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Perfect World Co., Ltd. (NASDAQ:PWRD)

Q4 2009 Earnings Call Transcript

March 1, 2010 07:00 am ET

Executives

Vivien Wang – IR Officer

Michael Chi – Founder, Chairman and CEO

Kelvin Lau – CFO

Analysts

Lisa Yang [ph] – Morgan Stanley

Wendy Huang – RBS

Wallace Cheung – Credit Suisse

Alicia Yap – Citigroup

Andrey Glukhov – Brean Murray

Jin Yoon – Nomura

Paul Keung – Oppenheimer

Eddie Leung – Bank of America

Hiu Dan [ph] – HSBC

Ming Zhao – SIG

Tucker Grinnan – HSBC

Operator

Good morning. My name is Brandon, and I will be your conference operator today. At this time I would welcome everyone to the Q4 and FY 2009 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer session. (Operator instructions). Thank you. Ms. Vivien Wang, you may now begin your conference.

Vivien Wang

Thank you, operator, and thank you, everyone, for joining us today for Perfect World’s fourth quarter and fiscal year 2009 earnings release conference call. We distributed our unaudited earnings release earlier today. You may find a copy of the press release on our official web site 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 business and operational developments and take us through our financial performance in the fourth 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 U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectation. Potential risks and uncertainties include, but are not limited to, those outlines in our public filings with the SEC including our annual report on Form 20-F. For more information about these risks and uncertainties please refer to our filings with the SEC.

Perfect World does not undertake any obligation to update any forward-looking statements as a result of new information, future events or otherwise, except as required under applicable law. Our earnings release and this call include discussion of certain non-GAAP financial measures. Our earnings release contains a reconciliation of the non-GAAP measure to the most directly comparable GAAP measures. And it’s available on our Web site, at www.pwrd.com under the Investor Relations section.

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

Michael Chi

Thank you, Vivien, and thanks everyone for joining us today. We are pleased to announce our results. 2009 was an exciting year as we successfully expanded on game portfolio by launching our first 2.5D MMORPG, Battle of the Immortals and first 2D turn-based MMORPG Fantasy Zhu Xian.

Both games quickly emerged as popular games in the market after their respective releases. Our existing games also contributed to our encouraging results as we consistently release new expansion pack to enhance game content. Zhu Xian and Perfect World II are two examples where new expansion packs led to meaningful growth. We highlight our competitive position in the online game industry by having a diversified pipeline of six truly differentiated games that span 3D, 2.5D, and 2D market segments.

We will continue to build the franchises. That includes flagship titles in each of these market segments, by taking advantage of our specialized game engines and production studios.

We are happy with our program in our overseas business as we saw a considerable amount of growth during the past year. We have further strengthened our overseas network by leveraging more of our games to additional countries and the regions.

Our North American operation has seen significant expansion as we also introduced the new games to the market through our wholly-owned subsidiary. We are the leaders in Chinese online games export market in terms of revenues and geographic coverage.

We recently established wholly-owned subsidiary in Europe given their programs progress and success we have seen in North America so far. This strategic decision will allow us to capture future growth opportunities in the European market by leveraging our experience in North America. And we also effectively expand our overseas operational capability.

We are excited for 2010 as we have a number of new and diversified games and expansion packs that are scheduled to be launched. Modified strategy of dedicating more resources to long-term projects has proven to be effective in lengthening the growth cycle of both our new and existing games. We will utilize proven executional capabilities and strong R&D and operating platform to consistently strive to meet the varied interests and expectations of online games players around the world to sustain the steady growth of our company.

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

Kelvin Lau

Thank you, Michael. As Michael mentioned, we released a number of expansion packs for our existing games in the fourth quarter, including what we mean by Chi Bi delivery models. Each of these expansion contains new and enhanced content that is stimulating gamers interests. (inaudible).

Our overseas expansion efforts also made good progress. During the quarter, we (inaudible) of the model in Vietnam, (inaudible) and in Russian federation and other Russian speaking territories. We also successfully launched Chi Bi in Thailand, Vietnam and Korea through local operators. And following the quarter end, we started an agreement to license (inaudible) models in Korea.

Now, I would like to take you through to our fourth quarter 2009 financial highlights. Our total revenues were RMB 607.9 million in 4Q '09, an increase of 3% from 3Q '09 and 45.5% from 4Q ''08.

Our online game operations revenues were RMB 541.8 million in 4Q '09, up 11.5% from last quarter and 49.4% from 4Q '08. The sequential growth was primarily attributable to a number of achievements including the launch of Fantasy Zhu Xian, the release of a (inaudible) for some of our existing games and a series of marketing activities.

ACU for games under operations in Mainland China was approximately 1,157,000 in 4Q '09, an increase of 62.3% from 3Q '09. And 67.7% from 4Q'08. APC for games operated in Mainland China under the item based revenue model was approximately 2,188,000 in 4Q '09, an increase of 33.2% from 3Q '09 and 41.5% from 4Q '08.

ARPU of games operated in Mainland China under the item based revenue model was RMB 223 in 4Q '09 as compared to RMB 266 in 3Q '09 and RMB 225 in 4Q ’08. The increase in ACU and APC from 3Q ’09 was mainly due to the sound performance of Fantasy Zhu Xian and the continuous popularity of a number of our certain games.

The decrease in ARPU from 3Q ’09 was mainly due to the dilution effect arising from the launch of Fantasy Zhu Xian during 4Q '09.

Our overseas licensing revenue were RMB 61.7 million in 4Q ’09, an increase of 4.9% from 3Q '09, and a 11.7% from 4Q '08. The sequential increase was mainly due to an increase in usage based royalty fees and was partially offset by a decrease in initial license fees.

Our film, television and other revenue dropped it to RMB 4.5 million in 4Q ’09, because our film, Sophie’s Revenge was released back in the third quarter. Most of the films, television and other revenue recognized in 4Q'09 was related to liasoning [ph] of the copyright for the movie Sophie’s Revenge. Our, film, television and other costs dropped for the same reason.

Our cost of revenue (inaudible) 86.6% in 4Q '09. This was after slightly down 83.9% in 3Q '09 and down marginally from 88.2% in 4Q '08. Our online game related cost increased from 3Q ’09 mainly due to increase in sales related stock cost.

If you look at our operating expenses, increased 26.6% from 3Q '09 and 14.1% from 4Q '08. The increase from last quarter was mainly due to the foreign factors. Number one. And RMB 46.7 million increase in sales and marketing expenses. This was largely due to an increase in advertising and promotional expenses associated with both launch of the new game Fantasy Zhu Xian, the launch of (inaudible) Q '09.

In addition, we also incurred a special charge of approximately RMB 17.5 million, associated with a change in the (inaudible) of certain intangible assets acquired from (inaudible) which are related to outsourcing (inaudible) most of the acquired outsourcing team into our game R&D business, to further enhance our R&D capability.

Number two, an RMB 5.4 million increase in R&D expenses primarily due to an increases in stock costs. Number three, an RMB 10.5 million increase in G&A expenses mainly due to an increase in stock costs, including a special year-end bonus.

Our income tax expenses was RMB17.5 million in 4Q '09 as compared to that RMB11.1 million in 3Q ‘09 and RMB 33.6 million in 4Q '08. The increase was 3Q '09 was mainly due to an increase in withholding tax on overseas licensing revenue and an increase in income tax associated with domestic online game operations.

Net income attributable to the Company’s shareholders was RMB270.8 million in 4Q09 as compared to RMB288.3 million in 3Q'09 and RMB124.8 million in

4Q'08.

Non-GAAP net income attributable to the Company’s shareholders was RMB292.8

million in 4Q'09 as compared to RMB308.5 million in 3Q'09 and RMB220 million in 4Q'08.

The decrease of 3Q'09 was mainly due to the special charge-off of approximately RMB 17.5 million as mentioned earlier. In addition, the launch of new game Fantasy Zhu Xian

and (inaudible) Perfect World II, both 3Q, 4Q09 also caused an increase in advertising and promotional expenses.

Basic and diluted earnings per ADS were RMB5.44 and RMB5.09respectively, in 4Q'09. This compares to RMB5.83 and RMB5.50 respectively in 3Q09. And RMB2.22 and RMB2.12 respectively, in 4Q08.

Non-GAAP basic and diluted earnings per ADS were RMB5.88 and RMB5.50 respectively in 4Q09, as compared to RMB6.24 and RMB5.88 respectively, in 3Q09 and RMB3.91 and RMB3.74 respectively in 4Q08.

In terms of financial guidance based on our current operations, total revenue for the first quarter of 2010 are expected to be between RMB620 million and RMB644 million, representing an increase of 2% to 6% on a sequential basis and an increase of 46% to 51% on a year-over-year basis. This reflects the expected growth from our existing games.

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

Vivien Wang

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

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Lisa Yang [ph] from Morgan Stanley

Lisa Yang – Morgan Stanley

Hi, good evening, Michael, Kelvin and Vivien. I have a question. My first question is regarding your overseas expansion. So far you have license to over 50 countries. Yet your license revenue has been going slow as your domestic revenue. I just wonder, can we expect the licensing revenue to accelerate in 2010? And what would you (inaudible) market for you? And then I have some follow-up.

Vivien Wang

(Foreign language)

Kelvin Lau

Hi, Lisa, thanks for your question. Okay, first of all, I will explain you. I think we have changes. I think one of our key strategies continues to expand our operation of business in overseas market. Yes, right now, we will launch many games in many countries over the road, yet I think, your observation is correct, the revenue growth in domestic market faster than the revenue growth in overseas market.

Go back to your question is, yes, I think, in a short run, China is still a primary market for the growth. You will agree with that. Okay. China realized the largest online gaming market in the world. So, we are focused on our business in China we want to increase our market shares in China. Having said that we are not giving up our overseas market, we are continuous to launch more games in more countries going forward in our overseas licensing business.

Lisa Yang – Morgan Stanley

Okay. I also have questions about your overseas self-operation. Could you give us some more details about your self-operations then? What are the games you plan to add forth to European market? Which country that is the best market for you? And how are you seeing about the European market compared to the U.S. self-operation? What are the challenges you are seeing in both U.S. and European markets?

Vivien Wang

(Foreign language)

Michael Chi

(Foreign language)

Unidentified Participant

In our observation, European market already sufficient for those markets who will be similar to the U.S. in terms of the operation as a size, would it some research and we think in terms of the revenue size there should be pretty comfortable to those in the U.S. operations, of course, business is at a long run, and in terms of the operating model should be it pretty similar to that in U.S. well, what we have also seen some of the experienced stuff from the U.S. should the European team to make sure that we are sharing enough knowledge and also lowering our costs? Thanks.

Lisa Yang – Morgan Stanley

Thank you. My last question is about your sales and marketing costs. Given take of the one-off items sales and marketing costs in the quarter stood down to over 20% quarter-on-quarter, so how should we look at your sales and marketing level going forward, especially, giving (inaudible) your new game launch every quarter, do you see any increase in costs and compensation for your new game?

Michael Chi

Lisa, yes, in Q4, there is a marketing expenses increase quite a lot. I think the key reason is as I mentioned in the presentation is we have a new game launch which is Fantasy Zhu Xian in Q4, so as I mentioned earlier, I think in the previous earnings call, whenever new game launch we got incurred, more as a marketing expense on new game launch. So in Q4, this is mainly due to the name game launch and also we have a big expansion platform for Perfect World II. I think this is a two classical event which costs our sales and marketing expenses to increase quite a lot in Q4.

Going forward, in Q1, I would say we have no new game launch and also leverage high new (inaudible) online game especially for 3D games. Up to now we have seen any very significant sales and marketing expenses incurred in Q1. So that’s why I can just (inaudible) in Q1. I think going forward for the whole year, sales and marketing expenses, it all depends on the exact timings of our new game launch and also it depends on the status of the competition in the market, so we can build real further return our marketing strategy going forward, yes.

Lisa Yang – Morgan Stanley

That’s helpful, thank you.

Michael Chi

Thank you.

Operator

And your next question is from Wendy Huang from RBS.

Wendy Huang – RBS

Thanks for taking my question. My first question, could you give the revenue (inaudible) in your portfolio, especially given the tendency which I can see is your momentum in the 4Q, one, have it already become the No. 2 game in terms of revenue contribution in 4Q.

Vivien Wang

(Foreign language)

Michael Chi

Yes, Windy, thanks for your question. I think as usual our apologies, not going to give the breakdown of our revenue by games. But I think what you said give just some color on the revenue is Zhu Xian is the biggest game for that, I think, in terms of percentage, I think Zhu Xian is maybe the highest profitable contributors for our whole game portfolio. For Zhu Xian, in Q4 because of the data you do have a chart, I know you guys keep on checking our data. So, the performance of Zhu Xian is not bad, it’s quite good in Q4. What I say this Zhu Xian contributes meaningful revenue in Q4, I think quite similar to Perfect World II in Q4, so, what I say, finish my answer, a very successful launch.

Wendy Huang – RBS

Okay. My second question is regarding your Q1 guidance. I just wonder whether are you implying any improvements in the ARPU side given that (inaudible) ARPU where started went up significantly in Q1?

Vivien Wang

(Foreign language).

Michael Chi

I think the factors for the revenue growth what we estimate I think Q1 is (inaudible) estimate I think there is a possibility that ARPU could go up a little bit. As I mentioned before, Fantasy Zhu Xian in Q4 experienced first quarter of launch so (inaudible) seen the first quarter the ARPU will be a little bit lower. So, our focus I think (inaudible) ARPU will improve a little bit in Q1, for the other games I think the ARPU will maintain comparatively against stable in Q1. So the major growth for Q1 is I think the major diverse becoming from (inaudible).

Wendy Huang – RBS

Okay. Lastly, could you give an update on the launch timing of your 2010?

Kelvin Lau

It’s quite difficult to confirm the timing for new game launch Zhu Xian ….

Wendy Huang – RBS

Based on current visibility?

Kelvin Lau

(inaudible) our two new games (inaudible) we have already started, intend to testing for this typical testing for this two games, we still have not confirmed or finalized the launch schedule for these two games, you got to wait for the feedback every south during the course benefiting for these two games.

Wendy Huang – RBS

Okay, thank you, Kelvin.

Kelvin Lau

Welcome.

Operator

(Operator instructions). Your next question is from the line of Wallace Cheung from Credit Suisse.

Wallace Cheung – Credit Suisse

Hi, Michael, Kelvin, Vivien.

Kelvin Lau

Hi.

Wallace Cheung – Credit Suisse

Hey, just quickly, so we have seen a quite superior margins decline in the fourth quarter '09. Can you give us a bit more highlight or color on the margin front in first quarter in 2010? I think the second question is can you give us more update about the same (inaudible) already booked around RMB14 million, are we going to see further investments for the movie? Thank you.

Vivien Wang

(Foreign language)

Kelvin Lau

Okay, thank you, Vivien. This is Kelvin. Question number one, regarding decrease in the margin, I mean, operating margin for Q4 as Vivien mentioned, I think there is two key reasons for the decrease in the margin. One is the one-time charges of the (inaudible) last year, RMB14.5 million. Another, RMB17.5 million. Another key reason is Vivien mentioned is because of the sales and marketing expenses for Fantasy Zhu Xian and expansion with Perfect World II. So these are the two key reasons for the decrease in operating margin in Q4. In Q1, we didn’t have these type of one-time charges of (inaudible) one-time charges again in the short run. So these would not be happening again in Q1.

And also sales and marketing expenses due to Chinese (inaudible) very significant sales and marketing expenses for our games up to end of February. So, I would say, there is a possibility that we can improve our margins in Q1, given that we don’t have any one-time charges and also the sales and marketing expenses (inaudible) high level in Q1. That’s question No. 1.

Question No. 2, is yes, in our balance sheet, you will see above RMB14.5 million sitting in the film cost, this is (inaudible) to the movie which we are going to produce in 2010, which is (inaudible), I think you heard about some news or articles that we are going to produce a movie called (inaudible) in this course, 14.5 million Sophie’s Revenge movie. Up to now we still haven’t finalized the total budget for this movie. Going forward, yes, I think we start the process of production and indeed this time our film cost will increase going forward.

Wallace Cheung – Credit Suisse

Thank you. Just quickly on the first question, I really seen a longer trend that because of intense competition as well as there will be more (inaudible) speaking the margin trend is going to come down further, vis-à-vis '09Q4? Thank you.

Kelvin Lau

I think it is possible because as you see, most of our peers are going to launch this year and also overseas market situation will become more and more competitive, so, going forward maybe we are going to spend more on sales and marketing expenses, but I think, internally we have a very tight and strict control on the sales and marketing expenses for our games. That’s why I say, we try to maintain our sales and marketing expenses for a level of about 10% to 15% of the revenue spending on the advertising and promotional expenses.

Wallace Cheung – Credit Suisse

Okay, thank you.

Operator

Your next question is from Alicia Yap of Citigroup.

Alicia Yap – Citigroup

Thank you, good evening, Michael, Kelvin, and Vivien, I have two questions, first of all regarding your sales and marketing spend, just want to understand where most of these new games and the Zhu Xian promotion came at the end of the quarter.

I was trying to understand is that when you reported your Q3 in mid-November did you expect your sales and marketing spend to be entire $16 million or was that some unexpected back end load of spending that occur at the end of the year? And if so can you explain why you decided to spend the money and did you need that to give extra push to Fantasy Zhu Xian and Perfect World II essential packs?

Vivien Wang

Alicia, (Foreign language).

Michael Chi

In fact Alicia, yes, thanks for your question. I think when we held our 3Q earning release by that time we still haven’t spend so much I think on the Fantasy Zhu Xian. I think most of the sales and marketing expenses incurred is approaching to end of last year, because after the launch, we do more promotions on orders front, (inaudible) promotion orders and so this is one of the key reasons why the sales and marketing expenses increased a lot in Q4.

Alicia Yap – Citigroup

Okay. And my second question is on your guidance range. So since you have been a little bit a wider range this time just want to understand why is that? And then is there any movie contribution to be expected in your first quarter and also on your overseas either maintain at a current level or would that be more a sequential decline? And then lastly on the Fantasy Zhu Xian for that it was slightly impacted by the winter vacation just want to know whether have you seen it will stabilize and rebound to the initial launch level?

Vivien Wang

(Foreign language).

Michael Chi

Alicia, okay, number one, okay, regarding the guidance I think if you look back to our guidance dated before normally, we would give a rate of 5% point, okay, this time its 2% to 6% I think it's not a wider range, I think these, I think consistently (inaudible) and in fact we give to the market, number one. Number two is, the movie, for Zhu Xian in Q1, we are not going to have any film, TV or other revenue. I think from movie, okay Q1.

Another question is overseas licensing revenue for Q1. It all depends on commercial launch day of Fantasy Zhu Xian or some other games in Korea or in Thailand, so it all depends when (inaudible) I think our new operators still haven’t confirmed whether the game commercialized I think Zhu Xian or some of our games in overseas countries, if they can launch the game, yes, we can achieve some growth in overseas licensing revenue. So right now still have to say, but I think in terms of the Europe, I would say there would be some upside on the (inaudible) if you do not consider the issues I speak. Last question is (inaudible) a little bit by the Chinese new year, in fact, our team is having good R&D team and also the sales and marketing team, they do a lot of work up to the Chinese new year’s time to further push up back our ACU and APC number for Fantasy Zhu Xian.

Alicia Yap – Citigroup

Okay, thank you very much.

Kelvin Lau

Okay, Alicia.

Operator

And your next question is from Andrey Glukhov, Brean Murray.

Andrey Glukhov - Brean Murray

Well, two things guys, first of all to drill down on the Q1 guidance on the metrics front if you expect ARPU to gravitate up as a function of Fantasy Zhu Xian I guess can you give us some color how fast the Fantasy Zhu Xian ARPU is ramping to which you would consider peak levels and in the similar vein if you look at the APA, given the negative Q1 seasonality do you think APA is going to be up or down sequentially?

Vivien Wang

(Foreign language).

Michael Chi

Thank you, Andrey. For question number one is the ARPU, I think for Fantasy Zhu Xian I think as Vivien mentioned before the ARPU is we got to wait for the quarter end to calculate that ARPU, so what I can tell you this, realize is, what is the forecast is, Fantasy Zhu Xian, most probably the ARPU will go up in Q1, when it can go up to a more mature level is you have to say, normally, for new games, it would take about three quarters, four quarters to go out to a more stable ARPU number like Zhu Xian, I think Zhu Xian, launch after one year, ARPU would go up to about twenty or fifty something like this so I would say Fantasy Zhu Xian also experienced after three quarters to four quarters will come to a more mature level. For the APC, yes, because this is an experienced, I think the Chinese new year, (inaudible) than the APC number would jump a little bit.

Andrey Glukhov - Brean Murray

Okay. And if I may follow up as far as the operating margin are concerned, what are you guys thinking about sales and marketing and operating margin so that in Q2 given that you have two game launches in that quarter, do you expect to sort of do a similar push to the launch of those two games as you have done in Q4?

Vivien Wang

(Foreign language).

Michael Chi

Andrei, I think you follow our content for years, normally, for new game launch it take us about a year, we launch games in Q2, most probably, I think for, as Vivien mentioned before for all those new game launch we have incurred about RMB10 million for the pre game pre launch sales and marketing expenses so for sure, there is a new game launch, our sales and marketing expenses is to go up so, normally whenever in that quarter whenever there is a new game launch the margin will go down a little bit.

Andrey Glukhov - Brean Murray

All right, thank you.

Michael Chi

You are welcome.

Operator

And your next question is from the line of Jin Yoon of Nomura.

Jin Yoon – Nomura

Hey, good evening, guys. Thanks for taking my questions, couple of questions on the existing quarter, on the fourth quarter, can you just give us a breakdown of how much the incremental growth this quarter was actually coming from Fantasy Zhu Xian how did your other games fare in the quarter? And going forward if the quarter was to end today and you’re looking for 2% to 6% growth, again, how much of that is going to be coming from your organic games, games excluding Fantasy Zhu Xian? And I have one follow-up question regarding ARPUs. Thanks guys.

Vivien Wang

(Foreign language).

Kelvin Lau

Okay, Jin, thanks for your question, I think the major driver for the revenue growth for Q4 is coming from Fantasy Zhu Xian. Like Vivien disclosed to you because we’re not going to give a very detailed breakdown of revenue by game. So as you can see our number one revenue contributor in Q4 so the major driver is coming from these two games in Q4 and also you can see our (inaudible) some growth and also our U.S. operations have achieved some growth as well in Q4.

Going to Q1 I would say the major driver would be coming from still companies Zhu Xian and Perfect World II, why because the Fantasy Zhu Xian

in Q4 is only about 71 base revenue contribution it’s not full for the revenue contribution, so going to Q1 Fantasy Zhu Xian will have a full quarter revenue contribution. And also we have a very successful and good expansion type launch for Perfect World II. In fact we already done some acquisition (inaudible) for the Perfect World II before the Chinese new year. So up to now you can see a pretty nice growth for Perfect World II.

Jin Yoon – Nomura

Okay, if I could follow-up with one more question regarding BOI, I know that the BOI you guys hope to in the past try to lower its ARPU going forward, can you just give us the state of where that game is today in terms of ARPU, how much further decline that you see in ARPU in that game and what kind of contributions, incremental contributions you can make in the present quarter? Thanks, I will stop there.

Vivien Wang

(Foreign language).

Kelvin Lau

Jin, well, (inaudible) has stabilized at a certain level of ACU so I think in the past few months we didn’t see any significant drop in terms of ACU or APC for BOI. That’s what I mentioned before. Right now, we are giving more rooms and more time for the team to fix all those issues in BOI, so our media team has a very nice strength to fix all those issues and try to push up the ACU and APC number. In terms of ARPU for BOI, we’re stable, no drop or no increase for BOI.

Jin Yoon – Nomura

Okay, thanks guys.

Operator

And your next question is from Paul Keung of Oppenheimer.

Paul Keung – Oppenheimer

Good evening, thanks for taking my question. All my questions relate to international subsidiary. With the announcement of European subsidiary today and I guess based on your track accrual what you have done in North America, we, as investors, expect to see similar pattern emerge in this year, we saw creating operating subsidiary in overseas market so that would just suggest creating (inaudible) to be next and then specifically the European subsidiary, what kind of upfront investment you are making in the operations, what impact would have in G&A and cost factor, is it going to be something extensive of your North America operations (inaudible) or is it going to be very much independent investment?

Vivien Wang

(Foreign language).

Michael Chi

(Foreign language).

Unidentified Participant

(inaudible) Europe to be similar to U.S. operations. We have done some research for some of the other companies that are doing operation in the U.S. and Europe and we are noting similar pattern and a lot of similarity in terms of the cost structure and operation and all that. And currently in the U.S. our operation, our party is helped by the (inaudible), on the one hand we have very experienced localized personnel to take care of the operations in U.S. because they know a lot of the knowledge in the local market, but on the other hand we also have a China team here to support, just to provide a lot of the technical support and all that.

Going forward for the Europe operation we are seeing a similar type of operation, where we will have experienced and localized personnel that are based in the Europe, we will also have a China team to support them and in the meanwhile we will also set some of the experience that U.S. operations team to the Europe to handle the operations, so based on our estimate in terms of the cost structure and the operation pattern it should be somewhat similar to that in the U.S. Thanks.

Paul Keung – Oppenheimer

Okay, thanks.

Operator

Your next question comes from the line of Eddie Leung of Bank of America

Eddie Leung – Bank of America

Good evening, Michael, Kelvin and Vivean. A couple of questions, the first one is, could you guys comment on the regulations and government, do you foresee any change in the regulation environment? Thanks

Vivien Wang

(Foreign language).

Michael Chi

(Foreign language)

Unidentified Participant

We have to think the regulatory environment is getting better and better. First of all, the government has been all have been supportive, all of the comic and online game industry. We actually with me attended some of the seminars held by both MLC [ph] and Gap [ph]. We received lot of the supportive comments from the government. Of course, there are some (inaudible) that unlike any companies should be taking we together with some of the other leading online games operators have recently initiated a program, where those parents can monitor their kids over addiction to the online game and send their complaints to the online game operator and we, as the operator, can take proper actions of points to the parents complaints.

It’s been a roughly month since we take all those programs and the initial feedback from both the society and the government are pretty positive and we do believe by solving further about the fatigue issue of those young kids, aged under 18, it will further help the overall industry to grow in an healthier manner. So, even though we think the environment for the online game industry is getting better and better. Thanks.

Eddie Leung – Bank of America

Thank you. My second question is on the (inaudible). It seems they did not grow that much believe that quarter. Any particular reason?

Vivien Wang

(Foreign language)

Kelvin Lau

Hi, Eddie. The reason for the decrease in (inaudible) customer is mainly because right before the national holiday, I mean, right before the end of Q3, most of the (inaudible) cap, so this is the key reason, push up to have some customer by the end of Q3.

So, I think if I want to win some at the end of Q4 it has gone back to quite a normal level already. Regarding the deferred revenue, in fact, we achieved some growth in development because of the launch of Fantasy Zhu Xian, the increase in deferred revenue is not as high as what you expect to be, because for Fantasy Zhu Xian, in the first quarter of the launch in Q4, most of the items we saw, the orders consumer items (inaudible) items. So that’s a key reason why the deferred revenue did not go up as high as what you expect. So going forward, I think when we go into second quarter and the third quarter I think more permanent items will be sold in the game so that the deferred revenue going forward, our expectations will go up.

Eddie Leung – Bank of America

Understood, Kelvin. Head count and R&D count for the number. Thanks.

Unidentified Participant

(Foreign language) The total headcount to be about 1900 by the end of the year. And the R&D is to be around 1300 by the end of the year. Thanks, Eddie.

Eddie Leung – Bank of America

Thank you.

Operator

And your next question comes from the line of Hiu Dan [ph] from HSBC.

Hiu Dan – HSBC

My question has been answered. Thank you.

Vivien Wang

Thanks, Hiu.

Operator

Your next question is from the line of Ming Zhao of SIG.

Ming Zhao – SIG

Good evening and thank you for taking my questions. First question on the ARPU, the view excludes Fantasy Zhu Xian, ARPU were down versus third quarter?

Kelvin Lau

It will be up if we exclude Fantasy Zhu Xian.

Ming Zhao – SIG

If you exclude Fantasy Zhu Xian what ARPU was up or down versus third quarter, that’s my third question.

Kelvin Lau

Yes, if you take out the Fantasy Zhu Xian, the Q4 ARPU compared with Q3 will be a little bit up, just a little bit.

Ming Zhao – SIG

Okay. All right. Just following that actually want to ask Michael about this we have seen some at least more than one competitors experiencing issues when ARPU hit some level. So, my question to you is how do you see your ARPU for the old games going forward? Are you focusing on the new users or you are focusing on ARPU growth?

Vivien Wang

(Foreign language)

Michael Chi

(Foreign language)

Ming Zhao – SIG

Okay, thank you.

Unidentified Participant

Our strategy has always been to rely in a marketable gain to diversify our risk and basically we are relying multiple growth drivers, so, whenever there is a new game launch, we typically would have an increasing user base and increasing operating metrics such as ACU and APC. In terms of ARPU, we as an operator are very clear that again ARPU is too high is to be a little dangerous. So, we as an operator, our goal is to achieve our ARPU in a pretty healthy level, comparative a lot with the games, the leading games in the market those are extremely high ARPU games in the market, our ARPU stands at a pretty healthy level which is today. And we are not in hurry to push up the ARPU, we never give our R&D team more operations team any guidance to push up the ARPU. Going forward, we will be more relying on the growing user base and on the ARPU side, we are happy to see a gradual growth pattern.

Ming Zhao – SIG

Thanks.

Operator

And your next question is from the line of Wallace Cheung from Credit Suisse.

Wallace Cheung – Credit Suisse

Hi, just one quick (inaudible) question on the FICO. I think, Michael is completely (inaudible) meeting with investors (inaudible). What is the progress so far like in terms of acquiring high post, not just targeting domestic market, but like for the overseas market, vis-à-vis are you already discussing with any kind of strategic partner for U.S. and European operations maybe any kind of like potential those on even in next year so. Thank you.

Vivien Wang

(Foreign language)

Michael Chi

(Foreign language)

Unidentified Participant

Our goal is to become one of the largest online game provider in the world. So we’ve seen pretty actively expanding our R&D capability both domestically and internationally. And we are actively looking at those studies that are with the good quality and can bring us synergy with us and can share a low cost structure with us as well, but currently we don’t have any confirmed upon. In terms of the philosophy of M&A, of course, we are actively looking for a lot of the good target, but we are taking a very conservative approach on it. We have to make sure that it will bring lot of the synergies to us and we need to make sure that it’s a value creative. So, we are pretty conservative in terms of looking for M&A and currently we don’t have any confirmed upon. Thanks.

Wallace Cheung – Credit Suisse

Hi, thank you. Just one quick, Lisa. Michael, are you satisfied with the overseas market business development so far? Thank you.

Vivien Wang

(Foreign language)

Michael Chi

(Foreign language)

Unidentified Participant

Michael think, our overseas business development is doing a pretty good but it will take lot time for us to further ramp up. Thanks.

Wallace Cheung – Credit Suisse

Thank you.

Operator

And your next question will be from Tucker Grinnan from HSBC.

Tucker Grinnan – HSBC

Yes, hi, thank you for the call. Two questions. First is could you give us the color in terms of current dynamics within the market in terms of the massive multiplayer versus casual and mini-casual gaming segments in terms of where China is on the curve.

We have always seen very strong numbers out of $0.10 on casual gaming and you got us removing sort of down market into 2.5 or 2.75G games, that’s interesting. The second is do you think the sector is fairly valued and do you think your company is fairly valued in terms of what the equity markets are assigning, particular, relative to large China internet names and companies like Tanzen [ph] where majority of the revenues are coming from online gaming?

Vivien Wang

(Foreign language)

Michael Chi

(Foreign language)

Unidentified Participant

Let me start the first question first. We are fairly more focusing on MMORPG development, more 3D game, is best to be those large high quality MMORPG game. Of course, we will keep an eye on the (inaudible) game but currently we are more focused on MMORPG because we think the segment has a lot of potential for us to grow for company.

Kelvin Lau

This is Kelvin. I think regarding your second question, in relation to the violation of online gaming in the market, I think it’s now (inaudible) come in on the choice that violation on an gaming company in the market because whereby focus position to come down. But I think having said that we are very optimistic with overall market on a gaming market situation in China, if you look at IDC [ph] data, I think going forward, the focus is combined to growth rate for, like gaming, China is probably most 17% to 20%, so, you can see China achieve very good revenue growth in terms of online gaming revenue last year. So, we are too very optimistic with the overall market situation in the revenue growth in China. So I think we got the (inaudible) the market.

Tucker Grinnan – HSBC

Just one follow-up question. There seems to be a perception from many investors is that the Chinese online gaming market is volatile and difficult to predict and therefore the sector should trade at some discount to other more predictable revenue stream. Do you see as an operator that the Chinese market is volatile that the structural dynamics in the market are uncertain and was is the risk premium that the market perceived, you perceived as an operator in terms of lack of visibility on the business going forward?

Kelvin Lau

I think to answer your question (inaudible) we are on an appropriate position to come in on this type of relation questions. I think online gaming business is a project base of business, so, I think, as I would say, this type of volatility I think it is a better operating, I think we are now going to come down on this.

Tucker Grinnan – HSBC

Thank you.

Unidentified Participant

This is the end of the conference call. The webcast replay will be available. Thank you.

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Source: Perfect World Co., Ltd. Q4 2009 Earnings Call Transcript
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