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The9 Limited (NCTY)

Q2 2006 Earnings Conference Call

August 9, 2006 9:00 pm ET

Executives

Jun Zhu - Chairman and Chief Executive Officer

Hannah Lee - Vice President and Chief Financial Officer

Dahlia Wei - Senior Investor Relations Manager

Analysts

Antonio Tambunan - Bear, Stearns & Co.

[Katherine Lawrence] - Citigroup

Wallace Cheung - Credit Suisse

[Lin Chi] - Lehman Brothers

Dick Wei - JP Morgan

Paul Keung - CIBC World Markets

Chang Qiu - Forun Technology Research

Jason Brueschke - Citigroup

Wallace Cheung - Credit Suisse

Leah Hao - Thomas Weisel Partners

Dick Wei - JP Morgan

Lin Chi - Lehman Brothers

Leah Hao - Thomas Weisel Partners

Presentation

Operator

Good day, ladies and gentlemen, and welcome to The9 Limited second quarter earnings conference call. My name is Shamika and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of today’s conference. As a reminder, this conference is being recorded for replay purposes.

(Operator Instructions)

I would now like to turn the presentation over to your host for today’s conference, Ms. Dahlia Wei, Senior IR Manager of The9 Limited. Please proceed, Madam.

Dahlia Wei

Thank you, Operator. Hello, everyone, and thank you for joining us today for the The9 second quarter 2006 financial results conference call. The management with me today are Mr. Jun Zhu, Chairman and Chief Executive Officer; and Hannah Lee, Vice President and Chief Financial Officer.

Before we start, I would like to read you the Safe Harbor statement.

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

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

Let me now turn the call over to Mr. Zhu, our CEO, to provide you with an overview for the quarter.

Jun Zhu (Translation)

Good morning and good evening, ladies and gentlemen. I would like to thank you for participating in today’s discussion of The9 second quarter 2006 earnings.

First, let me present a quick overview of the key financial and operational highlights for the second quarter 2006. Net revenue for the second quarter were $32.2 million. Net income was $21.5 million, for earnings of $0.43 per ADS.

For the second quarter of 2006, we attained WoW peak concurrent users of approximately 630,000, and average concurrent users of about 330,000, up 6% and 14% respectively compared to the previous quarter. As of June 30, 2006, over 5 million paid accounts have been activated for the WoW game.

In the second quarter of 2006, we introduced two more upgrade packages for WoW, Version 1.10 and Version 1.11 continuously enriching the game content of WoW. We also continued to promote the WoW games throughout mainland China. We launched the World of Warcraft national tournament campaign in April and concluded the event with an eye-catching banner contest in Shanghai in June. The event attracted more than 7,600 Internet cafes and guilds from 40 cities to send their participating teams to compete in the tournament.

The event successfully attracted nationwide user attention, thus not only enhancing the brand name of WoW and The9, it also has a positive impact on game playing time consumption.

Together with the ongoing Internet Café Upgrade program, and Member Get Member program, this marketing activity enabled us to further penetrate into second- and third-tier cities in mainland China.

In July, 2006, we participated in the ChinaJoy Expo in Shanghai, and showcased our various game products. With our high quality and diversified game offerings, The9’s booth attracted many interested visitors. We also invited top executives from The9’s developers of our licensed games to attend the ChinaJoy event. They flew over to Shanghai, presented at The9’s booth and interacted with Chinese online game players, game media, and to the public, and their appearance has become one of the hottest topics and highlights among online gamers and the media during the ChinaJoy event.

In July, 2006, we also kicked off a new round of co-marketing campaign with Coca Cola. Compared to last year, this year’s co-marketing program will focus more on increasing the game playing time consumption of WoW, in addition to enhancing the brand awareness of the game.

We expect this year’s co-marketing campaign will involve around nine weeks of intensified TV commercials, covering over 200 TV channels amongst close to 100 cities, and approximately 500 million Coke beverage packages containing WoW-related printing will be distributed all over China

With the continuous growth of WoW’s confirmed user level in the second quarter, our existing six server sites are close to their full capacity. In order to facilitate further user growth, we plan to launch the seventh server site in late Q3.

Now I will turn to our pipeline game portfolio. Our game portfolio is comprised of two aspects, licensed game and improved gradually internally developed games. I will talk about both aspects in detail.

With respect to our licensed games, in May, 2006, through a subsidiary, we licensed Hellgate: London, another high-caliber MMORPG with first-person shooting features. The license allows us to operate the game exclusively in China for three years after commercialization. With this, we have now secured four global leading games, including Guild Wars, Soul of the Ultimate Nation, Granado Espada, and Hellgate: London, contributing what we believe is a very strong game pipeline.

Based on the well-respected independent 17173 game ranking billboard in China, as of August 8, 2006, all four games were ranked as one of the top-ten most anticipated games by Chinese gamers.

For Guild Wars, we intend to launch beta testing in early Q4 and start commercialization before year-end 2006.

For Soul of the Ultimate Nation, we plan to commence beta testing for the game in the first quarter of 2007.

With respect to our proprietary, internally developed games, in relation to our first development effort, Joyful Journey West, we have made notable progress in the year 2006 to date, with Fantastic Melody Online now in off-store spaces, and Supergirl Online among co-developed spaces.

Recently, at ChinaJoy, we officially revealed the game Fantastic Melody Online, or FM Online in short. It is a 3D, round-action MMORPG that we developed through R&D outsourcing and is preliminary scheduled to be launched in China in mid-year 2007.

Supergirl online is an interactive entertainment community-based online game, with lots of interactive communication tools and in-game add-ons. This game is co-developed and co-operated through a joint venture between The9 and two business partners.

Guided by our vast quality game strategy, The9 on one hand continues to strengthen its position as a partner of choice in China for foreign developers, and on the other hand, maintains its efforts on game development through a diversified R&D approach. We believe we have built a very strong and diversified game pipeline and we are confident that the company is well-positioned for future growth.

Now I would like to talk about the latest developments regarding our overseas geographic expansion. In relation to the joint venture, of which we have 30% active interest that operates the WoW game in other regions of greater China. In July of 2006, we made a monetary investment in a new joint venture.

This joint venture has obtained the exclusive rights to operate two top-rated MMORPG’s, namely Granado Espada and the Hellgate: London, in eight southeast Asia countries. Geographic expansion is one of The9’s strategic initiatives, and we have always been exploring opportunities in other regions beyond China. We believe Southeast Asia’s online game market is growing rapidly, and this represent an excellent opportunity for us.

Overall, I think the second quarter is a solid quarter with excellent financial and operational results. Now, I would like to turn the call over to Hannah Lee, our CFO, to provide you with a more detailed discussion of our second quarter 2006 un-audited financial results.

Hannah Lee

Thank you, Jun, and hello, everyone. I will now take you through a review of our second quarter 2006 results, focusing on the key highlights.

For the second quarter of 2006, The9 reported net revenues of $32.2 million, a 21% increased compared to the previous quarter, and grew substantially from the same period last year.

The sequential growth of revenue was a combined result of increased average concurrent user level and includes ARPU, average revenue per user hour, over the previous quarter.

Net revenues attributable to WoW, which include revenues from game-playing time, merchandise, and installation package sales, were $32.0 million, and increase of 22% from the previous quarter, and accounted for 99% of total revenues in the second quarter.

ARPU, average revenue per user hour for the second quarter includes RMB0.37 from RMB0.35 in the previous quarter.

For the second quarter of 2006, gross profit increased to $15.5 million compared to $11.9 million in the previous quarter, with gross margin improved to 48% from 45% in the previous quarter.

This increase in gross margin was primarily as a result of economies of scale of certain cost of services component, such as server depreciation, Internet data center rentals, and intangible asset amortization, whereby these costs did not increase proportionately compared to the increase of our net revenues.

Operating expenses for the second quarter of 2006 increased by 41% to $6.8 million, from $4.8 million in the first quarter, in line with the increased trend of revenues. This was a combined result of increased sales and marketing expenses due to normalized marketing expenses for the World Cup in the second quarter, and increased general and administrative expenses due to higher professional fees related to our Sarbanes Oxley compliance project.

At the operating level, we reported a profit from operations of $8.8 million, up 23% from $7.1 million in the first quarter.

Net income for the second quarter was $10.5 million, a 43% increase from $7.4 million in the first quarter.

Fully diluted earnings per ADS was $0.43 for the second quarter of 2006 compared to $0.30 for the previous quarter. It should be noted that in the second quarter of 2006, we recognized the financial subsidy from the local government amounted to $1.4 million.

EBITDA for the second quarter of 2006 was $15.6 million, compared with an EBITDA of $12.5 million in the previous quarter. On a per share basis, EBITDA per share was $0.63 for the second quarter, compared to $0.51 for the previous quarter.

As of June 30, 2006, the company’s total cash and cash equivalence dollars was $82.3 million.

With the World Cup Soccer Tournament stretching from the latter parts of June to mid-July, 2006, as were other forms of entertainment, we had seen some impact on the World of Warcraft user level during such periods.

In the third quarter, in preparation of the upcoming Version 1.12 WoW upgrade, with a highly anticipated cross-server battlefield function, we plan to merge some server realms starting in mid-August. Although this realm merger plan is anticipated to have a temporary impact on World of Warcraft’s user level, we expect user experience to be further improved, and on an overall basis, beneficial to the game’s growth in the long run.

It should be noted that we plan to open a seventh WoW server site in late Q3, providing additional capacity and gearing up for the 1.12 version upgrade.

With this, I would like to thank you for your attention. This concludes our presentation. We are now ready to take questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Antonio Tambunan with Bear, Stearns. Please proceed.

Antonio Tambunan - Bear, Stearns & Co.

I had a little trouble getting on to the call. Did you guys go over any statistics for the AC or PC for the World of Warcraft?

Hannah Lee

Yes, we did. The PCU we have for Q2 was 630,000 and average concurrent users was 330,000.

Antonio Tambunan - Bear, Stearns & Co.

Thank you. Getting into my questions here, I just got off the call with WebZen, and I am just kind of curious about Sun. It appears, from what I am hearing on the WebZen side, that Sun still has quite a few issues in terms of the development. I think they indicated that the open beta was going to happen in fourth quarter and a commercial launch for Sun is going to be in the first quarter. How does that impact your scheduling and what is the outlook for Sun now in terms of your scheduling?

Jun Zhu (Translation)

We do have three months of time. We will communicate with WebZen and the Sun development. I think we will have time to solve those problems.

We now plan to launch our own beta testing for the Sun game in Q1 next year, and we have -- I think this game is well-expected for the Chinese online gamers.

Antonio Tambunan - Bear, Stearns & Co.

Does that mean the commercial launch is likely to happen in second quarter, or are we still talking a first quarter launch for Sun?

Hannah Lee

Antonio, right now because we are planning beta testing some time in quarter one, depending on the response from the players, we will be commercializing the game as soon as possible, which would likely be some time late Q1 or early Q2.

With respect to the questions that you have about the development of the game, as you know, WebZen is always trying to improve the game on an ongoing basis, which is what they do best, depending on the feedback from the players. It is just part of the development process.

We do not think, based on our current communication with WebZen, there are any significant issues noted. Most of them are feature enhancements and things that are improving the user’s experience, so we are -- as originally planned, we are still doing beta testing in Q1 of ’07.

Antonio Tambunan - Bear, Stearns & Co.

What is the progress of Supergirl right now, on the game?

Hannah Lee

The Supergirl game is still under development. We are planning to have the game in open beta testing some time in late Q3 or early Q4.

The game is our first attempt into the casual game area, and we are, because of the popularity of the Supergirl singing contest itself, and right now, with the anticipation levels from the casual gamers’ response, we believe the game would have a very good user level base when it will be launched some time later in the year.

Operator

Your next question comes from the line of Katherine Lawrence of Citigroup. As a reminder, please limit your questions to only one. Please proceed, ma’am.

Katherine Lawrence - Citigroup

We are seeing quite impressive numbers from WoW, especially given the World Cup and the fact that both Shanda and NetEast launched new games in the second quarter. Could you please talk about the impact of this competition and what drove the growth? I know you mentioned the increased user level and ARPU. Is this from increased marketing efforts, penetration into the second-tier cities, seasonality, or increased pricing?

Hannah Lee

Could you hold on? We will just translate your question to our Chairman.

Jun Zhu (Translation)

Since the World Cup Soccer game started June 10th, we saw a slight slowdown of user growth for WoW. The slight slowdown of the WoW game is kind of a cross-board issue for the online game industry. Were it not for the World Cup, our Q2 results could have been better.

I think the growth of the WoW game is very closely related to our efforts in number one, marketing and number two, the penetration into second-tier industrial cities. As I just said in my previous presentation, we launched two packets for WoW, 1.1 and 1.11. I believe the new addition to the WoW game content also helps us for the growth of WoW.

Some time in September, we are expecting a new upgrade, 1.12 with some cross-server battlefield functions. In preparation for that, we are conducting some server mergers and server rearrangement in August. We expect after the launch of this upgrade in September, our user growth will reach to a new level.

As we saw, last year’s co-marketing campaign with Coca Cola played a very key role in boosting the growth of the WoW game. This year, we are doing another round of co-marketing campaign with Coca Cola again, and also with the upcoming 1.12 upgrade, and we expect the WoW will continue to grow at a new pace.

Thank you.

Operator

Your next question comes from Wallace Cheung of Credit Suisse. Please proceed.

Wallace Cheung - Credit Suisse

My basic question is, why the ACU to PCU ratio in the second quarter goes up and why the ARPU goes up? Thank you.

Hannah Lee

With respect to your first question, why we have a rate in the ratio of ACU and PCU, as our CEO has just said, we had two upgrades which were introduced in the quarter. That increases the number of hours that each player plays throughout the game, so that increases the ACU.

PCU is actually only one day in the quarter, of which we achieved 630,000. On a consistent level, we have been achieving record-breaking high of PCU’s throughout the second quarter.

With respect to ARPU, with the unfortunate incident we have in Q1, ARPU was slightly affected and it was actually lower than what it should be, if there was no essential incident happening. If we compare that to the Q4 numbers that we had, it only increased slightly. We did increase -- we do see discount levels to the distributors very slightly, but it is not significantly less than what we give in the previous few quarters.

Wallace Cheung - Credit Suisse

Just a very quick follow-up. You do not experience any information loss in the second quarter, correct?

Hannah Lee

No, we did not, and we do not anticipate that to be. Measurements have been taken and we believe we have taken all the measures together with our partners to ensure that no such incident will ever happen again.

Operator

Your next question comes from Lin Chi of Lehman Brothers. Please proceed.

Lin Chi - Lehman Brothers

About Guild Wars, I understand the game is currently under closed beta. I just want to get an idea of the initial feedback exacted from the testing, and whether you can still stick to the original timeline. Thank you.

Hannah Lee

On Guild Wars, we have started internal closed beta testing recently. The response has been very well. It actually has increased on the list of the anticipation chart by independent portals. It is moving up the charts. We are still on track to launch the game within a year. As our CEO has mentioned, earlier on in his presentation, we are going to launch beta testing in Q4 and we will be commercializing the game by the end of the year.

Operator

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

Dick Wei - JP Morgan

I just have a quick question on the third quarter trend so far that you see, particularly after the World Cup. I know you do not give out guidance for the third quarter, but shall we be looking at some kind of sequential ACU growth, similar that we saw in the second quarter of 14%?

Jun Zhu (Translation)

From June 10th to July 10th, because of the World Cup, we do see a slowdown of our PCU numbers. After July 10th, the World Cup finished, we see the concurrent user level have an obvious bump.

I would like to add some points to Hannah’s answer to Wallace just now. Why our ACU had a significant growth in Q2 over the previous quarter, I think the content is very important, as we launched 1.10 and 1.11 upgrade versions in Q2, it helped as to grow our ACU number significantly.

As our six server sites are very close to their full capacity, we are now planning to launch the seventh server site in late Q3, and also, as I said, there will be a new upgrade version called 1.12. This version is very special in terms of it has a cross-server battlefield function. It is highly anticipated among WoW gamers.

I believe with the launch of seven server sites, and with this new upgrade version 1.12, it will greatly enhance our user growth.

Operator

Your next question comes from Paul Keung of CIBC World Markets. Please proceed.

Paul Keung - CIBC World Markets

Thank you. My question is how disruptive is the server merger and rearrangement going to be, and the version 1.12, on the quarter from a quantitative standpoint? Is it possible to see a flat sequential growth because of that disruption?

Hannah Lee

As we announced to the players a couple weeks ago, we are going to start merging several of the realms in each server, starting from mid-August. Each server, each time we anticipate the server site, that particular server site will have to be shut down for 48 to 72 hours. We do not have an accurate estimate as to how many hours exactly we need to shut down that particular one server. We only shut down one server at a time. We are doing it throughout mid-August to some time in mid-September, in anticipation for the launch of version 1.12.

After the realm merger, we anticipate with the launch of 1.12, and with the additional capacity, the average concurrent user and peak concurrent user will experience growth from that point onward.

Paul Keung - CIBC World Markets

I guess my question is because your server shutdowns, you time them on a Tuesday and a Wednesday, I believe when it is a lower period. You mentioned also that your peak, you are basically at near-capacity for six servers. I am just curious about if you prepare for what could be some disruption in games.

Jun Zhu (Translation)

We are, just as a point, we are actually merging the server realms, of which these server realms are not the most popular server realms. That actually helps us increase the efficiency of the servers. We do not merge all the servers in an effort to preserve a site. We pick those servers which are relatively less being used by the servers.

As you know, we always have maintenance days on Tuesday anyway. As you very rightly pointed out, Tuesday and Thursdays are when we decided to do them. These are the days where the user level is actually slightly lower compared to other days in the week.

Operator

Your next question comes from the line of Chang Qiu of Forun Technology Research. Please proceed.

Chang Qiu - Forun Technology Research

I have one question regarding the real name registration and anti-fatigue system. I do not know whether you have a clearer timeline for when this system will be implemented. Also, if implemented, what would be the impact to your user base?

Jun Zhu (Translation)

First, I would like to say that the anti-fatigue system has been put into testing since last year among several server realms of WoW games. From what we see from the attacking servers, we see very minimal impact for WoW from the anti-fatigue system.

The reason is that most of our WoW players are about 18 years old. The anti-fatigue system will apply to the minors below 18 years old, so it has very minimal impact on the WoW game.

I think the anti-fatigue system will be long-term beneficial to the game industry because, you know, not very good content will be regulated and the better regulated environment is good for the long-term growth for the whole industry.

As for the timetable you asked, the government has said that the whole system will be applied before year-end this year.

Operator

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

Jason Brueschke - Citigroup

I am going to talk a little bit generally is my question. What I am interested in talking about is your ability to -- it seems like you need to go out and be very effective in winning new game licenses that are being developed in Korea and other parts of the world, much more so than anybody else in China. Could you maybe describe what it is that you guys are doing that allows you to go into competition head-to-head for Hellgate: London, Guild Wars, GE?

You can consistently win the best games, and thus you have a better new game pipeline. Is it something about what you guys are doing internally? Is it an ability for you guys to offer better economics? Is it a function of success begets success? It seems to me at this point, you guys are the destination of choice for any new game that is being developed really just about anywhere in the world. Thank you.

Jun Zhu (Translation)

There are some aspects I will mention. First, internally we have a very sophisticated system to measure and evaluate what are the best games. The efficient evaluation enabled us to -- we have a better understanding compared to our peers.

The reason why we secure those games is not what has been rumored outside -- we offer the highest price. Even in the very competitive licensing agreements negotiation process, the final price we offer in the agreement is not the highest price.

Although we have a minimum guarantee and licensee arrangements, they are defined in certain clauses by the contract, and we think those arrangements are very reasonable.

I will also say the attitude I think is very important. Our attitude is always that we will offer a win-win deal for customers. Also, our chief strategy is to be the vendor of choice for all the foreign game developers in China.

Operator

You have a follow-up question from the line of Wallace Cheung of Credit Suisse. Please proceed.

Wallace Cheung - Credit Suisse

Basically, my question is asking why a lot of costs going up with that trend, be like an increase for the quarter as well? Thank you.

Hannah Lee

As I said in my presentation, we should have increase in sales and marketing, but those are in line with our growth in our revenue. Of course, we have to promote the games and, as we said a couple of times just now, we did launch Version 1.10 and 1.11 during the quarter. That is why we have the spend in the sales and marketing dollars, in order to promote those versions. That has proven to be very effective in helping to raise our revenue for the quarter.

With respect to the ongoing marketing spend, we think that the marketing we spent for World of Warcraft in Q2 is a normalized amount on a go-forward basis. However, because of the new games that we are planning to launch in the next six months, we are going to spend some sales and marketing dollars for the new games that we are going to launch, i.e. Guild Wars, Supergirl, and some preparation costs for Sun, but Sun’s preparation costs will likely be in the latter part of the year.

So on a go-forward basis and normalization for the World of Warcraft marketing spend, but there will be additional expense for pre-launch of the two games that we are going to push out to the markets.

With respect to general and administrative expense, we did experience an increase and the G&A expenses, mainly because of regulatory related expenses, mainly focusing on professional fees that we have to pay in respect to our Sarbanes Oxley preparation process. We did engage outside consultants to ensure and assist our internal audit department to ensure that we will be in compliance by the end of the year, and that also helps us in improving our internal control procedures and process within the company.

Wallace Cheung - Credit Suisse

Thank you. Just for a quick follow-up, are you trying to manage the operating margin in a more favorable manner, [inaudible]?

Hannah Lee

We do manage our business on a game-by-game basis. Is your question with respect to the operating margin for World of Warcraft? We are definitely trying to maintain a stable margin. As we said earlier, we are going to launch a seventh server farm in late Q3. In Q2, we did not launch any server farms. That is why there is an economy of scale, whereby we have built the capacity in Q1 and we are utilizing the capacity to increase our revenue in Q2, so the growth in the revenue is ramping up.

The Q1 period is more a preparation period, whereby we put in the additional costs. We do have to give time for people, for the particular server sites that build up throughout one or one-and-a-half quarters, so we anticipate in Q3, with a launch of the seventh server site, there will be additional server depreciation costs, there will be the additional Internet data center rentals, but we also anticipate there will be additional capacity, which will be able to allow more users to play the World of Warcraft game.

Operator

Your next question comes from the line of Leah Hao of Thomas Weisel Partners. Please proceed.

Leah Hao - Thomas Weisel Partners

I just wanted to see if you could provide some update on the other games in your pipeline, including Burning Crusade, GE, Hellgate: London, Joyful Journey West, just in terms of the timeline for closed beta, open beta, and commercial launch, please. Thank you.

Jun Zhu (Translation)

For The Burning Crusade, we are now still in discussion with Blizzard regarding a launching arrangement and server arrangement, as well as details regarding the customer services. I believe the discussion is near to the end, and I hope the discussion will go smooth.

Blizzard announced that Burning Crusade will be launched in the North America market in early next year, 2007, so we also hope to launch this upgrade version in China as soon as possible, so as to offer amazing content addition to the China market.

For GE and Hellgate: London, these two games, we plan to launch the two games in 2007. If we have more details come in for these two games, we will communicate with all of you as soon as possible.

Operator

Your next question is a follow-up question from the line of Dick Wei of JP Morgan. Please proceed.

Dick Wei - JP Morgan

Can you also tell me a bit about any of the operating metrics in the Taiwan operating unit that you have a minor stake in?

Hannah Lee

Because we are a minority interest shareholder of that particular joint venture that operates the World of Warcraft game outside of greater China, we are not at liberty to say the exact amount about peak concurrent users. We do however notice because these markets are small in the first place, and these are ex-growth markets, the user base did not grow compared to the previous quarter. It stayed relatively flat, and that is why the equity pick-up that we have in our P&L is actually quite stable compared to the previous quarter.

Dick Wei - JP Morgan

Any trend that you can see, in the first quarter, for example?

Hannah Lee

With respect to this particular joint venture, we do not anticipate there will be significant growth. We do, however, because of the launch of new patches, new upgrades, there will be some growth within those markets. These would not be significant.

Operator

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

Lin Chi - Lehman Brothers

Just a quick follow-up here. I understand from your press release about the seventh server farm that you are using more advanced model of servers, undoubtedly to ensure a more stable operating environment. In that case, is there any possibility that you will upgrade the servers for the first six server farms, to improve the stability?

Also, we talked about your upgrading the bandwidth for some of the server sites, and also buying additional back-up software, et cetera. Does that mean we should expect to see additional costs of revenue going forward? Thank you.

Hannah Lee

Yes, you are right. We are, with the seventh server site, we are buying more sophisticated servers, mainly to ensure that these servers meet the specific server specifications as required by the licensor. These particular types of servers, which provide better performance for the games and will improve the user experience, we are constantly upgrading the first few servers that we have, servers one through six. The cost is higher than the old types of servers that we are using, but they are not significantly higher.

Lin Chi - Lehman Brothers

How about bandwidth and software, and also your account, security system, et cetera? Will that incur additional costs?

Hannah Lee

The bandwidth with these will be more or less the same as the previous server sites that we have set up. I am sorry, the other part of the cost that you were asking was?

Lin Chi - Lehman Brothers

I think a password protection system introduced throughout the quarter.

Hannah Lee

We have introduced a virtual keyboard recently, which actually improved -- password protection provides a mechanism for users to better protect their password and better to protect their virtual items and these particular accounts. We actually started more service that would provide, as a security measure for the players, and that is not -- there will not be any additional significant costs that we need to incur. It is basically very minimal environment costs that we have to put in. It is not going to be ongoing.

However, it did increase the user experience, so it actually helps for the revenue.

Operator

Your final question comes from the line of Leah Hao of Thomas Weisel Partners. Please proceed.

Leah Hao - Thomas Weisel Partners

Just a follow-up, could you comment on the overall health of the gaming market over Q2 and so far, going in to Q3? Is that possible? Or the user growth for you guys was more specifically due to the launch of the newer version of World of Warcraft?

Hannah Lee

Sorry, Leah, could you repeat that question? I did not hear much, really.

Leah Hao - Thomas Weisel Partners

The question is regarding the overall health of the gaming market that you see over the quarter, last quarter and so far into Q3. Do you think the gamer interest is healthy, or the growth of the ACU or the usage for you guys is more specifically due to the launch of newer version of World of Warcraft?

Jun Zhu (Translation)

The whole online game market is China is still in a growth space, and the overall growth of course helps to the growth of the WoW game.

Specifically talking about WoW, the content upgrade as well as the second- and third-tier city penetration will also help WoW grow significantly in the future.

I want to give you an example. When the total activated accounts for WoW stands at 1.5 million last year, at that time the PCU already was 450,000. Now, our total activated accounts are around 5 million now. The PCU is still a little bit higher at 630,000, and that is because some of our players lend their friends the WoW game.

With our continuous upgrade versions, we add new content to the game, so the old players who leave the game for a while will come back to play the new content. Again, that is a key driver for our user growth.

If a very significant upgrade version was launched, I believe all of our gamers will come back to play the game again. That sets a very good foundation for user growth.

Operator

I would now like to turn the call back over to Ms. Dahlia Wei for closing remarks. Please proceed.

Dahlia Wei

This concludes today’s call. Thank you again and please feel free to contact us if you have any additional questions. Thank you.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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Source: The9 Q2 2006 Earnings Conference Call Transcript (NCTY)
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