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Executives

Vivien Wang - IR Officer

Michael Chi - Chairman and CEO

Kelvin Lau - CFO

Analysts

Alicia Yap - CitiGroup

Lisa Yang - Morgan Stanley

Eddie Leung - Banc of America

Scott - Oppenheimer

Tian Hou - Pali Capital

Vivian Li - Piper Jaffray

Andrey Glukhov - Brean Murray

Ming Zhao -SIG

Jin Yoon - Nomura

Eric Wen - MainFirst

Hiu Dan - HSBC

Atul Bagga - Thinkequity

Perfect World Company Ltd (PWRD) Q3 2009 Earnings Call November 16, 2009 7:00 AM ET

Operator

Welcome to the Perfect World Q3 2009 earnings conference call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session. (Operator instructions). Please be advised that this conference is being recorded, November 16, 2009.

I would now like to hand the conference over to our speaker today Ms. Wang, Investor Relations Officer of Perfect World. Thank you. Please go ahead.

Vivien Wang

Thank you, operator, and thank you, everyone, for joining us today for Perfect World’s third quarter 2009 earnings release conference call. We distributed our unaudited third quarter 2009 earnings release earlier today. You may find a copy of the press release on our official website or through the newswire.

Today, you will hear from Mr. Michael Chi, our Chairman and CEO, who will give us a brief introduction and overview. Mr. Kelvin Lau, our CFO, will then discuss some of our latest developments and operational developments and take us through our financial performance in the third quarter of 2009. Following the prepared marks, Mr. Chi, Mr. Lau and I will 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 US Private Securities Litigation Reform Act of 1995. Perfect World does not undertake any obligation to update any forward-looking statement as a result of new information, future events or otherwise, except as required under applicable law. For more information about the risks involved, please visit our filings with the SEC.

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

Michael Chi

Thank you, Vivien, and thanks everyone for joining us today for our third quarter 2009 earnings call.

We are pleased to announce of our third quarter results which exceeded our expectations this quarter. We launched a number of exciting expansion packs for existing games. One example of a successful launch is Zhu Xian 2.0 Special Edition, and we are optimistic about its contribution to the business moving forward.

We will continue to maintain the life cycle of our games by dedicating more resources to creating larger, more innovative expansion packs. At the end of the quarter, we successfully launched our first 2D term based MMORPG Fantasy Zhu Xian on October 22. This game has attracted a lot of interest since its launch and demonstrated our ability to leverage a strong 3D development capabilities and operating platform to effectively penetrate the 2D market.

We believe the games innovative features, content offerings, and the strong branding of our Zhu Xian franchise, we have had successfully pushed this game into lower tier segment. By creating a highly diversified portfolio of truly differentiated games, we continue to strengthen our competitive advantage in the industry.

Our reach headline currency consist of six games that spend 3D, 2.5D, and 2Dmarket segments. We are utilizing our specialized game engines and production studios that are tailored to each of this area to build a variety of franchise that include flagship titles in each of this market segments.

Our overseas development efforts are progressing nicely and we remain leader in the Chinese online across market in terms of the revenues and geographic coverage. During the quarter, we successfully launched our first 2.5D MMORPG, Battle of the Immortals in Taiwan, Hong Kong, and the Macau through our overseas partners.

We also launched some of our other games to various international markets through several operators and signed new licensing agreements with our overseas partners. We are satisfied with our progress in these areas, so far and plan to continue expanding our global network moving forward.

We released our first movie produced by our subsidiary PW Culture during the quarter. The release was a success and more importantly gave us an opportunity to promote our corporate brand and co-promote our games. This was a good start and we expect PW Culture to capture the growth of the broader entertainment industry, while generating valuable synergize with our core business through content generation and co-promotion in the future.

We are fully committed to producing differentiated games in 3D, 2.5D and 2D game markets. Thanks to our proprietary technology, the creativity of our R&D team and our strong operating platform, we are confident in our ability to raise and maintain our game players' interest in both new and existing games. With our proven execution capabilities, we aim to sustain the stable growth of our company and maximize shareholder value.

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

Kelvin Lau

Thank you Michael. We continue to enhance our game player's interest by further developing our existing games. This quarter, we brought out a number of expansion packs including the Island of Ice and Fire for Legend of Martial Arts, The Path to Divinity for Battle of the Immortals, Zhu Xian 2.0 Special Edition for Zhu Xian, and Party Time for Hot Dance Party.

We are also progressing positively on our overseas development efforts. During the quarter, we signed an agreement to license Hot Dance Party in Taiwan, Hong Kong and Macau. We successfully launched the Hot Dance Party in Thailand in each of Pocketpet Journey West Hot Dance Party and Battle of the Immortals in Taiwan, Hong Kong and Macau through respective local operators.

Following the quarter end, we signed an agreement with respective overseas partners to license Battle of the Immortals even better now and do send in Russian federation and other Russian speaking territories. We also launched Chi Bi in Thailand through an overseas operator.

Now, I would like to take you through our third quarter 2009 financial highlights. Our total revenue were RMB 590 million in 3Q ‘09, an increase of 13.2% from 2Q '09 and 54.5% from 3Q '08. Our online game operations revenues were RMB 485.9 million in 3Q '09, as comparative to RMB 475.1 million in 2Q '09 and RBM 324.5 million in 3Q '08. The sequential growth in online game operation revenues was primarily attributable to the successful release of expansion packs for some of our existing games and a series of successful marketing activities.

Our ACU for games under operation in Mainland China was approximately 713,000 in 3Q '09 as compared to 761,000 in 2Q '09 and 717,000 in 3Q '08. APC for games operator in Mainland China under the item based revenue model was approximately 1,643,000 in 3Q '09 as compared to 1,877,000 in 2Q '09 and 1,610,000 in 3Q '08.

ARPU of games operated in Mainland China under the item based revenue model was RMB 266 in 3Q '09, as compared to RMB 237 in 2Q '09 and RMB196 in 3Q ’08. While ACU and APC decreased by 6.3% and 12.5% from 2Q ’09, which was mainly due to the [adverse or negative] factors affecting certain games. We still manage to increase ARPU by 12.2% from 2Q ’09 through a series of successful promotions and the launch of new expansion packs.

Our overseas licensing revenue were RMB 58.8 million in 3Q ’09 as compared to RMB 46.2 million in 2Q ’09 and RMB 57.3 million in 3Q ’08. The increase from 2Q ’09 was mainly due to successful launch of Battle of the Immortals and Pocketpet Journey West in Taiwan, Hong Kong and Macau through local operators.

Our film and television revenue were RMB 45.3 million in 3Q ’09, as compared to Nil in 2Q ’09 and Nil in 3Q ’08. Other film and television revenue recognized that in 3Q ’09 were related to the movie Sophie’s Revenge that was released in August 2009.

Our cost of revenue the RMB 95 million in 3Q ’09, as compared to RMB 66.8 million in 2Q ’09 and RMB 47.3 million in 3Q ’08. Our online game related cost was RMB 68 million in 3Q ’09 as compared to RMB 66.8 million in 2Q ’09, and RMB 47.3 million in 3Q ’08.

Starting from August 2009, Beijing Perfect World Network Technology Company Limited, our controlled entity is subject to a 5.5% business tax and related tax in lieu of VAT. Previously, it was subject to 17% VAT for the revenues from online game business in the PRC and 10% surcharge of payable VAT, and was entitled to a 14% VAT refund which expires at the end of 2010.

Our film and television cost was RMB27.0 million in 3Q’09, as compared to Nil in 2Q’09 and Nil in 3Q’08. All the film and television cost recognized in 3Q’09 was related to the movie Sophie's Revenge.

Our gross profit RMB495.0 million in 3Q’09, an increase of 8.9% from 2Q’09 and 48% from 3Q’08. Gross margin was 83.9% in 3Q’09 as compared to 87.2% in 2Q’09 and 87.6% in 3Q’08.

Our operating Expenses were RMB197.3 million in 3Q’09, an increase of 12.8% from 2Q’09 and 46.7%from 3Q’08. The increase in operating expenses from 2Q’09 was mainly attributed to the foreign factors. Number one, an RMB15.3 million increase in sales and marketing expenses, this was largely due to an increase in advertising and promotional expenses associated with the launch of Zhu Xian 2.0 Special Edition expansion pack.

The expenses related to attending a nationwide industrial exhibition in 3Q’09, and the promotional expenses associated with the release of the movie Sophie’s Revenge. Number two, an RMB6.5 million increase in R&D expenses, this is primarily due to an increase in stock cost.

Our income tax expenses was RMB11.1 million in 3Q '09 as compared to RMB19.8 million in 2Q ‘09 and RMB8.8 million in 3Q '08. Upon the expiration of our authorized ADS repurchase program in October 2009, the Board decided that the undistributed dividends of Beijing Perfect World Software Company Ltd., the company's wholly-owned subsidiary will be reinvested and that this subsidiary will not declare or pay any dividends in the foreseeable future. As such, we ceased the accrual of withholding tax on earnings of this subsidiary. This caused a decrease of income tax expenses compared with 2Q, '09.

Given the aforementioned status, net income attributable to the company's shareholders was RMB288.3 million in 3Q '09, an increase of 9.8% from 2Q '9 and 45% from 3Q '08. Non-GAAP net income attributable to the company's shareholders was RMB308.5 million in 3Q ‘09, an increase of 9.1% from 2Q '09 and 45.4% from 3Q '08.

Basic and diluted earnings per ADS were RMB5.85 and RMB5.5 respectively, in 3Q '09. As of September 30, 2009, we had about RMB1.2 billion of cash and cash equivalents as compared to RMB945.7 million as of June 30, 2009. The increase was mainly due to net cash inflow generated from our online game operations.

In terms of financial guidance based on our current operations, total revenue for the fourth quarter of 2009, are expected to be between RMB578 million and RMB602 million, representing a decline of 2%, to an increase of 2% on a sequential basis and an increase of 38% and 44% on a year-over-year basis.

This reflects the expected growth from our existing games and anticipated contribution from the newly launched Fantasy Zhu Xian. We'll also take into consideration that we do not expect to release any movie 4Q '09.

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

Vivien Wang

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Alicia Yap with CitiGroup.

Alicia Yap - CitiGroup

Number one, do you expect to launch any new game in the first quarter 2010? If no new game targeted to be release in the first quarter, should we expect some lumpiness where you experience strong rebound in fourth quarter and then followed by more of flat first quarter or will there be more monetization drivers that we are not aware of?

Vivien Wang

Did you have a second question?

Alicia Yap - CitiGroup

Yes, my second question is regarding the effective tax rate. It came in at above 3.7 this quarter as you decided not to declare any evidence in the future. So, should we expect the effective tax rate to remain similar level for the fourth quarter in 2010?

(Foreign Language)

Michael Chi

(Foreign Language)

So with regard to your first question about the new game, whether we’ll have a new games to be launched in 1Q 2010, it really depends on the market situations, as well as our games development programs. So, we don’t have any confirmed timeline as of now, but we will make sure to keep the market informed. In terms of the growth, we are striving for a stable growth in the long run, so we will do our best. Thanks.

Kelvin Lau

Alicia, regarding your second question, regarding the effective tax rate that's why I mentioned I think in the presentation, I mentioned that because our ADS repurchase program has been expired in October 2009 and also the board has already decided that going forward our net profit will be as we think and further we invested for our future business growth.

So in the foreseeable future, we don’t expect the quantity flat or pay any dividend going forward. So, based on this, we are not required to provide for 5% of the dividend reporting tax. I think this is the key reason, why our effective tax rate decreased from Q2 7.17% to Q3's 3.17%.

So, that’s why I promise I think in the last earnings call, I will give public guidance to the market for effective tax rate. In Q4, I would expect similar effective tax rate will be applied in Q4, because we are now required 1.5% dividend including tax. Then trending into for the year 2010, I would say some our entities, we were subjected to a higher tax rate upon the expiration of some of the tax holiday.

So I will expect the overall effective tax rate will be between about 5% to 8% in the coming year. This is based on our current estimation and this maybe changed from time to time, but I think as I promise, I will keep public guidance on the effective tax rate to the market - I think - as time goes by. Thank you.

Operator

Your next question comes from [Lisa Yang] with Morgan Stanley.

Lisa Yang - Morgan Stanley

I've got three questions. My first question is could you please explain why APAs decline in the quarter and which games have caused the decline in APA? Also, if I look at your APA actually flattish on a year-over-year basis, so do you see a increasingly cannibalization for your games?

My second question is, as you now run seven to eight games in the portfolio with more games to come, how would you make your decision for resource allocations, and how do you decide the market in dollars and how do you avoid the cannibalization?

My third question is about your movie strategy. I understand you may tend to participate in some same name movies for Fantasy Zhu Xian, (inaudible) given movie as new business area for you and also has high domestic risks, I want to know how you plan to invest in this business and how to manage the risks?

(Foreign Language)

Michael Chi

(Foreign Language)

Okay. Regarding the first question about the ACU and APA, the decline for ACU and APA for 3Q as per we mentioned in earning releases, mainly due to the seasonal factors which affect our games, especially for Battle of Immortals, I think the decline for the overall ACU and APA for Q3 it’s mainly come from Battle of Immortals because according to our record most of the gamers or players for BOI are all those students and during the summer vacations, we believe being holiday for student, they are more involved in all those social activities and gatherings.

So, they quit from the computer for a while. So, but at least for all the other games I think except for BOI, all the other games, the APC and also the ACU are quite stable. There is no decline I think for all the other games.

So, this is the answer to the first question. Then for the second question, regarding the sales and marketing expenses, I think I mentioned it before in the previous earning release, we have a internal policy of allocating our sales and marketing expenses for all the games.

I think no matter it’s the 3D game, 2.5D game, 2D games, our policy is the same. We will allocate certain amount of sales and marketing budget for other new game launch, and certain percentage of the revenue generated from this game will be spend on all those sales and marketing expenses. So, this is open to other games.

(Foreign Language)

Kelvin Lau

(Foreign Language)

So, just now Michael added one point to your question number two because we are launching our game one by one in our pipeline and targeting different segments, which means that we won't launch a similar type of games at onetime at the same time, still we can better manage our resources in terms of marketing and order. So, that's for question number two, a additional comment. Then with regard to your third question about our movie strategy, we have three roles that we want to start, one is careful, meaning that we want to carefully review the return of risk on each of the project in which we invest. Two is value accretive, meaning that our goal is for our investments to be value accretive and three is synergy, meaning that we are looking for synergies between the movie and gaming business.

For example we do have a plan to shoot a movie with the same name of one of our game in the portfolio, in a pipeline which is (inaudible) because this is very famous content and we do look for synergy between the games and movies. So, all you know, our goal is for our investment to be value accretive at least most of them. Thanks.

Operator

Your next question comes from Eddie Leung with Banc of America.

Eddie Leung - Banc of America

I have a couple of questions. The first one is do you guys comment on the competitive landscape in the MMO market, it seems like some other MMORPG games are slowing down. You guys also seem kind of like a little bit mixed performance among MMO games in the third quarter.

Then along the same lines, do you have any plans for the advanced casual market [trying to grow]? The second question is on the regulation side, any updates on the regulation environment? Finally, just want to confirm that take the away the movie contribution in the third quarter, we would be seeing your game base is growing at 6% to 10% at the top line right? Thanks.

Vivien Wang

For Q4?

Eddie Leung - Banc of America

In Q4, yes.

(Foreign Language)

Michael Chi

(Foreign Language)

Okay. So with regard, Eddie, with regard to your first question, in terms of competitive landscape, our take is good quality games face less pressure from the competing games. That's why actually couple of quarters ago, we decided to pointing our strategy to put more resources to develop and operate our games to larger games.

Then secondly with regard to the advanced casual game, we do think the advanced casual game, the segment is growing, but currently we are more focused on developing MMORPG. So that's for your question number one.

Then for question number two in terms of regulations, we actually think the government has always been supporting the massive developers like us, who have progressive technologies. Yeah, so, yes, that’s our take. Then I’ll hand over the third question to Kelvin.

Kelvin Lau

Hi, Eddie, regarding your third question, you’re right. Look at both Q3 number, if you don’t consider the movie revenue, our total online gaming operation revenue for Q3 is about RMB545 million. The guidance we gave to the market for Q4 is minus 2 to 2%, which means the range for total revenue for Q4 is about 578 million to 602 million which is equivalent to about 6% to 11% for online gaming revenue. You’re right.

Eddie Leung - Banc of America

Understood. Hey, Kevin just one more follow-up. I would like to ask in the third quarter did you guys conduce to higher more R&D stuff?

Kelvin Lau

This is what we want to. In fact I think, we keep on looking for good talents, I think on the R&D area. So, there is a possibility, but I think, that’s I mentioned before it is quite difficult to hide very good talents in R&D. So, in Q4 I don’t expect there will be a very significant increase in R&D expenses for Q4.

Operator

Your next question comes from Paul Keung with Oppenheimer.

Scott - Oppenheimer

Hello, everyone. This is Scott calling for Paul. Then just a quick question on Fantasy Zhu Xian based on the user data that you have collected so far, what's the breakdown through gamers playing from home versus interactive phase and if you could, can you give us typical demographic profile of the Fantasy Zhu Xian's gamer base?

Vivien Wang

(Foreign Language)

Michael Chi

Okay. (Foreign Language) Michael.

Vivien Wang

Let's say it for the audience first and then you can have follow-up questions.

Scott - Oppenheimer

Okay.

Vivien Wang

All right. Thanks. First of all in terms of the home versus café users list for Fantasy Zhu Xian, we think it's very normal compared to all our other games. Secondly, in terms of the gamers demographic we think this game attracts a little bit of a younger generation compared to other MMORPGs and typically this type of game is home based, truly termed as the game has lower ARPU? Do you have any follow-up? Do you have any follow-up?

Operator

(Operator Instructions). Your next question comes from Tian Hou with Pali Capital.

Tian Hou - Pali Capital

Hi, Mike, Kevin, Vivien, I have two questions. One is, what is the movie business revenue in Q3 and also in Q4, that's the first question? The second question is regarding the ARPU and ATC accounts. I have issue over there and I think the company's strategy is to maintain lower ARPU level but to grow the user base, but in Q3, we saw the opposite.

So I just wonder what's the company's ongoing strategy? So if ongoing strategy is to maintain the lower use of lower ARPU and user base, how do we make traction of Q3's saturation going forward?

Vivien Wang

(Foreign Language)

Kelvin Lau

Tian, I going to answer your questions. So, question number one the total revenue recognized from the movie in Q3 is about RMB45 million in Q3. In Q4 I don’t expect any movie revenue will be generated in Q4, but there will be a revenue minimum amount related to the copyrights we sold to the TV station for the [Sumitomo Venture] I think this is just about RMB2 million to RMB3 million only, so its very minimum in Q4.

Then your second question is ARPU and APC, yes, you are right. Our strategy, I think we mentioned it before that we're trying to increase our gamer base and then going forward ARPU. We will be going down a little bit because we're going to launch more 3D games. Yes, in Q3 you saw that the opposite happened our APCs dropped and our ARPU increased. I think the main reason, I thought I explained it before the APC or ACU decreased mainly because of Battle of the Immortals, now it is better I think.

Also Tian, as what I mentioned before for BOI, because BOI was newly launched in Q2 this year, so normally for other new game launched the cash we collect, convert in revenue would be lower, the commercial would be lower. So more of the cash we collect for BOI in Q2 will go to the deferred revenue. So go into the second quarter Q3 some of the deferred revenue related to BOI was amortized and recognized as revenue in Q3. This is one of the key reason why our ARPU go up a little bit in Q3.

I think we are confident that I think going into Q4 and in 2010, our strategy that which can be achieved [but main news that] our ACU and APC can grow because as you may note we launched Fantasy Zhu Xian and also we launched our biggest benchmark for Zhu Xian by the end of Q3. So we also already seeing some pretty nice growth in terms of ACU for Fantasy Zhu Xian and also Zhu Xian. So, I mean, in the very short run you see, we can achieve our strategy.

Vivien Wang

There is one more comment on the ARPU. Quarter-over-quarter, you may have to see some variation on the ARPU, because it really depends on the type of our games and the mix of our games and the long-term schedule of our game, but in the long run, we do strive for a larger user base to sustain a stable growth of our company. Thanks.

Operator

Your next question comes from Vivian Li with Piper Jaffray.

Vivian Li - Piper Jaffray

I understand you don’t break up revenue for specific games. So relatively speaking can you give us some color on where do you see the current growth of game revenue come from, is it from the expansion pack of Zhu Xian or BOI or Fantasy Zhu Xian? Or maybe share with us which game do you expect to drive growth in the next quarter or so?

Then a quick second question is about outlook on overseas opportunity, which Prefect World has done very well. Can you give us some color on how the revenue shared looks like for the partnership you have signed and how do you think the revenue contribution for overseas licensing will look like in the next year? Thank you.

Kelvin Lau

For Q3, I think still Zhu Xian is our major revenue contributor. In Q3, Zhu Xian switch to ranking number and that followed by Perfect World II and Battle of the Immortals, these are top three games, I think in terms of revenue contribution in Q3. Going forward in Q4, I would state the major driver for our revenue growth should be coming from Zhu Xian because that’s what I mentioned. We launched our big expansion packs Zhu Xian 2.0 Special Version expansion pack by the end of Q3.

So, I will expect some revenue growth will be coming from Zhu Xian in Q4, and also another major driver it would be coming from Fantasy Zhu Xian, which we launched on 22 of October. So, we have 71 days revenues contribution from Fantasy Zhu Xian.

Then lastly I think is you may heard about that we are going to have an expansion pack for Perfect World II. It is going to be launched by the end of November or early December. So, some revenue growth will be coming from Perfect World II as well. This is yes; this is the major revenue growth for Q4.

Regarding the overseas licensing revenue, I think it all depends I think it will depend on several factors. Our policy or our strategies I think never changes. We are trying to launch more games to more countries going forward. You can see in the past few quarters, our overseas licensing revenue fluctuate within a range of 8% to 14%.

So, and also it all depends on what is the timing of others or all our games commercialized in overseas countries. So, our local operators in overseas countries to consider the market situation, so it all depends on overseas patterns, but I think in the short to the medium terms, we try to maintain our overseas licensing revenue around 10%

It also depends on our domestic online gaming revenue performance as well. So if we can achieve 10% of the total revenue as to overseas licensing revenue, then I think we have already done a good job.

Operator

Your next question comes from Andy Glukhov with Brean Murray.

Andrey Glukhov - Brean Murray

I guess a couple of things. First of all, I think most of us expect ARPU to go down sequentially here in Q4, given the launch of low ARPU Fantasy Zhu Xian, but if you guys were to back out Fantasy Zhu Xian and just consider sort of the existing content, given the expansion packs you have in Q4, would you expect the monetization of the base content to be roughly the same or would you expect to see ARPU also to pull back? Then I have a second question.

(Foreign Language)

Michael Chi

Andrey, thank you for that question? If you don't consider Fantasy Zhu Xian in Q4, I would say the overall ARPU will do down a little bit for Q4. Why, because Battle of the

Immortals right now at the stage is, we’re trying to stop some of our monetization activity for BOI and try to accumulate more gamer base for BOI. So that's why I said, I will expect, if they don’t consider Fantasy Zhu Xian in Q4, I would say the overall ARPU will go down little bit for, Q4, why because that we are in that stages, we are trying to stop some of our modular shift for BOI and try to accumulate more gamer base for BOI. So that’s why I said I will expect, if we go on with the monetization the overall ARPU will go down a little bit in Q4.

Andrey Glukhov - Brean Murray

Okay. Thanks. Then my second question, if I look or if I kind of backed into your US revenue it continues to grow here looks like fairly nicely, what do you expect, I think over the next couple of quarters considering you're starting sort of published Torchlight and generally presumably you're going to get a broader deal with Torchlight once it becomes an MMO?

Vivien Wang

Andrey, can you repeat your question?

Andrey Glukhov - Brean Murray

If I try to back into your US revenue, it grew very nicely here sequentially in Q3, what do you expect the trends in the US revenue to be in light of the fact that you also announced the publishing deal with Runic around Torchlight here?

Vivien Wang

(Foreign Language)

Michael Chi

(Foreign Language)

Okay. Andrew, let me answer your questions. Okay. Right now yes, we are quite satisfied with the performance of our US operations, so far right now we have already launched a three games in US including Perfect World II, Zhu Xian, and Pocketpet Journey West. You are right; I think from the number you can see that we have a very nice growth in terms of revenue for our US operations. Our policy is I think going forward we’re trying to launch more games in US. Of course we hope that to see our US operation to continue to grow. So, in fact we are keeping increasing our headcount in our US office. So, we are still quite optimistic with our US operation, our North America operation.

Regarding our second question in relation to the Torchlight. Andrey might be the Torchlight PC based version, which is now launched in North America has nothing related to Perfect World to IP or the revenues, I think it will go to Runic. The arrangement between Perfect World and Runic is, we acquired the publishing right of the Torchlight MMORPG online game version, not the PC based of version. We have some involvement in the Torchlight PC version; it's just on the distribution. We are one of the distributors of Torchlight PC based version in US.

So, I will explain in Q4 there will be minimal distribution revenue or income from Torchlight from Runic. So, of course we hope Torchlight MMORPG online version can be successful in China and also in US, but think right now it’s too early to comment because this can be scheduled to be launched in 2011.

Operator

Your next question comes from Ming Zhao with SIG [ph].

Ming Zhao -SIG

Thank you for taking my question. Good evening, just couple of questions here .First of all, I understand you said that ACU was down in 3Q due to Battle of the Immortals but the ARPU is up. Can I ask you what’s the reason for the ARPU being up, which game accounts for that? That's my first question. Second question is that this deferred revenue is up nicely at the end of third quarter. Is it due to Zhu Xian or Fantasy Zhu Xian or Battle of the Immortals? Thank you.

Kelvin Lau

Thank you Ming. Thank you for the question. Okay. It means that once the games ACU, then it is mainly because of Battle of the Immortals. ARPU up is also mainly because of Battle of the Immortals why because as I mentioned BOI Battle of the Immortals in Q2 is duly launched in Q2. So part of the cash we collect in this games was booked in deferred revenue. So, going into second quarter in Q3 part of the BOI deferred revenue was recognized as revenue. So, even though the ACU number dropped the ARPU increased. So, the overall increase in ARPU is also mainly because of the BOI, it's number one. Number two is the deferred revenue growth by the end of Q3, the deferred revenue growth was 7% I think the main reason is not because of Fantasy Zhu Xian, Fantasy Zhu Xian was launched in Q4 not Q3.

Ming Zhao -SIG

All right. Yeah.

Kelvin Lau

So, the deferred revenue increased mainly because we launched Zhu Xian 2 expansion pack by the end of Q3. So, the increase in the deferred revenue; that probably can be explained by the Zhu Xian 2 expansion pack.

Ming Zhao -SIG

Can I ask a quick follow-up to that? Did Battle of the Immortals it's usage come back to the end of 2Q level. Also, if you compare the Fantasy Zhu Xian with Battle of the Immortals, do you think you will be the similar monetization compared with the Battle of the Immortals in the fourth quarter?

(Foreign Language)

Michael Chi

For BOI, ACU right now is quite stable, but I think up to now still haven’t come up to the level as that of Q2 but one good news is we're going to have a big expansion platform Battle of the Immortals in early December. That's why I said, I think our short term goal is trying to increase our gamer base back to Q2 or more level. I think this is our biggest strategy for BOI in the short run.

Regarding the monetization and ARPU for Fantasy Zhu Xian, for Fantasy Zhu Xian, because it's a 2D game, our priority, our business strategy is trying to increase the game base in the short run. So at the very beginning I think since the game launched till now, we still haven't had so much monetization. I think for this game, we are trying to accumulate more and more gamers for this game, because for 2D games normally you can enjoy the better market in China. So game of business is very important for 2D games. So we are not hurry on monetizing this game at this stage.

Operator

Your next question comes from Jin Yoon with Nomura.

Jin Yoon - Nomura

I apologize I miss part of the conversation earlier in the call. If you look at Fantasy Zhu Xian I know that it’s a 2D game versus a 3D game for the original Zhu Xian, has there been any kind of cannibalization occurring in terms of monetization from the original Zhu Xian. Well first of all I stop there, then I will ask the follow-up question?

(Foreign Language)

Michael Chi

I am confident to tell you that there is no cannibalization we've had between Zhu Xian and Fantasy Zhu Xian.

Jin Yoon - Nomura

Okay.

Michael Chi

So when we launched the big expansion for Zhu Xian we saw some pretty nice growth in Zhu Xian ACU. Also after that we launched Fantasy Zhu Xian, there is no impact, no negative impact on our Zhu Xian in ACU and we also achieved pretty nice EBITDA ratio number for Fantasy Zhu Xian. So I am quite confident there is no cannibalization we’ve had between these 2D and 3D game.

Jin Yoon - Nomura

Sure. Then when it comes to Fantasy Zhu Xian, again I apologize if this question has been answered already, but given the fact that it is a 2D game and ARPU is typically a little bit less for a game like this than our 3D game. I guess where can you see kind of the medium ARPU or the average ARPU and a safe run rate for Fantasy Zhu Xian compared to some of your other games. I will go back into the queue afterwards. Thanks guys.

(Foreign Language)

Michael Chi

Regarding the Fantasy Zhu Xian, because we just launched the game on 22 October, so, it’s less than one month. So, it’s too early to comment on the estimated ARPU number for this 2D game. So, I think for other colleagues that’s what we mentioned, I think Fantasy Zhu Xian of 2D more cartoon term base. I think history showed us that these types of games ARPU will be lower, but do know to what level. I think this is quite and hard difficult for us to comment at this moment. I am sorry about it.

Operator

Your next question comes from Eric Wen with MainFirst.

Eric Wen - MainFirst

I have several housekeeping questions and then a question on pipeline. On housekeeping question, can you tell me, when do you expect export revenue of our Fantasy Zhu Xian to take place, which quarter, if you plan to export?

Second question is, just want to make sure if I hear Michael correctly that in 2010 you do have one movie plan which is Perfect World? Then the third question is given that there are some of the new games now especially like (Inaudible). I just wonder if that is the same Perfect World II Kelvin you talked about? Also as part of [EM], can you just give us a rundown of your 2010 number of games expected to be launched in 2010 again? Thanks.

Vivien Wang

(Foreign Language)

Michael Chi

(Foreign Language)

Vivien Wang

So to translate for the audience first and in case you have follow-up questions. First of all, with regard to the expectation for Fantasy Zhu Xian, we do expect for exports of game some time, because we're talking to some of the overseas operators but typically only after several months or one to two quarters do we discuss in detail about the export plan because we wanted to make sure, our game is to be export is passive in the domestic market. So that's for question number one and then for question number two, we do have a plan to shoot a movie, [Casa a Jumbo] with the same name as one of our game in the pipeline [Casa a Jumbo] for export at…., the timeline is not confirmed yet. It's not going to be 2010 because that's too early. Then yes about the run rate of Zhu Xian it's a big and essential asset for PW2 and obviously further it's just one of our project in our pipeline, we haven't announced the name yet. So for competitive reasons we will prefer not to disclose details at this point but we will surely keep the market informed when the time is ripe. Thanks.

Eric Wen - MainFirst

Vivien, just a real quick follow-up, can you just give me the number of new games you expect to launch in 2010? Thanks.

Michael Chi

New games in a pipeline written out, the first one is 2D called we have announced this already Dragon Fist is kind of is number one, the second game is what you mentioned is the project EM which is a western style 3D game and then we have [x3 2H- Shoo Tanku] and then we another 2D Martial Arts and MMORPG. We have Torchlight, we have media online 60 games. Regarding the launched schedule as I mentioned before we still have fixed launching schedule.

Operator

Your next question comes from [Hiu Dan] with HSBC.

Hiu Dan - HSBC

Good evening everyone and thank you for taking my question. Two questions here. First one will be on your film business. I have a question, is that any top line guidance of new movie games on your topline for '10 or maybe just give a number of percentage as your total revenue and do you think the 40% growth margins for this business is just BOI in the future. The second question is on the certain expense which was paid at 14.9% in this quarter. How much promotional expense was related to the film business? Thank you.

Vivien Wang

(Foreign language)

Kelvin Lau

Thank you. Thank you for your questions. Okay. Regarding the movie I think it is very difficult for us to estimate or give any guidance for the movie revenue. I [think coming to a] movie is very difficult to estimate. So, we’re not going to give any guidance on the movie business in the coming year. So, normally our policy is to give guidance in the coming quarters.

Hiu Dan - HSBC

Okay.

Kelvin Lau

So, number one, number two is regarding the gross margin. Yes, we’re pleased on the number I announced that you can come up with a 40.5% of the gross margin for service we went. So, I think different movie or different type of movie, have different performance or different cost structure or different box office ticket performance revenues.

So, it’s difficult I think to estimate. I think moving forward (Inaudible) if we change our estimated gross margin for this movie, is how much, I think it’s difficult it’s very, very difficult. I can not give any guidance on any new movies I think in the near term.

The sales and marketing expenses in relation to service we venture, is included in the sales and marketing expenses slide in our overall P&L. What I can tell you this, we spend about 8 million to 9 million that’s the marketing expenses on promoting this movie.

Operator

The next question comes from Atul Bagga with Thinkequity.

Atul Bagga - Thinkequity

Hey, guys. Thanks for taking my call. Couple of questions, number one on your fourth quarter guidance, so if I take out the movie business in third quarter as you mention it’s about 80% for some growth that you’re expecting in fourth quarter.

Can you pass through all that 8 to 10%? How much growth you expect to come from rebound of Battle of Immortals? How much you expect to come from Zhu Xian 2, and how much you expect from a Fantasy Zhu Xian? My second question is around your US operations. You mentioned that US business has grown nicely in third quarter.

Now of late, we have seen very strong growth in the Facebook and social networking games. Do you guys have any plans to get in that business? Then my last question on the models, I was wondering if you can breakout your overseas license revenue between how much license fees you have received, onetime fees that you have received and recognize in third quarter versus what's revenue share you are expecting? Thank you.

Vivien Wang

Atul, can you repeat your third question?

Atul Bagga - Thinkequity

Third question is about the overseas license revenue. How much of that is the onetime fees that you have received and recognized in the third quarter versus how much of that was the revenue share on an ongoing basis?

Vivien Wang

Got you. Thanks.

(Foreign Language).

Kelvin Lau

This is Kelvin. I'm going to answer your question number one and question number three. Okay. Question number one is Q4 revenue, as I have mentioned I think in the previous question, I expect the major revenue growth driver for Q4 is coming from Fantasy Zhu Xian, which we did launch on 22 October this year. The second driver will be coming from Zhu Xian because we launched a big expansion by Zhu Xian 2 by the end of Q3 and the third driver will be coming from Perfect World 2, which we are going to have a big expansion pack launched in late November or early December. The name of one important picture for the revenue growth so, we don’t go into details, of course we do not disclose details or specific numbers per game. I think I'm sorry. That's the question number one.

Question number two, I've already mentioned, the major reason for the overseas license revenue growth for Q3 is mainly because Pocketpet Journey West was commercially launched in Taiwan, Hong Kong and Macau. So this caused our overseas license revenue to increase in Q4. I'll say about 20% of our overseas license revenue in Q4 is coming from the upfront license fee recognition.

Michael Chi

So with regard to your second about social networking games, we're keeping a close eye on it but still far we don't have any confirmed upon to produce any social networking games as of now. Thank you.

Atul Bagga - Thinkequity

Thanks. Then a quick follow-up on my first question, as you had mentioned Fantasy Zhu Xian, Zhu Xian and Perfect World 2 are the big driver of growth and you had mentioned that you're seeing rebound in BOI, Battle of the Mortals, so the reason you are not expecting growth from Battle of the Mortals is it because you're expecting ARPU going down on that? Thank you.

Kelvin Lau

As what I mentioned in this call, I mentioned several times already for BOI right now we are not have it on monetizing this game. Our first priority is trying to accumulate ACU or the gamer base for BOI. That's why I didn't mention BOI is one of our major revenue driver growth in Q4. Thank you.

Operator

I would now like to turn the call back over to Ms. Wang for closing remarks.

Vivien Wang

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

Operator

That's concludes our conference for today. Thank you for participating. You may now disconnect.

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Source: Perfect World Company Ltd Q3 2009 Earnings Call Transcript
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