NCTY

Business Context and Reporting Period

The9 Limited, a Chinese online game developer and operator, filed Form 6-K on December 24, 2014, to disclose unaudited financial information for the six months ended June 30, 2014, in compliance with NASDAQ Rule 5250(c)(2). The company operates proprietary MMO, web, and mobile games, including Firefall, and maintains a wireless business unit and a joint venture for home entertainment set-top boxes.

Key Financial Metrics

Liquidity and Balance Sheet (As of June 30, 2014):

• Cash and cash equivalents: RMB 26,964,558 (US$ 4,346,598)
• Total Current Assets: RMB 85,103,416 (US$ 13,718,391)
• Total Current Liabilities: RMB 312,139,227 (US$ 50,315,821)
• Total Assets: RMB 373,615,863 (US$ 60,225,652)
• Total Liabilities: RMB 337,773,987 (US$ 54,448,060)
• Total Equity: RMB 35,841,876 (US$ 5,777,592)

Material Changes Versus Prior Period

• Revenue Decline: Net revenues decreased by approximately 40.5% year-over-year, dropping from RMB 46.1 million to RMB 27.4 million. Online game services revenue fell significantly from RMB 42.7 million to RMB 22.2 million.
• Gross Margin Deterioration: The company shifted from a gross profit of RMB 2.2 million in the prior period to a gross loss of RMB 14.3 million. Cost of services remained relatively flat (RMB 43.9 million vs. RMB 41.7 million) despite the revenue drop.
• Operating Expenses: Total operating expenses decreased from RMB 274.7 million to RMB 153.0 million, primarily driven by a reduction in product development costs (RMB 112.7 million to RMB 79.6 million) and general and administrative expenses (RMB 95.0 million to RMB 51.6 million).
• Impairment and Investment Items: The 2013 period included a significant impairment loss on investments of RMB 32.8 million, which was absent in the 2014 period. Conversely, the 2014 period included a gain on investment disposal of RMB 9.4 million and an impairment of advances to suppliers of RMB 3.6 million.
• Cash Position: Cash and cash equivalents declined sharply from RMB 157.0 million at year-end 2013 to RMB 27.0 million at mid-year 2014.

Outlook, Management Commentary, and Risks

Strategic Developments:

• Joint Venture: In July 2014, The9 formed a 50/50 joint venture with Qihoo 360 Technology Co., Ltd. named System Link Limited. In August 2014, a subsidiary licensed the game Firefall to this joint venture for mainland China operations. The agreement guarantees minimum payments of US$160 million over five years.
• Asset Sale: In August 2014, The9 sold its wholly-owned subsidiary, Shanghai Huopu Cloud Computing Terminal Technology Co., Ltd., for RMB 200 million in cash. This subsidiary held rights to royalties from the game Firefall.

Risks and Contingencies:

The filing includes a Safe Harbor statement noting that forward-looking statements are subject to risks including Chinese government policies, regulations on the online game industry, internet content regulations, and the ability to retain players and adapt to market competition. The company does not undertake an obligation to update forward-looking statements.

Investor Verification Checklist

• Verify the impact of the US$160 million minimum payment guarantee from the Qihoo 360 joint venture on future revenue recognition and cash flow.
• Confirm the utilization of the RMB 200 million cash proceeds from the sale of Huopu Cloud and its effect on liquidity.
• Assess the sustainability of the gross margin recovery given the significant drop in online game service revenue.
• Review the status of the "Refund of game points" liability (RMB 169.9 million), which remains unchanged and represents a significant portion of current liabilities.
• Monitor the company's ability to generate positive operating cash flow given the substantial accumulated deficit and recent cash burn.