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Giant Interactive Group Inc. (NYSE:GA)

Q3 2010 Earnings Call Transcript

November 16, 2010 8:00 pm ET

Executives

Rich Chiang – IR Manager

Eric He – CFO

Xuefeng Ji – VP, Product Development, Quality Control and Project Management

Wei Liu – President

Analysts

Alicia Yapp – Citigroup

Jenny Wu – Morgan Stanley

Thomas [ph] – Bank of America

Gary Ngan – UBS

Mark Marostica – Piper Jaffray

Atul Bagga – ThinkEquity

Sam Lowen [ph] – Oppenheimer

Amanda Inn [ph] – Royal Bank of Scotland

Nick Ling – Roth Capital

Operator

Good morning and good evening, ladies and gentlemen, I would like to welcome everyone to Giant Interactive Group's third quarter 2010 earnings conference call. All lines have been placed on mute to prevent background noise. After the presentation, there will be a question-and-answer session. (Operator instructions)

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

Rich Chiang

Good morning, ladies and gentlemen. Welcome to the third quarter 2010 earnings conference call for Giant Interactive Group. With me today are Ms. Wei Liu, President; Mr. Eric He, Chief Financial Officer; and Mr. Xuefeng 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, Mr. He, 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 terminology such as will, expects, anticipates, future, intends, plans, believes, estimates and similar statements and include, among others, statements regarding our continued efforts 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 20F filed on June 7th, 2010.

All forward-looking statements are qualified in their entirety by this cautionary 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 to dollars refer to U.S. 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. In third quarter, we continued to make sound progress on our key strategic imperatives and as expected delivered steady growth and overall improved financial performance. This quarter marks one year since cancellation of Treasure Box, and as you can see from our 16.7% year-over-year and 5.7% sequential top line growth.

Our efforts to appeal through a broader range of spending habits and key players engaged has clearly been successful in driving the recovery of our ZT Online flagship games. We continue to expand the number of players choosing to partake in in-game spending, which we believe is an essential step in fostering a healthier and more sustainable revenue base.

At the same time, our expanding portfolio of games is allowing us to target a more diverse and group of gamers and further bolster our long-term growth prospects. You can see our key operational metrics on Slide 6. Total active paying accounts or APA grew 4.4% sequentially and 35.1% year-over-year to 1.497 million. Average revenue per user or ARPU was 225 RMB, which grew 0.8% over last quarter, but declined 13.4% over the third quarter in 2009.

Average concurrent user or ACU, was 538,000, a 19.7% sequential decrease and 26.3% increase from the year-ago period. Peak concurrent user or PCU was down 11.5% sequentially, but up 14.5% year-over-year to 1.466 million. ACU and PCU were down on a sequential basis due to our cleanup of gold farming and robot accounts in the ZT Online Series of games.

As demonstrated by the growth in APA, our segmentation and diversification strategies are successfully allowing us to attain a broader and more sustainable revenue base. Our ZT Online franchise continues to make steady progress, and is attracting users across a range of spending habits. While our new games are effectively appealing to gamers across a wider spectrum of preferences, these very encouraging trends in operational results have once again resulted in improving financial performance.

Moving on to our financial results, as shown on Slide 7, net revenue for the quarter was $50.6 million, representing a 5.3% increase from last quarter and 16.7% increase from the third quarter of 2009. The drivers behind these increases are consistent with the operational trends seen in recent quarters, mainly ongoing recovery of ZT Online and the more meaningful contribution from ZT Online Green Edition.

Gross profit in the quarter grew 5% sequentially and 17.9% year-over-year to $43.1 million, representing a gross margin of 85.2%, up from year-ago period, essentially in line with last quarter. Total operating expenses for the quarter were $14.1 million, flat on a sequential basis and up 77.5% over the third quarter of 2009, mainly attributable to higher R&D spending, which increased 58.8% sequentially and 114.3% year-over-year to 7.9 million. These higher expenses were due to increased compensation to our R&D staff and hiring of new talents to aid in the development of new games.

Sales and marketing expenses were down 17.5% sequentially, as we launched fewer games and reduced the number of marketing campaigns relative to the second quarter, but were up 23.2% year-over-year, as we had significantly limited marketing activities in the third quarter of 2009. General and administrative expenses rose 30.8% from the last quarter and 25% from the second quarter of 2009 to 5 million. Both of these increases were mainly caused by compensation expenses recognized for repricing incentive-based share options and granting of restricted shares in the second quarter of 2010.

Net income attributable to the company’s shareholders in the second [ph] quarter were $31.2 million, representing a 12.2% and 5.6% sequential and year-over-year increase respectively.

The growth in the net income was driven by our increased revenue from online games as well as a rise in interest income during the third quarter. Basic and diluted earnings per ADS for the third quarter of 2010 were $0.14 and $0.13 respectively.

Moving to our balance sheet, as seen on Slide 9, as of September 30th, 2010, cash, cash equivalents, short-term investments, and held-to-maturity investments totaled $859.9 million [ph], an increase from June 30th, 2010. The increase was attributable to the cash generated from operations this quarter.

As I mentioned last quarter in August 2010, the board extended the term of share repurchase program, which had implemented in August 2009 for an additional year. Under this plan which is a part of our commitment to return value to our shareholders, we may repurchase up to 150 million of our ADSS.

As always, our performance – our financial performance is ultimately a product of success of our gain. In recent quarters, we have made great strides to diversify our portfolio with exciting new games that appeal wider possible range of preferences. We have also segmented our ZT Online Series in order to encourage spending across a broader base of players. In the third quarter, we continue to execute on these strategic imperatives as we continue to strengthen our pipeline. We made solid progress on various testing places and introduced new features, expansion packs within our existing games.

To maintain the popularity of our flagship, ZT Online and meet evolving preferences of our user base, in the third quarter, we continue to introduce new in-game enhancements. This is in line with our strategy to offer ongoing upgrades and new content and have been key drivers in ZT Online’s steady recovery.

We have also introduced expansion packs to ZT Online Green Edition and ZT Online Classic Edition. The new game play features our design to attract and encourage spending from both new and existing users. We continue to gear up for the much anticipated launch of ZT Online 2, which combines successful concept from ZT Online with many new game play options, innovative artworks and enhanced graphics, and a revised in-game economy.

This past October, we began performing a server-pressure test with limited persistent accounts to ensure the quality and the capability of our servers and to collect feedbacks from users. ZT Online 2 is slated to entering unlimited closed beta testing in the fourth quarter 2010. As you can see our ongoing development of our efforts within the ZT Online Series, our true testimony to our commitment to our segmentation strategy and our success on this front.

Similar to ZT Online Series, we continue to make ongoing progress updating, enhancing, fine-tuning the other games within our robust game portfolio and pipeline. We introduced new expansion packs for both King of Kings III and Giant Online in the third quarter and additional expansion packs for Dragon Soul and King of Kings III are slated to be launched toward the year-end.

I am pleased to report that Dragon Soul entered into closed beta testing in the third quarter. We also launched a revised version of XT Online in August, and are now rolling out new content based on gamers’ feedback ahead of the game’s scheduled launch into open beta testing in 2011. I am also pleased to report that in addition to our development progress in our home markets, we have signed licensing agreements in multiple countries for several of our games. These agreements will enhance our geographic footprint and further diversify our revenue streams.

In particular, Golden Land remains one of the most popular web games in Taiwan. In October, the game launched into open beta testing in Japan. We have already signed licensing agreements for the game in Brazil and Turkey, and we look forward to covering other regions around the globe. Additionally, Taiwanese version of the Giant Online was launched into open beta testing in September 2010.

Turning to our licensed games, Elsword remain on track to commence limited engineering testing at the end of this month, and the game is planned to commercially launch in China in 2011. Allods Online continue to be localized for the China markets, we will complete the initial Chinese version by year-end, which will then undergo engineering testing in the first half of 2011.

As you can see, we are clearly making substantial progress on development front as we improve our existing games and optimize our pipeline games. With our robust portfolio, solid strategy and innovative game plays, we believe we are well-poised to continue to building our player base and further strengthening our financial performance.

In the final quarter of 2010, we expect to see a continued top line expansion as the ZT Online Series continue to make steady progress, and as our new games also attract new users and continue incremental revenues. Once again, thank you for joining us.

We are now happy to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Alicia Yapp with Citigroup. Please proceed.

Alicia Yapp – Citigroup

Hi, good morning (inaudible). My first question is related to your upcoming game ZT 2. I understand that it is still currently in technical testing, but can you share results of gamer feedback so far and when the game is officially launched next year, should we expect the game to have a massive jump in PC and monetization right away or should we actually expect more like a moderate improvement similar to the performance of Green City experienced this year?

Eric He

Thank you, Alicia. Allow me to translate the question a little bit to VP Ji.

Xuefeng Ji

[Interpreted] For the progress on ZT Online 2, currently we started limited engine testing on October 25th and have been gathering feedback from limited number of gamers since then. The feedback has been pretty positive overall, and so, on the 19th of this month in November, we will start unlimited closed beta testing and move into a more formal launch in 2011. We have pretty good expectations for this game overall, and we will move with marketing and etcetera accordingly.

Wei Liu

[Interpreted] Presently, I would just like to add that the distinction between ZT Online 2 and the existing Series, especially with Classic Edition and Green Edition, all part of our segmentation strategy to cater towards the users, but three existing versions were all pretty similar in terms of game play. But ZT Online 2 is completely redesigned and will include brand new game play, overhaul graphics and revised in-game economy. So, it has very innovative game content, which will definitely separate it from the other ZT Online games.

Alicia Yapp – Citigroup

Okay. And just a follow up, so would that be – once the commercial launch, it will start monetizing right away, right?

Eric He

In fact, the monetization already started on a limited basis in the fourth quarter already.

Alicia Yapp – Citigroup

I see, okay. And my second question is related to your R&D expense. It is more than double compared to a year ago, so can you give us like some color, how much of it is due to salary adjustment and how much of it is due to the increase in headcount?

Wei Liu

[Interpreted] During the third quarter, our R&D expenses did have an increase and it was due to both headcount and salary compensation increase, but also included one-time charge for repricing of options. And going forward, we think R&D expenses will continue to go up along with the industry, but the magnitude of that jump shouldn’t be as large as what we experienced.

Alicia Yapp – Citigroup

Just a follow-up, so how many people total of R&D people you have this quarter versus last quarter?

Eric He

R&D headcount increased from the beginning of the year around 800, now it’s close to 1,000.

Alicia Yapp – Citigroup

Okay, thank you so much.

Operator

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

Jenny Wu – Morgan Stanley

Hi, thank you for taking my question. First of all, would you please help us understand the performance for your major games, especially the ZT Original and the ZT Green Edition particularly in terms of ARPU and APAs? Thank you.

Xuefeng Ji

[Interpreted] Jenny, we don’t break out specific numbers, but for both ZT Online Original and ZT Online Green Edition, the ARPU is at a very stable level and both are at very healthy appropriate levels for each of the games. And for both games, APA is continuing to steadily increase.

Jenny Wu – Morgan Stanley

Okay. Second question is about your 4Q growth pattern, and since you are going to (inaudible) past the ZT Online 2, what kind of growth should we expect for 4Q, and is it actually for your ARPU level and APA level?

Xuefeng Ji

[Interpreted] During the fourth quarter, we will begin limited closed beta testing for ZT Online 2, but since the beginning stages of the rollout of this game, our focus will not be on (inaudible) right away, our focus will be to get users to come into the game initially. So, ARPU levels will be at good and healthy levels where we will try to increase APA.

Jenny Wu – Morgan Stanley

Okay. Thank you.

Operator

Our next question comes from the line of Eddie Yang with Bank of America. Please proceed.

Thomas – Bank of America

Hi, good morning and good evening everyone. I am Thomas [ph] asking question on behalf of Eddie. Just a couple of quick questions. My first question is regarding the cleanup in gold farmer during the quarter. Can you elaborate more of how we should look at the ACU trend going into fourth quarter? Should we expect it will continue on a down trend, on the cleanup? That’s my first question, thanks.

Xuefeng Ji

[Interpreted] During the third quarter, we – due to, for the overall health of the games in our ZT Online Series, we decided to cleanup or delete. Some of these automated gold farmers are automated robots accounts in the game. And we believe that the results have been very positive, although APA numbers were down for the quarter. As you can see, users were still spending in the game and very active in the game, as you can see by the APA numbers, which increased. So, fourth quarter, things have – will be very stable and will likely to trend up.

Thomas – Bank of America

Okay, thanks. My second question is regarding the government grants and share-based compensation. Given these towards the end of the year, are there any color on the guidance for government grants, and for share-based compensation, should we expect SPC to go back to the second quarter level? Thanks.

Eric He

For the government grants, as you can see in the third quarter, we have a little bit higher than the normal numbers. It’s about 20 million RMB. That is for the high tech business grant. That usually comes into the fourth quarter. So, I expect that in the fourth quarter, our government grant compared with last year will be somewhat muted. For the share-based compensation adjustments, I think in the third quarter, there will be some kind of one-time charges. In the fourth quarter and moving ahead, I think this part of the amount will be decreased. So, we should expect that the impact should be only in the third quarter.

Thomas – Bank of America

Okay, thanks. I will get back in the queue.

Eric He

Thank you.

Operator

Our next question comes from the line of Gary Ngan with UBS. Please proceed.

Gary Ngan – UBS

Good morning, everyone; thanks for taking my question. So, on the bots and gold farming company combat, I understand that one of the key features of that game is actually internal bots. So, actually, can you go through why are you combating these bot companies? Like what are they doing differently compared to our internal bot system? And am I correct to understand that most of this combating is actually coming from ZT Green version rather than the ZT Original version?

Xuefeng Ji

[Interpreted] Yes indeed. We do have internal bots in the game, but these are features that benefit the real gamer in our games to help them along with game play. But during the third quarter, we decided to clean up these terminal gold farmers or robot accounts because these are not real gamers. They are sort of fake users, and they are lot more numerous than the internal bots that we have in the game as a game play feature. We did this throughout the ZT Online series, but there is probably slightly more of these accounts in ZT Online Green since it is a newer game, and but we did it for the overall health of the game, and the resells have been pretty positive so far, and it’s also a one-time deal in the third quarter.

Gary Ngan – UBS

Thanks a lot. And my second question is related to the share-based compensation and R&D. So, firstly am I correct to understand that the 5 million or so sequential increase in share-based compensation is the one-time charges that you just mentioned in the call? And also, the 200 R&D people, what role are they mostly in terms of the R&D process? Are they the higher salary type of staff or just general like fresh graduate people?

Eric He

Okay. Let me answer your question. For the share-based income, I think the majority of the increase will be one-time in nature, because as we reprice options, the bulk of the charges will happen into the third quarter, the quarter that we just exercised the price. But I think moving forward, we will use a new base to calculate the share-based fair value. I think the impact will be very, very minimum. You shouldn’t be able to feel too much. Secondly, I think Gary, you mentioned the 200 R&D people, you are referring to the incremental 200 people that increased in this year or you are referring to the – I don’t know where you get the 200 people from?

Gary Ngan – UBS

Because you just mentioned that in the earlier – this year, we have about 200 –

Eric He

Right, okay. You are talking about the incremental 200 R&D people.

Gary Ngan – UBS

I guess that’s right.

Eric He

I believe, yes, the new hirings are across the board. I think it includes programmers and including game designers and also some artists or graphic artists. So, I think it’s pretty much across the board. In terms of the ranks, I believe most of the people, they are middle-ranked R&D people. So, also, we have some senior hiring as well over that 10 months or 9 months.

Gary Ngan – UBS

Okay, thank you very much.

Operator

Our next question comes from the line of Mark Marostica of Piper Jaffray. Please proceed.

Mark Marostica – Piper Jaffray

Yes, thank you. I wanted to ask about potential cannibalization of ZT users by ZT 2. I know it's early days with ZT 2 and it hasn't officially launched. But what is your experience and expectation on that point?

Xuefeng Ji

[Interpreted] Thus far through our testing phases that is done in ZT Online 2, it seems that cannibalization impact should be pretty limited. Through the testing phases, we have gathered feedback from users and looked at the user trends from both the new and the existing games. ZT Online 2 is a brand new game with all new content. So, it’s very different, the existing ZT Online, ZT Online Green Edition, and ZT Online Classic Edition. So, it’s a brand new experience for the users and impact from cannibalization should not be – should be very minimal going forward.

Mark Marostica – Piper Jaffray

With the upcoming launch of ZT 2 and the marketing costs, selling and marketing expense sequential decline I think you saw in Q3. I'm wondering should we expect a material increase in the selling and marketing expenses in Q3, and just in general, how should we think about that line item over the next few quarters?

Eric He

Thank you, Mark. I think President Liu wants to add some comments into the last question that you just made. So, can I let her just finish her answer, then I will answer your question?

Mark Marostica – Piper Jaffray

Fair enough, thank you.

Wei Liu

[Interpreted] President Liu just wants to add for the ZT Online 2. It’s different versus the existing ZT Online Series. As you know, ZT Online Original and also the ZT Online Classic Edition, they are more targeted towards more high-end, higher-spending gamers. And so, the in-game economy for these games is targeted towards these two users. Green Edition, which came out last year was our first attempt to cater to lower-end demographic, and ZT Online 2 is designed to be somewhat in between them, or catering to a little bit of both of these crowd.

So, the in-game economy will be completely revised for ZT Online 2, and we will disclose more details about this in-game economy when we do a more formal launch next year in 2011. So, to sum up, we believe that we just have different versions of the ZT Online Series to cater towards, to give gamers different choices and to satisfy more diverse variety of gamers as far as our segmentation strategy.

Eric He

And then President Liu is going to answer the marketing expense questions for you, Mark.

Wei Liu

[Interpreted] So, ZT Online 2 will be extremely important product for us over the next year or two. And we will definitely utilize our resources to promote or push this product to be able to hopefully become a successful hit game in the online game industry. So, yes, sales marketing expenses will inevitably increase, but we are going to control it and keep sales marketing expenses at a reasonable level according to the performance success or feedback from gamers that we receive for ZT Online 2. So, it will not jump completely out of proportion compared to our revenue.

Mark Marostica – Piper Jaffray

Thank you.

Operator

Our next question comes from the line of Gary Ngan with UBS. Please proceed.

Gary Ngan – UBS

Thanks for taking my question again. So, actually I have a question just from a player's perspective, just talking about the different monetization level of different ZT Series. So, I am a low paying or even non-paying player, how would I actually choose between playing ZT Original and ZT Green? So, for example, I'm sure there's a lot of non-paying players in ZT Original, and why would not they actually move towards ZT Green version?

Xuefeng Ji

[Interpreted] For them, for these lower end users or non-paying users, generally, if there is an existing users, usually they will stick with ZT Online Original game. They are brand new users and want a new experience or maybe some new monetization or in-game economy activities, they would probably choose ZT Online 2, and if they mostly want to battle or PK, maybe choose ZT Online Classic Edition.

Eric He

I want to add some comments on this question as well. I think for those non-paying or low-paying accounts, I think what is very important to them is their social relations. I think for those guys, they will belong to a family, a tribe, or kingdom. You know, for those non-paying accounts, in fact, they can earn in-game token, in-game money and that’s what they get their satisfaction from. So, when you actually are existing gamers with ZT Original, you don’t pay any money or you pay very little money, but you have a bunch of friends, you have a bunch of family, tribes, you know, clan in the game. So, you can get a lot of attentions from your friends.

In fact, you can make some in-game tokens, which will allow you to purchase a lot of items in that particular game. So, for those gamers, they will choose to stay in original ones instead of moving towards the new one, because they need to actually all over again to establish all those relationships.

Gary Ngan – UBS

I see. That is actually very, very helpful. Thanks a lot. The other question I want to ask about is the launch strategy of ZT 2. So, can you go through a little bit, on the 19th of this month, the unlimited closed beta testing, would that actually control the number of accounts that we give out to players, or it would be already like everyone who wants to play can get an account? And the follow-up on that is, so what's your strategy or your view about ramping up marketing before launching these kinds of, sort of closed, unlimited closed beta testing versus tester game to run two to three months before actually launching a big marketing campaign? So, how would you actually balance these two strategies?

Xuefeng Ji

[Interpreted] Yes, on November 19th, the game will be indeed giving out unlimited accounts. So, any gamer who wants to come and play the game can do so. But we as an operator, we will still, of course be managing number of servers and also gathering feedback in order to enhance the game and come up with a new revision for the game play.

Currently, we don’t plan to have a big-scale marketing before Chinese New Year, but then, after that, the marketing will be in line or according to how the performance of the game goes and the feedback from users.

Wei Liu

[Interpreted] President Liu just wants to add that the marketing plans for ZT 2 in the first half of 2011, we will also have additional testing phases such as official closed data and open data. So, these are all timeframes or milestones where we do give out the appropriate marketing levels according to the success of the game and feedback from gamers.

Gary Ngan – UBS

I see. Thank you very much indeed.

Operator

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

Atul Bagga – ThinkEquity

Hi, guys. Thanks for taking my call. A couple of questions for you, plus a full year one more question on gold farming and robot accounts. Can you talk about how many such accounts that you guys cleaned up? And if you were to take out the impact of this cleanup, what was the current in ACU and PCU in the third quarter? And at this time, how many accounts do you still estimate are robot and gold farming accounts on your games? My second question is regarding your revenue break up. I think you've talked about your strategic objective of diversifying game portfolios. I was wondering if you can share some progress in terms of the number, what is the revenue breakup from different ZT titles and other games now, and where do you expect this breakup to be, let's say, in about a year's time, internally what are your targets for revenue breakup from different games, ZT, ZT 2, other games in ZT titles and also games outside of the ZT franchise? Thank you.

Eric He

Atul, let me answer the second part of the question. Maybe I will translate the first part to VP Ji, then I will answer the second part first. Atul, I think regarding this breakdown of the revenue, traditionally, the company actually does not break down the ZT Series revenues for competitive reasons. But I can tell you that as of now, the Original still accounts the bulk of the revenue, the bulk of the revenue. And I think as of this quarter, ZT Green version still is the second place. The third place is Classic; it’s sort of a ritual version. But I can tell you that as I mentioned it before that the ZT 2 actually started to collect revenue at this moment. I think already start to increase this impact in terms of the revenue stream.

I do expect that in next quarter, the impact from ZT 2 will increase. You asked about a year later, what would the revenue breakdown be, I think that will be a very, very tough question to answer at this moment. The reason being, we are adding many games along the way. ZT 2 is one of the major ones and also I think we are adding Elsword, our license game, we are adding another license game, Allods, in the second half of next year.

A year from now, I will imagine the breakdown for our revenue will be very much different from what we have right now. So, I hope that I can update you some detailed information regarding this along the way in next couple of months or quarters.

Xuefeng Ji

[Interpreted] During the third quarter, as you have noticed, we didn’t have many new game launches or new products out. So, hypothetically, if we do not do cleanup of gold farming or robot accounts, then our ACU levels would probably remain very stable compared to previous quarters.

Now, we did decide to do this cleanup, because we noticed that the real users in the game were spending a timeframe in the game and were very stable. So, we knew that they were going to remain in the game and we did this cleanup to benefit them over the long run. Again, we want to emphasize that the results have been pretty positive so far. And this has also been a more severe cleanup in the ZT Online Series. It’s also a one-time thing, and the benefit should be pretty positive going forward.

Atul Bagga – ThinkEquity

And do you guys, can you talk about what is your estimate, how many robots or gold forming accounts might still be active on these games or you pretty much got rid of that?

Xuefeng Ji

[Interpreted] Well, you can take a look at ACU decrease that happened in the third quarter. So, that’s a good indication of the number of accounts. And we did get rid of most or all of the gold farming or robot accounts. So, they are mostly all gone.

Eric He

Almost all.

Atul Bagga – ThinkEquity

Thanks. If I may, can I ask please one more question here? One of your competitors, recently they talked about delay in getting government approval on a new game and that's one of the reasons why their game is getting pushed out. And given that you guys are looking to license a couple of, or rather licensing a couple of imported games, can you share your thoughts about the regulation process, especially with the government approval on the imported games?

Wei Liu

[Interpreted] Yes. As you mentioned, the government approval process is a little bit more complicated these days. But for us, we focus on self-developing our own games. So, this is not as big of a concern for us. Obviously, for license games from overseas markets, this process takes a little bit longer time. But on the flip end, we can also use it longer timeframe to localize the game further for the preferences of local gamers.

Operator

Our next question comes from the line of Sam Lowen [ph] with Oppenheimer. Please proceed.

Sam Lowen – Oppenheimer

Good morning guys, thanks for taking my call. Just a few cleanup follow-up questions. I wanted to know, I know you guys said there aren't going to be any major marketing promotions I think until after Chinese New Year, if I remember correctly. But I just want to know for the next quarter and even looking at sales, first quarter, so should we expect then sales and marketing to be, I mean pretty much on par with 3Q since third quarter was kind of a low quarter than – because not many, there weren't many – any marketing campaigns or expenses happening etcetera.

Eric He

As we indicated at, for ZT 2, when we launch ZT 2, our tempo will be for the fourth quarter, we are not going to spend the whole lot of the resources to promote the game. We will actually do larger promotions after Chinese New Year. I think during this period, the main reason for this is because we wanted to listen, we wanted to listen to the feedbacks of the gamers. So, if you translate that same into the financial statements, I think sales and marketing will stay relatively muted as you said.

Sam Lowen – Oppenheimer

Okay, the next question is for R&D, now you guys are at a higher point, so is that going to be sustained, I just want to confirm that, to be around the high $7 million or $8 million mark for following through? Your headcount and your staff and your salaries are now based in, so is that going to be consistent now?

Eric He

For R&D expenses, I think there are two actually angles to look at it. As we mentioned in the third quarter, we have a one-time charge of repricing of our options and granted some restricted shares. That actually created some bumps in R&D numbers in the third quarter. I think that impact will disappear in the fourth quarter. So, I think again, R&D numbers in the fourth quarter will be relatively benign. But moving forward, as President Liu mentioned, R&D is very important for us, because we want to keep our competitiveness. We want to hire the best talents to develop our games. So, I think over the course of the next couple of quarters, we will try to maintain R&D expenses or spending as a 6 percentage or relatively 6 percentage of revenue.

Hopefully, R&D expenses will actually increase in conjunction with our revenue increase, so that we can stay competitive in the industry.

Sam Lowen – Oppenheimer

Okay, and last question, this is a follow-up. For your R&D, how much was it exactly was that from, excluding the actual headcount tally?

Eric He

Well, I think that actually relates to the detailed classifications. I don’t think we plan to disclose the detailed numbers. But if you can perhaps subtract some of the numbers from the GAAP and non-GAAP numbers, and you give a higher weight into the R&D people, so I think most of that differences between the GAAP and non-GAAP numbers were actually attributable to R&D staffs.

Of course, another big portion is G&A because some of the number actually, will actually attributable to the management team and also the directors’ options as well.

Sam Lowen – Oppenheimer

Okay, thanks guys. Appreciate it.

Eric He

Sure.

Operator

Our next question comes from the line of Amanda Inn [ph] with Royal Bank of Scotland. Please proceed.

Amanda Inn – Royal Bank of Scotland

Hi, good morning, thanks for taking my question. I have a question on deferred revenue. In 3Q, it kind of showed a short spike from the previous quarters. Could you give me some color on that?

Eric He

Yes, in the third quarter, actually our deferred revenue increased it. I believe that is because of the change of the player behavior. That actually bode well for us, because hopefully those increased deferred revenue will be released in the quarters ahead.

Amanda Inn – Royal Bank of Scotland

Okay. And I have a follow-up question on the exact launch date for ZT 2. You expect it the first quarter or second quarter or could you provide some guidance in there?

Eric He

I am sorry. Can you repeat the question, you said ZT 2 launch program, is that what you –?

Amanda Inn – Royal Bank of Scotland

Yes, the commercial, approximately when will it be commercially launched next year?

Eric He

Okay. As we indicated that we will do unlimited closed beta test in this month, actually November 19th. Then, we will actually solicit and listen, observe the feedbacks of the player. We will actually do larger launch after Chinese New Year. I believe in the west, people will say open beta that kind of launch, but in China, we will tend to use a different name. But I would say that after Chinese New Year, we will actually try to launch a pretty big releases for ZT 2. As to the open – the real open beta, I think it will be somewhere around in the first half of next year.

Amanda Inn – Royal Bank of Scotland

Okay, thank you very much. That’s helpful.

Operator

Our next question comes from the line of Nick Ling with Roth Capital. Please proceed.

Nick Ling – Roth Capital

Hi, thanks for taking my question. So, for the operating metrics decline in the third quarter, could you guys elaborate a little bit more that which game experienced the biggest decline in terms of ACU in the third quarter? Is it ZT Original, ZT Green or King of Kings III? Thank you.

Eric He

Nick, I appreciate your questions. As we actually talked about this operating metrics before, ACU and PCU decline was mainly due to our cleanup of gold farming and robot accounts among all those ZT Online Series of games. Particularly, I don’t think we distinguish whether the bulk of the decline is from Green version or it is from Original, I believe it’s pretty spread out. As VP Ji mentioned that Green version, actually we exercise a harder cleanup efforts during the third quarter.

Nick Ling – Roth Capital

Okay, thank you. So, a question may be for Mr. Ji. So, given the increasing competition from a game developer's perspective, what is the most important sector now to keep a player inside your game and keep some pay in for your accountant. Is it game play, visual or sound effects or a balanced in-game player like the economy system? Which sector should be given a bigger weight than the others? Thank you.

Eric He

You mean, game play, Nick? You mean, game play or game features in in-game? Nick, is that what you mean?

Nick Ling – Roth Capital

Yes, maybe I could ask Mr. Ji directly, okay?

Xuefeng Ji

[Interpreted] Nick, just to translate this answer into English, the important factors in the game to keep gamers playing and spending in the game, it actually depends on how long the gamer has been playing the game and when he enters the game. Initially, when he starts playing the game, when he tries the game, we want to give the gamer lots of innovative features to versus other games to attract the gamer and make him believe that this game has lot of fresh content for him. After a certain period when he decides to stay in the game, the community features or the in-game economy becomes more important because his interaction with several gamers and spending the monetization or other features in the in-game economy, when he decides to become more involved in this aspect, these things become more important, especially in an online game versus a single-player game where gamers can play for a very long time for many months, even many years. So, these factors are very important in keeping the gamer in the game and having him being very sticky.

Operator

At this time, I would now like to hand the call over to 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 again for joining us today.

Eric He

Thank you.

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