Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Here’s the entire text of the Q&A from The9’s (ticker: NCTY) 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

Ladies and Gentlemen, if you would like to ask a question on today’s conference call, you may do so by keying “*” followed by “1” on your touchtone telephone. To withdraw your question from the queue you may do so by keying “*” followed by “2”. Once again ladies and gentlemen, that is “*” “1” for questions.

And your first question comes from Stephen Ng with Cazenove. Please proceed.

Stephen Ng

Hi, Mr. Zhu, Hannah and James, congratulations on a very good quarter. I have three questions for you. Question one can you please talk about your, sort of, give us more idea on the latest PCU and ACU trend post Q3? I know that you mentioned something about PCU, but can you also tell us what the ACU was post Q3 because I think we are slightly concerned with the slowing growth in the market after hearing your competitor's latest trends? And the second question is, can you please talk about the introduction of the fatigue system in October and how that will affect your business? And then finally, can you please talk about additional pipeline and then also the timeline of new games? Thank you.

Hannah Lee

Through Interpreter

Thanks for the question Stephen. I will answer the first question and the Chairman will answer the second question and the third question with respect to fatigue system and the pipeline. The average concurrent user and Peak Concurrent User on an overall basis for quarter three was 476,000 and 240,000 as we just said, but the September numbers I can share with you is Peak Concurrent Users was over 467,000 and the ACCU numbers also over 240,000. There's an upward trend in October of post Q3, and the ACCU level is more than 260,000 and the PCCU level is definitely over 500,000. There is a stabilization of the ARPU numbers and the operating number for Q3 was RMB0.36.

Jun Zhu

Through Interpreter

Hannah, just now pointed out that for October the PCU for WoW was 500,000 concurrent users. It should be pointed out that during the June open beta testing of WoW the Peak Concurrent User number jumped directly to 450,000. So it quickly surpassed the important thresholds of 100 and 200 and 300,000 to reach the 450,000.

So for us to see the Peak Concurrent User number to be at the level of 500,000 in October gives us even more confidence that the concurrent user number of WoW in future will continue to grow.

The second question is about the fatigue system. At the moment, it's very difficult to measure the implication of the fatigue system implementation, but we believe that what the Chinese government has on mind is to promote the healthy sound development of this gaming industry. So, and we are also working with the government to achieve this goal.

And a lot of attention has recently been placed on the newly proposed anti-addiction framework, actually there have been a lot of regulations in attraction for many years in the past and The9 has been able to prosper within this structured regulated environment ever since it's entry into the online gaming industry several years ago.

Significantly, I believe that a stronger military structure will be beneficial to the incumbent leadership. For instance, the government has recently required a higher degree of capitalization for online game operators to prevent less capable game operators from offering poor quality services. As The9 Limited is a leading force in the local industry, I feel confident that we can thrive within all these guidelines and that the government may propose, especially as the government intentions has been and will continue to be focused on promoting a healthy and prosperous online gaming industry.

Let me talk about the pipeline and the new product plans.

This new product plans are part of our strategy, which I described as the two shields and the one spear.

Remember that one year ago I talked about the future outlook of the online gaming industry in China and I said that 3D games will represent the future.

And I also said that as the 3D games become the mainstream in this industry in China by then the effort we have made in the past, for example, The9 introduction of such 3D games, our licensing effort will help us to lay a very solid foundation and we will have the first entrance advantage.

And our strategy is to launch and operate only the best more successful games. Some of the new products have been in testing our publicized, some have not and then we will according to our original plan step-by-step offer those games to the market.

With the success of WoW and the number of users that we now see I believe that the 3D gaming market in China is really kicking off and with this kicking off of the 3D games the old versions, the 2D games, which I compare to as like a black and white TV versus the color TV, will be replaced by the 3D games.

I'll take this opportunity to talk about our R&D strategies.

Now we believe that R&D is very critical and important for our future long-term success, however, we will not be wasting our money by taking hurried action. We have a lean, strong, very effective R&D, in-house R&D team. Meanwhile, we will be outsourcing a lot of R&D.

And then we will continue to play close attention to the local, as well as overseas R&D houses, and to, so that we can make a decision when time is appropriate on which direction we should be pursuing more aggressively. So we believe that with this kind of R&D strategy we will have good opportunity to make a wise decision that is we can decide when to open the window of opportunity rather than break this window and only look at the broken glasses.

And we have made some initial progress and achievement with our overseas expansion strategy. We believe that in future, in the long-run the overseas business will help to add on the domestic business and lay a very solid foundation for the sustainable growth.

Company Speaker

Thank you, next question?

Stephen Ng

Can I have a follow-up? Is it possible to give us more concretes of timeline regarding to commercial launch of JJW, GE and also the introduction of the World of Warcraft expansion pack?

Jun Zhu

Through Interpreter

Well for JJW it will be commercialized in the year 2006. That is we will start to charge fees in for JJW in 2006 and for GE it will be commercialized in the second half of 2006. For WoW there is a new version called The Burning Crusades and we will be very interested in launching that new version. And we expected that the Burning Crusades will be available here in China for release in the year 2006 too.

Stephen Ng

Thank you.

Operator

Again your next question comes from Lin Che with Lehman Brothers.

Lin Che

Hi, congratulations on a good quarter. This is Lin on behalf of the Lu Sun ph. We have two questions here. The first one is it seems like World of Warcraft is doing very well in Taiwan. When would you expect bottom-line contributions on this new joint venture? Also, can you give a little bit more color on the operation status of WoW in Taiwan? The second question is when World of Warcraft is getting into second-tier and third-tier cities, what is the cost and ARPU implication? Also, can you update a little bit of the progress of this penetration? Thank you.

Jun Zhu

Through Interpreter

Hannah Lee

Excuse me, I did not hear your first question very clearly, could you repeat?

Lin Che

Okay, my first question was like World of Warcraft is doing quite well in Taiwan, Taiwan market. We know that it has started commercialization last week or earlier this week. I just wonder when will The9 expect bottom line contribution from that joint venture and also another operation there?

Jun Zhu

Through Interpreter

Indeed as you pointed out we have a joint venture in Taiwan operating our WoW in that market and starting from November 8, we will charge fees for the WoW in Taiwan. So it's commercialized, and we will release the financials from the Taiwan market for WoW in Q4, in the Q4 release.

Actually I had earlier on a projection that WoW has been very successful in the US market, in Europe and in South Korea, and I was very confident that it will be very successful in the Chinese market too. So I believe that for Taiwan we will see the success story be repeated and I think for the whole Southeast Asia market WoW will be a very successful game.

Now your second question is about entering into second-tier, third-tier cities. According to our survey and the research, the user base of WoW our judgment at the moment is that for WoW at the moment we'll continue to be focused on the first-tier cities.

However, the inland market for second-tier and third-tier cities offer a great opportunity for the further growth for this game and with the PC updates, the hardware updates in those markets we will gradually work with the targeted marketing partners and it will also cooperate with the hardware vendors to penetrate into those second-tier cities.

Thank you.

Lin Che

Okay, thanks.

Operator

And your next question comes from Antonio Tambunan with Bear Stearns.

Antonio Tambunan

Hi, good morning everybody. Congratulations on the great quarter. Just a couple smaller questions, I have a small follow-up on the second and third-tier cities. Is there any indication of what percent of your revenues are starting to appear from the second-tier cities and the reason I ask is another company had said that they were kind of surprised by your penetration in some of these second-tier cities. I'm just kind of curious how much of it? Was it like, are we talking like 1% or 5% of your total revenues or what kind of revenue spread have you seen so far?

Hannah Lee

To answer your question, Antonio, the exact distribution between the first and second and third-tier cities, proportionate percentage of revenue, we do not have the information in front of us yet right now. The distribution, of course, is more concentrated on the first-tier cities. The second and third-tier cities penetration is still in progress. It's currently for Q3 in the double-digit figure percentage and we are, as our Chairman and CEO just mentioned, we are doing more targeted marketing on internet café campaign and also working with local partners to speed up the process of the hardware configuration increase at the upgrading the computers over in the second and third-tier cities and that will gradually increase our penetration into the second and third-tier cities. With that, the success that we have achieved for Q3, and the ability to penetrate to the second and third-tier cities is definitively caught our peer company by surprise and is definitely higher than what they expected.

Jun Zhu

Through Interpreter

Well, let me add a few words. If we look at the development path of the online gaming and online games in the past few years starting from the game Mir. At first it was started off in the first-tier cities and then gradually it penetrated into the second-tier cities and then at the end it had quite a stable user base in a number of second-tier cities.

And also these two games also has its more popular cities, that is a number of cities that the game is more popular.

And I believe that for WoW, its expansion in the China market, the same thing will happen. This expansion will first start in the first-tier cities and then go into the second-tier cities.

In the past six months we have worked with Coca-Cola on a co-branding and marketing campaign and so this campaign now World of Warcraft has got a very strong mind share among the gaming population.

And I believe that with our future targeted marketing campaign all the gamers will find these games very attractive.

Antonio Tambunan

Okay thank you. I have one question on your, who you think your competitors in light of this, I don't mean just for World of Warcraft but even your pipeline going forward. Who do you see as your main competitor? Is it going to be I guess the NetEase’s 3D game? Do you see it as, I don't know, some of the Kingsoft games? Is there anybody that you see that you've marked as your biggest competitor or your biggest threat?

Jun Zhu

Through Interpreter

Let me say that I don't think World of Warcraft this year or for the short-term future will have any significant competitor in the China market.

Because when World of Warcraft was developed it took the development team several years and they spent more than hundreds of millions of US dollars, and if you look at our competitors games you rarely see anyone investing so much money and spending so many years time in developing a game.

And I said that the new version of World of Warcraft, The Burning Crusade will be commercialized and will be launched in the US market in 2006. We believe that the launch of this new version will just further extend the gap between the competitors in terms of a single game profit.

Antonio Tambunan

Okay and just one quick last question on your paid accounts, I just wanted to put in perspective. Your release says you have 2.5 million paid accounts activated since launch. I just want to kind of get an idea of like how much of this is done in June just for third quarter and how many you've seen for the month of October?

Jun Zhu

Through Interpreter

Let me invite Hannah out here to answer this question.

Hannah Lee

I think the last reported registered pay user number was 2 million. The actual number that we have for paying registered users as of the end of October was actually 2.8 million and we rounded up, rounded down actually to 2.5 million. There is a steady growth of new registered paid users on a daily basis and the trend is steady and is proceeding very well in the quarter in October, and we expect that with the more targeted campaign in the remainder of quarter four and in 2006, the number will remain steady and will go on upward trend hopefully.

Antonio Tambunan

Okay. Thank you very much.

Hannah Lee

Thank you.

Operator

And your next question comes from Wallace Cheung with Credit Suisse First Boston.

Wallace Cheung

Hi, good morning. Great, congratulations on a great quarter. A couple of questions, firstly, can you firstly comment on the cost trend in fourth quarter regarding the cost of goods sold and the product development costs marketing. Because I have a couple questions first of all, because do you have to spend more on the CapEx to have new server to support for the new gamers. And also because you have changed I think the kind of equipment slightly that the product development costs is dropped quite dramatically in the third quarter, but you are going to spend more maybe hiring more payroll to develop new games. Do we expect the product development costs to increase in the future? Finally, on the marketing side also like because you have the marketing company should we expect in the fourth quarter you have to spend more on marketing? And finally, you have around 18 million advance payment from renovation of new office. Should we expect that should be coming out in the fourth quarter directly? Thank you.

Hannah Lee

Thanks for the question, Wallace. For your first question about the cost trend, we expect the gross margin that we enjoyed in quarter three, up about 50% will remain on a stable, on a steady basis for quarter four. It will be along the same line as Q3 keeping in mind that it might be a slight increase with respect to depreciation that we have to take into account quarter four for the full quarter because in quarter three, we opened up the fifth server site on September 9, and the depreciation with respect to that particular server, that one server, was only included in quarter three for one month, and is only going to be three months of depreciation for the fifth server site. With respect to what are the significant costs for purchasing additional servers for a new server site, for quarter four we have no plans to increase the number of server sites. Currently we have five server sites and that will support about 700,000 Peak Concurrent Users. For quarter four, we expect that to be sufficient for our needs. But we’re depending on the result of the marketing campaign and the demand from the players and the expectation in 2006. We will consider adding user sites in 2006, but not in Q4 of 2005. With respect to your question about deferred revenue, the deferred revenue most of it for revenue that was sitting on the books at that September 30, 2005, have been taken into revenue in October and November. And there has been steady sales of our prepaid cards so the deferred revenue number will be kept maintained on a steady level or even increase as we sell more cards, through the distribution channels and expanding additional distribution channels and with the demand of more players wanting to play the game in the second and third-tier cities.

Wallace Cheung

Okay just one follow-up on the balance sheet, it seems very interesting that the both the advance from customers and deferred revenue going up quite strongly. But on the other hand on cash basis the cash level actually dropped. Maybe I haven't gone through everything in your items. Can you give me some advise why this is so opposite change in terms of the cash level change? Thanks.

Hannah Lee

Yes, there is a reduction of cash from the second quarter balance to the third quarter balance mainly because of the acquisition of the 31.1% of the joint venture company, which operates the World of Warcraft game in China. We have paid out about 10 million of cash in quarter three with respect to that purchase. And in addition to the 10 million another 10 million was offset with the previous loans that we provided to that joint venture partner. And that is the main reason. The cash that we brought in actually for, from the prepaid game cards was about US$28 million.

Wallace Cheung

How about the items like acquisition related liabilities?

Hannah Lee

I'm sorry, what…

Wallace Cheung

In the current liabilities items there's a 155.8 million from the which, I’m sorry quite substantial. Can you explain it?

Hannah Lee

Yeah, RMB155 million acquisition related liability. That is the amount we have to pay that translates into US$20 million. 10 million will be paid and have been paid in quarter four to date and another 10 million is going to be paid in quarter two of 2006. And that will complete the transaction with respect to the payment schedule.

Wallace Cheung

Okay, thank you.

Hannah Lee

Thank you.

Operator

And your next question for today comes from, Chang Qiu ph with Forum Technology Research.

Chang Qiu

Yeah, good morning. I have a few questions. Can you give us some idea regarding your user characteristics like, men-women ratio, and age profile?

Jun Zhu

Through Interpreter

The demographic character if we are talking about the WoW players well the demographic cut across the entire online gaming population. WoW is truly unique in this sense that it appeals to all gamers according to our survey numbers; basically there are male and female users. And then teens to add out some are seasoned MMORPG players. Some are first time players and our survey suggests that WoW gamers are coming from everywhere, some from other MMORPG games, some from PC offline games and some new gamers. So, WoW is truly special in that sense since that it has been able to expand across the whole online gaming population.

Chang Qiu

Okay. How about percentage of people playing in internet cafes versus playing at home, playing at work?

Jun Zhu

Through Interpreter

Well the ratio of WoW players are between those players who play in Internet cafes and those who play at home. This ratio is quite consistent with the overall ratio of online game players. In the past if we look at the online gaming population, 60% play in Internet cafes, 40% play at home. Nowadays this ratio has turned around. About 60% play at home and 40% play at Internet café and that is quite consistent with the ratio we have observed for WoW players.

Chang Qiu

Okay and for the new expansion pack for WoW could you give us a more specific time? Is it second half of 2006 or first half or which quarter?

Hannah Lee

The timetable, exact timetable, is not released by us yet, but I think a lot of articles on the Internet are saying that it will be first half of 2006. For us to bring in that version update for the China market we need to do localization, which simply involves translating everything from English to Chinese. That would depending on the sound of it, the volume of content. It would take about one or two months to translate everything and then we can bring it out to the Chinese markets, so there will be a one to two month lag from the date it was launched in the States compared to when it will be launched in China.

Chang Qiu

Okay, thank you.

Hannah Lee

Thank you.

Operator

And your next question comes from, Ming Zhao with Susquehanna Financial Group.

Ming Zhao

Hi, good morning guys. I have two questions. The first question, can you give us an update on your tax rate in this quarter and 2006? Second question, and maybe I have missed it, can you also give us an update on the marketing costs that we are going to see going forward because you have spent quite a lot of cash on the marketing in last quarter and in Q3. So what's your plan for Q4 and 2006? At some point when it hits the $13 million are you going to continue to spend at the high rate? Thank you.

Jun Zhu

Through Interpreter

Let me answer the second question and then I will ask our CFO Hannah to answer your first question.

We are committed in our marketing agreement to expand US$30 million in the four years for these games.

Let me say that this year, for example, this year we launched a coal or marketing campaign in partnership with Coca Cola and the benefit is that the numbers will generate from this campaign far exceeds the direct cost, direct expense The9 Limited spending.

So in the next four years we will continue to work with the partners to do marketing for the WoW and our marketing investment will be based on the actual requirement of this version of the game and I can say with a lot of confidence that the output from those marketing campaigns will far exceed the cash input we invest.

Hannah Lee

Hi, Ming. I want to add more concrete numbers to the question with respect to marketing. As I said in our last conference call in Q2, the marketing expense for World of Warcraft was about 2 million and that's mainly because we have close data, open data and also commercial launch all in that one single quarter. The marketing spend has actually decreased slightly in quarter three at about the 1.5 million lot dollar level. We expect that trend to, that level to be maintained for the remainder of 2005 and for 2006 it will be around that level. However, you have to keep in mind that whenever there is going to be significant upgrades to come out, for example, The Burning Crusade we will spend a bit more marketing to increase the awareness of the game and to market the game to make sure that people know that significant update is coming out and that is traditionally how marketing is done. With respect to your question about tax rate, the effective tax rate that we have for quarter three was about 5%. We expect the 5% to be maintained for the remainder of 2005 and for 2006. The entity that operates the World of Warcraft game in China enjoys a tax holiday from two calendar years and that starts in 2005 so i.e. in 2005 and 2006 that particular entity that operates World of Warcraft does not have to pay enterprise income tax, which normally would be 15%.

Ming Zhou

Okay thank you. That's very helpful.

Operator

And I do believe that, that is all the time we have for questions.

James Rhee

Okay operator thank you very much. That brings to a conclusion of our Q3 2005 results call. Thank you all for attending. Good night.

Operator

Ladies and gentlemen, thank you.

Related:

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY’S CONFERENCE CALL AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE CONFERENCE CALLS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY’S CONFERENCE CALL ITSELF AND THE APPLICABLE COMPANY’S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Full Transcript of The9’s 3Q05 Conference Call - Q&A (NCTY)
This Transcript
All Transcripts