The9 Limited — FY2018 Form 20-F
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a quarterly report; it does not provide a clear standalone 2018 Q4 income statement or cash-flow breakdown. Financial statements are prepared under U.S. GAAP. Unless stated otherwise, amounts below are RMB millions; U.S. dollar translations are for convenience.
Business context and results
The9 develops and operates online games, principally mobile games, and related services, primarily in China. It relies on a PRC variable-interest-entity structure, including Shanghai IT, to conduct licensed online-game operations. Online game services accounted for 94.6% of 2018 revenue. The company launched Knight Forever in 2018 and Pop Fashion in December; CrossFire New Mobile Game remained in development, with launch expected in the second half of 2019.
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | 17.5 (US$2.5m) | 73.2 |
| Gross profit | 1.0; approximately 5.7% gross margin | 49.4; approximately 67.5% gross margin |
| Operating loss | 104.8 | 113.3 |
| Net loss | 239.3 (US$34.8m) | 112.1 |
| Net loss attributable to ordinary shareholders | 258.0 (US$37.5m) | 175.3 |
| Cash used in operating activities | 101.2 (US$14.7m) | 86.7 |
| Cash and cash equivalents at year-end | 4.3 (US$0.6m) | 142.6 |
At December 31, 2018, total assets were 164.7, current assets 33.0, and current liabilities 908.4, resulting in net current liabilities of 875.4 (US$127.3m). Total shareholders’ deficit was 1,084.8; accumulated deficit was 3,233.1. Current liabilities included short-term borrowings of 112.5 and convertible notes of 375.3, with interest payable presented separately. The filing reports no dividends paid by PRC subsidiaries to the parent in 2016–2018.
Changes versus the prior year
- Revenue fell 76.1%, chiefly because Firefall licensing revenue recognized in 2017 did not recur after the game ceased operations; IPTV revenue was lower following a change to net agent presentation from August 2018; and Song of Knight ceased operations.
- Cost of revenue declined 31.1%, but much less than revenue. Operating expenses declined 35.0% to 106.0 as product-development, sales-and-marketing, and administrative costs were reduced. A 10.5 gain from disposal of The9 Education partly offset expenses.
- Despite the lower operating loss, net loss attributable to ordinary shareholders widened. Interest expense rose to 104.8, foreign exchange shifted from a 19.2 gain to a 20.3 loss, and 2017 included a non-recurring 60.5 recovery of equity investment in excess of cost.
- Operating cash outflow increased to 101.2, and year-end cash fell sharply from 142.6. Management attributed the 2018 cash decline mainly to operating outflows, including spending on new games and blockchain-related activities.
The company adopted ASC 606 from January 1, 2018 using the modified retrospective method; it reported no material effect. Prior-year revenue figures were not recast, so comparability is limited. The filing also says IPTV revenue presentation changed when The9 became an agent; revenue and cost comparisons should be considered in that context.
Liquidity, debt, outlook and risks
- Going concern: The auditor’s report and management disclosures identify substantial doubt about the company’s ability to continue as a going concern. The company reported recurring losses, negative operating cash flows, significant net current liabilities, and limited cash. The financial statements contain no adjustments that might result from the uncertainty.
- Debt and repayment: The US$40.05m secured convertible notes bear 12% annual interest and were due in December 2018, subject to holder extension. A March 2019 settlement agreement provides for repayment by May 31, 2019, using proceeds from a planned sale of mortgaged properties. The notes are secured by shares of two PRC subsidiaries and the Shanghai office building. The filing also identifies an overdue entrusted loan, with an outstanding balance including interest of about RMB43.3m, and a separate defaulted HK$92.3m loan secured by L&A shares.
- Funding plans and execution risk: Management cited potential equity or debt financing, related-party support, new-game launches and cost controls as possible funding sources, but gave no assurance these would succeed. It warned that failure to obtain capital could require licensing or selling assets, seeking an acquisition, or ceasing operations. A planned US$30m equity financing was terminated in February 2019.
- Outlook: Management expected CrossFire New Mobile Game to launch in the second half of 2019, subject to development, regulatory approvals and market acceptance. It also described blockchain-related services as a developing business; no quantified revenue guidance was provided.
- Subsequent strategic commitment: In March 2019, The9 agreed to form a 50/50 electric-vehicle joint venture with Faraday&Future, with a proposed contribution of up to US$600m in three installments, subject to conditions and funding arrangements. The filing reports an initial US$5m deposit. The scale and financing of this proposal are significant relative to year-end cash.
- Other material risks: Revenue is concentrated in a small game portfolio and substantially dependent on Shanghai IT and the VIE arrangements. PRC regulatory interpretation could affect those arrangements, game approvals or operations. The company also disclosed ongoing litigation involving Qihoo 360 and System Link, and a remaining RMB170.0m liability for refunds of unused World of Warcraft game points, expected to remain until 2029 under the company’s legal analysis.
Management concluded that internal control over financial reporting was effective at December 31, 2018. The auditor’s report notes that the PRC-based auditor was not then subject to PCAOB inspection.
Investor verification checklist
- Confirm whether the convertible notes and other overdue borrowings were repaid by the stated deadlines, whether the planned property sale closed, and what collateral or assets were affected.
- Review the company’s subsequent cash balances, financing, related-party support, and operating cash burn; assess whether funding plans are sufficient to address near-term liabilities.
- Track the electric-vehicle joint venture’s conditions, actual funding commitments and contributions, and any additional financing or dilution required.
- Verify launch timing, regulatory approvals, user adoption and monetization for CrossFire New Mobile Game and other new titles; assess whether revenue concentration has changed.
- Assess the enforceability and regulatory status of the VIE contracts and Shanghai IT’s operating licenses, given the company’s reliance on that structure for PRC operations.
- Monitor Qihoo 360 litigation, the defaulted L&A-share-backed loan, and the RMB170.0m game-point refund obligation, including any changes in estimated exposure.