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Giant Interactive Group, Inc. (NYSE:GA)

Q4 2012 Earnings Conference Call

February 26, 2013 8:00 p.m. EST

Executives

Rich Chiang – IR Director

Jazy Zhang – CFO

Wei Liu – President

Xue Feng Ji – VP of R&D

Analysts

Timothy Chan – Morgan Stanley

Eddie Leung – Merrill Lynch

Dick Wei – J.P. Morgan

Muzhi Li – Citigroup

Martin Bao – CICC

Andy Yeung – Oppenheimer

Jialong Shi – CLSA

Operator

Good morning and good evening, ladies and gentlemen. I would like to welcome everyone to Giant Interactive Group's Fourth Quarter and Full Year 2012 Earnings Conference Call.

After the presentation, there will be a question-and-answer session. Please follow the instructions given at that time if you would like to ask a question.

Now I would like to transfer the call to the moderator, Mr. Rich Chiang, Investor Relations Director of Giant Interactive.

Rich Chiang

Good morning, ladies and gentlemen. Welcome to the fourth quarter and full year 2012 earnings conference call for Giant Interactive Group. With me today are Ms. Wei Liu, President; Ms. Jazy Zhang, Chief Financial Officer; and Mr. Xue Feng Ji, Vice President of Research and Development.

As we proceed through our prepared remarks, we will refer to our results presentation which can be downloaded from our website at www.ga-me.com. Following the remarks, Ms. Liu, Ms. Zhang and Mr. Ji will be happy to take your questions.

Before we continue, I would like to remind you that statements on this call that are not strictly historical in nature constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and as defined in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements can be identified by terminologies such as will, expects, anticipates, future, intends, plans, believes, estimates and similar statements and, among others, include statements regarding the company’s expectation for sequential growth in 2013, the ability of the company to introduce new game types to maintain its growth rate and profitability that exceed industry average, the ability of the company to successfully diversify its revenues, the sustained progress and performance of ZT Online 2 after the launch of its first new expansion pack and micro-client version, sustained growth and diversity of the company’s user base after launch, distribution and testing of pipeline games including MMO games that are part of the company’s portfolio diversification strategy, the ability for World of Xianxia to become another blockbuster MMORPG of the company, the ability of the company to implement its strategy in connection with web games, such as expected commercial launches of Genesis of the Empire and The Sky, and the timetable for testing and releasing new games and expansion packs in the company’s game pipeline.

These forward-looking statements are not historical facts, but instead represent only our belief regarding future events, many of which by their nature are inherently uncertain outside of our control. Our actual results and financial condition and other circumstances may differ possibly materially from the anticipated results and financial condition indicated in these forward-looking statements.

Among the factors that could cause our actual results to differ from what we currently anticipate may include a deterioration in the performance of ZT Online 1 series and ZT Online 2, unexpected delays in developing expansion packs or in the timetable for testing and launching our games, our dependence on ZT Online 1 series and ZT Online 2 which currently account for the majority of our historical net revenues, failure of our web games, MMO pipeline games, first FPS game or other diversification or distribution efforts to grow as successful as expected, our uncertainties with respect to the PRC legal and regulatory environments and the volatility of the markets in which we operate.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results of Giant to be materially different from historical results or from any results expressed or implied by such forward-looking statements. These factors include but are not limited to the risks discussed in filings with the Securities and Exchange Commission including our Annual Report on Form 20-F filed on April 23, 2012 and in our amended annual report on Form 20-F/A for the fiscal year 2011 as filed with the Securities and Exchange Commission on September 26, 2012, both of which are available on the Securities and Exchange Commission website at www.sec.gov.

All forward-looking statements are qualified by this cautionary statement, and Giant undertakes no obligation to revise or update this information to reflect events or circumstances after today.

In addition, please note that references in the presentation to dollars refer to US dollars.

Now, I would like to turn the call over to our CFO, Jazy Zhang. Jazy?

Jazy Zhang

Thank you, Rich. Good morning and good evening, everyone. I will begin by reading the opening remarks from our President, Liu.

2012 marked another year of strong growth for Giant as we recorded a 20% year-over-year growth in net revenue. The fourth quarter of 2012 also marked a milestone as we were able to acknowledge 12 consecutive quarters of sequential revenue growth. In 2012, our flagship title ZT Online 2 continued to gain traction and we continued to provide new content for this increasingly popular game. We have also launched the micro-client version of ZT Online 2 which have performed well by attracting new players on Qihoo360's platform and contributing incremental revenue.

Our other existing titles have also done well. Elsword celebrated its first anniversary during the first -- sorry, fourth quarter of 2012, in which we launched a promotional campaign and added new content. In 2013 we plan to refresh the game by further adding an array of new content. Allods Online continued its steady performance, and we are releasing a new expansion pack in the first quarter 2013.

Glorious Mission, our first self-developed first-person shooter game played from the perspective of the Chinese military has already attracted over 1 million downloads of its single-player campaign version since the third quarter of 2012. Our development team is working on the online version and aims to conduct engineering testing in the first half of 2013.

Overall we are satisfied with our achievements in 2012. In the past year, in addition to the continued development of our new MMOs, we allocated a substantial amount of resources in building up our web game development teams, which we will mention in more detail shortly. Our execution and prudent spending led us to deliver growth in both top and bottom line, while maintaining a high margin. And at the same time, we have also made significant progress in diversifying our game portfolio, which will help to pave our way into overseas market.

2013 is another exciting year for Giant. It is also the defining year of our game portfolio diversification strategy. In terms of MMO games, our next self-developed flagship MMO title, World of Xianxia, has gone through various stages of testing and has received positive results. We are set to start our official closed beta testing in the second quarter of 2013, with its first large-scale marketing campaign. And we anticipate this title to become our largest new catalyst this year.

As for our web game offerings, two of them have entered respective final preparation stages after a year of intensive development. Both are set for commercial launches in the first half of 2013. We expect these two web games to become our second-largest new catalyst this year.

We're also moving into mobile game development this year, which will be a major additional strategic focus for our company. The increased use of smartphones and tablets over the past few years has substantially changed the gaming habits of many gamers. Mobile represents the future of online access and we aim to keep delivering the best gaming experiences no matter how games are delivered. Our game development teams have been studying the differences in preferences and habits that we see between traditional PC and mobile gamers. We will combine this knowledge with our industry-leading game design capabilities in our future mobile game development.

We began forming our internal mobile game development team last year, with the aim of producing a few high-quality games in 2013. We will allocate sufficient resources to continue to build a best-in-class mobile game development team, while also actively seeking merger and acquisition, as well as partnership opportunities to maximize our mobile game offering.

In terms of overseas expansion, we plan to further expand our international horizon on two fronts. First, we will continue to work with foreign game publishers for our existing and pipeline games on PCU web and mobile platforms, whichever is most suitable to the local market. Secondly, we will actively seek opportunities to license and publish major foreign titles in China, form co-development partnership and invest in foreign game studios.

This roadmap allows us to achieve our long-term objective which is to deliver shareholder value. Despite the impairment loss from our investment in 51.com, we are extremely confident in our core business and cash flow. As a result, our Board of Directors has declared a cash dividend of USD0.42 per ordinary share or ADS for fiscal year 2012, which implies a 50% payout of our GAAP EPS or EP ADS, excluding the impairment charge related to our investment in 51.com.

With all these growth and diversification catalysts, in addition to the resilient nature of the online game business regardless of fluctuations in the macroeconomic environment, we have never been more excited about the future of Giant. I have complete confidence that the new games in our pipeline will enable us to maintain our growth trajectory and reach new heights of success in 2013.

This concludes the opening remarks from President Liu. And I will now walk you through our key operational metrics and financials for the fourth quarter and full year 2012. Please refer to slide eight of our presentation.

Overall we are pleased to see our underlying business have a strong finish in 2012. In terms of our key operational metrics in the fourth quarter, active paying accounts or APA were up 2.6% sequentially and 6.1% year over year to 2.3 million. Average revenue per user or ARPU was RMB238, similar to the previous quarter and up 7.4% year over year. Average concurrent users or ACU were 702,000, up 1.1% sequentially and up 5.1% year over year. Lastly, our peak concurrent users or PCU were up 1.8% sequentially and up 1.3% year over year to 2.4 million.

The overall improvement in these user metrics was mainly driven by continuous popularity of our entire ZT Online franchise. The sequential rise in APA demonstrated our ability to convert new paying users, while ARPU increased year over year as users became more eager to spend as they progressed through ZT Online 2. The healthy performance of our core game portfolio contributed to our positive financial performance for the quarter, which is illustrated on slide 10 and 11 of our presentation.

Net revenue for the quarter was USD91.8 million, up 5.2% sequentially and up 15.5% year over year. For the full year 2012, net revenue was up 20.1% year over year to USD345.4. Our core business online game revenue grew 6.1% sequentially and 18.3% year over year to USD89.2. For the full year 2012, revenue from online games was up 22% year over year to USD333.1 million.

Gross profit for the quarter was USD79.2 million, up 5.4% sequentially and up 15.5% year over year. Gross margin was 86.3% in the fourth quarter 2012, remained flat compared with the third quarter 2012 and the fourth quarter 2011. For the full year 2012, gross profit was up 21.4% year over year to USD299.1 million. Gross margin was 86.6% compared to 85.6% for the full year 2011.

Total operating expenses for the quarter were up 12.3% sequentially and up 18.7% year over year to USD25.6 million. As a percentage of revenue, total operating expenses were 27.8% for the fourth quarter 2012 compared to 26.1% in the third quarter 2012 and 27.1% in the fourth quarter 2011. The sequential increase in operating expenses is mainly due to the increase in R&D expenses while the year-over-year increases in operating expenses were mainly attributable to the increases in R&D expenses, G&A expenses, and less government financial incentives, partially offset by less sales and marketing expenses in the fourth quarter 2012 as compared to the fourth quarter 2011.

Total operating expenses for the full year 2012 were USD89.6 million, up 22.4% year over year. The increase was mostly due to increases in R&D and G&A expenses, partially offset by the decrease in sales and marketing expenses and higher government financial incentives received in 2012 as compared to 2011.

R&D expenses for the quarter were up 26.9% sequentially and up 39.5% year over year to USD15.5 million. As a percentage of revenue, R&D expenses were 16.9% in the fourth quarter 2012 compared to 14% in the third quarter 2012 and 14% in the fourth quarter of 2011. The sequential increase in R&D expenses was mainly attributable to an increased headcount allocated to our new product lines and increased cash compensation for our R&D employees, including pay raises and performance-based bonuses. The year-over-year increase was primarily due to an increased headcount allocated to our new products, increased cash compensation, and increased share-based compensation expenses related to the restricted shares granted at the end of November 2011.

On a full-year basis, R&D expenses for 2012 were up 42% year over year to USD52.5 million, for the same reasons stated above.

Sales and marketing expenses for the quarter were up 4% sequentially and down 29.7% year over year to USD6.2 million. As a percentage of revenue, sales and marketing expenses were 6.8% this quarter compared to 6.9% in the previous quarter and 11.2% in the fourth quarter 2011. The sequential increase in sales and marketing expenses was minimal. The year-over-year decrease in sales and marketing expenses was mainly due to the large-scale marketing campaign related to the open beta testing of ZT Online 2 and Elsword in the fourth quarter of 2011, while in the fourth quarter 2012 the marketing for these games reverted back to the normal scale.

Sales and marketing expenses for fiscal 2012 were down 13.8% year over year to USD23.5 million. The higher sales and marketing expenses incurred in fiscal 2011 were associated with the commercial launch of ZT Online 2 and Elsword.

G&A expenses for the quarter were down 10.7% sequentially and up 24.7% year over year to USD5.5 million. As a percentage of revenue, G&A expenses were 6% this quarter compared to 7% last quarter and 5.5% in the same quarter a year ago. The sequential decrease in G&A expenses was mainly due to higher reimbursements related to our ADR program in the fourth quarter 2012 while the year-over-year increase was mainly attributable to the share-based compensation expenses related to the restricted shares granted at the end of November 2011 and less reimbursements related to our ADR program during the fourth quarter 2012 as compared to the fourth quarter 2011. For fiscal year 2012, G&A expenses were up 43.4% year over year to USD23.9 million as a result of the share-based compensation expenses related to restricted shares granted at the end of November 2011, and less reimbursements related to our ADR program in fiscal year 2012 as compared to fiscal 2011.

Moving on to our bottom line, net income attributable to the company's shareholders during the quarter was down 73.5% sequentially and down 66.4% year over year to USD13.3 million. The net margin for the quarter was 14.5% compared to 57.4% in the previous quarter and 49.8% in the fourth quarter 2011. The sequential and year-over-year decrease in net income attributable to the company's shareholders was mainly due to the booking of an impairment charge of USD38.6 million related to our investment in 51.com, partially offset by our general business growth.

Net income attributable to the company's shareholders in fiscal 2012 was up 12.9% year over year to USD159.5 million. The net margin for fiscal 2012 was 46.2% compared to 49.1% for fiscal 2011, which was primarily due to the investment loss related to 51.com.

Non-GAAP net income attributable to the company's shareholders during the quarter was up 2.2% sequentially and up 35.8% year over year to USD56.2 million. This number excludes non-cash share-based compensation expenses as well as one-time items such as accrued withholding tax associated with the repatriation of cash, special cash dividends, recognizing additional deferred tax assets, foreign exchange gains for the payment of the special cash dividend, and impairment loss of our 51.com investment.

Non-GAAP net margin was 61.2% compared to 63% in the previous quarter and 52.1% in the fourth quarter 2011. Non-GAAP net income attributable to the company's shareholders in fiscal 2012 was up 24.7% to USD217.4 million, primarily attributable to the growth of the company's game operations. Non-GAAP net margin for fiscal 2012 was 62.9% compared to 60.6% in fiscal year 2011.

Basic and diluted earnings per ADS for the quarter were USD0.06 and USD0.05 respectively on a GAAP basis and USD0.24 and USD0.23 respectively on a non-GAAP basis. Basic and diluted earnings per ADS for fiscal year 2012 on a GAAP basis were USD0.67 and USD0.66 respectively and USD0.92 and USD0.90 on a non-GAAP basis.

Moving on to our balance sheet on slide 12, as of December 31, 2012, our cash and cash equivalents and short-term investments totaled USD430.6 million compared to USD372 million as of September 30, 2012. The sequential increase was due to the increase in cash collection as a result of growth from our online game business.

We would like to take this opportunity to announce a cash dividend of USD0.42 per ADS or ordinary share on our outstanding shares. The ordinary cash dividend is payable to shareholders of record at the close of trading on May 20, 2013 US Eastern Time. The total cash payments will be approximately USD100.5 million. After this dividend payment, we plan to pay 2013 dividend on a semi-annual basis. The future payment amounts and dates are subject to approval by our Board of Directors and compliance with applicable laws.

While we are pleased with our performance this quarter, we expect revenue for the first quarter of 2013 to be nearly flat compared to the fourth quarter 2012. This is due to the first quarter typically being a weak season on hard core games, because during the Chinese New Year holiday, many people travel, and also because our new games will not be launched until the second quarter 2013. Nonetheless, we are extremely confident that our full year growth will be very healthy.

That concludes our prepared remarks. Once again, thank you for joining us today. We will now open the lines for questions.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions].

And your first question comes from the line of Timothy Chan of Morgan Stanley. Please ask your question.

Timothy Chan – Morgan Stanley

Good morning. Thanks very much for taking my questions. My first question will be about the web and mobile game business. Could you maybe share with us what is your strategy in terms of distribution and promotion of these games? They are quite different from MMORPG. And I have a second question. Thank you.

Jazy Zhang

Thank you, Tim. (Chinese language spoken)

Wei Liu

(Chinese language spoken)

Rich Chiang

For our web and mobile game strategy, first of all, on the web games front, how we're going to promote and distribute our future web games. Currently in China, the distribution channels for web games are already pretty established. We will have two web games launching in the first half of this year, and we will work with pretty much all of the major web game platforms available to distribute our games. However, for future web games to be launched, that will depend on -- depending on its genre or type, and maybe we can come up with other new or creative ways to market these games.

On the mobile front, this will become a major new strategic focus for us this year. But the major focus is to building up our team and developing our mobile games throughout this year. We'll have to wait until these new games are ready, and also for distribution channels for mobile games to be a little bit more established in China before we have more to announce on this front.

Timothy Chan – Morgan Stanley

Thanks. And my second question is about your re-acquisition from Huayi Brothers, and I know [you invested now], and if it implies any change in your strategy? Thank you.

Jazy Zhang

Okay, Tim, I'll take your question. So basically back in December 2010, we sold the controlling interest in Huayi Giant to Huayi Brothers Media Company. Huayi Brothers intends to explore their business into online game operating business. After trying that for two years and they realized that this is not their strength, and so we have mutually agreed to re-acquire their controlling interest at the same time. Following the purchase price allocation, after allocating certain amounts to the net assets and the residual growth to the goodwill, and so basically the core value is at the development, and we believe that they have huge potential, and we do expect our new games to be developed by this team.

Operator

Your next question comes from the line of Eddie Leung of Merrill Lynch. Please ask your question.

Eddie Leung – Merrill Lynch

Good morning. Thank you for taking my question. Just one question about the operating expenses. We noticed that there was an increase, a material increase in R&D costs in the fourth quarter. And of course we understand there could be salary increases and increase in headcount, et cetera. But could you share more color on how the costs impacted by the salary hikes as far as the headcount increased in the fourth quarter? For example, how many more R&D staff you hired in the quarter and how many people you would add for this year? Thank you.

Jazy Zhang

Thank you, Eddie, for your question. So basically there are two factors contributed to the increase in R&D expenses in Q4 last year. In terms of headcount, we hired additional 20-plus developers to R&D. Additionally, we, you know, as usual, we have given our R&D employees, on average, 6% to 8% of semi-annual raise, plus double pay -- double monthly pay for the yearend, plus other performance-based yearend bonuses. Combined these factors, it contributed to the increase in our R&D expenses in Q4.

Eddie Leung – Merrill Lynch

Is there any major increase in headcount for R&D in 2013? At the moment, as we speak, we know that there could be efforts to build up the mobile team.

Jazy Zhang

Yeah, we -- sorry, excuse me. We do expect additional headcount increase in R&D. However, this number is not going to be huge. I think it's going to be under 50 -- around 50. Around 50 for 2013. We will definitely update you as we have more updates.

Operator

Your next question comes from the line of Dick Wei of J.P. Morgan. Please ask your question.

Dick Wei – J.P. Morgan

Hi, good morning. Thank you for taking my questions. First question is about if you can share the current revenue breakdown by games and some of the trend going forward, it'll be great. Then I have a second question. Thanks.

Jazy Zhang

Thank you, Dick. We normally don't give very detailed revenue breakdown by games. However, we are willing to give you some color. So for the fourth quarter 2012, our ZT franchise, including ZT 1 series and ZT 2, continued to perform well. ZT -- the micro-client version of ZT 2 contributed incremental revenue. Additionally, we have a few other new games launched in Q4, which became additional growth driver.

Going forward, in 2013, we expect several major revenue growth drivers, including the revenue contribution from the two new web games, World of Xianxia and the continued growth from ZT Online 2 as well as its micro-client version.

Dick Wei – J.P. Morgan

Good. Thank you. Then my second question is on the mobile game development, if you can share what are some of the plans maybe in terms of the team size as well as the number of products that Giant is thinking to build, will be kind of launch date, that will be helpful. Thank you.

Jazy Zhang

Thank you. (Chinese language spoken)

Wei Liu

(Chinese language spoken)

Rich Chiang

For our mobile game strategy, as we just mentioned, mobile is one of our new major strategic focuses for this year. As everyone is aware, this is the future of online access, and in the mobile industry or the mobile sector, we've already seen some mobile games in China being able to generate pretty significant revenue. So we're definitely going to allocate sufficient resources to build up our mobile development on this front in terms of both self-developing mobile games and also mergers and acquisitions, partnerships and cooperation with external mobile teams as well.

For mobile development versus MMO development, well, in this view, we already know that the gaming habits of mobile gamers and client-based PC gamers are very different. We have spent some time now studying these differences, so that we'd be able to leverage our game experience, game design, and combine this knowledge and be able to deliver high-quality mobile games.

For our MMO games, we have already have a very long experience and track record, so we have a very clear understanding of what gamers want. But for mobile games, the industry is a little bit more early right now. At this stage, the tastes and preferences of mobile gamers are much more diverse. Because of this, we're going to continue exploring different opportunities in the mobile game market.

As for this year, we plan to establish around two to three mobile development teams, and each team will have -- can range from about 10 developers to upwards to around the size of a web game team, depending on the type of genre of the mobile game that we will be developing. All in all, this should be less than around 100 people dedicated to mobile for us by the end of this year.

Operator

Your next question comes from the line of Muzhi Li of Citigroup. Please ask your question.

Muzhi Li – Citigroup

Hi. Thank you for taking my questions. I would like the management to explain about the rationale behind the booking the investment loss for 51.com. The company made the purchase in 2008 at about USD51 million for 25% of stake. Why do the company suddenly realize that, you know, decided to book the loss and, you know, because there's no ready market for this preferred share securities so there's very little clarity, would you please explain? Thank you.

Jazy Zhang

Thank you. Thank you, Muzhi. Let me translate your question first.

(Chinese language spoken)

Wei Liu

(Chinese language spoken)

Rich Chiang

Regarding our impairment charge in 51.com social network, we made this strategic investment in this platform in 2008. At the time we are already predicting the convergence between social networking and the game industry. And we were hoping to leverage this investment in order to keep growing our user base, to leverage their user base to help to monetize more of our games.

As during that phase, we, unfortunately, we realized that the social networking users, more casual social networking users, were not that suitable to play some of these hard-core games, and it was -- the results were a little bit disappointing. After a while, 51.com was trying to pivot from being a social network into more of a social game, the developer and publisher. During this transition, it's been a sort of a rough transition. Some of their results had been -- have not reached some of the expectations, causing this impairment charge that we have booked on our financials this quarter. But 51.com is now more of a game company than a social network, we feel that we will have much more synergy with them in the future. And so we'll definitely continue to help them and cooperate with them and help them grow the business going forward.

Muzhi Li – Citigroup

Thank you. And my second question is regarding the margin trend. Would you please share your outlook for the margin trend in 2013? Thank you.

Jazy Zhang

Okay. Thank you, Muzhi, for your question. For 2013, we expect the margin -- let me just break it down into several margins. In terms of gross margin, we expect it to be pretty much the same as 2012, which is between 86% and 87%, that's for gross margin. For operating margin, we expect the range to be between 60% and 65%. As far as net margin, it will be, you know, in the first half of 2013, net margin will be slightly lower, but it will pick up in the second half due to new game launches. But overall on average, for the full year, it will be somewhere around 65% for net margin.

Operator

Your next question comes from the line of Martin Bao of CICC. Please ask your question.

Martin Bao – CICC

Thank you for taking my question. My question is regarding the user trend with the client games. We see that -- we see the active paying user had been growing over the last few quarters with our games and we see with some of our peers actually their user base, especially with the paying user base, are decreasing, so with two different trend in the markets. Will the company do rely on growing the user base in 2013 for the growth [inaudible] current games?

Jazy Zhang

Thank you, Martin, for your question. (Chinese language spoken)

Xue Feng Ji

(Chinese language spoken)

Rich Chiang

For the overall trend in our user numbers, throughout 2012, we have seen most of our user metrics throughout the year. I think this is a testament to how we've really been able to capture what gamers really want and their changing taste and preferences versus some of our competitors and versus the rest of the industry. As you know, over the past couple of years, gaming habits and tastes of gamers have been evolving throughout the industry.

For example, everyone is now busier, you can access the internet from your mobile device as well. The playing habits and time spent on games is more fragmented these days than ever before. We have seen that users transition from playing more long-term -- more longer hours during the weekend to weekdays in the past couple of years. We have seen that more and more people are now traveling throughout major holidays such as Chinese New Year, in China, creating a weaker seasonality for us.

So we believe that our understanding of what gamers' changing tastes and their preferences is superior among our peers, and our user base metric has also improved much greater than our competitors because ZT Online 2 has also been among the best new games in the industry over the past couple of years.

Now as for 2013 trends, so far we can see that the first quarter is going to be a weaker seasonality for us as, you know, people tend to travel more during the Chinese New Year period and also because and also because we have no new game launches during the first quarter. But as the second quarter rolls around, our new flagship title World of Xianxia will be launching into official closed beta testing with its first major marketing campaign. At that time we should see that our user metrics will improve over the current status.

Martin Bao – CICC

Thank you very much. That's helpful. (Chinese language spoken)

Operator

Your next question comes from the line of Andy Yeung of Oppenheimer. Please ask your question.

Andy Yeung – Oppenheimer

Hi, good morning. Thank you for taking my question. I have two questions. My first question is about the reception of World of Xianxia. After you had closed beta testing in November, can you give us some color in terms of user reception for the game? And how does that compare to ZT Online 2 during the same time, you know, during the same time at the [development process]?

Jazy Zhang

Thank you, Andy. (Chinese language spoken)

Xue Feng Ji

(Chinese language spoken)

Rich Chiang

For the testing results and feedback from World of Xianxia testing so far, as you know, we've been conducting unlimited account testing for the past couple of months, and the results have been very, very positive. Judging from its user numbers and spending potential, the results have exceeded our expectations, and along with other metrics that we have measured, causing us to promote this as our flagship title for 2013.

For example, some of our testing results, we have concluded that 90% of testers for this game have been begging us to launch this game quickly, which we will do officially in April. At that time, we believe that this will help our company grow our performance even more and diversify our game portfolio.

This game is inherently a little bit different than ZT Online 2, even though it's also a hard-core MMO. But in terms of game play it's very different. But the metrics that we have seen such as churn rates and other metrics are actually very similar compared to ZT Online 2 during its similar testing phase, before it was launched.

Andy Yeung – Oppenheimer

Great. My next question is a housekeeping question. Just wanted to know how your dividend policy impacts your tax rate this year.

Jazy Zhang

You know, we -- the effective tax rate for 2013 will be somewhere between 10% and 15%. The dividend payment will not further increase, will not further increase our tax rate. The tax rate that I told you guys previously already included the withholding tax related to the dividend payment.

Operator

Your next question comes from the line of Jialong Shi of CLSA. Please ask your question.

Jialong Shi – CLSA

Hi, good morning. Thanks for taking my question. I have a question on your 1Q guidance. We understand 1Q is typically a slow season. Could you let us know which games in your portfolio will likely see sequential declines in 1Q and which will likely be more resilient? Thank you.

Jazy Zhang

Thank you, Jialong. (Chinese language spoken)

Xue Feng Ji

Ni hao. (Chinese language spoken)

Rich Chiang

Regarding our first quarter guidance being relatively flat compared to the fourth quarter, as we mentioned, the first quarter will represent a weaker seasonality for us, as most of the older gamers in our hard-core ZT franchise tend to travel more versus gamers in more casual games. So we will not see much growth in our hard-core games. And also considering that we have no new game launches in the first quarter, this is why we have guided for a more flattish performance in the first quarter. However, after the Chinese New Year holiday, we have seen that some of our gamers have already resumed their playing habits from before.

Moving into the second quarter, as World of Xianxia and new games start becoming online, we're very confident that we'll resume our growth trends, and these new games will help us reach new levels of success.

Operator

Due to time limitations, I would now like to hand the conference call back to Mr. Rich Chiang. Please continue.

Rich Chiang

Thank you again for joining us today, and we look forward to talking to you about our progress in the near future. Have a nice day.

Operator

Ladies and gentlemen, that does conclude our conference for today. Thank you for participating. You may all disconnect.

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