Shanda Q4 2006 Earnings Call Transcript

Feb.13.07 | About: Shanda Interactive (SNDA)
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Shanda Interactive Entertainment Ltd. (NASDAQ:SNDA)

Q4 2006 Earnings Call

February 12, 2007 8:00 pm ET

Executives

Frank Liang - Director, Corporate Financing and Investor Relations

Tianqiao Chen - Chairman of the Board, Chief Executive Officer

Jun Tang - President, Director

Daniel Zhang - Chief Financial Officer, Vice President

Analysts

Dick Wei - JP Morgan

William Bao Bean - Deutsche Bank

James Mitchell - Goldman Sachs

Richard Ji - Morgan Stanley

Wallace Cheung - Credit Suisse

Alicia Yap - Bear Stearns

Qui Chen - Shaw Capital Management

Chang Qiu - Forun Technologies

Ming Zhao - Susquehanna Financial Group

Wendy Huang - Evolution Securities

Presentation

Operator

Ladies and gentlemen, welcome to today’s Shanda Interactive Entertainment fourth quarter and fiscal year 2006 earnings conference call. (Operator Instructions)

It is now my pleasure to turn the floor over to your host, Frank Liang, Shanda's Director of Investor Relations. Frank, you may begin.

Frank Liang

Thank you, Operator, and welcome, everyone, to Shanda's fourth quarter and fiscal year 2006 conference call. I would also like to give a special thanks to our friends in the U.S. who joined this call at the late hour. As always, we appreciate your participation.

With us today on the call are Tianqiao Chen, our CEO; Jun Tang, our President; and Daniel Zhang, our CFO. After the close of the U.S. market today, Shanda issued its fourth quarter and fiscal year 2006 earnings release. Copies of the release are given to you for information and reference during this call. A copy of the release is also available on Shanda's corporate website at www.snd.com.

The purpose of this call is to provide investors with further detail regarding our financial results and to provide a general update on the company. Following our formal remarks, we will be happy to take any questions you might have.

Before we begin, I would also like to remind you that during today’s call, we will make certain forward-looking statements that are intended to qualify under the Safe Harbor provisions for such statements, established in the U.S. Private Securities Litigation Reform Act of 1995. All statements during the conference call other than statements of historical fact are forward-looking statements.

Although we believe that our expectations expressed in our forward-looking statements are reasonable, we cannot assure you that our expectations will be correct. Risks and uncertainties could cause actual results to be materially different from our expectations, including the risks set forth in our filings with the U.S. Securities and Exchange Commission.

Now, with that, I would like to turn the call over to our CEO, Tianqiao Chen.

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Tianqiao Chen

Thank you, Frank, and thank you, everyone, for joining the conference call. In 2006, Shanda reinforced its reputation as a pioneer in the online game industry in China and further established its position as the market leader.

Our performance in 2006 proves that our new business model is sustainable and scalable. We saw sequential improvement in each quarter in 2006, and we closed the year with a very strong financial performance.

For the whole year 2006, we saw solid improvements in our business, with average quarterly growth of 11.4% for our total revenues; 13.4% for our online game revenues; and 19.4% for our MMORPG revenues. Continuous and steady revenue growth not only demonstrates a successful transition of our core business, but also validates the sustainability and huge potential of the CSP model.

In the fourth quarter of 2006, total net revenues grew 7.7% quarter over quarter and 13.5% year over year. This is the first time we achieved growth both on a quarterly and a yearly basis since we started our transition in late 2005. We also saw dramatic improvement in operating income and net income, which improved by 37.7% and 57.4% respectively.

On the MMORPG side, we are encouraged by the improvement in growth of active paying accounts and ARPU in the fourth quarter. Active paying accounts for MMORPG grew 6.7% quarter over quarter to 2.39 million, and ARPU increased 6.6% to RMB 55.1 from RMB 51.6 in the previous quarters.

The solid performance of our game business was driven by the CSP model and the release of new expansion packs for our major titles. In Q4, we released Mir II and Woool expansion packs, titled Treasure Box and Evil Inside. The expansion packs introduced brand new situations and features designed to complement the strength of the CSP model. Treasure Box and Evil Inside was favorably received by current users and responsible for attracting new users.

In 2007, we plan to release a large expansion packs for all of our MMORPG in each quarter, in an attempt to adapt to changing trends in user habits.

In Q1, the large expansion packs for major titles include Soul of [the Combat] for Mir II, Evil Inside II for Woool, [Lab House] for Magic Land and [Seige Attacks] for [Aquos]. In addition, we will continuously add new items, new functions, and organize new events for all of our games.

We believe all of these activities will enhance the quality and entertainment value of our games, as well as improve interactions between users.

In addition to releasing new expansion packs, we also plan to continue opening new server groups as a means to grow revenues and our user base. In late December of 2006, we opened two server groups on each for Mir II and Woool. The new server groups introduced a new game play environment which appeals to old users and attracts new users.

In summary, we believe that under the CSP model, the release of expansion packs for existing titles, new server groups, as well as improvements to in-game service, are just as important as the introduction of new games to the market.

Based on the existing large user base, updated older titles are even more capable of attracting new players and generating revenues than are successful new titles. Our results in the fourth quarter really enforce this point. Even though we did not launch any new titles, we still saw solid results on the MMORPG side with the improvements in active paying accounts and ARPU.

2007 will be a busy year for Shanda. Our content strategy will continue to focus on both licensed games and in-house development games. In each quarter of 2007, we plan to release expansion packs for all of our existing games. We also have plans to launch six new MMORPGs and 10 new casual games, including in-house development and licensed titles.

In March, we expect to announce the licensing of a high-quality 3D MMORPG. Moreover, Actoz, the South Korea company in which we have a controlling stake, has become our important game content providers in South Korea and will further solidify our pipeline in the future. For the past three years, this company has already developed and is developing several high-quality online games.

Overall, we believe that based on our first mover advantage in operating the CSP model, the new expansion packs and the new titles will generate continuous growth in 2007. Jun will go into a more detailed discussion of our pipeline a little later in the call.

Currently, Shanda is the most diversified online game operator in the industry, with nearly 20 titles in operation. Among them, three titles generate more than RMB 100 million annually, two generate more than RMB 50 million annually, while the rest generate around RMB 10 million to RMB 15 million annually. Each title is profitable, therefore our platform has been proven to be very successful.

Our market game operating models and in-site service and payment platform results in lower costs, higher margins and higher levels of user loyalty than our competitors. We believe all of these advantages will continue to generate additional synergy in the year 2007.

In summary, 2006 has been a very productive and profitable year for Shanda. But initially, the transition in late 2005, we successfully transitioned to the CSP revenue models, improved our operating performance and reinforced our leadership position. Given our diverse pipeline of new games and rich expansion packs for the existing games, a scalable and sustainable revenue model, and a unified operating platform, we expect another year of profitable growth.

We believe that with the fast penetration of PC ownership and broadband users in China, the Chinese online game market has a huge potential to grow for the year to come. We are also confident that Shanda will remain a leader in the industry and, in the process, create lasting shareholder value.

With that, I will turn the call to Jun.

Jun Tang

Thank you, Tianqiao. Our online game business posted another strong quarter in Q4, driven by growth in MMORPGs under the new CSP model. Total online game revenue increased 10% quarter over quarter to $57.6 million.

Our MMORPG games achieved another quarter of strong growth in Q4, with revenues risen 13.8% quarter over quarter to $48.4 million. The sequential growth in MMORPG revenues was primarily due to expansion packs for two of our most popular MMORPGs, Woool and Mir II, under the CSP revenue model.

Our CSP model continued to perform well in Q4. The number of active paying accounts for MMORPG users increased 6.7% quarter over quarter to 2.29 million, as expansion packs for Woool and Mir II attracted more paying users.

ARPU for MMORPGs improved to RMB 55.1 from RMB 51.6, due to the additional purchase of in-game premier features. Beginning this quarter, we will only disclose ARPU and active paying accounts instead of PCU and ACU, because we believe that ARPU and active paying accounts are more meaningful measures of our progress and to better model our business than ACU and PCU, following our transition to the CSP model.

Turning to the casual games, revenues for the first quarter, including revenues from [inaudible], declined 6.2% quarter over quarter to $9.2 million. Active paying accounts declined 6.2% quarter over quarter to 1.96 million, and ARPU for casual games increased slightly quarter over quarter to RMB 12.4.

The sequential decline from casual games was attributable to seasonality following the summer holiday period during Q3.

Our game pipeline is very strong in 2007. On the MMORPG side, we plan to launch six new MMORPGs, among which two will be launched in the first-half and the other four in the second-half. We will begin closed beta testing of LaTale, an MMORPG licensed from Actoz in February, and expect to announce a new, high-quality MMORPG in March.

We also plan to release expansion packs for all of our existing MMORGPs in each quarter. The expansions could be launched for major titles in Q1, including Soul of the Combat for Mir II, Evil Insider II for Woool, [Lab House] for Magic Land, [Seige Attacks] for [Aquos] and a slow expedition for The Age.

On the casual game side, we expect to launch 10 new casual games in 2007. Five will be released in the first-half of this year and the other five in the second-half. In addition, we will also launch a series of big expansions for our current casual games in the first-half of this year, including Legend of Dragon for Maplestory, as well as the next generation expansion packs for [Crazy Carts] and BNB.

In summary, our online game portfolio has continued to perform well. Our pipeline is strong and contains an attractive mix of MMORPGs and casual games, including licensed and in-house development games, and big expansion packs for existing titles. We believe this balanced approach to our portfolio and pipeline, combined with our efforts to establish game communities through our CSP model will allow Shanda to attract and retain a large number of users and maintain our leadership position in the industry.

With that, I will turn the call to Daniel.

Daniel Zhang

Thank you, Jun, and welcome, everyone. Fourth quarter total net revenue was $60.3 million, up 7.7% quarter over quarter and up 30.5% year over year. Gross margin was 62.9% of net revenues this quarter, up from 56.2% in Q3 2006 and up from 59.9% in Q405.

The improvement in gross margin was due to a higher revenue and lower cost of services. The decrease in cost of services was mainly the result of two factors. First, we reduced server costs by combining server groups and eliminating unnecessary servers under our unified operating platform. Second, the cost of EZ products went down due to decreased shipment. We are confident that this improvement of our gross margin is sustainable.

Income from operations was $19.9 million in the fourth quarter, up 37.7% quarter over quarter. Total operating expenses increased 6.2% quarter over quarter. Operating margins increased from 25.8% in Q3 to 33% in Q4. The sequential improvement in operating margin was due to higher gross margins and almost flat operating expenses as a percentage of net revenues.

The quarter-over-quarter decline of research and investment expenses in Q4 was mainly due to the decrease of EZ related development expenses. At the same time, general and administrative expenses also decreased due to our tighter budget controls in Q4, and sales and marketing expenses increased in support of new expansion packs and related marketing campaigns in this quarter.

Other income showed a sequential decline of 45.1% to $3.4 million, mainly due to the decline of government financial incentives in Q4. Our receipt of these government financial incentives is subject to time lags and inconsistent government administrative practice relating to payment times.

We expect to continue to receive government financial incentives in 2007, but the total amount received is expected to be less than that received this year.

Net income in Q4 was $30.8 million compared to net income of $18.1 million in Q3 and a net loss of $56.8 million in Q4 2005.

Diluted earnings per ADS were $0.42 in Q4 compared to diluted earnings per ADS of $0.26 for Q3 and a loss per diluted ADS of $0.94 in Q4 2005.

Non-GAAP income in Q4, which excludes net gain from disposal of Sina's stake, was $22.2 million compared to $18.1 million in Q3 and a non-GAAP loss of $2.2 million in Q4 2005.

Non-GAAP diluted earnings per ADS was $0.30 compared to $0.26 in Q3 and a non-GAAP diluted loss per ADS of $0.04 in Q4 2005.

The adjusted effective tax rate after excluding from profit before taxation, the net gain from disposal of Sina’s stake, which is free of income tax as the company was incorporated in [Cayman Islands], was 5.2% in Q4 2006 compared to 9.8% in Q3.

The adjusted effective tax rate in 2006 is 8.9%, after taking into account the effects on the tax of $1.3 million reversed by one of Shanda's operating companies in Q206 as a result of recognition as a technologically advanced enterprise, as well as the above mentioned untaxable investment income of $8.6 million.

The adjusted effective tax rate in 2005 was 12.1%. The reduction in adjusted effective tax rate year over year is primarily as a result of a change of the amount of taxable income in our operating companies, which are taxed at different rates.

Excluding the impact of new accounting standard or tax regulations, if any, the applicable effective tax rate for 2007 is expected to be in the range from 10% to 12%.

Turning to our balance sheet, deferred revenue decreased 2.8% quarter over quarter to $25.8 million in Q4, due to seasonality following the pre-national holiday purchasing of prepaid cars from our distributors in the third quarter. In addition, long-term prepayment increased 12.5% quarter over quarter to $12.8 million, and property, equipment and software increased 28.2% quarter over quarter to $44.7 million, primarily due to the purchasing of the office building on [inaudible] Road that we have previously been renting.

As of December 31, 2006, Shanda's cash and cash equivalents, short-term investments, and marketable securities total $453.9 million and are adequate to satisfy the needs to redeem the $275 million convertible bonds, which is recorded as a covered liability, given the first date of October 16, 2007.

Given that Shanda has successfully transitioned to a CSP revenue model, we would like to give our business outlook for the next quarter. Please note that the following outlook statements are forward-looking statements that are based on current expectations, assumptions, estimates and projections about our company, our operating conditions, customers’ acceptance of our service offerings, and the industry. These statements involve various risks and uncertainties and actual results may differ materially.

Our total net revenue target for the first quarter of 2007 is between the estimated range of $63.9 million and $65.7 million, representing an increase of 6% to 9% from the fourth quarter of 2006.

Our game revenue in Q1 2007 is expected to hit the historical peak. Our operating margin target for the first quarter of 2007 is expected to be no less than that in Q4 2006.

In giving our financial targets above, we caution that we cannot predict the future exchange rate of RMB against the U.S. dollar, and therefore cannot accurately and with any degree of certainty estimate the effect of any change in the exchange rate in our financial results. Accordingly, in giving our financial targets, we assume no change in exchange rate in the first quarter of 2007 and have adopted a foreign exchange rate as of December 31, 2006, which is $1 equals RMB 7.8087.

Our actual results could differ, however, from our financial targets as a result of fluctuations in the exchange rate.

That concludes my formal comments. Thank you, everyone, for joining us today. I would like now to turn the call back to Frank.

Frank Liang

Thank you, Daniel. We are now ready for questions. Mary, we can begin the Q&A session now.

Question-and-Answer Session

Operator

(Operator Instructions)

Our first question comes from Dick Wei with JP Morgan. Please go ahead.

Dick Wei - JP Morgan

Good morning, and congrats on the very strong quarter. The first question is if you can see some trend in ACU for the quarter, up or down for the quarter. Also, going forward, what is the company’s strategy of -- will the company focus more on going the ACU number or focus more on increasing the number of paying users?

Jun Tang

In the previous subscription model, the ACU and PCU are the key factors to reflect our business. After the transition of our business to the CSP model, we believe the active paying accounts and ARPU are the key factors to reflect our business. So starting with this quarter, we are not going to give the ACU and PCU number, and this is something we have been listening to investors and analysts in [inaudible].

However, we will certainly announce the big changes in ACU and PCU, if that has a fluctuation to our business. Going forward, if you look at our vast user base, and they are only 5% of the total users are paying users, so our strategy is to increase active paying accounts going forward.

Dick Wei - JP Morgan

Okay, so the focus will not necessarily be on growing the ACU but more on the number of paying accounts?

Jun Tang

That’s it, and again, there are only 5% of our total users are paying users, so our strategy is how we can increase more paying users.

Dick Wei - JP Morgan

My last question on the same path is what is the level you feel comfortable? Would it be like 20% of your users are paying, you would be comfortable with the number?

Jun Tang

Again, you know, if you look at our friends in Korea, their numbers are around 15% to 20% of total paying accounts, of all accounts. So certainly that is something we try to achieve, that number but it really takes time to achieve that number. But again, the potential is huge there. Today we only have 5%. If we can achieve a 15%, 20%, that would be beautiful but that is something -- we are working on that.

Dick Wei - JP Morgan

Great. Thanks a lot and congrats on a good quarter.

Operator

Our next question comes from William Bean from Deutsche Bank. Please go ahead.

William Bao Bean - Deutsche Bank

Hi, guys, nice quarter. If we are not going to be looking much at ACU and PCU going forward, could you give us a sense of what metrics we should be using? In terms of paying users and ARPU, can you give us a sense of what you would look at as successful? What is your goal there?

Jun Tang

I think again, the two main factors are the active paying accounts and the ARPU. Certainly we are working hard to improve the ARPU and the paying accounts. One other factor you may look at, the percentage of the paying accounts among our total users. That is additional to the numbers you may look at, but again, our paying user number is very, very low. It is only like 5%.

William Bao Bean - Deutsche Bank

What are your targets for those?

Jun Tang

Again, as I mentioned, our friends in Korea have reached 15% to 20%. That is our target, but it will take time.

William Bao Bean - Deutsche Bank

Okay, and I also noticed you stopped releasing your EZ sales this quarter. Could you give us an update there?

Jun Tang

We are still working with our part of the OEM vendor to, the shipment of the EZ parts. But due to seasonality issues, we see some of this lapse on the shipment, but again, we try to make a better platform, especially focusing on the content side for the EZ parts, so that is why our R&D team are working hard on improving upon the content.

William Bao Bean - Deutsche Bank

Sorry, maybe I wasn’t clear. In the past, you released unit sales numbers. Could you give us the unit sales numbers for Q4? Thanks.

Jun Tang

I think we released the numbers, the revenue numbers. If you look at our balance sheet, you can see the numbers of the revenue, the income from the other revenues. Basically, you can calculate the numbers, the shipment. Again, due to the weak seasonality and our push is more on focusing on the content side.

William Bao Bean - Deutsche Bank

Thank you.

Operator

Our next question comes from James Mitchell from Goldman Sachs. Please go ahead.

James Mitchell - Goldman Sachs

Great, thank you for taking the question. You mentioned in the preamble that you had three games that are doing over $100 million in revenue run-rate and two games that were doing over $50 million. I guess two of the three big games, Mir II and World of Legend, could you just slot Magical Land, Arch Lord, Maplestory, and BNB into the other two categories?

Jun Tang

Thank you for monitoring those numbers. Again, we are not going to give specific names for each of the categories, but again, we have three games over $100 million, two of them are over $50 million. The rest of them are profitable. That is something we can say.

James Mitchell - Goldman Sachs

Okay, and in terms of the 3D game that you will be announcing in March, that will be a free-to-play title or a pay-to-play title?

Jun Tang

We have proven the CSP model is a successful and sustainable model, so going forward, we will launch any new games with the CSP model. The new game we will announce in the next month will be the free-to-play model.

James Mitchell - Goldman Sachs

Okay, and finally for me, I think you are guiding for a revenue improvement in the first quarter, which is great. Within that, would you expect casual games to be seasonally up quarter on quarter, or not necessarily?

Tianqiao Chen

In the coming Q107, actually due to the seasonality and based on the experience in the previous years, we believe that with the impact of Spring Festival and as well as the winter holiday, we believe the casual games revenue will show a positive trend.

James Mitchell - Goldman Sachs

Okay. Thank you.

Operator

Our next question comes from Richard Ji from Morgan Stanley. Please go ahead.

Richard Ji - Morgan Stanley

Hi, good quarter, and congratulations. I am more curious about your long-term sustainable growth strategy, and the worry is around the licensing here. Can you shed a little bit of light on your latest new game, LaTale, and how is that game doing in Korea’s online game market? Then I have a follow-up.

Jun Tang

Going forward, we will continue to see the organic growth in our existing games and also we are going to launch six new titles for the MMORPG. Some of them will be licensed games, some of them will be in-house developed.

If you look at the next game we have the closed beta happening is LaTale, which was developed by the company called Actoz. We have a controlling stake over Actoz. Actoz has proven to be one of the most successful online developers in the company, in Korea and has launched several successful games in the past. We have great expectations on LaTale, and hopefully we can give you some of the results in the next quarter or so.

Richard Ji - Morgan Stanley

On the casual game side, obviously saw some weakness during the quarter. Other than seasonality, were there any other factors contributing to the softness? Going forward, how do you plan to ramp up your casual games business?

Jun Tang

Again, we have 10 new casual games to be launched in 2007, and hopefully by the time we do the conference call next quarter, we will give you some more details on the casual games.

Operator

Our next question comes from Wallace Cheung from Credit Suisse. Please go ahead.

Wallace Cheung - Credit Suisse

Hi, congratulations on a great quarter. A couple quick questions. Firstly, on the guidance, when you talk about growth of the net revenue, do we see the growth of MMORPG revenue still exceeding the casual game side?

Jun Tang

Yes, this is the first time we make forward forecasting. I think it is best to show the confidence we have, and we are more confident than ever in overseeing, managing and forecasting our business.

To answer your question, for both casual games and the MMORPG, certainly we are seeing the growth in MMORPGs are at least faster than the casual games. Also, in terms of the total numbers, the MMORPGs will have big numbers in terms of growth.

Wallace Cheung - Credit Suisse

Thank you. So do we still see both the active paying users and the ARPU of MMORPG still growing at a similar rate as the fourth quarter?

Jun Tang

Yes. Again, our total percentage of our paying accounts is still around 5%. That is our strategy, to grow our paying accounts. If you look at the past couple of quarters, we are focusing more on increased number of paying accounts rather than the ARPU. Going forward, I think that trend will continue to be like that. We are very happy to see that total increase on the paying account side.

Wallace Cheung - Credit Suisse

Thank you. My final question is I think Shanda has been doing very well to exceed the Sina stake at a pretty decent profit right now. Assuming that you have more than enough cash to pay back the convertible debt, how would you use the residual cash invested by the return, say in terms of share repurchase or if it is all for M&A? Thank you.

Tianqiao Chen

Actually, as we said in our script, so far we have adequate cash on hand to satisfy the needs for the company -- actually, we are now actively managing this cash on hand and seek the actual returns, of course, with a pre-condition of the [CP] and adequate liquidity, and we are trying various tools.

Also, we will fully utilize the cash to support the operations and development of our main business.

Operator

Our next question comes from Alicia Yap with Bear Stearns. Please go ahead.

Alicia Yap - Bear Stearns

Good morning. I have two quick questions. One is you mentioned that you are going to announce the big new MMO in March from a Korean company. Can you give us an update on the other one? Are you guys still negotiating with the other party that you never disclosed earlier?

Jun Tang

In early next month, we will be announcing an active agreement with a Korean company, which we believe is a very high-quality game. The second one, we are still in the stage of negotiating the terms with our partners. We hope to announce that in the second-half of this year.

Alicia Yap - Bear Stearns

Okay, great. The second question is on your soft console strategy. I think you guys are in the internal closed beta testing on that. Can you give us a little bit more color and update on the progress on that front? Thank you.

Jun Tang

Yes, again, the soft console is an alternative to X-Box and PS3, so we are working on that kind of technical side. Today, we are in the closed beta testing internally, and so far the results are very positive and we are very excited about that.

Alicia Yap - Bear Stearns

Can you elaborate a little bit more on your future strategies on this? Are you going to go ahead with what you did in the hardware side, or are you just going to just pass it out and see the future?

Jun Tang

This is a software solution, and it is a software solution for -- well, it is an alternative to the X-Box and PS3, so it is nothing relating to the hardware. But we are more focusing on the content. The virtual console is a platform. On top of the platform, we are going to release several new games, online games for this virtual console. We try to work with partners, like the OEM vendors or ask them to preload the software console, and then we can put more X-Box and PS3 type of games on to the software console.

Operator

Our next question comes from [Qui Chen] from Shaw Capital Management. Please go ahead.

Qui Chen - Shaw Capital Management

Yes, among the six games, the MMORPG games you are going to launch in 2007, which game or games do you think will be the broad-based games?

Jun Tang

Actually, we are very excited about each of the games. Certainly we cannot expect -- any of them can be a major blockbuster, but different people may have different tastes. Like our Chairman and CEO, probably he is more interested or more confident on the Mir II, which he is the designer of that game. Myself, I am more excited about games I had worked on and licensed with, so different people have different tastes on that. But again, we are very excited about each of them.

Qui Chen - Shaw Capital Management

Okay, so what is the strategy about the gaming in the -- using wireless, like cell phones or smart phones, things like that?

Jun Tang

We have acquired a company called Digital-Red, which is the number one mobile game company in China, which has developed more than hundreds of titles for the mobile. But again, the 3G is something we still need to wait and look at and see, so we cannot give you specific guidance for the online in the mobile games, but once we take off, I think that Shanda definitely is in a better position because Digital-Red is the number one company in China now.

Qui Chen - Shaw Capital Management

Okay. Thank you very much.

Operator

Our next question comes from Chang Qiu from Forun Technologies. Please go ahead.

Chang Qiu - Forun Technologies

Good morning, everyone, and also, congratulations. One clarification question: when you say your active paying account number is 5% of your user base, how do you define your user base? Is that the registered number of players or some other measure?

Jun Tang

Yes, the total number is the active account, the total number of active accounts, quarterly active accounts.

Chang Qiu - Forun Technologies

Which means -- how do you define that?

Jun Tang

The definition of the active account is -- by this quarter, you have logged on and played our games. That is the definition.

Chang Qiu - Forun Technologies

I see, okay. Another question is I actually need your view, or what you think in your mind. Right now, there is some game, free to play games, it looks like in the media. I am talking about they are even paying other players to play the game in order to make the game more interesting or something like that. I would like to get your view on that practice.

Jun Tang

Again, you probably heard it somewhere from other channels, but we have not seen that from my view. We cannot comment on other companies’ practices, but Shanda is definitely not doing that. I think we are making a better environment for our users today.

Chang Qiu - Forun Technologies

Okay, all right. Thank you.

Jun Tang

Thank you.

Operator

Our next question comes from Ming Zhao from Susquehanna Financial. Please go ahead.

Ming Zhao - Susquehanna Financial Group

Thank you. Good morning, everyone, congratulations, too. First question, I just wonder if you could comment on the competitive landscape. Some of your competitors also have a number of games in their pipeline. You guys are licensing more MMO games and developing casual games. Can you give us some color on how you feel about the competition?

Jun Tang

One thing, the overall Chinese online game market still has great potential to grow. According to the IBC, they still have a nice growth rate over the years. However, the competition is intensifying and a lot of companies are entering the online gaming industry, but at Shanda, we do have our position as a platform company. We have great experience in managing the business and also we have a vast user base.

Our strategy is to, both in the licensing and in-house development, we are going to have six great titles in 2007, so we are very confident about this 2007.

Ming Zhao - Susquehanna Financial Group

Okay. Second question is I know you do not provide ACU or PCU data. I guess for your old games and the operation, they may have lost some users. They may have gained some new users. Could you give us some color on a net basis, do you see the old games gaining users or losing users quarter over quarter?

Jun Tang

Again, starting with this quarter, we are not giving specific numbers on the ACU or the PCU. Definitely we will disclose the numbers if the numbers have fluctuations over our overall business.

The total numbers, seasonality, I think. We do see some of the games are increasing on the total user numbers, on the PCU and ACU. Some of them may have a slight decline off that, but we do not see a big change on that.

Ming Zhao - Susquehanna Financial Group

Last question on your top line guidance: the quarter over quarter growth, do you see it is mainly because of the paying user number increase, or do you see it is because of the ARPU growth?

Jun Tang

It is our strategy to grow the actual paying accounts faster than the ARPU growth. Last quarter, both had a nice growth in both ARPU and paid accounts. I think starting from this quarter, we would like to see more, try to grow more of the paying accounts, and you will see that.

Ming Zhao - Susquehanna Financial Group

Okay, great. Thank you.

Operator

Our next question comes from Wendy Huang from Evolution Securities. Please go ahead.

Wendy Huang - Evolution Securities

Good morning. Congratulations on the great quarter. I have two questions. First, do you have any plans to continue to merge servers going forward?

Jun Tang

We will still periodically review our operating situation and merge the servers to further reduce the operating costs, if necessary.

Wendy Huang - Evolution Securities

Okay, other than merging servers and the -- will you take other measures to improve the margins going forward?

Jun Tang

Yes, actually, we will always -- in past years, we have made a great effort to reduce our operating costs and to enhance our internal controls. I think this is an ongoing process. Going forward, we will still focus on it. Thank you.

Wendy Huang - Evolution Securities

My second question is about operating expenses. In the fourth quarter, your sales and marketing expenses is particularly high. Should we, with more new games launched in 2007, especially in the first quarter, should we expect sales and marketing expenses to maintain this high level?

Jun Tang

Actually, in Q4, our sales and marketing expenses, although it shows a sequential increase as compared to the previous quarter, but it is still less than 10% of our net revenue. I think this ratio is quite healthy.

Actually, we have very strict budget controls over sales and marketing activities, and we will effectively utilize our budget to make marketing and promotional activities. Of course, for each of the new games and new versions for existing titles, we will do certain marketing activities to help to promote it. Thank you.

Operator

(Operator Instructions)

Frank Liang

We will take another one, last question. Thank you.

Operator

We have a follow-up question from James Mitchell from Goldman Sachs. Please go ahead.

James Mitchell - Goldman Sachs

My question has been asked already, so I will skip this time.

Operator

We have a follow-up question from Dick Wei from JP Morgan. Please go ahead.

Dick Wei - JP Morgan

First question is on the investment in console games. How much investment do you plan to make on the console area?

Jun Tang

The console is a software solution and the investment for this software solution is purely R&D people. We have a very limited R&D people, the software engineers. You can calculate how much the investment would be if you took a period, the R&D people, that kind of a solution.

Dick Wei - JP Morgan

Approximately how many people are in that team, and when will the software console be launched?

Jun Tang

It is around 100.

Dick Wei - JP Morgan

And approximately when it will be launched?

Jun Tang

Again, we are still working on the technical solutions. Today we are in closed beta testing. Once closed beta is finished with, the open beta testing -- it is like releasing a new game.

Dick Wei - JP Morgan

Great. And the games in that software console environment, some of the games are the same as the usual casual game or MMORPG game environment. I guess the games are interchangeable?

Jun Tang

The software console is an alternative to the X-Box and the PS3, and also it provides a new platform for the online games. Certainly we can put our existing games to the software console. Also, we are going to add new games into the software console.

Dick Wei - JP Morgan

Last question is on the advertising side. If you could comment on the advertising revenue in the fourth quarter and how much of that is coming out from the in-game advertising? Thanks.

Daniel Zhang

I think if you look at our total user base, we have a vast user base and we have introduced the CSP model. So it is a lot easier for us to have the in-game advertising. With the coming year for the Olympics, I think the online advertising can explode over the next couple of years, especially with the in-game advertising. Shanda is working on the technical solutions on the in-game advertising and we have tested on one of our casual games, the credit card -- the company that we partnered with, Volkswagen and both Volkswagen and our new gamers are very positive on this IGA.

Still, we tried to work on the dynamic solutions for the IGA. In the meantime, we are talking to the existing technologies to see how we can partner with them as well.

Dick Wei - JP Morgan

Approximately how much was it in the fourth quarter? Are you able to discuss that?

Daniel Zhang

You mean for IGA?

Dick Wei - JP Morgan

Right.

Daniel Zhang

In terms of revenue, I would say for the coming quarter, we will not separate the forecast on it.

Dick Wei - JP Morgan

Okay, thanks.

Tianqiao Chen

Thank you. Okay, thank you everyone. I would like to add some comments and I have Nancy to translate for me.

(Translation)

I thank you, everybody, for joining the conference call today. About a year ago around this time, the last 4Q conference, we had shocked the market with a negative earning delivery. However, a year later today, we are able to reach the peak performance historically. That has successfully demonstrated our strategy in CSP model that has continued to deliver both growth in user base and also earnings.

Also, I would like to thank all analysts for supporting us in the past 12 months, and thank you for being here today with us.

Going forward, Shanda will continue to focus our core business in the following three strategies: First of all, we will continue to provide more rich content for our game platform. Shanda will implement the parallel approach of developing in-house games as well as licensing content from third-party producers.

On the content side, I would like to put your attention on our expansion pack model, because with the expansion pack model, we are utilizing our existing games and driving more user interest and therefore creating more revenue opportunities. This will continue to be an important strategy going forward.

Going forward, we will also continue to enhance our platform, which has proven to be very successful in delivering very successful games. Actually, all of our 20 games are profitable and however, look at our sales and marketing fees, we are not spending more as compared to our competitors. Therefore, this has reinforced our strategy and focus on the platform, which will continue to deliver rich content in the coming years.

It is worth noting that the distribution system, coupled with your excellent e-Payment system, has helped Shanda to generate revenues. As you know, Shanda has recently been recognized as the best e-Payment system among all e-commerce systems.

Also, going forward we will continue to focus on our existing users and raise the ARPU and raise the new revenue opportunity from every user in the existing paying accounts.

First of all, we would like to focus on our existing users. As you know, the paying account user accounts for only 5% of our active account users. Therefore, if we just focus on generating more revenue from existing users, we still have a tremendous upside to grow as compared to our counterparts in our career market, which is around 20%. Also, for example, like opportunities we can also focus on the revenue generating model.

As you know, in this advertising world IGA, which is the in-game advertising, has proven to be very successful and we have got a huge upside to it, and it is very difficult to implement a subscription model in the game world. However, the advertising-supported model has always helped us to generate profit. Therefore, with our existing platform, we will continue to focus on the IGA model as well.

Therefore, with our soft console -- our soft console will continue to help us to generate more users from the customers out there.

No matter if we generate more revenue for existing users or develop more users, we will continue to focus as a content and platform player in the game market.

We seek continued support from our audience and customers in the coming years.

(Translation Ends)

Thank you, everyone.

Frank Liang

Thank you. Operator?

Operator

Yes, sir.

Frank Liang

Thank you, everyone, for joining us on our conference call today. We will see you next quarter. Bye-bye.

Operator

Thank you, everyone. This concludes today’s conference call. You may now disconnect and please have a wonderful day.

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