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

Q4 2011 Earnings Call

March 15, 2012 9:00 pm ET

Executives

Joanne Deng – Investor Relations Manager

Michael Yufeng Chi – Founder, Chairman and Chief Executive Officer

Kelvin Wing Kee Lau – Chief Financial Officer

Vivien Wang – Vice President, Investor Relations and Corporate Communications

Analysts

Mark Marostica – Piper Jaffray

Jialong Shi – CLSA

Wendy Huang – Royal Bank of Scotland

Eddie Leung – Bank of America/Merrill Lynch

Nick Ning – Roth Capital

Ming Zhao – SIG

Martin Bao – CICC

Andy Yeung – Oppenheimer

Vincent Sun – Mirae Asset Securities

Atul Bagga – Lazard Capital

Stephen Zhang – Macquarie Funds Group

Jake Lee – Citigroup_

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Perfect World’s Fourth and Fiscal Year 2011 Conference Call. At this time, all participants are in a listen-only mode. Today’s presentation will be followed by a question-and-answer session (Operator Instructions). I must advise you that this conference is being recorded today Friday, March 16, 2012.

I would now like to hand the conference over to your host today Investor Relations Manager at Perfect World, Ms. Joanne Deng. Thank you, please go ahead.

Joanne Deng

Thank you, operator and thank you everyone for joining us today for Perfect World’s fourth quarter and fiscal year 2011 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 Newswire.

Today you will hear from Mr. Michael Chi, our Chairman and CEO, who will give us a brief update on our business. Mr. Kelvin Lau, our CFO, will then provide an overview of the quarter and the full-year and also an update of our dividend distribution plan. Ms. Vivien Wang, our Vice President of Investor Relations and Corporate Communications will then take us through some of our latest operational developments. And then she will pass the call back to Mr. Lau to go through our financial performance in the fourth quarter of fiscal year 2011. Following the prepared remarks, Mr. Chi, Mr. Lau and Ms. Wang would 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 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 in 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 Investor Relations section.

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

Michael Yufeng Chi

Okay. Thank you, Joanne. Thank you all for joining our call today. Our performance in the fourth quarter of 2011 was solid with quarter-over-quarter revenues increasing by 9.5%, rising above our expectations. This was largely due to strong performance from our existing games and the continued strength of our overseas business.

A key growth driver for us is our ability to successfully maintain user interest and the engagement in our existing games. In the fourth quarter, we continued to release a steady stream of expansion packs and content updates as well as extend our diversified portfolio of games.

We have been excited about our deep and well-rounded pipeline, which includes a number of attractive titles of different types, ranging from MMORPGs to web games and (inaudible) games. We recently unveiled a new upcoming title, a cartoon-style martial arts MMORPG for the Fantasy Condor Heroes. This game is adapted from the highly acclaimed Chinese novel, Return of the Condor Heroes, by Louis Cha. In addition to our highly anticipated Swordsman Online and Saint Seiya Online, we believe Fantasy Condor Heroes will also catch the attention of many players.

Our effective globalization strategy continues to serve as another key driver behind our growth. Our specialized production studios in China and worldwide support our well-established R&D capabilities, which in term bolster our industry-leading position. Our U.S. subsidiaries are developing several new world-class titles, including Neverwinter by Cryptic Studios. We are also actively expanding our deep global outreaching network.

During the fourth quarter, we partnered with Nexon to jointly establish a new company in Korea. The new company will manage and operate online games in Korea, and we expect this to further enhance our global operational capabilities and allow us to provide enhanced services to our users in the Korean market.

In order to further strengthen our position in the global gaming market, we will continue to leverage our overseas resources and the growing worldwide appeal of our brand.

In spite of our continuous efforts to provide high quality games and service to players, we will further enhance our execution capabilities. As such, I’m pleased to announce that the Company has appointed a Senior Vice President, Mr. Robert Xiao, as our Chief Operating Officer.

In this new role, Robert will oversee our business operations and business support functions. Robert joined The Perfect World as a Senior Vice President in charge of our human resources and administration in 2008. We are grateful for his significant contribution to our global business operations and the strategic development over the past few years.

And we believe with his strong execution capabilities, thorough understanding of Perfect World’s business and corporate culture, as well as his rich experience at various world-class multinational corporations in the past, he will be able to help us to further enhance the execution of our business strategies with unwavering focus on our commitments and strategy. We are confident in the value we are building for our shareholders over the long-term.

Thank you. Now, I will pass the call to Kelvin.

Kelvin Wing Kee Lau

Thank you, Michael. As Michael mentioned, our revenue is at the high end of our expectations and our bottom line also achieved strong sequential growth. Some of our existing games, such as our flagship game Zhu Xian, sustained strong performance in the domestic market in the fourth quarter.

In addition, we continued to excel in our overseas business. We generate over one-fourth of our total revenue from operating and licensing our games abroad and maintained a geographical coverage of over 100 countries and regions worldwide. These endorse our number 1 position amongst Chinese online gaming company in the overseas market.

Looking back at the fiscal year of 2011, both our top line and bottom line grew steadily from 2010, despite some natural quarterly fluctuations.

For the full year 2011, our revenue rose a solid 25.2%. This is a clear indication of the underlying health of our business in spite of an increasingly competitive environment. And thanks to our consistent healthy performers, we continuously generate free cash flow from our operations.

As our appreciation for our shareholders’ longstanding trust and support, on March 14, 2012, the Board of directors declared a special cash dividend in the aggregate amount of approximately $95 million to our shareholders of record, as of the close of business on April 6, 2012, at $0.04 per Class A and Class B ordinary shares or $2 per ADS, each representing five Class B ordinary shares of the Company.

The dividends are expected to be distributed in cash in or around April 2012. We intended to distribute the revenues – distribute dividends annually in the future. However, the distribution of any future dividends will be at the full discretion of the Board and it will be dependent upon our financial position, results of operations, available cash, capital requirements and other factors.

Bringing values to our shareholders is an important part of our commitment and we will continue to do what is necessary for the long-term health of our business and the best interest of our shareholders. Before I go to the financials, I would now pass the call to Vivien for a rundown of some of our operational developments.

Vivien Wang

Thank you, Kelvin. We had an active quarter in terms of releasing new content for our existing games. In order to further bolster our games and keep our users engaged. During the quarter, we released a number of expansion packs, these were Battle of the Gods for Empire of the Immortals, Perfect Life for Fantasy Zhu Xian, Unrivaled War Chariots for Chi Bi, Twilight City for Forsaken World, and Land of Darkness for Perfect World II.

We believe these common enhancements will be benefited for supporting our games in the longer run. In terms of our overseas operations, during the quarter, we launched Empire of the Immortals in Japan through our wholly-owned Japanese subsidiary and also in North America and Europe under the name of War of the Immortals through our wholly-owned U.S. and European subsidiaries.

Post-quarter end, we published Blacklight Retribution, a free-to-play first-person shooter game developed by the well-known U.S.-based Zombie Studios in North America. Through our overseas partners, during the quarter, we launched Dragon Excalibur in Taiwan, Hong Kong, Macau and Korea, Forsaken World and Legend of Martial Arts in Russia, and Perfect World II in the Spanish-speaking countries in Latin America.

Post-quarter end, we signed an agreement to license Battle of the Immortals to Brazil and also launched Chi Bi and Forsaken World in Indonesia. As our global network continues to expand and strengthen, we’re confident that overseas market will remain a solid source of growth for us over the long run.

Now, I’d like to pass the call back over to Kelvin for him to walk through our financials.

Kelvin Wing Kee Lau

Thank you, Vivien. Now for the fourth quarter 2011 financials. Total revenues were RMB776.4 million in 4Q11, as compared to RMB708.9 million in 3Q11 and RMB587.2 million in 4Q10.

Online game operation revenues, which include both domestic and overseas online game operations were RMB706.9 million in 4Q11, as compared to this RMB643.2 million in 3Q11 and RMB526.2 million in 4Q10. The sequential growth in online game operation revenue was primarily attributable to the continued strength of some of our existing games including our signature title “Zhu Xian”, as well as the continued strength of our overseas operations.

ACU for games under operation in mainland China was approximately 873,000 in 4Q11, as compared to 828,000 in 3Q11 and 999,000 in 4Q10.

Licensing revenues were RMB65.6 million in 4Q11, as compared to that RMB55.8 million in 3Q11, and RMB57.8 million in 4Q10. The sequential increase was primarily attributable to an increase in initial license fees arising from a number of new commercial launches overseas.

Other revenues were RMB3.9 million in 4Q11, as compared to RMB9.9 million in 3Q11, and RMB3.2 million in 4Q10. Cost of revenues was RMB137.1 million in 4Q11, as compared to RMB121.2 million in 3Q11 and RMB102.4 million in 4Q10. The sequential increase from 3Q11 was mainly due to an increase in staff cost including a special year-end bonus, sales-related taxes and server depreciation expenses in 4Q11.

Gross profit was RMB639.3 million in 4Q11, as compared to RMB587.7 million in 3Q11 and RMB484.9 million in 4Q10. Gross margin was 82.3% in 4Q11, as compared to that 82.9% in 3Q11 and 82.6% in 4Q10.

Operating expenses were RMB419.1 million in 4Q11, as compared to that RMB393.9 million in 3Q11 and RMB345.7 million in 4Q10. The sequential increase in operating expenses from 3Q11 was mainly attributed to a higher R&D expenses and G&A expenses in 4Q11.

R&D expenses were RMB186.5 million in 4Q11, as compared to RMB170.6 million in 3Q11 and RMB136.8 million in 4Q10. The sequential increase was primarily due to an increase in staff cost.

Sales and marketing expenses were RMB142.0 million in 4Q11, as compared to RMB146.7 million in 3Q11 and RMB153.5 million in 4Q10. As we did not launch any new game in 4Q11, sales and marketing expenses remained relatively flat.

General expenses were RMB90.6 million in 4Q11, as compared to RMB76.5 million in 3Q11 and RMB55.4 million in 4Q10. The sequential increase was mainly due to an increase in staff cost, including a special year-end bonus.

Operating profit was RMB220.2 million in 4Q11, as compared to RMB193.9 million in 3Q11 and RMB139.2 million in 4Q10. Non-GAAP operating profit was RMB244 million in 4Q11, as compared to RMB221.3 million in 3Q11 and RMB163.6 million in 4Q10.

Income tax expenses was RMB10.7 million in 4Q11, as compared to RMB78.8 million in 3Q11 and RMB13.1 million in 4Q10. The decrease from 3Q11 was mainly due to a lower withholding tax in 4Q11. An additional withholding tax was accrued in 3Q11 for prior-period undistributed earnings as a result of the change in our dividend policy to reflect our intention to distribute part of the earnings of our wholly-owned PRC subsidiaries to our shareholders from time-to-time. In 4Q11, such tax expense was accrued for undistributed earnings of current period.

Net income attributable to the Company’s shareholders was RMB260 million in 4Q11, as compared to RMB143.6 million in 3Q11 and RMB125.2 million in 4Q10. Non-GAAP net income attributable to the Company’s shareholders was RMB283.9 million in 4Q11, as compared to RMB171.1 million in 3Q11 and RMB149.7 million in 4Q10.

Basic and diluted earnings per ADS were RMB5.65 and RMB5.45 respectively in 4Q11, as compared to RMB2.96 and RMB2.83, respectively in 3Q11, and RMB2.50 and RMB2.36, respectively, in 4Q10. Non-GAAP basic and diluted earnings per ADS were RMB6.17 and RMB5.94 respectively in 4Q11, as compared to RMB3.53 and RMB3.37 respectively in 3Q11, and RMB2.98 and RMB2.82 respectively in 4Q10.

For fiscal year 2011 financial results, total revenue were RMB2,983.4 million in fiscal year 2011, as compared to RMB2,383.6 million in fiscal year 2010. Online game operation revenues, which include both domestic and overseas online game operations, were RMB2,708.5 million in fiscal year 2011, as compared to RMB2,156.3 million in fiscal year 2010.

The year-over-year increase was primarily attributable to the contribution from our recently launched new games such as Forsaken World, the continued popularity of some of our core existing games including Zhu Xian and Perfect World II in the domestic market, as well as the successful expansion of our overseas operations in North America, Europe and Japan.

Licensing revenues were RMB246.8 million in fiscal year 2011, as compared to RMB215.0 million in fiscal year 2010. The year-over-year increase was primarily attributable to the continued growth from our overseas licensing activities in various overseas markets as we continue to strengthen our global penetration during fiscal year 2011.

Gross profit was RMB2,503.5 million in fiscal year 2011, as compared to RMB2,004.2 million in fiscal year 2010. Gross margin was 83.9% in fiscal year 2011, as compared to 84.1% in fiscal year 2010.

Operating expenses were RMB1,480.2 million in fiscal year 2011, as compared to RMB1,125.8 million in fiscal year 2010. The year-over-year increase in operating expenses was mainly due to the expansion of our overall business operations and talent pool, as well as our overseas acquisitions.

Operating profit was RMB1,023.3 million in fiscal year 2011, as compared to RMB878.4 million in fiscal year 2010. Non-GAAP operating profit was RMB1,128.0 million in fiscal year 2011, as compared to RMB975.2 million in fiscal year 2010.

Net income attributable to the Company’s shareholders was RMB984.0 million in fiscal year 2011, as compared to RMB840.7 million in fiscal year 2010. Non-GAAP net income attributable to the Company’s shareholders was RMB1,088.7 million in fiscal year 2011, as compared to RMB937.5 million in fiscal year 2010.

In terms of financial guidance, based on the Company's growing operations, total revenue for the first quarter of 2012 I expect it to between RMB714 million and [RMB752 million]. These represent a mild decline on a sequential basis, but quarterly fluctuation is really a natural part of our normal product cycle. Some of the in-game promotional activities towards the end of the first quarter I expect it to take shape sometime after the end of the quarter.

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

Question-and-Answer Session

Operator

Ladies and gentlemen, welcome to the question-and-answer session. (Operator Instructions) Your first question comes from the line of Mark Marostica from Piper Jaffray. Go ahead please.

Mark Marostica – Piper Jaffray

Yes, thank you. First of all, nice job on the quarter. I wanted to get a sense in terms of how you are thinking about operating margins in the first quarter and for 2012 relative to recent performance. Thanks.

Kelvin Wing Kee Lau

Thanks, Mark. I think, Mark first of all our apologies. I think we just gave guidance in terms of our revenue in the coming quarter. I think we are not going to give any guidance on our margin – our operating margin in the coming quarter. I mention for normally in Q1, because of the Chinese New Year, we will cut down a little bit on the sales and marketing expenses. So, I will say that we will have some savings on the sales and marketing expenses in Q1. Also I think improving our operating margin or net margin, I think one of our major objective of goal adding in this year and also in the coming years.

Mark Marostica – Piper Jaffray

Okay. Great, thank you for the comment there. And then, regarding the game pipeline, can you give us a sense in terms of the timeline for expected launch of the games in your pipeline specifically Swordsman Online and Heaven Sword and Dragon Saber, if you could highlight those two and your other games in your pipeline that you talked about on the call? Thank you.

Kelvin Wing Kee Lau

Yeah, I’m more than happy to tell about the pipeline. First of all the Heaven Sword and Dragon Saber okay, we decided to have a official launch for our Heaven Sword and Dragon Saber in the summer of this year. That is number one. Number two is, we have another game called Fantasy Condor Heroes. So this game will also be launched in the summer of this year, this is being the second new game we are going to launch this year and also we have another one which is based on a very famous Japanese title called Saint Seiya Online. Saint Seiya Online, whenever we planned to launched this game, I think in Q4 this year. Regarding the [SCGH] or the Swordsman Online okay, our team are working very hard on this game and trying to do more modification and also introduce some more innovative features into the game and do more testing on the game before we launch the game. So, right now we still haven’t fixed the final launching schedule for Swordsman Online.

Operator

Thank you. Your next question comes from the line of Timothy Chan from Morgan Stanley. Go ahead please.

Timothy Chan – Morgan Stanley

Hello Michael, Kelvin, Vivien and Joanne. Good morning and thanks for taking my question. My first question is on, given the robust growth in web, mobile and social games, are you going to launch any of these titles this year and how large do you think your revenue contribution would be. And then I have a follow-up question. Thank you.

Kelvin Wing Kee Lau

Good morning, Tim thanks for the question. In fact, yes, I think everybody will aware that right now the web game or social game is growing real fast in China. Definitely, I think one of our key strategy is trying to more diversified our game portfolio going forward.

In fact, we already launch two SNS games in China up to now yes, two SNS games, so you can see in my other revenue in the P&L, you can see we already generated some revenue from this type of SNS game. In fact we have several teams looking on some small projects on the mobile games right now. And also we have another – we have several teams looking on some web games in (inaudible) in Beijing, right now. So, I think it can be surprised, if we are going to launch some web games this year. It’s possible, yeah.

Timothy Chan – Morgan Stanley

Okay, got it. I believe investors are very encouraged by a better dividend, you are also intend to make it a new policy going forward, and how should we think about the payout in the future, is that likely to be similar to the payout ratio that we have seen for 2011?

Kelvin Wing Kee Lau

Tim, as I mentioned in the remarks, okay, yes, it is our intention to offer to our shareholders, record dividend on an annual basis. But I think, right now the trend is, at the beginning of each year, I will submit a proposal to the board for approval to order dividend distribution, so I’d say based on our operating – our financial position, our position of cash and also our capital commitment, all these things. So, right now I can’t tell what rate or what percentage of each year’s profit will be distributed on an annual basis, I think each year I will go through the same process for the board approval. So, this is the case, yeah.

Timothy Chan – Morgan Stanley

Thanks very much.

Kelvin Wing Kee Lau

Yeah.

Operator

Thank you. Your next question comes from the line of Jialong Shi from CLSA. Go ahead, please.

Jialong Shi – CLSA

Hi, good morning, thanks for taking my question and congratulations on a very solid quarter. And my first question is a follow-up on the dividend and so what’s for this special dividend, what’s the ex-dividend day, when is the ex-dividend day?

Vivien Wang

Jialong, this will be decided by NASDAQ.

Jialong Shi – CLSA

Okay. And also –

Vivien Wang

As we announced. The record day is April 6 as we announced, but the ex-dividend day will be decided by NASDAQ.

Jialong Shi – CLSA

Okay. And then also my second question is about the overseas operation, just wondering how much of the revenue in 4Q came from overseas market both license and direct operations combined?

Kelvin Wing Kee Lau

Jialong, I already mentioned in my remarks, about one-fourth of our total revenue are generated from overseas market, okay. And also you can read from my P&L, okay. Overseas revenue represent about 8% to 9%, so 25 minus 8, is how much, is about 16, 17 is from U.S. or Japan, right.

Jialong Shi – CLSA

Okay, got it. Thank you. My last question is about the tax rate and you mentioned on the release, your tax expenses were lower in 4Q because you recorded lower withholding tax and so if we exclude the withholding tax from the total tax expenses, the regular tax will be even lower than previous quarters. So just wondering what is the tax rate we should model for 2012?

Kelvin Wing Kee Lau

Jialong, I also mentioned it in the last finance call, okay. The guidance I give to the market for the effective tax rate after we decided to change our dividend policy, I think the effective tax rate would change to about 14.5% to 16.5% per annum. So if you say is good accrual of the dividend tax, I think effective tax rate should be above 10% to 11%, something like this.

Jialong Shi – CLSA

Okay, got that. Thank you very much.

Kelvin Wing Kee Lau

You're welcome.

Operator

Ladies and gentleman, just in the interest of time, please be aware that you’ll need to ask one question and then move to the back of the line. Our next question comes from the line of Wendy Huang from RBS. Go ahead please.

Wendy Huang – Royal Bank of Scotland

Thanks for taking my question. Can you comment on the different momentum of your existing major games in Q1 so far? And also to what extent is your revenue guidance are affected by the seasonality, because it seems that you mentioned your guidance may reflect the normal product cycle. Thank you.

Kelvin Wing Kee Lau

Thank you, Wendy. So far all our existing games I think the performance are quite stable and also quite strong. As you can see, I think there is a valuable reason why we achieve very good result for Q4, especially for Zhu Xian. If you remember, we launched a big expansion for Zhu Xian in August last year. And then Zhu Xian as you remember then climbed up to a high level after we launched the big expansion. That means Zhu Xian still popular and also (inaudible) gamers. Also I also mentioned in Q4 my revenue increases mainly come from the Zhu Xian after we launch a big expansion where we do some activities for Zhu Xian in Q4 and profit went up in Q4.

Going to Q1 for my [observation] and also the data, I think all the games are still very stable and also very healthy. I think in Q1, yes, in terms of seasonality, the Q1 is a very good season, I think for us to monetize the game. In fact, we did some monetization activity for our core game in Perfect World II and also Zhu Xian. But the guidance right now is above I think lower than – I think the expected revenue for Q1 will be lower than Q4. I think the major reason is the revenue conversion rate for Q1 will be lower than Q4 because the activity we did in Q1 is mainly to encourage the gamer to buy all those permanent items, instead of consumable items. In fact in terms of the cash deposit we collect in Q1, I think there is – the total cash deposits expected and what we collected in Q4 last year. So I think from all this data, I will say all the games are right now are performing good and also stable.

Wendy Huang – Royal Bank of Scotland

Okay. Just to follow-up on your comment on Zhu Xian, so since it had a good run in both ACU and revenue in Q4, should we expect this games performance, maybe to pullback in Q1? And in that case, is there any other games current portfolio to offset that kind of decline?

Kelvin Wing Kee Lau

Okay, just one point, Wendy. In Q1, Perfect World 2 performance is very good, okay, because we did some monetization, that’s what we mentioned before. Chinese New Year is a very good season for us to do some monetization. So I would say, yes, Zhu Xian we went down a little bit in Q1, but I think (inaudible) to go up in Q1.

Vivien Wang

Wendy, just one point. This is, Vivien. As we said quarterly fluctuations for our games is very normal. So if you look at year-on-year results, you can see clearly that (inaudible) Perfect World 2 were quite a bit for us. So we are pretty confident in our existing games in terms of their performance in the long run. Thanks.

Operator

Thank you. Your next question comes from the line of Eddie Leung from Merrill Lynch. Go ahead please.

Eddie Leung – Bank of America/Merrill Lynch

Hey, good morning guys. Thank you for taking my questions. I only have one question. Could you share more color with us on the development in your overseas studios? For example, you guys mentioned that they are working on a game called Neverwinter. So just I’m trying to understand what’s the strategies are for those teams in overseas studios? Are they designing games mainly for the overseas market? And any synergy between the Chinese team as far as the overseas teams, anything like that will be very helpful. Thanks.

Kelvin Wing Kee Lau

Thank you, Eddie. In fact we have two teams, two studios right now in U.S. and been working on two major games for us. One is Cryptic. Cryptic very nice booking on the game called Neverwinter. And also we have a team in Seattle called Runic, they are working on a game called Torchlight.

I think the strategy is of course we want Neverwinter and Torchlight game to be successful in Europe and also in U.S. Of course, we are going to introduce Torchlight and also Neverwinter back to China, because I think Chinese gamer will I think can accept all those western style game. So in terms of synergy between the U.S. team and China team is okay, we can share experience and also, I think U.S. team can also allocate some of the [ad work] back to China. I think the key there is, I think we’ve seen Neverwinter or Torchlight they are free-to-play model so we can share some of our experience in China how to operate or how to design free-to-play model games and share this type of experience with our U.S. team and they are (Inaudible)

Eddie Leung – Bank of America/Merrill Lynch

Hey. Thank you, Kevin. Thanks.

Operator

Thank you. Your next question comes from the line of Nick Ning from Roth Capital. Go ahead please.

Nick Ning – Roth Capital

Hi, thanks for taking my questions and congratulations on a good quarter. So, I’m interested in Michael's view of how to balance between the increasing marketing spending and the sustainable revenue growth going forward instead of one time heavy promotion, which was followed by high attrition rate that it is in the past? I mean, what we see now is the most effective marketing method right now that will bring us the best return on investment and the last things (inaudible).Thank you.

Unidentified Company Representative

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Unidentified Company Representative

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Vivien Wang

Our long-term goal is to become particularly into a global leading game provider over the long run. And so the short-term performance is not our key focus. We will focus on further intense our R&D capabilities, our operational capabilities as well as to further enhance our service provided to our players over the long run and we are confident of our luck.

Nick Ning – Roth Capital

Okay, thanks and certainly a quick follow-up on your first quarter guidance. The sequential weakness as we expect us looking at due to this decline in ARPU or decline in ACU. Thank you.

Kelvin Wing Kee Lau

Nick, I think if you’re looking to maintain, okay in Q1. But I think yes, if as you can maintain than this (Inaudible) in Q1 is what I expect, okay. As well as I’d say in fact in Q1 my total cash collection I think is much better than Q4. I think the key is, we in Q1 technically we did trying to encourage again to buy all those permanent items and several consumable items.

Nick Ning – Roth Capital

Okay, thanks.

Operator

Thank you so much. The next question comes from the line of Ming Zhao from SIG. Go ahead please.

Ming Zhao – SIG

Hi, thank you, good morning. Two quick question if we look at your results on a quarter-over-quarter basis relatively is very high from one quarter to another, some quarter good, some quarter bad and the share price obviously overreact. So, would you consider given the most of the annual guidance, which could reduce the volatility in your shares. That’s my first question. Second question is we look at Tudou merger with Yukou, is that something Perfect World would consider when funding value for shareholders. Thank you.

Kelvin Wing Kee Lau

Hi, Ming, I think in terms of the annual guidance, I think for online gaming companies I think it is not easier for us to give upcoming four quarters guidance. So I think you are right. I think last year, we experienced a quarter-over-quarter fluctuation in terms of revenue. Okay, to be honest, last year, we did a very good job, okay. We (inaudible) I think compared with previous year compared with 2010 revenue already increased by 25% already.

So as well we mentioned a lot of times we are affected by seasonality. So and that’s one of my major jobs this year, trying to avoid this type of quarterly fluctuation and there is (inaudible) anybody did in Q1 you will see we are encouraged again as to buy other spending items in Q1 instead of trying to encourage them to spend more moneys on the customer buy them, so that we can recognize revenue (inaudible). And it is one of our major step this year, trying to avoid this type of quarterly fluctuations in terms of revenue this is exactly what we are doing.

In terms of annual guidance, Ming it’s difficult. It’s not easy for us to apply the annual guidance. I think first of all, we expect to providing a quarterly revenue guidance to the market. This is the response to your question number one. Question number two Ming, can you repeat your second question.

Ming Zhao – SIG

Yeah, my second question is, if we look at the Tudou and Yukou’s merger, and my question is that something Perfect World would consider doing to boost the shareholder value talking to other gaming companies.

Kelvin Wing Kee Lau

I think confirm that we don’t have any such plan on the table, okay. We never, never talk to anybody about this type of merger or our acquisition, no.

Ming Zhao – SIG

Okay, thank you.

Operator

Thank you. Your next question comes from the line of Martin Bao from CICC. Go ahead, please.

Martin Bao – CICC

Thank you for taking my question. I have a quick question regarding the business outlook. During the presentation you mentioned that you have had some in game promotional activities towards the end of this quarter. Could you provide us some color on these in gaming promotional activities. Thank you.

Kelvin Wing Kee Lau

Mart, I think normally, we will do some promotion. See for example, we will organize some new events during the Chinese New Year or after Chinese New Year take for example, big sales on some virtual items and also organize some events (inaudible) events amongst gamers to encourage gamers to spend more money or to buying more permanent items or consumable items. I think this is what call the promotional activities I think in the game.

Martin Bao – CICC

Okay, thank you.

Operator

Thank you, your next question comes from the line of Andy Yeung from Oppenheimer. Go ahead, please.

Andy Yeung – Oppenheimer

Hi, good morning. Thank you for taking my questions. My first question is about your joint venture with Nexon. And can you give us some color on the scope of your new company’s joint venture, and specifically what games would be operated under the new joint venture, and because of our operating your games in Korea with the new companies also expand into financial cooperation in game department in the future.

Kelvin Wing Kee Lau

Andy, thank you for your question, okay. We just established a company, we jointly established a company with Nexon in Seoul. The Company just established and also the team is on board already. So the first game we are going to launch through this JV platform is the Forsaken World. We expected to launch Forsaken World in summer in this summer this year in Korea.

So, right now is just, I think according to the agreement between Perfect World and Nexon, I think this probably is just purely an operation platform. Right now we still haven't any, start to negotiate with Nexon or any plans to stop the game people among in Korea. No, it is just a licensing arrangement.

Andy Yeung – Oppenheimer

Okay, got it okay. And just quick follow up on the use of cash, after your special dividend payout, what are your priorities for the use of your cash going forward?

Kelvin Wing Kee Lau

I think the usage of our cash is, I think always considered by the venture as how to make use of the best use of our cash okay. After the dividend payment, I think we still have above 300 plus million in preferred cash on hand. One of the major usage of our cash is, I think, we have already announced, that we have (inaudible) established. So we got to put aside some of our cash for the [recipient] investment and use in the M&A area.

Another one is as well we say that I think share repurchase is also one of the options. Okay, we will consider, going forward, I think, but then the share repurchase probably subject to the Board approval. And also, as I mentioned, we have several new games under development now and also when we launch new games, we’ve got to spend more CapEx on the service acquisition all these things. So, I think it’s the major usage of our cash going forward.

Andy Yeung – Oppenheimer

Great, that's very helpful. Thank you.

Operator

Your next question comes from the line of Vincent Sun from Mirae Asset. Go ahead please.

Vincent Sun – Mirae Asset Securities

Hi, good morning Michael, Kelvin, Vivien, and Joanne. Would you please comment on the expansion packs for Perfect World II and also for Forsaken World? What's their performance in the first quarter and also in the second quarter maybe, thank you?

Kelvin Wing Kee Lau

Yeah, we launch a big expansion pack for Perfect World II in December, what’s the name Vivien, please.

Vivien Wang

(Inaudible)

Kelvin Wing Kee Lau

Some of that is, the performance is good. Okay, I could tell you that Perfect World II we strongly believe that, I think Perfect World II I mean all those gamers will stay in the game. So, when we launched this expansion pack the ACU climbed to a high-level, that’s why I said in Q1, in my comment spoke about two things, contribute quite a lot and also the (inaudible) for to the increase in Q1. Forsaken World we also launch a big expansion for Forsaken World. I think right now the ACU number is quite stable, we are happy with the performance of Forsaken World in the domestic market and also in overseas market. So, I would say Forsaken World right now the ACU number is quite stable.

Vincent Sun – Mirae Asset Securities

Thank you. Thank you, very much.

Operator

Thank you. Our next question comes from the line of Atul Bagga from Lazard Capital. Go ahead please.

Atul Bagga – Lazard Capital

Hey, guys thanks for taking my questions and congratulations on a great quarter. I have two questions for you. A, I wanted to understand your views on the industry outlook for 2012 and the second question I had around monetization of your games, it seems like in Q4 your monetization could have been up versus Q3 and in Q1 seems like again you're planning, you are expecting somewhat similar monetization as Q4. Is this kind of a, did you expect or do you plan to keep monetization at the current level over a longer-term or do you foresee any changes either up or down in terms if your games ARPU from the current level? Thank you.

Kelvin Wing Kee Lau

Atul, I'll take your question number two first okay. In terms of monetization, I think we have, Atul, forgive me if, individual trends are for individual games to do the monetization. Like if were to monetization in Q1 and most probably in Q3 and then Q3 and Q4 and then most probably in Q2 so, I think each game has a different monetization trend for each game. So, another reason for the increase in Q4 revenues I think it is also the overseas market. We have five new game launches I think in the overseas markets. We recognize a decent amount of the user license fee and also in Q4, especially in December, it’s Christmas, especially in Russia the weather is so cold, all the gamers stay at home and play games. So normally in Q4 the overseas market revenue will grow up a bit in Q4. So that's another reason why our revenue performance was so good in Q4. So in terms of monetization, yes, I think been going forward, we will continue to do some monetization for each of our games. I think it’s normal.

So coming back to question number one, I think in terms of the competitive, I think our environment in China is specializing, I think you are also aware that in China right now, web game, social game is growing very, very fast. I think it created some challenges to MMORPG and I also mentioned before that one of our key strategies going forward is trying to diversified our game portfolio, that’s why we are going to launch more web games this year, and also we are going to launch some SNS game already. I think we will continue adding our SNS also web game project I think going forward.

Atul Bagga – Lazard Capital

Makes sense. Kelvin, just a follow up on the second question. can you talk a little bit about sequentially how fast the international business grew in second and fourth quarter versus third quarter and it seems like you probably had a full quarter contribution from Cryptic, and you talked about some of the other categories like Russia performed better than expectations? Can you talk about what was the sequential growth of overseas revenue? I am not talking about licensing revenue, but overseas games revenue.

Kelvin Wing Kee Lau

Yes. I think you are right. I think in Q4 we have a full quarter consolidation of Cryptic, I mean there is another reasons, thank you for your reminder. Cryptic also contribute a little bit on revenue growth in Q4. That is why I say Q4 is a very good season in overseas market to monetize again we are especially doing the Chinese New Year. So I would expect in Q1, the overseas market revenue will go down a little bit, I think it’s normal, I also explained in last year, normally Q1 in overseas market, the revenue would go down a little bit and also this is absolutely natural and normal.

Operator

Thank you. Our next question comes from the line of Steve Zhang from Macquarie. Go ahead, please.

Stephen Zhang – Macquarie Funds Group

And thank you for taking my questions. I just have one question in regards to your dividend policy. so it seems like this dividend was over half of your cash flow for the year. Can you talk a little more about that and given that you do have cash flow requirements for your buyback and also your VC investments and operating expenses. How do you expect to go with that strategy in the future? Do you think you’ll reduce it as the percentage of your cash flow? Thanks.

Kelvin Wing Kee Lau

Okay. That’s what we mentioned, this is a special dividend. This time is a special dividend, okay. The total amount of dividend we’re going to payout is about 98 million, (inaudible) 23% of my cash net of my short-term loan, okay. So we complete our IPO, since 2007, we haven’t paid out any dividend, okay for four years already. So I think this type of dividend I think is totally false, because it only represents about 23% of my cash net of short-term loan. And also up to end of 2010, my unrealized retained earnings is about RMB2.5 billion, something like this, okay.

So I think it’s about 27% of my undistributed earnings up to 2010 and also I think it’s still fair. So going forward, that’s why I say to adding the cash usage, adding as many on the capital M&A area and also on the – maybe share repurchase and also on some CapEx.

Operator

Thank you. We have a follow-up question from the line of Jialong Shi from CLSA. Go ahead, please.

Jialong Shi – CLSA

Hi, thanks. Just a quick follow-up. So what’s – I just want to know how – what’s your quarterly free cash flow?

Kelvin Wing Kee Lau

My quarterly free cash flow is about I think approximately, it’s close to my net profit, I would say it, a little bit higher than my net profit. It should be about RMB200 million to RMB250 million R&D free cash flow quarterly.

Jialong Shi – CLSA

Got that. Thank you very much.

Kelvin Wing Kee Lau

You’re welcome.

Operator

Thank you. And we have a follow-up question from the line of Wendy Huang from RBS. Go ahead please.

Wendy Huang – Royal Bank of Scotland

Thanks. Just some housekeeping questions from me. One is, where is the increasing number of the Internet companies to get delisted or privatization? Given the liquidity and volatility of Perfect World's share price and stocks, were you consider it to follow this suit, and also in the management or Board, what’s the benefit for Perfect World to staying as a public company?

Kelvin Wing Kee Lau

Wendy, I can confirm to you that, right now, we don’t have list of privatization or delisting trend on the table for discussion up to now. We don’t have these type of plan. Whenever we have this type of plan we will keep the market informed immediately, number one. Number two is okay, to maintain as a listed company I think it is very important to Perfect World, because as what Michael said, our long term vision is to become one major national online gaming supplier going forward.

So I think (inaudible) foreign investor and also [peer] competition in U.S. and overseas market. I think this is very helpful for our expansion. So I think, at this moment, I think we are happy to be a listed company in the NASDAQ.

Vivien Wang

And also, Wendy we believe that as long as we keep execute the soft price for ticket itself in the market.

Wendy Huang – Royal Bank of Scotland

Okay, and also some follow-up questions on your game pipeline. What is your latest launch coming for the Torchlight online and also you mentioned that you already launched (inaudible) game, Blacklight Retribution in North America. Do you have any plan to bring this game to China as well?

Kelvin Wing Kee Lau

Torchlight, I think we are at this time is going to launch Torchlight II, which is a multiplayer version U.S. in Q2. I think after the launch of this version, Torchlight II deal started the end of RPG version. I think the earliest time for them to launch the game would be at the end of next year or earlier 2014, for Torchlight MMORPG version. And then, what else?

Wendy Huang – Royal Bank of Scotland

FPS game, when will you launch that in China?

Kelvin Wing Kee Lau

Blacklight, up to now, the contrast between PWE and developer is, we just get the operation right in U.S. first. So I think it all depends on the performance of Blacklight in U.S. If it’s good, then we will negotiate with the developer to see whether they can (inaudible) the offers in China, so I think it’s still pending.

Wendy Huang – Royal Bank of Scotland

I see. And finally, just to confirm your earlier comments regarding share repurchase. So currently there is no share repurchase program in place, right?

Kelvin Wing Kee Lau

You’re right, you’re right. Right now, we don’t have any share repurchase program on the table, so I think that’s why I say it, we will consider I think one of the best use of our cash is share repurchase. So whenever we have our plan on the table we will submit to the Board for approval. Once approved we’ll announce it.

Wendy Huang – Royal Bank of Scotland

Okay, great. Thank you.

Operator

Your next question comes from the line of Jake Lee from Citigroup. Go ahead please.

Jake Lee – Citigroup

Hi, good morning. Thank you for taking my question, a quick question. Could you tell me your total staff number and what’s your plan for this year and next year. And it will be great if you discuss more about your R&D expenses and S&M expenses ratio. Thank you.

Kelvin Wing Kee Lau

Right now, our total head count globally I mean globally is about 4,000 plus okay head count including Cryptic, including U.S., including Japan, including Europe. In terms of R&D it’s about 2,200, 2,300 somewhere in this. So, I think right now in terms of R&D team I think we are picking and also sufficient in terms of (inaudible) enough to support our new game in the pipeline and also our new game in the coming two to three years time. So, I don’t expect we are going to further increase our R&D headcount this year. So in terms of our sales and marketing expenses ratio I think, is our policy. I did not to give this type of guidance to the market. But I think as Wang said, we are trying to improve our margin going forward, so one of the ways to improve our margin definitely is trying to perform a little more efficient, marketing campaign and also I think it is going forward, this is one of the ways to improve our margin. So I think this is our plan.

Operator

Ladies and gentlemen that does bring us to the end of our question-and-answer session. I’ll hand back to our host for closing.

Vivien Wang

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

Michael Yufeng Chi

Thank you.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for your attendance. You may all now disconnect.

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