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Edited Transcript of CYOU earnings conference call or presentation 24-Apr-17 11:00am GMT

Thomson Reuters StreetEvents

Q1 2017 Changyou.Com Ltd Earnings Call

Shijingshan District, Beijing Apr 24, 2017 (Thomson StreetEvents) -- Edited Transcript of Changyou.Com Ltd earnings conference call or presentation Monday, April 24, 2017 at 11:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Dewen Chen

Changyou.com Limited - CEO and Director

* Jasmine Zhou

Changyou.com Limited - CFO

* Margaret Shi

* Qing Wei

Changyou.com Limited - Chief Games Development Officer

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Conference Call Participants

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* Alicia Yap

Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research

* Han Joon Kim

Deutsche Bank AG, Research Division - VP and Research Analyst

* Hillman Chan

Macquarie Research - Research Analyst

* Thomas Chong

* Yue Wu

China International Capital Corporation Limited, Research Division - Analyst

* Zoe Zhao

Crédit Suisse AG, Research Division - Associate

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Presentation

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Operator [1]

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Thank you for standing by, and welcome to the Q1 2017 Changyou.com Limited Earnings Conference Call. (Operator Instructions) I must advise you that this conference is being recorded today, Monday, the 24th of April, 2017. I would now like to hand the conference over to your speaker today, Margaret Shi. Please go ahead, Margaret.

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Margaret Shi, [2]

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Thank you, operator. On the call today are Mr. Dewen Chen, CEO; Mr. Xiaojian Hong, COO; Ms. Jasmine Zhou, CFO; and Mr. Wei Qing, Chief Games Development Officer. For today's agenda, management will discuss highlights for the first quarter 2017. This will be followed by a question-and-answer session.

Before we continue, please allow me to read you Changyou's safe harbor statement. Statements that are not historical facts, including statements about the company's beliefs and expectations, are forward-looking statements. These statements are based on current plans, estimates and projections and, therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. For more information about the potential risks and uncertainties, please refer to the company's filings with the Securities and Exchange Commission, including its registration statement and most recent annual report on Form 20-F.

I will now turn the call over to our CEO, Dewen Chen.

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Dewen Chen, Changyou.com Limited - CEO and Director [3]

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(foreign language)

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Margaret Shi, [4]

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We got off to a good start in 2017 with total revenues of USD 120 million and non-GAAP net income of USD 35 million for the first quarter, both meeting the top end of our guidance.

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Dewen Chen, Changyou.com Limited - CEO and Director [5]

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(foreign language)

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Margaret Shi, [6]

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We started the year with a clear strategic focus, targeting MMORPG and [ advanced ] casual games in China, where we are now looking at expanding further overseas.

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Dewen Chen, Changyou.com Limited - CEO and Director [7]

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(foreign language)

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Margaret Shi, [8]

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In China, the main revenue growth driver for mobile games is now increasing user consumption, and in particular, increasing the desire and opportunity for gamers to pay within the games. As a result, the market is dominated by 2 major types of games: MMORPG and advanced casual games.

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Dewen Chen, Changyou.com Limited - CEO and Director [9]

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(foreign language)

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Margaret Shi, [10]

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MMORPG currently account for more than half of the market share for mobile games. Within this highly competitive environment, only games with high quality features, such as unique social functions, innovative gameplay, premium graphics and cutting-edge technology shall help a game stand out. Changyou has accumulated years of experience in developing MMORPGs in a PC game era and we have incubated a great group of creative and talented producers. Therefore, MMORPG will always be our strategic focus and we will work hard to continue developing the best games around.

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Dewen Chen, Changyou.com Limited - CEO and Director [11]

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(foreign language)

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Margaret Shi, [12]

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While MMORPG are a dominant genre in the market, advanced casual games are catching up. With short game sessions, quick gameplay and combative elements, advanced casual games are proving to be very popular with young players. We're encouraging our producers to test out ideas and to develop new games in this category, which will hopefully open new doors for Changyou down the line.

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Dewen Chen, Changyou.com Limited - CEO and Director [13]

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(foreign language)

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Margaret Shi, [14]

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As far as overseas games market are concerned, North America, in particular, is obviously substantial and is dominated by advanced casual games and SLG games. Currently, these 2 types of games are also growing in China and have been leading to a large overlap between the 2 regions. In response, we are working hard to break into various overseas markets for advanced casual games and SLG games. We also plan to explore some other innovative gaming genres, such as strategy role-playing games.

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Dewen Chen, Changyou.com Limited - CEO and Director [15]

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(foreign language)

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Margaret Shi, [16]

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Our strategy for new game development is now clear. Meanwhile, our strategy for existing games continue to evolve around extending the longevity of these games by creating sustainable in-game environments, which have proven to be effective over the last couple of quarters.

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Dewen Chen, Changyou.com Limited - CEO and Director [17]

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(foreign language)

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Margaret Shi, [18]

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TLBB PC revenue experienced a slight decline quarter-over-quarter due to the impact of the Chinese New Year holiday, but the decline was more moderate than our previous expectations. This was mainly because the expansion pack that we launched at end of last year continued to drive up revenue into the first quarter. In addition, we also adjusted our in-game operational strategy and gameplay. Over the past year, we have cut down on a number of in-game promotions which led to a stable user base. We will further reduce the number of in-game promotions during the second quarter in order to achieve a sustainable in-game environment and further prolong the game's lifespan. As such, we currently expect revenue from TLBB in the second quarter to decrease 15% quarter-over-quarter.

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Dewen Chen, Changyou.com Limited - CEO and Director [19]

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(foreign language)

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Margaret Shi, [20]

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TLBB 3D revenue was sequentially flat for the first quarter instead of the decline that we previously expected. After more than 2 years of operations, our top priority is to maintain user stability. During the first quarter, we launched 2 expansion packs in which we improved the [ classic ] battle system, held a Valentine's Day event and introduced new socially interactive gameplay. All of this helped to support user interest and monetization of the game. We plan to launch another new expansion pack in the second quarter and hope to keep the revenue level flat quarter-to-quarter.

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Dewen Chen, Changyou.com Limited - CEO and Director [21]

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(foreign language)

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Margaret Shi, [22]

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For new games, our long-awaited Legacy TLBB mobile game is scheduled to launch in mid-May. Wei Qing, our Chief Games Development Officer, will give you an update on the latest progress of the Legacy TLBB a bit later.

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Dewen Chen, Changyou.com Limited - CEO and Director [23]

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(foreign language)

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Margaret Shi, [24]

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Before we officially launch Legacy TLBB, our revenue projection for the game remain uncertain. Given the significance of this game to Changyou and the uncertainty inherent at this time, we believe that it is best to take a conservative approach and not include any projections for the game in our second quarter guidance. So overall, excluding the potential impact of Legacy TLBB, we are expecting to see a moderate decline sequentially in the segment revenue.

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Dewen Chen, Changyou.com Limited - CEO and Director [25]

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(foreign language)

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Margaret Shi, [26]

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Now let me turn the call over to Wei Qing.

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Qing Wei, Changyou.com Limited - Chief Games Development Officer [27]

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(foreign language)

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Margaret Shi, [28]

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We conducted a second round of tests on Legacy TLBB in March. The results were in line with our expectations and improved greatly over the first round of tests. In particular, we saw a major improvement in user behavior among noncore users after we adjusted the introductory session for new players and simplified some of the gameplay, making it easier for users to familiarize themselves with the game and play within the game. We plan to start our open beta testing in mid-May. Before then, our team will continue to modify the game and make incremental improvements based on the latest test results. We hope to give the game the greatest possible chance of becoming a hit.

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Qing Wei, Changyou.com Limited - Chief Games Development Officer [29]

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(foreign language)

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Margaret Shi, [30]

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Now let me turn the call over to our CFO, Ms. Jasmine Zhou, to discuss the financial highlights.

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Jasmine Zhou, Changyou.com Limited - CFO [31]

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Thank you, Wei Qing. Now let me walk you through our financial highlights for the first quarter.

Revenue. Total revenue was USD 120 million, meeting the top end of the company's guidance, down 8% both year-over-year and quarter-over-quarter. The depreciation of RMB against the U.S. dollar impacted our reported financial results on a yearly basis. On a constant exchange rate basis, total revenue in the first quarter of 2017 would have been USD 6 million higher, down 3% instead of 8% year-over-year. Online game revenue was in line with our guidance at USD 85 million, down 17% year-over-year and 11% quarter-over-quarter. The year-over-year decrease was mainly due to the natural decline in revenues of older games. The quarter-over-quarter decrease was mainly due to a seasonal downturn of revenues from TLBB around Chinese New Year holidays in the first quarter of 2017 as well as the natural decline in revenue for older games. Online advertising revenue was USD 6 million, down 26% year-over-year and 30% quarter-over-quarter. The year-over-year decrease was mainly due to fewer games being marketed on the 17173 website. The quarter-over-quarter decrease was mainly due to a seasonal trend in advertising, typical of the first quarter.

Cinema advertising revenue was USD 25 million, increased 81% year-over-year and 21% quarter-over-quarter. The year-over-year and quarter-over-quarter increases were a result of an active approach we took in acquiring more advertising resources. Internet value-added services revenue was USD 4 million, down 30% year-over-year and 36% quarter-over-quarter. The year-over-year decrease was a result of lower revenue from mobile Internet products in the first quarter of 2017. The quarter-over-quarter decrease was a result of lower revenue from PC Internet products in the first quarter of 2017.

Now let me provide some more details about our financials. From now on, most the figures discussed will be on non-GAAP basis. As a reminder, you can find a reconciliation of these non-GAAP measures in our published earnings release.

Non-GAAP gross profit was USD 81 million, down 8% year-over-year and 10% quarter-over-quarter. Gross margin was 67%, which compares with 68% in the first quarter of 2016 and 69% in the fourth quarter of 2016. Non-GAAP operating profit was USD 37 million, which compares with USD 33 million in the first quarter of 2016 and USD 37 million in the fourth quarter of 2016. Non-GAAP net income attributable to Changyou.com Limited was USD 35 million compared with USD 31 million in the first quarter of 2016 and USD 40 million in the fourth quarter of 2016. Non-GAAP fully diluted net income attributable to Changyou.com Limited per ADS was $0.66 compared with $0.58 in the first quarter of 2016 and $0.75 in the fourth quarter of 2016.

Next, moving on to the balance sheet and cash flow statement. As of March 31, 2017, we had cash and cash equivalents and short-term investments, total USD 836 million compared with USD 831 million as of December 31, 2016. For the first quarter, we had net operating cash inflow of USD 14 million.

Finally, for second quarter of 2017 guidance, we expect total revenue to be between USD 110 million and USD 120 million. This implies a flat second quarter at high end or a sequential decrease of 8% at low end. Within total revenue, online game revenue to be between USD 75 million and USD 85 million. This implies a flat second quarter at high end or a sequential decrease of 12% at low end. Non-GAAP net income attributable to Changyou.com Limited to be between USD 25 million and USD 30 million. Non-GAAP fully diluted net income attributable to Changyou.com Limited per ADS to be between $0.46 and $0.56. Share-based compensation expense to be around USD 2 million, assuming no new grants of share-based awards and that market price of our shares is unchanged.

In our guidance, we have adopted a presumed exchange rate of RMB 7 to USD 1 as compared with actual exchange rates of approximately RMB 6.888 to USD 1 for the first quarter of 2017.

As Dewen mentioned before, our second quarter guidance excludes the impact of Legacy TLBB mobile game due to revenue uncertainties inherent at this time.

This concludes our prepared remarks. Thank you for joining the call today. Operator, we would now like to open the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We will now take our first question, which comes from Alicia Yap of Citigroup.

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Alicia Yap, Citigroup Inc, Research Division - MD and Head of Pan-Asia Internet Research [2]

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I have two quick questions; number one is related to the TLBB legacy. What is the remaining improvement or the update that you need to change for the game before the open beta test? And do you expect TLBB legacy to attract away your existing TLBB 3D user as well as the TLBB PC user? And among your testing sample, do you know what is the percentage of the user from the existing TLBB user base?

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Margaret Shi, [3]

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(foreign language)

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Dewen Chen, Changyou.com Limited - CEO and Director [4]

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(foreign language)

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Margaret Shi, [5]

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Okay, just to answer first question, we have now less than 1 month before the official launch of the game. The game is pretty much close to completion. We're just making incremental improvements on the details such as the fonts, the dialogues and notifications within the game. So we won't expect any significant changes between now until the official launch. So we shouldn't see much of a delay in the actual launch date.

To answer the second question, from the tests we've seen so far, the most loyal hard-core TLBB PC players are not the target group. They're not very keen on trying new games, they're happy with their own game. So the new Legacy TLBB mobile game is really targeted towards those who have left, and those are the ones who have shown the most interest in China, the Legacy TLBB mobile game. In terms of TLBB 3D, it's more like the actions-based RPG game. So there isn't very much overlap between TLBB 3D and the Legacy TLBB. But so far from the results we're seeing, there shouldn't be too much effect on TLBB 3D, but we won't know until the new legacy TLBB mobile game is actually launched. Thank you.

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Operator [6]

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We'll now move to our next question, which comes from Zoe Zhao of Crédit Suisse.

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Zoe Zhao, Crédit Suisse AG, Research Division - Associate [7]

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I have two questions. First of all, on the decline of our TLBB 3D active monthly accounts, it was down by 66% this quarter. Do we see any impact from the competition, such as Tencent's Honor of Kings, et cetera, during Chinese New Year? And the second question is regarding the decline of 17173's revenue. What do we think about the implication from here? Does this decline mainly come from the big game titles or the smaller ones? (foreign language)

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Dewen Chen, Changyou.com Limited - CEO and Director [8]

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(foreign language)

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Margaret Shi, [9]

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Zoe, that was Dewen, let me just translate the first question. So in the disclosed metrics for mobile games, it's actually a combination of all our games, including those that were launched in Q3 last year. And those new games -- for those new games, the [ metrics ] declined very quickly, and that's why you're seeing a very rapid downward trend in the disclosed metrics. And for TLBB 3D sales, the metrics has declined a little bit over -- because of the Chinese New Year holiday. But in terms of the revenue, first quarter was fairly flat compared to the previous quarter, and we expect the second quarter revenue to be flat as well.

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Dewen Chen, Changyou.com Limited - CEO and Director [10]

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(foreign language)

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Margaret Shi, [11]

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The reason why we're seeing a downward trend for 17173 is because most of the advertisers on 17173 are for PC games. And then, as the PC game market continues to decline, we are seeing declining revenue for 17173. But we are shifting -- in the [ third ] quarter this year, we are shifting our strategy towards mobile games.

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Dewen Chen, Changyou.com Limited - CEO and Director [12]

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(foreign language)

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Margaret Shi, [13]

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Thank you.

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Operator [14]

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(Operator Instructions) We'll now move to our next question, which comes from Natalie Wu of CICC.

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Yue Wu, China International Capital Corporation Limited, Research Division - Analyst [15]

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Two questions here. The first one is regarding the -- like the margin profile. So regarding the gross profit margin of TLBB PC and the TLBB 3D, respectively, is the gross profit margin relatively stable for both of these games? And I'm wondering if management can share with us some color on the -- like gross profit margin of the 2 games, respectively? And also, for the TLBB...

(technical difficulty)

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Operator [16]

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We'll just move to the next question, that comes from Hillman Chan of Macquarie.

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Hillman Chan, Macquarie Research - Research Analyst [17]

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Regarding the beta testing of Legacy TLBB in March, we're excited to hear that the sales have improved greatly from the previous round. Is there any way that Wei Qing can quantify the improvement, be it the gamer participation, user retention or the in-game spending by users? And I have another follow-up question. (foreign language)

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Qing Wei, Changyou.com Limited - Chief Games Development Officer [18]

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(foreign language)

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Hillman Chan, Macquarie Research - Research Analyst [19]

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And my second question is regarding the pipeline...

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Margaret Shi, [20]

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Hillman, let me just first translate the answer. So in March, our test results compared to the November test was a big -- a huge improvement. But unfortunately, we cannot disclose the specifics, but in terms of we've seen very good improvement across all our metrics, including our 2-day retention rate, 7-day retention rate, 14-day retention rate, ARPU, paying ratio and lifetime value. So what we can say is that the results met with our expectations, and from now -- between now to May, we will still be making additional improvements and then we think there should be another upgrade from what we are seeing now until the actual launch of the game. Thank you.

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Hillman Chan, Macquarie Research - Research Analyst [21]

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My other question is regarding the pipeline. Could Wei Qing or management talk about the key titles in the pipeline? In particular, Xuan Yuan Jian with Tencent, and also new version of Sword and Fairy and also the PC title, (inaudible). (foreign language)

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Dewen Chen, Changyou.com Limited - CEO and Director [22]

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(foreign language)

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Margaret Shi, [23]

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For Xuan Yuan Jian, we did one test in January with Tencent and then we will -- so now we are sort of coming back and doing more modification on the game. So when we are ready, we'll probably do the next round of tests.

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Dewen Chen, Changyou.com Limited - CEO and Director [24]

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(foreign language)

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Margaret Shi, [25]

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So we're doing another round of tests on (inaudible) and if everything goes well, we should be launched by the end of this year.

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Dewen Chen, Changyou.com Limited - CEO and Director [26]

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(foreign language)

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Margaret Shi, [27]

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Other games are still under development and testing. So overall, we have about 26 games that's being -- under development right now.

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Dewen Chen, Changyou.com Limited - CEO and Director [28]

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(foreign language)

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Margaret Shi, [29]

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We have very high expectations for the quality of the games, so it's more important that we roll out high-quality games than the number of games that we launch in the year.

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Dewen Chen, Changyou.com Limited - CEO and Director [30]

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(foreign language)

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Margaret Shi, [31]

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Thank you.

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Operator [32]

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(Operator Instructions) We'll now move to our next question, which comes from Han Joon Kim of Deutsche Bank.

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Han Joon Kim, Deutsche Bank AG, Research Division - VP and Research Analyst [33]

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Just have one. You've mentioned that your aim is to stabilize the TLBB PC side. Can you just give us sort of a perspective on what you think the KPIs should look like and how close you are to stabilization? I mean, I think you mentioned, second quarter's were down a little bit, but does that mean that progressively into 3 and 4Q, we should be flatlining from there forward? Or how much further room do we have before we reach a soft landing?

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Margaret Shi, [34]

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(foreign language)

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Dewen Chen, Changyou.com Limited - CEO and Director [35]

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(foreign language)

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Margaret Shi, [36]

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So the TLBB PC game is in its 10th year of operation, and the PC market has evolved so much over the last few years. So the numbers we look at is the active -- the number of active users and how active they are in the game.

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Qing Wei, Changyou.com Limited - Chief Games Development Officer [37]

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(foreign language)

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Margaret Shi, [38]

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So overall, we think the rate of migration from PC games to mobile games has actually slowed down this year compared to the previous years.

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Qing Wei, Changyou.com Limited - Chief Games Development Officer [39]

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(foreign language)

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Margaret Shi, [40]

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So as a result, retaining these users and keeping them within the game is the most important KPI for us rather than increasing ARPU for those users.

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Qing Wei, Changyou.com Limited - Chief Games Development Officer [41]

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(foreign language)

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Margaret Shi, [42]

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Thank you.

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Operator [43]

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We'll now move to our next question, which comes from Thomas Chong of BOCI.

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Thomas Chong, [44]

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I have two quick questions. My first question is about our overseas strategy. Can management give us some color about which countries do we target first and our expected revenue contribution? And secondly, we see we are having a more closer relationship with Tencent. And are we open to any strategic investment?

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Margaret Shi, [45]

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(foreign language)

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Dewen Chen, Changyou.com Limited - CEO and Director [46]

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(foreign language)

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Margaret Shi, [47]

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So the target countries for overseas -- as part of our overseas expansion plan is North America and Europe, mostly the English-speaking countries.

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Dewen Chen, Changyou.com Limited - CEO and Director [48]

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(foreign language)

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Margaret Shi, [49]

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And the reason for that is more than half of our web games revenue from 7Road [ one of you had ] 7Road came from the overseas market.

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Dewen Chen, Changyou.com Limited - CEO and Director [50]

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(foreign language)

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Margaret Shi, [51]

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And then we also saw some great success that some of our peer companies have made in the overseas markets.

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Dewen Chen, Changyou.com Limited - CEO and Director [52]

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(foreign language)

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Margaret Shi, [53]

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And then also, in terms of the size of market for North America, it's very similar to China.

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Dewen Chen, Changyou.com Limited - CEO and Director [54]

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(foreign language)

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Margaret Shi, [55]

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For the second question, there's no talks related to what Wei just mentioned.

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Dewen Chen, Changyou.com Limited - CEO and Director [56]

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(foreign language)

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Margaret Shi, [57]

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Thank you.

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Operator [58]

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(Operator Instructions) We'll now move to our next question, which comes from Nancy Wu (sic) [ Natalie Wu ] of CICC.

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Yue Wu, China International Capital Corporation Limited, Research Division - Analyst [59]

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Is that me? This is Natalie. Sorry, it's me again. My line just got like cut-off just now. So actually, I still have a second question regarding the TLBB legacy. So as it is recorded on net revenue basis, so can we assume that a majority of the game to be recorded can be transformed to net profit line? So which means that net profit margin for this game would be very high? It would be great if management can help us understand the rough margin level of the new game to be launched? (foreign language)

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Jasmine Zhou, Changyou.com Limited - CFO [60]

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This is Jasmine... (foreign language) For Legacy TLBB mobile game, I think the margin will be improved, because it's a net basis. But starting from Q2, we will have -- get prepared for some new games to be launched in the second half of the year. So we'll have more spending in marketing. Then, I think that will be -- partially offset the positive impact of the margin. And for Q2, we're expecting actually the margin will be -- remain stable.

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Yue Wu, China International Capital Corporation Limited, Research Division - Analyst [61]

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So just a quick follow-up with the like R&D expenses. For this quarter -- for the first quarter, the R&D expenses declined over 10% in terms of absolute number. So just wondering, is there any kind of streamlining going on with the company? And what should we expect of the headcount of each department this year?

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Margaret Shi, [62]

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(foreign language)

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Dewen Chen, Changyou.com Limited - CEO and Director [63]

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(foreign language)

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Margaret Shi, [64]

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(foreign language)

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Dewen Chen, Changyou.com Limited - CEO and Director [65]

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(foreign language)

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Margaret Shi, [66]

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We don't have any plans for further headcount reduction, and the reason why you saw a decline this quarter was because of a reduction in bonus expenses.

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Operator [67]

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That concludes today's Q&A session. I would now like to hand it back to your speaker, Margaret Shi, for any closing or additional remarks.

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Margaret Shi, [68]

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Once again, I would like to thank you for joining today's call. If you have any follow-up questions, please don't hesitate to contact us. Thank you.

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Operator [69]

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Thank you. That concludes today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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Margaret Shi, [70]

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Thank you.