As filed with the Securities and Exchange Commission on October 10, 2003
Registration No. 333-
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM F-3
REGISTRATION STATEMENT
Under
The Securities Act of 1933
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NETEASE.COM, INC.
(Exact name of Registrant as specified in its charter)
-----------------
Cayman Islands Not Applicable
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Suite 1901, Tower E3
The Towers, Oriental Plaza
Dong Cheng District
Beijing 100738
People's Republic of China
(8610) 8518-0163
(Address, including zip code, and telephone number, including area
code, of Registrant's principal executive offices)
-----------------
CT Corporation
111 Eighth Avenue
New York, New York 10011
(212) 894-8940
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
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Copies to:
Jonathan H. Lemberg, Esq.
Paul W. Boltz, Esq.
Morrison & Foerster
21st and 23rd Floors
Entertainment Building
30 Queen's Road Central
Hong Kong
(852) 2585-0888
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Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date of this Registration Statement.
If the only securities being registered on this Form are being offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [_]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [x]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
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CALCULATION OF REGISTRATION FEE
Proposed Proposed
Amount Maximum Maximum Amount of
Title of Securities to to be Offering Price Aggregate Registration
be Registered Registered Per Share (1) Offering Price Fee
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Zero Coupon
Convertible
Subordinated Notes
due July 15, 2023 $ 100,000,000 151.94% $ 151,940,000 $ 12,291.95
-------------- ------------ -------------- ------------
Ordinary Shares,
$0.0001 par value 207,684,320(2) (2) (2) (3)
============== ============ ============== ============
(1) Estimated solely for the purpose of calculating the registration fee
pursuant to Rule 457(c) of the Securities Act of 1933, based on the bid
and ask prices for the Zero Coupon Convertible Subordinated Notes on
October 6, 2003.
(2) Includes 207,684,320 ordinary shares issuable upon conversion of the notes
at the initial conversion price of $0.4815 per share. Pursuant to Rule 416
under the Securities Act, such number of ordinary shares registered hereby
shall include an indeterminate number of additional ordinary shares that
may be issued from time to time upon conversion of the notes as a result
of antidilution adjustments, in circumstances described in the prospectus
that is part of this registration statement.
(3) Pursuant to Rule 457(i) under the Securities Act, there is no additional
filing fee with respect to the ordinary shares issuable upon conversion of
the notes because no additional consideration will be received in
connection with the exercise of the conversion privilege.
-----------------
The registrant hereby amends this registration statement on such date
or dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this registration
statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the registration statement shall become
effective on such date as the Commission acting pursuant to said Section 8(a)
may determine.
The information in this prospectus is not complete and may be changed. These
securities may not be sold until the registration statement filed with the
Securities and Exchange Commission is effective. This prospectus is not an offer
to sell these securities and it is not soliciting an offer to buy these
securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED OCTOBER 10, 2003
Preliminary Prospectus
NetEase.com, Inc.
$100,000,000 Principal Amount
Zero Coupon Convertible Subordinated Notes due July 15, 2023 and Ordinary Shares
Issuable Upon Conversion of the Notes
____________________
This prospectus covers resales from time to time by selling
securityholders of our Zero Coupon Convertible Subordinated Notes due July 15,
2023 held by certain selling securityholders and 207,684,320 of our ordinary
shares issuable upon conversion of the notes held by certain securityholders,
plus such indeterminate number of shares as may become issuable upon conversion
of the notes by reason of adjustment of the conversion price. The notes and the
ordinary shares may be sold from time to time by or on behalf of the selling
securityholders named in this prospectus or in supplements or amendments to this
prospectus in market transactions, in negotiated transactions or otherwise, and
at prices and at terms which will be determined by the then prevailing market
price for the notes or ordinary shares or at negotiated prices.
The interest rate on the notes will be zero, except as provided in this
prospectus. The notes are general unsecured obligations of NetEase.com, Inc. and
are subordinated to any existing or future senior indebtedness of NetEase.com,
Inc. They will mature on July 15, 2023, at which time they will be redeemed at
100% of their principal amount, together with accrued and unpaid interest, if
any. Prior to July 15, 2008, we may not redeem the notes at our option, except
upon a Merger Event (as defined in this prospectus), in which case we may be
required to redeem all of the notes for cash in an amount equal to the greater
of the trading price (as defined in this prospectus) of the notes plus 10% of
their principal amount or 100% of the principal amount of the notes, together
with accrued and unpaid interest, if any. On or after July 15, 2008, we may
redeem for cash all or part of the notes at a price equal to 100% of their
principal amount, together with accrued and unpaid interest, if any, if the
reference price of our ordinary shares (such reference price being a dollar
amount derived by dividing the closing price of our American Depositary Shares,
or ADSs, on the date of determination by the then applicable number of our
ordinary shares represented by one ADS) for 20 days out of any 30 consecutive
trading day (as defined in this prospectus) period, the last of which occurs no
more than five days prior to the date upon which notice of such redemption is
published, is at least 130% of the conversion price in effect on such last
trading day. Holders of notes may also require us to repurchase all or a portion
of their notes for cash on July 15, 2006, July 15, 2007, July 15, 2008, July 15,
2013 and July 15, 2018, at a price equal to 100% of the principal amount of the
notes, together with accrued and unpaid interest, if any, subject to certain
additional conditions. Further, upon a Fundamental Change or a Delisting Event
(as those terms are defined in this prospectus), each holder may require us to
repurchase for cash all or a portion of its notes at a price equal to 100% of
the principal amount of the notes, together with accrued and unpaid interest, if
any.
Holders may convert their notes at any time on or before the maturity date
at the conversion price (initially $0.4815 per ordinary share, subject to any
adjustments): (1) during any calendar quarter commencing after September 30,
2003, if the average of the reference prices of our ordinary shares for the last
five consecutive trading days of the calendar quarter preceding the quarter in
which the conversion occurs is more than 115% of the conversion price per share
on the last trading day of the preceding quarter, (2) if we have called the
notes for redemption, (3) if the trading price for the notes falls below a
certain level or (4) upon the occurrence of specified corporate transactions. We
may pay converting note holders ordinary shares, cash or a combination of cash
and ordinary shares for their notes.
A holder may deposit the ordinary shares it receives upon conversion of
its notes for the issuance of ADSs if certain specified conditions are met. Our
ADSs, each representing 100 ordinary shares, are quoted on The Nasdaq National
Market, Inc. under the symbol "NTES." The last reported sale price of our ADSs
on October 6, 2003 was $66.19 per ADS, which results in a reference price of
$0.6619 per share for our ordinary shares. The notes are eligible for trading in
The Portal(SM) Market, a subsidiary of The Nasdaq Stock Market.
Investing in the notes and ordinary shares involves risks. See "Risk
Factors" beginning on page 7.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
The date of this prospectus is , 2003.
_______________
TABLE OF CONTENTS
Page
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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS iii
WHERE YOU CAN FIND MORE INFORMATION iv
SUMMARY 1
RISK FACTORS 7
USE OF PROCEEDS 27
PRICE RANGE OF AMERICAN DEPOSITARY SHARES 27
EXCHANGE RATE INFORMATION 28
DIVIDEND POLICY 29
CAPITALIZATION 30
SELECTED CONSOLIDATED FINANCIAL DATA 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 34
RATIO OF EARNINGS TO FIXED CHARGES 49
DESCRIPTION OF NOTES 50
DESCRIPTION OF SHARE CAPITAL 71
DESCRIPTION OF AMERICAN DEPOSITARY SHARES 75
CAYMAN ISLANDS TAXATION 82
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES 83
SELLING SECURITYHOLDERS 90
PLAN OF DISTRIBUTION 92
LEGAL MATTERS 95
INDEPENDENT AUDITORS 95
_______________
Please note that in this prospectus, all references to Renminbi and RMB
are to the legal currency of China and all references to dollars, USD, $ and US$
are to the legal currency of the United States. References to "we," "us," "our
company" or "NetEase" in this prospectus are to NetEase.com, Inc.
_______________
We have not authorized any dealer, salesperson or other person to give
any information or represent anything not contained in this prospectus. You
should not rely on any unauthorized information. This prospectus does not offer
to sell or buy any shares in any jurisdiction in which it is unlawful. The
information in this prospectus is current as of the date on the cover.
ii
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains statements that may be of a forward-looking
nature. These statements are made under the "safe harbor" provisions of the U.S.
Private Securities Litigation Reform Act of 199g5. You can identify these
forward-looking statements by terminology such as "will," "expects,"
"anticipates," "future," "intends," "plans," "believes," "estimates" and similar
statements. The accuracy of these statements may be impacted by a number of
business risks and uncertainties that could cause actual results to differ
materially from those projected or anticipated, including those related to:
. the risk that we will not be able to continue to successfully
monetize the user base of the NetEase Web sites and that our
e-commerce and other fee-based services revenues will not continue
to grow;
. the risk that the current popularity of short messaging services
(SMS) in China will not continue for whatever reason, including
SMS being superseded by other technologies for which we are unable
to offer attractive products and services;
. the risk that we may not be able to continuously develop new and
creative online services;
. the risk that the online game market will not continue to grow or
that we will not be able to maintain our position in that market;
. the risk that the online advertising market in China will not
continue to grow and will remain subject to intense competition;
. the risk that we will not be able to control our expenses in
future periods;
. the possibility that our company and our board of directors have
not implemented effective or complete steps to ensure that the
circumstances which led to the restatement of our financial
statements for the year ended December 31, 2000 will not recur;
. the risk that we will not be able to develop and implement
additional operational and financial systems to manage our
operations;
. governmental uncertainties, general competition and price
pressures in the marketplace;
. uncertainty as to future profitability and the risk that security,
reliability and confidentiality concerns may impede broad use of
the Internet and e-commerce and other services; and
. other risks outlined in our filings with the Securities and
Exchange Commission, including our registration statement on Form
F-1, as amended.
We do not undertake any obligation to update this forward-looking
information, except as required under applicable law.
iii
WHERE YOU CAN FIND MORE INFORMATION
We file annual and current reports and other information with the
Securities and Exchange Commission, or the SEC. You may read and copy materials
that we have filed with the SEC at the SEC's public reference room at 450 Fifth
Street, N.W., Room 1024, Washington, D.C. 20549.
Please call the SEC at 1-800-SEC-0330 for further information on the
public reference room.
Our ADSs are quoted on The Nasdaq National Market under the symbol
"NTES," and our SEC filings can also be read at: Nasdaq Operations, 1735 K
Street, N.W., Washington, D.C. 20006.
Certain of our SEC filings are also available to the public on the SEC's
Internet website at http://www.sec.gov.
We incorporate by reference into this prospectus the documents listed
below and any future filings we make with the SEC under Sections 13(a), 13(c),
14 or 15(d) of the Exchange Act, including any filings after the date of this
prospectus, until this offering is completed. The information incorporated by
reference is an important part of this prospectus. Any statement in a document
incorporated by reference into this prospectus will be deemed to be modified or
superseded to the extent a statement contained in (1) this prospectus or (2) any
other subsequently filed document that is incorporated by reference into this
prospectus modifies or supersedes such statement.
. Our Annual Report on Form 20-F (File No. 000-30666) for our fiscal
year ended December 31, 2002 filed on June 27, 2003;
. The description of our ordinary shares and American Depositary
Shares, each representing 100 of our ordinary shares, set forth in
our Registration Statement on Form 8-A, filed on March 27, 2000
and amended on June 28, 2000 (File No. 000-30666);
. Our Current Report on Form 6-K (File No. 000-30666) filed on April
29, 2003;
. Our Current Report on Form 6-K (File No. 000-30666) filed on July
7, 2003;
. Our Current Report on Form 6-K (File No. 000-30666) filed on July
9, 2003;
. Our Current Report on Form 6-K (File No. 000-30666) filed on July
15, 2003; and
. Our Current Report on Form 6-K (File No. 000-30666) filed on July
31, 2003.
You may request a copy of these filings, the indenture for the notes,
the registration rights agreement or the form of note, at no cost, by writing to
us at: Investor Relations, NetEase.com, Inc., Suite 1901, Tower E3, The Towers,
Oriental Plaza, Dong Cheng District, Beijing, People's Republic of China 100738
or by telephoning us at (86-10) 8518-0163.
iv
SUMMARY
This summary contains basic information about us and this offering. Because
it is a summary, it does not contain all of the information that you should
consider before investing. You should read this entire prospectus carefully,
including the section entitled "Risk Factors" and our financial statements and
the notes thereto, some of which are incorporated into this prospectus by
reference, before making an investment decision.
Through our affiliates, we operate a leading interactive online and
wireless community in China and are a major provider of Chinese language content
and services through our Internet Portal, Wireless Business and Online Games
Business Departments. The monthly average daily page views of the NetEase Web
sites for the month ended September 30, 2003 exceeded 329.2 million, and as of
September 30, 2003, those sites had registered approximately 143.8 million
registered accounts. Headquartered in Beijing and with regional offices in
Shanghai and Guangzhou, NetEase has over 400 employees.
Our basic service offerings on the NetEase Web sites are available without
charge to our users. We generate revenues from fee-based wireless services,
online games, premium value-added services and advertising. Our principal areas
of focus are described below:
.. Internet Portal--The NetEase Web sites provide Internet users with Chinese
language online services centered around three core services--content,
community and communication, and commerce.
Content
Through more than 18 channels, the NetEase content channels provide news,
information and online entertainment to the Chinese public. The Web sites
consolidate and distribute content from more than one hundred international
and domestic content providers. Content channels include News,
Entertainment, Sports, Finance, Information Technology, Automobile,
Regional Sites for Guangdong and Shanghai, Astrology and Cartoon channels.
Community and Communication
The NetEase Web sites also provide a broad array of community and
communication products, including E-mail, Instant Messaging, Personals,
Matchmaking, Alumni Directories, Personal Homepages, Clubs, E-cards, Chat
Rooms and Community Forums. Some of these services are provided free of
charge to the users with an option to upgrade to a fee-based premium
service, whereas others are provided solely on a fee-based premium basis.
Commerce
We offer an online shopping service, providing Internet users in China with
the freedom to shop from their homes and offices or in Internet cafes and
thereby access products and information which might otherwise not be
conveniently available. In turn, our technology platform allows e-commerce
and traditional businesses to establish or expand their retail networks via
the NetEase Web sites.
In addition, through the NetEase Web sites, advertisers can reach NetEase's
large registered user base to conduct integrated marketing campaigns by
means of a full range of advertising formats and techniques. These include
banner advertising, direct e-mail, interactive media-rich sites, special
events, games and contests and other activities.
1
The NetEase Web sites also provide useful resources to our users, including
a Web directory, Web Search Service and Classified Ads. Our Web directory
is based on an open architecture system with over 3,000 volunteer editors
working to build a categorized directory of Chinese Web sites.
.. Wireless Value-Added Services--Through arrangements with mobile phone
operators China Mobile and China Unicom, we offer a wide-range of products
and services which allow users, for example, to receive news and valuable
information such as stock quotes and e-mails, download ring-tones and logos
for their mobile phones and participate in matchmaking communities and
interactive games. Combining content from our Internet Portal (both
user-generated and from our content partners) with the applications we have
developed in-house, our Wireless Business Department strives to offer
products and services that are responsive to our users' changing tastes and
needs.
Currently, most of our wireless value-added products and services are
provided to users in the form of short messaging services ("SMS"). NetEase
offers over 200 different SMS products and subscription packages with
pricing between RMB0.10 to RMB2.00 per SMS message or between RMB5.00 to
RMB30.00 per subscription per month. We receive a percentage of this amount
from China Mobile and China Unicom, which they bill and collect on our
behalf. In addition, we are required to pay China Mobile and China Unicom a
service fee.
In addition to our SMS offerings, we have begun introducing products and
services for emerging wireless technology standards, including multimedia
messaging ("MMS") products and wireless application protocol ("WAP")
portals which users access with mobile phones that utilize the new GPRS or
CDMA1X technology standards. We intend to continue to develop and introduce
wireless value-added products and services, such as MMS Virtual Pet and
Java games, as the market evolves and as new technologies develop.
.. Online Games--Through our Online Games Business Department, we focus on
offering massively multi-player online role-playing games ("MMORPGs") to
the Chinese market. MMORPGs are played over the Internet in "virtual
worlds" that exist on game servers to which thousands of players
simultaneously connect and interact. We both develop and license online
games that are targeted at the Chinese market, and we strive to provide the
highest quality game playing experience to our users.
To pay for game playing time, players can use our prepaid point card
system. Point card distribution channels include wholesalers, as well as
major retailers including 7-Eleven convenience stores in Guangzhou.
Corporate Information
NetEase.com, Inc., a Cayman Islands corporation, commenced operations in
1999. Our principal executive offices are located at Suite 1901, Tower E3, The
Towers, Oriental Plaza, Dong Cheng District, Beijing, People's Republic of China
100738. Our telephone number at this location is (86-10) 8518-0163. Our Web site
is located at http://www.netease.com. The information contained on our Web site
is not a part of this prospectus.
2
The Offering
This prospectus covers the resale of $100,000,000 aggregate principal
amount of the notes and 207,684,320 of our ordinary shares issuable upon
conversion of the notes, plus an indeterminate number of additional ordinary
shares that may be issued from time to time upon conversion of the notes as a
result of antidilution adjustments in circumstances described in this
prospectus.
We issued and sold $75,000,000 aggregate principal amount of the notes on
July 14, 2003 and $25,000,000 aggregate principal amount of the notes on July
31, 2003, in private offerings to Credit Suisse First Boston LLC. We were told
by Credit Suisse First Boston LLC that the notes were resold in transactions
which were exempt from registration requirements of the Securities Act of 1933,
as amended (referred to as the Securities Act in this prospectus) to persons
reasonably believed by Credit Suisse First Boston LLC to be "qualified
institutional buyers" (as defined in Rule 144A under the Securities Act).
Ordinary shares may be offered by the selling securityholders following the
conversion of their notes.
The following is a brief summary of the terms of the notes. For a more
complete description of the notes, see the section entitled "Description of
Notes" in this prospectus.
Notes $100,000,000 aggregate principal amount of our Zero
Coupon Convertible Subordinated Notes due July 15,
2023.
Interest Interest on the notes will be zero unless specified
defaults under the registration rights agreement
occur. See "Description of Notes--Registration
Rights."
Maturity of Notes July 15, 2023.
Subordination The notes will be general unsecured subordinated
obligations of NetEase. The notes will be
subordinated in right of payment to all existing
and future senior indebtedness. The notes will also
be effectively subordinated to the existing and
future indebtedness and other liabilities of our
subsidiaries. As of June 30, 2003, we had no
outstanding indebtedness, and we had total
liabilities of approximately $6.0 million. On that
date, our subsidiaries had no outstanding
indebtedness, other than intercompany indebtedness
and other normal trade payables and liabilities.
Conversion Rights Holders may convert their notes into our
ordinary shares at a conversion price of $0.4815
per share, subject to adjustment, at any time prior
to maturity:
. during any calendar quarter commencing after
September 30, 2003, if the average of the
reference prices (as defined in this prospectus)
of our ordinary shares for the last five
consecutive trading days of the calendar quarter
preceding the quarter in which the conversion
occurs is more than 115% of the conversion
3
price per share on the last trading day
of the preceding quarter;
. if we have called the notes for
redemption;
. if the average of the trading prices of
the notes for any five consecutive
trading day period is less than 100% of
the average of the conversion value (as
defined in this prospectus) of the notes
during that period; provided, however,
that no notes may be converted based on
the satisfaction of this condition
during the six month period immediately
preceding each specified date on which
the note holders may require us to
repurchase their notes (for example,
with respect to the July 15, 2006
repurchase date, the notes may not be
converted from January 15, 2006 to July
15, 2006) if on any day during such five
consecutive trading day period, the
reference price of our ordinary shares
is between the conversion price and 115%
of the conversion price; or
. upon the occurrence of specified
corporate transactions.
Upon conversion of the notes, we may also
choose to deliver cash to you, in lieu of
ordinary shares, or a combination of cash
and ordinary shares.
A holder may deposit the ordinary shares it
receives upon conversion of its notes for
the issuance of ADSs if certain specified
conditions are met.
Redemption of Notes at Our Option Beginning on July 15, 2008 and prior to the
close of business on the maturity date, we
may redeem the notes, in whole or in part,
for cash at a price equal to 100% of the
principal amount thereof, together with
accrued and unpaid interest, if any, if the
reference price of our ordinary shares for
20 out of any 30 consecutive trading day
period, the last of which occurs no more
than five days prior to the date upon which
notice of such redemption is published, is
at least 130% of the conversion price in
effect on such last trading day. See
"Description of Notes--Redemption of Notes
at Our Option."
We will also redeem all of the notes upon a
Merger Event (as defined in this
prospectus) for cash in an amount equal to
the trading price of the notes plus 10% of
their principal amount (or 100% of the
principal amount of the notes, if greater).
See "Description of Notes--Merger and
Consolidation."
4
Repurchase of the Notes at the Holders may require us to repurchase for
Option of the Holder cash all or a portion of their notes on
July 15, 2006, July 15, 2007, July 15,
2008, July 15, 2013 and July 15, 2018, at a
price equal to 100% of the principal amount
thereof, together with accrued and unpaid
interest, if any. See "Description of
Notes--Repurchase of Notes at the Option of
the Holder on Specified Dates."
Fundamental Change If a Fundamental Change (as defined in this
prospectus) occurs, each holder of notes
may require us to repurchase all or a
portion of such holder's notes at a price
equal to 100% of the principal amount
thereof, together with accrued and unpaid
interest, if any.
Delisting Event If our ADSs are no longer listed or quoted
for trading on The Nasdaq National Market
or our ordinary shares or other securities
representing our ordinary shares are not
listed or quoted for trading on a U.S.
national securities exchange, each holder
of notes may require us to repurchase all
or a portion of such holder's notes at a
price equal to 100% of the principal amount
thereof, together with accrued and unpaid
interest, if any.
Events of Default If there is an event of default on the
notes, the principal amount of the notes
plus accrued and unpaid interest, if any,
may be declared immediately due and
payable. See "Description of Notes--Events
of Default and Notice Thereof."
Use of Proceeds We will not receive any proceeds from the
sale of the notes or the ordinary shares
offered by this prospectus.
Form of Notes The notes were issued in book-entry form
and are represented by permanent global
certificates deposited with a custodian for
and registered in the name of a nominee of
The Depository Trust Company, or DTC, in
New York, New York.
Beneficial interests in any such securities
are shown on, and transfers are effected
only through, records maintained by DTC and
its direct and indirect participants and
any such interest may not be exchanged for
certificated securities, except in limited
circumstances. See "Description of
Notes--Book-Entry Delivery and Form."
Registration Rights We have agreed to file with the SEC the
shelf registration statement of which this
prospectus is a part for the resale of the
notes and the ordinary shares issuable upon
conversion of the notes under a
registration rights agreement. In the
5
event that we fail to comply with certain
of our obligations under the registration
rights agreement, certain interest will be
payable on the notes. See "Description of
Notes--Registration Rights."
Trading The notes are eligible for trading in The
PortalSM Market, a subsidiary of The Nasdaq
Stock Market. Our ADSs, each representing
100 ordinary shares, are traded on The
Nasdaq National Market under the symbol
"NTES."
Trustee for the Notes and The Bank of New York
Depositary for our American
Depositary Shares
6
RISK FACTORS
Before you make an investment decision regarding the notes or the
underlying ordinary shares, you should carefully consider all of the information
contained in this prospectus.
Risks Related to Our Company
Our business prospects are difficult to evaluate because we commenced our
operations in 1997, changed our business focus in 1998 and introduced several
new revenue sources in 2001.
Our business was established in June 1997 as an Internet software
developer. In mid-1998, our business focus changed to an Internet technology
provider, and we commenced developing the NetEase Web sites. In July 1999, we
commenced our e-commerce services, and in September 1999, we restructured our
operations to place our Internet portal operations in Guangzhou NetEase Computer
System Co., Ltd., or Guangzhou NetEase. In 2001, we began focusing on fee-based
premium services and online entertainment services, including wireless
value-added services, premium e-mail services, online games and other
subscription-type products. In 2002 and the first half of 2003, certain of these
new services, in particular wireless value-added services and online games,
enjoyed greater popularity (and generated greater profit) than our other
fee-based premium services, but we cannot be certain whether this trend will
continue.
Because we have a limited operating history, when you evaluate our business
and prospects you must consider the risks and difficulties frequently
encountered by companies in the early stages of development, particularly
companies in the new and rapidly evolving Internet service markets. In addition,
our change of business focus from developing Web-based software products to
developing and providing technological services to the NetEase Web sites and
then to also providing e-commerce and other services makes it difficult to
evaluate our future prospects. We cannot assure you that we will be able to
increase or maintain our revenues from online advertising and e-commerce and
other services.
We incurred significant losses in the past and may incur additional losses in
the future.
Although we had a net profit of US$2.0 million in 2002 and of US$17.5
million in the first six months of 2003, we incurred significant net losses in
2001, 2000 and 1999 and had only minimal profit in 1998. Accordingly, as of June
30, 2003, we had an accumulated deficit of approximately US$35.4 million. The
markets in which we operate are highly competitive, and given the relatively
short period of time during which we have achieved profitability, we cannot be
certain that we will be able to maintain or increase our profits. Moreover, as
our business expands, we may incur additional expenses which would also
adversely affect our profitability.
The market for the delivery of wireless value-added services is rapidly
evolving, and our ability to generate revenues from our wireless value-added
services could suffer if this market does not develop or we fail to address this
market effectively.
We must continue to adapt our strategy for wireless value-added services,
which contributed the bulk of our fee-based premium services and online
entertainment services revenue in 2002 and the first half of 2003, to compete in
the rapidly evolving wireless value-added services market. We currently offer
products and services for users of short messaging services (SMS) and, beginning
in 2003, for multi-media messaging services (MMS), both of which enable mobile
phone users to communicate with each other and receive information on their
phone screens. Competitors have introduced or developed, or are in the process
of introducing or developing, competing wireless value-added services accessible
through a variety of handheld devices. We cannot assure you that there will be
demand for the wireless value-added
7
services provided by us. In addition, there are numerous other technologies in
varying stages of development, such as third generation cellular phone
technology (3G), which could radically alter or eliminate the SMS and MMS
markets. Accordingly, it is extremely difficult to predict which services will
be successful in this market or the future size and growth of this market. In
addition, given the limited history and rapidly evolving nature of this market,
we cannot predict the price that wireless subscribers will be willing to pay for
these services. If acceptance of our wireless value-added services is less than
anticipated, our results from operations could be impacted.
Currently, we are dependent on our relationship with the two mobile phone
companies in China for our wireless value-added services revenues and the
alteration or termination of either or both of these relationships could
adversely impact our business.
Our wireless value-added services are conducted in conjunction with the two
mobile phone companies in China, China Mobile and China Unicom. If our strategic
relationship with either company is terminated or scaled-back, it may be
difficult, if not impossible, to find appropriate replacement partners with the
requisite licenses and permits, infrastructure and customer base to offer these
services, which could adversely affect our business. Our wireless value-added
services are provided through a number of contracts with the provincial
affiliates of China Mobile and with China Unicom, and each of these contracts is
non-exclusive and of a limited term (generally six months or one year). These
contracts may also be terminated in advance under certain circumstances. We
cannot be certain that we will be able to renew these contracts as necessary or
enter into new arrangements with these or other affiliates of China Mobile and
China Unicom. We may also be compelled to amend our arrangements with these
mobile phone carriers in ways which adversely affect our business.
We experienced a decline in the rate of growth of our online games which appears
to be a result of the outbreak of severe acute respiratory syndrome, or SARS,
and any recurrence of SARS or another widespread public health problem could
further adversely affect our business and results of operations.
During April and May 2003, we experienced a decline in the rate of growth
of our online game services which we believe resulted from the Chinese
government's closure of Internet cafes in Beijing and elsewhere to prevent the
spread of SARS. Many users of our online game services can only access those
services at Internet cafes. A renewed outbreak of SARS or another widespread
public health problem in China where virtually all of our revenue is derived and
in Beijing, Shanghai and Guangzhou where most of our employees are located could
have a negative effect on our operations. Our operations may be impacted by a
number of health-related factors, including, among other things:
. quarantines or closures of some of our offices which would severely
disrupt our operations,
. the sickness or death of our key officers and employees,
. closure of Internet cafes and other public areas where people access
the Internet, and
. a general slowdown in the Chinese economy.
Any of the foregoing events or other unforeseen consequences of public
health problems could adversely affect our business and results of operations.
We will continue to monitor the impact of SARS on our business.
8
E-commerce and other services have become the significant part of our revenue,
but continued growth in the popularity of these services and customers'
willingness and ability to pay for them is uncertain.
Our revenue growth depends on the increasing acceptance and use of our
e-commerce services, fee-based premium services, wireless value-added services
and online entertainment services. We have, however, only limited experience in
offering these services and cannot be certain that they will generate
sustainable revenue. Further, these services may never become widely accepted
for various reasons, many of which are beyond our control, including:
. inexperience with these technologies, some of which are largely new to
China, and customers' willingness to pay for online services;
. rapid changes in technology and customer tastes which could adversely
impact the popularity of our services, such as our fee-based wireless
value-added services and online games; and
. concerns about security, reliability, cost, ease of deployment,
administration and quality of service associated with conducting
business over the Internet.
Further, online payment systems in China are not as widely available or
acceptable to consumers in China as in the United States and elsewhere. Although
major Chinese banks have instituted online payment systems, these systems are
still at an early stage. In addition, a limited number of consumers in China
have credit cards or debit cards. The perceived lack of secure online payment
systems may limit the number of e-commerce transactions that we can service. If
online payment services do not develop, our ability to grow our e-commerce
business would be limited.
In connection with the introduction of our first online game, "Westward
Journey Online," at the end of 2001, we introduced a prepaid debit point card
which we believe has facilitated the usability and growth of all of our online
game services. To address the difficulty of making online payments in China,
users can buy this card at local stores and other locations in China. The points
contained in the card can then be used to pay for online services, such as
playing time for online games. We cannot be certain, however, that Internet
users in China will be willing to adopt this payment method on a wide-spread and
consistent basis or that it will be immune to the security and other concerns
which have thus far contributed to the relatively low level of e-commerce
activity in China. If the Internet does not become more widely accepted as a
medium for e-commerce and our other fee-based services, our ability to generate
increased revenue will be negatively affected.
If we fail to develop and introduce new fee-based services timely and
successfully, we will not be able to compete effectively and our ability to
generate revenues will suffer.
We operate in a highly competitive, quickly changing environment, and our
future success depends not only on the popularity of our existing fee-based
services but also on our ability to develop and introduce new fee-based services
that our customers and users choose to buy. If we are unsuccessful at developing
and introducing new fee-based services that are appealing to users with
acceptable prices and terms, our business and operating results would be
negatively impacted because we would not be able to compete effectively and our
ability to generate revenues would suffer. The development of new services can
be very difficult and requires high levels of innovation. The development
process can also be lengthy and costly, in particular for developing new online
games. If we fail to anticipate our users' needs and technological trends
accurately or are otherwise unable to complete the development of
9
services in a timely fashion, we will be unable to introduce new services into
the market to successfully compete.
The demand for new services is difficult to forecast, in part due to the
relative immaturity of the market for our fee-based services in China and
relatively short life cycles of Internet-based technologies. As we introduce and
support additional services and as competition in the market for our services
intensifies, we expect that it will become more difficult to forecast demand. In
particular, competition in the online game market is growing as more and more
online games are introduced by existing and new market participants.
We depend on China Mobile and China Unicom to maintain accurate records
concerning the fees paid by customers for wireless value-added services and our
portion of those fees, and we have had to make estimates on occasion as to what
revenues we should record in this regard. Any mistakes in this process could
adversely affect our business.
China Mobile and China Unicom pay us a portion of the fees they receive
from their customers for the wireless value-added services we provide, and we
are dependent on their ability to maintain accurate records of the services
provided and concomitant fees paid. We do not collect fees from these operators
in certain circumstances due to technical issues with their billing and
transmission systems. The rate of these billing and transmission failures varies
among the operators and also changes from month to month. Billing and
transmission failures may result in a significant reduction in our wireless
value-added services revenue.
In addition, we have only limited means to independently verify the
information provided to us in this regard, and our business could be adversely
affected if these mobile phone companies miscalculate the net revenue from the
services and our portion of that revenue. Further, we normally recognize revenue
based on statements from the mobile phone companies, but in very limited
circumstances, we may recognize revenue based on our own statistical records and
after consultation with the mobile phone companies. Recognizing revenue based on
such estimates could potentially require us to later make adjustments in our
financial records when the mobile phone companies' statements and cash payments
are received. Such estimates have not been made in connection with our fiscal
year-end accounts.
We expect that a portion of our future revenues will continue to come from our
advertising services, but the online advertising market in China is still
relatively new and subject to intense competition.
Although we anticipate that the revenues generated by our fee-based premium
services and online entertainment services will continue to constitute the major
portion of our future revenues, we believe that we will continue to rely on
advertising revenues as one of our major revenue sources for the foreseeable
future. Online advertising in China is still relatively new and many of our
current and potential advertisers have limited experience with the Internet as
an advertising medium, have not traditionally devoted a significant portion of
their advertising expenditures or other available funds to Web-based
advertising, and may not find the Internet to be effective for promoting their
products and services relative to traditional print and broadcast media. Our
ability to generate and maintain significant advertising revenue will depend on
a number of factors, many of which are beyond our control, including:
. the development of a large base of users possessing demographic
characteristics attractive to advertisers;
. the development of software that blocks Internet advertisements before
they appear on a user's screen;
10
. downward pressure on online advertising prices; and
. the effectiveness of our advertising delivery and tracking system.
In addition, China's entry into the World Trade Organization, and the
resulting gradual opening of its telecommunications sector, may facilitate more
foreign participation in the Chinese Internet market by such companies, for
example, as Yahoo! and American Online. Many of these Internet companies have
longer operating histories in the Internet market, greater name and brand
recognition, larger customer bases and databases and significantly greater
financial, technical and marketing resources than we have. The entry of
additional, highly competitive Internet companies into the Chinese market would
further heighten competition for advertising spending in China.
If the Internet does not become more widely accepted as a medium for
advertising, our ability to generate increased revenue will be negatively
affected.
Our advertising revenues are subject to the overall state of the online
advertising industry which is itself subject to general economic conditions.
Expenditures by advertisers tend to be cyclical, reflecting overall
economic conditions as well as budgeting and buying patterns. The demand for
Internet advertising in China has been generally stabilizing in recent quarters
but it still remains relatively soft as companies are reluctant to expand their
marketing and advertising budgets or delay spending their budgeted resources.
This has resulted in intense market competition which affected the general
pricing in the Internet advertising market in China, and we have had to devote
significant resources to maintain and enhance our revenue from advertising.
Because a portion of our revenue is derived from Internet advertising services,
our future revenue could be materially and adversely affected if we cannot adapt
successfully to new Internet advertising pricing models.
It is difficult to predict which Internet advertising pricing model, if
any, will emerge as the industry standard. This makes it difficult to project
our future online advertising rates and revenues. For example, in past periods,
our obligations to advertisers typically included guarantees of a minimum number
of impressions or times that an advertisement appears in pages viewed by users.
We have been largely successful in 2002 in moving to advertising contracts whose
fees are based on the actual time period that the advertisements appear on the
NetEase Web sites rather than based on guaranteed minimum impressions. We cannot
predict whether advertisers will continue to agree to this form of advertising
arrangement in the near-term or whether new pricing models will emerge which we
can successfully adopt and implement. Our advertising services revenues could be
materially and adversely affected if we are unable to adapt to new forms of
Internet advertising or if we fail to adopt the most profitable form.
Our business and our reputation were materially harmed because we had to restate
our financial statements.
Our rapid growth has placed and continues to place a significant strain on
our resources. In one particular instance in our history, we have not been able
to manage our growth effectively. Specifically, in the second quarter of 2001,
our board of directors through its audit committee initiated an investigation
into whether the terms of certain contracts between our company and third party
advertisers had been appropriately reflected in our financial statements. The
audit committee subsequently determined by the end of the investigation that the
terms and execution status of certain advertising contracts between our
11
company and third party advertisers and the nature of certain barter
transactions were such that revenue could not be recognized in fiscal year 2000.
We have taken a number of steps to strengthen our controls and procedures
to minimize the recurrence of this problem. We are also continuously working to
bolster our management team to ensure that the controls and procedures are
implemented in a consistent, effective manner. We believe that these improved
controls and procedures have been effective, but it is possible that the same or
new problems will arise as our business continues to expand. Further, as noted
below, we cannot be certain that we will be able to employ and retain suitable
senior managers to oversee the implementation of our controls and procedures in
the future.
If we make any mistakes in operating our business, our operating results
may fluctuate and cause the price of our ADSs to decline.
The success of our business is dependent on our ability to retain our existing
key employees and to add and retain new senior officers to our management.
We depend on the services of our existing key employees. Our success will
largely depend on our ability to retain these key employees and to attract and
retain qualified senior and middle level managers to our management team. We
also depend on our ability to attract and retain highly skilled technical,
editorial, marketing and customer service personnel in the future. We cannot
assure you that we will be able to attract or retain such personnel or that any
personnel we hire in the future will successfully integrate into our
organization or ultimately contribute positively to our business. The loss of
any of our key employees would significantly harm our business. We do not
maintain key person life insurance on any of our employees.
In the past, we have not been able to accurately or comprehensively track the
delivery of advertisements through the NetEase Web sites, which problem, if it
recurs, may make us less attractive to our present and potential advertisers.
We depend on third party proprietary and licensed advertisement serving
technology, as well as software which we developed ourselves, to deliver and
track all types of advertisements we offer to our advertising customers, such as
banner ads, text links, logo displays and pop-up advertisements. Advertisement
serving technology allows us to measure the demographics of our user base and
the delivery of advertisements on the NetEase Web sites. This technology is
still developing. It is important to advertisers that we accurately measure the
demographics of the user base of the NetEase Web sites and the delivery of
advertisements through the NetEase Web sites. To date, we believe that we have
implemented this system successfully, but we cannot be certain that it will be
effective as new forms of online advertising arise from time to time. Companies
may choose not to advertise on the NetEase Web sites or may pay less for
advertising if our advertisement serving system is not perceived to be reliable.
We believe we were a passive foreign investment company for the 2000, 2001 and
2002 taxable years, which will result in adverse U.S. tax consequences to U.S.
investors who held our shares or American Depositary Shares during any of those
taxable years, and we cannot be certain whether we will be treated as a passive
foreign investment company for the 2003 taxable year.
Based upon the nature of our income and assets, we believe we were a
passive foreign investment company for U.S. federal income tax purposes for the
2000, 2001 and 2002 taxable years, and we cannot be certain whether we will be
treated as a passive foreign investment company for the 2003 taxable year. The
determination of whether or not we are a passive foreign investment company is
made on an annual basis and depends on the composition of our income and assets,
including goodwill, from time to time.
12
The calculation of goodwill is based, in part, on the then market value of our
American Depositary Shares, which is subject to change. In addition, we have
made a number of assumptions regarding the calculation of goodwill and the
allocation of goodwill among active and passive assets. While we believe our
approach is reasonable, the relevant authorities in this area are unclear, so we
cannot assure you that our belief that we were a passive foreign investment
company for the 2000, 2001 and 2002 taxable years is accurate and we cannot
predict with certainty whether we will be treated as a passive foreign
investment company for the 2003 taxable year. U.S. investors who owned our
shares during any taxable year in which we were a passive foreign investment
company generally will be subject to increased U.S. tax liabilities and
reporting requirements for those taxable years and all succeeding years,
regardless of whether we continue to be a passive foreign investment company for
the 2003 taxable year and any succeeding years, although a shareholder election
to terminate such deemed passive foreign investment company status may be made
in certain circumstances. The same adverse U.S. tax consequences will apply to
our U.S. investors who acquire our shares during the 2003 taxable year or any
subsequent taxable year if we are treated as a passive foreign investment
company for that taxable year. Even if we were not a passive foreign investment
company for the 2000, 2001 or 2002 taxable years and/or are not treated as a
passive foreign investment company for the 2003 taxable year, we cannot assure
you that we will not become a passive foreign investment company for any future
taxable year. See "Certain United States Federal Income Tax Consequences."
Our revenues fluctuate significantly and may adversely impact the trading price
of our American Depositary Shares or any other securities which become publicly
traded.
Our revenues and results of operations have varied significantly in the
past and may continue to fluctuate in the future. Many of the factors that cause
such fluctuation are outside our control. Steady revenues and results of
operations will depend largely on our ability to:
. attract and retain users to the NetEase Web sites in the increasingly
competitive Internet market in China;
. successfully implement our business strategies as planned; and
. update and develop our Internet applications, services, technologies
and infrastructure.
Usage of our wireless value-added services and online games has typically
increased around the Chinese New Year holiday and other traditional Chinese
holidays. In contrast, advertising expenditures in China have historically been
significantly lower during the first calendar quarter of the year due to the
Chinese New Year holiday and the traditional close of advertisers' annual
budgets. Expenditures for our e-commerce services have also historically
followed the seasonal trend for advertising. If our revenues decrease or
expenses increase during these periods, we may not be able to offset our
expenses with sufficient revenues.
Accordingly, you should not rely on quarter-to-quarter comparisons of our
results of operations as an indication of our future performance. It is possible
that future fluctuations may cause our results of operations to be below the
expectations of market analysts and investors. This could cause the trading
price of our American Depositary Shares or any other securities of ours, such as
the notes and the underlying ordinary shares, to decline.
13
If Guangzhou NetEase, Guangyitong Advertising or Guangyitong Advertising's
ultimate shareholders violate our contractual arrangements with them, our
business could be disrupted, our reputation may be harmed and we may have to
resort to litigation to enforce our rights which may be time consuming and
expensive.
Because of current Chinese laws and restrictions, Guangzhou NetEase
operates the NetEase Web sites and Beijing Guangyitong Advertising Co., Ltd., or
Guangyitong Advertising, an 80%-owned subsidiary of Guangzhou NetEase, operates
the online advertising business pursuant to contractual arrangements with us.
Guangzhou NetEase is 80% owned by our founder, Chief Architect and a director,
William Lei Ding, and 20% owned by our former employee Bo Ding, William Lei
Ding's brother. Bo Ding owns the remaining 20% of Guangyitong Advertising.
The interests of the shareholders of Guangzhou NetEase may differ from
ours and those of our shareholders because they own a larger percentage of
Guangzhou NetEase than of our company. In addition, Guangzhou NetEase, as an
Internet content provider, and Guangyitong Advertising, as an advertising firm,
may be subject to laws and regulations in China that are incompatible with the
business strategies or operations of our company. Guangzhou NetEase, Guangyitong
Advertising or Guangyitong Advertising's ultimate shareholders could violate our
agreements with them by, among other things, failing to operate and maintain the
NetEase Web sites or advertising business in an acceptable manner, failing to
remit revenues to us on a timely basis or at all or diverting customers or
business opportunities from our company to Guangzhou NetEase. A violation of
these agreements could disrupt our business and adversely affect our reputation
in the market. If Guangzhou NetEase, Guangyitong Advertising or Guangyitong
Advertising's ultimate shareholders violate our agreements with them, we may
have to resort to litigation to enforce our rights. This litigation could result
in the disruption of our business, diversion of our resources and the incurrence
of substantial costs.
Because our contractual arrangements with Guangzhou NetEase, Guangyitong
Advertising and Guangyitong Advertising's ultimate shareholders do not detail
the parties' rights and obligations, our remedies for a breach of these
arrangements are limited.
Our current relationship with Guangzhou NetEase, Guangyitong
Advertising and Guangyitong Advertising's ultimate shareholders is based on a
number of contracts. The terms of these agreements are often statements of
general intent and do not detail the rights and obligations of the parties. Some
of these contracts provide that the parties will enter into further agreements
on the details of the services to be provided. Others contain price and payment
terms that are subject to monthly adjustment. These provisions may be subject to
differing interpretations, particularly on the details of the services to be
provided and on price and payment terms. It may be difficult for us to obtain
remedies or damages from Guangzhou NetEase, Guangyitong Advertising or
Guangyitong Advertising's ultimate shareholders for breaching our agreements.
Because we rely significantly on Guangzhou NetEase and Guangyitong Advertising
for our business, the realization of any of these risks may disrupt our
operations or cause degradation in the quality and service provided on, or a
temporary or permanent shutdown of, the NetEase Web sites.
Increased government regulation of the information industry in China may result
in the Chinese government requiring us to obtain additional licenses or other
governmental approvals to conduct our business which, if unattainable, may
restrict our operations.
The telecommunications industry, including Internet content provision
(known as ICP) services, is highly regulated by the Chinese government, the main
relevant government authority being the Ministry of Information Industry or MII.
Prior to China's entry into the World Trade Organization, or the WTO, the
Chinese government generally prohibited foreign investors from taking any equity
ownership
14
in or operating any telecommunications business. ICP services are classified as
telecommunications value-added services and therefore fell within the scope of
this prohibition. This prohibition was partially lifted following China's entry
into the WTO. Pursuant to the Administrative Rules for Foreign Investments in
Telecommunications Enterprises promulgated by the State Council dated December
5, 2001, foreign investors may now hold in the aggregate up to 49% of the total
equity in any value-added telecommunications business in China, subject to
certain geographic limitations. This percentage ceiling is to be increased to
50% by the second anniversary of China's entry into the WTO.
To operate the NetEase Web sites in compliance with all the relevant
ICP-related Chinese regulations, Guangzhou NetEase has successfully obtained an
ICP license issued by the Guangdong Provincial Telecommunications Bureau, or
Guangdong Bureau, dated as of December 14, 2000. On February 15, 2001, the News
Office of the Beijing Municipal People's Government approved Guangzhou NetEase's
application in respect of its news displaying services on the NetEase Web sites.
As for special approvals for other online services, Guangzhou NetEase has
submitted applications for online dissemination of health- and drug-related
information and Internet publishing. Guangzhou NetEase has also applied for
approval of our online game activities with the Ministry of Culture in
accordance with recently adopted regulations.
We rely exclusively on our contractual arrangements with Guangzhou
NetEase and its approval to operate as an Internet content provider for our
business operations. We believe that our present operations are structured to
comply with Chinese law. However, many Chinese regulations are subject to
extensive interpretive powers of governmental agencies and commissions. We
cannot be certain that the Chinese government will not take action to prohibit
or restrict our business activities. We are uncertain as to whether the Chinese
government will reclassify our business as a media or retail company, due to our
acceptance of Internet advertising fees and e-commerce related services fees as
sources of revenues, or as a result of our current corporate structure. Such
reclassification could subject us to penalties or fines or significant
restrictions on our business. Also, we may fail to obtain some or all the
licenses, permits or clearances we may need in the future, including, for
example, the requisite approvals for our online game business from the Ministry
of Culture. In addition, we may have difficulties enforcing our rights under our
agreements with Guangzhou NetEase and Guangyitong Advertising if either of these
parties breaches any of our agreements with them because we do not have approval
from appropriate Chinese authorities to provide Internet content services or
Internet advertising services. Future changes in Chinese government policies
affecting the provision of information services, including the provision of
online services, Internet access, e-commerce services and online advertising,
may impose additional regulatory requirements on us or our service providers or
otherwise harm our business.
Our business would be materially harmed if the Chinese government were to take
any action against us for the content on the NetEase Web sites.
The Chinese government has enacted regulations governing Internet
access and distribution of news and other information over the Internet. In the
past, the Chinese government has stopped the distribution of information over
the Internet that it believed to be inappropriate. We cannot predict the effect
of further developments in the Chinese legal system, particularly with regard to
the Internet, including the promulgation of new laws, changes to existing laws
or the interpretation or enforcement of laws.
If we are found to be in violation of any existing or future Chinese
laws or regulations, the relevant Chinese authorities would have broad
discretion in dealing with such a violation, including, without limitation, the
following:
. levying fines;
15
. revoking our business license;
. requiring us to restructure our corporate structure, operations or
relationship with Guangzhou NetEase or Guangyitong Advertising; and
. requiring us to discontinue any portion or all of our Internet
business or our relationship with Guangzhou NetEase or Guangyitong
Advertising.
Any such action would have a material adverse effect on our business,
financial condition and results of operations and on the holders of our ordinary
shares and American Depositary Shares.
We may not be able to conduct our operations without the services provided by
Guangzhou NetEase and Guangyitong Advertising.
Our operations are currently dependent upon our commercial relationships
with Guangzhou NetEase and Guangyitong Advertising, and we derive most of our
revenues from these companies. A portion of our revenues under our contracts
with these companies are based upon arbitrary amounts that have been agreed upon
in advance. If these companies are unwilling or unable to perform the agreements
which we have entered into with them, we may not be able to conduct our
operations in the manner in which we currently plan. In addition, Guangzhou
NetEase and Guangyitong Advertising may seek to renew these agreements on terms
that are disadvantageous to us. Although we have entered into a series of
agreements that provide us with substantial ability to control these companies,
we may not succeed in enforcing our rights under them. If we are unable to renew
these agreements on favorable terms, or to enter into similar agreements with
other parties, our business may not expand, and our operating expenses may
increase.
Guangzhou NetEase and Guangyitong Advertising are controlled by our controlling
shareholder, who may cause these agreements to be amended in a manner that is
adverse to us.
Our majority shareholder, William Lei Ding, is also the controlling
shareholder of Guangzhou NetEase and Guangyitong Advertising. As a result, Mr.
Ding may be able to cause these agreements to be amended in a manner that will
be adverse to our company, or may be able to cause these agreements not to be
renewed, even if their renewal would be beneficial for us. Prior to our initial
public offering of American Depositary Shares, a number of these agreements were
amended. Although we have entered into an agreement that prevents the amendment
of these agreements without the approval of the members of our Board other than
Mr. Ding, we can provide no assurances that these agreements will not be amended
in the future to contain terms that might differ from the terms that are
currently in place. These differences may be adverse to our interests.
Unexpected network interruption caused by system failures may reduce visitor
traffic and harm our reputation.
Both the continual accessibility of the NetEase Web sites and the
performance and reliability of our technical infrastructure are critical to our
reputation and the ability of the NetEase Web sites to attract and retain users
and advertisers. Any system failure or performance inadequacy that causes
interruptions in the availability of our services or increases the response time
of our services could reduce user satisfaction and traffic, which would reduce
the NetEase Web sites' appeal to users and advertisers. As the number of NetEase
Web pages and traffic increase, we cannot assure you that we will be able to
scale our systems proportionately. In addition, any system failures and
electrical outages could materially and adversely impact our business.
16
Computer viruses may cause delays or interruptions on our systems and may reduce
visitor traffic and harm our reputation.
Computer viruses may cause delays or other service interruptions on our
systems. In addition, the inadvertent transmission of computer viruses could
expose us to a material risk of loss or litigation and possible liability. We
may be required to expend significant capital and other resources to protect the
NetEase Web sites against the threat of such computer viruses and to alleviate
any problems. Moreover, if a computer virus affecting our system is highly
publicized, our reputation could be materially damaged and our visitor traffic
may decrease.
Computer hacking could damage our systems and reputation.
Any compromise of security, such as computer hacking, could cause
Internet usage to decline. "Hacking" involves efforts to gain unauthorized
access to information or systems or to cause intentional malfunctions or loss or
corruption of data, software, hardware or other computer equipment. Hackers, if
successful, could misappropriate proprietary information or cause disruptions in
our service. We may have to spend significant capital and human resources to
rectify any damage to our system. In addition, we cannot assure you that any
measures we take against computer hacking will be effective. A well publicized
computer security breach could significantly damage our reputation and
materially adversely affect our business.
If our exclusive providers of bandwidth and server custody service fail to
provide these services, our business could be materially curtailed.
We rely on affiliates of China Netcom and China Telecom to provide us
with bandwidth and server custody service for Internet users to access the
NetEase Web sites. If China Netcom, China Telecom or their affiliates fail to
provide such services, we may not be able to find a reliable and cost-effective
substitute provider on a timely basis or at all. If this happens, our business
could be materially curtailed.
If our exclusive providers of bandwidth and server custody service increase
their prices, our results of operations would suffer.
NetEase Beijing and Guangzhou NetEase contract with affiliates of China
Netcom and China Telecom for bandwidth and server custody services. Pursuant to
our contractual arrangements with Guangzhou NetEase, we pay for bandwidth and
server custody service costs incurred by Guangzhou NetEase. We have no control
over the costs of the bandwidth and server custody services provided by China
Netcom, China Telecom or their affiliates. China Netcom or China Telecom or both
may increase the prices we pay for these services. If this happens, our
operating costs may be higher than we anticipate and our results of operations
would suffer.
If third party content providers fail to develop and maintain the content we
need, the NetEase Web sites could lose viewers and advertisers.
We rely on a number of third parties to create traffic and provide
content in order to make the NetEase Web sites more attractive to advertisers
and consumers. Third parties providing content to the NetEase Web sites include
both commercial content providers with which we have contractual relationships
and our registered community members who post articles and other content on the
NetEase Web sites. If these third parties fail to develop and maintain
high-quality content, the NetEase Web sites could lose viewers and advertisers.
Most of our contractual arrangements with third party content
17
providers are not exclusive and are short-term or may be terminated at the
convenience of either party. There can be no assurance that our existing
relationships with commercial content providers will result in sustained
business partnerships, successful service offerings, traffic on the NetEase Web
sites or revenues for us.
We may be held liable for information displayed on, retrieved from or linked to
the NetEase Web sites.
We may face liability for defamation, negligence, copyright, patent or
trademark infringement and other claims based on the nature and content of the
materials that are published on the NetEase Web sites. We are currently
defending a number of defamation claims against NetEase Beijing and are involved
in several intellectual property infringement claims or actions. We believe that
the amounts claimed in these actions, in the aggregate, are not material to our
business. However, these amounts may be increased for a variety of reasons as
the claims progress, and we and our affiliates could be subject to additional
defamation or infringement claims which, singly or in the aggregate, could have
a material adverse effect on our business and results of operations, if
successful. We also could be subject to claims based upon content that is
accessible on the NetEase Web sites such as content and materials posted by
users on message boards, online communities, voting systems, e-mail or chat
rooms that are offered on the NetEase Web sites. By providing technology for
hypertext links to third-party Web sites, we may be held liable for copyright or
trademark violations by those third party sites. Third parties could assert
claims against us for losses incurred in reliance on any erroneous information
distributed by us. Moreover, users of the NetEase Web-based e-mail services
could seek damages from us for:
. unsolicited e-mails;
. lost or misplaced messages;
. illegal or fraudulent use of e-mail; or
. interruptions or delays in e-mail service.
We may incur significant costs in investigating and defending these
claims, even if they do not result in liability.
We may be subject to product liability claims because of our e-commerce
services.
There is the potential for product liability, warranty, commodity fraud
and similar claims against us by users who purchase goods and services through
our e-commerce services. We do not carry insurance to cover these kinds of
claims.
Information displayed on, retrieved from or linked to the NetEase Web sites may
subject us to claims of violating Chinese laws.
Violations or perceived violations of Chinese laws arising from
information displayed on, retrieved from or linked to the NetEase Web sites
could result in significant penalties, including a temporary or complete
cessation of our business. Chinese government agencies have announced
restrictions on the transmission of "state secrets" through the Internet. The
term "state secrets" has been broadly interpreted by Chinese governmental
authorities in the past. We may be liable under these pronouncements for content
and materials posted or transmitted by users on message boards, virtual
communities, chat rooms or e-mails. The Ministry of National Security and the
Ministry of Public
18
Security have authority to cause any local Internet service provider to block
any Web site. These ministries have, in the past, stopped the online
distribution of information that they believed to be socially destabilizing or
politically improper. If the Chinese government takes any action to limit or
eliminate the distribution of information through the NetEase Web sites, or to
limit or regulate any current or future community functions available to users
or otherwise block the NetEase Web sites, our business would be significantly
harmed.
Privacy concerns may prevent us from selling demographically targeted
advertising in the future which could make the NetEase Web sites less attractive
to advertisers.
We collect demographic data, such as geographic location, income level and
occupation, from our registered users in order to better understand users and
their needs. We provide this data to online advertisers, on an anonymous
aggregate basis, without disclosing personal details such as name and home
address, to enable them to target specific demographic groups. If privacy
concerns or regulatory restrictions prevent us from collecting this information
or from selling demographically targeted advertising, the NetEase Web sites may
be less attractive to advertisers.
Security and confidentiality concerns may impede our e-commerce and other
services and our growth.
A significant barrier to e-commerce and our other fee-based services has
been public concern over security and privacy of confidential information
transmitted over the Internet. If this concern is not adequately addressed, it
may inhibit the growth of the Internet as a means of conducting commercial
transactions. In addition, China's regulation of encryption technology is still
evolving, and it is possible that such regulations may limit the methods of
encryption that we can employ. If a well-publicized breach of Internet security
were to occur, general Internet usage could decline, which could reduce traffic
to the NetEase Web sites and impede our growth.
We may not be able to adequately protect our intellectual property, and we may
be exposed to infringement claims by third parties.
We rely on a combination of copyright, trademark and trade secrecy laws and
contractual restrictions on disclosure to protect our intellectual property
rights. Our efforts to protect our proprietary rights may not be effective to
prevent unauthorized parties from copying or otherwise obtaining and using our
technology. Monitoring unauthorized use of our products is difficult and costly,
and we cannot be certain that the steps we take will effectively prevent
misappropriation of our technology.
From time to time, we may have to resort to litigation to enforce our
intellectual property rights, which could result in substantial costs and
diversion of our resources. In addition, third parties have initiated litigation
against us for alleged infringement of their proprietary rights, and additional
claims may arise in the future. In the event of a successful claim of
infringement and our failure or inability to develop non-infringing technology
or content or license the infringed or similar technology or content on a timely
basis, our business could suffer. Moreover, even if we are able to license the
infringed or similar technology or content, license fees that we pay to
licensors could be substantial or uneconomical.
If our subsidiaries are restricted from paying dividends to us, our primary
internal source of funds would decrease.
We are a holding company with no significant assets other than our equity
interests in NetEase Information Technology (Beijing) Co., Ltd., or NetEase
Beijing, our wholly owned subsidiary formed in 1999. As a result, our primary
internal source of funds is dividend payments from NetEase Beijing. If
19
NetEase Beijing incurs debt on its own behalf in the future, the instruments
governing the debt may restrict NetEase Beijing's ability to pay dividends or
make other distributions to us, which in turn would limit our ability to pay
dividends on our shares and ADSs or to make any required payments to holders of
our notes. Under current Chinese tax regulations, dividends paid to us are not
subject to Chinese income tax. In addition, Chinese legal restrictions permit
payment of dividends only out of net income as determined in accordance with
Chinese accounting standards and regulations. Under Chinese law, NetEase Beijing
is also required to set aside a portion of its net income each year to fund
certain reserve funds. These reserves are not distributable as cash dividends.
Risks Related to Doing Business in China
A slow-down in the Chinese economy may slow down our growth and profitability.
The growth of the Chinese economy has been uneven across geographic regions
and economic sectors. There can be no assurance that growth of the Chinese
economy will be steady or that any slow down will not have a negative effect on
our business. Several years ago, the Chinese economy experienced deflation,
which may reoccur in the foreseeable future. The Chinese economy overall affects
our profitability as expenditures for advertisements and e-commerce and other
services may decrease due to slowing domestic demand.
Government regulation of the Internet may become more burdensome.
Government regulation of the Internet industry is burdensome and may become
more burdensome. New regulations could increase our costs of doing business and
prevent us from efficiently delivering our products and services over the
Internet. These regulations may stop or slow down the expansion of our customer
and user base and limit the access to the NetEase Web sites. In addition to new
laws and regulations, existing laws not currently applicable to the Internet
industry may be applied to the Internet.
The uncertain legal environment in China could limit the legal protections
available to you.
The Chinese legal system is a civil law system based on written statutes.
Unlike common law systems, it is a system in which decided legal cases have
little precedential value. In the late 1970s, the Chinese government began to
promulgate a comprehensive system of laws and regulations governing economic
matters. The overall effect of legislation enacted over the past 20 years has
significantly enhanced the protections afforded to foreign invested enterprises
in China. However, these laws, regulations and legal requirements are relatively
recent and are evolving rapidly, and their interpretation and enforcement
involve uncertainties. These uncertainties could limit the legal protections
available to foreign investors, including you.
Changes in China's political and economic policies could harm our business.
The economy of China has historically been a planned economy subject to
governmental plans and quotas and has, in certain aspects, been transitioning to
a more market-oriented economy. Although we believe that the economic reform and
the macroeconomic measures adopted by the Chinese government have had a positive
effect on the economic development of China, we cannot predict the future
direction of these economic reforms or the effects these measures may have on
our business, financial position or results of operations. In addition, the
Chinese economy differs from the economies of most countries belonging to the
Organization for Economic Cooperation and Development, or OECD. These
differences include:
20
. economic structure;
. level of government involvement in the economy;
. level of development;
. level of capital reinvestment;
. control of foreign exchange;
. inflation rates;
. methods of allocating resources; and
. balance of payments position.
As a result of these differences, our business may not develop in the same
way or at the same rate as might be expected if the Chinese economy were similar
to those of the OECD member countries.
Restrictions on currency exchange may limit our ability to receive and use our
revenues effectively.
Because almost all of our future revenues may be in the form of Renminbi,
any future restrictions on currency exchanges may limit our ability to use
revenue generated in Renminbi to fund our business activities outside China or
to make dividend or other payments in U.S. dollars. Although the Chinese
government introduced regulations in 1996 to allow greater convertibility of the
Renminbi for current account transactions, significant restrictions still
remain. We cannot be certain that the Chinese regulatory authorities will not
impose more stringent restrictions on the convertibility of the Renminbi,
especially with respect to foreign exchange transactions.
Risks Related to the Internet Industry in China
Underdeveloped telecommunications infrastructure may limit the growth of the
Internet market in China.
The telecommunications infrastructure in China is not well developed.
Although private sector Internet service providers exist in China, almost all
access to the Internet is maintained through ChinaNet, which is owned in part by
each of China Telecom and China Netcom, under the administrative control and
regulatory supervision of China's Ministry of Information Industry. In addition,
the government's interconnecting national networks connect to the Internet
through a government-owned international gateway. This international gateway is
the only channel through which a domestic Chinese user can connect to the
international Internet network. We rely on this infrastructure and China Netcom
to provide data communications capacity primarily through local
telecommunications lines. Although the government has announced plans to develop
aggressively the national information infrastructure, we cannot assure you that
this infrastructure will be developed. In addition, we will have no access to
alternative networks and services, on a timely basis if at all, in the event of
any infrastructure disruption or failure. The Internet infrastructure in China
may not support the demands associated with continued growth in Internet usage.
21
The limited use of personal computers in China limits our pool of potential
customers and restricts the growth of our business.
The Internet penetration rate in China is, and is expected to continue to
be, lower than that in the United States and other developed countries.
Alternate methods of obtaining access to the Internet, such as through mobile
phones, cable television modems or set-top boxes for televisions, are not widely
available in China at present. There can be no assurance that the number or
penetration rate of personal computers in China will increase rapidly or at all
or that alternate means of accessing the Internet will develop and become widely
available in China. If significant numbers of Chinese consumers are unable to
access the Internet, our ability to grow our business would be impeded.
There has been a steady decrease in the rate of the growth of Internet users in
China which could limit the overall size of our market and adversely affect our
revenues.
While the number of Internet users in China has been growing since its
introduction and continues to grow currently, we believe that the rate of this
growth has slowed in recent years. We cannot predict whether this trend will
continue at its current pace or at all, and the factors which will affect future
growth in the Internet industry in China, as described elsewhere in these Risk
Factors, are largely beyond our control. If this trend does continue, our
potential market may not be as large as we had expected, and there will be even
greater competition for Internet users in China. In that case, our ability to
generate revenues from advertising, e-commerce and other services could be
adversely affected.
The relatively high cost of accessing the Internet in China limits our potential
customer base and restricts the growth of our business.
Our growth is limited by the relatively high cost to Chinese consumers of
obtaining the hardware, software and communications links necessary to connect
to the Internet in China. If the costs required to access the Internet do not
significantly decrease, most of China's population will not be able to afford to
use our services. The failure of a significant number of additional Chinese
consumers to obtain affordable access to the Internet would make it difficult to
grow our business.
We may be unable to compete successfully against new entrants and established
industry competitors.
The Chinese market for Internet content and services is intensely
competitive and rapidly changing. Barriers to entry are minimal, and current and
new competitors can launch new Web sites at a relatively low cost. Many
companies offer competitive products or services including Chinese
language-based Web search, retrieval and navigation services, wireless
value-added services, online games and extensive Chinese language content,
informational and community features and e-mail. In addition, as a consequence
of China joining the World Trade Organization, the Chinese government has
partially lifted restrictions on foreign-invested enterprises so that foreign
investors may hold in the aggregate up to 49% of the total equity ownership in
any value-added telecommunications business, including an Internet business, in
China. This percentage ceiling is to be increased to 50% by the second
anniversary of China's entry into the WTO.
Currently, our competition comes from Chinese language-based Internet
portal companies as well as U.S.-based portal companies. Some of our current and
potential competitors are much larger and better capitalized than we are, and
currently offer, and could further develop or acquire, content and services that
compete with the NetEase Web sites. We also face competition from online game
developers and operators, Internet service providers, wireless value-added
service providers, Web site operators and providers of Web browser software that
incorporate search and retrieval features. Any of our present or
22
future competitors may offer products and services that provide significant
performance, price, creativity or other advantages over those offered by us and,
therefore, achieve greater market acceptance than ours.
Because many of our existing competitors as well as a number of potential
competitors have longer operating histories in the Internet market, greater name
and brand recognition, better connections with the Chinese government, larger
customer bases and databases and significantly greater financial, technical and
marketing resources than we have, we cannot assure you that we will be able to
compete successfully against our current or future competitors. Any increased
competition could reduce page views, make it difficult for us to attract and
retain users, reduce or eliminate our market share, lower our profit margins and
reduce our revenues.
Risks Related to the Offering of These Securities
One shareholder will have significant control over the outcome of shareholder
votes after this offering.
As of September 30, 2003, our founder and Chief Architect, William Ding,
beneficially owned approximately 50% of our outstanding ordinary shares.
Assuming all the notes could be, and are, immediately converted into ordinary
shares at the conversion price set forth on the cover page of this prospectus,
he will beneficially own approximately 47% of our outstanding ordinary shares.
Accordingly, Mr. Ding will continue to have significant control over the outcome
of any corporate transaction or other matter submitted to our shareholders for
approval, including mergers, consolidations and the sale of all or substantially
all of our assets.
The price of our ADSs has been volatile historically and may continue to be
volatile, which may make it difficult for holders to resell the notes, ordinary
shares issuable upon conversion of the notes or ADSs representing such ordinary
shares when desired or at attractive prices.
The trading price of our ADSs has been and may continue to be subject to
wide fluctuations. During 2002, the closing sale prices of our ADSs on The
Nasdaq National Market ranged from $0.70 to $13.05 per share and the last
reported sale price on October 6, 2003 was $66.19 per share. Our ADS price may
fluctuate in response to a number of events and factors. In addition, the stock
market in general, and the market prices for Internet-related companies in
particular, have experienced extreme volatility that often has been unrelated to
the operating performance of such companies. These broad market and industry
fluctuations may adversely affect the price of our ADSs, regardless of our
operating performance. Because the notes are convertible into our ordinary
shares and our ADSs represent ordinary shares, volatility or depressed prices
for our ADSs could have a similar effect on the price of the notes and our
ordinary shares. In addition, the existence of the notes may encourage short
selling in our ADSs by market participants because the conversion of the notes
could depress the price of our ADSs.
An active trading market for the notes or the ordinary shares issuable upon
conversion does not yet exist and may never develop.
There currently is no active trading market for the notes or the ordinary
shares issuable upon conversion of the notes and there can be no assurance as
to:
. the liquidity of any market for the notes or ordinary shares that
may develop,
. the ability of the holders to sell their notes or ordinary shares,
or
23
. the prices at which holders of the notes or ordinary shares would be
able to sell their securities.
If active markets were to exist, the notes or ordinary shares issuable upon
conversion could trade at prices higher or lower than their initial purchase
prices depending on many factors. We do not intend to apply for listing of the
notes or ordinary shares issuable upon conversion on any securities exchange or
for quotation on The Nasdaq National Market.
Resales of the notes and our ordinary shares issuable upon conversion of the
notes are subject to significant restrictions, and you will have to satisfy
certain requirements in order to deposit any ordinary shares you receive upon
conversion of the notes for the issuance of ADSs.
The notes and our ordinary shares issuable upon conversion of the notes may
be offered or sold only if:
. an applicable exemption from the registration requirements of the
Securities Act and applicable state securities laws applies to the
circumstances of the sale; or
. a registration statement covering the resale of these securities is
filed with the SEC and declared effective.
Although we are required to register resales of the notes and our ordinary
shares issuable upon conversion of the notes for a period of time (and this
prospectus is a part of a registration statement filed by us to fulfill this
requirement), the registration statement may not be available to holders at all
times. In addition, selling securityholders may be subject to certain
restrictions and potential liability under the Securities Act. Further, although
a market currently exists on The Nasdaq National Market for our ADSs, each of
which currently represents 100 ordinary shares, you will be obligated to provide
certain information in order for you to deposit your ordinary shares for the
issuance of ADSs as may be required by The Bank of New York, which is the
depositary for the ADS program, to establish that the shares and the ADSs that
will be issued upon the deposit will not be subject to any transfer restrictions
as described under "Description of American Depositary Shares." Specifically,
The Bank of New York has informed us that it intends to require holders who wish
to deposit ordinary shares that may have been issued upon conversion of the
notes to provide evidence satisfactory to it that:
(i) the shares have been resold in a transaction that is effectively
registered under the above-referenced resale registration statement,
(ii) the shares have been resold in a transaction that complies with Rule
144 under the Securities Act or
(iii) the exemption provided by Rule 144(k) under the Securities Act is
available and we have removed the transfer restriction legend from
the share certificate at the holder's request.
Such holders may also be required to deliver a legal opinion to The Bank of
New York to that effect at their own expense. If you cannot deposit your
ordinary shares for the issuance of ADSs in connection with a resale because the
registration statement discussed above is not effective at the time, the value
and liquidity of your investment could be materially adversely affected.
24
Fluctuation in the exchange rate between the U.S. dollar and the Renminbi could
adversely affect the value of our ADSs, and therefore of the notes and the
ordinary shares issuable upon conversion, and any cash dividend declared on our
ordinary shares.
Fluctuations in the currency exchange rate between the U.S. dollar and the
Renminbi could adversely affect the U.S. dollar value of ADSs, and therefore of
the notes and the ordinary shares issuable upon conversion of the notes. Because
holders of our ordinary shares and ADSs may elect to receive cash dividends, if
any, in U.S. dollars, fluctuations in the exchange rate could also affect the
value of any cash dividend declared in Renminbi and paid in U.S. dollars. In
addition, because our revenues are primarily denominated in Renminbi, our
valuation could be materially and adversely impacted by the devaluation of the
Renminbi if U.S. investors analyze our value based on the U.S. dollar equivalent
of our financial condition and results of operations.
The notes are subordinated to any of our existing and future senior indebtedness
and are effectively subordinated to all liabilities of our subsidiaries.
Therefore, we may be unable to repay our obligations under the notes.
The notes will be unsecured and subordinated in right of payment in full to
all of our existing and future senior debt. Because the notes are subordinated
to our senior debt, in the event of:
(i) our liquidation or insolvency,
(ii) a payment default on our designated senior debt,
(iii) a covenant default on our designated senior debt (as defined in
"Description of Notes--Subordination of Notes"), or
(iv) acceleration of the notes due to an event of default,
we will make payments on the notes only after our senior debt has been paid in
full or, in the case of clause (3), the designated senior debt has not been
accelerated within 179 days. After paying our senior debt in full, we may not
have sufficient assets remaining to pay any or all amounts due on the notes.
Our subsidiaries are separate legal entities and have no obligation to make
any payments on the notes or make any funds available for payment on the notes,
whether by dividends, loans or other payments. The payment of dividends and the
making of loans and advances to us by our subsidiaries may be subject to
statutory or contractual restrictions and are dependent upon the earnings of our
subsidiaries. Our subsidiaries will not guarantee the payment of the notes. Our
right to receive assets of any of our subsidiaries upon their liquidation or
reorganization, and your right to participate in these assets, will be
effectively subordinated to the claims of that subsidiary's creditors.
Consequently, the notes will be effectively subordinated to all liabilities,
including trade payables, of any of our subsidiaries and any subsidiaries that
we may in the future acquire or establish, except to the extent that we are
recognized as a creditor of such subsidiary, in which case our claims would
still be subordinated to any security interests in the assets of such subsidiary
and any debt of such subsidiary senior to that held by us.
As of June 30, 2003, (i) we had no debt outstanding and total liabilities
of $6.0 million and (ii) our subsidiaries had no outstanding indebtedness, other
than intercompany indebtedness and other normal trade payables and liabilities.
Neither we nor our subsidiaries are prohibited or limited under the Indenture
for the notes from incurring debt or acting as guarantors of debt for others in
whom we or our subsidiaries may have an interest. Our ability to pay our
obligations on the notes could be adversely affected by our or our subsidiaries'
incurrence of indebtedness or other liabilities. We and our subsidiaries may
from time to
25
time incur indebtedness and other liabilities, including senior debt. See
"Description of Notes--Subordination of Notes."
We may not have the ability to repurchase the notes in cash if a holder
exercises its repurchase right on the dates specified in this prospectus or upon
the occurrence of a change of control or a delisting.
Holders of the notes have the right to require us to repurchase the notes
at certain specified dates and upon the occurrence of a fundamental change, such
as a change of control, or a delisting of our securities, prior to maturity as
described under the headings "Description of the Notes--Repurchase of Notes at
the Option of the Holder on Specified Dates," "Description of the
Notes--Repurchase at Option of a Holder Upon a Fundamental Change" and
"Description of the Notes--Repurchase at Option of a Holder Upon a Delisting
Event." We may not have sufficient funds to make the required repurchase in cash
at such time or the ability to arrange necessary financing on acceptable terms.
In addition, our ability to repurchase the notes in cash may be limited by law
or the terms of other agreements relating to our indebtedness outstanding at the
time. Our failure to repurchase tendered notes would constitute an event of
default under the Indenture for the notes, which might constitute a default
under any other debt we may have. In such circumstances, or if a fundamental
change would constitute an event of default under our senior indebtedness, the
subordination provisions of the Indenture would possibly limit or prohibit
payments to you.
The conditional conversion feature of the notes could result in you receiving
less than the value of the ordinary shares into which a note is convertible.
The notes are convertible into our ordinary shares only if specified
conditions are met. If the specific conditions for conversion are not met, you
will not be able to convert your notes, and you may not be able to receive the
value of the ordinary shares into which the notes would otherwise be
convertible.
Sales of a significant number of ADSs in the public market, or the perception of
such sales, could reduce the price of the notes and impair our ability to raise
funds in new security offerings.
Sales of substantial amounts of our ADSs in the public market after this
offering, or the perception that those sales may occur, could cause the market
price of our ADSs to decline. Because the notes are convertible into ordinary
shares only at a conversion price in excess of the reference price of our
ordinary shares determined based on the applicable ADS trading price, such a
decline in the market price of our ADSs may cause the value of the notes to
decline.
You may face difficulties in protecting your interests, and our ability to
protect our rights through the U.S. federal courts may be limited, because we
are incorporated under Cayman Islands law.
Our corporate affairs are governed by our memorandum and articles of
association and by the Companies Law (2003 Revision) and common law of the
Cayman Islands. The rights of our shareholders and the fiduciary
responsibilities of our directors under Cayman Islands law are not as clearly
established as they would be under statutes or judicial precedents in the United
States. In particular, the Cayman Islands has a less developed body of
securities laws as compared to the U.S., and provides significantly less
protection to investors. Therefore, our shareholders may have more difficulties
in protecting their interests in the face of actions by our management,
directors or controlling shareholders than would shareholders of a corporation
incorporated in a jurisdiction in the United States. In addition, Cayman Islands
companies may not have standing to sue before the federal courts of the United
States. As a result, our ability to protect our interests if we are harmed in a
manner that would otherwise enable us to sue in a United States federal court
may be limited.
26
USE OF PROCEEDS
The proceeds from the sale of the notes and the ordinary shares offered by
this prospectus are solely for the account of the selling securityholders named
in this prospectus. Accordingly, we will not receive any proceeds from the sale
of the notes or the ordinary shares offered by this prospectus.
PRICE RANGE OF AMERICAN DEPOSITARY SHARES
ADSs, each representing 100 of our ordinary shares, have been listed on The
Nasdaq National Market since June 30, 2000. Our ADSs trade under the symbol
"NTES." Trading in our ADSs was suspended by The Nasdaq National Market from
September 4, 2001 until January 2, 2002.
For the year ended December 31, 2000 (June 30, 2000 through December 31,
2000), the high and low price of our ADSs on Nasdaq has ranged from $17.25 to
$2.75. For the year ended December 31, 2001 (January 1, 2001 through September
4, 2001), the high and low price of our ADSs on Nasdaq has ranged from $3.28125
to $0.51. For the year ended December 31, 2002, the high and low price of our
ADSs on Nasdaq has ranged from $13.74 to $0.65.
The following table provides the high and low sale prices for our ADSs on
The Nasdaq National Market for (1) each quarter in the two most recent financial
years and the first two quarters of 2003 and (2) each of the most recent six
months. On October 6, 2003, the last reported sale price for our ADSs was $66.20
per ADS.
Sales Price
-------------------
High Low
--------- -------
Quarterly highs and lows
First Quarter 2001 $ 3.28125 $ 1.00
Second Quarter 2001 2.45 1.12
Third Quarter 2001 (until September 4, 2001) 1.55 0.52
Fourth Quarter 2001 Trading Suspended
First Quarter 2002 1.47 0.65
Second Quarter 2002 1.57 0.67
Third Quarter 2002 3.65 1.40
Fourth Quarter 2002 13.74 1.80
First Quarter 2003 17.90 10.10
Second Quarter 2003 37.35 14.34
Third Quarter 2003 69.20 33.90
Monthly highs and lows
April 2003 $ 23.40 $ 14.34
May 2003 33.80 21.00
June 2003 37.35 28.17
July 2003 52.21 33.90
August 2003 51.90 38.81
September 2003 69.20 50.80
27
EXCHANGE RATE INFORMATION
We have published our financial statements in Renminbi, or RMB. Our
business is currently conducted in and from China in Renminbi. In this annual
report, all references to Renminbi and RMB are to the legal currency of China
and all references to U.S. dollars, dollars, $ and US$ are to the legal currency
of the United States. The conversion of Renminbi into U.S. dollars in this
annual report is based on the noon buying rate in The City of New York for cable
transfers of Renminbi as certified for customs purposes by the Federal Reserve
Bank of New York. For your convenience, this annual report contains translations
of some Renminbi or U.S. dollar amounts for 2003 at US$1.00: RMB8.2776, which
was the prevailing rate on June 30, 2003. The prevailing rate on October 3, 2003
was US$1.00: RMB8.2770. We make no representation that any Renminbi or U.S.
dollar amounts could have been, or could be, converted into U.S. dollars or
Renminbi, as the case may be, at any particular rate, the rates stated below, or
at all. The Chinese government imposes control over its foreign currency
reserves in part through direct regulation of the conversion of Renminbi into
foreign exchange and through restrictions on foreign trade.
The following table sets forth the average buying rate for Renminbi
expressed as per one U.S. dollar for the years 1998, 1999, 2000, 2001 and 2002
and for the six months ended June 30, 2003.
-------------------------- ---------------------------------------
Period Renminbi Average/(1)/
------ ----------------
-------------------------- ---------------------------------------
1998 8.2969
-------------------------- ---------------------------------------
1999 8.2785
-------------------------- ---------------------------------------
2000 8.2784
-------------------------- ---------------------------------------
2001 8.2772
-------------------------- ---------------------------------------
2002 8.2772
-------------------------- ---------------------------------------
Six Months Ended 8.2772
June 30, 2003
-------------------------- ---------------------------------------
---------------
(1) Determined by averaging the rates on the last business day of each month
during the relevant period.
The following table sets forth the high and low exchange rates for Renminbi
expressed as per one U.S. dollar during the past six months.
-------------------------- ---------------------------------------
Renminbi Average
----------------
-------------------------- ---------------------------------------
Month Ended High Low
----------- ---- ---
-------------------------- ------------------- -------------------
April 30, 2003 8.2774 8.2769
-------------------------- ------------------- -------------------
May 31, 2003 8.2771 8.2768
-------------------------- ------------------- -------------------
June 30, 2003 8.2776 8.2768
-------------------------- ------------------- -------------------
July 31, 2003 8.2776 8.2768
-------------------------- ------------------- -------------------
August 31, 2003 8.2775 8.2766
-------------------------- ------------------- -------------------
September 30, 2003 8.2775 8.2768
-------------------------- ------------------- -------------------
28
DIVIDEND POLICY
We have never declared or paid any cash dividends on our ordinary shares,
but it is possible that we may declare dividends in the future. We have
historically retained earnings to finance operations and the expansion of our
business. Any future determination to pay cash dividends will be at the
discretion of the board of directors and will be dependent upon our financial
condition, operating results, capital requirements and such other factors as the
board of directors deems relevant. Our payment of certain dividends may cause an
adjustment to the number of ordinary shares or amount of cash you receive upon
conversion of the notes as described under "Description of Notes--Conversion
Rights."
29
CAPITALIZATION
The following table sets forth our capitalization as of August 31, 2003.
This table should be read in conjunction with "Selected Consolidated Financial
Data" and our financial statements and related notes, which are incorporated by
reference in this prospectus. The table below does not reflect any changes
occurring after August 31, 2003.
As of August 31, 2003
--------------------------------
(in RMB) (in US$)
(Unaudited) (Unaudited)
Cash and cash equivalents 1,536,489,096 185,629,089
============= ===========
Long-term liabilities:
Zero Coupon Convertible Subordinated Notes due July
15, 2023 827,720,000 100,000,000
Other long-term liabilities 316,315 38,215
------------- -----------
Total long-term liabilities 828,036,315 100,038,215
------------- -----------
Shareholders' equity/(1)/
Ordinary shares, US$0.0001 par value:
1,000,300,000 shares authorized, 3,122,519,189
shares issued and outstanding as of August 31, 2003 2,585,038 312,308
Additional paid-in capital 990,538,234 119,670,690
Deferred compensation (177,872) (21,489)
Translation adjustments 205,790 24,862
Accumulated deficit (243,889,597) (29,465,229)
------------- -----------
Total shareholders' equity 749,261,593 90,521,142
------------- -----------
Total capitalization 1,577,297,908 190,559,357
------------- -----------
______________
Note: Translations of amounts from RMB into U.S. dollars for the convenience of
the reader were calculated at the noon buying rate of US$1.00=RMB8.2772 as of
August 29, 2003 (the last business day of the month) in The City of New York for
cable transfers of RMB as certified for customs purposes by the Federal Reserve
Bank of New York. No representation is made that the RMB amounts could have
been, or could be, converted into United States dollars at that rate on August
29, 2003, or at any other rate.
(1) Outstanding ordinary shares does not include (i) options to purchase
176,999,300 ordinary shares outstanding under our stock option plan at a
weighted average exercise price of US$0.0871 per ordinary share, and 234,079,824
additional shares available for grant under our Amended and Restated 2000 Stock
Incentive Plan as of August 31, 2003 and (ii) 210,000,000 ordinary shares
reserved for issuance upon conversion of the notes.
30
SELECTED CONSOLIDATED FINANCIAL DATA
The following data for the six months ended June 30, 2002 and June 30, 2003
and as of December 31, 2002 and June 30, 2003 have been derived from our
unaudited condensed consolidated financial statements for the six months ended
June 30, 2002 and 2003 and our audited financial statements as of December 31,
2002, which, in our opinion, include all adjustments consisting of normal
recurring adjustments necessary for a fair presentation of the results of the
unaudited interim period, and should be read in conjunction with those
statements, which are included in this prospectus beginning on page F-1 and
incorporated by reference into this prospectus.
For the Six Months Ended
------------------------------------------------
June 30, June 30, June 30,
2002 2003 2003
------------- ------------- ------------
RMB RMB USD
(Unaudited) (Unaudited) (Unaudited)
(Note)
Statement of Operations Data:
Revenues:
E-commerce and other services 50,305,380 221,110,803 26,711,946
Advertising services 1,975,760 32,821,080 3,965,048
Software licensing and related integration projects 157,539 165,115 19,947
------------- ------------- ------------
Total revenues 62,438,679 254,096,998 30,696,941
Sales and value-added taxes (3,122,580) (12,704,850) (1,534,847)
------------- ------------- ------------
Net revenues 59,316,099 241,392,148 29,162,094
------------- ------------- ------------
Cost of revenue:
E-commerce and other services and advertising services (29,002,467) (42,104,054) (5,086,505)
Share compensation cost (954,064) - -
------------- ------------- ------------
Total cost of revenues (29,956,531) (42,104,054) (5,086,505)
------------- ------------- ------------
Gross profit 29,359,568 199,288,094 24,075,589
Operating expenses:
Selling, general and administrative expenses (44,164,828) (49,276,764) (5,953,025)
Asset impairment loss (746,857) - -
Research and development expenses (7,449,972) (8,286,157) (1,001,034)
Share compensation cost (1,243,421) (278,224) (33,612)
------------- ------------- ------------
Total operating expenses (53,605,078) (57,841,145) (6,987,671)
------------- ------------- ------------
Operating profit (loss) (24,245,510) 141,446,949 17,087,918
Other income (expenses):
Interest income 4,230,815 3,646,491 440,525
Interest expenses (1,209,117) - -
Other, net 3,468,434 5,673,376 685,389
------------- ------------- ------------
Profit (loss) before tax (17,755,378) 150,766,816 18,213,832
Income tax charge - (6,064,414) (732,630)
------------- ------------- ------------
31
Net profit (loss) (17,755,378) 144,702,402 17,481,202
--------------- --------------- --------------
Net earnings (loss) per share, basic (0.01) 0.05 0.01
--------------- --------------- --------------
Net earnings (loss) per ADS, basic (0.59) 4.64 0.56
--------------- --------------- --------------
Net earnings (loss) per share, diluted (0.01) 0.04 0.01
--------------- --------------- --------------
Net earnings (loss) per ADS, diluted (0.59) 4.47 0.54
--------------- --------------- --------------
Weighted average number of ordinary shares
outstanding, basic 3,033,407,311 3,118,601,020 3,118,601,020
--------------- --------------- --------------
Weighted average number of ADS outstanding,
basic 30,334,073 31,186,010 31,186,010
--------------- --------------- --------------
Weighted average number of ordinary shares
outstanding, diluted 3,033,407,311 3,237,539,818 3,237,539,818
--------------- --------------- --------------
Weighted average number of ADS outstanding,
diluted 30,334,073 32,375,398 32,375,398
--------------- --------------- --------------
________________
Note: The conversion of RMB into U.S. dollars is based on the noon buying rate
of USD1.00=RMB8.2776 on June 30, 2003 in The City of New York for cable
transfers of RMB as certified for customs purposes by the Federal Reserve Bank
of New York. No representation is made that the RMB amounts could have been, or
could be, converted into U.S. dollars at that rate on June 30, 2003, or at any
other rate.
As of
---------------------------------------------------------
December 31, June 30, June 30,
2002 2003 2003
--------------- --------------- --------------
RMB RMB USD
(Unaudited) (Unaudited)
(Note)
Balance Sheet Data:
Assets:
Current assets:
Cash 560,069,711 728,706,065 88,033,496
Restricted cash 1,208,305 1,217,622 147,098
Prepayments and other current assets 6,110,689 11,839,622 1,430,321
Due from related parties, net 22,448,509 8,063,540 974,140
--------------- --------------- --------------
Total current assets 589,837,214 749,826,849 90,585,055
Non-current rental deposit 1,065,912 1,273,337 153,829
Property, equipment and software, net 26,379,182 25,680,523 3,102,412
Deferred tax assets 2,395,888 9,387,280 1,134,058
--------------- --------------- --------------
Total assets 619,678,196 786,167,989 94,975,354
--------------- --------------- --------------
32
Liabilities & Shareholders' Equity:
Current liabilities:
Accounts payable 3,814,614 4,419,563 533,919
Salary and welfare payable 16,023,380 13,089,024 1,581,258
Taxes payable 8,252,950 19,900,665 2,404,159
Deferred revenue 165,115 - -
Accrued liabilities 10,398,385 12,319,852 1,488,336
--------------- --------------- --------------
Total current liabilities 38,654,444 49,729,104 6,007,672
--------------- --------------- --------------
Long-term payable - 316,315 38,213
--------------- --------------- --------------
Total liabilities 38,654,444 50,045,419 6,045,885
--------------- --------------- --------------
Shareholders' equity:
Ordinary shares, US$0.0001 par value:
1,000,300,000,000 shares authorized,
3,100,162,537 shares issued and outstanding
as of December 31, 2002, and 3,145,561,689
shares issued and outstanding as of June 30,
2003 2,566,543 2,604,111 314,597
Additional paid-in capital 1,049,651,354 1,059,750,050 128,026,246
Less: Subscriptions receivable (33,113,848) (33,113,848) (4,000,416)
Deferred compensation (474,739) (196,515) (23,741)
Translation adjustments 228,910 210,838 25,471
Accumulated deficit (437,834,468) (293,132,066) (35,412,688)
--------------- --------------- --------------
Total shareholders' equity 581,023,752 736,122,570 88,929,469
--------------- --------------- --------------
Total liabilities and shareholders' equity 619,678,196 786,167,989 94,975,354
--------------- --------------- --------------
_____________
Note: The conversion of RMB into U.S. dollars is based on the noon buying rate
of USD1.00=RMB8.2776 on June 30, 2003 in The City of New York for cable
transfers of RMB as certified for customs purposes by the Federal Reserve Bank
of New York. No representation is made that the RMB amounts could have been, or
could be, converted into U.S. dollars at that rate on June 30, 2003, or at any
other rate.
33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion regarding our unaudited consolidated financial
data should be read together with our unaudited condensed consolidated financial
statements and their related notes included in this prospectus and our
consolidated financial statements and related notes, "Operating and Financial
Review and Prospects" and "Selected Financial Data" incorporated by reference in
this prospectus. The following discussion contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, including, without limitation,
statements regarding our expectations, beliefs, intentions or future strategies
that are signified by the words "expect", "anticipate", "intend", "believe", or
similar language. All forward-looking statements included in this prospectus are
based on information available to us on the date hereof, and we assume no
obligation to update any such forward-looking statements. Actual results could
differ materially from those projected in the forward-looking statements. In
evaluating our business, you should carefully consider the information provided
under the caption "Risk Factors" in this prospectus. We caution you that our
businesses and financial performance are subject to substantial risks and
uncertainties.
Overview
NetEase is a leading Internet technology company in China. Our innovative
online communities and personalized premium services, which allow registered
users to interact with other community members, have established a large and
stable user base for the NetEase Web sites which are operated by our affiliate.
As of September 30, 2003, we had registered approximately 143.8 million
accounts, and our average daily page views exceeded 329.2 million for the month
ended September 30, 2003.
In the first half of 2003, we continued to develop our various fee-based
premium services and online entertainment services, including wireless
value-added services, online games, premium e-mail services for individual users
and other subscription-type products. Our fee-based revenue accounted for
approximately 87% of our total revenue for the six months ended June 30, 2003.
We also believe that advertising revenue will continue to be one of our
significant revenue sources for the foreseeable future, but we anticipate that
the revenue generated by these fee-based premium services and online
entertainment services will continue to constitute the major portion of our
future revenue.
We achieved a net profit of RMB144.7 million (US$17.5 million) for the six
months ended June 30, 2003 and generated positive operating cash flows of
RMB165.9 million (US$20.0 million) during that period. Our accumulated deficit
was reduced from RMB437.8 million (US$52.9 million) as of December 31, 2002 to
RMB293.1 million (US$35.4 million) as of June 30, 2003. These accumulated losses
have been funded principally with proceeds from the issuance of our American
Depositary Shares at our initial public offering, which was completed in July
2000, and our previous private share offerings.
Our Corporate Structure
NetEase.com, Inc. was incorporated in the Cayman Islands on July 6, 1999 as
an Internet technology company in China. As of June 30, 2003, we had four
directly wholly owned subsidiaries, NetEase Information Technology (Beijing)
Co., Ltd., or NetEase Beijing, NetEase Information Technology (Shanghai) Co.,
Ltd., or NetEase Shanghai, NetEase (U.S.) Inc., or NetEase US, and NetEase
Interactive Entertainment Limited, or NetEase Interactive, which has a direct
wholly owned subsidiary, Guangzhou NetEase Interactive Entertainment Limited, or
Guangzhou Interactive.
NetEase Beijing and NetEase Shanghai were established in China on August
30, 1999 and May
34
14, 2000, respectively. NetEase US was established in the United States of
America on September 10, 1999. NetEase Interactive was established in the
British Virgin Islands on April 12, 2002, and Guangzhou Interactive was
established in China on October 15, 2002.
As the exclusive Internet technology provider to Guangzhou NetEase Computer
System Co. Ltd., or Guangzhou NetEase, we provide a variety of Internet
applications, technologies and services to support Guangzhou NetEase's operation
of the NetEase Web sites and our e-commerce related services.
Guangzhou NetEase is a limited liability company organized under the laws
of China and is controlled and owned by our principal shareholder. Guangzhou
NetEase has been approved by the Chinese authorities to operate as an Internet
content provider and operates the NetEase Web sites. Guangzhou NetEase's 80%
owned subsidiary, Beijing Guangyitong Advertising Co., Ltd., or Guangyitong
Advertising, is licensed by the Chinese authorities to operate an advertising
business and engages in Internet-related advertising design, production and
dissemination.
We have entered into a series of contractual arrangements with Guangzhou
NetEase and Guangyitong Advertising with respect to the operation of the NetEase
Web sites and the provision of advertising services. Our services to Guangyitong
Advertising constitute the majority of our advertising-related operations.
NetEase US remained inactive during the six months ended June 30, 2003.
Revenues
Our total revenue increased from RMB62.4 million in the six months ended
June 30, 2002 to RMB254.1 million (US$30.7 million) in the six months ended June
30, 2003. We generate our revenue from e-commerce and other services,
advertising services and software licensing and related integration projects. In
mid-1998, we changed our business model from a software developer to an Internet
technology company. In July 1999, we began to offer e-commerce platforms and to
provide online auction services in China through Guangzhou NetEase, a related
party. Thereafter, we operated a co-branded auction Web site with EachNet which
was ultimately terminated in July 2002, at which time we restarted our own
online auction platform providing free auction services to our registered users
until June 2003. In 2001, we also began focusing on fee-based premium services
and online entertainment services, including wireless value-added services,
online games, premium e-mail services and other subscription-type products. Our
focus on these services continued throughout the first six months of 2003.
Other than revenue from our related parties, Guangzhou NetEase and
Guangyitong Advertising, no customer individually accounted for greater than 10%
of our total revenue for the first six months of 2003.
E-commerce and Other Services Revenue
We currently derive all our e-commerce and other services revenue from fees
earned pursuant to a series of agreements with Guangzhou NetEase, a related
party, under which we provide Internet portal and e-commerce technologies and
advertising services to Guangzhou NetEase in exchange for a service fee. The
service fee that we charge includes substantially all of the e-commerce and
other services revenue recognized by Guangzhou NetEase, net of a 5.5% business
tax and certain surcharges that apply to the revenues recognized by Guangzhou
Netease.
Guangzhou NetEase earns its e-commerce related services revenue from
wireless value-added services, online games and other fee-based premium
services.
35
Wireless Value-Added Services
Guangzhou NetEase receives wireless value-added services revenue which
are currently predominantly derived from activities related to short messaging
services (known as SMS). Guangzhou NetEase derives wireless value-added services
revenue principally from providing value-added services through SMS to users
such as friends matching, news and information services, ring-tone and logo
downloads and various other related products that mobile phone users can access
under co-operative arrangements between Guangzhou NetEase and two Chinese mobile
phone operators, China Mobile and China Unicom. Recently, there has been a
consolidation in the market for products and services for users of SMS,
resulting in an overall strengthening of competition in 2003. To maintain and
grow our position in this market, we intend to continue improving our existing
products and services and developing new ones, but these efforts may not be
successful.
We are also focusing on developing products and services that can be
utilized in emerging wireless technologies. For example, beginning in July 2002,
Guangzhou NetEase also derived wireless value-added services revenue under a
separate cooperative arrangement with each of the Chinese mobile phone operators
by providing wireless application protocol (known as WAP) services to mobile
phone users with phones using the General Packet Radio Service (known as GPRS)
or CDMA1X wireless standards. More recently, in April 2003, we started to offer
products and services for users of multi-media messaging services (known as MMS)
under an additional co-operative agreement with one of the Chinese mobile phone
operators. We expect that our revenue derived from new services we develop that
are compatible with these and other new wireless technologies will represent a
larger portion of our wireless value-added services revenue in the future as
these new technologies become more widely available. However, we cannot be
certain that these new technologies or the products and services we develop for
them will be successful, and we expect to see increasing competition in this
area.
Online Games
Guangzhou NetEase receives all its online games revenue from its
customers through the sale of prepaid point cards. Customers can purchase
prepaid point cards in different locations in China, including Internet cafes,
convenience stores, supermarkets and bookstores, etc. Customers can register
their point cards in our system and use the points in the cards to play our
massively multi-player online role-playing games and use our other fee-based
services. We develop our own proprietary massively multi-player online
role-playing games, as well as license games from third party developers. We
expect that we will face continued competition as online game providers, mainly
from South Korea and to a lesser extent from the U.S., expand their presence in
this market or enter it for the first time.
Other Fee-Based Premium Services
Other fee-based premium services include premium e-mail, friends
matching and dating services, personal homepage hosting and online shopping
mall.
Advertising Services Revenue
We derive all our advertising services revenue from fees we earn from
Guangyitong Advertising, a related party, for services that we provide in
connection with advertisements placed on the NetEase Web sites and
advertising-related technical consulting services. We have entered into an
agreement with Guangyitong Advertising under which we are the exclusive provider
of advertising-related technical consulting services to Guangyitong Advertising
and under which we receive a service fee. The service fee that we charge
includes substantially all of the advertising revenue of Guangyitong Advertising
less all of
36
the accrued expenses incurred by Guangyitong Advertising, and net of a 5%
business tax, a 3% cultural development fee and certain surcharges that apply to
these revenues.
Software Licensing and Related Integration Projects Revenue
In the six months ended June 30, 2003, this category of revenue
included certain corporate solution services to a customer in connection with
the purchase of servers and computer equipment, development of software and
custody and maintenance of servers.
Although we continue to perform occasional corporate solutions services
for customers upon request, we expect this category of revenue to remain
immaterial to our business.
Cost of Revenues
E-commerce and Other Services and Advertising Services Costs
E-commerce and other services and advertising services costs represent
those direct costs for operating the NetEase Web sites, which consist primarily
of server custody and bandwidth fees, content fees, staff costs, share
compensation cost, depreciation and amortization of computers and software and
other direct costs.
NetEase Beijing, NetEase Shanghai and Guangzhou NetEase lease bandwidth
from China Telecom and China Netcom affiliates. NetEase Beijing and Guangzhou
NetEase have network servers co-located in facilities owned by China Telecom's
and China Netcom's affiliates, for which they pay custody fees to China Telecom
and China Netcom. In addition, as a result of our arrangements with Guangzhou
NetEase, we also pay for Guangzhou NetEase's bandwidth lease payments and server
custody fees on a monthly basis. These costs are recognized in full as incurred.
Staff costs consist primarily of compensation expenses for our
e-commerce and editorial professionals and also for our staff in our online
games business department, in particular, a group of employees known as the
"Game Masters" who are responsible for the daily co-ordination and regulation of
the activities inside our games' virtual worlds.
We depreciate our computer equipment, software and other assets (other
than leasehold improvements) on a straight-line basis over their estimated
useful lives, which range from two to five years.
Software Licensing and Related Integration Projects Costs
We did not incur any direct costs relating to software licensing and
related integration projects in the six months ended June 30, 2003 and 2002.
Operating Expenses
Operating expenses include selling, general and administrative expenses
and research and development expenses.
37
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of
marketing and advertising; salary and welfare expenses and share compensation
costs; office rental; recruiting expenses; travel expenses and depreciation
charges. We depreciate leasehold improvements, which are included in our
operating expenses, on a straight-line basis over the lesser of the relevant
lease term or their estimated useful lives.
Research and Development Expenses
Research and development expenses consist principally of compensation
for our research and development professionals.
Share Compensation Cost
In December 1999, we adopted a stock incentive plan, called the 1999
Stock Option Plan, for our employees, senior management and advisory board. In
2000, we replaced the 1999 Stock Option Plan with a new stock option plan,
called the 2000 Stock Option Plan. The 2000 Stock Option Plan was subsequently
amended and restated in May 2001. During the six months ended June 30, 2003, we
granted options to our employees and certain members of our senior management
under the 2000 Stock Option Plan. The vesting period for these options is four
years. In addition, certain of the options granted were cancelled as a result of
the resignation of these personnel.
For the six months ended June 30, 2003, we recorded share compensation
cost of approximately RMB0.3 million (US$33,612). This cost has been allocated
to (i) selling, general and administrative expenses and (ii) research and
development expenses, depending on the functions for which these personnel and
employees are responsible. The significant reduction in the share compensation
costs recorded for the six months ended June 30, 2003 as compared to the same
period in 2002 was due to the fact that the deferred compensation costs arising
from the share grants to certain members of senior management of the Company and
the share transfers from the principal shareholder to certain members of senior
management and employees of the Company during the years 1999 and 2000 were
fully amortized in accordance with the related vesting periods of the share
grants and share transfers by the end of 2002.
As of June 30, 2003, deferred compensation cost relating to share
option grants in the six months ended June 30, 2003 or prior years amounted to
RMB0.2 million (US$23,741), which is to be amortized and charged to expense in
subsequent periods. We may also incur additional share compensation cost in the
remainder of 2003 as a result of the possible recruitment of additional
management personnel and the granting of new share options to these personnel
and other members of our staff.
Income Taxes
Under the current laws of the Cayman Islands, we are not subject to tax
on income or capital gain. However, our revenues are primarily derived from our
Chinese subsidiaries. Chinese companies are generally subject to a 30% national
enterprise income tax, or EIT, and a 3% local income tax. Our subsidiary,
NetEase Beijing, received the relevant approval to be recognized as a "New and
High Technology Enterprise". According to the approval granted by the Haidian
State Tax Bureau in November 2000, NetEase Beijing is entitled to a reduced EIT
rate of 15% commencing from the year 2000. In addition, the approval also
granted NetEase Beijing with a full exemption from EIT from 2000 to 2002, a 50%
reduction in EIT from 2003 to 2005, and a full exemption from the local tax from
2000 onwards. However, these preferential tax treatments may be subject to
review by higher authorities. If these preferential tax treatments were not
available to NetEase Beijing, then it would be subject to the
38
normal tax rate of 30% EIT and a 3% local tax.
NetEase Shanghai is subject to EIT at the rate of 30% plus a local tax of
3%.
Guangzhou Interactive is entitled to a reduced EIT rate of 15% from 2003 to
2004 but will be subject to EIT rate of 30% plus a local tax rate of 3% from
2005 onward.
Guangzhou NetEase and Guangyitong Advertising are Chinese domestic
enterprises and are generally subject to a 33% EIT. However, Guangzhou NetEase
was categorized as a small-sized tax payer by the local tax bureau of Guangzhou,
China. According to the relevant tax circulars issued by the local tax bureau of
Guangzhou, Guangzhou NetEase is subject to different EIT rates depending on the
nature of its taxable revenues.
If the activities of NetEase.com, Inc. constitute a permanent
establishment in China, the income it earns in China would also be subject to a
30% EIT and 3% local income tax. Income of our company that is not connected to
a permanent establishment in China would be subject to a 10% withholding tax on
gross receipt from profit, interest, rentals, royalties and other income earned
in China. Dividends from NetEase Beijing to our company are exempt from Chinese
withholding tax.
We are subject to a business tax on our revenues derived from services
which is generally 5%. In addition, we are subject to a value-added tax ranging
from 6% to 17% for revenues we earn from the sale of computer hardware purchased
on behalf of our customers. We did not incur any value-added tax during the six
months ended June 30, 2003. Our effective value-added tax rate was 6% during the
six months ended June 30, 2002. In addition, Guangyitong Advertising is subject
to a cultural development fee at 3% on its Internet advertising fees, which
effectively reduces the revenues we derive from Guangyitong Advertising.
Subject to the approval of the relevant tax authorities, we had total
tax loss carryforwards of approximately RMB41.8 million (US$5.0 million) as of
June 30, 2003 for EIT purposes. Approximately RMB0.2 million (US$24,434),
RMB29.5 million (US$3.6 million) and RMB12.1 million (US$1.5 million) of such
losses will expire in 2005, 2006 and 2007, respectively.
The above tax loss carryforwards give rise to potential deferred tax
assets totaling RMB9.4 million (US$1.1 million). As noted below under "Critical
Accounting Policies and Estimates", a valuation allowance has been provided to
partly offset potential deferred tax assets due to the uncertainty surrounding
the realizability of such assets.
Critical Accounting Policies and Estimates
The preparation of financial statements often requires the selection of
specific accounting methods and policies from several acceptable alternatives.
Further, significant estimates and judgments may be required in selecting and
applying those methods and policies in the recognition of the assets and
liabilities in our consolidated balance sheet, the revenues and expenses in our
consolidated statement of operations and the information that is contained in
our significant accounting policies and notes to the consolidated financial
statements. Management bases its estimates and judgments on historical
experience and various other assumptions that are believed to be reasonable
under the circumstances. Actual results may differ from these estimates and
judgments under different assumptions or conditions.
We believe that the following are some of the more critical judgment
areas in the application of our accounting policies that affect our financial
condition and results of operation.
39
Critical Accounting Policies and Estimates Regarding Revenue Recognition
E-commerce and Other Services Revenue
Since December 1999, we have recognized e-commerce and other services
revenue that we earn through our arrangements with Guangzhou NetEase as the
services are rendered and the services revenues are earned under the e-commerce
and other services agreements, which is the same time Guangzhou NetEase
recognizes such revenue.
SMS and Other Wireless Value-Added Services
Wireless value-added services revenue, which represents Guangzhou
NetEase's share of the revenues under its cooperative arrangements with China's
two mobile phone operators, is recognized by us primarily based on monthly
statements received from those operators. The revenue is recognized net of the
mobile phone operators' share of revenue and uncollectible amounts because we
consider those operators to be the primary obligors in the information
transmission and delivery process which is a critical and integral part of our
wireless value-added services. In addition, this revenue recognition approach is
supported by the fact that the mobile phone operators must approve all products
and services pricing and they have significant influence over other terms under
our co-operative arrangements with them. Uncollectible amounts mainly represent
the mobile phone operators' transmission and billing problems resulting from
technical issues with their systems. We are unable to estimate or separately
confirm the amount of uncollectibles which is reflected in any particular
monthly statement and are totally reliant on the information provided by the
mobile phone operators in their monthly statements for purposes of our record
keeping.
Online Games
We recognize revenue at the time when the points on our prepaid point
cards are consumed and services are provided.
Other Fee-Based Premium Services
We recognize revenue for these services ratably over the period when
the services are provided, except in the case of the following services:
Online Shopping Mall - Guangzhou NetEase launched our online
shopping mall platform in July 2000. As of June 30, 2003, this
online shopping mall had 12 "online stores" operated by merchant
tenants. From the fourth quarter of 2001, most online stores pay
Guangzhou NetEase fixed service fees, which Guangzhou NetEase
recognizes ratably over the period of the leases of the e-commerce
platforms. Additionally, a small portion of the online stores pay
Guangzhou NetEase commissions based on that merchant's revenues
which are recognized on a monthly basis. Prior to 2002, we also
received referral fees from online shopping mall partners of the
NetEase Web sites which Guangzhou NetEase recognized when services
were rendered. As of June 30, 2003, there were no active referral
arrangements for which we were recognizing revenue, but we are
currently seeking to enter into new referral arrangements.
Online Auction - Prior to October 2000, Guangzhou NetEase earned
revenues from services to online auction sellers, whether
businesses or consumers, which Guangzhou NetEase recognized
ratably over the relevant period. In October 2000, we established
a co-branded online trading and auction channel in partnership
with EachNet. On June 25, 2002, we entered into an agreement with
EachNet to terminate
40
our strategic co-operation agreement and the co-branded Web site.
We earned both fixed upfront fees and referral fees from EachNet
during the period of co-operation. In July 2002, we re-started our
own online auction platform providing free services to our
registered users after the termination of the co-branded Web site
with EachNet, but we discontinued such services in June 2003.
Advertising Services Revenue
Since December 1999, we have recognized advertising services revenue
that we earn through our arrangement with Guangyitong Advertising as services
are rendered and the service revenues are earned under the advertising
agreements, which is the same time Guangyitong Advertising recognizes such
revenue.
Guangyitong Advertising derives its advertising fees principally from
short-term advertising contracts, though recently we have seen an increasing
number of advertisers who are willing to enter into long-term contracts.
Revenues from advertising contracts are generally recognized ratably over the
period in which the advertisement is displayed and collection of the resulting
receivables is probable. Guangyitong Advertising's obligations to the
advertisers have traditionally also included guarantees of a minimum number of
impressions or times that an advertisement appears in pages viewed by users.
These types of advertising contracts are known as CPM contracts. As a result, to
the extent that minimum guaranteed impressions were not met within the
contractual time period, Guangyitong Advertising deferred recognition of the
corresponding revenues until the remaining guaranteed impression levels were
achieved. In 2002, we began focusing on entering into advertising contracts
which fees are based on the actual time period that the advertisements appear on
the NetEase Web sites rather than based on guaranteed minimum impressions. This
transition is largely complete, and Guangyitong Advertising currently has only a
few CPM contracts in effect. However, it has entered into several "cost per
action" advertising contracts (known as CPA contracts) whereby revenue is
received by Guangyitong Advertising when an online user performs a specific
action such as purchasing a product from or registering with the advertiser.
Revenue for CPA contracts is recognized when the specific action is completed.
In the six months ended June 30, 2003, CPA contracts represented only a small
portion of our advertising revenue, and we expect that CPA contracts will
continue to represent a small portion of our advertising revenue in the
near-term.
There was no revenue and expense derived from barter transactions in
the six months ended June 30, 2003 or the six months ended June 30, 2002. We
engaged in certain advertising barter transactions in the six months ended June
30, 2002 and the six months ended June 30, 2003, for which the fair value is not
determinable within the limits of EITF Issue No. 99-17, and therefore no
revenues or expenses derived from these barter transactions were recognized.
These transactions primarily involved exchanges of advertising services rendered
by us for advertising, promotional benefits and information content provided by
the counterparties.
Software Licensing and Related Integration Projects
For the corporate solution services we provided in the six months ended
June 30, 2003, the revenue was recognized at the completion of the respective
services.
Other Critical Accounting Policies and Estimates
Deferred Tax Valuation Allowance
Management judgment is required in determining our provision for income
taxes, deferred tax
41
assets and liabilities and the extent to which deferred tax assets can be
recognized. We make a valuation allowance to reduce deferred tax assets to the
amount which is more likely than not to be realized. There can be no assurance
that we will be able to utilize all the net operating loss carryforwards before
their expiration.
Allowances for Doubtful Accounts
We maintain allowances for doubtful accounts receivable based on
various types of information, including aging analysis of accounts receivable
balances, historical bad debt rates, repayment patterns and credit worthiness of
customers and industry trend analysis. We also make specific provisions for bad
debts if there is strong evidence showing that the debts are likely to be
irrecoverable.
Litigation Reserve
No material litigation reserve existed as of June 30, 2003 because
management believed, and continues to believe, that the ultimate resolution of
the claim described below under the heading "Outstanding Litigation and
Contingent Liabilities" will not result in any material financial impact on our
company.
Material Commitments
As of June 30, 2003, we had lease commitments for office rentals of
RMB2.9 million (US$0.3 million), RMB5.8 million (US$0.7 million) and RMB3.7
million (US$0.5 million) payable in the second half of 2003 and in 2004 and
2005, respectively. In addition, we had lease commitments for server custody
fees of RMB3.8 million (US$0.5 million) payable in the second half of 2003.
Outstanding Litigation and Contingent Liabilities
In January 2003, Guangzhou NetEase was named in a copyright
infringement lawsuit in China, and the plaintiffs have claimed damages of US$1.0
million. We intend to vigorously defend our position and believe the ultimate
resolution of the matter will not have a material financial impact on our
company.
Repurchase of Shares
On July 4, 2003, the Company entered into an agreement with affiliates
of The News Corporation Limited ("Newscorp") to repurchase 27,142,000 ordinary
shares of the Company held by one of Newscorp's affiliates. The transaction was
completed in July 2003. Under the agreement, the Company paid Newscorp a net
aggregated amount of approximately US$4.6 million andthe right of Newscorp and
its affiliates to a certain amount of advertising on NetEase's websites which
had been granted under a strategic cooperation agreement between the parties was
waived. In accordance with the agreement, the Company is entitled to use US$2
million worth of advertising on Asian television properties of Newscorp at no
additional cost until March 28, 2004 or such other date as the parties shall
agree.
42
Consolidated Results of Operations
The following table sets forth a summary of our unaudited consolidated
statements of operations for the periods indicated both in Renminbi and as a
percentage of total revenues:
For the Six Months Ended
--------------------------------------------------------
June 30, 2002 June 30, 2003
--------------------------------------------------------
RMB % RMB %
Revenues:
E-commerce and other services 50,305,380 80.6 221,110,803 87.0
Advertising services 11,975,760 19.2 32,821,080 12.9
Software licensing and related
integration projects 157,539 0.2 165,115 0.1
------------------ ---------- ---------------- ------
Total revenues 62,438,679 100.0 254,096,998 100.0
Sales and value-added taxes (3,122,580) (5.0) (12,704,850) (5.0)
------------------ ---------- ---------------- ------
Net revenues 59,316,099 95.0 241,392,148 95.0
------------------ ---------- ---------------- ------
Cost of revenues:
E-commerce and other services and
advertising services (29,002,467) (46.4) (42,104,054) (16.6)
Share compensation cost* (954,064) (1.5) - -
------------------ ---------- ---------------- ------
Total cost of revenues (29,956,531) (47.9) (42,104,054) (16.6)
------------------ ---------- ---------------- ------
Gross profit 29,359,568 47.1 199,288,094 78.4
------------------ ---------- ---------------- ------
Operating expenses:
Selling, general and administrative
expenses (44,164,828) (70.7) (49,276,764) (19.4)
Assets impairment loss (746,857) (1.2) - -
Research and development expenses (7,449,972) (11.9) (8,286,157) (3.3)
Share compensation cost* (1,243,421) (2.0) (278,224) (0.1)
Class action settlement
------------------ ---------- ---------------- ------
Total operating expenses (53,605,078) (85.8) (57,841,145) (22.8)
------------------ ---------- ---------------- ------
Operating profit (loss) (24,245,510) (38.7) 141,446,949 55.6
Other income (expenses):
Interest income 4,230,815 6.8 3,646,491 1.4
Interest expense (1,209,117) (1.9) - -
Other, net 3,468,434 5.6 5,673,376 2.2
------------------ ---------- ---------------- ------
Profit (loss) before tax (17,755,378) (28.2) 150,766,816 59.2
Income tax charge - - (6,064,414) (2.4)
------------------ ---------- ---------------- ------
Net profit (loss) (17,755,378) (28.2) 144,702,402 56.8
* Share compensation cost
E-commerce and other services and
advertising services cost of revenues (954,064) (1.5) - -
Selling, general and administrative
expenses (1,043,825) (1.7) (189,988) (0.07)
Research and development expenses (199,596) (0.3) (88,236) (0.03)
------------------ ---------- ---------------- ------
Total (2,197,485) (3.5) (278,224) (0.1)
================== ========== ================ ======
43
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Revenues
Total revenues increased by 307.2% to RMB254.1 million (US$30.7
million) in the six months ended June 30, 2003 from RMB62.4 million in the six
months ended June 30, 2002.
Revenues from e-commerce and other services increased by 339.5% to
RMB221.1 million (US$26.7 million) in the six months ended June 30, 2003 from
RMB50.3 million in the six months ended June 30, 2002, as a result of the
substantial increase in revenue generated from our wireless value-added services
and our online games. In addition, revenues from our other fee-based services,
including dating and friends matching, e-mail services and other premium
services, also increased during the first half of 2003.
Wireless Value-Added Services and Other Fee-Based Premium Services -
The substantial increase in revenue generated from our wireless
value-added services was primarily due to the increase in the overall
popularity of SMS in China and in the range and popularity of our
proprietary products and services among the expanding population of
mobile phone users in China. We started the development of our wireless
business in 1999 and launched our SMS.163.com Web page and first
fee-based services in February 2001. At that time, the number and
variety of products and services offered were very limited and included
ring-tone and logo downloading and a few other services. As of June 30,
2003, we offered more than 200 different products and services, which
can be classified into four main categories, namely, news and
information subscription, multi-media downloading, community and
communication and Internet-related products and services.
The increase in revenue in the first half of 2003 as compared to the
first half of 2002 from our other fee-based premium services (excluding
online games), including premium e-mail, dating and friends matching
and personal homepage hosting, was primarily due to the increase in the
number of paying subscribers of our other fee-based services.
Our wireless value-added services and other fee-based premium services
together represented approximately 67.2% (first half of 2002: 96.3%) of
our total e-commerce and other services revenue in the first half of
2003. The major portion of this amount was derived from our wireless
value-added services in both 2002 and 2003.
Online Games - The substantial increase in the revenue generated from
our online games was due to launch of two titles in August 2002,
primarily our in-house developed game "Westward Journey Online Version
2.0" and to a lesser extent "PristonTale". Online games accounted for
approximately 32.8% (first half of 2002: 3.7%) of our total e-commerce
and other services revenue in the first half of 2003.
Advertising services revenues increased by 174.1% to RMB32.8 million
(US$4.0 million) in the six months ended June 30, 2003 from RMB12.0 million in
the six months ended June 30, 2002, primarily as a result of the expansion of
our sales staff from 27 employees to 35 employees and a general increase in
demand for online advertising in China during 2002. In particular, we gained
several new China-based advertising clients, including leading mobile phone and
car manufacturers, and were able to increase the number of advertising contracts
which are long-term (one year or more) in late 2002 and early 2003. Average
revenue per advertiser increased from approximately RMB82,000 (US$10,000) in the
six months ended June 30, 2002 to RMB115,000 (US$14,000) in the six months ended
June 30, 2003. The number of contracted advertisers using the NetEase Web sites
increased from 185 in the six months ended June 30, 2002 to 285 in the six
months ended June 30, 2003, with revenues from our top ten advertisers
44
comprising 23.0% of our total advertising services revenues in the six months
ended June 30, 2003 as compared to 38.4% in the six months ended June 30, 2002.
We expect that the online advertising market in China will continue to grow as
Internet usage in China increases and as more companies, in particular
China-based companies in a variety of industries, accept the Internet as an
effective advertising medium. Based on our recent experience, we also expect
that as advertisers generally become more familiar with online advertising, they
will be increasingly willing to enter into longer term contracts of up to six
months or more.
In the six months ended June 30, 2003, software licensing and related
integration projects revenue included certain corporate solution services to a
customer in connection with the purchase of servers and computer equipment,
development of software and custody and maintenance of servers. We cannot
predict whether we will continue to earn revenues from similar transactions in
the foreseeable future, but we expect that we will provide these or other
similar services to customers upon request. Such revenue totaled RMB0.2 million
(US$19,947) in the six months ended June 30, 2003, which was consistent with the
level of revenue for the six months ended June 30, 2002.
Cost of Revenues
Our cost of revenues increased by 40.6% to RMB42.1 million (US$5.1
million) in the six months ended June 30, 2003 from RMB30.0 million in the six
months ended June 30, 2002, primarily due to the growth of our online games
business. A significant portion of this increase was due to franchise and
revenue share fees related to the "PristonTale" and "Westward Journey Online"
games and, to a lesser extent, increased staff costs of our online games team.
As a result of the strong revenue growth, we achieved a gross profit of
RMB199.3 million (US$24.1 million) in the six months ended June 30, 2003 as
compared to a gross profit of RMB29.4 million in the six months ended June 30,
2002. Our gross margins increased from 30.8% in the first quarter of 2002 to
78.9% in the second quarter of 2003. The significant improvement in gross
margins was driven by economies of scale as the growth in revenue outpaced the
concurrent increase in cost of revenues. The gross margin for the six months
ended June 30, 2003 was 78.4%.
Franchise and revenue share fees costs related to the online games
comprised 8.3% of our total cost of revenues (totaling RMB3.5 million) in the
six months ended June 30, 2003, compared with 0.5% (totaling RMB0.2 million) in
the six months ended June 30, 2002. The increase was mainly due to the addition
of new titles and increased usage of the online games. We expect that franchise
and revenue share fees as a percentage of our total cost of revenues will
continue to increase in the near-term.
Staff costs consisted primarily of compensation expenses for our online
game and other e-commerce and editorial professionals and comprised 24.0% of our
total cost of revenues (totaling RMB10.1 million) in the six months ended June
30, 2003, compared with 27.2% (totaling RMB8.2 million) in the six months ended
June 30, 2002. The increase in costs was mainly due to the increase in the
number of employees during the second half of 2002 and first half of 2003, in
particular for the online games business department, which increased from 73
employees to 98 employees. We expect that staff costs as a percentage of our
total cost of revenues will continue to decrease in the near-term due to the
greater increase in the franchise and revenue share fees related to the online
games.
Operating Expenses
Total operating expenses increased by 7.9% to RMB57.8 million (US$7.0
million) in the six months ended June 30, 2003 from RMB53.6 million in the six
months ended June 30, 2002. Operating expenses as a percentage of total revenues
decreased from 85.9% in the six months ended June 30, 2002
45
to 22.8% in the six months ended June 30, 2003. The increase in total operating
expenses in the six months ended June 30, 2003 was mainly due to increased
selling, general and administrative expenses.
Selling, general and administrative expenses increased by 11.6% to
RMB49.3 million (US$6.0 million) in the six months ended June 30, 2003 from
RMB44.2 million in the six months ended June 30, 2002, primarily due to the
increase in staff costs of approximately RMB8.4 million (US$1.0 million) and
marketing cost of approximately RMB2.5 million (US$0.3 million), offset
partially by the decrease in professional fees of RMB6.6 million (US$0.8
million).
The asset impairment loss in 2002 represented the unamortised portion
of the costs incurred in the acquisition of an electronic payment gateway system
which we ceased using.
Research and development expenses increased by 11.2% to RMB8.3 million
(US$1.0 million) in the six months ended June 30, 2003 from RMB7.4 million in
the six months ended June 30, 2002, primarily due to an increase in the number
of programmers and technicians recruited to assist our online games business
during the period.
Other Income (Expenses)
Other income and expenses in the six months ended June 30, 2003 mainly
consisted of a write back of a provision for subscription receivables of
approximately RMB5.7 million (US$0.7 million) and interest income of RMB3.7
million (US$0.5 million). Other income and expenses in the six months ended June
30, 2002 mainly consisted of a write back of certain provisions for expenses and
claims payable for certain arbitration of RMB3.7 million, and interest income
and expenses of RMB4.2 million and RMB1.2 million, respectively. We repaid
RMB84.0 million in short-term bank borrowings during the year ended December 31,
2002, and as a result, both our interest income and interest expenses dropped
significantly in the six months ended June 30, 2003 as compared to the six
months ended June 30, 2002. The decrease in the net interest income in the six
months ended June 30, 2003 as compared with the six months ended June 30, 2002
was also due to the reduction of interest rates during the period.
Liquidity and Capital Resources
Our capital requirements relate primarily to financing:
. our working capital requirements, such as bandwidth and server
custody fees, staff costs, sales and marketing expenses and
research and development, and
. costs associated with the expansion of our business, such as the
purchase of servers.
Operating Activities
Cash provided by operating activities was RMB165.9 million (US$20.0
million) in the six months ended June 30, 2003, and cash used in operating
activities in the six months ended June 30, 2002 was RMB12.1 million. In the six
months ended June 30, 2003, cash provided by operating activities consisted
primarily of our operating profit adjusted for depreciation charges during the
six month period and an increase in provisions for bad and doubtful debts, taxes
payable and a decrease in the amount due from related parties, and offset in
part by an increase in prepayments and other current assets, deferred tax assets
and a decrease in salary and welfare payable. In the six months ended June 30,
2002, cash used in operating activities consisted primarily of our operating
loss adjusted for depreciation charges and share compensation cost during the
six month period and an increase in the amount due from related parties, and a
decrease in accrued liability, offset in part by an increase in taxes payable,
accounts payable and
46
salary and welfare payable.
Investing Activities
Cash used in investing activities was RMB7.3 million (US$0.9 million)
in the six months ended June 30, 2003, and cash provided by investing activities
was RMB52.0 million in the six months ended June 30, 2002. In the six months
ended June 30, 2003, cash used in investing activities mainly consisted of the
purchase of fixed assets. In the six months ended June 30, 2002, cash provided
by investing activities mainly consisted of the decrease in temporary cash
investments and the disposal of convertible preference shares, which was offset
in part by the cash used in the purchase of fixed assets.
Financing Activities
Cash provided by financing activities was RMB10.1 million (US$1.2
million) in the six months ended June 30, 2003, and cash used in financing
activities in the six months ended June 30, 2002 was RMB82.0 million. In the six
months ended June 30, 2003, the cash provided by financing activities mainly
consisted of the proceeds from the issuance of ordinary shares upon the exercise
of share options. In the six months ended June 30, 2002, the cash used in
financing activities mainly consisted of the repayment of bank loans of RMB84.0
million, which was offset in part by the partial collection of a subscription
receivable for the Series B preference shares issued in 2000.
We had no material commitments for capital expenditures as of June 30,
2003. Up to June 30, 2003, we spent approximately RMB6.5 million (US$0.8
million) for servers and computer equipment, and as our business grows, we plan
to spend an additional approximately RMB10.8 million (US$1.3 million) in 2003
towards purchases of additional servers and switches in order to accommodate the
expected increase in traffic on the NetEase Web sites.
Our net losses have been funded by our cash resources and to a lesser
extent from cash generated from revenue growth. Although we have been striving
to enhance our revenues and stabilize or decrease our operating expenses, we
cannot be certain these efforts will be successful in future periods which could
accelerate the depletion of our cash resources. In particular, our selling,
general and administrative expenses have remained relatively high due primarily
to staff costs, while our revenues from advertising services have been uneven in
the last several years. Further, although our revenues from e-commerce and other
services have grown significantly recently, we have only a limited track record
offering these services and cannot be certain that we will be able to maintain
or grow such revenue. Nonetheless, given our positive cash flows in recent
quarters and our issuance of US$100 million aggregate principal amount of Zero
Coupon Convertible Subordinated Notes in July 2003, we believe that such cash
and revenues will be sufficient for us to meet our obligations for the
foreseeable future.
Research and Development
We believe that an integral part of our future success will depend on
our ability to develop and enhance our products and services. Our product
development efforts and strategies consist of incorporating new technologies
from third parties as well as continuing to develop our own proprietary
technology.
We have utilized and will continue to utilize the products and services
of third parties to enhance our platform of technologies and services to provide
competitive and diverse Internet services to our users. We also have utilized
and will continue to utilize third-party advertisement serving technologies. In
addition, we plan to continue to expand our technologies, products and services
and registered user base through diverse online community products and services
developed internally. We will seek to
47
continually improve and enhance our existing products and services to respond to
rapidly evolving competitive and technological conditions. For the six months
ended June 30, 2002 and June 30, 2003, we spent RMB7.4 million and RMB8.3
million (US$1.0 million), respectively, on research and development activities.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates
primarily to the interest income generated by excess cash invested in short term
money market accounts and certificates of deposit. We have not used derivative
financial instruments in our investment portfolio. 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 Currency Risk
Substantially all our revenues and expenses are denominated in
Renminbi, but a substantial portion of our cash is kept in U.S. dollars.
Although we believe that, in general, our exposure to foreign exchange risks
should be limited, the value of our American Depositary Shares, or ADSs, will be
affected by the foreign exchange rate between U.S. dollars and Renminbi. For
example, to the extent that we need to convert U.S. dollars into Renminbi for
our operational needs and should the Renminbi appreciate against the U.S. dollar
at that time, our financial position and the price of our ADSs may be adversely
affected. Conversely, if we decide to convert our Renminbi (which amount has
grown as a result of our improved cash flows in recent quarters) into U.S.
dollars for the purpose of declaring dividends on our ADSs or otherwise and the
U.S. dollar appreciates against the Renminbi, the U.S. dollar equivalent of our
earnings from our subsidiaries and controlled entities in China would be
reduced.
We have not had any material foreign exchange gains or losses to date.
However, we have not engaged in any hedging activities, and we may experience
economic loss as a result of any foreign currency exchange rate fluctuations.
Trend Information
Other than as disclosed elsewhere in this prospectus or incorporated by
reference in this prospectus, we are not aware of any trends, uncertainties,
demands, commitments or events from the period of inception to June 30, 2003
that are reasonably likely to have a material effect on our net revenues,
income, profitability, liquidity or capital resources, or that caused the
disclosed financial information to be not necessarily indicative of future
operating results or financial conditions.
48
RATIO OF EARNINGS TO FIXED CHARGES
For the Six
For the Year Months
Ended December 31, Ended June 30,
------------------------------- -------------
1998 1999 2000 2001 2002 2003
---- ---- ---- ---- ---- ----
(Unaudited)
Ratio of Earnings to Fixed Charges N/A N/A N/A N/A 4.61 129.00
The ratio of earnings to fixed charges is calculated by dividing profit
before tax by fixed charges. Fixed charges include interest costs and one-third
of the rental expenses. We believe that one-third of the rental expenses is a
reasonable approximation of the interest factor in the rental expenses. Due to
our losses in the years ended December 31, 1999, 2000 and 2001, the ratios of
earnings to fixed charges were less than 1:1 for those years. To achieve a
coverage of 1:1 for those years, we would have had to generate additional
earnings of RMB52.0 million, RMB169.3 million and RMB233.2 million,
respectively.
49
DESCRIPTION OF NOTES
The notes were issued under an indenture dated as of July 14, 2003
(referred to as the Indenture in this prospectus) between us and The Bank of New
York, as trustee (referred to as the trustee in this prospectus). Copies of the
Indenture are available for inspection during normal business hours at the
principal office of the trustee being the date hereof at 101 Barclay Street,
21st Floor West, New York, N.Y. 10286, U.S.A. The statements under this section
relating to the Indenture and the notes are general summaries highlighting
certain important features of the Indenture and the notes and do not purport to
be complete. Such summaries make use of certain terms defined in the Indenture
and are qualified in their entirety by express reference to the Indenture. The
terms of the notes will also include those made a part of the Indenture by
reference to the Trust Indenture Act of 1939, as amended.
General
The notes are general unsecured obligations and are subordinate in
right of payment as described under "--Subordination of Notes." The notes are
limited to an aggregate principal amount of $100 million and are issued only in
denominations of $1,000 and integral multiples of $1,000. They will mature on
July 15, 2023 (unless earlier redeemed at our option, converted into ordinary
shares at the option of the holder or repurchased by us at the option of the
holder). We will not pay interest on the notes unless specified defaults under
the registration rights agreement occur.
See "--Book-Entry Delivery and Form" for information regarding the
form, documents and mechanics for transferring the notes.
The Indenture does not contain any restrictions on the payment of
dividends or the repurchase of our securities or any financial covenants. The
Indenture contains no covenants or other provisions to afford protection to
holders of notes in the event of a highly leveraged transaction or a change in
control of our company except to the extent described under "--Repurchase at
Option of a Holder Upon a Fundamental Change" and "--Merger and Consolidation."
We will maintain an office in The City of New York where the notes may
be presented for registration, payment, transfer, exchange or conversion. This
office will be an office or agency of the trustee. Except under limited
circumstances described below, the notes are issued only in fully-registered
book-entry form, without coupons, and will be represented by one or more global
notes. There will be no service charge for any registration of transfer or
exchange of notes. We and/or the trustee may, however, require holders to pay a
sum sufficient to cover any tax or other governmental charge payable in
connection with certain transfers or exchanges.
Conversion Rights
General
Holders have the option to convert any portion of the principal amount
of any note that is an integral multiple of $1,000 into our ordinary shares at
any time at a conversion price of $0.4815 per share prior to the close of
business on the maturity date in the following circumstances:
. during any calendar quarter commencing after September 30,
2003, if the average of the reference prices (as defined
below) of our ordinary shares for the last five consecutive
trading days of the calendar quarter preceding the quarter in
which the conversion occurs is more than 115% of the
conversion price per share on the last trading day of the
preceding quarter;
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. if we have called the notes for redemption;
. if the average of the trading prices of the notes for any five
consecutive trading day period is less than 100% of the
average of the conversion value (as defined in this
prospectus) of the notes during that period; provided,
however, that no notes may be converted based on the
satisfaction of this condition during the six month period
immediately preceding each specified date on which the note
holders may require us to repurchase their notes (for example,
with respect to the July 15, 2006 repurchase date, the notes
may not be converted from January 15, 2006 to July 15, 2006)
if on any day during such five consecutive trading day period,
the reference price of our ordinary shares is between the
conversion price and 115% of the conversion price; or
. upon the occurrence of specified corporate transactions.
A holder may deposit the ordinary shares it receives upon conversion of
its notes for the issuance of ADSs if it complies with the requirements
described under "Description of American Depositary Shares."
"Trading day" means each day on which the securities exchange or
quotation system which is used to determine the ADS sale price is open for
trading or quotation. "ADS sale price" means the closing per ADS (or ordinary
share, if applicable) sale price as reported in composite transactions for the
principal United States securities exchange on which the ADS (or ordinary share,
if applicable) is traded, or, if the ADS (or ordinary share, if applicable) is
not listed on a United States national or regional stock exchange, as reported
by Nasdaq, or, if the ADS (or ordinary share, if applicable) is not listed or
admitted to trading on any United States national or regional stock exchange or
quoted on Nasdaq, the average of the closing bid and ask prices in the
over-the-counter market as furnished by any New York Stock Exchange member firm
selected from time to time by us for that purpose.
The "reference price" of our ordinary shares on any date of
determination means a dollar amount derived by dividing the closing price of our
ADSs on that date by the then applicable number of our ordinary shares
represented by one ADS. On the date of this prospectus, one ADS represents 100
of our ordinary shares.
Conversion Upon Satisfaction of Market Price Condition
A holder may surrender any of its notes for conversion into our
ordinary shares during any quarter commencing after September 30, 2003 if the
average reference price of our ordinary shares for the last five trading days in
the preceding quarter exceeds 115% of the conversion price per share on the last
trading day of the preceding quarter. We will determine at the end of each
quarter whether the notes are convertible as a result of the price of our
ordinary shares and promptly notify the conversion agent (as defined in this
prospectus) and trustee, which in turn will notify the holders of the notes.
Conversion Upon Notice of Redemption
A holder may surrender for conversion any note called for redemption at
any time prior to the close of business on the day that is two business days
prior to the redemption date, even if the notes are not otherwise convertible at
such time.
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Conversion Upon Satisfaction of Trading Price Condition
If, after any five consecutive trading day period in which the average
of the trading prices (defined below) for the notes for such five trading day
period is less than 100% of the average of the conversion value (defined below)
for the notes during that period, then you may surrender notes for conversion at
any time during the following 10 trading days; provided, however, that no notes
may be converted based on the satisfaction of this condition during the six
month period immediately preceding each specified date on which the holders may
require us to repurchase their notes (for example, with respect to the July 15,
2006 repurchase date, the notes may not be converted from January 15, 2006 to
July 15, 2006), if on any day during such five consecutive trading day period,
the reference price of our ordinary shares is between the conversion price and
115% of the conversion price.
The "conversion value" of a note means the product of the reference
price of our ordinary shares on any date of determination multiplied by the
number of ordinary shares into which the note is convertible.
The "trading price" of the notes on any date of determination means the
average of the secondary market bid quotations per $1,000 principal amount of
notes received by the conversion agent for $5,000,000 principal amount of the
notes at approximately 3:30 p.m., The City of New York time, on such
determination date from three independent nationally recognized securities
dealers we select, provided that if at least three such bids are not received by
the conversion agent, but two such bids are received, then the average of the
two bids shall be used, and if only one such bid is received by the conversion
agent, this one bid shall be used. If the conversion agent cannot reasonably
obtain at least one bid for $5,000,000 principal amount of the notes from a
nationally recognized securities dealer or, in our reasonable judgment, the bid
quotations are not indicative of the secondary market value of the notes, then
the trading price of the notes will be determined in good faith by us taking
into account in such determination such factors as we, in our sole discretion,
deem appropriate. In connection with any conversion upon satisfaction of trading
price condition as described above, the conversion agent shall have no
obligation to determine the trading price of the notes; and we shall have no
obligation to make such determination unless a holder provides us with
reasonable evidence that the trading price of the notes is less than 100% of the
product of the reference price of our ordinary shares and the number of ordinary
shares issuable upon conversion of $1,000 principal amount of the notes; at
which time, we shall select and instruct the three independent nationally
recognized securities dealers to provide the conversion agent with the bid
quotations as provided above.
The "conversion agent" means, initially, The Bank of New York, acting
in such capacity, until a successor replaces it and, thereafter, shall mean such
successor.
Conversion Upon Specific Corporate Transactions
If we elect to:
. distribute to all holders of our ordinary shares any rights,
warrants or options entitling them to subscribe for or
repurchase, for a period expiring within 60 days of the date
of distribution, our ordinary shares at less than the then
current market price; or
. distribute to all holders of our ordinary shares any assets,
debt securities or certain rights to repurchase our
securities, which distribution has a per share value exceeding
10% of the reference price of our ordinary shares on the day
preceding the declaration date for such distribution,
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holders may convert their notes, unless such holders may participate in the
transaction on a basis and with notice that our board of directors determines to
be fair and reasonable. We must notify the holders of notes at least 20 days
prior to the ex-dividend date for any such distribution. Once we have given such
notice, holders may surrender their notes for conversion until the earlier of
the close of business on the business day prior to the ex-dividend date or our
announcement that such distribution will not take place. This provision shall
not apply if the holder of a note otherwise participates in the distribution
without conversion.
In addition, if we are a party to a consolidation, merger, share exchange,
sale of all or substantially all of our assets or other similar transaction, in
each case pursuant to which our ordinary shares would be converted into cash,
securities or other property, we must notify the holders at least 15 business
days prior to the anticipated effective date of the transaction. A holder may
surrender its notes for conversion at any time from and after the date which is
15 business days prior to the anticipated effective date of such transaction
until and including the date which is two business days before the actual date
of such transaction. If we are a party to a consolidation, merger, share
exchange, sale of all or substantially all of our assets or other similar
transaction, in each case pursuant to which our ordinary shares are converted
into cash, securities or other property, then at the effective time of the
transaction, a holder's right to convert its notes into ordinary shares will be
changed into a right to convert such notes into the kind and amount of cash,
securities and other property that such holder would have received if such
holder had converted such notes immediately prior to the transaction. If the
transaction also constitutes a Fundamental Change (as defined below), such
holder can require us to repurchase all or a portion of its notes as described
under "--Repurchase at Option of a Holder Upon a Fundamental Change." If the
transaction also constitutes a Merger Event (as defined below), we may be
required to redeem all of the notes as described under "--Merger and
Consolidation."
If a holder of a note has delivered notice of its election to have such
note repurchased at the option of such holder or as a result of a Fundamental
Change or a Delisting Event (as defined below), such note may be converted only
if the notice of election is withdrawn as described, respectively, under
"--Repurchase of Notes at the Option of the Holder on Specified Dates,"
"--Repurchase at Option of a Holder Upon a Fundamental Change" or "--Repurchase
at Option of a Holder Upon a Delisting Event."
Conversion Price Adjustments
We will adjust the conversion price if (without duplication):
(1) we issue to all holders of our ordinary shares additional
ordinary shares or other capital stock as a dividend or
distribution on our ordinary shares;
(2) we subdivide, combine or reclassify our ordinary shares;
(3) we issue to all holders of our ordinary shares any rights,
warrants or options entitling them to subscribe for or
purchase our ordinary shares for a period expiring not later
than 60 days after the applicable record date for the
distribution at a per share price that is less than the then
current market price; provided that no adjustment will be made
if holders of the notes may participate in the transaction on
a basis and with notice that our board of directors determines
to be fair and appropriate;
(4) we distribute to all holders of our ordinary shares evidences
of our indebtedness, shares of capital stock (other than our
ordinary shares), securities, cash, property, rights, warrants
or options, excluding:
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. those rights, warrants or options referred to in clause
(3) above;
. any dividend or distribution paid exclusively in cash on
and after July 15, 2008 and not referred to below; and
. any dividend or distribution referred to in clause (1)
above;
(5) (i) we make a dividend or other distribution consisting
exclusively of cash to all holders of ordinary shares declared
and paid at any time prior to July 15, 2008, and (ii) on and
after July 15, 2008, we make a cash distribution to all
holders of our ordinary shares that together with all other
all-cash distributions and consideration payable in respect of
any tender or exchange offer by us or one of our subsidiaries
for shares made within the preceding 12 months exceeds 5% of
our aggregate market capitalization on the date of the
declaration of the distribution; or
(6) we pay to holders of our ordinary shares in respect of a
tender or exchange offer (other than an odd-lot offer) by us
or any of our subsidiaries for ordinary shares a price per
ordinary share in excess of 110% of the reference price for
one share of our ordinary shares on the last date tenders or
exchanges may be made pursuant to such tender or exchange
offer.
The conversion price will not be adjusted until adjustments amount to
1% or more of the conversion price as last adjusted. We will carry forward any
adjustment we do not make and will include it in any future adjustment.
We will not issue fractional ordinary shares to a holder who converts a
note. In lieu of issuing fractional shares, we will pay cash based upon the
reference price of our ordinary shares on the date of conversion.
Except as described in this paragraph, no holder of notes will be
entitled, upon conversion of the notes, to any actual payment or adjustment on
account of accrued and unpaid interest, if any, or on account of dividends on
shares issued in connection with the conversion. If any holder surrenders a note
for conversion between the close of business on any record date for the payment
of an installment of interest, if any, and the opening of business on the
related interest payment date, the holder must deliver payment to us of an
amount equal to the interest payable on the interest payment date on the
principal amount to be converted together with the note being surrendered. The
foregoing sentence shall not apply to notes called for redemption on a
redemption date within the period between and including the record date and the
interest payment date.
The date of conversion shall be the date on which the note and all of
the items required for conversion shall have been so delivered and the
requirements for conversion have been met. A holder delivering a note for
conversion will be required to pay any taxes or duties payable in respect of the
issue or delivery of the ordinary shares upon conversion.
We may from time to time reduce the conversion price if our board of
directors determines that this reduction would be in the best interests of our
company. Any such determination by our board of directors will be conclusive,
and we shall endeavor to notify the trustee within three business days after
such determination. In turn, the trustee shall promptly notify the note holders.
Any such reduction in the conversion price must remain in effect for at least 20
trading days. In addition, we may from time to time reduce the conversion price
if our board of directors deems it advisable to avoid or diminish any income tax
to holders of our ordinary shares resulting from any stock or rights
distribution on our ordinary shares.
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Conversion Settlement Options
Upon conversion, we will satisfy all of our obligations (the
"Conversion Obligation") by delivering to converting holders (1) our ordinary
shares, (2) cash, or (3) a combination of cash and our ordinary shares, as
follows:
(1) Share Settlement. If we elect to satisfy the entire Conversion
Obligation in our ordinary shares, then we will deliver to converting holders a
number of our ordinary shares equal to the aggregate principal amount of the
notes to be converted divided by the conversion price then in effect.
(2) Cash Settlement. If we elect to satisfy the entire Conversion
Obligation in cash, then we will deliver to converting holders cash in an amount
equal to the product of (i) a number equal to the aggregate principal amount of
notes to be converted by any such holder divided by the conversion price then in
effect, and (ii) the average of the reference price of our ordinary shares on
each trading day during the applicable cash settlement averaging period (as
defined below).
(3) Combined Settlement. If we elect to satisfy a portion of the
Conversion Obligation in cash (the "Partial Cash Amount") and a portion in our
ordinary shares, then we will deliver to converting holders such Partial Cash
Amount plus a number of our ordinary shares equal to (a) the cash settlement
amount as set forth in clause (2) above minus such Partial Cash Amount divided
by (b) the average of the reference price of our ordinary shares on each trading
day during the applicable cash settlement averaging period.
If we choose to satisfy the Conversion Obligation by share settlement,
then settlement in shares will be made on or prior to the fifth trading day
following our receipt of a notice of conversion.
If we choose to satisfy the Conversion Obligation by cash settlement or
combined settlement, then we will notify holders, through the trustee, of the
dollar amount to be satisfied in cash at any time on or before the date that is
three business days following our receipt of a converting holder's notice of
conversion (the "Settlement Notice Period"). Share settlement will apply
automatically if we do not notify holders that we have chosen another settlement
method.
If we timely elect cash settlement or combined settlement, then holders
may retract their conversion notice at any time during the two business day
period beginning on the day after the Settlement Notice Period (the "Conversion
Retraction Period"). Holders cannot retract conversion notices (and conversion
notice therefore will be irrevocable) if we elect share settlement. If a holder
has not retracted its conversion notice, then cash settlement or combined
settlement will occur on the first trading day following the applicable cash
settlement averaging period. The "applicable cash settlement averaging period"
is the five trading day period beginning on the first trading day following the
end of the Conversion Retraction Period.
Subordination of Notes
The payment of the principal of, and interest, if any, on the notes is
subordinated to the prior payment in full, in cash or other payment satisfactory
to the holders of senior indebtedness, of all existing and future senior
indebtedness. If we dissolve, wind-up, liquidate or reorganize, or if we are the
subject of any bankruptcy, insolvency, receivership or similar proceedings, we
will pay the holders of senior indebtedness in full in cash or other payment
satisfactory to the holders of senior indebtedness before we pay the holders of
the notes. If the notes are accelerated because of an event of default under the
Indenture, we must pay the holders of senior indebtedness in full all amounts
due and owing thereunder
55
before we pay the holders of notes. The Indenture requires us to promptly notify
holders of senior indebtedness if payment of the notes is accelerated because of
an event of default under the Indenture.
We may not make any payment on the notes, repurchase or redeem
otherwise acquire the notes if:
. a default in the payment of any designated senior indebtedness
occurs and is continuing beyond any applicable period of grace,
or
. any other default of designated senior indebtedness occurs and is
continuing that permits holders of the designated senior
indebtedness to accelerate its maturity and the trustee receives
a payment blockage notice from us or other person permitted to
give such notice under the Indenture.
We are required to resume payments on the notes:
. in case of a payment default on designated senior indebtedness,
upon the date on which such default is cured or waived or ceases
to exist, and
. in case of a nonpayment default on designated senior
indebtedness, the earlier of the date on which such nonpayment
default is cured or waived or ceases to exist or 179 days after
the date on which the payment blockage notice is received.
No new period of payment blockage may be commenced for a default
unless:
. 365 days have elapsed since the effectiveness of the immediately
prior payment blockage notice, and
. all scheduled payments on the notes that have come due have been
paid in full in cash.
No nonpayment default that existed or was continuing on the date of
delivery of any payment blockage notice shall be the basis for a subsequent
payment blockage notice.
As a result of these subordination provisions, in the event of our
bankruptcy, dissolution or reorganization, holders of senior indebtedness may
receive more, ratably, and holders of the notes may receive less, ratably, than
our other creditors. These subordination provisions will not prevent the
occurrence of any event of default under the Indenture.
If either the trustee or any holder of notes receives any payment or
distribution or our assets in contravention of these subordination provisions
before all senior indebtedness is paid in full, then such payment or
distribution will be held by the recipient in trust for the benefit of holders
of senior indebtedness to the extent necessary to make payment in full of all
senior indebtedness remaining unpaid; provided, however, the trustee and any
agent may continue to make payments under the notes and shall not at any time be
charged with knowledge of the existence of any facts which would prohibit the
making of such payments until the trustee receives written notice that payments
may not be made. Prior to the receipt of this notice, the trustee and any agent
shall be entitled to assume conclusively that no such facts exist.
Substantially all of our operations are conducted through subsidiaries.
As a result, our cash flow and our ability to service our debt, including the
notes, would depend upon the earnings of our
56
subsidiaries. In addition, we would be dependent on the distribution of
earnings, loans or other payments by our subsidiaries to us.
Our subsidiaries are separate and distinct legal entities. Our
subsidiaries have no obligation to pay any amounts due on the notes or to
provide us with funds for our payment obligations, whether by dividends,
distributions, loans or other payments. In addition, any payment of dividends,
distributions, loans or advances by our subsidiaries will also be contingent
upon our subsidiaries' earnings and could be subject to contractual or statutory
restrictions.
Our right to receive any assets of any of our subsidiaries upon their
liquidation or reorganization, and therefore the right of the holders of the
notes to participate in those assets, will be structurally subordinated to the
claims of that subsidiary's creditors, including trade creditors. In addition,
even if we were a creditor of any of our subsidiaries, our rights as a creditor
would be subordinate to any security interest in the assets of our subsidiaries
and any indebtedness of our subsidiaries senior to that held by us.
As of June 30, 2003, we had no senior indebtedness outstanding and had
liabilities of $6.0 million. Our subsidiaries also had no outstanding
indebtedness, other than intercompany indebtedness and other normal trade
payables and liabilities.
Neither we nor our subsidiaries are limited from incurring senior
indebtedness or additional debt under the Indenture. If we incur additional
debt, our ability to pay our obligations on the notes could be affected. We
expect from time to time to incur additional indebtedness and other liabilities.
We are obligated to pay compensation to the trustee. We will indemnify
the trustee against any losses, liabilities or expenses incurred by it in
connection with its duties. The trustee's claims for such payments will be
senior to the claims of the holders of the notes.
"Designated senior indebtedness" means any senior indebtedness in which
the instrument creating or evidencing the indebtedness, or any related
agreements or documents to which we are a party, expressly provides that such
indebtedness is "designated senior indebtedness" for purposes of the Indenture;
provided that such instrument, agreement or other document may place limitations
and conditions on the right of such senior indebtedness to exercise the rights
of designated senior indebtedness.
"Indebtedness" means
(1) all of our indebtedness, obligations and other liabilities,
contingent or otherwise, (A) for borrowed money, including
overdrafts, foreign exchange contracts, currency exchange
agreements, interest rate protection agreements, and any loans
or advances from banks, whether or not evidenced by notes or
similar instruments, or (B) evidenced by credit or loan
agreements, bonds, debentures, notes or similar instruments,
whether or not the recourse of the lender is to the whole of
the assets of our company or to only a portion thereof, other
than any trade account payables or other accrued current
liability or obligation incurred in the ordinary course of
business in connection with the obtaining of materials or
services;
(2) all of our reimbursement obligations and other liabilities,
contingent or otherwise, with respect to letters of credit,
bank guarantees or bankers' acceptances;
(3) all of our obligations and liabilities, contingent or
otherwise,
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(a) in respect of leases required, in conformity with
generally accepted accounting principles, to be
accounted for as capitalized lease obligations on our
balance sheet;
(b) as lessee under other leases for facilities equipment
and related assets leased together therewith, whether
or not capitalized, entered into or leased for
financing purposes (as determined by us); or
(c) under any lease or related document, including a
purchase agreement, conditional sale or other title
retention agreement, in connection with the lease of
real property or improvements thereon (or any
personal property included as part of any such lease)
which provides that we are contractually obligated to
purchase or cause a third party to purchase the
leased property or pay an agreed upon residual value
of the leased property, including our obligations
under such lease or related document to purchase or
cause a third party to purchase such leased property
or pay an agreed upon residual value of the leased
property to the lessor (whether or not such lease
transaction is characterized as an operating lease or
a capitalized lease in accordance with generally
accepted accounting principles);
(4) all of our obligations, contingent or otherwise, with respect
to an interest rate, currency or other swap, cap, floor or
collar agreement or hedge agreement, forward contract or other
similar instrument or agreement or foreign currency hedge,
exchange, purchase or similar instrument or agreement;
(5) all of our direct or indirect guaranties, agreements to be
jointly liable or similar agreement by us in respect of, and
all of our obligations or liabilities, contingent or
otherwise, to purchase or otherwise acquire or otherwise
assure a creditor against loss in respect of, indebtedness,
obligations or liabilities of another person of the kinds
described in clauses (1) through (4);
(6) any indebtedness or other obligations described in clauses (1)
through (5) secured by any mortgage, pledge, lien or other
encumbrance existing on property which is owned or held by us,
regardless of whether the indebtedness or other obligation
secured thereby shall be assumed by us; and
(7) any and all deferrals, renewals, extensions, refinancings and
refundings of, or amendments, modifications or supplements to,
any indebtedness, obligation or liability of the kinds
described in clauses (1) through (6).
"Senior indebtedness" means the principal of, premium, if any,
interest, including any interest accruing subsequent to the commencement of any
bankruptcy or similar proceeding, whether or not a claim for post-petition
interest is allowable as a claim in the proceeding, and rent payable on or in
connection with, and all fees, costs, expenses and other amounts accrued or due
on or in connection with, indebtedness of our company whether secured or
unsecured, absolute or contingent, due or to become due, outstanding on the date
of the Indenture or thereafter created, incurred, assumed, guaranteed or in
effect guaranteed by us, including all deferrals, renewals, extensions or
refundings of, or amendments, modifications or supplements to, the foregoing.
Senior indebtedness does not include:
(1) indebtedness that expressly provides that such indebtedness
shall not be senior in right of payment to the notes or
expressly provides that such indebtedness is on the same basis
or junior to the notes; or
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(2) any indebtedness to any of our wholly-owned subsidiaries,
other than indebtedness to our subsidiaries arising by reason
of guarantees by us of indebtedness of such subsidiary to a
person that is not our subsidiary.
Redemption of Notes at Our Option
Prior to July 15, 2008, we may not redeem the notes at our option,
except in connection with a transaction described under "--Merger and
Consolidation" below. Beginning on July 15, 2008 and prior to the close of
business on the maturity date, we may redeem the notes, in whole or in part, for
cash at a redemption price equal to 100% of the principal amount thereof,
together with accrued and unpaid interest, if any, if the reference price of our
ordinary shares for 20 out of any 30 consecutive trading day period, the last of
which occurs no more than five days prior to the date upon which notice of such
redemption is published, is at least 130% of the conversion price in effect on
such trading day. We will give not less than 30 days' or more than 60 days'
notice of redemption by mail to holders of the notes. Holders may convert the
notes called for redemption as described under "--Conversion Rights--Conversion
Upon Notice of Redemption."
Upon redemption, holders of notes that are redeemed shall receive, in
exchange for such notes, the redemption price.
If we redeem less than all of the outstanding notes, the trustee shall
select the notes to be redeemed on a pro rata basis in principal amounts of
$1,000 or integral multiples of $1,000. If a portion of a holder's notes is
selected for partial redemption and the holder converts a portion of the notes,
the converted portion shall be deemed to be the portion selected for redemption.
Repurchase of Notes at the Option of the Holder on Specified Dates
On July 15, 2006, July 15, 2007, July 15, 2008, July 15, 2013 and July
15, 2018, each holder may require us to repurchase any outstanding notes for
which such holder has properly delivered and not withdrawn a written repurchase
notice, at a price equal to 100% of the principal amount of such notes, together
with accrued and unpaid interest, if any, subject to certain additional
conditions. Holders may submit their notes for repurchase to the paying agent at
any time from the opening of business on the date that is 20 business days prior
to the repurchase date until the close of business on the fifth business day
prior to the repurchase date.
We will pay the repurchase price in cash. For a discussion of the tax
treatment of a holder receiving cash, see "Certain United States Federal Income
Tax Consequences--U.S. Holders--Sale, Exchange or Redemption of the Notes or
Conversion of Notes Solely for Cash."
Required Notices and Procedure
On a date not less than 20 business days prior to the date that we are
required to repurchase the notes at the option of the holder, we will give
notice to all holders at their addresses shown in the register of the Registrar
(as defined below), and to beneficial owners as required by applicable law,
stating, among other things, the procedures that holders must follow to require
us to repurchase their notes.
The repurchase notice given by each holder electing to require us to
repurchase notes must be given so as to be received by the paying agent no later
than the close of business on the fifth business day prior to the repurchase
date and must state:
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. the certificate numbers of the holder's notes to be delivered for
repurchase, in the case of definitive notes;
. the aggregate principal amount of notes to be repurchased; and
. that the notes are to be repurchased by us pursuant to the
applicable provisions of the notes.
A holder may withdraw any repurchase notice by delivering a written
notice of withdrawal to the paying agent prior to the close of business on the
third business day prior to the repurchase date. The notice of withdrawal shall
state:
. the certificate numbers of the notes being withdrawn, in the case
of definitive notes;
. the aggregate principal amount of the notes being withdrawn; and
. the aggregate principal amount, if any, of the notes that remain
subject to the repurchase notice.
In connection with any repurchase offer, we will
. comply in all material respects with the provisions of Rule
13e-4, Rule 14e-1 and any other tender offer rules under the U.S.
Securities Exchange Act of 1934, as amended (referred to as the
Exchange Act in this prospectus), that may then apply;
. file a Schedule TO, if required, or any other required schedule
under the Exchange Act; and
. otherwise comply with all United States federal and state
securities laws.
Our obligation to pay the repurchase price for a note as to which a
repurchase notice has been delivered and not validly withdrawn is conditioned
upon the holder delivering the note, together with necessary endorsements, to
the paying agent at any time after delivery of the repurchase notice. We will
cause the repurchase price for the note to be paid promptly following the later
of the repurchase date or the time of delivery of the note.
If the paying agent holds money or securities sufficient to pay the
repurchase price of any note on the business day following the repurchase date
in accordance with the terms of the Indenture, then, immediately after the
repurchase date, the note will cease to be outstanding and interest on such note
will cease to accrue, whether or not the note is delivered to the paying agent.
After the note ceases to be outstanding, all other rights of the holder shall
terminate, other than the right to receive the repurchase price upon delivery of
the note.
We may not repurchase any note at any time when the subordination
provisions of the Indenture otherwise would prohibit us from making such
repurchase. If we fail to repurchase the notes when required, this failure will
constitute an event of default under the Indenture whether or not repurchase is
permitted by the subordination provisions of the Indenture.
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Repurchase at Option of a Holder Upon a Fundamental Change
If a Fundamental Change occurs, each holder of notes shall have the
right, at its option, to require us to repurchase all of its notes, or any
portion thereof that is an integral multiple of $1,000, on the date (the
"Fundamental Change Repurchase Date") selected by us that is not less than 10 or
more than 30 days after the Final Surrender Date (as defined below), at a price
equal to 100% of the principal amount of the notes, together with accrued and
unpaid interest, if any.
Unless we shall previously have called for the redemption of all of the
notes, within 30 days after the occurrence of a Fundamental Change, we are
obligated to deliver to the trustee and mail (or cause the trustee to mail) to
all holders of record of the notes a notice (the "Company Notice"), describing,
among other things, the occurrence of such Fundamental Change and of the
repurchase right arising as a result thereof, as well as the Final Surrender
Date and the Fundamental Change Repurchase Date. We must cause a copy of the
Company Notice to be published in a newspaper of general circulation in the
Borough of Manhattan, The City of New York, which newspaper shall be The Wall
Street Journal. To exercise the repurchase right, a holder must, on or before
the date that is, subject to any contrary requirements of applicable law, 60
days after the date of mailing of the Company Notice, which date shall be
referred to as the Final Surrender Date, give a written notice of the holder's
exercise of such right and surrender the notes (if such notes are represented by
a global note, by book-entry transfer to the conversion agent through the
facilities of DTC) with respect to which the right is being exercised, duly
endorsed for transfer to us, at any place where principal is payable. The
submission of such notice, together with such notes pursuant to the exercise of
a repurchase right, will be irrevocable on the part of the holder on the
Fundamental Change Repurchase Date (unless we fail to repurchase the notes on
the Fundamental Change Repurchase Date) and the right to convert the notes will
expire 5:00 pm The City of New York time on the business day immediately
preceding the Fundamental Change Repurchase Date.
The term "Fundamental Change" shall mean any of the following:
. a "person" or "group" (within the meaning of Sections 13(d) and
14(d)(2) of the Exchange Act), other than our existing
controlling shareholder William Ding and his affiliates, becoming
the "beneficial owner" (as defined in Rule 13d-3 under the
Exchange Act) of voting shares (as defined below) of our company
entitled to exercise more than 50% of the total voting power of
all outstanding voting shares of our company (including any right
to acquire voting shares that are not then outstanding of which
such person or group is deemed the beneficial owner); or
. any consolidation of us with, or merger of us into, any other
person, any merger of another person into us, or any sale, or
transfer of all or substantially all of our assets to another
person (other than (a) a stock-for-stock merger, (b) a merger
that does not result in any reclassification, conversion,
exchange or cancellation of outstanding ordinary shares, (c) a
merger that is effected solely to change our jurisdiction of
incorporation or (d) any consolidation with or merger of us into
one of our wholly owned subsidiaries, or any sale or transfer by
us of all or substantially all of our assets to one or more of
our wholly owned subsidiaries, in any one transaction or a series
of transactions; provided, in any such case the resulting
corporation or each such subsidiary assumes or guarantees our
obligations under the notes); provided, however, that a
Fundamental Change shall not occur with respect to any such
transaction if either (i) the reference price of our ordinary
shares for any five trading days during the ten trading days
immediately following the public announcement by us of such
transaction is at least equal to 105% of the conversion price in
effect on such trading day or (ii) the consideration in such
transaction to the holders of ordinary shares consists of cash,
securities that are, or immediately upon
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issuance will be, listed on a national securities exchange or
quoted on The Nasdaq National Market, or a combination of cash
and such securities, and the aggregate fair market value of such
consideration (which, in the case of such securities, shall be
equal to the average of the last sale prices of such securities
during the ten consecutive trading day period commencing with the
sixth trading day following consummation of the transaction) is
at least 105% of the conversion price in effect on the date
immediately preceding the closing date of such transaction.
"Voting shares" means all outstanding shares of any class or series
(however designated) of capital stock entitled to vote generally in the election
of members of the board of directors.
The repurchase right of a holder upon the occurrence of a Fundamental
Change could, in certain circumstances, make more difficult or discourage a
potential takeover of us and, thus, removal of incumbent management. The
Fundamental Change repurchase right, however, is not the result of management's
knowledge of any specific effort to accumulate ordinary shares or to obtain
control of us by means of a merger, tender offer, solicitation or otherwise.
Instead, the Fundamental Change repurchase feature is a standard term contained
in other similar debt offerings.
We may not repurchase any note at any time when the subordination
provisions of the Indenture otherwise would prohibit us from making such
repurchase. If we fail to repurchase the notes when required, this failure will
constitute an event of default under the Indenture whether or not repurchase is
permitted by the subordination provisions of the Indenture.
We could in the future enter into certain transactions, including
highly leveraged recapitalizations, that would not constitute a Fundamental
Change and would, therefore, not provide the holders with the protection of
requiring us to repurchase the notes.
If a Fundamental Change were to occur, we may not have sufficient funds
to pay the repurchase price for the notes tendered by holders. In addition, we
may in the future incur debt that has similar Fundamental Change provisions that
permit holders of such debt to accelerate or require us to repurchase the debt
upon the occurrence of events similar to a Fundamental Change.
Repurchase at Option of a Holder Upon a Delisting Event
In the event that the ADSs of our company are no longer listed or
quoted for trading on The Nasdaq National Market or the ordinary shares of our
company or any security representing such ordinary shares of our company are not
listed or quoted for trading on a national securities exchange in the United
States (the occurrence of such an event being referred to in this prospectus as
a "Delisting Event"), each holder of notes shall have the right, as its option
(the "Delisting Put Option"), to require us to repurchase all of its notes, or
any portion thereof that is an integral multiple of $1,000, on the date (the
"Delisting Put Date") selected by us that is not less than 10 or more than 30
days after the Delisting Put Surrender Date (as defined below), at a price equal
to 100% of the principal amount of the notes, together with accrued and unpaid
interest, if any; except in any case in which a Delisting Event occurs as a
result of a Merger Event as described under "--Merger and Consolidation," and we
redeem the notes as described thereunder. For the avoidance of any doubt, no
holder shall be entitled to exercise its Delisting Put Option if we are obliged
to exercise the Merger Redemption Option (as defined below) in case of a Merger
Event as described under "--Merger and Consolidation."
Within 30 days after the occurrence of the Delisting Event, we will
deliver to the trustee and mail to all holders of record of the notes a notice
(the "Delisting Notice") describing, among other things, the occurrence of such
Delisting Event and the repurchase right arising as a result thereof and specify
the
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Delisting Put Surrender Date and the Delisting Put Date. We must cause a copy of
the Delisting Notice to be published in a newspaper of general circulation in
the Borough of Manhattan, The City of New York, which newspaper shall be The
Wall Street Journal. To exercise the repurchase right, a holder must, on or
before the date (the "Delisting Put Surrender Date") that is, subject to any
contrary requirements of applicable law, 60 days after the mailing of the
Delisting Notice, give a written notice of the holder's exercise of such right
and surrender the notes (if such notes are represented by a global note, by
book-entry transfer to the conversion agent through the facilities of DTC) with
respect to which the right is being exercised, duly endorsed for transfer to us,
at any place where principal is payable on the notes. The submission of such
notice, and such surrender of the notes, will become irrevocable on the
Delisting Put Date (unless we fail to repurchase the notes on the Delisting Put
Date) and the right to convert the notes will expire 5:00 pm The City of New
York time on the business day immediately preceding the Delisting Put Date.
Events of Default and Notice Thereof
Each of the following will constitute an event of default under the
Indenture:
(1) a default in the payment of principal of, or premium, if any, on
any note or of the redemption price or of the repurchase price in
respect of any note when due, whether or not prohibited by the
subordination provisions of the Indenture;
(2) a default in the payment of interest, if any, on any note which
continues for 30 days or more after such payment is due, whether
or not prohibited by the subordination provisions of the
Indenture;
(3) a default in the performance of any other of our covenants or
agreements in the Indenture that continues for 60 days after a
written notice is sent to us by the trustee or the holders of at
least 25% in principal amount of outstanding notes,
(4) failure by us to make any payment when due, including any
applicable grace period, in respect of our indebtedness for
borrowed money, which payment is in an amount in excess of $10
million;
(5) default by us with respect to any of our indebtedness for
borrowed money, which default results in acceleration of any such
indebtedness that is in an amount in excess of $10 million; and
(6) certain events of bankruptcy, insolvency or reorganization.
If an event of default shall occur and be continuing and we provide the
trustee with express notice of such event of default in writing, the trustee is
required to mail to each holder of the notes a notice of the event of default
within 90 days after such default occurs. Except in the case of a default in
payment of the principal of, or premium, if any, or interest, if any, on, any
note, the trustee may withhold the notice if and so long as the trustee in good
faith determines that withholding the notice is in the interests of the holders
of the notes.
If an event of default shall occur and be continuing, the trustee or
the holders of not less than 25% in principal amount of outstanding notes may
declare the principal of, and interest, if any, on, all the notes to be due and
payable immediately. If the event of default relates to bankruptcy, insolvency
or reorganization, the notes shall automatically become due and payable
immediately, subject to applicable law. Any payment by us on the notes following
such acceleration will be subject to the subordination
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provisions described above. After any such acceleration, but before a judgment
or decree based on acceleration, the holders of a majority in aggregate
principal amount of the notes may, under certain circumstances, rescind and
annul such acceleration if all the events of default, other than the non-payment
of accelerated principal, have been cured or waived.
Holders of the notes may not enforce the Indenture or the notes except
as provided in the Indenture. Subject to the provisions of the Indenture
relating to the duties of the trustee in case an event of default shall occur
and be continuing, the trustee will be under no obligation to exercise any of
the rights or powers under the Indenture at the request or direction of any
holders of the notes, unless the holders shall have offered the trustee
indemnity and/or security satisfactory to it. Subject to the indemnification
provisions and certain limitations contained in the Indenture, the holders of a
majority in principal amount of the notes at the time outstanding will have the
right to direct the time, method and place of conducting any proceeding for any
remedy available to the trustee or exercising any trust or power conferred on
the trustee. Those holders may, in certain cases, waive any default except a
default in payment of principal of, or premium, if any, or interest, if any, on,
any note or a failure to comply with certain provisions of the Indenture
relating to conversion of the notes.
We are required to furnish the trustee annually with an officer's
certificate as to our compliance with the conditions and covenants provided for
in the Indenture and specifying any known defaults.
Additional Amounts
All payments in respect of the notes and delivery of ordinary shares
upon conversion of the notes shall be made free and clear of, and without
withholding or deduction for, any taxes, duties, assessments or governmental
charges of whatever nature imposed, levied, collected, withheld or assessed by
or within the Cayman Islands, Hong Kong or the People's Republic of China or any
authority therein or thereof having power to tax, unless such withholding or
deduction is required by law. In that event, we shall pay such additional
amounts ("Additional Amounts") or deliver such additional ordinary shares, as
the case may be, as will result in receipt by the holders of the notes of such
amounts such number of ordinary shares as would have been payable or deliverable
to the holders had no such withholding or deduction been required, except that
no such Additional Amounts shall be payable in respect of any tax or other
governmental charge that would not have been imposed but for a connection
between the holder or beneficial owner of a note and the Cayman Islands, Hong
Kong or the People's Republic of China or any political subdivision or any
authority thereof or therein, as the case may be, otherwise than merely holding
such note.
Unless the context otherwise requires, any reference in the notes to
payments shall be deemed to include any Additional Amounts which may be payable
as described above.
Discharge
The Indenture provides that we may terminate our obligations under the
Indenture at any time by delivering all outstanding notes to the trustee for
cancellation if we have paid all sums payable by us under the Indenture. At any
time within one year before the maturity of the notes or the redemption of all
the notes, we may terminate our substantive obligations under the Indenture,
other than our obligations to pay the principal of, and interest, if any, on,
the notes, by depositing with the trustee money or U.S. Government obligations
sufficient to pay all remaining indebtedness on the notes when due.
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Merger and Consolidation
We may not consolidate or merge with or into, or sell, lease, convey or
otherwise dispose of all or substantially all of our assets to another
corporation, person or entity (a "Merger Event") unless (i) (a) we are the
surviving person or the successor or transferee is a corporation organized under
the laws of the United States, any state thereof or in the District of Columbia,
or a corporation or comparable legal entity organized under the laws of a
foreign jurisdiction and whose equity securities are listed on a national
securities exchange in the United States or authorized for quotation on The
Nasdaq National Market, (b) the successor assumes all our obligations under the
notes and the Indenture (except, under certain circumstances, conversion
obligations) and enters into a supplemental indenture, (c) after such
transaction no event of default exists and (d) we deliver to the trustee an
officer's certificate and opinion of counsel that the transaction and the
supplemental indenture comply with the Indenture and that all conditions
precedent in the Indenture related to the transaction have been complied with or
(ii) we redeem the notes in whole for cash at the Merger Redemption Price (as
defined below), together with accrued and unpaid interest, if any.
If a Merger Event occurs and we do not meet the criteria under (i)
above, we shall have the obligation (the "Merger Redemption Obligation") to
redeem for cash all the notes on the date (the "Merger Redemption Date")
selected by us that is not less than 10 or more than 30 days after the Merger
Redemption Surrender Date (as defined below), at a price equal to the Merger
Redemption Price, together with accrued and unpaid interest, if any.
If the Merger Redemption Obligation applies, we will within 30 days
after the occurrence of a Merger Event deliver to the trustee and mail (or cause
the trustee to mail) to all holders of record of the notes a notice (the "Merger
Redemption Notice") describing, among other things, the occurrence of such
Merger Event and our obligation to repurchase the notes arising as a result
thereof and specifying the Merger Redemption Surrender Date and the Merger
Redemption Date. We must cause a copy of the Merger Redemption Notice to be
published in a newspaper of general circulation in the Borough of Manhattan, The
City of New York, which newspaper shall be The Wall Street Journal. Each holder
must, on or before the date (the "Merger Redemption Surrender Date") that is,
subject to any contrary requirements of applicable law, 60 days after the date
of mailing of the Merger Redemption Notice, surrender the notes (if such notes
are represented by a global note, by book-entry transfer to the conversion agent
through the facilities of DTC) with respect to which the right is being
exercised, duly endorsed for transfer to us, at any place where principal is
payable on the notes.
The term "Merger Redemption Price" shall mean, on any date of
determination, the sum of (i) 10% of the principal amount of a note plus (ii)
the trading price of the notes determined in accordance with the procedures
described under "--Conversion Rights--Conversion Upon Satisfaction of Trading
Price Condition"; provided however, that if the foregoing sum is less than the
principal amount of a note on the determination date, then the Merger Redemption
Price shall be the principal amount of a note.
Modification and Waiver
Subject to certain exceptions, supplements of and amendments to the
Indenture or the notes may be made by us and the trustee with the consent of the
holders of not less than a majority in aggregate principal amount of the
outstanding notes and any existing default or compliance with any provisions may
be waived with the consent of the holders of a majority in aggregate principal
amount of the outstanding notes. Without the consent of any holders of the
notes, we and the trustee may amend or supplement the Indenture or the notes to
cure any ambiguity, defect or inconsistency, to provide for the assumption of
our obligations to holders of the notes and to make certain changes with respect
to conversion rights in case of a merger or acquisition otherwise in compliance
with the Indenture or to make any change that does not
65
materially adversely affect the rights of any holder of the notes. Without the
consent of the holders of each note affected thereby, an amendment, supplement
or waiver may not:
(1) change the stated maturity date of the principal of, or premium,
if any, or interest, if any, on, any note, or adversely affect
the right to convert any note;
(2) reduce the principal amount or redemption price or repurchase
price of, or interest, if any, on, any note;
(3) change the currency for payment of principal of, or interest, if
any, on, any note;
(4) impair the right to institute suit for the enforcement of any
payment on or with respect to any note;
(5) modify the subordination provisions in a manner materially
adverse to the holders of the notes;
(6) reduce the above-stated percentage of outstanding notes necessary
to amend or supplement the Indenture or waive defaults or
compliance; or
(7) modify (with certain exceptions) any provisions of the Indenture
relating to modification and amendment of the Indenture or waiver
of compliance with conditions and defaults thereunder.
Concerning the Trustee
The Bank of New York, the trustee under the Indenture, has been
appointed by us as the initial paying agent, conversion agent and registrar (the
"Registrar") with regard to the notes. We and our subsidiaries may maintain
deposit accounts and conduct other banking transactions with the trustee or its
affiliates in the ordinary course of business, and the trustee and its
affiliates may from time to time in the future provide us with banking and
financial services in the ordinary course of their business.
In case an event of default shall occur (and shall not be cured) and
holders of the notes have notified the trustee, the trustee will be required to
exercise its powers with the degree of care and skill that a prudent person
would exercise under the circumstances in the conduct of such person's own
affairs. Subject to such provisions, the trustee is under no obligation to
exercise any of its rights or powers under the Indenture at the request of any
of the holders of notes, unless the holders shall have offered to the trustee
indemnity and/or security satisfactory to it.
Governing Law
The Indenture and notes are governed by and construed in accordance
with the laws of the State of New York.
Book-Entry Delivery and Form
The notes will be in the form of one or more global securities. The
global security has been deposited with the trustee as custodian for DTC and
registered in the name of a nominee of DTC. Except as set forth below, the
global security may be transferred, in whole and not in part, only to DTC or
another nominee of DTC. Holders of notes may hold beneficial interests in the
global security directly through DTC if they have an account with DTC or
indirectly through organizations which have accounts
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with DTC. Notes in definitive certificated form (called "certificated
securities") will be issued only in certain limited circumstances described
below.
DTC has advised us that it is:
. a limited purpose trust company organized under the laws of the
State of New York;
. a member of the Federal Reserve System;
. a "clearing corporation" within the meaning of the New York
Uniform Commercial Code; and
. a "clearing agency" registered pursuant to the provisions of
Section 17A of the Exchange Act.
DTC was created to hold securities of institutions that have accounts
with DTC (called "participants") and to facilitate the clearance and settlement
of securities transactions among its participants in such securities through
electronic book-entry changes in accounts of the participants, thereby
eliminating the need for physical movement of securities certificates. DTC's
participants include securities brokers and dealers, which may include the
initial purchaser, banks, trust companies, clearing corporations and certain
other organizations. Access to DTC's book-entry system is also available to
others such as banks, brokers, dealers and trust companies (called "indirect
participants") that clear through or maintain a custodial relationship with a
participant, whether directly or indirectly.
Pursuant to procedures established by DTC, DTC credits on its
book-entry registration and transfer system the principal amount of notes
represented by the global security to the accounts of participants. Ownership of
beneficial interests in the global security will be limited to participants or
persons that may hold interests through participants. Ownership of beneficial
interests in the global security are shown on, and the transfer of those
ownership interests are effected only through, records maintained by DTC (with
respect to participants' interests), the participants and the indirect
participants. The laws of some jurisdictions may require that certain purchasers
of securities take physical delivery of such securities in definitive form.
These limits and laws may impair the ability to transfer or pledge beneficial
interests in the global security.
Beneficial owners of interests in global securities who desire to
convert their interests into ordinary shares should contact their brokers or
other participants or indirect participants through whom they hold such
beneficial interests to obtain information on procedures, including proper forms
and cut-off times, for submitting requests for conversion.
So long as DTC, or its nominee, is the registered owner or holder of a
global security, DTC or its nominee, as the case may be, will be considered the
sole owner or holder of the notes represented by the global security for all
purposes under the Indenture and the notes. In addition, no beneficial owner of
an interest in a global security will be able to transfer that interest except
in accordance with the applicable procedures of DTC. Except as set forth below,
as an owner of a beneficial interest in the global security, a holder not be
entitled to have the notes represented by the global security registered in its
name, will not receive or be entitled to receive physical delivery of
certificated securities and will not be considered to be the owner or holder of
any notes under the global security. We understand that under existing industry
practice if an owner of a beneficial interest in the global security desires to
take any action that DTC, as the holder of the global security, is entitled to
take, DTC would authorize the participants to take such action and the
participants would authorize beneficial owners owning through such participants
to take such action or would otherwise act upon the instructions of beneficial
owners owning through them.
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We will make payments of principal of, and premium, if any, and
interest, if any, on, the notes represented by the global security registered in
the name of and held by DTC or its nominee to DTC or its nominee, as the case
may be, as the registered owner and holder of the global security. Neither we,
the trustee, nor any paying agent will have any responsibility or liability for
any aspect of the records relating to or payments made on account of beneficial
ownership interests in the global security or for maintaining, supervising or
reviewing any records relating to such beneficial ownership interests.
We expect that DTC or its nominee, upon receipt of any payment of
principal of, or premium, if any, or interest, if any, on, the global security,
will credit participants' accounts with payments in amounts proportionate to
their respective beneficial interests in the principal amount of the global
security as shown on the records of DTC or its nominee. We also expect that
payments by participants or indirect participants to owners of beneficial
interests in the global security held through such participants or indirect
participants will be governed by standing instructions and customary practices
and will be the responsibility of such participants or indirect participants. We
will not have any responsibility or liability for any aspect of the records
relating to, or payments made on account of, beneficial ownership interests in
the global security for any note or for maintaining, supervising or reviewing
any records relating to such beneficial ownership interests or for any other
aspect of the relationship between DTC and its participants or indirect
participants or the relationship between such participants or indirect
participants and the owners of beneficial interests in the global security
owning through such participants.
Transfers between participants in DTC will be effected in the ordinary
way in accordance with DTC rules and will be settled in same-day funds.
DTC has advised us that it will take any action permitted to be taken
by a holder of notes only at the direction of one or more participants to whose
account the DTC interests in the global security are credited and only in
respect of such portion of the aggregate principal amount of notes as to which
such participant or participants has or have given such direction. However, if
DTC notifies us that it is unwilling to be a depository for the global security
or ceases to be a clearing agency or an event of default has occurred and is
continuing under the Indenture, DTC will exchange the global security for
certificated securities that it will distribute to its participants and that
will be legended, if required.
Although DTC is expected to follow the foregoing procedures in order to
facilitate transfers of interests in the global security among participants of
DTC, it is under no obligation to perform or continue to perform such
procedures, and such procedures may be discontinued at any time. Neither we nor
the trustee will have any responsibility or liability for the performance by DTC
or the participants or indirect participants of their respective obligations
under the rules and procedures governing their respective operations.
Registration Rights
We have agreed pursuant to a registration rights agreement, with the
initial purchaser of the notes, Credit Suisse First Boston LLC, for the benefit
of the holders of the notes and the ordinary shares issuable upon the conversion
thereof, that we will file the shelf registration statement of which this
prospectus is a part with the SEC covering resales of the notes and ordinary
shares issuable upon conversion of the notes within 90 days of the initial sale
of the notes to Credit Suisse First Boston LLC. We will use our commercially
reasonable efforts to cause the shelf registration statement to become effective
within 180 days of that initial sale.
We will use commercially reasonable efforts to keep the shelf
registration statement effective after its effective date until the date which
is the earliest of:
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(1) the second anniversary of the effective date of the shelf
registration statement,
(2) such time as all the transfer restricted securities have been
sold pursuant to the shelf registration statement, transferred
pursuant to Rule 144 under the Securities Act or otherwise
transferred in a manner that results in such securities not being
subject to transfer restrictions under the Securities Act and the
absence of a need for a restrictive legend regarding registration
under the Securities Act, and
(3) such time as all of the transfer restricted securities held by
our nonaffiliates (from the time of issuance) are eligible for
sale pursuant to Rule 144(k) under the Securities Act or any
successor rule or regulation thereto.
A "transfer restricted security" means any note or ordinary share
issuable upon conversion of a note until the date the security has been
effectively registered under the Securities Act and disposed of under a shelf
registration statement or the date on which the security is distributed to the
public pursuant to Rule 144 under the Securities Act or is saleable pursuant to
Rule 144(k) under the Securities Act.
We will, in the event the shelf registration statement is filed, among
other things, provide to each securityholder for whom such shelf registration
statement was filed one copy of the shelf registration statement, notify each
such holder when the shelf registration statement has become effective and take
certain other actions as are required to permit resales of the transfer
restricted securities by such holders to third parties, including one
underwritten offering as described below.
We may suspend the use of the prospectus under certain circumstances
relating to pending corporate developments, public filings with the SEC and
similar events. Any suspension period shall not:
. exceed an aggregate of 45 days for all suspensions in any 90-day
period; or
. exceed an aggregate of 120 days for all suspensions in any
12-month period.
In the event that:
(1) by the 180th day after the first date of original issuance of the
notes, the shelf registration statement has not been declared
effective by the SEC, or
(2) after the shelf registration statement has been declared
effective, such shelf registration statement ceases to be
effective (subject to the blackout period described above and to
certain exceptions described in the registration rights
agreement) in connection with resales of transfer restricted
securities in accordance with and during the periods specified in
the registration rights agreement (each such event referred to in
clauses (2) and (3), a "Registration Default"),
additional interest will be payable on the notes from and including the date on
which any such Registration Default shall occur to, but excluding the date on
which all Registration Defaults have been cured, at the rate of 0.5% per annum
so long as such notes are transfer restricted securities. We will have no other
liabilities for monetary damages with respect to our registration obligations.
A holder who elects to sell any transfer restricted securities pursuant
to the shelf registration statement:
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. will be required to deliver a notice and questionnaire to us and
be named as a selling securityholder in the related prospectus;
. be required to deliver a prospectus to purchasers;
. will be bound by the provisions of the registration rights
agreement that apply to a holder making such an election,
including certain indemnification provisions.
We shall use commercially reasonably efforts to add any securityholders
who properly complete and deliver a notice and questionnaire to the shelf
registration statement as a selling securityholder by means of a pre-effective
amendment or, if permitted by the SEC, by means of a post-effective amendment or
prospectus supplement; provided that any such failure to file such pre-effective
amendment, post-effective amendment or prospectus supplement will not result in
the payment of additional interest.
The registration rights agreement provides that holders of at least 33%
of the then-outstanding transfer restricted securities may elect to have one
underwritten offering of those securities. The managing underwriter(s) for any
such offering must be selected by holders of a majority of the transfer
restricted securities to be included in the underwritten offering and must be
reasonably acceptable to us.
We will pay all registration expenses of the shelf registration;
provided that each selling securityholder will be responsible for its share of
certain expenses incurred in connection with an offering, as described under
"Plan of Distribution" below.
The summary in this prospectus of certain provisions of the
registration rights agreement does not purport to be complete and is subject to,
and is qualified in its entirety by reference to, all the provisions of the
registration rights agreement, a copy of which is available upon request to us.
Repurchase and Cancellation
All notes surrendered for payment, redemption, registration of transfer
or exchange or conversion shall, if surrendered to any person other than the
trustee, be delivered to the trustee. All notes delivered to the trustee shall
be cancelled promptly by the trustee. No notes shall be authenticated in
exchange for any notes cancelled as provided in the Indenture. We may, to the
extent permitted by law, repurchase notes in the open market or by tender offer
at any price or by private agreement. Any notes repurchased by us may, to the
extent permitted by law, be reissued or resold or may, at our option, be
surrendered to the trustee for cancellation. Any notes surrendered for
cancellation may not be reissued or resold and will be promptly cancelled. Any
notes held by us or one of our subsidiaries shall be disregarded for voting
purposes in connection with any notice, waiver, consent or direction requiring
the vote or concurrence of note holders.
Replacement of Notes
We will replace mutilated, destroyed, stolen or lost notes at a
holder's expense upon delivery to the trustee of the mutilated notes, or
evidence of the loss, theft or destruction of the notes satisfactory to us and
the trustee. In the case of a lost, stolen or destroyed note, indemnity
satisfactory to the trustee and us may be required at the expense of the holder
of such note before a replacement note will be issued.
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DESCRIPTION OF SHARE CAPITAL
As of September 30, 2003, our authorized share capital consisted of
1,000,300,000,000 ordinary shares, par value $0.0001 per share, and there were
3,126,540,189 ordinary shares issued and outstanding. We are a Cayman Islands
company and our affairs are governed by our Amended and Restated Memorandum and
Articles of Association and the Companies Law (2003 Revision) of the Cayman
Islands. The following are summaries of material provisions of our Amended and
Restated Memorandum and Articles of Association and the Companies Law insofar as
they relate to the material terms of our ordinary shares.
Rights, Preferences and Restrictions of Ordinary Shares
General. All of our outstanding ordinary shares are fully paid and
nonassessable. Certificates representing the ordinary shares are issued in
registered form. Our shareholders who are nonresidents of the Cayman Islands may
freely hold and vote their shares.
Dividends. The holders of ordinary shares are entitled to such
dividends as may be declared by our board of directors.
Voting Rights. Each ordinary share is entitled to one vote on all
matters upon which the ordinary shares are entitled to vote, including the
election of directors. Voting at any meeting of shareholders is by show of hands
unless a poll is demanded. A poll may be demanded by the Chairman or any other
shareholder present in person or by proxy. A quorum required for a meeting of
shareholders consists of at least two shareholders present or by proxy.
Any ordinary resolution to be made 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 cast attaching to the
ordinary shares. A special resolution is required for matters such as a change
of name. Holders of the ordinary shares may by ordinary resolution, among other
things, elect directors, appoint auditors, and make changes in the amount of our
authorized share capital.
Liquidation. On a return of capital on winding up or otherwise (other
than on conversion, redemption or repurchase of shares) assets available for
distribution among the holders of ordinary shares shall be distributed among the
holders of the ordinary shares pro rata. If the 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 amounts 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 are subject to forfeiture.
Redemption of Shares. We may issue shares on the terms that they are,
or at our option or at the option of the holders are, subject to redemption on
such terms and in such manner as we may determine by special resolution.
Variations 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
consent in writing of the holders of three-fourths of the issued
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shares of that class or with the sanction of a special resolution passed at a
general meeting of the holders of the shares of that class.
General Meetings of Shareholders
The directors may whenever they think fit, and they shall on the
requisition of our shareholders holding at the date of the deposit of the
requisition not less than one-tenth of our paid-up capital as at the date of the
deposit carries the right of voting at general meetings of our company, proceed
to convene a general meeting of our company. If the directors do not within 21
days from the date of the deposit of the requisition duly proceed to convene a
general meeting, the requisitionists, or any of them representing more than
one-half of the total voting rights of all of them, may themselves convene a
general meeting, but any meeting so convened shall not be held after the
expiration of three months after the expiration of such 21 days. Advanced notice
of at least five days is required for the convening of the annual general
meeting and other shareholders meetings.
Limitations on the Right to Own Shares
There are no limitations on the right to own our shares.
Limitations on Transfer of Shares
There are no provisions in our restated memorandum or articles of
association that would have an effect of delaying, deferring or preventing a
change in control and that would operate only with respect to a merger,
acquisition or corporate restructuring.
Disclosure of Shareholder Ownership
There are no provisions our restated memorandum or articles of
association governing the ownership threshold above which shareholder ownership
must be disclosed.
Changes in Capital
We may from time to time by ordinary resolution increase the share
capital by such sum, to be divided into shares of such amount, as the resolution
shall prescribe. The new shares shall be subject to the same provisions with
reference to the payment of calls, lien, transfer, transmission, forfeiture and
otherwise as the shares in the original share capital. We may by ordinary
resolution:
(a) consolidate and divide all or any of our share capital into
shares of larger amount than our existing shares;
(b) sub-divide our existing shares, or any of them into shares of
smaller amount than is fixed by our restated memorandum of
association, subject nevertheless to the provisions of Section
12 of the Companies Law; or
(c) cancel any shares which, at the date of the passing of the
resolution, have not been taken or agreed to be taken by any
person.
We may by special resolution reduce our share capital and any capital
redemption reserve fund in any manner authorized by law.
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Differences in Corporate Law
The Companies Law is modeled after that of the United Kingdom but does
not follow recent United Kingdom statutory enactments and differs from laws
applicable to United States corporations and their shareholders. Set forth below
is a summary of the significant differences between the provisions of the
Companies Law applicable to NetEase.com and the laws applicable to companies
incorporated in the United States and their shareholders.
Mergers and Similar Arrangements. Cayman Islands law does not provide
for mergers as that expression is understood under United States corporate law.
However, there are statutory provisions that facilitate the reconstruction and
amalgamation of companies, provided that the arrangement in question is approved
by a majority in number of each class of shareholders and 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 would have 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 satisfies itself that:
. the statutory provisions as to majority vote have been complied
with;
. the shareholders have been fairly represented at the meeting in
question;
. the arrangement is such as a businessman would reasonably
approve; and
. the arrangement is not one that would more properly be sanctioned
under some other provision of the Companies Law.
When a take-over offer is made and accepted by holders of 90% of the
shares within four months, the offeror may, within a two 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 unless there is evidence of fraud, bad faith or
collusion.
If the arrangement and reconstruction is thus approved, the dissenting
shareholder would have no rights comparable to appraisal rights, which would
otherwise ordinarily be available to dissenting shareholders of United States
corporations, providing rights to receive payment in cash for the judicially
determined value of the shares.
Shareholders' Suits. Our Cayman Islands counsel is not aware of any
reported class action or derivative action having been brought in a Cayman
Islands court. In principle, we will normally be the proper plaintiff and a
derivative action may not be brought by a minority shareholder. However, based
on English authorities, which would in all likelihood be of persuasive authority
in the Cayman Islands, exceptions to the foregoing principle apply in
circumstances in which:
. a company is acting or proposing to act illegally or ultra vires;
. the act complained of, although not ultra vires, could be
effected only if authorized by more than a simple majority vote;
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. the individual rights of the plaintiff shareholder have been
infringed or are about to be infringed; or
. those who control the company are perpetrating a "fraud on the
minority."
Indemnification. Cayman Islands law does not (other than as set forth
hereafter) limit the extent to which a company's organizational documents may
provide for indemnification of officers and directors, except to the extent any
such provision may be held by the Cayman Islands courts to be contrary to public
policy, such as to provide indemnification against civil fraud or the
consequences of committing a crime. Our Articles of Association provide for
indemnification of officers and directors for losses, damages, costs and
expenses incurred in their capacities as such, except through their own willful
neglect or default.
Insofar as indemnification or liability arising under the Securities
Act may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, we have been informed that in
the opinion of the U.S. Securities and Exchange Commission such indemnification
is against public policy as expressed in the Securities Act and is therefore
unenforceable.
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DESCRIPTION OF AMERICAN DEPOSITARY SHARES
The Bank of New York acts as the depositary bank for our American
Depositary Shares or ADSs. ADSs represent ownership interests in securities that
are on deposit with a depositary bank. ADSs are normally represented by
certificates that are commonly known as American Depositary Receipts or ADRs.
The depositary bank typically appoints a custodian to safekeep the securities on
deposit. In this case, the custodian is The Hongkong and Shanghai Banking
Corporation Limited, Custody and Clearing, Hong Kong office.
We have appointed The Bank of New York as depositary bank pursuant to a
deposit agreement entered into by us, The Bank of New York as depositary,
registered holders of outstanding ADSs and the owners of a beneficial interest
in ADSs evidenced by ADRs.
You should read this summary together with the deposit agreement and
the ADR. You can inspect a copy of the deposit agreement at the corporate trust
office of the depositary, currently located at 101 Barclay Street, New York, New
York 10286, and at the principal offices of the custodian, which acts as agent
of depositary, currently located at Basement 1 & 2, 1 Queen's Road Central, Hong
Kong. A copy of the deposit agreement is on file with the U.S. Securities and
Exchange Commission under cover of a registration statement on Form F-6. You may
obtain a copy of the deposit agreement as indicated under "Where You Can Find
More Information."
We are providing you with a summary description of the ADSs and your
rights as an owner of ADSs in the event that you convert your notes into
ordinary shares and then wish to deposit such ordinary shares for the issuance
of ADSs. Please remember that summaries by their nature lack the precision of
the information summarized and that a holder's rights and obligations as an
owner of ADSs will be determined by the deposit agreement and not by this
summary. We urge you to review the deposit agreement in its entirety as well as
the form of ADR attached to the deposit agreement.
If you become an owner of an ADS, you will become a party to the
deposit agreement and therefore will be bound to its terms and to the terms of
the ADR that represents your ADSs. The deposit agreement and the ADR specify our
rights and obligations as well as your rights and obligations as owner of ADSs
and those of the depositary. As an ADS holder, you appoint the depositary to act
on your behalf in certain circumstances. Although the deposit agreement is
governed by New York law, our obligations to the holders of our ordinary shares
will continue to be governed by the laws of the Cayman Islands, which may be
different from the laws in the United States.
You may hold ADRs either directly or indirectly through your broker or
other financial institution. If you hold ADRs directly, you are an ADR holder.
This description assumes you hold your ADRs directly. If you hold the ADRs
indirectly, you must rely on the procedures of your broker or other financial
institution to assert the rights of ADR holders described in this section. You
should consult with your broker or financial institution to find out what those
procedures are.
Deposit, Withdrawal and Cancellation
Each ADS currently represents 100 ordinary shares and will also
represent any other securities, cash or other property deposited with The Bank
of New York but not distributed to ADS holders. The depositary will only issue
ADSs in whole numbers. Accordingly, any amount of ordinary shares which is not
divisible into 100 (or the then current conversion ratio) cannot be deposited
for the issuance of ADSs, unless it is aggregated with other shares which
together are divisible by 100 (or the then current conversion ratio).
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The Bank of New York will issue ADRs if you or your broker deposit
ordinary shares or evidence of rights to receive ordinary shares with the
custodian. The issuance of ADSs may be delayed until the depositary or the
custodian receives confirmation that all required approvals have been given and
that the number of ordinary shares have been duly transferred to the custodian.
In addition, our deposit agreement provides that any ordinary shares deposited
for inclusion in the ADS program should be accompanied by appropriate
instruments of transfer or endorsement, in the form satisfactory to the
custodian, together with any certifications as may be reasonably required by the
depositary or the custodian. Ordinary shares cannot be deposited unless, upon
deposit, the ordinary shares will be free of all transfer restrictions.
Therefore, ordinary shares issued upon conversion of the notes cannot be
deposited unless (i) the shares have been resold in a transaction that is
effectively registered under the resale registration statement described above
under "Description of the Notes--Registration Rights," (ii) the shares have been
resold in a transaction that complies with Rule 144 under the Securities Act or
(iii) the exemption provided by Rule 144(k) under the Securities Act is
available and we have removed the transfer restriction legend from the share
certificate at the holder's request. We have been informed by The Bank of New
York that it intends to require holders who wish to deposit ordinary shares that
may have been issued upon conversion of the notes to provide evidence
satisfactory to it that the conditions specified in clause (i), (ii) or (iii) of
the preceding sentence have been satisfied. Such holders may also be required to
provide a legal opinion to that effect to The Bank of New York at their own
expense.
You may turn in your ADRs at The Bank of New York's office. Upon
payment of its fees and expenses and of any taxes or charges, such as stamp
taxes or stock transfer taxes or fees, The Bank of New York will deliver the
amount of deposited securities underlying the ADR at the office of the
custodian, or, at your request, risk and expense, The Bank of New York will
deliver the deposited securities at its office.
Share Dividends and Other Distributions
The Bank of New York has agreed to pay to you the cash dividends or
other distributions it or the custodian receives on shares or other deposited
securities after deducting its fees and expenses. You will receive these
distributions in proportion to the number of shares your ADRs represent.
Cash. The Bank of New York will promptly convert any cash dividend or
other cash distribution we pay on the shares into U.S. dollars, if it can do so
on a reasonable basis and can transfer the U.S. dollars to the United States. If
such conversion or distribution can be effected only with the approval or
license of any government or agency thereof, The Bank of New York shall file
such application for approval or license, if any. If such conversion is not
possible on a reasonable basis or any approval or license of any government or
agency is needed and cannot be obtained, the deposit agreement allows The Bank
of New York to distribute Renminbi only to those ADR holders to whom it is
possible to do so. It will hold Renminbi it cannot convert for the account of
the ADR holders who have not been paid. It will not invest Renminbi and it will
not be liable for interest.
Before making a distribution, any withholding taxes that must be paid
under United States law will be deducted. The Bank of New York will distribute
only whole U.S. dollars and cents and will round fractional cents to the nearest
whole cent. If the exchange rates fluctuate during a time when The Bank of New
York cannot convert the Renminbi, you may lose some or all of the value of the
distribution.
Shares. The Bank of New York may distribute new ADRs representing any
shares we may distribute as a dividend or free distribution, if we furnish it
promptly with satisfactory evidence that it is legal to do so. The Bank of New
York will only distribute whole ADRs. It will sell shares which would require it
to issue a fractional ADR and distribute the net proceeds in the same way as it
does with cash. If
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The Bank of New York does not distribute additional ADRs, each ADR will also
represent the new shares.
Rights to Receive Additional Shares. If we offer holders of our
ordinary shares any rights to subscribe for additional shares or any other
rights, The Bank of New York may make these rights available to you. We must
first instruct The Bank of New York to do so and furnish it with satisfactory
evidence that it is legal to do so. If we do not furnish this evidence and/or
give these instructions, and The Bank of New York decides it is practical to
sell the rights, The Bank of New York will sell the rights and distribute the
proceeds, in the same way as it does with cash. The Bank of New York may allow
rights that are not distributed or sold to lapse. In that case, you will receive
no value for them.
If The Bank of New York makes rights available to you, it will exercise
the rights and purchase the shares on your behalf. The Bank of New York will
then deposit the shares and issue ADRs to you. It will only exercise rights if
you pay it the exercise price and any other charges the rights require you to
pay.
U.S. securities laws may restrict the sale, deposit, cancellation and
transfer of the ADRs issued after exercise of rights. For example, you may not
be able to trade the ADRs freely in the United States. In this case, The Bank of
New York may issue the ADRs under a separate restricted deposit agreement which
will contain the same provisions as the deposit agreement, except for the
changes needed to put the restrictions in place.
Other Distributions. The Bank of New York will send to you anything
else we distribute on deposited securities by means it thinks are legal and
practical. If it cannot make the distribution in that way, The Bank of New York
has a choice. It may decide to sell what we distributed and distribute the net
proceeds in the same way as it does with cash or it may decide to hold what we
distributed, in which case the ADRs will also represent the newly distributed
property.
The Bank of New York is not responsible if it decides that it is
unlawful or impractical to make a distribution available to any ADR holders. We
have no obligation to register ADRs, shares, rights or other securities under
the Securities Act. We also have no obligation to take any other action to
permit the distribution of ADRs, shares, rights, or anything else to ADR
holders. This means that you may not receive the distribution we make on our
shares or any value for them if it is illegal or impractical for us to make them
available to you.
Voting Rights
You may instruct The Bank of New York to vote the shares underlying
your ADRs but only if we ask The Bank of New York to ask for your instructions.
Otherwise, you will not be able to exercise your right to vote unless you
withdraw the shares. However, you may not know about the meeting enough in
advance to withdraw the shares.
If we ask for your instructions, The Bank of New York will notify you
of the upcoming vote and arrange to deliver our voting materials to you. The
materials will:
(1) describe the matters to be voted on; and
(2) explain how you, on a specified date, may instruct The Bank of
New York to vote the shares or other deposited securities
underlying your ADRs as you direct. For instructions to be valid,
The Bank of New York must receive them on or before the date
specified. The Bank of New York will try, in compliance with
Cayman Islands law or Hong Kong
77
law and the provisions of our memorandum and articles of
association, to vote or to have its agents vote the shares or
other deposited securities as you instruct. The Bank of New York
will only vote or attempt to vote as you instruct.
If The Bank of New York does not receive voting instructions from you
by the specified date, it will consider you to have authorized us to vote the
number of deposited securities represented by your ADSs. The Bank of New York
will give us a discretionary proxy in those circumstances to vote on all
questions to be voted upon unless we notify the depositary that:
(1) we do not wish to receive a discretionary proxy;
(2) we think there is substantial shareholder opposition to the
particular question; or
(3) we think the particular question would have a material adverse
impact on our shareholders.
We cannot assure you that you will receive the voting materials in time
to ensure that you can instruct The Bank of New York to vote your shares. In
addition, The Bank of New York and its agents are not responsible for failing to
carry out voting instructions or for the manner of carrying out voting
instructions. This means that you may not be able to exercise your right to vote
and there may be nothing you can do if your shares are not voted as you
requested.
Fees and Expenses
ADR holders must pay: For:
US$5.00 (or less) per 100 ADSs Each issuance of an ADR, including
as a result of a distribution of
shares or rights or other property
Each cancellation of an ADR,
including if the agreement
terminates
US$1.50 (or less) per ADS Registration of transfer of receipts
US$0.02 (or less) per ADS Any cash payment
Registration or Transfer Fees Transfer and registration of shares
on the share register of the Foreign
Registrar from your name to the name
of The Bank of New York or its agent
when you deposit or withdraw shares
Expenses incurred by The Bank of New York Conversion of Renminbi to U.S.
dollars Cable, telex and facsimile
transmission expenses
Taxes and other governmental charges As necessary
The Bank of New York or the Custodian have
to pay on any ADR or any share underlying
an ADR, for example, stock transfer taxes,
stamp duty or withholding taxes
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Payment of Taxes
You will be responsible for any taxes or other governmental charges
payable on your ADRs or on the deposited securities underlying your ADRs. The
Bank of New York may refuse to transfer your ADRs or allow you to withdraw the
deposited securities underlying your ADRs until such taxes or other charges are
paid. It may apply payments owed to you or sell deposited securities underlying
your ADRs to pay any taxes owed and you will remain liable for any deficiency.
If it sells deposited securities, it will, if appropriate, reduce the number of
ADRs to reflect the sale and pay to you any proceeds, or send to you any
property, remaining after it has paid the taxes.
Reclassifications, Recaptalizations and Mergers
If we: Then:
. Change the nominal or par value of our The cash, shares or other securities received by The
shares; Bank of New York will become deposited securities.
Each ADR will automatically represent its equal share
. Reclassify, split up or consolidate any of of the new deposited securities.
the deposited securities;
. Distribute securities on the shares that The Bank of New York may, and will if we ask it to,
are not distributed to you; distribute some or all of the cash, shares or other
securities it received. It may also issue new ADRs or
. Recapitalize, reorganize, merge, ask you to surrender your outstanding ADRs in
liquidate, sell all or substantially exchange for new ADRs identifying the new deposited
all of our assets; or securities.
. Take any similar action
Amendment and Termination
We may agree with The Bank of New York to amend the deposit agreement
and the ADRs without your consent for any reason. If the amendment will cause
any of the following results, the amendment will become effective 30 days after
The Bank of New York notifies you of the amendment:
. adds or increases fees or charges, except for:
-- taxes and other government charges;
-- registration fees;
-- cable, telex or facsimile transmission costs; or
-- delivery costs or other such expenses; or
. prejudices any substantial right of ADR holders.
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At the time an amendment becomes effective, you are considered, by
continuing to hold your ADRs, to agree to the amendment and to be bound by the
ADRs and the deposit agreement, as amended.
The Bank of New York will terminate the deposit agreement if we ask it
to do so. In such case, The Bank of New York must notify you at least 30 days
before termination. The Bank of New York may also terminate the deposit
agreement if The Bank of New York has told us that it would like to resign and
we have not appointed a new depositary bank within 90 days.
After termination, The Bank of New York and its agents will be required
to do only the following under the deposit agreement:
. advise you that the deposit agreement is terminated; and
. collect distributions on the deposited securities and deliver the
deliverable portion of shares and other deposited securities upon
cancellation of ADRs.
One year after termination, The Bank of New York may sell any remaining
deposited securities by public or private sale. After that, The Bank of New York
will hold the proceeds of the sale, as well as any other cash it is holding
under the deposit agreement for the pro rata benefit of the ADR holders that
have not surrendered their ADRs or are unable to surrender their ADRs because
they represent less than a unit of shares. It will not invest the money and will
have no liability for interest. The Bank of New York's only obligations will be
an indemnification obligation and an obligation to account for the proceeds of
the sale and other cash. After termination, our only obligations will be an
indemnification obligation and our obligation to pay specified amounts to The
Bank of New York.
Limitations on Obligations and Liability to ADR Holders
The deposit agreement expressly limits our obligations and the
obligations of The Bank of New York, and it limits our liability and the
liability of The Bank of New York. We and The Bank of New York:
. are only obligated to take the actions specifically provided for
in the deposit agreement without negligence or bad faith;
. are not liable if either is prevented or delayed by law or
circumstances beyond their control from performing their
obligations under the deposit agreement;
. are not liable if either exercises discretion permitted under the
deposit agreement;
. have no obligation to become involved in a lawsuit or other
proceeding related to the ADRs or the deposit agreement on your
behalf of any other party; and
. may rely upon any documents they believe in good faith to be
genuine and to have been signed or presented by the proper party.
In the deposit agreement, we and The Bank of New York agree to
indemnify each other under designated circumstances.
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Requirements for Depositary Actions
Before The Bank of New York will issue or register the transfer of an
ADR, make a distribution on an ADR, or process a withdrawal of shares, The Bank
of New York may require:
. payment of stock transfer or other taxes or other governmental
charges and transfer or registration fees charged by third
parties for the transfer of any shares or other deposited
securities;
. production of satisfactory proof of the identity and genuineness
of any signature or other information it deems necessary; and
. compliance with regulations that it may establish, from time to
time, consistent with the deposit agreement, including
presentation of transfer documents.
The Bank of New York may refuse to deliver, transfer or register
transfers of ADRs generally when our books or the books of The Bank of New York
are closed, or at any time if The Bank of New York or we think it advisable to
do so.
You have the right to cancel your ADRs and withdraw the underlying
shares at any time except:
. when temporary delays arise because: (1) The Bank of New York or
we have closed its or our transfer books; (2) the transfer of
shares is blocked to permit voting at a shareholders' meeting; or
(3) we are paying a dividend on the shares;
. when you or other ADR holders seeking to withdraw shares owe
money to pay fees, taxes and similar charges; or
. when it is necessary to prohibit withdrawals in order to comply
with any laws or governmental regulations that apply to ADRs or
to the withdrawal of shares or other deposited securities.
This right of withdrawal may not be limited by any other provision of
the deposit agreement.
Pre-Release of ADRs
In compliance with the provisions of the deposit agreement, The Bank of
New York may issue ADRs before deposit of the underlying shares. This is called
a pre-release of the ADR. The Bank of New York may also deliver shares upon
cancellation of pre-released ADRs, even if the ADRs are cancelled before the
pre-release transaction has been closed out. A pre-release is closed out as soon
as the underlying shares are delivered to The Bank of New York. The Bank of New
York may receive ADRs instead of shares to close out a pre-release. The Bank of
New York may pre-release ADRs only under the following conditions:
. before or at the time of the pre-release, the person to whom the
pre-release is being made must represent to The Bank of New York
in writing that it or its customer owns the shares or ADRs to be
deposited;
. the pre-release must be fully collateralized with cash or other
collateral that The Bank of New York considers appropriate; and
. The Bank of New York must be able to close out the pre-release on
not more than five business days' notice.
In addition, The Bank of New York will limit the number of ADRs that
may be outstanding at any time as a result of pre-release to 30% of total shares
deposited, although The Bank of New York may disregard the limit from time to
time, if it thinks it is appropriate to do so.
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CAYMAN ISLANDS TAXATION
The Cayman Islands currently levy 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. There are no other taxes likely to
be material to NetEase levied by the Government of the Cayman Islands except for
stamp duties which may be applicable on instruments executed in, or after
execution brought within the jurisdiction of the Cayman Islands. The Cayman
Islands are not party to any double tax treaties. There are no exchange control
regulations or currency restrictions in the Cayman Islands.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of certain United States federal income tax
consequences relating to the purchase, ownership, and disposition of the notes
and of the ordinary shares into which the notes may be converted by an initial
purchaser. This description does not provide a complete analysis of all
potential tax consequences. The information provided below is based on the
Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations,
proposed Treasury Regulations, Internal Revenue Service ("IRS") published
rulings and court decisions, all as of the date hereof. These authorities may
change, possibly on a retroactive basis, or the IRS might interpret the existing
authorities differently. In either case, the tax consequences of purchasing,
owning or disposing of notes or ordinary shares could differ from those
described below. We do not intend to obtain a ruling from the IRS with respect
to the tax consequences of acquiring or holding the notes or ordinary shares.
This description is general in nature and does not discuss all aspects of
U.S. federal income taxation that may be relevant to a particular investor in
light of the investor's particular circumstances, or to certain types of
investors subject to special treatment under U.S. federal income tax laws (such
as banks or financial institutions, life insurance companies, tax-exempt
organizations, dealers in securities or foreign currencies, traders in
securities that elect to apply a mark-to-market method of accounting, persons
holding notes or ordinary shares as part of a position in a "straddle" or as
part of a "hedging," "conversion" or "integrated" transaction for U.S. federal
income tax purposes, persons subject to the alternative minimum tax provisions
of the Code, and persons that have a "functional currency" other than the U.S.
dollar). This description generally applies to purchasers of the notes who hold
the notes and the ordinary shares as capital assets. This description does not
consider the effect of any foreign, state, local or other tax laws that may be
applicable to particular investors.
Investors considering the purchase of notes and ordinary shares should
consult their own tax advisors regarding the application of the U.S. federal
income tax laws to their particular situations and the consequences of U.S.
federal estate or gift tax laws, foreign, state, or local laws, and tax
treaties.
U.S. Holders
As used in this prospectus, the term "U.S. Holder" means a beneficial owner
of a note or ordinary shares that is (i) a citizen or resident of the U.S. or
someone treated as a U.S. citizen or resident for U.S. federal income tax
purposes; (ii) a corporation or other entity taxable as a corporation for U.S.
federal income tax purposes organized in or under the laws of the U.S. or any
political subdivision thereof; (iii) an estate the income of which is subject to
U.S. federal income taxation regardless of its source; or (iv) a trust, if such
trust validly elects to be treated as a U.S. person for U.S. federal income tax
purposes, or if (a) a court within the U.S. can exercise primary supervision
over its administration and (b) one or more U.S. persons have the authority to
control all of the substantial decisions of such trust.
If a partnership (including for this purpose any entity treated as a
partnership for U.S. tax purposes) is a beneficial owner of the notes or
ordinary shares into which the notes may be converted, the U.S. tax treatment of
a partner in the partnership will generally depend on the status of the partner
and the activities of the partnership. A holder of the notes or ordinary shares
into which the notes may be converted that is a partnership and partners in such
partnership should consult their individual tax advisors about the U.S. federal
income tax consequences of holding and disposing of the notes and the ordinary
shares into which the notes may be converted.
For U.S. federal income tax purposes, U.S. Holders of ADSs will be treated
as owners of the underlying shares represented by such ADSs. Accordingly, this
discussion of U.S. federal income tax consequences to U.S. Holders of shares
applies equally to U.S. Holders of ADSs.
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If you are not a U.S. Holder, this subsection does not apply to you and you
should refer to "Non-U.S. Holders" below.
Contingent Debt Instrument Rules
If the amount or timing of any payments on a note is contingent, the note
could be subject to special rules that apply to contingent debt instruments.
These rules generally require a U.S. Holder to accrue interest income at a rate
higher than any stated interest rate on a note and to treat as ordinary income
(rather than capital gain) any gain recognized on a sale, exchange or retirement
of the note before the resolution of the contingencies. If, upon a Merger Event,
the company is required to redeem the notes, the amount paid to a U.S. Holder
could exceed the principal amount of the notes. Additionally, U.S. Holders would
be entitled to interest if the notes are not registered with the SEC within
prescribed time periods. We do not believe that, because of these potential
additional payments, the notes should be treated as contingent debt instruments.
Therefore, for purposes of filing tax on information returns with the IRS, we
will not treat the notes as contingent debt instruments. Unless otherwise noted,
this discussion assumes that the notes are not subject to the contingent debt
instrument rules.
Sale, Exchange or Redemption of the Notes or Conversion of Notes Solely for Cash
Subject to the passive foreign investment company rules discussed below, a
U.S. Holder generally will recognize capital gain or loss if the U.S. Holder
disposes of a note in a sale, redemption, exchange or conversion of the notes
solely for cash. The U.S. Holder's gain or loss will equal the difference
between the amount realized by the U.S. Holder and the U.S. Holder's adjusted
tax basis in the note. The U.S. Holder's adjusted tax basis in the note will
generally equal the amount the U.S. Holder paid for the note. The amount
realized by the U.S. Holder will include the amount of any cash and the fair
market value of any other property received for the note. The gain or loss
recognized by a U.S. Holder on a disposition of the note will be long-term
capital gain or loss if the U.S. Holder held the note for more than one year.
Long-term capital gains of non-corporate taxpayers are taxed at lower rates than
those applicable to ordinary income. The deductibility of capital losses is
subject to certain limitations.
Conversion of Note Solely for Ordinary Shares (and Cash in Lieu of a Fractional
Ordinary Share, if Any)
A U.S. Holder who converts a note into ordinary shares will not recognize
any income, gain or loss, except with respect to cash received in lieu of a
fractional ordinary share. The U.S. Holder's aggregate basis in the ordinary
shares (including any fractional ordinary share for which cash is paid) will be
equal to the U.S. Holder's adjusted basis in the note, and the U.S. Holder's
holding period for the ordinary shares will include the period during which the
U.S. Holder held the note. The U.S. Holder will recognize gain or loss upon the
receipt of cash paid in lieu of a fractional ordinary share measured by the
difference between the amount of cash received for the fractional share interest
and the U.S. Holder's tax basis in such fractional share interest.
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Conversion of Notes Partly for Ordinary Shares and Partly for Cash (Other Than
Solely in Lieu of a Fractional Ordinary Share)
A U.S. Holder who converts a note and receives a combination of ordinary
shares and cash (other than solely in lieu of a fractional ordinary share),
assuming the notes are securities for United States federal income tax purposes,
which is likely, will not recognize loss, but will generally recognize gain, if
any, on the notes so exchanged in an amount equal to the lesser of the amount of
(i) gain "realized" (i.e., the excess, if any, of the fair market value of the
ordinary shares received upon exchange plus cash received over the adjusted tax
basis in the notes tendered in exchange therefor) or (ii) cash received. Subject
to the passive foreign investment company rules discussed below, such gain will
be capital gain and will generally be long-term if the U.S. Holder's holding
period in respect of such note is more than one year. A U.S. Holder's tax basis
in the ordinary shares received should generally equal the adjusted tax basis in
notes tendered in exchange therefor, decreased by the cash received, and
increased by an amount of gain recognized. A U.S. Holder's holding period in the
ordinary shares received upon exchange of notes will include the holding period
of the notes so exchanged.
Constructive Dividends
If at any time we make a distribution of property to our stockholders that
would be taxable to the stockholders as a dividend for U.S. federal income tax
purposes and, in accordance with the anti-dilution provisions of notes, the
conversion price of notes is increased, such increase may be deemed to be the
payment of a taxable dividend, for United States federal income tax purposes, to
U.S. Holders of notes. For example, an increase in the conversion price in the
event of distributions of our debt instruments, or our assets, or an increase in
the event of an extraordinary cash dividend, generally will result in deemed
dividend treatment to holders of notes, but an increase in the event of stock
dividends or the distribution of rights to subscribe for our ordinary shares may
not.
Taxation of Dividends and Other Distributions on the Ordinary Shares
Subject to the passive foreign investment company rules discussed below,
all distributions to a U.S. Holder with respect to the ordinary shares, other
than certain pro rata distributions of our shares, will be includible in a U.S.
Holder's gross income as ordinary dividend income when received, but only to the
extent that the distribution is paid out of our current or accumulated earnings
and profits. For this purpose, earnings and profits will be computed under U.S.
federal income tax principles. The dividends will not be eligible for the
dividends-received deduction allowed to corporations. To the extent that the
amount of the distribution exceeds our current and accumulated earnings and
profits, it will be treated first as a tax-free return of your tax basis in the
ordinary shares, and to the extent the amount of the distribution exceeds the
U.S. Holder's tax basis, the excess will be taxed as capital gain.
Dividends paid in Renminbi will be included in your income as a U.S. dollar
amount based on the exchange rate in effect on the date that the U.S. Holder
receives the dividend, regardless of whether the payment is in fact converted
into U.S. dollars. If the U.S. Holder does not receive U.S. dollars on the date
the dividend is distributed, the U.S. Holder will be required to include either
gain or loss in income when the U.S. Holder later exchanges the Renminbi for
U.S. dollars. The gain or loss will be equal to the difference between the U.S.
dollar value of the amount that the U.S. Holder includes in income when the
dividend is received and the amount that the U.S. Holder receives on the
exchange of the Renminbi for U.S. dollars. The gain or loss generally will be
ordinary income or loss from United States sources. If we distribute as a
dividend non-cash property, the U.S. Holder will generally include in income an
amount equal to the U.S. dollar equivalent of the fair market value of the
property on the date that it is distributed.
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Dividends will constitute foreign source income for foreign tax credit
limitation purposes. 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 ordinary shares will be
"passive income" or, in the case of certain U.S. Holders, "financial services
income." In particular circumstances, a U.S. Holder that (i) has held the
ordinary shares for less than a specified minimum period during which it is not
protected from risk of loss, (ii) is obligated to make payments related to the
dividends, or (iii) holds the ordinary shares in arrangements in which the U.S.
Holder's expected economic profit, after non-U.S. taxes, is insubstantial will
not be allowed a foreign tax credit for foreign taxes imposed on dividends paid
on the ordinary shares.
Distributions to a U.S. Holder of shares or rights to subscribe for shares
that are received as part of a pro rata distribution to all our shareholders
should not be subject to U.S. federal income tax. The basis of the new shares or
rights so received will be determined by allocating the U.S. Holder's tax basis
in the ordinary shares between the ordinary shares and the new shares or rights
received, based on their relative fair market values on the date of
distribution. However, the basis of the new shares or rights will be zero if (i)
the fair market value of the new shares or rights is less than 15% of the fair
market value of the old ordinary shares at the time of distribution and (ii) the
U.S. Holder does not make an election to determine the basis of the new shares
by allocation as described above. The U.S. Holder's holding period in the new
shares or rights will generally include the holding period of the old ordinary
shares on which the distribution was made.
Taxation of Disposition of Ordinary Shares
Subject to the passive foreign investment company rules discussed below, a
U.S. Holder will recognize taxable gain or loss on any sale or exchange of an
ordinary shares equal to the difference between the amount realized (in U.S.
dollars) for the ordinary shares and the U.S. Holder's tax basis (in U.S.
dollars) in the ordinary shares. The gain or loss will be capital gain or loss.
Any gain or loss that you recognize will generally be treated as United States
source income or loss, except that losses will be treated as foreign source
losses to the extent you received dividends that were includible in the
financial services income basket during the 24-month period prior to the sale.
Passive Foreign Investment Company
We believe we were a passive foreign investment company for U.S. federal
income tax purposes for the taxable years ended on December 31st of 2000, 2001
and 2002, and we cannot be certain whether we will be treated as a passive
foreign investment company for the taxable year ending on December 31st of 2003.
If we are a passive foreign investment company in 2003, or in any subsequent
year in which a U.S. Holder holds the notes or ordinary shares, the U.S. Holder
generally will be subject to increased U.S. tax liabilities and reporting
requirements on receipt of certain dividends or on a disposition of ordinary
shares or, under proposed regulations, notes, although a shareholder election to
terminate such deemed passive foreign investment company status may be made in
certain circumstances. U.S. Holders should consult their own tax advisors
regarding our status as a passive foreign investment company, the consequences
of an investment in a passive foreign investment company, and the consequences
of making a shareholder election to terminate deemed passive foreign investment
company status if we no longer meet the income or asset test for passive foreign
investment company status in a subsequent taxable year.
A company is considered a passive foreign investment company for any
taxable year if either
. at least 75% of its gross income is passive income, or
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. at least 50% of the value of its assets (based on an average of the
quarterly values of the assets during a taxable year) is
attributable to assets that produce or are held for the production
of passive income.
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, more than 25% (by value) of the stock of such
corporation.
The determination that we were a passive foreign investment company for the
2000, 2001 and 2002 taxable years was based on our valuations of our assets,
including goodwill. In calculating goodwill, we have valued our total assets
based on our total market value determined using the average of the quarterly
selling prices of the shares for the relevant year and have made a number of
assumptions regarding the amount of this value allocable to goodwill. We believe
our valuation approach is reasonable. However, it is possible that the Internal
Revenue Service, or IRS, will challenge the valuation of our goodwill, which may
result in it becoming even more likely that we would be classified as a passive
foreign investment company for the 2003 taxable year as well as for subsequent
years. In addition, if our actual acquisitions and capital expenditures do not
match our projections, the likelihood that we are or will be classified as a
passive foreign investment company may also increase.
A separate determination must be made each year as to whether we are a
passive foreign investment company. As a result, our passive foreign investment
company status may change.
If we are a passive foreign investment company for any taxable year during
which a U.S. Holder holds notes or ordinary shares, the U.S. Holder will be
subject to special tax rules with respect to (i) any "excess distribution" that
the U.S. Holder receives on ordinary shares and (ii) any gain the U.S. Holder
realizes from a sale or other disposition (including a pledge) of (a) the
ordinary shares or (b), under proposed regulations which are not yet effective,
but are proposed to be effective from April 11, 1992, notes, unless the U.S.
Holder makes a "mark-to-market" election as discussed below. Distributions the
U.S. Holder receives in a taxable year that are greater than 125% of the average
annual distributions the U.S. Holder received during the shorter of the three
preceding taxable years or the U.S. Holder's holding period for the ordinary
shares will be treated as an excess distribution. Under these special tax rules:
. the excess distribution or gain will be allocated ratably over your
holding period for the ordinary shares or notes,
. the amount allocated to the current taxable year, and any taxable
year prior to the first taxable year in which we were a passive
foreign investment company, will be treated as ordinary income, and
. the amount allocated to each other year will be subject to tax at
the highest tax rate in effect for that year and the interest charge
generally applicable to underpayments of tax will be imposed on the
resulting tax attributable to each such 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, and gains (but not losses) realized on the sale of the ordinary shares
or notes cannot be treated as capital, even if the U.S. Holder holds the
ordinary shares or notes as capital assets.
A U.S. shareholder of a passive foreign investment company may avoid
taxation under the excess distribution rules discussed above by making a
"qualified electing fund" election to include the U.S.
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Holder's share of our income on a current basis. However, a U.S. Holder may make
a qualified electing fund election only if the passive foreign investment
company agrees to furnish the shareholder annually with certain tax information,
and we do not presently intend to prepare or provide such information.
Alternatively, a U.S. Holder of "marketable stock" in a passive foreign
investment company may make a mark-to-market election for stock of a passive
foreign investment company to elect out of the excess distribution rules
discussed above. If a U.S. Holder makes a mark-to-market election for the
ordinary shares, the U.S. Holder will include in income each year an amount
equal to the excess, if any, of the fair market value of the ordinary shares as
of the close of its taxable year over the U.S. Holder's adjusted basis in such
ordinary shares. A U.S. Holder is allowed a deduction for the excess, if any, of
the adjusted basis of the ordinary shares over their fair market value as of the
close of the taxable year only to the extent of any net mark-to-market gains on
the ordinary shares included in the U.S. Holder's income for prior taxable
years. Amounts included in a U.S. Holder's income under a mark-to-market
election, as well as gain on the actual sale or other disposition of the
ordinary shares, are treated as ordinary income. Ordinary loss treatment also
applies to the deductible portion of any mark-to-market loss on the ordinary
shares, as well as to any loss realized on the actual sale or disposition of the
ordinary shares, to the extent that the amount of such loss does not exceed the
net mark-to-market gains previously included for such ordinary shares. A U.S.
Holder's basis in the ordinary shares will be adjusted to reflect any such
income or loss amounts. The tax rules that apply to distributions by
corporations which are not passive foreign investment companies would apply to
distributions by us.
The mark-to-market election is available only for stock which is regularly
traded on a national securities exchange that is registered with the Securities
and Exchange Commission or on Nasdaq, or an exchange or market that the U.S.
Secretary of the Treasury determines has rules sufficient to ensure that the
market price represents a legitimate and sound fair market value. The
mark-to-market election would be available to a U.S. Holder unless our ordinary
shares are delisted from The Nasdaq National Market and do not subsequently
become regularly traded on The Nasdaq SmallCap Market or other qualified
exchange or market.
A U.S. Holder who holds ordinary shares in any year in which we are a
passive foreign investment company would be required to file IRS Form 8621
regarding distributions received on the ordinary shares and any gain realized on
the disposition of the ordinary shares.
Non-U.S. Holders
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
on dividends paid by us or on additional payments received with respect to the
notes unless the income is effectively connected with the Non- U.S. Holder's
conduct of a trade or business in the United States.
A Non-U.S. Holder generally will not be subject to U.S. federal income tax
on any gain attributable to a sale or other disposition of the notes or ordinary
shares unless such gain is effectively connected with the Non-U.S. Holder's
conduct of a trade or business within the United States or the Non-U.S. Holder
is a natural person who is present in the United States for 183 days or more and
certain other conditions exist. Dividends and gains that are effectively
connected with a Non-U.S. Holder's conduct of a trade or business in the United
States generally will be subject to tax in the same manner as they would be if
the Non-U.S. Holder were a U.S. Holder, except that the passive foreign
investment company rules will not apply. Effectively connected dividends and
gains received by a corporate Non-U.S. Holder may also be subject to an
additional branch profits tax at a 30% rate or a lower tax treaty rate.
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Information Reporting and Backup Withholding
In general, information reporting requirements will apply to dividends in
respect of the ordinary shares or the proceeds received on the sale, exchange or
redemption of ordinary shares or notes paid within the United States (and, in
certain cases, outside the United States) to U.S. Holders other than certain
exempt recipients, such as corporations, and backup withholding tax may apply to
such amounts if the U.S. Holder fails to provide an accurate taxpayer
identification number or to report interest and dividends required to be shown
on its U.S. federal income tax returns. The amount of any backup withholding
from a payment to a U.S. Holder will be allowed as credit against the U.S.
Holder's U.S. federal income tax liability provided that the appropriate returns
are filed.
A Non-U.S. Holder generally may eliminate the requirement for information
reporting and backup withholding by providing certification of its foreign
status to the payor, under penalties of perjury, on IRS Form W-8BEN.
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SELLING SECURITYHOLDERS
We originally issued the notes in a private placement on July 14, 2003 to
the initial purchaser, Credit Suisse First Boston LLC. The initial purchaser has
informed us that it resold the notes to purchasers in transactions exempt from
registration pursuant to Rule 144A promulgated under the Securities Act. Selling
securityholders may offer and sell the notes and the underlying ordinary shares
pursuant to this prospectus.
The following table contains information as of October 10, 2003 with
respect to the selling securityholders and the principal amount of notes and the
underlying ordinary shares beneficially owned by each selling securityholder
that may be offered using this prospectus. Unless set forth below and except for
the initial purchaser referenced above, none of the selling securityholders has
had within the past three years any material relationship with us or any of our
predecessors or affiliates.
Principal Amount at Number of
Maturity of Notes Percentage Ordinary Shares Percentage of
Beneficially Owned That of Notes That May Ordinary Shares
Name May Be Sold Outstanding Be Sold (1) Outstanding(2) (3)
Arbitex Master Fund, L.P. $ 7,500,000 7.50% 15,576,324 *
Argent Classic Convertible Arbitrage
Fund (Bermuda) Ltd. $ 1,300,000 1.30% 2,699,896 *
Argent Classic Convertible
Arbitrage Fund L.P. $ 600,000 * 1,246,106 *
Context Convertible Arbitrage
Fund, LP $ 800,000 * 1,661,475 *
Context Convertible Arbitrage
Offshore, Ltd. $ 1,200,000 1.20% 2,492,212 *
Credit Suisse First Boston LLC $ 5,000,000 5.00% 10,384,216 *
Forest Fulcrum Fund LP $ 840,000 * 2,273,748 *
Forest Multi-Strategy Master Fund SPC $ 1,145,000 1.145% 2,377,985 *
Forest Global Convertible Fund, Ltd.
Class A-5 $ 3,003,000 3.00% 6,230,529 *
Credit Suisse First Boston LLC $ 5,000,000 5.00% 10,384,216 *
JMG Capital Partners L.P. $ 5,000,000 5.00% 10,384,216 *
JMG Triton Offshore Fund, Ltd. $ 5,000,000 5.00% 10,384,216 *
KBC Financial Products USA Inc. $ 2,380,000 2.38% 4,942,886 *
Relay 11 Holdings Co. $ 204,000 * 423,676 *
Satellite Convertible Arbitrage Master
Fund, LLC $ 5,000,000 5.00% 10,384,216 *
Sphinx Convertible Arbitrage SPC $ 119,000 * 247,144 *
Xavex Convertible Arbitrage
10 Fund $ 100,000 * 207,684 *
-------------------------
* Less than 1%.
(1) Assumes conversion of all of the holder's notes at a conversion price of
0.4815 per ordinary share. This conversion price is subject to adjustment as
described under "Description of Notes--Conversion Rights." As a result, the
number of ordinary shares issuable upon conversion of the notes may increase in
the future.
(2) Calculated based on Rule 13d-3(d)(i) of the Exchange Act, using
3,126,540,189 ordinary shares outstanding as of October 8, 2003. In calculating
this amount for each holder, we treated as outstanding the number of ordinary
shares issuable upon conversion of all of that holder's notes, but we did not
assume conversion of any other holder's notes.
(3) Assumes that all holders of notes, or any future transferees, pledgees,
donees or successors of or from such holders of notes, do not beneficially own
any ordinary shares other than the ordinary shares issuable upon conversion of
the notes at the initial conversion rate.
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We prepared this table based on the information supplied to us by the
selling securityholders named in the table. The selling securityholders listed
in the above table may have sold or transferred, in transactions exempt from the
registration requirements of the Securities Act, some or all of their notes
since the date on which the information in the above table is presented.
Information about the selling securityholders may change from time to time. Any
changed information with respect to which we are given notice will be set forth
in prospectus supplements or amendments.
Because the selling securityholders may offer all or some of their notes or
the underlying ordinary shares from time to time, we cannot estimate the amount
of the notes or underlying ordinary shares that will be held by the selling
securityholders upon the termination of any particular offering. See "Plan of
Distribution."
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PLAN OF DISTRIBUTION
We will not receive any of the proceeds of the sale of the notes or the
ordinary shares issued upon conversion of the notes offered by this prospectus.
The notes and the underlying ordinary shares may be sold from time to time to
purchasers:
. directly by the selling securityholders;
. through underwriters, broker-dealers or agents who may receive
compensation in the form of discounts, concessions or commissions from
the selling securityholders or the purchasers of the ordinary shares.
The selling securityholders and any such broker-dealers or agents who
participate in the distribution of the notes and the underlying ordinary shares
may be deemed to be "underwriters." As a result, any profits on the sale of the
notes and the underlying ordinary shares by selling securityholders and any
discounts, commissions or concessions received by any such broker-dealers or
agents might be deemed to be underwriting discounts and commissions under the
Securities Act. If the selling securityholders were to be deemed underwriters,
the selling securityholders may be subject to certain statutory liabilities of,
including, but not limited to, Sections 11, 12 and 17 of the Securities Act and
Rule 10b-5 under the Exchange Act.
If the notes and the underlying ordinary shares are sold through
underwriters or broker-dealers, the selling securityholders will be responsible
for underwriting discounts or commissions or agent's commissions in addition to
the other fees and expenses set forth at the end of this section.
The notes and the underlying ordinary shares may be sold in one or more
transactions at:
. fixed prices;
. prevailing market prices at the time of sale;
. varying prices determined at the time of sale; or
. negotiated prices.
These sales may be effected in transactions:
. on any national securities exchange or quotation service on which the
notes and underlying ordinary shares may be listed or quoted at the
time of the sale, if any, including in the form of ADSs representing
ordinary shares;
. in the over-the-counter market;
. in transactions otherwise than on such exchanges or services or in the
over-the-counter market; or
. through the writing of options.
These transactions may include block transactions or crosses. Crosses are
transactions in which the same broker acts as an agent on both sides of the
trade.
In connection with sales of the notes and the underlying ordinary shares,
the selling securityholders may enter into hedging transactions with
broker-dealers. These broker-dealers may in turn engage in short sales of the
notes and the underlying ordinary shares in the course of hedging their
positions. The selling securityholders may also sell the notes and the
underlying ordinary shares short and deliver notes and the underlying ordinary
shares to close out short positions, or loan or pledge notes and
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the underlying ordinary shares to broker-dealers that in turn may sell the notes
and the underlying ordinary shares.
To our knowledge, there are currently no plans, arrangements or
understandings between any selling securityholders and any underwriter,
broker-dealer or agent regarding the sale of the notes and the underlying
ordinary shares by the selling securityholders. Selling securityholders may not
sell any or all of the notes and the underlying ordinary shares offered by them
pursuant to this prospectus. In addition, we cannot assure you that any such
selling securityholder will not transfer, devise or gift the notes and the
underlying ordinary shares by other means not described in this prospectus.
ADSs representing our ordinary shares are listed on the Nasdaq National
Market under the symbol "NTES." We do not intend to apply for the listing of the
notes or the underlying ordinary shares on any securities exchange or for
quotation through the Nasdaq National Market, but the notes are eligible for
trading in The Portal(SM) Market, a subsidiary of The Nasdaq Stock Market. We
cannot assure that the notes or the ordinary shares will be liquid or that any
trading for the notes will develop.
There can be no assurance that any selling securityholder will sell any or
all of the notes and the underlying ordinary shares pursuant to this prospectus.
In addition, any notes and the underlying ordinary shares covered by this
prospectus that qualify for sale pursuant to Rule 144 or Rule 144A of the
Securities Act may be sold under Rule 144 or Rule 144A rather than pursuant to
this prospectus.
The selling securityholders and any other person participating in such
distribution will be subject to the Securities Exchange Act of 1934, or the
Exchange Act. The Exchange Act rules include, without limitation, Regulation M,
which may limit the timing of purchases and sales of any of the notes and the
underlying ordinary shares by the selling securityholders and any other such
person. In addition, Regulation M of the Exchange Act may restrict the ability
of any person engaged in the distribution of the notes and the underlying
ordinary shares to engage in market-making activities with respect to the
particular notes and the underlying ordinary shares being distributed for a
period of up to five business days prior to the commencement of such
distribution. This may affect the marketability of the notes and the underlying
ordinary shares and the ability of any person or entity to engage in
market-making activities with respect to the notes and the underlying ordinary
shares.
Pursuant to the registration rights agreement filed as an exhibit to this
registration statement, we and the selling securityholders will be indemnified
by the other against certain liabilities, including certain liabilities under
the Securities Act or will be entitled to contribution in connection with these
liabilities.
We have agreed to pay all of the expenses incidental to the registration,
offering and sale of the notes and the underlying ordinary shares to the public
other than:
. costs incurred in connection with the printing and delivery of
prospectuses pursuant to Section 2(f) of the registration rights
agreement;
. costs incurred in connection with obtaining an opinion of counsel, a
comfort letter from our independent accountants and certain other
documents pursuant to Section 2(q) of the registration rights
agreement;
. all expenses payable in connection with a selling securityholder's
deposit of ordinary shares with The Bank of New York for the issuance
of ADSs; and
93
. if the offering is underwritten:
. underwriting discounts and commissions and transfer taxes, if
any, relating to the sale or disposition of the securities
pursuant to this prospectus;
. out-of-pocket expenses we reasonably incur in:
. facilitating an underwritten offering pursuant to Section
2(o) of the registration rights agreement;
. confirming or obtaining a rating for the notes, if so
requested pursuant to Section 2(r) of the registration
rights agreement; and
. assisting underwriters to comply with the rules of the
National Association of Securities Dealers, Inc., if
applicable, pursuant to Section 2(s) of the registration
rights agreement.
The following table sets forth the expenses, other than any expenses
payable by the selling securityholders as provided above, in connection with the
issuance and distribution of the securities being registered. All amounts
indicated are estimates (other than the registration fee):
Registration fee $ 12,292
Accounting fees and expenses $ 8,000
Printing and engraving $ 8,000
Legal fees and expenses of the registrant $ 25,000
Miscellaneous $ 5,000
--------------
Total $ 58,292
94
LEGAL MATTERS
The validity of the notes and ordinary shares issuable upon conversion of
the notes has been passed upon for our company by Maples and Calder Asia.
INDEPENDENT AUDITORS
The consolidated financial statements of NetEase and subsidiaries as of
December 31, 2000 and 2001 and for the years ended December 31, 1999, 2000 and
2001, incorporated by reference in this registration statement, were audited by
Arthur Andersen . Hua Qiang, as stated in their report incorporated by reference
in this prospectus. Arthur Andersen . Hua Qiang has ceased operations.
The consolidated financial statements as of and for the year ended December
31, 2002, incorporated by reference in this registration statement, have been
audited by PricewaterhouseCoopers, independent auditors, as stated in their
report incorporated by reference in this prospectus.
Arthur Andersen . Hua Qiang has not consented to the incorporation by
reference of their report on the financial statements of NetEase.com, Inc. for
the three years ended December 31, 2001 in this registration statement, and we
have dispensed with the requirement to file their consent in reliance upon Rule
437a of the Securities Act of 1933. Because Arthur Andersen . Hua Qiang has not
consented to the incorporation by reference of their report in this registration
statement, you will not be able to recover against Arthur Andersen . Hua Qiang
under Section 11 of the Securities Act of 1933 for any untrue statements of a
material fact contained in the financial statements audited by Arthur Andersen .
Hua Qiang or any omissions to state a material fact required to be stated
therein.
95
NETEASE.COM, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
FOR THE SIX MONTHS ENDED JUNE 30, 2003
December 31, June 30, June 30,
Note 2002 2003 2003
--------- ------------------ ------------------ -----------------
RMB RMB US$
(Unaudited) (Unaudited)
Assets
Current assets:
Cash 560,069,711 728,706,065 88,033,496
Restricted cash 1,208,305 1,217,622 147,098
Prepayments and other current assets 6,110,689 11,839,622 1,430,321
Due from related parties, net 22,448,509 8,063,540 974,140
------------------ ------------------ -----------------
Total current assets 589,837,214 749,826,849 90,585,055
Non-current rental deposit 1,065,912 1,273,337 153,829
Property, equipment and software, net 26,379,182 25,680,523 3,102,412
Deferred tax assets 2 2,395,888 9,387,280 1,134,058
------------------ ------------------ -----------------
Total assets 619,678,196 786,167,989 94,975,354
================== ================== =================
Liabilities & Shareholders' Equity
Current liabilities:
Accounts payable 3,814,614 4,419,563 533,919
Salary and welfare payable 16,023,380 13,089,024 1,581,258
Taxes payable 2 8,252,950 19,900,665 2,404,159
Deferred revenue 165,115 - -
Accrued liabilities 10,398,385 12,319,852 1,488,336
------------------ ------------------ -----------------
Total current liabilities 38,654,444 49,729,104 6,007,672
------------------ ------------------ -----------------
Long-term payable - 316,315 38,213
------------------ ------------------ -----------------
Total liabilities 38,654,444 50,045,419 6,045,885
------------------ ------------------ -----------------
Shareholders' equity:
Ordinary shares, US$0.0001 par value:
1,000,300,000,000 shares authorized,
3,100,162,537 shares issued and
outstanding as of December 31, 2002,
and 3,145,561,689 shares issued and
outstanding as of June 30, 2003 3 2,566,543 2,604,111 314,597
Additional paid-in capital 3 1,049,651,354 1,059,750,050 128,026,246
Less: Subscriptions receivable (33,113,848) (33,113,848) (4,000,416)
Deferred compensation (474,739) (196,515) (23,741)
Translation adjustments 228,910 210,838 25,471
Accumulated deficit (437,834,468) (293,132,066) (35,412,688)
------------------ ------------------ -----------------
Total shareholders' equity 581,023,752 736,122,570 88,929,469
------------------ ------------------ -----------------
Total liabilities and shareholders' equity 619,678,196 786,167,989 94,975,354
================== ================== =================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-1
NETEASE.COM, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
For the Six Months Ended
----------------------------------------------------
Note June 30, June 30, June 30,
2002 2003 2003
----------------- -------------- --------------
RMB RMB US$
(Unaudited) (Unaudited) (Unaudited)
Revenues:
E-commerce and other services 4 50,305,380 221,110,803 26,711,946
Advertising services from related parties 11,975,760 32,821,080 3,965,048
Software licensing and related integration projects 157,539 165,115 19,947
----------------- -------------- --------------
62,438,679 254,096,998 30,696,941
Sales and value-added taxes (3,122,580) (12,704,850) (1,534,847)
----------------- -------------- --------------
Net revenues 59,316,099 241,392,148 29,162,094
----------------- -------------- --------------
Cost of revenues:
E-commerce, advertising and other services (29,002,467) (42,104,054) (5,086,505)
Share compensation cost (954,064) - -
----------------- -------------- --------------
Total cost of revenues (29,956,531) (42,104,054) (5,086,505)
----------------- -------------- --------------
Gross profit 29,359,568 199,288,094 24,075,589
----------------- -------------- --------------
Operating expenses:
Selling, general and administrative expenses (44,164,828) (49,276,764) (5,953,025)
Asset impairment loss (746,857) - -
Research and development expenses (7,449,972) (8,286,157) (1,001,034)
Share compensation cost (1,243,421) (278,224) (33,612)
----------------- -------------- --------------
Total operating expenses (53,605,078) (57,841,145) (6,987,671)
----------------- -------------- --------------
Operating profit (loss) (24,245,510) 141,446,949 17,087,918
Other income (expenses):
Interest income 4,230,815 3,646,491 440,525
Interest expense (1,209,117) - -
Other, net 3,468,434 5,673,376 685,389
----------------- -------------- --------------
Profit (loss) before tax (17,755,378) 150,766,816 18,213,832
Income tax 2 - (6,064,414) (732,630)
----------------- -------------- --------------
Net profit (loss) (17,755,378) 144,702,402 17,481,202
================= ============== ==============
Other comprehensive income (loss)
Currency translation adjustment 1,664 (18,072) (2,183)
----------------- -------------- --------------
Comprehensive income (loss) (17,753,714) 144,684,330 17,479,019
================= ============== ==============
Net earnings (loss) per share, basic (0.01) 0.05 0.01
================= ============== ==============
Net earnings (loss) per ADS, basic (0.59) 4.64 0.56
================= ============== ==============
Net earnings (loss) per share, diluted (0.01) 0.04 0.01
================= ============== ==============
Net earnings (loss) per ADS, diluted (0.59) 4.47 0.54
================= ============== ==============
Weighted average number of ordinary
shares outstanding, basic 5 3,033,407,311 3,118,601,020 3,118,601,020
================= ============== ==============
Weighted average number of ADS outstanding,
basic 30,334,073 31,186,010 31,186,010
================= ============== ==============
Weighted average number of ordinary
shares outstanding, diluted 5 3,033,407,311 3,237,539,818 3,237,539,818
================= ============== ==============
Weighted average number of ADS outstanding,
diluted 30,334,073 32,375,398 32,375,398
================= ============== ==============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-2
NETEASE.COM, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS
For the Six Months Ended
----------------------------------------------
June 30, 2002 June 30, 2003 June 30, 2003
----------------------------------------------
RMB RMB US$
(Unaudited) (Unaudited) (Unaudited)
Cash flows from operating activities:
Net profit (loss) (17,755,378) 144,702,402 17,481,202
Adjustments for:
Depreciation 8,203,558 7,843,481 947,555
Share compensation cost 2,197,485 278,224 33,612
Increase (Decrease) in provision for doubtful debts (5,378) 2,527,133 305,298
Provision for assets impairment loss 746,857 - -
(Increase) Decrease in prepayments and other current assets 1,433,074 (5,728,933) (692,101)
(Increase) Decrease in due from related parties (12,506,261) 11,857,836 1,432,521
Decrease in deferred assets 783,352 - -
Increase in deferred tax assets - (6,991,392) (844,616)
Increase in accounts payable 1,944,401 604,949 73,083
Increase (Decrease) in deferred revenue 354,461 (165,115) (19,947)
Increase (Decrease) in salary and welfare payable 4,345,229 (2,934,356) (354,494)
Increase in taxes payable 1,603,672 11,647,715 1,407,137
Increase (Decrease) in accrued liabilities (3,445,822) 1,921,467 232,129
Increase (Decrease) in long-term payables - 316,315 38,213
------------ ------------ ------------
Net cash provided by (used in) operating activities (12,100,750) 165,879,726 20,039,592
------------ ------------ ------------
Cash flows from investing activities
Decrease in temporary cash investment 45,521,300 - -
Purchase of property, equipment and software (4,277,181) (7,144,822) (863,151)
Decrease in investment in convertible preference shares 9,701,293 - -
(Increase) Decrease in non-current deposit 1,087,487 (207,425) (25,059)
------------ ------------ ------------
Net cash provided by (used in) investing activities 52,032,899 (7,352,247) (888,210)
------------ ------------ ------------
F-3
NETEASE.COM, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS
(Cont'd)
For the Six months ended
----------------------------------------------------
June 30, 2002 June 30, 2003 June 30, 2003
--------------- ----------------- -----------------
RMB RMB US$
(Unaudited) (Unaudited) (Unaudited)
Cash flows from financing activities:
Repayment of short-term bank loans (84,000,000) - -
Proceeds from exercise of employee stock options - 10,136,264 1,224,541
Collection of subscriptions receivable from
issuance of Series B preference shares 1,986,720 - -
--------------- ----------------- -----------------
Net cash provided by (used in) financing
activities (82,013,280) 10,136,264 1,224,541
--------------- ----------------- -----------------
Effect of exchange rate changes on cash 1,664 (18,072) (2,183)
--------------- ----------------- -----------------
Net increase (decrease) in cash (42,079,467) 168,645,671 20,373,740
Less: (Increase) Decrease in restricted cash 89,112,548 (9,317) (1,126)
Cash, beginning of the period 479,608,534 560,069,711 67,660,881
--------------- ----------------- -----------------
Cash, end of the period 526,641,615 728,706,065 88,033,495
=============== ================= =================
Supplemental disclosures of cash flow information:
Cash paid during the period for income taxes - 6,064,414 732,630
=============== ================= =================
Cash paid during the period for interest 1,165,504 - -
=============== ================= =================
Supplemental schedule of non-cash investing and
financing activities:
Compensation costs, arising from transfer of
ordinary shares and issuance on stock options
in the Company to senior management personnel
and some non-employees of the Company 2,197,485 278,224 33,612
=============== ================= =================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-4
NETEASE.COM, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Retained
earnings Total
Ordinary Shares Additional Subscriptions Deferred (Accumulated Translation shareholders'
-----------------------
Share Amount paid-in capital receivable compensation deficit) adjustments equity
-------------------------------------------------------------------------------------------------------
RMB RMB RMB RMB RMB RMB RMB
Balance as of December
31, 2001 3,024,175,192 2,503,626 1,044,889,829 (35,100,568) (3,344,574) (454,136,106) 217,327 555,029,534
Collection of
subscriptions
receivable - - - 1,986,720 - - - 1,986,720
Ordinary shares issued
to a senior officer of
the Company as
compensation 6,250,000 5,175 (5,175) 335,961 - - 335,961
Ordinary shares issued
for services to be
provided by certain
employees 12,481,159 9,943 622,812 182,895 - - 815,650
Share compensation cost - - 252,873 787,486 - - 1,040,359
Net profit - - - - - (17,755,378) - (17,755,378)
Translation adjustments - - - - 1,664 1,664
--------------------------------------------------------------------------------------------------------
Balance as of June 30,
2002 3,042,906,351 2,518,744 1,045,760,339 (33,113,848) (2,038,232) (471,891,484) 218,991 541,454,510
========================================================================================================
Retained
earnings Total
Ordinary Shares Additional Subscriptions Deferred (Accumulated Translation shareholders'
-----------------------
Share Amount paid-in capital receivable compensation deficit) adjustments equity
-------------------------------------------------------------------------------------------------------
RMB RMB RMB RMB RMB RMB RMB
Balance as of December
31, 2002 3,100,162,537 2,566,543 1,049,651,354 (33,113,848) (474,739) (437,834,468) 228,910 581,023,752
Ordinary shares issued
to a senior officer of
the Company as
compensation 2,500,000 2,070 (2,070) - 134,060 - - 134,060
Ordinary shares issued
for services to be
provided by certain
employees 853,952 707 (707) - 88,236 - - 88,236
Ordinary shares issued
upon exercise of
employee options 42,045,200 34,791 10,101,473 - - - - 10,136,264
Share compensation cost - - - - 55,928 - - 55,928
Net profit - - - - - 144,702,402 - 144,702,402
Translation adjustments - - - - - - (18,072) (18,072)
--------------------------------------------------------------------------------------------------------
Balance as of June 30,
2003 3,145,561,689 2,604,111 1,059,750,050 (33,113,848) (196,515) (293,132,066) 210,838 736,122,570
========================================================================================================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-5
NETEASE.COM, INC.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Amounts expressed in renminbi ("RMB"), unless otherwise stated)
1. Principal Accounting Policies
Basis of consolidation
The accompanying condensed consolidated financial statements include the
financial statements of NetEase.com, Inc. (the "Company") and its controlled
entities (the "Group"). All significant transactions and balances between the
Company and its controlled entities have been eliminated upon consolidation.
Basis of presentation
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("US GAAP"). This basis of accounting differs from that used in the
statutory accounts of those companies within the Group established in China
("PRC Statutory Accounts"), which are prepared in accordance with accounting
principles and the relevant financial regulations applicable to enterprises
established in China ("PRC GAAP").
The preparation of financial statements in conformity with US GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the balance sheet dates and the reported amounts of revenues and expenses during
the reporting periods. Actual results might differ from those estimates.
The principal differences between US GAAP and PRC GAAP applicable to the Group
include the following:
. recognition of compensation costs arising from transfer of ordinary shares
in the Company by the principal shareholder to certain members of senior
management;
. recognition of compensation cost arising from grants of stock options to
the Company's employees, directors, consultants and advisory board members;
. basis for revenue recognition; and
. tax effects related to the above adjustments and recognition of deferred
tax assets.
The financial information as of and for the six months ended June 30, 2002 and
2003 are unaudited, but reflect all material recurring period end accruals and
cut-off adjustments which are considered necessary for a fair presentation of
the unaudited financial information.
F-6
1. Principal Accounting Policies (Cont'd)
Revenue recognition
The Group has adopted the provisions of the Staff Accounting Bulletin 101,
"Revenue Recognition", in its accounting policy on revenue recognition.
E-commerce and other services
The Group currently derives all its e-commerce and other services revenues from
fees earned from services provided to Guangzhou NetEase Computer System Company
Limited ("Guangzhou NetEase"), a related party. The Company derives e-commerce
and other services revenues from technical services provided to Guangzhou
NetEase which operates the NetEase Web sites for transactions conducted through
the Internet. The agreements entered into between NetEase Beijing and Guangzhou
NetEase allow NetEase Beijing to unilaterally adjust the amount of fees NetEase
Beijing is entitled to from the technical services provided to Guangzhou NetEase
such that all of the e-commerce and other services revenues recognized by
Guangzhou NetEase based on the recognition policy described below, net of 5.5%
business tax and certain surcharges, will fully accrue to NetEase Beijing.
A substantial portion of the transactions conducted by Guangzhou NetEase for
which the Group provides technical services to Guangzhou NetEase represents
wireless services which are currently predominantly derived from activities
related to short messaging services ("SMS"). Guangzhou Netease derives SMS
revenues principally from providing value-added services such as friends
matching, news and information services, ring-tone and logo downloads and
various other related products to mobile phone users under co-operative
arrangements with mobile phone operators. SMS revenues recognized by Guangzhou
Netease represent its share of the revenues under these co-operative
arrangements net of the amounts retained by the mobile phone operators for their
services performed.
Other transactions conducted by Guangzhou NetEase for which the Group provides
technical services to Guangzhou NetEase include on-line games, dating and
friends matching, mail box, online shopping mall, auctions and revenue sharing
from co-branded Web sites, etc.
Guangzhou NetEase recognizes its revenues from e-commerce and other services
when the services are provided.
The Group recognizes services revenues from Guangzhou NetEase at the same time
as Guangzhou NetEase recognizes its e-commerce and other services revenues.
Advertising services
The Group derives its advertising services revenues principally from the fees
earned from services provided to Guangyitong Advertising Company Limited
("Guangyitong Advertising"), a related party.
The agreements entered into between NetEase Information Technology (Beijing)
Company Limited ("NetEase Beijing") and Guangyitong Advertising allow NetEase
Beijing to unilaterally adjust the amount of fees NetEase Beijing is entitled to
from the technical consulting and related services provided to Guangyitong
Advertising such that all of the advertising revenues recognized by Guangyitong
Advertising based on the recognition policy described below, less all of the
accrued expenses incurred by Guangyitong Advertising, will fully accrue to
NetEase Beijing. Therefore, the Group
F-7
1. Principal Accounting Policies (Cont'd)
Revenue recognition (cont'd)
Advertising services (cont'd)
recognizes advertising services revenues from Guangyitong Advertising as the
service revenues are earned based on the related service agreement at the same
time as Guangyitong Advertising recognizes its advertising revenues.
Guangyitong Advertising derives its advertising fees principally from short-term
advertising contracts. Revenues from advertising contracts are generally
recognized ratably over the period in which the advertisement is displayed and
only if collection of the resulting receivables is probable. Guangyitong
Advertising's obligations may also include guarantees of a minimum number of
impressions or times that an advertisement appears in pages viewed by users. To
the extent that minimum guaranteed impressions are not met within the
contractual time period, Guangyitong Advertising defers recognition of the
corresponding revenues until the remaining guaranteed impression levels are
achieved.
Effective from December 20, 2000, Guangyitong Advertising has adopted the
consensus reached in Emerging Issue Task Force ("EITF") 99-17 to account for
barter transactions. According to EITF99-17, revenue and expense should be
recognized at fair value from a barter transaction involving advertising
services provided by Guangyitong Advertising only if the fair value of the
advertising services surrendered in the transaction is determinable based on the
entity's own historical practice of receiving cash, marketable securities, or
other consideration that is readily convertible to a known amount of cash for
similar advertising from buyers unrelated to the counterparty in the barter
transaction. During the six months ended June 30, 2003, Guangyitong Advertising
also engaged in certain advertising barter transactions for which the fair value
is not determinable within the limits of EITF 99-17 and therefore no revenues or
expenses derived from these barter transactions were recognized. These
transactions primarily involved exchanges of advertising services rendered by
Guangyitong Advertising for advertising, promotional benefits, information
content, consulting services, and software provided by the counterparties.
Software and related integration projects
Software and related integration projects include the elements of licensing,
services, and postcontract customer support ("PCS"). PCS, generally for one year
or less and occasionally beyond one year, are generally in the form of hotline
support and may involve unspecified upgrades or enhancements. These unspecified
upgrades or enhancements offered during PCS arrangements historically have been
and are expected to continue to be minimal and infrequent. The estimated costs
of providing PCS are insignificant. Sufficient vendor-specific objective
evidence does not exist to allocate the revenues from software and related
integration projects to the separate elements of such projects.
In accordance with American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") 97-2, revenues from software licensing and related
integration projects under which the Group provides PCS for one year or less are
recognized when the following criteria are met:
. persuasive evidence of an arrangement;
. delivery has occurred and services have been performed;
F-8
1. Principal Accounting Policies (Cont'd)
Revenue recognition (cont'd)
Software and related integration projects (cont'd)
. the sales amount is fixed or determinable; and
. collectibility is probable.
Revenues from those projects under which the Group provides PCS that extend
beyond one year are recognized ratably over the respective terms of the
contracts. Warranty on the hardware in the related integration projects is
substantially assumed by the original equipment vendors.
Deferred revenue
Deferred revenue represents prepayments by customers for services yet to be
completed as of the balance sheet dates.
Cost of revenues
Costs of e-commerce, advertising and other services, including cost
reimbursements to Guangzhou NetEase under the agreements with Guangzhou NetEase,
consist primarily of staff costs of those departments directly involved in
providing e-commerce, advertising and other services, depreciation and
amortization of computers and software, server custody fees, bandwidth and other
direct costs of providing these services. These costs are charged to the
statement of operations as incurred.
Material direct costs incurred in the development of platforms for providing
these services consist primarily of computer software developed or acquired.
They are capitalized and amortized in accordance with AICPA SOP 98-1 and costs
incurred prior to the application development stage are expensed as incurred.
Cash
Cash represents cash on hand and demand deposits placed with banks or other
financial institutions.
Financial instruments
Financial instruments of the Group primarily consist of due from related parties
and accounts payable. As of the balance sheet dates, their estimated fair value
approximated their carrying value.
F-9
1. Principal Accounting Policies (Cont'd)
Property, equipment and software
Property, equipment and software are stated at cost less accumulated
depreciation. Depreciation is calculated on the straight-line basis over the
following estimated useful lives, taking into account any estimated residual
value:
Computers .................... 3 years
Furniture and office equipment 5 years
Software ..................... 2-3 years
Vehicles ..................... 5 years
Leasehold improvements ....... lesser of the term of the lease or
the estimated useful lives of the assets
Costs of computer software developed or obtained for internal use are accounted
for in accordance with AICPA SOP 98-1, under which direct costs incurred to
develop the software during the application development stage and to obtain
computer software from third parties that can provide future benefits are
capitalized.
Impairment of long-lived assets
Prior to January, 2002, the Group evaluated the recoverability of long-lived
assets in accordance with Statement of Financial Accounting Standards ("SFAS")
No.121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of". As of January, 2002, the Group has adopted SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" which
addresses the financial accounting and reporting for the recognition and
measurement of impairment losses for long-lived assets. In accordance with these
standards, the Group recognizes impairment of long-lived assets in the event the
net book value of such assets exceeds the future undiscounted cash flows
attributable to such assets.
Advertising expenses
The Group recognizes advertising expenses in accordance with AICPA SOP 93-7
"Reporting on Advertising Costs". As such, the Group expenses the costs of
producing advertisements at the time production occurs, and expenses the cost of
communicating advertising in the period in which the advertising space or
airtime is used.
Foreign currency translation
The functional currency of the Group is RMB. Transactions denominated in
currencies other than RMB are translated into RMB at the exchange rates quoted
by the People's Bank of China (the "PBOC") prevailing at the dates of the
transactions. Monetary assets and liabilities denominated in foreign currencies
are translated into RMB using the applicable exchange rates quoted by the PBOC
at the balance sheet dates. The resulting exchange differences are included in
the determination of income.
Translations of amounts from RMB into United States dollars for the convenience
of the reader were calculated at the noon buying rate of US$1.00 = RMB8.2776 on
June 30, 2003 in The City of New York for cable transfers of RMB as certified
for customs purposes by the Federal Reserve Bank of New York. No representation
is made that the RMB amounts could have been, or could be, converted into United
F-10
1. Principal Accounting Policies (Cont'd)
Foreign currency translation (Cont'd)
States dollars at that rate on June 30, 2003, or at any other certain rate.
Stock-based compensation
In accordance with the provisions of SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure", the Group has selected the disclosure
only provisions related to employee stock options and follows the provisions of
Accounting Principles Board Opinion No. 25 ("APB 25") in accounting for stock
options issued to employees. Under APB 25, compensation expense, if any, is
recognized as the difference between the exercise price and the estimated fair
value of the ordinary shares on the measurement date, which is typically the
date of grant, and is recognized ratably over the service period, which is
typically the vesting period.
Stock-based employee compensation cost of RMB2.2 million and RMB0.3 million for
the six months ended June 30, 2002 and 2003, respectively, is expensed. The
following table illustrates the effect on net profit and earnings per share if
the Group had applied the fair value recognition provisions of the Financial
Accounting Standards board ("FASB") No.123, "Accounting for Stock-Based
Compensation", to stock-based employee compensation.
Six Months Six Months
Ended Ended
June 30, 2002 June 30, 2003
------------------- ------------------
Net profit (loss):
As reported (17,755,378) 144,702,402
Less: Additional stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (490,209) (1,878,073)
------------------- ------------------
Pro forma (18,245,587) 142,824,329
=================== ==================
Basic net earnings (loss) per ordinary shares:
As reported (0.01) 0.05
Pro forma (0.01) 0.05
Diluted net earnings (loss) per ordinary shares:
As reported (0.01) 0.04
Pro forma (0.01) 0.04
F-11
1. Principal Accounting Policies (Cont'd)
Income taxes
Deferred income taxes are provided using the balance sheet liability method.
Under this method, deferred income taxes are recognized for the tax consequences
of significant temporary differences by applying enacted statutory rates
applicable to future years to differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities. The tax
base of an asset or liability is the amount attributed to that asset or
liability for tax purposes. The effect on deferred taxes of a change in tax
rates is recognized in income in the period that includes the enactment date. A
valuation allowance is provided to reduce the amount of deferred tax assets if
it is considered more likely than not that some portion of, or all of, the
deferred tax asset will not be realized.
Net earnings (loss) per share ("EPS") and per American Depositary Share ("ADS")
In accordance with SFAS No. 128, "Computation of Earnings Per Share," basic EPS
is computed by dividing net profit attributable to ordinary shareholders by the
weighted average number of ordinary shares outstanding during the period.
Diluted EPS is calculated by dividing net profit by the weighted average number
of ordinary and dilutive ordinary equivalent shares outstanding during the
period. Ordinary equivalent shares consist of the ordinary shares issuable upon
the conversion of the convertible preference shares (using the if-converted
method) and ordinary shares issuable upon the exercise of outstanding stock
options (using the treasury stock method). Ordinary equivalent shares in the
diluted EPS computation are excluded in net loss periods as their effect would
be anti-dilutive.
Net earnings per ADS has been computed by multiplying the net earnings per share
by 100, which is the number of shares represented by each ADS.
Statutory reserves
In accordance with the Regulations on Enterprises with Foreign Investment of
China and their articles of association, NetEase Beijing, NetEase Information
Technology (Shanghai) Company Limited (" NetEase Shanghai") and Guangzhou
NetEase Interactive Entertainment Limited ("Guangzhou Interactive"), being
foreign invested enterprises established in China, are required to provide for
certain statutory reserves namely general reserve, enterprise expansion fund and
staff welfare and bonus fund which are appropriated from net profit as reported
in their PRC Statutory Accounts. NetEase Beijing, NetEase Shanghai and Guangzhou
Interactive, being wholly foreign owned enterprises, are required to allocate at
least 10% of their after-tax profit to the general reserve. NetEase Beijing,
NetEase Shanghai and Guangzhou Interactive may stop allocations to the general
reserve if such reserve has reached 50% of their respective registered capital.
Appropriations to the enterprise expansion fund and staff welfare and bonus fund
are at the discretion of the board of directors of NetEase Beijing, NetEase
Shanghai and Guangzhou Interactive, respectively. These reserves can only be
used for specific purposes and are not distributable as cash dividends.
Appropriations to the staff welfare and bonus fund will be charged to selling,
general and administrative expenses.
NetEase Shanghai and Guangzhou Interactive have been in an accumulated loss
position according to their PRC Statutory Accounts and no appropriations to
statutory reserves have been made.
F-12
1. Principal Accounting Policies (Cont'd)
Related parties
Parties are considered to be related if one party has the ability, directly or
indirectly, to control the other party or exercise significant influence over
the other party in making financial and operating decisions. Parties are also
considered to be related if they are subject to common control or common
significant influence.
2. Taxation
Income taxes
Cayman Islands
Under the current laws of the Cayman Islands, the Company is not subject to tax
on income or capital gain. Additionally, upon payments of dividends by the
Company to its shareholders, no Cayman Islands withholding tax will be imposed.
British Virgin Islands
NetEase Interactive is exempted from income tax on its foreign-derived income in
the British Virgin Islands. There are no withholding taxes in the British Virgin
Islands.
China
In accordance with "Income Tax Law of China for Enterprises with Foreign
Investment and Foreign Enterprises," foreign invested enterprises are generally
subject to enterprise income tax ("EIT") at the rate of 30% plus a local income
tax of 3%. NetEase Beijing, being a foreign invested enterprise and located in
the New Technology Industrial Development Experimental Zone in Beijing, has been
recognized as a "New and High Technology Enterprise". According to an approval
granted by the Haidian State Tax Bureau in November 2000, NetEase Beijing is
entitled to a reduced EIT rate of 15% commencing from the year 2000. In
addition, the approval also granted NetEase Beijing with a full exemption from
EIT from 2001 to 2002, a 50% reduction in EIT from 2003 to 2005, and a full
exemption from the local income tax from 2000 onwards.
NetEase Shanghai is subject to EIT at the rate of 30% plus a local tax of 3%.
Guangzhou Interactive is entitled to a reduced EIT rate of 15% from 2003 to 2004
and then is subject to EIT rate of 30% plus a local tax of 3% from 2005 onward.
F-13
2. Taxation (Cont'd)
Income taxes (cont'd)
As of January 1, 2003, and June 30, 2003, the tax impact of significant
temporary differences between the tax and financial statement bases of assets
and liabilities that gave rise to deferred tax assets were principally related
to the following:
As of As of
December 31, 2002 June 30, 2003
------------------- -------------------
Loss carryforwards 19,132,653 13,796,521
Valuation allowance (16,736,765) (4,409,241)
------------------- -------------------
Net deferred tax asset 2,395,888 9,387,280
=================== ===================
Subject to the approval of the relevant tax authorities, the Group had loss
carryforwards of approximately RMB41.8 million as of June 30, 2003 for EIT
purposes. Approximately RMB0.2 million, RMB29.5 million and RMB12.1 million of
these loss carryforwards will expire in 2005, 2006 and 2007, respectively. A
valuation allowance has been provided on the loss carryforwards of the Group due
to the uncertainty surrounding the realizability of such assets. There is no
assurance that the Group will be able to utilize the loss carryforwards before
their expiration.
In addition, the preferential EIT treatments that NetEase Beijing obtained may
be subject to review by higher authorities. If these preferential tax treatments
were not available to NetEase Beijing, NetEase Beijing would be subject to EIT
at 30% plus a local tax of 3% and the exemption and reduction described above
would not apply.
Business tax ("BT")
The Group is subject to BT on the provision of taxable services in China,
transfer of intangible assets and the sale of immovable properties in China. The
tax rates range from 3% to 20% of the gross receipts, depending on the nature of
the revenues. The applicable BT rate for the Group's revenues is generally 5%.
In addition, Guangyitong Advertising is subject to a cultural development fee at
3% on its Internet advertising fees, which effectively reduces the revenues the
Group derives from Guangyitong Advertising.
Taxes payable
As of As of
December 31, 2002 June 30, 2003
------------------- -------------------
BT 4,337,428 5,102,650
EIT - 8,683,853
Individual income taxes for employees 3,848,253 6,020,485
Other 67,269 93,677
------------------- -------------------
Total 8,252,950 19,900,665
=================== ===================
F-14
3. Capital Structure
Ordinary shares
The holders of ordinary shares in the Company are entitled to one vote per share
and to receive ratably such dividends, if any, as may be declared by the board
of directors of the Company. In the event of liquidation, the holders of
ordinary shares are entitled to share ratably in all assets remaining after
payment of liabilities. The ordinary shares have no preemptive, conversion, or
other subscription rights.
On March 23, 2001, the Company entered into an agreement ("the Acquisition
Agreement") whereby the Company acquired certain software for online games,
computers and the related intellectual property rights for cash consideration of
US$0.2 million from a private technology company. In addition, the Company
agreed to issue 7,742,168 ordinary shares in the Company to the founders of the
private technology company by installments on a quarterly basis starting from
June 23, 2001 through March 23, 2003 for the service to be provided by such
individuals as employees of the Company over such period. The total estimated
fair value of these shares of approximately RMB0.8 million valued at US$0.0125
per share at the date of agreement is recognized as deferred compensation, which
is to be amortized over the related vesting period. During the six months ended
June 30, 2003, the Company issued 853,952 ordinary shares (six months ended June
30, 2002: 1,928,469 ordinary shares) to an employee pursuant to the Acquisition
Agreement.
According to an agreement ("the Service Agreement") dated September 11, 2001
between the Company and a senior officer of the Company, the Company provided
the officer with 25,000,000 ordinary shares by quarterly installments over a
period of 18 months. As a result, deferred compensation cost of approximately
RMB1.3 million was recorded in 2001, which amount is being amortized over the
related vesting period of 18 months. During the six months ended June 30,2003,
the Company issued 2,500,000 ordinary shares (six months ended June 30, 2002:
6,250,000 ordinary shares) to the officer pursuant to the Service Agreement.
During the six months ended June 30, 2003, the Company also issued 42,045,200
ordinary shares (six months ended June 30, 2002: nil ) upon exercise of employee
options which were granted under the Company's stock option plan.
4. Revenues From E-commerce and Other Services
Six Months Six Months
Ended Ended
June 30, 2002 June 30, 2003
-------------------- ------------------
Wireless services and other fee-based services 48,454,230 148,795,690
Online games 1,851,150 72,315,113
-------------------- ------------------
Total 50,305,380 221,110,803
==================== ==================
F-15
4. Revenues From E-commerce and Other Services (Cont'd)
Revenue from wireless value-added services represents revenue earned by the
Group for providing technical services to Guangzhou NetEase in relation to its
wireless business. Guangzhou NetEase derives SMS revenues from providing
value-added services such as friends matching, news and information services,
ring-tone and logo downloads and various other related products to mobile phone
users in China.
Revenue from other fee-based services represents revenue earned by the Group for
providing technical services to Guangzhou NetEase in relation to various value
added services provided by the NetEase Web sites, including dating and friends
matching, mail box, personal homepage hosting and online shopping mall, etc.
Revenue from online game services represents revenue earned by the Group for
providing technical services to Guangzhou NetEase in relation to its online game
business. Guangzhou NetEase operates various online games platforms and derives
revenue from providing service to its registered game players.
5. Net Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted net earnings
(loss) per share for the six months ended June 30, 2002, and 2003:
Six Months Six Months
Ended Ended
June 30, 2002 June 30, 2003
-------------------- ------------------
Numerator:
Net profit (loss) attributable to ordinary
shareholders (17,755,378) 144,702,402
==================== ===================
Denominator:
Weighted average number of ordinary shares
outstanding, basic 3,033,407,311 3,118,601,020
Dilutive effect of employee stock options
- 118,938,798
-------------------- -------------------
Weighted average number of ordinary shares
outstanding, diluted 3,033,407,311 3,237,539,818
==================== ===================
6. Contingencies
Class Actions
On May 16, 2003, the plaintiffs in the class actions filed in 2001 against the
Company, certain of its current and former officers and directors, and the
underwriters of the Company's initial public offering, alleging violations of
the federal securities laws in the United States entered into a stipulation and
agreement of settlement with the defendants.
The court preliminarily approved this settlement on February 25, 2003, and all
persons who purchased the Company's ADSs during the period from July 3, 2000 to
August 31, 2001 were certified as a single class. Subsequently, notice was sent
to the class, and the court will hold a hearing before it gives final approval
to the settlement. The aggregate settlement amount for all claims in this
litigation is US$4.35 million, which amount has been paid by the Company into an
escrow
F-16
6. Contingencies (Cont'd)
Class Actions (cont'd)
account pending such final approval and charged to the statement of operations
for the year ended December 31, 2002.
On May 16, 2003, the definitive settlement of the class action litigation filed
in the U.S. District Court for the Southern District of New York against NetEase
and certain other parties was approved and declared final by the District Court.
The aggregate settlement amount, which was paid to those persons who purchased
the Company's American Depositary Shares during the period from July 3, 2000 to
August 31, 2001, was US$4.35 million. This settlement has been reflected in the
Company's third quarter and full-year financial statements for 2002 as a
one-time charge.
Copyright Infringement Lawsuit
In March 2003, Guangzhou NetEase was named in a copyright infringement lawsuit
in China and the plaintiffs claimed damages of US$1.0 million. The Group intends
to vigorously defend its position. Based on the legal advice it has obtained,
the Group believes the ultimate resolution of this matter will not have a
material financial impact on the Group.
7. Subsequent Events
Zero Coupon Convertible Subordinated Notes
The Company issued and sold US$75,000,000 and US$25,000,000 aggregate principal
amount of Zero Coupon Convertible Subordinated Notes due July 2023 on July 14,
2003 and on July 31, 2003, respectively, in private offerings to Credit Suisse
First Boston LLC. The notes are general unsecured obligations of the Company and
are subordinated to any existing or future senior indebtedness of the Company.
Description of the notes, such as conversion rights and redemption of the notes,
are provided in the prospectus filed as part of the related registration
statement. The Company intends to use the net proceeds of approximately US$97.2
million for general corporate purposes, including potential future acquisitions.
Repurchase of Shares
On July 4, 2003, the Company entered into an agreement with affiliates of The
News Corporation Limited ("Newscorp") to repurchase 27,142,000 ordinary shares
of the Company held by one of Newscorp's affiliates. The transaction was
completed in July 2003. Under the agreement, the Company paid Newscorp a net
aggregated amount of approximately US$4.6 million and the rights of Newscorp and
its affiliates to a certain amount of advertising on NetEase's websites which
had been granted under a strategic cooperation agreement between the parties
were waived. In accordance with the agreement, the Company is entitled to use
approximately US$2.0 million worth of advertising on Asian television properties
of Newscorp at no additional cost until March 28, 2004 or such other date as the
parties shall agree.
F-17
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 8. Indemnification of Directors and Officers
Cayman Islands law and Article 125 of our articles of association
provide that we may indemnify our directors, officers and trustee acting in
relation to any of our affairs against actions, proceedings, costs, charges,
losses, damages and expenses incurred by reason of any act done or omitted in
the execution of their duty in their capacities as such, except if they acted in
a willfully negligent manner or defaulted in any action against them.
We have entered into indemnification agreements with each of our
directors and officers under which we agree to indemnify each of them to the
fullest extent permitted by Cayman Islands law, our articles of association and
other applicable law, from and against all expenses and liabilities arising from
any proceeding, to which the indemnitee is or was a party, witness or other
participant, except expenses and liabilities (if any) incurred or sustained by
or through the indemnitee's own willful neglect or default. Upon the written
request by a director or officer, we will, within 10 days after receipt of the
request, advance funds for the payment of expenses, unless there has been a
final determination that the director or officer is not entitled to
indemnification for these expenses.
Insofar as indemnification for liabilities arising under the Securities
Act of 1933, as amended, may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or otherwise,
the registrant has been advised that in the opinion of the Securities and
Exchange Commission such indemnification is against public policy as expressed
in the Act and is, therefore, unenforceable.
Item 9. Exhibits
The following exhibits are filed herewith or incorporated by reference in
this prospectus:
Exhibit
Number Exhibit Title
------ -------------
3.1 Amended and Restated Memorandum of Association of
NetEase.com, Inc. (incorporated by reference to Exhibit 3.1
from Amendment No. 1 to the company's Registration Statement
on Form F-1 (file no. 333-11724) filed with the Securities
and Exchange Commission on May 15, 2000)
3.2 Amended and Restated Articles of Association of NetEase.com,
Inc. (incorporated by reference to Exhibit 3.2 from
Amendment No. 1 to the company's Registration Statement on
Form F-1 (file no. 333-11724) filed with the Securities and
Exchange Commission on May 15, 2000)
3.3 Amendment to Amended and Restated Articles of Association of
NetEase.com, Inc. dated as of June 5, 2003 (incorporated by
reference to Exhibit 1.3 from the company's Annual Report on
Form 20-F for the year Ended December 31, 2002 filed with
the Securities and Exchange Commission on June 27, 2003)
II-1
4.1 Specimen American Depositary Receipt of NetEase.com, Inc.
(incorporated by reference to Exhibit 4.1 from Amendment
No. 1 to the company's Registration Statement on Form F-1
(file no. 333-11724) filed with the Securities and Exchange
Commission on May 15, 2000)
4.2 Specimen Stock Certificate of NetEase.com, Inc.
(incorporated by reference to Exhibit 4.2 from Amendment No.
1 to the company's Registration Statement on Form F-1 (file
no. 333-11724) filed with the Securities and Exchange
Commission on May 15, 2000)
4.3 Registration Rights Agreement, dated as of July 8, 2003,
between NetEase.com, Inc. and Credit Suisse First Boston LLC
4.4 Indenture, dated as of July 14, 2003, by and between
NetEase.com, Inc. and The Bank of New York
5.1 Opinion of Maples & Calder Asia
10.1 Purchase Agreement, dated as of July 8, 2003, between
NetEase.com, Inc. and Credit Suisse First Boston LLC
12.1 Computation of Ratio of Earnings to Fixed Charges
23.1 Consent of PricewaterhouseCoopers, Independent Public
Accountants
23.2 Consent of PricewaterhouseCoopers, Independent Public
Accountants
23.3 Consent of Maples & Calder Asia (included in Exhibit 5.1)
24.1 Power of Attorney of certain directors and officers of
NetEase.com, Inc. (see signature page)
25.1 Form T-1 Statement of Eligibility of Trustee for Indenture
under the Trust Indenture Act of 1933
Item 10. Undertakings
1. The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933 (the "Act");
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or the most
recent post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered)
II-2
and any deviation from the low or high end of the estimated maximum
offering range may be reflected in the form of prospectus filed with
the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement; and
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement; provided, however, that the undertakings set forth in
clauses (i) and (ii) above shall not apply if the information required
to be included in a post-effective amendment by these clauses is
contained in periodic reports filed by the registrant pursuant to
Section 13 or Section 15(d) of the Securities Exchange Act of 1934 (the
"Exchange Act") that are incorporated by reference in this registration
statement.
(2) That, for the purpose of determining any liability under the Act,
each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the termination of
the offering.
2. The undersigned registrant hereby undertakes, that, for purposes of
determining any liability under the Act, each filing of the registrant's annual
report pursuant to Section 13(a) or Section 15(d) of the Exchange Act that is
incorporated by reference in the Registration Statement shall be deemed to be a
new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
3. Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers and controlling persons of the registrant
pursuant to the provisions described under Item 15 above, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
4. The undersigned registrant hereby undertakes that:
(a) For purposes of determining any liability under the Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Act shall be deemed to be part of this registration statement as of
the time it was declared effective.
(b) For the purpose of determining any liability under the Act, each
post-effective amendment that contains a form of prospectus shall be deemed to
be a new registration statement relating to the
II-3
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial bona fide offering thereof.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the
Registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form F-3 and has duly caused this registration
statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Beijing, the People's Republic of China, on October
10, 2003.
NETEASE.COM, INC.
By: /s/ Ted Sun
---------------------------------
Ted Sun
Acting Chief Executive Officer
and Director
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Ted Sun, Michael Tong and Denny Lee, and
each of them individually, as his true and lawful attorneys-in-fact and agents
with full power of substitution and resubstitution, for him and in his name,
place and stead, in any and all capacities to sign the registration statement
filed herewith and any or all amendments to said registration statement
(including post-effective amendments and registration statements filed pursuant
to Rule 462(b) under the Securities Act of 1933, as amended and otherwise), and
to file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission granting unto said
attorneys-in-fact and agents the full power and authority to do and perform each
and every act and thing requisite and necessary to be done in and about the
foregoing, as full to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents or any of them, or his or her substitute, may lawfully do or cause to be
done by virtue thereof.
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities indicated:
Name Title Date
--------------------------------------------------------------------------------
/s/ Ted Sun
------------------------ Acting Chief Executive Officer
II-4
Ted Sun and Director October 10, 2003
/s/ Denny Lee
------------------------
Denny Lee Chief Financial Officer October 10, 2003
/s/ Michael Tong
------------------------
Michael Tong Executive Director October 10, 2003
/s/ William Ding
------------------------
William Ding Chief Architect and Director October 10, 2003
/s/ Donghua Ding
------------------------
Donghua Ding Director October 10, 2003
/s/ Ronald Lee
------------------------
Ronald Lee Director October 10, 2003
/s/ Michael Leung
------------------------
Michael Leung Director October 10, 2003
/s/ Joseph Tong
------------------------
Joseph Tong Director October 10, 2003
II-5