As filed with the Securities and Exchange Commission on December 29, 2003
Registration No. 333-109628
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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Pre-Effective Amendment No. 1
to
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)
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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)
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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)
============== ============== =============== ============
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(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 previously paid the registration fee at the time of the
filing of its initial Registration Statement on October 10, 2003.
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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. We may
not sell these securities 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 DECEMBER 29, 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
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This prospectus covers resales from time to time by selling securityholders
of our Zero Coupon Convertible Subordinated Notes due July 15, 2023, held by the
selling securityholders listed in the section entitled, "Selling
Securityholder", and 207,684,320 of our ordinary shares issuable upon conversion
of the notes held by such selling securityholders and subject to adjustment.
The notes have the following provisions:
.The interest rate on the notes will be zero, unless we fail to satisfy our
obligations to register the notes and the ordinary shares issuable upon
conversion of the notes.
.The notes are general unsecured obligations of NetEase.com, Inc. and are
subordinated to any existing or future senior indebtedness of NetEase.com,
Inc.
.The notes 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 described on page 58 of this prospectus). 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 if certain conditions
relating to the trading price of our American Depositary Shares, or ADSs,
are met (as described on page 54 of this prospectus).
.Holders of the notes may 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
those additional conditions described on page 54 of this prospectus.
.Holders may convert their notes at any time on or before the maturity date
at the conversion price (which conversion price may be adjusted as provided
on page 50 of this prospectus) under those circumstances described on page
48 of this prospectus. We may pay converting note holders ordinary shares,
cash or a combination of cash and ordinary shares for their notes.
For a complete description of the terms and conditions of the notes, see
"Description of Notes" beginning on page 48 of this prospectus.
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 December 26, 2003 was $37.61 per ADS, which results in a reference
price of $0.3761 per share for our ordinary shares.
Investing in the notes and ordinary shares involves risks. See "Risk
Factors" beginning on page 8.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
adequacy or accuracy of this prospectus. Any representation to the contrary is a
criminal offense.
Please note that in this prospectus, all references to "Renminbi" and "RMB"
are to the legal currency of China and all references to "dollars," "USD," "$"
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.
The date of this prospectus is , 2003.
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TABLE OF CONTENTS
Page
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SUMMARY 1
RISK FACTORS 8
RATIO OF EARNINGS TO FIXED CHARGES 25
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS 26
USE OF PROCEEDS 26
WHERE YOU CAN FIND MORE INFORMATION 26
PRICE RANGE OF AMERICAN DEPOSITARY SHARES 27
EXCHANGE RATE INFORMATION 29
DIVIDEND POLICY 30
CAPITALIZATION 31
SELECTED CONSOLIDATED FINANCIAL DATA 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 34
DESCRIPTION OF NOTES 48
DESCRIPTION OF SHARE CAPITAL 64
DESCRIPTION OF AMERICAN DEPOSITARY SHARES 67
CAYMAN ISLANDS TAXATION 72
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES 73
SELLING SECURITYHOLDERS 78
PLAN OF DISTRIBUTION 81
LEGAL MATTERS 83
INDEPENDENT AUDITORS 83
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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.
SUMMARY
This summary contains a brief overview of us and the key aspects of the
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 subsidiaries and contracts with our affiliates Guangzhou
NetEase Computer System Co., Ltd. ("Guangzhou NetEase") and Beijing Guangyitong
Advertising Co., Ltd. ("Guangyitong Advertising"), 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 offerings.
Our business was founded by William Lei Ding, our Chief Architect and one
of our directors, in June 1997. Mr. Ding owns 100% of our largest shareholder,
Shining Globe International Limited, and 80% of Guangzhou NetEase. The other 20%
of Guangzhou NetEase is owned by Bo Ding, the brother of William Lei Ding.
Guangzhou NetEase has obtained approval from the Guangzhou telecommunications
administrative authorities to provide Internet content services, and its 80%
owned subsidiary, Guangyitong Advertising, holds a license to operate an
advertising business. The other 20% of Guangyitong Advertising is owned by Bo
Ding.
We conduct our business in China solely through our wholly owned
subsidiaries, NetEase Information Technology (Beijing) Co., Ltd. ("NetEase
Beijing"), NetEase Information Technology (Shanghai) Co., Ltd. ("NetEase
Shanghai"), NetEase Interactive Entertainment Ltd. and Guangzhou NetEase
Interactive Entertainment Limited.
Under current Chinese regulations, there are limitations on the percentage
interest foreign companies may have in value-added telecommunications businesses
in China, which include the operation of Internet content provision businesses
and wireless value-added services such as short-messaging services ("SMS"). In
addition, the operation by foreign or foreign-invested companies of advertising
businesses in China is subject to government approval. Because of these
restrictions, NetEase.com is not permitted directly to wholly own an Internet
content provider, wireless value-added services or advertising business.
NetEase.com has therefore entered into a series of agreements with Guangzhou
NetEase and Guangyitong Advertising. Under these contracts, we provide our
Internet and wireless value-added applications, services and technologies and
advertising services to Guangzhou NetEase and Guangyitong Advertising, and they
operate the NetEase Web sites and the online advertising business. For more
information on these agreements, see the section entitled "Related Party
Transactions" which is included in our annual report on Form 20-F for the year
ended December 31, 2002, which is incorporated by reference in this prospectus.
We do not have any direct ownership interest in Guangzhou NetEase or Guangyitong
Advertising.
Under our agreements with Guangzhou NetEase, we have agreed to pay the
operating costs of Guangzhou NetEase. Under our agreements with Guangyitong
Advertising, we have agreed to provide performance guarantees and guarantee
loans for working capital purposes to the extent required by Guangyitong
Advertising for its operations. Both Guangzhou NetEase and Guangyitong
Advertising are prohibited from incurring any debt without our prior approval.
The following diagram shows the current group structure of our subsidiaries
and affiliated companies:
1
[Diagram illustrating ownership structure of NetEase.com and contractual
relationships among NetEase.com's subsidiaries and affiliates]
NetEase.com generates substantially all of its revenue through Guangzhou
NetEase and Guangyitong Advertising.
Any violations by Guangzhou NetEase or Guangyitong Advertising of our
agreements with them could disrupt our operations, degrade our services or
shutdown our services. See page 8 of this prospectus for a detailed discussion
of the risks to NetEase.com regarding its dependency on Guangzhou NetEase and
Guangyitong Advertising.
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 an accumulated total of approximately 143.8 million registered
accounts. Headquartered in Beijing and with regional offices in Shanghai and
Guangzhou, we have over 400 employees.
We do not require our users to register in order to browse the NetEase Web
sites including the content channels, online shopping mall and classified ads or
use the Web directories and Internet search engine. We do require, however, that
our users register with us in order to utilize the other services that we
provide, including our fee-based services (such as our wireless value-added
services, online games, premium matchmaking and other premium services) as well
as our free services such as chat rooms, community forums, basic e-mail
services, basic matchmaking, basic personals, and instant messaging.
Registration requires a user to provide personal information including the
user's name, contact information and other statistical information (such as
educational level) and security information (such as a password).
Our basic service offerings on the NetEase Web sites are available without
charge to our users and include:
2
. content services (such as news, local information, online
entertainment, finance and weather);
. chat rooms;
. basic e-mail services;
. instant messaging;
. community forums;
. basic matchmaking;
. basic personals;
. basic alumni directory;
. basic clubs;
. classified ads;
. Web directories;
. Web searching; and
. online shopping services.
We generate revenue from our:
. wireless value-added services and other premium value-added services,
such as Web page hosting, premium email services, premium personals, premium
matchmaking, premium alumni directories, premium clubs, personal homepages, and
electronic greeting cards;
. online games; and
. advertising services.
Our principal areas of focus are our Wireless Value-Added Services, Online
Games and Internet Portal.
Wireless Value-Added Services
Through arrangements with mobile phone operators, China Mobile and China
Unicom, we offer a wide-range of services which allow users, for example,
to receive news and valuable information such as stock quotes and e-mails
on their mobile phones, download ring-tones and logos for their mobile
phones and participate in matchmaking communities and interactive games
through their mobile phones. Combining content from our Internet Portal
(both user-generated and from our content partners) with the applications
we have developed in-house, our wireless value-added services staff strives
to offer services that are responsive to our users' changing tastes and
needs.
Currently, most of our wireless value-added services are provided to users
in the form of SMS. NetEase offers over 200 different SMS 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, through Guangzhou
NetEase, receive a percentage of this amount from China Mobile and China
Unicom, which they bill and collect on our behalf. During the first nine
months of 2003 we received between 72% and 79% of the amounts collected
each month by China Mobile and China Unicom from mobile phone users for our
wireless value-added services.
In addition to our SMS, we have begun introducing services for emerging
wireless technology standards, including multimedia messaging ("MMS")
services 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 services, such as Java games, as the market evolves and as new
technologies develop.
Online Games
Through our Online Games services, 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 certain convenience stores in Guangzhou.
3
Internet Portal
The NetEase Web sites provide Internet users with Chinese language online
services centered around three core services--(1) content, (2) community
and communication, and (3) commerce. Our Internet portal revenues are
generated from advertising services provided to third party advertisers and
marketers, and individual users who subscribe to our fee-based premium
services.
Content
Through more than 18 channels, the NetEase Web site's content channels
provide news, information and online entertainment to the Chinese public.
The NetEase 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 services, including e-mail, instant messaging, personals,
matchmaking, alumni directories, personal homepages, clubs,
electronic-cards, chat rooms and community forums. As discussed above, some
of these services are provided free of charge to our users with, in some
cases, 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.
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.
For the nine months ended September 30, 2003, approximately 32.0% of our
revenue was derived from our online games, approximately 15.0% of our revenue
was derived from advertisements, and approximately 53.0% of our revenue was
derived from SMS and all other services. For the year ended December 31, 2002,
approximately 15.0% of our revenue was derived from advertisements,
approximately 69.0% of our revenue was derived from SMS and all other services,
and approximately 16.0% of our revenue was derived from our online games. For
the year ended December 31, 2001, approximately 50.0% of our revenue was derived
from advertisements and approximately 50.0% of our revenue was derived from SMS
and all other services; we did not offer online games during 2001.
Corporate Information
NetEase.com, Inc., a Cayman Islands corporation, was formed and commenced
operations in 1999. Our predecessor company was formed in 1997. 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 principal corporate
Web site is located at http://www.netease.com. The information contained on our
Web site is not a part of this prospectus.
4
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 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 on page 50 of 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
September 30, 2003, we had approximately $100.0 million of outstanding
indebtedness, and current liabilities of approximately $10.0 million. On that
date, our subsidiaries had no outstanding indebtedness, other than intercompany
indebtedness and other normal trade payables and liabilities. As of September
30, 2003, Guangzhou NetEase had no outstanding indebtedness, other than trade
payables equal to $33,760. As of September 30, 2003, we had not guaranteed any
indebtedness for Guangyitong Advertising. Under our agreements with Guangzhou
NetEase, we are responsible for the liabilities of Guangzhou NetEase. Under our
agreements with Guangyitong Advertising, we are obligated to provide any
guarantees needed by Guangyitong Advertising for its operation.
Conversion
Note 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 on page 54 of 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 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 on page 49 of 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
5
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, as more fully
described on page 50 of this prospectus.
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 the conditions described on page 67 of this
prospectus are met.
Redemption of Notes at Our Option
Beginning on July 15, 2008 and prior to the close of business on the maturity
date (July 15, 2023), 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 (as described on page 54 of this
prospectus) 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" on page 54 of this prospectus.
We will also redeem all of the notes upon a Merger Event (as defined on page 58
of 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" on page
58 of this prospectus.
Repurchase of the Notes at the Option of the Holder
Holders may require us to repurchase for 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" on page 54 of this prospectus.
Fundamental Change
If a Fundamental Change (as defined on page 56 of 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"
beginning on page 57 of this prospectus.
Use of Proceeds
We will not receive any proceeds from the sale of the notes or the ordinary
shares offered by this prospectus.
6
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" beginning on page 60 of this prospectus.
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 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" beginning on page 61 of this
prospectus.
Trading
Our ADSs, each representing 100 ordinary shares, are traded on The Nasdaq
National Market under the symbol "NTES."
Trustee for the Notes and Depositary for our American Depositary Shares
The Bank of New York.
7
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 in part because, through our
predecessor, we commenced operations in 1997, changed our business focus in
1998, reorganized and formed NetEase.com, Inc. in 1999 and introduced several
new sources of revenue in 2001. As a result, we face many risks associated with
early-stage companies, particularly our ability to compete in our market.
Our business was established in June 1997 as an Internet software developer
through the formation of our predecessor company. In mid-1998, our predecessor
company changed our business focus to an Internet technology provider, and
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. 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 services. 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. Some of
these risks relate to our ability to:
. attract buyers for our services;
. attract advertisers;
. attract a larger audience to the NetEase Web sites;
. derive revenue from our users from fee-based services;
. respond effectively to competitive pressures and address the effects
of strategic relationships or corporate combinations among our
competitors;
. maintain our current, and develop new, strategic relationships;
. increase awareness of our brand and continue to build user loyalty;
. attract and retain qualified management and employees;
. upgrade our technology to support increased traffic and expanded
services; and
. expand the content and services on the NetEase Web sites.
In addition, our change of business focus from developing Web-based
software services 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 revenue from our current service offerings.
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$27.6
million in the first nine months of 2003, we incurred significant net losses in
2001, 2000 and 1999 and had only minimal profit in 1998. Accordingly, as of
September 30, 2003, we had an accumulated deficit of approximately US$25.3
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.
8
The market for the delivery of wireless value-added services is rapidly
evolving, and our ability to generate revenue 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 a significant portion of our
fee-based premium services and online entertainment services revenue the first
nine months of 2003, to compete in the rapidly evolving wireless value-added
services market. We currently offer services for users of 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 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 depend on the contractual relationships of Guangzhou NetEase with
the two mobile phone operators in China at the national, provincial and local
level for our wireless value-added services revenue and the alteration or
termination of these relationships could adversely impact our business.
Our wireless value-added services (including SMS) are conducted in
conjunction with the two mobile phone operators in China, China Mobile and China
Unicom, which together service nearly all of China's mobile phone subscribers.
We rely exclusively on the national, provincial and local affiliates of these
two companies to deliver our wireless value-added services. If our various
contracts with either company are 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. Further, we derived
approximately 45% of our total revenue through our relationship with China
Mobile for the nine months ended September 30, 2003, and are therefore
particularly dependent on China Mobile.
Our services are provided through a number of contracts with the provincial
and local 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
or renew our arrangements with these mobile phone operators in ways which
adversely affect our business.
In addition, we are dependent on the policies that may be established from
time to time by China Mobile or China Unicom. For example, China Mobile banned
all cooperative arrangements known as "SMS Website Unions" in July 2003,
effectively precluding us and other service providers from marketing through
third party Web sites. In August 2003, China Mobile further banned us and other
service providers from using its network to charge customers for services which
were deemed by it to be not purely wireless services. In addition, our business
and financial condition may be further adversely affected by any future policy
changes implemented by China Mobile or China Unicom. China Mobile's adoption of
the policies described above contributed to a 20.7% decline in our revenue from
SMS and other e-commerce services between the second quarter ended June 30, 2003
and the third quarter ended September 30, 2003.
In the event Guangzhou NetEase's relationships with either China Mobile or
China Unicom are adversely altered or terminated, either through a change in the
contractual terms of these relationships or a change in the policies of either
company, our revenue would likely be adversely affected and we may be unable to
find alternatives that would replace such networks and revenue.
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:
9
. 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.
E-commerce and other related services (including wireless value-added services,
other fee-based premium services and online games) have become a significant
part of our business, constituting approximately 85% of our total revenue for
the nine months ended September 30, 2003, 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 game services. We have, however, only limited experience in offering
these services and cannot be certain that they will generate sustainable
revenue, particularly if we are unable to predict which services will be in
demand in the future and offer those services on a timely basis, compete against
other companies offering similar services and adapt our services to be
compatible with next generation technologies. Further, these services may never
become widely accepted for various reasons, many of which are beyond our
control, including:
. users' inexperience with these technologies, some of which are largely
new to China, and users' 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 and have not been widely accepted by users. In addition,
only 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 for our services and may limit our growth in these
areas. If secure and widely accepted online payment alternatives do not develop,
our ability to grow our e-commerce business would be limited. In response to
these factors and 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 developed as an alternative online payment system for our
services.
We believe that our prepaid debit point card has facilitated the usability
and growth of all of our online game services, although its development and
distribution has caused us to incur additional costs. 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.
Further, our users who must pay for our services with our prepaid debit point
card must take additional and possible inconvenient actions in using our
services, such as visiting a store to first purchase the card.
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 revenue 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
10
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 revenue 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 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.
The revenue that we derive from Guangzhou NetEase's contractual relationships
with each of China Mobile and China Unicom depends on records maintained by
those companies regarding the fees paid by customers for wireless value-added
services.
Each of China Mobile and China Unicom pays us a portion of the fees it
receives from its respective customers for the wireless value-added services we
provide, based on their internal records. Thus, a significant portion of our
revenue is dependent on each company's ability to maintain accurate records. We
do not collect fees for our services which are deemed to be "billing and
transmission failures," which means that the services were undeliverable to the
user because the user's phone was turned off for an extended period of time, the
user ceased to subscribe to the mobile network or his or her prepaid phone card
ran out of value, or the mobile phone operator's networks or our system
experienced technical problems. The rate of these billing and transmission
failures varies among each mobile phone operator and changes from month to
month. Future billing and transmission failures may result in a significant
reduction in our wireless value-added services revenue. While we maintain our
own records regarding the services we provide through their networks, we have no
ability to independently monitor the accuracy of billing statements of either
mobile phone operator. If there are significant discrepancies between our
records and the records of one of the mobile phone operators, after taking into
account historic levels of billing and transmission failures, we will typically
ask to work with that mobile phone operator to reconcile the difference.
Nonetheless, we have no ability to independently test or verify the mobile phone
operators' data.
The revenue for our wireless value-added services is normally recognized based
on monthly statements from China Mobile and China Unicom, but we occasionally
recognize this revenue on an estimated basis if these statements are late.
We normally recognize revenue based on statements that we receive
subsequent to a period end from the mobile phone operators, but in very limited
circumstances when the mobile phone operators' monthly billing statements are
later than the date of our quarterly earnings release, we may recognize revenue
on an estimated basis, using our own statistical records and after consultation
with the mobile phone operators. For full year accounts, we wait until all
statements are received before releasing our earnings figures. Consequently, no
estimates are involved in determining annual revenue for our wireless
value-added services, but from and including the first quarter of 2002 to and
including the third quarter of 2003 we have estimated a portion of our wireless
value-added services revenue in computing our revenue for particular quarters.
The difference between the estimated revenue and the actual revenue as confirmed
by the mobile phone operators, as a percentage of total wireless value-added
services revenue recognized over the relevant quarter, ranged from 0.1% to 4.5%.
Recognizing revenue based on such estimates could potentially require us to
later make adjustments in our financial records when the mobile phone operators'
statements and cash payments are received.
We expect that a portion of our future revenues will be derived from our
advertising services, which represented approximately 15.0% of our total revenue
for the nine months ended September 30, 2003, but we may not be able to compete
effectively in this market because it is relatively new and intensely
competitive, in which case our business and financial condition could be
adversely affected.
Although we anticipate that revenue generated by our fee-based premium
services and online entertainment services will continue to constitute a
majority of our future revenue, we believe that we will continue to rely on
advertising revenue as one of our major sources of revenue 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;
. downward pressure on online advertising prices; and
11
. 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 revenue is 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 revenue. 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 were 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 revenue 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,
based on information provided by an employee, our board of directors through its
audit committee initiated an investigation into whether the terms of a number of
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 a portion of our revenue could
not be recognized in fiscal year 2000 because:
. we could not identify reliable evidence to support the fair value of
services provided under certain advertising contracts,
. revenue from certain barter transactions did not meet the criteria for
recognition under the applicable accounting standards,
. certain contracts were found to lack economic substance, and
. certain advertising contracts were found to be subject to significant
extensions of performance periods that went beyond December 31, 2000.
Our restated total revenues for 2000 were RMB33.0 million (US$4.0 million),
resulting in a net loss of RMB169.3 million (US$20.4 million) or RMB6.78
(US$0.82) per American Depositary Share. We had originally reported total
revenues for 2000 of RMB68.9 million (US$8.3 million), with a net loss of
RMB142.8 million (US$17.3 million) or RMB5.72 (US$0.69) per American Depositary
Share. Our total operating expenses for 2000 were reduced by RMB7.2 million
(US$0.9 million) as a result of the restatement. The adjustments also decreased
our previously reported total assets by RMB72.8 million (US$8.8 million). Note
that translations of amounts from RMB into U.S. dollars for the convenience of
the reader in this paragraph were calculated at the noon
12
buying rate of US$1.00=RMB8.2774 as of December 29, 2000 in The City of New York
for cable transfers of RMB as certified for customs purposes by the Federal
Reserve Bank of New York.
We have taken a number of steps to strengthen our controls and procedures
to minimize a recurrence of this problem, including implementing more stringent
internal controls and procedures, particularly with regard to the use of
supplemental contracts and preparation and recordation of contracts which have
both a revenue and expense side, holding frequent management meetings relating
to financial matters with members of our finance, contract and sales teams,
among others, and holding frequent meetings with our outside auditors. We are
also continuously working to bolster our management team through rigorous hiring
practices and on-going educational programs to ensure that the controls and
procedures are implemented in a consistent, effective manner. To augment these
changes, we also formed an advertising contract performance group to ensure that
the performance of advertising contracts and the records generated to confirm
completion of performance are accurate and appointed a new executive management
team.
We believe that these improved controls and procedures and structural
changes 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. 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
13
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 revenue fluctuates significantly and may adversely impact the trading price
of our American Depositary Shares or any other securities which become publicly
traded.
Our revenue 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 revenue 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 revenue decreases or
expenses increase during these periods, we may not be able to offset our
expenses with sufficient revenue.
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.
If Guangzhou NetEase or Guangyitong Advertising or their 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.
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, such as, in the case of Guangyitong
Advertising, laws and regulations requiring us to verify the content of third
party advertising content we place on the NetEase Web sites. Guangzhou NetEase,
Guangyitong Advertising or their 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 revenue 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 their 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 their 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 their 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 their 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.
14
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 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
revenue, 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 adopts
policies or regulations, or takes any other action that restricts or bans
certain types of 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, including political or sexually
explicit content. 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.
Although none of the content that we currently produce contains material
that we believe would be considered inappropriate, some of our users may be
involved in producing and/or transmitting material that may be considered
inappropriate. Although we constantly monitor the content of the material
transmitted on the NetEase Web sites, we cannot assure you that we will in every
instance uncover and block transmission of all material that may be considered
inappropriate.
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;
. revoking our business license;
15
. 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
revenue from these companies. A portion of our revenue under our contracts with
these companies is 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.
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. A well publicized computer security breach
could significantly damage our reputation and materially adversely affect our
business.
Although we have not experienced any hacking activity that allowed
unauthorized access to any information stored on our network, caused any loss or
corruption of data, software or other computer equipment, we have been subject
to denial of service
16
attacks that have caused portions our network to be inaccessible for limited
periods of time. In addition, we have had denial of service attacks and viruses
or worms introduced into our network. Although we take a number of measures to
ensure that our systems are secure and unaffected by security breaches,
including ensuring that our servers are hosted at physically secure sites,
limiting access to server ports, and using isolated intranets, passwords, and
encryption technology, we cannot assure you that any measures we take against
computer hacking will be effective.
In addition, there have been a number of incidents where users, through a
variety of methods, were able to modify the rules of our online games,
particularly the online game we license from a third party. Although these users
did not gain unauthorized access to our systems, they were able to modify the
rules of our online games during game play in a manner that allowed them to
cheat and disadvantage our other online game users. At one point, cheating by
some of our online game users led to a decrease in the number of users of our
licensed online game "PristonTale". Although we have also taken a number of
steps to deter our users from engaging in cheating when playing our online
games, we cannot assure you that we or the third parties from whom we license
some of our online games will be successful or timely in taking corrective steps
necessary to prevent users from modifying the terms of our online games.
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 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 revenue 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;
17
. 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.
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 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 services 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 Beijing, our wholly owned subsidiary formed in 1999. As a
result, our primary internal source of funds is dividend payments from NetEase
Beijing. If NetEase Beijing incurs debt on its own behalf in the future, the
instruments governing the debt may restrict NetEase Beijing's ability to pay
18
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 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:
. 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.
19
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
revenue effectively.
Because almost all of our future revenue 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 interest, 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.
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
revenue.
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 revenue 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 services including Chinese language-based Web
search, retrieval and navigation services, wireless value-added services, online
games
20
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 future
competitors may offer 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 revenue.
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 November 30, 2003, our founder and Chief Architect, William Ding,
beneficially owned approximately 50.6% 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 47.5% 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 December 26, 2003 was $37.61. 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
. 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.
21
If our registration statement covering resales of the notes and our ordinary
shares issuable upon conversion of the notes is not effective or we have
suspended its use, it may be difficult or impossible for a holder to resell the
notes or ordinary shares.
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 (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. We may suspend the use of this prospectus under certain circumstances
relating to pending corporate developments, public filings with the Securities
and Exchange Commission and similar events. While our ability to suspend the use
of this prospectus is limited, we will be permitted to suspend the use of the
prospectus for up to an aggregate of 120 days during any 12-month period under
certain circumstances relating to possible acquisitions, financings or other
similar transactions. Under such circumstances, it may be difficult or
impossible for a holder to resell the notes or ordinary shares and the value and
liquidity of the notes and ordinary shares may also be adversely affected.
Holders of our ordinary shares issued upon conversion of the notes will be
required to satisfy certain requirements in order to deposit those ordinary
shares for the issuance of ADSs, which may be costly and time consuming to them.
If holders wish to deposit their ordinary shares for the issuance of ADSs,
they will be required to provide certain information to The Bank of New York,
which is the depositary for the ADS program, in order 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.
In addition, The Bank of New York may require those holders of ordinary
shares to deliver a legal opinion to that effect at the holder's own expense. If
the registration statement discussed above is not effective at the time of
deposit of the ordinary shares, the value and liquidity of the shares and a
holder's investment could be materially adversely affected.
Fluctuations in the currency exchange rate between the U.S. dollar and the
Renminbi could adversely affect the dollar value of our ADSs, and therefore of
the notes and the ordinary shares issuable upon conversion of the notes, and any
cash dividend declared on our ordinary shares.
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 revenue is 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,
22
(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 September 30, 2003, (i) we had approximately $100.0 million of
outstanding debt and approximately $10.0 million of current liabilities 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 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.
23
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.
24
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.
25
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 1995. 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 revenue will not continue to grow;
. the risk that the current popularity of SMS in China will not continue
for whatever reason, including SMS being superseded by other
technologies for which we are unable to offer attractive 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.
All forward-looking statements in this prospectus are made as of the date
hereof, based on information available to us as of the date hereof, and we
assume no obligation to update or revise any of these forward-looking statements
even if experience or future changes show that the indicated results or events
will not be realized.
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.
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.
26
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;
. Our Current Report on Form 6-K (File No. 000-30666) filed on July 31,
2003; and
. Our Current Report on Form 6-K (File No. 000-30666) filed on October
29, 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.
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 three quarters of 2003 and (2) each of the most recent six
months. On December 29, 2003, the last reported sale price for our ADSs was
$37.61 per ADS.
27
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
June 2003 37.35 28.17
July 2003 52.21 33.90
August 2003 51.90 38.81
September 2003 69.20 50.80
October 2003 72.00 44.81
November 2003 47.50 39.50
28
EXCHANGE RATE INFORMATION
We have published our financial statements in Renminbi and our business
is currently conducted in and from China in Renminbi. The conversion of Renminbi
into U.S. dollars in this prospectus 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, and
except as otherwise noted, this prospectus 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 December 23, 2003 was
US$1.00: RMB8.2769. 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 June 30, 2003 8.2772
-------------------------------------- --------------------------------------
----------
(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
------------------------- ------------------------- -------------------------
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
------------------------- ------------------------- -------------------------
October 31, 2003 8.2776 8.2765
------------------------- ------------------------- -------------------------
November 30, 2003 8.2772 8.2766
------------------------- ------------------------- -------------------------
29
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."
30
CAPITALIZATION
The following table sets forth our capitalization as of October 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 October 31, 2003.
As of October 31, 2003
----------------------
(in RMB) (in US$)
(Unaudited) (Unaudited)
Cash and cash equivalents/(1)/ 1,314,646,331 158,838,935
============= ===========
Long-term liabilities:
Zero Coupon Convertible Subordinated Notes due July 15, 2023 827,660,000 100,000,000
Other long-term liabilities 270,025 32,625
------------- -----------
Total long-term liabilities 827,930,025 100,032,625
------------- -----------
Shareholders' equity/(2)/
Ordinary shares, US$0.0001 par value: 1,000,300,000 shares
authorized, 3,126,688,189 shares issued and outstanding as
of October 31, 2003 2,588,063 312,696
Additional paid-in capital 992,927,937 119,968,095
Deferred compensation (159,230) (19,238)
Translation adjustments 210,838 25,474
Accumulated deficit (178,564,417) (21,574,610)
------------- -----------
Total shareholders' equity 817,003,191 98,712,417
------------- -----------
Total capitalization 1,644,933,216 198,745,042
------------- -----------
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=RMB8.2766 as of
October 31, 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
October 31, 2003, or at any other rate.
(1) As of October 31, 2003, the Company had invested RMB249.5 million (US$30.1
million) in short-term investments such as US government agency securities,
which amount was not classified as cash and cash equivalents.
(2) Outstanding ordinary shares does not include (i) options to purchase
172,417,300 ordinary shares outstanding under our stock option plan at a
weighted average exercise price of US$0.0889 per ordinary share, and 234,492,824
additional shares available for grant under our Amended and Restated 2000 Stock
Incentive Plan as of October 31, 2003 and (ii) 210,000,000 ordinary shares
reserved for issuance upon conversion of the notes.
31
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 11,975,760 32,821,080 3,965,048
Software licensing and related integration projects 157,539 165,115 19,947
------------- ------------- -------------
Total revenue 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 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)
------------- ------------- -------------
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.
32
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
------------- -------------- --------------
Liabilities and 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 an accumulated total of
approximately 143.8 million accounts, and our average daily page views exceeded
329.2 million for the month ended September 30, 2003.
During 2003, we have 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 services. Our fee-based e-commerce and other services 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 major
directly wholly owned subsidiaries, NetEase Information Technology (Beijing)
Co., Ltd., or NetEase Beijing, NetEase Information Technology (Shanghai) Co.,
Ltd., or NetEase Shanghai; and NetEase Interactive Entertainment Limited, or
NetEase Interactive, which has a direct wholly owned subsidiary, Guangzhou
NetEase Interactive Entertainment Limited, or Guangzhou Interactive. As of June
30, 2003, we also had a wholly owned subsidiary, NetEase (U.S.) Inc., or NetEase
US. NetEase US has remained inactive during 2003.
NetEase Beijing and NetEase Shanghai were established in China on August
30, 1999 and May 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.
NetEase Beijing provides technical consulting and related services to
Guangzhou NetEase and Guangyitong Advertising; NetEase Shanghai provides
technical consulting for our advertising services; and NetEase Interactive and
Guangzhou Interactive provide services for our online games.
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.
34
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.
See page 2 of this prospectus for a chart illustrating our corporate
structure and relationships with Guangzhou NetEase and Guangyitong Advertising.
We have recently taken steps to establish a new entity, Guangzhou Lingyi,
to provide certain wireless value-added services for next generation mobile
phones. William Ding will own 80% of Guangzhou Lingyi and Bo Ding, William
Ding's brother, will own 20% of Guangzhou Lingyi. We anticipate that Guangzhou
Lingyi will enter into contractual arrangements with us that are substantially
similar to those that we have entered into with Guangzhou NetEase.
Revenue
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.
Through our predecessor company, 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 services. 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 revenue 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.
Wireless Value-Added Services
Guangzhou NetEase receives wireless value-added services revenue which is
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 services 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
services and developing new ones, but these efforts may not be successful.
We are also focusing on developing 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
35
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
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 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, premium
matchmaking, premium personals, premium alumni directory, premium clubs,
personal home pages and electronic greeting cards.
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 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 revenue.
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 Revenue
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 online games staff, 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.
36
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.
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 revenue is 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 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%.
37
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 revenue.
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 revenue derived from services which
is generally 5%. In addition, we are subject to a value-added tax ranging from
6% to 17% for revenue 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 revenue 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 revenue 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.
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 revenue is 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 revenue 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 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
38
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 September 30, 2003, this online
shopping mall had 10 "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 revenue 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 September 30, 2003, there were no active referral arrangements,
but we are currently seeking to enter into new referral arrangements.
Online Auction - Prior to October 2000, Guangzhou NetEase earned
revenue 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 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 revenue is 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. Revenue
from advertising contracts is 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
revenue 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 revenue
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
39
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 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 and the 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.
40
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 revenue:
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 revenue (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)
=========== ======= =========== =====
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002
Revenue
Total revenue 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.
Revenue 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, revenue 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 and other fee-based premium services was primarily due to the
increase in popularity of our growing range of proprietary SMS 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 services offered were very limited and
included ring-tone and logo
41
downloading and a few other services. As of June 30, 2003, we offered more
than 200 different services, which can be classified into four main
categories, namely, news and information subscription, multi-media
downloading, community and communication and Internet-related services.
Our wireless value-added services and other fee-based premium services
together represented approximately 67.2% of our total e-commerce and other
services revenue in the first half of 2003, as compared to 96.3% in the
first half of 2002. 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 the 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". Westward Journey Online Version 2.0 accounted
for approximately 91% of the increase in online games revenue and
PristonTale accounted for approximately 9%. Online games accounted for
approximately 32.8% of our total e-commerce and other services revenue in
the first half of 2003, as compared to 3.7% in the first half of 2002.
Advertising services revenue 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 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 revenue from our top ten advertisers comprising
23.0% of our total advertising services revenue 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 revenue 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 Revenue
Our cost of revenue 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. A significant portion of this increase was due to franchise
and revenue share fees and, to a lesser extent, increased staff-related costs.
Franchise and revenue share fees costs comprised 27.5% of our total cost of
revenue (totaling RMB11.6 million) in the six months ended June 30, 2003,
compared with 3.6% (totaling RMB1.1 million) in the six months ended June 30,
2002. Increased franchise and revenue share fee costs accounted for
approximately 86.4% of the increase in our cost of revenue. We expect that
franchise and revenue share fees will continue to increase as a percentage of
our total cost of revenue 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 revenue (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 and accounted for approximately 15.7% of the increase in our
total cost of revenue. Our cost of revenue was partially offset by a reduction
in share compensation costs for the first half of 2003 as compared to the first
half of 2002, which accounted for approximately an 7.9% decrease in our total
cost of revenue. We expect that staff costs as a percentage of our total cost of
revenue will continue to decrease in the near-term due to the greater increase
in the franchise and revenue share fees related to online games.
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
42
increased from 47.1% in the first half of 2002 to 78.4% in the first half of
2003. The significant improvement in gross margins was driven by economies of
scale as the growth in our revenue outpaced the concurrent increase in our cost
of revenue.
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 revenue
decreased from 85.9% in the six months ended June 30, 2002 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 an increase in
staff costs of approximately RMB8.4 million (US$1.0 million) and marketing costs
of approximately RMB2.5 million (US$0.3 million), offset partially by a decrease
in professional fees of RMB6.6 million (US$0.8 million).
The asset impairment loss in 2002 represented the unamortised portion of
the cost 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 technical staff 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 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 a 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 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
43
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 of RMB2.0 million.
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 revenue 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 revenue from advertising services has been uneven in
the last several years. Further, although our revenue from e-commerce and other
services has 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 revenue 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 services. Our service 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 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, services and registered user base
through diverse online community services developed internally. We will seek to
continually improve and enhance our existing 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 revenue 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
44
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.
Third Quarter Ended September 30, 2003 Results
Our revenue for the third quarter ended September 30, 2003, was RMB146.3
million (US$17.7 million), representing a 7.4% increase over our total revenue
of RMB136.2 million (US$16.5 million) for the second quarter ended June 30,
2003, and a 96.6% increase over our total revenue of RMB74.4 million (US$9.0
million) for the corresponding period in 2002. We recorded a net profit of
RMB84.1 million (US$10.2 million), or US$0.33 and US$0.30 per basic and diluted
American Depositary Share, respectively, compared to the previous quarter's net
profit of RMB75.8 million (US$9.2 million), or US$0.29 and US$0.28 per basic and
diluted American Depositary Share, respectively. The same quarter in the
previous year had a net loss of RMB9.0 million (US$1.1 million).
SMS and Other E-Commerce Revenue
Our revenue from SMS and other e-commerce services for the third quarter of
2003 was RMB62.7 million (US$7.6 million), representing a 20.7% decrease from
our second quarter of 2003 SMS and other e-commerce services revenue of RMB79.1
million (US$9.6 million), and a 20.1% increase over our SMS and other e-commerce
services revenue of RMB52.2 million (US$6.3 million) for the corresponding
period in 2002. The decrease in SMS and other e-commerce services revenue from
the second quarter of 2003 was attributable primarily to increased competition
in the wireless service area, discontinuation of our cooperation arrangements
with certain third-party Web sites which were promoting our wireless services,
and discontinuation of our ability to charge customers for services on China
Mobile's network which were deemed by China Mobile to be not purely wireless
services.
Online Game Revenue
Revenue for our online game services for the third quarter of 2003 was
RMB56.5 million (US$6.8 million), representing a 55.9% increase over our
preceding quarter's online game services revenue of RMB36.2 million (US$4.4
million) and a 366.8% increase over our online game services revenue of RMB12.1
million (US$1.5 million) for the corresponding period in 2002. Increased revenue
for our online game services was largely due to the continued increase in
popularity of our online game title, Westward Journey Online Version 2, which
had approximately 1.2 million unique paying users during September 2003.
Advertising Services Revenue
Our advertising services revenue for the third quarter of 2003 was RMB27.1
million (US$3.3 million), representing a 30.0% increase over our advertising
services revenue of RMB20.8 million (US$2.5 million) for the preceding quarter
and a 168.7% increase over our advertising services revenue of RMB10.1 million
(US$1.2 million) for the corresponding period a year ago. The growth of our
advertising services revenue was mainly attributable to the continued growth of
the overall online advertising sector in China.
Gross Profit
We recorded a gross profit in the third quarter of 2003 of RMB121.2 million
(US$14.6 million), an increase of 12.7% over our previous quarter's gross profit
of RMB107.5 million (US$13.0 million) and 141.0% over our gross profit of
RMB50.3 million (US$6.1 million) for the corresponding period in 2002. Our
revenue growth together with a reduction in our cost of sales favorably impacted
our gross margins, which increased from 78.9% in the second quarter of 2003 to
82.8% in the third quarter of 2003. The reduction in our cost of sales was
mainly due to the saving of commissions payable resulting from the
discontinuation of our cooperation arrangements with certain third-party Web
sites which were promoting our wireless services.
Operating Expenses
Our total operating expenses for the third quarter of 2003 were RMB34.1
million (US$4.1 million), a 15.3% increase from the our second quarter of 2003
operating expenses of RMB29.6 million (US$3.6 million) and a 44.1% decrease from
our operating expenses of RMB61.0 million (US$7.4 million) for the corresponding
period in 2002. This increase was largely due to amortization expenses incurred
in connection with our offering of Zero Coupon Convertible Subordinated Notes,
which was completed in July 2003.
Operating Profit
45
We recorded an operating profit of RMB87.1 million (US$10.5 million) in the
third quarter of 2003, representing an increase over our second quarter of 2003
operating profit of RMB77.9 million (US$9.4 million). In the third quarter ended
September 30, 2002, we had an operating loss of RMB10.7 million (US$1.3
million).
Net Profit
In the third quarter of 2003 we recorded a net profit of RMB84.1 million
(US$10.2 million), an increase of 11.0% over our second quarter 2003 net profit
of RMB75.8 million (US$9.2 million) and an improvement over the net loss of
RMB9.0 (US$1.1 million) we recorded for the corresponding period in 2002.
Cash Balance and Note Issuance
As of September 30, 2003, our total cash balance was RMB1.6 billion
(US$192.6 million), a 118.4% increase from our total cash balance of RMB729.9
million (US$88.2 million) as of June 30, 2003. The increase was mainly
attributable to the issuance of our Zero Coupon Convertible Subordinated Notes
in the aggregate amount of US$100 million in July 2003. Cash flow generated from
operating activities was approximately RMB102.3 million (US$12.4 million) during
the third quarter of 2003.
Other Developments
Users of the NetEase Web sites continued to grow, with approximately 143.8
million accumulated registered accounts at the end of the third quarter of 2003,
an increase of 12.9% over the 127 million accounts at the end of the second
quarter of 2003 and a 78.1% increase over the 80.7 million accounts at the same
time in 2002.
The conversion of Renminbi into U.S. dollars in this section "Third Quarter
Ended September 30, 2003 Results" 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 on September 30 2003, of U.S.$1 =
RMB8.2771.
Trend Information
Except as disclosed below 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 September 30, 2003, that are reasonably likely
to have a material effect on our net revenue, 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.
Based on our observations, we believe that the following trends are likely
to have a material effect on our business in the near term:
. The rapid expansion of the wireless value-added services market in China
in recent years is expected by MII and industry commentators to continue for the
next several years. We expect that this expansion, if it occurs, will have two
fundamental effects on our business. First, it will present an ongoing
opportunity to increase our revenue from wireless value-added services. Second,
we believe, on the other hand, that it will encourage additional competitors to
enter the market which may adversely affect revenue growth in this area and
could have a material adverse effect on our business and financial condition.
. We expect that the wireless value-added services industry and customers
tastes for these services will continue to evolve rapidly, particularly as a
result of the transition from SMS-based services to new services which are
compatible with, and take full advantage of the capabilities of, next generation
mobile technologies such as 2.5G, which has recently begun in China. We believe
that the rapid evolution of this industry will require us to continue to devote
significant resources to developing and deploying new wireless valued-added
services.
. If wireless value-added services which are compatible with next
generation mobile technologies become popular in China, we believe that users
will demand increasingly engaging and content-rich services. We anticipate that
this transition, if it occurs, may increase competition among wireless
value-added service providers in China for content and strategic partnerships,
such as our partnership with MTV, and may increase the prices we may have to pay
for content.
. The pace of development of widely accepted online payment systems in
China has remained slow thus far. In response, we have developed and deployed a
prepaid debit point card as an alternative online payment system for our
services.
46
. We believe that there has been increasing demand by online game users for
new and unique online games and increasing competition in this area. We believe
that these trends will force us to devote additional resources to developing and
launching additional games, updating existing games at a faster rate than we
have in the past and licensing games from third parties.
. The decrease in the rate of growth of Internet users in China in recent
years may continue. In that case, we may have to increase our service offerings
or increase our marketing and advertising efforts in order for us to continue to
grow our business.
. A general increase in competition for online services has elevated the
importance of brand building and brand awareness. We believe that this trend may
require us to increase our marketing and advertising efforts and budgets in
order to keep our brand names and the NetEase Web sites visible and prominent.
47
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;
. 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.
48
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.
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.
49
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,
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:
. those rights, warrants or options referred to in clause (3)
above;
50
. 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.
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.
51
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 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
52
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 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,
(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
53
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
(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.
54
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:
. 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.
Repurchase at Option of a Holder Upon a Fundamental Change
55
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 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.
56
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
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
57
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 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.
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
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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 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
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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 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
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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.
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 also agreed to 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:
(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.
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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:
. 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.
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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 November 30, 2003, our authorized share capital consisted of
1,000,300,000,000 ordinary shares, par value $0.0001 per share, and there were
3,127,936,189 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 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.
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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.
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.
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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;
. 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).
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.
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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 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
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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 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 Conversion of Renminbi to U.S. dollars
York 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
Payment of Taxes
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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, Recapitalizations and Mergers
If we: Then:
.. Change the nominal or par value of The cash, shares or other securities
our shares; received by The Bank of New York will
become deposited securities. Each ADR
.. Reclassify, split up or consolidate will automatically represent its equal
any of the deposited securities; share of the new deposited securities.
.. Distribute securities on the shares The Bank of New York may, and will if
that are not distributed to you; we ask it to, distribute some or all
of the cash, shares or other
.. Recapitalize, reorganize, merge, securities it received. It may also
liquidate, sell all or issue new ADRs or ask you to surrender
substantially all of our assets; or your outstanding ADRs in exchange for
new ADRs identifying the new deposited
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.
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
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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.
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
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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.
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
In the opinion of Morrison & Foerster LLP, special U.S. counsel to
NetEase.com, Inc., the following summary accurately describes 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 a holder, subject to the limitations stated below. This description
does not provide a complete analysis of all potential tax consequences. Such
opinion is based on the Internal Revenue Code of 1986, as amended (the "Code"),
Treasury Regulations (including proposed Regulations and temporary Regulations)
promulgated thereunder, 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 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.
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 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
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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 will recognize any 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.
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 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 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 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
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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 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.
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 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
will be subject to increased U.S. tax liabilities and reporting requirements on
receipt of certain dividends or on a disposition at a gain 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
. 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
75
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. 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.
76
Non-U.S. Holders
A Non-U.S. Holder 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 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 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.
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.
77
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 December 29, 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
Maturity of Percentage
Notes Number of of
Name Beneficially Percentage Ordinary Ordinary Shares
Owned That May of Notes Shares That Outstanding
Be Sold Outstanding May Be Sold (1) (2)(3)
-------------------------------------------------------------------------------------------------------------
Amamath L.L.C.(4)(18) $ 20,000,000 20.00% 41,536,864 1.33%
-------------------------------------------------------------------------------------------------------------
Argent Classic Convertible Arbitrage $ 1,300,000 1.30% 2,699,896 *
Fund (Bermuda) Ltd.(5)
-------------------------------------------------------------------------------------------------------------
Argent Classic Convertible Arbitrage $ 600,000 * 1,246,106 *
Fund L.P.(6)
-------------------------------------------------------------------------------------------------------------
Argent Classic Convertible Arbitrage $ 100,000 * 207,684 *
Fund II L.P.(6)
-------------------------------------------------------------------------------------------------------------
Context Convertible Arbitrage Fund, LP(7) $ 800,000 * 1,661,475 *
-------------------------------------------------------------------------------------------------------------
Context Convertible Arbitrage Offshore, $ 1,200,000 1.20% 2,492,212 *
Ltd.(7)
-------------------------------------------------------------------------------------------------------------
Forest Fulcrum Fund LP(8)(18) $ 840,000 * 1,744,548 *
-------------------------------------------------------------------------------------------------------------
Forest Multi-Strategy Master Fund SPC(8) $ 1,145,000 1.145% 2,377,985 *
-------------------------------------------------------------------------------------------------------------
Forest Global Convertible Fund, Ltd. $ 3,003,000 3.00% 6,236,760 *
Class A-5(8)
-------------------------------------------------------------------------------------------------------------
GLG Market Neutral Fund(9) $ 5,000,000 5.00% 10,384,216 *
-------------------------------------------------------------------------------------------------------------
JMG Capital Partners L.P.(10) $ 5,000,000 5.00% 10,384,216 *
-------------------------------------------------------------------------------------------------------------
78
---------------------------------------------------------------------------------------------------------------
Principal
Amount at
Maturity of Percentage
Notes Number of of
Name Beneficially Percentage Ordinary Ordinary Shares
Owned That May of Notes Shares That Outstanding
Be Sold Outstanding May Be Sold (1) (2)(3)
---------------------------------------------------------------------------------------------------------------
JMG Triton Offshore Fund, Ltd.(11) $ 5,000,000 5.00% 10,384,216 *
---------------------------------------------------------------------------------------------------------------
KBC Convertible Arbitrage Fund(12)(18) $ 5,300,000 5.30% 11,007,268 *
---------------------------------------------------------------------------------------------------------------
KBC Convertible Mac28 Fund Ltd.(12)(18) $ 970,000 * 2,014,537 *
---------------------------------------------------------------------------------------------------------------
KBC Convertible Opportunities Fund(12)(18) $ 6,940,000 6.94% 14,413,291 *
---------------------------------------------------------------------------------------------------------------
KBC Financial Products USA, Inc. (17) $ 2,380,000 2.38% 4,942,887 *
-------------------------- --------------------------------------------------------------------------------------
KBC Multi Strategy Arbitrage Fund(12)(18) $ 1,270,000 1.27% 2,637,590 *
---------------------------------------------------------------------------------------------------------------
LLT Limited(8) $ 289,000 * 600,207 *
---------------------------------------------------------------------------------------------------------------
Lyxor Master Fund(13)(18) $ 200,000 * 415,368 *
---------------------------------------------------------------------------------------------------------------
Melody IAM, Ltd.(12)(18) $ 520,000 * 1,079,958 *
---------------------------------------------------------------------------------------------------------------
Polaris Vega Fund L.P.(14) $ 250,000 * 519,210 *
---------------------------------------------------------------------------------------------------------------
Relay 11 Holdings Co.(8) $ 204,000 * 423,676 *
---------------------------------------------------------------------------------------------------------------
Satellite Convertible Arbitrage Master $ 5,000,000 5.00% 10,384,216 *
Fund, LLC(16)
---------------------------------------------------------------------------------------------------------------
Sphinx Convertible Arbitrage SPC(8) $ 119,000 * 247,144 *
---------------------------------------------------------------------------------------------------------------
Sunrise Partners Limited Partnership(15)(18) $ 500,000 * 1,038,421 *
---------------------------------------------------------------------------------------------------------------
Xavex Convertible Arbitrage 10 Fund(6) $ 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
3,127,936,189 ordinary shares outstanding as of November 30, 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.
(4) Nicholas M. Maounis exercises voting/investment control.
(5) Henry Cox and Thomas Marshall exercise voting/investment control.
(6) Bruce McMahan, Saul Schwartzman and John Gordon exercise voting/investment
control.
(7) William Fertig and Michael Rosen exercise voting/investment control.
(8) Michael A. Boyd exercises voting/investment control.
(9) Noam Gottesman, Pierre Lagrane, Jonathan Green and Philippe Jabre exercise
voting/investment control.
(10) Jonathan Glaser exercises voting/investment control.
(11) Jonathan Glaser and Roger Richter exercise voting/investment control.
(12) Andy Preston exercises voting/investment control.
(13) Clark K. Hunt, Jonathan Bren and Ken Tananbaum exercise voting/investment
control.
(14) Gregory R. Levinson exercises voting/investment control.
(15) S. Donald Sussman exercises voting/investment control.
(16) Marty Brandt and Thomas Healy exercise voting/investment control.
(17) Luke Edwards exercises voting/investments control.
(18) The selling securityholder is either a broker-dealer or an affiliate of a
broker-dealer and has told us that it purchased the note in the ordinary course
of business and at the time of its purchase, did not have any agreements or
understandings, directly or indirectly, with any person to distribute the notes
or the share underlying the notes.
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
79
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.
Generally, only selling securityholders identified in the selling
securityholders table who beneficially own the securities set forth opposite
their respective names may sell offered securities under the registration
statement of which this prospectus forms a part. We may from time to time
include additional selling securityholders in an amendment to this registration
statement or a supplement to this prospectus.
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."
80
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 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. Upon resale using this prospectus,
the notes will cease to be 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
81
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
. 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 $ 50,000
Printing and engraving $ 20,000
Legal fees and expenses of the registrant $ 250,000
Miscellaneous $ 5,000
-----------
Total $ 337,292
82
LEGAL MATTERS
The validity of the notes and ordinary shares issuable upon conversion of
the notes has been passed upon for our company with respect to matters of Cayman
Islands law by Maples and Calder Asia. The validity of the notes has been passed
upon for our company with respect to New York law by Morrison & Foerster LLP.
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.
83
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$0.0001 par value:
1,000,300,000,000 shares authorized, 3,100,162,537
shares issued and outstanding as of December 31,
2002, and 3,145,561,689 shares issued and
outstanding as of June 30, 2003 3 2,566,543 2,604,111 314,597
Additional paid-in capital 3 1,049,651,354 1,059,750,050 128,026,246
Less: Subscriptions receivable (33,113,848) (33,113,848) (4,000,416)
Deferred compensation (474,739) (196,515) (23,741)
Translation adjustments 228,910 210,838 25,471
Accumulated deficit (437,834,468) (293,132,066) (35,412,688)
-------------- ------------- -------------
Total shareholders' equity 581,023,752 736,122,570 88,929,469
-------------- ------------- -------------
Total liabilities and shareholders' equity 619,678,196 786,167,989 94,975,354
============== ============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
F-1
NETEASE.COM, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
For the Six Months Ended
----------------------------------------------------
June 30, June 30, June 30,
Note 2002 2003 2003
---- -------------- ------------- -------------
RMB RMB US$
(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
Ordinary Shares
--------------------------
Additional
paid-in Subscription
Share Amount capital receivable
------------- ---------- ------------- ------------
RMB RMB RMB
Balance as of December 31, 2001 3,024,175,192 2,503,626 1,044,889,829 (35,100,568)
Collection of subscriptions receivable -- -- -- 1,986,720
Ordinary shares issued to a senior officer
of the Company as compensation 6,250,000 5,175 (5,175)
Ordinary shares issued for services to be
provided by certain employees 12,481,159 9,943 622,812
Share compensation cost -- -- 252,873
Net profit -- -- -- --
Translation adjustments -- -- --
------------- ---------- ------------- ------------
Balance as of June 30, 2002 3,042,906,351 2,518,744 1,045,760,339 (33,113,848)
============= ========== ============= ============
Retained
earnings Total
Deferred (Accumulated Translation shareholders'
compensation deficit) adjustments equity
------------ ------------ ----------- -------------
RMB RMB RMB RMB
Balance as of December 31, 2001 (3,344,574) (454,136,106) 217,327 555,029,534
Collection of subscriptions receivable -- -- -- 1,986,720
Ordinary shares issued to a senior officer
of the Company as compensation 335,961 -- -- 335,961
Ordinary shares issued for services to be
provided by certain employees 182,895 -- -- 815,650
Share compensation cost 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 (2,038,232) (471,891,484) 218,991 541,454,510
============ ============ =========== =============
Ordinary Shares
--------------------------
Additional
paid-in Subscription
Share Amount capital receivable
------------- ---------- ------------- ------------
RMB RMB RMB
Balance as of December 31, 2002 3,100,162,537 2,566,543 1,049,651,354 (33,113,848)
Ordinary shares issued to a senior officer
of the Company as compensation 2,500,000 2,070 (2,070) --
Ordinary shares issued for services to be
provided by certain employees 853,952 707 (707) --
Ordinary shares issued upon exercise of
employee options 42,045,200 34,791 10,101,473 --
Share compensation cost -- -- -- --
Net profit -- -- -- --
Translation adjustments -- -- -- --
------------- ---------- ------------- ------------
Balance as of June 30, 2003 3,145,561,689 2,604,111 1,059,750,050 (33,113,848)
============= ========== ============= ============
Retained
earnings Total
Deferred (Accumulated Translation shareholders'
compensation deficit) adjustments equity
------------ ------------ ----------- -------------
RMB RMB RMB RMB
Balance as of December 31, 2002 (474,739) (437,834,468) 228,910 581,023,752
Ordinary shares issued to a senior officer
of the Company as compensation 134,060 -- -- 134,060
Ordinary shares issued for services to be
provided by certain employees 88,236 -- -- 88,236
Ordinary shares issued upon exercise of
employee options -- -- -- 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 (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.
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 revenue 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.
F-6
1. Principal Accounting Policies (Cont'd)
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 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 revenue.
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 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 revenue.
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 revenue from software and related
integration projects to the separate elements of such projects.
F-7
1. Principal Accounting Policies (Cont'd)
Revenue recognition (cont'd)
Software and related integration projects (cont'd)
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;
. 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 employees 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.
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
F-8
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.
1. Principal Accounting Policies (Cont'd)
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
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-9
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.
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
F-10
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.
2. Taxation (Cont'd)
Income taxes (cont'd)
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.
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 revenue. The applicable BT rate for the Group's revenue 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 revenue 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-11
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
============= =============
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.
F-12
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 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-13
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)
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
5.2 Opinion of Morrison & Foerster LLP
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)
23.4 Consent of Morrison & Foerster LLP (included in Exhibit 5.2)
24.1* Power of Attorney of certain directors and officers of NetEase.com,
Inc. (see signature page)
II-1
Exhibit
Number Exhibit Title
---------- -------------------------------------------------------------------
25.1* Form T-1 Statement of Eligibility of Trustee for Indenture under
the Trust Indenture Act of 1933
* Previously filed.
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) 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 securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
II-2
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 December
29, 2003.
NETEASE.COM, INC.
By: /s/ Ted Sun
-----------------------------------
Ted Sun
Acting Chief Executive Officer
and Director
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 December 29, 2003
Ted Sun and Director
*
-------------------------- Chief Financial Officer, December 29, 2003
Denny Lee Principal Accounting Officer
and Director
*
-------------------------- Executive Director December 29, 2003
Michael Tong
*
-------------------------- Chief Architect and Director December 29, 2003
William Ding
*
-------------------------- Director December 29, 2003
Donghua Ding
*
-------------------------- Director December 29, 2003
Ronald Lee
*
-------------------------- Director December 29, 2003
Michael Leung
*
-------------------------- Director December 29, 2003
Joseph Tong
*By: /s/ Ted Sun
----------------------------------
Ted Sun, Attorney-in-Fact
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.
Name Title Date
-------------------------- ------------------------------ -------------------
/s/ Donald J. Puglisi
--------------------------
Puglisi & Associates Authorized U.S. Representative December 29, 2003
Donald J. Puglisi
II-3