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Changyou.com Limited (NASDAQ:CYOU)

Q4 2009 Earnings Call Transcript

February 1, 2010 7:00 am ET

Executives

Angie Chang – IR Manager

Alex Ho – CFO

Tao Wang – CEO

Analysts

Dick Wei – JP Morgan

Wallace Cheung – Credit Suisse

Eddie Leung – Bank of America/Merrill Lynch

Jenny Wu – Morgan Stanley

Kathy Chen – Goldman Sachs

Atul Bagga – ThinkEquity

Andrey Glukhov – Brean Murray

Wendy Huang – Royal Bank of Scotland

Alicia Yap – Citigroup

Vivian Li – Piper Jaffray

Operator

Good evening and thank you for standing by for Changyou’s quarter and full year 2009 earnings conference call. At this time, all participants are in a listen-only mode. After management’s prepared remarks, there will be a Q&A session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to your host for today’s conference Ms. Angie Chang, Changyou’s Investors Relations Manager. Please proceed.

Angie Chang

Thank you for joining Changyou to discuss our fourth quarter and full year 2009 results. You may find a copy of our earnings press release that we issued earlier on the IR section of our website at www.changyou.com/en or on Newswire services. On the call today are Mr. Tao Wang, CEO; Mr. Dewen Chen, President and COO; Mr. Alex Ho, CFO; and Mr. Xiaojian Hong, CTO.

On behalf of Mr. Wang, Mr. Ho will lead up by providing business highlights and discussing financial results for the fourth quarter and full year 2009. After the prepared remarks, he will be joined by the other officers to answer questions.

Before we continue, pleased allow me to read you Changyou’s Safe Harbor statements. Statements that are not historical facts, including statements about the company’s beliefs and expectations are forward-looking statements. These statements are based on current plans, estimates and projections, and therefore you should not place undue reliance on them.

Forward-looking statements involve inherent risks and uncertainties. The company cautions that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statements.

Potential risks and uncertainties include, but are not limited to, the current global financial and credit market crisis and its potential impact on China’s economy; the slower growth China’s economy experienced during the latter half of 2008 and in 2009, which may continue through 2010; and certain regulatory landscape in the People’s Republic of China; fluctuations in Changyou’s quarterly operating results, Changyou’s historical and possible future losses, and limited operating history; and the company’s reliance on Tian Long Ba Bu as its major revenue source.

Further information regarding these and other risks is included in Changyou’s registration statement on Form F1 originally filed on March 17, 2009 as amended through March 31, 2009 and other filings with the Securities and Exchange Commission. Please take note that unless otherwise noted, all figures mentioned during this conference call are in US dollars.

Now let me turn the call over to our CFO, Mr. Alex Ho. Alex?

Alex Ho

Thank you, Angie. Hello, everyone, and thank you for joining us today. I will begin by providing an overview of our business on behalf of Mr. Tao Wang, our CEO, who will be available to answer questions after our prepared remarks. We are pleased to report that the fourth quarter was another strong quarter for Changyou, keeping a historic year in which we completed a successful IPO and delivered consistent financial and operational growth.

During the fourth quarter, we achieved record total revenues of $70.7 million, up 3% quarter-over-quarter and in line with company guidance. Non-GAAP net profit for the quarter also grew 2% quarter-over-quarter to a record $42.2 million, in line with company guidance. For the full year, our total revenues reached a record $267.6 million, representing an increase of 33% from $201.8 million in 2008. Full year non-GAAP net income increased to $158.1 million, an increase of 39% from $113.3 million in 2008.

Our fourth quarter operational results reflect the solid momentum of our existing games and demonstrate the strength of our game operation and product development capabilities. The strategic releases of engaging game features developed based on user feedbacks throughout the year for our existing games and push our user base resulting in, one, aggregate registered users reaching 80.9 million in the fourth quarter from 75.1 million last quarter, an increase of 8% quarter-over-quarter and 41% year-over-year; two, aggregate peak concurring users, or PCU, growing to 990,000 in the fourth quarter from 910,000 last quarter, up 9% quarter-over-quarter and 19% year-over-year; and three, aggregate active paying accounts, or APA, reaching a high level of $2.4 million, flattish with last quarter and representing an increase of 21% year-over-year.

We achieved this result while making concrete efforts to keep average revenue per active paying account or ARPU at an affordable level of renminbi 196, up by 3% from renminbi 190 in the third quarter and 1% year-over-year. We are also pleased to report that Tian Long Ba Bu, or TLBB, continues to be one of the most popular games in China.

During the quarter, we saw TLBB’s PCU reaching a high of 870,000, reflecting an increase in both new and old users of the game after the successful launch of our major expansion pack for more addition in late September 2009. In order to assimilate gamers into the virtual community, we followed up in December with the release of our Christmas and New Year packs, which contain enhancement to the in-game community and chat platforms [ph] and fresh virtual item for the holiday seasons.

We also introduced Jian Ying Xia Qing in January with new riding animals, virtual pets and online activities in advance of New Year holiday. These and other strategic releases of new game contents throughout the year have continued to expand TLBB’s lifecycle, forming a solid revenue base for funding growth in our other existing and pipeline [ph] games. We will continue to provide game content update for TLBB with the next one planned for release in April.

For our Blade Online series, we saw growth in the fourth quarter as breakeven to continue to gain tractions amongst users. During the quarter, we conducted in-game marketing event and released new virtual items for both games in the series. As part of our ongoing commitment to broaden our user base and differentiate our game offerings, we recently separated the R&D teams for these two games in Blade Online series. We expect these will lead to distinct difference in game development and offer a variety of game plays that will attract additional users.

The solid performance of our existing games affirms our belief that game development should be user oriented and based on user feedback. It is with this principle in mind that our R&D team develops the games in our 2010 pipeline. Let me provide you with an update of our current development progress.

First, game development on our second in-house developed game Duke of Mount Deer, or DMD, is progressing smoothly, as we test our new dungeons and weapons in the closed beta version. A team of over 160 game engineers are currently working on the game, providing updates on a weekly basis to enrich game content and improve user experience. Gamer has so far responded positively to the tweaks, we have made various in-game functions, and the game is on track for open beta launch in the third quarter of 2010.

Second, we have converted Zhong Hua Ying Xiong, our Taiwan-licensed module MMORPG and first venture into the 3D segment, into simplified Chinese. Also, localization of the game for the Chinese market has more or less been completed. The game will enter technical closed beta testing tomorrow. And we expect to commence open beta testing in the second quarter of 2010.

Third, we licensed a new 2D turn-based cartoon-style MMORPG Da Hua Shui Hu. The game feature is a community-based game play that takes a humorous prince on the character and scenes from the Chinese classic novel, Outlaws of the Marsh. The game entered closed beta testing in early January, and we plan to begin open beta testing as early as March 2010. In light of the upcoming release of Da Hua Shui Hu, management is currently evaluating other suitable time slot in 2010 for the open betas of Immortal Faith and Legend of Ancient World. Both games continue to undergo closed beta testing and game development is progressing as planned.

2009 was an exceptional year for Changyou. And in closing, I would like to say we were very pleased with the progress we made. Our successful IPO in April enhanced our brand recognition while providing us the platform and resources to further expand our business. Building on the consistent growth of our existing games, we were able to generate record returns and make additional investments and advancement in our pipeline while delivering significant value to our shareholders.

Looking forward, we are optimistic heading into 2010 with a full line [ph] of games preparing for release during the year. Our user-centric game development platform and diversified portfolio of new and existing high quality games will allow Changyou to you establish significant presence in key markets and segments that will serve as catalyst for growth in the years to come.

Finally, I would like to take a moment to congratulate Mr. Dewen Chen, our Chief Operating Officer on his recent promotion to President, a role he will serve in addition to his duty as COO. Dewen is one of Changyou’s founders and has been instrumental to the strategic development of the company. We look forward to further contribution from him in his extended role.

This completes Tao’s prepared remarks. Let me now walk you through the financial highlights for the quarter.

As mentioned earlier, we generated solid financial and operational results for the fourth quarter of 2009, making it an outstanding year for Changyou. Starting with the top line, our total revenue for the fourth quarter of 2009 grew to $70.7 million, as previously guided, an increase of 3% sequentially and 21% year-over-year.

Revenue from game operation increased 3% sequentially and 22% year-over-year to $68.6 million. This overall increase was mainly due to increased popularity of our flagship game TLBB. Overseas licensing revenues were $2.1 million, an increase of 15% sequentially and 5% year-over-year. The increase was mainly due to increased momentum of TLBB in Vietnam and Malaysia.

The majority of remaining measures I will be discussing will be non-GAAP. Under US GAAP, share-based compensation expenses are charged through the quarter cost of revenue and operating. Total share-based compensation expenses for the fourth quarter were $3.3 million.

We believe excluding the share-based compensation expenses from a non-GAAP financial measure of net income makes a more meaningful comparison of Changyou’s operational results and improved investors understanding of Changyou’s performance. So we use non-GAAP measures in the following discussions to explain cost expense item and margins.

Non-GAAP cost of revenue increased 18% sequentially and 23% year-over-year to $5.4 million. The increase was mainly due to higher bandwidth cost and higher depreciation and amortization for new server put into operation for our existing games. Non-GAAP gross profit increased 2% sequentially and 21% year-over-year to $65.3 million. Non-GAAP gross margin was 92% for the quarter compared to 93% in the last quarter and 92% in the same quarter last year.

Non-GAAP operating expenses decreased 3% sequentially and 6% year-over-year to $17.7 million. Non-GAAP product development expenses increased 5% sequentially and decreased 12% year-over-year to $5.1 million. The sequential increase was primarily attributable to an increase in salary and benefits due to hiring of more game engineers. The year-over-year decrease was primarily the result of a change in our bonus program for key engineers, for whom we lessened cash bonuses after the share-base awards previously granted increased in value after the IPO.

Non-GAAP sales and marketing expenses increased 3% sequentially and decreased 5% year-over-year to $9.5 million. The sequential increase was primarily due to increased marketing and promotional activities for new content releases for our existing games. The year-over-year decrease was primarily because of savings in marketing and promotional spending due to our optimization of marketing campaigns in 2009.

Non-GAAP general and administrative expenses decreased 25% sequentially and 2% year-over-year to $3.1 million. The sequential decrease was primarily due to an increase in legal expenses to enforce our intellectual property rights in the previous quarter. The year-over-year decrease was primarily the result of a change in our bonus program for management, for whom we lessened cash bonuses after share-based awards previously granted increased in value after the IPO.

Non-GAAP operating profit increased 4% sequentially and 36% year-over-year to $47.6 million. Non-GAAP operating profit margin was 67% for the quarter, relatively unchanged from the previous quarter and up from 60% in the same quarter last year. Income tax expense was $6.3 million for the fourth quarter of 2009. For 2010 to 2011, our game operation in China will be subject to an income tax rate of 12.5%.

Non-GAAP net income was a record $42.2 million, an increase of 2% sequentially and 39% year-over-year. Non-GAAP net margin for the fourth quarter was 60%, relatively unchanged from the previous quarter and up from 52% for the same quarter last year. Non-GAAP fully diluted earnings per ADS was $0.79, up from $0.77 in the previous quarter and $0.64 in the same quarter last year.

Shifting to our balance sheet and cash flow position, as of December 31, 2009, we had cash and bank deposits of $226.9 million compared to $312.9 million as of September 30, 2009. Operating cash flow for the quarter was a net inflow of $46.2 million. The decrease in net cash balance is due to the payment of a $96.8 million IPO dividend to SOHU during the fourth quarter. We declared this dividend on April 1, 2009, as disclosed in the IPO prospectus. Receipts in advance and deferred revenue was $30.2 million as of December 31, 2009, up from $29.2 million as of September 30, 2009.

Finally, looking at our guidance for the first quarter of 2010, we expect, one, total revenues to be between $70 million and $73 million; two, non-GAAP net income to be between $41 million and $42.5 million; three, non-GAAP fully diluted earnings per ADS to be between $0.77 and $0.80; four, assuming no new grants of share-based awards, we estimate share-based compensation expense to be between $3.0 million to $3.5 million, reducing our fully diluted earnings per ADS under US GAAP by $0.06 to $0.07.

In conclusion, we are pleased with our fourth quarter results. In our first year as a standalone company, we conducted an impressive IPO and delivered financial record and operational metrics high. We have capitalized on our ability to translate game development and operational success into high profit margins and rich cash flow while investing in the future development of our existing and pipeline games. Going forward, we will continue to focus on user experience while leveraging our game development expertise to deliver long-term value to Changyou and our shareholders.

This concludes our prepared remarks for today. Operator, we will now open the call for questions. Operator?

Question-and-Answer Session

Operator

Yes, sir. (Operator instructions) And your first question comes from the line of Dick Wei with JP Morgan. Please proceed.

Dick Wei – JP Morgan

Hi, thanks for taking my questions. My question is on the first quarter guidance. Can you give more color as of how much you factor in for the new games Zhong Hua Ying Xiong and Da Hua Shui Hu in the guidance? Thanks.

Angie Chang

(Spoken in Foreign Language)

Alex Ho

Hi, Dick. In the first quarter guidance, because the Zhong Hua Ying Xiong -- the open beta is scheduled to be launched in the second quarter of 2010. So there is no revenue coming from the Zhong Hua Ying Xiong budgeting in the first quarter. And because -- for the Da Hua Shui Hu, actually we are going to open beta mode as well. So there very minimal has been considered in our Q1 project -- I mean, Q1 guidance.

Dick Wei – JP Morgan

Okay. So mainly it’s still coming out from TLBB?

Alex Ho

Correct.

Dick Wei – JP Morgan

Okay, great. Thanks.

Operator

(Operator instructions) And your next question comes from the line of Wallace Cheung from Credit Suisse. Please proceed.

Wallace Cheung – Credit Suisse

Hello?

Angie Chang

Hi.

Alex Ho

Hi, Wallace.

Wallace Cheung – Credit Suisse

Hi, thank you. Just quickly on the balance sheet items, can you explain why the fixed asset items and the intangible items going up? Thank you.

Angie Chang

(Spoken in Foreign Language)

Alex Ho

For the fixed asset, because as we announced it in our second quarter conference call, we actually have purchased an office building. So the fixed asset increased because of the payment for the office building amount to about $31 million during the quarter. That’s why you see an increase in the fixed assets. For the intangible assets, that increase by a few million is because during the quarter we also paid the initial licensing fee to sum up our licensed game as previously announced. So that’s why the intangible assets also got increased.

Wallace Cheung – Credit Suisse

Thank you. Just a quick follow-up. Does it include any payment for the 3D game engine?

Angie Chang

(Spoken in Foreign Language)

Alex Ho

Yes.

Wallace Cheung – Credit Suisse

So it’s like recognized in fixed asset item?

Alex Ho

Could you say it again?

Wallace Cheung – Credit Suisse

Is it recognized in intangible asset items?

Alex Ho

Yes.

Wallace Cheung – Credit Suisse

Okay. Thank you.

Alex Ho

Thank you.

Operator

And your next question comes from the line of Eddie Leung from Bank of America/Merrill Lynch. Please proceed.

Eddie Leung – Bank of America/Merrill Lynch

Hi, good evening, everyone, and congratulations to Dewen. I have a couple of questions on TLBB. Could you tell about the reason for the growth of APA to lag behind PCU and registered accounts in the fourth quarter? And can you just tell about the upcoming expansion packs for the game?

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) To answer your question, Eddie, it’s because we’ve adopted a more conservative strategy -- operating strategy in doing TLBB during the fourth quarter. Basically from our experience last year, we saw that in the fourth quarter of 2008 it’s typically quite difficult to increase the active paying accounts in the fourth quarter. And therefore we adopted a much more conservative approach and focused more on increasing -- on growing our user base. As such, that explains your first question. And then second, regarding your question about new content, basically we are going to be launching new game content in the first quarter as well as also in April.

Eddie Leung – Bank of America/Merrill Lynch

Understood. Thank you, guys. (Spoken in Foreign Language)

Tao Wang

(Spoken in Foreign Language)

Operator

And your next question comes from the line of Jenny Wu from Morgan Stanley. Please proceed.

Jenny Wu – Morgan Stanley

Hi, everyone, thank you for taking my questions. Just one regarding your employees, how many sales force you have now and what’s your plan to add new -- how many sales force and how many R&D people you are going to add for 2010?

Angie Chang

Are you talking about sales people and R&D people?

Jenny Wu – Morgan Stanley

Right.

Angie Chang

Sales force? Okay. (Spoken in Foreign Language)

Alex Ho

Hi, Jenny. Right now, as of December 31, 2009, for R&D, we only had about 520 engineers working on different projects. And we -- and for the offline marketing people, we have about 50 that we got them as our normal employees. But for the total team, we also employed some temporary staff for the offline marketing, which could be as high as like 600 people. For 2010, we expect to further increase our headcount mainly in the R&D area. So we plan to double our R&D workforce in 2010. For the offline marketing people, we don’t have plans to further expand that. So instead of expanding people on the offline marketing workforce, we planned to further upgrade the management system so as to increase the efficiency of those offline marketing guys.

Jenny Wu – Morgan Stanley

Okay. As a related question, given you are going to double the R&D staff and given your need to spend on sales and marketing for the new games, so what kind of margin trend can we expect? I mean, for -- okay, for 2010.

Angie Chang

(Spoken in Foreign Language)

Alex Ho

Jenny, I think for the existing game operations -- I mean, the operations for TLBB, BO and BO2, the margin for these operations will remain at a similar level as last year. However, as you correctly pointed out, we are going to launch five new games in 2010, particularly the Zhong Hua Ying Xiong that’s going to be launched in the second quarter and the DMD, which is going to be launched in the third quarter of this year. And we would need to further ramp up our marketing expenses surrounding the promotion of these games. So that will have a downward pressure on the margins in the second quarter and the third quarter, because, you know, typically for games that usually it takes like three to six months for the online gamers to actually ramp up their spending in the games. That’s one factor. And also the second factor is that the Zhong Hua Ying Xiong is a licensed game. So we also need to provide revenue-sharing to the developer -- Taiwanese developer. The typical revenue-sharing for licensed game is about 20% to 30% of the revenue to the developer. So you need to take both factors into consideration.

Jenny Wu – Morgan Stanley

Okay. Very clear. Thank you very much.

Alex Ho

Thank you, Jenny.

Operator

And your next question comes from the line of Kathy Chen with Goldman Sachs. Please proceed.

Kathy Chen – Goldman Sachs

Hi, thanks for taking my question. I have a follow-up question on TLBB. It looks like during the quarter ARPU for the game increased. Could you also give us some color about the ARPU strategy for the game? Going forward, should we expect that APAs may be more stable, but that will continue to steepen the ARPU growth? Thank you.

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) Okay. Basically if you look at our ARPU, actually we compare it to the ARPU in the fourth quarter of last year. The ARPU in Q4 of 2008 was renminbi 195 dollars per quarter. And then in the Q4 of 2009, this quarter, we had a renminbi of 196. So basically the ARPU has been maintained at a relatively steady level. And going forward, our management is going to continue to adopt very more conservative approach to ARPU. If our expansion packs that we launch are going to be successful, we expect there is going to be room for further ARPU growth in TLBB. But also at the same time, because a lot of our expansion packs are also focused on increasing the user base of TLBB, that would negate some of these facts from our normal -- from launching options [ph] like virtual items and stuff. So that’s going to negate some of the impacts of ARPU. So we think that we are going to be -- we are going to try our best to keep ARPU at a relative consistent growth -- or slower growth rate.

As long as TLBB continues to be our major revenue source, we are going to continue use -- adopting a more conservative strategy towards ARPU. And we are going to be spending more effort and focus on doing our new games. Thanks.

Kathy Chen – Goldman Sachs

Okay. Thank you.

Operator

And your next question comes from the line of Atul Bagga from ThinkEquity. Please proceed.

Atul Bagga – ThinkEquity

Hey, guys, thanks for taking my call. And congratulations, Dewen. For 2010 -- I know you guys are not guiding for 2010 revenue. I just wanted to see if you can share some of your internal expectations when you guys licensed the game ZHYX. What kind of revenue are you expecting? Maybe in terms of scale, how big do you think ZHYX could be? And just in terms of scale, how big do you think DMD could be? Thank you.

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) These two projects are going to be our main focus of our management team’s efforts this coming year. So we are going to try our best to do what we can with these games.

Atul Bagga – ThinkEquity

Thank you.

Operator

(Operator instructions) And your next question comes from the line of Andrey Glukhov with Brean Murray. Please begin.

Andrey Glukhov – Brean Murray

Yes, thanks for taking the question. Couple of things. First of all, on the international licensing revenue, it was quite strong this quarter. Did you guys have any upfront licensing fee recognition or was it all sort of organic? And then I have a follow-up.

Angie Chang

(Spoken in Foreign Language)

Alex Ho

Hi, Andrey. There is no upfront licensing -- let's put it this way. All the upfront licensing fee for us we actually amortize during the -- over the life of the game. So there is no one of -- upfront licensing fee is being recorded for the fourth quarter. And the increase for this -- for the overseas licensing revenues for the fourth quarter, as I mentioned in the script, it’s mainly because of the good performance of TLBB in Vietnam and Malaysia. And part of the reason is because those local operators further increased their marketing and promotional efforts for TLBB in their respective country.

Andrey Glukhov – Brean Murray

Okay. That helps. And then can you comment on the conversation rate that you are seeing right now in TLBB? You guys had a pretty impressive growth in the registered user base whereby the -- while active paying accounts remained basically flattish. So, is the conversion rate here is flattish and the active payers are flat while the registered is growing, or is the conversion is down a little bit in Q4?

Angie Chang

(Spoken in Foreign Language)

Unidentified Company Participant

(Interpreted) It’s still at a level of roughly at a 17% to 18% level in terms of conversion ratio.

Andrey Glukhov – Brean Murray

Okay, thanks.

Operator

And your next question comes from the line of Wendy Huang with the Royal Bank of Scotland. Please proceed.

Wendy Huang – Royal Bank of Scotland

Hi, thanks for taking my question. Wang Tao, you just mentioned about different seasonality for Q4 and Q1. I remember in the last Q1 -- Q1 ’09, your active paying accounts actually increased a lot, but ARPU declined. So should we expect a similar trend in the upcoming Q1 as well?

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) To answer your question, basically if we split it out, we think for TLBB, it’s probably the ARPU is going to stay roughly the same as in Q4. And however, for Blade Online or Blade Hero 2 series, we think the ARPU might go up a bit. And the reason is because after the launch of Blade Hero 2 last quarter, typically it takes about three to six months for gamers to start spending in the game and for us to start seeing an impact on ARPU. So we expect that with Blade Hero 2’s gamers getting more involved in the game, they would start spending and you are going to see ARPU going up.

Wendy Huang – Royal Bank of Scotland

Okay. And also could you shed some light on your expansion strategy? It seems that you launch expansion pack more frequently than before, but active paying accounts is still just flattish. So could you give some color on that?

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Spoken in Foreign Language)

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) So basically he said that our strategy is so to be launching for TLBB probably one expansion pack per quarter. But the reason why you might have seen there seems to be more game content updates, including something that we launched in December, and then we are saying that we are going to be launching some in January as well as in April. Some of those are more promotional and marketing events. So they are not exactly real expansion packs per se. Yes -- so they are just more game content updates packed together with sales and marketing activities.

Wendy Huang – Royal Bank of Scotland

Okay. Thank you.

Operator

And your next question comes from the line of Alicia Yap with Citigroup. Please proceed.

Alicia Yap – Citigroup

Hi. Can you share with us the latest progress on DMD closed beta testing? So for the most recent testing phase, how many testing accounts have you distributed and how was the churn rate for this round? And what are some of the feedback gamers have provided? And just on -- what are the major enhancements in fine-tuning your working on these final round development months?

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) So to answer your question, basically what we are doing – launching more major game content updates to the game on a weekly basis and then doing some minor tweaking to the game on a daily basis. And right now, the number of active users in the game is around 10,000 people. And we are going to be launching more new game content into the game at the end of April. And then after April we are going to be doing some overall fine-tuning of the entire game. And right now, if we are looking at the churn rate, basically it’s at a pretty healthy level. And we are really confident in this game.

Alicia Yap – Citigroup

Okay, thank you. And then can I have one follow-up on the super hero? So -- since the game got started, there is more technical testing tomorrow. So given it is very steady and continue robust performance in Taiwan, has that increased your confidence and expectation that the game will have these attractions in China market?

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) Actually it’s pretty mixed in terms of -- it's hard to predict, because what we are seeing is that a lot of games that get launched in China as well as in Taiwan, I mean, there are some that perform well in those markets, but there is also some that only performs well in one of the markets. So it’s pretty mix and it’s very hard to tell.

And we -- obviously since we licensed this game through our Qibao strategic licensing plan, we obviously think this is a game with very promising potential and it’s a good quality game. So right now we are working with the Taiwanese developer on the game content and on collecting user fees back so that we could make changes to the game that’s going to be to make it fit for the Chinese market.

So after we launch our first round of technical closed beta testing on Zhong Hua Ying Xiong tomorrow, we are going to be able to collect a lot more statistics and user feedback about the game. And with that, we believe we will be able to make more progress on the game and develop it.

Alicia Yap – Citigroup

Okay. Thank you very much.

Tao Wang

Thank you.

Operator

And your next question is a follow-up from Dick Wei with JP Morgan. Please proceed.

Dick Wei – JP Morgan

Hi, thanks for taking my follow-up. I still have a question on the DMD. Can you just give us any chances for the games for further delays for launch? I guess one of the reasons last year was because of higher market competition in the space, I’m not sure. What are some of the potential reasons that could lead to the delay of the game? And I think secondly, my question is that -- how about the outlook that you are targeting for DMD? I guess some of the competitive games, fantasy cartoon games are also seeing low ARPU, I’m not sure. Do you have any thoughts on that? Thanks.

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) Our main focus right now, when developing DMD, is still on trying to see how we can maximize our potential user base for the game. And how -- and it’s also -- it's always been our company’s operating strength in how we consistently increase our ARPU as well as active paying users and how that translates into revenues for the company. Right now we are experimenting with different modes -- game play in modes within the games. So this might take some time in terms of development. For example, it’s going to be one of the first games that’s going to be able to accommodate different display or graphic styles. So, basically combining the options of 2D, 2.5D and 3D into one game. Last year we did get some significant progress in developing our 3D game engine. And we want to be able to use this progress that we’ve learned into developing our new games and products. As the potential 3D game market is rather big, we do want to maximize the amount of users that will play our game -- our DMD game. Yes. And that’s basically the key reason.

Dick Wei – JP Morgan

So for the versions that will be launched in 3Q 2010, is it going to be still 2.5 version or will that be -- will that be like a 3D version of DMD? And if not, when should we expect kind of the 3D versions for DMD to come out?

Unidentified Participant

(Spoken in Foreign Language)

Tao Wang

(Interpreted) So basically it’s -- the player gets the option to choose whether they want to play as a 2.5D or a 3D game. Basically we have -- we have basically been able to implement our 3D game engines into the -- successfully implement the 3D game engine into the DMD game right now.

Dick Wei – JP Morgan

Okay, great. If I can just ask a question again, what are kind of the potential reasons for the delay of the game that you can foresee or you are today confident you will be launching in 3Q?

Unidentified Participant

(Spoken in Foreign Language)

Tao Wang

(Interpreted) It’s really mainly going to depend on the market situation. Right now we basically have five games planned for 2010. Three have more concrete launch date in mind, and for the other two, we are still trying to determine the appropriate time for open beta testing these games based on a review of our internal resources as well as competitor’s game timeline and on competition and et cetera.

Dick Wei – JP Morgan

Okay, great. Thank you very much.

Tao Wang

(Spoken in Foreign Language)

Operator

And your next question comes from the line of Vivian Li with Piper Jaffray. Please proceed.

Vivian Li – Piper Jaffray

Hi, thank you for taking my question. Can you comment quickly on your overseas operations, and particularly if you are considering export TLBB to the US market? If so, can you give us some color on the revenue potential? Thank you.

Unidentified Participant

(Spoken in Foreign Language)

Tao Wang

(Interpreted) Our focus for -- in terms of our overseas strategy is still to try to accumulate experience about the foreign markets as well as just gain operation experience. So -- and in terms of the current status of TLBB, we launched it -- we open beta the game in Q4. And right now based on what we are seeing, we don’t believe that the game is going to be a major contributing factor to our revenues in the near-term.

Vivian Li – Piper Jaffray

Okay, thank you.

Tao Wang

Thank you.

Operator

And you have a follow-up question from the line of Eddie Leung from Bank of America/Merrill Lynch. Please proceed.

Eddie Leung – Bank of America/Merrill Lynch

Hey, guys. Just a follow-up question on Zhong Hua Ying Xiong, (inaudible) and also talk a little bit about -- sometimes when a game is very successful overseas market, it may not be doing as well as in overseas market in Mainland China. Just curious on -- in terms of your marketing strategy, for the games, are you going to do anything special because the comic book perhaps is not as popular in Mainland as in Hong Kong or Taiwan? Thanks.

Angie Chang

(Spoken in Foreign Language)

Tao Wang

(Interpreted) To answer your question, Eddie, basically no one clarified that for China and Taiwanese markets, the key difference is more on towards the game content and not really on the marketing of the games. So we are going to be continuing to focus on looking into Zhong Hua Ying Xiong and see how we can improve the game and make it fit for the Chinese market. So in terms of marketing, we are just going to continue with our current marketing strategy that we do with other games.

Operator

And we are now approaching the end of the conference call. I would now like to turn the call over to Changyou’s Investor Relations Manager, Ms. Angie Chang, for her closing remarks. Please proceed.

Angie Chang

Once again, I would like to thank all of you for joining us on today’s call. If you have any follow-up questions, please do not hesitate to contact us. 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: Changyou.com Limited Q4 2009 Earnings Call Transcript
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