NetEase Inc (NTES) 2006 Q3 法說會逐字稿

Hello, everyone, and welcome to the NetEase third-quarter 2006 conference call. Just as a reminder, this call is being recorded. I would now like to turn the call over to your host, Ms. Brandi Piacente, Investor Relations for NetEase.com. Please go ahead.

Thank you, operator. Today you will first year from Mr. William Ding, Chief Executive Officer, and Mr. Michael Tong, Co-Chief Operating Officer, who will discuss some of the financial and operational highlights of the third quarter ended September 30, 2006. And finally, Mr. Denny Lee, Chief Financial Officer, will review the financials.

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 U.S. Private Securities Litigation Reform Act. Such statements are not guarantees of future performance and are subject to certain risks, uncertainties, assumptions and other factors.

Some of these risks are beyond the Company's control and could actually 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 replay of this conference call will be available on the NetEase corporate Website at corp.NetEase.com. I will now turn the conference call over to Mr. Michael Tong, Co-Chief Operating Officer, who will read the prepared remarks on behalf of William Ding, Chief Executive Officer of NetEase.

Thank you for joining us today. I will begin with an overview of each of our service segments. Total revenues for the third quarter decreased 0.6% quarter-over-quarter, but increased 23.6% year-over-year to $72.4 million. Online game revenues for the third quarter decreased 3.7% quarter-over-quarter, but increased 25.6% year-over-year to %59.2 million for the third quarter of 2006. Our online game revenues were impacted by worse than expected seasonality in the last month of the quarter. In addition to erroneous in-game projects that affected (indiscernible) user numbers during the quarter.

Certain users mistakenly identified an image in the game to be a Japanese flag and subsequently spread erroneous information and perceptions on our players. Such erroneous messages have expanded to a level that some players actually believe our games have been sold to Japanese investors. Once again, we also would like to take this opportunity to declare that our games are all self developed by Chinese in China and there is no relationship with our game to Japan.

Regardless of the impact on third-quarter's user numbers, Fantasy Westward Journey remains the most popular game in China and continues to dominate the MMORPG markets based on peak concurrent users' numbers or PCUs. Fantasy Westward Journey achieved peak concurrent users of approximately 1.22 million, down from 1.3 million for the second quarter and average concurrent users of 468,000.

We are looking to improve our Fantasy Westward Journey numbers and return to more normalized growth patterns with the game's latest expansion pack which will be released in the end of 2006. Westward Journey Online 2 achieved peak and average concurrent users of approximately 592,000 and 173,000 respectively for the third quarter compared to 561,000 and 197,000 respectively for the second quarter of '06.

Our latest release game, Datang, contributed modestly in its first quarter since commercialization on July 19th. We will continue to build new content and playing features and increase our marketing contribution for this game to drive user numbers.

For an update on our next generation online 3-D game, Tianxia II, development is progressing according to plan and we expect to commence open beta testing by the end of this year. So far we have tested Tianxia with approximately 6,000 accounts and the response has been very solid. We have been working on a number of minor improvements, but there have been no major technical or functionality issues. Our development progress has been steady and efficient and we are confident about the results of the upcoming open beta launch.

Turning to our new games -- Westward Journey 3, which we previously called Westward Journey 2.5 as a project code-name. The development progress is on plan and the internal beta testing will be launched during the second quarter of '07. This is a completely new game with a completely new engine, graphics and characters and we will migrate current Westward Journey 2 users with an exchange rate of user status numbers and data to this new game.

Longer-term we have four additional major games under development including the original Westward Journey 3 project, a new RPG or [LTS] type of (indiscernible) player online game and two advanced casual games. It is too early to provide details of these games, but it's important to note that between lifecycle expansions and expansions [facts] as well as new game development, our online game pipeline is full. We are fully capitalizing on our R&D and creative resources to keep momentum with the pace of the online game market which remains very strong in China.

Turning to our advertising services segment, revenues from advertising services increased 21.2% quarter-over-quarter and 13.6% year-over-year to $10.5 million for the third quarter of 2006. The revenue growth in this segment reflects the improved content and optimization of new products and services throughout the portal.

During the third quarter we released our new block services which has driven significant traffic already. We are confident to say that our block services are one of the most advanced in the market. Growth from technical stability functionality and registered number of users has reached over 13 million and is increasing at more than 100,000 new users daily. We will continue to improve the functionality of our block and also consolidate our other current community services such as alumni and bulletin board into the product.

In addition, a new redesigned homepage was also launched on the 12th of October which renders a better user experience and improved ROI to our advertisers and has been widely covered by the media as a new way to serve the Internet. Through several new strategic agreements and cooperative branding partnerships established during the third quarter we are continuing to improve and expand our online user experience and drive traffic volume within our online communities.

One example is that we signed a cooperative agreement with [101jobs].com, a leading Hong Kong recruitment group, to provide job information and career (indiscernible) to our users. Our cobranded job channels was officially launched on the 1st of October.

Improvement in content and product has also driven advertisers targeting high-end users and our advertisers now include premier automotive and computer manufacturers. Brand-names such as Daimler Chrysler, BMW, HP, Intel and IBM that target high-end and affluent audiences have increased their spending on our portals based on our user demographics and the high quality of our indirect advertising platform.

Average daily page views for the month of September were 535 million. Our third-quarter daily page view continues to rank NetEase.com as one of the most popular destinations in China and on the World Wide Web. And NetEase has also won the most number of rewards among major portals in annual China advertising awards festival which was recently organized by the China Advertising Association. And this is a very valued testament to the creativity and quality of services we offer within our online communities.

Now for a more detailed discussion of our financial performance for the third quarter I will turn the call over to Denny.

Thanks, Michael. I will now provide an overview of our financial highlights for the third quarter using numbers and percentages based on U.S. dollars. In order not to repeat what has just been explained by Michael on the revenue side, I will focus on explaining margins and expense fluctuations.

Speaking of that, in order to provide a more meaningful comparison of net current operating results to those periods prior to the Company's adoption of FAS 123R, which took effect this year, our discussion includes non-GAAP results for the third quarter. Reconciliations of NetEase.com financial measures are provided in that audited financial information including today's earnings release.

The Company's gross profit was $56.7 million in this quarter. Non-GAAP gross profit, which has excluded the impact of certain non-cash share based compensation expenses, was $57.2 million in this quarter, Representing a 2% quarter-over-quarter decrease and a 21.9% year-over-year increase. The decline in the Company's gross profit as compared with the preceding quarter was mainly due to the decrease in online game business revenue in this quarter.

Gross margins for the Company was 81.7% for the third quarter. Non-GAAP gross margin for the Company was 82.5% compared with 83.5% for the preceding quarter and 83.6% for the same quarter last year. The small decline in the gross margin in this quarter as compared with the preceding quarter was mainly due to the decline in the gross margin of our online game percentage as a result of the open beta testing of Datang at the beginning of this quarter.

Gross margin for advertising business was 56.1% this quarter. Non-GAAP gross margin was 58.9% compared to 53.3% for the preceding quarter and 68.1% for the third quarter of 2005. The increase in the gross margin was primarily due to stable costs relative to the revenue growth. Gross margin for the wireless (indiscernible) service and other business for the third quarter of 2006 was 3.4%.

Non-GAAP gross margin for the wireless segment was 7.6% compared to 1.9% for the preceding quarter and 11.3% for the same quarter a year ago. The slightly improved gross margin was mainly due to the increase in the higher margin SMS revenue in proportion to lower margin 2.5 G and other services revenue.

Operating expenses for the third quarter of 2006 totaled $16.6 million or 23% of total revenue. Total non-GAAP operating expenses for the third quarter of 2006 were $13.9 million compared with $14.1 million for the preceding quarter and $11.7 million for the same quarter last year.

The decrease in non-GAAP operating expenses in comparison to the preceding quarter was primarily due to a onetime write-off of $1.4 million in software costs for our licensed online 3-D game, Fly For Fun, in the second quarter. Partially offset by higher provision for double (indiscernible) expenses and increased research and development expenses associated with the increased staffing for enhancement of our existing product for the development of a new product in the third quarter.

Net profit for the third quarter totaled $39.8 million. Non-GAAP net profit for the third quarter totaled $43.1 million representing a 0.1% quarter-over-quarter increase and a 31.8% year-over-year increase. The increase in net profit in this quarter was mainly contributed by costs and effective tax rate reduction. We will continue to impose tight cost controls without harming our limiting our business growth.

We expect our effective tax rate to remain relatively stable; however, we also caution that is subject to a continuation of certain preferential tax treatment currently enjoyed by the companies within our group.

Basic and diluted earnings per ADS was $0.31 and $0.29 respectively for the third quarter, which includes the impact of approximately $3.3 million or $0.02 per ADS in non-cash -- non-cash share based compensation costs. This compared to $0.30 per ADS and $0.28 per diluted ADS for the second quarter of 2006 and $0.25 per basic ADS and $0.22 per diluted ADS for the third quarter of 2005.

As of September 30, 2006 our total cash and (indiscernible) balances was $478.7 million, up from $451.8 million at the end of June. Cash flow generated from operating activities was $43.6 million, an increase of 16% from the previous quarter and an 18.9% decrease from the third quarter of 2005.

In August our Board of Directors approved a share repurchase program of up to $100 million U.S. dollars of our outstanding ADS. As of the end of September 2006 we had effective transactions in the open market purchasing approximately 1 million ADS for an aggregate purchase amount of approximately $317.1 million including transaction costs, representing 17.1% of the total authorized share repurchase amount.

Now I would like to comment on our financial guidance for the fourth quarter ending 31st December, 2006. 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 total gross revenue to be between $65.4 million and $67.6 million for the fourth quarter with online game services revenue decreasing 6% to 9% quarter-over-quarter. Advertising services revenue decreasing 9% to 13% quarter-over-quarter. And wireless value added services and other revenue to be flat to a decrease of 10% quarter-over-quarter.

Net profit for the fourth quarter is expected to be between $32.3 million and $34.3 million. These estimates include the effect of share-based compensation expenses of approximately $3.2 million. Please note that such share-based compensation expenses are only our best estimate as of today and the actual expenses may differ from the estimates.

Also, we caution that we cannot predict the future exchange rate of RMB versus other currencies, and therefore cannot accurately estimate the effect of any changes in exchange rates on our financial results. Accordingly our guidance assumes no change in exchange rate in the fourth quarter and has adopted the same exchange rate as of 30th September, 2006 of US$1.00 to 7.904 RMB.

Our actual result could differ, however, from our guidance as a result of fluctuations in RMB exchange rates. Also lastly, in order to allow investors to focus more on the long-term value and strategy of our company, we will not be giving out quarterly guidance starting from 2007 first quarter. We will now be happy to take your questions. Operator, please go ahead.

(OPERATOR INSTRUCTIONS). Lu Sun, Lehman Brothers.

Good morning, everyone. I actually have two questions; I will speak Chinese first and then translate into English. Okay, my first question is actually regarding the fourth-quarter online game guidance. It seems like there is a pretty big drop Q on Q. Can management please comment on the competitive landscape and also some future outlook for the gaming industry? Thank you.

This is Michael. The main reason for the guidance of minus 6 to 9% is mainly because of the Fantasy Westward Journey. And we are looking at a similar rate of [12] for Fantasy Westward Journey similar to the rate of decreasing the guidance. And the main reason is because we have experienced quite a severe drop of the number of users around September which is the last month of this quarter.

And such a drop, even though we are looking at that contract to normalize growth, it seems that it is difficult to be able to achieve to a similar level like it was in July. So even compared to December to July, it is difficult for December to catch up with July figures. So it seems that we are going to experience quite a drop in a quarterly basis in this way.

And in terms of the competition in the market, I think why don't I just take a chance to go through why there is such a big drop in September. Obviously because, for one, as we explained, the Japanese flag and all of these things. In addition, I would say that obviously there are more -- there are some games in the market for example which I think are (indiscernible) that games like (indiscernible) which is the game offered by Kingsoft and also some other games are doing quite well in the market.

But I wouldn't say that they are totally targeting directly at Fantasy Westward Journey. But I think there are more free games in the market and in some way I would say that gamers definitely would like to try the free games a little bit. And that this has in some way affected Fantasy Westward Journey as well.

Wallace Cheung, Credit Suisse.

Operator?

Yes.

Can you let the person who asked who finished or comment on the answer first or at least we listen to "thank you". Can you go back to the first?

(OPERATOR INSTRUCTIONS)

Thank you. Thank you for the answer. But do you anticipate a very similar kind of challenge when you launch your Tianxia II -- a more promising 3-D game in the market? Because there are actually quite a few 3-D titles to be launched by your competitors as well?

I'm William. I concur.

Why don't I just translate in English very quickly? First of all, because Tianxia (indiscernible) very high confidence on the product and we have a very good quality game that we believe we're going to release. And secondly and most importantly is that similar level of quality of products that are in the market right now and all of them are fee based and charge on an hour basis or monthly paid. And so we don't believe that what we are facing in Fantasy Westward Journey with the three game's competitors would happen to our Tianxia.

Okay, thank you. I just have a quick follow-up on the advertising side, can I do that? My second question is on the online advertising side. There seems to be a pretty major deceleration in the year-on-year growth rate. I wondered -- especially relative to your competitors. What are the reasons behind that? Thank you.

Actually the simple answer is that we have actually terminated a couple of contracts that are related to kind of like a branding cooperation type of contracts during the quarter. And those branding contracts in Chinese is called (indiscernible), okay? And it's like a distribution type of Web basis. And because those are cooperative branding and our partners have violated the use of our locals and the use of our brands and have made some false marketing to -- we know to some of the buyers on those websites. And we have just terminated those contracts, and this has contributed to the majority of the decrease in the growth.

Okay, thank you.

Wallace Cheung, Credit Suisse.

Just one question. I will speak in Chinese first and secondly in English. My question is very simple. Has the online game (indiscernible) and has the management already focused (indiscernible) back issues and do we expect growth prospect on the Fantasy (indiscernible)?

Wallace, this is Michael. Why don't I take this question? We won't be able to say if the worst has been passed far the Japanese flag (indiscernible) or the event, how it is affecting Fantasy Westward Journey. And in fact, today if you see our homepage, we continue to make a declaration that our game has nothing to do or no relationship with Japan or (indiscernible). Again, from the numbers that we are seeing we believe we'll be able to go back to a normalized growth later on, that it's just difficult to be certain on this thing frankly.

And Wallace, this is Denny. I can give you some of the numbers and then you can visualize the real situation. For Fantasy Westward Journey, it accounted for around 17% of our total online game revenue right now. And for the month of September, it's actually because of various reasons as explained by Michael -- the Japanese flag and also the competition, everything, and also the back to school season in September. That game dropped around 24% when compared to the month of August. So it was a big, big drop which is beyond our expectation at that time.

And for the month of September, as you know, that is the national day holiday period, and is the normal peak season. The game already resumed growth comparing with September. However, based on the September results we projected November and December performance of the game it couldn't catch up the loss in September. And also the growth in October is not big enough. So therefore we are projecting an overall decline of like 6% to 9% of our total online game revenue in the fourth quarter. But we are still optimistic on the Fantasy Westward Journey as it is a new game and we expect to have our expansion pack to be launched by the end of the year.

(Spoken in Chinese).

It's double-digit growth.

Okay, thank you very much.

Richard Ji, Morgan Stanley.

I have two questions and the one is regarding Datang. Obviously it is at a low base right now and what is your plan for the game going forward? And especially when you may consider turning this into a brief play game? That's the first question. And the second question regarding Westward Journey 3, and this is the first-time, literally the first time ever we have seen any online game company -- Chinese online game company migrate the entire user base to a new game set. And can you also comment on that -- what kind of risk will be involved and what kind of upside will be involved?

Richard, I'm William. (Spoken in Chinese).

(Spoken in Chinese).

(Spoken in Chinese).

(Spoken in Chinese).

Okay. Let me tried to summarize all of this in English very quickly. For Datang, right now there has been a lot of similar titles, for example like a martial arts title that is free on the market right now. And this is why that we believe this is the main reason why Datang hasn't been doing so well because as a gamer they will -- when they look at the various offers on the market, obviously they will continue to try the free games first. Only those who are more advanced players and they choose between Datang and so on.

But for us, right now we will continue to improve the contents of Datang and we will continue to assume that we are using a fee-based model for Datang and we will not change the game for free, at least for the short to midterm. But at the same time the Company is researching on similar titles which is like a martial arts title, that if some games to become free and based on future item sales. And we have a team already doing that.

And at the same time, if there would be a new -- if we're going to make a free game then we would base it on the Datang technology and make a new game out of that and it would be a free game. But right now we are just planning on that and we will just -- for the purpose of this I will say that we will just assume that Datang will continue to be a fee-based game and we'll continue to improve the contents and continue to try to grow this game. Thanks.

(OPERATOR INSTRUCTIONS). Dick Wei, JPMorgan.

Good morning, William, Michael and Denny. My question is on the game market going forward, if William can comment on the player's growth, business model and profitability of the industry that would be great. Thanks.

I'm William. (Spoken in Chinese)

This is Michael; I will do a quick translation. In terms of the markets, we believe that the market will continue to grow very fast mainly because the users in terms of the demographics will continue to expand. In terms of the age, we will see more and more older and older users. And in terms of the sex -- I mean like they're currently majority male users and we continue to say more and more female users as well. And the mainstream will continue to be RPG and what we call casual games. But at the same time, competition will continue to increase as well.

On the business model wise, it used to be we mostly based on the fee-based games. We continue to see there are more and more free games being ordered in the market. We believe that there is a segment of the users in the market which we would call demand based games or what other people call virtual item based games. There would be a segment of such a market of users that would like to use this -- they would prefer these kinds of games.

And we believe that this will slowly become kind of a mainstream in the market. But it doesn't mean that there won't be any more fee-based game cards. There will also be -- continue to see a lot of fee-based games like the one that we have and those games we believe are higher quality and will continue to be a major part of the market as well. So, yes.

Great, thanks for the help. Just a quick question for Denny. (Spoken in Chinese) of negative (indiscernible) growth in the quarter. Can you make some comment on that?

What growth, sorry?

The property, plant and equipment in terms of the asset side.

This is Denny. The growth in the fixed asset basically this quarter is mainly due to the Guangzhou NetEase building because it's already disclosed in the press release. We are negotiating with a developer to buy Guangzhou office building in the coming quarters. And we have already moved into the building and incurred the renovations and also other furniture and fixtures, etc. So the increase in this quarter was mainly due to the new Guangzhou NetEase building. We'll have around 20,000 square meters and you guys are welcome to come to have a look. We are already using (indiscernible).

That's great. Thanks a lot.

(indiscernible), Deutsche Bank.

Can you talk about the development on search and do you see any growth in the third quarter?

The current search revenue that we are recognizing is the majority a partnership with Google right now. And for us the search revenue has been decreasing quarter-on-quarter basis. This is mainly because we have not been focusing on this part of our business right now.

Right. But do you plan to launch a search engine sometime soon?

Yes, but -- the search products -- we are actually working on a search product right now which is self developed. And we are looking at the launch of it in six to eight weeks time and hopefully in the early next year. But I think it's too early to give out further details on this because it's a new production and we don't have much information right now.

Okay, thanks.

Tony Gikas, Piper Jaffray.

A couple of quick questions for you. I think I missed part of the -- one of the earlier questions on what is the migration risk in moving all the WWJ2 users over to WWJ3? Does that present a risk? I mean, could we see a decline in the user base there of 5 or 10 or 15%? And the second part of that question -- is there a pricing opportunity when you're moving on to the new version of the game to take pricing higher? What are your intentions there? And then I have a follow-up.

I can just repeat what William had said. I think the migration of the users from the old Westward Journey 2 to Westward Journey 3, there has always been a risk for game users' migration. However, as you know that the Westward Journey 2 is already -- this is already a very, very old game, operated for more than four years already and users, they are leaving us anyway, and we report a continuous decline in revenue in the past few quarters.

So therefore, I think the (indiscernible), although there is a risk for the migration of the users from the old game to the new game; however, we will have our mappers to migrate. Make sure that they are happy. In the most important thing is we are confident in the new title, the Westward Journey 3, and we think that the users and like the new game and there will be a period of transitional period for the (indiscernible) run of the old game and also for the new game.

And the users who want to stay with the old game, they can continue to stay. But we will revisit the situation closer to the event to see how many people are actual left with the old game and that (indiscernible) how many servers will continue to be operating for the old game.

And then pricing on the new game?

We have not yet decided.

Okay. And it's sounding like there's a greater likelihood of moving to the free based videogames at some point in time could that impact -- would that impact sales on a near-term basis? And if so, what type of impact would that be? Would it take a one or two quarter sales decline or not so much?

For the free-base model. I cannot say that this is the norm going forward because I think the market has continued to be very extreme. For those successful games I think users, they are more than happy to play for an entrance fee or playing on a time basis. Whereas for some lower quality games, which is huge in terms of numbers, I thing is very difficult for them to charge a fee based on the playing time.

So for NetEase, we have our own R&D capability and we believe, for example, (indiscernible) is the game that we never fought off a fee-based. But going forward we will be flexible to consider whether for those again or for (indiscernible) that would develop to slip through the gaps of our pipeline, we would be using the free to play model or not.

Thank you for taking my question.

Antonio Tambunan, Bear Stearns.

I just have just some final questions. On licensing -- I have a two-part question on licensing. The first is -- this was asked last quarter -- where are you guys now in considering licensing games in the pipeline? And the second question I have is -- I know you guys have always been adverse to licensing a game outside of China. I'm kind of curious as to whether or not you're going to change that outlook, especially in light of the fact that perhaps (indiscernible), they just recently announced they're going to take one of the Chinese games and export it.

Where are you guys in terms of deciding whether or not you can expand your game to overseas markets -- maybe to less emerging markets like Vietnam or Thailand or something like that? So that's all I'm curious about right now.

On the second question, no, we have not changed. On the first question, which is basically no as well actually. Because we actually have a pretty full pipeline ourselves we believe and we do not feel that we would like to license games from other game developers right now. But of course this is still opportunistic. If there is specifically a high-quality game in the market we of course are welcome. We have been talking to some of the companies. But this is very, very remote again.

Well then, on the second question that I asked and your answer is no and I know you've been no for a long time now. I'm just kind of curious as to why or have you not considered that to be some --?

Because we're focused in China.

I know but --? So you have no interest at all and it's unlikely to change going forward at all?

no, that's right.

Okay, thank you.

Jason Brueschke, Citigroup.

My question really involves around your use of cash. You are sitting on nearly $480 million; you will no doubt be above $500 million at the end of the year. And when I look at the business and how various things are performing and some of the issues you're facing like the Japanese flag, I kind of struggle with the decision just to put that cash to use to buy back shares. And I'm wondering why you haven't been able to deploy that cash in a way that in one quarter fixes the Japanese flag incident. You have enough money to market directly to every single gamer in China.

And I guess the question is do you have any plans to do anything different with your cash going forward in terms of maybe stepping up your sales and marketing, maybe buying some domestic Chinese casual game companies or something like that, or are we just going to continue to see share buybacks as the primary vehicle that you put the cash (inaudible)?

(Spoken in Chinese).

The question is theoretical, but I think the answer is that we continue to believe that the way that we have been using our cash is the optimal way to -- the most optimal for the Company. And we have been very lean. We have a very thin R&D or (indiscernible) expenses and we continue to believe this is a very good way to utilize our cash for the Company and for the good of the Company. And repurchase will continue to be a way for us to utilize the cash.

Michael, kind of a follow-up to that. Two questions on Tianxia. One, could you maybe give us some particular differences between Datang and Tianxia besides the fact that one of them is a 2.5-D game and one is a 3-D game? Because leading up to the launch of Datang there was a period of time when you guys were very bullish about the game and its prospects and all the time and effort you put into it. And it seems to have struggled and Tianxia -- we still have that same optimism from you, and I think giving us some color about where these things differ I think will be helpful.

(Spoken in Chinese)

The product is totally different and it's very difficult to make a comparison amongst the two products. But anyway -- just to give you a bit more color -- the technology, the gameplay and the stability and all these things are totally different. And in fact the design group -- I would just make a very simple difference among this is the design group or the programmer group is basically -- for Tianxia has been the core group of our company who have been working with us for a long time. And comparatively, the Datang team is a bit more junior and those are the major differences I would make.

Okay. Let me ask you one last question. Do you have any plans to significantly market Tianxia more than you have Datang -- in open beta and in commercial?

I would say, yes, because in terms of (indiscernible) size is much bigger but compared to that of our -- again, compared to that of our competitors is still -- it wouldn't be much bigger than that of our competitors. And again, it's because that we are portal and we have a lot of influence on our users and also the way that we have been marketing a lot of time, word-of-mouth and those are lower cost comparatively. And also I would say it's performance-based. So compared to our competitor the answer is, no, it's not a huge marketing program. But compared to Datang, yes, (indiscernible) is much bigger.

Thank you.

James Mitchell, Goldman Sachs.

I apologize if this seems like another way of asking Jason's fine question. But if I look at your guidance for the fourth quarter it seems like you're guiding for revenue to be down 50 to 60 million Renminbi and then net income to be down by a similar 50 to 60 million Renminbi or US$6 million. Given you have some variable expenses in taxes, does that imply that you see some of your fixed costs increasing quarter-on-quarter?

James, this is Denny. I think in computing the guidance for Q4, revenue we have already been transparent on how we see each particular line of business they are doing. And for the expense side, basically we are calculating for example the G&A expenses to be around flat and also the increase in operating expenses is mainly coming from the selling and marketing expenses and also R&D.

Within the two -- I mean the selling and marketing expenses is the area that we've projected will be the (indiscernible) because of the new product launches, not just for the Tianxia, but also other portal products. And for R&D, as you know, that we have just increased our headcount by around 250 persons in this summer so that will also be fully affecting the fourth-quarter's, so it results in an increase in the R&D expenses.

Okay, great. And then just a sort of housekeeping item. For the third quarter, if I got the numbers right, it looked like your game average users were down about 7% sequentially, but then revenue was down (technical difficulty) sequentially. Is the deviance between game users and revenue deferred revenue of realization on prepaid cards or higher effective pricing?

I think this is mainly due to the pricing because more and more users, they are buying directly from us, the points from us rather than using point cards which the margin is higher.

Okay, thank you very much for taking my questions.

Ming Zhao, Susquehanna.

My question is according to your strategy right now do you plan in some cases you will turn (indiscernible)?

(Spoken in Chinese)

No, we don't have any plans to make it a free game. I guess we do will sum this up.

Thank you once again for joining us today. Please feel free to contact us if you have further questions.

That does conclude our conference call. We do thank you for your participation.