Earnings Call: Q2 2010

Aug 11, 2010

Thank you for standing by, and welcome to the Tencent Holdings Limited 2010 second quarter and interim results conference call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press star one on your telephone to join the question queue. Your name will be announced when it is your turn to ask a question. If you wish to cancel your question, please press the pound or hash key. I must advise you that this conference is being recorded today. I would now like to hand the conference over to your host today, Ms. Catherine Chan from Tencent. Please go ahead, Ms. Chan. Thank you, operator. Ladies and gentlemen, good evening, and welcome to Tencent's second quarter results conference call. Again, I am Catherine Chan from the IR team. Let us start by reminding you that this presentation includes forward-looking statements, which are underlined by a number of risks and uncertainties that may not be realized in future for various reasons. Besides information about general market conditions, this call active from a variety of sources outside of Tencent. For a detailed discussion of the risks that may impact our businesses and operations, please refer to our disclosure documents, downloadable on our website at www.tencent.com/IR. Having said that, let me introduce the management team on the call tonight. They are CEO Pony Ma, President Martin Lau, and Deputy CFO John Lo. So even we start with the key highlights. Martin will go through the business update and outlook, while John walks you through the financials. We move on to Q&A. Now let me turn the call over to Pony. Good evening, everyone. For the second quarter of 2010, we record growth in our operating and financial results as we continue to strengthen and leverage our online platforms. Our IVAS business grew substantially despite weaker seasonality from online games in the second quarter. Our IVAS business also registered healthy growth. In addition, our online advertising business was boosted significantly by more favorable seasonality during the quarter, as well as by increased demand associated with major events. Going through the headline numbers. Total revenue was CNY 4.7 billion, an increase of 10% quarter on quarter, almost 62% year-on-year. IVAS revenue was CNY 3.6 billion, an increase of 6% quarter on quarter or 66% year-on-year. MVAS revenue was CNY 674 million, an increase of 9% quarter on quarter or 43% year-on-year. Online advertising revenue was CNY 398 million, an increase of 95% quarter on quarter or 64% year-on-year. Gross profit was CNY 3.2 billion, an increase of 10% quarter-on-quarter or 64% year-on-year. Gross margin was 68%. Operating profit was CNY 2.4 billion, an increase of 10% quarter-on-quarter or 70% year-on-year. Operating margin was 51%. Net profit attributable to shareholders was CNY 1.9 billion, an increase of 7% quarter-on-quarter or 61% year-on-year. Moving on to an update of our key operating platforms. For our core IM platform, active user accounts grew 8% quarter-on-quarter to 632 million. PCU increased 4% quarter-on-quarter to 109 million. Active user accounts of Qzone grew 7% quarter-on-quarter to 458 million. QQ.com continued to record healthy growth in both PV and UV. In particular, QQ.com's traffic grew significantly during the World Cup event. PCU of QQ game portal decreased 9% quarter-on-quarter to 6.2 million from last quarter, during which the PCU was boosted by in-game promotions. ACU was flat from last quarter. Our wireless portal also continued to register growth in both traffic and users. Now I will hand over to Martin to talk about the business review and outlook. Thank you, Pony, and hello, everyone. Let's first talk about our IVAS business. Segment revenue was CNY 3.58 billion, an increase of 6% quarter-on-quarter or 66% year-on-year. The split between community VAS and online games has become 40% and 60%. Community VAS revenue was CNY 1.44 billion, an increase of 6% quarter-on-quarter or 57% year-on-year. The quarter-on-quarter growth was mainly due to the growth of QQ Membership and to a lesser extent, Qzone monthly subscriptions. Both are less sensitive to seasonal fluctuations. In terms of online games, our revenue was CNY 2.14 billion, an increase of 6% quarter-on-quarter or 73% year-on-year. The quarter-on-quarter growth was mainly driven by increased monetization of CrossFire and some contribution from newly launched games such as Dragon Power, QQ Fantasy World, and other web games. The second quarter is typically a weaker season for our gaming business as students spend more time to prepare for exams. As we look forward, although the summer holidays in the third quarter will be somewhat beneficial for our gaming products, the year-over-year growth rates of our overall IVAS business will definitely slow down as our revenue base have become bigger compared to last year. Looking forward, we believe the online game industry will see more regulations as it becomes an increasingly important and significant component of China's culture and entertainment industry. Some of these regulations might have an impact on our business. Going through the major community products, for QQ Membership, we continue to increase user loyalty and stickiness via the ongoing enhancement of functionalities and online privileges. After months of experimentation, we have stepped up our efforts to partner with more offline service providers to bundle lifestyle privileges into the monthly package. For Qzone, active user accounts increased 7% quarter-on-quarter to 458 million. Monthly subscription grew as we enhanced our offering via the bundling of items for social apps. We are implementing our open platform strategy prudently to add third-party apps, while at the same time ensuring the quality and user experience. During the quarter, we have launched several new third-party apps on Qzone and Xiaoyou. We are also closed beta testing our own developed APP called QQ Restaurant, in which players can see some continuation of usage experience from QQ Farm and QQ Ranch. As we have already accumulated a large user base of social games over previous quarters, we expect the positive impact of social apps to the growth of our active user base will moderate over time. For QQ Show, we will continue to promote its awareness among QQ users with increased marketing activities, as well as to add more features to the monthly subscription services in order to increase the stickiness of the paid subscribers. Moving on to online games. Let us start with the casual games. On the mini casual game front, we added three new games to our QQ game portal during the quarter and brought the total number of games to 97. The combined PCU and ACU were 6.2 million and 3.0 million respectively, compared to 6.8 million and 3 million last quarter. The fall in PCU, but not the ACU, was due to fewer in-game promotions, as well as some cannibalization from SNS games. For advanced casual games, combined PCU and ACU were 4 million and 1.5 million respectively, compared to 3.9 million and 1.4 million last quarter. For CrossFire, we released expansion packs and new items to increase the monetization, and the PCU for the quarter held at around 2 million. Other games were negatively impacted by weaker seasonality. For MMOGs, we are currently operating eight titles in total on our platform. The combined PCU and ACU were 3 million and 1.3 million respectively, in comparison to 2.9 million and 1.3 million last quarter. Dungeon & Fighter saw a slight dip in PCU and revenue due to our crackdown on bot programs, as well as weaker seasonality. During the quarter, we open beta launched two new titles. Dragon Power, which targets more hardcore gamers, was released in April with mixed results. While users were enthusiastic about the title, they also demanded for more content to be added. We are continuing to work with the developer of the game to develop deeper content and build a community on a gradual basis. On the other hand, our self-developed casual MMOG, QQ Fantasy World, which was released in late June, performed in line with our expectation. As MMOG players are increasingly looking for a differentiated gaming experience and as market competition intensifies, we are extending the development process for our pipeline titles to further upgrade the content and user experience. As such, we are delaying QQ Now finally, on our advertising business. Segment revenue was CNY 398 million, representing an increase of 95% quarter-on-quarter or 64% year-on-year. The quarter-on-quarter growth was mainly driven by more favorable seasonality in the second quarter, as well as growth in portal advertising associated with major events. In terms of revenue breakdown, IM-based advertising was RMB 161 million, an increase of 68% quarter-on-quarter or 36% year-on-year. Portal advertising was RMB 224 million, an increase of 124% quarter-on-quarter or 126% year-on-year. Search-based advertising was RMB 13 million, a decrease of 49% year-on-year. Our top 5 advertising categories are food and beverages, autos, online games, apparels, and consumer electronics. As our portal, QQ.com, continued to gain recognition from the industry, we have been able to acquire more advertisers. In addition, we benefited from World Expo and World Cup-related coverage and sponsorships, as well as the Beijing Auto Show during the quarter. Looking ahead, we strive to increase our market share in display advertising via continuous investment to increase QQ.com's media influence, and also to promote our brand through advertising and event sponsorships. For search advertising, as we are still working on our search product and building the associated advertising platform, we expect this part of the revenue to remain volatile for the coming quarters. I'll pass over to John to go through our financials. Thank you, Martin, and hello, everyone. For the second quarter of 2010, our audited consolidated total revenue was about RMB 4.67 billion, an increase of 10% quarter-on-quarter or 62% year-on-year. Operating profit was RMB 2.37 billion, an increase of 10% quarter-on-quarter or 70% year-on-year. Net profit was RMB 1.93 billion, an increase of 7% quarter-on-quarter or 61% year-on-year. Profit attributable to shareholders was RMB 1.92 billion, an increase of 7% quarter-on-quarter or 61% year-on-year. Basic earnings per share for the quarter was around RMB 1.05. Diluted earnings per share was around RMB 1.03. We reported the following special items for the second quarter of 2010. Share-based compensation expense was RMB 120 million, representing about 2.6% of total revenue. We recorded net other gains of RMB 27 million compared to net other losses of RMB 35 million last quarter. The change mainly reflected no donation to Tencent Charity from this quarter compared to RMB 40 million donated last quarter, recognition of gains from foreign exchange forward contracts, which we entered into to hedge the gains U.S. dollar-denominated bank borrowings, and increase in government subsidies. We recorded income tax expense of RMB 449 million in comparison to RMB 357 million last quarter. The increase primarily reflected higher profit before tax, increase in deferred tax liabilities recognized in respect of withholding taxes on unremitted retained earnings expected to be paid to overseas parent companies. Additional tax expense provided during the quarter upon the finalization of enterprise income tax assessment for 2009. Looking at the revenue breakdown, IVAS continues to be the biggest revenue contributor, representing 77% of total revenue in the second quarter. MVAS accounted for 14% and online advertising 9% of total revenue. In dollar terms, IVAS revenue was CNY 3.58 billion, an increase of 6% quarter-on-quarter or 66% year-on-year. MVAS revenue was CNY 674 million, an increase of 9% quarter-on-quarter or 43% year-on-year. Online advertising revenue was CNY 398 million, an increase of 95% quarter-on-quarter or 64% year-on-year. Total cost of revenues was CNY 1.48 billion, an increase of 12% quarter-on-quarter. As a percentage of revenues, total costs increased one percentage point to 32%. Going down to the segment level, IVAS gross margin dipped one percentage point to 69%. MVAS gross margin was stable at 64%, and gross margin for online advertising increased five percentage points to 17%, mainly driven by revenue growth. Moving on to operating expenses, selling and marketing expenses was CNY 230 million, an increase of 24% quarter-on-quarter or 101% year-on-year. The quarter-on-quarter increase reflected investments to promote our QQ.com brand during the World Expo and World Cup events. It represented 5% of total revenue. G&A expenses was CNY 666 million, an increase of 14% quarter-on-quarter, or 46% year-on-year. The quarter-on-quarter increase is driven by increased R&D expenses to support long-term growth. G&A represented 14% of total revenue. If we look at the expenses by nature, R&D expenses was CNY 407 million, an increase of 16% quarter-on-quarter or 54% year-on-year. It represented 61% of G&A in the second quarter or 9% of total revenue. Total staff costs, including share-based compensation, was CNY 751 million, an increase of 16% quarter-on-quarter or 61% year-on-year. It represented 16% of total revenue in the second quarter. As at end of quarter, we had 8,687 permanent employees and 2,678 outsourcing staff. Let's look at the margin ratios for the second quarter. Gross margin dipped 0.4 percentage points to 68.2%. Operating margin was flat at 50.8%. As we continue to enhance our R&D capabilities in highly competitive segments, such as online games, to maintain market leadership, and in new business areas such as search, to invest for long-term growth, this will put downward pressure on our operating margin on an ongoing basis. Net margin decreased 1.3 percentage points to 41.4%. Finally, I will provide a few financial figures for your reference. CapEx was CNY 566 million, compared to CNY 367 million last quarter. By breakdown, operating CapEx was CNY 283 million in comparison to CNY 343 million last quarter. Non-operating CapEx was CNY 283 million in comparison to CNY 24 million last quarter. We did not buy back any shares during the first half of the year. However, in July, 2.6 million shares have been repurchased from the open market for about 355 million Hong Kong dollars. As at quarter end, our cash position stayed at CNY 13.9 billion after the payment of $300 million for our investment in DST. The total number of shares in issue was 1.83 billion. That's all about financials. Thank you, John. Operator, shall we have the first question, please? Certainly. We will now begin the question and answer session. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the pound or hash key. Your first question comes from Dean Yoon of Nomura. Please ask your question. Hi. Good evening, everyone. Couple questions. Let me start with the advertising. Certainly, this quarter we saw some significant growth in advertising here. How much really is that attributable to the seasonal impact versus the one-off events such as the World Cup or the World Expo? What kind of growth should we assume this quarter? Can we assume that you will continue to gain market share compared to your closest competitors this quarter as well? Can you give some highlights of how much incremental advertising was attributed to the one-off events? I have a follow-up question regarding the product revenues. Thanks. Yeah. I think the one-off events did make a meaningful contribution to our advertising revenue. I think it is very difficult to completely separate the two, because for some of the advertisers that are associated with the events, they also have extra spending that actually spread across the platforms. I think it is more of a way for us to get advertisers, who otherwise would not be spending with us to advertise, particularly with the World Expo. I think it is a very high-end event, so we were able to attract some of the advertisers who, for the first time, advertise with us. At the same time, for some other advertisers who have been advertising with us to increase their budget to cover those events. I think those events, both World Expo and World Cup, did have positive impact on our advertising business. But I think it's very difficult to pinpoint exactly how much. Because they somewhat are related and some of that spending actually cannibalizes their spending, otherwise would be spent on our other parts of the platforms. Martin, when we look at your advertising business and look at these one-off events like World Cup, how do you guys price it? Or how do you give away inventory? If an advertiser wants to purchase an inventory for World Cup, do you require them to buy inventory in the third and fourth quarters just to smooth it out so we don't see that peak and valley? Or can they just buy inventory for that particular event alone? Typically, we don't actually require advertisers to have an ongoing commitment. So if they advertise for the period, we allow them to advertise for that inventory. But I think, as we build a relationship, we will do cross-selling. We'll try to, as I said, get them to advertise in other parts of the platform for that campaign during that period, as well as we'll try to sell additional inventory to them for other periods. Once we have developed a relationship. So I think overall, what we try to do with those major events is not just targeting these events as a one-off revenue opportunity. What we really wanted to do is actually to demonstrate to the advertisers that we have the platform to deliver a very high ROI for them, and hopefully that would actually translate into ongoing business opportunity in the future. So that's more strategic from our perspective. Great. If I could have one quick follow-up question regarding deferred revenues. Looks like deferred revenues on a year-over-year basis was up 65%, but on a sequential basis, it was flat. Can you give us some color in terms of why we are seeing kind of a flat deferred revenues, if that is more seasonality? Because we certainly have not seen it last year this time. Or if there is anything that we should attribute to the flat growth. Thanks, I will stop there. Sorry, which revenue are you talking about? Deferred revenues. That we saw a flat quarter-over-quarter growth in deferred. Just want to see if there is something attributable to that. Yeah, I think seasonality is a factor, and also I think, sometimes it is related to how much the channel actually stock up for our virtual currency as well. I think overall, we do not necessarily pay too much attention to this. I think there is also a deferral in our revenue in that line. During the first quarter, when there was a very big increase in the item sale related to promotions, then that typically increased the deferred revenue. As gaming becomes a more important part of our overall revenue, then the seasonality impact to deferred revenue has become higher. Perfect. Thanks, Martin. Sure. Your next question comes from James Mitchell of Goldman Sachs. Please ask your question. Great. Could I ask a couple of questions? One of them may sound a little bit foolish, so I apologize. Are there any costs associated with bundling real-world services into QQ Membership? Or should we view those bundling of real-world services as more like a Groupon model, where you leverage group purchasing power? Secondly, in the management discussion and analysis, there's a comment that the positive impact of social games on active user base of Qzone will lessen. I was wondering whether that's specifically with regard to social games having less of an impact at driving user growth for Qzone, or having less of an impact in terms of driving revenue generation at Qzone. Thank you. Yeah, I think for the first question, at this point in time, there's actually not that much of a cost associated with these offline services when it comes down to QQ Membership. A lot of it is actually sort of trying to find a win-win type of marketing and promotional relationship with the offline service provider so that we can bring the benefits to the QQ members, and at the same time, we deliver these users as high-value potential customers for the offline service providers. In terms of the social games, we're more referring to the active user base, because the active user base have become very high and the social games players have become quite a large number. I think as you look at purely from a lot of large numbers, the percentage increase for the social game players would increase, hence the percentage contribution to the increase of Qzone active users would also decrease over time. Now, when it comes to revenue generation, I think to some extent it should track with the active user base. But of course, I think there are things that we could potentially do to increase item sales, for example for our social games. But at this point in time, we still have not really decided to do it in a big way yet, because we still want to use these items to drive the monthly subscriptions. And because we do not necessarily know what the life cycle for these social games and how would new games actually substitute for old games as old games mature out. With these unknowns, we don't feel necessarily comfortable to drive up the item sale because some of these revenue then would become one-time revenue, which will not be good for our overall continuation of the revenue source. The real world things being bundled into QQ Membership, I should be thinking more about group discounts for movie theater tickets rather than Tencent giving away stuffed penguins? Correct. Okay. Thank you. Sure. Yeah. Next question, please. Your next question comes from the line of JP Morgan. Please ask your question. Hi, thanks for taking my question. First question is on the game front. I wonder what is the ARPU for different segments, and if you can also comment on the ARPU trends for some of the key games like CrossFire and DNF, that would be helpful. Thanks. Yeah. The ARPU for our casual game is from 40 to 75 CNY per quarter, whereas the ARPU for MMOG is from 75 to 105 CNY per quarter. I think in terms of churn numbers, we actually do not give out churn numbers. Just to give you a sense, I think CrossFire has maintained its user base pretty well, whereas Dungeon & Fighter, as we also talked about in our prepared comments, there has been some decrease in terms of the PCU, because we have been fighting bot programs on a pretty large-scale basis. As a result, the active user accounts actually also decreased. So there was an increase in terms of churn rates for the past quarter. Okay. Good. For CrossFire, it seems like there are some new items that helped the ARPU of the game as well. Yeah. There has been an expansion pack, and we have rolled out quite a bit of new items to increase. That's the reason why the monetization has been increased. All right, great. My second question is, just in general, on the mobile area, what are your thoughts in terms of the mobile accessing device? I wonder, does management think of it more as just like a piece extension to make the Tencent community stickier with more mobile service, or management thinks that there's more opportunity to create value to the user by offering hardware or mobile phone operating system or middle layer software. Just if management can share some thoughts on that would be great. Thanks. I think at this moment, we are primarily focused on the services themselves because we have a vast number of internet services, and many of these services would actually benefit from being able to be accessed by users when they are using a handheld device. Handheld device, we mean handsets as well as tablets, like the iPads. There are enough standards in the handsets that are occupying all our engineers' time in terms of customizing the application. I think what we wanted to do is actually to be a partner with all the value chain providers, such as operating system providers, such as chip providers, as well as handset manufacturers, such that we can actually make our services available across as many devices, as many operating systems as possible. Great. Thank you. Thank you. Next question, please. Your next question comes from Richard Ji of Morgan Stanley. Please ask your question. Sure. Hi, Pony, Martin, James, and Catherine. Thanks for taking my call. I have 2 questions. Let me start with the outlook going forward. Q3 typically is a peak season for online advertising as well as online gaming activity. Given what you said about the rising competition in the online gaming environment, will you please give us a little more color about how we should look at Q3, and should we expect a very strong seasonal acceleration as you have delivered them in the past? I think in terms of advertising right now, as we said, there is actually some impact of major events that is embedded in the second quarter results. I think if you are looking at quarter-on-quarter results, the seasonality comparison between third quarter and second quarter for this year would be less, I would say, compared to previous years, because second quarter has already got some kind of major events impact in it. In terms of online games, I think we are really looking at an industry that I would say, demanding for more. There are more sophisticated users. They are really looking for more differentiated content, better content. I think from an effort perspective, we as a company, would be more focused on trying to upgrade our development capability, and creating the right gaming environment to deliver such kind of higher standards of services. From that perspective, I think that would take some effort away from monetizing the users. I think when you are in a very much more benign environment, the developers can be spending more time on running in-game promotions and trying to capitalize on the seasonal factor. I think at this point in time, we are spending more time on dealing with the longer-term issues for the industry. On a relative basis, the amount of time spent on running in-game events will be less. Thank you, Martin. Secondly, is regarding social game, which turned out to be a new phenomenon across China. Can you elaborate a little more on expected revenue contribution in the future, and also, what would be the margin profile for a social game versus your hardcore MMORPG game? That would be helpful. Okay. In terms of social games, I think there are a couple thoughts in here. The number one is, from a revenue generation perspective, I think we would like to strike a balance between subscription revenue and item-based revenue. The ability for us to do that actually would differ between self-developed games and third-party games. Now, with respect to self-developed games, I think what we will try to do is actually to continue with our current policy, which is trying to make the items available mostly with the subscription packages, so that these apps will incrementally add to our subscription revenue. On that front, it will be more gradual and hopefully more sustainable. But at the same time, as you could recall with our prepared comments, we are also working with more and more third-party developers. With them, what we need to provide to them is revenue sharing. With that, the predominant way for generating revenue will be item-based revenue. On that front, I think there will be more of a short-term burst of a particular game's revenue. But at the same time, on the third-party applications, we are carrying our policy such that we are sharing a pretty big chunk of the revenue with them in terms of item-based revenue. So, in that regard, what we want to do is actually create an industry value chain such that there will be more and more application developers putting their applications with us. Okay. Yep. Thank you, Martin. Sure. Your next question comes from Alicia Yap of Citigroup. Please ask your question. Hi. Good evening. Thank you for taking my questions. My first question is regarding DNF, Dungeon & Fighter. Can you elaborate a little bit on the revenue decline? Did that happen throughout the entire second quarter, or was that happen in any particular month, and have you seen any pickup in July? Do you think with the future content update, will the game resume a more healthy growth and continue to contribute more meaningfully to your growth, or do you think that the game actually may have reached the maturity and may have start to trend down further in the next few quarters? Yeah, I think for Dungeon & Fighter, the main issue was actually a proactive action on our behalf to actually knock out the bot programs in the game. These bot programs are typically divided into two categories. The first one is actually used by individual players who are trying to gain advantage vis-a-vis other players. The other one is actually bot programs used by gold farming studios, trying to create virtual items and use them for sale. The second one actually is much larger in terms of number, whereas the first one is actually more detrimental to the balance of the game. So, we decided to take a pretty stern action against both categories, and that's why the PCU and active user base actually for DNF decreased during the second quarter. As we step into the summer, we're seeing some recovery of the user base. But what I have to say is, for the user base, for the active users that we knocked out, a lot of them are actually not really generating positive. Their impact to the game. Frankly, the presence of them actually are detrimental to the game. So it's essentially like doing a surgery and take out the tumors. So that's what we decided to do, and that should not have a negative implication for the game going forward. Of course, for a game like DNF, it actually relies quite a bit on the content and the expansion packs. So, we work very hard with the developers to try to roll out great content to sustain the longevity of the game. Okay. Thank you. My second question is regarding the mobile business. I think since fourth quarter last year, we have seen several quarters of solid growth, maybe due to the traction from the bundle packages with SMS and other features. Just wanted to get your thoughts on the overall growth potential for the MVAS business, and how will you leverage from the increased use of the mobile search going forward? I think, from a basic usage perspective, mobile internet and mobile internet services would actually sort of have a pretty significant increase going forward. As we talked about, more and more people have become mobile internet users because of the availability of data plans, because of the availability of higher-end mobile devices. What we have always talked about is that the business model on the mobile internet is actually quite underdeveloped. Because fundamentally, you have people who are spending less time dealing with a smaller screen, and they are getting onto the handsets on a burst of fragmented time basis. With this usage pattern, it's more difficult on an incremental basis to charge them through IVAS or charge them through online games. At the same time, we also have some billing challenges on the mobile devices as well. I think, as we look forward, we felt that there will be a very good potential for basic usage of mobile internet services to increase. As an industry, we need to figure out what are the ways to monetize this user base. But I think our experience tells us that if we have a large number of dedicated and sticky users, then someday down the road, we should be able to charge. I think on a short-term basis, we are still affected by the changing regulatory environment. For example, I think we're still suffering from the suspension of the WAP billing. At the same time, we also talked about, there will be yet another billing reminder that will be sent to monthly subscribers on the MVAS users, and that may have an impact on our business in the next couple of quarters, too. I see. Okay. Thank you. Just one follow-up on the housekeeping questions. What should we be looking for are the effective tax rate for the rest of this year and next year? Thank you. If we exclude the effect of deferred tax, the effective tax rate would be from 10%-15% for 2010, leaning towards the 15% side. Okay, great. Thank you. Your next question comes from Eddie Leung of Bank of America. Please ask your question. Hi, good evening, Pony, Martin, John, and Catherine. I have two questions. The first one is about your long-term strategy. Could you share with us your thoughts in terms of opportunities and risks in response to perhaps a slower internet user growth going forward, as you perhaps also mentioned in your call? Yeah, I think when a user base go to a critical mass, then the percentage increase in terms of internet users would come down, I think that's just inevitable. But I think when we look at internet as an industry, we felt that despite China has already reached a pretty large number in terms of internet users, the penetration is still lower than the developed countries, which means that on a long-term basis, there is some room for catch-up. So we're not talking about a stagnant market, we're talking about a slower growth market. That's number one. Number two is, we felt that internet, as it get rolled out in different places, through different devices, via different applications, it actually allows people to spend more time on the internet. That is one factor which has been happening in the past few years on top of the increase in terms of penetration. I think that trend will continue because with mobile internet, with a multitude of applications, it just allows more people to come into contact with the internet with more time. I think finally, in terms of the business opportunities, we were still looking at a relatively low income level for the Chinese consumers, and that has been increasing and will continue to increase. We have been seeing sort of a relatively low adoption of internet amongst businesses, and that is reflected in sort of lower penetration to e-commerce, lower advertising revenue. Over the longer run, we felt that this is an area that could have pretty significant growth opportunity as more business become online, as there are more e-commerce businesses, then the penetration of internet advertising would increase, and e-commerce would also increase, and that would give rise to opportunity. I think the big picture question in terms of the big buckets of potential growth, I think these are the areas that we focus on. Thank you, Martin. Dan, could you also give us the ranking for your community-based services in terms of growth in the quarter and contribution? Thanks. In terms of the growth rate in descending order would be membership, QQ Show, and Qzone. In terms of the absolute amount of growth would be membership, Qzone, and QQ Show. Thank you very much. Your next question comes from Gary Ng of UBS. Please ask your question. Good evening, everyone. Thanks for taking my question. First question is, could you share your thought with us, why do you decide to increase the monetization of CrossFire during second quarter, which is typically a seasonally slower quarter? Should we think about that as you actually increase monetization towards the later part of the second quarter instead of throughout the whole quarter? Well, I think a lot of these increases are associated with the content expansion packs. We actually rolled out content expansion packs on a regular basis, and as the content get consumed, then we try to put in expansion packs on a more frequent basis. I think we don't necessarily time these expansion packs, particularly with the seasonal factors. I see. Thanks. My follow-up question is, on the MMOG ARPU side, it seems that in the second quarter, we continue to have a pretty similar level of ARPU versus Q1. Whereas last quarter, you mentioned that at that point in time, because we timed the seasonality of Q1 to increase the monetization. Should we assume this kind of ARPU level as a new base for you to monetize the users, and that probably we should still expect some growth going forward, or that is already sort of the cap that you are controlling? Yeah. When we think about our ARPU, what we want to do is actually we want to make it reasonable for our users. I think that has been our philosophy, and we want to maintain that philosophy. I think as a game becomes more popular or as the game becomes more mature with the users, the users might be more receptive to paying for items, then we sometimes would naturally be able to extract a higher ARPU from the users. But we actually will never do it on a very forceful basis. That is the philosophy that will continue. In a way, we try to develop new items, develop new monetization mechanisms that are reasonable to the users. If we are successful, then there may be an increase in terms of ARPU. But if there is more competition, and if users are not that receptive to paying more money, then we will try to lessen it. But we will remain, I would say, on the lower end of the industry because of our philosophical belief. Right. Thanks. My final question is that I think your DNF and CrossFire license is due to renew sometime in 2011. How should we think about the margin for those two games going forward? Should we expect a significant increase in royalty sharing, or can you just give us some guidance on that? I think for CF, it is still quite some time to go. We essentially have a 5-year contract, so there will be quite a few years before we can actually sort of have visibility into the extension of the license. In terms of DNF, I think, the margin is kind of similar to what we are seeing right now. Thank you. Thank you very much. Thank you. Your next question comes from Wallace Cheung of Credit Suisse. Please ask your question. Hi. Thanks for taking my question, sir. Just regarding the community IVAS, it seems like the QQ Membership already picking up to be the largest revenue contribution unit with that business. Management comment on social games business, they likely to slow down. Going forward, can you comment on the growth of the QQ Membership? How can you sustain the growth rate? With all the social games, do we expect the community IVAS growth will slow down going forward? Thank you. I have another short second question. Thank you. I think for membership, it is actually more of a race against ourselves, right? Against our own creativity. Membership is a service that require us to continuously add new value to this package. So, in the past, it has been online privileges. There were a lot of online privileges associated with the IM, and we then added the online privileges associated with our games. That is why we are constantly looking out for new value to bring to our users. I think the latest experimentation point is to some offline privileges that we can provide to the user base. It is still early days in terms of adding these privileges because it is quite a laborious effort to try to bring offline service providers to provide online privileges to the online users. A lot of times, we run into difficulties around IT system, around the quality of the services that can be provided to the subscribers. I think that's a general direction that we'll head into, which is, as we continue to add online privileges, we'll also spend more efforts in adding offline privileges, so that there will be more value given to the QQ members and that would help us to keep them as paying users going forward. Hi. Yeah. Just a quick one, is that should we assume the QQ Membership, likely in the next few quarters that would continue to keep growing faster than the Qzone revenue? It's a little hard to say. Yeah, I think they carry different natures, right? Membership is more of an ongoing addition of privileges. By nature, it's less volatile. I think on Qzones, despite the fact that we try to bundle more of the social games into the monthly subscriptions, the nature of the revenue is still slightly more volatile compared to the QQ Memberships. Thank you. Just second quick question is, why the land use right in the second quarter seems like dropped a lot. Are you planning to build another building? We have actually purchased a lot of land in Shenzhen to build our office building. So that would be another sort of campus is undergoing the next 2 years' time? It would be a multi-year project. Yeah. When it's going to be complete and what's the planned CapEx? We don't have the exact figures yet because it's still in the planning phase. Okay. We have run out of space in a pretty significant basis in our existing building. Assuming there's no residential complex, right? Sorry, what was it? I am assuming there will be no residential complex to be built on this land. No. Okay. Thank you. Thank you so much. Thank you. Operator, in the interest of time, let's take the last three questions. The next question comes from Wendy Huang of RBS. Please ask your question. Thank you for taking my questions. First, can you comment on your strategy on the search business? How will you integrate search with your other QQ product, and how will you differentiate your search engine with the established player like Baidu? Yeah, I think we actually talked about this in the last call. Let me just repeat it again. In terms of the search service, we felt that the search service that is provided to the users right now still has a lot of room for improvement, no matter which service provider you take. On the fundamental architecture, as well as the functionality, there are still a lot of improvements that can be made to a search engine. That is one area that we are putting our resources into, i.e., improving the basic search experience such that it can provide more relevant data at the right time for the users. In terms of the second prong of the strategy, which is integration with our platforms, I think what we try to do is we would try to provide a search experience integration into our various platforms. Because what we discover is that search is a pretty fundamental need that actually arises from the various online platforms that we have, be it music, be it Qzone, be it even IM. There will be, at certain times, needs of the users to actually have some kind of search experience. What we try to do is to integrate our search engine with these different platforms to provide the search experience to the users at the right place, at the right time, when they need them. Okay. Secondly, you mentioned that the bot fighting in Q2 for DNF was a voluntary action. Should we expect this overhang from bot fighting to continue in Q3 for DNF? I think the overall environment is more benign as we speak right now. Because DNF is actually a very popular game, and there are a lot of gold farming studios that are focused on this game itself. So there may be resurgences of these kind of bot programs, and at that time, we may actually have to take action again. But I think for the first round of the bot fighting, we have cleaned up the environment by a pretty large extent. Okay. Finally, maybe can you comment on your micro blog services, provide some metric there, and also can comment on the regulation on the micro blog that we have seen recently. Thank you. That's all. Yeah, I think micro blog as a product, we felt that it's an emerging way for people to get access to information and spread information. We felt that it's complementary to our portal, to our Qzone, and also to some extent, to our IM. That's why it's a product that we would be spending more and more effort in terms of developing the product and rolling out the product. At this point in time, the product is still in beta testing. We need to make sure that the user experience is right. We want to make sure that the community is right. We also want to make sure that the platform can scale. But over the time, we would definitely step up our efforts to bring more users to our micro blog service. On the regulatory front, I think, it's like all other internet platforms, right? There needs to be a lot of attention paid to cleaning up the content, making sure that no disallowed content gets spread on the platform. We have a lot of people dedicated to that, and we have invested over the years, a lot of money into developing the systems to do content screening, and we will apply these investments to the micro blog service. Okay, great. Thank you. The next question comes from Eugene of Capital Corporation. Please ask your question. Thank you for taking my question. Good evening, Pony, Martin, Joe, and Catherine. Really congratulations on another strong quarter. I have actually a couple of questions. A follow-on question on micro blogs. I find that in the overseas market, it seems that SNS still remains very powerful, if we compare Facebook with Twitter. But in China, it seems that micro blogs may have more sustainable growth. Not sure whether the management have realized the difference or not. Really appreciate if you can share some of your thoughts on that. What is behind the difference? It seems that SNS face some technical problems in China, but the micro blog seems very strong now. That is first question. Jean, can you repeat what differences would you like us to explain? Between the- I would like to know the difference in China and with the overseas market. It seems that in the overseas market, SNS has very sustainable growth, like Facebook. But now in China, in the internet universe, many people talk about the technical kind of nature of the SNS. We already see some SNS websites are not very hot already. But it seems that in China, either the Tencent Weibo, or Sina Weibo still get lots of attraction. So what is the difference? Why Weibo can have more sustainable growth it seems, in China compared to SNS? Yeah. Well, I think micro blog- Is that clear or not? Let me just try to address your questions. Maybe as begin Chinese, because that way we work top. No, I think I probably have gotten what you are trying to ask. I think, at a scale level, micro blog right now is still much, much smaller than SNS. I think there is a lot of talks about micro blog, but if you look at the actual registered users or active user numbers, it is actually not even at the same orders of magnitude. But I think the reason why micro blog has gotten quite a bit of attention is that is also the difference between the China micro blog and Twitter in the Western market, is that there are portals which are using these micro blogs to extend the media product into the micro blog. Sina and ourselves actually invited a lot of celebrities to get onto the micro blog. These celebrities view micro blog as a way to extend their interaction with their fans, people who are following them. I think this media nature, and pretty proactive usage of the relationship with celebrities, and try to get them to be active users of the micro blog, is a reason why you feel more energy around micro blog in China, maybe compared to Twitter. I think it's also the same reason it gets disproportionate attention in the market. Yeah. Got it. Thank you very much. Actually, I'm also thinking about the media nature. I have other further things like, for Tencent Weibo, we are more a product-driven company. How we compete with, like Sina Weibo, because that company is more media-driven. It's what I'm thinking about it. I think, well, first of all, we are also a media company, right? QQ.com actually is the largest portal by traffic. At the same time, I think there can be multiple micro blogs in the market. I think for each one of online platform, you could actually build a micro blog that caters to your own platform and caters to the users that are on your platform. In a way, it's more like an extension of the existing online platforms that the different companies have. I think that's the way we look at it. Thank you. Another broad question for Pony or Martin. Currently, actually, I'm a membership for Tencent multiple products, except for RPG and ACG games. How to say, I feel satisfied with the experience of multiple web services. But I also realized that the QQ platform is becoming more and more sophisticated, and I think almost impossible to provide more services by yourself. Strategically, can we expect any systematic rollout to open the platform to third-party vendors in the foreseeable future? I realize we already have some trials on some separate sub-platforms like Huaqiang or Tenpay. I just wonder whether we have some systematic rollout on the platform open. I will stop here. Thank you. Yeah, I think it's definitely a direction that we're heading towards. As you rightly point out, the internet industry is becoming more and more sophisticated. User needs are more and more sophisticated. That's why one company cannot provide all the services, and we actually need to work with a lot of different other partners. I think as the industry really emerged from, I would say, nascent mode to a more sophisticated mode, whereas there are a clearer division of expertise among different internet companies, when there are actually more differentiated needs of the users being satisfied by different companies. I think there is much more opportunities for us as a platform to work with a lot of other companies to provide different applications. So that's number two. I think number three is, we're doing it on a prudent basis because we want to put our users at the forefront. We want to make absolutely sure that our users' experience and users' privacy and their account security are not compromised in this process. So that's why it's taking more time for us to prepare our platform for an opening, but we are making solid steps toward that. And congratulations again on this phone call. Thank you. Shall we have the last question, please? Certainly. Your last question comes from Eleanor Leung of CLSA. Please ask your question. Hi. Thanks for the call. I have two questions. The first question is regarding your game pipeline. Can you remind us whether there will be more new games in the second half, and what is the game pipeline outlook for 2011? I understand that you have delayed two games in 2011. The second question is regarding your marketing expenses. In the previous few quarters, you were guiding a higher marketing expenses, but when I look at marketing expenses as a percentage of revenue, it is still around 5%. Should we expect in the next few quarters or next year, it will still remain at a stable 5%? Okay. Let me talk about the game pipeline. In terms of game pipeline, we originally were planning to launch two MMOGs toward the end of this year. But as we talked about, we actually are lengthening our development process in order to improve the content quality and user experiences. That is why one of the two title will definitely be delayed into 2011, and the other one has also been delayed. But there is a chance that it may be launched toward the very tail end of this year, or it might be delayed into 2011. In terms of 2011, we do have quite a few new games that we are planning to be launched in 2011. But I think we are now reviewing the entire development cycle for all of our games in the pipeline, so we are not comfortable talking about that for now. We are focused on trying to get the next two games launched first. For selling and marketing expenses, actually, it has increased. The increase is mainly attributable to additional promotion and advertising expenses associated with World Cup and the World Expo sponsorship. I would say that about half of the cost has been captured in the second quarter, whereas the other half would be captured in the second half of the year. That would include brand advertising and other promotion activities. Right. So should we expect the operating margin remaining at such a high level or current high level going forward? In terms of the operating margin, there are a lot of factors that would affect that. One of which we have mentioned is the continuous investment in R&D, as well as some of the effect of the license games. So at this stage, it's very hard to say whether, as a whole, the operating margin would be affected. It really depends on whether we are able to get our proper revenue growing. If it is growing faster than the other expenses, say G&A and promotion expenses, then fortunately, it will have a better margin. Or else, if it keeps just at a flat or a flattish level, then it would be hurt by R&D expenses because we'll continue to invest for our long-term future. Yeah. I do want to say, that on a revenue growth basis, the year-on-year growth rate will be coming down as our revenue base becomes bigger. So that would add an additional challenge in terms of maintaining the operating margin. Okay, thanks. Okay, thank you very much. Thanks, operator. We are good to round up the conference call now. If you wish to check our press release and other financial information, please visit our website at www.Tencent.com/IR. We will also post a replay of this webcast on our IR website shortly. Thank you and see you next quarter. That does conclude our conference call today. Thank you for participating. Tencent 2010 second quarter and interim results conference call. You may all disconnect.