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THE9 Limited (NASDAQ:NCTY)

F4Q2012 Earnings Call

April 17, 2013 9:00 pm ET

Executives

Phyllis Sai – Investor Relations Manager

Jun Zhu – Chairman and Chief Executive Officer

George Lai – Chief Financial Officer

Analysts

Thomas Chong – BOCI Research Ltd.

Dick Wei – JPMorgan Securities Ltd.

Operator

Good day, ladies and gentlemen, and welcome to The9 Limited’s Second Half 2012 Financial Results Conference Call. My name is Ben and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference call. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today’s conference, Ms. Phyllis Sai, IR Manager of The9 Limited. Please proceed ma’am.

Phyllis Sai

Thanks, Ben. Hello, everyone, and thank you for joining us today for The9’s second half 2012 financial results conference call. With me today are Mr. Jun Zhu, Chairman and Chief Executive Officer, Mr. George Lai, Chief Financial Officer. Mr. Jun will read out his prepared remarks and then George will have a detailed discussion of our financials. Then we will open the floor to take questions, before we continue, as always please allow me to review the Safe Harbor statement in connection with today’s call.

During the course of today’s call, certain projections or forward-looking statements may be made regarding The9's future financial performance or future events. We wish to caution you that such statements or predictions are based on our current information and expectations and actual results may differ materially from those projected in the forward-looking statements.

We would also like to refer you to the documents that the company filed with the United States Securities and Exchange Commission. Those documents contain additional information concerning factors that could cause actual results to differ materially from those contained in the management’s projections or forward-looking statements.

Now, I will like to turn the call over to our Chairman and CEO, Mr. Jun.

Jun Zhu

[Foreign Language]

Good day ladies and gentlemen thanks for participating in our discussion of The9 second half of 2012 results. First of all I will like to express my sincere gratefulness to our shareholder’s long-term support to our large scale strategic adjustment in the past few years.

Today I will address your concerns on when we can turn into profitable and when we will launch our big new titles to the market.

[Foreign Language]

Based on our estimation, hopefully we can be profitable in the fourth quarter of this year.

[Foreign Language]

Firefall, a game developed by our U.S. studio, Red 5, opened numerous tests and delays during its seven years development with a total investment of approximately $100 million. We will commence a full scale open beta test on July 9 this year.

[Foreign Language]

QiJi2, a game developed by our in-house Korean R&D team will have its open beta test on September 28 this year to celebrate the test and the anniversary of the launch of QiJi2 in China.

[Foreign Language]

On June 25 this year, Planetside 2 will launch its open beta test.

[Foreign Language]

We have also made significant effort in the past two years to develop our web game and mobile Internet business to ensure our growth in near term. Today, we are not going into group details here.

[Foreign Language]

Okay, so now let me take you briefly through our overview of our quarterly financial results. Our net revenues in the third quarter of 2012 were $5.2 million, representing a decrease of 41% from $8.8 million in the second quarter of 2012 and an increase of 19% from $4.4 million in the third quarter of 2011. The decrease over the previous quarter was primarily due to a decrease in revenue from ShenXianZhuan. The year-over-year increase from the third quarter of 2011 was primarily due to an increase in revenue from ShenXianZhuan which was commercialized in August 2011.

Our net revenues in the fourth quarter of 2012 were $3.0 million, representing a decrease of 43% from $5.2 million in the third quarter of 2012 and a decrease of 33% from $4.5 million in the fourth quarter of 2011. Such decreases were primarily due to a decrease in revenues from ShenXianZhuan and other MMO games during the same periods.

Our gross profit in the third quarter of 2012 was $2.4 million, representing a decrease of 62% from $6.2 million in the second quarter of 2012 and an increase of 9% from $2.2 million in the third quarter of 2011. The decrease over the second quarter of 2012 was primarily due to a decrease in net revenue from ShenXianZhuan and an increase of amortization costs related to Firefall upon its small-scale launch in September 2012. The increase over the third quarter of 2011 was primarily due to an increase in net revenue from ShenXianZhuan.

Our gross loss in the fourth quarter of 2012 was $0.2 million, compared to gross profit of $2.4 million in the third quarter of 2012 and gross profit of $2.1 million in the fourth quarter of 2011, primarily reflecting a decrease in net revenue from ShenXianZhuan and other MMO games and increase of amortization costs related to Firefall.

In the third quarter of 2012, our operating expenses were $32.9 million, representing a 21% increase from $27.1 million in the second quarter of 2012, and a 45% increase from $22.7 million in the third quarter of 2011. These increases were primarily due to an increasing marketing expenses relating to Firefall and Planetside 2, an increase in product development expenses relating to Firefall and web and mobile games and a loss recorded in the third quarter of 2012 in connection with our restructuring of our investment in Fire Rain and Wanyouyl.

In the fourth quarter of 2012, our operating expenses were $23.9 million, representing a 27% decrease from $32.9 million in the third quarter of 2012 and a 6% increase from $22.5 million in the fourth quarter of 2011. The decrease over the third quarter of 2012 was primarily due to a decrease in marketing expenses, a decrease in product development expenses relating to mobile game business and the loss recorded in the third quarter of 2012 in connection with our restructuring of investments. The increase over the fourth quarter of 2011 was primarily due to an increase in marketing expenses related to Firefall and Planetside 2.

Net loss attributable to holders of ordinary shares was $27.1 million and $18.6 million for the third quarter and fourth quarter respectively. Fully diluted per share and per ADS was $1.1 million and $0.76 for the third quarter and fourth quarter respectively.

In December 2012, our Board approved a repurchase program to repurchase up to $10 million ADS over the next 12 months. Under this repurchase program, as of April 11, 2013, we have repurchased approximately 1.6 million ADS for an aggregate consideration of approximately $4.4 million.

Thank you for listening to our presentation today. At this time we will take questions. Operator, please.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from Thomas Chong from BOCI. Please ask your question.

Thomas Chong – BOCI Research Ltd.

Hi, good morning Jun Zhu and George. I have a couple of questions, the first question is regarding ShenXianZhuan, one of the issues encountered by this game in the third quarter and the fourth quarter, and how should we think about the performance of this game in 2013, and then I have a couple of follow-up, thanks.

George Lai

Okay, thank you for your question. So we think ShenXianZhuan is a typical Chinese made MMORPG game. We have achieved decent result in Q2, when we launched open beta of the game but afterwards due to our delay in expansion test and we predict this thing is not a very, we don’t have advanced technology and a break through in the traditional MMORPG market. So I think that’s the reason why in our pipeline we have a very different types of MMORPG or MMOFPS game to be launched including Firefall and also Planetside 2 and both of them are western developed game. So I think this is strategic move for The9 to move from traditional MMORPG games to more advanced MMO games.

Thomas Chong – BOCI Research Ltd.

I see, thanks George. The second question is regarding your new games like Planetside 2 and Firefall, do you guys tend to operate the games by yourself or should we expect there are some forms of cooperation like joint operation in China market in the future. And I looked at that in the press release that Firefall is to be launched in Europe and U.S. in July this year, and when should we expect Firefall to be commercially launched in China market? Thanks.

Jun Zhu

[Foreign Language]

George Lai

Okay, so let me translate it little bit, Planetside 2 is a game we licensed from Sony Online Entertainment, so we will only operate in China. And so for Firefall, you are right, we are going to launch the game in U.S. and in Europe in July this year and so our plan in China currently we plan to operate the game by ourselves.

Thomas Chong – BOCI Research Ltd.

I see. And my third question is regarding your mobile games strategy, I remember last time the discussion is about the potential business models, I just want to get a sense, can you guys rank the business models like micro-transactions, in-game advertising and pay-per-downloads. Can you rank which of these business models should be best in China and how do you see the situation regarding to mobile monetization compared to other market like U.S.? Thanks.

Jun Zhu

[Foreign Language]

George Lai

Okay. So let me translate. Yesterday we just launched our in-house developed mobile game called (inaudible) and we still haven’t received the result yet, but this is an example. We believe that the monetization of mobile game in China is still at a very immature stage, but we also emphasized the importance of this mobile market in China. So we have already stepped in into this mobile end market for more than two years and we will still continue to invest, and then we believe we will find a way to monetize the game very soon.

Thomas Chong – BOCI Research Ltd.

I see. Thanks, Jun Zhu and George. I’ll turn back to you.

George Lai

Thank you.

Jun Zhu

Thank you.

Operator

And your next question comes from the line of Dick Wei from JPMorgan. Please ask your question.

Dick Wei – JPMorgan Securities Ltd.

Hi. Good morning. Thanks for taking my questions. Just want to follow-up on the prior questions regarding the Firefall launch schedule in China. Thanks.

Jun Zhu

[Foreign Language]

George Lai

Okay. So let me translate. Currently our focus is still on the English version in U.S. and Europe. So after three months we will start to plan on when we can launch the game in China, Korea and western market. So now we need to focus on our resource on the U.S. and Europe market first.

Jun Zhu

[Foreign Language]

George Lai

So Mr. Zhu is very confident about the game. So actually we have already licensed the game to go in Southeast Asia, but this was due actually one to buyback the license for the Southeast Asia market.

Dick Wei – JPMorgan Securities Ltd.

That’s correct. What kind of initial feedback from the gamers that you can share and as far as maybe the business model for the game in China versus the rest of the world? Thanks.

Jun Zhu

[Foreign Language]

George Lai

Okay. So Mr. Zhu believes that there is no big difference between the monetization of games in China and in U.S., and currently he beliefs that all the [web-based] games and most popular games in China, online game markets are all from the western world of Korean. So it has been proved that there has been no significant improvement for domestic developed games in China. So, we believe that Firefall is a game we can explore to the global market in including U.S., Europe, and Korea and China.

Dick Wei – JPMorgan Securities Ltd.

Thank you. Maybe, I again have the last question. So, I guess Mr. Zhu commented a little bit about mobile games launch yesterday. I wonder, what is the development size of the team and maybe in a near-term what kind of products can we expect from the company, mobile game?

George Lai

Yeah, we have a team of about 60 people in our mobile game development team and the total investment size is more than RMB10 million.

Dick Wei – JPMorgan Securities Ltd.

Thank you. And new products will be offered?

George Lai

And so far all our 60 people team has been focusing on one mobile game, because we believe that this mobile game will be with a very high quality and we believe that in the current China mobile game market, there are too many games with low quality and occupying the market. And I think similar to the [online] game and the web game, the mobile game needs to have some breakthrough in terms of the technologies and the playability. So, we believe that after the launch of this game based on this survey we will continue to invest in the mobile game in China.

Dick Wei – JPMorgan Securities Ltd.

Okay, great. Thank you very much. Thanks for your time Zhu.

George Lai

Thank you, Dick.

Jun Zhu

[Foreign Language]

Operator

Your next question comes from the line of Tian Hou from T.H. Capital. Please ask your question

Unidentified Analyst

Hi. This is (inaudible) calling on behalf of Tian Hou. I have some questions about Firefall. The first one is can you update us the progress of license of Firefall in Russia, (inaudible) and other regions?

Jun Zhu

[Foreign Language]

George Lai

Mr. Zhu emphasize again he is very confident about the quality of Firefall in terms of the brand new game engine and also the depth of the content. So currently our plan is to operate Firefall either by THE9 or by Red 5 or (inaudible) only except the Southeast Asia which we have already signed an license agreement with RINA.

Unidentified Analyst

Okay. Thank you. The second question is about the current revenue size of Firefall. As Firefall started to be commercialized in December last year, I understand that it only had one months revenue contribution in Q4 last year. We understand that it does not evidence the revenue potentially in the future set back Tier 1s to get some colors about Firefall revenue in the first three months this year?

George Lai

Well, I need to clarify that actually Firefall has only started to sell of Founders Packs by the end of last year. So we haven’t really monetized the game yet. So it hasn’t been reflected in our financial in 2012. So as we have discussed earlier in this call, we have already announced that Firefall open beta will be in July 9 this year. So we believe that after the launch of the open beta the revenue coming from Firefall will be significantly increased.

Unidentified Analyst

Okay. Thank you. The third question is about your termination of the investments in Fire Rain and Wanyouyl, can you give some colors on that?

George Lai

Fire Rain is the developer of ShenXianZhuan. As I said earlier in the call, ShenXianZhuan performance after which it is peak in the middle of last year, it’s revenue has been dropped. So we have a strategic adjustment on our domestic game studio investments including Fire Rain and also Wanyouyl.

As I said and also Zhu Jun mentioned just now, we believe that the quality of traditional MMORPG game in China has seen some big improvement in the past few years and therefore the most popular games in China are mostly from the space or from Korea currently. So we have made that strategic decision to focus our resources on Firefall and also Planetside 2 and QiJi2. So this is the reason why we have given up our investment in Fire Rain and Wanyouyl.

Unidentified Analyst

Okay. My last question is about your marketing strategy. I read on the news that the night we present at the second Digital Centre at ChinaJoy this year, which is equally regarded as another primary digital center. Can you let us know what is your rationale behind this and what games would you promote at ChinaJoy?

George Lai

Will present on whether our booth will be in number one hall or number two hall isn’t really a big deal, that People are coming to ChinaJoy at most we’re talking about ten thousands of people, but for popular MMO game in China the user base is talking about millions of people. So we already set out much more effective marketing way to promote our coming three big titles and ChinaJoy is not our only way to promote our games.

Unidentified Analyst

That’s all my questions. Thank you.

George Lai

All right, thank you.

Operator

(Operator Instructions) And your next question comes from (inaudible) from Elevation. Please ask your question.

Unidentified Analyst

Yeah. Just a follow-up on the previous conversation. The question is about Firefall and the Founder’s Packs. Those have been for sale for both the third and fourth quarter of last year. I am wondering why you are not including any of those numbers from those sales. Are they not big enough, or can you give a little more information on what those sales were and how they effect your guidance for where you expect to make on monetizing?

George Lai

Founder’s Packs is only for testing purpose. So we have now record significant revenue regarding the sales of Founder’s Packs and also we will only recognize the revenue upon the consumption of in-game items. So much of the revenue, cash revenue coming from Founder’s Pack actually is still sitting on the defer revenue on our book. And so they will be some revenue wherein players consume their items in the game.

So, as I mentioned, we believe our Founder’s Packs. It’s just a promotion tool for us to let the gamers try to patch the game, give us feedback so that we can improve the game better. So our focus actually is still on the open beta test, which will be open to everyone interested to the game. We have already determined the open beta test stage will be July 9 this year.

Unidentified Analyst

Okay. And just looking at the income statement that you provided and I don’t see any kind of deferred revenue in line.

George Lai

(inaudible) on the balance sheet, but not in the income statement.

Unidentified Analyst

Okay, okay thank you.

Operator

There are no further questions from the phones at this time. I will now hand the conference back to Ms. Phyllis Sai.

Phyllis Sai

We would like to thank you all for participating in today’s call and since there is no more questions and we are looking forward to updating you on our progress next time. Please feel free to contact us with any additional questions. Have a good day.

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