Annual Reports

 
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Shanda Interactive Entertainment 20-F 2010
Form 20-F
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 20-F
(Mark One)
     
o   REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
OR
     
o   SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number: 000-50705
 
SHANDA INTERACTIVE ENTERTAINMENT LIMITED
(Exact name of Registrant as specified in its charter)
 
N/A
(Translation of Registrant’s name into English)
Cayman Islands
(Jurisdiction of incorporation or organization)
No. 208 Juli Road
Pudong New Area
Shanghai 201203, People’s Republic of China

(Address of principal executive offices)
Grace Wu
Chief Financial Officer
Shanda Interactive Entertainment Limited
No. 208 Juli Road
Pudong New Area

Shanghai 201203, People’s Republic of China
Telephone: (86-21) 5050-4740
Fax: (86-21) 5080-5132

(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
2 ordinary shares, par value US$0.01 per share
  The NASDAQ Stock Market LLC
The NASDAQ Global Select Market
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: 134,862,854 ordinary shares, par value US$0.01 per share.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
þ Yes       o No
If this report is an annual or transaction report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
o Yes       þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þ Yes       o No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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).
o Yes       o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.:
         
þ Large accelerated filer   o Accelerated filer   o Non-accelerated filer
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing.
         
þ U.S. GAAP   o International Financial Reporting Standards as
issued by the International Accounting Standard Boards
  o 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.
o Item 17       o Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
o Yes       þ No
 
 

 

 


 

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 Exhibit 8.1
 Exhibit 12.1
 Exhibit 12.2
 Exhibit 13.1
 Exhibit 13.2
 Exhibit 15.1

 

 


Table of Contents

Introduction
CONVENTIONS WHICH APPLY TO THIS FORM
Except where the context otherwise requires and for purposes of this form only:
    “advanced casual game” refers to a more sophisticated sub-category of casual games which are generally less time consuming and require less focus and attention than MMORPGs but possess certain elements of MMORPGs including a story line, elaborate graphics, availability of virtual items and frequent interactions among game players;
    “expansion pack” refers to an addition to an existing game that usually includes new game areas, weapons, objects, and/or an extended story line to a complete and already released game;
    “Hongwen entities” refers to Qidian, Jinjiang, Hongxiu, Jushi, and Huawen Tianxia;
    “Hurray!’s affiliated music companies” refers to Hurray! Freeland Digital Music Technology Co., Ltd., Beijing Huayi Brothers Music Co., Ltd. (“Huayi Music”), Beijing New Run Entertainment Development Co., Ltd., Guangzhou Hurray! Secular Bird Culture Communication Co., Ltd., Seed Music Group Limited, Xifule (Beijing) Culture Broker Co., Ltd (“Xifule”) and Beijing Hurray! Fly Songs International Culture Co., Ltd.;
    “Hurray! entities” refers to Hurray! Media, Seed Music Group Limited, Seed Music Co. Ltd., Leguan Seed (Beijing) Culture Consulting Co., Ltd. and Beijing Hurray! Times and, when referring to the Hurray! entities on or after January 18, 2010, Ku6 (Beijing) Technology Co., Ltd. and WeiMoSanYi (Tianjin) Technology Co., Ltd.;
    “Hurray! Holding” refers to Hurray! Holding Co., Ltd., a Cayman Islands company. In June 2009, we entered into a tender offer agreement with Hurray! Holding under which we commenced a tender offer to acquire at least 51% of Hurray! Holding’s outstanding ordinary shares. The tender offer was successfully completed in July 2009. As of March 31, 2010, we owned approximately 42.0% of Hurray! Holding’s outstanding ordinary shares. Unless the context requires otherwise, “Hurray!” also refers to the Hurray! entities, Hurray!’s affiliated music companies, Invest China Group Limited, Hurray Technologies, Profita Publishing Ltd., Leguan Seed (Beijing) Culture Consulting Co., Ltd., Beijing Hand-in-Hand, Shanghai Fu Ming Information Technology, Hurray Digital Media, Huayi Brothers Music, Huayi Brothers Broker, Huayi! Freeland Culture, Wuxi New Run Digital Music, and, in the context of describing its operations, the Hurray! VIEs, and, when referring to Hurray! Holding on or after January 18, 2010, Ku6 Holding Limited;
    “Hurray! PRC subsidiaries” refers to Beijing Hurray! Times and Leguan Seed (Beijing) Culture Consulting Co., Ltd. and, when referring to the Hurray! entities on or after January 18, 2010, Ku6 (Beijing) Technology Co., Ltd. and WeiMoSanYi (Tianjin) Technology Co., Ltd;
    “Hurray! VIEs” refers to Hurray! Solutions Ltd. (“Hurray! Solutions”), Beijing WVAS Solutions Ltd., Beijing Enterprise Network Technology Co., Ltd., Beijing Palmsky Technology Co., Ltd., Beijing Hutong Wuxian Technology Co., Ltd., Shanghai Magma Digital Technology Co., Ltd., Beijing Hengji Weiye Electronic Commerce Co., Ltd., Shanghai Saiyu Information Technology Co., Ltd., Henan Yinshan Digital Network Technology Co., Ltd., Xifule and their subsidiaries, and, when referring to the Hurray! entities on or after January 18, 2010, Ku6 (Beijing) Information Technology Co. Ltd. (“Ku6 Information”), Tianjin Ku6 Zheng Yuan Information Technology Co., Ltd. (“Tianjin Ku6”) and their subsidiaries;
    “light casual games” refers to flash games without user-end software operated by Mochi Media, Inc. (“Mochi Media”) and online chess and board games operated by Hangzhou Bianfeng Networking Co., Ltd., (“Bianfeng”) and its subsidiaries;
    “MMORPG” refers to massively multi-player online role-playing game;
    “online game” refers to MMORPGs, advanced casual games, and light casual games;

 

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    “our PRC subsidiaries” refers to Shanda Computer, Shengqu, Shengting and the Hurray! PRC subsidiaries;
    “our PRC operating companies” refers to the Shanda Networking entities, the Shulong entities, the Hongwen entities and the Hurray! VIEs;
    the “Reorganization” refers to the reorganization effort which we commenced in 2008, resulting in the establishment of Shanda Games, Shanda Online and Shanda Literature;
    the “Separation” refers to our transfer effective July 1, 2008 of substantially all of our assets and liabilities related to the MMORPG and advanced casual game business to Shanda Games, and Shengqu’s transfer of substantially all of its assets and liabilities unrelated to the MMORPG and advanced casual game business to Shanda Computer and Shanda’s other entities;
    “Shanda Games” refers to Shanda Games Limited, a Cayman Islands company, and, unless the context requires otherwise, includes its subsidiaries, including Shanda Games Holdings (HK) Limited, Shanda Games International (Pte) Ltd., Shanda Games Technology (HK) Limited, Shanda Games Korean Investment Limited, Actoz Soft Co., Ltd., Shengqu Information Technology (Shanghai) Co., Ltd. (“Shengqu”), Shengji Information Technology (Shanghai) Co., Ltd. (“Shengji”), Lansha Information Technology (Shanghai) Co., Ltd., and, in the context of describing its operations, its VIEs, including the Shulong entities and Shanghai Hongli Digital Technology Co., Ltd., and, when referring to Shanda Games after December 31, 2009, Goldcool Holdings Limited, Goldcool Holdings (HK) Limited, Kuyin Software (Shanghai) Co., Ltd. and Mochi Media;
    “Shanda Interactive” refers to Shanda Interactive Entertainment Limited;
    “Shanda Literature” refers to Shanda Literature Corporation, a Cayman Islands company wholly-owned by us, and, unless the context requires otherwise, its subsidiaries, including Shanda Literature Limited (HK), Shengting Information Technology (Shanghai) Co., Ltd. (“Shengting”), and, in the context of describing its operations, also includes its VIEs, including Shanghai Hongwen Networking Technology Co., Ltd. (“Hongwen”), Shanghai Xuanting Entertainment Technology Co., Ltd. (“Qidian”), Jinjiang Literature City (“Jinjiang”, Hongxiu.com (“Hongxiu”), Tianjin Jushi Wenhua Book Distribution Co., Ltd. (“Jushi”) and Tianjin Huawen Tianxia Book Distribution Co., Ltd. (“Huawen Tianxia”);
    “Shanda Networking entities” refers to Shanda Networking, Nanjing Shanda, Shengfutong and Yichong;
    “Shanda Online” refers to Shanda Online International (HK) Limited, a Hong Kong company wholly-owned by us, and, unless the context requires otherwise, its subsidiaries, including Shanda Computer (Shanghai) Co., Ltd. (“Shanda Computer”), and, in the context of describing its operations, also includes its VIEs, including Shanghai Shanda Networking Co., Ltd. (“Shanda Networking”), Nanjing Shanda Networking Co., Ltd. (“Nanjing Shanda”), Shanghai Shengfutong Electronic Business Co., Ltd. (“Shengfutong”) and Shanghai Yichong Electronic Business Co., Ltd. (“Yichong”);
    “Shulong entities” refers to Shanghai Shulong Technology Development Co., Ltd. (“Shanghai Shulong”), Shanghai Shulong Computer Technology Co., Ltd. (“Shulong Computer”), Nanjing Shulong Computer Technology Co., Ltd. (“Nanjing Shulong”), Chengdu Aurora Technology Development Co., Ltd. (“Chengdu Aurora”), Chengdu Simo Technology Co., Ltd. (“Chengdu Simo”), Tianjin Youji Technology Co., Ltd. (“Tianjin Youji”) and Chengdu Youji Technology Co., Ltd. (“Chengdu Youji”);
    “VIEs” refers to variable interest entities;
    “VIE agreements” refers to a series of contractual arrangements between a PRC company, on the one hand, and its VIEs and their shareholders, on the other hand, including contracts relating to the provision of services, software licenses and equipment, and certain shareholder rights and corporate governance matters; and
    “we”, “us”, “our company” and “our” refer to Shanda Interactive Entertainment Limited, its predecessor entities and its consolidated subsidiaries and affiliates.

 

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FORWARD-LOOKING INFORMATION
This annual report on Form 20-F contains forward-looking statements that are based on our current expectations, assumptions, estimates and projections about us and our industry. All statements other than statements of historical fact in this form are forward-looking statements. These forward-looking statements can be identified by words or phrases such as “may”, “will”, “expect”, “anticipate”, “estimate”, “plan”, “believe”, “is/are likely to” or other similar expressions. The forward-looking statements included in this form relate to, among others:
    our goals and strategies;
    our future business development, financial condition and results of operations;
    our projected revenues, earnings, profits and other estimated financial information;
    expected changes in our margins and certain costs or expenditures;
    our plans to expand and diversify the sources of our revenues;
    expected changes in the respective shares of our revenues from particular sources;
    our plans for staffing, research and development and regional focus;
    our plans to launch new products and services, and their projected economic lifespans;
    our plans for strategic partnerships with other businesses;
    our acquisition and divestiture strategy, and our ability to successfully integrate past or future acquisitions with our existing operations and complete planned divestitures;
    competition in the relevant industries;
    the outcome of ongoing, or any future, litigation or arbitration;
    the outcome of our annual PFIC evaluation;
    the expected growth in the number of Internet and broadband users in China, growth of personal computer penetration and developments in the ways most people in China access the Internet;
    changes in PRC governmental preferential tax treatment and financial incentives we currently qualify for and expect to qualify for; and
    PRC governmental policies relating to media and the Internet and Internet content providers and to the provision of advertising over the Internet.
These forward-looking statements involve various risks and uncertainties. Although we believe that our expectations expressed in these forward-looking statements are reasonable, we cannot assure you that our expectations will turn out to be correct. Our actual results could be materially different from and worse than our expectations. Important risks and factors that could cause our actual results to be materially different from our expectations are generally set forth in the “Risk Factors” section of Item 3 and elsewhere in this annual report. 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. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date on which the statements are made or to reflect the occurrence of unanticipated events.

 

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EXCHANGE RATE INFORMATION
This annual report contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. For all dates and periods through December 31, 2008, exchange rates of Renminbi into U.S. dollars 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. For January 1, 2009 and all later dates and periods, the exchange rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board. These rates are provided solely for your convenience and 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 following table sets forth information concerning the exchange rates in Renminbi and U.S. dollars for the periods indicated.
                                 
    Renminbi per U.S. Dollar Noon Buying Rate  
    Average(1)     High     Low     Period End  
2005
    8.1826       8.2765       8.0702       8.0702  
2006
    7.9579       8.0702       7.8041       7.8041  
2007
    7.5806       7.8127       7.2946       7.2946  
2008
    6.9193       7.2946       6.7800       6.8225  
2009
    6.8295       6.8470       6.8176       6.8259  
                 
    Renminbi per U.S. Dollar Exchange Rate  
    High     Low  
December 2009
    6.8299       6.8244  
January 2010
    6.8295       6.8258  
February 2010
    6.8330       6.8258  
March 2010
    6.8270       6.8254  
April 2010
    6.8275       6.8229  
May 2010 (through May 14, 2010)
    6.8285       6.8245  
 
     
(1)   Annual averages are calculated using month-end rates.
On December 31, 2009, the daily exchange rate was RMB6.8259 to US$1.00. On May 14, 2010, the daily exchange rate was RMB6.8263 to US$1.00.
PART I
Item 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not Applicable
Item 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not Applicable
Item 3. KEY INFORMATION
A. SELECTED FINANCIAL DATA
The following selected consolidated statement of operations data for the three years ended December 31, 2009 and the consolidated balance sheet data as of December 31, 2008 and 2009 have been derived from our audited consolidated financial statements, which have been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, an independent registered public accounting firm. The report of PricewaterhouseCoopers Zhong Tian CPAs Limited Company on our consolidated financial statements as of December 31, 2008 and 2009 and for each of the three years in the period ended December 31, 2009 is included elsewhere in this annual report on Form 20-F.

 

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During the year ended December 31, 2009, the Company changed the manner in which it accounts for business combinations with the adoption of Accounting Standard Codification, or ASC, 805 (formerly referred to as SFAS No. 141 (revised 2007), “Business combination”), and retrospectively applied ASC 810 (formerly referred to as SFAS 160, “Non-controlling Interest in Consolidated Financial Statements — an amendment of ARB No. 51”) relating to presentation and disclosure of noncontrolling interest in consolidated subsidiaries and ASC 470-20 (formerly referred to as FSP APB14-1, “Accounting for Convertible Debt Instruments that may be settled in cash upon conversion (including partial cash settlement)” with respect to accounting for convertible debt. As a result, our selected consolidated statement of operations data for the years ended December 31, 2005 and 2006 and our consolidated balance sheets as of December 31, 2005, 2006 and 2007 have been revised from our previously audited consolidated financial statements, which are not included in this annual report on Form 20-F to give effect to those changes. 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” included elsewhere in this annual report on Form 20-F. 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.
                                                 
    For the year ended December 31, (1)  
    2005     2006     2007     2008     2009  
    (in thousands)  
    RMB     RMB     RMB     RMB     RMB     US$  
Consolidated Statements of Operations and Comprehensive Income Data
                                               
Net revenues
    1,896,611       1,654,460       2,467,265       3,569,068       5,240,799       767,781  
Cost of revenue
    (614,427 )     (689,805 )     (807,102 )     (1,020,470 )     (1,482,191 )     (217,142 )
Gross profit
    1,282,184       964,655       1,660,163       2,548,598       3,758,608       550,639  
Operating expenses
    (660,285 )     (587,023 )     (658,199 )     (1,106,315 )     (1,719,225 )     (251,868 )
Income from operations
    621,899       377,632       1,001,964       1,442,283       2,039,383       298,771  
Interest income and investment income
    23,127       97,104       535,622       80,771       113,652       16,650  
Interest expenses (1)
    (166,226 )     (174,653 )     (144,091 )     (30,023 )     (100,739 )     (14,758 )
Other income, net
    174,903       133,913       28,041       29,380       203,578       29,824  
Income before income tax expenses, equity in loss of affiliated companies
    653,703       433,996       1,421,536       1,522,411       2,255,874       330,487  
Income tax expenses
    (96,711 )     (36,489 )     (133,836 )     (276,471 )     (485,774 )     (71,166 )
Equity in loss of affiliated companies
    (544,268 )     (26,227 )     (15,503 )     (337 )     (50,545 )     (7,405 )
Net income
    12,724       371,280       1,272,197       1,245,603       1,719,555       251,916  
Net income attributable to non-controlling interests and redeemable preferred shares issued by a subsidiary
    4,825       767       (7,015 )     (16,929 )     (126,991 )     (18,604 )
Net income attributable to Shanda Interactive
    17,549       372,047       1,265,182       1,228,674       1,592,564       233,312  
                                                 
    For the year ended December 31, (1)  
    2005     2006     2007     2008     2009  
    (in thousands, except per share and per ADS data)  
    RMB     RMB     RMB     RMB     RMB     US$  
Earnings per Share Data:
                                               
Income attributable to Shanda Interactive
    17,549       372,047       1,265,182       1,228,674       1,592,564       233,312  
Earnings per share, basic
    0.12       2.61       8.83       8.59       11.86       1.74  
Earnings per share, diluted
    0.12       2.57       8.65       8.49       11.45       1.68  
Earnings per ADS, basic(2)
    0.24       5.22       17.66       17.18       23.72       3.48  
Earnings per ADS, diluted(2)
    0.24       5.14       17.30       16.98       22.90       3.36  

 

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    As of December 31, (1)  
    2005     2006     2007     2008     2009  
    (in thousands)  
    RMB     RMB     RMB     RMB     RMB     US$(1)  
Consolidated Balance Sheets Data:
                                               
Cash and cash equivalents
    949,622       1,291,901       1,985,302       3,397,844       10,959,313       1,605,548  
Working capital(3)
    2,742,420       1,087,633       2,133,422       3,355,817       11,733,987       1,719,039  
Total assets
    4,465,108       5,143,246       4,762,732       6,467,847       16,159,447       2,367,372  
Total liabilities
    2,535,739       2,591,981       923,017       2,348,053       3,012,172       441,286  
Redeemable preferred shares issued by a subsidiary
                      144,735       157,983       23,144  
Total Shanda Interactive shareholders’ equity
    1,925,980       2,548,355       3,623,417       3,831,029       11,546,023       1,691,502  
Non-controlling interests
    3,389       2,910       216,298       144,030       1,443,269       211,440  
Total shareholders’ equity
    1,929,369       2,551,265       3,839,715       3,975,059       12,989,292       1,902,942  
     
 
 
(1)   Reflects retrospective application of ASC 810 (formerly referred to as SFAS 160, “Non-controlling Interests in Consolidated Financial Statements-an amendment of ARB No. 51.”) and ASC 470 (formerly referred to as FSP APB 14-1, “Accounting for Convertible Debt Instruments that May be Settled in Cash upon Conversion (Including Partial Cash Settlement).”)
 
(2)   Each ADS represents two ordinary shares.
 
(3)   Working capital represents total current assets less total current liabilities.
B. CAPITALIZATION AND INDEBTEDNESS
Not applicable
C. REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable
D. RISK FACTORS
Risks Relating to Our Online Game Business
We depend substantially on Shanda Games’s online game business.
In 2008, we commenced a reorganization of our businesses, which included the transfer of substantially all of our assets and liabilities related to our MMORPG and advanced casual game businesses to a newly-established legal entity, Shanda Games. On September 30, 2009, Shanda Games completed its initial public offering of its ADSs on the NASDAQ Global Select Market. As of March 31, 2010, we owned approximately 71.6% of Shanda Games’s outstanding ordinary shares. We are dependent upon Shanda Games’s online game business for a substantial majority of our net revenues. In 2008 and 2009, Shanda Games’s business accounted for approximately 94.6% and 91.7%, respectively, of our net revenues. We expect to continue to derive a substantial majority of our net revenues from Shanda Games in the near term. Thus, our business prospects, financial condition and results of operations would be materially and adversely affected by any factor that contributes to a decline in revenues from Shanda Games.

 

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Shanda Games depends substantially on two MMORPGs, which accounted for approximately 75.9% and 78.2% of its net revenues in 2008 and 2009, respectively, and 71.6% and 71.4% of our net revenues in 2008 and 2009, respectively, and have finite commercial lifespans.
Mir II and Woool, which are two of Shanda Games’s MMORPGs, contributed approximately 55.3% and 20.6% of Shanda Games’s net revenues, respectively, in 2008 and 56.4% and 21.8% of Shanda Games’s net revenues, respectively, in 2009. In turn, Mir II and Woool contributed approximately 52.1% and 19.5% of our net revenues, respectively, in 2008 and 51.5% and 19.9% of our net revenues, respectively, in 2009. We expect Shanda Games to continue to derive a substantial majority of its net revenues from Mir II and Woool in the near term. Thus, our business prospects, financial condition and results of operations would be materially and adversely affected by any factor that contributes to a decline in revenues from Mir II or Woool, including:
    any reduction in purchases of virtual items by Mir II or Woool players;
    a decrease in the popularity of either game in China due to increased competition or other factors;
    the loss of its rights to operate either game due to a termination of a license or other reasons;
    failure to improve, update or enhance Mir II or Woool in a timely manner; or
    any lasting or prolonged server interruption due to network failures or other factors or any other adverse developments specific to Mir II or Woool.
For example, in December 2009, Shanda Games introduced an expansion pack in Mir II which was not well received by the game’s users and led to some of the game’s users ceasing to purchase in-game items. Primarily as a result of the introduction of that expansion pack, we expect that Shanda Games’s quarter over quarter revenues for the first quarter of 2010 will decrease and our financial results will be adversely affected. While Shanda Games has introduced an additional expansion pack which it believes will assist to reverse the decline in revenues from Mir II, it cannot be certain that this expansion pack will in fact, achieve this desired goal.
As with other online games, Mir II and Woool have finite commercial lifespans. Shanda Games believes that Mir II and Woool, which were launched in 2001 and 2003, respectively, are in the more mature stages of their commercial lifespans. While Shanda Games was able to reverse the decreasing trend in revenues from these two games with the adoption of the item-based revenue model in November 2005 and has since been able to continue to increase its revenues from both games, we cannot assure you that Shanda Games’s revenues from these games will not decline in the future. Shanda Games may also be able to extend the commercial lifespan of Mir II and Woool by enhancing, expanding and upgrading Mir II and Woool to include new features that appeal to existing players and attract new players. If Shanda Games is not able to extend the commercial lifespan of Mir II and Woool, our business prospects, financial condition and results of operations may be materially and adversely affected.
Shanda Games’s future success relies on developing and sourcing new online games.
To remain competitive, Shanda Games must continue to develop and source new online games that appeal to game players. Shanda Games develops and sources new online games through its multi-channel strategy, including in-house development, licensing, investments and acquisitions, co-development and co-operation. However, we cannot assure you that Shanda Games will be successful in executing such a strategy. If Shanda Games fails to do so, our business, financial condition, results of operations and business prospects would be materially and adversely affected. The following summarizes risks relating to Shanda Games’s multi-channel strategy.
    In-house development of new online games and introduction of expansion packs for Shanda Games’s existing online games.
Shanda Games must continue to successfully develop new online games in-house to expand its game portfolio and introduce updates and expansion packs, which are more substantial enhancements than updates, for its existing games to extend the commercial lifespan of its existing games.
Shanda Games’s ability to develop successful new online games in-house will largely depend on its ability to (i) anticipate and effectively respond to changing game player interests and preferences and technological advances in a timely manner, (ii) attract, retain and motivate talented online game development personnel and (iii) execute effectively its online game development plans. In-house development requires a substantial initial investment prior to the launch of a game, as well as a significant commitment of future resources to produce updates and expansion packs.
Shanda Games’s ability to introduce successful updates and expansion packs for its existing online games will also depend on its ability to collect and analyze user behavior data and feedback from the player community in a timely manner and to effectively incorporate features into its updates and expansion packs to improve the variety and attractiveness of its virtual items. We cannot assure you that Shanda Games will be able to collect and analyze game player behavior data on a timely basis or that such data will accurately reflect game player behavior.

 

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    Maintaining good relationships with its licensors, extending licenses for its existing licensed online games and licensing new online games.
Shanda Games licenses many of its online games, including some of its most popular games, from third parties. In 2008 and 2009, Shanda Games derived approximately 65.7% and 69.1% of its net revenues, respectively, from online games that were licensed from third parties. As of March 31, 2010, Shanda Games licensed nine of its 26 MMORPGs and five of its eight advanced casual games from other game developers. See “Business Overview — Shanda Games” section of Item 4B. Shanda Games must maintain good relations with its licensors to ensure the continued smooth operation of its licensed games. Additionally, Shanda Games depends upon its licensors to provide technical support necessary for the operation of the licensed games, as well as updates and expansion packs that help to sustain interest in games. Moreover, certain marketing activities often require the consent of its licensors. Finally, its licenses may be terminated upon the occurrence of certain events, such as a material breach by Shanda Games. Only some of its license agreements allow it to automatically extend the term of the license without renegotiating with the licensors. Shanda Games may want to extend a license upon its expiration but may not be able to do so on terms acceptable to it or at all. Its licensors may also demand new royalty terms that are unacceptable to it. Shanda Games’s ability to continue to license its online games and to maintain good relationships with its licensors also affects its ability to license new games developed by the same licensors.
    Investments in and acquisitions of other businesses that Shanda Games believes may benefit its business.
Shanda Games intends to continue to invest in or acquire other businesses that complement its business or games that it believes may benefit it in terms of game player base or game portfolio. For example, in January 2010, Shanda Games entered into agreements to purchase Goldcool Holdings Limited, or Goldcool, a Shanghai-based online game developer and operator, and Mochi Media, which operates a leading platform for distributing and monetizing browser-based games worldwide. However, Shanda Games’s ability to grow through investments and acquisitions will depend on the availability of suitable candidates at an acceptable cost and its ability to consummate such transactions on commercially reasonable terms, such as its acquisitions of Goldcool and Mochi Media, as well as its ability to obtain any required governmental approvals. The identification and completion of these transactions may also require it to expend significant management and other resources. Moreover, the benefits of an investment or acquisition may take considerable time to materialize, and we cannot assure you that any particular transaction will achieve the intended benefits. Future acquisitions could also expose Shanda Games to potential risks, including those associated with the integration of new operations, technologies and personnel, unforeseen or hidden liabilities, the inability to generate sufficient revenues to offset the costs and expenses of the acquisitions and potential loss of, or harm to, its relationships with employees, customers, licensors and other suppliers as a result of integration of new businesses.
    Sourcing of new online games through co-development and co-operation.
Shanda Games co-develops online games with international game developers. Shanda Games also co-operates certain games in China under nonexclusive licenses granted by third-party Chinese developers who also operate those same games on their own platform. Shanda Games must maintain good relations with its co-developers and co-operators to ensure the continued smooth development and operation of its co-developed and co-operated games. Shanda Games may incur significant cost overrun in game product development in its co-development arrangements. In addition, its newly co-developed games may not be well received by its game players. Shanda Games’s ability to co-develop and co-operate successful online games also depends on the availability of co-development and co-operation partner candidates.

 

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Shanda Games’s new games, such as AION, may not be commercially successful, and Shanda Games may fail to launch new games according to its timetable, or at all.
In order to remain competitive, Shanda Games must introduce new online games that are attractive to its game players and can generate additional revenues and diversify its revenue sources. The games in its announced pipeline only represent its current expectations. Shanda Games may not launch these games or, if launched, they may not be commercially successful. The performance of Shanda Games’s existing online games is not an indication of the future performance of any game it is currently developing. Although Shanda Games has launched several new online games in the past three years, none of these games individually has been able to contribute 10% or more of its net revenues annually. There are many factors that could adversely affect the popularity of Shanda Games’s new games, and if its new games are not commercially successful, it may not be able to recover its game sourcing or development costs, which can be significant. For example, in April 2009, Shanda Games launched AION, an MMORPG that it licensed from NCSoft Corporation, a leading South Korean game developer, operator and publisher. While the launch of AION has generated significant market attention, we cannot assure you that AION will be commercially successful or meet market expectations. The failure of new games such as AION to become commercially successful could adversely affect market confidence in Shanda Games’s and in turn our future growth prospects and result in a drop in the market price of our ADSs.
The timing of the launch of Shanda Games’s pipeline games is also critical to its business. We also cannot assure you these games will be launched based on their current timetables or at all. A number of factors, including technical difficulties, insufficient game development personnel, a lack of marketing or other resources or acceptance of or interest in the new games among game players during the testing phase and adverse developments in Shanda Games’s relationship with the licensors of its new licensed games, could result in delays in launching or prevent it from launching its new games at all. If Shanda Games fails to launch new games according to its timetable or at all, it may disappoint the game player base, fail to meet the targets for its anticipated financial and operating results or lose its market leadership position to its competitors, any of which may have a material adverse effect on our business, financial condition and results of operations.
Shanda Games’s new games may attract game players away from its existing games.
Shanda Games’s new online games may attract game players away from its existing games and shrink its existing games’ player base, which could in turn make those existing games less attractive to other game players, resulting in decreased revenues from its existing games. Players of its existing games may also spend less money to purchase virtual items in its new games than they would have spent if they had continued playing its existing games. In addition, its game players may migrate from its existing games with a higher profit margin to new games with a lower profit margin. The occurrence of any of the foregoing could have a material and adverse effect on our business, financial condition and results of operations.
Changes or adjustments Shanda Games makes to its existing or new games may not be well received by its game players.
As Shanda Games develops new online games or introduces updates and expansion packs to its existing games, it closely monitors its game players’ tastes and preferences and may introduce or change certain game features or game play styles to make its games more attractive. We cannot assure you that these changes or adjustments will be well received by its game players, who may decide not to play the new game or cease playing the existing game. For example, in December 2009, Shanda Games introduced an expansion pack in Mir II which was not well received by the game’s users and led to some of the game’s users ceasing to purchase in-game items. As a result, any changes or adjustments Shanda Games makes to existing or new games may adversely impact our revenues and business prospects.

 

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The revenue models Shanda Games adopts for its online games may not be suitable.
Shanda Games currently operates substantially all of its online games using the item-based revenue model and has generated, and expects to continue to generate, a substantial majority of its revenues using this revenue model. Under the item-based model, its game players can play games for free, but may choose to pay for in-game virtual items and other value-added services provided by Shanda Games to enhance the game-playing experience. Although Shanda Games has adopted the item-based revenue model for substantially all of its online games, it may not be the best revenue model for its games. The item-based revenue model requires Shanda Games to develop or license online games that not only attract game players to spend more time playing, but also encourage them to purchase virtual items. The sale of virtual items requires Shanda Games to track closely game players’ tastes and preferences, especially as to in-game consumption patterns. If Shanda Games fails to develop or offer virtual items which game players purchase, it may not be able to effectively convert its game player base into paying users. In addition, the item-based revenue model may cause additional concerns from PRC regulators who have been implementing regulations designed to reduce the amount of time that the Chinese youth spend on online games and intend to limit the total amount of virtual currency issued by online game operators and the amount purchased by an individual game player. A revenue model that does not charge for playing time may be viewed by the PRC regulators as inconsistent with this goal. Furthermore, Shanda Games may change the revenue model for some of its online games if it believes the existing revenue models are not optimal. We cannot assure you that the revenue model that Shanda Games has adopted for any of its online games will continue to be suitable for that game, or that Shanda Games will not in the future need to switch its revenue model or introduce a new revenue model for that 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 a game and would be adversely affected by such a change, decreases in the number of game players or decreases in the revenues Shanda Games generates from the online games, which could materially and adversely affect our business, financial condition and results of operations.
Shanda Games faces risks associated with the licensing of its games internationally, and if it is unable to effectively manage these risks, its ability to expand its business internationally could be impaired.
As of March 31, 2010, Shanda Games licensed 15 online games to game operators in a number of countries or regions. Shanda Games plans to further license its existing and new games in more countries and regions.
Licensing its games in international markets exposes Shanda Games to a number of risks, including:
    identifying and maintaining good relations with game operators who are knowledgeable in, and can effectively distribute and operate its games in, international markets;
    negotiating licensing agreements with game operators on terms that are commercially acceptable to Shanda Games and enforcing the provisions of those agreements;
    developing games, updates and expansion packs catering to overseas markets and renewing Shanda Games’s license agreements with game operators upon expiration;
    maintaining the reputation of Shanda Games and its games, given that its games are operated by game operators in the international markets with different standards;
    protecting Shanda Games’s intellectual property rights overseas and managing the related costs;
    auditing the royalties Shanda Games is entitled to receive;
    complying with the different commercial and legal requirements of the international markets in which Shanda Games’s games are offered, such as game import regulatory procedures, taxes and other restrictions and expenses; and
    managing foreign currency risks.
In addition, Shanda Games’s plan to continue to license its games in international markets may also be adversely affected by public opinion or government policies in markets in which it licenses its games. For example, South Korea requires online game operators, such as Actoz, to obtain ratings classifications for online games and implement procedures to restrict minors from accessing online games. More recently, the Ministry of Culture, Sports and Tourism in South Korea has enacted rules which require certain online game operators to automatically log off underage users of certain online games and to slow down the Internet speed for underage users who have been logged on continuously for too many hours. If Shanda Games is not able to license its games internationally as planned, our business, financial conditions and results of operations would be materially and adversely affected.

 

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Shanda Games’s business may be materially harmed if its online games are not featured prominently in a sufficient number of Internet cafes in China.
A substantial number of game players access Shanda Games’s games through Internet cafes in China. Due to limited hardware capacity, Internet cafes generally feature a limited number of games on their computers. Shanda Games thus competes with a growing number of online game operators to have its online games featured on these computers. This competition has intensified in China due to a nationwide suspension of approval for the establishment of new Internet cafes in 2007. See “— Risks Relating to Regulation of the Internet and to Our Structure — The PRC government has tightened its regulation of Internet cafes, which are currently one of the primary venues for Shanda Games’s users to play online games.” If Shanda Games fails to feature its games prominently and sufficiently in Internet cafes in China or fails to do so in a cost-effective manner, our business, financial condition and results of operations may be materially and adversely affected.
The growth of the online game industry and market acceptance of Shanda Games’s online games remains uncertain.
The growth of the online game industry and the level of demand and market acceptance of Shanda Games’s online games are subject to a high degree of uncertainty and will depend on factors beyond its control, including:
    the growth rate in the number of users of personal computers, Internet and broadband in China and other markets in which Shanda Games’s online games are offered;
    whether the online game industry, particularly in China and the rest of the Asia-Pacific region, continues to grow and the rate of any such growth;
    changes in consumer demographics, tastes or preferences;
    the popularity and price of new online games and virtual items that Shanda Games and its competitors launch and distribute;
    Shanda Games’s ability to timely upgrade and improve its existing games to extend their commercial lifespan and to maintain or expand their market share in the online game industry;
    the availability and popularity of other forms of entertainment, particularly console system games such as those made by Microsoft, Nintendo and Sony, which are popular in many other countries and are becoming increasingly popular in China and other countries or regions in which Shanda Games markets its online games; and
    general economic conditions, particularly economic conditions that impact the level of discretionary consumer spending.
Shanda Games’s ability to plan for product development and distribution and promotional activities will be significantly affected by its ability to anticipate and adapt to relatively rapid changes in consumer tastes and preferences. 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 MMORPGs that Shanda Games operates, would adversely affect our business prospects and results of operations. Shanda Games must be able to track and respond to these changes in game players’ preferences in a timely and effective manner. Furthermore, given that the item-based revenue model relies on in-game purchases, Shanda Games must be able to track and respond quickly to changes in game preferences and consumer spending trends.
Shanda Games may not be able to adapt to the rapidly evolving online game industry in China.
China’s online game industry is rapidly evolving. Shanda Games must adapt to new industry trends, including changes in game players’ preferences, new revenue models, new game content distribution models, new technologies and new governmental regulations. Shanda Games strives to adapt its business in response to evolving trends and operations in order to maintain and strengthen its leadership in the industry. However, we cannot assure you that Shanda Games will be able to do so successfully, which may have a material adverse effect on our business, financial condition and results of operations.

 

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Shanda Games faces significant competition in the online game industry in China.
The online game industry in China is increasingly competitive. In recent years, numerous competitors have entered the online game industry in China. We expect more companies to enter the market and we expect a wider range of online games to be introduced to China. Competition from other online game operators, both based in China as well as overseas, is likely to increase in the future. Other online game operators or developers, such as China-based Changyou.com Limited, Giant Interactive Group, Inc., Kingsoft Corporation Limited, or Kingsoft, NetDragon Websoft Inc., NetEase.com, Nineyou International Limited, Perfect World Co., Ltd., Tencent Holdings Limited, and The9 Limited, as well as international game developers, such as Blizzard Entertainment, Inc., Electronic Arts Inc., NCSoft Corporation, Nexon Corporation, NHN Corp. and Webzen, Inc., are Shanda Games’s current or potential future competitors. As the online game industry in China is constantly evolving, Shanda Games’s current or future competitors may compete more successfully as the industry matures. In particular, any of these competitors may offer products and services that provide significant performance, price, creativity or other advantages over those offered by Shanda Games. These products and services may weaken Shanda Games’s brand name and achieve greater market acceptance than those of Shanda Games. In addition, at or around the time when Shanda Games launches its new MMORPGs or advanced casual games, competitors may launch similar games, which may compete with Shanda Games’s games for potential game players. Furthermore, any of Shanda Games’s current or future competitors may be acquired by, receive investments from or enter into other strategic or commercial relationships with, larger, more established and better financed companies and therefore obtain significantly greater financial, marketing and game licensing and development resources than Shanda Games has. In addition, increased competition in the online game industry in China could make it difficult for Shanda Games to retain existing players and attract new players. Moreover, Shanda Games may face competition from console games that have achieved significant success in markets other than China but have yet to be permitted to be sold in China due to regulatory and other reasons. If these game consoles, many of which are strengthening their online game features, are permitted to be sold in China, Shanda Games would face additional competition. Shanda Games also competes with other forms of entertainment, such as television and movies. If Shanda Games is unable to compete effectively, our business, financial condition and results of operations would be materially and adversely affected.
If Shanda Games fails to anticipate or successfully implement new technologies, its games may become obsolete or uncompetitive.
The online game industry is subject to rapid technological change. Shanda Games must anticipate the emergence of new technologies and assess their market acceptance. In addition, government authorities or industry organizations may adopt new standards that apply to game development. Shanda Games also must invest significant financial resources in product development to keep pace with technological advances. However, development activities are inherently uncertain, and Shanda Games’s significant expenditures on technologies may not generate corresponding benefits. If Shanda Games falls behind in adopting new technologies or standards, its existing games may lose popularity, and its newly developed games may not be well received by its game players. In addition, Shanda Games may incur significant cost overruns in product development, which could materially and adversely affect our business, financial condition and results of operations.
Shanda Games’s online games may contain errors or defects and are susceptible to cheating programs.
Shanda Games’s online games may contain errors or other defects. In addition, parties unrelated to it have developed, and may continue to develop, Internet cheating programs that enable game players to obtain unfair advantages over other game players who do not use such programs. Furthermore, certain cheating programs could cause the loss of a character’s superior features acquired by a player. The occurrence of errors or defects in Shanda Games’s online games or its failure to discover and disable cheating programs affecting the fairness of its game environment could disrupt its operations, damage its reputation and discourage players from playing its games. As a result, such errors, defects and cheating programs could materially and adversely affect our business, financial condition and results of operations.

 

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Risks Related to Shanda Online
Our company’s content providers depend on Shanda Online to provide services that are critical to our business.
Many of our company’s content providers, including Shanda Games, have engaged Shanda Online to provide certain integrated platform services. These content providers depend on Shanda Online for the provision of services that are critical to the operation of their businesses, including, among others, online billing and payment, customer service, user authentication, pre-paid card marketing and distribution and data support service. If Shanda Online breaches its obligations under the contractual arrangements to provide such service to any of our content providers, or refuses to renew these service agreements on terms acceptable to any of our content providers, or at all, our content providers may not be able to find a suitable alternative service provider or establish its own integrated service platform in a timely manner. Similarly, any failure of or significant quality deterioration in Shanda Online’s integrated service platform could materially and adversely affect our content providers’ businesses. For example, some of our company’s content providers rely on Shanda Online’s customer service representatives as the first point of contact to serve their users. Shanda Online handles such customer requests such as adding virtual currencies to accounts with pre-paid cards, retrieving forgotten passwords and recovering lost user accounts, and liaising with our content providers, for example to Shanda Games’s game management team if the inquiries involve game-related technical problems, such as recovering virtual items and in-game characters. Our content providers also rely on Shanda Online to provide user authentication services for their users who access their content through Shanda Online’s service platform, and for pre-paid card distribution. If Shanda Online fails to address customer service requests properly and in a timely manner, our users may be unable to access our content or attribute any unpleasant experience with Shanda Online’s customer service to our content providers or to us. Any negative impact to our reputation could lead to Shanda Online failing to retain current or failing to attract new users or content providers, in which case, our business, financial condition and results of operations could be materially and adversely affected.
Because Shanda Online offers its services to third-party content providers, our users may consume less of our internal content.
Shanda Online provides integrated services to third-party content providers that compete with our company’s content providers and may enter into additional similar commercial relationships with other content providers. These commercial relationships may strengthen these third-parties’ market shares and enable them to achieve market acceptance for their products and services, which may have a material adverse effect on our company’s content providers’ business. For example, the online games that Shanda Games’s competitors offer through Shanda Online’s integrated services platform may attract away players of Shanda Games’s online games and shrink its player bases. Furthermore, even though Shanda Online charges service fees to these third-party content providers, if Shanda Games’s current users spend money on its competitors’ games which are offered through Shanda Online’s integrated services platform that would otherwise have been spent on Shanda Games’s online games, our business, financial conditions and results of operations could be materially and adversely affected.
We could be liable for failure of, disruptions in, or third-party breaches of security of Shanda Online’s online payment platform.
Currently, many of our content providers rely on Shanda Online’s integrated service platform’s online payment system to sell virtual pre-paid cards to our users. Secured transmission of confidential information, such as our users’ credit card numbers and expiration dates, personal information and billing addresses, over public networks is essential to maintaining consumer confidence in such payment channels, which allow our content providers to collect payments on a timely basis. In addition, we expect that an increasing amount of the sales of pre-paid cards will be conducted over the Internet as a result of the growing use of online payment systems. As a result, associated online crime will likely increase as well and we cannot assure you that Shanda Online’s current security measures and those of the third parties with whom Shanda Online transacts business, are adequate. Security breaches of these online payment systems could result in non-collection of payments and expose Shanda Online or us to litigation and possible liability for failing to protect confidential game player information, which could harm Shanda Online’s reputation and its ability to attract users to its platform.

 

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Shanda Online relies on third-party distributors to maintain a stable and efficient distribution and payment network.
Online payment systems in China are at a developmental stage and are not as widely available or acceptable to consumers in China as in the United States. As a result, Shanda Online relies heavily on a multi-layer distribution and payment network comprised of third-party distributors for sales to, and collection of payment from, our users. As Shanda Online does not enter into long-term agreements with any of its distributors, we cannot assure you that Shanda Online will continue to maintain favorable relationships with them. Shanda Online also relies on third-party distributors to distribute pre-paid cards to users which allow access to our online entertainment content. Shanda Online typically offers discount pricing rates to distributors based on different factors. If Shanda Online fails to maintain a stable and efficient distribution and payment network, or the discount rates it pays to distributors were to increase, our business, financial condition and results of operations could be materially and adversely affected.
Shanda Online’s business may be affected by network interruptions, capacity shortfalls, security breaches or computer viruses.
Any failure to maintain the satisfactory performance, reliability, security and availability of Shanda Online’s network infrastructure, including as a result of natural disasters such as earthquakes and floods, may cause significant harm to Shanda Online’s reputation and its ability to attract and maintain users. Shanda Online maintains a distributed server network architecture with third-party service providers hosting servers in more than one hundred cities throughout China. Shanda Online does not maintain full backup for its server network hardware.
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 Shanda Online’s servers, including failures which may be attributable to sustained power shutdowns, or efforts to gain unauthorized access to its systems causing loss or corruption of data or malfunctions of software or hardware;
    any unanticipated surge in users or inability to support content resulting in an overload to Shanda Online’s server network which may cause interruptions to the service; and
    any disruption or failure in the national backbone network, which would prevent our users outside Shanghai from logging on to any of our content, for which the servers are all located in Shanghai.
In the past, Shanda Online’s 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. Shanda Online’s network systems are also vulnerable to damage from fire, flood, power loss, telecommunications failures, computer virus, hackings and similar events. Any network interruption or inadequacy that causes interruptions in the availability of the online entertainment content on its service platform or deterioration in the quality of access to Shanda Online’s online entertainment content could reduce its users’ satisfaction. In addition, any security breach caused by hacking, which involves 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 Shanda Online’s business, financial condition and results of operations. Shanda Online does not maintain insurance policies covering losses relating to its systems and it does not have business interruption insurance.

 

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The successful operation of Shanda Online’s business and implementation of its growth strategies, including its ability to accommodate additional content providers and users in the future, depend upon the performance and reliability of the Internet infrastructure and fixed line and wireless telecommunications networks in China.
Although there are private sector Internet service providers in China, almost all access to the Internet is maintained through state-owned telecommunications operators under the administrative control and regulatory supervision of the Ministry of Industry and Information Technology, or the MIIT. Shanda Online relies on this infrastructure to provide data communications capacity primarily through local telecommunications lines and wireless telecommunications networks. In addition, the national networks in China are connected to the Internet through international gateways controlled by the PRC government. These international gateways are the only channels through which a domestic user can connect to the Internet. Although the PRC government has announced plans to develop aggressively the national information infrastructure, Shanda Online cannot assure you that this infrastructure will be developed as planned or at all. In addition, Shanda Online has no access to alternative networks and services on a timely basis, if at all, in the event of any infrastructure disruption or failure. The Internet infrastructure in China may not support the demands necessary for the continued growth in Internet usage.
Shanda Online relies on Shanda Games for substantial portion of its revenues.
Shanda Online operates its integrated services platform through the Shanda Networking entities, including Shanda Networking, Nanjing Shanda, Shengfutong and Yichong which entered into a cooperation agreement with the Shulong entities, VIEs of Shanda Games, to provide certain online e-commerce platform services to Shanda Games for a period of five years commencing on July 1, 2008. Shanda Games has agreed to pay the Shanda Networking entities an amount equal to the difference between (x) the amount Shengfutong receives from distributors or users from the sale of the pre-paid cards and (y) a fixed percentage of the face value of a pre-paid card as agreed upon between Shanda Networking, Nanjing Shanda and Shanda Games. See “—Our company’s content providers depend on Shanda Online to provide services that are critical to our business.” This cooperation agreement is the source of a significant portion of Shanda Online’s revenues. If Shanda Games were to decide to not renew this agreement for any number of reasons, including user dissatisfaction with Shanda Online’s services, it could have a material adverse effect on our business, financial condition and results of operations.
Use of Shanda Online’s services for illegal purposes could harm its business.
The law relating to the liability of providers of online services for the activities of their users on their service is often challenged in the PRC and internationally. In violation of our policies, unlawful goods and stolen goods have been listed and traded on our services. Shanda Online may be unable to prevent our users from selling unlawful or stolen goods or unlawful services or selling goods or services in an unlawful manner, and it may be subject to allegations of civil or criminal liability for unlawful activities carried out by users through our services. The PRC government has also raised concerns about the use of online services for gambling, money laundering and illicit trade. See “— Risks Relating to Regulation of the Internet and to Our Structure — The PRC government may prevent us from distributing, and we may be subject to liability for, content deemed to be inappropriate.”
Although Shanda Online has prohibited the listing of stolen goods and certain high-risk items and implemented other protective measures, it may be required to spend substantial resources to take additional protective measures or discontinue certain service offerings, any of which could harm its business. Any costs incurred as a result of potential liability relating to the alleged or actual sale of unlawful goods or the unlawful sale of goods could harm its business. In addition, Shanda Online may receive media attention relating to the listing or sale of unlawful goods and stolen goods using our services. This negative publicity, even if factually incorrect, could damage its reputation, diminish the value of its brand names and make users reluctant to use its services. Shanda Online’s payment system is also susceptible to potentially illegal or improper uses. These may include illegal online gambling, fraudulent sales of goods or services, illicit sales of prescription medications or controlled substances, piracy of software and other intellectual property, money laundering, bank fraud, child pornography trafficking, prohibited sales of alcoholic beverages or tobacco products, and online securities fraud. Recent changes in law have increased the penalties for intermediaries providing payment services for certain illegal activities. Despite measures it has taken to detect and lessen the risk of this kind of conduct, including its ability to take legal action to recover its losses for certain violations of its acceptable use policy, illegal activities could still be funded using Shanda Online. Any resulting claims or liabilities could adversely affect our business.

 

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Shanda Online is dependent on the business performance of its content provider customers.
Shanda Online generates revenue from services it provides to both our company’s content providers and third-party content providers. The amount of services Shanda Online provides to these content providers is dependent on the amount of services that their users demand. The failure to secure new key customers, the loss of key customers or the occurrence of significant reductions in sales from a key customer would cause Shanda Online’s revenues to decrease and could have a material adverse effect on our business, financial condition and results of operations.
Shanda Online’s business is subject to online security risks, including security breaches and identity theft.
To succeed, online commerce and communications must provide a secure transmission of confidential information over public networks. Shanda Online’s security measures may not detect or prevent security breaches that could harm its business. Currently, a significant number of its users authorize it to bill their credit card accounts directly for all transaction fees charged by it. Its users routinely provide credit card and other financial information. Shanda Online relies on encryption and authentication technology licensed from third parties to provide the security and authentication to effectively secure transmission of confidential information, including customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect transaction data. In addition, any party who is able to illicitly obtain a user’s password could access the user’s transaction data. An increasing number of websites have reported breaches of their security. Any compromise of its security could harm Shanda Online’s reputation and business, and could result in a violation of applicable privacy and other laws. In addition, a party that is able to circumvent our security measures could misappropriate proprietary information, cause interruption in its operations, damage its computers or those of its users, or otherwise damage its reputation and business. Under credit card rules and its contracts with its card processors, if there is a breach of credit card information that it stores, or that is stored by PayPal’s direct credit card processing customers, Shanda Online could be liable to the credit card issuing banks for their cost of issuing new cards and related expenses. In addition, if Shanda Online fails to follow credit card industry security standards, even if there is no compromise of customer information, it could incur significant fines or loose its ability to give customers the option of using credit cards to fund their payments or pay their fees. If Shanda Online were unable to accept credit cards, our business would be seriously damaged.
Shanda Online’s servers are also vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, and it has experienced “denial-of-service” type attacks on our system that have made all or portions of its website unavailable for periods of time. Shanda Online may need to expend significant resources to protect against security breaches or to address problems caused by breaches. These issues are likely to become more difficult as it expands the number of places where it operates. Security breaches, including any breach by Shanda Online or by parties with which it has commercial relationships that result in the unauthorized release of its users’ personal information, could damage its reputation and expose it to a risk of loss or litigation and possible liability.
Shanda Online’s users, as well as those of other prominent Internet companies, have been and will continue to be targeted by parties using fraudulent “spoof” and “phishing” emails to misappropriate passwords, credit card numbers, or other personal information or to introduce viruses through “trojan horse” programs to its users’ computers. These emails appear to be legitimate emails sent by Shanda Online or a user of one of those businesses, but direct recipients to fake websites operated by the sender of the email or request that the recipient send a password or other confidential information via email or download a program. Despite its efforts to mitigate “spoof” and “phishing” emails through product improvements and user education, “spoof” and “phishing” remain a serious problem that may damage the “Shanda” brand, discourage use of the Shanda Online website, and increase its costs.
System failures could harm Shanda Online’s business.
Shanda Online has experienced system failures from time to time, and any interruption in the availability of its website will reduce its current revenues and profits, could harm its future revenues and profits, and could subject it to regulatory scrutiny. Frequent or persistent interruptions in its services could cause current or potential users to believe that its systems are unreliable, leading them to switch to its competitors or to avoid its site, and could permanently harm its reputation and brands. Additionally, because Shanda Online’s customers may use its products for critical transactions, any system failures could result in damage to its customers’ businesses. These customers could seek significant compensation from Shanda Online or us for their losses. Even if unsuccessful, this type of claim likely would be time consuming and costly to address.

 

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Although Shanda Online’s systems have been designed around industry-standard architectures to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, computer viruses, computer denial-of service attacks, and similar events. Some of its systems are not fully redundant, and its disaster recovery planning is not sufficient for all eventualities. Shanda Online’s systems are also subject to break-ins, sabotage, and intentional acts of vandalism. Despite any precautions it may take, the occurrence of a natural disaster, a decision by any of its third-party hosting providers to close a facility it uses without adequate notice for financial or other reasons, or other unanticipated problems at its hosting facilities could result in lengthy interruptions in its services.
Customer complaints or negative publicity about customer support or anti-fraud measures could diminish use of Shanda Online’s services.
Customer complaints or negative publicity about our customer support could severely diminish consumer confidence in and use of its services. Measures Shanda Online sometimes takes to combat risks of fraud and breaches of privacy and security have the potential to damage relations with its customers or decrease activity on its sites by making its sites more difficult to use or restricting the activities of certain users. These measures heighten the need for prompt and accurate customer support to resolve irregularities and disputes. Effective customer support requires significant personnel expense, and this expense, if not managed properly, could significantly impact our profitability. Failure to manage or train our customer support representatives properly could compromise our ability to handle customer complaints effectively. If Shanda Online does not handle customer complaints effectively, its reputation may suffer and it may lose its customers’ confidence.
Because Shanda Online provides a financial service and operates in a highly regulated environment, it must provide telephone as well as email customer support and must resolve certain customer contacts within relatively short time frames. As part of Shanda Online’s program to reduce fraud losses and prevent money laundering, it may temporarily restrict the ability of customers to withdraw their funds if such funds or the customer’s account activity are identified by Shanda Online’s risk models as suspicious. If Shanda Online is unable to provide quality customer support operations in a cost-effective manner, its users may have negative experiences, it may receive additional negative publicity, its ability to attract new customers may be damaged, and it could become subject to litigation. Negative publicity about, or negative experiences with, customer support for Shanda Online could cause its reputation to suffer or affect consumer confidence in the “Shanda” brand as a whole.
Risks Related to Our Other Businesses
The risk factors set forth below are believed to be important in that they may have a material impact upon the future financial performance of our other businesses, including Shanda Literature and Hurray!. For more information on the contribution of those business to our company’s financial results, see Item 5. Operating and Financial Review and Prospects.
Shanda Literature faces the risks of uncertainties regarding the growth of the online literature industry and market acceptance.
Shanda Literature operates an online-reading website where users can read literature published on the Internet. The online literature business is a relatively new and evolving industry and concept. Shanda Literature is dependent on authors using its various online platforms, as opposed to the traditional paperback format, to publish their literary works. As reading literary works online represents a new means of reading literary works, Shanda Literature cannot be certain that its users will prefer to read literary works online as opposed to the traditional paperback form. In addition, Shanda Literature cannot be certain that the authors will prefer to publish their literary works online on one of its literature platforms, as opposed to in paperback form. The failure of authors to publish, and its users to read, literary works online will likely adversely affect Shanda Literature’s business and prospects.
Shanda Literature’s business is dependent on its authors.
The literary works published on Shanda Literature’s online literature platforms are written by independent authors, including a small percentage of whom are responsible for a substantial amount of its revenues. Most of these authors are not bound by exclusivity restrictions. Shanda Literature has also recently begun contracting with popular offline authors to produce online content. If Shanda Literature is unable to retain its most popular authors or if those authors or its offline authors do not produce content that is appealing to its users, the revenues and profitability of Shanda Literature could by materially and adversely affected.
Pirated versions of copyrighted content on Shanda Literature may be viewable through other websites.
Pirated copies of literature works that are licensed to Shanda Literature are often posted on third-party websites. Unauthorized and pirated copies of Shanda Literature’s content may reduce the revenue it generates. Shanda Literature has taken, and will continue to take, a variety of actions to combat piracy. For example, in March 2010, Shanda Literature filed a copyright infringement case against Baidu, alleging that pirated copies of five of its novels could be viewed through links in Baidu search results and on a Baidu message board service. There can be no assurance that Shanda Literature’s efforts to enforce its rights and protect its intellectual property will be successful in preventing content piracy. Furthermore, litigation in China is generally expensive and time consuming and the amount of damage rewards are low in comparison to those in the United States and other developed countries.
Changes in Shanda Literature’s contracts with China’s telecommunications operators or the policies of the telecommunications operators could harm its business.
Shanda Literature has begun to offer wireless value-added services (“WVAS”) which allow its users to read literature it publishes over mobile networks. Shanda Literature’s WVAS business is subject to the risk that (i) it may not be able to successfully negotiate favorable terms with the three principal telecommunications operators in China, China Mobile Communications Corporation, or China Mobile, China United Telecommunications Corporation, or China Unicom, and China Telecommunications Corporation, or China Telecom (together, the “telecommunications operators”) and their provincial affiliates, (ii) the MIIT or the telecommunications operators may unilaterally change their policies and/or the enforcement of their current policies or (iii) the telecommunication operators may impose higher service or network fees on it, any of which could have a material and adverse effect on Shanda Literature’s revenues and profitability.

 

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Hurray! depends on China Mobile, China Unicom and China Telecom, the three principal telecommunications network operators in China, for the major portion of its revenue.
Hurray! offers its services over mobile networks to consumers through the telecommunications operators. These principal operators service the major portion of China’s approximately 747 million mobile phone subscribers as of December 31, 2009, according to the 2009 Statistic Bulletin on National Telecommunication Industry issued by China’s Ministry of Industry and Information Technology, or the MIIT. Hurray!’s agreements with these operators and their provincial affiliates are non-exclusive and have a limited term (generally one year for China Mobile and one or two years for China Unicom). Hurray! usually renews these agreements or enter into new ones when the prior agreements expire, but occasionally the renewal or new agreements can be delayed by periods of one month or more. In 2008, China Telecom and its provincial affiliates entered into new agreements with Hurray! in connection with the network assets that they acquired from China Unicom (as discussed below).
If any of China Mobile, China Unicom or China Telecom ceases to continue to cooperate with Hurray!, it would be impossible to find appropriate replacement telecommunications operators with the requisite licenses and permits, infrastructure and customer base to offer Hurray!’s WVAS to customers of such telecommunications operator. Hurray! derived approximately 50% of its combined WVAS revenue from China Mobile, 25% from China Unicom, and 21% from China Telecom in 2009.
In addition, the Chinese government has extensive involvement in determining the structure of the telecommunications industry in China. During the development of this industry, changes in government policy have resulted in major restructurings of the telecommunications operators, including the establishment of new operators and the combination of all or part of existing operators. In an effort to promote greater competition among the telecommunications operators and foster the development of 3G mobile networks, on May 24, 2008, the MIIT, the PRC National Development and Reform Commission, or the NDRC, and the PRC Ministry of Finance jointly issued the Notice on Strengthening the Reform of Telecommunications Systems, or the Telecommunications Notice, which aims to consolidate China’s existing telecommunications operators into three new telecommunications operators that can offer both mobile and fixed-line services. Under the Telecommunications Notice, China Mobile merged with China Railway Communication Co., Ltd., which operated a national fixed-line network, China Telecom acquired the Code Division Multiple Access (CDMA) wireless business and network from China Unicom, and China Unicom, which operates a Global System for Mobile communications (GSM) network and business, merged with China Netcom, which was principally a fixed-line operator. Due to the restructuring, Hurray!’s services to China Telecom have increased and its services to China Unicom have decreased beginning from October 1, 2008, the date that China Telecom officially acquired the CDMA wireless business and network from China Unicom. On January 7, 2009, the MIIT issued 3G licenses to China Mobile, China Unicom and China Telecom. China Mobile operates the TD-SCDMA network, China’s self-developed 3G standard, China Unicom operates the WCDMA, a 3G standard originally developed in Europe, and China Telecom operates CDMA2000, a 3G standard originally developed in the U.S.
Any future significant restructuring of any segment of the telecommunications industry in China, including in particular China Mobile, China Unicom or China Telecom (which are collectively referred to hereinafter in this annual report on Form 20-F as the “telecommunications operators”) or any other telecommunications operators in China and the potential combination of the mobile operations of various telecommunications operators in China, could significantly affect Hurray!’s relationships with these telecommunications operators. Due to Hurray!’s reliance on the telecommunications operators for its WVAS, any loss or deterioration of its relationships with them, due to their own business decisions or government-imposed restructurings, may result in severe disruptions to its business operations and the loss of a significant portion of revenue.

 

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Hurray! may not be able to successfully negotiate favorable terms with the telecommunications operators and their provincial affiliates.
Given the dominant market position of China Mobile, China Unicom and China Telecom, Hurray!’s leverage with these telecommunications operators is limited in terms of negotiating agreements, resolving disputes or otherwise. In particular, its agreements with them can be terminated in advance, penalties may be imposed or other parts of its services may be suspended or terminated, and approval for its new services may be delayed for a variety of reasons which vary among the individual agreements with the telecommunications operators, including, for example, if Hurray! breaches its obligations under the agreements, a high number of customer complaints are made about its services or it cannot satisfy the operational or financial performance criteria established by the applicable telecommunications operator.
Hurray! may also be compelled to alter its agreements with these telecommunications operators in ways which adversely affect its business, such as by limiting the services it can offer or imposing other changes that limit the revenue it can derive from such agreements. In the past, telecommunications operators have entered into new contracts in certain provinces with service providers which change the share percentages it retained for customer payments. The percentage of the payments from customers received by service providers has been decreasing since 2006. Hurray! may not be able to adequately respond to any such changes because it is not able to predict whether the telecommunications operators will unilaterally amend its contracts with them.
Unilateral changes in the policies of the MIIT and the telecommunications operators and in their enforcement of their policies have resulted in service suspensions and Hurray! having to pay additional charges to the telecommunications operators.
The MIIT and the telecommunications operators have a wide range of policies and procedures regarding customer service, quality control and other aspects of the WVAS industry. As the industry has evolved over the last several years, the telecommunications operators have refined these policies to improve overall service quality and increase customer satisfaction. For example, in May 2007, China Mobile began the operational practice of displaying service fee reminders and seeking express confirmation prior to processing the wireless application protocol (“WAP”) page download requests of mobile phone users. China Mobile also began the practice of only including links to its own WVAS offerings on the embedded menus of certain mobile handsets with customized software for China Mobile users. In the past, such embedded menus featured links to all popular products offered on China Mobile’s networks, including Hurray!’s products.
In August 2007, MIIT introduced new policies regarding WVAS that mobile phone users subscribe to on a free trial basis. Service providers are now required to notify such mobile phone users once the free trial period ends and must obtain confirmation from them prior to charging them for continued subscription to the services. Upon obtaining such confirmation, service providers are then required to notify mobile phone users of the exact pricing for such service and send billing reminders to them.
In November 2009, the telecommunications operators suspended the ability of their WAP service partners to charge for services in an effort to eradicate mobile pornography from their networks. The suspension applied to all of the telecommunications operators’ WAP service partners in China, regardless of a partner’s propensity to disseminate pornography. The telecommunications operators have not yet indicated how long their suspensions would last or whether they will expand current measures. These measures may bring pressure on the WVAS market in China and add to uncertainty of Hurray!’s WVAS operation in the coming quarters.
In addition, in the last several years, acting under the guidance of the MIIT, the telecommunications operators have been enforcing their customer service policies more rigorously than in the past and have initiated steps to improve customer service. This rigorous enforcement has resulted in a number of severe penalties imposed on Hurray! and other participants in the market in recent years. Penalties have included precluding service providers from offering certain services over a mobile operator’s network or from offering new services for a fixed period.

 

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Hurray! may not be able to adequately respond to these or other developments in mobile operator policies, or changes in the manner in which such policies are enforced. Furthermore, because the telecommunications operators’ policies are in a state of flux at this time and they are highly sensitive to customer complaints (even if the complaints have no merit), we cannot be certain that Hurray!’s business activities will always be deemed in compliance with those policies despite its efforts to so comply. Accordingly, Hurray! may be subject to monetary penalties or service suspensions or both, even for conduct which Hurray! believed to be permissible. Any future noncompliance with the telecommunications operators’ policies by Hurray!, whether inadvertent or not, could result in a material and adverse effect on its revenue and profitability.
The telecommunications operators may impose higher service or network fees on Hurray! for their own business purposes or if Hurray! is unable to satisfy customer usage and other performance criteria.
Fees for Hurray!’s WVAS are charged on a monthly subscription or per-use basis. As provided in its network service agreements, Hurray! relies on the telecommunications operators for both billing of and collection from, mobile phone users of fees for its services. As noted above under “— The termination or alteration of Hurray!’s various agreements with the telecommunications operators and their provincial affiliates would materially and adversely impact its revenue and profitability,” Hurray!’s negotiating leverage with the telecommunications operators is limited. As a result, the telecommunications operators could for their own business purposes unilaterally amend Hurray!’s agreements with them to increase the service or network fees that they retain from the revenues generated by Hurray!’s WVAS.
In addition, under these agreements, these service fees in some cases rise if Hurray! fails to meet certain customer usage, revenues and other performance criteria. Moreover, for 2G services, to the extent that the number of messages sent by Hurray! over networks of the telecommunications operators exceeds the number of messages its customers send to it, it must pay per message network fees, which decrease in several provinces as the volume of customer usage of its services increases. The number of messages sent by Hurray! will exceed those sent by its users, for example, if a user sends Hurray! a single message to order a game but Hurray! in turn must send that user several messages to confirm his or her order and deliver the game itself. We cannot be certain that Hurray! will be able to satisfy any performance criteria in the future or that the telecommunications operators will keep the criteria at their current levels. Any increase in the service or network fees of the telecommunications operators could reduce its gross margins.
The telecommunications operators may change their practices with regard to how service selections appear on their WAP portals.
The current practice of the telecommunications operators is generally to place the most popular WAP services at the top of the menu on the first page of the list of services available in each service category on their WAP portals. Services at the top of the menu are more accessible and therefore more frequently accessed than those services lower on the menu. This effectively reinforces the position of the most popular services. The placement of services on these menus creates significant competitive advantages for the top-ranked services and significant challenges for newer and less popular services. We believe that Hurray!’s prominent position on the WAP portals of the telecommunications operators has historically helped Hurray! maintain its position in the market. If any of the telecommunications operators changes its current practices so that the most popular services are not those that are the most accessible to customers, restricts the number or type of services a service provider is permitted to place on service menus or adopts new interface technologies that eliminate the current service menus, Hurray!’s services could become more difficult for users to access and could, therefore, become less popular. In addition, China Mobile only includes links to its own WVAS offerings on the embedded menus of mobile handsets with customized software for China Mobile users while excluding links to products from third-party WVAS service providers such as Hurray!. This practice has adversely affected Hurray!’s revenues. If additional similar changes occur, they will likely materially and adversely affect the revenue from Hurray!’s services.
The businesses of Hurray!’s affiliated music companies are subject to constantly changing consumer tastes.
Hurray! engages in artist development, music production, offline distribution and event organization in Mainland China and Taiwan through Hurray!’s affiliated music companies. Hurray! has also recently expanded its artist agency business.

 

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Each music recording and concert performance is an individual artistic work. The commercial success of a music product or concert depends on consumer taste, the quality and acceptance of competing offerings or events released into the marketplace at or near the same time, the availability of alternative forms of entertainment and leisure time activities, general economic conditions and other tangible and intangible factors, all of which can change quickly. Accordingly, there can be no assurance as to the financial success of any particular product, the timing of such success, or the popularity of any particular artist.
The future success of Hurray!’s affiliated music companies depends on their ability to continue to develop recorded music and organize concerts that are interesting and engaging to their target audience, primarily users of the Internet and WVAS in the case of their recorded music. If the audience determines that the content does not reflect their tastes, then the audience size could decrease, which would adversely affect Hurray!’s results of operations. The ability of Hurray!’s affiliated music entities to develop compelling content depends on several factors, including the following:
    technical expertise of their production and recording staff;
    popularity of the artists represented by Hurray!’s affiliated music companies;
    access to songs or songwriters; and
    effectiveness of online and offline marketing and promotional activities.
Furthermore, Hurray!’s affiliated music companies must invest significant amounts for development prior to the release of any product or organization of an event. These costs may not be recovered if the product or event is unsuccessful. There can be no assurance that such products or events will be successful releases or that any product or events will generate revenues sufficient to cover the cost of development or organization.
Hurray!’s expansion into the online video market may not be successful. China’s online video market is highly competitive, and Ku6 may be unable to compete successfully against established industry competitors and new entrants, some of which have greater financial resources than Ku6 does or currently enjoy a superior market position than Ku6 does.
In January 2010, Hurray! acquired Ku6, an online video site in China. Ku6’s operating results have varied significantly in the past, and may vary significantly in the future due to a number of factors that could have an adverse impact on the business, such as reliance on advertisers in certain industries for brand advertising revenues and reliance on certain key content providers for online video entertainment services. Hurray! may not be able to effectively utilize Ku6’s online video portal. Thus, the operational and financial results of the merger may differ from Hurray!’s expectations.
Additionally, there is significant competition among online video sites, which Hurray!’s management estimates to currently number over one hundred in China. A large number of independent online video sites, such as Youku.com and Tudou.com, compete against Ku6. In addition, the Internet portals in China, including Sina.com, Sohu.com and Baidu.com, which have longer operating histories and more experience in attracting and retaining users and managing customers than Ku6 does, have begun to launch their own video businesses. Online video sites are also increasingly competing to obtain rights to licensed content for their websites, which may result in increases in the price of licensed content and prevent Ku6 from obtaining attractive content on acceptable terms. Any of Ku6’s present or future competitors may offer online video services which provide significant technology, performance, price, creativity or other advantages over those offered by Ku6, and therefore achieve greater market acceptance than Ku6’s.
Ku6 and its affiliates (including Hurray! and/or Shanda) are, and may in the future be, subject to intellectual property rights claims due to infringement of video on Ku6.com, which are costly to defend against and, could result in payment of money damages.
Ku6 has had copyright claims filed against it by companies alleging that certain videos on Ku6.com infringe the rights of others. As a result of Hurray!’s acquisition of Ku6, Hurray! and Shanda may also be subject to copyright claims filed in certain jurisdictions due to Ku6’s infringement. Adverse results in these lawsuits may include awards of substantial monetary damages, costly royalty or licensing agreements, and may also result in a change in Ku6’s business practices, which could result in a loss of revenues for Ku6 or otherwise harm Ku6’s business.

 

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Ku6 depends on online advertising for a significant portion of its revenues, but the online advertisement market includes many uncertainties, which could cause its advertising revenues to decline.
Ku6 derives a significant portion of its revenues, and expects to derive a significant portion of its revenues for the foreseeable future, from the sale of advertising on its website. The growth of Ku6’s advertising revenues relies on increased revenue from the sale of advertising spaces on its website, which may be affected by many of the following risk factors:
    The online advertising market is new and rapidly evolving, particularly in China. As a result, many of Ku6’s current and potential advertising clients have limited experience using the Internet for advertising purposes and historically have not devoted a significant portion of their advertising budget to Internet-based advertising;
    Changes in government policy could restrict or curtail Ku6’s online advertising services. For example, in 2006 and 2007, the PRC government enacted a series of regulations, administrative instructions and policies to restrict online medical advertising. As a result of these regulations, Ku6 may lose some of its existing medical advertising clients;
    Advertising clients that have invested substantial resources in other methods of conducting business may be reluctant to adopt a new strategy that may limit or compete with their existing efforts; and
    The acceptance of the Internet as a medium for advertising depends on the development of a measurement standard.
No standards have been widely accepted for the measurement of the effectiveness of online advertising. Industry-wide standards may not develop sufficiently to support the Internet as an effective advertising medium. If these standards do not develop, advertisers may choose not to advertise on the Internet in general or through Ku6.com.
In addition, Ku6’s ability to generate and maintain significant online advertising revenues will also depend upon:
    the development of a large base of users possessing demographic characteristics attractive to advertising clients;
    the acceptance of online advertisement as an effective way for business marketing by advertising clients;
    the effectiveness of its advertising delivery, tracking and reporting systems; and
    the resistance pressure on online advertising prices and limitations on inventory.
Maintaining copyright protection controls may prove to be costly and Ku6’s revenue from online marketing services may not be able to offset its cost in acquiring legally licensed content.
Due to the prevalence of piracy in China, many online video sites provide links to and host content on their websites which may be protected by copyright. Ku6 has enhanced its monitoring efforts and instituted new policies that prohibit users from uploading copyright-protected content to Ku6.com. And althought Ku6 launched a campaign in November 2009 to delete all illegally uploaded foreign films, television series and other content which may be protected by copyright, we cannot be certain that all such content has been deleted.
Ku6 may be placed at a competitive disadvantage compared with its competitors who incur lower operating expenses by offering and not monitoring their websites for illegal content. While Ku6 derives most of its revenue from online marketing services, which may not be sufficient to offset the cost of acquiring legally licensed content, its competitors may be able to derive revenue from illegal content which requires little or no capital expenditure. Additionally, Hurray!’s management believes that the acquisition of Ku6 may have an impact on its future liquidity or capital resources as it purchases licensed content for Ku6.com. Hurray! may allocate a significant portion of its working capital to finance such acquisitions, working capital which would otherwise be available for other business segments. Hurray! may also require additional cash resources to operate Ku6. Hurray! cannot assure you that financing will be available in amounts or on terms acceptable to it, if at all. If Hurray! is unable to adequately finance its video business, the growth prospects of Ku6 and Hurray! could be adversely affected.

 

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Other Risks Related to Our Businesses
We face intense competition.
The businesses that the Shanda group engage in are rapidly evolving and intensely competitive, and are subject to changing technology, shifting user needs and frequent introductions of new products and services. We have many competitors in different industries, including online game operators, traditional portal operators, traditional search engine operators and e-commerce sites, social networking sites, traditional media companies, and providers of online products and services. Our current and potential competitors range from large and established companies to emerging start-ups. Established companies have longer operating histories and more established relationships with customers and end users, and they can use their experience and resources against us in a variety of competitive ways, including by making acquisitions and investing aggressively in research. Emerging start-ups may be able to innovate and provide products and services faster than we can. If our competitors are more successful than we are in developing compelling products and services or in attracting and retaining users, advertisers, and content providers, our revenues and growth rates could decline.
Acquisitions and investments could result in operating difficulties, dilution and other harmful consequences. We may also reorganize our business, including disposition of certain assets.
We have acquired a number of businesses in the past. We expect to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions to strengthen or supplement our core online interactive entertainment business. These transactions could be material to our financial condition and results of operations. Additionally, in line with our objective to improve our operating results, we may reorganize our business, including the disposition of certain assets and business units in order to allow management to focus on our core businesses. The process of integrating an acquired company, business, or technology or reorganizing has created, and will continue to create, unforeseen operating difficulties and expenditures. The areas where we face risks include:
    implementation or remediation of controls, procedures, and policies at the acquired company;
    diversion of management time and focus from operating our business to acquisition integration challenges;
    coordination of product, engineering, and sales and marketing functions;
    transition of operations, users, and customers onto our existing platforms;
    cultural challenges associated with integrating employees from the acquired company into our organization;
    retention of employees from the businesses we acquire;
    integration of the acquired company’s accounting, management information, human resource, and other administrative systems;
    liability for activities of the acquired company before and after the acquisition, including patent and trademark infringement claims, violations of laws, commercial disputes, tax liabilities and other known and unknown liabilities;
    litigation or other claims in connection with the acquired company, including claims from terminated employees, customers, former shareholders or other third parties;

 

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    in the case of foreign acquisitions, the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries; and
    failure to successfully further develop the acquired business.
Our failure to address these risks or other problems encountered in connection with our past or future acquisitions, investments and reorganizations could cause us to fail to realize the anticipated benefits of such transactions, incur unanticipated liabilities, and harm our business generally. Future acquisitions or reorganizations could also result in dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities, or amortization expenses, or write-offs of goodwill, any of which could harm our financial condition. Also, the anticipated benefit of such acquisitions, investments or reorganizations may not materialize. Furthermore, we may incur significant costs related to such transactions, including legal, accounting and other fees and expenses.
There can be no assurance that our diversification strategy will achieve its intented strategic objectives or improve our results of operations.
We plan to further diversify our business to other related interactive media businesses. For example, in July 2009, we acquired a 52.6% interest in Hurray! (which has subsequently been diluted to approximately 42.0% as of March 31, 2010) and in January 2010, Hurray! acquired a 100% interest in Ku6. In November 2009, we entered into a joint venture agreement with Hunan Broadcasting and Television Group, or Hunan TV, to establish a film and television production and distribution company. Each new business line may require the investment of additional capital and the significant involvement of our senior management to acquire or develop a new line of business and integrate it with our operations. We may experience delays, regulatory impediments and other complications in implementing our diversification strategy that could reduce our profitability and ultimately cause the strategy to fail. These complications may include obtaining licenses and registrations, adapting our technology platform, hiring personnel and raising capital. Our acquisition of Hurray! and its subsequent acquisition of Ku6 may have an impact on our profitability as Ku6 makes expenditures to purchase licensed content. Our expansion into new businesses will increase capital expenditures and research and development expenditures. There can be no assurance that we will be able to manage our recent or any future expansion or acquisition successfully, and any inability to do so could adversely affect our business, financial condition, or results of operations.
We may be subject to intellectual property infringement claims, which may force us to incur substantial legal expenses and, if determined adversely against us may materially disrupt our business.
We cannot be certain that entertainment content available on our website does not and will not infringe upon patents, copyrights, trademarks or other intellectual property rights held by third parties. We may be perceived or alleged to infringe upon patents, copyrights, trademarks or other intellectual property rights held by third parties and become subject to legal proceedings and claims from time to time relating to the intellectual property rights of others. For example, in 2003, Actoz and Wemade Entertainment Co., Ltd. filed a lawsuit against us in the Beijing First Intermediate People’s Court alleging copyright infringement and unfair competition claims with respect to Woool. These claims were settled in February 2007.
If we are found to have violated the intellectual property rights of others, we may be subject to monetary damages and be enjoined from using such intellectual property, or we may incur new or additional licensing costs if we wish to continue using the infringing content, be forced to develop or license alternatives or be forced to stop operating such entertainment content, any of which may materially and adversely affect our business and results of operations. In addition, we may incur substantial expenses and require significant attention of management in defending against these third-party infringement claims, regardless of their merit.
Some of our employees were previously employed at other companies, including some of our current and potential competitors. To the extent these employees or any employees we may hire in the future are involved in research that is similar to the research that they performed at their former employers, our competitors may file lawsuits or initiate proceedings against us alleging that these employees violated the intellectual property rights, such as trade secret rights, of their former employers. Although we are not aware of any pending or threatened claims alleging these types of violations of intellectual property rights, if any such claim arises in the future, litigation or other dispute resolution proceedings may be necessary to retain our ability to offer our current and future games, which could be costly and divert financial and management resources.

 

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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, service marks, trade secrets and other intellectual property as critical to our success. Unauthorized use of the intellectual property used in our business, whether owned by us or licensed to us, may adversely affect our business and reputation.
We rely on copyright, trademark, trade secret and other intellectual property law, as well as non-competition, confidentiality and license agreements with our employees, licensors, business partners and others to protect our intellectual property rights. Our employees are generally required to sign agreements acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership rights that they may claim in those works. Despite our precautions, third parties may obtain and use intellectual property that we own or license without our consent. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights may materially and adversely affect our business.
For instance, pirate game servers illegally operate unauthorized copies of our online games and enable players to play those games without purchasing prepaid cards for our online games. Despite our efforts to shut down pirate game servers, we believe that a significant number of pirate game servers continue to operate unauthorized copies of our online games. If pirate game servers continue to operate any of our online games, our business, financial condition and results of operations may be materially and adversely affected.
The validity, enforceability and scope of protection of intellectual property in Internet-related industries are uncertain and still evolving. In particular, the laws and enforcement procedures in the PRC are uncertain and do not protect intellectual property rights in this area to the same extent as do the laws and enforcement procedures in the United States and other developed countries. Policing unauthorized use of intellectual properties is difficult and expensive. Any steps we have taken to prevent the misappropriation of our intellectual properties may be inadequate. Moreover, 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 depend on our key personnel, and our business and growth prospects may be severely disrupted if we lose their services.
Our future success is heavily dependent upon the continued service of our key executives and other key employees. In particular, we rely on the expertise, experience and leadership ability of Tianqiao Chen, our founder, chairman of our board of directors, chief executive officer and president, in our business operations, and rely on his personal relationships with our employees, the relevant regulatory authorities, our content providers and service suppliers. We also rely on a number of key technology officers and staff for the development and operation of our content offerings.
If one or more of our key personnel are unable or unwilling to continue in their present positions, we may not be able to easily replace them and may incur additional expenses to recruit and train new personnel, our business could be severely disrupted, and our financial condition and results of operations could be materially and adversely affected. Furthermore, since our industry is characterized by high demand and intense competition for talent, we may need to offer higher compensation and other benefits in order to attract and retain key personnel in the future. We cannot assure you that we will be able to attract or retain the key personnel that we will need to achieve our business objectives. Furthermore, we do not maintain key-man life insurance for any of our key personnel.

 

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You should not place undue reliance on our financial guidance, nor should you rely on our quarterly operating results as an indication of our future performance because our quarterly operating results may be subject to significant fluctuations.
We may experience significant fluctuations in our quarterly operating results due to a variety of factors, many of which are beyond our control. Significant fluctuations in our quarterly operating results could be caused by any of the factors identified in this section, including, but not limited to:
    our ability to retain existing users, attract new users at a steady rate and maintain user satisfaction;
    the announcement or introduction of, or updates to, our existing games and other entertainment content by us or our competitors;
    technical difficulties, system downtime or Internet failures;
    the amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure;
    governmental regulations;
    seasonality effect for our business;
    a shortfall in our revenues relative to our forecasts and a decline in our operating results due to our inability to adjust to our users’ spending quickly;
    the inability to direct the performance of our independent public subsidiaries, Shanda Games and Hurray!;
    the introduction and nationwide roll-out of the third-generation wireless telecommunications network in China; and
    general economic conditions and economic conditions specific to the online entertainment industry and China.
As a result, you should not rely on quarter-to-quarter comparisons of our operating results as indicators of likely future performance. Our operating results may be below our expectations or the expectations of public market analysts and investors in one or more future quarters. If that occurs, the price of our ADSs could decline and you could lose part or all of your investment.
The PRC government may discontinue the preferential tax treatments or the government financial incentives currently available to us in the PRC.
On March 16, 2007, the National People’s Congress of China enacted a new enterprise income tax law, or the New EIT Law, as supplemented by various detailed implementation guidance, which became effective as of January 1, 2008. Under the New EIT Law, a preferential tax rate of 15% is applicable to enterprises that qualify as “high and new technology enterprises”, a status reassessed every three years. In addition, an enterprise is entitled to a 10% income tax rate for the year in which it is recognized as a “national key software enterprise”, a status reassessed every year. Shengqu, Shanda Computer, Shanda Networking, Bianfeng, Shanghai Shulong, Chengdu Aurora, Shanghai Holdfast Online Information Technology Co., Ltd., Chengdu Jisheng Technology Co., Ltd., or Chengdu Jisheng, were recognized as “high and new technology enterprises” in 2008 and are entitled to a 15% preferential income tax rate for the three-year period ending December 31, 2010. In addition, Shengqu also qualified as a national key software enterprise in 2008 and 2009, respectively, on December 31, 2008 and December 31, 2009. Accordingly, Shengqu was subject to a preferential income tax rate of 10% for 2008 and 2009. However, we cannot assure you that these enterprises will be able to maintain their status as “high and new technology enterprises” and/or “national key software enterprise.” If any of these enterprises that qualified as “high and new technology enterprise” or “national key software enterprise” fails to continue to qualify for such status, our income tax expenses would increase, which would have a material adverse effect on our net income and results of operations.

 

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In 2007, 2008, and 2009, we received aggregate government financial incentives of RMB57.5 million, RMB62.3 million and RMB221.9 million (US$32.5 million), respectively, which were calculated with reference to taxable revenue 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 to be further subject to the discretion of the municipal governments. If we had not received these government financial incentives in 2007, our income before income tax expenses, equity in loss of affiliated companies, non-controlling interests and redeemable preferred shares issued by a subsidiary would have been RMB1,364.0 million, a decrease of 4.0% from the reported amount. If we had not received these government financial incentives in 2008, our income before tax expenses, equity in loss of affiliated companies, non-controlling interests and redeemable preferred shares issued by a subsidiary would have been RMB1,460.1 million, a decrease of 4.1 % from the reported amount. If we had not received these government financial incentives in 2009, our income before tax expenses, equity in loss of affiliated companies, non-controlling interests and redeemable preferred shares issued by a subsidiary would have been RMB2,034.0 million (US$298.0 million), a decrease of 9.8% from the reported amount. As the receipt of these government financial incentives is subject to periodic time lags and inconsistent municipal government practice on payment times, for so long as we continue to receive these government financial incentives, our net income in a particular quarter may be higher or lower relative to other quarters based on the potentially uneven receipt by us of these government financial incentives in addition to any business or operating related factors we may otherwise experience. Moreover, the central government or municipal governments could determine at any time to eliminate or reduce these government financial incentives, generally with prospective effect. We cannot assure you that we will continue to enjoy these preferential tax treatments or government financial incentives in the future. The discontinuation or reduction of these preferential tax treatments or government financial incentives could materially and adversely affect our business, financial condition and results of operations.
There are significant uncertainties under the New EIT Law relating to our PRC enterprise income tax liabilities.
Under the New EIT Law, the profits of a foreign invested enterprise which are distributed to its immediate holding company outside the PRC will be subject to a withholding tax rate of 10%. Pursuant to a special arrangement between Hong Kong and the PRC, such rate is lowered to 5% if a Hong Kong resident enterprise owns over 25% of the PRC companies. However, according to a tax circular issued by the State Administration of Taxation in February 2009, if the main purpose of an offshore arrangement is to obtain a preferential tax treatment, the PRC tax authorities have the discretion to adjust the preferential tax rate enjoyed by the relevant offshore entity. In addition, under the New EIT Law, enterprises established under the laws of jurisdictions outside China with their “de facto management bodies” located within China may be considered to be PRC tax resident enterprises for tax purposes. For additional details on the preferential tax status, see “Item 5. Operating and Financial Review and Prospects — Taxation — PRC Enterprise Income Tax” and “Item 10. Additional Information — Exchange Controls.”
Although we are a Cayman Islands company and wholly own subsidiaries incorporated in Hong Kong, the PRC tax authorities may regard the main purpose of these Hong Kong entities as obtaining a lower withholding tax rate of 5%. As a result, the PRC tax authorities could levy a higher withholding tax rate to dividends received by our wholly-owned subsidiaries incorporated in Hong Kong from our PRC subsidiaries. In addition, a substantial majority of the members of our management team are located in China. Under current PRC laws and regulations, it is also uncertain whether we would be deemed PRC tax resident enterprises under the New EIT Law. If we are deemed PRC tax resident enterprises, our global income will be subject to PRC enterprise income tax at the rate of 25%.

 

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It is not clear whether or not we were a passive foreign investment company, or PFIC, for the taxable year ending December 31, 2009.
It is not clear whether or not we were a passive foreign investment company, or PFIC, for the taxable year ending December 31, 2009. That determination is subject to uncertainty because it is not clear how the VIE agreements between the PRC operating companies and us will be treated for purposes of the PFIC rules, and because of the uncertainty with respect to the valuation of our assets as well as the uncertain characterization of our assets and income, including goodwill, for purposes of the PFIC rules. If we are or were to become a PFIC, such characterization could result in adverse U.S. tax consequences to you if you are a U.S. investor. For example, if we are a PFIC, our U.S. investors will be subject to increased tax liabilities under U.S. tax laws and regulations and will become subject to additional reporting requirements. PFIC classification is tested annually, and our classification will therefore depend on the composition of our income and assets from time to time. Specifically, we will be classified as a PFIC for U.S. tax purposes if either: (i) 75% or more of our gross income in a taxable year is passive income, or (ii) the average percentage of our assets by value in a taxable year which produce or are held for the production of passive income (which includes cash) is at least 50%. The calculation of the value of our assets will be based, in part, on the quarterly market value of our shares and ADSs, which is subject to change. We cannot assure you that we were not a PFIC for 2009 or that we will not be a PFIC for 2010 or any future taxable year. For more information on the U.S. tax consequences to you that would result from our classification as a PFIC, please see the section entitled “Taxation—U.S. Federal Income Taxation—Passive Foreign Investment Company Rules.”
We may need to record impairment charges to earnings if our acquisition goodwill, investments in affiliate companies or acquired intangible assets is determined to be impaired.
We acquire, invest in or license content from various content providers and record any acquisition goodwill, investments in affiliate companies and acquired intangible assets on our balance sheet in connection with such acquisitions, investments and licensing, respectively. We are required to review our acquisition goodwill for impairment at least annually and review our investments in affiliate companies and acquired intangible assets for impairment when events or changes in circumstances indicate that the carrying value may not be recoverable, including a decline in stock price and market capitalization and slow down in our industry, which may result from recent global economic slowdown. If the carrying value of our acquisition goodwill, investments in affiliate companies or acquired intangible assets were determined to be impaired, we would be required to write down the carrying value. For example, we completed the purchase of a 29.9% equity stake in Actoz, the co-owner of Mir II, in February 2005, for a total consideration of RMB878 million (US$106.1 million), which represented an 81% premium over the open market price at the time that we entered into the purchase agreement in October 2004. In the fourth quarter of 2005, however, we recorded a non-cash impairment charge of RMB521.5 million (US$64.6 million) to reflect the fair value of our 38.1% stake in Actoz. We recognized the impairment charge primarily as a result of the continued decline in royalties payable to Actoz from our operation of Mir II in China. The decision to recognize impairment was also influenced by the decline in the market price for shares of Actoz, which in the fourth quarter of 2005 was determined to be other than temporary, mainly due to the continued decline in Mir II royalties.
We cannot assure you that we will have the ability to effectively integrate the operation of the acquired companies into our own and achieve the synergies contemplated at the time of entering into these transactions. If we are unable to achieve the synergies contemplated at the time of acquiring these companies, the carrying value of the acquired companies may not be recoverable. We are required by U.S. GAAP to review the impairment of goodwill at least on an annual basis. If an impairment is determined and charged to the earnings in our financial statements, we would be required to record charges to earnings in our financial statements during the period and our financial condition and results of operations would be materially and adversely affected.
We may lose the ability to consolidate certain of our businesses in our financial statements if our ownership percentage in those businesses is diluted.
We currently consolidate several businesses in which we hold less than 100% of the outstanding equity interests. These businesses may issue stock in connection with business transactions that could dilute our ownership percentage such that we no longer control those businesses and in which event we would have to deconsolidate them from our financial statements. For example, in June 2009, we entered into a tender offer agreement with Hurray! under which we commenced a tender offer to acquire at least 51% of Hurray!’s outstanding ordinary shares. We successfully completed the tender offer in July 2009, acquiring 52.6% of Hurray!’s outstanding ordinary shares, and began consolidating Hurray! in our financial statements. In January 2010, Hurray! issued common stock in connection with the acquisition of Ku6, which diluted our ownership percentage. As of March 31, 2010, we owned approximately 42.0% of Hurray!’s outstanding ordinary shares but appointed a majority of Hurray!’s directors. For the fiscal year ending December 31, 2009, we consolidated Hurray! in our financial statements. If we do not increase our holdings in Hurray! or if Hurray! issues additional common stock for any number of reasons, we may have to deconsolidate Hurray! Holding. Such a deconsolidation of Hurray! or our other businesses could affect our quarter over quarter financial comparison and could have a material and adverse impact on our financial statements.

 

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While we believe that we currently have adequate internal control procedures in place, we are still exposed to potential risks from legislation requiring companies to evaluate controls under Section 404 of the Sarbanes-Oxley Act of 2002.
We are subject to the reporting obligations under the U.S. securities laws. The Securities and Exchange Commission (the “SEC” or the “Commission”), as required under Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies to include a report of management on the effectiveness of such companies’ internal control over financial reporting in their respective annual reports. In addition, an independent registered public accounting firm for a public company must issue an attestation report on the effectiveness of such company’s internal control over financial reporting. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting and concluded that our internal control over financial reporting was effective as of December 31, 2009. In addition, our independent registered public accounting firm attested as to the effectiveness of our internal control and reported that our internal control over financial reporting was effective as of December 31, 2009. If we fail to maintain the effectiveness of our internal control over financial reporting, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with the Sarbanes-Oxley Act. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial reports. As a result, any failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could negatively impact the trading price of our ADSs. Furthermore, we may need to incur additional costs and use additional management and other resources in an effort to comply with Section 404 of the Sarbanes-Oxley Act and other requirements going forward.
Risks Relating to Regulation of the Internet and to Our Structure
If the PRC government finds that the agreements that establish the structure for operating our China business do not comply with PRC government restrictions on foreign investment in the online culture industry, including online game, online literature and online video, we could be subject to severe penalties.
On December 11, 2001, the PRC State Counsel promulgated the Regulations for the Administration of Foreign-invested Telecommunications Enterprises, or the FITE Regulations, which became effective on January 1, 2002 and were subsequently amended on September 10, 2008. Under the FITE Regulations, foreign ownership of companies that provide value-added telecommunications services is limited to 50%. In addition, foreign and foreign-invested enterprises are currently not able to apply for the licenses required to operate online culture products (including online games, literature and video) in China or to provide Internet information content, such as online advertising.
Accordingly, we operate our Internet-related businesses in China through our PRC operating companies, which are VIEs that are PRC domestic companies owned principally or completely by certain of our PRC employees, shareholders or PRC employees of our directly-owned subsidiaries. We control these companies and operate these businesses through contractual arrangements with the respective companies and their individual owners, but we have no equity control over these companies. Such restrictions and arrangements are prevalent in other PRC companies we have acquired. See “Item 4.C. Organizational Structure.”
On July 13, 2006, the MIIT issued the Circular on Strengthening the Administration of Foreign Investment in Value-added Telecommunications Services, or the MIIT Circular 2006. According to the MIIT Circular 2006, since the FITE Regulations went into effect, some foreign investors had engaged in value-added telecommunications services illegally by working with domestic value-added telecommunications enterprises to circumvent the requirements of the FITE Regulations by delegating domain names and licensing trademarks. In order to further strengthen the administration of FITEs, the MIIT Circular 2006 provides that any domain name or trademark used by a value-added telecommunications carrier shall be legally owned by such carrier or its shareholders. The MIIT Circular 2006 also provides that the operation site and facilities of a value-added telecommunications carrier shall be installed within the scope as prescribed by operating licenses obtained by the carrier and shall correspond to the value-added telecommunications services that the carrier has been approved to provide. In addition, value-added telecommunications carriers are required to establish or improve the measures of ensuring network security. As to the companies which have obtained the operating licenses for value-added telecommunications services, they are required to conduct self-examination and self-correction according to the said requirements and report the result of such self-examination and self-correction to the provincial branches of the MIIT.

 

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We cannot be sure that the PRC government would view our operating arrangements to be in compliance with PRC licensing, registration or other regulatory requirements, including without limitation the requirements described in the MIIT Circular 2006, with existing policies or with requirements or policies that may be adopted in the future. For example, as some of the domain names and trademarks that Shanda Games uses in its operations are not owned by Shanghai Shulong or its shareholders, Shanda Games may be in violation of the provisions of the MIIT Circular 2006. If any of our businesses is determined not to be in compliance with the MIIT Circular 2006, 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 its business and operating licenses, requiring it to discontinue or restrict its operations, blocking its website, requiring us to restructure our business or imposing additional conditions or requirements with which it may not be able to comply. We may also encounter difficulties in obtaining performance under or enforcement of related contracts.
In the opinion of our PRC counsel, except for otherwise disclosed in this annual report, in all material aspects, (1) the ownership structures of our company, Shanda Computer, Shengqu, Shengting and our PRC operating companies, other than the Hurray! entities, are in compliance with existing PRC laws and regulations; (2) our contractual arrangements with Shanda Networking, Shanghai Shulong, Hongwen and their respective shareholders are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect; and (3) the business operations of our company, Shanda Computer, Shengqu, Shengting and our PRC operating companies, other than the Hurray! entities, as described in this annual report, are in compliance with existing PRC laws and regulations. Additionally, in the opinion of Hurray!’s management, except for otherwise disclosed in this annual report, in all material aspects, (1) the ownership structures of Hurray! Holding, the Hurray! entities and the Hurray! VIEs are in compliance with existing PRC laws and regulations; (2) Hurray!’s contractual arrangements with the Hurray! VIEs and their respective shareholders are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect; and (3) the business operations of Hurray! Holding, the Hurray! entities and the Hurray! VIEs, as described in this annual report, are in compliance with existing PRC laws and regulations.
There are, however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Accordingly, we cannot assure you that the PRC regulatory authorities will not ultimately take a view that is contrary to our view. If we, our subsidiaries or any of our PRC operating companies are found to be in violation of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such violations, including:
    revoking our PRC operating companies’ business and operating licenses;
    discontinuing or restricting our PRC operating companies’ operations;
    imposing conditions or requirements with which we, our subsidiaries or any of our PRC operating companies may not be able to comply;
    requiring us, our subsidiaries or any of our PRC operating companies to restructure the relevant ownership structure or operations; or
    taking other regulatory or enforcement actions, including levying fines, that could be harmful to our business.
Any of these actions could cause our business, financial condition and results of operations to suffer and the price of our ADSs to decline.

 

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The contractual arrangements related to critical aspects of our operations with our PRC operating companies and their respective shareholders may not be as effective in providing operational control as direct ownership.
We rely on contractual arrangements with our PRC operating companies and their respective shareholders to operate our business. These contractual arrangements may not be as effective as direct ownership in providing us control over our PRC operating companies. Direct ownership would allow us, for example, to directly or indirectly exercise our rights as a shareholder to effect changes in the boards of our PRC operating companies, which, in turn, could effect changes, subject to any applicable fiduciary obligations, at the management level. However, under the current contractual arrangements, as a legal matter, if our PRC operating companies or their respective shareholders fails to perform its, his or her respective obligations under these contractual arrangements, we may have to incur substantial costs and expend significant resources to enforce those arrangements and rely on legal remedies under PRC law. These remedies may include seeking specific performance or injunctive relief, and claiming damages, any of which may not be effective.
Pursuant to equity pledge agreements, the shareholders of our PRC operating companies have pledged their ordinary shares in our PRC operating companies to several of our PRC subsidiaries. According to the PRC Property Rights Law, which became effective October 1, 2007, a pledge is created only when such pledge is registered with the relevant Administration for Industry and Commerce office. We have registered the equity pledges of the shareholders of Shanda Networking, Shanghai Shulong and Hongwen with the relevant Administration for Industry and Commerce. Hurray! is in the process of registering the equity pledges of the Hurray! VIEs with the relevant Administration for Industry and Commerce. However, all of these contractual arrangements are governed by PRC laws and provide for the resolution of disputes through either arbitration or litigation 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, we may be unable to exert effective control over our PRC operating companies, and our ability to conduct our business may be materially and adversely affected.
Shareholders of our PRC operating companies 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.
We conduct substantially all of our operations, and generate substantially all of our revenues, through our PRC operating companies. Our control over these entities is based upon the VIE agreements which are contractual arrangements with our PRC operating companies and their respective shareholders that provide us with the substantial ability to control our PRC operating companies. These shareholders 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.
For example, the two shareholders of Shanda Networking, Tianqiao Chen and Danian Chen, are also our controlling shareholders. As a result, they may be able to cause the contractual arrangements they have entered into with us to be amended in a manner to maximize their interest, economically or otherwise, even if such amendment is contrary to the interest of our company and our other shareholders. Although our audit committee charter requires the approval of our audit committee, which is comprised of our independent directors, to make any amendment to these agreements, we cannot assure you that such mechanism will be effective in preventing such amendment. Furthermore, the shareholders of our PRC operating companies may decide to breach their contracts with us if they believe such action furthers their own interest, or if they otherwise act in bad faith. In particular, the two shareholders of Shanghai Shulong, Dongxu Wang and Yingfeng Zhang and the two shareholders of Hongwen, Dongxu Wang and Mingfeng Chen are our employees. They are not our directors or principal shareholders. Therefore, they do not owe any fiduciary duty to our company and given that their economic stake in us is relatively small compared to their ownership interest in Shanghai Shulong and Hongwen, they may take actions that adversely affect us. If the shareholders of our PRC operating companies breach their contracts with us or otherwise have disputes with us, we may have to initiate legal proceedings, which involves significant uncertainty. Such disputes and proceedings may significantly disrupt our business operations, adversely affect our ability to control our PRC operating companies, and we cannot assure you that the outcome of such disputes and proceedings will be in our favor.

 

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Our arrangements with our PRC operating companies may be subject to scrutiny by the PRC tax authorities for transfer pricing adjustments.
We also could face material and adverse tax consequences if the PRC tax authorities determine that our contracts with our PRC operating companies were not entered into based on arm’s length negotiations. Although we based our contractual arrangements on those of similar businesses, if the PRC tax authorities determine that these contracts were not entered into on an arm’s length basis, they may adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment. A transfer pricing adjustment could result in a reduction, for PRC tax purposes, of deductions recorded by our PRC operating companies, which could adversely affect us by:
    increasing our PRC operating companies’ tax liability without reducing our PRC subsidiaries’ tax liability, which could further result in late payment fees and other penalties to our PRC operating companies for under-paid taxes; or
    limiting our PRC subsidiaries’ ability to maintain preferential tax treatments and government financial incentives, if the transfer pricing adjustment is significant.
As a result, any transfer pricing adjustment could have a material and adverse impact upon our financial condition.
Our corporate structure may restrict our ability to receive dividends from, and transfer funds to, our PRC subsidiaries and our PRC operating companies, which could restrict our ability to act in response to changing market conditions and reallocate funds from one Chinese affiliated entity to another in a timely manner.
We are a Cayman Islands holding company and substantially all of our operations are conducted through our PRC operating companies. We rely principally on dividends and other distributions on equity paid by our PRC subsidiaries for our cash requirements, including the funds necessary to allow us to pay dividends on the shares underlying our ADSs and the funds necessary to service any debt we may incur, or financing we may need for operations other than through our PRC subsidiaries. If our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict our PRC subsidiaries’ ability to pay dividends or make other distributions to the intermediate holding company and thus to us. We generate substantially all of our revenues through contractual arrangements with our PRC operating companies. However, PRC governmental authorities may require us to amend these contractual arrangements in a manner that would materially and adversely affect our PRC subsidiaries’ ability to pay dividends and other distributions to us. Furthermore, PRC legal restrictions permit payments of dividends by our PRC subsidiaries only out of their retained earnings, if any, determined in accordance with PRC accounting standards and regulations. Under PRC law, our PRC subsidiaries are also required to set aside a portion of their net income each year to fund certain reserve funds. These reserves are not distributable as cash dividends. As a result of these and other restrictions under PRC laws and regulations, our PRC subsidiaries and our PRC operating companies are restricted in their ability to transfer a portion of their net assets to us in the form of dividends, loans or advances, which restricted portion amounted to approximately RMB2,550.0 million (US$373.6 million), or 22.1%, of our total consolidated net assets as of December 31, 2009. Any limitation on the ability of our PRC subsidiaries and our PRC operating companies to transfer funds to us in the form of dividends, loans or advances could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay debt or dividends, and otherwise fund and conduct our business.
In addition, any transfer of funds from us to any of 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. It is not permitted under PRC law for our PRC companies to directly lend money to each other. Therefore, it is difficult to change our capital expenditure plans once the relevant funds have been remitted from our company to our PRC subsidiaries. These limitations on the free flow of funds between us and our PRC companies could restrict our ability to act in response to changing market conditions and reallocate funds from one Chinese entity to another in a timely manner.

 

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Regulations relating to offshore investment activities by PRC residents may subject us to fines or sanctions imposed by the PRC government, including restrictions on our PRC subsidiaries’ ability to pay dividends or make distributions to us and our ability to increase our investment in our PRC subsidiaries.
In October 2005, the State Administration of Foreign Exchange, or SAFE, promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Corporate Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or Circular 75, which states that if PRC residents use assets or ordinary shares in their PRC entities as capital contributions to establish offshore companies or inject assets or ordinary shares 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. Under this regulation, their failure to comply with the registration procedures set forth in such regulation 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 will 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 Circular 75 or other related rules. Any future failure by any of our shareholders who is a PRC resident, 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’ ability to pay dividends or make distributions to us and our ability to increase our investment in our PRC subsidiaries.
The laws and regulations governing the online entertainment industry in China are developing and subject to future changes. If we or any of our PRC operating companies fail to obtain or maintain all applicable permits and approvals, our business and operations would be materially and adversely affected.
The online entertainment industry in China is highly regulated by the PRC government. Various regulatory authorities of the PRC government, such as the State Council, the MIIT, the State Administration of Industry and Commerce, or the SAIC, the Ministry of Culture, or the MOC, the General Administration of Press and Publication, or the GAPP, the State Administration of Radio, Film and Television, or the SARFT, and the Ministry of Public Security, are empowered to promulgate and implement regulations governing various aspects of the Internet and the online entertainment industry.
Our PRC operating companies are required to obtain applicable permits or approvals from different regulatory authorities in order to provide their 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 operations online within China. An online game operator must also obtain an Internet culture operation license from the MOC, an Internet publishing license from the GAPP in order to distribute games through the Internet and approval from the MIIT to provide online bulletin board services. Shanghai Shulong currently holds an ICP license as well as the Internet culture operation license. Chengdu Aurora currently holds a regional ICP license as well as an Internet culture operation license. Shanghai Shulong currently does not hold an Internet publishing license and publishes its online games through cooperation with Shanda Networking, which holds such a license. In addition, Shanghai Shulong and Chengdu Aurora are in the process of applying for approval to provide online bulletin board services. If any of our PRC operating companies fails to obtain or maintain any of the required permits or approvals or if our practice is later challenged by government authorities, they may also be subject to various penalties, including fines and the discontinuation of or restriction on our operations. Any such disruption in business operations would materially and adversely affect our financial condition and results of operations.

 

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As the online entertainment industry is at an early stage of development in China, new laws and regulations may be adopted in the future to address new issues that arise from time to time. For example, in December 2009, the Also, different regulatory authorities may have different views regarding the licensing requirements for the operation of online entertainment and related businesses. As a result, substantial uncertainties exist regarding the interpretation and implementation of current and any future PRC laws and regulations applicable to the online entertainment industry and related businesses. While we believe that we comply with all material respects with all applicable PRC laws and regulations currently in effect, we cannot assure you that we will not be found in violation of any current or future PRC laws and regulations.
If we are required to comply with or are found to violate any laws or regulations governing virtual currency, pre-paid card issuance and usage, online payment or money laundering, we may have to obtain additional licenses or approvals, be forced to change our current business practice, or be subject to certain penalties.
On April 16, 2009, the People’s Bank of China, or PBOC, issued a notice regarding the payment and clearance business carried out by non-financial institutions, or the PBOC Notice. The PBOC Notice required non-financial institutions which engage in payment and clearance business to register with PBOC before July 31, 2009.
Because certain services currently provided by Shanda Online may be subject to the requirements of the PBOC Notice, Shengfutong, the wholly-owned subsidiary of Shanda Online has registered with PBOC. However, if PBOC requires Shanda Online to obtain additional licenses or approvals for its services, there is no guarantee that Shanda Online will be able to obtain such licenses or approvals. For example, in December 2009, the PBOC announced plans to require online payment service businesses to hold a license to operate its business. We cannot assure you that, if required, Shanda Online will be able to obtain such a license. In the event that Shanda Online fails to obtain any or all of the licenses or approvals required by PBOC, our business and financial condition, operations results and business prospects may be materially and adversely affected.
On June 4, 2009, the MOC and the Ministry of Commerce, or the MOFCOM, jointly issued a notice regarding strengthening online game virtual currency administration, or the Virtual Currency Notice. The Virtual Currency Notice requires enterprises which issue online game virtual currency (in the form of pre-paid card, pre-payment or pre-paid card point) or provide online game virtual currency transaction services, to apply for approval from the MOC through its provincial branches within 3 months following the date of the Virtual Currency Notice. Any enterprises which fail to submit the application will be subject to sanctions. In addition, the Virtual Currency Notice regulates, among other items, the amount of virtual currency an enterprise can issue, the retention period of user record, the function of virtual currency, and the return of unused virtual currency upon termination of online services. The Virtual Currency Notice prohibits enterprises, which provide online game virtual currency transaction services, from providing transaction services to players under the age of 18. It also prohibits online game operators from awarding in-game items or virtual currency to players based on random selection through lucky draws, wagers or lotteries.
Shanghai Shulong and Chengdu Aurora have applied for and obtained the above mentioned approval for its online game virtual currency related businesses. If our current or future operations are found to violate the Virtual Currency Notice or any other related regulations, our business and financial condition, operation results and business prospects may be materially and adversely affected.
Negative publicity in China has resulted in additional government regulations directed at online entertainment.
The media in China has reported incidents of violent crimes allegedly provoked by, or committed in connection with, online entertainment, especially online games. In addition, there have been widespread negative media reports that focus on how online games are addictive and how excessive game playing could distract students and interfere with their education. Certain non-governmental organizations may also organize protests or publicity campaigns against online game companies in order to protect youth from the risk of becoming addicted to certain online games. The PRC government may decide to adopt more stringent policies to monitor the online game industry as a result of adverse public reaction to perceived addiction to such games, particularly by minors. In 2007, eight PRC government authorities, including the GAPP, the Ministry of Education and the MIIT, jointly issued a notice requiring all Chinese online game operators to adopt an “anti-fatigue compliance system” in an effort to curb addiction to online games by minors. Under the anti-fatigue compliance 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 game players by half when those game players reach the “fatigue” level, and to zero when they reach the “unhealthy” level. In addition, online game players in China are now required to register their identity card numbers before they can play an online game. This system allows game operators to identify which game players are minors. It is unclear whether these restrictions would be expanded to apply to adult game players in the future. More stringent government regulations, including stricter anti-fatigue rules, could discourage game players from playing Shanda Games’s games, which could have a material adverse effect on our business, financial condition and results of operations.

 

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In addition, the PRC State Administration of Taxation recently 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 Shanda Games’s game players or our business.
Furthermore, similar adverse public reaction may arise, and similar government policies may be adopted, in other jurisdictions where Shanda Games licenses out its online games, which could materially and adversely affect its overseas licensing revenues.
Shanda Games may be required to reapply for approvals for imported online game products.
The MOC issued a Circular Concerning the Examination and Declaration of Imported Online Game Products on April 24, 2009. According to this circular, in the event of a change of the operator of an imported online game, the game’s existing import approval will be automatically revoked and the new operator must apply to the MOC for a new approval for the same game. As this circular is newly issued, it remains unclear how and to what extent this circular will be implemented or enforced.
On September 28, 2009, the GAPP, together with two other government authorities, issued a circular (Xin Chu Lian [2009] No. 13) which contains a similar provision to the MOC circular mentioned above. The GAPP circular also requires that, in the event of a change of the operator of an imported online game, the new operator must apply to the GAPP for a new approval for the same game, and the operation of the online game should be suspended until the GAPP approves the change in operator.
Shanda Games currently operates substantially all of its imported online games under import approvals granted by the MOC to Shanda Networking. Under the above mentioned circulars, Shanda Games may be required to reapply to the GAPP and MOC for approvals for imported online games granted to any of its affiliates. Shanda Games is committed to complying with the requirements of this circular. However, we cannot assure you that Shanda Games will succeed in obtaining all the approvals as required by this circular in time or at all. If Shanda Games fails to comply with the requirements of this circular or fail to obtain all the approvals for its imported online games, it may be subject to fines, revocation of its operating licenses, the discontinuation or restrictions on its operations and other sanctions that may be imposed by the GAPP and the MOC. As a result, our business, financial condition and results of operations could be materially and adversely affected.
The PRC government has tightened its regulation of Internet cafes, which are currently one of the primary venues for Shanda Games’s users to play online games.
Internet cafes are one of the primary places where Shanda Games’s games are played. In March 2001, the PRC government began tightening its regulation and supervision of Internet cafes. In particular, a large number of unlicensed Internet cafes have been closed. The PRC government has also imposed higher capital and facility requirements for the establishment of Internet cafes. Furthermore, the PRC government’s policy, which encourages the development of a limited number of national and regional Internet cafe chains and discourages the establishment of independent Internet cafes, may slow down the growth of Internet cafes. In February 2004, the government agencies in charge of Internet cafe licensing jointly issued a notice suspending the issuance of new Internet cafe licenses for a period of six months. In February 2007, 14 PRC government departments jointly issued a circular to strengthen the regulation of Internet cafes and online games. According to the circular, local authorities were banned from issuing new Internet cafe licenses for the remainder of 2007. Since this ban was imposed in 2007, to our knowledge, local authorities have not issued new Internet cafe licenses and it is unclear when local authorities will be permitted to issue new licenses again. In March 2010, the Ministry of Culture issued a circular to increase the punishment on Internet cafes which allow minors to enter and use Internet in their cafes. According to this circular, among other things, the authorities may revoke an Internet Cafe’s Internet culture operation license if that Internet cafe allows three or more minors to enter and use Internet in its cafe at one time. Governmental authorities may from time to time impose stricter requirements, such as the customers’ age limit and hours of operation, among others, as a result of the occurrence and perception of, and the media attention on, gang fights, arson and other incidents in or related to Internet cafes. Since a substantial portion of our users play our games in Internet cafes, any reduction in the number, or slowdown in the growth, of Internet cafes in China, or any new regulatory restrictions on their operations, could limit our ability to maintain or increase our revenues and expand our game player base, thereby adversely affecting our results of operations and growth prospects.

 

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The PRC government may prevent us from distributing, and we may be subject to liability for, content deemed to be inappropriate.
China has enacted laws and regulations governing Internet access and the distribution of news, information, published works or other content, as well as products and services, through the Internet. In the past, the PRC government has stopped the distribution of information through the Internet that it believes violates PRC law. The MIIT, the GAPP and the MOC have promulgated regulations that prohibit games from being distributed through the Internet if the games contain content that is found to, among other things, propagate obscenity, gambling or violence, instigate crimes, undermine public morality or the cultural traditions of China, or compromise state security or secrets. In addition, certain PRC social organizations have recently discussed the possibility of implementing a rating system for online entertainment. The effect that such a system could have on our business is unclear.
If any content we offer were deemed to violate any such content restrictions, we would not obtain the GAPP approval, may not be able to continue such offerings and could be subject to penalties, including confiscation of income, fines, suspension of business and revocation of our license for operating such online entertainment content, which would materially and adversely affect our business, financial condition and results of operations.
We may also be subject to potential liability for unlawful actions of our users or for content we distribute that is deemed inappropriate. Furthermore, we may be required to delete content that violates the laws of the PRC and report content that we suspect may violate PRC law. It may be difficult to determine the type of content that may result in liability for us, and if we are wrong, we may be prevented from operating our online entertainment content or other services in China.
In February 2007, the Ministry of Public Security, the MOC, the MIIT and the GAPP jointly issued a circular regarding online gambling. In order to clamp down on online games that involve gambling and online betting as well as address concerns that “virtual currency” might be used for money laundering or illicit trade, the circular (i) requires that online entertainment operators shall not charge commissions that employ “virtual currency” or other means in relation to winning or losing of games; (ii) requires online entertainment operators to set up quantity limits in guessing and betting games by using virtual currency; (iii) bans the exchange of “virtual currency” into real currencies or properties; and (iv) bans the provision of services for virtual currency transfer among game players. In February 2007, 14 PRC regulatory authorities jointly promulgated a circular with regard to further strengthening management of Internet cafes and online entertainment, according to which “virtual currency” shall be strictly regulated by the PBOC, and in particular: (i) the aggregate amount of “virtual currency” issued by online entertainment operators and the amount of “virtual currency” purchased by each individual online game player shall be restricted; (ii) “virtual currency” issued by online entertainment operators can only be used for purchasing virtual products and services provided by the online entertainment operators and shall not be used for purchasing tangible or physical products; (iii) the price for converting “virtual currency” back into the official currency by consumers shall not exceed the respective original purchase price; and (iv) trading of “virtual currency” is banned. We believe our online entertainment operations are in compliance with the provisions of these two circulars in all material aspects. There are, however, substantial uncertainties regarding the interpretation and application of these two circulars, and we cannot assure you that the PRC regulatory authorities will not take a view contrary to ours. If the PRC regulatory authorities deem our online operations to be in violation of either of these two circulars, the PBOC may confiscate the revenues generated through these illegal activities and/or impose fines on us in accordance with the Law of the PBOC and our business will be materially and adversely affected. It is unclear whether we will be subject to other penalties under current PRC laws.

 

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Currently there are no laws or regulations in the PRC specifically governing virtual asset property rights and therefore, it is not clear what liabilities, if any, online entertainment businesses may have for virtual assets.
Our online entertainment offerings may allow users to acquire virtual assets, for which there are no governing laws or regulations in China. For example, in the course of playing online games, some virtual assets, such as special equipment, player experience grades and other features of our users’ game characters, are acquired and accumulated. Such virtual assets can be important to online game players and in some cases are exchanged between players for monetary value. In practice, virtual assets can be lost for various reasons, often through unauthorized use of the game account of one user by other users and occasionally through data loss caused by a delay of network service or by a network crash. Currently, there are no PRC laws or regulations specifically governing virtual asset property rights. As a result, it is unclear who is the legal owner of virtual assets and whether and how the ownership of virtual assets is protected by law. In case of a loss of virtual assets, we may be sued by our online users and may be held liable for damages, which may negatively affect our business, financial condition and results of operations. Shanda Games has been involved in a number of lawsuits related to its in-game items in its online games, most of which have been settled and some of which are ongoing.
In addition, it is unclear under PRC law whether an operator of online games such as Shanda Games would have any liability to game players or other interested parties (whether in contract, tort or otherwise) for loss of such virtual assets by game players. Based on several judgments by PRC courts regarding the liabilities of online game operators for loss of virtual assets by game players, the courts have generally required online game operators to return such lost virtual items or be liable for the loss and damage incurred therefrom.
Due to our leading position in several Internet-related industries, we may be subject to claims under the Anti-Monopoly Law.
The new Anti-Monopoly Law (“AML”) was passed by the National People’s Congress on August 30, 2007 and came into effect on August 1, 2008. While certain aspects of the AML are unclear and dependent on subsequent interpretation and development, the law sets forth the prohibited conduct (referred to as “Monopolistic Acts”), the enforcement mechanisms, and the penalties for those who violate its provisions.
The AML prohibits Monopolistic Acts, including “monopoly agreements,” abuse of a dominant market position, and certain “concentrations”, which result or could result in the elimination or restriction of competition. The law also provides that the State Council will establish an Anti-Monopoly Commission with authority to make competition policy, publish guidelines, and lead and coordinate anti-monopoly enforcement work.
As of the date of this annual report, there have been only a limited number of enforcement actions and claims raised under the AML. It remains to be seen how the AML will be implemented in practice and what it will mean for us and other companies in China. Nevertheless, given the leading position several of our businesses have in the Chinese online entertainment markets, it is possible that some of our competitors and/or our users may seek to take advantage of the AML to make claims against us, which may have an adverse impact on our business, operation and financial conditions.
The PRC government may unintentionally restrict access to our online entertainment content.
The MIIT issued a Circular regarding the Pre-installment of Green Web Filter Software on Computers on May 19, 2009. According to this circular, starting from July 1, 2009, all computers sold in China are required to be installed with government-designated software to block “unhealthy words or pictures.” However, according to certain media reports, testing by experts suggest that the software, called Green Dam — Youth Escort, may be used to censor other websites deemed inappropriate by the government, disable programs when people input sensitive words, monitor personal communications and track where people surf on the Internet. On August 13, 2009, the minister of the MIIT announced that the Chinese government will not require all computers sold in China to be installed with the filter software, only computers used in schools, Internet cafes and other public places will be required to be installed with the filter software in order to prevent young people from being harmed by unhealthy online content.

 

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It is unclear how and to what extent it may be implemented by the MIIT. Although this circular is not intended to block access to online games, if it is strictly implemented, it could potentially discourage or restrict the use of the Internet by users of our online entertainment content, and consequently have an adverse impact on our business, operation and financial conditions.
Risks Relating to the People’s Republic of China
Substantially all of our assets are located in China and substantially all of our revenues are derived from our operations in China. Accordingly, our business, financial condition, results of operations and prospects are subject, to a significant extent, to economic, political and legal conditions and developments in China.
The PRC’s economic, political and social conditions, as well as government policies, could affect our business.
The PRC economy differs from the economies of most developed countries in many respects, including in the amount of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC economy has experienced significant growth since the late 1970’s, growth has been uneven, both geographically and among various sectors of the economy. The PRC government has implemented numerous measures to encourage economic growth and to guide the allocation of resources. Some of these measures may benefit the overall PRC economy, but also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us.
The PRC economy has been transitioning from a planned economy to a more market-oriented economy. Although the PRC government has implemented measures since the late 1970s emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets and the establishment of sound corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the PRC government. In addition, the PRC government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC government also exercises significant control over China’s economic growth through the allocation of resources, controlling payment of foreign currency denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies. These actions, as well as future actions and policies of the PRC government, could materially affect general economic conditions in China and could have a material adverse effect on our business and results of operations.
A severe and prolonged global economic recession and the corresponding slowdown in the Chinese economy could affect our business.
The effect of the recent global financial crisis has persisted, with most of the world’s major economies remaining in recession in 2010. While there has been improvement in some areas, it is still unclear whether the recovery is sustainable. There are uncertainties over the impact of the proposed Euro 110 billion bailout of Greece by the European Union and the International Monetary Fund and the impact this may have on the global economy. There is also considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of the world’s leading economies, including China’s. Continued concerns about the systemic impact of potential long-term and wide-spread recession, energy costs, geopolitical issues, the availability and cost of credit, the global housing and mortgage markets and the European debt crisis have contributed to increased market volatility and diminished expectations for economic growth around the world. The grim economic outlook has negatively affected business and consumer confidence and contributed to volatility of unprecedented levels. The Chinese economy also faces challenges. The stimulus plans and other measures implemented by the Chinese government may not avert an economic downturn amid a severe and prolonged global economic recession. Any prolonged slowdown in the Chinese economy may have a negative impact on our business, operating results and financial condition in a number of ways. For example, our customers may reduce or delay spending with us, while we may have difficulty expanding our customer base fast enough, or at all, to offset the impact of decreased spending by our existing customers.

 

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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 general economic and business matters. The overall effect of legislation since 1979 has been a significant enhancement of the protections afforded to various forms of foreign-invested enterprises in mainland China. Our PRC subsidiaries are wholly foreign owned enterprises, or WFOEs, which are enterprises incorporated in mainland China and wholly-owned by foreign investors. Our PRC subsidiaries are subject to laws and regulations applicable to foreign investment in mainland China in general and laws and regulations applicable to WFOEs in particular. However, these laws, regulations and legal requirements are constantly changing, and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to us and other foreign investors, including you. In addition, we cannot predict the effect of future developments in the PRC legal system, particularly with regard to the Internet, 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.
Restrictions on currency exchange may limit our ability to utilize our revenues effectively.
Most of our revenues and operating expenses are denominated in Renminbi. The Renminbi is currently freely convertible under the “current account”, which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account”, which includes foreign direct investment and loans.
Currently, our PRC subsidiaries may purchase foreign exchange for settlement of “current account transactions”, including payment of dividends to us and payment of license fees to foreign game licensors, and our PRC operating companies may purchase foreign exchange for payment of license fees to foreign game licensors without the approval of SAFE. Our PRC subsidiaries may also retain foreign exchange in its current account, subject to a ceiling approved by SAFE, to satisfy foreign exchange liabilities or to pay dividends. However, we cannot assure you that the relevant PRC governmental authorities will not limit or eliminate our ability to purchase and retain foreign currencies in the future.
Since a significant amount of our future revenues will be denominated in Renminbi, the existing and any future restrictions on currency exchange may limit our ability to utilize revenues generated in Renminbi to fund our business activities outside China, if any, or expenditures denominated in foreign currencies.
Foreign exchange transactions under the capital account are subject to limitations and require registration with or approval by the relevant PRC governmental authorities. In particular, if we finance our PRC subsidiaries by means of foreign currency loans, those loans cannot exceed certain statutory limits and must be registered with SAFE, and if we finance our PRC subsidiaries by means of capital contributions, those capital contributions must be approved by the MOFCOM. Our ability to use the U.S. dollar proceeds of the sale of our equity or debt to finance our business activities conducted through our PRC subsidiaries will depend on our ability to obtain these governmental registrations or approvals. In addition, because of the regulatory issues related to foreign currency loans to, and foreign investment in, domestic PRC enterprises, we may not be able to finance our PRC operating companies’ operations by loans or capital contributions. We cannot assure you that we can obtain these governmental registrations or approvals on a timely basis, if at all.
Fluctuations in exchange rates could result in foreign currency exchange losses.
Most of our revenues are denominated in Renminbi, while a portion of our expenditures are denominated in foreign currencies, primarily the U.S. dollar. Fluctuations in exchange rates, particularly those involving the U.S. dollar, may affect our costs and operating margins. In addition, these fluctuations could result in exchange losses and increased costs in Renminbi terms. Where our operations conducted in Renminbi are reported in U.S. dollars, such fluctuations could result in changes in reported results which do not reflect changes in the underlying operations. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar. Under the new policy, the Renminbi is permitted to fluctuate within a narrow and managed band against a basket of certain foreign currencies. This change in policy has resulted in a more than 21% appreciation of the Renminbi against the U.S. dollar as of March 31, 2010. While the international reaction to the

 

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Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further and more significant appreciation of the Renminbi against the U.S. dollar. On the other hand, as most of our revenues are denominated in Renminbi, any potential future devaluation of the Renminbi against U.S. dollars could negatively impact our results of operations. Moreover, we have material monetary assets and liabilities denominated in U.S. dollars, which mainly consist of our bank deposits and the convertible notes. The fluctuation of foreign exchange rate affects the value of these monetary assets and liabilities denominated in U.S. dollars. Generally, an appreciation of the Renminbi against U.S. dollars results in a foreign exchange loss for monetary assets denominated in U.S. dollars, and a foreign exchange gain for monetary liabilities denominated in U.S. dollars. On the contrary, a devaluation of the Renminbi against U.S. dollars results in a foreign exchange gain for monetary assets denominated in U.S. dollars, and a foreign exchange loss for monetary liabilities denominated in U.S. dollars. Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge all or part of our exposure or at all. In addition, our currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert Renminbi into U.S. dollars. Conversely, an increase in the value of the Renminbi could increase our reported earnings in U.S. dollar terms without a fundamental change in our business or operating performance.
Since our revenues are primarily denominated in Renminbi, our valuation could be materially and adversely affected by the devaluation of the Renminbi if U.S. investors analyze our value based on the U.S. dollar equivalent of our financial condition and results of operations.
Inflation in China and measures to contain inflation could negatively affect our profitability and growth.
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. If prices for our products and services rise at a rate that is insufficient to compensate for the rise in our costs, our business may be materially and adversely affected. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets, and restrictions on state bank lending. Such austerity measures can lead to a slowing of economic growth. A slowdown in the PRC economy could also materially and adversely affect our business and prospects.
We face risks related to natural disasters, health epidemics and other outbreaks of contagious diseases.
Our business could be adversely affected by natural disasters, avian influenza, or avian flu, SARS, H1N1 influenza, or H1N1 flu (also known as swine flu), or other epidemics or outbreaks. On April 14, 2010, China experienced an earthquake with a reported magnitude of 6.9 on the Richter scale in Qinghai Province, resulting in the death of over 2,000 people and on May 12, 2008, China experienced an earthquake with a reported magnitude of 8.0 on the Richter scale in Sichuan Province, resulting in the death of tens of thousands of people. As a result of the 2010 and 2008 earthquakes, we observed a one- and three-day period, respectively, of national mourning for the victims, during which several of our businesses suspended online activities, in accordance with a public notice issued by the PRC government. There have been recent reports of outbreaks of a highly pathogenic avian flu caused by the H5N1 virus, in certain regions of Asia and Europe. In 2005 and 2006, there have been reports on the occurrences of avian flu in various parts of China, including a few confirmed human cases. Since April 2009, there have been reports on the occurrences of H1N1 flu in Mexico, the United States, China and certain other countries and regions around the world. An outbreak of avian flu or H1N1 flu in the human population could result in a widespread health crisis that could adversely affect the economies and financial markets of many countries, particularly in Asia. Additionally, any recurrence of SARS, a highly contagious form of atypical pneumonia, similar to the occurrence in 2003 that affected China, Hong Kong, Taiwan, Singapore, Vietnam and certain other countries and regions, would also have similar adverse effects. These natural disasters, outbreaks of contagious diseases, and other adverse public health developments in China could severely disrupt our business operations and adversely affect our financial condition and results of operations. We have not adopted any written preventive measures or contingency plans to combat any future natural disasters or outbreak of avian flu, H1N1 flu, SARS or any other epidemic.

 

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We may be subject to fines and legal sanctions if we or our Chinese employees fail to comply with recent PRC regulations relating to employee stock options granted by overseas listed companies to PRC citizens.
On March 28, 2007, the SAFE issued the Application Procedure for Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plans or Stock Option Plans of Overseas Listed Companies, or Notice 78. Under Notice 78, PRC individuals who participate in an employee stock option holding plan or a stock option plan of an overseas listed company are required, through a PRC domestic agent or PRC subsidiary of the overseas listed company, to register with SAFE and complete certain other procedures. We and our Chinese employees who have been granted restricted shares or stock options pursuant to our share incentive plan are subject to Notice 78 because we are an overseas listed company. However, in practice, there exist significant uncertainties with regard to the interpretation and implementation of Notice 78. We are committed to complying with the requirements of Notice 78. However, we cannot provide any assurance that we or our Chinese employees will be able to complete, qualify under, or obtain any registration required by Notice 78. In particular, if we and/or our Chinese employees fail to comply with the provisions of Notice 78, we and/or our Chinese employees may be subject to fines and legal sanctions imposed by the SAFE or other PRC government authorities, as a result of which our business operations and employee option plans could be materially and adversely affected.
Risks Relating to Our ADSs
One shareholder has significant control over the outcome of our shareholder votes.
As of December 31, 2009, Premium Lead Company Limited, or Premium Lead, whose beneficial owner is Tianqiao Chen, our chairman and chief executive officer, owned approximately 44.5% of our outstanding ordinary shares. Accordingly, Premium Lead has and is expected to maintain significant control over the outcome of any corporate transaction or other matter submitted to our shareholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets.
If Premium Lead, which holds approximately 44.5% of our ordinary shares as of December 31, 2009, or any other major shareholder chooses to dispose of a material portion of the ordinary shares that it holds, the prevailing market price for our securities may decline.
On September 19, 2007, Skyline Media Limited, or Skyline Media, sold 9,131,878 of our ordinary shares pursuant to Rule 144 under the Securities Act of 1933. On the day of this sale, the market price for our ordinary shares decreased by approximately 6.8%. If Premium Lead, to whom Skyline Media transferred 60,000,000 of our ordinary shares on December 27, 2007 and whose beneficial owner is Tianqiao Chen, our chairman and chief executive officer, or any other major shareholder, chooses to sell a material portion of the ordinary shares that it holds, or indicates its intention to do so, the prevailing market price for our securities may decline.
The price of our ADSs has been volatile historically and may continue to be volatile, which may make it difficult for holders to resell the ADSs when desired or at attractive prices.
The trading price of our ADSs has been and may continue to be subject to wide fluctuations. Since we completed our initial public offering in May 2004, the sale prices of our ADSs on the NASDAQ Global Select Market ranged from US$10.58 to US$63.66 per ADS and the last reported sale price on May 14, 2010 was US$43.50.
Our ADS price may fluctuate in response to a number of events and factors, including among other factors:
    announcements of technological or competitive developments;
    regulatory developments in our target markets affecting us, our customers or our competitors;
    announcements regarding intellectual property rights litigation;

 

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    actual or anticipated fluctuations in our quarterly operating results;
    changes in financial estimates by securities research analysts;
    changes in the economic performance or market valuations of our products;
    addition or departure of our executive officers and key research personnel; and
    sales or perceived sales of additional ordinary shares or ADSs.
In addition, the financial markets in general, and the market prices for Internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our ADSs, regardless of our operating performance.
The price of our ADSs also could be affected by possible sales of our ordinary shares or ADSs by investors who view our 2% convertible senior notes due 2011, or the convertible notes, as a more attractive means of equity participation in our company and by hedging or arbitrage activity involving our ordinary shares and ADSs that we believe has developed as a result of the issuance of the convertible notes.
Conversion of the convertible notes may dilute the ownership interest of existing holders of our ordinary shares and ADSs.
Under certain circumstances, upon conversion of the convertible notes, we have the right to deliver our ordinary shares or ADSs representing such ordinary shares, in lieu of cash. If we decide to deliver ordinary shares or ADSs representing such ordinary shares, the ownership interests of existing holders of ADSs may be diluted. Any sales in the public market of our ADSs issuable upon such conversion could adversely affect prevailing market prices of our ADSs. In addition, the anticipated conversion of the notes into any ordinary shares or ADSs representing such ordinary shares could depress the price of our ADSs.
We may be unable to raise the funds to pay interest on the convertible notes or to purchase the convertible notes on the purchase dates or upon a fundamental change.
The convertible notes bear interest at an annual rate of 2.0%, payable semi-annually, and we in certain circumstances are obligated to pay additional interest. If a fundamental change occurs, holders of the convertible notes may require us to repurchase, for cash, all or a portion of their convertible notes. In addition, upon conversion of the convertible notes, we will pay the principal amount in cash. We used all of the net proceeds from the sale of the convertible notes, together with cash on hand, to repurchase US$175.0 million worth of our ADSs pursuant to an accelerated share repurchase program. We may not have sufficient funds for any required repurchase of the convertible notes or required payment of principal or interest, and we may have to obtain financing to make payments under the convertible notes. If we fail to pay interest or principal on the convertible notes or repurchase the convertible notes when required, we will be in default under the indenture governing the convertible notes.
Provisions of the convertible notes could discourage an acquisition of us by a third-party.
Certain provisions of the convertible notes could make it more difficult or more expensive for a third-party to acquire us. Upon the occurrence of certain transactions constituting a “fundamental change”, holders of the convertible notes will have the right, at their option, to require us to repurchase all of their notes or any portion of the principal amount of such notes in integral multiples of $1,000. We may also be required to issue additional shares upon conversion or provide for conversion into the acquirer’s capital stock in the event of certain fundamental changes.

 

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As a foreign private issuer with ADSs listed on the NASDAQ Global Select Market, we follow certain home country corporate governance practices instead of certain NASDAQ requirements.
As a foreign private issuer whose ADSs are listed on the NASDAQ Global Select Market, we are permitted to follow certain home country corporate governance practices instead of certain NASDAQ requirements. A foreign private issuer that elects to follow its home country practice must submit to the NASDAQ Stock Market LLC a written statement from an independent counsel in such issuer’s home country certifying that the issuer’s practices are not prohibited by the home country’s laws. In addition, a foreign private issuer must disclose in its annual reports filed with the SEC each NASDAQ requirement with which it does not comply followed by a description of its applicable home country practice.
As a company incorporated in the Cayman Islands with ADSs listed on the NASDAQ Global Select Market, we intend to follow our home country practice instead of NASDAQ requirements that mandate that:
    our board of directors be comprised of a majority of independent directors;
    our directors be selected or nominated by a majority of the independent directors or a nomination committee comprised solely of independent directors;
    our board adopt a formal written charter or board resolution addressing the director nominations process and such related matters as may be required under the U.S. federal securities laws; and
    the compensation of our executive officers be determined or recommended by a majority of the independent directors or a compensation committee comprised solely of independent directors.
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.
Our corporate affairs are governed by our memorandum and articles of association, the Companies Law (2007 Revision) and common law of the Cayman Islands. The rights of our shareholders to take action against the directors, actions by minority 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 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.
In addition, 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:
    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
    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 and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.
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.

 

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In addition, Cayman Islands companies may not have standing to sue before the federal courts of the United States. As a result, our ability to protect our interests if we are harmed in a manner that would otherwise enable us to sue in a United States federal court may be limited.
You may experience difficulties in effecting service of process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management.
We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in the PRC. In addition, most of our directors and officers are nationals and residents of countries other than the United States. A substantial portion of the assets of these persons are located outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons. It may also be difficult for you to enforce judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws against us and our officers and directors, most of whom are not residents in the United States and the substantial majority of whose assets are located outside of the United States. In addition, there is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments of U.S. courts against us or such persons predicated upon the civil liability provisions of the securities laws of the United States or any state due to the lack of reciprocal treaty in the Cayman Islands or the PRC providing statutory recognition of judgments obtained in the United States. The PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts. Furthermore, it is uncertain whether such Cayman Islands or PRC courts would be competent to hear original actions brought in the Cayman Islands or the PRC against us or such persons who reside outside the United States predicated upon the securities laws of the United States or any state.
Anti-takeover provisions in our organizational documents may discourage our acquisition by a third-party, which could limit your opportunity to sell your shares at a premium.
Our amended and restated memorandum and articles of association include provisions that could limit the ability of others to acquire control of us, modify our structure or cause us to engage in change of control transactions, including, among other things, the following:
    provisions that restrict the ability of our shareholders to call meetings and to propose special matters for consideration at shareholder meetings; and
    provisions that authorize our board of directors, without action by our shareholders, to issue preferred shares and to issue additional ordinary shares, including ordinary shares represented by ADSs.
These provisions could have the effect of depriving you of an opportunity to sell your ADSs at a premium over prevailing market prices by discouraging third parties from seeking to acquire control of us in a tender offer or similar transactions.
The voting rights of holders of ADSs are limited by the terms of the deposit agreement.
A holder of our ADSs may only exercise the voting rights with respect to the underlying ordinary shares in accordance with the provisions of the deposit agreement. Upon receipt of voting instructions of 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 ten 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. 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.

 

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We may be required to withhold PRC income tax on the dividends we pay you (if any), and any gain you realize on the transfer of our ordinary shares and/or ADSs may also be subject to PRC withholding tax.
Pursuant to the New EIT Law, we may be treated as a PRC resident enterprise for PRC tax purposes. See “— Risks Relating to Our Business—There are significant uncertainties under the New EIT Law relating to our PRC enterprise income tax liabilities.” If we are so treated by the PRC tax authorities, we would be obligated to withhold PRC income tax on payments of dividends on our shares and/or ADSs to investors that are non-resident enterprises of the PRC, because the dividends payable on our ordinary shares and/or ADSs would be regarded as being derived from sources within the PRC. The withholding tax rate depends on the provisions of the bilateral tax treaty, if any, between the PRC and the jurisdiction where the non-resident enterprise is incorporated. For example, for non-resident enterprises located in Hong Kong which own more than 25% of the shares or equity interest in a domestic PRC company, the rate is 5%, and for non-resident enterprises located in United States, the rate would be 10%. If the jurisdiction where the non-resident enterprise is incorporated does not have a bilateral tax treaty with the PRC, such as the Cayman Islands, a uniform rate of 10% will apply. In addition, any gain realized by any investors who are non-resident enterprises of the PRC from the transfer of our ordinary shares and/or ADSs could be regarded as being derived from sources within the PRC and be subject to a 10% PRC withholding tax. Moreover, under the PRC Individual Income Tax Law, or IITL, non-resident individual investors are required to pay PRC individual income tax on interests or dividends payable to the investors or any capital gains realized from the transfer of our ordinary shares and/or ADSs if such gains are deemed income derived from sources within the PRC. A non-resident individual refers to an individual who has no domicile in China and does not stay within the territory of PRC or who has no domicile in PRC and has stayed within the PRC for less than one year. Pursuant to the IITL and its implementation rules, for purposes of the PRC capital gains tax, the taxable income will be the balance of the total income obtained from the transfer of our ordinary shares and/or ADSs minus all the costs and expenses that are permitted under PRC tax laws to be deducted from the income. Therefore, if we are considered as a PRC resident enterprise and dividends we pay with respect to our ordinary shares and/or ADSs and the gains realized from the transfer of our ordinary shares and/or ADSs are considered income derived from sources within the PRC by relevant competent PRC tax authorities, such gains earned by non-resident individuals may also be subject to PRC withholding tax. The foregoing PRC withholding tax would reduce your investment return on our ordinary shares and/or ADSs and may also materially and adversely affect the price of our ordinary shares and/or ADSs.
You may be subject to limitations on transfer of your ADSs.
Your ADSs represented by American Depositary Receipts, or ADRs, 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 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 advisable to do so because of any requirement of law or any government or governmental body, or under any provision of the deposit agreement, or for any other reason.
Your right as a holder of ADSs to participate in any future rights offerings may be limited, which may cause dilution to your holdings.
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we cannot make rights available to our ADS holders in the United States unless we register the rights and the securities to which the rights relate under the Securities Act or an exemption from the registration requirements is available. In addition, the deposit agreement provides that the depositary bank will not make rights available to you unless the distribution to ADS holders of both the rights and any related securities are either registered under the Securities Act or 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, ADS holders may be unable to participate in our rights offerings and may experience dilution in their holdings. In addition, if the depositary is unable to sell rights that are not exercised or not distributed or if the sale is not lawful or reasonably practicable, it will allow the rights to lapse, in which case you will receive no value for these rights.

 

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Item 4. INFORMATION ON THE COMPANY
A. HISTORY AND DEVELOPMENT OF THE COMPANY
Our business was founded in December 1999 when Tianqiao Chen and Danian Chen established Shanda Networking to develop and operate “stame.com”, an online virtual community. At an early stage, we identified online games as an attractive media content segment with high growth potential and strong user interaction, and commercially launched Mir II, our first MMORPG in November 2001. In November 2003, we incorporated Shanda Interactive Entertainment Limited in the Cayman Islands. We completed our initial public offering of ADRs on the NASDAQ Global Market in May 2004. As a result of our financial performance, among other factors, we are currently listed on the NASDAQ Global Select Market.
Today, we are one of China’s leading interactive entertainment media companies. We offer a diversified entertainment content portfolio including, among other things, MMORPGs, advanced casual games and flash games without user-end software through Shanda Games and its subsidiaries, online (Internet and WVAS) and offline literature publication through Shanda Literature and its subsidiaries, online chess and board games platform through Bianfeng and its subsidiaries, an e-sports game platform through Haofang and WVAS, music and online video through Hurray! and its subsidiaries. We are expanding our content offerings into TV series and movies through a newly established joint venture with Hunan TV.
We offer an integrated service platform through Shanda Online, hosting a broad array of online entertainment content offered by ourselves or third-party content providers. Our integrated service platform offers a turnkey solution to distribute online entertainment content to our large and diversified user base.
The following information describes certain major developments in our history up to March 31, 2010.
    In July 2004, we acquired Hangzhou Bianfeng Networking Co., Ltd., or Hangzhou Bianfeng, which operates an online chess and board games platform;
    In September 2004, we acquired Shanghai Xuanting Entertainment Information Technology Co., Ltd., or Qidian, which operates Qidian.com, an original online literature platform;
    In May 2005, we acquired Shanghai Haofang Online Information Technology Co. Ltd., or Haofang, which operates a leading e-sports game platform in China;
    In November 2005, we acquired Wenzhou Chuangjia Technology Co., Ltd., or Gametea, which operates an online chess and board games platform in China;
    In August 2007, we acquired 50% of the equity interest in Jinjiang Literature City, or Jinjiang, which operates Jjwxc.net, an original online literature platform;
    In April 2008, we acquired 60% of the equity interest in Hongxiu.com, or Hongxiu, which operates an original online literature platform of the same name;
    In 2008, we commenced a reorganization. Specifically, we reorganized certain of our content businesses into Shanda Games, which develops, sources and manages intellectual property rights related to MMORPGs and advanced casual games; Shanda Literature, which operates online literature platforms; and other online content businesses. In addition, we established Shanda Online, which owns and operates an integrated service platform.
    In September 2008, we issued US$175 million in aggregate principal amount of 2.0% senior convertible notes due 2011 (the “Convertible Notes”) pursuant to Rule 144A under the Securities Act. All of the proceeds from the issuance of the Convertible Notes were used to repurchase our ADSs pursuant to an accelerated share repurchase program which we completed in March 2009. For more information on our accelerated share repurchase program, see Item 16E “Purchases of Equity Securities by the Issuer and Affiliated Purchasers” and Item 3 “Risk Factors”.

 

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    In 2009, we established the Institute for Innovation and Technology, or IIT, to conduct research on and develop new technology, products and services.
    In July 2009, we closed the tender offer of 52.6% of the outstanding shares of Hurray! Holding, Co., Ltd., or Hurray! (NASDAQ: HRAY), whose businesses include artist development, music production and offline distribution in China and distribution of music and music-related products such as ringtones, ring-back tones, and truetones, to mobile users in China through a wide range of WVAS platforms over mobile networks and through the Internet. We subsequently purchased a certain number of Hurray! shares from certain existing shareholders and through open market transactions. As of March 31, 2010, we held approximately 42.0% of Hurray!’s total outstanding shares calculated on a fully-diluted basis due to the dilution caused by the issuance of shares by Hurray! in connection with its acquisition of Ku6 in January 2010.
    On September 30, 2009, Shanda Games completed its initial public offering of its ADSs on the NASDAQ Global Select Market.
    In November 2009, we and Hunan TV established a joint venture, which plans to produce and distribute movies and television series, as well as engage in other related businesses such as agency services.
    In January 2010, Hurray! acquired Ku6, a leading online video portal in China. Ku6 is currently a wholly-owned subsidiary of Hurray! and has retained its brand name.
    In January 2010, Shanda Games acquired Goldcool, a Shanghai based online game developer and operator.
    In January 2010, Shanda Games acquired Mochi Media, a leading platform for distributing and monetizing browser-based games worldwide.
Our principal executive offices are located at 208 Juli Road, Pudong New Area, Shanghai 201203, China. Our telephone number is (86-21) 5050-4740. Our agent for service of process in the United States is CT Corporation System, located at 111 Eighth Avenue, New York, New York 10011.
B. BUSINESS OVERVIEW
We are one of China’s leading interactive entertainment media companies, offering a broad array of entertainment content to a large and diversified user base and an integrated service platform. Our business lines include:
    Shanda Games. Shanda Games offers MMORPGs and advanced casual games. Shanda Games also offers flash games without user-end software through recently acquired Mochi Media.

 

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    Shanda Literature. Shanda Literature provides literature and other publications offered through websites, wireless distribution and offline publications to a diversified user base. Shanda Literature also franchises the copyrights of its literature works to online game companies, television producers, movie studios and traditional offline book publishers, etc.
    Bianfeng. Bianfeng and its subsidiaries operate online chess and board games platforms.
    Haofang. Haofang operates an e-sports game platform.
    Hurray!. Hurray! provides a wide range of WVAS to mobile users in China, including music, games, ringtones, pictures and animation, community, and other media and entertainment services. It is also engaged in artist development, music production and offline distribution in China and Taiwan through several affiliates. Hurray! has expanded its business into online video portal market after its acquisition of Ku6 in January 2010.
    Shanda Online. Shanda Online operates an integrated service platform which provides distribution, payment, customer service, and other e-commerce services for online entertainment content.
Shanda Games
Shanda Games, our majority-owned subsidiary, is one of China’s leading online game companies in terms of revenues and the size and diversity of its game portfolio. Through its extensive experience in the online game industry in China, Shanda Games has created a scalable approach to develop, source and manage intellectual property rights relating to MMORPGs and advanced casual games. Shanda Games uses multiple channels, including through in-house development, licensing, investment and acquisition, co-development and co-operation, to build a large and diversified game portfolio and pipeline of various genres. Shanda Games operates a nationwide, secure network to host hundreds of thousands of users playing simultaneously, and monitors and adjusts the game environment to optimize its game players’ experience.
As of March 31, 2010, Shanda Games operated 26 MMORPGs and eight advanced casual games. Each MMORPG creates an evolving virtual world within which game players can play and interact with one another simultaneously over the Internet. Because MMORPGs require a significant amount of players’ time and commitment to develop the skills and character attributes required to progress to the next level, MMORPGs tend to develop high game player loyalty. Two MMORPGs, Mir II and Woool, generate the majority of Shanda Games’s revenues.
Advanced casual games are generally less time-consuming and require less focus and attention than MMORPGs but possess certain elements of MMORPGs such as a story line, elaborate graphics, availability of virtual items and frequent interaction among game players. Advanced casual games are an important component of Shanda Games’s overall growth strategy as such games generally attract a broader range of demographic groups, as well as more home users, than MMORPGs.
In January 2010, Shanda Games acquired Mochi Media, a leading platform for distributing and monetary browser-based games worldwide. Shanda Games offers flash games without user-end software through Mochi Media.

 

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The following table sets forth certain information relating to the MMORPGs that Shanda Games operated as of March 31, 2010.
                 
        Visual        
Game   Genre   Dimensions   Game Source   Launch Date
Mir II
  Martial arts adventure   2D   License(1)   November 2001
Woool
  Martial arts adventure   2D   In-house   October 2003
The Sign
  Martial arts adventure   3D   In-house   May 2004
The Age
  Martial arts adventure   2D   In-house   June 2004
Magical Land
  Fantasy   2D   In-house   July 2005
R.O.
  Fantasy   2D   License   September 2005
Archlord
  Fantasy   3D   License   July 2006
Latale
  Side-scrolling combat   2D   In-house   April 2007
Fengyun Online
  Martial arts adventure   3D   Acquisition   July 2007
World Hegemony
  Strategy web game   2D   In-house   November 2007
Might & Hero
  Strategy web game   2D   Investment   May 2008
Lineage
  Fantasy   2D   License   June 2008
Lineage II
  Fantasy   3D   License   June 2008
Tales of Dragons
  Fantasy   2D   In-house   July 2008
A Thousand Years III
  Martial arts adventure   2D   In-house   November 2008
AION
  Fantasy   3D   License   April 2009
JX Online World
  Martial arts adventure   2D   Co-operation   June 2009
Ghost Fighter Online
  Side-scrolling action   3D   Investment   August 2009
Luvinia Online
  Fantasy   3D   Acquisition   August 2009
ZU Online
  Martial arts adventure   3D   Investment   August 2009
Yuyan Online
  Martial arts adventure   2.5D(2)   Co-operation   September 2009
TS2 Online
  Turn-based   2D   License   December 2009
Hades Realm
  Martial arts adventure   2D   Acquisition   January 2010
Zodiac Tales
  Turn-based   2D   Acquisition   January 2010
Dukes and Lords
  Martial arts adventure   2D   Acquisition   January 2010
Woool of Heroes
  Martial arts adventure   2D   In-house   March 2010
 
     
(1)   Shanda Games licenses Mir II from Actoz, which is its majority-owned subsidiary. While Actoz controls the licensing of Mir II in China, Shanda Games continues to classify Mir II as a licensed game because Actoz shares a portion of the ongoing licensing fees it collects with a third-party that co-owns the intellectual property rights relating to Mir II.
 
(2)   2.5D refers to a game with 3D-rendered characters but a 2D game environment.
Advanced Casual Games
The following table sets forth certain information relating to the advanced casual games that Shanda Games operated as of March 31, 2010.
                 
        Visual        
Game   Genre   Dimensions   Game Source   Launch
BNB
  Battle   2D   License   August 2003
GetAmped
  Fighting   3D   License   May 2004
Maple Story
  Side-scrolling combat   2D   License   August 2004
Shanda Richman
  Strategy   3D   In-house   December 2005
Crazy Kart
  Racing   3D   In-house   March 2006
Kongfu Kids
  Fighting   3D   In-house   June 2007
Tales Runner
  Racing   3D   License   July 2007
Dead or Alive Online
  Fighting   3D   Co-development   May 2009
Some of Shanda Game’s online games are played on a web browser and typically do not require any user-end software to be installed apart from the web browser. The flash games without user-end software offered by Mochi Media are not included in the above tables.
Shanda Literature
We, through our wholly-owned subsidiary Shanda Literature, provide literature and other publications offered through websites, offline publication and wireless distribution to a diversified user base, and franchise the copyrights of its literature works to online game companies, television producers, movie studios, and traditional offline book publishers, etc.
Shanda Literature, which is one of the few companies in China with the necessary government approval to publish literature through the Internet or through a wireless network, generates its revenues by monetizing the copyrights relating to the literary works it publishes.

 

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In January 2010, Shanda Literature acquired 51% of the outstanding shares of Beijing Joy Media Co., Ltd., or Rongshuxia, which operates rongshuxia.com. To expand its business into offline book publication, Shanda Literature acquired several offline book publishers during 2009 and first quarter of 2010: 95% of the outstanding shares of Tianjing Jushi Wenhua Book Distribution Co., ltd., 51% of the outstanding shares of Tianjing Huawen Tianxia Book Co., Ltd., and 51% of the outstanding shares of Tianjing Zhongzhi Bowen Book Co., Ltd.
Shanda Literature allows its users to access limited portions of most of the literary works on its online literature platforms for free and charges users a subscription fee to access premium content. The literary works published on its online literature platforms are written by online authors, some of whom, depending on the user receptiveness to and the popularity of a particular literary work, have the opportunity to enter into a revenue-sharing agreement with Shanda Literature. Shanda Literature’s online literature platforms include:
    Qidian.com;
    Hongxiu.com;
    Jjwxc.net; and
    Rongshuxia.com.
As of March 31, 2010, the total aggregate number of characters published has reached over 51 billion.
Shanda Literature also provides offline book publishing service to its authors. Its offline book publishing companies include:
    Jushiwenhua;
    Huawentianxia; and
    Zhongzhibowen.
In addition, Shanda Literature provides access to handset optimized literature works through its wireless platform and cooperation with telecommunications operators. Shanda Literature has also licensed certain intellectual property rights related to some of its literary works to television producers, movie studios, online game developers and traditional offline book publishers, including our affiliated companies and third parties.
Shanda Literature’s platforms have received a number of awards. For example, Qidian received the “2009 Most Valuable Website” by New Weekly magazine, “Best Literature Website Of The Year” in the second China International Copyright Expo” and “Top 10 China Internet Brand” which is issued by Google China.
Bianfeng
We offer online chess and board games, mainly through Bianfeng and its subsidiaries. Online chess and board games include card games, traditional board games, mahjong and simple arcade games, etc.
Haofang
Haofang operates our e-sports games platform, through which a user can connect his or her computer with other users’ computers through the Internet to form a virtual private network, or VPN, to play a personal computer game. Without a VPN service, users of personal computer games would generally be limited to playing with other users that are either at the same personal computer or connected through a local area network.

 

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Hurray!
Hurray! derives most of its revenues from WVAS, which includes 2G services such as short message service, interactive voice response and ring back tone, and 2.5G services such as WAP, MMS, and Java™, each of which is available on the networks of China Mobile, China Unicom and China Telecom.
Hurray! began offering music and artist agency services in late 2008, which services include discovering, developing and representing recording artists and promoting, selling and licensing their works through designated third parties.
Hurray! entered the online video market in January 2010 when it acquired Ku6, one of the leading online video portals in China. Ku6.com hosts professionally-produced and user-generated video content from a network of media partners in China, around Asia and from around the world. Its online video business derives its revenue principally from advertising.
Shanda Online
Shanda Online operates an integrated service platform which provides distribution, payment, customer service, and other e-commerce services for online entertainment content, including, among others, MMORPGs, advanced casual games, light casual games, and online literature. Shanda Online provides such services to our internally developed and operated content as well as third-party content providers.
The service modules of Shanda Online’s platform include a digital content delivery system, a promotion-payment community system and a customer relationship management system. Shanda Online’s platform has also won a number of awards including “Best Call Center” from 2004 through 2009, “China’s Outstanding Customer Service Award”, “Top 10 Service Brands in China” and “Top 10 Most Influential Brands with High Customer Satisfaction.”

 

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As of March 31, 2010, 41 online third-party content developers and operators in China offered or have agreed to offer their content through Shanda Online’s service platform. In addition, 59 content providers have agreed to use Shanda Online’s distribution channels. We believe that these additional content offerings will help attract additional users to Shanda Online’s service platform.
Shanda Online is currently working to enhance and expand its infrastructure and its services, including, among other things, user-related services such as billing, authentication, registration, payment, promotion, customer service, content downloads; customer-related communications and community services, such as email, instant messaging, social networking services; and data mining services.
Competition
Shanda Games competes primarily with other online game developers and operators in China, including Changyou.com Limited, Giant Interactive Group, Inc., Kingsoft Corporation Limited, NetDragon Websoft Inc., NetEase.com, Nineyou International Limited, Perfect World Co., Ltd., Tencent Holdings Limited and The9 Limited. Shanda Games also competes with other private companies in China devoted to game development or operation, many of which are backed by venture capital funds and international competitors. Competition may also come from international game developers and operators. Shanda Games competes primarily on the basis of the quality or features of its online games, its operational infrastructure and expertise, the strength of its product management approach, and the services it offers that enhance our game players’ experience.
We believe that domestic game developers and operators, including Shanda Games, are likely to have a competitive advantage over international competitors entering the China market, as these companies are likely to lack operational infrastructure in China and content localization experience for the market. We cannot assure you, however, that this competitive advantage will continue to exist, particularly if international competitors establish joint ventures or form alliances with or acquire domestic game developers and operators. In addition, Shanda Games also competes for users against various offline games, such as console games, arcade games and handheld games, as well as various other forms of traditional or online entertainment.
Shanda Literature competes primarily with other online literature portals as well as traditional publishers who engage in offline publishing and who have begun to develop online literature businesses.
Bianfeng and Haofang compete primarily with other light casual game and e-sports game platforms such as ourgame.com and Tencent’s online chess and board platform.
Hurray! WVAS business competes primarily with other WVAS providers in China, including companies such as KongZhong, Linktone, Sina, Sohu, Tencent., Rock Mobile, A8 and China Mobile.
Hurray’s music and artist agency business faces competition from traditional record companies, including international record companies such as Warner Music, Universal, EMI and Sony BMG; and independent labels based in Hong Kong, Taiwan and China such as Taihe Rye, Rock Music, Ocean Butterfly and Zhushu; and WVAS providers such as Rock Mobile, a subsidiary of Rock Music, and A8, which have recently focused on music-related products and extended upstream to establish their own music production businesses in China.
Ku6 faces significant competition from over 100 other online video sharing sites. Among the independent online video sites, Tudou.com and Youku.com command over half of the online viewership market. Moreover, several large Internet portals in China, such as Sina.com, Sohu.com and Baidu.com have begun to launch their own video businesses. Other advertising media, such as newspapers, yellow pages, magazines, billboards and other forms of outdoor media, television and radio, compete for a share of its customers’ marketing budgets.
Shanda Online competes with different competitors in each of its service areas.

 

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Intellectual Property and Proprietary Rights
We rely on copyright, trademark, patent, trade secret and other intellectual property law, as well as non-competition, confidentiality and license agreements with our employees, suppliers, business partners and others to protect our intellectual property rights. Our employees are required to sign agreements acknowledging that all inventions, trade secrets, works of authorship, developments and other processes generated by them on our behalf are our property, and assigning to us any ownership rights that they may claim in those works. Despite these precautions, third parties may obtain and use intellectual property that we own or license without our consent. Unauthorized use of our intellectual property by third parties, and the expenses incurred in protecting our intellectual property rights, may adversely affect our business.
While we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of our intellectual property. This is particularly the case in China where the laws may not protect our proprietary rights as fully as in the United States. Infringement or misappropriation of our intellectual property could materially harm our business. We have registered a number of domain names including but not limited to www.snda.com, www.sdo.com and www.shandagames.com.
As of March 31, 2010, we owned 145 software copyrights, each of which has been registered with the State Copyright Bureau of the PRC.
As of March 31, 2010, we owned 118 trademarks, each in various classes, each of which has been registered with the China Trademark Office, and had 205 trademark applications, each in various classes, pending with the China Trademark Office. We have also filed applications to register certain trademarks in a number of other jurisdictions, including Germany, Hong Kong, South Korea, the United States, India, Japan, Canada, Singapore, Vietnam and New Zealand.
As of March 31, 2010, we held 35 patents granted by the State Intellectual Property Office of the PRC and we had 131 patent applications pending with the State Intellectual Property Office. In addition, we held patents that have been granted by select jurisdictions outside of China, including the US, Canada, Japan, European Union, South Korea and Singapore.
Regulatory Matters
The online media industry in China operates under a legal regime that consists of the State Council, which is the highest authority of the executive branch of the PRC central government, and the various ministries and agencies under its leadership. These ministries and agencies mainly include:
    the Ministry of Industry and Information Technology, or the MIIT;
    the Ministry of Culture, or the MOC;
    the General Administration of Press and Publication, or the GAPP;
    the State Copyright Bureau, or the SCB;
    the State Administration of Industry and Commerce, or the SAIC;
    the State Administration of Radio, Film and Television;
    the Ministry of Commerce, or the MOFCOM;
    the State Council Information Office;
    the Ministry of Public Security; and
    the Bureau of State Secrecy.

 

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The State Council and these ministries and agencies have issued a series of rules that regulate a number of different substantive areas of our business, which are discussed below.
Foreign Ownership Restrictions
PRC regulations currently limit foreign ownership of companies that provide Internet content services, which includes operating online games, to 50%. In addition, foreign and foreign-invested enterprises are currently not able to apply for an Internet Culture Business License from the MOC and Internet Publishing License from the GAPP for operating online games in China. In order to comply with foreign ownership restrictions, we operate our business in China through our VIEs, namely the Shulong entities with respect to Shanda Games, the Shanda Networking entities with respect to Shanda Online and the Hongwen entities with respect to Shanda Literature. The ordinary shares in Shanghai Shulong, Shanda Networking and Hongwen are owned by PRC citizens. Shengqu, Shanghai Shulong and the shareholders of Shanghai Shulong, Shanda Computer, Shanda Networking and the shareholders of Shanda Networking and Shengting, Hongwen and the shareholders of Hongwen entered into a series of agreements to provide Shengqu, Shanda Computer and Shengting with effective control of Shanghai Shulong, Shanda Networking and Hongwen, respectively. Under PRC law, Shanda Games cannot hold the licenses and approvals necessary to operate its online games because those licenses and approvals can only be held by domestic PRC persons and Shanda Games is not considered to be a domestic PRC person for this purpose.
In July 2009, we acquired a 51% interest in Hurray!. As of March 31, 2010, we owned approximately 42% of Hurray!’s outstanding ordinary shares. Hurray! is a foreign enterprise under PRC law and accordingly is ineligible to apply for a license to operate its WVAS and online video businesses. In order to comply with foreign ownership restrictions, Hurray! operates its WVAS business and online video business in China through the Hurray! entities, which are wholly-owned by shareholders of Hurray! and/or Ku6, and their wholly-owned subsidiaries. According to Hurray!’s management, the Hurray! VIEs hold all of the licenses and approvals that are required to operate their WVAS and online video businesses. Certain of the Hurray! entities have entered into VIE agreements with certain of the Hurray! VIEs and their shareholders. As a result of these contractual arrangements, as of December 31, 2009, we were considered the primary beneficiary of the Hurray! VIEs (except for the Hurray! VIEs associated with the Ku6 business, which Hurray did not acquire until January 2010), and accordingly, we consolidate the results of operations of the Hurray! VIE entities and their respective subsidiaries in our financial statements.
Except as otherwise disclosed in this annual report, we believe that, in all material aspects, (i) the ownership structures of our company, our wholly foreign-owned operating entities, and our PRC operating companies are in compliance with existing PRC laws and regulations, (ii) our contractual arrangements with Shanghai Shulong, Shanda Networking, Hongwen and the Hurray! VIEs and each of their shareholders are valid, binding and enforceable, and will not result in any violation of PRC laws or regulations currently in effect, and (iii) the business operations of our company, our wholly foreign-owned operating entities, and our PRC operating companies, as described in this annual report, are in compliance with existing PRC laws and regulations. There are, however, substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations. Accordingly, we cannot assure you that the PRC regulatory authorities will not ultimately take a view that is contrary to our view. If the PRC government finds that the agreements that establish the structure for operating our China business do not comply with PRC government restrictions on foreign investment in the online game industry, we could be subject to severe penalties.
Licenses
There are a number of aspects of our business which require us to obtain licenses from a variety of PRC regulatory authorities.
As ICPs, our PRC operating companies are required to either hold an ICP license or be sublicensed by qualified ICP license holders. Moreover, ICP operators providing ICP services in multiple provinces, autonomous regions and centrally administered municipalities may be required to obtain an inter-regional ICP license. Shanda Networking and Shanghai Shulong have already obtained inter-regional ICP licenses, which both cover short message services, or SMS services. Shanda Networking’s license also covered online bulletin board service. Shanda Networking is in the process of renewing its license to provide online bulletin board services. Nanjing Shulong and Shulong Computer currently conduct ICP businesses by having sublicensing arrangements with Shanghai Shulong, and Nanjing Shanda currently conducts its ICP business by having sublicensing arrangements with Shanda Networking.

 

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Each ICP license holder that engages in the supply and servicing of Internet cultural products, which include online games, must obtain an additional Internet Culture Business License from the MOC and an Internet Publishing License from the GAPP. Shanghai Shulong currently does not have an Internet Publishing License, and publishes its online games through cooperation with Shanda Networking, which holds such license. We believe this is consistent with the current practice in the online game industry in China. Shanghai Shulong is currently in the process of applying for an Internet Publishing License. In addition, the GAPP and the MOC require us to submit for their review and approval any online games we would like to import. If we import games without approval, the GAPP and the MOC may impose penalties on us, including revoking our Internet Culture Business License which is required for the operation of online games in China.
An Internet content provider that offers video and audio content, such as music and movies, is required to obtain a license from the SARFT. Shanda Networking and Ku6 currently hold this a license.
The Ministry of Public Security imposes a license requirement for any company that intends to engage in the development and sale of computer and information system safety guard products. Shanda Networking holds a computer and information system safety guard products sales license issued by the Ministry of Public Security.
Regulation of Telecommunications Services
The telecommunications industry, including the Internet sector, is highly regulated in China. Regulations issued or implemented by the State Council of China, the MIIT and other relevant government authorities cover many aspects of telecommunications network operation, including entry into the telecommunications industry, the scope of permissible business activities, interconnection and transmission line arrangements, tariff policy and foreign investment.
The principal regulations governing the telecommunications and Internet content services we provide in China include:
    Telecommunications Regulations (2000), or the Telecommunications Regulations. The Telecommunications Regulations categorize all telecommunications businesses in the PRC as either basic or value-added. ICP services are classified as value-added telecommunications businesses. Under the Telecommunications Regulations, commercial operators of value-added telecommunications services must first obtain an operating license from the MIIT or its provincial level counterparts.
    Administrative Measures on Internet Information Services (2000), or the Internet Measures. According to the Internet Measures, commercial ICP service operators must obtain an ICP license from the relevant government authorities before engaging in any commercial ICP operations within the PRC.
    Administrative Measures for Telecommunications Business Operating License (2009, revised), or the Telecommunications License Measures. The Telecommunications License Measures set forth the types of licenses required to operate value-added telecommunications services and the qualifications and procedures for obtaining such licenses. For example, an ICP operator providing value-added services in multiple provinces is required to obtain an inter-regional license, whereas an ICP operator providing the same services in one province is required to obtain a local license.
    Regulations for the Administration of Foreign-Invested Telecommunications Enterprises (2008, revised), or the FI Telecommunications Regulations. The FI Telecommunications Regulations set forth detailed requirements with respect to capitalization, investor qualifications and application procedures in connection with the establishment of a foreign-invested telecommunications enterprise. Under the FI Telecommunications Regulations, a foreign entity is prohibited from owning more than 50% of the total equity in any value-added telecommunication services business in China. To comply with these restrictions, we have entered into a series of agreements with each of our affiliated Chinese entities and their respective shareholders. We hold no ownership interest in any such affiliated Chinese entities.

 

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    Notice on Intensifying the Administration of Foreign Investment in Value-added Telecommunications Services (2006). Under this notice, an operating company holding a value-added telecommunications license (and not its shareholders) must own all related Internet domain names and registered trademarks. In addition, such company’s business site and equipment should comply with its approved licenses, and the company should establish and audit its internal Internet and information security policies and standards and emergency management procedures.
    Notice Concerning Short Message Services (2004). Under this Notice, telecommunications operators may only cooperate with licensed information service providers for SMS. This Notice sets forth requirements for provision of SMS by information service providers with respect to pricing, content and method of service provision. Certain types of SMS require customers’ explicit confirmation on acceptance of charges before such services can be billed for. This Notice also sets forth a high standard for customer services provided by information service providers and requires the service providers to provide an easy and clear cancellation mechanism for their customers to cancel subscribed services.
    Notice Concerning the Pricing and Billing of Mobile Information Services (2006). Under this notice, the pricing and billing of WVAS must be accurate, clear and fair. In addition, a WVAS provider cannot charge a customer unless the customer responds to two customer requests, and it must maintain detailed invoices for each customer for more than five months. In turn, the telecommunications operators are required to first deal with customer complaints, requests for refunds and related matters.
    Notice Concerning the Billing of Telecommunications Services (2007). Under this notice, no telecommunication enterprise may activate any service or function directly connected to their platforms, such as call reminder and voice inbox functions, unless the customer affirmatively consents to subscribing to them. For any free trial service subscribed by the mobile phone user, upon expiration of the free trial period, service providers may not charge the mobile phone user any fee for such service or function until the user re-confirms that it wishes to continue such service or function. When a customer calls the customer support line of a service provider, the service provider is prohibited from charging the customer a fee for such call unless the customer expressly confirms its consent to such charge regardless of whether automated or live support is provided. If automated support is provided, the customer is required to be furnished with pricing and billing information through a free voice notice.
In addition to regulations promulgated at the national level by the Chinese government, several provincial governments have issued provisional regulations requiring SMS service providers to obtain licenses from or register with the Telecommunications Administration Bureau at the provincial level before providing SMS service within the province.
Regulation of Internet Content
The PRC government has promulgated measures relating to Internet content through a number of ministries and agencies, including the MIIT, the MOC, the GAPP and the SARFT. These measures specifically prohibit Internet activities which includes the operation of online games that result in the publication of any content which is found to, among other things, propagate obscenity, gambling or violence, instigate crimes, undermine public morality or the cultural traditions of the PRC, or compromise state security or secrets. If an ICP license holder violates these measures, the PRC government may revoke its ICP license and shut down its websites.
In addition, the PRC government has promulgated regulations that require online game operators to implement anti-addiction measures for users under eighteen years of age. The regulations provide that the anti-addiction system must be formally implemented beginning on July 16, 2007. See Item 3.D. “Risks Relating to Regulation of the Internet and to Our Structure — Additional government regulations resulting from negative publicity in China regarding online games or otherwise may have a material adverse effect on our business, financial condition and results of operations.”

 

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Regulation of Information Security
Internet content in China is also regulated and restricted from a state security standpoint. The Standing Committee of the National People’s Congress, China’s national legislative body, issued a decision in December 2000 according to which any effort to conduct the following actions in China may be subject to criminal punishment in China: (1) gain improper entry into a computer or system of strategic importance; (2) disseminate politically disruptive information; (3) leak state secrets; (4) spread false commercial information; or (5) infringe intellectual property rights.
The Ministry of Public Security has promulgated measures that prohibit use of the Internet in ways which, among other things, result in a leakage of state secrets or a spread of socially destabilizing content. The Ministry of Public Security has supervision and inspection rights in this regard, and we may be subject to the jurisdiction of the local security bureaus. If an ICP license holder violates these measures, the PRC government may revoke its ICP license and shut down its websites.
Import Regulation
Our ability to license online games from abroad and import them into China is regulated in several ways. Shanda Games is required to register with the Ministry of Commerce any license agreement with a foreign licensor that involves an import of technologies, including online game software into China. Without that registration, Shanda Games cannot remit licensing fees out of China to any foreign game licensor. Furthermore, the State Copyright Bureau requires Shanda Games to register copyright license agreements relating to imported software. Without the State Copyright Bureau registration, Shanda Games is not allowed to publish or reproduce the imported game software in China. In addition, imported online game software is also required to pass a content examination by the GAPP and the MOC. Any imported online game software, which has not been examined and approved by the GAPP and the MOC, is not allowed to be put into operation in China.
Publishing Regulation
Our publishing activities include both online publishing and offline publishing. In order to engage in the online publishing business, we have obtained a license for online game publishing from the GAPP. We also hold the required government approval to engage in online literature publishing. As we do not hold the license for offline literature publishing, we cooperate with companies that are licensed to conduct such business.
Advertising Regulation
According to PRC laws and regulations, in order to conduct advertising and related business, a company must have an approved business scope that covers such businesses. Currently, we conduct our advertising and related businesses primarily through our subsidiaries, Shanghai Shengyue Advertisement Co., Ltd., Ku6 Information and Tianjin Ku6, each of which is licensed to conduct these businesses.
Intellectual Property Rights
The State Council and the State Copyright Bureau have promulgated various regulations and rules relating to protection of software in China. Under these regulations and rules, software owners, licensees and transferees may register their rights in software with the State Copyright Bureau or its local branches and obtain software copyright registration certificates. Although such registration is not mandatory under PRC law, software owners, licensees and transferees are encouraged to go through the registration process and registered software rights may be entitled to better protections. Shanda Games has registered all of its commercially launched in-house developed online games with the State Copyright Bureau.
Regulation on Broadcasting Audio/Video Programs through the Internet
On July 6, 2004, the State Administration of Radio, Film and Television, or the SARFT, promulgated the Rules for the Administration of Broadcasting of Audio/Video Programs through the Internet and Other Information Networks, or the A/V Broadcasting Rules. The A/V Broadcasting Rules apply to the opening, broadcasting, integration, transmission or download of audio/video programs via the Internet and other information networks. Anyone who wishes to engage in Internet broadcasting activities must first obtain an audio/video program transmission license, with a term of two years, issued by the SARFT, and operate pursuant to the scope as provided in such license. Foreign-invested enterprises are not allowed to engage in the above business.

 

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On April 13, 2005, the State Council announced Several Decisions on Investment by Non-state-owned Companies in Culture-related Businesses in China. These decisions encourage and support non-state-owned companies to enter certain culture-related businesses in China, subject to restrictions and prohibitions for investment in audio/video broadcasting, website news and certain other businesses by non-state-owned companies. These decisions authorize the Ministry of Culture, the SARFT and the General Administration of Press and Publication to adopt detailed implementation rules according to these decisions.
On December 20, 2007, the SARFT and the MIIT jointly issued the Rules for the Administration of Internet Audio and Video Program Services, commonly known as Document 56, which came into effect as of January 31, 2008. Document 56 reiterates the requirement set forth in the A/V Broadcasting Rules that online audio/video service providers must obtain a license from the SARFT. Furthermore, Document 56 requires all online audio/video service providers to be either wholly state-owned or state-controlled. According to relevant official answers to press questions published on the SARFT’s website dated February 3, 2008, officials from the SARFT and the MIIT clarified that online audio/video service providers that already had been operating lawfully prior to the issuance of Document 56 may re-register and continue to operate without becoming state-owned or controlled, provided that such providers have not engaged in any unlawful activities. This exemption will not be granted to online audio/video service providers established after Document 56 was issued. Shanda Networking has obtained an audio/video program transmission license which is valid from January 2009 to January 2012. Ku6 has obtained an audio/video program transmission license which is valid from June 2008 to June 2011.
Regulation of Music Production
The music industry, including the traditional record companies and the more recent digital music providers, is highly regulated in China. Laws and regulations issued or implemented by the NPC, the State Council of China, the SCB, the MOC, the MIIT and other relevant government authorities cover many aspects of the industry, including entry into the market, scope of permissible business activities, tariff policy and foreign investment.
The principal laws and regulations governing the music business in China include:
    Certification and Licensing System
The music industry is administered by specific ministries or agencies in China. A set of rules and regulations has been established for nearly every aspect of the traditional music business, from market entry to daily operation. In particular, our distribution of music through traditional physical channels (e.g., retail stores or chain stores) requires a license under the Regulations of the Phonographic Products (2002) and the Measures on Wholesaling, Retailing and Renting of the Phonographic Products (2006), while distribution through digital means (e.g., Internet or wireless means) requires official approval or record-keeping of music and its permissible content transmitted within the PRC by the MOC according to the Opinions on Regulation and Development of Music Transmitted via Network (2006). In addition, the Regulations for the Administration of Commercial Performance (promulgated in 2005, revised in 2008) and its Implementing Provisions (2009) and Measures on the Professional Intermediaries (2004) require professional performers and managers to obtain a license. The public performance of music also requires a license. These regulations are designed to enable the government to monitor the production, reproduction and publication of music, as well as the operations of record companies.
Failure to comply with the foregoing legal requirements could subject our affiliated music companies to civil, administrative and criminal penalties.

 

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    Regulation of Artist Agency
The artist agency industry is highly regulated in China. Regulations issued or implemented by the State Council of China, the Ministry of Culture and other relevant government authorities cover many aspects of artist agency, including entry into the artist agency industry, the scope of permissible business activities, tariff policy and foreign investment. The Regulations for the Administration of Commercial Performances (2005), as revised in 2008, and its related Implementing Regulations (2009) are the primary governing law related to our artist agency services. These regulations set forth detailed requirements with respect to different aspects of commercial performances including live musical performances. Under the commercial performances regulations, commercial performances require a performance brokerage company to obtain a commercial performance license in order to provide intermediary, agency and brokerage for commercial performances. Foreign companies are prohibited from owning more than 49% of the total equity in such brokerage companies in China. In the event we host commercial performances, we are required to file an application with the culture administrative department at the county level of the place where the performances are hosted. Hurray! Digital Media has been granted a commercial performance license for commercial performances.
Copyright
Under the PRC’s Copyright Law (1990), as revised in 2001 and in 2010, and its related Implementing Regulations (2002), creators of protected works enjoy personal and property rights with respect to publication, identification, alteration, reproduction, distribution, exhibition, performance, transmission, broadcasting and related activities. The term of a copyright is life plus 50 years for individual authors and 50 years for corporations. In consideration of the social benefits and costs of copyrights, China balances copyright protections with limitations that permit certain uses, such as for private study, research, personal entertainment and teaching, without compensation to the author or prior authorization.
To address copyright issues relating to the Internet, the PRC Supreme People’s Court on November 22, 2000 adopted the Interpretations on Some Issues Concerning Applicable Laws for Trial of Disputes over Internet Copyright, or the Interpretations, which were subsequently amended on December 23, 2003 and November 20, 2006. The Interpretations establish joint liability for ICP operators if they knowingly participate in, assist in or incite infringing activities or fail to remove infringing content from their websites after receiving notice from the rights holder. In addition, any act intended to bypass circumvention technologies designed to protect copyrights constitutes copyright infringement. Upon request, the ICP operators must provide the rights holder with registration information of the alleged violator, provided that such rights holder has produced relevant identification, copyright certificate and evidence of infringement. An ICP operator is exempted from any liabilities as long as it removes the alleged infringing content after receiving the rights holder’s notice accompanied with proper evidence.
To address the problem of copyright infringement related to the content posted or transmitted over the Internet, the SCB and the MIIT jointly promulgated the Measures for Administrative Protection of Copyright Related to Internet on April 29, 2005. This measure became effective on May 30, 2005.
This measure applies to situations where an ICP operator (i) allows another person to post or store any works, recordings, audio or video programs on the websites operated by such ICP operator or (ii) provides links to, or search results for, the works, recordings, audio or video programs posted or transmitted by such person, without editing, revising or selecting the content of such material. Upon receipt of an infringement notice from a legitimate copyright holder, an ICP operator must take remedial actions immediately by removing or disabling access to the infringing content. If an ICP operator knowingly transmits infringing content or fails to take remedial actions after receipt of a notice of infringement harming public interest, the ICP operator could be subject to administrative penalties, including: cessation of infringement activities; confiscation by the authorities of all income derived from the infringement activities; and payment of a fine of up to three times the unlawful income or, in cases where the amount of unlawful income cannot be determined, a fine of up to RMB100,000. An ICP operator is also required to retain all infringement notices for a minimum of six months and to record the content, display time and IP addresses or the domain names related to the infringement for a minimum of 60 days. Failure to comply with this requirement could result in an administrative warning and a fine of up to RMB30,000.
On May 18, 2006, the State Council promulgated the Protection of the Right of Communication through Information Network, which became effective on July 1, 2006. Under this regulation, an Internet service provider may be exempted from liabilities for providing links to infringing or illegal content if it does not know that such content is infringing other parties’ rights or is illegal. However, if the legitimate owner of the content notifies the Internet service provider and requests removal of the links to the infringing content, the Internet service provider would be deemed to have constructive knowledge upon receipt of such notification but would be exempted from liabilities if it removes or disconnects the links to the infringing content at the request of the legitimate owner. At the request of the alleged violator, the Internet service provider should immediately restore links to content previously disconnected upon receipt of initial non-infringing evidence.

 

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Hurray!’s online video business, Ku6, has adopted measures to mitigate copyright infringement risks. For example, Ku6’s policy is to remove links to web pages if it knows these web pages contain materials that infringe third-party rights or if it is notified by the legitimate copyright holder of the infringement with proper evidence.
Section 2, “Performance,” and Section 3, “Phonogram,” of Chapter IV of the Copyright Law cover major aspects of our business related to both online and offline music distribution. These provisions grant performers and record production companies personal and property rights (neighboring rights), including the right to fair compensation for the use of originals or copies of their works. In addition, authors of lyrics and music composers have separate and independent rights with respect to any particular song. The term of the copyright is 50 years after the first performance or authorized publication.
In addition, arrangements for the compulsory collection of license fees and the allocation of such fees were standardized by two interim provisions in the SCB’s Interim Provisions on Compulsory License of Phonogram (1993). In response to the changes posed by digital media, and in coordination with international treaties and agreements, the NPC took further action by amending the 1990 Copyright Law to specifically protect the online transmission of music (which is part of our music business). The newly added “digital” rights and responsibilities include a notice-and-takedown procedure for Internet service providers and certain anti-circumvention provisions. In combination, the Copyright Law, the Implementing Regulations, several administrative regulations and judicial interpretations constitute a relatively comprehensive legal framework for copyrights in China, although enforcement of such rights remains difficult. The Protection of the Right of Communication through Information Network (July 1, 2006) stipulates that the digital transmission of copyrightable works by Internet or wireless means, including by making them available via interactive on-demand or similar services, is subject to the regulations described above. In addition, the Chinese National Standing Committee voted to enter into the framework of the World Intellectual Property Organization’s World Copyright Treaty and World Performance and Phonogram Treaty in 2006.
The State Council and the State Copyright Bureau have promulgated various regulations and rules relating to protection of software in China. Under these regulations and rules, software owners, licensees and transferees may register their rights in software with the State Copyright Bureau or its local branches and obtain software copyright registration certificates. Although such registration is not mandatory under PRC law, software owners, licensees and transferees are encouraged to go through the registration process and registered software rights may be entitled to better protections. We have registered all of our commercially launched in-house-developed online games with the State Copyright Bureau.
Internet Cafe Regulation
Internet cafes are required to obtain a license from the MOC and the SAIC, and are subject to requirements and regulations with respect to location, size, number of computers, age limit of customers and business hours. Although we do not own or operate any Internet cafes, many Internet cafes distribute our virtual pre-paid cards. The PRC government has announced its intention, and has begun, to intensify its regulation of Internet cafes, which are currently the primary venue for our users to play online games. In February 2004, the SAIC and other related government agencies issued a notice to suspend issuance of new Internet cafe licenses for a six-month period. In January 2007, 14 PRC government departments jointly issued a circular in connection with the strengthening of Internet cafe and online game administration. According to the circular, local authorities were banned from issuing new Internet cafe licenses for the remainder of 2007. In March 2010, the MOC issued a circular to increase the punishment on Internet cafes which allow minors to enter and use the Internet. Intensified government regulation of Internet cafes could restrict our ability to maintain or increase our revenues and expand our customer base.
Privacy Protection
PRC law does not prohibit Internet content providers from collecting and analyzing personal information from their users. We require our users to accept a user agreement whereby they agree to provide certain personal information to us. PRC law prohibits Internet content providers from disclosing to any third parties any information transmitted by users through their networks unless otherwise permitted by law. If an Internet content provider violates these regulations, the MIIT or its local bureaus may impose penalties and the ICP may be liable for damages caused to its users.

 

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C. ORGANIZATIONAL STRUCTURE
We are a Cayman Islands-exempted company and we conduct our operations in China primarily through our PRC subsidiaries, which are our indirectly wholly-owned subsidiaries.
We are a Cayman Islands exempted company and we conduct our operations in China primarily through our PRC subsidiaries. We and our PRC subsidiaries are foreign or foreign-invested enterprises under PRC law and accordingly are ineligible to apply for licenses to operate online culture products (including online games, online literature and online video) or to sell online advertising. In order to comply with foreign ownership restrictions, our businesses operate in the following manner:
    Shanda Games operates its business in China through Shanghai Shulong, which is wholly-owned by Dongxu Wang and Yingfeng Zhang, two shareholders who are PRC citizens, and its wholly-owned subsidiaries.
 
    We operate our literature business in China through Hongwen, which is wholly-owned by Dongxu Wang and Mingfeng Chen, two shareholders who are PRC citizens, and its subsidiaries, Qidian, Jinjiang, Hongxiu, Rongshuxia, Jushi and Huawen Tianxia.
 
    We operate our integrated service platform through Shanda Networking, which is wholly-owned by Tianqiao Chen, our chairman, chief executive officer and president, and Danian Chen, our chief operating officer, both of whom are PRC citizens, and through Nanjing Shanda, Shengfutong and Yichong which are subsidiaries of Shanda Networking.
 
    In July 2009, we acquired a 52.6% interest in Hurray!. As of March 31, 2010, we owned approximately 42% of Hurray!’s outstanding ordinary shares. Hurray! is a foreign enterprise under PRC law and accordingly is ineligible to apply for a license to operate its WVAS and online video businesses. Hurray! operates its WVAS business and online video business in China through the Hurray! VIEs, which are wholly-owned by shareholders of Hurray! and/or Ku6, and their wholly-owned subsidiaries.
We believe that our PRC operating companies hold all of the licenses necessary to run our online entertainment businesses. See “Operating Results — Critical Accounting Policies — Consolidation of Variable Interest Entities” in Item 5A.
Our PRC subsidiaries have entered into a series of VIE Agreements with our PRC operating companies and their shareholders, including contracts relating to options to purchase shares, pledges of shares, provision of exclusive consulting services and other services, entrustment of shares, operation of business and other shareholder rights and corporate governance matters. As a result of these contractual arrangements, we are considered the primary beneficiary of our PRC operating entities, and accordingly we consolidate the results of operations of our PRC operating companies in our financial statements. However, none of us or our PRC subsidiaries owns the equity of our PRC operating companies, and, although we consolidate the results of our PRC operating companies in our consolidated financial statements and we can utilize their cash and cash equivalents in our operations through our contractual arrangements with our PRC subsidiaries, we do not have direct access to the cash and cash equivalents or future earnings of our PRC operating companies. These contractual agreements may only be amended with the approval of our audit committee or another independent body of our board of directors.
In addition, several of our PRC subsidiaries and our PRC operating companies have entered into operational agreements with our affiliates. For a description of these contractual arrangements, see “Major Shareholders and Related Party Transactions” in Item 7.

 

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The following diagram illustrates our corporate structure as of March 31, 2010.
(FLOW CHART)
 
     
(1)   Shanda Interactive holds a beneficial ownership interest in a number of subsidiaries, investee companies and variable interest entities, a list of which is set forth below.

 

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Subsidiaries and Investee Companies
The following table sets forth the direct and indirect subsidiaries and investee companies of Shanda Interactive Entertainment Limited as of March 31, 2010.
                 
    Shanda Interactive          
    Entertainment’s          
    Beneficial Ownership     Jurisdiction of    
    Percentage (1)     Incorporation   Business
Grandpro Technology Limited
    76.86 %   BVI   Investment holding company for equity interests in Grandpro Technology (Shanghai) Co., Ltd., an e-sports game platform operator
Shanghai Haofang Online Information Technology Co., Ltd.
    100 %   PRC   E-sports game platform operator
Grandpro Technology (Shanghai) Co., Ltd.
    100 %   PRC   E-sports game platform operator
Hangzhou Bianfeng Networking Co., Ltd.
    100 %   PRC   Operator of online chess and board game community
Chengdu Jisheng Technology Co., Ltd.
    97.62 %   PRC   Development and distribution of management software for Internet cafes
Shanda Literature Corporation
    100 %   Cayman Islands   Investment holding company of Shanda Literature
Shanghai Xuanting Entertainment Information Technology Co., Ltd.
    100 %   PRC   Operator of qidian.com
Shanghai Shengyue Advertisement Co., Ltd.
    100 %   PRC   Provider of online advertising services
Beijing Jinjiang Original Network Technology Co., Ltd.
    50 %   PRC   Operator of jjwxc.net
Beijing Grace Net Information Technology Co., Ltd.
    71 %   PRC   Operator of hongxiu.com
Beijing Joy Media Co., Ltd.
    100 %   PRC   Operator of Rongshuxia.com
 
     
(1)   For purposes of reporting beneficial ownership, we include interests held by controlled subsidiaries and nominee shareholders.
D. PROPERTY, PLANTS AND EQUIPMENT
Our principal executive offices are located at No. 208 Juli Road, Pudong New Area, Shanghai 201203, P.R.C. We own an aggregate of 25,712.87 square meters of office place in Shanghai, including approximately 9,000 square meters leased to Shanda Games, and 50,723 square meters of land in Shanghai which we plan to use for office space. In March 2010, we successfully bid to acquire a 56,667 square meter plot of land in Shanghai which we plan to develop for use as office space.
As of March 31, 2010, we occupied an aggregate of approximately 14,700 square meters of leased office space in a number of locations in China, excluding Shanda Games and Hurray!. We believe that our existing facilities are adequate for our current requirements.
Shanda Games leases its office space of approximately 9,000 square meters at No. 1 Office Building, No. 690 Bibo Road, Pudong New Area, Shanghai 201203, from Shanda Interactive. In addition, Shanda Games occupies an aggregate of approximately 14,000 square meters of leased office space in Beijing, Shenzhen, Chengdu, Hangzhou, Wuhan and various other cities in China and Hong Kong, Singapore and South Korea, including an office space of approximately 6,000 square meters leased by Actoz in South Korea.

 

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Hurray! and certain of its affiliates lease an approximate total of 2,710 square meters of office space at China Railway Construction Tower in Beijing. Hurray! also has branches and representative offices in Beijing, Shandong, Heilongjiang, Guangdong, Zhejiang, Liaoning, Chongqing, Shanghai, Henan and Sichuan. Hurray!’s music affiliates also lease an approximate total of 1,910, 150 and 330 square meters, respectively, of office space in Beijing, Guangzhou and Taiwan. Ku6 and its affiliates lease an approximate total of 3,000 square meters of office space in Beijing, Shanghai, Guangzhou, Tianjin and Xi’an.
Our servers are maintained at over 100 cities throughout China.
Item 4A. UNRESOLVED STAFF COMMENTS
None.
Item 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3. Key Information—D. Risk Factors” or in other parts of this annual report on Form 20-F.
Overview
We are one of China’s leading interactive entertainment media companies, offering a broad array of entertainment content to a large and diversified user base and an integrated service platform. Our business lines include:
    Shanda Games. Shanda Games offers MMORPGs and advanced casual games. Shanda Games also offers flash games without user-end software through recently acquired Mochi Media.
 
    Shanda Literature. Shanda Literature provides literature and other publications offered through websites, wireless distribution and offline publications to a diversified user base. Shanda Literature also franchises the copyrights of its literature works to online game companies, television producers, movie studios and traditional offline book publishers, etc.
 
    Bianfeng. Bianfeng and its subsidiaries operate an online chess and board games platform.
 
    Haofang. Haofang operates an e-sports game platform.
 
    Hurray!. Hurray! provides a wide range of WVAS to mobile users in China, including music, games, ringtones, pictures and animation, community, and other media and entertainment services. It is also engaged in artist development, music production and offline distribution in China and Taiwan through several affiliates. Hurray! has expanded its business into online video portal market after its acquisition of Ku6 in January 2010.
 
    Shanda Online. Shanda Online operates an integrated service platform which provides distribution, payment, customer service, and other e-commerce services for online entertainment content.

 

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Factors Affecting Results of Operations
Significant factors affecting our financial condition and results of operations include:
    our ability to successfully transition from a pure online game company to an interactive entertainment media platform and content and service provider;
 
    the continued improvement of existing services and introduction of additional services that Shanda Online offers on its integrated service platform;
 
    the willingness of content providers to offer their content through and the receptiveness of content providers to the services offered by Shanda Online’s integrated service platform;
 
    our users’ continued stickiness and willingness to consume the broad array of entertainment content offered on Shanda Online’s integrated service platform;
 
    the discounts offered for sales of our pre-paid cards;
 
    the willingness of users to purchase in-game virtual items or value-added services in online game-related content;
 
    the ability to offer various virtual items or value-added services that users prefer;
 
    the growth of the WVAS market in China and the ability of Hurray! to maintain good relationships with the telecommunications operators and to position its services on the WAP portals of the telecommunications operators;
 
    the ability of Hurray!’s music affiliates to develop artists, sustain a pipeline of new song releases and keep up with consumer music tastes;
 
    the ability of Ku6 to attract advertisers to offset the costs of acquiring licensed video content;
 
    the arrival of additional competition into the markets of each of our businesses;
 
    our ability to successfully grow through the identification and acquisition of complementary businesses on terms acceptable to us, our ability to successfully integrate acquired companies and realize synergies envisioned at the time of acquisition and our ability to complete planned divestitures;
 
    the cost of researching, developing and marketing new products and content;
 
    the future availability of preferential tax treatments and government financial incentives in China;
 
    the effect of PRC regulations on the conduct of our operations;
 
    operation results of companies acquired and/or consolidated in our financial statements; and
 
    the growth of Internet and personal computer use and the popularity of these media as a source of entertainment.
A. OPERATING RESULTS
In 2008, we commenced a reorganization of our business (the “Reorganization”). On June 27, 2008, our board of directors approved a master separation agreement, effective as of July 1, 2008, pursuant to which we transferred substantially all of our assets and liabilities related to the MMORPG and advanced casual game business to a newly-established legal entity, Shanda Games, and Shengqu transferred substantially all of its assets and liabilities unrelated to the MMORPG and advanced casual game business to Shanda Computer and our other entities (the “Separation”). As a result of the Separation, Shanda Games develops, sources and manages intellectual property rights related to MMORPGs and advanced casual games. In addition, we have established Shanda Literature, which operates our online literature platforms, Shanda Online, which owns and operates our integrated service platform, and other online content businesses. As of March 31, 2010, we also owned an approximate 42.0% interest in Hurray!, which provides WVAS and operates music and online video businesses.

 

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Structure of Our Business Prior to the Reorganization
Prior to the Reorganization, in order to comply with certain foreign ownership restrictions of companies that provide Internet content services, we operated our MMORPG and advanced casual game business primarily through the Shanda Networking entities, our integrated service platform through Shanda Networking and our other businesses through other VIEs. Shanda Networking and its shareholders were party to a set of VIE agreements with Shengqu and another set with Shanda Computer, pursuant to which we were considered the primary beneficiary of the Shanda Networking entities and consolidated the results of their operations in our financial statements.
Description of the Separation and Related Key Agreements
Effective as of July 1, 2008, we agreed to transfer all our assets and liabilities related to MMORPGs and advanced casual games to Shanda Games. Following the Separation, we have the following reporting segments:
    Shanda Games, which develops, sources and manages intellectual property rights relating to MMORPGs and advanced casual games;
 
    Shanda Online, which operates an integrated service platform that provides distribution, payment, customer service and other e-commerce services for online entertainment content; and
 
    Other, which includes businesses involved in literature businesses, advertising, the provision of management software to internet cafes, chess and board game platform, e-sports game platform, etc.
In order to comply with PRC laws restricting foreign ownership in the online entertainment businesses in China, our PRC subsidiaries operate their businesses through our PRC operating companies. See “— Critical Accounting Policies — Consolidation of Variable Interest Entities.”
In connection with the Separation, Shanda Games and Shanda Online entered into several operational agreements pursuant to which (i) Shengfutong is the exclusive sales agent of the Shulong entities for a period of five years commencing on July 1, 2008 for the distribution of pre-paid cards which can be used to access and play Shanda Games’s MMORPGs and advanced casual games on Shanda Online’s integrated service platform and (ii) Shanda Networking and Nanjing Shanda provide Shanda Games with certain online e-commerce platform services for a period of five years commencing on July 1, 2008. See “Major Shareholders and Related Party Transactions” in Item 7.
Selected Financial Information Regarding Business Segments
The segment information provided below has been prepared as if each reporting segment’s current corporate structure which separates our business into online games-related services and integrated service platform-related services had been in existence throughout the periods presented and as if the Separation had occurred as of the earliest period presented. Accordingly, for the period from January 1, 2007 to June 30, 2008, the information was prepared by combining the revenues and cost of revenues that were directly applicable to each reporting segment and for the period from July 1, 2008 to December 31, 2009, the information set forth below consists of the revenue and gross profit of each segment, including with respect to Shanda Games as a standalone entity subsequently to the Separation. Summarized below are the unaudited net revenues, costs of revenues and gross profits with respect to each reporting segment.
                                         
    Year Ended December 31, 2009  
    Shanda Games     Shanda Online     Others(1)     Elimination     Total  
    (RMB in millions)  
Net revenues
    4,806.7       1,066.2       524.5       (1,156.6 )     5,240.8  
Costs of revenues
    (1,933.5 )     (203.2 )     (295.9 )     950.4       (1,482.2 )
 
                             
Gross profit
    2,873.2       863.0       228.6       (206.2 )     3,758.6  
 
                             

 

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    Year Ended December 31, 2008  
    Shanda Games     Shanda Online     Others(1)     Elimination     Total  
    (RMB in millions)  
Net revenues
    3,376.8       784.1 (2)     268.2       (860.0 )     3,569.1  
Costs of revenues
    (1,489.4 )     (126.0 )     (171.9 )     766.8       (1,020.5 )
 
                             
Gross profit
    1,887.4       658.1       96.3       (93.2 )     2,548.6  
 
                             
                                         
    Year Ended December 31, 2007  
    Shanda Games     Shanda Online     Others(1)     Elimination     Total  
    (RMB in millions)  
Net revenues
    2,322.8 (3)     593.9 (4)     155.1       (604.5 )     2,467.3  
Costs of revenues
    (1,261.1 )     (79.8 )     (97.3 )     631.1       (807.1 )
 
                             
Gross profit
    1,061.7       514.1       57.8       26.6       1,660.2  
 
                             
 
     
(1)   We also generate revenues from other businesses, such as literature businesses, chess and board game platform, e-sports games platform, WVAS services, music and artist agency business, advertising, the provision of management software to Internet cafes, etc. Beginning in the third quarter of 2009, we began consolidating the financial results of Hurray!
 
(2)   Represents fees for certain technical services as calculated pursuant to contractual agreements entered into both prior to and in connection with the Separation. Therefore, net revenues in 2008 were calculated using these methods of calculating prior to and after the Separation, and net revenues for the years ended December 31, 2007, 2008 and 2009 may not be comparable.
 
(3)   For the period from January 1, 2007 through June 30, 2007, Shanda Games accounted for its investment in Actoz using the equity method of accounting. Beginning in the third quarter of 2007, Shanda Games began consolidating the financial results of Actoz.
 
(4)   For the year ended December 31, 2007, net revenues represented fees for certain technical services provided by Shanda Online primarily to Shanda Games pursuant to contractual agreements entered into prior to the Separation.
Revenues
Shanda Games
Shanda Games’s revenues primarily consist of revenues generated from the sale of in-game virtual items and game usage time for its MMORPGs and advanced casual games.
The following table sets forth, for the periods indicated, a breakdown of its net revenues into MMORPGs, advanced casual games and other revenues.
                                                 
    For the Year Ended December 31,  
    2007     2008     2009  
            % of Net             % of Net             % of Net  
    RMB     Revenues     RMB     Revenues     RMB     Revenues  
    (in millions, except percentages)  
Net revenues:
                                               
Online MMORPGs revenues
    2,016.1       86.8 %     2,987.8       88.5 %     4,476.7       93.1 %
Online advanced and light casual game revenues
    280.4       12.1 %     358.9       10.6 %     310.4       6.5 %
Other revenues(1)
    26.3       1.1 %     30.1       0.9 %     19.6       0.4 %
 
                                   
Total net revenues
    2,322.8       100.0 %     3,376.8       100.0 %     4,806.7       100.0 %
 
                                   
 
     
(1)   Other revenues primarily include fees received from game promotions and short messaging services fees earned.

 

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Shanda Games’s revenues primarily consist of revenues generated from the sale of in-game virtual items and game usage time for its MMORPGs and advanced casual games, which are net of a sales discount to distributors. For the periods prior to the Separation, the sales discount represented the difference between the face value of the prepaid card and the price at which Shanda Games sold the prepaid card to distributors or to game players. For the periods subsequent to the Reorganization, the sales discount represents the difference between the face value of the prepaid cards and the price at which Shengfutong sells the prepaid cards to third-party distributors and retailers or directly to game players. Therefore, with respect to each prepaid card sold, the amount of revenues Shanda Games records depends on the sales discount at which Shengfutong sells the prepaid card. Notwithstanding the foregoing, with respect to each prepaid card sold, Shanda Games is guaranteed a fixed percentage of the face value of a prepaid card in revenues.
Shanda Games’s revenues are net of the PRC business tax that its PRC operating companies pay on their gross revenues. The PRC business tax ranges from 3% to 5%.
Shanda Games operates games using one of two revenue models. For games operated using the item-based revenue model, the most significant factors that affect revenues are (i) the number of active paying accounts and (ii) the range, number and pricing of virtual items available for sale. The number of active paying accounts for any given period is equal to the number of game player accounts that spend virtual currency at least once during a given period and includes accounts of game players who spend virtual currency in beta testing of its online games. Shanda Games’s quarterly active paying accounts are equal to the aggregate number of active paying accounts for online games during a given quarter.
For games operated using the time-based revenue model, the most significant factors that affect revenues are (i) the number of users playing the game and (ii) the length of time that users play the game, or total user-hours. Shanda Games calculates total user-hours based on its average concurrent users. In a given period, the number of total user-hours equals the average concurrent users for that period multiplied by the number of hours in that period. In measuring average concurrent users, Shanda Games determines the number of users logged-on to games that adopt the time-based revenue model at one minute intervals, and then averages that number over the course of a day to derive daily averages. Average daily information is further averaged over a particular period to determine average concurrent users for that period.
Shanda Games’s online game business is subject to seasonality factors. Generally, Shanda Games’s game players spend more time playing its games in the first and third quarters of each year, which typically have more holidays, allowing for more time for leisure activities, whereas the second and fourth quarters are generally slower for its business as there are fewer holidays during those quarters.
Shanda Online
Shanda Online’s revenues primarily consist of revenues from distribution, payment, customer services and other related services offered to online entertainment content providers (primarily Shanda Games through 2009) through its integrated service platform and end-to-end service solution package. Shanda Online charges a fee for these online value-added services. The fee is typically structured as a fixed portion of the face value of the pre-paid card of the content provider, depending on the scope of services required by the content provider.
Prior to the Separation, service fees were incurred based on certain contractual arrangements entered into between both Shanda Computer and Shengqu and the Shanda Networking entities (the “Prior Contractual Arrangement”). After the Separation, Shanda Online began charging its content providers a service fee which is a fixed percentage of the portion of the face value of the prepaid cards that are used on the content providers’ content (the “Fixed Portion Arrangement”). Shanda Online’s net revenues in 2007 were calculated in accordance with the Prior Contractual Arrangement while its net revenues in 2008 were prepared based on the combination of terms and conditions of the Prior Contractual Arrangement and the Fixed Portion Arrangement. In 2009, the service fees paid to Shanda Online were based on the Fixed Portion Arrangement.
Shanda Online’s revenues are net of the PRC business tax that its PRC operating companies pay on their gross revenues. The PRC business tax ranges from 3% to 5%.

 

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For the year ended December 31, 2009, most of Shanda Online’s revenues were generated from transactions with intra-group entities.
Others
In addition, we also generate revenues from:
    operation and management of online literature content by charging subscription fees to our users for premium literature content and licensing copyrights;
 
    operation and management of traditional offline book publication through offline distribution channels;
 
    operation of online chess and board game platform and e-sports game platform via users’ virtual item consumption as well as VIP membership fees;
 
    the provision of management software to Internet cafe via charging, on a monthly basis, a fixed rate per each 100 computers that install our management software;
 
    advertising, sponsorship or a combination of both of which the revenue is recognized ratably over the displayed period of the advertisement and when the collectability is reasonably assured;
 
    wireless value-added service revenues are derived from providing personalized media, games, entertainment, communication services and online literature content to mobile phone customers; and
 
    operation and management of artist development, music production, offline distribution and events organization in China.
Revenues in Others are also net of the PRC business tax that related PRC operating companies pay on their gross revenues at a rate ranging from 3% to 5%.
Cost of revenues
Shanda Games
Shanda Games’s cost of revenues primarily consists of platform fees, upfront and ongoing licensing fees for its games and other miscellaneous expenses. The following table sets forth, for the periods indicated, a breakdown of Shanda Games’s cost of revenues by amount and percentage of its net revenues.
                                                 
    For the Year Ended December 31,  
    2007     2008     2009  
            % of Net                           % of Net  
    RMB     Revenues     RMB     % of Nets     RMB     Revenues  
    (in millions, except percentages)  
Net revenues of Shanda Games
    2,322.8       100.0 %     3,376.8       100.0 %     4,806.7       100.0 %
Cost of revenues:
                                               
Platform fees
    735.4       31.7 %     864.9       25.6 %     1,018.5       21.2 %
Upfront and ongoing licensing fees
    429.6       18.5 %     520.9       15.4 %     797.1       16.6 %
Others
    96.1       4.1 %     103.6       3.1 %     117.9       2.4 %
 
                                   
Total cost of revenues
    1,261.1       54.3 %     1,489.4       44.1 %     1,933.5       40.2 %
 
                                   
Gross profit/margin
    1,061.7       45.7 %     1,887.4       55.9 %     2,873.2       59.8 %
 
                                   

 

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Platform fees. Platform fees consist of (ii) fees paid to Shanda Online related to various support services, including online billing and payment, user authentication, customer service, anti-fatigue compliance, prepaid card marketing and data support services, and (ii) other expenses related to server leasing expense, depreciation of purchased servers and equipment, server and equipment maintenance fees, and software rental fees. Platform fees constituted approximately 31.7%, 25.6% and 21.2% of Shanda Games’s net revenues in 2007, 2008 and 2009, respectively. For 2007, the fees paid to Shanda Online were calculated in accordance with the terms and conditions of the Prior Contractual Arrangements and for 2008, based on the combination of both the Prior Contractual Arrangement and the Fixed Portion Arrangement. In 2009, the fees paid to Shanda Online were based on the Fixed Portion Arrangement. The decrease in platform fees as a percentage of net revenues resulted primarily from the fact that following the reorganization effective July 1, 2008, Shanda Games paid Shanda Networking a service fee related to various platform services, described in clause (1) in the first sentence of this paragraph, based upon a fixed percentage of the portion of the face value of prepaid cards distributed and used in games, which has resulted in lower fees as a percentage of Shanda Games’s net revenues. Shanda Games expects its platform fees as a percentage of its net revenues to remain generally stable going forward because a substantial portion of platform fees is based on a fixed percentage of the portion of the face value of prepaid cards used in games.
Upfront and ongoing licensing fees. The cost of licensing games from third-party game content providers consists of upfront licensing fees, which are generally paid in several installments, and ongoing licensing fees, the majority of which is equal to a percentage of the revenues generated from the relevant licensed game and, in some circumstances, includes a minimum guarantee. Upfront licensing fees are amortized on a straight-line basis over the shorter of the licensed period and the useful economic life of the relevant licensed game. Amortization of upfront licensing fees and ongoing licensing fees for games constituted approximately 18.5%, 15.4% and 16.6% of Shanda Games’s net revenues in 2007, 2008 and 2009, respectively. The increase in upfront and ongoing licensing fees as a percentage of net revenues from 2008 to 2009 is primarily due to the increase of amortization of upfront fee because of new games launched at the second half of 2008 and 2009. The decrease in ongoing licensing fees as a percentage of its net revenues from 2007 to 2008 is primarily due to the consolidation beginning from the third quarter of 2007 of the financial results of Actoz, which licenses several games to Shanda Games, including Mir II, which is latter’s top game in terms of revenues in 2008. While Actoz is Shanda Games’s majority-owned subsidiary and controls the licensing of Mir II in China, Shanda Games continue to classify Mir II as a licensed game because Actoz shares a portion of the ongoing licensing fees Shanda Games pays to Actoz with a third-party that co-owns the intellectual property rights relating to Mir II. Shanda Games expects its upfront and ongoing licensing fees as a percentage of net revenues to increase slightly in 2010 due to the full-year impact of games licensed from third parties.
Others. Other expenses include employee salary and welfare benefits, such as medical insurance, statutory housing contributions, unemployment insurance and pension benefits, for employees involved in the operation of online games, stock-based compensation for employees who operate games and office expenses. During the year ended December 31, 2007, Shanda Games recognized an impairment of intangible assets in the amount of RMB20.1 million, primarily relating to upfront and minimum royalty licensing fees of one of its games. Other expenses were approximately 4.1%, 3.1% and 2.4% of our net revenues in 2007, 2008 and 2009, respectively.
Shanda Online
Shanda Online’s cost of revenues mainly consists of server and equipment utilization costs, salary and benefits, cost of our customer loyalty program and other miscellaneous expenses.
Server and equipment utilization costs consist of server leasing expense, depreciation of purchased servers and equipment, server and equipment maintenance fee and software rental fees. Salary and benefits expense includes employee wages and welfare benefits, such as medical insurance, housing subsidies, unemployment insurance and pension benefits. Salary and benefits expense included in Shanda Online’s cost of revenue primarily relates to employees involved in the operation of its integrated service platform, including network maintenance, billing systems and customer service center. Shanda Online’s cost of revenues increased gradually from 2007 to 2009 primarily due to the increases in (i) salary and benefits with an increase in staff numbers and (ii) expenses related to the customer loyalty program, which were partially offset by the decrease of server and equipment utilization costs with a higher utilization rate of its servers and lower server procurement costs as a result of economies of scale. To secure our customers’ loyalty and further promote our services, we provide our customers with a customer loyalty program. This program allows our customers to accumulate membership points that vary depending on the services rendered and fees paid. Our customers may redeem these points for physical awards and virtual items. Shanda Online expects its server and equipment utilization costs to increase in 2010 as it will make more efforts to develop integrated service platform.

 

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Others
Costs associated with our other businesses mainly include service and network fees paid to telecommunications service providers, master CD production costs, artist and songwriter royalties, costs and expenses associated with the literary works published on our online literature platforms and online literature content copyright acquisition, production costs related to offline book publication, technical service charges (including commissions paid or payable to telecommunications providers), manufacturing costs of E-Key products, fees paid to Shanda Online related to various support services and other miscellaneous expenses.
The consolidation of the financial results of Hurray! beginning in September 2009 also increased the cost of revenues related to Hurray!'s business, mainly including the service and network fees paid to the telecommunications service providers under network service agreements related to WVAS business and master CD production costs and artist and songwriter royalties. In the second half of 2009, Shanda Literature began developing its offline book publication business through entering into partnerships and investments. Therefore, related publication cost increased accordingly.
Elimination
Elimination represents the inter-company transactions between the group companies, which are eliminated at the group level. It mainly includes transactions related to integrated platform services provided by Shanda Online to internally developed and operated content providers, such as Shanda Games, Shanda Literature, our chess and board game platform, our e-sports games platform and other inter-group transactions such as advertising services, sales of copyrights, sales of E-keys, property rental and management, Internet cafe technical services, upfront licensing fees and others.
Gross Profit
Consolidated gross profit for the years ended December 31, 2007, 2008 and 2009 were RMB1,660.2 million, RMB2,548.6 million and RMB3,758.6 million (US$550.6 million), respectively. Overall gross profit as a percentage of our net revenues was 67.3%, 71.4% and 71.7%, respectively, for the years ended December 31, 2007, 2008 and 2009.
Shanda Games’s gross profit for the years ended December 31, 2007, 2008 and 2009 were RMB1,061.7 million, RMB1,887.4 million and RMB2,873.2 million (US$420.9 million), respectively. Shanda Games’s gross profit as a percentage of our net revenues was 45.7%, 55.9% and 59.8%, respectively, for the years ended December 31, 2007, 2008 and 2009.
Shanda Online’s gross profit for the years ended December 31, 2007, 2008 and 2009 were RMB514.1 million, RMB658.1 million and RMB863.0 million (US$126.4 million), respectively. Shanda Online’s gross profit as a percentage of our net revenues was 86.6%, 83.9% and 80.9%, respectively, for the years ended December 31, 2007, 2008 and 2009.
Others’ gross profit for the years ended December 31, 2007, 2008 and 2009 were RMB57.8 million, RMB96.3 million and RMB228.6 million (US$33.5 million), respectively. Gross profit as a percentage of our net revenues was 37.3%, 35.9% and 43.6%, respectively, for the years ended December 31, 2007, 2008 and 2009.

 

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Operating Expenses
Our operating expenses were RMB658.2 million, RMB1,106.3 million and RMB1,719.2 million (US$251.9 million) in 2007, 2008 and 2009, respectively. The following table sets forth a breakdown of our operating expenses by amount and percentage of our net revenues, for the periods indicated:
                                                 
    For the Year Ended December 31,  
    2007     2008     2009  
            % of Net             % of Net             % of Net  
    RMB     Revenues     RMB     Revenues     RMB     Revenues  
    (in millions, except percentages)  
Net revenues
    2,467.3       100.0 %     3,569.1       100.0 %     5,240.8       100.0 %
 
                                   
Operating expenses:
                                               
Product development
    163.6       6.6 %     274.6       7.7 %     417.3       7.9 %
Sales and marketing
    179.7       7.3 %     318.0       8.9 %     517.0       9.9 %
General and administrative
    314.9       12.8 %     513.7       14.4 %     784.9       15.0 %
 
                                   
Total operating expenses
    658.2       26.7 %     1,106.3       31.0 %     1,719.2       32.8 %
 
                                   
Operating profit/margin
    1,002.0       40.6 %     1,442.3       40.4 %     2,039.4       38.9 %
 
                                   
Product development expenses. Our product development expenses primarily consist of salary and benefits expenses of personnel engaged in the product development of our online games, outsourced game and platform development expenses, share-based compensation, amortization of software used by our research and development staff, rental and management fees for office space used by our research and development staff and depreciation of equipment used in research and development activities. Product development expenses were 6.6%, 7.7% and 7.9% of our net revenues in 2007, 2008 and 2009, respectively.
In the fourth quarter of 2008, we established the Institute for Innovation and Technology (the “IIT”) to conduct research in order to position ourselves for our next decade of growth. The establishment of the IIT increased associated product development expenses. We expect our product development expenses to increase in 2010 as we continue to develop and upgrade content-related products and services as well as invest in our integrated service platform and other research and development efforts.
Sales and marketing expenses. Our sales and marketing expenses primarily consist of promotion and advertising expenses for our online entertainment content and integrated service platform, salary and benefits for our sales and marketing personnel, share-based compensation, and other expenses incurred by our sales and marketing personnel. Sales and marketing expenses were 7.3%, 8.9% and 9.9% of our net revenues in 2007, 2008 and 2009, respectively.
The increase of sales and marketing expenses from 2007 to 2009 is primarily due to the increase in our marketing promotion expenses as a result of our effort to enhance online and off-line marketing promotion activities to attract more new customers, such as for our online games, our integrated service platform and our literature business. We expect that our sales and marketing expenses to increase in 2010 as we continue to promote our entertainment content offerings and integrated service platforms, enhance our sales and marketing efforts in our existing markets and expand into new markets.
General and administrative expense. General and administrative expenses primarily consist of salary and benefits expenses for general management, finance and administrative personnel, professional service fees, business tax expense, share-based compensation and other expenses. General and administrative expenses were 12.8%, 14.4% and 15.0% of our net revenues in 2007, 2008 and 2009, respectively. Our business tax expense primarily relates to services and licensing fees charged by our PRC subsidiaries to our PRC operating companies as well as intercompany transactions.
The increase of general and administrative expenses from 2007 to 2009 is mainly due to increase of business tax charges in line with the increase of intercompany transactions; increase in administrative staff numbers to support business expansion; consolidation of the financial results of Hurray! beginning in September 2009; and increase in ESOP expenses due to the new compensation plan as disclosed in Shanda Games 2008 Equity Compensation Plan under the heading “Critical Accounting Policies — Share based compensation.” We expect the general and administrative expenses to increase in 2010 due to the increased business tax expense as a result of increasing volume of services to be performed by our PRC subsidiaries and of increasing volume of intercompany transactions and expenses associated with increasing supporting functions due to business expansion.

 

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Operating profit/margin. Operating profit as a percentage of our net revenues was 40.6%, 40.4% and 38.9% in 2007, 2008 and 2009, respectively.
Other income, net
Our other income, net consists of interest income and other non-operating income. We earn interest income from the deposit of our cash balance with banks. Other non-operating income primarily consists of government incentives. Due to the preferential treatments for qualified high technology companies in China and the incentive from local governments to encourage regional business development, certain of our PRC subsidiaries receive financial incentives from municipal governments that are calculated with reference to taxable income and revenues, as the case may be. The amount of the financial incentives and the timing to grant them are subject to determination by the government authorities. Upon receipt, these government financial incentives are recognized as other income in our statements of operations and comprehensive income in the F-pages. Please see “Other income, net” and note 6 to our consolidated financial statements” included elsewhere in this annual report on Form 20-F.
In 2007, 2008 and 2009, we received aggregate government financial incentives of RMB57.5 million, RMB62.3 million and RMB221.9 million (US$32.5 million), respectively, from municipal governments. Going forward, eligibility for the government financial incentives we are to receive requires that we continue to meet a number of government financial and non-financial criteria, which generally include:
    generating more than a minimum level of revenues from high-tech-related sales or services, determined as a percentage of total revenues;
 
    employing more than a minimum number of employees in product development; and
 
    expending more than a minimum amount on product development, determined as a percentage of total revenues.
The continued qualification is further subject to the discretion of the municipal government. Moreover, the central government or municipal government could determine at any time to immediately eliminate or reduce these financial incentives. Upon expiration of these government financial incentives, we will consider available options, in accordance with applicable law, that would enable us to qualify for additional government financial incentives to the extent they are then available to us. However, we cannot assure you that we will continue to enjoy these government financial incentives in the future.
In 2010, we expect to continue receiving government financial incentives related to our taxable income and revenues in 2009. However, the amount of such government financial incentives received from government authorities is not guaranteed and will be subject to periodic time lags and inconsistent municipal government practice on payment times.
Taxation
Under the current laws of the Cayman Islands and the British Virgin Islands, neither Shanda Interactive Entertainment Limited nor Shanda Holdings Limited, our wholly-owned subsidiary incorporated in the British Virgin Islands and Cayman Islands, is subject to tax on its income or capital gains. Under the current Hong Kong Inland Revenue Ordinance, our subsidiaries in Hong Kong are subject to 17.5% income tax for the year ended December 31, 2007 and 16.5% income tax for the year ended December 31, 2008 and 2009 on their taxable income generated from operations in Hong Kong.
PRC Enterprise Income Tax
Prior to January 1, 2008, our PRC operating entities were governed by the Income Tax Law of the PRC for Enterprises with Foreign Investment and Foreign Enterprises and the Provisional Regulations of the PRC on Enterprises Income Tax, or the Old EIT Laws. Pursuant to the Old EIT Laws, PRC enterprises were generally subject to Enterprise Income Tax, or the EIT, at a statutory rate of 33% (30% state income tax plus 3% local income tax), or 15% for certain technology enterprises, on PRC taxable income. Companies that are registered in the Pudong New District of Shanghai are, however, subject to a 15% preferential EIT rate pursuant to the local tax preferential treatment before January 1, 2008. Furthermore, foreign invested enterprises were exempted from PRC state income tax for two years, beginning with their first profitable year of operations, and were entitled to a 50% tax reduction for the subsequent three years. During the year ended December 31, 2007, certain of our subsidiaries and VIE subsidiaries in the PRC were subject to an applicable tax rate of 15% as a result of being qualified as technology advanced enterprises.

 

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In March 2007, the PRC government enacted the PRC Enterprise Income Tax Law, or the New EIT Law, and promulgated related regulation, Implementing Regulations for the New EIT Law. The law and regulation went into effect on January 1, 2008. The New EIT Law, among other things, imposes a unified income tax rate of 25% for both domestic and foreign invested enterprises. The New EIT Law provides a five-year transitional period for those entities established before March 16, 2007, which enjoyed a favorable income tax rate of less than 25% under the previous income tax laws and rules, to gradually change their rates to 25%.
On April 14, 2008, relevant governmental regulatory authorities released qualification criteria, application procedures and assessment processes for “high and new technology enterprises,” which will be entitled to a favorable statutory tax rate of 15%. On July 8, 2008, relevant governmental regulatory authorities further clarified that high and new technology enterprises previously qualified under the previous income tax laws and rules as of December 31, 2007, would be allowed to enjoy grandfather treatment for the unexpired tax holidays, on the condition that they were re-approved for “high and new technology enterprise status” under the regulations released on April 14, 2008.
In December 2008, the local governments announced the recognition of certain of our subsidiaries and VIEs, including Shengqu, Shanda Computer, Shanda Networking, Hangzhou Bianfeng, Shanghai Shulong, Shanghai Holdfast Online Information Technology Co., Ltd., Chengdu Aurora Technology Development Co., Ltd. and Chengdu Jisheng Technology Co., Ltd. as high, new technology enterprises. Accordingly, these entities are entitled to a preferential tax rate of 15%, which is effective retroactively to January 1, 2008. In addition, Shengqu was also qualified as a national key software enterprise for the year, 2008 and 2009, respectively, on December 30, 2008 and December 31, 2009. Accordingly, Shengqu is subject to a preferential income tax rate of 10% for the years 2008 and 2009.
The Corporate Income Tax Law also provides that “National Key Software Enterprises” can enjoy an income tax exemption for two years beginning with their first profitable year and a 50% tax reduction to a rate of 12.5% for the subsequent three years. Shanda Computer is qualified as a software enterprise, which is effective retroactively since January 1, 2008. As informed by the relevant tax bureau, Shanda Computer will be subject to a 0% income tax rate for the full year 2008 and a 50% tax reduction to an applicable rate from fiscal 2009 to fiscal 2011. With the policy related to the five-year transitional period, Shanda Computer was subject to a 0% income tax rate in 2008 and 10% income tax rate in 2009.
However, we cannot assure you that we will continue to enjoy these preferential tax treatments in the future.
As required by the New EIT Law, the profits of a foreign invested enterprise arising in 2008 and onwards that are distributed to its immediate holding company outside the PRC, will be subject to a withholding tax rate of 10%. A lower withholding tax rate will be applied if there is a tax treaty or arrangement between the PRC and the jurisdiction of the foreign holding company. Holding companies in Hong Kong that own more than 25% of the shares or equity interest in a domestic PRC company, for example, will be subject to a 5% withholding tax rate. As of December 31, 2009, we accrued a withholding tax of RMB69.6 million (US$10.2 million) based on the 5% withholding tax rate of the profits of our PRC subsidiaries in 2009 that these PRC subsidiaries plan to distribute to their immediate holding companies in Hong Kong. Except for this, since we intend to reinvest future earnings to further expand our business in China and therefore our foreign invested enterprises do not intend to declare dividends to their immediate foreign holding companies.
Equity in Losses of Affiliated Companies
We record our investment in affiliates under the equity method of accounting, and the losses of the affiliates are presented as “Equity in losses of affiliated companies” on the statements of operations and comprehensive income in F-pages.

 

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Non-controlling interest and redeemable preferred shares issued by a subsidiary
Non-controlling interest (“NCI”) is the portion of economic interest in Shanda Interactive’s majority-owned subsidiaries and VIEs which is not attributable, directly or indirectly, to us. On September 25, 2009, Shanda Games completed its initial public offering on the NASDAQ Global Select Market. As of December 31, 2009, we held 71.01% of the combined total of Shanda Games’s outstanding Class A and Class B ordinary shares. As a result, we continue to consolidate Shanda Games but recognize non-controlling interest reflecting the shares held by shareholders other than us. In July 2009, we acquired, by means of a tender offer, 1,155,045,300 ordinary shares of Hurray!, a NASDAQ listed company engaged in artist development, music production and wireless music distribution and other wireless value-added services in China, for a purchase price of $0.04 per share for a total consideration in cash of approximately US$46.2 million (equivalent to RMB315.6 million). At the completion of the tender offer in July 2009, we held 52.6% of the ordinary shares in Hurray! and became the majority shareholder of Hurray!. As a result, we consolidated Hurray!’s financial results beginning from September 1, 2009. Currently, the NCI in our consolidated financial statements mainly consist of NCI of Shanda Games and Hurray!.
In 2008, Grandpro Technology Limited (“Grandpro”), our subsidiary, entered into a series of agreements with Intel Capital Corporation, Shanghai International Shanghai Growth Investment Limited, CCIB SPC-Asia Pacific Small and Mid Cap Companies Segregated Portfolio, UG SPC-Asean Plus Three Segregated Portfolio, CCIB Opportunity Income Growth Fund, Huitung Investments (BVI) Limited and Google.Inc (collectively referred to as the “Investors”) to issue 9,600,000 series A Preferred Shares and 10,000,000 Series A-1 Preferred Shares to the Investors for a total consideration of US$19.6 million (equivalent to RMB 141,142,984). The par value of each preferred share is US$0.0001. The preferred shares are redeemable at the option of the Investors and as such are presented as mezzanine equity on the balance sheet and such amount is accreted to the redemption value from the issuance date to the redemption date. The accretion is included as a component of net income attributable to non-controlling interests in the statement of operations. The Series A Preferred Shares and the Series A-1 Preferred Shares issued by Grandpro are collectively referred to as the “Redeemable Preferred Shares.” The Preferred Shares are redeemable at the option of the Investors and as such are presented as mezzanine equity on the balance sheet and such amount is accreted to the redemption value from the issuance date to the redemption date. The accretion is included as a component of net income attributable to non-controlling interests in the statement of operations.
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 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 in our management’s judgment.
Revenue Recognition
We sold pre-paid cards, in both virtual and physical forms, to third-party distributors and retailers, including Internet cafes, as well as through direct online payment systems. The pre-paid cards entitle end users to access our online entertainment contents. All proceeds received from distributors or retailers from the sale of pre-paid cards are deferred when received. Deferred revenue is reduced as revenues are recognized.
For online game-related content, revenue is recognized under either the item-based revenue model or the time-based revenue model. Under the item-based revenue model, revenues are recognized over the estimated life of the in-game virtual items that game players purchase or as the in-game virtual items are consumed. Under the time-based revenue model, revenues are recognized based on the usage time consumed by the game players. Revenues are also recognized when game players who had previously purchased usage time are no longer entitled to access the online games in accordance with the published expiration policy. In addition, our e-sports platform also generated revenue from VIP membership fees, which are recognized throughout the usage period.

 

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For online literature content, revenue is recognized when the users pay a subscription fee for the premium literary contents.
We sell books either through book stores or through third-party distributors. Revenue from sales made through book stores or distributors is recognized when the products are sold to the end customers and collections are reasonably assured.
For advertising, revenue is recognized ratably over the displayed period of the advertisement and when the collectability is reasonably assured.
We derive revenue from the provision of management software to internet cafes by charging, on a monthly basis, a fixed rate per each 100 computers that install our management software.
We sell E-Key, a secure ID product, and other on-line game-related auxiliary products to customers. Revenues derived from the sale of E-Key and other on-line game-related auxiliary products are recognized when the titles of such products are transferred to the customers and collections are reasonably assured.
WVAS revenues are derived from providing personalized media, games, entertainment, literature content and communication services to mobile phone customers of the various subsidiaries of the telecommunications operators. Fees for these services, which are negotiated in network service agreements with the telecommunications operators and indicated in the message received on the mobile phone, are charged on a per-use basis or on a monthly subscription basis, and vary according to the type of services delivered. We contract with the telecommunications operators for the transmission of wireless services as well as for billing and collection services. The telecommunications operators provide us with a monthly statement that represents the principal evidence that service has been delivered and triggers revenue recognition for a substantial portion of our revenue. In certain instances, for revenues from WVAS business in Hurray!, when a statement is not received within a reasonable period of time, we make an estimate of the revenues and cost of services earned during the period covered by the statement based on its internally generated information, historical experience and/or other assumptions that are believed to be reasonable under the circumstances. The differences between our recorded revenue based on such estimates and actual revenue confirmed subsequently were not material.
We generate revenues from the sale of CDs either by providing the CD master to a distributor or by directly arranging for the volume production and subsequent wholesale of the CDs. In the former case, we receive a fixed fee, have no further obligations and recognize the fee as revenue when the master CD is provided. In the latter case, we ship the produced CDs to retail distributors and recognize wholesale revenues at the time of shipment less a provision for future estimated returns.
We recognize artist performance fees and corporate sponsorship or marketing event fees once the performance or the service has been completed. Where we act as the primary obligor in the transaction, revenues are recorded on a gross basis. Where we are considered an agent or where the artists separately contract with the event organizer, revenues are recorded on a net basis.
We license our music to third parties for guaranteed minimum royalty payments, normally received upfront and typically non-refundable. In such cases we recognize such fees as revenue on a straight-line basis over the life of the license and unrecognized revenues are included in liabilities. When the contract provides for additional payments if revenues exceed the minimum amount guaranteed, such amounts are included in revenues when we are notified of our entitlement to additional payments.
Our customers participate in a reward program, which provides physical awards and virtual items to customers based on accumulated membership points that vary depending on the services rendered and fees paid. The estimated incremental costs to provide physical rewards are recognized as cost of revenue and those to provide virtual items are recognized as reduction of revenue and accrued for as a current liability as members accumulate points. As members redeem awards or their entitlements expire, the accrued liability is reduced correspondingly.

 

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Consolidation of Variable Interest Entities
PRC regulations currently limit foreign ownership of companies that provide Internet content services, which includes the operation of online games, literature content and music-related content, to 50%. In addition, foreign and foreign-invested enterprises are currently not able to apply for the licenses required to operate online games, literature content and music-related content in China or to provide Internet information content.
In order to comply with these regulations, we conduct our business in the following manner.
Shanda Games. Shanda Games conducts all of its online game business through Shanghai Shulong, which is wholly-owned by certain of Shanda Games’s employees, as well as Nanjing Shulong and Shulong Computer, which are wholly-owned subsidiaries of Shanghai Shulong. These three companies hold the licenses and approvals to operate MMORPGS and advanced casual games in the PRC except for the Internet Culture Business License as disclosed in “Item 4B. Business Overview — Regulatory Matters - Licenses.” Shengqu owns the substantial majority of Shanda Games’s physical assets. The capital of Shanghai Shulong is funded by Shengqu and recorded as interest-free loans to the two shareholders of Shanghai Shulong. The portion of the loans for capital injection is eliminated with the capital of Shanghai Shulong during consolidation. The interest-free loans to the shareholders of Shanghai Shulong as of December 31, 2008 and 2009 were RMB10.8 million. Pursuant to the contractual arrangements with Shanghai Shulong, Shulong Computer and Nanjing Shulong, Shengqu provides services, software and technology license and equipment to Shanghai Shulong, Shulong Computer and Nanjing Shulong, in exchange for fees, determined according to certain agreed formulas. As a result of the VIE agreements between Shengqu and both Shanghai Shulong and its shareholders, Shengqu is considered the primary beneficiary of the Shulong entities and Shanda Games consolidates the results of operations of the Shulong entities. Therefore, Shanghai Shulong’s result of operations, assets and liabilities are consolidated in our financial statements.
Shanda Online. Shanda Online operates its integrated service platform business through the Shanda Networking entities. Shanda Networking currently holds an ICP license and an Internet culture operation license that are required to operate its platform business. At the same time, Shanda Computer has entered into a similar series of VIE agreements with both Shanda Networking and its shareholders and, therefore, Shanda Computer is considered the primary beneficiary of the Shanda Networking entities. Pursuant to the contractual arrangements with Shanda Networking, Nanjing Shanda and Shengfutong, Shanda Computer provides services and software and technology license to Shanda Networking, Nanjing Shanda and Shengfutong, in exchange for a fee, determined according to certain agreed formulas. Shanda Computer has also undertaken to provide financial support to Shanda Networking to the extent necessary for its operations. As a result of the VIE agreements between Shanda Computer and both Shanda Networking and its shareholders, Shanda Computer is considered the primary beneficiary of the Shanda Networking entities and Shanda Online consolidates the results of operations of the Shanda Networking entities, and, accordingly, Shanda Networking’s results of operations, assets and liabilities are consolidated in our financial statements.
Other. Other includes our businesses involved in literature businesses, advertising, chess and board game platform, e-sports game platform, WVAS, music and artist agency business and the provision of management software to Internet cafes. Similarly to Shanda Games and Shanda Online, (i) certain of our PRC operating companies hold the Internet related licenses that are required to operate these businesses, (ii) these PRC operating companies and their shareholders have entered into a series of VIE agreements with certain of our offshore and PRC subsidiaries which make our subsidiaries the primary beneficiary of the PRC operating companies and (ii) the results of operations, assets and liabilities of these PRC operating companies are consolidated in our financial statements.
Property and Equipment, Intangible Assets, Long-term Prepayments and Other Long-lived Assets
Our accounting for long-lived assets, including property and equipment, intangible assets, long-term prepayments and other long-lived assets, is described in notes 3(12), 3(13), 3(15) and 3(16) to our consolidated financial statements included in this annual report on Form 20-F. The recorded values of long-lived assets, including property and equipment, intangible assets, long-term prepayments and other long-lived assets are affected by a number of management estimates, including the estimated useful lives, residual values and impairment charges. Significant judgment is required in the assessment of the estimated useful lives of these assets, especially for game licenses. Changes in these estimates and assumptions could materially impact our financial position and results of operations.

 

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We assess the impairment for long-lived assets whenever events or changes in circumstances indicate that the applicable carrying amount may not be recoverable. During the year ended December 31, 2007, Shanda Games recognized an impairment of intangible assets charges to cost of sales in the amount of RMB20.1 million, relating to upfront and minimum royalty licensing fees of one of its games. During the years ended December 31, 2008 and 2009, we had no significant impairment charges for long-lived assets. The provision represents management’s best estimate.
Impairment of Investment in Affiliated Companies
We continually review our investments in affiliated companies to determine whether a decline in fair value below the carrying value is other than temporary. The primary factors we consider in its determination are the length of time that the fair value of the investment is below its carrying value; and the financial condition, operating performance and near-term prospects of the investee. In addition, we consider the reasons for the decline in fair value, be it general market conditions, industry-specific or investee-specific reasons, analysts’ ratings and estimates of 12-month share price targets for the investee changes in stock market price or valuation subsequent to the balance sheet date, and our intent and ability to hold the investment for a period of time sufficient to allow for a recovery in fair value. The determination of whether a decline in value is other than temporary requires significant judgment. If the decline in fair value is deemed to be other than temporary, the carrying value of the investment is written down to fair value. Write-downs for equity method investments are included in equity in losses of affiliated companies. No significant impairment losses were recorded in the years ended December 31, 2007, 2008 and 2009.
Impairment of Goodwill
We review our goodwill on an annual basis or more frequently if events or changes in circumstances indicate that the goodwill might be impaired as required by ASC 350 (formerly referred to as Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”). In performing this review, we are required to make an assessment of fair value for our goodwill under each reporting unit. When determining fair value, we utilize various assumptions, including projection of future cash flows. A change in these underlying assumptions will cause a change in the results of the test and, as such, could cause the fair value to be less than the respective carrying amount. In such event, we would be required to record a charge, which would significantly impact our earnings.
No impairment losses were recorded in the years ended December 31, 2007. We recorded an impairment loss of goodwill in the amount of RMB16.0 million in 2008, primarily related to an impairment of RMB14.5 million arising from the acquisition of Beijing Digital Red Software Technology Co., Ltd. An impairment loss of RMB4.0 million (US$0.6 million) was recorded in the year ended December 31, 2009, primarily related to Hurray!’s reporting unit arising from its acquisition of a music company in 2009.
Allowances for Doubtful Accounts
We determine the allowance for doubtful accounts when facts and circumstances indicate that the receivable is unlikely to be collected. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, we consider making additional allowances. During the years ended December 31, 2007, 2008 and 2009, we made provisions of RMB2.9 million, RMB15.8 million and RMB16.2 million (US$2.4 million) which was offset by RMB10.3 million, RMB5.9 million and RMB6.0 million (US$0.9 million) from the collection of overdue receivables for doubtful accounts, respectively.
Share-Based Compensation
Since January 1, 2006, we have accounted for grants made pursuant to the plans in accordance with, ASC 718 (formerly referred to as Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment”, or SFAS 123R), which requires all share-based payments to employees and directors, including grants of employee stock options and restricted shares, to be recognized as compensation expense in the financial statements over the vesting period of the award based on the fair value of the award determined at the grant date. The valuation provisions of ASC 718 apply to new awards, to awards granted to employees and directors before the adoption of ASC 718 whose related requisite services had not been provided, and to awards which were subsequently modified or cancelled. Under ASC 718, the number of share-based awards for which the service is not expected to be rendered for the requisite period should be estimated, and the related compensation cost not recorded for that number of awards.

 

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In accordance with ASC 718, we have recognized share-based compensation expenses, net of a forfeiture rate, using the straight-line method for awards with graded vesting features and service conditions only, and using the graded-vesting attribution method for awards with graded vesting features and performance conditions.
The determination of the fair value of share options on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including our expected stock price volatility over the vesting period, the risk-free interest rate, the expected dividend yield and actual and projected employee stock option exercise behavior. Furthermore, we are required to estimate forfeitures at the time of the grant and recognize share-based compensation expense only for those awards that are expected to vest. If actual forfeitures differ from those estimates, we may need to revise those estimates used in subsequent periods.
Shanda Interactive, Shanda Games and Hurray! each have authorized stock-based compensation plans:
(1) Shanda Interactive Entertainment Limited
2003 Share Incentive Plan
On March 31, 2003, Shanda BVI authorized a share option plan (the “2003 Share Incentive Plan”) that provides for the issuance of options to purchase up to 13,309,880 ordinary shares. Under the 2003 Share Incentive Plan, our directors may, at their discretion, grant any officers (including directors) and employees of Shanda BVI and/or its subsidiaries, and individual consultants or advisors (i) options to subscribe for ordinary shares, (ii) share appreciation rights to receive payment, in cash and/or our ordinary shares, equal to the excess of the fair market value of our ordinary shares, or (iii) other types of compensation based on the performance of our ordinary shares.
Following the Share Swap, pursuant to the share purchase agreement, Shanda Interactive has undertaken to assume all obligations for share options, whether vested or unvested, previously granted by Shanda BVI subject to the same terms and conditions as the 2003 Share Incentive Plan as adopted by Shanda BVI.
2005 Equity Compensation Plan
In October 2005, we authorized an equity compensation plan (the “2005 Equity Compensation Plan”) that provides for the issuance of options to purchase up to 7,449,235 ordinary shares, plus ordinary shares reserved for issuance, but not yet issued, under our 2003 Share Incentive Plan. Under the 2005 Equity Compensation Plan, our directors may, at their discretion, grant any officers (including directors) and employees of us and/or our subsidiaries, and individual consultants or advisors (i) options to subscribe for ordinary shares, (ii) share appreciation rights to receive payment, in cash and/or our ordinary shares, equal to the excess of the fair market value of our ordinary shares, or (iii) other types of compensation based on the performance of our ordinary shares.
Under the 2003 Share Incentive Plan and 2005 Equity Compensation Plan, the share-based compensation expenses of approximately RMB53.8 million, RMB47.5 million and RMB36.7 million (US$5.4 million) were recognized in the years ended December 31, 2007, 2008 and 2009, respectively.
(2) Shanda Games
In November 2008, Shanda Games authorized an equity compensation plan (the “Shanda Games 2008 Equity Compensation Plan”) that provides for the issuance of up to 44,000,000 Class A ordinary shares. Under the Shanda Games 2008 Equity Compensation Plan, the directors may, at their discretion, grant any officers (including directors) and employees of Shanda Games and/or its affiliates, and individual consultants or advisors (i) options to subscribe for Class A ordinary shares, (ii) share appreciation rights to receive payment, in cash and/or Shanda Games’s Class A ordinary shares, equal to the excess of the fair market value of Shanda Games’s ordinary shares, or (iii) other types of compensation based on the performance of Shanda Games’s ordinary shares. Share-based compensation expenses related to the option award granted by Shanda Games under the Shanda Games 2008 Equity Compensation Plan amounted to approximately RMB2.2 million and RMB103.9 million (US$15.2 million) for the years ended December 31, 2008 and 2009, respectively.

 

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On December 22, 2008, Shanda Games also granted Restricted Share Awards consisting of 407,770 Ordinary Shares (the “Restricted Shares”) under the Shanda Games 2008 Equity Compensation Plan. The restricted shares will be vested in equal installments over four calendar years on December 31 of each such calendar year, commencing on December 31, 2009, subject to the employee’s continued employment with Shanda Games. From July 14, 2009 through December 1, 2009, Shanda Games granted 251,920 and 6,068,500 Restricted Shares to Shanda Games’s and its affiliated companies’ employees, respectively, under the Shanda Games 2008 Equity Compensation Plan. The Restricted Shares will be vested in equal installments over each of the four anniversaries of the grant date of each such calendar year, commencing on the grant date, subject to the employee’s continued employment with Shanda Games or its affiliated companies’. Share-based compensation expense related to the Restricted Share award granted by Shanda Games under the Shanda Games 2008 Equity Compensation Plan amounted to RMB0.06 million and RMB3.0 million (US$0.4 million) for the years ended December 31, 2008 and 2009, respectively.
(3) Hurray!
Hurray!’s 2004 share incentive plan (the “Hurray! 2004 Share Incentive Plan”) allows Hurray! to offer incentive awards to its employees, directors, consultants or external service advisors. Under the terms of the Hurray! 2004 Share Incentive Plan, options are generally granted at prices equal to or greater than the fair market value on the grant date, expire ten years from the date of grant, and generally vest over three to four years. Since 2006, Hurray! has granted restricted purchase share awards in lieu of stock options under the Hurray! 2004 Share Incentive Plan to certain officers and senior management. Share-based compensation expenses related to the option award granted by Hurray! under the Hurray! 2004 Share Incentive Plan amounted to approximately RMB 0.3 million (US$0.04 million) for the period from the acquisition date through December 31, 2009.
Income Taxes and Valuation Allowance
We account for income taxes under the provisions of ASC 740 (formerly referred to as SFAS No. 109, “Accounting for Income Taxes”), with the required disclosures as described in note 7 to our consolidated financial statements included in this annual report on Form 20-F. Accordingly, we record valuation allowances to reduce our deferred tax assets when we believe it is more likely than not that we will not be able to utilize the deferred tax asset amounts based on our estimates of future taxable income and prudent and feasible tax planning strategies. As of December 31, 2008 and 2009, valuation allowances recognized were RMB59.7 million and RMB215.7 million (US$31.6 million), respectively. As of December 31, 2008 and 2009, we have recorded deferred tax assets, net of valuation allowances, of RMB124.1 million and RMB134.5 million (US$19.7 million), respectively. If events were to occur in the future which are not currently contemplated that would not allow us to realize all or part of our future net deferred tax assets, an adjustment would result by way of a charge to income tax expense in the period in which such determination was made.
ASC 740-10-25 (formerly referred to as FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes—An interpretation of FASB Statement No. 109”, or FIN 48) prescribes a recognition threshold and a measurement attribute for the financial statements recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit of being realized upon ultimate settlement. Our adoption of FIN 48 did not result in any adjustments to the opening balance of our retained earnings as of January 1, 2007. We did not have any interest and penalties associated with uncertain tax positions and did not have any significant unrecognized, uncertain tax positions for the years ended December 31, 2008 and 2009.

 

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Contingencies
We account for loss contingencies under the provisions of ASC 450-20 (formerly referred to SFAS No. 5, “Accounting for Contingencies”) with the required disclosures as described in note 25 to our consolidated financial statements included in this annual report on Form 20-F. We record loss contingencies when, based on information available, it is likely that a loss has been incurred and the amount of the loss can be reasonably estimated. Based on our current knowledge, which includes consultation with outside counsel handling our defense in these matters, we believe that we have made adequate provisions for current or unasserted claims. It is possible, however, that our future results of operations could be materially affected by changes in our estimates or in the effectiveness of our strategies relating to these proceedings. As of December 31, 2009, we did not have any accruals for loss contingencies.
Results of Operations
Basis of preparation. The segment information provided below has been prepared as if each reporting segment’s current corporate structure, which separates our business into MMORPGs and advanced casual games and integrated services platform-related categories, had been in existence throughout the periods presented and as if the Reorganization had occurred as of the earliest period presented. Accordingly, for the period from January 1, 2007 to June 30, 2008, the information was prepared by combining the revenues and cost of revenues that were directly applicable to each reporting segment and for the period from July 1, 2008 to December 31, 2009, the information set forth below consists of the revenue and gross profit of each segment, including with respect to Shanda Games as a standalone entity subsequently to the Separation. Accordingly, the net revenues for the years ended December 31, 2007, 2008 and 2009 may not be comparable.
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Net revenues. Our net revenues increased 46.8% from RMB3,569.1 million in 2008 to RMB5,240.8 million (US$767.8 million) in 2009.
Shanda Games’s net revenues, prior to elimination, including MMORPGs and advanced casual games, were RMB4,806.7 million (US$704.2 million) for the full year 2009, representing an increase of 42.3% from RMB3,376.8 million in 2008. The increase in Shanda Games’s MMORPGs and advanced casual games revenues was primarily due to an increase in net revenues from Shanda Games’s existing MMORPGs and the introduction and the full-year contribution of some of its new MMORPGs. Shanda Games’s net revenues from advanced casual games decreased as it released a major expansion pack and introduced new virtual items for one of Shanda Games’s significant advanced casual games in 2008 and did not release such an expansion pack in 2009.
Shanda Online’s net revenues for the full year 2009 were RMB1,066.2 million (US$156.2 million), representing an increase of 36.0% from RMB784.2 million in 2008. In 2009, the increase of Shanda Online’s revenues was mainly due to the increase of services provided to Shanda Games, other in-house content providers and other third-party content providers.
Other net revenues including our literature business, chess and board game platform, e-sports games platform, WVAS services, our music and artist agency business and other businesses for the full year 2009 were RMB524.5 million (US$76.8 million), representing an increase of 95.6% from RMB268.1 million in 2008. This increase in other net revenue was primarily due to an increase in revenue from online advertisements, licensing of management software to Internet cafes, subscription fees from our original online literature websites and offline book publication as well as the consolidation of the financial results of Hurray! beginning in September 2009.
Cost of revenues. Our cost of revenues increased 45.2% from RMB1,020.5 million in 2008 to RMB1,482.2 million (US$217.1 million) in 2009.
Shanda Games’s cost of revenues, including platform fees, upfront and ongoing licensing fees for online games and other miscellaneous expenses, were RMB1,933.5 million (US$283.3 million) for the full year 2009, representing an increase of 29.8% from RMB1,489.4 million in 2008. Shanda Games’s platform fees increased 17.8% from RMB864.9 million in 2008 to RMB1,018.5 million (US$149.2 million) in 2009 primarily due to the increased servers and services provided to support the growth in its game player base. Shanda Games’s upfront and ongoing licensing fees for online games increased 53.0% from RMB520.9 million in 2008 to RMB797.1 million (US$116.8 million) in 2009. The increase was primarily due to the commencement of amortization of upfront fees for new games launched in the second half of 2008 and in 2009.

 

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Shanda Online’s cost of revenues for the full year 2009 were RMB203.2 million (US$29.8 million), representing an increase of 61.3% from RMB126.0 million in 2008. The increase of Shanda Online’s cost of revenues was mainly due to the increase of salary and benefits resulting from the increase in staff headcount and the increase of expenses related to its customer loyalty program.
Costs associated with our other businesses mainly include service and network fees paid to the telecommunications service providers, master CD production costs, artist and songwriter royalties, costs and expenses associated with the literary works published on our online literature platforms and online literature works copyright acquisition, production costs related to offline book publication, technical service charges (including commissions paid or payable to telecommunications providers), manufacturing costs of E-Key products, fees paid to Shanda Online related to various support services and other miscellaneous expenses. Other businesses’ cost of revenues for the full year 2009 were RMB295.9 million (US$43.3 million), representing an increase of 72.1% from RMB171.9 million in 2008. The increase of costs in other businesses was mainly due to the increase in license fees paid to authors of literary works with the development of our online literature business and accompanying increase in staff with this business’s expansion. In the second half of 2009, Shanda Literature also began developing its offline book publication business by entering into investments and partnerships. Therefore, related publication cost also increased accordingly. The consolidation of the financial results of Hurray! beginning in September 2009 also increased the service and network fees paid to the telecommunications providers under network service agreements related to WVAS business and production cost of CD masters, artist and songwriter royalties.
Gross profit. As a result of the foregoing, our gross profit increased 47.5% from RMB2,548.6 million in 2008 to RMB3,758.6 million (US$550.6 million) in 2009. Our gross profit margin, which is equal to our gross profit divided by our net revenues, remained stable, increasing from 71.4% in 2008 to 71.7% in 2009.
Shanda Games’s gross profit increased 52.2% from RMB1,887.4 million in 2008 to RMB2,873.2 million (US$420.9 million) in 2009. Shanda Games’s gross profit margin, which is equal to its gross profit divided by its net revenues, increased from 55.9% in 2008 to 59.8% in 2009.
Shanda Online’s gross profit increased 31.1% from RMB658.1 million in 2008 to RMB863.0 million (US$126.4 million) in 2009. Shanda Online’s gross profit margin, which is equal to its gross profit divided by Shanda Online’s net revenues, decreased from 83.9% in 2008 to 80.9% in 2009.
Others’ gross profit increased 137.4% from RMB96.3 million in 2008 to RMB228.6 million (US$33.5 million) in 2009. Others’ gross profit margin, which is equal to its gross profit divided by net revenues, increased from 35.9% in 2008 to 43.6% in 2009.
Operating expenses. Our operating expenses increased 55.4% from RMB1,106.3 million in 2008 to RMB1,719.2 million (US$251.9 million) in 2009. This increase was primarily due to the following reasons:
    Our product development expenses increased 51.9% from RMB274.6 million in 2008 to RMB417.3 million (US$61.1 million) in 2009, primarily due to (i) an increase due to the increase in the headcount of research and development employees in 2009; (ii) an increase in outsourced product development costs as a result of our investments through Shanda Games’s 18 Capital investment fund; (iii) the consolidation of the financial results of Hurray! beginning in September 2009; and (iv) an increase of office expenses and employees’ expenses in the IIT. Product development expenses totaled approximately 7.7% and 8.0% of our net revenues in 2008 and 2009, respectively.
 
    Our sales and marketing expenses increased 62.6% from RMB318.0 million in 2008 to RMB517.0 million (US$75.8 million) in 2009, primarily due to (i) an increase in our marketing promotion expenses in 2009 as a result of increased online and off-line marketing promotion activities for Shanda Games, Shanda Online and Shanda Literature; and (ii) an increase of RMB31.7 million in salary and benefits expenses in 2009 arising from an increase in the headcount of sales and marketing employees. Sales and marketing expenses totaled approximately 8.9% and 9.9% of our net revenues in 2008 and 2009, respectively.

 

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    Our general and administrative expenses increased 52.8% from RMB513.7 million in 2008 to RMB784.9 million (US$115.0 million) in 2009 primarily due to: (i) an increase in share-based compensation costs mainly due to the launch of a new employee incentive plan by Shanda Games; (ii) an increase in salary and benefits expenses in 2009, due to an increase in headcount of employees engaged in general and administrative work with our business expansion; (iii) an increase of depreciation of property, equipment and software due to business expansion and purchase of land use rights; (iv) an increase in business taxes in 2009, primarily due to the increased number of intercompany transactions as a result of the Reorganization, the increased volume of services which our PRC subsidiaries provided and revenue collected from our PRC operating companies; (v) an increase in consulting, legal and audit fees in 2009, primarily for Shanda Games’s initial public offering and business acquisition; (vi) an increase of rental and management fees due to business expansion; and (vii) an increase in other general and administrative expenses in 2009, which relate primarily to office expenses and traveling expenses. General and administrative expenses accounted for approximately 14.4% and 15.0% of our net revenues in 2008 and 2009, respectively.
Income from operations. As a result of the foregoing, our operating income increased from RMB1,442.3 million in 2008 to RMB2,039.4 million (US$298.8 million) in 2009. Our operating margin, which is equal to our operating profit divided by our net revenues, has remained stable from 40.4% in 2008 to 38.9% in 2009.
Income before income tax expenses, equity in losses of affiliated companies. Our income before income tax expenses, equity in losses of affiliated companies and non-controlling interests increased 48.2% from RMB1,522.4 million in 2008 to RMB2,255.9 million (US$330.5 million) in 2009. This increase was primarily due to the aforementioned factors and the following factors:
  (i)   Interest expenses. Interest expenses increased from RMB30.0 million in 2008 to RMB100.7 million (US$14.8 million) in 2009 primarily due to (a) the amortization of debt issuance cost of Zero Coupon Senior Convertible Notes due 2014 which were issued in September 2008 and (b) the accrual of the interest expense of 2.0% Convertible Senior Notes due 2014 with effective interest method;
 
  (ii)   Investment income. We had investment income of RMB8.2 million in 2008 and investment income of RMB42.5 million (US$6.2 million) in 2009. The higher investment income in 2009 primarily related to gains from the investments in marketable securities; and
 
  (iii)   Other income. Our other income increased from RMB29.4 million in 2008 to RMB203.6 million (US$29.8 million) in 2009. Our other income in 2009 was primarily comprised of government financial incentives of RMB221.9 million (US$32.5 million), compared to RMB62.3 million in 2008, from local government authorities in China relating to business and income taxes we previously paid in the PRC.
Income tax expenses. Our income tax expenses increased 75.7% from RMB276.5 million in 2008 to RMB485.8 million (US$71.2 million) in 2009, primarily as a result of the net impact of the increase in our pre-tax income and the New EIT Law which became effective as of January 1, 2008 and applies a general enterprise income tax rate of 25% on both foreign-invested enterprises and domestic enterprises, unless such enterprise qualifies as a high and new technology enterprise or other preferential tax treatment.
As informed by the relevant tax bureau, Shanda Computer was recognized as a “Software Enterprise” and will be subject to a 0% income tax rate for the full year 2008 and a 50% tax reduction to an applicable rate from fiscal 2009 to fiscal 2011. As a result, Shanda Computer was subject to a 10% income tax rate in 2009. This resulted in the increase of the effective income tax rate from 18% in 2008 to 22% in 2009.
Equity in losses of affiliated companies. Our equity in losses of affiliates increased from RMB0.3 million in 2008 to RMB50.5 million (US$7.4 million) in 2009.

 

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Net income. As a result of the foregoing, our net income increased 38.1% from RMB1,245.6 million in 2008 to RMB1,719.6 million (US$251.9 million) in 2009.
Net income attributed to non-controlling interests and redeemable preferred shares issued by a subsidiary. Our net income attributed to non-controlling interest increased from RMB16.9 million in 2008 to RMB127.0 million (US$18.6 million) in 2009 primarily due to (i) the increase of non-controlling interest of Shanda Games after the successful initial public offering of Shanda Games in September 2009 and (ii) net income attributed to redeemable preferred shares issued by a subsidiary increased 177.7% from RMB4.8 million in 2008 to RMB13.2 million (US$1.9 million) in 2009 as the shares were outstanding for the full year 2009.
Net income attributed to Shanda Interactive. As a result of the foregoing, our net income attributed to Shanda Interactive increased 29.6% from RMB1,228.7 million in 2008 to RMB1,592.6 million (US$233.3 million) in 2009.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Net revenues. Our net revenues increased 44.7% from RMB2,467.3 million in 2007 to RMB3,569.1 million in 2008.
Shanda Games’s net revenues were RMB3,376.8 million for the full year 2008, representing an increase of 45.4% from RMB2,322.8 million in 2007. Net revenues from MMORPGs increased from RMB2,016.1 million in 2007 to RMB2,987.8 million in 2008. Net revenues from advanced casual games increased from RMB280.4 million in 2007 to RMB358.9 million in 2008. The increase in its online game related revenues was primarily due to an increase in net revenues from Shanda Games’s existing MMORPGs and advanced casual games and the introduction and the full-year contribution of some of its new MMORPGs.
Shanda Online’s net revenues for the full year 2008 were RMB784.1 million, representing an increase of 32.0% from RMB593.9 million in 2007.
Other net revenues including our literature business, chess and board game platform, e-sports games platform and other businesses for the full year 2008 were RMB268.2 million, representing an increase of 72.9% from RMB155.1 million in 2007. This increase in other net revenue was primarily due to an increase in revenue from online advertisement, licensing of management software to Internet cafes and subscription fees from our original online and offline literature websites.
Cost of revenues. Our cost of revenues increased 26.4% from RMB807.1 million in 2007 to RMB1,020.5 million in 2008. This increase was primarily due to the following reasons:
Shanda Games’s cost of revenues, including platform fees, upfront and ongoing licensing fees for online games and other miscellaneous expenses, were RMB1,489.4 million for the full year 2008, representing an increase of 18.1% from RMB1,261.1 million in 2007. Platform fees increased 17.6% from RMB735.4 million in 2007 to RMB864.9 million in 2008 primarily due to the increased servers and services provided to support the growth in game player base. The increase in the number of servers was partially offset by the elimination or combination of server groups for existing online games, as well as the introduction of new virtualization technologies which improve server efficiency. Shanda Games’s upfront and ongoing licensing fees for online games increased 21.3% from RMB429.6 million in 2007 to RMB520.9 million in 2008 primarily due to the commercialization in 2008 of licensed games, which commenced the amortization of the upfront licensing fees, and the increase of revenues derived from licensed games, which was partially offset by the decrease in ongoing license fees as a result of the consolidation of Actoz’s financial results beginning in the third quarter of 2007.
Shanda Online’s cost of revenues for the full year 2008 were RMB126.0 million, representing an increase of 57.9% from RMB79.8 million in 2007. Server and equipment utilization costs increased primarily due to the increased servers and services provided to support the growth of our user base and growth of our revenues generated from our entertainment content offerings. The increase of expenses relating to our customer loyalty program also resulted in the increase of Shanda Online’s cost of revenues. Salary and benefits increased primarily due to a salary increase and the bonus granted to the employees directly engaged in the platform service provision as a result of implementing a performance-based incentive program.

 

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Other cost of revenues for the full year 2008 were RMB171.9 million, representing an increase of 76.7% from RMB97.3 million in 2007. This increase in other cost of revenues was primarily due to the increased costs associated with the literary works published on our online literature platforms.
Gross profit. As a result of the foregoing, our gross profit increased 53.5% from RMB1,660.2 million in 2007 to RMB2,548.6 million in 2008. Our gross profit margin, which is equal to our gross profit divided by our net revenues, increased from 67.3% in 2007 to 71.4% in 2008 primarily due to the growth in net revenues.
Shanda Games’s gross profit increased 77.8% from RMB1,061.7 million in 2007 to RMB RMB1,887.4 million in 2008. Shanda Games’s gross profit margin, which is equal to its gross profit divided by Shanda Games’s net revenues, increased from 45.7% in 2007 to 55.9% in 2008.
Shanda Online’s gross profit increased 28.0% from RMB514.1 million in 2007 to RMB658.1 million in 2008. Shanda Online’s gross profit margin, which is equal to its gross profit divided by Shanda Online’s net revenues, decreased from 86.6% in 2007 to 83.9% in 2008.
Others’ gross profit increased 137.4% from RMB57.8 million in 2007 to RMB96.3 million in 2008. Others’ gross profit margin, which is equal to its gross profit divided by net revenues, decreased from 37.3% in 2007 to 35.9% in 2008.
Operating expenses. Our operating expenses increased 68.1% from RMB658.2 million in 2007 to RMB1,106.3 million in 2008. This increase was primarily due to the following reasons:
    Our product development expenses increased 67.9% from RMB163.6 million in 2007 to RMB274.6 million in 2008, primarily due to (i) an increase of the headcount of research and development employees in 2008; (ii) the adoption of a new performance-based compensation structure; (iii) the consolidation of Actoz’s financial result beginning from the third quarter of 2007; (iv) an increase in outsourced product development costs. Product development expenses totaled approximately 6.6% and 7.7% of our net revenues in 2007 and 2008, respectively.
 
    Our sales and marketing expenses increased 76.9% from RMB179.7 million in 2007 to RMB318.0 million in 2008, primarily due to (i) an increase in our marketing promotion expenses in 2008 as a result of our effort to enhance online and off-line marketing promotion activities to attract more new users; and (ii) an increase in salary and benefits expenses in 2008 arising from an increase of the headcount of sales and marketing employees. Sales and marketing expenses totaled approximately 7.3% and 8.9% of our net revenues in 2007 and 2008, respectively.
 
    Our general and administrative expenses increased 63.1% from RMB314.9 million in 2007 to RMB513.7 million in 2008 primarily due to: (i) an increase of RMB68.5 million in salary and benefits expenses in 2008, due to an increase in headcount of employees engaged in general and administrative work; (ii) an increase of RMB74.6 million in business taxes in 2008, primarily due to the increased intercompany transaction as a result of the Reorganization and the increased volume of services which our PRC subsidiaries provided and revenue collected from our PRC operating companies; (iii) an increase in doubtful accounts provision expenses in 2008, mainly due to the overdue receivables from online advertising; (iv) an increase in consulting, legal and audit fees in 2008, primarily due to the group’s corporate restructuring; and (v) the increase of RMB24.3 million in other general and administrative expenses in 2008, which relate primarily to office expenses, traveling expenses, rental and management fees and amortization of intangible assets. General and administrative expenses accounted for approximately 12.8% and 14.4% of our net revenues in 2007 and 2008, respectively.
Income from operations. As a result of the foregoing, our operating income increased from RMB1,002.0 million in 2007 to RMB1,442.3 million in 2008. Our operating margin, which is equal to our operating profit divided by our net revenues, has remained stable from 40.6% in 2007 to 40.4% in 2008.

 

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Income before income tax expenses, equity in loss of affiliated companies. Our income before income tax expenses, equity in loss of affiliated companies increased 7.1% from RMB1,421.5 million in 2007 to RMB1,522.4 million in 2008. This decrease was primarily due to the following factors:
  (i)   Interest income. Our interest income increased from RMB65.8 million in 2007 to RMB72.6 million in 2008. This increase was primarily due to the increase in our average cash and cash equivalents balances in 2008 relative to those in 2007;
 
  (ii)   Interest expenses. Following the application of ASC 470 (formerly referred to as FSP APB 14-1, “Accounting for Convertible Debt Instruments that May be Settled in Cash upon Conversion (Including Partial Cash Settlement))”, we recorded retrospective impact on our Zero Coupon Senior Convertible notes due 2014 in the amount of RMB131.0 million which was reflected in 2007’s consolidated operation result and on our Zero Coupon Senior Convertible notes due 2011 in the amount of RMB19.7 million which was reflected in 2008’s consolidated operation result. It resulted in the decrease of interest expenses from RMB144.1 million in 2007 to RMB30.0 million in 2008.
 
  (iii)   Investment income (loss). We had investment income of RMB469.8 million in 2007 and an investment income of RMB8.2 million in 2008. The higher investment income in 2007 primarily related to gains from the disposal of shares of SINA; and
 
  (iv)   Other income. Our other income increased from RMB28.1 million in 2007 to RMB29.4 million in 2008. Our other income in 2008 primarily consisted of government financial incentives of RMB62.3 million, compared to RMB57.5 million in 2007, from local government authorities in China relating to business and income taxes we previously paid in the PRC.
Income tax expenses. Our income tax expenses increased 106.6% from RMB133.8 million in 2007 to RMB276.5 million in 2008, primarily the net impact of the increase in our pre-tax income and the new enterprise income tax law which became effective as of January 1, 2008 and applies a general enterprise income tax rate of 25% on both foreign-invested enterprises and domestic enterprises, unless such enterprise qualifies as a high and new technology enterprise or other preferential tax treatment as well as the expiration of tax holiday of certain subsidiaries. The effective income tax rate increased from 9% in 2007 to 18% in 2008 primarily due to the following:
In 2007, the Group sold 4 million ordinary shares of SINA, pursuant to Rule 144 for approximately US$129.6 million (RMB1.0 billion). On May 11, 2007 and May 15, 2007, the Group sold the remaining 1,066,344 and 1,051,934 shares of SINA in open-market transactions for US$38.1 million (RMB292.5 million) and US$38.4 million (RMB294.3 million), respectively. This related investment income was non-taxable income and it resulted in higher effective income tax rate in 2007.
Equity in losses of affiliated companies. Our equity in loss of an affiliate decreased from RMB15.5 million in 2007 to RMB0.3 million in 2008. Equity in loss of an affiliate includes an investment loss incurred in the first half of 2007 from Actoz, which we began to consolidate in the third quarter of 2007.
Net income. As a result of the foregoing, our net income decreased 2.1% from RMB1,272.2 million in 2007 to RMB1,245.6 million in 2008.
Net income attributed to non-controlling interests and redeemable preferred shares issued by a subsidiary. Our net income attributed to non-controlling interest increased from RMB7.0 million in 2007 to RMB16.9 million in 2008.
Net income attributable to Shanda Interactive. As a result of the foregoing, our net income attributable to Shanda Interactive decreased 2.9% from RMB1,265.2 million in 2007 to RMB1,228.7 million in 2008.
B. LIQUIDITY AND CAPITAL RESOURCES
Cash Flows and Working Capital
Cash flows and working capital reflect the consolidation of operation results of Shanda Games and Hurray!. To date, we have financed our operations through internally generated cash, the sale of our redeemable preferred shares to an investor in March 2003, our initial public offering of ADSs in May 2004 and the offering of the convertible notes in October 2004 and September 2008. On September 25, 2009, Shanda Games completed an initial public offering on the NASDAQ Global Select Market. As a result, we have received the net proceeds from Shanda Games’s initial public offering of US$980.8 million (equivalent to RMB6,697.4 million) relating to both the sale of new shares by Shanda Games, as well as our sale of a portion of our existing holding of Shanda Games shares. It led to the increase of cash and cash equivalents from RMB 3,397.8 million as of December 31, 2008 to RMB10,959.3 million (US$1,605.5 million) as of December 31, 2009.

 

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The following table shows our cash flows with respect to operating activities, investing activities and financing activities in the years ended December 31, 2007, 2008 and 2009:
                                 
    For the year ended December 31,  
    2007     2008     2009  
    RMB     RMB     RMB     US$  
    (in thousands)  
Net cash provided by operating activities
    1,159,971.6       1,737,703.7       2,496,798.7       365,783.1  
Net cash provided by/(used in) investing activities
    1,687,789.2       (393,593.3 )     (2,374,235.0 )     (347,827.4 )
Net cash (used in)/provided by financing activities
    (2,053,295.7 )     141,763.3       7,430,910.2       1,088,634.5  
Effect of exchange rate change on cash
    (101,064.8 )     (73,330.8 )     7,994.4       1,171.2  
Net increase in cash and cash equivalents
    693,400.3       1,412,542.9       7,561,468.3       1,107,761.4  
Cash, beginning of period
    1,291,901.2       1,985,301.5       3,397,844.4       497,787.0  
Cash, end of period
    1,985,301.5       3,397,844.4       10,959,312.7       1,605,548.4  
Net cash provided by operating activities
We had net cash provided by operating activities of RMB2,496.8 million (US$365.8 million) in 2009 compared to RMB1,737.7 million in 2008. The cash provided by operating activities was primarily derived from our online games operations, advertising, costs and expenses associated with the literary works published on our online literature platforms and online literature works copyright acquisition, offline book publication, sales of our Internet cafe management software and revenues from wireless value-added services and music related to the consolidation of Hurray!’s financial results beginning from September 2009. The increase was primarily due to increase in our net income resulting from the growth of our business and our tight expense budget control. The increase in net cash provided by operating activity in 2009 was due to our net income attributable to our company of RMB1,719.6 million; an add-back of the non-cash expenses in the amount of RMB619.4 million, including share-based compensation expenses, depreciation of property and equipment, amortization of intangible assets, provision for losses on receivables and other assets, equity in loss of affiliated companies and unsettled interest expenses; an increase of RMB285.1 million in other payables and accruals; an increase in tax payable of RMB86.6 million due to an increase in our pre-tax income; and an increase of RMB31.7 million in licensing fees payable due to an increase in our revenues generated from licensed games. Our net cash provided by operating activities was partially reduced by payment of upfront licensing fees and prepayment of upfront licensing fees of RMB125.5 million relating to new online games that Shanda Games licensed from third parties and a decrease of RMB60.2 million in deferred revenue.
We had net cash provided by operating activities of RMB1,737.7 million in 2008 compared to RMB1,160.0 million in 2007. The cash provided by operating activities was primarily derived from our online games operations, advertising, subscription fees from our original online literature websites and sales of our Internet cafe management software. The increase was primarily due to increase in our net income resulting from the growth of our business and tight expense budget control. The increase in net cash provided by operating activity in 2008 was also due to an increase in deferred revenue.
Net cash provided by/(used in) investing activities
In 2009, we had net cash used in investing activities of RMB2,374.2 million (US$347.8 million), compared to net cash used in investing activities of RMB393.6 million in 2008. The net cash used in investing activities in 2009 mainly included an increase in bank deposits with maturity date over three months of RMB1,104.1 million (US$161.7 million), the payment of RMB702.1 million for the restricted cash through Shanda Games as the collateral for a loan in the amount equal to the US$102.5 million, the payment of RMB272.0 million (US$39.8 million) for the purchase of property, equipment, software and intangible assets, the increase of investments in subsidiaries of RMB206.0 million (US$30.2 million), prepayment for the purchase of land use rights and investments in affiliated companies, partially offset by a disposal in investment of marketable securities.

 

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In 2008, we had net cash used investing activities of RMB393.6 million, compared to net cash provided by investing activities of RMB1,687.8 million in 2007. This decrease in 2008 was primarily due to the payment of RMB119.8 million for the purchase of property, equipment, software and intangible assets, an increase in bank deposits with maturity date over three months of RMB134.5 million, investments in affiliated companies an increase in investment of marketable securities and the increase of investments in subsidiaries, as compared to proceeds of RMB1,593.4 million from the sale of an aggregate of 6,118,278 shares of SINA, and proceeds of RMB448.5 million from the sale of UBS enhanced yield portfolio AA USD in 2007.
Net cash (used in)/provided by financing activities
In 2009, we had net cash provided by financing activities of RMB7,430.9 million (US$1,088.6 million), compared to net cash provided by financing activities of RMB141.8 million in 2008. Our cash provided by financing activities in 2009 was primarily due to the proceeds of RMB6,697.4 million (US$980.8 million) from Shanda Games’s initial public offering in September 2009, the proceeds of RMB89.6 million (US$13.1 million) in connection with the stock options exercised by our employees and our subsidiaries’ officers, directors and employees, and cash received from a loan of US$102.5 million through Shanda Games, equivalent to RMB702.1 million, which was partially offset by the payments for conversion of convertible debt related to Convertible Senior Notes due 2011.
In 2008, we had net cash provided by financing activities of RMB141.8 million, compared to net cash used in financing activities of RMB2,053.3 million in 2007. Our cash provided by financing activities was primarily due to the proceeds from issuance of US$175.0 million (RMB1,171.3 million) aggregated principal amount of 2% Convertible Senior Notes due 2011 in September 2008, the proceeds from issuance of 1,960 redeemable preferred shares to investors with a total amount of US$19.6 million (RMB140.0 million) by Grandpro and the proceeds in connection with the stock options exercised by our officers, directors and employees, which was partially offset by the payment for repurchase of stock of RMB1,212.8 million.
Restrictions on Cash Transfers to the Company
Our cash and cash equivalents primarily consist of cash on hand, demand deposits, and liquid investments with original maturities of three months or less that are placed with banks and other financial institutions. Although we consolidate the results of our subsidiaries such as Shanda Games and Hurray! in our consolidated financial statements we do not have direct access to the cash and cash equivalents or future earnings of our subsidiaries.
To fund any cash requirements we may have, we may need to rely on dividends and other distributions on equity paid by our subsidiaries. Since substantially all of our operations are conducted through our indirect wholly and majority-owned China-based subsidiaries and VIEs, our subsidiaries may need to rely on dividends, loans or advances made by PRC subsidiary. Certain of these payments are subject to PRC taxes, including business taxes and value added tax, which effectively reduce the received amount. In addition, the PRC government could impose restrictions on such payments or change the tax rates applicable to such payments. See “Item 4. Organizational Structure” and “Item 10. Additional Information—Exchange Controls.”
In addition, PRC regulations currently permit payment of dividends of a PRC company only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Our WFOEs are also required to set aside at least 10% of their after-tax profit based on PRC accounting standards each year to their general reserves until the cumulative amount reaches 50% of their paid-in capital. These reserves are not distributable as cash dividends, or as loans or advances. Our WFOEs may also allocate a portion of their after-tax profits, as determined by their board of directors, to their staff welfare and bonus funds, and therefore may not be distributed to us.

 

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We believe that our existing cash and cash equivalents, cash flows from operations, short-term investments and marketable securities will be sufficient to meet the anticipated cash needs for our operating activities, capital expenditures and other obligations for at least the next twelve months. We may, however, require additional cash resources due to changed business conditions or other future developments. We may sell additional equities or obtain credit facilities to enhance our liquidity position or to increase our cash reserves for future operations. The sale of additional equity would result in further dilution to our shareholders. The incurrence of indebtedness would result in increased fixed obligations and could result in operating covenants that would restrict our operations. We cannot assure you that financing will be available in amounts or on terms acceptable to us, if at all. Please see “Exchange Controls” in Item 10 for a discussion of impediments to capital flows in and out of China.
From time to time, we evaluate possible investments, acquisitions or divestments and may, if a suitable opportunity arises, make an investment or acquisition or conduct a divestment, which may have a material effect upon our liquidity and capital resources. Please see “Recent Acquisitions” in this Item 5 for a description of our significant investments, acquisitions and divestments.
Capital Expenditures
We made capital expenditures of RMB70.4 million, RMB113.8 million, and RMB294.0 million (US$43.1 million) in 2007, 2008 and 2009, respectively. Our capital expenditures increased in 2009 primarily owing to purchases of computer equipment and office premises (building and land use rights). To date, the capital expenditures have primarily consisted of purchases of online game network infrastructure, software, as well as office premises. Beginning from 2008, capital expenditures are presented on accrual basis instead of cash basis to better represent our businesses development.
Since we will continue to purchase servers and IT equipment for new game operations, extend our service platform, perform extensive network upgrades and office expansion and purchase land for office expansion and/or other business initiatives, we expect the capital expenditures in 2010 to increase.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
We currently focus our research and development activities principally on the development of updates, expansion and sequels of our online game related content, the development of integrated service platform and wireless value-added services.
Our research and development efforts and plans consist of:
    outsourcing and in-house development of updates, expansions and sequels of our existing online game related content;
 
    sourcing new games via co-development, investment and in-house development;
 
    improving, via internal and outsourcing research and development, our integrated service platform, including our digital content delivery system, unified billing and payment system, customer relationship management system, and user authentication system and related security;
 
    improving our server management and control systems;
 
    maintaining our internal billing and transmission records related to wireless value-added services; and
 
    future development of the IIT.
Our research and development expenditures were RMB163.6 million, RMB274.6 million and RMB417.3 million (US$61.1 million) in 2007, 2008 and 2009, respectively.
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 period from January 1, 2009 to December 31, 2009 that are reasonably likely to have a material effect on our net 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.

 

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E. OFF-BALANCE SHEET ARRANGEMENTS
In connection and concurrently with the issuance of preferred shares of US$19.6 million by Grandpro in 2008, we provide a full guarantee to the investors in respect of the performance of Grandpro’s redemption obligations under the agreements.
Except for the guarantee mentioned above, we do not have any outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions or foreign currency forward contracts. We do not engage in trading activities involving non-exchange traded contracts.
F. CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following table sets forth our contractual obligations as of December 31, 2009:
                                         
    Payments Due by Period  
            Less than 1                     More than 5  
    Total     Year     1-3 Years     3-5 Years     Years  
Operating lease obligations:
                                       
Office premises
    19.7       13.0       6.7              
Computer equipment and others
    51.7       44.7       7.0              
Purchase of property and equipment and intangible asset obligations
    99.6       55.2       44.4              
Convertible debt principal
    1,135.3             1,135.3              
Convertible debt related interest expense*
    39.3       22.7       16.6              
 
                             
Total contractual obligations
    1,345.6       135.6       1,210.0              
 
                             
     
*   2.0% Convertible Senior Notes due 2011 bears interest at a fixed rate of 2.0% per annum.
As of December 31, 2009, substantially all of our operating lease arrangements for servers and related services provide for the calculation of lease payments based on formulas that reference the actual number of users of the relevant servers. Our rental expenses under these operating leases were RMB23.0 million, RMB21.9 million and RMB11.9 million (US$1.7 million) in 2007, 2008 and 2009, respectively. As future lease payments for these arrangements are based on the actual number of users and thus cannot be reasonably estimated, they are not included in the minimum lease payments shown above. As of December 31, 2009, we had entered into maintenance contracts in relation to the servers we owned amounting to RMB48.0 million (US$7.0 million).
In June 2009, Shengqu, a subsidiary of Shanda Games, entered into an arrangement with a bank in China whereby Shengqu obtained a loan of US$102.5 million to be repaid in June 2010. The loan accrues interest at 1.35% per annum and is collateralized with Shengqu’s Renminbi cash deposit of RMB702 million. The interest earned from the Renminbi cash deposit is 2.25% per annum. In connection with the loan, Shengqu also entered into a foreign currency forward contract with the same bank by fixing the exchange rate of U.S. dollar to RMB at 6.8445 at the time it repays the U.S. dollar loan. We recorded the foreign currency forward contract as a derivative and marked it to market at each balance sheet date. The loan is re-measured at each period end to Shengqu’s functional currency, Renminbi, and is netted off against its Renminbi cash deposit due to the existence of a legal setoff right. As of December 31, 2009, the financial liability related to the forward contract is not material.
In September 2008, we issued US$175 million (equivalent to RMB1,197 million) in aggregate principal amount of the Convertible Notes. For additional information on the Convertible Notes, see Note 18(2) to our consolidated financial statements included herein.
As of December 31, 2009, we had capital commitments for the purchase of property and equipment, and game license in the aggregate amount of RMB99.6 million (US$14.6 million).
Apart from the foregoing and the convertible notes described above, as of December 31, 2009, we had no significant impairment or did not have any other long-term debt obligations, operating lease obligations or purchase obligations.
We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.

 

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Item 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. DIRECTORS AND SENIOR MANAGEMENT
The following table sets forth certain information relating to our directors and executive officers as of March 31, 2010. The business address of each of our directors and executive officers is No. 208 Juli Road, Pudong New Area, Shanghai 201203, China.
             
Name   Age   Position
Tianqiao Chen(1)
    36     Chairman of the Board and Chief Executive Officer
Qunzhao Tan
    34     Non-executive Director
Danian Chen
    31     Director, Chief Operating Officer
Qianqian Luo(1)
    33     Non-executive Director
Jingsheng Huang(2)
    52     Independent Director
Chengyu Xiong(2)
    55     Independent Director
Zhao Kai(2)
    65     Independent Director
Jin Zhang
    36     Vice President
Grace Wu
    39     Director, Chief Financial Officer
Haifa Zhu
    37     Chief Investment Officer
Danning Mi
    41     Chief Information Officer
 
     
(1)   Member of the compensation committee.
 
(2)   Member of the audit committee.
Tianqiao Chen, one of our co-founders, has served as the chairman of our board of directors and our chief executive officer since our inception in December 1999. Mr. Chen established Shanda Networking with Danian Chen in December 1999. Prior to establishing Shanda Networking, Mr. Tianqiao Chen served as the vice director of the office of the president of Kinghing Trust & Investment Co., Ltd. from 1998 to 1999. From 1994 to 1998, Mr. Chen served in various management positions with Shanghai Lujiazui Group. Mr. Chen serves as a member of the board of directors of SinoMedia Holding Ltd., which is listed on the Hong Kong Stock Exchange. Mr. Tianqiao Chen holds a bachelor’s degree in economics from Fudan University. Mr. Tianqiao Chen is the brother of Danian Chen, our co-founder, and is married to Qianqian Luo, one of our directors.
Qunzhao Tan has served as a member of our board of directors in October 2006. Mr. Tan previously served as our president from April 2008 to January 2010, chief technology officer from July 2003 to January 2010, senior executive vice president from June 2006 to April 2008, senior vice president from August 2005 to June 2006, vice president from July 2003 to August 2005 and director of research and development from November 1999 to July 2003. Prior to joining us, Mr. Tan worked as an assistant in the Institute of Clean Coal Technology of East China University of Science and Technology from July 1996 to November 1999. Mr. Tan serves as a member of the board of directors of Actoz. Mr. Tan holds a bachelor’s degree in chemical engineering from East China University of Science and Technology.
Danian Chen, one of our co-founders, established Shanda Networking with Tianqiao Chen in December 1999. Mr. Danian Chen has served as chief operating officer since April 2008 and as a member of our board of directors since our inception in 1999. Mr. Danian Chen has served as our senior executive vice president since August 2005 and as our senior vice president from July 2003 to August 2005, and director of products from December 1999 to July 2003. Prior to co-founding Shanda Networking, Mr. Danian Chen worked in Xinghui International Transport Company, Haijie Shipping Agency Company and Jinyi Network from September 1996 to November 1999. Mr. Danian Chen is Tianqiao Chen’s brother.

 

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Qianqian Luo has served as our director since our inception in December 1999. Ms. Luo previously served as our director of administration from November 1999 to July 2003 and vice president from July 2003 to February 2004. Ms. Luo served as a project manager at the investment banking department of Kinghing Trust & Investment Co., Ltd. from 1998 to 1999. Ms. Luo holds a bachelor’s degree in economics from Financial & Banking Institute of China. Ms. Luo is married to Tianqiao Chen.
Jingsheng Huang has served as our director since October 2005. Since October 2005, Mr. Huang has served as Managing Director at Bain Capital. From January 2002 to September 2005, he was Managing Director China at SOFTBANK Asia Infrastructure Fund, or SAIF, and served as a director on the board of twelve SAIF portfolio companies in the technology, telecommunications and media sectors. Prior to joining SAIF, Mr. Huang was a partner at SUNeVision Ventures. Mr. Huang has also served as Senior Manager of Strategic Investments at Intel Capital, Director of Asia Pacific Research Operations at Gartner Group and Vice President of Marketing of Mtone Wireless. Mr. Huang holds an MBA degree from Harvard Business School, a master’s degree in sociology from Stanford University and a bachelor’s degree in English from Beijing Foreign Studies University.
Chengyu Xiong has served as our director since October 2005. Dr. Xiong is a professor and deputy dean of the School of Journalism and Communication at Tsinghua University. In addition, Dr. Xiong serves as the director of both the New Media Studies Center and the Cultural Industries Center at the School of Journalism. Dr. Xiong received his doctorate degree from Brigham Young University. Dr Xiong has written, edited and translated numerous books and articles.
Kai Zhao has served as our director since 2009. Mr. Zhao previously served as dean of the Journalism School of Fudan University, secretary general of the China Communist Party (CCP) committee of Wenhui-Xinmin United Press Newspaper Group, chief editor of Liberation Daily and secretary general of the CCP committee of Shanghai Municipal Radio, Film and Television Bureau as well as in various managerial roles at Shanghai Municipal Radio and Television Bureau, Oriental Radio Station, Shanghai People’s Radio Station and Qinghai Daily. Mr. Zhao received a Bachelor of Arts in Journalism from Fudan University, Shanghai in 1962.
Jin Zhang has served as vice president since June 2009. Prior to joining us, Ms. Zhang held roles as vice president in Lenovo Group, in charge of Human Resources in Great China, India, Russia and other global emerging markets. Ms. Zhang has years of experience in human resources management and was in charge of organization development, C&B management, strategic planning in human resources from 2002 — 2009. From 1999 — 2002, Ms. Zhang held various positions in Lenovo, including strategy department manager and quality management department manager. Ms. Zhang holds a master’s degree in Management from Renmin University of China.
Grace Wu has served as chief financial officer since November 2007 and as our director since December 2007. Ms. Wu previously served as our vice president of strategic investments. Prior to joining us, Ms. Wu was responsible for financial planning and analysis, investor relations and capital markets activities of AU Optronics Corp. Prior to that, Ms. Wu worked at Goldman Sachs and Lehman Brothers where she divided her responsibilities between the equity capital markets and investment banking divisions. Ms. Wu holds a bachelor’s degree from National Taiwan University and a Master of International Affairs degree in international banking and finance from Columbia University.
Haifa Zhu has served as chief investment officer since April 2008. Mr. Zhu previously served as assistant vice president of investments, director of platform operations, and deputy director of our new business center. Prior to joining us, Mr. Zhu was responsible for investments at Nuovo Assets Investment Ltd. from 2001 to 2004. Prior to joining Nuovo Assets, Mr. Zhu worked in technology management for Shanghai Academy of Science from 1996 to 2001. Mr. Zhu holds a master’s degree in business administration and a bachelor’s degree from Fudan University.
Danning Mi has served as chief information officer since April 2008. Mr. Mi previously served as assistant vice president from October 2005 to April 2008. Prior to joining Shanda, Mr. Mi served in various managerial capacities, including chief information officer, at Founder Technology Group. Mr. Mi holds a master’s in psychology and physics from Beijing Normal University.

 

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Duties of Directors
Under Cayman Islands law, our directors have a duty of loyalty to act honestly in good faith with a view to our best interests. Our directors also have a duty to exercise the care, diligence and skills that a reasonably prudent person would exercise in comparable circumstances. In fulfilling their duty of care to us, our directors must ensure compliance with our amended and restated memorandum and articles of association. A shareholder has the right in certain circumstances in a derivative action in the name of the company to seek damages if a duty owed by our directors is breached.
The functions and powers of our board of directors include, among others:
    convening shareholders’ meetings and reporting its work to shareholders at such meetings;
 
    implementing shareholders’ resolutions;
 
    determining our business plans and investment proposals;
 
    formulating our profit distribution plans and loss recovery plans;
 
    determining our debt and finance policies and proposals for the increase or decrease in our registered capital and the issuance of debentures;
 
    formulating our major acquisition and disposition plans, and plans for merger, division or dissolution;
 
    proposing amendments to our amended and restated memorandum and articles of association; and
 
    exercising any other powers conferred by the shareholders’ meetings or under our amended and restated memorandum and articles of association.
Terms of Directors and Executive Officers
Each of our directors holds office until a successor has been duly elected and qualified unless the director was appointed by the board of directors, in which case such director holds office until the next following annual meeting of shareholders at which time such director is eligible for reelection. All of our executive officers are appointed by and serve at the discretion of our board of directors.
B. COMPENSATION
In 2009, the aggregate cash compensation paid to our directors and executive officers as a group was RMB16.48 million (US$2.41 million). In addition, an aggregate of 2,865,000 restricted ordinary shares of Shanda Games were granted to our directors and officers in 2009. We have no service contracts with any of our directors or executive officers that provide benefits to them upon termination.
Equity Compensation Plans
In order to promote our success and to increase shareholder value by providing an additional means to attract, motivate, retain and reward selected directors, employees and other eligible persons, we have adopted our 2003 Share Incentive Plan and our 2005 Equity Compensation Plan. In March 2003, our board of directors adopted the 2003 Share Incentive Plan. An aggregate of 13,309,880 ordinary shares were reserved for issuance under the 2003 Plan.
In October 2005, our shareholders approved the 2005 Equity Compensation Plan at our annual general meeting of shareholders. An aggregate of 7,449,235 ordinary shares, which is equal to approximately 5.9% of our issued and outstanding ordinary shares as of March 31, 2010, were reserved for issuance under the 2005 Equity Compensation Plan.

 

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The table set forth below summarizes stock option activity under the plans for the years ended December 31, 2007, 2008 and 2009:
                                                 
    2007     2008     2009  
            Weighted             Weighted             Weighted  
            Average             Average             Average  
    Options     Exercise Price     Options     Exercise Price     Options     Exercise Price  
    Outstanding     (US$)     Outstanding     (US$)     Outstanding     (US$)  
Outstanding at beginning of year
    7,567,237       5.55       5,257,841       7.68       4,018,513       8.48  
Granted
    1,080,000       14.03       110,000       15.65              
Exercised
    (3,009,246 )     4.60       (1,227,728 )     4.97       (1,390,333 )     7.61  
Forfeited
    (370,900 )     7.42       (120,850 )     15.89       (70,004 )     14.72  
Expired
    (9,250 )     15.01       (750 )     15.55              
Outstanding at end of year
    5,257,841       7.68       4,018,513       8.48       2,558,176       8.78  
 
                                   
Vested and exercisable at end of year
    1,398,925       3.98       1,838,647       6.92       1,446,927       8.01  
 
                                   
Upon the adoption of the 2005 Equity Compensation Plan, we ceased granting options pursuant to the 2003 Share Incentive Plan. As of December 31, 2009, options to purchase 4,469,038 ordinary shares were available for grant under the 2003 Share Incentive Plan and the 2005 Equity Compensation Plan. The table set forth below summarizes outstanding and exercisable stock options under the 2003 Share Incentive Plan and the 2005 Equity Compensation Plan as of December 31, 2009
                                         
    Options outstanding at December 31, 2009       Options exercisable at December 31, 2009      
             Weighted Average                      
            Remaining                      
Exercise Prices    Number     Contractual Life     Weighted Average             Weighted Average  
(US$)   Outstanding     (years)     Exercise Price (US$)     Number Outstanding     Exercise Price (US$)  
1.516
    362,831       3.25       1.516       362,831       1.516  
5.50
    31,149       4.25       5.50       31,149       5.50  
6.8505
    1,247,110       6.50       6.8505       593,361       6.8505  
8.00
    35,850       4.57       8.00       35,850       8.00  
11.6406
    425,702       3.31       11.6406       128,202       11.6406  
15.02
    10,000       4.48       15.02       2,500       15.02  
15.33
    83,078       5.07       15.33       83,078       15.33  
15.55
    42,800       5.08       15.55       42,800       15.55  
16.86
    29,656       5.58       16.86       29,656       16.86  
17.60
    15,000       4.01       17.60             17.60  
18.0287
    100,000       3.77       18.0287       50,000       18.0287  
18.64
    100,000       3.79       18.64       50,000       18.64  
19.09
    75,000       3.83       19.09       37,500       19.09  
 
                             
Total: 
    2,558,176                       1,446,927          
 
                             
Both the 2003 Share Incentive Plan and the 2005 Equity Compensation Plan are administered by our compensation committee, which has the discretion to award equity compensation grants. Subject to the provisions of the 2003 Share Incentive Plan and the 2005 Equity Compensation Plan, including the limits upon the number of ordinary shares reserved for issuance under these plans, our compensation committee determines who will receive equity compensation awards, the type and timing of awards to be granted, vesting schedules, exercise prices and other terms and conditions of the awards.

 

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The table below sets forth the option grants made to our directors and executive officers pursuant to the plan as of March 31, 2010.
                                 
    Number of Shares                    
    Underlying Options     Per Share Exercise Price              
Name   Granted     (in US$)     Date of Grant     Date of Expiration  
Tianqiao Chen
    266,198       1.516     March 31, 2003   March 31, 2013
Danian Chen
    266,198       1.516     March 31, 2003   March 31, 2013
Qianqian Luo
    266,198       1.516     March 31, 2003   March 31, 2013
Jingsheng Huang
    *       1.516     March 31, 2003   March 31, 2013
Qunzhao Tan
    2,129,581       1.516     March 31, 2003   March 31, 2013
Qunzhao Tan
    150,000       6.8505     June 28, 2006   June 28, 2016
Grace Wu
    *       18.0287     October 8, 2007   October 8, 2013
Haifa Zhu
    *       5.5     March 1, 2004   March 1, 2014
Haifa Zhu
    *       15.55     January 28, 2005   January 28, 2015
Haifa Zhu
    *       6.8505     June 28, 2006   June 28, 2016
Haifa Zhu
    *       11.6406     March 24, 2007   March 24, 2013
Danning Mi
    *       16.86     August 1, 2005   August 1, 2015
Danning Mi
    *       6.8505     June 28, 2006   June 28, 2016
 
     
*   Upon exercise of all options granted, would beneficially own less than 1% of our outstanding ordinary shares.
In November 2008, Shanda Games adopted its 2008 Equity Compensation Plan which provides for the issuance of up to 44,000,000 shares.
Our 2008 Equity Compensation Plan is administered by Shanda Games’s compensation committee, which has the discretion to award equity compensation grants. Subject to the provisions of the 2008 Equity Compensation Plan, including the limits upon the number of ordinary shares reserved for issuance under these plans, Shanda Games’s compensation committee determines who will receive equity compensation awards, the type and timing of awards to be granted, vesting schedules, exercise prices and other terms and conditions of the awards.
The table below sets forth the option grants made to our directors and executive officers pursuant to the Shanda Games 2008 Equity Compensation Plan as of March 31, 2010.
                                 
    Number of Class A                    
    Ordinary Shares of                    
    Shanda Games to be     Exercise Price              
    Issued Upon Exercise of     Per Class A              
Name   Options     Ordinary Share     Date of Grant     Date of Expiration  
            (in US$)                  
Qunzhao Tan
    *       3.40     March 19, 2010   March 19, 2020
 
    * (1)         September 7, 2009   September 7, 2019
Danian Chen
    * (1)         September 7, 2009   September 7, 2019
Jingsheng Huang
    * (1)         September 7, 2009   September 7, 2019
Chengyu Xiong
    * (1)         September 7, 2009   September 7, 2019
Zhao Kai
    * (1)         September 7, 2009   September 7, 2019
Jin Zhang
    * (1)         September 7, 2009   September 7, 2019
Grace Wu
    * (1)         September 7, 2009   September 7, 2019
Haifa Zhu
    * (1)         September 7, 2009   September 7, 2019
Danning Mi
    * (1)         September 7, 2009   September 7, 2019
 
     
*   Upon exercise of all options granted, would beneficially own less than 1% of our outstanding ordinary shares.
 
(1)   Restricted shares.
For a description of our past stock option compensation expense and recent accounting changes, see “Item 5 Operating and Financial Review and Prospects–A. Operating Results–Critical Accounting Policies–“Share-based Compensation.”

 

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C. BOARD PRACTICES
Term and Severance Provisions of Directors and Executive Officers
Each of our directors holds office until a successor has been duly elected and qualified unless the director was appointed by the board of directors, in which case such director holds office until the next following annual meeting of shareholders at which time such director is eligible for reelection. All of our executive officers are appointed by and serve at the discretion of our board of directors. We have no service contracts with any of our directors or executive officers that provide benefits to them upon termination.
Our board has determined that three members of our board of directors, namely Mr. Huang, Mr. Xiong and Mr. Wu, are “independent” as that term is defined in Rule 5605(a)(2) of the NASDAQ Marketplace Rules.
Board Committees
Our board of directors has established an audit committee and a compensation committee.
Audit Committee
Our audit committee currently consists of Jingsheng Huang, Chengyu Xiong and Kai Zhao. Our board of directors has determined that all of our audit committee members are independent directors within the meaning of Rule 5605(a)(2) of the NASDAQ Marketplace Rules and meet the criteria for independence set forth in Section 10A(m)(3)(B)(i) of the Exchange Act.
Our audit committee is responsible for, among other things:
    selecting the independent auditors and preapproving all auditing and nonauditing services permitted to be performed by the independent auditors;
    annually reviewing an independent auditors’ report describing the auditing firm’s internal quality-control procedures, any material issues raised by the most recent internal quality-control review, or peer review, of the independent auditors and all relationships between the independent auditors and our company;
 
    setting clear hiring policies for employees or former employees of the independent auditors;
 
    reviewing with the independent auditors any audit problems or difficulties and management’s response;
 
    reviewing and approving all proposed related party transactions, as defined in Item 404 of Regulation S-K;
 
    discussing the annual audited financial statements with management and the independent auditors;
 
    discussing with management and the independent auditors major issues regarding accounting principles and financial statement presentations;
 
    reviewing reports prepared by management or the independent auditors relating to significant financial reporting issues and judgments;
 
    discussing earnings press releases, as well as financial information and earnings guidance provided to analysts and rating agencies;
 
    reviewing with management and the independent auditors the effect of regulatory and accounting initiatives, as well as off-balance sheet structures on our financial statements;
 
    discussing policies with respect to risk assessment and risk management;
 
    reviewing major issues as to the adequacy of our internal controls and any special audit steps adopted in light of material control deficiencies;

 

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    timely reviewing reports from the independent auditors regarding all critical accounting policies and practices to be used by our company, all alternative treatments of financial information within GAAP that have been discussed with management and all other material written communications between the independent auditors and management;
 
    establishing procedures for the receipt, retention and treatment of complaints received from our employees regarding accounting, internal controls or auditing matters and the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters;
 
    annually reviewing and reassessing the adequacy of our audit committee charter;
 
    such other matters that are specifically delegated to our audit committee by our board of directors from time to time;
 
    meeting separately, periodically, with management, the internal auditors and the independent auditors; and
 
    reporting regularly to the full board of directors.
Compensation Committee
Our current compensation committee consists of Tianqiao Chen and Qianqian Luo. Neither Mr. Chen nor Ms. Luo satisfy the “independence” requirements of the NASDAQ Marketplace Rules or meet the criteria for independence set forth in Section 10A(m)(3)(B)(i) of the Exchange Act. This home country practice of ours was established by our board of directors by reference to similarly situated issuers and differs from Rule 5605(d)(1)(B) of the NASDAQ Marketplace Rules that requires the compensation committees of U.S. companies to consist solely of independent directors. There are, however, no specific requirements under Cayman Islands law on the composition of our compensation committee. Our compensation committee is responsible for:
    reviewing and making recommendations to our board of directors regarding our compensation policies and forms of compensation provided to our directors and officers, including our chief executive officer;
 
    reviewing and determining bonuses for our officers and other employees;
 
    reviewing and determining stock-based compensation for our directors, officers, employees and consultants;
 
    administering our equity incentive plans in accordance with the terms thereof; and
 
    such other matters that are specifically delegated to the compensation committee by our board of directors from time to time.
D. EMPLOYEES
As of December 31, 2007, 2008 and 2009, we had 2,564, 3,124 and 5,721 full-time employees, respectively. The following table sets forth the number of our employees by business line as of December 31, 2009:
                 
    As of December 31, 2009  
    Number     Percent  
Headquarters
    465       8.1  
Shanda Online
    1,389       24.3  
Shanda Games
    1,959       34.2  
Hurray! and certain of its affiliates
    397       6.9  
Others
    1,511       26.4  
 
           
Total
    5,721       100.0  
 
           

 

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As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including housing, pension, medical and unemployment benefit plans. We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the local government from time to time. Members of the retirement plan are entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date. In addition to the benefits that we are required to provide to our employees pursuant to PRC regulations, we also provide life insurance and supplemental medical and housing insurance. The total amount of contributions we made to employee benefit plans in 2007, 2008 and 2009 were RMB37.0 million, RMB46.1 million and RMB71.8 million (US$10.5 million), respectively.
We believe that we maintain a good working relationship with our employees and we have not experienced any significant labor disputes or any difficulty in recruiting staff for our operations.
We enter into a standard annual employment contract with most of our officers, managers and employees. These contracts include a covenant that prohibits the officer, manager or employee from engaging in any activities that compete with our business during, and for one to two years after the period of their employment with us.
E. SHARE OWNERSHIP
Please see Item 7.A.
Item 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. MAJOR SHAREHOLDERS
The following table sets forth information with respect to the beneficial ownership, within the meaning of Rule 13d-3 of the U.S. Securities Exchange Act of 1934, as amended, or the Exchange Act, of our ordinary shares, as of March 31, 2010:
    each person known to us to own beneficially more than 5% of our ordinary shares; and
 
    each of our directors and executive officers who beneficially own ordinary shares within the meaning of Rule 13d-3 of the Exchange Act.
Beneficial ownership includes voting or investment power with respect to the securities. Except as indicated below, and subject to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all ordinary shares shown as beneficially owned by them. Percentage of beneficial ownership is based on 125,549,424 ordinary shares outstanding as of March 31, 2010.
                 
    Shares Beneficially Owned  
Name   Number     Percentage of Total  
Tianqiao Chen(1)
    62,454,538       49.7 %
Premium Lead Company Limited(2)
    60,000,000       47.8 %
Crystal Day Holdings Limited(3)
    11,938,212       9.5 %
FMR LLC(4)
    15,714,114       12.5 %
Orbis Group(5)
    13,732,752       10.9 %
Qianqian Luo(6)
    2,454,538       2.0 %
Jingsheng Huang
    *       *  
Qunzhao Tan(7)
    1,468,781       1.2 %
Danian Chen(8)
    1,156,270       0.9 %
Grace Wu
    *       *  
Haifa Zhu
    *       *  
Danning Mi
    *       *  
 
     
*   Upon exercise of all options currently exercisable or vesting within 60 days of the date of this table, would beneficially own less than 1% of our ordinary shares.

 

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(1)   Represents 60,000,000 ordinary shares owned by Premium Lead and 2,454,538 ordinary shares, comprised of 1,227,269 ADSs, held by DBS Trustees Limited acting as trustees of the Jade Trust. Ordinary shares held by DBS Trustees Limited acting as trustees of the Jade Trust are held for the benefit of Tianqiao Chen and his family members. The number of shares was taken from the Schedule 13G filed with the SEC by Tianqiao Chen on January 15, 2008. The percentage of beneficial ownership was calculated based on the amount of our ordinary shares outstanding as of March 31, 2010.
 
(2)   Tianqiao Chen is the sole shareholder of Shanda Media Limited, which owns 60% of First Step Investment Limited. First Step Investment Limited owns 60% of Premium Lead. Tianqiao Chen is a director of First Step Investment Limited and Premium Lead. The number of shares was taken from the Schedule 13G filed with the SEC by Premium Lead on January 15, 2008. The percentage of beneficial ownership was calculated based on the amount of our ordinary shares outstanding as of March 31, 2010.
 
(3)   Crystal Day Holdings Limited, a Hong Kong corporation, is wholly-owned by Silver Rose Investment Limited. Silver Rose Investment Limited is a British Virgin Islands corporation, which in turn is wholly-owned by HSBC International Trustee Limited acting as trustee of The C&T Trust. The number of shares was taken from the Schedule 13G filed with the SEC by Crystal Day Holdings Limited on January 7, 2008. The percentage of beneficial ownership was calculated based on the amount of our ordinary shares outstanding as of March 31, 2010.
 
(4)   The number of shares was taken from the Schedule 13G filed with the SEC by FMR LLC on February 16, 2010. The percentage of beneficial ownership was calculated based on the amount of our ordinary shares outstanding as of March 31, 2010.
 
(5)   The number of shares was taken from the Schedule 13G filed with the SEC by Orbis Group on January 11, 2010. The percentage of beneficial ownership was calculated based on the amount of our ordinary shares outstanding as of March 31, 2010.
 
(6)   Represents 2,454,538 ordinary shares, comprised of 1,227,269 ADSs, held by DBS Trustees Limited acting as trustees of the Jade Trust. Ordinary shares held by DBS Trustees Limited acting as trustees of the Jade Trust are held for the benefit of Tianqiao Chen and his family members. Ms. Luo is our director and the wife of Tianqiao Chen, our chairman and chief executive officer.
 
(7)   These ordinary shares, or stock options to purchase ordinary shares, are held by DBS Trustees Limited acting as Trustees of the Three Gorges Trust for the benefit of Qunzhao Tan and his family members.
 
(8)   Represents 1,156,270 ordinary shares, comprised of 198,000 ordinary shares and 479,135 ADSs, held by DBS Trustees Limited acting as trustees of the Chi Feng Trust. Ordinary shares held by DBS Trustees Limited acting as trustees of the Chi Feng Trust are held for the benefit of Danian Chen and his family members.
None of our existing shareholders have voting rights that differ from the voting rights of other shareholders. We are not aware of any arrangement that may, at a subsequent date, result in a change of control of our company. As of March 31, 2010, of the 125,549,424 issued and outstanding ordinary shares, approximately 50% of those ordinary shares were held in the United States in the form of ADSs by nine registered ADS holders.
B. RELATED PARTY TRANSACTIONS
Shanda Computer/Shanda Networking Arrangements
In order to comply with PRC regulations, as of the date of this annual report, we operate our service platform business in China through Shanda Networking, a company wholly-owned by Tianqiao Chen and Danian Chen, who are our founders and are also PRC citizens. We have entered into VIE agreements with Shanda Networking and its shareholders. The VIE agreements may only be amended with the approval of the audit committee of our board of directors.

 

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Shareholder Rights and Corporate Governance
Transfer of Ownership when Permitted by Law. On December 30, 2003, Shengqu entered into a purchase option and cooperation agreement, or the purchase option agreement, with Tianqiao Chen, Danian Chen and Shanda Networking. Effective as of July 1, 2008, Shengqu assigned the purchase option agreement to Shanda Computer. Due to the assignment, Tianqiao Chen and Danian Chen jointly granted Shanda Computer an exclusive option to purchase all of their equity interest in Shanda Networking, and Shanda Networking granted Shanda Computer an exclusive option to purchase all of its assets if and when (1) such purchase is permitted under applicable PRC law or (2) to the extent permitted by law, with respect to his individual interest, either Tianqiao Chen and Danian Chen ceases to be a director or employee of Shanda Networking or desires to transfer his equity interest in Shanda Networking to a third party. Shanda Computer may purchase such interest or assets by itself or designate another party to purchase such interest or assets. The exercise price of the option will be the lowest price permitted by PRC law, or a pro rata portion thereof for a purchase of a portion of the equity interest in, or assets of, Shanda Networking. Shanda Computer will bear the tax consequences of Tianqiao Chen and Danian Chen caused by any exercise by Shanda Computer of the option to purchase the equity interest in Shanda Networking. Following any exercise of the option, the parties will enter into a definitive share or asset purchase agreement and other related transfer documents within 30 days after written notice of exercise is delivered. Pursuant to the purchase option agreement, at all times before Shanda Computer acquires 100% of Shanda Networking’s shares or assets, Shanda Networking may not (1) sell, transfer, assign, dispose of in any manner or create any encumbrance in any form on any of its assets unless such sale, transfer, assignment, disposal or encumbrance relates to the daily operation of Shanda Networking or has been disclosed and consented to in writing by Shengqu; (2) enter into any transaction which may have a material effect on Shanda Networking assets, liabilities, operations, equity or other legal interests unless such transaction relates to the daily operation of Shanda Networking or has been disclosed and consented to in writing by Shanda Computer; and (3) distribute any dividends to its shareholders in any manner, and Tianqiao Chen and Danian Chen may not cause Shanda Networking to amend its articles of association to the extent such amendment may have a material effect on Shanda Networking’s assets, liabilities, operations, equity or other legal interests except for pro rata increases of registered capital required by law.
Voting Arrangement. Pursuant to two proxies executed and delivered by Tianqiao Chen and Danian Chen to Shanda Computer by Shanda Computer, on July 1, 2008, Tianqiao Chen and Danian Chen have granted Shanda Computer or any person designated by Shengqu the power to exercise their rights as the shareholders of Shanda Networking.
Share Pledge Agreement. Pursuant to a share pledge agreement, dated July 1, 2008, Tianqiao Chen and Danian Chen have pledged all of their equity interest in Shanda Networking to Shanda Computer to secure the payment obligations of Shanda Networking under all of the agreements between Shanda Networking and Shanda Computer. Under this agreement, Tianqiao Chen and Danian Chen have agreed not to transfer, assign, pledge or in other manner dispose of their interests in Shanda Networking or create any other encumbrance on their interests in Shanda Networking which may have a material effect on Shanda Computer’s interests without the written consent of Shengqu.
Other Related Party Transactions
Game License Agreements with Actoz. On November 26, 2008, Shanda Games entered into an agreement with Actoz to extend the term of our exclusive license to operate Mir II in China for up to eight years. Shanda Games has also entered into agreements with Actoz for an exclusive license to operate other online games in China, such as Lazeska. Shanda Games currently owns approximately 52.0% of the outstanding stock of Actoz.
Sale of Equity Interest of Actoz. On May 29, 2009, we entered into an agreement to sell all of our ordinary shares in Actoz, which represented 53.8% of the outstanding shares of Actoz, to Shanda Games in consideration for approximately US$70.2 million in cash.
Operational Agreements.
    Shengfutong, which is a subsidiary of Shanda Networking, and the Shulong entities entered into a sales agency agreement pursuant to which Shengfutong has agreed, for a period of five years commencing on July 1, 2008, to be the exclusive sales agency of the Shulong entities for the distribution of pre-paid cards which can be used to access and play Shanda Games’s MMORPGs and advanced casual games on Shanda Online’s integrated service platform. Shanda Games has agreed to pay the Shanda Networking entities an amount equal to the difference between (x) the amount Shengfutong receives from distributors or users from the sale of the pre-paid cards and (y) a fixed percentage of the face value of a pre-paid card as agreed upon between Shanda Networking, Nanjing Shanda and Shanda Games.

 

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    Shanda Networking and Nanjing Shanda, on the one hand, and the Shulong entities, on the other hand, entered into a cooperation agreement which provides that Shanda Networking and Nanjing Shanda should provide certain online e-commerce platform services to Shanda Games for a period of five years commencing on July 1, 2008. The services Shanda Networking and Nanjing Shanda have agreed to provide Shanda Games include, among others, online billing and payment, user authentication, customer service, anti-fatigue compliance, pre-paid card marketing and distribution and data support services. Shanda Games will pay Shanda Networking a fee which is equal to a fixed percentage of the portion of the face value of the pre-paid cards that are used in Shanda Games’s MMORPGs and advanced casual games.
Item 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Consolidated Financial Statements
Please see “Item 18. Financial Statements” for our audited consolidated financial statements filed as a part of this annual report.
Legal Proceedings
We are not involved in any legal matters that management believes will have a material adverse effect on our business.
Dividend Policy
We do not expect to pay dividends on our ordinary shares in the foreseeable future. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business, and do not anticipate paying any cash dividends on our ordinary shares, or indirectly on our ADSs, for the foreseeable future.
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 condition, contractual restrictions and other factors as our board of directors may deem relevant.
Holders of ADSs will be entitled to receive dividends, subject to the terms of the deposit agreement, to the same extent as the holders of our ordinary shares, less the fees and expenses payable under the deposit agreement. Cash dividends will be paid by the depositary to holders of ADSs in U.S. dollars, subject to the terms of the deposit agreement. Other distributions, if any, will be paid by the depositary to holders of ADSs in any means it deems legal, fair and practical.
B. SIGNIFICANT CHANGES
Since the date of the audited financial statements included as a part of this annual report, the following significant changes have occurred:
In January 2010, Hurray! completed its acquisition of Ku6, an online video site in China.
In January 2010, Shanda Games acquired Goldcool Holdings Limited, a Shanghai-based online game developer and operator.

 

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In January 2010, Shanda Games acquired Mochi Media, a leading platform for distributing and monetizing browser-based games worldwide.
In April 2010, Shanda Literature acquired 55% of the outstanding shares of Beijing Wangwen Xinyue Technology Co., Ltd., or Readnovel, which operates Readnovel.com.
In May 2010, Shanda Literature acquired 70% of the equity interest of Suzhou Jingwei Network Technology Co., Ltd., which operates the online literature website www.xxsy.com.
In May 2010, Hurray! announced that it agreed to sell all of its equity interest in Huayi Music to Huayi Brothers Media Corporation for an aggregate consideration of RMB34.5 million. Concurrently, Hurray! announced that it has terminated its agreements with Beijing Brothers ShengShi Enterprise Management Co., Ltd. and Beijing QiXinWeiYe Culture Development Co., Ltd., which were entered into when Hurray! purchased its equity interest in Huayi Music.
Item 9. THE OFFER AND LISTING
A. OFFER AND LISTING DETAILS
Price Range of American Depositary Shares
Our ADSs, each representing two of our ordinary shares, have been listed on The NASDAQ Global Market since May 13, 2004. Our ADSs trade under the symbol “SNDA.” The following table provides the high and low sale prices for our ADSs on The NASDAQ Global Select Market for (1) the years 2005, 2006, 2007, 2008 and 2009, (2) each of the quarters since the first quarter of 2008, and (3) each of the most recent six months. On May 14, 2010, the last reported sale price for our ADSs was US$43.50 per ADS.
                 
    Market Price (US$)  
    High     Low  
Yearly highs and lows
               
Year 2005
    42.90       14.80  
Year 2006
    22.21       12.23  
Year 2007
    39.89       20.59  
Year 2008
    37.60       21.08  
Year 2009
    63.66       26.19  
Quarterly highs and lows:
               
First quarter 2008
    34.89       25.91  
Second quarter 2008
    37.60       26.44  
Third quarter 2008
    30.74       22.06  
Fourth quarter 2008
    32.36       21.08  
First quarter 2009
    39.53       26.19  
Second quarter 2009
    63.66       40.80  
Third quarter 2009
    61.93       45.40  
Fourth quarter 2009
    53.14       40.34  
First quarter 2010
    59.00       38.50  
Second quarter 2010 (April 1, 2010 through May 14, 2010)
    46.34       42.38  
Monthly highs and lows:
               
November 2009
    50.41       45.20  
December 2009
    53.14       50.38  
January 2010
    59.00       46.06  
February 2010
    49.60       44.96  
March 2010
    44.98       38.50  
April 2010
    46.34       43.32  
May 2010 (May 1, 2010 through May 14, 2010)
    46.00       42.38  
B. PLAN OF DISTRIBUTION
Not applicable.
C. MARKETS
Our ADSs, each representing two of our ordinary shares, have been listed on The NASDAQ Global Market since May 13, 2004 under the symbol “SNDA.”
D. SELLING SHAREHOLDER
Not applicable.

 

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E. DILUTION
Not applicable.
F. EXPENSES OF THE ISSUE
Not applicable.
Item 10. ADDITIONAL INFORMATION
A. SHARE CAPITAL
Not applicable.
B. MEMORANDUM AND ARTICLES OF ASSOCIATION
We incorporate by reference into this annual report the description of our amended and restated memorandum and articles of association contained in our registration statement on Form F-1 (File No. 333-114177) filed with the SEC on May 7, 2004.
C. MATERIAL CONTRACTS
We have not entered into any material contracts other than in the ordinary course of business or other than those described in “Item 4. Information on the Company” and elsewhere in this annual report.
D. EXCHANGE CONTROLS
Most of our revenues are denominated in Renminbi, while a portion of our expenditures are denominated in foreign currencies, primarily the U.S. dollar. Fluctuations in exchange rates, particularly those involving the U.S. dollar, and the Korean Won, may affect our costs and operating margins. In addition, these fluctuations could result in exchange losses and increased costs in Renminbi terms. Where our operations conducted in Renminbi are reported in dollars, such fluctuations could result in changes in reported results which do not reflect changes in the underlying operations. Since January 1, 1994, the PRC government has used a unitary managed floating rate system. Under that system, the People’s Bank of China, or PBOC, publishes a daily base exchange rate with reference primarily to the supply and demand of the Renminbi against the U.S. dollar and other foreign currencies in the market during the previous day. Authorized banks and financial institutions are allowed to quote buy and sell rates for Renminbi within a specified bank around the central bank’s daily exchange rate. On July 21, 2005, PBOC announced an adjustment of the exchange rate of the U.S. dollar to Renminbi from 1:8.27 to 1:8.11 and modified the system by which the exchange rates are determined. While the international reaction to the Renminbi revaluation has generally been positive, there remains significant international pressure on the PRC government to adopt an even more flexible currency policy, which could result in a further reevaluation and a significant fluctuation of the exchange rate of the Renminbi against the U.S. dollar, including possible devaluations. As most of our revenues are denominated in Renminbi, such a potential future devaluation of the Renminbi against the U.S. dollar could negatively impact our results of operations.
In October 2005, SAFE promulgated regulations that require registration with local SAFE in connection with direct or indirect offshore investment by PRC residents, including PRC individual residents and PRC corporate entities. These regulations apply to our shareholders who are PRC residents and also apply to our prior and future offshore acquisitions.
The SAFE regulations retroactively require registration by March 31, 2006 of direct or indirect investments previously made by PRC residents in offshore companies. If a PRC resident with a direct or indirect stake in an offshore parent company fails to make the required SAFE registration, the PRC subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the PRC subsidiaries. Further, failure to comply with various SAFE registration requirements described above could result in liability under PRC law for foreign exchange evasion.

 

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For more information about foreign exchange control and other foreign exchange regulations in China, see “Risk Factors” in Item 3.
E. TAXATION
The following is a general summary of certain Cayman Islands, PRC and U.S. federal income tax considerations relevant to holders of our ADSs. The discussion is not intended to be, nor should it be construed as, legal or tax advice to any particular holder of our ADSs. The discussion is based on laws and relevant interpretations thereof in effect as of the date hereof, all of which are subject to change or different interpretations, possibly with retroactive effect. The discussion does not address U.S. state or local tax laws, or tax laws of jurisdictions other than the Cayman Islands and the United States.
Cayman Islands Taxation
The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty or withholding tax applicable to us or to any holder of our securities. There are no other taxes likely to be material to us levied by the Government of the Cayman Islands except for stamp duties, which may be applicable on instruments executed in, or after execution brought within the jurisdiction of the Cayman Islands. No stamp duty is payable in the Cayman Islands on transfers of shares of Cayman Islands companies except those which hold interests in land in the Cayman Islands. The Cayman Islands is not party to any double tax treaties. There are no exchange control regulations or currency restrictions in the Cayman Islands.
Pursuant to Section 6 of the Tax Concessions Law (1999 Revision) of the Cayman Islands, the Company has obtained an undertaking from the Governor-in-Council:
  (1)   that no law which is enacted in the Cayman Islands imposing any tax to be levied on profits or income or gains or appreciation shall apply to the Company or its operations; and
 
  (2)   that the aforesaid tax or any tax in the nature of estate duty or inheritance tax shall not be payable on the shares, debentures or other obligations of the Company.
The undertaking for the Company is for a period of twenty years from November 25, 2003.
People’s Republic of China Taxation
In 2007, China passed a new Enterprise Income Tax Law, or the New EIT Law, and its implementing rules, both of which became effective on January 1, 2008. The New EIT Law created a new “resident enterprise” classification, which, if applied to us, would impose a 10% withholding tax on dividends payable to our non-PRC shareholders and, while less clear, with respect to gains derived by our non-PRC shareholders from disposition of our shares or ADSs, if such dividends or gains are determined to have been derived from sources within China. The New EIT Law and its implementing rules are unclear as to how to determine the sources of such dividends or gains. See “Risk Factors—Risk Relating to Our ADSs—We may be required to withhold PRC income tax on the dividends we pay you (if any), and any gain you realize on the transfer of our ordinary shares and/or ADSs may also be subject to PRC withholding tax.”
If we are not deemed as a resident enterprise, then dividends payable to our non-PRC shareholders and gains from disposition of our shares of ADSs by our non-PRC shareholders will not be subject to PRC income tax withholding.
U.S. Federal Income Taxation
The following summary describes certain U.S. federal income tax consequences of owning and disposing of our ADSs as of the date hereof, but it does not purport to be a comprehensive description of all tax considerations that may be relevant to a particular person’s decision to hold our ADSs. The discussion is applicable to U.S. Holders (as defined below) who hold our ADSs as capital assets. As used herein, the term “U.S. Holder’’ means a holder of an ADS that is for U.S. federal income tax purposes:
    an individual citizen or resident of the United States;
 
    a corporation (or other entity treated as a corporation for U.S. federal income tax purposes) created or organized in or under the laws of the United States, any state thereof or the District of Columbia;

 

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    an estate the income of which is subject to U.S. federal income taxation regardless of its source; or
 
    a trust if it (1) is subject to the primary supervision of a court within the United States and one or more U.S. persons have the authority to control all substantial decisions of the trust or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person.
This summary does not describe all of the U.S. federal income tax consequences that may be applicable to you if you are subject to special treatment under the U.S. federal income tax laws, including if you are:
    a dealer in securities or currencies;
 
    a financial institution;
 
    a regulated investment company;
 
    a real estate investment trust;
 
    an insurance company;
 
    a tax-exempt entity, including an “individual retirement account” or “Roth IRA”;
 
    a person holding our ADSs as part of a hedging, integrated or conversion transaction, a constructive sale or a straddle;
 
    a trader in securities that has elected the mark-to-market method of accounting for your securities;
 
    a person liable for alternative minimum tax;
 
    a person who owns 10% or more of our voting stock;
 
    a partnership or other pass-through entity for U.S. federal income tax purposes;
 
    a person whose “functional currency” is not the U.S. dollar; or
 
    a person who has acquired our ADSs pursuant to the exercise of any employee stock option or otherwise as compensation.
The discussion below is based upon the provisions of the Internal Revenue Code of 1986, as amended (the “Code’’), and proposed, temporary and final regulations, rulings and judicial decisions thereunder as of the date hereof, and such authorities may be replaced, revoked or modified so as to result in U.S. federal income tax consequences different from those discussed below. In addition, this summary is based, in part, upon representations made by the depositary to us and assumes that the deposit agreement, and all other related agreements, will be performed in accordance with their terms.
If a partnership holds ADSs, the tax treatment of a partner will generally depend upon the status of the partner and the activities of the partnership. If you are a partner of a partnership holding our ADSs, you should consult your tax advisors.
This summary does not contain a detailed description of all the U.S. federal income tax consequences to you in light of your particular circumstances. If you are considering the purchase, ownership or disposition of our ADSs, you should consult your own tax advisors concerning the U.S. federal income tax consequences to you in light of your particular situation as well as any consequences arising under the laws of any other taxing jurisdiction.
The U.S. Treasury has expressed concerns that intermediaries in the chain of ownership between the holder of American depositary shares and the issuer of the security underlying the American depositary shares may be taking actions that are inconsistent with the claiming of foreign tax credits for U.S. holders of American depositary shares. Such actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate holders. Accordingly, the described availability of the reduced tax rate for dividends received by certain non-corporate holders below could be affected by actions taken by intermediaries in the chain of ownership between the holder of an ADS and our company.

 

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ADSs
If you hold ADSs, for U.S. federal income tax purposes, you generally will be treated as the owner of the underlying ordinary shares that are represented by such ADSs. Accordingly, deposits or withdrawals of ordinary shares for ADSs will not be subject to U.S. federal income tax.
Taxation of Dividends
We do not anticipate paying dividends on our ordinary shares or indirectly on our ADSs, in the foreseeable future. See “Dividend Policy” in Item 8.
Subject to the “Passive Foreign Investment Company Rules” discussion below, the gross amount of distributions on the ADSs will be taxable as dividends, to the extent paid out of our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. We do not expect to maintain earnings and profits calculations in accordance with U.S. federal income tax principles. Therefore, it is expected that a distribution will generally be reported as a dividend. Such income will be includable in your gross income as ordinary income on the day actually or constructively received by the depositary. Such dividends will not be eligible for the dividends received deduction allowed to corporations under the Code.
Subject to the description above regarding concerns expressed by the U.S. Treasury and subject to applicable limitations, dividends paid to certain non-corporate U.S. investors in taxable years beginning before January 1, 2011 may be taxable at a maximum of 15%. You should consult your own tax advisors regarding the availability of the reduced tax rate on dividends given your particular circumstances.
To the extent that the amount of any distribution exceeds our current and accumulated earnings and profits for a taxable year, as determined under U.S. federal income tax principles, the distribution will first be treated as a tax-free return of capital, causing a reduction in the adjusted basis of the ADSs, and the balance in excess of adjusted basis will be taxed as capital gain recognized on a sale or exchange. However, we do not expect to keep earnings and profits in accordance with U.S. federal income tax principles. Therefore, you should expect that a distribution will generally be treated as a dividend (as discussed above).
As described in “Taxation — People’s Republic of China Taxation,” if we were deemed to be a resident enterprise under PRC tax law, dividends paid with respect to our ADSs might be subject to PRC withholding taxes. For U.S. federal income tax purposes, the amount of a dividend would include any amounts withheld by us in respect of PRC taxes. The amount of the dividend generally will be treated as foreign-source dividend income to you and will not be eligible for the dividends-received deduction generally available to U.S. corporations under the Code. Subject to applicable limitations (including, among other things, a specified minimum holding period for the ADSs during which you are not protected from risk of loss), and in the case of ADSs subject to the discussion above regarding concerns expressed by the U.S. Treasury, any PRC income taxes withheld from dividends will be creditable against the your U.S. federal income tax liability. The rules governing foreign tax credits are complex, and you should consult your tax advisors regarding the creditability of foreign taxes in your particular circumstances. Instead of claiming a credit, you may, at your election, deduct such PRC taxes, if any, in computing taxable income. An election to deduct foreign taxes instead of claiming foreign tax credits must apply to all taxes paid or accrued in the taxable year to foreign countries and possessions of the United States.
Taxation of Capital Gains
For U.S. federal income tax purposes and subject to the discussion under “Passive Foreign Investment Company” below, you will recognize taxable gain or loss on any sale or exchange of ADSs in an amount equal to the difference between the amount realized for the ADSs and your tax basis in the ADSs. Such gain or loss will generally be capital gain or loss. Capital gains of individuals derived with respect to capital assets held for more than one year are eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations. Any gain or loss recognized by you will generally be treated as U.S.-source gain or loss.

 

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As described in “Taxation—People’s Republic of China Taxation,” if we were deemed to be a resident enterprise under PRC tax law, gains from dispositions of our ADSs may be subject to PRC withholding tax. In that case, your amount realized would include the gross amount of the proceeds of the sale or disposition before deduction of the PRC tax. Although any such gain of yours would generally be characterized as U.S.-source income, if you are eligible for the benefits of the income tax treaty between the United States and the PRC you may be able to elect to treat the disposition gain as foreign-source gain for foreign tax credit purposes. You should consult your tax advisors regarding your eligibility for benefits under the income tax treaty between the United States and the PRC and the creditability of any PRC withholding tax on disposition of gains in your particular circumstances.
Passive Foreign Investment Company Rules
It is not clear whether or not we were a passive foreign investment company (a “PFIC”) for the taxable year ending December 31, 2009, and whether or not we are or will be one in the future. That determination is subject to uncertainty because it is not clear how the VIE agreements between the PRC operating companies and us will be treated for purposes of the PFIC rules, and because of the uncertainty with respect to the valuation of our assets as well as the uncertain characterization of our assets and income, including goodwill, for purposes of the PFIC rules.
In general, we will be a PFIC for any taxable year in which:
    at least 75% of our gross income is passive income; or
 
    at least 50% of the value (determined on a quarterly basis) of our assets is attributable to assets that produce or are held for the production of passive income.
For this purpose, passive income generally includes dividends, interest, royalties and rents (other than royalties and rents derived in the active conduct of a trade or business and not derived from a related person). If we own at least 25% (by value) of the stock of another corporation, we will be treated, for purposes of the PFIC tests, as owning our proportionate share of the other corporation’s assets and receiving our proportionate share of the other corporation’s income.
PFIC classification is tested annually. Accordingly, it is possible that we may be a PFIC in the current or any future taxable year due to our asset or income composition. Because we have valued our goodwill based on the market value of our equity, a decrease in the price of our ADSs may also result in our becoming a PFIC. If we are a PFIC for any taxable year during which you hold our ADSs, you will be subject to special tax rules discussed below.
Provided that you do not make a mark-to-market election described below, if we are a PFIC for any taxable year during which you hold our ADSs, you will be subject to special tax rules with respect to any “excess distribution” received and any gain realized from a sale or other disposition, including a pledge, of ADSs. Distributions received in a taxable year will be treated as excess distributions to the extent they exceed 125% of the average annual distributions received during the shorter of the three preceding taxable years or your holding period for the ADSs. Under these special tax rules:
    the excess distribution or gain will be allocated ratably over your holding period for the ADSs;
 
    the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we were a PFIC, will be treated as ordinary income; and
 
    the amount allocated to each other year will be subject to tax at the highest tax rate in effect for that year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.
In addition, non-corporate U.S. Holders will not be eligible for reduced rates of taxation on any dividends paid by us in taxable years beginning before January 1, 2011, if we are a PFIC in the taxable year in which such dividends are paid or in the preceding taxable year. You will be required to file Internal Revenue Service Form 8621 if you hold our ADSs in any year in which we are classified as a PFIC.
If we are a PFIC for any taxable year and any of our foreign subsidiaries is also a PFIC, a U.S. Holder would be treated as owning a proportionate amount (by value) of the shares of the lower-tier PFIC for purposes of the application of these rules. You are urged to consult your tax advisors about the application of the PFIC rules to any of our subsidiaries.

 

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Alternative treatment will be available if you make a valid election to include gain on the stock of a PFIC as ordinary income under a mark-to-market method, provided that such stock is regularly traded on a qualified exchange. Under current law, the mark-to-market election may be available to holders of ADSs because the ADSs will be listed on the NASDAQ Global Market, which constitutes a qualified exchange, although there can be no assurance that the ADSs will be “regularly traded” for purposes of the mark-to-market election.
If you make an effective mark-to-market election, you will include in each year as ordinary income the excess of the fair market value of your ADSs at the end of the year over your adjusted tax basis in the ADSs. You will be entitled to deduct as an ordinary loss each year the excess of your adjusted tax basis in the ADSs over their fair market value at the end of the year, but only to the extent of the net amount previously included in income as a result of the mark-to-market election. Your adjusted tax basis in the ADSs will be increased by the amount of any income inclusion and decreased by the amount of any deductions under the mark-to-market rules. If you make a mark-to-market election, it will be effective for the taxable year for which the election is made and all subsequent taxable years unless the ADSs are no longer regularly traded on a qualified exchange or the Internal Revenue Service consents to the revocation of the election. You are urged to consult your tax advisors about the availability of the mark-to-market election and whether making the election would be advisable in your particular circumstances.
We do not intend to provide information necessary for you to make a “qualified electing fund” election, which if available would result in tax treatment different from the general tax treatment for PFICs described above (which alternative tax treatment could, in certain circumstances, mitigate the adverse tax consequences of holding shares in a PFIC).
You are urged to consult your tax advisors concerning the U.S. federal income tax consequences of holding ADSs if we are considered a PFIC in any taxable year.
Information Reporting and Backup Withholding
In general, information reporting will apply to dividends in respect of our ADSs and the proceeds from the sale, exchange or redemption of our ADSs that are paid to you within the United States (and in certain cases, outside the United States), unless you are an exempt recipient such as a corporation. Backup withholding may apply to such payments if you fail to provide a taxpayer identification number or certification of other exempt status or fail to report in full dividend and interest income.
Any amounts withheld under the backup withholding rules will be allowed as a refund or a credit against your U.S. federal income tax liability provided the required information is timely furnished to the Internal Revenue Service.
F. DIVIDENDS AND PAYING AGENTS
Not applicable.
G. STATEMENTS BY EXPERTS
Not applicable.
H. DOCUMENTS ON DISPLAY
We have filed with the SEC a registration statement on Form F-1, a registration statement on Form F-6, a registration statement on Form F-3, and a registration statement on Form 8-A, including relevant exhibits and schedules under the Securities Act, covering the ordinary shares represented by the ADSs, as well as the ADSs. You should refer to our registration statements and their exhibits and schedules if you would like to find out more about us and about the ADSs and the ordinary shares represented by the ADSs. This annual report summarizes material provisions of contracts and other documents to which we refer you. Since the annual report may not contain all the information that you may find important, you should review a full text of these documents.

 

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The SEC also maintains a website that contains reports, proxy statements and other information about issuers, such as us, who file electronically with the SEC. The address of that site is http://www.sec.gov. The information on that website is not a part of this annual report.
We will furnish to The Bank of New York, Mellon, as depositary of our ADSs, copies of our annual report. When the depositary receives these reports, it will upon our request promptly provide them to all holders of record of ADSs by e-mail. Hard copies of our annual report will be provided on demand. We will also furnish the depositary with all notices of shareholders’ meetings and other reports and communications in English that we make available to our shareholders. The depositary will make these notices, reports and communications available to holders of ADSs and will upon our request mail to all holders of record of ADSs the information contained in any notice of a shareholders’ meeting it receives.
We are subject to periodic reporting and other informational requirements of the Exchange Act as applicable to foreign private issuers. Accordingly, we will be required to file reports, including annual reports on Form 20-F, and other information with the SEC. As a foreign private issuer, we are exempt from the rules of the Exchange Act prescribing the furnishing and content of proxy statements to shareholders. The registration statements, reports and other information so filed can be inspected and copied at the public reference facilities maintained by the SEC at Room 1580, 100 F Street, N.E., Washington D.C. 20549. You can request copies of these documents upon payment of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference rooms.
I. SUBSIDIARY INFORMATION
Not applicable.
Item 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our exposure to interest rate risk primarily relates to the interest income generated by excess cash invested in demand deposits, investments in fixed deposits with maturity over three months, PRC government and PRC corporate bonds, and interest expenses to be incurred, if we seek to obtain a credit facility to satisfy our cash requirement for repurchase of our convertible notes. We have not used derivative financial instruments in our investment portfolio in order to reduce interest rate risk. Interest earning instruments carry a degree of interest rate risk. However, our future interest income may change, subject to market interest rate movement.
Foreign Currency Risk
Most of our revenues and expenses are denominated in Renminbi, with a portion in U.S. dollar and Korean Won. We have not had any material foreign exchange gains or losses. Although in general, our exposure to foreign exchange risks should be limited, the value of your investment in our ADSs will be affected by the foreign exchange rate between U.S. dollars and Renminbi because the value of our business is effectively denominated in Renminbi, while the ADSs will be traded in U.S. dollars. Furthermore, a decline in the value of the Renminbi could reduce the U.S. dollar equivalent of the value of the earnings from, and our investments in, our PRC companies. Based on the amount of our cash and cash equivalents as of December 31, 2009, a 10% change in the exchange rates between the Renminbi and the U.S. dollar would result in an increase or decrease of RMB730 million (US$106.9 million) of our total amount of cash and cash equivalents.
In China, very limited hedging transactions are available to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging transactions in the future, the availability and effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure at all. See “Exchange Controls” in Item 10, “Additional Information.”

 

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Item 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
D. American Depositary Shares
The Bank of New York, Mellon is our Depositary for our American Depositary Receipt (“ADR”) program. The Depositary’s office is located at 101 Barclay Street, New York, New York, 10286, U.S.A. Our ADRs are traded under the code “SNDA” on the NASDAQ Global Select Market. Each of our ADRs represents two shares of par value US$0.01 per share.
Holders of our ADRs may have to pay to the Depositary, either directly or indirectly, fees or charges up to the amounts set forth below:
         
Persons depositing or withdrawing shares or
   
surrendering or being issued ADRs must pay:
  For:
 
       
Taxes, stamp duty and other governmental charges
    As necessary
 
       
Registration fees
    For the registration of transfers of ADSs
 
       
Cable, telex and facsimile transmission expenses
    As necessary
 
       
A fee of $5.00 or less per 100 ADS
    The execution and delivery of ADRs and the surrender of ADRs
 
       
 
    Distributions other than cash, shares, or rights to subscribe for additional shares
 
       
A fee of $0.02 or less per ADS
    Any cash distributions
 
       
 
    For depositary services, except to the extent a fee of $.02 was charged for any cash distributions during the same calendar year
 
       
Any charges, fees or expenses incurred by the Depositary or its agents for servicing the deposited securities (which charge shall be payable at the sole discretion of the Depositary by billing holders for such charge or by deducting such charge from one or more cash dividends or other cash distributions).
    As necessary
The Depositary, has agreed to reimburse certain reasonable expenses related to our ADR program and incurred by us in connection with the program. For the year ended December 31, 2009, the Depositary reimbursed $243,118 for costs related to the program.
PART II
Item 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
Not applicable.
Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
A. – D. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
Not applicable.

 

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E. USE OF PROCEEDS
Not applicable
Item 15. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this annual report, our principal executive officer and principal financial officer have performed an evaluation of the effectiveness of our disclosure controls and procedures as defined and required under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, they have concluded that our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports that we file and furnish under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in by the SEC’s rules and regulations.
Management’s Report on Internal Control over Financial Reporting
Management of Shanda Interactive Entertainment Limited (together with its consolidated subsidiaries, the “Group”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. The Group’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. The Group’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Group; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Group are being made only in accordance with authorizations of management; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Group’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the Group conducted an assessment of the effectiveness of its internal control over financial reporting based upon criteria established by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control — Integrated Framework. Based on this assessment, management determined that the Group’s internal control over financial reporting was effective as of December 31, 2008.
The effectiveness of our internal control over financial reporting as of December 31, 2009 has been audited by PricewaterhouseCoopers Zhong Tian CPAs Limited Company, our independent registered public accounting firm, as stated in its report included on page F-2.
Changes in Internal Control over Financial Reporting
During the year ended December 31, 2009, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Mr. Jingsheng Huang qualifies as an Audit Committee Financial Expert as defined by the applicable rules of the SEC.

 

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Our board of directors has determined that Mr. Jingsheng Huang is independent as such term is defined by Rule 5605 of the NASDAQ Marketplace Rules.
Item 16B. CODE OF ETHICS
Our board of directors has adopted a code of ethics, which is applicable to our senior executive and financial officers. In addition, our board of directors has adopted a code of conduct, which is applicable to all of our directors, officers and employees. We have made our code of ethics and our code of conduct publicly available on our website at www.snda.com.
Item 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered by our principal external auditors for the periods indicated. We did not pay any other fees to our principal external auditors during the periods indicated below.
                         
    For the year ended December 31,  
    2008     2009  
    RMB     RMB     US$  
    (in thousands)  
 
Audit fees (1)
    13,020       26,290       3,850  
Including: Shanda Games
          11,540       1,690  
Hurray!
          2,380       349  
Audit-related fees (2)
    4,780       550       81  
Including: Shanda Games
                 
Hurray!
                 
Others (3)
    450              
Including: Shanda Games
                 
Hurray!
                 
Total
    18,250       26,840       3,931  
 
     
(1)   Audit fees means the aggregate fees in each of the fiscal years listed for professional services rendered by our principal auditors for the audit of our annual consolidated financial statements or services that are normally provided by the auditors in connection with statutory and regulatory filings or engagements. Services comprising the fees disclosed under this category also involve principally limited reviews performed on our consolidated financial statements and the audits of the annual financial statements of our subsidiaries and affiliated companies.
 
(2)   Audit-related fees means the aggregate fees in each of the fiscal years listed for assurance and related services by our principal auditors that are reasonably related to the performance of the audit or review of our financial statements and are not reported under “Audit fees.”
 
(3)   Other fees means the aggregate fees for compliance, advisory and other tax related service.
Item 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
We have not been granted an exemption from the applicable listing standards for the audit committee of our board of directors.

 

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Item 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
                                 
                            (d) Maximum  
                            Approximate U.S.  
                    (c) Total Number of     dollar Value of ADS  
                    ADS Purchased as Part     that May Yet Be  
    (a) Total Number of     (b) Average Price     of Publicly     Purchased Under the  
Period   ADS Purchased (1)     Paid per ADS in US$ (2)     Announced Plan     Plan in US$  
March 1 – March 31, 2010
    4,699,639       42.28       4,699,639       223,988,021  
April 1 – April 30, 2010
    2,211,072       44.71       2,211,072       125,130,992  
May 1 – May 14, 2010
    1,185,319       44.15       1,185,319       72,799,158  
 
     
(1)   On September 8, 2008, we announced that our board of directors authorized us to repurchase up to $200 million worth of our outstanding ADS from time to time and on December 30, 2008, our broad of directors authorized us to repurchase an additional $100 million worth of outstanding ADSs. On March 22, 2010, we announced that our board of directors authorized us to repurchase up to $300 million worth of our outstanding ADS from time to time.
 
(2)   Average price paid per ADS repurchased is the execution price, excluding commissions paid to brokers.
Item 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
Not applicable.
Item 16G. CORPORATE GOVERNANCE
Pursuant to the NASDAQ Marketplace Rules, foreign private issuers such as our company may follow home-country practice in lieu of certain NASDAQ corporate governance requirements. A majority of our directors do not qualify as independent directors. In addition, we do not have a nominations committee, nor is independent director involvement required in the selection of director nominees or in the determination of executive compensation. This home country practice of ours differs from Rule 5605(b), (d) and (e) of the NASDAQ Marketplace Rules, because there are no specific requirements under Cayman Islands law on director independence or on the establishment of a nominations committee, and neither are there any requirements on independent directors’ involvement in the selection of director nominees nor in the determination of executive compensation.
Our board of directors has adopted a code of ethics, which is applicable to our senior executive and financial officers. In addition, our board of directors has adopted a code of conduct, which is applicable to all of our directors, officers and employees. We have made our code of ethics and our code of conduct publicly available on our website. See also “Item 16B. Code of Ethics.
In addition, our board of directors has adopted a set of corporate governance guidelines. The guidelines reflect certain guiding principles with respect to our board’s structure, procedure and committees. The guidelines are not intended to change or interpret any law or our amended and restated memorandum and articles of association.
We also have established a disclosure committee, which is comprised of certain members of senior management. Pursuant to the disclosure committee’s charter, which was ratified by our board of directors, the disclosure committee is responsible for establishing, evaluating and supervising our disclosure controls and procedures and internal financial controls.
PART III
Item 17. FINANCIAL STATEMENTS
Not applicable

 

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Item 18. FINANCIAL STATEMENTS
The consolidated financial statements for Shanda Interactive and its subsidiaries are included at the end of this annual report.
Item 19. EXHIBITS
       
Number   Description
1.1
  Amended and Restated Memorandum and Articles of Association of Shanda Interactive Entertainment Limited (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form F-1 (file no. 333-114177) filed with the Commission on May 7, 2004).
 
   
2.1
  Specimen Ordinary Share Certificate (incorporated by reference to Exhibit 4.1 to our Registration Statement on Form F-1 (file no. 333-114177) filed with the Commission on May 7, 2004).
 
   
2.2
  Specimen of American Depositary Receipts (incorporated by reference to Exhibit A to Exhibit 1 to our Registration Statement on Form F-6 POS (file no. 333-114759) filed with the Commission on June 9, 2004).
 
   
2.3
  Form of Deposit Agreement (incorporated by reference to Exhibit 1 to our Post-Effective Amendment No. 1 to the Form F-6 (file no. 333-114759) filed with Commission on June 9, 2004).
 
   
2.4
  Sale and Purchase Agreement, among Shanda Interactive Entertainment Limited, Jong Hyun Lee, Il Wang Park, Byung Chan Park, Jin Ho Lee. Sang Jun Roh, Sung Gon Bae and Yong Sung Cho, dated November 29, 2004 in connection with the sale of shares of Actoz Soft Co., Ltd. to Shanda Interactive Entertainment Limited (incorporated by reference to Exhibit 2.7 to our 2004 annual report on Form 20-F (file no. 000-50705) filed with the Commission on May 31, 2005).
 
   
4.1
  Employee Stock Option Plan and form of share option agreement (incorporated by reference to Exhibit 10.1 to our Registration Statement on Form F-l (file no. 333-114177) filed with the Commission on April 2, 2004).
 
   
4.2
  Employee Equity Compensation Plan (incorporated by reference to Exhibit 99.2 to our press release on Form 6-K (file no. 000-50705) filed with the Commission on September 22, 2005).
 
   
4.3
  Shanda Games Limited 2008 Equity Compensation Plan (Incorporated by reference to Exhibit 10.01 to Shanda Games Limited’s Registration Statement on Form F-1 (file no. 333-161708) filed with the Commission on September 3, 2009).
 
   
4.4
  Articles of Association of Shengqu Information Technology (Shanghai) Co., Ltd. (incorporated by reference to Exhibit 10.21 to our Registration Statement on Form F-l (file no. 333-114177) filed with the Commission on April 2, 2004).
 
   
4.5
  Equity Entrustment Agreement among Tianqiao Chen, Danian Chen and Shanda Computer (Shanghai) Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.4 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.6
  Equity Pledge Agreement among Tianqiao Chen, Danian Chen and Shanda Computer (Shanghai) Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.5 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.7
  Proxy executed by Tianqiao Chen in favor of Shanda Computer (Shanghai) Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.6 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).

 

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Number   Description
4.8
  Proxy executed by Danian Chen in favor of Shanda Computer (Shanghai) Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.7 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.9
  Assignment Agreement of Purchase Option and Cooperation Agreement among Shanda Computer (Shanghai) Co., Ltd., Shanghai Shanda Networking Development Co., Ltd., Shengqu Information Technology Co., Ltd., Tianqiao Chen and Danian Chen dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.8 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.10
  Business Operation Agreement among Shanda Computer (Shanghai) Co., Ltd., Shanghai Shanda Networking Development Co., Ltd., Tianqiao Chen and Danian Chen dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.9 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.11
  Exclusive Consulting and Service Agreement between Shanda Computer (Shanghai) Co., Ltd. and Shanghai Shanda Networking Development Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.10 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.12
  Termination Agreement to the Share Pledge Agreement among Shengqu Information Technology (Shanghai) Co., Ltd., Tianqiao Chen and Danian Chen dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.11 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.13
  Equity Entrustment Agreement among Dongxu Wang, Yingfeng Zhang, Shengqu Information Technology (Shanghai) Co., Ltd. and Shanghai Shulong Technology Development Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.12 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.14
  Equity Pledge Agreement among Dongxu Wang, Yingfeng Zhang and Shengqu Information Technology (Shanghai) Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.13 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.15
  Business Operation Agreement among Dongxu Wang, Yingfeng Zhang, Shengqu Information Technology (Shanghai) Co., Ltd. and Shanghai Shulong Technology Development Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.17 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.16
  Proxy executed by Dongxu Wang in favor of Shengqu Information Technology (Shanghai) Co., Ltd. dated July 1, 2008 (incorporated by reference to Exhibit 4.14 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.17
  Proxy executed by Yingfeng Zhang in favor of Shengqu Information Technology (Shanghai) Co., Ltd. dated July 1, 2008 (incorporated by reference to Exhibit 4.15 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.18
  Equity Disposition Agreement among Dongxu Wang, Yingfeng Zhang, Shengqu Information Technology (Shanghai) Co., Ltd. and Shanghai Shulong Technology Development Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.16 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).

 

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Number   Description
4.19
  Exclusive Consulting and Service Agreement between Shengqu Information Technology (Shanghai) Co., Ltd. and Shanghai Shulong Technology Development Co., Ltd. dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.18 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.20
  Loan Agreement between Shengqu Information Technology (Shanghai) Co., Ltd. and Dongxu Wang dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.19 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.21
  Loan Agreement between Shengqu Information Technology (Shanghai) Co., Ltd. and Yingfeng Zhang dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.20 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.22
  Termination Agreement to the Loan Agreement between Shanghai Shanda Networking Co., Ltd. and Yingfeng Zhang dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.21 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.23
  Termination Agreement to the Share Purchase Option Agreement among Shanghai Shulong Technology Development Co., Ltd., Shanghai Shanda Networking Co., Ltd. and Yingfeng Zhang dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.22 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.24
  Termination Agreement to the Share Pledge Agreement between Shanghai Shanda Networking Co., Ltd. and Yingfeng Zhang dated July 1, 2008 (English Translation) (incorporated by reference to Exhibit 4.23 to our annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 30, 2009).
 
   
4.25
  Software Licensing Agreement among Shanghai Shanda Networking Co., Ltd., Shanghai Pudong New Area Imp. & Exp. Corp. and Actoz Soft Co., Ltd., dated June 29, 2001, (incorporated by reference to Exhibit 10.17 to our Registration Statement on Form F-1 (file no. 333-114177) filed with the Commission on April 20, 2004).
 
   
4.26
  Supplemental Agreement among Shanghai Shanda Networking Co., Ltd., Actoz Soft Co., Ltd. and Wemade Entertainment Co., Ltd., dated July 14, 2002, (incorporated by reference to Exhibit 10.18 to our Registration Statement on Form F-1 (file no. 333-114177) filed with the Commission on April 2, 2004).
 
   
4.27
  Settlement Agreement between Shanghai Shanda Networking Co., Ltd., and Actoz Soft Co., Ltd., dated August 19, 2003, (incorporated by reference to Exhibit 10.22 to our Registration Statement on Form F-1 (file no. 33-114177) filed with the Commission on April 20, 2004).
 
   
4.28
  Amendment Agreement among Shanghai Shanda Networking Co., Ltd., Actoz Soft Co., Ltd, Shanghai Pudong Import & Export Co., Ltd. and Shengqu Information Technology (Shanghai) Co., Ltd., dated August 19, 2003, (incorporated by reference to Exhibit 10.23 to our Registration Statement on Form F-1 (file no. 333-114177) filed with the Commission on April 20, 2004).
 
   
4.29
  Extension Agreement among Actoz Soft Co., Ltd, Shanghai Shanda Networking Co., Ltd., and Shanghai Pudong Imp.& Exp. Co., Ltd., dated September 22, 2005 (Incorporated by reference to Exhibit 4.21 to our 2005 annual report on Form 20-F (file no. 000-50705) filed with the Commission on June 29, 2006).
 
   
4.30
  Extension Agreement II among Actoz Soft Co., Ltd, Shengqu Information Technology (Shanghai) Co., Ltd. and Shanghai Pudong Imp.& Exp. Co., Ltd., dated November 26, 2008 (Incorporated by reference to Exhibi