Good evening, ladies and gentlemen, and welcome to the Quarter Three 2005 The9 Limited Earnings Conference Call. My name is Amanda and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will be facilitating a Question and Answer session towards the end of the conference. If at any time you do require assistance, you may key “*” followed by “0”. And coordinator will be happy to assist you. As a reminder, this conference call is being recorded for replay purposes. I would now like to hand the conference over to your host for today, Mr. James Rhee, Senior Director of Investor Relations. Please proceed sir.
James Rhee, Senior Director of Investor Relations
Thank you operator. Hello everyone and thank you for joining us today for The9's Third Quarter 2005 Financial Results Conference Call. Management with me today are Mr. Jun Zhu, Chairman and Chief Executive Officer; as well as Ms. Hannah Lee, Vice President and Chief Financial Officer. We also have translator Christine Chen, for today's call.
Before we start, I would like to review the Safe Harbor statement. During the course of today's call certain projections or forward-looking statements may be made regarding The9's future financial performance or future events. We wish to caution you that such statements or predictions are based upon current information and expectations and actual results may differ materially from those projected in the forward-looking statements. We would also like to refer you to documents that the company filed with the US Securities and Exchange Commission. Those documents contain additional information concerning factors that could cause actual results to differ materially from those contained in the management's projections or forward-looking statements.
Let me now turn the call over to Mr. Zhu, our CEO, who will provide you with an overview of our business for the quarter.
Jun Zhu, Chairman, Chief Executive Officer and Member of Compensation Committee
Good morning, ladies and gentlemen. I'd like to thank you for participating in our discussion of The9 Limited., Q3 2005 earnings.
First, I would like to present a quick overview of key financial and operating highlights before moving on to a discussion of our strategy and recent developments. The revenue and earnings generating potential of the World of Warcraft, in China markets is now starting to be evident. Net revenue for Q3 2005 was US$22.8 million, representing 232% quarter-on-quarter growth. World of Warcraft operation accounted for 98% of total revenue for this quarter.
Net income was US$4.7 million or earning of US$0.19 per ADS compared with a net loss of US$2.8 million in the second quarter. I'd like to note that we had a foreign exchange loss associated of US$1 million related to the RMB appreciation in this quarter, all representing an impact of about $0.04 per share.
For Q3 we attained a WoW Peak Concurrent User of 467,000 and ACU of about 240,000. Notably, after our normalization of our customer usage patterns in the month of July, we have witnessed a steady upward trend in ACU during Q3.
Most recently our October metrics are very impressive. For October the PCU is over 500,000 and ACU exceeds that of September and new accounts activation continues every day. As of October 31, 2005, over 2.5 million paid accounts have been activated since the commercialization of WoW.
We believe that The9's operational know-how and focus on customer needs have led to WoW, a strong start in China. The marketing efforts highlighted by our co-marketing campaign with Coca-Cola, The9's and WoW now command The9 share of the local gaming population.
This will help for margin user growth and to sustain the popularity of WoW over the long-run, as we begin implementing a targeted marketing plan to expand our leadership in first-tier cities and to improve our penetration into the second-tier and third-tier cities. For example, we expect to work with access providers and hardware vendors.
So we at The9 would like to express our gratitude to our loyal shareholders for your year's confidence, in our ability to successfully operate WoW. We also thank Blizzard Entertainment for their commitment to excellence and the support of WoW in China market, as well as other partners such as Coke, Intel and the China Telecom. Going forward, we will continue to cooperate closely with our partners to achieve even greater success for WoW in China and we are confident that we can grow our WoW revenues and the user base.
I would now like to discuss our long-term growth strategy.
Since the establishment of The9 Limited in 1999 we have witnessed the inception of the, online gaming industry in China and its rapid growth. During the past few years, our visionary approach and entrepreneurial spirit enabled the company to take advantage of this market opportunity in China.
Our past success provides a launching pad from where we can achieve long-term growth and achieve our goal of being the top online gaming company in Asia. We would like to describe our core growth strategy as two shields and one spear.
Our first shield involves maintaining our position as the pattern of choice in China. With our successful track record for licensing games like MU and WoW classification of GE ph next year we will showcase to the world our operating ability.
Through commitment and creativity, The9 will continue to deliver the ultimate customer entertainment experience and attain optimized performance So, in the end, the top developers will seek to work with us versus our competitors.
And our second shield in this strategy is in-house development. Our first in-house developed game Joyful Journey West is now in open beta testing and this game is the first attempt of our in-house development team. We expect to launch Joyful Journey West in early 2006. JJW is just the beginning of a number of in-house developed games and our R&D projects are underway and are expected to have the second half of 2006. Among these games, one is tailored for the export opportunity in the Southeast Asia market.
In order to further enhance our R&D capability going forward, we have attracted a number of top talents as to join the team, to join the team of The9 Limited. and will continue to explore overseas opportunities.
And then once there in this strategy refers to penetrating into the online gaming market overseas our participation in WoW operations in other parts of Greater China is a solid first step in this direction.
So this one spear pointing at overseas market will help to add on our current operation in China. It will also serve as the outlet for exporting our in-house developed games. So this will fortify our position as a partner of choice in China and elsewhere.
Now I would like to give the microphone to Hannah Lee, our CFO, who will offer a more detailed discussion of our Q3 results.
Hannah Lee, Chief Financial Officer, Vice President and Compliance Officer
Thank you, Zhu and Christine, and hi everyone. I will now take you through a review of our third quarter financial results. Rather than run piece meal over each line item, I will focus on the key points.
For the third quarter of 2005, The9 Limited reported net revenues of US$22.8 million, an increase of 232% from the second quarter of 2005 or 2,096% from the corresponding period in 2004. The increase was mainly due to a significant growth in revenues from our online game services, as a result of The9's operations of World of Warcraft for our full calendar quarter.
World of Warcraft's revenue accounted for US$22.3 million of third quarter's US$22.8 million total net revenue, or 98%.
With PCCU and ACCU of 467,000 and 240,000 respectively in the third quarter average revenue per user-hour, ARPU, was 0.36 in RMB.
Note that prior to the launch of World of Warcraft, our revenues were quite small due to the fact that sales of MU, which is jointly operated through 9Webzen, are accounted for using an equity method instead of consolidation. We do receive revenues from MU in the form of game operating support, but such are insignificant vis-à-vis with WoW.
Gross profits grow by 207% sequentially to US$11.4 million, with gross margins declining to 50.1% for the third quarter from 54.1% in the second quarter of 2005. The decline in gross margin was primarily due to two factors. First, we recorded approximately one-month amortization of intangible assets of US$0.9 million relating to assets acquired in connection with The9's acquisition of the remaining 31.1% interest in C9I, the entity that operates the World of Warcraft game in China. And second, costs such as internet data center rental, server depreciation and certain costs, certain staff costs incurred prior to the commercial launch of World of Warcraft has been included in product development expenses, whereas after World of Warcraft commercial launch, such costs are included as cost of services.
At the operating level, we recorded a profit of operations of US$6.2 million, compared with a loss from operations of US$3.2 million in the second quarter of 2005. The turnaround was mainly due to a full quarter WoW revenue coupled with a significant decrease in product development cost in quarter three.
As discussed just now, certain costs incurred prior to the commercial launch of World of Warcraft was classified as product development expenses in quarter two as such cost related development and testing of the World of Warcraft game. In addition, in quarter two we recognized US$0.6 million advances paid to third party developers, which relates to early stage game development of our second self-developed game as product development costs.
Other expenses in quarter three were US$0.3 million, compared to net other income of US$0.6 million in quarter two of 2005. This decrease was primarily due to the foreign exchange loss of US$1.0 million due to the appreciation of the Chinese RMB versus the US dollar, which was partially offset by the US$0.7 million of revenue from the sale of Pass9. A proprietary integrated membership management and payment system.
As Zhu just mentioned, the foreign exchange loss impact our earnings by about $0.04 per share. I would like to address two additional topics. First, regarding our 9Webzen affiliate, in the 9-month period and quarterly period ended September 30, 2005, The9's equity from 9Webzen and the share of the total asset of 9Webzen were less than 20% of The9's operating income and total assets respectively for the corresponding period. Therefore, The9 has decided not to present 9Webzen's separate financial statement from the third quarter of 2005 onward.
Secondly, we have decided to supplement our financial statement with non-GAAP measures of adjusted EBITDA and adjusted EBITDA per share. These non-GAAP financial measures are provided to enhance investors overall understanding of the Company's financial performance. Adjusted EBITDA for quarter three 2005 was US$7.2 million, compared to negative adjusted EBITDA of US$0.7 million for the previous quarter. On a per share basis, adjusted EBITDA per share was US$0.3 for third quarter, compared to a negative US$0.03 for the previous quarter.
With this I would like to thank you again for your attention and this concludes our presentation. We're now ready to take your question, Operator?
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