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Giant Interactive Group Inc. (NYSE:GA)

Q1 2011 Earnings Call

May 12, 2011 09:00 PM ET

Executives

Rich Chiang – IR Manager

Eric He – CFO

Wei Liu – President

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

Analysts

Jenny Wu – Morgan Stanley

Lisa Yuan – Goldman Sachs

Mark Marostica – Piper Jaffray

Eddie Leung – Bank of America/Merrill Lynch

Wendy Huang – RBS

Andy Yeung – Oppenheimer

Gary Ngan – UBS

Adam Krejcik – Roth Capital Partners

Atul Bagga – ThinkEquity

Vincent Sun – Mirae Asset Securities

Operator

Good morning and good evening, ladies and gentlemen. I would like to welcome everyone to Giant Interactive Group’s First Quarter 2011 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. Please follow the instructions given at that time, if you would like to ask a question.

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

Rich Chiang

Good morning, ladies and gentlemen. Welcome to the first quarter 2011 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 historical in nature constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended and as defined in the Private Securities Litigation Reform Act of 1995.

These forward-looking statements can be identified by terminologies such as “will,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar statements and 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 20-F filed on June 7, 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’d 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. Our strong results for the first quarter extended our recent trend of increasing top and bottom line results. As we continue to benefit from our successful game segmentation and portfolio diversification strategies as note in our earnings release, our core online gaming business performed well, supported by the increasingly positive response through ZT Online 2 as well as steady contribution from our existing games.

We began official closed beta testing of ZT Online 2 in the second quarter and recently achieved the PCU of 300,000. I am pleased to report that we reached this milestone with minimum cannibalizations from our – from the original ZT Online, highlighting the strong interest in growing potential of this new game.

We are very pleased with the progress of ZT Online 2 thus far, and we expect to build on this positive momentum in the coming quarters. We also benefit this quarter from an increase in other revenues which was related to our first-person shooter game that we developed as a result of government grant. We believe that being awarded this project, demonstrated our team’s technical expertise in this genre in China. We expect this revenue to decrease in the end of the second quarter, but we plan to leverage the technology used from this project to develop future MMO games.

In addition to encouraging response to ZT Online 2, we continued to make steady progress on our self-developed and licensed pipeline games, which should lead to additional value drivers in 2011. In short, we are again developing a consistent track record of execution with improving financial and operational results and effective cost controls. And we believe we have the right strategy in place to drive further growth in the years ahead.

With that I will move onto our key operational metrics on slide six. Total Active Paying Accounts or APA grew 1.5% sequentially and grew 29.6% year-over-year to 1.779 million. Average Revenue Per User or ARPU was RMB216 million, up 0.5% over last quarters and down 1.7% over the first quarter of 2010. Average Concurrent Users or ACU was 586,000 or 0.4% sequential increase and 0.3% decrease year-over-year. Peak Concurrent User or PCU was up 11.9% sequentially and up 18.9% year-over-year to 1.916 million.

We believe this steady improvement in our key performance indicators demonstrates the excitement generated by ZT Online 2 and the success of our game segmentation strategy. We are seeing a rise in number of players choosing to pocket in in-game spending and overall growth and the popularity of our games.

With our original ZT Online still contributing to this favorable trend as ZT Online 2 remains in its ramp-up phases. In addition, APA growth has again outpaced ARPU growth, which indicates that we are successfully attracting players with broad range of spending CapEx. We believe these trends are necessary to building on stronger and more sustainable revenue base which is our ultimate goal.

Once again, these improving operating metrics have translated into healthy financial results as seen on the slide seven. Net revenue for the quarter was $61.6 million, representing a 9.6% increase from the fourth quarter of 2010 and 32.5% increase from the first quarter of last year. Our net revenue for the quarter benefited from the growth in our online games revenues as well as increase in other revenue I noted earlier.

For the quarter, other revenue was $2.2 million compared to approximately $17,000 in the fourth quarter of 2011, I’m sorry, fourth quarter of 2010 and $25,000 in the first quarter of 2010. Gross profit for the first quarter first quarter of 2011 was $52 million, representing a 9.4% sequential increase and 31.3% year-over-year rise. Gross margin of 84.4% was down slightly from 84.5% in the previous quarter and down from 85.2% in the first quarter of 2010.

Total operating expenses for the first quarter of 2011 were $14 million, a decrease of 45.7% sequentially and increase of 13.1% year-over-year. The sequential decrease resulted from our continued focus on cost control as well as the lack of RMB46.5 million impairment loss incurred in the fourth quarter of 2010. R&D expenses decreased 20.9% sequentially and increased 56.2% year-over-year to $8 million in the first quarter. The sequential decrease was due to the fact that we paid year-end bonuses in the fourth quarter and a decrease in amortization of our capitalized development costs.

The year-over-year increase was mainly the result of increased R&D staff headcount and compensation over the previous year. Sales and marketing expenses were down 18.1% sequentially and 15.5% year-over-year in the first quarter to $3.8 million due to fewer marketing campaigns and reduction in our marketing liaison personnel. General and administrative expenses decreased 31.5% from the last quarter and decreased 7% from the first quarter of 2010 to $3.6 million, as we paid out bonuses in the fourth quarter of 2010 and received increased reimbursements related to our ADR programs starting from the first quarter of 2011.

Net income attributable to the company’s shareholders in the first quarter rose 13.3% sequentially and 41.5% year-over-year to $40 million, representing a margin of 65%. Basic and diluted earnings per ADS for the first quarter of 2011 were $0.18 and $0.17 respectively. Moving to our balance sheet seen on slide nine as of March 31, 2011 cash, cash equivalents and short term investments totaled $944.7 million, an increase from December 31, 2010 attributable to the cash generated from the operations this quarter.

In summary, we are pleased with our steadily improved financial performances and believe that we are well positioned to maintain this momentum in the year ahead. A key factor in our success has been our focus development of the portfolio of innovative and engaging games. We are seeing the result of this focus in the success today of ZT Online 2 and we believe we have additional value drivers under development.

Looking at our recent progress, throughout the first quarter, we continued to introduce various enhancements into ZT Online series of games to keep players engaged. This enhancement include a new expansion pack for ZT Online, a variety of new features for ZT Online Classic addition, and addition of more casual game play elements to ZT Online Green addition.

We also continued to develop our highly explained new flagship game ZT Online 2 with enriched content and game play and a new in-game economic system. As noted, the response to ZT Online 2 has been very positive helping the game to achieve 300,000 peak concurrent users recently. Official closed beta testing begun in April. We expect to keep enhancing the game and to initiate larger scale marketing activities in the current quarter.

During the first quarter, we continue to add new contents to Giant Online previous expansion pack in celebration of the games third anniversary. And in April, released another space theme expansion packs to keep players engaged. We also introduced new contents through the first expansion pack for Dragon Soul. Enhanced game play and added a new features for XT Online and Golden Land. Geographic footprints for all this three themes – games are all three of these games now extend beyond China.

I am pleased to report that we have signed exclusive licensing agreement with FPT Online to operate XT Online in Vietnam beginning in the second half of this year. As for our other licensing agreements, last quarter, we announced that we have a licensing partnership with Neonga AG to operate Dragon Soul in the US, Canada and selected European countries. And we are providing full support where possible to ensure the game success in these markets.

Golden Land as you know has the broadest geographic footprint of any of our games with licenses in countries across four continents. We have also have a new self-development game to tell you about today. Spirits of Warriors is a 3D MMORPG that we developed using RenderWare graphics engines. The story is based on the Three Kingdoms Period in ancient Chinese history. We expect to commence limited closed beta testing for this game in mid-2011.

Finally, both of our licensed games will reach new milestones in upcoming quarters with Elsword entering a new round of engineering tests and Allods Online entering a preliminary engineering tests. As you can see we are making solid headways on our key initiatives, our game portfolio and paying player base are both expanding, enabling us to deliver improving financial results, and positioning us to deliver long-term growth. Furthermore, our ongoing efforts to control costs and maintain a link cost base ensure that as we expand our business, we will be able to drive profitability and create value for our shareholders.

Taking into our consideration our expanding paying players base, that encouraging performance of ZT Online 2, we expect to build our positive momentums in the second quarters. Although the other revenue gains we had this quarter will diminish and end in the second quarter. We expect to see online game revenue accelerate as we commence more aggressive marketing campaigns for ZT Online 2. We expect this combination to lead to a continued top line growth in the second quarter of 2011.

Once again thank you for joining us today. We will now happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We request that you take one question and one follow-up. And our first question comes from Jenny Wu with Morgan Stanley. Please proceed.

Jenny Wu – Morgan Stanley

Hi, thank you for taking my questions. Congratulations on a great quarter. And my first question is regarding your APA and ARPU. In 1Q, if we’re excluding ZT Online 2, what will be change for APA and ARPU Q-on-Q? And then my second question is regarding your ZT Online 2, and based on – can you give us more details on its performance, such as the order demographics like the (inaudible) and also the ratio of the paying gamers versus the total gamers and the potential ARPU levels? Thank you.

Eric He

Okay, Jenny let me translate this question to President Liu. Maybe she can help you out on this question. (Foreign Language – Chinese)

Wei Liu

(Foreign Language – Chinese). Just to translate the answer to the first question about APA and ARPU. As you know, as we’ve seen in our first quarter, because we have seen very positive performance from ZT Online 2, APA has increased and ARPU has remained very stable. Now, we don’t disclose or breakdown performance by individual games. So unfortunately we won’t be able to tell you right now what the APA and ARPU would be if we discount or take out the ZT 2.

Xuefeng Ji

(Foreign Language – Chinese) For ZT Online 2, the age demographics is actually pretty similar to the original ZT Online, but user behavior and usage, it had some differences, for example ZT Online 2, the game play emphasizes more casual and maybe more cooperation and things of that nature. So these are some methods we use to differentiate these two products. And so far the response has been very positive. We are still set a lead time to build out the user base in ZT 2.

Jenny Wu – Morgan Stanley

Okay, as a follow-up to this, firstly, for the ZT Online or internet, if you’re growing or this is a pretty much flat, flattish year-on-year. And then secondly for ZT Online 2, what’s the ratio of the paying gamers versus the total gamers?

Wei Liu

(Foreign Language – Chinese) As far as ZT Online, the original game, over the past couple of quarters since the beginning of 2010, we have seen that this game has been steadily growing. And currently it’s still very stable. And so doing quite healthy right now, without much cannibalization or effects from the launch of ZT Online 2.

Xuefeng Ji

(Foreign Language – Chinese) So for the paying player percentage in ZT Online 2. It is higher than – that percentage is actually higher than our other games, but we’re still in a very early stage in the operation and launch of ZT Online 2. So we suspect that this percentage could trend higher in the future.

Operator

And our next question comes from Lisa Yuan with Goldman Sachs. Please proceed.

Lisa Yuan – Goldman Sachs

Hi, good morning, congratulations on a great quarter. Can you talk a little bit about the trend on Green ZT? And my second question is can you comment on your dividend policy, if you have any plan to increase the payout ratio?

Xuefeng Ji

(Foreign Language – Chinese) For our ZT Online Green edition, now prior to the launch of ZT Online 2, Green addition now looking back we consider sort of a testing ground for the new in-game economy, the new idea that we had for ZT 2. So these two in-game economies are very similar. Having said that, as we were launching ZT 2, we did see some users migrate to the newer version. But now currently after the launch has occurred ZT Green has remained very stable.

Eric He

As to dividend payout ratios, as you know, in the past few years, our dividend payout ratio has been in a range of the 25% to 33%. I think our payout ratio will stay very stable in the years to come.

Lisa Yuan – Goldman Sachs

Thank you.

Operator

Our next question comes from Mark Marostica with Piper Jaffray. Please proceed.

Mark Marostica – Piper Jaffray

Yes, thank you. Nice work on the quarter. I just wanted to get a little bit color on your R&D expenses, and your current R&D staff headcount now and what you anticipate it will be by the end of the year?

Wei Liu

(Foreign Language – Chinese) For our R&D department, currently we have around 900 people and this should increase moderately over at the end of this year. As for R&D expenses, we had some special situations or circumstances in the first quarter causing very large decline, but R&D expenses should grow moderately over the next year or so also.

Eric He

Next couple of quarters.

Mark Marostica – Piper Jaffray

Okay, got it. And then just as a follow-up, Eric, you mentioned a new game entering limited closed beta mid-2011, Spirit of Warriors. Can you talk about the genre of the game and how it may be different or the same perhaps with some of your existing games? And if you expect, what management expects from that game in terms of its performance at this early stage?

Eric He

Okay, sure. Let me translate the question to our VP, Ji and he can better answer the question. (Foreign Language – Chinese)

Xuefeng Ji

(Foreign Language – Chinese) For Spirits of the Warriors, it is a new in-house developed 3D MMO that we’re announcing. It is based on the Three Kingdom story in ancient Chinese history. And it’s very – has a lot of martial arts involved. It’s a self-developed 3D game and we believe that the graphics will be very attractive, will really stand out. And also the Three Kingdom story line or theme behind this game. I think a major difference or specialty is that most Three Kingdom games in the marketplace are more strategy based but this game should be able to differentiate itself.

Xuefeng Ji

(Foreign Language – Chinese) As Three Kingdoms is very popular storyline in Chinese society; we expect that this game should be somewhat successful but expectations for the game will have to be analyzed depending on how the testing processes go.

Operator

And our next question comes from Eddie Leung with Bank of America/Merrill Lynch. Please proceed.

Eddie Leung – Bank of America/Merrill Lynch

Hi, good morning everyone. Thanks for taking my questions. My first question is about your longer term strategy. It seems like the leading income lead for you guys have seen some recovery in the industry and perhaps you guys are picking market share, now on the other hand we have also seen some of your competitors trying some initiatives in different or other pieces, for example like TV, movie, web games, mobile games, etcetera. So could you guys talk about your longer term strategy? Do you think you will continue to focus on online games, and if there is any other initiatives that you think may be worth to pursue? And then my second question is perhaps more to address to Eric. Could you elaborate little bit more about the one-time revenues this quarter, just to understand whether it would be repetitive and the nature of it, about one-time gains from the new game, how should we think [ph]? Thanks.

Eric He

Okay, let me translate the first question to President Liu, and then I’ll answer your question directly later on. (Foreign Language – Chinese)

Wei Liu

(Foreign Language – Chinese) As for our long-term strategy, we like to think of it in three parts, our main source [ph] or main business is still to remain on focusing on online games especially leveraging our self-development capabilities, focusing on developing hit games for the industry because we believe the industry is still growing. It’s still very healthy. And if we can come out with successful fun to play hit games, we will be able to do very well. The second part would be more focused on community aspect, such as web games, social games, SNS games. This is a trend that’s going to grow and we will monitor the situation. We will both consider self-development, for example we already have our first web game out. And we will also consider licensing or cooperation opportunities.

And because we have – throughout the years we’ve definitely noticed the convergence between games and social networking. So we’re definitely very keen on spending resources on this front as well. The third part would be investments, or M&A and looking at opportunities in the Chinese internet or social networking space. And hopefully bring driving more value giving back to investors as well.

Eric He

I did want to add a couple of points that Mr. Liu just said, maybe being leftover during the translation. I think on the second part, she also mentioned that we actually invested in a mobile game platform company, and the company is doing very well. I think we’re going to continue to capitalize on this, the mobile game proliferation in the country. Hopefully we can do something in cooperation with mobile game platform that we invested.

I think that for the third part of Ms. Liu’s answer that she also mentioned that we not only will invest in this gaming arena or internet arena, we also look for the high growing, fast growth type of the company. Hopefully we can generate our shareholders value and company values for the shareholders.

As far as one-time revenue happened in the first quarter, it is a government grant allowed us to develop single play or internet games in the genre of FPS. I think this is a very important milestone for us because this government agency has looked into many different choices and teams in this country. And they finally decided that we are the best partners to work with, because we have the right team, we have the technology. We can deliver what we promised. So it’s a very, very exciting moment for us because the fact that we have not been granted to disclose their identity, I think what we will do is we will do a conference call sometime in June to tell people of what that is.

And for this particular project, would generate revenue for us in the first quarter and second quarter as I’ve said the revenue in the second quarter would diminish to somewhat and this technology actually will be used for us to develop FPS MMO type of the games towards the end of the year. And that will be very exciting. And again we are not being permitted to disclose details on this. Hopefully in June when we have the conference – the press conference we will talk more about this.

Operator

And our next question comes from Wendy Huang with RBS. Please proceed.

Wendy Huang – RBS

Thanks for taking my questions and congratulations on the great quarter. First, Eric, I just wondered if you can give me some idea about operating margin trend, if I exclude the $14 million, non-recurring revenue related to the FPS project, the operating margin should be around 58%. So this is also kind of consistent with the historical high level you achieved in the past. So do you think going forward, the operating margin should remain at such high-level. And secondly, can you give me some update on your investments in your social networking companies 51.com and what kind of synergies or progress are you seeing on this investment? And my third question is about your ZT Online 2, just wondered if you can share your view, what do you think you can do to bring the current PCU level from 300,000 to 0.5 million level and what you can do to bring this again from 0.5 million to 1 million level? Thank you.

Eric He

Let me try to answer your question backwards. I would like to ask VP, Ji to answer the third question first, then I will answer your first and second questions.

Wendy Huang – RBS

Sure.

Eric He

(Foreign Language – Chinese)

Xuefeng Ji

(Foreign Language – Chinese) As far as ZT Online 2, currently we have achieved over 300,000 peak concurrent users, but in our minds it is – the game itself still has a lot of room for improvement in terms of game play and content. So we will continue to revise the game, listen to player’s feedback, and enhance and add new content to the game continuously. So we will continue to utilize both developments and also operational activities to try to continue building on this user base. And also we will also utilize the marketing tactics as well to try to raise the user levels from current levels.

(Foreign Language – Chinese) In our opinion, a truly great game, also has a great reputation from gamers through word of mouth. And so once we achieve this in our minds, we believe that the game can take on a life of its own and attract even more users through word of mouth.

Eric He

Let me try to answer Wendy, your first question regarding our operating margins. And I think for the second portion that the synergy that we have with 51.com, I would like to direct that question to President Liu to answer to you. So for operating margin as you can see the first quarter margin was fantastic, it was very good. As we mentioned that there are couple of one-time issues. But looking forward into the second quarter and the rest of the year, we think the margin would stay relatively strong, however having said that I have to also point out, for example in this current quarter as we mentioned it, that we initiated some sales and marketing campaigns for ZT 2, it was actually cost us [ph] something but on the other hand ZT 2 is starting contributing good revenue to us.

So the net result is remained to be seen, but I would say that if there is a little bit fluctuation, I think it will be within a very tight range. So I would expect that operating margin moving forward to be quite stable. If there is any fluctuation, it should be in a very tight range. The second question is regarding the 51.com. I would like to address that question to President Liu.

Wei Liu

(Foreign Language – Chinese) As far synergies with 51.com, we would like to answer this in two parts. First of all, our expertise lies in hardcore online which are not always very suitable for users of social network, SNS websites such as 51.com. So I think in the future as we continue to build our portfolio of web and casual games, we will likely have more synergy to be able to leverage the user base in 51.com then.

Another part, part two would be currently our founder is here Mr. Shi and also our development team. Throughout the years I’ve been discussing or thinking about the convergence between online games and SNS. So in the future, we believe that games will further utilize social interactions and more community features. So this is a genre, an area that we are moving towards as well.

Operator

And our next question comes from Andy Yeung with Oppenheimer. Please proceed.

Andy Yeung – Oppenheimer

Good morning, thank you for taking my questions. My first question is about your timetable for commercial launch of your ZT 2. You mentioned that you have launched closed betas in same quarter. Have you launched your large scale marketing campaign for ZT 2 yet and also what’s your timeline for open betas and commercial launching?

Xuefeng Ji

(Foreign Language – Chinese) For the timetable for open beta testing in ZT Online 2, this will depend on how further testing go and further revisions to the game itself and feedback of the gamers. Currently preliminary timetable will probably be in the third quarter or fourth quarter of this year.

Andy Yeung – Oppenheimer

And so you haven’t launched your large scale marketing campaign for ZT 2 yet or have you – should we expect that ramping up over the next couple of quarters?

Eric He

I think we did actually launched marketing campaign in the month of April. We call it closed beta test. So that is our one milestone. VP, Ji mentioned that for open beta it will be in the third quarter or the fourth quarter and that actually will require additional marketing campaigns efforts during that time.

Andy Yeung – Oppenheimer

Okay, got it. And then next question is little bit about your long-term online game development plan. I think most of your games MMORPG, what’s your view in other genre, for example for first-person shooting games and do you have any plan to launch other game genres?

Wei Liu

(Foreign Language – Chinese) For genres or future direction of our R&D development, now most – the bulk of our expertise still lies in developing hardcore MMORPGs. So currently most of our development is still focused on these types of games. So even throughout the 2012, I think most of the games that we’re planning to do are considered as genre, but we will try other genres as well. For example, we will leverage the technology we’ve learned from doing our one-time first-person shooter single-player version. And work on a consumer gamer version that is going to be online in multiplayer, and also trying to build our portfolio of web games and more casual games as well.

Operator

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

Gary Ngan – UBS

Good morning, everyone, and thanks for taking my questions. My first question is, if we look at some other recent addition [ph] company, a lot of disclosure in their monthly active accounts or monthly active users seems to be based on valuation of those numbers. So would you mind sharing what’s Giant’s total monthly active users are, let’s say defined as people – accounts who have logged in at this month [ph] per month?

Eric He

Gary, can you repeat your question, I have a hard time to understand your question, sorry.

Gary Ngan – UBS

Just very quickly, would you mind sharing with us what is the monthly active accounts i.e., the people who logged in once every month into the Giant system, whether they pay or not or just not play the games once in every month?

Eric He

Okay. (Foreign Language – Chinese)

Xuefeng Ji

(Foreign Language – Chinese)

Eric He

I am sorry Gary, we have never disclosed this kind of numbers. So I don’t think we have this numbers handy for you. If you need the numbers, we can maybe discuss a little bit offline, but I don’t have this number of hand right now.

Gary Ngan – UBS

Sure. My second question is if we looked at the time spent per user or per gamer over the past couple of years in the old games like ZT 2. Do you see any significant difference in terms of the time per user spent, because over the past few years, there seems to be many other different entertainment options such as social networks, web or videos. So just want to get a sense of what – are there any particular change in user behavior in these games?

Eric He

Okay, good. I’ll translate this question and VP, Ji will answer the question for you. (Foreign Language – Chinese)

Xuefeng Ji

(Foreign Language – Chinese) Yes, Gary you’ve touched upon actual trend that’s been going on over the past couple of years. Over the past one or two years we have also noticed that user behavior or time spent in online games has been impacted by other forms of entertainment like you mentioned SNS, micro twitters, micro blogs or video sites. We have noticed that durations of each login has actually decreased somewhat, but with these trends our development teams has to adjust our game play to mask these trends. For example, not making requests long enough for gamers to play, but having them engaged enough to come back.

Operator

Our next question comes from Adam Krejcik with Roth Capital Markets. Please proceed.

Adam Krejcik – Roth Capital Partners

Yes, hi, good morning, thanks for taking my question. Eric, I was wondering if you could just elaborate a little bit more in terms of the top line revenue trends we should expect in Q2 for example. Is it safe to assume that the other revenue might decline by 50% or more, just trying to get a sense of how much other revenue you might book in Q2? And then for your core online game business, I think you’ve been enjoying mid to high-single digit sequential growth for the past couple of quarters. Is it also safe to assume that you’ll be able to maintain this trend with the growth of ZT 2 and then I have a follow-up question. Thanks.

Eric He

Sure, Adam. Yes, I think as mentioned that other revenue games in the first quarter is going to diminish in the second quarter, and it will end actually in second quarter. So you can expect that the number for that game is going to be somewhat smaller. As we indicated in our earnings release, we said that our revenue from online – online games revenue will continue to ramp-up. So if we were to achieve what we actually projected earlier. So we actually are looking into our online game revenue to accelerate in the second quarter.

I think this trend is definitely being supported and helped by the robust ramp-up of ZT 2. So we are pretty confident that the revenue stream for next couple of quarters should continue to grow in a very positive way.

Adam Krejcik – Roth Capital Partners

Okay, and then I have a question on ZT 2. I just want to understand it’s been very well received, can you kind of elaborate, do you think it’s the new in-game economy system that’s driving a lot of user interest or just game playing content. So will you consider using this in-game economy since it’s been successful on future releases going forward.

Eric He

Sure. Xuefeng you didn’t heard, wouldn’t you – I would like to direct your second question to our VP, Ji because he understand more thoroughly than I do. So allow me to translate your question. (Foreign Language – Chinese)

Xuefeng Ji

(Foreign Language – Chinese) For ZT Online 2, the positive results we have seen so far are due to many reasons including the revised in-game economy. But as a whole, I think the entire playing experience is better than some of the games that we’ve seen recently. I think especially the community features in the game is really interactive and makes the experience really sticky so that when gamers play the game, its very fun and at least a very positive lasting experience for them.

Operator

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

Atul Bagga – ThinkEquity

Hi guys, congratulations on a great quarter.

Eric He

Thank you.

Atul Bagga – ThinkEquity

And thanks for taking my call. I have a couple of questions for you. A, I wanted to understand the use of cash. You guys have now close to $950 million and the cash balance have been growing pretty steadily. What is the minimum level of cash that you’re implementing new balance sheet within your business, and how should we think about the use of cash going forward? That’s one and then I have another question after that. Thank you.

Eric He

I think yes, we are very fortunate to generate cash from our operations quarter after quarters. And this quarter is another cash flow positive quarter for us. Right now the cash stood at $944 million. I think for us, moving forward as you can know that we continued to generate cash, but I think we will – as mentioned it before we will maintain our annual dividend and we would like to actually use this cash in a most productive way. I think as mentioned by President Liu, earlier in this conference call that we actually would like to put this money into very productive usage such as we would like to invest into the gaming area or internet related area which can help our business or become a complementary to our business.

As President Liu, mentioned that we are MMO hardcore game type of the developers, we know the best in this genre, we may not know too much in other area, lighter core games or even some social games or web games. So if there is suitable opportunities, we definitely would like to put that money into this kind of usage. And also as you mentioned that we would like to look forward opportunities will bring us high growth, will actually grow our business, will help out our business to grow even further, and to hopefully [ph] return good gains for our shareholders.

All of those investment opportunities will be considered. But as you can see that in the past we have been very prudent because we don’t want to squander all this money and we see this money as a money that’s hard earned and would like to generate shareholders value in a long run. So yes, I think we will be cautious and prudently manage with the money and moving forward, hopefully that we can generate higher or better value for the shareholders.

Atul Bagga – ThinkEquity

And if so, just so I understand, is there a change in the philosophy regarding M&As, in the past you guys have made some investments, but generally those investments had been pretty small in nature. Should we expect to see some larger M&As or investments coming from Giant over the next say, six to 12 months?

Eric He

I think in terms of the investments, in terms of looking for the opportunities we have not changed our strategy or the policies. As I said that we have been very prudent and we would like to look forward a good opportunities which will return the good return for us. So I don’t think we change anything particularly and we are looking to several opportunities at this moment. I do not think there is anything in particularly different from what we have been thinking in the past.

Atul Bagga – ThinkEquity

Okay, got you. And my second question was about your ACU number and APA number. It seems like if I look at the correlation between ACU and APA, it seems like this conversion ratio from non-paying user to paying user has gone up in the quarter. Can you talk about what has been driving that? What are you guys doing different in the games now? What’s this, what you’ve done in the past?

Eric He

Can you repeat that conversion part, because I do not understand exactly what you mean conversions of the paying account and non-paying account. Can you elaborate that a little bit please?

Atul Bagga – ThinkEquity

Yes, so basically what I meant is your ACU number has been kind of flattish to sequentially, but your APA has gone up almost 5% in Q1. Is it a reflection of the number of people who are playing versus paying that’s going up?

Eric He

Okay, good. This is a very good question. I am glad that you mentioned. I think this question came. The best person to answer the question is our VP, Ji, actually we discussed this a little bit before this conference call. Just hang-on for a second, let me translate this little bit. (Foreign Language – Chinese)

Xuefeng Ji

(Foreign Language – Chinese) Atul, that’s a very good question. Over the past one or two years, we’ve seen that the rise of SNS, social networking and other forms of entertainment grab the attention of gamers. And gamers are spending less time or actually their each login duration is little bit shorter than previous years. So the game user’s behavior has been a little bit affected.

That’s why our development teams have to sort of change some game play in the game to match these trends. For example in ZT 2 and also in the original ZT, we’ve made the experience somewhat a little bit more (inaudible) so we don’t need to have gamers playing that hard, that long for as much as before. But the game is still fun. So they are coming back to play the games. So that’s why ACU has been somewhat flat but APA number of paying accounts has been rising this quarter.

Eric He

If I may, I just want to add one point so that I want to make sure that people understand why when people actually reduce their duration in the game, will actually affect ACU more, in fact more PCU and APU will not be affected that much. Because when we calculate ACU, what we do is we would take every sample of every minutes of the concurrent users. For example, for this hours, we would have 50 figures of each minutes, say how many people are online, the concurrent user online. But in the past people may spend two hours, three hours to logon. But now they’ve shortened per logon time.

So you would have sometimes that concurrent users start to become less. So when you actually add all those minutes, the simply minutes of concurrent users in particular day, you got something like a 1,444 minutes altogether the numbers and divide it by 1,440 to get ACU numbers. So when you have a shorter duration. So your ACU would tend to stabilize, would not actually increase that much. But PCU is the highest point, usually happen in the evenings. So the PCU number will not be affected that much. And as to APA, as another matter is paying accounts, as we mentioned that the paying behavior actually is still the same and because our game design actually changed towards gamers behavior, we actually would like to attract gamers to come back to the game more often, more frequently instead of staying hang-off [ph] in a game for a long period of time. I hope that help you to understand the answer.

Operator

And our next question comes from Vincent Sun with Mirae Asset. Please proceed.

Vincent Sun – Mirae Asset Securities

Hi, thanks for taking my questions. My question is regarding to ZT 2. So we all know the game is performing very well and (inaudible) so what’s management’s current are expectation about this game in terms of (inaudible) and also what expectation about the ARPU? (Foreign Language – Chinese)

Xuefeng Ji

Okay, thank you. (Foreign Language – Chinese) For our expectations on ZT 2, currently it has achieved 300,000 PCU. Already a very good initial sign but there are still a lot of more work to go. We are currently, under further testing and revision gathering feedback from gamers and keep on trying to enhance the game playing contents for the game. Our next goal would be to try to raise the PCU to 400,000 peak concurrent users.

We want to take things step-by-step. As for the ARPU of the game, currently it’s in between 3,000 [ph] ZT Online and ZT Green.

Operator

At this time, I’d like to hand it back to Mr. Rich Chiang for concluding 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

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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