Edgar Filing: Giant Interactive Group Inc.

Amendment No.1 to Form 20-F

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549.

AMENDMENT NO. 1

FORM 20-F

(Mark One)

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

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

For the fiscal year ended December 31, 2011

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

For the transition period from to .

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

Date of event requiring this shell company report

Commission file number: 001-33759

Giant Interactive Group Inc.

(Exact name of Registrant as specified in its charter)

Not applicable

(Translation of Registrant’s name into English)

Cayman Islands

(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)

Jazy Zhang Chief Financial Officer

11/F, No. 3 Building, 700 Yishan Road

Shanghai, 200233,

People’s Republic of China

Telephone: (86 21) 3397 9999

Facsimile: (86 21) 3397 9947

(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: 235,234,959 ordinary shares.

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer.

Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨

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

U.S. GAAP x

International Financial Reporting Standards as issued

by the International Accounting Standards Board ¨

Other ¨

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. ¨ Item 17 ¨ 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). ¨ Yes x No

EXPLANATORY NOTE

This amendment no. 1 on Form 20-F/A hereby amends Items 3, 5, 8, 17, 18 and 19 of Giant Interactive Group Inc.’s annual report on Form 20-F for the fiscal year ended December 31, 2011, which was filed on April 23, 2012. This amendment no. 1 is being filed for the purpose of providing additional details to our disclosures in the original report as well as providing additional clarifying information in the notes to our financial statements pursuant to comments we received from the Staff of the U.S. Securities and Exchange Commission in connection with its review of our periodic filings. This amendment no. 1 is not intended to revise other information presented in our annual report on Form 20-F for the fiscal year ended December 31, 2011 as originally filed, which remains unchanged.

This amendment no. 1 on Form 20-F/A does not reflect events occurring after the filing of the original Form 20-F and does not modify or update the disclosure therein in any way other than as required to reflect the amendments discussed above. As a result, this amendment no. 1 to the annual report on Form 20-F/A continues to speak as of April 23, 2012, except for Notes 2, 3, 9, 13 and 17 to the Item 17 and 18 Financial Statements, as to which the date is September 26, 2012.

GIANT INTERACTIVE GROUP INC.

TABLE OF CONTENTS


		Page

FORWARD-LOOKING STATEMENTS			1

PART I.

ITEM 3.	KEY INFORMATION		2

ITEM 5.	OPERATING AND FINANCIAL REVIEW AND PROSPECTS		29

ITEM 8.	FINANCIAL INFORMATION		45

PART III.

ITEM 17.	FINANCIAL STATEMENTS		47

ITEM 18.	FINANCIAL STATEMENTS		47

ITEM 19.	EXHIBITS		47

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS			F-1

FORWARD-LOOKING STATEMENTS

This amendment no. 1 on Form 20-F/A 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,” and “Financial Information”. 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 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;

•

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.

PART I.

ITEM 3. KEY INFORMATION

A. Selected Financial Data

The selected consolidated financial data for the three years ended December 31, 2009, 2010, and 2011, and the selected consolidated balance sheet data as of December 31, 2010 and 2011, were derived from our consolidated financial statements, which have been audited by Ernst & Young Hua Ming LLP, an independent registered public accounting firm. The report of Ernst & Young Hua Ming LLP, as well as our audited consolidated financial statements as of December 31, 2010 and 2011, and for each of the three years ended December 31, 2011, are included elsewhere in this annual report. The selected consolidated balance sheet data as of December 31, 2007 and 2008, and selected consolidated statement of operations and comprehensive income data for the years ended December 31, 2007 and 2008, have been derived from our audited consolidated financial statements for the years ended December 31, 2007 and 2008, which are not included in this annual report.

Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results do not necessarily indicate our results expected for any future periods. You should read the selected consolidated financial data in conjunction with the consolidated financial statements and the related notes included under “Item 18. Financial Statements” and “Item 5. Operating and Financial Review and Prospects”

Consolidated Statement of Operations and Comprehensive Income Data:


	Year Ended December 31,
	2007			2008			2009			2010			2011
	RMB			RMB			RMB			RMB			RMB			US$
	(In thousands, except per share and per ADS data)
Net revenue:
Online games		1,521,396			1,589,676			1,293,018			1,289,481			1,701,343			270,316
Licensing revenues		6,140			4,391			10,687			42,667			54,538			8,665
Other revenue, net		—			612			130			668			36,336			5,773

Total net revenue		1,527,536			1,594,679			1,303,835			1,332,816			1,792,217			284,754
Cost of services		(174,086	)		(217,899	)		(204,070	)		(199,122	)		(257,246	)		(40,872	)

Gross profit		1,353,450			1,376,780			1,099,765			1,133,694			1,534,971			243,882
Operating (expenses) income:
Research and product development		(26,918	)		(88,539	)		(113,354	)		(186,037	)		(230,209	)		(36,577	)
Sales and marketing		(189,403	)		(241,575	)		(119,600	)		(143,006	)		(169,982	)		(27,007	)
General and administrative		(74,130	)		(141,786	)		(121,446	)		(119,447	)		(103,727	)		(16,481	)
Government financial incentives		16,779			63,084			88,460			57,386			47,746			7,586
Impairment of intangible assets		—			—			—			(46,558	)		—			—

Total operating expenses		(273,672	)		(408,816	)		(265,940	)		(437,662	)		(456,172	)		(72,479	)

Income from operations		1,079,778			967,964			833,825			696,032			1,078,799			171,403
Interest income		53,878			184,964			102,200			136,098			141,587			22,496
Investment income (loss)		2,562			1,171			(5,971	)		—			3,048			484
Unrealized loss on investment held-for-trading		—			(300	)		—			—			—			—
Other (expense) income, net		126			(843	)		14,025			65,466			43,558			6,921

Income before income tax expenses		1,136,344			1,152,956			944,079			897,596			1,266,992			201,304

Income tax expenses		—			(39,368	)		(85,060	)		(89,322	)		(352,378	)		(55,987	)
Share of loss of an equity investee		—			—			—			(648	)		(8,218	)		(1,306	)
Net income		1,136,344			1,113,588			859,019			807,626			906,396			144,011
Net loss (income) attributable to non controlling interests		—			—			295			3,563			(26,429	)		(4,199	)

Net income attributable to the Company’s shareholders		1,136,344			1,113,588			859,314			811,189			879,967			139,812

Other comprehensive loss, net of tax
Foreign currency translation		(51,927	)		(192,424	)		(12,769	)		(73,194	)		(84,728	)		(13,462	)
Reclassification adjustment		—			—			(1,814	)		—			—			—
Unrealized holding gains (losses)		—			76,969			(30,951	)		(14,540	)		(15,998	)		(2,542	)

Total other comprehensive loss, net of tax		(51,927	)		(115,455	)		(45,534	)		(87,734	)		(100,726	)		(16,004	)

Comprehensive income		1,084,417			998,133			813,780			723,455			779,241			123,808

Net earnings per ordinary shares, basic		5.40			4.65			3.80			3.57			3.79			0.60
Net earnings per ordinary shares, diluted		5.25			4.49			3.67			3.47			3.79			0.60
Net earnings per ADS⁽¹⁾, basic		5.40			4.65			3.80			3.57			3.79			0.60
Net earnings per ADS, diluted		5.25			4.49			3.67			3.47			3.79			0.60
Shares used in computation, basic		210,574,196			239,458,633			226,278,227			227,308,854			232,004,879			232,004,879
Shares used in computation, diluted		216,255,503			247,895,076			233,960,556			233,928,400			232,004,879			232,004,879

(1)	Each ADS represents one ordinary share

Selected Consolidated Balance Sheet Data:


	Year Ended December 31
	2007		2008		2009		2010		2011
	(RMB)		(RMB)		(RMB)		(RMB)		(RMB)		(US$)
	(in thousands)
Assets
Cash and cash equivalents⁽¹⁾		7,295,470		1,696,273		1,097,155		2,776,936		950,321		150,991
Short-term investments⁽¹⁾		—		3,371,828		3,802,050		3,253,362		919,775		146,138
Total current assets⁽¹⁾		7,373,495		5,236,061		5,102,972		6,304,005		2,179,246		346,247

Property and equipment, net		127,631		213,905		178,670		143,286		349,668		55,557
Investment in equity investees⁽²⁾		—		—		—		35,126		351,400		55,832
Total non-current assets		214,228		766,363		1,349,690		804,138		1,371,985		217,987
Total assets		7,587,723		6,002,424		6,452,662		7,108,143		3,551,231		564,234
Deferred revenue		324,971		403,130		321,291		442,795		529,204		84,082
Total current liabilities		1,282,199		603,608		547,448		700,314		1,014,916		161,254

Total liabilities		1,282,199		629,294		547,869		700,500		1,029,798		163,618

Total Giant Interactive Group Inc.’s equity		6,305,524		5,373,130		5,897,185		6,392,860		2,495,648		396,519

Non controlling interest		—		—		7,608		14,783		25,785		4,097
Total liabilities and equity		7,587,723		6,002,424		6,452,662		7,108,143		3,551,231		564,234

(1)

In the third quarter of 2011, we declared and paid out a special dividend of US$3.00 per share to our ADS and ordinary share shareholders, out of which the payout was physically financed partially through the declaration and payout of dividends to the Company by one of its PRC subsidiaries. As such, the dividends were subject to a 10% withholding tax and therefore, we accrued a one-time withholding income tax amount of RMB259.4 million (US$41.2 million) associated with the repatriation of cash for the special dividend paid during the third quarter 2011.

(2)	In September 2011, we invested US$50.0 million in the Yunfeng e-Commerce Funds for the purpose of purchasing shares of the Alibaba Group, China’s leading e-commerce company.

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 RMB 6.2939 to US$1.00, the noon buying rate in effect as of December 31, 2011. 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 April 13, 2012, the noon buying rate was RMB6.3022 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)
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
2011		6.2939		6.4475		6.2939		6.6364
October 2011		6.3547		6.3710		6.3534		6.3825
November 2011		6.3765		6.3564		6.3400		6.3839
December 2011		6.2939		6.3482		6.2939		6.3733
2012
January 2012		6.3080		6.3119		6.2940		6.3330
February 2012		6.2935		6.2997		6.2935		6.3120
March 2012		6.2975		6.3125		6.2975		6.3315
April 2012 (through April 13, 2012)		6.3022		6.3048		6.2975		6.3123

(1)	Averages for a period are calculated by using the average of the exchange rates on the end of each month during the period. Monthly averages are calculated by using the average of the daily rates during the relevant period.

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

The ZT Online franchise of massively multiplayer online role playing games, or MMORPGs, have historically accounted for substantially all of our net revenues. Any decrease in the popularity of these games would materially and adversely affect our results of operations.

The ZT Online franchise, which consists of the ZT Online 1 Series and ZT Online 2, have historically accounted for a significant portion of our net revenues. In 2006 we commercially launched ZT Online, which together with ZT Online PTP, ZT Online Classic Edition, and ZT Online Green Edition, constitutes the ZT Online 1 Series. In 2011 we commercially launched ZT Online 2, which is part of the ZT Online franchise but differs from the ZT Online 1 Series games in a number of ways, including its story, gameplay, graphics, maps, quests, and characters. The most significant change in ZT Online 2 is its in-game economy. ZT Online 2’s next generation in-game economy, the transaction-based revenue model which allows players to purchase in-game items from other players that have earned such items by leveling up their in-game characters and accomplishing in-game objectives, is designed to target lower spending and non-spending users as compared to that of ZT Online 1 Series, in which revenue is generated from the players’ consumption of game points to purchase items sold by the in-game store. Although we currently operate eleven games, six of which are not part of the ZT Online franchise, we expect that we will continue to derive substantially all of our net revenues from the ZT Online franchise in the near term. Our business prospects, financial condition and results of operations would therefore be materially and adversely affected by any factor that contributes to a decline in revenue from the ZT Online franchise, including:

•

any reduction in purchases of virtual items by players of the ZT Online franchise games;

•

any decrease in the popularity of the ZT Online 1 Series or ZT Online 2 due to competition or otherwise;

•

failure to improve, update or enhance the ZT Online franchise games in a timely or effective manner; or

•

any lasting or prolonged server interruption due to network failures or other factors.

For example, in the third quarter of 2009 our quarterly net online game revenues decreased by approximately 20% from the prior quarter, falling by RMB73.7 million to RMB287.5 million. The sequential decrease was mainly attributable to the Company’s decision to cancel certain in-game monetization features, such as “Treasure Box” in ZT Online.

As with other online games, the ZT Online franchise games have finite commercial lifespans. Although our ongoing release of new version of the ZT Online franchise games helps to extend the commercial life of the games, to ensure the continued popularity of the ZT Online 1 Series and ZT Online 2, we will need to expend considerable resources to improve and update the games on a timely basis with new content and features that appeal to our players. Any decline in the popularity of the ZT Online franchise games, whether as a result of the failure to provide timely and popular updates or otherwise, would materially and adversely affect our business prospects, financial condition and results of operation.

If we are unable to successfully develop and license new popular online games, our business, financial condition and results of operations may be materially and adversely affected.

In order to maintain our long-term profitability and financial and operational success, we must continually develop or license new online games that are attractive to our players. While many new online game products are regularly introduced to the market, only a small number of “hit” titles account for a significant portion of total revenue in our industry. As the online game market is limited in size, successful hit product launches by our competitors may take a larger share of the market, which could cause revenues generated by our products to fall below expectations.

The success of our internally developed games will largely depend on our ability to anticipate and effectively respond to changing tastes and preferences of our players and to 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, identifying new third party developed online games with strong market potential, and obtaining license to those online games on commercially reasonable terms, requires a significant degree of effort. If we are not able to successfully develop or license new hit online games that attract large numbers of players and result in substantial online game revenues, our business, financial condition and results of operations may be materially and adversely affected.

We are substantially dependent upon the MMORPG segment of China’s online game industry. Any decline in the size of the MMORPG market segment, due to competition from other video game products, other entertainment products or otherwise, would materially and adversely affect our results of operations.

The MMORPG segment of China’s online game industry, from which we derive substantially all of our revenues, is both rapidly evolving and subject to competition from other forms of video games and other entertainment products. The future prospects for the MMORPG market segment in China will depend on a number of factors beyond our control, including:

•

the growth of personal computer, internet and broadband users and their penetration in China;

•

whether the MMORPG segment of China’s online game industry continues to grow and the rate of any such growth;

•

the availability and popularity of other forms of video game products, such as social networking games offered on Tencent’s Qzone platform, mobile games offered on Apple’s iOS platform, and console games playable on game consoles made by Sony, Nintendo and Microsoft;

•

the availability and popularity of other forms of online and offline entertainment, such as movies, television programs and other video content;

•

changes in consumer demographics and consumer tastes and preferences; and

•

general economic conditions, particularly economic conditions adversely affecting discretionary consumer spending.

Although MMORPGs are currently popular in China, there is no assurance that they will continue to be popular in China or elsewhere. A decline in the popularity of online games in general, or the MMORPG market segment in particular, will materially and adversely affect our business prospects, financial condition and results of operations.

The reorganization of our game development studios could materially and adversely affect our results of operations as a portion of the profits from games developed or operated by these studios will be shared with the non controlling shareholder of these studios.

In 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, by which we believe will provide greater incentive to the game development teams to make their games commercially successful. Upon completion of the studio reorganization, all of the Company’s self-developed games except for the four games in the ZT Online 1 Series will be supported by studios that include key members of our development team as non controlling shareholders.

As a result of our game development studio reorganization, a portion of the net income generated by games developed or supported by these game development studios will be attributable to the non controlling shareholders of the studios. The Company consolidates its financial results with those of the reorganized studios, and then presents the net income or loss attributable to the non controlling shareholders as a separate non controlling interest line item under the heading “net income or loss attributable to non controlling interests”. The Company’s consolidated income attributable to its shareholders is arrived at after deducting this non controlling interest. In 2011, total non controlling interest related to our reorganized studios was RMB26.4 million (US$4.2 million). If our games developed and/or supported by these studios become more popular and profitable in the future, this non controlling interest amount will increase, which may result in a lower net income attributable to Company’s shareholders and may materially and adversely affect our results of operations.

There are risks that the revenue model we adopt for ZT Online 2 may not be suitable.

In connection with the introduction of ZT Online 2, we adopted a new transaction-based revenue model, which differs in material ways from the item-based revenue model that we use in connection with most of our online games. Unlike the item-based revenue model, we generally do not sell in-game virtual items directly to players in the transaction-based revenue model. Instead, the players must either earn in-game items by leveling up their in-game characters and accomplishing in-game objectives, or purchase in-game items from other players that have earned such items. We generate revenue by selling the virtual currency to players to purchase in-game items from other players. In addition, we also charge a transaction fee on each sale and purchase of an in-game item between two players.

Although ZT Online 2, which uses this new transaction-based revenue model, has experienced significant revenue growth from the start of the official implementation of the game, we cannot assure you that this new revenue model will ultimately be accepted by players and generate sustainable revenue for us. If the transaction-based revenue model is not suitable for ZT Online 2, we may need to switch to a different revenue model for the game. A change in revenue model could result in various adverse consequences, including disruptions of the game operations, criticism from game players who have invested time and money in the game and would be adversely affected by such a change, decreases in the number of our game players or decreases in the revenues we generate from the game.

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. In recent years, numerous competitors have entered the online game industry in China. 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 principal competitors include China-based online game companies such as Tencent Holdings, Ltd., Changyou.com Limited, Perfect World Co., Ltd., Shanda Games Limited and NetEase.com. In addition, we expect international game developers to continue to license more of their games for operation in China.

Many of our 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 competitors may be acquired by, receive investments from or enter into other cooperative relationships with larger, more 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 international competitors may establish cooperative relationships with our local competitors, which 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.

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

We have experienced significant fluctuations in our operating results from period to period due to a variety of factors, many of which are beyond our control. Significant fluctuations in our operating results could be caused by any of the following factors, among others:

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our ability to retain existing users of our games and attract new users;

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the introduction of new games or expansion packs by us or our competitors;

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changes in our game features and the corresponding impact on player behavior and purchasing patterns;

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the adoption of new, or changes in existing government regulations;

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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;

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game development costs for our self-developed games, and license costs and royalty payments for licensed games;

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the amount of overseas licensing net revenues generated through our licensing arrangements with operators of our games;

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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;

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the success of our advertising and promotional efforts;

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seasonality effect during holidays in the first quarter and fourth quarter, when fewer of our targeted players play our games; and

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economic conditions in general and specifically with respect to the online game industry in China.

For example, our net revenues declined 18% in 2009, which we believe was primarily due new regulations promulgated by the PRC government in connection with certain game features, and corresponding changes to our in-game monetization features.

As a result, our operating results may vary from period to period, would 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. In the event that our operating results do not meet our expectations or those of the public market analysts and investors, the price of our ADSs may decline.

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 expanding our ZT Online franchise, reorganizing our game development studios to incentivize our key developers, acquiring additional licenses to operate third party developed games in China and pursuing additional licensing opportunities for operating our games overseas, and expanding into non-MMORPG market segments by developing web games, and games for operating on mobile and tablet platforms.

For example, we have reorganized our game development studios by establishing various subsidiaries that are generally 51% owned by us and 49% owned by the relevant key development team members based on our Win@Giant incubation initiative, with an aim to facilitate our development of new online games. Each reorganized studio only focuses upon producing and supporting their own internally developed games, which we believe will provide the game developers greater incentive to make their games commercially successful. Pursuant to such reorganization arrangement, Giant Online, one of our existing MMORPGs, is supported by Shanghai Juhuo Network Technology Co., Ltd., or Juhuo Network, and ZT Online 2 is supported by Shanghai Jujia Network Technology Co., Ltd., or Jujia Network. For additional information regarding the reorganization of our game development studios, see “Item 4. Business Overview – Game Development and Sourcing – Game Development.”

In addition, we have established an internal development team focusing on producing web games, which are online games that do not require installation of client side server software, thereby reducing the time required for players to begin playing the games. We are also exploring development of games to be operated on mobile and tablet devices.

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 maintained relatively stable in 2010 and 2011. 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.

Our business may be materially harmed if our games are not featured in a sufficient number of internet cafés in China.

A substantial number of players access our game through internet cafés. Due to limited storage space on their computer hard drives for client side game software, internet cafés generally only feature a select 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. After the suspension of approving new internet cafés in 2007, the total number of internet cafés in the PRC was limited and controlled by relevant authorities. Governmental authorities may from time to time impose even stricter requirements, such as customer age limit and hours of operation for internet cafés, in response to certain media report on gang fights, arson and other incidents that may relate to internet cafés. 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 personal computers 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 personal computers in China has increased in recent years, the penetration rate for personal computers 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 personal computers 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. The limited use of personal computers 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, or failure of our distributors to comply with the terms of our distribution agreements, 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 used by customers in China as in the United States. As a result, although we make our game points available for online purchase through our official game website, our business is dependent on the performance of our regional distributors, who are composed of independent third parties. In 2011, 75.2% of our sales proceeds were generated through sales of prepaid game cards to our distributors. Our largest distributor accounted for 4.5% of our sales proceeds in 2011. 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. 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 and adversely disrupt our business and harm our net revenues.

In addition, our distributors and internet cafés and other outlets in which they sell our prepaid game cards may violate our distribution agreements. Examples of violations include:

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failure to meet minimum sales targets or penetration targets, or failure to maintain minimum price levels for our prepaid game cards;

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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

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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 these types of violations in the past, which resulted in our terminating of their existing distribution agreements. 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. We may also be liable in China for legal or regulatory violations by any of our distributors.

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 2011, 24.8% of our sales proceeds were generated by players purchasing our game points directly through our official game website, and the remaining 75.2% from purchasing physical or virtual game cards through our distributors. The direct game point purchasing through our official game website is processed by a variety of third-party online payment service providers, including Alipay.com Co., Ltd, Shanghai China UnionPay E-Payment Service Co., Ltd, 99Bill Corporation, China Payment and Remittance Service Co., Ltd. and several major commercial banks. In such transactions, secure transmission of our players’ confidential billing information 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 can be used for multiple accounts under a player’s name, to better ensure the security of our players’ accounts. While we have not experienced any breach of our security measures to date, current security measures may be inadequate. 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 systems we use.

In addition, we do not have control over the security measures of our third-party online payment service providers, and those 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 satisfactory performance, reliability, security and availability of our network infrastructure, including issues arising from the internet infrastructure in China, security breaches caused by hacking and transmission of computer viruses, and natural disasters such as floods and earthquakes, may cause significant harm to our reputation and our ability to retain existing and attract new game players. In addition, 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. Any network interruption or inadequacy that causes interruptions in the availability of our games or deterioration in the quality of access to our games could reduce our game 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 systems and we do not have business interruption insurance.

Changes in our estimates of the virtual items sold within our games may have a negative impact on our net revenue and results of operations.

We generally recognize revenues from virtual items sold to players of our free-to-play online games over the estimated lifespan of the relevant virtual items as determined by historical player usage patterns and playing behavior. We continuously monitor the useful life of each type of virtual item we sell and make adjustments as appropriate. Any such adjustment may cause our revenues to be recognized over a significantly different time period, which may have a negative impact on our net revenue 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. In addition, 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 reputation and result in a decline in our active paying users. This could materially and adversely affect our business, financial condition and results of operations.

We depend on our key personnel, and our business and growth prospects may be severely disrupted if we lose their services or are unable to attract new key employees.

Our future success is heavily dependent upon the continued service of our key executive officers and other key employees. In particular, we rely on the expertise, experience and leadership of Yuzhu Shi, our founder, chairman and chief executive officer, and Ms. Wei Liu, our president, in connection with our business operations and game development. We also rely on their personal relationships with our employees, the relevant regulatory authorities, and our distributors. In addition, we are dependent on a number of key technology officers and staff for the development and operation of our online games. Furthermore, we need to continue to attract and retain skilled and experienced online game development personnel to maintain our competitiveness.

If one or more of our key personnel are unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all and may incur additional expenses to recruit and train new personnel. These difficulties may disrupt our business, and our financial condition and results of operations could be materially and adversely affected. We do not maintain key-person life insurance for any of our key personnel. In addition, if any of our executive officers or key employees joins a competitor or forms a competing company, we may lose know-how, trade secrets, suppliers and key professionals and staff. All of our employees, including each of our executive officers and key employees, have entered into an employment agreement with us, which contains customary non-compete provisions. Although non-compete provisions are generally enforceable under PRC laws, PRC legal practice regarding the enforceability of such provisions may not be as well-developed, and therefore we cannot assure you that a PRC court would enforce such provisions. Furthermore, since the demand and competition for talent is intense in our industry, particularly for online game development personnel and related technical personnel, we may need to offer higher compensation and other benefits in order to attract and retain key personnel in the future, which could increase our compensation expenses. In the fourth quarter of 2008, we introduced Win@Giant, an incubation program designed to attract and retain talented employees, developers and business partners. Under Win@Giant, we have reorganized our game development studios by establishing various subsidiaries that are generally 51% owned by us and 49% owned by the relevant key development team members, with an aim to facilitate our development of new online games. Each reorganized studio only focuses on producing and supporting internally developed games, which we believe will give them greater incentive to make their games commercially successful.

While this program is intended to supplement and not to 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 qualified game developers or other key personnel that we will need to achieve our business objectives.

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

We may expand our business through selective acquisitions in the future. We do not, however, have significant experience in completing acquisitions or integrating new companies into our existing operations. In the event that we pursue acquisition opportunities in the future, we will face a number of risks that could materially and adversely affect our business and results of operations, including overpaying for the acquisitions, an inability to realize the synergies contemplated at the time of executing the transactions, difficulties in integrating the acquired companies, the diversion of management resources from other strategic and operational issues, the inability to retain the key employees of the acquired companies, and unknown and unforeseen assumed liabilities. For example, in 2010 we acquired the entire equity interest in Beijing Julun Network Technology Co., Ltd., or Julun Network, an online game developer, and a controlling equity interest in Hangzhou Snow Wolf Software Co. Ltd., or Snow Wolf Software, a Hangzhou based game development studio. In 2011, we acquired the remaining 49% equity interest of Shanghai Juyan Network Technology Co., Ltd., or Juyan Network, at a consideration of RMB3.5 million (US$0.56 million) which result in Juyan Network becoming a wholly-owned subsidiary of Shanghai Zhengduo Information Technology Co., Ltd., or Zhengduo Information. Subsequent to the acquisition related to Julun Network, Julun Network recorded losses in 2010 and 2011. If we fail to properly address these risks associated with any future acquisitions, our business, results of operations and financial condition may be materially and adversely affected.

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 that we have may adversely affect our business and reputation.

We have historically relied on a combination of trademark and copyright law, trade secret protection, internal security measures 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, 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, 2011, we own a total of 479 registered trademarks in China and overseas and are in the process of applying for the registration of 213 trademarks in China and 40 trademarks overseas. We cannot assure you that any of these trademark applications will ultimately be successful or will provide adequate protection for our business. Some of our pending applications or registrations may also be successfully challenged or invalidated by others. If our trademark applications or registrations are not successful, we may have to use different marks or otherwise enter into arrangements with third parties.

In addition, China’s online game market often faces challenges from pirate servers, which are game servers operating unauthorized copies of online games that enable players to play those games without purchasing prepaid game cards or game points from the authorized operators. We mitigate the risk of pirate servers by maintaining stringent security controls over our server side software at our offices and insisting upon high security standards at the various internet data centers where our servers are housed. In addition, once pirate servers are identified, we will promptly work with local government authorities to shut the servers down. If pirate game servers continue to operate any of our games, our business, financial condition and results of operations may be materially and adversely affected.

Implementation of intellectual property laws in China has historically been lacking, primarily because of difficulties in enforcement. Accordingly, intellectual property right protection in China may not be as effective as in the United States or other developed 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 and property insurance for our offices on Yishan Road, Guilin Road and Songjiang district in Shanghai, we also do not carry any other 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, 2011, and our independent registered public accounting firm concurred our management’s conclusion, our management may conclude in the future that our internal controls are not effective. 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.

We are an online game company, and therefore our experience with investment activities is limited.

We explore selected investment opportunities that may have strategic value to us or that are purely financial in nature, with the primary objective of providing us with a more favorable rate of return than that customary of ordinary bank deposits.

For example, as of December 31, 2010 and 2011, we had certain short-term and long-term held-to-maturity investments, amounting to RMB1,850.0 million and RMB700.0 million (US$111.2 million), respectively. In order to derive higher investment returns for the Company, we invested RMB100.0 million (US$15.9 million) in a trust arrangement with China Resources SZITIC Trust Co., Ltd. in May 2011 who in turn invested in certain real estate development projects in Ningbo and Chengdu. Similarly, in November 2011, we entered into a trust arrangement with China Railway Trust Co., Ltd., an affiliate of state owned China Railway Group Limited, to invest RMB 600.0 million, (US$95.3 million), which was used to fund a short-term loan provided to Zhonghang Wanke Co., Ltd. (“Zhonghang Wanke”), a large commercial and residential real estate development company located in the P.R.C. Although our held-to-maturity investment contracts are secured or wholly guaranteed by a reputable financial institution, a credit-worthy company, or by the properties of the underlying investment projects, any default by the trust companies or the borrowers under these trust arrangements, or any deterioration in the financial condition of the secured collateral or these financial institution or project companies could cause significant loss to us and have a material adverse effect on our financial condition and results of operations.

In addition, we have made certain equity investments. In April 2011, we committed to investing RMB30.0 million (US$4.8 million) in Beijing Innovation Work Investment Center (LP), an early-stage internet and technology company investment fund operating throughout China, which is led by Mr. Kai-Fu Lee. Out of the RMB30.0 million commitment, RMB9.0 million had been invested by the end of 2011. In September 2011, we invested RMB317,050,000 (US$50,374,172) in the Yunfeng e-Commerce Funds (the “Yunfeng Fund”) for the purpose of purchasing shares of the Alibaba Group Holding Limited (the “Alibaba Group”), China’s leading e-commerce company, that became available as part of the employee liquidity program offered by Alibaba Group to its employees. The Yunfeng Fund has a term of ten years, which may be extended for additional successive one-year periods up to a maximum of two years, and may be further extended upon the written election or vote of a majority in interest of the limited partners. The Yunfeng Fund purchased ordinary shares of the Alibaba Group at a price per share of US$13.50. The Company‘s interests in the Alibaba Group are held indirectly through its partnership interests in the Yunfeng Fund and subject to transfer restrictions, including a lockup period until December 31, 2012. If (i) the Company transfers its partnership interest in the Yunfeng Fund; (ii) the Yunfeng Fund sells its shares of the Alibaba Group; or (iii) the Alibaba Group makes an initial public offering of its shares, in each case, at a price per share of the Alibaba Group that is significantly less than the price per share paid by the Yunfeng Fund, the Company could recognize a significant loss and its financial condition and results of operations could be materially and adversely affected.

These investments are made in contemplation that the underlying businesses obtain and/or sustain continued business growth, eventually go public or be acquired, which there are no guarantees of occurring, if at all. In addition, some of these equity investments may only provide limited exits to us and therefore our investments may be illiquid until their respective maturity, or potentially until a liquidity event occurs with respect to the underlying companies that we hold indirect interest in.

Although these equity investments may offer us potentially higher returns, these returns are not guaranteed and 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 operations 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.

We have licensed seven of our self-developed games for operation in various countries, regions and territories of Asia, Europe and North America by a variety of different operating partners. In 2011, our revenues from licensing our games to third party operators was approximate RMB54.5 million (US$8.7 million), accounting for approximately 3.0% of our total net revenues. Licensing our games for operation in overseas markets exposes us to a number of risks, including difficulties in:

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identifying and maintaining good relations with game operators who are knowledgeable, and can effectively distribute and operate our games, in overseas markets;

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negotiating licensing agreements with game operators on terms that are commercially acceptable to us and enforcing the provisions of those agreements;

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developing games, updates and expansion packs catering to overseas markets and renewing our license agreements with game operators upon expiration;

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maintaining the reputation of our company and our games, given that our games are operated by game operators in the international markets with different standards;

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protecting our intellectual property rights overseas and managing the related costs;

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receiving and auditing the royalties we are entitled to receive;

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complying with the different commercial and legal requirements of the international markets in which our games are offered, such as game import regulatory procedures, taxes and other restrictions and expenses; and

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managing our foreign currency risks.

If we are unable to manage these risks effectively, our ability to license our games overseas may be impaired, which may materially and adversely affect our business, financial conditions and results of operations would be materially and adversely affected.

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 may lose control of Giant Network, resulting in its deconsolidation, and could be subject to severe penalties, including shutting down of our operations.

Various regulations in China currently restrict or prevent foreign and foreign-invested entities from engaging in operating online games in China. Since we are a Cayman Islands exempted company and therefore are a foreign or foreign-invested enterprise under PRC law, neither we nor our PRC subsidiary are eligible to hold a license to operate online games in China. To comply with PRC laws and regulations, we operate our online games in China through a series of contractual arrangements entered into between our wholly owned 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 value-added telecommunications business operating license, or ICP license, issued by the Shanghai Communications Administration, a local office of the Ministry of Industry and Information Technology of the PRC, or the MIIT, 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 “Item 4. Information on the Company — Organizational Structure” and “Item 7. 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 MIIT publicly released the Notice on Strengthening the Administration of Foreign Investment in Operating Value-added Telecommunications Business, dated July 13, 2006, or the MIIT 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 foreign investors in any form, or providing any resources, sites or facilities to foreign investors that intend to conduct value-added telecommunication business illegally in China. There is currently no official interpretation or implementation practice under the MIIT Notice. Due to a lack of interpretative materials from the authorities, it is uncertain whether the MIIT would consider our corporate structure and the contractual arrangements as a kind of foreign investment in telecommunication services. Therefore, it is unclear what impact the MIIT Notice might have on us or the other Chinese internet companies that have adopted the same or similar corporate structures and contractual arrangements as ours.

In addition, on September 28, 2009, GAPP, together with the National Copyright Administration, and the National Office of Combating Pornography and Illegal Publications jointly issued a Notice on Further Strengthening on the Administration of Pre-examination and Approval of Online Games and the Examination and Approval of Imported Online Game (Xin Chu Lian [2009] No. 13), or the GAPP Notice. The GAPP Notice restates that foreign investors are not permitted to invest in online game-operating businesses in China via wholly owned, equity joint venture or cooperative joint venture investments and expressly prohibits foreign investors from gaining control over or participating in domestic online game operators through indirect ways such as establishing other joint venture companies, or contractual or technical arrangements. However, the GAPP Notice does not provide any interpretation of the term “foreign investors” or makes a distinction between foreign online game companies and companies under a similar corporate structure like ours, including those listed Chinese internet companies that focus on online game operation. Thus, it is unclear whether GAPP will deem our corporate structure and operations to be in violation of these provisions.

Furthermore, as certain other government authorities such as the Ministry of Commerce, or MOFCOM, the Ministry of Culture, or the MOC, and the MIIT did not join GAPP in issuing the GAPP Notice, the views of these authorities are uncertain in clarifying the scope of implementation and enforcement of the GAPP Notice.

We cannot be sure that the PRC government would view our contractual arrangements to be in compliance with PRC licensing, registration or other regulatory requirements, including without limitation, the requirements described in the MIIT Notice and the GAPP Notice, existing policies, or with requirements or policies that may be adopted in the future. If any of our businesses is determined not to be in compliance with the MIIT Notice or the GAPP Notice, the PRC government could take a number of regulatory or enforcement actions that could be harmful to our business, including but not limited to: levying fines, revoking our business and operating licenses, discontinuing or restricting our operations, blocking our website, requiring us to restructure our business or imposing additional conditions or requirements that we cannot comply with. We may also encounter difficulties in obtaining performance or enforcement of related contracts, thereby losing our control of Giant Network, resulting in its deconsolidation. Any of these actions could cause our business, financial condition and results of operations to suffer and subsequently the market price of our ADSs to decline.

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 contractual arrangements with Giant Network and its shareholders in China to operate our business. For a description of these contractual arrangements, see “Item 4. Information on the Company — Organizational Structure” and Item 7, “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 or indirectly exercise our rights as a shareholder to (i) effect changes in the board of directors 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. Because we rely on these contractual arrangements to effect control and management of Giant Network, we are exposed to the risk that the shareholders of Giant Network may fail to perform his or her respective obligations under these contractual arrangements. In addition, the shareholders of Giant Network may potentially have a conflict of interest with us, and they may breach their contracts with us or cause such contracts to be amended in a manner contrary to the interest of our company, if they believe such action furthers their own interest, or if they otherwise act in bad faith. If any of the foregoing were to occur, we may have to incur substantial costs and expend significant resources to enforce these contractual arrangements.

In addition, 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 our PRC subsidiaries Zhengtu Information and Zhengju Information, our affiliated entity Giant Network, Giant Network’s shareholders and our reorganized game development studios 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 Giant Network, 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 underpayment of taxes.

The discontinuation, reduction or delay of any of the preferential tax treatments or the government financial incentives currently available to us in the PRC could materially and adversely affect our business, financial condition and results of operations.

Under PRC Enterprise Income Tax Law effective on January 1, 2008, or New EIT Law, foreign invested companies such as Zhengtu Information, and domestic companies such as Giant Network, are subject to a unified income tax rate of 25%. Various favorable income tax rates are, however, available for qualified enterprises in encouraged sectors of the economy. Companies that qualify as a high and new technology enterprise, or HNTE, a status which is reassessed every three years, are subject to an income tax rate of 15%. In addition, companies that qualify as a software development enterprise are exempt from income tax for two years and subject to an income tax rate of 12.5% for the following three years.

In 2008, the Shanghai government granted Zhengtu Information HNTE status, which was successfully renewed in 2011. In 2011, the Shanghai government recognized our three PRC subsidiaries as software development enterprises, including Shanghai Jujia Network Technology Co. Ltd., or Jujia Network, and Shanghai Juhuo Network Technology Co. Ltd., or Juhuo Network, two of our 51% owned game development studios and Shanghai Zhengju Information Technology Co., Ltd., or Zhengju Information, wholly owned by Shanghai Zhengduo Information Technology Co., Ltd., or Zhengduo Information. In addition, Wuxi Giant Network Technology Co., Ltd., or Wuxi Network also received certificates for software development enterprises in 2011.

We cannot assure you, however, that our PRC companies will be able to continue to qualify for preferential tax treatment. If any of our PRC companies that qualified for preferential tax treatments fails to continue to qualify in a subsequent year, our income tax expenses would increase, which may have a material adverse effect on our net income and results of operations. For additional information regarding the preferential tax treatments of our various PRC companies, see “Item 5. Operating and Financial Review and Prospects — Operating Results — Income Tax Expense — China.”

In addition, in 2009, 2010 and 2011, our PRC companies received financial incentives from the government in an aggregate amount of RMB88.5 million, RMB57.4 million and RMB47.7 million (US$7.6 million), respectively, which were calculated with reference to taxable revenues and taxable income. To be eligible for the government financial incentives, we are required to continue to meet a number of financial and non-financial criteria and, even if we meet these criteria, the grant of any incentive is still subject to the discretion of the municipal government. Moreover, the central government or municipal government could at any time eliminate or reduce these government financial incentives. Since the government has discretion in the timing of payment and the amount of the financial incentive, we cannot assure you that we will be able to continue to enjoy these government financial incentives or receive such incentives promptly. The discontinuation, reduction or delay of these government financial incentives could have a material adverse effect on our business, financial condition and results of operations.

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”, or Circular 82, clarified that dividends and other income paid by such “resident enterprises” will be considered to be PRC sourced 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 New EIT Law, 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, Circular 82 details that certain Chinese-controlled enterprises will be classified as “resident enterprises” if the following are located or resident in China: (i) senior management personnel and departments that are responsible for daily production, operation and management; (ii) financial and personnel decision making bodies; (iii) key properties, accounting books, company seal, and minutes of board meetings and shareholders’ meetings; and (iv) half or more of the directors or senior management having voting rights.

Although the determining criteria set forth in Circular 82 may reflect the State Administration of Taxation’s general position on how the “de facto management body” test should be applied in determining the tax resident status of offshore enterprises, Circular 82 only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by individuals or foreign enterprises like us. Therefore, we do not currently consider our company or any of our overseas subsidiaries to be a PRC resident enterprise. However, if the PRC tax authorities determine that our Cayman Islands 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 our non-PRC holding companies from our PRC subsidiaries would qualify as “tax-exempted income”, any such dividends paid to our non-PRC holding companies 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 Islands 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.”

The PRC New EIT Law will affect tax exemptions on the dividends we receive and we may not able to obtain certain treaty benefits on such dividends.

We are a holding company incorporated under the laws of the Cayman Islands. We conduct substantially all of our business through our PRC subsidiaries and affiliated entities from which we derive all of our income from these subsidiaries. Prior to January 1, 2008, dividends derived by foreign enterprises from business operations in China were not subject to the PRC enterprise income tax. However, such tax exemption ceased after January 1, 2008 with the effectiveness of the New EIT Law and a withholding tax rate of 10% will apply on such dividends (subject to reductions by the relevant tax treaties, if applicable).

According to the Notice of the State Administration of Taxation on Summary Table of Treaty Rates for Dividends, or Circular 112, which was issued on January 29, 2008 and the Arrangement between the PRC and the Hong Kong Special Administrative Region on the Avoidance of Double Taxation and Prevention of Tax Evasion, or the Double Taxation Arrangement (Hong Kong), which became effective on December 8, 2006, dividends from our PRC subsidiaries paid to us through our Hong Kong subsidiary may be subject to a withholding tax at a reduced rate of 5% if such Hong Kong entity owns at least 25% of the equity interest of the PRC company. The ultimate withholding tax rate will be determined by treaty between the PRC and the tax residence of the holder of the PRC subsidiary. The State Administration of Taxation promulgated a tax notice on October 27, 2009, or Circular 601, which provides that tax treaty benefits will be denied to “conduit” or shell companies without business substance and a beneficial ownership analysis will be used based on a “substance-over-the-form” principle to determine whether or not to grant treaty benefits. It is unclear at this early stage whether Circular 601 applies to dividends from our PRC subsidiaries paid to us through our Hong Kong subsidiary. However, the issuance of Circular 601 shows that there can be no assurance that the Double Taxation Arrangement between China and Hong Kong could be successfully applied as noted above. If our Hong Kong subsidiary cannot be regarded as the beneficial owner of such dividends, it will not be entitled to the treaty benefits under the Double Taxation Arrangement (Hong Kong) and thus the dividends will be subject to normal withholding tax of 10% as provided by the PRC New EIT Law.

The recently adopted PRC tax reform pilot program, which was initiated in Shanghai and may be extended to other cities in the future, requires us to pay value added tax instead of business tax in Shanghai and it could result in unfavorable tax consequences to us.

The PRC government recently adopted a PRC tax reform pilot program, which was initiated in Shanghai and may be extended to other cities in the future. On November 16, 2011, the Ministry of Finance and the State Administration of Taxation jointly issued the Circular on the Pilot Program for the Collection of Value Added Tax Instead of Business Tax, or Circular 110, and the Circular on the Pilot Program for the Collection of Value Added Tax Instead of Business Tax in Transportation and Certain Modern Service Sectors in Shanghai, or the Circular 111, to provide specific implementation rules for the pilot program, which became effective January 1, 2012. Pursuant to Circular 110 and Circular 111, starting from January 1, 2012, companies which are classified by Shanghai’s local tax authorities in transportation and certain modern service sectors in Shanghai are required to pay a Value Added Tax, or VAT, instead of the business tax. Specifically, a 17% rate applies to the movable property leasing services, an 11% rate applies to the transportation services and a 6% rate applies to certain other modern services, such as research and development, technological services, culture, logistics and consultation. This tax reform pilot program is new and its interpretation and enforcement involve significant uncertainties. In the event that our other PRC subsidiaries located in Shanghai engage in business falling within the category of certain modern service sectors, or if we are unable to obtain sufficient amount of qualified VAT invoices from our suppliers to offset the net revenue subject to such VAT, our PRC subsidiaries, which pay business tax at a 5% tax rate for such part of their business before the tax reform pilot program takes effect, may face unfavorable tax consequences, which may adversely affect our business, financial condition and results of operations.

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 and amended in 2009, 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, or the National Security Review Mechanism Circular, 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.

In addition, the Rules of Ministry of Commerce on Implementation of Security Review Mechanism of Mergers and Acquisitions of Domestic Enterprises by Foreign Investors promulgated by the MOFCOM in August 2011, or the MOFCOM Security Review Rules, effective September 1, 2011, which implements the National Security Review Mechanism Circular, provides that, a security review by MOFCOM is required for mergers and acquisitions of PRC domestic enterprises by foreign investors (i) having “national defense and security” concerns, and (ii) where the foreign investors may acquire the “de facto control” of the PRC domestic enterprises having national security concerns such as key farm products, key energy and resources, and key infrastructure, transportation, technology and major equipment manufacturing industries. Neither the National Security Review Mechanism Circular nor the MOFCOM Security Review Rules, however, defines the term of “key” or “major,” nor has it exhausted all the industries that may be deemed as sensitive industries subject to the security review. When deciding whether a specific merger or acquisition of a domestic enterprise by foreign investors is subject to MOFCOM’s security review, the principle of “substance over form” should be applied and foreign investors are prohibited from bypassing the security review requirement by way of structuring transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore transactions. 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 MIIT, 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 to maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.

The internet industry, including the operation of online games, in China is highly regulated by the PRC government. Various regulatory authorities of the central PRC government, such as the State Council, the MIIT, the State Administration for Industry and Commerce, or the SAIC, the MOC, GAPP, the State Administration of Radio, Film and Television, and the Ministry of Public Security, are empowered to promulgate and implement regulations governing various aspects of the internet and the online game industry.

We are required to obtain applicable permits or approvals from different regulatory authorities in order to provide online game services. For example, an internet content provider, or ICP, must obtain a value-added telecommunications business operation license, or ICP license, from the MIIT or its local offices in order to engage in any commercial ICP operations within China. An online game operator must also obtain an internet culture operation license from the MOC, and an internet publishing license from GAPP, in order to operate and distribute games through the internet. Giant Network holds a valid ICP License, a valid internet culture operation license and a valid internet publishing license. As the online game industry is at its 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. While we believe that we comply in all material respects with all applicable PRC laws and regulations currently in effect, we cannot assure you that we will be able to obtain timely, or at all, required licenses or any other new license required in the future. We also cannot assure you that we will not be found in violation of any current or future PRC laws and regulations.

Further strengthened supervision of the online game industry may adversely affect our online game operations.

The authority, roles and responsibilities of the 22 PRC governmental departments with oversight of the online game industry in China, including GAPP and the MOC, are currently ambiguous and we may face stricter scrutiny in the future regarding the day-to-day operations of our online game business. For example, our online game business may be adversely affected by ambiguities and potential conflicts between notices issued by GAPP and the MOC. GAPP initially stated in the GAPP Notice that it is the only governmental department with authority for examination and pre-approval of online games, and that all online game operators must obtain an internet publishing license to provide online game services. Pursuant to the GAPP Notice, additional approvals from GAPP are required when game operators release new versions or expansion packs, or make any changes to the originally approved online game. In addition, on July 1, 2009, GAPP issued the Notice on Strengthening the Approval and Administration of Imported Online Games, in which GAPP stated that it is the only governmental department authorized by the State Council to approve the importation of online games from offshore copyright owners. In the event of any failure to meet the above-mentioned requirements, an operator may face heavy penalties, such as being ordered to stop operation, or having its business license revoked. Our online game business may be adversely affected by these two GAPP notices. The launch of expansion packs and imported games might be delayed because of the extra approval required. Such delay in releasing expansion packs or imported games may result in higher costs for our online game operation and have an adverse effect on our game revenue.

On June 3, 2010, the MOC issued the Tentative Measures for Online Game Administration, or the Online Game Measures, which became effective on August 1, 2010, aiming to further strengthen the MOC’s supervision of the online game industry. Specifically, the Online Game Measures reiterate that the MOC has the power to review the content of all online games except online game publications that have been pre-approved by GAPP. However, the Online Game Measures do not clearly specify what constitutes “online game publication.” Furthermore, the Online Game Measures provide that all domestic online games must be filed with the MOC within 30 days after their launch, while all imported online games are subject to a content review prior to their launch. If a substantial change (for example, any significant modification to a game’s storyline, language, tasks, or trading system) is made to an existing imported or domestic online game, it will be subject to a new content review.

Our online game business may be adversely affected by the Online Game Measures. The Online Game Measures do not set forth any specific procedure for the required filing and content review procedures for online games and therefore may cause delay when we try to file or apply for content review with the MOC. In addition, the Online Game Measures do not resolve certain inconsistencies and ambiguities resulting from pronouncements included in previous notices issued by GAPP and the MOC. Due to the ambiguities here and elsewhere regarding the 22 governmental departments, including GAPP and the MOC, that have oversight of the online game industry, there may potentially be stricter and more abrupt scrutiny of our operations. If any of our online game operating entities cannot comply with any of the stipulations of any PRC governmental department regarding the online game industry, we may be subject to various penalties and our online game business may be adversely affected.

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.

The PRC government has adopted regulations governing internet access and the distribution of news and other information over the internet. Under these regulations, internet content providers and internet publishers are prohibited from posting or displaying over the internet any content that, among other things, violates PRC laws and regulations, impairs the national dignity of China, or is obscene, superstitious, fraudulent or defamatory. When internet content providers and internet publishers, including online game operators, find that information falling within the above scope is transmitted on their websites or is stored in their electronic bulletin service systems, they are required to terminate the transmission of such information or delete such information immediately, keep records, and report to relevant authorities. Failure to comply with these requirements could result in the revocation of our ICP license and other required licenses and the closure of our websites. Website operators may also be held liable for prohibited information displayed on, retrieved from or linked to their websites.

In addition, the MIIT has published regulations that subject website operators to potential liability for the actions of game players and others using their websites, including liability for violations of PRC laws prohibiting the dissemination of content deemed to be socially destabilizing.

As a result, we periodically make changes to our games based on feedback gathered from users and in order to comply with government regulations. For example, during the third quarter of 2009, we canceled several in-game monetization features in compliance with a virtual currency regulation issued by the Ministry of Culture, or MOC. The most important cancelled feature was the virtual treasure box, which contained in-game items worth more than the cost of the treasure box itself. 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 during the second quarter of 2009 to approximately 1,108,000, during the third quarter of 2009. Future rule changes to our games could lead to declines in active paying players, which may materially and adversely affect our business, results of operation and financial condition.

As these regulations are 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 an MMORPG developer and operator. In addition, we may not be able to control or restrict the content of other internet content providers linked to or accessible through our websites, or content generated or placed on our websites by our game players, 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 curtail our games, which may reduce our game player base, the amount of time our games are played or the purchases of virtual items.

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. In addition, the Virtual Currency Notice 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.

The PRC State Administration of Taxation has also previously announced that it will tax game players on the income derived from the trading of virtual currencies at the rate of 20%. However, it is currently unclear how the tax will be collected or if there will be any effect on our game players or our business.

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 addition, it is unclear under PRC law whether an operator of online games such as us would have any liability (whether in contract, tort or otherwise) for loss of such virtual assets by game players. 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.

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

Due to a relatively high degree of game player loyalty, easy access to personal computers and internet cafés, and the lack of other appealing forms of entertainment in China, many teenagers in China frequently play online games. This may result in these teenagers spending less time on or refraining from other activities, including education, vocational training, and sports, which could result in adverse public reaction and stricter government regulation. For example, the PRC government has promulgated anti-fatigue-related regulations to limit the amount of time minors can play online games. See “Risk Factors — Risks Related to the Regulation of Our Business – Our operations may be adversely affected by a broadening of the addiction-related regulations.” The PRC government has also tightened its regulations on internet cafés, currently one of the primary places where online games are played, including limiting the issuance of internet café operating licenses and imposing higher capital and facility requirements for the establishment of internet cafés. See “Risk Factors — Risks Related to the Regulation of Our Business – Intensified government regulation of internet cafés could limit our ability to maintain or increase our net revenues and expand our customer base.” In addition, in January 2011, MIIT and seven other central government authorities jointly issued a circular pursuant to which online game operators are required to maintain a system to communicate with the parents of minors that play the operator’s online games, to monitor the activities of the minors and to suspend their accounts if so requested by their parents.

Adverse public opinion, and the stricter government regulations that often result there from, could discourage game players from playing our games and could result in government regulations that impose additional limitations on the operations of online games. For example, in January 2011, the MOC, MIIT 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, under which 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 are required to monitor the activities of the minors and suspend the accounts of minors if so requested by their parents or guardians. Additional government regulations, whether issued in response to adverse public opinion or otherwise, could be issued in the future and may have a material and adverse effect upon our business, results of operation and financial condition.

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.

In October 2005, the State Administration of Foreign Exchange, or the SAFE, promulgated 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, which states that if PRC residents use assets or equity interests in their PRC entities as capital contributions to establish offshore companies or inject assets or equity interests of their PRC entities into offshore companies to raise capital overseas, they must register with local SAFE branches with respect to their overseas investments in offshore companies. They must also file amendments to their registrations if their offshore companies experience material events involving capital variation, such as changes in share capital, share transfers, mergers and acquisitions, spin-off transactions, long-term equity or debt investments or uses of assets in China to guarantee offshore obligations.

In addition, SAFE has further issued a series of implementation guidances, including the most recent Notice on Printing and Distributing the Implementing Rules for the Administration of Foreign Exchange in Fund-Raising and Round-trip Investment Activities of Domestic Residents Conducted via Offshore Special Purpose Companies, or Circular 19, which was effective as of July 1, 2011. Circular 19 standardized more specific and stringent supervision on the registration and supplemental registration for established special purpose vehicles, or SPVs, relating to Notice 75. Under these regulations, a PRC resident’s failure to comply with the registration procedures set forth in such regulations may result in fines or sanctions imposed by the PRC government, including restrictions being imposed on the foreign exchange activities of the relevant PRC entity, including the payment of dividends and other distributions to its offshore parent, as well as restrictions on the capital inflow from the offshore entity to the PRC entity.

We are committed to complying with and to ensuring that our shareholders who are subject to the regulations 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 comply with other requirements required by Notice 75 or other related rules. Any failure by any of our shareholders who are PRC residents, or controlled by a PRC resident, to comply with relevant requirements under this regulation could subject us to fines or sanctions imposed by the PRC government, including restrictions on our PRC subsidiaries’ abilities to pay dividends or make distributions to us and our ability to increase our investment in our PRC subsidiaries.

We may be subject to fines and legal sanctions if we or our employees fail to comply with recent PRC regulations relating to employee stock incentive plan granted by overseas listed companies to PRC domestic individuals.

In December 2006, the People’s Bank of China, or PBOC, 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 domestic individual’s participation in the employee stock ownership plan or stock options plan of an overseas listed company. In February 2012, the SAFE promulgated the Notice on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas-Listed Company, or the Stock Option Rule, which replaced 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 issued by SAFE on March 28, 2007. Under the Stock Option Rule, PRC domestic individuals who participate in any stock incentive plan including employee stock holding plan, stock option plan or similar plan of an overseas publicly-listed company are required, through a PRC agent of such overseas publicly-listed company, to register with the relevant local SAFE branch and complete certain other procedures and transactional foreign exchange matters related to the stock incentive plan. Under the Stock Option Rule, PRC domestic individuals include PRC citizens (including Hong Kong, Macao and Taiwan nationals) and foreign nationals who have continuously resided in China for at least a year, and a PRC agent may be a domestic company participating in the stock incentive plan or a domestic institution that is qualified to engage in assets custodian business and has been duly designated by a domestic company. 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.

However, as a result of uncertainty concerning the reconciliation of the new regulation and ambiguities in SAFE registration procedures for registering PRC individuals’ share obtained from exercise of share options, 299 PRC individuals in all who have exercised their options to purchase our ordinary shares in accordance with our Employee Share Option Scheme in 2011 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 individuals 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 individual 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.

Our operations may be adversely affected by a broadening of the addiction-related regulations.

The Chinese government may decide to adopt more stringent policies to monitor the online game industry to cover adult players 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 GAPP, the Ministry of Education and the MIIT 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, which 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. Although we currently do not permit minors to play our online games, if these restrictions are expanded to apply to adult players in the future, they could have a material and adverse effect on our business, financial condition and operating results.

On July 1, 2011, eight PRC government authorities, including the GAPP, the Ministry of Education, MIIT and five others, promulgated a further notice to strengthen the implementation of the anti-addiction system and real-name registration, entitled the Notice on Initializing the verification of Real-name Registration for Anti-Addiction System on Internet Games, or the Real-name Registration Notice, which took effect on October 1, 2011. The Real-name Registration Notice’s main focus is to prevent minors from using an adult’s ID to play Internet games and, accordingly, the notice provides more stringent punishment for online game operators for not implementing the anti-addiction and real name registration measures properly and effectively. The most severe punishment contemplated by the Real-name Registration Notice includes suspension of operation of online games, revocation of game operator’s licenses and approvals, rejection or suspension of game operator’s application for approvals, licenses, or filings for any new game if such game operator is found to be in violation of any of the government issued notices including the Anti-Addiction Notice, the Monitor System Circular or the Real-name Registration Notice. The Real-name Registration Notice further increases our operating risks, as we will be required to allocate more resources to real-name verification and anti-addiction systems, which may lead to an increase in operating costs. In addition, the amount of time that minors will be able to spend playing online games such as ours will be further limited, which may cause a reduction in our revenues. Furthermore, if we are found to be violating the Real-name Registration Notice, we may be required to suspend or discontinue our online game operations.

Our holding company structure may restrict our ability to receive dividends from, or transfer funds to, our PRC subsidiaries and our PRC affiliated entities, which could restrict our ability to act in response to changing market conditions and reallocate funds among our Chinese entities in a timely manner.

We are a Cayman Islands holding company and conduct substantially all of our operations through our PRC subsidiaries and affiliated entities. We may rely on dividends and other distributions on equity by our PRC subsidiaries for our cash requirements, including the funds to pay dividends on the ordinary shares underlying our ADSs. Furthermore, under PRC laws and regulations, each PRC subsidiary is only permitted to pay dividends out of its retained earnings, if any, determined in accordance with PRC accounting standards and regulations. Under PRC law, each PRC subsidiary is also required to set aside at least 10% of its after-tax profit based on PRC accounting standards each year to its general reserves until the cumulative amount of such reserves reaches 50% of its registered capital. These reserves are not distributable as cash dividends, loans or advances. Each PRC subsidiary may also 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 us. As a result of these and other restrictions under PRC laws and regulations, each PRC subsidiary is restricted from transferring a portion of its assets to us as dividends, loans or advances, which restricted portion amounted to approximately RMB211.0 million and RMB368.8 million (US$58.6 million), or 3.3% and 14.8% of our total consolidated net assets as of December 31, 2010 and 2011, respectively. Any limitation on the ability of our PRC subsidiaries to transfer funds to us as dividends, loans or advances could materially and adversely limit our ability to make offshore investments or acquisitions that could benefit our businesses and pay dividends.

In addition, any funds we transfer to our PRC subsidiaries, either as a shareholder loan or as an increase in registered capital, is subject to registration or approval of PRC governmental authorities, including the relevant administration of foreign exchange and/or the relevant examining and approval authority. Each entity of our PRC subsidiaries and affiliated entities is prohibited by PRC law to directly lend money to another. Therefore, it is difficult to change our capital expenditure plans once the relevant funds have been remitted from our company to our PRC subsidiaries and affiliated entities. These limitations on the free flow of funds between us and our PRC subsidiaries and affiliated entities could restrict our ability to act in response to changing market conditions and reallocate funds among our PRC subsidiaries and affiliated entities on a timely basis.

Risks Relating to China

Our business, financial condition and results of operations, as well as our ability to obtain financing, may be adversely affected by the downturn in the global or Chinese economy. In addition, we may be adversely affected by the possible “hard landing” of China’s economy in the future.

The global financial markets have experienced significant disruptions since 2008, the economic effects of which have persisted through 2011. China’s economy has also faced challenges. To the extent that there have been improvements in some areas, it is uncertain whether such recovery is sustainable, in particular under current European economic and sovereign debt crisis. Because substantially all of our business operations are conducted in China, our business and prospects may be materially and adversely affected by any deterioration in China’s macroeconomic environment.

There is a possibility that China’s economic growth rate may materially decline in the near future, which may have adverse effects on our financial condition and results of operations. Risk of a material slowdown in China’s economic growth rate is based on several current or emerging factors including: (i) overinvestment by the government and businesses and excessive credit offered by banks; (ii) a rudimentary monetary policy; (iii) excessive privileges to state-owned enterprises at the expense of private enterprises; (iv) the dwindling supply of surplus labor; (v) a decrease in exports due to weaker demand overseas; and (vi) failure to boost domestic consumption. Although we are uncertain about the extent to which the recent global financial and economic crisis and potential rapid slowdown of China’s economic growth may impact our business in the short term and long term, there is a risk that our business, results of operations and prospects would be materially and adversely affected by any ongoing global economic downturn or slowdown of China’s growth rate.

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 sometime 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.

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.

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

The 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 and China’s foreign exchange policies. The conversion of Renminbi into foreign currencies, including U.S. dollars, was historically based on exchange rates set by the PBOC. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi solely to the U.S. dollar. Under this revised policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. Following the removal of the U.S. dollar peg, the Renminbi has appreciated more than 5% against the U.S. dollar as of the end of 2011.

Substantially all of our revenues and costs are denominated in Renminbi. Any significant revaluation of the Renminbi may materially inflate our revenues and earnings as expressed in U.S. dollars without reflecting any material change in our results of operations.

The audit report included in this annual report are prepared by auditors who are not inspected by the Public Company Accounting Oversight Board and, as such, our investors are deprived of the benefits of such inspection

Our independent registered public accounting firm that issues the audit reports included in our annual reports filed with the US Securities and Exchange Commission, as auditors of companies that are traded publicly in the United States and a firm registered with the US Public Company Accounting Oversight Board (United States) (“the “PCAOB”), is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our auditors are located in the Peoples’ Republic of China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB.

Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

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 trading price of our ADSs has been and may continue to be subject to wide fluctuations. Since we completed our initial public offering on November 6, 2007, the closing price of our ADSs on the New York Stock Exchange has ranged from US$3.02 to US$20.46 per ADS and the last reported closing price on April 20, 2012 was US$5.44.

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:

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actual or anticipated fluctuations in our quarterly operating results;

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announcements of competitive developments;

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changes in the economic performance or market valuations of companies with comparable businesses;

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negative market and investor perception in response to recent accounting irregularities at other Chinese companies listed in the U.S.;

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regulatory developments in China affecting us, our industry, our corporate structure or our advertisers;

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announcements regarding litigation or administrative proceedings involving us;

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changes in financial estimates by securities research analysts;

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addition or departure of our executive officers;

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issuance of material dividends; and

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sales or perceived sales of additional common shares or ADSs.

For example, on September 12, 2011, the trading price of our ADS declined from US$8.00 to US$4.61, which was primarily due to a special cash dividend of US$3 per ADS that we issued to our shareholders as of record August 31, 2011.

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 our controlling 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 March 31, 2012, we had 236,396,009 outstanding ordinary shares, of which 131,228,540 or 55.51% were beneficially owned by Yuzhu Shi, our founder, chairman and chief executive officer, and his daughter Ms. Jing Shi. If Mr. Shi or his daughter decides to sell any of these shares 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 shareholder.

As of March 31, 2012, Yuzhu Shi, our chairman and chief executive officer, and his daughter Jing Shi, together beneficially owned approximately 55.51% 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 investments, mergers or other business combination transactions. 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 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, 2011. 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 2012 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 — Taxation — U.S. Federal Income Taxation — Passive foreign investment company.”

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.

As we are a Cayman Islands company, you may face difficulties in protecting your interests, and our ability to protect our rights through the U.S. federal courts may be limited. You may have less protection of your shareholder rights than you would if we were incorporated in a U.S. jurisdiction.

Our corporate affairs are governed by our amended and restated memorandum and articles of association, the Companies Law of the Cayman Islands and the common law of the Cayman Islands. The rights of our shareholders to take action against the directors, actions by non controlling shareholders and the fiduciary responsibilities of our directors 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 that from the 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 precedents in some jurisdictions in the United States. In particular, the Cayman Islands has a less developed body of securities law as compared to the United States, and provides significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in the federal court of the United States.

Moreover, most of our directors and officers are nationals and residents of countries other than the United States. Substantially all of our assets and a substantial portion of the assets of these persons are located outside the United States.

The Cayman Islands courts are also unlikely:

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to recognize or enforce against us judgments of courts of the United States based on certain civil liability provisions of U.S. securities laws; and

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to impose liabilities against us, in original actions brought in the Cayman Islands, based on certain civil liability provisions of U.S. securities laws that are penal in nature.

There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of 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) or, in certain circumstances, an in personam judgment for non-monetary relief, and would give a judgment based thereon provided that (a) such courts had proper jurisdiction over the parties subject to such judgment (b) such courts did not contravene the rules of natural justice of the Cayman Islands, (c) such judgment was not obtained by fraud, (d) the enforcement of the judgment would not be contrary to the public policy of the Cayman Islands, (e) 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 (f) there is due compliance with the correct procedures under the laws of the Cayman Islands.

As a result of all of the above, our public shareholders may have more difficulties in protecting their interests in the face of actions by our management, directors or controlling shareholders than would shareholders of a public company incorporated in a jurisdiction in the United States.

You may have difficulties in enforcing judgments obtained against us.

We are incorporated in the Cayman Islands, and conduct all of our operations in China through our subsidiaries and affiliated entities 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 “Risk Factors — Risks Related to Our Ordinary Shares and ADSs — You may have difficulties in enforcing judgments obtained against us” and “Risk Factors — Risks Relating to China — The PRC legal system embodies uncertainties which could limit the legal protections available to you and us.”

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.

As of March 31, 2012, Yuzhu Shi, our founder, chairman and chief executive officer, and his daughter Ms. Jing Shi beneficially owned approximately 55.51% of the total voting rights in our company. As a result, we are a “controlled company” as defined under Section 303A of the Listed Company Manual of the New York Stock Exchange, or the NYSE. So long as we remain a controlled company as defined under that rule, we are exempt from certain NYSE corporate governance requirements, including:

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that a majority of our board of directors consist of independent directors;

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that we have a corporate governance and nominating committee that is composed entirely of independent directors; and

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that we have a compensation committee that is composed entirely of independent directors.

Although we voluntarily comply with the compensation committee, and the corporate governance and nominating committee requirements of the NYSE, we do not currently voluntarily comply with the requirement that a majority of our board of directors consist of independent directors. As a result of our reliance on the “controlled company” exemption, our independent directors might not have the same degree of influence on the decisions of our board of directors that they otherwise would.

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 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 amendment no.1 to our annual report on Form 20F/A. 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 “Forward Looking Statements.” In evaluating our business, you should carefully consider the information provided under Item 3.D, “Key Information — Risk Factors.” in this amendment no. 1 to our annual report on Form 20-F/A. 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 currently operate eleven online games, among which nine are self-developed, including the five games in the ZT Online franchise.

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.

In addition to 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 operation licenses for Elsword, a 3D Casual MMO, and Allods Online, a 3D MMORPG in China. Elsword was commercially launched in the fourth quarter of 2011 while Allods Online is expected to be launched later in 2012.

While we expect the MMORPG segment of China’s online game industry to continue to grow, we nonetheless intend to develop additional games in other game segments such as webgame and mobile games. According to statistics released by GAPP in December 2011, game revenue generated in 2011 from webgames and mobile games were RMB5.54 billion (US$880 million) and RMB1.7 billion (US$270 million), respectively, which experienced year-over-year growth of approximately 32.4% and 86.8%, respectively. We believe webgames and mobile games will continue to enjoy a higher growth rate than MMORPG in the near future. As one of our key growth strategies for 2012, our webgame development is on track with six projects currently in production. These projects span various genres including an action role playing game based on the Three Kingdoms era, an action role playing game based on the core gameplay and features of the ZT Online franchise, an advanced 3D game using the Unity engine designed for international markets, a strategy game leveraging our experience from developing The Golden Land, and two casual games suitable for publication on social network platforms. These projects are expected to enter various stages of testing during the second half of 2012, with launches beginning then and in 2013. In addition, we began to explore growth and investment opportunities, recruit talents and seek domestic cooperation opportunities with game developers in the mobile game sector in 2011 and envision a cross platform strategy to enable our users to play our games on personal computers, tablets and mobile phones.

Although substantially all of our revenues are generated through our own game operations in China, we have begun to derive revenues from licensing our games to third party operators in other territories including Southeast Asia, Japan, South Korea, Brazil, North America, Europe, Russia and other Russian speaking territories since 2006.

In 2009, 2010 and 2011, our net revenues were RMB1,303.8 million, RMB1,332.8 million and RMB1,792.2 million (US$284.8 million), respectively. Our net income for the same years was RMB859.0 million, RMB807.6 million and RMB906.4 million (US$144.0 million), respectively. As of December 31, 2010 and December 31, 2011, deferred revenues and advances from distributors totaled RMB518.3 million and RMB611.5 million (US$97.2 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 China were 1,713,000 and 2,339,000 for 2010 and 2011, respectively. Our quarterly average concurrent users for all of the games we operate in China were 595,000 and 642,000 for 2010 and 2011, 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 personal computers 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 presents 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 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;

•

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;

•

the reorganization of our game development studios and the profit sharing mechanism in connection with such reorganization;

•

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;

•

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;

•

change in pricing strategies for our new games and its impact on our operating metrics;

•

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 and the National Day holidays in the fourth quarter, when fewer of our targeted players play 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; and

•

the success of our investments and merger and acquisition activities.

Reorganization of Our Game Development Studios

As a result of our game development studio reorganization in 2009 and 2010, a portion of the net income generated by games developed or supported by our game development studios will be attributable to the non controlling shareholders of the studios. We expect such reorganization will help increase our net revenues and gross margin, but our net income may be adversely affected as a result of the profit-sharing mechanism. Under such arrangement, in particular in the case of ZT Online 2 which contributed to a substantial portion of our net revenues in 2011 and is expected to be the key driver of our revenue growth in 2012. As revenues generated from ZT Online 2 continue to grow, we believe that our top line growth stimulated by this new profit-sharing mechanism will help mitigate the adverse impact resulted from the net revenues attributable to the non controlling shareholders of the game development studios.

Key Operating Metrics

Our management uses a number of user statistics to evaluate the performance of our company, including, among others, average concurrent users, peak concurrent users, active paying users and average revenues per user. The following tables set forth the above-mentioned user statistics of our company for the periods indicated.


	December 31, 2010		March 31, 2011		June 30, 2011		September 30, 2011		December 31, 2011
	(in thousands, except average revenues per user)
Average Concurrent Users		584		586		654		661		667
Peak Concurrent Users		1,713		1,916		2,122		2,297		2,339
Active Paying Players		1,693		1,779		1,994		2,087		2,167
Average Revenues per User (RMB)		215		216		212		217		221

Although we commercially launched ZT Online 2 in September 2011, the number of players of our ZT Online 1 series remained quite stable and therefore we did not experience any substantial decrease in our user statistics for ZT Online 1 Series. Along with the growth in our online game net revenues and the commercial launch of ZT Online 2, the number of our average concurrent users, peak concurrent users and active paying users continued to grow in 2011 on a quarterly basis. The user statistics for average concurrent users, peak concurrent users and active paying users in the fourth quarter of 2010 were 584,000, 1,713,000 and 1,693,000, respectively, as compared to 667,000, 2,339,000 and 2,167,000 in the fourth quarter of 2011, respectively. The average revenues per user, or ARPU, increased slightly from RMB215 to RMB221 (US$35.1) between the fourth quarter of 2010 to the fourth quarter of 2011 primarily as a result of the increasing popularity of ZT Online 2 after its official implement. As ZT Online 2 is still at an early stage of its lifecycle, we expect that the number of players of ZT Online 2 will continue to increase and that the ARPU for ZT Online 2 will gradually pick up, making ZT Online 2 the main growth driver of our online game net revenues in 2012.

Net revenues

Our net revenues consist of online game net revenues, licensing net revenues, and other net revenues. The following table sets forth a breakdown of our net revenues for the years indicated.


	For the Year Ended December 31,
	2009					2010					2011
	(RMB)		% of Net revenues			(RMB)		% of Net revenues			(RMB)		(US$)		% of Net revenues
	(in millions, except percentages)
Net revenues:
Online game revenues		1,293.0		99.2	%		1,289.4		96.7	%		1701.4		270.3		95.0	%
Licensing revenues		10.7		0.8	%		42.7		3.2	%		54.5		8.7		3.0	%
Other net revenues		0.1		—	%		0.7		0.1	%		36.3		5.8		2.0	%
Total net revenues		1,303.8		100.0	%		1,332.8		100.0	%		1,792.2		284.8		100.0	%

Online Game Net Revenues

Online game net revenues represent revenues that we generate from operating our online games in China. Our online game net revenues are shown net of sales discounts and business taxes related to the sale of prepaid game cards and game points. Our sales discounts consist of distributor discounts, which were typically 10% of the face value of our prepaid game cards sold to distributors in 2011, and volume-related incentives, which we pay in the form of free prepaid game cards up to generally 3% and 3.5% of the volume sold by the relevant distributor.

Business taxes are generally equal to 5% of the proceeds we receive from the sale of our prepaid game cards and game points. In 2009, 2010 and 2011, our revenue was net of business tax in the amount RMB72.7 million, RMB85.0 million and RMB111.2 million (US$17.7 million), respectively, representing 5.3%, 6.0% and 6.2%, respectively, of our gross revenues in those years.

In addition to generating online game net revenues by selling our prepaid game cards through our distribution network, we also sell game points through our website. For sales made through our website, we receive the full purchase price less an online payment processing service fee that equals to 0.3% of the purchase price, which we reflect in our cost of services. In 2011, 75.2% of our sales proceeds were derived from prepaid game cards sold through our distributors, while 24.8% of our sales proceeds were derived from game point sales made through our official game website.

Licensing Net Revenues

Licensing net revenues consist of net revenues generated from the licensing of our games to third party operators for operation both inside and outside of China. Our license agreements with third party operators generally provide for an initial license fee and a monthly revenue-based royalty fee. The initial license fee is recognized ratably over the term of the license. The royalty fees are generally equal to a fix percentage of the revenues generated by the third party operators from operating our game. In the future, we expect our licensing net revenues to increase as we continue to look for additional strategic licensing opportunities for our games for operation by third party operators in other overseas territories.

Cost of Services

Our cost of services consist of a portion of our business taxes and surcharges, compensation for employees and other personnel operating our games, computer equipment maintenance and co-location fees and internet access fees, depreciation of equipment and amortization of software and other intangible assets, and licensing fees. The following table sets forth a breakdown of our cost of services by amounts and percentages of our net revenues for the periods indicated.


	For the Year Ended December 31,
	2009						2010						2011
	(RMB)			% of Net revenues			(RMB)			% of Net revenues			(RMB)			(US$)			% of Net revenues
	(in millions, except percentages)
Net revenues		1,303.8			100.0	%		1,332.8			100.0	%		1,792.2			284.8			100	%
Cost of services:
Sales taxes and surcharges		(39.1	)		(3.0	)%		(37.2	)		(2.8	)%		(72.8	)		(11.6	)		(4.1	)%
Compensation		(45.4	)		(3.5	)%		(41.8	)		(3.1	)%		(51.4	)		(8.2	)		(2.9	)%
Computer maintenance, co-location and internet access fees		(58.2	)		(4.5	)%		(53.8	)		(4.0	)%		(55.1	)		(8.7	)		(3.1	)%
Depreciation and amortization		(49.4	)		(3.8	)%		(57.4	)		(4.3	)%		(48.4	)		(7.7	)		(2.7	)%
Licensing fees		—			—	%		—			—	%		(19.7	)		(3.1	)		(1.1	)%
Miscellaneous		(12.0	)		(0.9	)%		(8.9	)		(0.7	)%		(9.8	)		(1.6	)		(0.5	)%
Total cost of services		(204.1	)		(15.7	)%		(199.1	)		(14.9	)%		(257.2	)		(40.9	)		14.4	%

Sales Taxes and Related Surcharges

Our cost of services includes business taxes, value-added tax, or VAT, and related surcharges on technical and consulting fees and royalty fees charged by each of the Group’s PRC subsidiaries, Zhengtu Information, Jujia Network, Juhuo Network and Snow Wolf Software to the Group’s VIE subsidiary, Giant Network. 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 “Item 5. Operating and Financial Review and Prospects — Income Tax Expense — China.”

Compensation

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 services. Compensation expenses include employee wages, share-based compensation and welfare benefits, such as social insurance, medical insurance, housing subsidies, unemployment insurance and pension benefits. We expect an increase in compensation expenses in 2012 primarily due to increases in wages and benefits.

Computer Maintenance Co-location and Internet Access Fees

Our costs associated with the maintenance of computer equipment, co-location fees and internet access fees primarily consist of 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 is 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 more complicated problems. In 2012, we expect our co-location and internet access fees and server maintenance costs to remain relatively stable as compared to 2011. We may, however, decide to install servers in new locations across China, which would further increase our costs.

Depreciation and Amortization

Our depreciation of equipment and amortization of software and other intangible assets relate primarily to depreciation of our servers and other computer equipment as well as capitalized product development costs. 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 2012, we expect these expenses to remain stable or decrease in connection with the development of our potential game projects.

Licensing Fees

Our cost of services did not include any third-party game licensing fees in 2009 or 2010 as all of our games in operation during those years were either self-developed or acquired. In the fourth quarter of 2011, however, we commercially launched our first licensed game, Elsword, and began recording licensing fees. Our game licensing fees consist of upfront licensing fees, which we generally pay in several installments, and ongoing royalty fees, which are generally equal to a percentage of the revenues we generate from operation of the relevant game. Upfront licensing fees are amortized on a straight-line basis over the shorter of the license period or the useful economic life of the relevant game. We expect our licensing fees to increase in 2012 as a result of the full-year effect of operating Elsword, and the potential commercial launch of Allods Online.

Operating (Expenses) Income

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


	For the Year Ended December 31,
	2009						2010						2011
	(RMB)			% of Net revenues			(RMB)			% of Net revenues			(RMB)			(US$)			% of Net revenues
	(in millions, except percentages)
Net revenues		1,303.8			100.0	%		1,332.8			100.0	%		1,792.2			284.8			100.0	%
Operating (expenses) income:
Research and product development expenses		(113.4	)		(8.7	)%		(186.0	)		(14.0	)%		(230.2	)		(36.6	)		(12.8	)%
Sales and marketing expenses		(119.6	)		(9.2	)%		(143.0	)		(10.7	)%		(170.0	)		(27.0	)		(9.5	)%
General and administrative expenses		(121.4	)		(9.3	)%		(119.4	)		(9.0	)%		(103.7	)		(16.5	)		(5.8	)%
Government financial incentives		88.5			6.8	%		57.4			4.3	%		47.7			7.6			2.7	%
Impairment		—			—	%		(46.7	)		(3.5	)%		—			—			—	%
Total operating expenses		(265.9	)		(20.4	)%		(437.7	)		(32.9	)%		(456.2	)		(72.5	)		(25.4	)%

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 teams, as well as the cost of software and the depreciation of the computers and equipment used by them.

In 2012, we expect our research and product development expenses to increase along with an increase in headcount of our product development teams in connection with the development of webgames, ZT Online 2, several 3D MMORPG games and our first player shooter game, and as a result of granting restricted shares to employees in November, 2011.

Sales and Marketing Expenses

Our sales and marketing expenses primarily consist of 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, and welfare benefits for our sales and marketing team, the cost of promotional events, the purchase of promotional souvenirs, and payments made to our internet café employee administrators in return for attracting new paying players.

General and Administrative Expenses

Our general and administrative expenses primarily consist of salary, benefits and share-based compensation for our general management, finance and administrative personnel, as well as professional services fees and other expenses. We expect our general and administrative expenses to increase in 2012 due to higher share-based compensation.

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 and enterprise income tax. Although the financial incentives that we have already received are not subject to repayment to the local government, our eligibility to receive these incentives in the future is conditional upon 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 at any time terminate or reduce such financial incentives. As such, given we have no basis to reasonably estimate the amount of financial incentives to be received from the government, if any, we recognized these amounts on our income statement only upon receipt of the funds.

Income Tax Expense

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 Islands, British Virgin Island or Hong Kong withholding tax will be imposed.

China

All of our online game revenue is generated in China and therefore is subject to China’s enterprise income tax. Under the current laws of China, foreign invested companies such as Zhengtu Information, and domestic companies such as Giant Network, are subject to a unified income tax rate of 25%. Various favorable income tax rates are, however, available to qualified enterprises in certain government encouraged sectors. Companies that qualify as a high and new technology enterprise, or HNTE, a status which is reassessed every three years, are subject to an income tax rate of 15%. In addition, companies that qualify as a software development enterprise are exempt from income tax for the first two years and then subject to an income tax rate of 12.5% for the following three years.

In 2008, the Shanghai government granted Zhengtu Information and Giant Network HNTE status, which resulted in an income tax rate of 15% for these companies for the three-year period ending December 31, 2010. In 2011, Zhengtu Information successfully renewed its HNTE status, thereby extending its 15% tax rate through December 31, 2013. However, Giant Network’s HNTE status was not renewed as the Company reorganized its tax structure using the game development studios such as Jujia Network and Juhuo Network, which are entitled to preferential tax treatment as described below, where the license fees are earned by these entities pursuant to the agreements between Jujia Network and Giant Network and between Juhuo Network and Giant Network, respectively. The change in HNTE status had an impact on deferred tax assets of Giant Network of RMB53.7 million in 2011, which is expected to be recoverable within the next twelve months. The change in HNTE status of Giant Network in 2011 did not have a material impact on our effective tax rate as the substantial majority of Giant Network’s net revenues, besides the license fees paid to Jujia Network and Juhuo Network, were paid to Zhengtu Information pursuant to contractual arrangements between the two companies. For a summary of these contractual arrangements see “Item 7. Major Shareholders and Related Party Transactions — Related Party Transactions.”

In 2011, the Shanghai government recognized Jujia Network and Juhuo Network as software development enterprises, and exempted these companies from income tax for 2011 and 2012, and reduced the tax rate from 25% to 12.5% for the following three years from 2013 to 2015. Although most of our other PRC subsidiaries and affiliated entities were subject to the standard income tax rate of 25% in 2011, the contribution to our income from these entities during 2011 was not material. We believe that Shanghai Zhengju Information Technology Co., Ltd., or Zhengju Information, which was recognized as software enterprise in year 2011, may make a material contribution to our taxable income in 2012.

Under the current laws of China, the profits of a foreign invested enterprise that are distributed to its immediate holding company outside the PRC are subject to a withholding tax rate of 10%. A lower withholding tax rate is applied if there is a tax treaty or arrangement between the PRC and the jurisdiction of the foreign holding company. For example, holding companies in Hong Kong that own more than 25% of the equity interest in a PRC company are subject to a 5% withholding tax rate if the Hong Kong holding companies are regarded as the beneficial owners of such dividends. Accordingly, dividends that are paid by Zhengtu Information to Eddia are subject to a 10% withholding tax, and dividends paid by our PRC subsidiaries to Giant HK are subject to a 5% withholding tax provided that Giant HK is treated as the beneficial owner of the dividends. See “Risk Factors-Risks Related to the Regulation of Our Business- The PRC New EIT Law will affect tax exemptions on the dividends we receive and we may not able to obtain certain treaty benefits on such dividends.”

Net Loss (Gain) Attributable to Non Controlling Interests

Net loss or gain attributable to non controlling interests, primarily relates to the non controlling interests in our various game development studios following our studio reorganization. Several of our games are supported by game development studios that are 51% owned by us and 49% owned by the relevant key member of the studio, including ZT Online 2 which is supported by Jujia Network and Giant Online which is supported by Juhuo Network. Accordingly, the non controlling shareholders of Jujia Network and Juhuo Network are entitled to a portion of the net income generated by ZT Online 2 and Giant Online, respectively. We account for this portion of net income as a net gain attributable to non controlling interests. For a summary of the cooperation agreements for ZT Online 2 with Jujia Network, and for Giant Online with Jujia Network, see “Item 7. Major Shareholders and Related Party Transactions — Related Party Transactions.”

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

We generate out online game revenue from the sale of our prepaid game cards 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, 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, we recognize revenue ratably over the estimated lifespan of the specific item.

•

for unused non-permanent consumable items, we recognize revenues immediately once the designated player is deemed inactive.

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 lifespan is determined based on the historical paying player usage pattern and playing behavior. When the lifespan 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 type of virtual item’s estimated lifespan, we select a starting date, and track the lifespan of that type of item purchased by players on that date. We 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.

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.

We also operate MMORPG under a pay-to-play model for one of our older games, ZT Online PTP which accounted for an insignificant amount of our online game revenue. Under this model, we receive subscription fees from distributors for the sale of time units, which allow players to access its online games. The distribution of time units to players typically is made by sales of prepaid game cards, in physical or virtual form. The prepaid game cards entitle the players to access our online game for a specified period of time in accordance with our published expiration policy. All subscription fees are deferred when received and revenues are recognized based upon the actual usage of time units by players, or when players are no longer entitled to access the online games in accordance with our published expiration policy.

Licensing Net Revenues

We license certain of our games, including ZT Online, ZT Online Green Edition, The Golden Land, XT Online, Giant Online, Dragon Soul and ZT Online 2 to overseas third-party operators since 2006. For additional information regarding licensing of our games, see “Item 4. Information on The Company - Business Overview – Distribution and Marketing - Licensing Net Revenues”. The royalty income is determined based on an agreed upon 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 contract, ZT Online Green Edition—Online Software Cooperation Agreement (“Cooperation Agreement”) with Shenzhen Tencent Computer Systems Company Limited (“Tencent Computer” or “Tencent”) to attract more players to play ZT Online Green Edition from the Tencent QQ Game platform user base. Under the Cooperation Agreement, we receive royalty income in exchange for licensing ZT Online Green Edition, and service fees for providing servers, broadband resources and technical consulting services (collectively known as “IT services”) to Tencent. We account for the royalty income and service fees in accordance with ASC 985-605-25-3 Software Not Requiring Significant Production, Modification, or Customization. The royalty income and service fees are both determined based on an agreed upon percentage of game points consumed by players with accounts registered with Tencent. 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 over the remaining period of the Cooperation Agreement, commencing from the time when contingencies have been resolved.

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. In 2010 and 2011, we capitalized approximately RMB10.8 million and RMB4.8 million (US$0.8 million) of our online game development costs with respect to ZT Online 2, Spirits of Warriors and several other new games under development.

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. 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 expected losses of Giant Network. Therefore, we are considered the primary beneficiary of Giant Network. Accordingly, Giant Network is a variable interest entity of our company under U.S. GAAP and we consolidate its results in our consolidated financial statements. 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 greater than 90 days but less than 365 days, are mainly fixed rate time deposits that 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 (“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 standards for financial instruments. As of December 31, 2011, we had no trading securities that were bought and held principally for the purpose of selling them in the near term.

The securities that we intent to and have the ability to hold to maturity are classified as held-to-maturity securities and are 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 is other than temporary using estimated fair values of the pledged collaterals or financial guarantees. If we conclude that we do not intend to, nor are we required to sell an impaired held-to-maturity security before the recovery of its amortized cost, such impairment is considered temporary and the held-to-maturity security may continue to be recognized at the amortized cost.

If we intend to sell an impaired held-to-maturity security or it is more likely than not that we will be required to sell it prior to the recovery of its amortized cost basis, we will record at the balance sheet date an other-than-temporary impairment loss equal to the entire excess of the held-to-maturity security’s amortized cost basis over its fair value.

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.

Available-for-Sale Investment

We have designated our investment in Five One Network Development Co. Ltd., or 51.com, and 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 input 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. On December 31, 2011, the total fair value of our available-for-sale investments was RMB386.9 million (US$61.5 million), which represented approximately 10.9% of our total assets.

Long-term Investment and Investments in Equity Investees

We account for our investments in the Yunfeng e-Commerce Funds and the Beijing Innovation Work Investment Center (LP) using the equity method and cost method, respectively.

Long-term investment represents cost method investments. In accordance with ASC subtopic 325-20 (“ASC 325-20”), Investments-Other: Cost Method Investments, for investments in an investee over which the company does not have significant influence, the company carries the investment at cost and only adjusts for other-than-temporary declines in fair value and distributions of earnings. The management regularly evaluates the impairment of its 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. The impairment charge was nil for the years ended December 31, 2009, 2010 and 2011.

Investments in equity investees represent investments in entities in which the company can exercise significant influence but does not own a majority equity interest or control, and are accounted for using the equity method of accounting in accordance with ASC subtopic 323-10 (“ASC 323-10”), Investments-Equity Method and Joint Ventures: Overall.

Where consolidation is not appropriate, the company applies the equity method of accounting that is consistent with ASC 323 “Investments - Equity Method and Joint Ventures” to entities in which the company holds either more than twenty percent or greater interest or less than a twenty percent interest but has the ability to exercise significant influence over operating and financial policies; and in the cases of investments in limited partnerships in which the company holds a three percent or greater interest. For investments other than those described above, the company applies the cost method of accounting that is consistent with ASC 325 “Investments – Other”.

Under the equity method, the company initially records its investment at cost and prospectively recognizes its proportionate share of each equity investee’s net income or loss on its consolidated statements of operations. 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 the consolidated balance sheets. The company also evaluates the equity method investments for impairment under ASC 323-10. An impairment loss on the 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 to ten 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 the existing equipment. Changes in these estimates and assumptions could materially impact our financial position and results of operations.

Held-to-maturity securities

The Company has designated its investment in Resources SZITIC Trust Co., Ltd. (“CR Trust”) for a period of five years as held-to-maturity in accordance with ASC320-10 as the Company has the intent and ability to hold the securities until maturity. Held-to-maturity investment securities are recorded at amortized cost. Interest income from the held-to-maturity investment securities is recognized when earned. Premiums and discounts, if any, are amortized or accreted over the life of the related security as an adjustment to interest income using the effective-interest method.

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 flow is 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 involved applying an appropriate discount rate to estimated cash flow forecasts. Based on our analysis, we recorded an impairment charge of RMB46,557,669 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. We did not record any impairment charge in 2011.

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 tax rate change is recognized as an increase or decrease to income tax expense during the year in which the change takes effect.

Management believes it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with future reversals of existing taxable temporary differences, will be sufficient to fully recover the deferred tax assets. In the event that the Company determines all or part of the net deferred tax assets are not realizable in the future, the Company will make an adjustment to the valuation allowance which would be charged to earnings in the period when such determination is made.

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 of a tax position required to be met 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. As of and for the year ended December 31, 2011, the Company recorded an unrecognized tax benefit of approximately RMB44.5million, which is mainly related to the excess share-based compensation deductions.

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.

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, 2011, the amounts of unrecognized share-based compensation cost related to share-based options and restricted shares issued to employees were RMB3.2 million (US$0.5 million) and RMB238.0 million (US$37.8 million). The deferred cost of share-based options and restricted shares are expected to be recognized over a weighted-average vesting period of 1.23 years and 2.76 years, respectively. 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


	For the Year Ended December 31,
	2009						2010						2011
	(RMB)			% of Net revenues			(RMB)			% of Net revenues			(RMB)			(US$)			% of Net revenues
	(in millions, except percentages)
Total net revenues		1,303.8			100.0	%		1,332.8			100.0	%		1,792.2			284.8			100.0	%
Cost of services		(204.1	)		(15.6	)%		(199.1	)		(14.9	)%		(257.2	)		(40.9	)		(14.4	)%
Gross profit		1,099.7			84.4	%		1,133.7			85.1	%		1,535.0			243.9			85.6	%
Operating (expenses) income:
Research and product development		(113.4	)		(8.7	)%		(186.0	)		(14.0	)%		(230.2	)		(36.6	)		(12.8	)%
Sales and marketing		(119.6	)		(9.2	)%		(143.0	)		(10.7	)%		(170.0	)		(27.0	)		(9.5	)%
General and administrative		(121.4	)		(9.3	)%		(119.4	)		(9.0	)%		(103.7	)		(16.5	)		(5.8	)%
Government financial incentives		88.5			6.7	%		57.4			4.3	%		47.7			7.6			2.7	%
Impairment of intangible assets		—			—			(46.7	)		(3.5	)%		—			—			—
Total operating expenses		(265.9	)		(20.5	)%		(437.7	)		(32.9	)%		(456.2	)		(72.5	)		(25.4	)%
Income from operations		833.8			63.9	%		696.0			52.2	%		1,078.8			171.4			60.2	%
Interest income		102.2			7.8	%		136.1			10.2	%		141.6			22.5			7.9	%
Investment (loss) income		(6.0	)		(0.5	)%		—			—			3.0			0.5			0.2	%
Other income, net		14.1			1.1	%		65.4			4.9	%		43.6			6.9			2.4	%
Income before income tax expenses		944.1			72.3	%		897.5			67.3	%		1,267.0			201.3			70.7	%
Income tax expenses		(85.1	)		(6.5	)%		(89.3	)		(6.7	)%		(352.4	)		(56.0	)		(19.7	)%
Share of loss of an equity investee		—			—			(0.6	)		—			(8.2	)		(1.3	)		(0.5	)%
Net income		859.0			65.8	%		807.6			60.6	%		906.4			144.0			50.5	%

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

Net Revenues. Our total net revenues increased by 34.5% from RMB1,332.8 million in 2010 to RMB1,792.2 million (US$284.8 million) in 2011. The increase of our net revenues was mainly attributable to the official implementation of ZT Online 2. Net revenues from online games increased 31.9% from RMB1,289.4 million in 2010 to RMB1,701.4 million (US$270.3 million) in 2011. These increases were mainly attributable to the growth in revenue generated from ZT Online 2. Net revenues from licensing increased 27.6% from RMB42.7 million in 2010 to RMB54.5 million (US$8.7 million) in 2011, while other net revenues increased from RMB0.7 million in 2010 to RMB36.3 million (US$5.8 million) in 2011, primarily as a result of certain game development services provided to independent third parties during the year.

Cost of Services. Our cost of services increased by 29.2% from RMB199.1 million in 2010 to RMB257.2 million (US$40.9 million) in 2011. The increase in our cost of services was primarily attributable to an increase in business tax due to the increase in net revenues and an increase of compensation expense for our personnel.

Gross Profit and Margin. Our gross profits increased 35.4% from RMB1,133.7 million in 2010 to RMB1,535.0 million (US$243.9 million) in 2011, primarily due to the increase in our net revenues. Our gross profit margin increased from 85.1% in 2010 to 85.6% in 2011.

Operating Expenses . Our operating expenses increased 4.2% from RMB437.7 million in 2010 to RMB456.2 million (US$72.5 million) in 2011. The increase in our operating expenses was primarily due to an increase in our research and development expenses used to broaden our game pipeline, an increase in our sales and marketing expenses in connection with marketing campaigns for new games, and a decrease in the amount of government financial incentives that we received, partially offset by a decrease in our general and administrative expenses. In addition, our 2010 impairment charge relating to the K III software, and the lack of any such impairment charge in 2011, partially offset the general increase in our operating expenses.

Research and Product Development Expenses. Our research and product development expenses increased 23.8% from RMB186.0 million in 2010 to RMB230.2 million (US$36.6 million) in 2011. The increase in our research and product development expenses was primarily due to the R&D department’s expansion to accommodate additional product development and existing game enhancements. In addition, in 2011, we capitalized RMB4.8 million (US$0.8 million) of research and product development costs, compared to RMB10.8 million of such capitalized costs in 2010. We expect our research and product development expenses to increase in 2012 as we continue to expand our game pipeline through internal game development.

Sales and Marketing Expenses. Our sales and marketing expenses increased 18.9% from RMB143.0 million in 2010 to RMB 170.0 million (US$27.0 million) in 2011. The increase in our sales and marketing expenses was primarily due to our increased marketing efforts to support our games, such as ZT Online 2 and Elsward. Our advertising expense increased 61.3% from RMB65.3 million in 2010 to RMB105.3 million (US$16.7 million) in 2011.

General and Administrative Expenses. Our general and administrative expenses decreased 13.2% from RMB119.4 million in 2010 to RMB103.7 million (US$16.5 million) in 2011. The decrease in our general and administrative expenses was primarily due to stricter cost controls and an increase in reimbursements from the depositary bank of RMB27.6 million (US$4.4 million) related to our American Depositary Receipt program in 2011.

Government Financial Incentives. The amount of government financial incentives we received decreased 16.9% from RMB 57.4 million in 2010 to RMB47.7 million (US$7.6 million) in 2011. This financial incentive mainly relates to the sales tax paid.

Income from Operations. As the result of the foregoing, our income from operations increased 55.0% from RMB696.0 million in 2010 to RMB1,078.8 million (US$171.4 million) in 2011. As a percentage of total net revenues, income from operations increased from 52.2% in 2010 to 60.2% in 2011.

Interest Income. Our interest income increased 4.0% from RMB136.1 million in 2010 to RMB141.6 million (US$22.5 million) in 2011. The increase in our interest income was mainly attributable to more efficient treasury management even when taking into account the effects of our one-time special cash dividend paid in September 2011, which reduced our balance of cash and cash equivalents and short-term investments by approximately RMB4,539.9 million (US$721.3 million).

Income Tax Expense. Our income tax expense increased 294.6% from RMB 89.3 million in 2010 to RMB 352.4 million (US$56.0 million) in 2011. The increase in our income tax expense was mainly attributable to a one-time withholding tax accrued in the second quarter 2011 in connection with the repatriation of cash for a special cash dividend paid in September 2011 which is offset by a RMB53.7 million increase in deferred tax assets due to the change in tax rate of Giant Network from 15% to 25%.

Investment Income (Loss). In 2011, we have recorded investment income amounted to RMB3 million (US$0.48 million) in connection with our minority investments in certain software companies.

Net Income (Loss) Attributable to Non Controlling Interests. In 2011, our net income attributable to non controlling interests was RMB26.4 million (US$4.2 million), compared to a net loss attributable to non controlling interests of RMB3.6 million in 2010. This increase was due to the completion of our studio reorganization in 2011 and the increase in revenue generated by ZT Online 2, which is supported by Jujia Network, one of our game development studios that is 51% owned by us and 49% owned by key members of the development team.

Net Income Attributable to Our Shareholders. Our net income attributable to our shareholders increased 8.5% from RMB811.2 million in 2010 to RMB880.0 (US$139.8 million) in 2011. As a percentage of total net revenues, net income attributable to our shareholders decreased from 60.9% in 2010 to 49.1% in 2011, which was mainly due to a one-time withholding tax accrued amounting to RMB259.4 million (US$41.2 million) associated with the repatriation of cash for the special dividend paid during the third quarter 2011.

Dividends. We paid dividends to our shareholders in the amount of RMB279.1 million and RMB4,810.2 million (US$764.3 million) in 2010 and 2011, respectively. Dividends paid in 2011 included both an annual dividend in the amount of RMB270.3 million (US$43.0 million), which was paid in March and April of 2011, and a special dividend in the amount of RMB4,539.9 million (US$721.3 million), which was paid in September 2011. On March 5, 2012, we declared a cash dividend in the amount of RMB 447.2 million (US$71.0. million), which were paid on March 29 and April 5, 2012.

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 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 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 other operating expenses.

Gross Profit and Margin. Our gross profits increased 3.1% from RMB1,099.7 million in 2009 to RMB1,133.7 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 RMB265.9 million in 2009 to RMB437.7 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 in 2010. The increase in our research and product development expenses was primarily due to an increase in staff, increase 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 RMB93.6 million in 2009 to RMB144.0 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 Expense. Our sales and marketing expenses increased 19.6% from RMB119.6 million in 2009 to RMB143.0 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 RMB31.4 million in 2009 to RMB65.3 million in 2010.

General and Administrative Expense. Our general and administrative expenses decreased 1.6% from RMB121.4 million in 2009 to RMB119.4 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 RMB16.4 million in 2010. The decrease in our share-based compensation expense attributable to general and administrative employees was primarily due to our accelerated share-based compensation amortization policy and the fact that no new share options were issued 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 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 RMB46.7 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 in 2010. As a percentage of total net revenues, income from operations decreased from 63.9% 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 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 RMB85.1 million in 2009 to RMB89.3 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 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 in 2009 and 2010, respectively. On February 22, 2011, we declared an additional dividend in the amount of RMB270.3 million, which we paid in full to our shareholders in March and April of 2011.

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 financing our investments as well as funding our share repurchase program and dividend payments.

As of December 31, 2011, we had RMB950.3 million (US$151.0 million) in cash and cash equivalents, out of which RMB743.5 million (US$118.1 million) was held by our PRC subsidiaries, RMB113.2 million (US$18.0 million) was held by the Company’s offshore holding companies and RMB 93.6 million (US$14.9 million) was held by Giant Network, our VIE, and its subsidiaries. Although we consolidate the results of Giant Network and its subsidiaries in our consolidated financial statements, we do not have direct access to the cash and cash equivalents or future earnings of Giant Network and its subsidiaries. However, these cash balances can be indirectly utilized by us for our normal operations pursuant to the contractual arrangements that provide us with the substantial ability to control Giant Network, its subsidiaries and their operations.

To fund any unforeseen cash requirements, we may need to rely on dividends and other distributions on equity paid by our PRC subsidiaries. PRC regulations currently permit payment of dividends of a PRC company only out of retained earnings as determined in accordance with accounting standards and regulations in China. The significant differences between the retained earnings as determined in accordance to PRC accounting standards as compared to those as presented in our financial statements are mainly due to the revenue recognition using a cash basis (under the PRC accounting standards) versus an accrual basis (under US GAAP) and the corresponding impact on deferred tax. In addition, wholly foreign-owned enterprises in China are required to allocate at least 10% of their respective after-tax profits each year, if any, to fund certain reserve funds unless these reserves have reached 50% of the registered capital of the enterprises. These reserves are not distributable as cash dividends.

As of December 31, 2011, total amount of cash and cash equivalents and short-term investments held by our PRC subsidiaries that will be made available for distribution to our offshore holding companies as dividends was US$236.6 million. If additional dividends were declared and distributed to our offshore holding companies by our PRC subsidiaries, our PRC subsidiaries would be subject to withholding tax under the PRC tax laws. For example, as of December 31, 2011, the accrued and unpaid foreign withholding taxes in relation to the undistributed earnings was US$23.7 million, which represents the withholding taxes related to the portion of our foreign subsidiaries’ undistributed earnings of US$236.6 million accumulated prior to December 31, 2010 that are expected to be distributed in the form of dividends in the near future. For our foreign subsidiaries’ earnings after December 31, 2010, we intend to permanently reinvest them to finance our future operations.

Giant Network and its subsidiaries are not subsidiaries of the Company, and therefore no cash held by Giant Network and its subsidiaries will be transferred to the Company or its offshore holding companies in the form of dividends. As such, Giant Network and its subsidiaries would not be subject to any withholding tax obligation in this respect. Nevertheless, majority revenues generated by Giant Network and its subsidiaries are transferred to the PRC subsidiaries in the form of license fees and service fees through contractual arrangements.

Under the current laws of China, the profits of a foreign invested enterprise, when distributed to its immediate holding company outside the PRC, are subject to a withholding tax rate of 10%. A lower withholding tax rate is applied if there is a tax treaty or arrangement between the PRC and the jurisdiction of the foreign holding company. For example, holding companies in Hong Kong that own more than 25% of the equity interest in a PRC company are subject to a 5% withholding tax rate. Accordingly, dividends that Zhengtu Information pays Eddia are subject to a 10% withholding tax, and dividends paid by our PRC subsidiaries to Giant HK are subject to a 5% withholding tax.

In the second quarter of 2011, as part of our cash management measures, we invested RMB100 million (US$15.89 million) to Resources SZITIC Trust Co., Ltd. for a period of five years for the real estate projects. In April 2011, we also committed to investing RMB30 million (US$4.77 million) in Beijing Innovation Work Investment Center (LP), an investment fund led by Mr. Kai-Fu Lee that focuses on early-state internet and technology companies operating in China. In September 2011, we invested US$50 million in the Yunfeng e-Commerce Funds for the purpose of purchasing shares of the Alibaba Group, China’s leading e-commerce company.


	For the Year Ended December 31,
	2009			2010			2011
	(RMB)			(RMB)			(RMB)			(US$)
	(in millions)
Net of cash provided by operating activities		751.8			1,032.1			1,274.7			202.5
Net cash provided by (used in) investing activities		(1,021.9	)		958.3			1,653.3			262.7
Net cash used in financing activities		(316.6	)		(250.6	)		(4,709.5	)		(748.3	)
Cash and cash equivalents at the end of the year		1,097.2			2,776.9			950.3			151.0

Operating Activities

For 2009, 2010 and 2011, our net cash provided by operating activities primarily resulted from our net income of RMB859.3 million, RMB807.6 million and RMB906.4 million (US$144.0 million), respectively. Cash flow from deferred revenues in each of these periods was RMB81.8 million cash outflow, RMB121.5 million cash inflow and RMB86.4 million cash inflow (US$13.7million), respectively. Deferred revenues and advances from distributors represent amounts that we have received for sales of our prepaid game cards from our distributors and game points purchased on our website that have not yet been recognized as revenues. See “Item 5 — Critical Accounting Policies — Revenue Recognition — Online Game Net Revenues” above. Our cash flows from advances from distributors in 2009, 2010 and 2011 were RMB2.9 million cash inflow, RMB14.1 million cash outflow and RMB6.8 million (US$1.1million) cash inflow, respectively.

Investing Activities

In 2009, our net cash used in investing activities was RMB1,021.9 million, which primarily consisted of a held-to-maturity investment in the amount of RMB500.0 million and fixed deposit investments in the amount of RMB429.9 million.

In 2010, our net cash provided by investing activities was RMB958.3 million, which was mainly attributable to the maturity of short-term investments during the year.

In 2011, our net cash used in investing activities was RMB1,653.3 million (US$262.7 million), which was mainly attributable to the maturity of short-term investments during the year, an investment in equity investees in the amount of RMB317.1 million (US $50.4 million), an investment in held-to-maturity securities in the amount of RMB100 million (US$15.9million) and purchase of property and equipment in the amount of RMB244.6 million (US$38.9 million). In 2011, total cash payment for short-term investments was RMB3,733.3 million (US$593.2 million), and total cash received from matured short-term investments was RMB6,047.5 million (US$960.9 million).

Financing Activities

Our financing activities include paying dividends, repurchasing our shares in the open market and issuing shares upon the exercise of stock options.

In 2009, our net cash used in financing activities was RMB316.6 million, which included dividends paid to shareholders in the amount of RMB277.7 million and RMB62.8 million used to repurchase our shares in the open market pursuant to our share repurchase program. These amounts of cash used in financing activities were partially offset by our receipt of RMB18.7 million in proceeds from the exercise of stock options by our officers, directors and employees, and our receipt of a capital contribution from non controlling interests in the amount of RMB5.1 million.

In 2010, our net cash used in financing activities was RMB250.6 million, which included dividends paid to shareholders in the amount of RMB279.1 million. This amount of cash used in financing activities was partially offset by our receipt of RMB17.8 million in proceeds from the exercise of stock options by our officers, directors and employees.

In 2011, our net cash used in financing activities was RMB4,709.5 million (US$748.3 million), which included dividends paid to shareholders in the amount of RMB4,810.2 million (US$764.3 million). This amount of cash used in financing activities was partially offset by our receipt of RMB138.5 million (US$22.0 million) in proceeds from the exercise of stock options by our officers, directors and employees.

We believe that our current cash and cash equivalents and cash flows from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months. We may, however, require additional cash resources due to changed business conditions or other future developments, including any investments, or acquisitions we may decide to pursue.

Capital Expenditures

Our capital expenditures were RMB143.0 million, RMB42.3 million and RMB279.8 million (US$44.5 million) in 2009, 2010 and 2011, respectively. In 2009, our capital expenditures primarily related to the use of RMB85.2 million to purchase a land parcel in Zhuhai City, upon which we expect to construct a research and development center in the future. See also “F. Tabular Disclosure of Contractual Obligations.” In 2010, our capital expenditures primarily related to the purchase of software and other operational equipment. In 2011, our capital expenditures primarily related to the purchase and decorations of our office building on Yishan Road which amounted to RMB208.2 million.

C. Research and Development

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 is only focused upon producing and supporting their own internally developed games, which we believe will give them greater incentive to make their games commercially successful. As a result of this reorganization, Giant Online, one of our existing MMORPGs, is supported by Juhuo Network, and ZT Online 2 is supported by Jujia Network. Our research and product development expenses were RMB113.4 million, RMB186.0 million and RMB230.2 million (US$36.6 million) in 2009, 2010 and 2011, respectively. 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” and “Risk Factors —The reorganization of our game development studios could materially and adversely affect our results of operations as a portion of the profits from games developed or operated by these studios will be shared with the non controlling shareholder of these studios.”

D. Trend Information

Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the year ended December 31, 2011 that are reasonably likely to have a material adverse effect on our revenues, income, profitability, liquidity or capital resources, or that caused the disclosed financial information to be not necessarily indicative of future operating results or financial conditions.

E. Off-balance sheet Arrangements

We do not have any outstanding off-balance sheet guarantees, interest rate swap transactions or foreign currency foreign contracts. We do not engage in trading activities involving non-exchange traded contracts. In our ongoing business, we do not enter into transactions involving, or otherwise form relationships with, unconsolidated entities or financials partnerships that are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

F. Tabular Disclosure of Contractual Obligations

A summary of our contractual obligations at December 31, 2011 is as follows:


	Contractual Obligations
	Less than 1 Year		1 – 3 Years		3 – 5 Years		More than 5 Years		Total		Total
	RMB		RMB		RMB		RMB		RMB		US$
	(In thousands)
Capital commitments		3,859		—		—		—		3,859		613
Operating leases⁽¹⁾		16,967		4,670		—		—		21,637		3,438
Licensing fees		15,105		—		—		—		15,105		2,400
Investment commitments		21,000		—		—		—		21,000		3,337
Total		56,931		4,670		—		—		61,601		9,788

(1)	Operating leases are for office premises research and development facility.

ITEM 8. FINANCIAL INFORMATION

A. Consolidated statements and other financial information.

We have appended consolidated financial statements filed as part of this annual report. See “Item 18. Financial Statements.”

Legal 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.

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.

The Company subsequently settled all pending litigations with the Qui Group on November 3, 2011, including the securities class action filed in the United States District Court, Southern District of New York with a settlement agreement, or the 2011 Settlement Agreement. Pursuant to the 2011 Settlement Agreement, we shall cause our insurer to make the settlement payment of US$13 million to the escrow agent of our insurers within thirty (30) days after preliminary approval of the settlement by the Court. The preliminary approval of the settlement was ordered by the Court on August 2, 2011. As of the date of this annual report, the settlement payment has been paid in full, and all pending lawsuits between the parties have been dismissed. The settlement payment was made solely by our insurers and we did not record any loss related to this settlement.

We are currently not a party to, nor are we aware of, any legal proceeding, investigation or claim which, in the opinion of our management, is likely to have a material adverse effect on our business, financial condition or results of operations.

Dividend Policy

The table below sets forth information with respect to cash dividends that we have paid to our shareholders out of our listing company’s net distributable profits, which are determined using an equity method basis of accounting for the standalone listing company financial statements, during the three-year period ending December 31, 2011.


Date Declared	Date Paid	Total Amount
February 27, 2009	April 14, 2009	RMB277.7 million
April 15, 2010	May 10, 2010	RMB279.1million
February 22, 2011	March 30 and April 8, 2011	RMB270.3 million
August 8, 2011	September 9, 2011	RMB4,539.9 million

In the future, cash dividends, if any, will be declared at the discretion of our board of directors, and will depend upon our future operations and earnings, capital requirements and surplus, general financial conditions, shareholders’ interests, contractual restrictions and other factors as our board of directors may deem relevant. Our ability to pay dividends is generally dependent upon our receipt of dividends from Zhengtu Information, our wholly owned subsidiary in China. In order for Zhengtu Information to pay dividends to us, however, it must comply with the requirements of PRC law. For additional information regarding the applicable PRC rules and regulations, see “Item 10. Additional Information — Exchange Controls — Regulation of Foreign Currency Exchange and Dividend Distribution — Dividend Distribution.” In order for us to make payment for our dividend declared on August 8, 2011, Zhengtu Information paid dividends to us. We currently intend to retain earnings generated by our PRC subsidiaries in 2011 and afterwards to fund our operations and expand our business.

Holders of ADSs will be entitled to receive dividends, subject to the terms of the deposit agreement, to the same extent as holders of our ordinary shares, less the fees and expenses payable thereunder. See “Description of American Depositary Shares.” Cash dividends will be paid in U.S. dollars.

B. Significant Changes

We have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.

PART III.

ITEM 17. FINANCIAL STATEMENTS.

We have elected to provide financial statements pursuant to Item 18.

ITEM 18. FINANCIAL STATEMENTS.

Our consolidated financial statements are included at the end of this annual report.

ITEM 19. EXHIBITS.


Exhibit Number		Description of Document

1.1*		Memorandum and Articles of Association of Giant Interactive Group Inc. (incorporated by reference to Exhibit 3.1 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

2.1*		Specimen Certificate for Common Shares of Giant Interactive Group Inc. (incorporated by reference to Exhibit 4.2 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

2.2*		Form of American Depositary Receipt of Giant Interactive Group Inc. (incorporated by reference to Exhibit 4.1 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

2.3*		Form of Deposit Agreement among the Giant Interactive Group Inc., Citibank, N.A., and holders and beneficial owners of American Depositary Shares issued thereunder (incorporated by reference to Exhibit 4.3 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.1*		Employee Share Option Scheme (incorporated by reference to Exhibit 10.1 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.2*		Forms of option grant agreements for the Employee Share Option Scheme (incorporated by reference to Exhibit 10.2 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.3*		2007 Performance Incentive Plan (incorporated by reference to Exhibit 10.3 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.4*		Forms of option grant agreement and SAR grant agreement under the 2007 Performance Incentive Plan (incorporated by reference to Exhibit 10.4 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.5*		Form of Indemnification Agreement with the directors of Giant Interactive Group Inc. (incorporated by reference to Exhibit 10.5 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.6*		Form of Employment Agreement for Executive Officers of Giant Interactive Group and Employment Agreement of Yuzhu Shi (incorporated by reference to Exhibit 10.6 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.7*		Form of Irrevocable Powers of Attorney of all the recorded shareholders of Shanghai Giant Network Technology Co., Ltd. (a/k/a Shanghai Zhengtu Network Technology Co., Ltd.), namely Yuliang Feng, Haixiao Lin, Wei Liu, Chen Cheng, Lv Zhang, Tao Yue, Fabing Qu, Yonggui Wang, Kai Chen and Shanghai Lanlin Bio-Technology Co., Ltd., dated September 7, 2006 and Irrevocable Powers of Attorney of Lv Zhang (incorporated by reference to Exhibit 10.7 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.8*		Purchase Option and Cooperation Agreement among Shanghai Giant Network Technology Co., Ltd. (a/k/a Shanghai Zhengtu Network Technology Co., Ltd.) recorded shareholders of Shanghai Giant Network Technology Co., Ltd., namely Yuliang Feng, Haixiao Lin, Wei Liu, Chen Cheng, Lv Zhang, Tao Yue, Fabing Qu, Yonggui Wang, Kai Chen and Shanghai Lanlin Bio-Technology Co., Ltd, and Shanghai Zhengtu Information Technology Co., Ltd. dated September 7, 2006 (incorporated by reference to Exhibit 10.8 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)



4.9*		Share Pledge Agreement among Shanghai Giant Network Technology Co., Ltd. (a/k/a Shanghai Zhengtu Network Technology Co., Ltd.) recorded shareholders of Shanghai Giant Network Technology Co., Ltd., namely Yuliang Feng, Haixiao Lin, Wei Liu, Chen Cheng, Lv Zhang, Tao Yue, Fabing Qu, Yonggui Wang, Kai Chen and Shanghai Lanlin Bio-Technology Co., Ltd, and Shanghai Zhengtu Information Technology Co., Ltd. dated September 7, 2006 (incorporated by reference to Exhibit 10.9 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.10*		Online Game Software Sales and Licensing Agreement between Shanghai Giant Network Technology Co., Ltd. (a/k/a Shanghai Zhengtu Network Technology Co., Ltd.) and Shanghai Zhengtu Information Technology Co., Ltd. dated September 6, 2006 (incorporated by reference to Exhibit 10.10 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.11*		Exclusive Technical Consulting and Service Agreement between Shanghai Giant Network Technology Co., Ltd. (a/k/a Shanghai Zhengtu Network Technology Co., Ltd.) and Shanghai Zhengtu Information Technology Co., Ltd. dated September 7, 2006 (incorporated by reference to Exhibit 10.11 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.12*		Supplementary Agreement among Shanghai Giant Network Technology Co., Ltd. (a/k/a Shanghai Zhengtu Network Technology Co., Ltd.), recorded shareholders of Shanghai Giant Network Technology Co., Ltd., namely Yuliang Feng, Haixiao Lin, Wei Liu, Chen Cheng, Lv Zhang, Tao Yue, Fabing Qu, Yonggui Wang, Kai Chen and Shanghai Lanlin Bio-Technology Co., Ltd, Shanghai Zhengtu Information Technology Co., Ltd., and Yuzhu Shi (incorporated by reference to Exhibit 10.12 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.13*		Supplementary Agreement among Shanghai Giant Network Technology Co., Ltd. (a/k/a Shanghai Zhengtu Network Technology Co., Ltd.), recorded shareholders of Shanghai Giant Network Technology Co., Ltd., namely Yuliang Feng, Haixiao Lin, Wei Liu, Chen Cheng, Lv Zhang, Tao Yue, Fabing Qu, Yonggui Wang, Kai Chen and Shanghai Lanlin Bio-Technology Co., Ltd, Shanghai Zhengtu Information Technology Co., Ltd. and Yuzhu Shi dated August 27, 2007 (incorporated by reference to Exhibit 10.13 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.14*		Subscription Agreement between Giant Interactive Group Inc. and Standard Chartered Private Equity Limited (incorporated by reference to Exhibit 10.14 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.15*		Registration Rights Agreement between Giant Interactive Group Inc. and Standard Chartered Private Equity Limited (incorporated by reference to Exhibit 10.15 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)

4.16*		Translation of Office Lease and Property Management Contract between Shanghai Zhengtu Information Technology Co., Ltd. and Shanghai Jiante Biotechnology Co., Ltd. (initially filed with the Commission on June 17, 2011)

4.17*		Translation of Office Lease Contract between Shanghai Zhengtu Information Technology Co., Ltd. and Shanghai Jiante Biotechnology Co., Ltd. (initially filed with the Commission on June 17, 2011)

4.18*		Translation of ZT Online 2 User Platform Software Distribution and License Agreement between Shanghai Jujia Network Technology Co., Ltd. and Shanghai Giant Network Technology Co., Ltd. dated August 25, 2011.

4.19*		Translation of ZT Online 2 Game Distribution and License Agreement between Shanghai Jujia Network Technology Co., Ltd. and Shanghai Giant Network Technology Co., Ltd. dated August 27, 2011, as amended by a Supplement dated June 20, 2011.

4.20*		Translation of Giant Online User Platform Software Distribution and License Agreement between Shanghai Juhuo Network Technology Co., Ltd. and Shanghai Giant Network Technology Co., Ltd. dated June 21, 2011.

4.21*		Sunshine Insurance Investment Transfer Agreement between Union Sky Holding Group, Ltd. and Shanghai Giant Network Technology Co., Ltd. dated August 8, 2011.

8.1*		List of Subsidiaries

11.1*		Code of Business Conduct and Ethics (incorporated by reference to Exhibit 99.1 from our F-1 registration statement (File No. 333-146681), as amended, initially filed with the Commission on October 31, 2007)



12.1p		CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

12.2p		CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

13.1*		CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

13.2*		CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

23.1*		Consent of Grandall Law Firm (Shanghai)

23.2p		Consent of Independent Registered Public Accounting Firm

23.3*		Consent of Jones Lang LaSalle Sallmanns

101.INSp		XBRL Instance Document

101.SCHp		XBRL Taxonomy Extension Schema Document

101.CALp		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEFp		XBRL Taxonomy Extension Definition Linkbase Document

101.LABp		XBRL Taxonomy Extension Label Linkbase Document

101.PREp		XBRL Taxonomy Extension Presentation Linkbase Document

*	Filed with 2011 Form 20-F

p	Filed with this amendment no. 1

SIGNATURE

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F/A and that it has duly caused and authorized the undersigned to sign this amendment no. 1 to the annual report on its behalf.

Date: September 26, 2012


GIANT INTERACTIVE GROUP INC.

		/S/ JAZY ZHANG
Name:		Jazy Zhang
Title:		Chief Financial Officer

GIANT INTERACTIVE GROUP INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


	Page

Financial Statements

Report of Independent Registered Public Accounting Firm		F-2

Consolidated Balance Sheets as of December 31, 2010 and 2011		F-3

Consolidated Statements of Operations and Comprehensive Income for the Years Ended December 31, 2009, 2010 and 2011		F-4

Consolidated Statements of Cash Flows for the Years Ended December 31, 2009, 2010 and 2011		F-5 – F-6

Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2009, 2010 and 2011		F-7

Notes to the Consolidated Financial Statements		F-8 – F-67

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

Giant Interactive Group Inc.

We have audited the accompanying consolidated balance sheets of Giant Interactive Group Inc. (the “Company”) as of December 31, 2010 and 2011, and the related consolidated statements of operations and comprehensive income, cash flows and changes in shareholders’ equity for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Giant Interactive Group Inc. at December 31, 2010 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Giant Interactive Group Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 23, 2012 expressed an unqualified opinion thereon.

/s/ Ernst & Young Hua Ming LLP

Shanghai, The People’s Republic of China

April 23, 2012

(except for Notes 2, 3, 9, 13 and 17, as to which the date is September 26, 2012)

F-2

GIANT INTERACTIVE GROUP INC.

CONSOLIDATED BALANCE SHEETS


			December 31,
	Note		2010			2011
			(RMB)			(RMB)			(US$)
ASSETS
Current assets:
Cash and cash equivalents				2,776,936,322			950,321,028			150,990,805
Short-term investments		3		3,253,362,000			919,774,660			146,137,476
Accounts receivable (net of allowance of RMB5,953,066 and RMB4,075,162 (US$647,478) for 2010 and 2011)				9,800,407			13,692,673			2,175,547
Prepayments and other current assets		5		132,727,408			111,951,828			17,787,354
Due from related parties		21		25,000,000			3,410,114			541,813
Inventories				433,953			317,019			50,369
Deferred tax assets		17		105,745,171			179,779,122			28,564,026


Total current assets				6,304,005,261			2,179,246,444			346,247,390


Non-current assets:
Property and equipment, net		6		143,286,303			349,667,907			55,556,635
Intangible assets, net		7		33,954,716			26,448,716			4,202,278
Due from research and development entity partners				10,783,600			7,637,000			1,213,397
Goodwill		8		22,201,960			22,201,960			3,527,536
Investment in equity investees		9		35,125,945			351,400,224			55,831,872
Long-term investment		10		20,495,239			29,495,239			4,686,322
Available-for-sale securities		12		423,302,661			386,851,118			61,464,453
Held-to-maturity securities		13		—			100,000,000			15,888,400
Deferred tax assets		17		13,145,488			17,100,182			2,716,945
Other assets		11		101,842,080			81,182,192			12,898,551


Total non-current assets:				804,137,992			1,371,984,538			217,986,389


Total assets				7,108,143,253			3,551,230,982			564,233,779


LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Payables and accrued expenses (including payables and accrued expenses of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB47,739,568 and RMB72,956,998 (US$11,591,700) as of December 31, 2010 and 2011, respectively		14		144,436,022			171,610,885			27,266,224
Advances from distributors (including advances from distributors of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB75,506,955 and RMB82,327,668 (US$13,080,549) as of December 31, 2010 and 2011, respectively)				75,506,955			82,327,669			13,080,549
Due to a related party (including due to a related party of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB14,248,095 and RMB10,720,869 (US$1,703,375) as of December 31, 2010 and 2011, respectively)		21		—			540,345			85,852
Deferred revenue (including deferred revenue of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB434,738,212 and RMB518,363,112 (US$82,359,604) as of December 31, 2010 and 2011, respectively)				442,795,002			529,204,385			84,082,109
Tax payable (including tax payable of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB371,748 and RMB64,733 (US$10,285) as of December 31, 2010 and 2011, respectively)				22,191,957			38,561,157			6,126,751
Unrecognized tax benefit (including unrecognized tax benefit of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB1,990,061 and RMB5,911,803 (US$ 939,291) as of December 31, 2010 and 2011, respectively		17		14,758,798			44,451,522			7,062,636
Deferred tax liabilities (including deferred tax liabilities of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB nil and RMB1,650,000 (US$262,159) as of December 31, 2010 and 2011, respectively)		17		624,770			148,219,632			23,549,728


Total current liabilities				700,313,504			1,014,915,595			161,253,849


Non-current liabilities:
Deferred tax liabilities (including deferred tax liabilities of Shanghai Giant Network Technology Co., Ltd. and its subsidiaries without recourse to Giant Interactive Group Inc. of RMB nil and RMB14,869,840 (US$2,362,579) as of December 31, 2010 and 2011, respectively)		17		186,496			14,882,313			2,364,561


Total liabilities				700,500,000			1,029,797,908			163,618,410


Commitments and contingencies		25		—			—			—

Shareholders’ equity
Ordinary shares (par value US$0.0000002 per share; 500,000,000 shares authorized as at December 31, 2010 and December 31,2011, respectively; 263,110,626 shares issued and 228,019,412 shares outstanding at December 31, 2010; 273,110,626 shares issued and 235,234,959 shares outstanding at December 31, 2011)				417			430			68
Additional paid-in capital				6,087,534,887			4,350,262,526			691,187,106
Statutory reserves		24		43,890,273			14,125,819			2,244,367
Accumulated other comprehensive loss				(300,504,420	)		(401,229,786	)		(63,748,993	)
Retained earnings				2,738,731,300			655,013,363			104,071,142
Treasury stock		22		(2,176,792,033	)		(2,122,524,316	)		(337,235,151	)


Total Giant Interactive Group Inc.’s equity				6,392,860,424			2,495,648,036			396,518,539

Non controlling interests		15		14,782,829			25,785,038			4,096,830


Total shareholders’ equity				6,407,643,253			2,521,433,074			400,615,369


Total liabilities and shareholders’ equity				7,108,143,253			3,551,230,982			564,233,779

The accompanying notes are an integral part of the consolidated financial statements.

F-3

GIANT INTERACTIVE GROUP INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE

INCOME


			For the year ended December 31,
	Note		2009			2010			2011
			(RMB)			(RMB)			(RMB)			(US$)
Net revenue:
Online games				1,293,018,121			1,289,480,817			1,701,343,096			270,316,194
Licensing revenues				10,687,252			42,666,674			54,537,719			8,665,171
Other revenue, net				130,074			667,960			36,336,494			5,773,287


Total net revenue				1,303,835,447			1,332,815,451			1,792,217,309			284,754,652
Cost of services				(204,069,659	)		(199,122,245	)		(257,246,446	)		(40,872,344	)


Gross profit				1,099,765,788			1,133,693,206			1,534,970,863			243,882,308

Operating (expenses) income
Research and product development				(113,354,460	)		(186,036,564	)		(230,209,370	)		(36,576,585	)
Sales and marketing				(119,600,377	)		(143,006,150	)		(169,981,540	)		(27,007,347	)
General and administrative				(121,446,102	)		(119,447,009	)		(103,727,165	)		(16,480,587	)
Government financial incentives		16		88,460,000			57,386,000			47,746,000			7,586,075
Impairment of intangible assets				—			(46,557,669	)		—			—


Total operating expenses				(265,940,939	)		(437,661,392	)		(456,172,075	)		(72,478,444	)


Income from operations				833,824,849			696,031,814			1,078,798,788			171,403,864

Interest income				102,200,467			136,097,898			141,587,341			22,495,963
Investment (loss) income				(5,970,899	)		—			3,047,619			484,218
Other income, net				14,024,846			65,465,834			43,558,342			6,920,724


Income before income tax expenses				944,079,263			897,595,546			1,266,992,090			201,304,769

Income tax expenses		17		(85,060,010	)		(89,322,402	)		(352,378,221	)		(55,987,261	)
Share of loss of an equity investee				—			(648,106	)		(8,218,001	)		(1,305,709	)


Net income				859,019,253			807,625,038			906,395,868			144,011,799

Net loss (income) attributable to non controlling interests		15		294,493			3,562,795			(26,428,994	)		(4,199,144	)


Net income attributable to the Company’s shareholders				859,313,746			811,187,833			879,966,874			139,812,655


Other comprehensive loss, net of tax

Foreign currency translation				(12,768,786	)		(73,194,240	)		(84,727,808	)		(13,461,893	)
Reclassification adjustment				(1,813,513	)		—			—			—
Unrealized holding losses				(30,951,002	)		(14,540,051	)		(15,997,558	)		(2,541,756	)


Total other comprehensive loss, net of tax				(45,533,301	)		(87,734,291	)		(100,725,366	)		(16,003,649	)


Comprehensive income				813,780,445			723,453,542			779,241,508			123,809,006


Earnings per share:		18

Basic				3.80			3.57			3.79			0.60
Diluted				3.67			3.47			3.79			0.60

Weighted average ordinary shares:

Basic				226,278,227			227,308,854			232,004,879			232,004,879
Diluted				233,960,556			233,928,400			232,004,879			232,004,879

The accompanying notes are an integral part of the consolidated financial statements.

F-4

GIANT INTERACTIVE GROUP INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


	For the year ended December 31,
	2009			2010			2011
	(RMB)			(RMB)			(RMB)			(US$)
Cash flows from operating activities:
Net income		859,019,253			807,625,038			906,395,868			144,011,799
Adjustments for:
Deferred taxes		12,130,935			(31,980,857	)		83,932,389			13,335,514
Share-based compensation expense		30,575,390			33,289,216			29,335,181			4,660,892
Depreciation of property and equipment		52,965,806			54,444,577			60,877,662			9,672,486
Amortization of intangible assets and other assets		15,703,041			31,657,738			19,607,751			3,115,358
Loss from disposal of property and equipment		204,061			4,213,443			2,034,664			323,276
Impairment of intangible assets		—			46,557,669			—			—
Provision for (recovery of) doubtful debts		162,318			(1,031,746	)		(1,877,904	)		(298,369	)
Net realized gain on investment held-for-trading		(320,777	)		—			—			—
Gain on deconsolidation of a subsidiary		—			(68,774,051	)		(4,993,146	)		(793,331	)
Share of loss of an equity investee		—			648,106			8,218,001			1,305,709
Changes in assets and liabilities:
Increase in accounts receivable		(961,407	)		(7,144,958	)		(2,014,362	)		(320,050	)
(Increase) decrease in prepayments and other current assets		(77,397,505	)		21,524,192			18,024,537			2,863,811
(Increase) decrease in due from related parties		(3,592	)		3,592			(3,320,543	)		(527,581	)
(Increase) decrease in due from research-and-development entity partners		—			(10,783,600	)		3,146,600			499,944
Decrease in inventories		728,747			290,102			116,934			18,579
Increase in other assets		(85,239,597	)		—			—			—
Increase in payables and accrued expenses		29,302,376			22,543,374			15,133,759			2,404,512
Increase (decrease) in advance from distributors		2,945,310			(14,057,759	)		6,820,714			1,083,702
Increase in due to a related party		—			—			782,830			124,379
Increase in unrecognized tax benefit		5,142,414			4,803,660			29,692,724			4,717,699
(Decrease) increase in income tax payable		(11,358,696	)		16,807,255			16,369,200			2,600,804
(Decrease) increase in deferred revenue		(81,839,193	)		121,503,917			86,409,383			13,729,068


Net cash provided by operating activities		751,758,884			1,032,138,908			1,274,692,242			202,528,201


Cash flows from investing activities:
Payment for short-term investments		(3,239,964,493	)		(6,823,806,000	)		(3,733,267,990	)		(593,156,547	)
Proceeds received from maturity of short-term investments		2,810,062,992			7,872,494,000			6,047,547,330			960,858,503
Deposit for purchase of an office building		—			(18,921,000	)		—			—
Investment in equity investees		—			(3,000,000	)		(317,050,000	)		(50,374,172	)
Increase in long-term investments		—			(20,495,239	)		(9,000,000	)		(1,429,956	)
Payment for available-for-sale investments		(34,157,500	)		—			—			—
Payment for held-to-maturity securities		(500,000,000	)		—			(100,000,000	)		(15,888,400	)
Purchase of property and equipment		(20,969,714	)		(20,880,588	)		(244,571,881	)		(38,858,558	)
Capitalized product development costs and purchased software		(35,383,116	)		(15,653,901	)		(11,002,249	)		(1,748,081	)
Proceeds from deconsolidation of a subsidiary		—			28,625,000			—			—
Deconsolidation of subsidiaries		—			(25,000,000	)		(4,608,901	)		(732,281	)

Proceeds from disposal of intangible assets		—			—			25,000,000			3,972,100
Proceeds from disposal of property and equipment		—			—			223,580			35,523
Acquisition of a subsidiary, net of cash acquired		(1,510,103	)		(15,016,811	)		—			—


Net cash (used in) provided by investing activities		(1,021,921,934	)		958,345,461			1,653,269,889			262,678,131

The accompanying notes are an integral part of the consolidated financial statements.

F-5

GIANT INTERACTIVE GROUP INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT’D)


	For the year ended December 31,
	2009			2010			2011
	(RMB)			(RMB)			(RMB)			(US$)
Cash flows from financing activities:
Proceeds from exercise of share options		18,734,326			17,760,783			138,511,514			22,007,263
Dividends to shareholders		(277,652,205	)		(279,122,994	)		(4,810,164,772	)		(764,258,214	)
Dividends to non controlling interests		—			—			(12,250,000	)		(1,946,329	)
Repurchase of shares		(62,846,075	)		—			(22,960,759	)		(3,648,097	)
Capital contribution from non controlling interests		5,145,000			10,737,017			937,000			148,874
Capital contribution to non controlling interests		—			—			(3,554,500	)		(564,753	)


Net cash used in financing activities		(316,618,954	)		(250,625,194	)		(4,709,481,517	)		(748,261,256	)


Effect of exchange rate changes on cash and cash equivalents		(12,335,583	)		(60,078,122	)		(45,095,908	)		(7,165,018	)

Net (decrease) increase in cash and cash equivalents		(599,117,587	)		1,679,781,053			(1,826,615,294	)		(290,219,942	)
Cash and cash equivalents at the beginning of year		1,696,272,856			1,097,155,269			2,776,936,322			441,210,747


Cash and cash equivalents at the end of year		1,097,155,269			2,776,936,322			950,321,028			150,990,805


Supplemental disclosures:
Income tax paid		(99,688,366	)		(116,066,099	)		(109,454,531	)		(17,390,574	)
Withholding income tax paid associated with the repatriation of cash for a special dividend		—			—			(111,357,239	)		(17,692,883	)
Tax benefit realized from stock options		555,978			920,398			6,731,453			1,069,520
Interest received		72,139,558			150,531,887			153,658,020			24,413,801
Non-cash investing activities:
Deconsolidation of subsidiaries
- Intangible assets		—			25,000,000			—			—
- Due from related parties		—			(25,000,000	)		57,429			9,125
- Non-controlling interests		—			3,750,000			(2,158,537	)		(342,957	)
- Acquisition of property and equipment and intangible assets included in payables and accrued expenses		(3,161,223	)		1,889,955			5,165,018			820,639
- Investment in Huayi Giant Information		—			(32,774,051	)		—			—

The accompanying notes are an integral part of the consolidated financial statements.

F-6

GIANT INTERACTIVE GROUP INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY


	Note	Number of Ordinary shares			Ordinary shares		Additional paid-in capital			Statutory reserves			Accumulated other comprehensive loss			Retained earnings			Treasury stock			Total Giant Interactive Group Inc.’s equity			Non controlling interest			Total shareholders’ equity
		(RMB)			(RMB)		(RMB)			(RMB)			(RMB)			(RMB)			(RMB)			(RMB)			(RMB)			(RMB)
Balance as of January 1, 2009			227,018,426			417		5,985,416,631			43,890,273			(167,236,828	)		1,625,004,920			(2,113,945,958	)		5,373,129,455			—			5,373,129,455
Net income for the year			—			—		—			—			—			859,313,746			—			859,313,746			(294,493	)		859,019,253
Non-controlling interest
- Non controlling interests from acquisition of a subsidiary			—			—		—			—			—			—			—			—			2,758,100			2,758,100
- Equity movement			—			—		—			—			—			—			—			—			5,145,000			5,145,000
Comprehensive income:
- Foreign currency translation			—			—		—			—			(12,768,786	)		—			—			(12,768,786	)		—			(12,768,786	)
- Reclassification adjustment			—			—		—			—			(1,813,513	)		—			—			(1,813,513	)		—			(1,813,513	)
- Unrealized holding losses	12		—			—		—			—			(30,951,002	)		—			—			(30,951,002	)		—			(30,951,002	)
Exercise of share options	19		1,371,366			—		18,734,326			—						—			—			18,734,326			—			18,734,326
Share-based compensation	19		—			—		32,038,720			—			—			—			—			32,038,720			—			32,038,720
Repurchase of shares	19		(1,570,785	)		—		—			—			—			—			(62,846,075	)		(62,846,075	)		—			(62,846,075	)
Dividends to shareholders	23		—			—		—			—			—			(277,652,205	)		—			(277,652,205	)		—			(277,652,205	)


Balance as of December 31, 2009			226,819,007			417		6,036,189,677			43,890,273			(212,770,129	)		2,206,666,461			(2,176,792,033	)		5,897,184,666			7,608,607			5,904,793,273
Net income for the year			—			—		—			—			—			811,187,833			—			811,187,833			(3,562,795	)		807,625,038
Non-controlling interest
- Beijing Huayi Giant Information Technology Co., Ltd. (“Huayi Giant Information”)			—			—		—			—			—			—			—			—			3,750,000			3,750,000
- Deconsolidation of Huayi Giant Information			—			—		—			—			—			—			—			—			(3,750,000	)		(3,750,000	)
- Equity movement			—			—		—			—			—			—			—			—			10,737,017			10,737,017
Comprehensive income:
- Foreign currency translation			—			—		—			—			(73,194,240	)		—			—			(73,194,240	)		—			(73,194,240	)
- Reclassification adjustment			—			—		—			—			—			—			—			—			—			—
- Unrealized holding losses	12		—			—		—			—			(14,540,051	)		—			—			(14,540,051	)		—			(14,540,051	)
Exercise of share options	19		1,200,405			—		17,760,783			—			—			—			—			17,760,783			—			17,760,783
Share based compensation	19		—			—		33,584,427			—			—			—			—			33,584,427			—			33,584,427
Repurchase of shares	19		—			—		—			—			—			—			—			—			—			—
Dividends to shareholders	23		—			—		—			—			—			(279,122,994	)		—			(279,122,994	)		—			(279,122,994	)


Balance as of December 31, 2010			228,019,412			417		6,087,534,887			43,890,273			(300,504,420	)		2,738,731,300			(2,176,792,033	)		6,392,860,424			14,782,829			6,407,643,253
Issuances of shares						13		—			—			—			—			—			13			—			13
Net income for the year			—			—		—			—			—			879,966,874			—			879,966,874			26,428,994			906,395,868
Non-controlling interest
- Equity movement			—			—		—			—			—			—			—			—			836,998			836,998
- Deconsolidation of Shanghai Juxi Network Technology Co., Ltd. (“Juxi Network”)			—			—		—			—			—			—			—			—			(1,091,241	)		(1,091,241	)
- Deconsolidation of Shanghai Juxian Network Technology Co., Ltd. (“Juxian Network”)			—			—		—			—			—			—			—			—			(1,067,296	)		(1,067,296	)
- Consolidation of Shanghai Juyan Network Technology Co., Ltd. (“Juyan Network”)			—			—		—			—			—			—			—			—			(1,855,246	)		(1,855,246	)
- Dividend declared by Shanghai Jujia Network Technology Co., Ltd. (“Jujia Network”)			—			—		—			—			—			—			—			—			(12,250,000	)		(12,250,000	)
Comprehensive income:
- Foreign currency translation			—			—		—			—			(84,727,808	)		—			—			(84,727,808	)		—			(84,727,808	)
- Unrealized holding losses	12		—			—		—			—			(15,997,558	)		—			—			(15,997,558	)		—			(15,997,558	)
Exercise of share options	19		8,148,519			—		99,668,141			—			—			(47,960,922	)		77,228,476			128,935,695			—			128,935,695
Reversal of statutory reserves			—			—		—			(32,958,749	)		—			32,958,749			—			—			—			—
Appropriation to statutory reserves			—			—		—			3,194,295			—			(3,194,295	)		—			—			—			—
Capital discount from acquiring non-controlling interests of Juyan Network			—			—		(1,599,254	)		—			—			—			—			(1,599,254	)		—			(1,599,254	)
Share based compensation	19		—			—		29,335,181			—			—			—			—			29,335,181			—			29,335,181
Repurchase of shares	19		(932,972	)		—		—			—			—			—			(22,960,759	)		(22,960,759	)		—			(22,960,759	)
Dividends to shareholders	23		—			—		(1,864,676,429	)		—			—			(2,945,488,343	)		—			(4,810,164,772	)		—			(4,810,164,772	)


Balance as of December 31, 2011 (RMB)			235,234,959			430		4,350,262,526			14,125,819			(401,229,786	)		655,013,363			(2,122,524,316	)		2,495,648,036			25,785,038			2,521,433,074


Balance as of December 31, 2011 (US$)			235,234,959			68		691,187,106			2,244,367			(63,748,993	)		104,071,142			(337,235,151	)		396,518,539			4,096,830			400,615,369

The accompanying notes are an integral part of the consolidated financial statements.

F-7

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

1.	ORGANIZATION AND NATURE OF OPERATIONS

The accompanying consolidated financial statements include the financial statements of Giant Interactive Group Inc. (the “Company” or “Giant Interactive”), its subsidiaries, Shanghai Giant Network Technology Co., Ltd. (“Giant Network” or the “VIE”) and its subsidiaries, collectively referred to as the “Group”.

Giant Interactive was incorporated in the Cayman Islands on July 26, 2006 and became the holding company of the Group.

The Group is engaged in the development and operation of online games in the People’s Republic of China (the “PRC”). The Group primarily develops and operates online games through its subsidiary, Zhengtu Information, and its VIE subsidiary, Giant Network.

Details of the Company’s subsidiaries are as follows:


Entities	Date of incorporation/ establishment	Place of incorporation/ establishment	Percentage of shareholding/ ownership			Principal activities

Subsidiaries:
Eddia International Group Limited (“Eddia International”)	July 26, 2006	British Virgin Islands (“BVI”)		100.00	%	Investment holding
Shanghai Zhengtu Information Technology Co., Ltd. (“Zhengtu Information”)	September 6, 2006	PRC		100.00	%	Online game development and maintenance
Giant Interactive (HK) Limited (“Giant HK”)	December 22, 2008	Hong Kong		100.00	%	Investment holding
Zhuhai Zhengtu Information Technology Co., Ltd. (“Zhuhai Zhengtu”)	February 19, 2009	PRC		100.00	%	Online game research and development
Hangzhou Snow Wolf Software Co., Ltd. (“Snow Wolf Software”)	Acquired on May 18, 2009	PRC		51.07	%	Online game research and development
Shanghai Zhengduo Information Technology Co., Ltd. (“Zhengduo Information”)	July 8, 2009	PRC		100.00	%	Online game development and maintenance
Shanghai Jujia Network Technology Co., Ltd. (“Jujia Network”)	October 20, 2009	PRC		51.00	%	Online game research and development
Shanghai Juhuo Network Technology Co., Ltd. (“Juhuo Network”)	November 4, 2009	PRC		51.00	%	Online game development and maintenance
Shanghai Juhe Network Technology Co., Ltd. (“Juhe Network”)	November 4, 2009	PRC		51.00	%	Online game research and development
Shanghai Juyan Network Technology Co., Ltd. (“Juyan Network”)	January 4, 2010	PRC		100.00	%	Online game research and development
Chengdu Jufan Network Technology Co., Ltd. (“Jufan Network”)	March 29, 2010	PRC		51.00	%	Online game research and development
Shanghai Zhengju Information Technology Co., Ltd. (“Zhengju Information”)	April 28, 2010	PRC		100.00	%	Online game research and development
Shanghai Juquan Network Technology Co., Ltd. (“Juquan Network”)	May 19, 2010	PRC		51.00	%	Online game research and development

F-8

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

1.	ORGANIZATION AND NATURE OF OPERATIONS (CONT’D)


Subsidiary	Date of incorporation/ establishment	Place of incorporation/ establishment	Percentage of shareholding/ ownership		Principal activities

Variable Interest Entity (the “VIE”)
Shanghai Giant Network Technology Co., Ltd. (“Giant Network”)	November 14, 2004	PRC		—	Internet content provider

Held directly by Giant Network:
Wuxi Giant Network Technology Co., Ltd. (“Wuxi Network”)	December 28, 2009	PRC		—	Online game research and development
Wuxi Tiema Network Technology Co., Ltd. (“Tiema Network”)	June 3, 2010	PRC		—	Online game research and development
Shanghai Juxin Network Technology Co., Ltd. (“Juxin Network”)	October 9, 2010	PRC		—	Online game research and development
Beijing Giant Glorious Mission Network Technology Co., Ltd. (“Beijing Giant”)	October 13, 2010	PRC		—	Online game research and development
Beijing Julun Network Information Technology Co., Ltd. (“Julun Network”)	Acquired on November 19, 2010	PRC		—	Online game research and development
Shanghai Haoji Network Technology Co., Ltd. (“Haoji Network”)	Acquired on November 24, 2010	PRC		—	Online game research and development
Wuxi Tiequan Network Technology Co., Ltd. (“Tiequan Network”)	May 23, 2011	PRC		—	Online game research and development

F-9

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

1.	ORGANIZATION AND NATURE OF OPERATIONS (CONT’D)

In September 2006, in contemplation of an initial public offering, the Group completed a reorganization (the “Reorganization”) which was necessary to comply with PRC law and regulations that restrict foreign ownership of a company that provides Internet content services, which includes operating online games.

As part of the Reorganization, Mr. Yuzhu Shi, his immediate family and the other eighteen individual shareholders of Giant Network through their respective BVI holding companies, established the Company and Eddia International. Mr. Yuzhu Shi and his immediate family, through their BVI holding companies, Union Sky Holding Co., Ltd. and Vogel Holding Group Limited, are the controlling shareholders of the Company since incorporation. Subsequently, on September 6, 2006, Eddia International established Zhengtu Information, a wholly-owned foreign enterprise, which entered into a series of agreements with Giant Network. Pursuant to these agreements, Giant Network transferred most of its employees and operating assets, including the rights to operate its online game, ZT Online, to Zhengtu Information, except for certain assets that an online game operator must own to be an Internet license holder. In return, Zhengtu Information exclusively provides certain technical and consulting services and software licenses to Giant Network in exchange for fees, which can be adjusted at the Company’s discretion, through its direct ownership interest in Zhengtu Information as well as provide financial support to Giant Network, as necessary. As a result of these agreements, the Company is considered the primary beneficiary of Giant Network through Zhengtu Information (see Note 2) and accordingly, Giant Network’s results of operation and financial condition are consolidated in the financial statements of the Group.

In January 2011, Zhengduo Information purchased 49% equity interest in Juyan Network that it previously owned 51% equity interest in, at a consideration of approximately RMB3,500,000 (US$556,000). As a result, the Company through Zhengduo Information owns 100% equity interest in Juyan Network.

On May, 2011, Wuxi Network and 7 individuals invested approximately RMB 300,000 (US$48,000) to establish Tiequan Network. The Company, through its VIE, Giant Network, owns 25.8% equity interest of Tiequan Network (Giant Network owns 50.6% equity interest in Wuxi Network and Wuxi Network owns 51% equity interest of Wuxi Tiequan).

On August 15, 2011, Zhengduo Information, wholly owned by Giant HK, injected paid-in capital of approximately RMB 29,000,000 (US$4,608,000) to Zhengju Information, which was a wholly owned enterprise by Giant Network as of December 31, 2010. On September 14, 2011, Giant Network retrieved all of its investment of approximately RMB 1,000,000 (US$159,000), which resulted in Zhengju Information being a wholly owned subsidiary by Zhengduo Information.

F-10

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation and use of estimates

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).

The preparation of consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported amounts of its assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods. Significant estimates and assumptions reflected in the Company’s consolidated financial statements include, but are not limited to, revenue recognition, acquired intangible assets and related goodwill, estimating the useful lives of long-lived assets and intangible assets, assessing the initial valuation of assets acquired and liabilities assumed in a business combination and the subsequent impairment assessment of long-lived assets, intangible assets and related goodwill, share-based compensation expenses, deferred tax assets and related valuation allowance, income tax uncertainties, provision for doubtful debts, impairment and valuation of all investment types. Management bases the estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could materially differ from these estimates. Certain amounts previously reported have been reclassified to conform to the current year presentation.

Consolidation

The consolidated financial statements include the financial statements of the Company, its subsidiaries, the VIE and its subsidiaries for which a subsidiary of the Company, Zhengtu Information, is the primary beneficiary. All transactions and balances between the Company, its subsidiaries, the VIE and its subsidiaries have been eliminated upon consolidation. Results of acquired subsidiaries are consolidated.

The attribution of net income and other comprehensive income or loss items, if any, are allocable to the Company and its non-controlling interests based on their respective ownership percentages of the entities to which these underlying items are derived from.

The Group has adopted Financial Accounting Standards Codification (“ASC”) Subtopic 810-10 (“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.

F-11

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Consolidation (Cont’d)

PRC laws and regulations restrict foreign ownership to operate online games. In order to comply with these foreign ownership restrictions, the Company operates its online games in China through Giant Network, a variable interest entity, which is 75% owned by Mr. Yuzhu Shi, who is also a principal shareholder of the Company. Zhengtu Information has the unilateral right to control Giant Network, including its financial interests, through the following contractual arrangements which have been entered into amongst Zhengtu Information, Giant Network and its equity holders:

Online Games Software Sales and Licensing Agreements

Pursuant to the Online Games Software Sales and Licensing Agreements between Zhengtu Information, Jujia Network, Juhuo Network, Snow Wolf Software and Giant Network, Zhengtu Information, Jujia Network, Juhuo Network and Snow Wolf Software license their online game software to Giant Network in return for an upfront fee and royalty fees charged at fixed rates ranging from 24% to 65% of the game revenues derived from four game series, on a monthly basis. In addition, such royalty fee rates are adjustable at the sole discretion of Zhengtu Information, Jujia Network, Juhuo Network and Snow Wolf Software respectively. These agreements have indefinite terms and can only be terminated if both parties mutually agree in writing.

Exclusive Technical Consulting and Service Agreement

Pursuant to the Exclusive Technical Consulting and Service Agreement between Zhengtu Information and Giant Network, Zhengtu Information is to provide exclusive technical and consulting services in return for fees computed based on the total operating expenses incurred by Zhengtu Information and Giant Network plus a reasonable markup, which is also adjustable at the sole discretion of Zhengtu Information. The initial term of this agreement is expected to expire on September 6, 2016 and is renewable at the sole discretion of Zhengtu Information. Pursuant to this agreement, in the event that either party to this agreement (i) breaches its obligations thereunder in full or in part and fails to cure such breach effectively and in a timely manner, which leads to a material damage to the non-breaching party; (ii) materially fails to perform its undertakings under this agreement; or (iii) any of the representations given by such party is untrue, in each case the non-breaching party shall have the right to terminate this agreement. Notwithstanding the above, if Giant Network wishes to terminate this agreement before the expiration of its term, it shall serve a written notice to Zhengtu Information six-months prior to the expiration of the agreement and obtain Zhengtu Information’s consent, and shall be liable for a penalty of RMB20,000,000 and compensate Zhengtu Information for all its losses resulting from such early termination.

During the years ended December 31, 2009, 2010 and 2011, total fees charged under the agreements above totaled approximately RMB989,000,000, RMB1,135,000,000 and RMB1,474,000,000 (US$234,000,000), respectively, which represented substantially all of Giant Network’s operating profits for the years presented.

F-12

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Consolidation (Cont’d)

Power of Attorney

Pursuant to the Purchase Option and Cooperation Agreement, each of the equity holders of Giant Network has signed an irrevocable Power of Attorney to grant Zhengtu Information’s designee, Mr. Yuzhu Shi, the power to exercise all the voting rights of such shareholder in shareholders’ meeting, including but not limited to deciding to sale or transfer of all or part of such shareholder’s equity interests in, and appointing and selecting directors, general managers and other senior management of Giant Network. This agreement remains effective as long as the Purchase Option and Cooperation Agreement are effective.

Purchase Option and Cooperation Agreement

Pursuant to the Purchase Option and Cooperation Agreement and its supplementary agreements amongst Zhengtu Information and the equity holders of Giant Network, the equity holders of Giant Network granted Zhengtu Information or its designated party, an exclusive irrevocable option to purchase all or part of their equity interests, when and to the extent permitted under the PRC law, at an amount equal to RMB10,000,000 or the lowest price permitted by the PRC law. Giant Network cannot declare any profit distributions or grant loans in any forms without the prior written consent of Zhengtu Information. All funds received by the equity holders of Giant Network or their designees (including but not limited to dividends and loans) must be remitted in full to Zhengtu Information and Giant Network, respectively. If Giant Network or its equity holders commit a material breach of the Purchase Option and Cooperation Agreement or its supplementary agreements and fail to cure or remedy such breach, Zhengtu Information reserves the right to either terminate the agreement and demand the breaching party for compensation for all damages and losses, or to enforce the further performance of the agreement in addition to the claim for all damages and losses against the breaching party.

Share Pledge Agreement

Pursuant to the Share Pledge Agreement between Zhengtu Information and the equity holders of Giant Network, the equity holders of Giant Network have contemporaneously pledged all their equity interests in Giant Network to secure the payment obligations of Giant Network under the VIE agreements. This agreement is valid as long as the other VIE agreements are effective.

Letter of Financial Support

Pursuant to Letter of Financial Support, Zhengtu Information agreed to provide unlimited financial support to Giant Network during its operations and agreed to forego the right to seek repayment in the event that Giant Network is unable to repay such funding.

As of December 31, 2011, the share capital and accumulated losses of Giant Network was RMB10,000,000 (US$1,588,840) and RMB73,485,950 (US$11,675,742), respectively, as compared to RMB10,000,000 and RMB127,393,934, respectively, as of December 31, 2010.

F-13

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Consolidation (Cont’d)

Despite the lack of technical majority ownership, there exists a parent-subsidiary relationship between the Company and Giant Network through the irrevocable proxy agreement, whereby the equity holders of Giant Network has effectively assigned all of their voting rights underlying their equity interest in Giant Network to Zhengtu Information. In addition, through the other aforementioned agreements, the Company demonstrates its ability and intention to continue to exercise the ability to absorb substantially all of the profits and all of the expected losses of Giant Network through Zhengtu Information. Thus the Company is also considered the primary beneficiary of Giant Network through Zhengtu Information. Accordingly, Giant Network and its subsidiaries’ results are consolidated in the Company’s financial statements under Financial Accounting Standards Codification (“ASC”) Subtopic 810-10 (“ASC 810-10”), Consolidation: Overall.

In the opinion of management and the Company’s PRC counsel, (i) the ownership structure of the Company and Giant Network, through Zhengtu Information, are in compliance with existing PRC laws and regulations,(ii) the contractual arrangements with Giant Network and its shareholder are valid and binding, and will not result in any violation of PRC laws or regulations currently in effect; and (iii) the Company’s business operations are in compliance with existing PRC laws and regulations in all material respects.

Even though the equity holders of Giant Network also hold equity interests in the Company, they may fail or cause Giant Network to fail to perform the obligations under the VIE agreements. The Company may have to incur substantial costs and expend efforts to enforce the Company’s rights under these agreements, where it has to rely on legal remedies under the PRC law.

However, there are substantial uncertainties regarding the interpretation and application of current and future PRC laws and regulations. Accordingly, the Company cannot be assured that the PRC regulatory authorities will not ultimately take a contrary view to its opinion. If the current ownership structure of the Company and its contractual arrangements with Giant Network, through Zhengtu Information, are prospectively found to be in violation of any existing or future PRC laws and regulations, the Company may be required to restructure its ownership structure and operations in the PRC to comply with the new PRC laws and regulations. The restructuring of its organization structure to comply with new PRC laws and regulations may cause the Company to lose control of its VIE, thus resulting in its deconsolidation. In the opinion of management and the Company’s PRC counsel, the likelihood of such events provoking deconsolidation in respect of the Company’s current ownership structure or the contractual arrangements with Giant Network is remote based on current facts and circumstances.

F-14

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Consolidation (Cont’d)

As of December 31, 2011 and 2010, the aggregate carrying amounts of the Company’s total assets and total liabilities of Giant Network and its subsidiaries were RMB706,478,031 (US$112,248,055) and RMB587,825,321 and RMB706,865,023 (US$ 112,309,542) and RMB574,594,639, respectively. There are no pledges or collateralization of Giant Network and its subsidiaries’ assets that can only be used to settle Giant Network and its subsidiaries’ obligations during the periods presented. For the periods presented, creditors of Giant Network and its subsidiaries do not have recourse to the general credit of the Company, who is also considered the primary beneficiary of Giant Network through Zhengtu Information, and as such, have been parenthetically presented on the face of the Company’s Consolidated Balance Sheets. The Company has not provided any financial or other support that it was not previously contractually required to provide to Giant Network during the periods presented.

The following table represents the overall contribution by our Giant Network, the VIE, and its subsidiaries as well as the Company and other entities within the Group to the Group’s total net income and total comprehensive income:


	For year ended December 31,
	2010			2011
	RMB			RMB
Net income (loss) attributable to the Company’s shareholders
Giant Network and its subsidiaries		1,091,837,769			1,515,790,079
The Company and other entities within the Group		(280,649,936	)		(635,823,205	)

		811,187,833			879,966,874
Other comprehensive loss
Giant Network and its subsidiaries		—			—
The Company and other entities within the Group		(87,734,291	)		(100,725,366	)

		(87,734,291	)		(100,725,366	)

Comprehensive income		723,453,542			779,241,508

In addition, Giant Network and its subsidiaries accounted for approximately RMB1,342,000,000 (US$213,222,000) net increase in cash and cash equivalents in 2011. Furthermore, as of December 31, 2011, Giant Network and its subsidiaries held cash and cash equivalents of approximately RMB93,600,000 (US$14,872,000), investments in equity investees of approximately RMB33,300,000 (US$5,291,000), other assets of approximately RMB579,600,000 (US$92,089,000) and other liabilities of approximately RMB706,900,000 (US$112,315,000), respectively.

Foreign currency translation and transactions

The Company’s, its BVI and Hong Kong subsidiary’s functional currency is the United States dollars (“US$”). The functional currency of the Company’s PRC subsidiaries is the Chinese Renminbi (“RMB”), based on the criteria of ASC subtopic 830-10 (“ASC 830-10”), Foreign Currency Matters: Overall. The Company uses the RMB as its reporting currency. The Company uses the average exchange rate for the year and the exchange rate at the balance sheet date to translate its operating results and financial position, respectively. Translation differences are recorded in accumulated other comprehensive loss, a component of shareholders’ equity.

Transactions denominated in foreign currencies are translated into the functional currency at the exchange rates prevailing on the transaction dates. Assets and liabilities denominated in foreign currencies are remeasured into the functional currency at the exchange rates prevailing at the balance sheet date. The resulting realized and unrealized exchange gains and losses are included in the consolidated statements of operations and comprehensive income.

F-15

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Convenience translation

Amounts in US$ are presented for the convenience of the reader and are translated at the noon buying rate of US$1.00 to RMB6.2939 on December 31, 2011 in the City of New York for cable transfers of RMB as certified for customs purposes by the Federal Reserve Bank of New York. No representation is made that the RMB amounts could have been, or could be, converted into US$ at such rate.

Long-term Investment and Investments in equity investees

Long-term investment represents cost method investments. In accordance with ASC subtopic 325-20 (“ASC 325-20”), Investments-Other: Cost Method Investments, for investments in an investee over which the Company does not have significant influence, the Company carries the investment at cost and only adjusts for other-than-temporary declines in fair value and distributions of earnings. The management regularly evaluates the impairment of its 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. The impairment charge was nil for the years ended December 31, 2009, 2010 and 2011.

Investments in equity investees represent investments in entities in which the Company can exercise significant influence but does not own a majority equity interest or control are accounted for using the equity method of accounting in accordance with ASC subtopic 323-10 (“ASC 323-10”), Investments-Equity Method and Joint Ventures: Overall.

Where consolidation is not appropriate, the Company applies the equity method of accounting that is consistent with ASC 323 “Investments — Equity Method and Joint Ventures” to entities in which the Company holds either more than 20 percent or greater interest or less than a 20 percent interest but has the ability to exercise significant influence over operating and financial policies; and in the cases of investments in limited partnerships in which the Company holds a three percent or greater interest. For investments other than those described above, the Company applies the cost method of accounting that is consistent with ASC 325 “Investments — Other”.

Under the equity method, the Company initially records its investment at cost and prospectively recognizes its proportionate share of each equity investee’s net income or loss into its consolidated statements of operations. 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 the consolidated balance sheets. The Company evaluated the equity method investments for impairment under ASC 323-10. An impairment loss on the equity method investments is recognized in the consolidated statements of income when the decline in value is determined to be other-than-temporary.

F-16

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

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 mainly fixed rate time foreign deposits that are classified as short-term investments which are stated at their approximate fair value.

The Company accounts for its investments in accordance to ASC subtopic 320-10 (“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 Company has no securities that were bought and held principally for the purpose of selling them in the near term to which would be classified as trading securities.

The securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and are stated at amortized cost. For individual securities classified as held-to-maturity securities, the Company evaluates whether a decline in fair value below the amortized cost basis is other than temporary using estimated fair values of the pledged collaterals or financial guarantees. If the Company concludes that it does not intend or is not required to sell an impaired debt security before the recovery of its amortized cost basis, the impairment is considered temporary and the held-to-maturity securities continue to be recognized at the amortized costs.

When the Company intends to sell an impaired debt security or it is more likely than not that it will be required to sell prior to recovery of its amortized cost basis, an other-than-temporary impairment loss equal to the entire excess of the debt security’s amortized cost basis over its fair value is recognized at the balance sheet date.

F-17

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Property and equipment

Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the following estimated useful lives:


Computer equipment		5 years
Leasehold improvements		Over the shorter of the lease term or the estimated useful lives of the assets
Furniture and fixtures		5 years
Motor vehicles		5 years
Property		42 years

Fixed assets have an estimated residual equal to 5% of the original cost.

Repair and maintenance costs are charged to expense as incurred, whereas the cost of renewals and betterments that extend the useful life of a fixed asset are capitalized as an addition to the related asset. Retirements, sales and disposals of assets are recorded by removing the cost and accumulated depreciation from the asset and accumulated depreciation accounts with any gain or loss reflected in the consolidated statements of operations and comprehensive income.

F-18

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Intangible assets

The Group recognizes costs to develop its online game products in accordance with ASC subtopic 985 Software. Online game product development costs consist primarily of payroll, depreciation and other overhead expenses incurred by the Group to develop, maintain, monitor and manage the Group’s online gaming products. Costs incurred for the development of online game products prior to the establishment of technological feasibility are expensed when incurred and are included in product development expenses. Once an online game product has reached technological feasibility, all subsequent online game product development costs are capitalized until the product is available for marketing. Technological feasibility is evaluated on a product-by-product basis, but typically encompasses both technical design and game design documentation and only occurs when the online games have a proven ability to operate in an online game environment. Since the inception of the Group, the amount of online game development costs qualifying for capitalization as intangible assets was approximately RMB34,002,000 (US$5,402,000) and is being amortized over the estimated life of the corresponding online games.

Purchased software is stated at cost less accumulated amortization. Amortization is computed using the straight-line method over three years.

The intangible asset arising from the acquisition of a Snow Wolf Software consists of one online software game and was recorded at its fair value with a useful life of 4 years and will be amortized on a straight line basis over the useful life. The intangible assets arising from the Julun Network acquisition also consist of one online software game and were recorded at its fair value with an estimated useful life of 4 years, and will be amortized on a straight line basis over the useful life.

The Group recognizes website and internally used software development costs in accordance with ASC subtopic 350-40 (“ASC 350-40”), Intangibles-Goodwill and Other: Internal-Use Software. As such, the Group expenses all costs that are incurred in connection with the planning and implementation phases of development and costs that are associated with repair or maintenance of the existing websites and software. Costs incurred in the development phase are capitalized and amortized over their estimated expected life. Since the inception of the Group, the amount of property and equipment costs qualifying for capitalization has been insignificant and as a result those costs have been expensed as incurred.

Impairment of long-lived assets and intangible assets

Long-lived assets, including intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with ASC subtopic 360-10 (“ASC 360-10”), Property, Plant and Equipment: Overall. When such events occur, the Company assesses the recoverability of the long lived assets by comparing the carrying amount to the estimated future undiscounted cash flow associated with the related assets. 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 estimated fair value. Fair value is generally determined by discounting the cash flows expected to be generated by the assets, when the market prices are not readily available for the long-lived assets.

There were no indicators of impairment noted during the year ended December 31, 2011. The Group recorded an impairment loss associated with an online game and its related intellectual property rights amounting to RMB46,557,669 (Note 7) during the year ended December 31, 2010. The impairment loss recorded in year ended December 31, 2009 was nil.

F-19

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

10)

Goodwill

Goodwill represents the excess of the purchase price over the estimated fair value of net tangible and identifiable intangible assets acquired. The Group’s goodwill and acquisition related intangible assets outstanding at December 31, 2011 were related to the Group’s acquisition of two subsidiaries. In accordance with the provisions of ASC subtopic 350 (“ASC 350”), Goodwill and Other Intangible Assets, goodwill amounts are not amortized, but rather are tested for impairment at least annually or more frequently if there are indicators of impairment present.

In accordance to ASC 350, the Company has assigned and assessed goodwill for impairment at the reporting unit level. A reporting unit is an operating segment or one level below the operating segment. The Company has determined that it has one reporting unit, which is also its only reportable segment.

During the fourth quarter of 2011, the Company early adopted the principles as prescribed in Accounting Standards Update 2011-08 (ASU 2011-08), “Testing Goodwill for Impairment” issued by the FASB in order to complete its goodwill impairment test. In accordance with ASU 2011-08, the Company based its goodwill impairment testing on a qualitative assessment for its reporting units that carried a goodwill balance. The qualitative assessment included an in-depth analysis of many factors, including general economic conditions, industry and market conditions, a broad scope of financial factors, and the Company’s price of its ADS, as well as other drivers of a fair value analysis. As a result of the Company’s qualitative assessment, it was concluded that it was more-likely-than-not that the fair value of its reporting units was greater than its carrying value.

Prior to the adoption of ASU 2011-08, the performance of the annual impairment test involved a two-step process as required by ASC 350. The first step of the impairment test involved comparing the fair value of the reporting unit with its carrying amount, including goodwill. Fair value was primarily determined by computing the future discounted cash flows expected to be generated by the reporting unit. If the reporting unit’s carrying value exceeded its estimated fair value, the Group would then be required to perform the second step of the goodwill impairment test to determine the amount of impairment loss, if any.

The second step requires that the fair value of the reporting unit be allocated to its underlying assets and liabilities in a manner similar to a purchase price allocation in order to determine the implied fair value of the reporting unit’s goodwill. If the implied goodwill fair value is less than its carrying value, the difference is recognized as impairment loss.

No impairment losses were recognized for each of three years ended December 31, 2009, 2010 and 2011.

F-20

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

11)

Available-for-sale investment

The Company has designated its investment in convertible redeemable preferred shares (“Preferred Share”) of Five One Network Development Co., Ltd. (“51.com”) and Mobile Embedded Technology Inc. (“MET”) as available-for-sale in accordance with ASC320-10. Such available-for-sale investments are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive income (loss) in shareholders’ equity. Realized gains or losses are charged to earnings during the period in which the gain or loss is realized. If the Company determines a decline in fair value is other-than-temporary, the cost basis of the individual security is written down to its estimated fair value. The new cost basis will not be adjusted 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 (loss) through a credit or charge to shareholders’ equity except for an other-than-temporary impairment, which would be charged to current period 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.

12)

Held-to-maturity securities

The Company has designated its investment in Resources SZITIC Trust Co., Ltd. (“CR Trust”) for a period of five years as held-to-maturity in accordance with ASC320-10 as the Company has the intent and ability to hold the securities until maturity. Held-to-maturity investment securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Interest income from the held-to-maturity investment securities is recognized when earned. Premiums and discounts, if any, are amortized or accreted over the life of the related security as an adjustment to interest income using the effective-interest method.

F-21

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

13)

Fair value of financial instruments

Financial instruments of the Group primarily comprise of cash and cash equivalents, accounts receivable, certain other current assets, amounts due from related parties and research-and-development (“R&D”) entity partners, short-term investments, investments in available-for-sale securities, held-to-maturity investment, and payables and accrued expenses. Except for the Company’s investment in preferred shares, as of December 31, 2010 and 2011, the carrying values of these financial instruments approximated their fair values due to the short-term maturity of these instruments. The carrying amount of our held-to-maturity investment is measured at amortized cost. The carrying amount of the Group’s available-for-sale investments were initially stated at fair value and subsequently re-measured and recorded at fair value at every year.

14)

Other assets

Other assets represent amounts paid for the right to use land in the PRC and are recorded at purchase cost less accumulated amortization. Amortization is provided on a straight-line basis over the terms of the respective land use rights agreements, which are approximately 50 years.

15)

Revenue recognition

Online game revenue

The Group currently provides online game services in the PRC and recognizes revenue in accordance to the criteria of ASC subtopic 605 (“ASC 605”), Revenue Recognition when persuasive evidence of an arrangement exists, the service has been rendered, the sales price is fixed or determinable, and collectability is reasonably assured.

The Group operates Massively Multiplayer Online Role-Playing Games (“MMORPG”) under a free-to-play model. Under this model, players can access the games free of charge but may purchase game points for in-game premium features.

The Group sells prepaid cards, in physical or virtual forms, for its in-game premium features to distributors who in turn sell the prepaid cards to end customers. The prepaid game cards provide customers with a pre-specified number of game points for consumption. All prepaid cards sold to distributors require upfront advance cash payments. The Group also sells game points through online sales directly to end customers using their credit or debit cards, which is generally settled by the banks within one to two days. Proceeds from the sale of prepaid game cards from distributors and online sale of game points are initially recognized as an advance from distributors. These prepaid fees are reclassified to deferred revenue upon the end users’ online registration and conversion of the game points into the respective user accounts.

F-22

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

15)

Revenue recognition (Cont’d)

The Group’s end users are required to “activate” the prepaid game cards by using access codes and passwords to transfer the value of those cards to game points in their personal user accounts. The Group does not recognize revenue for game cards which are sold but not yet converted into game points and used by customers to purchase premium features as the Group is required to provide future services, in the form of in-game premium features, related to those cards or points. Deferred revenue is recognized as revenue over the estimated life span of the premium features purchased or as the premium features purchased with the game points are consumed. In-game premium features include virtual services and consumable virtual items and permanent virtual items. In terms of virtual services and consumable virtual items, revenue is recognized either ratably or upon consumption depending on whether services and items be recognized as time-based or usage-based. In terms of permanent virtual items, revenue is recognized over the estimated life span which is determined on the basis of historical player usage patterns and playing behaviors. When the estimated life span of certain permanent virtual items is unable to be reliably determined on the basis of historical paying player patters or behaviors, the related revenues would be recognized over the estimated game life span. Future usage patterns may differ from the historical usage patterns on which the Company’s revenue recognition policy is based. The Company is committed to continually monitoring its actual operational statistics and usage patterns of its online games and to comparing these actual statistics with its original estimates and to refining these estimates and assumptions when they are materially differed from the actual statistics.

Prepaid cards sold by the Group have an expiration period of two years, if not returned or activated, after which the Group could suspend the cards and will recognize the related advance from distributors and/or deferred revenue. The Group has implemented a return policy for distributors to return cards that are unsold six months after purchased from the Group. As of December 31, 2011, the Group has not received any returns. In addition, no refunds are allowed once game points have been transferred to the end users’ personal user accounts.

F-23

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

15)

Revenue recognition (Cont’d)

The Group sells prepaid game cards at a discount to its distributors. The Group accounts for such discounts in accordance with ASC subtopic 605-15 (“ASC 605-15”), Revenue: Product. Such discounts are initially accounted for as a reduction of deferred revenue. As a result, deferred revenue includes the value of activated discounted and undiscounted prepaid cards and game points, which are subsequently recognized as revenue on a weighted average basis when the Group provides future services in the form of premium features.

The Group also operates MMORPG under a pay-to-play model. Under this model, the Group receives subscription fees from distributors for the sale of time units, which allow end users to access its online game products. The distribution of time units to the end users typically is made by sales of prepaid game cards, in physical or virtual form. The prepaid game cards entitle the end users to access the Group’s online game products for a specified period of time in accordance with the Group’s published expiration policy. All subscription fees are deferred when received and revenue is recognized based upon the actual usage of time units by the end users, or at the point when the end users are no longer entitled to access the online game products in accordance with the Group’s published expiration policy.

Licensing revenue

The Group also receives 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 the Group, beginning on October 1, 2008, such royalty income is recorded at the estimated fair value of the personnel services paid by the third party paid on behalf of the Group in accordance with the provisions of ASC subtopic 845-10 (“ASC 845-10), Nonmonetary Transactions: Overall.

The Group also licenses ZT Online to overseas third parties in Vietnam and Russia from 2009 and 2010, respectively. In 2011, the Group also licensed Golden land to overseas third parties in the United States and South Korea. The royalty income is determined based on an agreed upon 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.

F-24

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

15)

Revenue recognition (Cont’d)

In 2009, the Company and Shenzhen Tencent Computer Systems Company Limited (“Tencent Computer” or “Tencent”) entered into a three year contract, ZT Online Green Edition — Online Software Cooperation Agreement (“Cooperation Agreement”) to attract more players to play ZT Online Green Edition from the Tencent QQ Game platform user base. Under the Cooperation Agreement, the Company receives royalty income in exchange for licensing ZT Online Green Edition, and service fees for providing servers, broadband resources and technical consulting services (collectively known as “IT services”). The Group accounts for the royalty income and service fees in accordance with ASC 985-605-25-3 Software Not Requiring Significant Production, Modification, or Customization. The royalty income and service fees are both determined based on an agreed upon percentage of game point revenue earned from players with accounts registered with Tencent. The royalty income is recognized as net revenue, upon receipt of a confirmation of sales activity from Tencent and all contingencies associated with royalty payments have been resolved and no remaining performance obligations exist. The service fees are contingent upon the future delivery of the IT services and game point revenue is earned from players with accounts registered with Tencent. Service fees are recognized on a straight-line basis commencing from the point in time at which the contingency has been resolved, over the remaining period of the Cooperation Agreement.

F-25

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

15)

Revenue recognition (Cont’d)

The Group’s VIE subsidiary is subject to a 5% business tax and related surcharges on the revenues earned from the sale of game points by Giant Network and are deducted from online game revenues. The Group’s PRC subsidiary, Zhengtu Information, is also subject to a 5% business tax and related surcharges on its royalty income earned and are deducted from overseas licensing income. Such business tax and related surcharges for the years ended 2009, 2010 and 2011 are RMB72,701,726, RMB 85,019,261 and RMB111,185,658 (US$17,665,622), respectively.

The Group does not defer any costs associated with the sale of its prepaid cards or game points.

16)

Cost of services

Cost of services consists primarily of payroll, depreciation and amortization, maintenance and rental of computer equipment, production costs for prepaid game cards, and other overhead expenses directly attributable to the provision of the Company’s online game services.

Cost of services also includes a 5% business tax, 3% (net) VAT and related surcharges on technical and consulting fees and royalty fees charged by the Group’s PRC subsidiaries, Zhengtu Information, Jujia Network, Juhuo Network and Snow Wolf Software to the Group’s VIE subsidiary, Giant Network. Such business tax, VAT and related surcharges for the years ended December 31, 2009, 2010 and 2011 are RMB39,066,834, RMB37,192,656 and RMB72,804,988 (US$11,567,548), respectively.

17)

Advertising expenses

Advertising costs are expensed when incurred as sales and marketing expenses and amounted to approximately RMB31,426,000, RMB65,297,000 and RMB105,308,000 (US$16,732,000) for the years ended December 31, 2009, 2010 and 2011, respectively.

18)

Research and product development expenses

Costs incurred for the development of online game products prior to the establishment of technological feasibility and costs incurred for maintenance after the online game products are available for marketing are expensed when incurred and are included in research and product development expenses.

F-26

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

19)

Comprehensive Income

Comprehensive income is defined as the change in equity of the Company during a period from transactions and other events and circumstances excluding transactions resulting from investments by owners and distributions to owners. Comprehensive income is reported in the consolidated statements of operations and comprehensive income and consolidated statements of changes in shareholders’ equity. Accumulated other comprehensive loss of the Company consists of the foreign currency translation adjustments and unrealized holding gains and losses of available-for-sale investments (net of any reclassification adjustments) and their corresponding deferred tax impact, if any.

20)

Share-based compensation

The Group’s employees participate in the Company’s 2006 and 2007 stock incentive plan including share options and restricted shares, which is more fully described in Note 19. In 2010, the Group granted restricted shares to employees. The Group accounts for its share-based payments pursuant to ASC subtopic 718-10 (“ASC 718-10”), Compensation-Stock Compensation: Overall. According to ASC 718-10, all grants of share options to employees are recognized in the consolidated financial statements based on their grant date fair values. The Company’s share options and restricted shares are subject to graded vesting provisions. Fair value of share options is determined with the assistance of an independent third party valuation firm, using a binomial option pricing model derived by management. Fair value of restricted shares is determined by the fair market value at the grant day. The Group has elected to recognize compensation expense using the accelerated method for all share options and restricted shares with service conditions that have a graded vesting schedule.

ASC 718-10 requires forfeitures to be estimated at the time of grant and revised, if necessary, in the subsequent year if actual forfeitures differ from initial estimates. Share-based compensation expense is recorded net of estimated forfeitures such that expense was recorded only for those share-based awards that are expected to vest. Forfeiture rate is estimated based on historical and future expectation of employee turnover rate and are adjusted to reflect future change in circumstances and facts, if any.

F-27

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

20)

Share-based compensation (Cont’d)

The Group records share-based compensation expense for awards granted to non-employees in exchange for services at fair value in accordance with the provisions of ASC subtopic 505-50 (“ASC 505-50”), Equity: Equity based Payment to Non-employees. For the awards granted to non-employees, the Group records compensation expense equal to the fair value of the share options at the service performance date. The fair value of the unvested share options is recalculated at each reporting date as the service agreements signed with the non-employees do not include significant disincentive for non-performance. There were no share options issued to non-employees during the years ended December 31, 2009, 2010, and 2011, respectively.

A change in any of the terms or conditions of stock options shall be accounted for as a modification of the plan. Therefore, the Group calculates incremental compensation cost of a modification as the excess of the fair value of the modified option over the fair value of the original option immediately before its terms are modified, measured based on the share price and other pertinent factors at the modification date. For vested share options, the Group would recognize incremental compensation cost in the period the modification occurs and for unvested share options, the Group would recognize, over the remaining requisite service period, the sum of the incremental compensation cost and the remaining unrecognized compensation cost for the original award on the modification date.

21)

Leases

Leases are classified at the inception date as either a capital lease or an operating lease. For the lessee, a lease is a capital lease if any of the following conditions exist: a) ownership is transferred to the lessee by the end of the lease term, b) there is a bargain purchase option, c) the lease term is at least 75% of the property’s estimated remaining economic life or d) the present value of the minimum lease payments at the beginning of the lease term is 90% or more of the fair value of the leased property to the lessor at the inception date. A capital lease is accounted for as if there was an acquisition of an asset and an incurrence of an obligation at the inception of the lease. All other leases are accounted for as operating leases wherein rental payments are expensed as incurred. The Group has no capital leases for any of the years stated herein.

F-28

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

22)

Income taxes

The Group follows the liability method in accounting for income taxes in accordance to ASC subtopic 740-10 (“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. The Group records a valuation allowance to offset deferred tax assets if based on the weight of available evidence, it is more-likely-than-not that some portion, or all, of the deferred tax assets will not be realized. The effect on deferred taxes of a change in tax rates is recognized in income in the year that includes the enactment date.

23)

Accounting for uncertain income tax positions

The Group adopted ASC 740-10 (“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. The Group did not incur a cumulative adjustment upon the adoption of ASC 740-10. The Group has elected to classify interest and penalties related to an uncertain tax position, if and when required, as part of income tax expense in the consolidated statements of operations and comprehensive income. As of and for the year ended December 31, 2011, the Company recorded an unrecognized tax benefit of RMB44,451,522 (US$7,062,636), which is mainly related to excess share-based compensation deductions.

24)

Earnings per share

Earnings per share are calculated in accordance with ASC subtopic 260-10 (“ASC 260-10”), Earnings Per Share: Overall. Basic earnings per share is computed by dividing net income attributable to holders of ordinary shares by the weighted average number of ordinary shares outstanding during the period. Diluted earnings per share are computed using the weighted average number of shares and dilutive equivalent shares outstanding during the period. Dilutive equivalent shares consist of ordinary shares issuable upon the exercise of stock options granted, with an exercise price less than the average fair market value for such period, using the treasury stock method. Dilutive equivalent shares are excluded from the computation of diluted earnings per share if their effects would be anti-dilutive.

25)

Financial incentives

Government financial incentives are recognized as income upon receipt (see Note 16) as there are no conditions or continuing performance obligations of the Company attached to any of the governmental financial incentives received.

F-29

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

26)

Share Repurchase Program

Pursuant to a Board of Directors’ resolution on December 24, 2007, the Company’s management is authorized to repurchase up to US$200 million of the Company’s ADSs (“Share Repurchase Plan 1”). This plan terminated in accordance with its terms on February 13, 2008 with a total of 17,484,100 ADSs repurchased on the open market, for a total consideration of US$200 million. During 2007 and 2008, the Company repurchased 1,429,100 ADSs and 16,055,000 ADSs, respectively, under this plan for a consideration of US$17.3 million and US$182.7 million, respectively.

On August 11, 2008, the Board of Directors unanimously authorized management to repurchase another up to US$150 million of the Company’s ADSs (“Share Repurchase Plan 2”). The Board of Directors also agreed to review the Company’s share repurchase program periodically, and to adjust the amount authorized for repurchase as necessary. During 2008 and 2009, the Company has repurchased 14,947,200 ADSs and 1,570,785 ADSs, respectively, under this plan for a consideration of US$97.8 million and US$9.2 million, respectively.

In August 2009, the Board of Directors terminated the Share Repurchase Plan 2 and approved a new share repurchase plan (“Share Repurchase Plan 3”), authorizing the Company to repurchase up to US$150 million of its ADSs. Under this share repurchase plan, the Company may repurchase its shares within one year, unless further extended or shortened by the Board of Directors, as prescribed under the board resolution and as defined by SEC regulations. No ADSs were repurchased under this plan.

In September 2011, the Board of Directors approved a new share repurchase plan (“Share Repurchase Plan 4”), authorizing the Company to repurchase up to US$50 million of its ADSs, under the same terms and provision as that of the Share Repurchase Plan 3 except for the effective period which is from September 2011 to September 2012. Under this share repurchase plan, the Company may repurchase its shares within one year. As of December 31, 2011, the Company has repurchased 932,972 ADSs under this plan for total consideration of US$3.6 million.

The Company accounted for those shares repurchase as Treasury Stock at cost in accordance to ASC Subtopic 505-30 (“ASC 505-30”), Treasury Stock (Pre-codification: Accounting Principles Board Opinion No. 6), and is shown separately in the Shareholders’ Equity as the Company has not yet decided on the ultimate disposition of those ADSs acquired. When the Company decides to retire the treasury stock or use the treasury stock to settle the exercise of share options (Note 22), the difference between the original issuance price and the repurchase price is charged to retained earnings.

F-30

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

27)

Segment reporting

The Group follows ASC subtopic 280 (“ASC 280”), Segment Reporting. The Group’s chief operating decision-maker, who has been identified as the Chief Executive Officer, reviews the consolidated results when making decisions about allocating resources and assessing performance of the Group as a whole and hence, the Group has only one reportable segment. The Group operates and manages its business as a single segment through the provision of online gaming services. As the Group’s long-lived assets are substantially all located in the PRC and substantially all the Group’s revenues are derived from within the PRC, no geographical segments are presented.

28)

Concentration of risk

Credit risk

Financial instruments that potentially subject the Group to significant concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments, amounts due from related parties and R&D entity partners. As of December 31, 2010 and 2011, substantially all of the Group’s cash and cash equivalents and short-term fixed rate time deposits were held by Chinese major financial institutions located in the PRC and Hong Kong. Historically, deposits in Chinese banks are secured due to the state policy on protecting depositors’ interests. However, China promulgated a new Bankruptcy Law in August 2006 that has come into effect on June 1, 2007, which contains a separate article expressly stating that the State Council promulgates implementation measures for the bankruptcy of Chinese banks based on the Bankruptcy Law when necessary. Under the new Bankruptcy Law, a Chinese bank can go into bankruptcy. In addition, since China’s concession to the World Trade Organization, foreign banks have been gradually permitted to operate in China and have been significant competitors against Chinese banks in many aspects, especially since the opening of the Renminbi business to foreign banks in late 2006. Therefore, the risk of bankruptcy of those Chinese banks in which the Group has deposits has increased. In the event of bankruptcy of one of the banks which holds the Group’s deposits, it is unlikely to claim its deposits back in full since it is unlikely to be classified as a secured creditor based on PRC laws. Since the global financial crisis began during the third quarter of 2008, the risk of bankruptcy of those banks in which the Group has deposits or investments has increased significantly. In the event of bankruptcy of one of these financial institutions, it may be unlikely to claim its deposits or investments back in full. The Group continues to monitor the financial strength of these financial institutions.

Amounts due from related parties and R&D entity partners are typically unsecured, interest free and without any fixed term of repayment. Any negative events or deterioration in financial well-being with respect to Group’s related parties and R&D entity partners may cause material loss to the Group and have a material effect on the Group’s financial condition and results of operations.

F-31

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

28)

Concentration of risk (Cont’d)

Credit risk (Cont’d)

The Company’s available-for-sale investments, 51.com and MET are reported at fair value, with unrealized gains and losses recorded in accumulated other comprehensive income (loss) in shareholders’ equity (Note 12). The held-to-maturity investment in Resources SZITIE Trust Co., Ltd. (“CR Trust”) is secured and bears a fixed yield of 3% and a variable yield ranging from 14% and 19.5% per year with a maturity term of five years and an option for the holders to redeem after the end of three years from the date of establishment. The short-term held-to-maturity investment in China Railway Trust (“China Railway”) is secured, bears fixed yields of 9.1% per annum and has fixed maturity date. The principal amounts of China Railway is wholly guaranteed by the land use right and construction in progress of the project. Any negative events or deterioration in financial well-being with respect to the counterparties of the above investments and the underlying collateral may cause material loss to the Group and have a material effect on the Group’s financial condition and results of operations.

Business and economic risk

The Group participates in a highly technical industry and believes that changes in any of the following areas could have a material adverse effect on the Group’s future financial position, results of operations or cash flows: changes in the overall demand for services; competitive pressures from other online gaming companies; advances and new trends in new technologies and industry standards; changes in bandwidth suppliers; changes in certain strategic relationships or distributor relationships; regulatory considerations; and risks associated with the Group’s ability to attract and retain employees necessary to support its growth.

More than 90% of the Group’s revenues for the year ended December 31, 2009, 2010 and 2011 were primarily derived from a single online game. No individual customer (both distributor and end user) accounted for more than 10% of net revenues for the year ended December 31, 2009, 2010 and 2011.

The Group’s operations could be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than 20 years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC political, economic and social conditions (Note 2.2). There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.

F-32

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

28)

Concentration of risk (Cont’d)

Currency convertibility risk

Substantially all of the Group’s businesses are transacted in RMB, which is not freely convertible into foreign currencies. On January 1, 1994, the PRC government abolished the dual rate system and introduced a single rate of exchange as quoted daily by the People’s Bank of China. However, the unification of the exchange rates does not imply the convertibility of RMB into U.S. dollar or other foreign currencies. All foreign exchange transactions continue to take place either through the People’s Bank of China or other banks authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.

Foreign currency exchange rate risk

From July 21, 2005, the RMB is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. On June 19, 2010, the People’s Bank of China announced the end of the RMB’s de facto peg to U.S. dollar, a policy which was instituted in late 2008 in the face of the global financial crisis, to further reform the RMB exchange rate regime and to enhance the RMB’s exchange rate flexibility. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market. The depreciation of the U.S. dollar against RMB was approximately 3.3% in 2010 and 4.6% in 2011. Any significant revaluation of RMB may materially and adversely affect the Company’s cash flows, revenues, earnings and financial position, and the value of, and any dividends payable on, the ADS in U.S. dollars. As a result, an appreciation of RMB against the U.S. dollar would result in foreign currency translation losses when translating the net assets of the Company from the U.S. dollar into RMB.

29)

Dividends

Dividends of the Company are recognized when declared. Relevant laws and regulations permit payments of dividends by the PRC subsidiaries and affiliated companies only out of their retained earnings, if any, as determined in accordance with respective accounting standards and regulations.

F-33

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

2.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

30)

Recent accounting pronouncements

In May 2011, the FASB issued Accounting Standards Update 2011-04 (ASU 2011-04), “Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” ASU 2011-04 clarifies the application of existing fair value measurement and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. Management is in the process of assessing whether there would be a material impact of the provisions of ASU 2011-04 on the financial position, results of operations or cash flows of the Company.

In June 2011, the FASB issued Accounting Standards Update 2011-05 (ASU 2011-05), “Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in shareholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This pronouncement is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. In December 2011, the FASB issued ASU 2011- 12 (ASU 2011-12), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. ASU 2011-12 defers the requirement in ASU 2011-05 that entities present reclassification adjustments for each component of accumulated other comprehensive income (“AOCI”) in both net income and other comprehensive income on the face of the financial statements. ASU 2011-12 requires entities to continue to present amounts reclassified out of AOCI on the face of the financial statements or disclose those amounts in the notes to the financial statements. The effective date of ASU 2011-12 is consistent with ASU 2011-05, which is effective for fiscal years and interim periods beginning after December 15, 2011 for public entities. The provisions of ASU 2011-05 and ASU 2011-12 are not expected to have a material impact on the presentation of the Company’s consolidated financial statements.

In September 2011, the FASB issued Accounting Standards Update 2011-08 (ASU 2011-08), “Testing Goodwill for Impairment.” ASU 2011-08 is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a “qualitative” assessment to determine whether further impairment testing is necessary. Specifically, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. Although this standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, the Company has opted to early adopt it. The provisions of ASU 2011-08 did not have a material impact on the financial position, results of operations or cash flows of the Company.

F-34

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

3.	SHORT-TERM INVESTMENTS

Short-term investments consisted of the following as of December 31, 2010 and December 31, 2011:


	December 31, 2011
	Carrying Value		Unrealized Gains/(Losses)		Estimated Fair Value		Estimated Fair Value
	(RMB)		(RMB)		(RMB)		(US$)

Held-to-maturity securities
- Fixed rate time deposits		319,774,660		—		319,774,660		50,807,077
- Investment contract
- China Railway Trust (3)		600,000,000		—		600,000,000		95,330,399

Total short-term investments		919,774,660		—		919,774,660		146,137,476


	December 31, 2010
	Carrying Value		Unrealized Gains/(Losses)		Estimated Fair Value
	(RMB)		(RMB)		(RMB)

Held-to-maturity securities
- Fixed rate time deposits		1,403,362,000		—		1,403,362,000
- Investment contract
- New China Trust (1)		500,000,000		—		500,000,000
- Shanghai Lingang and Anhui Hailuo (2)		1,350,000,000		—		1,350,000,000


Total short-term investments		3,253,362,000		—		3,253,362,000

(1)

On August 21, 2009, the Group entered into a two year investment contract amounting to RMB500,000,000 with a fixed quarterly yield of 1.5% (6% per annum) with new China Trust. The investment contract is secured by 45,040,000 A-shares of Shanghai Pudong Development Bank (“PDB”), a company listed on the Shanghai Stock Exchange. Management has accounted for this investment as short-term investment held-to-maturity in accordance with ASC 320-10 at amortized cost adjusted for any related premiums (discounts) over the estimated remaining period until maturity. There was no impairment indicators present associated with these investment contracts at December 31, 2010. Proceeds with respect to this investment have been received by the Group on the maturity date of August 21, 2011.

(2)

On December 24, 2010, the Company entered into investment contracts with Shanghai Lingang and Anhui Hailuo amounting to RMB850,000,000 and RMB500,000,000, respectively, with fixed interests of 4.0% and 4.2% per annum, respectively and maturity of 150 days and 157 days, respectively. The principal amounts of the Shanghai Lingang and Anhui Hailuo investment contracts are wholly guaranteed by China Minsheng Banking Corp. Ltd, a company that is listed on both the Shanghai and Hong Kong Stock Exchange. Management has accounted for these investment contracts as short-term investments held-to-maturity in accordance with ASC 320-10 at amortized cost adjusted for any related premiums (discounts) over the estimated remaining period until maturity. There was no impairment indicators present associated with these investment contracts at December 31, 2010. Proceeds with respect to these investments have been received by the Group on May 30, 2011.

F-35

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

3.	SHORT-TERM INVESTMENTS (CONT’D)

(3)

During November 2011, the Company made an investment in China Railway Trust (the “Trust”), an affiliate of state owned China Railway Group Limited, of RMB 600,000,000 (US$95,330,399), which was used to fund a short-term loan provided from the Trust to Zhonghang Wanke Co., Ltd. (“Zhonghang Wanke”), a large scale commercial and residential real estate development company with operations throughout the P.R.C., with an annual interest rate of 13% and a maturity term of one year. This short-term investment is in a real estate project of Zhonghang Wanke, which excluding management fees charged by the Trust, is expected to yield a net return to the Company of 9.1%. The principal and interest of the investment loan are collateralized by a certain land use right and any associated construction-in-progress. The Company has accounted for this investment loan as a short-term held-to-maturity investment in accordance with ASC 320-10 at its amortized cost. There was no impairment indicators associated with this held-to-maturity investment at December 31, 2011.

The Company recorded interest income related to its short-term investments amounting to RMB102,202,930 (US$16,238,410) for the year ended December 31, 2011 (2010: RMB136,097,898, 2009: RMB102,200,467) in the consolidated statements of operations and comprehensive income.

4.	DECONSOLIDATION OF SUBSIDIARIES

In January 2011, a third party individual injected RMB3,000,000 (US$476,652) to Juxi Network, and obtained 17.65% of Juxi Network’s equity, which decreased Zhengduo Information’s equity interest from 50.98% to 41.98%. Upon the loss of control, Zhengduo Information recognized a gain of RMB4,993,146 (US$793,331), representing the difference between the fair value of the equity investment amounting to RMB6,128,039 (US$973,647) and pro rata portion of the investment retained of RMB1,134,893 (US$180,316). The fair value of the retained equity interest was derived from the sale price of the Group’s 17.65% interest to the individual adjusted for a discount for a lack of control. Gain on the deconsolidation of Juxi Network is included in “Other (expense) income, net” in the accompanying consolidated statement of operations and comprehensive income.

In February 2011, an individual who was a shareholder of Juxian Network injected RMB1,000,000 (US$158,884) to Juxian Network, which decreased Zhengduo Information’s equity interest of Juxian from 51.00% to 40.80%. Upon the loss of control, Zhengduo Information did not recognize any significant gain.

F-36

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

5.	PREPAYMENTS AND OTHER CURRENT ASSETS

Prepayments and other current assets consist of the following:


	December 31,
	2010		2011
	(RMB)		(RMB)		(US$)

Prepaid expenses (1)		9,934,564		10,658,844		1,693,520
Staff advances (2)		6,768,392		5,012,447		796,398
Advances to suppliers		12,081,460		4,046,085		642,858
Rental deposits		1,814,117		1,985,049		315,393

Prepaid game distribution license fee (3)		12,914,265		14,392,878		2,286,798
Tax receivable		950,286		2,333,537		370,762
VAT refundable		22,705,555		24,802,871		3,940,779
Interest receivable		18,792,361		6,721,682		1,067,968
Proceeds receivable on deconsolidation of a subsidiary (4)		28,625,000		28,625,000		4,548,054
Advances to shareholder of Huayi Giant Information		7,500,000		7,500,000		1,191,630
Others		10,641,408		5,873,435		933,194


Total		132,727,408		111,951,828		17,787,354

(1)	Prepaid expenses mainly relate to prepayments for insurance fee and Internet Data Center (“IDC”) services or space rental and facilities.

(2)	Staff advances mainly relate to cash advances given to certain employees for use during business operations and are recognized as sales and marketing expenses when expensed.

(3)

In January 2010, and February 2010, respectively, the Group entered into agreements with third parties to license online games. As part of the agreements, the Group is required to make upfront payments for the licenses. As of December 31, 2011, the Group has paid RMB14,392,878 (US$2,286,798) in upfront payments, which is being recorded as a prepaid game distribution license fee.

(4)

The Group had a receivable due from the shareholder of Huayi Giant Information amounting to RMB 28,625,000 (US$4,548,054) due to the disposition of Huayi Giant Information in 2010. According to the disposition agreement, the settlement of the remaining consideration is subject to the completion of legal and administrative procedures by Huayi Giant Information, including obtaining of an Internet Content Provider certificate, Internet Publishing License and Internet Operation License.

F-37

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

6.	PROPERTY AND EQUIPMENT

Property and equipment and their related accumulated depreciation as of December 31, 2010 and 2011 are as follows:


	December 31,
	2010			2011
	(RMB)			(RMB)			(US$)

Computer equipment		276,843,360			320,195,440			50,873,932
Leasehold improvements		927,186			2,159,574			343,121
Furniture and fixtures		18,449,740			21,534,695			3,421,518
Motor vehicles		4,669,096			4,669,096			741,845
Property		—			211,497,878			33,603,629

		300,889,382			560,056,683			88,984,045
Less: Accumulated depreciation		(157,603,079	)		(210,388,776	)		(33,427,410	)


Property and equipment, net		143,286,303			349,667,907			55,556,635

Depreciation expense for the years ended December 31, 2009, 2010 and 2011, were RMB52,965,806, RMB54,444,577 and RMB60,877,662 (US$9,672,486) respectively.

7.	INTANGIBLE ASSETS

Intangible assets and their related accumulated amortization as of respective balance sheet date:


	As of December 31, 2011
	Gross Carrying Value		Accumulated Amortization			Impairment		Deconsolidation of a subsidiary		Net Carrying Value		Net Carrying Value
	(RMB)		(RMB)			(RMB)		(RMB)		(RMB)		(US$)

Online game product development costs		34,001,748		(19,184,411	)		—		—		14,817,337		2,354,238
Purchased software		55,720,779		(45,454,037	)		—		—		10,266,742		1,631,221
Acquired software from acquisition of subsidiaries		1,624,891		(260,254	)		—		—		1,364,637		216,819
Intangible assets, net		91,347,418		(64,898,702	)		—		—		26,448,716		4,202,278


	As of December 31, 2010
	Gross Carrying Value		Accumulated Amortization			Impairment			Deconsolidation of a subsidiary			Net Carrying Value
	(RMB)		(RMB)			(RMB)			(RMB)			(RMB)

Online game product development costs		28,745,846		(10,074,220	)		—			—			18,671,626
Purchased software		50,575,054		(36,775,426	)		—			—			13,799,628
Acquired software from acquisition of subsidiaries		1,624,891		(141,429	)		—			—			1,483,462
KOK 3 game software		80,073,005		(8,515,336	)		(46,557,669	)		(25,000,000	)		—
Intangible assets, net		161,018,796		(55,506,411	)		(46,557,669	)		(25,000,000	)		33,954,716

Amortization expenses for the years ended December 31, 2009, 2010 and 2011 were RMB15,123,412, RMB29,918,850 and RMB17,868,863 (US$2,839,076) respectively.

F-38

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

7.	INTANGIBLE ASSETS (CONT’D)

The estimated annual amortization expense for each of the five succeeding fiscal years is as follows:


	Amortization
	(RMB)		(US$)
For the years ending December 31,
2012		11,079,577		1,760,367
2013		8,671,209		1,377,716
2014		3,748,707		595,610
2015		1,856,488		294,966
2016		1,080,202		171,627

8.	GOODWILL

Goodwill is comprised of the following:


	December 31,
	2010		2011
	(RMB)		(RMB)		(US$)

Goodwill from the acquisition of Snow Wolf Software		6,224,587		6,224,587		988,987
Goodwill from the acquisition of Julun Network		15,977,373		15,977,373		2,538,549


Balance as of December 31		22,201,960		22,201,960		3,527,536

As of December 31, 2010 and 2011, the Company assessed impairment on its goodwill derived from the acquisition of Snow Wolf Software and Julun Network. No impairment loss was recognized in any of the periods presented.

9.	INVESTMENT IN EQUITY INVESTEES


Name of the Equity Investees	Equity Interest Owned by the Company
	At December 31, 2010			At December 31, 2011

Shanghai Tonghua Network Technology Co., Ltd. (“ Tonghua”)		30.00	%		30.00	%
Beijing Huayi Giant Information Technology Co., Ltd. (“Huayi Giant Information”)		34.00	%		34.00	%
Juxi Network					41.98	%
Juxian Network					40.80	%
Yunfeng E-commerce A Fund, L.P. and Yunfeng E -Commerce B Fund, L.P. (Collectively known as the “Yunfeng Fund”)					10.42	%


	At December 31, 2010							Increased (decreased) during the year ended December 31, 2011						At December 31, 2011
	Cost of Investments (RMB)		Share of equity income (RMB)			Investment in equity investees (RMB)		Cost of investments (RMB)			Share of equity income (RMB)			Cost of investments (RMB)		Share of equity income (RMB)			Investment in equity investees (RMB)		Investment in equity investees (US$)

Tonghua		3,000,000		(648,106	)		2,351,894		—			(1,083,151	)		3,000,000		(1,731,257	)		1,268,743		201,583
Huayi Giant Information		32,774,051		—			32,774,051		(4,782	)		538,265			32,769,269		538,265			33,307,534		5,292,034
Juxi Network (Note 4)		—		—			—		6,128,039			(163,888	)		6,128,039		(163,888	)		5,964,151		947,608
Juxian Network (Note 4)		—		—			—		1,319,023			(1,191,127	)		1,319,023		(1,191,127	)		127,896		20,321
Yunfeng Fund (1)		—		—			—		317,050,000			(6,318,100	)		317,050,000		(6,318,100	)		310,731,900		49,370,326


Total		35,774,051		(648,106	)		35,125,945		324,492,280			(8,218,001	)		360,266,331		(8,866,107	)		351,400,224		55,831,872

F-39

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

9.	INVESTMENT IN EQUITY INVESTEES (CONT’D)

(1)

In September 2011, the Company invested an aggregate amount of RMB317,050,000 (US$50,374,172) as a limited partner in Yunfeng Fund, for the purpose of purchasing shares of Alibaba Group Holdings Limited (the “Alibaba Group”), China’s leading e-commerce company. Yunfeng Fund has purchased ordinary shares of the Alibaba Group at a price per share of US$13.50. The term of the Yunfeng Fund is 10 years, which may be extended for additional successive one-year periods up to a maximum of two years, and may be further extended upon the written election or vote of a majority in interest of the limited partners.

Given that the Company holds more than three percent interest in Yunfeng Fund and the significance of this investment, the investment is accounted for under the equity method as prescribed in ASC323-10. As of and for the year ended December 31, 2011, the total assets, liabilities and operating loss of Yunfeng fund were RMB3,051,110,433 (US$484,772,626), RMB89,687,234 (US$14,249,866) and RMB63,008,814 (US$10,011,092), respectively.

There were no impairment indicators present associated with the investment in these equity investees as at December 31, 2010 and 2011.

10.

LONG-TERM INVESTMENT


	December 31,
	2010		2011
	(RMB)		(RMB)		(US$)

Shanghai Ruichuang Network Technology Co., Ltd. (1)		20,495,239		20,495,239		3,256,366
Beijing Innovation Works Development Fund		—		9,000,000		1,429,956

Total		20,495,239		29,495,239		4,686,322

(1)

On November 18, 2010, the Company purchased 3% of Shanghai Ruichuang Network Technology Co., Ltd’s ordinary shares for a total consideration of RMB20,495,239, which was accounted for as a cost method investment as prescribed by ASC 323-10. There was no impairment indicators present associated with this investment as at December 31, 2010 and 2011. This investment was subsequently sold in February 2012 with net proceeds of approximately RMB20,800,000 (US$3,305,000).

F-40

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

11.

OTHER ASSETS

The other assets as of December 31, 2010 and 2011 are as follows:


	December 31,
	2010			2011
	(RMB)			(RMB)			(US$)

Land use right		85,239,597			85,239,597			13,543,208
Deposit for purchase for office building		18,921,000			—			—
Accumulated amortization		(2,318,517	)		(4,057,405	)		(644,657	)


Other asset, net		101,842,080			81,182,192			12,898,551

In June 2009, the Group made a prepayment for the purchase of a land use right amounting to RMB85,239,597 in Zhuhai Hi-Tech Industrial Area in Guangdong Province.

F-41

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

11.

OTHER ASSETS (CONT’D)

In June 2010, the Group made a deposit for the purchase of an office building amounting to RMB18,921,000 in Shanghai, pursuant to which total consideration of the office building (Note 6) was paid and the legal title of the building was transferred to the Company during 2011.

12.

AVAILABLE-FOR-SALE INVESTMENTS

(i)

Series C Preferred Shares in 51.com

On July 1, 2008, the Company entered into an agreement to purchase 18,508,208 redeemable convertible Series C Preferred Shares of 51.com (the “Series C Preferred Shares”) in exchange for the surrender of a promissory note of RMB34,312,761 (US$5,000,000) and cash consideration of RMB314,370,245 (US$45,809,524). The Company has evaluated and determined that there was no embedded derivative requiring bifurcation from the Series C Preferred Shares under the requirements of ASC 815. The embedded conversion option, redemption option and the deemed liquidation event did not qualify for derivative accounting because the underlying ordinary shares into which the Series C Preferred Shares can be converted into, are neither publicly traded nor readily convertible to cash.

The Company recorded its investment in the Series C Preferred Shares as an available-for-sale investment. Subsequent to initial recognition, the available-for-sale investment is measured at fair value with changes in fair value recognized in accumulated other comprehensive loss included in shareholders’ equity. As of December 31, 2010 and 2011, the Company recorded the investment in 51.com at a fair value of RMB374,838,369 and RMB335,946,356 (US$53,376,501), respectively, with RMB14,467,019 decrease and RMB20,890,689 (US$3,319,196) decrease, respectively, in fair value of the investment debited, respectively, to other comprehensive loss. As at December 31, 2010 and 2011, the Company has accumulated unrealized holding gains of approximately RMB39,563,000 and RMB18,672,000 (US$2,967,000) recorded within accumulated other comprehensive income related to its investment in 51.com.

(ii)

Series A Preferred Shares in MET

On September 13, 2009, the Company entered into an agreement to purchase 5,000,000 redeemable convertible Series A Preferred Shares of MET (the “Series A Preferred Shares”) in exchange for cash consideration of RMB34,157,500 (US$5,000,000). The Company has evaluated and determined that there was no embedded derivative requiring bifurcation from the Series A Preferred Shares under the requirements of ASC 815. The embedded conversion option, redemption option and the liquidation preference did not qualify for derivative accounting because the underlying ordinary shares into which the Series A Preferred Shares can be converted into, are neither publicly traded nor readily convertible to cash.

F-42

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

12.

AVAILABLE-FOR-SALE INVESTMENTS (CONT’D)

(ii)

Series A Preferred Shares in MET (Cont’d)

The Company recorded the investment in the Series A Preferred Shares as an available-for-sale investment. Subsequent to initial recognition, the available-for-sale investment is measured at fair value with changes in fair value recognized in accumulated other comprehensive loss included in shareholders’ equity. As of December 31, 2010 and 2011, the Company recorded the investment in MET at a fair value of RMB48,464,292 and RMB50,904,762 (US$8,087,952), respectively, with a depreciation of RMB73,032 and appreciation of RMB4,893,132 (US$777,440), respectively in fair value of the investment (credited) debited to other comprehensive loss for the years ended December 31, 2010 and 2011. As at December 31, 2010 and 2011, the Company has accumulated unrealized holding gains of approximately RMB15,800,000 and RMB20,693,000 (US$3,288,000) recorded within accumulated other comprehensive income related to its investment in MET.

13.

HELD-TO-MATURITY SECURTIES

During the second quarter of 2011, the Company invested RMB100,000,000 (US$15,888,400) in Resources SZITIC Trust Co., Ltd. (“CR Trust”) with an expected fixed yield of 3% and a variable net yield ranging from 14% to 19% per year. The term of the CR Trust is five years with an option for the beneficiaries to redeem after the end of three years from the date of establishment. Such option is not exercisable by the beneficiaries when the trust has previously distributed principal amounts of more than 60% of the total initial trust fund at establishment. The investment is guaranteed by China Yin Tai Holding Co., Ltd.. Management has accounted for this investment as a held-to-maturity security in accordance with ASC 320-10 at amortized cost. The estimated fair value of the investment as at December 31, 2011, approximates its carrying value as there were no impairment indicators present, events or changes in circumstances having occurred or are expected to occur, since the inception of the Company’s investment in CR Trust, that would have an adverse effect on the underlying value of the investment.

The Company recorded interest income related to this investment amounting to RMB1,972,603 (US$313,415) for the year ended December 31, 2011 in the consolidated statements of operations and comprehensive income.

14.

PAYABLES AND ACCRUED EXPENSES

Payables and accrued expenses consist of the following:


	December 31,
	2010		2011
	(RMB)		(RMB)		(US$)

Payroll and welfare payables		53,966,217		54,073,187		8,591,364
Business tax, related surcharges and other taxes		35,985,994		43,899,929		6,974,996
Other payables
- Property and equipment and intangible assets		2,488,295		7,653,313		1,215,989
- stock option (1)		4,675,495		11,753,633		1,867,464
Accrued expenses		27,384,398		51,905,425		8,246,941
Customer deposit		8,000,000		—		—
Professional fee accruals		7,627,340		—		—
Others		4,308,283		2,325,398		369,470


Total		144,436,022		171,610,885		27,266,224

F-43

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

14.

PAYABLES AND ACCRUED EXPENSES (CONT’D)

(1)	Starting from 2008, the Company used a broker to facilitate the cashless exercise of share options by employees which results in the Group receiving stock options proceeds from the broker and a related pass through proceeds amount due to employees, which is recorded within other payables.

15.

NON CONTROLLING INTERESTS

A reconciliation of the carrying amounts of subsidiaries consolidated by the Group and the non controlling interests is as follows:


	December 31, 2010						December 31, 2011
	Group			Non controlling Interests			Group			Non controlling Interests
	(RMB)			(RMB)			(RMB)			(RMB)

Beginning balance		5,047,654			7,608,607			12,460,938			14,782,829
Equity		11,059,685			10,737,017			11,910,070			836,998
Huayi Giant Information		21,250,000			3,750,000			—			—
Deconsolidation of Huayi Giant Information		(21,250,000	)		(3,750,000	)		—			—
Deconsolidation of Juxi Network (Note 4)		—			—			(1,134,893	)		(1,091,241	)
Deconsolidation of Juxian Network (Note 4)		—			—			(1,319,023	)		(1,067,296	)
Consolidation of Juyan Network (1)								(1,927,203	)		(1,855,246	)
Dividend declared by Jujia Network		—			—			(12,750,000	)		(12,250,000	)
Net (loss) income		(3,646,401	)		(3,562,795	)		28,292,434			26,428,994

Ending balance		12,460,938			14,782,829			35,532,323			25,785,038

Ending balance (US$)								5,645,518			4,096,830

(1)

In January 2011, Zhengduo Information acquired the remaining 49% equity interest of Juyan Network at a consideration of RMB approximately 3,500,000 (US$556,000). Subsequent to this acquisition, Juyan Network becomes a wholly-owned subsidiary of Zhengduo Information. This was accounted for as an equity transaction, where the difference between the fair value of the purchase consideration and the carrying amount of non-controlling interest of approximately RMB1,600,000 (US$ 254,000) was recorded as additional paid-in capital.

16.

GOVERNMENT FINANCIAL INCENTIVES

The financial incentives are granted by the municipal government to reward the Group for prompt tax payments and qualification as a high technology project. Such financial incentives are recorded within operating expenses as they are calculated with reference to business tax, value-added tax, and enterprise income tax, if any, paid or withheld by the Group companies at a predetermined percentage. The central government or municipal government could decide at any time to immediately eliminate or reduce these financial incentives. There is no guarantee that the Group will continue to receive these government financial incentives in the future. There are no conditions or performance obligations attached to these government financial incentives and once received, are not refundable. As a result, government financial incentives are recognized as income when received.

F-44

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

17.

INCOME TAX EXPENSES

Cayman Islands, British Virgin Island, and Hong Kong

Under the current laws of Cayman Islands, British Virgin Island and Hong Kong, the Group is not subject to tax on its income or capital gains. In addition, upon payments of dividends by the Group to its shareholders, no Cayman Islands, British Virgin and Hong Kong withholding tax will be imposed.

In accordance with the new PRC Enterprise Income Tax Laws (the “PRC Income Tax Laws”) effective from January 1, 2008, enterprises established under the laws of foreign countries or regions and whose “place of effective management” is located within the PRC territory are considered PRC resident enterprises, subject to the PRC income tax at the rate of 25% on worldwide income. The definition of “place of effective management” shall be referred to an establishment that exercises, in substance, overall management and control over the production and business, personnel, accounting, properties, etc. of an enterprise. The Company, if considered a PRC tax residence enterprise for tax purpose, would be subject to the PRC Enterprise Income Tax at the rate of 25% on its worldwide income.

Based on the assessment of facts and circumstances available at December 31, 2010 and 2011, management believes that the Company, Eddia International and Giant HK are more likely than not non-PRC tax resident enterprises. It is possible the assessment of tax residency status may change in the next twelve months, pending announcement of new PRC tax rules in the future. The Group will continue to monitor its tax status.

China

The Group’s subsidiaries, the VIE and its subsidiaries that are each incorporated in the PRC are subject to Corporate Income Tax (“CIT”) on the taxable income as reported in their respective statutory financial statements adjusted in accordance with the PRC Income Tax Laws, respectively. Pursuant to the PRC Income Tax Laws, the Group’s PRC subsidiaries, the VIE and its subsidiaries are subject to a CIT statutory rate of 25%.

Zhengtu Information was granted a 5-year tax holiday in 2006 which entitles it to enjoy a two-year CIT exemption followed by three-year 50% CIT reduction starting from the year 2006 to 2010. Under the PRC Income Tax Laws, it should be entitled to transitional rules whereby the CIT rate could gradually increase from 15% (which was the Zhengtu Information’s applicable tax rate in 2007) to 25% from the year 2008 to 2012 (i.e. 18%, 20%, 22%, 24% and 25% for 2008, 2009, 2010, 2011, 2012 and onwards, respectively) and the 5-year tax holiday could be retained until exhausted.

The certificate of “High and New Technology Enterprise” (the “HNTE”) (valid from 2008 to 2010) obtained by Zhengtu Information on November 25, 2008, which was issued by Shanghai Science and Technology Commission, has expired in year 2011.

F-45

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

17.

INCOME TAX EXPENSES (CONT’D)

In April 2012, Zhengtu Information has obtained the renewed certificate. In accordance with the PRC Income Tax Laws, an enterprise awarded with the HNTE status may enjoy a preferential CIT rate of 15% for three years and the status is renewable.

Giant Network, a VIE to which Zhengtu Information is deemed the primary beneficiary, has been recognized as a HNTE effective from 2008, and therefore enjoys a preferential tax rate of 15% from 2008 to 2010. Giant Network did not apply for the HNTE renewal in 2011. Therefore Giant Network’s applicable tax rate for 2011 is 25% for current income provision and deferred taxes.

On December 3, 2010, Snow wolf received certificate for Software enterprise. In year 2011, Jujia Network, Juhuo Network, Zhengju Information and Wuxi Network, all being subsidiaries of the Company, received certificates for Software Enterprises. They are entitled to full exemption from corporate income tax (“CIT”) for the first and second profitable years, and a further 50% exemption for the three succeeding years (12.5%: 50% of 25% CIT rate).

Zhengduo Information, Zhuhai Zhengtu, Juhe Network, Juyan Network, Haoji Network, Juquan Network, Jufan Network, Tiema Network, Juxin Network, Julun Network, Beijing Giant and Tiequan Network are not entitled to enjoy any preferential tax rate for year 2011 and their applicable CIT rate is 25%.

The PRC Income Tax Law also imposes a 10% withholding income tax for 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 withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. The foreign invested enterprise will be subject to the withholding tax starting from January 1, 2008. There was no distribution of dividends from the Group’s PRC subsidiaries in 2009 and 2010. In 2011, the Company made a one-time special dividend to its shareholders, out of which the payout was physically financed partially through the declaration and payout of dividends to the Company by Zhengtu Information. Thus, the Company provided deferred tax liabilities amounting to RMB259,415,894 for the withholding taxes due associated with the distribution of the retained earnings accumulated from December 31, 2007 to December 31, 2010. As of December 31, 2011, the amount of undistributed earnings of the Group’s PRC subsidiaries, which would be subject to withholding taxes to the extent dividends were declared and distributed by the Company’s foreign invested enterprises to their respective immediate holding companies that reside outside of China, was RMB2,602,737,384 (US$413,533,323).

The Company had minimal operations in jurisdictions other than the PRC. Income before income tax expenses consists of:


	For the year ended December 31,
	2009		2010		2011
	(RMB)		(RMB)		(RMB)		(US$)

PRC		936,154,635		881,077,042		1,229,776,487		195,391,805
Non-PRC		7,924,628		16,518,504		37,215,603		5,912,964


Total		944,079,263		897,595,546		1,266,992,090		201,304,769

F-46

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

17.

INCOME TAX EXPENSES (CONT’D)

(a)

Current Tax

Income tax expenses consist of:


	For the year ended December 31
	2009		2010			2011
	(RMB)		(RMB)			(RMB)		(US$)

Current income taxes		83,328,105		121,303,259			268,076,187		42,593,017
Deferred income tax (benefits)/expenses		1,731,905		(31,980,857	)		84,302,034		13,394,244


Taxation for the year		85,060,010		89,322,402			352,378,221		55,987,261

A reconciliation of the differences between the statutory tax rate and the effective tax rate for CIT is as follows:


	For the year ended December 31
	2009			2010			2011
	(RMB)			(RMB)			(RMB)			(US$)
Expected taxation at PRC CIT statutory rate of 25%		236,019,816			224,398,887			316,748,023			50,326,193
Favorable tax rate		(49,059,531	)		(25,488,282	)		(130,226,808	)		(20,690,956	)
Tax holiday		(71,351,432	)		(105,110,278	)		(12,694,680	)		(2,016,982	)
Non-deductible expenses (non-taxable income), net		(4,718,414	)		7,679,477			3,904,248			620,323
Additional 50% tax deduction for qualified research and development expenses		(10,380,859	)		(15,257,615	)		(18,935,961	)		(3,008,621	)
Tax exempted VAT refund		(12,779,323	)		—			—			—
Change in valuation allowance		—			—			2,885,413			458,446
Deferred tax benefits on future tax rate difference		(2,670,247	)		(3,659,750	)		(58,833,362	)		(9,347,680	)
One-time withholding tax accrual for dividend		—			—			259,415,894			41,217,035
Provision-to-return adjustment		—			6,759,963			(9,884,546	)		(1,570,497	)


Taxation for the year		85,060,010			89,322,402			352,378,221			55,987,261

Deferred tax benefits on future tax rate difference relates to the increase of deferred tax assets recognized by Giant Network as a result of the impact of the change in the future enacted tax rate from 15% to 25% from the non-renewal of Giant Network’s HNTE status in 2011.

The benefit of tax holiday per basic and diluted earnings per share is as follows:


	For the year ended December 31
	2009		2010		2011
	(RMB)		(RMB)		(RMB)		(US$)

Basic		0.32		0.46		0.05		0.01
Diluted		0.30		0.45		0.05		0.01

F-47

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

17.

INCOME TAX EXPENSES (CONT’D)

(b)

Deferred Tax

The tax effects of temporary differences that give rise to deferred tax at December 31, 2010 and 2011 are as follows:


	December 31,
	2010		2011
	(RMB)		(RMB)			(US$)

Current deferred tax assets
Deferred revenue and advance from distributors		77,208,660		151,140,044			24,013,734
Accrued expenses		12,142,057		18,344,188			2,914,598
Allowance for doubtful debt		1,127,960		611,274			97,122
Share-based compensation expense		8,117,107		5,036,662			800,245
Tax loss		7,149,387		7,532,367			1,196,773
Less: valuation allowance		—		(2,885,413	)		(458,446	)

Net current deferred tax assets		105,745,171		179,779,122			28,564,026


Non-current deferred tax assets
Intangible assets amortization		11,069,031		11,357,297			1,804,492
Share-based compensation expense		2,076,457		2,826,219			449,041
Deferred revenue		—		2,916,666			463,412

Net non-current deferred tax assets		13,145,488		17,100,182			2,716,945


	December 31,
	2010		2011
	(RMB)		(RMB)			(US$)

Current deferred tax liabilities
Intangible assets amortization		624,770		—			—
Deferred revenue		—		2,408,961			382,746
Withholding tax		—		145,810,671			23,166,982

Net current deferred tax liabilities		624,770		148,219,632			23,549,728


Non-current deferred tax liabilities
Intangible assets amortization		186,496		298,980			47,503
Upfront fee amortization		—		14,583,333			2,317,058

Net non-current deferred tax liabilities		186,496		14,882,313			2,364,561

As of December 31, 2011, the Group recorded a valuation allowances of RMB2,885,413 (US$458,446) for Zhuhai Zhengtu as management has assessed that it is more-likely-than-not that Zhuhai Zhengtu’s deferred tax assets will not be realizable. Management has assessed that it is more-likely-than-not that the deferred tax assets for all other entities within the Group are realizable as of December 31, 2011.

As of December 31, 2011, the Company had net operating tax losses in the total amount of RMB 30,129,468 (US$4,787,090) in the PRC, which can be carried forward to future years and utilized by respective Chinese subsidiaries of the Company according to the prevailing PRC CIT rules and regulations. The balance of net operating tax losses of the Company as of December 31, 2011 will expire between the years 2015 and 2017.

The Company intends to permanently reinvest all undistributed earnings generated by its foreign subsidiaries beginning in 2011 and onward 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.

F-48

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

17.

INCOME TAX EXPENSES (CONT’D)

(c)

Unrecognized Tax Benefits

The following table summarizes the activity related to the Group’s unrecognized tax benefits from January 1, 2010 to December 31, 2011:


	RMB
Balance as of January 1, 2010		9,955,138
Increases related to current year tax positions		4,803,660


Balance as of December 31, 2010 and January 1, 2011		14,758,798
Increases related to current year tax positions		29,692,724


Balance as of December 31, 2011		44,451,522

Balance as of December 31, 2011 (US$)		7,062,636

As of December 31, 2010 and 2011, the Group recorded an unrecognized tax benefit of RMB14,758,798 and RMB44,451,522 (US$7,062,636), respectively, related to excess share-based compensation expense deductions. The unrecognized tax benefit resulting from the difference between the share-based compensation expense deduction and the cumulative amount of compensation cost would be recorded to additional paid-in capital, when recognized. It is possible that the amount of unrecognized tax benefits will change in the next twelve months, pending clarification of current tax law or audit by the tax authorities. However, an estimate of the range of the possible change cannot be made at this time.

For the years ended December 31, 2009, 2010 and 2011, no interest or penalties related to uncertain tax positions were recognized.

The Group’s subsidiaries, the VIE and its subsidiaries registered in the PRC are subject to PRC CIT on the taxable income as reported in their PRC statutory accounts adjusted in accordance with relevant PRC Income Tax Laws. The Group’s tax years 2005 through 2011 remain subject to examination by tax authorities.

F-49

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

18.

EARNINGS PER SHARE

Computation of basic earnings per share and diluted earnings per share are as follows:


	December 31
	2009			2010		2011
	(RMB)			(RMB)		(RMB)			(US$)

Numerator:
Net income attributable to ordinary shareholders		859,313,746			811,187,833		879,966,874			139,812,655
Numerator for basic earnings per share		859,313,746			811,187,833		879,966,874			139,812,655
Numerator for diluted earnings per share		859,313,746			811,187,833		879,966,874			139,812,655


Denominator:
Number of shares outstanding, opening		227,018,426			226,819,007		228,019,412			228,019,412
Weighted average number of shares issued		726,931			489,847		4,104,619			4,104,619
Weighted average number of shares repurchased		(1,467,130	)		—		(119,152	)		(119,152	)


Weighted average number of shares outstanding – basic		226,278,227			227,308,854		232,004,879			232,004,879
Dilutive effect of share options		7,682,329			6,619,546		—			—


Weighted average number of shares outstanding – diluted		233,960,556			233,928,400		232,004,879			232,004,879

As of December 31, 2011, the Company issued 4,254,882 ordinary shares to its share depositary bank which will be used to settle stock option awards upon their exercise. No consideration was received by the Company for this issuance of ordinary shares. These ordinary shares are issued but not outstanding and are treated as escrowed shares for accounting purposes and therefore, have been excluded from the computation of earnings per share. Any ordinary shares not used in the settlement of stock option awards will be returned to the Company.

19.

SHARE OPTION AND RESTRICTED SHARE SCHEME

2006 Stock Incentive Plan

On September 30, 2006, the Company authorized a share option scheme (the “2006 Stock Incentive Plan”) that provides for the issuance of options to purchase up to 16,000,000 ordinary shares. Under the 2006 Stock Incentive Plan, the directors may, at their discretion, grant any officers (including directors), employees of the Group and consultants (collectively, the “grantees”) options to subscribe for ordinary shares. The share options have a maximum term of six years. The 2006 Stock Incentive Scheme provides for the same terms to all grantees. These awards vest over a five year period, with 20% of the options to vest on each of the first, second, third, fourth and fifth anniversaries of the award date as stipulated in the share option agreement.

The Company granted 920,000 and 3,800,000 share options to the directors, employees and consultants of the Group on March 19, 2007 and May 15, 2007, respectively. Such options were granted under the 2006 Stock Incentive Plan at an exercise price of US$2.00 per share, with 20% vesting annually.

On July 2, 2007, all consultants were transferred to employee status as they have been recruited as the Group’s employees. The fair value of the options to those consultants have been re-measured on the date those consultants became the Group’s employees and the compensation charges have been accounted for prospectively from the date of the change in employment status.

F-50

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

19.

SHARE OPTION AND RESTRICTED SHARE SCHEME (CONT’D)

Suspension of 2006 Stock Incentive Scheme

On October 12, 2007, the Company suspended the 2006 Stock Incentive Scheme. All unissued options authorized under the 2006 Stock Incentive Scheme have been returned to the general share pool and the Company will not grant any further options under the 2006 Stock Incentive Scheme. Existing issued awards under the 2006 Stock Incentive Scheme are not affected by the suspension.

2007 Stock Incentive Scheme

On October 12, 2007, the Company authorized the 2007 Stock Incentive Scheme that provides for the issuance of awards to officers (including directors), employees of the Group and consultants (collectively, “the grantees”).

Types of awards available for grant under the 2007 Stock Incentive Scheme include, but not limited to, share options (including both incentive and non-qualified), stock appreciation rights (“SAR”), performance-based awards and restricted stock. Performance-based awards are only granted to officers and employees of the Group and the performance goals are determined by the Board of Directors. Such performance-based awards may be paid in cash or shares which will be determined upfront. The Board of Directors will determine the type, the number, the exercise price and the vesting terms of the awards. The maximum number of shares authorized for issuance under the 2007 Stock Incentive Scheme is 23,700,000. The share options and SARs, if and when issued, have a maximum term of ten years. The 2007 Stock Incentive Plan provides for two terms to grantees. These awards vest either over a five or a four year period, with 20% or 25%, respectively, of the options to vest on each of the first, second, third, fourth and fifth anniversaries of the award date as stipulated in the share option agreement. The Company did not grant any SAR or performance based awards as of December 31, 2010.

On October 17, 2007, the Board of Directors approved the grant of 1,743,500 share options (non performance-based and to be settled in shares) to certain officers and employees of the Group pursuant to the 2007 Stock Incentive Scheme. The exercise price of these options is US$15.50.

On February 1, 2008, February 14, 2008 and September 9, 2008, the Board of Directors approved the grant of 60,000, 50,000 and 560,500 share options (non performance-based and to be settled in shares) at the exercise prices of US$10.29, US$10.50 and US$8.01, respectively, pursuant to the 2007 Stock Incentive Scheme to certain officers and employees of the Group.

On February 27, 2009, the Board of Directors approved the grant of 335,000 share options (non performance-based and to be settled in shares) at the exercise prices of US$6.00, pursuant to the 2007 Stock Incentive Scheme.

F-51

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

19.

SHARE OPTION AND RESTRICTED SHARE SCHEME (CONT’D)

By a resolution of the Board of Directors on April 23, 2010, 797,000 restricted shares under 2007 Stock Incentive Scheme were granted to the Company’s certain officers and employees. One fifth of the total restricted shares will become vested upon each annual anniversary of the grant date during the following five years.

On January 14, 2011, the Board of Directors approved the grant of 60,000 share options (non performance-based and to be settled in shares) at the exercise prices of US$7.24 to the independent directors with a vesting period of 4 years, pursuant to the 2007 Stock Incentive Scheme.

On October 31, 2011, the Board of Directors approved the grant of 14,000,000 restricted shares under 2007 Stock Incentive Scheme to the Company’s selected employees and management members of the Company. One fifth of the total restricted shares will become vested upon each annual anniversary of the grant date during the following five years.

On September 17, 2010, the Board of Directors approved a resolution to reduce the exercise prices for certain outstanding service-based share options that were granted by the Company in 2007, 2008 and 2009 to the current fair market value of ordinary shares underlying such options. A total of 2,414,000 options belonging to 120 employees of the Company were repriced under 2007 Stock Incentive Scheme. The current fair market value was US$6.36, which was the closing price of our ADSs traded on the NYSE as of September 17, 2010 (“modification date”), which was the last trading day prior to the board approval. All eligible share option grantees affected by such changes had entered into amended share option agreements with the Company. The total incremental compensation cost for the modification is RMB8,273,839. RMB5,300,346 of the total incremental compensation cost was related to vested share options and therefore, was recognized as share-based compensation expenses on the date of modification. The remaining unrecognized incremental compensation cost related to unvested share options will be amortized from the modification date to the end of the remaining vesting period.

On August 8, 2011, the Company’s Board of Directors authorized the accelerated vesting of 400,000 share options that were issued under the 2007 Stock Incentive Scheme to a certain employee upon his resignation from the Company. Share-based compensation expense of approximately RMB7,000,000 (US$1,112,000) relating to the unvested share options was reversed upon his resignation, whereas incremental compensation expenses of approximately RMB10,000,000(US$1,589,000) relating to the accelerated vesting of such share options was immediately recognized as share-based compensation expense on the date of modification.

On October 31, 2011, the Company’s Board of Directors authorized the repricing of certain stock options granted to the existing employees, directors, and officers to USD4.07 per share, that were issued under the 2007 Performance Incentive Plan at exercise price that was originally ranging from USD6.00 to USD7.24 per share. A total of 1,098,600 options belonging to 84 employees of the Company were repriced under 2007 Stock Incentive Scheme. The current fair market value was US$4.07, which was the closing price of our ADSs traded on the NYSE as of October 28, 2011 (“modification date”), which was the last trading day prior to the board approval. All eligible share option grantees affected by such changes had entered into amended share option agreements with the Company.

F-52

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

19.

SHARE OPTION AND RESTRICTED SHARE SCHEME (CONT’D)

The total incremental compensation cost for the modification is RMB 2,114,102(US$335,897). RMB1,449,156 (US$230,248) of the total incremental compensation cost was related to vested share options and therefore, was recognized as share-based compensation expense on the date of modification. The remaining unrecognized incremental compensation cost related to unvested share options will be amortized from the modification date to the end of the remaining vesting period.

Stock Option

The fair value of stock options was estimated using a binomial option pricing model. The binomial model requires the input of highly subjective assumptions including the expected stock price volatility and the expected price multiple at which employees are likely to exercise stock options. The Company uses historical data to estimate forfeiture rate. For expected volatilities, the Company has made reference to historical volatilities of several comparable companies. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

The fair values of stock options granted to employees were estimated using the following weighted average assumptions:


	Granted in 2009			Granted in 2011

Suboptimal exercise factor		1.5			1.5
Risk-free interest rates		2.94	%		3.42	%
Expected volatility		60.40			50.98
Expected dividend yield		2.5	%		2.5	%
Fair value of share option		RMB17.35 to RMB22.37			RMB15.75 to RMB19.85
Estimated forfeiture rate		2% per annum			2% per annum

F-53

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

19.

SHARE OPTION AND RESTRICTED SHARE SCHEME (CONT’D)

The following table summarizes the Company’s share option activity as of and for the year ended December 31, 2010 and 2011.


	Number of options			Weighted average exercise price(USD)		Weighted average remaining contractual life (Years)		Aggregate intrinsic value (USD)

Outstanding, December 31, 2010 and January 1, 2011		11,385,629			2.80		2.95		49,161,052
Granted		60,000			6.71		—		—
Exercised		(7,993,119	)		2.50		—		—
Forfeited/Cancelled		(260,560	)		4.92		—		—


Outstanding, December 31, 2011		3,191,950			2.69		2.61		4,446.298


Vested and expected to vest at December 31, 2011		3,128,111			2.69		2.61		4,357.372

Exercisable at December 31, 2011		2,187,850			2.68		2.36		3,070.057

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the fair value of the Company’s shares as at December 31, 2011, for those awards that have an exercise price currently below the fair value of the Company’s shares. The total intrinsic value of options exercised during the year ended December 31, 2011 was approximately RMB278,174,000 (US$44,197,000) (2010: RMB 33,700,000, 2009: RMB53,100,000)).

The weighted average estimated fair value of options granted to employees of the Group at grant date during the fiscal year ended 2011 was RMB18.45 (US$2.93) (2009: RMB20.32). There were no share options granted during 2010. The total fair value of options vested during the year ended December 31, 2009, 2010 and 2011 was RMB26,551,305, RMB29,951,523 and RMB37,166,249 (US$5,905,122), respectively.

As of December 31, 2011, there was RMB3,249,083 (US$516,227) of unrecognized estimated 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 1.23 years. To the extent the actual forfeiture rate is different from the original estimated, actual share-based compensation related to these awards may be different.

F-54

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

19.

SHARE OPTION AND RESTRICTED SHARE SCHEME (CONT’D)

The following table sets forth the components of share-based compensation expense for share options issued to employees from the Company’s share option scheme both in absolute amount and as a percentage of net revenue for the year indicated.


	For the year ended December 31
	2009		2010		2011
	(RMB)		(RMB)		(RMB)		(US$)		%

Net revenue		1,303,835,447		1,332,815,451		1,792,217,309		284,754,652		100	%


Cost of services		1,245,984		612,529		562,225		89,329		0.03	%
Research and product development expenses		9,573,183		6,664,626		2,269,898		360,650		0.13	%
Sales and marketing expenses		1,139,408		60,891		199,684		31,727		0.01	%
General and administrative expenses		18,616,815		14,532,565		7,901,262		1,255,384		0.44	%


Total share-based compensation included in cost of services and total operating expenses		30,575,390		21,870,612		10,933,069		1,737,090		0.61	%

Restricted Shares awards

The fair value of a restricted share is simply the closing price of the unrestricted share as of the valuation date minus the present value of the expected dividends during the vesting period. The risk-free rate for periods within the contractual life of the share is based on the U.S. Treasury yield curve in effect at the time of grant.

The fair values of restricted shares granted to employees were estimated using the following weighted average assumptions:


	Granted in 2010			Granted in 2011

Risk-free interest rates		0.46%-2.61	%		0.14%-0.93	%
Expected dividend yield		5	%		5	%
Fair value of restricted shares		RM44.04 to RMB49.27			RMB17.39 to RMB22.62

The following table summarized the Company’s restricted shares activity under 2007 Stock Incentive Scheme:


	Number of restricted shares			Weighted average grant date fair value (USD)

Outstanding, December 31, 2010 and January 1, 2011		777,000			5,440,896
Granted		12,670,000			40,299,824
Exercised		(155,400	)		(1,149,096	)
Forfeited/Cancelled		(136,000	)		(945,200	)
Outstanding, December 31, 2011		13,155,600			43,646,424

Vested and expected to vest as of December 31, 2011		12,382,299			41,166,971

As of December 31, 2011, there was RMB238,041,628 (US$37,821,006) of unrecognized estimated share-based compensation cost related to restricted shares issued to employees. That deferred cost is expected to be recognized over a weighted-average vesting period of 2.76 years. To the extent the actual forfeiture rate is different from the original estimated, actual share-based compensation related to these awards may be different.

F-55

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

19.

SHARE OPTION AND RESTRICTED SHARE SCHEME (CONT’D)

The following table sets forth the components of share-based compensation expense for restricted shares issued to employees from the Company’s share option scheme both in absolute amount and as a percentage of net revenue for the year indicated.


	For the year ended December 31
	2009		2010		2011
	(RMB)		(RMB)		(RMB)		(US$)		%

Net revenue		1,303,835,447		1,332,815,451		1,792,217,309		284,754,652		100	%


Cost of services		—		1,180,570		1,797,223		285,550		0.10	%
Research and product development expenses		—		7,994,861		11,771,687		1,870,333		0.66	%
Sales and marketing expenses		—		368,900		518,445		82,373		0.03	%
General and administrative expenses		—		1,874,274		4,314,757		685,546		0.24	%


Total share-based compensation included in cost of services and total operating expenses		—		11,418,604		18,402,112		2,923,802		1.03	%

The total share-based compensation cost capitalized as part of intangible assets — online game product costs for the year ended December 31, 2009, 2010 and 2011 are RMB 1,463,330, RMB 295,211 and RMB87,497 (US$13,902), respectively.

F-56

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

20.

EMPLOYEE BENEFITS

The full-time employees of the Company’s subsidiaries, the VIE and its subsidiaries that are incorporated in the PRC are entitled to staff welfare benefits, including medical care, housing subsidies, unemployment insurance and pension benefits. These companies are required to accrue for these benefits based on certain percentages of the employees’ salaries in accordance with the relevant regulations, and to make contributions to the state-sponsored pension and medical plans out of the amounts accrued for medical and pension benefits. The Group’s PRC subsidiaries, the VIE and its subsidiaries have no legal obligation for the benefits beyond the contributions made. The total amounts expensed in the consolidated statements of operations and comprehensive income for such employee benefits amounted to RMB22,890,106, RMB33,346,393 and RMB42,567,100, (US$6,763,231), for the years ended December 31, 2009, 2010 and 2011, respectively. The PRC government is responsible for the medical benefits and ultimate pension liability to these employees.

21.

RELATED PARTY TRANSACTIONS

The principal related parties with which the Group had transactions during the years presented are as follows:


Name of related party		Relationship with the Group

Shanghai 51 network development Co., Ltd. (“51 Network”)		A VIE of 51.com invested by Giant Interactive

Yangxun Computer Technology (Shanghai) Co. Ltd.		A VIE of MET invested by Giant Interactive

Prexton Investment Ltd., (“Prexton Investment”)		Company with the same key senior executive of the Company

Shanghai Jiante Biotechnology Co., Ltd.(“Shanghai Jiante”)		Company controlled by Mr. Shi Yuzhu

Huayi Giant Information		Equity investee

Juxian Network		Equity investee

Juxi Network		Equity investee

Union Sky Holding Group Limited (“Union Sky”)		Company’s shareholder

F-57

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

21.

RELATED PARTY TRANSACTIONS (CONT’D)

Significant related party transactions were as follows:


	For the year ended December 31,
	2010			2011
	(RMB)			(RMB)			(US$)

Technical service fee paid to 51 network		(12,789	)		—			—
Other revenue from 51 network		—			445,580			70,796
Rental fee to Prexton Investment		(3,592	)		—			—
Rental fee to Shanghai Jiante		(3,180,000	)		(12,000,000	)		(1,906,608	)
Advances to Huayi Giant Information		25,000,000			—			—
Royalty fee charged by Huayi Giant Information		—			(18,485,392	)		(2,937,033	)
Technical service fee charge by Huayi Giant Information		—			(7,500,000	)		(1,191,630	)
Other service fee from Huayi Giant Information		—			4,354,136			691,803
Payment of individual income tax related to the exercise of share options by Juxian Network		—			(374,213	)		(59,456	)
Technical service fee charge from Juxian Network		—			3,039,202			482,881
Prepayment to Shanghai Jiante (1)		—			958,800,000			152,337,978
Repayment from Union Sky (1)		—			(958,800,000	)		(152,337,978	)
Interest income from Union Sky (1)		—			21,471,866			3,411,536
Licensing income from Yangxun		—			1,200,000			190,661
Marketing expense charged by Yangxun		—			(1,080,200	)		(171,626	)

(1)

In April 2011, the Company made a prepayment to Shanghai Jiante, for a commitment to invest RMB958,800,000 (US$152,337,978) in Sunshine Insurance Group Corporation, Ltd., a privately held insurance company, which was due to investor sentiment, regulatory and other considerations, the Company subsequently unwound in August 2011 by transferring it to Union Sky for the full amount of the prepayment plus accrued interest of RMB21,471,866 (US$3,411,536), which was accrued from April through August 2011. Both these amounts were settled in cash in September, 2011.

Effective June 2009, Lager Network is no longer the Company’s related party as the Company’s senior executive has resigned from the directorship of Lager Network.

Due from related parties as of December 31, 2010 and 2011 are as follows:


	December 31,
	2010		2011
	(RMB)		(RMB)		(US$)
Receivable from:
-Huayi Giant Information		25,000,000		23,642		3,757
-Juxi Network		—		16,863		2,679
-Juxian Network		—		3,369,609		535,377

Total		25,000,000		3,410,114		541,813

Due to a related party as of December 31, 2010 and 2011 are as follows:


	December 31,
	2010		2011
	(RMB)		(RMB)		(US$)
Payable to:
-Juxian Network		—		540,345		85,852

Total		—		540,345		85,852

All balances with the related parties as of December 31, 2010 and 2011 were unsecured, interest-free and have no fixed term of repayment.

F-58

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

22.

TREASURY STOCK

During 2011, the Company has repurchased 932,972 ADSs amounting to approximately RMB 22,960,759 (US$3,648,097) under the Share Repurchase Plan 4.

As of December 31, 2011, the Company has repurchased a total 34,935,057 ADSs, amounting to approximately RMB2,200,000,000 (US$350,000,000). As of December 31, 2010, the Company repurchased a total of 34,002,085 ADSs, amounting to approximately RMB2,177,000,000.

Out of the repurchased ADSs, 1,314,272 ADSs were subsequently used to settle the exercise of share options.

23.

DIVIDEND

Pursuant to a Board of Directors’ resolution dated February 21, 2011, the Company declared a total dividends of RMB270,314,878 (US$42,948,709) paid out of the Company’s 2010 net distributable profits, which are determined using an equity method basis of accounting for the stand-alone listed company financial statements, to the shareholders of the Company who were registered members of the Company as of March 18, 2011.

Pursuant to a Board of Directors’ resolution dated August 8, 2011, the Company declared a total dividends of RMB4,539,849,894 (US$721,309,505) paid out of the Company’s net distributable profits, which are determined using an equity method basis of accounting for the stand-alone listed company financial statements, to the shareholders of the Company who were registered members of the Company as of August 31, 2011.

The payments of these dividends were financed out of available cash held by the Company, subsequent to the declaration of dividends to the Company by Zhengtu Information (Note 17). In 2009, 2010 and 2011, the Company has paid dividends of RMB277,652,205, RMB 279,122,994 and RMB4,810,164,772 (US$764,258,214) respectively.

F-59

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

24.

STATUTORY RESERVES

In accordance with the Regulations on Enterprises with Foreign Investment of China and the articles of association, Zhengtu Information and Zhengduo Information, being foreign invested enterprises established in the PRC, are required to provide for certain non-distributable reserves, namely general reserve fund, enterprise expansion fund and staff welfare and bonus fund, all of which are appropriated from after-tax profit as reported in its PRC statutory financial statements. Zhengtu Information and Zhengduo Information are required to allocate at least 10% of their after-tax profits to the general reserve fund until such fund has reached 50% of their registered capital. Appropriations to the enterprise expansion fund and staff welfare and bonus fund are at the discretion of the board of directors of Zhengtu Information and Zhengduo Information. Appropriation to the staff welfare and bonus fund, if any is charged to general and administrative expenses. There have not been any appropriations to the enterprise expansion fund and staff welfare and bonus fund made for the any of the periods stated herein.

In accordance with the PRC Company Laws, Giant Network, Jujia Network and Juhuo Network, being domestic companies, must make appropriations from their after-tax profits as reported in their PRC statutory financial statements to non-distributable reserve funds, namely statutory surplus fund, statutory public welfare fund and discretionary surplus fund. Giant Network, Jujia Network and Juhuo Network are required to allocate at least 10% of their after-tax profits to the statutory surplus fund until such fund has reached 50% of their registered capital.

General reserve fund and statutory surplus fund are restricted to set-off against losses, expansion of production and operation and increasing registered capital of the respective company. Staff welfare and bonus fund and statutory public welfare fund are restricted to the capital expenditures for the collective welfare of employees. Enterprise expansion fund is restricted to expansion of production and operation and increasing registered capital of the respective company. The reserves are not allowed to be transferred to the Company in terms of cash dividends, loans or advances, neither are they allowed for distribution except under liquidation.

As of December 31, 2011, Giant Network, Zhengtu Information, Zhengduo Information, Jujia Network and Juhuo Network have appropriated RMB5,000,000 (US$794,420), RMB5,931,525 (US$942,424), RMB113,338 (US$18,008) , RMB 2,500,000 (US$397,210) and RMB 580,956 (US$92,305) to statutory surplus fund and general reserve fund, respectively.

The following amounts that are restricted from being distributed include paid-in capital and statutory reserve funds of the Company’s subsidiaries and the equity of Giant Network and its subsidiaries, as determined pursuant to the PRC generally accepted accounting principles, totaling an aggregate of RMB368,750,172(US$58,588,502) and RMB211,003,295 as at December 31, 2011 and 2010, respectively.

F-60

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

25.

COMMITMENTS AND CONTINGENCIES

Operating lease agreements

The Group has entered into operating lease arrangements mainly relating to its office premises and computer equipment. Payments under operating leases are expensed on a straight-line basis over the periods of the respective leases. The terms of the leases do not contain rent escalation or contingent rents. Future minimum lease payments for non-cancelable operating leases as of December 31, 2011 are as follows:


	Office premises		Computer equipment		Total
	(RMB)		(RMB)		(RMB)		(US$)

2012		4,656,953		12,310,520		16,967,473		2,695,860
2013		3,170,626		—		3,170,626		503,762
2014		1,498,958		—		1,498,958		238,160


Total		9,326,537		12,310,520		21,637,057		3,437,782

Total rental expenses were RMB70,216,710, RMB65,034,773 and RMB77,345,611 (US$12,288,980) for the years ended December 31, 2009, 2010 and 2011 respectively.

Commitments

Capital commitments

The Company has a commitment to invest a remaining amount of RMB21,000,000 (US$3,336,564) in Beijing Innovation Works Development Fund and the commitment is due on demand.

Capital commitments for purchases of property and equipment as of December 31, 2011 are approximately RMB3,859,180 (US$613,162). The payments for the commitments for these purchases are expected to be settled within the next twelve months.

Online game licensing fee commitments

The Company has commitments to pay licensing fees to third parties of RMB15,105,360 (US$2,400,000) as of December 31, 2011, which will be paid according to certain specified milestones.

F-61

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

25.

COMMITMENTS AND CONTINGENCIES (CONT’D)

Contingencies

Class actions

Two securities class actions have been filed against the Company. The first was filed on November 26, 2007, entitled Pyramid Holdings, Inc V. Giant Interactive Group Inc. (United States District court, Southern District of New York (07cv10588); and the second was filed on December 20, 2007, entitled Brooks v Giant Interactive Group Inc. (United States District court, Southern District of New York (07cv11423). The actions assert similar allegations and seek similar damages, both alleging claims pursuant to Section 11 and Section 12(a)(2) of the Securities Exchange Act of 1933, on behalf of all persons who purchased Company’s ADSs pursuant to or traceable to the Company’s initial public offering from November 1, 2007, though November 10, 2007. The Company, Merrill Lynch & Co. and UBS Investment Bank are named as defendants. Plaintiffs also request that the action be maintained as class action and request relief in the form of class damages plus interest, attorneys’ fees, experts’ fee and other costs, and a rescinding of the initial public offering.

Specifically, plaintiffs allege that the Company’s Registration Statement and prospectus contained untrue statement of material facts, omitted to state other facts necessary to make the statement made not misleading and were not prepared in accordance with the applicable rules and regulations. Plaintiffs were allegedly harmed when the Company’s stock price declined on November 19, 2007, when the Company announced its third quarter financial results and disclosed that during third quarter 2007, the Company’s average concurrent users (“ACU”) and peak concurrent users (“PCU”) decreased from the second quarter following a rule change made to ZT Online. Plaintiffs claim that the Company did not explain or describe the rule change in the Registration Statement or Prospectus, did not explain or highlight the alleged negative trend in ACU and PCU and did not disclose the supposed negative impact that rule change was having at the time of the initial public offering.

The actions were consolidated by stipulation on January 31, 2008, into Giant Interactive Group Inc. Securities Litigation. On August 5, 2008, the United States District court, Southern District of New York (“Court”) appointed a Lead Plaintiff and its Counsel in the consolidated action. The Lead Plaintiff filed a Consolidated Amended Complaint on October 6, 2008. The Company, Merrill Lynch & Co. and UBS Investment Bank filed motions to dismiss the Consolidated Amended Complaints 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 the Company’s motion to dismiss the Complaint, because the Court required more facts and evidence prior to making the ruling.

F-62

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

25.

COMMITMENTS AND CONTINGENCIES (CONT’D)

The class action was closed on November 2011 and the final judgment was against the Company. The settlement amounted to US$13,000,000 based on approximately 16.5% of the class’s maximum provable damages, in excess of the average percentage of recovery in many securities class-action lawsuit. Such settlement was fully made by the Company’s insurance carriers to the counterparty before the end of 2011.

Income taxes

As of December 31, 2011, the Group has recognized RMB44,451,522 (US$7,062,636) (2010: RMB14,758,798) of unrecognized tax benefits, which have been classified as current liabilities. The final outcome of these tax uncertainties is dependent upon various matters including tax examinations, changes in regulatory tax laws, interpretation of those tax laws or expiration of status of limitation. However, based on the number of jurisdictions, the uncertainties associated with the status of examinations, including the protocols of finalizing audits by the relevant tax authorities, there is a high degree of uncertainty regarding the future cash outflows associated with these tax uncertainties.

26.

FAIR VALUE MEASUREMENT

Effective January 1, 2008, the Group adopted ASC subtopic 820-10 (“ASC 820-10”), Fair Value Measurement and Disclosure: Overall. ASC 820-10 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Although the adoption of ASC 820-10 did not impact the Group’s financial condition, results of operations or cash flow, ASC 820-10 requires additional disclosures to be provided on fair value measurement.

F-63

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

26.

FAIR VALUE MEASUREMENT (CONT’D)

ASC 820-10 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

Level 1 — Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 — Include other inputs that are directly or indirectly observable in the marketplace.

Level 3 — Unobservable inputs which are supported by little or no market activity.

ASC 820-10 describes three main approaches to measuring the fair value of assets and liabilities: (1) market approach; (2) income approach and (3) cost approach. The market approach uses prices and other relevant information generated from market transactions involving identical or comparable assets or liabilities. The income approach uses valuation techniques to convert future amounts to a single present value amount. The measurement is based on the value indicated by current market expectations about those future amounts. The cost approach is based on the amount that would currently be required to replace an asset.

In accordance with ASC 820-10, the Company measures trading securities and available-for-sale investments at fair value. The respective available-for-sale investments are classified within Level 3 as its valuation is based on a model utilizing unobservable inputs which require significant management judgment and estimation.

Assets measured at fair value on a recurring basis are summarized below:


	Fair Value Measurement at December 31, 2011 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Unobservable inputs (Level 3)		Fair Value at December 31, 2011
	(RMB)		(RMB)		(RMB)		(RMB)		(US$)

Available-for-sale investments		—		—		386,851,118		386,851,118		61,464,453


Total		—		—		386,851,118		386,851,118		61,464,453


	Fair Value Measurement at December 31, 2010 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Unobservable inputs (Level 3)		Fair Value at December 31, 2010
	(RMB)		(RMB)		(RMB)		(RMB)

Available-for-sale investments		—		—		423,302,661		423,302,661


Total		—		—		423,302,661		423,302,661

F-64

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

26.

FAIR VALUE MEASUREMENT (CONT’D)

The following table summarizes the valuation of the available-for-sale investments:


	Amount
	(RMB)
Fair value of available-for-sale investment as at January 1, 2010		450,966,634
Unrealized gain in fair value of Series A Preferred Shares in MET (see Note 12)		(73,032	)
Unrealized loss in fair value of Series C Preferred Shares in 51.com (see Note 12)		(14,467,019	)
Transfer in and/or out of Level 3		—
Effect of exchange rate change		(13,123,922	)


Fair value of available-for-sale investment as at December 31, 2010		423,302,661

Unrealized loss in fair value of Series A Preferred Shares in MET (see Note 12)		4,893,132
Unrealized loss in fair value of Series C Preferred Shares in 51.com (see Note 12)		(20,890,689	)
Transfer in and/or out of Level 3
Effect of exchange rate change		(20,453,986	)


Fair value of available-for-sale investment as at December 31, 2011		386,851,118

Fair value of available-for-sale investment as at December 31, 2011 (US$)		61,464,453

The fair value of available-for-sale investment in Series C Preferred Share of 51.com as of December 31, 2010 and 2011 was estimated using an enterprise value allocation (“EVA”) model.

The EVA model requires inputs of highly subjective assumptions including the expected stock price volatility and the probability of occurrence under three different scenarios (which is based on management reasonable estimation), namely 1) an initial public offering occurs (“IPO”), 2) 51.com liquidates (“Liquidation”) and 3) 51.com’s preferred share are redeemed at maturity (“Redemption”). For the expected volatilities, the Company has made reference to historical volatilities of several comparable companies. The risk-free rate is based on the yield of U.S. Dollar China Sovereign Bond as of December 31, 2010 and 2011 with the term corresponding to the maturity of the preferred shares.

The fair value of the Series C Preferred Share of 51.com was estimated using the following assumptions:


	December 31,
	2010			2011

Risk-free interest rates		1.27	%		0.72	%
Expected volatility		38.04	%		50.92	%
Probabilities of different scenarios:
- IPO		50	%		25	%
- Liquidation		25	%		25	%
- Redemption		25	%		50	%

F-65

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

26.

FAIR VALUE MEASUREMENT (CONT’D)

The fair value of the 100% equity interest of 51.com was determined based on an independent valuation using an income approach.

In September 2009, the Company made an investment in MET’s Series A Preferred Shares with both redemption and conversion features. This investment is recognized as an available-for-sale investment and its fair value was estimated using an enterprise value allocation (“EVA”) model as of December 31, 2011.

The EVA model requires inputs of highly subjective assumptions including the expected stock price volatility and the probability of occurrence under three different scenarios (which is based on management reasonable estimation), namely 1) an initial public offering occurs (“IPO”), 2) MET liquidates (“Liquidation”) and 3) MET’s preferred share are redeemed at maturity (“Redemption”). For the expected volatilities, the Company has made reference to historical volatilities of several comparable companies. The risk-free rate is based on the yield of U.S. Dollar China Sovereign Bond as of December 31, 2011 with the term corresponding to the maturity of the preferred shares.

The fair value of the MET’s Series A Preferred Shares was estimated using the following assumptions:


	December 31,
	2010			2011

Risk-free interest rates		1.87	%		0.35	%
Expected volatility		61.71	%		52.36	%
Probabilities of different scenarios:
- IPO		50	%		—
- Liquidation		25	%		25	%
- Redemption		25	%		75	%

The fair value of the 100% equity interest of MET was determined based on an independent valuation using an income approach.

In accordance with ASC 820, the Company measures acquired intangible assets, goodwill and impairment of intangible assets at fair value. These assets are classified within Level 3 because they are valued using an income approach using discounted cash flows derived on management’s assumptions and estimates as further discussed in Notes 2.9, 2.10, and 7.

F-66

GIANT INTERACTIVE GROUP INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

For the years ended December 31, 2009, 2010 and 2011

26.

FAIR VALUE MEASUREMENT (CONT’D)

Assets measured at fair value on a non-recurring basis are summarized as below:


	Fair Value at December 31, 2010		Total impairment loss recognized for the year ended December 31, 2010		Fair Value at December 31, 2011		Total impairment loss recognized for the year ended December 31, 2011
	(RMB)				(RMB)		(RMB)

Acquired intangible assets-software		1,146,029		—		—		—
Goodwill		15,977,373		—		—		—
KOK 3 game software		—		46,557,669		—		—

The above impairment loss was included in “Impairment of intangible assets” in the consolidated statements of operations and comprehensive income.

27.

SUBSEQUENT EVENTS

Dividends

Pursuant to a Board of Director’s resolution dated February 24, 2012, the Company declared a dividend of approximately RMB447,000,000 (US$71,000,000), US$0.30 per share, paid out of the Company’s 2011 net distributable profits, which are determined using an equity method basis of accounting for the standalone listing company financial statements, to the shareholders of the Company who were registered members of the Company as of March 23, 2012. The payments of these dividends are financed out of available cash held by the Company, subsequent to the declaration of dividends to the Company by Zhengtu Information (Note 17). The dividends were paid on March 29 and April 5, 2012.

F-67