NCTY

Business Context and Reporting Period

Company: The9 Limited (NASDAQ: NCTY)
Filing Type: Form 6-K (Report of Foreign Private Issuer)
Reporting Period: Unaudited results for the quarters ended March 31, 2009 (Q1) and June 30, 2009 (Q2).
Business Overview: The9 is an online game operator and developer in China. The reporting period was significantly impacted by the expiration of its license to operate World of Warcraft (WoW) on June 7, 2009.

Key Financial Metrics

Material Changes vs. Prior Periods

• Revenue Decline: Q2 2009 revenue dropped 32% quarter-over-quarter (QoQ) and 37% year-over-year (YoY). The primary driver was the cessation of WoW operations on June 7, 2009. Q1 revenue was relatively stable, up 4% QoQ but down 3% YoY.
• Profitability Shift: The company swung from a net income of RMB99.0 million in Q2 2008 to a net loss of RMB79.2 million in Q2 2009. Q1 2009 also recorded a net loss of RMB46.8 million, compared to a net income of RMB75.6 million in Q1 2008.
• Impairments and Write-offs:
  • Q1: Gross profit was reduced by a RMB103.2 million write-off of prepaid royalties and withholding tax related to the non-renewal of the WoW license.
  • Q2: Operating expenses included a RMB30.2 million impairment of goodwill related to WoW.
• Item-Sales Games: Revenues from item-sales based games (e.g., Granado Espada) declined 47% YoY in Q1 and 58% YoY in Q2 due to lower-than-expected performance.

Guidance, Outlook, and Management Commentary

Management Commentary:

• Jun Zhu (CEO): Acknowledged significant revenue reduction following the WoW license expiration but expressed confidence in recovery by leveraging the growth of China's online game market.
• Xiaowei Chen (President): Highlighted the execution of a diversification strategy, including investments in the The9 Development Center (TDC) and equity investments in game studios to strengthen the proprietary pipeline.

Business Developments:

• Launched commercial operations for EA SPORTS FIFA Online 2 (May 2009) and Atlantica (June 2009).
• Licensed World of Fighter to Gamania for operation in Hong Kong, Macau, and Taiwan.
• Secured an exclusive license to operate Kingdom Heroes 2 Online in mainland China.

Stock Repurchase Program: As of June 30, 2009, The9 had repurchased approximately 2.5 million ADSs for an aggregate of US$32.7 million under a US$50 million program authorized in September 2008. The program was scheduled to end on September 12, 2009.

Risks and Contingencies:

• Liability for Refunds: A significant liability for the refund of prepaid WoW game cards was accrued, increasing from RMB37.9 million in Q1 to RMB199.4 million in Q2 due to a rebate program.
• Regulatory and Market Risks: Forward-looking statements cite risks related to Chinese government policies, internet regulations, and the ability to retain players and acquire new titles.

Investor Verification Checklist

• WoW Transition Impact: Verify the extent of revenue loss from WoW and the timeline for new titles (FIFA Online 2, Atlantica) to offset this gap.
• Refund Liability: Confirm the cash outflow required to settle the RMB199.4 million liability for WoW point card refunds.
• Item-Sales Performance: Investigate the operational issues causing the decline in Granado Espada and other item-sales games.
• Non-GAAP Reconciliation: Review the reconciliation of GAAP to Non-GAAP results, noting that Non-GAAP income excludes significant impairments and write-offs that impacted GAAP losses.
• Cash Position: Monitor cash burn rate given the shift to net losses and the ongoing stock repurchase program.