primarily网易yeah

PROSPECTUS4500000AmericanDepositarySharesNeteasecomIncRepresenting450000000OrdinarySharesThisisNetease.
com'sinitialpublicoffering.
Netease.
comisselling4,500,000AmericanDepositaryShares.
EachADSrepresents100ordinaryshares.
TheU.
S.
underwritersareoffering2,250,000ADSsintheU.
S.
andCanadaandtheinternationalmanagersareoffering2,250,000ADSsoutsidetheU.
S.
andCanada.
Priortothisoffering,nopublicmarketexistedfortheADSs.
TheADSshavebeenapprovedforquotationontheNasdaqNationalMarketunderthesymbol''NTES''.
InvestingintheADSsinvolvesrisksthataredescribedinthe''RiskFactors''sectionbeginningonpage9ofthisprospectus.
PerADSTotalPublicofferingprice.
US$15.
50US$69,750,000Underwritingdiscount.
US$1.
085US$4,882,500Proceeds,beforeexpenses,toNetease.
com.
US$14.
415US$64,867,500TheU.
S.
underwritersmayalsopurchaseuptoanadditional337,500ADSsfromNetease.
comatthepublicofferingprice,lesstheunderwritingdiscount,within30daysfromthedateofthisprospectustocoverover-allotments.
Theinternationalmanagersmaysimilarlypurchaseuptoanadditional337,500ADSsfromNetease.
com.
NeithertheSecuritiesandExchangeCommissionnoranystatesecuritiescommissionhasapprovedordisapprovedofthesesecuritiesordeterminedifthisprospectusistruthfulorcomplete.
Anyrepresentationtothecontraryisacriminaloffense.
TheADSswillbereadyfordeliveryonoraboutJuly6,2000.
MerrillLynchFarEastLimitedMerrillLynchCoDeutscheBancAlexBrownThedateofthisprospectusisJune29,2000.
TABLEOFCONTENTSPageProspectusSummary1Netease.
com,Inc.
8RiskFactors.
9Forward-LookingStatementsContainedinthisProspectusMayNotProvetoBeAccurate.
23UseofProceeds.
24DividendPolicy.
24Capitalization.
25Dilution.
27ConventionsWhichApplytothisProspectus28ExchangeRateInformation.
28EnforcementofCivilLiabilities.
29SelectedConsolidatedFinancialData.
30Management'sDiscussionandAnalysisofFinancialConditionandResultsofOperations.
32Business42Management61PrincipalShareholders.
65RelatedPartyTransactions.
66DescriptionofShareCapital.
70DescriptionofAmericanDepositaryShares.
74SharesEligibleforFutureSale81Taxation83Underwriting.
88NoticetoCanadianResidents93LegalMatters.
95Experts.
95WhereYouCanFindAdditionalInformation95IndextoConsolidatedFinancialStatements.
F-1Youshouldrelyonlyontheinformationcontainedinthisprospectus.
InformationcontainedontheWebsitesoperatedbyGuangzhouNeteaseComputerSystemCo.
,Ltd.
,ortheNeteaseWebsites,doesnotconstitutepartofthisprospectus.
Wehavenot,andtheunderwritershavenot,authorizedanypersontoprovideyouwithdifferentinformation.
Ifanyoneprovidesyouwithdifferentorinconsistentinformation,youshouldnotrelyonit.
Wearenot,andtheunderwritersarenot,makinganoffertosellthesesecuritiesinanyjurisdictionwheretheofferorsaleisnotpermitted.
Youshouldassumethattheinformationappearinginthisprospectusisaccurateonlyasofthedateonthefrontcoverofthisprospectus.
Ourbusiness,nancialcondition,resultsofoperationsandprospectsmayhavechangedsincethatdate.
PROSPECTUSSUMMARYInadditiontothissummary,weurgeyoutoreadtheentireprospectuscarefully,especiallytherisksofinvestingintheADSsdiscussedunder''RiskFactors,''beforedecidingwhethertobuyanyADSs.
Netease.
com,Inc.
OurBusinessWearealeadingInternettechnologycompanyinChina.
Wepioneeredthedevelopmentofapplications,servicesandothertechnologiesfortheInternetinChina.
UsingourInternettechnologies,theWebsitesoperatedbyourafliate,GuangzhouNeteaseComputerSystemCo.
,Ltd.
,ortheNeteaseWebsites,offerChineseInternetusersChineselanguage-basedonlinecontent,communityandelectroniccommerce,ore-commerce,services.
AccordingtoasurveybytheChinaInternetNetworkInformationCenter,orCNNIC,datedJanuary2000,theNeteaseWebsiteswererankedthesecondmostrecommendedbyChineseInternetusers.
WebelieveweweretherstInternettechnologycompanyinChinatoofferafreeWeb-basede-mailservicethatsupportsboththeChineseandEnglishlanguages.
UnlikemanyotherInternetcompaniesthatprovideChineselanguageInternetservices,wearefocusedonInternetusersinChina.
MostofouremployeesareChinesenationals;theirculturalandlinguisticinsightsenableustotailorourservicestotheneedsofChineseInternetusers.
Ouraveragedailypageviewsfortheseven-dayperiodendedMay31,2000exceeded20million.
TheNeteaseWebsitesprovideadestinationforChineseInternetuserstoidentifyandaccessresources,services,contentandinformationontheInternet.
TheNeteaseWebsitesaggregate,organizeandprovideaccessto15separatechannelsofonlinecontentthroughcontentdistributionrelationshipswithover140internationalanddomesticChineselanguagecontentproviders.
WebelieveweweretherstInternettechnologycompanyinChinatoofferanonlineservicethatallowsuserstocreateaproletoorganizeandreceiveinformationofpersonalinterest,orapersonalizationservice.
Inaddition,theNeteaseWebsitescontainover378,000Webpagescreatedandmaintainedbyourusers,orpersonalhomepages,enablinguserstoexpressthemselves,toshareideas,interestsandareasofexpertiseandtopublishpersonalcontentaccessiblebyotherChineseInternetusers.
WebelievewewereoneoftherstInternetcompaniesinChinatoofferonlineinteractivecommunityservices.
OurcommunityservicesallowuserswhoregisterwiththeNeteaseWebsitestocommunicatewithotherregisteredcommunitymembersthroughavarietyofcommunityproductsandservices.
Ourcommunityoffersover200communityforumswhereregisteredcommunitymemberscanpostmessagesandarticlesforviewingbyotherusers.
TheNeteaseWebsitescontainover13,700personalcommunityforums,whereregisteredcommunitymemberscreatetheirownforumtopics.
Neteaseregisteredcommunitymemberscanchat,participateinsurveysandsendinstantmessagestootherregisteredmembers.
WebelieveweweretherstInternetcompanytoofferonlineauctionservicesinChina.
Weofferapermanentbusiness-to-consumerauctionserviceontheNeteaseWebsites,featuringawiderangeofproducts.
Oure-commerceapplications,servicesandtechnologies,ore-commerceplatform,acceptavarietyofonlinepaymentoptions,includingonlinecreditanddebitcards.
Usersmayalsopaybycheckorchoosecash-on-delivery.
Wehaveestablishedallianceswithlogisticsproviders,allowingvendorsonourplatformtoarrangedeliveryoftheirgoodsatreducedrates.
WeincurredanetlossofapproximatelyUS$6.
3millionin1999.
AsofMarch31,2000wehadanaccumulateddecitofapproximatelyUS$9.
2million.
1OurMarketOpportunityTheonlineadvertisingmarketandthee-commercemarketinChinaareintheirearlystagesofdevelopment.
Inaddition,ChinahasonlyrecentlybeguntobuildoutitsInternetinfrastructure.
ThelimitedavailabilityofInternetaccessinChina,aswellastherelativelyhighcostofpersonalcomputers,hasinhibitedgrowthinthenumberofChineseInternetusers.
AccordingtothesurveyreportissuedbyCNNICinJanuary2000,thetotalnumberofInternetusersinChinaasofDecember31,1999reached8.
9million.
WeexpectChina'sInternetmarkettoexperiencerelativelyrapidgrowthoverthenextfewyears.
Forexample,accordingtoareportissuedbyInternationalDataCorporation,orIDC,thenumberofInternetusersinChinaisexpectedtoincreaseto33.
1millionby2004.
WebelievethatacontinuedreductioninInternetaccesscostsandpersonalcomputerpricesinChinawillfurtherpromoteInternetuseinChina.
WebelievethatthepotentialforInternetaccessthroughtelevision-baseddevicesusingcableorsatellitetechnologyandwirelessdevicesmayfurtheraccelerateInternetgrowth.
WebelievethatthepotentialforgrowthintheInternetindustryinChinapresentsasignicantopportunityforcompaniesthatfocusontheChineseInternetmarket.
Inaddition,therearefewChina-basedWebsitesthatofferChineseInternetusersacombinationofcontent,communityande-commerceintheChineselanguage.
OurStrengthsandStrategyWearefocusedonprovidingInternettechnologyandsolutionstothedevelopingInternetmarketinChina.
Webelievethatbyofferinganintegratedplatformofonlinecontent,communityande-commerceservices,wearewellpositionedtocapitalizeonthegrowthoftheInternetmarketinChina.
OurgoalistomaketheNeteaseWebsitestheleadingonlinenetworkinChina.
Keystrategiesforachievingourgoalareto:AggressivelyextendourbrandnamerecognitiontomaketheNetease,Netease''aswritteninChinese),and163.
combrandnamessynonymouswiththeInternetamongusersinChina.
Continuetodevelopuser-friendlyInternettechnologyfocusedonthemarketinChinabyadaptingandmodifyingexistingtechnologiesforChineselanguage-basedInternetapplicationsaswellasdevelopingourownproprietaryChineselanguage-basedInternetapplications.
Enrich,expandandpersonalizethecontentofferedontheNeteaseWebsitestomakeitmoretailoredforandrelevanttoourusers'dailylivesandtoprovideouruserswithamorecustomizedandcomprehensiveInternetexperience.
Expandthenumberofourregisteredusersandregisteredcommunitymembersbyenhancingthequalityofourcommunityservicesandbyintroducingnewapplications,servicesandtechnologyforourinteractiveonlinecommunity.
Inadditiontoourexistingcommunities,weplantodeveloptechnologytosupportabusinesscommunityontheInternet.
Expandoure-commerceservicesbyexpandingouronlinee-commerceplatform,byassistingtraditionalvendorstoestablishtheire-commercestrategies,andbyleveragingourregistereduserstotargetproductstospecicdemographicgroups.
Expandouronlineadvertiserbasebyaggressivelyextendingourbrandrecognition,bycontinuingtopromotetheInternetasanalternativemethodforadvertisers,byofferingdemographicallytargetedadvertisingservicestoattractonlineadvertisersandbyutilizingthirdpartyadvertisingnetworksandadvertisingagencies.
EstablishandextendstrategicallianceswithoracquireprominentInternetcompanies,e-commerceservicecompanies,traditionalmediacompaniesandtechnologycompanies.
2OurHistoryandRecentDevelopmentsOurbusinesswasfoundedinJune1997.
Ourinitialbusinessobjectivewastodeveloplarge-scaledistributedsoftwaresystemsforuseontheInternetinChina.
Inmid-1998,wechangedourbusinessmodelfromasoftwaredevelopertoanInternettechnologycompany.
InJuly1999,weestablishedanewholdingcompany,Netease.
com,Inc.
,intheCaymanIslands.
InSeptember1999,werestructuredouroperationsinordertocomplywithincreasingregulationoftheInternetindustryinChina.
Aspartofthisrestructuring,substantiallyallofGuangzhouNetease'sxedandintangibleassetsandexistingInternetapplications,servicesandtechnologieswereacquiredbyNeteaseInformationTechnology(Beijing)Co.
,Ltd.
,orNeteaseBeijing,awhollyownedsubsidiaryofNetease.
comformedinAugust1999.
Inaddition,therightstousethefollowinguniformresourcelocators,orURLs,weretransferredfromGuangzhouNeteasetoNetease.
com:www.
netease.
com;www.
163.
com;www.
126.
com;www.
yeah.
net;andwww.
nease.
net.
UndercurrentChineseregulationsandpolicies,foreignorforeign-investedentitiesmaynotownoroperatetelecommunicationsbusinessesinChina,whichmayincludetheoperationofInternetcontentprovisionbusinesses.
Inaddition,theownershipbyforeignorforeign-investedentitiesofadvertisingbusinessesinChinaissubjecttogovernmentapproval.
GuangzhouNetease,whichis80%ownedbyourfounder,ChairmanoftheBoard,Co-ChiefTechnologyOfcerandmajorityshareholder,WilliamLeiDing,hasreceivedapprovalfromtheGuangzhoutelecommunicationsadministrativeauthoritiestoprovideInternetcontentservices,andits80%ownedsubsidiary,BeijingGuangyitongAdvertisingCo.
,Ltd.
,orGuangyitongAdvertising,holdsalicensetooperateanadvertisingbusiness.
Becauseoftherestrictionsdescribedabove,Netease.
comiscurrentlynotpermittedtoownanequityinterestinGuangzhouNeteaseanddoesnothaveapprovaltoownanequityinterestinGuangyitongAdvertising.
RisksrelatingtotheimpactofChineselawonouroperationsaredescribedonpages10,11,15and17.
WehaveagreedtoacquiretheoperationsofortheequityinGuangzhouNeteaseoranypartthereofwhenChineselawpermitsforeignownershipofanInternetcontentproviderinChina.
WehavealsoagreedtoacquiretheoperationsoforGuangzhouNetease'sequityinterestinGuangyitongAdvertisingwhenChineselawsregardingforeignownershipofadvertisingbusinessesarerelaxed.
WecannotassureyouthatChineselawswilleverpermitourownershipofGuangzhouNeteaseorGuangyitongAdvertisingorthatitwillbeeconomicallyviabletoacquirethesebusinessesatthattime.
WeenteredintoaseriesofagreementswithGuangzhouNeteaseandGuangyitongAdvertisingeffectiveJanuary1,2000.
Undertheseagreements,weprovideourInternetportalande-commercetechnologiesandadvertisingservicestoGuangzhouNeteaseandGuangyitongAdvertising,andGuangzhouNeteaseandGuangyitongAdvertisingoperatetheNeteaseWebsitesandtheonlineadvertisingbusiness,respectively.
ToensurethatGuangyitongAdvertisingwillnotdoanythingdetrimentaltoourjointendeavors,wehaveenteredintoanoperatingagreementwithGuangyitongAdvertisinganditsultimateshareholdersandaproxyagreementwithGuangyitongAdvertising'sultimateshareholdersthatallowustodirectthepoliciesandmanagementthatguidetheongoingactivitiesofGuangyitongAdvertising.
OuragreementswithGuangzhouNeteaseandGuangyitongAdvertisingaredescribedinmoredetailinthesection''RelatedPartyTransactions''onpage66,andseveralrisksrelatingtothesecontractsaredescribedonpages10,11and12.
3InMarch2000weissuedourSeriesBpreferenceshares,convertibleinto256,055,600ofourordinaryshares,toanafliateofTheNewsCorporationLimitedforUS$35millionincashandUS$5millionofadvertisinginventory.
Weexpecttousethecashproceedsofthisprivateplacementformarketing,contentdevelopment,serverandbandwidthexpenditures,researchanddevelopmentandworkingcapitalandgeneralcorporatepurposes.
Inconnectionwiththistransaction,weenteredintoanagreementwithanafliateofTheNewsCorporationthatprovidesforcooperationbetweenusandTheNewsCorporation.
TheagreementalsoprovidesforTheNewsCorporationtoprovideuswithUS$5millionofadvertisinginventoryandforTheNewsCorporationtopurchaseUS$5millionofadvertisingontheNeteaseWebsites.
Formoreinformationregardingthisstrategicalliance,see''Business—StrategicAlliances—TheNewsCorporation''onpage52.
OurOfcesOurprincipalexecutiveofceislocatedat15thFloor,NorthTower,BeijingKerryCentre,No.
1GuanghuaRoad,ChaoyangDistrict,Beijing100020,People'sRepublicofChina,andourtelephonenumberis(8610)6561-8811.
WealsohaveofcesinGuangzhouandShanghai.
4TheOfferingAmericanDepositarySharesofferedbyNetease.
com:U.
S.
offering.
2,250,000ADSsInternationaloffering2,250,000ADSsTotal.
4,500,000ADSsTheADSs.
EachADSrepresents100ordinaryshares,parvalueUS$0.
0001pershare.
TheADSswillbeevidencedbyAmericanDepositaryReceipts.
TounderstandthetermsoftheADSs,youshouldcarefullyreadthesectioninthisprospectusentitled''DescriptionofAmericanDepositaryShares.
''Wealsoencourageyoutoreadthedepositagreement,whichisanexhibittotheregistrationstatementthatincludesthisprospectus.
Ordinarysharesoutstandingaftertheoffering.
3,010,555,600sharesUseofproceeds.
Ournetproceedsfromthisofferingwithoutexerciseoftheover-allotmentoptionswillbeapproximatelyUS$62.
6million.
Weintendtousethesenetproceedsformarketing,contentdevelopment,serverandbandwidthexpenditures,researchanddevelopmentandworkingcapitalandgeneralcorporatepurposes.
Riskfactors.
See''RiskFactors''andotherinformationincludedinthisprospectusforadiscussionoffactorsyoushouldcarefullyconsiderbeforedecidingtoinvestintheADSs.
NasdaqNationalMarketsymbolNTESTheordinarysharesoutstandingimmediatelyafterthisofferingexcludethefollowing:anyordinarysharesrepresentedbytheADSstobeissuedpursuanttotheunderwriters'over-allotmentoptions;295,148,000ordinarysharesissuableupontheexerciseofoptionsoutstandingasofJune15,2000underourstockincentiveplansataweightedaverageexercisepriceofUS$0.
091pershare;and50,527,000ordinarysharesreservedasofJune15,2000forfutureissuanceunderourstockincentiveplan.
5SUMMARYFINANCIALDATAYoushouldreadthefollowinginformationinconjunctionwithourconsolidatednancialstatementsandrelatednotes,''SelectedConsolidatedFinancialData''and''Management'sDiscussionandAnalysisofFinancialConditionandResultsofOperations''includedelsewhereinthisprospectus.
OurnancialstatementsarepresentedinChineserenminbiandpreparedinaccordancewithU.
S.
GAAPasofDecember31,1998and1999andfortheperiodbetweenJune24,1997(dateofinception)toDecember31,1997andtheyearsendedDecember31,1998and1999.
Foryourconvenience,nancialstatementsfortheyearendedandasofDecember31,1999alsohavebeentranslatedintoU.
S.
dollars.
Thesenancialdatareectourreorganizationandhavebeenpreparedasifourcurrentcorporatestructurehadbeeninexistencethroughouttherelevantperiods.
Theproformapersharedatagiveeffecttotheconversionofouroutstandingpreferencesharesintoordinarysharesthatwilloccurupontheconsummationofthisoffering.
Foradditionalinformationregardingtheproformadata,see''Capitalization''onpage25.
FromJune24,1997(inception)toDecember31,1997FortheYearEndedDecember31,199819991999(RMB)(RMB)(RMB)(US$)StatementofOperationsData:Revenues.
100,0003,115,43216,771,0062,025,607Salesandvalue-addedtaxes6,600)(230,749)(1,150,169)(138,918)Netrevenues.
93,4002,884,68315,620,8371,886,689Costofrevenues.
68,614)(1,189,188)(12,096,235)(1,460,986)Grossprot.
24,7861,695,4953,524,602425,703Operatingexpenses30,844)(1,262,957)(56,790,659)(6,859,190)Operatingprot(loss)6,058)432,538(53,266,057)(6,433,487)Otherincome(expenses)65,337)1,363,142164,640Income(loss)beforetax6,058)367,201(51,902,915)(6,268,847)Provisionforincometax.
1,000)(34,464)(71,338)(8,616)Netincome(loss)7,058)332,737(51,974,253)(6,277,463)Netincome(loss)pershare,basicanddiluted.
0.
01)0.
01(0.
03)(0.
01)Netincome(loss)perADS,basicanddiluted.
0.
01)0.
02(2.
73)(0.
33)Weightedaveragenumberofsharesoutstanding1,868,817,2001,868,817,2001,900,430,6001,900,430,600WeightedaveragenumberofADSsoutstanding18,688,17218,688,17219,004,30619,004,306Proformanetincome(loss)perordinaryshare,basicanddiluted0.
01)0.
01(0.
02)(0.
01)Proformanetincome(loss)perADS,basicanddiluted.
0.
01)0.
02(2.
36)(0.
29)Proformaweightedaveragenumberofordinarysharesoutstanding1,868,817,2001,868,817,2002,200,430,6002,200,430,600ProformaweightedaveragenumberofADSsoutstanding.
18,688,17218,688,17222,004,30622,004,3066FromJune24,1997(inception)toDecember31,1997FortheYearEndedDecember31,199819991999(RMB)(RMB)(RMB)(US$)OtherFinancialData:Capitalexpenditures187,7701,083,2489,312,3831,124,752Netcashprovidedby(usedin):Operatingactivities.
261,823)1,232,379(15,687,474)(1,894,737)Investingactivities.
187,770)(1,083,248)(9,312,383)(1,124,752)Financingactivities.
500,000—142,600,41517,223,313Thefollowingtablesetsforthourbalancesheetdata:asofDecember31,1999:onanactualbasis;onaproformabasistoreecttheissuanceandsaleof2,560,556SeriesBpreferencesharesinMarch2000andtheconversionofouroutstandingSeriesAandSeriesBpreferencesharesintoordinarysharesthatwilloccurupontheconsummationofthisoffering;andasadjustedtogiveeffecttotheissuanceandsaleof4,500,000ADSsofferedherebyattheinitialpublicofferingpriceofUS$15.
50perADS,afterdeductingestimatedunderwritingdiscounts,commissionsandofferingexpenses.
AsofDecember31,1999ActualProFormaProFormaAsAdjustedRMBUS$RMBUS$RMBUS$BalanceSheetData:Cash.
117,800,09614,227,924407,582,59649,227,924926,024,187111,845,424Workingcapital126,556,80315,285,562424,618,80351,285,562943,060,394113,903,062Property,plantandequipment.
9,508,4371,148,4319,508,4371,148,4319,508,4371,148,431Totalassets143,728,18217,359,524474,908,18257,359,524993,349,773119,977,024Totalcurrentliabilities.
.
.
.
.
7,662,942925,5317,662,942925,5317,662,942925,531Totalshareholders'equity.
136,065,24016,433,993467,245,24056,433,993985,686,831119,051,4937NETEASE.
COM,INC.
OurbusinesswasfoundedbyWilliamLeiDing,ourChairmanoftheBoardandCo-ChiefTechnologyOfcer,inJune1997.
Mr.
Dingowns100%ofourmajorityshareholder,ShiningGlobeInternationalLimited,andowns80%ofGuangzhouNetease.
InSeptember1999,werestructuredouroperationsinordertocomplywithincreasingregulationoftheInternetindustryinChina.
Aspartofthisrestructuring,substantiallyallofGuangzhouNetease'sxedandintangibleassetsandexistingInternettechnologieswereacquiredbyNeteaseBeijing,ourwhollyownedsubsidiary.
TherightstouseallofGuangzhouNetease'sURLsweretransferredtoNetease.
com.
GuangzhouNeteasehasobtainedapprovalfromtheGuangzhoutelecommunicationsadministrativeauthoritiestoprovideInternetcontentservices,andits80%ownedsubsidiary,GuangyitongAdvertising,holdsalicensetooperateanadvertisingbusiness.
Theother20%ofGuangzhouNeteaseandofGuangyitongAdvertisingisownedbyouremployee,BoDing,thebrotherofWilliamLeiDing.
UndercurrentChineseregulations,foreignorforeign-investedcompaniesmaynotownoroperatetelecommunicationsbusinessesinChina,whichmayincludetheoperationofInternetcontentprovisionbusinesses.
Inaddition,theoperationbyforeignorforeign-investedcompaniesofadvertisingbusinessesinChinaissubjecttogovernmentapproval.
Becauseoftheserestrictions,Netease.
comisnotpermitteddirectlytoownanInternetcontentprovisionoradvertisingbusiness.
Netease.
comhasthereforeenteredintoaseriesofagreementswithGuangzhouNeteaseandGuangyitongAdvertisingunderwhichweprovideourInternetapplications,servicesandtechnologiesandadvertisingservicestoGuangzhouNeteaseandGuangyitongAdvertising,andGuangzhouNeteaseandGuangyitongAdvertisingoperatetheNeteaseWebsitesandtheonlineadvertisingbusiness.
Formoreinformationontheseagreements,see''RelatedPartyTransactions''onpage66.
ThetablebelowillustratesourcorporatestructureandtherelationshipbetweenNetease.
comandGuangzhouNeteaseandtheirmajorshareholders.
8RISKFACTORSInvestmentinourADSsinvolvesahighdegreeofrisk.
Youshouldconsidercarefullythefollowinginformationabouttheserisks,togetherwiththeotherinformationcontainedinthisprospectus,beforeyoudecidewhethertobuyourADSs.
Anyofthefollowingriskscouldhaveamaterialadverseeffectonourbusiness,resultsofoperationsandnancialcondition.
Inanysuchcase,themarketpriceofourADSscoulddecline,andyoumayloseallorpartofthemoneyyoupaytobuyourADSs.
RisksRelatedtoOurCompanyOurbusinessprospectsaredifculttoevaluatebecausewecommencedouroperationsin1997andchangedourbusinessfocusin1998.
OurbusinesswasestablishedinJune1997asanInternetsoftwaredeveloper.
Inmid-1998ourbusinessfocuschangedtoanInternettechnologyproviderandwecommenceddevelopingtheNeteaseWebsites.
InJuly1999,wecommencedoure-commerceserviceandinSeptember1999werestructuredouroperationstoplaceourInternetportaloperationsinGuangzhouNetease.
Becausewehavealimitedoperatinghistory,whenyouevaluateourbusinessandprospectsyoumustconsidertherisksanddifcultiesfrequentlyencounteredbycompaniesintheearlystagesofdevelopment,particularlycompaniesinthenewandrapidlyevolvingInternetservicemarkets.
OurrecentchangeofbusinessfocusfromdevelopingWeb-basedsoftwareproductstodevelopingandprovidingtechnologicalservicestotheNeteaseWebsitesandprovidinge-commerceservicesalsomakesitdifculttoevaluateourfutureprospects.
Revenuesfromoursoftwarelicensingandrelatedintegrationprojectsbusinessexceededrevenuesfromouradvertisingande-commercerelatedservicesuntilSeptember1999.
Wecannotassureyouthatwewillbeabletoincreaseormaintainourrevenuesfromonlineadvertisingande-commerceservices.
Weincurredsignicantlossesinthepastandexpectlossestocontinueinthefuture.
Weincurredsignicantlossesin1999andhadonlyminimalprotin1998.
Weexpecttocontinuetoincursignicantlossesintheforeseeablefuture.
AsofMarch31,2000,wehadanaccumulateddecitofapproximatelyUS$9.
2million.
Inrecentquarters,ourexpenseshavegrownfasterthanourrevenues.
Inaddition,weanticipateourspendingtoincreasesignicantlyduetoourincreasedcapitalexpenditures,marketingcostsandthecostofadditionalpersonnel.
Accordingly,itispossiblethatouroperatinglossesmayincreaseandwemaynotachieveprotabilityintheforeseeablefutureorever.
OurrevenuesuctuatesignicantlyandmayadverselyimpactthetradingpriceofourADSs.
Ourrevenuesandresultsofoperationshavevariedsignicantlyinthepastandmaycontinuetouctuateinthefuture.
Manyofthefactorsthatcausesuchuctuationareoutsideourcontrol.
Steadyrevenuesandresultsofoperationswilldependlargelyonourabilityto:attractandretainuserstotheNeteaseWebsitesintheincreasinglycompetitiveInternetmarketinChina;successfullyimplementoure-commercestrategiesasplanned;andupdateanddevelopourInternetapplications,services,technologiesandinfrastructure.
Wederivedapproximately64.
4%and93.
1%ofourrevenuesfromadvertisingservicesin1999andintherstquarterof2000,respectively.
Seasonalvariationinthelevelofadvertisingexpendituresbyonlineadvertiserswillalsocauseuctuationsinourrevenuesandoperatingresults.
InChina,advertisingexpenditureshavehistoricallybeensignicantlylowerduringtherstcalendarquarteroftheyearduetotheChineseNewYearholidayandthetraditionalcloseofadvertisers'annualbudgets.
Ifourrevenuesdecreaseorexpensesincreaseduringtheseperiods,wemaynotbeabletooffsetourexpenseswithsufcientrevenues.
9Accordingly,youshouldnotrelyonquarter-to-quartercomparisonsofourresultsofoperationsasanindicationofourfutureperformance.
Itispossiblethatfutureuctuationmaycauseourresultsofoperationstobebelowtheexpectationsofmarketanalystsandinvestors.
ThiscouldcausethetradingpriceofourADSstodecline.
IfGuangzhouNetease,GuangyitongAdvertisingorGuangyitongAdvertising'sultimateshareholdersviolateourcontractualarrangementswiththem,ourbusinesscouldbedisrupted,ourreputationmaybeharmedandwemayhavetoresorttolitigationtoenforceourrightswhichmaybetimeconsumingandexpensive.
BecauseofcurrentChineselawsandrestrictions,GuangzhouNeteaseoperatestheNeteaseWebsitesandGuangyitongAdvertising,an80%-ownedsubsidiaryofGuangzhouNetease,operatestheonlineadvertisingbusinesspursuanttocontractualarrangementswithus.
GuangzhouNeteaseis80%ownedbyourfounder,ChairmanoftheBoard,Co-ChiefTechnologyOfcerandmajorityshareholder,WilliamLeiDingand20%ownedbyouremployeeBoDing,WilliamLeiDing'sbrother.
BoDingownstheremaining20%ofGuangyitongAdvertising.
TheinterestsoftheshareholdersofGuangzhouNeteasemaydifferfromoursandyoursbecausetheyownalargerpercentageofGuangzhouNeteasethanofourcompany.
Inaddition,GuangzhouNetease,asanInternetcontentprovider,andGuangyitongAdvertising,asanadvertisingrm,maybesubjecttolawsandregulationsinChinathatareincompatiblewiththebusinessstrategiesoroperationsofourcompany.
GuangzhouNetease,GuangyitongAdvertisingorGuangyitongAdvertising'sultimateshareholderscouldviolateouragreementswiththemby,amongotherthings,failingtooperateandmaintaintheNeteaseWebsitesoradvertisingbusinessinanacceptablemanner,failingtoremitrevenuestousonatimelybasisoratallordivertingcustomersorbusinessopportunitiesfromourcompanytoGuangzhouNetease.
Aviolationoftheseagreementscoulddisruptourbusinessandadverselyaffectourreputationinthemarket.
IfGuangzhouNetease,GuangyitongAdvertisingorGuangyitongAdvertising'sultimateshareholdersviolateouragreementswiththem,wemayhavetoresorttolitigationtoenforceourrights.
Thislitigationcouldresultinthedisruptionofourbusiness,diversionofourresourcesandtheincurrenceofsubstantialcosts.
BecauseourcontractualarrangementswithGuangzhouNetease,GuangyitongAdvertisingandGuangyitongAdvertising'sultimateshareholdersarenewanddonotdetailtheparties'rightsandobligations,ourremediesforabreachofthesearrangementsarelimited.
OurcurrentrelationshipwithGuangzhouNetease,GuangyitongAdvertisingandGuangyitongAdvertising'sultimateshareholdersisbasedonanumberofrecentlyexecutedcontracts.
Thetermsoftheseagreementsareoftenstatementsofgeneralintentanddonotdetailtherightsandobligationsoftheparties.
Someofthesecontractsprovidethatthepartieswillenterintofurtheragreementsonthedetailsoftheservicestobeprovided.
Otherscontainpriceandpaymenttermsthataresubjecttomonthlyadjustment.
Theseprovisionsmaybesubjecttodifferinginterpretations,particularlyonthedetailsoftheservicestobeprovidedandonpriceandpaymentterms.
ItmaybedifcultforustoobtainremediesordamagesfromGuangzhouNetease,GuangyitongAdvertisingorGuangyitongAdvertising'sultimateshareholdersforbreachingouragreements.
Inaddition,wehaveverylimitedexperienceinimplementingtheseagreements.
BecausewerelysignicantlyonGuangzhouNeteaseandGuangyitongAdvertisingforourbusiness,therealizationofanyoftheserisksmaydisruptouroperationsorcausedegradationinthequalityandserviceprovidedon,oratemporaryorpermanentshutdownof,theNeteaseWebsites.
IncreasedgovernmentregulationoftheinformationindustryinChinamayresultintheChinesegovernmentreclassifyingourbusinessasatelecommunications,mediaorretailbusinesswhichmayrestrictouroperations.
TheChinesegovernmentregulatesInternetaccess,distributionofnewsandotherinformationandprovisionofcommerceandadvertisingservicesthroughstrictbusinesslicensingrequirementsandother10governmentalregulations.
NeteaseBeijingislicensedtooperateasaninformationtechnologycompanyandisnotlicensedtooperateasanInternetcontentprovider,retailbusinessoradvertisingbusiness.
GuangzhouNeteaseobtainedapprovalinJanuary2000fromtheGuangzhoutelecommunicationsadministrativeauthoritiestoprovideInternetcontentservices.
WerelyexclusivelyonourcontractualarrangementswithGuangzhouNeteaseanditsapprovaltooperateasanInternetcontentproviderforourbusinessoperations.
WebelievethatourpresentoperationsarestructuredtocomplywithChineselaw.
WehavebeeninformedbyourChineselegalcounselthatwehaveobtainedallnecessarypermits,licensesandclearancesfromgovernmentalagenciesinChinanecessaryforoperatingourbusiness.
However,manyChineseregulationsaresubjecttoextensiveinterpretivepowersofgovernmentalagenciesandcommissions.
WecannotbecertainthattheChinesegovernmentwillnottakeactiontoprohibitorrestrictourbusinessactivities.
WeareuncertainastowhethertheChinesegovernmentwillreclassifyourbusinessasamediaorretailcompany,duetoouracceptanceofInternetadvertisingfeesande-commercerelatedservicesfeesassourcesofrevenues,orasaresultofourcurrentcorporatestructure.
Suchreclassicationcouldsubjectustopenaltiesornesorsignicantrestrictionsonourbusiness.
WearealsouncertainastowhethertheChinesegovernmentwillreclassifyourbusinessasatelecommunicationsbusiness,potentiallyresultinginsignicantrestrictionsonourbusiness.
Wemayfailtoobtainsomeorallthelicenses,permitsorclearanceswemayneedinthefuture.
Inaddition,wemayhavedifcultiesenforcingourrightsunderouragreementswithGuangzhouNeteaseandGuangyitongAdvertisingifeitherofthesepartiesbreachesanyofouragreementswiththembecausewedonothaveapprovalfromappropriateChineseauthoritiestoprovideInternetcontentservicesorInternetadvertisingservices.
FuturechangesinChinesegovernmentpoliciesaffectingtheprovisionofinformationservices,includingtheprovisionofonlineservices,Internetaccess,e-commerceservicesandonlineadvertising,mayimposeadditionalregulatoryrequirementsonusorourserviceprovidersorotherwiseharmourbusiness.
OurbusinesswouldbemateriallyharmediftheChinesegovernmentweretotakeanyactionagainstusforthecontentontheNeteaseWebsites.
TheChinesegovernmenthasrecentlyenactedregulationsgoverningInternetaccessanddistributionofnewsandotherinformationovertheInternet.
Inthepast,theChinesegovernmenthasstoppedthedistributionofinformationovertheInternetthatitbelievedtobeinappropriate.
WecannotpredicttheeffectoffurtherdevelopmentsintheChineselegalsystem,particularlywithregardtotheInternet,includingthepromulgationofnewlaws,changestoexistinglawsortheinterpretationorenforcementoflaws.
IfwearefoundtobeinviolationofanyexistingorfutureChineselawsorregulations,therelevantChineseauthoritieswouldhavebroaddiscretionindealingwithsuchaviolation,including,withoutlimitation,thefollowing:levyingnes;revokingourbusinesslicense;requiringustorestructureourcorporatestructure,operationsorrelationshipwithGuangzhouNeteaseorGuangyitongAdvertising;andrequiringustodiscontinueanyportionorallofourInternetbusinessorourrelationshipwithGuangzhouNeteaseorGuangyitongAdvertising.
Anysuchactionwouldhaveamaterialadverseeffectonourbusiness,nancialconditionandresultsofoperationsandontheholdersofourADSs.
Ourbusinessplanisbaseduponanunprovenbusinessmodelthatmaynotbesuccessful.
Ourbusinessplanisnewandrelativelyunproven.
Themarketforourtechnologyandservicesisnewandrapidlydeveloping.
Ourbusinessplandependsuponincreasedrevenuesgeneratedfromonlineadvertisingande-commercerelatedservicesontheNeteaseWebsites.
Onlineadvertisingande-commerceinChinaare11unprovenbusinesses.
ManyofourcurrentandpotentialadvertisershavelimitedexperiencewiththeInternetasanadvertisingmedium.
TheyhavenottraditionallydevotedasignicantportionoftheiradvertisingexpenditurestoWeb-basedadvertising.
TheymaynotndtheInterneteffectiveforpromotingtheirproductsandservicesrelativetotraditionalprintandbroadcastmedia.
Likewise,manyofourcurrentandpotentialmerchantcustomershavelimitedexperiencewiththeInternetandonlinesales,distributionandfulllmentprocesses.
TheyhavenottraditionallysoldtheirproductsovertheInternet.
Tobesuccessful,wemustdevelopandmarketproductsandservicesthateitherhaveachievedorarelikelytoachievebroadmarketacceptancebyInternetusers,onlineadvertisersande-commercevendorsinChina.
Youshouldnotrelyonourhistoricalnancialresultsasanindicatoroffutureresults.
WestartedasanInternetsoftwaredeveloperandinmid-1998changedourbusinessfocustoInternettechnology.
Withinthelastyear,weexpandedourInternetadvertisingoperationsandbegantooffere-commerceplatformsandtoprovideonlineauctionservicesinChina.
Asaresultofthesechangesinourbusiness,youshouldnotrelyonourhistoricalresultsofoperationsandnancialconditionasanindicatoroffutureresults.
Formoreinformation,see''Management'sDiscussionandAnalysisofResultsofOperationsandFinancialCondition''onpage32.
BecausethemajorityofourrevenueisderivedfromInternetadvertisingservices,ourfuturerevenuecouldbemateriallyandadverselyaffectedifwecannotadaptsuccessfullytonewInternetadvertisingpricingmodels.
ItisdifculttopredictwhichInternetadvertisingpricingmodel,ifany,willemergeastheindustrystandard.
Thismakesitdifculttoprojectourfutureonlineadvertisingratesandrevenues.
OuradvertisingservicesrevenuescouldbemateriallyandadverselyaffectedifweareunabletoadapttonewformsofInternetadvertisingorifwefailtoadoptthemostprotableform.
WemaynotbeabletoconductouroperationswithouttheservicesprovidedbyGuangzhouNeteaseandGuangyitongAdvertising.
OuroperationsarecurrentlydependentuponourcommercialrelationshipswithGuangzhouNeteaseandGuangyitongAdvertising,andwederivemostofourrevenuesfromthesecompanies.
Aportionofourrevenuesunderourcontractswiththesecompaniesarebaseduponarbitraryamountsthathavebeenagreeduponinadvance.
Ifthesecompaniesareunwillingorunabletoperformtheagreementswhichwehaveenteredintowiththem,wemaynotbeabletoconductouroperationsinthemannerinwhichwecurrentlyplan.
Mostoftheseagreementshaveatermofoneyear,andtheymaynotberenewedinfutureyears.
Inaddition,GuangzhouNeteaseandGuangyitongAdvertisingmayseektorenewtheseagreementsontermsthataredisadvantageoustous.
Althoughwehaveenteredintoaseriesofagreementsthatprovideuswithsubstantialabilitytocontrolthesecompanies,wemaynotsucceedinenforcingourrightsunderthem.
Ifweareunabletorenewtheseagreementsonfavorableterms,ortoenterintosimilaragreementswithotherparties,ourbusinessmaynotexpand,andouroperatingexpensesmayincrease.
GuangzhouNeteaseandGuangyitongAdvertisingarecontrolledbyourcontrollingshareholder,whomaycausetheseagreementstobeamendedinamannerthatisadversetous.
Ourmajorityshareholder,WilliamLeiDing,isalsothecontrollingshareholderofGuangzhouNeteaseandGuangyitongAdvertising.
Asaresult,Mr.
Dingmaybeabletocausetheseagreementstobeamendedinamannerthatwillbeadversetoourcompany,ormaybeabletocausetheseagreementsnottoberenewed,eveniftheirrenewalwouldbebenecialforus.
Priortothisoffering,anumberoftheseagreementswererecentlyamendedtocontainthetermsthataredescribedinthisprospectus.
AlthoughwehaveenteredintoanagreementthatpreventstheamendmentoftheseagreementswithouttheapprovalofthemembersofourBoardotherthanMr.
Ding,wecanprovidenoassurancesthattheseagreementswillnotbeamendedinthefuturetocontaintermsthatmightdifferfromthetermsthatarecurrentlyinplace.
Thesedifferencesmaybeadversetoourinterests.
12Unexpectednetworkinterruptioncausedbysystemfailuresmayreducevisitortrafcandharmourreputation.
BoththecontinualaccessibilityoftheNeteaseWebsitesandtheperformanceandreliabilityofourtechnicalinfrastructurearecriticaltoourreputationandtheabilityoftheNeteaseWebsitestoattractandretainusersandadvertisers.
Anysystemfailureorperformanceinadequacythatcausesinterruptionsintheavailabilityofourservicesorincreasestheresponsetimeofourservicescouldreduceusersatisfactionandtrafc,whichwouldreducetheNeteaseWebsites'appealtousersandadvertisers.
AsthenumberofNeteaseWebpagesandtrafcincrease,wecannotassureyouthatwewillbeabletoscaleoursystemsproportionately.
Inaddition,anysystemfailuresandelectricaloutagescouldmateriallyandadverselyimpactourbusiness.
Computervirusesmaycausedelaysorinterruptionsonoursystemsandmayreducevisitortrafcandharmourreputation.
Computervirusesmaycausedelaysorotherserviceinterruptionsonoursystems.
Inaddition,theinadvertenttransmissionofcomputervirusescouldexposeustoamaterialriskoflossorlitigationandpossibleliability.
WemayberequiredtoexpendsignicantcapitalandotherresourcestoprotecttheNeteaseWebsitesagainstthethreatofsuchcomputervirusesandtoalleviateanyproblems.
Moreover,ifacomputervirusaffectingoursystemishighlypublicized,ourreputationcouldbemateriallydamagedandourvisitortrafcmaydecrease.
Computerhackingcoulddamageoursystemsandreputation.
Anycompromiseofsecurity,suchascomputerhacking,couldcauseInternetusagetodecline.
''Hacking''involveseffortstogainunauthorizedaccesstoinformationorsystemsortocauseintentionalmalfunctionsorlossorcorruptionofdata,software,hardwareorothercomputerequipment.
Hackers,ifsuccessful,couldmisappropriateproprietaryinformationorcausedisruptionsinourservice.
Wemayhavetospendsignicantcapitalandhumanresourcestorectifyanydamagetooursystem.
Inaddition,wecannotassureyouthatanymeasureswetakeagainstcomputerhackingwillbeeffective.
Awellpublicizedcomputersecuritybreachcouldsignicantlydamageourreputationandmateriallyadverselyaffectourbusiness.
Ifourexclusiveproviderofbandwidthandservercustodyservicefailstoprovidetheseservices,ourbusinesscouldbemateriallycurtailed.
WerelyexclusivelyonChinaTelecomanditsafliatestoprovideuswithbandwidthandservercustodyserviceforInternetuserstoaccesstheNeteaseWebsites.
IfChinaTelecomoritsafliatesfailtoprovidetheseservices,wemaynotbeabletondareliableandcost-effectivesubstituteprovideronatimelybasisoratall.
Ifthishappens,ourbusinesscouldbemateriallycurtailed.
Ifourexclusiveproviderofbandwidthandservercustodyserviceincreasesitsprices,ourresultsofoperationswouldsuffer.
NeteaseBeijingandGuangzhouNeteasecontractexclusivelywithChinaTelecomanditsafliatesforbandwidthandservercustodyservices.
PursuanttoourcontractualarrangementswithGuangzhouNetease,wepayforbandwidthandservercustodyservicecostsincurredbyGuangzhouNetease.
WehavenocontroloverthecostsofthebandwidthandservercustodyserviceprovidedbyChinaTelecomanditsafliates.
ChinaTelecomoritsafliatesmayincreasethepricewepayfortheseservices.
Ifthishappens,ouroperatingcostsmaybehigherthanweanticipateandourresultsofoperationswouldsuffer.
Ifthirdpartycontentprovidersfailtodevelopandmaintainthecontentweneed,theNeteaseWebsitescouldloseviewersandadvertisers.
WerelyonanumberofthirdpartiestocreatetrafcandprovidecontentinordertomaketheNeteaseWebsitesmoreattractivetoadvertisersandconsumers.
ThirdpartiesprovidingcontenttotheNeteaseWeb13sitesincludebothcommercialcontentproviderswithwhichwehavecontractualrelationshipsandourregisteredcommunitymemberswhopostarticlesandothercontentontheNeteaseWebsites.
Ifthesethirdpartiesfailtodevelopandmaintainhigh-qualitycontent,theNeteaseWebsitescouldloseviewersandadvertisers.
Mostofourcontractualarrangementswiththirdpartycontentprovidersarenotexclusiveandareshort-termormaybeterminatedattheconvenienceofeitherparty.
Therecanbenoassurancethatourexistingrelationshipswithcommercialcontentproviderswillresultinsustainedbusinesspartnerships,successfulserviceofferings,trafcontheNeteaseWebsitesorrevenuesforus.
Ifthirdpartyadvertisementservingtechnologyfails,ouradvertisingservicesrevenuescoulddecline.
WedependonthirdpartyproprietaryandlicensedadvertisementservingtechnologytodeliveradvertisementstotheNeteaseWebsites.
AdvertisementservingtechnologyallowsustomeasurethedemographicsofouruserbaseandthedeliveryofadvertisementsontheNeteaseWebsites.
Thistechnologyisstilldeveloping.
AdvertisersmaychoosenottoadvertiseontheNeteaseWebsitesormaypaylessforadvertisingiftheydonotperceiveourabilitytotrackandmeasurethedemographicsofourusersorthedeliveryofadvertisementstobereliable.
Ifsuchadvertisementservingtechnologybecomesunavailableorfailstoaddressouradvertisingneedsproperly,ouradvertisingbusinessmaybemateriallyandadverselyaffectedandouradvertisingservicesrevenuescoulddecline.
Ifwecannotsuccessfullyrunandmanageourbusiness,wewillnotbeabletohire,integrateandretainkeypersonnel.
Wedependontheservicesofourexecutiveofcersandkeyemployees.
Oursuccesswilllargelydependonourabilitytoretainourexistingexecutiveofcersandkeyemployeesandtoattractandretainqualiedseniorandmiddlelevelmanagers,aswellashighlyskilledtechnical,editorial,marketingandcustomerservicepersonnelinthefuture.
Competitionforsuchpersonnelisintense.
Wecannotassureyouthatwewillbeabletoattractorretainsuchpersonnelorthatrecentlyhiredpersonneloranypersonnelwehireinthefuturewillsuccessfullyintegrateintoourorganizationorultimatelycontributepositivelytoourbusiness.
Thelossofanyofourseniorexecutiveofcers,orthefailureofanyofourrecentlyhiredexecutiveofcers,tointegrateintoouroperations,wouldsignicantlyharmourbusiness.
Inparticular,oursuccessdependsonthecontinuedeffortsofWilliamLeiDing,ourChairmanoftheBoard,Co-ChiefTechnologyOfcerandmajorityshareholder.
Wedonotmaintainkeypersonlifeinsuranceonanyofouremployees.
Wemaybeheldliableforinformationdisplayedon,retrievedfromorlinkedtotheNeteaseWebsites.
Wemayfaceliabilityfordefamation,negligence,copyright,patentortrademarkinfringementandotherclaimsbasedonthenatureandcontentofthematerialsthatarepublishedontheNeteaseWebsites.
WealsocouldbesubjecttoclaimsbaseduponcontentthatisaccessibleontheNeteaseWebsitessuchascontentandmaterialspostedbyusersonmessageboards,onlinecommunities,votingsystems,emailorchatroomsthatareofferedontheNeteaseWebsites.
Byprovidingtechnologyforhypertextlinkstothird-partyWebsites,wemaybeheldliableforcopyrightortrademarkviolationsbythosethirdpartysites.
Thirdpartiescouldassertclaimsagainstusforlossesincurredinrelianceonanyerroneousinformationdistributedbyus.
Forexample,wepostcreditevaluationsofourusersbaseduponinformationprovidedtousbyusersofourauctionservices.
Suchcreditevaluationpostingscouldbesubjecttoclaimsthatsuchinformationisinaccurateordefamatory.
Moreover,usersoftheNeteaseWeb-basede-mailservicescouldseekdamagesfromusfor:unsolicitede-mails;lostormisplacedmessages;illegalorfraudulentuseofe-mail;orinterruptionsordelaysine-mailservice.
Wemayincursignicantcostsininvestigatinganddefendingtheseclaims,eveniftheydonotresultinliability.
14Wemaybesubjecttoproductliabilityclaimsbecauseofoure-commerceservices.
Thereisthepotentialforproductliability,warranty,commodityfraudandsimilarclaimsagainstusbyuserswhopurchasegoodsandservicesthroughoure-commerceservices.
Wedonotcarryinsurancetocoverthesekindsofclaims.
Informationdisplayedon,retrievedfromorlinkedtotheNeteaseWebsitesmaysubjectustoclaimsofviolatingChineselaws.
ViolationsorperceivedviolationsofChineselawsarisingfrominformationdisplayedon,retrievedfromorlinkedtotheNeteaseWebsitescouldresultinsignicantpenalties,includingatemporaryorcompletecessationofourbusiness.
Recently,Chinesegovernmentagencieshaveannouncedrestrictionsonthetransmissionof''statesecrets''throughtheInternet.
''Statesecrets''hasbeenbroadlyinterpretedbyChinesegovernmentalauthoritiesinthepast.
Wemaybeliableunderthesenewpronouncementsforcontentandmaterialspostedortransmittedbyusersonmessageboards,virtualcommunities,chatroomsore-mails.
TheMinistryofNationalSecurityandtheMinistryofPublicSecurityhaveauthoritytocauseanylocalInternetserviceprovidertoblockanyWebsite.
Theseministrieshave,inthepast,stoppedtheonlinedistributionofinformationthattheybelievedtobesociallydestabilizingorpoliticallyimproper.
IftheChinesegovernmenttakesanyactiontolimitoreliminatethedistributionofinformationthroughtheNeteaseWebsites,ortolimitorregulateanycurrentorfuturecommunityfunctionsavailabletousersorotherwiseblocktheNeteaseWebsites,ourbusinesswouldbesignicantlyharmed.
PrivacyconcernsmaypreventusfromsellingdemographicallytargetedadvertisinginthefuturewhichcouldmaketheNeteaseWebsiteslessattractivetoadvertisers.
Wecollectpersonaldatafromourregisteredusersinordertobetterunderstandusersandtheirneeds.
Weintendtoprovidethisdatatoonlineadvertiserstoenablethemtotargetspecicdemographicgroups.
Ifprivacyconcernsorregulatoryrestrictionspreventusfromcollectingthisinformationorfromsellingdemographicallytargetedadvertising,theNeteaseWebsitesmaybelessattractivetoadvertisers.
Securityandcondentialityconcernsmayimpedeoure-commerceservicesandourgrowth.
Asignicantbarriertoe-commercehasbeenpublicconcernoversecurityandprivacyofcondentialinformationtransmittedovertheInternet.
Ifthisconcernisnotadequatelyaddressed,itmayinhibitthegrowthoftheInternetasameansofconductingcommercialtransactions.
Inaddition,China'sregulationofencryptiontechnologyisstillevolving,anditispossiblethatsuchregulationsmaylimitthemethodsofencryptionthatwecanemploy.
Ifawell-publicizedbreachofInternetsecurityweretooccur,generalInternetusagecoulddecline,whichcouldreducetrafctotheNeteaseWebsitesandimpedeourgrowth.
UntilChina'sTrademarkOfceissuesactualtrademarkregistrationcerticates,theremaybeuncertaintywithrespecttoourlegalrightstothe''''marks.
China'strademarklawadoptsa''rst-to-le''systemforobtainingtrademarkrights.
Asaresult,therstapplicanttoleanapplicationforregistrationofamarkwillpreemptallotherapplicants.
Prioruseofanunregisteredmarkisgenerallyirrelevantexceptfor''wellknown''marks.
GuangzhouNeteasehasledwithChina'sTrademarkOfcetrademarkapplicationsformarksincorporatingtheword''Netease''inEnglishandthemarkNetease''aswritteninChinese)intraditionalandsimpliedChinesecharacters.
GuangzhouNeteasehasagreedtotransferthesetrademarkstouswhentheyareissued.
However,untilactualregistrationcerticatesareissuedbytheTrademarkOfce,wemaynotbeabletosuccessfullydefendorclaimanylegalrightsinthesemarks.
15Wemaynotbeabletoadequatelyprotectourintellectualproperty,andwemaybeexposedtoinfringementclaimsbythirdparties.
Werelyonacombinationofcopyright,trademarkandtradesecrecylawsandcontractualrestrictionsondisclosuretoprotectourintellectualpropertyrights.
Oureffortstoprotectourproprietaryrightsmaynotbeeffectivetopreventunauthorizedpartiesfromcopyingorotherwiseobtainingandusingourtechnology.
Monitoringunauthorizeduseofourproductsisdifcultandcostly,andwecannotbecertainthatthestepswetakewilleffectivelypreventmisappropriationofourtechnology.
Fromtimetotime,wemayhavetoresorttolitigationtoenforceourintellectualpropertyrights,whichcouldresultinsubstantialcostsanddiversionofourresources.
Inaddition,thirdpartiesmayinitiatelitigationagainstusforallegedinfringementoftheirproprietaryrights.
Intheeventofasuccessfulclaimofinfringementandourfailureorinabilitytodevelopnon-infringingtechnologyorlicensetheinfringedorsimilartechnologyonatimelybasis,ourbusinesscouldsuffer.
Moreover,evenifweareabletolicensetheinfringedorsimilartechnology,licensefeesthatwepaytolicensorscouldbesubstantialoreconomicallyunviable.
Ifwecannotmanageourgrowtheffectively,ourbusinessmaysuffer.
Ourrapidgrowthhasplacedandcontinuestoplaceasignicantstrainonourresources.
Wemaynotbeabletomanageourgrowtheffectively.
Ifwemakemistakesinoperatingourbusiness,ouroperatingresultsmayuctuateandcausethepriceofourADSstodecline.
ThenumberofouremployeeshasgrownfromtenatDecember31,1998to199atMay31,2000.
Inaddition,GuangzhouNeteasehad45employeesatMay31,2000.
Weplantocontinuetohirenewemployeestoexpandouroperationssignicantlyandtopursueexistingandpotentialmarketopportunities.
Thisgrowthwillplaceasignicantdemandonourmanagementandouroperationalresources.
Inordertomanagegrowtheffectively,wemustimplementandimproveouroperationalsystems,proceduresandcontrolsonatimelybasis.
Ifwecannotmanagegrowtheffectively,ourbusinessmaysuffer.
Ifwecannotobtainsufcientfundstomeetourcapitalrequirementsandtogrowourbusiness,wemaybeforcedtodelaydeploymentofservicesorcurtailorceaseouroperations.
Ourcapitalrequirementsaredifculttoplaninourrapidlychangingindustry.
Asourbusinesscontinuestogrow,weexpecttohavesubstantialfuturecapitalrequirementstofurtherdevelopandimproveourexistingservicesandtoexpandourbusiness.
Becausewearelikelytogeneratelossesfortheforeseeablefuture,wewillneedsignicantexternalnancingtofundouroperations.
Ourabilitytoobtainadditionalnancingdependsonanumberoffactors,suchasmarketconditionsandouroperatingperformance.
Therecanbenoassurancethatwewillbeabletoobtainadditionalnancinginatimelymanneranduponacceptableterms,ifatall.
Ifwefailtoobtainnecessaryfundsuponacceptableterms,wemaybeforcedtodelaythedeploymentofourservicesorotherwisecurtailorceaseouroperations.
Wemaybecomeapassiveforeigninvestmentcompany,whichcouldresultinadverseU.
S.
taxconsequencestoU.
S.
investors.
Baseduponthenatureofourincomeandassets,wemaybeclassiedasapassiveforeigninvestmentcompany,orPFIC,bytheUnitedStatesInternalRevenueService,orIRS,forU.
S.
federalincometaxpurposes.
SuchcharacterizationcouldresultinadverseU.
S.
taxconsequencestoyouifyouareaU.
S.
investor.
Forexample,ifweareaPFIC,ourU.
S.
investorswillbecomesubjecttoincreasedtaxliabilitiesunderU.
S.
taxlawsandregulationsandwillbecomesubjecttoburdensomereportingrequirements.
ThedeterminationofwhetherornotweareaPFICwillbemadeonanannualbasisandwilldependonthecompositionofourincomeandassets,includinggoodwill,fromtimetotime.
Specically,wewillbeclassiedasaPFICforU.
S.
taxpurposesif50%ormoreofourassets,basedonanannualquarterlyaverage,arepassiveassets,or75%ormoreofourannualgrossincomeisderivedfrompassiveassets.
Thecalculationofgoodwillwillbebased,in16part,onthethenmarketvalueofourADSs,whichissubjecttochange.
Inaddition,thecompositionofourincomeandassetswillbeaffectedbyhowwespendthecashweraiseinthisoffering.
WecannotassureyouthatwewillnotbeaPFICforthecurrentoranyfuturetaxableyear.
See''Taxation—UnitedStatesFederalIncomeTaxation—U.
S.
Holders—PassiveForeignInvestmentCompany''onpage83.
Ifoursubsidiariesarerestrictedfrompayingdividendstous,ourprimaryinternalsourceoffundswoulddecrease.
WeareaholdingcompanywithnosignicantassetsotherthanourequityinterestsinNeteaseBeijing,ourwhollyownedsubsidiary.
Asaresult,ourprimaryinternalsourceoffundsisdividendpaymentsfromNeteaseBeijing.
IfNeteaseBeijingincursdebtonitsownbehalfinthefuture,theinstrumentsgoverningthedebtmayrestrictNeteaseBeijing'sabilitytopaydividendsormakeotherdistributionstous,whichinturnwouldlimitourabilitytopaydividendsonoursharesandADSs.
UndercurrentChinesetaxregulations,dividendspaidtousarenotsubjecttoChineseincometax.
Inaddition,ChineselegalrestrictionspermitpaymentofdividendsonlyoutofnetincomeasdeterminedinaccordancewithChineseaccountingstandardsandregulations.
UnderChineselaw,NeteaseBeijingisalsorequiredtosetasideaportionofitsnetincomeeachyeartofundcertainreservefunds.
Thesereservesarenotdistributableascashdividends.
RisksRelatedtoDoingBusinessinChinaSlow-downoftheChineseeconomymayslowdownourgrowthandprotability.
ThegrowthoftheChineseeconomyhasbeenunevenacrossgeographicregionsandeconomicsectors.
Suchgrowthhasbeenslowingrecently.
TherecanbenoassurancethatgrowthoftheChineseeconomywillnotcontinuetodecreaseorthatanyslowdownwillnothaveanegativeeffectonourbusiness.
TheChineseeconomyisexperiencingdeation,whichmaycontinueintheforeseeablefuture.
TheChineseeconomyoverallaffectsourprotabilityasexpendituresforadvertisementsande-commerceservicesmaydecreaseduetoslowingdomesticdemand.
GovernmentregulationoftheInternetmaybecomemoreburdensome.
GovernmentregulationoftheInternetindustryisburdensomeandmaybecomemoreburdensome.
NewregulationscouldincreaseourcostsofdoingbusinessandpreventusfromefcientlydeliveringourproductsandservicesovertheInternet.
TheseregulationsmaystoporslowdowntheexpansionofourcustomeranduserbaseandlimittheaccesstotheNeteaseWebsites.
Inadditiontonewlawsandregulations,existinglawsnotcurrentlyapplicabletotheInternetindustrymaybeappliedtotheInternet.
TheuncertainlegalenvironmentinChinacouldlimitthelegalprotectionsavailabletoyou.
TheChineselegalsystemisacivillawsystembasedonwrittenstatutes.
Unlikecommonlawsystems,itisasysteminwhichdecidedlegalcaseshavelittleprecedentialvalue.
Inthelate1970s,theChinesegovernmentbegantopromulgateacomprehensivesystemoflawsandregulationsgoverningeconomicmatters.
Theoveralleffectoflegislationenactedoverthepast20yearshassignicantlyenhancedtheprotectionsaffordedtoforeigninvestedenterprisesinChina.
However,theselaws,regulationsandlegalrequirementsarerelativelyrecentandareevolvingrapidly,andtheirinterpretationandenforcementinvolveuncertainties.
Theseuncertaintiescouldlimitthelegalprotectionsavailabletoforeigninvestors,includingyou.
ChangesinChina'spoliticalandeconomicpoliciescouldharmourbusiness.
TheeconomyofChinahashistoricallybeenaplannedeconomysubjecttogovernmentalplansandquotasandhas,incertainaspects,beentransitioningtoamoremarket-orientedeconomy.
AlthoughwebelievethattheeconomicreformandthemacroeconomicmeasuresadoptedbytheChinesegovernmenthavehadapositiveeffectontheeconomicdevelopmentofChina,wecannotpredictthefuturedirectionoftheseeconomicreformsortheeffectsthesemeasuresmayhaveonourbusiness,nancialpositionorresultsofoperations.
In17addition,theChineseeconomydiffersfromtheeconomiesofmostcountriesbelongingtotheOrganizationforEconomicCooperationandDevelopment,orOECD.
Thesedifferencesinclude:economicstructure;levelofgovernmentinvolvementintheeconomy;levelofdevelopment;levelofcapitalreinvestment;controlofforeignexchange;inationrates;methodsofallocatingresources;andbalanceofpaymentsposition.
Asaresultofthesedifferences,ourbusinessmaynotdevelopinthesamewayoratthesamerateasmightbeexpectediftheChineseeconomyweresimilartothoseoftheOECDmembercountries.
FluctuationintheexchangeratebetweentheU.
S.
dollarandtherenminbicouldadverselyaffectthevalueofourADSsandanycashdividenddeclaredonthem.
FluctuationsinthecurrencyexchangeratebetweentheU.
S.
dollarandtherenminbicouldadverselyaffecttheU.
S.
dollarvalueofourADSs.
BecauseholdersofourADSsmayelecttoreceivecashdividends,ifany,inU.
S.
dollars,uctuationsintheexchangeratecouldalsoaffectthevalueofanycashdividenddeclaredinrenminbiandpaidinU.
S.
dollars.
Inaddition,becauseourrevenuesareprimarilydenominatedinrenminbi,ourvaluationcouldbemateriallyandadverselyimpactedbythedevaluationoftherenminbiifU.
S.
investorsanalyzeourvaluebasedontheU.
S.
dollarequivalentofournancialconditionandresultsofoperations.
Restrictionsoncurrencyexchangemaylimitourabilitytoreceiveanduseourrevenueseffectively.
Becausealmostallofourfuturerevenuesmaybeintheformofrenminbi,anyfuturerestrictionsoncurrencyexchangesmaylimitourabilitytouserevenuegeneratedinrenminbitofundourbusinessactivitiesoutsideChinaortomakedividendpaymentsinU.
S.
dollars.
AlthoughtheChinesegovernmentintroducedregulationsin1996toallowgreaterconvertibilityoftherenminbiforcurrentaccounttransactions,signicantrestrictionsstillremain.
WecannotbecertainthattheChineseregulatoryauthoritieswillnotimposemorestringentrestrictionsontheconvertibilityoftherenminbi,especiallywithrespecttoforeignexchangetransactions.
RisksRelatedtotheInternetIndustryinChinaTheInternetmarkethasnotbeenprovenasaneffectivecommercialmediuminChina.
ThemarketforInternetproductsandservicesinChinahasonlyrecentlybeguntodevelop.
ThenumberofInternetusersandtheInternetpenetrationrateinChinaare,andareexpectedtocontinuetobe,significantlylowerthanthoseintheUnitedStatesandotherdevelopedcountries.
SincetheInternetisanunprovenmediumforcommerceinChina,ourfutureoperatingresultsfromonlineadvertisingande-commerceserviceswilldependsubstantiallyupontheincreaseduseandacceptanceoftheInternetforcollectionofinformation,distributionofproductsandservices,deliveryofadvertisementsandfacilitationofcommerceinChina.
TheInternetmaynotbecomeaviablecommercialmarketplaceinChinaforvariousreasonsintheforeseeablefuture.
MoresalientimpedimentstoInternetdevelopmentinChinainclude:consumerdependenceontraditionalmeansofcommerce;inexperiencewiththeInternetasanadvertisingmediumorsalesanddistributionchannel;18competitionfromotherformsofmediasuchasbroadcastandprint;inadequatedevelopmentofthenecessaryinfrastructuretofacilitatee-commerce;concernsaboutsecurity,reliability,cost,easeofdeployment,administrationandqualityofserviceassociatedwithconductingbusinessovertheInternet;andinexperiencewithcreditcardusageorwithothermeansofelectronicpayment.
IftheInternetisnotwidelyacceptedasamediumforadvertisingande-commerceinChina,ourbusinessprospectswillbeadverselyaffected.
UnderdevelopedtelecommunicationsinfrastructuremaylimitthegrowthoftheInternetmarketinChina.
ThetelecommunicationsinfrastructureinChinaisnotwelldeveloped.
AlthoughprivatesectorInternetserviceprovidersexistinChina,almostallaccesstotheInternetismaintainedthroughChinaNet,currentlyownedbyChinaTelecom,undertheadministrativecontrolandregulatorysupervisionofChina'sMinistryofInformationIndustry.
Inaddition,thegovernment'sinterconnectingnationalnetworksconnecttotheInternetthroughagovernment-ownedinternationalgateway.
ThisinternationalgatewayistheonlychannelthroughwhichadomesticChineseusercanconnecttotheinternationalInternetnetwork.
WerelyonthisinfrastructureandChinaTelecomtoprovidedatacommunicationscapacityprimarilythroughlocaltelecommunicationslines.
Althoughthegovernmenthasannouncedplanstodevelopaggressivelythenationalinformationinfrastructure,wecannotassureyouthatthisinfrastructurewillbedeveloped.
Inaddition,wewillhavenoaccesstoalternativenetworksandservices,onatimelybasisifatall,intheeventofanyinfrastructuredisruptionorfailure.
TheInternetinfrastructureinChinamaynotsupportthedemandsassociatedwithcontinuedgrowthinInternetusage.
TheundevelopedonlinepaymentsystemsinChinamayrestrictourabilitytodevelopoure-commerceservicebusiness.
OnlinepaymentsystemsinChinaareinadevelopmentalstageandarenotaswidelyavailableoracceptabletoconsumersinChinaasintheUnitedStatesandelsewhere.
AlthoughmajorChinesebanksareinstitutingonlinepaymentsystems,thesesystemsarestillatanearlystage.
Inaddition,alimitednumberofconsumersinChinahavecreditcardsordebitcards.
Thelackofadequateonlinepaymentsystemsmaylimitthenumberofe-commercetransactionsthatwecanserviceandmayincreasetheriskofnon-paymentfortransactionseffectedthroughoure-commerceplatform.
Ifonlinepaymentservicesdonotdevelop,ourabilitytogrowoure-commercebusinesswouldbelimited.
ThelimiteduseofpersonalcomputersinChinalimitsourpoolofpotentialcustomersandrestrictsthegrowthofourbusiness.
WebelievethemarketpenetrationratesofpersonalcomputersandonlineaccessinChinaarefarlowerthansuchratesworldwide.
AlternatemethodsofobtainingaccesstotheInternet,suchasthroughcabletelevisionmodemsorset-topboxesfortelevisions,arenotwidelyavailableinChinaatpresent.
TherecanbenoassurancethatthenumberorpenetrationrateofpersonalcomputersinChinawillincreaserapidlyoratallorthatalternatemeansofaccessingtheInternetwilldevelopandbecomewidelyavailableinChina.
IfsignicantnumbersofChineseconsumersareunabletoaccesstheInternet,ourabilitytogrowourbusinesswouldbeimpeded.
TherelativelyhighcostofaccessingtheInternetinChinalimitsourpotentialcustomerbaseandrestrictsthegrowthofourbusiness.
OurgrowthislimitedbytherelativelyhighcosttoChineseconsumersofobtainingthehardware,softwareandcommunicationslinksnecessarytoconnecttotheInternetinChina.
Ifthecostsrequiredtoaccess19theInternetdonotsignicantlydecrease,mostofChina'spopulationwillnotbeabletoaffordtouseourservices.
ThefailureofasignicantnumberofadditionalChineseconsumerstoobtainaffordableaccesstotheInternetwouldmakeitdifculttogrowourbusiness.
Wemaybeunabletocompetesuccessfullyagainstnewentrantsandestablishedindustrycompetitors.
TheChinesemarketforInternetcontentandservicesisintenselycompetitiveandrapidlychanging.
Barrierstoentryareminimal,andcurrentandnewcompetitorscanlaunchnewWebsitesatarelativelylowcost.
ManycompaniesoffercompetitiveproductsorservicesincludingChineselanguage-basedWebsearch,retrievalandnavigationservicesandextensiveChineselanguagecontent,informationalandcommunityfeaturesande-mail.
Inaddition,asaconsequenceofChina'sattempttojointheWorldTradeOrganization,theChinesegovernmentmayliftorreducerestrictionsonforeignorforeign-investedenterprisestopermittheirinvestmentandparticipationintelecommunicationsbusinesses,includingInternetbusinesses,inChina.
Currently,ourcompetitioncomesfromChineselanguage-basedWebsearchandretrievalcompaniesaswellasU.
S.
-basedportalcompanies.
Someofourcurrentandpotentialcompetitorsaremuchlargerandbettercapitalizedthanweare,andcurrentlyoffer,andcouldfurtherdeveloporacquire,contentandservicesthatcompetewiththeNeteaseWebsites.
WealsofacecompetitionfromInternetserviceproviders,WebsiteoperatorsandprovidersofWebbrowsersoftwarethatincorporatesearchandretrievalfeatures.
Anyofourpresentorfuturecompetitorsmayofferproductsandservicesthatprovidesignicantperformance,price,creativityorotheradvantagesoverthoseofferedbyusand,therefore,achievegreatermarketacceptancethanours.
BecausemanyofourexistingcompetitorsaswellasanumberofpotentialcompetitorshavelongeroperatinghistoriesintheInternetmarket,greaternameandbrandrecognition,betterconnectionswiththeChinesegovernment,largercustomerbasesanddatabasesandsignicantlygreaternancial,technicalandmarketingresourcesthanwehave,wecannotassureyouthatwewillbeabletocompetesuccessfullyagainstourcurrentorfuturecompetitors.
Anyincreasedcompetitioncouldreducepageviews,makeitdifcultforustoattractandretainusers,reduceoreliminateourmarketshare,lowerourprotmarginsandreduceouradvertisingrevenues.
RisksRelatedtothisOfferingOneshareholderwillcontroltheoutcomeofshareholdervotesafterthisoffering.
Currently,ourfounder,ChairmanoftheBoardandCo-ChiefTechnologyOfcer,WilliamLeiDing,beneciallyownsapproximately68.
7%ofouroutstandingordinaryshares,andaftertheofferingwillbeneciallyownapproximately58.
5%ofouroutstandingordinaryshares.
Accordingly,Mr.
Dingwillcontroltheoutcomeofanycorporatetransactionorothermattersubmittedtoourshareholdersforapproval,includingmergers,consolidationsandthesaleofallorsubstantiallyallofourassets.
Hewillalsohavethepowertopreventorcauseachangeincontrol.
IfanactivetradingmarketforourADSsdoesnotdevelop,thepriceofourADSsmaysufferandmaydeclinebelowtheinitialofferingprice.
Priortotheoffering,therehasbeennopublicmarketforourordinarysharesorADSs.
TheinitialpricetothepublicforourADSswillbedeterminedbynegotiationsbetweenusandourunderwritersandmaynotbeindicativeofthepriceatwhichADSswilltradefollowingthecompletionoftheoffering.
Wecannotassureyouthatanactivetradingmarketwilldeveloporbesustainedfollowingthecompletionoftheoffering,orthatthemarketpriceofourADSswillnotdeclinebelowtheinitialofferingprice.
20MarketuctuationsmayadverselyaffectthemarketpriceofourADSs.
Thesecuritiesmarketshavefromtimetotimeexperiencedsignicantpriceandvolumeuctuationsthatarenotrelatedtotheoperatingperformanceofparticularcompanies.
ThesemarketuctuationsmayalsomateriallyandadverselyaffectthemarketpriceofourADSs.
ThesalebyourexistingshareholdersofasubstantialnumberofourADSsinthepublicmarketcouldadverselyaffectthepriceofourADSs.
Immediatelyafterthecompletionoftheoffering,wewillhave3,010,555,600ordinarysharesoutstanding,including4,500,000ADSs,representing450,000,000ordinaryshares,soldinthisoffering.
OurADSssoldinthisofferingwillbeeligibleforimmediateresaleinthepublicmarketwithoutrestrictionsandthoseheldbyourexistingshareholdersmayalsobesoldinthepublicmarketinthefuturepursuantto,andsubjecttotherestrictionscontainedin,Rule144undertheSecuritiesActandapplicablelock-upagreements.
IfanyexistingshareholderorshareholderssellasubstantialamountofADSs,theprevailingmarketpriceforourADSscouldbeadverselyaffected.
YouwillexperienceimmediateandsubstantialdilutioninthebookvalueofADSspurchased.
TheinitialpublicofferingpriceperADSissubstantiallyhigherthanthenettangiblebookvalueperADSpriortotheoffering.
Accordingly,whenyoubuyourADSsintheoffering,attheinitialpublicofferingpriceofUS$15.
50perADS,youwillincuranimmediatedilutionofUS$11.
55perADS.
See''Dilution''onpage27.
Youmayfacedifcultiesinprotectingyourinterests,andourabilitytoprotectourrightsthroughtheU.
S.
federalcourtsmaybelimited,becauseweareincorporatedunderCaymanIslandslaw.
OurcorporateaffairsaregovernedbyourmemorandumandarticlesofassociationandbytheCompaniesLaw(1998Revision)andcommonlawoftheCaymanIslands.
TherightsofourshareholdersandthefiduciaryresponsibilitiesofourdirectorsunderCaymanIslandslawarenotasclearlyestablishedastheywouldbeunderstatutesorjudicialprecedentsintheUnitedStates.
Inparticular,theCaymanIslandshasalessdevelopedbodyofsecuritieslawsascomparedtotheU.
S.
,andprovidessignificantlylessprotectiontoinvestors.
Therefore,ourpublicshareholdersmayhavemoredifficultiesinprotectingtheirinterestsinthefaceofactionsbyourmanagement,directorsorcontrollingshareholdersthanwouldshareholdersofacorporationincorporatedinajurisdictionintheUnitedStates.
Inaddition,CaymanIslandscompaniesmaynothavestandingtosuebeforethefederalcourtsoftheUnitedStates.
Asaresult,ourabilitytoprotectourinterestsifweareharmedinamannerthatwouldotherwiseenableustosueinaUnitedStatesfederalcourtmaybelimited.
Yourabilitytobringanactionagainstusoragainstourdirectorsandofcers,ortoenforceajudgmentagainstusorthem,willbelimitedbecauseweareincorporatedintheCaymanIslands,becauseweconductasubstantialportionofouroperationsinChinaandbecausethemajorityofourdirectorsandofcersresideoutsideoftheU.
S.
WeareincorporatedintheCaymanIslands,andweconductasubstantialportionofouroperationsinChinathroughNeteaseBeijing.
MostofourdirectorsandofcersresideoutsideoftheUnitedStates.
Asaresult,itmaybedifcultorimpossibleforyoutobringanactionagainstusoragainsttheseindividualsintheCaymanIslandsorinChinaintheeventthatyoubelievethatyourrightshavebeeninfringedunderthesecuritieslawsorotherwise.
Evenifyouaresuccessfulinbringinganactionofthiskind,thelawsoftheCaymanIslandsandofChinamayrenderyouunabletoenforceajudgmentagainstourassetsortheassetsofourdirectorsandofcers.
FormoreinformationregardingtherelevantlawsoftheCaymanIslandsandChina,see''EnforcementofCivilLiabilities''onpage29.
21Wehavenotdeterminedanyspecicuseforasignicantportionoftheproceedsfromthisofferingandwemayusetheproceedsinwayswithwhichyoumaynotagree.
Wehavenotallocatedthemajorityofthenetproceedsofthisofferingtoanyparticularpurpose.
Rather,ourmanagementwillhaveconsiderablediscretionintheapplicationofthenetproceedsreceivedbyus.
Youwillnothavetheopportunity,aspartofyourinvestmentdecision,toassesswhethertheproceedsarebeingusedappropriately.
Youmustrelyonthejudgmentofourmanagementregardingtheapplicationofthenetproceedsofthisoffering.
Thenetproceedsmaybeusedforcorporatepurposesthatdonotimproveoureffortstoachieveprotabilityorincreaseourstockprice.
Thenetproceedsfromthisofferingmaybeplacedininvestmentsthatdonotproduceincomeorthatlosevalue.
22FORWARD-LOOKINGSTATEMENTSCONTAINEDINTHISPROSPECTUSMAYNOTPROVETOBEACCURATEManystatementsmadeinthisprospectusunderthecaptions''ProspectusSummary,''''RiskFactors,''''Management'sDiscussionandAnalysisofFinancialConditionandResultsofOperations,''''Business''andelsewhereareforward-lookingstatementsthatreectourcurrentexpectationsandviewsoffutureevents.
Theseforward-lookingstatementscanbeidentiedbywordsorphrasessuchas''may,''''will,''''expect,''''anticipate,''''estimate,''''plan,''''believe,''''is/arelikelyto''orothersimilarexpressions.
Theforward-lookingstatementsincludedinthisprospectusrelateto,amongothers:ourgoalsandstrategies;ourfuturebusinessdevelopment,resultsofoperationsandnancialcondition;theexpectedgrowthofandexpectedchangesintheInternetindustry,inthedemandforInternetandInternet-relatedtechnologiesandservices,andinthemarketplace;competitioninChina;andChinesegovernmentalpoliciesregardingtheInternetandinformationindustry.
Theseforward-lookingstatementsinvolverisksanduncertainties.
Thereareimportantfactorsthatcouldcauseactualresultstodiffermateriallyfromthoseexpressedorimpliedbytheseforward-lookingstatements,includingthosediscussedunder''RiskFactors.
''ThisprospectuscontainsdatarelatedtoourmarketandtheInternet.
Thesemarketdataincludeprojectionsthatarebasedonanumberofassumptions.
Theseassumptionsinclude,amongothers,that:nosignicantfailureoftheInternetwilloccur;thenumberofpeopleonlineinChinaandthetotalnumberofhoursspentonlinewillincreasesignicantlyoverthenextthreetofouryears;thepersonalcomputerpenetrationrateinChinawillincreasesignicantlyoverthenextthreetofouryears;thevalueofonlineadvertisingexpendituresspentwillincreasesignicantlyinChina;andInternetsecurityandprivacyconcernswillbeadequatelyaddressed.
Ifanyoneormoreoftheforegoingassumptionsturnsouttobeincorrect,actualresultsmaydifferfromtheprojectionsbasedontheseassumptions.
Wethereforeadvisethatyoudonotplaceunduerelianceontheseforward-lookingstatements.
TheInternet-relatedmarketsmaynotgrowattheratesprojectedbymarketdata,oratall.
ThefailureofthesemarketstogrowattheprojectedratesmayhaveamaterialadverseeffectonourbusinessandthemarketpriceofourADSs.
Inaddition,therelativelynewandrapidlychangingnatureoftheInternetindustrysubjectsanyprojectionsorestimatesrelatingtothegrowthprospectsorfutureconditionoftheInternet-relatedmarketstosignicantuncertainties.
Theforward-lookingstatementsmadeinthisprospectusrelateonlytoeventsorinformationasofthedateonwhichthestatementsaremadeinthisprospectus.
ExceptasotherwiserequiredbythesecuritieslawsoftheUnitedStates,weundertakenoobligationtoupdateanyforward-lookingstatementstoreecteventsorcircumstancesafterthedateonwhichthestatementsaremadeortoreecttheoccurrenceofunanticipatedevents.
23USEOFPROCEEDSWeestimatethatthenetproceedsfromthisoffering,afterdeductingunderwritingdiscountsandtheestimatedofferingexpensespayablebyusandassumingnoexerciseoftheover-allotmentoptions,willbeapproximatelyUS$62.
6million,basedupontheinitialofferingpriceofUS$15.
50perADS.
Theprincipalpurposeofthisofferingistoincreaseourworkingcapital.
Asofthedateofthisprospectus,wehavenotallocatedanyspecicportionofthenetproceedstoanyparticularpurposealthoughweintendtousethenetproceedsforsuchpurposesasincreasingourbandwidth,hiringadditionalpersonnel,expandingourmarketingoperationsandcapitalexpendituressuchashardware.
Weanticipateallocatingaportionofthenetproceedsasfollows:US$15milliontomarketing;US$1milliontocontentdevelopment;US$3milliontoserverandbandwithexpenditures;andUS$2milliontoresearchanddevelopment.
Accordingly,ourmanagementwillhavesignicantexibilityinapplyingthenetproceedsoftheoffering.
Wemayalsouseaportionoftheproceedstoacquireorinvestincomplementarybusinesses,productsandtechnologies;however,wecurrentlyhavenocommitmentsoragreementswithrespecttoanysuchtransaction.
Pendinguseofthenetproceeds,weintendtoinvestournetproceedsinshort-term,interestbearing,U.
S.
governmentsecuritiesorholdtheminshort-termbankdeposits.
TheseinvestmentsmayhaveamaterialadverseeffectontheU.
S.
federalincometaxconsequencesofyourinvestmentinourADSs.
ItispossiblethatwemaybecomeapassiveforeigninvestmentcompanyforUnitedStatesfederalincometaxpurposes,whichcouldresultinnegativetaxconsequencesforyou.
Theseconsequencesaredescribedinmoredetailin''RiskFactors—RisksRelatedtoOurCompany—Wemaybecomeapassiveforeigninvestmentcompany,whichcouldresultinadverseU.
S.
taxconsequencestoU.
S.
investors''and''Taxation—UnitedStatesFederalIncomeTaxation—U.
S.
Holders—PassiveForeignInvestmentCompany.
''DIVIDENDPOLICYWehaveneverdeclaredorpaidcashdividendsonourordinaryshares.
Wecurrentlyintendtoretainallavailablefundsandanyfutureearningsforuseintheoperationandexpansionofourbusinessanddonotanticipatepayinganycashdividendsonourordinaryshares,orindirectlyonourADSs,fortheforeseeablefuture.
InvestorsseekingcashdividendsshouldnotpurchaseourADSs.
Futurecashdividends,ifany,willbeatthediscretionofourboardofdirectorsandwilldependuponourfutureoperationsandearnings,capitalrequirementsandsurplus,generalnancialcondition,contractualrestrictionsandotherfactorsastheboardofdirectorsmaydeemrelevant.
AnydividendwedeclarewillbepaidtotheholdersofADSs,subjecttothetermsofthedepositagreement,tothesameextentasholdersofourordinaryshares,lessthefeesandexpensespayableunderthedepositagreement.
Otherdistributions,ifany,willbepaidbythedepositarytoholdersofourADSsinanymeansitdeemslegal,fairandpractical.
Anydividendwillbedistributedbythedepositary,intheformofcashoradditionalADSs,totheholdersofourADSs.
Cashdividendsonourordinaryshares,ifany,willbepaidinU.
S.
dollars.
See''DescriptionofAmericanDepositaryShares''onpage74.
24CAPITALIZATIONThefollowingtablesetsforth,asofDecember31,1999:ouractualcapitalization;ourcapitalizationonaproformabasistoreecttheissuanceandsaleof2,560,556SeriesBpreferencesharesinMarch,2000andtheconversionofouroutstandingSeriesAandSeriesBpreferencesharesintoordinarysharesthatwilloccurupontheconsummationofthisoffering;andourcapitalizationasadjustedtogiveeffecttotheissuanceandsaleof4,500,000ADSsofferedherebyattheinitialpublicofferingpriceofUS$15.
50perADS,afterdeductingunderwritingdiscounts,commissionsandestimatedofferingexpenses.
TherenminbiamountsoftheparvalueofordinarysharesandSeriesAandSeriesBpreferenceshareshavebeentranslatedusingthehistoricalexchangeratesprevailingonthedatesofcontribution.
ThecorrespondingU.
S.
dollaramountshavebeentranslatedfromtherenminbiamountsforconveniencepurposesbasedontheexchangerateatDecember31,1999,whichisdifferentfromthehistoricalexchangerates.
Additionalpaid-incapitalincludesanamountofRMB45,413,399arisingfromanagreementbyourmajorityshareholdertotransfer109,694,200ordinarysharesbeneciallyownedbyourfounder,ChairmanoftheBoard,andCo-ChiefTechnologyOfcer,WilliamLeiDing,tocertainseniormanagementpersonnelandkeyemployeesandrepresentsthefairmarketvalueofthesesharesonthedateofsuchagreement.
ThesesharetransferswereeffectedinJanuary2000.
Additionalpaid-incapitalalsoincludesanamountofRMB10,876,318arisingfromanagreementbyourmajorityshareholdertotransfer26,271,300ordinarysharesbeneciallyownedbyWilliamLeiDingtocertainoftheseindividualsforservicestoberenderedbythemoverthreeyearsstartingfromJanuary1,2000.
ThesesharetransfersaretobeeffectedonJanuary1,2001,2002and2003uponcompletionofeachfullyearofservice.
ThetotalestimatedfairvalueofthesesharesvaluedatUS$0.
05pershareatthedateofgrantisrecognizedasdeferredcompensationwhichwillbeamortizedovertherelatedvestingperiods.
Inaddition,additionalpaid-incapitalalsoincludesanamountofRMB866,864arisingfromthegrantofoptionstoacquire3,000,000ordinarysharestoouradvisoryboardmembersforservicestoberenderedbythemovertwoyearsstartingfromtheendof1999.
25Youshouldreadthistableinconjunctionwith''Management'sDiscussionandAnalysisofFinancialConditionandResultsofOperations''andourconsolidatednancialstatementsandrelatednotes,includedelsewhereinthisprospectus.
AsofDecember31,1999ActualActualProFormaProFormaProFormaAsAdjustedProFormaAsAdjustedRMBUS$RMBUS$RMBUS$Cash117,800,09614,227,924407,582,59649,227,924926,024,187111,845,424Shareholders'equity:Ordinaryshares,US$0.
0001parvalue;999,740,000,000sharesauthorized:2,004,500,000sharesissuedandoutstandingactual;2,560,555,600sharesissuedandoutstandingproforma;3,010,555,600sharesissuedandoutstandingproformaasadjusted.
.
.
.
.
1,659,447200,4292,119,790256,0292,492,368301,029SeriesAconvertiblepreferenceshares,US$0.
01parvalue;3,000,000sharesauthorizedissuedandoutstandingactual;zerosharesauthorizedandoutstandingproformaandproformaasadjusted.
248,36729,998————SeriesBconvertiblepreferenceshares,US$0.
01parvalue:zerosharesauthorized,issuedandoutstandingactual,proformaandproformaasadjusted(2,600,000sharesauthorizedand2,560,556sharesissuedandoutstandingpriortoconversion)Additionalpaid-incapital.
.
.
.
.
.
197,604,00123,866,658528,572,02563,841,0561,046,641,039126,413,556Deferredcompensation.
11,743,182)(1,418,344)(11,743,182)(1,418,344)(11,743,182)(1,418,344)Accumulateddecit.
51,703,393)(6,244,748)(51,703,393)(6,244,748)(51,703,393)(6,244,748)Totalshareholders'equity.
.
136,065,24016,433,993467,245,24056,433,993985,686,832119,051,493Totalcapitalization136,065,24016,433,993467,245,24056,433,993985,686,832119,051,49326DILUTIONOurnettangiblebookvalueasofDecember31,1999wasapproximatelyUS$56.
4million,orUS$0.
022perordinaryshare,and$2.
20perADS.
Nettangiblebookvalueperordinaryshareisdeterminedbydividingournettangiblebookvaluebythenumberofoutstandingordinaryshares.
Ournettangiblebookvalueisdeterminedbysubtractingthevalueofourintangibleassetsandtotalliabilitiesfromourtotalassets.
Dilutionisdeterminedbysubtractingnettangiblebookvalueperordinarysharefromtheassumedpublicofferingpriceperordinaryshare.
ThenumberofordinarysharesusedtocalculatedilutionassumestheconversionofouroutstandingSeriesAandSeriesBpreferencesharesintoordinarysharesthatwilloccurupontheconsummationofthisoffering.
WithouttakingintoaccountanyotherchangesinsuchnettangiblebookvalueafterDecember31,1999,otherthantogiveeffecttooursaleofSeriesBpreferenceshares,convertibleinto256,055,600ordinaryshares,inMarch2000attheequivalentofUS$0.
156perordinaryshare,and$15.
62perADS,andoursaleofthe4,500,000ADSsofferedinthisoffering,attheinitialpublicofferingpriceofUS$15.
50perADSandafterdeductionofunderwritingdiscountsandcommissionsandestimatedofferingexpenses,ourasadjustednettangiblebookvalueatDecember31,1999wouldhavebeenUS$119.
1million,US$0.
040peroutstandingordinaryshare,includingordinarysharesunderlyingouroutstandingADSs,and$3.
95perADS.
ThisrepresentsanimmediateincreaseinnettangiblebookvalueofUS$0.
018perordinaryshare,or$1.
75perADS,toexistingshareholdersandanimmediatedilutioninnettangiblebookvalueofUS$0.
115perordinaryshare,or$11.
55perADS,topurchasersofADSsinthisoffering.
Thefollowingtableillustratesthisperordinarysharedilution,assumingallADSsareexchangedforordinaryshares:InitialpublicofferingpriceperordinaryshareUS$0.
155ProformatangiblebookvalueperordinaryshareatDecember31,1999,assumingconversionofSeriesAandSeriesBpreferenceshares0.
022Increaseinnettangiblebookvalueperordinaryshareattributabletopricepaidbynewinvestors.
0.
018Nettangiblebookvalueperordinaryshareaftertheoffering.
0.
040Dilutioninnettangiblebookvalueperordinarysharetonewinvestorsintheoffering.
US$0.
115DilutioninnettangiblebookvalueperADStonewinvestorsintheofferingUS$11.
55ThefollowingtablesummarizesonaproformabasisthedifferencesasofDecember31,1999betweentheshareholdersatourmostrecentscalyearendandthenewinvestorswithrespecttothenumberofordinarysharespurchasedfromus,thetotalconsiderationpaidandtheaveragepriceperordinarysharepaid.
Thetotalordinarysharesdonotincludethefollowing:675,000ADSs(alloraportionofwhichmaybeintheformofordinaryshares)issuablepursuanttotheexerciseofover-allotmentoptionsgrantedtotheunderwriters;optionsoutstandingasofMay11,2000topurchase283,668,000ordinarysharesataweightedaverageexercisepriceofUS$0.
088perordinaryshare,issuedpursuanttoourstockincentiveplan;and62,007,000ordinarysharesreservedasofMay11,2000forissuanceupontheexerciseofoptionsthatmaybegrantedinthefuturepursuanttoourstockincentiveplan.
OrdinarySharesPurchasedTotalConsiderationAveragePricePerOrdinaryShareEquivalentAveragePricePerADSEquivalentNumberPercentAmountPercent(US$)Existingshareholders.
2,560,555,60085.
157,223,00045.
10.
0222.
23Newinvestors450,000,00014.
969,750,00054.
90.
15515.
50Total3,010,555,600100.
0126,973,000100.
00.
0424.
22Totheextentthatanyoftheoutstandingoptionsareexercised,therewillbefurtherdilutiontonewinvestors.
27CONVENTIONSWHICHAPPLYTOTHISPROSPECTUSUnlessweindicateotherwise,allinformationinthisprospectusreectsthefollowing:noexercisebytheunderwritersoftheirover-allotmentoptionstopurchaseupto675,000additionalADSsrepresenting67,500,000ordinaryshares;conversionofalloutstandingSeriesAandSeriesBpreferencesharestoordinarysharesupontheclosingofthisoffering;a100foronestocksplitofourordinaryshareseffectedinMarch2000;andnoexerciseofoutstandingemployeestockoptions.
EXCHANGERATEINFORMATIONOurbusinessiscurrentlyconductedinandfromChinainrenminbi.
PeriodicreportswillbemadetoshareholdersandwillbeexpressedinU.
S.
dollarsusingthethencurrentexchangerates.
Inthisprospectus,allreferencestorenminbi,yuanandRMBaretothelegalcurrencyofChinaandallreferencestoU.
S.
dollars,dollars,$andUS$aretothelegalcurrencyoftheUnitedStates.
TheconversionofrenminbiintoU.
S.
dollarsinthisprospectusisbasedonthenoonbuyingrateinTheCityofNewYorkforcabletransfersofrenminbiascertiedforcustomspurposesbytheFederalReserveBankofNewYork.
Foryourconvenience,thisprospectuscontainstranslationsofsomerenminbiorU.
S.
dollaramountsfor1999atUS$1.
00:RMB8.
2795,whichwastheprevailingrateonDecember31,1999.
TheprevailingrateatMay1,2000wasUS$1.
00:RMB8.
2799.
WemakenorepresentationthatanyrenminbiorU.
S.
dollaramountscouldhavebeen,orcouldbe,convertedintoU.
S.
dollarsorrenminbi,asthecasemaybe,atanyparticularrate,theratesstatedbelow,oratall.
TheChinesegovernmentimposescontroloveritsforeigncurrencyreservesinpartthroughdirectregulationoftheconversionofrenminbiintoforeignexchangeandthroughrestrictionsonforeigntrade.
TheexchangeratefromU.
S.
dollartorenminbihasuctuatedbetweenarangeofUS$1.
00:RMB8.
2770andUS$1.
00:RMB8.
5000overthepastveyears.
ThefollowingtablesetsforthvariousinformationconcerningexchangeratesbetweentherenminbiandtheU.
S.
dollarfortheperiodsindicated.
Theseratesareprovidedsolelyforyourconvenienceandarenotnecessarilytheexchangeratesthatweusedinthisprospectusorwilluseinthepreparationofourperiodicreportsoranyotherinformationtobeprovidedtoyou.
ThesourceoftheseratesistheFederalReserveBankofNewYork.
Averageexchangeratesduringtheperiodarecalculatedbyaveragingtheratesonthelastbusinessdayofeachmonthduringtherelevantperiod.
FortheYearEndedDecember31,ExchangeRate:RMBperUS$1.
0019951996199719981999Exchangerateatendofperiod.
8.
33748.
32848.
31008.
27898.
2795Averageexchangerateduringperiod.
8.
36858.
33958.
31938.
29698.
2785Highestexchangerateduringperiod.
8.
45848.
50008.
32908.
31808.
2800Lowestexchangerateduringperiod8.
32038.
32678.
29118.
27748.
277028ENFORCEMENTOFCIVILLIABILITIESWeareincorporatedintheCaymanIslandsbecauseofthefollowingbenetsfoundthere:politicalandeconomicstability;aneffectivejudicialsystem;afavorabletaxsystem;theabsenceofexchangecontrolorcurrencyrestrictions;andtheavailabilityofprofessionalandsupportservices.
However,certaindisadvantagesaccompanyincorporationintheCaymanIslands.
Thesedisadvantagesinclude:(1)theCaymanIslandshasalessdevelopedbodyofsecuritieslawsascomparedtotheUnitedStatesandprovidessignicantlylessprotectiontoinvestors;and(2)CaymanIslandscompaniesmaynothavestandingtosuebeforethefederalcourtsoftheUnitedStates.
Ourconstituentdocumentsdonotcontainprovisionsrequiringthatdisputes,includingthosearisingunderthesecuritieslawsoftheUnitedStates,betweenus,ourofcers,directorsandshareholdersbearbitrated.
AsubstantialportionofourcurrentoperationsisconductedinChinathroughNeteaseBeijing,ourwholly-ownedChinesesubsidiary.
AllormostofourassetsarelocatedinChina.
WehaveappointedCTCorporationSystem,111EighthAvenue,NewYork,NY10011,asouragentuponwhomprocessmaybeservedinanyactionbroughtagainstusunderthesecuritieslawsoftheUnitedStates.
AmajorityofourdirectorsandofcersarenationalsorresidentsofjurisdictionsotherthantheUnitedStatesandasubstantialportionoftheirassetsarelocatedoutsidetheUnitedStates.
Asaresult,itmaybedifcultforashareholdertoeffectserviceofprocesswithintheUnitedStatesuponthesepersons,ortoenforceagainstusorthemjudgmentsobtainedinUnitedStatescourts,includingjudgmentspredicateduponthecivilliabilityprovisionsofthesecuritieslawsoftheUnitedStatesoranystateintheUnitedStates.
MaplesandCalderAsia,ourcounselastoCaymanIslandslaw,andCommerce&FinanceLawOfce,ourcounselastoChineselaw,haveadvisedusthatthereisuncertaintyastowhetherthecourtsoftheCaymanIslandsorChinawould:(1)recognizeorenforcejudgmentsofUnitedStatescourtsobtainedagainstusorourdirectorsorofcerspredicateduponthecivilliabilityprovisionsofthesecuritieslawsoftheUnitedStatesoranystateintheUnitedStates;or(2)entertainoriginalactionsbroughtintheCaymanIslandsorChinaagainstusorourdirectorsorofcerspredicateduponthesecuritieslawsoftheUnitedStatesoranystateintheUnitedStates.
MaplesandCalderAsiahasfurtheradvisedusthatanalandconclusivejudgmentinthefederalorstatecourtsoftheUnitedStatesunderwhichasumofmoneyispayable,otherthanasumpayableinrespectoftaxes,nes,penaltiesorsimilarcharges,maybesubjecttoenforcementproceedingsasadebtinthecourtsoftheCaymanIslandsunderthecommonlawdoctrineofobligation.
Commerce&FinanceLawOfcehasadvisedusfurtherthattherecognitionandenforcementofforeignjudgmentsareprovidedforunderChineseCivilProceduresLaw.
ChinesecourtsmayrecognizeandenforceforeignjudgmentsinaccordancewiththerequirementsofChineseCivilProceduresLawbasedeitherontreatiesbetweenChinaandthecountrywherethejudgmentismadeoronreciprocitybetweenjurisdictions.
29SELECTEDCONSOLIDATEDFINANCIALDATAThefollowingtablepresentstheselectedconsolidatednancialinformationforourbusiness.
Youshouldreadthefollowinginformationinconjunctionwiththesectionofthisprospectusentitled''Management'sDiscussionandAnalysisofFinancialConditionandResultsofOperations''andourconsolidatednancialstatementsandrelatednotesbeginningonpageF-1ofthisprospectus,whichwerepreparedinaccordancewithU.
S.
GAAP.
Thefollowingdatahavebeenderivedfromourauditedconsolidatednancialstatementsandshouldbereadinconjunctionwiththosestatements,whichareincludedinthisprospectusbeginningonpageF-1.
TheproformapersharedatagiveeffecttotheconversionofouroutstandingSeriesApreferencesharesintoordinarysharesthatwilloccurupontheconsummationofthisoffering.
Theproformapersharedatadoesnotgiveeffecttotheissuanceof2,560,556SeriesBpreferencesharesofparvalueUS$0.
01each,whichtookplaceafterDecember31,1999.
Foradditionalinformationregardingtheproformadata,see''Capitalization''onpage25.
FromJune24,1997(inception)toDecember31,1997FortheYearEndedDecember31,199819991999RMBRMBRMBUS$StatementofOperationsData:Revenues:Advertisingservices(includingrevenuesfromrelatedparties)172,85010,796,0741,303,953Softwarelicensingandrelatedintegrationprojects100,0002,942,5823,515,831424,643E-commercerelatedservices2,459,101297,011Totalrevenues100,0003,115,43216,771,0062,025,607Salesandvalue-addedtaxes6,600)(230,749)(1,150,169)(138,918)Netrevenues.
93,4002,884,68315,620,8371,886,689Costofrevenues:Advertisingande-commercerelatedservices.
13,614)(242,657)(11,837,416)(1,429,726)Softwarelicensingandrelatedintegrationprojects55,000)(946,351)(258,819)(31,260)Totalcostofrevenues68,614)(1,189,188)(12,096,235)(1,460,986)Grossprot.
24,7861,695,4953,524,602425,703Operatingexpenses:Selling,generalandadministrative.
22,844)(311,957)(51,055,489)(6,166,495)Researchanddevelopment8,000)(951,000)(5,735,170)(692,695)Totaloperatingexpenses.
30,844)(1,262,957)(56,790,659)(6,859,190)Operatingprot(loss):(6,058)432,538(53,266,057)(6,433,487)Otherincome(expenses):Saleof163.
netusageright1,500,000181,170Interestincome2895,719357,16043,138Other,net.
289)(71,056)(494,018)(59,668)Income(loss)beforetax6,058)367,201(51,902,915)(6,268,847)Provisionforincometax.
1,000)(34,464)(71,338)(8,616)Netincome(loss)7,058)332,737(51,974,253)(6,277,463)30FromJune24,1997(inception)toDecember31,1997FortheYearEndedDecember31,199819991999RMBRMBRMBUS$Netincome(loss)pershare,basicanddiluted.
0.
01)0.
01(0.
03)(0.
01)Netincome(loss)perADS,basicanddiluted.
0.
01)0.
02(2.
73)(0.
33)Weightedaveragenumberofsharesoutstanding1,868,817,2001,868,817,2001,900,430,6001,900,430,600WeightedaveragenumberofADSsoutstanding18,688,17218,688,17219,004,30619,004,306Proformanetincome(loss)perordinaryshare,basicanddiluted.
0.
01)0.
01(0.
02)(0.
01)Proformanetincome(loss)perADS,basicanddiluted0.
01)0.
02(2.
36)(0.
29)Proformaweightedaveragenumberofordinarysharesoutstanding1,868,817,2001,868,817,2002,200,430,6002,200,430,600ProformaweightedaveragenumberofADSsoutstanding18,688,17218,688,17222,004,30622,004,306OtherFinancialData:Capitalexpenditures.
187,7701,083,2489,312,3831,124,752Netcashprovidedby(usedin):Operatingactivities261,823)1,232,379(15,687,474)(1,894,737)Investingactivities187,770)(1,083,248)(9,312,383)(1,124,752)Financingactivities500,000—142,600,41517,223,313AsofDecember31,19981999RMBRMBUS$BalanceSheetData:Cash.
199,538117,800,09614,227,924Workingcapital(decit)345,804)126,556,80315,285,562Property,plantandequipment.
1,171,4839,508,4371,148,431Totalassets2,388,242143,728,18217,359,524Totalcurrentliabilities.
1,562,5637,662,942925,531Totalshareholders'equity.
825,679136,065,24016,433,99331MANAGEMENT'SDISCUSSIONANDANALYSISOFFINANCIALCONDITIONANDRESULTSOFOPERATIONSYoushouldreadthefollowingdiscussionandanalysisofournancialconditionandresultsofoperationsinconjunctionwithourconsolidatednancialstatementsandtherelatednotesincludedinthisprospectusbeginningonpageF-1.
Ourconsolidatednancialstatementsandthenancialdataincludedinthisprospectusreectourreorganizationandhavebeenpreparedasifourcurrentcorporatestructurehadbeeninexistencethroughouttherelevantperiods.
Thefollowingdiscussionandanalysiscontainforward-lookingstatementsthatinvolverisksanduncertainties.
Foradditionalinformationregardingtheserisksanduncertainties,pleasesee''RiskFactors''beginningonpage9.
OverviewNetease.
comwasincorporatedintheCaymanIslandsonJuly6,1999asanInternettechnologyprovider.
GuangzhouNeteasewasorganizedonJune24,1997underthelawsofChinaandiswhollyownedbyChinesenationals.
Ourinitialbusinessobjectivewastodeveloplarge-scaledistributedsoftwaresystemsforuseontheInternetinChina.
Inmid-1998,wechangedourbusinessmodelfromasoftwaredevelopertoanInternettechnologycompanyandcommenceddevelopingtheNeteaseWebsites.
InSeptember1999werestructuredouroperations.
Aspartofthisrestructuring,allofGuangzhouNetease'sxedandintangibleassetsandexistingInternetapplications,servicesandtechnologieswereacquiredbyNeteaseBeijing,ourwhollyownedsubsidiary.
Inaddition,therightstouseallofGuangzhouNetease'sURLsweretransferredtoNetease.
com.
GuangzhouNeteasehasbeenapprovedbytheChineseauthoritiestooperateasanInternetcontentproviderandoperatestheNeteaseWebsites.
GuangzhouNetease's80%ownedsubsidiary,GuangyitongAdvertising,islicensedbytheChineseauthoritiestooperateanadvertisingbusinessandengagesinInternet-relatedadvertisingdesign,productionanddissemination.
AstheexclusiveInternettechnologyprovidertoGuangzhouNetease,weprovideavarietyofInternetapplications,technologiesandservicestosupportGuangzhouNetease'soperationoftheNeteaseWebsitesandoure-commerceservices.
ThetechnologiesweprovidetoGuangzhouNeteaseincludeChineselanguage-basedonlinesoftwareandrelatedtechnology,onlineadvertisingtechnology,portaltechnologyande-commercetechnology.
OurservicestoGuangzhouNeteaseanditssubsidiaryconstitutesubstantiallyallofouroperations.
WehaveenteredintoaseriesofcontractualarrangementswithGuangzhouNeteaseandGuangyitongAdvertisingwithrespecttotheoperationoftheNeteaseWebsitesandtheprovisionofadvertisingservices.
Formoreinformation,see''RelatedPartyTransactions''onpage66ofthisprospectus.
RevenuesOurtotalrevenuesgrewfromRMB100,000in1997(fromJune24toDecember31)toRMB3.
1millionin1998andRMB16.
8million(US$2.
0million)in1999.
Wegenerateourrevenuesfromsoftwarelicensingandrelatedintegrationprojects,advertisingservicesande-commercerelatedservices.
BecausewestartedasanInternetsoftwaredeveloper,softwarelicensingandrelatedintegrationprojectsaccountedforamajorityofourtotalrevenuesin1997and1998.
Inmid-1998,wechangedourbusinessfocustoInternettechnology.
Theproportionofourtotalrevenuesattributabletosoftwarelicensingandrelatedintegrationprojectsdecreasedfrom100%ofourrevenuesin1997to21.
0%ofourtotalrevenues,orRMB3.
5million(US$425,000),in1999.
InApril1999,weceasedlicensingoursoftware.
Conversely,theproportionofourtotalrevenuesattributabletoadvertisingservicesincreasedfromzeroin1997to64.
4%ofourtotalrevenues,orRMB10.
8million(US$1.
3million),in1999.
Ouradvertisingservicesrevenuesincreasedsignicantlyinthesecondhalfof1999asaresultofourexpandedInternetadvertisingoperationsfollowingourestablishmentofanadvertisingsalesdepartmentinmid-1999.
InJuly1999,webegantooffere-commerceplatformsandtoprovideonlineauctionservicesinChina.
Thetotalrevenuesgeneratedbyoure-commercerelatedservicesconstituted14.
6%ofourtotalrevenues,orRMB2.
5million(US$297,000),in1999.
Weexpectthat,goingforward,advertisingande-commercerelatedserviceswillconstitutetheprimarysourcesofourfuturerevenues.
32In1998,salesofsoftwarelicensestoGuangzhouFeihuaTelecomCo.
,Ltd.
andJinhuaPostalBureauaccountedfor12.
8%and12.
5%,respectively,ofourtotalrevenues.
In1999,InternetadvertisingservicestoTopResultPromotionLtd.
andBigsaveLtd.
accountedfor14.
1%and12.
3%,respectively,ofourtotalrevenues.
Wederived20.
1%ofourrevenuesin1999frombartertransactions.
Inexchangeforadvertisementsontheadvertisingmediaofourcustomers,weprovideanequalamountinvalueofadvertisingtosuchcustomersontheNeteaseWebsites.
Werecordourbartertransactionsattheestimatedfairmarketvalueoftheservicesreceivedorestimatedfairmarketvalueoftheservicesprovided,whicheverismorereadilydeterminable.
In1999,revenuesderivedfrombartertransactionswereRMB3.
4million(US$409,000).
Ofthatamount,RMB2.
4million,or70.
0%,relatedtoadvertisingservicesrevenuefromTopResultPromotionLtd.
Aspartofourmarketingcampaignin1999,wepurchasedadvertisementsdisplayedonoutdooradvertisingmediafromTopResultinexchangeforadvertisingspaceontheNeteaseWebsitesthatTopResultsoldtoitscustomers.
Wedidnotderiveanyofourrevenuesin1997or1998frombartertransactions.
Advertisingservicesrevenues.
WederiveouradvertisingservicesrevenuesprincipallyfromfeeswereceivefromadvertisersontheNeteaseWebsitesandthefeesweearnfromGuangyitongAdvertisingforservicesthatweprovideinconnectionwithadvertisementsplacedontheNeteaseWebsitesandadvertising-relatedtechnicalconsultingservices.
Ouradvertisingfeesarederivedprincipallyfromshort-termadvertisingcontracts.
Revenuesfromthesecontractsarerecognizedratablyovertheperiodinwhichtheadvertisementisdisplayedandcollectionoftheresultingreceivablesisprobable.
Ourobligationstotheadvertiserstypicallyalsoincludeguaranteesofaminimumnumberofimpressionsortimesthatanadvertisementappearsinpagesviewedbyusers.
Asaresult,totheextentthatminimumguaranteedimpressionsarenotmetwithinthecontractualtimeperiod,wedeferrecognitionofthecorrespondingrevenuesuntiltheremainingguaranteedimpressionlevelsareachieved.
WehaveenteredintoanagreementwithGuangyitongAdvertisingunderwhichwearetheexclusiveproviderofadvertising-relatedtechnicalconsultingservicestoGuangyitongAdvertising,andunderwhichwereceiveaservicefee.
SinceDecember1999,wehaverecognizedadvertisingservicesrevenuesthatweearnthroughthisarrangementasservicesarerenderedandtheservicerevenuesareearnedundertheagreement.
TheservicefeethatwechargeincludessubstantiallyalloftheadvertisingrevenuesofGuangyitongAdvertising,netofa5%businesstaxanda3%culturaldevelopmentfeethatapplytotheserevenues.
Softwarelicensingandrelatedintegrationprojectsrevenues.
Softwarelicensingandrelatedintegrationprojectsrevenuesconsistoffeesreceivedfromcustomersforlicensesthatpermitthemtouseoure-mailsoftwareproductsforaspecifieddurationorinperpetuity.
Substantiallyallofoursoftwarerevenuesarederivedfromourinternallydevelopede-mailsoftwareproducts.
Oursoftwarelicensingandrelatedintegrationprojectsrevenueshavehistoricallyalsoincludedrevenuesgeneratedfromrelatedhardwaresales.
Oursoftwarelicensingandrelatedintegrationprojectsbusinessincludessuchservicesasplanning,design,systemintegrationandcustomizationofourproprietaryandthirdpartysoftwareproducts.
WeceasedlicensingoursoftwareinApril1999.
Wegenerallychargeaxedpriceforoure-mailsoftwarelicensingproductsorapricethatisreadilydeterminableonthebasisofasignedlicensingagreement.
Werecognizeoursoftwarelicensingrevenuesupondeliveryofourproductsifwedonothaveanysignicantpost-deliveryobligations.
Wegenerallyprovideourcustomerswithoneyearofpost-contractsupportonoursoftwareproducts.
Suchsupporttypicallyincludeshotlineandon-callservicesweprovidetoourcustomerstomaintainorupgradetheoperationofthesoftwareproductslicensed.
Weoccasionallyagreetoprovidepost-contractsupportservicesthatextendbeyondoneyear.
Insuchevent,wewouldrecognizerevenuesforapplicablecontractsratablyoverthetermsofthosecontracts.
E-commercerelatedservicesrevenues.
Oure-commercerelatedservicesrevenuesarederivedprincipallyfromvariousservicecontractsforWebsiteconstruction,marketsurveys,auctionsandnewspublishingconductedthroughtheInternet.
Ouronlineauctionsellers,whetherbusinessesorconsumers,typicallypayusanauctioncommissionuponconsummationofthesale.
Theauctioncommissionisbasedonthesellingpriceoftheproductsoldonlineandmayvarydependingupontheproductsold.
Wealsosometimes33chargeouronlineauctionsellersaxedone-timeregistrationfeeforpostingtheirproductsontheNeteaseWebsites.
Werecognizeoure-commercerelatedservicesrevenuesasfollows:(1)inthecaseofauctioncommissions,uponconsummationoftheonlinesale;(2)inthecaseofregistrationfees,ratablyovertheperiodinwhichtheproductforsaleisdisplayedontheNeteaseWebsites;and(3)inthecaseofothere-commercerelatedservicesrevenues,uponcompletionofthetotalcontractandacceptancebyourcustomers.
Oure-commercerelatedservicesbusinessisrelativelynewandhasnotconstitutedamaterialportionofourtotalrevenuesinthepast.
Inthefuture,duetoChineserestrictionsonforeignparticipationinretailbusinesses,wewillnotchargecommissionsbasedonsalesconsummated.
Wewillinsteadchargeaxedservicefeeforleaseofoure-commerceplatform.
CostofRevenuesAdvertisingande-commercerelatedservicescosts.
Advertisingande-commercerelatedservicescostsconsistofbandwidthandservercustodyfees,sharecompensationcosts,staffcostsanddepreciation.
NeteaseBeijingandGuangzhouNeteaseleasebandwidthfromChinaTelecomafliates.
BothNeteaseBeijingandGuangzhouNeteasehavenetworkserversco-locatedinfacilitiesownedbyChinaTelecom'sBeijing,GuangzhouandShanghaiafliates,forwhichtheypaycustodyfeestoChinaTelecom.
Wepayforourbandwidthleasepaymentsandservercustodyfeesonamonthlybasis.
Inaddition,asaresultofourarrangementswithGuangzhouNetease,wealsopayforGuangzhouNetease'sbandwidthleasepaymentsandservercustodyfeesonamonthlybasis.
Thesecostsarerecognizedinfullasincurred.
Staffcostsconsistprimarilyofcompensationexpensesforourtechnologyandeditorialprofessionals.
Ourstaffcostshaverisenasourbusinesshasexpandedandwehavehiredmorepersonnel.
Basedonourcurrentestimatesofgrowthinouroperations,weexpectthatthenumberofourpersonnelwillcontinuetoincreaseintheneartermandthatsuchincreasesmaybesignicantfromtimetotime.
Wedepreciateourassetsotherthanleaseholdimprovementsonastraight-linebasisovertheirestimatedusefullives,whichrangefromthreetoveyears.
Wedepreciateleaseholdimprovements,whichareincludedinouroperatingexpenses,onastraight-linebasisoverthelesseroftherelevantleasetermortheirestimatedusefullives.
Weexpectthatourplannedsignicantcapitalexpenditurestoexpandandenhanceourinfrastructurewillsubstantiallyincreaseourdepreciationexpensesinthenearfuture.
Softwarelicensingandrelatedintegrationprojectscosts.
Softwarelicensingandrelatedintegrationprojectscostsconsistprincipallyofstaffcostsforintegrationprojectsandhardwarecosts.
Werecognizethesecostsatthesametimeaswerecognizetherelatedrevenues.
OperatingExpensesOperatingexpensesincludeselling,generalandadministrativeexpensesandresearchanddevelopment.
Selling,generalandadministrativeexpenses.
Selling,generalandadministrativeexpensesconsistprimarilyofmarketingandadvertising;sharecompensationcosts,salaryandwelfareexpenses;ofcerental;amortizationofleaseholdimprovements;andtravelexpenses.
Asweexpandthescopeofouroperations,weexpectselling,generalandadministrativeexpensestocontinuetoincreasefortheforeseeablefuture.
Weintendtocontinuetohirenewsalesandmarketingpersonnelandcontinuetoincreaseourmarketingandadvertising34expensestofurtherincreaseourbrandawareness.
Inaddition,sinceourbusinessisdependentuponGuangzhouNetease,whichoperatestheNeteaseWebsites,andGuangzhouNeteasewillnothaveanysignicantrevenues,weexpectthatwewillneedtonancetheoperatingcostsofGuangzhouNetease.
Accordingly,wewillaccrueforthestaffcostsandothergeneralandadministrativeexpensesofGuangzhouNeteaseastheyareincurredandincludetheminourselling,generalandadministrativeexpenses.
Researchanddevelopment.
Researchanddevelopmentconsistsofcompensationforourresearchanddevelopmentprofessionalsandin1998,feesandexpensesofexternalconsultantsweusedtodevelopourtechnologyplatformsandseveralnewproducts.
ShareCompensationCostsIn1999,ShiningGlobeInternationalLimited,whichis100%ownedbyWilliamLeiDing,ourfounder,ChairmanoftheBoardandCo-ChiefTechnologyOfcer,agreedtotransferanaggregateof109,694,200ordinarysharestocertainseniormanagementpersonnelandkeyemployees.
ThesesharetransferswereeffectedinJanuary2000.
Thesharetransfercommitmentsweremadetoprovideincentivestoseniormanagementpersonnelandkeyemployeestojoinourcompany.
Thefairmarketvalueofthesesharesasofthedateofsuchagreement(RMB45.
4millionorUS$5.
5million)waschargedtoourearningsin1999assharecompensationcostsinaccordancewithU.
S.
GAAP,withacorrespondingincreaseinadditionalpaid-incapital.
Inaddition,WilliamLeiDing,hasagreedtotransferatotalofapproximately26,270,000ordinarysharestocertainoftheseemployeesforservicestoberenderedbythemoveraperiodofthreeyearscommencingJanuary1,2000.
Thetotalestimatedfairvalueoftheseshares,valuedatUS$0.
05pershareatthedateofgrant,isrecognizedasdeferredcompensationwhichwillbeamortizedovertherelatedvestingperiods.
Moreover,inMarch2000WilliamLeiDingtransferredapproximately1,900,000sharestocertainemployees,whichweexpectwillresultinsharecompensationcostsofapproximatelyRMB2.
5millionin2000.
Thesecostshavebeenallocatedto(i)advertisingande-commercerelatedservicecosts,(ii)selling,generalandadministrativeexpensesand(iii)researchanddevelopmentexpensesdependingonthefunctionsforwhichthesepersonnelandemployeesareresponsible.
IncomeTaxesUnderthecurrentlawsoftheCaymanIslands,wearenotsubjecttotaxonincomeorcapitalgain.
However,ourrevenuesareprimarilyderivedfromourChinesesubsidiary.
Chinesecompaniesaregenerallysubjecttoa30%nationalenterpriseincometax,orEIT,anda3%localincometax.
Oursubsidiary,NeteaseBeijing,intendstoapplytotherelevanttaxauthoritiestobeclassiedasa''high-tech''company.
ThisdesignationwouldentitleNeteaseBeijingtopreferentialtreatmentunderChinesetaxlaws.
IfNeteaseBeijingreceivestherelevantapprovals,itwouldoperatefreeofEITfortherstthreeyearsofoperationsandwouldbeentitledtoa50%taxreductionforthesubsequentthreeyears.
Wecannotbesure,however,thatwewillobtainapprovalsfromtherelevanttaxauthoritiestobeentitledtothesetaxbenets,thatwewouldactuallyrealizethesebenetsifChinesetaxlawsorinterpretationschangeorthatwewillqualifyforthesebenets.
SeeNote9toourconsolidatednancialstatements.
IftheactivitiesofNetease.
comconstituteapermanentestablishmentinChina,theincomeitearnsinChinawouldalsobesubjecttoa30%EITand3%localincometax.
IncomeofNetease.
comthatisnotconnectedtoapermanentestablishmentinChinawouldbesubjecttoa20%withholdingtaxongrossreceiptfromprot,interest,rentals,royaltiesandotherincomeearnedinChina.
Ifsuchincomeisearnedfromsourceswithinthedesignatedspecialeconomiczonesorotherdesignatedareas,thewithholdingtaxisreducedto10%.
DividendsfromNeteaseBeijingtoNetease.
comareexemptfromChinesewithholdingtax.
GuangzhouNeteaseisaChinesedomesticenterpriseandisgenerallysubjecttoa33%EIT.
In1997and1998,GuangzhouNeteasewasclassiedasasmall-sizedtaxpayerbythelocaltaxbureauofGuangzhouandwassubjecttoEITat1%ofthetotalamountofitsrevenuesandotherincome.
35Wearegenerallysubjecttoabusinesstaxof5%onourservicerevenues.
Wearealsosubjecttoanadditionalculturaldevelopmentfeeof3%onouradvertisingrevenues,butwhichdoesnotapplytoouradvertisingservicesrevenuesderivedfromGuangyitongAdvertising.
OurrevenuesfromintegrationprojectsinChinaaregenerallysubjecttoa17%valueaddedtaxwhichisoffsetbyvalueaddedtaxespaidonpurchases.
In1997and1998,becauseGuangzhouNeteasewasclassiedasasmall-sizedtaxpayer,itsrevenuesfromintegrationprojectsweresubjecttoareducedvalueaddedtaxof6%butnooffsetwasallowed.
NeteaseBeijinghadtaxnetoperatinglosscarryforwards,orNOLs,ofRMB6.
6million(US$797,000)asofDecember31,1999forEITpurposes.
TheseNOLswillexpirein2004.
Avaluationallowancehasbeenprovidedtooffsetgrossdeferredtaxassetsduetotheuncertaintysurroundingtherealizabilityofsuchassets.
WecannotassureyouthatNeteaseBeijingwillbeabletousealloranyofitsNOLsbeforetheyexpire.
ConsolidatedResultsofOperationsThefollowingtablesetsforthasummaryofourauditedconsolidatedstatementsofoperationsfortheperiodsindicatedbothinrenminbiandasapercentageoftotalrevenues:FromJune24toDecember31,1997YearEndedDecember31,19981999RMB%RMB%RMB%Revenues:Advertisingservices172,8505.
510,796,07464.
4Softwarelicensingandrelatedintegrationprojects.
100,000100.
02,942,58294.
53,515,83121.
0E-commercerelatedservices.
2,459,10114.
6Totalrevenues.
100,000100.
03,115,432100.
016,771,006100.
0Salesandvalue-addedtaxes.
6,600)(6.
6)(230,749)(7.
4)(1,150,169)(6.
9)Netrevenues93,40093.
42,884,68392.
615,620,83793.
1Costofrevenues:Advertisingande-commercerelatedservices(includingsharecompensationcostsofRMB6,296,816in1999)13,614)(13.
6)(242,657)(7.
8)(11,837,416)(70.
6)Softwarelicensingandrelatedintegrationprojects.
55,000)(55.
0)(946,531)(30.
4)(258,819)(1.
5)Totalcostofrevenues.
68,614)(68.
6)(1,189,188)(38.
2)(12,096,235)(72.
1)Grossprot24,78624.
81,695,49554.
43,524,60221.
0Operatingexpenses:Selling,generalandadministrativeexpenses(includingsharecompensationcostsofRMB34,346,268in1999)22,844)(22.
9)(311,957)(10.
0)(51,055,489)(304.
4)Researchanddevelopment(includingsharecompensationcostsofRMB4,770,315in1999)8,000)(8.
0)(951,000)(30.
5)(5,735,170)(34.
2)Totaloperatingexpenses30,844)(30.
9)(1,262,957)(40.
5)(56,790,659)(338.
6)Operatingprot(loss)6,058)(6.
1)432,53813.
9(53,266,057)(317.
6)Otherincome(expenses):Saleof163.
netusageright.
1,500,0008.
9Interestincome(expenses)2890.
35,7190.
2357,1602.
1Others,net.
289)(0.
3)(71,056)(2.
3)(494,018)(2.
9)Income(loss)beforetax.
6,058)(6.
1)367,20111.
8(51,902,915)(309.
5)Provisionforincometax.
1,000)(1.
0)(34,464)(1.
1)(71,338)(0.
4)Netincome(loss)7,058)(7.
1)332,73710.
7(51,974,253)(309.
9)YearEndedDecember31,1999ComparedtoYearEndedDecember31,1998Revenues.
TotalrevenuesincreasedRMB13.
7million(US$1.
7million),or438.
3%,toRMB16.
8million(US$2.
0million)in1999fromRMB3.
1millionin1998.
SoftwarelicensingandrelatedintegrationprojectsaccountedforRMB573,000(US$69,000)ofthisincrease,primarilyduetorevenuesrecognizedfromincreasedsalesofsoftwarelicensesinthelasthalfof1998andinearly1999,priortoourceasingsoftware36licensesalesinApril1999.
AdvertisingservicesaccountedforRMB10.
6million(US$1.
3million)oftheincreaseintotalrevenues.
ThegrowthinadvertisingservicesrevenuesresultedprimarilyfromexpandedInternetadvertisingoperationsfollowingourestablishmentofamarketingdepartmentinmid-1999andanincreaseinadvertisingactivityontheNeteaseWebsites.
Thegrowthalsoreectsafullyearofadvertisingservicesrevenuesascomparedtoonlyonequarterin1998.
E-commercerelatedservicesaccountedforRMB2.
5million(US$297,000)oftheincreaseintotalrevenues.
Thegrowthine-commercerelatedservicesrevenuesreectsourintroductionoftheseservicesinJuly1999.
Costofrevenues.
OurcostofrevenuesincreasedRMB10.
9million,or917.
2%,toRMB12.
1million(US$1.
5million)in1999fromRMB1.
2millionin1998,primarilyduetotheoverallexpansionofourbusiness,increasedstaffcosts,sharecompensationcostsandincreasedservercustodyfeesanddepreciationasaresultofournewlyacquiredservers.
Weincreasedourstafffrom10employeesatDecember31,1998to161employeesatDecember31,1999.
Grossprotasapercentageoftotalrevenuesdecreasedfrom54.
4%in1998to21.
0%in1999.
Operatingexpenses.
Operatingexpensesincreased4,396.
6%toRMB56.
8million(US$6.
9million)in1999fromRMB1.
3millionin1998,primarilyduetosubstantialsharecompensationcosts.
Operatingexpensesalsoincreasedasaresultoftheoverallexpansionofourbusiness,increasedsalesandmarketingandadvertisingexpendituresandincreasedpersonnelcompensationcosts.
Operatingexpensesasapercentageoftotalrevenuesincreasedfrom40.
5%to338.
6%primarilybecauseofthesubstantialincreasesinsharecompensationcostsandselling,generalandadministrativeexpenses.
Selling,generalandadministrativeexpensesincreased16,263.
8%toRMB51.
1million(US$6.
2million)in1999fromRMB312,000in1998primarilyduetosubstantialsharecompensationcostsandsignicantincreasesinmarketingexpenses.
Selling,generalandadministrativeexpensesalsoincreasedasaresultofsignicantpersonnelincreasesin1999.
Researchanddevelopmentexpensesincreased503.
1%toRMB5.
7million(US$693,000)in1999fromRMB951,000in1998.
In1998,weincreasedourfocusonresearchanddevelopmenttodevelopourtechnologyplatformsandseveralnewproductsandhiredexternalconsultantstoassistinthisdevelopment,resultinginhighercosts.
Becauseourtechnologyplatformswereputinplacein1998,wehadlessneedforresearchanddevelopmentin1999anddidnotoutsourceanyofthiswork.
Thesignicantincreaseinresearchanddevelopmentexpensesin1999wasduetothesubstantialsharecompensationcosts.
Otherincome(expenses).
Otherincome(expenses)in1999consistedprimarilyofoursaleinJuly1999ofourrighttousetheWebsitedomainname,www.
163.
net,forRMB1.
5million(US$181,000),aone-timenon-recurringevent.
Otherincome(expenses)in1999alsoincludedinterestincome.
Theincreaseofinterestincomein1999comparedto1998wasprimarilyduetoanincreaseincashprimarilyasaresultofequitynancings,offsetinpartbylowerinterestratesoncashdeposits.
Others,net,consistedprimarilyofawrite-offduetothefailureofoneofourserversandaccruedtaxpenalties.
PeriodfromJune24toDecember31,1997OurbusinesswasestablishedinJune1997withtheobjectiveofdevelopinglarge-scaledistributedsoftwaresystemsfortheInternet.
Inmid-1998,wechangedourbusinessobjectivetodevelopingInternettechnologiesandservicesfortheNeteaseWebsites.
WethereforedonotbelievethatacomparisonbetweentheperiodfromJune24,1997toDecember31,1997andtheyearendedDecember31,1998ismeaningful.
ThefollowingdiscussionsummarizesourresultsofoperationsfortheperiodfromJune24,1997(inception)toDecember31,1997.
Revenues.
TotalrevenuesforthepartialyearperiodwereRMB100,000.
Theyconsistedentirelyofsoftwarelicensingandrelatedintegrationprojectsrevenues.
37Costofrevenues.
OurcostofrevenueswasRMB69,000forthispartial1997period.
Softwarelicensingandrelatedintegrationprojectscostsaccountedfor80.
2%ofthetotalcostofrevenues.
Operatingexpenses.
OperatingexpenseswereRMB31,000.
Operatingexpensesduringthisinitialstartupperiodasapercentageoftotalrevenueswere30.
9%.
Selling,generalandadministrativeexpensesaccountedfor74.
1%ofouroperatingexpensesduringthisperiod.
QuarterlyResultsofOperationsDataThefollowingtablesetsforthselectedunauditedquarterlyconsolidatedstatementofoperationsdataforeachofthevescalquartersendedMarch31,2000inrenminbi.
Ourmanagementbelievesthisdatahasbeenpreparedsubstantiallyonthesamebasisastheconsolidatedauditednancialstatementsincludedelsewhereinthisprospectus,includingallnecessaryadjustments,consistingonlyofnormalrecurringadjustments,necessaryforafairpresentationofsuchdata.
Operatingresultsforanyquarterarenotnecessarilyindicativeofresultsforanyfuturequarter.
YoushouldreadthequarterlydataforthefourquarterssetforthbelowendedDecember31,1999inconjunctionwithourconsolidatednancialstatementsandtherelatednotesincludedelsewhereinthisprospectus.
QuarterEndedMarch31,1999June30,1999September30,1999December31,1999March31,2000RMBRMBRMBRMBRMBRevenues:Advertisingservices.
213,011600,9012,385,5177,596,6456,613,031Softwarelicensingandrelatedintegrationprojects716,8241,759,653922,166117,188117,188E-commercerelatedservices2,459,101370,850Totalrevenues929,8352,360,5543,307,68310,172,9347,101,069Salesandvalue-addedtaxes65,416)(192,863)(320,502)(571,388)(635,487)Netrevenues.
864,4192,167,6912,987,1819,601,5466,465,582Costofrevenues:Advertisingande-commercerelatedservices.
191,583)(288,411)(1,271,545)(10,085,877)(5,926,968)Softwarelicensingandrelatedintegrationprojects139,137)(116,438)(3,244)——Totalcostofrevenues.
330,720)(404,849)(1,274,789)(10,085,877)(5,926,968)Grossprot.
533,6991,762,8421,712,392(484,331)538,614Operatingexpenses:Selling,generalandadministrative234,573)(890,180)(3,692,792)(46,237,944)(22,445,315)Researchanddevelopment12,500)(12,500)(183,453)(5,526,717)(2,923,322)Totaloperatingexpenses.
247,073)(902,680)(3,876,245)(51,764,661)(25,368,637)Operatingprot(loss)286,626860,162(2,163,853)(52,248,992)(24,830,023)Otherincome(expenses):Saleof163.
netusageright1,500,000——Interestincome(expenses)1,0393,398(31,027)383,750896,496Others,net.
302,074)(71,965)(38,919)(81,060)—Income(loss)beforetax14,409)791,595(733,799)(51,946,302)(23,933,527)Provisionforincometax.
9,298)(26,623)(35,417)——Netincome(loss)23,707)764,972(769,216)(51,946,302)(23,933,527)Ouradvertisingservicesrevenuesincreasedsignicantlyduring1999primarilyasaresultofanincreaseinadvertisingactivityontheNeteaseWebsites.
Conversely,revenuesfromoursoftwarelicensingandrelatedintegrationprojectsdecreasedsignicantlybecauseweceasedlicensingoursoftwareinApril1999.
Weintroducedoure-commercerelatedservicesinthethirdquarterof1999andbegangeneratingrevenuesfromtheseservicesinthefourthquarterof1999.
Thechangesinourcostofrevenuesandselling,generalandadministrativeexpensesduringtheyearreectthesechangesinourbusiness.
38OthermaterialchangesinourquarterlynancialdataincludedsharecompensationcostsofRMB45.
4million(US$5.
5million)incurredinthefourthquarter,againofRMB1.
5million(US$181,000)inthethirdquarterfromoursaleoftherighttousethedomainnamewww.
163.
netandinterestincomeofRMB384,000(US$46,000)inthefourthquarterearnedoncashwereceivedfromanequitynancing.
InthethreemonthsendedMarch31,2000,ouradvertisingservicesrevenuedeclinedfromRMB7,596,645toRMB6,613,031,comparedtothepreviousquarter,primarilyasaresultofseasonalvariationsintheInternetadvertisingbusiness.
Oure-commercerelatedservicesrevenuesdeclinedfromRMB2,459,101toRMB370,850.
Webelievethisisaresultofseasonalvariations,aswellastheevolvingnatureofthee-commercebusinessinChina.
OurcostofrevenuesdecreasedfromRMB10,085,877toRMB5,926,968andouroperatingexpensesdecreasedfromRMB51,764,661toRMB25,368,637,primarilyasaresultofloweredsharecompensationcosts.
Thiswaspartiallyoffsetbyincreasesinrecruiting,consultantandmarketingexpenses,aswellasexpensesassociatedwithourincreasedheadcountandthehiringofseniormanagementpersonnel.
Ourrevenuesandresultsofoperationshavevariedsignicantlyinthepastandmayuctuateinthefutureduetoacombinationoffactors,including:theabilityoftheNeteaseWebsitestoattractandretainusers;demandforadvertisingontheInternetingeneralandontheNeteaseWebsitesinparticular;ourabilitytosuccessfullyimplementoure-commercestrategies;ourabilitytoupdateanddevelopourInternetportalsystemsandinfrastructure;technicaldifcultiesthatusersmayexperienceontheNeteaseWebsites;competitioninInternetmarkets,includingourcompetitors'performanceineachoftheaboveaspects;growthandacceptanceoftheInternetinChina;changesinChinesegovernmentalregulations;andgeneraleconomicconditionsinChina.
LiquidityandCapitalResourcesOurcapitalrequirementsrelateprimarilytonancing:(1)ourworkingcapitalrequirements,suchasbandwidthandservercustodyfees,staffcosts,salesandmarketingexpensesandresearchanddevelopment,and(2)costsassociatedwiththeexpansionofourbusiness,suchasthepurchaseofservers.
Cashprovidedby(usedin)operatingactivitieswas(RMB15.
7millionorUS$1.
9million)in1999,RMB1.
2millionin1998and(RMB262,000)in1997.
In1999,cashusedinoperatingactivitiesconsistedprimarilyofouroperatinglossandincreasesinaccountsreceivableandprepayments,offsetinpartbyincreasesinaccountspayable,salaryandwelfarepayable,taxespayableandotheraccruedliabilities.
In1998,thenetcashprovidedbyoperatingactivitiesconsistedprimarilyofouroperatingprot,increasesinaccountspayable,salaryandwelfarepayable,taxespayableandotheraccruedliabilitiesandanincreaseindeferredrevenue,offsetinpartbyincreasesinaccountsreceivable,andothercurrentassets.
In1997,thenetcashusedinoperatingactivitiesconsistedprimarilyofouroperatinglossandincreasesinothercurrentassetsandaccountsreceivable,offsetinpartbydepreciationandincreasesinaccountspayable,salaryandwelfarepayable,taxespayableandotheraccruedliabilities.
39CashusedininvestingactivitieswasRMB9.
3million(US$1.
1million)in1999,RMB1.
1millionin1998andRMB188,000in1997,allusedtoacquireproperty,plantandequipment.
CashprovidedbynancingactivitieswasRMB142.
6million(US$17.
1million)in1999,zeroin1998andRMB500,000in1997.
In1999,weraisedanaggregateofRMB18.
4million(US$2.
2million)incapitalthroughtheissuanceofordinarysharesandanaggregateofRMB124.
2million(US$15.
0million)throughtheissuanceofSeriesApreferencesharestoTheGoldmanSachsGroup,Inc.
,SoftbankChinaInvestmentsNo.
1LimitedandBAPEFInvestmentsXILimitedinprivateplacements.
Cashprovidedbynancingactivitiesin1997consistedofacapitalcontributionofRMB500,000(US$60,000)byourmajorityshareholder.
InMarch2000,weissuedourSeriesBpreferenceshares,convertibleinto256,055,600ordinaryshares,toBestAllianceProtsLimited,acompanycontrolledbyTheNewsCorporationLimited,forRMB289.
7million(US$35million)incashandanamountofadvertisingandpromotionalinventoryvaluedatUS$5milliontobeprovidedoverthreeyears.
TheadvertisingcanbeplacedonNewsCorporation'smajorityownedorcontrolledmediaproperties,includingChannel[V],ESPNStarSports,PhoenixTVandSTARTV.
Weexpecttousethecashproceedsofthisprivateplacementformarketing,contentdevelopment,serverandbandwidthexpenditures,researchanddevelopmentandworkingcapitalandgeneralcorporatepurposes.
Inaddition,TheNewsCorporationanditsafliateswillpurchaseUS$5millionofadvertisingontheNeteaseWebsitesoverathreeyearperiod.
Wehavenancedourworkingcapitalandothernancingrequirementsthroughprivateplacementsofourequitysecuritieswithstrategicinvestorsandcarefulmanagementofourbillingcycle.
AsofDecember31,1999,almostallofouraccountsreceivablewerewithin60dayspastdue.
Asourbusinesscontinuestoexpand,weexpectthatourworkingcapitalrequirementswillgrowandwewillneedtoraiseadditionalcapital.
Weexpectthatourfutureminimumleasecommitmentsandcapitalexpendituresin2000willtotalapproximatelyRMB12.
5million(US$1.
5million).
Wecurrentlyanticipatethatthenetproceedsofthisoffering,togetherwithavailablefundsandcashflowsgeneratedfromoperations,willbesufficienttomeetouranticipatedneedsforworkingcapital,capitalexpendituresandbusinessexpansionthroughatleastthenext12months.
Thereafter,wemayneedtoraiseadditionalfunds.
Wemayneedtoraiseadditionalfundssooner,however,tofundmorerapidexpansion,todevelopneworenhancedservicesorproductsortorespondtocompetitivepressures.
Ourfutureliquidityandcapitalrequirementswilldependuponnumerousfactors,includingcostsandtimingofproductdevelopmenteffortsandthesuccessofsuchefforts,thesuccessofourexistingandnewtechnologyserviceofferingsandcompetingtechnologicalandmarketdevelopments.
Weplantoraiseadditionalfunds,ifnecessary,throughnewissuancesofourequitysecuritiesprimarilythroughprivateplacementstoaccreditedinvestorsorthroughborrowingsfromlendinginstitutions.
Therecanbenoassurancethatadditionalnancingwillbeavailabletousonfavorabletermswhenneeded,ifatall.
Ifadequatefundsarenotavailableonacceptableterms,wemaybeunabletofundandexpandouroperations,developorenhanceourservices,takeadvantageoffutureopportunitiesorrespondtocompetitivepressures.
Anysuchlimitationcouldhaveamaterialadverseeffectonourbusiness,nancialconditionandoperatingresults.
See''RiskFactors''onpage9.
QuantitativeandQualitativeDisclosuresAboutMarketRiskInterestRateRisk.
Ourexposuretomarketrateriskforchangesininterestratesrelatesprimarilytotheinterestincomegeneratedbyexcesscashinvestedinshorttermmoneymarketaccountsandcerticatesofdeposit.
Wehavenotusedderivativenancialinstrumentsinourinvestmentportfolio.
Interestearninginstrumentscarryadegreeofinterestraterisk.
Wehavenotbeenexposednordoweanticipatebeingexposedtomaterialrisksduetochangesininterestrates.
However,ourfutureinterestincomemayfallshortofexpectationsduetochangesininterestrates.
40ForeignCurrencyRisk.
Substantiallyallourrevenuesandexpensesaredenominatedinrenminbi.
Wehavenothadanymaterialforeignexchangegainsorlosses.
Althoughingeneral,ourexposuretoforeignexchangerisksshouldbelimited,thevalueofyourinvestmentinourADSswillbeaffectedbytheforeignexchangeratebetweenU.
S.
dollarsandrenminbibecausethevalueofourbusinessiseffectivelydenominatedinrenminbi,whiletheADSswillbetradedinU.
S.
dollars.
Furthermore,adeclineinthevalueofrenminbicouldreducetheU.
S.
dollarequivalentofthevalueoftheearningsfrom,andourinvestmentsin,oursubsidiariesandcontrolledentitiesinChina.
ImpactofYear2000WebelievethatalloursystemsareYear2000compliant.
Costsincurredtodate,andexpectedfuturecosts,toaddressandremedyYear2000complianceissueshavenotbeen,andarenotexpectedtobe,material.
RecentAccountingPronouncementsInJune1998,theFinancialAccountingStandardsBoardsissuedSFASNo.
133,''AccountingforDerivativeInstrumentsandHedgingActivities.
''Thisstatementrequirescompaniestorecordallderivativesonthebalancesheetasassetsorliabilitiesmeasuredatfairvalue.
Gainsandlossesresultingfromchangesinfairmarketvaluesofthosederivativeinstrumentswouldbeaccountedfordependingontheuseoftheinstrumentandwhetheritqualiesforhedgeaccounting.
SFASNo.
133willbeeffectiveforthescalyearendingDecember31,2001.
Wecurrentlydonotengageorplantoengageininvestinginderivativeinstrumentsorhedgingactivities.
41BUSINESSOverviewWeareoneoftheleadingInternettechnologycompaniesinChina.
WithourInternetapplications,servicesandtechnology,weprovideChineseInternetuserswithChineselanguage-basedonlineservicescenteredaroundthreecoreinter-relatedservices—content,communityande-commerce.
GuangzhouNetease,whichhasreceivedapprovalfromtheTelecommunicationsOfceofGuangzhouCitytoengageintheInternetcontentproviderbusiness,operatesandmaintainstheNeteaseWebsitespursuanttocontractualarrangementswithus.
InasurveyreportdatedJanuary2000bytheChinaInternetNetworkInformationCenter,orCNNIC,anon-protserviceundertheadministrativecontroloftheChineseAcademyofSciencesandsupervisedbytheMinistryofInformationIndustry,theNeteaseWebsiteswererankedasthesecondmostpopularinChina.
Ouraveragedailypageviewsfortheseven-dayperiodendedMay31,2000exceeded20million.
WebelievewearewellpositionedtocapitalizeontherapidgrowthanticipatedintheInternetmarketinChina.
TheNeteasecontentchannelsofferusersanextensiverangeoflocal,regionalandinternationalChineselanguagecontent,Web-basedcommunicationservicesandsophisticatedsearchcapabilitiesandprovideadestinationforChineseInternetuserstoidentifyandaccessresources,services,contentandinformationontheInternet.
AsofMay31,2000,theNeteaseWebsiteshadapproximately:4.
9millionregisteredmembers;1.
2millionregisteredcommunitymembers;378,000personalhomepages;29,500simultaneouschatroomparticipants;and3millione-mailaccounts.
Registeredcommunitymemberscanpersonalizetheironlineexperiencebypublishingtheirowncontentandinteractingwithotherusersthathavesimilarinterests.
UndertheNetease()and163.
combrands,weprovidevariousfreeservices,includingChineselanguage-basede-mail,onlinechatrooms,discussionforumsandanauctionplatformwhereregisteredmemberscanpurchaseavarietyofproductsandservices.
WehaveestablishedaU.
S.
subsidiary,Netease.
com(U.
S.
),whichdoesbusinessinCaliforniaas163Netease.
com,Inc.
TheNeteaseWebsites'marketpositionasaleadingInternetdestinationforChineseInternetusersoffersonlineadvertisersande-commercevendorsaccesstoalargeandrapidlygrowingmarketofChineseInternetusers.
WebelieveweweretherstChina-basedInternetcompanytooffere-commerceauctionservicesinChina.
Wehostapermanentonlineauctionsitethatoffersawiderangeofproductsinpartnershipwithvariousbrandnameretailers.
WebelievethatdemandforourservicesisgrowingrapidlyasthenumberofInternetusersinChinaincreases.
WithourstrongfocusontheChinesedomesticmarket,weaimtohavetheNeteaseWebsitesbecometheleadingonlineservicedestinationforInternetusersinChina.
IndustryOverviewTheGlobalInternetMarket.
TheInternethasgrownrapidlysinceitsinitialcommercializationintheearly1990s.
IDCprojectsthatthenumberofInternetusersworldwidewillgrowfromapproximately261.
4millionattheendof1999toapproximately623.
3millionbytheendof2003.
Theexistingproliferationof42WebsitesanddevelopmentofInternetapplicationsandtechnologieshaveallowedonlineadvertisersandmerchantstotargetspecicdemographicandgeographicgroupsandtocapturevaluabledataabouttheirbuyingpatternsandconsumerpreferences,therebyenhancingtheeffectivenessofonlineadvertisementsandpromotingthegrowthofe-commerce.
ForresterResearchInc.
estimatesthatworldwideonlineadvertisingspendingwillincreasefromapproximatelyUS$3.
3billionin1999toapproximatelyUS$33.
1billionby2004,whichwouldrepresentapproximately6.
8%oftraditionaladvertisingexpendituresprojectedfor2003.
IDCestimatesthatworldwidebusinessandconsumere-commercerevenueswillgrowfromUS$130.
5billionin1999toUS$1,640billionin2003.
AsInternetadvertisingande-commercemarketsmature,ForresterResearchbelievesonlineadvertisersandretailerswillincreasinglyspendtheirmarketingbudgetsonmorefocusedWebsitestoreachspecicdemographicgroups.
TheInternetMarketinChina.
ThemarketsinChinaforonlineadvertisingande-commerceareintheirearlystagesofdevelopment.
ChinahasonlyrecentlybeguntoexpanditsInternetinfrastructure.
WebelievethattherelativelyhighcostofpersonalcomputersandInternetaccessinChinahaslimitedthenumberofpotentialInternetusersinChina.
AccordingtotheCNNICJanuary2000surveyreport,thenumberofInternetusersinChinagrewto8.
9millionatDecember31,1999.
ThefollowingtableillustratesthegrowthinthenumberofChineseInternetusersaccordingtodatafromCNNICsurveyreportsdatedJuly1998,January1999,July1999andJanuary2000:July1998January1999July1999January2000InternetUsersinChina1.
2million2.
1million4.
0million8.
9millionInternetsubscriptioncostshavedecreasedsignicantlyduringrecentyears,allowingincreasedgrowthinInternetuseinChina.
ThefollowingtableillustratesthisdecreaseaccordingtothelatestdatareportedbyBDA(China)Ltd.
InternetsubscriptioncostsarebasedonChinaNetsubscriptioncostsfor40hoursofInternetaccessasreportedinthethirdmonthofeachyear,includinglocaltelephonecharges:19961997199819992000MonthlyInternetsubscriptioncosts(inRMB)744744444294222TheInternetmarketinChinaisexpectedtocontinuetoexperiencerapidgrowthoverthenextfewyears.
Forexample,accordingtoIDC,thenumberofInternetusersinChinaisexpectedtoincreaseto25.
2millionby2003.
WebelievethatacontinuedreductioninaccesscostsandpersonalcomputerpricesinChinawillfurtherenhancethegrowthinInternetuseinChina.
ThepotentialforInternetaccessthroughtelevision-basedandwirelessInternetaccessdevicesmayfurtheraccelerateInternetgrowth.
AccordingtoKaganWorldMedia,therewere58.
0millioncabletelevisionhouseholdsoutofatotal248.
4milliontelevisionhouseholdsinChinaattheendof1998,whichrepresentsasignicantpotentialmarketfortelevision-basedInternetaccessdevices.
TheJanuary2000CNNICsurveyreportfoundthatasofDecember31,1999morethan200,000ChineseInternetuserswereaccessingtheInternetthroughmeansotherthanpersonalcomputers.
InresponsetotherapidgrowthinInternetusage,theChinesegovernmenthassignicantlyincreasedtheamountofbandwidthcapacitybetweenChinaandothercountries.
ThefollowingtablesetsforthinformationrelatingtothegrowthofinternationalbandwidthcapacityinChinaaccordingtodatafromCNNICsurveyreportsdatedOctober1997,July1998,January1999,July1999andJanuary2000.
October1997July1998January1999July1999January2000InternationalCapacityofInternetBackboneProviders(inmegabits)25.
484.
6143.
3241.
0351.
0China'sprincipalcommercialInternetbackbonetransportproviderisChinaNet,currentlyownedbyChinaTelecomwhichisundertheadministrativecontrolandregulatorysupervisionofChina'sMinistryofInformationIndustry.
ChinaNetisalsothecountry'slargestInternetserviceprovider,commonlyreferredtoas43anISP.
AlthoughChinahasapproximately200otherISPs,thevastmajorityaresmallandlocalized.
WebelieveChinaNet'sdominantpositionintheISPmarketisattributable,inpart,toitsownershipandcontrolofasignicantportionoftheChineseInternetbackbone.
UrbancentersinChinarepresentedapproximately30%ofChina'spopulationorroughly374.
9millionpeoplein1998,accordingtotheChinaStatisticalYearBook(1999).
DespitethefactthatChinahasoneofthelowestpercapitagrossdomesticproducts,orGDPs,inAsiaand,webelieve,oneofthelowestInternetpenetrationratesinAsia,theseurbancentersconstituteamoreafuentpopulationwithhigherInternetusagerelativetotheirruralcounterparts.
Forexample,in1998,Beijing,ShanghaiandGuangdongProvince,threeofChina'slargestInternetmarkets,hadanaveragepercapitaGDPofUS$2,110,whichisalmostthreetimestheUS$755averagepercapitaGDPforthewholeofChina.
Asaresult,webelievethaturbancentersinChinarepresentamoreattractivemarketopportunityforusthanlesserdevelopedareasofChina.
ThefollowingtableillustratesthedemographicproleofInternetusersinChinasurveyedaccordingtodatafromtheCNNICsurveyreportdatedJanuary2000:Age%GeographicLocationofInternetUsers%Olderthan60.
0.
4Beijing.
21.
251-601.
2Guangdong12.
941-504.
5Shanghai.
11.
236-405.
7Jiangsu.
5.
931-3510.
2Shandong.
5.
225-3032.
8Zhejiang.
4.
518-2442.
8Otherlocations39.
1EducationLevel%InternetAccessLocation%PrimarySchool3.
0Home50.
0HighSchool13.
0Ofce.
37.
0PolytechnicSchool32.
0InternetCafe11.
0Undergraduate.
45.
0OtherLocations.
2.
0Master6.
0Doctor1.
0Gender%AverageTimeOnlineperWeek(hours).
.
.
.
17Male.
79.
0Female21.
0AstheInternetbecomesmorepervasiveinChina,theopportunitiesforonlineadvertisingande-commercearealsoexpectedtogrow.
ForresterResearchestimatesthatonlineadvertisingexpendituresinChinawillgrowfromUS$8.
0millionin1999toUS$220.
0millionby2003.
IDCforecastse-commercerevenuesinChinatoreachUS$11.
7billionby2004fromUS$43.
0millionin1999.
OurOpportunityTheInternetmarketinChinaisunderdevelopedascomparedtotheUnitedStatesandotherdevelopedcountries.
WebelievethatthepotentialforgrowthoftheInternetindustrypresentsasignicantopportunityforcompaniesthattargetChineseInternetusers.
TherearefewWebsitesthatofferChineseInternetusersacombinationofcontent,communityande-commerceintheChineselanguage.
MostofthemajorWebsitesintheChineselanguagearetargetedatChinesespeakingusersthroughouttheworldandarenotspecicallytailoredtoInternetusersinChina.
44InternetTechnologyandSolutionsTargetedatChina.
WebelievetherearefewcompaniesthatfocusontheprovisionofInternettechnologyandsolutionstothedevelopingChineseInternetindustry.
InternettechnologiesandsolutionscreatedforEnglishspeakingInternetuserstypicallycannotbedirectlyintegratedintoChineselanguage-basedInternetapplicationsbecauseofthedouble-bytecharactersusedintheChineselanguage.
WebelievethelackofavailableInternettechnologysolutionsfortheChinesespeakingmarkethasinhibitedthegrowthoftheInternetinChina.
OnlineContentandCommunityforChineseUsers.
DespitetherapidgrowthinInternetusersinChinawebelievetherearefewChineselanguageonlineportalandcommunitydestinationsdesignedexclusivelyforChineseInternetusersthatprovidethefollowingservices:in-depthandfocusedlocalcontentaswellasavarietyofmediachannelscoveringawidevarietyofregionalandinternationaltopics;China-basedonlinecommunityforumswhereInternetusersinChinacancommunicateandexchangeideasonawidevarietyoftopics;andreliable,easytouse,sophisticatedInternetapplicationsandtoolsintheChineselanguage,includinge-mail,onlinechat,fulltextsearchcapabilitiesandinstantmessaging.
InadditiontotheNeteaseWebsites,anumberofotherWebsitesthatfocusonChinesespeakingInternetusersgloballyareattemptingtoprovidetheseservices.
However,webelievethatfewhavesuccessfullyaddressedtheuniqueneedsandinterestsofInternetusersinChina.
BecausetheseWebsiteshavebroadgeographicmarkets,theydonottargetamajorityoftheircontentorcommunityfunctionsatthemarketinChina.
InanattempttotargetInternetusersinChina,someEnglishlanguageportalWebsiteshavetranslatedportionsoftheircontentintotheChineselanguage.
However,theseWebsiteshavegenerallylimitedtheirChinesetranslationstoselectedtopicalcontent.
E-commerceinChina.
E-commerceinChinaisnotasdevelopedasinsomeothercountries.
AccordingtotheCNNICJanuary2000surveyreport,asofDecember31,1999,only7.
7%ofInternetusersinChinahadusedtheInternetfore-commerce.
Webelievethereareonlyalimitednumberofwellestablishede-commercesitesinChinathatbothattractalargenumberofusersandprovideaplatformforvendorstoselltheirproductsonline.
WebelievethatastheInternetbecomesmorepervasiveinChina,theopportunitiesfore-commercewillalsoexpand.
WebelievetheChinesemarketoffersrelativelyfewerestablishedretailnetworksthanmoredevelopedcountries,especiallyinthenon-metropolitanareas.
Anestablishede-commercenetworkwillgiveInternetusersinChinaaccesstoproductsandinformationaboutvariousproductstowhichtheywouldnototherwisehaveaccess.
Webelievewearewellpositionedtoleverageourtechnologyplatformanddatabaseofuserstocaptureasignicantportionoftheincreasinge-commercemarket.
OnlineAdvertisinginChina.
TheInternetisarelativelynewmediumforadvertisersinChina.
Webelievethatmostonlineadvertisersconsistofinformationtechnologyandmobilephonecompanies.
WebelieveweareoneofthelargestInternetcompaniesinChinathathasdevelopedthesystemsnecessarytosupportlarge-scaleonlineadvertising.
OurSolutionWeofferacomprehensivesuiteofInternettechnologies,servicesandsolutionstoInternetusersinChina.
Webelievethatbyofferinganintegratedplatformofonlinecontent,communityande-commercerelatedservices,wearewellpositionedtocapitalizeonthegrowthoftheInternetindustryinChina.
OurtechnologyandservicesaredevelopedinChinaspecicallyforInternetusersinChina.
Ourintegratedplatform45ofapplications,technologyandservicesisavailabletoInternetusersthroughtheNeteaseWebsitesfreeofcharge.
TheNeteaseWebsiteswererankedbytheCNNICJanuary2000surveyreportasthesecondmostrecommendedbyInternetusersinChina.
Keyadvantagesofoursolutioninclude:PioneerinDevelopingTechnologyandSolutionsforChina'sInternetMarket.
WehavebeendevelopingInternettechnologyandsolutionssinceourinceptioninJune1997.
WebelievewearewellpositionedtodevelopandadaptthelatestInternetapplications,servicesandtechnologiesfortheChineselanguage.
Ourtechnologiesandservicesaresupportedbyaresponsiveandscalabletechnologyarchitecture.
WebelieveourproductsandservicesareamongthemostreliableandeasytouseforChinesespeakers.
Allofourplatformsweredesignedtoincludeuser-friendlyinterfacesandeasytounderstandinstructions.
WebelieveweweretherstInternetcompanyinChinatooffer:–aduallanguagefreee-mailservice;–aChineselanguagesearchengine;–aninteractivecommunityplatformwhichallowsregisteredcommunitymemberstopostarticlesandmessages,chatandsendinstantmessages;–personalhomepagescreatedandmaintainedbyourusers;–onlineauctionplatforms;–aplug-intocustomizethelookandfeelofWebbrowsers;–onlinenewslettersintheChineselanguage;and–Chineselanguageonlinegreetingcards.
ExtensiveContentontheNeteaseWebsiteswithFocusonInternetUsersinChina.
UnlikeotherInternetcompanieswhosemarketsincludeChina,wearehighlyfocusedonInternetusersinChinaandtoalesserextent,ChineseexpatriateInternetuserslocatedabroad.
MostofouremployeesareChinesenationals.
TheirculturalandlinguisticinsightsenableustotailorourservicestotheneedsofInternetusersinChina.
Becauseofourspecicmarketfocus,webelievewearebetterabletoattractInternetusersinChinathanotherInternetcompanieswithabroadergeographicfocus.
Wecurrentlyofferacontentdistributionandmanagementsystemthatsupportsthepublicationof15separatecontentchannelsfeaturingavarietyoflocal,regionalandinternationalcontent.
Inaddition,weofferfreeWebsitehostingandarecurrentlyhostingmorethan378,000personalhomepagescreatedandmaintainedbyInternetusersinChina.
FocusonCommunityandPersonalization.
Ourapplications,servicesandtechnologieshaveastrongfocusonfacilitatingcommunicationbetweenInternetusersinChina.
WebelievetheNeteaseonlinecommunitywasoneoftherstinChinaandasofMay31,2000includedover200forums.
WebelievethattheNeteaseonlinecommunityisthelargestinChina.
AsofMay31,2000,theNeteaseWebsiteshadover1.
2millionregisteredcommunitymembers.
TheNeteasecommunitypostsapproximately20,000newarticlesdaily.
TheNeteasecommunityplatformalsoallowsmemberstochat,sendinstantmessagestootherregisteredcommunitymembersandvoteinsurveys.
WebelievewewerealsotherstChina-basedInternetcompanytolaunchapersonalizationservice,my.
163.
com,whichallowsuserstochoosetheirowncontentandinteractwithotherswithsimilarinterests.
AttractivePlatformforE-commerceandOnlineAdvertising.
Webelieveourexpandingnumberofusersprovideonlineadvertisersandmerchantswithanattractiveplatformforadvertisingande-commerce.
OurtechnologyenablesvendorsandonlineadvertiserstoreachInternetusersinChinawhoarerelativelyafuent,educatedandtechnologicallysavvy.
WeoffervendorsaplatformtoselltheirproductsonlinetousersinChina.
Inaddition,weofferbothonlineadvertisersandmerchantstargetedaudiencesthroughtheNeteaseonlinecommunitiesandcontent46channels.
AsInternetusageinChinaacceleratesandthemarketforInternetservicesdevelops,webelievethatwearestrategicallywell-positionedtodelivervaluetoonlineadvertisersandmerchantstargetingtheChinesemarket.
OurBusinessStrategyOurgoalistomaketheNeteaseWebsitestheleadingonlinenetworkinChina.
Keystrategiesforachievingourgoalareto:AggressivelyExtendBrandNameRecognition.
WebelievethatbrandnamerecognitionwillbeincreasinglyimportantinChinaasmoreChineseconsumersmoveonlineandadditionalWebsitescompetefortheseusers.
OurgoalistomakeourbrandnamesynonymouswiththeInternetamongusersinChina.
WebelievethatextensivebrandnamerecognitionwillattractInternetusersinChina,aswellasonlineadvertisersande-commercevendors.
Weintendtocontinuetobuildbrandawarenessthrough:acomprehensivesetofmarketingcampaigns,includingspecialpromotionalevents;traditionalandonlineadvertisingcampaign;strategicalliances;andproactivepublicrelations,whichincludesfrequentcommunicationswithourusers,ourcustomersandChinesegovernmentalagencies.
ContinuetoDevelopUser-FriendlyInternetApplications,ServicesandTechnologiesfortheChineseMarket.
Weintendtocontinueourfocusondevelopinguser-friendlytechnologiesfortheInternetindustryinChina.
WewilladaptandmodifyexistingtechnologiesforChineselanguage-basedInternetapplicationsaswellasdevelopourownproprietaryChineselanguageInternetapplications.
Weplantocontinuetoenhanceourplatformswithuser-friendlyinterfacesandwitheasytounderstanduserinstructions.
Toincreasethenumberofourusers,weintendtoworkwithvariousproviderstodevelopbroadbandofferingsandwillcontinuetoexploreopportunitiestoofferwirelessapplicationprotocoltechnologies.
Weemploy40technologyprofessionalsandGuangzhouNeteaseemploys23technologyprofessionals.
Enrich,ExpandandPersonalizeNeteaseContent.
TheNeteaseWebsitescontaincontentfromover140localandinternationalcontentproviders,includingChinaComputerWorld,ChinaEconomicTimes,ChinaSportsNewspaper,ChinaYouthDaily,PopularCinemaandNetvigator.
Toexpandourchannelofferings,weintendtoworkwithverticalportaldevelopersandtopurchaseorlicenseexistingcontentfromtraditionalmediaproviders.
WeintendtocontinuetoexpandourcontentalliancestoallowtheNeteaseWebsitestooffercontentthatwillbemoretailoredforandrelevanttoourusers'dailylives.
Webelievethiswill:furtherdifferentiatetheNeteaseWebsitesfromcompetingWebsitesandenhanceourcompetitiveposition;provideuserswithamorecustomized,comprehensiveandsatisfyingInternetexperience;andincreasethenumberofvisitstotheNeteaseWebsitesandthelengthoftimeeachuserstaysonthosesites.
ExpandtheNumberofOurRegisteredUsersandRegisteredCommunityMembers.
Toexpandthenumberofregisteredcommunitymembers,weplantoenhancethequalityofourcommunityservicesandintroducenewapplications,servicesandtechnologyforouronlinecommunitythatwillmaketheInternetinChinaanincreasinglyimportantmediumforexchangingideas.
Inadditiontoourexistingcommunities,weplantodeveloptechnologytosupportauser-friendlybusinesscommunityontheInternet.
WeintendtoofferapackageofInternetapplications,servicesandtechnologiestosmallandmediumsizedcompaniesinChina,includinge-mail,documenthosting,wordprocessingandotherinteractivecommunityservicestopromoteourbrandnameamongcorporateclientsandtoincreasethenumberofourregisteredcommunitymembers.
WeplantoleverageourtechnologyandWeb-basedproductstoincreasetheNeteasecommunity.
Forinstance,wemaylicenseourproprietarye-mailservicesinexchangeforaccesstothelicensee'sdatabaseofmembers.
47ExpandOurE-commerceServices.
WebelievethatagrowingnumberofconsumersinChinawilllooktotheInternetasanalternativesourceofcommerceinthefuture.
WebelieveweweretherstcompanytoofferonlineauctionplatformsinChina.
Wewillleverageuponthisexperienceandourregisteredusersandregisteredcommunitymemberstoactivelydevelopandpursuee-commerceopportunities.
Weintendtoassisttraditionalvendorstoestablishtheire-commercestrategies.
Weintendtoexpandouronlinecommerceapplications,servicesandtechnologies,oroure-commerceplatform,andtouseouruserproleinformationtomarketproductstospecicdemographicgroups.
Wealsoplantoleverageourregistereduserdatabasetodevelopdirectmarketingopportunities.
ExpandtheBaseofOnlineAdvertisersonOurNetwork.
OnlineadvertisersontheNeteaseWebsitesconsistprimarilyofmerchantsfromtheinformationtechnologyandtelecommunicationsindustries.
Weintendtobroadenthisbaseofonlineadvertisersandtocontinuetoattractpremieronlineadvertisersthroughaggressivelypromotingourbrandnameandimprovingourdemographicprolingtechnologytoidentifyusersthatwebelievewillbeattractivetoonlineadvertisers.
WebelievethatastheonlineadvertisingindustryinChinadevelops,demographicallytargetedadvertisingwillcommandhigherpricesfromonlineadvertiserscomparedtonon-targetedadvertising.
WewillcontinuetopromotetheInternetasanalternativemethodforadvertiserstoreachendusers.
Inaddition,weintendtousethirdpartyadvertisingnetworkstoincreasetheNeteaseonlineadvertiserbase.
EstablishandExtendStrategicAlliancesandAcquisitions.
ToincreasetrafcontheNeteaseWebsites,furtherpenetratetheInternetmarketandextendourbrandrecognition,wewillcontinuetoseekpotentialstrategicallianceswithprominentInternetcompanies,leadingonlinecontentproviders,e-commerceservicecompanies,traditionalmediacompaniesandtechnologycompanies.
Wealsointendtoseekacquisitionandjointventureopportunitiesthatcomplementouroperations.
OurProductsandServicesTheNeteaseWebsitesofferChineseInternetusersanetworkofChineselanguage-basedonlinecontentchannels,communityproducts,e-commerceservicesandotherWeb-basedapplicationsandservicestoenhancetheirInternetexperience.
TheNeteaseWebsitesoffercontentchannels,afulltextChineselanguagesearchengine,adirectory,e-mailandcommunitytools.
Wealsoprovidee-commerceplatformsthatallowvendorstosellorauctiontheirproductsonline.
Ourcontent,communityande-commerceplatformsarealldesignedwithuserfriendlyinterfacesandeasytounderstandinstructions.
OurMembersTheNeteaseWebsiteshaveusers,registeredusersandregisteredcommunitymembers.
AnyusermayvisittheNeteaseWebsiteswithoutregistering.
Onlineregistrationisavailableatalltimesandisfastandeasy.
TheNeteaseregisteredusersconsistofuserswhohaveregisteredfore-mailordomainnameregistrationservicesandalsoincluderegisteredcommunitymembers.
Onlyregisteredcommunitymemberscanpostarticlesinourcommunityforums.
Onlyregistereduserscanuseoure-mailsystemandparticipateine-commerceservices.
TheNeteaseusersprovideuswithvaluabledemographicandpreferenceinformationthatwillallowustotargetaudienceswithrelevantonlineadvertising.
OurContentTheNeteasehomepageprovidesadestinationforChineseInternetuserstoidentifyandaccessresources,services,contentandinformationontheInternet.
TheNeteaseWebsitesaggregate,organizeanddeliverinformationtomeettheneedsofInternetusersinChina.
Ourmediachannelsprovideuserswithanefcientandeasywaytoexploreandutilizeawealthofinformationandcontentorganizedaroundavarietyoftopics.
OurcontentdistributionplatformenablestheNeteaseWebsitestoofferin-depthlocalcontentaswellasavarietyoflocallyrelevantregionalandinternationalcontent.
Ourcontentdistributiontechnologyaggregatescontentfromover140contentpartners.
48WedonotproduceourowncontentfortheNeteaseWebsites.
TheNeteaseWebsitescurrentlyinclude15mediachannelsinthefollowingcategories:newsinformationtechnologyentertainmentsportsnancewomen'sissuesgamesculturescienceleisurehealthcareeducationjobsandcareersrealestatefashionWearecurrentlyintheprocessoflaunchingnewchannelsthatwillbroadenthecontentcoverageontheNeteaseWebsites.
ThroughtheNeteaseWebsites,ouruserscansubscribeto26electronicmagazines,whicharedeliveredtosubscribersbye-mail.
Theseelectronicmagazinesarepublishedbymediachanneleditorsandincludethefollowingtopics:informationtechnologynewslifestyleinBeijingphilosophysportsmusichealthliteratureauctionsnancestockinvestmentEnglishstudyjobsearchstoriesandanecdotesmusic,bookandotherreviewsspecialreportssciencerealestaterelationshipseducationemotionallifeentertainmentNeteaseweeklyupdatesstampcollectingAsofMay31,2000,wehadover960,000subscribersandover2.
6millionsubscriptionstoourelectronicmagazines.
Personalization.
WebelieveweweretherstInternetcompanytooffertechnologyforpersonalizedportalsinChina.
TheNeteaseWebsitesofferusersapersonalizedportalservice,my.
163.
com,whichallowsregistereduserstochoosetheirowncontentandtointeractwithotheruserswithsimilarinterests.
My.
163.
comallowsregistereduserstocreateapersonalprolethatdirectlyorganizesanddeliversinformationofpersonalinterest,including,amongothers:stockquotes;stockportfoliomanagement;news;weather;andsports.
WebPageHosting.
Weofferregisteredusers,freeofcharge,upto100megabytesofcomputerstorageforWebpagescreatedandmaintainedbyourusers,orpersonalhomepages.
Wealsooffertoolstoassistusersinbuildingtheirhomepages.
TheNeteasepersonalhomepagescreateaWeb-basedcommunityforInternetuserstoexpressthemselves,toshareideas,interestsandexpertise,andtopublishpersonalcontentaccessiblebyotheruserswithcommoninterests.
WhilewebelievemostoftheNeteasehomepagesareofinteresttoasmallcircleoffriendsandfamilies,theNeteasehomepagemembersincludeacoregroupofpeoplewhocreatehomepageswithcontenthavingbroaderappeal.
TrafccomesfrombothinsideournetworkofWeb49sitesandfromnon-registeredusersvisitingfromoutside.
Non-registereduserstypicallyndregisteredusers'personalhomepagesthroughsearchengines.
OurCommunityWithourleadingonlinecommunitytechnology,theNeteaseWebsiteshaveestablishedalargeonlinecommunitymemberbase.
WelaunchedwhatwebelievetobeoneoftherstonlinecommunitiesinChinainDecember1998.
Userscanregisterwithusonlinetointeractwithotherregisteredcommunitymembers.
Webelievethatasusersbecomemoreinvolvedwithouronlinecommunity,theywillreturntotheNeteaseWebsitesfrequently.
Neteaseuserscaninteractthroughavarietyofcommunityproductsandservices.
Weofferourproductsandservicesfreeofcharge.
Theyinclude:E-mail.
OurtechnologyandservicesprovideregistereduserswithafreeWeb-basede-mailservicewhichsupportsboththeChineseandEnglishlanguages.
Registereduserscanaccesse-mailthroughpostofceprotocol3servers,whichallowuserstoreceivee-mailontheirowne-mailapplicationswithoutopeningtheirWebbrowser.
Wecompletedthecodingofourduallanguagee-mailsysteminDecember1997.
Thise-mailsystemhasbeenlicensedtoanumberofleadingunafliatedInternetcompaniesinChina,including163.
net,263.
net,188.
net(ChinaTelecom'slocalafliateslocatedinGuangzhou,Beijing,andZhejiang,respectively),andChinadotcom.
OnlineCommunity.
WeofferNeteaseregisteredcommunitymembersover200forumswheretheycanpostmessagesandarticlesforviewingbyotherregisteredcommunitymembersandotherusers.
Communitymembersmayalsocreatetheirownforumsinadditiontothoseweoffer.
Wehostover13,700suchpersonalcommunityforums.
TheNeteaseonlinecommunitiesarehostedbyvolunteers,whoarechosenbyusbasedontheircontributionstothecommunities.
TheNeteasecommunityvolunteersmonitorourcommunityforumsandselectappropriatearticlesforposting.
Inaddition,theymonitorthepersonalhomepageshostedbytheNeteaseWebsites.
InstantMessaging.
WeofferNeteaseregisteredusersaplatformtonotifytheironlinefriendsandotheruserswithsimilarinterestswhentheyareonline,allowingNeteaseregistereduserstoparticipateinreal-timedialogues.
Chat.
OurchatservicesallowNeteaseregistereduserstointeractinreal-timegrouporone-on-onediscussions.
Unlikehypertextmarkuplanguage,orHTML,ourJava-basedchattechnologyallowsuserstoparticipateinchatswithoutdownloadingchatsoftware.
TheNeteasechatroomsarearrangedaroundtopicsofinterestincluding,amongothers,relationshipsanddating,campuslifeandtechnology.
Registereduserscanalsocreatetheirownpersonalchatrooms.
Easebar.
WedevelopedEasebar,afreebrowsertoolbarthatprovidesInternetuserswithquickaccesstotheirfavoritedestinationsandallowsuserstocustomizethelookandfeeloftheirWebbrowsers.
Easebarremainsonauser'sscreenandprovidesquickaccesstospecicareasoftheWeb.
UserscancustomizeEasebarbyaddingbuttonsandchangingtheirsequencetottheirneeds.
UserscanstoretheirbookmarksonEasebarwiththeEasebarbookmarksbuttonandaccessthemfromanycomputer.
VotingSystem.
Weconductnumerouspollsonvarioussocial,culturalandothertopicstoprovideourregistereduserswiththeopportunitytoexpresstheirviewsandalsotolearnabouttheopinionsofotherInternetusers.
ElectronicGreetingCards.
WebelieveweweretherstInternetcompanytoofferChineseInternetusersonlinegreetingcardsinChinese.
Ourgreetingcardshavedifferentdesignsfor50variousoccasions,includingNewYear'sDay,ChineseNewYear,Christmas,birthdays,Valentine'sDay,andothercelebrations.
Wemakenewdesignsavailableonaregularbasis.
Ausermaysendanelectroniccardwithoutregisteringwithus.
WerecentlyenteredintoanagreementwithOdigo,Inc.
,developersoftheOdigoreal-timecommunicationssoftwareforInternetusers.
InconjunctionwithOdigo,webegantoofferafreeChineseversionoftheOdigosoftwaretoourusersinMay2000.
Thesoftwareoffersco-browsing,peoplesearchbyinterest,instantmessaging,voicechatting,notespostingandsearchingforsites.
ThesoftwarealsoenablesouruserstoseeotherOdigomembersonthesamepageorsitetheyarevisitingandinitiateaconversation,ifdesired.
OurE-commerceServicesWebelievee-commercewillbecomethemostrapidlygrowingsub-sectorofChina'sInternetmarket,despitethefactthatthereareanumberofobstaclesthatneedtobeovercome.
Theseobstaclesincludealowcreditcardpenetrationrate,thelackofsecureonlinepaymentsystemsandthelackofreliableandefcientproductdistributionnetworks.
However,webelievethattheseobstacleswillbeovercomeintime,andthate-commercewillgeneratesignicantrevenuesinthefuture.
Oure-commerceservicesfocusonwellknownbrandnamevendorsandproductstoattractusers.
Oure-commercesolutionsfocusonbusiness-to-consumere-commerceandonbrandedvendorssuchasSogo,LufthansaandKodak.
Wealsoofferaconsumer-to-consumere-commerceplatformtoattracttrafcandasaconveniencetoourusers.
Usersutilizingourconsumer-to-consumerplatformarrangetheirownpaymenttermsandfulllmentprocedures.
WebelieveweweretherstInternettechnologycompanyinChinatoprovideonlinee-commerceauctionservices.
OurauctionservicewasinitiallylaunchedinJuly1999byauctioningpersonalcomputerstoconsumersin24provincesthroughoutChina.
WelaunchedtheNeteasepermanentauctionsite,auctions.
163.
com,inNovember1999.
TheNeteasepermanentauctionsiteoffersawiderangeofproducts,including:computersandperipheralstelecommunicationsproductssoftwareandgameshouseholdappliancesbooks,audioandvideoproductsvehiclesandaccessoriesInternet-relatedproductsartsandcollectiblessportsandtnessequipmentrealestate(purchaseandleasing)cosmeticsandclothingonlineticketingchildren'sproductsandtoysWeofferanonlineuserservicesmenuwhichallowsregistereduserstogodirectlytovarioussectionsoftheNeteaseauctionsite.
TheNeteaseWebsitealsoincludesasectionwhichfeaturespromotionalproductsandautomaticallyliststhelatest20andthesixmostpopularauctionitemspostedtoourauctionsite.
Usersregisteroncetoopenbothbuyingandsellingaccounts.
Ourstaffmonitorseachusertoensurethatsuchuser'sonlineactivitiesareappropriate.
Wealsoprovideregistereduserswithasimpleandaccuratesearchenginetoidentifyanitemonauction.
Oursearchenginenotonlyhelpsuserssearchforaparticularitemonauction,butalsohelpsthemsearchforuserinformationbyaregistereduser'sreferencenumber,nameore-mailaddress.
Ourplatformalsooffersanautomaticcategorywatchsystem.
Aregisteredusermayrecordaparticularproductinwhichheorsheisinterested.
Whenanewproductisaddedtothecategorywatchsystem,ane-mailwillautomaticallybesenttoinformtheregistereduserthattheproductisbeingputonauction.
Wealsoprovideacreditevaluationsystemsupportedbyourregisteredusers.
OurstaffaswellasotherregisteredusersmaypostcreditevaluationsofotherusersormerchantsontheNeteaseauctionsite.
AsofMay31,2000,theNeteaseauctionplatformhadover68,500registeredusersand38,000registeredproducts.
TheNeteaseauctionplatformhadmorethan70,000averagedailypageviewsduringthemonthofMay2000.
51WehaveenteredintoanagreementwithCapitalInformationDevelopmentCo.
,Ltd.
tojoinitsCapitalE-commerceCityservices.
Theseservicesinclude:vericationoftheidentityofthepartiestoane-commercetransaction;onlinepaymentservices,includingVisa,Mastercard,AmericanExpress,JCBandDiner'sClubcreditcards,anddebitandcreditcardsissuedbytheBankofChinaandtheIndustrialandCommercialBankofChina;datatransactionsecurityservices;andmediationofdisputes.
Thetimenecessaryforonlinepaymentstocleartypicallyrangesfrominstantaneoustotwoworkingdays.
Registeredusersmayalsopaybycheckorchoosecash-on-delivery.
Vendorsusingoure-commerceplatformareresponsiblefordistributionandfulllment.
However,wehaveestablishedanon-exclusivealliancewithChinaExpressMailServicesCompany,orCEMS,allowingbusinessesthatsellgoodsonourplatformtouseCEMSatdiscountedratestodelivergoodstomorethan1,900citiesinChina.
Inaddition,wehaveformedanon-exclusivealliancewithDailyExpressServiceswhichfocusesondeliveryinBeijing.
Wehavetypicallychargedsellersanauctioncommissionuponconsummationofthesalebasedonaxedpercentageofthesellingpriceoftheproductsold.
Wealsosometimeschargeouronlineauctionsellers,whetherbusinessesorconsumers,axedone-timeregistrationfeeforpostingtheirproductsontheNeteaseWebsites.
Goingforward,wewillchargevendorsaxedfeeforuseoftheNeteasee-commerceplatform.
Weofferane-commercecustomerservicesupportteamthatstaffstoll-freetelephonehotlines.
Inaddition,weofferaWeb-basedcallcenter.
StrategicAlliancesWehaveenteredintostrategicalliancesandpartnershipswithcompaniesthatcomplementourproductsandservicesinanumberofareas.
TheNewsCorporationInconnectionwiththeissuanceofourSeriesBpreferenceshares,weenteredintoanagreementwithNewsDigitalVentures,anafliateofTheNewsCorporationLimited,whichprovidesforcooperationbetweenusandTheNewsCorporation.
AspartoftheconsiderationfortheissuanceofourSeriesBpreferenceshares,TheNewsCorporationanditsafliateswillprovideuswithon-airadvertisingandpromotionalinventorywithavalueofUS$5milliononTheNewsCorporation'smediaproperties,includingChannel[V],ESPNStarSports,PhoenixTVandSTARTV.
WemustuseatleastUS$1millionoftheinventorywithinoneyear,andatleastUS$2millionineachofthenexttwoyears.
Inaddition,TheNewsCorporationanditsafliateswillspendUS$5milliononon-lineadvertisingontheNeteaseWebsitesduringthistime.
WeandTheNewsCorporationwillalsocross-licenseInternettoolsandtechnologiesontermstobemutuallyagreedupon,andwillsharecustomerinformationgeneratedbyeitherpartyusingthecross-licensedtoolsandtechnology.
TheNewsCorporationwillhavearightofrstrefusaltoprovideChineselanguagecontenttotheNeteaseWebsitesintheareasofpopularmusic,sportsandmoviesandgeneralentertainment.
TheNewsCorporationwillofferustheopportunitytoparticipateincross-promotionalandmarketingactivities,includingcreatingspecialco-brandedmarketingandpromotionalevents.
OurobligationsandTheNewsCorporation'sobligationstopurchaseadvertisingandpromotionalinventoryfromoneanother,andthearrangementsrelatingtothecross-licenseofInternettoolsandtechnologies,remainsubjecttothenegotiationofdenitiveagreements.
52ContentPartnershipsandAlliancesThroughourcontentpartnershipsourusershaveaccesstoabroadofferingofChineselanguagecontentontheNeteaseWebsites.
OurcontentpartnersdisplaytheircontentononeormoreoftheNeteaseWebsitesandmediachannelsfreeofchargeorinexchangeforashareofrevenue,alicensingfee,accesstooriginalcontentproducedbytheNeteasecommunityoracombinationofthesearrangements.
WedistributethiscontentthroughourcontentdistributionsystemtoGuangzhouNetease,whichdeterminestheappropriatecontenttopublishontheNeteaseWebsites.
Ourcontentalliancesaregenerallynon-exclusive.
Wehaveestablishedover140localandinternationalcontentallianceswithnewsagencies,papermedia,Web-basedservicesandpersonalWebsites.
GuangzhouNeteaserecentlyenteredintoanagreementwithAsiaMD.
comLimitedtocreateaco-brandedpageinourhealthcarechannelforwhichAsiaMD.
comwillbetheexclusivecontentprovider.
E-CommerceSolutionsWehaveenteredintoastrategicallianceagreementwithBEASystem(HongKong)Co.
,Ltd.
,aninternationalon-linesolutionssupplier,pursuanttowhichweagreedtouseBEA'sWeblogicCommerceServerforoure-commerceservices.
Wealsoagreedtojointlyestablishane-commerceresearchanddevelopmentcenter,wherethetwopartiescanjointlydevelopmarket-orientede-commerceplatformsandintegratedsystems,andtojointlymarketandpromoteeachother'sproductsandservices.
WealsocommittedtopurchasenolessthanUS$2millionofBEA'sproductsandservicesbyMarch2002.
WirelessApplicationProtocolInordertodevelopwirelessapplicationprotocol,orWAP,relatedservicesforChina'smobiledatamarket,wehaveenteredintonon-bindinglettersofintentwithanumberofinternationalwirelesstelecommunicationsappliancesuppliers,includingMotorola,Siemens,EricssonandCMGTelecommunications.
Theselettersofintentstatetheparties'intentiontoworkcloselytodevelopcontentandapplicationsforwirelessInternetdevicesandtoexploremobiledatamarketsinChina.
Forexample,SiemenswillprovidelinkstoourservicesonitshandsetsandMotorolawillrecognizeNetease.
comasitsrstofcialWAPpartnerandrstofcialwirelessportalpartnerinChina.
GuangzhouNeteaserecentlyenteredintoamemorandumofunderstandingwithChinaUnicomtojointlyexplorebusinessopportunitiesrelatingtoWAPapplications.
Pursuanttothismemorandumofunderstanding,wewillcustomizeandoptimizetheNeteaseInternetinformationcontentforChinaUnicom'sWAPmobilephoneservices,andChinaUnicomwillpromoteourinformationservicestoitscustomers.
Inaddition,ChinaUnicomandwewilljointlyconstructaWAPportalforChinaUnicom.
WehaveagreedtoassistChinaUnicomtodevelopInternetapplications,suchasshortmessagetransmission,communitybroadcastingandotherWAP-relatedapplications,foruseonChinaUnicom'swirelessnetworks.
AuctionPartnersGuangzhouNeteasehasenteredintoseparatecooperationagreementswithClubCitiInformationTechnology(Beijing)Co.
,Ltd.
theoperatoroftheauctionWebsitewww.
clubciti.
com.
cn,andwithJindianWanweiTechnologyCo.
,Ltd.
,theoperatoroftheauctionWebsitewww.
yabuy.
com.
GuangzhouNeteasehasalsoenteredintoacooperationagreementwithpAsia,Inc.
,theoperatoroftheauctionWebsitecoolbid.
com.
cn,andwehaveenteredintoacooperationagreementwithShenzheneWayCo.
,theoperatoroftheauctionWebsiteibid.
com.
cn.
Theseagreementsprovideformutualpromotionalactivitiesandforthecreationofco-brandedWebsites.
Inaddition,eachofClubCiti,JindianWanwei,pAsiaandShenzheneWaywillpayset-upfees,referralfeesfornewregisteredusersthatjoinitsservicethroughtheNeteaseWebsites,andtransactionbasedfees.
53SalesandMarketingSalesOrganizationWebelievethegrowingnumberofInternetusersinChinarepresentsanattractiveconsumermarketforonlineadvertisers.
Tocapitalizeonthisadvertisingopportunity,weestablishedanadvertisingsalesforceinMay1999.
GuangyitongAdvertisingsellsbanneradvertisementsontheNeteaseWebsites,includinganimatedandinteractivebanneradvertisements,buttonadvertisements,sponsorships,textlinksaswellasadvertisingonourelectronicnewsletters.
Inaddition,wehavebeenappointedbyGuangzhouNeteasetosolicitadvertisingcustomersfortheNeteaseWebsitesoutsideofChina.
TogetherwithGuangyitongAdvertising,wecurrentlyhave22advertisingsalesprofessionalslocatedinBeijingandseveninShanghai.
Weexpecttoaddadditionalsalesprofessionalsineachoftheselocations.
Inaddition,onlineadvertisingontheNeteaseWebsitesisalsosoldthroughonlineadvertisingsalesnetworksandadvertisingagencies.
AsofMay31,2000,someoftheonlineadvertiserswhohaveadvertisedontheNeteaseWebsitesincluded:BigsaveLtd.
CivilineInternationalInformationTechnologyCo.
NokiaGreatWallComputerCo.
Ltd.
IntelLegendMotorolaIBMChinaConstructionBankAlibabaMarketingWeemployavarietyoftraditionalandonlinemarketingprogramsandpromotionalactivitiestobuildourbrandaspartofouroverallmarketingstrategy.
Inaddition,weplaceadvertisementsonhigh-prolethird-partyWebsitesaswellasontheNeteaseWebsites.
Toincreaseourbrandawareness,wealsoholdpromotionalactivitiessuchasnewproductorservicelaunchesandspecialsportsandholidayevents.
InSeptember1999,welaunchedamajormarketingcampaigninkeyInternetmarketsinChina,usingtraditionalmediasuchasprint,outdoor,televisionandInternetadvertising.
OuroutdooradvertisingconsistsofpostingtheNeteaseWebsiteaddressesonsubways,busesandsignposts.
Wehavealsostartedanationaltelevisioncampaign.
Wewilllaunchanumberofspecialeventsoverthenext15monthstoextendourbrandnamerecognitioninChina.
WerecentlyconductedourBestBusinessPlancontest,where,alongwithsponsorssuchasGreatWallComputerCo.
andSoftbankChinaVentureInvestmentsLimited,wejudgedthebestInternet-basedstart-upbusinessplanandawardedthetopwinneraprizeofRMB500,000,thesamesumwithwhichourcompanywasfounded.
ResearchandDevelopmentWebelievethatanintegralpartofourfuturesuccesswilldependonourabilitytodevelopandenhanceourproductsandservices.
Ourproductdevelopmenteffortsandstrategiesconsistofincorporatingnewtechnologiesfromthirdpartiesaswellascontinuingtodevelopourownproprietarytechnology.
WehaveutilizedandwillcontinuetoutilizetheproductsandservicesofthirdpartiestoenhanceourplatformoftechnologiesandservicestoprovidecompetitiveanddiverseInternetservicestoourusers.
Wealsohaveutilizedandwillcontinuetoutilizethird-partyadvertisementservingtechnologies.
Inaddition,weplantocontinuetoexpandourtechnologies,productsandservicesandregistereduserbasethroughdiverseonlinecommunityproductsandservicesdevelopedinternally.
Forinstance,werecentlydevelopedandintroducedEasebar,aWeb-browserplug-inthatenablesregistereduserstocustomizethelookandfeeloftheirWebbrowser.
WeusetheJavaprogramminglanguageindevelopingourtechnologieswhichenablesinteractive54contentpublishingacrosstheInternetascomparedtoHTMLwhichismoreusefulforstaticcontentpublishing.
Javaisadynamicdevelopmenttoolwiththecapabilitytosynchronizeandexecutemulti-processapplicationsinacross-platformform.
Wewillseektocontinuallyimproveandenhanceourexistingproductsandservicestorespondtorapidlyevolvingcompetitiveandtechnologicalconditions.
InfrastructureandTechnologyOurinfrastructureandtechnologyhavebeendesignedforreliability,scalabilityandexibilityandareadministeredbyourtechnicalstaff.
TheNeteaseWebsitesaremadeavailablethroughmorethan130networkserversco-locatedinthefacilitiesofChinaTelecom'sBeijing,ShanghaiandGuangzhouafliates.
TherearealsosevenserversdedicatedtoCerNet.
163.
comlocatedatleadinguniversitiesinBeijing.
CerNetisChina'seducationandresearchnetworkandisavailabletouniversitystudentsanduniversitystaffinChina.
TheseserversoperatewithNetscape'sWebserversoftwareandGuangzhouNeteaseleasesdedicatedlineswith200and130megabitspersecondcapacityfromChinaTelecom'sBeijingandGuangzhouafliates,respectively.
Inaddition,NeteaseBeijingleasesdedicatedlineswith100megabitspersecondcapacityfromeachofChinaTelecom'sBeijingandShanghaiafliates.
OurhardwareplatformincludesSunMicrosystemsEnterpriseservers,DellPowerEdge6300serversandNetworkApplianceStorageservers.
OuroperatingsystemismainlyUNIX-basedandincludesfreeBSDandSolaristechnology.
Toprovideloadbalancingandtofurtherreduceuser'saccesstime,weuseIBMNetworkDispatchproducts.
WehavelicensedandoptimizedStoryServerfromVignetteCorporationtoprovideefcientandresponsivemanagementofWebcontent.
WelicenseNetGravity'sadvertisementservingtechnologytoprovideinternaladvertisinginventorymanagementandanalysissystemstoserveouronlineadvertisingcustomers.
Inaddition,welicenseWebTrendsoftwaretotrackpageviewsontheNeteaseWebsites.
OurauctionplatformissupportedbyaSolarisoperatingsystemandSunMicrosystemsEnterprise5000servers.
WelicensetechnologyfromOpensiteTechnologies,Inc.
,aU.
S.
-basedoatingpricingapplicationsystemsupplier.
WehavemodiedOpensite'sfunctionalitiesbyremodelingtheuserinterfaceandadjustingthesystemtoconformtotheonlinepaymentformatprovidedbydomesticChinesebanks.
WeusebothOracleandSybasedatabasesystemstomanageourregistereduserdatabaseande-commerceplatforms.
Wearealsoplanningtosetupacomprehensivebehaviortrackingsystemtorecordthebehaviorpatternsofourusers.
WeintendtocontinuetouseacombinationofinternallydevelopedsoftwareproductsaswellasthirdpartyproductstoenhanceourInternetmediaservicesinthefuture.
CompetitionAnumberofcompaniesoffercompetitiveproductsorservicesinChina,ourmainoperatingmarket.
TheseincludeSina,Sohu,163.
net,263.
net,Chinadotcom,21cn.
comandeast.
net.
WefacecompetitionfromU.
S.
-basedportalssuchasYahoo!
andYahoo!
ChinesewhohavetranslatedsomeoftheircontentfromtheEnglishlanguagetotheChineselanguage.
WealsofacecompetitionfromWebsitesthatoperateoutsideourmarketandoffercontentintheEnglishlanguage,whichmaybeattractivetoaportionofChineseInternetusers.
Further,wefacecompetitionfromotherWebsitesthatofferonlinecommunityproducts.
Wealsofacecompetitionfromothere-commerceserviceprovidersservicingourmarketincludingSinaand8848.
net.
Someofourexistingandpotentialcompetitorshavesignicantlygreaternancialandmarketingresourcesthanwedo.
55TheCNNICJanuary2000surveyreportlistedtheNeteaseWebsitesasthesecondmostrecommendedamongallWebsitesinChina.
Accordingtothissurveyreport,thetoptenWebsitesmostrecommendedbyInternetusersinChinawere:1.
www.
sina.
com.
cn;2.
theNeteaseWebsites;3.
www.
sohu.
com.
cn;4.
www.
163.
net;5.
www.
yahoo.
com;6.
www.
263.
net;7.
cn.
yahoo.
com;8.
www.
china.
com;9.
www.
21cn.
com;and10.
www.
east.
net.
cn.
Inthefuture,weexpecttofaceincreasedcompetitionfromnewInternetmediacompaniesthatchoosetotargetgeneral,specialinterestand/ordemographicmarkets(suchasverticalportals).
Wearealsoaffectedbycompetitionfromlicenseesofoure-mailsoftware.
WemayencounterindirectcompetitionfromprovidersofWeb-basedsoftwareandotherInternetrelatedproducts.
Wealsocompetewithtraditionalformsofmediaforadvertising-relatedrevenue.
Therecanbenoassurancethatwewillbeabletocompetesuccessfullyagainstourcurrentorfuturecompetitorsorthatcompetitionwillnothaveamaterialadverseeffectonourbusiness,resultsofoperationsandnancialcondition.
WebelievetheprincipalcompetitivefactorsintheInternetmarketinChinaare:brandrecognition;user-friendliness;focusonInternetusersinChina;developmentoftechnologytailoredfortheChineseInternetindustry;comprehensiveness,qualityandresponsivenessofproductsandservices;availabilityoftargetedcontent;personalizedexperienceandonlinecommunityapplications,servicesandtechnologies;andtheabilitytoattractandretaintalent.
GovernmentalRegulationsThetelecommunicationsindustry,includingcomputerinformationandInternetaccessservices,ishighlyregulatedbytheChinesegovernment.
RegulationsissuedorimplementedbytheStateCouncil,theMinistryofInformationIndustry,ortheMII,andotherrelevantgovernmentauthoritiescovervirtuallyeveryaspectoftelecommunicationsnetworkoperation,includingentryintothetelecommunicationsindustry,thescopeofpermissiblebusinessactivities,interconnectionandtransmissionlinearrangements,tariffpolicyandforeigninvestment.
InMarch1998,theNationalPeople'sCongressapprovedagovernmentrestructuringplanthatdirectedtheMIItoassume,amongotherthings,theregulatory,administrativeandotherresponsibilitiesof,andrightspreviouslyexercisedby,theformerMinistryofPostsandTelecommunications.
TheMII,undertheleadershipoftheStateCouncil,isresponsiblefor,amongotherthings:formulatingandenforcingtelecommunicationsindustrypolicy,standardsandregulations;grantinglicensestoprovidetelecommunicationsandInternetaccessservices;56formulatingtariffandservicechargepoliciesfortelecommunicationsandInternetaccessservices;supervisingoperationsoftelecommunicationsandInternetaccessserviceproviders;maintainingfairandorderlymarketcompetitionamongoperators;andmanagingtheday-to-dayadministrationofthenationaltelecommunicationssector.
Recently,theBeijingMunicipalAdministrativeBureauofIndustryandCommerceissuedacircularadoptingaregistrationandlingprocessforInternet-relatedbusinessactivitiescarriedoutintheBeijingMunicipality.
SuchInternet-relatedbusinessactivitiesincludee-commerce,on-lineadvertising,Webpagedesign,on-lineproductpromotion,networktechnicalservicesandinformationsourcingandprovision.
NeteaseBeijing,GuangyitongAdvertisingandGuangzhouNeteaseareintheprocessofregisteringpursuanttothisnewregulation.
RegulationofInternetContentServicesandInternetAccessServicesTheProvisionalRulesonAdministrationofInternationalConnectiontoComputerInformationNetworks(Amended),promulgatedbytheStateCouncilonMay20,1997andtheirimplementingrules,promulgatedbytheStateCouncilonMarch6,1998,layoutthebasicorganizationalandadministrativestructureofChina'sInternetservicesnetworks.
TheMIIregulatesInternetcontentservicesandInternetaccessservicesinthesamemannerthatitregulatestelecommunicationsservices.
InternetcontentservicesinChinaareregulatedastelecommunicationsvalueaddedservices.
Untilrecently,withseveralexceptionalcasesapprovedbytheStateCouncil,theChinesegovernmentgenerallyprohibitedforeigninvestorsfromtakinganyequityownershipinoroperatinganytelecommunicationsbusiness,andclassiedInternetnetworkservicesandInternetcontentservicesastelecommunicationsvalueaddedservices.
TherecentlysignedagreementbetweenthegovernmentsoftheUnitedStatesandChinaregardingChina'sentryintotheWorldTradeOrganizationallowsforeigninvestorstoown30%ofChineseInternetcompany,whichcanbeincreasedto49%bytheyear-endof2000andto50%bytheyear-endof2001.
However,thisagreementhasnotbeenratied.
ChinahasalsoenactedotherregulationsgoverningInternetconnectionsandthedistributionofinformationovertheInternet.
AccordingtotheAdministrativeMeasuresonChinaPublicMultimediaTelecommunications,InternetcontentprovidersarerequiredtobeveriedbytheMIIortheprovincialTelecommunicationsAdministrationBureauinordertoengageinthebusinessofprovidingInternetcontentservices.
InternetcontentprovidersmustalsoenterintoaninterconnectionagreementandanundertakingletterforinformationsecuritywithChinaTelecomorothernodeserviceproviders.
IthasbeenreportedrecentlythattheNewsandPublicationBureauplanstosetupanofceforpurposesofregulatingtheInternetcontentprovisionbusinessinChina.
RegulationofContentUndertheAdministrativeMeasuresonSecurityProtectionforInternationalConnectionstoComputerInformationNetworks,anyuseoftheChineseInternetinfrastructurewhichresultsinabreachofthepublicsecurityortheprovisionofsociallydestabilizingcontentisaviolationofChineselawsandregulations.
AbreachofthepublicsecurityincludestheinfringementoflegalrightsandinterestsofChinaandChinesecitizensaswellasillegalorcriminalactivities.
57Sociallydestabilizingcontentincludescontentthat:violatesChina'sConstitution,laws,oradministrativeregulations;incitessubversionoftheState,harmsnationalunityordamagesthereputationofaStateorgan;involvesobscenities,pornography,gambling,violenceorinstigatescriminalacts;oropenlyhumiliatesorlibelsanotherparty.
If,throughtheprovisionofourcontentande-commerceproductsandservicestoNeteaseusersinChinawecommitanyoftheaboveviolations,whetherwithorwithoutintent,wemaybesubjecttosignicantliability.
PotentialsanctionswouldincludebeingdisconnectedfromChinaTelecom'snetworkorblockedinChina.
Wherebreachesaresevere,criminalproceedingsmaybeinitiatedagainstus.
BecauseofthestrictregulationsrelatingtothetypeofcontentthatmaybetransmittedthroughtheChineseInternetinfrastructureandourconservativeinterpretationofsuchregulations,thecontentweprovideovertheNeteasenetworkofWebsitesisstringentlyeditedandmaynotbeasappealingasotherWebsites.
UndertheAdministrativeMeasuresonSecurityProtectionforInternationalConnectiontoComputerInformationNetworks,entitieswithcomputerinformationnetworksthatareconnectedtotheInternetarerequiredtomakecertainlingswithrelevantauthoritiesdesignatedbylocalpublicsecuritybureaus.
NeteaseBeijing,GuangyitongAdvertisingandGuangzhouNeteaseareintheprocessofmakingsuchlingswiththerelevantauthorities.
Wealsomonitorthecomplianceoftheabove-mentionedcontentrestrictionsonourcommunityforumsinthefollowingways:priortoregisteringwithanyoftheNeteasecommunityforums,allusersmustagreetoabidebyrestrictionsoncontentsetforthinourpostedlegalnotice;andeachuseroftheNeteasecommunityforumsisrequiredtoprovideane-mailaddress.
RegulationofAdvertisements:PublicationsTheStateAdministrationofIndustryandCommerce,orSAIC,isthegovernmentagencyresponsibleforregulatingadvertisingactivitiesinChina.
TherearenolawsorregulationsinChinaspecicallygoverningonlineadvertisingbusinesses.
TheSAIChasnotexpresslyassertedorissuedanyregulatorydocumentsstatingthattheInternetisconsideredanadvertisingmediumunderitsrules,norhastheSAICextendeditsjurisdictiontoonlineadvertisements.
However,wecannotpredictwhatstancetheSAICoranyotherChinesegovernmentalagenciesmayadoptinthefuture.
GuangyitongAdvertisingholdsanadvertisingoperatinglicenseandoperatesouronlineadvertisingbusiness.
IftheSAICweretotreatourcurrenttechnologicalservicetoGuangyitongAdvertisingasanonline''AdvertisementPublisher''asdenedintheAdvertisingLawinChina,wewouldneedtoapplytothelocalSAICtoamendourbusinesslicensetoauthorizeustoconductanonlineadvertisingbusinessinaccordancewiththeAdministrativeRegulationsonAdvertisingandtheDetailedImplementingRulesthereof.
WecannotassureyouthatsuchapplicationwouldbeapprovedbytheSAIC.
Failuretoobtainsuchapprovalmayresultinpenaltiesincluding:beingbannedfromengaginginonlineadvertisingactivities,conscationofillegalearnings;andnes.
58Ontheotherhand,ifanapplicationwereapprovedbytheSAICandweweredeemedtobeanonline''AdvertisementPublisher,''wewouldbeheldresponsibleforexaminingrelevantdocumentsandverifyingthecontentofadvertisementswepostonline.
TheStateNewsandPublicationBureau,orSNPB,isthegovernmentagencyresponsibleforregulatingpublishingactivitiesinChina.
TherearecurrentlynolawsorregulationsinChinaspecicallygoverningtheonlinepublicationindustry.
TheSNPBhasnotyetexpresslyasserted,orissuedanyregulatorydocumentsstating,thattheInternetisconsideredanelectronicpublicationmediaunderitsrules,norhastheSNPBextendeditsjurisdictiontoonlinepublications.
However,wecannotpredictwhatstancetheSNPBoranyotherChinesegovernmenalagenciesmayadoptinthefuture.
IftheSNPBweretoextenditsjurisdictiontoencompasspublicationsontheInternet,wemayberegardedbytheSNPBasan''ElectronicPublisher''asdenedintheChineseAdministrativeRulesonElectronicPublications,andwewouldneedtoapplytotheSNPBforapprovalsoastobeauthorizedtoconductourelectronicpublicationbusinessinaccordancewiththeAdministrativeRulesonElectronicPublicationandtheDetailedImplementingRulesthereof.
WecannotassureyouthatsuchapplicationwouldbeapprovedbytheSNPB.
Failuretoobtainsuchapprovalmayresultinpenaltiesincluding:beingbannedfromengaginginonlinepublishingactivities,conscationofillegalearnings;andnes.
Ontheotherhand,ifourapplicationisapprovedbytheSNPBandwearedeemedtobean''ElectronicPublisher,''wewouldbeheldresponsibleforexaminingrelevantdocumentsandverifyingthecontentofourpublications.
RegulationofE-CommerceAtpresent,therearenospecicChineselawsgoverninge-commerceordeninge-commerceactivities.
NoChinesegovernmentauthorityhasbeendesignatedtoregulatee-commerce.
Thereareexistingregulationsgoverningretailandauctionbusinesseswhichrequirecompaniestoobtainlicensesinordertoengageinthesebusinesses.
However,itisunclearwhethertheseexistingregulationswillbeappliedtoe-commerce.
ThereisnoassurancethattheChinesegovernmentwillnot,inthefuture,promulgatespecicregulationsgoverninge-commerce,designateagovernmentagencytoregulatee-commerceactivitiesorapplyexistingretailandauctionregulationstoe-commerceactivities.
Anyoftheseactionscouldhaveamaterialadverseeffectonourbusiness.
IntellectualPropertyandProprietaryRightsWerelyprimarilyonacombinationofcopyrightlawsandcontractualrestrictionstoestablishandprotectourintellectualpropertyrights.
Werequireouremployeestoenterintoagreementsrequiringthemtokeepconfidentialallinformationrelatingtoourcustomers,methods,businessandtradesecretsduringandaftertheiremploymentwithus.
Ouremployeesarerequiredtoacknowledgeandrecognizethatallinventions,tradesecrets,worksofauthorship,developmentsandotherprocesses,whetherornotpatentableorcopyrightable,madebythemduringtheiremploymentareourproperty.
Theyalsosignallnecessarydocumentstosubstantiateoursoleandexclusiverighttothoseworksandtotransferanyownershipthattheymayclaiminthoseworkstous.
Whileweactivelytakestepstoprotectourproprietaryrights,suchstepsmaynotbeadequatetopreventtheinfringementormisappropriationofourintellectualproperty.
Infringementormisappropriationofourintellectualpropertycouldmateriallyharmourbusiness.
Weowntheintellectualproperty(otherthanthecontent)relatingtotheNeteaseWebsitesandthetechnologythatenableson-linecommunity,personalizationande-commerceservicesonthosesites.
Welicensecontentfromvariousfreelanceprovidersandothercontentproviders.
59WehavefulllegalrightsoverandhaveregisteredthefollowingdomainnameswithNetworkSolutions,Inc.
:www.
netease.
com;www.
163.
com;www.
yeah.
net;www.
126.
com;andwww.
nease.
net.
GuangzhouNeteasehasalsoappliedforregisteredtrademarksforNeteaseinbothChineseandEnglishwithChina'sTrademarkOfce.
China'strademarklaw,however,adoptsa''rst-to-le''systemforobtainingtrademarkrights,wherebytherstapplicanttoleanapplicationforregistrationofamarkwillpreemptallotherapplications.
Prioruseofanunregisteredmarkisgenerallyirrelevantexceptfor''wellknown''marks.
China'sTrademarkOfcehasissuedaregistrationcerticateforoneoftheEnglishNeteasemarkstoGuangzhouNetease.
GuangzhouNeteaseisintheprocessoftransferringthisregisteredtrademarktoNeteaseBeijing.
China'sTrademarkOfcehasnotyetissuedaregistrationcerticateforotherEnglishNeteasemarksortheChineseNeteasemarks.
Asaresult,untilactualregistrationcerticatesareissuedbytheTrademarkOfce,wemaynotbeabletosuccessfullydefendorclaimanylegalrightsinthethoseEnglishNeteasemarksortheChineseNeteasemarks.
Manypartiesareactivelydevelopingandseekingpatentprotectionforcommunity,e-commerceandrelatedWebtechnologies.
Weexpectthesepartiestocontinuetotakestepstoprotectthesetechnologies,includingseekingpatentprotection.
Theremaybepatentsissuedorpendingthatareheldbyothersandthatcoversignicantpartsofourtechnology,businessmethodsorservices.
Forexample,weareawarethatanumberofpatentshavebeenissuedinareasofe-commerce,Web-basedinformationindexingandretrieval,andonlinedirectmarketing.
Disputesoverrightstothesetechnologiesarelikelytoariseinthefuture.
Wecannotbecertainthatourproductsdonotorwillnotinfringevalidpatents,copyrightsorotherintellectualpropertyrightsheldbythirdparties.
Wemaybesubjecttolegalproceedingsandclaimsfromtimetotimerelatingtotheintellectualpropertyofothers.
EmployeesAsofMay31,2000,wehad199employeesandGuangzhouNeteasehad45employees,including67inmedia,63intechnology,27insales,20inmarketing,12inbusinessdevelopment,8ine-commerce,12incustomerservice,15inaccounting,2innance,10inadministrationand8inhumanresources.
Weplantoexpandourworkforcewithinthenext15months,withourcustomerservice,editorial,marketing,sales,andtechnologydepartmentsexpectedtohavethehighestemployeegrowth.
Noneofouremployeesarerepresentedbyalaborunion.
Weconsiderourrelationswithouremployeestobegood.
FacilitiesOurBeijingofcescurrentlyoccupyapproximately2,212squaremetersunderaleasethatexpiresinFebruary2003.
Wealsooccupy766squaremetersunderaleaseinShanghaithatexpiresinDecember2002.
GuangzhouNeteaseoccupies113squaremetersunderaleasethatexpiresinMarch2001.
Webelievethatwewillbeabletoobtainadequatefacilities,principallythroughtheleasingofappropriateproperties,toaccommodateourfutureexpansionplans.
LegalProceedingsWearenotcurrentlyapartytoanymateriallitigationandarenotawareofanypendingorthreatenedlitigation.
60MANAGEMENTThefollowingtablesetsforththename,ageandpositionofeachdirectorandexecutiveofcerofourcompany.
NameAgePositionKingF.
Lai40Director;ChiefExecutiveOfcerWilliamLeiDing28Director;ChairmanoftheBoardandCo-ChiefTechnologyOfcerHelenHaiwenHe31Director;ChiefFinancialOfcerJackL.
Xu32Co-ChiefTechnologyOfcerSusanChen41ChiefOperatingOfcerTedSun32DirectorXiang-DongYang35DirectorKathyXinXu33DirectorMichaelSuiBauTong29DirectorKingF.
LaijoinedourcompanyasChiefExecutiveOfceronApril1,2000.
Mr.
LaipreviouslyworkedforeightyearsatSaatchi&SaatchiAdvertisingastheirChiefExecutiveOfcerforofcesinChinaandTaiwan.
PriortohisemploymentwithSaatchi&SaatchiAdvertising,heworkedforhisownmarketingconsultingrm,TheMarketingPartnership,from1987to1992.
Mr.
LaistudiedEnglishliteratureforthreeyearsattheUniversityofPennsylvania.
WilliamLeiDing,ourfounder,hasservedasdirector,ChairmanoftheBoardandCo-ChiefTechnologyOfcersinceJuly1999.
UntilApril1,2000,Mr.
DingalsoservedasourinterimChiefExecutiveOfcer.
Mr.
DingestablishedGuangzhouNetease,ourafliate,inMay1997.
PriortoestablishingGuangzhouNetease,Mr.
DingspentoneyearatGuangzhouFeijieCo.
asasystemsanalyst,fromJune1996toApril1997,oneyearatSybase(China)asaprojectmanager,fromMay1995toMay1996,andtwoyearsatChinaTelecomNingboBranchasatechnicalengineer,fromJuly1993toMay1995.
Mr.
DingholdsaBachelorofSciencedegreeinCommunicationTechnologyfromtheUniversityofElectronicScienceandTechnologyofChina.
HelenHaiwenHehasservedasourChiefFinancialOfcersinceAugust1999,priortowhichshespentveandhalfyearsasaninvestmentbankeratBear,Stearns&Co.
Inc.
focusingontheGreaterChinamarketandtheAsiantechnologyindustry,includingtheInternetsector.
Ms.
HeholdsaMasterofScienceinComputerSciencefromtheUniversityofArizonaandaBachelorofSciencedegreeinComputerSciencefromTianjinUniversity.
Ms.
HeisalsoaCharteredFinancialAnalyst.
JackL.
XujoinedourcompanyasCo-ChiefTechnologyOfcerinMay2000.
Mr.
XupreviouslyservedastheSeniorManagerforSearchTechnologyatExcite@HomeCorporation,oneofthepremiersearchenginesontheWeb,fromJune1999toMay2000.
PriortoworkingforExcite@Home,heservedasSeniorEngineeringManagerofExciteIncorporatedfromDecember1996toJune1999.
PriorjoiningExciteIncorporated,heworkedasaresearcheratUniversityofCaliforniaatBerkeleyintheeldoffulltextsearchenginetechnologies.
Mr.
XuwasaPh.
D.
candidateinInformationManagementandSystemsatUniversityofCaliforniaatBerkeley.
HeholdsaMasterofSciencedegreeinInformationSciencefromZhongshanUniversityandaBachelorofArtsdegreeinInformationSciencefromZhongshanUniversity.
SusanChenisexpectedtojoinourcompanyasChiefOperatingOfcerinJuly2000.
Ms.
ChenservedasVicePresidentofMarketingofFarEasToneTelecommunicationsCo.
sinceJuly1997.
BeforejoiningFarEasTone,Ms.
Chenservedasadirectorinvariouseldsofmarketing,salesandbusinessdevelopmentforAmericanExpressTaiwanfromApril1991toJuly1997.
PriortoheremploymentwithAmericanExpressTaiwan,sheworkedwithJohnson&Johnson(Taiwan)fromFebruary1982toApril1991.
Ms.
ChenholdsaBachelorofArtsdegreeinBusinessAdministrationfromTamkongUniversity.
61TedSunhasservedasourdirectorsinceDecember1999.
Mr.
SunservedasaManagingDirectorofBearStearnsAsiaLimitedfromNovember1996toMay2000.
PriortoNovember1996,Mr.
SunwasanassistantdirectorwithPeregrineCapitalLimited.
Mr.
SunholdsaBachelorofSciencedegreeinEconomicsfromtheWhartonSchoolofBusiness,UniversityofPennsylvania.
Xiang-DongYanghasservedasourdirectorsinceDecember1999.
Mr.
YangisalsoaManagingDirectorofTheGoldmanSachsGroup,Inc.
andCo-HeadoftheGoldmanSachsPrincipalInvestmentAreainex-JapanAsia.
Mr.
YangholdsaBachelorofArtsdegreeineconomicsfromHarvardUniversityandMasterofBusinessAdministrationfromHarvardBusinessSchool.
KathyXinXuhasservedasourdirectorsinceDecember1999.
Since1998,Ms.
XuhasbeenaPrincipalofBaringPrivateEquityPartners(HongKong)Ltd.
,anAsianventurecapitalrmspecializingininformationtechnology.
AtBaring,Ms.
Xuhasledtherm'sinvestmentsinseveralsuccessfulcompanies,includingVandaSystem,Comtech,NetstarandNetease.
PriortoworkingwithBaring,sheservedasaninvestmentmanagerforPeregrineDirectInvestmentsLimitedandwasasenioraccountantforPriceWaterhouse,bothinHongKong.
Ms.
XuholdsaBachelorofArtsdegreeinEnglishliteraturefromNanjingUniversity.
SheisqualiedintheUKasacertiedpublicaccountant.
MichaelSuiBauTonghasservedasourdirectorsinceDecember1999.
Mr.
TongiscurrentlyamanagerinchargeofventurecapitalinvestmentforSoftbankChinaVentureInvestmentsLimited,whereheevaluatesandmonitorsSoftbankChinaVenture'sinvestments.
Previously,heservedasamanagerinchargeofventurecapitalinvestmentforNomuraChinaVentureInvestmentsLimitedfrom1996to1999andservedasanexecutiveofcerforJardineFlemingSecuritiesCompanyLimitedfrom1995to1996.
Mr.
TongholdsaBachelorofBusinessAdministrationdegreeinAccountingfromtheUniversityofWisconsin.
BoardofDirectorsandBoardCommitteesOurboardofdirectorsconsistsofsevenmembers,includingfournon-executivedirectors.
Weexpectthatallcurrentdirectorswillcontinuetoserveaftertheoffering.
AftertheclosingofthisOffering,TheNewsCorporationLimitedwillhavetherighttonominateonedirectortoourboardofdirectors.
Uponnomination,certainofourshareholdersholdingamajorityofouroutstandingshareshaveagreedtovotetheirsharesinfavoroftheappointmentoftheNewsCorporation'snominateddirector.
See''RelatedPartyTransactions''onpage66.
Theauditcommitteereportstotheboardregardingtheappointmentofourindependentpublicaccountants,thescopeandresultsofourannualaudits,compliancewithouraccountingandnancialpoliciesandmanagement'sproceduresandpoliciesrelativetotheadequacyofourinternalaccountingcontrols.
TheauditcommitteeconsistsofXiang-DongYang,KathyXinXuandMichaelSuiBauTong.
Thecompensationcommitteeoftheboardofdirectorsreviewsandmakesrecommendationstotheboardregardingourcompensationpoliciesandallformsofcompensationtobeprovidedtoourexecutiveofcersanddirectors.
Inaddition,thecompensationcommitteereviewsbonusandstockcompensationarrangementsforallofourotheremployees.
ThecurrentmembersofthecompensationcommitteeareXiang-DongYang,KathyXinXuandMichaelSuiBauTong.
Nointerlockingrelationshipscurrentlyexistorhaveexistedbetweenourboardofdirectorsorcompensationcommitteeandtheboardofdirectorsorcompensationcommitteeofanyothercompany.
DutiesofDirectorsUnderCaymanIslandslaw,ourdirectorshaveastatutorydutyofloyaltytoacthonestlyingoodfaithwithaviewtoourbestinterests.
Ourdirectorsalsohaveadutytoexercisethecare,diligenceandskillsthatareasonablyprudentpersonwouldexerciseincomparablecircumstances.
Infulllingtheirdutyofcaretous,ourdirectorsmustensurecompliancewithourmemorandumandarticlesofassociation.
Ashareholderhastherighttoseekdamagesifadutyowedbyourdirectorsisbreached.
62TermsofDirectorsandOfcersAlldirectorsholdofceuntilthenextannualmeetingofshareholdersoruntiltheirsuccessorshavebeendulyelectedandqualied.
OfcersareelectedbyandserveatthediscretionoftheBoardofDirectors.
AdvisoryBoardWeformedanadvisoryboardinDecember1999.
Theadvisoryboardiscomposedofthefollowing:NameAgeOccupationWilliamAdamopoulos37ManagingDirector,ForbesAsiaJohnnyChan40ChiefExecutiveOfcer,Techpacic.
comLimitedDuncanClark32Partner,BDA(China)Ltd.
JonathanLemberg40ManagingPartner,HongKongOfce,Morrison&FoersterLLPDavidWilliams31Partner,AsiaPacic,DraperFisherJurvetson,andAdvisortotheEmergingMarketsInternetGroup,MerrillLynch(AsiaPacic)LimitedWeexpectthattheadvisoryboardwillprovideconsultationandadvisoryservicesinconnectionwithourbusinessdevelopment,includingareasrelatedtostrategicpartnership,marketingandnancing.
Theinitialtermofeachmemberoftheadvisoryboardistwoyears.
Webelievethattheparticularknowledgeandexpertiseofeachmemberoftheadvisoryboardwillbeaninvaluablecontributiontoourgrowthandfuturesuccess.
CompensationofDirectorsandExecutiveOfcersFortheyearendedDecember31,1999,theaggregatecashcompensationtoourexecutiveofcerswasapproximatelyUS$63,000.
Wedidnotpayanycashcompensationtoourdirectorsin1999.
FortheyearendedDecember31,1999,optionstoacquireanaggregateof69,135,000ordinarysharesweregrantedtoourdirectorsandexecutiveofcersasagroup.
StockIncentivePlansOur1999stockincentiveplanwasadoptedbyourboardofdirectorsinDecember1999andapprovedbyourshareholdersinJanuary2000.
Our2000stockincentiveplan,whichsupersedesthe1999plan,wasadoptedbyourboardofdirectorsandourshareholdersinFebruary2000.
Thepurposeoftheplansistoattractandretainthebestavailablepersonnel,toprovideadditionalincentivestoouremployees,directorsandconsultantsandtopromotethesuccessofourbusiness.
TheplansprovideforthegrantingofincentivestockoptionswithinthemeaningofSection422oftheInternalRevenueCode,asamended,nonstatutorystockoptionsandotherequity-basedrights.
Anaggregateof345,675,000ofourordinaryshares,orapproximately13.
5%ofourtotaloutstandingsharesasofJune15,2000,arereservedforissuanceundertheplans.
The13.
5%reservedsharesareallocatedundertheplansasfollows:11%to12%ofthesharesarereservedforawardstobegrantedtotheChiefExecutiveOfcer,theCo-ChiefTechnologyOfcers,theChiefOperatingOfcer,theChiefFinancialOfcer,theSeniorVicePresidentsinSales,MarketingandBusinessDevelopment,theGeneralManagerofourShanghaisubsidiaryandthemembersofourboard,andtheremaining2-3%arereservedforawardstootheremployeesandconsultants.
Optionstoacquire295,148,000ordinaryshareswereoutstandingasofJune15,2000,153,553,000ofwhichwereheldbyourdirectorsandexecutiveofcersasagroup.
Wheretheawardagreementpermitstheexerciseorpurchaseoftheawardforacertainperiodoftimefollowingtherecipient'sterminationofservicewithus,ortherecipient'sdisabilityordeath,theawardwillterminatetotheextentnotexercisedorpurchasedonthelastdayofthespeciedperiodorthelastdayoftheoriginaltermoftheaward,whicheveroccursrst.
63Withrespecttoawardsgrantedtoourdirectorsorofficerswhoarealsoouremployees,theplansareadministeredbyourboardofdirectorsoracommitteedesignatedbyourboardofdirectorsconstitutedtopermitsuchawardstobeexemptfromSection16(b)oftheSecuritiesExchangeActof1934,asamended,inaccordancewithRule16b-3thereunder.
Withrespecttoawardsgrantedtootherparticipants,theplansareadministeredbyourboardofdirectorsoracommitteedesignatedbyit.
Ineachcase,ourboardofdirectorsorthecommitteeitdesignateswilldeterminetheprovisions,termsandconditionsofeachaward,including,butnotlimitedto,theawardvestingschedule,repurchaseprovisions,rightsoffirstrefusal,forfeitureprovisions,formofpaymentuponsettlementoftheaward,paymentcontingenciesandsatisfactionofanyperformancecriteria.
Theplanadministratorwilldeterminethevestingscheduleofawardsgrantedundertheplan.
Typically,optionsgrantedunderthe1999plantoemployeesvestuponthecompletionoftheirrstfullyearofservice;optionsgrantedunderthe1999plantoseniormanagementpersonnelandunderthe2000plantoemployeeswhohavenotbeengrantedoptionsunderthe1999planvestattherateof20%onaspeciedvestingcommencementdate,20%uponcompletionofonefullyearofserviceand30%uponcompletionofeachofthenexttwoyears;andoptionsgrantedunderthe1999plantomembersofouradvisoryboardvest20%onthedateofappointmentand10%eachquarteroverthenexttwoyears.
OutstandingoptionsheldbycertainseniormanagementpersonnelandkeyemployeeswillvestinfulluponWilliamLeiDing'sceasingtobeourmajorityshareholder.
Inaddition,50%oftheunvestedoutstandingoptionsheldbyoneofourexecutiveofcerswillvestinfullupontheconsummationofthisoffering.
Optionsgrantedunderthe2000plantoemployeeswhohavebeengrantedoptionsunderthe1999planvestattherateof25%onaspeciedvestingcommencementdate,and37.
5%oneachoftherstandsecondanniversaryofthevestingcommencementdate.
Incentivestockoptionsarenottransferablebytheoptioneeotherthanbywillorthelawsofdescentordistributionandareexercisableduringthelifetimeoftheoptioneeonlybytheoptionee.
Otherawardsaretransferablebygifttofamilymembersoruponadivorce.
Theexercisepriceofincentivestockoptionsmustbeatleastequaltothefairmarketvalueofoursharesonthedateofgrant,andthetermoftheoptionmustnotexceedtenyears.
Thepurchasepriceofnon-qualiedstockoptionsmustbeatleast85%ofthefairmarketvalueofoursharesonthedateofgrant.
Withrespecttoanemployeewhoownssharespossessingmorethan10%ofthevotingpowerofallclassesofouroutstandingcapital,theexercisepriceofanyincentivestockoptionmustequalatleast110%ofthefairmarketvalueofoursharesonthedateofgrantandthetermoftheoptionmustnotexceedveyears.
Theexerciseorpurchasepriceofotherawardswillbesuchpriceasdeterminedbytheadministrator.
Theconsiderationtobepaidforthesharesuponexerciseorpurchaseofanawardwillbedeterminedbytheadministratorandmayincludecash,check,ordinaryshares,apromissorynote,ortheassignmentofpartoftheproceedsfromthesaleofsharesacquireduponexerciseorpurchaseoftheaward.
Ifathirdpartyacquiresusthroughthepurchaseofallorsubstantiallyallofourassets,amergerorotherbusinesscombination,allawardswillbecomefullyvestedandexercisableimmediatelypriortosuchtransactionandallunexercisedawardswillterminateunless,ineithercase,theawardsareassumedbythesuccessorcorporationoritsparent.
Unlessterminatedsooner,the1999and2000planswillterminateautomaticallyinDecember,2009andFebruary,2010,respectively.
Ourboardhastheauthoritytoamend,suspendorterminatetheplanssubjecttoshareholderapprovalofamendmentstotheextentnecessarytocomplywithapplicablelawandprovidednosuchactionmayaffectawardspreviouslygrantedundertheplans.
64PRINCIPALSHAREHOLDERSThefollowingtablesetsforthinformationwithrespecttothebenecialownershipofourordinaryshares,onafullydilutedbasis,asofMay31,2000assumingtheconversionofallSeriesAandSeriesBPreferenceSharesintoordinarysharesandasadjustedtoreectthesaleoftheADSsofferedherebyby:(1)eachpersonknowntoustoownbeneciallymorethan5%ofourordinaryshares;and(2)allofourdirectorsandexecutiveofcersasagroup.
BenecialownershipisdeterminedinaccordancewiththerulesoftheSecuritiesandExchangeCommissionandincludesvotingorinvestmentpowerwithrespecttothesecurities.
Exceptasindicatedbelow,andsubjecttoapplicablecommunitypropertylaws,thepersonsnamedinthetablehavesolevotingandinvestmentpowerwithrespecttoallordinarysharesshownasbeneciallyownedbythem.
Thenumberofordinarysharesoutstandingusedincalculatingthepercentageforeachlistedpersonincludestheordinarysharesofunderlyingoptionsheldbysuchpersonsthatareexercisablewithin60daysofMay31,2000,butexcludesordinarysharesunderlyingoptionsheldbyanyotherperson.
Percentageofbenecialownershipisbasedon2,560,555,600ordinarysharesoutstandingasofMay31,2000,and3,010,555,600ordinarysharesoutstandingaftercompletionofthisoffering,eachassumingtheconversionofallSeriesAandSeriesBPreferenceSharesintoordinaryshareseffectiveuponcompletionofthisoffering.
SharesBeneciallyOwnedPriortothisOfferingSharesBeneciallyOwnedAfterthisOfferingNameandAddressNumber%Number%ShiningGlobeInternationalLimited/WilliamLeiDing1,764,090,50068.
71,764,090,50058.
515thFloor,NorthTower,BeijingKerryCentre,No.
1GuanghuaRoad,ChaoyangDistrict,Beijing100020People'sRepublicofChinaTheNewsCorporationLimited.
256,055,60010.
0256,055,6008.
5c/oNewsDigitalVentures620AvenueoftheAmericasNewYork,NY10011Alldirectorsandexecutiveofcersasagroupofninepersons1,845,228,00071.
51,859,055,00061.
1ShiningGlobeInternationalLimitedis100%ownedbyWilliamLeiDing,ourfounder,ChairmanoftheBoardandCo-ChiefTechnologyOfcer.
SharesownedbyShiningGlobeincludeoptionstoacquire6,913,500ordinarysharesthatareexercisablewithin60daysofMay31,2000andheldbyMr.
Ding.
SharesownedbyallofourdirectorsandexecutiveofcersasagroupincludessharesbeneciallyownedbyWilliamLeiDingandalsoincludes23,045,000sharesandoptionstopurchase4,609,000sharesbeneciallyownedbyanexecutiveofcerwithrespecttowhichvotingandinvestmentpowerissharedwithsuchofcer'sspouse.
Sharesbeneciallyownedbyourdirectorsandexecutiveofcerspriortothisofferingincludesadditionaloptionstoacquire7,393,500ordinarysharesthatareexercisablewithin60daysofMay31,2000.
Sharesbeneciallyownedbyallofourdirectorsandexecutiveofcersafterthisofferingincludesoptionstoacquire32,743,000ordinarysharesthatareexercisablewithin60daysofMay31,2000,includingoptionstoacquire13,827,000ordinarysharesthatwillbecomeexercisableuponcompletionofthisoffering.
Wearenotawareofanyarrangementthatmay,atasubsequentdate,resultinachangeofcontrolofourcompany.
65RELATEDPARTYTRANSACTIONSNetease.
comandNeteaseBeijingenteredintoaseriesofagreementswithGuangzhouNetease,GuangyitongAdvertisingandtheshareholdersofGuangzhouNeteaseandGuangyitongAdvertisingunderwhichweprovideourInternetande-commerceapplications,servicesandtechnologiesandadvertisingservicestoGuangzhouNeteaseandGuangyitongAdvertising,andGuangzhouNeteaseandGuangyitongAdvertisingoperatetheNeteaseWebsitesandouronlineadvertisingbusiness.
WedonotbelieveNetease.
comandNeteaseBeijingcouldhaveobtainedtheseagreements,takenasawhole,fromunrelatedthirdparties.
Webelievethatthetermsofeachagreementarenolessfavorablethanthetermsthatwecouldobtainfromdisinterestedthirdparties.
GuangzhouNeteaseisoneofalimitednumberofcompaniesinChinatohavesecuredapprovalfromtheGuangzhoutelecommunicationsadministrativeauthoritiestoengageintheInternetcontentproviderbusiness.
Throughouragreements,wehavetheexclusiverighttobenetfromthisapproval.
Inaddition,wehavesecuredsignicantrightsoverGuangyitongAdvertisingandtheultimateshareholdersofGuangyitongAdvertisingandhaveobtainedthecommitmentoftheultimateshareholdersofGuangyitongAdvertisingtoallowittodirectthepoliciesandmanagementoftheongoingactivitiesofGuangyitongAdvertising.
WebelievethattheshareholdersofGuangzhouNeteaseandGuangyitongAdvertisingwillnotreceivematerialbenetsfromtheseagreementsexceptasshareholdersofNetease.
com.
BecauseoftheuncertainandchanginglegalandregulatoryenvironmentinChina,mostoftheseagreementshavetermsofoneyear,exceptfortheDomainNamesLicenseAgreementbetweenNetease.
comandGuangzhouNeteasewhichhasatermofveyears,andtheOperatingAgreementamongNeteaseBeijing,GuangyitongAdvertisingandtheultimateshareholdersofGuangyitongAdvertisingwhichhasatermoftwentyyears.
Inaddition,theVotingRightsTrustAgreementamongNeteaseBeijingandWilliamLeiDingandBoDing,asultimateshareholdersofGuangyitongAdvertisinghasatermoftenyears.
Theseagreementsaredescribedbelow.
DomainNameLicenseAgreementbetweenNetease.
comandGuangzhouNetease.
Netease.
comgrantedGuangzhouNeteasetherighttousethedomainnames''netease.
com,''''163.
com,''''126.
com,''''yeah.
net''and''nease.
net''ontheNeteaseWebsitesinChinaforlicensefeesofRMB10,000peryear.
Netease.
commaywaivethisfeeinthefuture.
ByaSupplementalAgreemententeredintobetweenthepartiesinMay2000,thetermofthisagreementhasbeenextendedfromoneyeartoveyears.
CopyrightLicenseAgreementbetweenNeteaseBeijingandGuangzhouNetease.
NeteaseBeijinggrantedGuangzhouNeteasetherighttouseNeteaseBeijing'sWebpagelayoutinChinaforaroyaltyofRMB10,000peryear.
NeteaseBeijingmaywaivethisfeeinthefuture.
TrademarkLicenseAgreementbetweenNeteaseBeijingandGuangzhouNetease.
NeteaseBeijinggrantedGuangzhouNeteasealicensetouseNeteaseBeijing'sregisteredtrademarksontheNeteaseWebsitesinChinaforlicensefeesofRMB10,000peryear.
NeteaseBeijingmaywaivethisfeeinthefuture.
ExclusiveTechnicalServicesMasterAgreementbetweenNeteaseBeijingandGuangzhouNetease.
NeteaseBeijingprovidesGuangzhouNeteasewithtechnicalservicesfortheoperationoftheNeteaseWebsites,including-servermaintenance;-serverapplicationsoftwaredevelopment;-Internetapplicationsoftwaredevelopment;-training;and-e-commercerelatedservices.
GuangzhouNeteasepaysmonthlyservicefeestoNeteaseBeijingbasedontheactualoperatingcircumstancesoftheparties.
NeteaseBeijingmayunilaterallyadjustsuchfees.
NeteaseBeijingisGuangzhouNetease'sexclusiveprovideroftheseservices.
66NeteaseBeijinghastherighttotransferandsellitsinterestsinthisExclusiveTechnicalServicesMasterAgreementoranyotheragreementsbetweenitandGuangzhouNetease.
ExclusiveConsultingandServicesAgreementbetweenNeteaseBeijingandGuangyitongAdvertising.
NeteaseBeijingprovidesGuangyitongAdvertisingwithtechnicalconsultingandrelatedservicesforalladvertisementspublishedontheNeteaseWebsites.
GuangyitongAdvertisingsubmitsdesignsofadvertisementstobepublishedontheNeteaseWebsites,andNeteaseBeijingcompletestherelatedtechnicalworkanddeliversthecompletedadvertisementstoGuangyitongAdvertising.
GuangyitongAdvertisingpaysfeestoNeteaseBeijingbasedontheactualoperatingcircumstancesoftheparties,whichconsistofsubstantiallyallofGuangyitongAdvertising'sadvertisingrevenue,netoftherelatedbusinesstaxandculturaldevelopmentfee.
NeteaseBeijingmayunilaterallyadjustsuchfees.
NeteaseBeijingwillbeGuangyitongAdvertising'sexclusiveprovideroftheseservices.
Theinitialtermofthisagreementwillbe10years.
ExclusiveAdvertisingAgencyAgreementbetweenNetease.
comandGuangzhouNetease.
GuangzhouNeteaseappointedNetease.
comasitsadvertisingagenttosolicitadvertisingcustomersonbehalfofGuangzhouNeteaseinmarketsoutsideofChina.
Netease.
compaysGuangzhouNetease10%ofthetotaladvertisingrevenueunderthisagreementpermonth.
OnlineAdvertisingAgreementbetweenGuangzhouNeteaseandGuangyitongAdvertising,asamendedbyaSupplementalAgreemententeredintoinMay2000.
GuangzhouNeteasesellsallofthebannerspaceontheNeteaseWebsitestoGuangyitongAdvertisingandpublishestheadvertisementsprovidedbyGuangyitongAdvertisingonthebannerspacepurchasedbyGuangyitongAdvertising.
GuangyitongAdvertisingpaysGuangzhouNeteaseRMB10,000peryear.
GuangzhouNeteasemaywaivethisfeeinthefuture.
Theinitialtermofthisagreementwillbe10years.
TrademarkTransferAgreementbetweenGuangzhouNeteaseandNeteaseBeijing.
GuangzhouNeteasehasagreedtotransferitsregisteredtrademarkstoNeteaseBeijing.
SupplementalAgreementbetweenNeteaseBeijingandGuangzhouNetease.
NeteaseBeijingmaynotgrantthelicensetouseitsdomainname,copyrightandtrademarktoanythirdpartywithoutGuangzhouNetease'sconsentandmaynotprovidetechnicalservicetoanythirdparty.
OperatingAgreementamongNeteaseBeijing,GuangyitongandtheultimateshareholdersofGuangyitongAdvertising.
Toensurethesuccessfulperformanceofthevariousagreementsbetweentheparties,GuangyitongAdvertisinganditsultimateshareholdershaveagreedthattheywillnotenterintoanytransaction,orfailtotakeanyaction,thatwouldsubstantiallyaffecttheassets,liabilities,equityoroperationsofGuangyitongAdvertisingwithoutthepriorwrittenconsentofNeteaseBeijing.
ThepartieshaveagreedthatuponNeteaseBeijing'sdeterminationandatanytimewhenNeteaseBeijingisabletoobtainapprovaltoinvestinandoperatealloranypartofGuangyitongAdvertising,NeteaseBeijingwillacquirealloftheassetsorequityinterestsofGuangyitongAdvertising,totheextentpermittedbyChineselaw.
TheconsiderationforsuchacquisitionswillbebasedonthebookvalueofGuangyitongAdvertisingatthetimeofacquisition.
NeteaseBeijinghasagreedthatitwillprovideperformanceguaranteesandguaranteeloansforworkingcapitalpurposestotheextentrequiredbyGuangyitongAdvertisingforitsoperations.
TheultimateshareholdersofGuangyitongAdvertisinghaveagreedthatuponinstructionfromNeteaseBeijing,theywillappointorterminateGuangyitongAdvertising'sboardmembers,GeneralManager,ChiefFinancialOfcerandotherseniorofcers.
NeteaseBeijinghastherighttotransferandsellitsinterestsintheOperatingAgreementoranyotheragreementsbetweenitandGuangyitongAdvertising.
67ShareholderVotingRightsTrustAgreementamongWilliamLeiDing,BoDingandNeteaseBeijing.
BoDingirrevocablyappointsNeteaseBeijingtorepresenthimtoexerciseallthevotingrightstowhichheisentitledasashareholderofGuangyitongAdvertisingandWilliamLeiDingandBoDingagreetocauseGuangzhouNeteasetoirrevocablyappointNeteaseBeijingtorepresentGuangzhouNeteasetoexerciseallthevotingrightstowhichGuangzhouNeteaseisentitledasashareholderofGuangyitongAdvertising.
TerminationAgreementsbetweenNeteaseBeijingandGuangzhouNetease.
NeteaseBeijingandGuangzhouNeteaseterminatedpreviouslyexistingcontractsrelatedtoNeteaseBeijing'srightswithrespecttotheoperationofGuangzhouNetease,theleaseofequipmentfromNeteaseBeijingtoGuangzhouNeteaseandthesubleaseofleasedlinesfromNeteaseBeijingtoGuangzhouNetease.
UndertheTerminationAgreements,NeteaseBeijingagreestoprovidewithoutchargetoGuangzhouNeteaseequipmentrelatedtotheoperationofInternetinformationservices.
AgreementbetweenNeteaseBeijingandGuangzhouNetease.
NeteaseBeijingagreestopaytheoperatingcostsofGuangzhouNetease.
LetterofAgreement.
EachofWilliamLeiDingandBoDinghaveagreedthatanyamendmentstobemadetotheExclusiveConsultingandServicesAgreement,theShareholderVotingRightsTrustAgreement,andtheOperatingAgreementdescribedabove,aswellasallotheragreementstowhichGuangzhouNetease,GuangyitongAdvertisingand/orWilliamLeiDingandBoDingareparties,shallbesubjecttotheapprovalbythevoteofamajorityofourboard,excludingthevoteofWilliamLeiDing.
Messrs.
Dinghavealsoagreedthat,ifanyamendmentstotheabovementionedagreementsrequireavoteoftheshareholdersofNetease.
com,GuangzhouNeteaseorGuangyitongAdvertising,asapplicable,bothofthemwillvoteintheircapacityasdirectorindirectshareholdersofthesecompaniestoactbasedupontheinstructionsofourboard.
VotingArrangementAftertheclosingofthisoffering,TheNewsCorporationLimitedwillhavetherighttonominateonedirectortoourboardofdirectors.
Uponnomination,certainofourshareholdersholdingamajorityofouroutstandingshares,includingourlargestshareholder,ShiningGlobe,haveagreedtovotetheirsharesinfavouroftheappointmentofTheNewsCorporation'snominateddirector.
TheNewsCorporation'srighttonominateonedirectorandcertainofourshareholders',includingShiningGlobe's,agreementtovotetheirsharesinfavourofthedirectornominatedbyTheNewsCorporation,willbeineffectforsolongasTheNewsCorporationownsmorethan4.
25%ofourtotalissuedandoutstandingsharecapital.
Co-SaleRightsUnderthetermoftheinvestors'rightsagreementamongTheNewsCorporation,ShiningGlobeandcertainothershareholders,forsolongasTheNewsCorporationownsatleast4.
25%ofouroutstandingsharecapital,ithastheright,atitsoption,tosellitssharesifShiningGlobeproposestosellanyofitsshares,onthesametermsandconditionsasShiningGlobe.
TotheextentanyprospectivepurchaserofShiningGlobe'ssharesrefusestopurchaseTheNewsCorporation'sshares,ShiningGlobemaynotsellitssharesunlessShiningGlobepurchasesTheNewsCorporation'sshares.
StrategicAlliancewithTheNewsCorporationInMarch2000,weissued2,560,556ofourSeriesBpreferencesharestoBestAllianceProtsLimited,acompanycontrolledbyTheNewsCorporationLimited,inexchangeforUS$35millionincashtogetherwithon-airadvertisingandpromotionalservices.
Inconnectionwiththisissuance,weenteredintoanagreementwithNewsDigitalVentures,anafliateofTheNewsCorporationLimited,whichprovidesforcooperationbetweenusandTheNewsCorporation.
AspartoftheconsiderationfortheissuanceofourSeries68Bpreferenceshares,TheNewsCorporationanditsafliateswillprovideuswithon-airadvertisingandpromotionalinventorywithavalueofUS$5milliononTheNewsCorporation'smediaproperties,includingChannel[V],ESPNStarSports,PhoenixTVandSTARTV.
WemustuseatleastUS$1millionoftheinventorywithinoneyear,andatleastUS$2millionineachofthenexttwoyears.
Inaddition,TheNewsCorporationanditsafliateswillspendUS$5milliononon-lineadvertisingontheNeteaseWebsitesduringthistime,includingUS$1millionwithinoneyearandUS$2millionineachofthenexttwoyears.
IfNewsCorporationanditsafliatesarecollectivelythelargestcommittedbuyerofadvertisingontheNeteaseWebsites,theywillbeentitledtopurchasethisadvertisingontermsthatarenolessfavorablethanthosethatareapplicabletoanyothernon-afliatedbuyer.
WeandTheNewsCorporationwillalsocross-licenseInternettoolsandtechnologiesontermstobemutuallyagreedupon,andwillsharecustomerinformationgeneratedbyeitherpartyusingthecross-licensedtoolsandtechnology.
TheNewsCorporationwillhavearightofrstrefusaltoprovideChineselanguagecontenttotheNeteaseWebsitesintheareasofpopularmusic,sportsandmoviesandgeneralentertainment.
TheNewsCorporationwillofferustheopportunitytoparticipateincross-promotionalandmarketingactivities,includingcreatingspecialco-brandedmarketingandpromotionalevents.
OurobligationsandTheNewsCorporation'sobligationstopurchaseadvertisingandpromotionalinventoryfromoneanother,andthearrangementsrelatingtothecross-licenseofInternettoolsandtechnologies,remainsubjecttothenegotiationofdenitiveagreements.
ShareTransferstoCertainSeniorManagementPersonnelandKeyEmployeesIn1999,ShiningGlobeInternationalLimited,whichis100%ownedbyWilliamLeiDing,ourfounder,ChairmanoftheBoardandCo-ChiefTechnologyOfcer,agreedtotransferanaggregateof109,694,200ordinarysharestocertainseniormanagementpersonnelandkeyemployees.
ThesesharetransferswereeffectedinJanuary2000.
Thesharetransfercommitmentsweremadetoprovideincentivestoseniormanagementpersonnelandkeyemployeestojoinourcompany.
Thefairmarketvalueofthesesharesasofthedateofsuchagreement(RMB45.
4millionorUS$5.
5million)waschargedtoourearningsin1999assharecompensationcostsinaccordancewithU.
S.
GAAP,withacorrespondingincreaseinadditionalpaid-incapital.
Inaddition,ShiningGlobealsoagreedtotransferatotalof26,271,300ordinarysharesforservicestoberenderedbysomeofthoseindividualsoverthreeyears,commencingJanuary1,2000.
Thetotalestimatedfairvalueoftheseshares,valuedatUS$0.
05pershareatthedateofgrant,isrecognizedasdeferredcompensation,whichwillbeamortizedovertherelatedvestingperiods.
Furthermore,inMarch2000,WilliamLeiDingtransferredapproximately1,900,000sharestocertainemployees,whichweexpectwillresultinsharecompensationcostsofapproximatelyRMB2.
5millionin2000,andhasagreedtotransferatotalofapproximately26,300,000sharestoemployeesoveraperiodofthreeyearscommencingJanuary2001.
Dependinguponthefairmarketvalueofthosesharesatthetimetheyaretransferred,wearelikelytoincuradditionalsharecompensationcosts.
69DESCRIPTIONOFSHARECAPITALAsofthedatehereof,ourauthorizedsharecapitalconsistsof:999,740,000,000ordinaryshares,parvalueofUS$0.
0001each;3,000,000SeriesApreferenceshares,parvalueofUS$0.
01each;and2,600,000SeriesBpreferenceshares,parvalueUS$0.
01each.
Asofthedatehereof,thereare:2,004,500,000ordinarysharesissuedandoutstanding;3,000,000SeriesApreferencesharesissuedandoutstanding;and2,560,556SeriesBpreferencesharesissuedandoutstanding.
AllofourissuedandoutstandingSeriesAandSeriesBpreferenceshareswillautomaticallybeconvertedintoordinarysharesonabasisofonehundredordinarysharestoonepreferenceshareupontheclosingofthisoffering.
WeareaCaymanIslandscompanyandouraffairsaregovernedbyourMemorandumandArticlesofAssociationandtheCompaniesLaw(1998Revision)oftheCaymanIslands.
Upontheclosingofthisoffering,wewilladoptanAmendedandRestatedMemorandumandArticlesofAssociation.
ThefollowingaresummariesofmaterialprovisionsofourAmendedandRestatedMemorandumandArticlesofAssociationandtheCompaniesLawinsofarastheyrelatetothematerialtermsofourordinaryshares.
WehaveledcopiesofourcompleteAmendedandRestatedMemorandumandArticlesofAssociationasexhibitstoourregistrationstatementonFormF-1.
OrdinarySharesGeneral.
Allofouroutstandingordinarysharesarefullypaidandnonassessable.
Certicatesrepresentingtheordinarysharesareissuedinregisteredform.
OurshareholderswhoarenonresidentsoftheCaymanIslandsmayfreelyholdandvotetheirshares.
Dividends.
Theholdersofordinarysharesareentitledtosuchdividendsasmaybedeclaredbyourboardofdirectors.
VotingRights.
Eachordinaryshareisentitledtoonevoteonallmattersuponwhichtheordinarysharesareentitledtovote,includingtheelectionofdirectors.
See''RelatedPartyTransactions—VotingArrangement''regardingTheNewsCorporationLimited'srighttonominateadirectortoourboardofdirectorsandtheagreementofcertainofourshareholderstovoteinfavoroftheelectionofsuchdirector.
Votingatanymeetingofshareholdersisbyshowofhandsunlessapollisdemanded.
ApollmaybedemandedbytheChairmanoranyothershareholderpresentinpersonorbyproxy.
Aquorumrequiredforameetingofshareholdersconsistsofatleasttwoshareholderspresentorbyproxy.
Shareholders'meetingsareheldannuallyandmaybeconvenedbytheboardofdirectorsonitsowninitiativeoruponarequesttothedirectorsbyshareholdersholdingintheaggregate10%ormoreofourvotingsharecapital.
Advancenoticeofatleastvedaysisrequiredfortheconveningoftheannualgeneralmeetingandothershareholdersmeetings.
Anordinaryresolutiontobemadebytheshareholdersrequirestheafrmativevoteofasimplemajorityofthevotesattachingtotheordinarysharescastinageneralmeeting,whileaspecialresolutionrequirestheafrmativevoteofnolessthantwo-thirdsofthevotescastattachingtotheordinaryshares.
Aspecialresolutionisrequiredformatterssuchasachangeofname.
Holdersoftheordinarysharesmaybyordinaryresolution,amongotherthings,electdirectors,appointauditors,andmakechangesintheamountofourauthorizedsharecapital.
Liquidation.
Onareturnofcapitalonwindinguporotherwise(otherthanonconversion,redemptionorpurchaseofshares)assetsavailablefordistributionamongtheholdersofordinarysharesshallbedistributedamongtheholdersoftheordinarysharesonaproratabasis.
Iftheassetsavailablefordistributionareinsufficienttorepayallofthepaid-upcapital,theassetswillbedistributedsothatthelossesarebornebyourshareholdersproportionately.
70CallsonSharesandForfeitureofShares.
Ourboardofdirectorsmayfromtimetotimemakecallsuponshareholdersforanyamountsunpaidontheirsharesinanoticeservedtosuchshareholdersatleast14dayspriortothespeciedtimeandplaceofpayment.
Thesharesthathavebeencalleduponandremainunpaidaresubjecttoforfeiture.
RedemptionofShares.
Wemayissuesharesonthetermsthattheyare,oratouroptionorattheoptionoftheholdersare,subjecttoredemptiononsuchtermsandinsuchmanneraswemaydeterminebyspecialresolution.
VariationsofRightsofShares.
Alloranyofthespecialrightsattachedtoanyclassofsharesmay,subjecttotheprovisionsoftheCompaniesLaw,bevariedeitherwiththeconsentinwritingoftheholdersofthree-fourthsoftheissuedsharesofthatclassorwiththesanctionofaspecialresolutionpassedatageneralmeetingoftheholdersofthesharesofthatclass.
PreferenceSharesUponcompletionofthisoffering,alloutstandingSeriesAandSeriesBpreferenceshareswillautomaticallybeconvertedintoordinarysharesonthebasisofonehundredordinarysharestoonepreferenceshare.
DifferencesinCorporateLawTheCompaniesLawintheCaymanIslandsismodeledafterthatoftheUnitedKingdombutdoesnotfollowrecentUnitedKingdomstatutoryenactmentsanddiffersfromlawsapplicabletoUnitedStatescorporationsandtheirshareholders.
SetforthbelowisasummaryofthesignicantdifferencesbetweentheprovisionsoftheCompaniesLawapplicabletoNetease.
comandthelawsapplicabletocompaniesincorporatedintheUnitedStatesandtheirshareholders.
MergersandSimilarArrangements.
CaymanIslandslawdoesnotprovideformergersasthatexpressionisunderstoodunderUnitedStatescorporatelaw.
However,therearestatutoryprovisionsthatfacilitatethereconstructionandamalgamationofcompanies,providedthatthearrangementinquestionisapprovedbyamajorityinnumberofeachclassofshareholdersandcreditorswithwhomthearrangementistobemade,andwhomustinadditionrepresentthree-fourthsinvalueofeachsuchclassofshareholdersorcreditors,asthecasemaybe,thatarepresentandvotingeitherinpersonorbyproxyatameeting,ormeetingsconvenedforthatpurpose.
TheconveningofthemeetingsandsubsequentlythearrangementmustbesanctionedbytheGrandCourtoftheCaymanIslands.
Whileadissentingshareholderwouldhavetherighttoexpresstothecourttheviewthatthetransactionoughtnottobeapproved,thecourtcanbeexpectedtoapprovethearrangementifitsatisesitselfthat:thestatutoryprovisionsastomajorityvotehavebeencompliedwith;theshareholdershavebeenfairlyrepresentedatthemeetinginquestion;thearrangementissuchasabusinessmanwouldreasonablyapprove;andandthearrangementisnotonethatwouldmoreproperlybesanctionedundersomeotherprovisionoftheCompaniesLaw.
Whenatake-overofferismadeandacceptedbyholdersof90%oftheshareswithinfourmonths,theofferermay,withinatwomonthperiod,requiretheholdersoftheremainingsharestotransfersuchsharesonthetermsoftheoffer.
AnobjectioncanbemadetotheGrandCourtoftheCaymanIslandsbutthisisunlikelytosucceedunlessthereisevidenceoffraud,badfaithorcollusion.
71Ifthearrangementandreconstructionisthusapproved,thedissentingshareholderwouldhavenorightscomparabletoappraisalrights,whichwouldotherwiseordinarilybeavailabletodissentingshareholdersofUnitedStatescorporations,providingrightstoreceivepaymentincashforthejudiciallydeterminedvalueoftheshares.
Shareholders'Suits.
OurCaymanIslandscounselisnotawareofanyreportedclassactionorderivativeactionhavingbeenbroughtinaCaymanIslandscourt.
Inprinciple,Netease.
comitselfwillnormallybetheproperplaintiffandaderivativeactionmaynotbebroughtbyaminorityshareholder.
However,basedonEnglishauthorities,whichwouldinalllikelihoodbeofpersuasiveauthorityintheCaymanIslands,exceptionstotheforegoingprincipleapplyincircumstancesinwhich:acompanyisactingorproposingtoactillegallyorultravires;theactcomplainedof,althoughnotultravires,couldbeeffectedonlyifauthorizedbymorethanasimplemajorityvotewhichhasnotbeenobtained;andthosewhocontrolthecompanyareperpetratinga''fraudontheminority.
''IndemnicationCaymanIslandslawdoesnotlimittheextenttowhichacompany'sarticlesofassociationmayprovideforindemnicationofofcersanddirectors,excepttotheextentanysuchprovisionmaybeheldbytheCaymanIslandscourtstobecontrarytopublicpolicy,suchastoprovideindemnicationagainstcivilfraudortheconsequencesorcommittingacrime.
OurArticlesofAssociationprovideforindemnicationofofcersanddirectorsforlosses,damages,costsandexpensesincurredintheircapacitiesassuch,exceptthroughtheirownwillfulneglectordefault.
InsofarasindemnicationforliabilitiesarisingundertheSecuritiesActof1933maybepermittedtodirectors,ofcersorpersonscontrollingtheregistrantpursuanttotheforegoingprovisions,wehavebeeninformedthatintheopinionoftheSecuritiesandExchangeCommissionsuchindemnicationisagainstpublicpolicyasexpressedintheSecuritiesActof1933andthereforeisunenforceable.
RegistrationRightsUnderthetermsofourinvestors'rightsagreementswithcertainofourshareholders,includingShiningGlobeandTheNewsCorporation,atanytimeonorafterthedatewhichissixmonthsaftertheclosingofthisoffering,anyholderofoutstandingordinarysharesnotpreviouslysoldtothepublicoreligibleforsalepursuanttoRule144(k)inanythree-monthperiodwhoisapartytotheinvestors'rightsagreementmay,ononeoccasiononly,requireustoregisterforpublicsalealloranyportionoftheregistrablesharesheldbythepartiestotheinvestors'rightsagreementwhorequestinclusionintheregistration.
RegistrablesharesconsistofordinarysharesthatwereissueduponconversionofourSeriesAandSeriesBpreferenceshares.
Weareonlyrequiredtoregistersuchsharesiftheyhaveananticipatedaggregatepublicofferingprice,beforeunderwritingdiscountsandcommissions,ofatleastUS$2million.
Further,ifwebecomeeligibletoleregistrationstatementsonFormF-3undertheSecuritiesAct,holdersofoutstandingregistrableshareswhoarepartiestotheinvestor'srightsagreementmayrequireustoregisteronFormF-3forpublicsalealloranyportionoftheregistrablesharesheldbythepartiestotheinvestors'rightsagreementwhorequestinclusionintheregistration.
WeareonlyrequiredtoeffectsuchregistrationonFormF-3ifallsharestoberegisteredhaveanaggregatepricetothepublicofatleastUS$1millionandifwehavenotalreadyeffectedtwosuchregistrationswithintheprevioustwelvemonths.
Inaddition,holdersofregistrableshareswhoarepartiestotheinvestors'rightsagreementsmay,ononeoccasiononlyperholder,requireustoregistertheirordinaryshareswhenweleanyregistrationstatementundertheSecuritiesActotherthanaregistrationstatementrelatingtoanyemployeebenetplanorcorporatereorganization.
Thistypeofregistrationrightisknownasa''piggyback''registrationright.
72Theforegoingregistrationrightsaresubjecttocertainconditionsandlimitations,including:therightoftheunderwritersinanyunderwrittenofferingtolimitthenumberofordinarysharestoberegisteredforpublicsalebyshareholders.
ourrighttodelayforupto60daysduringanytwelvemonthperiodthelingofaregistrationstatementifourboardofdirectorsdeterminesthattheregistrationwouldbeseriouslydetrimentaltousandourshareholdersatthattime.
Wearegenerallyrequiredtobearalloftheexpensesofallregistrations,exceptunderwritingdiscountsandcommissions.
RegistrationofanyoftheordinarysharesheldbyshareholderswithregistrationrightswouldresultinthosesharesbecomingfreelytradablewithoutrestrictionundertheSecuritiesActimmediatelyaftertheeffectivenessoftheregistration.
Wehaveagreedtoindemnifytheholdersofregistrationrightsinconnectionwithdemand,FormF-3andpiggybackregistrationsincertaincircumstances.
Ourobligationsundertheinvestors'rightsagreementstoregisterordinarysharesterminatethreeyearsaftertheclosingofthisoffering.
Co-SaleRightsSee''RelatedPartyTransactions—Co-SaleRights''regardingtherightofTheNewsCorporationLimitedtoparticipateinsalesofsharesofourordinarysharesbyShiningGlobe.
InspectionofBooksandRecordsHoldersofourADSswillhavenogeneralrightunderCaymanIslandslawtoinspectorobtaincopiesofourlistofshareholdersorourcorporaterecords.
However,wewillprovideourshareholderswithannualauditednancialstatements.
See''WhereYouCanFindAdditionalInformation''onpage95.
73DESCRIPTIONOFAMERICANDEPOSITARYSHARESTheBankofNewYorkwillactasthedepositarybankfortheAmericanDepositaryShares.
AmericanDepositarySharesarefrequentlyreferredtoas''ADSs''andrepresentownershipinterestsinsecuritiesthatareondepositwithadepositarybank.
ADSsarenormallyrepresentedbycerticatesthatarecommonlyknownasAmericanDepositaryReceiptsor''ADRs.
''Thedepositarybanktypicallyappointsacustodiantosafekeepthesecuritiesondeposit.
Inthiscase,thecustodianisTheHongkongandShanghaiBankingCorporationLimited,CustodyandClearing,HongKongofce.
WehaveappointedTheBankofNewYorkasdepositarybankpursuanttoadepositagreementtobeenteredintobyus,TheBankofNewYorkasdepositary,registeredholdersofoutstandingADSsandtheownersofabenecialinterestinADSsevidencedbyADRs.
YoushouldreadthissummarytogetherwiththedepositagreementandtheADR.
Youcaninspectacopyofthedepositagreementatthecorporatetrustofceofthedepositary,currentlylocatedat101BarclayStreet,NewYork,NewYork10286,andattheprincipalofcesofthecustodian,whichwillactasagentofdepositary,currentlylocatedatBasement1&2,1Queen'sRoadCentral,HongKong.
Wehavealsoledacopyofthedepositagreementasanexhibittotheregistrationstatementthatincludesthisprospectus.
WeareprovidingyouwithasummarydescriptionoftheADSsandyourrightsasanownerofADSs.
Pleaserememberthatsummariesbytheirnaturelacktheprecisionoftheinformationsummarizedandthataholder'srightsandobligationsasanownerofADSswillbedeterminedbythedepositagreementandnotbythissummary.
WeurgeyoutoreviewthedepositagreementinitsentiretyaswellastheformofADRattachedtothedepositagreement.
AmericanDepositaryReceiptsTheBankofNewYorkwillissuetheADRs.
TheownershipinterestineachsharewillberepresentedbyoneADR.
Theshares,ortherighttoreceiveshares,willbedepositedbyuswiththecustodian.
EachADRwillalsorepresentsecurities,cashorotherpropertydepositedwithTheBankofNewYorkbutnotdistributedtoADRholders.
YoumayholdADRseitherdirectlyorindirectlythroughyourbrokerorothernancialinstitution.
IfyouholderADRsdirectly,youareanADRholder.
ThisdescriptionassumesyouholdyourADRsdirectly.
IfyouholdtheADRsindirectly,youmustrelyontheproceduresofyourbrokerorothernancialinstitutiontoasserttherightsofADRholdersdescribedinthissection.
Youshouldconsultwithyourbrokerornancialinstitutiontondoutwhatthoseproceduresare.
BecauseTheBankofNewYorkwillactuallybethelegalowneroftheshares,youmustrelyonittoexercisetherightsofashareholder.
TheobligationsofTheBankofNewYorkaresetoutinadepositagreementamongus,TheBankofNewYorkandyou,asanADRholder.
ThedepositagreementandtheADRsaregenerallygovernedbyNewYorklaw.
However,ourobligationstotheholdersofordinaryshareswillcontinuetobegovernedbythelawsoftheCaymanIslandswhichmaybedifferentfromthelawsintheUnitedStates.
ShareDividendsandOtherDistributionsTheBankofNewYorkhasagreedtopaytoyouthecashdividendsorotherdistributionsitorthecustodianreceivesonsharesorotherdepositedsecuritiesafterdeductingitsfeesandexpenses.
YouwillreceivethesedistributionsinproportiontothenumberofsharesyourADRsrepresent.
74Cash.
TheBankofNewYorkwillconvertanycashdividendorothercashdistributionwepayonthesharesintoU.
S.
dollars,ifitcandosoonareasonablebasisandcantransfertheU.
S.
dollarstotheUnitedStates.
IfthatisnotpossibleorifanyapprovalfromChinesegovernmentisneededandcannotbeobtained,thedepositagreementallowsTheBankofNewYorktodistributetherenminbionlytothoseADRholderstowhomitispossibletodoso.
ItwillholdtherenminbiitcannotconvertfortheaccountoftheADRholderswhohavenotbeenpaid.
Itwillnotinvesttherenminbianditwillnotbeliableforinterest.
Beforemakingadistribution,anywithholdingtaxesthatmustbepaidunderUnitedStateslawwillbededucted.
See''Taxation—UnitedStatesFederalIncomeTaxation—U.
S.
Holders—TaxationofDividendsandotherDistributionsontheSharesorADSs''onpage84.
TheBankofNewYorkwilldistributeonlywholeU.
S.
dollarsandcentsandwillroundfractionalcentstothenearestwholecent.
IftheexchangeratesuctuateduringatimewhenTheBankofNewYorkcannotconverttherenminbi,youmaylosesomeorallofthevalueofthedistribution.
Shares.
TheBankofNewYorkmaydistributenewADRsrepresentinganyshareswemaydistributeasadividendorfreedistribution,ifwefurnishitpromptlywithsatisfactoryevidencethatitislegaltodoso.
TheBankofNewYorkwillonlydistributewholeADRs.
ItwillsellshareswhichwouldrequireittoissueafractionalADRanddistributethenetproceedsinthesamewayasitdoeswithcash.
IfTheBankofNewYorkdoesnotdistributeadditionalADRs,eachADRwillalsorepresentthenewshares.
RightstoReceiveAdditionalShares.
Ifweofferholdersofourordinarysharesanyrightstosubscribeforadditionalsharesoranyotherrights,TheBankofNewYorkmaymaketheserightsavailabletoyou.
WemustrstinstructTheBankofNewYorktodosoandfurnishitwithsatisfactoryevidencethatitislegaltodoso.
Ifwedonotfurnishthisevidenceand/orgivetheseinstructions,andTheBankofNewYorkdecidesitispracticaltoselltherights,TheBankofNewYorkwillselltherightsanddistributetheproceeds,inthesamewayasitdoeswithcash.
TheBankofNewYorkmayallowrightsthatarenotdistributedorsoldtolapse.
Inthatcase,youwillreceivenovalueforthem.
IfTheBankofNewYorkmakesrightsavailabletoyou,itwillexercisetherightsandpurchasethesharesonyourbehalf.
TheBankofNewYorkwillthendepositthesharesandissueADRstoyou.
Itwillonlyexerciserightsifyoupayittheexercisepriceandanyotherchargestherightsrequireyoutopay.
U.
S.
securitieslawsmayrestrictthesale,deposit,cancellationandtransferoftheADRsissuedafterexerciseofrights.
Forexample,youmaynotbeabletotradetheADRsfreelyintheUnitedStates.
Inthiscase,TheBankofNewYorkmayissuetheADRsunderaseparaterestricteddepositagreementwhichwillcontainthesameprovisionsasthedepositagreement,exceptforthechangesneededtoputtherestrictionsinplace.
OtherDistributions.
TheBankofNewYorkwillsendtoyouanythingelsewedistributeondepositedsecuritiesbymeansitthinksarelegal,fairandpractical.
Ifitcannotmakethedistributioninthatway,TheBankofNewYorkhasachoice.
Itmaydecidetosellwhatwedistributedanddistributethenetproceedsinthesamewayasitdoeswithcashoritmaydecidetoholdwhatwedistributed,inwhichcasetheADRswillalsorepresentthenewlydistributedproperty.
TheBankofNewYorkisnotresponsibleifitdecidesthatitisunlawfulorimpracticaltomakeadistributionavailabletoanyADRholders.
WehavenoobligationtoregisterADRs,shares,rightsorothersecuritiesundertheSecuritiesAct.
WealsohavenoobligationtotakeanyotheractiontopermitthedistributionofADRs,shares,rights,oranythingelsetoADRholders.
Thismeansthatyoumaynotreceivethedistributionwemakeonoursharesoranyvalueforthemifitisillegalorimpracticalforustomakethemavailabletoyou.
75Deposit,WithdrawalandCancellationTheBankofNewYorkwillissueADRsifyouoryourbrokerdepositsharesorevidenceofrightstoreceiveshareswiththecustodian.
Uponpaymentofitsfeesandexpensesandofanytaxesorcharges,suchasstamptaxesorstocktransfertaxesorfees,TheBankofNewYorkwillregistertheappropriatenumberofADRsinthenamesyourequestandwilldelivertheADRsatitsofcetothepersonsyourequest.
YoumayturninyourADRsatTheBankofNewYork'soffice.
Uponpaymentofitsfeesandexpensesandofanytaxesorcharges,suchasstamptaxesorstocktransfertaxesorfees,TheBankofNewYorkwilldeliver:(1)thedeliverableportionoftheunderlyingsharestoanaccountdesignatedbyyou;and(2)thedeliverableportionofanyotherdepositedsecuritiesunderlyingtheADRattheofceofthecustodian.
Or,atyourrequest,riskandexpense,TheBankofNewYorkwilldeliverthedeliverableportionofthedepositedsecuritiesatitsofce.
The''deliverableportion''oftheADSswillbethemaximumnumberofwholeunitsofsharesrepresentedbytheADSsbeingturnedinbyyouatonetime.
IfyouturninADSsthatdonotconstituteanintegralmultipleof5,000ADSs,TheBankofNewYorkwilldelivertoyouthedeliverableportionoftheADSsandanADRrepresentingtheremainingamount.
VotingRightsYoumayinstructTheBankofNewYorktovotethesharesunderlyingyourADRsbutonlyifweaskTheBankofNewYorktoaskforyourinstructions.
Otherwise,youwillnotbeabletoexerciseyourrighttovoteunlessyouwithdrawtheshares.
However,youmaynotknowaboutthemeetingenoughinadvancetowithdrawtheshares.
Ifweaskforyourinstructions,TheBankofNewYorkwillnotifyyouoftheupcomingvoteandarrangetodeliverourvotingmaterialstoyou.
Thematerialswill:(1)describethematterstobevotedon;and(2)explainhowyou,onaspecieddate,mayinstructTheBankofNewYorktovotethesharesorotherdepositedsecuritiesunderlyingyourADRsasyoudirect.
Forinstructionstobevalid,TheBankofNewYorkmustreceivethemonorbeforethedatespecied.
TheBankofNewYorkwilltry,incompliancewithChineselawandtheprovisionsofourmemorandumandarticlesofassociation,tovoteortohaveitsagentsvotethesharesorotherdepositedsecuritiesasyouinstruct.
TheBankofNewYorkwillonlyvoteorattempttovoteasyouinstruct.
WecannotassureyouthatyouwillreceivethevotingmaterialsintimetoensurethatyoucaninstructTheBankofNewYorktovoteyourshares.
Inaddition,TheBankofNewYorkanditsagentsarenotresponsibleforfailingtocarryoutvotinginstructionsorforthemannerofcarryingoutvotinginstructions.
Thismeansthatyoumaynotbeabletoexerciseyourrighttovoteandtheremaybenothingyoucandoifyoursharesarenotvotedasyourequested.
76FeesandExpensesADRholdersmustpay:For:US$5.
00(orless)per100ADSsEachissuanceofanADR,includingasaresultofadistributionofsharesorrightsorotherpropertyEachcancellationofanADR,includingiftheagreementterminatesUS$1.
50(orless)perADSRegistrationoftransferofreceiptsUS$0.
02(orless)perADSAnycashpaymentRegistrationorTransferFeesTransferandregistrationofsharesontheshareregisteroftheForeignRegistrarfromyournametothenameofTheBankofNewYorkoritsagentwhenyoudepositorwithdrawsharesExpensesincurredbyTheBankofNewYorkConversionofPRCrenminbitoU.
S.
dollarsCable,telexandfacsimiletransmissionexpensesTaxesandothergovernmentalchargesTheBankofNewYorkortheCustodianhavetopayonanyADRorshareunderlyinganADR,forexample,stocktransfertaxes,stampdutyorwithholdingtaxesAsnecessaryPaymentofTaxesYouwillberesponsibleforanytaxesorothergovernmentalchargespayableonyourADRsoronthedepositedsecuritiesunderlyingyourADRs.
TheBankofNewYorkmayrefusetotransferyourADRsorallowyoutowithdrawthedepositedsecuritiesunderlyingyourADRsuntilsuchtaxesorotherchargesarepaid.
ItmayapplypaymentsowedtoyouorselldepositedsecuritiesunderlyingyourADRstopayanytaxesowedandyouwillremainliableforanydeciency.
Ifitsellsdepositedsecurities,itwill,ifappropriate,reducethenumberofADRstoreectthesaleandpaytoyouanyproceeds,orsendtoyouanyproperty,remainingafterithaspaidthetaxes.
Reclassications,RecaptalizationsandMergersIfwe:Changethenominalorparvalueofourshares;Reclassify,splituporconsolidateanyofthedepositedsecurities;Distributesecuritiesonthesharesthatarenotdistributedtoyou;Recapitalize,reorganize,merge,liquidate,sellallorsubstantiallyallofourassets;orTakeanysimilaractionThen:Thecash,sharesorothersecuritiesreceivedbyTheBankofNewYorkwillbecomedepositedsecurities.
EachADRwillautomaticallyrepresentitsequalshareofthenewdepositedsecurities.
TheBankofNewYorkmay,andwillifweaskitto,distributesomeorallofthecash,sharesorothersecuritiesitreceived.
ItmayalsoissuenewADRsoraskyoutosurrenderyouroutstandingADRsinexchangefornewADRsidentifyingthenewdepositedsecurities.
77AmendmentandTerminationWemayagreewithTheBankofNewYorktoamendthedepositagreementandtheADRswithoutyourconsentforanyreason.
Iftheamendmentwillcauseanyofthefollowingresults,theamendmentwillbecomeeffective30daysafterTheBankofNewYorknotiesyouoftheamendment:addsorincreasesfeesorcharges,exceptfor:—taxesandothergovernmentcharges;—registrationfees;—cable,telexorfacsimiletransmissioncosts;or—deliverycostsorothersuchexpenses;orprejudicesanysubstantialrightofADRholders.
Atthetimeanamendmentbecomeseffective,youareconsidered,bycontinuingtoholdyourADR,toagreetotheamendmentandtobeboundbytheADRsandthedepositagreementasamended.
TheBankofNewYorkwillterminatethedepositagreementifweaskittodoso.
Insuchcase,TheBankofNewYorkmustnotifyyouatleast30daysbeforetermination.
TheBankofNewYorkmayalsoterminatethedepositagreementifTheBankofNewYorkhastoldusthatitwouldliketoresignandwehavenotappointedanewdepositarybankwithin90days.
Aftertermination,TheBankofNewYorkanditsagentswillberequiredtodoonlythefollowingunderthedepositagreement:adviseyouthatthedepositagreementisterminated;andcollectdistributionsonthedepositedsecuritiesanddeliverthedeliverableportionofsharesandotherdepositedsecuritiesuponcancellationofADRs.
Oneyearaftertermination,TheBankofNewYorkmaysellanyremainingdepositedsecuritiesbypublicorprivatesale.
Afterthat,TheBankofNewYorkwillholdtheproceedsofthesale,aswellasanyothercashitisholdingunderthedepositagreementfortheproratabenetoftheADRholdersthathavenotsurrenderedtheirADRsorareunabletosurrendertheirADRsbecausetheyrepresentlessthanaunitofshares.
Itwillnotinvestthemoneyandwillhavenoliabilityforinterest.
TheBankofNewYork'sonlyobligationswillbeanindemnicationobligationandanobligationtoaccountfortheproceedsofthesaleandothercash.
Aftertermination,ouronlyobligationswillbeanindemnicationobligationandourobligationtopayspeciedamountstoTheBankofNewYork.
LimitationsonObligationsandLiabilitytoADRHoldersThedepositagreementexpresslylimitsourobligationsandtheobligationsofTheBankofNewYork,anditlimitsourliabilityandtheliabilityofTheBankofNewYork.
WeandTheBankofNewYork:areonlyobligatedtotaketheactionsspecicallyprovidedforinthedepositagreementwithoutnegligenceorbadfaith;arenotliableifeitherispreventedordelayedbylaworcircumstancesbeyondtheircontrolfromperformingtheirobligationsunderthedepositagreement;78arenotliableifeitherexercisesdiscretionpermittedunderthedepositagreement;havenoobligationtobecomeinvolvedinalawsuitorotherproceedingrelatedtotheADRsorthedepositagreementonyourbehalfofanyotherparty;andmayrelyuponanydocumentstheybelieveingoodfaithtobegenuineandtohavebeensignedorpresentedbytheproperparty.
Inthedepositagreement,weandTheBankofNewYorkagreetoindemnifyeachotherunderdesignatedcircumstances.
RequirementsforDepositaryActionsBeforeTheBankofNewYorkwillissueorregisterthetransferofanADR,makeadistributiononanADR,orprocessawithdrawalofshares,TheBankofNewYorkmayrequire:paymentofstocktransferorothertaxesorothergovernmentalchargesandtransferorregistrationfeeschargedbythirdpartiesforthetransferofanysharesorotherdepositedsecurities;productionofsatisfactoryproofoftheidentityandgenuinenessofanysignatureorotherinformationitdeemsnecessary;andcompliancewithregulationsitmayestablish,fromtimetotime,consistentwiththedepositagreement,includingpresentationoftransferdocuments.
TheBankofNewYorkmayrefusetodeliver,transferorregistertransfersofADRsgenerallywhenourbooksorthebooksofTheBankofNewYorkareclosed,oratanytimeifTheBankofNewYorkorwethinkitadvisabletodoso.
YouhavetherighttocancelyourADRsandwithdrawtheunderlyingsharesatanytimeexcept:whentemporarydelaysarisebecause:(1)TheBankofNewYorkorwehavecloseditsorourtransferbooks;(2)thetransferofsharesisblockedtopermitvotingatashareholders'meeting;or(3)wearepayingadividendontheshares;whenyouorotherADRholdersseekingtowithdrawsharesowemoneytopayfees,taxesandsimilarcharges;orwhenitisnecessarytoprohibitwithdrawalsinordertocomplywithanylawsorgovernmentalregulationsthatapplytoADRsortothewithdrawalofsharesorotherdepositedsecurities.
Thisrightofwithdrawalmaynotbelimitedbyanyotherprovisionofthedepositagreement.
Pre-ReleaseofADRsIncompliancewiththeprovisionsofthedepositagreement,TheBankofNewYorkmayissueADRsbeforedepositoftheunderlyingshares.
Thisiscalledapre-releaseoftheADR.
TheBankofNewYorkmayalsodeliversharesuponcancellationofpre-releasedADRs,eveniftheADRsarecancelledbeforethepre-releasetransactionhasbeenclosedout.
Apre-releaseisclosedoutassoonastheunderlyingsharesaredeliveredtoTheBankofNewYork.
TheBankofNewYorkmayreceiveADRsinsteadofsharestocloseoutapre-release.
TheBankofNewYorkmaypre-releaseADRsonlyunderthefollowingconditions:beforeoratthetimeofthepre-release,thepersontowhomthepre-releaseisbeingmademustrepresenttoTheBankofNewYorkinwritingthatitoritscustomerownsthesharesorADRstobedeposited;79thepre-releasemustbefullycollateralizedwithcashorothercollateralthatTheBankofNewYorkconsidersappropriate;andTheBankofNewYorkmustbeabletocloseoutthepre-releaseonnotmorethanvebusinessdays'notice.
Inaddition,TheBankofNewYorkwilllimitthenumberofADRsthatmaybeoutstandingatanytimeasaresultofpre-releaseto30%oftotalsharesdeposited,althoughTheBankofNewYorkmaydisregardthelimitfromtimetotime,ifitthinksitisappropriatetodoso.
80SHARESELIGIBLEFORFUTURESALEUponcompletionofthisoffering,wewillhaveoutstanding4,500,000ADSsrepresentingapproximately15.
0%ofourordinaryshares.
AlloftheADSssoldinthisofferingandtheordinarysharestheyrepresentwillbefreelytransferablebypersonsotherthanour''afliates''withoutrestrictionorfurtherregistrationundertheSecuritiesAct.
SalesofsubstantialamountsofourADSsinthepublicmarketcouldadverselyaffectprevailingmarketpricesofourADSs.
Priortothisoffering,therehasbeennopublicmarketforourordinarysharesortheADSs,andwhileapplicationhasbeenmadefortheADSstobequotedontheNasdaqNationalMarket,wecannotassureyouthataregulartradingmarketwilldevelopintheADSs.
WedonotexpectthatatradingmarketwilldevelopforourordinarysharesnotrepresentedbytheADSs.
Lock-UpAgreementsOurdirectors,executiveofcers,holdersofourpreferencesharesand5%shareholdershavesignedlock-upagreementsunderwhichtheyhaveagreed,subjecttosomeexceptions,nottotransferordisposeof,directlyorindirectly,anyofourordinarysharesintheformofADSsorotherwise,oranysecuritiesconvertibleintoorexchangeableorexercisableforsharesofourordinaryshares,intheformofADSsorotherwise,foraperiodof180daysafterthedateofthisprospectus.
Theseagreementsarediscussedin''Underwriting—NoSalesofSimilarSecurities''onpage89ofthisprospectus.
Aftertheexpirationofthe180-dayperiod,theordinarysharesorADSsheldbyourdirectors,executiveofcers,holdersofourpreferencesharesor5%shareholdersmaybesoldsubjecttotherestrictionsunderRule144undertheSecuritiesActorbymeansofregisteredpublicofferings.
Rule144Ingeneral,underRule144ascurrentlyineffect,aperson(orpersonswhosesharesareaggregated),whohasbeneciallyownedourordinarysharesforatleastoneyearisentitledtosellwithinanythreemonthperiodanumberofshares,intheformofADSsorotherwise,thatdoesnotexceedthegreaterofthefollowing:1%ofthethenoutstandingnumberofsharesofourordinaryshares,intheformofADSsorotherwise,whichwillequalapproximately30.
1millionsharesimmediatelyafterthisoffering;ortheaverageweeklytradingvolumeofourordinaryshares,intheformofADSsorotherwise,duringthefourcalendarweeksprecedingthedateonwhichnoticeofthesaleisledwiththeSecuritiesandExchangeCommission.
SalesunderRule144mustbethroughunsolicitedbrokers'transactions.
Theyarealsosubjecttomannerofsaleprovisions,noticerequirementsandtheavailabilityofcurrentpublicinformationaboutus.
Rule144(k)UnderRule144(k),apersonwhoisnotoneofourafliatesatanytimeduringthethreemonthsprecedingasale,andwhohasbeneciallyownedtheshares,intheformofADSsorotherwise,proposedtobesoldforatleasttwoyears,includingtheholdingperiodofanypriorownerotherthananafliate,isentitledtosellthoseshareswithoutcomplyingwiththemannerofsale,publicinformation,volumelimitationornoticeprovisionsofRule144.
Therefore,unlessotherwiserestricted,''144(k)shares''maybesoldatanytime.
Rule701Ingeneral,underRule701oftheSecuritiesActascurrentlyineffect,eachofouremployees,consultantsoradvisorswhopurchasesshares,intheformofADSsorotherwise,fromusinconnectionwithacompensatorystockplanorotherwrittenagreementiseligibletoresellsuchshares,intheformofADSsorotherwise,inrelianceonRule144,butwithoutcompliancewithsomeoftherestrictions,includingtheholdingperiod,containedinRule144.
81RegistrationRightsUponcompletionofthisoffering,theholdersof556,055,600ofourordinarysharesortheirtransfereeswillbeentitledtorequestthatweregistertheirordinarysharesundertheSecuritiesAct,followingtheexpirationofthelockupagreementsdescribedabove.
See''DescriptionofShareCapital—RegistrationRights''onpage72.
StockIncentivePlansAtJune15,2000,optionstopurchase295,148,000ofourordinaryshareswereissuedandoutstandingunderourstockincentiveplans.
Alloftheseshareswillbeeligibleforsaleinthepublicmarketfromtimetotime,subjecttovestingprovisions,Rule144volumelimitationsapplicabletoourafliatesandtheexpirationoflock-upagreements.
WeintendtolearegistrationstatementundertheSecuritiesActcoveringthe345,675,000ordinarysharesreservedforissuanceunderourstockincentiveplans.
Thisregistrationstatementisexpectedtobeledwithin90daysafterthedateofthisprospectusandwillautomaticallybecomeeffectiveuponling.
Followingsuchling,sharesregisteredundertheregistrationstatementwill,subjecttothelockupagreements,Rule144volumelimitationsapplicabletoafliatesandthelapsingofourrepurchaserights,beavailableforsaleintheopenmarketupontheexerciseofvestedoptions90daysaftertheeffectivedateofthisprospectus.
82TAXATIONThefollowingsummaryofthematerialCaymanIslandsandUnitedStatesfederalincometaxconsequencesofaninvestmentinourADSsisbaseduponlawsandrelevantinterpretationsthereofineffectasofthedateofthisprospectus,allofwhicharesubjecttochange.
Thissummarydoesnotdealwithallpossibletaxconsequencesrelatingtoaninvestmentinthecommonstock,suchasthetaxconsequencesunderstate,localandothertaxlaws.
TotheextentthatthediscussionrelatestomattersofCaymanIslandstaxlaw,itrepresentstheopinionofMaplesandCalderAsia,specialCaymanIslandscounseltous.
TotheextentthediscussionrelatestomattersofUnitedStateslaworlegalconclusionsandsubjecttothequalicationsherein,itrepresentstheopinionofMorrison&FoersterLLP,ourspecialU.
S.
counsel.
CaymanIslandsTaxationTheCaymanIslandscurrentlyleviesnotaxesonindividualsorcorporationsbaseduponprots,income,gainsorappreciationandthereisnotaxationinthenatureofinheritancetaxorestateduty.
TherearenoothertaxeslikelytobematerialtoNetease.
comleviedbytheGovernmentoftheCaymanIslandsexceptforstampdutieswhichmaybeapplicableoninstrumentsexecutedin,orafterexecutionbroughtwithinthejurisdictionoftheCaymanIslands.
TheCaymanIslandsisnotpartytoanydoubletaxtreaties.
TherearenoexchangecontrolregulationsorcurrencyrestrictionsintheCaymanIslands.
UnitedStatesFederalIncomeTaxationThefollowingisasummaryoftheprincipalUnitedStatesfederalincometaxconsequencesunderpresentlawofaninvestmentinthesharesorADSs.
ThissummaryappliesonlytoinvestorsthatholdthesharesorADSsascapitalassetsandthathavetheU.
S.
dollarastheirfunctionalcurrency.
Thefollowingdiscussiondoesnotdealwiththetaxconsequencestoanyparticularinvestorortopersonsinspecialtaxsituationssuchas:banks;insurancecompanies;brokerdealers;tradersthatelecttomarktomarket;tax-exemptentities;personsliableforalternativeminimumtax;personsholdingashareorADSaspartofastraddle,hedging,conversionorintegratedtransaction;orholdersthatactuallyorconstructivelyown10%ormoreofourvotingstock.
ProspectivepurchasersareurgedtoconsulttheirtaxadvisorsabouttheUnitedStatesfederal,stateandlocaltaxconsequencestothemofthepurchase,ownershipanddispositionofsharesorADSs.
ThediscussionbelowoftheUnitedStatesfederalincometaxconsequencesto''U.
S.
Holders''willapplyifyouarethebenecialownerofsharesorADSsandyouareacitizenorresidentoftheUnitedStates;acorporationorpartnershiporganizedunderthelawsoftheUnitedStates,anyStateortheDistrictofColumbia;83anestatewhoseincomeissubjecttoUnitedStatesfederalincometaxationregardlessofitssource;atrustthatissubjecttothesupervisionofacourtwithintheUnitedStatesandthecontrolofoneormoreUnitedStatespersons;oratrustthathasavalidelectionineffectunderapplicableU.
S.
TreasuryregulationstobetreatedasaUnitedStatesperson.
IfyouarenotdescribedasaU.
S.
Holder,youwillbeconsidereda''Non-U.
S.
Holder.
''Non-U.
S.
HoldersshouldconsultthediscussionbelowregardingtheUnitedStatesfederalincometaxconsequencesapplicabletoNon-U.
S.
Holders.
U.
S.
HoldersTaxationofDividendsandOtherDistributionsontheSharesorADSsSubjecttothepassiveforeigninvestmentcompanyrulesdiscussedbelow,allourdistributionstoyouwithrespecttothesharesorADSs,otherthancertainproratadistributionsofoursharesorADSs,willbeincludibleinyourgrossincomeasordinarydividendincomewhenyou,inthecaseofshares,orTheBankofNewYork,inthecaseofADSs,receivethedistribution,butonlytotheextentthatthedistributionispaidoutofourcurrentoraccumulatedearningsandprots.
Forthispurpose,earningsandprotswillbecomputedunderUnitedStatesfederalincometaxprinciples.
Thedividendswillnotbeeligibleforthedividends-receiveddeductionallowedtocorporations.
Totheextentthattheamountofthedistributionexceedsourcurrentandaccumulatedearningsandprots,itwillbetreatedrstasatax-freereturnofyourtaxbasisinyoursharesorADSs,andtotheextenttheamountofthedistributionexceedsyourtaxbasis,theexcesswillbetaxedascapitalgain.
DividendspaidinrenminbiwillbeincludedinyourincomeasaU.
S.
dollaramountbasedontheexchangerateineffectonthedatethatyouorTheBankofNewYorkreceivesthedividend,regardlessofwhetherthepaymentisinfactconvertedintoU.
S.
dollars.
IfyoudonotreceiveU.
S.
dollarsonthedatethedividendisdistributed,youwillberequiredtoincludeeithergainorlossinincomewhenyoulaterexchangetherenminbiforU.
S.
dollars.
ThegainorlosswillbeequaltothedifferencebetweentheU.
S.
dollarvalueoftheamountthatyouincludeinincomewhenyoureceivethedividendandtheamountthatyoureceivewhenyouactuallyexchangetherenminbiforU.
S.
dollars.
ThegainorlossgenerallywillbeordinaryincomeorlossfromUnitedStatessources.
Ifwedistributetoyounon-cashproperty,youwillincludeinincomeanamountequaltotheU.
S.
dollarequivalentofthefairmarketvalueofthepropertyonthedatethatitisdistributed.
Dividendswillconstituteforeignsourceincomeforforeigntaxcreditlimitationpurposes.
Thelimitationonforeigntaxeseligibleforcreditiscalculatedseparatelywithrespecttospecicclassesofincome.
Forthispurpose,dividendsdistributedbyuswithrespecttothesharesorADSswillbe''passiveincome''or,inthecaseofcertainU.
S.
Holders,''nancialservicesincome.
''Specialrulesapplytoindividualswhoseforeignsourceincomeduringthetaxableyearconsistsentirelyof''qualiedpassiveincome''andwhosecreditableforeigntaxespaidoraccruedduringthetaxableyeardonotexceed$300($600inthecaseofajointreturn).
Further,inparticularcircumstances,aU.
S.
Holderthat(i)hasheldthesharesorADSsforlessthanaspeciedminimumperiodduringwhichitisnotprotectedfromriskofloss,(ii)isobligatedtomakepaymentsrelatedtothedividends,or(iii)holdsthesharesorADSsinarrangementsinwhichtheU.
S.
Holder'sexpectedeconomicprot,afternon-U.
S.
taxes,isinsubstantialwillnotbeallowedaforeigntaxcreditforforeigntaxesimposedondividendspaidonthesharesorADSs.
YouwillnotbeeligibleforaforeigntaxcreditagainstyourU.
S.
federalincometaxliabilityfortaxespaidbyusthataredeemedunderChineselawtohavebeenpaidbyourshareholders.
84DistributionstoyouofsharesorADSsorrightstosubscribeforsharesorADSsthatarereceivedaspartofaproratadistributiontoallourshareholdersshouldnotbesubjecttoUnitedStatesfederalincometax.
ThebasisofyournewsharesorADSsorrightssoreceivedwillbedeterminedbyallocatingyourbasisintheoldsharesbetweentheoldsharesorADSsandthenewsharesorADSsorrightsreceived,basedontheirrelativefairmarketvaluesonthedateofdistribution.
However,thebasisoftherightswillbezeroif(i)thefairmarketvalueoftherightsislessthan15%ofthefairmarketvalueoftheoldsharesorADSsatthetimeofdistributionor(ii)therightsarenotexercisedandexpire.
TaxationofDispositionofSharesorADSsSubjecttothePassiveForeignInvestmentCompanyRulesdiscussedbelow,youwillrecognizetaxablegainorlossonanysaleorexchangeofashareofADSequaltothedifferencebetweentheamountrealized(inU.
S.
dollars)fortheshareorADSandyourtaxbasis(inU.
S.
dollars)intheshareorADS.
Thegainorlosswillbecapitalgainorloss.
IfyouareanindividualwhohasheldtheshareorADSformorethanoneyear,youwillbeeligibleforreducedratesoftaxation(generally20%).
YoumaydeductanylossresultingfromthesaleorexchangeofashareorADSonlyagainstothercapitalgains.
Ifyouareanindividual,uptoUS$3,000ofcapitallossinexcessofyourcapitalgainsmaybedeductedagainstordinaryincome.
Excesslossesmaybecarriedforward.
AnygainorlossthatyourecognizewillgenerallybetreatedasUnitedStatessourceincomeorloss.
PassiveForeignInvestmentCompanyWebelievethatwearenotapassiveforeigninvestmentcompanyforUnitedSatesfederalincometaxpurposesanddonotexpecttobecomeapassiveforeigninvestmentcompanyinthefuture.
Acompanyisconsideredapassiveforeigninvestmentcompanyforanytaxableyearifeitheratleast75%ofitsgrossincomeispassiveincome,oratleast50%ofthevalueofitsassets(basedonanaverageofthequarterlyvaluesoftheassetsduringataxableyear)isattributabletoassetsthatproduceorareheldfortheproductionofpassiveincome.
Wewillbetreatedasowningourproportionateshareoftheassetsandearningourproportionateshareoftheincomeofanyothercorporationinwhichweown,directlyorindirectly,morethan25%(byvalue)ofthestock.
Indeterminingthatwearenotapassiveforeigninvestmentcompany,wearerelyingonourprojectedacquisitionandcapitalexpenditureplansforthecurrentyearandforfutureyears.
Inaddition,thisdeterminationisbasedonourcurrentvaluationofourassets,includinggoodwill.
Incalculatinggoodwill,wehavevaluedourtotalassetsbasedonourtotalmarketvaluedeterminedusingthelowestsellingpriceofthesharesforthepastyearandhavemadeanumberofassumptionsregardingtheamountofthisvalueallocabletogoodwill.
Webelieveourvaluationapproachisreasonable.
However,itispossiblethattheInternalRevenueServicewillchallengethevaluationofourgoodwill,whichmayalsoresultinusbeingclassiedasapassiveforeigninvestmentcompany.
Inaddition,ifouractualacquisitionsandcapitalexpendituredonotmatchourprojections,wemaybecomeapassiveforeigninvestmentcompany.
Wemustmakeaseparatedeterminationeachyearastowhetherweareapassiveforeigninvestmentcompany.
Asaresult,ourpassiveforeigninvestmentcompanystatusmaychange.
Inparticular,aswehavevaluedourgoodwillbasedonthemarketvalueofoursharesorADSs,adecreaseinthepriceofoursharesorADSsbelowthelowesttradingpriceofthesharesorADSsforthepastyear,mayresultinusbecomingapassiveforeigninvestmentcompany.
IfweareapassiveforeigninvestmentcompanyforanytaxableyearduringwhichyouholdsharesorADSs,youwillbesubjecttospecialtaxruleswithrespecttoany''excessdistribution''thatyoureceiveand85anygainyourealizefromasaleorotherdisposition(includingapledge)ofthesharesorADSs,unlessyoumakea''mark-to-market''electionasdiscussedbelow.
Distributionsyoureceiveinataxableyearthataregreaterthan125%oftheaverageannualdistributionsyoureceivedduringtheshorterofthethreeprecedingtaxableyearsoryourholdingperiodforthesharesorADSswillbetreatedasanexcessdistribution.
UnderthesespecialtaxrulestheexcessdistributionorgainwillbeallocatedratablyoveryourholdingperiodforthesharesorADSs,theamountallocatedtothecurrenttaxableyear,andanytaxableyearpriortothersttaxableyearinwhichwewereapassiveforeigninvestmentcompany,willbetreatedasordinaryincome,andtheamountallocatedtoeachotheryearwillbesubjecttotaxatthehighesttaxrateineffectforthatyearandtheinterestchargegenerallyapplicabletounderpaymentsoftaxwillbeimposedontheresultingtaxattributabletoeachsuchyear.
Thetaxliabilityforamountsallocatedtoyearspriortotheyearofdispositionor''excessdistribution''cannotbeoffsetbyanynetoperatinglosses,andgains(butnotlosses)realizedonthesaleofthesharesorADSscannotbetreatedascapital,evenifyouholdthesharesorADSsascapitalassets.
Ifweareapassiveforeigninvestmentcompany,youmayavoidtaxationundertherulesdescribedabovebymakinga''qualiedelectingfund''electiontoincludeyourshareofourincomeonacurrentbasis,ora''deemedsale''electiononcewenolongerqualifyasapassiveforeigninvestmentcompany.
However,youmaymakeaqualiedelectingfundelectiononlyifweagreetofurnishyouannuallywithcertaintaxinformation,andwedonotpresentlyintendtoprepareorprovidesuchinformation.
Alternatively,aU.
S.
Holderof''marketablestock''inapassiveforeigninvestmentcompanymaymakeamark-to-marketelectionforstockofapassiveforeigninvestmentcompanytoelectoutofthetaxtreatmentdiscussedthreeparagraphsabove.
Ifyoumakeamark-to-marketelectionforthesharesorADSs,youwillincludeinincomeeachyearanamountequaltotheexcess,ifany,ofthefairmarketvalueofthesharesorADSsasofthecloseofyourtaxableyearoveryouradjustedbasisinsuchsharesorADSs.
Youareallowedadeductionfortheexcess,ifany,oftheadjustedbasisofthesharesorADSsovertheirfairmarketvalueasofthecloseofthetaxableyear.
However,deductionsareallowableonlytotheextentofanynetmark-to-marketgainsonthestockincludedinyourincomeforpriortaxableyears.
Amountsincludedinyourincomeunderamark-to-marketelection,aswellasgainontheactualsaleorotherdispositionofthesharesorADSs,aretreatedasordinaryincome.
Ordinarylosstreatmentalsoappliestothedeductibleportionofanymark-to-marketlossonthesharesorADSs,aswellastoanylossrealizedontheactualsaleordispositionofthesharesorADSs,totheextentthattheamountofsuchlossdoesnotexceedthenetmark-to-marketgainspreviouslyincludedforsuchsharesorADSs.
YourbasisinthesharesorADSswillbeadjustedtoreectanysuchincomeorlossamounts.
Thetaxrulesthatapplytodistributionsbycorporationswhicharenotpassiveforeigninvestmentcompanieswouldapplytodistributionsbyus.
Themark-to-marketelectionisavailableonlyforstockwhichisregularlytradedonanationalsecuritiesexchangethatisregisteredwiththeCommissionoronNasdaq,oranexchangeormarketthattheU.
S.
SecretaryoftheTreasurydetermineshasrulessufcienttoensurethatthemarketpricerepresentsalegitimateandsoundfairmarketvalue.
WeexpectthattheADSswillbelistedontheNasdaqNationalMarketand,consequently,themark-to-marketelectionwouldbeavailabletoyouwerewetobeorbecomeapassiveforeigninvestmentcompany.
IfyouholdsharesorADSsinanyyearinwhichweareapassiveforeigninvestmentcompany,youwouldberequiredtoleInternalRevenueServiceForm8621regardingdistributionsreceivedonthesharesorADSsandanygainrealizedonthedispositionofthesharesorADSs.
86Non-U.
S.
HoldersIfyouareaNon-U.
S.
Holder,yougenerallywillnotbesubjecttoUnitedStatesfederalincometaxondividendspaidbyusunlesstheincomeiseffectivelyconnectedwithyourconductofatradeorbusinessintheUnitedStates.
YougenerallywillnotbesubjecttoUnitedStatesfederalincometaxonanygainattributabletoasaleorotherdispositionofthesharesorADSsunlesssuchgainiseffectivelyconnectedwithyourconductofatradeorbusinesswithintheUnitedStatesoryouareanaturalpersonwhoispresentintheUnitedStatesfor183daysormoreandcertainotherconditionsexist.
DividendsandgainsthatareeffectivelyconnectedwithyourconductofatradeorbusinessintheUnitedStatesgenerallywillbesubjecttotaxinthesamemannerastheywouldbeifyouwereaU.
S.
Holder.
EffectivelyconnecteddividendsandgainsreceivedbyacorporateNon-U.
S.
Holdermayalsobesubjecttoanadditionalbranchprotstaxata30%rateoralowertaxtreatyrate.
InformationReportingandBackupWithholdingIngeneral,informationreportingforU.
S.
FederalincometaxpurposeswillapplytodistributionsmadeonthesharesorADSspaidwithintheUnitedStatestoanon-corporateUnitedStatespersonandonsalesofthesharesorADSstoorthroughaUnitedStatesofceofabrokerbyanon-corporateUnitedStatesperson.
PaymentsmadeoutsidetheUnitedStateswillbesubjecttoinformationreportinginlimitedcircumstances.
Inaddition,backupwithholdingofU.
S.
Federalincometaxatarateof31%willapplytodistributionsmadeonsharesorADSswithintheUnitedStatestoanon-corporateUnitedStatespersonandonsalesofsharesorADSstoorthroughaUnitedStatesofceofabrokerbyanon-corporateUnitedStatespersonwho:failstoprovideanaccuratetaxpayeridenticationnumber,isnotiedbytheInternalRevenueServicethatbackupwithholdingwillberequired,orincertaincircumstances,failstocomplywithapplicablecerticationrequirements.
TheamountofanybackupwithholdingcollectedwillbeallowedasacreditagainstUnitedStatesfederalincometaxliabilityprovidedthatappropriatereturnsareled.
ANon-U.
S.
Holdergenerallymayeliminatetherequirementforinformationreportingandbackupwithholdingbyprovidingcerticationofitsforeignstatustothepayor,underpenaltiesofperjury,onIRSFormW-8BEN.
87UNDERWRITINGWeintendtooffertheADSsintheU.
S.
andCanadathroughtheU.
S.
underwritersandelsewherethroughtheinternationalmanagers.
MerrillLynch,Pierce,Fenner&SmithIncorporatedandDeutscheBankSecuritiesInc.
areactingasU.
S.
representativesoftheU.
S.
underwritersnamedbelow.
SubjecttothetermsandconditionsdescribedinaU.
S.
purchaseagreementamongusandtheU.
S.
underwriters,andconcurrentlywiththesaleof2,250,000ADSstotheinternationalmanagers,wehaveagreedtoselltotheU.
S.
underwriters,andtheU.
S.
underwritersseverallyhaveagreedtopurchasefromus,thenumberofADSslistedoppositetheirnamesbelow.
U.
S.
UnderwriterNumberofADSsMerrillLynch,Pierce,Fenner&SmithIncorporated1,345,500DeutscheBankSecuritiesInc.
724,500ChaseSecuritiesInc.
60,000SalomonSmithBarneyInc.
60,000UBSWarburgLLC.
60,000Total2,250,000WehavealsoenteredintoaninternationalpurchaseagreementwiththeinternationalmanagersforsaleofADSsoutsidetheU.
S.
andCanadaforwhomMerrillLynchFarEastLimitedandDeutscheBankSecuritiesInc.
areactingasleadmanagers.
Subjecttothetermsandconditionsintheinternationalpurchaseagreement,andconcurrentlywiththesaleof2,250,000ADSstotheU.
S.
underwriterspursuanttotheU.
S.
purchaseagreement,wehaveagreedtoselltotheinternationalmanagers,andtheinternationalmanagersseverallyhaveagreedtopurchasefromus,thenumberofADSslistedoppositetheirnamesbelow.
InternationalManagerNumberofADSsMerrillLynchFarEastLimited1,462,500DeutscheBankSecuritiesInc.
787,500Total2,250,000TheinitialpublicofferingpriceperADSandthetotalunderwritingdiscountperADSareidenticalundertheU.
S.
purchaseagreementandtheinternationalpurchaseagreement.
MerrillLynchFarEastLimitedisactingastheglobalcoordinatorandbookrunnerfortheoffering.
TheU.
S.
underwritersandtheinternationalmanagershaveagreedtopurchasealloftheADSssoldundertheU.
S.
andinternationalpurchaseagreementsifanyoftheseADSsarepurchased.
Ifanunderwriterdefaults,theU.
S.
andinternationalpurchaseagreementsprovidethatthepurchasecommitmentsofthenondefaultingunderwritersmaybeincreasedorthepurchaseagreementsmaybeterminated.
TheclosingsforthesaleofADSstobepurchasedbytheU.
S.
underwritersandtheinternationalmanagersareconditionedononeanother.
WehaveagreedtoindemnifytheU.
S.
underwritersandtheinternationalmanagersagainstcertainliabilities,includingliabilitiesundertheSecuritiesAct,ortocontributetopaymentstheU.
S.
underwritersandinternationalmanagersmayberequiredtomakeinrespectofthoseliabilities.
TheunderwritersareofferingtheADSs,subjecttopriorsale,when,asandifissuedtoandacceptedbythem,subjecttoapprovaloflegalmattersbytheircounsel,includingthevalidityoftheADSs,andotherconditionscontainedinthepurchaseagreements,suchasthereceiptbytheunderwritersofofcer'scerticatesandlegalopinions.
Theunderwritersreservetherighttowithdraw,cancelormodifyofferstothepublicandtorejectordersinwholeorinpart.
88CommissionsandDiscountsTheU.
S.
representativeshaveadvisedusthattheU.
S.
underwritersproposeinitiallytooffertheADSstothepublicattheinitialpublicofferingpriceonthecoverpageofthisprospectusandtodealersatthatpricelessaconcessionnotinexcessofUS$.
651perADS.
TheU.
S.
underwritersmayallow,andthedealersmayreallow,adiscountnotinexcessofUS$.
10perADStootherdealers.
Aftertheinitialpublicoffering,thepublicofferingprice,concessionanddiscountmaybechanged.
Thefollowingtableshowsthepublicofferingprice,underwritingdiscountandproceedsbeforeexpensestous.
TheinformationassumeseithernoexerciseorfullexercisebytheU.
S.
underwritersandtheinternationalmanagersoftheirover-allotmentoptions.
PerADSWithoutOptionWithOptionPublicofferingpriceUS$15.
50US$69,750,000US$80,212,500UnderwritingdiscountUS$1.
085US$4,882,500US$5,614,875Proceeds,beforeexpenses,tousUS$14.
415US$64,867,500US$74,597,625Theexpensesoftheoffering,notincludingtheunderwritingdiscount,areestimatedatUS$2,250,000andarepayablebyus.
Over-allotmentOptionsWehavegrantedoptionstotheU.
S.
underwritersandtheinternationalmanagerstopurchaseupto675,000additionalADSsatthepublicofferingpricelesstheunderwritingdiscount.
TheU.
S.
underwritersandtheinternationalmanagersmayexercisetheseoptionsfor30daysfromthedateofthisprospectussolelytocoveranyover-allotments.
IftheU.
S.
underwritersexercisetheseoptions,eachwillbeobligated,subjecttoconditionscontainedintheU.
S.
purchaseagreement,topurchaseanumberofadditionalADSsproportionatetothatU.
S.
underwriter'sinitialamountreectedintheabovetable.
IntersyndicateAgreementTheU.
S.
underwritersandtheinternationalmanagershaveenteredintoanintersyndicateagreementthatprovidesforthecoordinationoftheiractivities.
Undertheintersyndicateagreement,theU.
S.
underwritersandtheinternationalmanagersmaysellADSstoeachotherforpurposesofresaleattheinitialpublicofferingprice,lessanamountnotgreaterthanthesellingconcession.
Undertheintersyndicateagreement,theU.
S.
underwritersandanydealertowhomtheysellADSswillnotoffertosellorsellADSstonon-U.
S.
ornon-Canadianpersonsortopersonstheybelieveintendtoreselltonon-U.
S.
ornon-Canadianpersons,exceptinthecaseoftransactionsundertheintersyndicateagreement.
Similarly,theinternationalmanagersandanydealertowhomtheysellADSswillnotoffertosellorsellADSstoU.
S.
personsorCanadianpersonsortopersonstheybelieveintendtoreselltoU.
S.
orCanadianpersons,exceptinthecaseoftransactionsundertheintersyndicateagreement.
NoSalesofSimilarSecuritiesWeandourexecutiveofcers,directors,holdersofourpreferencesharesand5%shareholdershaveagreed,withexceptions,nottosellortransferanyADSsandcommonstockfor180daysafterthedateofthisprospectuswithoutrstobtainingthewrittenconsentoftheglobalcoordinator.
Specically,weandtheseotherindividualsandentitieshaveagreednottodirectlyorindirectly:offer,pledge,sellorcontracttosellanyordinarysharesandADSs,sellanyoptionorcontracttopurchaseanyordinarysharesandADSs,89purchaseanyoptionorcontracttosellanyordinarysharesandADSs,grantanyoption,rightorwarrantforthesaleofanyordinarysharesandADSs,lendorotherwisedisposeofortransferanyordinarysharesandADSs,requestordemandthatwelearegistrationstatementrelatedtotheordinarysharesandADS,orenterintoanyswaporotheragreementthattransfers,inwholeorinpart,theeconomicconsequenceofownershipofanyordinarysharesandADSswhetheranysuchswaportransactionistobesettledbydeliveryofordinaryshares,ADSsorothersecurities,incashorotherwise.
Thislockupprovisionappliestoordinaryshares,ADSsandtosecuritiesconvertibleintoorexchangeableorexercisablefororrepayablewithordinarysharesorADSs.
ItalsoappliestoordinarysharesandADSsownednoworacquiredlaterbythepersonexecutingtheagreementorforwhichthepersonexecutingtheagreementlateracquiresthepowerofdisposition.
However,thisrestrictionwillnotlimitourabilityto:issueawardsandsecuritiesissuableupontheexerciseofawardsundertheplansdescribedunder''Management-StockOptionPlans'';andfilearegistrationstatementonFormS-8inordertoregisterthesharesavailableundertheseplans.
issueordinaryshares,ADSsandothersecuritiesinconnectionwithmerger,acquisition,strategicallianceorjointventuretransactions,providedthatuntiltheendofthe180-daylock-upperiod,suchsecuritiesshallnotberegisteredundertheSecuritiesAct,andtherecipientsofsuchsecuritiesshallhaveagreedtothesamelockuprestrictions.
ReservedADSsAtourrequest,theunderwritershavereserved,attheinitialpublicofferingprice,upto225,000ofourADSsincludedintheoffering,forsaletoemployees,consultants,advisors,customersandstrategicpartnersthroughadirectedshareprogram.
ThenumberofADSsavailableforsaletothegeneralpublicwillbereducedtotheextentthatthesepersonspurchasesuchreservedADSs.
TherecanbenoassurancethatanyofthereservedADSswillbepurchased.
AnyreservedADSsthatarenotorallyconrmedforpurchasewithinonedayofthepricingoftheofferingwillbeofferedbytheunderwriterstothegeneralpubliconthesametermsastheotherADSsofferedhereby.
Weintendtograntinterestbearingloanstocertainconsultants,advisors,customersandstrategicpartnerstoenablethemtopurchasesuchreservedADSsinthisoffering.
QuotationontheNasdaqNationalMarketWeexpecttheADSstobeapprovedforquotationontheNasdaqNationalMarket,subjecttonoticeofissuance,underthesymbol''NTES''.
Beforethisoffering,therehasbeennopublicmarketforourordinarysharesorADSs.
Theinitialpublicofferingpricewillbedeterminedthroughnegotiationsamongus,theglobalcoordinator,theU.
S.
representativesandtheleadmanagers.
Inadditiontoprevailingmarketconditions,thefactorstobeconsideredindeterminingtheinitialpublicofferingpriceare:thevaluationmultiplesofpubliclytradedcompaniesthattheglobalcoordinator,theU.
S.
representativesandtheleadmanagersbelievetobecomparabletous,ournancialinformation,thehistoryof,andtheprospectsfor,ourcompanyandtheindustryinwhichwecompete,anassessmentofourmanagement,itspastandpresentoperations,andtheprospectsfor,andtimingof,ourfuturerevenues,90thepresentstateofourdevelopment,andtheabovefactorsinrelationtomarketvaluesandvariousvaluationmeasuresofothercompaniesengagedinactivitiessimilartoours.
AnactivetradingmarketfortheADSsmaynotdevelop.
ItisalsopossiblethataftertheofferingtheADSswillnottradeinthepublicmarketatorabovetheinitialpublicofferingprice.
Theunderwritersdonotexpecttosellmorethan5%oftheADSsintheaggregatetoaccountsoverwhichtheyexercisediscretionaryauthority.
PriceStabilization,ShortPositionsandPenaltyBidsUntilthedistributionoftheADSsiscompleted,SECrulesmaylimitunderwritersandsellinggroupmembersfrombiddingforandpurchasingourADSs.
However,theU.
S.
representativesmayengageintransactionsthatstabilizethepriceoftheADSs,suchasbidsorpurchasestopeg,xormaintainthatprice.
TheunderwritersmaycreateashortpositionintheADSsinconnectionwiththeoffering,i.
e.
,theycouldsellmoreADSsthanarelistedonthecoverofthisprospectus.
TheU.
S.
representativesmayreducethatshortpositionbypurchasingADSsintheopenmarket.
TheU.
S.
representativesmayalsoelecttoreduceanyshortpositionbyexercisingallorpartoftheover-allotmentoptionsdescribedabove.
TheunderwritersmaysellmoreADSsthancouldbecoveredbyexercisingalloftheover-allotmentoptions,inwhichcase,theywouldhavetocoverthesesalesthroughopenmarketpurchases.
PurchasesoftheADSstostabilizeitspriceortoreduceashortpositionmaycausethepriceoftheADSstobehigherthanitmightbeintheabsenceofsuchpurchases.
TheU.
S.
representativesmayalsoimposeapenaltybidonunderwritersandsellinggroupmembers.
ThismeansthatiftheU.
S.
representativespurchaseADSsintheopenmarkettoreducetheunderwriters'shortpositionortostabilizethepriceofsuchADSs,theymayreclaimtheamountofthesellingconcessionfromtheunderwritersandsellinggroupmemberswhosoldthoseADSs.
TheimpositionofapenaltybidmayalsoaffectthepriceoftheADSsinthatitdiscouragesresalesofthoseADSs.
NeitherwenoranyoftheunderwritersmakeanyrepresentationorpredictionastothedirectionormagnitudeofanyeffectthatthetransactionsdescribedabovemayhaveonthepriceoftheADSs.
Inaddition,neitherwenoranyoftheunderwritersmakeanyrepresentationthattheU.
S.
representativesortheleadmanagerswillengageinthesetransactionsorthatthesetransactions,oncecommenced,willnotbediscontinuedwithoutnotice.
OtherRelationshipsSomeoftheunderwritersandtheirafliateshaveengagedin,andmayinthefutureengagein,investmentbankingandothercommercialdealingsintheordinarycourseofbusinesswithus.
Theyhavereceivedcustomaryfeesandcommissionsforthesetransactions.
SellingRestrictionsThisprospectusdoesnotconstituteanofferof,oraninvitationbyoronbehalfof,usorbyoronbehalfoftheunderwriters,tosubscribefororpurchase,anyoftheADSsinanyjurisdictiontoanypersontowhomitisunlawfultomakesuchanofferorsolicitationinthatjurisdiction.
ThedistributionofthisprospectusandtheofferingoftheADSsincertainjurisdictionsmayberestrictedbylaw.
Weandtheunderwritersrequirepersonsintowhosepossessionthisprospectuscomestoinformthemselvesaboutandtoobserveanysuchrestrictions.
91SettlementCycleWeexpectthatdeliveryoftheADSswillbemadeagainstpaymentthereforonoraboutthedatespeciedinthelastparagraphofthecoverpageofthisprospectus,whichisthefourthbusinessdayinNewYorkfollowingthedateofthisprospectus.
PursuanttoRule15c6-1undertheSecuritiesExchangeActof1934,tradesinthesecondarymarketgenerallyarerequiredtosettleinthreebusinessdaysunlessthepartiestoanysuchtradeexpresslyagreeotherwise.
Accordingly,purchaserswhowishtotradetheADSsonthedateofthisprospectusorthenextfoursucceedingbusinessdayswillberequired,byvirtueofthefactthatthesesecuritieswillsettleinT+4,tospecifyanalternatesettlementcycleatthetimeofanysuchtradetopreventafailedsettlementandshouldconsulttheirownadvisors.
92NOTICETOCANADIANRESIDENTSTheOfferingTheofferinginCanadaisbeingmadesolelyintheProvinceofOntario.
ResaleRestrictionsThedistributionoftheADSsinCanadaisbeingmadeonaprivateplacementbasis.
Accordingly,anyresaleofsuchADSsmustbemadeinaccordancewithanexemptionfromtheregistrationandprospectusrequirementsofapplicablesecuritieslaws.
PurchasersoftheADSsareadvisedtoseeklegaladvicepriortoanyresaleoftheADSs.
RepresentationbyPurchasersConrmationsoftheacceptanceofofferstopurchasetheADSswillbesenttopurchasersinCanadawhohavenotwithdrawntheirofferstopurchasepriortotheissuanceofsuchconrmations.
Eachpurchaserwhoreceivesapurchaseconrmationwill,bythepurchaser'sreceiptthereof,bedeemedtorepresenttousandthedealerfromwhomsuchpurchaseconrmationisreceivedthatsuchpurchaserisentitledunderapplicableprovincialsecuritieslawstopurchasesuchADSswithoutthebenetofaprospectusqualiedundersuchsecuritieslaws.
EnforcementofLegalRightsTheADSsbeingofferedarethoseofaforeignissuerandOntariopurchaserswillnotreceivethecontractualrightofactionprescribedbysection32oftheRegulationundertheSecuritiesAct(Ontario)(nowOntarioSecuritiesCommissionRule45-501,21O.
S.
C.
B.
127).
Asaresult,Ontariopurchasersmustrelyonotherremediesthatmaybeavailable,includingcommonlawrightsofactionfordamagesorrescissionorrightsofactionunderthecivilliabilityprovisionsoftheU.
S.
federalsecuritieslaws.
AllofourdirectorsandofcersandtheexpertsnamedhereinmaybelocatedoutsideCanadaand,asaresult,itmaynotbepossibleforCanadianpurchaserstoeffectserviceofprocesswithinCanadauponusorsuchpersons.
AllorasubstantialportionofourassetsandtheassetsofsuchpersonsmaybelocatedoutsideCanadaand,asaresult,itmaynotbepossibletosatisfyajudgmentagainstusorsuchpersonsinCanadaortoenforceajudgmentobtainedinCanadiancourtsagainstusorsuchpersonsoutsideCanada.
Section130.
1oftheSecuritiesAct(Ontario)providesthatwhereanofferingmemorandumcontainsamisrepresentation,apurchaserwhopurchasesasecurityofferedbytheofferingmemorandumduringtheperiodofdistributionshallbedeemedtohavereliedonthemispresentationifitwasamisrepresentationatthetimeofpurchaseandsuchpurchasershallhavearightofactionfordamagesorrecissionagainsttheissueronwhosebehalfthedistributionwasmade.
ExchangeRatesCertainnancialinformationintheprospectusisdisclosedinChineserenminbi.
93Thefollowingtablesetsforth,fortheperiodsindicated,certaininformationwithrespecttotherateofexchangeforChineserenminbiexpressedinCanadiandollars(''Cdn.
$'').
Cdn.
$per1.
00ChineseRenminbiYearAverage(1)PeriodEnd(2)1995.
0.
16430.
16401996.
0.
16400.
16521997.
0.
16700.
17281998.
0.
17920.
18551999.
0.
17950.
1753(1)Representstheaverageofthenoonmid-marketrateasreportedbyDowJones&Company,Inc.
(2)Representsthenoonmid-marketrateasreportedbyDowJones&Company,Inc.
onthelasttradingdayoftheperiod.
94LEGALMATTERSThevalidityoftheADSsandcertainotherlegalmatterswillbepasseduponforusbyMorrison&FoersterLLP,HongKong.
CertainlegalmattersinconnectionwiththisofferingwillbepasseduponfortheunderwritersbyBrown&Wood,HongKong.
ThevalidityoftheordinarysharesrepresentedbytheADSsofferedinthisofferingwillbepasseduponforusbyMaplesandCalderAsia,HongKong.
LegalmattersastoChineselawwillbepasseduponforusbyCommerce&FinanceLawOfce,BeijingandfortheunderwritersbyGongChengLawOfce,Beijing.
Morrison&FoersterLLPmayrelyuponMaplesandCalderAsiawithrespecttomattersgovernedbyCaymanIsland'slawanduponCommerce&FinanceLawOfce,Beijing,withrespecttomattersgovernedbyChineselaw.
Brown&WoodmayrelyuponGongChengLawOfcewithrespecttomattersgovernedbyChineselaw.
PartnersandemployeesofMorrison&FoersterLLPmaypurchaseupto36,000ADSsinthisoffering.
PartnersandemployeesofCommerce&FinanceLawOfcemaypurchaseupto6,000ADSsinthisoffering.
EXPERTSOurconsolidatednancialstatementsasofDecember31,1998and1999andfortheperiodfromJune24,1997(inception)toDecember31,1997andtheyearsendedDecember31,1998and1999includedinthisprospectushavebeenauditedbyArthurAndersenHuaQiang,independentpublicaccountants,asstatedintheirreportsappearingherein,andareincludedinrelianceuponthereportsofArthurAndersenHuaQianggivenontheirauthorityasexpertsinaccountingandauditing.
Thestatementsincludedinthisprospectusunderthecaption''RiskFactors—RisksRelatedtoOurCompany'';''RiskFactors—RisksRelatedtoDoingBusinessinChina'';RiskFactors—RisksRelatedtotheInternetIndustryinChina'';''Business—GovernmentRegulation'';''ProspectusSummary—Netease.
com,Inc.
'';and''RelatedPartyTransactions'',totheextenttheyconstitutemattersofChineselaw,havebeenreviewedandconrmedbyCommerceandFinanceLawOfce,specialPRCcounseltotheCompany,asexpertsinsuchmatters,andareincludedhereininrelianceuponsuchreviewandconrmation.
WHEREYOUCANFINDADDITIONALINFORMATIONWehaveledwiththeSecuritiesandExchangeCommissionaregistrationstatementonFormF-1,includingrelevantexhibitsandschedulesundertheSecuritiesActwithrespecttotheADSandunderlyingordinaryshares,tobesoldinthisoffering.
Thisprospectus,whichconstitutesapartoftheregistrationstatement,doesnotcontainalloftheinformationcontainedintheregistrationstatement.
YoushouldreadtheregistrationstatementanditsexhibitsandschedulesforfurtherinformationwithrespecttousandourADSs.
ImmediatelyuponcompletionofthisofferingwewillbecomesubjecttoperiodicreportingandotherinformationalrequirementsoftheExchangeActasapplicabletoforeignprivateissuers.
Accordingly,wewillberequiredtolereports,includingannualreportsonForm20-F,andotherinformationwiththeSEC.
Asaforeignprivateissuer,weareexemptfromtherulesoftheExchangeActprescribingthefurnishingandcontentofproxystatementstoshareholders.
Theregistrationstatement,reportsandotherinformationsoledcanbeinspectedandcopiedatthepublicreferencefacilitiesmaintainedbytheSECatRoom1024,JudiciaryPlaza,450FifthStreet,N.
W.
,Washington,D.
C.
20549,andattheregionalofcesoftheSECatSevenWorldTradeCenter,13thFloor,NewYork,NewYork10048and500WestMadisonStreet,Chicago,Illinois60661.
Youcanrequestcopiesofthesedocumentsuponpaymentofaduplicatingfee,bywritingtotheSEC.
PleasecalltheSECat1-800-SEC-0330forfurtherinformationontheoperationofthepublicreferencerooms.
OurSEClings,includingtheregistrationstatementandotherinformationmayalsobeinspectedattheofcesoftheNasdaqNationalMarket,ReportsSection,1735KStreet,N.
W.
,Washington,D.
C.
20006.
95NETEASE.
COM,INC.
INDEXTOCONSOLIDATEDFINANCIALSTATEMENTSPageReportofArthurAndersenHuaQiang,IndependentPublicAccountantsF-2ConsolidatedBalanceSheetsF-3ConsolidatedStatementsofOperations.
F-4ConsolidatedStatementsofShareholders'EquityF-5ConsolidatedStatementsofCashFlows.
F-6NotestoConsolidatedFinancialStatementsF-7F-1REPORTOFINDEPENDENTPUBLICACCOUNTANTSTotheBoardofDirectorsandShareholdersofNetease.
com,Inc.
:WehaveauditedtheaccompanyingconsolidatedbalancesheetsofNetease.
com,Inc.
(aCaymanIslandscorporation)asofDecember31,1998,and1999andtherelatedconsolidatedstatementsofoperations,shareholders'equityandcashowsfortheperiodfromJuly24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999expressedinChineserenminbi(''RMB'').
ThesenancialstatementsaretheresponsibilityofNetease.
com,Inc.
'smanagement.
Ourresponsibilityistoexpressanopiniononthesenancialstatementsbasedonouraudits.
WeconductedourauditsinaccordancewithgenerallyacceptedauditingstandardsintheUnitedStatesofAmerica.
ThoseStandardsrequirethatweplanandperformtheauditstoobtainreasonableassuranceaboutwhetherthenancialstatementsarefreeofmaterialmisstatement.
Anauditincludesexamining,onatestbasis,evidencesupportingtheamountsanddisclosuresinthenancialstatements.
Anauditalsoincludesassessingtheaccountingprinciplesusedandsignicantestimatesmadebymanagement,aswellasevaluatingtheoverallnancialstatementpresentation.
Webelievethatourauditsprovideareasonablebasisforouropinion.
Inouropinion,theconsolidatednancialstatementsreferredtoabovepresentfairly,inallmaterialrespects,thenancialpositionofNetease.
com,Inc.
asofDecember31,1998and1999andtheresultsofitsoperationsandcashowsfortheperiodfromJuly24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999,inconformitywithgenerallyacceptedaccountingprinciplesintheUnitedStatesofAmerica.
ArthurAndersenHuaQiangBeijing,People'sRepublicofChinaMay11,2000(exceptwithrespecttothematterdiscussedinNote13(c),astowhichthedateisJune15,2000)F-2NETEASE.
COM,INC.
CONSOLIDATEDBALANCESHEETSNoteDecember31,1998December31,1999December31,1999ProFormaShareholders'EquityDecember31,1999RMBRMBUS$(Note2)RMB(Note10)(Unaudited)AssetsCurrentassets:Cash199,538117,800,09614,227,924Accountsreceivable.
647,9886,633,299801,171Prepayments.
5—5,822,014703,184Othercurrentassets6357,2332,947,091355,950Duefromrelatedparties.
412,0001,017,245122,864Totalcurrentassets.
1,216,759134,219,74516,211,093Property,plantandequipment,net71,171,4839,508,4371,148,431Totalassets2,388,242143,728,18217,359,524Liabilities&Shareholders'EquityCurrentliabilities:Accountspayable.
370,2921,142,224137,958Salaryandwelfarepayable828,6851,869,403225,787Taxespayable9201,4471,417,864171,250Deferredrevenue959,7821,593,851192,506Accruedliabilities.
2,357697,65084,262Duetorelatedparties941,950113,768Totalcurrentliabilities.
1,562,5637,662,942925,531Shareholders'equity:SeriesAconvertiblepreferenceshares,US$0.
01parvalue:3,000,000sharesauthorized,issuedandoutstanding(aggregatepreferenceonliquidationofUS$15million)10—248,36729,998—Ordinaryshares,US$0.
0001parvalue:1,000,000,000,000sharesauthorized,2,004,500,000sharesissuedandoutstanding.
10—1,659,447200,4291,907,814Additionalpaid-incapital.
10500,000197,604,00123,866,658197,604,001Statutoryreserve.
54,819———Deferredcompensation.
11,743,182)(1,418,344)(11,743,182)Retainedearnings(accumulateddecit)270,860(51,703,393)(6,244,748)(51,703,393)Totalshareholders'equity825,679136,065,24016,433,993136,065,240Totalliabilities&shareholders'equity.
2,388,242143,728,18217,359,524Theaccompanyingnotesareanintegralpartofthesenancialstatements.
F-3NETEASE.
COM,INC.
CONSOLIDATEDSTATEMENTSOFOPERATIONSNoteForthePeriodfromJune24toDecember31,1997FortheYearEndedDecember31,1998FortheYearEndedDecember31,1999FortheYearEndedDecember31,1999RMBRMBRMBUS$Revenues:Advertisingservices(includingrevenuesofRMB818,075(US$98,807)fromrelatedpartiesin1999)4—172,85010,796,0741,303,953Softwarelicensingandrelatedintegrationprojects.
.
.
100,0002,942,5823,515,831424,643E-commercerelatedservices2,459,101297,011Totalrevenues100,0003,115,43216,771,0062,025,607Salesandvalue-addedtaxes9(6,600)(230,749)(1,150,169)(138,918)Netrevenues.
93,4002,884,68315,620,8371,886,689Costofrevenues:Advertisingande-commercerelatedservices(includingsharecompensationcostsofRMB6,296,816(US$760,531)andcostreimbursementstoarelatedpartyofRMB1,974,834(US$238,521)in1999)13,614)(242,657)(11,837,416)(1,429,726)Softwarelicensingandrelatedintegrationprojects.
.
.
(55,000)(946,531)(258,819)(31,260)Totalcostofrevenues.
68,614)(1,189,188)(12,096,235)(1,460,986)Grossprot.
24,7861,695,4953,524,602425,703Operatingexpenses:Selling,generalandadministrativeexpenses(includingsharecompensationcostsofRMB34,346,268(US$4,148,351)andcostreimbursementstoarelatedpartyofRMB466,259(US$56,315)in1999)22,844)(311,957)(51,055,489)(6,166,495)Researchanddevelopment(includingsharecompensationcostsofRMB4,770,315(US$576,159)in1999)8,000)(951,000)(5,735,170)(692,695)Totaloperatingexpenses.
30,844)(1,262,957)(56,790,659)(6,859,190)Operatingprot(loss)6,058)432,538(53,266,057)(6,433,487)Otherincome(expenses):Saleof163.
netusagerights.
1,500,000181,170Interestincome.
2895,719357,16043,138Other,net.
289)(71,056)(494,018)(59,668)Income(loss)beforetax6,058)367,201(51,902,915)(6,268,847)Provisionforincometax.
9(1,000)(34,464)(71,338)(8,616)Netincome(loss)7,058)332,737(51,974,253)(6,277,463)Netincome(loss)pershare,basicanddiluted.
0.
01)0.
01(0.
03)(0.
01)Netincome(loss)perADS,basicanddiluted0.
01)0.
02(2.
73)(0.
33)Weightedaveragenumberofordinarysharesoutstanding.
.
.
1,868,817,2001,868,817,2001,900,430,6001,900,430,600WeightedaveragenumberofADSsoutstanding18,688,17218,688,17219,004,30619,004,306Proformanetincome(loss)pershare,basicanddiluted.
.
(0.
01)0.
01(0.
02)(0.
01)Proformanetincome(loss)perADS,basicanddiluted.
.
.
(0.
01)0.
02(2.
36)(0.
29)Proformaweightedaveragenumberofordinarysharesoutstanding.
1,868,817,2001,868,817,2002,200,430,6002,200,430,600ProformaweightedaveragenumberofADSsoutstanding.
.
.
18,688,17218,688,17222,004,30622,004,306Theaccompanyingnotesareanintegralpartofthesenancialstatements.
F-4NETEASE.
COM,INC.
CONSOLIDATEDSTATEMENTSOFSHAREHOLDERS'EQUITYConvertiblePreferenceSharesOrdinarySharesAdditionalPaid-inCapitalDeferredCompensationStatutoryReservesRetainedEarnings(AccumulatedDecit)TotalShareholders'EquitySharesAmountSharesAmountRMBRMBRMBRMBRMBRMBRMBBalanceasofJune24,1997Capitalcontribution.
500,000———500,000Netloss.
7,058)(7,058)BalanceasofDecember31,1997.
500,000——(7,058)492,942Netincome332,737332,737Appropriationstostatutoryreserves.
54,819(54,819)—BalanceasofDecember31,1998.
500,000—54,819270,860825,679Reorganizationadjustment745,181)—(54,819)—(800,000)Netloss.
51,974,253)(51,974,253)OrdinarysharesissuedforcashatUS$0.
015pershare.
66,666,70055,1838,222,386———8,277,569OrdinarysharesissuedforcashatUS$0.
0155pershare.
64,516,10053,4018,223,714———8,277,115Ordinaryshareissuedtoprincipalowneraspartofreorganization(Note2)1,868,817,2001,547,138(1,547,138)OrdinaryshareissuedforcashatUS$0.
05pershare4,500,0003,7251,859,004———1,862,729ConvertiblepreferencesharesissuedforcashatUS$5.
00pershare.
.
3,000,000248,367——123,934,635———124,183,002Sharecompensationcosts(Note10)57,156,581(11,743,182)——45,413,399BalanceasofDecember31,1999.
3,000,000248,3672,004,500,0001,659,447197,604,001(11,743,182)—(51,703,393)136,065,240Theaccompanyingnotesareanintegralpartofthesenancialstatements.
F-5NETEASE.
COM,INC.
CONSOLIDATEDSTATEMENTSOFCASHFLOWSForthePeriodfromJune24,1997toDecember31,1997FortheYearEndedDecember31,1998FortheYearEndedDecember31,1999FortheYearEndedDecember31,1999RMBRMBRMBUS$Cashowsfromoperatingactivities:Netincome(loss)7,058)332,737(51,974,253)(6,277,463)Adjustmentsfor:Depreciation9,55589,980975,429117,813Sharecompensationcosts45,413,3995,485,041(Increase)inaccountsreceivable.
9,000)(638,988)(5,985,311)(722,907)(Increase)inprepayments5,822,014)(703,184)(Increase)inothercurrentassets320,000)(37,233)(2,589,858)(312,804)(Increase)induefromrelatedparties.
12,000)(1,005,245)(121,414)Increaseinaccountspayable.
55,000243,340771,93293,234Increaseinsalaryandwelfarepayable.
1,52727,1581,840,718222,323Increaseindeferredrevenue.
959,782634,06976,583Increaseintaxespayable7,144194,3031,216,417146,919Increaseinaccruedliabilities.
1,00973,300695,29383,978Increaseinduetorelatedparties141,95017,144Netcashprovidedby(usedin)operatingactivities.
261,823)1,232,379(15,687,474)(1,894,737)Cashowsfrominvestingactivities:Purchasesofproperty,plantandequipment.
187,770)(1,083,248)(9,312,383)(1,124,752)Cashowsfromnancingactivities:Proceedsfromcapitalcontribution.
500,000———Proceedsfromordinarysharesissued.
18,417,4132,224,460Proceedsfromconvertiblepreferencesharesissued.
124,183,00214,998,853Netcashprovidedbynancingactivities.
500,000—142,600,41517,223,313Netincreaseincash50,407149,131117,600,55814,203,824Cash,beginningofperiod/year.
50,407199,53824,100Cash,endofperiod/year50,407199,538117,800,09614,227,924Supplementaldisclosuresofcashowinformation:Cashpaidduringtheperiod/yearforincometaxes.
8,15811,5571,396Supplementalscheduleofnoncashinvestingandnancingactivities:Compensationcosts,arisingfromtransferofordinarysharesintheCompanytoseniormanagementpersonnel(Note10)45,413,3995,485,041Theaccompanyingnotesareanintegralpartofthesenancialstatements.
F-6NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)1.
OrganizationandNatureofOperationsTheaccompanyingconsolidatednancialstatementsincludethenancialstatementsofNetease.
com,Inc.
(the''Company'')anditscontrolledentitieswhichconsistofNeteaseInformation(Beijing)Co.
,Ltd.
(''NeteaseBeijing'')andNetease(U.
S.
)Inc.
(''NeteaseUS'').
TheCompanyandthesecontrolledentitiesarehereinaftercollectivelyreferredtoasthe''Group''.
TheCompanywasincorporatedintheCaymanIslandsonJuly6,1999.
AsofDecember31,1999,theCompanyhadtwowhollyownedsubsidiaries,NeteaseBeijingandNeteaseUS.
NeteaseUShasnotstarteditsoperationsyet.
TheGroupisprincipallyengagedindevelopingandprovidingInternet-relatedadvertising,softwarelicensingandotherservices.
TheGroup'sbusinesseswerepreviouslyconductedbyGuangzhouNetease,alimitedliabilitycompanyestablishedinthePeople'sRepublicofChina(''China''),andcontrolledandownedbythesameindividualwhoistheprincipalshareholderoftheCompany.
InSeptemberandOctober1999,ordinarysharesintheCompanywereissuedtotheprincipalshareholderoftheCompanywhocontrolledGuangzhouNetease,andNeteaseBeijingwasformedbytheCompany.
TheordinarysharesintheCompanywereissuedinconnectionwiththeacquisitionbyNeteaseBeijingofallthexedassetsofGuangzhouNeteaseasofAugust31,1999attheirbookvalue,andallotherintangibleassetsandcontractrightsnotreectedonthebalancesheetofGuangzhouNeteaseasofSeptember1,1999,foratotalconsiderationofapproximatelyRMB1.
4millionpursuanttoanagreementdatedSeptember1,1999andasupplementalagreementdatedSeptember24,1999(hereinafterreferredtoasthe''September1999Reorganization'').
Asaresultofthesetransactions,NeteaseBeijingtookoverthebusinesspreviouslyownedbyGuangzhouNetease.
AsthesameindividualcontrolstheexistingInternet-relatedbusinessoftheGroupbothbeforeandaftertheSeptember1999Reorganization,theSeptember1999ReorganizationhasbeenaccountedforasareorganizationofcompaniesundercommoncontrolinamannersimilartothatinpoolingofinterestaccountinginaccordancewithAICPAAccountingInterpretations(AIN)39ofAccountingPrinciplesBoardOpinionNo.
16—TransfersAndExchangesBetweenCompaniesUnderCommonControl.
AlltheassetsacquiredbyNeteaseBeijingfromGuangzhouNeteasehavebeenstatedattheirhistoricalamountstoGuangzhouNetease.
TheGroupconductsitsbusinesswithinoneindustrysegment—thebusinessofdevelopingandprovidingInternet-relatedadvertising,softwarelicensingande-commercerelatedservicesinChina.
TheindustryinwhichtheGroupoperatesissubjecttoanumberofindustry-specicriskfactors,including,butnotlimitedto,rapidlychangingtechnologies;signicantnumbersofnewentrants;dependenceonkeyindividuals;competitionfromsimilarproductsfromlargercompanies;customerpreferences;theneedforthecontinuedsuccessfuldevelopment,marketing,andsellingofitsproductsandservices;theneedfornancing;andtheneedforpositivecashowsfromoperations.
TheGroupiscurrentlytargetingtheChinesemarket.
TheChinesegovernmentregulatesInternetaccess,thedistributionofnewsandotherinformationandtheprovisionofcommercethroughstrictbusinesslicensingrequirementsandothergovernmentalregulations,whichinclude,amongtheothers,thoserestrictingforeignownershipinChinesecompaniesprovidingInternetaccess,informationandotheronlineInternetservices.
ManagementisoftheopinionthattheGroup'sbusinessescomplywithexistingChineselawsandregulations.
However,theinterpretationandapplicationofcurrentorproposedrequirementsandregulationsmayhaveanadverseeffectontheGroup'sbusiness,nancialconditionandresultsofoperations.
F-7AsignicantportionoftheGroup'sbusinessistransactedinRMB,whichisnotfreelyconvertibleintoothercurrencies.
ApprovalofforeigncurrencypaymentsbytheStateAdministrationofForeignExchangeofChinarequiresapaymentapplicationformtobesubmittedtogetherwithsuppliers'invoices,shippingdocuments,andsignedcontracts.
TheGrouphasalimitedoperatinghistoryandhasnotgeneratedsignicantrevenues.
Asaresult,theGroupissubjecttorisksassociatedwithearly-stagecompaniesinnewandrapidlyevolvingmarkets.
AsofDecember31,1999,theGrouphadanaccumulateddecitofapproximatelyRMB51.
7millionandhascontinuedtoincurlossessubsequenttothatdate.
ManagementbelievesthattheGroup'sexistingcashresources,thecapitalinowsfromplannedadditionalnancingandcashgeneratedfromrevenuegrowthwillbesufcientforittomeetitsobligationsthroughatleastDecember31,2000.
2.
PrincipalAccountingPoliciesBasisofconsolidationTheconsolidatednancialstatementsincludethenancialstatementsoftheCompanyanditscontrolledentities.
AsexplainedinNote1above,theSeptember1999Reorganizationhasbeenaccountedforasareorganizationofcompaniesundercommoncontrolinamannersimilartothatinpoolingofinterestaccounting.
AllsignicanttransactionsandbalancesbetweentheCompanyanditscontrolledentitieshavebeeneliminateduponconsolidation.
BasisofpresentationTheaccompanyingconsolidatednancialstatementshavebeenpreparedinaccordancewithgenerallyacceptedaccountingprinciplesintheUnitedStatesofAmerica(''USGAAP'').
ThisbasisofaccountingdiffersfromthatusedinthestatutoryaccountsofthosecompanieswithintheGroupestablishedinChina(''PRCStatutoryAccounts''),whicharepreparedinaccordancewithaccountingprinciplesandtherelevantnancialregulationsapplicabletoenterprisesestablishedinChina(''PRCGAAP'').
ThepreparationofnancialstatementsinconformitywithUSGAAPrequiresmanagementtomakeestimatesandassumptionsthataffectthereportedamountsofassetsandliabilitiesanddisclosuresofcontingentassetsandliabilitiesatthebalancesheetdatesandthereportedamountsofrevenuesandexpensesduringthereportingperiods.
Actualresultsmightdiffersignicantlyfromthoseestimates.
TheprincipaldifferencesbetweenUSandPRCGAAPapplicabletotheGroupincludethefollowing:recognitionofcompensationcostsarisingfromtransferofordinarysharesintheCompanybytheprincipalshareholdertocertainmembersofseniormanagement;adjustmentofdepreciationexpensesonequipmentsoastomoreaccuratelyreecttheusefuleconomiclivesoftheseassets;basisforrevenuerecognition;andtaxeffectsrelatedtotheaboveadjustments.
RevenuerecognitionTheGrouphasadoptedtheprovisionsoftheStaffAccountingBulletin101,''RevenueRecognition''initsaccountingpolicyonrevenuerecognition.
NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-8AdvertisingservicesTheGroupderivesitsadvertisingservicesrevenuesprincipallyfromfeesreceivedfromadvertisersontheNeteaseWebsitesandthefeesearnedfromservicesprovidedtoarelatedparty(seeNote4).
Advertisingfeesarederivedprincipallyfromshort-termadvertisingcontracts.
Revenuesfromadvertisingcontractsarerecognizedratablyovertheperiodinwhichtheadvertisementisdisplayedandcollectionoftheresultingreceivablesisprobable.
TheGroup'sobligationstypicallyalsoincludeguaranteesofaminimumnumberofimpressionsortimesthatanadvertisementappearsinpagesviewedbyusers.
Totheextentthatminimumguaranteedimpressionsarenotmetwithinthecontractualtimeperiod,theGroupdefersrecognitionofthecorrespondingrevenuesuntiltheremainingguaranteedimpressionlevelsareachieved.
StartingfromDecember1999,theGroupalsoderivesadvertisingservicesrevenuesfromadvertising-relatedtechnicalconsultingservicesprovidedtoarelatedparty(seeNote4).
TheGrouprecognizesadvertisingservicesrevenuesfromtherelatedpartyasservicesarerenderedandtheservicerevenuesareearnedbasedontherelatedserviceagreement(seeNote13).
Revenuesfrombartertransactionsprimarilyrelatetoadvertising.
Bartertransactionsarerecordedattheestimatedfairmarketvalueoftheservicereceivedorestimatedfairmarketvalueoftheadvertisementgiven,whicheverismorereadilydeterminable.
FortheperiodfromJune24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999,revenuesderivedfrombartertransactionswereapproximatelyzero,zeroandRMB3.
4million,respectively.
ApproximatelyRMB2.
4millionofthebarterrevenuesfortheyearendedDecember31,1999arosefromtheexchangeoftheGroup'sInternetadvertisingspaceforadvertisementsofanoutdooradvertisingmediacompany,fromwhichtheGroupalsopurchasedadvertisementsforcash(seeNote3).
Accordingly,measurableandreliablefairvalueforsuchtransactionshasbeenobtainedfromcomparablecashpurchases.
SoftwareandrelatedintegrationprojectsSoftwareandrelatedintegrationprojectsincludetheelementsoflicensing,services,andpostcontractcustomersupport(''PCS'').
PCS,generallyforoneyearorlessandoccasionallybeyondoneyear,aregenerallyhotlinesupportinnatureandmayinvolveunspeciedupgradesorenhancements.
TheseunspeciedupgradesorenhancementsofferedduringPCSarrangementshistoricallyhavebeenandareexpectedtocontinuetobeminimalandinfrequent.
TheestimatedcostsofprovidingPCSareinsignicant.
Sufcientvendor-specicobjectiveevidencedoesnotexisttoallocatetherevenuesfromsoftwareandrelatedintegrationprojectstotheseparateelementsofsuchprojects.
InaccordancewithAICPAStatementofPosition97-2,revenuesfromsoftwarelicensingandrelatedintegrationprojectsunderwhichtheGroupprovidePCSforoneyearorlessarerecognizedwhenthefollowingcriteriaaremet:persuasiveevidenceofanarrangement;deliveryhasoccurredandserviceshavebeenperformed;thesalesamountisxedordeterminable;andcollectibilityisprobable.
RevenuesfromthoseprojectsunderwhichtheGroupprovidesPCSthatextendbeyondoneyeararerecognizedratablyovertherespectivetermsofthecontracts.
Warrantyonthehardwareintherelatedintegrationprojectsissubstantiallyassumedbytheoriginalequipmentvendors.
NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-9E-commercerelatedservicesRevenuesfrome-commercerelatedservicesarederivedprincipallyfromvariousshort-termservicecontractsforconstructionofWebsites,marketsurveys,auctions,newspublishing,etc.
forcustomersconductedthroughtheInternet,aswellasregistrationfeesandcommissionschargedtoauctionsellersforpostingtheirproductsontheWebsitesoperatedbytheCompany'safliate,GuangzhouNetease(the''NeteaseWebSites'').
E-commercerelatedservicesarerecognized(i)inthecaseofauctioncommissions,uponconsummationoftheonlinesale,(ii)inthecaseofregistrationfees,ratablyovertheperiodinwhichtheproductforsaleisdisplayedontheNeteaseWebsitesand(iii)inthecaseofothere-commercerelatedservicerevenues,uponcompletionoftherespectivetotalcontractandacceptancebythecustomers.
Deferredrevenuesrepresentprepaymentsbycustomersforservicesyettobecompletedasofthebalancesheetdates.
Costofadvertisingande-commercerelatedservicesCostofadvertisingande-commercerelatedservicesconsistingprimarilyofstaffcostsofthosedepartmentsdirectlyinvolvedinprovidingadvertisingande-commercerelatedservices,depreciationandamortizationofcomputersandsoftware,servercustodyfees,bandwidthandotherdirectcostsofprovidingtheseservicesarechargedtothestatementofoperationsasincurred.
Materialdirectcostsincurredinthedevelopmentofplatformsforprovidingtheseservicesconsistprimarilyofcomputersoftwaredevelopedoracquired.
TheyarecapitalizedandamortizedinaccordancewithAICPAStatementofPosition98-1andcostsincurredpriortotheapplicationdevelopmentstagewereexpensedasincurred.
CashCashrepresentscashonhandanddemanddepositsplacedwithbanksorothernancialinstitutions.
IncludedinthecashbalanceasofDecember31,1999areamountsdenominatedinUnitedStatesdollarstotalingUS$14.
1million(equivalenttoapproximatelyRMB116.
8million).
FinancialinstrumentsFinancialinstrumentsoftheGroupprimarilyconsistofaccountsreceivableandaccountspayable.
Asofthebalancesheetdates,theirestimatedfairvalueapproximatedtheircarryingvalue.
Property,plantandequipmentProperty,plantandequipmentarestatedatcostlessaccumulateddepreciation.
Depreciationiscalculatedonthestraight-linebasisoverthefollowingestimatedusefullives,takingintoaccountanyestimatedresidualvalue:Furnitureandofceequipment.
5yearsComputers.
3yearsSoftware.
3yearsLeaseholdimprovements.
lesserofthetermoftheleaseortheestimatedusefullivesoftheassetsCostsofcomputersoftwaredevelopedorobtainedforinternaluseareaccountedforinaccordancewithAICPAStatementofPosition98-1,underwhichdirectcostsincurredtodevelopthesoftwareduringtheNETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-10applicationdevelopmentstageandtoobtaincomputersoftwarefromthirdpartiesthatcanprovidefuturebenetsarecapitalized.
AsofDecember31,1999,thecapitalizablecostsofinternallydevelopedcomputersoftwarearenotsignicant.
AdvertisingexpensesAdvertisingexpensesarechargedtothestatementofoperationswhenincurred.
ForeigncurrencytranslationThefunctionalcurrencyoftheGroupisRMB.
TransactionsdenominatedincurrenciesotherthanRMBaretranslatedintoRMBattheexchangeratesquotedbythePeople'sBankofChina(the''PBOC'')prevailingatthedatesofthetransactions.
MonetaryassetsandliabilitiesdenominatedinforeigncurrenciesaretranslatedintoRMBusingtheapplicableexchangeratesquotedbythePBOCatthebalancesheetdates.
Theresultingexchangedifferencesareincludedinthedeterminationofincome.
TranslationsofamountsfromRMBintoUnitedStatesdollarsfortheconvenienceofthereaderwerecalculatedatthenoonbuyingrateofUS$1.
00=RMB8.
2795onDecember31,1999inTheCityofNewYorkforcabletransfersofRenminbiascertiedforcustomspurposesbytheFederalReserveBankofNewYork.
NorepresentationismadethattheRenminbiamountscouldhavebeen,orcouldbe,convertedintoUnitedStatesdollarsatthatrateonDecember31,1999,oratanyothercertainrate.
StockoptionsTheGrouphasadoptedtheprovisionsofStatementofFinancialAccountingStandardsNo.
123(''SFAS123''),''AccountingforStock-BasedCompensation.
''InaccordancewiththeprovisionsofSFAS123,theGrouphaselectedthedisclosureonlyprovisionsrelatedtoemployeestockoptionsandfollowstheprovisionsofAccountingPrinciplesBoardOpinionNo.
25(''APB25'')inaccountingforstockoptionsissuedtoemployees.
UnderAPB25,compensationexpense,ifany,isrecognizedasthedifferencebetweentheexercisepriceandtheestimatedfairvalueoftheordinarysharesonthemeasurementdate,whichistypicallythedateofgrant,andisrecognizedovertheserviceperiod,whichistypicallythevestingperiod.
IncometaxesDeferredincometaxesareprovidedusingthebalancesheetliabilitymethod.
Underthismethod,deferredincometaxesarerecognizedforthetaxconsequencesofsignicanttemporarydifferencesbyapplyingenactedstatutoryratesapplicabletofutureyearstodifferencesbetweenthenancialstatementcarryingamountsandthetaxbasesofexistingassetsandliabilities.
Thetaxbaseofanassetorliabilityistheamountattributedtothatassetorliabilityfortaxpurposes.
Theeffectondeferredtaxesforachangeintaxratesisrecognizedinincomeintheperiodthatincludestheenactmentdate.
Avaluationallowanceisprovidedtoreducetheamountofdeferredtaxassetsifitisconsideredmorelikelythannotthatsomeportionof,orallof,thedeferredtaxassetwillnotberealized.
Netincome(loss)pershare(''EPS'')andperAmericanDepositaryShare(''ADS'')InaccordancewithStatementofFinancialAccountingStandardsNo.
128,''ComputationofEarningsPerShare,''basicEPSiscomputedbydividingnetincome(loss)attributabletoordinaryshareholdersbytheNETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-11weightedaveragenumberofordinarysharesoutstandingduringtheperiod.
DilutedEPSiscalculatedbydividingnetincome(loss)bytheweightedaveragenumberofordinaryanddilutiveordinaryequivalentsharesoutstandingduringtheperiod.
Ordinaryequivalentsharesconsistoftheordinarysharesissuableupontheconversionoftheconvertiblepreferenceshares(usingtheif-convertedmethod)andordinarysharesissuableupontheexerciseofoutstandingstockoptions(usingthetreasurystockmethod).
OrdinaryequivalentsharesinthedilutedEPScomputationareexcludedinnetlossperiodsastheireffectwouldbeanti-dilutive.
ThenumberoftheseordinaryequivalentsharesexcludedfromthedilutedEPScomputationamountedtozero,zeroand323,695,000fortheperiodfromJune24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999respectively.
ProformabasicanddilutedEPSiscomputedbasedontheweightedaveragenumberofordinarysharesoutstandinggivingeffecttotheassumedconversionofSeriesApreferencesharesoutstandingasofDecember31,1999,thatwillautomaticallyconvertuponcompletionoftheCompany'sinitialpublicoffering(seeNote10fordetails)(usingtheif-convertedmethodfromtheoriginalissuancedate).
ProformadilutedEPSexcludestheimpactofstockoptionsinthenetlossperiodsastheeffectoftheirinclusionwouldbeantidilutive.
Theweightedaverageandproformaweightedaveragenumberofordinarysharesoutstandingincludetheeffectoftheone-hundred-for-onesharesplitasdiscussedinNote13.
Netincome(loss)perADShasbeencomputedbymultiplyingthenetincome(loss)pershareby100,whichisthenumberofsharesrepresentedbyeachADS.
TheweightedaveragenumberofordinarysharesoutstandingfortheperiodfromJune24,1997toDecember31,1997andfortheyearendedDecember31,1998,forthepurposesofEPScalculations,representthenumberofordinarysharesissuedtotheprincipalownerofGuangzhouNetease,whichconductedtheGroup'sbusinessespriortotheSeptember1999Reorganization.
StatutoryreservesInaccordancewiththeRegulationsonEnterpriseswithForeignInvestmentofChinaanditsarticlesofassociation,NeteaseBeijing,beingawhollyforeignownedenterpriseestablishedinChina,isrequiredtoprovideforcertainstatutoryreservesnamelygeneralreserve,enterpriseexpansionfundandstaffwelfareandbonusfundwhichareappropriatedfromnetprotasreportedinitsPRCStatutoryAccounts.
NeteaseBeijingisrequiredtoallocateatleast10%ofitsafter-taxprottothegeneralreserve.
NeteaseBeijingmaystopallocationstothegeneralreserveifsuchreservehasreached50%ofitsregisteredcapital.
AppropriationstotheenterpriseexpansionfundandstaffwelfareandbonusfundareatthediscretionoftheboardofdirectorsofNeteaseBeijing.
Thesereservescanonlybeusedforspecicpurposesandarenotdistributableascashdividends.
Appropriationstothestaffwelfareandbonusfundwillbechargedtoselling,generalandadministrativeexpenses.
NeteaseBeijinghasbeeninalosspositionaccordingtoitsPRCStatutoryAccountsandnoappropriationstostatutoryreserveshavebeenmade.
RelatedpartiesPartiesareconsideredtoberelatedifonepartyhastheability,directlyorindirectly,tocontroltheotherpartyorexercisesignicantinuenceovertheotherpartyinmakingnancialandoperatingdecisions.
Partiesarealsoconsideredtoberelatediftheyaresubjecttocommoncontrolorcommonsignicantinuence.
NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-12RecentaccountingpronouncementInJune1998,theFinancialAccountingStandardsBoardissuedStatementofFinancialAccountingStandardsNo.
133(''SFAS133''),''AccountingforDerivativeInstrumentsandHedgingActivities''.
Thisstatementrequirescompaniestorecordallderivativesonthebalancesheetasassetsorliabilitiesmeasuredatfairvalue.
Gainsandlossesresultingfromchangesinfairmarketvaluesofthosederivativeinstrumentswouldbeaccountedfordependingontheuseoftheinstrumentandwhetheritqualifiesforhedgeaccounting.
SFAS133willbeeffectivefortheGroup'syearendingDecember31,2001.
TheGroupdoesnotexpectthattheimplementationofSFAS133willhaveasignificantimpactonitsfinancialposition,resultsofoperationsorcashflows.
3.
ConcentrationsMajorcustomersRevenuesfromcustomersthatindividuallyrepresentgreaterthan10%ofthetotalrevenuesfortheperiodfromJune24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999areasfollows:CustomersForthePeriodfromJune24,1997toDecember31,1997FortheYearEndedDecember31,1998FortheYearEndedDecember31,1999GuangzhouFeihuaTelecomCo.
,Ltd.
90,000398,729—JinhuaPostalBureau.
390,000—TopResultPromotionLtd.
2,369,363BigsaveLtd.
2,075,000AlloftherevenuesfromTopResultPromotionLtd.
resultedfrombartertransactions.
BandwidthandservercustodyserviceproviderTheGroupreliesexclusivelyonatelecommunicationsserviceprovideranditsafliatesforbandwidthandservercustodyservice.
DependenceonGuangzhouNeteaseTheGroupreliesexclusivelyonGuangzhouNetease,whichhasapprovaltooperateasanInternetcontentprovider,fortheoperationoftheNeteaseWebsites.
CreditriskTheGroupisprincipallyengagedindevelopingandprovidingInternet-relatedadvertising,softwarelicensingandotherservicestobusinessesprimarilyinChina.
TheGroupgenerallydoesnotrequirecollateralforitsaccountsreceivable.
4.
RelatedPartyTransactionsDuringtheyearendedDecember31,1999,theGrouphadadvertisingrevenuesfromshareholdersoftheCompanyamountingtoapproximatelyRMB539,000.
NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-13DuringtheyearendedDecember31,1999,theGroupreimbursedGuangzhouNeteaseatotalofapproximatelyRMB2,441,000forthecostsofoperatingtheNeteaseWebsites.
DuringtheyearendedDecember31,1999,theGroupderivedapproximatelyRMB279,000ofadvertisingservicesrevenuesfromGuangyitongAdvertisingCo.
,Ltd.
(''GuangyitongAdvertising''),arelatedcompanythatis80%ownedbytheprincipalshareholderoftheGroupforadvertising-relatedtechnicalconsultingandservicesperformed.
Asofthebalancesheetdates,duefromrelatedpartiesrepresentsamountsreceivablefromshareholdersforservicesperformed,temporaryadvancestoofcersoftheGroup,andadvancestoGuangzhouNetease.
DuetorelatedpartiesrepresentsamountspayabletoGuangyitongAdvertising.
Thebalanceswithrelatedpartieswereunsecured,interest-freeandrepayableondemand.
AsofDecember31,1999,theamountsduefromrelatedpartiesincludedanamountdenominatedinUnitedStatesdollarsofUS$50,000(equivalenttoapproximatelyRMB415,000).
AllotherrelatedpartybalancesaredenominatedinRMB.
5.
PrepaymentsDecember31,1998December31,1999Prepaidadvertisingexpenses.
4,433,441Prepaidrentals.
362,617Prepaymentforofceequipmentpurchases288,602Prepaidlegalfees.
347,971Others.
389,383—5,822,0146.
OtherCurrentAssetsDecember31,1998December31,1999Temporarydepositsforrentedpremises1,722,460Interestreceivable383,828Advances.
315,000369,406Others.
42,233471,397357,2332,947,0917.
Property,PlantandEquipmentDecember31,1998December31,1999Computers1,218,7608,327,804Furnitureandofceequipment.
52,258433,125Software854,972Leaseholdimprovements967,5001,271,01810,583,401Less:Accumulateddepreciation.
99,535)(1,074,964)Netbookvalue.
1,171,4839,508,437NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-148.
EmployeeBenetsThefull-timeemployeesofthosecompanieswithintheGroupwhichareestablishedinChinaareentitledtostaffwelfarebenetsincludingmedicalcare,welfaresubsidies,unemploymentinsuranceandpensionbenets,etc.
Thesecompaniesarerequiredtoaccrueforthesebenetsbasedoncertainpercentagesoftheemployees'salariesinaccordancewiththerelevantregulations.
ThetotalprovisionforsuchemployeebenetsamountedtoapproximatelyRMB2,000,RMB27,000andRMB1.
4millionfortheperiodfromJune24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999respectively.
Thesecompaniesarealsorequiredtomakecontributionstothestate-sponsoredpensionandmedicalplansoutoftheamountsaccruedformedicalandpensionbenets.
ThesecontributionsfortheperiodfromJune24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999amountedtoapproximatelyzero,zeroandRMB194,000respectively.
TheChinesegovernmentisresponsibleforthemedicalbenetsandultimatepensionliabilitytotheseemployees.
9.
TaxationIncometaxesCaymanIslandsUnderthecurrentlawsoftheCaymanIslands,theCompanyisnotsubjecttotaxonincomeorcapitalgain.
Additionally,uponpaymentsofdividendsbytheCompanytoitsshareholders,noCaymanIslandswithholdingtaxwillbeimposed.
People'sRepublicofChinaForeignInvestedEnterprisesInaccordancewith''IncomeTaxLawofChinaforEnterpriseswithForeignInvestmentandForeignEnterprises,''foreigninvestedenterprisesaregenerallysubjecttoenterpriseincometax(''EIT'')attherateof30%plusalocaltaxof3%.
NeteaseBeijing,beingaforeigninvestedenterpriseandlocatedintheNewTechnologyIndustrialDevelopmentExperimentalZoneinBeijing,iseligibletoapplyforareducedEITrateof15%ifitisrecognizedasaNewandHighTechnologyEnterprise.
ANewandHighTechnologyEnterpriseisalsoeligibletoapplyforafullexemptionfromEITfortherstthreeyearsofitsoperationsanda50%reductioninEITforthefollowingthreeyears.
ThesetaxpreferencesaresubjecttotheapprovaloftherelevantChinesetaxauthorities.
DomesticEnterprisesGuangzhouNeteaseisaChinesedomesticenterpriseandisgenerallysubjecttoEITatarateof33%.
FortheperiodfromJune24,1997toDecember31,1997andfortheyearendedDecember31,1998,GuangzhouNeteasewascategorizedasasmall-sizedtaxpayerbythelocaltaxbureauofGuangzhou,China.
AccordingtotherelevanttaxcircularsissuedbythelocaltaxbureauofGuangzhou,GuangzhouNeteasewassubjecttoEITcalculatedat1%ofthetotalamountofitsrevenuesandthegrossamountsofotherincome,whichprincipallyaccountedforthedifferencebetweentheprovisionforincometaxesatthestatutoryrateof33%andtheeffectivetaxratesforthoseperiods.
NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-15ThefollowingisareconciliationbetweentheEITstatutoryrateandtheGroup'seffectiveEITrate:ForthePeriodfromJune24,1997toDecember31,1997FortheYearEndedDecember31,1998FortheYearEndedDecember31,1999EITstatutoryrate33.
0%)33.
0%(33.
0%)Non-deductiblesharecompensationcosts.
13.
1%Effectoftaxrateapplicabletosmall-sizeddomesticenterprises.
49.
5%(23.
6%)(0.
2%)Effectoflowertaxrateapplicabletohi-techenterprises.
18.
3%Valuationallowancefordeferredtaxassets1.
9%EffectiveEITrate.
16.
5%9.
4%0.
1%AsofDecember31,1999,thetaximpactofsignicanttemporarydifferencesbetweenthetaxandnancialstatementbasesofassetsandliabilitiesthatgaverisetodeferredtaxassetswereprincipallyrelatedtothefollowing:Netoperatinglosscarryforwards(primarilyinNeteaseBeijingrelatingtoEITapplicabletoforeigninvestedenterprises)984,128Valuationallowance984,128)Netdeferredtaxassets.
NeteaseBeijinghadtaxnetoperatinglosscarryforwardsofapproximatelyRMB6.
6millionasofDecember31,1999forEITpurposes.
Thesecarryforwardswillexpirein2004.
Avaluationallowancehasbeenprovidedtooffsetgrossdeferredtaxassetsduetotheuncertaintysurroundingtherealizabilityofsuchassets.
TherecanbenoassurancethatNeteaseBeijingwillbeabletoutilizenetoperatinglosscarryforwardsbeforetheirexpiration.
ForeignEnterprisesIntheeventthattheactivitiesoftheCompanyandNeteaseUS,beingforeignenterprisesforChinesetaxpurposes,constituteapermanentestablishmentinChina,theywouldbesubjecttoEITtotheextentofincomesourcedinChina.
ThenormalEITrateis30%plusalocaltaxof3%onthenettaxableincome.
IncomeoftheCompanyandNeteaseUSthatisnotconnectedtoapermanentestablishmentinthePRCwouldbesubjecttoa20%withholdingtaxongrossreceiptsfromprot,interest,rentals,royaltiesandotherincomesourcedinChina.
Ifsuchincomeisearnedfromsourceswithinthedesignatedspecialeconomiczonesorotherdesignatedareas,thewithholdingtaxisreducedto10%.
DividendsfromNeteaseBeijingtotheCompanyareexemptfromChinesewithholdingtax.
Businesstax(''BT'')TheGroupissubjecttoBTontheprovisionoftaxableservicesinChina,transferofintangibleassetsandthesaleofimmovablepropertiesinChina.
Thetaxratesrangefrom3%to20%ofthegrossreceipts,NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-16dependingonthenatureoftherevenues.
TheapplicableBTratefortheGroup'srevenuesisgenerally5%.
Inaddition,theGroupissubjecttoaculturaldevelopmentfeeat3%onitsInternetadvertisingrevenues.
Valueaddedtaxes(''VAT'')TheGroupissubjecttoVATatarateof17%onrevenuesfromthesaleofcomputerhardwarepurchasedonbehalfofcustomersaspartoftheintegrationprojectsrelatedtosoftwarelicensing,whichispayableafteroffsettingagainsttheinputvalueaddedtaxpaidonpurchases.
FortheperiodfromJune24,1997toDecember31,1997andtheyearendedDecember31,1998,GuangzhouNeteasewascategorizedasasmall-sizedtaxpayerandthereforewasrequiredtopayVATcalculatedat6%onsuchrevenueswithnoinputVAToffset.
TaxespayableDecember31,1998December31,1999VAT154,294374,232BT532)529,662Incometaxes27,30687,086Culturaldevelopmentfee.
5,18676,591Others.
15,193350,293201,4471,417,86410.
CapitalStructureOrdinarysharesTheholdersofordinarysharesintheCompanyareentitledtoonevotepershare.
Subjecttocertainpreferencesattributabletotheoutstandingpreferenceshares(seebelow),theholdersofordinarysharesareentitledtoreceiveratablysuchdividends,ifany,asmaybedeclaredbytheboardofdirectorsoftheCompany.
Intheeventofliquidation,theholdersofordinarysharesareentitledtoshareratablyinallassetsremainingafterpaymentofliabilities,subjecttopriordistributionrightsofpreferredshareholders.
Theordinaryshareshavenopreemptive,conversion,orothersubscriptionrights.
InNovember1999,inconsiderationforcertainmembersoftheseniormanagementjoiningtheGroup,theprincipalshareholderoftheCompanycommittedtotransferatotalof109,694,200ordinarysharesintheCompanytosuchindividualswithnovestingperiodrequirement.
Theestimatedfairvalueofthesesharescommittedtobetransferred,valuedatUS$0.
05pershareatthedateofcommitment,isrecognizedascompensationcostsimmediately.
Inaddition,theprincipalshareholderoftheCompanyalsoagreedtotransferatotalof26,271,300ordinarysharesintheCompanyforservicestoberenderedbycertainofthoseindividualsoverthreeyearsstartingfromJanuary1,2000.
ThetotalestimatedfairvalueofthesesharesvaluedatUS$0.
05pershareatthedateofgrantisrecognizedasdeferredcompensationwhichwillbeamortizedovertherelatedvestingperiods.
ConvertiblepreferencesharesTheSeriesApreferencesharesareconvertibleonabasisof100ordinarysharesforonepreferenceshare.
ThesepreferenceshareswillbeautomaticallyconverteduponclosingofapublicofferingoftheordinarysharesintheCompanypriortoDecember31,2000thatmeetscertainthresholdconditionsontheamountsofvaluationandproceeds,oruponthewrittenconsentofholdersofthesepreferenceshares.
NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-17TheSeriesApreferencesharescarrycertainpreferencesondividendpaymentandreturnofcapitalincaseofawindingupoftheCompany.
Writtenconsentoftheholdersofmorethan50%ofthesepreferencesharesmustbeobtainedforanyacquisition,merger,reorganization,substantialdisposalofassets,alterationofcapitalamounts,disposalofinterestinanysubsidiaryorassociatecompany,andliquidationorwinding-upoftheCompany.
11.
StockOptionPlansInDecember1999,theCompanyadoptedanincentiveandnon-statutorystockoptionplanfortheCompany'sseniormanagementandemployees(the''1999StockIncentivePlan'').
TheCompanyhasreservedatotalof345,675,000ordinarysharesforissuanceundertheplan.
OptionsforthemembersoftheCompany'sseniormanagementbecomeexercisableattherateof20%onthevestingcommencementdatewhichwasSeptember1,1999,20%uponcompletionofonefullyearand30%uponcompletionofeachofthenexttwofullyearsthereafter.
TheseoptionswillalsovestuponthefounderoftheGroupceasingtobetheprincipalshareholderoftheGroup.
Inaddition,certainoftheseoptionswillvestuponclosingofapublicofferingoftheordinarysharesintheCompany.
TheoptionsforthemembersoftheCompany'sseniormanagementexpireonSeptember1,2009.
TheexercisepriceisUS$0.
065pershare.
OptionsfortheemployeesvestuponcompletionoftherstfullyearofservicebytherespectiveemployeesfromthatthedatetheyrstjoinedtheGroupandexpireattheendofthefthyearoftheirrespectiveserviceperiods.
TheexercisepriceoftheoptionsfortheemployeesisUS$0.
07pershare.
TheCompanyalsograntedoptionstoacquireatotalof3,000,000ordinarysharestoitsadvisoryboardmembers.
Twentypercentoftheseoptionsvestonthedateofappointment,whichwastheendof1999,and10%willvesteachquarteroverthenexttwoyearsthereafter.
TheexercisepriceisUS$0.
065pershare.
Thetotalestimatedfairvalueoftheoptionsgrantedtotheadvisoryboardmembersofapproximately867,000isrecognizedatthedateofgrantasdeferredcompensationwhichwillbeamortizedovertherelatedvestingperiod.
TheestimatedfairvalueoftheoptionsgrantedtoadvisoryboardmemberisestimatedonthedateofgrantusingtheBlack-Scholesoptionpricingmodel.
Thefollowingassumptionswereusedforthegrant:risk-freeinterestrateof2.
97%;estimatedfairvalueofUS$0.
050perordinaryshare;expecteddividendyieldof0%forallperiods;expectedlifeoftwoyears;andexpectedvolatilityof155%forallperiods.
Informationrelatingtostockoptionsoutstandingisasfollows:SharesWeightedAverageExercisePriceBalance,December31,1998Optionsgranted121,960,000US$0.
065Balance,December31,1999121,960,000US$0.
065AsofDecember31,1999,optionstopurchase23,695,000ordinaryshareswereexercisable.
Underthestockoptionplans,optionstopurchase223,715,000ordinaryshareswereavailableforfuturegrant.
ThefairvalueofordinarysharesonthedatesofstockoptiongrantswasdeterminedbymanagementbasedontherecentNETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-18issuanceofpreferenceshares,considerationofsignificantmilestonesachievedbytheGroupandothermarketconsiderations.
OptionsoutstandingandexercisablebypricerangeasofDecember31,1999,wereasfollows:ExercisePriceNumberOutstandingWeightedAverageRemainingContractualLifeNumberVestedUS$0.
065.
118,225,0009.
5423,645,000US$0.
07.
3,735,0004.
4750,000121,960,0009.
3823,695,000ForthepurposesofSFAS123proformadisclosure,theestimatedfairvalueofeachseniormanagementoremployeeoptiongrantisestimatedonthedateofgrantusingtheBlack-Scholesoptionpricingmodel.
Thefollowingassumptionswereusedforthegrants:risk-freeinterestratesof3.
30%and2.
97%fortheoptionsforseniormanagementandemployeesrespectively;estimatedfairvalueofUS$0.
05andUS$0.
07fortheoptionsgrantedtoseniormanagementpersonnelandtoemployees,respectively;expecteddividendyieldof0%forallperiods;expectedlivesoftenyearsandveyearsfortheoptionsforseniormanagementandemployeesrespectively;andexpectedvolatilityof0%forallperiods.
Hadthecompensationcostsfortheplanbeendeterminedbasedontheestimatedfairvalueoftheoptionsatthegrantdatesforawardsundertheplan,theGroup'snetincome(loss)andnetincome(loss)perordinaryshareonaproformabasisfortheperiodfromJuly24,1997toDecember31,1997,andfortheyearsendedDecember31,1998and1999wouldhavebeenasfollows:ForthePeriodfromJune24,1997toDecember31,1997FortheYearEndedDecember31,1998FortheYearEndedDecember31,1999Netincome(loss):Asreported.
7,058)332,737(51,974,253)Proforma.
7,058)332,737(52,965,737)Basicanddilutednetincome(loss)perordinaryshare:Asreported.
0.
01)0.
01(0.
03)Proforma.
0.
01)0.
01(0.
03)12.
CommitmentsandContingenciesCommitmentsAsofDecember31,1999,futureminimumleasecommitmentswereasfollows:OfceRentalServerCustodyFeeTotal20001,069,5146,762,0007,831,5142001983,080604,0001,587,0802002612,835—612,835200343,798—43,798Total2,709,2277,366,00010,075,227Inaddition,theCompanyhastotalcapitalcommitmentsamountingtoapproximatelyRMB2.
4million.
NETEASE.
COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-19InsurancecoverageAsofDecember31,1999,theGroupdidnothaveinsuranceonitsproperty,plantandequipmentofapproximatelyRMB9.
5million.
Year2000IssueTheYear2000Issuearisesbecausemanycomputerizedsystemsusetwodigitsratherthanfourtoidentifyayear.
Date-sensitivesystemsmayrecognizetheyear2000as1900orsomeotherdate,resultinginerrorswheninformationusingyear2000datesisprocessed.
Inaddition,similarproblemsmayariseinsomesystemswhichusecertaindatesin1999torepresentsomethingotherthanadate.
TheeffectsoftheYear2000Issuemaybeexperiencedbefore,on,orafterJanuary1,2000,and,ifnotaddressed,theimpactonoperationsandnancialreportingmayrangefromminorerrorstosignicantsystemsfailurewhichcouldaffecttheGroup'sabilitytoconductnormalbusinessoperations.
Managementhasbeenaddressingthisissue;however,giventhenatureofthisrisk,itisnotpossibletobecertainthatallaspectsoftheYear2000IssueaffectingtheGroup,includingthoserelatedtotheeffortsofcustomers,suppliers,orotherthirdparties,willbefullyresolvedwithoutadverseimpactontheGroup'soperations.
13.
SubsequentEvents(a)AgreementswithGuangzhouNeteaseOnFebruary3,2000,tosatisfyChineseregulations,theCompanyandNeteaseBeijingenteredintoaseriesofagreementswithGuangzhouNeteasewherebyGuangzhouNeteasewilloperatetheNeteaseWebsiteswithitsInternetcontentcompanyapprovalandthetechnologiesandotherservicesprovidedbytheCompanyandNeteaseBeijing.
Theseservicesinclude:useofdomainnames;useofcopyrightedWeb-pagelayout;useofregisteredtrademarks;useofequipment;andprovisionoftechnicalandconsultingservices.
Undertheseagreements,substantiallyalloftheincomereceivedbyGuangzhouNeteasewillbepaidtotheCompanyandNeteaseBeijing.
GuangzhouNeteaseisarelatedpartybecauseitisalsocontrolledbytheprincipalshareholderoftheCompany.
ThebusinessoftheGroupisdependentuponGuangzhouNeteasewhichoperatestheNeteaseWebsites.
TheGroupexpectsthatitwillneedtoprovidenancialsupportintheformofcostreimbursementstoGuangzhouNetease.
UntilGuangzhouNeteasedemonstratesthatitcansupportitsownoperationsthroughitsrevenuesfromthirdpartycustomers,theGroupwillaccrueforthecostsandexpensesofGuangzhouNeteaseinexcessofitsrevenuesasthecostsareincurredbyGuangzhouNetease.
UndertheagreementswithGuangzhouNetease,theGroupistoreceivepaymentsfromGuangzhouNeteaseforthetechnologiesandotherservicesitprovides.
SuchpaymentswillbeaccountedforascostreimbursementsunlesstherearecorrespondingrevenuesreceivedbyGuangzhouNeteasefromunrelatedparties.
TheeffectoftheaccountingwillbethatrevenuesthattheGrouprecordsrelatedtotransactionswithGuangzhouNeteasewillnotexceedtherevenuesthatGuangzhouNeteasederivesfromunrelatedparties.
Also,theGroupwillrecordlossesarisingfromtheprovisionofnancialsupporttoGuangzhouNetease.
TransactionswithGuangzhouNeteasewillbeaccountedforanddisclosedasrelatedpartytransactions.
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NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-20(b)AgreementswithGuangyitongAdvertisingInMay2000,NeteaseBeijingenteredintoaseriesofagreementswithGuangyitongAdvertisingandtheultimateownersofGuangyitong.
Theseagreementsinclude:aten-yearirrevocableproxygivenbytheultimateownersofGuangyitongAdvertisingwhichallowsNeteaseBeijingtoexercisealloftheshareholdervotingrightsofGuangyitongAdvertising;anoperatingagreementprovidingforthefollowing:—GuangyitongAdvertisingwillappointonlythoseindividualsnominatedbyNeteaseBeijingasitsseniormanagementpersonnel;—themajordecisionsofGuangyitongAdvertisinghavetobeapprovedbyNeteaseBeijing,includingthoserelatingtonancing;transferofownershipinterests,signicantacquisitions,disposalsorpledgesofassets;andamendmentandassignmentofcontracts;—NeteaseBeijinghasacommitmenttopurchasetheassetsandbusinessofGuangyitongAdvertisingattheirnetbookvalueonceitobtainstheapprovalfromtheChineseGovernmenttodosounderChineselaw;and—NeteaseBeijingwillissueguaranteesforthebenetofGuangyitongAdvertisingwhenconsiderednecessaryforGuangyitongAdvertising'soperations;aten-yearexclusiveconsultingandtechnicalservicesagreementprovidingforthefollowing:—NeteaseBeijingistheexclusiveprovideroftechnicalconsultingandrelatedservicestoGuangyitongAdvertisingforalltheadvertisementswhichGuangyitongAdvertisingwillreceiveandpublishontheNeteaseWebsites;and—NeteaseBeijingwillchargeGuangyitongAdvertisingamonthlyfeefortheaboveservices.
TheservicefeemaybeunilaterallyadjustedbyNeteaseBeijingsuchthatNeteaseBeijingmayreceivealloftheprotsandcashowsofGuangyitongAdvertising;anundertakingbytheprincipalshareholderoftheCompanyandtheultimateownersofGuangyitongAdvertisingthattheywillnotvoteinanyshareholders'ordirectors'meetingsoftheCompanyonanyamendmentsorsupplementstotheagreementswithGuangyitongAdvertisingexceptasdirectedbytheCompany'sBoard.
Undertheseagreements,GuangyitongAdvertisingwillbefullydependentonthetechnicalconsultingandotherservicesprovidedbyNeteaseBeijingtooperateitsonlineadvertisingbusiness.
SubstantiallyalloftherevenuesreceivedbyGuangyitongAdvertisingwillbepaidtoNeteaseBeijing.
GuangyitongAdvertisingisarelatedpartybecauseitisalso80%ownedbytheprincipalshareholderoftheCompany.
ThenancialstatementsofGuangyitongAdvertisingwillnotbeconsolidatedwiththoseoftheGroupbecauseofthemajorityequityinterestthattheprincipalshareholderoftheCompanyhasbothintheCompanyandGuangyitongAdvertising.
TransactionswithGuangyitongAdvertisingwillbeaccountedforanddisclosedasrelatedpartytransactions.
(c)NewoptionsgrantedInFebruaryandMarch2000,theCompanygrantedoptionstoacquireatotalof50,070,000ordinarysharestotheCompany'semployeesatanexercisepriceofUS$0.
100pershare.
FromMarchtoMay,2000,theCompanygrantedoptionstoacquireatotalof7,387,000ordinarysharestoothernewemployeesatanexerciseNETEASE.
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NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-21priceofUS$0.
156pershare.
FromMaytoJune15,2000,theCompanygrantedoptionstoacquireatotalof3,780,000ordinarysharestoothernewemployeesatanexercisepriceequaltotheinitialpublicofferingpriceoftheCompany'sordinaryshares.
InMay2000,theCompanyalsograntedoptionstoacquireatotalof100,000ordinarysharestoanewemployeeatanexercisepriceofUS$0.
20pershare.
OptionsforthoseemployeeswhojoinedtheGroupin1999vestoveraperiodofthreeyearsbeginningwiththecompletionofthesecondfullyearofservicebytherespectiveemployees.
Optionsforotheremployeesvestoveraperiodoffouryearsbeginningwiththecompletionofonefullyearfromthedateofgrant.
OnFebruary1,2000,theCompanygrantedoptionstoacquireatotalof1,200,000ordinarysharestoadirectorandoptionstoacquireatotalof550,000ordinarysharestotwoconsultants.
TheseoptionsgenerallyvestoveraperiodoftwoyearsbeginningonFebruary1,2000.
TheexercisepriceoftheseoptionsisUS$0.
100pershare.
Deferredcompensationcostsrelatedtotheseoptiongrantstothedirectorandtwoconsultantsin2000wereapproximatelyRMB1,337,000.
TheestimatedfairvalueoftheoptionsgrantedtothedirectorandtheconsultantsisestimatedonthedateofgrantusingtheBlack-Scholesoptionpricingmodel.
Thefollowingassumptionswereusedforthegrants:risk-freeinterestrateof2.
97%;estimatedfairvalueofUS$0.
10perordinaryshare;expecteddividendyieldof0%forallperiods;expectedlifeofveyears;andexpectedvolatilityof155%forallperiods.
FromFebruarytoJune15,2000,theCompanyalsograntedoptionstoacquireatotalof120,081,000ordinarysharestocertainnewmembersoftheCompany'sseniormanagementatexercisepricesrangingfromUS$0.
065toUS$0.
156pershare.
Theseoptionsgenerallyvestoveraperiodofthreetofouryearsbeginningwiththecompletionofonefullyearfrom(i)February1,2000,(ii)thedateofemploymentor(iii)thedateofofferofemployment.
InconnectionwiththeaboveoptiongrantstheCompanyexpectstorecorddeferredsharecompensationcostsofapproximatelyRMB33.
3millionwhichwillbeamortizedandchargedtoexpensestartingfromthegrantdateandthroughtheendofthevestingperiodsoftheunderlyingoptions.
ThecompensationcostswerecalculatedbaseduponanassumedfairvalueoftheCompany'sordinarysharesofUS$0.
10pershareonFebruary1,2000andUS$0.
156persharefromMarchtoMay,2000.
InformationrelatingtostockoptionsoutstandingsubsequenttoDecember31,1999isasfollows:SharesAverageExercisePriceBalance,December31,1999.
121,960,0000.
065Optionsgranted.
183,168,0000.
109Optionscancelled.
9,980,000)0.
091Balance,June15,2000.
295,148,0000.
091(d)SeriesBpreferencesharesOnMarch23,2000,theCompanyenteredintoaSeriesBPreferenceSharesPurchaseAgreementpursuanttowhichtheCompanyissued2,560,556SeriesBpreferencesharesofUS$0.
01eachatanissuancepriceofUS$15.
60persharefortotalconsiderationofapproximatelyUS$40million,ofwhichUS$35millionistobepaidupincashandUS$5millionistobepaidupbyadvertisingtobeprovidedbytheshareholderoftheSeriesBpreferencesharesanditsafliatedcompaniesontheirtelevisionchannelsoveraperiodofthreeyears.
TheCompanywillaccountfortheadvertisinginventoryasadeferredassetwhichwillberecognizedasanexpensewhentheairtimeisusedinaccordancewithAICPAStatementofPosition93-7.
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COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-22TheSeriesBpreferenceshareshavethesameconversionfeaturesastheSeriesApreferenceshares.
TheSeriesBpreferenceshareshaveanaggregateliquidationpreferenceequaltothetotalconsiderationforwhichtheyareissued.
TheycarrythesamepreferencesasthoseofSeriesApreferencesharesondividendpaymentbuthavecertainpreferencesoverSeriesApreferencesharesonreturnofcapitalincaseofawindingupoftheCompany.
TheCompanyalsoenteredintoastrategicco-operationagreementwiththeshareholderofitsSeriesBpreferenceshareswhichprovidesfor,amongotherthings,advertisingspendingofUS$5millionfromtheshareholderoverthenextthreeyears,crosslicensingofInternettoolsandtechnologies,licensingofcontentinformation,andotherco-operativemarketingandpromotionaleventsoncommercialtermstobeagreedbetweenthetwoparties.
(e)TransferofAdditionalOrdinarySharesbyPrincipalShareholdersInaddition,inMarch2000theprincipalshareholderoftheCompanytransferredanadditionalapproximately1,900,000ordinarysharestocertainemployees,forwhichtheCompanywillincursharecompensationcostsofapproximatelyRMB2.
5millionin2000.
(f)SharesplitByaresolutionoftheshareholdersoftheCompanyonMarch31,2000,theordinarysharesintheCompanyweresplitonaone-hundred-for-onebasis.
Theeffectsofthesharesplithavebeenreectedinthenancialstatementsonaretroactivebasisforalltheperiodspresented.
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COM,INC.
NOTESTOCONSOLIDATEDFINANCIALSTATEMENTS—(Continued)(Amountsexpressedinrenminbi(''RMB''),unlessotherwisestated)F-23ThroughandincludingJuly24,2000(the25thdayafterthedateofthisprospectus),alldealerseffectingtransactionsinthesesecurities,whetherornotparticipatinginthisoffering,mayberequiredtodeliveraprospectus.
Thisisinadditiontothedealers'obligationtodeliveraprospectuswhenactingasunderwritersandwithrespecttotheirunsoldallotmentsorsubscriptions.
4500000AmericanDepositarySharesNeteasecomIncRepresenting450000000OrdinarySharesPROSPECTUSMerrillLynchFarEastLimitedMerrillLynchCoDeutscheBancAlexBrownJune29,2000