UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 20-F

(Mark One)

o		REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2010

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Giant Interactive Group Inc.

(Exact name of Registrant as specified in its charter)

(Translation of Registrant’s name into English)

(Jurisdiction of incorporation or organization)

11/F, No. 3 Building, 700 Yishan Road
Shanghai, 200233, People’s Republic of China
(Address of principal executive offices)

(Name, Telephone, E-mail and/or Facsimile Number and Address of Company Contact Person)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

Title of each class		Name of each exchange on which registered
American Depositary Shares, each representing one ordinary share, par value US$0.0000002 per share		New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act.
None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
None

     Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report: 228,019,412 ordinary shares.

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No

     If this report is an annual or transaction report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. o Yes þ No

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes o No

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

     Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

     U.S. GAAP þ International Financial Reporting Standards as issued by the International Accounting Standards Board o Other o

     If “Other” has been checked in response to the previous question indicate by check mark which financial statement item the registrant has elected to follow. o Item 17 o Item 18

     If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

 

 

GIANT INTERACTIVE GROUP INC.

TABLE OF CONTENTS

		Page
INTRODUCTION			1
FORWARD-LOOKING STATEMENTS			2
PART I.			3
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS			3
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE			3
ITEM 3. KEY INFORMATION			3
ITEM 4. INFORMATION ON THE COMPANY			27
ITEM 4A. UNRESOLVED STAFF COMMENTS			45
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS			45
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES			59
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS			66
ITEM 8. FINANCIAL INFORMATION			67
ITEM 9. THE OFFER AND LISTING			68
ITEM 10. ADDITIONAL INFORMATION			69
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			73
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES			74
PART II.			74
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES			74
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS			74
ITEM 15. CONTROLS AND PROCEDURES			74
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT			76
ITEM 16B. CODE OF ETHICS			76
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES			76
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES			76
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS			76
ITEM 16G. CORPORATE GOVERNANCE			77
PART III.			78
ITEM 17. FINANCIAL STATEMENTS			78
ITEM 18. FINANCIAL STATEMENTS			78
ITEM 19. EXHIBITS			78
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS			81
EX-4.16
EX-4.17
EX-8.1
EX-12.1
EX-12.2
EX-13.1
EX-13.2
EX-23.1
EX-23.2
EX-23.3
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

INTRODUCTION

     Except where the context otherwise requires and for purposes of this annual report only:

	•		“we,” “us,” “our company,” and “our,” refer to Giant Interactive Group Inc., its predecessor entities and subsidiaries, and its consolidated affiliated entities;
	•		“China” or “PRC” refers to the People’s Republic of China, excluding, for purposes of this annual report only, Taiwan and the Special Administrative Regions of Hong Kong and Macau;
	•		monthly “average concurrent users,” or “ACU,” of any of our games is determined as follows: we first determine the number of users logged onto the game at five-minute intervals, and average that data over the course of a day to derive the daily average. The daily average data are then averaged over the monthly period to derive the monthly average concurrent users;
	•		quarterly “active paying players,” or “APP,” is the aggregate number of accounts for our games that have been charged at least once during the quarterly period;
	•		quarterly “average concurrent users,” or “ACU,” of any of our games is the average of monthly average concurrent users of such game during the quarterly period;
	•		quarterly “average revenues per user,” or “ARPU,” is our online game net revenues during the quarterly period divided by the quarterly active paying players of these games during the quarterly period; our definition of ARPU may not be comparable to similarly titled measures presented by other online game companies;
	•		quarterly “peak concurrent users,” or “PCU,” of any of our games is the peak concurrent users of such game during the quarterly period;
	•		a “shard” is, with respect to an online game, one of multiple independent copies of the game world. In a “sharded” game, such as ZT Online or Giant Online, players may only interact with other players in one shard at one time;
	•		All references to “Renminbi” or “RMB” are to the legal currency of China, all references to “US dollars”, “dollars”, “$” or “US$” are to the legal currency of the United States, and all references to “HK$” are to the legal currency of the Hong Kong Special Administrative Region of China;
	•		“ordinary shares” refers to our ordinary shares, par value US$0.0000002 per share;
	•		“ADSs” refers to our American depositary shares, each of which represents one ordinary share;
	•		“ADRs” refers to American depositary receipts, which, if issued, evidence our ADSs;
	•		“PRC GAAP” refers to accounting principles and the relevant financial regulations applicable to PRC enterprises; and
	•		“US GAAP” refers to generally accepted accounting principles in the United States.

     This annual report on Form 20-F includes our audited consolidated statements of operation data for the years ended December 31, 2008, 2009 and 2010 and audited consolidated balance sheet data as of December 31, 2009 and 2010.

     We and certain of our shareholders completed the initial public offering of 65,777,036 ADSs, each representing one ordinary share, on November 6, 2007. Our ADSs are listed on the New York Stock Exchange under the symbol “GA.”

FORWARD-LOOKING STATEMENTS

     This annual report on Form 20-F contains forward-looking statements that relate to our current expectations and views of future events. The forward-looking statements are contained principally in the items entitled “Information on the Company,” “Risk Factors,” “Operating and Financial Review and Prospects,” “Financial Information,” and “Quantitative and Qualitative Disclosures About Market Risk.” Our forward-looking statements relate to events that involve known and unknown risks, uncertainties and other factors, including those listed under “Risk Factors,” which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

     In some cases, these forward-looking statements can be identified by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, among other things, statements relating to:

	•		our anticipated growth and marketing strategies;
	•		our future business development, results of operations and financial condition;
	•		our ability to develop and commercialize new online games, including our ability to manage our development expenses;
	•		market acceptance of our online games;
	•		our ability to introduce expansion packs and updates to our existing online games;
	•		our ability to license our online games to third party operators;
	•		our ability to manage our existing licensing arrangements, including our ability to anticipate and manage licensing fees;
	•		competition from other online game developers and operators;
	•		our expectations for a rise in online payment systems and associated online crime;
	•		our ability to anticipate and manage Internet access fees and server maintenance costs;
	•		our intentions regarding management of our employees and liaison personnel;
	•		our ability to comply with regulation applying to online games;
	•		our ability to effectively protect our existing and future intellectual property and not to infringe on the intellectual property of others;
	•		our ability to expand our business through organic growth and strategic acquisitions;
	•		our ability to integrate and manage our investment in Five One Network Development Co., or 51.com;
	•		fluctuations in general economic and business conditions in China; and
	•		impact of the current worldwide economic crisis on our business.

     If any one or more of the assumptions underlying the market data turns out to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward-looking statements.

     The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. Except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise, after the date on which the statements are made or to reflect the occurrence of unanticipated events. You should read this annual report and the documents that we reference in this annual report completely and with the understanding that our actual future results may be materially different from what we expect.

Market Data and Forecasts

     This annual report also contains data related to the online gaming industry in China. This market data includes projections that are based on a number of assumptions. The online gaming market may not grow at the rate projected by market data, or at all. The failure of this market to grow at the projected rate may have a material adverse effect on our business and the market price of our ADSs. In addition, the rapidly changing nature of the online gaming industry subjects any projections or estimates relating to the growth prospects or future condition of our market to significant uncertainties. Furthermore, our actual results may differ from the projections if any one or more of the assumptions underlying the market data turns out to be incorrect. You should not place undue reliance on market forecasts regarding the online gaming industry in China.

     Unless otherwise indicated, information in this annual report concerning economic conditions and our industry is based on information from independent industry analysts and publications, as well as our estimates. Except where otherwise noted, our estimates are derived from publicly available information released by third party sources, as well as data from our internal research, and are based on such data and our knowledge of our industry, which we believe to be reasonable.

PART I.

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     Not applicable.

ITEM 3. KEY INFORMATION

A. Selected Financial Data

     The selected consolidated financial data for the three years ended December 31, 2008, 2009 and 2010, and the selected consolidated balance sheet data for the two years ended December 31, 2009 and 2010, were derived from our audited consolidated financial statements appearing in this annual report beginning on page F- 1 . The selected consolidated balance sheet data for the years ended December 31, 2006, 2007 and 2008 have been derived from our audited consolidated balance sheets as of December 31, 2006, 2007 and 2008, which are not included in this annual report. The selected consolidated statement of operations and comprehensive income data for the years ended December 31, 2006 and 2007 have been derived from our audited consolidated financial statements for the year ended December 31, 2006 and 2007, which are not included in this annual report. The following consolidated financial data summary for the periods and as of the dates indicated below should be read in conjunction with, and are qualified in their entirety by reference to, our consolidated financial statements and related notes and Item 5, “Operating and Financial Review and Prospects” below.

     Our audited consolidated financial statements are prepared in accordance with US GAAP, and have been audited by Ernst & Young Hua Ming, an independent registered public accounting firm. The report of Ernst & Young Hua Ming on the consolidated financial statements as of December 31, 2009 and 2010 is included elsewhere in this annual report.

     Our historical results for any prior period are not necessarily indicative of results to be expected for any future period.

Consolidated Statement of Operations and Comprehensive Income Data:

		Year Ended December 31,
		2006				2007				2008				2009				2010
		RMB				RMB				RMB				RMB				RMB				US$
		(In thousands, except per share and per ADS data)
Net revenue:
Online games			408,499				1,521,396				1,589,676				1,293,018				1,289,481				195,376
Licensing revenues			—				6,140				4,391				10,687				42,667				6,465
Other revenue, net			—				—				612				130				668				101
Total net revenue			408,499				1,527,536				1,594,679				1,303,835				1,332,816				201,942
Cost of services			(45,195	)			(174,086	)			(217,899	)			(204,070	)			(199,122	)			(30,170	)
Gross profit			363,304				1,353,450				1,376,780				1,099,765				1,133,694				171,772
Operating (expenses) income:
Research and product development			(14,799	)			(26,918	)			(88,539	)			(113,354	)			(186,037	)			(28,187	)
Sales and marketing			(80,460	)			(189,403	)			(241,575	)			(119,600	)			(143,006	)			(21,668	)
General and administrative			(26,098	)			(74,130	)			(141,786	)			(121,446	)			(119,447	)			(18,098	)
Government financial incentives			1,621				16,779				63,084				88,460				57,386				8,695
Impairment of intangible assets			—				—				—				—				(46,558	)			(7,054	)
Total operating expenses			(119,736	)			(273,672	)			(408,816	)			(265,940	)			(437,662	)			(66,312	)
Income from operations			243,568				1,079,778				967,964				833,825				696,032				105,460
Interest income			1,136				53,878				184,964				102,200				136,098				20,621
Investment income (loss)			—				2,562				1,171				(5,971	)			—				—
Unrealized loss on investment held-for-trading			—				—				(300	)			—				—				—
Other (expense) income, net			(86	)			126				(843	)			14,025				65,466				9,919
Income before income tax expenses			244,618				1,136,344				1,152,956				944,079				897,596				136,000
Income tax expenses			—				—				(39,368	)			(85,060	)			(89,322	)			(13,534	)
Share of loss of an equity investee			—				—				—				—				(648	)			(98	)
Net income			244,618				1,136,344				1,113,588				859,019				807,626				122,368
Net loss attributable to non controlling interests			—				—				—				295				3,563				540

		Year Ended December 31,
		2006				2007				2008				2009				2010
		RMB				RMB				RMB				RMB				RMB				US$
		(In thousands, except per share and per ADS data)
Net income attributable to the Company’s shareholders			244,618				1,136,344				1,113,588				859,314				811,189				122,907
Other comprehensive loss, net of tax
Foreign currency translation			146				(51,927	)			(192,424	)			(12,769	)			(73,194	)			(11,090	)
Reclassification adjustment			—				—				—				(1,814	)			—				—
Unrealized holding gains (losses)			—				—				76,969				(30,951	)			(14,540	)			(2,203	)
Total other comprehensive loss, net of tax			146				(51,927	)			(115,455	)			(45,534	)			(87,734	)			(13,293	)
Comprehensive income			244,764				1,084,417				998,133				813,780				723,455				109,614
Net earnings per ordinary shares, basic			1.22				—				—				—				—				—
Net earnings per ordinary shares, diluted			1.22				—				—				—				—				—
Net earnings per ADS(1), basic			—				5.40				4.65				3.80				3.57				0.54
Net earnings per ADS, diluted			—				5.25				4.49				3.67				3.47				0.53
Shares used in computation, basic			200,000,000				210,574,196				239,458,633				226,278,227				227,308,854				227,308,854
Shares used in computation, diluted			200,148,401				216,255,503				247,895,076				233,960,556				233,928,400				233,928,400

Selected Consolidated Balance Sheet Data:

		December 31,				December 31,				December 31,				December 31,				December 31,
		2006				2007				2008				2009				2010
		(RMB)				(RMB)				(RMB)				(RMB)				(RMB)				(US$)
		(in thousands)
Assets
Cash and cash equivalents			451,371				7,295,470				1,696,273				1,097,155				2,776,936				420,748
Total current assets			466,658				7,373,495				5,236,061				5,102,972				6,304,005				955,152
Property and equipment, net			36,491				127,631				213,905				178,670				143,286				21,710
Total non-current assets			38,146				214,228				766,363				1,349,690				804,138				121,839
Total assets			504,804				7,587,723				6,002,424				6,452,662				7,108,143				1,076,991
Total current liabilities			238,867				1,282,199				603,608				547,448				700,314				106,108
Total liabilities			254,942				1,282,199				629,294				547,869				700,500				106,136
Total shareholders’ equity			249,862				6,305,524				5,373,130				5,897,185				6,392,860				968,615
Non controlling interest			—				—				—				7,608				14,783				2,240
Total liabilities and equity			504,804				7,587,723				6,002,424				6,452,662				7,108,143				1,076,991

     Selected Operating Data:

		For the quarter ended
		March 31,				June 30,				September 30,				December 31,				March 31,
		2010				2010				2010				2010				2011
		(in thousands, except average revenues per user)
Average Concurrent Users			588				670				538				584				586
Peak Concurrent Users			1,611				1,657				1,466				1,713				1,916
Active Paying Players			1,373				1,435				1,497				1,693				1,779
Average Revenues per User (RMB)			220				223				225				215				216

Exchange Rate Information

     Our business is conducted in China and substantially all of our net revenues are denominated in Renminbi. This annual report contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. Conversions of Renminbi into U.S. dollars in this annual report are based on the noon buying rate in The City of New York for cable transfers of Renminbi as certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this annual report were made at a rate of RMB6.6000 to US$1.00, the noon buying rate in effect as of December 31, 2010. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On June 10, 2011, the noon buying rate was RMB6.4801 to US$1.00.

     The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated.

		Noon Buying Rate
Period		Period End				Average(1)				Low				High
						(RMB per US$1.00)
2006			7.8041				7.9723				7.8041				8.0702
2007			7.2946				7.5806				7.2946				7.8127
2008			6.8225				6.9477				6.7800				7.2946
2009			6.8259				6.8307				6.8176				6.8470
2010			6.6000				6.7696				6.6000				6.8330
December			6.6000				6.6497				6.6000				6.6745
2011
January			6.6017				6.5964				6.5809				6.6364
February			6.5713				6.5761				6.5520				6.5965
March			6.5488				6.5645				6.5483				6.5743
April			6.4900				6.5267				6.4900				6.5477
May			6.4786				6.4957				6.4786				6.5073
June (through June 10, 2011)			6.4801				6.4790				6.4754				6.4824

B. Capitalization and Indebtedness

     Not applicable.

C. Reasons for the Offer and Use of Proceeds

     Not applicable.

D. Risk Factors

Risks Relating to Our Business and Industry

     Our limited operating history and the unproven long-term potential of our online game business model make evaluating our business and prospects difficult.

     We began offering our first product, the free-to-play massively multiplayer online role playing game, or MMORPG, ZT Online, on a commercial basis in January 2006. As of the date of this annual report, we operate eight additional MMORPGs, one casual massively multiplayer online game, or MMO, and one strategy browser game. All but one of these games is based upon the free-to-pay revenue model and we expect the substantial majority of our net revenues to continue to be generated by free-to-play

games. Under this revenue model, players are able to play the online game free of charge for an unlimited amount of time, but are charged for purchases of in-game items, such as weapons, clothing and other accessories. While other online game companies have adopted the free-to-play revenue model, it is still relatively new compared to the more proven time-based model. The free-to-play model requires us to design games that not only attract players to spend more time playing, but also encourage them to purchase in-game items. The sale of in-game items requires us to track closely consumers’ preferences, especially in-game spending trends.

     Due to both our limited operating history and the relatively new free-to-play online game revenue model, it may be difficult for you to evaluate our business, financial performance and prospects. In addition, we may not have sufficient experience to address the risks and difficulties frequently encountered by young companies using relatively new business models in rapidly evolving markets, such as China’s online game market. These risks and difficulties include, but are not limited to, our potential failure to develop, acquire or license additional online games that are appealing to players, our ability to retain existing players and attract new players for our online games, our ability to adapt to competitive market conditions and our ability to respond in a timely manner to technological changes or resolve unexpected network interruptions. If we are unsuccessful in addressing these risks and difficulties, our business, financial condition and results of operations may be adversely affected.

     We have been, and may continue to be, substantially dependent on ZT Online Series, which has accounted for nearly all of our historical net revenues. Any reduction in ZT Online Series’ player base or any decrease in its popularity could materially and adversely affect our business, financial condition and results of operations, and any change in the accounting policies relating to that game could cause our online game revenues to fluctuate.

     Since inception, sales of virtual value-added items and services related to the ZT Online Series have accounted for nearly all of our net revenues. We commercially launched ZT Online in 2006 and subsequently commercially launched or introduced multiple versions of ZT Online, which includes ZT Online Classic Edition, ZT Online PTP and ZT Online Green Edition. ZT Online, together with multiple versions of ZT Online launched, introduced or to be launched in the future, are collectively referred to as the “ZT Online Series”. In addition, we have developed ZT Online II, the sequel to ZT Online, which is currently under closed beta testing. Although we currently operate eleven games, seven of which are not part of the ZT Online Series, we expect that we will continue to derive the majority of our net revenues in 2011 from the ZT Online Series. Our business will therefore remain highly sensitive to the profitability and popularity of the ZT Online Series, and any reduction in the ZT Online Series games player base or any decrease in its popularity in China due to competition with our other online games or those of third parties or otherwise could materially and adversely affect our business, financial condition and results of operations. For example, in the third quarter of 2009 our quarterly net online game revenues decreased by RMB73.7 million to RMB287.5 million from RMB361.2 million the prior quarter, which we believe was primarily due to a change in our monetization features for ZT Online to reduce the number of in-game promotional items. Furthermore, any lasting or prolonged server interruption due to network failures or other factors or any other adverse developments specific to the ZT Online Series could prevent and otherwise deter players from making purchases of virtual items and services. This could also materially and adversely affect our business, financial condition and results of operations.

     With respect to those virtual items that we sell that are not consumed at a predetermined time or otherwise do not have a limitation on repeated use, our accounting policies require us to recognize the related revenue over the estimated lifespan of that virtual item as determined by historical player usage patterns and playing behavior. In some cases, this period can be as long as the estimated lifespan of the game. We continuously monitor the useful life of each type of virtual item we sell and of our games, and will adjust these as appropriate. Any such adjustment may cause our revenues to be recognized over a significantly different time period, and may cause our net revenues to fluctuate from prior periods. For example, in 2010, based on our internally calculated gameplay statistics, we determined that inactive players of ZT Online are players who have not played our game in 270 days consecutively, as opposed to 180 days as determined in 2008, 2009 and to 90 days as determined in 2007. As a result of this change, we have lengthened the period we amortize the life of certain virtual items, thereby reducing our online game net revenues.

     We will also need to expend considerable resources to ensure ZT Online Series’ continued success. To maximize the lifespan of an online game, it is necessary to continuously improve and update the game on a timely basis with new content and features that appeal to our players. We may fail to develop improvements, updates and/or enhancements on a timely basis, if at all. Any such failure may cause the game to lose popularity, which could result in lower net revenues.

     If we are unable to develop, purchase or license additional online games that are attractive to players and result in overall revenue growth, our business, financial condition and results of operations may be materially and adversely affected and our ability to recover related product research and development costs, purchase costs or licensing fees may become limited.

     In order to maintain our long-term profitability and financial and operational success, we must continually develop, purchase or license new online games that are attractive to players to replace our existing online games as they reach the end of their useful economic life. We currently operate eleven games and we have licensed or developed additional games that we plan to operate in the future. Our new games may not be released on time and may not be profitable or popular among online game players in China. If our newly introduced games fail to attract new players or fail to result in increased online game revenues, our business, financial condition and results of operations may be materially and adversely affected.

     The success of our internally developed games will largely depend on our ability to anticipate and effectively respond to changing play’s tastes and preferences and continually make technical advances to our platform. Developing games internally requires substantial initial investment prior to commercial launch of the games as well as a significant commitment of future resources. In addition, our ability to purchase or license successful online games will depend on their availability at acceptable terms, including price, our ability to compete effectively against other potential purchasers or licensees to attract the developers of these games, and our ability to obtain government approvals required for the purchase or licensing and operation of these games. The games that we develop, purchase or license may not be attractive to players, may be viewed by the regulatory authorities as not complying with

content restrictions, may not be launched as scheduled or may not compete effectively with our competitors’ games. Additionally, new technologies in our competitors’ online game programming or operations could render our games obsolete or unattractive to players, thereby limiting our ability to recover related product research and development costs, purchase costs and licensing fees. If we are not able to successfully develop, purchase or license online games appealing to players, our future profitability and growth prospects will decline.

     Our new online games may attract away players of our established games, which could materially and adversely affect our business, results of operations and financial condition.

     We currently operate eleven games, including five games in the ZT Online Series, and we have licensed or developed additional games that we plan to operate in the future. Our new or future games may attract players away from our older games. In particular, since our new game ZT Online II is a sequel to and shares the same basic plot and features as our older game ZT Online, this new game may attract players away from ZT Online. Although we intend to target different types of players through ZT Online Series and ZT Online II and therefore minimize players of our existing games leaving such games in favor of our future games, we anticipate such movement may occur. This would decrease our established games’ number of concurrent users, which could make these games less attractive to other players. Furthermore, if former players of our established games spend less money to purchase virtual items and services or playing time on our new online games than they would have spent if they had continued playing our established games, our business, results of operations and financial condition could be materially and adversely affected.

     We face significant competition, which could reduce our market share and adversely affect our business, financial condition and results of operations.

     The online game industry in China is highly competitive. Given the relatively low entry barriers to operating online games, we expect more companies to enter the online game industry in China and a wider range of online games to be introduced to the China market. Our MMORPGs mainly compete with certain MMORPGs developed and/or operated in China, including Fantasy Westward Journey, developed and operated by NetEase.com, Inc.; World of Warcraft, developed by Blizzard Entertainment and operated by NetEase.com, Inc.; Tian Long Ba Bu, developed and operated by Changyou.com Limited; Zhu Xian, developed and operated by Perfect World, Co., Ltd.; and MIR, developed and operated by Shanda Interactive Entertainment Limited. Our principal competitors also include online game companies such as CDC Corporation, Kingsoft Corporation, Nineyou International Limited, Tencent Holdings Ltd., Webzen Inc., The 9 Limited, Changyou.com Limited, Perfect World, Co., Ltd., Shanda Interactive Entertainment Limited, NetEase.com, GigaMedia Limited, and Net Dragon Websoft Inc. Furthermore, we expect companies from more developed gaming markets, such as the United States and South Korea, to continue to enter into the online game industry in China and more games developed by overseas entities will be licensed to be operated in Chinese markets.

     Many of our existing competitors, as well as a number of potential new competitors, have longer operating histories, greater brand name recognition, larger international player bases and significantly greater game development, technical, financial and marketing resources than we have. Furthermore, any of our current or future competitors may be acquired by, receive investments from or enter into other commercial relationships with larger, more well-established and well-financed companies and therefore obtain greater financial, marketing and development and licensing resources than we have. This may allow them to devote greater resources than we can to the development and promotion of new online games and technologies similar to or better than our own. These competitors may engage in more extensive research and development, undertake more far-reaching marketing campaigns, adopt more aggressive pricing policies and make more attractive offers of employment to our existing and potential employees than we can. In addition, our existing and potential international competitors may establish cooperative relationships among themselves or with our local competitors. This may significantly enhance their competitiveness in the online game industry in China. New and increased competition may result in larger discounts demanded by our distributors, or price reductions in our virtual items and services, any of which could adversely affect our net revenues. In addition, the increased competition in the online game industry in China could make it difficult for us to retain and expand our existing player base, which could reduce the number of dedicated players and players with high disposable incomes that play our games and from whom we derive most of our net revenues. If we are unable to compete effectively in the online game market in China, our business, financial condition and results of operations would be materially and adversely affected.

     We and our games have been, and in the future may be, subject to negative publicity, which may discourage people from playing our games and adversely affect our business, financial condition, results of operations and prospects.

     ZT Online has developed a large player base since its commercial launch in January 2006, and has therefore been the subject of a large volume of media reports and communications on the Internet by players as well as bloggers and other online commentators, some of which have been negative. ZT Online has also been the subject of criticism relating to technical problems affecting the game from time to time. Some media reports and Internet postings regarding us, our chairman and our games have been false or misleading. Although we take steps to refute and correct this false and misleading information when it comes to our attention, these efforts may not be successful. Negative publicity about our games may lead players to stop playing those games, and might also make them less willing to play any future games that we introduce, all of which could materially and adversely affect our business, financial condition, results of operations and prospects.

     Our operating results fluctuate from period to period, making them difficult to predict.

     Our operating results from period to period are highly dependent upon, and will fluctuate, based on the following factors:

	•		the availability, quality and playability of our games;
	•		the period of time over which we recognize revenue for some of our virtual items in our free-to-play games, which in certain cases is based on the estimated lifespan of our virtual items, which may be adjusted from time to time;

	•		the number of games that we and our competitors offer players, and our respective pricing;
	•		changes in our game features and the corresponding impact on player behavior and purchasing patterns (for example, our changes in the monetization structure of ZT Online to reduce the number of in-game promotional activities led to a decrease in our APP in the third quarter of 2008 and cancellation of selected monetization features such as “Treasury Box” in the third quarter of 2009);
	•		the quality, variety, popularity and mix of virtual items and services available for purchase in our free-to-play games and related in-game promotional efforts;
	•		game development costs and licensing or royalty payments for games potentially licensed in the future;
	•		the amount of overseas licensing net revenues generated through our licensing arrangements with operators of our games;
	•		our introduction of new online games, which may attract players away from our established games, and the mix of sales of our games;
	•		the mix of sales through our distributors (who purchase prepaid game cards at a discount to their face value) and direct sales of game points to players through our website;
	•		the breadth and depth of our distribution network and the corresponding availability of our prepaid game cards;
	•		the success of our advertising and promotional efforts; and
	•		seasonality of our sales of prepaid game cards and revenue recognition based on our game players’ behavior, during and around the Chinese New Year holidays in the first quarter, and the National Day holidays in the fourth quarter, when fewer of our targeted players play our games.

     Due to these and other factors, our operating results will vary from period to period, will be difficult to predict for any given period, may be adversely affected from period to period and may not be indicative of our future performance.

     Our limited resources may affect our ability to manage our growth.

     Our growth to date has placed, and our anticipated further expansion will continue to place, a significant strain on our management, systems and resources. For example, during the period following the commercial launch of our first online game in January 2006 to December 2010, our total employees (not including liaison personnel) increased from approximately 200 to 1,844. We intend to increase our employee headcount even further, by increasing our number of research and development and customer service representatives. In addition to training and managing our workforce, we will need to continue to develop and improve our financial and management controls and our reporting systems and procedures.

     We may not be able to successfully implement our growth strategies, which would materially and adversely affect our revenue, profitability and competitiveness.

     We are pursuing a number of growth strategies, including developing new online games and related products and services to attract more players, enhancing existing online games to retain existing players, reorganizing our game development studios, pursuing opportunities for acquisitions and investments, expanding into markets outside of China, and entering into strategic cooperation arrangements.

     For example, we are reorganizing our game development studios by establishing various subsidiaries that are generally 51% owned by us and 49% owned by the relevant development team members based on our Win@Giant incubation initiative, with an aim to facilitate our development of new online games. Each reorganized studio will focus upon producing and supporting internally developed games, and will be incentivized based upon the success of these games. Pursuant to this reorganization, Giant Online, one of our existing MMORPGs, will be supported by Shanghai Juhuo Network Technology Co., Ltd., or Juhuo Network, and the development and subsequent supportive work for ZT Online II will be conducted by Shanghai Jujia Network Technology Co., Ltd., or Jujia Network.

     In addition, in connection with the establishment of our reorganized studios, we provide loans to certain development team members to finance their capital contributions to the studios, and such loans are typically provided on an unsecured and interest free basis without any fixed term for repayment. As of December 31, 2010, the outstanding principal amount of these loans was RMB 10.8 million (US$1.6 million). Any deterioration in the financial condition of these reorganized studios, or the game developers to whom we have made loans, may result in losses to us and could have a material adverse effect on our financial condition and results of operations.

     We are also pursuing opportunities for acquisitions and investments. For example, we acquired a controlling equity interest in Hangzhou Snow Wolf Software Co. Ltd., or Snow Wolf, a game development studio, in May 2009 and we acquired the entire equity interest of Beijing Julun Network Technology Co. Ltd., or Julun Network, another game development studio, in November 2010. In addition, we have made minority investments in 51.com, a Chinese social networking site, Mobile Embedded Technology Inc., a mobile platform operating company, and Shanghai Ruichuang Network Technology Co., operator of the internet portal website www.2345.com.

     We are also exploring strategic cooperation arrangements with other internet service providers. For example, in the fourth quarter of 2010, in order to explore the potential convergence between online games and other entertainment media, we established a cooperative relationship with Huayi Brothers Media Corporation, or Huayi Brothers, a diverse media, entertainment and leisure group. We sold to Huayi Brothers our controlling interest in Huayi Giant, which holds the intellectual property and development team for K III. Following the sale, Huayi Brothers holds a 51% interest in Huayi Giant, while we hold a 34% interest and the employees of Huayi Giant hold a 15% interest. In addition, in October 2009 we entered into a three year non-exclusive license agreement for ZT Online Green Edition with Shenzhen Tencent Computer Systems Company Limited, or Tencent. Pursuant to the license, Tencent operates ZT Online Green Edition on its QQ Game platform in exchange for a royalty payable to us.

     Our experience with our various new growth strategies is limited. Accordingly, we cannot assure you whether all or any of these strategies will be successful. If we are unable to implement our growth strategies, our revenue and profitability may not grow as we expect, and our competitiveness may be materially and adversely affected.

     We may not sustain our historical growth rate or profitability.

     We have experienced significant revenue growth in a relatively short period of time. After commercially launching our first game in January 2006, net revenues increased from RMB408.5 million in 2006 to RMB1,527.5 million in 2007 and to RMB1,594.7 million in 2008, representing a 273.9% increase in 2007 and an 4.4% increase in 2008. However, our net revenues decreased by 18.2% to RMB1,303.8 million in 2009 and increased slightly to RMB1,332.8 million in 2010. Although we believe the decrease of our net revenues in 2009 was largely due to new regulations on certain game features promulgated by the PRC government and a change of our in-game monetization features, we may not sustain our historical levels of revenue growth in future periods due to a number of different factors, including, among others, economic factors out of our control, competitiveness in the online game industry, in which market share can be quickly acquired or lost, the greater difficulty of growing at sustained rates from a larger net revenue base, the need to increase our research and product development expenses in order to develop new and successful games, the potential need to expend greater amounts in order to license or acquire new games, and our inability to prevent our other costs and operating expenses from increasing. Accordingly, you should not rely on the results of any prior period as an indication of our future operating performance.

     We may be adversely affected by the slowdown of China’s economy caused in part by the global crisis in the financial services and credit market starting from the second half of 2008.

     We rely on the spending of our game players for our revenues, which may in turn depend on the players’ level of disposable income, perceived future earnings capabilities and willingness to spend. China’s economy experienced a slowdown after the second quarter of 2008, when the quarterly growth rate of gross domestic product reached 11.9%. A number of factors have contributed to this slowdown, including appreciation of the Renminbi, which has adversely affected China’s exports, and tightening macroeconomic measures and monetary policies adopted by the PRC government aimed at preventing overheating of China’s economy and controlling China’s high level of inflation. The slowdown was further exacerbated by the recent global crisis in the financial services and credit markets, which in recent months has resulted in extreme volatility and dislocation of the global capital markets. In the first quarter of 2009, the growth rate of China’s gross domestic product decreased to 6.1%, and the closing of the Shanghai Stock Exchange Composite Index dropped from its high of 6,124 reached on October 16, 2007 to 2,481 on May 21, 2010.

     It is uncertain how long the global crisis in the financial services and credit markets will continue and the degree of adverse impact it will have on the global economy and the economies in China and other jurisdictions where we license our games. If our game players reduce their spending on playing our games due to such uncertain economic conditions, our net revenues may be adversely affected.

     Our business may be materially harmed if we do not feature our games in a sufficient number of Internet cafés in China.

     A substantial number of players access our game through Internet cafés. Due to limited space on their computer hard drives, Internet cafés generally only feature a limited number of games on their computers. We thus compete with a growing number of other online game operators to ensure that our games are featured on these computers. This competition may intensify in China due to a nationwide suspension of approval for the establishment of new Internet cafés since 2007. We have taken steps to ensure that our games are featured in a sufficient number of Internet cafés, such as maintaining good relationships with Internet café administrators, requiring our distributors to maintain a sales presence in a wide range of Internet cafés and through general sales and marketing efforts. If we fail to maintain good relationships with Internet café administrators, or if we and/or our distributors fail to successfully persuade Internet cafés to feature our online games on their computers, our business, financial condition and operating results may be materially and adversely affected.

     The limited use of PCs in China and the relatively high cost of Internet access with respect to per capita gross domestic product may limit the development of the Internet in China and impede our growth.

     Although the use of PCs in China has increased in recent years, the penetration rate for PCs in China is much lower than in the United States. In addition, despite a decrease in the cost of Internet access in China due to a decrease in the cost of PCs and the introduction and expansion of broadband access, the cost of personal Internet access remains relatively high in comparison to the average per capita income in China. The PRC government has also promulgated a number of regulations to curb the growth of Internet cafés. See “— Intensified government regulation of Internet cafés could limit our ability to maintain or increase our net revenues and expand our customer base.” The limited use of PCs in China, the relatively high cost of personal Internet access and increased restrictions on Internet cafés may limit the growth of our business. Furthermore, any Internet access or telecommunications fee increase could reduce the number of players that play our online games and materially and adversely affect our business, financial condition and results of operations.

     We rely on our nationwide distribution network for a significant portion of our net revenues. Failure to maintain good relationships with our distributors could materially disrupt our business and harm our net revenues.

     Online payment systems in China are still in a relatively early stage of development and are not as widely acceptable to customers in China as in the United States. As a result, although we make our prepaid game cards available for purchase online using an online payment system, our business is dependent on the performance of our regional distributors. In 2008, 2009 and 2010, 88.53%, 86.03% and 84.08%, respectively, of our sales proceeds were generated through sales of prepaid game cards to our distributors. Our largest distributor accounted for 6.1%, 6.3% and 5.6%, of our sales proceeds in 2008, 2009 and 2010, respectively. Maintaining relationships

with existing distributors may be difficult and time-consuming. Although we typically enter into annual contracts with our distributors, our distribution agreements are not exclusive and do not prohibit our distributors from selling our competitors’ game cards. Our failure to maintain good relationships with our distributors could restrict our sales channels or encourage our distributors to seek to distribute our competitors’ products, each of which could materially disrupt our business and harm our net revenues. Furthermore, our growth strategy entails expanding our distribution network, which may be difficult to achieve in a timely manner or at all.

     We may be unable to effectively manage our nationwide distribution network. Any failure by our distributors to operate in compliance with our distribution agreements and applicable law may result in liability to us, may interrupt the effective operation of our distribution network, may harm our games’ reputation and may result in decreased net revenues.

     We have limited ability to manage the activities of our distributors, who are independent from us. In addition, our distributors and the Internet cafés and other outlets in which they sell our prepaid game cards may violate our distribution agreements or the sales agreements between our distributors and the retail outlets. Such violations may include, among other things:

	•		failure to meet minimum sales targets or penetration targets, or failure to maintain minimum price levels for our prepaid game cards in accordance with our distribution agreements;
	•		failure to properly promote our online games in local Internet cafés and other important outlets, or failure to cooperate with our sales and marketing team’s efforts in their designated territories; and
	•		selling our prepaid game cards outside their designated territories, possibly in violation of the exclusive distribution rights that we have granted to other distributors.

     Some of our distributors have committed such types of violations in the past, which resulted in our terminating our existing distribution agreements with the offending parties. If we decide to fine, suspend or terminate our distributors for acting in violation of our distribution agreements, or if the distributors fail to address material violations committed by any of their retail outlets, our ability to effectively sell our prepaid game cards in any given territory could be negatively impacted. These and similar actions could also negatively affect our games and our corporate image, possibly resulting in loss of players and a decline in sales. Additionally, we may be liable in China for legal or regulatory violations by any of our distributors.

     We have significantly reduced our number of liaison personnel.

     Beginning in the third quarter of 2008, we reduced our number of liaison personnel, from over 2,500 employees to approximately 1,150 employees by December 31, 2010, in order to reduce costs. We believe the reduction in our sales and marketing team will enhance our productivity while allowing us to maintain our previous ability to market our games and generate net revenues. However, the loss of part of our previous sales and marketing team may result in us being unable to sufficiently market our games, our former employees being employed by our competitors, or our remaining employees being unable to meet our productivity standards, which could materially and adversely affect our business, results of operations and financial condition.

     We may be subject to administrative fines and other penalties in Taiwan.

     In October 2006, we entered into a series of transactions whereby we attempted to obtain a 51% indirect equity interest in Lager Network, the Taiwan-based developer of K III and the graphics engine we use in Giant Online, and holder of the license to operate ZT Online in Hong Kong, Macau, Taiwan, Malaysia and Singapore. Our Taiwan legal counsel, Lee & Li, advised us that these transactions were void from the outset because of legal and administrative restrictions in Taiwan that apply to ownership of Taiwanese assets by PRC persons. These transactions were subsequently unwound. If the Taiwan regulators were to view our investment in Lager Network as not being void from the outset, we may be required to take further action to unwind our acquisition of Lager Network, and our rights to any consequent equity interests in Lager Network could be suspended, we could be ordered to cease and withdraw our consequent investment in Lager Network within a specified period, and we could be fined for our continued non-compliance. This could materially and adversely affect our business, results of operations and financial condition.

     We could be liable for breaches of security of our website and third-party online payment system, which may have a material adverse effect on our reputation and business.

     In 2008, 2009 and 2010, 11.47%, 13.97% and 15.92% of our sales proceeds respectively, were generated from sales of our game points through a third-party online payment system. In such transactions, secure transmission of confidential information, such as customers’ debit and credit card numbers and expiration dates, personal information and billing addresses, over public networks, including our official game website, is essential for maintaining consumer confidence. We currently provide password protection for all of our player accounts. In addition to the general password protection, we also sell a dynamic password generator, which could be used for multiple accounts under a player’s name, to better ensure the security of our plays’ accounts. While we have not experienced any breach of our security measures to date, such current security measures may be inadequate. In addition, we expect that an increasing number of our sales will be conducted over the Internet as result of the growing use of online payment systems. We also expect that associated online crime will likely increase accordingly. We must therefore be prepared to increase our security measures and efforts so that our customers have confidence in the reliability of the online payment system that we use. We do not have control over the security measures of our third-party online payment operator, and its security measures may not be adequate at present or may not be adequate with the expected increased usage of online payment systems. We could be exposed to litigation and possible liability if we fail to secure confidential customer information, which could harm our reputation, ability to attract customers and ability to encourage players to purchase our game points.

     Unexpected network interruptions, security breaches or computer virus attacks could have a material adverse effect on our business, financial condition and results of operations.

     Any failure to maintain the satisfactory performance, reliability, security and availability of our network infrastructure may cause significant harm to our reputation and our ability to attract and maintain players. All of the game servers operating our games, and all

of the servers handling log-in, billing and data back-up matters for us are hosted and maintained by third party service providers. Major risks involved in such network infrastructure include any break-downs or system failures resulting in a sustained shutdown of all or a material portion of our servers, including failures which may be attributable to sustained power shutdowns, or efforts to gain unauthorized access to our systems causing loss or corruption of data or malfunctions of software or hardware.

     In the past, our server network has experienced unexpected outages for several hours and occasional slower performance in a number of locations in China as a result of failures by third party service providers. Our network systems are also vulnerable to damage from fire, flood, power loss, telecommunications failures, computer viruses, hacking and similar events. Any network interruption, virus or other inadequacy that causes interruptions in the availability of our online games or deterioration in the quality of access to our online games could reduce our players’ satisfaction and ultimately harm our business, financial condition and results of operations. In addition, any security breach caused by hackings, which involve efforts to gain unauthorized access to information or systems, or to cause intentional malfunctions or loss or corruption of data, software, hardware or other computer equipment, and the inadvertent transmission of computer viruses could have a material adverse effect on our business, financial condition and results of operations. We do not maintain insurance policies covering losses relating to our network systems and we do not have business interruption insurance.

     Enhancements and rules changes to our games have resulted, and may continue to result, in players deciding not to play our games or making legal claims against us, which could materially and adversely affect our business, results of operations and financial condition.

     We periodically introduce expansion packs and make changes to our games based on feedback gathered from users and in order to encourage player behavior consistent with the basic principles of our game-playing environment. For example, in the third quarter of 2009, we canceled certain in-game monetization features, of which the most important feature is virtual treasure box, which may contain in-game items worth more than the cost of the treasure box itself, and allowing players to hire in-game “substitute players,” which enables them to raise their characters’ experience levels without actually playing. We believe this change was the main reason for the subsequent temporary decrease in our active paying players, which fell by 7.9% from approximately 1,204,000 as of the quarter ended June 30, 2009 to 1,108,000 as of the quarter ended September 30, 2009. Our active paying players subsequently increased to approximately 1,138,000 in the quarter ended December 31, 2009 and continuously rose to approximately 1,693,000 in the quarter ended December 31, 2010. However, the ability for players to adjust to game enhancements or policy changes and return to playing our games may or may not occur in response to future enhancements or changes in policies we introduce, which could materially and adversely affect our business, results of operations and financial condition.

     Additionally, our players may choose to litigate if they are dissatisfied with our game adjustments. For example, in May 2007 we were sued for damages in a local court by a player in Jilin Province in response to a rule change we implemented, whereby payments of gold coins on our virtual insurance policies, exchangeable for transferable virtual items, were modified to payments of gold coin vouchers, exchangeable for non-transferable virtual items. We had made this rule change to discourage selling of these virtual items on third-party auction websites, which could result in lower revenues generated for us by our games and which we believe is inconsistent with our game-playing principles. On November 30, 2007, the court dismissed the case for the failure to state a claim. While the amount of damages sought in this lawsuit was not significant, an unfavorable judgment against us could have subjected us to lawsuits from other players seeking damages based on similar claims, the aggregate of which could be substantial. Future litigation could result in substantial costs and diversion of our resources, and could disrupt our business, as well as have a material adverse effect on our financial condition and results of operations.

     Undetected programming errors or defects in our games and the proliferation of cheating programs could materially and adversely affect our business, financial condition and results of operations.

     Our online games may contain undetected programming errors or other defects. In addition, parties unrelated to us have in the past, and may again in the future, develop Internet cheating programs that enable our users to acquire superior features for their game characters for which they would otherwise be required to pay or otherwise earn through game play. Furthermore, certain cheating programs could cause the loss of a character’s superior features acquired by a player. The occurrence of undetected errors or defects in our games, and our failure to discover and disable cheating programs affecting the fairness of our game environment, could damage our and our games’ reputations and result in players being discouraged from playing our games and purchasing virtual items and services in our games. This could materially and adversely affect our business, financial condition and results of operations.

     Our business depends substantially on the continuing efforts of our senior management, and our business may be severely disrupted if we lose their services.

     Our future success heavily depends upon the continued services of our senior management. In particular, we rely on the expertise and experience of Yuzhu Shi, our founder, controlling beneficial owner and chief executive officer, in our business operations and game development, and rely on his personal relationships with our employees, the relevant regulatory authorities, our distributors, our advertising media and Lager Network, the developer of K III and the graphics engine we use in Giant Online and holder of the license to operate ZT Online in Hong Kong, Macau, Taiwan, Malaysia and Singapore. We do not maintain key-man life insurance for any of our senior management. If one or more of our senior management are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all. As a result, our business may be severely disrupted, our financial conditions and results of operations may be materially adversely affected, and we may incur additional expenses to recruit and train personnel.

     Each of our executive officers has entered into an employment agreement with us, which contains confidentiality and non-competition provisions. If any disputes arise between our executive officers and us, we cannot assure you the extent to which any of these agreements could be enforced in China, where these executive officers reside and hold most of their assets, in light of the uncertainties with China’s legal system.

     Our founder, controlling beneficial owner and chief executive officer, Yuzhu Shi, was previously involved in various enterprises, some of which were the subject of claims or legal actions.

     Over the past 20 years, our founder, controlling beneficial owner and chief executive officer, Yuzhu Shi, previously founded, managed or was substantially involved in various enterprises, including Zhuhai Giant Hi-Tech Group Limited, or Zhuhai Giant, Giant Investment Co., Ltd., or Giant Investment, Shanghai Jiante Shengming Technology Co., Ltd., Shanghai Jiante Bio-Technology Co., Ltd., Ready Finance Limited, Stone Group Holdings Limited and Shanghai Youyuan Gardening Co., Ltd. Zhuhai Giant was founded by Mr. Shi in 1991, and Mr. Shi served as its president from 1992 to 1995. In 1998, Zhuhai Giant engaged in an unsuccessful real estate venture, which caused Zhuhai Giant to cease operations with significant outstanding debts and claims for repayment. Zhuhai Giant settled these claims through negotiations with the relevant claimants. In addition, Giant Investment and its subsidiaries were previously the subject of several claims, administrative actions and negative publicity relating to the alleged false advertising of one of its products. Previous or potential new claims relating to these enterprises, or negative publicity relating thereto, could divert Mr. Shi’s attention from the management of our company, discourage investors or lenders from providing capital or loans that we may require in the future.

     If we are unable to attract, train and retain key individuals and highly skilled employees, our business may be adversely affected.

     If our business continues to expand, we will need to hire and retain additional qualified employees, including skilled and experienced online game developers. Since our industry is characterized by high demand and intense competition for talent, we may need to offer higher compensation and other benefits in order to retain key personnel in the future. In the fourth quarter of 2008, we introduced Win@Giant, an incubation program designed to attract talented employees, developers and business partners. While this program is intended to supplement and not replace our normal hiring efforts, we cannot assure you that this program will be successful or that we will be able to attract or retain the qualified game developers or other key personnel that we will need to achieve our business objectives. As a rapidly growing company, our ability to train and integrate new employees into our operations may not meet the increasing demands of our business, which could adversely affect our business and future growth prospects.

     Future acquisitions may have an adverse effect on our ability to manage our business.

     Selective acquisitions form part of our strategy to expand our business. For example, in the third quarter of 2008, we acquired a 25% interest in 51.com, a China based social networking company, for approximately US$51.1 million. In the third quarter of 2009, we acquired a 20% interest in Mobile Embedded Technology Inc., a mobile platform operation company, for US$5.0 million. In 2010, we acquired a 100% interest in Julun Network, a small game company engaged in MMORPG development. We do not, however, have significant experience integrating any new companies into ours or utilizing assets from acquired companies in our business, and we believe that integration of a new company’s operation and personnel will require significant management attention. 51.com is currently operating as an independent entity from us. Should we decide to further integrate 51.com or any future acquired businesses into our business, the diversion of our management’s attention from our business and any difficulties encountered in the integration process could have an adverse effect on our ability to manage our business.

     We may pursue acquisitions of companies, technologies and personnel that are complementary to our existing business. However, our ability to grow through future acquisitions or investments or hiring will depend on the availability of suitable acquisition and investment candidates at an acceptable cost, our ability to compete effectively to attract these candidates, and the availability of financing to complete larger acquisitions. Since we expect the online game industry to consolidate in the future, we may face significant competition in executing our growth strategy. Future acquisitions or investments could result in potential dilutive issuances of equity securities or incurrence of debt, contingent liabilities or impairment of goodwill and other intangible assets, any of which could adversely affect our financial condition and results of operations. The benefits of an acquisition or investment may also take considerable time to develop and any particular acquisition or investment may not produce the intended benefits.

     Future acquisitions would also expose us to potential risks, including risks associated with the assimilation of new operations, technologies and personnel, unforeseen or hidden liabilities, the diversion of resources from our existing businesses, sites and technologies, the inability to generate sufficient revenue to offset the costs and expenses of acquisitions and potential loss of, or harm to, our relationships with employees, customers, licensors and other suppliers as a result of the integration of new businesses.

     Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business.

     We regard our copyrights, trademarks, trade secrets and other intellectual property as critical to our success. Unauthorized use of the intellectual property used in our business may adversely affect our business and reputation.

     We have historically relied on a combination of trademark and copyright law, trade secret protection and restrictions on disclosure to protect our intellectual property rights. Although we presently enter into confidentiality and invention assignment agreements with most of our employees, in the past we only required more senior employees or those in commercially or technically sensitive positions to do so. We cannot assure you that these confidentiality agreements will not be breached, that we will have adequate remedies for any breach, or that our proprietary technology will not otherwise become known to, or be independently developed by, third parties.

     As of December 31, 2010, we own 286 registered trademarks in China and overseas in total and are in the process of applying for the registration of 201 trademarks in China and 50 trademarks overseas. We cannot assure you that any of these trademark applications will ultimately proceed to registration or will result in registration with scope adequate for our business. Some of our pending applications or registrations may be successfully challenged or invalidated by others. If our trademark applications are not successful, we may have to use different marks for affected services or technologies, or enter into arrangements with any third parties who may have prior registrations, applications or rights, which might not be available on commercially reasonable terms, if at all.

     Implementation of intellectual property laws in China has historically been lacking, primarily because of ambiguities in the laws and difficulties in enforcement. Accordingly, intellectual property right protection in China may not be as effective as in the United States or other countries. Policing unauthorized use of our proprietary technology, trademarks and other intellectual property is difficult and expensive, and litigation may be necessary in the future to enforce our intellectual property rights. Future litigation could result in substantial costs and diversion of our resources, and could disrupt our business, as well as have a material adverse effect on our financial condition and results of operations.

     We may be subject to infringement and misappropriation claims in the future, which may cause us to incur significant expenses, pay substantial damages and be prevented from providing our services or technologies.

     Our success depends, in part, on our ability to carry out our business without infringing the intellectual property rights of third parties. We may be subject to litigation involving claims of patent, copyright or trademark infringement, or other violations of intellectual property rights of third parties. In particular, the patent field covering online games and related technology is rapidly evolving and surrounded by a great deal of uncertainty, and we cannot assure you that our technologies, processes or methods would not be covered by third-party patents, either now existing or to be issued in the future. Future litigation may cause us to incur significant expenses, and third-party claims, if successfully asserted against us, may cause us to pay substantial damages, seek licenses from third parties, pay ongoing royalties, redesign our services or technologies, or prevent us from providing services or technologies subject to these claims. Even if we were to prevail, any litigation would likely be costly and time-consuming and divert the attention of our management and key personnel from our business operations.

     We have no general business insurance coverage, which may result in our incurring substantial costs and the diversion of resources.

     Insurance companies in China offer limited business insurance products and do not, to our knowledge, offer business liability insurance. While business interruption insurance is available to a limited extent in China, we have determined that the risks of disruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to subscribe for such insurance. As a result, we do not have any business liability, disruption or litigation insurance coverage for our operations in China. Except for legally required automobile liability insurance, we also do not carry any property or casualty insurance. Any business disruption or litigation, or any liability or damage to, or caused by, our facilities or our personnel may result in our incurring substantial costs and the diversion of resources.

     We may be unable to maintain an effective system of internal control over financial reporting, and as a result we may be unable to accurately report our financial results or prevent fraud.

     We are subject to provisions of the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act requires that we include a report from management on the effectiveness of our internal control over financial reporting in our annual reports on Form 20-F. In addition, our independent registered public accounting firm must attest to and report on the operating effectiveness of our internal control over financial reporting. While our management concluded that our internal control over financial reporting is effective as of December 31, 2010, and our independent registered public accounting firm reported on our internal controls over financial reporting, our management may conclude in the future that our internal controls are not effective. Our or our independent public accounting firm’s failure to conclude that our internal control over financial reporting is effective could result in a loss of investor confidence in the reliability of our reporting processes, which could materially and adversely affect the trading price of our ADSs.

     Our reporting obligations as a public company will continue to place a significant strain on our management, operational and financial resources and systems for the foreseeable future. Our failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial reporting processes, which in turn could harm our business and negatively impact the trading price of our ADSs.

     The successful operation of our business depends upon the performance and reliability of the Internet infrastructure and fixed telecommunications networks in China.

     Our business depends on the performance and reliability of the Internet infrastructure in China. Almost all access to the Internet is maintained through state-owned telecommunication operators under the administrative control and regulatory supervision of the Ministry of Information Industry of China. In addition, the national networks in China are connected to the Internet through international gateways controlled by the PRC government. These international gateways are the only channels through which a domestic user can connect to the Internet. Although the PRC government has pledged to improve the Internet infrastructure in China as part of its stimulus packaged introduced in the first quarter of 2009, a more sophisticated Internet infrastructure may not be developed in China. We or the players of our online games may not have access to alternative networks in the event of disruptions, failures or other problems with China’s Internet infrastructure.

     We face certain risks associated with our investment activities, including credit risks related to our held to maturity investment contracts.

     We explore selected investment opportunities that may have strategic value to us or that are purely financial in nature, including investment contracts that provide us with a more favorable rate of return than ordinary bank deposits.

     In addition, as of December 31, 2009 and 2010, we had held to maturity investment contracts, which we classify as short-term investments on our balance sheet, amounting to RMB 500.0 million and RMB 1,850.0 million (US$280.3 million), respectively. Although our held to maturity investment contracts are secured or wholly guaranteed by reputable financial institutions, any deterioration in the financial condition of the secured collateral or these financial institutions could cause significant loss to us and have a material effect on our financial condition and results of operations.

     For example, in April 2011, we committed to invest RMB 958.8 million (US$145.3 million) in a privately held insurance company, though such investment remains subject to the approval of the China Insurance Regulatory Commission. We are an online game company, and our experience with investment activities is limited. As such, we may not be able to achieve an adequate rate of return and may suffer losses on our investments. If we experience significant losses in connection with our investment activities, our financial condition and results of operation may be materially and adversely affected.

     We face risks associated with the licensing of our games overseas, and if we are unable to effectively manage these risks, they could impair our ability to expand our business internationally.

     As of the date of this annual report, we have granted to Lager Network the license to operate ZT Online in Hong Kong, Macau, Taiwan, Malaysia and Singapore. We have also granted an exclusive license to VinaGame Software Service Joint Stock Company, or VinaGame, to operate ZT Online in Vietnam. We granted an exclusive license to Astrum Nival, LLC, or Astrum Nival, to operate ZT Online in the Russia and other Russian speaking territories. We have signed a licensing agreement with Neonga AG, a German online game company to license Dragon Soul in the USA, Canada, and Europe excluding Russia and Russian speaking countries. In addition, we have also licensed The Golden Land to overseas market including Taiwan, Brazil, Turkey, Korea, Japan, Thailand, and North America and Europe, and licensed XT Online to Vietnam market. We may further license our existing and new games in other countries and regions. The offering of our games in the international markets could expose us to a number of risks, including:

	•		difficulties in identifying and maintaining good relationships with licensees who are knowledgeable about, and can effectively distribute and operate our games in, international markets;
	•		difficulties in maintaining the reputation of our company and our games, given that our games are operated by licensees in the international markets pursuant to their own standards;
	•		difficulties in and costs of protecting our intellectual property rights internationally;
	•		difficulties and costs relating to compliance with the different commercial and legal requirements of the international markets in which we offer our games, such as game import regulatory procedures, taxes and other restrictions and expenses;
	•		difficulties and uncertainties in obtaining software export contract registration license from the relevant PRC authorities;
	•		fluctuations in currency exchange rates; and
	•		interruptions in cross-border Internet connections or other system failures.

Risks Related to the Regulation of Our Business

     PRC regulations relating to our industry are evolving. Any adverse or unanticipated regulatory changes could significantly harm our business or limit our ability to operate.

     Substantial uncertainties and restrictions exist with respect to the application and implementation of PRC laws and regulations in the online game industry. If the PRC government finds that our past or current structure for our business operations does not comply with PRC laws and regulations, we could be subject to severe penalties, including the shutting down of our operations.

     Foreign ownership in Internet content providers, which includes online games, is subject to significant restrictions under current PRC laws and regulations. The PRC government regulates Internet access and the operation of online games through strict business licensing requirements and other laws and regulations, which also include limitations on foreign ownership in PRC companies that provide Internet content. Specifically, foreign investors are not allowed to own more than a 50% equity interest in any Internet content provider. In addition, foreign and foreign-invested enterprises are currently not able to apply for the required licenses for operating online games in China.

     Because we are a Cayman Islands company, we and our PRC subsidiary are treated as foreign or foreign-invested enterprises under PRC laws and regulations. To comply with PRC laws and regulations, we operate our online games in China through a series of contractual arrangements entered into between our PRC subsidiary, Shanghai Zhengtu Information Technology Co., Ltd, or Zhengtu Information, and Shanghai Giant Network Technology Co., Ltd, or Giant Network, which is beneficially owned by certain of our officers and directors and other individuals, all of whom are PRC citizens. Giant Network holds a Telecommunications and Information Services Operating License, or ICP license, issued by the Shanghai Municipal Information Commission, a local branch of the Ministry of Information Industry, which allows Giant Network to provide Internet content distribution services in Shanghai. This license is essential to the operation of our business.

     Despite the lack of technical majority ownership, there exists a parent-subsidiary relationship between our Cayman Islands Company and Giant Network through the irrevocable proxy agreement, whereby equity holders of Giant Network effectively assigned all of their voting rights underlying their equity interest to our Cayman Islands Company. We have entered into contractual arrangements with Giant Network pursuant to which Zhengtu Information, our wholly owned subsidiary, provides technical support and an exclusive software license to Giant Network. As a result of these contractual arrangements, under U.S. GAAP, we are also considered the primary beneficiary of Giant Network and, accordingly, we consolidate its historical results in our financial statements. For detailed descriptions of these contractual arrangements, see “Information on the Company — Organizational Structure” and “Major Shareholders and Related Party Transactions — Related Party Transactions.”

     The relevant PRC regulatory authorities have broad discretion in determining whether a particular contractual structure is in violation of the law. For example, on July 26, 2006, the Ministry of Information Industry publicly released the Notice on Strengthening the Administration of Foreign Investment in Operating Value-added Telecom Business, dated July 13, 2006, or the MII Notice, which reiterates certain provisions under China’s Administrative Rules on Telecommunications Enterprises prohibiting a domestic company that holds an ICP license from renting, transferring or selling a telecommunications license to a foreign investors

in any form, or providing any resources, sites or facilities to foreign investors that intend to conduct value-added telecom business illegally in China. There is currently no official interpretation or implementation practice under the MII Notice. It remains uncertain how the MII Notice will be enforced and whether or to what extent the MII Notice may affect the legality of the corporate and contractual structures adopted by online game companies that operate in China, such as ours. We have made inquiries with officials at the Ministry of Information Industry but have not yet been able to obtain a definitive answer regarding implementation of the MII Notice and any implications for the legality of our corporate and contractual structures. If our corporate and contractual structures are deemed by the Ministry of Information Industry to be illegal, either in whole or in part, we may have to modify such structures accordingly to comply with regulatory requirements. However, we cannot assure you that we can achieve this without material disruption to our business.

     On September 28, 2009, the General Administration of Press and Publications, or the GAPP, the National Copyright Administration, and National Office of Combating Pornography and Illegal Publications jointly published the Notice Regarding the Consistent Implementation of the “Stipulations on ‘Three Provisions"' of the State Council and the Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Pre-examination and Approval of Internet Games and the Examination and Approval of Imported Internet Games (Xin Chu Lian [2009] No. 13), or the GAPP Notice. The GAPP Notice restates the general principle espoused in recently promulgated regulations that foreign investment is not permitted in Internet game operating businesses in China. Article IV of the GAPP Notice prohibits foreign investors from participating in Internet game operating businesses via wholly owned, equity joint venture or cooperative joint venture investments in China, and from controlling and participating in such businesses directly or indirectly through contractual or technical support arrangements. In the event of a violation of these provisions, GAPP shall, in conjunction with the relevant departments of the PRC, investigate and handle the same in accordance with the law. In serious cases, the relevant licenses and registrations shall be cancelled. However, as a detailed interpretation of the GAPP Notice has not been issued, it is not yet clear how this GAPP Notice will be implemented. Furthermore, as some other government authorities like the Ministry of Commerce, the MOC, and the MII did not join GAPP in issuing the Notice, the views of these bodies will be indefinite in clarifying the scope of implementation and enforcement of the GAPP Notice. Our PRC legal counsel, Grandall Legal Group (Shanghai), is of the view that, subject to the interpretation and implementation of the GAPP Notice, the ownership structure of Zhengtu Information and Giant Network and our contractual arrangements with Giant Network and its shareholders comply with and, immediately before our initial public offering, complied with current Chinese laws and regulations. In the opinion of our Chinese counsel, there are, however, substantial uncertainties regarding the interpretation and application of current or future Chinese laws and regulations and there may be changes and other developments in Chinese laws and regulations or their interpretations. Accordingly, Chinese government authorities may ultimately take a view that is inconsistent with the opinion of our PRC legal counsel. If the past or current ownership structures, contractual arrangements and businesses of our company, Zhengtu Information or Giant Network are found to be in violation of any existing or future PRC laws or regulations, including the MII Notice and the GAPP Notice, the relevant regulatory authorities would have broad discretion in dealing with such violations, including:

	•		revoking the business and operating licenses of Zhengtu Information or Giant Network, which are essential to the operation of our business;
	•		levying fines;
	•		confiscating our income or the income of Zhengtu Information or Giant Network;
	•		shutting down our servers or blocking our website;
	•		discontinuing or restricting our operations or the operations of Zhengtu Information or Giant Network;
	•		imposing conditions or requirements with which we, Zhengtu Information or Giant Network may not be able to comply;
	•		requiring us, Zhengtu Information or Giant Network to restructure the relevant ownership structure, operations or contractual arrangements;
	•		restricting or prohibiting our use of the proceeds from our public offering to finance our business and operations in China; and
	•		taking other regulatory or enforcement actions that could be harmful to our business.

     Any of these events could materially and adversely affect our business, financial condition and results of operations.

     The contractual arrangements with our affiliated Chinese entity and its shareholders, which relate to critical aspects of our operations, may not be as effective in providing operational control as direct ownership. In addition, these arrangements may be difficult and costly to enforce under PRC law.

     We rely on and expect to continue rely on contractual arrangements with Giant Network and its shareholders in China to operate our business. For a description of these contractual arrangements, see “Information on the Company — Organizational Structure” and “Major Shareholders and Related Party Transactions — Related Party Transactions.” These contractual arrangements may not be as effective as direct ownership in providing us control over Giant Network. Direct ownership would allow us, for example, to directly exercise our rights as a shareholder to (i) effect changes in the board of Giant Network, which, in turn, could effect changes, subject to any applicable fiduciary obligations, at the management level, and (ii) derive economic benefits from the operations of Giant Network by causing it to declare and pay dividends. However, under the current contractual arrangements, as a legal matter, if Giant Network or its shareholders fails to perform their respective obligations under these contractual arrangements, we may have to incur substantial costs and expend significant resources to enforce those arrangements, and rely on legal remedies under PRC law. These remedies may include seeking specific performance or injunctive relief, and claiming damages, any of which may not be effective. For example, if any of Giant Network’s shareholders refuses to transfer its equity interest in Giant Network to us or our

designee when we exercise the purchase option pursuant to these contractual arrangements, or if any of those individuals otherwise act in bad faith towards us, we may have to take legal action to compel it to fulfill its contractual obligations. In addition, as Giant Network is jointly owned by its shareholders, it may be difficult for us to change our corporate structure or to bring claims against it or its shareholders if any of them fails to perform their obligations under the related contracts or does not cooperate with any such actions by us.

     If (i) the relevant PRC authorities invalidate these contractual arrangements for violation of PRC laws, rules and regulations, (ii) Giant Network or its shareholders terminate the contractual arrangements or (iii) Giant Network or its shareholders fail to perform their obligations under these contractual arrangements, our business operations in China would be adversely and materially affected, and the value of your ADSs would substantially decrease. Further, if we fail to renew these contractual arrangements prior to their expiration, we would not be able to continue our business operations unless the then-current PRC law allowed us to directly operate the relevant businesses in China.

     In addition, if Giant Network or all or part of their assets become subject to liens or rights of third-party creditors, we may be unable to continue some or all of our business activities, which could materially and adversely affect our business, financial condition and results of operations. If Giant Network undergoes a voluntary or involuntary liquidation proceeding, its shareholders or unrelated third-party creditors may claim rights to some or all of its assets, thereby hindering our ability to operate our business, which could materially and adversely affect our business, our ability to generate revenue and the market price of your ADSs.

     All of these contractual arrangements are governed by PRC laws and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC laws and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In the event we are unable to enforce these contractual arrangements, which relate to critical aspects of our operations, we may be unable to exert effective control over Giant Network and our ability to conduct our business may be negatively affected.

     The contractual arrangements entered into among our PRC subsidiary, our affiliated entity and its shareholders may be subject to audit or challenge by the PRC tax authorities; a finding that our PRC subsidiary or our affiliated entity owes additional taxes could substantially reduce our net income and the value of your investment.

     Under PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the PRC tax authorities. We could face material and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements among Zhengtu Information, our PRC subsidiary, Giant Network, our affiliated entity, and Giant Network’s shareholders do not represent arm’s-length prices and adjust any of their income in the form of a transfer pricing adjustment. A transfer pricing adjustment could, among other things, result in, for PRC tax purposes, a reduction of expense deductions recorded by Zhengtu Information or Giant Network or an increase in taxable income, all of which could in turn increase our tax liabilities. In addition, the PRC tax authorities may impose late payment fees and other penalties on Zhengtu Information or Giant Network for under-paid taxes.

     Our business benefits from certain preferential tax treatment and other government incentives. Expiration, discontinuation, or reduction of such treatment will increase our tax burden and reduce our net income.

     Under certain PRC tax laws effective until December 31, 2007, the PRC government provided various incentives to domestic companies in the software and certain technology industries in China in order to encourage development of those industries. Both Zhengtu Information and Giant Network historically received preferential income tax treatments due to their status as software enterprises and high-tech enterprises located in the Caohejing Economic Development Zone of Xuhui District of Shanghai. Specifically, both entities enjoyed a reduced enterprise income tax rate of 15%, as compared to the statutory rate of 33%, and fixed-term tax exemptions and reductions prior to 2007, and with respect to Zhengtu Information, in 2007. See “Item 5. Operating and Financial Review and Prospects — A. Operating Results — Taxation — China.” In addition, we have been receiving government financial incentives based on business taxes and VAT paid by us, and for qualification as high technology projects and expect to continue to receive them through December 31, 2014 because there are no conditions or performance-based obligations attached to these incentives other than our continued registration in our present district in Shanghai and they are not subject to refund. These incentives were granted by the Shanghai local government, and there can be no assurance that such incentives we are currently enjoying will not be modified or challenged by the central government or the taxation authority. We received financial incentives totaling RMB63.1 million and RMB88.5 million and RMB57.4 million (US$8.7 million) in 2008, 2009 and 2010, respectively. If these incentives are modified or otherwise challenged by any government authority, the loss will reduce our net income.

     In 2007 China passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementing rules, both of which became effective on January 1, 2008. The New EIT Law (i) reduces the top rate of enterprise income tax from 33% to 25%, (ii) permits companies to continue to enjoy their existing tax incentives, subject to certain transitional phase-out rules, and (iii) replaces tax incentives under the old laws with new tax incentives, subject to new qualification criteria (for example, the New EIT Law permits a new category of “high- and new-technology enterprises” to enjoy a reduced enterprise tax rate of 15%). Under the phase-out rules, enterprises established before the promulgation date of the New EIT Law and which were granted preferential EIT treatment under the then effective tax laws or regulations may continue to enjoy their preferential tax treatments until their expiration. Accordingly, Zhengtu Information, an enterprise established before the promulgation date of the New EIT Law, will continue to enjoy its preferential treatment under the phase-out rules. In addition, certain government authorities announced the new implementation of rules named Administrative Measures for Determination of High and New Technology Enterprises for application and assessment of “high- and new-technology enterprise” in April 2008 and every qualified company needs to re-apply for this qualification 3 months prior to the expiration of the valid period according to the new implementation rules. Zhengtu Information and Giant Network had

obtained the qualification certificates of “high- and new-technology enterprises” status with a valid period of three years starting from 2008 to 2010. Therefore, Zhengtu Information and Giant Network will need to apply for an additional three-year extension upon the expiration of the current qualification certificate if they desire to continue to enjoy the 15% reduced rate for the calendar year of 2011. If they fail to maintain the “High and New Technology Enterprise” qualification, the applicable EIT rate may increase to up to 25%, which could have a material adverse effect on our results of operations. We cannot assure you that the tax authorities will not, in the future, discontinue any of our preferential tax treatments, potentially with retroactive effect. The discontinuation of any of our preferential tax treatments could materially increase our tax obligations. See “Item 5. — Operating and Financial Review and Prospects — A. Operating results — Taxation — China.”

     We may be classified as a “resident enterprise” under the PRC New EIT Law; such classification could result in unfavorable tax consequences to us and our non-PRC shareholders.

     The New EIT Law provides that enterprises established outside of China whose “de facto management bodies” are located in China are considered “resident enterprises” and are generally subject to the uniform 25% enterprise income tax rate on their worldwide income. In addition, a circular issued by the State Administration of Taxation regarding the standards used to classify certain Chinese enterprise controlled companies established outside of China as “resident enterprises” clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC source income, subject to PRC enterprise income tax, currently at a rate of 10%, when recognized by non-PRC shareholders. This circular also subjects such “resident enterprises” to various reporting requirements with the PRC tax authorities. Under the implementation regulations to the enterprise income tax, a “de facto management body” is defined as a body that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and treasury, and acquisition and disposition of properties and other assets of an enterprise. In addition, the circular mentioned above details that certain Chinese-invested enterprises will be classified as “resident enterprises” if the following are located or resident in China: senior management personnel and departments that are responsible for daily production, operation and management; financial and personnel decision making bodies; key properties, accounting books, company seal, and minutes of board meetings and shareholders’ meetings; and half or more of the directors or senior management having voting rights. If the PRC tax authorities determine that our Cayman Island holding company is a “resident enterprise,” a number of unfavorable PRC tax consequences could follow. First, we may be subject to enterprise income tax at the rate of 25% on our worldwide income, as well as PRC enterprise income tax reporting obligations. Second, although under the New EIT Law and the Implementing Rules, dividends paid to us from our PRC subsidiaries would qualify as “tax-exempted income”, any such dividends paid to our company or our Hong Kong subsidiary may be subject to an enterprise income tax and the PRC foreign exchange control authorities have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, dividends paid by us to our non-PRC shareholders and capital gains recognized by them with respect to the sale of our stock may be treated as income derived from sources within the PRC and as a result may be subject to a PRC income tax. Such determination could have a material adverse effect on our net income and results of operations, and may require us to withhold tax on our non-PRC shareholders. We are actively monitoring the “resident enterprise” classification rules and our Cayman Island holding company’s facts and circumstances relative to the classification rules. Similar results could follow if our BVI subsidiary is considered a PRC “resident enterprise.”

     PRC laws and regulations establish complex procedures for some acquisitions of Chinese companies by foreign investors, which could make it more difficult for us to pursue growth through acquisitions in China.

     PRC laws and regulations, such as the M&A Rules promulgated by six PRC regulatory agencies in 2006, the Anti-Monopoly Law promulgated by the PRC National People’s Congress in 2007 and the Circular on the Establishment of a National Security Review Mechanism for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors promulgated by the General Office of the PRC State Council in 2011, establish procedures and requirements that could make some acquisitions of Chinese companies by foreign investors and companies more time-consuming and complex, including requirements in some instances that various governmental authorities be notified in advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. We may expand our business in part by acquiring complementary businesses. Complying with the requirements of the relevant PRC laws and regulations to complete such transactions could be time-consuming, and any required approval processes may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

     We and our investors face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.

     In connection with the new EIT Law, the Ministry of Finance and State Administration of Taxation jointly issued, on April 30, 2009, the Notice on Issues Concerning Process of Enterprise Income Tax in Enterprise Restructuring Business, or Circular 59. On December 10, 2009, the State Administration of Taxation issued the Notice on Strengthening the Management on Enterprise Income Tax for Non-resident Enterprises Equity Transfer, or Circular 698. Both Circular 59 and Circular 698 are effective retroactively to January 1, 2008. Under the two circulars, non-PRC-resident enterprises may be subject to income tax on capital gains generated from their transfers of equity interests in PRC resident enterprises, or an Indirect Transfer. Using a “substance over form” principle, the PRC tax authorities have discretion under Circular 59 and Circular 698 to make adjustments to the taxable capital gains based on the difference between the fair value of the equity interests transferred and the cost of the investment. In addition, by promulgating and implementing the circulars, the PRC tax authorities have increased their scrutiny of the direct or indirect transfer of equity interests in a PRC resident enterprise by a non-PRC-resident enterprise. For example, Circular 698 specifies that the PRC State Administration of Taxation is entitled to redefine the nature of an equity transfer where offshore vehicles are interposed for tax-avoidance purposes and without reasonable commercial purpose.

     There is uncertainty as to the application of Circular 698. For example, while the term “Indirect Transfer” is not clearly defined, it is understood that the relevant PRC tax authorities have jurisdiction regarding requests for information over a wide range of foreign entities having no direct contact with China. Moreover, the implementation of Circular 698, such as the process and format of the reporting of an Indirect Transfer to the competent tax authority of the relevant PRC resident enterprise remains unclear. In addition, there are not any formal declarations with regard to how to determine whether a foreign investor has adopted an abusive arrangement in order to reduce, avoid or defer PRC tax. Circular 698 may be determined by the tax authorities to be applicable to our private equity financing transactions, disposal of our subsidiaries, acquisitions of complementary businesses, or disposal of shares or ADSs in our company, where non-PRC resident investors are involved. As a result, we and our non-PRC resident investors may, when doing transactions that involve the transfer of our shares or equity interests of our subsidiaries, become at risk of being taxed under Circular 698 and may be required to expend valuable resources to comply with Circular 698 or to establish that we or our non-PRC resident shareholders should not be taxed under Circular 698, which may have a material adverse effect on our financial condition and results of operations or such non-PRC resident investors’ investments in us.

     Intensified government regulation of Internet cafés could limit our ability to maintain or increase our net revenues and expand our customer base.

     Starting in 2001, the Chinese government began tightening its supervision of Internet cafés, closing unlicensed Internet cafés, requiring those remaining open to install software to prevent access to sites deemed subversive and requiring web portals to sign a pledge not to host subversive sites. In February 2007, 14 PRC national government authorities, including the Ministry of Information Industry, the Ministry of Culture and the General Administration of Press and Publication, jointly issued a notice suspending nationwide approval for the establishment of new Internet cafés beginning 2007 and enhancing the punishment for Internet cafés admitting minors. This suspension may continue indefinitely. Furthermore, the Chinese government’s policy, which encourages the development of a limited number of national and regional Internet café chains and discourages the establishment of independent Internet cafés, may slow down the growth of Internet cafés.

     As Internet cafés are the primary venue for users to play our games, any reduction in the number, or any slowdown in the growth, of Internet cafés in China will limit our ability to maintain or increase our net revenues and expand our customer base, which will in turn materially and adversely affect our business and results of operations.

     The laws and regulations governing the online game industry in China are developing and subject to future changes. If we fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.

     The online game industry in China is highly regulated by the Chinese government. Various regulatory authorities of the Chinese central government, such as the State Council, the GAPP, the Ministry of Culture and the Ministry of Public Security, are empowered to issue and implement regulations governing various aspects of the online game industry.

     We are required to obtain various permits or approvals from different regulatory authorities in order to operate online games. For example, an Internet content provider, or ICP, must obtain an ICP license in order to engage in any commercial ICP operations within China. In addition, an online game operator must also obtain a license from the Ministry of Culture and a license from the GAPP in order to distribute games through the Internet. Some of the licenses are subject to annual inspection by relevant government authorities, such as the ICP license. If we fail to maintain any of these required permits or approvals, we may be subject to various penalties, including fines and the discontinuation or restriction of our operations. Any such disruption in our business operations would materially and adversely affect our business, financial condition and results of operations.

     Since we have licensed some of our games to overseas companies for operation outside mainland China, such as ZT Online to Lager Network, VinaGame and Astrum Nival, Dragon Soul to Neonga AG, The Golden Land to overseas markets including Taiwan, Brazil, Turkey, Korea, Japan, Thailand, and North America and Europe, XT Online to the Vietnam market and we may further license our existing and new games in other countries and regions, we are required to submit our software export contracts to the data center of the Ministry of Commerce and obtain a software export contract registration license for such software exports. Failure to obtain this license may cause us to incur penalties such as warning and restrictions on or discontinuation of our self-export operations. For the games that we commercially launched in or after 2011, such as Elsword and Allods Online, there is an additional set of regulatory requirements with which we must comply. This includes obtaining game content approval from the Ministry of Culture, completing registration with the Ministry of Commerce and the State Copyright Bureau, obtaining a software product registration certificate from the Ministry of Information Industry, and obtaining a publication approval from the General Administration of Press and Publication and other procedures or formalities which the relevant authorities further require. Any failure by us to obtain these permits or approvals may cause us to suspend operation of our online games, or otherwise cause us to incur penalties, including fines and restrictions on or discontinuation of our operations, which could materially and adversely affect our business, financial condition and results of operations

     As the online game industry is at an early stage of development in China, new laws and regulations may be adopted from time to time to require additional licenses and permits other than those we currently have, and address new issues that may arise. As a result, substantial uncertainties exist regarding the interpretation and implementation of current and any future Chinese laws and regulations applicable to the online games industry. While we believe that, we are in compliance with all applicable Chinese laws and regulations currently in effect with the exception of those the violation of which has been disclosed in this annual report or would not otherwise have an adverse effect on Zhengtu Information and Giant Network as a whole, we cannot assure you that we will not be found in violation of any current or future Chinese laws and regulations.

     Regulation and censorship of information disseminated over the Internet in China may adversely affect our business, and we may be liable for information displayed on, retrieved from, or linked to our websites.

     In recent years, the Chinese government has adopted certain regulations governing Internet access and the distribution of news and other information over the Internet. Under these regulations, ICPs and Internet publishers are prohibited from posting or displaying over the Internet content that contradicts the fundamental principles of China’s Constitution; compromises state security, divulges state secrets, subverts state power or damages national unity; harms the dignity or interests of the state; incites ethnic hatred or racial discrimination or damages inter-ethnic unity; sabotages China’s religious policy or propagates heretical teachings or feudal superstitions; disseminates rumors, disturbs social order or disrupts social stability; propagates obscenity, pornography, gambling, violence, murder or fear or incites the commission of crimes; insults or slanders a third party or infringes upon the lawful rights and interests of a third party; or includes other content prohibited by laws or administrative regulations. Any person that fails to comply with these requirements may have its ICP license and other required licenses revoked and its websites shut down. In the past, failure to comply with these requirements has resulted in the closure of some websites. Website operators may also be held liable for censored information displayed on, retrieved from or linked to their websites. We believe that we are currently in compliance with the regulations and policies mentioned above. However, the Chinese government authorities may not take a view that is consistent with ours.

     The Ministry of Information Industry has published regulations that subject website operators to potential liability for content included on their websites and the actions of users and others using their websites, including liability for violations of Chinese laws prohibiting the dissemination of content deemed to be socially destabilizing. The Ministry of Public Security has the authority to order any local Internet service provider, or ISP, to block any Internet website maintained outside China at its sole discretion. Periodically, the Ministry of Public Security has stopped the dissemination over the Internet of information which it believes to be socially destabilizing. The State Secrecy Bureau, which is directly responsible for the protection of State secrets of the Chinese government, is authorized to block any website it deems to be leaking State secrets or failing to meet the relevant regulations relating to the protection of State secrets in the dissemination of online information.

     As these regulations are relatively new and subject to interpretation by the relevant authorities, it may not be possible for us to determine in all cases the type of content that could result in liability for us as a website operator. In addition, we may not be able to control or restrict the content of other ICPs linked to or accessible through our websites, or content generated or placed on our websites by our users, despite our attempt to monitor such content. To the extent that regulatory authorities find any portion of our content objectionable, they may require us to limit or eliminate the dissemination of such information or otherwise curtail the nature of such content on our websites, which may reduce our user traffic and have a material adverse effect on our financial condition and results of operations. In addition, we may be subject to significant penalties for violations of those regulations arising from information displayed on, retrieved from or linked to our websites, including a suspension or shutdown of our operations.

     The PRC government controls virtually all Internet access in China, and requires all computers sold in China to be installed with government-designated software to censor websites deemed inappropriate by the government, which may potentially discourage or restrict the use of the Internet or our online games, and consequently adversely impact our business, financial conditions and results of operation.

     The PRC government controls virtually all Internet access in China and may occasionally block Internet access throughout the country or in certain regions due to political concerns, in particular in response to, or out of concerns with respect to, special incidents or significant events, thereby preventing people in China, including our game players, from accessing the Internet and playing our online games.

     On May 19, 2009, the MII issued a notice regarding the Pre-installment of Green Dam Web Filter Software on Computers. According to this notice, commencing on July 1, 2009, all computers sold in China are required to be installed with a government-designated software, called Green Dam — Youth Escort, to block “unhealthy words or pictures.” However, according to media reports, such software may compromise the security of personal information. Given the controversy generated by this notice, the MII announced on June 30, 2009 that it would extend the deadline for the implementation of the notice. According to recent media reports, the minister of the MII further stated on August 13, 2009 that the Chinese government will not require all computers sold in China to be installed with the filter software but that computers used in schools, Internet cafes and other public places will be required to be installed with the filter software in order to prevent young people from being harmed by unhealthy online content. It is currently unclear to what extent this notice would be implemented. Although this notice is not intended to block access to online games, if any content of our online games is found by the filter software to contain “unhealthy words or pictures,” our website may be blocked by the software, and as a result users who play our games will not be able to access our online games, which would have an adverse effect on our business, financial conditions and results of operation.

     Compliance with the laws or regulations governing virtual currency may result in us having to obtain additional approvals or adversely affect our game operation revenues.

     In June 2009, the MOC and the Ministry of Commerce jointly published the Notice on Strengthening the Administration Work of the Virtual Currency in Online Games, or the Virtual Currency Notice, to require businesses that (i) issue online game virtual currency (in the form of prepaid cards and/or pre-payment or prepaid card points) or (ii) offer online game virtual currency transaction services to apply for approval from the MOC through its provincial branches within three months following the date of such notice. The Virtual Currency Notice prohibits businesses that issue online game virtual currency from providing services that would enable the trading of such virtual currency. Any business that fails to submit the requisite application will be subject to sanctions, including but not limited to warnings, mandatory corrective measures and fines. The Virtual Currency Notice also prohibits online game operators from allocating virtual items or virtual currency to players based on random selection through lucky draw, wager or lottery which involves cash or virtual currency directly paid by the players. The Virtual Currency Notice also regulates, among other things, that game operators may not issue virtual currency to game players through means other than purchased by game players with legal currency. Moreover, any businesses that do not provide online game virtual currency transaction services are required to adopt

technical measures to restrict the transfer of online game virtual currency among accounts of different game players. The MOC issued the Tentative Measures for Online Games Administrative, or the Online Game Measures, in June 2010, which provides, among other things, that virtual currency issued by online game operators may only be used in exchange for the operator’s own online game products and services and may not be used to pay for the products and services of other entities. The above restrictions may limit our ability to maintain or increase our revenues and adversely affect our results of operations and business prospects.

     Regulations relating to offshore investment activities by PRC residents may increase our administrative burdens and create regulatory uncertainties that could restrict our overseas and cross-border investment activity, and a failure by our shareholders who are PRC residents to make any required applications and filings pursuant to such regulations may prevent us from being able to distribute profits and could expose us and our PRC resident shareholders to liability under PRC law.

     A Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Notice 75, was promulgated by the PRC State Administration of Foreign Exchange, or SAFE, in October 2005 that requires registration with the local SAFE in connection with direct or indirect offshore investments by PRC residents. The regulation applies to our shareholders who are PRC residents and also applies to our offshore acquisitions.

     The Notice 75 retroactively requires registration by March 31, 2006 of direct or indirect investments previously made by PRC residents in offshore companies. SAFE issued subsequent guidance to its local branches for implementing Notice 75. The guidance standardizes more specific and stringent supervision on the registration relating to Notice 75. Specifically it requires PRC residents holding any equity interest in offshore companies, directly or indirectly, controlling or nominal, to make registration with SAFE and imposes obligations on the PRC subsidiaries of offshore companies to facilitate and urge registrations by relevant PRC residents and to file with SAFE the stock options granted by offshore companies to any PRC resident. The registration and filing procedures under Notice 75 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquisocial networking distributions, equity sale proceeds, or the return of funds upon a capital reduction.

     We have already notified our shareholders, and the shareholders of the offshore entities in our corporate group, who are PRC residents to urge them to make the necessary applications and filings as required under this regulation. However, as a result of uncertainty concerning the reconciliation of the new regulation and ambiguities in SAFE registration procedures for registering PRC residents’ share obtained from exercise of share options, 190 PRC individuals in all who have exercised their options to purchase our ordinary shares in accordance with our Employee Share Option Scheme in 2010 are currently unable to register their share ownership with Shanghai SAFE. These individuals are actively communicating with Shanghai SAFE to seek alternative solutions. We do not expect that the inability by those individuals to register share ownership with Shanghai SAFE will have a material adverse effect on our business. We are committed to complying, and to ensuring that our shareholders who are subject to the regulation comply, with the relevant rules. However, we cannot assure you that all of our shareholders who are PRC residents will comply with our request to make or obtain any applicable registrations or approvals required by the regulation or other related legislation. The failure or inability of our PRC resident shareholders to receive any required approvals or make any required registrations may subject us to fines and legal sanctions, restrict our overseas or cross-border investment activities, limit our PRC subsidiary’s ability to make distributions or pay dividends or affect our ownership structure, as a result of which our acquisition strategy and business operations and our ability to distribute profits to you could be materially and adversely affected.

     SAFE rules and regulations may limit our ability to transfer the net proceeds from our initial public offering to Giant Network, our variable interest entity, or VIE, in the PRC, which may adversely affect the business expansion of Giant Network, and we may not be able to convert the net proceeds from our initial public offering into Renminbi to invest in or acquire any other PRC companies, or establish other VIEs in the PRC.

     On August 29, 2008, SAFE promulgated Circular 142, a notice regulating the conversion by a foreign-invested company of foreign currency into Renminbi by restricting how the converted Renminbi may be used. The notice requires that the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies may only be used for purposes within the business scope approved by the applicable governmental authority and may not be used for equity investments within the PRC. In addition, SAFE strengthened its oversight of the flow and use of the registered capital of a foreign-invested company settled in Renminbi converted from foreign currencies. The use of such Renminbi capital may not be changed without SAFE’s approval, and may not in any case be used to repay Renminbi loans if the proceeds of such loans have not been used. Violations of Circular 142 will result in severe penalties, such as heavy fines. As a result, Circular 142 may significantly limit our ability to transfer the net proceeds from our initial public offering to Giant Network through our subsidiary in the PRC, which may adversely affect the business expansion of Giant Network, and we may not be able to convert the net proceeds from our initial public offering into Renminbi to invest in or acquire any other PRC companies, or establish other VIEs in the PRC.

     We may be subject to fines and legal sanctions if we or our employees who are PRC citizens fail to comply with recent PRC regulations relating to employee stock options granted by overseas listed companies to PRC citizens.

     In December 2006, the People’s Bank of China promulgated the Administrative Measures on Individual Person Foreign Exchange, or the PBOC Regulation, setting forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under the current account and the capital account. In January 2007, SAFE issued the implementation rules for the PBOC Regulation which, among others, specified the approval requirement for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plan or stock options plan of an overseas listed company. On March 28, 2007, SAFE promulgated the Implementing Procedures on Administration of Foreign Exchange regarding PRC Individuals’ Participating in Employee Stock Ownership Plan and Stock Option Plan of Overseas Listed Companies, or the Stock Option Rule, to

further clarify the formalities and application documents in connection with the subject matter. Under the Stock Option Rule, PRC citizens who are granted stock options or restricted share units, or issued restricted shares by an overseas publicly-listed company are required, through a PRC agent or PRC subsidiary of such overseas publicly-listed company, to complete certain other procedures and transactional foreign exchange matters upon the examination by, and approval of, SAFE. Failure to comply with the Stock Option Rule may subject the plan participants, the company offering the plan or the relevant intermediaries, as the case may be, to fines and legal or administrative sanctions under PRC foreign exchange regime.

     Our business may be adversely affected by public opinion and government policies in China.

     Internet cafés, which are currently the most important outlets for online games, have been criticized by the general public in China for having exerted a negative influence on young people. Due primarily to such adverse public reaction, regulators in China have tightened their regulation of Internet café operations through, among other things, suspending the issuance of new operating licenses and further reducing the hours during which the Internet cafés are permitted to remain open for business. Also, local and higher-level governmental authorities may from time to time decide to more strictly enforce age limits and other requirements relating to Internet cafés as a result of the occurrence of, and the media attention on, gang fights, arson and other incidents in or related to Internet cafés. As most of our customers access our games from Internet cafés, any restrictions on Internet café operations could result in a reduction of the amount of time our customers spend on our online games or a reduction in or slowdown in the growth of our player base. Moreover, any adverse public reaction to the online game industry may discourage players from spending too much time playing our online games, which could limit the growth of or reduce our net revenues. In addition, it is also possible that the Chinese government authorities may decide to adopt more stringent policies to monitor the online game industry as a result of adverse public reaction or otherwise. Any such restrictions on online game playing would adversely affect our business and results of operations.

     Our operations may be adversely affected by implementation of addiction-related regulations.

     The Chinese government may decide to adopt more stringent policies to monitor the online game industry as a result of adverse public reaction to perceived addiction to online games, particularly by minors. On April 15, 2007, eight PRC government authorities, including the GAPP, the Ministry of Education and the Ministry of Information Industry issued a Notice on the Implementation of Online Game Anti-Addiction System to Protect the Physical and Psychological Health of Minors, or the Anti-Addiction Notice, requiring all Chinese game operators to adopt an “anti-addiction system” in an effort to curb addiction to online games by minors. Under the anti-addiction system, three hours or less of continuous play is defined to be “healthy,” three to five hours is defined to be “fatiguing,” and five hours or more is defined to be “unhealthy.” Game operators are required to reduce the value of game benefits for minor players by half when those players reach the “fatigue” level, and to zero when they reach the “unhealthy” level. In addition, online game players in China are now required to register their identity card numbers before they can play an online game. This system allows game operators to identify which players are minors. Failure to comply with the requirements under the Anti-Addiction Notice may subject us to penalties, including but not limited to suspension of our operation of online games, revocation of our licenses and approvals for our operations, rejection or suspension of our application for approvals, licenses, or filings for any new game, or prohibiting us from operating any new game. We currently do not permit juvenile players to play our online games. If these restrictions are expanded to apply to adult players in the future, it could have a material and adverse effect on our business, financial condition and operating results.

     Our corporate structure may limit our ability to receive dividends from, and transfer funds to, our PRC subsidiary, which could restrict our ability to act in response to changing market conditions.

     We are a Cayman Islands holding company and substantially all of our operations are conducted through our PRC subsidiary, Zhengtu Information, and our affiliated entity, Giant Network. Current regulations in China permit our PRC subsidiaries to pay dividends to us only out of its accumulated distributable profits, if any, determined in accordance with their articles of association and PRC accounting standards and regulations. The ability of Zhengtu Information to make dividends and other payments to us may be restricted by factors that include changes in applicable foreign exchange and other laws and regulations. In particular, under PRC law, our subsidiary may only pay dividends after 10% of its after-tax profits have been set aside as reserve funds, unless such reserves have reached at least 50% of its registered capital. Such cash reserve may not be distributed as cash dividends. The PRC Income Tax Law also imposes a 10% enterprise income tax on dividends distributed by a foreign invested enterprise to its immediate holding company outside China, which were exempted under the previous income tax and rules. A lower enterprise income tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company, and subject to certain conditions upon Chinese tax authority’s approval. The foreign invested enterprise will be subject to the withholding tax starting on January 1, 2008. There was no distribution of dividends from the Group’s PRC subsidiaries in 2009 and 2010. Zhengtu Information is also required to allocate a portion of its after-tax profits, as determined by its board of directors, to its staff welfare and bonus funds, which may not be distributed to its shareholders. In addition, if our operating subsidiary incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or make other payments to us. Moreover, the profit available for distribution from our operating subsidiary is determined in accordance with generally accepted accounting principles in China. This calculation may differ from one performed in accordance with U.S. GAAP. As a result, we may not have sufficient distributions from our PRC subsidiaries to enable necessary profit distributions to us or any distributions to our shareholders in the future, the calculation of which would be based upon our financial statements prepared under U.S. GAAP.

     Distributions by our PRC subsidiaries to us other than as dividends may be subject to governmental approval and taxation. Any transfer of funds from our company to our PRC subsidiaries, either as a shareholder loan or as an increase in registered capital, is subject to registration or approval of Chinese governmental authorities, including the relevant administration of foreign exchange and/or the relevant examining and approval authority. These limitations on the free flow of funds between us and our PRC subsidiaries could restrict our ability to act in response to changing market conditions.

Risks Relating to China

     Our operations may be adversely affected by changes in China’s economic, political, social and environmental conditions.

     Substantially all of our business operations are conducted in China and substantially all of our net revenues are derived from our sale of virtual items and services in our online games in China. Accordingly, our results of operations, financial condition and future prospects are subject to a significant degree to economic, political and social conditions in China. The PRC economy differs from the economies of most developed countries in many respects, including the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth in the past three decades, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operation may be adversely affected by changes in tax regulations applicable to us. Since early 2004, the PRC government has implemented certain measures to control the pace of economic growth. Such measures may cause a decrease in the level of economic activity in China, including a decline in individual spending activities, which in turn could adversely affect our results of operational and financial condition.

     In particular, our business is primarily dependent upon the economy and the business environment in China. Our growth strategy is based upon the assumption that demand in China for online games will continue to grow with the Chinese economy. However, the growth of the Chinese economy has been uneven across geographic regions and economic sectors. Several years ago the Chinese economy also experienced deflation, which may reoccur in the foreseeable future. We cannot assure you that the Chinese economy will continue to grow, or that if there is growth, such growth will be steady and uniform, or that if there is a slowdown, such slowdown will not have a negative effect on our business.

     Natural disasters may also adversely affect our business and results of operation. For example, on May 12, 2008 an earthquake of magnitude 8.0 struck southwest China and caused the death of over 70,000 people. The State Council published a public notice on observation of the three-day mourning period from May 19, 2008 to May 21, 2008. On April 14, 2010, an earthquake of magnitude 7.1 struck southwest China and caused the death of over 2,000 people. The State Council published another public notice on observation of one mourning day on April 21, 2010. According to the public notices, all public recreational activities were to be suspended during the mourning period. In compliance with the public notice, we suspended all our three games, namely ZT Online, ZT PTP and Giant Online, and suspended revenue collection as a result of game play during the three-day period in order to express our condolences to the earthquake victims.

     The PRC legal system embodies uncertainties which could limit the legal protections available to you and us.

     The PRC legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal cases have little precedential value. In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly enhanced the protections afforded to various forms of foreign investment in China. Our PRC subsidiary, Zhengtu Information, is a foreign-invested enterprise incorporated in China. It is subject to laws and regulations applicable to foreign investment in China in general and laws and regulations applicable to foreign-invested enterprises in particular. However, these laws, regulations and legal requirements change frequently, and their interpretation and enforcement involve uncertainties. For example, we may have to resort to administrative and court proceedings to enforce the legal protection that we enjoy either by law or contract. However, since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy than in more developed legal systems. In addition, such uncertainties, including the inability to enforce our contracts, could materially and adversely affect our business and operations. Furthermore, the PRC legal system is based in part on government policies and internal rules (some of which are not published on a timely basis or at all) that may have a retroactive effect. As a result, we may not be aware of our violation of these policies and rules until some time after the violation. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. Furthermore, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries. Accordingly, we cannot predict the effect of future developments in the PRC legal system, particularly with regard to the online game industry, including the promulgation of new laws, changes to existing laws or the interpretation or enforcement thereof, or the preemption of local regulations by national laws. These uncertainties could limit the legal protections available to us, and our foreign investors, including you.

     There are currently no laws or regulations in the PRC governing virtual asset property rights and therefore it is not clear what liabilities, if any, online game operators may have relating to the loss of virtual assets.

     In the course of playing online games, some virtual assets, such as special equipment, player experience grades and other features of our players’ game characters, are acquired and accumulated. Such virtual assets can be highly valued by online game players and in some cases are traded between players for actual money or real assets. In practice, virtual assets can be lost for various reasons, such as data loss caused by delay of network service or by a network crash. There are currently no PRC laws and regulations governing virtual asset property rights. As a result, it is unclear who the legal owner of virtual assets is and whether the ownership of virtual assets is protected by law. In the event of a loss of virtual assets, we may be sued by players and may be held liable for damages, which may negatively affect our business, financial condition and results of operations.

     Restrictions on the convertibility of Renminbi into foreign currencies may limit our ability to make dividends or other payments in U.S. dollars or fund possible business activities outside China.

     Substantially all of our net revenues are currently generated in Renminbi. Any future restrictions on currency exchanges may limit our ability to use net revenues generated in Renminbi to make dividends or other payments in U.S. dollars or fund possible business activities outside China. Although the PRC government introduced the Foreign Exchange Administration Rules in 1996, as amended in August 2008, to allow greater convertibility of Renminbi for current account transactions, significant restrictions still remain, including primarily the restriction that enterprises may only buy, sell and/or remit foreign currencies at those banks authorized to conduct foreign exchange business after providing valid commercial documents. In addition, remittance of foreign currencies abroad and conversion of Renminbi for capital account items, including direct investment and loans, is subject to government approval in China, and companies are required to open and maintain separate foreign exchange accounts for capital account items. We cannot assure you the Chinese regulatory authorities will not impose more stringent restrictions on the convertibility of Renminbi, especially with respect to foreign exchange transactions.

     You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us, our management or the experts named in the annual report.

     We conduct substantially all of our operations in China and substantially all of our assets are located in China. In addition, all of our directors and executive officers reside within China. As a result, it may not be possible to effect service of process within the United States or elsewhere outside China upon some of our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. It would also be difficult for investors to bring an original lawsuit against us or our directors or executive officers before a Chinese court based on U.S. federal securities laws or otherwise. Moreover, our PRC legal counsel, Grandall Legal Group (Shanghai), has advised us that the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.

     Any future outbreak of the H1N1 virus (swine flu), avian flu or severe acute respiratory syndrome in China, or similar adverse public health developments, may severely disrupt our business and operations and reduce the market for our products and services.

     Adverse public health epidemics or pandemics could disrupt businesses and national economies in China. For example, from December 2002 to June 2003, China and certain other countries experienced an outbreak of a new and highly contagious form of atypical pneumonia now known as severe acute respiratory syndrome, or SARS. During May and June of 2003, many businesses in China were closed by the PRC government to prevent transmission of SARS. The World Health Organization has announced that there is a high likelihood of an outbreak of avian flu, with the potential to be as disruptive if not more disruptive than SARS. Recently, the World Health Organization has warned of the global spread of the H1N1 virus (swine flu), which has been reported as affecting individuals in China and have resulted in quarantines for individuals exposed to and infected by the virus. Any recurrence of the SARS outbreak, an avian flu outbreak, an H1N1 virus outbreak or development of a similar health hazard in China may disrupt consumer spending. In addition, health or other government regulation may require temporary closure of our offices and operations or of the third party service providers that host and maintain our servers. Lastly, such outbreak may cause the sickness or death of our key management and employees. Any of such occurrences would adversely affect our business and results of operations.

     Fluctuation in the value of the Renminbi may have a material adverse effect on your investment.

     The change in value of the Renminbi against the U.S. dollar and other currencies is affected by, among other things, changes in China’s political and economic conditions. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the current policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a significant appreciation of the Renminbi against the U.S. dollar. As substantially all of our costs and expenses are denominated in Renminbi, the revaluation beginning in July 2005 and potential future revaluation has and could further increase our costs in U.S. dollar terms. For example, to the extent that we need to convert U.S. dollars we receive from our U.S. investments, if any, into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we receive from the conversion. Conversely, if we decide to convert our Renminbi into U.S. dollars for the purpose of making payments for dividends on our shares or ADSs or for other business purposes, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us.

Risks Related to Our Ordinary Shares and ADSs

     The market price for our ADSs may be volatile which could result in a loss to you.

     The market price for our ADSs is likely to be highly volatile and subject to wide fluctuations in response to a number of factors, including:

	•		actual or anticipated fluctuations in our quarterly operating results;
	•		announcements of competitive developments;
	•		changes in the economic performance or market valuations of companies with comparable businesses;
	•		regulatory developments in China affecting us, our industry, our corporate structure or our advertisers;
	•		announcements regarding litigation or administrative proceedings involving us;
	•		changes in financial estimates by securities research analysts;
	•		addition or departure of our executive officers;
	•		release or expiry of lock-up or other transfer restrictions on our outstanding common shares or ADSs; and
	•		sales or perceived sales of additional common shares or ADSs.

     In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also have a material adverse effect on the market price of our ADSs.

     Future sales or perceived sales of ADSs or ordinary shares by existing shareholders could cause our ADS price to decline.

     If our existing shareholders sell, indicate an intention to sell or are perceived to intend to sell substantial amounts of our ordinary shares in the public market, the trading price of our ADSs could decline. As of December 31, 2010, we had 228,019,412 outstanding ordinary shares. On October 31, 2009, the two year lockup agreement entered into by our current chief executive officer and chairman, Yuzhu Shi, during our public offering expired with respect to 102,000,000 of our ordinary shares, which he may sell in conformance with Rules 144 and 701 of the Securities Act of 1933. In addition, as of December 31, 2010, the 7,097,369 ordinary shares subject to outstanding options under our 2006 Plan and 2007 Plan are eligible for sale in the public market to the extent permitted by the provisions of their various vesting agreements, lock-up agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold in the public market, the trading price of our ordinary shares could decline.

     Our corporate actions are substantially controlled by our principal shareholders and their affiliated entities.

     As at December 31, 2010, our principal shareholders and their affiliated entities owned approximately 57.75% of our outstanding ordinary shares. These shareholders, acting individually or as a group, could exert control over and substantially influence matters such as electing directors and approving mergers or other business combination transactions. For example, between February 2006 and June 2007, prior to the establishment of our current board of directors, including our independent directors, Giant Network and Zhengtu Information made interest-free advances in the total amount of RMB900.0 million to Shanghai Jiante Shengming Technology Co., Ltd., a company controlled by Yuzhu Shi, our controlling beneficial owner. This concentration of ownership and voting power may also discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company that might reduce the price of our ADSs. These actions may be taken even if they are opposed by our other shareholders.

     We may need to take certain actions to avoid being deemed an investment company under the Investment Company Act of 1940.

     The Investment Company Act of 1940 requires registration of, and imposes stringent regulation upon, companies that are primarily engaged in the business of investing, reinvesting, owning, holding or trading securities. In addition, a company may be deemed to be an investment company if it owns investment securities with a value exceeding 40% of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis, unless an exemption or safe harbor applies. Securities issued by companies other than majority-owned subsidiaries are generally regarded as investment securities under the Investment Company Act.

     Although we are not primarily engaged in the business of investing, reinvesting, owning, holding or trading securities, we may nonetheless be deemed an investment company under the Investment Company Act due to our various held to maturity securities and our minority investments, all of which are regarded as investment securities under the Investment Company Act. In addition, in the event that one or more of our investee companies completes an initial public offering or is sold to an acquirer, the value of our investment in such investee company may substantially increase, which may result in us being deemed to be an investment company.

     In order to avoid being deemed an investment company under the Investment Company Act, we may need to take actions, including buying, refraining from buying, selling or refraining from selling securities when we would otherwise not choose to do so. For example, we may need to acquire additional income or loss generating assets that we might not otherwise have acquired, forego opportunities to acquire interests in companies that would be important to our strategy, or sell certain assets that are considered to be investment securities, including interests in our investee companies.

     In the event that we are deemed to be an investment company, because we are not a U.S. company we will not be permitted to register as an investment company under the Investment Company Act. Accordingly, we will not become subject to regulation under the Investment Company Act. We will, however, face other restrictions as a result of being deemed to be an investment company, including but not limited to no longer being permitted to make a public offering of our securities in the United States. Although we believe that our current cash and cash equivalents and cash flows from operations are sufficient to meet our anticipated needs in the near term, such a prohibition on public offerings of our securities in the United States would limit our future access to capital and could restrict our future growth prospects.

     We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or ordinary shares.

     Depending upon the value of our ADSs or ordinary shares and the nature of our assets and income over time, we could be classified as a passive foreign investment company or PFIC for U.S. federal income tax purposes. We will be classified as a PFIC in any taxable year if either: (a) the average quarterly value of our gross assets that produce passive income, or are held for the production of passive income, is at least 50% of the average quarterly value of our total gross assets or (b) 75% or more of our gross income for the taxable year is passive income. According to these technical rules, we would likely become a PFIC for a given taxable year if our market capitalization were to decrease significantly while we hold substantial cash and cash equivalents in that year.

     We believe that we were not a PFIC for U.S. federal income tax purposes for our taxable year ended December 31, 2010. However the application of the PFIC rules is subject to uncertainty in several respects, and we must make a separate determination after the close of each taxable year as to whether we were a PFIC for such year. As such, although we intend to conduct our business activities in a manner to reduce the risk of our classification as a PFIC in the future, we currently hold, and expect to continue to hold,

a substantial amount of cash and other passive assets, and, because the value of our assets is likely to be determined in large part by reference to the market prices of our ADSs and ordinary shares, which are likely to fluctuate, there can be no assurance that we will not be classified as a PFIC for 2011 or any future taxable year. If we are a PFIC for any taxable year during which a U.S. investor held our ADSs or ordinary shares, certain adverse U.S. federal income tax consequences would apply to the U.S. investor. See “Item 10. — Additional Information — E. Taxation — U.S. Federal Income Taxation — Passive foreign investment company.”

     You may lose some or all of the value of a distribution by the depositary if the depositary cannot convert RMB into U.S. dollars on a reasonable basis at the time of such distribution for regulatory or other reasons.

     The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of ordinary shares your ADSs represent.

     The depositary will convert any cash dividend or other cash distribution we pay on the ordinary shares into U.S. dollars, if it can do so on a practicable basis and can transfer the U.S. dollars to the United States. If that is not possible or if any approval from any government is needed and cannot be obtained, the depositary is allowed to distribute RMB only to those ADS holders to whom it is possible to do so. It will hold RMB it cannot convert for the account of the ADS holders who have not been paid. However, it will not invest RMB and it will not be liable for interest. In addition, if the exchange rates fluctuate during a time when the depositary cannot convert RMB at the time of such distribution for regulatory or other reasons, the ADS holders who have not been paid may lose some or all of the value of the distribution.

     Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings and you may not receive cash dividends if it is impractical to make them available to you.

     We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to you in the United States unless we register the rights and the securities to which they relate under the Securities Act or an exemption from the registration requirements is available. Also, under the deposit agreement, the depositary will not make rights available to you unless both the rights and any related securities are registered under the Securities Act, or the distribution of them to ADS holders is exempted from registration under the Securities Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under the Securities Act. Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings.

     In addition, the depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives on our common shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of common shares your ADSs represent. However, the depositary may, at its discretion, decide that it is impractical to make a distribution available to any holders of ADSs. For example, the depositary may determine that it is not practicable to distribute certain property through the mail, or that the value of certain distributions may be less than the cost of mailing them. In these cases, the depositary may decide not to distribute such property and you will not receive such distribution.

     We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you may have less protection of your shareholder rights than you would under U.S. law.

     Our corporate affairs are governed by our amended and restated memorandum and articles of association, the Cayman Islands Companies Law and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities laws than the United States. In addition, some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands.

     The Cayman Islands courts are unlikely:

	•		to recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or
	•		to entertain original actions brought against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

     There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the Cayman Islands will generally recognize as a valid judgment, a final and conclusive judgment in personam obtained in the federal or state courts in the United States under which a sum of money is payable (other than a sum of money payable in respect of multiple damages, taxes or other charges of a like nature or in respect of a fine or other penalty) and would give a judgment based thereon provided that (i) such courts had proper jurisdiction over the parties subject to such judgment; (ii) such courts did not contravene the rules of natural justice of the Cayman Islands; (iii) such judgment was not obtained by fraud; (iv) the enforcement of the judgment would not be contrary to the public policy of the Cayman Islands; (v) no new admissible evidence relevant to the action is submitted prior to the rendering of the judgment by the courts of the Cayman Islands; and (vi) there is due compliance with the correct procedures under the laws of the Cayman Islands. You should also read “Description of Share Capital — Differences in Corporate Law” for some of the differences between the corporate and securities laws in the Cayman Islands and the United States.

     You will have limited ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them, because we are incorporated in the Cayman Islands, because we conduct a majority of our operations in China and because the majority of our directors and officers reside outside the U.S.

     We are incorporated in the Cayman Islands, and conduct all of our operations in China through our subsidiary and affiliated entity established in China. All of our directors and officers reside outside the United States and substantially all of the assets of those persons are located outside the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the applicable securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. For more information regarding the relevant laws of the Cayman Islands and China, see “Enforceability of Civil Liabilities.”

     Shareholders of Cayman Islands exempted companies such as ourselves have no general rights under Cayman Islands law to inspect corporate records and accounts or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our articles of association to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

     Cayman Islands companies may not have standing to initiate a derivative action in a federal court of the United States. As a result, your ability to protect your interests if you are harmed in a manner that would otherwise enable you to sue in a United States federal court may be limited.

     As a result of all of the above, public shareholders may have more difficulty in protecting their interests in the face of actions taken by management, members of the board of directors or controlling shareholders than they would as public shareholders of a U.S. company.

     As a “controlled company,” we are exempt from certain New York Stock Exchange corporate governance requirements, which may result in our independent directors not having as much influence as they would if we were not a controlled company.

     We are a “controlled company” as defined under Section 303A of the Listed Company Manual of the New York Stock Exchange, or the NYSE, because one of our shareholders holds more than 50% of our voting power. As a result, for so long as we remain a controlled company as defined under that rule, we are exempt from, and our shareholders generally are not provided with the benefits of, some of the NYSE corporate governance requirements, including that:

	•		a majority of our board of directors must be independent directors;
	•		our compensation committee must be composed entirely of independent directors; and
	•		our corporate governance and nominating committee must be composed entirely of independent directors.

     Although our board previously included a majority of independent directors, upon the resignation of Mr. David Feng Yu from our board in June 2011, our board consists of three independent directors and three non-independent directors. See “Directors and Senior Management.”

     The voting rights of holders of ADSs are limited in several significant ways by the terms of the deposit agreement.

     Holders of our ADSs may only exercise their voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Upon receipt of voting instructions from a holder of ADSs in the manner set forth in the deposit agreement, the depositary will endeavor to vote the underlying ordinary shares in accordance with these instructions. Under our amended and restated memorandum and articles of association and Cayman Islands law, the minimum notice period required for convening a general meeting is five days. When a general meeting is convened, you may not receive sufficient notice of a shareholders’ meeting to permit you to withdraw your ordinary shares to allow you to cast your vote with respect to any specific matter at the meeting. In addition, the depositary and its agents may not be able to send voting instructions to you or carry out your voting instructions in a timely manner. We will make all reasonable efforts to cause the depositary to extend voting rights to you in a timely manner, but we cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary to vote your shares. Furthermore, the depositary and its agents will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any such vote. As a result, you may not be able to exercise your right to vote and you may lack recourse if your ordinary shares are not voted as you requested.

     The depositary of our ADSs will, except in limited circumstances, grant to us a discretionary proxy to vote the ordinary shares underlying your ADSs if you do not vote at shareholders’ meetings, which could adversely affect your interests and the ability of our shareholders as a group to influence the management of our company.

     Under the deposit agreement for the ADSs, the depositary will give us a discretionary proxy to vote our ordinary shares underlying your ADSs at shareholders’ meetings if you do not vote, unless:

	•		we have failed to timely provide the depositary with our notice of meeting and related voting materials;
	•		we have instructed the depositary that we do not wish a discretionary proxy to be given;
	•		we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;
	•		a matter to be voted on at the meeting would have a material adverse impact on shareholders; or
	•		voting at the meeting is made on a show of hands.

     The effect of this discretionary proxy is that you cannot prevent our ordinary shares underlying your ADSs from being voted, absent the situations described above, and it may make it more difficult for shareholders to influence the management of our company. Holders of our ordinary shares are not subject to this discretionary proxy.

     You may not receive distributions on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you.

     The depositary of our ADSs has agreed to pay you the cash dividends or other distributions it or the custodian for our ADSs receives on our ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in proportion to the number of our ordinary shares your ADSs represent. However, the depositary is not responsible if it is unlawful or impractical to make a distribution available to any holders of ADSs. For example, it would be unlawful to make a distribution to a holder of ADSs if it consists of securities that require registration under the Securities Act but that are not properly registered or distributed pursuant to an applicable exemption from registration. The depositary is not responsible for making a distribution available to any holders of ADSs if any government approval or registration is required for such distribution. We have no obligation to take any other action to permit the distribution of our ADSs, ordinary shares, rights or anything else to holders of our ADSs. This means that you may not receive the distributions we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you. These restrictions may have a material and adverse effect on the value of your ADSs.

     You may be subject to limitations on transfer of your ADSs.

     Your ADSs, represented by American depositary receipts, are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems expedient in connection with the performance of its duties. The depositary may close its books from time to time for a number of reasons, including in connection with corporate events such as a rights offering, during which time the depositary needs to maintain an exact number of ADS holders on its books for a specified period. The depositary may also close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary thinks it is necessary or advisable to do so in connection with the performance of its duty under the deposit agreement, including due to any requirement of law or any government or governmental body, or under any provision of the deposit agreement.

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

     We commenced operations in 2004 through Shanghai Zhengtu Network Technology Co., Ltd., a limited liability company organized under PRC laws. On October 16, 2007 this entity changed its name to Shanghai Giant Network Technology Co., Ltd., or Giant Network.

     In order to implement an offshore holding company structure to comply with Chinese laws imposing restrictions on foreign ownership in the online game businesses in China, on July 26, 2006, Yuzhu Shi, our current chief executive officer and chairman, and his daughter, Jing Shi, together with 18 other individual shareholders (most of whom are direct or beneficial shareholders of Giant Network) established our current Cayman Islands holding company, Giant Network Technology Limited, or Giant, and its wholly owned subsidiary, Eddia International Group Limited, or Eddia, in the British Virgin Islands. Eddia established Shanghai Zhengtu Information Technology Co., Ltd., or Zhengtu Information, a wholly owned subsidiary in China on September 6, 2006, and contributed US$1,500,000 as its registered capital. As a result, we own 100% of the equity of Zhengtu Information through Eddia. On June 11, 2007, Giant changed its name from Giant Network Technology Limited to Giant Interactive Group Inc.

     Following the establishment of our offshore holding structure, all of our online game business continues to be operated through Giant Network. The beneficial shareholders of Giant Network currently include Yuzhu Shi, who beneficially owns or controls 75% of Giant Network’s equity interests through his beneficial ownership of Shanghai Lanlin Bio-Technology Co., Ltd., and an additional 18 PRC individuals who beneficially own the remaining 25%. We have entered into contractual arrangements with Giant Network pursuant to which our wholly owned subsidiary, Zhengtu Information, provides technical support and consulting services to Giant Network. In addition, we have entered into agreements with Giant Network and its shareholders, providing us with the ability to effectively control this entity. Accordingly, we have consolidated the historical results of Giant Network in our financial statements as a variable interest entity, or VIE, pursuant to U.S. GAAP. For additional information on our organizational structure, see Item 4.C, “Organizational Structure.”

     On November 6, 2007, we completed our initial public offering, which involved the sale by us and some of our shareholders of 65,777,036 of our ADSs, representing 65,777,036 of our ordinary shares.

     In 2009 and 2010 we established various subsidiaries, in which we own an approximately 51% interest through various holding companies, as part of a reorganization of our game development studios. For additional information regarding the reorganization of our game development studios, see Item 4.B, “Business Overview — Game Development and Sourcing — Game Development.”

     In May 2009, the Company acquired a 51% interest in Snow Wolf to further enrich our game pipeline and enhance our research and development capability. In November 2010, we acquired a 100% interest in Julun Network and a 50% interest in Shanghai Haoji Network Technology Co. Ltd., or Haoji Network, two additional game development studios.

     In the fourth quarter of 2010, we sold our controlling interest in Beijing Huayi Giant Information Technology Co., Ltd, or Huayi Giant, which holds the intellectual property and development team of K III, a 3D MMORPG game, to Huayi Brothers.

     Our principal executive offices are located at 11/F No. 3 Building, 700 Yishan Road, Shanghai, 200233, People’s Republic of China. Our telephone number at this address is +86 21 3397-9999 and our fax number is +86 21 3397-9948. Our website address is www.ga-me.com. The information contained on our website is not part of this annual report.

B. Business Overview

Overview

     We are a leading online game developer and operator in China in terms of market share. We focus on massively multiplayer online role playing games, or MMORPGs, which are played through networked game servers on which tens of thousands of players are able to simultaneously connect and interact.

     We commercially launched our first internally-developed MMORPG, ZT Online, in January 2006. We now operate eleven online games, among which nine are self-developed, including the five games in the ZT Online Series.

     We believe that our success is largely attributable to our ability to internally develop, operate and market high quality MMORPGs tailored to China’s core game player audience, which we define as players between the ages of 18 and 40. As of December 31, 2010, our game development team consisted of 934 members, which includes dedicated product development and enhancement teams for each of our MMORPG and MMO games.

     Notwithstanding our historical success with internally developed games, we began to expand our game pipeline by licensing games from third party developers. In December 2009 and January 2010, respectively, we acquired the exclusive mainland China operation licenses for Elsword and Allods Online, two 3D MMORPGs.

     We have built nationwide distribution and marketing networks to sell and market our prepaid game cards and game points. As of December 31, 2010, our distribution network consisted of more than 130 non-exclusive regional distributors and reached over 96,000 retail outlets, including Internet cafés, software stores, supermarkets, bookstores, newspaper stands and convenience stores located throughout China. We also sell game points through our official game website. As of December 31, 2010, our marketing network consisted of over 1,150 personnel throughout China.

     Although substantially all of our revenues are generated through our own game operation in China, we have began deriving revenues from licensing of our games to third party operators in other territories including Hong Kong, Macau, Taiwan, Malaysia, Singapore, Vietnam, Russia and other Russian speaking territories. In addition, we have also licensed our ZT Online Green Edition to Shenzhen Tencent Computer Systems Company Limited, or Tencent, on a non-exclusive basis for operation of such game on Tencent’s QQ game platform in China.

     In 2008, 2009 and 2010, our net revenues were RMB1,594.7 million, RMB1,303.8 million and RMB1,332.8 million (US$201.9 million), respectively. Our net income for the same periods was RMB1,113.6 million, RMB859.0 million and RMB811.2 million (US$122.9 million), respectively. Our quarterly peak concurrent users for all of the games we operate in mainland China were 1,572,000 and 1,713,000 for 2009 and 2010, respectively, and our quarterly average concurrent users for all of the games we operate in mainland China were 474,000 and 595,000 for 2009 and 2010, respectively.

Our Games

     We currently operate eleven games, including nine MMORPGs, one casual MMO game and one strategy browser game. While each of our games is unique, they all share certain common characteristics, including their targeted market and their interoperability. Each of our MMORPGs target China’s core online game market, which we define as players between the ages of 18 and 40. We believe that members of this demographic generally have greater disposable income and are more willing to spend money to improve their characters’ standing in the game. We also believe that our ability to effectively target this market segment has helped facilitate our relatively high average revenue per user. In addition, our games have a high degree of interoperability, which enables a player to access all of our games through one single account.

     The following table sets forth certain information relating to the games that we operate as of June 10, 2011.

Game		Style		Game Source		Launch Date/ Status
ZT Online		Free to Play 2D MMORPG		Self-Developed		First Quarter 2006
ZT Online PTP		Pay to Play 2D MMORPG		Self-Developed		Fourth Quarter 2007
Giant Online		Free to Play 2.5D MMORPG		Self-Developed		Fourth Quarter 2007
ZT Online Classic Edition		Free to Play 2D MMORPG		Self-Developed		Third Quarter 2008
ZT Online Green Edition		Free to Play 2D MMORPG		Self-Developed		Second Half 2009
My Sweetie		Free to Play 2D Casual MMO		Acquired		Second Half 2009
K III		Free to Play 3D MMORPG		Transitional License		Second Half 2009
The Golden Land		Free to Play Strategy Browser Game		Self-Developed		Second Half 2009
XT Online		Free to Play 2.5D MMORPG		Self-Developed		Closed Beta Testing
ZT Online II		Free to Play 2D MMORPG		Self-Developed		Closed Beta Testing
Dragon Soul		Free to Play 3D MMORPG		Self-Developed		Closed Beta Testing

     ZT Online

     ZT Online, or “Zheng Tu” in Chinese, is a two-dimensional, or 2D, online role-playing game set in ancient China, and was the first game that was wholly developed by our internal product development team. ZT Online players assume one of five different roles,

including soldiers and magicians, in 10 different “kingdoms.” Players develop skills, use magical weapons and team up with other players to fight against monsters and players from other kingdoms. Revenues from the ZT Online Series accounted for substantially all of our net revenues in 2008, 2009 and 2010.

     In order to play ZT Online, players must log onto one of our multiple shards, or independent copies of the game world. Players can only interact with other players in his or her respective shard at any given time, but our technology allows players to “travel” among the different shards. We have developed proprietary technology for use in ZT Online that allows over 40,000 players to play together in a single shard at any given time, which we believe is higher than many of the other MMORPGs currently operated in China.

     ZT Online is free of charge to play. Players may purchase physical or virtual prepaid game cards and game points from our official game website or from Internet cafés and other distribution points which allow their characters to obtain “gold coins,” one of the currencies used in the ZT Online game. Players may also earn “silver coins” for their characters when they successfully fulfill tasks or adventures in the game world. The game also has “gold coin vouchers,” which are offered both as a salary to players who meet certain requirements and as a reward in connection with certain of our promotions. Gold coin vouchers are not exchangeable for gold coins or silver coins, and can only be used by players to purchase certain specified and non-transferable virtual items and services. Players may trade silver coins for gold coins, and vice-versa, inside the game. Neither gold coins, gold coin vouchers, nor silver coins may be used by players to purchase any items or services outside of the ZT Online game. However, certain players make use of third party auction websites to sell their game accounts, which may include gold coins, gold coin vouchers and silver coins, for real money. See “Risk Factors — Risks Relating to Our Business and Industry — Enhancements and rules changes to our games have resulted, and may continue to result, in players deciding not to play our games or making legal claims against us, which could materially and adversely affect our business, results of operations and financial condition.”

     ZT Online allows players to purchase a wide range of virtual items and services for their characters using their gold and/or silver coins. These include weapons, clothing, pets, ceremonies and rites, and many others. Some virtual items are consumed at a predetermined rate or otherwise have limitations on repeated use, for example a magic shield that can only be carried for seven days or medicine that can only be consumed once, while other items may continue to exist for an undetermined time until receiving a certain amount of damage in the game from battle and other causes. Weapons may be repaired or replaced by purchases of certain in-game raw materials or by payment of additional gold or silver coins.

     ZT Online offers an uninterrupted play experience, where players can choose to enter the game 24 hours a day, seven days a week. ZT Online can be accessed from any location with an Internet connection.

     ZT Online PTP

     ZT Online PTP is the first pay-to-play MMORPG that we developed. Although ZT Online PTP is based on the ZT Online free-to-play game, unlike ZT Online, ZT Online PTP requires players to pay to play the game by purchasing physical or virtual prepaid game cards from our official game website or from Internet cafés and other distribution points. Virtual items and services are not sold in the game, and therefore players must focus on building up their characters’ experience to advance in the game. As of the date of this annual report, ZT Online PTP does not have a material amount of active players, and therefore we may choose to discontinue the operation of this game in the near future.

     Giant Online

     Giant Online is an internally developed modern-era military-themed MMORPG. Giant Online players may assume one of the 14 different roles, such as detectives and spies. As with ZT Online, the game world in Giant Online is divided into numerous kingdoms. Each player must guide his or her character to develop skills and cooperate with other players to fight against players from other kingdoms. In addition to the functions that traditional MMORPGs provide, Giant Online includes a variety of other features and functions that we believe could enhance players’ entertainment experience. Players can equip their characters with a range of modern weapons. Apart from waging war, characters can also engage in various forms of in-game social interaction, such as friendship and even romance.

     Giant Online is a 2.5 dimensional game, or 2.5D game, meaning that the background and items in the game are depicted three dimensionally, while the characters are depicted two dimensionally and the player’s viewing angle is fixed and does not pivot. Although 2.5 dimensional games typically require more computing capacity than two dimensional games such as ZT Online, our product development team has developed server software that effectively offsets technical restraints and facilitates the development of a larger player base.

     Giant Online was developed by an internal studio that we are reorganizing into Juhuo Network, one of our 51% owned game development studios. For a discussion of our ongoing game development studio reorganization, see “Game Development and Sourcing — Game Development.”

     ZT Online Classic Edition

     ZT Online Classic Edition is a version of ZT Online for players who prefer the original monetization features of ZT Online, which we launched in 2006.

     ZT Online Green Edition

     ZT Online Green Edition is a version of ZT Online that features an enhanced in-game economy to benefit lower spending and non-paying accounts, along with additional maps, skills and items.

     King of Kings III

     King of Kings III, or K III, is a three-dimensional MMORPG experience set in a European-style magical world. Players assume the roles of K III heroes as they explore a virtual world of forests, medieval cities and castles. K III is the third episode of the King of

Kings series of MMORPGs, which was first launched in Taiwan in 1999. We acquired the intellectual property rights to K III from Lager Network in the third quarter of 2007. In December 2010, we transferred the intellectual property rights of K III for RMB25 million to our affiliated company Huayi Giant, in which we currently own a 34% interest, and classify this game as licensed rather than acquired as a result of such diposal. Following the sale of our controlling interest in Huayi Giant to Huayi Brothers, we have continued to operate K III but we have done so on transitional basis in cooperation with Huayi Giant. We expect to transfer full operation of K III to Huayi Giant in the future.

     My Sweetie

     My Sweetie is a free-to-play 2.5D casual MMO game, which allows players to create virtual characters, raise virtual pets on their computers and go online to interact with other virtual pet-owners. My Sweetie is the first game developed pursuant to our Win@Giant program. As of the date of this annual report, My Sweetie does not have a material amount of active players, and therefore we may choose to discontinue operation of this game in the near future.

     The Golden Land

     The Golden Land is a free-to-play medieval strategy browser game, which was developed by Juhe Network, one of our 51% owned game development studios.

     XT Online

     XT Online is a free-to-play 2.5D ancient Chinese martial arts MMORPG that was developed by Snow Wolf, a game development studio in which we acquired a 51% interest in May 2009. XT Online enables users to practice different schools or styles of martial arts with the goal of becoming a master, while focusing on brotherhood and trust-building with other martial artists.

     ZT Online II

     ZT Online II is an internally-developed free-to-play 2D sequel to our flagship game ZT Online. ZT Online II features new 2D graphics with vivid background and artwork, enriched gameplay, embedded casual farming experiences, magical pet raising system and a more balanced in-game economy.

     In comparison to ZT Online, which mainly generates the revenue from selling virtual items to users, ZT Online II utilizes a new model in-game economy targeting lower spending and non-spending users, in which revenue is generated from the user’s consumption of game points for trading virtual items created by users themselves. We consider this new model of in-game economy to be a “third generation” in-game economy, which contrasts with first generation time-based games and second generation item-based games like ZT Online.

     ZT Online II was developed by an internal studio that we are reorganizing into Jujia Network, one of our 51% owned game development studios. For a discussion of our ongoing game development studio reorganization, see “Game Development and Sourcing — Game Development.”

     Dragon Soul

     Dragon Soul is an internally developed 3D ancient Chinese MMORPG developed by Chengdu Jufan Network Technology Co. Ltd., or Jufan Network, one of our 51% owned game development studios. Dragon Soul utilizes a self-developed 3D engine, featuring realistic lighting and maps without boundaries.

     Game Pipeline

     The following table sets forth certain information relating to select games from our pipeline as of June 10, 2011.

Game		Style		Game Source		Status
Elsword		Free to Play 3D MMO		License		Localization
Allods Online		Free to Play 3D MMORPG		License		Internal Testing
Spirits of the Warriors		Free to Play 3D MMORPG		Self-Developed		Internal Testing

     Elsword

     In December 2009, we licensed from KOG of South Korea Co., Ltd. or KOG, the mainland China operation rights for Elsword, a 3D side-scrolling, advanced casual MMO. We conducted engineering testing in November of 2010 and anticipate another round of engineer testing in the second quarter of 2011.

     Allods Online

     In January 2010, we licensed from Mail.Ru Inc., or Mail.Ru, the mainland China operation rights for Allods Online, a 3D free-to-play MMORPG developed by Astrum Nival, a studio owned by Mail.Ru. Allods Online is primarily operated in the Russian speaking markets, US, Europe (UK, Germany and France), Turkey, Japan, Brazil, the Philippines and Taiwan.

     Spirits of the Warriors

     Spirits of the Warriors is a free-to-play 3D MMORPG based on the Three Kingdoms period of ancient Chinese history. This game was developed by Julun Network, which became a wholly-owned subsidiary upon completion of our acquisition in November 2010.

Operation of Our Games

     Our platform support team and our maintenance team presently consist of a total of approximately 80 personnel, and are responsible for managing our game platform and our games’ in-game environments, respectively.

     We rely on our platform support team to maintain and upgrade our approximately 4,838 servers in 200 server groups located in Internet data centers in seven cities throughout China. We employ platform support personnel at the locations where our server groups are housed, and therefore are able to resolve any hardware or software issues generally within several hours or less.

     Our maintenance team supervises our games’ in-game environments to ensure that Internet connection and data transmission are adequate and that game features are functioning properly and also to police against harmful or illegal behavior by players. We also use input from our maintenance team when developing game updates and enhancements.

Game Development and Sourcing

     Nine of the eleven games that we currently operate are self-developed. Recently, we have also licensed the rights to operate games from certain third party developers in mainland China. In addition, we expand our game portfolio and our business generally, through acquisitions, investments or other strategic cooperation agreements.

     Game Development

     Nine of the eleven games that we currently operate are self-developed. Our game development process generally begins with the approval of a new game concept by our management team. Following approval by management, game concepts are presented to our design department, which consisted of 158 employees as of December 31, 2010. The design department creates a game development plan, which includes a proposed storyline, technical parameters and baseline artwork.

     We assemble a dedicated development team for each new game project. As of December 31, 2010, we employed 934 game developers, including software programmers, platform technicians and media specialists. Most of our software programmers and platform technicians have extensive game and software development experience. We rely on our quality control department at each stage of the game development process to ensure quality and playability. Our quality control team consisted of approximately 27 members as of December 31, 2010, most of whom have university or graduate degrees.

     In the fourth quarter of 2008, we introduced Win@Giant, an incubation program designed to, among other things, identify, recruit and incentivize talented individuals in the areas of game design and development. In 2009 and 2010, in connection with our Win@Giant initiative, we began to reorganize our game development studios by establishing various subsidiaries that are 51% owned by us and 49% owned by the relevant development team members. Each reorganized studio will focus upon producing and supporting internally developed games, and will be incentivized based upon the success of these games. As a result of this reorganization, Giant Online, one of our existing MMORPGs, will be supported by Juhuo Network, and the development and subsequent support work for ZT Online II will be conducted by Jujia Network. For a discussion of risks relating to our game development studio reorganization, see “Risk Factors — Risks Related to Our Business and Industry — We may not be able to successfully implement our growth strategies, which would materially and adversely affect our revenue, profitability and competitiveness.”

     Game Updates and Enhancement

     For each game in operation we maintain a dedicated team that develops expansion packs, updates and patches. We derive many of our game enhancement ideas from our players by maintaining multiple channels through which they can provide comments and suggestions. These channels include online surveys, online discussion forums, instant messaging and our twenty-four hour telephone hotline.

     Because most of our games are self-developed, we do not need to spend time and resources to localize these games for the China market, which helps to reduce the time required to develop and release expansion packs and updates.

     We release expansion packs, updates and patches for our games on a regular basis. Expansion packs are large enhancements that include many new features and generally require several months to develop. Updates are less extensive than expansion packs, but often include new maps, virtual items and virtual services. We distribute updates electronically through our official game website and in DVD form through our marketing network. Patches are generally designed to fix bugs and are developed and released as needed.

     Game Licensing

     We have recently licensed the rights to operate games in mainland China from certain third party developers. In December 2009 we entered into a license agreement to operate Elswood, which was developed by KOG, and in January 2010 we entered into a license agreement to operate Allods Online, which was developed by Mail.Ru. The cost of games licensed from third party developers generally consists of an upfront licensing fee, which we typically pay in installments, and royalties, which are equal to a percentage of revenues we generate from operating the games. Generally our license agreements expire three years after the commencement of open beta testing. Our licensors also agree to provide us with basic technical support, as well as updates developed for the games we license, each without additional charge during the term of the license.

     Investment, Acquisition and Strategic Cooperation

     We also expand our game portfolio, and our business generally, through acquisition of games developed by third parties, acquisitions or making minority investments in companies both for strategic and financial purposes. For example, in the third quarter of 2007, we acquired the intellectual property rights for K III from Lager Network, a Taiwan-based game developer, in November 2010 we acquired the entire equity interest of Julun Network, an online game developer, and in May 2010 we acquired a controlling equity interest in Snow Wolf, a Hangzhou based game development studio. In addition, we have made minority investments in 51.com, a leading Chinese social networking site, Mobile Embedded Technology Inc., a mobile platform operating company, and Shanghai Ruichuang Network Technology Co., operator of the internet portal website www.2345.com.

     In addition, we explore select investment opportunities that may have strategic value to us or that are purely financial. For example, in April 2011, we committed to invest RMB 958.8 million (US$145.3 million) in a privately held insurance company, though such investment remains subject to the approval of the China Insurance Regulatory Commission. For a discussion of risks

relating to our investment activities, see “Risk Factors — Risks Related to Our Business and Industry — We face certain risks associated with our investment activities, including credit risks related to our held to maturity investment contracts.”

     We also cooperate with other companies to develop and operate online games. For example, in the fourth quarter of 2010, in order to explore the potential convergence between online games and other entertainment media, we established a cooperative relationship with Huayi Brothers, a diverse media, entertainment and leisure group. We sold to Huayi Brothers our controlling interest in Huayi Giant, which holds the intellectual property and development team for K III. Following the sale, Huayi Brothers holds a 51% interest in Huayi Giant, while we hold a 34% interest and the employees of Huayi Giant hold a 15% interest. Although we have continued to operate K III following the sale of our controlling interesting in Huayi Giant, we have done so on a transitional basis in cooperation with Huayi Giant. We expect to transfer full operation of K III to Huayi Giant in the future.

     In addition, in October 2009 we entered into a three year non-exclusive license agreement for ZT Online Green Edition with Shenzhen Tencent Computuer Systems Company Limited, or Tencent. Pursuant to the license, Tencent operates ZT Online Green Edition on its QQ Game platform in exchange for a royalty payable to us.

Distribution and Marketing

     Distribution

     We maintain an official game website dedicated to our games, and we distribute our game software to players for free via that website. We also distribute our free game software on data DVD-ROM disks at selected Internet cafés.

     We distribute our physical prepaid game cards and virtual prepaid game cards through our distribution network and also distribute virtual prepaid game cards through our official game website. Our physical prepaid game cards expire two years after printing, and our virtual prepaid game cards expire one year after issuance.

     Distribution Network

     As of the fourth quarter of 2010, our distribution network includes more than 130 non-exclusive regional distributors. Our distributors purchase our prepaid game cards from us at a pre-set discount. They subsequently resell our prepaid game cards to retail outlets and sub-distributors, who distribute them to Internet cafés, newsstands, convenience stores, software stores and book stores. We require full payment prior to delivery of prepaid game cards to distributors. We provide refunds for unsold inventory after six months under certain circumstances, but only to the extent that the inventory has not already expired. We have not had any refund requests from distributors since we commercially launched our first game in January 2006. We offer distributors a volume-related incentive upon the consummation of sales which is payable every six months in the form of prepaid game cards. We also provide distributors with monthly and annual performance-based bonuses, which have not been significant.

     We generally enter into an annual distribution agreement with each physical and virtual prepaid game card distributor for a designated sales territory. Our distribution agreements contain both pre-set sales targets and pre-set penetration targets, whereby distributors are required to sell our prepaid game cards in a minimum number of Internet cafés in its designated sales territory. We also require that each distributor work closely with and support our marketing team and its activities. Our distribution agreements are not exclusive, and do not prohibit our distributors from working with our competitors.

     Direct Online Sales

     We sell virtual prepaid game cards directly to players through our official game website using an online payment system jointly supported by China Union Pay (a system provided by Shanghai ChinaPay E-Payment Service Co., Ltd), China PnR (a system provided by Shanghai China Payment and Remittance Network Technology Co., Ltd), China Alipay (a system provided by Alipay.com Co., Ltd) and China 19Pay (a system provided by Beijing Speedpay Technology Co., Ltd) to facilitate online payment from most major commercial banks within China. China Union Pay, China PnR and China Alipay charge us service fees of 0.45%, 0.45% and 0.40%, respectively, on our direct sales, which are significantly less than discounts and volume-related incentives given to distributors.

     Licensing of Our Games

     In addition to operating our games in China, we license our games to overseas online game operators in various countries, and to other PRC companies, for operation on their respective platforms. The following table sets forth certain information relating to our material license agreements with third parties for the operation of our games as of June 10, 2011.

Name		Territory of License		Licensee		Date of License
ZT Online		Vietnam		VinaGame Software Service Joint Stock Company		March 2008
ZT Online		Taiwan\Hong Kong\Macau\ Malaysia\ Singapore		Lager Network Technologies Inc.		October 2006
ZT Online		Russia and Russian speaking countries		Astrum Nival LLC		September 2009
ZT Online Green Edition		Mainland China		Tencent		October 2009
The Golden Land		Taiwan\Hong Kong\Macau		King Rex Himedia Co., Ltd		March 2010
Giant Online		Taiwan\Hong Kong\Macau		International Games System Co., Ltd.		April 2010
The Golden Land		Brazil/Turkey		Beijing ELEX Technological Co. Ltd.		July 2010

Name		Territory of License		Licensee		Date of License
The Golden Land		Japan		Aeria Inc.		July 2010
The Golden Land		Thailand		ENMO Company Limited		January 2011
The Golden Land		South Korea		NCSoft Corporation		January 2011
Dragon Soul		USA\Canada\Europe (excluding Russia and Russian speaking countries)		Neonga AG		January 2011
XT Online		Vietnam		FPT Online Joint Stock Company		January 2011
The Golden Land		USA\Canada\Europe (excluding Turkey, Russia and Russian speaking countries)		Aeria Games & Entertainment Inc.		March 2011

     Pursuant to our license agreements, we allow the licensees to exclusively operate, promote, service and distribute our games and game-related products in the licensed territories. In return, we are entitled to ongoing royalties, which are based on the volume of consumption of game points by players with game accounts registered with the licensees. The licensees are generally responsible for the sales and marketing of our games in the given territories. The licensees are also responsible for maintenance of the network infrastructure and customer service, while we are responsible for technical support, including providing upgraded versions and periodic updates of our game. Our license agreements are typically for a term of two to five years.

     In addition, in October 2009, we entered into a three year ZT Online Green Edition — Online Software Cooperation Agreement with Shenzhen Tencent Computer Systems Company Limited, or Tencent, to attract more players to play ZT Online Green Edition from the Tencent QQ Game platform user base. Pursuant to the cooperation agreement, Tencent is entitled to operate ZT Online Green Edition on its QQ Game platform in China and we will receive ongoing royalties.

     Marketing

     As of December 31, 2010, we employed approximately 1,150 liaison personnel in provincial capitals and special municipalities in China. We significantly reduced our sales and marketing staff during 2010 from over 1,550 staff at December 31, 2009 due to a reduction in marketing campaigns and tighter cost controls. In the near-term, we intend to keep our number of liaison personnel at current levels. We advertise our games on Internet portals such as Tencent.com, 17173.com and Sina.com. Our Internet advertisements link visitors directly to our game website, where they can register to play our games.

     Our marketing team organizes promotional events at Internet cafés throughout China. These mainly consist of renting out portions of Internet cafés for players to play our games for free. We believe that this exposes our games to a larger audience and enables us to expand our player base. We also promote our games by distributing marketing posters and promotional souvenirs such as cell phone straps to Internet cafés that are part of our distribution network. We believe that these are effective strategies to reach a broad audience because a large number of our players access our games at Internet cafés.

     We organize in-game promotional events, such as lucky draws, which we believe encourages the development of virtual communities among our players, increases player interest in our games and introduces players to new features of our games. Moreover, we frequently post in-game announcements to promote new features and other improvements to our games and to announce our in-game events.

     Due to the social appeal of online games, word-of-mouth is also a major channel for promoting our games. One of our ongoing marketing strategies is to continue to build our player base and nationwide distribution network to retain our existing players and attract new players.

Pricing

     We sell prepaid game cards through our distributors and game points through our official game website that enable players to purchase virtual items and services for their characters in our games. Each prepaid game card contains a unique access code and password that enables players to add value to their game account. Currently, prepaid game cards and game points may only be used to play one of our online games, although a player may choose which game account, among all accounts held by the player, to apply the prepaid game card or the game points. Players use their prepaid game cards or game points to purchase gold coins, which can then be used to purchase a particular virtual item or service.

     The prepaid game cards offered by our distributors are sold in a variety of denominations, from RMB10 (approximately US$1.52) to RMB500 (approximately US$75.76). Purchasers can also purchase virtual prepaid game points on our official game website for any whole number denomination, starting at a minimum of RMB15 (approximately US$2.27). We generally develop a pricing curve to set the retail prices for the virtual items and services that we offer in our games. Pricing curves are developed primarily based on the magnitude of the advantage to the player’s character that the virtual item or service represents, demand for the virtual item or service, user game playing and payment patterns, and game development costs. Since the commercial launch of ZT Online in January 2006, we have tracked and accumulated player data from our games, which provides us with an extensive database to analyze player patterns and to establish pricing curves for particular types of virtual items and services in our games.

Customer Service

     We regard customer service as one of our key marketing tools and we are committed to providing prompt responses to our players’ inquiries. We provide service to our customers through four principal channels:

	•		our call center, which serves our customers 24 hours per day, seven days per week;
	•		instant messaging;
	•		dedicated online discussion forums; and
	•		e-mail.

     Examples of services we provide include addressing problems in adding game points to game accounts with prepaid game cards, retrieving forgotten passwords and recovering lost game accounts, virtual items and in-game characters. In addition, we also investigate and address irregularities in game operation reported by players, including eliminating cheating programs that are used by players to enable their game characters to acquire superior in-game capabilities.

     As of December 31, 2010, our dedicated customer service team consisted of 347 employees. With the growth of our player base and the expansion of our game portfolio, we expect to continue to expand the size of our customer service team. In addition to providing customer service to our players, our representatives also collect player comments and generate weekly reports for our management and operations that summarize important issues raised by players as well as how such issues have been addressed.

Our Proprietary Technology

     As a developer of MMORPGs, we have focused our technology development efforts on making our games truly massively multiplayer. These efforts have resulted in proprietary server technology that enables a greater number of players to simultaneously interact in our games. This technology allows us to “cluster” together a number of servers to create greater capacity for each of the shards in which our players’ characters exist. For example, in ZT Online, ZT Online PTP, ZT Online Classic Edition, and ZT Online Green Edition over 40,000 players are able to interact in a single shard, which we believe is more than most other MMORPGs in China.

Operational Infrastructure

     We believe we have a reliable and secure operational infrastructure to fully support our games. As of December 31, 2010, our server network for our game operations consisted of approximately 4,838 servers in 200 server groups with the capacity to accommodate up to six million concurrent online users. These servers, all of which are owned by us, are located at Internet data centers in seven major cities in China, consisting of Shanghai, Beijing, Shenzhen, Xi’an, Tianjin, Zhengzhou and Nanjing, each of which has a fully redundant power supply and diesel power generator backup.

     We directly access the Internet backbone network through 82 gigabyte bandwidth lines jointly supplied by China Telecom and China Netcom. Our primary hardware suppliers include Hewlett-Packard, Huawei, Cisco and Network Appliance, and we have entered into agreements with each of them for warranty and maintenance services for our hardware platform. As of December 31, 2010, we employed 54 technical support staff to maintain our current technology infrastructure and develop new software features to further enhance the functionality of our management and security systems.

     We take stringent measures to ensure the security of our players’ data on our servers. We have successfully obtained ISO 27001 certification, which relates to all forms of information security.

Competition

     We compete principally with the following three groups of competitors in China:

	•		domestic online game developers and operators in China, including Nineyou International Limited, Kingsoft Corporation, Perfect World Co., Ltd., Changyou.com Limited, Shanda Games Limited, Tencent Holdings Ltd, Net Dragon, The9 Limited and CDC Corporation.
	•		major Internet portal operators in China, including NetEase.com, Inc. and major Chinese Internet portals, all of which leverage their existing strength in aggregating content, and marketing and cross-selling among their established Internet user base to promote online games; and
	•		overseas online game developers, including Blizzard Entertainment and Webzen Inc.

     Our MMORPGs are currently competing with, among others, the following MMORPGs in China:

	•		Fantasy Westward Journey, developed and operated by NetEase.com, Inc.;
	•		World of Warcraft, developed by Blizzard Entertainment and operated by NetEase.com, Inc. in China;
	•		Tian Long Ba Bu, developed and operated by Changyou.com Limited;
	•		Zhu Xian, developed and operated by Perfect World, Co., Ltd.; and
	•		MIR II, developed by Wemade Entertainment Co. Ltd. and operated by Shanda Games Limited.

     Our existing and potential competitors may compete with us in marketing activities, quality of online games, and for our distribution network. Some of our existing and potential competitors have significantly greater financial and marketing resources than we do. For a discussion of risks relating to competition, see “Risk Factors — Risks Related to Our Business and Industry — We face significant competition, which could reduce our market share and adversely affect our business, financial condition and results of operations.”

Intellectual Property

     Our intellectual property is an essential element of our business operations. Our intellectual property rights include trademarks and domain names associated with the name “Zheng Tu” and “ztgame” in China, and copyrights and other rights associated with our websites, technology platform, self-developed software and other aspects of our business.

     We rely on copyright, trademark, trade secret and other intellectual property law, as well as non-competition, confidentiality and license agreements with our employees, suppliers and business partners to protect our intellectual property rights. Our employees are generally required to enter into agreements pursuant to which they undertake to keep confidential all information relating to our methods, business and trade secrets during, and for two years after, the period of their employment with us.

     We are the registered owner of the following software copyrights in China, each of which we have registered with the State Copyright Bureau of China:

Registered Software		Copyright Owner
ZT Online Software Version 1.0		Zhengtu Information
ZT Online Software Version 2.0		Zhengtu Information
Zhengtu Consolidated User Platform Software Version 1.0		Giant Network
Giant Online Software Version 1.0		Zhengtu Information
ZT Online Software Version 3.0		Zhengtu Information
ZT Online II Software Version 1.0		Zhengtu Information
ZT Online Software Green Edition		Zhengtu Information
My Sweetie Software Version 1.0		Zhengtu Information
The Golden Land Software Version 1.0		Zhengtu Information
XT Online Software Version 1.0		Snow Wolf
Dragon Soul Software Version 1.0		Zhengtu Information
Spirits of the Warriors		Julun Network

     We own the rights to over 29 domain names, including our official websites and domain names registered in connection with ZT Online.

     As of December 31, 2010, we own 286 registered trademarks in China and overseas and are in the process of applying for the registration of 201 trademarks in China and 50 trademarks overseas. Despite our precautions, it may be possible for third parties to obtain and use our intellectual property. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business. See “Risk Factors — Risks Relating to Our Business — Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business.”

     We purchased the intellectual property rights to the MMORPG K III from Lager Network pursuant to a letter of intent executed in May 2007 and a supplemental agreement executed in July 2007. Pursuant to these arrangements, Lager Network perpetually assigned to Zhengtu Information all worldwide rights, title and exclusive license to the computer source code, generic code, game engine, graphic materials, artwork, story lines, music, sound effects, documentation and all other materials related to K III. This includes all patents, patent applications, trademarks, trade names, trade secrets, processes, compositions of matter, formulas, designs, inventions, proprietary rights, know-how and any other confidential or proprietary information embodied by K III, except for certain patents that have been perpetually licensed to Zhengtu Information by Lager Network. Pursuant to the supplemental agreement, we have all rights in any improvements we make to, or any derivative works we make from, K III. Furthermore, Lager Network is required under the supplemental agreement to provide us with maintenance and technical support for K III indefinitely, and assigns to us in advance any improvements to K III developed by it in the course of providing technical support and maintenance. In consideration for this transfer of K III and its related rights to us, we issued 4,000,000 of our ordinary shares to Lager Network’s indirect shareholder, Huth Group Limited.

     In the fourth quarter of 2010, we sold our controlling interest in our joint venture Huayi Giant, which had obtained the intellectual property and development team of our 3D MMORPG K III, to Huayi Brothers. After the share transfer, we and the research and development team each a hold minority stake in the joint venture and Huayi Brothers is now the majority shareholder of Huayi Giant. Following the sale of our controlling interest in Huayi Giant to Huayi Brothers, we have continued to operate K III but we have done so on a transitional basis in cooperation with Huayi Giant. We expect to transfer full operation of K III to Huayi Giant in the near future.

     In addition, in December 2009, we signed an exclusive agreement with KOG to operate Elsword in mainland China. The game is currently expected to begin engineering testing in the second half of 2011.

     In January 2010, we entered into an Exclusive Agreement with Mail.Ru pursuant to which we are authorized to operate Allods Online in mainland China. Allods Online is currently operated in the Russian speaking markets, and is under closed beta testing in Europe and United States. Over the coming months, we will begin engineering testing in the second quarter of 2011.

Insurance

     Insurance companies in China offer limited business insurance products and do not, to our knowledge, offer business liability insurance. While business interruption insurance is available to a limited extent in China, we have determined that the risks of disruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to subscribe for such insurance. As a result, we do not have any business liability, disruption or litigation insurance coverage for our operations in China. Except for legally required automobile liability insurance, we also do not carry any property or casualty insurance. Any business disruption or litigation, or any liability or damage to, or caused by, our facilities or our personnel may result in our incurring substantial costs and the diversion of resources.

     Besides the legally required social insurance, we maintain commercial health insurance and life insurance coverage for all our employees and executive officers. In addition, we maintain directors and officers insurance.

Facilities

     Our principal offices consist of approximately 11,200 square meters of space located at No. 3 Building, 700 Yishan Road, Shanghai, which is a building that we are in the process of purchasing. In addition, our principal research and development facilities are located at 988 Zhongkai Road, Zhongshan Street, Songjiang District, Shanghai, in facilities that consist of approximately 7,500 square meters of office space and 91 staff apartments. We lease our Songjiang facilities from Shanghai Jiante, a related party that is controlled by our chairman and chief executive officer, Mr. Shi. For a discussion of our lease agreement with Shanghai Jiante, see “Item 7.B. Related Party Transactions.” We also lease additional office space in Shanghai, Chengdu, Hangzhou, Beijing, Wuxi and Zhuhai. We believe our existing facilities are adequate for our current requirements and that additional space can be obtained on commercially reasonable terms to meet our future requirements.

Legal and Administrative Proceedings

     We may from time to time become a party to various legal or administrative proceedings arising in the ordinary course of our business.

     On November 26 and December 20, 2007, Pyramid Holdings, Inc. and Rosie L. Brooks, respectively, filed a class action against us in the United States District Court, Southern District of New York, for alleged violations of federal securities laws with our initial public offering. On July 30, 2008, the Court consolidated these actions into one class action and appointed a group of individual shareholders made up of Dunping Qui, Xie Yong, Linming Shi, and Arthur Michael Gray, or the Qui Group, and their counsel as lead plaintiffs and lead plaintiffs’ counsel, respectively, under the Private Securities Litigation Reform Act.

     On October 6, 2008, the Qui Group filed a consolidated amended complaint, or the Complaint, asserting claims for violations of Sections 11 and 12(a)(2) of the Securities Act of 1933. The Complaint alleges that plaintiffs purchased ADSs issued pursuant to or traceable to our initial public offering and that the registration statement and prospectus for that offering contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading and were not prepared in accordance with the applicable rules and regulations.

     Specifically, the Complaint alleges that prior to our initial public offering, we implemented a rule change to discourage “gold farming activities” in ZT Online. Gold farming occurs when companies hire individuals to play the game to generate online currency that is sold on third party websites for cash. According to the Complaint, this rule change caused a decline in average concurrent users, or ACU, and peak concurrent users, or PCU, and that the registration statement and prospectus in connection with our initial public offering failed adequately to disclose these declines. The Complaint seeks a declaration that action is a proper class action; damages to class members with interest; that the initial public offering be rescinded; and litigation costs and expenses, including attorneys’ fees, accountants’ fees and experts’ fees.

     We filed a motion to dismiss the Complaint for failure to state a claim on November 21, 2008. This motion has been fully briefed and was deemed submitted to the Court for decision as of February 25, 2009. On August 5, 2009, the Court denied our motion to dismiss the Complaint, because the Court required more facts and evidence prior to making the ruling. Following document and deposition discovery, the parties participated in a mediation in March 2011. We are currently in negotiations to settle this lawsuit. As negotiations are still ongoing, our management, after consulting its external legal counsel, determined that it is unable to assess or conclude on the likelihood of an unfavorable outcome or any possible loss to the Company. In the event that we reach a settlement with the counterparty and obtain relevant approval from the Court, the settlement payment will be made solely by our insurers to the counterparty directly and we do not expect to record any loss related to this settlement.

Regulation

     Our business, including the operation of online games and the posting of online game-related content on our websites, is subject to various Chinese laws and regulations relating to the telecommunications industry, the Internet and the online game industry, and is regulated by various government authorities, including the State Council, the Ministry of Information Industry, or MII, the GAPP, the State Administration for Industry and Commerce, or SAIC, the Ministry of Culture, or MOC, the National Copyright Administration, or NCA, the Ministry of Public Security, or MPS, and the Bureau of State Secrecy, or BSS.

     The principal Chinese regulations governing Internet content as well as online game services in China include:

	•		Telecommunications Regulations (2000);
	•		the Administrative Rules for Foreign Investments in Telecommunications Enterprises (2008);
	•		the Administrative Measures for Telecommunications Business Operating Licenses (2009);
	•		the Internet Information Services Administrative Measures (2000);
	•		the Tentative Measures for Administration of Internet Culture (2011);
	•		the Notice on Issues Relating to the Implementation of The Tentative Measures for Administration of Internet Culture (2011);
	•		the Tentative Measures for Administration of Internet Publication (2002);
	•		the Foreign Investment Industrial Guidance Catalogue (2007);
	•		the Administrative Measures on Software Products (2009);
	•		the Notice on Enhancing the Content Review Work of Online Game Products (2004);
	•		Some Opinions of the Ministry of Culture and the Ministry of Information Industry on the Development and Administration of Online Games (2005);
	•		the Notice on the Work of Purification of Online Games (2005);

	•		the Notice on Strengthening the Administration of Foreign Investment in the Operation of Value-Added Telecommunication Business (2006);
	•		the Notice on the Implementation of Online Game Anti-addiction System to Protect the Physical and Psychological Health of Minors (2007);
	•		the Administrative Measures on Internet Electronic Bulletin Board Services (2000);
	•		the Measures on Computer Software Copyright Registration (2002);
	•		the Notice of the Ministry of Culture on Enhancing the Supervision on Internet Culture Market (2002);
	•		the Notice relating to Further Strengthening the Administration Work on Internet Cafés and Internet Games (2007);
	•		the Administrative Provisions on the Publishing of Electronic Publications (2008);
	•		the Notice on Strengthening the Administration of the Virtual Currency in Online Games (2009);
	•		the Notice Regarding the Consistent Implementation of the Stipulations on “Three Provisions” of the State Council and the Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Pre-examination and Approval of Internet Games and the Examination and Approval of Imported Internet Games (2009);
	•		the Notice on Improving and Strengthening the Administration of Content in Online Games (2009);
	•		the Tentative Measures for Online Game Administration (2010) ; and
	•		the Notice on the Implementation of the Tentative Measures for Online Game Administration (2010).

Restrictions on Foreign Ownership

     Current Chinese laws and regulations impose substantial restrictions on foreign ownership of Internet content and online game businesses in China. Pursuant to these regulations, a foreign investor is currently prohibited from owning more than 50.0% of the equity interest in a foreign-invested telecommunications enterprise that provides value-added telecommunications services (including wireless paging business in basic telecommunications services). Internet content services are classified as basic telecommunications businesses and value-added telecommunications businesses. In addition, foreign-owned enterprises are currently not permitted to apply for licenses to operate online games in China. As a result, we conduct our Internet content and online game businesses in China through contractual arrangements entered into between our PRC subsidiary, Shanghai Zhengtu Information Technology Co., Ltd, or Zhengtu Information, and Shanghai Giant Network Technology Co., Ltd, or Giant Network, which is wholly owned by Lv Zhang, Wei Liu, Chen Cheng, Tao Yue, Kai Chen, Haixiao Lin, Yonggui Wang, Fabing Qu, Yuliang Feng and Shanghai Lan Lin Bio-Technology Co., Ltd, all of whom are PRC citizens or entities.

     In July 2006, the MII issued the Notice on Strengthening the Administration of Foreign Investment in the Operation of Value Added Telecommunication Business, or the New MII Notice, which reiterates certain provisions under the Administrative Rules on Telecommunications Enterprises. According to the New MII Notice, foreign investors can only operate a telecommunications business in China by establishing a telecommunications enterprise with a valid telecommunications business operation license. Domestic ICP license holders are prohibited from leasing, transferring or selling telecommunications business operation licenses to foreign investors in any form, or providing any resource, sites or facilities to foreign investors to facilitate the illegal operation of telecommunications business in China. The New MII Notice also requires that ICP license holders (including their shareholders) directly own the domain names and registered trademarks used by such ICP license holders in their daily operations. The New MII Notice further requires each ICP license holder to have the necessary facilities for its approved business operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunication service providers are required to improve the network and information security, draft relevant information safety administration regulations and set up networks and information safety emergency plans. The provincial communications administration bureaus in charge of telecommunications services are required to ensure that existing ICP license holders will conduct a self-assessment of their compliance with the New MII Notice and to submit status reports to the MII before November 1, 2006. For those who are not in compliance with the above requirements and fail to rectify the noncompliance within the limited period set by provincial communications administration bureaus, the provincial communications administration bureaus may revoke their operating licenses.

     In September 2009, the GAPP, the State Bureau of Copyright and the National Office of Combating Pornography and Illegal Publications jointly published the Notice Regarding the Consistent Implementation of the Stipulations on “Three Provisions” of the State Council and the Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Pre-examination and Approval of Internet Games and the Examination and Approval of Imported Internet Games, or the GAPP Notice. The GAPP Notice restates the general principle espoused in recently promulgated regulations that foreign investment is not permitted in Internet game operating businesses in China. Article IV of the GAPP Notice prohibits foreign investors from participating in Internet game operating businesses via wholly owned, equity joint venture or cooperative joint venture investments in China, and from controlling and participating in such businesses directly or indirectly through contractual or technical support arrangements. In the event of a violation of these provisions, GAPP shall, in conjunction with the relevant departments of the State, investigate and handle the same in accordance with the law. In serious cases, the relevant licenses and registrations shall be cancelled. See “Risk Factors — Risks Related to the Regulation of Our Business — Substantial uncertainties and restrictions exist with respect to the application and implementation of PRC laws and regulations in the online game industry. If the PRC government finds that our past or current structure for our business operations does not comply with PRC laws and regulations, we could be subject to severe penalties, including the shutting down of our operations.”

     In the opinion of our PRC legal counsel, Grandall Legal Group (Shanghai), subject to the interpretation and implementation of the GAPP notice, the ownership structure of Zhengtu Information and Giant Network and our contractual arrangements with Giant Network and its shareholders comply with all existing PRC laws, rules and regulations. However, in the opinion of our PRC legal counsel, there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations and there may be changes and other developments in the PRC laws and regulations or their interpretations. Accordingly, we cannot assure you that Chinese government authorities will ultimately take a view that is consistent with the opinion of our PRC legal counsel.

Regulation of Licenses

     Online game operators are required to hold a variety of permits and licenses, which, among others, include:

     ICP License. Under current Chinese laws and regulations, a commercial operator of Internet content services must obtain a value-added telecommunications business operating license for Internet content from the appropriate telecommunications authorities in order to carry on any commercial Internet content operations in China. At present, our affiliated entity Giant Network holds a valid ICP License.

     Internet Culture Operation License. With respect to the online game industry in China, since online games fall into the definition of “Internet culture products” under the Tentative Measures for Administration of Internet Culture (2011), a commercial operator of online games must, in addition to the ICP license, obtain an Internet culture operation license from the appropriate culture administrative authorities for its operation of online games. At present, Giant Network holds a valid Internet culture operation license.

     Internet Publishing License. The GAPP and the MII jointly impose a license requirement for any company that intends to engage in Internet publishing, defined as any online transmission act by an Internet information service provider to select, edit and publish content or programs on the internet or transmit such content or programs to for public browsing, perusal, use or downloading. According to the Tentative Measures for Administration of Internet Publication (2002), the provision of online games is deemed an Internet publication activity. Therefore, an online game operator must obtain the approval from the appropriate press and publication administrative authorities as an Internet publisher in order to carry on its online game businesses in China. Giant Network does not hold an Internet publishing license, and is currently publishing our online games through third parties who own Internet publishing licenses, consistent with the current practice of our competitors and other entities in China.

     Online Bulletin Board Service Approval. The MII has promulgated rules requiring ICP license holders that provide online discussion forum services to obtain approval from, the relevant telecommunication authorities. Giant Network has received these approvals in connection with the discussion forums that we operate.

     In addition to the aforementioned permits and licenses that are required for online game operators, additional permits or licenses are required for each online game that an operator operates. These include, among others, those set forth below in “Regulation of Internet Content” and “Regulation of Information Security.”

Regulation of Internet Content

     The Chinese government has promulgated measures relating to Internet content through a number of ministries and agencies, including the MII, the MOC and the GAPP. These measures specifically prohibit Internet activities, which include the operation of online games that result in the publication of any content which is found to, among other things, propagate obscenity, gambling or violence, instigate crimes, undermine public morality or the cultural traditions of China, or compromise State security or secrets. If an ICP license holder violates these measures, the Chinese government may revoke its ICP license and shut down its websites. Under the Administrative Provisions on the Publishing of Electronic Publications promulgated on February 21, 2008 and other regulations issued by GAPP, if a PRC company is contractually authorized to publish online games imported or licensed from abroad, it must obtain the approval of, and register the copyright license contract with, GAPP. In addition, according to the Notice on the Work of Purification of Online Games jointly issued by the MOC, the MII and other governmental authorities in June 2005, online games must be registered and filed as software products in accordance with the Administrative Measures on Software Products for the purpose of being operated in China. Furthermore, in accordance with the Notice on Enhancing the Content Review Work of Online Game Products (2004) promulgated by the MOC, imported and domestic online games are subject to a content review by or filing with the MOC prior to operation of the same in China. On April 24, 2009, the MOC issued the Public Announcement on Regulating Applications for the Examination of the Content of Imported Online Game, or the Announcement. The Announcement emphasizes that enterprises operating imported online games must have the content of those games examined and approved by the MOC. On November 13, 2009, the MOC issued the Circular on Improving and Strengthening the Administration of Content in Online Games. This circular emphasizes that a correct culture value tendency shall be maintained to enhance the culture implication in online games, and modes of the games which mainly comprise of upgrading by killing beasts, the PK system and the marriage system in the game shall be restricted to protect minor game players by guiding them in registration and limiting their gaming time through technical measures. This circular also requires online game operators to establish and maintain committees to monitor game content.

     On June 3, 2010, the MOC issued the Tentative Measures for Online Game Administration, or the Online Game Measures (effective on August 1, 2010). The Online Game Measures defines “online games” as “game products and services composed of software programs and information databases, provided via the internet or mobile networks or other information networks” and requires that domestic online games must be filed with the MOC within 30 days of their initial launch and in case of any substantial change (for example, any prominent modification to a game’s storyline, language, tasks or trading system). The Online Game Measures also require that all imported online games be subject to content review prior to their launch.

     On July 30, 2010, the MOC issued the Notice on the Implementation of the Tentative Measures for Online Game Administration, which took effect on date of its issuance. This notice emphasizes the protection of minors playing online games and requests online game operators to promote real-name registration of their game users.

Regulation of Information Security

     Internet content in China is also regulated and restricted in relation to state security. The Standing Committee of the National People’s Congress, China’s national legislative body, has enacted a law that can subject offenders to criminal punishment in China if he or she engages in any effort to: (1) gain improper entry into a computer or system of strategic importance; (2) disseminate politically disruptive information; (3) leak state secrets; (4) spread false commercial information; or (5) infringe intellectual property rights.

     The MPS has promulgated measures that prohibit use of the Internet in ways which, among other things, result in a leakage of state secrets or a spread of socially destabilizing content. The MPS has supervision and inspection rights in this regard, and we may be subject to the jurisdiction of its local security bureaus. If an ICP license holder violates these measures, the Chinese government may revoke its ICP license and shut down its websites.

Import and Export Regulation

     Our ability to obtain intellectual property rights to online games from outside of China and from Hong Kong, Macau and Taiwan is subject to several regulatory restrictions. We are required to obtain approval of imported Internet games from the GAPP. In the event our imported Internet games operation services in China have not been examined and approved by the GAPP, the GAPP may inform the relevant local department for the administration of press and publication to ban the same in accordance with the law and suspend the our relevant operation, and inform the department for the administration of telecommunications to cancel the relevant Internet access service and close down the related websites. The Ministry of Commerce requires us to register any agreement with an exporter of technology, including those exporters based in Hong Kong, Macau, Taiwan and areas outside of China, whenever we import technologies such as online game software into China. In addition, the Ministry of Culture requires us to submit each online game that we wish to import for content review and approval. If we import into China and operate online games without obtaining game content approval, the Ministry of Culture may impose certain penalties on us, including the revocation of our Internet culture operation license that we require to operate online games in China. Furthermore, the State Copyright Bureau requires us to register copyright import agreements that relate to imported software. Without completing registration with the State Copyright Bureau, we are not permitted to publish or reproduce imported game software in China. The Ministry of Information Industry also requires us to register online games that we wish to import into China. We require this registration in order to operate an imported online game in China.

     Our ability to export our software is regulated in various ways. According to the Software Export Administration and Statistic Measures jointly issued by the Ministry of Commerce, the Ministry of Science and Technology, the National Bureau of Statistics of China and SAFE on October 25, 2001, we are also required to submit our software export contracts to the data center of the Ministry of Commerce and obtain a registration license. In addition, if the software is deemed to be software for which exports are restricted, we are required to obtain the Ministry of Commerce’s approval before we may begin substantial negotiations regarding the software export and we are also required to obtain an approval certificate from the Ministry of Commerce before we sign the software export contract. If our software is deemed to contain a national secret, we must obtain approval from the Ministry of Science and Technology before we may commence substantial negotiations regarding the software export.

Intellectual Property Rights

     China has adopted comprehensive legislation governing intellectual property rights, including trademarks, patents and copyrights. China has adhered to the main international conventions on intellectual property rights and has become a member of the Agreement on Trade Related Aspects of Intellectual Property Rights upon its accession to the World Trade Organization in December 2001.

     China amended its Copyright Law in 2001 and 2010 to widen the scope of works eligible for copyright protection. The amended Copyright Law extends copyright protection to cover Internet activities and products disseminated over the Internet. Copyrighted software is protected under the Copyright Law and other regulations. In addition, there is a voluntary registration system administered by the China Copyright Protection Center.

     Registered trademarks are protected under the Trademark Law adopted in 1982 and revised in 2001. Trademarks can be registered with the Trademark Office of the SAIC for renewable ten-year periods. Trademark license agreements are required to be filed with the Trademark Office of the SAIC.

     The PRC Patent Law protects external design patents, invention patents and utility patents. Invention patents are valid for 20 years, whereas utility patents and external design patents are each valid for 10 years.

     The MII amended its Administrative Measures on China Internet Domain Names in the PRC in 2004. According to the revised regulation, domain name owners are required to register their domain names. The regulation prohibits the registration and use of domain names with the following content that may:

	•		be in violation of the basic principles set forth in the PRC Constitution;
	•		jeopardize state security, disclose any state secret, subvert state power or harm national unification;
	•		damage state honor or interests;
	•		incite ethnic hatred or discrimination or damage ethnical unity;

	•		harm state religious policies or advocate heresy or feudal superstition;
	•		disseminate rumors, disrupt social order or sabotage social stability;
	•		disseminate obscenity, pornography or induce gambling, violence, murder, terror or other crimes;
	•		humiliate or slander any other person, or infringe the legal interests of any other person; or
	•		be otherwise prohibited by the PRC laws or administrative regulations.

     Domain name disputes are governed by the Measures on Domain Name Dispute Resolution of China Internet Network Information Center promulgated by CNNIC, and amended on February 14, 2006 and becoming effective as of March 17, 2006, under which CNNIC can authorize domain name dispute resolution institutions to decide such disputes.

     On May 18, 2006, the State Council promulgated the Regulations on Protection of the Right of Dissemination through Information Networks, which became effective on July 1, 2006. The new regulations require that every organization or individual who disseminates a third party’s work, performance, audio or visual recording products to the public through information networks shall obtain permission from, and pay compensation to, the legitimate copyright owner of such products, unless otherwise provided under relevant laws and regulations. The legitimate copyright owner may take technical measures to protect his or her right of dissemination through information networks and any organization or individual shall not intentionally avoid, destroy or otherwise assist others in avoiding such protective measures unless permissible under law.

Software Copyright Regulations

     In order to protect the rights and interests of computer software copyright owners, on December 20, 2001 the State Council enacted Regulations on the Protection of Computer Software which became effective on January 1, 2002. Subsequently, the State Bureau of Copyright formulated the Measures on the Registration of Computer Software Copyright on February 20, 2002. According to the Regulations on the Protection of Computer Software, anyone who publishes, revises or translates computer software without the owner’s approval shall be civilly liable. For the software copyrights of legal persons or other organizations, the term of protection for the software copyright is 50 years, ending on December 31 of the fiftieth year after the first publication of the software. The software copyright owner may follow registration procedures with the State Bureau of Copyright and obtain a Registration Certificate of Software Copyright, which is the prima facie proof of copyright ownership.

Software Development Activity Regulations

     On October 27, 2000, the MII issued the Administrative Measures on Software Products to regulate software products and promote the development of the software industry in the PRC. This regulation has been amended and replaced by the new Software Measures issued by the MII on March 1, 2009, effective as of April 10, 2009. Pursuant to the new Software Measures, software developers or producers are allowed to sell or license their software products independently or through agents. Software products developed in the PRC can be registered with the local provincial government authorities in charge of the information industry and filed with the MII. Upon registration, the software products shall be granted registration certificates. Each registration certificate is valid for five years and may be renewed upon expiration. Software products developed in the PRC that satisfy the requirements of the Software Measures and have been registered and filed in accordance with the Software Measures may enjoy preferential treatments under relevant policy of the State Council. The MII and other relevant departments may supervise and inspect the development, production, sale and import and export of software products in the PRC.

Internet Café Regulation

     Internet cafés are required to obtain an Internet Culture Operation license from the MOC and then register with the SAIC, and are subject to requirements and regulations with respect to their location, size, number of computers, business hours and the age limit of our customers. For instance, a regulation prohibits Internet cafés from operating during the hours from 12 a.m. to 8 a.m. and from granting minors access to Internet cafés. Although we do not own or operate any Internet cafés, many Internet cafés distribute our prepaid game cards. The Chinese government has promulgated several regulations administrating Internet cafés, thereby intensifying restrictions on Internet cafés, which are currently the primary retail outlets for our prepaid game cards and venue for players to play our online games. A notice jointly issued by 14 PRC national government authorities, including the MII, the MOC and the GAPP in February 2007 suspended nationwide approval for the establishment of new Internet cafés in 2007 and enhanced the punishment for Internet cafés admitting minors. Intensified government regulation of Internet cafés could restrict our ability to maintain or increase our net revenues and expand our player base.

Virtual Currency Regulations

     According to the Notice relating to Further Strengthening the Administration Work on Internet Cafés and Internet Games, the People’s Bank of China has been directed to strengthen the administration of the virtual currency in Internet games to avoid any adverse impact to the real economic and financial order. This notice provides that the total amount of the virtual currency issued by Internet game operators and the amount purchased by individual users should be strictly limited, the virtual transactions and the real transactions by way of electronic commerce should be strictly divided, and virtual currency should only be used to purchase virtual items.

     In June 2009, the MOC and the Ministry of Commerce jointly published the Notice on Strengthening the Administration Work of the Virtual Currency in Online Games, or the Virtual Currency Notice, to require businesses that (i) issue online game virtual currency (in the form of prepaid cards and/or pre-payment or prepaid card points) or (ii) offer online game virtual currency transaction services to apply for approval from the MOC through its provincial branches within three months following the date of such notice. The Virtual Currency Notice prohibits businesses that issue online game virtual currency from providing services that would enable the trading of such virtual currency. Any business that fails to submit the requisite application will be subject to sanctions, including

but not limited to warnings, mandatory corrective measures and fines. The Virtual Currency Notice also prohibits online game operators from allocating virtual items or virtual currency to players based on random selection through lucky draw, wager or lottery which involves cash or virtual currency directly paid by the players. The Virtual Currency Notice also regulates, among other things, that game operators may not issue virtual currency to game players through means other than purchased by game players with legal currency. Moreover, any businesses that do not provide online game virtual currency transaction services are required to adopt technical measures to restrict the transfer of online game virtual currency among accounts of different game players.

     On July 20, 2009, the MOC promulgated the Filing Guidelines on Online Game Virtual Currency Issuing Enterprises and Online Game Virtual Currency Trading Enterprises, which specifically defines “issuing enterprise” and “trading enterprise” and stipulates that a single enterprise may not operate both types of business. For further clarifying virtual currency operations, in the Online Game Measures, the MOC establishes that the issuance of virtual currency falls within the scope of “online game operations” and provides, among other things, that virtual currency issued by online game operators may only be used in exchange for the operator’s own online game products and services and may not be used to pay for the products and services of other entities. In addition, when applying for permission to issue virtual currency, a virtual currency issuer must file detailed information about its currency with the MOC, including form, extent of circulation, unit purchase price, and how the virtual currency will be refunded upon termination of services. Issuers are prohibited from altering the unit purchase price of the virtual currency after filing, and must complete filing procedures with the MOC or its local counterparts before issuing new types of virtual currency.

     On May 31, 2010, the SAIC issued the Tentative Measures for the Administration of Online Commodities Trading and Relevant Services, or the Online Commodities Trading Measures, which took effect on July 1, 2010, to regulate online commodity trading and online service activities. The Online Commodities Trading Measures stipulate various obligations of online service providers, and particularly their obligation to protect the interests of customers. Under the Online Commodities Trading Measures, online service providers must ensure that information they release online is authentic, accurate, complete and sufficient and must comply with all applicable laws in respect of intellectual property rights protection and anti-unfair competition.

Privacy Protection

     Chinese law does not prohibit Internet content providers from collecting and analyzing personal information from their users. We require our players to accept a user agreement whereby they agree to provide certain personal information to us. Chinese law prohibits Internet content providers from disclosing to any third parties any information transmitted by users through their networks unless otherwise permitted by law. If an Internet content provider violates these regulations, the MII or its local bureaus may impose penalties, and the Internet content provider may be liable for damages caused to its users.

Protection of Minors

     In April 2007, eight government authorities, including among others the MII, the GAPP and the Ministry of Education, jointly issued the Notice on the Implementation of Online Game Anti-addiction System to Protect the Physical and Psychological Health of Minors, or the Anti-Addiction Notice, requiring all Chinese game operators to adopt an “anti-addiction system” in an effort to curb addictive behavior by minors (defined as those under the age of 18 years). Under the Anti-Addiction Notice, three hours or less of continuous play by minors is considered to be “healthy,” three to five hours of continuous play by minors is considered to be “fatiguing,” and five hours or more of continuous play by minors is considered to be “unhealthy.” Game operators are required to reduce the value of game benefits by half if the minor player has reached the “fatiguing” level, and to reduce the value of game benefits to zero if the minor player has reached the “unhealthy” level. The Anti-Addiction Notice does not limit adults’ playing time. In order to implement the Anti-Addiction Notice, game operators must adopt a real-name registration system, which will require online game players to register their real identification information before they can play online games to verify their age and identity. Failure to comply with the requirements under the Anti-Addiction Notice may subject us to penalties, including but not limited to suspension of our operation of online games, revocation of our licenses and approvals for our operations, rejection or suspension of our application for approvals, licenses, or filings for any new game, or prohibiting us from operating any new game.

     On January 15, 2011, MOC, MII and six other central government authorities jointly issued a circular entitled Implementation of Online Game Monitor System of the Guardians of Minors, or the Monitor System Circular, aiming to provide specific protection measures to monitor the online game activities of minors and curb addictive online game playing behaviors of minors. Under the Monitor System Circular, online game operators are required to adopt various measures to maintain a system to communicate with the parents or other guardians of minors playing online games and online game operators are required to monitor the online game activities of minors, and must suspend the account of a minor if so requested by the minor’s parents or guardians. The monitoring system has been formally implemented commencing March 1, 2011.

Employment Contracts

     On June 29, 2007, the National People’s Congress promulgated the Employment Contract Law of PRC, or ECL, which became effective as of January 1, 2008. The ECL requires employers to provide written contracts to their employees, restricts the use of temporary workers and aims to give employees long-term job security.

     Pursuant to the ECL, employment contracts lawfully concluded prior to the implementation of the ECL and continuing as of the date of its implementation shall continue to be performed. Where an employment relationship was established prior to the implementation of the ECL but no written employment contract was concluded, a contract must be concluded within one month after its implementation.

Overseas Investment by Domestic Resident Regulations

     In October 2005, SAFE issued the Notice on Issues Relating to the Administration of Foreign Exchange in Fund-raising and Return Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Notice 75, which

became effective as of November 1, 2005. Under Notice 75, PRC residents, whether natural or legal person, must register with the relevant local SAFE branch prior to their establishment or control of an offshore entity established for the purpose of overseas equity financing involving onshore assets or equity interests held by them, and must also make filings with SAFE thereafter upon the occurrence of certain material capital changes. The notice applies retroactively to direct or indirect investments previously made by PRC residents in offshore companies. SAFE issued subsequent guidance to its local branches for implementing Notice 75. The guidance standardizes more specific and stringent supervision on the registration relating to Notice 75. Specifically it requires PRC residents holding any equity interest in special purpose vehicles, or SPVs, directly or indirectly, controlling or nominal, to make registration with SAFE and imposes obligations on the PRC subsidiaries of SPVs to facilitate and urge registrations by relevant PRC residents and to file with SAFE the stock options granted by SPVs to any PRC resident. The registration and filing procedures under Notice 75 are prerequisites for other approval and registration procedures necessary for capital inflow from the offshore entity, such as inbound investments or shareholders loans, or capital outflow to the offshore entity, such as the payment of profits or dividends, liquisocial networking distributions, equity sale proceeds, or the return of funds upon a capital reduction.

New M&A Regulations and Overseas Listings

     In August 8, 2006, six government agencies including the Ministry of Commerce, the State Assets Supervision and Administration Commission, or SASAC, the State Administration for Taxation, the State Administration for Industry and Commerce, the CSRC, and SAFE, jointly promulgated a regulation entitled “Regulation on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors,” or the New M&A Rule. Under the New M&A Rule, effective as of September 8, 2006, acquisition of any PRC enterprise, directly or indirectly, by a foreign investor need to be approved by Ministry of Commerce or its local branches; and furthermore, when such investor and the acquired PRC enterprise have any affiliating relationship, special approval from Ministry of Commerce is required. The New M&A Rule also contains a provision requiring offshore SPVs formed for listing purposes through acquisitions of PRC domestic companies and controlled by PRC individuals to obtain the approval of the CSRC prior to publicly listing their securities on an overseas stock exchange.

     On September 21, 2006, the CSRC published on its official website procedures regarding its approval of overseas listings by SPVs. The CSRC approval procedures require the filing of a number of documents with the CSRC and it would take several months to complete the approval process. However, other than documents required to be submitted, no other details with respect to the timing, criteria and process for obtaining any required approval from CSRC have been specified. Therefore, it remains unclear how the New M&A Rule or the CSRC procedures will be interpreted, amended and implemented by the relevant authorities.

Employee Share Options

     In December 2006, the People’s Bank of China promulgated the Administrative Measures on Individual Person Foreign Exchange, or the PBOC Regulation, setting forth the respective requirements for foreign exchange transactions by individuals (both PRC or non-PRC citizens) under the current account and the capital account. In January 2007, SAFE issued the implementation rules for the PBOC Regulation which, among others, specified the approval requirement for certain capital account transactions such as a PRC citizen’s participation in the employee stock ownership plan or stock options plan of an overseas listed company. On March 28, 2007, SAFE promulgated the Implementing Procedures on Administration of Foreign Exchange regarding PRC Individuals’ Participating in Employee Stock Ownership Plan and Stock Option Plan of Overseas Listed Companies, or the Stock Option Rule, to further clarify the formalities and application documents in connection with the subject matter. Under the Stock Option Rule, PRC individuals who will participate in the employment stock ownership plan or the stock option plan of an overseas listed company are required to appoint a domestic agent to deal with the relevant foreign exchange matters in the PRC. For participants of an employment stock ownership plan, an overseas custodian bank should be retained by the domestic agent to hold on trusteeship all overseas assets held by such participants under the employment stock ownership plan. In the case of a stock option plan, a financial institution with stock brokerage qualification at the place where the overseas listed company is listed or a qualified institution designated by the overseas listed company is required to be retained to handle matters in connection with exercise or sale of stock options for the stock option plan participants. For participants who had already participated in an employment stock ownership plan or stock option plan before the date of the Stock Option Rule, the Stock Option Rule requires their domestic employers or domestic agents to make up for the relevant formalities within three months of the date of the Stock Option Rule. Failure to comply with the Stock Option Rule may subject the plan participants, the company offering the plan or the relevant intermediaries, as the case may be, to penalties under PRC foreign exchange regime. However, as these rules have only been recently promulgated, it is currently unclear as to how these rules will be interpreted and implemented. In addition, the General Administration of Taxation has issued certain circulars concerning employee stock options. Pursuant to these circulars, our employees working in China who exercise stock options will be subject to PRC individual income tax. Our PRC subsidiaries have obligations to file documents related to employee stock options with relevant tax authorities and withhold individual income taxes of those employees who exercise their stock options. If our employees fail to pay and we fail to withhold their income taxes, we may face sanctions imposed by tax authorities or any other PRC government authorities.

C. Organizational Structure

     The following diagram illustrates our current corporate structure and the place of formation and affiliation of each of our subsidiaries and our affiliated entity as of the date of this annual report: ⁽¹⁾

     

Contractual Arrangements with the Consolidated Affiliated Entity and Its Shareholders

     Our relationships with Giant Network, our affiliated entity, and its shareholders are governed by a series of contractual arrangements. These contractual arrangements are as set forth below. Amendments to the contractual agreements set forth below (including but not limited to any change in pricing, loan approval or payment of dividends), must be approved by our board of directors.

     Under Chinese law, Giant Network is an independent legal person and is not exposed to liabilities incurred by us; however, Zhengtu Information effectively has control over Giant Network through control of Giant Network’s management and the assignment to Zhengtu Information of Giant Network’s shareholders’ rights. Other than pursuant to the contractual arrangements between Giant Network and Zhengtu Information, Giant Network does not transfer any other funds generated from its operations to us.

     Agreements that Provide Us with the Substantial Ability to Control and an Option to Acquire Giant Network

     We have entered into certain agreements that provide us with the substantial ability to control Giant Network and its shareholders, and we have obtained an exclusive option to purchase all of the equity interests of Giant Network. These agreements include:

	•		Irrevocable Powers of Attorney. Under irrevocable powers of attorney, each of the shareholders of Giant Network has granted to the designee of Zhengtu Information, Yuzhu Shi, the power to exercise all voting rights of such shareholder in shareholders’ meetings, including but not limited to the power to determine the sale or transfer of all or part of such shareholder’s equity interest in, and appoint and elect the directors, general managers and other senior management of Giant Network. No payments are required to be made under these irrevocable powers of attorney. These irrevocable powers of attorney have terms of ten years and will be automatically renewed for another ten years unless otherwise objected to by Zhengtu Information. However, these irrevocable powers of attorney will be terminated if Zhengtu Information replaces the designee, at which time each of the shareholders will issue a new power of attorney to such new designee.
	•		Share Pledge Agreement. Under the share pledge agreement by and among Zhengtu Information, Giant Network and shareholders of Giant Network, each of the shareholders of Giant Network has pledged all of its equity interests in Giant Network to Zhengtu Information to guarantee the performance of Giant Network under the relevant service agreements including the exclusive technical consulting and service agreement, the online game software sales and licensing agreement and other paid services or licensing agreements that are entered into between Zhengtu Information and Giant Network from time to time. Each of the shareholders of Giant Network also agreed that, without the prior written consent of Zhengtu Information, it will not transfer or create a pledge over its equity interests in Giant Network, or cause board or shareholder meetings of Giant Network to pass any resolution to sell, transfer or create a pledge over its equity interests in Giant Network, except if such transfer is conducted pursuant to the purchase option and cooperation agreement or would not affect the pledge’s effectiveness by and among the shareholders of Giant Network, as pledgers, with prior written notice to Zhengtu Information.
			In the event Giant Network is liquidated or dissolved, subject to any requirements under applicable PRC law, all of its assets must be sold to Zhengtu Information or an eligible party designated by Zhengtu Information at a purchase price equal to the net assets of Giant Network or the minimum price permissible by PRC law. Giant Network’s shareholders are required to remit to Zhengtu Information any interests that have been distributed to them in connection with its liquidation or dissolution, subject to PRC law. In the event Zhengtu Information is liquidated or dissolved, following any expenditures required by PRC law and repayment of its liabilities to any creditors, all remaining assets will be distributed to its sole shareholder, Eddia.

			If Giant Network or any of the shareholders of Giant Network breaches its respective contractual obligations under the share pledge agreement, Zhengtu Information, as pledgee, will be entitled to demand the immediate repayment of all outstanding amounts under the relevant service agreements, or enforce the pledge. Presently, Zhengtu Information would not be able to hold equity interests in Giant Network itself upon enforcement of the pledge due to restrictions on foreign ownership of operators of online games in China. However, Zhengtu Information may still enforce the pledge by obtaining proceeds from the sale of the pledged property in a transaction mutually agreed upon with Giant Network or by petitioning the court to have the pledged property auctioned. According to the irrevocable powers of attorney described above, Yuzhu Shi, as the attorney-in-fact of all the shareholders of Giant Network, may approve the sale of a pledged interest to any individual or entity designated by Zhengtu Information and permissible by PRC law. See “Risk Factors — Risks Related to the Regulation of Our Business — Substantial uncertainties and restrictions exist with respect to the application and implementation of PRC laws and regulations in the online game industry. If the PRC government finds that our past or current structure for our business operations does not comply with PRC laws and regulations, we could be subject to severe penalties, including the shutting down of our operations.” The agreement will continue to be effective until the expiration of all relevant service agreements.
	•		Purchase Option and Cooperation Agreement. Pursuant to the purchase option and cooperation agreement among Zhengtu Information, Giant Network and shareholders of Giant Network, each of the shareholders of Giant Network has irrevocably and unconditionally granted Zhengtu Information or its designee an exclusive option to purchase, at any time if and when permitted under Chinese law, all or any portion of the equity interests in Giant Network for the minimum price permissible by Chinese law or RMB10,000,000, whichever is higher. Any consideration received from the sale by Giant Network’s shareholders or any persons or entities designated by them will be remitted to Giant Network. The agreement will continue to be effective until all equity interests in Giant Network have been transferred to Zhengtu Information or its designee. This agreement provides further that if any profits or dividends of Giant Network are remitted to its shareholders or Yuzhu Shi, who is a designated recipient by those shareholders, these recipients will be required to return all proceeds to Zhengtu Information in accordance with any applicable PRC laws and regulations. Furthermore, if any loans or other funds are remitted to Yuzhu Shi and the shareholders of Giant Network, or any persons or entities designated by them, these recipients will be required to remit those proceeds back to Giant Network. Zhengtu Information will extend its financial support to Giant Network including, but not limited to, advancing payments for any losses incurred by Giant Network. In the event that Giant Network is liquidated or dissolved, subject to any requirements under applicable PRC law, all the assets of Giant Network will be sold to Zhengtu Information at the minimum price permissible by PRC law. If Giant Network or any of its shareholders materially breaches any of its obligations under the purchase option and cooperation agreement, Zhengtu Information can request that corrective remedies be made within a reasonable period of time. If the breach is not corrected, Zhengtu Information can, among other things, terminate the agreement and request compensation for all damages and losses.

     Exclusive Technical Consulting and Services Agreement and Online Game Software Sales and Licensing Agreement that Transfers Economic Benefits from the Affiliated Entity to Us

     We have entered into a series of contractual arrangements with Giant Network, pursuant to which economic interests in Giant Network are transferred to us:

	•		Exclusive Technical Consulting and Service Agreement. Pursuant to the exclusive technical consulting and services agreement, Zhengtu Information is the exclusive provider of technical support and consulting services to Giant Network in exchange for service fees, which will be determined on an arms-length and reasonable basis based on the costs and expenses incurred by Zhengtu Information and Giant Network. Under this agreement, Giant Network may not, among other things, transfer its rights and obligations thereunder to any third party without the prior written consent of Zhengtu Information. If Giant Network breaches the exclusive technical consulting and service agreement, Zhengtu Information can demand such breaches be corrected within sixty days and is entitled to receive compensation of all damages and losses. In the case of any material breach, Zhengtu Information is entitled to terminate the agreement. Zhengtu Information could seek to terminate the agreement in the event that Giant Network stops paying fees to Zhengtu Information, which would otherwise result in Zhengtu Information providing technical consulting and services for no consideration. This agreement has a term of ten years and is renewable at the option of Zhengtu Information. According to PRC laws, Zhengtu Information can demand payment from Giant Network for services that have already been rendered but that have not yet been paid for, and may resort to legal remedies if it does not receive payment. We rely on Giant Network to act as our operating company in China, and derive a substantial portion of our revenues from Giant Network pursuant to the exclusive technical consulting and services agreement. Accordingly, termination of this agreement would immediately prevent Zhengtu Information from obtaining consulting and service fees from Giant Network and therefore would materially and adversely affect our business, results of operations and financial condition. See “Risk Factors — Risks Related to the Regulation of Our Business — The contractual arrangements with our affiliated Chinese entity and its shareholders, which relate to critical aspects of our operations, may not be as effective in providing operational control as direct ownership. In addition, these arrangements may be difficult and costly to enforce under PRC law.”
	•		Online Game Software Sales and Licensing Agreement . Under the online game software sales and licensing agreement between Zhengtu Information and Giant Network, Zhengtu Information has agreed to grant Giant Network an exclusive license within China to launch and sell our games, ZT Online, Giant Online, and other game-related products. Our wholly owned subsidiary, Zhengtu Information, retains all the intellectual property rights associated with the game, client-end software and server software according to the agreement. Other than the initial fee to be paid by Giant Network in installments, Giant Network is also required to pay a royalty fee to Zhengtu Information on a monthly basis. The agreement

states that Giant Network cannot alter the licensed software by itself or through a third party without the prior written consent of Zhengtu Information. The agreement also states that Giant Network cannot sell or sub-license the software and products outside of the PRC, or export or assist any third party to export the software and products from the PRC. Zhengtu Information is entitled to, among other things, terminate the agreement if Giant Network materially breaches the agreement. The agreement will continue to be effective until both parties agree to terminate it in writing.

D. Property, Plant and Equipment

     See “Information on the Company — Facilities” and “Information on the Company — Operational Infrastructure.”

ITEM 4A. UNRESOLVED STAFF COMMENTS

     Not applicable.

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

     The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included in this annual report. This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. See “Introduction — Forward Looking Statements.” In evaluating our business, you should carefully consider the information provided under Item 3.D, “Key Information — Risk Factors.” We caution you that our businesses and financial performance are subject to substantial risks and uncertainties.

A. Operating Results

Overview

     We are a leading online game developer and operator in China in terms of market share. We focus on massively multiplayer online role playing games, or MMORPGs, which are played through networked game servers on which tens of thousands of players are able to simultaneously connect and interact.

     We commercially launched our first internally-developed MMORPG game, ZT Online, in January 2006. We now operate eleven online games, among which nine are self-developed, including the five games in the ZT Online Series.

     We offer virtual items and services available for in-game purchase in our free-to-play games. Players of our games can obtain virtual items and services by using game points purchased through our distribution network in the form of physical or virtual prepaid game cards or directly on our game website.

     Notwithstanding our historical success with internally developed games, we began to expand our game pipeline by licensing games from third party developers. In December 2009 and January 2010, respectively, we acquired the exclusive mainland China operation licenses for Elsword and Allods Online, two 3D MMORPGs.

     Although substantially all of our revenues are generated through our own game operation in China, we have began deriving revenues from licensing our games to third party operators in other territories including Hong Kong, Macau, Taiwan, Malaysia, Singapore, Vietnam, Russia and other Russian speaking territories. In addition, we have also licensed ZT Online Green Edition to Shenzhen Tencent Computer Systems Company Limited, or Tencent, on a non-exclusive basis for operation on Tencent’s QQ game platform in China.

     In 2008, 2009 and 2010, our net revenues were RMB1,594.7 million, RMB1,303.8 million and RMB1,332.8 million (US$201.9 million), respectively. Our net income for the same years was RMB1,113.6 million, RMB859.0 million and RMB807.6 million (US$122.9 million), respectively. As of December 31, 2009 and December 31, 2010, deferred revenues and advances from distributors totaled RMB410.9 million and RMB518.3 million (US$78.5 million), respectively. Deferred revenues and advances from distributors represent amounts that we have received for sales of our prepaid game cards and game points that have not yet been recognized as net revenues. Our quarterly peak concurrent users for all of the games we operate in mainland China were 1,572,000 and 1,713,000 for 2009 and 2010, respectively. Our quarterly average concurrent users for all of the games we operate in mainland China were 474,000 and 595,000 for 2009 and 2010, respectively.

Factors Affecting Our Results of Operations

     We have benefited from a number of trends that are currently accelerating the growth of the online game industry in China, including overall economic growth that has resulted in increased disposable income and discretionary consumer spending; increasing use of the Internet with the growth of PC and broadband Internet penetration; growing popularity of online games, compared with other forms of entertainment; and favorable demographic trends, particularly the growth in China’s core online game-playing population. However, recent competitiveness in the online game industry in China present new challenges to our business.

     Company-specific factors that may affect our future financial condition and results of operations include the following:

	•		the availability, quality and playability of our games;
	•		the period of time over which we recognize revenue for some of our virtual items in our free-to-play games, which in certain cases is based on the estimated lifespan of our virtual items, which are adjusted from time to time;
	•		the number of games that we offer players, and our pricing relative to our competitors;
	•		the popularity of our competitors’ games and the growing competitiveness in the market;
	•		recent focus by our competitors on adapting to our model of a smaller number of very popular games as opposed to larger variety of games;

	•		our research and development efforts, which tend to be more costly during the development stage of a new game, and ability to incorporate the latest gaming technologies and graphics into our games;
	•		costs of expansion and purchase of servers and equipment in anticipation of new games;
	•		changes in our game rules and the corresponding impact on player behavior and purchasing patterns;
	•		the quality, variety, popularity and mix of virtual items and services available for purchase in our free-to-play games and related in-game promotional efforts;
	•		game development costs for our self-developed games;
	•		licensee fees and royalty payments for games licensed from third party developers;
	•		the amount of overseas licensing net revenues generated through our licensing arrangements with operators of our games;
	•		our introduction of new online games, which may attract players away from our established games, and the mix of sales of our games;
	•		the mix of sales through our distributors (who purchase prepaid game cards at a discount to their face value) and direct sales of game points to players through our website;
	•		the breadth and depth of our distribution network and the corresponding availability of our prepaid game cards;
	•		the success of our advertising and promotional efforts;
	•		seasonality of our sales of prepaid game cards and revenue recognition based on our game players’ behavior, during and around the Chinese New Year holidays in the first quarter, the Labor Day holidays in the second quarter, and the National Day holidays in the fourth quarter, when fewer of our targeted players play our games; and
	•		the success of our investments and merger and acquisition activities.

Pricing

     We sell prepaid game cards through our distributors and game points through our official game website that enable players to conveniently purchase virtual items and services for their characters in our games. Each prepaid game card contains a unique access code and password that enables players to add value to their game account. Currently, prepaid game cards and game points may only be used to play one of our online games, although a player may choose which game account, among all accounts held by the player, to apply the prepaid game card or the game points. Players use their prepaid game cards or game points to purchase gold coins, which can then be used to purchase a particular virtual item or service.

     The prepaid game cards offered by our distributors are sold in a variety of denominations, from RMB10 (approximately US$1.52) to RMB500 (approximately US$75.76). Purchasers can also purchase virtual prepaid game points on our official game website for any whole number denomination, starting at a minimum of RMB15 (approximately US$2.27).

     We generally develop a pricing curve to set the retail prices for the virtual items and services that we offer in our games. Pricing curves are developed primarily based on the magnitude of the advantage to the player’s character that the virtual item or service represents, demand for the virtual item or service, user game playing and payment patterns, and game development costs. Since the commercial launch of ZT Online in January 2006, we have tracked and accumulated player data from our games, which provides us with an extensive database to analyze player patterns and to establish pricing curves for particular types of virtual items and services in our games.

Revenues

Net Revenues

     Online Game Net Revenues

     Online game net revenues represent revenues that we generate from operating our free-to-play and our pay-to-play games. In 2008, 2009 and 2010, our online game net revenues were RMB1,589.7 million, RMB1,293.0 million and RMB1,289.5 million (US$195.4 million), respectively, representing 99.7%, 99.2% and 96.7%, respectively, of our total net revenues in those years. The substantial majority of our online game net revenues from these years were derived from our first online game, ZT Online, and a series of games derived therefrom, including ZT Online II, ZT Online PTP, ZT Online Green Edition, and ZT Online Classic Edition.

     Our online game net revenues are shown net of distributor discounts and volume-related incentives provided, and business taxes and related surcharges on the sale of prepaid game cards and game points incurred, by Giant Network. Distributor discounts were typically 11% of the face value of the prepaid game cards sold to distributors in 2009, as compared to 11% in 2008 and 14% in 2007, with volume-related incentives in the form of free prepaid game cards generally up to 3%. To attract distributors, new online game companies in China frequently offer higher discounts. In 2008, 2009 and 2010, our revenue was net of business tax in the amount of RMB95.4 million, RMB72.7 million and RMB85.0 million (US$12.9 million), respectively, representing 5.7%, 5.3% and 6.0%, respectively, of our gross revenues in those years. See “Taxation — China — Business Taxes and Related Surcharges.”

     During 2008, 2009 and 2010, 88.5%, 86.03% and 84.08%, respectively, of our sales proceeds were derived from prepaid game cards (reflecting a specified amount of game points) sold through our distributors, and 11.5%, 13.97% and 15.92%, respectively, were derived from game point sales made through our official game website. As described below, we are only required to pay a 0.40 — 0.45% service fee (included in our cost of services) on sales of game points through our official game website.

     Overseas and Domestic Licensing Net Revenues

     Overseas licensing net revenues represent license fees that we derive from the license of our games to other operators. In 2007, we licensed our ZT Online to Lager Network for operation in Hong Kong, Macau and Taiwan. Under our license agreement with Lager

Network, we are entitled to receive from Lager Network ongoing usage-based royalties. The usage-based royalties are determined based on the volume of consumption of game points by players with game accounts registered with Lager Network. In 2008, in response to certain foreign currency restrictions between Taiwan and the PRC, we entered into an arrangement with Lager Network whereby Lager Network will pay for services rendered by certain of our employees to partially offset outstanding royalty fees due to us. Beginning on October 1, 2008, such royalty income is recorded at the fair value of the personal services paid by Lager Network on behalf of us. We have considered the recoverability of the remaining unsettled royalty fee and made a provision for RMB6.6 million as of December 31, 2008. In 2009, we derived RMB10.7 million, in overseas licensing net revenues from our license of ZT Online to Lager Network, and our exclusive license to VinaGame to operate ZT Online in Vietnam. In 2010, we derived RMB9.0 million (US$1.4 million) in licensing net revenues from our license of ZT Online to Lager Network, our exclusive license to VinaGame and our exclusive license to Astrum Nival to operate ZT Online in Russia. In addition, we also licensed ZT Online Green Edition to Tencent in 2010. In October 2009, we entered into a three year ZT Online Green Edition — Online Software Cooperation Agreement with Tencent to attract more players to play ZT Online Green Edition from the Tencent QQ Game platform user base. Pursuant to the cooperation agreement, Tencent is entitled to operate ZT Online Green Edition on its QQ Game platform user base in China and we will receive a royalty income in exchange for licensing ZT Online. In 2010, we recorded a RMB33.7 million (US$5.1 million) royalty income from our cooperation with Tencent.

     In the future, we expect to generate more overseas licensing net revenues by licensing additional games, such as ZT Online FTP, Giant Online, The Golden Land and Dragon Soul, to operators outside of China, and by increasing the number of markets into which we license our games. We intend to remain selective in the licensing of our games to third parties and limit licensing to situations we feel present opportunities for us to expand our brand while maintaining quality control over our licensed games. We anticipate that the revenues generated from our overseas licensing net revenues in 2011 will be higher than that of 2010, as we expect more revenues from overseas markets such as Russia and Taiwan.

     Revenue Collection

     Online Game Net Revenues. We generate our online game net revenues through sales of prepaid game cards through our distribution network and game points on our website. For prepaid game card sales made through our distribution network, we receive the full purchase price, less the applicable discount, from the distributors prior to delivering the prepaid game cards to them. For sales made through our website, we receive the full purchase price, less the 0.40 — 0.45% service fee, which are reflected in our cost of services paid to our online payment system operator prior to issuing game points to the purchasers. As a result, we generally do not have any accounts receivable. We make available to each distributor refunds for unsold prepaid game cards after six months, but only to the extent that the cards have not already expired, are undamaged and are not part of the first batch of prepaid game cards purchased by the distributor. Furthermore, distributors may only return a preset portion of the prepaid game cards that they had originally purchased. We have not had any refund requests from distributors since we commercially launched our first game in January 2006. Once game points are registered to a specific game account, we do not allow any refunds of game points.

     Overseas and Domestic Licensing Net Revenues. Under our license agreement with Lager Network, we are entitled to receive from Lager Network ongoing usage-based royalties. The ongoing usage-based royalties are determined based on the volume of consumption of game points by players with game accounts registered with Lager Network, and are payable to us by Lager Network in accordance with a mutually agreed arrangement. In 2008, we entered into an arrangement with Lager Network whereby Lager Network will pay for services rendered by certain of our employees to partially offset outstanding royalty fees due to us. Under our license agreement with VinaGame, Astrum Nival, Tencent Holding and other foreign operators, we are entitled to ongoing usage-based royalties determined based on the volume of consumption of game points by players with game accounts registered with the operators and are payable to us by the operators in accordance with a mutually agreed schedule.

     Advances from Distributors, Deferred Revenue and Online Game Net Revenue Recognition

     We account for amounts received from distributors upon the sale of our prepaid game cards prior to their registration to specific game accounts as advances from distributors in our consolidated balance sheet. Once a prepaid game card is registered to a specific game account, we account for related amounts as deferred revenues.

     For most of our online sales, game points are automatically registered to the purchaser’s game account, with the amount received accounted for as deferred revenue on our consolidated balance sheet. In less than 1% of cases, purchasers do not specify a game account. Under those circumstances, we account for amounts received as advances from distributors until the purchaser specifies a game account, at which time we account for the relevant amount as deferred revenues.

     With respect to our free-to-play games, we recognize online game net revenue upon the consumption or expiration of virtual items or services purchased by players. For some virtual items, we recognize online game net revenues ratably over the estimated lifespan of that product or the estimated lifespan of the game. See “— Critical Accounting Policies — Revenue Recognition” below. We also recognize online game net revenue when unregistered and suspended prepaid game cards or unregistered and suspended game points purchased on our website expire, which is generally two years after the printing of physical prepaid game cards and one year from the date of issuance of virtual cards. No such revenue was recognized in 2009 and 2010.

     As of December 31, 2010, we had advances from distributors of RMB75.5 million (US$11.4 million) and deferred revenues of RMB442.8 million (US$67.1 million).

Cost of Services

     Our cost of services primarily consists of a portion of our business taxes and surcharges, compensation for personnel operating our games, maintenance of computer equipment, co-location fees and Internet access fees and depreciation of equipment and amortization of software and other intangible assets. Our cost of services are generally less volatile than our net revenues, primarily

because the components of our cost of services, such as co-location and internet access fees and depreciation and amortization of our equipment, software and other intangible assets generally remain stable. As of December 31, 2010, our cost of services did not include any licensing fees, as we internally developed or acquired all of the games that we operated as of that date. We do, however, expect that we will incur licensing fees in the future as we have recently been licensed the operation rights to operate Elsword and Allods Online in the mainland China.

     Sales Taxes and Related Surcharges

     Our cost of services includes business taxes, value-added tax or VAT, and related surcharges that Zhengtu Information pays on revenues that it derives from its contractual arrangements with Giant Network. In 2008, 2009 and 2010, these business taxes, VAT and related surcharges constituted 30.5%, 19.1% and 18.7%, respectively, of our total cost of services, and were equal to 4.2%, 3.0% and 2.8%, respectively, of our net revenues. Giant Network incurs additional business taxes and related surcharges in connection with sales of our prepaid game cards and game points. However, we present our net revenues net of these taxes and related surcharges. See “— Taxation — China — Business Tax and Related Surcharges.”

     Compensation for Personnel Operating our Games

     We account for compensation expenses for our employees that are directly involved in the operation of our online games, including our maintenance team, platform team and customer support team, as a cost of service. In 2008, 2009 and 2010, these expenses constituted 19.3%, 22.2% and 21.0%, respectively, of our total cost of services and equaled 2.6%, 3.5% and 3.1%, respectively, of our net revenues. Compensation expenses include employee wages, share-based compensation and welfare benefits, such as social insurance, medical insurance, housing subsidies, unemployment insurance and pension benefits.

     Maintenance of Computer Equipment, Co-location Fees and Internet Access Fees

     Our costs associated with the maintenance of computer equipment, co-location fees and Internet access fees constituted 26.7%, 28.5% and 27.0%, respectively, of our total cost of services and were equal to 3.6%, 4.5% and 4.0%, respectively, of our net revenues in 2008, 2009 and 2010. The bulk of these expenses related to co-location and Internet access fees charged by third-party Internet data centers from which we operate our servers. Another large component of these expenses are server maintenance costs. We typically rely on Internet data centers to resolve our minor server problems, but use our own Shanghai-based maintenance team to resolve larger problems. In 2011, we expect to our co-location and Internet access fees and server maintenance costs to remain at approximately the same amounts as in 2010. We may, however, decide to install servers in new locations in China, which could increase our costs further.

     Depreciation of Equipment and Amortization of Software and Other Intangible Assets

     Our depreciation of equipment and amortization of software and other intangible assets related primarily to our servers and other computer equipment as well as capitalized product development costs, constituted 18.5%, 24.2% and 28.8%, respectively, of our total cost of services and were equal to 2.5%, 3.8% and 4.3%, respectively, of our net revenues in 2008, 2009 and 2010. We include depreciation and amortization expenses within our cost of services when the relevant assets are directly related to the operation of our platform and provision of online games. Depreciation and amortization expenses are characterized as operating expenses in all other cases. In 2011, we expect increases in these expenses in connection with the development of ZT Online II, XT Online, The Golden Land, Dragon Soul and other potential game projects.

Operating Expenses

     Operating expenses consist of research and product development expenses, sales and marketing expenses, general and administrative expenses and government financial incentives. The following table sets forth a breakdown of our operating expenses for the years indicated.

		For the Year Ended December 31,
		2008				2009				2010
		(RMB)				(RMB)				(RMB)				(US$)
		(in thousands)
Gross profit			1,376,780				1,099,765				1,133,693				171,772
Operating (expenses) income:
Research and product development expenses			(88,539	)			(113,354	)			(186,037	)			(28,187	)
Sales and marketing expenses			(241,575	)			(119,600	)			(143,006	)			(21,668	)
General and administrative expenses			(141,786	)			(121,446	)			(119,447	)			(18,098	)
Government financial incentives			63,084				88,460				57,386				8,695
Impairment			—				—				(46,558	)			(7,054	)
Total operating expenses			(408,816	)			(265,940	)			(437,661	)			(66,312	)

     Research and Product Development Expenses

     Our research and product development expenses primarily consist of employee wages, share-based compensation and welfare benefits for our product development team, and the cost of software, and depreciation of the computers and equipment, used by our product development team.

     Until a game reaches technological feasibility, we expense all research and product development expenses. We capitalize research and product development expenses for a game once that game becomes technologically feasible, and we continue to capitalize those expenses until the game is commercially launched. See “— Critical Accounting Policies — Online Game Product Development Costs” below. For our first game, ZT Online, we determined that technological feasibility occurred in August 2005, and we expensed RMB4.0 million and capitalized RMB1.6 million of related development costs prior to commercial launch in January 2006. For Giant Online, we determined that technological feasibility occurred on January 21, 2007. As of December 31, 2010, we capitalized a total of RMB7.9 million (US$1.2 million) in research and development expenses with respect to ZT Online II, My Sweetie, The Golden Land and Dragon Soul. In 2011, we expect our research and product development expenses to increase as we hire new personnel in connection with the development of ZT Online II and other potential new games.

     Sales and Marketing Expenses

     Our sales and marketing expenses primarily relate to advertising, including television and Internet portal advertisements, and national and regional newspapers and magazine advertisements. Our sales and marketing expenses also include employee wages, share-based compensation, welfare benefits for our sales and marketing team, the cost of promotional events, the purchase of promotional souvenirs, and payments made to Internet café administrators in return for attracting new paying players.

     General and Administrative Expenses

     General and administrative expenses primarily consist of employee wages, share-based compensation and welfare benefits for our management, finance and administrative personnel, professional service fees, lease payments in relation to our office space, property management fees, administrative expenses and entertainment expenses.

     Government Financial Incentives

     The government financial incentives that Zhengtu Information and Giant Network receive from the Shanghai local government are calculated with reference to their sales tax, individual income tax withholdings and enterprise income tax. Although the financial incentives that we have already received are not subject to repayment back to the local government, our eligibility to receive these incentives in the future is conditioned on our continued registration in our present district in Shanghai and the continued qualification of our games as high-tech projects. In addition, our ongoing eligibility for these financial incentives is further subject to the discretion of the Shanghai local government, and either the central government or the local government could determine at any time to immediately eliminate or reduce these financial incentives. As such, given we have no basis to estimate the amount of financial incentives to be received from the government, if at all, we recognized these amounts into income only upon receipt of the funds.

Taxation

     Cayman Islands, British Virgin Islands and Hong Kong

     Under the current laws of the Cayman Islands, the British Virgin Islands and Hong Kong, we are not subject to tax on our income or capital gains in these jurisdictions. In addition, upon the payment of dividends by us to our shareholders, no Cayman Island, British Virgin Island or Hong Kong withholding tax will be imposed.

     China

     Income and Withholding Taxes. Zhengtu Information and Giant Network are incorporated in China, and are subject to Chinese enterprise income tax, or EIT, on their taxable income. Under certain PRC tax laws effective until December 31, 2007, because Zhengtu Information was registered in the Caohejing Economic Development Zone of Xuhui District of Shanghai and had been recognized as a New and High Technology Enterprise, or HNTE, it was granted a preferential EIT rate of 15%. Furthermore, Zhengtu Information enjoyed a two-year exemption from EIT followed by a three-year 50% reduction in its EIT rate, which started in 2006. The qualification of Zhengtu Information as a software development enterprise is required to be reassessed on an annual basis. Giant Network had been recognized as a HNTE and has been granted a preferential EIT rate of 15% for 2008 to 2010. As Giant Network was qualified as a “Software Enterprise” in 2006 and 2007, it was exempted from EIT.

     In 2007, China passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementing rules, both of which became effective on January 1, 2008. Under the New EIT Law, enterprises that were established and already enjoyed preferential tax treatments before March 16, 2007, the date on which the New EIT Law was passed, will continue to enjoy them (i) in the case of reduced tax rates, for a period of five years from January 1, 2008, subject to certain phase-out rules, or (ii) in the case of fixed-term tax holidays, until the expiration of such term. The New EIT Law also permits a new category of HNTE to enjoy a reduced enterprise tax rate of 15%. Under these phase-out rules, we expect the applicable income tax rate of Zhengtu Information to gradually increase from its 2007 level. In addition, enterprises established before the promulgation date of the New EIT Law and which were granted preferential EIT treatment under the then effective tax laws or regulations may continue to enjoy their preferential tax treatments until their expiration. Accordingly, Zhengtu Information, an enterprise established before the promulgation date of the New EIT Law, will continue to enjoy its preferential treatment subject to the phase-out rules, under which it will continue to enjoy the 50% reduction of the EIT for the 2008 to 2010 taxable years. The 50% reduction may result in a tax rate of 9%, 10% and 11% for taxable years of 2008, 2009 and 2010 respectively. In April 2008, certain government authorities announced the new implementation rules for application and assessment of HNTE named Administrative Measures for Determination of High and New Technology Enterprises and every qualified company needs to re-apply for this qualification 3 months prior to the expiration of the valid period according to the new implementation rules. Zhengtu Information had obtained the qualification certificates of HNTE status in 2008 with a valid period of three years from 2008 to 2010. However, Zhengtu Information is not allowed to enjoy the reduced tax rate under the phase-out rules

as described above and the preferential income tax rate of 15% at the same time. Zhengtu Information has adopted the reduced rate under phase-out rules for its remaining 3-year tax holiday (i.e., 9%, 10% and 11% for 2008, 2009 and 2010 respectively). It is expected that Zhengtu Information will succeed in renewing its HNTE certificate upon the expiration of its current HNTE certificate, it should be entitled to the preferential tax rate of 15% in 2011 and onwards. But if it fails to maintain the “High and New Technology Enterprise” qualification, the applicable EIT rate may increase to up to 25%.

     Giant Network, a VIE to which Zhengtu Information is deemed the primary beneficiary, has been recognized as a HNTE effective from 2008, and therefore received a preferential tax rate of 15% in 2009 and 2010. It is also expected that Giant Network will succeed in renewing its HNTE certificate upon the expiration of its current HNTE certificate. Giant Network should be entitled to the preferential tax rate of 15% in 2011 and onwards. But if it fails to maintain the “High and New Technology Enterprise” qualification, the applicable EIT rate may increase to up to 25%.

     Shanghai Zhengduo Information Technology Co., Ltd., Zhuhai Zhengtu Information Technology Co., Ltd., Wuxi Giant Network Technology Co. Ltd., Jujia Network, Juhuo Network, Juhe Network, Snow Wolf, Shanghai Juyan Network Technology Co. Ltd., Shanghai Juxi Network Technology Co., Ltd., Shanghai Juxian Network Technology Co., Ltd., Haoji Network, Shanghai Juquan Network Technology Co., Ltd., Jufan Network, Shanghai Zhengju Information Technology Co. Ltd, Wuxi Tiema Networking Technology Co. Ltd., Shanghai Juxin Network Technology Co., Ltd., Julun Network and Beijing Juren Zhengtu Information Technology Co., Ltd. are not entitled to enjoy any preferential tax rate for year 2010 and their applicable EIT rate is 25%.

     The New Tax Law provides that an income tax rate of 20% will generally be applicable to dividends from our PRC subsidiaries. However, pursuant to the New Tax Law and the Implementation Rules to the New Income Tax Law, or the Implementation Rules, promulgated on December 6, 2007 and effective on January 1, 2008, our Cayman holding company, Eddia will be subject to a 10% enterprise income tax and Giant HK, under a special arrangement between China and Hong Kong, will be subject to a 5% enterprise income tax for such dividends paid to them, unless our Cayman holding company, Eddia and Giant HK are treated as a “China tax resident enterprise.”

     Under the New Tax Law, an enterprise established outside of the PRC with “de facto management bodies” within the PRC is considered a resident enterprise and will normally be subject to the enterprise income tax at the rate of 25% on its worldwide income. Under the Implementation Rules of the New Tax Law, “de facto management body” is defined as the body that has material and overall management and control over the business, personnel, accounts and properties of the enterprise. In addition, a circular issued in 2009 by the State Administration of Taxation regarding the standards used to classify certain Chinese enterprise controlled companies established outside of China as “resident enterprises” provides that certain Chinese-invested enterprises will be classified as “resident enterprises” if the following are located or resident in China: senior management personnel and departments that are responsible for daily production, operation and management; financial and personnel decision making bodies; key properties, accounting books, company seal, and minutes of board meetings and shareholders’ meetings; and half or more of the directors or senior management having voting rights. Based on the assessment of facts and circumstances available, we are more likely than not a non-PRC tax resident enterprise. Accordingly, we have not accrued for PRC enterprise income tax at December 31, 2010.

     As of December 31, 2010, we had net operating tax losses in the total amount of RMB 28,597,548 in the PRC, which can be carried forward to future years and utilized by our respective Chinese subsidiaries according to the prevailing PRC CIT rules and regulations. The balance of our net operating tax losses as of December 31, 2010 will expire between years 2015 and 2016.

     The Company intends to permanently reinvest all undistributed earnings of its foreign subsidiaries, as of December 31, 2010, to finance its future operations. The amount of unrecognized deferred tax liabilities for temporary differences related to investments in foreign subsidiaries is not determined because such a determination is not practicable.

     Sales Taxes and Related Surcharges. We incur two different types of business taxes and related surcharges, each of which we account for differently. Giant Network is subject to Chinese business tax at the rate of 5% on the proceeds received from its sale of prepaid game cards and game points. Zhengtu Information is subject to Chinese business tax of 5% on its technical consulting service fees. These service fees are also subject to local surcharges that are related to this business tax, including city construction, state and local education surcharges. Our net revenues are presented net of these business taxes and related surcharges, which were RMB95.4 million, RMB72.7 million and RMB85.0 million (US$12.9 million) for the year ended December 31, 2008, 2009 and 2010, respectively.

     Zhengtu Information is also subject to business tax at the rate of 5% and VAT at the rate of 3% (net) in connection with the revenues that it derives from its contractual arrangements with Giant Network. We account for this business tax, VAT and related surcharges as a component of our cost of services. In 2008, 2009 and 2010, this amounted to RMB66.4 million, RMB39.1 million and RMB37.2 million (US$5.6 million), respectively.

Critical Accounting Policies

     We prepare our financial statements in conformity with U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the financial statements and the reported amounts of net revenues and expenses during the financial reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our financial statements as their application places the most significant demands on our management’s judgment.

     Revenue Recognition

     Online Game Net Revenues. With respect to both our free-to-play games and our pay-to-play game, we generate sale proceeds from the sale of our prepaid game cards (representing a specified amount of game points) through our distribution network and the sale of game points directly through our official game website. Amounts that we receive for the sale of prepaid game cards prior to their registration to a specific player account are accounted as advances from distributors on our consolidated balance sheet. Once a prepaid game card is registered to a specific player account, amounts received are accounted for as deferred revenues on our consolidated balance sheet. Game points purchased from us on our official game website are typically automatically registered to the purchaser’s game account, and the related purchase price is accounted for as deferred revenues.

     For our free-to-play games, we recognize revenue only after a player uses game points registered to that player’s game account to purchase a virtual item or service as follows:

	•		for all virtual services, and “consumable” virtual items, including those that are consumed at a predetermined time or that otherwise have limitations on repeated use (for example a virtual shirt that can only be worn for 30 days or a virtual potion that can only be consumed once), we recognize revenues ratably or upon full consumption or expiration of the service or item.
	•		for “permanent” virtual items, or those that are not consumed at a predetermined time or otherwise do not have a limitation on repeated use (for example a virtual sword), we recognize revenue ratably over the estimated lifespan of the specific item. When we commence sale of a new virtual item, including at the commercial launch of a new game, we use available information to estimate that virtual item’s lifespan. The estimated life span is determined based on the historical paying player usage pattern and playing behavior. When the life span of certain virtual items cannot be reliably determined based on historical player pattern and behavior, the related revenues are recognized over the estimated life of the related game. To determine a specific virtual item’s estimated lifespan we select a starting date, and track the lifespan of all of that type of item purchased by players on that date. For ZT Online, the time between the starting date and the point at which 95% of the tracked virtual items have been destroyed or replaced, or at which purchasers of such “permanent” virtual items have not logged into the game for 180 consecutive days, as of 2008, 2009 and for 270 consecutive days as of 2010 (thereby being deemed an inactive player), is used as that item’s estimated lifespan. We will continue to monitor the average lifespan of our virtual items and the estimated lifespan of our games, which may differ from the historical periods on which our revenue recognition policy was previously based. Any change in our estimates, particularly as our games mature and gain greater operating history and data and thereby enable us to refine our estimates, may result in our revenues being recognized on a different basis than in prior periods and may cause our operating results to fluctuate.
	•		for unused non-permanent consumable items, we recognize revenues immediately once the designated player is deemed inactive.

     We do not recognize revenue related to virtual items and services purchased by players using gold or silver coins, or gold or silver vouchers issued pursuant to our virtual insurance policies.

     For our pay-to-play games, the first of which we commercially launched in the fourth quarter of 2007, we recognize revenue when game points, which are registered to a player’s game account and which represent that player’s prepaid playing time, are actually used by the player to play our games.

     We also recognize revenue when unregistered prepaid game cards or unregistered game points purchased directly on our website expire and are suspended, which is generally two years after the printing of physical game cards and one year from the issuance of virtual cards. Registered game points do not expire. No such revenue was recognized in 2009 and 2010.

     Licensing Net Revenues

     We receive royalty income from a third party incorporated in Taiwan, which was a related party prior to June 2009, in exchange for licensing ZT Online and providing related technical support. The license allows the operation of the games in Hong Kong, Taiwan, Macau, Singapore and Malaysia. The royalty fees are determined based on an agreed percentage of game points consumed by the players with accounts registered with the third party, net of applicable withholding tax, which becomes fixed or determinable at the time actual usage occurs. The related royalty income is recognized on a monthly basis, as the third party confirms its sales activity for the period. As a result of the foreign currency restrictions over the remittance of funds from Taiwan to the PRC to repay outstanding payables to us, beginning on October 1, 2008, such royalty income is recorded at the estimated fair value of the personnel services paid by the third party on behalf of us in accordance with the provisions of ASC subtopic 845-10, or ASC 845-10, Nonmonetary Transactions: Overall.

     We also license ZT Online to overseas third parties in Vietnam from 2009 and in Russia from 2010. The royalty income is determined based on an agreed percentage of game points consumed by the players with accounts registered with the game vendors, net of applicable withholding tax, which becomes fixed or determinable at the time actual usage occurs. The related royalty income is recognized on a monthly basis as the game vendors confirm their sales activities for the period, provided that the collectability is probable.

     On October 28, 2009, we entered into a three-year ZT Online license agreement with Tencent to attract more players to play ZT Online Green Edition from the Tencent QQ Game platform user base. Under the terms of the license agreement, we receive royalty income in exchange for licensing ZT Online, and service fees for providing servers, broadband resources and technical consulting services, collectively referred to as IT services. We account for the royalty income and service fees in accordance with ASC subtopic 605-25-2, or ASC 605-25-25, Revenue Recognition for Multiple-Element Arrangements. The royalty income and service fees are both determined based on an agreed percentage of game point revenue earned from players with accounts registered with Tencent, net of applicable withholding tax. Royalty payments are recognized as revenue, when all contingencies associated with royalty payments have been resolved, when no remaining performance obligations exist relating to those payments and upon receipt of a confirmation

of sales activity from Tencent. The service fees are contingent upon the future delivery of the IT services and game point revenue earned from players with accounts registered with Tencent. Service fees are recognized on a straight-line basis from the point in time at which the contingency has been resolved, over the remaining period of the license agreement.

     Online Game Product Development Costs

     We recognize software development costs incurred in connection with the development of our games in accordance with the Statement of Financial Accounting Standards Codification, or ASC, subtopic 985 Software. As such, we expense our game development costs incurred prior to technological feasibility. Once a game becomes technologically feasible, all subsequent development costs for that product are capitalized until that product is available for general release. Determination of technological feasibility requires significant judgment. Technological feasibility is evaluated on a game-by-game basis, but typically encompasses both technical design and game design documentation and only occurs when the online game has a proven ability to operate in an online game environment. After an online game is released, the capitalized product development costs are amortized based on the expected life of the game. This expense is recorded as a component of cost of services. Since our establishment in November 18, 2004 through December 31, 2010, the amount of online game development costs qualifying for capitalization totaled RMB42.5 million (US$6.4 million). Of this amount, 3.97% relates to ZT Online, 10.73% relates to ZT Online II, 21.53% relates to Giant Online, 34.78% relates to K III, 7.41% relates to The Golden Land and 21.03% relates to Dragon Soul. In 2008, we did not capitalize any online game development costs. In 2009 and 2010, we capitalized approximately RMB21.6 million and RMB10.8 million (US$1.64 million) of our online game development costs in accordance with relevant accounting standards. For ZT Online, ZT Online II, Giant Online, The Golden Land, and Dragon Soul, the capitalized development costs are being amortized over their respective estimated life spans.

     Consolidation of Variable Interest Entity

     We have adopted ASC Subtopic 810-10, or ASC 810-10, Consolidation: Overall. ASC 810-10 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties.

     PRC laws and regulations currently prohibit or restrict foreign-invested companies from providing Internet content services, which includes operating online games. To comply with these foreign ownership restrictions, we operate our online game business in China through our affiliated entity Giant Network, which is wholly owned by PRC citizens or entities. Giant Network holds the licenses and approvals that are required to operate our online game business. Zhengtu Information has entered into a series of contractual arrangements with Giant Network and its shareholders. See “Item C — Organizational Structure.” Despite the lack of technical majority ownership, there exists a parent-subsidiary relationship between us and Giant Network through an irrevocable proxy agreement, whereby the equity holders of Giant Network effectively assigned all of their voting rights underlying their equity interest in Giant Network to us. As a result of these contractual arrangements, we have the substantial ability to control Giant Network and absorb substantially all the profits and all the expected losses of Giant Network. Therefore, we are considered the primary beneficiary of Giant Network. Accordingly, Giant Network is a VIE of our company under U.S. GAAP and we consolidate its results in our consolidated financial statements. We have consulted with our PRC legal counsel in assessing our ability to control Giant Network through these contractual arrangements. Any changes in PRC laws and regulations that affect our ability to control Giant Network might preclude us from consolidating Giant Network in the future.

     Cash, Cash Equivalents and Short-Term Investments

     Cash and cash equivalents represent cash on hand, demand deposits and money market fund placed with banks or other financial institutions. All highly liquid investments with a stated maturity of 90 days or less from the date of purchase are classified as cash equivalents. All highly liquid investments with stated maturities of greater than 90 days but less than 365 days, are classified as short-term investments which are stated at their approximate fair value.

     We account for our investments in accordance to ASC subtopic 320-10, or ASC 320-10, Investments — Debt and Equity Securities: Overall. ASC 320-10 classifies the investments in debt securities as “held-to-maturity”, “trading” or “available-for-sale”, whose classification determines the respective accounting methods stipulated by the accounting standard for financial instruments. The securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities. Trading asset investments include marketable debt instruments in which we did not document our intention to hold the investments to maturity at acquisition and classified the investments as trading. Unrealized holding gains and losses for trading securities are included in earnings. We held no trading securities as of December 31, 2010.

     The securities that we have positive intent and ability to hold to maturity are classified as held-to-maturity securities and stated at amortized cost. For individual securities classified as held-to-maturity securities, we evaluate whether a decline in fair value below the amortized cost basis is other than temporary in accordance to ASC subtopic 320-10, or ASC 320-10, Investments — Debt and Equity Securities: Overall. If the decline in fair value is judged to be other than temporary, the cost basis of the individual security would be written down to fair value as a new cost basis and the amount of the write-down is included in earnings. Dividend and interest income, including amortization of the premium and discount arising at acquisition, for all categories of investments in securities are included in earnings. Any realized gains or losses on the sale of the investments are determined on a specific identification method, and such gains and losses are reflected as a component of interest income.

     Any negative events or deterioration in financial well-being with respect to the counterparties and the underlying collateral could materially impact our financial position and results of operations.

     Available-for-Sale Investment

     We have designated our investment in convertible redeemable preferred shares of Five One Network Development Co. Ltd., or 51.com, and the convertible redeemable preferred shares of Mobile Embedded Technology Inc., or MET, as available-for-sale investments. Such available-for-sale investments are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive income in shareholders’ equity. Realized gains or losses are charged to earnings during the period in which the gain or loss is realized. If we determine a decline in fair value is other than-temporary, the cost basis of the individual security is written down to fair value as a new cost basis and the amount of the write-down is accounted for as a realized loss. The new cost basis will not be changed for subsequent recoveries in fair value. Determination of whether declines in value are other-than-temporary requires significant judgment. Subsequent increases and decreases in the fair value of available-for-sale securities will be included in comprehensive income through a credit or charge to shareholders’ equity except for an other-than-temporary impairment, which will be charged to earnings.

     The fair value of our available-for-sale investments were estimated using an enterprise value allocation model, or EVA model. The EVA model requires inputs of highly subjective assumptions including the expected stock price volatility and the probability of occurrence of certain events. Unfavorable changes in these estimates and assumptions could materially impact our financial position and results of operations.

     The total fair value of our available-for-sale investments is RMB423.3 million (US$64.1 million), which represents 6.0% of our total assets at December 31, 2010.

     Long-term Investment and Investments in Equity Investees

     We account for our long-term investments in unconsolidated investee companies by using either the cost method or the equity method. Investments in entities in which we are not able to exercise significant influence are accounted for using the cost method of accounting in accordance with ASC subtopic 325-20, Investments-other: Cost Method Investments. Under the cost method, we initially record the investment at cost and only adjust for other-than-temporary declines in fair value and distributions of earnings. We regularly evaluate the impairment of our cost method investments based on the performance and financial position of the investee as well as other evidence of estimated market values. Such evaluation includes, but is not limited to, reviewing the investee’s cash position, recent financing, projected and historical financial performance, cash flow forecasts and current and future financing needs. An impairment loss is recognized in the consolidated statements of operations equal to the excess of the investment’s cost over its fair value at the balance sheet date of the reporting period for which the assessment is made. The fair value would then become the new cost basis of investment. Our impairment charges for cost method investments were nil for the years ended December 31, 2009 and 2010.

     Investments in entities in which we can exercise significant influence but do not own a majority equity interest or otherwise control are accounted for using the equity method of accounting in accordance with ASC subtopic 323-10, or ASC 323-10, Investments-Equity Method and Joint Ventures: Overall. Under the equity method, we initially record the investment at cost and adjust the carrying amount of the investment to recognize our proportionate share of the equity investee’s net income or loss into our consolidated statements of operations after the date of acquisition. The difference between the cost of the equity investee and the amount of the underlying equity in the net assets of the equity investee is recognized as equity method goodwill included in equity method investment on our consolidated balance sheet. We evaluate our equity method investments for impairment under ASC 323-10. An impairment loss in equity method investments is recognized in the consolidated statements of income when the decline in value is determined to be other-than-temporary.

     Useful Life of Long-Lived Assets

     Property, equipment and intangible assets are stated at historical cost less accumulated depreciation and amortization. Depreciation of property and equipment is computed using a straight-line method over the estimated useful lives of the assets, which are generally five years. Amortization of intangible assets is computed using a straight-line method over the estimated useful lives of the assets, which are generally three years. Judgment is required to determine the estimated useful lives of assets, especially for servers, including determining how long existing equipment can function and when new technologies will be introduced to replace existing equipment. Changes in these estimates and assumptions could materially impact our financial position and results of operations.

     Impairment of Long-Lived Assets and Intangible Assets

     We review our long-lived assets and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We assess the recoverability of those assets by comparing the carrying amount to the estimated future undiscounted cash flow associated with them. If the future net undiscounted cash flows are less than the carrying amount of the assets, the assets are considered impaired and an expense is recognized equal to the amount required to reduce the carrying amount of the assets to their then fair value. During the year ended December 31, 2010, we assessed certain indicators of impairment impacting the K III game software’s revenue and cash flow forecasts which were primarily attributed to increasing competition coupled with declines in customer demand. We tested the K III game software for impairment using an income approach, which involves applying an appropriate discount rate to estimated cash flow forecasts. Based on our analysis, we recorded an impairment charge of RMB46,557,669 (US$7,054,192), for the year ended December 31, 2010, which is included in the line “Impairment of intangible assets” in our consolidated statements of operations and comprehensive income.

     Income Taxes

     We follow the liability method in accounting for income taxes in accordance with ASC subtopic 740-10, or ASC 740-10, Income Taxes: Overall. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted tax rates that will be in effect in the year in which the differences are expected to reverse. We record a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is

more-likely-than-not that all or some portion of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized in income during the year in which the change becomes effective.

     Accounting for uncertain income tax positions

     We adopted ASC subtopic 740-10, or ASC 740-10, Income Taxes: Overall on January 1, 2007 which clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. We did not incur a cumulative adjustment upon the adoption of ASC 740-10 Income Taxes. We have elected to classify interest and penalties related to an uncertain tax position, if and when required, as part of income tax expense in our consolidated statements of operations and comprehensive income.

     Share-Based Compensation

     We have accounted for share-based compensation that we pay to directors, management, employees, consultants and other eligible persons pursuant to the Employee Share Option Scheme, or 2006 Plan, and the 2007 Performance Incentive Plan, or the 2007 Plan, in accordance with ASC subtopic 718-10, or ASC 718-10, Compensation — Stock Compensation: Overall, and ASC subtopic 505-50, or ASC 505-50, Equity: Equity based Payment to Non-employees. Under the fair value recognition provisions of ASC 718-10, share-based compensation cost is measured at the grant date and service performance date for share options issued to employees and non-employees, respectively, based on the fair value of the award and is recognized as an expense on an accelerated recognition basis, net of estimated forfeitures, over the requisite service period, which is generally the vesting period. There were no share options issued to consultants in 2009 and 2010.

     On September 30, 2006, our board of directors adopted the 2006 Plan. As of December 31, 2010, we had options with respect to 5,414,229 of our ordinary shares granted and outstanding under the 2006 Plan. Our board of directors adopted the 2007 Plan on October 9, 2007 and reserved 7,800,000 ordinary shares for issuance under the 2007 Plan, for which the share number has been increased to 10,700,000 in accordance with the resolution of the Board in August 2010. As of December 31, 2010, we had options with respect to 6,748,400 of our ordinary shares granted and outstanding under the 2007 Plan. No further options will be granted by us under the 2006 Plan.

     We use the binomial option pricing model to determine the fair value of our share options. The binomial model requires us to input certain complex and subjective assumptions, including our expected share price volatility over the term of the award, expected employee share option exercise behavior, risk-free interest rates and the expected forfeiture rate. With respect to expected share price volatility, we reference historical volatilities of the shares of several comparable companies. The risk-free interest rate for periods within the life of the share option is based on the U.S. Treasury yield curve in effect at the time of the related grant. We use historical turnover data to estimate the employee forfeiture rate.

     If factors change and we employ different assumptions to estimate our share-based compensation expense for new awards in the future, or if we decide to use a different pricing model, our share-based compensation in future periods may differ significantly from what we have recorded in prior periods and could materially affect our gross profit, income from operations, net income and net income per share.

     The application of its principles provided in ASC 718-10 may be subject to further interpretation and refinement over time. There are significant differences among pricing models and there is a possibility that we will adopt different pricing models in the future. This may result in a lack of consistency in future periods and materially affect the fair value estimates of our share-based compensation. It may also result in a lack of comparability with other companies that use different models, methods and assumptions.

     As of December 31, 2010, we had RMB38.6 million (US$5.8 million) of unrecognized share-based compensation cost related to share options issued to employees. That deferred cost is expected to be recognized over a weighted-average vesting period of 2.95 years. To the extent the actual forfeiture rate is different from original estimate, actual share-based compensation related to these awards may be different from the expectation.

Results of Operations

     The following tables set forth selected results of operations data by amount and as a percentage of our total net revenues for the years indicated. You should read the following tables in conjunction with the audited consolidated financial information and related notes contained elsewhere in this annual report.

Selected Consolidated Statement of Operations Data:

		Year Ended December 31,
		2008								2009								2010
						% of								% of												% of
						Total Net								Total Net												Total Net
		Amount				Revenues				Amount				Revenues				Amount				Amount				Revenues
		RMB				RMB				RMB				RMB				RMB				US$				RMB
		(In thousands, except percentages)
Online games revenue			1,589,676				99.68	%			1,293,018				99.17	%			1,289,481				195,376				96.75	%
Licensing revenues			4,391				0.28	%			10,687				0.82	%			42,667				6,465				3.20	%
Other revenue, net			612				0.04	%			130				0.01	%			668				101				0.05	%
Total net revenue			1,594,679				100.00	%			1,303,835				100	%			1,332,816				201,942				100	%

		Year Ended December 31,
		2008								2009								2010
						% of								% of												% of
						Total Net								Total Net												Total Net
		Amount				Revenues				Amount				Revenues				Amount				Amount				Revenues
		RMB				RMB				RMB				RMB				RMB				US$				RMB
		(In thousands, except percentages)
Cost of services			(217,899	)			(13.66	)%			(204,070	)			(15.65	)%			(199,122	)			(30,170	)			(14.94	)%
Gross profit			1,376,780				86.34	%			1,099,765				84.35	%			1,133,694				171,772				85.06	%
Operating (expenses) income
Research and development			(88,539	)			(5.56	)%			(113,354	)			(8.69	)%			(186,037	)			(28,187	)			(13.97	)%
Sales and marketing			(241,575	)			(15.15	)%			(119,600	)			(9.17	)%			(143,006	)			(21,668	)			(10.73	)%
General and administrative			(141,786	)			(8.89	)%			(121,446	)			(9.32	)%			(119,447	)			(18,098	)			(8.96	)%
Government financial incentives			63,084				3.96	%			88,460				6.78	%			57,386				8,695				4.31	%
Impairment of intangible assets			—				—				—				—				(46,558	)			(7,054	)			(3.49	)%
Total operating expenses			(408,816	)			(25.64	)%			(265,940	)			(20.40	)%			(437,662	)			(66,312	)			(32.84)	%
Income from operations			967,964				60.70	%			833,825				63.95	%			696,032				105,460				52.22	%
Interest income			184,964				11.60	%			102,200				7.84	%			136,098				20,621				10.21	%
Investment income (loss)			1,171				0.07	%			(5,971	)			(0.46	)%			—				—				—
Unrealized loss on investment held-for-trading			(300	)			(0.02	)%			—				—				—				—				—
Other income and (expense)			(843	)			(0.05	)%			14,025				1.08	%			65,466				9,919				4.92	%
Income before income tax expenses			1,152,956				72.30	%			944,079				72.41	%			897,596				136,000				67.35	%
Income tax expenses			(39,368	)			(2.47	)%			(85,060	)			(6.52	)%			(89,322	)			(13,534	)			(6.70	)%
Share of loss of an equity investee			—				—				—				—				(648	)			(98	)			(0.05	)%
Net income			1,113,588				69.83	%			859,019				65.89	%			807,626				122,368				60.60	%

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

     Net Revenues.

     Our total net revenues increased 2.2% from RMB1,303.8 million in 2009 to RMB1,332.8 million (US$201.9 million) in 2010. The increase of our net revenues is mainly attributable to a steady increase in revenue generated by the ZT Online Series and the increase in our licensing income from our cooperation with Tencent. In 2010, the majority of our total net revenue continued to be generated by ZT Online.

     Cost of Services.

      Our cost of services decreased by 2.4% from RMB204.1 million in 2009 to RMB199.1 million (US$30.2 million) in 2010. The decrease in our cost of services was primarily attributable to more stringent cost control with respect to our internet data center costs and our other operating expenses.

     Gross Profit and Margin.

      Our gross profits increased 3.1% from RMB1,099.8 million in 2009 to RMB1,133.7 million (US$171.8 million) in 2010, primarily due to the increase in our net revenue. Our gross profit margin increased from 84.3% in 2009 to 85.1% in 2010.

     Operating Expenses.

      Our operating expenses increased 64.6% from RMB 265.9 million in 2009 to RMB 437.7 million (US$66.3 million) in 2010. The increase in our operating expenses was due to an increase in our research and development expenses, an increase in our sales and marketing expenses, a decrease in the amount of government financial incentives that we received, and an impairment charge relating to the K III software, partially offset by a decrease in our general and administrative expenses.

     Research and Product Development Expenses.

      Our research and product development expenses increased 64.1% from RMB113.4 million in 2009 to RMB186.0 million (US$28.2 million) in 2010. The increase in our research and product development expenses was primarily due to an increase in staff, increases in compensation, including share-based compensation expense, and a decrease in the amount of capitalized research and development costs. Our compensation expense for research and product development employees increased 53.7% from RMB 93.6 million in 2009 to RMB 144.0 million (US$21.9 million) in 2010. In addition, in 2010, we capitalized RMB10.8 million of research and product development costs, compared to RMB21.6 million of such capitalized costs in 2009. We expect our research and product development expenses to increase in 2011 as we continue to expand our game pipeline through internal game development.

     Sales and Marketing Expenses.

      Our sales and marketing expenses increased 19.6% from RMB119.6 million in 2009 to RMB143.0 million (US$21.7 million) in 2010. The increase in our sales and marketing expenses was primarily due to our increased marketing efforts to support our games. Our advertising expense increased 108% from RMB 31.4 million in 2009 to RMB65.3 million in 2010.

     General and Administrative Expenses.

      Our general and administrative expenses decreased 1.6% from RMB121.4 million in 2009 to RMB119.4 million (US$18.1 million) in 2010. The decrease in our general and administrative expenses was primarily due to a decrease in share-based compensation expense and a decrease in external human resource search service expenses. Our share-based compensation expense for general and administrative employees decreased 11.9% from RMB 18.6 million in 2009 to RMB 16.4 million (US$2.5 million) in 2010. The decrease in our share-based compensation expense attributable to general and administrative employees was primarily a result of our accelerated share-based compensation amortization policy and the fact that no new share options were issued to management during the year.

     Government Financial Incentives.

      The amount of government financial incentives we received decreased 35.1% from RMB88.5 million in 2009 to RMB57.4 million (US$8.7 million) in 2010. The decrease in government financial incentives was primarily due to a decrease in the amount of sales taxes we paid in 2009 as compared to 2008.

     Impairment Loss.

      In 2010, we recorded an impairment charge of RMB46.6 million (US$7.1 million) relating to the K III game software.

     Income from Operations.

      Our income from operations decreased by 16.5% from RMB 833.8 million in 2009 to RMB696 million (US$105.5 million) in 2010. As a percentage of total net revenues, income from operations decreased from 64.0% in 2009 to 52.2% in 2010. The decrease in our income from operations was primarily due to our increase in research and development expenses, our increase in sales and marketing expenses, and the impairment charge related to the K III game software.

     Interest Income.

      Our interest income increased 33.2% from RMB102.2 million in 2009 to RMB136.1 million (US$20.6 million) in 2010. The increase in our interest income was mainly attributable to the increase in market interest rates and more efficient treasury management.

     Income Tax Expense.

      Our income tax expense increased 4.9% from RMB 85.1 million in 2009 to RMB89.3 million (US$13.5 million) in 2010. The increase in our income tax expense was mainly attributable to a 1% increase in the applicable income tax rate in one of our primary subsidiaries from 10% in 2009 to 11% in 2010.

     Investment Income (Loss).

      In 2009, we recorded an investment loss amounted to RMB6.0 million, which was related to our securities trading activities. In 2010, we no longer held any trading securities, as such, we did not record any investment income or loss.

     Net Income Attributable to Our Shareholders and Net Margin.

      Our net income attributable to our shareholders decreased 5.6% from RMB859.3 million in 2009 to RMB811.2 (US$122.9 million) in 2010. Our net income margin also decreased from 65.9% in 2009 and to 60.9% in 2010.

     Dividends.

      We paid dividends to our shareholders in the amount of RMB277.7 million and RMB279.1 million (US$42.3 million) in 2009 and 2010, respectively. On February 22, 2011, we declared an additional dividend in the amount of RMB270.3 million (US$41.2 million), which we have paid in full to our shareholders.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

     Net Revenues.

      Our net revenues decreased 18.2% from RMB1,594.7 million in 2008 to RMB1,303.8 million in 2009. The decrease in our net revenues was primarily due to new government regulations with respect to certain game features as well as our adjustments to in-game monetization mechanism, partially offset by an increase in our overseas licensing revenues as a result of our license of ZT Online to VinaGame for operation in Vietnam. In 2009, the majority of our total net revenue continued to be generated by ZT Online.

     Cost of Services.

      Our cost of services decreased 6.4% from RMB217.9 million in 2008 to RMB204.1 million in 2009. The decrease in our cost of services was primarily due to a decrease in our business taxes and related surcharges, which reflected our decreased online game revenues and increased control of operating expenses.

     Gross Profit and Margin.

      Our gross profits decreased 20.1% from RMB1,376.8 million in 2008 to RMB1,099.8 million in 2009. The decrease in our gross profits was primarily due to the decrease in our net revenue, partially offset by a decrease in our cost of services. Our gross margin decreased from 86.3% in 2008 to 84.3% in 2009.

     Operating Expenses.

      Our operating expenses decreased 35% from RMB408.8 million in 2008 to RMB265.9 million in 2009. The decrease in our operating expenses was primarily due to a decrease in our sales and marketing expense.

     Research and Product Development Expenses.

      Our research and product development expenses increased 28% from RMB88.5 million in 2008 to RMB113.4 million in 2009. The increase in our research and product development expense was primarily due to increased costs associated with the development of ZT Online II, as well as our Win@Giant program, which serves as an important source for our product development efforts. Our research and product development costs were partially offset by the capitalization of RMB21.6 million in game development expenditures.

     Sales and Marketing Expenses.

      Our sales and marketing expenses decreased 50.5% from RMB241.6 million in 2008 to RMB119.6 million in 2009. The decrease of our sales and marketing expense was primarily due to a decrease in our advertising expense and a decrease in our compensation expense. Our advertising expense decreased by 55.4% from RMB70.4 million in 2008 to RMB31.4 million in 2009. Our compensation expenditure for our liaison personnel decreased by 35.2% from RMB77.1 million in 2008 to RMB50.0 million in 2009 due to a reduction in the number of marketing liaison personnel.

     General and Administrative Expenses.

      Our general and administrative expenses decreased 14.4% from RMB141.8 million in 2008 to RMB121.4 million in 2009. The decrease in our general and administrative expense was primarily due to a decrease in employee wages and welfare benefits and a decrease in share-based compensation expense. Our compensation expense for general and administrative employees decreased by 15.4% from RMB71.4 million in 2008 to RMB60.3 million in 2009. The decrease in our share-based compensation expense attributable to general and administrative employees was primarily a result of our accelerated share-based compensation amortization policy and the fact that no new share options were issued to management during the year.

     Government Financial Incentives.

      The amount of government financial incentives we received increased 40.3% from RMB63.1 million in 2008 to RMB88.5 million in 2009. The increase in government financial incentives was primarily due the increase in our tax payments in 2008 as compared to 2007.

     Income from Operations.

      Our income from operations decreased 13.9% from RMB968 million in 2008 to RMB833.8 million in 2009. As a percentage of total net revenues, income from operations increased from 60.7% in 2008 to 64.0% in 2009. The decrease in our income from operations was primarily due to the decrease in our online game revenues, partially offset by our lower operating expenses.

     Interest Income.

      Our interest income decreased 44.8% from RMB185.0 million in 2008 to RMB102.2 million in 2009. The decrease in our interest income was primarily due to a reduction in interest rates offered by banks in China.

     Income Tax Expense.

      Our income tax expense increased 116% from RMB39.4 million in 2008 to RMB85.1 million in 2009. The increase in our income tax expense was primarily due to the lower base in 2008 as a result of the reversal of unrecognized tax benefits, reversal of valuation allowance of deferred tax assets, an increased deferred tax assets in 2008, an increase in the applicable income tax rate from 9% in 2008 to 10% in 2009 pursuant to relevant PRC laws and regulations, and the full-year effect of the expiration of the two-year tax exempt status for Zhengtu Information during 2007. In addition, we recognized an income tax expense of RMB28.4 million for our Cayman company in accordance with FIN 48 Accounting for Uncertainty in Income Taxes — an interpretation of FASB statement No. 109, which was offset by the reversal of unrecognized tax benefits of RMB30.9 million as a result of Giant Network’s qualification as a software enterprise for year 2007.

     Investment Income (Loss).

      We recorded investment income of RMB1.2 million in 2008, and recorded an investment loss of RMB6 million in 2009. The investment loss in 2009 related to our securities trading activities.

     Net Income Attributable to Our Shareholders and Net Margin.

      Our net income attributable to our shareholders decreased 22.9% from RMB1,113.6 million in 2008 to RMB859.3 million in 2009. Our net income margin also decreased from 69.8% in 2008 to 65.9% in 2009.

     Dividends.

      We paid dividends to our shareholders in the amount of RMB 593.5 million and RMB277.7 million in 2008 and 2009, respectively.

B. Liquidity and Capital Resources

     Cash Flows and Working Capital.

     On November 6, 2007, we completed our initial public offering, resulting in net proceeds to us of approximately US$792.7 million, which we have used in investments as well as to fund our share repurchase program.

     As of December 31, 2008, 2009 and 2010, we had RMB1,696 million, RMB1,097.2 million and RMB2,776.9 million (US$420.7 million), respectively, in cash and cash equivalents. In 2008, 2009 and 2010, our cash needs were derived primarily from our operating expenses and our cost of services, and to a lesser extent our capital expenditures. See “— Capital Expenditures.”

		For the year ended December 31,
		2008				2009				2010
		(RMB)				(RMB)				(RMB)				(US$)
		(in thousands)
Net of cash provided by operating activities			1,109,700				751,759				1,032,139				156,385
Net cash provided by (used in) investing activities			(3,874,244	)			(1,021,922	)			958,345				145,204
Net cash used in financing activities			(2,583,868	)			(316,619	)			(250,625	)			(37,974	)
Cash and cash equivalents at the end of the year			1,696,273				1,097,155				2,776,936				420,748