Business Context and Reporting Period
Company: The9 Limited (Nasdaq: NCTY)
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2009
Business Overview: The9 is a Cayman Islands-incorporated company primarily engaged in the development and operation of online games in the People's Republic of China (PRC). The company operates through a variable interest entity (VIE) structure due to PRC restrictions on foreign ownership of internet content provision licenses. The company's historical revenue was heavily dependent on the exclusive license to operate World of Warcraft (WoW) in China, which expired on June 7, 2009, and was not renewed.
Key Financial Metrics (Year Ended Dec 31, 2009)
| Metric | 2009 (RMB '000) | 2009 (US$ '000) | 2008 (RMB '000) |
|---|---|---|---|
| Total Revenues | 802,629 | 117,586 | 1,806,130 |
| Net Revenues | 760,516 | 111,416 | 1,711,491 |
| Gross Profit | 48,043 | 7,038 | 713,542 |
| Gross Margin | 6.3% | 6.3% | 41.7% |
| Operating Loss | (482,841) | (70,737) | 134,549 |
| Net Loss | (409,932) | (60,055) | 96,181 |
| Net Loss Attributable to Ordinary Shareholders | (405,152) | (59,355) | 96,836 |
| Loss Per Share (Basic & Diluted) | (15.94 RMB) | (2.34 US$) | 3.50 RMB |
| Cash and Cash Equivalents (Year End) | 1,675,081 | 245,401 | 2,152,586 |
| Total Assets | 2,324,958 | 340,608 | 3,263,009 |
| Total Equity | 2,013,450 | 294,972 | 2,719,242 |
Note: Exchange rate used for translation: RMB 6.8259 = US$ 1.00.
Material Changes vs. Prior Period
- Revenue Decline: Total revenues decreased by 55.6% from RMB 1.81 billion in 2008 to RMB 803 million in 2009. This was primarily due to the non-renewal of the WoW license, which accounted for approximately 88% of 2009 revenues and 91% of 2008 revenues.
- Profitability Reversal: The company swung from a net income of RMB 96.2 million in 2008 to a net loss of RMB 410 million in 2009.
- Margin Compression: Gross margin collapsed from 41.7% in 2008 to 6.3% in 2009. This was driven by significant write-offs of prepaid royalties (RMB 103.2 million) and additional depreciation expenses (RMB 40.0 million) related to WoW assets that could no longer be utilized.
- Impairment Charges: The company recorded RMB 78.9 million in impairment charges in 2009, including RMB 30.2 million for goodwill, RMB 27.5 million for upfront license fees, and RMB 21.2 million for computer equipment.
- Cash Flow: Net cash used in operating activities was RMB 106.1 million in 2009, compared to net cash provided by operating activities of RMB 692.6 million in 2008.
Guidance, Outlook, and Risks
Management Commentary and Outlook
- Product Pipeline: The company has not identified a product to replace WoW. Future revenues depend on the success of other licensed games (e.g., Soul of the Ultimate Nation, Granado Espada, Atlantica, EA Sports FIFA Online 2) and proprietary games (e.g., JiuZhouZhanJi, World of Fighter).
- Revenue Model Shift: The company is transitioning from a time-based revenue model (used for WoW) to an item-based revenue model (free-to-play with in-game purchases) for its remaining portfolio.
- Liquidity: Management stated that cash balances as of December 31, 2009, were sufficient to meet operating requirements for the next 12 months. However, cash flows will be adversely impacted if a replacement for WoW is not found.
Material Risks and Contingencies
- License Expirations: Licenses for Soul of the Ultimate Nation (expires May 2010) and Granado Espada (expires November 2010) are up for renewal. Failure to renew these could further impact revenues.
- Legal Proceedings:
- Securities Class Action: Consolidated lawsuits (Glaser v. The9 Ltd. and O'Dea v. The9 Ltd.) allege misrepresentations regarding the likelihood of renewing the WoW license. The company plans to file a motion to dismiss.
- Intellectual Property: A Beijing Superior Court judgment in February 2010 ruled that WoW client packages sold in 2007 infringed on font rights, requiring compensation of RMB 1.57 million. The company has appealed.
- Regulatory Environment: The company operates in China through contractual arrangements with affiliated entities (VIEs) due to foreign ownership restrictions. Changes in PRC regulations regarding foreign investment, internet content, or virtual currency could disrupt operations.
- Refund Liability: The company announced a refund plan for unactivated WoW game point cards. The maximum potential refund liability is approximately RMB 200.4 million, with RMB 4.0 million refunded in 2009.
Key Facts for Investor Verification
- WoW Replacement Strategy: Verify the progress and market reception of new proprietary and licensed games intended to replace the lost WoW revenue stream.
- License Renewals: Monitor the status of renewal negotiations for Soul of the Ultimate Nation and Granado Espada, which are critical to near-term revenue stability.
- Refund Liability Settlement: Track the actual cash outflow related to the WoW point card refund program and the associated legal liability.
- Legal Outcomes: Follow the status of the securities class action lawsuit and the appeal of the Beijing font infringement judgment.
- Regulatory Compliance: Assess the impact of evolving PRC regulations on the VIE structure and the company's ability to hold necessary operating licenses.