would be available to answer your questions.

Before we continue, please note that the discussion today will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigations Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations. Potential risks and uncertainties include but not limited to those outlined in our public filings with the SEC, including our annual report on Form 20-F.

For more information about these risks and uncertainties, please refer to our filings with the SEC. Perfect World does not undertake any obligations to update any forward-looking statement as a result of new information, future events, or otherwise except as required under applicable law. Our earnings release and this call include discussions of certain non-GAAP financial measures. Our earnings release contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures and is available on our website at www.pwrd.com under the Investor Relations section.

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

Michael Chi

Thank you, Joanne and thank you all for joining our call today. Our top line result in the fourth quarter was in line with our expectation. During 2012, we launched in in-game promotional activities and mainly focused on long-term project in our pipeline as content enhancement for our investing games in order to maintain a healthy life cycle for our portfolio and sustainable growth of our business.

As such, our results for 2012 came in softer than our previous year’s results. However, we believe this was a necessary step for the long-term growth of our business and are confident that our efforts over the past year will translate into more high-quality entertainment and services for our players worldwide in 2013 and beyond.

The success of the games we have delivered over the past few years has been a result of our close collaboration of all of our talented staff and our dedicated management team. I would like to extend my deep appreciation to all of them.

Especially, I would like to thank Robert, our Co-CEO, for his persistent efforts to push forward the development and the implementation of our corporate strategy together with me. Through his years of contribution to the company, the Board of Directors and I have grown great confidence in his outstanding leadership and execution capabilities.

As such, while remaining Chairman of the Board of Directors to oversee the company’s strategic direction, I have decided to step down from the Co-CEO position, and the board has decided to appoint

Robert as the company’s CEO. The board and I will continue to support Robert in his role as the company’s CEO.

We are confident in his future leadership on that company to overcome challenges and create a better Perfect World.

Now I’m pleased to pass the call over to our CEO, Mr. Robert Xiao.

Robert Xiao

Thank you, Michael. I would also like to thank the board and our shareholders for all your trust and support. 2012 was quiet for us in terms of new game launches. However, we believe it was necessary for us to focus on working on areas that we will pay off in the future for the long run. During the quarter, aside from furthering enhancing our recently-launched new MMORPG, Return of the Condor Heroes, we also continued to work on expanding our future portfolio, a number of attractive titles in our pipeline are currently under development, including our highly anticipated MMORPGs, Swordsman Online and Saint Seiya Online. These two titles are now in the final stages of development and we look forward to bringing them to Chinese players later this year.

We also plan to introduce more of our web games and mobile games to various markets this year and further diversify our future pipeline. In addition to these games that are under development by our Chinese studios, our pipeline also includes a number of world-class titles. We have obtained exclusive rights to operate DotA 2 in Mainland China. This world-famous title with a unique mix of action, RTS and RPG gameplay has attracted substantial attention from gamers all around the world.

Another world-class title in our pipeline is Neverwinter, a highly-anticipated MMORPG that is being developed in the U.S. by our subsidiary Cryptic Studios. We’re looking forward to this initial launch in North America very soon. We also continue to strengthen our operational capabilities in both China and overseas in addition to operating a variety of MMORPGs and web games in China, we also have established an overseas network through our subsidiaries and licensing activities with overseas partners covering over 100 countries and regions which over one-fourth of the total revenue generated from various overseas markets.

Continued focusing our global operational capability is an important part of our strategies. As such, I’m very pleased to announce that the company has appointed Ms. Yu Chi, our Senior Vice President and Chief Publishing Officer of Asia responsible for our game operations of publishing in Asia; and Mr. Alan Chen, our Senior Vice President and Chief Publishing Officer of Europe and U.S. responsible for our game operations and publishing in the U.S. and European market.

In summary, looking forward, we will maintain our unchanged dedication to be a really more premium quality client-based games, further expanding our global presence while putting more resources and efforts on development of our web games and mobile games in the future strengthen our further portfolios. We are hopeful that these efforts will become new growth drivers for our business and generate long-term value for our shareholders.

We continue to generate a healthy cash flow from our operation and remain confident in our long-term outlook as such, I’m pleased to announce that we would like to return value to our shareholders to show our appreciation for their longstanding trust and support. On March 10, 2013, the board of directors declared annual cash dividend in aggregate amount of approximately $22 million to our shareholders of record as of the close of business on April 8, 2013, at $0.09 for Class A or Class B ordinary share or $0.45 per ADS, each representing five Class B ordinary shares of the company. The cash dividends are expected to be distributed in or around April 2013.

We intend to distribute dividends annually in the future. However, the distribution of any future dividends will be at the full discretion of the board and will be dependent upon our financial position, result of operations, available cash, capital requirements, and other factors. Bringing value to our shareholders is an important part of our commitment, and we will continue to do what is necessary for the long-term health of our business and the best interest of our shareholders.

Now I’ll pass the call to Vivien for an update on some of our recent operational development. Vivien?

Vivien Wang

Thank you, Robert. During the fourth quarter, we’re continually enhancing our existing games by releasing new content through a number of expansion packs to keep our users engaged. We released Legend of Yellow Emperor for Dragon Excalibur, Heavenly Scripture for Fantasy Zhu Xian, The Wolf for Forsaken World, Call of Heaven for Perfect World.

Shortly after the quarter, we released the King of the Gods for Battle of the Immortals. Our efforts to strengthen our portfolio of lighter games has also seen some recent profit. Launch our web game, Adventure in the Three Kingdoms earlier this year. As Robert mentioned earlier, we plan to introduce more web games and mobile games to continue building on our portfolio of lighter games.

In terms of our overseas operations, during the quarter, we launched RaiderZ in North America through our subsidiary in the U.S. and release the German, Polish and Russian versions of Torchlight 2, a popular pay-per-install game developed by Runic Games, our majority-owned subsidiary in the U.S.

We also begun to our position and to be in Southeast Asia through our own overseas subsidiary. Post quarter end, we launched the Turkish version Blacklight Retribution is we’re to play first-person shooter game through our European subsidiaries. We also begun of the Battle of the Immortals in Korea through our Korean subsidiaries and recently signed an agreement to license Forsaken World in Vietnam.

Looking forward, we plan to continue expanding in both the domestic and overseas markets to deliver innovative content to gamers all over the world.

Now, I’d like to pass the call over to Kelvin for him to walk through our financials.

Kelvin Lau

Thank you, Vivien. Now for the fourth quarter 2012 financials. Total revenues were RMB 679.9 million in 4Q 2012, as compared with RMB 695.8 million in 3Q 2012, and RMB 776.4 million in 4Q 2011.

Online game operations revenues, which include both domestic and overseas online game operations, were RMB 599.7 million in 4Q 2012, as compared a bit with RMB 608.2 million in 3Q 2012, and RMB 706.9 million in 4Q 2011.

ACU for games under operations in Mainland China was approximately RMB 620,000 in 4Q 2012, as compared to the RMB 601,000 in 3Q 2012, and RMB 873,000 in 4Q 2011. The increase in ACU from 3Q 2012 was mainly attributable to a rebound in user copy for some of our existing games such as Zhu Xian.

Licensing revenues were RMB 36.5 million in 4Q 2012, as compared with RMB 39 million in 3Q 2012, and RMB 65.6 million in 4Q 2011. The decrease on 3Q 2012 was primarily due to lower initial license fees in certain overseas market in 4Q 2012.

Other revenues were RMB 43.7 million in 4Q 2012 as compared to RMB 48.6 million in 3Q 2012, and RMB 3.9 million in 4Q 2011. Most of the other revenue for 4Q 2012 was associated with Torchlight 2. A couple of pay-per-install game is our majority subsidiary based in the U.S.

Cost of revenue was RMB 157.3 million 4Q 2012 as compared to RMB 128.9 million in 3Q 2012 and RMB 127.1 million in 4Q 2011. The increase from 3Q 2012 was mainly due to an impairment associated with certain of our smaller games in 4Q 2012.

Gross profit was RMB 522.6 million in 4Q 2012 as compared to RMB 566.9 million in 3Q 2012 and RMB 659.3 million in 4Q 2011. Gross margin was 76.9% in 4Q 2012 as compared to 81.5% in 3Q 2012 and 82.3% in 4Q 2011. Operating expenses were RMB 510.2 million in 4Q 2012 as compared to RMB 457.5 million in 3Q 2012 and RMB 419.1 million in 4Q 2011.

The increase in operating expenses from 3Q 2012 was mainly due to the goodwill impairment associated with our Japanese subsidiaries and higher R&D expenses partially offset by decreases in sales and marketing expenses, and general administrative expenses in 4Q 2012.

R&D expenses were RMB 230.9 million 4Q 2012, as compared to RMB 197.1 million in 3Q 2012 and RMB 186.5 million in 4Q 2011. The increase from 3Q 2012 was primarily due to an increase in staff cost, including a special year-end bonus.

Sales and marketing expenses were RMB 159.7 million 4Q 2012, as compared to RMB 177.1 million in 3Q 2012 and RMB 142 million in 4Q 2011. The decrease from 3Q 2012 was primarily due to a decrease in advertising and promotional expenses in 4Q 2012. In 4Q 2012, we did not launch any major new games or release as many major expansion packs as in 3Q 2012.

G&A expenses were RMB 78.8 million 4Q 2012, as compared to RMB 83.3 million in 3Q 2012 and RMB 90.6 million in 4Q 2011. The decrease from 3Q 2012 was mainly due to a decrease in staff cost.

Goodwill impairment was RMB 40.8 million 4Q 2012, as compared to Nil in 3Q 2012 and Nil in 4Q 2011. The increase was primarily due to the goodwill impairment associated with our Japanese subsidiary.

Operating profit was RMB 12.4 million in 4Q 2012, as compared to RMB 109.4 million in 3Q 2012 and RMB 220.2 million in 4Q 2011. Excluding the share-based compensation charge and the goodwill impairment, non-GAAP operating profit was RMB 67.1 million in 4Q 2012, as compared to RMB 127.5 million in 3Q 2012 and RMB 244 million in 4Q 2011.

Total other income was RMB 75.6 million in 4Q 2012, as compared to the RMB 16.1 million in 3Q 2012 and RMB 48 million – RMB 49.0 million in 4Q 2011.

The increase from 3Q 2012 was largely due to a foreign exchange gain and an equity investment gain recognized in 4Q 2012, while respective losses were recognized in 3Q 2012. In addition, the sequential increase was also attributable to an increase in government grant subsidies income.

Income tax expense was RMB 1.1 million 4Q 2012, as compared to the RMB 29.1 million in 3Q 2012 and RMB 10.7 million in 4Q2011. The decrease from 3Q 2012 was mainly due to the R&D super deduction recognized during the annual tax filing for some of our PRC entities.

Net income attributable to the company’s shareholders was RMB 86.4 million in 4Q 2012, as compared to RMB 86.2 million in 3Q 2012 and RMB 260 million in 4Q 2011. Excluding the share-based compensation charge and the goodwill impairment, non-GAAP net income attributable to the company’s shareholders was RMB 141.1 million in 4Q 2012, as compared to RMB 104.3 million in 3Q 2012 and RMB 283.9 million in 4Q 2011.

Basic and diluted earnings per ADS were RMB 1.79 and RMB 1.78 respectively in 4Q 2012, as compared to RMB 1.78 and RMB 1.77 respectively 3Q 2012, and RMB 5.65 and RMB 5.45 respectively, 4Q 2011. Excluding the share-based compensation charge and the goodwill impairment, non-GAAP basic and diluted earnings per ADS were RMB 2.92 and RMB 2.90, respectively in 4Q12, as compared to RMB 2.16 and RMB 2.14, respectively, in 3Q 2012, and RMB 6.17 and RMB 5.94, respectively, in 4Q11.

For fiscal year 2012 financial results, total revenues were RMB 2,770.6 million in fiscal year 2012 as compared to RMB 2,983.4 million in fiscal year 2011. Online game operating revenues, which include both domestic and overseas online game operations, were RMB 2,499.4 million in fiscal year 2012 as compared to RMB 2,708.5 million in fiscal year 2011.

The year-over-year decrease was primarily due to lower monetization of some of our existing games for our domestic operations and was partially offset by the continuous space of our U.S. and European subsidiaries. After all, additional contribution from our recently launched new game Return of the Condor Heroes in the domestic market.

Licensing revenues were RMB 171.6 million in fiscal year 2012 as compared to RMB 246.8 million in fiscal year 2011. The year-over-year decrease was primarily because we did not launch any new games in the domestic market until the end of 3Q 2012, which led to less availability of new games for export to overseas markets in the fiscal year 2012.

Other revenues were RMB 99.6 million in fiscal year 2012, as compared to RMB 28.1 million in fiscal year 2011. The year-over-year increase was primarily associated with the revenue contribution from Torchlight 2, our popular pay-per-install game released in fiscal year 2012. Cost of revenues were RMB 539.9 million in fiscal year 2012, as compared to RMB 479.9 million in fiscal year 2011. The year-over-year increase was primarily due to an impairment associated with certain of our smaller games and an increase in staff cost in fiscal year 2012.

Gross profit was RMB 2,230.7 million in fiscal year 2012, as compared to RMB 2,503.5 million in fiscal year 2011. Gross margin was 80.5% in fiscal year 2012, as compared to 83.9% in fiscal year 2011.

Operating expenses were RMB 1,718.9 million in fiscal year 2012, as compared to RMB 1,480.2 million in fiscal year 2011. The year-over-year increase in operating expenses was mainly due to an increase in staff cost and the goodwill impairment associated with our Japanese subsidiaries.

Operating profit was RMB 511.8 million in fiscal year 2012, as compared to RMB 1,023.3 million in fiscal year 2011. Excluding the share-based compensation charge and the goodwill impairment, non-GAAP operating profit was RMB 623.7 million in fiscal year 2012, as compared to RMB 1,128 million in fiscal year 2011.

Net income attributable to the company’s shareholders was RMB 540.7 million in fiscal year 2012, as compared to RMB 984 million in fiscal year 2011. Excluding the share-based compensation charge and the goodwill impairment, non-GAAP net income attributable to the company’s shareholders was RMB 652.6 million in fiscal year 2012, as compared to RMB 1.0887 million in fiscal year 2011.

Basic and diluted earnings per ADS were RMB 11.31 and RMB 11.15 respectively in fiscal year 2012, as compared to RMB 20.18 and RMB 19.27 respectively in fiscal year 2011. Excluding the share-based compensation charge and the goodwill impairment, non-GAAP basic and diluted earnings per ADS were RMB 13.65 and RMB 15.46 respectively in fiscal year 2012, as compared to RMB 22.33 and RMB 21.32 respectively in fiscal year 2011.

In terms of the financial guidance, based on our current operations, total revenue for the first quarter of 2013 are expected to be between RMB 592 million and RMB 619 million. Torchlight 2, our popular pay-per-install game, contributed better-than expected revenues in the fourth quarter. We do not expect the revenue contribution from this game to be as significant in the first quarter of 2013.

In addition, we did not launch any major new games in the first quarter of 2013 and decided to slow down some of the in-game monetization in order to maintain a healthy life cycle of our existing games in the longer run.

This conclude our prepared remarks. We are ready to take your questions now. Operator, we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Eddie Leung from Merrill Lynch. Please ask your question.

Eddie Leung – Merrill Lynch

Hey, good morning, guys. Just can I have like two quick questions? The first one is, I wondered if Kelvin you could also indicate whether there is any impairment charge in your cost of services in the fourth quarter? And then secondly, also the question about the investment in – that we see from – going forward how can shareholders and there is attractive success and failure of those investments? Any guidance would be great. Thanks.

Kelvin Lau

Yes, good morning, Eddie. Thanks for the question. Okay. Regarding the first question, regarding the impairment, as what I mentioned in my remark, we did two major impairments in Q4 last year one of the impairment is related to the – some of our small games. You should know the other game testing will capitalize some of the R&D expenses. Right now the game, I think the performance is not as good as what we expect. So given the year-end assessment we decided okay to write-off this capitalized R&D expenses so this is one of the major impairment we’ve talked about in the cost of revenue in Q4.

Another impairment we did a goodwill impairment as what we said in the remark it’s all we did it to the Japanese subsidiary C&C Media because this goodwill is generated during the acquisition of the C&C media two years ago. Right now the Japanese subsidiary is not – I think right now – it is not as good as what we expect mainly because there are MMO market right now in Japan I think is not as – developing as good as what we expect. I think that Japan right now is I think – leader or dominated by the mobile. So going forward for the Japan operation, we are shifting a little bit to the mobile as well. So the RMB 14 million impairment is solely related to the Japanese subsidiaries. This is for the question number one.

Question number two is regarding the investment in the front. According to the requirement that we got to disclose, I think the performance of our fund in 2012 on an annual basis. So I think we will disclose a property, the performance of the plan according to the requirement of SEC or by – according to the U.S. GAAP. So you will find out obviously that I think the 2012. Thank you, Eddie.

Operator

Your next question comes from the line of Timothy Chan from Morgan Stanley. Please ask your question.

Timothy Chan – Morgan Stanley

Good morning. Thanks very much for taking my questions. My question is actually related to your web and mobile games strategy. How many of these games are going to be launched this year? And I want the painting as to position as of developer where is it as a platform in the web or mobile games sector. Thank you.

Robert Xiao

Thank you, Timothy, for the question. We do have relatively large number of web game and mobile game sale pipeline. We prefer not to disclose at this point of time in detailed numbers on these games because of the competitive leaders. But looking forward, we believe that our effort in R&D will pay it off because we do have the technology, we do have the artistic design capability which ahead of most of the studios in China. We’re going to put a lot of effort this year and we already launched Web game, it’s called the Three Kingdoms. The initial operational data was pretty good. So we’re improving our confidence in terms of how we can develop, get into this area, develop this type of games and we were pretty confident in that.

In terms of operation in the future, we’re pretty open in terms of publishing these games through our own networks or publishing this work with our partners as well. So we’re pretty open in how we’re going to publish and operate this game. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Muzhi Li from Citigroup. Please ask your question.

Muzhi Li – Citigroup

Hi. Thank you for taking my questions. I’d like to ask about the recent announcement you made for additional investment into VC fund. As far as I know that the key investment in China is pretty crowded, recurrence at guiding lower, and also the domestic IPO market is crowded. So who – why do you think this is a good investment to use the shareholder’s money to offer to put into VC fund and what is the current AUM of this fund and who runs this fund? Do you have some name that we can refer to? Thank you.

Kelvin Lau

Thank you for the questions. I think bringing well to the shareholders I think is one of our major commitment for Perfect World. So I’d rather say we just declared annual cash dividend of approximately I think $20 million to the shareholders. I think this is one of our commitment to the shareholders. Regarding the VC Fund is – there are investment in the VC Fund mainly focused on the early stage high-growth company in the TMT center. And then the immediate purpose is trying to get some potential synergy with our core business in the market.

Right now, we decided to increase our funds into the VC and expected the VC to put the investor in the PE Fund. I think the PE Fund right now is primarily focused on the – on investing in media in all those mature companies in the consumer and retail financial sectors, health care, TMT, energy, natural resources, manufacturing industry in China. And then the purpose of this is trying to more diversify our investment portfolio, lower the risk. I think it’s the major reason.

Regarding the NIM of the PE, I think what we inform is I think right now, the PE prefers not to disclose a NIM at this moment. So I think when we get the approval from the PE, we will probably disclose the NIM and a general plan of the PE Fund. Yes.

Vivien Wang

But this is PE Fund is a very famous fund. It’s consist of far more senior members of global private equity and financial service firms and a former senior executive of a Fortune 500 company. These core team members in the fund to manage the PE investment of nearly $3 billion in aggregate, so are pretty confident with the performance, yes. Thanks.

Operator

Your next question comes from the line of Mark Marostica from Piper Jaffray. Please ask your question.

Mark Marostica – Piper Jaffray

Yes. Hoping you can give us a little bit of a better idea on the timing of your upcoming game launches particularly Neverwinter, Saint Seiya Online, and Swordsman Online and overseas?

Robert Xiao

Yes. Thanks for the question. I think we were pretty much along with the – our committed pipeline. So the Neverwinter will be launched in Q2 and Saint Seiya and Swordsman Online would be launched mid-year this year. So far the production resulted it’s pretty up to the schedule so we are pretty confident there will be a – beat the timeline we required them to be launched. Thank you.

Operator

Your next question comes from the line of Andy Yeung from Oppenheimer. Please ask your question.

Andy Yeung – Oppenheimer

Hi there. Good morning. Thank you for taking my questions. My question is about the sort of housekeeping questions which is the total other income line, can you tell us how much of that is coming from government subsidies and how much of that was due to foreign exchange gains and equity investment gains?

Kelvin Lau

Thank you for the question. Our apologies. I deem not to disclose I mean very detail on each items. But I think I can give you some color I think including in the Q4 last year other incoming debt largely coming from the exchange gains because in Q4, there’s a depreciation of U.S. dollar against RMB and we have in our book we have U.S. dollar payable amount due from Hong Kong company due to gaming companies.

So we signed quite a lot from the depreciation of U.S. dollar in Q4. So generally – so that the amount of exchange gain in Q4. Certainly, I think the government subsidies, I mean to be honest, we cannot disclose the amount of government – how much the government subsidizes to us. So I would say that the amount is highly similar to that of last year. So these two components I think represent the major part of the other income for Q4 last year.

Vivien Wang

And in terms of income from equity investment, it’s actually in our P&L. You can check the number in there. Thanks.

Operator

Your next question comes from the line of George Meng from Macquarie. Please ask your question.

George Meng – Macquarie

Hey, good morning, everyone. Thank you very much for taking my question. So my question is related to your first quarter 2013 guidance. I wonder why the guidance looks quite soft given that normally Q1 historically is a good – a strong quarter, a seasonally strong quarter for – especially for domestic markets. So do you see any change of the kind of pattern that people play games during maybe the Chinese New Year Holiday? Do you see that people are now playing less games during Chinese holidays? And also, that soft – a little bit softer than expected guidance imply that the new game, The Return of the Condor Heroes, is not as good as we expected before? Thanks.

Michael Chi

Thanks for the question. I think first of all, I got to say that Condor – Return of Condor Heroes up to now, the performance, I think we are satisfied with the performance of Return of Condor Heroes. And also, Return of Condor Heroes right now is clearly stable in terms of ACU and also the revenue contribution to the whole group.

We made a bit of change in our monetization strategy for our existing old games in Q1 this year, especially for the quarter two and – quarter two and Zhu Xian.

As what we’ve mentioned in the remark, I think we decided to further slowdown the monetization of our core game (inaudible) in Q1. So as to ensure that I think, to prolong or to maintain the healthy life cycle of the game. As well as – you have seen, we didn’t launch any new games last year. Our big titles will be launched in midyear, this year in China. So adding to the conservative, we got to make sure that our – all games can continue to maintain at a stable level so we dare not to do so many aggressive monetization activity for (inaudible). I think this is one of the key reason why in the first quarter we decided to slowdown the monetization and this is the key reason why we have a soft guidance for Q1 and this is the major reason.

From our observation, in Chinese New Year, this is still the – we didn’t observe any any major changes in the gamers’ behavior or their patterns, I mean in Q1. So net-net, we still think MMO still remained one of our – still our dominant revenue contributor in this year so that’s why we are quite confident there. Our new game like Saint Seiya and Swordsman Online and Neverwinter will contribute meaningful revenue for us this year.

Vivien Wang

And also, Torchlight is another reason that for a softer guidance, our total revenue in Q1. Because Torchlight 2 is a pay-per-install game. There is more of a one kind of revenue for us in Q3 and Q4. We do not expect significant revenue coming from those games in Q1. Thank you.

Operator

Your next question comes from the line of William Huang from Barclays. Please ask your question.

William Huang – Barclays

Hi, morning. Thank you for taking my call. My question is about expensive margin trend. In Q4, it seems like overall expense and I figure R&D increased significantly and due to some kind of bonus to develop, so how should we view the expense level and the margins trend going forward? Or should we expect any slightly rebound in the next few quarters? Thank you.

Kelvin Lau

Thank you. For competitive reason, I think also apology, we are not giving – we are not going to give any guidance on the margin. We will just give the guidance that’s linked for the revenue. Regarding your question as in relation to the R&D expenses, yes, in Q4 last year, our R&D expenses increased quite a lot. I think there’s two reasons, that’s why I said in Q4 we paid some special dividend to some teams which launched games successfully in the second half of this year, so this has specialty, we gave it to a bonus – we’ve given to some teams.

Second question is what I say going forward, we are going to invest more on mobile and the web game so the head count also increased a little bit in Q4, online staff on developing mobile and web games. So there’s the two major reasons for the increase in R&D expenses for last quarter.

Operator

Your next question comes from the line of Martin Bao from CICC. Please ask your question.

Martin Bao – CICC

Thank you for taking my question. My question is due regarding your ongoing operation with the client games as we see that the ACU improved the quarter of according to fourth quarter. And I’m wondering whether you will continue to implement the low monetization strategy not just in the first quarter but throughout the year maybe into the future for those existing operating games. And how would you operate those new games compared with the old games? Thank you very much.

Robert Xiao

I think our current strategy is very clear that we want to extend the lifecycle lifetime for our existing games especially those big games we already have like Zhu Xian and Perfect World. So the monetization activity we decide to put on is totally decided by whatever we see, a trend of people coming back or we can generate more people and the lifecycle seems to be extended. All the decisions in the future will be decided upon the observation of the user behavior. Furthermore, in terms of new games we will continue to monitor in the balance between monetization and the maintaining a healthy lifecycle. We believe that by constantly adjusting that and observing that, we’ll be able to monetize as much as possible, and at the same time maintain a healthier, longer performance lifetime through these games. Thank you.

Operator

Your next question comes from the line of Jia Long Shi from CLSA. Please ask your question.

Jia Long Shi – CLSA

Hi, good morning. Thanks for taking my call, and I have a housekeeping question, for your rate reported ACU for 4Q just wondering if it included user for your Web games or it was solely for your current games?

Vivien Wang

It’s currently MMORPG games. We haven’t included Web games in the SKU number yet.

Jia Long Shi – CLSA

Thank you.

Vivien Wang

Yes.

Operator

Your next question comes from the line of Muzhi Li from Citigroup. Please ask your question.

Muzhi Li – Citigroup

Hi. Thanks for taking my questions. I would like to ask about the company’s game, the new game operation in 2013. Do you think the lower monetization of the old games, revenue contribution might be made out by the new games’ contribution in 2013 and maintain the same level of total monetization in 2013 as a whole? Thank you.

Kelvin Lau

Muzhi, I think for the monetization, I think it all depends on the individual games. So I do – if I understand clearly about your question is, I think there is none mixed. Each individual game will determine I think their monetization in one way, or it all depends I think the balance between the game life cycle and the monetization activities.

But normally, I think for new games like Swordsman online or sincere on that one every year, initially our practice is we are not going to do aggressive monetization at the beginning phase of the game. So I think the major purpose at the beginning is time to kick the gamers. I think accumulate more user base for the new games.

So for new games, I mean the strategy is like this. For old games, I think, it all depends I think on the balance between the monetization and the game life cycle, yes.

Vivien Wang

But of course, as we’re announcing a number of our games, key titles throughout this year, we are positive for the outlook for 2013. Thanks.

Operator

(Operator Instructions) Your next question comes from the line of Mark Marostica from Piper Jaffray. Please ask your question.

Mark Marostica – Piper Jaffray

Yes, thanks for taking my question. Just a follow up, housekeeping item, the taxes for fourth quarter reading the press release it looks like you got a very significant tax benefit. Which should we be looking for in terms of tax for – like the tax rate for 2013? Thanks.

Kelvin Lau

Thank you, Mark. I think the deliberate increase in the income tax expenses for Q4 as well, eventually, R&D super deduction by the end of the year because at the year so I think we’ve got to recognize this where we confirm that with the cash pre-order I enjoyed to have this super deduction in relation to R&D. So this is very special. I think at the end of every year, so going forward, I still maintain my guidance for the tax rate for 2013 should be around 19% to 21% of the effective tax rate because most of our PLC entities right now is at the stage of 50% of the pre-rating, I think, tax rate. We are still enjoying the 50% deduction of the CIT in China.

So I think there’s no similar change in terms of the tax structure in China this year, so that still remain at about – my estimation is 19% to 21% effective tax rate for this year. Thank you, Mark.

Operator

(Operator Instructions) There are no further questions at this time. I’d now like to hand the call back over to Ms. Joanne Deng for closing remarks.

Sorry my apologies...

Joanne Deng

Thank you.

Operator

We now have a question from Nick Ning from 86 Research. Please ask your question.

Nick Ning – 86 Research

Hi, thanks for taking my question. So just curious on what is our view on how to make a successful client games in this market right now versus say three to four years ago, what’s the difference? And what’s – how to make a successful web game in our view and what’s our difference from the – from making client based game? Thank you.

Robert Xiao

Okay. The call – thanks for the question but I think the call is now very clear from our end. But I guess you were asking the question comparing the client base and the web base product, what is the success factor for now and compare to four years ago, is that the question?

You couldn’t answer. Okay, I’m sorry. Our view is very simple, four years ago, probably they’re less competitive client base in Marmon in China. So now the market itself is much more competitive, better technology, better artistic design and more teams are being able to get into the fine base sector. So for now compared with four years ago, whatever successful studio could do is to get the best technology and best artistic design people and really put up the best title together. So it may require a little bit longer of development time cycle, a bigger team, a little bit more investment than four years ago. And then the product itself has to be one of the best products to attract more eyeballs in this market now.

So in summary, in client base, we do see a number of players are not increasing significantly as four years ago, but eventually the market is still sizable. It’s still the major money generation kind of a body in the gaming market. A lot of competitors are in this region, in this sector so it’s hotter than four years ago.

In the web game sector, I think four years ago, we don’t see too many web games yet, but now they’re still becoming a little more mature than four years ago. It’s the same trend, you have to have the best people, have to have the best technology and being able to produce the best quality games.

And so again, looking at the trend it is not only the trend for the gaming sector but the trend for many of the different product in the service market. So our goal or our policy is very simple we already have the best technology and best people in our company and we’re going to focus in on producing the best quality games in any of the sectors we’re in. By doing that, we believe that we’ll be catching up the market and make sure we generate more profit and producing more value for the shareholders. I hope that answer your question. Thank you.

Operator

(Operator Instructions) It does appear to be no further questions at this time. So I would now like to hand the call back over to Ms. Joanne Deng for closing remarks.

Joanne Deng

Thank you. This is the end of the conference call. The webcast 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.

Robert Xiao

Thank you. Thank you so much. Thank you.

Michael Chi

Thank you.

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