| · | Foreign Exchange Administration Rules (1996), as amended in 1997 and 2008; and |
| · | Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996). |
| 44 |
Pursuant to the Foreign Exchange Administration Rules (1996), as amended in 1997 and 2008, the RMB is generally freely convertible for trade and service-related foreign exchange transactions, but not for direct investment, loans, investment in securities, or other transactions through a capital account outside China unless the prior approval of SAFE or authorized banks is obtained. Furthermore, foreign investment enterprises in China in general may purchase foreign exchange without the approval of SAFE or authorized banks for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. Foreign investment enterprises that need foreign exchange for the distribution of profits to their shareholders may effect payment from their foreign exchange account or purchase and pay foreign exchange at the designated foreign exchange banks to their foreign shareholders by producing board resolutions for such profit distribution. Under the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), based on their needs, foreign investment enterprises are permitted to open foreign exchange settlement accounts for current account receipts and payments of foreign exchange along with specialized accounts for capital account receipts and payments of foreign exchange at certain designated foreign exchange banks.
On November 19, 2012, SAFE promulgated the Circular of Further Improving and Adjusting Foreign Exchange Administration Policies on Foreign Direct Investment, or SAFE Circular 59, which became effective on December 17, 2012. The major developments under SAFE Circular 59 were that the opening of various special purpose foreign exchange accounts (e.g. pre-establishment expenses account, foreign exchange capital account, guarantee account) no longer required the approval of SAFE. Furthermore, multiple capital accounts for the same entity may be opened in different provinces, which was not possible before the issuance of SAFE Circular 59. Reinvestment of RMB proceeds by foreign investors in the PRC no longer required SAFE approval or verification, and remittance of foreign exchange profits and dividends by a foreign-invested enterprise to its foreign shareholders no longer required SAFE approval.
On May 10, 2013, SAFE promulgated the Circular on Printing and Distributing the Provisions on Foreign Exchange Administration over Domestic Direct Investment by Foreign Investors and the Supporting Documents, which specifies that the administration by SAFE or its local branches over direct investment by foreign investors in the PRC shall be based on registration. Institutions and individuals shall register with SAFE and/or its branches for their direct investment in the PRC. Banks shall process foreign exchange business relating to the direct investment in the PRC based on the registration information provided by SAFE and its branches.
On February 13, 2015, SAFE issued the Circular on Further Simplifying and Improving the Foreign Exchange Administration Policies on Direct Investments, or SAFE Circular 13, which took effect on June 1, 2015. Pursuant to SAFE Circular 13, the administrative examination and approval procedures with SAFE or its local branches relating to the foreign exchange registration approval for domestic direct investments as well as overseas direct investments have been cancelled, and qualified banks are delegated the power to directly conduct such foreign exchange registrations under the supervision of SAFE or its local branches.
On April 26, 2016, SAFE issued the Circular of the State Administration of Foreign Exchange on Further Promoting Trade and Investment Facility and Improving the Examination and Verification of the Authenticity, pursuant to which when handling the remittance of profits exceeding the equivalent of US$50,000 abroad for a domestic institution, a bank should examine the authenticity of the transaction by reviewing related corporate approvals, tax filing record and other materials.
On June 9, 2016, SAFE promulgated the Notice of the State Administration of Foreign Exchange on Reforming and Standardizing the Foreign Exchange Settlement Management Policy of Capital Account, or SAFE Circular 16, effective on June 9, 2016, which reiterates some of the rules set forth in Circular 19, but changes the prohibition against using RMB capital converted from foreign currency-denominated registered capital of a foreign-invested company to issue RMB entrusted loans to a prohibition against using such capital to issue loans to non-affiliated enterprises.
Dividend Distribution.Distribution. The principal regulations governing distribution of dividends of foreign holding companies include:
| · | The Wholly Foreign Invested Enterprise Law (1986), as amended in 2000 and 2016; and |
| 45 |
| · | Administrative Rules under the Wholly Foreign Invested Enterprise Law (1990), as amended in 2001 and 2014. |
Under these regulations, foreign investment enterprises in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign investment enterprises in China are required to allocate at least 10% of their respective profits each year, if any, to fund certain reserve funds until the cumulative total of the allocated reserve funds reaches 50% of an enterprise’s registered capital and a portion of their respective after-tax profits to their staff welfare and bonus reserve funds as determined by their respective board of directors or shareholders. These reserves are not distributable as dividends.
Regulations on Foreign Exchange in Certain Onshore and Offshore Transactions
On July 4, 2014, SAFE issued SAFE Circular 37, which is the Circular on Several Issues Concerning Foreign Exchange Administration of Domestic Residents Engaging in Overseas Investment, Financing and Round-Trip Investment via Special Purpose Vehicles. SAFE Circular 37 and its detailed guidelines require PRC residents to register with the local branch of SAFE before contributing their legally owned onshore or offshore assets or equity interest into any SPV directly established, or indirectly controlled, by them for the purpose of investment or financing. In addition, when there is (a) any change to the basic information of the SPV, such as any change relating to its individual PRC resident shareholders, name or operation period or (b) any material change, such as increase or decrease in the share capital held by its individual PRC resident shareholders, a share transfer or exchange of the shares in the SPV, or a merger or split of the SPV, the PRC resident must register such changes with the local branch of SAFE on a timely basis. According to the relevant SAFE rules, failure to comply with the registration procedures set forth in SAFE Circular 37 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore companies of SPVs, including the payment of dividends and other distributions to its offshore parent or affiliate and the capital inflow from such offshore entity, and may also subject the relevant PRC residents and onshore companies to penalties under PRC foreign exchange administration regulations. Further, failure to comply with various SAFE registration requirements described above would result in liability for foreign exchange evasion under PRC laws. On February 13, 2015, SAFE issued SAFE Circular 13, which is the Circular on Further Simplifying and Improving the Foreign Exchange Administration Policies on Direct Investments, which took effect on June 1, 2015. Under SAFE Circular 13, qualified banks are delegated the power to register all PRC residents’ investments in SPVs pursuant to SAFE Circular 37, saving for supplementary registration application made by PRC residents who failed to comply with SAFE Circular 37, which shall still fall into the jurisdiction of the local branch of SAFE.
As a result of the uncertainties relating to the interpretation and implementation of SAFE Circular 37 and other regulations of SAFE, Circular 13, we cannot predict how these regulations will affect our business operations or strategies. For example, our present or future PRC subsidiaries’ ability to conduct foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, may be subject to compliance with such SAFE registration requirements by relevant PRC residents, over whom we have no control. In addition, we cannot assure you that any such PRC residents will be able to complete the necessary approval and registration procedures required by the SAFE regulations. We have requested all of our shareholders who, based on our knowledge, are PRC residents or whose ultimate beneficial owners are PRC residents to comply with all applicable SAFE registration requirements, but we have no control over our shareholders. We cannot assure you that the PRC beneficial owners of our company and our subsidiaries have completed the required SAFE registrations. Nor can we assure you that they will be in full compliance with the SAFE registration in the future. Any non-compliance by the PRC beneficial owners of our company and our subsidiaries may subject us or such PRC resident shareholders to fines and other penalties. It may also limit our ability to contribute additional capitals to our PRC subsidiaries and our subsidiaries’ ability to distribute profits or make other payments to us.
| C. | Organizational Structure |
The following diagram illustrates our organizational structure, the place of formation, ownership interest of each of our significant subsidiaries and material affiliated entities that operate our major game platforms in China as of the date of this annual report:
| 46 |
| D. | Property, Plants and Equipment |
Our headquarters are located on premises comprising approximately 14,000 square meters in an office building in Shanghai, China. We purchased the office building in which our headquarters are located, and lease all of our other premises from unrelated third parties.third-parties. Our office building has been mortgaged to secure the Convertible Notes in the aggregate principal amount of US$40,050,000 issued and sold to Splendid Days and an entrusted loan of approximately RMB31.6 million (US$4.9 million) that we obtained from a third party in December 2015.2015, which may be sold to repay the Convertible Notes. We may switch to another principal executive office. In addition, we have subsidiaries located in the United States Singapore and South KoreaSingapore and small branch offices in Beijing, Nanjing, Wuhan, Xi’an, Chengdu and Shenyang, China. Our equipment consists substantially of numerous servers and network devices located in four Internet data centers in China.
| Item 4A. | UNRESOLVED STAFF COMMENTS |
None.
| Item 5. | OPERATING AND FINANCIAL REVIEW AND PROSPECTS |
The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our consolidated financial statements and their related notes included in this annual report. This report contains forward-looking statements. See “—G. Safe Harbor.” In evaluating our business, you should carefully consider the information provided under the caption “Risk Factors” in this annual report. We caution you that our businesses and financial performance are subject to substantial risks and uncertainties.
| A. | Operating Results |
The major factors affecting our results of operations and financial conditions include:
| · | our revenues’ composition and sources of revenues; |
| · | our cost of revenue; and |
| · | our operating expenses. |
Revenue Composition and Sources of RevenueRevenue.. In 2013, 20142016, 2017 and 2015,2018, we generated substantially all of our revenues from online game services, and the remaining portion of our revenues from other services. The following table sets forth our revenues generated from providing online game services and other services, both asin absolute amounts and as percentages of total revenues for the periods indicated.
| For the Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| For the Year Ended December 31, | 2016 | 2017 | 2018 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2013 | 2014 | 2015 | RMB | % | RMB | % | RMB | US$ | % | |||||||||||||||||||||||||||||||||||||||||||||||
| RMB | % | RMB | % | RMB | US$ | % | (in thousands, except percentages) | |||||||||||||||||||||||||||||||||||||||||||||||||
| (in thousands, except percentages) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Revenue: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Revenue(1): | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Online game services | 95,131 | 89.2 | 55,418 | 85.5 | 40,504 | 6,253 | 86.9 | 48,566 | 86.3 | 71,564 | 97.8 | 16,551 | 2,407 | 94.6 | ||||||||||||||||||||||||||||||||||||||||||
Other revenues | 11,496 | 10.8 | 9,422 | 14.5 | 6,106 | 943 | 13.1 | 7,720 | 13.7 | 1,644 | 2.2 | 941 | 137 | 5.4 | ||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
| ||||||||||||||||||||||||||||||||||||||||||||||||||
Total revenues | 106,627 | 100.0 | 64,840 | 100.0 | 46,610 | 7,196 | 100.0 | 56,286 | 100.0 | 73,208 | 100.0 | 17,492 | 2,544 | 100.0 | ||||||||||||||||||||||||||||||||||||||||||
(1) Effective from January 1, 2018, we adopted ASC topic 606, a new accounting standard on the recognition of revenue, and have applied such accounting standards to the year ended December 31, 2018. The financial data for the year ended December 31, 2016 and 2017 have not been recast and as such are not comparable with the financial data for the year ended December 31, 2018.The adoption of ASC topic 606 did not have material impact on our financial results.
Online Game Services. In 2013, 20142016, 2017 and 2015,2018, revenues from our online game services amounted to RMB95.1RMB48.6 million, RMB55.4RMB71.6 million and RMB40.5RMB16.6 million (US$6.32.4 million), respectively. We primarily generate our online game service revenues through item-based revenue models. Under an item-based revenue model, players of our games play the games for free, but are charged for purchases of in-game items, such as performance-enhancing items, clothing and accessories. Thus, we generate revenues through the sale of such in-game premium features that players use game points to purchase. The distribution of points to end users is typically made through sales of prepaid game cards and prepaid online points. Fees from prepaid game cards and prepaid online points are deferred when initially received. This revenue is recognized over the life of the premium features or as the premium features are consumed. Future usage patterns may differ from the historical usage patterns on which the virtual items and services consumption model is based. We will continue to monitor the operational statistics and usage patterns affecting our recognition of these revenues.
| 47 |
Before August 1, 2018, we recorded our IPTV revenue on a gross basis. As we became an agent in the operation of IPTV games since August 1, 2018, we started to record our IPTV revenues net of amounts we paid to third-party operators.
Other Revenues. Other revenues mainly included revenues from mobile advertisementthe provision of technical services to customers.
Effective from January 1, 2018, we adopted ASC topic 606, a new accounting standard on the recognition of revenue, and trainings.applied the modified retrospective method to contracts that were not completed as of January 1, 2018 and we have applied such accounting standards to the year ended December 31, 2018. The adoption of ASC topic 606 did not have material impact on our financial results.
Cost of Revenue. Our cost of revenue consists of costs directly attributable to rendering our services, including online game royalties, payroll, sharing to third partythird-party game platform, telecom carries and other suppliers, depreciation and rental of Internet data center sites, depreciation and amortization of computer equipment and software intangible assets amortization and other overhead expenses directly attributable to the services we provide.
Before August 1, 2018, we recorded our IPTV revenue on a gross basis. As we became an agent in the operation of IPTV games since August 1, 2018, we started to record our IPTV revenues net of amounts we paid to third-party operators, and such amounts were no longer included in the cost of revenue.
Operating Expenses. Our operating expenses consist primarily of product development expenses, sales and marketing expenses, general and administrative expenses impairmentand gain on equipment, intangible assets and other long-lived assets and allowance on long-term receivables.disposal of subsidiaries.
Product Development Expenses. Our product development expenses consist primarily of compensation to our product development personnel, outsourced research and development expenses, equipment and software depreciation charges and other overhead expenses for the development of our proprietary games. Our product development expenses amounted to RMB213.2RMB78.0 million, RMB156.3RMB45.1 million and RMB135.0RMB24.6 million (US$20.83.6 million) for the yearsyear ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively. Most of our proprietary online games have entered into their final stages of development and we have the ability to control the level of discretionary spending on product development in the near future.
Sales and Marketing Expenses. Our sales and marketing expenses consist primarily of advertising and marketing expenses incurred to promote our games and compensation expenses relating to our sales and marketing personnel. Our sales and marketing expenses amounted to RMB116.7RMB21.3 million, RMB51.8RMB9.1 million and RMB31.7RMB2.3 million (US$4.90.3 million) for the yearsyear ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively.
General and Administrative Expenses. Our general and administrative expenses consist primarily of compensation and travel expenses for our administrative staff, depreciation of property and equipment, entertainment expenses, administrative office expenses, as well as fees paid to professional service providers for auditing, legal services and legal services.equity transactions. General and administration expenses amounted to RMB162.0RMB129.0 million, RMB111.2RMB108.8 million and RMB131.8RMB89.6 million (US$20.313.0 million) for the yearsyear ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively. General and administrative expenses continued to decrease from 20132016 to 2015 reflecting2018, which reflects our cost cutting efforts. We expect general and administrative expenses including share-based compensation expenses will remain relatively stable at the current level in the near future.
Impairment on Long-livedIntangible Assets. ImpairmentWe had impairment charges relate to the impairment on certain equipment and intangible assets amounting to RMB5.7 million, nil and nil for the years ended December 31, 2013, 2014 and 2015, respectively.
(Provision)Reversal ofProvision for Allowance forLong-term Receivables andPrepayments.We recorded allowance on long-term receivable of RMB29.7 million, RMB3.6 million and RMB8.4 million (US$1.3 million) for the years ended December 31, 2013, 2014 and 2015, respectively. We reversed the provision of RMB17.9RMB68.0 million for the year ended December 31, 2014. The allowance2016. We did not have such impairment charges for the year ended December 31, 2017 and 2018.
Impairment Loss on long-term receivableGoodwill. We had no impairment charges of goodwill for the year ended December 31, 2017 and 2018. We had impairment charges on goodwill of RMB10.6 million for the year ended December 31, 2016, which represented the impairment of goodwill in 2013 was primarilyconnection with our acquisition of Red 5 in 2010. In 2016, due to certain prepayment made to an equipment supplier. In 2014,the weaker-than-expected operating performance of Red 5, we reversed all such allowance as we reevaluated the collectability of the receivables and determinedconcluded that the payments can be collected. We collected the amount in full in 2015. The allowance on long-term receivable in 2015goodwill was related to the receivable from WoW game points refund agent.fully impaired.
| 48 |
Gain/loss on Disposal of Subsidiaries. We recorded a gainGain on disposal of a subsidiary of RMB3.3 million (US$0.5 million) in October 2015 in connection with the disposal of 58% equity interest in Shanghai Jiucheng Advertisement, which operates our mobile advertising platform.subsidiaries. We recorded ahad gain on disposal of subsidiaries of RMB10.5 million (US$1.5 million) for the year ended December 31, 2018, including gain on disposal of RMB165.4The9 Education of RMB10.0 million in 2014 in connection with disposal of our equity interests in Huopu Cloud and Shanghai Kai Yue Information Technology Co. Ltd., or Kai Yue.(US$1.5 million). We did not record anyhad no gain on disposal of subsidiaries in 2013.for the year ended December 31, 2016 and 2017.
Other Operating Income(Expenses). We had other operating expensesincome of RMB1.6RMB0.3 million and RMB0.2 million (US$0.20.03 million) in 2015, representing a loss onfor the year ended December 31, 2017 and 2018, respectively, both primarily attributable to office rental income. We had other operating income of RMB3.6 million for the year ended December 31, 2016, including primarily IDC rental income and office rental income of RMB4.2 million, which were partially offset by the disposal of property, equipment and software. Our other operating income in 2013 and 2014 represented rental income, which amounted to RMB120,000 and RMB75,000, respectively.
Holding Company Structure
We are a holding company incorporated in the Cayman Islands and rely primarily on dividends and other distributions from our subsidiaries and our affiliated entities in China for our cash requirements. Current PRC regulations restrict our affiliated entities and subsidiaries from paying dividends in the following two principal aspects: (i) our affiliated entities and subsidiaries in China are only permitted to pay dividends out of their respective accumulated profits, if any, determined in accordance with PRC accounting standards and regulations; and (ii) these entities are required to allocate at least 10% of their respective accumulated profits each year, if any, to fund certain capital reserves until the cumulative total of the allocated reserves reach 50% of registered capital, and a portion of their respective after-tax profits to their staff welfare and bonus reserve funds as determined by their respective boards of directors. These reserves are not distributable as dividends. See “Item 4. Information on the Company—B. Business Overview—Government Regulations.” In addition, failure to comply with relevant SAFE regulations may restrict the ability of our subsidiaries to make dividend payments to us. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China —PRCChina—PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident shareholders or us to penalties and fines, and limit our ability to inject capital into our PRC subsidiaries, limit our subsidiaries’ ability to increase their registered capital, distribute profits to us, or otherwise adversely affect us.”
Income and Sales Taxes
The National People’s Congress of the PRC adopted and promulgated the EIT Law on March 16, 2007. The EIT Law went into effect as of January 1, 2008 and revised on February 24, 2017 and December 29, 2018, and unified the tax rate generally applicable to both domestic and foreign-invested enterprises in the PRC. Our company’s subsidiaries and affiliated entities in the PRC are generally subject to EIT at a statutory rate of 25%. Our subsidiaries and affiliated entities in the PRC that hold a HNTE qualification are entitled to enjoy a 15% preferential EIT rate.
In addition, under the EIT Law, enterprises organized under the laws of their respective jurisdictions outside the PRC may be classified as either “non-resident enterprises” or “resident enterprises.” Non-resident enterprises are subject to withholding tax at the rate of 20% with respect to their PRC-sourced dividend income if they have no establishment or place of business in the PRC or if such income is not related to their establishment or place of business in the PRC, unless otherwise exempted or reduced according to treaties or arrangements between the PRC central government and the governments of other countries or regions. The State Council has reduced the withholding tax rate to 10% in the newly promulgated implementation rules of the EIT Law. As we are incorporated in the Cayman Islands, we may be regarded as a “non-resident enterprise.” We hold equity interests in certain PRC subsidiaries through subsidiaries in Hong Kong. According to the Tax Agreement between the PRC and Hong Kong, dividends paid by a foreign-invested enterprise in the PRC to its corporate shareholder in Hong Kong holding 25% or more of its equity interest may be subject to withholding tax at the maximum rate of 5% if certain criteria are met. Entitlement to such lower tax rate on dividends according to tax treaties or arrangements between the PRC central government and governments of other countries or regions is further subject to approval and filing procedures of relevant tax authority.
Furthermore,
| 49 |
In February 2018, the SAT promulgatedissued the Announcement of the State Administration of Taxation on Issues Relating to “Beneficial Owner” in Tax Treaties on issues relating to “beneficial owner” in tax treaties, or Circular 601No. 9, which took effect on April 1, 2018. Circular No. 9 provides a more elastic guidance forto determine whether the applicant engages in substantive business activities to constitute a “beneficial owner.” When determining whether a residentthe applicant’s status of a contracting state is the “beneficial owner” of an Item of income under China’sregarding tax treatments in connection with dividends, interests or royalties in the tax treaties, several factors, including without limitation, whether the applicant is obligated to pay more than 50% of his or her income in the past twelve months to residents in third country or region, whether the business operated by the applicant constitutes the actual business activities, and whether the other country or region to the tax arrangements. Accordingtreaties does not levy any tax or grant tax exemption on relevant incomes at all or levy tax at an extremely low rate, will be taken into account, and it will be analyzed according to Circular 601,the actual circumstances of the specific cases. This circular further provides that applicants who intend to prove his or her status of the “beneficial owner” shall submit the relevant documents to the relevant tax bureau according to the Administrative Measures for Non-Resident Enterprises to Enjoy Treatments under Tax Treaties, pursuant to which non-resident taxpayers which satisfy the criteria to be entitled to tax treaty benefits may, at the time of tax declaration or withholding declaration through a beneficial owner generally mustwithholding agent, enjoy the tax treaty benefits, and be engaged in substantial business activities. Ansubject to follow-up administration by the tax authorities. If the non-resident taxpayer does not apply to the withholding agent or conduit company will not be regarded as a beneficial owner and, therefore, will not qualify for treaty benefits. The conduit company normally refers to a company that is set up for the purposetax treaty benefits, or such taxpayer does not satisfy the criteria to be entitled to tax treaty benefits, the withholding agent should withhold tax pursuant to the provisions of avoiding or reducing taxes or transferring or accumulating profits. In June 2012, SAT further promulgated Circular 30 which provides that thePRC tax authorities shall make the decision based on comprehensive consideration of all determining factors provided in Circular 601 rather than the status of a single determining factor.laws. We cannot assure you that any dividends to be distributed by us or by our subsidiaries to our non-PRC shareholders and ADS holders whose jurisdiction of incorporation has a tax treaty with China providing a different withholding arrangement will be entitled to the benefits under the relevant withholding arrangement.
The EIT law deems an enterprise established offshore but having its management organ in the PRC as a “resident enterprise” that will be subject to PRC tax at the rate of 25% of its global income. Under the Implementation Rules of the New Enterprise Income Tax Law, the term “management organ” is defined as “an organ which has substantial and overall management and control over the manufacturing and business operation, personnel, accounting, properties and other factors.” On April 22, 2009, the SAT further issued Circular 82. According to Circular 82, a foreign enterprise controlled by a PRC company or a PRC company group shall be deemed a PRC resident enterprise, if (i) the senior management and the core management departments in charge of its daily operations are mainly located and function in the PRC; (ii) its financial decisions and human resource decisions are subject to the determination or approval of persons or institutions located in the PRC; (iii) its major assets, accounting books, company seals, minutes and files of board meetings and shareholders’ meetings are located or kept in the PRC; and (iv) more than half of the directors or senior management with voting rights reside in the PRC. On July 27, 2011, SAT issued SAT Bulletin 45 which further clarified the detailed procedures for determination of the resident status provided in Circular 82, competent tax authorities in charge and post-determination administration of such resident enterprises. Although our offshore companies are not controlled by any PRC company or PRC company group, we cannot assure you that we will not be deemed to be a “resident enterprise” under the EIT Law and thus be subject to PRC EIT on our global income.
According to the EIT Law and its implementation rules, dividends are exempted from income tax if such dividends are received by a PRC resident enterprise on equity interests it directly owns in another PRC resident enterprise. However, foreign corporate holders of our shares or ADSs may be subject to taxation at a rate of 10% on any dividends received from us or any gains realized from the transfer of our shares or ADSs if we are deemed to be a resident enterprise or if such income is otherwise regarded as income “sourced within the PRC.” See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry—The PRC income tax laws may increase our tax burden or the tax burden on the holders of our shares or ADSs, and tax benefits available to us may be reduced or repealed, causing the value of your investment in us to suffer.decrease.”
With respect to sales taxes, before December 31, 2011, all the services provided by our PRC subsidiaries were subject to business taxes at the rate of 5%. In October, 2011, China’s Ministry of Finance and the SAT jointly issued the Circular 110 to launch the VAT reform pilot program in Shanghai. Following the Circular 110, the Ministry of Finance and the SAT jointly issued the Circular 111 in November 2011 to provide detailed implementation rules for the program. The two circulars, which would be effective from January 1, 2012, stipulated that certain services, subject to the pilot programs, shall be subject to VAT instead of business tax. On July 31, 2012, the Ministry of Finance and the SAT jointly issued Circular 71 which further extended areas subject to the pilot program to eight more provinces. On December 12, 2013, the Ministry of Finance and the SAT jointly issued the Interim Implementation Rules on the Pilot Program for the Collection of Value Added Tax Instead of Business Tax and a series of other rules, which annulled the preceding trial rules and extended applicable areas of the pilot program to the whole country. As a result of such Implementation Rules, some of our services provided by Shanghai IT and The9 Computer are subject to VAT at the rate of 6%. Shanghai IT and The9 Computer, as General VAT Payers under the applicable tax regulations, may reduce their Input VAT. Certain services provided by Shanghai The9 Education Technology Co., Ltd. and other PRC subsidiaries or affiliated PRC entities shall be subject to VAT at the rate of 3%, and these companies as Small-scale VAT Payers under the applicable tax regulations may not reduce their VAT payable by their Input VAT.
On March 23, 2016, the Ministry of Finance and the SAT jointly issued the Circular on the Pilot Program for Overall Implementation of the Collection of Value Added Tax Instead of Business Tax, or Circular 36, which will taketook effect on May 1, 2016. Pursuant to Circular 36, all companies operating in construction, real estate, finance, modern service or other sectors which were required to pay business tax are required to pay VAT in lieu of business tax.tax As a result of Circular 36, the services provided by Shanghai IT, The9 Computer and C9I Shanghai Shanghai Fire Wing and The9 Education as general VAT payers will be subject to VAT at the rate of 6%, and the services provided by our other PRC subsidiaries or affiliated PRC entities as small-scale VAT payers will be subject to VAT at the rate of 3%.
Our subsidiaries in the United States are registered in California and are subject to U.S. federal corporate marginal income tax at a rate of 34%21% for the taxable year ending December 31, 2018 and subsequent taxable years and state income tax at a rate of 0.48%8.84%, respectively.
| 50 |
Inflation
Since our inception, inflation in China has not materially affected our results of operations. According to the National Bureau of Statistics of China, the year-over-year percent changes in the consumer price index for December 2016, 2017 and 2018 increases of 2.1%, 1.8% and 1.9%, respectively. Although we have not been materially affected by inflation, we may be affected if China experiences higher rates of inflation in the future.
Critical Accounting Policies
We prepare financial statements in conformity with U.S. Generally Accepted Accounting Principles, or U.S. GAAP, which requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities on the date of the financial statements, and the reported amounts of revenue and expenses during the financial reporting period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our accounting policies require higher degrees of judgment than others in their application. We consider the policies discussed below to be critical to an understanding of our financial statements as their application assists management in making their business decisions.
Consolidation of Variable Interest Entities, or VIEs
PRC laws and regulations, including the GAPP Circular and the Network Publication Measures, currently prohibit or restrict foreign ownership of Internet-related businesses. We believe, consistent with the view of our PRC legal counsel, that our current structure complies with these foreign ownership restrictions, subject to the interpretation and implementation of the GAPP Circular.Circular and the Network Publication Measures. Specifically, we operate our business through Shanghai IT and have entered into a series of contractual arrangements with Shanghai IT and its equity owners. See the contractual arrangements set forth in “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions.” As a result of these contractual arrangements, we are entitled to receive service fees for services provided to Shanghai IT for an amount determined at our discretion, up to 90% of PRC entities’ profits. In addition, the equity owners of record for these entities have pledged all their equity interests in the VIEs to us as collateral for all of their payments due to the wholly-owned foreign enterprise, or WOFE, and to secure performance of all obligations of the VIEs and their shareholders under various agreements. In addition, the agreements provide that any dividend distributions made by the VIEs, if any, are required to be deposited in an escrow account over which we have exclusive control. Moreover, through the Call Option Agreements and Shareholder Voting Proxy Agreements, each shareholder of the VIEs granted WOFE or any third parties designated by the WFOEWOFE an irrevocable power of attorney to act on all matters pertaining to the VIEs. We believe that the terms of the Call Option Agreements are currently exercisable and legally enforceable under the PRC laws and regulations. We also believe that the minimum amount of consideration permitted by the applicable PRC law to exercise the options does not represent a financial barrier or disincentive for us to exercise our rights under the Call Option Agreements. A simple majority vote of our board of directors is required to pass a resolution to exercise our rights under the Call Option Agreements, for which consent of the shareholder of the VIEs is not required. As a result of the totality of these arrangements, we have both the power to direct activities that most significantly impact the VIEs economic performance and the obligation to absorb losses of or right to receive benefits from the VIEs that are significant to Shanghai IT. As a result, we concluded we are the primary beneficiary of Shanghai IT and as such Shanghai IT is consolidated VIE of our company.
The GAPP Circular reiterates and reinforces the long-standing prohibition of foreign ownership of Internet-related publication businesses via direct, indirect or disguised methods.methods, and the Network Publication Measures provides that the manner of project cooperation shall be subject to prior examination and approval by the GAPPRFT. However, it is not clear whether theGAPPRFT and MIIT have regulatory authority of GAPPRFT applies toover the regulation of ownership structures of online game companies based in China and online game operation in China. In addition, the GAPP Circular doesand the Network Publication Measures do not specifically invalidate VIE agreements, and we are not aware of any online game companies adopting similar contractual arrangements as ours having been penalized or ordered to terminate such arrangements since the GAPP Circular first became effective. Therefore, we believe that our ability to direct the activities of Shanghai IT that most significantly impact our economic performance is not affected by the GAPP Circular. Any changes in PRC laws and regulations that affect our ability to control Shanghai IT might preclude us from consolidating Shanghai IT in the future. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry—PRC laws and regulations restrict foreign ownership of Internet content provision, Internet culture operation and network publication serviceInternet publishing licenses, and substantial uncertainties exist with respect to the application and implementation of PRC laws and regulations.”
| 51 |
Revenue Recognition
We recognize revenues when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration expected to be entitled to in exchange for those goods or services. Depending on the terms of the contract and the laws that apply to the contract, control of the goods or services may be transferred over time or at a point in time. We do not believe that significant management judgments are involved in revenue recognition. We adopted ASC topic 606 using the modified retrospective transition approach method, reflecting the cumulative effect of initially applying the new standard to revenue recognition in 2018. We evaluated all revenue streams to assess the impact of implementing ASC topic 606 on revenue contracts. The adoption of ASC topic 606 did not change our consolidated balance sheets, consolidated statement of cash flows, or consolidated statement of changes in equity as of, or for the year ended, December 31, 2018.
Online Game Servicesgame services
We earn revenue from provision of online game operation services to players on ourthe game servers and third party platformthird-party platforms and overseas licensing of the online game to other operators. We recognize revenues when persuasive evidence of an arrangement exists,grant operation right on authorized games, together with associated services which are delivered or performed, our price is fixed or determinable and collectability is reasonably assured.
Online game servicesrendered to players on our game server
the customers over time. We generate revenue primarily from the sale of our prepaid game cards and prepaid online points for our online game services products to distributors who in turn ultimately sell them to players. We also sell the points directly to players via certain online payment platforms.
We utilize aadopt virtual item/item / service consumption model to recognize revenue. Under this model, we generatefor the online game service revenues through the sale of in-game premium features. In this model, playersservices. Players can access our basiccertain games free of charge, and then maybut many of them purchase game points to acquire in-game premium features. We may act as principal or agent through the various transaction arrangements we entered into.
The distributiondetermination on whether to record the revenue gross or net is based on an assessment of pointsvarious factors, including but not limited to players is typically made through sales of prepaid game cards and prepaid online points. Fees for prepaid game cards and prepaid online pointswhether we (i) are deferred when initially received. This revenue is recognized over the estimated lifeprimary obligor in the arrangement; (ii) have general inventory risk; (iii) change the product or perform part of the premium featuresservices; (iv) have latitude in establishing the selling price; and (v) have involvement in the determination of product or as the premium features are consumed.
For in-game premium features that are immediately consumed, revenueservice specifications. The assessment is recognized upon consumption. For premium features with a stated expiration time, which ranges from one to 180 days, revenue is recognized ratably over the period starting from when the feature is first used to the expiration time. For perpetual features with no predetermined expiration, revenue is recognized ratably over the estimated average livesperformed for all of the perpetual features, which are typically less than one year. When estimating the average lives of the in-game perpetual features, we consider the average period that players typically play the game, other player behavior patterns, and factors including the acceptance and popularity of expansion packs, promotional events launched, and market conditions. Future usage patterns of players may differ from the historical usage patterns on which the virtual item / service consumption revenue recognition model is based. We continually monitor the operational statistics and usage patterns.licensed online games.
Online game services over third party platformWhen acting as principal
Certain social games, TV games, certain web games and certain MMOGS, have adopted the virtual item / service consumption model, and are launched on the third party
Revenues from online game platforms and telecom carriers. Revenue from social and web games operated through third party game platforms are recognized upon consumption of the in-game premium features with the amount net of remittance to the third party game platforms as we do not set the pricing of the in-game currency of the third party game platforms.
Revenue from TV gamesoperation operated through telecom carriers and certain MMOGS operated on the third party game platformsonline games operators are recognized upon consumption of the in-game premium features based on the gross amountof revenue sharing-payments to third-party operators, but net of VAT. We obtain revenue from the sale of in-game virtual items. Revenues are recognized when the virtual items are consumed or over the estimated lives of the virtual items, which are estimated by considering the average period that active players and players' behavior patterns derived from operating data. Accordingly, commission fees paid to third-party operators are recorded as cost of revenues.
When acting as agent
With respect to games license arrangements we entered into with third-party operators, if the terms provide that (i) third-party operators are responsible for providing game desired by the game players; (ii) the hosting and maintenance of game servers for running the games are the responsibility of third-party operators; (iii) third-party operators have the right to review and approve the pricing of in-game virtual items and the specification, modification or update of the game made by us; and (iv) publishing, providing payment solution and market promotion services are the responsibilities of third-party operators and we are responsible to provide the primary obligorlicense of intellectual property and subsequent technical services, then we consider ourselves as an agent of the third-party operators in such arrangement with game players. Accordingly, we record the game revenues from these licensed games, operation. The remittancenet of amounts paid to the telecom carrier and third party game platforms is recognized as costs of revenue when incurred.third-party operators.
Licensing revenue
We license our proprietary online games to other game operators and receive license fees and royalty income in connection with their operation of the games. License fee revenue is recognized overevenly throughout the license period upon the commercializationafter commencement of the game, ingiven that our intellectual property rights subject to the overseas market. Royalty incomelicense are considered to be symbolic and the licensee has the right to access such intellectual property rights as they exist over time when the license is granted. Monthly revenue-based royalty payments are recognized when earned,the relevant services are delivered, provided that collectability is reasonably assured.
Other Revenues
Other We view the third-party licensee operators as our customers and recognize revenues include those generated from trainingon a net basis, as we do not have the primary responsibility for fulfillment and advertisingacceptability of the game services.
Training and advertisement
| 52 |
Training and advertisement revenueTechnical services
Technical services mainly include revenues generated from providing technical trainingblockchain-related consulting services where we provide services related to college students on mobile applicationthe designing, programming and priorother related services to the sale of our 58% equity interest in our mobile advertising platform, advertising services on our mobile advertising platform. customers.
These revenues are recognized when delivery of the website advertisementservice has occurred or when services have been rendered and the collection of the related fees isare reasonably assured.
Contract balances
Timing of revenue recognition may differ from the timing of invoicing to customers. Accounts receivable represent amounts invoiced and revenue recognized prior to invoicing, when we satisfy its performance obligations and have the unconditional right to payment.
Deferred revenue relates to unsatisfied performance obligations at the end of the period and primarily consists of fees received from game players in the online game services and technical services. For deferred revenue, due to the generally short-term duration of the contracts, the majority of the performance obligations are satisfied in the following reporting period. The amount of revenue recognized that was included in deferred revenue balance at the beginning of the period was RMB5.4 million (US$0.8 million) for the year ended December 31, 2018.
Income Taxes
We account for income taxes under the asset and liability method. Deferred taxes are determined based upon the differences between the carrying value of assets and liabilities for financial reporting and tax purposes at currently enacted statutory tax rates for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period of change.
A valuation allowance is provided on deferred tax assets to the extent that it is more likely than not that such deferred tax assets will not be realized. The total income tax provision includes current tax expenses under applicable tax regulations and the change in the balance of deferred tax assets and liabilities. Realization of the future tax benefits related to the deferred tax assets is dependent on many factors, including our ability to generate taxable income within the period during which the temporary differences reverse or our tax loss carry forwards expire, the outlook for the PRC economic environment, and the overall future industry outlook. We consider these factors in reaching our conclusion on the recoverability of the deferred tax assets and determine the valuation allowances necessary at each balance sheet date.
We recognize the impact of an uncertain income tax position at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant tax authority. Income tax related interest is classified as interest expenses and penalties as income tax expense. As of December 31, 2013, 20142016, 2017 and 2015,2018, we did not have any material liability for uncertain tax positions. Our policy is to recognize, if any, tax-related interest as interest expenses and penalties as income tax expenses. For the yearsyear ended December 31, 2013, 20142016, 2017 and 2015,2018, we did not have any material interest and penalties associated with tax positions.
Intangible Assets
Our intangible assets consist primarily of acquired game licenses and acquired game development costs from business combination.
Acquired game licenses are amortized on a straight-line basis over the shorter of the useful economic life of the relevant online game or license period, which range from two to seven years. Amortization of upfront licensing fees commences upon the monetization of the related online game. We recognize intangible assets acquired through business acquisitions as assets separate from goodwill. Acquired in-process research and development costs are initially considered an indefinite-lived asset. Subsequently, they are recorded as acquired game development cost upon completion of the research and development efforts and are amortized on a straight-line basis over the useful economic life of the relevant online game. Amortization of acquired game development cost commences upon the monetization of the related online game.
| 53 |
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as a result of an acquisition we make.our business acquisition. Goodwill is not amortized, but tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. In September 2011, the Financial Accounting Standards Board, or FASB, issued an authoritative pronouncement related to testing goodwill for impairment. The guidance permits us to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. We have adopted this pronouncement since 2012. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, we complete a two-step goodwill impairment test in December of each year, we test impairment of goodwill at the reporting unit level and recognize impairment in the event that the carrying value exceedsyear. The first step is to compare the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step is to compare the implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. Goodwill impairment assessment requires significant judgment, including assumptions used to determineThe excess of the fair value of the reporting units. We determineunit over the fair value of our reporting units based onamounts assigned to the present value of estimated future cash flows of the reporting units. If the carrying amountassets and liabilities is in excess of the fair value, step two requires the comparison of the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the reporting unit’s goodwill with the carrying amountvalue of the reporting unit’s goodwill. Anyany assets or liabilities. An impairment loss is recognized for any excess ofin the carrying value of the reporting unit’s goodwill over the implied fair value of the reporting unit’s goodwill is recorded as an impairment loss.goodwill. After completing our annual impairment reviews during the fourth quarter of 2013, 2014 and 2015, the reporting unit that was subject to the annual impairment testing had a fair value which exceeded its respective carrying value by a significant margin with no risk of failing the first step of the impairment test. WeIn 2016, due to the weaker-than-expected operating performance of Red 5, we concluded that goodwill was notfully impaired as of December 31, 2013, 2014 and 2015.2016. There was no goodwill as of December 31, 2017 or December 31, 2018.
Share-Based Compensation
Under ourthe 2004 Stock Option Plan, or the Option Plan, we granted options to purchase a total of 355,000 and 10,110,000 optionsordinary shares of our company to our employees and directors in 2013 and 2015, respectively. We did not grant any options under the Option Plan in 2014. We granted options to purchase a total of 6,000,000, nil and 8,250,000 ordinary shares of our company in 2016, 2017 and 2018, respectively.
We measure the cost of employee services received in exchange for stock-based compensation measured at the grant date fair value of the award. For the awards that are modified, we determine the incremental cost as the excess of the fair value of the modified award over the fair value of the original award immediately before its terms are modified, measured based on the share price and other pertinent factors at that date. We recognize the compensation costs, net of the estimated forfeiture, on a straight-line basis over the vesting period of the award, which generally ranges from one to four years. Forfeiture rates are estimated based on historical forfeiture patterns and adjusted to reflect future changes in circumstances and facts, if any. If actual forfeitures differ from those estimates, the estimates may be revised in subsequent periods. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest.
Determining the fair value of stock options requires significant judgment. We measure the fair value of the stock options using the Black-Scholes option-pricing model with assumptions made regarding expected term, volatility, risk-free interest rate, and dividend yield. The expected term represents the period of time that the awards granted are expected to be outstanding. The expected term is determined based on historical data on employee exercise and post-vesting employment termination behavior, or the “simplified” method for stock option awards with the characteristics of “plain vanilla” options for 2010 and 2011. Expected volatilities are based on historical volatilities of our ordinary shares. Risk-free interest rate is based on U.S. government bonds issued with maturity terms similar to the expected term of the stock-based awards. While we paid a discretionary cash dividend in January 2009, we do not anticipate paying any recurring cash dividends in the foreseeable future.
In addition, on December 8, 2010, we granted 1,500,000 ordinary shares to Jun Zhu, our chairman and chief executive officer, which will only be vested if our company achieves certain income targets and the shares are not entitled to receive dividends until they become vested. Of such shares, 500,000 ordinary shares were vested and issued to Incsight Limited, a company wholly ownedwholly-owned by Jun Zhu, on November 17, 2015. We considered the grant of ordinary shares as an incentive to retain Mr. Jun Zhu’s services with our company. The awarded non-vested shares would be valid for five years from December 8, 2010. The fair value of the granted non-vested shares is US$6.48 per share, the market price on the date of grant. We record share-based compensation expenses for these performance-based awards based upon our estimate of the probable outcome at the end of the performance period (i.e., the estimated performance against the performance targets). We periodically adjust the cumulative share-based compensation recorded when the probable outcome for these performance-based awards is updated based upon changes in actual and forecasted operating results. Our actual performance against the performance targets could differ materially from our estimates.
| 54 |
In May 2011, we granted 30,000 ordinary shares to each of our four non-executive directors, of which 10,000 ordinary shares vest for each director on July 1 of each year from 2011 to 2013 so long as such director continues his service as of such date. An aggregate of 40,000 ordinary shares vested in each of July 2011, July 2012 and July 2013, respectively. The fair value of the shares granted was US$6.03 per share, being the market price on the date of the grant.
In February 2006, Red 5 adopted a Stock Incentive Plan, or Red 5 Stock Incentive Plan, under which Red 5 may grant to its employees, director and consultants stock options to purchase common stocks or restricted stocks of Red 5. Red 5 granted options to purchase an aggregate of 28,963,258 shares of common stock under the Red 5 Stock Incentive Plan from April 6, 2010 to December 31, 2013. In September 2012, Red 5 granted an aggregate of 6,122,435 restricted common stocks to two directors of Red 5 including Mr. Zhu for their services to Red 5. We measure the share-based compensation based on the fair value of the award as of the grant date. We measure the fair value of the stock options using the Black-Scholes option-pricing model with assumptions made regarding the fair value of the common stock, expected term, volatility, risk-free interest rate, and dividend yield.
In January 2018, we granted 8,250,000 options to directors, officers and consultants, of which 5,750,000 shares would vest based on their services period with our company and 2,500,000 shares granted would vest subject to their performance condition. We measured the fair value of the options using the Black-Scholes option-pricing model. In September 2018, we canceled a total of 6,200,000 shares granted in January 2018.
Share-based compensation expenses of RMB29.2RMB28.1 million, RMB3.7RMB38.0 million and RMB34.0RMB3.9 million (US$5.20.6 million) were recognized for the yearsyear ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively, for options and warrants granted to our company’s and its subsidiaries’ employees and directors, including incremental compensation cost due to the modificationacceleration vesting and exercise of option exercise priceoptions in April 2013 and November 2015.June 2017.
Impairment Loss of Equity InvestmentInvestments
We assess our equity investments for impairment on a periodic basis by considering factors including, but not limited to, current economic and market conditions, the operating performance of the investees including current earnings trends, the technological feasibility of the investee’s products and technologies, the general market conditions in the investee’s industry or geographic area, factors related to the investee’s ability to remain in business, such as the investee’s liquidity, debt ratios, and cash burn rate and other company-specific information including recent financing rounds. If it has been determined that the carrying amount of equity investment areis higher than related fair value and that this decline is other-than-temporary, the carrying value of the equity investment is adjusted downward to reflect these declines in value. Impairment loss relating to investment in an equity investeeon investments of RMB41.7RMB2.8 million, nilRMB9.1 million and nilRMB9.2 million (US$1.3 million) was recognized in 2013, 20142016, 2017 and 2015,2018, respectively.
Impairment on Long-lived Assets and Allowance on Long-term Receivable
We review long-lived assets and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. We assess the recoverability of long-lived assets and intangible assets (other than goodwill) by comparing the carrying amount to the estimated future undiscounted cash flow associated with the related assets. We recognize impairment of long-lived assets and intangible assets in the event that the net book value of such assets exceeds the estimated future undiscounted cash flow attributable to such assets. We use estimates and judgment in our impairment tests, and if different estimates or judgments had been utilized, the timing or the amount of the impairment charges could be different. Impairment charges relating to equipmentintangible assets and other assets amounting to RMB1.9RMB68.0 million, nil and nil were recognized in 2013, 20142016, 2017 and 2015,2018, respectively. Impairment charges relating to intangible assets and other assets amounting to RMB3.8 million, RMB3.6 million and RMB8.4 million (US$1.3 million) were recognized in 2013, 2014 and 2015, respectively. Impairment charges relating to other long-lived assets amounting to RMB11.8 million, nil and nil were recognized in 2013, 2014 and 2015, respectively. We determine the allowances on long-term receivables when facts and circumstances indicate that the long-term receivable is unlikely to be collected. When the collectability of the long-term receivable became likely subsequently, we reverse the allowance. We provided allowance on long-term receivables amounting to RMB17.9 million in 2013 while in 2014 we reversed the allowance on long-term receivables amounting to RMB17.9 million.
| 55 |
Refund of WoW Game Points
As a result of non-renewal of WoW license on June 7, 2009, we announced a refund plan in connection with unactivatedinactivated WoW game point cards. According to the plan, unactivatedinactivated WoW game point card holders are eligible to receive a cash refund from us. We recorded a liability in connection with both unactivatedinactivated points cards and activated but unconsumed point cards of approximately RMB200.4 million, of which RMB4.0 million was refunded in 2009. Upon the loss of the WoW license, we concluded that the nature of the obligation substantively changed from deferred revenue, for which we had the ability to satisfy the underlying performance obligation, to an obligation to refund players for their unconsumed points. Thus, we have accounted for this refund liability by applying the relevant derecognitionde-recognition guidance when determining the proper accounting treatment. In accordance with this guidance, the refund liability associated with these WoW game points, to the extent not refunded, will be recorded as other operating income after we are legally released from the obligation to refund amounts under the applicable laws. As we announced the refund plan on September 7, 2009, the statute of limitations of the creditors (in this case the game players with claims for refund of unactivatedinactivated WoW game point cards) to assert their claims for refund is two years from such date under applicable laws and thus our legal liability relating to the unactivatedinactivated WoW game point cards was extinguished on September 7, 2011 and the associated liability amounting to RMB26.0 million was recognized as other operating income for the year ended December 31, 2011. With respect to the remaining refund liability, based on current PRC laws, to the extent not refunded, we, in consultation with legal counsel, have determined that we will be legally released from this liability in 2029, which represents 20 years from the date of discontinuation of WoW in 2009. However, if management were to publicly announce a refund policy, we would be legally released from any remaining liability for these activated, but unconsumed points, sooner than 20 years. To date, we have determined not to publicly announce any refund policy with respect to this remaining liability, and no refunds have been claimed. The remaining refund liability relating to the activated, but unconsumed WoW game points was RMB170.0 million (US$26.224.7 million) as of December 31, 2015.2018.
Convertible Notes and Beneficial Conversion Feature (“BCF”)
We have issued convertible notes and warrants in December 2015. We have evaluated whether the conversion feature of the notes is considered an embedded derivative instrument subject to bifurcation in accordance with ASC 815,Accounting for Derivative Instruments and Hedging Activities.Activities. Based on our evaluation, the conversion feature is not considered an embedded derivative instrument subject to bifurcation as conversion option does not provide the holder of the notes with means to net settle the contracts. Convertible notes, for which the embedded conversion feature does not qualify for derivative treatment, are evaluated to determine if the effective rate of conversion pursuant to the terms of the convertible note agreement is below market value. In these instances, the value of the BCF is determined as the intrinsic value of the conversion feature, which is recorded as deduction to the carrying amount of the notes and credited to additional paid-in-capital. For convertible notes issued with detachable warrants, a portion of the note’s proceeds is allocated to the warrant based on the fair value of the warrants as of the date of issuance. The allocated fair values for the warrants and BCF are both recorded in the financial statements as debt discounts from the face amount of the notes, which are then accreted to interest expense over the life of the related debt using the effective interest method.
Warrants
Warrants
We account for the detachable warrants issued in connection with convertible notes under the authoritative guidance on accounting for derivative financial instruments indexed to, and potentially settled in, a company’s own stock. We classify warrants in our consolidated balance sheet as a liability which is revalued at each balance sheet date subsequent to the initial issuance. We use the Black-Scholes pricing model to value the warrants. Determining the appropriate fair-value model and calculating the fair value of warrants requires considerable judgment. A small change in the estimates used may cause a relatively large change in the estimated valuation. The estimated volatility of our common stock at the date of issuance, and at each subsequent reporting period, is based on historic fluctuations in our stock price. The risk-free interest rate is based on U.S. government bondswith a maturity similar to the expected remaining life of the warrants at the valuation date. The expected life of the warrants is based on the historical pattern of exercises of warrants.
Redeemable Non-controllingNoncontrolling Interests
Redeemable non-controlling interests are equity interests of our consolidated subsidiary not attribute to us that have redemption features that are not solely within our control. These interests are classified as temporary equity because their redemption is considered probable. These interests are measured at the greater of estimated redemption value at the end of each reporting period or the initial carrying amount of the redeemable non-controllingnoncontrolling interests adjusted for cumulative earningearnings (loss) allocations.
| 56 |
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued an
A list of recent accounting standard update on revenue recognitionpronouncements that will be appliedare relevant to all contracts with customers. The update requires an entityus is included in note 2 to recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. It also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU No. 2015-14, deferring the effective date for ASU 2014-09 by one year, and thus, the new standard will be effective for fiscal years beginning after December 15, 2017, with early application permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The guidance allows for either a full retrospective or a modified retrospective transition method. We are currently assessing the impact that the guidance will have on our financial condition and results of operations.
In February 2015, the FASB issued ASU 2015-02 to respond to stakeholders’ concerns about the current accounting for consolidation of certain legal entities. Stakeholders expressed concerns that current generally accepted accounting principles (GAAP) might require a reporting entity to consolidate another legal entity in situations in which the reporting entity’s contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity’s voting rights, or the reporting entity is not exposed to a majority of the legal entity’s economic benefits or obligations. Financial statement users asserted that in certain of those situations in which consolidation is ultimately required, deconsolidated financial statements are necessary to better analyze the reporting entity’s economic and operational results. Previously, the FASB issued an indefinite deferral for certain entities to partially address those concerns. However, the amendments in this update rescind that deferral and address those concerns by making changes to the consolidation guidance. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. We are in the process of evaluating the impact of the standard on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03 to simplify presentation of debt issuance costs,statements, which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. We have adopted this guidance as of December 31, 2015. The adoption of this guidance did not have a material effect on our financial condition, results of operations and cash flows.
In May 2015, the FASB issued ASU 2015-07, Topic 820, and Fair Value Measurement, which permits a reporting entity, as a practical expedient, to measure the fair value of certain investments using the net asset value per share of the investment. Currently, investments valued using the practical expedient are categorized within the fair value hierarchy on the basis of whether the investment is redeemable with the investee at net asset value on the measurement date, never redeemable with the investee at net asset value, or redeemable with the investee at net asset value at a future date. For investments that are redeemable with the investee at a future date, a reporting entity must take into account the length of time until those investments become redeemable to determine the classification within the fair value hierarchy.
In November 2015, the FASB issued ASU 2015-17 to simplify the presentation of deferred income taxes, which requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendmentsincluded in this update apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this update. We have adopted this guidance during the year ended December 31, 2015 with a retroactive application. The adoption of this guidance did not have a material effect on our financial condition, results of operations and cash flows.annual report.
In January 2016, the FASB issued ASU 2016-01 to improve and to achieve convergence of their respective standards on the accounting for financial instruments and enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information. The amendments in this update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The FASB board is also addressing measurement of credit losses on financial assets in a separate project. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this guidance did not have a material effect on our financial condition, results of operations and cash flows.
In February 2016, the FASB issued ASU 2016-02 to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. We are in the process of evaluating the impact of the standard on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-06, which clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments in this update is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. For public business entities, the amendments in this update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. An entity should apply the amendments in this update on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, which eliminates the requirement to retroactively adopt the equity method of accounting. The amendments require that the equity method investor adds the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The amendments in this update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Early application is permitted. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, which simplifies several aspects of the accounting for employee share-based payment transactions for both public and non-public entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. For public entities, the ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. Early adoption will be permitted in any interim or annual period for which financial statements have not yet been issued or have not been made available for issuance. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.
Results of Operations
The following table sets forth a summary of our consolidated statements of operations for the periods indicated.
| For the Year Ended December 31, | For the Year Ended December 31, | |||||||||||||||||||||||||||||||
| 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |||||||||||||||||||||||||||
| RMB | RMB | RMB | US$(1) | RMB | RMB | RMB | US$(1) | |||||||||||||||||||||||||
Consolidated Statement of Operation Data | ||||||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||||
| Revenues(2): | ||||||||||||||||||||||||||||||||
Online game services | 95,131,347 | 55,417,700 | 40,504,363 | 6,252,797 | 48,565,620 | 71,564,023 | 16,552,080 | 2,407,255 | ||||||||||||||||||||||||
Other revenues | 11,495,630 | 9,421,865 | 6,105,523 | 942,530 | 7,719,902 | 1,644,143 | 941,335 | 136,911 | ||||||||||||||||||||||||
Sales taxes | (1,850,908 | ) | (562,674 | ) | (198,555 | ) | (30,652 | ) | (86,236 | ) | (59,610 | ) | (60,557 | ) | (8,808 | ) | ||||||||||||||||
|
|
|
| |||||||||||||||||||||||||||||
Net revenues | 104,776,069 | 64,276,891 | 46,411,331 | 7,164,675 | 56,199,286 | 73,148,556 | 17,431,858 | 2,535,358 | ||||||||||||||||||||||||
Cost of revenue | (107,803,360 | ) | (85,782,569 | ) | (67,743,995 | ) | (10,457,871 | ) | (48,518,779 | ) | (23,782,054 | ) | (16,435,590 | ) | (2,390,457 | ) | ||||||||||||||||
|
|
|
| |||||||||||||||||||||||||||||
Gross profit (loss) | (3,027,291 | ) | (21,505,678 | ) | (21,332,664 | ) | (3,293,196 | ) | ||||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||||||||||
| Gross profit | 7,680,507 | 49,366,502 | 996,268 | 144,901 | ||||||||||||||||||||||||||||
| Operating (expenses)/income: | ||||||||||||||||||||||||||||||||
| Product development | (77,991,408 | ) | (45,112,396 | ) | (24,555,308 | ) | (3,571,421 | ) | ||||||||||||||||||||||||
| Sales and marketing | (21,286,647 | ) | (9,089,969 | ) | (2,325,818 | ) | (338,276 | ) | ||||||||||||||||||||||||
| General and administrative | (129,047,846 | ) | (108,824,680 | ) | (89,853,331 | ) | (13,029,355 | ) | ||||||||||||||||||||||||
| Impairment on intangible assets | (68,003,805 | ) | — | — | — | |||||||||||||||||||||||||||
| Impairment loss on goodwill | (10,561,857 | ) | — | — | — | |||||||||||||||||||||||||||
| Gain on disposal of subsidiaries | — | — | 10,473,159 | 1,523,258 | ||||||||||||||||||||||||||||
| Total operating expenses | (306,891,563 | ) | (163,027,045 | ) | (105,991,298 | ) | (15,415,794 | ) | ||||||||||||||||||||||||
| Other operating income | 3,604,749 | 349,954 | 229,538 | 33,385 | ||||||||||||||||||||||||||||
| Loss from operations | (295,606,307 | ) | (113,310,589 | ) | (104,765,492 | ) | (15,237,508 | ) | ||||||||||||||||||||||||
| Impairment on equity investment and available-for-sale investment | (244,798,058 | ) | — | (1,386,174 | ) | (201,611 | ) | |||||||||||||||||||||||||
| Impairment on other investments | (2,806,439 | ) | (9,109,312 | ) | (7,776,157 | ) | (1,130,995 | ) | ||||||||||||||||||||||||
| Interest income | 161,144 | 30,525 | 193,928 | 28,206 | ||||||||||||||||||||||||||||
| Interest expenses | (56,471,609 | ) | (83,922,200 | ) | (104,776,674 | ) | (15,239,135 | ) | ||||||||||||||||||||||||
| Fair value change on warrants | 48,057,204 | 12,615,466 | 2,251,427 | 327,456 | ||||||||||||||||||||||||||||
| (Loss)/gain on disposal of equity investee and available-for-sale investment | (1,217,405 | ) | 115,349 | — | — | |||||||||||||||||||||||||||
| Foreign exchange (loss)/gain | (13,131,779 | ) | 19,206,747 | (20,331,430 | ) | (2,957,084 | ) | |||||||||||||||||||||||||
| Other income, net | 3,179,508 | 4,669,587 | 1,598,663 | 232,516 | ||||||||||||||||||||||||||||
| Loss before income tax expense and share of loss in equity method investments | (562,633,741 | ) | (169,704,427 | ) | (234,991,909 | ) | (34,178,155 | ) | ||||||||||||||||||||||||
| Income tax benefit | 6,079,282 | — | — | — | ||||||||||||||||||||||||||||
| Recovery of equity investment in excess of cost | — | 60,548,651 | — | — | ||||||||||||||||||||||||||||
| Share of loss in equity investments | (110,535,486 | ) | (2,937,131 | ) | (4,292,887 | ) | (624,375 | ) | ||||||||||||||||||||||||
| Net loss | (667,089,945 | ) | (112,092,907 | ) | (239,284,796 | ) | (34,802,530 | ) | ||||||||||||||||||||||||
| Net (loss)/gain attributable to noncontrolling interest | (58,584,204 | ) | 3,955,640 | (16,332,968 | ) | (2,375,532 | ) | |||||||||||||||||||||||||
| Net (loss)/gain attributable to redeemable noncontrolling interest | (14,724,152 | ) | 2,117,303 | (5,858,902 | ) | (852,142 | ) | |||||||||||||||||||||||||
| Net loss attributable to The9 Limited | (593,781,589 | ) | (118,165,850 | ) | (217,092,926 | ) | (31,574,856 | ) | ||||||||||||||||||||||||
| Accretion on redeemable noncontrolling interest | (82,890,188 | ) | (57,126,233 | ) | (40,918,773 | ) | (5,951,389 | ) | ||||||||||||||||||||||||
| Net loss attributable to holders of ordinary shares | (676,671,777 | ) | (175,292,083 | ) | (258,011,699 | ) | (37,526,245 | ) | ||||||||||||||||||||||||
| For the Year Ended December 31, | ||||||||||||||||
| 2013 | 2014 | 2015 | ||||||||||||||
| RMB | RMB | RMB | US$(1) | |||||||||||||
Operating expenses: | ||||||||||||||||
Product development | (213,243,567 | ) | (156,253,036 | ) | (135,042,829 | ) | (20,847,020 | ) | ||||||||
Sales and marketing | (116,672,411 | ) | (51,758,100 | ) | (31,692,522 | ) | (4,892,482 | ) | ||||||||
General and administrative | (161,958,423 | ) | (111,157,250 | ) | (131,768,503 | ) | (20,341,552 | ) | ||||||||
(Provision) reversal of provision for allowance for long-term receivable and prepayment | (29,741,076 | ) | 14,371,918 | (8,439,580 | ) | (1,302,847 | ) | |||||||||
Impairment of long-lived assets | (5,725,046 | ) | — | — | — | |||||||||||
Gain on disposal of subsidiaries | — | 165,392,382 | 3,339,394 | 515,514 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total operating expenses | (527,340,523 | ) | (139,404,086 | ) | (303,604,040 | ) | (46,868,387 | ) | ||||||||
Other operating income (expenses) | 120,000 | 75,000 | (1,563,518 | ) | (241,366 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Loss from operations | (530,247,814 | ) | (160,834,764 | ) | (326,500,222 | ) | (50,402,949 | ) | ||||||||
Impairment on investments | (47,970,885 | ) | — | — | — | |||||||||||
Interest income | 8,376,355 | 3,414,559 | 775,152 | 119,663 | ||||||||||||
Interest expenses | — | — | (6,397,192 | ) | (987,556 | ) | ||||||||||
Fair value change on convertible bonds and warrants | — | — | (7,129,161 | ) | (1,100,553 | ) | ||||||||||
Gain on disposal of equity investee and available-for-sale investment | — | 33,153,452 | — | — | ||||||||||||
Other income (expenses), net | 9,301,565 | (963,125 | ) | (1,916,755 | ) | (295,896 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Loss before income tax expense and share of loss in equity method investments | (560,540,779 | ) | (125,229,878 | ) | (341,168,178 | ) | (52,667,291 | ) | ||||||||
Share of loss in equity investments | (2,375,826 | ) | (3,712,530 | ) | (13,013,791 | ) | (2,008,983 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net loss | (562,916,605 | ) | (128,942,408 | ) | (354,181,969 | ) | (54,676,274 | ) | ||||||||
Net loss attributable to noncontrolling interest | (36,655,033 | ) | (21,443,321 | ) | (16,655,902 | ) | (2,571,228 | ) | ||||||||
Net loss attributable to redeemable noncontrolling interest | — | (20,876,617 | ) | (32,697,713 | ) | (5,047,657 | ) | |||||||||
Net loss attributable to The9 Limited | (526,261,572 | ) | (86,622,470 | ) | (304,828,354 | ) | (47,057,389 | ) | ||||||||
Accretion on redeemable noncontrolling interest | — | 21,076,744 | 79,805,706 | 12,319,878 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net loss attributable to holders of ordinary shares | (526,261,572 | ) | (107,699,214 | ) | (384,634,060 | ) | (59,377,267 | ) | ||||||||
Notes:
| (1) | Translation from |
| (2) | Effective from January 1, 2018, we adopted ASC topic 606, a new accounting standard on the recognition of revenue, and have applied such accounting standards to the year ended December 31, 2018. The financial data for the year ended December 31, 2016 and 2017 have not been recast and as such are not comparable with the financial data for the year ended December 31, 2018. The adoption of ASC topic 606 did not have material impact on our financial results. |
| 57 |
Year 20152018 Compared to Year 20142017
Revenues. Our revenues decreased by 28.1%76.1%, from RMB64.8RMB73.2 million in 20142017 to RMB46.6RMB17.5 million (US$7.22.5 million) in 2015,2018, primarily due to a decreasethe decreases in (i) Firefall license revenue from our online game services.System Link by RMB37.9 million (US$5.5 million) as Firefall ceased operations and all revenue had been recognized in 2017, (ii) IPTV revenue by RMB5.3 million (US$0.8 million) in 2018 as we started to record revenues net of amounts we paid to third-party operators of IPTV games since August 1, 2018, and (iii) revenue from Song of Knight by RMB1.3 million (US$0.2 million) as Song of Knight ceased operations in 2018.
Online Game Services. Our revenues from our online game services decreased by 26.9%76.8%, from RMB55.4RMB71.6 million in 20142017 to RMB40.5RMB16.6 million (US$6.32.4 million) in 2015.2018. The decrease was primarily attributable to the decreases in (i) Firefall license revenue from System Link by RMB37.9 million (US$5.5 million) as Firefall ceased operations and all revenue had been recognized in 2017, (ii) IPTV revenue by RMB5.3 million (US$0.8 million) in 2018 as described below, and (iii) revenue generated from Song of Knight by RMB1.3 million (US$0.2 million) as Song of Knight ceased operations in 2018.
Our revenues from TV games decreased by 30.8% from RMB17.2 million in 2017 to RMB11.9 million (US$1.7 million) in 2018. The decrease was partly attributable to the change of the revenue recognition policy of the revenue from TV games. Previously, we recorded our IPTV revenue on a gross basis. As we became an agent in the operation of IPTV games since August 1, 2018, we started to record revenues net of amounts we paid to third-party operators, and such amount of fees were no longer included in our cost of revenue. As a result, we did not record any revenues from TV games after August 1, 2018.
Other Revenues. Revenues generated from other products and services decreased from RMB1.6 million in 2017 to RMB0.9 million (US$0.1 million) in 2018, primarily due to a decrease in revenue generated by our education business conducted by The9 Education as we disposed The9 Education in January 2018.
Cost of Revenue. Cost of revenue decreased by 31.1% from RMB23.8 million in 2017 to RMB16.4 million (US$2.4 million) in 2018, primarily due to (i) the decrease in payroll as a result of the optimization of our organizational structure in 2018, and (ii) the change of revenue recognition policy of IPTV revenues.
Operating Expenses. Operating expenses decreased by 35.0% from RMB163.0 million in 2017 to RMB106.0 million (US$15.4 million) in 2018.
Product Development Expenses. Product development expenses decreased by 45.5% from RMB45.1 million in 2017 to RMB24.6 million (US$3.6 million) in 2018. The decrease was primarily due to a decrease in revenuessalaries for the product development personnel as the headcount of product development personnel decreased.
Sales and Marketing Expenses. Sales and marketing expenses decreased by 74.6% from PC online games which decreased from RMB33.4RMB9.1 million in 20142017 to RMB16.1RMB2.3 million (US$2.50.3 million) in 2015. Such2018. The decrease in sales and marketing expenses was primarily due to a decrease in the salaries for the sales and marketing personnel and a decrease of marketing expenses.
General and Administrative Expenses. General and administrative expenses decreased by 17.6% from RMB108.8 million in 2017 to RMB89.6 million (US$13.0 million) in 2018. The decrease was primarily due to a decrease in payroll-related expenses as a result of our cost control measures and a decrease in share-based compensation expenses.
Gain on Disposal of Subsidiaries.We recorded gain on disposal of subsidiaries of RMB10.5 million (US$1.5 million) in 2018. The increase is mainly due to a gain from disposal of The9 Education completed in January 2018.
| 58 |
Other Operating Income. We had an other operating income of RMB0.2 million (US$0.03 million) in 2018, including primarily office rental income. We had an other operating income of RMB0.3 million in 2017, including primarily office rental income.
Impairment on Other Investment. We recorded an impairment of other investment amounting of RMB7.8 million (US$1.1 million) in 2018, primarily due to the decrease in the market value of our investments in Shanghai Ronglei, Plutux, Smartposting and Beijing Ti Knight. We recorded an impairment of other investment amounting to RMB9.1 million in 2017, primarily due to the decrease in the market value of our investment in Smartposting and Beijing Ti Knight.
Interest Income. Interest income increased from RMB0.03 million in 2017 to RMB0.2 million (US$0.03 million) in 2018.
Interest Expenses. Interest expenses increased from RMB83.9 million in 2017 to RMB104.8 million (US$15.2 million) in 2018, primarily due to the increase in accrued interest expenses on the Convertible Notes. The interest expenses of the Convertible Notes were calculated by using effective interest rate method.
Fair Value of Change on Warrants. We had a fair value of change on convertible bonds and warrants of RMB2.3 million (US$0.3 million) in 2018, primarily due to a decrease in our share price as of December 31, 2018 compared to December 31, 2017.
Gain (loss) on disposal of equity investee and available-for-sale investment. We had no gain or loss on disposal of equity investee and available-for-sale investment in 2018. We recorded a gain on disposal of equity investee and available-for-sale investment of RMB0.1 million in 2017 in connection with the disposal our partial shareholding in L&A.
Foreign exchange gain (loss). We recorded foreign exchange loss of RMB20.3 million (US$3.0 million) in 2018, as compared to foreign exchange gain of RMB19.2 million in 2017, primarily due to the appreciation of U.S. dollar against Renminbi in 2018.
Other Income, Net. We recorded other net income of RMB1.6 million (US$0.2 million) in 2018, as compared to other net income of RMB4.7 million in 2017, primarily due to a decrease in government subsidies received in 2018.
Recovery of equity investment in excess of cost. We did not record any recovery of equity investment in excess of cost in 2018, while we recorded recovery of equity investment in excess of cost of RMB60.5 million in 2017, which was non-recurring in nature.
Net Loss Attributable to Holders of Ordinary Shares. Primarily as a result of the cumulative effect of (i) the decreaseabove factors, net loss attributable to our holders of our average quarterly paying userordinary shares increased from 42,620RMB175.3 million in 20142017 to 10,364RMB258.0 million (US$37.5 million) in 2015, and (ii)2018.
Year 2017 Compared to Year 2016
Revenues. Our revenues increased by 30.1%, from RMB56.3 million in 2016 to RMB73.2 million in 2017, primarily due to the increase of our average quarterly revenue per paying user from RMB254 in 2014 to RMB369 (US$56.9) in 2015.
The number of quarterly active users refers to the number of users who log into our games at least once during a quarter. The number of average quarterly active users is the average of quarterly active users for each of the four quarters during a year. Quarterly paying user refers to the number of users who purchase virtual currency at least once for our online games during a quarter. Average quarterly paying user is the average of quarterly paying users for each of the four quarters during a year. Quarterly revenue per paying user refers to our revenues from online games during a given quarter divided by the numberrecognition of the quarterly paying users. Average quarterly revenue per paying user is the average of quarterly revenues per paying users for each of the four quarters during a year.remaining unamortized Firefall licensing fees from System Link.
Online Game Services. Our revenues from TV gamesour online game services increased by 47.4%, from RMB19.2RMB48.6 million in 20142016 to RMB22.8RMB71.6 million (US$3.5 million) in 2015. This2017. The increase was primarily due to an increase in our average quarterly revenue per paying userrevenues from RMB37the recognition of remaining unamortized Firefall licensing fees from System Link of RMB33.4 million in 20142017. Such increase was partially offset by the decrease in revenues due to RMB49 (US$7.4)the cease of operations of Firefall in 2015.the United States and Europe and Song of Knights in China in July 2017.
Our revenues from TV games decreased from RMB24.0 million in 2016 to RMB17.2 million in 2017. Unlike PC online games, our TV games are operated through telecommunication carriers and we do not maintain information relating to active users pursuant to our cooperation agreements with the telecom carriers.
The average quarterly revenue per paying user of our PC online games is significantly higher than that of our TV games because the PC online game players are mostly teenagers with higher spending power while the TV game players are mostly children and elderly people with lower spending power.
| 59 |
Other Revenues. Revenues generated from other products and services decreased by 35.2%78.7% from RMB9.4RMB7.7 million in 20142016 to RMB6.1RMB1.6 million (US$0.9 million) in 2015,2017, primarily due to a decrease in revenueour revenues from ourproviding technical training to college students on mobile advertising platform. We disposed of 58% equity interest in Shanghai Jiucheng Advertising, which operates our mobile advertising platform, in October 2015. We account for Shanghai Jiucheng Advertisement as an equity investment after such disposal.application programming.
Cost of Revenue. Cost of revenue decreased by 21.0%51.0% from RMB85.8RMB48.5 million in 20142016 to RMB67.7RMB23.8 million (US$10.5 million) in 2015. The decrease was2017, primarily driven bydue to a decrease in amortization of the rental cost in connection with the Internet data centers, which is in line with revenue decrease,intangible assets following an impairment of intangible assets and a decrease in employee salary and welfares as we continued to reduce the headcountsIPTV cost in our customer service department in 2015 as part of our cost saving efforts.2017.
Operating Expenses. Operating expenses increaseddecreased by 117.8%46.9% from RMB139.4RMB306.9 million in 20142016 to RMB303.6RMB163.0 million (US$46.9 million) in 2015.2017.
Product Development Expenses. Product development expenses decreased by 13.6%42.2% from RMB156.3RMB78.0 million in 20142016 to RMB135.0RMB45.1 million (US$20.8 million) in 2015.2017. The decrease was primarily due to thea decrease ofin staff cost relating to research and development staff costa decrease in depreciation expenses of fixed assets and development outsourcing expenses due to less volumerental fees of outsourced development works.Red 5 as Red 5 ceased the operation of Firefall in 2017 and had no business operations since then.
Sales and Marketing Expenses. Sales and marketing expenses decreased by 38.8%57.3% from RMB51.8RMB21.3 million in 20142016 to RMB31.7RMB9.1 million (US$4.9 million) in 2015.2017. The decrease in sales and marketing expenses was primarily due to decreaseda decrease in expenses incurred for Firefall in North America and Europe in 2015.Firefall.
General and Administrative Expenses. General and administrative expenses increaseddecreased by 18.5%15.7% from RMB111.2RMB129.0 million in 20142016 to RMB131.8RMB108.8 million (US$20.3 million) in 2015.2017 The decrease was primary due to a decrease in payroll-related expenses under our cost control measures and a decrease in agency fees and related charges for the pledge of L&A shares.
(Provision) reversalImpairment on Intangible Assets. We had impairment charges on certain intangible assets of provision for allowance for long-term receivables and prepayments.We recorded allowance of other receivable of RMB8.4 million (US$1.3 million) in 2015. In 2014, we had allowance for long-term receivables and prepayments charges of RMB3.6RMB68.0 million and we reversed an allowancenil for the year ended December 31, 2016 and 2017, respectively.
Impairment Loss on long-term receivables of RMB17.9 million in 2014 as we reevaluated the collectability of the receivables and determined that the payments can be collected. We collected the amount in full in 2015.
Gain/loss on Disposal of SubsidiariesGoodwill. We recorded a gain on disposalimpairment of a subsidiarygoodwill of RMB3.3RMB10.6 million (US$0.5 million) in October 2015 in connection withand nil for the disposal of 58% equity interest in Shanghai Jiucheng Advertisement, which operates our mobile advertising platform. We recorded a gain on disposal of subsidiaries of RMB165.4 million in 2014 in connection with disposal of our equity interests in Huopu Cloudyear ended December 31, 2016 and Kai Yue.2017, respectively.
Other Operating (Expenses) Income(Expenses). We recorded rentalhad an operating income of RMB75,000RMB0.3 million in 2017, including primarily office rental fee. We had an operating income of RMB3.6 million in 2016, including primarily IDC rental fee and loss onoffice rental fee of RMB4.2 million, which were partially offset by the disposal of property, equipment and software of RMB1.6 million (US$0.2 million) in 2014 and 2015, respectively.
Interest IncomeImpairment on Available-for-sale Investment. We had interest incomedid not record impairment on available-for-sale investments in 2017. We recorded an impairment on available-for-sale investment of RMB0.8 million (US$0.1 million) in 2015, compared to net interest income of RMB3.4RMB244.8 million in 2014,2016, primarily due to a decrease in the share price of L&A, which we classify as available-for-sale investment.
Impairment on Other Investment. We recorded an impairment of other investment amounting to RMB9.1 million in 2017, primarily due to the decrease in the market value of our investment in Smartposting and Beijing Ti Knight. We recognized the impairment of RMB5.1 million and RMB4.0 million for Smartposting and Beijing Ti Knight, respectively, in 2017. We recorded an impairment of other investment amounting of RMB2.8 million in 2016, primarily due to a decrease in the market value of our investment in Tandem Fund II, L.P., or the Tandem Fund.
Interest Income. Interest income decreased from RMB0.2 million in 2016 to RMB0.03 million in 2017, primarily due to a decrease in our bank cash balancedeposits during the year of 2015.2017.
Interest Expenses. We had interestInterest expenses of RMB6.4increased from RMB56.5 million (US$1.0 million) in 2015, compared2016 to nilRMB83.9 million in 2014,2017, primarily due to the accrual ofincrease in accrued interest expenses of RMB5.9 million (US$0.9 million) in connection withon the Convertible Notes issued in December 2015 and RMB0.5 million (US$0.08 million) in connection with loans in 2015.Notes.
Fair Value of Change on Convertible Bonds and Warrants. We had a fair value of change on convertible bonds and warrants of RMB7.1RMB12.6 million (US$1.1 million) in 20152017, primarily due to a decrease in our share price as of December 31, 20152017 compared to the issuance date of the Convertible Notes and the Warrants.December 31, 2016.
Other Income (Expenses), Net. Other expenses were RMB1.9 million (US$0.3 million) in 2015, which mainly reflected exchange loss. Other expenses were RMB1.0 million in 2014, which mainly reflected exchange loss, partially offset by the government subsidy we received.
| 60 |
Gain (loss) on Disposaldisposal of Equity Investeeequity investee and Available-for-Sale Investmentavailable-for-sale investment. We have disposed partial shareholding in L&A and recorded a gain on disposal of equity investee and available-for-sale investment of RMB33.2RMB0.1 million in 20142017. We recorded a loss on disposal of equity investee and available for sale investment of RMB1.2 million in November 2016 in connection with the disposal of Beijing Linkage, Tandem Fund II, L.P.all of our equity interest in Crowdstar Inc., our equity investee, to a third-party investor.
Foreign exchange gain (loss). We recorded foreign exchange gain of RMB19.2 million in 2017, as compared to foreign exchange loss of RMB13.1 million in 2016, primarily due to the depreciation of U.S. dollars against Renminbi in 2017.
Other Income (Expenses), Net. We recorded other net income of RMB4.7 million in 2017, as compared to other net expenses of RMB3.2 million in 2016, primarily due to the government subsidies received in 2017.
Recovery of equity investment in excess of cost. We recorded recovery of equity investment in excess of cost of RMB60.5 million in 2017, primarily related to the settlement payment of US$25.0 million received due to the termination of the CrossFire 2 license agreement related to and the joint venture agreement entered into by and between Oriental Shiny and Smilegate. Oriental Shiny and Smilegate agreed to terminate the CrossFire 2 license agreement in October 2017, and a settlement agreement was entered into by and among Qihoo 360, Smilegate and us. Pursuant to the settlement agreement, the joint venture agreement between Oriental Shiny and Smilegate would be terminated subsequent to the settlement payments of an aggregate amount of US$50.0 million by Smilegate. Smilegate later made settlement payments of US$25.0 million to Qihoo 360 and us, respectively. During 2017, we offset our share of losses in System Link for 2017 against the compensation of US$25.0 million from Smilegate and reduced our investment in System Link to nil. The remaining portion of the compensation, i.e. RMB60.5 million, was recorded as a gain as we have no further funding obligation to System Link or Tandem Fund, and Youjia Group Limited, or Youjia. We did not have any such gain or loss in 2015.Oriental Shiny.
Net Loss Attributable to Holders of Ordinary Shares. AsPrimarily as a result of the cumulative effect of the above factors, net loss attributable to our holders of ordinary shares was RMB384.6 million (US$59.4 million) in 2015, compared to the net loss of RMB107.7decreased from RMB676.7 million in 2014.
Year 2014 Compared2016 to Year 2013
Revenues. Our revenues decreased by 39.2%, from RMB106.6RMB175.3 million in 2013 to RMB64.8 million in 2014, primarily due to a decrease in revenue from our online game services.
Online Game Services. Our revenues from our online game services decreased by 41.7%, from RMB95.1 million in 2013 to RMB55.4 million in 2014. The decrease was primarily due to a decrease in revenues from PC online games, including web games Winning Goal and Winning Dunk, and MMO games Planetside 2 and SUN, which decreased from RMB67.1 million in 2013 to RMB33.5 million in 2014. Such decrease was primarily due to the net effect of (i) the increase of our average quarterly revenue per paying user from RMB228 in 2013 to RMB254 in 2014, and (ii) the decrease in average quarterly paying users which was in line with the decrease in average quarterly active users from 2,095,890 in 2013 to 983,805 in 2014.
The number of quarterly active users refers to the number of users who log into our games at least once during a quarter. The number of average quarterly active users is the average of quarterly active users for each of the four quarters during a year. Quarterly paying user refers to the number of users who purchase virtual currency at least once for our online games during a quarter. Average quarterly paying user is the average of quarterly paying users for each of the four quarters during a year. Quarterly revenue per paying user refers to our revenues from online games during a given quarter divided by the number of the quarterly paying users. Average quarterly revenue per paying user is the average of quarterly revenues per paying users for each of the four quarters during a year.
Our revenues from TV games decreased from RMB21.6 million in 2013 to RMB19.2 million in 2014. This decrease was primarily due to a decrease in the number of average quarterly paying users from 211,880 in 2013 to 132,116 in 2014, partially offset by an increase in our average quarterly revenue per paying user from RMB25 in 2013 to RMB37. Unlike PC online games, our TV games are operated through telecommunication carriers and we do not maintain information relating to active users pursuant to our cooperation agreements with the telecom carriers.
The average quarterly revenue per paying user of our PC online games is significantly higher than that of our TV games because the PC online game players are mostly teenagers with higher spending power while the TV game players are mostly children and elderly people with lower spending power.
Other Revenues. Revenues generated from other products and services decreased by 18.0% from RMB11.5 million in 2013 to RMB9.4 million in 2014. The decrease is mainly due to a decrease in revenue from our mobile advertising platform caused by intense market competition.
Cost of Revenue. Cost of revenue decreased by 20.4% from RMB107.8 million in 2013 to RMB85.8 million in 2014. The decrease was primarily driven by a decrease of the rental cost in connection with the Internet data centers, which is in line with revenue decrease, and a decrease in employee salary and welfares as we continued to reduce the headcounts in our customer service department in 2014 as part of our cost saving efforts. In addition, while we recorded impairment cost of royalty fee for Planetside 2 due to the lower-than-expected revenue generated in 2013.
Operating Expenses. Operating expenses decreased by 73.6% from RMB527.3 million in 2013 to RMB139.4 million in 2014.
Product Development Expenses. Product development expenses decreased by 26.7% from RMB213.2 million in 2013 to RMB156.3 million in 2014. The decrease was primarily due to the decrease of research and development staff cost and development outsourcing expenses due to less volume of outsourced development works.
Sales and Marketing Expenses. Sales and marketing expenses decreased by 55.6% from RMB116.7 million in 2013 to RMB51.8 million in 2014. The decrease in sales and marketing expenses primarily reflected less expenses incurred for launching Firefall in North America and Europe in 2014 compared to those incurred for launching Planetside 2 in 2013.
General and Administrative Expenses. General and administrative expenses decreased by 31.4% from RMB162.0 million in 2013 to RMB111.2 million in 2014, primarily due to a decrease in share based compensation and professional services fees.
Impairment on Long-lived Assets.Impairment charges relate to the impairment on certain equipment and intangible assets amounting to RMB5.7 million and nil for the years ended December 31, 2013 and 2014, respectively.
(Provision) reversal of provision for allowance for long-term receivables and prepayments. We recorded allowance for long-term receivables and prepayments amounting to RMB29.7 million in 2013. In 2014, we had allowance for long-term receivables and prepayments charges of RMB3.6 million, and we reversed an allowance on long-term receivables of RMB17.9 million in 2014 as we reevaluated the collectability of the receivables and determined that the payments can be collected. We collected the amount in full in 2015.
Gain on Disposal of Subsidiaries. We recorded a gain on disposal of subsidiaries of RMB165.4 million in 2014 in connection with the disposal of our equity interests in Huopu Cloud and Kai Yue. We did not record any gain on disposal of subsidiaries in 2013.
Other Operating Income. We recorded rental income of RMB120,000 and RMB75,000 in 2013 and 2014, respectively, as other operating income.
Impairment on Available-for-Sale Investment. In 2014, we did not incur any impairment loss on available-for-sale investment. We had RMB6.3 million of impairment loss on available-for-sale investment in 2013.
Investment Income from Cost Method Investment. Our investment income from cost method investment was RMB1.1 million in 2014. We did not have investment income from cost method investment in 2013.
Interest Income, Net. Net interest income decreased by 59.2% from RMB8.4 million in 2013 to RMB3.4 million in 2014, mainly due to the decrease in cash balance during the first half year of 2014.
Other Income (Expenses), Net. Other expenses were RMB1.0 million in 2014, which mainly reflected exchange loss, partially offset by the government subsidy we received. Other income was RMB9.3 million in 2013, which mainly reflected a refund of game license fee, exchange gains and a government subsidy.
Gain on Disposal of Equity Investee and Available-for-Sale Investment. We recorded a gain on disposal of equity investee and available-for-sale investment of RMB33.2 million in 2014 in connection with the disposal of Beijing Linkage, Tandem Fund and Youjia. We did not record any gain on investment disposal in 2013.
Impairment Loss on Investments. In 2014, we did not incur any impairment loss on investment. We had RMB41.7 million of impairment loss on investment in 2013 in connection with our investments in several early-stage mobile game and application development companies in the United States and China.
Net Loss Attributable to Holders of Ordinary Shares. As a result of the cumulative effect of the above factors, net loss attributable to our holders of ordinary shares was RMB107.7 million in 2014, compared to the net loss of RMB526.3 million in 2013.2017.
| B. | Liquidity and Capital Resources |
We are a holding company and conduct our operations primarily through our subsidiaries and affiliated PRC entities in China. As a result, our cash requirements and our ability to pay dividends principally depend upon dividends and other distributions from our subsidiaries, which in turn are derived principally from earnings generated by our affiliated PRC entities. Specifically, The9 Computer, (oneone of our subsidiaries in China)China, obtains funds from the PRC entities in the form of payments under the exclusive technical service agreements, pursuant to which The9 Computer is entitled to determine the amount of payment.
We acknowledge that the PRC government imposes controls on the convertibility of the RMB into foreign currencies, and in certain cases, the remittance of currency out of China. However, under existing PRC foreign exchange regulations, payments of current account items, including profit distributions and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior approval from SAFE, by complying with certain procedural requirements. Therefore, we are able to pay dividends in foreign currencies without prior approval from SAFE.SAFE or designated banks. Approval from or registration with appropriate government authorities and authorized banks is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies.
Furthermore, if our subsidiaries or any newly formed subsidiaries incur debt on their own behalf, the agreements governing their debt may restrict their ability to pay dividends to us. See “Item 3. Key Information —D.Information—D. Risk Factors—Risks Related to Doing Business in China—Restrictions on currency exchange in China limit our ability to utilize our revenues effectively, make dividend payments and meet our foreign currency denominated obligations.”
Current PRC regulations restrict our affiliated entities and subsidiaries from paying dividends in the following two principal aspects: (i) our affiliated entities and subsidiaries in China are only permitted to pay dividends out of their respective accumulated profits, if any, determined in accordance with PRC accounting standards and regulations; and (ii) these entities are required to allocate at least 10% of their respective accumulated profits each year, if any, to fund certain capital reserves until the cumulative total of the allocated reserves reaches 50% of registered capital, and a portion of their respective after-tax profits to their staff welfare and bonus reserve funds as determined by their respective boards of directors. Although the statutory reserves can be used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective companies, companies may not distribute the reserve funds as cash dividends except upon a liquidation of these subsidiaries. In addition, dividend payments from our PRC subsidiaries could be delayed as we may only distribute such dividends upon completion of annual statutory audits of the subsidiaries. As of December 31, 2015,2018, such restricted portion was RMB23.3RMB8.2 million (US$3.61.2 million). We have not directed our PRC subsidiaries or affiliated entities to distribute any dividends to-date.
| 61 |
The aggregate net assets as of December 31, 2013, 20142016, 2017 and 2015,2018, as reflected on our statutory accounts, including registered capital and statutory reserves, waswere approximately RMB67.0RMB76.1 million, RMB52.0 million and RMB75.6RMB42.4 million and RMB97.9 million (US$15.16.2 million) lowerhigher than the amountamounts determined under U.S. GAAP, respectively.
Cash Flows and Working Capital
We financedfund our operations primarily through our available cash in hand as well as cash generated from our operating, financing and investing activities. As of December 31, 2013, 20142016, 2017 and 2015,2018, we had RMB157.0RMB38.9 million, RMB181.5RMB142.6 million and RMB49.0RMB4.3 million (US$7.60.6 million), respectively, in cash and cash equivalents. The decrease in the cash and cash equivalents from 20142017 to 20152018 was primarily due to the cash outflows to finance capital investment in a joint venture andfrom operating activities forassociated with our product development and sales and marketing offset by net proceeds from the issuance and sale of the Convertible Notes to Splendid Days and the entrusted loan provided by a third party in December 2015.efforts for our new games. The increase in the cash and cash equivalents from 20132016 to 20142017 was primarily due to the net effectbecause we received US$25.0 million settlement payment from one of cash consideration received from the disposal of Huopu Cloud and the proceeds from the investment made by Shanghai Oriental Pearl Culture Development Co., Ltd.our investees in Red 5 offset by the net cash outflow from operating activities for product development and sales and marketing.2017.
We have an accumulated deficit of approximately RMB2,304RMB3,233.1 million (US$355.7470.2 million) and total current liabilities exceeded total assets by approximately RMB743.7 million (US$108.2 million) as of December 31, 2015,2018. We also had a net loss of approximately RMB354.2RMB239.3 million (US$54.734.8 million) for the year ended December 31, 2015,2018, and have not generated significant revenues or positive cash flows from operations since 2009. We expect to continue to incur product development and sales and marketing expenses for licensed and proprietary new games in order to achieve revenue growth. To meet our capital needs, we have engaged and are considering multiple alternatives, including but not limited to additional equity financings, debt financings, other financing transactions, launch new games and cost control, which areas discussed below.
Sales of Equity Interest of Red 5
In March 2016, we entered into a non-binding memorandum of understanding, or MOU, with L&A International Holding Limited, or L&A, a Cayman Islands company with shares publicly listed on the Growth Enterprise Market of the Hong Kong Stock Exchange, We may continue to incur losses, negative cash flows from operating activities and certain other shareholders of Red 5. Pursuant to the MOU, we have agreed to exchange approximately 30.6% equity interest that we own in Red 5 for such number of newly issued shares of L&A which has the same value as the exchanged Red 5 equity interest. The other participating shareholders of Red 5 will exchange an aggregate of approximately 14.4% equity interest in Red 5 based on the same terms. The total valuation for the 45% equity interest in Red 5 subject to this exchange is expected to be approximately US$76.5 million, subject to adjustments by no more than 15% based on the results of due diligence exercises to be conducted by both parties. The completion of the transaction is subject to the parties’ execution of definitive agreements and customary closing conditions to be stipulated therein. If the transaction is completed in accordance with valuation of the MOU, we expect to receive ordinary shares of L&A with a valuation ranging from US$44 million to US$60 million. We expect these shares to be publicly traded and can be traded with any restrictionnet current liabilities in the public market in Hong Kong. As a result, we believe that the completion of this transaction can provide a source of funding for our operations.
Additional External Debt Financing
In March 2016, the Bank of Shanghai, or BOS, issued a commitment letter whereby BOS agreed to grant us a one-year credit facility of RMB50 million (US$7.7 million). We can apply to withdraw loans from the facility if we require liquidity for our operations. As of March 31, 2016, we had withdrawn RMB4.9 million (US$0.8 million) from this credit facility.
Launch of New Games
We plan to have a large-scale commercial launch of Firefall in China in the second half of 2016. In addition, we plan to launch our proprietary mobile game Song of Knights in 2016. As of the date of this annual report, we have licensed Song of Knights to different game operators for distribution in Korea, Vietnam, Taiwan, Malaysia, Hong Kong, Singapore and Macau.
Cost Control
We do not have significant short-term loans or liabilities to third parties. Currently a significant portion of our cash requirements is attributable to payroll-related costs. We have the ability to control the level of discretionary spending on payroll by reducing our headcount within a short period of time when necessary.
There can be no assurance that we will be able to successfully complete any of the foregoing transactions or conduct the cost control measures with results favorable to us, or at all.future. If we are unablenot able to obtain the necessaryreturn to profitability or raise sufficient capital to cover our capital needs, we will need to license or sell our assets, seek to be acquired by another entity and/or cease operations.may not continue as a going concern. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry—We may continue to incur losses, negative cash flows from operating activities and net current liabilities in the future. If we are not able to return to profitability or raise sufficient capital to cover our capital needs, we may not continue as a going concern.”
Launch of New Games
We have launched and plan to launch our proprietary mobile online games, including the CrossFire New Mobile Game, Audition, Q Jiang San Guo and Pop Fashion. In November 2017, we entered into an exclusive publishing agreement with a third-party company, pursuant to which this third-party company was granted an exclusive right to publish the CrossFire New Mobile Game and Audition in China. We have invested significant financial and personnel resources in development of our proprietary CrossFire New Mobile Game and we expect to launch this game in 2019.
Issue of Tokens
In 2018, we stepped into the blockchain-related service market. We invested in several blockchain-related companies to conduct related services and development of blockchain-technology-enabled products. In January 2018, we have subscribed a total of 5,297,257 tokens at a consideration of US$2.0 million from a third-party company and the tokens are expected to be issued in 2019.
Other External Financing
We intend to obtain financial support from related parties in the future.
| 62 |
Cost Control
Currently a significant portion of our cash requirements is attributable to payroll-related costs. We have the ability to control the level of discretionary spending on payroll by reducing our headcount within a short period of time when necessary. However, there can be no assurance that we will be able to successfully conduct the cost control measures with results favorable to us, or at all.
If we are unable to obtain the necessary capital, we will need to license or sell our assets, seek to be acquired by another entity and/or cease operations. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry— We may not be able to obtain additional financing to support our business and operations, and our equity or debt financings may have an adverse effect on our business operations and share price.”
We believe that, withupon the successful implementation of the foregoing potential sources of cash flow and potential cost control measures, we may have sufficient financial resources to meet our anticipated operating cash flow requirements, to meet our obligations and to pay off liabilities as and when they fall due for the twelve12 months following the date of this annual report.
We did not have any outstanding balance of bank or other borrowings as of December 31, 2013, 2014 and 2015, except for an entrustment loan of approximately RMB31.6 million (US$4.9 million) from a third party that we obtained in December 2015. Pursuant to the relevant entrusted loan agreement dated December 11, 2015, such entrusted loan bears an interest at a rate of 12% per year, for an initial term of three years, subject to an extension for two years. The loan is secured by a mortgage over our office building in Shanghai which we currently use as our principal executive offices. As of the date of this annual report, the entire principal amount of the entrusted loan remained outstanding.In March 2016, Shanghai IT, our affiliated PRC entity, obtained a commitment letter from the Bank of Shanghai for a one-year credit facility of RMB50 million (US$7.7 million), of which we have withdrawn RMB4.9 million (US$0.8 million) as of March 31, 2016.
Pursuant to the Convertible Note and Warrant Purchase Agreement dated November 24, 2015, on December 11, 2015, we issued and sold the Convertible Notes in the aggregate principal amount of US$40,050,000 to Splendid Days Limited, or Splendid Days. We received net proceeds of US$36,850,000 from the sale of the Convertible Notes. The Convertible Notes are divided forinto three tranches in principal amounts of US$22,250,000, US$13,350,000 and US$4,450,000, respectively, which will be convertible at the option of the holder at any time into our ADSs at initial conversion prices of US$2.6,7.8, US$5.215.6 and US$7.823.4 per ADS, each representing three ordinary shares, respectively, provided that at no time shall the holder convert any portion of the Convertible Notes if subsequent to such conversion such holder will hold more than 20% of the total outstanding and issued shares of our company. The Convertibles Notes bear interest at a rate of 12% per year, payable when the principal amount of the Convertible Notes becomes due, and have initial terms of three years, subject to an extension for two years at the discretion of the holder. The initial conversion prices are subject to adjustments for share splits, reverse splits, share dividends and distributions, and certain issuances (or deemed issuances) of ordinary shares or ADSs for consideration less than the conversion price then in effect. In addition, the holder of the Convertible Notes is entitled to any extraordinary cash dividend (to the extent that it exceeds the accrued interest amount per share) and dividend in kind that we distribute based on the number of shares into which the Convertible Notes are then convertible. Following a “change of control,” as such term is defined in the Convertible Notes, the holder of the Convertible Notes will be entitled to require us to redeem all or part of the Convertible Notes, at a price payable in cash equal to 100% of the outstanding principal amount of the Convertible Notes, plus all accrued and unpaid interestsinterest thereon, if any. In addition, pursuant to the terms of the Convertible Notes, if there is a continuing event of default, the holder will be entitled to declare any of the Convertible Notes immediately due and payable, and request redemption by us at a price equal to the outstanding principal amount plus all accrued and unpaid interestsinterest thereon, if any. “Events of default” as defined in the Convertible Notes include, among other things, an event of default under any indebtedness in the amount exceeding US$500,000.
Pursuant to the same agreement, on December 11, 2015, we issued to Splendid Days four tranches of warrants in an aggregate principal amount of US$9,950,000. The Warrants are divided into four tranches in principal amounts of US$5,000,000, US$2,750,000, US$1,650,000 and US$550,000, respectively, which will be exercisable for our ADSs at the option of the holder at any time at initial exercise prices of US$1.5,4.5, US$2.6,7.8, US$5.215.6 and US$7.823.4 per ADS, each representing three ordinary shares, respectively. The initial exercise prices are subject to adjustments for share splits, reverse splits, share dividends and distributions, distribution of assets, certain issuances (or deemed issuances) of ordinary shares or ADSs for consideration less than the exercise price then in effect, as applicable for each warrant. In addition, the holder of the Warrants with initial exercise prices of US$2.6,7.8, US$5.215.6 and US$7.823.4 per ADS, each representing three ordinary shares, is entitled to any cash dividend (to the extent that it exceeds the notional interest amount attributable to such Warrants) and dividend in kind that we distribute based on the number of shares into which the Warrants are then exercisable. The tranche of Warrants with an exercise price of US$1.54.5 per ADS, each representing three ordinary shares, has a term of five years, while the remaining three tranches have initial terms of three years, subject to an extension for two years ifwhich have expired as of the holder exercises its discretion to extenddate of this annual report. We entered into a deed of settlement with Splendid Days, the termholder of the Convertible Notes.Notes, in March 2019, pursuant to which the Convertible Notes should be repaid by May 31, 2019. The Convertible Notes are secured by a pledge of our 100% equity interests in two of our wholly-owned subsidiaries in China, including The9 Computer and C9I Shanghai, and a mortgage over our office building in Shanghai which we currently use as our principal executive offices.Shanghai. We expect to repay the Convertible Notes by the proceeds from planned sale of the mortgaged properties. Pursuant to the agreement, we will registerhave registered the ordinary shares into which the Convertible Notes are convertible and the Warrants are exercisable on a registration statement on F-3, and use our best efforts to cause such registration statement to bewhich was declared effective by the SEC as promptly as possible after the initial filing.on June 17, 2016.
| 63 |
The following table sets forth the summary of our cash flows for the periods indicated:
| For the Year Ended December 31, | For the Year Ended December 31, | |||||||||||||||||||||||||||||||
| 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | |||||||||||||||||||||||||||
| RMB | RMB | RMB | US$ | RMB | RMB | RMB | US$(1) | |||||||||||||||||||||||||
| (in thousands) | (in thousands) | |||||||||||||||||||||||||||||||
Net cash used in operating activities | (357,570 | ) | (269,098 | ) | (175,587 | ) | (27,106 | ) | (179,768 | ) | (86,652 | ) | (101,201 | ) | (14,719 | ) | ||||||||||||||||
Net cash (used in)/provided by investing activities | (2,932 | ) | 197,752 | (208,996 | ) | (32,263 | ) | (9,985 | ) | 161,923 | (17,315 | ) | (2,518 | ) | ||||||||||||||||||
Net cash (used in)/provided by financing activities | (38,689 | ) | 100,222 | 257,937 | 39,818 | |||||||||||||||||||||||||||
| Net cash provided by (used in) financing activities | 190,092 | 44,073 | (18,357 | ) | (2,670 | ) | ||||||||||||||||||||||||||
Effect of foreign exchange rate changes on cash | 1,899 | (4,381 | ) | (5,826 | ) | (899 | ) | (10,472 | ) | 4,529 | (1,495 | ) | (218 | ) | ||||||||||||||||||
| Cash reclassified as held for sale | — | (20,127 | ) | — | — | |||||||||||||||||||||||||||
Net (decrease)/increase in cash and cash equivalents | (397,292 | ) | 24,495 | (132,472 | ) | (20,450 | ) | (10,133 | ) | 103,746 | (138,368 | ) | (20,125 | ) | ||||||||||||||||||
Cash and cash equivalents at beginning of year | 554,279 | 156,987 | 181,482 | 28,016 | 49,011 | 38,878 | 142,624 | 20,744 | ||||||||||||||||||||||||
Cash and cash equivalents at end of year | 156,987 | 181,482 | 49,011 | 7,566 | 38,878 | 142,624 | 4,256 | 619 | ||||||||||||||||||||||||
Operating Activities
Net cash used in operating activities was RMB175.6RMB101.2 million (US$27.114.7 million) in 2015,2018, compared to RMB269.1RMB86.7 million in 20142017 and RMB357.6RMB179.8 million in 2013.2016. The decreasesincrease of net cash used in operating activities from 2013 to 2014 and from 2014 to 2015 werein 2018 was mainly due to decreasesan increase in cash outflow associated with product development and sales and marketing expenses. In particular, theblockchain business.
The net cash used in operating activities in 20152018 primarily reflected a net loss of RMB354.2RMB239.3 million (US$54.734.8 million) in 2015,, partially offset by the adjustmentsinterest expense on Convertible Notes of RMB98.3 million (US$14.3 million), provision for share-based compensation expensedoubtful other receivables of RMB34.0RMB21.0 million (US$5.23.1 million), changes in due to related partyimpairment on equity and other investment of RMB61.5RMB9.2 million (US$9.5 million) primarily due to the receipt of the initial license fee of Firefall in China, amortization of intangible assets of RMB19.1 million (US$2.91.3 million), depreciation and amortization of property, equipment and software and land use right of RMB11.6RMB5.6 million (US$1.80.8 million) and allowanceadjustments for share-based compensation expense of receivables of RMB8.4RMB3.9 million (US$1.30.6 million).
The net cash used in operating activities in 20142017 primarily reflected a net loss of RMB128.9 million in 2014 and the gain on disposal of subsidiary of RMB165.4RMB112.1 million, partially offset by the interest expense on convertible note of RMB77.0 million, recovery of equity investment in excess of cost of RMB60.5 million, adjustments for share-based compensation expense of RMB38.0 million, consulting fee paid by equity of RMB13.5 million, and depreciation and amortization of property, equipment and software and land use right of RMB7.2 million.
The net cash used in operating activities in 2016 primarily reflected a net loss of RMB667.1 million, partially offset by the impairment of available-for-sales investment of RMB244.8 million, adjustments for share-based compensation expense of RMB28.1 million, impairment of intangible assets of RMB68.0 million, amortization of intangible assets of RMB28.9RMB10.2 million, and depreciation and amortization of property, equipment and software of RMB15.7 million. The net cash used in 2013 primarily reflected a net loss of RMB562.9 million, partially offset by an adjustment for impairment loss on other long-lived assets of RMB29.7 million, an adjustment for impairment loss on investments of RMB48.0 million, and an adjustment for a stock-based compensation expenses of RMB29.2RMB7.3 million.
Investing Activities
Net cash used in investing activities was RMB209.0RMB17.3 million (US$32.32.5 million) in 2015,2018, which primarily included (i) cash used for investment in System Linkadvance payment of RMB223.4US$2.0 million (US$34.5 million),to subscribe tokens of a third party, (ii) loan receivable due from ZET9purchase of RMB9.9other investments of RMB5.3 million (US$1.50.8 million), and (iii) capital expenditures including purchase of property, equipment and software of RMB10.6 million (US$1.6 million), partially offset by collection of long-term receivableproceeds from WoW game points refund agent which amounted to RMB17.9 million (US$2.8 million) and receipt of proceeds of RMB12.2 million (US$1.9 million) in connection with the disposal of our equity interest in Kai Yue.assets and liabilities held for sale of RMB2.8 million (US$0.4 million).
Net cash provided by investing activities was RMB197.8RMB161.9 million in 2014,2017, which primarily included (i) the settlement payment of US$25.0 million from our investee in 2017, (ii) purchase of investment in Ti Knight Inc. of RMB4.0 million, (iii) loan receivable due from ZTE9 of RMB4.0 million, and (iv) proceeds from disposal of subsidiaries of RMB163.7 million relating to Huopu Cloud and Kai Yue, (ii) proceeds from disposal of equity investees of RMB25.0 million and proceeds from disposal of available-for-saleother investment of RMB6.3 million, relating to Beijing Linkage,in Tandem Fund and Youjia, (iii) proceeds from refund of upfront license fees and upfront property, equipment and software purchase payment of RMB4.0 million, partially offset by the cash used for capital expenditures including purchase of property, equipment and software of RMB3.1RMB1.2 million.
| 64 |
Net cash used in investing activities was RMB2.9RMB10.0 million in 2013,2016, which primarily included (i) loan receivable due from ZTE9 of RMB2.8 million, (ii) capital expenditures including purchase of property, equipment, software and softwarelicense of RMB7.1RMB8.3 million, and cash paid to acquire equity investees and available-for-sale investments of RMB9.2 million relating to ZTE9 and Tandem Fund, partially offset by proceedsa dividend of RMB0.7 million from refund of our investmentTandem Fund.
Financing Activities
Net cash used in G10 Entertainment Corporation, a Korean online game developer and operator, of RMB7.3financing activities in 2018 was RMB18.4 million and our investments relating(US$2.7 million), primarily attributable to the salerepayment of OpenFeintRMB29.1 million (US$4.2 million) of RMB5.5 million.
Financing Activities
a loan from a related party, partially offset by a loan from a related party of RMB11.0 million (US$1.6 million). Net cash provided by financing activities in 20152017 was RMB258.0RMB44.1 million, (US$39.8 million), primarily attributable to loans of RMB73.9 million, borrowed from related parties, contributions from noncontrolling interest of RMB20.0 million, partially offset by repayments on the issuance and sale of the Convertible Notes in the aggregate principal amount of US$40,050,000 to Splendid Days in December 2015 and an entrustedbank loan of RMB31.6RMB25.5 million (US$4.9 million) provided by a third party.Bank of Shanghai. Net cash provided by financing activities in 20142016 was RMB100.2RMB190.1 million, primarily attributable to issuancea loan of redeemable noncontrolling interest relating to the investment madeRMB79.2 million borrowed from a financial services company and secured by a pledge of shares of L&A, a bank loan of RMB25.0 million provided by Bank of Shanghai Oriental Pearl Culture Development Co., Ltd. in Red 5and loans of RMB118.3 million. Net cash used in financing activities in 2013 was RMB38.7RMB60.0 million primarily attributable to cash used to repurchase our ADSs in the amount of RMB29.0 million,borrowed from related parties, partially offset by cash generatedrepayments on loans of RMB34.8 million from stock option exercisesrelated parties. We also obtained funding for the development of CrossFire New Mobile Game through fund-raising on Inner Mongolia Culture Assets and Equity Exchange of RMB57.5 million in the amount of RMB4.3 million.
As a result of non-renewal of WoW license on June 7, 2009, we announced a refund plan in connection with unactivatedinactivated WoW game point cards. According to the plan, unactivatedinactivated WoW game point card holders are eligible to receive a cash refund from us. We recorded a liability in connection with both unactivatedinactivated points cards and activated but unconsumed point cards of approximately RMB200.4 million, of which RMB4.0 million was refunded in 2009. Upon the loss of the WoW license, we concluded that the nature of the obligation substantively changed from deferred revenue, for which we had the ability to satisfy the underlying performance obligation, to an obligation to refund players for their unconsumed points. Thus, we have accounted for this refund liability by applying the relevant derecognitionde-recognition guidance when determining the proper accounting treatment. In accordance with this guidance, the refund liability associated with these WoW game points, to the extent not refunded, will be recorded as other operating income after we are legally released from the obligation to refund amounts under the applicable laws. As we announced the refund plan on September 7, 2009, the statute of limitations of the creditors (in this case the game players with claims for refund of unactivatedinactivated WoW game point cards) to assert their claims for refund is two years from such date under applicable laws and thus our legal liability relating to the unactivatedinactivated WoW game point cards was extinguished on September 7, 2011 and the associated liability amounting to RMB26.0 million was recognized as other operating income for the year ended December 31, 2011. With respect to the remaining refund liability, based on current PRC laws, to the extent not refunded, we, in consultation with legal counsel, have determined that we will be legally released from this liability in 2029, which represents 20 years from the date of discontinuation of WoW in 2009. However, if management were to publicly announce a refund policy, we would be legally released from any remaining liability for these activated, but unconsumed points, sooner than 20 years. To date, we have determined not to publicly announce any refund policy with respect to this remaining liability, and no refunds have been claimed. The remaining refund liability relating to the activated, but unconsumed WoW game points was RMB170.0 million (US$26.224.7 million) as of December 31, 2015.2018.
Capital Expenditures
We incurred capital expenditures of RMB21.6RMB8.3 million, RMB22.6RMB0.5 million and RMB30.1RMB0.5 million (US$4.7 million) in 2013, 20142016, 2017 and 2015,2018, respectively. The capital expenditures principally consisted of purchases of servers, computers and other items related to our network infrastructure and license fees.infrastructure. If we license new games or enter into strategic joint ventures or acquisitions, we may require additional funds for necessary capital expenditures.
| C. | Research and Development, Patents and Licenses, etc. |
Our research and development efforts are primarily focused on the development of our proprietary online games the localization of licensed games from foreign developers, and the maintenance of our websites. Our research and development expenses were RMB213.2RMB78.0 million, RMB156.3RMB45.1 million and RMB135.0RMB24.6 million (US$20.83.6 million) in 2013, 20142016, 2017 and 2015,2018, respectively.
| 65 |
| D. | Trend Information |
Other than
Except as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events for the period from January 1, 20152018 to December 31, 20152018 that are reasonably likely to have a material adverse effect on our net sales or revenues, results of operations, profitability, liquidity or capital resources, or that would cause the reported financial information not necessarily to be indicative of future operating results or financial conditions.
| E. | Off-Balance Sheet Arrangements |
We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third parties.third-parties. We have not entered into any off-balance sheet derivative instruments. Furthermore, we do not have any retained or contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us or engages in leasing, hedging or research and development services with us.
| F. | Tabular Disclosures of Contractual Obligations |
The following table sets forth our contractual obligations and other commitments under as of December 31, 2015:2018:
| Payments Due by Period | ||||||||||||||||||||
| Total | Less than 1 year | 1-2 years | 3-5 years | More than 5 years | ||||||||||||||||
| (RMB) | ||||||||||||||||||||
Long-term borrowings(1) | 31,624,560 | — | — | 31,624,560 | — | |||||||||||||||
Convertible notes payable(2) | 260,068,679 | — | — | 260,068,679 | — | |||||||||||||||
Interest expense on long-term borrowings and notes payable | 105,000,724 | — | — | 105,000,724 | — | |||||||||||||||
Operating lease obligations(3) | 34,281,716 | 8,389,540 | 7,159,779 | 18,732,397 | — | |||||||||||||||
| Payments Due by Period | ||||||||||||||||||||
| Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | ||||||||||||||||
| (in thousands of RMB) | ||||||||||||||||||||
| Short-term borrowings(1) | 112,461 | 112,461 | — | — | — | |||||||||||||||
| Convertible notes payable(2) | 274,871 | 274,871 | — | — | — | |||||||||||||||
| Interest expense on short-term borrowings | 118,872 | 118,872 | — | — | — | |||||||||||||||
| Total | 506,204 | 506,204 | — | — | — | |||||||||||||||
Notes:
| (1) |
| (2) | Represents the Convertible Notes in an aggregate principal amount of US$40,050,000 which bear interest at a rate of 12% per year, payable when the principal amount of the Convertible Notes becomes due. The Convertible Notes have initial terms of three years, subject to an extension to five years at the discretion of the holder. |
| G. | Safe Harbor |
This annual report on Form 20-F contains statements of a forward-looking nature. These statements are made under the “safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terminology such as “may,” “will,” “expects,” “anticipates,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are likely to”to,” “considers” or other and similar expressions. The accuracy of these statements may be impacted by a number of risks and uncertainties that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include, but are not limited to, the following:
| · | our ability to return to profitability or raise sufficient capital to cover our capital needs; |
| · | our ability to successfully launch and operate additional games in China and overseas; |
| · | our ability to develop, license or acquire additional online games that are attractive to users; |
| · | the maintenance and expansion of our relationships with game distributors and online game developers, including our existing licensors; |
| 66 |
| · | our ability to maintain and expand our relationships with joint venture partners and other business partners; |
| · | our ability to develop blockchain related service business; |
| · | uncertainties in and the timeliness of obtaining necessary governmental approvals and licenses for operating any new online game; |
| · | risks inherent in the online game business; |
| · | risks associated with our future acquisitions and investments; |
| · | our ability to compete effectively against our competitors; |
| · | risks associated with our corporate structure and the regulatory environment in China; and |
| · | other risks outlined in our filings with the SEC including this annual report on Form 20-F. |
These risks are not exhaustive. We operate in an emerging and evolving environment. New risk factors emerge from time to time and it is impossible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any specific factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
We would like to caution you not to place undue reliance on forward-looking statements and you should read these statements in conjunction with the risk factors disclosed in “Item 3. Key Information—D. Risk Factors.” We do not undertake any obligation to update forward-looking statements except as required under applicable law.
| Item 6. | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES |
| A. | Directors and Senior Management |
The following table sets forth information regarding our directors and executive officers as of the date of this annual report.
Directors and Executive Officers | Age | Position/Title | ||
| Jun Zhu |
| |||
| Director, Chairman of the Board and Chief Executive Officer | |||
Davin | Independent Director | |||
Kwok Keung Chau(1)(2) | Independent Director | |||
Ka Keung Yeung(1)(2) | Independent Director | |||
George Lai (Lai Kwok Ho) | Director and Chief Finance Officer | |||
| President | |||
| Chris Shen | 50 | Vice President |
Notes:
| (1) | Member of Audit Committee. |
| (2) | Member of Compensation Committee. |
Biographical Information
Jun Zhu is one of our co-founders. He has served as the chairman of our board of directors and chief executive officer since our inception. Prior to founding The9,our company, Mr. Zhu co-founded Flagholder New Technology Co. Ltd., an information technology company based in China, in 1997, and served as its director from 1997 to 1999. From 1993 to 1997, Mr. Zhu worked at QJ (U.S.A.) Investment, Ltd., a trading company in the United States. Mr. Zhu attended an undergraduate program at Shanghai Jiaotong University.
| 67 |
Davin AlexanderA. Mackenzie has served as our independent director since July 2005. Mr. Mackenzie is currently the General Manager of Greater China for Scape, a developer and operator of purpose-build student accommodation, and the Managing Director – Asia Pacific for the Madison Sports Group, the promoter of the Six Day series of track cycling events. Mr. Mackenzie was a consultant of Spencer Stuart Beijing Office, a renowned global executive search company. Mr. Mackenzie is also a director of MicroCred Group, a France-based investment company, Sports Beijing, a non-profit recreational youth sports organization, andfrom 2012 to 2016. Currently, he serves as a director of Mountain Hazelnut Ventures, a private agricultural company. From 2009 to 2011, Mr. Mackenzie was the Beijing representative of Brocade Capital Limited, a private equity advisory firm that he founded in 2009. From 2008 to 2009, Mr. Mackenzie was the managing director and Beijing representative of Arctic Capital Limited, a pan-Asia private equity advisory firm. Between 2000 and 2008, Mr. Mackenzie held the same positions in Peak Capital LLC, another private equity investment and advisory firm that focuses on the China market. Prior to Peak Capital, Mr. Mackenzie worked with the International Finance Corporation, a private sector arm of The World Bank Group, for seven years, including four years as the resident representative for China and Mongolia. Mr. Mackenzie has also worked at Mercer Management Consultants in Washington, D.C., and at First National Bank of Boston in Taiwan. Mr. Mackenzie received a bachelor’s degree in Government from Dartmouth College. He received a master’s degree in international studies and an MBA degree from the Wharton School of Business at the University of Pennsylvania. Mr. Mackenzie has also completed the World Bank Executive Development Program at Harvard Business School.
Kwok Keung Chau has served as our independent director since October 2015. Mr. Chau is an executive director, the chief financial officer and the company secretary of Comtec Solar Systems Group Limited a Hong Kong listed company (Stock Code: 712)(HKEx: 00712), responsible for corporate financial and general management. He currentlyCurrently, he also serves as an independent non-executive director and the chairman of the audit committee of Qingdao Port International Co., Ltd., a Hong Kong listed company (Stock Code: 6198) (HKEx: 06198) and an independent non-executive director and the chairman of the audit committee of China Xinhua Education Group Limited (HKEx: 02779). He acted as a member of supervisory board of RIB Software AG, a software company in Germany, which was listed in Frankfurt Stock Exchange, from May 2010 to June 2013. Prior to joining Comtec Solar in November 2007, Mr. Chau served in various positions at China.com Inc., a Hong Kong listed company (Stock Code: 8006) from October 2005 to October 2007, including vice president of the finance department, chief financial officer, company secretary and authorisedauthorized representative. Prior to joining China.com Inc., Mr. Chau had several yearsserved as the deputy group financial controller of experience in finance at different companiesChina South City Holdings Limited, a Hong Kong listed company (Stock Code: 1668) from August 2003 to April 2005. Before that, he served as the financial controller of Shanghai Hawei New Material and a professional firm.Technology co., Ltd. from June 2002 to August 2003. Mr. Chau has been a fellow member of the Association of Chartered Certified Accountants since June 2002, a member of the Hong Kong Institute of Certified Public Accountants since July 2005 and a Chartered Financial Analyst of the CFA Institute since September 2003. Mr. Chau received his bachelor’s degree in business administration from the Chinese University of Hong Kong in May 1998.
Ka Keung Yeung has served as our independent director since July 2005. Mr. Yeung isalso serves as the executive vice president and chief financial officerdirector of Phoenix Satellite Television HoldingsNew Media Limited or Phoenix, a listed company in Hong Kong, and is in charge of corporate finance and administration.(NYSE: FENG). He is also the company secretary and qualified accountant. Mr. Yeung joined Phoenix in March 1996 and is in charge of all of Phoenix’s internal and external financial management and arrangements and also supervises administration and personnel matters. Mr. Yeung also serves as a director of Phoenix New Media, a subsidiary of Phoenix and a company listed on the NYSE. Mr. Yeung graduated from the University of Birmingham and is qualified as a chartered accountant. Upon returning to Hong Kong, he worked at Hutchison Telecommunications and STAR in the fields of finance and business development.
George Lai has served as our chief financial officer since July 2008 and our director since January 2016. Prior to joining us, Mr. Lai worked for Deloitte Touche Tohmatsu since 2000. Mr. Lai worked in several different Deloitte offices, including Hong Kong, New York and Beijing. During his eight years at Deloitte, Mr. Lai played key roles in the audit function in a number of IPO projects in the United States and China. He also assisted public companies in the United States, Hong Kong and China with a wide range of accounting matters. Mr. Lai received his bachelor of business administration, with a focus in professional accountancy, from the Chinese University of Hong Kong. Mr. Lai holds various accounting professional qualifications, including from AICPA, FCCA and HKICPA.
Arthur Lau has served as our president since January 2018. Mr. Lau is currently the co-founder and partner of Ark Pacific Capital Management, a multi-strategy alternative asset manager focusing in Greater China, and also served as the directors of multiple portfolio companies. Prior to that, he was an investment director of Elliott Advisors, the Asian office of Elliott Associates, a global hedge fund managing over US$30 billion of assets. Before that, Mr. Lau was a technology, media and telecom investment banker at Citigroup and an investment banker at JPMorgan. Mr. Lau graduated from The London School of Economics and Political Science with a Bachelor of Laws degree and holds a Master of Economics degree from The University of Hong Kong.
| 68 |
Chris Shen has served as our vice president since January 2006. Mr. Shen joined us in August 2005 as our senior director of marketing and is in charge of our mobile social gaming platform and marketing and public relations activities. Prior to joining us, Mr. Shen served as the group account director and account director for several renowned advertising agencies in Shanghai and Taipei, mainly serving multinational companies in various industries, such as consumer goods, financial services and retail. During the past twelve years, Mr. Shen helped numerous local and international brands plan and executed various marketing initiatives. Mr. Shen received his bachelor’s degree in management science from the National Chiao Tung University in Taiwan.
| B. | Compensation |
Compensation of Directors and Executive Officers
In 2015,2018, the aggregate cash compensation paid to our executive officers was approximately RMB5.5RMB4.8 million (US$0.90.7 million). We paid a total of RMB1.2RMB1.0 million (US$0.20.1 million) in cash to our non-executive directors for their services in 2015.2018. In addition, in September 2018, we issued 30,000,000 ordinary shares in the form of restricted shares to our directors, employees and consultant in accordance with our stock option plan. Simultaneous with the new grants, options to purchase 6,200,000 ordinary shares by certain grantees were cancelled. In January 2019, we forfeited and cancelled 15,000,000 ordinary shares in aggregate in the form of restricted shares held by relevant directors, employees and consultant. Those incentive shares are subject to a six-month lock-up period and will vest in installments upon the satisfaction of certain service period conditions of the grantees. No director or executive officer is entitled to any severance benefits upon termination of his or her employment with or appointment by our company. On December 8, 2010, we granted 1,500,000 ordinary shares to Jun Zhu, our chairman and chief executive officer, which will only be vested if our company achieves certain income targets and the shares are not entitled to receive dividends until they become vested. Of such shares, 500,000 ordinary shares were vested and issued to Incsight Limited, a company wholly owned by Jun Zhu, on November 17, 2015. In May 2011, our board of directors granted 30,000 ordinary shares to each of our four non-executive directors then in office, of which 10,000 ordinary shares vest for each director on July 1 of each year from 2011 to 2013 so long as such director continues his services as of such date. An aggregate of 40,000 ordinary shares, 40,000 ordinary shares and 40,000 ordinary shares were vested in July 2011, 2012 and 2013, respectively. The fair value of the shares granted was US$6.03 per share, being the market price on the date of the grant.
Share Incentive Plan
Fifth
Eighth Amended and Restated 2004 Stock Option Plan
Our board of directors and our shareholders have adopted and approved the 2004 Stock Option Plan, as amended and restated, or the Option Plan, in 2004 in order to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentives to employees, directors and consultants and to promote the success of our business. The Option Plan was amended and restated in December 2006, November 2008, August 2010, November 2010, November 2015, August 2016, June 2017 and November 2015.December 2018. By the last amendment and restatementto the Option Plan in November 2015,December 2018, we increased the total number of ordinary shares reserved under the Option Plan from 6,449,61434,449,614 to 14,449,614.100,000,000. As of February 29, 2016,28, 2019, options to purchase 12,877,7181,050,000 ordinary shares under the Option Plan were outstanding.outstanding and 15,000,000 restricted shares were issued. In April 2013,September 2018 our board granted an aggregate amount of 30,000,000 restricted shares to our directors, officers and consultant. In exchange for such restricted shares grant, we forfeited and cancelled the stock options in the total amount of 6,200,000 shares previously granted to our directors in January 2018. In January 2019, our board of directors approved an adjustment to the exercise priceforfeited and cancel 15,000,000 out of options to purchase 2,829,94130,000,000 restricted shares previously granted from 2008 to 2011 under our Option Plan to establish a new exercise price for such share options at US$2.41 per ADS, which was the closing price of our ADSs as of April 22, 2013. In November 2015, our board of directors approved an adjustment to the exercise price of options to purchase 4,629,100 shares previously granted from 2010 to 2015 under our Option Plan to establish a new exercise price for such share options at US$1.53 per ADS, which was the closing price of our ADSs on November 9, 2015.
granted. The following table provides a summary of the options and restricted shares granted to our directors, executive officers and other individuals as a group under the Option Plan as of February 29, 201628, 2019 and that remained outstanding.
| Total Number of Ordinary Shares Underlying Options Outstanding† | Exercise Price (in US$) | Expiration date | Restricted Shares Outstanding | Total Number of Ordinary Shares Underlying Options | Exercise Price (in US$) | Expiration Date | ||||||||||||||||||||
Jun Zhu | 8,000,000 | 1.53 | June 13, 2020 – November 17, 2020 | 7,500,000 | — | — | March 4, 2021 | |||||||||||||||||||
Davin Alexander Mackenzie | 610,000 | 1.53 | April 22, 2018 – November 17, 2020 | * | — | — | — | |||||||||||||||||||
Kwok Keung Chau | 500,000 | 1.53 | November 17, 2020 | * | — | — | — | |||||||||||||||||||
Ka Keung Yeung | 610,000 | 1.53 | April 22, 2018 – November 17, 2020 | * | — | — | — | |||||||||||||||||||
George Lai | 907,900 | 1.53 | April 22, 2018 – November 17, 2020 | 1,500,000 | — | — | March 4, 2021 | |||||||||||||||||||
| Arthur Lau | — | * | 0.93 | January 24, 2023 | ||||||||||||||||||||||
Chris Shen | * | 1.53 | August 27, 2020 – November 17, 2020 | — | — | — | — | |||||||||||||||||||
All Directors and Senior Executive Officers as a Group† | 10,947,900 | 1.53 | April 22, 2018 – November 17, 2020 | |||||||||||||||||||||||
| All Directors and Senior Executive Officers as a Group | ||||||||||||||||||||||||||
| Restricted Shares | 9,900,000 | — | — | March 4, 2021 | ||||||||||||||||||||||
| Options | — | * | 0.93 | January 24, 2023 | ||||||||||||||||||||||
Other Individuals as a Group (other than those listed above) | 1,929,818 | 1.53 | June 13, 2020 – November 17, 2020 | 5,100,000 | * | 0.93 | January 24, 2023 | |||||||||||||||||||
* Less than 1% of our total issued and outstanding shares.
TerminationTypes of OptionsAwards.. Where the option agreementThe Option Plan permits the exercise orawards of options, stock purchase of the options granted for a certain period of time following the recipient’s termination of service with us, or the recipient’s disability or death, the options will terminate to the extent not exercised or purchased on the last day of the specified period or the last day of the original term of the options, whichever occurs first.rights, restricted shares and restricted share units.
Administration. Our stock option planOption Plan is administered by our board of directors or an option administrative committee designated by our board of directors and constituted to comply with applicable laws. In each case, our board of directors or the committee it designates will determine the provisions, terms and conditions of each optionaward grant, including, but not limited to, the option vesting schedule, repurchase provisions, forfeiture provisions, form of payment upon settlement of the award, payment contingencies and satisfaction of any performance criteria.
Award Agreement. Awards granted under our Option Plan are evidenced by an award agreement that contains, among other things, terms, conditions and limitations for each award, which may include the term of the award, the provisions concerning exercisability and forfeiture upon termination of employment or consulting arrangements, as determined by our board.
Eligibility.We may grant awards to our employees, directors and consultants of our company.
Vesting Schedule. Options granted under our stock option plan vest over a two to four year period following a specified vesting commencement date. In general, the options granted will vest overplan administrator determines the vesting period on a monthly basis, subjectschedule, which is specified in the relevant award agreement.
Exercise of Options.The plan administrator determines the exercise price for each award, which is stated in the award agreement. The vested portion of option will expire if not exercised prior to the recipient of the options continuing to be employed by us on each vesting date.
Option Agreement. Options granted under our stock option plan are evidenced by an option agreement that contains, among other things, provisions concerning exercisability and forfeiture upon termination of employment or consulting arrangements,time as determined by our board. In addition, the option agreement also provides that options granted under our stock option plan are subject to a 180-day lock-up period following the effective date of a registration statement filed by us under the Securities Act, if so requested by us or any representative of the underwriters in connection with any registration of the offering of any of our securities.
Option Exercise. The term of options granted under our stock option plan may not exceed five years from the date of grant. The consideration to be paid for our shares upon exercise of an option or purchase of shares underlying the option will be determined by the plan administrator and may include cash, check, ordinary shares, a promissory note, consideration received by us under a cashless exercise program implemented by us in connection with our stock option plan, or any combinationdetermines at the time of the foregoing methods of payment.its grant.
Third-Party Acquisition. If a third party acquires us through the purchase of all or substantially all of our assets, a merger or other business combination, all outstanding options or share purchase rightsawards will be assumed or equivalent options or rightsshare awards substituted by the successor corporation or parent or subsidiary of the successor corporation. In the event that the successor corporation refuses to assume or substitute for the options or share purchase rights, all options or share purchase rights will become fully vested and exercisable immediately prior to such transaction and all unexercised awards will terminate unless, in either case, the awards are assumed by the successor corporation or its parent.
Changes in Capitalization and Other Adjustments. If we shall at any time increase or decrease the number of outstanding shares, or change in any way the rights and privileges of our outstanding shares, by means of a payment or a stock dividend or any other distribution upon such ordinary shares, or through a stock split, subdivision, consolidation, combination, reclassification or recapitalization involving such ordinary shares, then in relation to the ordinary shares that are covered by the optionsawards granted or available under the plan and are affected by one or more of the above events, the number, rights and privileges shall be increased, decreased or changed in like manner as if such ordinary shares had been issued and outstanding, fully paid and non-assessable at the time of such occurrence.
Termination of Plan. Unless terminated earlier, our stock option planOption Plan will expire in 2024.2038. Our board of directors has the authority to amend, alter, suspend or terminate our stock option plan.Option Plan. However, no such action may (i) impair the rights of any optioneegrantee unless agreed by the optioneegrantee and the stock option plan administrator, or (ii) affect the stock option plan administrator’s ability to exercise the powers granted to it under our stock option plan.Option Plan.
| C. | Board Practices |
Board of Directors
Our board of directors consists of the following five directors: Jun Zhu, Kwok Keung Chau, Davin A. Mackenzie, Ka Keung Yeung and George Lai. A director is not required to hold any shares in our company by way of qualification. A director may vote with respect to any contract, proposed contract or arrangement in whichnotwithstanding that he is materiallymay be interested so long as he has discloseddeclared the nature of the interest at a meeting of the directors. A director may exercise all the powers of our company to borrow money, and to mortgage or charge its undertaking, property and uncalled capital or any part thereof, and issue debentures, debenture stock or other securities whenever money is borrowed, or as security for any debt, liability or obligation of our company or of any third party.
| 70 |
Committees of the Board of Directors
Audit Committee. Our audit committee consists of Messrs. Kwok Keung Chau, Davin A. Mackenzie and Ka Keung Yeung, all of whom satisfy the “independence” definition under Rule 5605 of the Nasdaq Stock Market, Inc. Marketplace Rules, or the Nasdaq Rules, and the audit committee independence standard under Rule 10A-3 under the Exchange Act. All the members of our audit committee meet the “financial expert” definition of the Nasdaq Rules.
The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of our company. The audit committee is responsible for, among other things:
| · | selecting the independent auditors and pre-approving all auditing and non-auditing services permitted to be performed by the independent auditors; |
| · | reviewing and approving all proposed related party transactions; |
| · | discussing the annual audited financial statements with management and the independent auditors; |
| · | annually reviewing and reassessing the adequacy of our audit committee charter; |
| · | meeting separately and periodically with management and the independent auditors; |
| · | reporting regularly to the full board of directors; and |
| · | such other matters that are specifically delegated to our audit committee by our board of directors from time to time. |
Compensation Committee. Our compensation committee consists of Messrs. Kwok Keung Chau, Davin A. Mackenzie and Ka Keung Yeung, all of whom meet the “independence” standards for compensation committee members under the Nasdaq Rules. The compensation committee assists the board in reviewing and approving the compensation structure of our executive officers, including all forms of compensation to be provided to our executive officers. The compensation committee will be responsible for, among other things:
| · | reviewing and determining the compensation for our five most senior executives; |
| · | reviewing the compensation of our other employees and recommending any proposed changes to the management; |
| · | reviewing and approving director and officer indemnification and insurance matters; |
| · | reviewing and approving any employee loans in an amount equal to or greater than US$60,000 (or such amount as from time to time announced by the relevant regulatory bodies as requiring the approval of the Committee); and |
| · | reviewing periodically and approving any long-term incentive compensation or equity plans, programs or similar arrangements, annual bonuses, employee pensions and welfare benefits plans. |
Duties of Directors
Under Cayman Islands law, our directors owe to our company have fiduciary duties, including a duty of loyalty, a duty to act honestly and a duty to act in what they consider in good faith and with a view to be in our best interests. Our directors must also exercise their powers only for a proper purpose. Our directors also owe to our company a duty to act with care and diligence that a reasonably prudent person would exercise in comparable circumstances and a duty to exercise the skill and care.they actually possess. It was previously considered that a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. However, English and Commonwealth courts have moved towards an objective standard with regard to the required skill and care and these authorities are likely to be followed in the Cayman Islands. In fulfilling their duty of care to us, our directors must ensure compliance with our memorandum and articles of association, as amended and restated from time to time. We have the right to seek damages if a duty owed by our directors is breached.
| 71 |
Terms of Directors
Our board of directors is currently divided into three classes with different terms. This provision would delay the replacement of a majority of our directors and would make changes to the board of directors more difficult than if such provision were not in place. Our independent directors, namely Kwok Keung Chau, Davin A. Mackenzie and Ka Keung Yeung, were re-elected (elected in the case of Kwok Keung Chau) at our 20152018 annual general meeting and each of them is serving a three-year term until the 20182021 annual general meeting or until his successor is duly elected and qualified, whichever is earlier. Jun Zhu, our chairman and chief executive officer, was re-elected as a director at our 20132016 annual general meeting and is serving a three-year term until the 20162019 annual general meeting or until his successor is duly elected and qualified, whichever is earlier. George Lai, our chief financial officer whoand director, was appointed by our board of directorsre-elected as a director to fillat our 2018 annual general meeting and is serving a casual vacancy on our board of directors, holds officethree-year term until our 2016the 2021 annual general meeting or until his successor is duly elected and qualified, whichever is earlier. Upon expiration of the term of office of each class, succeeding directors in each class will be elected for a term of three years. Directors may be removed from office by ordinary resolution of shareholders at any time before the expiration of his/her term. Pursuant to the natural expiration of the directorial terms, elections for directors would be held on the date of the annual general meeting of shareholders.
Voting Agreement
On November 26, 2004, Incsight and Bosma, our two largest shareholders, entered into a voting agreement with respect to the election of our board of directors. Both parties have agreed to vote their respective shares to ensure that our board of directors consists of: (i) one director designated by Incsight, so long as it holds 5% or more of our total outstanding shares, which is currently Jun Zhu; (ii) one director designated by Bosma, so long as it holds 5% more of our total outstanding shares; (iii) two individuals mutually acceptable to Incsight and Bosma, but who are not otherwise affiliated with either of them, our company or any of our shareholders; and (iv) an additional individual who is not affiliated with either Incsight, Bosma, our company or any of our shareholders. Both parties agreed to vote to ensure that none of the directors elected pursuant to the voting agreement shall be removed from office, except for cause or unless by the affirmative vote of both parties. In addition, each of Incsight and Bosma agrees to elect one or two individuals designated by the other party as directors so long as each of them holds not less than 20% of the total issued shares of our company. The voting agreement shall continue until both parties mutually agree in writing to terminate it.
| D. | Employees |
As of December 31, 2015,2018, we had 565105 employees, amongof which 429103 were based in China, including 5942 in management and administration, 414 in our customer service centers, 8213 in game operations, sales and marketing, and 24744 in product development, including supplier management personnel and technical support personnel, 133and two were based in the United States and three were based in other regions.States. We had 611354 and 498236 employees as of December 31, 20132016 and 2014,2017, respectively. The decrease in the number of employees as of December 31, 20142018 as compared to that of December 31, 20132017 was primarily due to our disposal of Huopu Cloud.business restructuring. We consider our relations with our employees to be good.
| E. | Share Ownership |
As of February 29, 2016,28, 2019, there were 37,283,929133,355,358 ordinary shares outstanding, including 26,971,530 ordinary shares issued to The Bank of New York Mellon, our ADS depositary, to facilitate our future issuance of ADSs upon the exercise of options under our share incentive plan.outstanding.
The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of February 29, 201628, 2019 by:
| Ordinary Shares Beneficially Owned | ||||||||
| Number(1) | %(2) | |||||||
Directors and Executive Officers: | ||||||||
Jun Zhu(3) | 11,786,282 | 28.0 | % | |||||
Davin Alexander Mackenzie(4) | 396,565 | 1.1 | % | |||||
Kwok Keung Chau | * | * | ||||||
Ka Keung Yeung(5) | 396,115 | 1.1 | % | |||||
George Lai(6) | 381,498 | 1.0 | % | |||||
Chris Shen | * | * | ||||||
All Directors and Senior Executive Officers as a Group(7) | 13,465,956 | 30.8 | % | |||||
Principal Shareholders: | ||||||||
Incsight Limited(8) | 7,019,428 | 18.8 | % | |||||
Splendid Days Limited(9) | 11,974,826 | 24.3 | % | |||||
Bosma Limited(10) | 4,612,522 | 12.4 | % | |||||
Quality Event Limited(11) | 4,393,159 | 11.8 | % | |||||
| · | each of our directors and executive officers who are also our shareholders; and |
| · | each person known to us to own beneficially more than 5% of our ordinary shares. |
| Ordinary Shares Beneficially Owned | ||||||||
Amount(1) | %(2) | |||||||
| Directors and Executive Officers: | ||||||||
| Jun Zhu(3) | 21,483,530 | 16.1 | ||||||
| Davin A. Mackenzie | * | * | ||||||
| Kwok Keung Chau | * | * | ||||||
| Ka Keung Yeung | * | * | ||||||
| George Lai (Lai Kwok Ho)(4) | 1,500,000 | 1.1 | ||||||
| Arthur Lau | — | — | ||||||
| Chris Shen | * | * | ||||||
| All Directors and Senior Executive Officers as a Group(5) | 24,257,990 | 18.2 | ||||||
| Principal Shareholders: | ||||||||
| Plutux Labs Limited(6) | 21,000,000 | 15.7 | ||||||
| Leading Choice Holdings Limited(7) | 21,000,000 | 15.7 | ||||||
| Splendid Days Limited(8) | 15,028,844 | 10.1 | ||||||
| IE Limited(9) | 12,500,000 | 9.4 | ||||||
| Incsight Limited(3)(10) | 7,019,428 | 5.3 | ||||||
| 72 |
Notes:
| * | Less than 1% of our total outstanding shares. |
| (1) | Beneficial ownership is determined in accordance with the rules of the SEC, and includes voting or investment power with respect to the securities. In computing the number of shares beneficially owned by a person and the percentage ownership of that person, we have included shares that the person has the right to acquire within 60 days of February |
| (2) | Percentage of beneficial ownership is based on |
| (3) | Includes (i) 6,107,334 ordinary shares and 912,094 ordinary shares represented by ADSs held by Incsight Limited, a British Virgin Islands company |
| (4) | Includes |
| Includes ordinary shares, ordinary shares represented by ADSs, restricted shares and ordinary shares issuable upon exercise of options held by all of our directors and executive officers as a group. |
| (6) | Includes |
| (7) | Includes 21,000,000 ordinary shares held by Leading Choice Holdings Limited. The address for Leading Choice Holdings Limited is Unit 1005, 10/F, tower A, New Mandarin Plaza, 14 Science Museum Road, Tsim Sha Tsui, Hong Kong. |
| (8) | Includes an aggregate |
| Includes 12,500,000 ordinary shares |
| (10) | Includes 6,107,334 ordinary shares and 912,094 ordinary shares represented by |
To our knowledge, as of February 29, 2016, 26,971,53028, 2019, 52,916,595 ordinary shares, represented by the ADSs, or approximately 72.3%39.7% of the issued and outstanding shares, were held by one record shareholder in the United States, namely, The Bank of New York Mellon, our ADS depositary. The number of beneficial owners of our ADSs in the United States is likely to be much larger than the number of record holders of our ordinary shares in the United States.
None of our shareholders has different voting rights from other shareholders as of the date of this annual report. We are currently not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.
| Item 7. | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS |
| A. | Major Shareholders |
Please refer to “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”
| B. | Related Party Transactions |
Arrangements with Affiliated PRC Entities
Current PRC laws and regulations impose substantial restrictions on foreign ownership of entities involved in ICP, Internet culture operation and Internet publishing businesses, including online game operations, in China. Therefore, we conduct part of our activities through a series of agreements with Shanghai IT, our key affiliated PRC entity. Shanghai IT holds the requisite licenses and approvals for conducting ICP, Internet culture operation and Internet publishing businesses in China. Shanghai IT is owned by our employee Wei Ji, who acquired his equity interests in Shanghai IT from Jun Zhu in November 2011, and our employee Zhimin Lin, who acquired his equity interests in Shanghai IT from Yong Wang in April 2014.
We have obtained the exclusive right to benefit from Shanghai IT’s licenses and approvals. In addition, through a series of contractual arrangements with Shanghai IT and its shareholders, we are able to direct and control the operation and management of Shanghai IT. We believe that the individual shareholders of Shanghai IT will not receive material personal benefits from these agreements except as shareholders or employees of The9 Limited.
| 73 |
We do not believe we could have obtained these agreements, taken as a whole, from unrelated third parties. Because of the uncertainty relating to the legal and regulatory environment in China, the terms of most of the agreements were not defined unless terminated by the parties thereto. According to our PRC counsel, Zhong Lun Law Firm, subject to the interpretation and implementation of the GAPP Circular and the Network Publication Measures, these agreements, except those that have already been terminated, are valid, binding and enforceable under the current laws and regulations of China. The principal provisions of these agreements are described below.
Exclusive Technical Service Agreement. We provide Shanghai IT with technical services for the operation of computer software and related businesses, including the provision of systematic solutions for the operation of Internet websites, the rental of computer and Internet facilities, daily maintenance of Internet servers and databases, the development and update of relevant computer software, and all other related technical and consulting services. Shanghai IT pays service fees to us based on their actual operating results at a service fee equal to 90% of all operating profit generated by Shanghai IT. We are the exclusive provider of these services to Shanghai IT. According to the relevant PRC rules and regulations, related party transactions should be negotiated at the arm’s length basis and apply reasonable transfer pricing methods. However, the determination of service fees is under the sole discretion of us. This agreement does not have specific clauses on renewal but does have an initial term of 20 years (with the earliest expiration date being December 31, 2029). By virtue of the governance rights we maintain over Shanghai IT, through the terms of the other agreement noted above, we are able to unilaterally renew, extend or amend the service agreement at our discretion.
Shareholder Voting Proxy Agreement. Each of the shareholders of Shanghai IT has entered into a shareholder voting proxy agreement with us, under which each shareholder of Shanghai IT irrevocably grants any third parties designatedesignated by us the power to exercise all voting rights to which he/she is entitled as a shareholder of Shanghai IT, including the right to attend shareholders meetings, to exercise voting rights and to appoint directors, a general manager, and other senior management of Shanghai IT. The power of proxy is irrevocable and may only be terminated at our discretion.
Call Option Agreement. We entered into a call option agreement with each of the shareholders of Shanghai IT, under which the parties irrevocably agreed that, at our sole discretion, we and/or any third parties designated by us will be entitled to acquire all or part of the equity interests in Shanghai IT, to the extent permitted by the then-effective PRC laws and regulations. The consideration for such acquisition will be the price equal to the lower of the amount of the registered capital of Shanghai IT and the minimum amount permissible by the then- applicablethen-applicable PRC law. The shareholders of Shanghai IT have also agreed not to enter into any transaction, or fail to take any action, that would substantially affect the assets, liabilities, equity, operations or other legal rights of Shanghai IT without our prior written consent, including, without limitation, declaration and distribution of dividends and profits; sale, assignment, mortgage or disposition of, or encumbrances on, Shanghai IT’s equity; merger or consolidation; creation, assumption, guarantee or incurrence of any indebtedness; entering into other materials contracts. This agreement shall not expire until such time as we acquire all equity interests of Shanghai IT subject to applicable PRC laws.
Loan Agreement. From 2002 to May 2005, we provided an aggregate of RMB23.0 million in loan to the then shareholders of Shanghai IT, namely Jun Zhu and Yong Wong, for the purposes of capitalizing and increasing the registered capital of Shanghai IT. Such loan agreement was assumed by the current shareholders of Shanghai IT when Jun Zhu transferred the equity interest in Shanghai IT to Wei Ji in 2011 and Yong Wang transferred the equity interests in Shanghai IT to Zhimin Lin in 2014. Pursuant to the terms of this loan agreement, we granted an interest-free loan to each shareholder of Shanghai IT for the explicit purpose of making a capital contribution to Shanghai IT. The loans have an unspecified term and will remain outstanding for the shorter of the duration of The9 Computer or that of the Shanghai IT, or until such time that we elect to terminate the agreement (which is at our sole discretion) at which point the loans are payable on demand. Such loan shall only become immediately due and payable when we send a written notice to the borrowers requesting repayment. Currently, Zhimin Lin and Wei Ji have pledged all of their equity interests in Shanghai IT in favor of us under the equity pledge agreements. In the event of a breach of any term in the loan agreement or any other agreements by either Shanghai IT or its shareholders, we will be entitled to enforce our rights as a pledgee under the agreement.
| 74 |
Equity Pledge Agreements. To secure the full performance by Shanghai IT or its shareholders of their respective obligations under the Shareholder Voting Proxy Agreement, the Call Option Agreement and the Loan Agreement, the shareholders of Shanghai IT have pledged all of their equity interests in Shanghai IT in favor of us under two equity pledge agreements. In addition, the dividend distributions to the shareholders of Shanghai IT, if any, will be deposited in an escrow account over which we have exclusive control. The pledge shall remain effective until all obligations under such agreements have been fully performed. The shareholder has the obligation to maintain ownership and effective control over the pledged equity. Under no circumstances, without our prior written consent, may the shareholder transfer or otherwise encumber any equity interests in Shanghai IT. If any event of default as provided for therein occurs, The9 Computer, as the pledgee, will be entitled to dispose of the pledged equity interests through transfer or assignment and use the proceeds to repay the loans or make other payments due under the above loan agreement up to the loan amounts. Each of the shareholders of Shanghai IT has registered the pledge of its equity interests with the relevant local administration for industry and commerce pursuant to the new PRC Property Rights Law. In the event of a breach of any term in the above agreements by either Shanghai IT or its shareholders, we will be entitled to enforce our pledge rights over such pledged equity interests to compensate for any and all losses suffered from such breach.
Arrangements with Fire Rain and Wanyouyl
Fire Rain. In 2012, we deconsolidated Hangzhou Fire Rain Network Technology Co., Ltd., or Fire Rain, which was previously our consolidated affiliated entity. As of the date of deconsolidation, we retained a 25% equity interest and contractual rights to receive repayment of game development expenditures of RMB17 million and a contractual right to receive 20% of the gross revenues generated by the game. Of the advancement of RMB17.0 million we made to Fire Rain, RMB4.5 million was repaid in January 2013. In addition, certain cash advances to Fire Rain were secured by the personal guarantee of the spouse of a third-party shareholder of Fire Rain. In April 2013, we agreed that such shareholder will transfer a 33.5% equity interest in Fire Rain to us and in return we will release the personal guarantee provided. In March 2014, another shareholder transferred a 4% equity interest in Fire Rain to us. In June 2015, an individual shareholder transferred his 37.5% equity interest in Fire Rain to us, upon which we started to hold 100% equity interest in Fire Rain.
Wanyouyl. In 2012, we deconsolidated Shenzhen Wanyouyinli Technology Co., Ltd., or Wanyouyl, which was previously our consolidated affiliated entity. We retained a contractual right to receive 20% of future revenues of Era Zero developed by Wanyouyl, subject to a cap of RMB10 million. In 2013, 2014 and 2015, we received RMB2.6 million, nil and nil, respectively, from the 20% revenue sharing arrangement for the game developed by Wanyouyl. As of November 9, 2015, Wanyouyl owed Huopu Cloud RMB4.8 million (US$0.7 million). Pursuant to an assignmeng agreement entered into on December 31, 2015 among Huopu Cloud, Wanyouyl, Tianwangkongjian and its controlling shareholder Zexiang Zhang, Wanyouyl delegated its obligation to repay the debt of RMB4.8 million (US$0.7 million) to Tianwangkeji, and the debt shall have a term of five years from January 1, 2016 to December 31, 2020. Zexiang Zhang shall pledge his 20% equity interest in Tianwangkeji to a party designated by us to guarantee his performance under assignment agreement. On January 4, 2016, we entered into an interest assignment agreement with Huopu Cloud, pursuant to which Huopu Cloud assigned its aforesaid creditor’s right to us, and an equity pledge agreement with Zexiang Zhang, pursuant to which he pledged his 20% equity interest in Tianwangkeji to us.
Stock Option Grants
See “Item 6. Directors, Senior Management and Employees—B. Compensation —Share Incentive Plan—Fifth Amended and Restated 2004 Stock Option Plan.”
Investments or Agreements entered into with Affiliated Entities or Associates
In April 2012, we entered into a loan agreement with Beijing Linkage, our related party in which we own 45% equity interest. Pursuant to the loan agreement, we made a loan in the amount of RMB6.8 million to Beijing Linkage for it to make capital increase in its invested company. There was RMB5.3 million outstanding balance of such loan as of December 31, 2012. In March 2013, we entered into another loan agreement with Beijing Linkage, pursuant to which we made another loan in the amount of RMB4.5 million to Beijing Linkage for providing working capital to its invested company. Certain other shareholders of Beijing Linkage, namely Yong Lv, Qiang Zhang and Linzhen Cheng, have pledged their equity interests in Beijing Linkage for Beijing Linkage’s obligations under the aforesaid RMB4.5 million working capital loan. Total loan amounted to RMB9.8 million as of December 31, 2013, and was fully recorded in impairment due to Beijing Linkage’s doubtful ability of repayment, and was fully impaired in 2013 due to the concern on its recoverability. In November 2014, we sold all of our equity interests in Beijing Linkage to Qiang Zhang, one of its existing shareholders, for RMB14.0 million cash receipt as consideration. In addition, Beijing Linkage agreed to repay the total outstanding loan of RMB9.8 million to us. The RMB14 million consideration and part of the loan repayment RMB5.3 million were received in November 2014. The remaining amount of RMB4.5 million as loan repayment (US$0.7 million) was received in January 2015.
In February 2013, we established a new joint venture, namely ZTE9, in cooperation with Shanghai Zhongxing Communication Technology Enterprise Co., Ltd. and Shanghai Ruigao Information Technology Co., Ltd., in Wuxi, Jiangsu province of China, to develop and operate home entertainment set top box business. In February 2014, Guangdong Hongtu Guangdian Investment Limited Company made a capital investment of RMB12.5 million to acquire 10% equity interests in ZTE9. As of December 31, 2015,2018, we held 30.2%26.0% equity interest in ZTE9. For the year ended December 31, 2013, 2014 and 2015,ZTE9 charged net royalty charged byand other service fee related to IPTV business to us in an amount of RMB13.0 million, RMB7.1 million and RMB5.2 million (US$0.8 million) in 2016, 2017 and 2018, respectively. We provided IPTV related advertising service to ZTE9 in an amount of RMB0.5 million, nil and nil in 2016, 2017 and 2018, respectively. Total amount due to ZTE9 for providing game contents on IPTV to usbusiness was RMB6.0RMB16.8 million, RMB2.7 million and RMB6.8RMB5.1 million and RMB6.3 million (US$1.00.7 million), respectively. As as of December 31, 2015, the outstanding balance due to ZTE9 was RMB6.02016, 2017 and 2018, respectively.
In 2016, 2017 and 2018, we lent RMB2.8 million, (US$0.9 million). In 2015, we extended a loan of RMB9.9RMB4.0 million and RMB0.6 million (US$1.50.1 million) to ZTE9 to fund its operations, allrespectively. The loans are interest-free. As of which remainedDecember 31, 2016, 2017 and 2018, total outstanding amount for loan due from ZTE9 was RMB12.7 million, RMB2.1 million and RMB1.0 million (US$1.0 million), respectively.
In 2014, we entered into a license agreement with System Link, a 50% joint venture of us, for publishing and operating Firefall for a five-year term in China. Under this license agreement, System Link should pay to Red 5 and Red 5 Singapore licensing fees and royalties in an aggregate amount of at least US$160.0 million during the term of the agreement. In 2015, System Link paid US$10.0 million to us as licensing fees. We recorded the US$10.0 million as amount due to the related party and was to amortize the amount over the five-year period. System Link has become dormant since the cessation of Firefall in March 2016 and the termination of the licensing arrangement of CrossFire 2 in November 2017. As Red 5 is no longer required to render any services to System Link in relation to Firefall, Red 5 recognized the remaining unamortized licensing fees for Firefall as revenues in 2017. The balance due to System Link was nil as of December 31, 2015.2017 and 2018, respectively. We recognized licensing revenue of RMB13.6 million and RMB51.1 million for the years ended December 31, 2016 and 2017, respectively.
In 2016, we charged service fee, including IDC rental fee, office rental fee and etc., to Big Data (previously known as Jiucheng Advertisement) amounted to RMB4.5 million and the service fee was paid in 2016. In 2017, the service fee amounted to RMB0.1 million.
In 2016, Asian Way entered into a license agreement with T3, an equity investee of us, for developing a game using augmented reality (AR) technologies based on the intellectual property relating to the game Audition. Upon commercial launch, Asian Way will share certain percentages of revenues of the game to T3. The game is still under development as of December 31, 2018.
In 2017, we entered into a share purchase agreement with Incsight Limited, which is controlled by Mr. Jun Zhu, our chairman and chief executive officer. Pursuant to this agreement, Mr. Jun Zhu will acquire 12,500,000 newly issued shares of us for a total cash consideration of US$15.0 million. The transaction was terminated in February 2019 and the previously issued shares were surrendered and cancelled.
| 75 |
In 2017, we entered into a share purchase agreement with Ark Pacific Special Opportunities Fund I, L.P., which beneficially owns more than 10% of share capital in our company. Pursuant to this agreement, Ark Pacific Special Opportunities Fund I, L.P. will acquire 12,500,000 newly issued shares of us for a total cash consideration of US$15.0 million. The transaction was terminated in February 2019 and the previously issued shares were surrendered and cancelled.
Loan from Related Parties
Mr. Jun Zhu, the chairman and chief executive officer, extended aggregate of RMB60.0 million, RMB73.9 million and RMB11.0 million (US$1.6 million) in loan was interest-freeto us in 2016, 2017 and will be due from March to August 2016.2018, respectively. The loans are interest-free. As of December 31, 2016, 2017 and 2018, RMB25.2 million, RMB75.2 million and RMB57.1 million (US$8.3 million) of such loan remained outstanding, respectively.
Stock Option Grants
See “Item 6. Directors, Senior Management and Employees—B. Compensation—Share Incentive Plan—Eighth Amended and Restated 2004 Stock Option Plan.”
| C. | Interests of Experts and Counsel |
Not applicable.
| Item 8. | FINANCIAL INFORMATION |
| A. | Consolidated Statements and Other Financial Information |
We have appended consolidated financial statements filed as part of this annual report.
Legal Proceedings
In May 2011, Diego Maradona, a former Argentina soccer star, filed a lawsuit in the Beijing No. 1 Intermediate People’s Court against Shanghai IT and a third-party company in China, alleging that the defendants used his name and image in a web and social game operated by us without his authorization. In July 2011, the plaintiff amended his complaint to include The9 Computer as a defendant. The plaintiff in the case demanded, among others, that the defendants pay RMB20 million for his alleged losses. In June 2013, the Beijing No.1 People’s Intermediate Court issued a judgment against us for infringing the portraiture right of the plaintiff and required us to pay a total of RMB3 million as economic damages and other related fees to the plaintiff. We have appealed the case to the Beijing People’s Superior Court. A hearing was held by the court on December 26, 2013 and the court made a decision rejecting our appeal on April 10, 2014. We made a petition to the Supreme Court and the Supreme Court accepted our petition on July 14, 2014. The Supreme Court made a decision upholding the Beijing No. 1 Intermediate People’s Court decision on December 16, 2014. According to the judgment, we shall pay to the plaintiff an aggregate amount of RMB3 million (US$0.5 million) and any accrued interests thereof for late payment. In February 2015, we entered into a settlement agreement with the plaintiff to pay a total of RMB3.3 million (US$0.5 million) to settle the matter.
On December 30, 2014, Shanghai Anjiu Network Information Limited, or Shanghai Anjiu, filed a lawsuit in Shanghai Pudong People’s Court against Shanghai IT, claiming us for an advertisement fee of approximately RMB1.5 million and a penalty of RMB82,000. Shanghai IT and Shanghai Anjiu settled this case for paying a total of RMB1.4 million (US$0.2 million) to the plaintiff in January 2015.
On September 30, 2015, a former employee who served as a human resources generalist of Red 5 filed a complaint before the Superior Court of California, County of Orange, against Red 5 and its affiliates are currently in dispute with Qihoo 360 and its affiliates regarding System Link and Firefall and various legal proceedings have been initiated and are ongoing in connection with such dispute. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry—Our equity investments or establishment of joint ventures and any material disputes with our company for wrongful termination of employment, and claimed general damages in excess of US$1.0 million and special damages in excess of US$0.5 million. On February 22, 2016, we submittedinvestment or joint venture partners may have an answer to complaint and demand to the court to defend the action. We believe that such proceeding, when finally resolved, is unlikely to have a material adverse effect on our financial results, of operations, financial positionbusiness prospects and cash flows.
our ability to manage our business.” Other than the foregoing, we are not currently a party to any material litigation or other legal proceeding and are not aware of any pending or threatened litigation or other legal proceeding that may have a material adverse impact on our business, financial condition and results of operations.proceeding.
Dividend Policy
We currently intend to retain most, if not all, of our available funds and any future earnings for use in the operation and expansion of our business. Our board of directors has discretion as to whether we will distribute dividends in the future, subject to applicable laws. In addition, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our board of directors. Even if our board of directors determines to distribute dividends, the form, frequency and amount of our dividends will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions, legal restrictions and other factors as the board of directors may deem relevant. Any dividend we declare will be paid to the holders of ADSs, subject to the terms of the deposit agreement, to the same extent as holders of our ordinary shares, less the fees and expenses payable under the deposit agreement. Any dividend we declare will be distributed by the depositary bank to the holders of our ADSs. Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.
| B. | Significant Changes |
Except as otherwise disclosed in this annual report, we have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.
| 76 |
| Item 9. | THE OFFER AND LISTING |
| A. | Offer and Listing Details |
Our ADSs, each currently representing onethree ordinary share, have beenshares, are listed on the Nasdaq Global Market since December 15, 2004.Capital Market. Our ADSs are traded under the symbol “NCTY.” The following table provides the high and low trading prices for ourOur ADSs had been listed on the Nasdaq Global Market forfrom December 15, 2004 to October 2018. Effective May 9, 2018, we effected a change of the periods specified.ratio of the ADSs to ordinary shares from one ADS representing one ordinary share to three ordinary shares. In October 2018, we transferred our listing venue to the Nasdaq Capital Market.
| Sales Price | ||||||||
| High | Low | |||||||
Annual High and Low | ||||||||
2011 | 8.49 | 2.90 | ||||||
2012 | 7.98 | 2.71 | ||||||
2013 | 4.50 | 2.08 | ||||||
2014 | 4.22 | 1.52 | ||||||
2015 | 4.49 | 0.90 | ||||||
Quarterly High and Low | ||||||||
First Quarter 2014 | 3.20 | 2.09 | ||||||
Second Quarter 2014 | 2.83 | 2.10 | ||||||
Third Quarter 2014 | 4.22 | 2.27 | ||||||
Fourth Quarter 2014 | 2.51 | 1.52 | ||||||
First Quarter 2015 | 1.71 | 1.09 | ||||||
Second Quarter 2015 | 2.14 | 1.21 | ||||||
Third Quarter 2015 | 1.66 | 1.09 | ||||||
Fourth Quarter 2015 | 4.49 | 0.90 | ||||||
First Quarter 2016 | 3.28 | 1.81 | ||||||
Monthly High and Low | ||||||||
October 2015 | 1.49 | 0.90 | ||||||
November 2015 | 4.49 | 1.31 | ||||||
December 2015 | 4.40 | 2.84 | ||||||
January 2016 | 3.14 | 2.00 | ||||||
February 2016 | 3.28 | 1.81 | ||||||
March 2016 | 2.72 | 2.11 | ||||||
April 2016 (through April 8, 2016) | 2.55 | 2.23 | ||||||
| B. | Plan of Distribution |
Not applicable.
| C. | Markets |
Our ADSs, each representing onethree ordinary share,shares, have been listed on the Nasdaq Capital Market since October 2018 and previously Nasdaq Global Market since December 15, 2004 under the symbol “NCTY.”
| D. | Selling Shareholders |
Not applicable.
| E. | Dilution |
Not applicable.
Not applicable.
| Expenses of the Issue |
Not applicable.
| Item 10. | ADDITIONAL INFORMATION |
| A. | Share Capital |
Not applicable.
| B. | Memorandum and Articles of Association |
We are an exempted company incorporated in the Cayman Islands and our affairs are governed by our memorandum and articles of association and the Companies Law (2013(2018 Revision) of the Cayman Islands, which is referred to as the Companies Law below.
As of the date of this annual report, our authorized share capital is US$2,500,000,3,500,000, consisting of 250,000,000350,000,000 ordinary shares, par value of US$0.01 each. The following are summaries of material provisions of our currently effective amended and restated memorandum and articles of association and the Companies Law insofar as they relate to the material terms of our ordinary shares.
Ordinary Shares
General. All of our outstanding ordinary shares are fully paid and non-assessable. Certificates representing the ordinary shares are issued in registered form. Our shareholders may freely hold and vote their shares.
Dividends. The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors subjectdirectors.In addition, our shareholders may declare dividends by ordinary resolution, but no dividend shall exceed the amount recommended by our directors. Under the laws of the Cayman Islands, our company may pay a dividend out of either profit or share premium account, provided that in no circumstances may a dividend be paid if this would result in our company being unable to pay its debts as they fall due in the Companies Law.ordinary course of business.
| 77 |
Voting Rights. Each ordinary share is entitled to one vote on all matters upon which the ordinary shares are entitled to vote. Voting at any meeting of shareholders is by show of hands unless a poll is demanded. A poll may be demanded by any shareholderone or more shareholders together holding at leastnot less than ten percent of the shares given a right to vote at the meeting,paid up voting share capital, present in person or by proxy.
A quorum required for a meeting of shareholders consists of holders of not less than one-third of all issued and outstanding shares entitled to vote. Shareholders’ meetingsThe Company shall, if required by the Companies Law, in each year hold a general meeting as its annual general meeting and shall specify the meeting as such in the notices calling it. The Company may hold an annual general meeting but shall not (unless required by the Companies Law) be held annually.obliged to hold an annual general meeting. Annual general meetings and extraordinary general meetings may be convened by our board of directors on its own initiative. Extraordinary general meetings shall be convened by our board of directors upon a request to the directors by shareholders holding in aggregate at leastnot less than 33% of our voting share capital. Advance notice of at least seven business days is required for the convening of our annual general meeting and other shareholdersextraordinary general meetings.
An ordinary resolution to be passed by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the ordinary shares cast in a general meeting, while a special resolution requires the affirmative vote of no less than two-thirds of the votes attaching to the ordinary shares cast in a general meeting and includes a unanimous written resolution expressly passed as a special resolution. A special resolution is required for important matters such as a change of name, a decrease of our share capital, or amending theour memorandum and articles of association. Holders of theour ordinary shares may effect certain changes by ordinary resolution, including an increase of our share capital, the consolidation and division of all or any of our share capital into shares of a larger amount than our existing share capital, and the cancellation of any shares.
Transfer of Shares. Subject to the restrictions of our articles of association, as applicable, any of our shareholders may transfer all or any of his or her ordinary shares by an instrument of transfer in the usual or common form or any other form approved by our board. The transferor shall be deemed to remain the holder of the shares until the name of the transferee is entered in the register of members in respect thereof.
Liquidation. On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of shares), assets available for distribution among the holders of ordinary shares shall be distributed among the holders of the ordinary shares as the liquidator deems fair. If our assets available for distribution are insufficient to repay all of the paid-up capital, the assets will be distributed so that the losses are borne by our shareholders proportionately.
Calls on Shares and Forfeiture of Shares. Our board of directors may from time to time make calls upon shareholders for any amountsmoneys unpaid on their shares in a notice served to such shareholders at least 14 days prior to the specified time and place of payment. The shares that have been called upon and remain unpaid on the specified time are subject to forfeiture.
Redemption and Repurchase of Shares. Subject to the provisions of the Companies Law and our articles of association, we may issue shares on terms that are subject to redemption, at our option or at the option of the holders, on such terms and in such manner as may be determined by our board of directors. Our company may also repurchase any of our shares (including any redeemable shares) provided that the manner of such purchase has been approved by ordinary resolution of our shareholders or the manner of such purchase is in accordance with our articles of association. Under the Companies Law, the redemption or repurchase of any share may be paid out of our company’s profits or out of the proceeds of a fresh issue of shares made for the purpose of such redemption or repurchase, or out of capital (including share premium account and capital redemption reserve) if the company can, immediately following such payment, pay its debts as they fall due in the ordinary course of business. In addition, under the Companies Law no such share may be redeemed or repurchased (a) unless it is fully paid up, (b) if such redemption or repurchase would result in there being no shares outstanding, or (c) if the company has commenced liquidation.
Variation of Rights of Shares. All or any of the special rights attached to any class of shares may, subject to the provisions of the Companies Law, be varied either with the written consent of a majority of the issued shares of that class or with the sanction of an ordinary resolution passed at a general meeting of the holders of the shares of that class.
| 78 |
Inspection of Books and Records. Holders of our ordinary shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or our corporate records. However, we will provide our shareholders with annual audited financial statements. See “—H. Documents on Display.”
Differences in Corporate Law
The Companies Law is modeled after that of English law but does not follow recent English law statutory enactments. In addition, the Companies Law differs from laws applicable to Delaware corporations and their shareholders. Set forth below is a summary of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to Delaware corporations and their shareholders.
Mergers and Similar Arrangements. The Companies Law permits mergers and consolidations between Cayman Islands companies and between Cayman Islands companies and non-Cayman Islands companies. For these purposes:
| · | a “merger” means the merging of two or more constituent companies and the vesting of their undertaking, property and liabilities in one of such companies as the surviving company; and |
| · | a “consolidation” means the combination of two or more constituent companies into a consolidated company and the vesting of the undertaking, property and liabilities of such companies to the consolidated company. |
In order to effect such a merger or consolidation, the directors of each constituent company must approve a written plan of merger or consolidation, which must then be authorized by:
| · | a special resolution of the shareholders of each constituent company; and |
| · | such other authorizations, if any, as may be specified in such constituent company’s articles of association. |
The plan of merger or consolidation must be filed with the Registrar of Companies together with a declaration as to the solvency of the consolidated or surviving company, a declaration as to the assets and liabilities of each constituent company and an undertaking that a copy of the certificate of merger or consolidation will be given to the members and creditors of each constituent company that notification of the merger or consolidation will be published in the Cayman Islands Gazette. Dissenting shareholders haveSave in certain limited circumstances, a shareholder of a Cayman constituent company who dissents from the rightmerger or consolidation is entitled to be paidpayment of the fair value of theirhis shares (which, if they follownot agreed between the requiredparties, will be determined by the Cayman Islands court) upon dissenting to the merger or consolidation, provided the dissenting shareholder complies strictly with the procedures subjectset out in the Companies Law. The exercise of dissenter rights will preclude the exercise by the dissenting shareholder of any other rights to certain exceptions.which he or she might otherwise be entitled by virtue of holding shares, save for the right to seek relief on the grounds that the merger or consolidation is void or unlawful The fair value of the shares will be determined by the Cayman Islands court if it cannot be agreed among the parties. Court approval is not required for a merger or consolidation which is effected in compliance with these statutory procedures.
In addition, there are statutory provisions that facilitate the reconstruction and amalgamation of companies, by way of schemes of arrangement, provided that the arrangement is approved by a majority in number of each class of shareholders or creditors with whom the arrangement is to be made, and who must in addition represent three-fourths in value of each such class of shareholders or creditors, as the case may be, that are present and voting either in person or by proxy at a meeting, or meetings, convened for that purpose. The convening of the meetings and subsequently the arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a dissenting shareholder has the right to express to the court the view that the transaction ought not to be approved, the court can be expected to approve the arrangement if it determines that:
| · | the statutory provisions as to majority vote have been met; |
| · | the shareholders have been fairly represented at the meeting in question and the statutory majority are acting bona fide without coercion of the minority to promote interests adverse to those of the class; |
| 79 |
| · | the arrangement is such that may be reasonably approved by an intelligent and honest man of that class acting in respect of his interest; and |
| · | the arrangement is not one that would more properly be sanctioned under some other provision of the Companies Law. |
The Companies Law also contains a statutory power of compulsory acquisition which may facilitate the arrangement is not one that would more properly be sanctioned under some other provision“squeeze out” of the Companies Law.
dissentient minority shareholder upon a tender offer. When a take-overtender offer is made and accepted by holders of 90% of the shares affected within four months, the offeror may, within a two month period commencing on the expiration of such four month period, require the holders of the remaining shares to transfer such shares on the terms of the offer. An objection can be made to the Grand Court of the Cayman Islands but this is unlikely to succeed in the case of an offer which has been so approved unless there is evidence of fraud, bad faith or collusion.
If the arrangement and reconstruction is thus approved, theor if a tender offer is made and accepted, a dissenting shareholder would have no rights comparable to appraisal rights, which would otherwise ordinarily be available to dissenting shareholders of Delaware corporations, providing rights to receive payment in cash for the judicially determined value of the shares.
Shareholders’ Suits. The Cayman Islands courts can be expected to follow English case law precedents. The Cayman Islands courts can be expected to apply and follow common law principles (namely the rule in Foss v Harbottle and the exceptions thereto) that permit a minority shareholder to commence a class action against the company or a derivative action in the name of the company to challenge (1) an act that is outside the company’s corporate powers or that is illegal, (2) an act constituting a fraud against the minority shareholders where the wrongdoers are themselves in control of the company, and (3) an action requiring a resolution passed by a qualified or special majority that has not been obtained.
Directors’ Fiduciary Duties. Under Delaware corporate law, a director of a Delaware corporation has a fiduciary duty to the corporation and its shareholders. This duty has two components: the duty of care and the duty of loyalty. The duty of care requires that a director act in good faith, with the care that an ordinarily prudent person would exercise under similar circumstances. Under this duty, a director must inform himself of, and disclose to shareholders, all material information reasonably available regarding a significant transaction. The duty of loyalty requires that a director act in a manner he reasonably believes to be in the best interests of the corporation, he must not use his corporate position for personal gain or advantage. This duty prohibits self-dealing by a director and mandates that the best interest of the corporation and its shareholders take precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the shareholders generally. In general, actions of a director are presumed to have been made on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation. However, this presumption may be rebutted by evidence of a breach of one of the fiduciary duties. Should such evidence be presented concerning a transaction by a director, a director must prove the procedural fairness of the transaction, and that the transaction was of fair value to the corporation.
As a matter of Cayman Islands law, a director of a Cayman Islands company is in the position of a fiduciary with respect to the company and therefore it is considered that he owes the following duties to the company — company—a duty to act in good faith in the best interests of the company, a duty not to make a personal profit out of his position as director (unless the company permits him to do so), a duty not to put himself in a position where the interests of the company conflict with his personal interest or his duty to a third party and a duty to exercise powers for the purpose for which such powers were intended. A director of a Cayman Islands company owes to the company a duty to act with skill and care. It was previously considered that a director need not exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. However, there are indications that the English and Commonwealth courts are moving towards an objective standard with regard to the required skill and care and these authorities are likely to be followed in the Cayman Islands.
Shareholder Action by Written Consent. Under the Delaware General Corporation Law, a corporation may eliminate the right of shareholders to act by written consent by amendment to its certificate of incorporation. Cayman Islands law and our articles of association provide that shareholders may approve corporate matters by way of written resolution signed by or on behalf of each shareholder who would have been entitled to vote on such matter at a general meeting without a meeting being held.
| 80 |
Shareholder Proposals. Under the Delaware General Corporation Law, a shareholder has the right to put any proposal before the annual meeting of shareholders, provided it complies with the notice provisions in the governing documents. A special meeting may be called by the board of directors or any other person authorized to do so in the governing documents, but shareholders may be precluded from calling special meetings. Cayman Islands law and our articles of association allow our shareholders holding not less than 33 per cent of the paid up voting share capital of our company to requisition a shareholder’s meeting.
Cumulative Voting. Under the Delaware General Corporation Law, cumulative voting for elections of directors is not permitted unless the corporation’s certificate of incorporation specifically provides for it. Cumulative voting potentially facilitates the representation of minority shareholders on a board of directors since it permits the minority shareholder to cast all the votes to which the shareholder is entitled on a single director, which increases the shareholder’s voting power with respect to electing such director. As permitted under Cayman Islands law, our articles of association do not provide for cumulative voting.
Removal of Directors. Under the Delaware General Corporation Law, a director of a corporation may be removed with the approval of a majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides otherwise. Under our articles of association, directors can be removed with or without cause, but only by an ordinary resolution of our shareholders.In addition, a director’s office shall be vacated if the votedirector (i) becomes bankrupt or makes any arrangement or composition with his creditors; (ii) is found to be or becomes of a majorityunsound mind; (iii) resigns his office by notice in writing to the company; (iv) without special leave of absence from our board of directors, is absent from meetings of the holdersboard for six consecutive months and the board resolves that his office be vacated or; (v) is removed from office pursuant to any other provisions of our shares voting at a general meetingmemorandum and articles of association or the unanimous written resolution of all shareholders.Companies Law.
Transactions with Interested Shareholders. The Delaware General Corporation Law contains a business combination statute applicable to Delaware public corporations whereby, unless the corporation has specifically elected not to be governed by such statute by amendment to its certificate of incorporation, it is prohibited from engaging in certain business combinations with an “interested shareholder” for three years following the date that such person becomes an interested shareholder. An interested shareholder generally is a person or group who or which owns or owned 15% or more of the target’s outstanding voting stock within the past three years. This has the effect of limiting the ability of a potential acquiroracquirer to make a two-tiered bid for the target in which all shareholders would not be treated equally. The statute does not apply if, among other things, prior to the date on which such shareholder becomes an interested shareholder, the board of directors approves either the business combination or the transaction which resulted in the person becoming an interested shareholder. This encourages any potential acquiroracquirer of a Delaware public corporation to negotiate the terms of any acquisition transaction with the target’s board of directors.
Cayman Islands law has no comparable statute. As a result, we cannot avail ourselves of the types of protections afforded by the Delaware business combination statute. However, although Cayman Islands law does not regulate transactions between a company and its significant shareholders, it does provide that such transactions must be entered into bona fide in the best interests of the company and for a proper corporate purpose and not with the effect of constituting a fraud on the minority shareholders.
Dissolution; Winding Up. Under the Delaware General Corporation Law, unless the board of directors approves the proposal to dissolve, dissolution must be approved by shareholders holding 100% of the total voting power of the corporation. Only if the dissolution is initiated by the board of directors may it be approved by a simple majority of the corporation’s outstanding shares. Delaware law allows a Delaware corporation to include in its certificate of incorporation a supermajority voting requirement in connection with dissolutions initiated by the board. Under the Companies Law, our company may be dissolved, liquidated or wound up by either an order of the courts of the Cayman Islands or by a special resolution, or by an ordinary resolution on the basis that our company is unable to pay its debts as they fall due. The court has authority to order winding up in a number of specified circumstances including where it is, in the opinion of the court, just and equitable to do so.
Variation of Rights of Shares. Under the Delaware General Corporation Law, a corporation may vary the rights of a class of shares with the approval of a majority of the outstanding shares of such class, unless the certificate of incorporation provides otherwise. Under our articles of association, if our share capital is divided into more than one class of shares, we may vary the rights attached to any class only with the written consent of the holders of at least a majority of the shares of such class or with the sanction of a resolution passed by at least a majority of the holders of such class present in person or by proxy at a separate general meeting of the holders of the shares of that class.
| 81 |
Amendment of Governing Documents. Under the Delaware General Corporation Law, a corporation’s governing documents may be amended with the approval of a majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides otherwise. As permitted by Cayman Islands law, our memorandum and articles of association may be amended with the vote of at least two-third holdersby a special resolution of our shares at a general meeting or the unanimous written resolution of all shareholders.
Anti-Takeover Provisions in Memorandum and Articles of Association. Some provisions of our memorandum and articles of association may discourage, delay or prevent a change in control of our company or management that shareholders may consider favorable, including provisions that:
| · | authorize our board of directors to issue preference shares in one or more series and to designate the price, rights, preferences, privileges and restrictions of such preference shares without any further vote or action by our shareholders; and |
| · | create a classified board of directors pursuant to which our directors are elected for staggered terms, which means that shareholders can only elect, or remove, a limited number of directors in any given year. |
However, under Cayman Islands law, our directors may only exercise the rights and powers granted to them under our memorandum and articles of association for a proper purpose and for what they believe in good faith to be in the best interests of our company.
Rights of Non-Resident or Foreign Shareholders. There are no limitations imposed by our memorandum and articles of association on the rights of non-resident or foreign shareholders to hold or exercise voting rights on our shares. In addition, there are no provisions in our memorandum and articles of association governing the ownership threshold above which shareholder ownership must be disclosed.
Inspection of Books and Records. Under the Delaware General Corporation Law, any shareholder of a corporation may for any proper purpose inspect or make copies of the corporation’s stock ledger, list of shareholders and other books and records. Holders of our shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or corporate records. However, we will provide our shareholders with annual audited financial statements.
Shareholder Rights Plan
On January 8, 2009, our board of directors declared a dividend of one ordinary share purchase right, or a Right, for each of our ordinary shares outstanding at the close of business on January 22, 2009. See “Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds.”
| C. | Material Contracts |
We have not entered into any material contracts other than in the ordinary course of business and other than those described in “Item 4. Information on the Company” or elsewhere in this annual report.
| D. | Exchange Controls |
See “Item 4. Information on the Company—B. Business Overview—Government Regulations—Regulations on Foreign Currency Exchange and Dividend Distribution.”
| E. | Taxation |
Cayman Islands Taxation
In the opinion of our Cayman Islands counsel, Maples and Calder (Hong Kong) LLP, the Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax or estate duty. No Cayman Islands stamp duty will be payable unless an instrument is executed in, or after execution, brought to,into, or produced before a court of the Cayman Islands. The Cayman Islands is not party to any double tax treaties which are applicable to payments made to or by our company. There are no exchange control regulations or currency restrictions in the Cayman Islands.
Payments of dividends and capital in respect of the shares will not be subject to taxation in the Cayman Islands and no withholding will be required on the payment of a dividend or capital to any holder of the Shares, nor will gains derived from the disposal of the shares be subject to Cayman Islands income or corporation tax.
| 82 |
People’s Republic of China Taxation
If we are considered a PRC resident enterprise under the EIT Law, our shareholders and ADS holders who are deemed non-resident enterprises may be subject to the 10% EIT on the dividends payable by us or any gains realized from the transfer of our shares or ADSs, if such income is deemed derived from China, provided that (i) such foreign enterprise investor has no establishment or premises in China, or (ii) it has establishment or premises in China but its income derived from China has no real connection with such establishment or premises. Furthermore, if we are considered a PRC resident enterprise and relevant PRC tax authorities consider the dividends we pay with respect to our shares or ADSs and the gains realized from the transfer of our shares or ADSs to be income derived from sources within the PRC, it is also possible that such dividends and gains earned by non-resident individuals may be subject to the 20% PRC individual income tax. It is uncertain whether, if we are considered a PRC resident enterprise, holders of our shares or ADSs would be able to claim the benefit of tax treaties or arrangements entered into between China and other jurisdictions.
If we are required under the PRC tax law to withhold PRC income tax on our dividends payable to our non-PRC resident shareholders and ADS holders, or if any gains realized from the transfer of our shares or ADSs by our non-PRC resident shareholders and ADS holders are subject to the EIT or the individual income tax, your investment in our shares or ADSs could be materially and adversely affected.
U. S. Federal Income Taxation
The following discussion is a summary of U.S. federal income tax considerations to U.S. Holders (as defined below) relating to the ownership and disposition of the ADSs or ordinary shares. This discussion applies only to U.S. Holders of the ADSs or ordinary shares as “capital assets” (generally, property held for investment). This discussion is based on the tax laws of the United States in effect as of the date of this annual report and on U.S. Treasury regulations in effect or, in some cases, proposed as of the date of this annual report, as well as judicial and administrative interpretations thereof available on or before such date. All of the foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described below.
The following discussion is for general information only and does not address all of the tax considerations that may be relevant to any particular investor or to persons in special tax situations such as:
| · | banks and other financial institutions; |
| · | insurance companies; |
| · | pension plans; |
| · | cooperatives; |
| · | regulated investment companies; |
| · | real estate investment trusts; |
| · | broker-dealers; |
| · | traders that elect to use a mark-to-market method of accounting; |
| · | U.S. expatriates or entities subject to the U.S. anti-inversion rules; |
| · | tax-exempt entities (including private foundations); |
| · | persons liable for alternative minimum tax; |
| · | persons whose functional currency is not the U.S. dollar; |
| 83 |
| · | persons holding ADSs or ordinary shares as part of a straddle, hedging, conversion or integrated transaction for U.S. federal income tax purposes; |
| · | persons holding ADSs or ordinary shares through a bank, financial institution or other entity, or a branch thereof, located, organized or resident outside the United States; |
| · | persons that directly, indirectly or constructively own 10% or more of our stock (by vote or value); |
| · | investors required to accelerate the recognition of any item of gross income with respect to our ADSs or ordinary shares as a result of such income being recognized on an applicable financial statement; |
| · | partnerships or other pass-through entities, or persons holding ADSs or ordinary shares through such entities; or |
| · | persons who acquired ADSs or ordinary shares pursuant to the exercise of any employee share option or otherwise as compensation. |
In addition, the discussion below does not address any U.S. state, local or non-U.S. tax considerations, the Medicare tax, alternative minimum tax, or any non-income tax (such as U.S. federal estate or gift tax) considerations.
U.S. HOLDERS ARE URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE APPLICATION OF THE U.S. FEDERAL TAX RULES TO THEIR PARTICULAR CIRCUMSTANCES AS WELL AS THE STATE, LOCAL, NON-U.S. AND OTHER TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF ADSs OR ORDINARY SHARES.
The
For the purpose of this discussion, below of the U.S. federal income tax consequences toa “U.S. Holders” will apply to you if you areHolder” is a beneficial owner of ADSs or ordinary shares and you are,that is, for U.S. federal income tax purposes:
| · | an individual who is a citizen or resident of the United States; |
| · | a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) organized under the laws of the United States, any state thereof or the District of Columbia; |
| · | an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or |
| · | a trust that (1) is subject to the primary supervision of a court within the United States and the control of one or more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable U.S. Treasury regulations to be treated as a U.S. person. |
If a partnership (or other entity taxable as a partnership for U.S. federal income tax purposes) is a beneficial owner of our ADSs or ordinary shares, the tax treatment of a partner in such partnership will depend on the status of such partner and the activities of such partnership. If you are a partner or a partnership holding our ADSs or ordinary shares, you are urged to consult your tax advisor as to the particular U.S. federal income tax considerations of an investment in the ADSs or ordinary shares that is applicable to you.
It is generally expected that a holderU.S. Holder of ADSs should be treated, for U.S. federal income tax purposes, as the beneficial owner of the underlying shares represented by the ADSs. The remainder of this discussion assumes that a holderU.S. Holder of ADSs will be treated in this manner. Predicated upon such treatment, deposits or withdrawals of our ordinary shares for our ADSs will not be subject to U.S. federal income tax. The U.S. Treasury has expressed concerns that intermediaries in the chain of ownership between the holder of an ADS and the issuer of the security underlying the ADS may be taking actions that are inconsistent with the beneficial ownership of the underlying security (for example, pre-releasing ADSs to persons that do not have beneficial ownership of the securities underlying the ADSs). Accordingly, the creditability of any foreign tax credits or the availability of the reduced tax rate for dividends received by certain non-corporate U.S. Holders, including individual U.S. Holders (as discussed below), could be affected by actions taken by intermediaries in the chain of ownership between the holders of ADSs and our company if as a result of such actions the holders of ADSs are not properly treated as beneficial owners of underlying ordinary shares.
Passive Foreign Investment Company Considerations
Based on the market price of our ADSs and the value and composition of our assets and liabilities, we believe we were not a passive foreign investment company (“PFIC”) for U.S. federal income tax purposes for the taxable year ended December 31, 2015.However, as previously disclosed, although not free from doubt, we believed that we were a PFIC for U.S. federal income tax purposes for prior years.
A non-U.S. corporation will be a PFIC for any taxable year if either:
| · | at least 75% of its gross income for such year consists of certain types of passive income (the “income test”); or |
| 84 |
| · | at least 50% of the average quarterly value of its assets (as generally determined on the basis of fair market value) produce or are held for the production of passive income (the “asset test”). |
For this purpose, cash and assets readily convertible into cash are generally classified as passive assets and goodwill and other unbooked intangibles associated with active business activities may generally be classified as non-passive assets. Passive income generally includes, among other things, dividends, interest, royalties and rents (other than certain royalties and rents derived in the active conduct of a trade or business and not derived from a related person), and gains from the disposition of passive assets. The classification of certain of our income as active or passive and certain of our assets as producing active or passive income, and hence whether we expect to be or will become a PFIC, depends on the interpretation of certain U.S. Treasury Regulations, including certain regulations relating to royalty income and income from intangible assets, as well as certain Internal Revenue Service (“IRS”) guidance relating to the classification of assets as producing active or passive income and certain IRS guidance relating to the distinction between services income and royalties for U.S. federal income tax purposes. Such regulations and guidance are potentially subject to different interpretations. If the percentage of our passive income or our assets treated as producing passive income increases, we may be more likely to be treated as a PFIC for such taxable year.
We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in which we own, directly or indirectly, at least 25% (by value) of the stock. In applying this rule, however, it is not clear whether the contractual arrangements between us and our affiliated entities will be treated as ownership of stock. Moreover, it is not clear whether gain recognized from the sale of stock (or an arrangement treated as ownership of stock for U.S. federal income tax purposes) in a 25% (by value) or greater owned subsidiary (or VIE) is characterized as passive or as if we had held and sold directly our proportionate share of our subsidiary’s (or VIE’s) assets.
Although the law in this regard is not clear, we treat our VIEs as being owned by us for U.S. federal income tax purposes because we exercise effective control over them and are entitled to substantially all of their economic benefits. As a result, we consolidate the VIEs’ results of operations in our consolidated U.S. GAAP financial statements. If it were determined that we are not the owner of our VIEs for U.S. federal income tax purposes, the composition of our income and assets would change and we may be more likely to be treated as a PFIC for the taxable year ended December 31, 2018 and any subsequent taxable year.
We must make a separate determination after Assuming that we are the close of each taxable year as to whether we were a PFIC for that year. Because the valueowner of our assets for purposes of the asset test generally will be determined by reference to the market price of our ADSs or ordinary shares from time to time, our PFIC status will depend in part on the market price of our ADSs or ordinary shares, which may fluctuate significantly,VIEs and the composition of our assets and liabilities. Basedbased on the market price of our ADSs and the value and composition of our assets and liabilities, we believe that we were not a PFIC for U.S. federal income tax purposes for the taxable year ended December 31, 2015.2018 and do not anticipate becoming a PFIC in the foreseeable future. However, as previously disclosed, although not free from doubt, we believed that we were a PFIC for U.S. federal income tax purposes for prior years.
While we do not anticipate being a PFIC in the current taxable year or the foreseeable future, there can be no assurance in this regard because the determination of whether we will be or become a PFIC is a factual determination made after the close of each taxable year that will depend, in part, on the composition of our income and assets.. Fluctuations in the market price of our ADSs may cause us to become a PFIC for the current or subsequent taxable years because the value of our assets for purposes of the asset test generally will be determined by reference to the market price of our ADSs or ordinary shares from time to time (which may be volatile).
Furthermore, because there are uncertainties in the application of the relevant rules, it is possible that the Internal Revenue Service, or IRS, may challenge our classification of certain income or assets as non-passive, or our valuation of our goodwill and other unbooked intangibles, each of which may result in our company becoming classified as a PFIC for the current or subsequent taxable years. If we are a PFIC for any taxable year during which you hold ADSs or ordinary shares, we generally will continue to be treated as a PFIC with respect to you for all succeeding years during which you hold ADSs or ordinary shares. However, if we cease to be a PFIC, provided that you have not made a mark-to-market election, as described below, you may avoid some of the adverse effects of the PFIC regime by making a “deemed sale” election with respect to the ADSs or ordinary shares, as applicable. If such election is made, you will be deemed to have sold our ADSs or ordinary shares you hold at their fair market value and any gain from such deemed sale would be subject to the rules described in the following two paragraphs. After the deemed sale election, so long as we do not become a PFIC in a subsequent taxable year, your ADSs or ordinary shares with respect to which such election was made will not be treated as shares in a PFIC and you will not be subject to the rules described below with respect to any “excess distribution” you receive from us or any gain from an actual sale or other disposition of the ADSs or ordinary shares. The rules dealing with deemed sale elections are very complex.You are strongly urged to consult your tax advisors as to the possibility and consequences of making a deemed sale election if we cease to be a PFIC and such election becomes available to you.
Passive Foreign Investment Company Rules
For each taxable year that we are treated as a PFIC with respect to you, you will be subject to special tax rules with respect to any “excess distribution” you receive and any gain you recognize from a sale or other disposition (including a pledge) of the ADSs or ordinary shares, unless you make a “mark-to-market” election as discussed below. Distributions you receive in a taxable year that are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your holding period for the ADSs or ordinary shares will be treated as an excess distribution. Under these special taxthe PFIC rules, if you receive any excess distribution or recognize any gain from a sale or other disposition of the ADSs or ordinary shares:
| 85 |
| · | the excess distribution or recognized gain will be allocated ratably over your holding period for the ADSs or ordinary shares; |
| · | the amount allocated to the current taxable year, and any taxable years in your holding period prior to the first taxable year in which we became a PFIC (a “pre-PFIC year”), will be taxable as ordinary income; |
| · | the amount allocated to each prior taxable year, other than a pre-PFIC year, will be subject to the highest tax rate in effect for individuals or corporations, as applicable to the U.S. Holder for each such year; and |
| · | the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each prior taxable year other than a pre-PFIC year. |
The tax liability for amounts allocated to years prior to the year of disposition or excess distribution cannot be offset by any net operating losses for such years, and gains (but not losses) from the sale or other disposition of the ADSs or ordinary shares cannot be treated as capital, even if you hold the ADSs or ordinary shares as capital assets.
If we are a PFIC for any taxable year and any of non-U.S. subsidiaries is also a PFIC, a U.S. Holder would be treated as owning a proportionate amount (by value) of the shares of the lower-tier PFIC for purposes of the application of these rules, and could incur liability for the deferred tax and interest charge described below if either (1) we receive a distribution from, or dispose of all or part of our interest in, the lower-tier PFICs or (2) you dispose of all or part of your ADSs or ordinary shares. It is possible that one or more of our subsidiaries were PFICs for the taxable year ending December 31, 2015.2018. You should consult your tax advisors regarding the application of the PFIC rules to any of our subsidiaries.
The tax liability for amounts allocated to years prior to the year of disposition of “excessive distribution” cannot be offset by any net operating losses for such years, and gains (but not losses) realized on the sale of the ADSs or ordinary shares cannot be treated as capital, even if you hold the ADSs or ordinary shares as capital assets.
Alternatively, a U.S. Holder of “marketable stock” (as defined below) of a PFIC may make a mark-to-market election for such stock to elect out of the PFIC rules described above regarding excess distributions and recognized gains. If you make a valid mark-to-market election for the ADSs or ordinary shares, you will include in income for each year that we are a PFIC an amount equal to the excess, if any, of the fair market value of the ADSs or ordinary shares as of the close of your taxable year over your adjusted basis in such ADSs or ordinary shares. You will be allowed a deduction for the excess, if any, of the adjusted basis of the ADSs or ordinary shares over their fair market value as of the close of the taxable year. However, deductions will be allowable only to the extent of any net mark-to-market gains on the ADSs or ordinary shares included in your income for prior taxable years. Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the ADSs or ordinary shares, will be treated as ordinary income. Ordinary loss treatment will apply to the deductible portion of any mark-to-market loss on the ADSs or ordinary shares, as well as to any loss from the actual sale or other disposition of the ADSs or ordinary shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such ADSs or ordinary shares. Your basis in the ADSs or ordinary shares will be adjusted to reflect any such income or loss amounts. If you make a mark-to-market election, any distributions that we make generally would be subject to the tax rules discussed below under “—Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares,” except that the lower tax rate applicable to qualified dividend income would not apply.
The mark-to-market election is available only for “marketable stock,” which is stock that is traded in greater thande minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market, as defined in applicable U.S. Treasury regulations. Although our ADSs are currently listed on, and historically regularly traded on, Nasdaq, which is a qualified exchange or other market for these purposes, no assurance can be given that the ADSs will be regularly traded on an established securities market in the United States for any taxable year. Moreover, if our ADSs are delisted (as described in “Item 3. Key Information—D. Risk Factors—Risks Related to Our Shares and ADSs— Our ADSs may be delisted from the Nasdaq Capital Market as a result of our not meeting the Nasdaq Capital Market continued listing requirements.”), then the mark-to-market election generally would be unavailable to U.S. Holders. If any of our subsidiaries are or become PFICs, the mark-to-market election will likely not be available with respect to the shares of such subsidiaries that are treated as owned by you. Consequently, you could be subject to the PFIC rules with respect to income of the lower-tier PFICs the value of which already had been taken into account indirectly via mark-to-market adjustments. You should consult your tax advisors as to the availability and desirability of a mark-to-market election, as well as the impact of such election on interests in any lower-tier PFICs.
| 86 |
Alternatively, a U.S. Holder of stock in a PFIC may make a “qualified electing fund” election with respect to such corporation to elect out of the PFIC rules described above regarding excess distributions and recognized gains. A U.S. Holder that makes a qualified electing fund election with respect to a PFIC generally will include in income such holder’s pro rata share of the corporation’s income on a current basis. However, you may make a qualified electing fund election with respect to your ADSs or ordinary shares only if we furnish you annually with certain tax information, and we currentlyWe do not intend to prepare or provide such information.information necessary for U.S. Holders to make qualified electing fund elections which, if available, would result in tax treatment different from the general tax treatment for PFICs described above.
Unless otherwise provided by the U.S. Treasury, each U.S. shareholder of a PFIC is required to file an annual report containing such information as the U.S. Treasury may require. In addition, if you hold ADSs or ordinary shares in any year in which we are a PFIC, you will be required to file Internal Revenue ServiceIRS Form 8621 regarding distributions received on the ADSs or ordinary shares and any gain realized on the disposition of the ADSs or ordinary shares. You should consult your tax advisors regarding any reporting requirements that may apply to you.
YOU ARE STRONGLY URGED TO CONSULT YOUR TAX ADVISORS REGARDING THE IMPACT OF OUR BEING A PFIC FOR PRIOR YEARS ON YOUR INVESTMENT IN OUR ADSs AND ORDINARY SHARES AS WELL AS THE APPLICATION OF THE PFIC RULES AND THE POSSIBILITY OF MAKING A MARK-TO-MARKET OR DEEMED SALE ELECTION.
Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares
Subject to the PFIC rules discussed above, the gross amount of any distribution we make to you with respect to the ADSs or ordinary shares generally will be includible in your gross income as dividend income on the date of receipt by the depositary, in the case of ADSs, or by you, in the case of ordinary shares, but only to the extent that the distribution is paid out of our current or accumulated earnings and profits (as computed under U.S. federal income tax principles). The dividends will not be eligible for the dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations. To the extent the amount of the distribution exceeds our current and accumulated earnings and profits, (as computed under U.S. federal income tax principles) such excess amount will be treated first as a tax-free return of your tax basis in your ADSs or ordinary shares, and then, to the extent such excess amount exceeds your tax basis, as a capital gain. Because we do not intend to determine our earnings and profits on the basis of U. S. federal income tax principles, any distribution paid will generally be reported as a “dividend” for U. S. federal income tax purposes.
With respect to certain non-corporate U.S. Holders, including individual U.S. Holders, dividends will be taxed at the lower capital gains rate applicable to “qualified dividend income,” provided that (1) the ADSs or ordinary shares, as applicable, are readily tradable on an established securities market in the United States, or we are eligible for the benefits of a qualifying income tax treaty with the United States that includes an exchange of information program, (2) we are neither a PFIC nor treated as such with respect to you for the taxable year in which the dividend was paid and the preceding taxable year, and (3) certain holding period requirements are met. Under Internal Revenue ServiceIRS authority, common or ordinary shares, or ADSs representing such shares, are considered for the purpose of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on Nasdaq, as are our ADSs (but not our ordinary shares). There can be no assurance that our ADSs will be considered readily tradable on an established securities market in the United States in later years. Moreover, if our ADSs are delisted and not readily tradable on an established securities market in the United States (as described in “Item 3. Key Information—D. Risk Factors—Risks Related to Our Shares and ADSs— Our ADSs may be delisted from the Nasdaq Capital Market as a result of our not meeting the Nasdaq Capital Market continued listing requirements.”), clause (1) above would not be satisfied, and dividends would not qualify for the preferential rate applicable to qualified dividend income. Since we do not expect that our ordinary shares will be listed on an established securities market in the United States, it is unclear if the dividends that we pay on our ordinary shares thatwhich are not backed by ADSs currently meet the conditions required for the reduced tax rate. Furthermore, as previously disclosed, although not free from doubt, we believedbelieve that we were a PFIC for U.S. federal income tax purposes for prior years. If we are treated as a “resident enterprise” for PRC tax purposes under the EIT Law (see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry—The PRC income tax laws may increase our tax burden or the tax burden on the holders of our shares or ADSs, and tax benefits available to us may be reduced or repealed, causing the value of your investment in us to suffer”), we may be eligible for the benefits of the income tax treaty between the United States and the PRC. You should consult your tax advisors regarding the availability of the lower capital gains rate applicable to qualified dividend income for dividends paid with respect to our ADSs or ordinary shares.
| 87 |
Dividends will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are taxed as qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign tax credit limitation in general will be limited to the gross amount of the dividend, multiplied by the reduced tax rate applicable to qualified dividend income and divided by the highest tax rate normally applicable to dividends. The limitation on foreign taxes eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with respect to the ADSs or ordinary shares generally will constitute “passive category income” but could, in the case of certain U.S. Holders, constitute “general category income.”
If PRC withholding taxes apply to dividends paid to you with respect to our ADSs or ordinary shares (see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry—The PRC income tax laws may increase our tax burden or the tax burden on the holders of our shares or ADSs, and tax benefits available to us may be reduced or repealed, causing the value of your investment in us to suffer”decrease”), subject to certain conditions and limitations, such PRC withholding taxes may be treated as foreign taxes eligible for credit against your U.S. federal income tax liability. The rules relating to the determination of the foreign tax credit are complex, and you should consult your tax advisors regarding the availability of a foreign tax credit in your particular circumstances, including the effects of any applicable income tax treaties.
Taxation of Disposition of the ADSs or Ordinary Shares
Subject to the PFIC rules discussed above, you will recognize taxable gain or loss on any sale, exchange or other taxable disposition of an ADS or ordinary share equal to the difference between the amount realized (in U.S. dollars) for the ADS or ordinary share and your tax basis (in U.S. dollars) in the ADS or ordinary share. If the consideration you receive for the ADS or ordinary share is not paid in U.S. dollars, the amount realized will be the U.S. dollar value of the payment received. In general, the U.S. dollar value of such a payment will be determined on the date of receipt of payment if you are a cash basis taxpayer and on the date of disposition if you are an accrual basis taxpayer. However, if the ADSs or ordinary shares, as applicable, are treated as traded on an established securities market and you are either a cash basis taxpayer or an accrual basis taxpayer who has made a special election, you will determine the U.S. dollar value of the amount realized in a foreign currency by translating the amount received at the spot rate of exchange on the settlement date of the sale. The gain or loss generally will be a capital gain or loss. If you are a non-corporate U.S. Holder, including an individual U.S. Holder, that has held the ADS or ordinary share for more than one year, you generally will be eligible for reduced tax rates. The deductibility of capital losses is subject to limitations.
Any gain or loss that you recognize on a disposition of ADSs or ordinary shares generally will be treated as U.S. source income or loss for foreign tax credit limitation purposes (in the case of loss, subject to certain limitations). However, if we are treated as a “resident enterprise” for PRC tax purposes and PRC tax were to be imposed on any gain from the disposition of the ADSs or ordinary shares (see “Item 3. Key Information — Information—D. Risk Factors — Factors—Risks Related to Our Company and Our Industry — Industry—The PRC income tax laws may increase our tax burden or the tax burden on the holders of our shares or ADSs, and tax benefits available to us may be reduced or repealed, causing the value of your investment in us to suffer”decrease”), a U.S. Holder that is eligible for the benefits of the income tax treaty between the United States and the PRC may elect to treat the gain as PRC source income for foreign tax credit purposes. You should consult your tax advisors regarding the proper treatment of gain or loss in your particular circumstances, including the effect of any applicable income tax treaties.
Information Reporting
Dividend payments with respect to ADSs or ordinary shares and proceeds from the sale, exchange or redemption of ADSs or ordinary shares generally will be subject to information reporting to the Internal Revenue Service.
U.S. Holders who are individuals generally will be required to report our name, address and such information relating to an interest in the ADSs or ordinary shares as is necessary to identify the class or issue of which your ADSs or ordinary shares are a part. These requirements are subject to exceptions, including an exception for ADSs or ordinary shares held in accounts maintained by certain financial institutions and an exception applicable if the aggregate value of all “specified foreign financial assets” (as defined in the Code) does not exceed certain thresholds.
U.S. Holders should consult their tax advisors regarding the application of the information reporting rules.
| F. | Dividends and Paying Agents |
Not applicable.
| G. | Statement by Experts |
Not applicable.
| 88 |
| H. | Documents on Display |
We are subject to the periodic reporting and other informational requirements of the Exchange Act. Under the Exchange Act, we are required to file reports and other information with the SEC. Copies of reports and other information, when so filed, may be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the SEC. The SEC also maintains a web site at www.sec.gov that contains reports, proxy and information statements, and other information regarding Registrants that make electronic filings with the SEC using its EDGAR system. As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.
Our financial statements have been prepared in accordance with U.S. GAAP.
We will furnish our shareholders with annual reports, which will include a review of operations and annual audited consolidated financial statements prepared in conformity with U.S. GAAP.
| I. | Subsidiary Information |
For a listing of our subsidiaries, see “Item 4. Information on the Company—C. Organizational Structure.”
Not applicable.
| Item 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Interest Rate Risk
Our exposure to interest rate risk for changes in interest rates relates primarily to the interest income generated by excess cash invested in bank deposits. We have not used any derivative financial instruments in our investment portfolio or for cash management purposes. Interest-earning instruments carry a degree of interest rate risk. We have not been exposed nor do we anticipate being exposed to material risks due to changes in interest rates. However, our future interest income may fall short of expectations due to changes in interest rates.
Foreign Exchange Risk
We are exposed to foreign exchange risk arising from various currency exposures. Our payments to overseas developers, a portion of our financial assets and the Convertible Notes are denominated in U.S. dollars and other foreign currencies, while a significant portion of our revenues are denominated in RMB, the legal currency in China. We have not used any forward contracts or currency borrowings to hedge our exposure to foreign currency risk. The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. Any significant revaluation of RMB against the U.S. dollar may materially affect our earnings and financial position, and the value of, and any dividends payable on, our ADS in U.S. dollars. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—Future movements in exchange rates between the U.S. dollar and the RMB may adversely affect the value of our ADSs.”
A hypothetical 10% increase or decrease in the exchange rate of the U.S. dollar against the RMB would have resulted in an increase or decrease of RMB26.0RMB27.5 million (US$4.0 million) in the aggregate principal amount of our U.S. dollar-denominated convertible notes outstanding as of December 31, 2015.2018.
| Item 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES |
| A. | Debt Securities |
Not applicable.
| B. | Warrants and Rights |
Not applicable.
| C. | Other Securities |
Not applicable.
| 89 |
| D. |
The Bank of New York Mellon, our ADS depositary, collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deductions from cash distributions, or by directly billing investors, or by charging the book-entry system accounts of participants acting for them. The depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.
Persons depositing or withdrawing shares must pay: | For: | |
| US$5.00 (or less) per 100 ADSs (or portion of 100 ADSs) |
| |
| · Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates | ||
| US$0.02 (or less) per ADS |
| |
| A fee equivalent to the fee that would be payable if securities distributed to you had been shares and the shares had been deposited for issuance of ADSs |
| |
| US$0.02 (or less) per ADS per calendar year |
|
|
| |
| Registration or transfer fees |
| |
| Expenses of the depositary |
| |
| · Converting foreign currency to U.S. dollars | ||
| Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes |
| |
| Any charges incurred by the depositary or its agents for servicing the deposited securities | · As necessary |
• As necessary
The depositary has agreed to reimburse us for expenses we incur that are related to the administration and maintenance of our ADS facility including, but not limited to, investor relations expenses, the annual Nasdaq Stock Market continued listing fees or any other program related expenses every year. There are limits on the amount of expenses for which the depositary will reimburse us, but the amount of reimbursement available to us is not related to the amounts of fees the depositary collects from investors. As of December 31, 2015,2018, we had US$0.10.2 million reimbursement receivable for the year 2015,2018, after deducting withholding tax, from the depositary as reimbursement for legal fees and administrative expenses.
| Item 13. | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES |
None.
| 90 |
| Item 14. | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS |
Shareholder Rights Plan
On January 8, 2009, our board of directors declared a dividend of one ordinary share purchase right, or a Right, for each of our ordinary shares outstanding at the close of business on January 22, 2009. As long as the Rights are attached to the ordinary shares, we will issue one Right (subject to adjustment) with each new ordinary share so that all such ordinary shares will have attached Rights. When exercisable, each Right will entitle the registered holder to purchase from us one ordinary share at a price of US$19.50 per ordinary share, subject to adjustment.
The Rights will expire on January 8, 2019, subject to our right to extend such date and are exercisable only if a person or group obtains ownership of or announces a tender offer for 15% or more of our voting securities (including ADSs representing our ordinary shares). Upon exercise, all Rights holders except the potential acquirer will be entitled to acquire our shares or the acquirer’s shares at a discount. We are entitled to redeem the Rights in whole at any time on or before the acquisition by a person or group of 15% or more of our voting securities (which for these purposes include ADSs representing ordinary shares), or exchange the Rights, in whole or in part, at an exchange ratio of one ordinary share, and of other securities, cash or other assets deemed to have the same value as one ordinary share, per Right, subject to adjustment.
Use of Proceeds
Not Applicable.
| Item 15. | CONTROLS AND PROCEDURES |
Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, has performed an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)13a-15I under the Exchange Act) as of the end of the period covered by this report, as required by Rule 13a-15(b) under the Exchange Act. Based upon that evaluation, our management haschief executive officer and chief financial officer have concluded that, as of December 31, 2015,2018, our disclosure controls and procedures were effective in ensuring that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act was recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such item is defined in Rules 13a-15(f) under the Exchange Act, for our company. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements in accordance with U.S. GAAP and includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of a company’s assets, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that a company’s receipts and expenditures are being made only in accordance with authorizations of a company’s management and directors, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of a company’s assets that could have a material effect on the consolidated financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process, and it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
As required by Section 404 of the Sarbanes-Oxley Act and related rules as promulgated by the SEC, our management assessed the effectiveness of the internal control over financial reporting as of December 31, 20152018 using criteria established in “Internal Control—Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, our management concluded that our internal control over financial reporting was effective as of December 31, 2015.2018.
Attestation Report of the Registered Public Accounting Firm
This annual report on Form 20-F does not include an attestation report of our registered public accounting firm because our company is neither an accelerated filer nor a large accelerated filer, as such terms are defined in Rule 12b-2 under the Exchange Act.
| 91 |
Changes in Internal Control over Financial Reporting
Our management has evaluated, with the participation of our chief executive officer and chief financial officer, whether any changes in our internal control over financial reporting that occurred during our last fiscal year have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on the evaluation we conducted, our management has concluded that no such changes occurred during the period covered by this annual report on Form 20-F.
| Item 16A. | AUDIT COMMITTEE FINANCIAL EXPERT |
See “Item 6. Directors, Senior Management and Employees—C. Board Practices.”
| Item 16B. | CODE OF ETHICS |
Our board of directors has adopted a code of ethics that applies to our directors, officers, employees and agents, including certain provisions that specifically apply to our chief executive officer, chief financial officer, principal accounting officer, controller, vice presidents and any other persons who perform similar functions for us. We hereby undertake to provide to any person, without charge, a copy of our code of business conduct and ethics within ten working days after we receive such person’s written request.
| Item 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
The following table sets forth the aggregate fees by categories specified below in connection with certain professional services rendered by Deloitte Touche Tohmatsu Certified Public Accounts LLP,Grant Thornton, our principal external auditors for the periods indicated below.
| 2014 | 2015 | |||||||||||
| RMB | RMB | US$ | ||||||||||
Audit fees(1) | 5,275,328 | 4,500,000 | 694,680 | |||||||||
Audit-related fees(2) | — | — | — | |||||||||
Tax fees(3) | 4,924 | 152,003 | 23,465 | |||||||||
| 2017 | 2018 | |||||||||||
| RMB | RMB | US$ | ||||||||||
| Audit fees(1) | 2,640,000 | 2,510,000 | 365,064 | |||||||||
| Tax fees(2) | — | — | — | |||||||||
| (1) | “Audit fees” means the aggregate fees billed in each of the fiscal years listed for professional services rendered by our principal auditors for the audit of our annual financial statements. |
| “Tax fees” means the fees billed for tax compliance services, including the preparation of tax returns and tax consultations. |
The policy of our audit committee is to pre-approve all audit and non-audit services provided by our independent registered public accounting firm, including audit services, audit-related services, tax services and other services as described above, other than those forde minimus services which are approved by our audit committee prior to the completion of the audit.
| Item 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES |
Not applicable.
| Item 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS |
None.
| Item 16F. | CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT |
Not applicable.
| Item 16G. | CORPORATE GOVERNANCE |
We are an exempted company incorporated in the Cayman Islands and our corporate governance practices are governed by applicable Cayman Islands law. In addition, because our ADSs are listed on the Nasdaq GlobalCapital Market, we are subject to corporate governance requirements of the Nasdaq. However, Nasdaq Marketplace Rule 5615(a)(3) permits foreign private issuers like us to follow “home country practice” with respect to certain corporate governance matters, and we may decide to follow the “home country practice” on a case-by-case basis. In each of November 2015 and August 2016, our board of directors approved an increase in the total number of ordinary shares reserved for issuance under our Option Plan, for which we have followed “home country practice” in lieu of obtaining a shareholder approval pursuant to Nasdaq Marketing Rule 5635(c). We are committed to a high standard of corporate governance. As such, we endeavor to comply with most of the Nasdaq corporate governance practices and believe that we are currently in compliance with the Nasdaq corporate governance practices.
| 92 |
| Item 16H. | MINE SAFETY DISCLOSURE |
Not applicable.
| Item 17. | FINANCIAL STATEMENTS |
We have elected to provide financial statements pursuant to Item 18.
| Item 18. | FINANCIAL STATEMENTS |
The consolidated financial statements for The9 Limited and its subsidiaries are included at the end of this annual report.
| Item 19. | EXHIBITS |
| 93 |
| 94 |
| (incorporated by reference to Exhibit 4.23 from our Annual Report on Form 20-F filed with the Securities and Exchange Commission on April 11, 2016) | ||
| ||
| 4.24 | Share Purchase Agreement dated June 15, 2017 between IE Limited and the Registrant (incorporated by reference to Exhibit 4.1 from Schedule 13D filed by IE Limited with the Securities and Exchange Commission on July 12, 2017) |
| 95 |
| * | Filed with this Form 20-F. |
| ** | Furnished with this Form 20-F. |
| 96 |
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
| The9 Limited | ||||
| ||||
| By: | /s/ Jun Zhu | |||
| Name: Jun Zhu | ||||
| Title: | Chairman and Chief Executive Officer | |||
Date: April 11, 2016
| 97 |
THE9 LIMITED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
| Page | ||||
| F-2 | ||||
| F-3 | ||||
Consolidated Balance Sheets as of December 31, | F-5 | |||
| F-6 | ||||
| F-9 | ||||
| F-10 | ||||
Schedule 1 – | F-84 | |||
| F-1 |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Shareholders of The9 Limited:
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of The9 Limited, and its subsidiaries and its variable interest entities (the “Group”) as of December 31, 20142018 and 2015, and2017, the related consolidated statements of operations and comprehensive loss, changes in equity, and cash flows for each of the three years in the period ended December 31, 20152018, and the related notes and the financial statement schedule included in Schedule 1. These consolidated(collectively referred to as the “consolidated financial statements and financial statement schedule are the responsibility of the Group’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States)statements”). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Group is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, suchthe consolidated financial statements present fairly, in all material respects, the financial position of the Group atas of December 31, 20142018 and 2015,2017, and the results of theirits operations, changes in equity and their cash flows for each of the three years in the period ended December 31, 2015,2018, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects, the information set forth therein.
Our audits also comprehended the translation of Renminbi amounts into United States dollar amounts and, in our opinion, such translation has been made in conformity with the basis stated in Note 3. Such United States dollar amounts are presented solely for the convenience of readers in the United States of America.
Going concern
The accompanying consolidated financial statements have been prepared assuming that the Group will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Group’s recurring losses from operationsGroup has an accumulated deficit of approximately RMB3,233.1 million (US$470.2 million) as of December 31, 2018, and negative cash flows from operations,incurred a net loss of approximately RMB239.3 million (US$34.8 million) for the year ended December 31, 2018. These conditions, along with other matters set forth in Note 2, in the consolidated financial statements, raise substantial doubt about itsthe Group’s ability to continue as a going concern. Management’s plans concerningin regard to these matters are also discussed in Note 2 to the consolidated financial statements.2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ Deloitte Touche Tohmatsu Certified
Change in accounting principles
As discussed in Note 2 to the consolidated financial statements, the Group has changed its method of accounting for revenue from contracts with customers in 2018 due to the adoption of ASC 606 “Revenue from Contracts with Customers”.
Basis for opinion
These consolidated financial statements are the responsibility of the Group’s management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Accountants LLPCompany Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Group in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Group is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
| /s/ GRANT THORNTON |
We have served as the Group’s auditor since 2016.
Shanghai, China
April 11, 2016
THE9 LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2013, 2014 AND 2015
| 2013 | 2014 | 2015 | 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
Revenues: | ||||||||||||||||
Online game services | 95,131,347 | 55,417,700 | 40,504,363 | 6,252,797 | ||||||||||||
Other revenues | 11,495,630 | 9,421,865 | 6,105,523 | 942,530 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
| 106,626,977 | 64,839,565 | 46,609,886 | 7,195,327 | |||||||||||||
Sales taxes | (1,850,908 | ) | (562,674 | ) | (198,555 | ) | (30,652 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Total net revenues | 104,776,069 | 64,276,891 | 46,411,331 | 7,164,675 | ||||||||||||
Cost of revenues | (107,803,360 | ) | (85,782,569 | ) | (67,743,995 | ) | (10,457,871 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Gross loss | (3,027,291 | ) | (21,505,678 | ) | (21,332,664 | ) | (3,293,196 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Operating (expenses) income: | ||||||||||||||||
Product development | (213,243,567 | ) | (156,253,036 | ) | (135,042,829 | ) | (20,847,020 | ) | ||||||||
Sales and marketing | (116,672,411 | ) | (51,758,100 | ) | (31,692,522 | ) | (4,892,482 | ) | ||||||||
General and administrative | (161,958,423 | ) | (111,157,250 | ) | (131,768,503 | ) | (20,341,552 | ) | ||||||||
(Provision)/reversal of provision for allowance for long-term receivables and prepayments | (29,741,076 | ) | 14,371,918 | (8,439,580 | ) | (1,302,847 | ) | |||||||||
Impairment of long-lived assets | (5,725,046 | ) | — | — | — | |||||||||||
Gain on disposal of subsidiaries | — | 165,392,382 | 3,339,394 | 515,514 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total operating expenses | (527,340,523 | ) | (139,404,086 | ) | (303,604,040 | ) | (46,868,387 | ) | ||||||||
Other operating income (expenses) | 120,000 | 75,000 | (1,563,518 | ) | (241,366 | ) | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Loss from operations | (530,247,814 | ) | (160,834,764 | ) | (326,500,222 | ) | (50,402,949 | ) | ||||||||
Impairment on investments | (47,970,885 | ) | — | — | — | |||||||||||
Interest income | 8,376,355 | 3,414,559 | 775,152 | 119,663 | ||||||||||||
Interest expense | — | — | (6,397,192 | ) | (987,556 | ) | ||||||||||
Fair value change on warrants liability | — | — | (7,129,161 | ) | (1,100,553 | ) | ||||||||||
Gain on disposal of equity investee and available-for-sale investment | — | 33,153,452 | — | — | ||||||||||||
Other income (expenses), net | 9,301,565 | (963,125 | ) | (1,916,755 | ) | (295,896 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Loss before income tax expense and share of loss in equity method investments | (560,540,779 | ) | (125,229,878 | ) | (341,168,178 | ) | (52,667,291 | ) | ||||||||
Income tax expense | — | — | — | — | ||||||||||||
Share of loss in equity method investments | (2,375,826 | ) | (3,712,530 | ) | (13,013,791 | ) | (2,008,983 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net loss for the year | (562,916,605 | ) | (128,942,408 | ) | (354,181,969 | ) | (54,676,274 | ) | ||||||||
Net loss attributable to noncontrolling interest | (36,655,033 | ) | (21,443,321 | ) | (16,655,902 | ) | (2,571,228 | ) | ||||||||
Net loss attributable to redeemable noncontrolling interest | — | (20,876,617 | ) | (32,697,713 | ) | (5,047,657 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Attributable net loss to The9 Limited | (526,261,572 | ) | (86,622,470 | ) | (304,828,354 | ) | (47,057,389 | ) | ||||||||
Change in redemption value of redeemable noncontrolling interest | — | 21,076,744 | 79,805,706 | 12,319,878 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net loss attributable to holders of ordinary shares | (526,261,572 | ) | (107,699,214 | ) | (384,634,060 | ) | (59,377,267 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Other comprehensive income (loss) | ||||||||||||||||
Unrealized loss on available-for-sale investment | (16,600 | ) | — | — | — | |||||||||||
Currency translation adjustments | (688,963 | ) | (1,203,960 | ) | 5,009,430 | 773,323 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Total comprehensive loss | (563,622,168 | ) | (130,146,368 | ) | (349,172,539 | ) | (53,902,951 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
| F-2 |
CONSOLIDATED STATEMENTS OF OPERATIONOPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2013, 20142016, 2017 AND 20152018
| 2013 | 2014 | 2015 | 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
Comprehensive loss attributable to: | ||||||||||||||||
noncontrolling interest | (35,084,526 | ) | (22,995,718 | ) | (16,912,488 | ) | (2,610,838 | ) | ||||||||
redeemable noncontrolling interest | — | (20,876,617 | ) | (32,697,713 | ) | (5,047,657 | ) | |||||||||
The9 Limited | (528,537,642 | ) | (86,274,033 | ) | (299,562,338 | ) | (46,244,456 | ) | ||||||||
Net loss attributable to holders of ordinary shares per share: | ||||||||||||||||
- Basic and diluted | (22.71 | ) | (4.65 | ) | (16.55 | ) | (2.56 | ) | ||||||||
Weighted average number of shares outstanding: | ||||||||||||||||
- Basic and diluted | 23,174,823 | 23,164,695 | 23,235,848 | 23,235,848 | ||||||||||||
| 2016 | 2017 | 2018 | 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Revenues: | ||||||||||||||||
| Online game services | 48,565,620 | 71,564,023 | 16,551,080 | 2,407,255 | ||||||||||||
| Other revenues | 7,719,902 | 1,644,143 | 941,335 | 136,911 | ||||||||||||
| 56,285,522 | 73,208,166 | 17,492,415 | 2,544,166 | |||||||||||||
| Sales taxes | (86,236 | ) | (59,610 | ) | (60,557 | ) | (8,808 | ) | ||||||||
| Total net revenues | 56,199,286 | 73,148,556 | 17,431,858 | 2,535,358 | ||||||||||||
| Cost of revenues | (48,518,779 | ) | (23,782,054 | ) | (16,435,590 | ) | (2,390,457 | ) | ||||||||
| Gross profit | 7,680,507 | 49,366,502 | 996,268 | 144,901 | ||||||||||||
| Operating (expenses) income: | ||||||||||||||||
| Product development | (77,991,408 | ) | (45,112,396 | ) | (24,555,308 | ) | (3,571,421 | ) | ||||||||
| Sales and marketing | (21,286,647 | ) | (9,089,969 | ) | (2,325,818 | ) | (338,276 | ) | ||||||||
| General and administrative | (129,047,846 | ) | (108,824,680 | ) | (89,583,331 | ) | (13,029,355 | ) | ||||||||
| Impairment on goodwill | (10,561,857 | ) | - | - | - | |||||||||||
| Impairment on intangible assets | (68,003,805 | ) | - | - | - | |||||||||||
| Gain on disposal of subsidiaries | - | - | 10,473,159 | 1,523,258 | ||||||||||||
| Total operating expenses | (306,891,563 | ) | (163,027,045 | ) | (105,991,298 | ) | (15,415,794 | ) | ||||||||
| Other operating income, net | 3,604,749 | 349,954 | 229,538 | 33,385 | ||||||||||||
| Loss from operations | (295,606,307 | ) | (113,310,589 | ) | (104,765,492 | ) | (15,237,508 | ) | ||||||||
| Impairment on equity investment and available-for-sale investment | (244,798,058 | ) | - | (1,386,174 | ) | (201,611 | ) | |||||||||
| Impairment on other investments | (2,806,439 | ) | (9,109,312 | ) | (7,776,157 | ) | (1,130,995 | ) | ||||||||
| Interest income | 161,144 | 30,525 | 193,928 | 28,206 | ||||||||||||
| Interest expense | (56,471,609 | ) | (83,922,200 | ) | (104,776,674 | ) | (15,239,135 | ) | ||||||||
| Fair value change on warrants liability | 48,057,204 | 12,615,466 | 2,251,427 | 327,456 | ||||||||||||
| (Loss) gain on disposal of equity investee and available-for-sale investment | (1,217,405 | ) | 115,349 | - | - | |||||||||||
| Foreign exchange (loss) gain | (13,131,779 | ) | 19,206,747 | (20,331,430 | ) | (2,957,084 | ) | |||||||||
| Other income, net | 3,179,508 | 4,669,587 | 1,598,663 | 232,516 | ||||||||||||
| Loss before income tax expense and share of loss in equity method investments | (562,633,741 | ) | (169,704,427 | ) | (234,991,909 | ) | (34,178,155 | ) | ||||||||
| Income tax benefit | 6,079,282 | - | - | - | ||||||||||||
| Recovery of equity investment in excess of cost | - | 60,548,651 | - | - | ||||||||||||
| Share of loss in equity method investments | (110,535,486 | ) | (2,937,131 | ) | (4,292,887 | ) | (624,375 | ) | ||||||||
| Net loss | (667,089,945 | ) | (112,092,907 | ) | (239,284,796 | ) | (34,802,530 | ) | ||||||||
| Net (loss) gain attributable to noncontrolling interest | (58,584,204 | ) | 3,955,640 | (16,332,968 | ) | (2,375,532 | ) | |||||||||
| Net (loss) gain attributable to redeemable noncontrolling interest | (14,724,152 | ) | 2,117,303 | (5,858,902 | ) | (852,142 | ) | |||||||||
| Net loss attributable to The9 Limited | (593,781,589 | ) | (118,165,850 | ) | (217,092,926 | ) | (31,574,856 | ) | ||||||||
| Change in redemption value of redeemable noncontrolling interest | (82,890,188 | ) | (57,126,233 | ) | (40,918,773 | ) | (5,951,389 | ) | ||||||||
| Net loss attributable to holders of ordinary shares | (676,671,777 | ) | (175,292,083 | ) | (258,011,699 | ) | (37,526,245 | ) | ||||||||
| Other comprehensive loss, net of tax: | ||||||||||||||||
| Currency translation adjustments | (1,754,639 | ) | (9,525,761 | ) | (1,314,265 | ) | (191,153 | ) | ||||||||
| Total comprehensive loss | (668,844,584 | ) | (121,618,668 | ) | (240,599,061 | ) | (34,993,683 | ) | ||||||||
| F-3 |
THE9 LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2016, 2017 AND 2018
| 2016 | 2017 | 2018 | 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Comprehensive (loss) gain attributable to: | ||||||||||||||||
| Noncontrolling interest | (66,293,454 | ) | 13,457,650 | (24,888,425 | ) | (3,619,871 | ) | |||||||||
| Redeemable noncontrolling interest | (14,724,152 | ) | 2,117,303 | (5,858,902 | ) | (852,142 | ) | |||||||||
| The9 Limited | (587,826,978 | ) | (137,193,621 | ) | (209,851,734 | ) | (30,521,670 | ) | ||||||||
| Net loss attributable to holders of ordinary shares per share: | ||||||||||||||||
| - Basic and diluted | (28.34 | ) | (5.24 | ) | (4.15 | ) | (0.60 | ) | ||||||||
| Weighted average number of shares outstanding: | ||||||||||||||||
| - Basic and diluted | 23,874,102 | 33,426,448 | 62,114,760 | 62,114,760 | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-4 |
AS OF DECEMBER 31, 20142017 AND 20152018
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
ASSETS | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | 181,482,300 | 49,010,541 | 7,565,924 | |||||||||
Accounts receivable, net of allowance for doubtful accounts of RMB480,926 and RMB991,743 as of December 31, 2014 and 2015, respectively | 11,804,750 | 7,153,663 | 1,104,335 | |||||||||
Advances to suppliers | 733,339 | 898,126 | 138,647 | |||||||||
Prepayments and other current assets | 56,573,321 | 9,463,149 | 1,460,858 | |||||||||
Deferred costs | 9,745 | — | — | |||||||||
Amounts due from a related party | 5,250,000 | 10,732,643 | 1,656,835 | |||||||||
|
|
|
|
|
| |||||||
Total current assets | 255,853,455 | 77,258,122 | 11,926,599 | |||||||||
Investments in equity investees | 39,223,925 | 267,539,694 | 41,301,012 | |||||||||
Property, equipment and software, net | 36,346,230 | 33,846,518 | 5,225,002 | |||||||||
Goodwill | 9,746,054 | 10,342,694 | 1,596,637 | |||||||||
Intangible assets, net | 97,539,341 | 78,876,486 | 12,176,431 | |||||||||
Land use right, net | 70,273,296 | 68,352,386 | 10,551,790 | |||||||||
Other long-lived assets, net | 8,348,409 | 1,879,021 | 290,071 | |||||||||
|
|
|
|
|
| |||||||
TOTAL ASSETS | 517,330,710 | 538,094,921 | 83,067,542 | |||||||||
|
|
|
|
|
| |||||||
LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND SHAREHOLDERS’ EQUITY (DEFICIT) | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable (including accounts payable of the consolidated VIEs without recourse to the Group of 15,458,464 and 7,292,389 as of December 31, 2014 and December 31, 2015 respectively) | 40,213,660 | 41,248,455 | 6,367,665 | |||||||||
Other taxes payable (including other taxes payable of the consolidated VIEs without recourse to the Group of 443,467 and 266,323 as of December 31, 2014 and December 31, 2015 respectively) | 932,431 | 551,445 | 85,128 | |||||||||
Advances from customers (including advances from customers of the consolidated VIEs without recourse to the Group of 7,192,127 and 8,913,065 as of December 31, 2014 and December 31, 2015 respectively) | 16,833,165 | 19,605,593 | 3,026,582 | |||||||||
Amounts due to related parties (including amounts due to related parties of the consolidated VIEs without recourse to the Group of 7,203,895 and 11,865,648 as of December 31, 2014 and December 31, 2015 respectively) | 6,304,956 | 77,730,267 | 11,999,485 | |||||||||
Deferred revenue (including deferred revenue of the consolidated VIEs without recourse to the Group of 4,990,959 and 4,732,678 as of December 31, 2014 and December 31, 2015 respectively) | 20,434,962 | 18,552,217 | 2,863,969 | |||||||||
Refund of game points (including refund of game points of the consolidated VIEs without recourse to the Group of 169,998,682 as of both December 31, 2014 and December 31, 2015) | 169,998,682 | 169,998,682 | 26,243,274 | |||||||||
Warrants (including warrants of consolidated VIEs without recourse to the Group of nil as of both December 31, 2014 and December 31, 2015) | — | 64,414,941 | 9,943,953 | |||||||||
Accrued expense and other current liabilities (including accrued expense and other current liabilities of the consolidated VIEs without recourse to the Group of 26,346,672 and 19,082,615 as of December 31, 2014 and December 31, 2015 respectively) | 41,872,851 | 35,864,424 | 5,536,514 | |||||||||
|
|
|
|
|
| |||||||
Total current liabilities | 296,590,707 | 427,966,024 | 66,066,570 | |||||||||
Long-term accounts payable (including long-term accounts payable of the consolidated VIEs without recourse to the Group of nil as of both December 31, 2014 and December 31, 2015) | 18,992,201 | — | — | |||||||||
Long-term debt (including long-term debt of consolidated VIEs without recourse to the Group of nil as of both December 31, 2014 and December 31, 2015) | — | 31,726,575 | 4,897,739 | |||||||||
December 31, | December 31, | December 31, | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| ASSETS | ||||||||||||
| Current assets: | ||||||||||||
| Cash and cash equivalents | 142,624,020 | 4,256,449 | 619,075 | |||||||||
| Accounts receivable, net of allowance for doubtful accounts of RMB1,039,958 and RMB1,149,864 as of December 31, 2017 and 2018, respectively | 2,607,568 | 592,897 | 86,233 | |||||||||
| Advances to suppliers | 8,102,278 | 15,808,042 | 2,299,184 | |||||||||
| Prepayments and other current assets | 6,616,297 | 6,148,787 | 894,304 | |||||||||
| Amounts due from related parties | 2,492,842 | 6,207,846 | 902,894 | |||||||||
| Assets held for sale | 20,669,377 | - | - | |||||||||
| Total current assets | 183,112,382 | 33,014,021 | 4,801,690 | |||||||||
| Investments | 48,243,558 | 45,216,118 | 6,576,412 | |||||||||
| Property, equipment and software, net | 20,721,252 | 17,352,445 | 2,523,808 | |||||||||
| Land use right, net | 64,510,566 | 62,589,656 | 9,103,288 | |||||||||
| Other long-lived assets, net | 6,521,420 | 6,515,200 | 947,597 | |||||||||
| TOTAL ASSETS | 323,109,178 | 164,687,440 | 23,952,795 | |||||||||
| LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND SHAREHOLDERS’ EQUITY (DEFICIT) | ||||||||||||
| Current liabilities: | ||||||||||||
| Short-term borrowings (including short-term borrowings of the consolidated VIEs without recourse to the Group of nil as of both December 31, 2017 and 2018) | 108,743,369 | 112,461,383 | 16,356,830 | |||||||||
| Accounts payable (including accounts payable of the consolidated VIEs without recourse to the Group of RMB6,706,484 and RMB 5,920,126 as of December 31, 2017 and 2018, respectively) | 37,129,671 | 38,035,661 | 5,532,057 | |||||||||
| Other taxes payable (including other taxes payable of the consolidated VIEs without recourse to the Group of RMB169,300 and RMB1,398,996 as of December 31, 2017 and 2018, respectively) | 1,714,992 | 2,949,082 | 428,926 | |||||||||
| Advances from customers (including advances from customers of the consolidated VIEs without recourse to the Group of RMB24,558,422 and RMB23,976,676 as of December 31, 2017 and 2018, respectively) | 47,558,542 | 39,631,950 | 5,764,228 | |||||||||
| Amounts due to related parties (including amounts due to related parties of the consolidated VIEs without recourse to the Group of RMB55,361,287 and RMB62,268,751 as of December 31, 2017 and 2018, respectively) | 88,939,108 | 71,849,633 | 10,450,096 | |||||||||
| Deferred revenue (including deferred revenue of the consolidated VIEs without recourse to the Group of RMB4,568,595 and nil as of December 31, 2017 and 2018, respectively) | 5,576,269 | 159,125 | 23,144 | |||||||||
| Refund of game points (including refund of game points of the consolidated VIEs without recourse to the Group of RMB169,998,682 as of both December 31, 2017 and 2018) | 169,998,682 | 169,998,682 | 24,725,283 | |||||||||
| Warrants (including warrants of consolidated VIEs without recourse to the Group of nil as of both December 31, 2017 and 2018) | 3,742,271 | 1,490,844 | 216,834 | |||||||||
| Convertible notes (including convertible notes of consolidated VIEs without recourse to the Group of nil as of both December 31, 2017 and 2018) | 260,563,020 | 375,257,140 | 54,578,887 | |||||||||
| Interest payable (including interest payable of consolidated VIEs without recourse to the Group of nil as of both December 31, 2017 and 2018) | 9,505,843 | 15,298,961 | 2,225,142 | |||||||||
| Accrued expenses and other current liabilities (including accrued expenses and other current liabilities of the consolidated VIEs without recourse to the Group of RMB69,543,098 and RMB67,862,435 as of December 31, 2017 and 2018, respectively) | 83,700,051 | 81,291,306 | 11,823,330 | |||||||||
| Liabilities directly associated with assets held for sale | 2,273,532 | - | - | |||||||||
| Total current liabilities | 819,445,350 | 908,423,767 | 132,124,757 | |||||||||
| TOTAL LIABILITIES | 819,445,350 | 908,423,767 | 132,124,757 | |||||||||
| Commitments and contingencies (Note 30) | ||||||||||||
| Redeemable noncontrolling interest (Note 28) | 306,014,668 | 341,074,539 | 49,607,234 | |||||||||
| SHAREHOLDERS’ EQUITY (DEFICIT): | ||||||||||||
| Ordinary shares (US$0.01 par value; 44,544,036 and 91,315,465 shares issued and outstanding as of December 31, 2017 and 2018, respectively) | 3,328,852 | 6,502,658 | 945,772 | |||||||||
| Additional paid-in capital | 2,527,215,315 | 2,496,069,065 | 363,038,188 | |||||||||
| Statutory reserves | 28,071,982 | 28,071,982 | 4,082,900 | |||||||||
| Accumulated other comprehensive loss | (16,445,748 | ) | (9,204,556 | ) | (1,338,746 | ) | ||||||
| Accumulated deficit | (3,015,968,137 | ) | (3,233,061,063 | ) | (470,229,228 | ) | ||||||
| The9 Limited shareholders’ deficit | (473,797,736 | ) | (711,621,914 | ) | (103,501,114 | ) | ||||||
| Noncontrolling interest | (328,553,104 | ) | (373,188,952 | ) | (54,278,082 | ) | ||||||
| Total shareholders’ deficit | (802,350,840 | ) | (1,084,810,866 | ) | (157,779,196 | ) | ||||||
| TOTAL LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND SHAREHOLDERS’ EQUITY | 323,109,178 | 164,687,440 | 23,952,795 | |||||||||
Convertible notes (including convertible notes of consolidated VIEs without recourse to the Group of nil as of both December 31, 2014 and December 31, 2015) Deferred tax liabilities, non-current (including deferred tax liabilities, non-current of the consolidated VIEs without recourse to the Group of nil as of both December 31, 2014 and December 31, 2015) TOTAL LIABILITIES Commitments and contingencies (Note 33) Redeemable noncontrolling interest (Note 31) SHAREHOLDERS’ EQUITY (DEFICITS): Ordinary shares (US$0.01 par value; 23,201,601 and 23,701,601 shares issued and outstanding as of December 31, 2014 and December 31, 2015, respectively) Additional paid-in capital Statutory reserves Accumulated other comprehensive loss Accumulated deficit The9 Limited shareholders’ equity (deficit) Noncontrolling interest Total shareholders’ equity (deficit) TOTAL LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND SHAREHOLDERS’ EQUITY (DEFICIT) — 135,182,536 20,868,587 5,362,427 5,690,705 878,494 320,945,335 600,565,840 92,711,390 131,497,104 178,605,097 27,571,876 1,885,153 1,917,620 296,030 2,075,900,461 2,080,041,288 321,103,042 28,071,982 28,071,982 4,333,567 (8,638,604 ) (3,372,588 ) (520,638 ) (1,999,192,344 ) (2,304,020,698 ) (355,679,505 ) 98,026,648 (197,362,396 ) (30,467,504 ) (33,138,377 ) (43,713,620 ) (6,748,220 ) 64,888,271 (241,076,016 ) (37,215,724 ) 517,330,710 538,094,921 83,067,542
The accompanying notes are an integral part of these consolidated financial statements.
| F-5 |
THE9 LIMITED
Additional paid-in capital Statutory reserves Accumulated deficit Equity (deficit) Noncontrolling interest Balance as of January 1, 2014 Net loss Currency translation adjustments Exercise of options Change in redemption value of redeemable noncontrolling interest Share-based compensation Change in equity interest attributable to noncontrolling interest Change in equity interest attributable to non-controlling interest due to restructuring of Red 5 Singapore Conversion of loans due from Red 5 to equity Issuance of shares of Red 5 upon exercise of stock options Balance as of December 31, 2014 The9 Limited shareholder’s equity (deficit) Ordinary shares Accumulated
other
comprehensive
loss
attributable
to The9
limited Total Shareholders’
Equity (deficit) (US$0.01 par value) Number of
shares Par value RMB RMB RMB RMB RMB RMB RMB RMB 23,146,859 1,881,784 2,152,320,786 28,071,982 (8,987,041 ) (1,912,569,874 ) 260,717,637 (70,584,494 ) 190,133,143 — — — — — (86,622,470 ) (86,622,470 ) (21,443,321 ) (108,065,791 ) 348,437 — 348,437 (1,552,397 ) (1,203,960 ) 54,742 3,369 809,266 — — — 812,635 — 812,635 (21,076,744 ) — — — (21,076,744 ) — (21,076,744 ) — — 2,703,685 — — — 2,703,685 968,615 3,672,300 — — (42,692,211 ) — — — (42,692,211 ) 42,692,211 — 15,068,103 — — — 15,068,103 (15,068,103 ) — — — (31,784,850 ) — — — (31,784,850 ) 31,784,850 — — — 552,426 — — — 552,426 64,262 616,688 23,201,601 1,885,153 2,075,900,461 28,071,982 (8,638,604 ) (1,999,192,344 ) 98,026,648 (33,138,377 ) 64,888,271
Additional paid-in Statutory reserves Accumulated deficit Equity (deficit) Noncontrolling interest Balance as of January 1, 2015 Net loss Currency translation adjustments Change in redemption value of redeemable noncontrolling interest Noncontrolling interest on The9 Education Issuance of ordinary shares upon vesting of restricted shares Change in noncontrolling interest due to disposal of Jiucheng Advertisement Co., Ltd. Purchase additional equity interest in a subsidiary Beneficial conversion feature on convertible notes Share-based compensation Change in equity interest attributable to noncontrolling interest Issuance of shares of Red 5 upon exercise of stock options Balance as of December 31, 2015 Balance as of December 31, 2015 (US$ except share data, Note 3) The9 Limited shareholder’s equity (deficit) Ordinary shares
capital Accumulated
other
comprehensive
loss
attributable
to The
limited Total Shareholders’
Equity (deficit) (US$0.01 par value) Number
of shares Par
value RMB RMB RMB RMB RMB RMB RMB RMB 23,201,601 1,885,153 2,075,900,461 28,071,982 (8,638,604 ) (1,999,192,344 ) 98,026,648 (33,138,377 ) 64,888,271 — — — — — (304,828,354 ) (304,828,354 ) (16,655,902 ) (321,484,256 ) 5,266,016 — 5,266,016 (256,586 ) 5,009,430 — (79,805,706 ) — — — (79,805,706 ) — (79,805,706 ) — — 366,631 — — — 366,631 4,133,369 4,500,000 500,000 32,467 (32,467 ) — — — — — — — — — — — — — (298,336 ) (298,336 ) — — (2,408,096 ) — — — (2,408,096 ) 1,751,297 (656,799 ) — — 52,679,692 — — — 52,679,692 — 52,679,692 — — 33,184,307 — — — 33,184,307 823,322 34,007,629 — — 80,903 — — — 80,903 (80,903 ) — — — 75,563 — — — 75,563 8,496 84,059 23,701,601 1,917,620 2,080,041,288 28,071,982 (3,372,588 ) (2,304,020,698 ) (197,362,396 ) (43,713,620 ) (241,076,016 ) 23,701,601 296,030 321,103,042 4,333,567 (520,638 ) (355,679,505 ) (30,467,504 ) (6,748,220 ) (37,215,724 )
| Ordinary shares | Additional paid-in capital | Statutory reserves | Accumulated other comprehensive income (loss) | Accumulated deficit | Equity (deficit) attributable to The9 Limited | Noncontrolling interest | Total shareholder equity (deficit) | |||||||||||||||||||||||||||||
| (US$0.01 par value) | ||||||||||||||||||||||||||||||||||||
| Number of shares | Par value | |||||||||||||||||||||||||||||||||||
| RMB | RMB | RMB | RMB | RMB | RMB | RMB | RMB | |||||||||||||||||||||||||||||
| Balance as of January 1, 2016 | 23,701,601 | 1,917,620 | 2,080,041,288 | 28,071,982 | (3,372,588 | ) | (2,304,020,698 | ) | (197,362,396 | ) | (43,713,620 | ) | (241,076,016 | ) | ||||||||||||||||||||||
| Net loss | - | - | - | - | - | (593,781,589 | ) | (593,781,589 | ) | (58,584,204 | ) | (652,365,793 | ) | |||||||||||||||||||||||
| Currency translation adjustments | - | - | - | - | 5,954,611 | - | 5,954,611 | (7,709,250 | ) | (1,754,639 | ) | |||||||||||||||||||||||||
| Minority interest change in redemption value | - | - | (82,890,188 | ) | - | - | - | (82,890,188 | ) | - | (82,890,188 | ) | ||||||||||||||||||||||||
| Exercise of options | 213,900 | 14,022 | 2,128,532 | - | - | - | 2,142,554 | - | 2,142,554 | |||||||||||||||||||||||||||
| Partial disposal of Red 5 | - | - | 244,798,058 | - | - | - | 244,798,058 | - | 244,798,058 | |||||||||||||||||||||||||||
| Share-based compensation | - | - | 27,689,259 | - | - | - | 27,689,259 | 362,476 | 28,051,735 | |||||||||||||||||||||||||||
| Change in equity interest attributable to noncontrolling interest | - | - | 253,396,755 | - | - | - | 253,396,755 | (253,396,755 | ) | - | ||||||||||||||||||||||||||
| Issuance of shares of Red 5 upon exercise of stock options | - | - | 436,128 | - | - | - | 436,128 | 603,704 | 1,039,832 | |||||||||||||||||||||||||||
| Balance as of December 31, 2016 | 23,915,501 | 1,931,642 | 2,525,599,832 | 28,071,982 | 2,582,023 | (2,897,802,287 | ) | (339,616,808 | ) | (362,437,649 | ) | (702,054,457 | ) | |||||||||||||||||||||||
| F-6 |
THE9 LIMITED
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2017
| Ordinary shares | Additional paid-in capital | Statutory reserves | Accumulated other comprehensive income (loss) | Accumulated deficit | Equity (deficit) attributable to The9 Limited | Noncontrolling interest | Total shareholder equity (deficit) | |||||||||||||||||||||||||||||
| (US$0.01 par value) | ||||||||||||||||||||||||||||||||||||
| Number of shares | Par value | |||||||||||||||||||||||||||||||||||
| RMB | RMB | RMB | RMB | RMB | RMB | RMB | RMB | |||||||||||||||||||||||||||||
| Balance as of January 1, 2017 | 23,915,501 | 1,931,642 | 2,525,599,832 | 28,071,982 | 2,582,023 | (2,897,802,287 | ) | (339,616,808 | ) | (362,437,649 | ) | (702,054,457 | ) | |||||||||||||||||||||||
| Net loss | - | - | - | - | - | (118,165,850 | ) | (118,165,850 | ) | 3,955,640 | (114,210,210 | ) | ||||||||||||||||||||||||
| Currency translation adjustments | - | - | - | - | (19,027,771 | ) | - | (19,027,771 | ) | 9,502,010 | (9,525,761 | ) | ||||||||||||||||||||||||
| Disposal of Yunmei Partnership | - | - | - | - | - | - | - | 117,983 | 117,983 | |||||||||||||||||||||||||||
| Contributions from noncontrolling interest | - | - | - | - | - | - | - | 20,000,000 | 20,000,000 | |||||||||||||||||||||||||||
| Exercise of options | 6,328,535 | 425,483 | (425,483 | ) | - | - | - | - | - | - | ||||||||||||||||||||||||||
| Share-based compensation | - | - | 37,727,861 | - | - | - | 37,727,861 | 301,852 | 38,029,713 | |||||||||||||||||||||||||||
| Accretion in redemption value of redeemable noncontrolling interest | - | - | (57,126,233 | ) | - | - | - | (57,126,233 | ) | - | (57,126,233 | ) | ||||||||||||||||||||||||
| Change in equity interest attributable to noncontrolling interest | - | - | (7,060 | ) | - | - | - | (7,060 | ) | 7,060 | - | |||||||||||||||||||||||||
| Issuance of shares | 14,300,000 | 971,727 | 21,446,398 | - | - | - | 22,418,125 | - | 22,418,125 | |||||||||||||||||||||||||||
| Balance as of December 31, 2017 | 44,544,036 | 3,328,852 | 2,527,215,315 | 28,071,982 | (16,445,748 | ) | (3,015,968,137 | ) | (473,797,736 | ) | (328,553,104 | ) | (802,350,840 | ) | ||||||||||||||||||||||
| F-7 |
THE9 LIMITED
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2018
| Ordinary shares | Additional paid-in capital | Statutory reserves | Accumulated other comprehensive (income) loss | Accumulated deficit | Equity (deficit) attributable to The9 Limited | Noncontrolling interest | Total shareholder equity (deficit) | |||||||||||||||||||||||||||||
| (US$0.01 par value) | ||||||||||||||||||||||||||||||||||||
| Number of shares | Par value | |||||||||||||||||||||||||||||||||||
| RMB | RMB | RMB | RMB | RMB | RMB | RMB | RMB | |||||||||||||||||||||||||||||
| Balance as of January 1, 2018 | 44,544,036 | 3,328,852 | 2,527,215,315 | 28,071,982 | (16,445,748 | ) | (3,015,968,137 | ) | (473,797,736 | ) | (328,553,104 | ) | (802,350,840 | ) | ||||||||||||||||||||||
| Net loss | - | - | - | - | - | (217,092,926 | ) | (217,092,926 | ) | (16,332,968 | ) | (233,425,894 | ) | |||||||||||||||||||||||
| Currency translation adjustments | - | - | - | - | 7,241,192 | - | 7,241,192 | (8,555,457 | ) | (1,314,265 | ) | |||||||||||||||||||||||||
| Derecognition of noncontrolling interests | - | - | - | - | - | - | - | (20,000,000 | ) | (20,000,000 | ) | |||||||||||||||||||||||||
| Share-based compensation | - | - | 3,645,751 | - | - | - | 3,645,751 | 252,577 | 3,898,328 | |||||||||||||||||||||||||||
| Accretion in redemption value of redeemable noncontrolling interest | - | - | (40,918,773 | ) | - | - | - | (40,918,773 | ) | - | (40,918,773 | ) | ||||||||||||||||||||||||
| Issuance of shares | 46,771,429 | 3,173,806 | 6,126,772 | - | - | - | 9,300,578 | - | 9,300,578 | |||||||||||||||||||||||||||
| Balance as of December 31, 2018 | 91,315,465 | 6,502,658 | 2,496,069,065 | 28,071,982 | (9,204,556 | ) | (3,233,061,063 | ) | (711,621,914 | ) | (373,188,952 | ) | (1,084,810,866 | ) | ||||||||||||||||||||||
| Balance as of December 31, 2018 (US$ except share data, Note 3) | 91,315,465 | 945,772 | 363,038,188 | 4,082,900 | (1,338,746 | ) | (470,229,228 | ) | (103,501,114 | ) | (54,278,082 | ) | (157,779,196 | ) | ||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
| F-8 |
THE9 LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2013, 20142016, 2017 AND 20152018
| 2013 | 2014 | 2015 | 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net loss | (562,916,605 | ) | (128,942,408 | ) | (354,181,969 | ) | (54,676,274 | ) | ||||||||
Adjustments for: | ||||||||||||||||
Loss on disposal of property, equipment and software | 13,137 | 1,346,972 | 1,563,518 | 241,366 | ||||||||||||
Gain on disposal of subsidiaries | — | (165,392,382 | ) | (3,339,394 | ) | (515,514 | ) | |||||||||
Employee compensation relating to the issuance of redeemable noncontrolling interest | — | 13,034,797 | — | — | ||||||||||||
Share-based compensation expense | 29,237,416 | 3,672,300 | 34,007,629 | 5,249,873 | ||||||||||||
Impairment on investments | 47,970,885 | — | — | — | ||||||||||||
Provision/(reversal of provision) for allowance for long-term receivables and prepayments | 29,741,076 | (14,371,918 | ) | 8,439,580 | 1,302,847 | |||||||||||
Impairment of long-lived assets | 5,725,046 | — | — | — | ||||||||||||
Allowance for doubtful accounts receivable | 1,224,425 | 76,246 | 711,908 | 109,900 | ||||||||||||
Impairment on upfront prepaid royalties and deferred costs | 13,096,101 | — | — | — | ||||||||||||
Depreciation and amortization of property, equipment and software | 19,035,455 | 15,665,588 | 11,563,567 | 1,785,107 | ||||||||||||
Amortization of prepaid land use right | 1,920,909 | 1,920,911 | 1,920,910 | 296,537 | ||||||||||||
Amortization of intangible assets | 23,015,765 | 28,854,483 | 19,136,842 | 2,954,219 | ||||||||||||
Share of loss in equity method investments | 2,375,826 | 3,712,530 | 13,013,791 | 2,008,983 | ||||||||||||
Gain on disposal of investment in equity investee and available-for-sales investment | — | (33,153,452 | ) | — | — | |||||||||||
Exchange loss (gain) | (1,507,157 | ) | 3,086,602 | 7,313,303 | 1,128,979 | |||||||||||
Fair value change on warrant liability | — | — | 7,129,161 | 1,100,553 | ||||||||||||
Amortization of discount on convertible note | — | — | 2,609,771 | 402,879 | ||||||||||||
Changes in operating assets and liabilities: Change in accounts receivable | (3,894,295 | ) | 7,257,096 | 3,630,201 | 560,406 | |||||||||||
Change in advance to suppliers | (3,277,573 | ) | — | (164,787 | ) | (25,439 | ) | |||||||||
Change in prepayments and other current assets | 23,085,521 | (1,767,972 | ) | 11,928,473 | 1,841,439 | |||||||||||
Change in prepaid royalties | (453,785 | ) | 4,878,579 | — | — | |||||||||||
Change in deferred costs | (1,867,820 | ) | 58,472 | 9,745 | 1,504 | |||||||||||
Change in other long-lived assets | 13,115,217 | 7,732,074 | (1,970,192 | ) | (304,145 | ) | ||||||||||
Change in accounts payable | 8,665,354 | (9,104,630 | ) | 565,870 | 87,355 | |||||||||||
Change in amounts due to related party | 4,799,753 | 1,505,203 | 61,454,444 | 9,486,931 | ||||||||||||
Change in other taxes payable | (2,735,038 | ) | (306,421 | ) | (405,070 | ) | (62,532 | ) | ||||||||
Change in advances from customers | 1,017,996 | (2,062,884 | ) | 2,823,656 | 435,897 | |||||||||||
Change in deferred revenue | (142,057 | ) | 321,706 | (1,882,745 | ) | (290,646 | ) | |||||||||
Change in other payables and accruals | (4,815,188 | ) | (7,118,898 | ) | (1,465,002 | ) | (226,155 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net cash used in operating activities | (357,569,636 | ) | (269,097,406 | ) | (175,586,790 | ) | (27,105,930 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
| 2016 | 2017 | 2018 | 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Cash flows from operating activities: | ||||||||||||||||
| Net loss | (667,089,945 | ) | (112,092,907 | ) | (239,284,796 | ) | (34,802,530 | ) | ||||||||
| Adjustments for: | ||||||||||||||||
| Loss (gain) on disposal of property, equipment and software | 1,765,367 | 18,460 | (183,767 | ) | (26,728 | ) | ||||||||||
| Gain on disposal of subsidiaries | - | - | (10,473,159 | ) | (1,523,258 | ) | ||||||||||
| Share-based compensation expense | 28,051,735 | 38,029,713 | 3,898,328 | 566,988 | ||||||||||||
| Impairment on equity investments | - | - | 1,386,174 | 201,611 | ||||||||||||
| Impairment on other investments | 2,806,439 | 9,109,312 | 7,776,157 | 1,130,995 | ||||||||||||
| Impairment on available-for-sale investment | 244,798,058 | - | - | - | ||||||||||||
| Impairment of intangible assets | 68,003,805 | - | - | - | ||||||||||||
| Provision for doubtful accounts receivable | - | 47,948 | 109,939 | 15,990 | ||||||||||||
| Impairment on advances to suppliers | - | - | 7,765,482 | 1,129,443 | ||||||||||||
| Provision for doubtful other receivables | - | - | 21,042,700 | 3,060,534 | ||||||||||||
| Impairment of goodwill | 10,561,857 | - | - | - | ||||||||||||
| Consulting fee paid by equity | - | 13,454,692 | 4,172,800 | 606,909 | ||||||||||||
| Depreciation and amortization of property, equipment and software | 7,317,920 | 5,299,059 | 3,650,261 | 530,908 | ||||||||||||
| Amortization of land use right | 1,920,910 | 1,920,910 | 1,920,910 | 279,385 | ||||||||||||
| Amortization of intangible assets | 10,151,356 | - | - | - | ||||||||||||
| Recovery of equity investment in excess of cost | - | (60,548,651 | ) | - | - | |||||||||||
| Share of loss in equity method investments | 110,535,486 | 2,937,131 | 4,292,887 | 624,375 | ||||||||||||
| Loss (gain) on disposal of investment in equity investee and available-for-sales investment | 1,217,405 | (115,349 | ) | - | - | |||||||||||
| Foreign currency exchange loss (gain) | 13,131,779 | (19,206,747 | ) | 20,331,430 | 2,957,084 | |||||||||||
| Fair value change on warrant liability | (48,057,204 | ) | (12,615,466 | ) | (2,251,427 | ) | (327,456 | ) | ||||||||
| Amortization of discount and interest on convertible note | 50,409,270 | 76,990,826 | 98,308,205 | 14,298,335 | ||||||||||||
| Changes in operating assets and liabilities: | ||||||||||||||||
| Change in accounts receivable | (1,453,441 | ) | 5,742,365 | 1,904,732 | 277,032 | |||||||||||
| Change in advance to suppliers | (8,187,039 | ) | 2,462,761 | (1,400,665 | ) | (203,718 | ) | |||||||||
| Change in prepayments and other current assets | (2,162,566 | ) | 3,169,076 | (20,575,190 | ) | (2,992,537 | ) | |||||||||
| Change in other long-lived assets | 1,879,021 | - | 6,220 | 905 | ||||||||||||
| Change in accounts payable | (4,200,259 | ) | 2,073,797 | 905,990 | 131,771 | |||||||||||
| Change in amounts due to related parties | (2,063,553 | ) | (53,060,754 | ) | (1,628,877 | ) | (236,910 | ) | ||||||||
| Change in deferred tax liability | (6,079,282 | ) | - | - | - | |||||||||||
| Change in other taxes payable | (267,451 | ) | 1,430,998 | 1,234,090 | 179,491 | |||||||||||
| Change in advances from customers | 7,106,374 | 21,137,125 | (2,336,252 | ) | (339,794 | ) | ||||||||||
| Change in deferred revenue | (2,630,344 | ) | (10,345,604 | ) | (5,417,144 | ) | (787,891 | ) | ||||||||
| Change in interest payable | 3,827,510 | 5,452,770 | 6,053,191 | 880,400 | ||||||||||||
| Change in accrued expenses and other current liabilities | (1,061,524 | ) | (7,943,127 | ) | (2,408,745 | ) | (350,338 | ) | ||||||||
| Net cash used in operating activities | (179,768,316 | ) | (86,651,662 | ) | (101,200,526 | ) | (14,719,004 | ) | ||||||||
| Cash flows from investing activities | ||||||||||||||||
| Proceeds from disposal of other investment | 409,694 | 1,158,040 | - | - | ||||||||||||
| Proceeds from disposal of equity investee and available-for-sale investment | - | 115,349 | - | - | ||||||||||||
| Proceeds from disposal of cost method investee | 737,894 | - | - | - | ||||||||||||
| Purchase of other investments | - | (4,000,000 | ) | (5,300,000 | ) | (770,853 | ) | |||||||||
| Advances to subscribe tokens | - | - | (14,070,581 | ) | (2,046,481 | ) | ||||||||||
| Disbursement for loans receivable from a related party | (2,800,000 | ) | (4,000,000 | ) | (600,000 | ) | (87,266 | ) | ||||||||
| Collection of loans receivable from related party | - | 3,000,000 | - | - | ||||||||||||
| Proceeds from disposal of property, equipment and software | - | 292,074 | 81,848 | 11,904 | ||||||||||||
| Proceeds from disposal of assets and liabilities classified as held for sale | - | - | 2,800,000 | 407,243 | ||||||||||||
| Settlement payment from investee | - | 165,812,500 | - | - | ||||||||||||
| Purchase of property, equipment and software | (1,714,075 | ) | (454,560 | ) | (226,717 | ) | (32,975 | ) | ||||||||
| Purchase of intangible assets | (6,618,977 | ) | - | - | - | |||||||||||
| Net cash (used in) provided by investing activities | (9,985,464 | ) | 161,923,403 | (17,315,450 | ) | (2,518,428 | ) | |||||||||
| Cash flows from financing activities: | ||||||||||||||||
| Proceeds from exercise of stock options | 2,142,549 | - | - | - | ||||||||||||
| Proceeds from exercise of stock options of a subsidiary | 1,039,832 | - | - | - | ||||||||||||
| Cash from pledged loan | 79,190,933 | - | - | - | ||||||||||||
| Proceeds from bank borrowings | 24,992,214 | - | - | - | ||||||||||||
| Repayments of bank borrowings | - | (25,528,388 | ) | - | - | |||||||||||
| Proceeds from Inner Mongolia Culture Assets and Equity Exchange | 57,500,000 | - | - | - | ||||||||||||
| Loan from a related party | 60,009,400 | 73,930,427 | 11,030,602 | 1,604,335 | ||||||||||||
| Repayment of a loan from a related party | (34,782,586 | ) | (23,950,421 | ) | (29,127,540 | ) | (4,236,425 | ) | ||||||||
| Proceeds from other loans | - | 19,881,900 | - | - | ||||||||||||
| Repayments of other loans | - | (20,260,085 | ) | (260,073 | ) | (37,826 | ) | |||||||||
| Contribution from noncontrolling interest | - | 20,000,000 | - | - | ||||||||||||
| Net cash provided by (used in) financing activities | 190,092,342 | 44,073,433 | (18,357,011 | ) | (2,669,916 | ) | ||||||||||
| Effect of foreign exchange rate changes on cash and cash equivalents | (10,471,027 | ) | 4,527,918 | (1,494,584 | ) | (217,379 | ) | |||||||||
| Cash reclassified as held for sale | - | (20,127,148 | ) | - | - | |||||||||||
| Net change in cash and cash equivalents | (10,132,465 | ) | 103,745,944 | (138,367,571 | ) | (20,124,727 | ) | |||||||||
| Cash and cash equivalents, beginning of year | 49,010,541 | 38,878,076 | 142,624,020 | 20,743,802 | ||||||||||||
| Cash and cash equivalents, end of year | 38,878,076 | 142,624,020 | 4,256,449 | 619,075 | ||||||||||||
| Supplemental disclosure of cash flow information: | ||||||||||||||||
| Interest paid | 1,077,374 | 892,159 | 260,073 | 37,826 | ||||||||||||
| Income taxes paid | - | - | - | - | ||||||||||||
Non-cash investing and financing activities | ||||||||||||||||
| Accrued purchases of property, equipment and software | 1,832,201 | - | - | - | ||||||||||||
| Receivable related to the disposition of a subsidiary | - | 1,600,000 | - | - | ||||||||||||
| Shares issued for equity investments and other investments | - | - | 3,091,986 | 449,711 | ||||||||||||
Cash flows from investing activities Decrease (Increase) in restricted cash Proceeds from disposal of short term investment Proceeds from disposal of subsidiaries Proceeds from disposal of cost method investee Proceeds from disposal of equity method investees Proceeds from disposal of available-for-sale investment Purchase of equity method and available-for-sale investments Disbursement for loans receivable from a related party (including the former equity method investee before the disposal of its equity interest held by the Group in 2014) Collection of loans receivable from related party (including the former equity method investee before the disposal of its equity interest held by the Group in 2014) Proceeds from disposal of property, equipment and software Proceeds from refund of investment Refund of upfront license fees Refund of long-term receivables Purchase of property, equipment and software Purchase of intangible assets Net cash provided by (used in) investing activities Cash flows from financing activities: Proceeds from stock option exercises Proceeds from exercises of stock options of a subsidiary Issuance of redeemable noncontrolling interest Purchase of noncontrolling interest Repurchase of ordinary shares Proceeds from bank borrowings Proceeds from the issuance of convertible notes Payment for the issuance cost related to convertible notes Amount due to related parties Loan from a related party Repayment a loan from a related party Contribution from noncontrolling interest Payment for long-term payable Net cash provided by (used in) financing activities Effect of foreign exchange rate changes on cash and cash equivalents Net change in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Supplemental disclosure of cash flow information: Accrued purchases of property, equipment and software Accrued purchases of intangible assets Receivable related to the disposition of a subsidiary Details of the non-cash transactions regarding disposal of Jiucheng Advertisement and Red 5 are set out in Note 7 and Note 30. 2013 2014 2015 2015 RMB RMB RMB US$ 37,959 700,000 — — 877,350 — — — — 163,715,759 12,178,328 1,880,010 5,469,593 — — — — 25,040,812 — — — 6,274,326 — — (9,158,160 ) — (223,428,600 ) (34,491,432 ) (4,500,000 ) (5,250,000 ) (9,870,000 ) (1,523,665 ) 4,500,000 5,250,000 4,500,000 694,680 146,500 1,148,851 340,962 52,635 7,252,493 — — — — 2,000,000 — — — 2,000,000 17,927,763 2,767,570 (7,057,543 ) (3,127,931 ) (10,644,290 ) (1,643,195 ) (500,000 ) — — — (2,931,808 ) 197,751,817 (208,995,837 ) (32,263,397 ) 4,304,447 812,635 — — 32,603 616,688 84,059 12,976 — 118,262,180 — — — — (656,799 ) (101,392 ) (29,030,699 ) — — — — — 31,624,560 4,881,991 — — 260,068,680 40,147,686 — — (20,779,520 ) (3,207,805 ) — — 2,597,440 400,976 — — 30,000,000 4,631,202 — — (30,000,000 ) (4,631,202 ) — — 4,500,000 694,680 (13,995,293 ) (19,469,853 ) (19,501,485 ) (3,010,511 ) (38,688,942 ) 100,221,650 257,936,935 39,818,601 1,898,778 (4,380,962 ) (5,826,067 ) (899,389 ) (397,291,608 ) 24,495,099 (132,471,759 ) (20,450,115 ) 554,278,809 156,987,201 181,482,300 28,016,039 156,987,201 181,482,300 49,010,541 7,565,924 2,085,286 1,747,081 1,841,541 284,285 56,109,371 36,775,866 20,010,351 3,089,066 — 12,750,000 — —
The accompanying notes are an integral part of these consolidated financial statements.
| F-9 |
THE9 LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2013, 20142016, 2017 AND 20152018
1. ORGANIZATION AND NATURE OF OPERATIONS
The accompanying consolidated financial statements include the financial statements of The9 Limited, (the “Company”), which was incorporated on December 22, 1999 in the Cayman Islands, its subsidiaries and variable interest entities (“VIE subsidiaries” or “VIEs”"VIEs").
The Company, its subsidiaries and VIE subsidiaries are, collectively referred to as the “Group”.
The Group is principally engaged in the development and operation of online games and internet related businesses, including massively multiplayer online games (“MMOGs”("MMOGs"), mobile games, web games and TV games. The Group commercial launched Firefall, a proprietary game developed by Red 5 in North America and Europe in 2014. It conducted a limited commercial release in China in November 2015 and expect to have a large-scale commercial launch in China in the second half of 2016. The Group also expect to launch a proprietary mobile game, Song of Knights in 2016.
The Company’sGroup's principal subsidiaries and VIE subsidiaries are as follows as of December 31, 2015:2018:
Name of | Date of | Place of | Legal Ownership | |||||
| ||||||||
GameNow.net (Hong Kong) | Hong Kong | 100 | % | |||||
The9 Computer Technology Consulting (Shanghai) Co., Ltd. (“The9 Computer”) | 100 | % | ||||||
China The9 Interactive Limited (“C9I”) | Hong Kong | 100 | % | |||||
China The9 Interactive (Shanghai) Limited (“C9I Shanghai”) | PRC | 100 | % | |||||
| PRC | 100 | % | |||||
| Jiu Jing Era Information Technology (Beijing) Ltd. (“Jiu Jing”) | April-2007 | PRC | 100 | % | ||||
| JiuTuo (Shanghai) Information Technology Ltd. ("Jiu Tuo") | July-2007 | PRC | 100 | % | ||||
| China Crown Technology Ltd. ("China Crown Technology") | November-2007 | Hong Kong | 100 | % | ||||
| ||||||||
| ||||||||
| ||||||||
| Hong Kong | 100 | % | |||||
Asian Way Development | Hong Kong | 100 | % | |||||
New Star International Development | Hong Kong | 100 | % | |||||
| ||||||||
| ||||||||
Red 5 Studios, Inc. (“Red 5”) | USA | | 34.71% (Note 2) | |||||
Red 5 Singapore Pte. Ltd. (“Red 5 Singapore”) | Singapore | | 34.71% (Note 2) | |||||
The9 Interactive, Inc. (“The9 Interactive”) | USA | 100 | % | |||||
| 100 | % | ||||||
| ||||||||
City Channel Ltd. (“City | Hong Kong | 100 | % | |||||
| The9 Singapore Pte. Ltd. (“The9 Singapore”) | April-2010 | Singapore | 100 | % | ||||
| Fast Supreme Development Limited (“Fast Supreme”) | July-2017 | Hong Kong | 99.99 | % | ||||
| Ninebit Inc. (“Ninebit”) | January -2018 | Cayman Islands | 100 | % | ||||
| 1111 Limited (“1111”) | January -2018 | Hong Kong | 100 | % | ||||
| Supreme Exchange Limited (“Supreme”) | December-2018 | Malta | 90 | % | ||||
| Variable interest entity: | ||||||||
Shanghai The9 Information Technology Co., Ltd. (“Shanghai IT”) | PRC | N/A (Note 4) |
|
Subsidiaries and VIEs of Shanghai IT:
| Name of Entity | Registration | Registration | ||||||
| ||||||||
| ||||||||
| by Shanghai IT | |||||||
Shanghai Jiushi Interactive Network Technology Co., Ltd. (“Jiushi”) | PRC | | 80 | % | ||||
| PRC | | 100 | % | ||||
| May-2015 | PRC | 60 | % | ||||
| Wuxi Interest Dynamic Network Technology Co., Ltd. (“ | PRC | 100 | % | |||||
| PRC | 100 | % | |||||
| November-2007 | Hong Kong | 100 | % | ||||
| Shanghai Morning Technology Co., Ltd. | PRC | |||||||
| 100 | |||||||
| ||||||||
| F-11 |
2. PRINCIPAL ACCOUNTING POLICIES
<1> Basis of presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted accounting principles in the United States of America (“US GAAP”). Significant accounting policies followed by the Group in the preparation of the accompanying consolidated financial statements are summarized below.
The accompanying consolidated financial statements have been prepared on a going concern basis. The Group has accumulated deficit of approximately RMB2,304RMB 3,233.1 million (US$355.7470.2 million) and total current liabilities exceeded total assets by approximately RMB743.7 million (US$108.2 million) as of December 31, 2015,2018. The Group also suffered a net loss of approximately RMB354.2RMB239.3 million (US$54.734.8 million) for the year ended December 31, 2015.2018. The Group expects to continue to incur product development and sales and marketing expenses for licensed and proprietary new games and blockchain-technology-enabled products in order to achieve overall revenue growth. These factors raise substantial doubt about the Group’s ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts of liabilities that might result from the outcome of this uncertainty.
To meet its capital needs, the Group is considering multiple alternatives, including, but not limited to, additional equity financings, debt financingsfinancing, launch of new games and new operation, other funding transactionsexternal financing, and cost controls as outlined below. There can be no assurance that the Group will be able to complete any such transaction on acceptable terms or otherwise. If the Group is unable to obtain the necessary capital, it will need to pursue a plan to license or sell its assets, seek to be acquired by another entity, and/or cease operations.
Sales
Additional Equity Financing
On November 24, 2015, the Group entered into an agreement with a third-party investor for a private placement of Equity Interestsecured convertible notes and warrants for gross proceeds of Red 5
US$40,050,000. This transaction closed on December 11, 2015. Pursuant to the terms of the agreement, the convertible notes shall mature in 2018, subject to a two-year extension at the discretion of the investor. Upon the maturity of convertible notes and warrants, if the third-party investor did not opt to extend or convert into ordinary shares, the Group may consider to sell certain assets to repay this obligation. In March 2016,2019, the Group entered into a non-binding memorandumdeed of understanding (“MOU”) with L&A International Holding Limited (“L&A”), a Cayman Island Company with shares publicly listedsettlement agreement relating to the settlement of convertible notes which expired in Hong Kong, and a certain other shareholder of Red 5 Studios, Inc. (“Red 5”). UnderDecember 2018, pursuant to which the terms of this MOU,convertible notes should be repaid by May 31, 2019 through the Group will exchange approximately 30.6% of its equity interest in Red 5 for such number of newly issued shares of L&A of equivalent value based on a valuation agreed by all parties. The other participating shareholders of Red 5 will exchange an aggregate of approximately 14.4% equity interest in Red 5 based on the same terms. The total valuation for the 45% of equity interest in Red 5 subject to this exchange is expected to be approximately US$76.5 million, subject to adjustments by no more than 15% based on the results of due diligences conducted by both parties. The completionproceeds from planned sale of the transaction is subject to the parties’ execution of definitive agreements and customary closing conditions to be stipulated therein. Should the transaction is to be completed in accordance with valuation of the MOU, the Group is expected to receive ordinary shares of L&A with a valuation ranging between US$44 million to US$60 million. The Group expect these shares to be publicly traded and without restriction for sale in the public market in Hong Kong. As such, the Group believes the completion of this transaction can provide a source of funding for its operations.
| F-12 |
Addition external debt financing
In March 2016, Bank of Shanghai (BOS) issued a commitment letter whereby BOS agrees to grant the Group a credit facility of RMB50 million (US$7.7 million). The Group can apply to withdraw the funding from BOS should they require liquidity for its operations. As of the report date, the Group had withdrawn RMB4.9 million (US$0.8 million) under this credit facility.
Launch of new gamesNew Games and New Operation
The Group plans to have a large-scaled commercial launch of Firefallour proprietary online mobile games on different platforms, including the CrossFire New Mobile Game, Q Jiang San Guo, Audition and Pop Fashion, on different platforms. In November 2017, the Group entered into an exclusive publishing agreement with two third-party companies, pursuant to which these third-party companies were granted an exclusive right to publish the CrossFire New Mobile Game and Audition in China in the second half of 2016. In addition,China. The Group planshas invested significant financial and personnel resources in development of our proprietary CrossFire New Mobile Game and the Group expects to launch this game in 2019.
In 2018, the proprietary mobile game SongGroup stepped into the blockchain-related service market. The Group has invested in several blockchain-related companies to conduct related services and development of Knightsblockchain-technology-enabled products. In January 2018, the Group subscribed a total of 5,297,257 tokens to be issued by Telegram Inc. at a consideration of US$2.0 million with a third-party company and the tokens are expected to issue in 2016. We had already licensed Song of Knights to different game operators for distribution in Korea, Vietnam, Taiwan, Malaysia, Hong Kong, Singapore and Macau.2019.
Cost ControlOther External Financing
The Group does notintends to obtain financial support from related parties in 2019.
Cost Controls
Currently, a significant portion of our cash outflows is attributable to payroll-related costs. We have significant short term loans or liabilities to third parties. Currently the biggest use of cash for the Group is payroll related costs. When Management deems it is necessary, the Group has the ability to control the level of discretionary spending on payroll costs by reducing theour headcount of the Group within a short period of time.time when necessary.
<2> Consolidation
The consolidated financial statements include the financial statements of the Company,The9 Limited, its subsidiarysubsidiaries and VIEs in which it has a controlling financial interest. The results of theA subsidiary areis consolidated from the date on which the CompanyGroup obtained control and continuecontinues to be consolidated until the date that such control ceases. A controlling financial interest is typically determined when a company holds a majority of the voting equity interest in an entity. However, ifIf the companyGroup demonstrates its ability to control the VIEsa VIE through its rights to all the residual benefits of the VIEsVIE and its obligation to fund losses of the VIEsVIE, then the entityVIE is consolidated. All intercompany balances and transactions between the Company,The9 Limited, its subsidiarysubsidiaries and VIEs have been eliminated in consolidation.
In April 2010, the Group acquired a controlling interest in Red 5. In June 2016, the Group completed a share exchange transaction with L&A International Holding Limited (“L&A”) and certain other shareholders of Red 5 (see Note 8). After the transaction, the Group owned 34.71% shareholding in Red 5. As the Group controls a majority of Board of Director seats and has continuously funded the operation of Red 5, the Group still retained effective control over Red 5. Red 5 remained as a consolidated entity of the Group as of December 31, 2018.
| F-13 |
PRC laws and regulations currently prohibit or restrict foreign ownership of internet-related business. In September 2009, the General Administration of Press and Publication (“GAPP”Radio, Film and Television ("GAPPRFT") further promulgated the Circular Regarding the Implementation of the Department Reorganization Regulation by State Council and Relevant Interpretation by State Commission Office for Public Sector Reform and theto Further Strengthening ofStrengthen the Administration of Pre-approval on Online Games and Approval on Import Online Games (the “GAPP Circular”). Pursuant to Administrative Measures on Network Publication (the “Network Publication Measures”) jointly issued by GAPPRFT and the Ministry of Information Industry (which has subsequently been reorganized as the Ministry of Industry and Information Technology) (“MIIT”) on February 4, 2016, effective from March 2016, wholly foreign-owned enterprises, Sino-foreign equity joint ventures and Sino-foreign cooperative enterprises shall not engage in the provision of web publishing services, including online game services. Prior examination and approval by GAPPRFT are required on project cooperation involving internet publishing services between an internet publishing services and a wholly foreign-owned enterprise, Sino-foreign equity joint venture, or the GAPP Circular.Sino-foreign cooperative enterprise within China or an overseas organization or individual. It is unclear whether PRC authorities will deem our VIE structure as a kind of such "manners of cooperation" by foreign investors to gain control over or participate in domestic online game operators, and it is not clear that thewhether GAPPRFT and MIIT have regulatory authority ofover the GAPP applies to the regulation of ownership structures of online game companies based in the PRC. While the GAPP Circular is applicable to the GroupChina and its businessonline game operations in terms of publication and pre-approval of online games, to date, GAPP has not issued any interpretation of Section 4 of the GAPP Circular to specifically invalidate VIE agreements and, to the Group’s knowledge, has not taken any enforcement action under Section 4 of the GAPP Circular against any of the companies that rely on contractual arrangements with VIEs to operate online games in the PRC.China. Therefore, the Group believes that its ability to direct thethose activities of its VIEs that most significantly impact their economic performance is not affected by the GAPP Circular.
<3> Use of estimates
The preparation of the consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affectedaffect the reported amount of the assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported revenues and expenses during the reported periods. Significant accounting estimates reflected in the Group’sGroup's consolidated financial statements include the valuation of non-marketable equity investments and determination of other-than temporaryother-than-temporary impairment, allowance for doubtful accounts and prepayment,prepayments, revenue recognition, goodwill impairment, assessment of recoverabilityimpairment of long-lived assets and goodwill impairment,available-for-sale investments, assessment of impairment of other long-lived assets, fair value of redeemable noncontrolling interest, the fair value of the warrants, share-based compensation expense, consolidation of VIEs, valuation allowances for deferred tax assets, and contingencies. Such accounting policies are impactedaffected significantly by judgments, assumptions and estimates used in the preparation of our consolidated financial statements, and actual results could differ materially from these estimates.
| F-14 |
<4> Foreign currency translation
The Group’s reporting currency is the Renminbi (“RMB”). The Group’sGroup's functional currency, with the exception of its subsidiaries, Red 5, The9 Interactive, and Red 5 Singapore, Red5 Korea and The9 Korea, is the RMB. The functional currency of Red 5, The9 Interactive, and Red 5 Singapore, Red5 Korea and The9 Korea is the United States Dollar (“dollar ("US$”," or “US dollars”"U.S. dollar"), United States Dollar,U.S. dollar, and Singapore Dollar, Korean Won and Korean Won,dollar, respectively. Assets and liabilities of Red 5, The9 Interactive, and Red 5 Singapore, Red5 Korea and The9 Korea are translated at the current exchange rates quoted by the People’s Bank of China (the “PBOC”) in effect at the balance sheet dates. Equity accounts are translated at historical exchange rates and revenues and expenses are translated at the average exchange rates in effect during the reporting period to RMB. Gains and losses resulting from foreign currency translation to reporting currency are recorded in accumulated other comprehensive lossincome (loss) in the consolidated statements of changes in equity for the years presented.
Transactions denominated in currencies other than functional currencies, are translated into functional currencies at the exchange rates prevailing at the dates of the transactions. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations and comprehensive loss. Monetary assets and liabilities denominated in foreign currencies are translated into functional currencies using the applicable exchange rates at the balance sheet dates. All such exchange gains and losses are included in other income (expense)foreign exchange (loss) gain in the consolidated statements of operations and comprehensive loss.
<5> Cash and cash equivalents
Cash and cash equivalents represent cash on hand and highly-liquid investments with an originala maturity date when acquired of three months or less. AtAs of December 31, 20142017 and 2015,2018, cash and cash equivalents were comprised primarily of bank deposits. Included in cash and cash equivalents as of December 31, 20142017 and 20152018 are amounts denominated in US DollarsU.S. dollar totaling US$4.921.0 million and US$0.10.08 million, respectively.
The RMB is not a freely convertible currency. The PRC State Administration for Foreign Exchange, under the authority of the People’s Bank of China, controls the conversion of RMB into foreign currencies. The value of the RMB is subject to changes in central government policies and to international economic and political developments affecting supply and demand in China’s foreign exchange trading system market. The Company’sGroup’s aggregate amount of cash and cash equivalents denominated in RMB amounted to RMB150.5RMB5.2 million and RMB48.1RMB3.6 million (US$7.40.5 million) as of December 31, 20142017 and 2015,2018, respectively.
| F-15 |
<6> Allowance for doubtful accounts
Accounts receivable mainly consist of receivables from prepaid card distributors and third partythird-party game platforms, and other receivables, which are included in prepayments and other current assets, both of which are recorded net of allowance for doubtful accounts. The Group determines the allowances for doubtful accounts when facts and circumstances indicate that the receivable is unlikely to be collected. Allowances for doubtful accounts are charged to general and administrative expenses. If the financial condition of the Group’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company provided allowance for doubtful accounts of RMB1.2 million, RMB0.08nil, RMB0.05 million and RMB0.7RMB21.2 million (US$0.13.1 million) in 2013, 2014for the years ended December 2016, 2017 and 2015,2018, respectively.
<7> Prepaid royalties and deferred costs
Royalties paid to the licensors of games are initially recognized as prepaid royalties when paid and subsequently recognized as deferred costs upon the customers’ online registration and activation of their cards or online points. Royalties payable to the licensors or receivable from collection agents upon customers’ charging their accounts are initially recorded as deferred costs upon the customers’ online registration and activation of their cards or online points. Deferred costs are then ultimately recognized as cost of services in the consolidated statements of operations and comprehensive loss based upon the actual consumption of game premium features or usage of the game playing time by the customers or when the likelihood that the Group would provide further services to those customers becomes remote.
<8> Investments in equity method investee and loan to equity method investee
Equity investments are comprised of investments in privately held companies. The Group uses the equity method to account for an equity investment over which it has the ability to exert significant influence but does not otherwise have control. The Group records equity method investments at the cost of acquisition, plus the Group’sGroup's share in undistributed earnings and losses since acquisition. For equity investments over which the Group does not have significant influence or control, the cost method of accounting is used.
The Group has historically provided loansfinancial support to certain equity investees in order to provide to them financial support.
the form of loans. If the Group’sGroup's share of losses of the undistributed losses exceeds the carrying amount of an investment accounted for by the equity method, the Group continues to report losses up to the investment carrying amount, including any loans balance todue from the equity investees.
The Group assesses its equity investments and loans to equity investees for impairment on a periodic basis by considering factors including, but not limited to, current economic and market conditions, the operating performance of the investees including current earnings trends, the technological feasibility of the investee’s products and technologies, the general market conditions in the investee’s industry or geographic area, factors related to the investee’s ability to remain in business, such as the investee’s liquidity, debt ratios, and cash burn rate, and other company-specific information including recent financing rounds. If it has been determined that the equity investment is less than its related fair value and that this decline is other-than-temporary, the carrying value of the investment and loan to equity investee is adjusted downward to reflect these declines in value.
| F-16 |
<9>8> Available-for-sale investments
Investments in debt and equity securities are, on initial recognition, classified into the three categories: held-to-maturity securities, trading securities and available-for-sale securities. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses recognized in accumulated other comprehensive income. As of December 31, 2014 and 2015, the Group did not hold trading securities or held-to-maturity securities.
When there is objective evidence that an available-for-sale investment is impaired, the cumulative losses from declines in fair value that had been recognized directly in other comprehensive income are removed from equity and recognized in earnings. When the available-for-sale investment is sold, the cumulative fair value adjustments previously recognized in accumulated other comprehensive income are recognized in the current period operating results. When the Group determines that the impairment of an available-for-sale equity security is other-than-temporary, the Group recognizes an impairment loss in earnings equal to the difference between the investment’sinvestment's cost and its fair value at the balance sheet date of the reporting period for which the assessment is made. When other-than-temporary impairment has occurred for an available-for-sale debt security and the Group intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, an impairment loss is recognized in earnings equal to the difference between the investment’sinvestment's amortized cost basis and its fair value at the balance sheet date. The new cost basis will not be changed for subsequent recoveries in fair value. To determine whether a loss is other-than-temporary, the Group reviews the cause and duration of the impairment, the extent to which fair value is less than cost, the financial condition and near-term prospects of the issuer, and the Group’s intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery of its amortized cost.
| F-17 |
<10>9> Property, equipment and software, net
Property, equipment and software are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the following estimated useful lives:
| Leasehold improvements | ||
| Computer and equipment | 3 to 4 years | |
| Software | 5 years | |
| Office furniture and fixtures | 3 years | |
| Motor vehicles | 5 years | |
| Office buildings | 10 to 20 years |
<11>10> Goodwill
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as a result of the Group’s business acquisition. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. In September 2011, the Financial Accounting Standards Board (“FASB”("FASB") issued an authoritative pronouncement related to testing goodwill for impairment. The guidance permits us to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The CompanyGroup adopted this pronouncement since 2012. If it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the Group completes a two-step goodwill impairment test in December of each year. The first step compares the fair value of each reporting unit to its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the implied fair value of goodwill to the carrying value of a reporting unit’sunit's goodwill. The implied fair value of goodwill is determined in a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying value of goodwill over the implied fair value of goodwill.
| F-18 |
<11> Assets held for sale
Assets held for sale represent property, equipment and software for business operation that has met the criteria of held for sale accounting, as specified by Accounting Standards Codification (“ASC”) 360,Property, Plant, and Equipment. The effect of suspending depreciation on the property, equipment and software held for sale is immaterial to the results of operations for both 2017 and 2018. The sales of the assets held for sale as of December 31, 2017 have been completed in 2018.
<12> Intangible assets, net
Intangible assets consist primarily of acquired game licenses and acquired game development costs from business combinations.
Acquired game licenses are amortized on a straight-line basis over the shorter of the useful economic life of the relevant online game or license period, which range from two to seven years. Amortization of acquired game licenses commences upon the monetization of the related online game.
The Group recognizes intangible assets acquired through business acquisitions as assets separate from goodwill. Acquired in-process research and development costs are initially considered an indefinite-lived asset. Subsequently, theyUpon completion of the research and development efforts, these costs are recorded as acquired game development cost upon completion of the research and development effortscosts and are amortized on a straight-line basis over the useful economic life of the relevant online game. Amortization of acquired game development cost commences upon the monetization of the related online gamegame.
<13> Land use right, net
Land use right represents operating lease prepayments to the PRC’s land bureau for usage of the parcel of land where the Group’sGroup's office building is located. Amortization is calculated using the straight-line method over the estimated land use right period of 44 years.
| F-19 |
<14> Impairment of long-lived assets and allowance on long-term receivables
The Group evaluates its long-lived assets, including finite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable or that the useful life is shorter than the Group had originally estimated. The Group assesses the recoverability of the long-lived assets by comparing the carrying amount to the estimated future undiscounted cash flow expected to result from the use of the assets and their eventual disposition. If the sum of the expected undiscounted cash flows is less than the carrying amount of the assets, the Group would recognize an impairment loss based on the fair value of the assets.
Indefinite-lived intangible assets are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of the intangible asset to its carrying amount. If the carrying amount exceeds the fair value, an impairment loss is recognized in an amount equal to that excess.
<15> Revenue recognition
On January 1, 2018, the Group adopted ASC 606,Revenue from Contracts with Customers, applying the modified retrospective method to contracts that were not completed as of January 1, 2018. The adoption of ASC 606 did not have a material impact on the Group's accumulated deficit as of January 1, 2018. Results for reporting periods beginning on or after January 1, 2018 are presented under ASC 606, while prior period results are not adjusted.
The adoption of ASC 606 did not change the Group's consolidated balance sheets, consolidated statement of cash flows, or consolidated statement of changes in equity as of, or for the year ended December 31, 2018.
Revenues are recognized when control of the promised goods or services is transferred to the Group's customers, in an amount that reflects the consideration of the Group determines an allowance on doubtful long-term receivables when facts and circumstances indicate that the long-term receivable is unlikelyexpects to be collected. Whenentitled to in exchange for those goods or services. Depending on the collectabilityterms of the long-term receivable became likely subsequently,contract and the Group reverseslaws that apply to the allowancecontract, control of the goods or services may be transferred over time or at a point in time.
<15>Revenue recognition
Online game services
The Group earns revenue from provision of online game operation services to players on the Group’s game servers and third party platformthird-party platforms and overseas licensing of the online game to other operators. The Group recognizes revenues when persuasive evidence of an arrangement exists,grants operation right on authorized games, together with associated services which are delivered or performed, our price is fixed or determinable and collectability is reasonably assured.
Online game servicesrendered to players on the Group’s game server
The Group sells its prepaid online points for its online game products directly to players via certain online payment platforms.customers over time. The Group adopts virtual item / service consumption model for the online game services.
Players can access certain games free of charge, but maymany purchase game points to acquire in-game premium features. The distributionGroup may act as principal or agent through the various transaction arrangements entered.
| F-20 |
The determination on whether to record the revenue gross or net is based on an assessment of pointsvarious factors, including but not limited to playerswhether the Group (i) is typically made by sales of prepaid game cards and prepaid online points. Fees for prepaid game cards and prepaid online points are deferred when received. Revenue is recognized over the estimated lifeprimary obligor in the arrangement; (ii) has general inventory risk; (iii) change the product or perform part of the premium featuresservices; (iv) has latitude in establishing the selling price; (v) has involvement in the determination of product or service specifications. The assessment is performed for all of licensed online games.
When acting as the premium features are consumed.
For in-game premium features that are immediately consumed, revenue is recognized upon consumption. For premium features with a stated expiration time, which rangeRevenues from one to 180 days, revenue is recognized ratably over the period starting from when the feature is first used to the expiration time. For perpetual features with no predetermined expiration, revenue is recognized ratably over the estimated average lives of the perpetual features, which are typically less than one year. When estimating the average lives of the in-game perpetual features, the Group considers the average period that players typically play the game, other player behavior patterns, and factors including the acceptance and popularity of expansion packs, promotional events launched, and market conditions. Future usage patterns of players may differ from the historical usage patterns on which the virtual item / service consumption revenue recognition model is based. The Group continually monitors the operational statistics and usage patterns.
Onlineonline game operation services over third party platform
Certain social games, TV games, certain web games and certain MMOGS, have adopted the virtual item / service consumption model, and are launched on the third party game platforms and telecom carriers. Revenue from social and web games operated through third party game platforms are recognized upon consumption of the in-game premium features with the amount net of remittance to the third party game platforms as the Group does not set the pricing of the in-game currency of the third party game platforms.
Revenue from TV games operated through telecom carriers and certain MMOGS operated on the third party game platformsonline games operators are recognized upon consumption of the in-game premium features based on the gross amountof revenue sharing-payments to third-party operators, but net of value-added tax (“VAT”). The Group obtains revenue from the sale of in-game virtual items. Revenues are recognized as the virtual items are consumed or over the estimated lives of the virtual items, which are estimated by considering the average period that active players and players' behavior patterns derived from operating data. Accordingly, commission fees paid to third-party operators are recorded as cost of revenues.
When acting as agent
With respect to games license arrangements entered into by third-party operators, if the terms provide that (i) third-party operators are responsible for providing game desired by the game players; (ii) the hosting and maintenance of game servers for running the games is the responsibility of third-party operators; (iii) third-party operators have the right to review and approve the pricing of in-game virtual items and the specification, modification or update of the game made by the Group; and (iv) publishing, providing payment solution and market promotion services are the responsibilities of third-party operators and the Group is responsible to provide intellectual property licensing and subsequent technical services, then the primary obligorGroup considers itself as an agent of the third-party operators in such arrangement with game players. Accordingly, the Group records the game revenues from these licensed games, operation. The remittancenet of amounts paid to the telecom carrier andthird-party operators.
| F-21 |
Licensing revenue
The Group authorizes third party game platformsparties to operate its online games where games licensed out mainly include online games developed in house. The Group receives monthly revenue-based royalty payments from the third-party licensee operators. The Group receives additional up-front license fees from certain third-party licensee operators who are entitled to an exclusive right to access the games where initial license fee is allocated solely on the license. The amount is recognized as costs of revenue when incurred.
Licensing revenue
The Group licenses certain proprietary online games to other game operators and receives license fees and royalty income in connection with their operation of the games. License fee revenue is recognized overevenly throughout the license period upon the commercializationafter commencement of the game, ingiven that the licensees’ market. Royalty incomeGroup's intellectual property rights subject to the license are considered to be symbolic and the licensee has the right to access such intellectual property rights as they exist over time when the license is granted. Monthly revenue-based royalty payments are recognized when earned,the relevant services are delivered, provided that collectability is reasonably assured. The Group views the third-party licensee operators as its customers and recognizes revenues on a net basis, as the Group does not have the primary responsibility for fulfillment and acceptability of the game services.
Other revenuesTechnical services
Other revenues mainly include those generated from training. Training revenue include revenues generated from providing technical training
Technical services are blockchain-related consulting services where the Group is to college students on mobile application programming.provide designing, programming, drafting of white paper, and related services to its customers. These revenues are recognized when delivery of the serviceservices has occurred or when services have been rendered and the collection of the related fees is reasonably assured.
Contract balances
Timing of revenue of revenue recognition may differ from the timing of invoicing to customers. Accounts receivable represent amounts invoiced and revenue recognized prior to invoicing, when the Group has satisfied its performance obligations and has the unconditional right to payment.
Deferred revenue related to unsatisfied performance obligations at the end of the period and primarily consists of fees received from game players in the online game services and technical services. For deferred revenue, due to the generally short-term duration of the contracts, the majority of the performance obligations are satisfied in the following reporting period. The amount of revenue recognized that was included in deferred revenue balance at the beginning of the period was RMB5.4 million (US$0.8 million) for the year ended December 31, 2018.
| F-22 |
<16>Advances from customers and deferred revenue
The Group licenses proprietary games to operators in other countries and receives license fees and royalty income. License fee received in advance of the monetization of the game is recorded in advances from customers.
Online points that have been sold but not activated are recognized as advances from customers. Online points that have been activated but for which online game services will be rendered in the future are recognized as deferred revenue. Deferred revenue is recognized as income based upon the actual consumption of in-game premium features by players or when the likelihood that the Group would provide further online game service to those customers is remote.
| F-23 |
The Group licenses proprietary games to operators in other countries and receives license fees and royalty income. License fee received in advance of the monetization of the game is recorded in advances from operators.
<17>Convertible note and warrants
Convertible Notes and Beneficial Conversion Feature (“BCF”("BCF")
The Group issued convertible notes and warrants in December 2015. The Group has evaluated whether the conversionfeature of the notes is considered an embedded derivative instrument subject to bifurcation in accordance with ASC 815,Accounting for Derivative Instruments and Hedging Activities. Based on the Group’sGroup's evaluation, the conversion feature is not considered an embedded derivative instrument subject to bifurcation as conversion option does not provide thethe holder of the notes with means to net settle the contracts. Convertible notes, for which the embedded conversion feature does not qualify for derivative treatment, are evaluated to determine if the effective rate of conversion per the terms of the convertible note agreement is below market value. In these instances, the value of the BCF is determined as the intrinsic value of the conversion feature is recorded as deduction to the carrying amount of the notes and credited to additional paid-in-capital. For convertible notes issued with detachable warrants, a portion of the note’snote's proceed is allocated to the warrant based on the fair value of the warrants at the date of issuance. The allocated fair value for the warrants and the value of the BCF are both recorded in the consolidated financial statements as a debt discount from the face amount of the notes, which is then accreted to interest expense over the life of the related debt using the effective interest method.
The Group has early adopted ASU 2015-3, simplifyingAccounting Standards Update (“ASU”) 2015-03,Simplifying the presentationPresentation of debt issuance costsDebt Issuance Costs, to present the occurred debt issuance costs as a direct deduction from the convertible note rather than as an assets.asset. Amortization of the costs is reported as interest expense.
| F-24 |
Warrants
The Group accounts for the detachable warrants issued in connection with convertible notes under the authoritative guidance on accounting for derivative financial instruments indexed to, and potentially settled in, a company's own stock. The Group classifies warrants in its consolidated balance sheet as a liability which is revalued at each balance sheet date subsequent to the initial issuance. The Group uses the Black-ScholesBlack-Scholes-Merton pricing model (the “Black-Scholes Model”) to value the warrants. Determining the appropriate fair-value model and calculating the fair value of warrants requires considerable judgment. A small change in the estimates used may cause a relatively large change in the estimated valuation. The estimated volatility of the Group’s common stock at the date of issuance, and at each subsequent reporting period, is based on historichistorical fluctuations in the Company’s stock price. The risk-free interest rate is based on United States Treasury zero-coupon issues with a maturity similar to the expected remaining life of the warrants at the valuation date. The expected life of the warrants is based on the historical pattern of exercises of warrants.
| F-25 |
<18>Cost of revenuesales
Cost of revenuesales consists primarily of online game royalties, payroll, revenue sharing to third partythird-party game platform, telecom carriescarriers and other suppliers, depreciation, maintenance and rental of Internet data center sites, depreciation and amortization of computer equipment and software, production costs for prepaid game cards, intangible assets amortization and other overhead expenses directly attributable to the services provided.
| F-26 |
<19>Product development costs
For software development costs, including online games, to be sold or marketed to customers, the Group expenses software development costs incurred prior to reaching technological feasibility. Once a software product has reached technological feasibility, all subsequent software costs for that product are capitalized until that product is released for marketing. After an online game is released, the capitalized product development costs are amortized over the estimated product life. To date, the Group has essentially completed its software development concurrently with the establishment of technological feasibility, and, accordingly, no costs have been capitalized.
For website and internally used software development costs, the Group expenses all costs that are incurred in connection with the planning and implementation phases of development and costs that are associated with repair or maintenance of the existing websites and software. Costs incurred in the application and infrastructure development phase are capitalized and amortized over the estimated product life. Since the inception of the Group, the amount of internally generated costs qualifying for capitalization has been immaterial and, as a result, all website and internally used software development costs have been expensed as incurred.
Product development costs consist primarily of outsourced research and development expenses, payroll, depreciation chargecharges and other overhead expenses for the development of the Group’s proprietary games. Other overhead product development costs include costs incurred by the Group to develop, maintain, monitor, and manage its websites.
<20>Sales and marketing expenses
Sales and marketing expenses consist primarily of advertising and promotional expenses, payroll and other overhead expenses incurred by the Group’s sales and marketing personnel. Advertising expenses in the amount of RMB52.8RMB2.5 million, RMB22.5RMB0.9 million and RMB3.2RMB0.3 million (US$0.50.04 million) for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively, were expensed as incurred.
| F-27 |
<21>Government grants
Unrestricted government subsidies from local government agencies allowing the Group full discretion to utilize the funds were RMB 1.0RMB1.1 million, RMB1.2RMB2.3 million and RMB0.3RMB1.6 million (US$0.040.2 million) for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively, which were recorded in other income, (expense)net in the consolidated statements of operations and comprehensive loss.
| F-28 |
<22>Share-based compensation
The Group has granted share-based compensation awards to certain employees under several equity plans. The Group measures the cost of employee services received in exchange for an equity award, based on the fair value of the award at the date of grant. Share-based compensation expense is recognized net of estimated forfeitures, determined based on historical experience. The Group recognizes share-based compensation expense over the requisite service period. For performance and market-based awards which also require a service period, the Group uses graded vesting over the longer of the derived service period or when the performance condition is considered probable. The Company determines the grant date fair value of stock options using a Black-Scholes-Merton option pricing model (the “Black-Scholes Model”)Black-Scholes Model with assumptions made regarding expected term, volatility, risk-free interest rate, and dividend yield. The fair value of the stock options containing a market condition areis estimated using a Monte Carlo simulation model. For options awarded by private subsidiaries of the Group, the fair value of shares is estimated based on the equity value of the subsidiary. The Group evaluates the fair value of the subsidiary by making judgments and assumptions about the projected financial and operating results of the subsidiary. Once the equity value of the subsidiary is determined, it is allocated (as applicable) into the various classes of shares and options using the option-pricing method, which is one of the generally accepted valuation methodologies.
The expected term represents the period of time that stock-based awards granted are expected to be outstanding. The expected term of stock-based awards granted is determined based on historical data on employee exercise and post-vesting employment termination behavior. Expected volatilities are based on historical volatilities of the Company’s ordinary shares. Risk-free interest rate is based on United States (“US”) government bonds issued with maturity terms similar to the expected term of the stock-based awards.
The Group recognizes compensation expense, net of estimated forfeitures, on all share-based awards on a straight-line basis over the requisite service period, which is generally a one-to-four year vesting period or in the case of market-based awards, over the greater of the vesting period or derived service period. Forfeiture rate is estimated based on historical forfeiture patterns and adjusted to reflect future changes in circumstances and facts, if any. If actual forfeitures differ from those estimates, the estimates may need to be revised in subsequent periods. The Group uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest.
| F-29 |
For stock option modifications, the Group compares the fair value of the original award immediately before and after the modification. For modifications, or probable-to-probable vesting conditions, the incremental fair value of fully vested awards is recognized as expense on the date of the modification, with the incremental fair value of unvested awards recognized ratably over the new service period.
On June 6, 2017, the Board of Directors of the Group approved cancellation of a portion of the options and accelerated vesting of the remaining options in addition to the repricing of the exercise price which was US$0.00. Pursuant to the option agreement entered with the optionees, options totaling 6,328,535 were exercised and options totaling 10,806,665 were canceled. An independent appraiser engaged by the Group prepared a valuation report assessing the fair value of the options. The cancellation and acceleration of the options shall be considered as an option modification. Subject to ASC 718-20-35, the remaining unrecognized compensation cost of unvested stock option measured at grant date shall be recognized at the date of modification. The incremental compensation cost which is the excess of the fair value of the replacement award over the fair value of the cancelled award shall be recognized at the date of cancelation.
<23>Leases
Leases for which substantially all of the risks and rewards of ownership of assets remain with the leasing company are accounted for as operating leases. Payments made under operating leases net of any incentives received by the Group from the leasing company are charged to the consolidated statements of operations and comprehensive lossearnings on a straight-line basis over the lease periods.
<24>Income taxes
Current income taxes are provided for in accordance with the laws and regulations applicable to the Group as enacted by the relevant tax authorities. Income taxes are accounted for under the asset and liability method. Deferred taxes are determined based upon differences between the financial reporting and tax bases of assets and liabilities at currently enacted statutory tax rates for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized as income in the period of change. A valuation allowance is provided on deferred tax assets to the extent that it is more likely than not that such deferred tax assets will not be realized. The total income tax provision includes current tax expenses under applicable tax regulations and the change in the balance of deferred tax assets and liabilities.
The Group recognizes the impact of an uncertain income tax position at the largest amount that is more-likely-than not to be sustained upon audit by the relevant tax authority. Income tax related interest is classified as interest expenses and penalties as income tax expense.
| F-30 |
<25> Redeemable non-controllingnoncontrolling interests
Redeemable non-controllingnoncontrolling interests are equity interests of our consolidated subsidiary not attributeattributable to the Group that havehas redemption features that are not solely within the Group’sGroup's control. These interests are classified as temporary equity because their redemption is considered probable. These interests are measured at the greater of estimated redemption value at the end of each reporting period or the initial carrying amount of the redeemable non-controllingnoncontrolling interests adjusted for cumulative earnings (loss) allocations.
<26> Noncontrolling interest
A noncontrolling interest in a subsidiary or VIE of the Group represents the portion of the equity (net assets) in the subsidiary or VIE not directly or indirectly attributable to the Group. Noncontrolling interests isare presented as a separate component of equity in the consolidated balance sheet and modifies the presentation of net income by requiring earnings and other comprehensive income loss to be attributed to controlling and noncontrolling interest.
<27> Loss per share
Basic loss per share is computed by dividing net loss attributable to the holders of ordinary shares by the weighted average number of ordinary shares outstanding during the year. Diluted loss per share is calculated by dividing net income attributable to the holders of ordinary shares as adjusted for the effect of dilutive ordinary share equivalents, if any, by the weighted average number of ordinary shares and dilutive ordinary share equivalents outstanding during the period. Ordinary share equivalents of stock options and warrants are calculated using the treasury stock method. However, ordinary share equivalentsmethod, and are not included in the denominator of the diluted earnings per share calculation when inclusion of such shares would be anti-dilutive, such as in a period in which a net loss is recorded.
<28>Segment reporting
The Group has one operating segment whose business is developing and operating online games and related services. The Group’s chief operating decision maker is the chief executive officer, who reviews consolidated results when making decisions about allocating resources and assessing performance of the Group. The Group generates its revenues from customers in the PRC,Greater China, North America, and other areas.
<29> Certain risks and concentration
Financial instruments that potentially subject the Group to significant concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable and prepayments and other current assets. As of December 31, 20142017 and 2015,2018, substantially all of the Group’s cash and cash equivalents were held by major financial institutions, which management believes are of high credit worthiness.
| F-31 |
<30> Fair value measurements
Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the CompanyGroup considers the principal or most advantageous market in which it would transact and it considers assumptions that market participants would use when pricing the asset or liability. The fair value measurement guidance provides a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement as follows:
Level 1 inputs are unadjusted quoted prices in active markets for identical assets that the management has the ability to access at the measurement date.
Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that are not active, inputs other than quoted prices that are observable for the asset (i.e., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 inputs include unobservable inputs to the valuation methodology that reflect management’s assumptions about the assumptions that market participants would use in pricing the asset. The managementManagement develops these inputs based on the best information available, including their own data.
<31>Financial instruments
Financial instruments primarily consist of cash and cash equivalents, restricted cash, short-term investment,investments, accounts receivable, accounts payable, short-term borrowings, warrants and convertible notes, long-term accounts payable and long-term debt.notes. The carrying value of the Group’s cash and cash equivalents, restricted cash, short-term investment,investments, accounts receivable, and accounts payable and short-term borrowings approximate their market values due to the short-term nature of these instruments. Warrants are recorded in the consolidated balance sheets based on fair value. TheBoth carrying value of long-term accounts payable approximates itsand fair value as the impact to discount the long-term payable with interest rate is insignificant. The carrying value of long-term debt approximates its fair value as its interest rates is at the same level of the current market yield for comparable loans. The carrying value of convertible notes as of December 31, 2015 was RMB129.32018 were RMB375.3 million (US$20.0 millions) and the fair value of the convertible notes was approximately RMB193.5 million (US$29.854.6 million) as of December 31, 2015..
| F-32 |
<32> Recent accounting pronouncements
Leases
In May 2014, the Financial Accounting Standards Board (FASB) issued an accounting standard update on revenue recognition that will be applied to all contracts with customers. The update requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. It also requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. In August 2015,February 2016, the FASB issued ASU No. 2015-14, deferring the effective date for ASU 2014-09 by one year, and thus, the2016-02,Leases (Topic 842) which replaces existing lease guidance. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. The new guidance will becontinue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income. The standard is effective for fiscal yearsthe Group beginning after December 15, 2017,January 1, 2019, with early application permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.permitted. The guidance allows for either a full retrospective ornew standard is required to be applied with a modified retrospective transition method. The Company is currently assessing the impact that the guidance will have on the Company’s financial condition and results of operations.
In February 2015, the FASB issued ASU 2015-02approach to respond to stakeholders ‘concerns about the current accounting for consolidation of certain legal entities. Stakeholders expressed concerns that current generally accepted accounting principles (GAAP) might require aeach prior reporting entity to consolidate another legal entity in situations in which the reporting entity’s contractual rights do not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity’s voting rights, or the reporting entity is not exposed to a majority of the legal entity’s economic benefits or obligations. Financial statement users asserted that in certain of those situations in which consolidation is ultimately required, deconsolidated financial statements are necessary to better analyze the reporting entity’s economic and operational results. Previously, the FASB issued an indefinite deferral for certain entities to partially address those concerns. However, the amendments in this Update rescind that deferral and address those concerns by making changes to the consolidation guidance. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. The Group is in the process of evaluating the impact of the standard on its consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03 to simplify presentation of debt issuance costs, which requires that debt issuance costs related to a recognized debt liability beperiod presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. The Group early adopted this guidance as of December 31, 2015.various optional practical expedients. The adoption of this guidance didis not expected to have a material effect on the Company’sGroup’s financial condition, results of operations and cash flows.
Financial Instruments – Credit Losses
In May 2015,June 2016, the FASB issued ASU 2015-07, Topic 820,2016-13,Financial Instruments – Credit Losses (Topic 326), to provide financial statement users with more useful information about expected credit losses. ASU 2016-13 also changes how entities measure credit losses on financial instruments and Fair Value Measurement, which permits a reporting entity, as a practical expedient, to measure the fair valuetiming of certain investments using the net asset value per share of the investment. Currently, investments valued using the practical expedientwhen such losses are categorized within the fair value hierarchy on the basis of whether the investment is redeemable with the investee at net asset value on the measurement date, never redeemable with the investee at net asset value, or redeemable with the investee at net asset value at a future date. For investments that are redeemable with the investee at a future date, a reporting entity must take into account the length of time until those investments become redeemable to determine the classification within the fair value hierarchy.
recorded. In November 2015,2018, the FASB issued ASU 2015-17,No. 2018-19,Codification Improvements to simplifyTopic 326, Financial Instruments—Credit Losses. The amendment clarifies that receivables arising from operating leases are not within the presentationscope of deferred income taxes, which requires that deferred tax liabilitiesSubtopic 326-20. Instead, impairment of receivables arising from operating leases should be accounted for in accordance with Topic 842, Leases. ASU 2016-13 and assets be classified as noncurrent in a classified statement of financial position. The amendments in this Update apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilitiesASU 2018-19 are effective for fiscal years and assets of a tax-paying component of an entity be offsetinterim periods within those years beginning after December 15, 2019, and presented as a single amountearly adoption is not affected by the amendments in this Update. The Group has adopted this guidance during the year endedpermitted for periods beginning after December 31, 2015 with a retroactive application.15, 2018. The adoption of this guidance didis not expected to have a material effect on the Company’sGroup’s financial condition, results of operations and cash flows.
| F-33 |
Fair Value Measurements
In January 2016,August 2018, the FASB issued ASU 2016-01,No. 2018-13,Fair Value Measurement (Topic 820). The new guidance modifies disclosure requirements related to improve and to achieve convergence of their respective standards on the accounting for financial instruments and enhance the reporting model for financial instruments to provide users of financial statements with more decision-useful information.fair value measurement. The amendments in this Update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The Board also is addressing measurement of credit losses on financial assets in a separate project. For public business entities, the amendments in this UpdateASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of this guidance did not have a material effect on the Company’s financial condition, results of operations and cash flows.
In February 2016, the FASB issued ASU 2016-02, to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. The Group is in the process of evaluating the impact of the standard on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-06, which clarifies the requirements for assessing whether contingent call (put) options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the four-step decision sequence. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. An entity should apply the amendments in this Update on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Group is in the process of evaluating the impact of adoption of this guidance on the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, which eliminates eliminate the requirement to retroactively adopt the equity method of accounting. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.2019. Implementation on a prospective or retrospective basis varies by specific disclosure requirement. Early adoption is permitted. The amendments should be applied prospectivelystandard also allows for early adoption of any removed or modified disclosures upon their effective date to increases in the levelissuance of ownership interest or degree of influence that result in thethis ASU while delaying adoption of the equity method. Earlier application is permitted.additional disclosures until their effective date. The Group is in the process of evaluating the impact of adoption of this guidance is not expected to have a material effect on the consolidatedGroup’s financial statements.condition, results of operations and cash flows.
| F-34 |
Nonemployee Share-Based Payment
In March 2016,June 2018, the FASB issued ASU 2016-09, which simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classificationNo. 2018-07,Improvements to Nonemployee Share-Based Payment Accounting. The amendments in the statement of cash flows. For public entities, thethis ASU isare effective for annual reportingfiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, including interim periods within those annual2018. This ASU intends to reduce cost and complexity and to improve financial reporting periods. Early adoption will be permitted in any interim or annual period for share-based payments issued to nonemployees. The ASU expands the scope of Topic 718, Compensation—Stock Compensation, which financial statements have not yet beencurrently only includes share-based payments issued or have not been made availableto employees, to also include share-based payments issued to nonemployees for issuance.goods and services. The standard is effective for the Group is in the process of evaluating the impact ofbeginning December 15, 2018, with early application permitted. The adoption of this guidance is not expected to have a material effect on the consolidatedGroup’s financial statements.condition, results of operations and cash flows.
3. CONVENIENCE TRANSLATION
The Group, with the exception of its subsidiary,subsidiaries, Red 5, The9 Interactive and Red 5 Singapore, Red5 Korea and The9 Korea, maintains its accounting records and prepares its financial statements in RMB. The United StatesU.S. dollar (“US dollar” or “US$”) amounts disclosed in the accompanying financial statements are presented solely for the convenience of the readers at the rate of US$1.00 = RMB6.4778,RMB6.8755, representing the noon buying rate in the City of New York for cable transfers of RMB, as certified for customs purposes by the Federal Reserve Bank of New York, on December 31, 2015.2018. Such translations should not be construed as representations that the RMB amounts represent, or have been or could be converted into, United States dollars at that or any other rate.
| F-35 |
4. VARIABLE INTEREST ENTITIES
The Group is the primary beneficiary of certainits VIEs, including i) Shanghai IT which was designed by the Group to comply with PRC regulations that prohibit direct foreign ownership of businesses that operate online games in the PRC and ii) Mengxiang Hulian, which is a start-up research and development company (“R&D VIE”) developing games and software funded by the Group. Due to the weaker than expected performance of the game developed by Mengxiang Hulian, the Group has stopped funding Mengxiang Hulian and it had become an inactive company as of December 31, 2014.
Shanghai Huopu Cloud Computing Terminal Technology Co., Ltd. (“Huopu Cloud”) was considered as an VIE of the Group since its establishment in 2010. In 2014, the Group sold Houpu Cloud to a third party (Note 32).
Shanghai IT
Shanghai IT was designed by the Group to comply with PRC regulations that prohibit direct foreign ownership of businesses that operate online and TV games in the PRC.
Shanghai IT and its VIE subsidiaries
There are a fewcertain key contractual arrangements between the Group’sGroup's subsidiary, The9 Computer (the “WOFE”(wholly-owned foreign enterprise, the "WOFE") and respectiveeach of the VIEs that provide the Group with a controlling financial interestcontrol over the VIEs and upon whichVIEs. As a result of these contracts, the Group concluded that it is required to consolidate these entitiesthe VIEs pursuant to the guidance in ASC 810.
A summary of thethese contractual agreements referenced above is as follows:
| 1) | Loan |
| 2) | Equity |
| F-36 |
| 3) | Call |
| 4) | Shareholder |
| 5) | Exclusive |
| F-37 |
The Group shall be deemed to have a controlling financial interest in a VIE if it has both of the following characteristics:
a. The power to direct the activities of a VIE that most significantly impact the VIE’sVIE's economic performance; and
b. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.
In determining that the Group has “the"the power to direct the activities of the VIE that most significantly impact the VIEs’VIEs' economic performance,”" the Group looked to the specific provisions of the Call Option Agreementcall option agreement and Shareholder Voting Proxy Agreement.shareholder voting proxy agreement. These agreements, as summarized above, provide the WOFE effective control over all of the corporate and operating decisions of the VIEs, and as such, the Group’s management concluded that the WOFE has the requisite power to direct the activities of the VIEs that most significantly impact the VIEs’ economic performance. In assessing the Group’sGroup's obligation to absorb losses, the Group notes that it has funded through the loan agreements all of the entities’entities' share capital and also provides financial support as necessary to the entities through intercompany transactions. The Group’sGroup's rights to receive economic benefits that are significant to the VIEs are embodied firstly in the Equity Pledge Agreementsequity pledge agreements that secure the equity owners’owners' obligations under the relevant agreements, and ascribes to the WOFE all of the economic benefits of the equity interests including rights to any dividends declared. Secondly, the Exclusive Technical Service Agreementexclusive technical service agreement further secures the ability of WOFE to receive substantially all of the economic benefits from each of the VIEs on behalf of the Group.
In conclusion, because the Group, through its wholly owned subsidiary The9 Computer, has (1) the power to direct the activities of the VIEs that most significantly affect the VIE’sVIE's economic performance, and (2) the right to receive benefits from the VIEs that could potentially be significant to the VIEs, itthe Group has been deemed to be the primary beneficiary of the VIEs and has consolidated the respective VIEs since the date of execution of such agreements.
Shareholders of the VIEs may potentially have conflicts of interest with the Company, and they may breach their contracts with the PRC subsidiaries or cause such contracts to be amended in a manner contrary to the interests of the Company.Group. As a result, the CompanyGroup may have to initiate legal proceedings, which involve significant uncertainty. Such disputes and proceedings may significantly disrupt the Company’sGroups business operations and adversely affect the Company’sGroup's ability to control the VIEs. In light of the fact thatAs most of the shareholders of the VIEs are directors, officers, shareholders or employees of the Company or the PRC subsidiaries,Group, management is of the view that the risk that misaligned interests may lead to deconsolidation in the foreseeable future is remote and insignificant.
| F-38 |
PRC laws and regulations currently limit foreign ownership of companies that provide Internet content services, which include operating online games. In addition, foreign invested enterprises are currently not eligible to apply for the required licenses for operatingto operate online games in the PRC. The CompanyThe9 Limited is incorporated in the Cayman Islands and is considered a foreign entity under the PRC laws. Due to restrictions on foreign ownership of the provision ofcompanies that provide online games, the Company is dependent on the licenses held byGroup has entered into contractual arrangements with Shanghai IT to conduct its online games business through its subsidiaryVIEs in the PRC. Shanghai IT holds the necessary licenses and approvals that are essential for the online game business. The9 Computer has entered into contractual arrangements with Shanghai IT for use of its relevant licenses and websites.business in China. Shanghai IT is principally owned by certain shareholder and employee of the Company. Pursuant to certain other agreements and undertakings, the CompanyThe9 Limited in substance controls Shanghai IT. In the opinion of the Company’s directors, the Company’sThe Group believes that its current ownership structures and its contractual arrangements with Shanghai IT and its equity owners, as well as its operations, are in compliance with all existing PRC laws and regulations. However, thereThere may, however, be changes and other developments in the PRC laws and regulations or their interpretation. Specifically, following the recent promulgation of the GAPP Circular, it is unclear whether the authorities will deem our VIE structure and contractual arrangements with Shanghai IT as an “indirect or disguised” way byfor foreign investors to gain control over or participate in domestic online game operators, and challenge our VIE structure accordingly.
If the Company, its PRC subsidiaries and VIEs areGroup is found to be in violation of any existing or future PRC laws or regulations, or failfails to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion in dealing with such violations, including requiring the CompanyGroup to undergo a costly and disruptive restructuring, such as forcing the CompanyThe9 Limited to transfer its equity interest in the PRC subsidiariesVIEs to a domestic entity or invalidating the VIE agreements. If the PRC government authorities impose penalties which cause the CompanyGroup to lose its rights to direct the activities of and receive economic benefits from the VIEs, the CompanyGroup may lose the ability to consolidate and reflect in its financial statements the financial condition,position, and results of operation of the VIEs.
The Group, has concluded thathowever, does not believe such actions would result in the aforementioned contractual arrangements are legally enforceable and provideliquidation or dissolution of the Group, with full control of the WOFEs or VIEs. However, the
The aforementioned contractual arrangements with the VIEs and their respective shareholders are subject to risks and uncertainties:
| · | The VIEs or their shareholders could fail to obtain the proper operating licenses or fail to comply with other regulatory requirements. As a result, the PRC government could impose fines, new requirements or other penalties on the VIEs or the Group mandate a change in ownership structure or operations for the VIEs or the Group, restrict the VIEs or the Group's use of financing sources, or otherwise restrict the VIEs or the Group's ability to conduct business. |
| · | The aforementioned contractual agreements may be unenforceable or difficult to enforce. The equity pledge agreements may be deemed improperly registered or the VIEs or the Group may fail to meet other requirements. Even if the agreements are enforceable, they may be difficult to enforce given the uncertainties in the PRC legal system. |
| F-39 |
| · | The PRC government may declare the aforementioned contractual agreements invalid. They may modify the relevant regulation, have a different interpretation of such regulations, or otherwise determine that the Group or the VIEs have failed to comply with the legal obligations required to effectuate such contractual arrangements. |
| · | It may be difficult to finance the VIEs by means of loans or capital contributions. Loans from The9 Limited to the VIEs must be approved by the relevant PRC government body and such approval may be difficult or impossible to obtain. The VIEs are domestic PRC enterprises owned by nominee shareholders, thus the Group is not likely to finance activities of the VIEs by means of direct capital contributions. |
If the Company, its PRC subsidiaries and VIEs are found to be in violation of any existing or future PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion in dealing with such violations, including requiring the Company to undergo a costly and disruptive restructuring such as forcing the Company to transfer its equity interest in the PRC subsidiaries to a domestic entity or invalidating the VIE agreements. If the PRC government authorities impose penalties which cause the Company to lose its rights to direct the activities of and receive economic benefits from the VIEs, the Company may lose the ability to consolidate and reflect in its financial statements the results of operation of the VIEs. The Company, however, does not believe such actions would result in the liquidation or dissolution of the Company, the WOFEs or VIEs.
R&D VIE
Mengxiang Hulian is a primarily start-up research and development company developing games and software funded by the Group starting from 2011. The Group had arrangements with Mengxiang Hulian (the “R&D” company) pursuant to which the Group provided substantial financial support and obtained equity interests in these entities. The Group has acquired or has an option to acquire the exclusive licenses in Mainland China or worldwide for the games and software under development by these entities. As of December 31, 2014 and 2015, the Group held equity interest of 20% of Mengxiang Hulian.
Under the above arrangements with the R&D company, the Group has the power to make decisions that most significantly affect the entities’ operations and effectively assumed a majority of economic risks associated with these entities, and has the obligation to absorb losses and the right to receive returns that are significant to these entities. As such, prior to the reconsideration events discussed below, it was determined that the Group is the primary beneficiary of these entities and has included them in its consolidated financial statements since their respective dates of incorporation.
Summary financial information of the VIE subsidiaries included in the accompanying consolidated financial statements with intercompany balances and transactions eliminated are as follows:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ (Note 3) | ||||||||||
Total assets | 130,055,790 | 141,614,244 | 21,861,472 | |||||||||
Total liabilities | 231,634,266 | 222,151,400 | 34,294,267 | |||||||||
| December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Total assets | 99,468,575 | 80,531,978 | 11,712,890 | |||||||||
| Total liabilities | 335,667,587 | 335,980,249 | 48,866,300 | |||||||||
Net Revenue Net profit (loss) December 31,
2013 December 31,
2014 December 31,
2015 December 31,
2015 RMB RMB RMB US$ (Note 3) 86,574,297 42,697,861 34,390,944 5,309,047 (201,412,786 ) 101,628,848 (95,285,846 ) (14,709,600 )
| 2016 | 2017 | 2018 | 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Net revenues | 38,445,435 | 19,995,118 | 16,567,372 | 2,409,624 | ||||||||||||
| Net loss | (80,050,853 | ) | (71,839,112 | ) | (49,024,050 | ) | (7,130,252 | ) | ||||||||
The VIEs contributed an aggregate of 82.6%68.4%, 66.4%27.3% and 74.1%95.0% of the consolidated net revenues for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively. The Company’s operations not conducted through contractual arrangements with the VIE primarily consist of its product development on Firefall in the United States. As of the fiscal years ended December 31, 20142017 and 2015,2018, the VIEs accounted for an aggregate of 25.1%30.8% and 26.3%48.9%, respectively, of the consolidated total assets, and 72.2%41.0% and 37.0%, respectively, of the consolidated total liabilities.
There are no consolidated
The VIE’s assets that are not used as collateral for the VIE’s obligations, and can only be used to settle the VIE’sVIE's obligations.
Relevant PRC laws and regulations restrict the VIE subsidiaries from transferring a portion of itstheir net assets, equivalent to the balance of its statutory reserve and its share capital, to the CompanyGroup in the form of loans and advances or cash dividends. Please refer toSee Note 2926 for disclosure of restricted net assets.
5
| F-40 |
.5. ADVANCES TO SUPPLIERS
Advances to suppliers are as follows:
| December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Advance to subscribe tokens | - | 14,070,581 | 2,046,481 | |||||||||
| Company registration fee | - | 1,383,962 | 201,289 | |||||||||
| Advertising fee | 255,259 | 255,259 | 37,126 | |||||||||
| Financing fee | 7,497,988 | - | - | |||||||||
| Others | 349,031 | 98,240 | 14,288 | |||||||||
| 8,102,278 | 15,808,042 | 2,299,184 | ||||||||||
The Group has obtained financing for the early phase development of CrossFire New Mobile Game from the Inner Mongolia Culture Assets and Equity Exchange. As of December 31, 2018, the Group had paid RMB7.5 million (US$1.1 million) as the financing fee of the total funds raised and to be raised amounting to RMB157.5 million (US$22.9 million). According to the agreement, the Group paid the total financing fee of RMB7.5 million upon receipt of the first payment in October 2016 (see Note 17). Due to unforeseen circumstances, the Group is not planning to finance the remaining RMB100.0 million (US$14.5 million) and due to non-recovery of the advance financing fee, the Group has fully impaired the advance financing fee as of December 31, 2018.
On February 6, 2018, the Group entered into an agreement with a third-party company to subscribe a total of 5,297,257 tokens at a consideration of US$2.0 million and the tokens are expected to issue in 2019.
6. PREPAYMENTS AND OTHER CURRENT ASSETS
Prepayments and other current assets are as follows:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
Receivable from a former equity method investee | 4,500,000 | — | — | |||||||||
Consideration receivable for a disposal of a subsidiary | 12,750,575 | — | — | |||||||||
Receivable from a supplier (Note 14) | 17,927,763 | — | — | |||||||||
Prepayments and deposits | 10,929,101 | 3,220,205 | 497,114 | |||||||||
Employee advances | 1,963,858 | 2,717,027 | 419,437 | |||||||||
Others | 8,502,024 | 3,525,917 | 544,307 | |||||||||
|
|
|
|
|
| |||||||
| 56,573,321 | 9,463,149 | 1,460,858 | ||||||||||
|
|
|
|
|
| |||||||
6. PREPAID ROYALTIES AND DEFERRED COSTS
| December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Employee advances | 1,732,451 | 2,158,987 | 314,012 | |||||||||
| Input VAT recoverable | 2,249,958 | 1,448,075 | 210,614 | |||||||||
| Prepayments and deposits | 659,581 | 693,111 | 100,809 | |||||||||
Other receivables | 1,974,307 | 1,848,614 | 268,869 | |||||||||
| 6,616,297 | 6,148,787 | 894,304 | ||||||||||
Due to a weaker than expected operating performance of certain games, and the expectation that the net cash flow of these games will not be sufficient to recover the carrying amount of the prepaid royalties, the Group recognized an impairment loss for prepaid royalties associated with such games of RMB10.4 million, nil and nil for the years ended December 31, 2013, 2014, and 2015, respectively, and an impairment loss for deferred cost of RMB2.7 million, nil and nil for the years ended December 31, 2013, 2014, and 2015, respectively. The impairment charges of prepaid royalties and deferred cost were included in cost of services in the consolidated statements of operations and comprehensive loss.
| F-41 |
7. INVESTMENTS IN EQUITY INVESTEES
The Group’s investments in equity investees comprise the following:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ (Note 3) | ||||||||||
Investments accounted for under equity method: | ||||||||||||
ZTE9 network technology Co., Ltd., Wuxi (“ZTE9”) | 67,020 | — | — | |||||||||
System Link Corporation Limited (“System Link”)<1> | — | 215,631,351 | 33,287,744 | |||||||||
Shanghai Jiucheng Advertisement Co., Ltd. (“Jiucheng Advertisement”) <2> | — | 12,751,438 | 1,968,483 | |||||||||
Investments accounted for under cost method: | ||||||||||||
Shanghai Institute of Visual Art of Fudan University (“SIVA”) | 10,000,000 | 10,000,000 | 1,543,734 | |||||||||
G10 Entertainment Corporation (“G10”) Ltd. | 24,892,921 | 24,892,921 | 3,842,805 | |||||||||
CrowdStar Inc. (“Crowdstar”) | 1,627,099 | 1,627,099 | 251,181 | |||||||||
Tandem Fund II, L.P. (“Tandem Fund”) | 2,636,885 | 2,636,885 | 407,065 | |||||||||
|
|
|
|
|
| |||||||
Total | 39,223,925 | 267,539,694 | 41,301,012 | |||||||||
|
|
|
|
|
| |||||||
| December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| ( Note 3) | ||||||||||||
| Investments accounted for under equity method: | ||||||||||||
| ZTE9 Network Technology Co., Ltd., Wuxi (“ZTE9”) | - | - | - | |||||||||
| System Link Corporation Limited ("System Link") <1> | - | - | - | |||||||||
| Shanghai Big Data Cultures & Media Co., Ltd. (“Big Data”) <2> | 9,496,519 | 6,146,104 | 893,914 | |||||||||
| Maxline Holdings Limited (“Maxline”) <7> | - | 1,367,285 | 198,863 | |||||||||
| Leading Choice Holdings Limited (“Leading Choice”) <8> | - | - | - | |||||||||
| Investments accounted for under cost method: | ||||||||||||
| Shanghai Institute of Visual Art of Fudan University (“SIVA”) | 10,000,000 | 10,000,000 | 1,454,440 | |||||||||
| T3 Entertainment Co., Ltd. (“T3”) <3> | 24,892,921 | 24,892,921 | 3,620,525 | |||||||||
| Smartposting Co, Ltd. (“Smartposting”) <4> | 3,854,118 | 2,809,808 | 408,670 | |||||||||
| Beijing Ti Knight Network Technology Co., Ltd. (“Beijing Ti Knight”) <5> | - | - | - | |||||||||
| Tandem Fund II, L.P. (“Tandem Fund”) <6> | - | - | - | |||||||||
| Shanghai The9 Education Technology Co., Ltd. (“The9 Education Technology”) <9> | - | - | - | |||||||||
| Shanghai Ronglei Culture Communication Co., Ltd. (“Shanghai Ronglei”) <10> | - | - | - | |||||||||
| Plutux Limited (“Plutux”) <11> | - | - | - | |||||||||
| Total | 48,243,558 | 45,216,118 | 6,576,412 | |||||||||
<1> System Link
In August 2014, the Group formed a joint venture, System Link, with Qihoo 360 Technology Co., Ltd., or (“Qihoo 360.360”). Pursuant to the joint venture agreement, Qihoo 360 and the Group will each own 50% equity interest in the joint venture and share profits based on the equity interest each party holds in the joint venture.holds. In August 2014, Red 5 Singapore entered into a license agreement with System Link for publishing and operating Firefall in the PRC under a five-year term in mainland China. Under this license agreement, System Link is expected to pay Red 5 Singapore no less than US$160 million (inclusive of license fee and royalties) during the term of the agreement. The Group accounts for its investment in System Link as an equity method investment. The total capital contributionbeginning from the Group is RMB 223.4 million (US$35 million) as of December 31, 2015. The Group recordsreceived an upfront payment of US$10.0 million related to the license in 2015 and the Group began amortizing the upfront license payment over the license term starting in 2015 at the launch of game by System Link. The licensing agreement also calls for the Group to receive a lossUS$150.0 million minimum royalty payment. The Group did not recognize any of RMB 11.1this amount as the amount is unlikely to be received from System Link.
| F-42 |
In August 2015, System Link entered into an agreement with Smilegate Entertainment, Inc. (“Smilegate”) to form a joint venture company, Oriental Shiny Star Limited (“Oriental Shiny”), for the operation of CrossFire 2. In the event of a successful commercial launch of CrossFire 2, Smilegate will receive a 30% equity share of Oriental Shiny.
In November 2015, Oriental Shiny entered into a license and distribution agreement with Smilegate for publishing and operating CrossFire 2 on an exclusive basis for a five-year term in the PRC (the “License Agreement”). In consideration for the exclusive license, Oriental Shiny made an upfront payment of US$50.0 million and was to make additional payments totaling US$450.0 million based on certain development and operation milestones of CrossFire 2. The payment of license fees is guaranteed by the Group and Qihoo 360 proportional to their equity interest in System Link.
The Group made total capital contributions to System Link of US$35.0 million as of both December 31, 2016 and 2017. The Group recorded losses of RMB111.1 million (US$1.716.2 million) in share of loss in equity method and a gain of RMB3.3 million (US$0.5 million) in other comprehensive incomeSystem Link for the year ended December 31, 2015.2016.
The
In October 2017, Oriental Shiny and Smilegate agreed to terminate the License Agreement. In November 2017, Smilegate made a settlement payment of US$25.0 million to both the Group and Qihoo 360, total of US$50.0 million. A settlement agreement was signed among the Group, Qihoo 360 and Smilegate whereby subsequent to the payment of US$50.0 million, the joint venture agreement signed among Oriental Shiny and Smilegate has terminated. During 2017, the Group offset its 2017 share of losses in System Link against the US$25 million recovery and reduced its investment in System Link to nil, with the remaining portion of the recovery, RMB60.5 million (US$8.8 million), recorded as gain as the Group has filedno future funding obligation to System Link Corporation Limited’s consolidated financial statement as indicated in our annual report on Form 20-F for the year endedor Oriental Shiny.
As of December 31, 2015, as the 20%2016, System Link was a significant subsidiary test was met for the current yearbut not consolidated, and separate financial statements were provided in accordance with Rule 3-09 of SEC Regulation S-X. As of December 31, 2017, System Link met the criteria as a significant subsidiary but the Group has applied for and received a waiver from the SEC to not provide separate financial statements because the Group reduced its investment in System Link to nil in 2017 and the disclosure of separate financial statements of System Link does not have a material effect on the Group’s financial statements.
| F-43 |
Presented below is summarized financial information of System Link:
| Unaudited December 31, 2017 | Unaudited December 31, 2018 | Unaudited December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Balance sheet data: | ||||||||||||
| Current assets | 11,472,721 | 6,653,280 | 967,679 | |||||||||
| Noncurrent assets | 20,005 | 2,092 | 304 | |||||||||
| Current liabilities | (983,142,842 | ) | (974,039,557 | ) | (141,668,178 | ) | ||||||
| Noncurrent liabilities | - | - | - | |||||||||
| Noncontrolling interest | (479 | ) | (94 | ) | (14 | ) | ||||||
| Audited For the year ended December 31, 2016 | Unaudited For the year ended December 31, 2017 | Unaudited For the year ended December 31, 2018 | Unaudited For the year ended December 31, 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Operating data: | ||||||||||||||||
| Revenue | 173,897 | - | - | - | ||||||||||||
| Gross loss | (150,131,075 | ) | (825,402,887 | ) | - | - | ||||||||||
| Loss from operations | (218,841,017 | ) | (825,746,051 | ) | (35,243 | ) | (5,126 | ) | ||||||||
| Net loss | (222,102,758 | ) | (826,681,381 | ) | 4,219,931 | 613,764 | ||||||||||
| Net loss attributable to equity holders | (222,102,760 | ) | (826,681,380 | ) | 4,219,931 | 613,764 | ||||||||||
| F-44 |
<2> Jiucheng AdvertisementBig Data
In June 2015, the Group granted 33.3% equity interest of Shanghai Jiucheng Advertisement Co., Ltd. (“Jiucheng Advertisement”) to two of its employees for nil consideration. The Group recorded share-basedshared based compensation of RMB 2.7RMB2.7 million as a result of this transaction as the equity interest was considered a share-based award for thistheir service. In October, 2015, the Group entered into an agreement with Fei Fan Information Technology Co., Ltd. (“Fei Fan”), whereby Jiucheng Advertisement acquired 100% equity interest in Fei Fan in exchange of 30% equity interest in Jiucheng Advertisement. Upon the completion of the exchange, the Group’sGroup's equity interest in JinchengJiucheng Advertisement was diluted to 46.7%. The Group accounted for the exchange as a disposal of subsidiary with a gain of RMB 3.3RMB3.3 million (US$0.5 million) recognized upon disposal and an acquisition of an equity method investment in Jiucheng Advertisement at fair value. In November 2015, The Group’sthe Group's equity interest in Jiucheng Advertisement was further diluted to 42%42.0% as a result of capital injection by other shareholders. In August 2016, Jiucheng Advertisement raised capital from the Group and a third-party, the Group's equity interest in Jiucheng Advertisement became 43.7%. In October 2016, the Group's equity interest in Jiucheng Advertisement further increased to 44.5% after the execution of certain terms under the investment agreements among certain investors of Jiucheng Advertisement.
In October 2014,December 2016, the Group entered into an agreement with third-party investors of Jiucheng Advertisement. According to the agreement, the Group would repurchase an additional 19.11% equity interest in Jiucheng Advertisement for RMB18.3 million (US$2.7 million) from those third-party investors if Jiucheng Advertisement is not listed on the PRC’s National Equities Exchange and Quotations (“NEEQ”), commonly known as the New Third Board, before December 31, 2017. In March 2017, Jiucheng Advertisement was renamed as Shanghai Big Data Cultures & Media Co., Ltd. (“Big Data”). In September 2017, Big Data listed its shares on NEEQ. As Big Data has listed its shares on NEEQ and has fulfilled its obligation, hence the Group was relieved of its obligation to repurchase 19.11% equity interest in Big Data from those third-party investors. After the listings, the Group holds a 44.46% equity interest in Big Data. In 2018, there was no change in the equity interest of Big Data.
| F-45 |
<3> T3
In April 2008, the Group, through China Crown Technology, invested US$38.3 million in cash to subscribe to 3,031,232 preferred shares issued by G10 Incorporation (“G10”), an established Korean online game developer and operator, which accounted for less than 20% of the equity interest in G10 on an as converted basis. The preferred shares are convertible, non-redeemable and with a liquidation preference. Considering the liquidation preference is substantive and not available to common shares, the preferred shares are not in substance common shares and equity accounting is not applicable. Further, considering the rights and obligations of these shares, they are not considered debt securities. Accordingly, the Group accounted for the investment in G10 under the cost method. The initial investment was US$39.5 million, including US$1.2 million transaction cost. Pursuant to the Series B Preferred Share Subscription Agreement entered into between G10 and the Group, the purchase price would be reduced by up to US$25.0 million if G10’s consolidated net income does not reach the predetermined target for the period from July 1, 2009 to June 30, 2010. The target was not met in the predetermined period, and both parties reached a settlement agreement in November 2010 whereby the purchase price was reduced by US$10.0 million, payable in 26 equal monthly installments beginning in February 2011. The adjustment to the purchase price was accounted for as a reduction in the carrying value of the underlying investment at the time of the settlement. The Group also performed an impairment assessment and recognized an impairment loss of RMB184.9 million for the year ended December 31, 2010. All the refund of purchase price under the settlement agreement had been received.
In December 2011, pursuant to the agreements between the shareholders of G10 and T3, a wholly-owned subsidiary of G10, G10 was spun off and the shareholders of G10 became shareholders of T3 at the same shareholding percentage. In February 2012, the changes in shareholding structures of G10 and T3 was completed and the Group owned 32,290 ordinary shares of T3, which reflects the same percentage of equity the Group owned in G10 on an as converted basis.
The Group performed an impairment assessment and determined that there is no impairment in the investment as of December 31, 2017 and 2018, respectively.
<4> Smartposting
In June 2017, the Group completed a share exchange transaction with IE Limited (“IE”), which was a listed company on Korean Securities Dealers Automated Quotations of Korea Exchange (“KOSDAQ”) for issuance and sale of 12,500,000 ordinary shares of the Group with a 10 year lock-up period. In exchange, IE transferred 14.55% equity interest in Smartposting, a wholly-owned subsidiary of IE. The fair value of 14.55% equity interest in Smartposting was considered to be the value of the assets surrendered to the Group in this non-monetary exchange transaction. Due to weaker than expected operating performance of Smartposting, the Group recorded an impairment of RMB5.1 million and RMB1.1 million (US$0.2 million) for the years ended December 31, 2017 and 2018.
| F-46 |
<5> Beijing Ti Knight
In June 2017, the Group entered into an investment agreement with shareholders of Beijing Ti Knight where the Group will invest a total of RMB9.0 million (US$1.3 million) in Beijing Ti Knight. As of December 31, 2018, the Group has invested RMB4.9 million (US$0.7 million). Due to weaker than expected operating performance, the investment in Beijing Ti Knight was fully impaired and the impairment of RMB4.0 million and RMB0.9 million (US$0.1 million) was recorded for the years ended December 31, 2017 and 2018, respectively (see Note 30).
<6> Tandem Fund
In December 2016, the Group recorded an impairment loss on Tandem Fund of RMB2.8 million (US$0.4 million) based on the fair market value of Tandem Fund. In January 2017, the Group disposed to a third party, 100% of its equity interest in an equity method investee for a cash consideration of RMB14 million and further recovered loan receivables of RMB9.8 million to the same equity method investee. The Company had previously fully impaired the investment in 2013 as well as provided a full allowance for the loan receivables due to the tight liquidity position combined with less than satisfactory performance of the investee. The Group recorded a gain of RMB23.8 as a result of this disposal.
In 2014, the Group disposed 75% of itsentire interest in Tandem Fund to a third-party for casha consideration of RMB11.0RMB1.2 million a(US$0.2 million) which was equivalent to the carrying amount of the investment. No gain of RMB3.1 millionor loss was recognized upon disposal.on the disposal in 2017.
<7> Maxline
In January 2018, the Group completed a share exchange transaction with Red Ace Limited (“Red Ace”), which was a private company incorporated under the laws of the British Virgin Islands for issuance and sale of 3,571,429 ordinary shares of the Group with a specific lock-up period. In exchange, Red Ace transferred 29% equity interest in Maxline, an associate of Red Ace. The fair value of 29% equity interest in Maxline was considered to be the value of the assets surrendered to the Group in this non-monetary exchange transaction.
| F-47 |
<8> Leading Choice
In September 2018, the Group completed a share exchange transaction with Leading Choice Investment Holdings Limited (“Leading Choice Investment”), which was a private company incorporated under the laws of Hong Kong for issuance and sale of 21,000,000 ordinary shares of the Group with a specific lock-up period. In exchange, Leading Choice Investment transferred 20% equity interest in Leading Choice, a wholly-owned subsidiary of Leading Choice Investment. The fair value of 20% equity interest in Leading Choice was considered to be the nominal value of ordinary shares of the Group in the non-monetary exchange transaction. In 2018, due to weaker than expected operating performance of Leading Choice, the Group recorded an impairment of RMB1.4 million (US$0.2 million) for the year ended December 31, 2018.
| F-48 |
<9> The9 Education Technology
In April 2018, the Group has invested RMB0.4 million (US$0.1 million) in The9 Education Technology. But due to weaker than expected operating performance, the investment in The9 Education Technology was fully impaired and the impairment of RMB0.4 million (US$0.1 million) was recorded for the year ended December 31, 2018.
<10> Shanghai Ronglei
In December 2017, the Group has entered into an investment agreement with shareholders of Shanghai Ronglei where the Group will invest a total of RMB5.0 million (US$0.7 million) in Shanghai Ronglei. As of December 31, 2018, the Group has invested RMB4.0 million (US$0.6 million) but due to weaker than expected operating performance, the investment in Shanghai Ronglei was fully impaired and the impairment of RMB4.0 million (US$0.6 million) was recorded for the year ended December 31, 2018.
<11> Plutux
In September 2018, the Group completed a share exchange transaction with Plutux Labs Limited (“Plutux Labs”), which was a private company incorporated under the laws of Cayman Islands for issuance and sale of 21,000,000 ordinary shares of the Group with a specific lock-up period. In exchange, Plutux Labs transferred 8% equity interest in Plutux, a wholly-owned subsidiary of Plutux Labs. The fair value of 8% equity interest in Plutux was considered to be the nominal value of ordinary shares of the Group in the non-monetary exchange transaction. In 2018, due to weaker than expected operating performance of Plutux, the Group recorded an impairment of RMB1.4 million (US$0.2 million) for the year ended December 31, 2018.
The Group recorded impairment charges relating to its investment in equity investeesand others of RMB41.7RMB2.8 million, nilRMB9.1 million and nilRMB9.2 million (US$1.3 million) for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively.
| F-49 |
8. AVAILABLE-FOR-SALE INVESTMENTS
Investment in Youjia Group Limited (“Youjia”)L&A
In November 2011,June 2016, the Group acquired 925,926 redeemable and convertible preferredalong with certain other shareholders of Red 5 completed a share exchange transaction with L&A, a Cayman Islands company with shares publicly listed on the Growth Enterprise Market of the Hong Kong Stock Exchange (Stock Code: 8195). The Group exchanged approximately 30.6% equity interest (on a fully-diluted basis) in Red 5 for a total of 723,313,020 (after a one-to-five stock split) newly issued shares of Youjia,L&A, after deducting 6% of shares received (46,168,920 shares) as payment of a mobile social application developer basedservice fee to a third-party consultant.
In June 2016, Asian Development, a wholly-owned subsidiary incorporated in Hong Kong, borrowed a total of HK$92.3 million from a financial services company, which was secured by a pledge of 417,440,000 shares of L&A (see Note 16). In 2016, Asian Development was in default on the PRC,loan due to a sharp decline in share price of L&A. The lender is entitled to foreclose on the pledged shares and become the legal and beneficial owner of the pledged shares (see Note 30.3). In 2016, the Group provided a full impairment allowance of RMB244.8 million (US$35.6 million) on the investment in L&A. In 2018, the loan remained in default and the lender did not make any claim against Asian Development to recover any outstanding amounts under the agreement.
In 2017, the Group sold 18,360,000 shares in L&A for a consideration of US$1.0 million. The Group’s investment represented 6.67%RMB0.1 million (US$0.01 million). In an extraordinary general meeting in October 2017, Board of Youjia’s equity interest on an as converted basisDirectors of L&A passed a resolution to consolidate every twenty issued and unissued shares into one share. After the share consolidation and as of both December 31, 2011. The Group recorded the investment in Youjia as an available-for-sale investment as the redeemable convertible preference share is in substance a debt security. During 2013, based on an evaluation of the financial results2017 and condition of Youjia,2018, the Group provided full impairment provision of Youjia.
In April 2014, the Group disposed all of itsowned 14,375,651 shares in Youjia to a third party for a cash consideration of US$1.0 million (RMB6.3 million), a gain of RMB6.3 million (US$1.0 million) for the year ended December 31, 2014 is recognized upon disposal.L&A.
| F-50 |
9. PROPERTY, EQUIPMENT AND SOFTWARE, NET
Property, equipment and software and related accumulated depreciation and amortization are as follows:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | December 31, 2017 | December 31, 2018 | December 31, 2018 | |||||||||||||||||||
| RMB | RMB | US$ | RMB | RMB | US$ | |||||||||||||||||||
| (Note 3) | (Note 3) | |||||||||||||||||||||||
Office buildings | 67,881,751 | 69,276,652 | 10,694,472 | 69,341,652 | 69,341,652 | 10,085,325 | ||||||||||||||||||
Computer and equipment | 123,158,909 | 118,052,297 | 18,224,134 | |||||||||||||||||||||
| Computers and equipment | 85,311,170 | 84,134,612 | 12,236,872 | |||||||||||||||||||||
Leasehold improvements | 12,571,448 | 11,008,880 | 1,699,478 | 11,503,400 | 10,365,904 | 1,507,658 | ||||||||||||||||||
Office furniture and fixtures | 10,395,482 | 11,355,064 | 1,752,920 | 6,472,915 | 6,194,658 | 900,976 | ||||||||||||||||||
Motor vehicles | 11,092,117 | 10,889,632 | 1,681,070 | 8,487,925 | 7,038,397 | 1,023,692 | ||||||||||||||||||
Software | 18,175,695 | 18,424,967 | 2,844,325 | 15,833,764 | 15,832,264 | 2,302,707 | ||||||||||||||||||
Less: accumulated depreciation and amortization | (206,929,172 | ) | (205,160,974 | ) | (31,671,397 | ) | (176,115,819 | ) | (175,555,042 | ) | (25,533,422 | ) | ||||||||||||
|
|
| ||||||||||||||||||||||
| Property, equipment and software, net, held for sale | (113,755 | ) | - | - | ||||||||||||||||||||
Net book value | 36,346,230 | 33,846,518 | 5,225,002 | 20,721,252 | 17,352,445 | 2,523,808 | ||||||||||||||||||
|
|
| ||||||||||||||||||||||
Depreciation and amortization charges for the years ended December 31, 2013, 20142016, 2017 and 20152018 amounted to RMB19.0RMB7.3 million, RMB15.7RMB5.3 million and RMB11.6RMB3.7 million (US$1.80.5 million), respectively. The office building was mortgaged as collateral for the convertible notes and bank borrowing in year 2015 (Note 20(see Note 19 and 21)Note 16).
Due to weaker than expected operating performance of certain games, the Group recognized impairment provisions on computer equipment of RMB1.9 million, nil and nil in 2013, 2014, and 2015 respectively.
| F-51 |
10. GOODWILL
The changes
Changes in the carrying amount of goodwill for the years ended December 31, 2013, 20142016, 2017 and 20152018 are as follows:
| Gross Amount | Accumulated Impairment Loss | Net Amount | ||||||||||
| RMB | RMB | RMB | ||||||||||
Balance at January 1, 2013 | 10,011,247 | — | 10,011,247 | |||||||||
Translation difference | (300,393 | ) | — | (300,393 | ) | |||||||
|
|
|
|
|
| |||||||
Balance at December 31, 2013 | 9,710,854 | — | 9,710,854 | |||||||||
Translation difference | 35,200 | — | 35,200 | |||||||||
|
|
|
|
|
| |||||||
Balance at December 31, 2014 | 9,746,054 | — | 9,746,054 | |||||||||
Translation difference | 596,640 | — | 596,640 | |||||||||
|
|
|
|
|
| |||||||
Balance at December 31, 2015 | 10,342,694 | — | 10,342,694 | |||||||||
|
|
|
|
|
| |||||||
Balance at December 31, 2015 US$ (Note 3) | 1,596,637 | — | 1,596,637 | |||||||||
|
|
|
|
|
| |||||||
| Gross amount | Accumulated impairment loss | Net amount | ||||||||||
| RMB | RMB | RMB | ||||||||||
| Balance at January 1, 2016 | 10,342,694 | - | 10,342,694 | |||||||||
| Impairment allowance | - | (10,561,857 | ) | (10,561,857 | ) | |||||||
| Translation difference | 219,163 | - | 219,163 | |||||||||
| Balance at December 31, 2016 | 10,561,857 | (10,561,857 | ) | - | ||||||||
| Translation difference | - | - | - | |||||||||
| Balance at December 31, 2017 and 2018 | - | - | - | |||||||||
| Balance at December 31, 2017 and 2018 US$ (Note 3) | - | - | - | |||||||||
In 2010, the Group recognized goodwill of RMB10.9US$1.6 million in connection with the acquisition of Red 5. The5.The Group measures the consideration it transfers at fair value, which may be calculated as the sum of the acquisition-date fair values of the assets transferred, liabilities incurred to former owners of the acquiree, and equity instruments issued. The costs directly attributable to the acquisition are expensed as incurred. Identifiable assets acquired and liabilities assumed are measured separately at their fair value as of the acquisition date, irrespective of the extent of any noncontrolling interests. Contingent consideration is measured at fair value and recorded as a liability. The excess of (i) the total cost of acquisition, fair value of the noncontrolling interests and acquisition-date fair value of any previously held equity interest in the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference would be recognized directly in the consolidated statementstatements of operations and comprehensive loss.
The
In 2016, due to weaker than expected operating performance of Red 5, the Group performed annual impairment test ondetermined that goodwill aswas fully impaired. Impairment loss of RMB10.6 million (US$1.5 million) was recorded for the year ended December 31, 2013, 2014 and 2015, respectively, as the fair value was greater than carrying value of the reporting unit, no impairment was recorded.
| F-52 |
11. INTANGIBLE ASSETS, NET
Gross carrying amount, accumulated amortization and net book value of the intangible assets as of December 31, 20142017 and 20152018 are as follows:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
Acquired game licenses | 146,925,649 | 146,925,649 | 22,681,412 | |||||||||
Acquired game development cost | 12,285,000 | 12,285,000 | 1,896,477 | |||||||||
Less: Accumulated amortization | (55,738,585 | ) | (74,875,427 | ) | (11,558,774 | ) | ||||||
Impairment provision | (4,394,381 | ) | (4,394,381 | ) | (678,376 | ) | ||||||
Translation difference | (1,538,342 | ) | (1,064,355 | ) | (164,308 | ) | ||||||
|
|
|
|
|
| |||||||
Net book value of intangible assets subject to amortization | 97,539,341 | 78,876,486 | 12,176,431 | |||||||||
|
|
|
|
|
| |||||||
| December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Acquired game licenses | 146,925,649 | 146,925,649 | 21,369,449 | |||||||||
| Acquired game development cost | 12,285,000 | 12,285,000 | 1,786,779 | |||||||||
| Less: accumulated amortization | (85,026,783 | ) | (85,026,783 | ) | (12,366,633 | ) | ||||||
| Less: impairment allowance | (72,398,186 | ) | (72,398,186 | ) | (10,529,879 | ) | ||||||
| Translation difference | (1,785,680 | ) | (1,785,680 | ) | (259,716 | ) | ||||||
| Net book value of intangible assets subject to amortization | - | - | - | |||||||||
In 20142017 and 2015, RMB1.8 million and nil2018, none of acquired game licenses werehad expired respectively, and were written offor been written-off from the cost basis and accumulated amortization.
Since its acquisition by the Group on April 6, 2010, Red 5 has been substantially devotingdevoted its operating activities to fulfill its obligations under a game development and license agreement executed in 2006 and amended in 2009 between Red 5 and a third partythird-party game publisher to develop Firefall in exchange for cash consideration from the third partythird-party publisher. Prior to the acquisition, Red 5 received a total of US$24.7 million cash consideration as an advance recoupable against future royalties payable to Red 5. Red 5 retained the ownership of the game and granted the third partythird-party publisher an exclusive, non-transferable term license to market and distributesdistribute the game and host the game tofor customers in specified regions after Red 5 completes the game development. Red 5 continues to perform its obligations under the agreement post-acquisition, including the provision of post-contract customer support for the hosted version of the game to the third partythird-party publisher during the term of the license. The initial term of the agreement is from February 2006 through the fifth anniversary of the first commercial release of the initial game. Thereafter, the agreement can be renewed in two-year terms.
| F-53 |
In September 2011, Red5 Korea, Red 5 Singapore and Red5Red 5 entered into a series of agreements with the third partythird-party game publisher. Pursuant to the agreement, Red 5 Singapore were substituted in full for the third partythird-party publisher as a party under the game development and license agreement between Red 5 and the third partythird-party game publisher, including the exclusive, , non-transferable term license to market and distribute the game and host the game tofor customers in specified regions. Under the agreements, the Group paid US$10.0 million and guaranteed an additional payment of US$12.7 million to the third partythird-party game publisher due within four years. In addition, the Group is subject to additional contingent payments to be calculated based on certain percentages of the proceeds received from future game licensing and royalties, if any. The total consideration paid, including the US$1010.0 million and the guaranteed amount of US$12.7 million, was recorded as acquired game license and thelicense. The contingent payments will be recorded as cost of services when incurred. The amountbalance of accounts payable which is expectedrelated to due on or beforethis game license fee was US$3.1 million as of December 31, 2016 amounted to US$ 3.1 million (RMB20.0 million) was recorded in accounts payable under current liabilities.2018.
The Group pledged the intellectual property in relation to the game to secure the guaranteed amount. Following this license acquisition, the previously recognized backlog of US$0.4 million in relation to the game development and license agreement acquired in the Red 5 acquisition was reclassified to acquireacquired game licenses as it was considered to be additional cost to acquire the game license paid in prior year.license.
Amortization expense related to intangible assets was RMB23.0RMB10.2 million, RMB28.9 millionnil and RMB19.1 million (US$3.0 million)nil for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively. As of December 31, 2015, the estimated aggregate amortization expense from existing intangible assets for each of the five succeeding fiscal years is as follows:
| RMB | US$ | |||||||
| (Note 3) | ||||||||
2016 | 21,964,146 | 3,390,680 | ||||||
2017 | 21,964,146 | 3,390,680 | ||||||
2018 | 21,964,146 | 3,390,680 | ||||||
2019 | 12,984,048 | 2,004,391 | ||||||
2020 | — | — | ||||||
|
|
|
| |||||
Total | 78,876,486 | 12,176,431 | ||||||
|
|
|
| |||||
The Group has been monitoring its licensed games that have not commercially launched, including but not limited to their market acceptance and operational performance in other regions where they are commercially launched and operated by other operators. The Group incorporates these factors into its continuous evaluation of the forecasted results of the respective games and takingtakes into account the Group’s expected commercial launch and cash flows in the evaluation of potential impairment of the carrying value of upfront licensing fees. Based on the Group’s impairment tests, impairment provisionsallowance on upfront licensing fees of RMB3.8RMB68.0 million, nil and nil were recognizedprovided in 2013, 20142016, 2017 and 2015,2018, respectively.
| F-54 |
12. LAND USE RIGHT, NET
Gross carrying amount, accumulated amortization and net book value of land use right are as follows:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | December 31, 2017 | December 31, 2018 | December 31, 2018 | |||||||||||||||||||
| RMB | RMB | US$ | RMB | RMB | US$ | |||||||||||||||||||
| (Note 3) | (Note 3) | |||||||||||||||||||||||
Land use right | 85,160,348 | 85,160,348 | 13,146,492 | 85,160,348 | 85,160,348 | 12,386,059 | ||||||||||||||||||
Less: accumulated amortization | (14,887,052 | ) | (16,807,962 | ) | (2,594,702 | ) | (20,649,782 | ) | (22,570,692 | ) | (3,282,771 | ) | ||||||||||||
|
|
| ||||||||||||||||||||||
Net book value | 70,273,296 | 68,352,386 | 10,551,790 | 64,510,566 | 62,589,656 | 9,103,288 | ||||||||||||||||||
|
|
| ||||||||||||||||||||||
Amortization charge for the years ended December 31, 2013, 20142016, 2017 and 20152018 amounted to RMB1.9 million, RMB1.9 million and RMB1.9 million (US$0.3 million), respectively. The land use right was mortgaged for the convertible notes and bank borrowing in 2015 (see Note 19 and Note 16).
13. OTHER LONG-LIVED ASSETS, NET
Other long-lived assets are as follows:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
Receivable from WoW game points refund agent (Note 19) | 7,894,836 | — | — | |||||||||
Others | 453,573 | 1,879,021 | 290,071 | |||||||||
|
|
|
|
|
| |||||||
Total | 8,348,409 | 1,879,021 | 290,071 | |||||||||
|
|
|
|
|
| |||||||
| December 31, 2017 | December 31, 2018 | December 31 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Prepaid license fee | 6,515,200 | 6,515,200 | 947,597 | |||||||||
| Other | 6,220 | - | - | |||||||||
| Total | 6,521,420 | 6,515,200 | 947,597 | |||||||||
Prepaid license fee represents the payment made by the Group pursuant to an IP license agreement with an online game company in January 2016 to use its IP to develop a mobile game. The mobile game is expected to be launched in 2019.
| F-55 |
14. ALLOWANCE (REVERSAL OF ALLOWANCE) OF LONG-TERM RECEIVABLE
| December 31, 2013 | December 31, 2014 | December 31, 2015 | December 31, 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
Allowance (reversal of allowance) of receivables | 17,927,763 | (17,927,763 | ) | — | — | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | 17,927,763 | (17,927,763 | ) | — | — | |||||||||||
|
|
|
|
|
|
|
| |||||||||
The Group prepaid RMB20.0 million to a supplier for purchasing computers and equipment in 2011. Due to game’s performance being much lower than expectations, the Group cancelled the purchase plan and requested for a refund on the prepayment from the supplier in 2013. However, the supplier did not have enough funds to return all prepayment which was deemed a strong indicator that recovery of the refund is doubtful. In February 2014, the Group agreed a repayment schedule with the supplier, under which the prepayment is required to be refunded in four installments during the next three years, and the first installment, which was RMB2.0 million, had been received on March, 2014. Due to the significant doubts as to the collectability of the remaining amount, management provided an allowance for the remaining prepayment receivable of RMB17.9 million as of December 31, 2013. The Company continued to negotiate with the supplier for the settlement of remaining receivables. In December 2014, the supplier promised to repay all the remaining RMB17.9 million before March 31, 2015. The Group revaluated the collectability of the receivables and determined the payments can be collected and therefore reversed the allowance of RMB17.9 million as of December 31, 2014. In March, 2015, the Group received payment of RMB17.9 million from the supplier.
15. IMPAIRMENT ON PREPAYMENT FOR EQUIPMENT AND OTHER ASSETS
| December 31, 2013 | December 31, 2014 | December 31, 2015 | December 31, 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
Impairment on prepayment for equipment and other assets | 11,813,313 | 3,555,845 | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Total | 11,813,313 | 3,555,845 | — | — | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
The Group prepaid RMB 11.8 million to a supplier for certain asset which was planned to be used in game promotion activity. In 2013, the management decided to change the game promotion plans and as a result the asset was no longer required under the new promotion plan and as such Group decided not to take title to the asset from the supplier and wrote off the non-refundable prepayment.
For the year ended December 31, 2014, the Group recorded RMB 3.6 million impairment on the prepayment to certain suppliers with which the Group terminated the transaction and wrote off the repayment balance considering its low collectability.
16. FAIR VALUE MEASUREMENTS
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The fair values of the common stock warrants were measured using the Black-Scholes option-pricing model (Note 22)Model (see Note 23). Inputs used to determine estimated fair value of the warrant liabilities include the estimated fair value of the underlying stock at the valuation date, the estimated term of the warrants, risk-free interest rates, expected dividends and the expected volatility of the underlying stock. The significant unobservable inputs used in the fair value measurement of the warrant liability are the fair value of the underlying stock at the valuation date and the estimated term of the warrants. The fair value of convertible note is based on a discounted cash flow model with an unobservable input of discount rate. (Level 3).
The Group measured the fair value of its investment in Youjia using the income approach based on a weighted average of multiple discounted cash flow scenarios, which required the use of unobservable inputs (Level 3) including assumptions of projected revenue, expenses, capital spending, and other costs, as well as a discount rate calculated based on the risk profile of the online game industry and company-specific risk adjustments. The available-for-sale investment in Youjia was fully impaired in 2013 and then sold in 2014.
The following table presents the changes in the available-for-sale investment that were measured at fair value on a recurring basis using significant Level 3 inputs for the year ended December 31, 2013, 2014 and 2015. The Group did not have other assets or liabilities measured at fair value on a recurring basis using significant Level 3 inputs during the years ended December 31, 2013, 2014 and 2015.
Fair Value Measurements Using Significant Unobservable Inputs (Level 3) | ||||||||||||
| 2013 | 2014 | 2015 | ||||||||||
| RMB | RMB | RMB | ||||||||||
Balance at the beginning of the year | 6,285,500 | — | — | |||||||||
Unrealized loss recognized in other comprehensive income | (16,600 | ) | — | — | ||||||||
Impairment losses included in earnings | (6,268,900 | ) | — | — | ||||||||
|
|
|
|
|
| |||||||
Balance at the end of the year | — | — | — | |||||||||
|
|
|
|
|
| |||||||
In 2015, the Group issued warrants in connection with its convertible notes. The warrants are recorded at fair market value at the date of issuance and subsequently at each reporting date. The following table presents the change in the warrants liability that were measured at fair value on a recurring basis using significant Level 3 inputs during the year 2015 (Note 22)2017 and 2018 (see Note 20).
| 2015 | 2015 | |||||||
| RMB | US$ (Note 3) | |||||||
Balance at issuance date | 57,285,780 | 8,843,400 | ||||||
Unrealized loss recognized in other comprehensive income | 7,129,161 | 1,100,553 | ||||||
|
|
|
| |||||
Balance at the end of the year | 64,414,941 | 9,943,953 | ||||||
|
|
|
| |||||
December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Balance at issuance date/beginning of year | 16,357,737 | 3,742,271 | 544,290 | |||||||||
| Fair value change on warrants liability recognized in other comprehensive income | (12,615,466 | ) | (2,251,427 | ) | (327,456 | ) | ||||||
| Balance at the end of the year | 3,742,271 | 1,490,844 | 216,834 | |||||||||
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
| F-56 |
The following table displays assets and liabilities measured at fair value on a non-recurring basis for the years ended December 31, 2013, 2014 and 2015, respectively.
| ||||||||||||||||||||
| ||||||||||||||||||||
| ||||||||||||||||||||
| ||||||||||||||||||||
| ||||||||||||||||||||
| ||||||||||||||||||||
| ||||||||||||||||||||
17.15. TAXATION
Cayman Islands and British Virgin Islands
Under the current tax laws of the Cayman Islands, and British Virgin Islands, the Company and its subsidiaries areGroup is not subject to tax on theirits income or capital gains. In addition, upon payment of dividends by the CompanyThe9 Limited to its shareholders, no Cayman Islands withholding tax will be imposed.
Hong Kong
The Group’s subsidiaries incorporated in Hong Kong did not have assessable profits that were derived in Hong Kong during the years ended December 31, 2013, 20142016, 2017 and 2015.2018. Therefore, no Hong Kong profitincome tax has been provided for in the years presented.
Singapore
The Group’s subsidiaries incorporated in Singapore did not have assessable profits that were derived in Singapore during the years ended December 31, 2013, 20142016, 2017 and 2015.2018. Therefore, no Singapore income tax has been provided for in the years presented.
The
PRC
The Group’s subsidiaries and VIE subsidiaries incorporated in the PRC are subject to Enterprise Income Tax (“EIT”) on the taxable income as reported in their respective statutory financial statements adjusted in accordance with the PRC Enterprise Income Tax Law (“EIT Law”), which went into effect as of January 1, 2008. The Group’s subsidiaries and VIE subsidiaries in the PRC are generally subject to EIT at a statutory rate of 25%. However, the subsidiaries that are located in the Pudong New District of Shanghai enjoy five-year transitional EIT rates, which refer to the phase-in rates of 18%, 20%, 22%, 24% and 25% for the 5 years period from 2008 to 2012 and theThe subsidiaries that hold a “High and New Technology Enterprise” (“HNTE”) qualification are subject to a 15% preferential EIT rate.
In November 2008, Shanghai IT received approval from certain government authorities to be qualified as a HNTE. This approval entitles Shanghai IT to enjoy a 15% preferential EIT rate during the period from 2008 to 2010. The HNTE qualification is valid for three years and every qualified HNTE company is required to re-apply for it in the three years after receiving approval. In October 2014,2017, Shanghai IT renewed its HNTE qualification and obtained approval in 2015,2018, which entitles Shanghai IT to enjoy a preferential EIT rate of 15% during the period from 20142018 to 2016.2020. Total tax savings of Shanghai IT were nil for the years ended December 31, 2013, 20142016, 2017 and 2015, respectively.2018.
United States
The Group’s subsidiaries incorporated in the U.S. are registered in the state of California and are subject to U.S. federal corporate marginal income tax rate of 34%21% and state income tax rate of 0.48%0.28%, respectively. The Group has assessed the recently enacted tax reform in the United States and concluded that there is no material effect to the financial statements.
| F-57 |
On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act includes significant changes to the U.S. corporate income tax system including a federal corporate rate reduction from 34% to 21%; limitations on the deductibility of interest expense and executive compensation; creation of the base erosion anti-abuse tax (“BEAT”), a new minimum tax; and the transition of U.S. international taxation from a worldwide tax system to a modified territorial tax system. A majority of the provisions in the Tax Act are effective January 1, 2018.
The Tax Act creates a new requirement that certain income such as Global Intangible Low-Taxed Income (“GILTI”) earned by a controlled foreign corporation (“CFC”) must be included in the gross income of the CFC U.S. shareholder. The Group has evaluated these provisions of the Tax Act and whether taxes due on future U.S. inclusions related to GILTI be recorded as current-period expense when incurred, or factored into measurement of deferred taxes. The Group concluded that there is no material effect to the financial statements.
Composition of income tax expense
The current and deferred portions of income tax expense included in the consolidated statements of operations and comprehensive loss are as follows:
| For the year ended December 31, | For the year ended December 31, | |||||||||||||||||||||||||||||||
| 2013 | 2014 | 2015 | 2015 | 2016 | 2017 | 2018 | 2018 | |||||||||||||||||||||||||
| RMB | RMB | RMB | US$ | RMB | RMB | RMB | US$ | |||||||||||||||||||||||||
| (Note 3) | (Note 3) | |||||||||||||||||||||||||||||||
Current income tax expense | — | — | — | — | ||||||||||||||||||||||||||||
China | — | — | — | — | - | - | - | - | ||||||||||||||||||||||||
Other jurisdictions | — | — | — | — | - | - | - | - | ||||||||||||||||||||||||
Deferred taxation | 134,391,290 | (21,011,979 | ) | 6,324,015 | 976,260 | |||||||||||||||||||||||||||
China | 70,063,810 | (62,051,840 | ) | (31,447,143 | ) | (4,854,602 | ) | (22,553,453 | ) | (84,042,632 | ) | (39,763,083 | ) | (5,783,301 | ) | |||||||||||||||||
Other jurisdictions | 64,327,480 | 41,039,861 | 37,771,158 | 5,830,862 | 46,848,751 | (124,313,755 | ) | (19,816,235 | ) | (2,882,151 | ) | |||||||||||||||||||||
| Subtotal | 24,295,298 | (208,356,387 | ) | (59,579,318 | ) | (8,665,452 | ) | |||||||||||||||||||||||||
Change in valuation allowance | (134,391,290 | ) | 21,011,979 | (6,324,015 | ) | (976,260 | ) | |||||||||||||||||||||||||
China | (70,063,810 | ) | 62,051,840 | 31,447,143 | 4,854,602 | 22,553,453 | 84,042,632 | 39,763,083 | 5,783,301 | |||||||||||||||||||||||
Other jurisdictions | (64,327,480 | ) | (41,039,861 | ) | (37,771,158 | ) | (5,830,862 | ) | (52,928,033 | ) | 124,313,755 | 19,816,235 | 2,882,151 | |||||||||||||||||||
|
|
|
| |||||||||||||||||||||||||||||
Income tax (expense) benefit | — | — | — | — | ||||||||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||||||||||
| Subtotal | (30,374,580 | ) | 208,356,387 | 59,579,318 | 8,665,452 | |||||||||||||||||||||||||||
| Income tax benefit | (6,079,282 | ) | - | - | - | |||||||||||||||||||||||||||
Reconciliation of the differences between statutory tax rate and the effective tax rate
Reconciliation between the statutory EIT rate and the Group’s effective tax rate is as follows:
For the year ended 2016 | For the year ended 2017 | For the year ended 2018 | ||||||||||||||||||||||
| For the year ended December 31, 2013 | For the year ended December 31, 2014 | For the year ended December 31, 2015 | ||||||||||||||||||||||
PRC Statutory EIT rate | 25 | % | 25 | % | 25 | % | ||||||||||||||||||
| PRC statutory EIT rate | 25 | % | 25 | % | 25 | % | ||||||||||||||||||
Effect of different tax rates in other jurisdictions | (2 | %) | 10 | % | (1 | %) | (4 | )% | (2 | )% | 2 | % | ||||||||||||
Effect of future tax rate change | 1 | % | (1 | %) | (1 | %) | (1 | )% | (22 | )% | 1 | % | ||||||||||||
Change of prior year deferred tax assets | 1 | % | (0 | %) | (1 | %) | (1 | )% | (8 | )% | (11 | )% | ||||||||||||
Change of valuation allowance | (24 | %) | (16 | %) | (2 | %) | (13 | )% | 61 | % | (2 | )% | ||||||||||||
(Income) not subject to tax and non-deductible expenses, net | 0 | % | 2 | % | (1 | %) | ||||||||||||||||||
| Income not subject to tax and non-deductible expenses, net | 0 | % | (1 | )% | 0 | % | ||||||||||||||||||
Effect of expired net operating loss | (1 | %) | (20 | %) | (19 | %) | (6 | )% | (53 | )% | (15 | )% | ||||||||||||
|
|
| ||||||||||||||||||||||
Effective EIT rate | 0 | % | (0 | %) | 0 | % | 0 | % | 0 | % | 0 | % | ||||||||||||
|
|
| ||||||||||||||||||||||
| F-58 |
Significant components of deferred tax assets
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
Temporary differences related to expenses and accruals | 1,926,262 | 3,285,994 | 507,271 | |||||||||
Temporary differences related to provision for advances to suppliers | 1,621,968 | 888,961 | 137,232 | |||||||||
Temporary differences related to provision for doubtful accounts | 191,012 | 1,510,153 | 233,126 | |||||||||
Other | 5,609,163 | 5,900,763 | 910,921 | |||||||||
Temporary differences related to depreciation, amortization, and impairment of equipment and intangible assets | 11,710,677 | 12,728,642 | 1,964,964 | |||||||||
Startup expenses and advertising fee | 25,761,300 | 26,010,125 | 4,015,271 | |||||||||
Temporary differences related to research and development credits | 988,010 | 1,045,470 | 161,393 | |||||||||
Temporary differences related to equity investment | 1,795,745 | 1,531,567 | 236,433 | |||||||||
Foreign tax credits | 15,113,930 | 16,039,192 | 2,476,025 | |||||||||
Temporary differences related to provision for prepayment for equipment | 5,000,000 | 5,000,000 | 771,867 | |||||||||
Tax loss carry forwards | 492,204,751 | 505,784,660 | 78,079,697 | |||||||||
|
|
|
|
|
| |||||||
Total deferred tax assets | 561,922,818 | 579,725,527 | 89,494,200 | |||||||||
Less: Valuation allowance | (561,922,818 | ) | (579,725,527 | ) | (89,494,200 | ) | ||||||
|
|
|
|
|
| |||||||
Total deferred tax assets | — | — | — | |||||||||
|
|
|
|
|
| |||||||
For the year ended 2017 For the year ended 2018 For the year ended 2018
December 31,
December 31,
December 31, RMB RMB US$ (Note 3) Temporary differences related to expenses and accruals 1,858,263 1,087,421 158,159 Temporary differences related to impairment on advances to suppliers 533,377 2,451,767 356,595 Temporary differences related to provision for doubtful accounts 1,604,986 3,077,784 447,645 Others 6,859,651 7,152,217 1,040,247 Temporary differences related to depreciation, amortization, and impairment of equipment and intangible assets 23,180,705 23,165,631 3,369,301 Startup expenses and advertising fees 12,156,135 608,399 88,488 Temporary differences related to research and development credits 1,047,514 1,106,956 161,000 Temporary differences related to equity investments 2,599,887 3,978,269 578,615 Foreign tax credits 16,070,561 - - Temporary differences related to provision for prepayment for equipment 5,000,000 5,000,000 727,220 Tax loss carry forwards 330,832,639 294,535,956 42,838,478 Total deferred tax assets 401,743,718 342,164,400 49,765,748 Less: Valuation allowance (401,743,718 ) (342,164,400 ) (49,765,748 ) Total deferred tax assets - - -
Significant components of deferred tax liabilities
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
Temporary differences related to amortization of intangible assets | 5,362,427 | 5,690,705 | 878,494 | |||||||||
Movement of valuation allowance on deferred tax assets
| For the year ended December 31, 2014 | For the year ended December 31, 2015 | For the year ended December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
Balance at January 1 | 582,934,797 | 561,922,818 | 86,745,935 | |||||||||
Increase (decrease) in valuation allowance | (21,011,979 | ) | 17,802,709 | 2,748,265 | ||||||||
|
|
|
|
|
| |||||||
Balance at December 31 | 561,922,818 | 579,725,527 | 89,494,200 | |||||||||
|
|
|
|
|
| |||||||
For the year ended 2017 | For the year ended 2018 | For the year ended 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Beginning balance | 610,100,105 | 401,743,718 | 58,431,200 | |||||||||
| Decrease in valuation allowance | (208,356,387 | ) | (59,579,318 | ) | (8,665,452 | ) | ||||||
| Ending balance | 401,743,718 | 342,164,400 | 49,765,748 | |||||||||
For the years ended December 31, 20142017 and 2015,2018, the Group recorded a reversal of valuation allowance and an increase of valuation allowance of approximately RMB21.0RMB208.4 million and RMB17.8RMB59.6 million (US$2.78.7 million) was provided, respectively. The Group considers positive and negative evidence to determine whether some portion or all of the deferred tax assets will more likely than not be realized. This assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the duration of statutory carry forward periods, the Group’s experience with tax attributes expiring as unused and tax planning alternatives. Valuation allowances have been established for deferred tax assets based on a more-likely-than-not threshold. The Group’s ability to realize deferred tax assets depends on its ability to generate sufficient taxable income within the carry forward periods provided for in the tax law.
As of December 31, 2015,2018, the Group’s PRC subsidiaries had net operating loss carry forwards of RMB817.1RMB392.1 million, of which RMB162.9RMB41.0 million, RMB327.9RMB113.6 million, RMB190.2RMB99.5 million, RMB46.3RMB71.1 million and RMB89.8RMB66.9 million will expire in 2016, 2017, 2018, 2019, 2020, 2021, 2022 and 2020,2023, respectively. The Group has provided a full valuation allowance as it is not more likely than not that the net operating losses can be utilized before expiry.
| F-59 |
As of December 31, 2015,2018, Red 5 had net operating loss carry forwards for federal and state income tax purposes of approximately US$124.2125.5 million and US$68.764.7 million, respectively, which will begin to expire in 2026 and 2016,2028, respectively. Red 5 also had credits for increasing research activities available to offset future federal and state taxes payable of approximately US$0.1 million and US$0.1 million, respectively, that will begin to expire in 2026 for federal purposes and which have no expiration for state purposes. Red 5 had foreign tax credits for federal purposes of approximately US$2.5 million, which begin to expirehas expired in 2016.2018. Pursuant to US tax laws and regulations, the utilization of an acquired entity’s net operationoperating losses and credits are subject to annual limitation computed based on the fair value of the acquired entity. As a result of the limitation, the Group provided a full valuation allowance as it is not more likely than no not that the net operating losses and credits carried forward can be utilized before expiration.
In accordance with the Enterprise Income TaxEIT Law, (“EIT Law”), dividends, which arise from profits of foreign invested enterprises (“FIEs”) earned after January 1, 2008, are subject to a 10% withholding income tax. In addition, under tax treaty between the PRC and Hong Kong, if the foreign investor is incorporated in Hong Kong and qualifies as the beneficial owner, the applicable withholding tax rate is reduced to 5%, if the investor holds at least 25% in the FIE, or 10%, if the investor holds less than 25% in the FIE. A deferred tax liability should be recognized for the undistributed profits of PRC companies unless the CompanyGroup has sufficient evidence to demonstrate that the undistributed dividends will be reinvested and the remittance of the dividends will be postponed indefinitely. The Group plans to indefinitely reinvest undistributed profits earned after December 31, 2007 from its China subsidiaries in its operations in the PRC. Therefore, no withholding income taxes for undistributed profits of the Company’s subsidiaries incorporated in PRC have been provided as of December 31, 2013, 20142017 and 2015.2018.
Under applicable accounting principles, a deferred tax liability should be recorded for taxable temporary differences attributable to the excess of financial reporting basis over tax basis in a domestic subsidiary. However, recognition is not required in situations where the tax law provides a means by which the reported amount of that investment can be recovered tax-free and the enterprise expects that it will ultimately use that means. The Group has not recorded any such deferred tax liability attributable to the undistributed earnings of its financial interests in VIEs because these entities do not have any accumulated earnings as of December 31, 2013, 20142017 and 2015.2018.
The Group made its assessment of the level of authority for each tax position (including the potential application of interests and penalties) based on the tax positions’ technical merits, and measured the unrecognized benefits associated with the tax positions. The Group did not have any unrecognized tax benefits as of December 31, 2013, 20142017 and 2015.2018. The Group does not anticipate that unrecognized tax benefits will significantly increase or decrease within the next twelve months. For the years ended December 31, 2013, 20142016, 2017 and 2015,2018, the Group did not have any material interest and penalties associated with its tax positions.
| F-60 |
According to PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due to computational errors made by the taxpayer or withholding agent. The statute of limitations will be extended five years under special circumstances, which are not clearly defined (but an underpayment of tax liability exceeding RMB 0.1 million is specifically listed as a special circumstance). In the case of a related party transaction, the statute of limitations is ten years. There is no statute of limitations in the case of tax evasion. From inception to 2015,2018, the Group is subject to examination of the PRC tax authorities. Red 5’s federal income tax returns and state income tax returns for 2006 through 20152018 are open tax years, subject to examination by the relevant tax authorities.
18.
16. SHORT-TERM BORROWINGS
Short-term borrowings are as follows:
December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Pledged loan | 77,118,809 | 80,836,823 | 11,757,228 | |||||||||
| Long-term borrowing due within one year | 31,624,560 | 31,624,560 | 4,599,602 | |||||||||
| Total | 108,743,369 | 112,461,383 | 16,356,830 | |||||||||
In June 2016, the Group completed a share exchange transaction with L&A for a total of 769,481,940 (after a 1 to 5 stock split) newly issued shares of L&A. In June 2016, Asian Development borrowed a total of HK$92.3 million from a financial services company at an annual interest rate of 2% for a term of 24 months, which is secured by a pledge of 417,440,000 shares of L&A. The outstanding balance as of December 31, 2018 is RMB84.5 million (US$12.3 million), which includes RMB3.6 million (US$0.5 million) of interest payable, and the pledged loan was due in June 2018. Asian Development has defaulted the loan in June 2016 due to a sharp decline in share price of L&A (see Note 30.3)
In December 2015, the Group entered an entrusted bank borrowing agreement, amounted to RMB31.6 million (US$4.6 million), with a subsidiary of the convertible notes investor (see Note 19) and China Merchants Bank as entrustment bank. The borrowing agreement has matured in December 2018, with an annual interest rate of 12% due on maturity of the loan. The loan is secured by the Group’s office buildings. The outstanding balance as of December 31, 2018 is RMB43.3 million (US$6.3 million), including RMB11.7 million (US$1.7 million) of interest payable. The entrusted bank borrowing was due in December 2018 but has not repaid as of December 31, 2018. The Group has entered into a deed of settlement with the investor of convertible notes on March 12, 2019 where the Group will proceed to the disposal of office buildings and to repay both convertible notes and entrusted bank borrowing. Annual interest rate of the loan remained at 12% up to settlement date.
| F-61 |
17. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Other payables
Accrued expenses and accrualsother current liabilities are as follows:
| December 31, 2014 | December 31, 2015 | December 31, 2015 | December 31, 2017 | December 31, 2018 | December 31, 2018 | |||||||||||||||||||
| RMB | RMB | US$ | RMB | RMB | US$ | |||||||||||||||||||
| (Note 3) | (Note 3) | |||||||||||||||||||||||
Staff cost related payables | 18,758,212 | 15,705,966 | 2,424,583 | 7,461,738 | 4,245,967 | 617,550 | ||||||||||||||||||
Professional services | 12,312,998 | 12,070,384 | 1,863,346 | 7,250,470 | 6,879,775 | 1,000,622 | ||||||||||||||||||
| Utility fee | 2,013,127 | 1,547,898 | 225,132 | |||||||||||||||||||||
Product development services | 5,820,394 | 1,648,410 | 254,471 | 849,446 | 892,216 | 129,767 | ||||||||||||||||||
Marketing and promotion | 452,920 | 3,988 | 616 | |||||||||||||||||||||
| Funds raised for CrossFire New Mobile Game (see below) | 57,499,910 | 57,499,910 | 8,363,015 | |||||||||||||||||||||
Others | 4,528,327 | 6,435,676 | 993,498 | 8,625,360 | 10,225,540 | 1,487,244 | ||||||||||||||||||
|
|
| ||||||||||||||||||||||
| 41,872,851 | 35,864,424 | 5,536,514 | ||||||||||||||||||||||
|
|
| ||||||||||||||||||||||
| Total | 83,700,051 | 81,291,306 | 11,823,330 | |||||||||||||||||||||
The Group has financed the early phase development ofCrossFire New Mobile Gamethrough fund raising from the Inner Mongolia Culture Assets and Equity Exchange. As of December 31, 2018, the Group had raised RMB57.5 million (US$8.4 million). Under this fund raising arrangement, the Group will share certain percentages of the revenues from CrossFire new mobile game to the investors providing funding to the Group. Due to unforeseen circumstances, the Group is not planning to finance the remaining RMB100.0 million (US$14.5 million) and due to non-recovery of the advance financing fee, the Group has fully impaired the advance financing fee as of December 31, 2018. In November 2017, the Group entered into an exclusive publishing agreement with a third-party company, pursuant to which this third-party company was granted with an exclusive right to publish the CrossFire New Mobile Game in China and the game is expected to be launched in the second half of 2019.
19.
18. Refund of WoW game points
As a result of the loss of the WoWWorld of Warcraft (“WoW”) license on June 7, 2009, the Group announced a refund plan in connection with inactivated WoW game point cards, which the Group recorded as advance from customers. According to the plan, inactivated WoW game point card holders are eligible to receive a cash refund from the Group. The Group recorded a liability in connection with both inactivated points cards and activated but unconsumed point cards of approximately RMB200.4 million, of which RMB4.0 million was refunded in 2009.
| F-62 |
Upon the loss of the WoW license, the Group concluded the nature of the obligation substantively changed from deferred revenue, for which the Group had the abilityresponsibility to satisfy the underlying performance obligation, to an obligation to refund players for their unconsumed points. The Group has accounted for this refund liability by applying the derecognition guidance specified in ASC 405-20. In accordance with this guidance, the refund liability associated with these WoW game points, to the extent not refunded, will be recorded as other operating income after the Group is legally released from the obligation to refund amounts under the applicable laws. In consultation with its legal counsel, the Group concluded the legal liability relating to the inactivated WoW game point cards was extinguished in September 2011 on the basis that the legal liability lapsed two years from the date the Group publicly announced the refund policy that applied to these cards. Accordingly, the associated liability amounting to RMB26.0 million (US$4.23.8 million) was recognized as other operating income for the year ended December 31, 2011. With respect to the remaining refund liability, based on current PRC laws, to the extent not refunded, the Company, in consultation with legal counsel has determined that it will be legally released from this liability in September 2029, which represents 20 years from the discontinuation of WoW in 2009. However, if the Group were to publicly announce a refund policy, the Group would be legally released from any remaining liability for these activated, but unconsumed points that remained two years from the date of such announcement. To date, the Group has determined not to publicly announce any refund policy with respect to this remaining liability, and no refunds have been claimed. The remaining refund liability relating to the activated, but unconsumed WoW game points is RMB170.0 million (US$26.224.7 million) as of both December 31, 2015.
In 2009, the Group engaged an agent to facilitate the refund to game players2017 and provided an advance payment to the agent for RMB43.3 million for this purpose. In 2013, 2014 and 2015, nil were refunded to game point card holders through the agent, respectively. In February 2012, the Group entered into an agreement with the agent pursuant to which the agent will refund the advance to the Group in installments over a five year period after deducting any further refunds paid to game point card holders. As of December 31, 2015, the balance of the advance payment to the agent was RMB8.4 million (US$1.3 million). As of December 31, 2015, the Group wrote off the remaining RMB8.4 million receivable because it is unlikely that the agent will refund to us since the business relationship between the Group and the agent have been terminated.2018.
20. LONG-TERM DEBT
The Group entered an entrusted bank borrowing agreement, amounted to RMB 31.6 million (US$4.9 million), with a third party investor and China Merchants Bank as entrustment bank. The borrowing is due in November 2018, with two years extension and bears an annual interest rate of 12% due up maturity of the loan. The loan is secured by the real property of the office building of the Group. The balance as of December 31, 2015 is RMB 31.7 million (US$ 4.9 million) also includes RMB 0.1 million (US$ 0.02 million) interest payable.
21.19. CONVERTIBLE NOTES
On November 24, 2015, the Group entered into an agreement with a third partythird-party investor for a private placement of secured convertible notes and warrants for a gross proceeds of US$40,050,000, which the40,050,000. The transaction closed on December 11, 2015. Pursuant to the terms of the agreement, the convertible notes shall mature in December 2018, subject to an extension for two years at the discretion of the investor. The convertible notes accrue interest at a rate of twelve percent (12%)12% per annum and are payable upon maturity of the notes. The notes are secured by the equity interest of the Group’sGroup's subsidiaries (The9 Computer and C9I Shanghai), and the Group’s office buildings with a total net book value of RMB24.3 million.RMB16.0 million as of December 31, 2018. The third-party investor of the notes is entitled to put the convertible notes to the Group upon a change in control and upon an event of default. The Group has entered into a deed of settlement with the investor of convertible notes on March 12, 2019 where the Group will proceed to the disposal of office buildings and to repay both convertible notes and entrusted bank borrowing. Annual interest rate of the loan remained at 12% up to settlement date.
| F-63 |
The notes are divided into three tranches and can be converted into a total of 11,695,513 shares of the Group’sGroup's ADS at any time as follows:
| ||||||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||
The conversion prices are subject to anti-dilution adjustments and in the event the Company issueGroup issues ordinary shares at a price per share lower than the applicable conversion price in effect immediately prior to the issuance. As of December 31, 2015,2018, no adjustments to the conversion prices had occurred.
The Group has determined that there was BCF attributable to the Tranche A convertible loan as the conversion price is lower than market value at the date of issuance of the convertible note. The value of the BCF is determined to be US$8.1 million, (RMB 52.7 million), which is equal to the intrinsic value of the conversion feature. The convertible notes are recorded at net carrying value at the date of issuance as follows:
| US$ | RMB | |||||||
Principle Amount | 40,050,000 | 260,068,680 | ||||||
Less: | ||||||||
Fair value allocated to warrants (Note 22) | 8,821,883 | 57,285,780 | ||||||
Beneficial conversion feature | 8,112,556 | 52,679,692 | ||||||
Issuance Cost | 3,200,000 | 20,779,520 | ||||||
Net carrying value | 19,915,561 | 129,323,688 | ||||||
| US$ | ||||
| Principal Amount | 40,050,000 | |||
| Less: | ||||
| Fair value allocated to warrants (Note 20) | 8,821,883 | |||
| Beneficial conversion feature | 8,112,556 | |||
| Issuance cost | 3,200,000 | |||
| Net carrying value | 19,915,561 | |||
The fair value of warrants, BCF and issuance costs are recorded as debt discount and accreted to interest expense over 3three years using the effective interest method. The convertible notes should be repaid with principal and interest based on the agreement. As of December 31, 2015,2017 and 2018, the total carrying amount of the convertible notes is RMB 131.9 million (US$ 20.3 million)principal and interest payable is RMB 3.3 million(US$0.5RMB260.6 million and RMB375.3 million (US$54.6 million)., respectively. Interest expenseexpenses recognized related to the convertible note is RMB 5.9notes are RMB50.4 million, RMB77.0 million and RMB98.3 million (US$ 0.914.3 million) for the yearyears ended December 31, 2015.2016, 2017 and 2018, respectively.
22.
| F-64 |
20. WARRANTS
The warrants issued in conjunction with the convertible notes expire November 24, 2020 and are exercisable at any time after the commitment date to purchase up to 4,778,846 shares of the Company’sGroup's ADS as follows:
For the tranches A, B and C, the expiration date is the third anniversary of the issuance date or if the holder has exercised its option to extend the maturity date of all or any portion of the convertible notes in accordance with the terms and conditions thereof, the fifth anniversary of the issuance date. Tranches A, B and C expired on December 20, 2018. Tranche I will expire in December 2020. | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| |||||||||||||||||||||||||||||||||||||||||||||||||||||
| |||||||||||||||||||||||||||||||||||||||||||||||||||||
| |||||||||||||||||||||||||||||||||||||||||||||||||||||
The exercise prices of the warrants are subject to anti-dilution adjustments and in the event the Company issue ordinary shares at a price per share lower than the applicable exercise price in effect immediately prior to the issuance. As of December 31, 2015,2018, no adjustments to the exercise prices had occurred.
The Group performs valuations of the warrants using a probability weighted Black-Scholes option pricing model.Model. This model requires input of assumptions including the risk-free interest rates, volatility, expected life and dividend rates, and has also considered the likelihood of “down-round”"down-round" financings. Selection of these inputs involves management’smanagement's judgment and may impactaffect net income.
The assumptions used in the Black-Scholes option pricing model for the warrants wereTranche I was as follows:
| Warrants | Tranche I | ||||
Risk-free interest rate | % | ||||
Expected volatility of common stock | % | ||||
Dividend yield | 0.00 | % | |||
Expected life of warrants | |||||
The fair value of the warrants as of issuance date, and December 31, 20152017 and 2018 is RMB 57.3RMB3.7 million (US$8.8 million) and RMB 64.4RMB1.5 million (US$9.90.2 million), respectively. The change in fair value of the warrantwarrants liability resulted in a loss of RMB 7.1RMB48.1 million, RMB12.6 million and RMB2.3 million (US$1.10.3 million) for the yearyears ended December 31, 2015.2016, 2017 and 2018, respectively.
23. SHARE REPURCHASE PROGRAM
| F-65 |
In December 2012, the Company’s Board approved share buyback of up to US$10 million of its ADSs over the next 12 months. Under this share repurchase program, the Company spent an aggregate purchase consideration of approximately US$0.1 million and repurchased approximately 0.04 million shares of its ADSs during the year ended December 31, 2012. During the year ended December 31, 2013, the Company spent approximately US$4.6 million and repurchased approximately 1.7 million shares of ADSs.
24.21. SHAREHOLDER RIGHTS PLAN
On January 8, 2009, the Company adopted a shareholder rights plan. The shareholder rights plan is designed to protect the best interests of the Company and its shareholders by discouraging third partiesthird-parties from seeking to obtain control of the Company in a tender offer or similar hostile transaction. The shareholder rights plan was amended on March 9, 2009.2009, June 8, 2017 and June 16, 2017.
Pursuant to the terms of the shareholder rights plan, as amended, one right was distributed with respect to each ordinary share of the Company outstanding at the close of business on January 22, 2009. The rights will become exercisable only if a person or group (the “Acquiring Person”) obtains ownership of 15% or more of the Company’s voting securities (including by acquisition of the Company’s ADSs representing ordinary shares) (a “Triggering Event”), subject to certain exceptions. In the case of a Triggering Event, the rights plan entitles shareholders other than the Acquiring Person to purchase, for an exercise price of US$19.50, a number of shares with a value twice that of the exercise price. The number of shares each such shareholder will be entitled to purchase is equal to the product of (i) the number of shares then owned by such shareholder and (ii) two times the exercise price divided by the then current market price per share. The rights plan will continue in effect until January 8, 2019, unless the plan is terminated by the Company or the rights are redeemed by the Company before the plan expires. The plan has not been exercisable yet.as of December 31, 2018. As of the issuance date of financial statements, the rights plan has expired and not been extended.
25.22. EMPLOYEE BENEFITS
The full-time
Full-time employees of the Company’sGroup’s subsidiaries and VIE subsidiaries that are incorporatedregistered in the PRC are entitled to staff welfare benefits, including medical care, welfare subsidies, unemployment insurance and pension benefits through a PRC government-mandated multi-employer defined contribution plan. These companiesentities are required to accrue for these benefits based on certain percentages of the employees’ salaries in accordance with the relevant regulations, and to make contributions to the state-sponsored pension and medical plans out of the amounts accrued for medical and pension benefits. The total amounts charged to the consolidated statements of operations and comprehensive loss for such employee benefits amounted to RMB15.3RMB15.4 million, RMB19.5RMB12.9 million and RMB13.1RMB7.9 million (US$21.1 million) for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively. The PRC government is responsible for the medical benefits and ultimate pension liability to these employees.
26.
| F-66 |
23. SHARE-BASED COMPENSATION
26.1
23.1 Share Option Plan
On December 15, 2004, in connection with its initial public offering, the Company adopted a share option plan (“2004 Option Plan”). As of December 31, 2013, the total number of ordinary shares reserved in the 2004 Option Plan was 6,449,614 shares. The maximum contractual term of the awards under this plan shall be no more than five years from the date of grant. The options granted under this plan shall be at the money on the date of grant and typically vest over a three-year period, with one third of the options to vest on the each of the anniversary after the grant date. The 2004 Option Plan was amended in November 2015 to increase the maximum aggregate number of ordinary shares to 14,449,614 Shares.shares. The 2004 Option Plan was amended in August 2016 to increase the maximum aggregate number of ordinary shares to 34,449,614 shares.In December 2018, the 2004 Option Plan was amended to increase the maximum aggregate number of ordinary shares to 100,000,000 shares.On June 6, 2017, the Group and optionees have entered into certain stock option agreements, pursuant to which the Group has granted to the optionees options to acquire the ordinary shares, par value US$0.01 each, of the Group. According to the agreements, 6,328,535 options were exercised to ordinary shares, and 10,806,665 options were canceled. As of December 31, 2015,2018, options to purchase 12,877,7182,050,000 ordinary shares wereare outstanding and options to purchase 120,92589,956,594 ordinary shares wereare available for future grant under the 2004 Option Plan.
Stock Options
The following table summarizes the Company’sGroup’s share option activities with its employees and directors:
| Number of Options | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | |||||||||||||
Outstanding at January 1, 2015 | 3,070,491 | US$ | 2.41 | 1.03 | — | |||||||||||
Granted | 1,910,000 | |||||||||||||||
Exercised | — | |||||||||||||||
Forfeited | (302,773 | ) | US$ | 4.52 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Outstanding at December 31, 2015 | 4,677,718 | US$ | 1.53 | 4.41 | US$ | 7,577,903 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Vested and expected to vest at December 31, 2015 | 4,677,718 | US$ | 1.53 | 4.41 | US$ | 7,577,903 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Exercisable at December 31, 2015 | 3,085,410 | US$ | 1.53 | 4.42 | US$ | 4,998,364 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Number of Options | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | ||||||||||||
| Outstanding as of January 1, 2018 | - | - | - | Nil | |||||||||||
| Granted | 5,750,000 | US$ | 0.93 | - | Nil | ||||||||||
| Exercised | - | - | - | Nil | |||||||||||
| Forfeited | (5,700,000 | ) | US$ | 0.93 | - | Nil | |||||||||
| Outstanding as of December 31, 2018 | 50,000 | US$ | 0.93 | 4.07 | Nil | ||||||||||
| Vested and expected to vest as of December 31, 2018 | 50,000 | US$ | 0.93 | 4.07 | Nil | ||||||||||
| Exercisable as of December 31, 2018 | 50,000 | US$ | 0.93 | 4.07 | Nil | ||||||||||
| F-67 |
The options expected to vest are estimated by applying the pre-vesting forfeiture rate assumptions to total unvested options. The total intrinsic value of options exercised during the year was US$119,624, US$21,701 and nil for yearyears ended December 31, 2013, 20142016, 2017 and 2015, respectively.2018.
On January 24, 2018, as approved by the Board of Directors, the Group granted share options totaling 5,750,000 shares to directors, officers and consultants. The remaining shares shall become vested in a series of 36 successive equal monthly installments upon grantees’ completion of each month of service to the Company over the 36-month period measured from the grant date. On September 4, 2018, the Group canceled a portion of the options totaling 4,700,000 share options granted to directors, officers and consultants. The remaining 1,000,000 share options were forfeited due to the resignation of directors.
The weighted-average grant-date fair value of options granted during the years 2013 and 20152018 was US$0.99 and US$0.65, respectively. No options were granted during 2014.0.51. The fair value of the share options were measured on the respective grant dates based on the Black-Scholes option pricing model, with below assumptions made regarding expected term and volatility, risk-free interest rate and dividend yield:
Risk-free interest rate Expected life (years) Expected dividend yield Volatility Fair value of options at grant date For the year
ended
December
31, 2013 For the year
ended
December
31, 2015 0.35 % 1.22 % 3.25 3.35 0 0 59.39 % 59.74 % US$ 0.99 US$ 0.65
On November 17, 2015, The Group granted three tranches of share options to certain directors, officers and key employees totaling 8,200,000 shares with predetermined market conditions as summarized below:
Options | Target Price (US$) | Number of Options Vesting | ||||||
Tranche I | 2.6 | 4,555,556 | ||||||
Tranche II | 5.2 | 2,733,334 | ||||||
Tranche III | 7.8 | 911,110 | ||||||
|
|
|
| |||||
Total | 8,200,000 | |||||||
|
| |||||||
Of these share options granted, 7,000,000 options is subject only to the predetermined market condition and will vest immediately when the Company’s ADS stock price reaches the respective target stock prices as noted above (“Predetermined Market Condition”). The Vesting of the remaining 1,200,000 options are subject to a 3 year service period in addition to Predetermined Market Condition.
Activities relating to share options subject to with only Predetermined Market Condition are summarized as follows:
| Number of Options | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | |||||||||||||
Outstanding at January 1, 2015 | — | — | ||||||||||||||
Granted | 7,000,000 | US$ | 1.53 | |||||||||||||
Exercised | — | |||||||||||||||
Forfeited | — | |||||||||||||||
|
|
|
|
|
|
|
| |||||||||
Outstanding at December 31, 2015 | 7,000,000 | US$ | 1.53 | 4.88 | US$ | 11,340,000 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Vested and expected to vest at December 31, 2015 | 7,000,000 | US$ | 1.53 | 4.88 | US$ | 11,340,000 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Exercisable at December 31, 2015 | 3,888,889 | US$ | 1.53 | 4.88 | US$ | 6,300,000 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
The weighted-average grant-date fair value of options granted with only Predetermined Market Condition during the year 2015 was US$0.69, US$0.68, US$0.60 for Tranche I,II and III, respectively. The fair values for these shares options is calculated using the Monte Carlo Simulation mode with the key following assumption:
For the year ended | |||||
| |||||
| % | ||||
Expected | |||||
| % | ||||
Volatility | 78.55 | % | |||
| Fair value of options at grant date | US$ | ||||
On August 6, 2016, The Group granted share options totaling 6,000,000 shares to Mr. Zhu Jun, chairman and chief executive officer, and a third-party consultant as a reward for facilitating the Mongolia funding platform with total funding amount of RMB157.5 million (US$22.9 million) to the Group. According to ASC 718, the share option was applicable to the performance condition due to the share options would be vested in line with the percentage of funding received by the Group. In 2017, the options totaling 5,000,000 granted to Zhu Jun were canceled. As of December 31, 2018, options totaling 1,000,000 shares to a third-party consultant were outstanding.
On January 24, 2018, as approved by the Board of Directors, the Group granted share options totaling 2,500,000 shares to directors and consultant, subject to both Predetermined Market Conditionperformance conditions, of which 1,000,000 shares granted will vest upon the success of improvement on the Group's online game business and service conditions are as followed:1,500,000 shares will vest upon the success of the Group's fund raising. On September 4, 2018, the Group canceled a portion of the options totaling 1,500,000 share options granted to director and consultant.
| Number of Options | Weighted- Average Exercise Price | Weighted- Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | |||||||||||||
Outstanding at January 1, 2015 | — | — | ||||||||||||||
Granted: | 1,200,000 | US$ | 1.53 | — | ||||||||||||
Exercised | ||||||||||||||||
Forfeited | — | |||||||||||||||
|
|
|
|
|
|
|
| |||||||||
Outstanding at December 31, 2015 | 1,200,000 | US$ | 1.53 | 4.88 | US$ | 1,944,000 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Vested and expected to vest at December 31, 2015 | 1,200,000 | US$ | 1.53 | 4.88 | US$ | 1,944,000 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
Exercisable at December 31, 2015 | 18,530 | US$ | 1.53 | 4.88 | US$ | 30,019 | ||||||||||
|
|
|
|
|
|
|
| |||||||||
| F-68 |
The weighted-averagefollowing table summarizes the share option activities subject to performance condition:
| Number of Options | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | |||||||||||||
| Outstanding as of January 1, 2018 | 1,000,000 | US$1.86 | 3.60 | Nil | ||||||||||||
| Granted | 2,500,000 | US$0.93 | - | Nil | ||||||||||||
| Exercised | - | - | - | Nil | ||||||||||||
| Forfeited | (1,500,000 | ) | US$0.93 | - | Nil | |||||||||||
| Outstanding as of December 31, 2018 | 2,000,000 | US$1.86 | 2.06 | Nil | ||||||||||||
| Vested and expected to vest as of December 31, 2018 | 2,000,000 | US$1.86 | 2.06 | Nil | ||||||||||||
| Exercisable as of December 31, 2018 | 365,079 | US$1.86 | 0.06 | Nil | ||||||||||||
The grant-date fair value of share options granted with multiple conditionsperformance condition during the year 20152018 was US$0.71, US$0.68, US$0.60 for Tranche I,II and III, respectively.0.51. The fair valuesvalue of the awards that are based on the marketperformance condition werewas calculated using the Monte Carlo Simulation mode with the key following assumption:
| ||||
| ||||
| ||||
| ||||
|
Modification of Share-Based Awards
On April 22, 2013, the Company modified the exercise prices of share options granted to 234 directors, officers and employees granted to US$2.41 per share, which was the market price on the date of modification. The original exercise price of the modified options ranged from US$7.36 to US$4.78.
On June 13, 2015, the company extended the expiration dates of the stock options granted to 25 directors, officers and employees, with expirations dates of August 26, 2015 and December 10, 2015 to August 26, 2020, and the exercise price of these share options was also reduced to US$1.78 which was the closing sale price on June 12, 2015.
On November 17, 2015, the Company modified the exercise prices of share options granted to 15 directors, officers and employees to US$1.53 per share, the closing price of the last trading day. The original exercise price of the modified options ranged from US$1.78 to US$2.41.
During 2013, 2014 and 2015, as a result of these modifications, the Group recognized incremental compensation cost of RMB3.8 million (US$0.6 million), RMB0.9 million (US$0.2 million) and RMB11.8 million (US$1.8 million) respectively upon modification for the vested portion.
The fair value of options, of which exercise prices were modified in April 2013, June 2015 and November 2015, were measured on the modification date based on the Black-Scholes option pricing model with the following assumptions:
| For the year ended December 31, 2013 | For the year ended December 31, 2015 | |||||||
Risk-free interest rate | 0.09%-0.24 | % | 0.50%-1.12 | % | ||||
Expected remaining life (years) | 0.57-2.20 | 1.32-2.61 | ||||||
Expected dividend yield | 0 | 0 | ||||||
Volatility | 36%-65 | % | 64%-71 | % | ||||
Fair value of incremental cost | US$ | 0.16-US$0.43 | US$ | 0.21-US$0.73 | ||||
| Risk-free interest rate | 2.19 | % | ||
| Expected life (years) | 2.93 | |||
| Expected dividend yield | 0.00 | % | ||
| Volatility | 78.55 | % | ||
| Fair value of options at grant date | US$ | 0.51 |
Cancelation and Acceleration Vesting of Share-Based Awards
On June 6, 2017, the Group canceled a portion of the options totaling 10,806,665 and accelerated the vesting and exercise of the remaining options totaling 6,328,535 for options granted to 15 directors, officers and employees. The exercise price was modified to US$0.00, which the original exercise price of the accelerated vesting options ranged from US$1.53 to US$1.86. The incremental compensation cost recognized due to the cancelation and acceleration vesting of options was RMB33.0 million (US$4.8 million) in 2017. The fair value of the options canceled and accelerated vested under service and performance condition was measured on the modification date using Binomial Tree Pricing Model with the following assumptions:
| Risk-free interest rate | 1.16%-1.62 | % | ||
| Expected life (years) | 4.49-5.00 | |||
| Expected dividend yield | 0.00 | % | ||
| Volatility | 62%-74 | % | ||
| Fair value of options at modification date | US$0.06-US$0.31 |
| F-69 |
The fair value of the options canceled and accelerated vested under market condition was measured on the modification date using the Monte Carlo Simulation model with the following assumptions:
| Risk-free interest rate | 1.52 | % | ||
| Expected life (years) | 5.00 | |||
| Expected dividend yield | 0.00 | % | ||
| Volatility | 72 | % | ||
| Fair value of options at modification date | US$0.18-US$0.25 |
Share-Based Compensation
For the years ended December 31, 2013, 20142016, 2017 and 2015,2018, the CompanyGroup recorded share-based compensation of RMB16.7RMB28.1 million, RMB0.1RMB38.0 million and RMB32.0RMB3.9 million (US$4.90.6 million), respectively, for options granted to the Company’sGroup’s employees and directors, including incremental compensation cost due to the modification of the option exercise prices in April 2013, June 2015 and November 2015.directors.
As of December 31, 2015,2018, there was approximately RMB25.4RMB7.5 million (US$3.91.1 million) unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested options. Thisnonvested options, for the options with performance condition issued to non-employee, a third-party consultant, subject to ASC 505-50. Unrecognized compensation cost is expectedwould be addressed in Commitment (see Note 30). The cost related to beperformance condition option was recognized over a weighted-average period of 3.81 years.according to the funding schedule. Total unrecognized compensation cost may be adjusted for future changes in estimated forfeitures.
Restricted Ordinary Shares
26.2 Ordinary
On September 4, 2018, the Group granted an aggregate amount of 30,000,000 restricted ordinary shares to directors, officers and consultants. In exchange for such restricted ordinary shares granted, the Group forfeited and canceled the stock options in the total amount of 6,200,000 shares previously granted on January 24, 2018. Half of each individual's shares will only vest if the Group meets certain target on non-GAAP profit before tax in 2019. If the Group fails to achieve this target, such half of each individual's shares will be forfeited and canceled. The remaining half of each individual’s shares is subjected to a half year lock-up period. After the half year lock-up period, such remaining shares shall become vested in 36 successive equal monthly installments upon grantees’ completion of each month of service to the Group measured from the last day of each month after the vesting commencement date.
| F-70 |
23.2 Ordinary Shares Granted to Incsight Limited (“Incsight”)
Incsight is a company incorporated in the British Virgin Islands and wholly owned by Mr. Jun Zhu.Zhu Jun. On December 8, 2010, as approved by the Board of Directors, the Company granted 1,500,000 ordinary shares to Incsight, subject to performance conditions, of which 500,000 ordinary shares granted will vest when the Group achieves breakeven and 1,000,000 ordinary shares will vest when the Group’sGroup's cumulative profit reaches US$55.0 million in a quarter subsequent to the quarter in which the Group breaks even. The ordinary shares granted are not entitled to receive dividends until vested. The Board of Directors considered the grant of ordinary shares as an incentive to retain Mr. Zhu’sZhu Jun’s services with the Group. The awarded non-vestednonvested shares would be valid for five years from December 8, 2010. For the quarter ended September 30, 2014, the Group achieved breakeven. It iswas considered probable the performance targets will be met for the total of 1,500,000 ordinary shares. The fair value of the granted non-vestednonvested shares was US$6.48 per share, the market price on the date of grant. On December 7, 2015, 500,000 ordinary shares granted to Incsight Limited were vested. The awarded non-vestednonvested shares would bewere valid for additional three years and had expired on December 7, 2018. The Group recorded share-based compensation of RMB7.6RMB1.9 million, RMB2.2RMB0.5 million and RMB1.2million (US$0.2 million)nil for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively. The following table reflectedreflects the activity of non-vestednonvested shares for the year ended December 31, 2015:2018:
Number of Options | Weighted-Average Grant-Date Fair Value | |||||||||||||||
| Number of Options | Weighted- Average Grant- Date Fair Value | |||||||||||||||
Non-vested at January 1, 2015 | 1,500,000 | US$ | 6.48 | |||||||||||||
| Nonvested as of January 1, 2018 | 1,000,000 | US$ | 6.48 | |||||||||||||
Granted | — | — | - | - | ||||||||||||
Forfeited | — | — | (1,000,000 | ) | US$ | 6.48 | ||||||||||
Vested | (500,000 | ) | US$ | 6.48 | - | - | ||||||||||
|
| |||||||||||||||
Non-vested at December 31, 2015 | 1,000,000 | US$ | 6.48 | |||||||||||||
|
| |||||||||||||||
| Nonvested as of December 31, 2018 | - | - | ||||||||||||||
26.3 Ordinary shares granted to non-executive directors
| F-71 |
In May 2011, the Board of Directors granted 30,000 ordinary shares to each of the Group’s four non-executive directors, of which 10,000 ordinary shares vest for each director on July 1 of each year from 2011 to 2013 so long as such directors continue their services during the period. An aggregate of 40,000 ordinary shares vested in July 2011, 201223.3 Stock Options and 2013, respectively. The fair value of the shares granted was US$6.03 per share, being the market price on the date of the grant. The Group recorded share-based compensation of RMB0.4 million, nil and nil for the year ended December 31, 2013, 2014 and 2015, respectively.
26.4 Stock options and ordinary shares grantedOrdinary Shares Granted by Red 5
In February 2006, Red 5 adopted a Stock Incentive Plan (“Red 5 Stock Incentive Plan”) under which Red 5 may grant to its employees, director and consultants stock optionoptions to purchase common stockshares or restricted stock.shares. As of December 31, 2010, 13,626,955 shares were reserved under Red 5 Stock Incentive Plan. In September, 2011, Red 5 further increased the number of common stocksshares reserved to 22,855,591 shares.22,855,591. If an option shall expire or terminate for any reason without having been exercised in full, the reserved shares subject to such option shall again be available for subsequent option grants under the plan. From the inception of this plan to December 31, 2015,2018, Red 5 granted a total of 38,191,879 options to its employees and directors at the exercise price ranging from US$0.0001 to US$0.2450 per share, which vest over four years commencing from grant date. Options expire within a period of not more than ten years from the grant date. An option granted to a person who is a greater than 10% shareholder on the date of grant may not be exercisable more than five years after the grant date. As of December 31, 2015, option2018, options to purchase 10,649,8935,111,250 shares of common stock were outstanding and options to purchase 10,301,44415,480,087 shares of common stock were available for future grant.
The following table summarizes the Red 5’s share option activities with its employees and directors:directors for the year ended December 31, 2018:
| Number of Options | Weighted- Average Exercise Price per Option | Weighted- Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | |||||||||||||
Outstanding at January 1, 2015 | 5,550,357 | US$ | 0.122 | 2.61 | US$ | 1,133,349 | ||||||||||
Granted | 9,228,621 | |||||||||||||||
Exercised | (300,000 | ) | US$ | 0.045 | US$ | 1,200 | ||||||||||
Forfeited | (3,829,085 | ) | US$ | 0.120 | ||||||||||||
Outstanding at December 31, 2015 | 10,649,893 | US$ | 0.061 | 4.73 | Nil | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Vested and expected to vest at December 31, 2015 | 10,649,893 | US$ | 0.061 | 4.73 | Nil | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Exercisable at December 31, 2015 | 3,422,692 | US$ | 0.087 | 3.67 | Nil | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Number of Options | Weighted-Average Exercise Price per Option | Weighted-Average Remaining Contractual Term (years) | Aggregate Intrinsic Value | ||||||||||||
| Outstanding as of January 1, 2018 | 5,476,250 | US$ | 0.053 | 3.08 | Nil | ||||||||||
| Granted | - | - | - | Nil | |||||||||||
| Exercised | - | - | - | Nil | |||||||||||
| Forfeited | (365,000 | ) | US$ | 0.115 | - | Nil | |||||||||
| Outstanding as of December 31, 2018 | 5,111,250 | US$ | 0.049 | 2.24 | Nil | ||||||||||
| Vested and expected to vest as of December 31, 2018 | 5,111,250 | US$ | 0.049 | 2.24 | Nil | ||||||||||
| Exercisable as of December 31, 2018 | 4,810,176 | US$ | 0.049 | 2.24 | Nil | ||||||||||
The option’s intrinsic value was calculated by the excess of the estimated fair value of Red 5’s common shares, which was determined by the companyGroup with the assistance of an independent valuation firm.
The options expected to vest are estimated by applying the pre-vesting forfeiture rate assumptions to total unvested options. The total intrinsic value of options exercised for the year ended December 31, 2013, 20142016, 2017 and 20152018 were US$14,762, US$162,279 and US$1,200, respectively.nil.
| F-72 |
The fair value of options granted ranged from US$0.012 to US$0.149, measured on the grant date based on the Black-Scholes option pricing model with assumptions made regarding expected term and volatility, risk-free interest rate and dividend yield:
Risk-free interest rate | 0.78%-5.00 | % | ||
Expected life (years) | 4.00-6.00 | |||
Expected dividend yield | % | |||
Volatility | 38.89%-69.36 | % |
In September 2012, Red 5 granted 6,122,435 shares of restricted common stock to two directors of Red 5 including Mr. Zhu for their services to Red 5. Of these shares, 60% were vested on the grant date. The remaining shares shall become vested in a series of 36 successive equal monthly installments upon grantees’ completion of each month of service to Red 5 over the 36-month period measured from the grant date.The following table reflected the activity of non-vested shares for the year ended December 31, 2015:
| Number of Options | Weighted- Average Grant-Date Fair Value | |||||||
Non-vested at January 1, 2015 | 612,244 | US$ | 0.01193 | |||||
Granted | — | |||||||
Forfeited | — | |||||||
Vested | (612,244 | ) | US$ | 0.01193 | ||||
|
|
|
| |||||
Non-vested at December 31, 2015 | — | US$ | 0.01193 | |||||
|
|
|
| |||||
Red 5 recorded share-based compensation of RMB3.8RMB0.4 million, RMB1.0RMB0.3 million and RMB0.8RMB0.04 million (US$0.1million)0.01 million) for options and shares of restricted common stock granted for the yearyears ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively. The share-based payment awards were recorded as a component of noncontrolling interest in the consolidated financial statements.
As of December 31, 2015,2018, there was approximately RMB0.8RMB0.04 million (US$0.1million)0.01 million) of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vestednonvested share-based awards granted to Red 5 grantees. This cost is expected to be recognized over 3.20.2 years. Total unrecognized compensation cost may be adjusted for future changes in estimated forfeitures.
26.5 Non-vested equity interest of Jiushi granted to employees
In July 2011, the Group granted 20% equity interest of the newly established Jiushi to two employees as an incentive to retain these two employees’ services, which they will earn over three-year period. The fair value of the granted equity interest was estimated to be RMB2.2 million. The Group recorded share-based compensation of RMB0.7 million, RMB0.4 million and nil for the years ended December 31, 2013, 2014 and 2015, respectively.
27.24. RELATED PARTY TRANSACTIONS AND BALANCES
Transaction with equity investee
In 2013, the Group entered into an agreement with ZTE9, an equity investee of the Group, to jointly operate IPTV games in China jointly.China. According to the agreement, the groupGroup pays ZTE9 a royalty fee for providing game contents on IPTV. Net royalty and other service fees related to IPTV business charged by ZTE9 to the Group amounted to RMB6.8RMB7.1 million and RMB10.1RMB5.2 million (US$1.60.8 million) for yearthe years ended December 31, 20142017 and 2015,2018, respectively. The Group provided IPTV related supporting service to ZTE9 of nil and RMB0.2 million (US$0.03 million) for the years ended December 31, 2017 and 2018, respectively. Total amount due to ZTE9 amounted to RMB6.3for IPTV business was RMB2.7 million and RMB7.7RMB5.1 million (US$1.20.7 million) as of December 31, 20142017 and 20152018, respectively. In 2014, theThe Group lent RMB5.3RMB4.0 million (US$0.9 million) to ZTE9 to fund it operation. The loan was interest-free and was due and repaid in June, 2015. In 2015, the Group lent RMB9.9RMB0.6 million (US$1.50.1 million) to ZTE9 to fund its operation. The loan was interest-freeoperations in 2017 and due2018, respectively. ZTE9 has repaid RMB1.7 million (US$0.3 million) in March-August, 2016.2018. Total amount due from ZTE9 for outstanding loans was RMB5.3RMB2.1 million and RMB9.9RMB1.0 million (US$1.50.1 million) as of December 31, 20142017 and 2015,2018, respectively.
AsIn 2017, the Group charged service fee to Big Data of RMB0.05 million. In 2018, the service fee charged was RMB0.05 million (US$0.01 million), and the outsourcing service fee was RMB0.4 million (US$0.06 million) of which RMB0.1 million (US$0.01 million) remained outstanding as of December 31, 2015, the amount due to Jiucheng Advertisement was RMB 4.0 million (US$0.6 million).2018.
| F-73 |
In 2014, the Group entered into a license agreement with System Link, Corporation Ltd., a 50% joint venture of the Group, for publishing and operating Firefall for a five-year term in mainland China.the PRC. Under this license agreement, System Link is expected to pay toRed 5 and Red 5 Singapore a total of no less than US$160160.0 million (including license fee and royalties) during the term of the agreement. In 2015, System Link paid US$1010.0 million to the Group as license.license fee. The Group recordsrecorded the amountUS$10.0 million as amount due to the related party and amortizeswas to amortize the amount over the five-year period. System Link has been dormant since the cessation of Firefall in March 2016 and the termination of CrossFire 2 license in November 2017. Red 5 Singapore filed a lawsuit against System Link in 2016. Due to ongoing litigation and non-operation of Firefall, Red 5 was no longer required to render any service to System Link in relation to the operation of Firefall. As of December 31, 2015,such, Red 5 recognized the remaining unamortized license fee as revenue in 2017. The balance of amount due to System Link (non-current) was nil as both of December 31, 2017 and 2018. The Group recognized licensing revenue of RMB13.6 million, RMB 51.1 million and nil for the years ended December 31, 2016, 2017 and 2018, respectively. Litigation against System Link by Red 5 Singapore is RMB 63.4on-going as of December 31, 2018.
Transaction with T3
In 2016, Asian Way entered into a license agreement with T3, an equity investee of the Group, for developing a game using augmented reality (AR) technologies based on the intellectual property relating to the game. Upon commercial launch, Asian Way will share certain percentages of revenues of the game to T3. The game is still under development as of December 31, 2018.
Transaction with Mr. Zhu Jun
Mr. Zhu Jun, the chairman and chief executive officer, provided loans of RMB73.9 million and RMB11.0 million (US$9.8million)1.6 million) to the Group in 2017 and revenue recognized is RMB1.72018, respectively. The loans were interest-free and the outstanding balance of RMB75.2 million and RMB57.1 million (US$ 0.38.3 million). remained as of December 31, 2017 and 2018, respectively.
28.
| F-74 |
25. LOSS PER SHARE
Loss per share is calculated as follows:
| For the year ended December 31, 2013 | For the year ended December 31, 2014 | For the year ended December 31, 2015 | For the year ended December 31, 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
Numerator: | ||||||||||||||||
Net loss attributable to ordinary shareholders before accretion on redeemable noncontrolling interest | (526,261,572 | ) | (86,622,470 | ) | (304,828,354 | ) | (47,057,389 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Accretion on redeemable noncontrolling interest | — | (21,076,744 | ) | (79,805,706 | ) | (12,319,878 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Net loss attributable to ordinary shareholders | (526,261,572 | ) | (107,699,214 | ) | (384,634,060 | ) | (59,377,267 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Denominator: | ||||||||||||||||
Denominator for basic and diluted loss per share – weighted-average shares outstanding | 23,174,823 | 23,164,695 | 23,235,848 | 23,235,848 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Loss per share | ||||||||||||||||
- Basic and diluted | (22.71 | ) | (4.65 | ) | (16.55 | ) | (2.56 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
| For the year ended December 31, 2016 | For the year ended December 31, 2017 | For the year ended December 31, 2018 | For the year ended December 31, 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Numerator: | ||||||||||||||||
| Net loss attributable to ordinary shareholders before accretion on redeemable noncontrolling interest | (593,781,589 | ) | (118,165,850 | ) | (217,092,926 | ) | (31,574,856 | ) | ||||||||
| Accretion on redeemable noncontrolling interest | (82,890,188 | ) | (57,126,233 | ) | (40,918,773 | ) | (5,951,389 | ) | ||||||||
| Net loss attributable to ordinary shareholders | (676,671,777 | ) | (175,292,083 | ) | (258,011,699 | ) | (37,526,245 | ) | ||||||||
| Denominator: | ||||||||||||||||
| Denominator for basic and diluted loss per share – weighted-average shares outstanding | 23,874,102 | 33,426,448 | 62,114,760 | 62,114,760 | ||||||||||||
| Loss per share | ||||||||||||||||
| - Basic and diluted | (28.34 | ) | (5.24 | ) | (4.15 | ) | (0.60 | ) | ||||||||
The Company had 4,797,391, 4,570,49122,914,046, 5,778,846 and 18,656,5646,828,846 stock options, warrants and nonvested shares outstanding as of December 31, 2013, 20142016, 2017 and 2015,2018, respectively, which were excluded in the computation of diluted loss per share in the periods presented, as their effect would have been anti-dilutive due to the net loss reported in such periods.
29.
26. RESTRICTED NET ASSETS
Pursuant to laws applicable to entities incorporated in the PRC, the subsidiaries and the VIEs of the Group in the PRC must make appropriations from after-tax profit to non-distributable reservereserved funds. These reserve funds include one or more of the following: (i) a general reserve, (ii) an enterprise expansion fund and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits, the general reserve fund requires annual appropriation of 10% of after tax profit (as determined under accounting principles generally accepted in the PRC at each year-end) until the accumulative amount of such reservereserved fund reaches 50% of their registered capital; the other fund appropriations are at the subsidiaries’subsidiaries' discretion. These reservereserved funds can only be used for specific purposes of enterprise expansion and staff bonus and welfare are not distributable as cash dividends. The appropriation to these reserves by the Group’s PRC entities were nil, nil andwas nil for the years ended December 31, 2013, 20142016, 2017 and 2015.2018. The accumulated reserves as of December 31, 2015 is RMB 3.8 million.2018 were RMB3.8 million (US$0.6 million). In addition, due to restrictions on the distribution of registered capital from the Company’s PRC subsidiaries, the PRC subsidiaries’ registered capital of 19.5RMB8.2 million (US$1.2 million) as of December 31, 2015,2018, were considered restricted. As a result of these PRC laws and regulations, as of December 31, 2015,2018, approximately RMB23.3RMB12.0 million (US$3.61.8 million), were not available for distribution to the Company by its PRC subsidiaries in the form of dividends, loans or advances.
30.
| F-75 |
27. NONCONTROLLING INTEREST
As of December 31, 2015,2018, the Group’s non-controlling interestGroup's noncontrolling interests mainly included equity interestsinterest in Red 5Mengxiang Hulian, The9 Education, and equity awards granted as compensation by the Group’sGroup's subsidiaries. The following schedule shows the effects of changes in the ownership interest of The9 Limited in its subsidiaries on equity attributed to The9 Limited for the years ended December 31, 2013, 20142016, 2017 and 2015.2018.
| December 31, 2013 | December 31, 2014 | December 31, 2015 | ||||||||||
| RMB | RMB | RMB | ||||||||||
Net loss attributable to The9 Limited | (526,261,572 | ) | (86,622,470 | ) | (304,828,354 | ) | ||||||
Transfers (to) from the noncontrolling interest | ||||||||||||
Increase in The9 Limited’s additional paid-in capital for issuance of shares by Red 5 upon stock option exercise | 25,992 | 552,426 | 75,563 | |||||||||
Change in equity interest attributable to non-controlling interest due to restructuring of Red 5 Singapore (1) | — | 15,068,103 | ||||||||||
Change in The9 Limited’s additional paid-in capital for adjustment on noncontrolling interest due to change in ownership interest as a result of loan conversion (2) | — | (31,784,850 | ) | — | ||||||||
Change in The9 Limited’s additional paid-in capital for adjustment on noncontrolling interest as a result of issuance of common shares of Red 5 upon vesting of stock options and restricted shares | 3,072,133 | (42,692,211 | ) | 80,903 | ||||||||
|
|
|
|
|
| |||||||
Change from net loss attributable to The9 Limited and transfers (to) from noncontrolling interests | (523,163,447 | ) | (145,479,002 | ) | (304,671,888 | ) | ||||||
|
|
|
|
|
| |||||||
| December 31, 2016 | December 31, 2017 | December 31, 2018 | December 31, 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Net loss attributable to The9 Limited | (593,781,589 | ) | (118,165,850 | ) | (217,092,926 | ) | (31,574,856 | ) | ||||||||
| Transfers (to) from the noncontrolling interest: | ||||||||||||||||
| Increase in The9 Limited's additional paid-in capital for issuance of shares by Red 5 upon stock option exercise | 436,128 | - | - | - | ||||||||||||
| Change in The9 Limited's additional paid-in capital for adjustment on noncontrolling interest as a result of issuance of common shares of Red 5 upon vesting of stock options and restricted shares (1) | 253,396,755 | (7,060 | ) | - | - | |||||||||||
| Change from net loss attributable to The9 Limited and transfers (to) from noncontrolling interests | (339,948,706 | ) | (118,172,910 | ) | (217,092,926 | ) | (31,574,856 | ) | ||||||||
| (1) | In |
31.
| F-76 |
28. REDEEMABLE NON-CONTROLLINGNONCONTROLLING INTEREST
In January 2014, Red5Red 5 issued 27,438,952 Series B redeemable convertible preferred shares (“SBPS”)SBPS to a third partythird-party investor, Shanghai Oriental Pearl Culture Development Co., Ltd., (“("Oriental Pearl”Pearl"), for an aggregate consideration of RMB118.3 million (US$19.217.2 million). In conjunction with the issuance of SBPS, Oriental Pearl also purchased 5,948,488 common shares of Red 5 from two executives of Red 5 at the same per share price as the per share price of SBPS for an aggregate consideration of RMB25.6 million(US$4.2million (US$3.7 million). The purchase price for these common shares was determined to be less than fair value as the transaction aswas contemplated in conjunction with the issuance of the SPBS. The difference between the purchase price and fair value of SBPS as determined by the Group with the assistance of an independent valuation firm, which amounted to RMB131.3 million (US$21.2 million)19.1million), was recognized as a compensation paid to the two executives in the amount of RMB13.0 million (US$2.11.9 million).
Due to share exchange transaction with L&A in 2016, a 37% share of SBPS was owned by L&A. As of December 31, 2018, the holders of SBPS were as follows:
| Holder | December 31, 2017 | December 31, 2018 | ||||||
| Number of Shares | Number of Shares | |||||||
| L&A International Holdings Limited | 10,180,553 | 10,180,553 | ||||||
| Shanghai Oriental Pearl Culture Development Co., Ltd. | 17,258,399 | 17,258,399 | ||||||
As of December 31, 2014, the Group considered the redemption of the SBPS to be possible.probable. The Group accreted the carrying value of SBPS to redemption value using the effective interest rate method over the period from the issuance date to the Redemption Date.redemption date.
The key terms of the SBPS are as follows:
Conversion
Each SBPS may be converted at any time into common shares at the then applicable conversion price. The initial conversion ratio is 1:1, subject to adjustment in the event of (i) share splits, share combinations, share dividends or distribution, other dividends, recapitalizations and similar events, or (ii) issuance of common shares at a price per share less than the conversion price in effect on the date of or immediately prior to such issuance. In that case, the conversion price shall be reduced concurrently to the subscription price of such issuance.
| F-77 |
The SBPS shall be automatically converted into common shares immediately prior to the consummation of a public offering of Red 5’s shares wherein gross proceeds are at least US$30,000,000, immediately following the public offering (the “Qualifying IPO”).
The conversion option can only be settled by issuance of common shares except that fractional shares may be settled in cash.
Dividends
The holder of each share of SBPS shall be entitled to receive dividends at the rate per share of $0.038237 per annum if and when a dividend is declared.declared on common shares. The Preferred Sharespreferred shares participate in dividends on an as-converted basis and must be paid prior to any payment on common shares.
Upon conversion, any declared or accrued but unpaid dividends will be converted into common shares at the same applicable conversion price.
Redemption
At any time on or after April 1, 2017, if requested by at least 50% of the holders of SBPS then outstanding, , Red 5 shall redeem all of the outstanding SBPS at a redemption price equal to 200% of the issuance price in three equal annual installments. The full amount of the redemption price due but not paid shall accrue interest daily at a rate of 10% per annum from the issuance date of SBPS.SBPS (see Note 30).
Voting
Each SBPS has voting rights equivalent to the number of common shares to which it is convertible at the record date. The holders of SBPS shall vote together with the common shareholders, and not as a separate class or series, on all matters put before the shareholders.
Liquidation
The holders of Preferred SharesSBPS have preference over holders of common shares with respect to distribution of assets upon voluntary or involuntary liquidation of the Company.Red 5. The holders of Preferred SharesSBPS shall be entitled to receive 100% of the original issue price(“price ("preferred liquidation”liquidation"). The holders of Preferred SharesSBPS are also entitled to distribution of remaining assets from preferred liquidation, along with other shareholders, while the total distribution entitled to the holders of Preferred SharesSBPS should not exceed 200% of the original issue price.
| F-78 |
A reconciliation of Redeemableredeemable noncontrolling interest is as follows:
| Year ended December 31, | ||||||||
| 2014 | 2015 | |||||||
Redeemable noncontrolling interest opening balance | — | 131,497,104 | ||||||
Issuance of Redeemable noncontrolling interest | 131,296,977 | — | ||||||
Net loss attributable to redeemable noncontrolling interest | (20,876,617 | ) | (32,697,713 | ) | ||||
Accretion of Redeemable noncontrolling interest | 21,076,744 | 79,805,706 | ||||||
|
|
|
| |||||
Redeemable noncontrolling interest ending balance | 131,497,104 | 178,605,097 | ||||||
|
|
|
| |||||
| For the year ended December 31, 2017 | For the year ended December 31, 2018 | For the year ended December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| Redeemable noncontrolling interest opening balance | 246,771,132 | 306,014,668 | 44,507,987 | |||||||||
| Issuance of redeemable noncontrolling interest | - | - | - | |||||||||
| Net profit/(loss) attributable to redeemable noncontrolling interest | 2,117,303 | (5,858,902 | ) | (852,142 | ) | |||||||
| Accretion of redeemable noncontrolling interest | 57,126,233 | 40,918,773 | 5,951,389 | |||||||||
| Redeemable noncontrolling interest ending balance | 306,014,668 | 341,074,539 | 49,607,234 | |||||||||
32.29. DISPOSAL OF SUBSIDIARIESA SUBSIDIARY
In July 2014, the Group
On August 21, 2018, Beijing Yingke entered into ana proposed acquisition agreement with Shanghai IT and Yunmei Partnership, which owned 70% and 30% equity interest in The9 Education, respectively. Beijing Yingke has proposed to acquire the entire equity interest of The9 Education for consideration of RMB12.0 million, payable to Shanghai IT and Yunmei Partnership for RMB8.6 million and RMB3.6 million, respectively.
The proposed acquisition is to sell itsthe shell company of The9 Education, which is listed on NEEQ. Beijing Yingke will not take over the operation of educational services of The9 Education. In November 2017, The9 Education passed a resolution for issuance of additional 20,000,000 new ordinary shares with a par value of RMB1 each, and the new shares were taken and paid-up by Beijing Yingke. In 2017, Shanghai IT received an advance of RMB6.8 million from Beijing Yingke, and Shanghai IT transferred 5,600,000 ordinary shares to Beijing Yingke accordingly. As of December 31, 2017, disposal of The9 Education was yet to be completed. Shanghai IT owned an 8.75% equity interest in The9 Education and controls The9 Education through a VIE Huopu Cloud, for a total considerationstructure. In January 2018, the assets and liabilities of RMB200 million (US$32.2 million) to a third-party purchaser. Pursuant to the agreement, the Group paid RMB30 million (US$4.8 million) to Huopu Cloud’s development team to retain them in Huopu Cloud and undertook Huopu Cloud’s operating costs and expensesThe9 Education have been transferred from the date of disposalshell company to December 31, 2014 in the amount of RMB19 million (US$3.1 million). Huopu Cloud developed and held a web game Qijiguilai. AsShanghai IT or disposed upon completion of the transfer date, the net assets held by Huopu Cloud amounted to RMB11 million (US$1.8 million).The Group recognized a net gain of RMB 140 million (US$22.5 million) upontransaction.
Followed the disposal of Huopu Cloud in 2014.
In 2014,shell company, the Group establishedhas disposed of the business operation of educational services for a subsidiary with two individual shareholders, Shanghai Kaiyue Information and technology Co., Ltd. (“Kaiyue”), while the Group owned 85% equity interest of Kaiyue. Kaiyue developed and held a mobile application named KingReader for online reading. In December 2014, the Company sold their 85% equity interest of Kaiyue to a third-party investor for an aggregate consideration of RMB 25.5 million (US$4.1 million), and recognized a net gain of RMB 25.5 million (US$4.1 million) upon theminimal consideration. The disposal of educational services does not have a significant effect on the subsidiaryGroup's operations and financial results. The disposal transaction on The9 Education has completed in 2014.January 2019.
| F-79 |
33.30. COMMITMENTS AND CONTINGENCIES
33.1
30.1 Operating lease commitments
The Group has entered intono significant outstanding operating lease arrangements relating to the use of certain premises and internet data centers. Future minimum lease payments for non-cancellable operating leases as of December 31, 2015 are as follows:
2016 2017 2018 2019 2020 RMB US$ (Note 3) 8,389,540 1,295,122 7,159,779 1,105,279 6,819,782 1,052,793 6,497,790 1,003,086 5,414,825 835,905 34,281,716 5,292,185
Total rental expenses amounted to RMB38.2RMB12.7 million, RMB22.2RMB4.8 million and RMB19.4RMB0.5 million (US$3.00.07 million) for the years ended December 31, 2013, 20142016, 2017 and 2015,2018, respectively.
33.2
30.2 Other operating commitments
In October 2016, the Group had raised RMB57.5 million (US$8.4 million), and the Group plans to raise an additional RMB100.0 million (US$15.4 million) until CrossFire New Mobile Game is launched. Under this fund raising arrangement, the Group will share certain percentages of the revenues from CrossFire New Mobile Game to investors providing funding to the Group. In August 2016, the Group granted a third-party consultant 1,000,000 options to acquire shares of the Group as payment for consulting services related to the RMB157.5 million (US$22.9 million) financing plan of CrossFire Mobile Game with Inner Mongolia Culture Assets and Equity Exchange. The options will vest in accordance with the schedule of the actual funding to be received. In October 2016, 365,079 options were vested after the Group received the first funding of RMB57.5 million (US$8.4 million). As of December 31, 2018, due to unforeseen circumstances, the Group has outsourced the development and operation of CrossFire Mobile Game to a third-party company and the Group is not planning to raise the remaining RMB100.0 million (US$14.5 million). Due to non-recovery of advance paid for financing fee, the Group has provided full impairment on the advance as of December 31, 2018. In January 2019, total 1,000,000 options granted to the third-party consultant were canceled.
In June 2017, Shanghai IT has entered into an investment agreement with the shareholders of Beijing Ti Knight where Shanghai IT will invest a total of RMB9.0 million (US$1.3 million) in Beijing Ti Knight. As of December 31, 2018, Shanghai IT has invested RMB4.9 million (US$0.7 million) and has a remaining capital contribution commitment amounting to RMB4.1 million (US$0.6 million). Shanghai IT’s purchase commitment amounting to RMB6.8 million (US$1.0 million) for the outsourcing development agreement entered on October 9, 2016 with Beijing Ti Knight will be waived if Shanghai IT’s accumulated investment in Beijing Ti Knight is more than RMB6.0 million (US$0.9 million). Hence, as of December 31, 2018, the Group has both a capital commitment and a purchase commitment amounting to RMB4.1 million (US$0.6 million) and RMB6.8 million (US$1.0 million), respectively, but the purchase commitment will be waived under the condition that accumulated investment in Beijing Ti Knight by Shanghai IT is more than RMB6.0 million (US$0.9 million). As of December 31, 2018, the agreements have not been terminated but the related outsourcing development of the related game has been transferred to a third-party company.
| F-80 |
30.3 Contingencies
In June 2016, Asian Development borrowed HK$92.3 million (US$11.8 million) from a financial services company at an annual interest rate of 2% for a term of 24 months. This loan is secured by 417,440,000 shares of L&A (see Note 16). Pursuant to the financing agreement (“Agreement”), such loan is considered to be in default since the market price of the pledged shares had fallen below the collateralized stock price by more than 35% for ten consecutive trading days. Asian Development had not made any remediation pursuant to the Agreement. Upon default, the lender shall be entitled to foreclose the pledged shares and become the legal and beneficial owner of the pledged shares. If the market value of the pledged shares cannot cover the total outstanding amount owed by Asian Development to the lender under the Agreement, the lender may claim against Asian Development to recover any outstanding amounts under the Agreement, in addition to foreclosure of the pledged shares as mentioned above.
As mentioned in Note 24, Red 5 and its affiliates are currently in dispute with Qihoo 360 and its affiliates regarding System Link and Firefall and various legal proceedings have been initiated and are ongoing in connection with such dispute. The process of legal proceedings may be lengthy and costly and may divert the attention of the management. If the Group cannot settle the dispute with Qihoo 360 and cannot obtain a judgment in favor of the Group, additional costs or damages may be incurred to adversely affect the Group’s business, financial condition and results of operations. The dispute is still in process as of December 31, 2018. The Group has entered into an additional agreement with an attorney in December 2018 regarding the dispute with Qihoo 360 where the Group shall pay a total of RMB8.0 million (US$1.2 million) as the attorney fee. The Group has expensed first installment of the attorney fee amounting to RMB3.0 million (US$0.4 million) as of December 31, 2018 and will pay the remaining attorney fee of RMB5.0 million (US$0.7 million) after the court decision is issued in the future.
The Group may be subject to other legal or administrative proceedings in the ordinary course of business. The Group does not believe that any currently pending legal or administrative proceeding to which the Group is a party will have a material adverse effect on the business or financial condition.
| F-81 |
As described in Note 28, in August 2014, Red 5 issued 27,438,952 Series B redeemable convertible preferred shares of Red 5 to a new investor, Oriental Pearl. Due to the stock exchange transaction with L&A in 2016, a 37% share of the SBPS was owned by L&A as of December 31, 2018 (see Note 28). Per Articles of Association of Red 5, major holders of SBPS, at any time on or after April 1, 2017 (the “Redemption Election”), can require Red 5 to redeem all, but not less than all, of the outstanding shares of SBPS, as applicable, in three equal annual installments. New Star, a wholly owned subsidiary of the Group, owns 39,766,589 Series A redeemable convertible preferred shares which have similar terms with the Series B redeemable convertible preferred shares. The redemption value of SBPS was US$16.5 million for the first installment, US$18.1 million for the second installment and US$19.9 million for the third installment. Since Red 5 is in a net liability position, the Group does not believe the preferred shareholders will request such redemption. As of the report date, there was no such preferred shareholder requiring Red 5 to redeem the preferred shares.
34.
31. SEGMENT REPORTING
The Group operates in one segment whose business is developing and operating online games and related services. The Group’s chief operating decision maker is the chief executive officer, who reviews consolidated results when making decisions about allocating resources and assessing performance of the Group. The Group generates its revenues from customers in the Greater China (including PRC, Taiwan, Hong Kong and Macau), North America and other areas.areas for the years ended December 31, 2016, 2017 and 2018.
The following geographic area information includes revenue based on location of players for the years ended December 31, 2013, 20142016, 2017 and 2015:2018:
| 2016 | 2017 | 2018 | 2018 | |||||||||||||||||||||||||||||
| 2013 | 2014 | 2015 | 2015 | RMB | RMB | RMB | US$ | |||||||||||||||||||||||||
| RMB | RMB | RMB | US$ (Note 3) | (Note 3) | ||||||||||||||||||||||||||||
PRC | 85,483,458 | 41,969,350 | 33,201,421 | 5,125,416 | ||||||||||||||||||||||||||||
| Greater China | 48,041,372 | 19,690,716 | 16,430,205 | 2,389,674 | ||||||||||||||||||||||||||||
North America | 13,135,914 | 14,906,530 | 8,382,753 | 1,294,074 | 3,012,901 | 51,156,109 | - | - | ||||||||||||||||||||||||
Other areas | 6,156,697 | 7,401,011 | 4,827,157 | 745,185 | 5,145,013 | 2,301,731 | 1,001,653 | 145,684 | ||||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||||||||||
Total | 104,776,069 | 64,276,891 | 46,411,331 | 7,164,675 | 56,199,286 | 73,148,556 | 17,431,858 | 2,535,358 | ||||||||||||||||||||||||
|
|
|
| |||||||||||||||||||||||||||||
A majority of the Group’sGroup's assets are located in PRC.Greater China.
35.
| F-82 |
32. SUBSEQUENT EVENTS
In March 2016,January 2019, the Group canceled a total of 15,000,000 ordinary shares including 7,500,000 and 4,500,000 ordinary shares in the form of restricted ordinary shares previously granted to Zhu Jun and Qin Jie on September 4, 2018.
In June 2017, the Group entered into a non-binding memorandumshare purchase agreement with Incsight Limited (“Incsight”), pursuant to which the Group will issue and sell 12,500,000 ordinary shares of understandingthe Group, par value of US$0.01, at a per share price of US$1.20 to Incsight for an aggregate consideration of US$15.0 million. In February 2019, the Group and Incsight have entered into a termination agreement and Incsight ceased to hold beneficial ownership in 12,500,000 ordinary shares.
In February 2018, Ark Pacific Special Opportunities Fund I, L.P. (“MOU”AP Fund”) with L&A International Holdingassigned its rights and obligations under the share purchase agreement as a whole, as well as 12,500,000 unpaid ordinary shares to a third-party, Jupiter Explorer Limited (“L&A”Jupiter”), and Jupiter assumed all the rights and obligations of AP Fund under the share purchase agreement. In February 2019, the Group and Jupiter have entered into a Cayman Island Companytermination agreement and Jupiter ceased to hold beneficial ownership in 12,500,000 ordinary shares.
In March 2019, the Group entered into a deed of settlement agreement with Splendid Days Limited ("SDL") relating to the settlement of convertible notes which expired in December 2018, pursuant to which the convertible notes should be repaid by May 31, 2019 through the proceeds from planned sale of the mortgaged properties. In January 2019, the Group granted a total of 11,700,000 restricted ordinary shares publicly listedto two third-party consultants as payment for consulting services related to thesettlement of the convertible notes.
In March 2019, the Group entered into a joint venture agreement with Faraday & Future Inc. ("F&F") to establish a joint venture to manufacture, market, distribute and sell electric cars in Hong Kong, and a certain other shareholder of Red 5 Studios, Inc. (“Red 5”).China. Under the terms of this MOU,joint venture agreement, the Groupwill exchange approximately 30.6%make capital contribution of up to US$600.0 million in three equal installments to the joint venture, and F&F will make contributions including its use rights for a piece of land in China to manufacture electric cars and will grant the joint venture an exclusive license to manufacture, market, distribute and sell certain F&F’s car models and other potential selected car models in China, in each case subject to the satisfaction of certain conditions, such as establishment of the joint venture and funding arrangements.The Group has paid the initial deposit of US$5.0 million as of the issuance date of these financial statements. The Group is considering different ways to raise the required capital, including additional equity interest in Red 5 for suchfinancing.
In April 2019, the Group announced an extraordinary general meeting (the “EGM”) of shareholders to be held on May 6, 2019. The EGM will consider and vote on the proposals of : (i) Increase of the number of newly issuedauthorized shares to 5,000,000,000 which will be divided into 4,300,000,000 Class A ordinary shares (“Class A Ordinary Shares”) , 600,000,000 Class B ordinary shares (“Class B Ordinary Shares”) and 100,000,000 ordinary shares to be determined in accordance with the Amended and Restated Memorandum and Articles of L&A of equivalent value basedAssociation; (ii) Class A Ordinary Share shall entitle the holder thereof to one vote per share, and each Class B Ordinary Share shall entitle the holder thereof to fifty (50) votes per share on a valuation agreed by all parties. The other participating shareholders of Red 5 will exchange an aggregate of approximately 14.4% equity interest in Red 5 based on the same terms.
In March 2016, Bank of Shanghai (BOS) issued a commitment letter whereby BOS agreesmatters subject to grant the Group a credit facility of RMB50 million (US$7.7 million). The Group can apply to withdraw the funding from BOS should they require liquidity for its operations. Asvote at general meetings of the report date,Group; and (iii) the Group had withdrawn RMB4.9 million (US$0.8 million) under this credit facility.Group’s Amended and Restated Memorandum and Articles of Association.
| F-83 |
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY -
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
| 2013 | 2014 | 2015 | 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
Cost of revenue | (127,706 | ) | — | — | — | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Gross loss | (127,706 | ) | — | — | — | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Operating expenses: | ||||||||||||||||
Product development | (1,284,261 | ) | 632,437 | (70,941 | ) | (10,951 | ) | |||||||||
Sales and marketing | (14,536,253 | ) | 0 | (120,735 | ) | (18,638 | ) | |||||||||
General and administrative | (32,056,416 | ) | (9,392,137 | ) | (38,475,787 | ) | (5,939,640 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Total operating expenses | (47,876,930 | ) | (8,759,700 | ) | (38,667,463 | ) | (5,969,229 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Loss from operations | (48,004,636 | ) | (8,759,700 | ) | (38,667,463 | ) | (5,969,229 | ) | ||||||||
Interest income (expenses), net | 869 | 32 | (5,858,848 | ) | (904,450 | ) | ||||||||||
Fair value change on convertible bonds and warrants | — | — | (7,129,161 | ) | (1,100,553 | ) | ||||||||||
Other income (expenses), net | (69,198 | ) | 9,756 | (2,267,335 | ) | (350,016 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Loss before income tax expense and share of loss in equity method investments | (48,072,965 | ) | (8,749,912 | ) | (53,922,807 | ) | (8,324,248 | ) | ||||||||
Income tax expense | — | — | — | — | ||||||||||||
Equity in income (loss) of subsidiaries and VIEs | (478,188,607 | ) | (77,872,558 | ) | (250,905,547 | ) | (38,733,141 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
Net loss | (526,261,572 | ) | (86,622,470 | ) | (304,828,354 | ) | (47,057,389 | ) | ||||||||
Other comprehensive income (loss) | ||||||||||||||||
Unrealized loss on available-for-sale investment | (16,600 | ) | — | — | — | |||||||||||
Currency translation adjustments | (2,259,470 | ) | 348,437 | 5,266,016 | 812,933 | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Total comprehensive loss | (528,537,642 | ) | (86,274,033 | ) | (299,562,338 | ) | (46,244,456 | ) | ||||||||
|
|
|
|
|
|
|
| |||||||||
| 2016 | 2017 | 2018 | 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Revenue | - | - | - | - | ||||||||||||
| Cost of revenue | - | - | - | - | ||||||||||||
| Gross loss | - | - | - | - | ||||||||||||
| Operating expenses: | ||||||||||||||||
| Product development | (34,101 | ) | (43,710 | ) | - | - | ||||||||||
| Sales and marketing | (262,674 | ) | (231,884 | ) | - | - | ||||||||||
| General and administrative | (40,881,238 | ) | (62,979,090 | ) | (21,435,150 | ) | (3,117,613 | ) | ||||||||
| Total operating expenses | (41,178,013 | ) | (63,254,684 | ) | (21,435,150 | ) | (3,117,613 | ) | ||||||||
| Loss from operations | (41,178,013 | ) | (63,254,684 | ) | (21,435,150 | ) | (3,117,613 | ) | ||||||||
| Interest expenses | (50,409,271 | ) | (76,989,899 | ) | (98,308,205 | ) | (14,298,335 | ) | ||||||||
| Fair value change on convertible bonds and warrants | 48,057,204 | 12,615,466 | 2,251,427 | 327,456 | ||||||||||||
| Foreign exchange (loss) gain | (17,116,102 | ) | 35,473,519 | 1,963,364 | 285,560 | |||||||||||
| Other income (expenses), net | 5,952,464 | (21,649,514 | ) | (18,180,060 | ) | (2,644,180 | ) | |||||||||
| Loss before income tax expense and share of loss in equity method investments | (54,693,718 | ) | (113,805,112 | ) | (133,708,624 | ) | (19,447,112 | ) | ||||||||
| Income tax expense | - | - | - | - | ||||||||||||
| Recovery of equity investment in excess of cost | - | 60,548,651 | - | - | ||||||||||||
| Equity in loss of subsidiaries and VIEs | (539,087,871 | ) | (64,909,389 | ) | (83,384,302 | ) | (12,127,744 | ) | ||||||||
| Net loss | (593,781,589 | ) | (118,165,850 | ) | (217,092,926 | ) | (31,574,856 | ) | ||||||||
| Other comprehensive income (loss), net of tax: | ||||||||||||||||
| Currency translation adjustments | 5,954,611 | (19,027,771 | ) | 7,241,192 | 1,053,188 | |||||||||||
| Total comprehensive loss | (587,826,978 | ) | (137,193,621 | ) | (209,851,734 | ) | (30,521,668 | ) | ||||||||
| F-84 |
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY -
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED BALANCE SHEETS
| December 31, 2014 | December 31, 2015 | December 31, 2015 | ||||||||||
| RMB | RMB | US$ | ||||||||||
ASSETS | ||||||||||||
Cash and cash equivalents | 2,754,295 | 28,984 | 4,474 | |||||||||
Prepayments and other current assets, net | 55,258 | 912,003 | 140,791 | |||||||||
Amounts due from intercompany | 1,188,956,211 | 1,425,500,136 | 220,059,300 | |||||||||
|
|
|
|
|
| |||||||
Total current assets | 1,191,765,764 | 1,426,441,123 | 220,204,565 | |||||||||
|
|
|
|
|
| |||||||
Investments in subsidiaries | (1,092,897,996 | ) | (1,420,228,235 | ) | (219,245,461 | ) | ||||||
|
|
|
|
|
| |||||||
Total assets | 98,867,768 | 6,212,888 | 959,104 | |||||||||
|
|
|
|
|
| |||||||
LIABILITIES | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | 164,162 | 148,204 | 22,879 | |||||||||
Other payables and accruals | 676,958 | 3,829,603 | 591,189 | |||||||||
Warrants | 64,414,941 | 9,943,953 | ||||||||||
|
|
|
|
|
| |||||||
Total current liabilities | 841,120 | 68,392,748 | 10,558,021 | |||||||||
Convertible notes | — | 135,182,536 | 20,868,587 | |||||||||
|
|
|
|
|
| |||||||
Total liabilities | 841,120 | 203,575,284 | 31,426,608 | |||||||||
|
|
|
|
|
| |||||||
SHAREHOLDERS’ EQUITY | ||||||||||||
Ordinary shares | 1,885,153 | 1,917,620 | 296,030 | |||||||||
Additional paid-in capital | 2,075,900,461 | 2,080,041,288 | 321,103,042 | |||||||||
Statutory reserves | 28,071,982 | 28,071,982 | 4,333,567 | |||||||||
Accumulated other comprehensive loss | (8,638,604 | ) | (3,372,588 | ) | (520,638 | ) | ||||||
Accumulated deficit | (1,999,192,344 | ) | (2,304,020,698 | ) | (355,679,505 | ) | ||||||
|
|
|
|
|
| |||||||
Total shareholders’ equity | 98,026,648 | (197,362,396 | ) | (30,467,504 | ) | |||||||
|
|
|
|
|
| |||||||
Total liabilities, and shareholders’ equity | 98,867,768 | 6,212,888 | 959,104 | |||||||||
|
|
|
|
|
| |||||||
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY –
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
| 2013 | 2014 | 2015 | 2015 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net loss | (526,261,572 | ) | (86,622,470 | ) | (304,828,354 | ) | (47,057,389 | ) | ||||||||
Adjustments for: | ||||||||||||||||
Employee share-based compensation expense | 24,683,804 | 2,337,019 | 33,184,307 | 5,122,772 | ||||||||||||
Fair value change on warrants liability | — | — | 7,129,161 | 1,100,553 | ||||||||||||
Amortization of discount on convertible note | — | — | 2,609,771 | 402,879 | ||||||||||||
Equity in income (loss) of subsidiaries and VIEs | 478,188,607 | 77,872,558 | 250,905,547 | 38,733,141 | ||||||||||||
Change in prepayments and other current assets | 14,253,727 | (199 | ) | (856,745 | ) | (132,259 | ) | |||||||||
Change in accounts payable | (31,607 | ) | (27,382 | ) | (15,958 | ) | (2,463 | ) | ||||||||
Change in amounts due from intercompany | 32,990,799 | 4,294,984 | (236,543,924 | ) | (36,516,087 | ) | ||||||||||
Change in other payables and accruals | 1,858,984 | (1,702,034 | ) | 6,401,724 | 988,255 | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Net cash used in operating activities | 25,682,742 | (3,847,524 | ) | (242,014,471 | ) | (37,360,598 | ) | |||||||||
|
|
|
|
|
|
|
| |||||||||
Cash flows from financing activities: | ||||||||||||||||
Proceeds from stock option exercises | 4,304,447 | 812,635 | — | — | ||||||||||||
Proceeds from the issuance of convertible bonds | — | — | 260,068,680 | 40,147,686 | ||||||||||||
Payment for the issuance cost related to convertible bonds | (20,779,520 | ) | (3,207,805 | ) | ||||||||||||
Repurchase of ordinary shares | (29,030,699 | ) | ||||||||||||||
|
|
|
|
|
|
|
| |||||||||
Net cash provided by (used in) financing activities | (24,726,252 | ) | 812,635 | 239,289,160 | 36,939,881 | |||||||||||
|
|
|
|
|
|
|
| |||||||||
Net change in cash and cash equivalents | 956,490 | (3,034,889 | ) | (2,725,311 | ) | (420,717 | ) | |||||||||
Cash and cash equivalents, beginning of year | 4,832,694 | 5,789,184 | 2,754,295 | 425,191 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
Cash and cash equivalents, end of year | 5,789,184 | 2,754,295 | 28,984 | 4,474 | ||||||||||||
|
|
|
|
|
|
|
| |||||||||
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY -
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED BALANCE SHEETS
AS OF DECEMBER 31, 2017 AND 2018
| December 31, 2017 | December 31, 2018 | December 31, 2018 | ||||||||||
| RMB | RMB | US$ | ||||||||||
| (Note 3) | ||||||||||||
| ASSETS | ||||||||||||
| Current assets: | ||||||||||||
| Cash and cash equivalents | 18,733 | 18 | 3 | |||||||||
| Prepayments and other current assets, net | 59,008 | 61,979 | 9,014 | |||||||||
| Amounts due from intercompany | 1,380,804,221 | 1,305,838,856 | 189,926,384 | |||||||||
| Total current assets | 1,380,881,962 | 1,305,900,853 | 189,935,401 | |||||||||
| Investments in subsidiaries and VIEs | (1,586,024,281 | ) | (1,635,525,945 | ) | (237,877,382 | ) | ||||||
| Total assets | (205,142,319 | ) | (329,625,092 | ) | (47,941,981 | ) | ||||||
| LIABILITIES | ||||||||||||
| Current liabilities: | ||||||||||||
| Accrued expenses and other current liabilities | 4,350,126 | 5,248,838 | 763,412 | |||||||||
| Warrants | 3,742,271 | 1,490,844 | 216,834 | |||||||||
| Convertible notes | 260,563,020 | 375,257,140 | 54,578,887 | |||||||||
| Total current liabilities | 268,655,417 | 381,996,822 | 55,559,133 | |||||||||
| Total liabilities | 268,655,417 | 381,996,822 | 55,559,133 | |||||||||
| SHAREHODERS' EQUITY (DEFICIT) | ||||||||||||
| Ordinary shares | 3,328,852 | 6,502,658 | 945,772 | |||||||||
| Additional paid-in capital | 2,527,215,315 | 2,496,069,065 | 363,038,188 | |||||||||
| Statutory reserves | 28,071,982 | 28,071,982 | 4,082,900 | |||||||||
| Accumulated other comprehensive loss | (16,445,748 | ) | (9,204,556 | ) | (1,338,746 | ) | ||||||
| Accumulated deficit | (3,015,968,137 | ) | (3,233,061,063 | ) | (470,229,228 | ) | ||||||
| Total shareholders’ deficit | (473,797,736 | ) | (711,621,914 | ) | (103,501,114 | ) | ||||||
| Total liabilities and shareholders' equity | (205,142,319 | ) | (329,625,092 | ) | (47,941,981 | ) | ||||||
| F-85 |
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2016 2017 AND 2018
| 2016 | 2017 | 2018 | 2018 | |||||||||||||
| RMB | RMB | RMB | US$ | |||||||||||||
| (Note 3) | ||||||||||||||||
| Cash flows from operating activities: | ||||||||||||||||
| Net loss | (593,781,589 | ) | (118,165,850 | ) | (217,092,926 | ) | (31,574,856 | ) | ||||||||
| Adjustments for: | ||||||||||||||||
| Employee share-based compensation expense | 27,689,259 | 37,727,861 | 3,645,751 | 530,252 | ||||||||||||
| Fair value change on warrants liability | (48,057,204 | ) | (12,615,466 | ) | (2,251,427 | ) | (327,456 | ) | ||||||||
| Amortization of discount and interest on convertible note | 50,409,270 | 76,990,826 | 98,308,205 | 14,298,335 | ||||||||||||
| Foreign exchange loss (gain) | 17,116,102 | (35,473,519 | ) | (1,963,364 | ) | (285,560 | ) | |||||||||
| Recovery of equity investment in excess of cost | - | (60,548,651 | ) | - | - | |||||||||||
| Equity in loss of subsidiaries and VIEs | 539,087,871 | 64,909,389 | 83,384,302 | 12,127,744 | ||||||||||||
| Consulting fee paid by equity | - | 13,454,692 | 4,172,800 | 606,909 | ||||||||||||
| Change in prepayments and other current assets | (62,274 | ) | 915,269 | (2,971 | ) | (432 | ) | |||||||||
| Change in accounts payable | (148,204 | ) | - | - | - | |||||||||||
| Change in amounts due from intercompany | 3,021,127 | (130,954,737 | ) | 30,882,203 | 4,491,630 | |||||||||||
| Change in accrued expenses and other current liabilities | 2,613,023 | (2,092,500 | ) | 898,712 | 130,712 | |||||||||||
| Net cash used in operating activities | (2,112,619 | ) | (165,852,686 | ) | (18,715 | ) | (2,722 | ) | ||||||||
| Cash flows from investing activity: | ||||||||||||||||
| Settlement payment from investee | - | 165,812,500 | - | - | ||||||||||||
| Cash flows from financing activities: | ||||||||||||||||
| Proceeds from stock option exercises | 2,142,554 | - | - | - | ||||||||||||
| Net cash provided by (used in) financing activities | 2,142,554 | - | - | - | ||||||||||||
| Net change in cash and cash equivalents | 29,935 | (40,186 | ) | (18,715 | ) | (2,722 | ) | |||||||||
| Cash and cash equivalents, beginning of year | 28,984 | 58,919 | 18,733 | 2,725 | ||||||||||||
| Cash and cash equivalents, end of year | 58,919 | 18,733 | 18 | 3 | ||||||||||||
| Supplement disclosure of cash flow information: | ||||||||||||||||
| Interest paid | - | - | - | - | ||||||||||||
| Income taxes paid | - | - | - | - | ||||||||||||
| F-86 |
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
NOTES TO SCHEDULE I
1) Schedule I has been provided pursuant to the requirements ofRule 12-04(a) and5-04(c) ofRegulation S-X, which require condensed financial information as to the financial position, changes in financial position and results of operations of a parent company as of the same dates and for the same periods for which audited consolidated financial statements have been presented when the restricted net assets of consolidated subsidiaries exceed 25 percent of consolidated net assets as of the end of the most recently completed fiscal year.
2) As disclosed in Note 1 to the consolidated financial statements, the CompanyThe9 Limited (the “Company”) was incorporated in December 22, 1999 in the Cayman Islands to be the holding company of the Group principally engaged in the development and operation of online games and internet related businesses, including massively multiplayer online games (“MMOGs”("MMOGs"), mobile games, web games and TV games.
3) The condensed financial information has been prepared using the same accounting policies as set out in the consolidated financial statements except that the equity method has been used to account for investments in its subsidiaries and VIE.VIEs. For the parent company, the Company records its investments in subsidiaries and VIE under the equity method of accounting as prescribed inASC 323, Investments-Equity Method and Joint Ventures . Such investments are presented on the Condensed Balance Sheets as “Investment in subsidiaries and VIE”VIEs” and the subsidiaries and VIE’VIEs’ profit or loss as “Equity in income/loss of subsidiaries”subsidiaries and VIEs” on the Condensed Statements of Comprehensive Loss. Ordinarily under the equity, an investor in an equity method investee would cease to recognize its share of the losses of an investee once the carrying value of the investment has been reduced to nil absent an undertaking by the investor to provide continuing support and fund losses. For the purpose of this Schedule I, the parent company has continued to reflect its share, based on its proportionate interest, of the losses of subsidiaries and VIE regardless of the carrying value of the investment even though the parent company is not obligated to provide continuing support or fund losses.
4) As of December 31, 20142017 and 2015,2018, there were no material contingencies, significant provisions of long-term obligations, mandatory dividend or redemption requirements of redeemable stocks or guarantees of the Company. No dividend was paid by the Company’sCompany's subsidiaries to the Company in 2013, 20142016, 2017 and 2015.2018.
5) Translations of balances in the additional financial information of The9 Limited (“Parent CompanyCompany”) — Financial Statements Schedule I from RMB into US$ as of December 31, 2018 and for the year ended December 31, 2014 and 20152018 are solely for the convenience of the readers and were calculated at the rate of US$1.00 = RMB6.4788,RMB6.8755, representing the noon buying rate set forth in the H.10 statistical release of the U.S. Federal Reserve Board on December 31, 2015.2018. No representation is made that the RMB amounts could have been, or could be, converted, realized or settled into US$ at that rate on December 31, 2015,2018, or at any other rate.
F-72
| F-87 |