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Here’s the entire text of the Q&A from Shanda Interactive’s (ticker: SNDA) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Question-and-Answer Session

Operator

Thank you. The floor is now open for questions. If you do have a question at this time, please press “*” “1” on your touchtone phone. Once again, to queue up for a question, it is “*” key followed by the number “1” on your touchtone phone at this time. Please note that while asking your question, we ask that you lift your handset to provide optimum sound quality. Our first question is coming from Safa Rashtchy of Piper Jaffray.

Safa Rashtchy

Hi, good morning. I wanted to see if you could elaborate a little bit on the operating cost this quarter? Shujun, you mentioned that it had to do mostly with headcount and I might have missed some of your comments as to what was requiring such a big headcount increase and were there other marketing expenses, and was this a one-time expense that you incurred this quarter, or should we assume this level of operating expense in the coming quarters? And I had a quick follow-up. Thank you.

Shujun Li

Through Interpreter

Let me just quickly translate that Shujun just reiterated that it is a big increase in terms of operating costs for us from second quarter to third quarter, really in the following areas. First of all on the sales and marketing activities, those are related to the new game launch as well as the EZ product launch and on top of that we have done some marketing and promotional donation events, etcetera to really improve the overall perception of online game market and for social cause. And secondly, the human related cost is also in the area of new games development, as well as in new initiatives. And lastly, is the salary and wage increase to make Shanda more competitive in this market, to be able to attract and maintain a stable talent pool and that would result in future growth. And lastly, is that there is a one-time legal fee that is about RMB 8 million, which we probably wouldn’t see it recurring on a regular basis. So overall, the expenses are higher but as a percentage of our total revenues as the new game revenue, as well as EZ series part of the revenues continue to increase, should not that be quite as high. And, Tianqiao will have some input as well.

Tianqiao Chen

Through Interpreter

Tianqiao would just like to add a few points. First of all, as Shujun talked about the number of changes, I would just like to quickly comment why and why we’re doing this.

Tianqiao Chen

Through Interpreter

For the past four quarters, Shanda had double-digit quarter-over-quarter growth very consistently and either both from objectively also subjectively we need to continue to invest into our foundation so that we can generate future growth.

Tianqiao Chen

Through Interpreter

This quarter there were really two areas that we have invested heavily and that should generate longer-term sustainable growth. First of all is on the wage and salary related compensation. We have raised on average our employee salary by 20%. This had made Shanda a lot more competitive in this very dynamic market in terms of keeping our talents. And secondly, is in the marketing expenses and activities a lot of that is surrounded to Shanda’s brand, as well as the overall online game industry to create a very positive macro environment for this online game industry’s overall growth and as long as the industry grows we, as one of the industry leaders, will certainly benefit from that.

Tianqiao Chen

Through Interpreter

And overall I think the main thing, main thinking behind this period of time is that we need to continue to build into our foundation to really be able to compete in the future market and generate sustainable growth in the future, so please keep that in mind as we go on.

Safa Rashtchy

Okay, thank you. If I may, as a quick follow-up and you may have covered this, I missed the early part of the call, if so, I can take it offline. You indicated that Mir II, obviously, is a mature game and is declining. It still constitutes a significant part of your revenue. Given that even though you have the other games pulling and you will have some pipeline, how should you look at the sequential growth in Q4 and beyond? When do you think the effects of declining user base from Mir II would be offset by your new games?

Company Speaker

Through Interpreter

The first point is that Mir II has been in the market for four years and its inherent life cycle to this date we have already expected this will happen. The decline would be within our expectation and we have already started to prepare for this more than two years ago. As you recall, more than two years ago Mir II essentially accounted for 100% of our total revenue and as we disclosed in our Prospectus, IPO Prospectus, that will be a major risk to Shanda. But since two years ago we have added on various other types of games, including our in-house developed games, as well as casual gaming, so we have very successfully diversified our revenue stream into from different types of games and various source and I think looking at third quarter we think that the declines effect from Mir II has been largely offset by the increase from other games, so we have done quite well on that regard.

Company Speaker

Through Interpreter

I talked about the past, let me comment on the future. Overall the online gaming markets in China has been around for more than four years ago, since we first launched Mir II and looking at the current game titles in the market that are around three, four years old, all of them seem to have reached the peak or started to decline already. To prepare for that we already have built a very strong game pipeline with the games from Dungeons & Dragons, for example, and also from Actoz, as well as casual games that we’re developing in-house. So going forward we do not expect any particular single game to contribute to the majority of our total revenue, whereas we see revenue streams coming from a more diversified portfolio and Shanda truly becomes a platform operator.

Company Speaker

Through Interpreter

I think the fact that Shanda has reduced dependency on a single game is a sign of Shanda maturing as a platform company. Again, I think our core competence is in operating a overall interactive entertainment content platform and that shows in our EZ strategy, as I talked about earlier. I remember last time on the conference call Safa also asked me, when do we expect the home strategy to contribute to revenue. Well, I can clearly tell you that in fourth quarter this year we expect that to be EZ strategy product will already start to contribute and I think going forward this will also help to offset the decline from Mir II.

Safa Rashtchy

Thank you. I was going to ask you that again. Thank you.

Operator

Thank you. Our next question is coming from Wallace Cheung of Credit Suisse First Boston.

Wallace Cheung

Hi. Good morning. Two questions. First, if we take out the cost related to EZ series, what should be the estimated operating margin and operating profits from pure online game business and plus the other revenue. And second question is, can you give us some indication about the production costs of say an EZ center, EZ Pod and EZ Mini? Thank you.

Company Speaker

Through Interpreter

If we take out the expenses related to EZ products in terms of development and investment on the platform side, as well as sales and marketing expenses and also the one-time large legal expense, I believe our operating margin should be pretty much in line with last quarters.

Company Speaker

Through Interpreter

The centerpiece or the integral part of the overall EZ strategy and EZ product is essentially the EZ Center software solution, which as you know software doesn’t have a lot of cost, so that will not really affect our margin. However, initially as we kick off this market we will take on the products as well, for example, the EZ Pod, as well as EZ Station. As I mentioned earlier, we expect that the total cost incurred, as well as capital tied to the EZ strategy to be less than US$20 million.

Wallace Cheung

Just one follow-up question, so if the case like I’m selling EZ Pod at 458 RMB, do you mean that say, this is taken care into the production cost into consideration that, that pricing still can help you to make some that margin on the product? Thank you.

Company Speaker

Through Interpreter

The pricing, for example, for EZ Pod at 458 is essentially, well as you know, EZ Pod is the EZ series and software plus a remote control. So the value proposition is really in the EZ Center software solution and, as you know, the software margins are in what kind of range you already having idea. So I would say that it would not have too much of an impact on Shanda’s overall margin and we’re certainly making money on that.

Wallace Cheung

Thank you very much.

Operator

Thank you. Our next question is coming from Antonio Tambunan of Bear Stearns.

Antonio Tambunan

Hi. Good morning. Most of my heavier questions were already asked by Safa and Wallace. I want to ask on some of the more detailed smaller level questions. You mentioned your ARPU increased. I’m kind of curious how much of that was impacted by the mix in the monthly card sales versus time block sales? I mean was it impacted by the fatigue system?

Company Speaker

Through Interpreter

Shujun’s answer to the ARPU question is that first of all overall it really is a result of the increased loyalty of our users to Shanda’s platform as to the various service and operating and also activities that we create for them. And secondly is that because our direct online sales where the end users pay by credit card or debit card has increased significantly during this quarter to more than 17% of our total sales. So that has directly resulted in a higher ARPU from the games. Tianqiao commented also that earlier Safa asked about why we are incurring so much cost and I mentioned that it’s because we’re building into the foundation and you can show that, you can see that the results of direct online payment increase is because of our work in Shanda’s integrating back end processing as well as all the user interface, the work that we have done in the past, and we believe that this foundation will help us in the future as we rollout the home strategy, and then in terms of making payment easy for end users et cetera.

Antonio Tambunan

Okay got you. Your, now is the fall in your Mir II users concentrated in any one or two month period for the quarter or and are we still seeing a decline continuing to this quarter, like a heavy decline or is it starting to flatten out on the thick line side?

Company Speaker

Through Interpreter

I think as Jun talked about earlier its really the decline in Mir II is really a result of four years accumulated life cycle issues and we do see that it will continue to have gradual decline. However, Shanda’s operational expertise and experience we will continue to use that to try to reduce that decline or to slow down that impact. And for all these reasons that you know for the past few years we really have not been able to expand Mir II by using expansion packs or upgrades. The result that you see of Mir II is purely because of our expertise in terms of providing service and offering the online game community. So we will continue to rely on that to further prolong Mir II’s life cycle.

Antonio Tambunan

Okay and my last question very quickly, you mentioned Turbines, D&D game and the three Actoz game is coming in 2006. Is there any one or group of games that you are putting more emphasis on? Are you putting more emphasis or bigger expectations in terms of a bigger hand from D&D or the Actoz games? And that’s my last question.

Company Speaker

Through Interpreter

Well, as you know, that D&D has been in development for quite sometime and it’s the highly anticipated high quality game, so we certainly have a lot of expectations for that. And Actoz has supplied many quality games to Chinese market in the past, so the three games coming from Actoz also looks very attractive to us. So, I think currently, you know, we have good expectations for all of them.

Antonio Tambunan

Okay. That’s about it. Thank you very much.

Company Speaker

Thank you.

Operator

Thank you. We have our next question coming from James Mitchell of Goldman Sachs.

James Mitchell

Hi. Good morning. I noticed in the full release you mentioned that, are you confirmed that you have extended the Mir II and the BNB licenses for three years. Is there any change to the license fee structure being in the high 20 percents?

Company Speaker

Through Interpreter

For both Mir II and BNB extension, there is some slight change in the royalty structure. However, the change is not very significant and it shouldn’t impact us that much.

James Mitchell

Okay. And then, my other question was you mentioned that you increased salaries by 20% during the quarter. Did that happen at early in the quarter or did it happen later in the quarter and we have a full flow through in the fourth quarter?

Company Speaker

Through Interpreter

We finished the salary increase in July.

James Mitchell

So, the impact should be fully baked into the third quarter and then, okay thank you.

Company Speaker

Yeah.

James Mitchell

Great that’s all my questions.

Operator

Thank you, our next question is coming from Chang Qiu of Forun Technology.

Chang Qiu

Right. Good morning. Could you give us some idea of what’s the ACU trend for the MMORPG games and also for the casual games in the last few months, especially going from September to October?

Company Speaker

Through Interpreter

I think in terms of ACU on the MMORPG side we already discussed that, you know, Mir II has entered the later stages of its lifecycle so the effect of that will be reflected in the ACU trend. On the casual game side it’s been fairly stable.

Chang Qiu

Okay a question for Shujun, you mentioned that you have a newer tax rate for the year 2005, so which means in the fourth quarter we should basically say no income tax?

Shujun Li

After we gather as we said, the account incentives in this quarter, our next quarter the tax rate should be, the income tax should be around 9.3% of our total revenue. That will last for several quarters.

Chang Qiu

Okay thank you. The other question, for the EZ Center or EZ Pod right now, how is the market demand? Do you see get any tractions or initial tractions?

Company Speaker

Through Interpreter

Related to the EZ Pod EZ Center I would say that the market traction has already been quite significant. Overall, Shanda’s transition is very well known among the industry players. For example, Intel’s unlike and as far as the hardware manufacturers and also content providers. So, you know, a lot of people do pay attention to this initiative and the market reacts to that as well. And in terms of marketing we will, of course, continue to commit marketing expenses and marketing resources to that.

Company Speaker

Through Interpreter

I also like to add that the partnership with Intel that we have signed earlier is essentially a co-marketing and promotion partnership where the two of us will jointly rollout at least half a million EZ Pod or EZ Center units over the next year. And what’s more important is that once users install either the EZ Pod or EZ Center onto their PC, then they are very likely to become loyal Shanda users, they will contribute to recurring revenue streams. In addition to Intel’s distribution Shanda will also have direct sales through our existing extensive distribution platform, so I am very confident of the prospect of EZ Pod EZ Center products and we’ll certainly share good news with the markets as soon as we have them.

Company Speaker

Through Interpreter

Shujun also added that the sales revenue from either the product or the hardware as a one-time revenue. However, the users that you locking onto your platform will generate recurring revenue streams in the future. And in the past we have explained that, it’s been very difficult to keep track of registered users for online games because they can easily register multiple accounts and they can switch in and out very quickly. However, once they become a platform user through the EZ product, then we can keep track of the registered or paying user account and we can model the future growth a lot easier.

Chang Qiu

Okay so for the recurring part of the revenue is that, how much is it? Per month, maybe?

Company Speaker

Through Interpreter

We are still discussing on the pricing strategy and the pricing for a la carte service versus a bundled monthly package. But we should expect that to be a lot higher than a typical online gamers monthly card contribution, which would be about 35RMB.

Chang Qiu

Okay. All right thank you and good luck.

Company Speaker

Thank you.

Company Speaker

Thank you.

Company Speaker

Thank you very much.

Donglei Zhou

It’s already ten past ten, so I think we will conclude this conference call. If you have follow-up questions, please feel free to contact us. Thank you.

Company Speaker

Thank you.

Company Speaker

Thank you.

Operator

Thank you. This does conclude today’s conference. Please disconnect all lines at this time and have a great day.

Related:

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