NetEase Inc (NTES) 2005 Q2 法說會逐字稿

Hello everyone and welcome to the NetEase 2005 second quarter conference call. I would now like to turn the call over to Miss Brandy Pearce [Suntay]. Please go ahead ma’am.

Thank you operator. 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 we will open the call up to 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 subject to certain risks, uncertainties, assumptions and other factors. Some of these risks are beyond the Company’s control and can cause actual results to differ materially from those mentioned in today’s press release and this discussion.

Risks related to the fluctuations in the value of the Renminbi with respect to other currencies could also adversely affect the Company’s business and financial results.

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 of this conference call will be available on the NetEase corporate website at corp.netease.com.

I will now turn the call over to Mr. Ted Sun, Acting Chief Executive Officer of NetEase.

Thank you Brandy. Hello everyone and thank you for joining us. I'm extremely pleased to report that during the second quarter Fantasy Westward Journey continued to gain even more popularity among Chinese gamers attracting 710,000 peak concurrent users in June. And maintaining its leading position as 1 of the most popular MMORPGs in China.

Fantasy Westward Journey, together with Westward Journey II, in total attracted over 1.2m peak concurrent users playing each in-house developed MMORPGs.

The success of these 22 games is a testament to the strength of our in-house development capabilities and our extensive distribution network. And I will let my colleague discuss this business with you in more detail in a minute.

The success of our high margin On-line Games business helped drive revenue growth in the second quarter with total revenues up over 90.2% year-over-year and 27.2% sequentially over the last quarter. These results enable us to report another record quarter of net profit.

Our Advertising business performed well this quarter partly as a result of the second quarter seasonally increased in online advertising and our accelerating popularity among our portal users. In the second quarter we witnessed strong year-over-year growth of approximately 30.8% as our efforts to improve our portal and channel content and further strengthening of our advertising sales and marketing efforts contributed to another solid quarter of growth. We view the future of this business as one with enormous potential as we drive new users to our community through the enhancement of existing services and channels on our portal.

We are currently exploring new ways to leverage the revenue potential of our channels through strategic partnerships that will improve the best of channel content to our users. With improved channel offerings we believe that we will be well positioned to attract more users and increase use of loyalty, which in turn drives advertising spending.

We continue to monitor our Wireless VAS business as we wait for the tough competition in the wake of an evolving regulatory environment to develop further. We hope that at some point the market will be less turbulent and will provide opportunities for companies like NetEase with solid resources to re-enter this space.

Second quarter revenues for this business dropped slightly, mainly due to decrease in revenue from SMS business. However, we continue to believe that the long-term potential of our SMS services, such as MMS, WAP, IVR and COLORing Back Tones are steadily increasing and could provide the strategic growth opportunity in the near future.

Let me turn now to Michael who will provide an overview of the Online Game business for the quarter.

Thank you Ted. Hello everyone. I am extremely pleased to report that total revenues for this business grew 146.5% year-over-year driven by the continued success of Fantasy Westward Journey and Westward Journey Online II. And grew 31.1% sequentially over last quarter for our Online Game revenue.

As Ted mentioned, in the second quarter of 2005, Fantasy Westward Journey grew to 710,000 peak concurrent users in late June and maintained its leading position as 1 of the most popular MMORPG in China. We are very proud of this success and attribute it to a number of factors, including content enhancements through expansion packs released during the first quarter, the continued effort to expand the Company’s distribution network to access the game and distribution of point cards and further penetration into the market by enhanced sales and marketing efforts and online driven events.

The success of our in-house developed 2D games is not only evidence of the continued health of China’s MMORPG market, but a demonstration of the skill of our team to bring to markets to produce games that drive loyalty from our users.

We believe we have strong views in combining traditional Chinese culture and advanced gaming technology, which has always proven to be a winning combination for us. This gives NetEase a distinct advantage over our competitors.

Turning now to our new game pipeline. We are pleased to report that our 3D game is on schedule and we have made significant progress in the development stages of this game.

Our plans to launch our 3D game in closed beta during Q3 remain unchanged. We are confident and excited about the entry of our next blockbuster game into the market. As the first to develop such a highly advanced game, we believe that it could contribute significant revenue in 2006.

Additionally, the development work on our next generation 2.5D martial arts MMORPG Da Tang is also progressing well. Both games are on track and will be ready for closed beta in the third quarter.

Beta testing for Fly For Fun is ongoing. The first stage of beta testing for Fly For Fun was designed to address medical issues and susceptibility and we are yet to announce the commercial launch for the game.

Finally, as mentioned previously, we beta launched the initial platform of multiplayer arcade style casual games in the second quarter of 2005. We expect this genre of online games to attract a wider range of users than MMORPGs and leverage our portal community. We anticipate that the total number of casual games, including successive add ons, will total around 20 by the end of the year.

Let me know 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 the press release I will review the financial highlights of the quarter and provide some additional information on key metrics and results.

Total revenues for the second quarter were $50.4m. This represents strong year-over-year growth of 90.2% and a sequential quarterly increase of 27.2% driven by our Online Games and Advertising business.

We report another record quarter of net profit which reached $29.3m, or $0.83 per diluted ADS in the second quarter. This represents 147% increase over the corresponding period in 2004 and a 57.8% sequential increase over last quarter.

The ongoing success of our 2 in-house developed online games improved revenue in our Online Game business up to a record high of $41.5m. This represents a significant year-over-year increase of 146.5% and a 31.1% increase over last quarter.

Revenue from Advertising business for the second quarter were $6.5m, representing a strong year-over-year increase of 30.8% as new advertisers continued to be attracted to our large base of loyal users. Additionally, we posted a sequential increase of 18% in revenue, mainly due to the new sponsorship and partnership advertising contract in the second quarter and to a lesser extent, to the traditional second quarter seasonal increase in demand.

As Ted mentioned earlier, our Wireless Value Added Services and Other business continues to face enhanced competition and declining popularity of SMS products. This caused total revenue from this segment to fall by 2.7% quarter-over-quarter to $2.4m.

Overall gross profit for the second quarter was $39.5m, a 99% year-over-year increase and a 29.1% increase over last quarter.

Higher revenue growth in our Online Game business favorably impacted gross margin in this segment, which increased from 89% to 90.2% in the second quarter.

Gross margins in our Advertising Services business remained largely stable in the second quarter whereas gross margin for Wireless Value Added and Others decreased to 18.4% in the second quarter mainly due to server depreciation charge which were high in the second quarter due to a rise in the number of free email users.

Total operating expenses for the quarter were $9.7m, representing a 25.8% increase over the corresponding period a year ago and a 11.5% sequential decrease over last quarter, mainly due to the $2.5m expenses incurred in last quarter resulting from the purchase of the 3D gaming technology as discussed in the previous quarter’s earnings release.

Our effective tax rate decreased in the second quarter because we have recently confirmed with the relevant tax regulators 1 of our operating subsidiary qualifies as a software company under the applicable tax law and the current practice of the local tax authority. Therefore is entitled to a reduced enterprise income tax rate of 10.5% instead of the 18% tax rate which applied in the first quarter of 2005.

Moving to the balance sheet. As of June 30, 2005, our total cash and held-to-maturity investments were $329m, a 9.6% increase from the previous quarter. We reported an operating cash flow of $30.9m for the quarter.

Also, for the Chinese government recent decision to peg the exchange rate of the Chinese RMB against a number of currencies rather than just the US dollar has caused the RMB to appreciate slightly against the dollar. Although we cannot predict the future direction of RMB exchange rates with other currencies, we believe that the appreciated exchange rate with the dollar if it continues or further appreciation occurs will tend to have a positive impact on our reported financial results since we generate all our revenue in RMB, which has become more valuable in dollar terms.

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

Thank you Denny. I would now like to take you through our financial guidance for the third 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 that the total gross revenues of the Company in the third quarter this year to be between $58 and $59.7m with Online Game Services revenue to increase by 12 to 15% quarter-over-quarter.

Advertising Services revenue to increase by 25 to 30% quarter-over-quarter and Wireless Value Added Services and Others revenue to be flat to a decrease of 5% quarter-over-quarter.

Net profit we expect to continue to increase during the third quarter to between $32.6 to $34.2m.

Let me conclude by saying that we believe NetEase has the right strategy, resources and infrastructure in place to continue to deliver strong financial results to our shareholders. With Fantasy Westward Journey’s current success and exciting game pipeline in place, we expect that the remaining half of year 2005 will be a positive period for our Online Game business.

We also believe that our efforts to improve channel content and grow our portal traffic will lead to increased advertising revenues.

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

Thank you. [OPERATOR INSTRUCTIONS]. We’ll go first to Safa Rashtchy of Piper Jaffray.

Good morning Ted and Denny, everyone. Congratulations on a great quarter.

Good morning Safa.

My first question is just a housekeeping item. Ted, on the guidance that you gave are you using the new exchange rate as opposed to the numbers that I assume were based on the old exchange rate? Can you just clarify that?

Yes it is based on the exchange rate that we used for the second quarter. So the new exchange rate.

Okay, can you tell us what that rate was?

8.11.

Okay. Great. Thank you. Second question is that the level of guidance you provided, obviously you had a tremendous quarter with 31% sequential growth. Why do you expect that growth to slow down significantly to, and I believe I heard you say 12 to 15% in Q4 -- Q3 rather?

This is Michael. I will answer this question. Let me explain first on the growth of the Q2 was mainly because of 1 -- there is an expansion pack released for Fantasy Westward Journey in late March. And the effect of that is flow into most of the Q2 of course and also there is also a major technical improvement that we explained in our previous conference call also in -- that was spent in Q1 and the result of that is also flow into Q2. And the reason for we gave this guidance of 12 to 15% is the reason is the transition of the expansion pack of Fantasy Westward Journey which we are going to release in September. So we will see, or expect, that for Fantasy Westward Journey the growth -- the high growth will be resumed when we are going to release the next expansion pack. So there is kind of the transitional period between expansion pack for Fantasy Westward Journey.

Of course there is also an expansion pack just being released for Westward Journey II right now. But of course with Westward Journey II of course it is a much older game and even with the release of expansion pack we are only estimating low single digit growth for the game. That’s why if we combine the 2 together, 12 to 15% we think it is a very reasonable projection for the Online Game business.

Okay. Thank you Michael. That helps. Second, if you could talk about what success so far you’ve had, or what is the assessment you have of your casual game platform and what do you see for that genre of games to play, especially in 2006. I understand it is still new, but to what degree do you expect it to be a component of the Online Gaming revenue?

Right. Let me update you a bit more on the casual games. We have just go into -- we have launched the casual games on July 1, specifically for beta testing, open beta testing. So far we have registered users of a bit over 300,000 right now, which is a number that is up to management expectation for 1 month of open beta operations. And also without much of the marketing effort as yet.

We are going to turn this into commercial within 2 week’s time. Commercial of course meaning that the players, 2 player game is also still free of charge. But that we are only going to charge on the virtual items or kind of the special membership for these games.

Right now we have 10 games. 10 casual games in the platform and that we are planning to have around 20 games by the end of the year and this is going to be an ongoing effort to continue to have more and more casual games to be developed for this platform. So on average it will be around 8 to 10 games for every half a year and also for 2006 as well and all the way going forward.

For 2006 we are already in the plan to decide more advanced casual games rather than the casual games that we have just released. These more advanced casual games would be comparison of more like cart racing games or other kind of sports games where we have already seen successful and proven cases in places like Korea that these games can generate more revenue as the casual games. And this is also a very important growth strategic growth area for us in 2006.

Right and 1 last question if I may? Could you just comment in general about your assessment of both the competitive landscape, certainly with introduction of World of Warcraft and other games, as well as regulatory environment. Are they getting any more difficult and to what degree? Whether the fact in your guidance has been kind of still your expectation, or is it the same as you’ve seen in the past?

Of course, on the competitive landscape, we continue to see more and more new games coming out from different operators, including those of course listed operators and also operators that you may not have heard of those names before.

Of course there will be a lot of open beta ongoing in the market where it used to be. But the way we view it is that most of these games contents, or the quality of these games can be compared to that of the games that we operate in right now and the games that we are going to launch. So the conclusion of that is there might be some like a kind of disruption in the market when they make a lot of marketing effort and there will be some players going to the open beta for those games for a while. But we are very confident that when these players compare with those games -- with the games that we have, they will definitely come back to us -- come to our games after they played these games, or both games.

So this is kind of the market place that has been happening for the past 2 years and there has always been a lot of games or competition outside that we have already proven that we continue to grow our games. And we continue to very confident about the quality of our games.

Secondly, on the regulatory environment, is that of course people have been talking about what has been called a fatigue system, or the anti-eviction system that is being discussed with the general administration of press and publications. I can give you a bit more detail on this.

There has been a discussion between the JPP and the major second operators of the game operators in China to decide on an anti-eviction system. And this is mainly for the purpose of long-term growth of the industry rather than to let the JPP is not supporting the industry. In fact, JPP is definitely supporting the industry with lots of effort and so for the long-term growth of this industry, JPP decided that these 7 operators should improve anti-eviction systems. We have a lot of discussion with JPP on that and also the scheme has basically been decided. But since that issue -- I think it should be a formal announcement from JPP rather than from us. That’s why I cannot give you much of the details. I can give you a bit of details right now.

1 very important point is that there will not be any mandatory lock off in the games. That means that the scheme is that basically for the first few hours the users receive the normal experience points and then for the next few hours they users will receive less of experience points. But there won't be any mandatory lock off of the game okay. There will be time required for the testing and implementation of these systems into the games and that is going to take, in my own personal experience, opinion, at least a few months. And also we believe that there will be minimal effect to the 2 games that we are operating right now mainly because first the games that we have right now we have very similar systems that is already implemented into the games for long time already. Basically the system is that the player will get double the points of the experience for the first few hours when they play the game. So we have already implemented similar systems in our games since we started operating these games.

And secondly, is also because that the ARPU of our games is not very high anyway. So we don’t feel that there should be any major effect in our games.

Okay. Thank you Michael very much. That’s helpful.

Let me clarify on the exchange rate. The Q3 guidance that we are giving in US dollar terms is in the exchange rate of 8.2765, which is the same as the second quarter. We have not used the new exchange rate because we want to maintain the comparability, which means that there will be around less than 2% increase if we were using the 8.11, which is the new exchange rate. Let me clarify that.

Okay. So you only have 2% upside built into your guidance. Thank you.

Our next question comes from Lu Sun with Lehman Brothers.

Hi everyone. Congratulations on the good results. I have 2 questions. The first 1 is on your Online Advertising business. The guidance for the third quarter extremely very strong and that is especially true compared to some of your competitors. Can you actually give us some guidance related to the rest of the year because it seems like some of the local handset makers and consumer product companies are experiencing financial difficulties? Do you think that will impact your business? And I will have another follow up. Thank you.

Yes in third quarter we are expecting an increase of 25 to 30% quarter-over-quarter growth in Advertising Services and that’s due to first of all the seasonal reason. Because usually our advertisers are spending more money during the summer holiday and we have more, a higher proportion of advertisers in those categories.

In terms of Q4, we do not usually give guidance in the following quarter. But as you can see from our historical pattern, Q4 is usually a lower season and experience a decrease from Q3. And we are expecting similar pattern for this year as well.

Do you see any problem collecting money from some of the advertisers that are in the consumer electronic business, or consumer product business?

From electronic companies, yes I think the--

Especially the handset makers.

Sorry?

Especially as the handset makers.

I think we are having some receivable issues with a computer maker rather than a handset maker. But for consumer product companies, most of our advertisers are international companies such as Pepsi, McDonalds. So we do not really have any receivable issues with them.

Okay and my second question is for your Online Games business. I just want to check whether the Da Tang internal beta trial is going on well and also for the major title Tian Xia that will be launched in the fourth quarter. I want to get a sense on your marketing budget for the game and also how you differentiate this game from the other major titles in the market such as World of Warcraft and [NH2] II. Thank you.

Yes sure. On Da Tang, the internal beta is progressing well and that we are planning to have the close beta to be launched within somewhere around 4 to 6 weeks. And for Tian Xia as we also explained that the closed beta is decided to be launched within the third quarter which is as mentioned before. Simply, again on Da Tang, the specific functions or features of this game is that it is based on martial arts and then it is also based on historical the Tang Dynasty background where it is the 2.5D game where the graphics requirements for the game is very low. Although that performance of the graphics, I mean when the players play it, they feel like that it is kind of like a 3D graphics. So it is a very good game targeted towards second, third or to a third tier sittings.

And then for Tian Xia, again that we continue to feel very confident about this game. Tian Xia, the 3D game we believe that again that the graphics for this game is the best of which we have ever seen for any domestically developed games which is also basically on par with that of our competitors like World of Warcraft, or NH2. But in addition to that is that we have very strong research on the Chinese culture background. That is being implemented into the game and that is also very suitable to the taste of our customers and that of course we have been able to prove that. Most of the customers or the players actually like to play Chinese culture style games and also the game has also been improved and enhanced over the past few months, especially where World of Warcraft has increase of course increased the standard for online games. So for Tian Xia we think that we've been able to differentiate the games with that of our competitors.

What is your marketing budget for these games? Do you think that the marketing budget will actually depress your margin going into the fourth quarter?

The marketing budget for this game will be starting more on the fourth quarter and also in the first quarter of ’06 of course. The marketing budget, as we mentioned before, is not going to be like really huge. We are expecting around somewhere around $1 to $2m. Let’s put it this way. Somewhere around $2m+ for both games together. US dollars.

Okay. Thank. Okay. Thank you very much.

We’ll go to our next question from Dick Wei of JP Morgan.

Hi good morning Ted, Michael and Denny.

Good morning.

Congrats on a good quarter. I have 2 questions. The first question is can you talk about on your games pipeline in 2006/2007 and the licensed games and Westward Journey III?

The second question that I have is I noticed that during the second quarter there were more game merchandise like t-shirts and also some quite expensive items like 99.9% pure silver plate for $870. I wonder where are those merchandise are booked in terms of the category and how much do you think those revenues will be in the second quarter and going forward? Thanks.

Let me explain a bit on the game pipeline. On the game pipeline for 2006 or course we will continue to look at possibilities of licensing more games in China outside from China. In terms of the tenor of those license games we are expecting to license games that is probably not MMORPG but somewhere small like the casual MMORPG or advanced casual games. That is the kind of game that we are targeting to license principally in the later half of this year. also in 2006 as well. Simply because we already have 2 very good MMORPGs coming out and that we also have the low level casual games already in place in our casual game platform.

For 2006, Westward Journey III is also we have physically we have set up the team for more than 6 months basic design of the game and that we are planning to have this game to be in a very, very preliminary plan right now is to have the game to be launched somewhere in late 2006. Then we have also recently established another team. That is for the purpose of designing a new game and developing a new game that is going to be released in mid 2007.

Other than that, of course there will continue to be expansion packs for the games that we are operating right now and also including the games of course Da Tang and Tian Xia. That is going to be launched in this year. So in 2006 we will also have some expansion pack for both Da Tang and Tian Xia and of course also expansion pack for Westward Journey II and Fantasy Westward Journey.

Then for the casual games, as I have just mentioned before, right now is 10 games. By the end of the year it will be around a total of 20 games and the continued ongoing effort is to have around 8 to 10 games per half a year. Those will be more advanced games as well.

And Dick on the game sale merchandise sales, the amount in Q2 was very insignificant. It is being grouped under the Wireless and Others category which means that the Online Game revenue line that we are reporting, they are purely the online game playing time revenue instead of the merchandise sales.

Just maybe a follow up on the game development. For the longer term do you expect to develop more like 1 to 2 games per year down the road?

For major, major MMORPG yes that is probably correct. Around 1 to 2 major MMORPG.

Great. Thanks a lot. Congrats again on a good quarter.

Our next question comes from Wallace Cheung of CSFB.

Hi. Good morning. Great quarter for everyone. Just a couple of housekeeping questions first. Can we have the breakdown of the Wireless Value Added Service fee in terms of SMS, MMS and IVR?

Okay Wallace. In 2005 second quarter the Wireless and Others revenue totaled $15.7m and among that approximately $11m is from SMS. Then around $5m or so is from the 2.5G services. The other around $3.5m is from the Other variable portal premium services such as VIP email etc. And the other less than $500,000 is from the merchandise, game merchandise sales.

And another housekeeping question is what is the amount of pay search revenue in second quarter?

Is around 11% of the total Advertising revenue in the second quarter.

About the same as the first quarter?

Yes.

Right and then I recognize the deferred revenue item in second quarter that the increase is actually I think comparing with the first quarter increase is actually lower. Is there anything indicated in the future sales of prepaid cards?

No. In fact revenue, deferred revenue, does not have much of an indication of the sales of the -- the sales come into deferred revenue does not have much of an indication of the future sales of the Online Game revenue.

Right.

It fluctuates from quarter-to-quarter all the time.

Okay and also another question regarding I recognize the number of shares and also the value of the shares is actually increasing. Is this because someone, or the Company actually issuing new options for keeping maybe some good employees in the Company?

Yes. We in the second quarter we actually issued around 700,000 ADS of different options to our key employees including middle management which is key to our business. This compares with the 1.7m options issued last year in 2004. This is significantly reduced. That is the information.

Is it possible to have the latest number of options outstanding?

I don’t have it on hand, but I can give you later if you want it.

Thank you. I think another question is actually related to my previous questions actually. It seems the growth of the R&D expenses is quite low compared with the growth of the revenue. Given your team is so successful, I'm just wondering how the management can actually keep the good pattern growth in the team given that there is maybe a lot of new entrants, global players, they try to grab your team members? [Indiscernible].

Well first of all the salaries are already very competitive to that of our competitors. Also of course, basically most of the employees have options been given to them. But compensation is not just the only thing that we are giving to our staff. We also have developed a very good training program, both in-house and both from third parties, to be given -- well basically there has been given for the past over 1.5 years to 2 years for all our staff. And also we have a lot of good pattern. Basically we are the strongest in self-development in China right now. We’ve got a good and competitive compensation and also good training. Actually I don’t see much of a reason why these guys want to work in the second tier grades.

Okay. Thank you so much. A very good quarter. Congratulations. Thank you.

Thank you.

We’ll move next to Richard Gee of Morgan Stanley.

Hi Denny, Ted and Michael.

Hello Richard.

Hi. A very impressive quarter. I have 2 questions. Number 1 you haven’t touched up on the potential impact of World of Warcraft on your game, especially as World of Warcraft was commercially launched in the June time frame. And you're also guiding a slightly lower growth in Online Games for next quarter. How much of that lower growth is due to the impact of World of Warcraft?

Well World of Warcraft, the game has already turned into commercial for almost 2 months right now and of course there has been some people suspecting that when a game turns commercial that the player actually have to decide to play only 1 game and then there will be more of an effect over the current market place. But so far we don’t see much of an effect mainly because for 1 is that our games and World of Warcraft, the games that we are operating now and the World of Warcraft is targeting at very, very different demographics. The games that we have is 2D games right now. Players, distributors announce most evenly distributed in the country where World of Warcraft is still a game mostly targeted towards the first tier cities. And also it is Western culture and Chinese culture differences.

So I actually don’t see much of an effect that is having on Fantasy Westward Journey or Westward Journey II from World of Warcraft and simply as I mentioned.

My follow up question is that people have failed to give you credit for your channel strategy and I think it means at the end of the day your game content, your distributing channel for your online game has been extremely effective. Can you elaborate a little more on your channel strategy, particularly in comparison against your chief rivals such as Shanda, such as [indiscernible]?

Well simply said, if we don’t have the distribution channel how can we make these numbers? So basically we--

But I was trying to get more color on sorry.

Bit more specifics?

Sure.

In China it is in fact a very well designed distribution channel that we have been doing since the very beginning of having the Online Game business. And that is we are basically selling our products in a direct way rather than on relying on ourselves to the kind of national or the provincial distributors. The good thing about it is that our distribution channels is much more direct and we don’t have any reliance on these guys. And also the profitability and the margin for us is much better than compared to our competitors. So I don’t see why you are not giving credit to the distribution channels that we have been developing for the past 2 years.

Yes. I guess what I'm saying is that you guys should be billed more credit. That’s what I'm saying.

Okay.

For your channel distribution. Okay yes, thank you. That’s all the questions I have.

Thank you.

We’ll go next to Frank Shi of CLSB -- of CLSA.

Good morning guys. 1 question on the games and 1 question on the Online Advertising business. On the Games business, I know it is hard but is it possible to breakdown the growth in your Games business down to the growth in number of unique players and in the number of hours each player plays?

My question on the Advertising business. Can you give us a breakdown by your customers’ industry? Which industry contributes the most of your Advertising revenue and which is second?

Yes let me answer the Advertising 1 first because that is more simple. The IT services and products represent the largest revenue, advertising revenue industry group for us.

Right and then has that been changing, or do you think that the IT portion is going down or is it going faster than others?

That has been pretty consistent for IT services and products.

Okay. Thank you.

And then for the Online Game, the ARPU for both games has been pretty consistent and steady. And for Westward Journey II, basically the ARPU for Westward Journey II has been around 46 hours per month and that’s in the first quarter. And also for the second quarter it is around, basically around the same number. Perhaps a little bit higher which is around 47 hours per month.

Then for Fantasy Westward Journey, which we also have very similar numbers. For Fantasy Westward Journey for the first quarter, basically we have also around 44 hours per month. Then for the second quarter is around 43 hours per month.

Right great. Maybe I have another 2 questions on the Games business. 1 is with your competitors launching similar games as your Fantasy Westward Journey and in the Q-bank games, do you think the competition is going to come up? Do you think that they will be a major threat?

My second question on the Games side. How do you differentiate yourself in the casual games business because it seems like everyone is rushing to that market?

Yes it is true. These are very good questions. For the casual games, well let me expand on the casual games first. It is true that the casual games have the lower barrier of entry and that a lot of competitors are rushing into the market right now. But the way we see it is that the self-development team of NetEase are being able to implement and integrate all these casual games into one single platform. It is very important advantage over our competitors because the way we see it is our competitors when they import games here and there from Korea or from the United States, it is very difficult to be put into 1 single platform. Then it will definitely increase the churn rate of these guys and we can keep a very low churn rate simply because of this 1 single platform.

Then second is of course in our strategy we are going to design more advanced casual games in the later half of this year. Not so in 2006 and we believe that the quality of these games and also the kind of sophisticatedness and the game place -- the game playability of these games we also make the differentiation compared to our competitors.

Secondly is on the Q version games being released in the market right now. Again, I think these Q version games they will be here and there all the time and small disruption into the market place, especially when these games have a huge marketing budget and expenses. But again, in terms of the quality of these games and the contents of these games, we believe that those are not so much comparable to that of the games that we have launched and operate in so far. So during the opening of these games, maybe some players will try those games. But we are very confident that these players when they try both games they would purchase our games.

Okay. Thank you.

Okay, thank you Frank for the questions. Next will be our final question.

We’ll move next to Jason Brueschke of Pacific Growth Equity.

Thank you. Good morning gentlemen and congratulations on the quarter. I'm going to try to tie 2 of the previous questions together. Safa’s question on the possible regulatory changes around the fatigue system or the anti I guess you called it a -- forgot exactly what you called it. It was called the fatigue system. Then Frank’s question about the number of hours per month that your players are playing. If I understood Michael’s answer, it’s twofold. That this change is likely to go into effect probably in the fourth quarter. This is my question. With your average players playing 46 to 47 hours a month or whatever your games allowance – 45 -, could you explain why if assuming these play on the weekends and may play for a longer blocks of period of times, we don’t expect to see maybe weekend play being impacted by this new fatigue system?

Yes, again on the fatigue system I can explain. Well I can explain what I can say so far because I think we should wait for some announcement from JPP. But again, the main point is that there will not be any mandatory lock off from this entire section of fatigue systems to be implemented. So these players basically can continue to play the game but they will receive less of an experience point. But the games that we have been designing so far we already have similar systems in the game.

And secondly is that the ARPU that we have mentioned it’s well somewhere like 45, 46 hours, which is around 1.5 hours per day. So a typical -- basically a typical usage maybe they play around like 1 hour or so, or 2 hours -- 1 hour or so during the weekdays and then maybe 3 hours on Saturday and then 3 hours on Sunday. Something like that. Which we think is definitely within the healthy or non-addiction time period that is being implemented.

Great. Thanks Michael, that’s helpful. Maybe just skip to another couple of questions on the Gaming business. You’ve indicated that you're going to be in closed beta this quarter for both Da Tang and the 3D games. Can you give us an estimation as to how long you expect to be in closed beta? I think you were in closed beta for quite a while with Fly For Fun and I'm wondering is do you expect it to be a similar length of time, longer or shorter than with Fly For Fun?

Right. Again, Fly For Fun is our management expectations that when we are trying to fix the games in terms of the serviceability, it’s an imported game, it’s a game being designed by our Korean partners and we have faced with a lot of difficulties in learning into a new service systems. But the service systems that we are going to use for Da Tang and also for Tian Xia is all self-developed and is also an extension of Westward Journey and Fantasy Westward Journey. So we have -- our guys are very familiar with those systems. This gives us a much better confidence on being to have a much shorter closed beta period. And we are expecting to have closed beta of around 3 months altogether with open beta of around 4 months or so before commercial launch.

Great. Maybe 2 final questions related to Fantasy. You’ve given us the peak concurrent user numbers at the end of Q2 and your peak concurrent user numbers at the end -- excuse me. At the end of Q1 and at Q2. So it went from 585 to 710. Could you tell us what the linearity of that was and what I'm wondering is did you see faster growth in the month of April than you did say in the month of June, or was it just pretty much a steady slope throughout the entire quarter?

We can go a bit into the July figures. But again the peak concurrent users is not an indicator of the revenue being to be expected. It’s not a straight formula of the peak concurrent users being a linear proportion from to that of the revenue that we are generating. This peak concurrent usage it’s a figure that we are trying to publish to the players. There are a lot of players in the game and is to raise the publicity of the game.

In the summer months, the peak concurrent usage, especially kind of skewed because in the summer months most of the players kind of diffused. They're playing over the weekdays and the weekends to play the games rather than to have no push all the time during the weekend. So peak concurrent usage was not to have any expectation of another high PCU of so during the summer months. But it doesn’t meant the game is not growing at all.

Okay and then maybe more of a housekeeping question. Could you give us the revenue breakdown on Gaming between what Fantasy’s Q2 revenues were and what Westward Journey revenues were in the quarter?

For the quarter approximately 40% of the revenue comes from the Westward Journey II and 60% from Fantasy.

Great. Thank you gentlemen very much.

Thank you. Again, thank you for joining us today. If you have any further questions, please do not hesitate to contact myself, Denny, Michael or our Investor Relations representatives. Thank you everyone.

That does conclude today’s conference. Have a great day.