NetEase Inc (NTES) 2004 Q1 法說會逐字稿

Hello everyone and welcome to the NetEase 2004 First Quarter Conference Call. Today Mr. Michael Tong, Executive Director and Mr. Denny Lee, CFO will discuss the company's 2004 first quarter results. At the end of the call, Mr. Tong and Mr. Lee will be available to answer your questions.

Before we continue, please note, that the discussion today will contain forward-looking statements relating to future performance of the company, and they are intended to qualify for the Safe Harbor from liabilities established as the United States Private Securities Litigation Reform Act.

Such statements are not guarantees of future performance and are despite the company's best intentions, subject to certain risks, uncertainties, assumptions and other factors, some of which are beyond the company's control, and can cause the actual results to differ materially from those mentioned in today's press release and this discussion.

The company does not undertake any obligation to update the forward-looking information except as required by law.

As a reminder this conference is being recorded. In addition a Web cast of this conference call will be available on the NetEase corporate Web site at corp.netease.com.

I will now turn the conference over Mr. Michael Tong, Executive Director of NetEase. Please go ahead, sir.

Thank you, operator. Hello everyone and thank you for joining us. I am very pleased to be here today to review another strong quarter for NetEase.

But before I begin, I'd like to first express the company's best wishes to Ted Sun for a speedy recovery. With the support of the senior management team, Denny and I have assumed Ted's day-to-day responsibilities while he is away. We all look forward to his return. Now let me walk you though some of the highlights of the quarter.

Firstly, China's Internet and wireless market continues to remain a source of great opportunity for the company. The increasing Internet and mobile phone penetration rate in China continues to drive growth in demand for Internet and wireless products and services, such as online content, online community and products, massively multi-player online games, wireless value-added services, mobile Internet and Internet advertising.

Turning to our individual business segments.

Our growth this quarter was again mainly driven by our online games business. In particular the strong performance of our two self-developed titles. Our newest game, Fantasy Westward Journey, which open data launched in December 2003 and launched commercially in January 2004, was promptly embraced by Chinese gamists, as evidenced by its impressive results for the quarter, with peak concurrent users reaching 111,000 and average concurrent usage of 54,000 for the month of March 2004.

As expected, we have seen minimal cannibalization between the new game and Westward Journey Online Version II. With peak and concurrent users -- peak and average concurrent users numbers for Westward Journey Online Version II going to 253,000 and 135,000 respectively, for the month of March 2004.

The popularity of both self-developed games demonstrates NetEase success in developing and operating online games in China.

Our in-house development capabilities are real competitive advantage for the online games business, since they allow us to develop products that appeal to specific Chinese tastes and sensibilities. This, along with the support of the NetEase portal's large user base, is allowing the company to gain online game marketing share, we believe.

As for our online game pipeline, we plan to launch a new licensed game later this year and we continue to self-develop our 3D game for the release at the end of the year.

While our wireless value-added and other services revenues were affected this quarter by competitive marketplace in SMS services, we see potential opportunities to develop our business in higher-end wireless value-added services.

We will continue to develop wireless value-added services and products that will focus on areas with highest areas of entries and leverage the community and email strength of our Internet portal.

We continue to enjoy a strong response to our instant messaging services, Popo, which grew to 12 million registered accounts as of March 31, 2004. We see strong future market opportunities for this product and we are in the process of finalizing our pricing strategy with respect to its SMS services.

Our advertising services business performed well this quarter, despite the seasonal slowdown in Internet advertising. This success is largely due to our efforts to increase value to our current and future advertisers through, for example, the revamp of several areas of the portal, further investment in content development, and a series of marketing activities to reinforce NetEase's position as a leading Chinese portal.

We are optimistic about the growth prospects for the advertising business this year, as we work to take advantage of the strong demand, and for online promotional services in China. In particular, we expect to benefit from a number of events this year, such as the 2004 Olympics that are attracting a large interest in Internet advertising in China.

Going forward, we will continue to invest in strengthening the content of the NetEase portal, in order to attract new users and grow our advertising base. Now let me turn the call to Denny Lee, our CFO, who will review the numbers with you, in details.

Thank you, Michael. Let me start in by reviewing our income statement. Please note that all figures are in U.S. Dollars.

Total net revenue and net profits for the first quarter 2004 reached at record levels. Total net revenues increased at 15.5% quarter-over-quarter and 66.8% year-over-year to $22.6 million. Net profit of $12.6 million for the quarter, equivalent to 40 cents per basic ADS or 38 cents per diluted ADS, representing a 10.5% increase quarter-over-quarter, and a 50.8% increase year-over-year.

Revenue from our online games business showed strong growth during the quarter, increasing 41.4% quarter-over-quarter, to $12.1 million. The strong growth in this revenue segment was largely due to the popularity of our two self-developed online games Westward Journey Online Version II and Fantasy Westward Journey.

Revenues from wireless value-added and other services for the quarter decreased at 12.3% quarter-over-quarter to $6.8 million. The decrease is attributable to the increasing competition in the SMS service market.

Although revenues from 2.5G applications remain modest, growth in this area was better than expected.

Advertising revenues for the quarter increased at 13.9% quarter-over-quarter to $3.6 million. As Michael mentioned, we achieved a strong growth in this segment, even though the first quarter is traditionally a slow one for Internet advertising in China.

Gross profits for the quarter increased at 16.3% quarter-over-quarter and 72.5% year-over-year, to $19.1 million. Revenue growth also favorably impacted gross margins, which increased from 84.2% in the preceding quarter to 84.8% in the first quarter.

Total operating expenses for the quarter were $6.1 million, a 33.3% increase from the previous quarter and a 78.9% increase for the corresponding period a year ago. The increase was mainly driven by sales and marketing expenses, which were up this quarter to $2.6 million, due to increasing marketing, in connection with the launching of the company's new online game, Fantasy Westward Journey, and the revamping of the Web site homepage.

The company reported an operating profit of $13 million in the first quarter representing a 9.7% improvement over last quarter and a 69.6% improvement over the previous year's third quarter -- first quarter.

Moving to our balance sheet and cash flow statement. As of 31st of March 2004, the company's total net cash balance was $223 million with an operating cash flow of $17.6 million during the quarter.

Let me end by saying that we are pleased with the results of this past quarter. NetEase continues to benefit from a strong business model, based on diversified revenue stream, where we are able to expand revenue and growth margins. We will continue to invest in new people, products, services and to ensure we build on our past success, and continue to create value for our shareholders.

We are now happy to take any questions you may have. Operator?

Thank you. The Q&A session will begin (inaudible) electronically. [OPERATOR INSTRUCTIONS] And our first question comes from Safa Rashtchy with Piper Jaffray.

Good morning, Michael, Denny. Michael, it's good to hear from you and our best wishes for Ted to get well soon as well.

Could you talk a little bit about your wireless operations? Specifically what exactly within the competitive landscape caused the sequential decline in revenues? Are you seeing pricing pressure?

Or were there subscriber losses for product reasons? And also if you could just expand a little bit on the composition of what your wireless service is, in terms of the SMS versus 2.5G or other services and how you see that developing throughout the year. And I have a quick follow-up.

Hi, Safa, this is Denny. Let me answer your first question, the reason for the decrease in the wireless and other value-added services revenue. And then I will pass on to Michael to give more details on the composition of the current wireless value-added services revenue.

Actually in the past quarter, we are seeing increased competition in the wireless service segment, in particular on the SMS area. The decrease in revenue was actually in line with the decrease in the number of active unit users during the past quarter. On the other hand we experienced a slight increase in the ARPU, which means that we are losing those lower-end customers.

In particular, we are seeing the decrease in the revenue and also the decrease in the number of unit users, in the news and information downloading area. Because these categories of service are more commodity-like and then because of the increased competition, people can easily switch to the other SPs. And this type of revenue is not very sticky.

This is the main -- basically the main reason for the decrease in our wireless and other service revenue.

And let me pass over to Michael for the details on the composition of the SMS or wireless revenue.

Hi, Safa.

Hi, Michael.

Hi. On the composition of the wireless business, we are seeing a drop mainly in the news and information, and ring tone or locals type, of low-level products and services for the wireless business.

But on the other hand we are actually seeing a stable growth on the Web-based application related wireless services, and dating and community type of wireless services which are, what we think are, high-end applications for the wireless value-added services.

And we are also seeing growth, in terms of the MMS and WAP related 2.5G applications, for the value-added services. So again, we are looking at kind of, the transition in the business right now. And turning from the drop of, like the news and information and ring tone type of business, into more sophisticated products like, what I explained, like the Web-based applications, community dating and 2.5G applications for the wireless.

But obviously I have to explain that the transition is not very quick and that's why we are seeing an decrease in the revenue for this quarter.

So in the issues that you had in the past two quarters, namely, some accounting issues, in terms of getting the actual number of Web union subscribers from the mobile operators, as well as transitioning out of the subscribers who had come to you through Web union. Those were some of the reasons that wireless revenues were weaker in the past few quarters. Have those been completely gone and kind of, out of your system now?

I would say that the effect of these three reasons are basically all gone right now. Especially on the Web union, where we actually have stopped that arrangement about -- more than six months ago. So we don't see a lot of -- much of the effect, affecting our churn of the users.

OK, at the same time, when you stop using it, you started developing your local sales force. Can you give us an update on where you are in terms of deploying the sales force? And how many provinces you have covered and what is your goal by the end of the year?

We have now -- we have -- for this quarter, we have now over 15 provinces that we have covered and have connected independent -- directly with such provinces. And we continue to build our sales force and covering these provinces and we have people who work locally on those provinces.

OK. And one last question. I apologize for taking this, but it would help us understand the model. If you could talk about the games side a little bit. What level do you think Westward Fantasy can go?

Can it possibly exceed what you have had with Westward Journey, or are we talking about different types of games? And if you could give a little bit more detailed update on when you plan to launch the next game, and when do you plan to have the 3D game fully operational?

Sure. On Fantasy Westward Journey, as we have explained, we have achieved a very good results for the quarter. And we do expect this game to achieve something close to Westward Journey II by the end of this year.

So is that the peak of the Fantasy Westward Journey? We don't think so, as it is not our target. So we are looking at a much higher target. But -- for timing wise we think we could achieve the peak of Westward Journey II last year, for Fantasy Westward Journey to achieve that by end of this year. And we expect this peak to continue to grow over the 2005.

And for the pipeline, we are expecting to sign a -- to enter a contract with another game and to be licensed and to be launched by the end of this year. And for our own 3D game, which is self-developed, we are expecting to launch that game also, by the end of this year, or early next year.

So those will be both Q4 events, or Q1 '05?

That is most likely to be like the open data in Q4 and commercially launched in Q1 '05. For the 3D self-developing.

OK, I must say, one last question. I think you mentioned something about the increase in sales and marketing but I missed it. It was a pretty substantial increase compared to your spending pattern. Can you talk about why there was such a big increase in sales and marketing?

Safa, this is Denny. I think you mean the increase in SG&A expenses during the past quarter.

Correct.

Main is -- what mainly contributed by the increase in marketing expenses. Because as you know that in the last quarter we have two major events. The first event is the launching of the Fantasy Westward Journey, which is the game that we are now running, the second self-developed game, and that we actually have a quite a big marketing event for the launching.

And also the second major event that we had in the past quarter was the revamping of our front page. We actually have a series of marketing and promotion events. And that spend, as we said, is around $2.1 million in the last quarter. And this is the sole reason for the increase in the SG&A expenses.

And going forward, we are talking to -- not to reshape, but to control our marketing expenses, to the level of around 10-12% of the total net revenue of the company. And, yes.

All right. Thank you very much.

Thank you.

Thank you.

Our next question comes from Jay Chang with CSFB.

Hi Michael. Hi, Denny.

Hi, Jay.

And please send my regards to Ted. I wish him a speedy recovery.

On my gaming -- I guess, on my estimates, it looks like the net adds for average concurrent users for Westward Journey II actually slowed down quite a -- not significantly, but slightly. And obviously Fantasy probably had a significant amount of average concurrent users.

A, are -- I guess, could you give us a breakdown of how you see where those users are coming from? And kind of, discuss -- did you protect your market share? Are there geographic penetrations? And on top of the, for the, kind of, slowdown on Westward Journey II, do you think that's a level, Michael around, I think you primarily add around 17,000 average concurrent users for the quarter. Is that something you see going forward in Q2 or do you see that declining I guess from here on out?

So let me talk a bit more about the Westward Journey II first. Because last year for this quarter, is actually the SARS quarter. So it is very difficult to compare last year to this year on Westward Journey II.

But I would say that this quarter in anyway, is seasonally not a very good quarter, because it is not a summer quarter and it is not a national date quarter -- that has the national date and things like that. Or the Christmas holiday season.

So what happens is that we feel that there is a, kind of, a slow in growth of the Westward Journey II as you have mentioned, which is very correct. But we're expecting that because the coming of the national day -- I mean the Labor Day for the May first in the second quarter, and also the coming of the summer months in the third quarter. We are expecting a better growth for Westward Journey in the next two quarters. So that's for Westward Journey II.

Obviously there is -- there are some players who have migrated to Fantasy Westward Journey. But the percentage is very low, which we have seen, something around 4% or 5% being migrated to Fantasy Westward Journey. Which is a good thing because it has actually started out and gathered the very first critical mass for Fantasy Westward Journey to bring it into a very popular game.

And for Fantasy Westward Journey, as I've explained that we are trying to achieve the target of what Westward Journey II has done for the last year. So, we're expecting Fantasy Westward Journey to achieve such kind of levels by the end of this year.

And then, just back to the SG&A, I guess I was a little bit confused because on percentage of net revenue -- that's total SG&A, I get around 20% plus and getting the rest at 10-12%?

All right, Jay. Let me explain that. Because the 10% -- 10-12% is only for the marketing, selling expenses, excluding the administrative expenses. In the past quarter, we have around 11% of the total SG&A attributable to the selling and marketing. And the remaining of our, I mean, the half of it is relating to administrative expenses.

OK. Great.

Ten percent is only regarding the selling and marketing expenses.

OK. Great. And then, just one last question on the launches of the license games and the 3D games. Is there a -- I mean, although it may be early, but is there any potential for charging higher prices?

Is that something you're seeing from some of the more, bigger value-added games that are coming out, like World of War Craft and A3. Is that a trend, or you think because of the competitive landscape, prices will probably remain around 40 cents, 30 cents per hour?

I would say that price would probably remain around 40 cents. I don't see any pressure for it to go down. But, I also don't see that there's any plan for us to increase it either.

OK. Thank you.

Yes, thanks.

Thank you.

And we'll take our next question from James Reed (ph) with Bear Stearns.

Yes, hello. Good morning, gentlemen. Before I get into my questions, I just want to say to everyone up there I wish Ted Sun the best. I'd like to congratulate you guys, not only for the great quarter, but also, what appears to be your management team's ability to diversify successfully away from Wireless VAS.

A year ago, Wireless VAS comprised about 60% of your revenue base. But, recently, online gaming has basically displaced that as the major contributor to sales but also, in terms of the key to growth drivers, going forward.

If I'm not mistaken, I believe online gaming contributed 53% of sales this past quarter. And my question is specifically on that sector. You've been successful in developing the MML (ph) RPGs and just curious if you have any intention to develop or introduce any type of casual game platform or portal?

Secondly, if you have any intention, perhaps, with Fantasy Westward Journey, of producing any type of other merchandizing or animation based off the content there?

And finally, with your 200 million in reserves, do you have any intentions of, perhaps, acquiring game studios or doing anything on that -- doing anything on those lines? Thank you.

OK. Thank you. Casual games portals, in fact, we have the team working on that, but in terms of launch of that casual game portal, it is our plan that if this is going to be something more closer to the end of third quarter or the beginning of the fourth quarter.

So, I think it's still early to say now, when we can actually launch that casual game portal. And this casual game portal would be quite different from the general market expectation of like the board games or the card games of the rates of hours online and things like that.

This casual game portal would be more like -- of a higher-level type of games, which is still very casual but it is not the kind of board game or card games. For Westward Journey or for Fantasy Westward Journey, we are looking at many different ideas. It is definitely preliminary to say that we're going to expand that into other merchandise.

So, it is a very good -- it will be good opportunity for us to extend into other merchandise. Even, talking about something like educational software, or Fantasy Westward Journey characters and things like that.

So, we have all these kinds of ideas. And we will choose what is best for the company and best for the games and what is -- what makes sense practically, so that before we actually start to expand those.

And for acquisition opportunities for game studios and so on, in fact, we have always been looking at -- on that front. And for those 14 developers, especially in China, there are not that many opportunities, because most of them are still very young. And we have -- when we are going to acquire such kinds of studios, we'll make sure that those studios will have a very good fit, both in terms of the management team and revenue and the type of products before we actually move on to acquire those game studios.

It is difficult to find in China. We are also looking at possibilities in some of the -- something like Korea and Taiwan. It's definitely too preliminary to say.

OK. Thank you very much.

And we'll move on to Wallace Chung (ph) with DBS Ticker (ph).

Hi, good morning Mike, Denny. Pretty good results from the online games. Hello? Yes. I think -- two questions. First of all, on the Westward Journey II when we see the peak coming out? And also, regarding the -- on advertising, can you give us the order backlog this year? Thank you.

Yes. Sure. On Westward Journey II, because we are going to experience the Labor Day holiday very soon, and also because the summer months are coming, I think Westward Journey II will still continue to see a growth over this period.

After the school starts, maybe there will be a slow period -- effective slowdown in the growth, but that really depends on how we see both, how it goes out in the summer months and so on, before we actually can answer you, when the peak after that will be exactly.

OK. And in terms of -- Wallace, in terms of the advertising backlog, I think our sales teams are -- has always been reaching a lot of the existing and also the potential big advertisers. And we feel that this year, 2004, is a big advertising year for the PLC customers, advertising customers.

And because we are not going to disclose the backlog information. However, we got the feeling that this year is going to be a good year for us. Why I'm saying that is because if you look at the Q-over-Q in the first quarter, we actually, in the past quarter, record a 13.9% increase comparing with last quarter in 2003. And where I think we compare year-over-year last year, same period was -- it was like a slack period -- business without growth.

So, this is actually a very good trend and we are very encouraging on that because of our continued effort improving our content and also improving our sales force. So, overall, I think, in 2004, we see that the online advertising we'll be doing better than the market average, which the market -- being around 50-60%. We think that at this moment, we are comfortable that we are doing better than that.

OK. Thank you.

And our next question comes from Frank Shiel (ph) with CLFA (ph) Investment.

Good morning, guys. Question on the online advertising. Can you give us drivers of the growth? Is it number of advertisers or it's high in price or spending -- a more spending average, increase in average spending by the advertisers.

I would say that in the past quarter, the increase, the growth is mainly driven by the volume, which is an increase in the number of advertisers and to a lesser extent is due to the price increase. Because (inaudible) actually at the end of last year, at the beginning of this first quarter, generally, we have actually increased our rate price all across the order inventory.

Right. On the price increase, I understand that you probably have some long-term agreement with the large customers, so if the higher price truly reflect that in your first quarter numbers or we should expect more growth coming out of the price increase in coming quarters.

It's already recaptured. It depends on which part of the rough side property they are facing their advertising. For example, for some of our more popular pages like front page and also the (inaudible) channel et cetera.

Then the price increase has already been recaptured in the past quarter. And going forward, it depends on the -- actually, the demand and supply. But, we are overall, very comfortable with the pricing.

OK. Great. Thank you. Question on the online games business, what s the trend for the average hours per week of the gamers? It's going up or stable or down?

I think it's very stable right now. And it's something around 47-50 hours per month for each user.

OK. Great. Also, we see some of the competitors have this private service issue. Basically they got their different volumes going away. How big is the issue for you guys?

It is not an issue for us. There is nothing Frank. No. We don't see any of our private service being arranged for our games at all, in any of the places.

OK. Great. Thank you.

Thanks.

And we'll move next to Liz Khan (ph) with Lehman Brothers.

Hi. Good morning. I just want to ask a little bit more on the wireless business. Can you actually give us the average unique paying user for wireless business? And what is your longer-term plan on this business?

Because it seems like you're losing market share in this business and you're doing much better on games. So, is this a business line where you pay less attention to, or even possibly drop out from this game -- from this business?

Let me give you the -- let me give you the numbers first.

Yes.

For the month of March 2004, number of unique paid and collective users is around two million users. This figure -- because, again, the marker practice is also as confusing and there are many different ways to define these numbers. But the way I define it as unique paying and collective users for -- two million for month of March 2004. This, if you look at our sales line and divide it by this number, you'll see that we're actually experiencing a higher ARPU for this quarter.

OK.

And longer term, we are obviously, losing market share in terms of the SMS business. But, I would not really say that it's only on the low level type of business, such as the ring tones, logos and some of the -- maybe some news and so on.

In fact, we are actually growing on wireless service in terms of the high-end level type of products. Especially, because as a portal, and as a portal with a lot of different applications such as the e-mails and then as the Popo, we are actually experiencing growth in terms of Web-based related SMS and value -- wireless value added services.

So, we are definitely trying to drop out of this game. In fact, we are having a different game plan. This game plan, of course, is in transition mode and this transition mode -- it's obviously not over yet. But I think we are building high-end applications that is also wireless-related. So, that we have much higher area of entry versus some other smaller service providers.

OK. So, regarding Popo, how many users do you have right now and how many of them are you charging for the service that you provide?

Hi. Right now, Popo has over 12 million relative to users. And out of the 12 million, we are charging somewhere around 350,000 users for a monthly rate of around (inaudible). But, the charging scheme is actually a little bit, lets say, complicated. That means the Popo users also would have some kind of Popo currency that they can use to spend on wireless services.

And those Popo currencies they earn, somewhat like a game mechanism where they will earn if they have more use -- friends and so on.

OK. Thank you.

And our next question comes from Cheng Ku (ph) with Foreline Technology (ph).

Right, good morning. Congratulations to Denny and Michael.

Thank you.

Thank you.

I have one question for the games -- for the new game, Fantasy Westward Journey, are you right now, successful with attracting female players? Or if it's successful, do you have any numbers to support it?

Actually, it is very difficult to know exactly how many female players we have for each game. Because the male and females, when they register, it may not be true.

So, what I'm doing -- we have been doing is really just researching on doing, like, the focus group and so on and those kind of -- type of surveys and so on. And I think the composition between male and female is about the same right now. And something like 25% female and 75% male; or is less female.

OK. You said is that also same percentage amount with Westward Journey II?

Yes, the amount -- the numbers I've just mentioned is for Westward Journey II. And for Fantasy Westward Journey, it's a little bit higher on the female.

What's the percentage?

Something -- it's really an estimate and something around like 30%, 35% for female.

I see. OK. OK. For online advertising, what you see going forward? Or do you see also, you know, at the next Q -- second quarter, third quarter, normally is seasonally stronger. Do you see that too in your business?

Yes. For the online advertising assets, as I've said, we have a very good start in this year, where the revenue increase of 13.9% quarter-over-quarter, which is -- Q1 was -- is traditionally the low season for online advertising.

So, we are very optimistic in the coming quarters. And in particular, because of the different events coming up. The Olympics and also the F1 (ph) et cetera. And these are -- will help our sports page and also will be a very good opportunity for us to grow our advertising business.

I see. So, are you comfortable with the double-digit growth for the second quarter and third quarter?

We do not give out very exact guidance, but I can say that overall year-over-year, we are comfortable that the growth will be better than the market, which the market says that the growth rate is around 50-60% this year, on average.

OK.

So, we will be -- still be doing better than the market, year-over-year.

OK. A clarification just with the earlier question. You mentioned the S (ph) -- and the sales and the marketing and the increase because of the managing of Fantasy Westward Journey and also redesign of the front page.

My understanding is that some of data was like a one-time expense. And then, later you say, in the future, S&M will be here around 10-12% of net revenue. So, -- which means SG&A will just be around 23% of net revenues?

This is correct. Yes, because, for advertising is more event driven. But in 2004 actually the company is planning to increase our effort in overall marketing and also advertising. And also for, for example, the online game business. We have the plan to roll out several new products during this year. So what I'm saying is, on average, month-over-month, I mean, the marketing strength will be around 22%. And occasionally, in certain (inaudible) and the marketing expense might be higher percentage compared to percentage of the net revenue. But for some months it will be lower. But on average, it will be around 10-12%. That's what I'm saying.

OK, OK. On the income tax, by the - you see you know, 7% will be the rough amount for this year or you appear more inclined for the 10%. Therefore you guided earlier or maybe communicated earlier?

Actually, in the past, I have been trying to be prudent, saying that it is for this year, 2004, is around 10%. Actually, this is a prudent estimate but I mean, the -- we are trying to reduce it. You cut your tax rate by having obtained tax exemptions for some of our subsidiaries. And I would say that around 89%, on average, for the year of 2004 we will be reasonable estimate at this moment.

OK, all right, thanks.

Thank you, thank you.

And our next question comes from Patrick Bryn (ph) with Primary & Capital (ph).

Hi, good morning guys. I was wondering, there's quite a few conferences here in the U.S. with many of the online media companies from China coming over -- are you guys coming to any of the upcoming conferences for the month of May?

We are still deciding on the exact timing for which conference to attend but may I take note and we will let you know once we have decided.

Sure, that'll be great. And then, you talked about the strength in terms of the online advertising market and how you plan to grow, much, much faster than the current market rate of 50-60%. I was wondering if you could talk about what you're seeing in terms of the pricing environment for the current market?

How -- you mean the online advertising market?

Yes, in terms of how you guys price things and what the rates are and what you're seeing in terms of demand.

Yes, because, as I've said, in the first quarter, we have already increased our rate of price. This is the same as our competitors. I think all of us have increased our pricing. But obviously, it depends on the property -- which property we are talking about? For those more popular properties like the Front Page and like the news for some of our competitors and the price will be higher for us, for example, the entertainment channels and it will be higher.

But we have been trying to push a lot of the advertising into our Web page instead of just focusing on the Front Page. And that's the reason why we have been doing a lot of revamping of our different Web pages and we have some new channels delivered in the past, just like the business channel, which is focusing on business news and we will continue to develop such vertical channels.

Great, thank you very much.

Thank you.

And we'll move on to Mark Argento with ThinkEquity Partners.

Yes, hello. Just a couple of question regarding margins, in particular, are you guys targeting any margin expansion for this year? And specifically, on a segment basis, we saw, I believe, gaming margins increase this quarter whereas wireless margins were down modestly. And also, could you reconcile your new strategy on the wireless side as far as going after some of the higher end products and what that could do to margins through the course of the year? Thanks.

OK. In terms of the margin, I mean, I can go over with you for the gross margin of each individual item. For the online game, first of all, online game, we have seen, it is the highest margin business among the three -- sometimes as high as 90%, 91%.

In the past quarter, it was around 90.2%, gross margin. And this is actually a very scalable business. And as long as the revenue can grow and the incremental cost actually is growing much lower than -- slower than the revenue growth. So given the receptiveness of our two game West Virginia on our Version II and also plan to see Westward Journey. We have seen that the margin we are comfortable that it could be maintained at such a level, at least, in the coming quarters at least.

And for the online, sorry, for the wireless business, it has come down a little bit from 86% in last quarter to 85% this quarter -- the past quarter, I mean. And actually, this type of business is also very gettable. The margin is very high and actually the revenue comes down in the past quarter. However, the total revenue also comes down. So the margin was a little bit reduced. So it really depends on, in the coming quarters, whether we'll be able to start to have a growth in this business. But I will say that the margin will be comfortably maintained at the 80 level.

And for the online game, online advertising line of business, the margin is lowest among the three because some of the common costs for the maintaining quarter, for example (inaudible) for the editors et cetera, have been -- in the market practice have been included in this segment.

So this explains for the low margins for this business. And the margin has been quite stable for a while, around 66%. And actually we are seeing, that level of margin can be maintained. So for the company as a whole, in the past quarter, we have 85% gross margin and which is a slight increase from last quarter. And I am comfortable that the gross margin will be maintained at this level in the coming quarters, given the strong growth in our online game, which is the highest margin business.

And down to the operating margin, it really depends on how much we spend on our marketing, and also on the administrative expenses. As I've said, we try to keep the level of marketing funding at the level of 10-12%. And depending on whether that quarter we have a particular promotional event or not and SG&A expenses will be higher this coming quarter because of the legal compliance with the U.S. Regulatory Rules, Sarbanes-Oxley Act et cetera. And also -- but it will be quite relatively stable.

And for the R&D, we try to maintain it at the level of 5% of total net revenue. So, on the overall, I am very comfortable that the operating margin will be maintained at the level of high 50-60%. But it really depends on the particular month.

OK and for the next question -- sorry, what is your next question?

Sorry. I was going to ask you how many unique users you had in regards to the video game or the online gaming product this quarter? I think you said last quarter it was about 1.6 and I just wanted to get an idea where that number was? And then, as far as the two million users on the SMS business, could you give us a comparable number for Q4?

For the online game we have around 2.5 unique paying users for the month of March, for two games together. And for the comparative figure for the wireless business, I've mentioned that we have around two million unique paying users for the month of March. And for the month of December, it would be in line with the revenue decrease or the revenue level of December. And we have seen a very small increase in the output.

OK, thank you.

Thank you.

Thank you.

Our next question comes from Jeffrey Shue (ph) with Buena Vista Fund Management.

Good morning Denny and Michael. How are you?

Good, thank you.

Just want to go over your peak concurrent target for the second quarter for WJ2 and Westward Journey and you mentioned what your 2004 peak concurrent is for SWJ. What is your peak concurrent target for WJ2 in 2004?

With regard to the new games, I now you have one that's 3D, it's coming out in the 4th quarter, what about the other new game -- the other MMO RPG that you're developing, when are you expecting to open a beta test on that? Are you having any intention to have any kind of unlimited monthly plan instead of a paid system? Those are my questions for the gaming side.

On the SMS, could you give me a target for your Q-on-Q growth? Are we going to see continued decline of the same percentage as we did in the first quarter?

And on your advertising business, 13.9% Q-on-Q growth is much better than your original guidance. What was so good in the first quarter that led to this? And can you give me an idea of what the second quarter will look like?

And lastly, on the legal side, any update on the Wells Notice? How is that proceeding? Those are my questions, thanks.

OK, thank you very much.

OK, on the game side -- I know I asked you that first -- on the game side, as I was saying, when I go through on each of these games, on Westward Journey to again, firstly, we are going to have new content to be added into the game, which includes making of new weapons and different things, adding new content, which is one of the major expansion packs that we are going to put after the last expansion pack that was put around these times of last year.

And this new expansion package is going to be done somewhere around June or July for this year. So we are still expecting a growth in Westward Journey 2, especially that for the coming months it's going to be day-to-day and the summer months out there, we have new contents, we are in a good time we do more marketing. So we are still experiencing Westward Journey 2 growth in the coming, these two or three quarters, something like that.

So what exactly is the peak numbers that we are targeting at? I am sorry, that is very difficult to say because the peak for March was 252,000 versus a peak of 224,000 in December and we added something like 2,000 -- 28,000 over this quarter on the peak number of conference users. And we are expecting maybe similar or a bit in the slowdown in the growth but it is still definitely growing.

And for the Fantasy Westward Journey, which is the new game, we are seeing peak concurrent users of 111,000 for the month of March. We are obviously expecting quite a bit of growth in Fantasy Westward Journey. It would be very difficult to divide it into quarter two and quarter three and quarter four but as I've mentioned, I am trying to achieve kind of a growth rate, where in quarter four we will see something double of this peak concurrent users for Fantasy Westward Journey.

So that's -- I think then it will be easier to look at it, what it is going to be like for Q2 and Q3. And I think, obviously for Q3, because it's all summer months, I think we will be able to achieve even a higher rate on that. But on average, over this next three quarter, maybe something like, a bit over 200,000 or 220,000 -- something like that. And so that's for Fantasy Westward Journey.

And for the 3D games, as I've mentioned, something around open data in later part of Q4 and probably, commercial launch in the first Q of 2005. And at the same time, for the whole pipeline, we also are developing and are looking, which is also 3D and we are also looking at a launch of open data, somewhere around Q2 or Q3 of 2005 and then we are also looking at another thing, which is just Westward Journey 3 to be launched somewhere around the end of 2005 and early 2006. This I think, answers all your questions on the game part.

Any intention to have a monthly payment system?

For that we don't have any intention yet. Because we have analyzed the players and the users paying habit and also analyzed the number of players who have been paying the amount of dollars and the number of hours that they play over different charts. And we don't see that there is much difference if we are going to have a limited monthly payment plan, if we set the price somewhere around RMB 30 per month and so we don't have any plan on that.

Sorry, just to go back to Westward Journey II, for a second -- should we expect quarter-on-quarter growth, maybe in the single digits or low double digits?

I'm sorry, even that would be difficult to answer.

OK and maybe quickly going through your (inaudible) questions -- for the SMS guidance because we are not giving out our right guidance on that and in particular, that area of business is very predictable. So we tend to be prudent for the next quarter. And however the beauty of our business is, we have a very diversified business, we have three different revenue source and our business overall performance will not be affected by any individual, transitional turning of individual business.

And on the advertising side, in the past quarter, I think we have done three things. Firstly, we managed to increase some of our public enterprising. And secondly, we, based on the revamping of our Web page -- front page. We have regained a lot of the reductiveness of the advertises on our overall, as a marketing or as an advertising media.

And also, currently, we have been successful in pushing a lot of facts into the front page instead of just focusing on the front page, which is having a very limited inventory space.

And regarding your last question about the Wells Notice, we have been co-operating with the Regulatory Body and with the lawyers as well and we will update the investors and the public when there is time -- there is a new development.

Great thanks.

So, I think we answered all of your questions because we have already been overrun. So we just stop the Conference call. And thank you everyone and we are looking forward to seeing you next quarter. Thank you Operator.

You're welcome. That does conclude our Conference Call for today. We do thank you for your participation.