Perfect World (NASDAQ:PWRD), a Chinese online gaming company specializing in developing 3D MMORPGs (massively multiplayer online role playing games), reported its Q2 2014 earnings on August 18. At $149 million, the company witnessed a 4.2% sequential and 32.6% annual growth in revenues in Q2 2014. The growth was the combined effect of the increased revenue contribution from domestic PC client-based games such as “Swordsman Online” and “DOTA2″, as well as the continued strength of Perfect World’s mobile games. The sequential top line growth was also associated with a change in the estimated player lives of certain PC client-based games, which were shortened in Q2 2014 as a result of a regular assessment of the player life cycles of its games. Net income for the quarter declined 20.2% sequentially but almost doubled compared to the same quarter last fiscal.
In addition to launching expansion packs and content updates for its existing games portfolio, Perfect World believes that new PC games as well as an expanding mobile and console game pipeline will fuel its growth in the future.
Rich Pipeline of New PC Games & International Diversification To Drive Growth
- Why We Are Revising Our Price Estimate For Perfect World
- Perfect World Q4 2014 Earnings Preview: Environment Has Improved, But Challenges Remain
- Why We Expect Perfect World’s Paying User Base To Shrink
- Perfect World’s 2014: The Quest For Sustained Gamer Interest
- Perfect World Q3 Earnings: Mobile Games Deliver Revenue Growth
- Perfect World Earnings Preview: Lack Of New Game Releases The Only Concern
Fueling Perfect World’s its revenue growth in Q2 2014 was both its flagship title “‘Swordsman Online” as well as the recently launched “Dota 2”, a world-class title which the company has exclusive rights to operate in mainland China. The company plans to launch a steady stream of expansion packs and content updates for its existing games throughout the year. Additionally, it has a rich pipeline of new games consisting of ‘Legend of the Condor Heroes‘, a highly-anticipated 3D MMORPG based on one of Louis Cha’s classic martial arts novels, and ‘Neverwinter’, a MMORPG developed by Cryptic Studios. Perfect World claims that the PC version of ‘Neverwinter’ has been well received by gamers in North America and Europe, and is expected to be launched in China later this year.
Perfect World has established a strong overseas network through its subsidiaries and licensing activities with overseas partners. It now covers over 100 countries and regions with around one-fourth of its total revenue being generated from various overseas markets. We expect the revenue contribution from International markets to increase in the future.
Expanding Portfolio of Mobile & Web Games Will Help Cater To The Changing Dynamics In The Gaming Industry
Lately, Perfect World has increased its focus on mobile games due to the increasing usage of mobile devices for playing games online. The company continued to build strong momentum in its mobile game portfolio in Q2 2014. Towards the end of the quarter, it launched the 3D mysterious fantasy MMORPG mobile game ‘Forsaken World’. More recently, it has introduced the 2D turn-based cartoon-style RPG mobile game, ‘CrossGate Mobile’, which it claims has become a hit since its launch. Other upcoming titles include ‘Touch’, ‘Forever Mars’ and ‘Swordsman Mobile’. The contribution of mobile to Perfect World’s revenues increased from under 10% in Q4 last year to about 15% in Q1 2014. 
Perfect World created a new console division in December 2013 to target current and next-generation console (i.e., XBox One and Playstation 4) users. The Chinese video game industry generated $13 billion in revenues in 2013. This represents about 15% of the worldwide video game marketplace even though video consoles were banned in China until recently. The Chinese government lifted the ban, after almost 14 years, in early January 2014.  With the lifting of the ban on game consoles in China, we expect the country’s share in the worldwide video game market to increase in the future.
As part of its efforts to build its game console pipeline, Perfect World has established a long-term partnership with Microsoft, through whose Xbox One platform it plans to bring several console games to players in China. ‘Neverwinter’ is one of the highly-anticipated titles to be launched along with the debut of Xbox One devices in mainland China.
Rising Mobile Contribution Can Impact Gross Margin
In Q2 2014, Perfect World reported gross margin of 73.1%, as compared to 73.6% in Q1 2014 and 76.5% in Q2 2013, respectively. Mobile revenues are recorded by Perfect World on a gross basis. This means that the distribution channel’s share is recognized as cost of revenues, leading to lower gross margins from mobile as compared to the PC platform. Mobile gross margins are usually between 40%-50%, while PC margins are much higher at 75%-80%. As the contribution of mobile games to Perfect World’s total revenue is expected to rise in the future, it can put pressure on the company’s gross margin going forward.
Q3 2014 Outlook
– Total revenue between RMB 956 million and RMB 1,003 million, a 3% to 8% sequential growth.Notes:
- Perfect World’s (PWRD) CEO Robert Xiao on Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, May 19, 2014 [↩]
- China suspends ban on video game consoles after more than a decade, Reuters, January 07, 2014 [↩]