Business Context and Reporting Period
Company: The9 Limited (NASDAQ: NCTY)
Filing Type: Form 6-K (Report of Foreign Issuer)
Reporting Period: Second Quarter ended June 30, 2006
Business Overview: The9 is a leading online game operator in China, primarily focused on operating and developing Massively Multiplayer Online Role Playing Games (MMORPGs). Its core revenue driver is the exclusive operation of Blizzard Entertainment's World of Warcraft (WoW) in mainland China.
Key Financial Metrics
| Metric | Q2 2006 (RMB) | Q2 2006 (US$) | Q1 2006 (RMB) | Q1 2006 (US$) |
|---|---|---|---|---|
| Net Revenues | 257.6 million | 32.2 million | 212.1 million | 26.5 million |
| Net Income | 84.3 million | 10.5 million | 58.8 million | 7.4 million |
| EBITDA (Non-GAAP) | 124.7 million | 15.6 million | 99.6 million | 12.5 million |
| Diluted EPS | 3.42 | 0.43 | 2.42 | 0.30 |
| Cash and Equivalents | 657.8 million | 82.3 million | 611.7 million | 76.5 million |
| Gross Profit Margin | 48% | - | 45% | - |
Note: US$ amounts are based on an exchange rate of RMB 7.9943 to US$1.00 as of June 30, 2006.
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased 21% quarter-over-quarter (QoQ) and 363% year-over-year (YoY). WoW-specific revenues grew 22% QoQ to RMB256.2 million, accounting for 99.9% of WoW net revenues via game playing time.
- Profitability: Net income rose 43% QoQ. Excluding a one-time RMB11.2 million government subsidy, adjusted net income increased 24% sequentially.
- Operating Expenses: Increased 41% QoQ to RMB54.1 million, driven by normalized marketing for WoW and higher professional fees for Sarbanes-Oxley compliance.
- EBITDA: Non-GAAP EBITDA grew 25% QoQ to RMB124.7 million.
- Liquidity: Cash balances increased by RMB46.1 million QoQ, primarily due to prepaid card sales, partially offset by royalty payments and license fees for new games.
Outlook, Management Commentary, and Risks
Management Commentary
CEO Jun Zhu highlighted strong top-line and bottom-line growth, noting WoW reached peak concurrent users of 630,000 and over 5 million activated paid accounts as of June 30, 2006. CFO Hannah Lee confirmed plans to open a 7th WoW server site in late Q3 2006 and emphasized the strength of the game pipeline.
Recent Developments
- New Licenses: Secured exclusive rights to operate Hellgate: London in mainland China in May 2006.
- Expansion: Made an equity investment in a joint venture in late July 2006 to operate Granado Espada and Hellgate: London in eight Southeast Asian countries.
- Pipeline: Strong portfolio includes Guild Wars, Soul of the Ultimate Nation, and proprietary titles like Joyful Journey West.
Risks and Contingencies
The filing includes a Safe Harbor statement regarding forward-looking statements. Key risks include limited operating history, Chinese government political and economic policies, regulations governing the online game industry, intensified regulation of Internet cafes, and the ability to retain players and acquire appealing new games.
Investor Verification Checklist
- Revenue Concentration: Verify the sustainability of revenue growth given that 99.9% of WoW revenues come from game playing time and WoW dominates total net revenue.
- Non-Recurring Income: Assess the impact of the RMB11.2 million government subsidy on net income; verify organic growth excluding this item.
- Capital Expenditures: Monitor cash outflows related to prepaid royalties for Blizzard and license fees for new titles like Hellgate: London.
- Regulatory Environment: Evaluate potential impacts of Chinese government regulations on Internet cafes and online content on user growth.
- Share-Based Compensation: Review the impact of SFAS 123(R) adoption on future operating expenses (RMB4.8 million in Q2).