The9 Limited — FY2015 Form 20-F
Reporting period: Fiscal year ended December 31, 2015. This is an annual report, not a standalone Q4 filing. Financial statements use U.S. GAAP; amounts below are primarily RMB millions, with USD equivalents as reported.
Business context and reporting period
The9 develops and operates online games, including PC, mobile and TV games, and related services, primarily in China. Online games generated 86.9% of 2015 revenue. The company relies on contractual arrangements with Shanghai IT, a PRC variable-interest entity (VIE), for key operating licenses and activities; Shanghai IT generated 74.1% of consolidated revenue.
Financial performance and condition
| Metric | FY2015 | FY2014 |
|---|---|---|
| Revenue | 46.6 (US$7.2m) | 64.8 |
| Net revenue, after sales taxes | 46.4 (US$7.2m) | 64.3 |
| Gross loss | (21.3); margin approximately (46.0%) | (21.5); margin approximately (33.5%) |
| Operating loss | (326.5) (US$50.4m) | (160.8) |
| Net loss | (354.2) (US$54.7m) | (128.9) |
| Net loss attributable to ordinary shareholders | (384.6) (US$59.4m), including 79.8 accretion on redeemable noncontrolling interest | (107.7) |
| Operating cash flow | (175.6) (US$27.1m) | (269.1) |
| Cash and cash equivalents, year-end | 49.0 (US$7.6m) | 181.5 |
| Current assets / current liabilities | 77.3 / 428.0 | 255.9 / 296.6 |
| Total assets / total liabilities | 538.1 / 600.6 | 517.3 / 320.9 |
| Total shareholders’ equity | (241.1) | 64.9 |
PC online game revenue fell to RMB16.1m from RMB33.4m, while TV game revenue rose to RMB22.8m from RMB19.2m. Average quarterly paying users for PC games dropped to 10,364 from 42,620, partly offset by higher revenue per paying user. Product development and sales and marketing expenses declined, but general and administrative expense rose to RMB131.8m from RMB111.2m. Reported operating expenses increased substantially, in part because FY2014 included a RMB165.4m gain on subsidiary disposals; FY2015 recorded only RMB3.3m of disposal gain.
Investing cash outflow was RMB209.0m, principally reflecting RMB223.4m invested in System Link. Financing cash inflow was RMB257.9m, mainly from convertible notes and borrowing. The company reported net current liabilities of approximately RMB350.7m and negative equity at year-end.
Material changes, outlook and risks
- Liquidity and going concern: The company had an accumulated deficit of RMB2,304m and recurring operating losses and negative operating cash flow. The independent auditor’s report highlights substantial doubt about the company’s ability to continue as a going concern. Management stated it believed available and potential funding and cost controls would cover needs for the 12 months after the report date, but that assessment depends on sources that may not be realized.
- Debt and dilution: In December 2015, The9 issued US$40.05m of secured convertible notes at 12% annual interest, with initial conversion prices of US$2.60, US$5.20 and US$7.80 per ADS. It also issued warrants with US$9.95m aggregate stated amount and exercise prices from US$1.50 to US$7.80. Notes are secured by interests in two PRC subsidiaries and the Shanghai office building; change-of-control and default provisions can require cash redemption. A separate RMB31.6m entrusted loan bears 12% interest and is secured by the office building.
- Potential financing: A March 2016 Red 5 share-exchange MOU with L&A was non-binding; The9 expected L&A shares valued at US$44m–US$60m if completed. Bank of Shanghai committed a RMB50m credit facility, of which RMB4.9m had been drawn by March 31, 2016. Neither source was assured as of the filing.
- Games and commitments: Management planned a large-scale China launch of Firefall in the second half of 2016 and Song of Knights in 2016. CrossFire 2 was still under development by Smilegate. Its license calls for up to US$300m in fees for the initial term and a further US$200m for a possible extension, plus royalties; The9’s guarantees and funding obligations through its joint-venture structure expose it to significant costs if launch or monetization disappoints.
- Other unusual items: The9 retained a RMB170.0m liability for unconsumed World of Warcraft points; the filing states it expects legal release in 2029 absent a new refund policy. The 2015 warrant fair-value change generated a RMB7.1m loss. The company also recorded RMB13.0m of share-of-loss from equity-method investments.
- Principal risks: Declining game revenue and dependence on a limited number of titles; execution and funding risks for new games and joint ventures; competition; PRC regulatory uncertainty and VIE enforceability; restrictions on moving cash from China; foreign-exchange exposure; and potential dilution, debt enforcement, or Nasdaq continued-listing issues. A California former-employee lawsuit sought damages; management said it did not expect a material adverse effect. A Maradona-related case was settled for RMB3.3m in 2015.
Important facts for investors to verify
- Confirm the company’s near-term cash runway, facility availability and any subsequent financing or asset-sale transactions; distinguish committed funding from proposed or conditional sources.
- Review the convertible notes’ outstanding principal, interest accrual, conversion and warrant terms, security, covenants and potential dilution, alongside the RMB31.6m secured loan.
- Track CrossFire 2 development, launch approvals, milestone-linked license payments, royalties and the extent of The9’s guarantees or additional funding obligations.
- Assess whether Firefall and Song of Knights launches translate into paying users and sustainable revenue, given continued losses and declining legacy-game users.
- Review the RMB170.0m WoW refund liability, recoverability of receivables and investments, and the effect of negative equity and net current liabilities.
- Monitor PRC VIE, licensing and foreign-investment rules, and whether cash can be transferred from operating entities to the holding company.