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, 2005. The filing was submitted on February 23, 2006. The company's primary revenue driver is the operation of Blizzard Entertainment's World of Warcraft (WoW) in China, which commenced commercial operations in June 2005. In December 2005, The9 secured an exclusive license to operate Soul of The Ultimate Nation (SUN), a Korean 3D MMORPG, to diversify its portfolio.
Key Financial Metrics
| Metric | Q4 2005 (RMB) | Q4 2005 (US$) | FY 2005 (RMB) | FY 2005 (US$) |
|---|---|---|---|---|
| Net Revenues | 212.2 million | 26.3 million | 465.0 million | 57.6 million |
| Net Income | 68.3 million | 8.5 million | 72.5 million | 9.0 million |
| Adjusted EBITDA (Non-GAAP) | 108.9 million | 13.5 million | 151.7 million | 18.8 million |
| Diluted EPS (RMB) | 2.82 | 0.35 | 2.92 | 0.36 |
| Cash and Cash Equivalents | 488.2 million (US$60.5 million) as of Dec 31, 2005 |
Revenue Composition (Q4 2005): Net revenues attributable to WoW operations were RMB211.2 million (US$26.2 million), representing the vast majority of total revenue. Online game services gross revenues were RMB220.7 million.
Material Changes vs. Prior Period
- Revenue Growth: Q4 2005 net revenues grew 15% quarter-over-quarter (QoQ) and 2,407% year-over-year (YoY). FY 2005 revenues grew 1,239% YoY, driven almost entirely by the launch and expansion of WoW.
- Profitability: Q4 2005 net income increased 81% QoQ and 196% YoY for the full year. The company moved from an operating loss of RMB9.8 million in FY 2004 to an operating profit of RMB59.7 million in FY 2005.
- Margins: Gross profit margin declined to 46% in Q4 2005 from 50% in Q3 2005. This was due to increased amortization of intangible assets related to the acquisition of the remaining 31.1% interest in the WoW operating entity and full-quarter depreciation of a new server site.
- Other Income: Q4 2005 saw a significant improvement in other income (RMB12.2 million) compared to Q3 expenses, primarily due to a RMB13.4 million financial subsidy from the local government.
- Equity Transactions: The company sold 21% of its equity interest in 9Webzen (operator of MU), reducing its stake from 51% to 30%, recognizing a gain of RMB6.7 million.
Outlook, Risks, and Management Commentary
Management Commentary: CEO Jun Zhu highlighted strong WoW performance with peak concurrent users of approximately 530,000 and 3.3 million paid accounts activated as of year-end. CFO Hannah Lee noted the solid foundation for long-term growth and the commercial launch of a WoW joint venture in other parts of Greater China.
Recent Developments: The9 obtained the exclusive license for Soul of The Ultimate Nation (SUN) in December 2005. The company is also developing its first proprietary MMORPG, Joyful Journey West.
Risks and Contingencies:
- Regulatory Environment: Risks include political and economic policies of the Chinese government and intensified regulation of Internet cafes.
- Market Dynamics: The company faces risks related to retaining players, adapting to consumer preferences, and competition.
- Revenue Recognition: The filing notes that revenue from prepaid WoW playing time is recognized based on actual usage data provided by the licensor, as The9 does not have direct access to this information.
Investor Verification Checklist
- WoW Dependency: Verify the extent of revenue concentration in World of Warcraft (approx. 99.5% of Q4 net revenue) and the risks associated with reliance on a single title.
- Revenue Recognition Methodology: Confirm the process for validating usage data provided by the licensor for revenue recognition, given the lack of direct access to end-user data.
- Intangible Asset Amortization: Review the impact of the RMB25.2 million amortization expense in Q4 on future profitability and cash flow projections.
- Government Subsidies: Assess the sustainability of the RMB13.4 million government subsidy received in Q4 and its impact on "Other Income."
- Joint Venture Performance: Monitor the performance of the 9Webzen joint venture (now 30% owned) and the new SUN license to evaluate diversification success.