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

Q4 2013 Earnings Conference Call

March 10, 2014 9:00 p.m. ET

Executives

Joanne Deng – Associate IR Director

Robert Xiao – CEO

Vivien Wang – VP of Capital Markets and Corporate Communications

Kelvin Lau – CFO

Analysts

Eddie Leung – Bank of America-Merrill Lynch

Natalie Wu – CICC

George Meng – Macquarie

Wendy Huang – Standard Chartered

Thomas Chong – BOCI

William Fung – Barclays

Muzhi Li – Citigroup

Nick Ning – 86Research

Operator

Hello, ladies and gentlemen. This is Vincent [ph], and I'll be the operator for this conference call.

I would like to welcome everyone to the Perfect World Company Limited Fourth Quarter and Fiscal Year 2013 Earnings Conference Call. [Operator Instructions]

Now I would like to turn the call over to Ms. Joanne Deng, Associate Investor Relations Director of Perfect World. Ms. Deng, please proceed.

Joanne Deng

Thank you, operator, and thank you everyone for joining us today for Perfect World's fourth quarter and fiscal year 2013 earnings release conference call. We distributed our unaudited earnings release earlier today. You may find a copy of the press release on our official website or through the newswires.

Today you will hear from Mr. Robert Xiao, our CEO, who will give us a brief overview of the quarter and fiscal year 2013, a brief update on our business, as well as an update on our dividend distribution plan. After that, Vivien Wang, our Vice President of Capital Markets and Corporate Communications, will take us through some of our latest operational elements. And then she will pass the call to Mr. Kelvin Lau, our CFO, who will take you through our financial performance in the fourth quarter and fiscal year 2013. Following the prepared remarks, Mr. Xiao, Mr. Lau and Ms. Wang will be available to answer your questions.

Before we continue, please note that our discussion today will contain forward-looking statements made under the Safe Harbor provisions of the US 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 expectations. Potential risks and uncertainties include but are not limited to those outlined 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 statement as a result of new information, future events or otherwise except as required under applicable law.

Our earnings release and this call include discussions of certain non-GAAP financial measures. Our earnings release contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures and is available on our website at www.pwrd.com, under the IR section.

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

Robert Xiao

Thank you, Joanne, and thank you all for joining our call today. I would like to also thank the Board and our shareholders for all your trust and support.

In terms of the financial performance, our fourth quarter revenue rose 11% sequentially and beat the high end of our expectations. During the quarter, a number of our games such as our flagship client-based MMORPG Zhu Xian continued to perform well. And our first hardcore mobile game Return of the Condor Heroes was also an important part of this quarter's revenue growth.

While we constantly work on energizing our existing games with new expansion packs and content updates during each quarter, we have also been focusing on developing a more comprehensive and well-rounded pipeline. Our pipeline contains a number of attractive client-based games, namely the highly-anticipated DOTA 2 and our 3D MMORPG Legend of the Condor Heroes, along with a variety of web and mobile games. DOTA 2 is currently at the initial stage of commercialization and we expect to have a full large-scale launch in China soon. We are also preparing to launch another world-class title, Neverwinter, in China later this year.

On the mobile side, following the popular Return of the Condor Heroes, we recently launched another hardcore mobile game Fantasy of the Immortals which is also our first 3D RPG mobile game. On top of our current, exciting mobile game portfolio, we would like to further expand it by introducing more high-quality mobile games such as Forsaken World to the market going forward.

The successes we have seen [ph] so far from our game not only show the strength of our pipeline but also our well-established capabilities in global market. Neverwinter, for example, an MMORPG developed by our Cryptic Studio in the U.S., has been well-received in different markets. This is an achievement we could not have obtained without the strong global R&D capability and development teams behind us.

We are also very happy with the progress we made to strengthen our overseas network, which helped us retaining our leading position among Chinese online gaming companies in overseas markets. As more games are now operated by our own subsidiaries in overseas market and we continue to cooperate with other overseas partners in various markets, we believe we will continue to make progress moving forward.

Looking back at 2013, we saw a revenue growth of 10.2% on a year-over-year basis. We are glad that we successfully took our business through the challenging market transition and advanced the development of the core PC MMO business by introducing several popular MMORPGs such as the popular Swordsman Online and Saint Seiya Online.

More importantly, we are very pleased that we have obtained initial success of diversifying our business in new areas other than traditional PC MMORPG, as we made solid strides in the mobile area, with the successful debut of our first 2D RPG mobile game Return of the Condor Heroes.

Our solid footprint has never stopped us from searching for new areas of growth and building our influence beyond the traditional online gaming market. We have been proactively seeking great investment opportunities on other gaming companies, such as companies with great products and growth potential. At the same time, we have explored this through seeking for strategic partnership with leading companies in various industries.

Very recently we signed a strategic partnership framework agreement with Huawei, which as you all know is a leading multinational telecommunication equipment supplier and terminal device manufacturer. Together, we plan to pair our high-quality gaming products and services with our -- with their terminal devices, to bring premium entertainment experiences to our users.

To help lead us in this effort, we appointed Mr. Alex Xu, our Senior Vice President in Charge of the Business Development and Investment as our Chief Business Officer. We believe Alex will help us better capture new growth opportunities in the global market in this fast-growing industry.

Moreover, our comprehensive and diverse portfolio, strong global R&D capability and well-established operating network give us confidence that we can grow our self as a sustainable business over the long term.

As we continue to generate health cash flow from our operations, the Board of Directors declared annual cash dividends on March 8, 2014 in the aggregate amount of approximately $24 million to our shareholders of record as of the close of business on April 3, 2014, at 9.6 U.S. cents per Class A or Class B ordinary share, or $0.48 per ADS, each representing five Class B ordinary shares of the company.

The cash dividends are expected to be distributed in or around April 2014. We intend to distribute any dividends in the future. However, the distribution of our future dividends will be at the full discretion of the Board and will be dependent on our financial position, result of the operation, available cash, capital requirement and other factors. We will always stay committed to bringing value to our shareholders and focusing on the long-term health of our business and the best interests of our shareholders.

Now I'll pass the call to Vivien for an update on some of our recent operational developments. Vivien?

Vivien Wang

Thank you, Robert. For the healthy lifecycle of our existing games and their long-term sustainability, we released a series of expansion packs during the quarter, including Sanjie Tianshu [ph] for Zhu Xian, The Glorious Rebirth for Perfect World II, Heavenly Fortress for Fantasy Zhu Xian, Childhood Sweetheart for Return of the Condor Heroes, and Glory of Ice and Fire for Forsaken World. As part of our efforts to build our portfolio into a more comprehensive one in early January, as Robert has mentioned, we launched both the iOS and the Android version of our mobile game Fantasy of the Immortals.

Our overseas business has also been performing well. Through our overseas subsidiaries, during the quarter we began to operate Neverwinter in Russia and other Russian-speaking territories, and Perfect World II in Singapore and Malaysia. Recently we also launched Neverwinter in Brazil through our overseas subsidiary.

Meanwhile, we remain active in overseas licensing activities through our overseas partners. During the quarter we signed agreements to license Swordsman Online to Vietnam and our upcoming MMORG Legend of the Condor Heroes to Taiwan. Through our various overseas partners, we also launched Battle of the Immortals in Turkey and Azerbaijan, and Swordsman Online in Taiwan.

Moving on, we also took a number of steps to broaden our growth opportunities. During the quarter we further invested in two leading Chinese gaming portals, TGBus.com and PTBus.com, which we believe will create synergies and provide better support for our gaming business.

And in December 2013 we entered into a definitive agreement to sell Beijing Huanxiang Zongheng Chinese Literature Website Company Limited, the entity that operates our Chinese online reading business. We have completed the transaction by the end of 2013. We think divesting [ph] from this business will allow us to better devote our focus to our core gaming business.

With our well-rounded portfolio and pipeline, innovative R&D teams worldwide, and extensive global operating network, we remain committed to delivering innovative high-quality content to gamers all over the world.

I will now pass the call over to Kelvin, for a review of our financials.

Kelvin Lau

Thank you, Vivien. Now for the fourth quarter 2013 financials.

Total revenues were RMB914.3 million, compared with RMB820.2 million in the previous quarter and RMB679.9 million in the same quarter last year.

Online game operation revenues, which include both domestic and overseas online game operations, were RMB843.8 million, compared with RMB750.2 million in the previous quarter and RMB599.7 million in the same quarter last year. The sequential growth was primarily attributable to the strong performance of our new mobile game Return of the Condor Heroes, along with the solid contribution from some existing client-based games such as our flagship title Zhu Xian.

ACU for PC online games under operation in mainland China was approximately 803,000, compared with 778,000 in the previous quarter and 620,000 in the same quarter last year. The increase from the previous quarter was mainly attributable to the initial commercialization of the world-class online game DOTA 2.

Licensing revenues were RMB48.6 million, compared with RMB39.1 million in the previous quarter and RMB36.5 million in the same quarter last year. The increase from the previous quarter was primarily due to an increase in the initial license fees arising from new commercial launches overseas and the sequential growth in the usage-based royalty fees in certain overseas market.

Other revenues were RMB21.9 million, compared with RMB30.9 million in the previous quarter and RMB43.7 million in the same quarter last year. Most of the other revenues from 4Q 2013 are associated with Torchlight 2, a popular pay-per-install game developed by Runic Games, our majority-owned subsidiary based in the U.S. Installations of Torchlight 2 increased following some promotional activities for this game in 3Q 2013, while there were no similar promotional activities in 4Q 2013.

Cost of revenues was RMB227.5 million, compared with RMB182.5 million in the previous quarter and RMB157.3 million in the same quarter last year. The increase from the previous quarter was mainly due to an impairment associated with certain of our smaller games, as well as an increase in revenue sharing with mobile game distribution platforms as a result of the strong performance of our mobile games in 4Q 2013.

Gross profit was RMB686.8 million, compared with RMB637.7 million in the previous quarter and RMB522.6 million in the same quarter last year. Gross margin was 75.1%, compared with 77.8% in the previous quarter and 76.9% in the same quarter last year.

Operating expenses were RMB677.0 million, compared with RMB522.6 million in the previous quarter and RMB494.7 million in the same quarter last year. The increase in operating expenses from the previous quarter was mainly due to the goodwill impairment associated with our Japanese subsidiary, as well as higher R&D expenses, sales and marketing expenses, and general and administrative expenses in 4Q 2013.

R&D expenses were RMB271.5 million, compared with RMB236 million in the previous quarter and RMB230.9 million in the same quarter last year. The increase from the previous quarter was primarily due to an increase in staff cost, including a special year-end bonus.

Sales and marketing expenses were RMB233.1 million, compared with RMB210.2 million in the previous quarter and RMB148.0 million in the same quarter last year. The increase from the previous quarter was primarily due to an increase in advertising and promotional expenses as we released a number of major expansion packs for our client-based MMORPGs and started to ramp up promotions for mobile games in 4Q 2013.

G&A expenses were RMB95.2 million, compared with RMB76.4 million in the previous quarter and RMB75 million in the same quarter last year. The increase from the previous quarter was mainly due to an increase in staff cost and the impairment of the trademark recognized from the acquisition of our Japanese subsidiary in April 2010.

Goodwill impairment was RMB77.3 million, compared with nil in the previous quarter and RMB40.8 million in the same quarter last year. The goodwill impairment was associated with our Japanese subsidiary. As of December 31, 2013, all goodwill arising from the acquisition of our Japanese subsidiary in April 2010 was fully impaired.

Operating profit was RMB9.8 million, compared with RMB115.1 million in the previous quarter and RMB27.9 million in the same quarter last year. Excluding the share-based compensation charge and goodwill impairment, non-GAAP operating profit was RMB108.6 million, compared with RMB135.7 million in the previous quarter and RMB82.6 million in the same quarter last year.

Total other income was RMB59.6 million, compared with RMB26.6 million in the previous quarter and RMB64.7 million in the same quarter last year. The increase from the previous quarter was largely attributable to an increase in government grant subsidy income.

Income tax expenses was RMB2.2 million, compared with RMB14.1 million in the previous quarter and RMB1.1 million in the same quarter last year. The decrease from the previous quarter was primarily as a result of an R&D super deduction recognized during the annual tax filing for some of the company's PRC entities in 4Q 2013.

Gain from disposal of discontinued operations net of tax was RMB166.3 million, compared with nil in the previous quarter and nil in the same quarter last year. In December 2013, we announced our definitive agreement to sell Beijing Huanxiang Zongheng Chinese Literature Website Company Limited, the entity that operated our Chinese online reading business. As of December 31, 2013, we have completed this transaction and recorded the related gain in the consolidated statements of operations according to the U.S. GAAP.

Net income attributable to the company's shareholders was RMB209.8 million, compared with RMB120.9 million in the previous quarter and RMB86.4 million in the same quarter last year. Excluding the share-based compensation charge, goodwill impairment and gain from disposal of discontinued operations, non-GAAP net income attributable to the company's shareholders was RMB163.8 million, compared with RMB141.5 million in the previous quarter and RMB141.1 million in the same quarter last year.

Basic and diluted earnings per ADS were RMB4.25 and RMB4.18, respectively, compared with RMB2.47 and RMB2.41, respectively, in the previous quarter, and RMB1.79 and RMB1.78, respectively, in the same quarter last year. Excluding the share-based compensation charge, goodwill impairment and gain from disposal of discontinued operations, non-GAAP basic and diluted earnings per ADS were RMB3.33 and RMB3.26, respectively, compared with RMB2.89 and RMB2.82, respectively, in the previous quarter, and RMB2.92 and RMB2.9, respectively, in the same quarter last year.

Now for the fiscal year 2013 financial results. Total revenues were RMB3,052.7 million in the fiscal year 2013, compared with RMB2,770.6 million in fiscal year 2012.

Online game operations, which include both domestic and overseas online game operations, were RMB2,800.3 million in fiscal year 2013, compared with RMB2,499.4 million in fiscal year 2012. The year-over-year increase was primarily attributable to the strong performance of several new game launched in China and the continued strength of our U.S. and European subsidiaries.

Licensing revenues were RMB149.3 million in fiscal year 2013, compared with RMB171.6 million in fiscal year 2012. The year-over-year decrease was primarily because more of our games began to be operated by our own subsidiaries in some overseas market in fiscal year 2013.

Other revenues were RMB103 million in fiscal year 2013, compared with RMB99.6 million in fiscal year 2012.

Cost of revenues were RMB711.6 million in fiscal year 2013, compared with RMB539.9 million in fiscal year 2012. In fiscal year 2013 we have successfully launched several new games, resulting in increases in revenue sharing, sales-related taxes and internet data center cost.

Gross profit was RMB2,341 million in fiscal year 2013, compared with RMB2,230.7 million in fiscal year 2012. Gross margin was 76.7% in fiscal year 2013, compared with 80.5% in fiscal year 2012.

Operating expenses were RMB2,003.1 million in fiscal year 2013, compared with RMB1,664.7 million in fiscal year 2012. The year-over-year increase in operating expenses was mainly due to an increase in advertising and promotional expenses associated with several major new games launched during the year and staff costs.

Operating profit was RMB337.9 million in fiscal year 2013, compared with RMB565.9 million in fiscal year 2012. Excluding the share-based compensation charge and the goodwill impairment, non-GAAP operating profit was RMB491.1 million in fiscal year 2013, compared with RMB677.9 million in fiscal year 2012.

Net income attributable to the company's shareholders was RMB542.4 million in fiscal year 2013, compared with RMB540.7 million in fiscal year 2012. Excluding the share-based compensation charge, the goodwill impairment and the gain from disposal of discontinued operations, non-GAAP net income attributable to the Company's shareholders was RMB550.8 million in fiscal year 2013, compared with RMB652.6 million in fiscal year 2012.

Basic and diluted earnings per ADS were RMB11.12 and RMB10.95, respectively, in fiscal year 2013, compared with RMB11.31 and RMB11.15, respectively, in fiscal year 2012. Excluding the share-based compensation charge, goodwill impairment and gain from the disposal of discontinued operations, non-GAAP basic and diluted earnings per ADS were RMB11.29 and RMB11.12, respectively, in fiscal year 2013, compared with RMB13.65 and RMB13.46, respectively, in fiscal year 2012.

In terms of financial guidance, based on our current operations, total revenues for the first quarter of 2014 are expected to be between RMB841 million and RMB887 million, representing a slight decline from the strong fourth quarter of 2013, but still an increase of 36% to 43% on a year-over-year basis. Due to the long holiday of the Chinese New Year, we decided to slow down the promotional activities for our client-based MMORPGs in the first quarter of 2014.

This concludes our prepared remarks. We are ready to take your questions now. Operator, we are ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Your first question today comes from the line of Eddie Leung from Merrill Lynch. Eddie, please go ahead.

Eddie Leung – Bank of America-Merrill Lynch

Hey, good morning guys. Thank you for taking my questions. I have two questions.

The first one is about your mobile game initiative. Could you give us some color on the revenue contribution from mobile games? And you also mentioned in your press release that the decline in gross margins would be affected by the contribution of mobile games. Could you also add more color on the gross margin of your mobile game business?

And then my second question is for the 2014 outlook. I understand you don’t provide guidance on margins, but given the volatility in your sales and marketing expenses, any color, for example, in the first quarter of sales and marketing expenses, would be appreciated. Thanks.

Kelvin Lau

Thank you. Good morning, Eddie. Thanks for the question.

Okay. Your first question regarding the revenue contribution or from our mobile game. To be honest, we cannot disclose specifically how much revenue was contributed from mobile games in 4Q. But maybe I can give you some color. In 4Q, as I mentioned in my remarks, I think we have a very strong performance from our mobile game Return of Condor Heroes in 4Q. In fact, Return of Condor Heroes really contributed quite a lot in Q4. The total mobile game contribution is I think still slightly less than 10%, represents slightly less than 10% of our total revenue from the same Q.

Your follow-up question is on the gross margin. Yes, as I mentioned, because we keep -- we record the mobile game revenue on a gross basis, that means we pick up all the revenue from mobile game in our revenue line. But I think, as you know, we deduct the share of 40% to 50% of our revenue to the distribution channels. And this type of revenue sharing will be booked in our cost of revenue. That is why you can see my margin, I think compared with previous quarter or compared with Q2 last year, margin dropped to about 76% to 77%. The major reason is mainly because of this type of revenue sharing, the distribution platform.

And your second question is on the margin. So again we are not going to give any guidance or trend on our -- on the margin this year. But I think, Eddie, you know that every year, especially in Q1, our sales and marketing expenses will be decreased a little bit because of the Chinese New Year, because we cannot do so much promotion and advertising in the Chinese New Year. So I believe, in terms of marketing expenses, will decrease in Q1, yes. Thank you.

Eddie Leung – Bank of America-Merrill Lynch

Thank you.

Operator

Your next question today comes from the line of Natalie Wu from CICC. Natalie, please go ahead.

Natalie Wu – CICC

Hi, this is Natalie Wu from CICC. Thanks for taking my question, and congratulations on a strong quarter.

My question is, we have seen your efforts in console game preparation. When do you expect that the monetization of console games will happen?

And you have mentioned that you have Forsaken World in your mobile games pipeline this year. So I want to ask, what is your mobile game pipeline other than that, and how do we expect your mobile game contribution to your revenue this year? Thanks.

Robert Xiao

Thank you, Natalie, for your question. I think in terms of the console games, we are moving forward with our console games in China as well as in our overseas R&D facilities. Our intention is very clear that we want to capture the new wave of TV-based game in China. I think we are positioned relatively well in doing that amount of Chinese game builders. I think in terms of mobile games, yes, we are having Forsaken World pipeline as a 3D hardcore MMORPG type of mobile game. It's under testing now and we believe that the game will be launched in the near future.

I think our pipeline, because mobile game has a different kind of behavior in terms of the users, in terms of the passing of the launching, so we are not advancing [ph] to the market that -- to notify the market that what is exactly we're going to publish in the long haul, but rather to pick the right timing before we decided to launch the game in certain markets. So we definitely will tell the market when we're going to do that. But in our pipeline, we do have a few mobile games on the way, including other games on other platform, especially on PC and TV. We all prepared new games to launch this year, and so I believe in the pipeline overall we have a dozen different new games to be launched in diversified portfolio across different platforms.

Thank you for your question.

Operator

Your next question today comes from the line of George Meng from Macquarie. George, please go ahead.

George Meng – Macquarie

Hi, good morning. Thank you very much for taking my question. I have two questions. The first one is on mobile games, and maybe this is for Robert. So in your current mobile game portfolio and pipeline, basically you have like Return of the Condor Heroes, Empire of the Immortals, Forsaken World, so all these are MMORPG games. And I think that all have them have like roots in your existing PC titles.

But I also noticed like recently you've kind of announced that you will do some kind of like card games like Dong Xie Xi Du going forward. So I just wonder, what's your overall strategy? Especially going forward. Do you have any plans beyond your core MMORPG and also your existing PC titles? That's my first question. Thanks.

Robert Xiao

Okay. Thank you, George. Great question. I think our strategy is very clear that we started from whatever we do the best, right? So the MMORPGs on the PC platform, we definitely have the in-depth knowledge and experiences to build better hardcore games. But we just don’t stop there. Basically looking forward we are having more diversified portfolio down the line even in the mobile sector. I think, for example, another PC-based game, Touch, will be built on the mobile. That basically is not a traditional hardcore MMORPG type.

But again we're going to try to find some other titles that we will build specifically for mobile. And it could be kind of different from whatever we've been -- built so far for mobile traditional hardcore. We definitely will be looking at the card game, looking at the SOG, looking at even more casual games in the market. And we just want to built a complete -- more comprehensive portfolio to satisfy not only a very small group of users but broaden our user base. Thank you.

George Meng – Macquarie

Okay, cool. And very quickly, a follow-up on this. Do you have any operating metric to share on your mobile game in the fourth quarter or maybe at present, or you don’t share operating metrics?

Kelvin Lau

I think as what I say, in Q4, at this moment, mobile just represent not a quite significant amount of our total revenues. So up to now we still cannot disclose any specific mobile game operating metrics. But I think I have already mentioned to you that in Q4 our mobile game represent about 10% or slightly less than 10% of total revenue. I think this is a important metric for you guys.

George Meng – Macquarie

Okay, great. Thanks. My second question is related to your platform. So some of your competitors are talking about they want to become, especially on the mobile side, they want to become a platform play rather than just a content play. So do you have any update on your [Lao Hung] game app? And also because you originally acquired TGBus and PTBus, can you share with us any plans there in terms of developing the game platforms or game media? And also, financially, what the revenue impact on the acquisition of the TGBus and PTBus, and also what's the revenue impact on the disposal of Zhongheng maybe on the top line and also on the bottom line. Thanks.

Robert Xiao

I think that's a very complicated question, but I'll try to sort it out. Basically, number one, so-called platform, whatever, for us is very simple. It's just how we really directly impact or communicate or interact with the consumers. So the overall thing of building mobile media like Tiger ourselves, and then buying, you know, acquiring some of the mobile base and also console-based media, has actually enabled us to, number one, understand the consumers better; number two is directly influence the consumers to take our product.

I think in doing that we had built -we have built a bigger and bigger network of, you know, communicating, interacting with consumer directly. And utilizing that, definitely we're going to distribute more of our games to make sure that not only the product itself but also the branding of Perfect World is penetrating deeper.

In terms of the impact on the top line, bottom line, I think the big acquisition of a bunch of media was happening on the late Q2 -- Q4. So in Q4, definitely, we don’t see too much. I think, looking forward, we believe that the media itself was not contributing too much significant growth in the top line or bottom line in the near future. Eventually we are looking at it as a strategic investment in terms of understanding specific markets and directly contacting or interacting with consumer groups.

Thank you.

Operator

[Operator Instructions]

Your next question today comes from the line of Wendy Huang from Standard Chartered. Wendy, please go ahead.

Wendy Huang – Standard Chartered

Thank you. I just have one question about your console game strategy. Do you have any plans to work with any console game device maker? And also given the recent regulatory environment change surrounding the console game, do you think we will really actually see a big user growth or a very big addressable market for the console game given how fast the PC client-based game has been occupying the gaming user base in the past ten years? Thank you.

Robert Xiao

All right, Wendy. Thank you for your question. I think I would rather not only talking on the console market but relatively a broader space, broader scope, that is on the TV-based gaming. You know, we believe that in the future, maybe not too far, that TV-based gaming would be a major part of the gaming market.

And on TV-based gaming, that there is always a pyramid, that you have a very sophisticated, more expensive, hardcore based device and games on the top, which is console, or we call the traditional type of console machine. And then in the middle, there will be, you know, some of the lighter, cheaper, not so sophisticated broader scope devices. We really like, you know, whatever Huawei is building, the Tron [ph] type of devices.

And on the bottom, much more people usage is the set-top box and smart TV type, even though this type cannot run very sophisticated hardcore games because of the processing power of the hardware, but eventually that will reach much more consumer.

So we believe in the market segment there will be four -- three different, you know, tiers of market. And our strategy, number one, is focus on the high-tier to mid-tier because those requires comprehensive or high-quality kind of sophisticated games that fit into our dream of building that. Of course we're not giving up on the lower tier or broader-based market as well, evidenced by that we had started to work with different manufacturers of the TV set-top box. And we're going to develop more strategic partnership with all three kind of hardware developers to build games for the TV game market.

And in the future we believe that the PC, the mobile and TV, representing big screen, mid-screen and small screen, and the three different markets will also have reached certain kind of balance in terms of game playing. But we are getting ready to build our portfolio along that line, at the same time building our strategic alliances with different -- not only the hardware manufacturer but also distributor and all kinds of telecom operator, you know, all the players in the entire value chain, we're trying to build a strategic alliances with all of them, and make sure we are well-positioned in the future in all three of these gaming market in the ever-growing, fast-growing market of gaming. Thank you.

Wendy Huang – Standard Chartered

Thank you. Maybe just to follow up on that. You mentioned in the prepared remark about your cooperation with Huawei. So can you elaborate on that cooperation? Is that mainly for the mobile game or you also have -- also it's about cooperation with Huawei to maybe benefit your other game categories going forward? And also if you can provide some detail on the economic terms such as, for example, the fees that you will be paying Huawei on each user base or whatever, that would be helpful as well. Thank you.

Robert Xiao

I think we're not in the position to disclose too much detail on the detail contracting with any of our partners. But I can tell that basically the collaboration with Huawei was started from whatever their new device, it's called Tron. They launched actually -- they showed the world for the very first time in the CES this year, earlier this year.

You know, it is Android-based, so-called micro-console type of machine, and then high performance. We like it very much. And it's, you know, one of the best we saw so far. So we are collaborating with them at the very first stage to build specific high-quality game from that device.

And down the road, definitely the strategic alliance, you know, collaboration agreement naturally covers a lot of different areas. But allow me not to disclose at this point of time. And whenever there's something happens, we'll definitely inform you. Thank you.

Operator

Your next question today comes from the line of Thomas Chong from BOCI. Thomas, please go ahead.

Thomas Chong – BOCI

Hi. Good morning, Robert, Kelvin and Vivien. Thanks for taking my questions. I have two questions.

My first question is regarding your R&D headcount. Can management provide some color about how many R&D people last year and your expectation for this year? And what's the percentage of them would be focusing on mobile games?

And my second question is regarding localization. Given that Neverwinter will be launched in China this year, what are the key things that you need to do in order to localize the game and launch it successfully in China? Thanks.

Kelvin Lau

Thanks, Thomas. Regarding the R&D headcount, by the end of last year we have approximately I think 2,500 R&D -- around 2,500 R&D people all over the world, including the U.S. and in China. I think quite a lot of our R&D people are working on mobile gamers. You see we have a strong pipeline on our mobile game. So I think -- I cannot disclose exactly how many people are working on mobile game, but I can tell you there is quite a lot of people in mobile world right now working on mobile game.

Regarding DOTA 2 localization, as what Robert says in his remarks, we work closely with WOW, the developer of DOTA 2. I think we will consult WOW regarding all those localization. I think one of the media partners converted it from English-Chinese, I think we can handle this. But regarding some of the game localization, we have to consult and discuss with WOW before we give the localization. Most of the localization are handled by ourselves, but we closely work with WOW on the localization. Yes.

Thomas Chong – BOCI

Thank you.

Operator

Your next question comes from the line of William Fung from Barclays. William, please go ahead.

William Fung – Barclays

Hi. Thank you for taking my call. My question is about MMO games. So in terms of your core MMO titles such as Swordsman Online, how is user engagement trend so far? And do we see a higher user churn rate since December of last year, particularly when competitor launched some blockbuster titles like Blade and Soul? Thank you.

Robert Xiao

I think in the traditional MMO -- PC MMORPG market, that you see that whenever there's competitive titles launched, basically it will generate more fuss in the market and people will definitely go there. But I think in the long run, for [indiscernible] in PC MMORPG gaming, basically, you know, the thing is as long as you do your job, you do your, you know, expansion packs and DR base [ph], you know, the core players that will stick with you for relatively longer time.

And that's the trend and basically that's the, whatever happens for many of the games we have, and our competitor also have the same patent. So we believe that all the games we are running having the character of lasting a relatively longer time than the like new areas of mobile game or web game stuff.

But at the same time our focus is definitely building more and more content updates to them to make sure that those people really like the title or people enjoy when the game will stick up with a longer time. And that's definitely the trend we have on our MMORPGs.

Thank you.

Operator

Your next question today comes from the line of Muzhi Li from Citigroup. Muzhi, please go ahead.

Muzhi Li – Citigroup

Hi. Thanks for taking my question. Can the management discuss the performance for the desktop games and probably rank the revenue contributions of the top three or four games? And also, I would like to know about how the new game performances versus the old ones. The new gaming, those games that launched in 2013. Thank you.

Kelvin Lau

Thank you for the question. I think our policy is not to disclose individual games performance. I think you are talking about our desktop games, that means our PC-based game. Some color on this is I think right now Zhu Xian is still the largest one for us, followed by [Chinese language spoken] Swordsman Online, and then Perfect World II. I think these three are still our three major revenue contributor and the biggest game for us.

Robert Xiao

Perfect World International.

Kelvin Lau

Perfect World International. I think as I mentioned in my remarks, in Q4 another major revenue contributor is from the mobile game Return of Condor Heroes.

Thank you.

Operator

Your next question today comes from the line of Nick Ning from 86Research. Nick, please go ahead.

Nick Ning – 86Research

Thank you for taking my questions. So just wondering if you could elaborate a little bit about this -- your write-down related to your subsidiary. I remember that we see the write-down of RMB40 million in Q4 2012. So this additional write-down is about a similar entity? And how does that impact [indiscernible]? Thank you.

Kelvin Lau

Yes, I think you are talking about C&C, right, the Japanese subsidiary. We acquired C&C in 2010 as I mentioned in the remarks. So I think in the past three years the financial performance of C&C is not as good as what we expect. I think actually we said [ph] the forecast is not as good as what we expect, especially the MMORPG market. As you know, I think right now in Japan, the gaming market is dominated by the mobile sector. So according to GAAP [ph], by the end of each year we get to do an assessment on the goodwill generated during the acquisition.

So when you compare the actual performance with the forecast and then the actual number is lower than [indiscernible] we have to do the impairment on the goodwill generated during the acquisition. So that's why I mentioned, I think by the end of last year, as of December 31, 2013, all the goodwill in relation to our Japanese subsidiary has already fully impaired.

Nick Ning – 86Research

Thank you. And congrats [ph].

Operator

[Operator Instructions]

There are no further questions on the line at this time.

I would now like to hand the call back to Ms. Joanne Deng for closing remarks.

Joanne Deng

Thank you. This is the end of the conference call.

The webcast replay will be available at Perfect World's official website www.pwrd.com, under our IR section. If you have any additional question, please feel free to contact us.

Robert Xiao

Thank you. Thank you everyone.

Operator

Ladies and gentlemen, that does conclude the call for today. Thank you all for your participation. You may now disconnect.

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Source: Perfect World's CEO Discusses Q4 2013 Results - Earnings Call Transcript

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