The9 Limited — FY2011 Form 20-F
Reporting period: Fiscal year ended December 31, 2011. This is an annual report, not a standalone 2011 fourth-quarter filing; the provided filing does not give a clear Q4-only financial result. Financial statements are audited and prepared under U.S. GAAP. Amounts below are in RMB unless otherwise stated.
Business context
The9 develops and operates online games, principally in China, and is expanding into proprietary games and mobile social gaming. Its business was materially reshaped by the nonrenewal of its World of Warcraft (WoW) license, which expired in June 2009 and had represented approximately 88% of 2009 revenue. In 2011, the company launched ShenXianZhuan and The9 Game Zone; Firefall remained in beta testing, with a planned 2012 launch.
Financial performance and liquidity
| Metric | FY2011 | FY2010 |
|---|---|---|
| Revenue | RMB112.5 million (US$17.9 million) | RMB108.5 million |
| Net revenue, after sales taxes | RMB106.4 million | RMB102.8 million |
| Gross profit (loss) | RMB67.3 million | RMB0.4 million loss |
| Operating loss | RMB384.0 million | RMB353.8 million |
| Net loss | RMB313.2 million | RMB518.7 million |
| Net loss attributable to ordinary shareholders | RMB284.3 million (US$45.2 million); RMB11.39 per share | RMB499.6 million; RMB19.89 per share |
| Net cash used in operating activities | RMB270.9 million | RMB247.6 million |
| Cash and cash equivalents at year-end | RMB1,071.7 million | RMB1,416.2 million |
| Total assets | RMB1,628.9 million | RMB1,857.3 million |
| Current assets / current liabilities | RMB1,168.7 million / RMB311.5 million | RMB1,561.5 million / RMB316.3 million |
Gross margin improved to 63.2% of net revenue from a slight gross loss in 2010, largely as service costs fell 62.1% to RMB39.1 million. Operating expenses rose 35.1% to RMB477.3 million, including product development expense of RMB212.1 million, sales and marketing expense of RMB90.5 million, and general and administrative expense of RMB174.7 million. The operating loss therefore widened despite improved gross profit. The filing reports no debt securities and no derivative or foreign-currency borrowing arrangements; it does report RMB60.0 million of long-term accounts payable, largely associated with the Firefall license arrangements.
Changes and unusual items
- Revenue increased 3.6% year over year, mainly from TV, web and social games, but remained far below pre-WoW levels.
- The company recognized RMB44.4 million gain on disposal of its OpenFeint investment and RMB26.0 million of other operating income when the legal liability for unactivated WoW game points was extinguished.
- RMB170.0 million of activated WoW game-point refund liability remained at year-end. The company also reported RMB42.9 million advanced to a refund agent; in February 2012, the agent agreed to return the remaining advance in five annual installments, and the first RMB8.6 million installment was received.
- The company paid US$10.0 million and guaranteed a further US$12.7 million under the Firefall license arrangements; RMB20.0 million was estimated payable in 2012. The game’s intellectual property was pledged to secure the guaranteed amount.
- The company recorded a RMB44.4 million gain on the OpenFeint disposal, while investment impairment fell to zero from RMB196.1 million in 2010. These items helped reduce net loss, but the operating loss increased.
Outlook, risks and contingencies
Management said cash on hand was sufficient for anticipated operating requirements and obligations over the following 12 months. It expected product-development spending to continue increasing and anticipated significant investment in mobile gaming. No quantitative revenue or earnings guidance is provided. The company’s stated growth priorities include developing proprietary games, obtaining licenses, expanding mobile gaming and selectively acquiring studios.
- Key business risks include dependence on game licensors, uncertain commercial success of new titles, intense competition, and continued losses and operating cash outflows.
- The PRC operating structure relies on contractual arrangements with variable-interest entities that hold important licenses. The filing describes uncertainty over how Chinese authorities may interpret and enforce rules affecting foreign control of online game operators.
- Other material exposures include the RMB170.0 million WoW refund liability, game-approval and licensing requirements, foreign-exchange controls, and possible restrictions on transferring funds from China.
- Two notable pending claims were disclosed: a Beijing Founder font-infringement appeal with compensation and legal fees still subject to the final result, and a Maradona image/name claim seeking RMB20 million. The company accrued approximately RMB2 million for the latter. The WoW-related securities class action was dismissed in 2011.
- Management and the independent auditor concluded internal control over financial reporting was effective as of December 31, 2011; the auditor issued an unqualified opinion on the financial statements.
Investor verification priorities
- Assess whether new and proprietary games can generate meaningful revenue and whether Firefall’s launch, distribution and royalty commitments meet expectations.
- Reconcile the improvement in net loss with the widening operating loss, including the effects of the OpenFeint gain and WoW liability release.
- Track cash burn, cash balances and the recoverability and timing of the refund agent’s remaining advance.
- Review the status and accounting treatment of the WoW refund obligation, Founder appeal and Maradona litigation.
- Verify the status of PRC licenses, VIE contractual arrangements, and the ability to move cash from China; also consider the filing’s stated PFIC status for U.S. tax purposes in 2011.
- Confirm share-count and dilution disclosures: the cover reports 28,783,929 ordinary shares outstanding at year-end, while the financial statements report 24,456,805 issued and outstanding at December 31, 2011.