Perfect World's CEO Discusses Q2 2011 Results - Earnings Call Transcript
Perfect World Co., Ltd. (NASDAQ:PWRD) Q2 2011 Earnings Conference Call August 22, 2011 10:00 PM ET
Executives
Vivien Wang – VP, IR and Corporate Communications
Michael Chi – Chairman and CEO
Kelvin Lau – CFO
Analysts
Timothy Chan – Morgan Stanley
Mark Marostica – Piper Jaffray
Wendy Huang – RBS
Andy Yeung – Oppenheimer
Jialong Shi – CLSA
Nick Ning – ROTH Capital
Chao Wang – Merrill Lynch
Vincent Sun – Mirae Asset
Wallace Cheung – Credit Suisse
Nan Lee – SIG
Atul Bagga – ThinkEquity
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Perfect World second quarter 2011 earnings call.
At this time, all participants are in a listen-only mode. There will be a presentation, followed by a question-and-answer session (Operator Instructions). I must advise you that this conference is being recorded today, Tuesday, the 23rd of August, 2011.
I'd now like to hand the conference over to your first speaker today, Ms. Vivien Wang, VP, Investor Relations and Corporate Communications. Please go ahead, ma’am.
Vivien Wang
Thank you, operator, and thank you, everyone for joining us today for Perfect World second quarter 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 introduction and overview. Mr. Kelvin Lau, our CFO, will then discuss some of our latest business and operational developments and take us through our financial performance in the second quarter’s 2011. Following the prepared remarks, Mr. Chi, Mr. Lau and I will 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 risk and uncertainty 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 includes discussion of certain non-GAAP financial measures. Our earnings release contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures and is available on our website at www.pwrd.com under the Investor Relations section.
I would now like to turn the call over to Michael.
Michael Chi
Thank you, Vivien, and thanks everyone for joining us today.
The second quarter was another strong quarter for us, as both top and the bottom line number was strong. Our results came in above our expectations, even though there was no big promotional holiday in this quarter similar to the Chinese New Year. The revenue growth was mainly due to solid performance of the recently launched new games, including Forsaken World and Empire of the Immortals and the continued strength from our existing portfolio. In addition, we also showed strong growth in our overseas operations.
As many of you may have noticed, a few days ago, we launched unlimited closed beta testing for our Heaven Sword and Dragon Saber. This is our first 2D martial-arts MMORPG, which is based on classic martial arts novel by Louis Cha, a famous Chinese writer. So far we have been receiving positive feedback from gamers and traffic is still growing. We look forward to launching full-scale open data testing for this game soon. We are confident in the games’ future growth, but as part of the games’ growth trajectory we do not see that significant revenue contribution from these games until later this year.
Looking ahead, we are pleased with our diverse pipeline, which is a big strong point of our company. In addition to Heaven Sword and Dragon Saber, Swordsman Online and a number of other exciting titles in our pipeline, we recently announced that we are working on Saint Seiya Online. This is a 3D MMORPG based on a world famous comic Saint Seiya. Saint Seiya is a classic series that millions of Chinese know from years ago and it will definitely attract new fans in China soon.
In the near future, we look forward to launching over a dozen of exciting games that are currently under development, spanning a variety of types, including MMORPGs, web games and SNS games. At the same time we are also very happy to see that signature titles, including Zhu Xian and Perfect World II, performing consistently well as we regularly release new expansion packs. We will continue to energize our existing titles with a steady stream of new content in order to keep gamers involved and attract new gamers.
In the overseas market, we continued to expand our reach globally. This quarter was saw strong performance from our subsidiaries in the United States, Europe and Japan. In particularly, we received a very positive feedback from players in the US and the Europe, for Forsaken World, which was designed for global players. Our overseas licensing activities also progressed very well and facilitates our expansion around the world. Additionally, we acquired Cryptic Studios in the US recently. This is a reputable online game company based in California. This strategic acquisition brings world-class games like Champions Online, Star Trek Online and Neverwinter Nights, as well as other projects into our diversified portfolio and pipeline. It will also help us grow in the US and the Europe and further strengthen our R&D and operations around the world.
We think the future of our industry is great. The number of Internet users in China is growing fast each year and there is a greater possibility that the online gamer population in China will also grow rapidly. At the same time, we believe the growth potential of the online gamer population in the traditional large gaming markets like the US, Europe and Japan creates new opportunities. Online gaming is also taking off in a number of emerging markets. With our strong R&D continued innovation, extensive global operating network and diversified portfolio and pipeline, we believe we are well positioned to capture all these growth opportunities, while we deliver a sustainable growth over the long-term.
Thank you. Now, I will pass the call to Kelvin.
Kelvin Lau
Thank you, Michael. As Michael mentioned, despite the absence of happy promotional season like the Chinese New Year, we actually posted the strongest top and bottom-line result in the history of our company. Thanks to the solid performance of a number of our titles in the domestic market as far as the strong growth in our overseas operations.
In the second quarter, we introduced new contents to our existing titles. We released an expansion Fantasy Zhu Xian 2.0 for our turn-based 2D MMORPG Fantasy Zhu Xian, Road to Glory for our 3D MMORPG Zhu Xian, and The Five Tiger Generals for Chi Bi. A few days ago, we launched unlimited closed beta testing for our 2D martial-arts MMORPG, Heaven Sword and Dragon Saber. And so far we received a good feedback from our players. We also released a new expansion pack called The Master Thief for our 3D MMORPG Legend of Martial Arts very recently.
Our overseas business is also performing well. We remain number-one in the overseas market amongst Chinese online gaming companies, and recently we had a series of quick developments. Through our own overseas subsidiaries, we launched the Forsaken World in Japan, and the French version and German version of Perfect World II in Europe. In addition, our US subsidiary, obtained a licensing agreement to publish Blacklight Retribution. Blacklight Retribution is a free-to-play first person shooter game developed by Zombie Studio, a well-known leading game developer based out in the US.
During the quarter, through various overseas partners, we launched the Hot Dance Party in the Philippines, Battle of the Immortals in Indonesia, Forsaken World in Hong Kong and Macau, as well as Fantasy Zhu Xian in Russia. We also signed in agreements to license Empire of the Immortals to Taiwan, Chi Bi to Indonesia, Legend of Martial Arts and Forsaken World to Russia. Shortly after the quarter, we successfully launched the Empire of the Immortals in Taiwan, Forsaken World in the Philippines, and Zhu Xian in Indonesia through our local partners. We also entered into an agreement to license Dragon Excalibur to Taiwan, Hong Kong and Macau.
Before I go through the second quarter financial highlights, I would like to quickly explain some updates to our financial statements. As of June 30th, 2011 we’ve presented the asset and liability of our film business as "assets and liabilities held for sale" on the consolidated balance sheet. We also reported the operating results from the film business as discontinued operations in the consolidated statements of operations for the quarter ended June 30th, 2011 and prior comparative quarters. These changes we saw from our recent agreement to sell Perfect World Beijing Pictures Co., Ltd., the entity that operates Perfect World’s film business to Beijing Ever Joy Pictures Co., Ltd., which is majority-owned by Michael, for a total consideration of RMB360 million. This decision was made and fully authorized by our Board, and a Special Committee consisting of all Independent Directors of the Board. It is expected to sharpen our focus on our core online game development and operation business and to maximize shareholder value over time.
Now, I would like to take you through our second quarter 2011 financial highlights. Total revenues were RMB779.6 million in 2Q11 compared to RMB718.5 million in 1Q11 and RMB592.5 million in 2Q10. Our online game operation revenues were RMB712.1 million in 2Q11, compared with RMB646.2 million in 1Q11 and RMB533.3 million in 2Q10. The sequential growth from 1Q11 was primarily attributable to the strong growth of our recently launched new games including Forsaken World and Empire of the Immortals, the continued strength of some of our existing games such as Perfect World II, as well the increased contribution from our overseas operations in the US, Europe and Japan. ACU for games under operation in mainland China was approximately 890,000 in 2Q11, compared with 905,000 in 1Q11 and 886,000 in 2Q10.
Our overseas licensing revenue were RMB61.8 million in 2Q11, compared with RMB63.6 million in 1Q11 and RMB55.1 million in 2Q10. The slight decrease from 1Q11 was mainly due to lower initial license fees as we had fewer significant new games launches in overseas markets in 2Q11. This was partially offset by the continued growth in usage-based royalty fees in 2Q11.
Our other revenues were RMB5.6 million in 2Q11, compared with RMB8.7 million in 1Q11 and RMB4.1 million in 2Q10.
Our gross profit was RMB665.9 million in 2Q11, as compared with RMB610.6 million in 1Q11 and RMB495 million in 2Q10. Gross margin was 85.4% in 2Q11, compared with 85% in 1Q11 and 83.5% in 2Q10.
Our operating expenses were RMB345.5 million in 2Q11, compared with RMB321.7 million in 1Q11 and RMB273.7 million in 2Q10. The increase in operating expenses from 1Q11 was mainly due to increased sales and marketing expenses and higher R&D expenses, and was partially offset by lower G&A expenses.
Our R&D expenses were RMB161 million in 2Q11, compared with RMB146.3 million in 1Q11 and RMB90.7 million in 2Q10. The increase from 1Q11 was primarily due to an increase in staff cost.
Our sales and marketing expenses were RMB121.4 million in 2Q11, compared with RMB103.7 million in 1Q11 and RMB120.3 million in 2Q10. The increase from 1Q11 was largely due to higher advertising and promotional expenses associated with our recently-launched new games as well as the releases of several expansion packs for the existing games in 2Q11.
Our G&A expenses were RMB63.1 million in 2Q11, compared with RMB71.7 million in 1Q11 and RMB62.7 million in 2Q10. The decrease from 1Q11 was mainly due to a decrease in staff cost.
Our operating profit was RMB320.4 million in 2Q11, compared with RMB288.9 million in 1Q11 and RMB221.3 million in 2Q10. Non-GAAP operating profit was RMB348 million in 2Q11, compared with RMB314.6 million in 1Q11 and RMB246.3 million in 2Q10.
Our income tax expenses was RMB38.6 million in 2Q11, compared with RMB33.7 million in 1Q11 and RMB29.6 million in 2Q10. The increase from 1Q11 was in line with the growth in operating profit in 2Q11.
Net income attributable to the company’s shareholders was RMB316.6 million in 2Q11, compared with RMB263.7 million in 1Q11 and RMB196.6 million in 2Q10. Non-GAAP net income attributable to the company's shareholders was RMB344.3 million in 2Q11, compared with RMB289.5 million in 1Q11 and RMB221.7 million in 2Q10.
Basic and diluted earnings per ADS were RMB6.30 and RMB5.98, respectively, in 2Q11, compared with RMB5.25 and RMB4.99, respectively, in 1Q11, and RMB3.93 and RMB3.71, respectively, in 2Q10. Non-GAAP basic and diluted earnings per ADS were RMB6.86 and RMB6.50, respectively, in 2Q11, compared with RMB5.76 and RMB5.48, respectively, in 1Q11, and RMB4.43 and RMB4.19, respectively, in 2Q10.
In terms of financial guidance, as part of the normal product cycle, we plan to decelerate promotional activities for some of its existing games in the third quarter in order to lengthen the life cycle of our existing games and maintain long-term sustainable growth. Furthermore, as we normally focused on fostering user traffic and further nurturing new games at the earliest stages, Heaven Sword and Dragon Saber is not expected to have significant revenue contribution in the third quarter. As such, based on our current operation, total revenues for the third quarter of 2011 are expected to be between RMB756 million and RMB803 million, representing a range similar to the revenues in the second quarter of 2011, but still an increase of 15% to 22% on a year-over-year basis.
Overall, we are confident in our recent moves and in our long-term outlook. As of August 21st, 2011 we have repurchased an aggregate of 2,305,749 ADS in the open market under our $100 million share repurchase program. We expect a continuous implementing this share repurchase program to increase shareholders’ value in a manner consistent with market conditions. Most importantly, this reflects our confidence in our business outlook.
This concludes the prepared remarks for today. We're happy to take your questions. Operator, we are ready for questions.
Question-and-Answer Session
Operator
Thank you. We will now begin the question-and-answer session. (Operator Instructions). Your first question comes from Timothy Chan, Morgan Stanley. Please ask the question.
Timothy Chan – Morgan Stanley
Hi, Michael, Kelvin, and Vivien, good morning. Thanks for taking my questions and congratulations on a very strong quarter. I have two questions. The first one is, I’m very interested to learn about your new games, Heaven Sword and Dragon Saber, how does that compare to your initial expectation, and are there any operating data that you may be able to share with us? And I have a follow-up question after that. Thank you.
Vivien Wang
[Foreign Language – Chinese]
Kelvin Lau
Tim, thanks for the question. Yes, we’ve just started unlimited closed beta testing for the Heaven Sword and Dragon Saber on the 18th of this month. So I think right now it’s still at a very, very initial stage, because this is only unlimited closed beta testing. And also our policy is not to disclose in the special – specific operating data for each games. But I will tell you this so far the feedback from the gamers is still positive, so we are planning to start the large-scale official open beta or commercial launch of these games in September. So we are still quite positive on these games.
Timothy Chan – Morgan Stanley
Thank you. My second question is regarding your disposal of the movie business. Could you just share with us more details? I mean, for example, why at this point in time and as well as the financial impact to Perfect World. Thank you.
Kelvin Lau
Yes. We sold our film business several weeks ago. I think the major reason for selling our film business as we mentioned in our announcement is, I think the major reason is we want to more focus and sharpen our focus on our core business, which is online gaming business, so we decided to sell our film business.
We sold the film business at a premium, so the – at a premium price, but I think there would be – there will be no impact on the P&L in Q3. Why? Because this is a related party transactions, so all the premium we get from this transaction will be booked in our additional capital in the equity account, so there is no impact on our P&L in Q3.
Timothy Chan – Morgan Stanley
Thank you very much. It’s very helpful.
Kelvin Lau
Thank you.
Operator
Thank you. And your question comes from Mark Marostica from Piper Jaffray. Please ask the question.
Mark Marostica – Piper Jaffray
Thank you and congratulations on the quarter. My first question relates to your selling and marketing line and specifically your comment about decelerating promotional activities for some of the existing games. First, which games specifically are you planning to pullback on the promotional activities for? And then tied to that, how should we think about the trend going forward in selling and marketing, specifically for Q3 as a result of that, and then consideration of the launch of Heaven Sword and Dragon Saber and other games?
Vivien Wang
[Foreign Language – Chinese]
Kelvin Lau
Thanks for the question. If you look at our Q2 result, in fact our sales and marketing expenses increased quite a lot compared with Q1. I think the main reason for the increase in the sales and marketing expenses in Q2 is mainly because we launched some expansion – new expansion packs for existing games like Zhu Xian, like Chi Bi. So just the Chi Bi is why the sales and marketing expenses went up in Q2.
We expect our sales and marketing expenses will also further go up in Q3. Why? Because as I mentioned, we just launched unlimited closed beta testing for our new games Heaven Sword and Dragon Saber. So this we incurred some more sales and marketing expenses in Q3. And also there is a big event in Q3, the China Joy, so we also incurred some sales and marketing expenses on participating on this big event. So I will expect Q3 sales and marketing expenses will further go up as compared with Q2. Thank you.
Operator
Thank you. Our next question comes from Wendy Huang from RBS. Please ask the question.
Wendy Huang – RBS
Thanks. My question is still about operating margin and the sales and marketing expenditures. I remembered last quarter you also guided operating margin to come down quite significantly due to the promotions, et cetera. But in fact what turned out this quarter in Q2 is actually operating margin remained quite strong. So I wonder what has changed in the past three months to change the actual results of the operating margin in Q2 and also how should we look at the magnitude of change for the operating margin in Q3. Thank you.
Kelvin Lau
Thanks for your question, Wendy. In think in Q2 nothing changed except for the revenue, okay? As I said, in Q2, I think the guidance we gave to the market for Q2 is based on the best estimate when we gave the guidance in May. But, eventually, the performance for Perfect World II and also for our recent launched game, Forsaken World and Empire of the Immortals have been – performance in late May and June is better than what we expect, so you can see our revenue growth by a lot in Q2. So you can see in Q1, our margin has already grew up – going back to 34% or 36% already.
So by that time we say, “Okay, if the middle guidance due to negative 5%, then my market will go down, but eventually my revenue grew up quite a lot. So my market grew up in well off in Q2.” I think this is why our market grew quite a lot in Q2, because of the – our revenue are very solid and good performance. So going into Q3, I think, as we mentioned, our sales and marketing expenses will go up because of the Heaven Sword and Dragon Saber launch and also the China Joy event expenses. So I think I gave the answer to your questions.
Wendy Huang – RBS
Okay. Thank you. And I have a follow-up regarding Zhu Xian, I don’t think you’ve mentioned this game in your press release. So what’s the churn of this game in Q2 and Q3 so far? Thank you.
Kelvin Lau
Zhu Xian in Q2 was very stable. One of the reason being there is no significant fluctuation in terms of revenue for Zhu Xian in Q2 compared with Q1.
Vivien Wang
We also look forward to launch a big expansion pack for this game soon in Q3.
Wendy Huang – RBS
Okay, thanks.
Operator
Thank you. Our next question comes from the line of Andy Yeung from Oppenheimer. Please ask the question.
Andy Yeung – Oppenheimer
Hi, good morning. Thank you for taking my questions. My first question is about the user traffic and monetizations during the quarter. You’ve mentioned that your second quarter’s revenue were both by Forsaken World and Empire of the Immortals, and some of the strength coming from your existing title Perfect World II. Can you give us some color on your dynamics within your player traffic and your monetization that should be for those titles during the same quarter?
Kelvin Lau
Thanks for the question. First of all, yes, in Q2, our overall aggregate ACU number dropped a little bit compared with Q1. Internally we’ve seen this normal, because – especially for those two recently launched game Forsaken World and Empire of the Immortals, because we launched in Q4 last year. So when we go through the Q1, I think these two games will come down a little bit in terms of ACU after the peak, because some gamers will go into the game and these test the game and if they don’t like the game, then they quit. So I think this is normal trend for all those new games after launch there will be a temporary drop in ACU number for these two recently launched games.
So in terms – we view it as a very normal slightly declined in the ACU number. So we are still very confident with these two games and also our existing games, like as I mentioned Zhu Xian and Perfect World II. I think right now the ACU number for these major existing games are very stable. So we are still very comfortable with the ACU number right now.
Andy Yeung – Oppenheimer
Okay, okay. And then just one follow-up question about the acquisition of Cryptic Studios. It looked like Cryptic Studios’ games tend to be more US or western centric, so I just wonder how well do you think those games would translate into Chinese market, and also what’s your long-term plan for Cryptic Studios, both for your international and the Western Chinese markets?
Kelvin Lau
I think the major purpose for this strategic acquisition of Cryptic – I think there are three reasons for this acquisition.
One is, by acquiring Cryptic, I think Cryptic can provide more western styled games so as to reach and further diversify our game portfolio. So going forward we can have Chinese style, martial-art style and then western styled games in our game portfolio so as to more diversify our game portfolio.
Secondly, by acquiring Cryptic, you can have as more easy or more efficient to penetrate into US and Europe markets by getting use of this type of western styled game. I think this will be very helpful for our US and European expansion.
Number three is, we love I think the technology and R&D team of the Cryptic. Cryptic, right now, they have a team of a very famous and also experienced R&D capability teams in Cryptic. So I think by acquiring Cryptic, we will further strengthen our R&D capability I think in all of our gaming markets. So this, I think these are the three key reasons why we decided to acquire Cryptic.
Going forward, yes, I think the outlook is we will hope Cryptic can generate and develop more western styled games. We strongly believe that in China, I think the gamers can accept western styled games. I think we can see some successful examples in China for in terms of western styled games. So for all those, Cryptic can be fed – it can be launched in Asian countries. Yes, thank you.
Andy Yeung – Oppenheimer
Yes, great. That’s helpful. Thank you.
Operator
Thank you. Your next question comes from Jialong Shi, CLSA. Please ask the question.
Jialong Shi – CLSA
Hi, good morning, Michael, Kelvin, and Vivien. Congratulations on a strong 2Q. I have a couple of questions. My first question is regarding revenues. Could you tell us how much percentage of your revenue in 2Q came from domestic market?
Kelvin Lau
Jialong, I think our policy is not to provide specifically I think the breakdown of the revenues. If you look at our financial statement, we break it down into online game operation and also –
Jialong Shi – CLSA
So yes, our policy is not to disclose anything specifically. I think the breakdown of specific.
Vivien Wang
But as we mentioned – Jialong, as we mentioned in earning call, overseas operation, overseas licensing in total accounts for about one-fourth of our total revenue, so you can write-off the domestic operations.
Jialong Shi – CLSA
Okay. One-fourth of the total revenue.
Vivien Wang
From overseas, yes.
Jialong Shi – CLSA
Okay, got it. And my second question is about the newly acquired Cryptic Studios. I understand you have completed it recently. Just wondering, for your 3Q guidance, if you are factoring any contribution from Cryptic Studios?
Kelvin Lau
Yes. But I think the contribution from Cryptic in Q3 would not be very significant. Why? Because we just closed the deal so we are going to consolidate Cryptic’s financial statement just for one-and-a-half months, that’s number one. Number two, Cryptic compared with – totaled with the whole group is too small, because right now the game they’re operating now is small. What we are expecting is to have big game label, which is going to be launched in the coming year. So the impact on the consolidation for Q3 will be I think not significant from Cryptic.
Jialong Shi – CLSA
Understood. So then when are you going to launch the game from Cryptic Studios in China? And also if you could provide some advise on the announced schedule for Torchlight II from Runic Games. That would be very helpful.
Kelvin Lau
Torchlight from Runic, as mentioned, I think the MMORPG version is going to be – is scheduled to be launched in late 2012 or early 2013, okay? For Cryptic games, Neverwinter, I think our schedule is going to – trying to launch the game in late 2012 or early 2013. So we are going to launch the game in US first and then followed by Asian countries.
Jialong Shi – CLSA
Thanks.
Kelvin Lau
Welcome.
Operator
Thank you. Your next question comes from the line of Nick Ning from ROTH Capital. Please ask the question.
Nick Ning – ROTH Capital
Hi, thanks for taking my question, and congratulations on the strong quarter. So my question is where did the 10% online game operation growth come from in the second quarter? Was it mainly from China or overseas? Thanks.
Vivien Wang
Nick, can you repeat your question?
Nick Ning – ROTH Capital
So your online game operation line grew by 10% quarter-on-quarter. I was wondering where does this 10% growth came from in the second quarter. Was it mainly from China or overseas operation?
Kelvin Lau
Nick, I think the increases come from both, okay? We achieved a revenue growth in domestic market in China and also from overseas, as I mentioned in the remark. So our revenue growth is contributed by our domestic revenue growth mainly from Perfect World II and also from our two recently launched game Forsaken World and Empire of the Immortals, and also as well as – and also some contribution from US and also Japan, and Europe. Why? Because we just launched the Forsaken World in US and Forsaken World in March this year. So you can see, in Q2, in fact US and Euro has achieved a pretty nice growth in Q2. So it contributed quite a lot as well.
Nick Ning – ROTH Capital
Okay, thanks. That’s helpful. So regarding your guidance, should we expect a decline in China game operations in future, if you decelerate promotions for the existing games, while overseas games – overseas should continue ride, or is this the other way round?
Kelvin Lau
I would expect our overseas to continue to grow, especially in the US and also in Europe. Domestic market will slowdown a little bit. I think to be fair Nick, I think we already achieved the highest record revenue growth this quarter. That means if in Q3 we can maintain I think the similar level of revenue RMB780 million, I think that we have done a real good job. So as I mentioned, we plan to decelerate a little bit on our existing gaming in China so as to lengthen our lifecycle for games. And [inaudible] expect so many contribution from this game during the unlimited closed beta testing stage and also we are not in hurry to monetize this game at this stage. We are trying to stabilize this traffic; we are trying to accumulate the user base at this stage.
Nick Ning – ROTH Capital
Okay, thanks. So my last question is it sounds like Michael is very upbeat about the online gaming market outlook. So what is management rough estimate of the overall online game market’s growth in 2011 in China? In management’s view, is it to be more driven by ARPU or user number, particularly how about the growth in the MMORPG market for 2011 and the next year?
Kelvin Lau
I think as I have said we are still very, very confident with our online gaming market in China. But I think we have to guess what’s the percentage growth for the online gaming market. I think this is not our job to do this, but internally of course we have this estimation, but I think it is not appropriate for us to disclose estimation in this situation. But [inaudible] online gaming market in China, so yes.
Nick Ning – ROTH Capital
Okay, thanks. That’s very helpful.
Operator
Thank you. And our next question comes from Chao Wang from Merrill Lynch. Please ask the question.
Chao Wang – Merrill Lynch
Hi. Thanks for taking the question. My question is regarding your overseas business. Could you let us know the breakdown between your own operation and your licensing revenue? Thanks.
Kelvin Lau
This is an easy question, okay? As we have mentioned, okay, overseas operation represent above 10% to 20%, right for operation? So look at my financial statement, the overseas licensing revenue is how much then you minus it, then you will come up with your answer to your questions.
Chao Wang – Merrill Lynch
I mean the revenue breakdown between your – I mean the – from your overseas subsidiary the direct operation.
Kelvin Lau
Yes, my owned subsidiary operation is included in the online game operation lines, okay?
Chao Wang – Merrill Lynch
Okay.
Kelvin Lau
Thank you.
Operator
Thank you. And your next question comes from Vincent Sun from Mirae Asset. Please ask the question.
Vincent Sun – Mirae Asset
Hi, Michael, Kevin, and Vivien. Thanks for taking my question. So could you please comment on your web game and the social game? Thank you.
Vivien Wang
[Foreign Language – Chinese]
Michael Chi
[Foreign Language – Chinese]
Vivien Wang
We think MMORPG market will still definitely grow, but at the same time we also think that web game and social networking game are taking off in China. Actually two years ago we were already involved in a web game development area, back then we acquired majority stake in Ye Net, a web game company. Recently we are seeing more and more meaningful contributions coming from the web game and the social networking game sector, that’s why we are enhancing our involvement into these areas. We have several teams – internal teams that are working on social networking game and web game.
At this point, we believe that with the strong R&D capability, also with a lot of the MMORPG experience we can definitely better enhance the web game, the social networking game experience to gamers which is a competitive advantage to us among a lot of peers in the web game and social networking areas. Actually we’ve already seeing a pretty nice performance from some of our social networking games in the overseas market, which also attract a lot of the co-operator from the domestic markets. With our strong R&D capability, we do believe that we can – we have a competitive advantage in this area as well. Thanks.
Vincent Sun – Mirae Asset
Thank you. I’ve got a follow-up question on the web games, do you have any games in your pipeline to launch, say next year? Thank you.
Vivien Wang
Yes we do. In our earning call, we do mention that we have a more than a dozen of games that include MMO and web game and social game. But for intense competitive reason we prefer not to disclose too much details at this point.
Vincent Sun – Mirae Asset
Thank you. That’s very helpful.
Operator
Thank you. (Operator Instructions). And your next question comes from the line of Wallace Cheung from Credit Suisse. Please ask the question.
Wallace Cheung – Credit Suisse
Hi Michael, Kelvin, and Vivien. Congratulations on a very good quarter. Very simple questions. As we are seeing the ACU numbers has been keeping quite stable in the last couple of quarters, but the rational [ph] is keep going up. I mean, for sure, we know you’ve got a lot of game portfolios and – but can we just get into a little more details how – what exactly are type of new features, activities that you have particularly implemented in the games? And are we going to see the same situation keep flapping the ACU but rather than keep growing in the next couple of quarter’s time and just simply focus on the domestic basis only?
Vivien Wang
[Foreign Language – Chinese]
Kelvin Lau
Wallace, thanks for your question. Yes, in the past few quarters our ACU number we’ve been quite stable, but our revenue growth, I think the main reason is our ARPU growth for these games. I think, as well we mentioned a lot of times in the earnings call, we did quite a lot of monetization for our gaming Perfect World II and Zhu Xian, so we push up the revenue. Then monetize these two games is already adding four to five PSOs, so the gamers are very sticky and also they are the old gamers in the games. So it’s much easier – I think for these old games it is much easier for us to do monetization. This is what -- we certainly what we have to – well we have already have seen in these two games.
Even though we do more monetization activities in these two games, in these two quarters, I think the good news is that their ACU number is very stable, that means that gamers are very, very sticky on this game. So in terms of features, I think we did have very special new features in introducing them into the game. Only these we introduced new expansion pack for these in the games. So I think ARPU growth is one of the key reasons for the revenues to go up.
Vivien Wang
And in the industry it’s a rule of thumb that the longer you offer the game, the higher the ARPU you can get, especially from older existing games it’s a natural trend for older games to grow ARPU over time gradually. Thanks.
Wallace Cheung – Credit Suisse
Well, thank you. Just one quick follow-up as we’ve seen the third quarter as you may review for the marketing and sales to some of the old games that are we going to expect days sort of a roughing the [inaudible] of the existing games [inaudible] to slowdown most significantly in 2012. Thank you.
Vivien Wang
[Foreign Language – Chinese]
Kelvin Lau
Yes, I think, Wallace, yes, as I mentioned in the remark, yes, we are planning to decelerate the monetization activities for existing, because in the past two quarters, Perfect World II and Zhu Xian. Especially Perfect World II we are going to slowdown the monetization. But Zhu Xian, we still have a chance, because Zhu Xian, we didn’t do so many monetizing in Q2. But we did quite a lot in Q1. So, yes, that’s the key reason why we expected the revenue growth, it will be similar to that in Q1. I think in terms of revenue among the total amount should be similar to Q2. There is no similar growth in Q3.
Vivien Wang
And also as our normal operating technique, we are repeating the cycle of enhancing content and monetization. So content and monetization we constantly do thus to enhance our user experience and we ensure us a [inaudible] growth of our company in games in the long run. So Q3 is a normal and natural cycle for us. We need to decelerate monetization a little bit before we can reaccelerate again.
Wallace Cheung – Credit Suisse
Thank you.
Operator
Thank you. Your next question comes from Nan Lee, SIG. Please ask the question.
Nan Lee – SIG
Thank you for taking my question. Good morning, everyone. I just have a quick follow-up question on the acquisition of Cryptic Studios. You mentioned about the impact on the top-line, could you also comment on the impact on the OpEx in the third quarter and also the future quarter? Well, can you please also comment the potential margin impact? Thank you.
Vivien Wang
[Foreign Language – Chinese]
Kelvin Lau
As I mentioned, I think Cryptic, we’re going to consolidate the Cryptic’s financial statements starting from mid August. So clearly when that was compared with the whole group, it is still small and insignificant. So I do expect the revenue contribution from Cryptic will be not be so significant in Q3, especially only one-and-a-half months of consolidation.
Cryptic, the situation right now there, they have almost turnaround very recently, so the impact on the bottom line is also very minimal to the whole group. So as mentioned, we are expecting the big titles we recognized which is going to be launched in the coming year. So – and then we will keep on adding for acquiring Cryptic is previously Cryptic is very keen on looking on all those substitution based model game.
So when Perfect World acquired Cryptic, one of the contribution from Perfect World to Cryptic is we can share our free-to-play experience with Cryptic. So I want to emphasize is that never we’ve done a free-to-play model game, so we’re going to launch this game in US and also in China, so we expect to run these type if free-to-play model game. We have a bigger potential in US and also in China. And also Star Trek Online, after the acquisition, in fact Cryptic is working on the free-to-play model for Star Trek Online. This is going to be launched by the end of this year as well. So I think free-to-play model we have a bigger potential in US market and also in China market. Thank you.
Operator
Thank you. And your next question comes from Atul Bagga from ThinkEquity. Please ask the question.
Atul Bagga – ThinkEquity
Hi guys, thanks for taking my question, and congrats on the great quarter. Kelvin, I have a couple of questions. First question is on monetization. Can you talk about where the growth in monetization is coming from? Is it from increasing the conversation rate of free-to-playing user or is it just growing RPPU? You talked about, in third quarter, you want to reduce that to – for the longevity of the game, can you talk about where is that balance? I mean we have seen Q1, your ARPU went up significantly from last year and Q2 again seems like ARPU was high. Where is that line where you think that that’s going to affect the longevity and below that line it’s not going to affect the longevity? And then I have the second question about your M&A strategy.
Vivien Wang
[Foreign Language – Chinese]
Kelvin Lau
Atul, thanks for your question. I think in the past two quarters, the revenue growth has mainly come from the increase in ARPU, yes. So that’s what we mentioned in this conference call are being for fruition [ph] this to mature game. The longer the ARPU is operating the game, [inaudible] ARPU is normal. So we are still confident that the ARPU level for these two games. This can be factored from the ACU number is very stable for these two games, so that means the gamers are too sticky. We also – okay we have the same concern as well. So that’s why in Q3 we are present to decelerate or slowdown the development decision for these two games, so as trying to lengthen the lifecycle for these two games. So yes.
Vivien Wang
Again, we are doing a repeated cycle of enhanced user experience throughput on new expansion pipes and new content and to monetization so as to not to hurt the lifecycle of our gains.
Atul Bagga – ThinkEquity
Fair enough. My second question is about your M&A strategy. Should we continue to expect more M&A from Perfect World? And if so where – we heard today that you talked about web game, SNS game in China and you talked about overseas growth. Can you talk about your M&A strategy where you’re going to be more focused, is it going to be more China focused, overseas or is it going to be both?
Kelvin Lau
Yes. I think, Atul, we are opened to all those – all the opportunities which can help Perfect World grow further to grow further in the gaming market and also in other some related areas, okay? So, in fact, we are looking at some web game, social game and also MMOPRG studios in US and also in China. I think we are looking for positives to help for our future growth, so we are open. And then in terms of M&A, I think as long as we have some target which is being ready to close to then we can keep the market informed.
Atul Bagga – ThinkEquity
Okay, good enough. Thank you, guys.
Kelvin Lau
Thank you.
Vivien Wang
Thanks.
Operator
Thank you. And your next question comes from Gregory Chow [ph] from Citigroup. Please ask the question.
Gregory Chow – Citigroup
Hello. Good morning, congratulations to the strong performance of the quarter. I have one question on behalf of Jenny Wu. And I want to know do you have provided the breakdown of the users and the sales for each major games as in your financial statement where it only provides ACU of the total games?
Vivien Wang
Sorry, Greg, as a policy we don’t provide breakdown by games for ACU numbers for competitive reasons.
Gregory Chow – Citigroup
So then the average user numbers it’s also okay.
Vivien Wang
Sorry, we don’t provide breakdown for revenue either. But as you know, Zhu Xian and Perfect World II are two of our largest games that maintain very stable for us. We also have a couple of newly launched games that are performing very well. For example, Forsaken World and Enter of the Immortals.
Gregory Chow – Citigroup
Okay. Besides would you please provide some details about your game pipeline?
Kelvin Lau
In terms of pipeline we’ve mentioned couple of times this, we have several games in our pipeline. What we are worried is of course is Heaven Sword and Dragon Saber we are going to have our open beta official commercial launch in September. And then our big titles in that pipelines is [inaudible], Swordsman Online, [inaudible] which we are trying to launch in the first half of next year. And then we also announced that we have a big title, a game, a 3D game called Saint Seiya, which is going to be launched in the coming year as well. So some of the games are being for competitive reason we are preferring not to disclosing the name of the title at this moment. So when this goes through the closed beta testing or goes through the open beta we will announce the name of the game. But I can tell you in the coming year, more 3D games is coming up. All 3D games are coming out from Perfect World in the coming year.
Gregory Chow – Citigroup
Okay, thanks.
Operator
Thank you. (Operator Instructions).
Vivien Wang
Operator, are we seeing more questions?
Operator
Yes, ma’am. The next question comes from Wendy Huang from RBS. Please ask the question.
Wendy Huang – RBS
Thanks for taking my question again. Just wonder if you can give more color on the 3D game Forsaken World in the domestic market in Q2? Thank you.
Kelvin Lau
Forsaken World is very stable. As I mentioned, Forsaken World experience, [inaudible] ACU number in Q2 I think its net will decline after the peak for this type of 3D games. So we’re still happy with this type of level, ACU number for Forsaken World. In fact, Forsaken World represents I think contributing – I think in terms of revenue contributions number three in my game portfolio, so we’re happy for the Forsaken World so far.
Wendy Huang – RBS
So despite of the user decline, how is the revenue trend of this game in domestic market in Q2? And also has the ACU level being stabilizing in Q3 so far?
Kelvin Lau
Yes, in Q2, in the Q3, Forsaken World, the ACU number is still quite stable compared with Q2. And I also mentioned, one of the key reasons for my revenue growth in Q2 that grade is coming from one of the reason is Forsaken World. Forsaken World in terms – in fact revenue in Q2 compared with Q1 increased by a lot, because it’s at an initial state for all those new game launch we dare not to do so many monetization for Forsaken World in Q1. So in Q2, we did some monetization for Forsaken World. So Forsaken World revenue in Q2 went up high a lot.
Wendy Huang – RBS
Then should we expect this game’s domestic revenue to stay at high level in Q3, or should we expect it to continue to grow in revenue level, despite of the stable user level?
Kelvin Lau
I think Q3 we just expect I think Forsaken World just [inaudible] in Q2 then we’ll be fine.
Wendy Huang – RBS
Okay. And lastly, can you elaborate a little bit on the first person shooting game that you mentioned in your prepared remark? Thank you.
Kelvin Lau
The Blacklight Retribution is [inaudible] operated by our subsidiary, Perfect World Entertainment in US. So this is the first first person shooting games we are going to operate in US, so let’s see the result of this game in US first.
Wendy Huang – RBS
Okay. And also you mentioned that you repurchased 2.3 million shares as of August, will that affect the share counts in Q3 in terms of the EPS recapitulation as well? Thank you.
Kelvin Lau
Yes, yes. All those shares that we repurchased from the all those market will be cancelled, will be cancelled. So the total number of ADS will be going down in Q3.
Wendy Huang – RBS
Okay. That’s great, thanks Kelvin.
Operator
Thank you. There are no further questions at this time. Please continue Ms. Wang.
Vivien Wang
Thank you. This is the end of the conference call. The webcast replay will be available at Perfect World’s official website www.pwrd.com under IR section. If you have any additional questions, please feel free to contact us. Thanks.
Kelvin Lau
Thank you.
Operator
Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You can now disconnect.
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