NetEase Inc (NTES) 2005 Q1 法說會逐字稿

Hello everyone, and welcome to the NetEase 2005 first quarter conference call. Today you will hear from Mr. Ted Sun, Acting Chief Executive Officer; Mr. Michael Tong, Chief Operating Officer; and Mr. Denny Lee, Chief Financial Officer. After their prepared remarks, Mr. Sun, 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 are intended to qualify for 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, 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 could cause 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 this forward-looking statement except as required by law.

As a reminder, this conference is being recorded. In addition, a webcast of this conference call is available at the NetEase corporate website at corp.netease.com. I will now turn the conference call over to Mr. Ted Sun, Acting Chief Executive Officer of NetEase. Please go ahead, sir.

Thank you, operator. Hello, everyone, and thank you for joining us. I’m very pleased to review NetEase’s first quarter performance with you today.

During the first quarter, Fantasy Westward Journey continued to gain even more popularity among Chinese gamers, attracting 588,000 peak concurrent users in March, and quickly became the No. 1 most popular MMORPG in China in April. This month, additionally, Fantasy Westward Journey, together with Westward Journey Online Version 2, in total attracted over 1 million peak concurrent users playing NetEase’s in-house developed MMORPG games. The overwhelming success of these two games is a testament to the strength of our in-house development capability and our extensive distribution network. And I will let Michael discuss this business with you in more detail in a minute. The overwhelming success of our high-margin online game business helped drive revenue growth in the first quarter with total revenues of over 57% year-over-year and enabled us to report another record quarter of net profit.

Our advertising business performed solidly this quarter despite a traditionally first quarter seasonal slowdown with strong year-over-year growth of around 31% as our efforts to improve our portal and general contents paid off.

We are currently exploring new ways to leverage the revenue potential of our content channels through strategic partnerships that will include the best of our content to our users, and initial results of these efforts are beginning to take fruit. During the first quarter, we signed agreements with Cellphone.com [ph] and China Finance Online [ph], which have enhanced the content of our real estate and finance channels, respectively.

Additionally, we are pleased to report that earlier this month, Lee Ling [ph], a well-known Chinese consumer sports brand, became the title sponsor of our sports channel. With improved channel offerings, we can attract more users and increase user loyalty, which in turn drives advertising spending.

Our wireless VAS business faced another tough quarter of intense competition and declining popularity of SMS products. This was reflected in a sequential drop in revenues for this segment. We continue to believe, however, in the long-term potential of non-SMS services such as, MMS, WAP, IVR, and COLORing Back Tones, which are steadily increasing in popularity. While we experienced strong demand for our WAP services during the first quarter, this growth was not sufficient to offset the decrease in SMS and MMS revenues.

Let me turn, now, to Michael, who will provide you with an overview of the online game business for the quarter.

Thank you, Ted. Hello, everyone. In discussing further details about online games, I am pleased to note that total revenues for this business grew 135% year-over-year, driven by the success of Fantasy Westward Journey. As Ted mentioned, in the first quarter 2005, Fantasy Westward Journey grew to 588,000 peak concurrent users in March, and, this April, became the most popular MMORPG game in China. Strong demand for Fantasy Westward Journey can be attributed to a number of factors, including expansion packs released during the first quarter, improved back-end game technology leading to smoother game play, higher capacity for each server, and an increase in server numbers during the Chinese New Year holiday, which is, traditionally, a busy season for online game playing.

Our other in-house developed game, Westward Journey II, has continued to grow during the quarter, and has remained one of the top five MMORPG games in China, achieving record peak and average concurrent user numbers in March of 389,000 and 175,000, respectively. The success of our two in-house developed 2-D games is evidence of the continued health of China’s 2-D MMORPG market. But it also demonstrates NetEase’s ability to develop games that fuse Chinese culture with the latest gaming technology, which has proved to be a winning combination. This gives NetEase a distinct advantage over our competitors.

This quarter, we invested in a new 3-D game networking technology to further boost our in-house development capabilities, enabling us to develop even more sophisticated 3-D games in the future.

Turning, now, to our new game pipeline, we will continue to release expansion packs for the games currently operating. And beta testing for our latest licensed 3-D game, Fly for Fun, is ongoing. The first stage of beta testing was designed to address technical issues and surface [ph] stability. We are now completing the fine-tuning, and we expect that Fly for Fun will be ready for commercial launch in the second half of this year.

Continuing our successful formula of combining Chinese culture and the finest gaming technology, the development work on our two next-generation in-house developed MMORPG games, the 3-dimensional based game on Chinese mythology and a 2.5-D game set during the Tang Dynasty, is progressing well. We anticipate both games will be ready for beta testing in the second half of 2005.

Finally, as mentioned previously, we will be adding casual games to our games lineup. We expect this genre of online games to attract a wider range of users than MMORPGs. We plan to beta-launch an initial platform of nine multi-player casual games in the second quarter of 2005 with successive add-ons to bring the total number of casual games to the platform to 20 by the end of the year.

Let me now turn the call over to Denny, who will go into a little more detail on the numbers for the last quarter.

Thank you, Michael. Rather than repeating all the numbers in our press release, I will review the financial highlights of the quarter and provide some additional information on key results.

Total revenues for the first quarter were $39.6 million. This represents a strong year-over-year growth of 57.6%, driven by our online games and advertising business, and a sequential quarterly increase of 17.9%. We reported another record quarter of net profits, which reached $18.6 million, or $0.53 per ADS diluted in the first quarter. This represents a 48.1% increase over the corresponding period in 2004 and an 18.2 percent sequential increase.

The ongoing success of our two in-house developed online games drove revenue in our games business up to a record high of $31.7 million. This represents a significant year-over-year increase of 135.3%, and a 25.9% increase over the previous quarter.

Revenues for the advertising services for the first quarter were $5.5 million, representing a strong year-over-year increase of 31.3% as new advertisers continue to be attracted to our large base of loyal users. We posted only a small sequential increase of 1.3% in revenue due to the traditional first quarter seasonal slowdown.

As Ted mentioned earlier, our wireless value-added and other fee-based services business continue to face intense competition and declining popularity of SMS products. This caused total revenues from this segment to fall by 18.7% quarter over quarter to $2.4 million.

Overall gross profits for the quarter was $30.6 million, a 59.9% year-over-year increase and a 22.1% increase over the previous quarter. Higher revenue growth in our online game business, favorably impacted by gross margin in this segment; we’ve increased it from 88.3% to 89% in the first quarter.

Gross margins in our advertising business decreased slightly due to the increased bandwidth costs and server custody [ph] fees during the quarter. Gross margin for wireless value-added and other fee-based premium services increased sequentially due to our one-time expenses resulting from prepay revenue for SMS service incurred during the fourth quarter of 2004. There was no such one-time expense in the first quarter.

Total operating expenses for the quarter were $10.9 million, representing a 79.1% increase over the corresponding period a year ago, and a 17.4% sequential increase, including the R&D expenses resulting from the purchase of a 3-D game technology in the first quarter.

Our effective tax rate increased in the first quarter due to one of our subsidiaries, which was previously exempted from paying PRC income tax becoming subject to a 18% tax rate during the quarter. This 18% consists of 15% enterprise income tax plus a local tax of 3%.

Moving to our balance sheet, as of 31st of March 2005, our total cash and held-to-maturity investments totaled $300.3 million, an 8.6% increase from the previous quarter. We reported operating cash flow of $24.6 million during the quarter.

I will now turn back to Ted for his closing remarks.

Thank you, Denny. I would now like to read you our financial guidance for the second quarter of year 2005.

Please note that the following outlook statements are based on current expectations. These statements are forward-looking, and actual results may differ materially. We expect the total gross revenues of the company in the second quarter this year to be between US$46 million and US$47 million, with online game services revenue to increase by 18 to 20% quarter over quarter; advertising services revenue to increase by 15 to 20% quarter over quarter; and wireless and other fee-based premium services revenue to be flat to a decrease of 5% quarter over quarter. Net profit, we expect it to continue to increase during the second quarter to between US$23 million to US$23.8 million.

Let me conclude by saying that NetEase’s long-term financial outlook has never been better. With Fantasy Westward Journey’s current success and an exciting games pipeline in place, year 2005 promises to be a strong year of our online game business. We also believe that our efforts to improve content, channel content, and grow our portal traffic will lead to an increased advertising revenues.

Finally, we expect the contribution of 2.5G and other non-SMS services to account for a growing proportion of our wireless value-added services business.

I’ll now be happy to take your questions. Operator, please open the floor for Q&A.

Thank you, sir. [Operator instructions.] And our first question comes from Safa Rastchy with Piper Jaffray.

Good morning, or good afternoon, I guess. Congratulations on a great quarter. A couple of questions on the online gaming side. Could you give us your outlook -- and perhaps you did, and I might have missed this since I missed part of the beginning of the call. Your outlook for Westward Journey II -- to what degree can you reignite [ph] some growth in it with additions or patches, and to what degree the introduction of the new games that you have planned might actually further accelerate its maturity? I have a quick follow-up.

Okay, Michael, do you want to comment on that?

Yes, sure. For Westward Journey Online II, we will continue to have additional patches and new upgrades and expansion packs for the game during the year. We are planning to have two more expansion packs during the year, one coming from right before summer and another one coming probably by the end of the later half of the year. We will continue to see the growth of this game, and we believe, and we expect, that we can continue to grow this game for the next nine to 12 months for this year -- going from now. Did I answer your question, Safa?

Yes; that’s good. Second, on Fantasy. And again, if you talked about this earlier, I apologize; I’ll take it off line. But could you talk about what happened during the quarter that there was a noticeable pickup in its popularity. Were there features that you added, or was it just the overall competitive landscape of the games that are available? What caused it to kind of rise to such prominence in the quarter?

Sure. For the growth of Fantasy Westward Journey during the first quarter, it had growth, I think, out of the expectations of a lot of people. The reasons are, for one, we have improved our back-end technology, which specifically is to increase the capacity of each of our servers. And also be able to host the games with better stability and smoother connections with our users.

Secondly, of course, it is also a seasonal effect of the Chinese New Year, and also Valentine’s Day and so on during the quarter.

And thirdly, of course, is also an expansion pack that we have released during March of this quarter. All of this together has contributed to the growth of Fantasy Westward Journey during the first quarter.

And Fantasy Westward Journey continued to be a very unique positioning of games in the Chinese market right now, and we believe the game will continue to grow at a very good rate.

Okay. And one last question, if I may. On the wireless front, could you give us, maybe, a little bit of longer-term outlook, Ted, or Michael, or both of you, if you can comment on it? When do you think we might see some pickup in your wireless revenues, and what kind of services might contribute to such a pickup?

I think the main growth -- we’re expecting a main growth will come from W-A-P, WAP, services, as it was demonstrated in last quarter that the highest growth among our wireless products are from WAP services.

So essentially, as SMS becomes stable and at a pretty low level, the growth of WAP will shift overall revenue for your wireless segment?

This is our expectation. Michael, do you have anything to add?

Yes, for the SMS, I think we are expecting it to be more stable going from now, and mainly because most of the provinces have already been migrated to the mixed [ph] systems. So for SMS, I think it is going to be stable.

Okay, great. Thank you very much. I’ll let others have [unintelligible].

Thank you, Safa.

We’ll now move on to Lu Sun with Lehman Brothers.

Hi, Lu.

Hi. Congratulations on a great quarter. I have three questions. The first one is on your online advertising revenue. It seems like you see a very nice seasonal pickup. Can you also give us some indication of the visibility towards the third quarter and fourth quarter if you can, because I think, like, the eBay contracts [they're really] kicking in. But what else are you seeing? Are you seeing any other big advertisers starting to advertise with you because of all the Googling content [ph]?

Yes. About the advertising revenue, actually, we are seeing a higher visibility this year than any time before because of the few partnership or sponsorship agreements that we have. Those are all longer-term contracts, including the one that you have mentioned about eBay, and the title sponsorship of our sports channel from Lee Ling, as well as the strategic content partnership with cellphone.com [ph] and China Finance Online. All these contracts are at least one year. So it is -- they are providing us with higher visibility of advertising revenue for the coming quarters.

I see. The second question is about your online games business. Now, a lot of people are very concerned about World of Warcraft and its impact on your 3-D launch going into the second half. And also, I think your competitor, Shanda is also launching Magical Land with affiliated marketing efforts with Pepsi Cola. Do you think that will actually have an impact on your revenue growth outlook for the second half? And also on your costs, especially marketing costs, going into the second half?

Michael, can you talk about that?

Yes, sure. For World of Warcraft, I think the game is going to be open beta today. So I think it will not be too wise for us to talk about exactly how many concurrent users or give an estimate on this game. But the points that we have made in our last, previous conference call -- that is, the Chinese culture of the game, and also the tenant [ph] code -- the hardware configuration and requirements for WoW -- seems to be still some of the bigger problems for World of Warcraft. But anyway, we will see what will happen to World of Warcraft very soon, so there is no point to talk about it today.

How it's going to affect our games right now -- I think, again, for the games that we are currently operating, the Fantasy Westward Journey and Westward Journey Online II, I think both games will probably be the least games affected in the market, mainly because those are Chinese traditional games and they are 2-D games with much lower hardware requirements.

For the Magical Land, I think they are also going to be launched with open beta also today. This game, in looking at the surface, seems to be similar to that of Fantasy Westward Journey, but we have played a game, and it is actually quite different than that of Fantasy Westward Journey. And we believe it is also trying to address different markets. So the numbers, the projections, that we have given just now -- the 18 to 20% -- we have already accounted for some of the margin of error with the potential impact from the release of these two games.

But, of course, we will see what happens exactly. Because, anyway, there is the open beta today for both games.

In terms of costs, marketing costs, we have also accounted for some of the margin that we will need to increase the marketing costs if there is any potential disruption of the market. But I think, for the second quarter, that’s the profit guidance -- that we have already accounted for some of the potential marketing cost increase already.

And I want to add that we are also exploring joint marketing programs with other consumer products, such as World of Warcraft with Coke and Magical Land with Pepsi. We are also exploring different marketing programs with other consumer product companies, and that would tend to be enhancing our marketing coverage while not increasing our marketing costs.

I see. And my third question is on your wireless business. Can you actually give us a breakdown as to how much revenue is actually coming from Web and how much is coming from SMS?

Yes. In Q1?

Yes.

In Q1, 34% of our wireless and other services revenue from SMS and around 20% from 2.5G.

Okay.

Of 2.5G, around 70% from WAP. So altogether, that means around 14% of the wireless and other services revenue from WAP.

Okay. And finally, you have some IBIS [ph] loss? No?

Yes, very minimal.

Okay, great. Thank you very much.

Thank you.

And our next question will come from Dick Yu [ph] from JP Morgan.

Hi. Good morning, guys.

Good morning, Dick.

Congratulations on a good quarter. Just a few questions. The first question is that regarding online advertising, I noticed that for the first quarter, the gross margins declined. As has been suggested, this was due to increase in vendors’ costs. I wonder, for the rest of the year, do we expect to see gross margin continue to trend down from this level because of the increased content partnerships you have going forward?

Actually, the content partnerships are not increasing our content costs. The content providers actually are paying us rather than we pay them. So, as Denny mentioned earlier, the main reason for increasing cost of revenue for advertising business in the first quarter was due to the additional bandwidth cost. And we do not expect that to continue in the coming quarters.

I see. And then, what about your search engine strategy going forward? I understand your partnership with Google is going to end in July.

Yes. Our partnership with Google was one year, and will expire at the end of June. But we are already discussing with them renewing the contract, and most likely the arrangement will continue for at least the coming year.

And then, the last question I have is on a game. Michael mentioned that there are some technical optimizations that lead to higher server capacity. Is it going to help sequential increase in terms of revenue for the games in the second quarter, or mostly it is reflected in the first quarter already?

It should have a recurring impact for the future as well. But Michael, can you comment more about that?

Yes, sure. It is an optimization of the server back-end technology that increases the capacity of each of the servers basically from around 2,500 per server to around 305,000 per server right now. So it makes the gamers have a smoother connection, and also to have the more stable connections with the games. And also, of course, increasing the capacity so that there is no need for them to migrate to different servers at different times.

So we will continue to increase and to optimize the capacity as well for the following quarters. But of course, we will not be sure when will be the next jump of the server capacity. But just on this server capacity improvement during the first quarter itself, I think it is already a recurring element for the growth of Q2 and Q3 as well.

Okay, thank you, guys.

Thank you, Dick.

And we move on to James Rhee with Bear, Stearns.

Hi, James.

Hello, good morning. Can you hear me?

Yes.

Okay, great. Thank you. A quick question on your casual games. Could you please describe your revenue model for that effort? Will it be, for instance, time-based, subscription-based, or do you expect most revenue to come from advertising? Thank you.

Our casual game platform will be launched before the end of Q2. And Michael, can you talk about the current progress as well as our future revenue potential from the casual games business?

Yes, sure. In fact, we are going to have to close beta for this casual game platform starting from mid-May, which is 2 to 3 weeks from now. And we are expecting to see the -- you can call it “open beta” or “conventional launch” for the casual games by the end of June.

The reason that I’m saying that it is going to be both open beta or conventional launch is because we are not going to charge on the playing time for these games, but we are going to charge on the virtual items for these games. So this is going to be our revenue model.

And also, of course, when there will be advertising opportunities, we will also be looking at different possibilities and working with different brands and companies on advertising opportunities with the casual games. Sorry? You have a question?

Oh, no. No, go ahead; sorry.

In terms of the revenue contributions, I think because in the beginning we will only start charging very small amounts of virtual items and so on, I think in the earlier time for this game, it’s more going to be aggregating the users. So I think in terms of revenue contributions, we will only start to see some more material contributions by the later part of this year; probably in the fourth quarter or so.

In our initial launch of our casual games platform, there will be 9 games together.

Right; yes.

Okay. Could I ask one follow-up, please?

Yes.

Related to the item transactional revenue model, I’m -- I think that’s an interesting way to go, and should be quite beneficial after ramp-up.

Do you have any interest in creating a type of virtual item trading platform? You know that happens with MMOs and if that is something which NetEase may be pursuing? Thank you.

Michael, can you comment on that as well?

We do not intend to hold any virtual-item trading platform for our MMORPG games simply because the company, as the principal provider of these games, if we are going to launch such an exchange platform, I think there will be conflict between doing the MMORPG games and also launching this kind of exchange platform.

And it is also -- we think that it is not a very good image to our users that we do encourage users to exchange their virtual items. We are more a pro-gamer type of a company that we want our gamers to actually play our games rather than just trying to make money out of our games.

Okay, thank you very much.

We’ll now move on to Richard Gee with Morgan Stanley.

Oh, hi. Hi, Michael. A very strong quarter.

Hi, Richard.

Hi; thank you.

I have two questions regarding online games. No. 1, clearly, there was very robust growth for your online MMORPG games. I’m just wondering, how much of that user growth comes from new users, and how much of that comes from cannibalization of existing users of other games, particularly the competing games? Then I have one follow-up.

Michael, can you talk about that as well?

Yes, sure, of course. We believe the markets continue to grow at a rate that we have explained before, which also IDCs have kind of estimated before in the market growth for each year for the total game market, it should be around 40% to 50% during this year. And we continue to see that the market is growing at this kind of rate.

And of course, the growth of Fantasy Westward Journey has of course beat this rate, and obviously, there will be some of the users coming from other games in the markets right now. And these other games could be any different kind of games, and we do not target specific groups of games that are trying to pull their consumers to come to our game. I think it’s just a general increase and general transfer from other games.

Good. And given that you have two 3-D games in your pipeline, one is the Fly for Fun and the other one is the 3-D mythology game, which I believe is, hopefully, going to be a potential blockbuster for you guys again. And can you just comment on the 3-D readiness of the Internet café and what do you expect things may change in the second half of the year, particularly as World of Warcraft will roll out? How will that show up later for you on the income of the 3-D hardware deployment income of [unintelligible]?

Yes, sure; of course. For the 3-D games, again, I think it’s not a function in the market where if it is a 3-D game or a 2-D game. More, it’s a function of the hardware requirements of each of these games. And out of all these 3-D games, there are a range of different hardware requirements. Some 3-D games require a lower hardware requirement, and some 3-D games require higher hardware configurations.

So for us, we -- the 3-D games we are going to launch, for example, for Fly for Fun, for us, we are looking at about 75 to 80% coverage of all the Internet café PCs. And for the 3-D games that we are going to launch in the later half of this year, we are also looking at at least 50% or above coverage in the Internet cafés’ PCs. And for your information, of course, the home users’ PCs probably have the higher hardware configuration anyway. So it means that, if we have Internet cafés’ PC coverage of 50%, we will probably have around 75% of the home PCs’ coverage.

So it’s almost like a target that we are working on right now which is the most important. For the 3-D game market right now, obviously, we haven’t seen much of the real 3-D games that are really successful in the markets right now. But of course we would also want to see -- our view is that we want to see reasonable success with the 3-D games that we are going to see in the market -- for example, World of Warcraft, and Witchwood [ph] also have to increase, or to accelerate, the upgrading trend for the Internet cafés’ PCs.

And one last question. On your online pricing, can you comment on your pricing power? I’m particularly interested in your price increase for your [unintelligible].

In Q1, the pricing has been pretty stable, although we have increased our very top price at the beginning of the year. But given the market condition, we are giving a higher discount, so effectively, the price level has been pretty stable in Q1 when compared with Q4 last year. And we expect the price level to be stable in Q2 as well.

Thank you.

We’ll now move on to Frank Shi with CLSA.

Good morning.

Good morning.

I have four questions. One is, can you talk a bit more about your expansion pack? I want to have an idea of how many percent of those additional players are one-time and how many sort of are permanent on your games. Because, really, you have sort of even-driven additions to your game. That’s the first question.

Second question is for Denny. Are you guys going to have sort of any consistent way of calculating your number of shares? Because I’ve noticed that on your footnote, you’ve changed the way of calculating your number of diluted shares.

And my third question -- you talk about higher bandwidth cost. My question is, is it driven by higher price charged by the teleco price, or is it driven by the more bandwidth you purchase for your overall portal offering?

And then, my last question would be, what kind of casual games are you guys going to be offering? Is it card games or other kinds of games? Okay, thanks.

Okay. Maybe, Michael, can you address the questions relating to games first -- the expansion pack and the casual games?

Yes, sure; of course. For the expansion pack, basically it’s an automated download of the expansion pack to each of the players’ computers or in the Internet café. So it would be difficult to say exactly how many new users are joining the expansion pack. Especially that for each of these expansion packs, there is kind of a time lag for it to really make the growth of these games. For example, for Westward Journey II, the expansion pack, last one, was released in late January and the result and the effect for the growth of this expansion pack only comes in, kicks in, in almost March of 2005, which is about one month after the expansion pack is released.

That said, it’s mostly because these expansion packs are sometimes complicated for the users, and then they do need to sometimes to digest and to understand the expansion pack to really make it fun.

So it would be difficult to say at different times what are the percentage of users that are using these expansion packs or not. But I think the most important thing is that we will continue to see these expansion packs resulting in growth of these games, and also to sustain, for example, for Westward Journey II, to sustain the growth of this game.

The other questions relating to games is on the casual games. The examples of casual games would be something -- out of the nine games that we are going to launch in June, four games will be the board and chess games. So we will have some board games and margin [ph] games alike, which are fairly general casual games. But we will also have some kind of what I call “mid-level” casual games. Those mid-level casual games will be examples like a Puzzle Bubble-type [ph] or a Tetras-type [ph] of games.

Thank you.

Thank you.

Frank, I’m Denny. Regarding your questions on the share count, in particular, the diluted share counts for calculating the diluted EPS number, I think you mentioned about a change in the calculation base. But that is actually to reflect the change in the US GAAP. There is a US GAAP called EITF 04-08, which becomes effective as of last year end. So from last year end onward, we have already changed the basis of calculation to reflect the potential, the contingency issue, of our shares on the convertible bonds.

As you know, we have $100 million US convertible bond, and that convertible bond is depending on a particular condition; in particular the price levels -- whether they can convert to ADS or not. And in the past, before the effective of the EITF 04-08, if the conditions, including the price, does not meet with the required conversion level, then we don’t need to consider the contingent issue of our shares. However, after the EITF has been effective, I think it’s equal to everyone that this contingent issue about shares should be taken into account in calculating the diluted share count. So effectively, we increased our share count by around 2 million ADS. And that change has been applied retroactively back to the previous quarter. In the last quarter we already -- in Q4, we already explained that and also reflected the change and restated all the EPS numbers in accordance with the change in EITF.

And also, regarding your third question about the bandwidth cost. In Q1, we have purchased additional bandwidth so as to increase bandwidth capacity instead of the telecos increasing the price. As you know, as our business is growing, we will need to incur additional bandwidth costs. But the bandwidth cost increase will not be as fast as the growth in the revenue. So I think the bandwidth cost will continue to increase as our business grows. However, that will not impact on the margin very much going forward.

We’ll take our next question from Jason Brueschke at Pacific Growth Equities.

Thank you. Let me add my congratulations on a fantastic quarter, gentlemen. Let me maybe follow up on a specific question that Lu Sun asked that I’m not sure was completely answered. One of the questions she asked was what might be the possible impact on the launch of either the Tang or your 3-D game of the fact that you will most likely have World of Warcraft out there and perhaps doing strongly. You have a -- I’ll add to that, and say Shanda had announced that they may bring Dungeons and Dragons to the Dungeons and Dragons Online about the same time.

Should we be thinking that, if those two games are doing strongly, that you might delay the launch of your 3-D game and/or how should we be thinking about what contingencies in terms of increasing marketing expense you would do to get your game maybe some buzz and attraction if there are two powerful 3-D games on the market at the time?

Michael, can you comment on that?

Yes, sure; of course. Again, our view is that we actually want to see that the total 3-D game market or, I would say, the higher hardware configuration market, continues to see growth in that area. Obviously, because we are also working on our 3-D games that are going to be launched in the later half of this year. So if World of Warcraft has a reasonably good performance, I think it is a good thing to see for the health of the market.

And for the 3-D games that we are going to launch, we think it is going to be a fairly competitive product, firstly, in terms of the games played. I think we have the best understanding of the Chinese consumers and gamers in the market right now. And also, in terms of the Chinese mythology-type of culture, I think we are also the companies with the best expertise. And in terms of the graphics, I have looked at World of Warcraft and also our own 3-D game. I think we are maybe on par. So looking at different elements of making a game successful, I think we have actually got a very, very competitive product, if not a better product. So we only want to see that the overall 3-D markets are in a very healthy mode.

And in terms of the marketing costs, as Ted explained, I think the process that we need to make, some of them will involve some costs. But actually, some of them well actually doesn't require a lot of cost; it could be a partnership with different promoters of brands in the market right now which might not actually involve a lot of cost. And again, the projections and the guidance that we are giving out we have already accounted for some of the contingencies that -- if we need to increase our marketing costs.

Denny, can I maybe just follow up? Can you maybe give us a little bit more color on what exactly are your assumptions? You say the guidance for Q2 specifically has taken into account your assumptions of possible impact of not only World of Warcraft but Magical Land. Kind of, what are those assumptions? Are you assuming that they’re going to take no business from you, or what percentages of possible drainage, especially during the open beta period, are your assumptions?

For the open beta of the two games of World of Warcraft and Magical Land, the assumption is that we might actually experience slower growth for May and also June during the open beta of these two games for Fantasy Westward Journey and Westward Journey Online II -- slower growth compared to that of Q1. So basically that’s the assumption.

And for the marketing expense, we have a margin of around increments of $2 to $3 million or [ph] MMB in terms of the increments in marketing expense that we might need to put out as also kind of the margin.

Thank you. Maybe my last question is, with respect to Fly for Fun, could you give us, maybe, some more specific details of when? You said the second half of the year. Are there any concurrent user numbers presently? And what are the concurrent user numbers that you guys think you need to have before you would take Fly for Fun commercial? Thanks.

Yes; sure. For Fly for Fun, the peak concurrent users right now are around 23,000 during this open beta. Obviously, it’s a very small number and it’s lower than our own expectations. I think we will at least need to have 50,000 peak to use if we are going to commercially launch the game. Typically, when we commercially launch a game, half of the users will probably leave the game. So that’s only a general idea for your information what will happen when we commercial launch the game.

Great. Thank you.

Yes.

Thank you. Next will be our final question.

Thank you, sir. The final question today will come from Wallace Cheung with DBS Vickers.

Hi, guys. Great quarter. Just wanted to check a couple of figures. What is the amount of revenue from fantasy in terms of the total online game revenue?

Yes. The total revenue for Fantasy Westward Journey was $144.8 million. And that’s the gross revenue.

It’s gross. Okay, thank you.

And for Westward Journey Online II, it was $117.3 million.

While we support [unintelligible] as far as Westward Journey II, I think it’s the first time.

Yes.

Secondly, can you give us an idea about the instant messaging developments in terms of subscribers and peak concurrent users?

Michael, can you comment on that?

For the Pau-Pau.

Yes, sure. For the Pau-Pau, the total registered number of users in March is around 27 million. And for the peak concurrent users in March, it was 423,000.

Great; thank you. And also, regarding search, can you give us the idea about the search revenue in first quarter and maybe even in the fourth quarter last year?

Yes. In the first quarter, the revenue derived from search engine was around 11% of the total advertising revenue.

And how about --?

It was a very similar level in Q4 last year.

Great, thank you. And finally, I couldn’t catch up to figures regarding what is what. What's the percentage from 2.5G?

The 2.5G percentage?

Yes, [unintelligible] percent from SMS, right? And what’s the revenue from--?

Thirty-four percent from SMS and 20% from 2.5G.

Twenty percent. What’s the remaining [part] of it?

The remaining other fee-based products such as email, etc. Mainly email.

Exactly; mainly email. Okay, great. Thank you. [Break]

And, gentlemen, I’ll turn the conference back to you for any closing or additional remarks.

Again, thank you for joining us today. If you have any additional questions, please do not hesitate to contact myself, Denny, Michael, or any of our investor relationship representatives. Thank you, everyone.

Once again, that does conclude today’s conference. We thank you for your participation.