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Giant Interactive Group, Inc. (NYSE:GA)

Q2 2009 Earnings Call

August 19, 2009 8:00 am ET

Executives

Rich Chiang – Investor Relations Manager

Yuzhu Shi - Chairman of the Board, Chief Executive Officer

Wei Liu - President, Director

Eric He - Chief Financial Officer

Analysts

Wendy Huang - RBS

Jenny Wu - Morgan Stanley

Alicia Yap - Citigroup

Atul Bagga - ThinkEquity

Eddie Leung - Banc of America/Merrill Lynch

Andrey Glukhov - Brean Murray, Carret & Co

Jin Yoon – Nomura International

James Mitchell - Goldman Sachs

James Lee - Sterne Agee

Tian Hou – Pali Capital

Presentation

Operator

Good morning, ladies and gentlemen, I would like to welcome everyone to Giant Interactive Group's Second Quarter 2009 Earnings Conference Call. (Operator's Instructions) After the presentation there will be a question-and-answer session. (Operator's Instructions) Now I would like to transfer the call to your moderator, Mr. Rich Chiang, Investor Relations Manager of Giant Interactive Incorporated. Please proceed, sir.

Richard Chiang

Good morning, ladies and gentlemen, welcome to the second quarter 2009 earnings conference call for Giant Interactive Group. With me today are Mr. Yuzhu Shi, our Chairman and Chief Executive Officer, Miss Wei Liu, President, and Mr. Eric He, Chief Financial Officer.

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, Mr. Shi, Miss Liu, and Mr. He, 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 27(NYSE:A) of the Securities Act of 1933 as amended, and Section 21(NYSE:E) 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 terminology such as will, expect, anticipate, future, intend, plan, believe, estimates, and other similar statements, and include among others, statements regarding our continued effort to increase shareholder value through strategic investments and expansion or adjustment of game content and features.

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, risks and uncertainties related to the progress, timing, costs, and results of game testing and product development, competition from other online game companies, and the additional risks discussed in filings with the Securities and Exchange Commission, including our annual report on Form 20(NYSE:F) filed on June 19th, 2009.

All forward-looking statements are qualified in their entirety by this precautionary statement and Giant undertakes no obligation to revise or update this information to reflect events or circumstances after the date hereof.

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

Now I would like to pass the call over to Eric He, our Chief Financial Officer.

Eric He

Thank you, Rich. Good morning and good evening, everyone. Thank you for joining us today. As we previously guided for in the second quarter 2009, due to our strategic decision to deemphasize sales and marketing in the first half of 2009, in order to channel our efforts towards proper development of our pipeline games. This resulted in the expected decline of our game performance.

As shown on slide six, total active paying accounts, or APA, was 1.204 million, representing a 2.6% sequential decrease from the first quarter of 2009 and a 31.6% decrease year over year.

Average revenue per user, or ARPU, of RMB 300, was basically flat on a sequential basis, and an increase of 4.9% year over year. Average concurrent users, or ACU, was 453,000, a decrease of 14.7% sequentially and 26.9% year over year. Peak concurrent users, or PCU, declined by 8.3% from previous quarter and decreased by 38.4% year over year to $1.44 million.

Despite the softness in our game metrics, we were able to deliver solid financial performance as we continue expanding our game portfolio to cater a broader array of player preferences.

So let me first report our second quarter 2009 financial highlights as shown on slide seven. Net revenue for the quarter of $53.3 million was in line with our previous guidance and decreased 2.5% sequentially and 27.9% year over year.

Gross profit decreased by 1.4% sequentially to $45.3 million and was down 30.8% year over year. Gross margin of 85% was up slightly from the first quarter of 2009, but was down somewhat by 89% in the prior year period.

Net income decreased 0.1% sequentially to $34 million which was a year-over-year decline of 33.9%. Net margin increased to 63.7% for the second quarter 2009, compared to 62.1% in the first quarter 2009 and 69.5% in the second quarter 2008. The primary reason that we were able to maintain our net income level quarter over quarter and actually enhance net margin was stringent cost management, which I will discuss on slide eight.

Operating expenses for the quarter totalled $11 million, representing an 8.3% sequential decline and 36.8% year-over-year decrease. R&D spending decreased by 10.2% sequentially, primarily due to capitalization of certain R&D expenses for development of our new games.

In addition, sales and marketing expenses declined 20.1% sequentially and 71.1% year-over-year, due to our tighter cost controls over liaison personnel and reduced marketing campaigns. At the end of the second quarter 2009 we had approximately 1,600 liaison personnel.

General and administrative expenses were up 8.6% sequentially and up 5.3% year over year, mainly attributable to an increase of our human resources related consulting fees.

Both basic and diluted EPS for the quarter were $0.15, both relatively stable compared to the first quarter of 2009.

Moving to the balance sheet on slide nine, cash and cash equivalents and short-term investments combined as of June 30th, 2009, decreased slightly to $736.1 million. This increase is primarily a result of dividend payment of $40.6 million and the prepayment of land of Zhuhai for future R&D center in the amount of $12.5 million, during the second quarter of 2009.

Now, in addition to our financial performance, I would like to provide some updates on our game developments for second quarter 2009, starting on slide 11.

First, as many of you may know, we introduced a segmentation strategy for our flagship game, ZT Online approximately a year ago, in order to attract both new and formal players, enhance our community base, and increase player loyalty. Building off of this strategy, we will continue to expand our ZT Online brand into a series of versions targeting different types of ZT fans with various preferences.

As for the original ZT Online, we've begun testing an expansion pack called Parenthood Simulation in July, which has begun generating some positive traction among players. Our ZT Online Classic Edition is maintaining stable performance and we are preparing expansion packs for this classic version called Unparalleled Martial Arts.

We are also developing a new version called ZT Online Green Edition, targeting lower-spending accounts with modified economics systems and weapon-item systems. This version of ZT game will lessen the differences in power between high-paying and low-paying gamers through many balanced game plays and features. We expect to begin testing ZT Online Green Edition in October.

In addition, development of a sequel, ZT Online II is on track and is planned to commence engineering tests towards the end of 2009.

Now for a brief overview of the other games we have listed on slide 12. We release this new set of features and in-game items for Giant Online and are planning to unlock the next military rank for players to achieve, in the third quarter.

As for King of Kings III, a 3D free to play medieval magical MMORPG, in the second quarter we received feedback from the gamers as a result of limited closed-beta testing of the game and are fine-tuning the game accordingly. In July we launched the second phase of limited closed-beta testing. We are expecting to begin closed beta tests in the fourth quarter.

Dragon Soul is a 3D ancient Chinese PK MMORPG developed by our R&D team based in Chengdu, Sichuan. The game utilizes a self-developed 3D engine. We currently expect to begin engineering testing in the fourth quarter.

The Golden Land is a self-developed medieval strategy web game. This is quite different from our other MMORPG games and is part of our stronger diversification strategy to capture a broader range of players. We are currently conducting engineering testing and expect The Golden Land to enter closed beta testing in the fourth quarters.

Finally, our Win@Giant incubation program is also starting to pickup. My Sweetie is a 2.5D casual MMORPG that allows gamers to create virtual avatars and raise virtual pets and interact with other virtual pet's owners online.

Also from our Win@Giant program, XT Online is the 2.5D ancient Chinese martial arts MMORPG. We are currently conducted limited closed beta testing and expect to begin closed beta testing in the fourth quarter.

For Empire of Sports, a 3D MMORPG game featuring a wide range of sports events, in the second quarter we began limited engineering testing and are now revising economic systems, quantitative balancing, and improving user interface.

This completes my update on the game development. As you can see, our portfolio continues to grow and diversify as we target a broader universe of players.

As for the share repurchase program on slide 13, for the 150 million share repurchase program we announced last year, as of June 30th, 2009, we have repurchased an aggregate of 16.5 million ADSs on open market for total consideration of $106.9 million. We did not repurchase any shares during the second quarter 2009. In this month, the board of directors terminated this plan and approved another share repurchase plan, authorizing the company to repurchase up to 150 million of our ADSs.

This completes my update on the second quarter 2009 activities. Now looking ahead to the third quarter 2009, although it's detailed online, our new expansion pack is gaining traction and we are seeing improved user numbers. Any positive financial impact is likely to lag behind as a result based on our current estimates. We expect to generate total net revenue in the range of 310-345 million RMB for the third quarter 2009.

In conclusion, we remain confident in our long-term outlook and believe that we have many solid opportunities for growth. As we continue to strengthen our R&D capabilities, leverage our extensive sales and marketing networks, and keep players engaged via constant upgrades and enhancements, we are confident in our ability to ultimately create long-term shareholder values.

This completes our presentations. Now we are open to questions.

Question-and-Answer Session

(Operator's Instructions) Your first question comes from the line of Wendy Huang with RBS. Please proceed.

Wendy Huang - RBS

Hi. Thanks for taking my question — two questions. First, you guided the revenue to decline sequentially by 5%-15% in the next quarter, I just wonder with the lower revenue bases how the gross margin looks like in Q3 '09?

Eric He

Wendy, I think our gross margin over the last couple of quarters has been maintained very well. I do expect that the gross margins should be maintained at a quite reasonable range as we have shown in the first and the second quarters. So I do not expect that the gross margin will change too much in the third quarter.

Wendy Huang - RBS

Okay. Secondly, could you maybe share with us about the new user activation for ZT Online in the past two quarters? I mean, including the paying users and the non-paying users.

Eric He

Okay. I would like to direct this question to our President Liu, to share that answer with you.

Wei Liu

In terms of user profiles, the users in past one or two quarters, as you can see from our operating metrics, the APA, active paying accounts, has been pretty stable. So during the first half of this year as we decreased our marketing activities it actually has affected brand new users or paying users more, so there is slight softness in terms of that kind of users.

Wendy Huang - RBS

If the new users for the ZT series games is actually declining, then what is the rationale behind launching another two versions of your ZT Online series games, I mean the Green Edition and also the ZT Online II in the next 12 months?

Wei Liu

As ZT Online was first launched in 2006, it is considered a mature game now, having been in operation for a couple years. So we do need to come out with new content and expansion packs to keep the game fresh. During the third quarter we began rolling out our newest expansion pack for ZT Online called Parenthood Simulation and also, in conjunction, increased some marketing activities or campaigns around that. As a result we have seen user numbers come back and rise back up which is a very positive sign.

Now in light of that, because ZT Online is known, has a reputation, or is very popular with very high-spending gamers, there is a certain segment of the gaming population who cannot spend that much who are lower spenders and who would want a sort adjusted in-game economy to fulfill their needs.

Because ZT Online, the original version, is so popular, we cannot make very drastic changes in the original version without upsetting different demographics within that game. Therefore we need to come out with a new version of the game such as the Green Edition, to cater to say, lower spenders.

Wendy Huang - RBS

Thanks. I just want to get an idea whether the returning users you talked about in the ZT Online just now, if many paying users growth in Q3 or is that non-paying user growth?

Wei Liu

For our expansion pack called Parenthood Simulation, the original goal was more focused on increasing the community aspects of the game, increasing interactivity, stickiness, user numbers in general. So as a result, we believe that we’ve accomplished this so far.

Wendy Huang - RBS

Thank you very much.

Operator

Your next question comes from the line of Jenny Wu with Morgan Stanley. Please proceed.

Jenny Wu - Morgan Stanley

Hi. My question is, first of all, would you please remind us what percentage of gamer accounts are actually paying?

Eric He

The paying accounts is hovering 7%-8% of total active players. This has been pretty stable.

Jenny Wu - Morgan Stanley

Okay. And another question for Q2, your APA declined less than ACU and the PCU, how should we understand this set of data? Does that mean more nonpaying gamers last more than those paying members, is that true?

Eric He

Yes. As you can see from our operating metrics, our ACU in the second quarter actually declined a little more than active paying accounts, so from those statistics I think your conclusion is correct. Nonpaying accounts actually declined a little heavier than the paying accounts.

Jenny Wu - Morgan Stanley

Okay. Then related question also for Q2, your APA declined, but the ARPU actually stayed flattish Q on Q, and you just mentioned there is not much marketing in the promotion. So should we expect that this ARPU level would actually be the normal level going forward for your call gamers?

Eric He

I would like to direct this question to President Liu.

Wei Liu

Currently yes, in ZT Online the ARPU is considered pretty stable, but once our new games are launched then that will impact the ARPU.

Jenny Wu - Morgan Stanley

Okay. That is all my questions. Thank you.

Operator

Your next question comes from the line of Alicia Yap of Citigroup. Please proceed.

Alicia Yap - Citigroup

Thanks. I have two questions. First of all regarding your Q3 guidance, what has happened recently that caused you to provide very weak guidance? Obviously you don't have new games, that is one of the reasons. I just want to know how much is that the impact from the reason virtual currency regulations?

Wei Liu

For our guidance for the third quarter of 2009 there's three reasons why the guidance was lower than expected. First of all in late June, the Ministry of Culture came out with new regulations concerning virtual currency and we voluntarily cancelled the remaining treasure box function in our ZT Online starting in the beginning of July, and this had some impact on our performance.

The second reason is ZT Online's newest expansion pack, Parenthood Simulation, the goal was primarily focused on the community features of the game, not necessarily revenue benefit. The third reason is our new pipeline games experienced some delay such as King of Kings III in order to enrich the game content and make it even more fun.

Alicia Yap - Citigroup

Okay. Thank you. My second question is a little bit longer and is mainly on the ZT Online versions. So you currently have three versions of ZT which is the time-based, free to play, and the classic versions, and you're going to launch the Green Edition and the sequel coming out as ZT Online II. So can you help us understand the major difference between the Classic Edition and the Green Edition, and then the difference between the Green Edition and the ZT Online II.

So, I understand that the purpose of having different versions is to attract different user base, but how do you market that to players? Do you think the gamers are quite confused in terms of which version is suitable for them, and do you think you can still attract new users or is it more to attract back old users? And lastly, if you can rank in terms of the ARPU for your different versions of ZT?

Wei Liu

Yes. Currently we operate three versions of our ZT Online series. There's the original ZT Online, ZT Online P2P, and ZT Online Classic Edition. Now in our pipeline we have two other ones, ZT Online Green Edition and ZT Online II. First of all, for ZT Online II, this is a brand new 2D MMORPG, the sequel to our flagship game, and it's a brand new game with all new graphics, gameplay, in-game economy, et cetera. And with this we are expecting to get some brand new users into the series.

Now, as for the differences between ZT Online, the original, ZT Classic and ZT Green, they're all considered different versions of our original flagship game. The original ZT Online is our flagship game and has a high ARPU, catering to high-spending gamers. Classic Edition, which was launched in the third quarter of 2008, makes some adjustment in terms of the in-game economy by canceling all the promotional items that existed in the original ZT Online. So therefore, you can think of it as going back to an older version of ZT Online's in-game economy. Now, the upcoming Green Edition revises and enhances the current in-game economy even further, improving it for lower spending gamers, providing better balance for them and catering to their needs.

So in terms of ARPU, the highest ARPU would be the original ZT Online, then it would the Classic Edition, and then it would be the Green Edition with probably the lowest ARPU.

And as for the user profiles, Classic Edition should attract former gamers of the series while Green Edition should attract both new and former gamers.

Alicia Yap - Citigroup

Okay, understood. Thank you very, very much.

Operator

Your next question comes from the line of Atul Bagga with ThinkEquity. Please proceed.

Atul Bagga - ThinkEquity

Hey, guys. Thanks for taking my call, a couple of questions for you. So this is the fourth straight quarter that you have reduced the sales and marketing expenses sequentially. Can you talk a little about what kind of impact you have seen on your churn rate and also with this reduced sales marketing expenses scale, are you guys seeing any trend in your cost of acquisition?

Eric He

Churn on what, I am sorry?

Atul Bagga - ThinkEquity

Cost of acquisition and also churn rate, (interposing) of your customers.

Wei Liu

Yes. Our sales marketing expenses depends heavily on whether or not we have new products to launch, and so therefore during the past couple of quarters we have been pretty quiet on that front. The advertising that we do are directed towards new gamers. Once we capture their attention and they come into the game, their churn rate would depend on the game play and whether the game is actually fun to play or not.

Eric He

So the longer — of course we can actually spend our sales and marketing expenses to prolong this acquisition of new clients, but the longer that it lasts, that means cost of acquisition of a new client will increase. I think our philosophy of the sales and marketing strategy is not to prolong our sales and marketing expenses. On the other hand, we want to increase our gameplay and increase the user experience so that it will create a lot of stickiness that the gamer will actually voluntarily stay in game.

Atul Bagga - ThinkEquity

That makes sense. The second question is on treasure box. So can you help us understand what percentage of your revenue you use to count from treasure box and by eliminating these treasure boxes is this kind of a lost opportunity or is there a way to maybe make up on that portion of the revenue maybe by converting some of these chance based features into skill based features? And also, many of your competitors have not yet eliminated treasure box, do you guys have any plans to reintroduce these treasure box features on your games? Thank you.

Wei Liu

Yes. The impact from treasure box is actually on a few fronts for both paying and non-paying users. But the makeup for that, we are developing and working on new features within the game to engage and monetize users.

Currently we have no plans to reintroduce treasure box into our game. We would want to fully support the Ministry of Culture in whatever direction they're heading into.

Atul Bagga - ThinkEquity

Sure. And can you guys quantify what percentage of your revenue came from treasure box-like features?

Eric He

I will direct this question to President Liu. I think she can elaborate a little bit.

Wei Liu

Well, actually treasure box impacts various aspects within the game in terms of gameplay so it's actually hard to pinpoint the exact percentage of revenues sometimes.

Operator

Your next question comes from the bank of Eddie Leung with Banc of America/Merrill Lynch. Please proceed.

Eddie Leung - Banc of America/Merrill Lynch

Please proceed. I have a couple of questions. The first one is regarding your pipeline as well as some of the expansion packs for the existing games. Could you share with us that which games within your upcoming 12 months have more R&D resources behind it at the moment? Or I will put it that way, which games do you guys have more hope in to make the success rates higher within your upcoming games?

Wei Liu

Out of our future pipeline games, a couple of them are already in the testing phase, namely King of Kings III, The Golden Land, and XT Online. And at this point we have been receiving various feedback from gamers on each of them, most of them overall positive.

In terms of our internal expectations, we have probably the highest expectations for ZT Online II, the sequel to our flagship game and we are putting the most resources in developing this game, and that includes the graphics and gameplay enhancements and so forth. We plan to enter into engineering testing for ZT Online II in November of this year.

Eddie Leung - Banc of America/Merrill Lynch

Thank you. And my second question is about, I would say the competitive landscape. It seems like recently some of your peers focus more on operations and some of your peers actually put more resources behind R&D. It seems like the division of labor within the industry becomes more obvious these days. Could you share your thoughts on this trend and how you think about the future for Giant? Thanks.

Wei Liu

As for Giant Interactive, we focus on our own research and development and self developing our own games. We believe that gameplay is key whether the game is well designed or not, whether it's fun to play, and there is really no use in operating a mediocre game. So we'll continue to focus on this front and do our best to come out with the best games that are fun to play for our gamers.

Eddie Leung - Banc of America/Merrill Lynch

Understood. Thank you.

Operator

Your next question comes from the line of Andrey Glukhov with Brean Murray. Please proceed.

Andrey Glukhov - Brean Murray, Carret & Co

Yes. Thanks for taking the question. I guess if I can followup on the ARPU question, the high ARPU historically in ZT Online is sort of predicated on having sort of a large in-game economy, so as we start the final segmentation of the user base and as we diverse some of the users to the other variants of ZT, are you guys concerned that the core ARPU in ZT Online is going to take a hit because larger spending users have less incentive to spend?

Wei Liu

From our perspective we think that there are indeed different segments of gamers out there; some like games, some prefer games with high ARPU because they enjoy having that sort of power associated with being a sort of high-spending high-level user. But indeed, there is a majority of the general gaming population who would prefer a lower spending game. But there is still a place for high ARPU games such as our ZT Online. For our very sticky high-spending customers in that game, by now they've become very accustomed to the in-game economy and gameplay of ZT Online and we would not be concerned that they would want to leave for other versions or games.

Also we've noted that the community aspect is very important within the game. Users have built up relationships with other gamers in the game, with their peers, and by now they've become very sticky and are more unlikely to leave the game.

Andrey Glukhov - Brean Murray, Carret & Co

Thanks. And the followup question would be in the past couple of instances when you guys moved the games into a large-scaled closed beta, that's already started to generate some revenue for the company. As you look at the games that are coming up, when you talk about large-scale closed beta, would you expect to see any kind of associated revenue from it?

Wei Liu

Yes. We usually begin collecting revenue during the closed-beta testing phase.

Andrey Glukhov - Brean Murray, Carret & Co

Thank you.

Operator

Your next question comes from the line of Jin Yoon with Nomura. Please proceed.

Jin Yoon - Nomura International

Good evening, Rich and Eric, a couple of questions. In the quarter, how is the games shaping out in the first six weeks of the quarter and where can we see kind of an upward surprise given that we still have approximately six more weeks in the quarter.

And second of all, given your guidance in the present quarter, where can we see — this one's related to the first question, what are the factors that we could see kind of a V-shaped recovery in APAs and ARPUs and so forth that we saw in the first quarter after the steep decline in the fourth quarter? I'll stop there.

Eric He

Steep decline in the fourth quarter? I am sorry, I missed the last part of the question.

Jin Yoon - Nomura International

When you guys had the steep decline in the —

Eric He

It was the third quarter last year, were you talking about that?

Jin Yoon - Nomura International

Oh, the third quarter.

Eric He

Yeah. So — I am sorry, Jin, I want to clarify the question that you said. The first six weeks of the game launch or you are talking about the rest six weeks of this quarter?

Jin Yoon - Nomura International

Yeah. I am talking about the first six weeks of this quarter, how the game has been faring thus far in terms of your APUs and PCUs in terms of gaining momentum back into the game after your new expansion pack? And where is the upward surprise that we could see, or what factors could we see in terms of an upward surprise in the quarter that could certainly beat your guided range?

Wei Liu

Currently in the third quarter in the beginning we launched the newest expansion pack for ZT Online and that has been very helpful in increasing user numbers back up again. In terms of APA and ARPU, those are very hard to forecast before the quarter ends, so unfortunately we don't have anything to say right now. But for the guidance that we gave in our earnings release that we gave this time, it's a very probable or likely scenario that could end up happening.

Jin Yoon - Nomura International

All right. Thanks, guys.

Operator

Your next question comes from the line of James Mitchell with Goldman Sachs. Please proceed.

James Mitchell - Goldman Sachs

Great, thank you, I had a couple of questions. One was with regards to your guidance as well, is the low revenue guidance for the third quarter predicated purely on lower ARPU due to the removal of virtual treasure boxes, or does it assume fewer players versus the second quarter?

And then a second question with regards to the proliferation of ZT subsidiaries, will you allow players to migrate their accounts or their characters from one ZT subgame to another ZT subgame? And do you worry for the Green Edition specifically that the Green Edition will siphon off the nonpaying users from ZT Online and therefore it becomes less fun for the paying users using ZT Online who are accustomed to lauding it over nonpaying users?

Eric He

James, let me answer the latter part of your question first. For each individual addition or version, they are totally separated. So the gamer will not be able to go across from server from this one particular Green version to say free to play or to the Classic Edition. You can treat it as a totally separate different game. So I think in order to leave original games, they will have to sacrifice or give away a lot that they have built up in the previous games. So I hope that I answered the second part of the questions.

For the guidance I would like to ask President Liu to discuss that a little bit.

Wei Liu

For our third quarter guidance the cancelation of treasure boxes is the primary reason for our guidance.

James Mitchell - Goldman Sachs

Great. And just in terms of the Green Edition potentially siphoning off nonpaying users from ZT Online, even if people don't actually move their accounts over, just the risk that the underlying human-being players move over, do you think that the biggest spenders on ZT Online will stay on ZT Online because they like the in-game economy or do you think that part of the attraction to them of the in-game economy is the fact that because they spend more money than the free users they have a better experience, therefore if there is fewer free users they may be less loyal to ZT Online?

Wei Liu

Yes. For cannibalization, if we use the introduction of the Classic Edition as an example, which was launched in the third quarter of last year, Classic Edition is similar to ZT Online just like how the Green Edition will be similar to the original game, except for differences in terms of in-game economy.

Now, Classic Edition didn't really cannibalize ZT Online much, if at all. So judging by that we're not very concerned about Green Edition cannibalizing users, or especially free users, away from ZT Online. As mentioned before, gamers who have already established themselves in the game have been playing a certain game and they're more unlikely to move onto a brand new game because they've built up relationships with other gamers and the stickiness of the community.

James Mitchell - Goldman Sachs

Great. Thank you very much.

Operator

Your next question comes from the line of James Lee with Sterne Agee. Please proceed.

James Lee - Sterne Agee

Thanks for taking my questions. Can you give us an update on when at Giant, I am just curious how many people you recruited this quarter and how much money you spent on acquisition? I am especially interested about the game studio in Tianjin, what price did you pay for the studio and how many developers you acquired and could you give us some more color what this a late stage or early stage company? And also lastly, just want to ask about your R&D philosophy in general, has that been changing versus what you are thinking before? Are you typically thinking more time in terms of developing games, and how do you ensure that game launches are getting done on time, especially the fact that some of your peers have been delaying their launches? Thank you.

Eric He

Wow. That is a lot of questions. Thank you, James.

Wei Liu

Yes. For our Win@Giant game incubation program, so far it started in January of this year and for the first half of this year it has been very effective so far. We’ve received over 2,800 applicants into the program. After extensive evaluation we've accepted five projects so far, two of which have been announced, My Sweetie and XT Online and both of them have reached limited closed-beta testing phase so far. Both are different types of games than what we have existing.

Going forward, the Win@Giant incubation program will remain or become a very important aspect of our company with the goal being to get good talent, good products, and to diversify our portfolio. And all of these things are along the same lines of our overall R&D philosophy.

Now in terms of managing the game projects, we have a dedicated department within our company to manage all of our game projects. There is two parts of the development phase. There is the initial development and design of the game itself and this we have to be very strict and insure that it meets certain milestones on time. But for the second part, once the game is ready to be tested where we invite gamers to come and play the game and test the game and get feedback from these gamers, this we are less strict on any deadlines or timelines associated with this part of the testing because we need to get as many gamers and gather their feedback and keep enhancing and improve the game until gamers feel that it is to their satisfaction level.

James Lee - Sterne Agee

If I can add a followup question regarding the R&D site, is it fair to say that the testing phase is getting longer and longer given the fact that you’re seeing more competition out there? And also the gamers tastes in general may have increased as they are more games out there in the marketplace? And also, if any color on the Tianjin studio acquisition in terms of how much you paid for the studio, thank you.

Eric He

James, let me answer first your question on the second part. I believe the studio that you mentioned is the one that we have in an incubation program that we have in Hangzhou and it is not in Tianjin, so for that one we actually did not disclose specifically the dollar amount, but I can tell you that the total amount of investment is insignificant compared with our financial resources at this moment.

I think you are right that in a sense that currently R&D efforts have — a great effort to us because just as you said, the testing period has become longer and longer and as President Liu mentioned that we need to actually develop very good products so we need to actually spend a lot of game design effort, we need to make sure that programs have no bugs, and things like that. So it's going to take quite a significant amount of time for us to develop good games.

And plus, because the landscape has become competitive, as you said that the gamer actually has more choices, so I think in terms of the quality of the games, gamer actually requires the higher quality of the games. So all of this actually directs to spending more on our R&D. So we do expect that in the third quarter and the fourth quarter our R&D expenses will creep up a little bit.

Operator

Due to time constraints, we have time for one further question. Your question comes from the line of Tian Hou with Pali Capital. Please proceed.

Tian Hou - Pali Capital

Good evening. I think I rather to have a bigger picture question. You having (inaudible) almost two years and after two years we saw a different version of ZT Online and ZT Online is aged game. It doesn't matter how you repackage them, different version, it's aged. So we all know when someone becomes old, it doesn't matter what clothes he wears, he's old, it's no good anymore. And then we saw the company did some acquisitions, 51.com is a failure, and you have this Win@Giant — I don't think so far whether you see any success on that. So you have several strategies, but it doesn't really show me a giant step at all. You have a ton of cash, you have small steps, no progress. I just really wonder, what is your strategy, what do you really want to do? How are you going to move forward — two years stagnation is pretty long? So that's my question.

Eric He

Well thank you, Tian. I think you raised a lot of good questions. Let me answer your questions. First of all, yes, it's been almost two years since IPO. We are a development company that focuses on so-called blockbuster games, and ZT definitely has reached very great success in the past. But if you look back at the history of online games, there are a lot of games that actually have lasted more than five years or 10 years, including very famous World of Warcraft, as well (inaudible) of other companies.

So I don't think it's necessary to comment that a three or four-years game is an aged game and there is no way to go further or do better. In fact, we believe that as long as we can provide good upgrades and updates, a game can last an even longer time. So we are a company who will focus on our R&D capability to extend our lifespan of our game.

In terms of Win@Giant, since we just started the program in January of this year, now it's only a half year, so it's a little premature to tell whether this is a good or bad program because as we indicated, we only have about two games coming out from Win@Giant, for Sweetie is a casual game. We do not have too much expectation anyway and for XT Online, in fact it's never been launched, and I think we wait a couple of months and see the result of XT. We do have some good confidence on XT Online.

As to 51.com, again, it's a very successful social network website. If it can continue to gain user base, we think 51.com can become a very good company. If you look at the $0.10 five or 10 years ago, you would think $0.10, there is no way to make money so you probably would jump into a very similar conclusion as you did a couple of minutes ago.

So I think we shouldn't jump into a conclusion too early at this moment. I think we are very confident on what we are doing right now. We believe that we are going to deliver a long-term shareholder value at this point.

Wei Liu

I think we concur with Tian's questions a little bit. Almost two years after IPO, we do believe that some of the performance that we deliver is not up to our expectations, we admit that. However, we do believe there's some important aspects of this team which still has been kept intact. That is a perseverance and our passion is to the game development. All of those are very important to build a very long-term, so called, long-term companies. We think that all this long-term belief is very important for us to develop and become a great game development company over the long term.

So I think now it's two years after IPO. It's a little bit too early to jump into conclusion that we won't be successful because our goal is to become a 100 year-old company in the future.

Tian Hou - Pali Capital

Okay. I just have a followup comment. As far as desire for a long-term successful company, I guess every IPO company has the same desire, but how to get there is crucial and we live in the everyday, not 100 years later. So if you don't do it today correctly, smartly, I doubt you can ever reach this. So my suggestion is really why don't you guys really study your strategy — what do you really want? See, we cover companies not only Giant, but also other companies, and there are some gaps. So that's my comment.

Wei Liu

Thank you.

Eric He

Well, thank you for your comments. We would try to remember your comments.

Operator

I would now like to turn the call back to Giant’s IR Manager, Mr. Rich Chiang, for closing remarks.

Rich Chiang

Thank you again for joining us today and we look forward to updating you on our progress in the near future.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.

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