Business Context and Reporting Period
The9 Limited (NASDAQ: NCTY), a leading online game operator in China, reported its unaudited financial results for the second quarter ended June 30, 2007. The filing was submitted on August 29, 2007. The company operates licensed MMORPGs including World of Warcraft and Soul of The Ultimate Nation (SUN), and is transitioning from a single-game to a multi-game portfolio.
Key Financial Metrics
| Metric | Q2 2007 (RMB) | Q2 2007 (US$) |
|---|---|---|
| Net Revenues | 270.0 million | 35.5 million |
| Gross Profit | 114.6 million | 15.1 million |
| Net Income | 50.6 million | 6.6 million |
| EBITDA (Non-GAAP) | 108.6 million | 14.3 million |
| Diluted EPS | 1.90 | 0.25 |
| Cash and Cash Equivalents | 2.09 billion | 274.2 million |
Margins: Gross profit margin decreased to 42% (from 48% in Q1 2007). Operating margin decreased to 15% (from 27% in Q1 2007).
Liquidity: As of June 30, 2007, total cash and cash equivalents were RMB 2.09 billion. The filing does not explicitly state long-term debt figures, but notes significant capital expenditures for server upgrades and prepaid royalty payments.
Material Changes vs. Prior Period
- Revenue: Net revenues remained stable quarter-over-quarter (QoQ) but increased 5% year-over-year (YoY). Subscription-based game revenues decreased 8% QoQ and 4% YoY due to World of Warcraft server shutdowns for upgrades. Item-sales based revenues (driven by SUN) were RMB 16.3 million.
- Profitability: Net income decreased 23% QoQ and 40% YoY. EBITDA decreased 8% QoQ and 13% YoY.
- Expenses: Operating expenses increased 28% QoQ and 38% YoY, driven by product development for SUN and Guild Wars, marketing for SUN, and higher share-based compensation.
- Cash Position: Cash balances increased significantly from RMB 859.6 million in Q1 2007 to RMB 2.09 billion in Q2 2007, primarily due to a US$167 million equity investment from Electronic Arts Inc.
Guidance, Outlook, and Risks
Management Commentary: Management described Q2 2007 as a "transitional quarter." They expressed satisfaction with the results despite temporary server shutdowns for World of Warcraft upgrades. The commercialization of SUN in late May 2007 helped offset revenue declines. Management anticipates World of Warcraft will resume strong growth following the "Before the Storm" patch and the upcoming "The Burning Crusade" expansion.
Outlook: The company is executing a diversification strategy, having secured licenses for "Field of Honor" and "Audition." They aim to capitalize on a broad portfolio of high-quality games for long-term sustainable growth.
Risks and Contingencies:
- Litigation: On June 18, 2007, Beijing Beida Founder Electronics Company filed a lawsuit alleging intellectual property infringement regarding copyrighted fonts in a game operated by The9. The plaintiff seeks RMB 100 million. The9 intends to defend the case and believes the outcome will not have a material adverse effect.
- Regulatory and Market Risks: Forward-looking statements highlight risks related to Chinese government policies, internet regulations, and the ability to retain players and acquire new games.
Investor Verification Checklist
- Verify the impact of the World of Warcraft server upgrades on future revenue growth post-Q2 2007.
- Monitor the commercial performance and user adoption of the newly launched game, Soul of The Ultimate Nation (SUN).
- Track the status of the intellectual property lawsuit filed by Beijing Beida Founder Electronics Company.
- Confirm the timeline and market reception of the "The Burning Crusade" expansion for World of Warcraft.
- Review the utilization of the US$167 million cash infusion from Electronic Arts Inc. regarding capital expenditures and royalty payments.