Business Context and Reporting Period
The9 Limited (NASDAQ: NCTY), a leading online game operator in China, reported unaudited financial results for the fourth quarter and fiscal year ended December 31, 2006. The filing was submitted on February 16, 2007. The company's primary revenue driver is the operation of Blizzard Entertainment's World of Warcraft (WoW) in mainland China, which accounted for the vast majority of net revenues.
Key Financial Metrics
Fourth Quarter 2006
- Net Revenues: RMB282.7 million (US$36.2 million), up 21% quarter-over-quarter (QoQ) and 33% year-over-year (YoY).
- Net Income: RMB105.1 million (US$13.5 million), up 63% QoQ and 54% YoY.
- EBITDA (Non-GAAP): RMB146.6 million (US$18.8 million), up 39% QoQ and 35% YoY.
- Diluted EPS: RMB4.25 (US$0.54).
- Cash and Cash Equivalents: RMB937.8 million (US$120.2 million) as of December 31, 2006.
Fiscal Year 2006
- Net Revenues: RMB985.8 million (US$126.3 million), up 112% YoY.
- Net Income: RMB312.5 million (US$40.0 million), up 331% YoY.
- EBITDA (Non-GAAP): RMB476.3 million (US$61.0 million), up significantly from RMB151.6 million in 2005.
- Diluted EPS: RMB12.72 (US$1.63).
- Gross Profit Margin: 47% for the full year, compared to 48% in 2005.
Material Changes vs. Prior Period
The substantial revenue and profit growth is primarily attributed to the full-year commercial operation of World of Warcraft in 2006, compared to only seven months of operation in 2005. WoW revenues alone reached RMB281.4 million in Q4 2006. Gross profit margins improved sequentially in Q4 to 48% due to increased server utilization following server merges and the opening of new sites in Q3 2006.
Operating expenses increased 23% QoQ to RMB54.7 million, driven by sales and marketing for upcoming game launches (Guild Wars and Soul of the Ultimate Nation) and higher year-end professional fees. Other income improved significantly due to a RMB19.8 million government subsidy received in Q4 2006.
Guidance, Outlook, and Risks
Management Commentary and Outlook
Management highlighted record revenues and earnings, noting that WoW achieved peak concurrent users of over 680,000 in Q4 2006. The company expects 2007 to be a strong year with the launch of the World of Warcraft: The Burning Crusade expansion pack and the rollout of new titles including Guild Wars, Soul of the Ultimate Nation, Ragnarok Online 2, Emil Chronicle Online, and Huxley.
Risks and Contingencies
- Unaudited Data: The financial information is preliminary and unaudited; adjustments may occur upon completion of the audit for the Form 20-F.
- Internal Controls: Management has not yet completed its evaluation of internal controls over financial reporting under the Sarbanes-Oxley Act.
- Forward-Looking Statements: Risks include Chinese government regulations, competition, player retention, and the ability to secure appealing game licenses.
- Unusual Items: Net income included a RMB19.8 million government subsidy in Q4 and a RMB23.4 million gain on the disposal of a Taiwan joint venture, offset partially by a RMB20.4 million impairment loss on an equity investment.
Investor Verification Checklist
- Verify the impact of the RMB19.8 million government subsidy on Q4 net income and the RMB31.0 million total subsidy for the fiscal year.
- Confirm the final audited figures in the upcoming Form 20-F, as current data is preliminary.
- Assess the sustainability of the 48% gross margin following server optimization and the potential impact of new game launches on operating expenses.
- Review the details of the RMB23.4 million gain on investment disposal and the RMB20.4 million impairment loss to understand their effect on core operating performance.
- Monitor the progress of the Sarbanes-Oxley internal control evaluation and any potential restatements.