Nov 8, 2007
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Executives
Brandi Piacente - The Piacente Group Michael Tong - Co-Chief Operating Officer, Director Onward Choi - Acting Chief Financial Officer William Ding - Chief Executive Officer, Director
Analysts
Richard Ji - Morgan Stanley Wallace Cheung - Credit Suisse Analyst for Paul Keung – CIBC Dick Wei - JP Morgan Analyst for Ming Zhao - SIG Tony Gikas - Piper Jaffray Alicia Yapp - Citi Investment Research James Mitchell - Goldman Sachs Evan Wilson - Pacific Crest Tian Hou - C.E. Unterberg
Operator
Good evening, ladies and gentlemen. Thank you very much for standing by and welcome to the NetEase third quarter financial results conference call.
(Operator Instructions) At this time I would like to turn the conference over to Brandi Piacente, Investor Relations for NetEase. Please go ahead ma’am.
Brandi Piacente
Thank you, operator. Please note that the discussions today will contain forward-looking statements relating to future performance of the company that we are intending to qualify under the Safe Harbor from liability as established by the US Private Securities Litigation Reform Act.
Such statements are not guarantees of future performance and are subject to certain risks, uncertainties, assumptions and other factors. Some of these risks are beyond the company’s control and could cause actual results to differ materially from those mentioned in today’s press release and this discussion.
A general discussion of the risk factors that could affect NetEase’s business and financial results is included in the certain filings of the company with the Securities and Exchange Commission, including its annual report on Form 20-F. The company does not undertake any obligation to update this forward-looking information, except as required by law.
As a reminder this conference is being recorded. In addition, a webcast replay of this conference call will be available on the NetEase corporate website at corp.NetEase.com.
I will now turn the conference over to Michael Tong, co- Chief Operating Officer, who will read prepared remarks on behalf of Mr. William Ding, Chief Executive Officer of NetEase.
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Michael Tong
Thank you, Brandi. Thanks everyone for joining us.
Total revenues for the third quarter were $76.2 million compared to $74.5 million for the second quarter of 2007 and $76.3 million for the third quarter of 2006. Online game revenues were $62.5 million for the third quarter compared to $63.4 million for the second quarter of 2007 and $62.4 million for the third quarter of 2006.
During the third quarter, we continued to expand our research and development for new games, including fee-based and item-based games. Westward Journey Online III, the upgraded version of Westward Journey Online II, was commercialized on September 12th.
Based on the results of a market survey we conducted with gamers during the third quarter, we decided Westward Journey Online II would continue to operate along with Westward Journey Online III. We also plan to launch one and two expansion packs for both games respectively on an annual basis.
This will enable the company to develop a new game market that will appeal to those players who prefer Westward Journey Online III. In addition, this will enable us to retain players of Westward Journey Online II, who have expressed their continuous support and preference on this game.
For the third quarter, PCUs (peak concurrent users) and ACUs (average concurrent users) for Westward Journey Online II were 305,000 and 124,000 respectively, compared with 505,000 and 162,000 respectively for the second quarter. Our newest expansion pack for Fantasy Westward Journey was launched on September 25th and we will continue to issue expansion packs and patches on a regular basis to support and expand the product life cycle of this game.
For the third quarter, PCUs and ACUs for Fantasy Westward Journey were 1.44 million and 517,000 respectively, compared with 1.47 million and 491,000 respectively for the second quarter. In other games, we are on track for our upcoming closed beta testing for Tianxia II and we are continuing our developments on free to play item-based games including Tianxia II and Fly for Fun.
Turning to our portal business, increased traffic from portal, email, and blogs have provided an additional platform for generating advertising revenues. Our enhanced blog services included the consolidation of similar blog content as well as better quality and quantity of graphics.
We are also pleased with our progress in creating and commercializing new services through our free email services, which continues to lead the Chinese e-mail markets. Overall we achieved solid growth in our advertising services during the third quarter, which brought in a total revenue of $11.4 million for the third quarter of 2007, compared to $8.7 million for the second quarter of 2007, and $11.1 million for the third quarter of 2006.
We are committed to building our capacity and market share in the high growth domestic markets, with improved content and integrating with our different products as the Beijing 2008 Olympic Games draw closer. Finally, since our last quarter conference call, we have added significant enhancements to our search engine.
This includes more highly competitive features, such as tool bars, desktop pictionary, audio dictionary and enhanced intelligence in returning search results based on diverse user search criteria. With that, I would like to turn the call over to Onward Choi for his review of our third quarter financial results.
Onward Choi
Thank you, Michael. I will now provide an overview of our financial highlights using numbers and percentages based on US dollars.
In order not to repeat what has just been explained by Michael on the revenue side, I will focus on explaining margins and expense fluctuations along with net profits. Third quarter gross profit was $59 million, compared to $58.4 million in the preceding quarter, and $59.8 million for the same period in 2006.
The quarter-over-quarter increase in gross profit was primarily due to high advertising services revenue in the third quarter of 2007. The year-over-year decrease was mainly due to the decrease in wireless value-added services revenue.
Gross margin for the online game business for the third quarter of 2007 was 89.4%, compared to 90.2% and 89.4% for the preceding quarter and the third quarter of 2006, respectively. The quarter-over-quarter decrease was primarily due to lower game revenues resulting from increased competition coupled with high cost of revenues.
High cost of revenues was mainly the result of increased headcount and high operational costs incurred during the third quarter of 2007. The year-over-year gross margin remained relatively stable.
Gross margin for the advertising business for the third quarter of 2007 was 54% compared to 47.2% and 36.1% for the preceding quarter and the third quarter of 2006 respectively. The quarter-over-quarter increase in gross margin was primarily driven by the increase in advertising services revenue coupled with a lesser extent of increase in content costs in the third quarter of 2007.
The year-over-year decline in gross margin was primarily driven by increased content costs incurred during the third quarter of 2007. Gross loss margin for the wireless value-added services and others business for the third quarter of 2007 was 33.3%, compared to gross loss margin of 28.1% and gross profit margin of 3.4% for the preceding quarter and the third quarter of 2006, respectively.
Both the quarter-over-quarter and year-over-year deepening in gross loss margin was primarily due to decreased revenue from wireless value-added services while operating expenses remained relatively fixed. Total operating expenses for the third quarter of 2007 were $23.9 million, compared to $19.1 million and $17.5 million for the preceding quarter and the third quarter of 2006, respectively.
Both the quarter-over-quarter and year-over-year increase was primarily driven by increased spending on the advertising and marketing promotion of Westward Journey Online III and Fantasy Westward Journey, and higher staff-related cost as a result of an increase in research and development headcount. Net profit for the third quarter of 2007 totaled $34.7 million, compared to $41.7 million $42.0 million for the preceding quarter and the third quarter of 2006, respectively.
In June 2007, we received a reinvestment incentive tax refund of $3.2 million, which significantly reduced the company's income tax expense for the second quarter of 2007. We reported basic and diluted earnings per ADS of $0.28 and $0.27 for the third quarter of 2007, respectively.
This compares to basic and diluted earnings per ADS of $0.34 and $0.31 for the preceding quarter and $0.33 and $0.30 for the third quarter of 2006, respectively. As of September 30, 2007, our total cash and time deposit balance was $410.9 million, compared to $525.6 million and $505.0 million as of December 31, 2006 and September 30, 2006, respectively.
In addition, there was a restricted cash balance of $100.1 million as of September 30, 2007 primarily related to the our committed revolving loan facility, which is effective for a period from May 17, 2007 to July 31, 2008. The loan facility can be used at our discretion to fund any redemption requests made by the holders of its zero coupon convertible subordinated notes in accordance with the terms of those notes.
As of September 30, 2007, we reclassified the callable obligations of the convertible notes as short-term payable in accordance with the terms of issue. Cash flow generated from operating activities was approximately $45.3 million for the third quarter of 2007, compared to $44.2 million and $46.0 million for the preceding quarter and the third quarter of 2006, respectively.
On July 2, 2007, the board authorized a share repurchase program of up to $120 million of the NetEase’s outstanding ADS. As of September 30, 2007 we had spent in aggregate a total purchase consideration of approximately $30.8 million including transaction costs.
The share repurchase program will end on July 1, 2008. Thank you for your attention.
We would now be happy to take your questions. Operator, please go ahead.
Operator
(Operator Instructions) Our first question comes from Richard Ji - Morgan Stanley.
Richard Ji - Morgan Stanley
I have two questions. Starting with your Westward Journey II migration, at the end of last quarter you guided us that you planned to migrate Westward Journey II to Westward Journey III.
I just want to clarify that the migration will no longer happen and your latest status. Also relating to the question is that during the quarter have you seen Westward Journey II user volume stabilize or recover after you stopped the migration process?
Michael Tong
What happened is when we launched Westward Journey III we believed that with the new features and the new graphics and engines that we would be able to draw a lot of the uses from Westward Journey II and migrate all of them to Westward Journey III. But it happens that Westward Journey II players are so loyal to the game that even with the new features and all these new graphics that the Westward Journey II players continue to like to stay in Westward Journey II and the majority of those gamers stay in Westward Journey II.
Effectively, what happened is we actually draw a lot of new users into Westward Journey III rather than from migrating from Westward Journey II. As we said in the script that we have done a lot of surveys to see what happens, how the players think about the games and most of the Westward Journey II players, even with the new engine and the new features they still decided to stay on the Westward Journey II.
There is a slight drop with the Westward Journey II players when Westward Journey III was in open beta that drop has been stabilized right now and within the Westward Journey III players we have found that majority, over 50% of the accounts are newly opened accounts, rather than Westward Journey II players.
Richard Ji - Morgan Stanley
Regarding advertising revenue, indeed it climbed nicely quarter over quarter and I just want to find out, what is the price increase that happened during the quarter? Going forward, do you see further price increase in anticipation of the Olympics?
Onward Choi
Well of course our price increase is effective on the first of July basically the beginning of this quarter. The price increase is very complicated.
On an overall basis, I would say the price increase is around 10% compared to before. But that is not really the main reason for the increase in advertising business.
It really is the increase of our traffic, especially on the content channels and our other products including the email and the blogs. Most of that we are able to commercialize the email better than before.
I would say these are really the reasons for the increase rather than purely for the price increase. Our policy has always been that we increase our price during the middle of the year and the beginning of the year.
So the next price increase is going to be in January of 2008, and of course most likely during the Olympic time then there will be another price increase which happens to be just the right time where we usually do it with our policy, that happens on first of July. That’s the plan, but the price in the market is also swinging up because of the Olympics.
We might actually change the policy next year and see what happens in the market.
Operator
Your next question comes from Wallace Cheung - Credit Suisse.
Wallace Cheung - Credit Suisse
A question on the Westward Journey III. I think we found that in September before the commercial launch, I think that whole user base is pretty high and then after commercial launch the PCU, it actually was down quite a bit.
Can you talk a bit more about this, the situation after the commercial launch? Any plans to drive the user levels up again?
My second question will be related to the advertising. Can you talk a little bit more also about 2008 Olympics?
I think recently William had talked about strategies and what the expectation on the advertising growth on any kind of new content strategies going forward? Thank you.
Michael Tong
For Westward Journey III, during the open beta of Westward Journey III I think we saw the PCU of a bit over 210,000 during the open beta and after the commercialization of it the PCU of the game reached about 150,000 and that actually happens around the national holiday, but I can only give you the PCU numbers, and I wasn’t able to give you the ACU numbers because the game only has been commercialized for 18 days during the past quarter. I’m not able to give you 18-day numbers for a non-reported financial period.
That’s the flavor for the Westward Journey III, anyway. The second question, is on the Olympics.
The main point for the Olympic is that for the content strategy we have been working with different business partners including the likes of Reuters and so on. Also we are consolidating our different products including the email, blogs, and different content channels to really have an integrated and consolidated products where we can allow our users to be involved in the Olympics on all of our products, so that they can experience our products, all of them, through the Olympics.
I think it’s a very great opportunity for us to promote NetEase as a portal with a good breadth of all the products where the users can experience it in one single portal. I think on the advertising side, of course during the Olympics a lot of the advertisers will be very interested to ride on this opportunity.
We have just had a press release to explain our strategy for the portal during the Olympic time and a lot of the media has covered that, and a lot of them are very excited about it and so are we.
Wallace Cheung - Credit Suisse
How is the percentage of revenue, online game revenue, coming from Westward Journey III in the third quarter?
Onward Choi
I will take these questions, Wallace. We’ve gone through the distribution of the revenue from the game side.
Basically the Fantasy Westward Journey contributed about [78]% of the total revenues arising from the online games, whereas about [90]% being contributed from the Westward Journey II and the rest for the Westward Journey III.
Wallace Cheung - Credit Suisse
Oh, the rest is Westward Journey III?
Onward Choi
Yes. It’s actually contributed to about 1.5% on the overall games revenue for the third quarter.
Wallace Cheung - Credit Suisse
Can you comment on Datang as well?
Onward Choi
For Datang, the percentage contribution is more or less the same as Westward III. It is about 1.3%.
Operator
Thank you for you question, sir. Your next question comes from Dick Wei with JP Morgan.
Please go ahead with your question sir. Mr.
Dick Wei, please go ahead with your question. He must have stepped out.
Our next question come from the line of Paul Keung with CIBC. Please go ahead with your question.
Brandi Piacente
Operator, it seems that we are having some audio issues, it doesn’t sound like it’s on our end. So maybe if you can check?
Operator
I’m sorry. Please go ahead.
Analyst for Paul Keung – CIBC
I just have a question on your general strategy. Except Datang and Tianxia II do you have any new game development plan either from M&A licensing or from your in-house development?
Michael Tong
On the licensing we have been talking to a lot of different potential partners, but again right now we don’t have anything that we are able to disclose. All I can say is that we have been working very hard to find business partners for the possibility of licensing games and so on.
Analyst for Paul Keung – CIBC
If any plan is on the way, would it be on ’08 so we can know better? What’s the timeframe of you will have a plan you can announce?
Michael Tong
We don’t know. It’s only when we can announce then we will announce, then we will tell you, but when we cannot announce...
Analyst for Paul Keung – CIBC
I understand, I just want to ask from more of a growth strategy... Also wireless value-added service, seeing as it is not profitable, are you going or get rid of it in the future?
Michael Tong
I think with regard to our segments of the business, I think we currently have no plan of closing this segment and we are still keeping expertise and this is what we can update you for the time being.
Onward Choi
The business itself is profitable. When you see the gross loss margin in that particular business line of revenue and business, it is actually wireless and other.
That other actually includes a lot of depreciation costs of the email services that we provide as a free business so that is in the other. Independently, the wireless business itself is actually profitable.
Analyst for Paul Keung – CIBC
That’s great. Also, what’s the process right now on the CFO search in process?
Michael Tong
Onward is our Acting CFO right now, and I think it’s up to the board to decide, is it Onward to continue to be the Acting CFO or become the CFO?
Analyst for Paul Keung – CIBC
In the future in all those expenses as a percentage of revenue, would you expect if there’s no new games added, just like the current status, would you expect them to be stable? Including margins.
Michael Tong
All I can say is I will give you a very simple analysis on this, is that Fantasy Westward Journey III actually increased it’s revenue by 4.3% on a quarter-to-quarter basis. So on an overall basis, I would say that this game itself is still on an increasing trend.
Of course, given that we have done a very successful summer promotion during the third quarter and that is also part of the increase and also seasonally is part of the increase, but overall, the game increased by 4.3% from Q3 over Q2. When we look at Westward Journey II or Westward Journey III altogether, given that Westward Journey III only upgraded for 18 days during the third quarter and if I use the word “quarterize” that revenue contributed during the third quarter, then I would say then at least Westward Journey III and II added together is very stabilized compared to the total revenue of Westward Journey II in Q2.
Also we have, of course, Datang and some other popogames and so on. So I think I would say that the game business is stabilized and there is a bit of good and bad.
The good is since we have decided that we separate Westward Journey II and Westward Journey III into two games we are looking forward to be able to attract more new users for Westward Journey III and the game design will go on to try to attract new users. Whereas for Westward Journey II, we will try to design the games satisfy all the current users of Westward Journey II.
It is a very clear strategy going forward. In this way, I think Westward Journey III will be a game that we are trying to grow further rather than maybe some of the investors and analysts may understand before that Westward Journey III is only a replacement of Westward Journey II; but it is not, because now we have decided that Westward Journey III is trying to grow and trying to attract new users.
So that’s the game business, and obviously we are also looking at the possibility of licensing new games and we are also developing other new games as well. So that’s how I would describe our games business going forward.
Operator
Your next question comes from Dick Wei - JP Morgan.
Dick Wei - JP Morgan
Can you characterize what happened in the third quarter for Westward Journey II? It looks like the ACU was down 20% plus quarter over quarter and I don’t know if it is due to some users trying out Westward Journey III.
But some comments that you have is that the users are not really overlapping. Can you describe that?
Michael Tong
I think on explaining the drop in Westward Journey II is that during the open beta of Westward Journey III a lot of the Westward Journey II players decided to trial Westward Journey III during this one-month period of time, and that’s why there is a decrease of ACUs in Westward Journey II. I would say that since we have now decided and announced to all the players that the two games will be totally separate and there will continue to be expansion packs and further development for Westward Journey II that we are seeing that the decrease has been stabilized for Westward Journey II.
That’s how we feel about it right now.
Dick Wei - JP Morgan
So going forward, would you feel that Westward Journey II plus Westward Journey III together will see revenue growth for the next couple of quarters?
Michael Tong
That’s our target.
Dick Wei - JP Morgan
I don’t know if someone asked about sales and marketing expenses, but fundamentally is there any change in philosophy in terms of NTES’ marketing spending? I think historically the company has been quite conservative in spending against some other games companies out there now.
Maybe you are spending 12% or 20% of the top line in sales and marketing, I don’t know. Any fundamental change in your view in that respect?
Michael Tong
I would say there is no change in the philosophy. I would say yes, during the third quarter that we see an increase in the marketing expense.
That is purely because for one that we have launched on the Westward Journey III, and at the same time we also have done some summer promotions for the Fantasy Westward Journey, so there is a hike in the marketing expense. But our general philosophy has never changed, and we’ll continue to as you mentioned, we are more conservative in marketing expense, and we will continue to be very conservative.
I think that this hike is partly an exceptional expense. That is purely because of the launch of the Westward Journey III, and so that’s the reason why.
Dick Wei - JP Morgan
You mentioned you see more monetization from your email service. Could you further describe that, please?
Michael Tong
Sure. On the e-mail service, I think one of the hardest things is email in the media has been very difficult for the advertisers to understand before.
We have been doing a lot of education to our agencies and to the advertisers, and this seems to bear some fruits right now. Secondly, we have also developed more spaces and in the email services.
Innovative services where we for example, that we put customized stock lists right beside the email landing page where the users can choose the stocks that they monitor or they purchase and provide financial information, which is obviously very hot in China right now. So that becomes some spaces where we are able to provide to the users and which the users are satisfied and happy with, but at the same time we are able to generate more advertising revenue.
So the strategy really is not just to pick a space within the email page, but rather to provide more services and content to the email users and at the same time increase our advertising space for that.
Operator
Your next question comes from Ming Zhao - SIG.
Analyst for Ming Zhao - SIG
As you mentioned, you launched new advertisements to place inventory in your free email services, so in your third quarter advertising revenue, how much was contributed by this new inventory?
Michael Tong
I don’t have the particular statistics on that, especially because it is hard to calculate this way because you know a lot advertisements are placed as a package and because of this inventory we are able to draw some new advertisers, especially including those financial institutions and fund companies. We are able to use that particular inventory to draw a lot of new advertisers from that financial industry and the particular place that they put the advertising includes that inventory, but also includes some other inventory as well.
It would be not fair to just say how much that we generated from that one space, but rather how this one space will be able attract new advertisers, especially from the financial industry and so that’s how I’ll answer it.
Analyst for Ming Zhao - Susquehanna
After you postponed the conversion between Westward Journey II and III we saw both games resume growth. So will you operate them as two separate games going forward?
Or you will convert these two games and if so, when?
Michael Tong
We will operate the two games separately. This is what the users want and like.
Analyst for Ming Zhao - Susquehanna
When do you plan to launch closed beta testing and open beta testing for Tianxia R and Datang?
William Ding
We have plans to launch our closed beta testing of Tianxia R in the first quarter of 2008. This is our plan.
Analyst for Ming Zhao - Susquehanna
I’m asking for Datang. How about Datang?
Michael Tong
For Datang it’s before the end of the second quarter of next year.
Operator
Your next question comes from Tony Gikas - Piper Jaffray.
Tony Gikas - Piper Jaffray
I just want to go back to the sales and marketing costs. So you ran some promotions during the quarter.
Is that going to continue into the December quarter at all, or will the sales and marketing expense go back to a normalized level? Can you tell us the percentage of users that migrated from Westward Journey II over to Westward Journey III?
With the Olympics coming next year do you expect user trends on the gaming side of the business to change? Do you expect any slow down or interruptions in that business?
Michael Tong
On the first question, is again, the marketing expense is purely on the launch of Westward Journey III. So I would expect going forward it the overall marketing expense should be lower than the third quarter and it would go to normalized, more or less like before.
So that’s the expectation. For the second question for the Westward Journey III players -- actually I explained this before -- that we see around 60% of them are new users.
Of course 40%, is from users that migrated from Westward Journey II. So that’s the percentage out of Westward Journey IIII players.
I hope that answers your question. The next question is on the Olympics.
I don’t know how to estimate that but I think the best thing that we are thinking about and what we are doing on that is that obviously we will have Olympic-related game play or design within our games so that our gamers will continue to play in our games and be able to also enjoy the Olympics and also be able to ride on this Olympics and to have games just like Olympic games that we have those kind of personality and play features within our games so that they can enjoy both at the same time, within our games. So that’s the simplest strategy to do it.
Operator
Your next question comes from Alicia Yapp - Citi Investment Research.
Alicia Yapp - Citi Investment Research
I have a couple questions. First of all on the sales and marketing costs, do you plan to also boost up your marketing cost when you launch your Tianxia II and Datang II later or any other expansion pack on Westward Journey III and Fantasy Westward Journey as well?
Michael Tong
I think that the marketing costs going forward for the launch of the expansion pack and other new games would be basically compared to the previous way of how we do it, and so that I won’t say there will be any kind of specific boost; it would be the normal way of doing our marketing.
Alicia Yapp - Citi Investment Research
So you plan to launch Tianxia II closed beta in the first quarter ‘08. What is the plan for the commercial launch and do you have any plans to convert Tianxia to actually a free-to-play model?
Michael Tong
The current plan for Tianxia II continues to be a time-based game and then again in general we are able to commercialize a game after around two months after the open beta launch.
Alicia Yapp - Citi Investment Research
Can you comment in general on the China online games industries? Have you seen any change in the competitive landscape, or do you expect to see a major shift of competitive forces in light of the recent online games IPO?
Thank you.
Michael Tong
Well in commenting on the Chinese game industry is that while we continue to see the overall growth of the industry being very healthy, we see a lot of new users coming into the industry. We see broadband penetration continuing to increase and overall Internet penetration continuing to increase.
Obviously there has been a lot more competition in the game industry, and we see new companies being IPO’d during the past quarter. We saw at least three during the past half year.
Obviously that’s continuing a trend of more and more item-based games rather than pay-to-play games, and that’s why we also have item-based games coming out from ourselves, the like of Fly for Fun and the like of Datang. Of course, for NetEase we continue to be very strong in terms of the research and development and we have a very good team and a very huge team in developing different projects to compete in this market.
Operator
Your next question comes from James Mitchell - Goldman Sachs.
James Mitchell - Goldman Sachs
Well thank you for taking my questions, which are kind of housekeeping questions. First, if I look at the user numbers you disclosed for Fantasy Westward Journey and Westward Journey II, it seems to be up around 2% quarter on quarter, whereas the game revenue is down around 1% quarter on quarter.
Is there anything underlying that in terms of distribution discounts or is just a rounding error? Secondly, if I look at the game gross margins ticking down quarter on quarter, is that principally because you have released a new game or going forward if you have similar revenue from basically three large games rather than from two large games, would that automatically be a slightly lower gross margin activity publishing three games with the same revenue than two games with similar revenue?
Thank you.
Onward Choi
For the first question I think there has not been much change in our discount policy for the sales of the point cards. The decrease in revenues for the games business as compared in terms of the percent change, I can say that the main difference from the recognition of these expired points contributes to the decrease.
As for the second question about the gross margins, I think the slight drop in the gross margin as compared with the last quarter’s was mainly because we have increased more of our headcount to strengthen our teams to run the business, and this accounts for the reason for the decrease in the gross margins.
James Mitchell - Goldman Sachs
So in the second quarter you have a slightly higher of proportion of revenue from expired points and in the third quarter you had a slightly lower proportion of that?
Michael Tong
Yes.
Operator
Your next question comes from Evan Wilson - Pacific Crest.
Evan Wilson - Pacific Crest
Could you help us quantify the extra costs that you expect to incur by being forced to operate both Westward Journey II and Online Journey III? Specifically, do you get any synergies between the games with respect to marketing support, infrastructure costs, etcetera?
The second question would be on Fantasy Westward Journey, since you decided to release Westward Journey III as an item-based game, clearly you think that for some games an item-based sales model is the right strategy. Could you talk to us about what would need to change or what your perspective is of the potential of Fantasy Westward Journey being item-based sometime in the future?
Thanks.
Michael Tong
You actually have a very good question. When we decided to have the two games totally separate and operated separately, we also have thought about the question of dividing the teams into two and luckily we have a very good pool of good programmers and designers.
So basically we are able to promote a senior programmer to head the game going forward for Westward Journey II, and then the original chief designer for the whole project becomes the Westward Journey III. They continue to work on the Westward Journey III.
So that’s basically what we did. Of course, we continue to have a pool of good resources.
So I think on the programming side and on the graphics side, it’s easier for us to allocate. It’s really the design team that we really have thought about and believe that we will still be able to solve this problem, which is a very big operational problem.
On the second point is that we don’t have any plan to make Fantasy Westward Journey to become an item-based game, so simply that.
Evan Wilson - Pacific Crest
Just a follow-up on the first response. Is there any way that you could give us a percentage, some type of percentage quantification on the costs associated with operating the second game on top of your existing costs?
Or your previous costs for Westward Journey II?
Michael Tong
I’m sorry, I can’t. I can’t give you a percentage because we have our programmers, graphics designers and R&D team in one single pool so it would very hard to decide that, but that is really again, it’s not the problem.
The problem is really on the design team. Are we able to find the right design team to continue to operate the two games separately?
The answer is that we decided and we have fixed that and basically solved the problem.
Operator
Your next question comes from Tian Hou - C.E. Unterberg.
Tian Hou - C.E. Unterberg
I just wondered if you have any expansion pack release plans? Is it in Q4 or Q1?
I know you just released one for Fantasy Westward Journey, and how about for Westward Journey II and III?
Michael Tong
So for Fantasy Westward Journey there will not be any new expansion pack for Q1, because we have just released one in the end of September. So the next one should be around six months later, most likely to at the beginning of the second quarter.
William Ding
For Westward Journey II, I think that would be maybe one that we would plan in the second quarter of 2008.
Tian Hou - C.E. Unterberg
So how about Westward Journey III?
Michael Tong
That would most likely be in the same quarter as well, I think.
Tian Hou - C.E. Unterberg
I saw from your website you have some server changes like Westward Journey III server migration; and then also Fantasy Westward Journey you have some announcements that you may merge some servers. So, my question is really, how do many servers do you have for each of games right now?
Michael Tong
Sorry, I don’t have this particular number right now, and, can I give you it by email?
Tian Hou - C.E. Unterberg
Yes, no problem.
Operator
At this time, there are no further questions. Please go ahead with your concluding statements.
Brandi Piacente
Thank you once again for joining us today. Please feel free to contact us if you have further questions.
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