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(Mark One)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
☐ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
☐ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report . . . . . . . . . . . . . . . . . . .
For the transition period from ___________ to __________
Commission file number : 000-30666
NETEASE, INC.
(Exact name of Registrant as specified in its charter)
N/A
(Translation of Registrant’s name into English)
Cayman Islands
(Jurisdiction of incorporation or organization)
NetEase Building, No. 599 Wangshang Road
Binjiang District, Hangzhou, 310052
People’s Republic of China
(Address of principal executive offices)
Charles Zhaoxuan Yang
NetEase Building, No. 599 Wangshang Road
Binjiang District, Hangzhou, 310052
People’s Republic of China
Phone (86 571) 8985-3378
Email ir@service.netease.com
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of Each Class
American Depositary Shares, each representing 5 ordinary
shares, par value US$0.0001 per share
Trading Symbol(s)
NTES
Name of Each Exchange On Which Registered
NASDAQ Global Select Market
Ordinary shares, par value US$0.0001 per share*
NASDAQ Global Select Market*
Ordinary shares, par value US$0.0001 per share
9999
The Stock Exchange of Hong Kong Limited
*Not for trading, but only in connection with the listing of American depositary shares on the NASDAQ Global Select Market.
Securities registered or to be registered pursuant to Section 12(g) of the Act:
NONE
(Title of Class)
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Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
NONE
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:
3,349,335,066 ordinary shares, par value US$0.0001 per share.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
⌧ Yes ☐ No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or (15) (d) of the Securities
Exchange Act of 1934.
☐ Yes ⌧ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.
⌧ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
⌧ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or an emerging growth company. See the definitions
of “large accelerated filer,” “accelerated filer,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ⌧
Accelerated filer ☐
Non-accelerated filer ☐
Emerging growth company ☐
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the
extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act. ☐
† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards
Codification after April 5, 2012.
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial
reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ⌧ Yes ☐
No
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP ⌧
International Financial Reporting Standards as issued
by the International Accounting Standards Board ☐
Other ☐
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow:
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
☐ Item 17 ☐ Item 18
☐ Yes ⌧ No
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.
☐ Yes ☐ No
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INTRODUCTION
PART I.
Item 1.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 8.
Item 9.
Item 10.
Item 11.
Item 12.
PART II.
TABLE OF CONTENTS
Page
Identity of Directors, Senior Management and Advisors
Offer Statistics and Expected Timetable
Key Information
Information on the Company
Operating and Financial Review and Prospects
Directors, Senior Management and Employees
Major Shareholders and Related Party Transactions
Financial Information
The Offer and Listing
Additional Information
Quantitative and Qualitative Disclosures About Market Risk
Description of Securities Other than Equity Securities
Item 13.
Item 14.
Item 15.
Item 16A.
Item 16B.
Item 16C.
Item 16D.
Item 16E.
Item 16F.
Item 16G.
Item 16H.
Defaults, Dividend Arrearages and Delinquencies
Material Modifications to the Rights of Security Holders and Use of Proceeds
Controls and Procedures
Audit Committee Financial Expert
Code of Ethics
Principal Accountant Fees and Services
Exemptions from the Listing Standards for Audit Committees
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Change in Registrant’s Certifying Accountants
Corporate Governance
Mine Safety Disclosure
PART III.
Item 17.
Item 18.
Item 19.
Financial Statements
Financial Statements
Exhibits
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5
5
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114
121
128
129
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145
145
149
149
149
149
150
150
150
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151
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This annual report on Form 20-F includes our audited consolidated financial statements as of December 31, 2019 and 2020 and for the years
ended December 31, 2018, 2019 and 2020. Translations in this annual report of amounts from RMB into U.S. dollars for the convenience of the reader
were calculated at the noon buying rate of US$1.00: RMB6.5250 on the last trading day of 2020 (December 31, 2020) as set forth in the H.10 statistical
release of the U.S. Federal Reserve Board.
INTRODUCTION
Conventions that Apply to This Annual Report on Form 20-F
Unless the context otherwise requires, references in this annual report on Form 20-F to:
● “2009 RSU Plan” are to our 2009 Restricted Share Unit Plan adopted in November 2009;
● “2019 RSU Plan” are to our 2019 Restricted Share Unit Plan adopted in October 2019;
● “ADSs” are to the American depositary shares, each of which represents five ordinary shares;
● “AI” are to artificial intelligence;
● “AR” are to augmented reality;
● “Boguan” are to Guangzhou Boguan Telecommunication Technology Co., Ltd., a company established under PRC laws;
● “CAC” are to the Cyberspace Administration of China;
● “CBIRC are to the China Banking and Insurance Regulatory Commission;
● “CBRC” are to the China Banking Regulatory Commission;
● “CCASS” are to the Central Clearing and Settlement System established and operated by Hong Kong Securities Clearing Company Limited, a
wholly-owned subsidiary of Hong Kong Exchange and Clearing Limited;
● “CCGs” are to collectible card games;
● “China” and “PRC” are to the People’s Republic of China, excluding, for the purposes of this annual report only, Hong Kong, Macau and Taiwan;
● “CSRC” are to the China Securities Regulatory Commission;
● “FIEs” are to Foreign Invested Enterprises;
● “GAPP” are to the General Administration of Press and Publication of China;
● “Guangzhou NetEase” are to Guangzhou NetEase Computer System Co., Ltd., a company established under PRC laws;
● “Hangzhou Leihuo” are to Hangzhou NetEase Leihuo Technology Co., Ltd. (formerly known as Hangzhou NetEase Leihuo Network Co., Ltd. for
identification purposes), a company established under PRC laws;
● “HK$” or “HK dollars” are to the legal currency of Hong Kong;
● “HNTEs” are to High and New Technology Enterprises;
● “Hong Kong Listing Rules” are to the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited, as amended or
supplemented from time to time;
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● “Hong Kong Stock Exchange” are to The Stock Exchange of Hong Kong Limited;
● “Hong Kong NetEase” are to Hong Kong NetEase Interactive Entertainment Limited, a company incorporated under Hong Kong laws;
● “ICP(s)” are to Internet content provider(s);
● “NetEase Hangzhou” are to NetEase (Hangzhou) Network Co., Ltd., a company established under PRC laws;
● “Machine learning” are to an application of AI that provides systems the ability to automatically learn and improve from experience without being
explicitly programmed;
● “MAUs” for Youdao are to the average of the monthly number of unique mobile or PC devices, as the case may be, through which such product and
service is accessed at least once in that month (duplicate access to different products and services is not eliminated from the calculation) for a
specific period with respect to each of Youdao’s products and services (except for smart devices). MAUs for Youdao are calculated using internal
company data, treating each distinguishable device as a separate MAU even though some users may access Youdao’s products and services using
more than one device and multiple users may access our services using the same;
● “MMORPGs” are to massively multi-player online role-playing games;
● “MII” and later “MIIT” are to the Ministry of Information Industry of China, which later became the Ministry of Industry and Information
Technology of China;
● “MOBA” are to multi-player online battle arena;
● “MOC” and later “MOCT” are to the Ministry of Culture of China which later became the Ministry of Culture and Tourism of China;
● “MOF” are to the Ministry of Finance of China;
● “MOFCOM” are the Ministry of Commerce of China;
● “NCIIC” are to the Ministry of Public Security’s National Citizen Identity Information Center of China;
● “NDRC” are to the National Development and Reform Commission of China;
● “NMT” are to neural machine translation;
● “NPPA” are to the National Press and Publication Administration of China;
● “NRTA” are to the National Radio and Television Administration of China;
● “OCR” are to optical character recognition;
● “R&D” are to research and development;
● “RMB” or “Renminbi” are to the legal currency of the People’s Republic of China;
● “RPGs” are to role-playing games;
● “PBOC” are to the People’s Bank of China;
● “SAFE” are to the State Administration of Foreign Exchange of China;
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● “SAIC” are the State Administration for Industry and Commerce of China, currently known as SAMR;
● “SAMR” are to the State Administration for Market Regulation of China;
● “SAPPRFT” are to State Administration of Press, Publication, Radio, Film and Television of China, formerly the General Administration of Press
and Publication of China and the State Administration of Radio, Film and Television of China, and since March 2018 has been reformed and became
the National Radio and Television Administration and the National Press and Publication Administration (National Copyright Administration);
● “SCIO” are to the State Council Information Office of China;
● “SEC” are to the United States Securities and Exchange Commission;
● “SFO” are to the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong), as amended or supplemented from time to time;
● “shareholder(s)” are to holder(s) of shares and, where the context requires, ADSs;
● “share(s)” or “ordinary share(s)” are to ordinary share(s) in our capital with par value of US$0.0001 per share;
● “SLGs” are to simulation games;
● “STA” are to the State Taxation Administration of China;
● “US$,” “dollars” and “U.S. dollars” are to the legal currency of the United States;
● “U.S. Exchange Act” are to the United States Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder;
● “U.S. GAAP” are to accounting principles generally accepted in the United States;
● “variable interest entities,” “VIE” or “VIEs” are to our variable interest entities, or any one of them, the financial results of which are consolidated
into our consolidated financial statements as if they were our subsidiaries;
● “VR” are to virtual reality;
● “we,” “us,” “our company” and “our” are to NetEase, Inc., where the context requires, its subsidiaries (which includes the consolidated affiliated
entities) from time to time;
● “Yanxuan” are to Hangzhou NetEase Yanxuan Trading Co., Ltd., a company established under PRC laws;
● “Youdao” are to Youdao, Inc., a company incorporated under Cayman Islands laws, and listed on The New York Stock Exchange under the symbol
“DAO” in October 2019 and a majority-controlled subsidiary of our company;
● “Youdao Computer” are to Beijing NetEase Youdao Computer System Co., Ltd, a company established under PRC laws; and
● “Youdao Information” are to NetEase Youdao Information Technology (Beijing) Co., Ltd., a company established under PRC laws.
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Trademarks and Service Marks
We own or have been licensed rights to trademarks, service marks and trade names for use in connection with the operation of our business. All other
trademarks, service marks or trade names appearing in this annual report that are not identified as marks owned by us are the property of their respective
owners.
Solely for convenience, some trademarks, service marks and trade names referred to in this annual report are listed without the ®, (TM) and (sm)
symbols, but we will assert, to the fullest extent under applicable law, our applicable rights in these trademarks, service marks and trade names.
Forward-Looking Information
This annual report on Form 20-F contains statements of a forward-looking nature. These statements are made under the “safe harbor” provisions
of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking statements by terminology such as “will,”
“expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar statements. The accuracy of these statements may be impacted
by a number of business risks and uncertainties that could cause actual results to differ materially from those projected or anticipated, including risks
related to:
● the risk that the online game market, including mobile games and PC games, will not continue to grow or that we will not be able to maintain our
leading position in that market, which could occur if, for example, our new online games or expansion packs and other improvements to such
existing games do not become as popular as management anticipates;
● the risk that we will not be successful in our product diversification efforts, including the expansion of our mobile games into overseas markets, our
entry into strategic licensing arrangements and the expansion of our streaming music offerings and online education services;
● the risk of changes in Chinese government regulation of the online game, online education, online music, e-commerce or online advertising markets
that limit future growth of our revenues or cause our revenues to decline;
● the risk that we may not be able to continuously develop new and creative online services or that we will not be able to set, or follow in a timely
manner, trends in the market;
● the risk that we will not be able to control our expenses in future periods;
● governmental uncertainties (including possible changes in the effective tax rates applicable to us and our subsidiaries and affiliates and our ability to
receive and maintain approvals of the preferential tax treatments), general competition and price pressures in the marketplace;
● the direct and indirect impact of COVID-19 on our business;
● the risk that fluctuations in the value of the Renminbi with respect to other currencies could adversely affect our business and financial results; and
● other risks outlined in our filings with the SEC.
We do not undertake any obligation to update this forward-looking information, except as required under applicable law.
PART I.
Item 1. Identity of Directors, Senior Management and Advisors
Not applicable.
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Item 2. Offer Statistics and Expected Timetable
Not applicable.
Item 3. Key Information
A. [Reserved]
B. Capitalization and Indebtedness
Not applicable.
C. Reasons for the Offer and Use of Proceeds
Not applicable.
D. Risk Factors
The following summarizes some, but not all, of the risks provided below. Please carefully consider all of the information discussed in this Item
3.D. “Risk Factors” in this annual report for a more thorough description of these and other risks.
Risks Related To Our Company And Our Industry
● Risks Related to Our Online Games Business
● Risks relating to developing new online games and growing the popularity of existing online games
● Risks relating to claims regarding our gaming contents resulting in negative publicity or a governmental response
● Risks relating to international operations of our online game services
● Risks relating to third-party platforms that distribute our mobile games and collect payments
● Risks relating to maintaining our existing licenses of game or intellectual property
● Risks relating to illegal game servers, acts of cheating by players and sales and purchases by players of our game accounts and virtual
items through third-party auction websites
● Risks Related to Our Other Businesses
● Risks relating to user acceptance of Youdao, and market trend of integration of technology and learning, and the development and
application of our technologies to support and expand Youdao’s product and services
● Risks relating to obtaining legal and regulatory approvals, licenses or permits of our intelligent learning, music streaming, e-
commerce, advertising and other innovative businesses
● Risks relating to obtaining licenses for the music content necessary to provide our music streaming services, and our ability to attract
and retain users
● Risks relating to generating and maintaining significant advertising revenue
● Risks relating to growing our e-commerce business
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● Risks Related to Our Operations Overall
● Risks relating to competing successfully against new entrants and established industry competitors and keeping up with rapid changes
in technologies and user behavior and innovating and exploring new areas of operations
● Risks relating to gross profit margin and profitability affected by changes in our mix of revenues
● Risks relating to credit risk on our accounts receivable
● Risks relating to a prolonged slowdown in the PRC or global economy
● Risks relating to compliance with laws and other obligations regarding data protection in China and outside of China
● Risks relating to breaches of our information technology systems and system failure or performance inadequacy that causes
interruptions of our services
● Risks relating to our ability to retain our existing key employees and to add and retain senior officers to our management
● Risks relating to natural disasters, widespread public health problems, other outbreaks and epidemics and other events
Risks Related To Our Corporate Structure
● Risks relating to regulatory changes relating to the contractual arrangements with our VIEs and the viability of our current corporate
structure, corporate governance and business operations
● Risks relating to maintaining operational control of our VIEs through contractual arrangements
● Risks relating to the shareholders who have significant influence over our company and our affiliated entities
● Risks relating to our arrangements with our affiliated entities
Risks Related To Doing Business In China
● Risks relating to China’s political and economic policies
● Risks relating to compliance with and changes in PRC laws and regulations relating to telecommunications, internet, foreign
investment, tax, online games, virtual asset property rights, consumer protection and financial transactions
● Risks relating to claims and liabilities based on the information and content on our platforms
● Risks relating to uncertainties with respect to the Anti-Monopoly Guidelines for the Internet Platform Economy Sector
● Risks relating to our ability to protect our intellectual property from being infringed
● Risks relating to currency exchange rates
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Risks Related To Our ADSs And Shares
● Risks relating to being delisted from the Nasdaq under the Holding Foreign Companies Accountable Act if the PCAOB continues to be
unable to inspect our independent registered public accounting firm for three consecutive years
● Risks relating to the volatility of the trading price of our ADSs and shares
● Risks relating to the different listing rules and regulations that apply to us
● Risks relating to the limitation of the voting, inspection and other rights of holders of ADSs
You should carefully consider the following risk factors in addition to the other information set forth in this annual report. If any of the
following risks were actually to occur, our company’s business, financial condition and results of operations prospects could be adversely affected and
the value of our ADSs and shares would likely suffer.
RISKS RELATED TO OUR COMPANY AND OUR INDUSTRY
Risks Related to Our Online Games Business
If we fail to develop and introduce popular, high-quality online games in a timely and successful manner, we will not be able to compete
effectively and our ability to generate revenues will suffer.
We operate in a highly competitive, quickly changing environment, and player preferences for online games are difficult to predict. Our future
success depends not only on the popularity of our existing online games but also on our ability to develop new high-quality online games and expand our
game portfolio with games in a variety of genres that are in line with market trends and to successfully monetize such games. The development of
successful new online games can be challenging and requires high levels of innovation, a deep understanding of the online game industry in China and
the other markets where our games are published (including with respect to evolving business models), and an ability to anticipate and effectively
respond to changing interests and preferences of game players in a timely manner. Moreover, each of our new games requires long periods of time for
research and development and testing and also typically experiences a long ramp-up period as players become familiar with the game. If we are
unsuccessful at developing and introducing new online games that are appealing to players with acceptable pricing and terms, our business, financial
condition and results of operations will be negatively impacted because we would not be able to compete effectively and our ability to generate revenues
would suffer.
In addition, new technologies in online game programming or operations could render our current online titles or games in development
obsolete or unattractive to our players, thereby limiting our ability to recover development costs and potentially adversely affecting our future revenues
and profitability. For example, the online game industry in China has been transitioning to mobile games, which have become increasingly popular as
internet users in China rely more and more on mobile devices, such as smart phones and tablets, to access the internet. In response to this trend, we
devote significant resources to developing games that can be operated on mobile devices. We have commercially launched over 100 in-house developed
and licensed mobile games as of December 31, 2020 including the Fantasy Westward Journey mobile game, Westward Journey Online mobile game,
Onmyoji, the mobile version of New Ghost, Invincible, Knives Out, All About Jianghu, Identity V, Life-After, Fantasy Westward Journey 3D and Sky. As
the market for mobile games is rapidly evolving, with games in an expanding range of genres being introduced by us and our competitors, we cannot
guarantee that we will be able to effectively compete in the mobile game market. We will also need to continue investing in the development of new
technologies and bring new features and functionalities to our games, as well as enhance the user experience on our various platforms.
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We are not able to predict if or when we will commercially launch additional new games and the pace at which our new games will penetrate the
online game market in China or elsewhere, if at all. A number of factors, including technical difficulties, lack of sufficient game development
capabilities, personnel and other resources and failure to obtain or delays in obtaining relevant governmental authorities’ approvals could result in
delayed launching of our new games or the cancellation of the development of our pipeline games. Any delays in product releases or problems arising
following the commercial release of one or more new online games such as programming errors, or “bugs”, could negatively impact our business and
reputation and could cause our results of operations to be materially different from expectations. We believe that expectations of players regarding the
quality, performance and integrity of our online games and services are high, and if any of these issues occurs, players may stop playing our online games
and may be less likely to return to such games as often in the future, which may negatively impact our business.
If we are unable to continue to extend the life of existing online games that will encourage continued engagement with the games through the
addition of new features or functionalities, our business may be negatively impacted.
To prolong the lifespan of our online games, we need to continually improve and update them on a timely basis with new features and
functionalities that appeal to existing game players, attract new game players and improve overall player loyalty to such games. As a result, we have
devoted, and expect to continue to devote, significant resources to maintain and raise the popularity of our online games through the release of new
versions and/or expansion packs on a periodic basis. Developing successful updates and expansion packs for our existing games depends on our ability
to anticipate market trends in the online game industry. We must also collect and analyze player behavior data and feedback from our online community
in a timely manner and utilize this information to effectively incorporate features into our updates and expansion packs to improve the variety and
attractiveness of our gameplay and any virtual items sold within the games.
In the course of operating online games, including the release of updates and expansion packs to existing games, certain game features may
periodically be introduced, changed or removed. We cannot assure you that the introduction, change or removal of any game feature will be well
received by our game players, who may decide to reduce or eliminate their playing time in response to any such introduction, change or removal. As a
result, any introduction, change or removal of game features may adversely impact our business, financial condition and results of operations.
We are unable to predict whether these activities will be successful or adversely affect our profitability given the significant resources required.
Moreover, because of the rapidly evolving nature of the online games market in China and elsewhere, we cannot estimate the total life cycle of any of our
games, particularly our more recently launched mobile or PC games, and changes in players’ tastes or in the overall market for online games in China
and elsewhere could alter the life cycle of each version or upgrade or even cause our players to stop playing our games altogether.
Any difficulties or delays in receiving approval from the relevant government authorities for our new games or new expansion packs for, or
material changes to, our existing games could adversely affect such games’ popularity and profitability.
All games we release in China require government approvals. Moreover, even after certain games have received government approvals, certain
expansion packs with material changes to the content and additions to the descriptions of those games may require further government approvals. We
cannot be certain of the duration of any necessary approval processes, and any delay in receiving such government approvals may adversely affect the
profitability and popularity of such games. In particular, game approvals in 2018 experienced certain delays, although the approvals resumed starting
from the end of 2018. Since then, China’s game regulatory authority has officially published a few lists of newly approved game titles, including a
number of our online games, and the approval processes for game titles appears to have returned to normal in 2019. We are not certain of the cause of the
delays in 2018. In addition, no laws, regulations or official clarifications had been promulgated or published in relation to such delay and resumption of
the assessment and pre-approval procedures, and it is unclear whether there will be any similar delays in the future. We cannot predict the effect any
future delay in approvals may have on our results of operations.
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According to several news reports in December 2018, PRC regulators established the Online Games Ethics Committee for the purpose of
reviewing online games, and based on the assessment conducted by the Online Games Ethics Committee, PRC regulators reviewed and rejected nine of
an initial batch of 20 games. As of the date of the filing of this annual report, no official laws and regulations had been promulgated or published in
relation to the assessment criteria and procedures of the Online Games Ethics Committee. However, the formation of the Online Games Ethics
Committee and its assessment criteria and procedures could impact our ability to launch and publish new games going forward, and require us to spend
more time and costs in preparing and receiving the approvals necessary to launch our games. In addition, our games that have already received the
relevant pre-approval may also be subject to further review by the Online Games Ethics Committee, and we may be required to modify the content of our
games, which will further add to our regulatory compliance costs and expenses.
Reports of violence and crimes related to online games or any claims of our gaming contents to be, among others, obscene, superstitious,
defamatory or impairing public interest, may result in negative publicity or a governmental response that could have a material and adverse
impact on our business.
The media in China has reported incidents of violent crimes allegedly inspired by online games and theft of virtual items between users in online
games. While we believe that such events were not related to our online games, it is possible that our reputation, as one of the leading online game
providers in China, could be adversely affected by such behavior. In response to the media reports, in August 2005 the Chinese government enacted
regulations to prohibit all minors under the age of 18 from playing online games in which players are allowed to kill other players, an activity that has
been termed Player Kills, or PK. The Chinese government has also taken steps to limit online game playing time for all minors under the age of 18. See
below “—Risks Related to Doing Business in China—The Chinese government has taken steps to limit online game playing time for all minors and to
otherwise control the content and operation of online games. These and any other new restrictions on online games may materially and adversely impact
our business and results of operations.” If the Chinese government determines that online games have a negative impact on society, it may impose
certain additional restrictions on the online game industry, which could in turn have a material and adverse effect on our business and results of
operations.
In addition, the Chinese government and regulatory authorities prohibit any internet content that, among other things, violates PRC laws and
regulations, endangers the national security of China, or is obscene, superstitious, violent or defamatory. When internet content providers and internet
publishers, including online game operators, find that information falling within the above-mentioned scope is transmitted on their websites or is stored
in their electronic bulletin service systems, they are required to terminate the transmission of such information or delete such information immediately,
keep records, and report to relevant authorities. Failure to comply with these requirements could result in the revocation of our internet content provider,
or ICP, license and other required licenses to operate our business. Internet content providers like us may also be held liable for prohibited information
displayed on, retrieved from or linked to their websites. In addition, any claim of us failing to comply with these prohibitions may result in negative
publicity and government actions, which in turn could have a material and adverse impact on our business.
Because our long-term growth strategy involves further expansion of our online game services to players outside of China, our business will be
susceptible to risks associated with international operations.
An important component of our growth strategy involves the further expansion of our online game services and game player base
internationally. In particular, we have launched our popular games Knives Out and Identity V in Japan, North America and other markets across the globe,
and MARVEL Super War in several Southeast Asia markets. In the future, we may launch our online games in other international markets. The expansion
of our online game services to markets outside of China will involve a variety of risks, including:
● difficulties in anticipating the preferences of game players in markets outside of China;
● challenges in formulating effective local sales and marketing strategies targeting users from various jurisdictions and cultures;
● challenges in identifying appropriate local business partners, including local game operators, and establishing and maintaining good
working relationships with them;
● changes in a specific country’s or region’s political or economic conditions;
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● unexpected changes in regulatory requirements, taxes or trade laws;
● difficulties in managing a business in new markets with diverse cultures, languages, customs, legal systems, alternative dispute systems and
regulatory systems;
● more stringent regulations relating to data security and the unauthorized use of, or access to, commercial and personal information;
● currency exchange rate fluctuations and the resulting effect on our revenue and expenses, and the cost and risk of entering into hedging
transactions if we choose to do so in the future;
● laws and business practices favoring local competitors or general preferences for local vendors;
● limited or insufficient intellectual property protection; and
● adverse tax burdens and foreign exchange controls that could make it difficult to repatriate earnings and cash.
Our limited experience in operating our business outside of China increases the risk that any potential future expansion efforts that we may
undertake will not be successful. If we invest substantial time and resources to expand our international operations and are unable to do so successfully
and in a timely manner, our business and operating results will suffer.
We rely on third-party platforms to distribute our mobile games and collect payments. If we fail to maintain our relationships with these
platforms, or if our revenue-sharing arrangements with these platforms change to our detriment, our mobile games business may be adversely
affected.
In addition to our proprietary distribution channels, we publish our mobile games through the Apple iOS app store and other mobile application
stores or platforms owned and operated by third parties. We rely on these third parties to promote and distribute our mobile games, record gross billings,
maintain the security of their platforms to prevent fraudulent activities, provide certain user services and, in some instances, process payments from
users. Further, we believe that our games benefit from the strong brand recognition, large user base and the stickiness of these mobile platforms.
We are subject to these third parties’ standard terms and conditions for application developers, which govern the promotion, distribution and
operation of games and other applications on their platforms. If we violate, or if a platform provider believes that we have violated, its terms and
conditions, the particular platform provider may discontinue or limit our access to that platform, which could harm our business. Our business could also
be harmed if these platforms decline in popularity with users or modify their discovery mechanisms for games, the communication channels available to
developers, their terms of service or other policies such as distribution fees, how they label free-to-play games or payment methods for in-app purchases.
These platforms’ operators could also develop their own competitive offerings that could compete with our mobile games.
Furthermore, a few of these third-party platforms dominate the mobile application distribution channels. Any changes in the revenue-sharing
arrangements that we have with any of the major third-party application distribution platforms may materially impact our revenue and profitability.
Failure to renew any revenue-sharing agreement or any other material agreement with these major third-party distribution platforms may result in
discontinued or limited access to such distribution platforms, which could harm our business. In addition, changes in the credit period or the settlement
cycle terms of these third-party platforms may materially and adversely affect our cash flow. Disputes with third-party platforms, such as disputes
relating to intellectual property rights, distribution fee arrangements and billing issues, may also arise from time to time and we cannot assure you that we
will be able to resolve such disputes in a timely manner or at all. If our collaboration with a major third-party platform terminates for any reason, we may
not be able to find a replacement in a timely manner or at all and the distribution of our games may be adversely affected. Any failure on our part to
maintain good relationships with a sufficient number of popular platforms for the distribution of our games could cause the number of our game
downloads and activations to decrease, which will have a material adverse effect on our business, financial condition and results of operations.
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Our business, financial condition and results of operations depend in part on the overall growth of the online game industry in China and the
other markets where our games are operated, the growth of which is subject to a number of factors that are beyond our control.
Our business, financial condition and results of operations depend in part on continued growth of the online game industry in China and other
markets where our games are published, particularly the Asia-Pacific region and North America. The online game industry is affected by a number of
factors that are beyond our control, including:
● general economic conditions and the level of discretionary spending devoted by players to non-essentials such as acquiring in- game virtual
items;
● the availability and popularity of other forms of interactive entertainment, particularly games on console systems which are more popular
in North America, Europe and Japan, and other leisure activities;
● the availability of reliable telecommunication and internet infrastructure and sufficient server bandwidth in the markets where we operate;
● evolving PC, smartphone and tablet technologies;
● changes in game player demographics and public tastes and preferences;
● any government restrictions on the playing of online games; and
● the availability and popularity of alternative gameplay models such as cloud-gaming services.
There is no assurance that the online game industry will continue to grow in future periods at any particular rate or at all.
We may not be successful in making our mobile games profitable, and our profits from mobile games may be relatively lower than the profits we
have enjoyed historically for PC games.
We generate a large portion of revenue in our online games segment from our mobile games. 71.0%, 71.4% and 71.9% of our total net game
revenues were generated from mobile games for the years ended December 31, 2018, 2019 and 2020, respectively. In addition, 55.8%, 56.0% and 53.3%
of our total net revenues were generated from mobile games for the years ended December 31, 2018, 2019 and 2020, respectively, and 22.8%, 22.4% and
20.8% of our total net revenues were generated from our PC games for the same periods, respectively. Our profits from our mobile games, even if the
games are successful, are generally lower than our profits generated from PC games, because, in order to gain access to our games on mobile application
stores, which are the primary distribution channel for our mobile games, we must enter into revenue-sharing arrangements that result in lower profit
margins compared with those of our PC games. In addition, our mobile games tend to cover a wider variety of genres, some of which have historically
had relatively lower profitability than that of our PC games. Furthermore, we are releasing more of our mobile games overseas, which may involve
additional marketing and distribution costs and further impact the profitability of our mobile games.
We have devoted and expect to continue to devote a significant amount of resources to the development of our mobile games, but the relatively
lower profit margins and other uncertainties make it difficult to predict whether we will continue to succeed in making our mobile game operations
profitable. If we do not succeed in doing so, our business, financial condition and results of operations will be adversely affected.
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A significant portion of our revenue from online game services is generated from the sale of virtual items within the games, and if we do not
develop desirable virtual items and properly price them or if this revenue model ceases to be successful, our business, financial condition and results of
operations may be materially and adversely affected.
All of our mobile games and many of our PC games currently utilize the item-based revenue model. Under this revenue model, our game
players are able to play the games for free, but are charged for the purchase of virtual items in the games. We believe that this attracts a wider audience
of players and increases the number of potential paying users. However, the success of this business model largely depends on whether we can attract
game players to play our games and whether we can successfully encourage more players to purchase virtual items. Game players will only pay for
virtual items if they are perceived to provide value and enhance their playing experience, and we must closely monitor and analyze in-game consumption
patterns and player preferences to understand what items will be appealing and the appropriate price for them. Moreover, we must offer sufficient in-
game purchasing opportunities to make our games profitable, while ensuring that the games are fun to play including for players who purchase no virtual
items. We might fail to accurately identify and introduce new and popular virtual items or price them properly or may not be able to market our virtual
items effectively. In addition, the item-based revenue model may not continue to be commercially successful and in the future we may need to change
our revenue model to a time-based or other revenue model. Any change in revenue model could result in disruption of our game operations and a
decrease in the number of our game players and thereby materially and adversely affect our business, financial condition and results of operations.
Providing a high level of customer service for our players is crucial to maintaining and growing the popularity of our online games, and any
failure to do so could harm our reputation and our business.
We devote significant resources to provide high quality customer services to our game players 24 hours a day, seven days a week, through
telephone and online support. We also maintain a team of highly trained “Game Masters” which supervise the activities within our games to provide
assistance to players as needed and stop any cheating or unfair behavior to ensure the game has an atmosphere of fun and fair play. These activities are
crucial to retaining our existing game players and attracting new players who expect a high-quality playing experience from our online games. In
addition, our license agreements with third-party developers may also require us to provide specified minimum levels of customer support, and any
breach of such obligations could result in the developer terminating our license agreement with them and other damages.
If we underestimate the popularity of certain games or an unexpected event occurs with respect to the operation of a game, we might receive
increased complaints asserting that we were unprepared and did not provide adequate customer service. If we fail to maintain effective player support
which meets the expectations of players, it could harm our reputation and the popularity of our online games, which may materially and adversely affect
our business, financial condition and results of operations.
We may not be able to maintain stable relationships with our existing game licensors, and we may experience difficulties in the operation of the
online games licensed from them.
In addition to our internally-developed games, we also offer several mobile and PC games licensed from third-party developers, which
accounted for 7.5%, 7.5% and 9.1% of our total net revenues in 2018, 2019 and 2020, respectively. For example, starting in August 2008, Blizzard
Entertainment, Inc. (together with its affiliated companies, referred to as Blizzard in this annual report) agreed to license certain online games developed
by it to Shanghai EaseNet Network Technology Co., Ltd., or Shanghai EaseNet, for operation in the PRC. Shanghai EaseNet is a PRC company owned
by William Lei Ding, our Chief Executive Officer, director and major shareholder, and has contractual arrangements with us and with the joint venture
established between Blizzard and us. In January 2019, Shanghai EaseNet and Blizzard extended the term of the existing game licenses by Blizzard to
Shanghai EaseNet to January 2023. These games include World of Warcraft®, StarCraft® II, Diablo® III, Hearthstone®, Heroes of the Storm® and
Overwatch®, all of which have been commercially launched. We are also currently co-developing Diablo ImmortalTM, a mobile massively multiplayer
online action role-playing game, or MMO action-RPG, with Blizzard. In addition to our relationship with Blizzard, in May 2016, we entered into a five-
year exclusive agreement with Mojang AB, a subsidiary of Microsoft, pursuant to which Microsoft and Mojang agreed to license the operation of
Minecraft in the PRC to us until 2022. In May 2019, we extended the term of the Minecraft license for an additional year to August 2023. If we are
unable to maintain stable relationships with our existing game licensors, or if any of our licensors establishes similar or more favorable relationships with
our competitors in violation of its contractual arrangements with us or otherwise, we may not be able to ensure the smooth operation of these licensed
online games, and our licensors could terminate or fail to renew the license agreements with us, which could harm our operating results and business.
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Moreover, the success of our arrangements with our game licensors depends on the popularity of the games licensed to us by them in the
Chinese market, which is affected by, among other things, the frequency and success of updates and expansion packs to those games developed by them
over which we have no control. Any failure of such licensors to provide game updates, enhancements and new versions in a timely manner and that are
appealing to game players, provide assistance that enables us to effectively promote the games, or otherwise fulfill their obligations under our license
agreements could adversely affect the game-playing experience of our game players, damage our reputation, or shorten the life-spans of those games, any
of which could result in the loss of game players, acceleration of our amortization of the license fees we have paid for those games, or a decrease in or
elimination of our revenues from those games.
In addition, certain events may limit our licensors’ ability to develop or license online games, such as claims by third parties that their online
games infringe such third parties’ intellectual property rights or their inability to acquire or maintain licenses to use another party’s intellectual property
in their online games. In the case of such events, our licensors may be unable to continue licensing online games to us or to continue participating in any
joint venture with us, regardless of the stability of our relationship with them.
We also cannot be certain that these licensed online games will be viewed by the regulatory authorities as complying with content restrictions,
will be attractive to users or will be able to compete with games operated by our competitors. We may not be able to fully recover the costs associated
with licensing these online games if the games are not popular among users in the PRC, and any difficulties in the operation of these licensed games
could harm our business, financial condition and results of operations.
We receive relatively lower profits from the operation of online games that we license from third-party developers, and we are subject to certain
financial obligations in connection with such licenses.
Our revenue sharing arrangements for games that we license from third-party developers provide us with relatively less profit than games that
we develop in-house. Moreover, to secure the rights to games from such developers, we are required, as licensee of the games, to pay them royalties for
the games over the terms of the licenses, to make minimum marketing expenditure commitments, or to provide funds for hardware to operate the games.
See Item 4.B. “Business Overview—Our Services—Online Game Services—Our Games—Our Game Library—Licensed Games.” for details about
these arrangements. In some cases, we may not be able to recoup our investments in such games. We often must make such commitments and
investments without knowing whether the games we are licensing will be successful and generate sufficient revenues to enable us to recoup our costs or
for the games to be profitable.
Future alliances may expose us to potential risks, including those associated with the assimilation of new operation technologies and personnel,
unforeseen or hidden liabilities, and potential business disputes with our partners, among others.
Strategic alliances with key players in the online game industry and other related industry sectors form part of our strategy to expand our
portfolio of online games. In some cases, such alliances may involve our investment into strategic partners, as we have done with a number of game
development studios in various countries. However, our ability to grow through future alliances, including through joint ventures and direct investments,
will depend on the availability of suitable partners at reasonable terms, our ability to compete effectively to attract these partners, the availability of
financing to complete larger joint ventures and investments, and our ability to obtain any required governmental approvals. Further, the benefits of an
alliance may take considerable time to develop, and we cannot be certain that any particular alliance will produce its intended benefits.
Future alliances could also expose us to potential risks, including risks associated with the assimilation of new operation technologies and
personnel, unforeseen or hidden liabilities, the inability to generate sufficient revenue to offset the costs and expenses of alliances and potential loss of, or
harm to, our relationships with employees, customers, licensors and other suppliers as a result of integration of new businesses. Further, we may not be
able to maintain a satisfactory relationship with our partners, which could adversely affect our business and results of operations. We have relatively
limited experience in identifying, financing or completing strategic alliances compared with some of our competitors. Such transactions and the
subsequent integration process would require significant attention from our management. The diversion of our management’s attention and any
difficulties encountered with respect to the alliances or in the process of integration could have an adverse effect on our ability to manage our business.
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Termination of our material intellectual property licenses could have a material adverse effect on our business.
Certain of our online games rely on intellectual property license agreements which give us the right to use certain names, characters, logos or
storylines in connection with online games developed by us. For example, we have a partnership with Marvel Entertainment to create mobile games
based on Marvel characters and storylines and a partnership with Warner Bros. Interactive Entertainment to create a mobile game based on characters and
storylines inspired by the Wizarding World. If we were to breach any material term of these license agreements, the licensor could terminate the
agreement. If the licensor were to terminate our rights to use any such intellectual property for this reason or any other reason, or if a licensor decides not
to renew a license agreement upon the expiration of the license term, the loss of such rights could have a material adverse effect on our business. In
addition, it can be difficult to identify a suitable intellectual property that can be adapted for use in online games and is recognizable to players in China
and elsewhere, and we face significant competition for the rights to such intellectual property from other online game companies. Obtaining license
rights, and particularly exclusive license rights, to use third-party intellectual property for use in online games can involve significant expense. In
addition, we have previously obtained, and intend to continue to seek to obtain, license rights for works from certain intellectual property owners based
outside of China, and our ability to utilize their intellectual property in China may be adversely affected by the scrutiny of such arrangements by the
relevant Chinese authorities.
Even if we obtain license rights for such intellectual property, we cannot assure you that games that we develop utilizing it will be popular and
commercially successful and that we will be able to recoup the amounts we pay for the license rights. Moreover, after the expiration of the terms of our
license agreements with the relevant copyright holders, we may not be able to renew the agreements with commercial terms that are favorable to us, if at
all. Our inability to renew such agreements could force us to discontinue the related online games and have a significant adverse impact on our online
game operations and revenues.
Our new games may attract game players away from our existing games, which may have a material adverse effect on our business, financial
condition and results of operations.
Our new online games, including mobile games and PC games, may attract game players away from our existing games and shrink the player
base of our existing online games, which could in turn make those existing games less attractive to other game players, resulting in decreased revenues
from our existing games. Players of our existing games may also spend less money to purchase time or virtual items in our new games than they would
have spent if they had continued playing our existing games. In addition, our game players may migrate from our existing games with a higher profit
margin to new games with a lower profit margin. The occurrence of any of the foregoing could have a material and adverse effect on our business,
financial condition and results of operations.
Illegal game servers and acts of cheating by players of online games could harm our business and reputation and materially and adversely affect
our results of operations.
Several of our competitors have reported in past years that certain third parties have misappropriated the source codes of their games and set up
illegal game servers and let their customers play such games on illegal servers without paying for the game playing time. While we already have in place
numerous internal control measures to protect the source codes of our games from being stolen and to address illegal server usage and, to date, our games
have not to our knowledge experienced such usage, our preventive measures may not be effective. The misappropriation of our game server installation
software and installation of illegal game servers could harm our business and reputation and materially and adversely affect our results of operations.
In addition, acts of cheating by players of online games could lessen the popularity of our online games and adversely affect our reputation and
our results of operations. There have been a number of incidents in previous years where users, through a variety of methods, were able to modify the
rules of our online games. Although these users did not gain unauthorized access to our systems, they were able to modify the rules of our online games
during gameplay in a manner that allowed them to cheat and disadvantage our other online game users, which often has the effect of causing players to
stop using the game and shortening the game’s lifecycle. While we have taken a number of steps to deter our users from engaging in cheating when
playing our online games, we cannot assure you that we or the third parties from whom we license some of our online games will be successful or timely
in taking corrective steps necessary to prevent users from modifying the rules of our online games.
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If we suspect a player of installing cheating programs on our online games, or of engaging in other types of unauthorized activities, we may
freeze that player’s game account or even ban the player from logging on to our games and other media. Such activities to regulate the behavior of our
users are essential to maintaining a fair playing environment for our users. However, if any of our regulatory activities are found to be wrongly
implemented, our users may institute legal proceedings against us for damages or claims. Our business, financial condition and results of operations may
be materially and adversely affected as a result.
Our online games will be less likely to be successful if we cannot adopt and implement innovative and effective marketing strategies to attract
attention to our games from game players in our targeted demographic groups.
A relatively large number of mobile and PC games are typically available at any given time in the markets in which we launch and operate our
online games, and such games compete for attention from the same game player population that we target. Our ability to successfully promote and
monetize our online games will depend on our ability to adopt and effectively implement innovative marketing strategies, and particularly marketing
through online media such as our 163.com website, social media sites, game live streaming sites and other online game forums, and our ability to cross-
market new games to players of our current online games. We also engage in a wide range of other promotional activities such as hosting game
tournaments and a forum that provides an online community for elite game players, key opinion leaders and masters of the online game industry to
interact. If we fail to adopt and implement such marketing and cross-marketing strategies, or if the marketing strategies of our competitors are more
innovative and effective than ours, our online games will be less likely to be successful and as a result we may not be able to achieve an acceptable level
of revenue from those games.
Some of our players make sales and purchases of our game accounts and virtual items through third-party auction websites, which may have a
negative effect on our net revenues.
Some of our players make sales and purchases of our game accounts and virtual items through unauthorized third-party auction websites in
exchange for real money, which we do not and are unable to track or monitor. We do not generate any net revenues from these transactions.
Accordingly, purchases and sales of our game accounts or virtual items on third-party websites could lead to decreased sales by us and also put
downward pressure on the prices that we charge players for our virtual items and services, all of which could result in lower revenues generated for us by
our games. New players may decide not to play our games as a result of any rule changes we might implement to restrict the players’ ability to trade in
game accounts or virtual items, which could materially adversely affect our business, financial condition and results of operations.
In addition, such trading activities could run afoul of PRC regulations on virtual currency and subject traders and us to potential liability. See
“—Risks Related to Doing Business in China—Restrictions on virtual currency may adversely affect our online game revenues.”
Risks Related to Our Other Businesses
The success and future growth of our Youdao business will be affected by the user acceptance and market trend of integration of technology and
learning.
We offer online courses and a number of other learning services and learning products via our majority-controlled subsidiary, Youdao. Youdao
operates in the intelligent learning industry, and its business model features integrating technology closely with learning to provide a more efficient and
engaging learning experience. Intelligent learning remains a relatively new concept in China, and there are limited proven methods to project user
demand or preference or available industry standards. Even with the proliferation of internet and mobile devices in China, we believe that some of
Youdao’s target students may still be inclined to choose traditional face-to-face courses over online courses as they find the former more intimate and
reliable. We cannot assure you that Youdao’s products and services will continue to be attractive to our users in the future. If Youdao’s offering of
learning services and learning products becomes less appealing to our users, the financial condition and results of operations of our Youdao business
could be materially and adversely affected.
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If we fail to develop and apply our technologies to support and expand Youdao’s product and service offerings or if we fail to timely respond to
the rapid changes in industry trends and user preferences, our Youdao business may be materially and adversely affected.
Over the years, we have developed a number of core technologies to support Youdao’s comprehensive suite of products and services. We also
rely on technologies to build and maintain Youdao’s information technology infrastructure. The intelligent learning industry is subject to rapid
technological changes and innovations and is affected by unpredictable product lifecycles and user preferences. Our technologies may become obsolete
or insufficient, and we may have difficulties in following and adapting to technological changes in the intelligent learning industry in a timely and cost-
effective manner. New technologies and solutions developed and introduced by Youdao’s competitors could render its offerings less attractive or obsolete
thus materially affecting Youdao’s business and prospects. In addition, our substantial investments in Youdao’s technology may not produce expected
results. If we fail to continue to develop, innovate and utilize our technologies to support and expand Youdao’s product and service offerings or if our
competitors develop or apply more advanced technologies, the financial condition and results of operations of our Youdao business could be materially
and adversely affected.
Our intelligent learning, music streaming, e-commerce, advertising and other innovative businesses are subject to a broad range of laws and
regulations. Any lack of requisite approvals, licenses or permits applicable to these businesses or any failure to comply with applicable laws or
regulations may have a material and adverse impact on our business, financial condition and results of operations.
Our intelligent learning, music streaming, e-commerce, advertising and other innovative businesses are subject to a broad range of laws and
regulations, and future laws and regulations may impose additional requirements and other obligations.
For example, the private education industry in the PRC is subject to various regulations, and certain aspects of Youdao’s business operations
may be deemed not to be in full compliance with them. Among other things, a “private school” is required to obtain approval or a permit from the
relevant government authorities in China. However, it remains unclear in practice as to whether and how online education service providers, in particular
those that provide, among other things, after-school training services to primary and secondary school students, need to comply with the operating permit
requirement under applicable PRC law. In addition, various PRC regulations require that Youdao make certain filings with the relevant provincial
regulatory authorities for education and to comply with certain regulatory requirements for its intelligent learning business. Certain aspects of Youdao’s
business may be deemed to not be in full compliance with such applicable regulatory requirements. The relevant government authorities may, from time
to time, conduct inspections on compliance with such regulations. We have been making and will continue to make efforts to comply with such
regulations as well as requirements from the relevant government authorities during such inspections. As of the date of this annual report, we have
completed or submitted applications for the filings required by such applicable regulations for most of the mobile apps Youdao operates. We are also
preparing the required filings for Youdao’s newly launched and other learning apps. We cannot assure you, however, that we will complete all such
filings and comply with other regulatory requirements in a timely manner, or at all. It is also uncertain whether and how the PRC government would
promulgate additional laws, regulations and guidance regarding the online private education industry, and there is no assurance that we can comply with
any such newly promulgated laws, regulations and guidance in a timely manner. Moreover, Youdao’s business may be required to apply for and obtain
additional licenses, permits or recordation or expand the scope of the licenses already obtained, given the significant uncertainties of the interpretation
and implementation of certain regulatory requirements applicable to online education business.
Our e-commerce business is also subject to numerous PRC laws and regulations that regulate retailers generally or govern online retailers
specifically. See below “—Risks Related to Doing Business in China—We are subject to consumer protection laws that could require us to modify our
current business practices and incur increased costs.” We may also be required to obtain licenses and permits from different regulatory authorities in
order to sell certain categories of products on our e-commerce platform. In addition, the online activities of all of these businesses are subject to PRC
regulations governing foreign ownership of companies in the internet industry and the licensing requirements pertaining to them, as well as internet
access and the distribution of online content including music, music videos, online educational content and other forms of content over the internet. See
below “—Risks Related to Our Corporate Structure” and “—Risks Related to Doing Business in China.”
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If the PRC governmental authorities determine that we are not in compliance with all the requirements under applicable laws and regulations,
we may be subject to fines and/or other sanctions, and our operations could be disrupted. As these industries are evolving rapidly in China, it is also
uncertain whether and how the PRC government would promulgate additional laws and regulations regarding our intelligent learning, music streaming,
e-commerce, advertising and other innovative businesses. If the PRC government requires additional licenses or permits or provides more strict
supervision requirements in the future in order for us to conduct these businesses, there is no guarantee that we would be able to obtain such licenses or
permits or meet all the supervision requirements in a timely manner, or at all. Failure to maintain or regain compliance may materially and adversely
affect our business, financial condition and results of operations.
Our controlling interest in Youdao may be diluted if Youdao raises additional capital with the issuance and sale of additional equity in the
future.
Youdao, our majority-controlled subsidiary listed on the New York Stock Exchange, may need additional capital in the future to fund its
continued operations and support its business growth. As Youdao will continue to invest heavily in improving technologies, expanding its marketing
efforts, hiring qualified faculty and R&D, personnel and offering additional products, services and contents, Youdao may not generate sufficient revenue
to offset such expenses. In the future, should Youdao require additional liquidity and capital resources to fund its business and operations, Youdao may
need to obtain additional financing, including issuing and selling additional equity or equity-linked securities, or issuing additional equity awards to
incentivize its employees, which would dilute our interest in Youdao.
We may be unable to obtain licenses for the music content necessary to provide our music streaming services or to obtain such licenses at an
economically viable cost.
Our ability to offer online music streaming services through our music streaming platform, NetEase Cloud Music, depends upon maintaining
commercially viable licenses or arrangements with copyright owners for music content which is popular in China. The majority of our agreements with
copyright owners are usually non-exclusive, while some of our competitors have been entering into exclusive arrangements for music distribution rights
in China. Therefore, our competitors offer certain music content that we do not have and we may lose users if those music content caters to their
preferences. The competition in China for exclusive or non-exclusive licenses to distribute music content is fierce. As a result, certain owners of music
content or exclusive rights to distribute music content have increased the fees they charge us for their content or distribution rights. This trend could
increase our costs and operating expenses and could adversely affect our ability to obtain music content at an economically viable cost.
Furthermore, there is no guarantee that the licenses or arrangements we have now will be renewed in the future. If we are unable to secure and
maintain the licenses or similar arrangements that we desire, the size and quality of our music catalog offered by our music streaming platform and the
financial condition and results of operations of this business may be materially and adversely affected, which in turn could negatively impact the
attractiveness of our brand name and online services in general to our users.
If we fail to anticipate user preferences to provide online music streaming content catering to user demands, or maintain the activeness of our
user community, our ability to attract and retain users may be materially and adversely affected.
The success of our music streaming business relies on our ability to anticipate changes in user preferences and industry dynamics, and respond
to such changes in a timely, appropriate and cost-effective manner. Music that was once popular with our users may become less attractive if user
preferences evolve. If we fail to cater to the tastes and preferences of our users, or fail to deliver superior user experiences, we may suffer from reduced
user traffic and engagement, and the financial condition and results of operations of this business may be materially and adversely affected.
We are also self-producing music content, and we plan to continue investing in our self-produced music, but we cannot guarantee that our self-
produced music caters to the preferences and tastes of our users, failure of which could negatively impact our financial condition and results of
operations.
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We expect that a portion of our future revenues will continue to come from our advertising services, but we may not be able to compete
effectively in this market because it is evolving and intensely competitive, in which case our ability to generate and maintain advertising revenue
in the future could be adversely affected.
Although we anticipate that the revenues generated by our online games will continue to constitute the major portion of our future revenues, we
believe that we will continue to rely on advertising as a source of revenue for the foreseeable future. The popularity of online advertising in China has
been growing quickly in recent years, and many of our current and potential advertisers have gained experience with using the internet as an advertising
medium. Our ability to generate and maintain significant advertising revenue will depend on a number of factors, many of which are beyond our control,
including:
● macroeconomic conditions and the general level of advertiser spending;
● the development of a large base of users possessing demographic characteristics attractive to advertisers;
● competition with other major and emerging online advertising platforms;
● the development of software that blocks internet advertisements before they appear on a user’s screen;
● downward pressure on online advertising prices; and
● the effectiveness of our advertising delivery and tracking system.
Changes in government policy could also restrict or curtail our online advertising services.
Our e-commerce business is subject to challenges and risks, which may have a negative impact on our financial performance.
We established our e-commerce platform, Yanxuan, in April 2016. Yanxuan primarily sells our private label products, including electronic
products, food, apparel, homeware, kitchenware and other general merchandise which we mainly source directly from original design manufacturers in
China. This business exposes us to challenges and risks that could negatively impact our financial performance. We have incurred significant expenses on
a variety of different marketing and brand promotion efforts designed to enhance the recognition of our Yanxuan platform and increase sales of our
products on such platform. However, our brand promotion and marketing activities may not be well received by our customers and may not result in the
levels of product sales that we anticipate.
We face intense competition from other e-commerce players, private label manufacturers and retailers. The e-commerce industry in China is
subject to rapid market change, the introduction of new business models, and the entry of new and well-funded competitors. If we are unable to compete
effectively, our e-commerce business’s financial condition and results of operations would be materially and adversely affected. To effectively compete
with our competitors in the e-commerce industry, we are also required to adjust and refine our marketing approaches or to introduce new marketing
approaches because the marketing approaches and tools in the consumer products market in China are constantly evolving. If we are unable to design
marketing activities that will appeal to the Chinese consumers or market in a cost-effective manner, revenues from our e-commerce business will be
adversely affected. In addition, our e-commerce business requires us to manage a large volume of inventory effectively and requires a large amount of
working capital. If we fail to manage our inventory effectively, we may be subject to a heightened risk of inventory obsolescence, a decline in inventory
values, and significant inventory write-downs or write-offs, which may materially and adversely affect our e-commerce business and financial position.
Moreover, the future growth of our e-commerce business depends on our ability to continue to attract new customers as well as new purchases
from existing customers. Constantly changing consumer preferences have affected and will continue to affect the online retail industry. We must stay
abreast of emerging consumer preferences and anticipate product trends that will appeal to existing and potential customers. If we are unable to offer
products that attract new customers and new purchases from existing customers, our e-commerce business may be materially and adversely affected.
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Furthermore, our profit margin from the e-commerce business, even if the business is successful, is likely to be relatively lower than our profit
margin from certain of our other businesses, such as our online game business and advertising business. If we cannot successfully address challenges
specific to the e-commerce business and compete effectively, we may not be able to recover the costs of our investments, and our future results of
operations and growth prospects may be materially and adversely affected.
Risks Related to Our Operations Overall
We may be unable to compete successfully against new entrants and established industry competitors.
The Chinese market for internet content and services is intensely competitive and rapidly changing. Our competition primarily comes from
global online game developers and operators, such as Tencent, established online and offline education service providers in China, as well as leading
digital media and entertainment providers. Some of our current and potential competitors are much larger than we are, and currently offer, and could
further develop or acquire, content and services that compete with us. We mainly compete to:
● attract, engage and retain users based on the design, quality, popularity and efficacy of our content offerings, the overall user experience of
our products and services, as well as the effectiveness of our marketing activities;
● attract and retain motivated and capable talent, including engineers, game designers, product developers and creative professionals to build
compelling content, tools and functions; and
● win collaboration relationships with game studios and content owners based on our level of expertise in systematically developing original
games, delivering a compelling user experience through operational know-how and customizing established game titles for rapid expansion
into overseas markets.
Our ability to compete depends on a number of other factors as well, some of which may be beyond our control, including alliances, acquisitions
or consolidations within our industries that may result in stronger competitors, and changes in the regulatory environment in the markets we operate.
Existing and new competitors may leverage their established platforms or market positions, or introduce innovative business models, to launch highly-
engaging content, products or services that may attract a large user base and achieve rapid growth, which may materially and adversely affect our
business expansion and results of operations. We increasingly face competition from domestic and international players operating in our markets.
Because many of our existing competitors as well as a number of potential competitors have longer operating histories in the internet market, greater
name and brand recognition, better connections with the Chinese government, larger customer bases and databases and significantly greater financial,
technical and marketing resources than we have, we cannot assure you that we will be able to compete successfully against our current or future
competitors or that competition will not have a material and adverse effect on our business, financial condition and results of operations.
If we fail to keep up with rapid changes in technologies and user behavior, our future success may be adversely affected.
Our future success will depend on our ability to respond to rapidly changing technologies, adapt our products and services to evolving industry
standards and improve the performance and reliability of our products and services. Our failure to adapt to such changes could harm our business. In
addition, changes in user behavior resulting from technological developments may also adversely affect us. For example, the number of people accessing
the internet through mobile devices, including mobile phones, tablets and other hand-held devices, has increased in recent years, and we expect this trend
to continue while 4G, 5G and more advanced mobile communications technologies are broadly implemented. If we fail to develop products and
technologies that are compatible with all mobile devices, or if the products and services we develop are not widely accepted and used by users of various
mobile devices, we may not be able to penetrate the mobile markets. In addition, the widespread adoption of new internet, networking or
telecommunications technologies or other technological changes could require substantial expenditures to modify or integrate our products, services or
infrastructure. If we fail to keep up with rapid technological changes to remain competitive, our future success may be adversely affected.
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We cannot guarantee that our efforts to innovate and explore new areas of operations would be successful or bring positive financial impact to
us.
In addition to our existing businesses, we continue to invest significant resources in innovation and exploring new products, services and
technologies to cater to the rapidly changing customer demands and trends in the internet industry. However, the success of new products and services
depends on a number of factors including the quality of our products or services, the acceptance by the targeted customers and our assessment of market
demands and trends.
Furthermore, our competitors are constantly developing innovations, on both mobile devices and personal computers, to enhance users’ online
experience in areas that we currently operate or areas that we wish to expand our operations into. As a result, our efforts to continually innovate and
explore new growth strategies and introduce new products and services to attract more customers to our services, may not be successful, and we cannot
guarantee that our innovation efforts could bring positive financial impact to us.
Our gross profit margin and profitability may be affected by changes in our mix of revenues.
Our gross profit may fluctuate from period to period due to a shifting mix of services and products we sell due to changes in the relative demand
for them in the marketplace. Shifts in the mix of our revenue contributed by our different business lines (or by shifts in the sales of individual services or
products within such businesses) can impact our gross profit because they generally produce a different level of gross margin. For example, in general
our Youdao and innovative businesses and others segments have had lower gross profit margins compared to our online game services segment. These
individual gross margins in turn can be impacted in any given period by factors such as competition, the implementation of new regulatory requirements
and other factors. If the mix of services and products sold shifts from higher margin business lines to lower margin lines as a result of differing growth
rates among such lines (or to lower margin services and products within business lines), our overall gross profit margin and profitability may be
adversely affected.
We are exposed to credit risk on our accounts receivable, which may be heightened during periods of uncertain economic conditions.
Our outstanding accounts receivable are not covered by collateral or credit insurance. While we have procedures to monitor and limit exposure
to credit risk on our accounts receivable, which risk is heightened during periods of uncertain economic conditions, there can be no assurance such
procedures will effectively limit our credit risk and enable us to avoid losses, which could have a material adverse effect on our financial condition and
operating results.
A prolonged slowdown in the PRC or global economy may materially and adversely affect our results of operations, financial condition,
prospects and future expansion plans.
We derive a substantial portion of our revenue from China. As a result, our revenue and net income are impacted to a significant extent by
economic conditions in China and globally, as well as economic conditions specific to online and mobile internet usage and advertising. The global
economy, markets and levels of consumer spending are influenced by many factors beyond our control, including consumer perception of current and
future economic conditions, political uncertainty, levels of employment, inflation or deflation, real disposable income, interest rates, taxation and
currency exchange rates.
The rate of economic growth in the PRC has been experiencing a slowdown, and China’s gross domestic product increased by 2.3% in 2020, the
lowest annual growth rate since 1976, primarily as a result of the COVID-19 pandemic. In addition, any future escalation of the ongoing trade war
between the United States and China or ongoing impact of the coronavirus may negatively impact the growth in both the Chinese economy and the
global economy as a whole. Although the PRC government has implemented a number of measures to address the slowdown, we cannot be certain that
these measures will be successful. Any continuing or worsening slowdown could significantly reduce domestic commerce in China, including through
the internet generally and within our ecosystem. An economic downturn, whether actual or perceived, a further decrease in economic growth rates or an
otherwise uncertain economic outlook in China or any other market in which we may operate could have a material adverse effect on our business,
financial condition and results of operations.
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We are subject to a variety of laws and other obligations regarding data protection in China, and our failure to comply with any of them could
result in proceedings against us by governmental entities or others and harm our public image and reputation, which could have a material
adverse effect on our business, results of operations and financial condition.
We are subject to laws in China relating to the collection, use, sharing, retention, security and transfer of confidential and private information,
such as personal information and other data. These laws apply not only to third-party transactions, but also to transfers of information between our
company and our subsidiaries and VIEs and among our company, our subsidiaries, VIEs and other parties with which we have commercial relations.
These laws are continuing to develop, and the PRC government may adopt other rules and restrictions in the future. Non-compliance could result in
penalties or other significant legal liabilities.
According to the Cyber Security Law of the People’s Republic of China, or Cyber Security Law, which was promulgated by the National
People’s Congress Standing Committee on November 7, 2016, and took effect on June 1, 2017, we, as a network operator, are obligated to provide
technical assistance and support to public security and national security authorities in order to protect national security or assist with criminal
investigations. In addition, the Cyber Security Law provides that personal information and important data collected and generated by an operator of
critical information infrastructure in the course of its operations in the PRC must be stored in the PRC. We have undertaken significant measures in an
effort to ensure compliance with the Cyber Security Law. In April 2020, the CAC and several other government authorities jointly promulgated the
Measures for Cybersecurity Censorship, or the Censorship Measures, which took effect on June 1, 2020. In accordance with the Censorship Measures,
any purchase of network products and services by critical information infrastructure operators, which affects or may affect state security, shall be subject
to cybersecurity censorship fields. Since the measures were recently promulgated, there exists uncertainties with respect to their interpretation and
implementation.
In addition, the SAMR and Standardization Administration jointly issued the Standard of Information Security Technology—Personal
Information Security Specification (2020 edition), which took effect on October 2020. Pursuant to these standard, any entity or person who has the
authority or right to determine the purposes for and methods of using or processing personal information are considered as a personal information
controller. Such personal information controller is required to collect information in accordance with applicable laws, and except in certain specific
events that are expressly exempted in the standard, prior to collecting such data, the information provider’s consent is required. Furthermore, the CAC
issued the Provisions on the Cyber Protection of Children’s Personal Information, or the Children’s Provisions, which took effect on October 1, 2019.
According to the Children’s Provisions, no organization or individual is allowed to produce, release or disseminate information that infringes upon the
personal information security of children under 14. Network operators collecting, storing, using, transferring or disclosing children’s personal
information are required to enact special protections for such information. We generally comply with industry standards and have established privacy
policies to ensure such compliance. However, compliance with any additional laws could be expensive, and may place restrictions on the conduct of our
business and the manner in which we interact with our customers. Any failure to comply with applicable regulations could also result in notification for
rectification, confiscation of illegal earnings, fines or other penalties and legal liabilities against us. For example, we may receive notification for
rectification regarding our products from competent governmental authorities, and we will take steps to rectify the situation accordingly.
Recently, there has been an increased focus on ensuring that mobile apps comply with privacy regulations. The Announcement of Launching
Special Crackdown Against Illegal Collection and Use of Personal Information by Apps was issued with effect on January 23, 2019 and commenced a
coordinated effort among the CAC, MIIT, the Ministry of Public Security and the SAMR to combat the illegal collection and use of personal information
by mobile apps throughout the PRC. On October 31, 2019, the MIIT issued the Notice on the Special Rectification of Apps Infringing Users’ Rights and
Interests, pursuant to which app providers were required to promptly rectify issues the MIIT designated as infringing app users’ rights such as collecting
personal information in violation of PRC regulations and setting obstacles for user account deactivation. In July 2020, MIIT issued the Notice on
Carrying out Special Rectification Actions in Depth against the Infringement upon Users’ Rights and Interests by Apps, to rectify the following
problems: (i) illegal collection and use of personal information of users by the APP and the Software Development Kit (“SDK”); (ii) conduct of setting
up obstacles and frequently harassing users; (iii) cheating and misleading users; and (iv) inadequate implementation of application distribution platforms’
responsibilities. In accordance with the Notice, by the end of August 2020, the management system for the national APP technical testing platform shall
be put into use, and by December 10, 2020, the testing of 400,000 mainstream APPs shall be completed. If any of our mobile apps are not in compliance
with these regulations, we could be subject to potentially serious penalties, including revocation of our business licenses and permits.
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Our privacy policies and practices concerning the use and disclosure of data are posted on the NetEase websites and other online and mobile
platforms. Any failure by us, our business partners or other parties with whom we do business to comply with its posted privacy policies or with other
applicable privacy-related or data protection laws and regulations could result in proceedings against us by governmental entities or others, which could
have a material adverse effect on our business, financial condition and results of operations. In addition, any negative publicity on our website or
platform’s safety or privacy protection mechanism and policy could harm our public image and reputation and have a material and adverse effect on our
business, results of operations and financial condition.
We may be subject to a variety of laws and other obligations regarding data protection in jurisdictions outside of China, and our failure to
comply with any of them could result in proceedings against us by governmental entities or others and harm our public image and reputation,
which could have a material adverse effect on our business, results of operations and financial condition.
We may be subject to similar data protection laws and other obligations in jurisdictions outside of China where we operate, including the
European Union General Data Protection Regulation (“GDPR”), the California Consumer Privacy Act of 2018 (“CCPA”) and the California Privacy
Rights and Enforcement Act (“CPRA”).
The GDPR applies directly in all European Union member states from May 25, 2018 and applies to companies with an establishment in the
European Economic Area, or EEA, and to certain other companies not in the EEA that offer or provide goods or services to individuals located in the
EEA or monitor individuals located in the EEA. The GDPR implements stringent operational requirements for controllers and processors of personal
data, including, for example, expanded disclosures on how personal data is to be used, limitations on retention of information and implementation of
appropriate safeguards for transfer of personal data out of the EEA, increased cyber security requirements, mandatory data breach notification
requirements and higher standards for controllers to demonstrate that they have obtained a valid legal basis for certain data processing activities. Failure
to comply with European Union laws and other laws relating to the security of personal data may result in significant fines, such as those applicable
under the GDPR which can amount up to EUR20,000,000 or up to 4% of the total worldwide annual turnover of the preceding financial year, if greater,
and other administrative penalties including criminal liability.
California has also recently enacted legislation affording consumers expanded privacy protections, including the CCPA, that went into effect as
of January 1, 2020. For example, the CCPA gives California residents (including employees, though only in limited circumstances until January 1, 2023),
expanded rights to transparency (e.g., detailed information about how personal information is collected, used, and shared) regarding, access to, and
deletion of their personal information, and a right to opt out of the sharing of certain personal information. The California Attorney General issued
implementing regulations that also add requirements on businesses. The CCPA provides for civil penalties for violations enforced by the California
Attorney General, as well as a private right of action for certain data breaches that may increase data breach litigation and liability, in light of the
potential for statutory damages. Additionally, a new privacy law, the CPRA was approved by California voters in the November 3, 2020 election. The
CPRA significantly modifies the CCPA, potentially resulting in further uncertainty and requiring us to incur additional costs and expenses in efforts to
comply. The passing of the CCPA, CPRA, and other laws globally is prompting similar legislative developments in other states in the United States,
which could create the potential for a patchwork of overlapping but different state laws, and is inspiring federal legislation, even if unlikely to pass.
Complying with emerging and changing requirements may cause us to incur substantial costs or require us to change our business practices.
Non-compliance could result in penalties or significant legal liability, including for example, penalties calculated as a percentage of global revenue under
the GDPR.
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We may be subject to breaches of our information technology systems, including security breaches and improper access to or disclosure of our
data or user data, which could materially adversely affect our reputation and our results of operations and financial position and expose us to
liability claims.
Any compromise of the security of our information technology systems could materially adversely affect the operations of NetEase’s websites
and other online and mobile platforms, and result in improper disclosure of personal information and other data. We transmit and store over our systems
confidential and private information of our users, such as personal information, including names, user IDs and passwords, and payment or transaction
related information. For example, we rely on our information technology systems to record and monitor the purchase and consumption of virtual items
by our game players, which constitute a significant portion of the revenue generated from our online games. In addition, in relation to our e-commerce
business, almost all of the orders and some of the payments for products we offer are made through our websites and our mobile applications, and some
online payments for our products are settled through third-party online payment services. We also share certain personal information about our
customers with contracted third-party couriers, such as their names, addresses, phone numbers and transaction records. Moreover, we have accumulated
a large volume of data, which covers customer’s browsing and consumption behavior information, product manufacturing and sales information,
warehousing and distribution information and customer service information, among others.
Hackers develop and deploy viruses, worms, and other malicious software programs to attack websites or other online and mobile platforms and
gain access to networks and data centers, and there have been a number of well-publicized malicious attacks against a variety of companies worldwide to
gain access to non-public information. Hackers may also act in a coordinated manner to launch distributed denial of service attacks, or other coordinated
attacks, that may cause service outages or other interruptions. In addition, we distribute our contents to users based on user interest levels indicated by
their past viewing behavior. As a result, our content distribution platforms and the results of our user behavior analysis are subject to attempts of
improper access or creating false or undesirable user accounts for purposes of spreading misinformation.
Although we believe that we have not experienced any hacking activity or security breach that allowed unauthorized access to any information
stored on our information technology systems or caused any loss or corruption of personal information and other data, software or other computer
equipment, we have been subject to denial of service attacks that have caused portions of our network to be inaccessible for limited periods of time.
Although these are industry wide problems that affect many companies worldwide, we anticipate that we may be subject to additional attacks in the
future because of the high profile of our company in the Chinese internet industry.
We take a number of measures to ensure that our information technology systems are secure, including ensuring that our servers are hosted at
physically secure sites and limiting access to server ports. We also use encryption and authentication technologies to secure the transmission and storage
of data. These security measures may be compromised as a result of third-party security breaches, employee error, malfeasance, faulty password
management, or other irregularities. Third parties may also attempt to fraudulently induce employees or customers into disclosing user names, passwords
or other sensitive information, which may in turn be used to access our information technology systems. We expect that we will be required to continue
to expend significant resources on system security, data encryption, and other security measures to protect our systems and data, but these security
measures cannot provide absolute security.
In the case of a breach of our systems, our data on the purchase and consumption of virtual items by our game players and other personal
information of our users such as users of our intelligent education and e-commerce products may be compromised. As a result, our ability to accurately
recognize revenues from certain of our online games and the playing experience of our game players could be materially and adversely affected.
Moreover, if a computer security breach allows unauthorized access to or release of personal information and other data of our users, our reputation and
brand could be materially damaged and use of the NetEase websites and other online and mobile platforms could decrease. We could also be exposed to
a risk of loss or litigation and possible liability, which could result in a material adverse effect on our business, results of operations and financial
condition.
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The success of our business is dependent on our ability to retain our existing key employees and to add and retain senior officers to our
management.
We depend on the services of our existing key employees. Our success will largely depend on our ability to retain these key employees and to
attract and retain qualified senior and middle level managers to our management team. Future changes in management could cause material disruptions
to our business. We also depend on our ability to attract and retain in the future highly skilled technical, editorial, marketing and customer service
personnel, especially experienced online game software developers. We cannot assure you that we will be able to attract or retain such personnel or that
any personnel we hire in the future will successfully integrate into our organization or ultimately contribute positively to our business. In particular, the
market for experienced online game software programmers is intensely competitive in China. While we believe we offer compensation packages that are
consistent with market practice, we cannot be certain that we will be able to hire and retain sufficient experienced programmers to support our online
games business. We may also be unsuccessful in training and retaining less-experienced programmers on a cost-effective basis. The loss of any of our
key employees would significantly harm our business. We do not maintain key person life insurance on any of our employees.
Unexpected network interruption caused by system failures may reduce visitor traffic and harm our reputation.
Both the continual accessibility of the NetEase websites and other online and mobile platforms and the performance and reliability of our
technical infrastructure are critical to our reputation and the ability of the NetEase websites and other online and mobile platforms to attract and retain
users and advertisers. Any system failure or performance inadequacy that causes interruptions in the availability of our services or increases the response
time of our services could reduce user satisfaction and traffic, which would reduce the NetEase websites and other online and mobile platforms’ appeal to
users and advertisers. As the number of NetEase websites, mobile applications and traffic increase, we cannot assure you that we will be able to scale
our systems proportionately. Any system failures and electrical outages could materially and adversely impact our business.
Our operations are vulnerable to natural disasters, widespread public health problems and other events.
We have limited backup systems and have experienced system failures and electrical outages from time to time in the past, which have disrupted
our operations. Most of our servers and routers are currently located at several different locations in China. Our disaster recovery plan may not fully
ensure safety in the event of damage from fire, floods, typhoons, earthquakes, power loss, telecommunications failures, break-ins and similar events. If
any of the foregoing occurs, we may experience a system shutdown. We do not carry any business interruption insurance. To improve performance and
to prevent disruption of our services, we may have to make substantial investments to deploy additional servers. We carry property insurance with low
coverage limits that may not be adequate to compensate us for all losses, particularly with respect to loss of business and reputation that may occur.
Our business could be adversely affected by widespread public health or other outbreaks and epidemics.
COVID-19, a novel strain of coronavirus, has spread worldwide. Many governments around the world have implemented a variety of measures
to reduce the spread of COVID-19, including travel restrictions and bans, instructions to residents to practice social distancing, quarantine advisories,
shelter-in-place orders and required closures of non-essential businesses. The COVID-19 pandemic has negatively impacted the global economy,
disrupted global supply chains and created significant volatility and disruption of financial markets. While COVID-19 vaccines have been approved in
various countries, the production, distribution and administration of any such vaccines on a widespread basis may take a significant amount of time, and
there can be no assurances as to the long-term safety and efficacy of such vaccines or if the current vaccines will be effective against new strains of the
coronavirus that causes COVID-19.
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There is significant uncertainty around the duration of this disruption on a national and global level, as well as the ongoing effects on our
business. This outbreak has caused, and may continue to cause us and certain of our business partners, including game licensors, suppliers, customers,
advertisers and manufacturers, to implement temporary and/or permanent adjustments of work schemes allowing employees to work from home. We
have taken measures to reduce the impact of this outbreak, including monitoring our employees’ health and optimizing our technology system to support
potential growth in game player traffic. However, we and certain of our business partners might still experience lower work efficiency and productivity,
which may adversely affect our service quality. This outbreak has also caused governments and others to place restrictions on our employees’ and our
business partners’ ability to travel. In addition, the deterioration in economic conditions in connection with the outbreak globally has caused, and may
continue to cause, decreases or delays in advertising and marketing service spending (in particular, due to the cancellation and/or delay of live in-person
events) and budgets of customers across our platforms. As a result of any of the above developments, our business, financial condition and results of
operations could be materially and adversely affected.
The extent to which COVID-19 impacts our results will depend on future developments, which are highly uncertain and cannot be predicted,
including new information which may emerge concerning the severity of COVID-19 and any of its variants and the actions to contain COVID-19 or treat
its impact, among others. There have also been other outbreaks of epidemics in China and globally in recent years. Our operations could be disrupted if
any future outbreak occurs in China, where substantially all of our revenue is derived, or in Beijing, Shanghai, Guangzhou and Hangzhou, where most of
our employees are located. Our operations may be impacted due to closures of our offices or the quarantining, sickness or death of any of our key officers
and employees. Our operations could also be severely disrupted if such health problems or outbreak lead to a general slowdown in the Chinese economy
or if our suppliers, customers or business partners were affected by such outbreaks or health epidemics.
From time to time we may evaluate and consummate strategic investments or acquisitions, which could require significant management
attention, disrupt our business and adversely affect our financial results.
We from time to time evaluate and enter into discussions regarding a wide array of potential long-term investments, merger or acquisition
transactions. Any transactions that we enter into could be material to our financial condition and results of operations. The process of integrating with
another company or integrating an acquired company, business, asset or technology may create unforeseen operating difficulties and expenditures. The
areas where we face risks include:
● significant costs of identifying and consummating acquisitions;
● diversion of management time and focus from operating our business to acquisition integration challenges;
● difficulties in integrating the management, technologies and employees of the acquired businesses;
● implementation or remediation of controls, procedures and policies at the acquired company;
● coordination of products and services, engineering and sales and marketing functions;
● retention of employees from the businesses we acquire;
● liability for activities of the acquired company before the acquisition;
● potential significant impairment losses related to goodwill and other intangible assets acquired or investments in other businesses;
● litigation or other claims in connection with the acquired company;
● significant expenses in obtaining approvals for the transaction from shareholders and relevant government authorities in China;
● in the case of overseas acquisitions, the need to integrate operations across different cultures and languages and to address the particular
economic, currency, political and regulatory risks associated with specific countries; and
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● failure to achieve the intended objectives, benefits or revenue-enhancing opportunities.
Our failure to address these risks or other problems encountered in connection with our future acquisitions and investments could cause us to
fail to realize the anticipated benefits of such acquisitions or investments, incur unanticipated liabilities and expenses and harm our business generally. If
we use our equity securities to pay for acquisitions, we may dilute the value of your American depositary shares, or ADSs, and the underlying ordinary
shares. If we borrow funds to finance acquisitions, such debt instruments may contain restrictive covenants that could, among other things, restrict us
from distributing dividends. Such acquisitions and investments may also lead to significant amortization expenses related to intangible assets,
impairment charges or write-offs.
We face risks associated with our long-term and short-term investments.
We currently invest a portion of our capital in long-term and short-term investments. As of December 31, 2020, our long-term investments
mainly consisted of investment in equity method investees, equity investments with readily determinable fair values and equity investments without
readily determinable fair values, and our short-term investments mainly consisted of financial products issued by commercial banks in China with a
variable interest rate indexed to the performance of underlying assets and a maturity date within one year when purchased. These investments may earn
yields substantially lower than anticipated, and any failure to realize the benefits we expected from these investments may materially and adversely affect
our business and financial results.
We had investment losses of RMB22.4 million, investment income of RMB1,306.3 million and investment income of RMB1,610.0 million
(US$246.8 million) for the years ended December 31, 2018, 2019 and 2020, respectively.
If our server and bandwidth service providers fail to provide these services, our business could be materially curtailed.
We mainly rely on affiliates of China Telecom, China Unicom, and China Mobile to provide us with server and bandwidth service for internet
users to access the NetEase websites and other online and mobile platforms. If China Telecom, China Unicom, and China Mobile or their affiliates fail to
provide such services or raise prices for their services, we may not be able to find a reliable and cost-effective substitute provider on a timely basis or at
all. If this happens, our business could be materially curtailed.
We also rely on cloud servers maintained by third-party cloud service providers particularly for our overseas games. We do not control the
operation of these providers or their facilities, and the facilities are vulnerable to damage, interruption or misconduct. Unanticipated problems at these
facilities could result in lengthy interruptions in our services. Problems with our cloud service providers or the telecommunications network providers
with whom they contract could adversely affect the experience of our users. Any change in service levels at our cloud servers or any errors, defects,
disruptions, or other performance problems with our platform could harm our business or reputation or we could be required to retain the services of
replacement providers, which could increase our operating costs.
We may be held liable for information or content displayed on, retrieved from or linked to the NetEase websites and other NetEase’s online and
mobile platforms.
We may face liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the nature and content
of the materials that are published on the NetEase websites and other products and services. We are involved in intellectual property infringement claims
or actions from time to time and are occasionally subject to defamation claims or infringement claims related to individual’s publicity rights. We believe
that the amounts claimed in these actions, in the aggregate, are not material to our business. However, these amounts may be increased for a variety of
reasons as the claims progress, and we and our affiliates could be subject to additional defamation or infringement claims which, singly or in the
aggregate, could have a material adverse effect on our business and results of operations, if successful. Also, we may be subject to administrative actions
brought by relevant PRC competent governmental authorities and in the most severe scenario criminal prosecution for alleged infringement, and as a
result may be subject to fines and other penalties and be required to discontinue infringing activities. Furthermore, as we expand our operations outside of
China, we may be subject to claims brought against us in jurisdictions outside of China.
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We also could be subject to copyright, defamation and other claims based upon user-generated content that is accessible on the NetEase websites
or other online and mobile platforms such as content and materials posted or uploaded by users on message boards, online communities, social media
platforms, voting systems, e-mail, chat rooms or our other online and mobile platforms including NetEase Cloud Music, NetEase CC live streaming
platform and the NetEase NewsApp. By providing technology for hypertext links to third-party websites, we may be held liable for copyright or
trademark violations by those third- party sites. Third parties could assert claims against us for losses incurred in reliance on any erroneous information
distributed by us. Moreover, users of the NetEase web-based e-mail services could seek damages from us for:
● unsolicited e-mails;
● lost or misplaced messages;
● illegal or fraudulent use of e-mail; or
● interruptions or delays in e-mail services.
We may incur significant costs in investigating and defending these claims, even if they do not result in liability.
Divestitures of businesses and assets may have a material and adverse effect on our business and financial condition.
We have undertaken, and may undertake in the future, partial or complete divestitures or other disposal transactions in connection with certain
of our businesses and assets, particularly ones that are not closely related to our core focus areas or might require excessive resources or financial capital,
to help our company meet its objectives. For example, in September 2019, we sold our e-commerce platform Kaola. These decisions are largely based on
our management’s assessment of the business models and likelihood of success of these businesses. However, our judgment could be inaccurate, and we
may not achieve the desired strategic and financial benefits from these transactions. Our financial results could be adversely affected by the impact from
the loss of earnings and corporate overhead contribution/allocation associated with divested businesses. In addition, as our net income/(loss) from
discontinued operations are non-recurrent, it may be difficult for investors and analysts to predict our future earnings potential based on our historical
financial performance.
Dispositions may also involve continued financial involvement in the divested business, such as through guarantees, indemnities or other
financial obligations. Under these arrangements, performance by the divested businesses or other conditions outside of our control could affect our future
financial results. We may also be exposed to negative publicity as a result of the potential misconception that the divested business is still part of our
consolidated group. On the other hand, we cannot assure you that the divesting business would not pursue opportunities to provide services to our
competitors or other opportunities that would conflict with our interests. If any conflicts of interest that may arise between the divesting business and us
cannot be resolved in our favor, our business, financial condition, results of operations could be materially and adversely affected.
Furthermore, reducing or eliminating our ownership interests in these businesses might negatively affect our operations, prospects, or long-term
value. We may lose access to resources or know-how that would have been useful in the development of our own business. Our ability to diversify or
expand our existing businesses or to move into new areas of business may be reduced, and we may have to modify our business strategy to focus more
exclusively on areas of business where we already possess the necessary expertise. We may sell our interests too early, and thus forego gains that we
otherwise would have received had we not sold. Selecting businesses to dispose of or spin off, finding buyers for them (or the equity interest in them to
be sold) and negotiating prices for what may be relatively illiquid ownership interests with no easily ascertainable fair market value will also require
significant attention from our management and may divert resources from our existing business, which in turn could have an adverse effect on our
business operations.
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The Hong Kong Stock Exchange granted us a waiver from strict compliance with the requirements in Paragraph 3(b) of Practice Note 15 to the
Hong Kong Listing Rules such that we are able to list a subsidiary entity (other than one involving our online game business) on the Hong Kong Stock
Exchange within three years of the Listing. We may consider a spin-off listing on the Hong Kong Stock Exchange for one or more of our businesses
(other than our online game business) within the three-year period subsequent to the Listing. The waiver granted by the Hong Kong Stock Exchange is
conditional upon us confirming to the Hong Kong Stock Exchange in advance of any spin-off that it would not render our Company incapable of
fulfilling the eligibility requirements under Rule 19C.05 of the Hong Kong Listing Rules based on the financial information of the entity or entities to be
spun-off at the time of the Company’s Listing (calculated cumulatively if more than one entity is spun-off).
RISKS RELATED TO OUR CORPORATE STRUCTURE
If the PRC government finds that the contractual arrangements with our VIEs do not comply with applicable PRC laws and regulations, or if
these regulations or their interpretations change in the future, we may be subject to penalties or be forced to relinquish our interests in those
operations.
Due to legal restrictions on foreign investment in Chinese companies providing value-added telecommunications services and holding ICP
licenses and other regulated licenses, we operate all of our business segments through contractual arrangements with the VIEs and their equity holders.
The contractual arrangements enable us to (i) hold effective control over the VIEs; (ii) receive substantially all of the economic benefits of our VIEs; and
(iii) have an exclusive option to purchase all or part of the equity interests in the VIEs when and to the extent permitted by PRC law or request any
existing shareholders of the VIEs to transfer any or part of the equity interests in the relevant VIE to another PRC person or entity designated by us at any
time at our discretion. Because of the contractual arrangements, we are the primary beneficiary of the VIEs and their respective subsidiaries and
consolidate the results of operations of the VIEs into ours. Our VIEs and their respective subsidiaries hold the licenses, approvals and key assets that are
essential for our business operations.
If the PRC government finds that our contractual arrangements do not comply with the existing or future restrictions on foreign investment, or if
the PRC government otherwise finds that we, the VIEs or any of their subsidiaries are in violation of the existing or future PRC laws or regulations or
lack the necessary permits or licenses to operate our business, the relevant PRC regulatory authorities would have broad discretion in dealing with such
violations or failures, including, without limitation:
● revoking our business and operating licenses;
● discontinuing or restricting our operations;
● imposing fines or confiscating any of our income that they deem to have been obtained through illegal operations;
● imposing conditions or requirements with which we may not be able to comply;
● requiring us to restructure the relevant ownership structure or operations;
● restricting our financing activities to finance the business and operations of our VIEs; or
● taking other regulatory or enforcement actions that could be harmful to our business.
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Any of these actions could cause significant disruption to our business operations, and may materially and adversely affect our business,
financial condition and results of operations. In addition, it is unclear what impact the PRC government actions would have on us and on our ability to
consolidate the financial results of any of the VIEs in our consolidated financial statements, if the PRC governmental authorities find our legal structure
and contractual arrangements to be in violation of PRC laws, rules and regulations. If any of these penalties results in our inability to direct the activities
of VIEs that most significantly impact their economic performance and/or our failure to receive the economic benefits from the VIEs, we may not be able
to consolidate the VIEs and their respective subsidiaries into our consolidated financial statements. Please also see the below risk factors “— Substantial
uncertainties exist with respect to how the 2019 Foreign Investment Law may impact the viability of our current corporate structure, corporate
governance and business operations.” and “— Risks Related to Doing Business in China—The Chinese government restricts the ability for foreign
investors to invest in and operate in certain types of telecommunications and internet businesses.”
Substantial uncertainties exist with respect to how the 2019 Foreign Investment Law may impact the viability of our current corporate
structure, corporate governance and business operations.
On March 15, 2019, the Standing Committee of National People’s Congress promulgated the 2019 PRC Foreign Investment Law, which became
effective on January 1, 2020. The 2019 PRC Foreign Investment Law replaces the trio of existing laws regulating foreign investment in China, namely,
the Wholly Foreign-owned Enterprises Law, the Sino-foreign Equity Joint Ventures Law, and the Sino-foreign Cooperative Joint Ventures Law, together
with their implementation rules and ancillary regulations, and embodies an expected PRC regulatory trend to rationalize its foreign investment regulatory
regime in line with prevailing international practice and the legislative efforts to unify the corporate legal requirements for both foreign and domestic
investments. However, uncertainties still exist in relation to interpretation and implementation of the 2019 PRC Foreign Investment Law, especially in
regard to, including, among other things, the nature of VIE structure, the promulgation schedule of both the “negative list” under the 2019 PRC Foreign
Investment Law and specific rules regulating the organization form of foreign-invested enterprises within the five-year transition period. The VIE
structure has been adopted by many PRC-based companies, including us, to obtain necessary licenses and permits in the industries that are currently
subject to foreign investment restrictions in China. While the 2019 Foreign Investment Law and its implementation regulations which took effect on
January 1, 2020 do not define contractual arrangements as a form of foreign investment explicitly, we cannot assure you that future laws and regulations
will not provide for contractual arrangements as a form of foreign investment. Therefore, there can be no assurance that our control over our VIEs
through contractual arrangements will not be deemed as foreign investment in the future.
In the event that any possible future laws, administrative regulations or provisions deem contractual arrangements as a way of foreign
investment, or if any of our operations through contractual arrangements is classified in the “restricted” or “prohibited” industry in the future “negative
list” under the 2019 Foreign Investment Law, our contractual arrangements may be deemed as invalid and illegal, and we may be required to unwind the
VIE contractual arrangements and/or dispose of any affected business. Also, if future laws, administrative regulations or provisions mandate further
actions to be taken with respect to existing contractual arrangements, we may face substantial uncertainties as to whether we can complete such actions in
a timely manner, or at all. In addition, the 2019 Foreign Investment Law provides that foreign invested enterprises established according to the existing
laws regulating foreign investment may maintain their structure and corporate governance within a five-year transition period, which means that we may
be required to adjust the structure and corporate governance of certain of our PRC subsidiaries after such transition period. Failure to take timely and
appropriate measures to cope with any of these or similar regulatory compliance challenges could materially and adversely affect our current corporate
structure, corporate governance and business operations.
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Our contractual arrangements with our VIEs may not be as effective in providing operational control as direct ownership. If our VIEs or their
ultimate shareholders violate our contractual arrangements with them, our business could be disrupted, our reputation may be harmed and we
may have to resort to litigation to enforce our rights, which may be time consuming and expensive.
Our VIEs are owned by shareholders whose interests may differ from ours and those of our shareholders because they own a larger percentage
of such companies than of our company. These affiliated companies or their ultimate shareholders could violate our arrangements with them by, among
other things, failing to operate and maintain the NetEase websites and other online and mobile platforms, or their various businesses in an acceptable
manner, failing to remit revenue to us on a timely basis or at all or diverting customers or business opportunities from our company. In addition, the
operation of the online games licensed from Blizzard is dependent on Shanghai EaseNet, which is owned by William Lei Ding, our Chief Executive
Officer, director and major shareholder, and has contractual arrangements with us and with the joint venture established between Blizzard and us. The
interests of Mr. Ding and the joint venture may differ from ours and those of our shareholders. A violation of the foregoing agreements could disrupt our
business and adversely affect our reputation in the market. If these companies or their ultimate shareholders violate our agreements with them, we may
have to incur substantial costs and expend significant resources to enforce those arrangements and rely on legal remedies under the PRC laws. Many
PRC laws, rules and regulations are relatively new, and because of the limited volume of published decisions and their non-binding nature, the
interpretation and enforcement of these laws, rules and regulations involve substantial uncertainties. These uncertainties may impede our ability to
enforce these agreements, or cause us to suffer significant delay or other obstacles in the process of enforcing these agreements, and may materially and
adversely affect our results of operations and financial position.
Because our contractual arrangements with certain of our affiliated entities and their ultimate shareholders do not detail the parties’ rights and
obligations, our remedies for a breach of these arrangements are limited.
Our current relationship with certain affiliated entities, including Guangzhou NetEase, Hangzhou Leihuo, Youdao Computer, Shanghai EaseNet,
and their ultimate shareholders is based on a number of contracts, and these affiliated companies are considered our VIEs for accounting purposes. The
terms of these agreements are often statements of general intent and do not detail the rights and obligations of the parties. Some of these contracts
provide that the parties will enter into further agreements on the details of the services to be provided. Others contain price and payment terms that are
subject to monthly adjustment. These provisions may be subject to differing interpretations, particularly on the details of the services to be provided and
on price and payment terms. It may be difficult for us to obtain remedies or damages from these affiliated entities or their ultimate shareholders for
breaching our agreements. Because we rely significantly on these companies for our business, the realization of any of these risks may disrupt our
operations or cause degradation in the quality and service provided on, or a temporary or permanent shutdown of, the NetEase websites or other online
and mobile platforms.
One of our shareholders has significant influence over our company.
Our founder, Chief Executive Officer and director, William Lei Ding, beneficially owned, as of March 31, 2021, approximately 43.2% of our
total outstanding shares and is our largest shareholder. Accordingly, Mr. Ding has significant influence in determining the outcome of any corporate
transaction or other matter submitted to the shareholders for approval, including mergers, consolidations, the sale of all or substantially all of our assets,
election of directors and other significant corporate actions. He also has significant influence in preventing or causing a change in control. In addition,
without the consent of this shareholder, we may be prevented from entering into transactions that could be beneficial to us. The interests of Mr. Ding may
differ from the interests of our other shareholders.
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A majority of the share capital of certain of our affiliated entities are held by our major shareholder, who may cause these agreements to be
amended in a manner that is adverse to us.
William Lei Ding, directly or indirectly holds the majority interest in certain of our VIEs. As a result, Mr. Ding may be able to cause the
agreements related to those companies to be amended in a manner that will be adverse to our company, or may be able to cause these agreements not to
be renewed, even if their renewal would be beneficial for us. Although we have entered into an agreement that prevents the amendment of these
agreements without the approval of the members of our board of directors other than Mr. Ding, we can provide no assurances that these agreements will
not be amended in the future to contain terms that might differ from the terms that are currently in place. These differences may be adverse to our
interests. In addition, William Lei Ding also holds the entire share capital of Shanghai EaseNet, and we can provide no assurance that Mr. Ding will not
cause the agreements related to Shanghai EaseNet to be amended in the future in a manner that will be adverse to us or to contain terms that might differ
from the terms that are currently in place. These differences may be adverse to our interests.
We may not be able to conduct our operations without the services provided by certain of our affiliated entities.
Our operations are currently dependent upon our commercial relationships with our VIEs, and we derive most of our revenues from these
companies. If these companies are unwilling or unable to perform the agreements which we have entered into with them, we may not be able to conduct
our operations in the manner in which we currently do. In addition, our VIEs may seek to renew these agreements on terms that are disadvantageous to
us. Although we have entered into a series of agreements that provide us with substantial ability to control these companies, we may not succeed in
enforcing our rights under them. If we are unable to renew these agreements on favorable terms, or to enter into similar agreements with other parties,
our business may not expand, and our operating expenses may increase.
Our corporate structure may restrict our ability to receive dividends from, and transfer funds to, our PRC subsidiaries and VIEs, which could
restrict our ability to act in response to changing market conditions and reallocate funds internally in a timely manner.
NetEase, Inc. is a holding company with no significant assets other than cash on hand and its equity interests in its directly and indirectly-owned
subsidiaries, including those set forth in the organizational diagram appearing in Item 4.B. “Business Overview—Our Organizational Structure.” As a
result, our primary internal source of funds for our cash and financing requirements is dividend payments and other distributions on equity from our
subsidiaries. If these subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay
dividends or make other distributions to us, which in turn would limit our ability to pay dividends on our ordinary shares and service any debt we may
incur. PRC tax authorities may also require us to amend our contractual arrangements with our VIEs and their respective shareholders in a manner that
would materially and adversely affect the ability of our subsidiaries to pay dividends and other distributions to us. In addition, Chinese legal restrictions
permit payment of dividends only out of net income as determined in accordance with Chinese accounting standards and regulations. Under Chinese law,
our PRC subsidiaries and VIEs are also required to set aside a portion of their net income each year to fund certain reserve funds, except in cases where a
company’s cumulative appropriations have already reached the statutory limit of 50% of that company’s registered capital. These reserves are not
distributable as cash dividends. Also see “—Risks Related to Doing Business in China—We may be treated as a resident enterprise for PRC tax purposes
under the Enterprise Income Tax Law, which may subject us to PRC income tax on our global income and result in dividends payable by us to our
foreign investors, and gains on the sales of our ordinary shares or ADSs, becoming subject to taxes under PRC tax laws, which may materially reduce the
value of your investment.” Any limitation on the ability of our PRC subsidiaries and VIEs to transfer funds to us in the form of dividends or other
distributions could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay
debt or dividends, and otherwise fund and conduct our business.
In addition, any transfer of funds from us to any of our PRC subsidiaries or VIEs, either as a shareholder loan or as an increase in registered
capital, is subject to certain statutory limit requirements and registration or approval of the relevant PRC governmental authorities, including the relevant
administration of foreign exchange and/or the relevant examining and approval authority.
Therefore, it is difficult to change our capital expenditure plans once the relevant funds have been remitted from our company to our PRC
subsidiaries or VIEs. These limitations on the free flow of funds between us and our PRC subsidiaries and VIEs could restrict our ability to act in
response to changing market conditions and reallocate funds internally in a timely manner.
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Our arrangements with certain of our affiliated entities and their respective shareholders may cause a transfer pricing adjustment and may be
subject to scrutiny by the PRC tax authorities.
We could face material and adverse tax consequences if the PRC tax authorities determine that our contracts with our VIEs and their respective
shareholders were not entered into based on arm’s-length negotiations. Although our contractual arrangements are similar to those of other companies
conducting similar operations in China, if the PRC tax authorities determine that these contracts were not entered into on an arm’s-length basis, they may
adjust our income and expenses for PRC tax purposes in the form of a transfer pricing adjustment which may result in an increase in our taxes. In
addition, the PRC tax authorities may also impose late payment interest.
A transfer of shares of certain of our affiliated entities may trigger tax liability.
If we need to cause the transfer of shareholdings of our VIEs from their current respective shareholders to any other individual, we may be
required to pay individual income tax in the PRC on behalf of the transferring shareholder. Such individual income tax would be based on any gain
deemed to have been realized by such shareholder on such transfer, and may be calculated based on a tax rate of 20% applied to the transferring
shareholder’s interest in net book value of the entity whose shares are being transferred minus the original investment cost. A significant tax obligation
arising from any such transfer of shares could materially adversely affect our business and results of operations.
We may lose the ability to use and enjoy assets held by any of our principal VIEs that are important to the operation of our business if such VIE
declares bankruptcy or becomes subject to a dissolution or liquidation proceeding.
Our principal VIEs hold assets that are material to our business operations, such as our certain intellectual property and core licenses and
permits. Although the VIE contracts between our subsidiaries and VIEs and the shareholders of our VIEs contain terms that prohibit the shareholders of
our VIEs from adversely affecting the existence of the VIEs, in the event the shareholders breach this obligation and voluntarily liquidate our VIEs, or if
any of our VIEs declare bankruptcy and all or part of its assets become subject to liens or rights of third-party creditors, we might be unable to continue
some or all of our business operations. Furthermore, if any of our VIEs were to undergo a voluntary or involuntary liquidation proceeding, its
shareholders or unrelated third-party creditors might claim rights to some or all of such VIE’s assets and their rights could be senior to our rights under
the VIE contracts, thereby hindering our ability to operate our business.
RISKS RELATED TO DOING BUSINESS IN CHINA
The political relationships between China and other countries may affect our business, financial condition, results of operations, cash flows and
prospects.
We have launched more than 50 mobile games in global markets since 2015 and also offer certain other services outside of China. As a result,
China’s political relationships with other countries in which our services are available may affect our business operations. For instance, in September
2020, after heightened tensions between China and India over the disputed Himalayan mountain border, the government of India announced the ban of
118 mobile applications of Chinese origin, including several of our products. In addition, in September 2020, former U.S. President Donald Trump issued
an executive order blocking TikTok and WeChat from processing transactions for U.S. citizens and from being downloaded in U.S. app stores due to
national security concerns. This executive order is currently under review by U.S. federal courts. In January 2021, President Trump also issued an
executive order prohibiting transactions between U.S. individuals and companies and eight Chinese applications, including AliPay and QQ. Although
the foregoing executive orders are not directed at our services and the ban in India has not materially impacted our online games services revenue, there
can be no assurance that the deterioration of political relationships between China and other foreign jurisdictions will not result in further bans or
restrictions on our products.
We have been closely monitoring domestic policies in the United States designed to restrict certain Chinese companies from supplying or
operating in the U.S. market. These policies include the Clean Network project initiated by the U.S. Department of State in August 2020 and new
authorities granted to the Department of Commerce to prohibit or restrict the use of information and communications technology and services, or ICTS.
While a substantial majority of our business is conducted in China, policies like these may deter U.S. users from accessing and/or using our products and
services in the United States, which could adversely impact our user experience and reputation.
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Likewise, we are monitoring policies in the United States that are aimed at restricting U.S. persons from investing in or supplying certain
Chinese companies. The United States and various foreign governments have imposed controls, license requirements and restrictions on the import or
export of technologies and products (or voiced the intention to do so). For instance, the United States is in the process of developing new export controls
with respect to “emerging and foundational” technologies, which may include certain AI and semiconductor technologies. In addition, the U.S.
government may potentially impose a ban prohibiting U.S. persons from making investments in or engaging in transactions with certain Chinese
companies. Measures such as these could deter suppliers in the United States and/or other countries that impose export controls and other restrictions
from providing technologies and products to, making investments in, or otherwise engaging in transactions with Chinese companies. As a result, Chinese
companies would have to identify and secure alterative supplies or sources of financing, while they may not be able to do so in a timely manner and at
commercially acceptable terms, or at all. In addition, Chinese companies may have to limit and reduce their research and development and other business
activities, or cease conducting transactions with parties, in the United States and other countries that impose export controls or other restrictions. Like
other Chinese companies, our business, financial condition and results of operations could be adversely affected as a result.
In addition, there can be no assurance that our customers will not alter their perception of us or their preferences as a result of adverse changes
to the state of political relationships between China and the relevant foreign jurisdiction. Any tensions and political concerns between China and the
relevant foreign jurisdictions may adversely affect our business, financial condition, results of operations, cash flows and prospects.
Changes in government regulation of the telecommunications and internet industries in China may result in uncertainties in interpretation
and/or the Chinese government requiring us to obtain additional licenses or other governmental approvals to conduct our business, both of
which may restrict our operations.
The telecommunications and internet industry, including ICP services and online games, is highly regulated by the Chinese government. In
addition, the telecommunication and internet-related laws and regulations are relatively new and constantly evolving, and their interpretation and
enforcement involve significant uncertainties. As a result, in certain circumstances, it may be difficult to determine what actions or omissions may be
deemed to be in violation of applicable laws and regulations in this area.
The evolving PRC regulatory system for the telecommunications and internet industries may lead to the establishment of new regulatory
agencies. For example, in May 2011, the State Council announced the establishment of the CAC, whose primary role is to facilitate the policy-making
and legislative development in the telecommunications and internet industries by coordinating with other relevant governmental agencies in connection
with online content administration and handling cross-ministry regulatory matters in relation to such industries.
In addition, we are uncertain as to whether the Chinese government will reclassify our business as a media or retail company, due to our
acceptance of fees for internet advertising, online games, e-commerce, and other innovative services as sources of revenues, or as a result of our current
corporate structure. Such reclassification could subject us to penalties, fines or significant restrictions on our business. Moreover, NetEase, Inc. may
have difficulties enforcing its rights under the agreements with our VIEs if any of these parties breaches any of the agreements with them because
NetEase, Inc. does not have approval from appropriate Chinese authorities to provide internet content services, internet advertising services, e-commerce
services or other innovative services. Future changes in Chinese government policies affecting the provision of information services, including the
provision of online services, internet access, e-commerce services, online advertising and online gaming may impose additional regulatory requirements
on us or our service providers or otherwise harm our business.
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The Chinese government restricts the ability for foreign investors to invest in and operate in certain types of telecommunications and internet
businesses.
Foreign ownership of certain types of telecommunications and internet businesses which we operate, including value-added telecommunications
services, internet cultural services and internet publication services, is subject to restrictions under applicable PRC laws. For example, on September 28,
2009, GAPP, together with the National Copyright Administration and National Office of Combating Pornography and Illegal Publications issued a
Notice Regarding the Consistent Implementation of the “Regulation on Three Provisions” of the State Council and the Relevant Interpretations of the
State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Examination and Approval of Online Games
and the Examination and Approval of Imported Online Games, or Circular 13. According to Circular 13, foreign investors are not permitted to invest in
online game operating businesses in China via wholly-owned, equity joint venture or cooperative joint venture investments and expressly prohibits
foreign investors from gaining control over or participating in domestic online game operators through indirect ways such as establishing other joint
venture companies, or contractual or technical arrangements. In addition, the Administration of Online Publishing Service jointly issued by the
SAPPRFT and the MIIT, effective on March 10, 2016, forbids foreign investments in the online publishing business.
With respect to our internet media business, the CAC’s Provisions for the Administration of Internet News Information Services, which became
effective from June 1, 2017, expressly prohibit any Sino-foreign equity joint venture or cooperative joint venture or any foreign-funded enterprise to
conduct internet-based news information services. We believe we are in compliance with such requirement because our internet media business is
conducted through our contractually controlled VIEs that are PRC entities. Additionally, in accordance with the Several Opinions on the Introduction of
Foreign Capital to the Culture Sector (Wen Ban Fa [2005] No. 19) issued by the MOC on July 6, 2005, foreign investors (excluding Hong Kong and
Macau) are prohibited from establishing or operating internet-based cultural institutions. It is unclear what activities count as “operating internet-based
cultural institutions,” however certain services we provide in our innovative businesses and others segment are likely to be deemed as such. We believe
we are also in compliance with this requirement because we operate our other innovative businesses and other services through our contractually
controlled VIEs.
It is unclear whether the authorities will deem our VIE structure as a kind of “indirect way” for foreign investors to gain control over or
participate in domestic online game operators, internet-based news information services or internet-based cultural institutions. If our VIE structure is
deemed as one such “indirect way,” our VIE structure may be challenged by the authorities and the authorities may require us to restructure our VIE
structure and take action to prohibit or restrict our business operations. In such case, we may not be able to operate or control business in the same
manner as we currently do and may not be able to consolidate the VIEs. Please also see “Risks Related to Our Corporate Structure” above for a
discussion of the risks associated with our VIE structure.
In recent years, the PRC government has been promoting foreign investment reform in some sectors and purported to loosen the foreign
investment restrictions in those sectors. For example, the Notice of the MIIT on Removing the Restrictions on Foreign Equity Ratios in Online Data
Processing and Transaction Processing (Operating E-commerce) Business promulgated by the MIIT on June 19, 2015, allows foreign investors to hold up
to 100% of the equity interests in an online data processing and transaction processing business (operational e-commerce) in China. In addition, the
NDRC and the MOFCOM jointly published the 2019 edition of the Special Administrative Measures for Access of Foreign Investments, or the 2019
Negative List, which came into effect on July 30, 2019 and has been replaced by the 2020 edition of the Special Administrative Measures for Access of
Foreign Investments, or the 2020 Negative List. The 2019 Negative List and the 2020 Negative List have removed some of the previous restrictions on
value-added telecommunications providers by allowing foreign investors to hold up to 100% of the equity interests in e-commerce, domestic multi-party
communication, e-storage and forwarding and call center businesses in China. It is unclear how these new policies will be implemented. More generally,
the authorities in China have broad discretion in the determination and interpretation of the rules and regulations regarding foreign investment in the
telecommunications and internet business, which may adversely impact our financial statements, operations and cash flows.
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The Chinese government has taken steps to limit online game playing time for all minors and to otherwise control the content and operation of
online games. These and any other new restrictions on online games may materially and adversely impact our business and results of
operations.
As part of its anti-addiction online game policy, the Chinese government has taken several steps to discourage minors under the age of 18 from
continuously playing online games once they exceed a set number of hours of continuous play. For example, in July 2005, the MOC and the MII jointly
issued the Opinions on Online Game Development and Management which requires online game operators to develop systems and software for identity
certification, to implement anti-addiction modifications to game rules and to restrict players under 18 years of age from playing certain games.
Subsequently, in August 2005, GAPP proposed an online game anti-addiction system that would have reduced and eliminated experience points that a
user can accumulate after three and five hours of consecutive playing, respectively. In March 2006, GAPP amended its proposal to require players to
register with their real names and identity card numbers and to apply the anti-addiction system only to players under 18 years of age. In April 2007,
GAPP and several other government authorities jointly promulgated the Notice Concerning the Protection of Minors’ Physical and Mental Well-being
and Implementation of Anti-addiction System on Online Games, or the Anti-Addiction Notice, which confirmed the real-name verification proposal and
required online game operators to develop and test their anti-addiction systems from April 2007 to July 2007, after which no online games can be
registered or operated without an anti-addiction system in accordance with the Anti-Addiction Notice. Accordingly, we implemented our anti-addiction
system to comply with the Anti-Addiction Notice. Since its implementation, we have not experienced a significant negative impact on our business as a
result of the Anti-Addiction Notice. The Law of the PRC on the Protection of Minors (“Minors Protection Law”) issued by the National People’s
Congress Standing Committee on September 4, 1991 was recently amended on October 17 2020 and will take effect on June 1, 2021, pursuant to which,
online game service provider shall classify the game products in accordance with relevant regulations and standards, give age-appropriate tips and take
technical measures to prevent minors from contacting improper game or game function. Violation of the Minors Protection Law could result in
rectification, confiscation of illegal gains and penalties.
To identify that a game player is a minor and is thus subject to the online game anti-addiction system, a real-name registration system must be
adopted to require players to register their real identity information before playing online games. Pursuant to the Notice Regarding the Initiation of Work
on the Online Games Real-Name Verification System to Prevent Online Gaming Addiction, or the Commencement of Real-Name Authentication Notice,
issued by eight government authorities on July 1, 2011, online game (excluding mobile game) operators must submit the identity information of game
players which needs to be further verified to the National Citizen Identity Information Center, a subordinate public institution of the Ministry of Public
Security, for verification since October 1, 2011, in an effort to prevent minors from using an adult’s ID to play online games. Violation of the Anti-
addiction Notice and the Commencement of Real-name Authentication Notice could result in the termination of the operation of online games. On
August 30, 2018, the Implementation Scheme on Comprehensive Prevention and Control of Adolescent Myopia, or the Implementation Scheme, was
issued jointly by eight PRC regulatory authorities at the national level, including the NPPA and the NRTA. The Implementation Scheme provides that as
a part of the plan to prevent myopia among children, the NPPA will control the number of new online games and take steps to restrict the amount of time
children spend on playing online games. On October 25, 2019, the NPPA promulgated the Notice on Preventing Minors from Indulging in Online Games,
according to which the length of minors’ use of online games should be strictly controlled. It requires all online game users to register their identification
information. The total length of time for minors to access online games must be limited on a daily basis. Every day from 22:00 to 8:00 the next day,
online game companies are not permitted to provide game services to minors in any form. Game services provided to minors must not exceed 3 hours per
day on public holidays and 1.5 hours on other days. In addition, online transactions are capped monthly at RMB200 or RMB400, depending on a minor’s
age. We have updated our anti-addiction systems accordingly to comply with the above-mentioned requirements. We do not believe that the
Implementation Scheme has any material impact on our gaming operations, but we cannot assure you that any future regulations or restrictive rules will
not adversely affect our operations.
On July 10, 2019, the MOCT announced the abolishment of the Interim Measures for the Administration of Online Games, or the Online Games
Measures, which had previously regulated activities related to the online game industry, including requirements that game operators follow new
registration procedures, publicize information about the content and suitability of their games, prevent access by minors to inappropriate games, avoid
certain types of content in games targeted to minors, avoid game content that compels players to kill other players, manage virtual currency in certain
ways and register users with their real identities. As of the date of the filing of this annual report, no laws and regulations had been promulgated or
published to replace the Online Games Measures. We cannot be sure if or when any future regulations or restrictive rules in this regard will be
promulgated and whether they would negatively impact our operations, including by increasing our compliance costs and negatively impacting our
ability to launch and operate new games.
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The Chinese government has not enacted any specific laws regarding virtual asset property rights and, accordingly, it is not clear what
liabilities, if any, online game providers may have for virtual assets.
One of the features of our PC and mobile MMORPG which helps to build a large user base and maintain loyalty is that users can accumulate
virtual tools, powers and rankings as they play the games. We believe that these virtual assets are highly valued by our users, particularly long-term users,
and are traded among users. However, on occasion, such assets can be lost if, for example, a user’s identity is stolen by another user or we experience a
system error or crash. Other than the PRC Civil Code, which was passed by the National People’s Representative Meeting on May 28, 2020 and took
effect on January 1, 2021, which prescribes that network virtual property will be protected according to the laws and regulations stipulating the protection
of such property, the Chinese government has not yet enacted any specific laws regarding virtual property rights. Accordingly, we have no basis to
determine what are the legal rights, if any, associated with virtual assets and what liabilities we could be exposed to for the loss or destruction of virtual
assets. We could therefore potentially be held liable for the way in which we handle and protect virtual assets.
Restrictions on virtual currency may adversely affect our online game revenues.
A large part of our online game revenues are collected through the sale of prepaid points, as described elsewhere on this annual report.
On February 15, 2007, the MOC, the PBOC, and 12 other PRC regulatory authorities jointly issued the Notice on the Reinforcement of the
Administration of Internet Cafés and Online Games, or the Internet Cafés Notice, which strengthens the administration of virtual currency in online
games to avoid any adverse impact on the PRC economy and financial system. Under the Internet Cafés Notice, the total amount of virtual currency
issued by online game operators and the amount purchased by individual users should be strictly limited, with a clear distinction between virtual
transactions and real transactions, so that virtual currency should only be used to purchase virtual items.
On June 4, 2009, the MOC and the MOFCOM jointly issued the Notice on Strengthening the Administration of Online Game Virtual Currency,
or the Online Game Virtual Currency Notice, which defined “Virtual Currency” as a type of virtual exchange instrument that is issued by online game
operators, purchased directly or indirectly by the game user by exchanging legal currency at a certain exchange rate, saved outside the game programs,
stored in servers provided by the online game operators in electronic record format and represented by specific numeric units. In addition, the Online
Game Virtual Currency Notice categorizes companies involved with virtual currency as either issuers or trading platforms and prohibits companies from
simultaneously engaging both as issuers and as trading platforms. The Online Game Virtual Currency Notice’s objective is to limit the circulation of
virtual currency and thereby reduce concerns that it may impact real world inflation. To accomplish this, the Online Game Virtual Currency Notice
requires online game operators to report the total amount of their issued virtual currencies on a quarterly basis and to refrain from issuing
disproportionate amounts of virtual currencies in order to generate revenues. In addition, the Online Game Virtual Currency Notice reiterates that virtual
currency can only be provided to users in exchange for an RMB payment and can only be used to pay for virtual goods and services of the issuers. Online
game operators are strictly prohibited from conducting lucky draws or lotteries in which participants pay cash or virtual currency to win game items or
virtual currency. The Online Game Virtual Currency Notice also requires online game operators to keep transaction data records for no less than 180 days
and to not provide virtual currency trading services to minors.
In order to comply with the requirements of the Online Game Virtual Currency Notice, we may need to change our prepaid point card
distribution and database systems, resulting in higher costs of our online game operation, lower sales of our prepaid cards, or other changes in our
business model. Such changes may therefore have an adverse effect on our revenues from online games.
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Information displayed on, retrieved from or linked to the NetEase websites and other online and mobile platforms may subject us to claims of
violating PRC laws.
Internet companies in China are subject to a variety of existing and new rules, regulations, policies, and license and permit requirements on the
distribution of information over the mobile and internet. Under these rules and regulations, content service providers are prohibited from posting or
displaying over the mobile or internet content that, among others, violates PRC laws and regulations, impairs the national security of China, is obscene,
superstitious, defamatory, or may be deemed by relevant government authorities as “socially destabilizing” or leaking “state secrets” of China. Violations
or perceived violations of Chinese laws arising from information displayed on, retrieved from or linked to the NetEase websites and other online and
mobile platforms could result in significant penalties, including a temporary or complete cessation of our business.
Multiple organizations are involved in the administering of such regulations, including the Propaganda Department of the Chinese Communist
Party, which has been given the responsibility to censor news published in China to ensure a particular political ideology, and the CAC, which has been
given the responsibility to protect, supervise and administer cyber security issues in China. In addition, the MIIT has published implementing regulations
that subject online information providers to potential liability for content included in their media and the actions of subscribers and others using their
systems, including liability for violation of PRC laws prohibiting the distribution of content deemed to be socially destabilizing. The Ministry of Public
Security has also from time to time prohibited the distribution over the internet of information which it believes to be socially destabilizing. In addition,
the NRTA is involved in the supervising, administering and reviewing of the content and quality of radio and television programs and internet audio-
visual programs. The MOCT is involved in guiding and administering the literary and artistic undertakings and artistic creation and production.
The Ministry of Public Security has the authority to require any local internet service provider to block any website maintained outside China at
its sole discretion. The State Secrecy Bureau, which is directly responsible for the protection of state secrets of all PRC government and Chinese
Communist Party organizations, is authorized to block any website it deems to be leaking state secrets or failing to meet the relevant regulations relating
to the protection of state secrets in the distribution of online information. The term “state secrets” has been broadly interpreted by Chinese governmental
authorities in the past. We may be liable under any of these pronouncements for content and materials posted, uploaded or transmitted by users on our
platform. User-generated content is accessible on the NetEase websites and our other online and mobile platforms including NetEase News App and
NetEase Cloud Music, such as content and materials posted or uploaded by users on message boards, online communities and social media platforms. We
have implemented an efficient and thorough content screening and monitoring mechanism for NetEase Cloud Music and our other platforms which
involve both automated filtering and manual review, to timely remove any inappropriate or illegal content, including interactive content on our platform.
However, such procedures may not prevent all illegal or impropriate content or comments from being posted, and our editorial staff may fail to review
and screen such content or comments effectively. Failure to identify and prevent illegal or inappropriate content from being distributed on our platform
may subject us to liability. To the extent that PRC regulatory authorities find any content on our platform objectionable, they may require us to limit or
eliminate the dissemination of such content on our platform in the form of take-down orders or otherwise. In addition, PRC laws and regulations are
subject to interpretation by the relevant authorities, and it may not be possible to determine in all cases the types of content that could result in our
liability as a platform operator.
In addition, under the relevant regulations, internet companies which provide bulletin board systems, chat rooms or similar services, such as our
company, must apply for the approval of the State Secrecy Bureau. As the implementing rules of these regulations have not been issued, we do not know
how or when we will be expected to comply, or how our business will be affected by the application of these regulations.
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We face uncertainties with respect to the interpretation and implementation of the Guidelines to Anti-Monopoly in the Field of Internet
Platforms.
The PRC Anti-monopoly Law, which took effect on August 1, 2008, prohibits monopolistic conduct such as entering into monopoly
agreements, abusing market dominance and concentration of undertakings that may have the effect of eliminating or restricting competition. On February
7, 2021, the Anti-Monopoly Commission of the State Council promulgated the Guidelines to Anti-Monopoly in the Field of Internet Platforms, or the
Anti-Monopoly Guidelines, which took effect on the same date and operate as a compliance guidance for platform economy operators under the existing
PRC anti-monopoly laws and regulations. The Anti-Monopoly Guidelines aim at specifying some of the circumstances under which an activity of
internet platforms may be identified as monopolistic conduct as well as setting out filing procedures for concentration of undertakings involving variable
interest entities. The Anti-Monopoly Guidelines mainly covers five aspects, including general provisions, monopoly agreements, abusing market
dominance, concentration of undertakings, and abusing of administrative powers eliminating or restricting competition.
Given the uncertainties of the interpretation and implementation of the Anti-Monopoly Guidelines and considering the evolving legislative
activities and varied local implementation practices of anti-monopoly and competition laws and regulations in the PRC, we may be required to make
expenditures and adjust our business practice to comply with existing or future laws and regulations, which may increase our costs and limit our ability to
operate our business. In addition, failure or perceived failure to comply with Anti-Monopoly Guidelines or other anti-monopoly related laws and
regulations may result in investigations or enforcement actions, litigation or claims against us and could have an adverse effect on our business, financial
conditions and results of operations.
We may not be able to adequately protect our intellectual property and may be exposed to infringement claims by third parties.
We rely on a combination of copyright, trademark, patent and trade secrecy laws and contractual restrictions on disclosure to protect our
intellectual property rights. Our efforts to protect our proprietary rights may not be effective in preventing unauthorized parties from copying or
otherwise obtaining and using our technology or imitating our name, private label merchandise or other intellectual property. Monitoring unauthorized
use of our intellectual property is difficult and costly, and we cannot be certain that the steps we take will effectively prevent misappropriation of our
technology or other intellectual property.
From time to time, we may have to resort to litigation to enforce our intellectual property rights, which could result in substantial costs and
diversion of our resources. In addition, our current and future business activities, including our portal service and private label merchandise, may
infringe upon the proprietary rights of others, and third parties may assert infringement claims against us, including claims alleging, among other things,
copyright, trademark or patent infringement. Third parties have initiated litigation against us for alleged infringement of their proprietary rights, and
additional claims may arise in the future. In the event of a successful claim of infringement and our failure or inability to develop non-infringing
technology or content or to license the infringed or similar technology or content on a timely basis, our business could suffer. Moreover, even if we are
able to license the infringed or similar technology or content, license fees that we pay to licensors could be substantial or uneconomical. See Item 4.B.
“Business Overview—Intellectual Property.”
We are subject to consumer protection laws that could require us to modify our current business practices and incur increased costs.
Our e-commerce business is subject to numerous PRC laws and regulations that regulate retailers generally or govern online retailers
specifically, such as the Consumer Protection Law. If these regulations were to change or if we or our suppliers were to violate them, the costs of certain
products or services could increase, or we could be subject to fines or penalties or suffer reputational harm, which could reduce demand for the products
or services offered on our e-commerce platform and hurt our business and results of operations. For example, the amended Consumer Protection Law,
which became effective in March 2014, strengthens the protection of consumers and imposes more stringent requirements and obligations on business
operators, with a particular focus on businesses that operate via the Internet. Pursuant to the Consumer Protection Law, consumers are generally entitled
to return goods purchased within seven days upon receipt without giving any reasons if the purchases are made through the Internet. Consumers whose
interests have been harmed due to their purchase of goods or acceptance of services on e-commerce platforms may claim damages from sellers or service
providers.
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Laws and regulations regarding consumer protection, particularly those involving transactions conducted over the Internet, frequently change
and are subject to interpretation. We are therefore unable to predict the ultimate cost of compliance of the relevant laws or regulations or their effect on
our operations. We may be required to make significant expenditures or modify our business practices to comply with existing or future laws and
regulations, which may increase our costs and materially limit our ability to operate our business.
Regulatory restrictions on financial transactions may adversely affect the operation and profitability of our business.
On June 14, 2010, the PBOC issued the Measures for the Administration of Non-financial Institutions Engaging in Payment and Settlement
Services, or the PBOC Measures, which became effective on September 1, 2010 and has been revised on April 29, 2020, and require that non-financial
institutions engaging in the business of effecting payments and settlements before September 1, 2010 obtain a permit from the PBOC by August 31, 2011
to continue operating their business. We currently operate an online payment platform used by both distributors of our prepaid points and end-users of
our online services, which requires a permit under the PBOC Measures. In addition, on December 28, 2015, the PBOC issued a notice regarding the
Administrative Measures for the Internet Payment Services of Non-banking Payment Institutions, or the PBOC Notice 43, which took effect on July 1,
2016. According to the PBOC Notice 43, a payment institution is required to follow the principles of “know your clients,” and maintain records on its
clients using their real names when opening payment accounts for its clients. Pursuant to the PBOC Notice 43, a payment institution shall not engage in,
including in a disguised form, such businesses as securities, insurance, credit loans, financing, wealth management, guarantee, trust, currency exchange,
cash deposit and withdrawal services. In addition, a payment institution is required to, based on client identity, conduct affiliated management of all the
payment accounts opened by the same client. On January 13, 2017, the PBOC issued the Notice of the PBOC on Matters concerning Implementing the
Centralized Deposit of the Funds of Pending Payments of Clients of Payment Institutions, which requires that from April 17, 2017, payment institutions
transfer a portion of customer reserve funds to a specifically designated bank account upon the request of the PBOC and that no interest be allowed to
accrue upon the transferred customer reserve funds for the time being. On June 29, 2018, the PBOC issued a further notice, namely the Notice of the
General Office of PBOC on Matters Concerning the Centralized Deposit of the Full Amount of Customer Reserve Funds by Payment Institutions, which
requires payment institutions to cause up to 100% of the customer reserve funds to be transferred to the above-mentioned account. On January 19, 2021,
the PBOC issued the Measures for Deposit and Management of Customer Reserve Funds by Non-bank Payment Institutions, or the Measures for
Customer Reserve Funds, which became effective on March 1, 2021. The Measures for Customer Reserve Funds define “Clients’ Reserves” as funds
actually received by non-bank payment institutions when processing payments for clients and payable upon clients’ order, which shall be fully deposited
by the non-bank payment institutions into a dedicated deposit account held in the custody of banking institutions. The Measures for Customer Reserve
Funds standardize the centralized deposit and management business of customer’s reserves after centralized deposit of reserves, further refine the
provisions on deposit, use and transfer of reserves, clarify the corresponding reserve management responsibilities of the PBOC and its branches, clearing
institutions and reserve banks, set punishment standards for violations of customer’s reserves and promote the healthy development of the industry health
development. A six-month transitional period shall be set up since the implementation of the Measures for Customer Reserve Funds.
We are in compliance with the PBOC Notice 43 and the recent PBOC requirements to transfer our customer reserve funds to its designated bank
account, however, we cannot predict how the regulations relating to financial transactions will evolve or be certain that we will be able to maintain
compliance with all relevant regulations at a reasonable cost. Any inability to continue operating our current online payment platform would likely
materially and adversely affect the operation and profitability of our business.
The uncertain legal environment in China could limit the legal protections available to you.
The Chinese legal system is a civil law system based on written statutes. Unlike common law systems, it is a system in which decided legal
cases have less precedential value. In the late 1970s, the Chinese government began to promulgate a comprehensive system of laws and regulations
governing economic matters. The overall effect of legislation enacted over the past 40 years has significantly enhanced the protections afforded to
foreign invested enterprises in China. However, many of these laws, regulations and legal requirements are relatively recent and are evolving rapidly,
and their interpretation and enforcement involve uncertainties. These uncertainties could limit the legal protections available to foreign investors.
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Contract drafting, interpretation and enforcement in China involve significant uncertainty.
We have entered into numerous contracts governed by PRC law, many of which are material to our business. As compared with contracts in the
United States, certain contracts governed by PRC law may contain less detail and may not be as comprehensive in defining contracting parties’ rights and
obligations in some instances. As a result, those contracts are more vulnerable to disputes and legal challenges. In addition, contract interpretation and
enforcement by the court in China is not as developed as in the United States, and the result of contract dispute in certain cases is subject to significant
uncertainties. Therefore, we cannot assure you that we will not be subject to disputes under our material contracts, and if such disputes arise, we cannot
assure you that we will prevail. Any dispute involving material contracts, even without merit in plaintiff’s regard, may materially and adversely affect
our reputation and our business operations, and may cause the price of our ADSs and/or shares to decline.
Changes in China’s political and economic policies could harm our business.
The economy of China has historically been a planned economy subject to governmental plans and quotas and has, in certain aspects, been
transitioning to a more market-oriented economy. Although we believe that the economic reform and the macroeconomic measures adopted by the
Chinese government have had a positive effect on the economic development of China, we cannot predict the future direction of these economic reforms
or the effects these measures may have on our business, financial position or results of operations. In addition, the Chinese economy differs from the
economies of most countries belonging to the Organization for Economic Co-operation and Development, or OECD. These differences include:
● economic structure;
● level of government involvement in the economy;
● level of development;
● level of capital reinvestment;
● control of foreign exchange;
● inflation rates;
● methods of allocating resources; and
● balance of payments position.
As a result of these differences, our business may not develop in the same way or at the same rate as might be expected if the Chinese economy
were similar to those of the OECD member countries.
Our business benefits from certain PRC government incentives. Expiration of, or changes to, these incentives and PRC tax laws could have a
material adverse effect on our operating results.
Under China’s Enterprise Income Tax Law, the enterprise income tax, or EIT, rate payable by domestic and foreign-invested enterprises is
25.0%. Preferential tax treatments are granted to entities that conduct business in encouraged sectors and to entities that are classified as HNTEs, or
“Software Enterprises” or “Key Software Enterprises,” whether such entities are foreign invested enterprises or domestic companies.
A number of our subsidiaries enjoy preferential tax rates by being recognized as an HNTE and/or a “Key Software Enterprise.” For example,
Boguan, NetEase Hangzhou and certain other PRC subsidiaries were qualified as HNTEs and enjoyed a preferential tax rate of 15% for 2018, 2019 and
2020. In 2018, 2019 and 2020, Boguan, NetEase Hangzhou and certain other PRC subsidiaries were also qualified as Key Software Enterprises and
enjoyed a further reduced preferential tax rate of 10% for 2017, 2018 and 2019. The related tax benefit was recorded in 2018, 2019 and 2020,
respectively. See Item 5.A. “Operating Results—Income Taxes.”
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Although we will attempt to obtain or maintain similar preferential tax statuses for our subsidiaries in the future, we cannot assure you that we
will obtain or maintain any particular preferential tax status, and typically the relevant government agencies do not confirm that we have obtained or
maintained a particular tax status until late in a given tax year or the following tax year. The qualifications for HNTE or “Software Enterprise” or “Key
Software Enterprise” status are subject to an annual assessment by the relevant government authorities in China, and the PRC policies on preferential tax
treatments may change from time to time. For example, a circular jointly promulgated by the NDRC, STA and certain other government authorities on
March 29, 2021 sets forth additional criteria for the “Key Software Enterprise” enjoying preferential tax rates, and provides that the qualifications for
“Key Software Enterprise” shall be jointly approved by NDRC, STA and several other central governmental authorities from 2020. If the government
authorities determine that we cannot meet the prescribed criteria for the “Key Software Enterprise”, we will not maintain the preferential tax status as a
“Key Software Enterprise”. Without any preferential tax status, the standard EIT rate of 25.0% will apply. Moreover, if there are further changes to the
relevant income tax laws and their implementation, our subsidiaries and VIEs may need to pay additional taxes, which could have a material adverse
effect on our results of operations.
We may be treated as a resident enterprise for PRC tax purposes under the Enterprise Income Tax Law, which may subject us to PRC income
tax for our global income and result in dividends payable by us to our foreign investors, and gains on the sales of our ordinary shares or ADSs,
becoming subject to taxes under PRC tax laws, which may materially reduce the value of your investment.
Under the Enterprise Income Tax Law, enterprises established outside of the PRC whose “de facto management bodies” are located in the PRC
are considered “resident enterprises,” and will generally be subject to the uniform 25.0% EIT rate for their global income. Under the implementation
rules of the Enterprise Income Tax Law, “de facto management body” is defined as the body that has material and overall management control over the
business, personnel, accounts and properties of the enterprise. In April 2009, the PRC tax authority promulgated a circular to clarify the criteria for
determining whether the “de facto management bodies” are located within the PRC for enterprises established outside of the PRC that are controlled by
entities established within the PRC. However, the relevant laws and regulations remain unclear regarding treatment of an enterprise established outside
the PRC that is not controlled by entities established within the PRC.
Some of our management is currently located in the PRC. Accordingly, we may be considered a “resident enterprise” and may therefore be
subject to the EIT rate of 25.0% of our global income, and as a result, the amount of dividends we can pay to our shareholders could be reduced. We
cannot confirm whether we will be considered a “resident enterprise” because the implementation rules are unclear at this time.
Under the implementation rules of the Enterprise Income Tax Law, dividends paid to “non-resident enterprises” by “resident enterprises” on
profits earned after January 1, 2008 are regarded as income from “sources within the PRC” and therefore subject to a 10.0% withholding income tax,
while dividends on profits earned before January 1, 2008 are not subject to the withholding income tax. Similarly, gains realized on the transfer of
ordinary shares or ADSs by “non-resident enterprises” are also subject to a 10.0% PRC EIT if such gains are regarded as income derived from sources
within the PRC. A lower withholding income tax rate is applied if the “non-resident enterprises” are registered in Hong Kong or other jurisdictions that
have a favorable tax treaty arrangement with China. Nevertheless, the Announcement on Issues Concerning “Beneficial Owners” in Tax Treaties, or the
STA Circular 9, which was issued on February 3, 2018 by the STA and effective on April 1, 2018, provides that a “non-resident enterprise” which does
not engage in substantive business activities may not be deemed to be a beneficial owner that is entitled to the above-mentioned reduced income tax rate
of 5%. It is unclear at this stage whether STA Circular 9 applies to dividends from our PRC subsidiaries paid to us through our Hong Kong subsidiaries.
It is possible that under STA Circular 9 our Hong Kong subsidiaries would not be considered to be the beneficial owners of any such dividends, and that,
if such dividends are subject to withholding, such withholding rate would be 10% rather than the favorable 5% rate generally applicable under the tax
treaty between mainland China and Hong Kong.
Because we may be treated as a “resident enterprise,” any dividends paid to the investors which are considered “non-resident enterprises” and
individual shareholders who are non-PRC residents may be subject to withholding income tax, and gains realized on the transfer of our ordinary shares or
ADSs by such investors may be subject to PRC income tax if such dividends or gains are deemed to be from PRC sources, which may adversely and
materially affect the value of the investment in our shares or ADSs. The tax rate for gains and dividends is 10% for “non-resident enterprise”
shareholders and 20% for non-PRC individual shareholders, subject to any reduction or exemption set forth in applicable tax treaties. However, it is
unclear whether in practice non-PRC shareholders would be able to obtain the benefits of income tax treaties entered into between PRC and their
countries or areas.
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We and our shareholders face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises by a non-PRC
company.
On February 3, 2015, the STA issued the Bulletin on Issues of Enterprise Income Tax on Indirect Transfers of Assets by Non-PRC Resident
Enterprises, or Bulletin 7, which has been further amended by the Announcement on Issues Concerning the Withholding of Enterprise Income Tax at
Source on Non-PRC Resident Enterprises, or Bulletin 37, issued by the STA on October 17, 2017 and amended on June 15, 2018. Pursuant to these
bulletins, subject to a safe harbor for purchase and sale of equity securities through a public securities market, an “indirect transfer” of assets, including
equity interests in a PRC resident enterprise, by non-PRC resident enterprises may be re-characterized and treated as a direct transfer of PRC taxable
assets, if the arrangement does not have a reasonable commercial purpose and was established for the purpose of avoiding payment of PRC enterprise
income tax. As a result, gains derived from this indirect transfer may be subject to PRC enterprise income tax.
Fluctuation in Renminbi exchange rates could adversely affect the value of our ADSs and any cash dividend declared on them.
The value of the RMB against the U.S. dollar and other currencies is affected by changes in China’s political and economic conditions and by
China’s foreign exchange policies, among other things. On July 21, 2005, the PRC government changed its policy of pegging the value of the RMB to the
U.S. dollar, and the RMB appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this
appreciation halted and the exchange rate between the RMB and the U.S. dollar remained within a narrow band. Then, the RMB had appreciated more
than 10% since June 2010 until it began to depreciate against the U.S. dollar in January 2014. Between January 2014 and December 2020, the RMB
depreciated against the U.S. dollar by approximately 7%. It is difficult to predict how market forces or PRC or U.S. government policy may impact the
exchange rate between the RMB and the U.S. dollar in the future. In addition, there remains significant international pressure on the PRC government to
adopt a substantial liberalization of its currency policy, which could result in more uncertainties in the value of the RMB against the U.S. dollar.
Our revenues are primarily denominated in Renminbi, and any significant depreciation of the RMB may affect the value of, and dividends (if
any) payable on, our ordinary shares or ADSs in U.S. dollar terms. For example, to the extent that we need to convert U.S. dollars into RMB for our
operations, appreciation of the RMB against the U.S. dollar would have an adverse effect on the RMB amount we would receive from the conversion.
Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of making payments for dividends on our ordinary shares, repaying our
U.S. dollar denominated loans or other payment obligations or for other business purposes, appreciation of the U.S. dollar against the RMB would have a
negative effect on the U.S. dollar amount available to us. In addition, appreciation or depreciation in the value of the RMB relative to U.S. dollars would
affect our financial results reported in U.S. dollar terms regardless of any underlying change in our business or results of operations. In 2020, we
experienced a RMB3.1 billion foreign exchange loss mainly due to the RMB appreciating against the U.S. dollar by nearly 7%. This loss had a
significant effect on our profit and our cash dividend.
Restrictions on currency exchange may limit our ability to utilize our revenues effectively.
Most of our revenues and operating expenses are denominated in Renminbi. The Renminbi is currently freely convertible under the “current
account” which includes dividends, trade and service-related foreign exchange transactions, but not under the “capital account” which includes foreign
direct investment and loans.
Under existing PRC foreign exchange regulations, payments of current account items, including payment of dividends, interest payments and
trade and service-related foreign exchange transactions, can be made in foreign currencies without prior approval of SAFE, by complying with certain
procedural requirements. Our PRC subsidiaries and affiliates may also retain foreign exchange in its current account to satisfy foreign exchange
liabilities or to pay dividends.
Since a significant amount of our future revenues will be denominated in Renminbi, the existing and any future restrictions on currency
exchange may limit our ability to utilize revenues generated in Renminbi to fund our business activities outside China, if any, or expenditures
denominated in foreign currencies. In order to limit the flow of capital out of China, the overall current regulatory environment relating to foreign
exchange controls in China suggests that, as a matter of practice, SAFE has been making it increasingly difficult to obtain foreign exchange approvals for
offshore dividend payments or capital account settlement.
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In addition, foreign exchange transactions under the capital account are subject to limitations and require registration with or approval by the
relevant PRC governmental authorities. In particular, any transfer of funds from us to any of our PRC subsidiaries or VIEs, either as a shareholder loan
or as an increase in registered capital, is subject to certain statutory limit requirements and registration or approval of the relevant PRC governmental
authorities, including the relevant administration of foreign exchange and/or the relevant examining and approval authority. Our ability to use the U.S.
dollar proceeds of the sale of our equity or debt to finance our business activities conducted through our PRC subsidiaries or VIEs will depend on our
ability to obtain these governmental registrations or approvals. In addition, because of the regulatory issues related to foreign currency loans to, and
foreign investment in, domestic PRC enterprises, we may not be able to finance the operations of our PRC subsidiaries or VIEs by loans or capital
contributions. We cannot assure you that we can obtain these governmental registrations or approvals on a timely basis, if at all. Any future restrictions
imposed by SAFE or tightened foreign exchange control by SAFE as a matter of practice may adversely affect our ability to utilize our revenues
effectively and pay dividends to our shareholders.
Failure to comply with PRC regulations regarding the registration requirements for employee equity incentive plans may subject our PRC
citizen employees or us to fines and other legal or administrative sanctions.
On February 15, 2012, SAFE issued the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals
Participating in Stock Incentive Plan of Overseas-Listed Company, or the Stock Incentive Plan Rule. Under the Stock Incentive Plan Rule, PRC citizens
who are granted share options or other employee equity incentive awards by an overseas publicly-listed company are required, through a qualified PRC
agent or a PRC subsidiary of such overseas publicly-listed company, to register with SAFE and complete certain other procedures related to the share
options or other employee equity incentive plans. If we or such PRC participants fail to comply with these regulations, we or such PRC participants may
be subject to fines and other legal or administrative sanctions.
The Chinese government has strengthened the regulation of investments made by Chinese residents in offshore companies and reinvestments in
China made by these offshore companies. Our business may be adversely affected by these restrictions.
The SAFE has adopted certain regulations that require registration with, and approval from, Chinese government authorities in connection with
direct or indirect control of an offshore entity by Chinese residents. The term “control” under SAFE regulation is broadly defined as the operation rights,
beneficiary rights or decision-making rights acquired by PRC residents in the offshore special purpose vehicles or PRC companies by means of
acquisition, trust, proxy, voting rights, repurchase, convertible bonds or other arrangements. The SAFE regulations retroactively require registration of
investments in non-Chinese companies previously made by Chinese residents. In particular, the SAFE regulations require Chinese residents to register
with SAFE information about offshore companies in which they have directly or indirectly invested and to make follow-up registrations in connection
with certain material transactions involving such offshore companies, such as mergers or division, capital increases and decreases, in equity transfer or
exchange. A newly established enterprise in China which receives foreign investments is also required to provide detailed information about its
controlling shareholders and to certify whether it is directly or indirectly controlled by a domestic entity or resident.
In the event that a Chinese shareholder with a direct or indirect stake in an offshore parent company fails to make the requisite SAFE
registration, the Chinese subsidiaries of such offshore parent company may be prohibited from making distributions of profit to the offshore parent and
from paying the offshore parent proceeds from any reduction in capital, share transfer or liquidation in respect of the Chinese subsidiaries. Further,
failure to comply with the various SAFE registration requirements described above can result in liability under Chinese law for foreign exchange
evasion.
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These regulations may have a significant impact on our present and future structuring and investment. We have requested our shareholders who
to our knowledge are PRC residents to make the necessary applications, registrations and amendments as required under these regulations. We intend to
take all necessary measures to ensure that all required applications and registrations will be duly made and all other requirements will be met. We further
intend to structure and execute our future offshore acquisitions in a manner consistent with these regulations and any other relevant legislation. However,
because it is presently uncertain how the SAFE regulations, and any future legislation concerning offshore or cross-border transactions, will be
interpreted and implemented by the relevant government authorities in connection with our future offshore financings or acquisitions, we cannot provide
any assurances that we will be able to comply with, qualify under, or obtain any approvals required by the regulations or other legislation. Furthermore,
we cannot assure you that any PRC shareholders of our company or any PRC company into which we invest will be able to comply with those
requirements. The inability of our company or any PRC shareholder to secure required approvals or registrations in connection with our future offshore
financings or acquisitions may subject us to legal sanctions, restrict our ability to pay dividends from our Chinese subsidiaries to our offshore holding
company, and restrict our overseas or cross-border investment activities or affect our ownership structure.
RISKS RELATED TO OUR ADSs AND SHARES
The trading price of our ADSs has been and is likely to continue to be, and the trading price of Shares can be, volatile, which could result in
substantial losses to holders of our ADSs and/or shares.
The trading price of our ADSs has been and is likely to continue to be volatile and could fluctuate widely in response to a variety of factors,
many of which are beyond our control. The trading price of our shares, likewise, can be volatile for similar or different reasons. For example, the trading
prices of our ADSs ranged from US$53.17 to US$103.53 per ADS in 2020 and the trading prices of our ordinary shares ranged from HK$125.00 to
HK$167.00 per ordinary share in 2020. In addition, the performance and fluctuation of the market prices of other companies with business operations
located mainly in China, especially internet and technology companies that have listed their securities in Hong Kong and/or the United States, may affect
the overall investor attitude towards Chinese public companies. The securities of some of these companies have experienced and may continue to
experience significant volatility, resulting from, among other things, underperformance and deteriorating financial results, negative news or perceptions
about inadequate corporate governance practices, and fraudulent behaviors of such companies. Consequently, the trading performance of our shares
and/or ADSs may be adversely and materially affected, regardless of our actual operation performance.
In addition to market and industry factors, the price and trading volume for our shares and/or ADSs may be highly volatile for factors specific to
our operation, including the following:
● variations in our results of operations that are not in line with market or research analyst expectations or changes in financial estimates by
securities research analysts;
● announcements of studies and reports relating to the quality of our product and service offerings or those of our competitors;
● changes in the economic performance or market valuations of other market players in our industries;
● announcements made by us or our competitors of new features or functionalities or other product and service offerings, investments,
acquisitions, strategic relationships, joint ventures or capital commitments;
● press and other reports, whether or not true, about our business, including negative reports published by short sellers, regardless of their
veracity or materiality to us;
● litigation and regulatory allegations or proceedings that involve us and our directors;
● additions to or departures of our management;
● political or market instability or disruptions, and actual or perceived social unrest in the markets where we operate;
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● fluctuations of exchange rates among the Renminbi, the Hong Kong dollar and the U.S. dollar;
● sales or perceived potential sales or other dispositions of existing or additional ADSs or other equity or equity-linked securities;
● any actual or alleged illegal acts of our senior management or other key employees;
● any share repurchase program; and
● regulatory developments affecting us or our industry, customers, licensors and other suppliers.
In particular, our revenues and results of operations have varied significantly in the past and may continue to fluctuate in the future, which may
adversely impact the trading price of our ADSs and shares. Historically, usage of our online games has generally increased around the Chinese holidays,
in particular winter and summer school holidays. Our Youdao platform tends to have larger student enrollments in the second and fourth quarters when it
offers more courses including, for example, test preparation courses for school exams in the spring and fall semesters and China’s national college
entrance exams, national postgraduate entrance exams and college English tests, compared to the rest of the year. Revenues from certain of our
innovative businesses and others, including advertising services, have followed the same general seasonal trend throughout each year, with the first
quarter of the year being the weakest quarter due to the Chinese New Year holiday and the traditional close of customers’ annual budgets, and the fourth
quarter as the strongest. Our e-commerce business revenues are relatively lower during the Chinese New Year holiday season in the first quarter of each
year, while sales in the fourth quarter are higher than each of the preceding three quarters due to a variety of promotional activities conducted by retail
and e-commerce businesses in China. Accordingly, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of
our future performance. It is possible that future fluctuations may cause our results of operations to be below the expectations of market analysts and
investors. This could cause the trading price of our shares, ADSs or any other securities of ours which may become publicly traded to decline.
Furthermore, the stock market in general experiences price and volume fluctuations that are often unrelated or disproportionate to the operating
performance of companies like us, such as the large decline in share prices in the United States in early 2020. These market and industry fluctuations may
significantly affect the trading price of our shares and/or ADSs. In the past, following periods of instability in the market price of a company’s securities,
shareholders have often instituted securities class action suits against that company.
Substantial future sales or perceived potential sales of our shares, ADSs, or other equity or equity-linked securities in the public market could
cause the price of our shares and/or ADSs to decline.
Sales of our shares, ADSs, or other equity or equity-linked securities in the public market, or the perception that these sales could occur, could
cause the market price of our shares and/or ADSs to decline significantly. All of our shares represented by ADSs were freely transferable by persons
other than our affiliates without restriction or additional registration under the U.S. Securities Act. The shares held by our affiliates are also available for
sale, subject to volume and other restrictions as applicable under Rule 144 of the U.S. Securities Act, under trading plans adopted pursuant to Rule 10b5-
1 or otherwise.
Divesture in the future of our shares and/or ADSs by shareholders, the announcement of any plan to divest our shares and/or ADS, or hedging
activity by third-party financial institutions in connection with similar derivative or other financing arrangements entered into by shareholders, could
cause the price of our shares and/or ADSs to decline.
Furthermore, although all of our directors and executive officers have agreed to a lock-up of their shares, any major disposal of our shares
and/or ADSs by any of them upon expiration of the relevant lock-up periods (or the perception that these disposals may occur upon the expiration of the
lock-up period) may cause the prevailing market price of our shares and/or ADSs to fall which could negatively impact our ability to raise equity capital
in the future.
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The different characteristics of the capital markets in the United States and Hong Kong may negatively affect the trading prices of our shares
and/or ADSs.
We are subject to Hong Kong and U.S. listing and regulatory requirements concurrently. The Nasdaq and Hong Kong Stock Exchange have
different trading hours, trading characteristics (including trading volume and liquidity), trading and listing rules, and investor bases (including different
levels of retail and institutional participation). As a result of these differences, the trading prices of our shares and our ADSs may not be the same, even
allowing for currency differences. Fluctuations in the price of our ADSs due to circumstances peculiar to the U.S. capital markets could materially and
adversely affect the price of the shares, or vice versa. Certain events having significant negative impact specifically on the U.S. capital markets may
result in a decline in the trading price of our shares notwithstanding that such event may not impact the trading prices of securities listed in Hong Kong
generally or to the same extent, or vice versa. Because of the different characteristics of the U.S. and Hong Kong capital markets, the historical market
prices of our ADSs may not be indicative of the trading performance of our shares, and vice versa.
Exchange between our ADSs and shares may adversely affect the liquidity and/or trading price of each other.
Subject to compliance with U.S. securities law and the terms of the Deposit Agreement, any holder of ADSs may withdraw the underlying
shares represented by the ADSs pursuant to the terms of the Deposit Agreement for trading on the Hong Kong Stock Exchange. Holders of our shares
may also deposit shares with the depositary in exchange for the issuance of our ADSs. In the event that a substantial number of ADSs are deposited with
the depositary in exchange for shares or vice versa, the liquidity and trading price of our ADSs on Nasdaq and shares on the Hong Kong Stock Exchange
may be adversely affected.
The time required for the exchange between ADSs and shares might be longer than expected and investors might not be able to settle or effect
any sale of their securities during this period, and the exchange of shares into ADSs involves costs.
There is no direct trading or settlement between Nasdaq and the Hong Kong Stock Exchange on which our ADSs and the shares are respectively
traded. In addition, the time differences between Hong Kong and New York and unforeseen market circumstances or other factors may delay the
withdrawal of shares underlying the ADSs or the deposit of shares in exchange for ADSs. Investors will be prevented from settling or effecting the sale
of their securities during such periods of delay. In addition, there is no assurance that any exchange of ADSs into shares (and vice versa) will be
completed in accordance with the timelines investors may anticipate.
Furthermore, the depositary for the ADSs is entitled to charge holders fees for various services including for the issuance of ADSs upon deposit
of shares, cancelation of ADSs, distributions of cash dividends or other cash distributions, distributions of ADSs pursuant to share dividends or other free
share distributions, distributions of securities other than ADSs and annual service fees. As a result, shareholders who exchange shares into ADSs, and
vice versa, may not achieve the level of economic return the shareholders may anticipate.
As a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate
governance matters that differ significantly from Nasdaq rules.
As a Cayman Islands exempted company listed on Nasdaq, we are subject to Nasdaq rules. However, Nasdaq rules permit a foreign private
issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is
our home country, may differ significantly from Nasdaq rules applicable to U.S. domestic issuers. For instance, we are not required to:
● have a majority of the board be independent (although all of the members of the audit committee must be independent under the U.S. Exchange
Act);
● have a compensation committee or a nominating or corporate governance committee consisting entirely of independent directors;
● have regularly scheduled executive sessions for non-management directors; or
● have executive sessions of solely independent directors each year.
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We have relied on and intend to continue to rely on some of these exemptions. Specifically, our board of directors adopted our 2009 RSU Plan
and 2019 RSU Plan without seeking shareholder approval which is generally required under Rule 5635(c) of the Nasdaq Marketplace Rules. There is no
specific requirement under Cayman Islands law for shareholder approval to be obtained with respect to the establishment or amendment of equity
compensation arrangements. In situations where we choose to follow home country practices, our shareholders may be afforded less protection than they
otherwise would under Nasdaq rules applicable to U.S. domestic issuers.
We are a foreign private issuer within the meaning of the rules under the U.S. Exchange Act, and as such we are exempt from certain provisions
applicable to U.S. domestic public companies.
Because we qualify as a foreign private issuer under the U.S. Exchange Act, we are exempt from certain provisions of the securities rules and
regulations in the United States that are applicable to U.S. domestic issuers, including:
● the rules under the U.S. Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q or current reports on Form 8-K;
● the sections of the U.S. Exchange Act regulating the solicitation of proxies, consents, or authorizations in respect of a security registered under
the U.S. Exchange Act;
● the sections of the U.S. Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for
insiders who profit from trades made in a short period of time; and
● the selective disclosure rules by issuers of material nonpublic information under Regulation FD.
We are required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to continue to
publish our results on a quarterly basis as press releases, distributed pursuant to Nasdaq rules. Press releases relating to financial results and material
events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive
and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, holders of our ADSs may be afforded less
protection or information than they would under the U.S. Exchange Act rules applicable to U.S. domestic companies.
We are a company listed on the Hong Kong Stock Exchange under Chapter 19C and as such are not subject to certain provisions of the Hong
Kong Listing Rules.
As a company listed under Chapter 19C of the Hong Kong Listing Rules, we have adopted different practices as to certain matters as compared
with many other companies listed on the Hong Kong Stock Exchange. We are not subject to certain provisions of the Hong Kong Listing Rules pursuant
to Rule 19C.11, including, among others, rules on notifiable transactions, connected transactions, share option schemes, content of financial statements as
well as certain other continuing obligations.
In addition, we have been granted a number of waivers and/or exemptions from strict compliance with, among others, the Hong Kong Listing
Rules and the SFO. We have also been granted a ruling from the Securities and Futures Commission of Hong Kong, as a result of which the Takeovers
Codes do not apply to us. Therefore, we will adopt different practices as to those matters as compared with other companies listed on the Hong Kong
Stock Exchange that do not enjoy those exemptions or waivers. However, if 55% or more of the total worldwide trading volume, by dollar value, of our
shares and ADSs over our most recent fiscal year takes place on the Hong Kong Stock Exchange, the Hong Kong Stock Exchange will regard us as
having a dual primary listing in Hong Kong and we will no longer enjoy certain exemptions or waivers from strict compliance with the requirements
under the Hong Kong Listing Rules, the Takeovers Codes and the SFO, which could result in our incurring of incremental compliance costs.
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The voting rights of holders of ADSs are limited by the terms of the Deposit Agreement.
Holders of ADSs may exercise their voting rights with respect to the underlying shares represented by their ADSs only in accordance with the
provisions of the Deposit Agreement. Upon receipt of voting instructions from them in the manner set forth in the Deposit Agreement, the depositary will
endeavor, in so far as practicable, to vote the underlying shares represented by their ADSs in accordance with these instructions. However, the depositary
and its agents may not be able to send voting instructions to holders of ADSs or carry out their voting instructions in a timely manner. We will make all
reasonable efforts to cause the depositary to extend voting rights to holders of ADSs in a timely manner, but they may not receive the voting materials in
time to ensure that they can instruct the depositary to vote the underlying shares represented by their ADSs. Furthermore, the depositary and its agents
will not be responsible for any failure to carry out any instructions to vote, for the manner in which any vote is cast or for the effect of any vote. As a
result, holders of ADSs may not be able to exercise their rights to vote and they may lack recourse if the underlying shares represented by their ADSs are
not voted as they requested.
Except in limited circumstances, the depositary will give us a discretionary proxy to vote our shares underlying the ADSs if holders of these
ADSs do not give voting instructions to the depositary, which could adversely affect the interests of holders of shares and/or the ADSs.
Under the Deposit Agreement, the depositary will give us a discretionary proxy to vote the shares underlying the ADSs at shareholders’
meetings if holders of these ADSs do not give voting instructions to the depositary, unless:
● we have instructed the depositary that we do not wish a discretionary proxy to be given;
● we have informed the depositary that there is substantial opposition as to a matter to be voted on at the meeting;
● a matter to be voted on at the meeting would have a material adverse impact on shareholders; or
● voting at the meeting is made on a show of hands.
The effect of this discretionary proxy is that, if holders of ADSs fail to give voting instructions to the depositary, they cannot prevent our shares
underlying their ADSs from being voted, except under the circumstances described above. This may make it more difficult for shareholders to influence
our management. Holders of our shares are not subject to this discretionary proxy.
Holders of ADSs may be subject to limitations on transfer of their ADSs.
ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time
when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers
of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deems it advisable to do so because of
any requirement of law or of any government or governmental body, or under any provision of the Deposit Agreement, or for any other reason.
Holders of ADSs may not receive distributions on our shares if the depositary decides it is impractical or unlawful to make such distributions.
The depositary has agreed to pay cash to holders of ADSs to the extent that we decide to distribute cash dividends or other cash distributions on
our shares or other deposited securities. In the second quarter of 2019, our board of directors determined that quarterly dividends will be set at an amount
equivalent to approximately 20%-30% of our anticipated net income after tax in each fiscal quarter. Our board of directors also approved an additional
special dividend equivalent to US$0.69 per ADS in the third quarter of 2019. However, the determination to make dividend distributions and the amount
of such distributions in any particular quarter, if any, will be made at the discretion of our board of directors and will be based upon our operations and
earnings, cash flow, financial condition and other relevant factors. This dividend policy can be changed or terminated at any time in the discretion of the
board of directors.
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To the extent that there is a distribution in shares, rights or other securities and properties, the depositary has agreed to distribute to holders of
ADSs the shares, rights or other distributions it or the custodian receives on our shares or other deposited securities after deducting its fees and expenses.
ADS holders will receive these distributions in proportion to the number of shares their ADSs represent. However, the depositary may, at its discretion,
decide that it is impractical to make a distribution available to holders of ADSs. For example, it would be unlawful to make a distribution to a holder of
ADSs if it consists of securities that require registration under the U.S. Securities Act but that are not properly registered or distributed pursuant to an
applicable exemption from registration. We have no obligation to take any other action to permit the distribution of shares, rights or anything else to
holders of ADSs. This means that holders of ADSs may not receive the distributions we make on our shares if it is impractical for us to make them
available. These restrictions may materially reduce the value of the ADSs.
If we fail to maintain an effective system of internal control over financial reporting, we may lose investor confidence in the reliability of our
financial statements which in turn could negatively impact the trading price of our shares and/or ADSs or otherwise harm our reputation.
The SEC, as required under Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies to include a report of
management on the effectiveness of such companies’ internal control over financial reporting in their respective annual reports. In addition, an
independent registered public accounting firm for a public company may be required to issue an attestation report on the effectiveness of such company’s
internal control over financial reporting.
Our management conducted an evaluation of the effectiveness of our internal control over financial reporting and concluded that our internal
control over financial reporting was effective as of December 31, 2020. Our independent registered public accounting firm has also, in its audit report,
concluded that our internal control over financial reporting was effective in all material aspects as of December 31, 2020. Please refer to Item 15
“Controls and Procedures.” However, if we fail to maintain effective internal control over financial reporting in the future, our management and our
independent registered public accounting firm may not be able to conclude that we have effective internal control over financial reporting in accordance
with the Sarbanes-Oxley Act of 2002. Moreover, effective internal control over financial reporting is necessary for us to produce reliable financial
reports. As a result, any failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the
reliability of our financial statements, which in turn could negatively impact the trading price of our shares and/or ADSs or otherwise harm our
reputation. Furthermore, we may need to incur additional costs and use additional management and other resources in an effort to comply with Section
404 of the Sarbanes-Oxley Act of 2002 and other requirements going forward.
Our auditor, like other independent registered public accounting firms operating in China, is not permitted to be subject to inspection by the
Public Company Accounting Oversight Board, and consequently you are deprived of the benefits of such inspection. Under the recently passed
Holding Foreign Companies Accountable Act, our ADSs may be delisted from Nasdaq if the PCAOB continues to be unable to inspect our
independent registered public accounting firm in the next three years. In addition, various legislative and regulatory developments related to
U.S.-listed China-based companies due to lack of PCAOB inspection and other developments may have a material adverse impact on our listing
and trading in the U.S. and the trading prices of our ADSs.
Our auditor, the independent registered public accounting firm that issued the audit report included elsewhere in this annual report, as an auditor
of companies that are registered with the SEC and traded publicly in the United States and a firm registered with the U.S. Public Company Accounting
Oversight Board, or PCAOB, is subject to the laws in the United States pursuant to which the PCAOB conducts regular inspections to assess its
compliance with the applicable professional standards. Our auditor is located in, and organized under the laws of, the PRC, which is a jurisdiction where
the PCAOB has been unable to conduct inspections without the approval of the Chinese authorities.
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In May 2013, the PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation, or the MOU, with
the CSRC, and the PRC Ministry of Finance, or the MOF. The MOU establishes a cooperative framework between the parties for the production and
exchange of audit documents relevant to investigations in the United States and the PRC. The PCAOB continues to engage in discussions with the CSRC
and the MOF to permit joint inspections in China of audit firms that are registered with the PCAOB and audit China-based companies that trade on U.S.
exchanges. However, the implementation procedures of the MOU remain uncertain.
In December 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their
oversight of financial statement audits of U.S.-listed companies with significant operations in China. On April 21, 2020, the SEC and the PCAOB issued
another joint statement reiterating the greater risk that disclosures will be insufficient in many emerging markets, including China, compared to those
made by U.S. domestic companies. In discussing the specific issues related to the greater risk, the statement again highlights the PCAOB’s inability to
inspect audit work paper and practices of accounting firms in China, with respect to their audit work of U.S. reporting companies.
In June 2020, the U.S. President issued a memorandum ordering the President’s Working Group on Financial Markets, or the PWG, to submit a
report to the President within 60 days of the memorandum that includes recommendations for actions that can be taken by the executive branch and by
the SEC or the PCAOB on Chinese companies listed on U.S. stock exchanges and their audit firms. In August 2020, the PWG released the report. In
particular, with respect to jurisdictions that do not grant the PCAOB sufficient access to fulfill its statutory mandate, or NCJs, the PWG recommended
that enhanced listing standards be applied to companies from NCJs for seeking initial listing and remaining listed on U.S. stock exchanges. Under the
enhanced listing standards, if the PCAOB does not have access to work papers of the principal audit firm located in a NCJ for the audit of a U.S.-listed
company as a result of governmental restrictions, the U.S.-listed company may satisfy this standard by providing a co-audit from an audit firm with
comparable resources and experience where the PCAOB determines that it has sufficient access to the firm’s audit work papers and practices to inspect
the co-audit (however, there is currently no legal framework under which such a co-audit could be conducted for a company in China without prior
governmental approval). The report recommended a transition period until January 1, 2022 before the new listing standards apply to companies already
listed on U.S. stock exchanges. Under the PWG recommendations, if we fail to meet the enhanced listing standards before January 1, 2022, we could
face de-listing from the Nasdaq, deregistration from the SEC and/or other risks, which may materially and adversely affect, or effectively terminate, our
ADS trading in the United States. There were recent media reports about the SEC’s proposed rulemaking in this regard. It is uncertain whether the PWG
recommendations will be adopted, in whole or in part, and the impact of any new rule on us cannot be estimated at this time.
This lack of PCAOB inspections in China prevents the PCAOB from fully evaluating audits and quality control procedures of our independent
registered public accounting firm. As a result, we and our investors are deprived of the benefits of such PCAOB inspections. The inability of the PCAOB
to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our independent registered public accounting firm’s
audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. In addition, the SEC may
initiate proceedings against our independent registered public accounting firm, whether in connection with an audit of our company or other China-based
companies, which could result in the imposition of penalties against our independent registered public accounting firm, such as suspension of its ability
to practice before the SEC. All of these could cause investors and potential investors in us to lose confidence in our audit procedures and reported
financial information and the quality of our financial statements.
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As part of a continued regulatory focus in the United States on access to audit and other information currently protected by national law, in
particular China’s, in June 2019, a bipartisan group of lawmakers introduced bills in both houses of Congress that would require the SEC to maintain a
list of issuers for which the PCAOB is not able to inspect or investigate an auditor report issued by a foreign public accounting firm. The Ensuring
Quality Information and Transparency for Abroad-Based Listings on our Exchanges (EQUITABLE) Act prescribes increased disclosure requirements for
such issuers and, beginning in 2025, the delisting from national securities exchanges such as Nasdaq of issuers included for three consecutive years on
the SEC’s list. On May 20, 2020, the U.S. Senate passed S. 945, the Holding Foreign Companies Accountable Act, or the Act. The Act was approved by
the U.S. House of Representatives on December 2, 2020. The Act was signed into law by the president of the United States on December 19, 2020. In
essence, the Act requires the SEC to prohibit foreign companies from listing securities on U.S. securities exchanges if a company retains a foreign
accounting firm that cannot be inspected by the PCAOB for three consecutive years, beginning in 2021. On March 24, 2021, the SEC adopted interim
final rules relating to the implementation of certain disclosure and documentation requirements of the Act. We will be required to comply with these rules
if the SEC identifies us as having a “non-inspection” year under a process to be subsequently established by the SEC. The SEC is assessing how to
implement other requirements of the Act, including the listing and trading prohibition requirements described above. The enactment of the Act and any
additional rulemaking efforts to increase U.S. regulatory access to audit information in China could cause investor uncertainty for affected SEC
registrants, including us, the market price of our ADSs could be materially adversely affected, and we could be delisted if we are unable to meet the
PCAOB inspection requirement in time. Our ordinary shares are currently listed on the Hong Kong Stock Exchange. If we are delisted from the Nasdaq,
the conversion of ADSs and transfer of the ordinary shares to Hong Kong will necessitate time and certain expenses. The trading price of our ordinary
shares may be adversely affected as a result of a substantial number of ADSs being converted to ordinary shares, and there can be no assurance that an
active trading market for ordinary shares on the Hong Kong Stock Exchange will be sustained.
Our audit committee is aware of the Act and regularly communicates with our independent auditor to monitor developments in the rulemaking.
We may be adversely affected by the outcome of the administrative proceedings brought by the SEC against the Big Four PRC-based
accounting firms.
In December 2012, the SEC brought administrative proceedings against the Chinese affiliates of the “big four” accounting firms (the “Big Four
PRC-based Accounting Firms”), including our independent registered public accounting firm, alleging that these accounting firms had violated U.S.
securities laws and the SEC’s rules and regulations thereunder by failing to provide to the SEC the firms’ audit papers and other documents related to
certain PRC-based companies that are publicly traded in the United States.
In January 2014, the administrative law judge presiding over the matter reached an initial decision that the Big Four PRC-based Accounting
Firms had each violated the SEC’s rules of practice by failing to produce the audit work papers and related documents directly to the SEC. The initial
decision further determined that each of the firms should be censured and barred from practicing before the SEC for a period of six months.
In February 2015, the Big Four PRC-based Accounting Firms each agreed to a censure and to pay a fine to the SEC to settle the dispute and
avoid suspension of their ability to practice before the SEC and to audit U.S.-listed companies. The settlement required the Big Four PRC-based
Accounting Firms to follow detailed procedures and to seek to provide the SEC with access to these firms’ audit documents via the CSRC. Under the
terms of the settlement, the underlying proceeding against the Big Four PRC-based Accounting Firms was deemed dismissed with prejudice four years
after entry of the settlement. The four-year anniversary occurred on February 6, 2019. While we cannot predict if the SEC will further challenge the Big
Four PRC-based Accounting Firms’ compliance with U.S. law in connection with U.S. regulatory requests for audit work papers or if the results of such
a challenge would result in the SEC imposing penalties such as suspensions, if the Big Four PRC-based Accounting Firms are subject to additional
remedial measures, we may not be able to continue to meet our reporting obligations under the Exchange Act, which may ultimately result in our
deregistration by the SEC and delisting from the Nasdaq, in which case our market capitalization may decline sharply and the value of your investment in
our ADSs and shares may be materially and adversely affected.
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Holders of our ADSs and shares may have difficulty effecting service of process and enforcing judgments obtained against us and our
management, the ability of U.S. authorities to bring actions in the PRC may also be limited, and our Articles of Association include certain
provisions that may be different from common practices in Hong Kong.
We are a Cayman Islands company, and the major portion of our assets are located outside the United States and Hong Kong. A substantial
portion of our current operations are conducted in the PRC. In addition, some of our directors and executive officers are nationals and residents of
countries or areas other than the United States and Hong Kong. A substantial portion of the assets of these persons are located outside the United States
and Hong Kong. As a result, it may be difficult or impossible for holders of our shares and ADSs to effect service of process within the United States or
Hong Kong upon these persons, or to bring an action against us or against these individuals in the United States or Hong Kong in the event that they
believe that their rights have been infringed under the U.S. federal securities laws, Hong Kong laws or otherwise. Even if shareholders are successful in
bringing an action of this kind, the laws of the Cayman Islands and China may render them unable to enforce a judgment against our assets or the assets
of our directors and officers. There is uncertainty as to whether the courts of the Cayman Islands or the PRC would recognize or enforce judgments.
Furthermore, class action lawsuits, which are available in the United States for investors to seek remedies, are generally uncommon in the Cayman
Islands and the PRC.
The SEC, the U.S. Department of Justice and other U.S. authorities may also have difficulties in bringing and enforcing actions against us or our
directors or executive officers in the PRC. The SEC has stated that there are significant legal and other obstacles to obtaining information needed for
investigations or litigation in China. China has recently adopted a revised securities law which provides, among other things, that without governmental
approval in China, no entity or individual in China may provide documents and information relating to securities business activities to overseas
regulators which could present significant legal and other obstacles to obtaining information needed for investigations and litigation conducted outside of
China.
Furthermore, our Articles of Association are specific to us and include certain provisions that may be different from common practices in Hong
Kong, such as the absence of requirements that the appointment, removal and remuneration of auditors must be approved by a majority of our
shareholders.
As a result of the foregoing, our public shareholders may have more difficulty in protecting their interests through actions against us, our
management, our directors or our major shareholders than they would as public shareholders of a company incorporated in the United States or Hong
Kong.
It may be difficult for overseas regulators to conduct investigations or collect evidence within China.
Shareholder claims or regulatory investigation that are common in the United States generally are difficult to pursue as a matter of law or
practicality in China. For example, in China, there are significant legal and other obstacles to providing information needed for regulatory investigations
or litigation initiated outside China. Although the authorities in China may establish a regulatory cooperation mechanism with the securities regulatory
authorities of another country or region to implement cross-border supervision and administration, such cooperation with the securities regulatory
authorities in the Unities States may not be efficient in the absence of mutual and practical cooperation mechanisms. Furthermore, according to Article
177 of the PRC Securities Law, or Article 177, which became effective in March 2020, no overseas securities regulator is allowed to directly conduct
investigations or evidence collection activities within the territory of the PRC. While detailed interpretations of or implementation rules under Article 177
have yet to be promulgated, the inability for an overseas securities regulator to directly conduct investigations or evidence collection activities within
China may further increase difficulties you may face in protecting your interests.
If we are classified as a passive foreign investment company, or PFIC for United States federal income tax purposes, such classification could
result in adverse U.S. federal income tax consequences to U.S. investors.
We could be classified as a PFIC by the U.S. Internal Revenue Service for U.S. federal income tax purposes. Such characterization could result
in adverse U.S. federal income tax consequences to you if you are a U.S. investor. For example, U.S. investors who owned our ADSs or shares during
any taxable year in which we were a PFIC generally are subject to increased U.S. tax liabilities and reporting requirements for that taxable year and all
succeeding years, regardless of whether we actually continue to be a PFIC, although a shareholder election to terminate such deemed PFIC status may be
available in certain circumstances.
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The determination of whether or not we are a PFIC is made on an annual basis and depends on the composition of our income and assets,
including goodwill, from time to time. Specifically, we will be classified as a PFIC for U.S. tax purposes for a taxable year if either (a) 75% or more of
our gross income for such taxable year is passive income, or (b) 50% or more of the average percentage of our assets during such taxable year either
produce passive income or are held for the production of passive income. For such purposes, if we directly or indirectly own 25% or more of the shares
of another corporation, we generally will be treated as if we (a) held directly a proportionate share of the other corporation’s assets, and (b) received
directly a proportionate share of the other corporation’s income.
We do not believe that we were a PFIC for the taxable years 2018, 2019 and 2020. Based on certain estimates and assumptions, we do not
expect to be a PFIC for taxable year 2021. The PFIC determination is highly fact intensive and made at the end of each taxable year. We hold and will
continue to hold a substantial amount of cash and cash equivalents, and our PFIC status may depend in large part in the market price of our ADSs and
shares which is likely to fluctuate. For these reasons, there can be no assurance that we will not be a PFIC in taxable year 2020 or that we will not be a
PFIC in any future taxable year or that the U.S. Internal Revenue Service will not challenge our determination concerning our PFIC status.
If we are or become a PFIC, and, if so, if one or more of our subsidiaries or VIEs are treated as PFICs, U.S. investors would be subject to
adverse U.S. federal income tax consequences, such as increased tax liability on capital gains and actual or deemed dividends, interest charges on certain
taxes treated as deferred, and additional reporting requirements under U.S. federal income tax laws and regulations. Whether U.S. investors make (or are
eligible to make) a timely mark-to-market election may affect the U.S. federal income tax consequences to U.S. investors with respect to the acquisition,
ownership and disposition of our ADSs or shares and any distributions such U.S. investors may receive. We do not expect to provide the information
regarding our income that would be necessary in order for a U.S. investor to make a qualified electing fund (the “QEF”) election if we are classified as a
PFIC. Investors should consult their own tax advisors regarding all aspects of the application of the PFIC rules to our ADSs or shares.
If we are a PFIC in any year with respect to a U.S. investor, the U.S. investor will be required to file an annual information return on IRS Form
8621 (or other then applicable IRS Form or statement) regarding distributions received on our ADSs or shares an annual information return (also on IRS
Form 8621 or other then applicable IRS Form or statement) relating to their ownership of our ADSs or shares. U.S. investors should consult their tax
advisors regarding the potential application of the PFIC regime and related reporting requirements.
For further discussion of the adverse U.S. federal income tax consequences of our possible classification as a PFIC, see Item 10.E “Additional
Information—Taxation—United States Federal Income Taxation.”
There is uncertainty as to whether Hong Kong stamp duty will apply to deposits of our ordinary shares into or withdrawal of our ordinary
shares from the ADS facility or trading of our ADSs.
In connection with our initial public offering of shares in Hong Kong, we established a branch register of members in Hong Kong (the “Hong
Kong share register”). Our shares that are traded on the Hong Kong Stock Exchange, including those represented by ADSs, are registered on the Hong
Kong share register, and the trading of these shares on the Hong Kong Stock Exchange are subject to the Hong Kong stamp duty. To facilitate conversion
between ADSs and shares and their respective trading on Nasdaq and the Hong Kong Stock Exchange, we moved a portion of our issued shares,
including all of the ordinary shares deposited in our ADS program, from our Cayman share register to our Hong Kong share register.
Under the Hong Kong Stamp Duty Ordinance, any person who effects any sale or purchase of Hong Kong stock, defined as stock the transfer of
which is required to be registered in Hong Kong, is required to pay Hong Kong stamp duty. The stamp duty is currently set at a total rate of 0.2% of the
greater of the consideration for, or the value of, shares transferred, with 0.1% payable by each of the buyer and the seller. In February 2021, Hong Kong
raised the stamp duty from 0.1% to 0.13%, effective August 2021.
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To the best of our knowledge, Hong Kong stamp duty has not been levied in practice on the trading of ADSs representing shares of companies
that are listed in both the United States and Hong Kong and that have maintained all or a portion of their ordinary shares, including ordinary shares
underlying ADSs, in their Hong Kong share registers, or on the deposit of shares in or withdrawal of shares from ADS facilities of that kind. However, it
is unclear whether, as a matter of Hong Kong law, the trading of ADSs representing shares of these dual-listed companies or the deposit of shares in or
withdrawal of shares from those ADS facilities constitutes a sale or purchase of the underlying Hong Kong-registered ordinary shares that is subject to
Hong Kong stamp duty. We advise investors to consult their own tax advisors on this matter. If Hong Kong stamp duty is determined by the competent
authority to apply to the trading of those ADSs or deposits of shares in or withdrawal of shares from those ADS facilities, the trading price and the value
of your investment in our ADSs and/or shares may be affected.
Item 4. Information on the Company
A. History and Development of the Company
Our business was founded in June 1997 and our Company was incorporated on July 6, 1999 under the Cayman Companies Act (2020 Revision).
Our principal executive offices are located at NetEase Building, No. 599 Wangshang Road, Binjiang District, Hangzhou, People’s Republic of China
310052. Our telephone number is (86-571) 8985-3378.
Our key business milestones are summarized below:
● Founding of our business
● Launch of free web-based e-mail services
Business model shifted from software development to internet technology with the launch of our NetEase website
(“www.163.com”)
● Launches of advertisement services, online platforms, online shopping malls, and other internet services in China
● Listing on Nasdaq on June 30
1997
1998
1999
2000
● Introduction of fee-based premium services and online entertainment services, including online games, wireless value-added
2001
services and other subscription-type services
● Launch of our first PC-client MMORPG game, Westward Journey Online, our widely popular in-house developed game series
● Launch of our Fantasy Westward Journey series, our second widely popular original game series
2001
2004
● Founding of Youdao, an intelligent learning company that now offers learning content, applications and solutions, as well as
2006
online marketing services
● Launch of NetEase Cloud Music, our music streaming platform
● Launch of our first mobile game, the mobile version of Fantasy Westward Journey II
● Launch of our e-commerce platform, Kaola
● Launch of Yanxuan, our private label e-commerce business
● Sale of Kaola to Alibaba
● Listing of Youdao on the New York Stock Exchange on October 26
● Listing on Hong Kong Stock Exchange on June 11
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2013
2013
2015
2016
2019
2019
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Our principal capital expenditures for 2020 consisted mainly of the construction of our new office buildings in Guangzhou and Shanghai in
China and the acquisition of new servers in connection with the operation of our businesses for a total of approximately RMB1,055.6 million (US$161.8
million). Our principal capital expenditures for 2019 consisted mainly of the construction of our new office buildings and warehouses in Guangzhou and
Hangzhou, acquisition of new servers in connection with the operation of our online games and developing the expansion packages of such games, and
upgrades of our online service infrastructure for a total of approximately RMB1,209.5 million. Our principal capital expenditures for 2018 consisted
mainly of the construction of our new office buildings in Hangzhou and Guangzhou, acquisition of new servers in connection with the operation of our
online games and developing the expansion packages of such games, and upgrades of our online service infrastructure, for a total of approximately
RMB2,169.4 million. In addition, in connection with the licensing of certain online games by Blizzard to Shanghai EaseNet for operation in the PRC,
during the respective terms of the licenses, Shanghai EaseNet as licensee of the games is required to pay royalty fees to Blizzard for the games, have a
minimum marketing expenditure commitment, and provide funds for hardware to operate the games.
As of December 31, 2020, we had capital expenditure commitments of RMB1,113.2 million (US$170.6 million) for 2021 onwards, which
primarily consist of commitments made in connection with the construction of new office buildings in Guangzhou and Shanghai.
The SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers that file
electronically with the SEC, including us, at http://www.sec.gov. Our company website can be accessed at http://ir.netease.com.
B. Business Overview
OUR ORGANIZATIONAL STRUCTURE
We conduct our business in China through our subsidiaries, including our VIEs. Due to legal restrictions and prohibitions on foreign investment
in Chinese companies providing, among other things, value-added telecommunications services, internet cultural services and internet publication
services, we operate all of our business segments through contractual arrangements with the VIEs and their VIE equity holders. The contractual
arrangements enable us to: (a) collectively exercise effective control over our VIEs and their subsidiaries; (b) receive substantially all of the economic
benefits of our VIEs and their subsidiaries; and (c) have an exclusive option to purchase all or part of the equity interests in our VIEs when and to the
extent permissible under PRC laws. The VIEs hold ICP licenses and other regulated licenses in which foreign investment is restricted or prohibited and
operate our internet businesses and other businesses. Under the contractual arrangements, we provide our computer software, mobile applications,
technologies and relevant services to such affiliated companies and they operate the NetEase online game services, education platforms, websites, as well
as our other online businesses. For more information on these agreements, see Item 7.B. “Major Shareholders and Related Party Transactions—Related
Party Transactions.”
Starting in August 2008, Blizzard agreed to license certain online games to Shanghai EaseNet for operation in the PRC. Shanghai EaseNet is a
PRC company wholly-owned by William Lei Ding, our Chief Executive Officer, director and major shareholder and has contractual arrangements with
the joint venture established between, and owned equally by, Blizzard and us. The joint venture was established concurrently with the licensing of games
from Blizzard in August 2008 and provides technical services to Shanghai EaseNet.
As a result of these contractual arrangements, we bear the risks of, and enjoy the rewards associated with, and therefore are the primary
beneficiary of these entities. We therefore consolidate the results of operations of these entities and their subsidiaries in our consolidated financial
statements. See also Item 5 “Operating and Financial Review and Prospects.”
Any violations by our VIEs of our agreements with them could disrupt our operations or adversely affect our services. See Item 3.D. “Risk
Factors” for a detailed discussion of the risks to NetEase, Inc. regarding its dependency on these companies.
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The diagram below shows our significant subsidiaries, as that term is defined under Section 1-02 of Regulation S-X under the Securities Act,
and certain other subsidiaries and VIEs as of April 1, 2021, other than our joint venture with Blizzard, which is described separately in this section.
(1) Hangzhou NetEase Leihuo Technology Co., Ltd. is owned by two of our employees.
(2) Each of Guangzhou NetEase Computer System Co., Ltd and Hangzhou Ledu Technology Co., Ltd. is 99.0% owned by William Lei Ding, our
founder, Chief Executive Officer and director, and 1.0% by two of our employees, respectively. Our indirect, wholly owned subsidiary NetEase
Information Technology (Beijing) Co., Ltd. is also a party to certain contractual arrangements with Guangzhou NetEase Computer System Co., Ltd.
(3) Beijing NetEase Youdao Computer System Co., Ltd. is 71.1% owned by William Lei Ding and 28.9% owned by the chief executive officer of
Youdao, Inc.
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OUR SERVICES
We have a successful online game business, developing and operating a rich portfolio of highly popular titles. We currently offer over 140
mobile and PC games across a wide range of genres, satisfying the ever growing and diversifying needs of the gamer community. Leveraging our user
insights and execution expertise, we have also incubated and developed in-house a pipeline of innovative and successful businesses, including intelligent
learning and other businesses, ranging from music streaming and private label e-commerce to internet media, e- mail service and others. For a breakdown
of total revenue by segment for the last three financial years, see Item 5.A. “Operating and Financial Review and Prospectus—Operating Results.”
Online Game Services
Our Games
Our game products and services are comprised of in-house developed mobile and PC games as well as games licensed from renowned global
developers. As a global early mover that anticipated and captured the trend toward mobile games, we have significantly expanded our portfolio of mobile
game offerings in recent years. At the same time, our flagship titles continue to provide solid support for our online games business with persistent
longevity and user loyalty. In addition, while solidifying our leadership position in the Chinese domestic market, we have also expanded globally with
launches in Japan, Southeast Asia, the United States and other international markets.
Our Game Library
Mobile games
Mobile games have gained increasing popularity and an expanding user base as internet users in China and across the world rely more and more
on mobile devices to access the internet. We are one of the largest mobile game providers globally in terms of game revenue, having commercially
launched over 100 mobile games of various genres as of December 31, 2020, including in-house developed and licensed MMORPGs, collectible card
games, or CCGs, first-person shooter games, battle arena games, and simulation games, or SLGs. We generate our mobile games revenue primarily from
the sale of in-game virtual items within the games, and such revenue accounted for 71.9% of our net revenues from online game services in 2020.
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To date, the majority of our most popular mobile games are in-house developed games. We have launched the mobile versions of our in-house
developed flagship MMORPGs, including the Fantasy Westward Journey and Westward Journey Online mobile games. We distribute our mobile games
through partnerships with major Android- and iOS-based application stores in China, as well as our proprietary distribution channels. We offer a variety
of in-game virtual items that players can purchase, including avatars, skills, privileges and other in-game consumables, features and functionalities.
The table below sets forth certain of our major mobile games developed in-house:
Game
Mobile Version of Fantasy Westward Journey II
Fantasy Westward Journey mobile game
Westward Journey Online mobile game
Invincible
The mobile version of New Ghost
Onmyoji
Knives Out
Rules of Survival
All About Jianghu
Onmyoji Arena
Identity V
Ancient Nocturne
Life-After
Fantasy Westward Journey 3D
Onmyoji: The Card Game
Fantasy Westward Journey H5
PC games
Genre
Turn-based MMORPG
Turn-based MMORPG
Turn-based MMORPG
SLG
Real-time MMORPG
CCG & RPG
Battle Arena
Battle Arena
Real-time MMORPG
MOBA
Battle Arena
CCG & RPG
Cooperative Survival RPG
3D MMORPG
CCG
MMORPG
Date of Initial
Launch
July 2013
March 2015
September 2015
October 2015
May 2016
September 2016
November 2017
November 2017
January 2018
January 2018
April 2018
September 2018
November 2018
December 2019
December 2019
June 2020
We launched our first PC based MMORPG, Westward Journey Online, in December 2001. Subsequently, we launched Westward Journey Online
II in August 2002 and our second original PC based MMORPG, Fantasy Westward Journey, in January 2004. Westward Journey Online II and Fantasy
Westward Journey were upgraded to New Westward Journey Online II and Fantasy Westward Journey Online in 2013. Both game series remain popular
with gamers today as a result of continued content updating and innovation in play modes over the past two decades.
PC game players can purchase prepaid points to pay for game playing time, virtual items and other fee-based services that enhance their playing
experience such as special powers, costumes, weapons and other accessories. We regularly introduce new virtual items and other fee-based services, as
well as change the features of virtual items based on player feedback, market trends and other factors.
The table below sets forth our major PC games developed in-house:
Game
New Westward Journey Online II (a comprehensive upgrade
of Westward Journey Online II)
Fantasy Westward Journey Online (previously known as
Fantasy Westward Journey II)
Tianxia III
New Ghost (a new version of Ghost II)
Justice
Genre
Date(s) of Launch and Major Upgrade
2D MMORPG, classical
Chinese setting
2D MMORPG, classical
Chinese setting
3D MMORPG, classical
Chinese setting
2.5D MMORPG, classical
Chinese setting
3D MMORPG, classical
Chinese setting
August 2002
September 2013
January 2004
July 2013
October 2011
April 2012
September 2015
June 2018
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Licensed Games
In addition to our in-house developed mobile and PC games, we also offer games licensed from other international game developers, including
Blizzard and Microsoft. For further details, see Item 4.B. “Business Overview—Our Services—Online Game Services—International Partnership and
Investment.” Revenues from licensed games accounted for 7.5%, 7.5% and 9.1% of our total revenues in 2018, 2019 and 2020, respectively.
Global Presence
We continue to advance our games and make inroads that expand our reach in overseas markets. We have launched more than 50 mobile games
in global markets since 2015. Our mobile game, Knives Out, has remained popular in Japan since its launch in 2017 and topped Japan’s iOS grossing
chart multiple times in 2020. Identity V, which we launched in Japan in 2018, and Life-after, which we launched in Japan in 2019, were also ranked in
Japan’s iOS grossing chart multiple times in 2020, further evidencing our potential to operate a diverse range of games in overseas markets over the long
term.
In addition to our success in Japan, we have expanded our footprint across more regions. In December 2019, we launched MARVEL Super War
in several Southeast Asian markets where it topped many of the iOS download charts. In 2020, we also introduced EVE Echoes and MARVEL Duel to
overseas markets. We have also further enhanced our global R&D capabilities by launching a video game studio in Canada in 2019 and opening up our
Sakura Studio in Japan in 2020.
International Partnership and Investment
Building on our strong in-house content development capabilities, we have formed strategic partnerships and collaborations with world-famous
game studios and content owners. As a leader in online games in China, we have successfully attracted leading international game studios and content
owners with our development and operational capabilities, such as Blizzard, Marvel, Microsoft and Warner Bros. Interactive Entertainment, to co-
develop and/or operate games in China and abroad. In addition, we established a series of IP collaborations with various third parties. We also invest in
leading global studios across the world to strengthen our development capabilities and diversity.
For example, we have been partnering with Blizzard since 2008 to exclusively operate a number of its games in China, including World of
Warcraft, the StarCraft II series, Diablo III, Hearthstone, Heroes of the Storm and Overwatch. Blizzard has also licensed on an exclusive basis in China
its Battle.net® platform to us, which enables multi-player interaction within these games and other online services. In January 2019, we further extended
our partnership to January 2023. Furthermore, we are currently co-developing Diablo ImmortalTM, an MMO action-RPG, with Blizzard. We have also
entered into a partnership with Marvel in May 2019 to create original entertainment content based on internationally beloved Marvel characters and
stories. We are jointly developing products including games and comic books that feature Marvel characters for users in China and beyond.
In addition, in May 2016, we entered into a five-year exclusive agreement with Microsoft, pursuant to which Microsoft agreed to license both
the mobile and PC versions of Minecraft to us for operation in China until 2022. In May 2019, we extended the term of the Minecraft license for an
additional year to August 2023. We successfully introduced both versions of Minecraft in China across various platforms in 2017.
We continue to establish and deepen collaboration with other leading international game studios, including entering into a joint development
agreement with Codemasters, a leading UK game studio focusing on racing games, as well as making minority investments in Bungie, an independent
game studio in the United States, Quantic Dream, an independent game studio based in Paris, and Behaviour Interactive Inc., Canada’s leading
independent game studio.
Game Design and Development
Building upon the success of our classic titles, we have accumulated a better and deeper understanding of our users in terms of their interests
and preferences in style, aesthetics and gameplay. We have integrated our experience and know-how into the design of our new games, enhancing our
ability to deliver popular titles to users. We have established multiple studios of game developers to research and develop new games and expansion
packs.
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Our Franchises
We continue to build upon existing successful games to offer multi-dimensional content by leveraging our in-house developed franchises and
intellectual property. Our Fantasy Westward Journey and Westward Journey Online franchises remain popular and have been instilled in the collective
memory of a generation of Chinese players. We further expanded the reach of these franchises through the introduction of Fantasy Westward Journey 3D
and Fantasy Westward Journey H5 in 2019 and 2020, respectively, captivating both returning fans and new players.
In addition to growing and strengthening our existing franchise, we have continually incubated new ideas and delivered new and long- lasting
game titles to our users. For example, Onmyoji is one of our younger franchises built in-house. As we introduce more innovative new storylines,
characters and other content, the influence of Onmyoji’s IP continues to grow and resonate with more game players. Onmyoji topped the China iOS
grossing chart multiple times during 2019 after more than three years of operation, and it has spun off three mobile games in MOBA, card and simulation
genres, been adapted into a feature motion picture, a musical, a network series and inspired some themed coffee shops. Another in-house developed
young IP is Identity V, which we believe has the potential to become another successful NetEase franchise. We are continually enriching this IP through a
variety of initiatives, including e-sports, game collaborations and off-line activities. We have hosted a number of high-profile events featuring Identity V,
including both international and regional series tournaments.
The prerequisite to building a successful franchise is the ability to create popular game IPs in-house, which is propelled by our strong R&D
capabilities. Over the past two decades, we have built a large in-house R&D team with talented and passionate game creators. We empower each of our
talent with our game-enthusiastic corporate culture and our carefully-designed training program. For more description on our R&D capabilities, see Item
4.B. “Business Overview—Our Services—Online Game Services—Game R&D and Technologies.”
Content Quality and User Experience
We focus on providing an innovative and superior user experience in game design and development and strive to make games of the highest
quality. From the initial proposal to final launch, our games will typically go through a number of carefully designed steps including market research,
proposal, demo, repeated prototype review and beta testing to ensure that the best quality and user experience can be delivered to our players.
In addition to creating a highly realistic and immersive gaming experience through the use of advanced technologies, we also employ innovative
gamification thinking that takes into consideration both the in-game and out-of-game user experience. We have also launched offline gaming experience
stores to allow for dynamic and spontaneous offline interactions among game players, as well as create an offline user feedback channel.
Game R&D and Technologies
Our consistent and significant investment in innovative game research and development is a key contributor to the success of our online game
business and has been widely recognized in the games industry. In 2019, we were awarded the “Top Ten Game Research and Development Companies in
China” award by the China Audio-video and Digital Publishing Association.
Our Proprietary Game R&D Capabilities
Proprietary R&D is the key focus of our game business. We continually strengthen and upgrade our game R&D infrastructure through recruiting
and cultivating top talent, optimizing our game production pipeline, and fostering a culture of creativity and innovation. We have founded a number of in-
house research institutions to explore the application of various technologies in games.
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We strive to recruit and grow the best talent in the industry. Our training programs at NetEase Games Academy are widely recognized in China
as a premier online games training institution for creative minds. One of our training programs was awarded the 2020 ATD Excellence in Practice
Awards by the Association for Talent Development, one of the most authoritative international awards in the global talent development industry. In
addition, we also established our in-house game AI research institutions to focus on the researching big data, user persona, reinforcement learning,
computer vision and graphics, natural language processing, speech synthesis and music generation. Having built a virtuous cycle among our talent,
established development pipeline and dynamic culture of innovation and craftsmanship, our strong R&D capabilities continue to enable high-quality
production and expansion of successful games.
Key Game Technologies
Our game R&D is centered around using technologies to deliver a superior and differentiated user experience. The key areas of our proprietary
game technologies include:
Proprietary game engines: In addition to game development, we have continually invested in proprietary game engine R&D. Since the initial
launch of our first game engine, NeoX, in 2005, we have continually expanded and optimized our proprietary engines to systematically support enhanced
game features and aesthetics. As part of our early strategy to focus on mobile games, we successfully adapted NeoX to iOS and Android systems as well
as developed Messiah, a 3D game engine specifically designed for mobile platforms. We believe that our R&D in game engines and games reinforces
each other and promotes a virtuous cycle of innovation. NeoX and Messiah enable us to systematically develop mobile games with the highest quality in
lighting, audio, special effects, physics and animation, and other key game features, while our drive for better games in turn motivates development of
more powerful engines.
User profile analytics: We perform an in-depth analysis of our users profile by analyzing activities and performances in games, in-game
purchasing preferences and other data and information with artificial intelligence, or AI technologies. We leverage our user data on an aggregate basis to
guide game development and upgrades, marketing and other activities.
Intelligent non-player characters (NPCs): Enabled by deep learning technology, we have created intelligent NPCs that can join players’ in-game
activities, simulate real-life interactions, facial expressions and body language and enable a more engaging gaming experience. We also deploy multiple
reinforcement learning technologies to produce NPCs with diverse styles and difficulty levels, catering to a wide range of player preferences.
Natural language processing (NLP): We apply NLP technology in our games to enable players to develop their own storyline by carrying out
conversations with NPCs and explore hidden elements in the game, creating an immersive gaming experience for players.
Advanced game graphics: Our advanced game graphics enable game players to create unique characters with customized facial features. We
also offer automatic character customization based on real-life photographs uploaded by players. In addition, we deploy high-quality 3D game graphics
and automatic scene generation in our games.
Intelligent Learning Services – Youdao
Youdao’s Products and Services
Youdao is an intelligent learning company in China with over 120 million MAUs in 2020 and operates in a number of overseas markets. We
founded Youdao in 2006 and launched the flagship Youdao Dictionary in 2007, which remains the top language app in China in terms of MAUs. Youdao
experienced rapid growth since its founding and completed its public listing on the New York Stock Exchange in October 2019.
Building on the early success of Youdao Dictionary, we have attracted a massive user base, built a strong brand, and expanded into a broad
range of products and services addressing lifelong learning needs of pre-school, K-12 and college students as well as adult learners, including online
learning services and smart devices. Our smart devices seamlessly integrate advance AI algorithms and data analytics which supplement our online
courses and learning products and further enhance user experience and efficiency.
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We currently generate the majority of the revenues for Youdao’s learning services from its online courses in the form of the tuition fees received
from students. We generate revenues of Youdao’s learning products from sales of smart devices and revenues from Youdao’s online marketing services
through the provision of different formats of advertisements.
Online Courses. We have developed a comprehensive offering of online courses catering to the diverse learning needs of different age groups.
Our online course offerings currently consist of Youdao Premium Courses, NetEase Cloud Classroom and China University MOOC.
Interactive Learning Apps. We offer a wide range of interactive learning apps to nearly all age groups. We are committed to delivering a fun and
effective learning experience across these apps through an abundance of gamified features, as well as social functions allowing users and students to
share their learning progress with friends through social media. Our current key interactive learning apps include Youdao Math, Youdao Fun Reading,
and Youdao Vocabulary Builder.
Enterprise Services. We offer Youdao Smart Cloud, a cloud-based platform that allows third-party app developers, smart device brands and
manufacturers to access our advanced optical character recognition (OCR) capability and neural machine translation (NMT) engine and incorporate them
into their apps, devices, and services through application programming interfaces. We also license our OCR and NMT technologies and solutions to
customers on a non-cloud basis. In addition, in collaboration with the Higher Education Press, we also provide colleges and universities with a cloud-
based platform for them to build their online course offerings, as well as a range of ancillary technological support services.
Online Knowledge Tools
● Youdao Dictionary. Launched in 2007, Youdao Dictionary is our first major product and flagship online language tool. Today, it remains
China’s most popular and trusted online dictionary and translation tool with 52 million average MAUs in 2020. As of December 31, 2020,
Youdao Dictionary offered over 31 million entries across 109 languages.
● Other Online Dictionary and Translation Tools. In addition to Youdao Dictionary, we also offer Youdao Translation, a tool specifically
designed to support translation needs of business and leisure travelers across over 31 languages via camera and speech translation, U-
Dictionary, an online dictionary and translation app we offer in Indonesia and other overseas markets, and Youdao Kids’ Dictionary, a K-12
focused smart and fun tool that offers translation services in Chinese and English.
Smart Devices
We develop and offer smart devices, including Youdao Dictionary Pen, Youdao Super Dictionary, Youdao Smart Pen, Youdao Pocket Translator,
and Youdao Cloud Pen, to make learning more productive and efficient for our users. Our smart devices are developed and designed by us or in
collaboration with third parties, while the manufacturing of such devices is outsourced to third-party manufacturers under original equipment
manufacturer agreements.
Technology-driven Learning Experience
We integrate technologies into every major aspect of the learning and teaching process to ensure a superb learning experience across Youdao’s
products and services. Over the years, we have built proprietary OCR, NMT, language data mining and voice recognition technologies and data analytics
that serve as the foundation to our products and services. Such technologies are iteratively refined based on the vast data generated by our users.
For example, we offer a set of advanced AI-based technologies to make learning more personalized and efficient while maintaining a high level
of human touch. We have also built massive “knowledge graphs” depicting different knowledge points, concepts and learning objectives, supported by a
large quiz bank curated by our course development professionals to help students understand the subject matter. In addition, we have adopted an adaptive
learning approach which tracks each student’s learning progress and dynamically adapts teaching to the student’s unique learning needs. We collect
student learning and behavior data throughout their learning cycles to help us understand their learning progress and predict through our adaptive
learning model how they will perform to achieve future learning objectives.
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We also offer a seamless online and offline hybrid learning experience through the use of our smart devices. We encourage students to use our
Youdao Smart Pen, which automatically converts the student’s handwriting into data that is synced up with our systems, allowing the student to view
automatic grading results of exercises completed, correct answers and explanations, and suggested exercises to reinforce what is learnt, in almost real
time. This has significantly improved our students’ learning efficiency and allowed us to deepen our insights into our students’ learning progress.
Other Innovative Business and Services
We derive our innovative businesses and others revenues primarily from NetEase Cloud Music, Yanxuan, NetEase CC Live streaming,
advertising services, premium e-mail and other value-added services.
NetEase Cloud Music
We launched the NetEase Cloud Music streaming platform in April 2013. Since then, NetEase Cloud Music has focused on delivering a
differentiated and premium listening experience in terms of the quality and variety of music offered. Its pursuit of offering an excellent user experience
has led to a highly loyal and active user base.
NetEase Cloud Music is home to a large number of independent musicians. We focus on discovering and promoting rising artists with big data
analytics. In addition, we offer musicians tools and solutions to promote and monetize their work.
We also diversify and further enrich our music offerings with licensed and sub-licensed content. NetEase Cloud Music operates under a
freemium business model in which basic services are free while some enhanced features are available on a paid basis. In addition to providing the main
music playback, download and search services, we also provide music social functions, such as song reviews, song list recommendations based on
historical playback records.
In 2019, we also added a new community module, Cloud Village, to further develop a music community that fosters discussion, creation and
sharing of personalized expression around music. We launched a music-inspired live streaming app, LOOK in 2018 to provide an additional platform for
independent musicians and other performers to showcase their music talents and interact directly with their audience. Fans can leave comments and send
virtual gifts to broadcasters while they perform live. In early 2020, we hosted an online music festival where more than 50 artists live streamed their
performances to a massive audience across China. In our newly launched Cloud Music version 8.0, we focused on bringing our young users elevated
personalized experiences to express themselves. We also extended the playlist mode’s capabilities to videos and podcasts and offered new Karaoke
functions.
Yanxuan
Our e-commerce platform, Yanxuan, primarily sells our private label products, including consumer electronics, food, apparel, homeware,
kitchenware and other general merchandise which we primarily source from original design manufacturers, or ODMs, in China. With its slogan Quality
Products, for Quality Life, Yanxuan is dedicated to helping consumers build a quality yet affordable life by providing selected daily life products with
outstanding quality and design.
Under Yanxuan’s ODM model, it establishes close partnerships with selected manufacturers in China to design and manufacture products and
sells them directly to customers. The ODM model enables Yanxuan to provide quality goods with lower cost by eliminating brand premium and channel
intermediaries such as distributors and retailers. It also utilizes data analytics to help these suppliers enhance their efficiency and product appeal,
particularly in terms of merchandise design and production. In addition to the online platform, we have also opened several offline stores in Hangzhou
and Shanghai, inviting more consumers to discover the popular items on our Yanxuan through experiential retail.
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Other Innovative Services
We also offer a wide range of other innovative services, including NetEase Media which is a well-established internet media platform in China
delivering professional news and other quality information such as popular sports events, industry forums, celebrity close-ups, technology and fashion
trends, and online entertainment to our users. Our media platform has three components, the NetEase News mobile application, www.163.com portal and
a set of other vertical mobile products. It offers numerous features that promote user interactions and foster a vibrant online user community who
actively contribute to the commentary sections. Our drive for journalistic integrity and high-quality content offerings has enabled us to attract an
attractive demographic of engaged users. Our portal www.163.com also serves as a one-stop gateway for users to conveniently access our other online
services, such as online games, e-mail, e-commerce, video and music streaming, e-reading and a set of other websites and mobile applications.
Other innovative businesses also include NetEase CC Live streaming, a platform offering various live streaming content with a primary focus on
game broadcasting, and NetEase Pay, our payment platform. In addition, we offer free and fee-based email services through NetEase Mail, China’s
leading email service provider since 1997.
TECHNOLOGIES AND IT INFRASTRUCTURE
As one of the inaugural class of internet platforms and one of the first to provide e-mail services to the masses in China, we have consistently
prioritized investing in technologies since our inception. With our strong R&D capabilities and advanced technologies, we successfully digitalized
traditional offline services, such as music and learning, and significantly transformed entertainment, learning and other activities. We focus on exploring
viable applications of cutting-edge technologies to meaningfully enhance our service offerings and deliver a superior experience for our users.
Empowered by advanced AI, big data analytics and other core proprietary technologies, we deliver engaging content and services that are highly
individualized and personalized across our businesses.
AI and Machine Learning
Our powerful AI and machine learning capabilities enable us to effectively process ultra-large-scale data generated from across our services and
products, optimize recommendations, personalize offerings and predict user behavior. Our key AI and machine learning capabilities include:
● Industry-leading technologies focusing on user experience: Based on the vast text, pictures, audio and video content generated by our users, we have
developed advanced technologies such as natural language processing, automatic speech recognition (ASR) and text-to-speech (TTS) technologies
that enable us to deliver an enjoyable and effective user experience.
● AI-powered applications, such as content recommendation and customization: We are a leader in developing and adopting AI technologies in content
recommendation and customization, which enables us to achieve greater user engagement and stickiness.
Big-Data Analytics
We take a holistic approach to big data innovation, with a focus on gaining deeper understanding of our users in order to provide better services,
products and experience. Building on technologies that can process and analyze bulk data generated by millions of users instantaneously, our platform
adopts a service-oriented architecture that allows easy up-scaling and frequent upgrading of the products. Our key data analytics capabilities include:
● Scale: We have accumulated a massive user base and vast and complex user data across our online games, intelligent learning, music and media
businesses. The data generated every day not only provides us with high-quality profile information, but also contains a large amount of user-
generated content and interactions, including text, images, audio and video. We maintain a high standard of data protection and privacy while
productively using our data to inform our business operations and development.
● High-value data: Content, relationships and behavioral data based on user activities and interactions enable us to create more accurate user profiles.
Based on this data, we can be more intuitive and comprehensive in reflecting user interests and preferences, and provide valuable user reference data
for a wide spectrum of R&D, marketing, user engagement and other strategic initiatives.
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● Leading data analytical technology: Our big data analytical capability enables comprehensive analysis of services and products offered and timely
adjustments.
Graphics, Augmented Reality and Virtual Reality
We have developed numerous technologies to create immersive and effective entertainment and learning experiences. In addition to creating
quality 3D game graphics and automatic scene generations in games, we have launched and will continue to launch our virtual reality (VR) games to
offer game players a lifelike, free and dynamic open world game experience. Outside of games, NetEase Cloud Music has also leveraged augmented
reality in its marketing and user engagement activities.
IT Infrastructure
Our infrastructure and technology have been designed for reliability, scalability and flexibility and are administered by our technical staff. Our
NetEase websites and other online and mobile platforms are made available primarily through network servers co-located in the facilities of China
Telecom’s affiliates, China Unicom’s affiliates and China Mobile’s affiliates. As of December 31, 2020, there were approximately 112,000 of such co-
located servers, including servers supporting the operation of the games licensed to Shanghai EaseNet by Blizzard, using leased dedicated lines mainly
from various affiliates of China Telecom, China Unicom and China Mobile. We also utilize certain cloud-based servers maintained by third parties such
as Amazon.
In addition, we have developed our own systems to facilitate sales planning, targeting, trafficking, inventory management and reporting tools,
such as advertisement tracking systems for our advertising services.
We have also established a comprehensive user profile system, which we monitor and review on a regular basis. We also deploy a single sign-on
system that allows users to easily access our services offered through the various NetEase products. We intend to continue to use a combination of
internally developed software products as well as third-party products to enhance our products and services in the future.
SALES AND MARKETING
We employ a variety of online and traditional sales and marketing programs and promotional activities to build our brand as part of our overall
marketing strategy. We focus on building brand awareness through online marketing campaigns, proactive public relations and other offline advertising.
We invest in a series of marketing activities to further strengthen our brand image and continue to grow our user base, including collaborating with
leading social media, video and live streaming platforms, TV, movie and stage production companies as well as book and comic publishers to extend our
brand to a broader potential user group.
Online Game Services
Our mobile games are available on the Apple app store for iOS and third-party Android app stores. In addition, to leverage our existing user
bases, we also publish our mobile games through our own internet properties. We conduct in-game marketing campaigns in connection with special
holiday editions or launches of new games or expansion packs throughout the year. We have also promoted our games in collaboration with online and
offline third-party promoters.
Youdao
Youdao generates user traffic and leads primarily from online channels. As a key sales and marketing strategy, Youdao cross-sells its
comprehensive portfolio of products and services, which allows it to effectively scale its business with modest traffic acquisition and marketing spending.
In addition, Youdao also employs mobile marketing, such as brand advertisements and marketing campaigns on app stores, leading mobile news apps and
social media platforms, as well as through optimization techniques designed to improve its ranking in popular search engines’ results. Youdao also
engages in offline marketing and branding to supplement its overall sales and marketing strategies.
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Innovative Businesses and Others
For our innovative businesses and other online services, content and services are generally provided through mobile applications or their
respective websites. Users purchase our services either at a pre-determined package rate or on an item-based basis, and payments are made using third-
party online payment platforms or NetEase Pay. We attract users through a variety of channels, such as our sponsored searches, social and online
advertising, internet video and television advertising and other advertising channels. We also offer our customers special pricing discounts in connection
with promotion activities and strive to expand our products selection to attract more visitors. Advertising services are conducted through our dedicated
advertising services sales force, or through online advertising sales networks and advertising agencies.
INTELLECTUAL PROPERTY
We rely on a combination of copyright, trademark, patent and trade secrecy laws and contractual restrictions on disclosure to protect our
intellectual property rights. We require our employees to enter into agreements requiring them to keep confidential all information relating to our
customers, methods, business and trade secrets during and after their employment with us. Our employees are required to acknowledge and recognize
that all inventions, trade secrets, works of authorship, developments and other processes, whether or not patentable or copyrightable, made by them
during their employment are our property. They also sign all necessary documents to substantiate our sole and exclusive right to those works and to
transfer any ownership that they may claim in those works to us.
We have registered a number of domain names. We have also successfully registered numerous trademarks with China’s Trademark Office,
including marks incorporating the words “NetEase” and “Yeah!” in English and for marks for “NetEase” as written in Chinese in traditional and
simplified Chinese characters. In addition, we have registered trademarks involving Chinese characters and phrases that have meanings relating to our
web pages, products and services, including our online games, intelligent learning services, online music services, chat services, e-commerce and certain
other online services. In addition, we have registered a number of trademarks involving the “NetEase” name as well as the names and logos of our
products and services in the United States, the European Union, the Republic of Korea, Japan, Hong Kong, Macau, Taiwan, Thailand and other
jurisdictions.
In addition, we have registered our various in-house developed games and other online products with the National Copyright Protection Center
of China. Moreover, we have filed certain patent applications with the National Intellectual Property Administration of China, U.S. Patent and Trademark
Office, European Patent Office and Japan Patent Office, and have obtained Certificates of Design Patent, Utility Model Patent and/or Invention Patent for
technologies related to our games, live video, news, educational products, e-commerce and finance, NetEase Cloud Music, hardware products, cloud
technology, augmented reality technology, computer technology and e-mail from the National Intellectual Property Administration of China, as well as
Certificates of Utility Patent and Certificates of Design Patent in the United States, Europe and Japan.
In addition, Youdao owns the intellectual property relating to in-house developed content used on its platform and the registrations of the core
trademarks “Youdao.” We also own the intellectual property (other than the content) relating to the NetEase websites and other online and mobile
platforms, and the technology that enables online community, personalization, online games, news sharing, instant messaging, video streaming, NetEase
Cloud Music, Yanxuan and other services on those platforms. We license content from various freelance providers and other content providers.
While we actively take steps to protect our proprietary rights, such steps may not be adequate to prevent the infringement or misappropriation of
our intellectual property. See Item 3.D. “Risk Factors—Risks Related to doing business in China—We may not be able to adequately protect our
intellectual property, and we may be exposed to infringement claims by third parties.”
COMPETITION
Our competition primarily comes from global online game developers and operators, such as Tencent, established online and offline education
service providers in China, as well as leading digital media and entertainment providers. Some of our current and potential competitors are larger than we
are, and currently offer, and could further develop or acquire, content and services that compete with us. The areas in which we compete primarily
include:
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User traffic, time and spending. We compete to attract, engage and retain users based on the design, quality, popularity and efficacy of our
content offerings, the overall user experience of our products and services, as well as the effectiveness of our marketing activities.
Talent. We compete for motivated and capable talent, including engineers, game designers, product developers and creative professionals to
build compelling content, tools and functions.
Global collaboration opportunities. We compete to win collaboration relationships with well-known global IP and content owners based on our
level of expertise in systematically developing in-house developed games, delivering a compelling user experience through operational knowhow and
customizing established game titles for rapid expansion into overseas markets.
There can be no assurance that we will be able to compete successfully against our current or future competitors or that competition will not
have a material adverse effect on our business, results of operations and financial condition.
CORPORATE SOCIAL RESPONSIBILITY
Since our founding, we have been highly committed to environmental, social and corporate responsibility matters. Through our product and
service offerings, we aim to improve people’s lives by leveraging technologies to offer innovative services such as online games, intelligent learning and
music streaming. Aspiring to make high-quality education and learning services accessible to everyone, we have been making headway in improving and
promoting online and live-streamed courses, which make it possible for users in less-developed regions in China to access quality and diverse
educational resources. In 2020, we donated hardware, software and high-quality learning content to schools in Hunan province, enabling over 12,000
students to have access to online courses.
Furthermore, our Cloud Music platform has become an important avenue for raising awareness of social issues, such as animal protection and
children’s wellbeing, through its music and fund-raising campaigns. Yanxuan has also leveraged its business platform to help local artisans and
merchants sell their products in a bid to contribute to China’s poverty reduction efforts. Moreover, our games have demonstrated their social value by
providing platforms for users to collaborate, contribute ideas, raise awareness of social issues and promote science popularization. For example, students
rebuilt their campuses in Minecraft and held virtual graduation ceremonies, despite school closures related to COVID-19. Fantasy Westward Journey
mobile games collaborated with WildAid to bring public attention to the protection of wild animals. In addition, we have developed game modes to
educate users on cybersecurity awareness. We have also partnered with organizations to use our anime characters to educate the public on the prevention
of respiratory diseases.
In addition, we stand out in our commitment to equality and diversity in our recruitment and promotion policies. We are included in the
Bloomberg Gender-Equality Index’s 2020 global list of 325 public companies that are committed to gender equality in the workplace, an accolade that
we are enormously proud of. We also value diversity highly and currently have employees from more than 30 countries and regions, including the United
States, Japan, South Korea and Canada. We empower each of our talent with our carefully-designed training program. One of our training programs were
awarded the “2020 ATD Excellence in Practice Awards” by the Association for Talent Development, one of the most authoritative international awards in
the global talent development industry.
Given that the majority of our operations are conducted online, we leave limited impact on the environment with a small carbon footprint. We
are committed to carbon mitigation measures and will continue to explore ways to further improve energy efficiency. All our servers are compliant with
industry energy efficiency standards in China, and we intentionally choose partners with a strong commitment to carbon emission reduction in our
collaboration with third-party cloud servers.
RISK MANAGEMENT AND INTERNAL CONTROL
We have devoted ourselves to establishing and maintaining risk management and internal control systems consisting of policies and procedures
that we consider to be appropriate for our business operations, and we are dedicated to continuously improving these systems.
We have adopted and implemented comprehensive risk management policies in various aspects of our business operations, such as financial
reporting, information system, internal control, human resources and investment management.
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Financial reporting risk management
We have in place a set of accounting policies in connection with our financial reporting risk management, such as financial reporting
management policies, budget management policies, treasury management policies, financial statements preparation policies and finance department and
staff management policies. We have various procedures and IT systems in place to implement our accounting policies, and our finance department
reviews our management accounts based on such procedures. We also provide regular training to our finance department employees to ensure that they
understand our financial management and accounting policies and implement them in our daily operations.
Information system risk management
Sufficient maintenance, storage and protection of user data and other related information is critical to our business. We have implemented
various internal procedures and controls to ensure that user data is protected and that leakage and loss of such data is avoided.
We believe it is crucial that our users understand how we handle their information so that they can make informed choices in deciding how such
information is used and shared. To this end, we collect personal information and data from users only with their prior consent, and we offer our users opt-
out or opt-in options. We have established and implemented a strict companywide policy on data collection, usage, disclosure, transfer and storage. In
accordance with our policy, we are required to go through the following procedures: (i) providing notice to users as to why and how their data is being
collected and used; (ii) providing users with the choice to opt-out or opt-in; (iii) making continuous efforts to prevent loss or leakage of user data; and
(iv) providing users with access to their own personal information collected by us.
We have implemented a network of process and software controls to protect individual personal information and privacy. We encrypt user data
in network transmission. For back-end storage, we also use various encryption technologies at software and hardware levels to protect sensitive user data.
To minimize the risk of data loss or leakage, we conduct regular data backup and data recovery tests.
We prioritize user data security and privacy by strictly following our defined policy. We have obtained the certificates of ISO 27001 and filing
certificates of Classified Protection of Information Security for some of our entities and products. We have established a coordination mechanism with
third-party agencies to handle information security threats in a timely manner.
At the enterprise level, we established a systematic and universal user account authorization and management mechanism based on which we
periodically review the status of user accounts and the related authorization information. We regularly perform security configuration assessment on our
databases and servers and implement procedures for system log management.
We have put in place a series of back-up management procedures. We deploy different back-up mechanisms, including local back-ups and
offsite back-ups, depending on the needs of our business, to minimize the risk of user data loss or leakage. We have also established protocols for the
design, implementation and monitoring of offsite back-ups. We also require any access to or processing of user data to go through strict assessment and
approval procedures in order to ensure that only valid and legitimate requests are executed.
We provide information security training to our employees and conduct ongoing trainings, and we discuss any issues or necessary updates from
time to time. We also have an emergency response mechanism to evaluate critical risks, formulate disaster response plans and perform emergency drills
on a regular basis. In addition, each of our business units is responsible for ensuring that the usage, maintenance and protection of user data are in
compliance with our internal information security policy and the applicable laws and regulations.
Internal control risk management
We have designed and adopted strict internal procedures to ensure the compliance of our business operations with the relevant rules and
regulations. Our internal control team works closely with our legal, compliance and finance departments as well as our business units to: (a) perform risk
assessments and give advice on risk management strategies; (b) improve business process efficiency and monitor internal control effectiveness; and (c)
promote risk awareness throughout our Company.
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In accordance with our internal procedures, our in-house legal department performs the basic function of reviewing and updating the form of
contracts we enter into with our consumers, merchants and relevant third-parties. Our legal department examines the contract terms and reviews relevant
documents for our business operations, and the necessary underlying due diligence materials, before we enter into any contract or business arrangements.
Our in-house legal department reviews our services for regulatory compliance before they are made available to the general public. Our in-house
legal department works with relevant business units to obtain requisite governmental approvals or consents, including preparing and submitting all
necessary documents for filing with relevant government authorities within the prescribed regulatory timelines.
We continually review the implementation of our risk management policies and measures to ensure our policies and implementation are
effective and sufficient.
Human resources risk management
We provide regular and specialized training tailored to: (a) the needs of our employees in different departments, and (b) our anti-bribery &
corruption policy. We regularly organize internal training sessions conducted by senior employees or outside consultants.
We have in place an employee handbook and a code of conduct approved by our management and have distributed them to all our employees.
The handbook contains internal rules and guidelines regarding work ethics, fraud prevention mechanisms, negligence and corruption. We provide
employees with regular training as well as resources to explain the guidelines contained in the employee handbook.
We have in place an anti-bribery and corruption policy to safeguard against any corruption within our Company. The policy explains potential
bribery and corruption conduct and our anti-bribery and corruption measures. We make our internal reporting channel open and available for our staff to
report any bribery and corruption acts, and our staff can also make anonymous reports to our ethics committee. Our ethics committee is responsible for
investigating the reported incidents and taking appropriate measures.
Investment risk management
We invest in or acquire businesses that are complementary to our business, such as businesses that can expand the services we offer and
strengthen our R&D capabilities.
In general, we intend to hold our investments for the long term. In order to protect our interests as shareholders and control the potential risks
associated with our investments, we generally request our investee companies to grant us customary investor protective rights.
Our finance department monitors the deal performance on a regular basis. Our finance and legal departments cooperate with deal team on deal
analysis, communication, execution, risk control and reporting. Any material factors will be timely reported to the senior management or board of
director for further decision.
Audit committee experience and qualification and board oversight
We have established an audit committee to monitor the implementation of our risk management policies across our company on an ongoing
basis to ensure that our internal control system is effective in identifying, managing and mitigating risks involved in our business operations.
The audit committee consists of three members, namely Michael Leung, Alice Cheng and Joseph Tong, all of whom are independent non-
executive directors. Michael Leung is the chairperson of the audit committee. For the professional qualifications and experiences of the members of our
audit committee, see “Directors and Senior Management.”
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We also maintain an internal audit department which is responsible for reviewing the effectiveness of internal controls and reporting to the audit
committee and senior management on any issues identified. Our internal audit department members hold regular meetings with management to discuss
any internal control issues we face and the corresponding measures to implement toward resolving such issues. The internal audit department reports to
the audit committee to ensure that any major issues identified are channeled to the committee on a timely basis. The audit committee then discusses the
issues and reports to the board of directors, if necessary.
Ongoing measures to monitor the implementation of risk management policies
Our audit committee, internal audit department and senior management together monitor the implementation of our risk management policies on
an ongoing basis to ensure our policies and implementation are effective and sufficient.
INSURANCE
We consider our insurance coverage to be adequate as we have in place all the mandatory insurance policies required by Chinese laws and
regulations and in accordance with the commercial practices in our industry. Our employee-related insurance consists of pension insurance, maternity
insurance, unemployment insurance, work-related injury insurance, medical insurance and housing funds, as required by Chinese laws and regulations.
We also purchase supplemental commercial medical insurance and accident insurance for our employees.
In line with general market practice, we do not maintain any business interruption insurance or product liability insurance, which are not
mandatory under PRC laws. We do not maintain key person life insurance, insurance policies covering damages to our network infrastructures or
information technology systems. We carry property insurance with low coverage limits that may not be adequate to compensate us for all losses,
particularly with respect to loss of business and reputation that may occur. We also do not maintain insurance policies against risks relating to the
Contractual Arrangements. In 2020, we did not make any material insurance claims in relation to our business.
GOVERNMENT REGULATIONS
Regulations on Foreign Investment
On March 15, 2019, the National People’s Congress promulgated the 2019 PRC Foreign Investment Law, which became effective on January 1,
2020, and replaced the Wholly Foreign-owned Enterprises Law, the Sino-foreign Equity Joint Ventures Law, and the Sino-foreign Cooperative Joint
Ventures Law. Investment activities in the PRC by foreign investors are principally governed by the Catalogue of Industries for Encouraging Foreign
Investment, or the Encouraging Catalogue, and the Special Management Measures (Negative List) for the Access of Foreign Investment, or the Negative
List, both of which were promulgated and are amended from time to time by the MOFCOM, and the NDRC. The Encouraging Catalogue and the
Negative List lay out the basic framework for foreign investment in China, classifying businesses into three categories with regard to foreign investment:
“encourage”, “restricted” and “prohibited”. Industries not listed in the Encouraging Catalogue and the Negative List are generally deemed as falling into
a fourth category “permitted” unless specifically restricted by other PRC laws. On December 27, 2020, MOFCOM and the NDRC released the Catalog of
Industries for Encouraging Foreign Investment (2020 Version), which became effective on January 27, 2021, to replace the previous Encouraging
Catalogue. On June 23, 2020, MOFCOM and the NDRC released the Special Management Measures (Negative List) for the Access of Foreign
Investment (2020 Version), which became effective on July 23, 2020, to replace the previous 2019 Negative List. To comply with the above foreign
investment restrictions and to obtain necessary licenses and permits in industries that are currently subject to foreign investment restrictions in China, we
operate in China through our variable interest entities. See Item 4.B. “Business Overview—Our Organizational Structure.” There remain substantial
uncertainties with respect to the interpretation and application of existing or future PRC laws and regulations on foreign investment. See Item 3.D. “Risk
Factors—Risks Related to Our Corporate Structure.”
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According to the 2019 PRC Foreign Investment Law, foreign investment shall enjoy “pre-entry national treatment,” which generally means that
at an investment-entrance stage, foreign investment should be treated no less favorably than domestic investment, except for foreign investments in
industries deemed to be “restricted” or “prohibited” in the “negative list.” The 2019 PRC Foreign Investment Law provides that foreign invested entities
operating in “restricted” or “prohibited” industries will require entry clearance and other approvals. However, uncertainties still exist when it comes to
interpreting or implementing the 2019 PRC Foreign Investment Law and its implementation rules. For example, the 2019 PRC Foreign Investment Law
does not comment on the concept of “de facto control” or contractual arrangements with variable interest entities. It does, however, have a catch-all
provision under the definition of “foreign investment,” which includes investments made by foreign investors in China through means stipulated by laws
or administrative regulations or other methods prescribed by the State Council. As such, there remains a leeway for future Laws to define contractual
arrangements as a form of “foreign investment.” Furthermore, the 2019 PRC Foreign Investment Law provides that foreign invested enterprises
established according to the existing laws regulating foreign investment may maintain their structure and corporate governance for five years after the
2019 PRC Foreign Investment Law is implemented, which means that foreign invested enterprises may be required to adjust their structure and corporate
governance after five years. For further details, please see Item 3.D. “Risk Factors — Risks Related to Our Corporate Structure.”
On December 26, 2019, the State Council promulgated the Implementation Rules to the Foreign Investment Law, which became effective on
January 1, 2020, and repealed the Provisional Regulations on the Duration of Sino-Foreign Equity Joint Venture, the Regulations on Implementing the
Wholly Foreign-Invested Enterprise Law of the PRC, and the Regulations on Implementing the Sino-Foreign Cooperative Joint Venture Enterprise Law
of the PRC. The implementation rules further clarified and elaborated on the relevant provisions of the 2019 PRC Foreign Investment Law. However,
given that these implementation rules were only recently enacted, a number of uncertainties still exist in relation to the interpretation and implementation
of the 2019 PRC Foreign Investment Law.
On December 30, 2019, the MOFCOM and the SAMR, jointly promulgated the Measures for Information Reporting on Foreign Investment,
which became effective on January 1, 2020. Pursuant to the measures, where a foreign investor directly or indirectly carries out investment activities in
China, the foreign investor or the foreign-invested enterprise must submit the investment information to the competent commerce department for further
handling.
On December 19, 2020, MOFCOM and the NDRC jointly promulgated the Measures for the Security Review of Foreign Investments, which
took effect on January 18, 2021, pursuant to which a security review shall be conducted for foreign investments that affect or may affect national security.
The measures established a working mechanism for the security review of foreign investments, or the Security Review Working Mechanism, to be
responsible for organizing, coordinating and guiding the security review of foreign investments. For foreign investments in material information
technology and internet products and services which relate to national security, the foreign investors who obtain the actual controlling stake in the
investee enterprise in the PRC shall declare to the office of the Security Review Working Mechanism prior to implementation of the investments.
Regulations on Telecommunication Services
In September 2000, China’s State Council promulgated the Telecommunications Regulations of the PRC (the “Telecom Regulations”), which
was revised in February 2016. The Telecom Regulations categorized all telecommunications businesses in China as either a “basic telecommunications
business” or “value-added telecommunications business,” ICP services, e-mail services, and other telecommunications businesses operated by us are
classified as value-added telecommunications businesses. According to the Telecom Regulations, the commercial operator of these services must obtain
an operating license. The Telecom Regulations also set out extensive guidelines with respect to different aspects of telecommunications operations in
China.
On December 28, 2015, MIIT issued the Telecommunication Services Classification Catalog (2015 Edition), which replaced the then-operative
Telecommunication Services Classification Catalog (2003 Edition).The 2015 Catalog took effect on March 1, 2016 and was amended on June 6, 2019.
The Catalog divided the information services business into an additional five sub-categories and reclassified the online data processing and transaction
processing services business from a “basic telecommunications business” to a “value-added telecommunications business.” In 2017, MIIT issued the new
version of the Measures for the Administration of Telecom Business Licensing (the “MIIT Measures 2017),” which became effective on September 1,
2017. Similar to the 2009 version, the MIIT Measures 2017 require companies who are engaged in telecommunications businesses to have a Telecom
Business License. However, the MIIT Measures 2017 removed the previous requirement to file trans-regional value-added telecommunications business
permits.
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In December 2001, in order to comply with China’s commitments with respect to its entry into the WTO, the State Council promulgated the
Regulation for the Administration of Foreign-Invested Telecommunications Enterprises (the “FITE Regulations”), which was last revised in February
2016. The FITE Regulations set out detailed requirements with respect to capitalization, investor qualifications, and application procedures in connection
with establishing a foreign invested telecom enterprise. Pursuant to the FITE Regulations, foreign investors may hold an aggregate of no more than 50%
of the total equity in any value-added telecommunications business in China. The Notice of the MIIT on Removing the Restrictions on Foreign Equity
Ratios in Online Data Processing and Transaction Processing (Operating E-commerce) Business issued by the MIIT in June 2015 set out an exception,
under which, foreign investors may hold up to the entire equity interest in online data processing and transaction processing (operating e-commerce)
businesses. However, the FITE Regulations do not define “online data processing and transaction processing (operating e-commerce) business,” and its
interpretation and enforcement involve significant uncertainties. In addition, the Negative List removes some of the previous restrictions on value-added
telecommunications providers by allowing foreign investors to hold up to the entire equity interest in domestic multi-party communication, e-storage and
forwarding and call center businesses in China. However, other requirements provided by the SAPPRFT and MIIT regulations still apply.
The Circular of the MII on Intensifying the Administration of Foreign Investment in Value-Added Telecommunication Services (the “2006 MII
Circular”), was promulgated by MII on July 13, 2006. The 2006 MII Circular provides that: (i) any domain name used by a valued-added
telecommunications service provider must be legally owned by the service provider or its shareholder(s); (ii) any trademark used by a value-added
telecommunications service provider must be legally owned by the service provider or its shareholder(s); (iii) the operation site and facilities of a value-
added telecommunications service provider must be installed within the scope prescribed by the operating licenses obtained by the service provider and
must correspond to the value-added telecommunications services that the service provider has been approved to provide; and (iv) a value-added
telecommunications service provider must establish or improve the measures of ensuring information security. Companies that have obtained operating
licenses for value-added telecommunications services are required to conduct self-examination and self-correction according to the requirements above
and report their results to MII. To comply with these requirements, Guangzhou NetEase submitted its self-correction report to MII in 2007 and our VIEs
have registered the domain names used by them.
Regulations on Internet Information Services
The Measures for the Administration of Internet Information (the “ICP Measures”), issued by the State Council went into effect on September
25, 2000 and was revised on January 8, 2011. Under the ICP Measures, any entity that provides information to internet users must obtain an operating
license from the MII, or its local branch at the provincial level in accordance with the Regulations on Telecommunication Services described above.
The Provisional Regulations for the Administration of Website Operation of News Publications, which was jointly issued by the SCIO, and MII
on November 6, 2000, stipulates that websites of non-news organizations shall not publish news items produced by themselves, and that their websites
shall be approved by SCIO after securing permission from SCIO at the provincial level. On June 1, 2017, the latest Provisions for the Administration of
Internet News Information Services, promulgated by the CAC, came into effect, which superseded the previous regulations. According to the revised
provisions, to provide internet-based news information services to the public via internet websites, applications, forums, blogs, micro-blogs, public
accounts, instant communication tools and online live-stream, providers must obtain an Internet News Information Service License, issued by the CAC or
a local cyberspace administration. In addition, the provisions prohibit organizations from establishing foreign, partially or wholly owned, entities that
invest or operate internet-based news information services. The CAC and the local cyberspace administrative offices are responsible for the supervision,
management and inspection of internet-based news information services.
In December 2016, the MOC issued the Circular on the Administrative Measures for Business Activities Relating to Online Performance,
pursuant to which an internet platform operator that provides online performance shall: (i) apply for a Network Culture Operation License with the
relevant provincial-level authority; (ii) notify the MOC of any access or performance channels created for domestic performers within ten days; and (iii)
submit an application to the MOC before creating any access or performance channels for foreign performers. On June 19, 2018, the MOCT issued the
National Cultural Market Blacklist Management Measures, which created a public ‘blacklist’ for companies that did not comply with the regulations on
internet culture activities and imposed penalties and credit restrictions for non-compliance.
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In addition, the SAPPRFT issued a Notice on Strengthening the Management of Live-Streaming Service for the Network Audio-visual
Programs in September 2016, pursuant to which an internet live-streaming service provider shall: (i) provide necessary censorship on the content of live-
streams; (ii) establish a mechanism to timely identify unlawful content, prevent any unlawful content from being distributed and replace the content with
backup programs; and (iii) record live-streaming programs and keep the records for at least 60 days. Shortly after this notice, in November 2016, the
CAC promulgated the Administrative Provisions on Internet Live-Streaming Services, pursuant to which an internet live-streaming service provider
shall: (i) establish a live-streaming content review platform; (ii) require authentication for the registration of live-streaming content providers; and (iii)
enter into a service agreement with live-streaming service users to specify each of the live-streaming service user’s and the content provider’s rights and
obligations.
In November 2018, the CAC, together with the Ministry of Public Security, published the Provisions on the Safety Assessment for Internet
Information Services Capable of Creating Public Opinions or Social Mobilization. These provisions require certain internet information service providers
to conduct safety assessment in relation to the: (i) the legal compliance status of their information services, new technologies and new applications; (ii)
effectiveness of their implementation of safety measures as required by applicable laws and regulations; and (iii) effectiveness of their safety and risk
control measures.
On June 27, 2002, the MII and the GAPP jointly promulgated the Provisional Measures for the Administration of Internet Publishing, which
was replaced by the Rules for the Administration of Online Publishing Service jointly issued by SAPPRFT and MIIT that became effective on March 10,
2016. These rules require online publishers to secure approval from the SAPPRFT for their operations. The term “online publication service” refers to
providing online publications to the public through information networks. The term “online publications” is defined as the digital works with publishing
features such as editing, production or processing provided to the public through information networks (including contents from books, newspapers,
periodicals, audio and video products, electronic publications that have already been formally published or works that have been made public in other
media format, and the digital works of literature, art and science). These rules also forbid foreign investment in the online publishing sector.
On July 8, 2004, State Food and Drug Administration of China issued the Measures for the Administration of Internet Drug Information
Services, which was amended in 2017. The measures stipulate that websites publishing drug-related information must obtain a license from local food
and drug administrations.
Pursuant to the Measures for the Administration of Internet E-mail Services (the “Internet E-mail Measures”), which was issued by MII on
February 20, 2006, e-mail service providers must obtain value-added telecommunications business operating licenses or file for recordation as non-profit
internet service providers. In addition, each e-mail service provider must keep a record of the timing, sender’s or recipient’s e-mail address and IP address
of each e-mail transmitted through its servers for 60 days. The Internet E-mail Measures also state that an internet e-mail service provider is obligated to
keep confidential the users’ personal registered information and internet e-mail addresses. An internet e-mail service provider and its employees may not
illegally use any user’s personal registered information or internet e-mail address, and may not, without consent of the user, divulge the user’s personal
registered information or internet e-mail address, unless otherwise prescribed by another Law.
The State Administration of Radio, Film and Television (the “SARFT”) and MII jointly issued the Regulations for the Administration of Internet
Audiovisual Program Services (the “Audiovisual Regulations”) on December 20, 2007, which was revised on August 28, 2015 by the SAPPRFT. The
Audiovisual Regulations require that online audio and video service providers obtain a permit from NRTA in accordance with the Audiovisual
Regulations.
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On November 18, 2019, the CAC, the MOCT and the NRTA jointly issued the Promulgation of the Administrative Provisions on Online Audio
and Video Information Services (the “Audio and Video Provisions”), which took effect on January 1, 2020. The Audio and Video Provisions require that
online audio and video information service providers: (i) acquire relevant qualifications required by law and regulations; (ii) adopt rules and policies in
relation to, for example, user registration, information distribution and review, information security management, emergency disposal, educational
training for employees, the protection of minors and intellectual property rights protection; (iii) verify personal information submitted by users as
required under applicable laws; and (iv) undertake technical and other necessary measures to ensure network security and stable operations.
Organizations and individuals are prohibited from utilizing online audio and video information services and the related information technology to carry
out illegal activities that infringe upon the legitimate rights and interests of others. The Audio and Video Provisions further set out requirements for the
creation, distribution and transmission of audio videos based on new technologies and applications such as deep learning and virtual reality, including
requirements for safety evaluation, labeling requirements and mechanisms for refuting fake rumors.
On October 23, 2015, the MOC issued its Notice on Further Strengthening and Improving the Management of Online Music. According to this
notice, entities should examine and verify the content of online music by themselves, while the culture management administration should supervise
compliance upon and following the content’s publication.
On August 7, 2014, the CAC issued the Interim Provisions on Managing the Development of Public Information Services on Instant Messaging
Tools (the “Instant Messaging Interim Provisions”), which stipulate that instant messaging tool service providers must enter into an agreement with their
users during account registration to require them to abide by “Seven Principals,” including, without limitation, compliance with applicable laws and
social ethics.
On December 29, 2011, MIIT issued the Several Provisions on Regulating the Market Order for Internet Information Services (the “Market
Order Provisions”). According to the provisions, internet information service providers (“IISP(s)”), are prohibited from a wide range of activities that
would infringe upon the rights and interests of users or other IISPs, including but not limited to, maliciously forcing incompatibility on services and
products provided by other IISPs; deceiving, misleading or forcing users to use or not to use services and products provided by other IISPs; changing
users’ browser configurations or other configurations without notifying and obtaining permission from the users; and bundling their terminal software
with other software without providing clear notice to users. In addition, IISPs are prohibited from collecting information that is related to users and can
serve to identify users’ identities solely or in conjunction with other information without the users’ consent or providing other people with the
information, unless otherwise permitted or required under Laws.
On April 17, 2015, the National Copyright Administration of the People’s Republic of China issued the Circular on Regulating the Order of
Internet Reproduction of Copyrighted Works. Under this circular, in order to reproduce the work of others, internet media must comply with relevant
provisions of the copyright laws and regulations and, unless otherwise provided by law or regulation, must obtain permission from, and pay remuneration
to, the owner of the copyrighted work, and must indicate the name of the author as well as the title and the source of the work, and may not infringe any
other rights or interests of the copyright owner. Moreover, when reproducing the works of others, internet media must not make material alterations to the
content of the work.
The Standing Committee of National People’s Congress adopted the Copyright Law of the PRC in 1990 and amended it in 2001, 2010 and 2020,
respectively. The latest amended Copyright Law will take effect on June 1, 2021, pursuant to which, relevant provisions on copyright protection in
cyberspace have been further improved and the description of “cinematographic works or works created using methods similar to film making” are
revised as “audio-visual works”.
On June 28, 2016, the CAC published the first regulation of mobile applications in the PRC, the Administrative Provisions on Information
Services for Mobile Internet Applications (the “App Administrative Provisions”). These provisions expressly require mobile application providers to
obtain the relevant operation licenses and hold the mobile application providers strictly responsible for the implementation of information security
management regarding the applications they distribute or operate. The App Administrative Provisions also require mobile application providers to: (i)
verify the identity and contact information of their registered users; (ii) establish an appropriate mechanism to protect its users’ personal data; (iii)
develop an adequate censorship mechanism for any information published through their applications; (iv) protect their users’ rights to be informed if their
applications need to gain access to the users’ personal details and refrain from accessing the functions unrelated to the relevant applications without the
users’ consent; (v) protect their users’ intellectual property rights; and (vi) maintain internal records of users’ activities for 60 days.
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On December 15, 2019, the CAC issued the Provisions on the Ecological Governance of Network Information Content, which took effect on
March 1, 2020. For the purpose of these provisions, the term “ecological governance of network information contents” refers to the relevant activities
carried out by governments, enterprises, society, internet users and other parties to promote positive energy, and dispose of illegal and harmful
information. According to these provisions, a network information content service platform has a duty to act as the information content administrator, to
strengthen the ecological governance of the network information content on the platform and to promote the formation of positive cyber culture towards
kindness. Network information content service platforms are required to set up the mechanism of ecological governance of the network information
content, develop detailed rules for ecological governance of network information content on the platform, and improve the systems for user registration,
account management, information release and examination, post and comments examination, ecological page management, real-time inspection,
emergency response, and disposal of cyber rumors and black industry chain information.
Regulations on Information Security and Censorship
Regulations governing information security and censorship include:
● The Law of the PRC on the Preservation of State Secrets (1988, revised in 2010) and its Implementation Rules (2014);
● The Counter-espionage Law of the PRC (2014);
● The Rules of the PRC for Protecting the Security of Computer Information (1994, revised in 2011);
● The Administrative Measures for Protection of the Security of International Internetworking of Computer Information Networks (1997,
revised in 2011);
● Provisions for the Administration of Keeping Secrets in the International Internetworking of Computer Information Systems (2000);
● The Notice issued by the Ministry of Public Security of the PRC Regarding Issues Relating to the Implementation of the Administrative
Measure for the Security Protection of International Connections to Computer Information Networks (2000);
● The Decision of the Standing Committee of the National People’s Congress Regarding the Safeguarding of Internet Security (2000, revised
in 2009);
● The Provisions on the Technical Measures for the Protection of the Security of the Internet (2006);
● The Administrative Regulations for the Classified Protection of Information Security (2007);
● The Decision of the Standing Committee of the National People’s Congress on Strengthening Network Information Protection (2012);
● Provisions on Protection of Personal Information of Telecommunication and Internet Users (2013);
● Internet User Account Name Management Regulations (2015);
● Cyber Security Law of the PRC (the “Cyber Security Law”) (2017 Edition);
● Detailed Rules for the Implementation of the Counter-espionage Law of the PRC (2017);
● Provisions on the Cyber Protection of Children’s Personal Information (the “Children’s Provisions”) (2019);
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● Interpretation of the Supreme People’s Court and the Supreme People’s Procuratorate on Several Issues Concerning the Application of Law
in the Handling of Criminal Cases Involving Illegal Use of Information Networks and Assistance in Criminal Activities Committed through
Information Networks (the “Fa Shi No. 15”) (2019);
● Announcement of Launching Special Crackdown against Illegal Collection and Use of Personal Information by Apps (2019);
● Information Security Technology —Personal Information Security Specification (2020 edition);
● Notice of MIIT on Carrying out Special Rectification Actions in Depth against the Infringement upon Users’ Rights and Interests by Apps
(2020); and
● Measures for Cybersecurity Censorship (2020).
Under various Laws, ICP operators and internet publishers are prohibited from posting or displaying any content that:
● opposes the fundamental principles set out in China’s Constitution;
● compromises state security, divulges state secrets, subverts state power or damages national unity;
● harms the dignity or interests of the state;
● incites ethnic hatred or racial discrimination or damages inter-ethnic unity;
● sabotages China’s religious policy or propagates heretical teachings or feudal superstitions;
● disseminates rumors, disturbs social order or disrupts social stability;
● propagates obscenity, pornography, gambling, violence, murder or fear or incites the commission of crimes;
● insults or slanders a third party or infringes upon the lawful rights and interests of a third party; or
● includes other content prohibited by laws or administrative regulations.
Failure to comply with the content censorship requirements may result in the revocation of licenses and the closing down of the concerned
websites or other online and mobile platforms. In addition, it is mandatory for internet companies in the PRC to complete security-filing procedures and
regularly update information security and censorship systems for their websites and other online and mobile platforms with the local public security
bureau. On June 22, 2007, the Ministry of Public Security, the State Secrecy Bureau, the State Cryptography Administration Bureau and the SCIO jointly
issued the Administrative Regulations for the Classified Protection of Information Security, according to which websites should determine the protection
classification of their information systems pursuant to a classification guideline and file their classification with the Ministry of Public Security or its
bureaus at or above the municipal level with subordinate districts.
On December 28, 2012, the Standing Committee of the National People’s Congress issued the Decision on Strengthening Network Information
Protection (the “Information Protection Decision”), which provides that electronic information through which a citizen’s identity can be identified or in
which a citizen’s privacy is involved (“Personal Information”), is protected and no person shall steal, illegally obtain, sell or illegally provide to others
any Personal Information. Also, according to the Information Protection Decision, where a network service provider provides website access service, or
handles network access formalities for fixed-line telephones or mobile phones, or provides information publication services to its users, it shall require
users to provide authentic identity information when concluding agreements or confirming provisions of its service with the users.
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On July 16, 2013, MIIT issued the Provisions on Protection of Personal Information of Telecommunication and Internet Users, which defines
“Personal Information” as information that can identify the user either on its own or in combination with other information that is collected in the course
of providing services by telecommunication business operators and internet information service providers, and sets out detailed provisions concerning the
collection and utilization of Personal Information.
On February 4, 2015, the CAC issued the Internet User Account Name Management Regulations, which defines “Internet User Account Name”
as an account name registered or used in internet information services, including without limitation, blogs, micro-blogs, instant communication tools,
forums and thread comments. In addition, according to the regulations, internet information service providers must prohibit their users from using any
illegal or harmful information in their account name, avatar, profile or other registration information.
On November 7, 2016, the Standing Committee of the National People’s Congress promulgated the Cyber Security Law, which became
effective on June 1, 2017. In accordance with the Cyber Security Law, network operators must comply with applicable laws and regulations and fulfill
their obligations to safeguard network security in conducting business and providing services. Network service providers must take technical and other
necessary measures as required by Laws to safeguard the operation of networks, respond to network security effectively, prevent illegal and criminal
activities, and maintain the integrity, confidentiality and usability of network data. In addition, network operators must not collect personal information
irrelevant to their services. In addition, the Cyber Security Law provides that personal information and important data collected and generated by an
operator of critical information infrastructure in the course of its operations in the PRC must be stored in the PRC. In the event of any unauthorized
disclosure, damage or loss of collected personal information, network operators must take immediate remedial measures, notify the affected users and
report the incidents to the relevant authorities in a timely manner.
On April 11, 2017, the CAC released the Draft Measures on Security Assessment of the Cross-Border Transfer of Personal Information and
Important Data (the "Draft Cross-Border Transfer Measures"), which require personal information and important data collected or produced by network
operators during their operations in China to be stored within China. According to the Draft Cross-Border Transfer Measures, assessment by relevant
regulatory authority or the national cyberspace authority under certain circumstances must be completed before transferring the data overseas.
Furthermore, data may not be transferred overseas without consent from the concerned individual(s), or if the transfer endangers the interests of
individuals or public security. The CAC completed the solicitation of comments on the Draft Cross-Border Transfer Measures in May 2017, but there
remain substantial uncertainties with respect to its final content and enactment timetable.
The Administrative Provisions on the Information Services Provided through Official Accounts of Internet Users, the Administrative Provisions
on the Information Services Provided through Chat Groups on the Internet, the Administrative Provisions on Internet Follow-up Comment Services, and
the Administrative Provisions on Internet Forum and Community Services each requires that providers of the aforesaid services shall, under the principle
of requiring “mandatory registration of legal name of users and encouraged voluntary use of real name as screen name,” authenticate the identity of each
of their registered users and take necessary measures to protect their users’ personal identity.
On May 28, 2019, the CAC promulgated the Draft Data Security Measure for public consultation. The Data Security Measure provides for a
number of implementing provisions concerning aspects of data collection, data usage and processing, and data security administration. Network operators
that violate the Data Security Measures may be subject to public exposure, confiscation of illegal gains, suspension or a shut-down of their business,
disabling of their website or the revocation of relevant business permits or licenses.
On March 6, 2020, the SAMR and Standardization Administration jointly issued the Standard of Information Security Technology—Personal
Information Security Specification (GB/T 35273-2020), which took effect on October 1, 2020 and substitute the 2017 version. Pursuant to the standard,
any entity or person who has the authority or right to determine the purposes for and methods of using or processing personal information are seen as a
personal information controller. Such personal information controller is required to collect information in accordance with applicable laws, and except in
certain specific events that are expressly exempted in the standard, prior to collecting such data, the information provider’s consent is required. The 2020
version of Personal Information Security Specification includes the following changes compared with the 2017 version: (i) adding new requirements to
prevent excessive collection of personal data; (ii) adding new requirements concerning user profiling and personalized display; (iii) Adding new
requirements concerning third-party plugins; (iv) adjusting requirements on organizational measures; and (v) adding new requirements concerning
personal biometric data.
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On April 13, 2020, the CAC and several other government authorities jointly promulgated the Measures for Cybersecurity Censorship (the
“Censorship Measures”), which took effect on June 1, 2020. In accordance with the Censorship Measures, any purchase of network products and services
by critical information infrastructure operators, which affects or may affect state security, shall be subject to cybersecurity censorship fields. Since the
measures were recently promulgated, there exists uncertainties with respect to their interpretation and implementation.
On May 28, 2020, the National People’s Congress issued the PRC Civil Code, which took effect on January 1, 2021. In accordance with the
PRC Civil Code, natural person’s personal information shall be protected by law, and the processing of personal information shall be subject to the
principle of legitimacy, rightfulness and necessity, with no excessive processing.
The Draft PRC Data Security Law was released by the National People’s Congress Standing Committee in July 2020 for public consultation.
The Draft PRC Data Security Law stipulates the measures to support and promote data security and development, to establish and optimize the national
data security management system, and to clarify organizations’ and individuals’ responsibilities in data security.
On September 22, 2020, the Ministry of Public Security issued the Guiding Opinions on Implementing the Multi-Level Protection System for
Cybersecurity and the Security Protection System for Critical Information Infrastructure, which took effect on the same date. The work objectives of the
above-mentioned Guiding Opinions include: (i) implementing the cybersecurity MLPS; (ii) establishing and implementing the critical information
infrastructure security protection system; (iii) markedly increasing cybersecurity monitoring, early warning and emergency response capabilities; and (iv)
creating a comprehensive cybersecurity protection and control system. Since the measures were recently promulgated, there exists uncertainties with
respect to their interpretation and implementation.
The Draft Personal Data Protection Law (the “Draft PDPL”) was released by the National People’s Congress Standing Committee in October
2020 for public consultation. The Draft PDPL stipulates the scope of personal information and the ways of processing personal information, establishes
rules for processing personal information and for transferring personal information offshore, and clarifies the individual’s rights and the processor’s
obligations in the process of personal information. The Draft PDPL also strengthens the punishment for those who illegally process personal information.
The Draft PDPL is still subject to public consultation and will be further revised in the future.
As we expand our operations internationally, we may be also subject to privacy laws and data security laws of other jurisdictions in which we
operate, including the GDPR. The GDPR applies directly in all European Union member states from May 25, 2018 and applies to companies with an
establishment in the European Economic Area, or EEA, and to certain other companies not in the EEA that offer or provide goods or services to
individuals located in the EEA or monitor individuals located in the EEA. The GDPR implements stringent operational requirements for controllers and
processors of personal data, including, for example, expanded disclosures on how personal data is to be used, limitations on retention of information and
implementation of appropriate safeguards for transfer of personal data out of the EEA, increased cyber security requirements, mandatory data breach
notification requirements and higher standards for controllers to demonstrate that they have obtained a valid legal basis for certain data processing
activities. Failure to comply with European Union laws and other laws relating to the security of personal data may result in significant fines, such as
those applicable under the GDPR which can amount up to EUR20,000,000 or up to 4% of the total worldwide annual turnover of the preceding financial
year, if greater, and other administrative penalties including criminal liability.
California has also recently enacted legislation affording consumers expanded privacy protections, including the CCPA, that went into effect as
of January 1, 2020. For example, the CCPA gives California residents (including employees, though only in limited circumstances until January 1, 2023),
expanded rights to transparency (e.g., detailed information about how personal information is collected, used, and shared) regarding, access to, and
deletion of their personal information, and a right to opt out of the sharing of certain personal information. The California Attorney General issued
implementing regulations that also add requirements on businesses. The CCPA provides for civil penalties for violations enforced by the California
Attorney General, as well as a private right of action for certain data breaches that may increase data breach litigation and liability, in light of the
potential for statutory damages. Additionally, a new privacy law, the CPRA was approved by California voters in the November 3, 2020 election. The
CPRA significantly modifies the CCPA, potentially resulting in further uncertainty and requiring us to incur additional costs and expenses in efforts to
comply.
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Regulations on Online Games
Pursuant to the Provisional Regulations for the Administration of Online Culture promulgated by the MOC in May 2003, and last revised in
December 2017, online game operators are required to obtain an Internet Culture Operating License from relevant local departments of the MOC. On
May 14, 2019, the General Office of the MOCT issued the Circular on Adjusting the Scope of Examination and Approval of Online Culture Business
Permit and Further Regulating the Work Concerning Examination and Approval (the “MOCT Notice 81”), pursuant to which, the MOCT is no longer
responsible for the administration and supervision of online games and local counterparts of the MOCT may no longer approve Internet Culture
Operating Licenses that involve online game operation via information networks (with or without distribution of virtual currency of online games) and
virtual currency of online games trading operation via information networks. Internet Culture Operating Licenses that are already issued and only contain
the above business scope will remain effective until their expiration. As of date of the annual report, no laws, regulations or official guidelines have been
promulgated on whether the responsibility of MOCT for regulating online games will be undertaken by another governmental department.
On June 4, 2009, the MOC and MOFCOM jointly issued the Notice on Strengthening Administration on Online Game Virtual Currency (the
“Online Game Virtual Currency Notice”). According to this notice, online game virtual currency should only be used to exchange virtual services
provided by the issuing enterprise for a designated extent and time, and is strictly prohibited from being used to purchase tangible products or any service
or product of another enterprise. In addition, the Online Game Virtual Currency Notice requires the issuing enterprise to give users 60 days prior notice
and refund in the form of legal tender or other forms acceptable to users in case it plans to terminate the provision of its products or services.
The publication of online games also requires approval from SAPPRFT in accordance with the Rules for the Administration of Online
Publishing Service. In March 2018, the Central Committee of the Communist Party of China issued the Plans for Deepening the Institutional Reform of
the Party and State and the National People’s Congress issued the Institutional Reform Plan of the State Council (collectively, the “Institutional Reform
Plans”). According to the Institutional Reform Plans, the SAPPRFT is reformed and became the NRTA, under the State Council and NPPA under the
Propaganda Department of the Central Committee of the Communist Party of China, and the MOC is reformed and became the MOCT. Starting from
March 2018, the SAPPRFT at the national level temporarily suspended its approval of online games, which was later resumed in December 2018. Since
the first quarter of 2019, the NPPA has kept publishing the Online Game Approval Lists on its website.
In addition, in April 2007, GAPP and several other government authorities jointly promulgated the Notice Concerning the Protection of Minors’
Physical and Mental Well-being and Implementation of Anti-addiction System on Online Games (the “Anti-Addiction Notice”), which confirms the real
name verification scheme and anti-addiction system standard made by GAPP in previous years and requires online game operators to develop and test
their anti-addiction systems from April 2007 to July 2007, after which no online games can be registered or operated without an anti-addiction system, in
accordance with the Anti-Addiction Notice. On January 15, 2011, the MOC and several other government authorities jointly issued the Notice on
Implementation Program of Online Game Monitoring System of the Guardians of Minors (the “Monitoring System Notice”), which requires online game
operators to adopt certain measures to maintain an interactive system for the protection of minors. Through communication with online game operators,
parents may monitor and restrict online game activities by minors, including restriction or suspension of playtime. On July 1, 2011, GAPP and several
other government authorities jointly issued the Notice Regarding the Initiation of Work on the Online Games Real-Name Verification System to Prevent
Online Gaming Addiction, which requires that online game operators be responsible for data registration and identification of online game users, and that
online game operators shall duly submit user identification information for verification with the Ministry of Public Security’s National Citizen Identity
Information Center (the “NCIIC”), which will be in charge of real-name verification for the national anti-addiction system. In addition, online game
operators must ensure that, via the NCIIC real-name verification, users with fraudulent identification data be enrolled in the operators’ anti-addiction
systems.
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On July 25, 2014, the SAPPRFT issued the Notice Regarding the Implementation of the Anti-Addiction and Real-Name Verification System in
Online Games, which requires online game operators to complete their real-name verification procedure for online games when applying for publication
of online games. On August 30, 2018, the Implementation Scheme on Comprehensive Prevention and Control of Adolescent Myopia (the
“Implementation Scheme”) was issued jointly by eight PRC regulatory authorities at the national level, including the NPPA and the NRTA. The
Implementation Scheme provides that as a part of the plan to prevent myopia among children, the NPPA will control the number of new online games,
and take steps to restrict the amount of time children spend on playing online games. On October 25, 2019, the NPPA promulgated the Notice on
Preventing Minors from Indulging in Online Games, according to which the length of minors’ use of online games should be strictly controlled. It
requires all online game users to register their identification information. The total length of time for minors to access online games must be limited on a
daily basis. Every day from 22:00 to 8:00 the next day, online game companies are not permitted to provide game services to minors in any form. Game
services provided to minors must not exceed three hours per day on public holidays and 1.5 hours on other days. In addition, online transactions are
capped monthly at RMB200 or RMB400, depending on a minor’s age.
On September 7, 2009, the Office of the Central Institutional Organization Commission issued the Notice on Interpretation of the Office of the
Central Institutional Organization Commission on Several Provisions relating to Animation, Online Games and Comprehensive Law Enforcement in the
Culture Market in the “Three Provisions” jointly promulgated by the MOC, the SARFT and the GAPP, or Circular 35. According to this Circular 35,
GAPP shall be responsible for the examination and approval of online games made available on the internet, and once an online game is available on the
internet, it shall be solely and completely administrated by the MOC. The circular further clarifies that the GAPP shall be responsible for the examination
and approval of the game publications authorized by overseas copyright owners to be made available on the internet, and all other imported online games
shall be examined and approved by the MOC. However, according to the MOCT Notice 81, the MOCT shall no longer be responsible for administration
and supervision of online games and the local counterparts of the MOCT shall no longer approve or issue online culture business permits that involve
business scope such as online game operation via information network. As of the date of the annual report, Circular 35 has not been repealed and is still
effective. Given that the MOCT Notice 81 is relatively new and it is unclear how these three Provisions will be amended, we are unable to fully assess
what impact, if any, these new requirements may have on our business.
On September 28, 2009, GAPP, the National Copyright Administration and the National Office of Combating Pornography and Illegal
Publications jointly published the Notice Regarding the Consistent Implementation of the “Regulation on Three Provisions” of the State Council and the
Relevant Interpretations of the State Commission Office for Public Sector Reform and the Further Strengthening of the Administration of Examination
and Approval of Online Games and the Examination and Approval of Imported Online Games, or Circular 13. According to Circular 13, no entity should
engage in the operation of online games without receiving an Internet Publishing License and the approval from GAPP. Circular 13 expressly prohibits
foreign investors from participating in online game operating business via wholly owned, equity joint venture or cooperative joint venture investments in
China, and from controlling and participating in these businesses directly or indirectly through contractual or technical support arrangements. Moreover,
for online games that have been approved by GAPP, when the operational entity changes, or when new versions, expansion packs or new content is
implemented, the operating entity shall once again undertake the same procedures for examination and approval by GAPP of the changed operating
entity, new versions, expansion packs or new content. On May 24, 2016, SAPPRFT issued the Circular on the Administration over Mobile Game
Publishing Services, or Circular 44, which came into effect on July 1, 2016, and provides that no mobile game shall be published and operated online
without the approval of the SAPPRFT.
The Interim Measures for the Administration of Online Games (the “Online Games Measures”) were issued by the MOC in June 2010 and
repealed on July 10, 2019. The Online Games Measures set forth certain requirements regarding online games, including requirements that game
operators follow certain registration procedures, publicize information about the content and suitability of their games, prevent access by minors to
inappropriate games, avoid certain types of content in games targeted at minors, avoid game content that compels players to kill other players, manage
virtual currency in certain ways and register users with their real identities. Accordingly, the Notice on Implementing Interim Measures for the
Administration of Online Games (the “Online Games Notice”), in which several provisions of the Online Games Measures are supplemented, has also
been repealed. In addition, since June 2018, the MOCT at the national level has closed the post-filing recording online system, through which the
domestic online games were filed according to the post-filing requirements under the Online Games Measures and the Online Game Notice. As of date of
the annual report, no government authority has issued or promulgated any provisions to replace the above-mentioned regulations.
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On February 18, 1994, the State Council promulgated the Rules of the PRC for Protecting the Security of Computer Information Systems, and
amended in 2011, which defines “Security Products for Computer Information Systems” as software and hardware products designed for the protection
of computer information security and stipulates that a license must be obtained before selling Security Products for Computer Information Systems. The
Ministry of Public Security issued the Measures for the Administration of Security Products for Computer Information Systems Examination and Sales
on December 12, 1997 confirming that a license for the sale of security products for computer information systems must be obtained as a precondition for
sales of these products.
The Regulations for the Administration of Audio and Video Products, which was released by the State Council on December 25, 2001 and last
amended in November 2020, requires that the publication, production, duplication, importation, wholesale, retail and renting of audio and video products
are subject to a license issued by competent authorities.
On June 19, 2018, the MOCT issued the National Cultural Market Blacklist Management Measures, according to which the cultural
administrative department or the comprehensive law enforcement agency of the cultural market shall list the entities and persons in the cultural market
that have seriously violated laws and have broken their trust in the national cultural market blacklist, and shall make it public, and adopt credit constraints
and joint punishment.
The CAC issued the Children’s Provisions, which took effect on October 1, 2019. According to the Children’s Provisions, no organization or
individual is allowed to produce, release or disseminate information that infringes upon the personal information security of children under 14. Network
operators collecting, storing, using, transferring or disclosing children’s personal information are required to enact special protections for this
information.
Recently, there has been an increased focus on ensuring that mobile apps comply with privacy regulations. The Announcement of Launching
Special Crackdown Against Illegal Collection and Use of Personal Information by Apps was issued with effect on January 23, 2019, and commenced a
coordinated effort among the CAC, the MIIT, the Ministry of Public Security and the SAMR to combat the illegal collection and use of personal
information by mobile apps throughout the PRC. On October 31, 2019, the MIIT issued the Notice on the Special Rectification of Apps Infringing Users’
Rights and Interests, pursuant to which app providers were required to promptly rectify issues the MIIT designated as infringing app users’ rights such as
collecting personal information in violation of PRC regulations and setting obstacles for user account deactivation. On July 22, 2020, MIIT issued the
Notice on Carrying out Special Rectification Actions in Depth against the Infringement upon Users’ Rights and Interests by Apps to rectify the following
problems (i) illegal processing of personal information of users by the APP and the SDK; (ii) the conduct of setting up obstacles and frequently harassing
users; (iii) cheating and misleading users; and (iv) inadequate implementation of application distribution platforms’ responsibilities.
On October 21, 2019, the Supreme People’s Court and the Supreme People’s Procuratorate jointly issued the Fa Shi No. 15, which became
effective on November 1, 2019. The Fa Shi No. 15 interpreted several issues concerning the application of law in handling criminal cases such as
refusing to fulfil the obligation of managing the security of information networks, illegally using information networks and assisting in criminal activities
committed through information networks, in accordance with the Criminal Law of the PRC and the Criminal Procedure Law of the PRC.
Regulations on Private Education
The PRC Education Law (the “Education Law”), sets forth provisions relating to the fundamental education systems of the PRC, including a
school system of pre-school education, primary education, secondary education and higher education, a system of nine-year compulsory education and a
system of education certificates. The Education Law stipulates that the government formulates plans for the development of education, establishes and
operates schools and other types of educational institutions, and in principle, enterprises, institutions, social organizations and individuals are encouraged
to operate schools and other types of educational organizations in accordance with PRC Laws.
On December 28, 2002, the Standing Committee of the National People’s Congress, promulgated the Law for Promoting Private Education (the
“Private Education Law”), which was last amended on December 29, 2018. Under the amended Private Education Law, sponsors of private schools may
choose to establish non-profit or for-profit private schools at their own discretion and the establishment of the private schools shall be subject to
approvals granted by relevant government authorities and registered with relevant registration authorities.
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On August 10, 2018, the Ministry of Justice, or MOJ, published the draft amendment to the Regulations on the Implementation of the Law for
Promoting Private Education of the PRC (the “MOJ Draft”), for public comment. As of the date of the annual report, the MOJ Draft is still pending for
final approval and is not in effect. The MOJ Draft stipulates that private schools using internet technology to provide online diploma-awarding
educational courses shall obtain the private school operating permit of similar academic education at the same level, as well as the internet operating
permit. Institutions that use internet technology to provide training and educational activities, vocational qualification and vocational skills training, or
providing an internet technology service platform for the above activities, would need to obtain the corresponding internet operating permit and file with
the administrative department for education or the department of human resources and social security at the provincial level where the institution is
domiciled, and these institutions shall not provide educational and teaching activities that requires the private school operating permit. The internet
technology service platform that provides the training and educational activities shall review and register the identity information of institutions or
individuals applying for access to the platform.
The MOJ Draft further stipulates that the establishment of private training and educational organizations enrolling students of kindergarten,
primary school, middle and high school age and providing activities relating to cultural and educational courses at school, or examination related and
further education-related tutoring and other cultural and educational activities, shall obtain a private school operating permit from the administrative
departments for education at or above the county level. The establishment of private training and educational organizations that provide activities aiming
at quality promotion, personality development in the areas of linguistic competence, arts, physical activities, technology, and activities targeting at
cultural education for adults and non-degree continuing education, can apply to register as the legal person directly; however, such private training and/or
educational organizations shall not carry out the cultural and educational activities mentioned above, which requires a private school operating permit. In
addition, entities implementing group-based education shall not control non-profit schools by merger, acquisition, franchise or contractual arrangements.
Uncertainties exist with respect to the interpretation and application of the existing and future Laws governing the online private education
industry, as well as when and how the MOJ Draft would come into effect and how the local government would promulgate implementing rules relating to
the specific requirements applicable to online education service providers.
Regulations on After-school Tutoring and Educational Apps
On February 13, 2018, the Ministry of Education, or the MOE, the Ministry of Civil Affairs, the Ministry of Human Resources and Social
Security and the SAIC (currently known as the SAMR) jointly promulgated the Circular on Alleviating After-school Burden on Elementary and
Secondary School Students and Implementing Inspections on After-school Training Institutions, or Circular 3. Pursuant to Circular 3, the above
government authorities will carry out a series of inspections on after-school training institutions and order those with material potential safety risks to
suspend business for self-inspection and rectification, and those without proper establishment licenses or school operating permits to apply for relevant
qualifications and certificates under the guidance of competent government authorities. Moreover, after-school training institutions must file with the
local education authorities and make public the classes, courses, target students, class hours and other information relating to their academic training
courses (including primarily courses on Chinese and mathematics). After-school training institutions are prohibited from providing academic training
services beyond the scope or above the level of school textbooks, or organizing any academic competitions or level tests for students of elementary or
middle schools. In addition, elementary or middle schools may not reference a student’s performance in the after-school training institutions as part of
their admission criteria.
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On August 6, 2018, the State Council issued the Opinion on the Regulation of the Development of After-school Training Institutions, or State
Council Circular 80, which primarily regulates after-school training institutions targeting K-12 students. State Council Circular 80 reiterates prior
guidance that after-school training institutions must obtain a private school operating permit, and further requires these institutions to meet certain
minimum requirements. According to the circular, after-school training institutions are required to disclose and file relevant information regarding the
institution, including their training content, schedule, targeted students and school timetable to the relevant education authority, and their training classes
may not end later than 8:30 p.m. each day or otherwise conflict with the teaching time of local primary and secondary schools. In relation to online
education service providers, State Council Circular 80 generally provides that regulatory authorities of networking, culture, information technology, radio
and television industries shall cooperate with the education department in supervising online education within their relevant industry. On May 6, 2020,
the General Office of the MOE promulgated the Notice on the Negative List of Advanced Trainings for Six Compulsory Education Subjects (for Trial
Implementation), which, in accordance with the State Council Circular 80, prohibits after-school training institutions from providing advanced trainings
that do not follow the formal school curricula to the students in primary school and secondary school, and further defined activities that will be regarded
as advanced training in the subjects of Chinese, mathematics, English, physics, chemistry and biology.
On August 30, 2018, the MOE, SAMR and certain other government authorities issued the Implementation Scheme which requires, among
others, that the schools shall (i) shall use electronic products based on the principle of necessity, shall not rely on electronic products for teaching and
homework assignment and shall rather assign paper-based homework in principle, and the teaching time using electronic products shall account for, in
principle, not more than 30% of the total teaching time, and (ii) shall strictly implement the learning and development guidelines for children aged 3-6,
pay attention to the value of life and play for these children and shall not teach them primary-school-level lessons.
On November 20, 2018, the General Office of the MOE, the General Office of the SAMR and the General Office of the Ministry of Emergency
Management of the PRC jointly issued the Notice on Improving the Specific Governance and Rectification Mechanisms of After-school Education
Institutions, or Circular 10, which provides that provincial education departments shall be responsible for the filing of training institutions that uses
internet technology to provide online training for primary and middle school students. Provincial education departments shall regulate the online after-
school training institutions based on the management policies governing offline afterschool training institutions. In addition, online after-school
education institutions shall file the information of their courses, such as names, contents, target students, syllabi and schedules with the provincial
education departments and shall publish the name, photo, class schedule and certificate number of the teacher qualification license of each teacher on
their websites.
On December 25, 2018, the General Office of the MOE issued the Notice on Strictly Forbidding Harmful APP Entering Primary and Secondary
Schools, which stipulates, among other things, that: (i) local primary schools, secondary schools and education departments, shall conduct comprehensive
investigation on apps used on campus, and shall call off using any apps that contain harmful content such as commercial advertisements and internet
games, or increase the burden on students; and (ii) the filing and reviewing system of learning apps shall be established.
The Central Committee of the Communist Party and the State Council jointly issued the Opinions on the Further Reform of Education and
Teaching and Comprehensive Improvement on the Compulsory Education Quality (the “Opinions”), which became effective on June 23, 2019. The
Opinions stipulates, among other things, that: (i) the SAMR and its local counterparts shall be responsible for the registrations and filings of all after-
school training institutions and shall supervise and govern their operational behaviors, such as advertising, fee collecting, and antitrust competitions; and
(ii) the integrated application of information technology and education shall be promoted, and the “education plus internet” operation model shall be
encouraged, but in the meantime, the approval and supervision system for digital educational resource applied by schools shall be established.
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Moreover, the MOE, jointly with certain other PRC government authorities, issued the Opinions on Guiding and Regulating the Orderly and
Healthy Development of Educational Mobile Apps on August 10, 2019 (the “Opinions on Educational Apps”), which requires, among others, mobile
apps that provide services for school teaching and management, student learning and student life, or home-school interactions, with school faculty,
students or parents as the main users, and with education or learning as the main application scenarios (the “Educational Apps”), be filed with competent
provincial regulatory authorities for education. The Opinions on Educational Apps also requires, among others, that: (i) before filing, the Educational
App’s provider obtain the ICP license or complete the ICP filing and obtain the certificate and the grade evaluation report for graded protection of
cybersecurity; (ii) Educational Apps whose main users are under the age of 18 must limit the use time, specify the range of suitable ages, and have
strictly monitored content; (iii) before an Educational App is introduced as a mandatory app to students, the Educational App must be approved by the
applicable school through its collective decision-making process and be filed with the competent education authority; and (iv) Educational Apps adopted
by education authorities and schools as their uniformly used teaching or management tools shall not charge the students or parents any fee, and not offer
any commercial advertisements or games. On November 11, 2019, MOE issued the Administrative Measures on Filing of Educational Mobile Apps. In
2020, the MOE established a public complaints channel with respect to educational apps. The educational apps provider or user may be complained due
to a wide variety of matters, among other things, failure to complete the filing or obtain relevant permits, existence of internet illegal or improper
information, collect or unreasonably use personal information in violation of relevant laws and regulations, violations of the requirements on educational
apps used by primary and secondary schools, violations of the Online After-school Training Opinions. The MOE sets a scoring system with respect to
such complaints. Each educational app provider shall have 12 points during a period of 12 months. If serious complaints were to occur and substantiated
by relevant government authority, corresponding penalty points will be recorded and such educational app provider may be required to rectify relevant
noncompliance. In the event that 12 penalty points are recorded within a period of 12 months or the most serious compliant were to occur, filings of
relevant educational apps may be revoked, relevant educational apps may be removed from apps store, educational apps provider may be blacklisted and
made public and the involved provider may be prohibited to submit filings of educational apps within 6 months.
On September 19, 2019, the MOE, jointly with certain other PRC government authorities, issued the Guidance Opinions on Promoting the
Healthy Development of Online Education, which provides, among other things, that: (i) social forces are encouraged to establish online education
institutions, develop online education resources, and provide high quality education services; and (ii) an online education negative list shall be
promulgated and industries not included in the negative list are open for all types of entities to enter into.
On June 10, 2020, the General Office of MOE and the General Office of SAMR promulgated the Notice on Issuing the Form of Service
Contract for After-school Training Provided to Primary and Secondary School Students, which requires the local competent regulatory authorities to
guide the relevant parties to use the form of service contract for after-school training activities provided to primary and secondary school students. The
form of service contract covers the obligations and rights of parties involved in the after-school training, including detailed provisions on training fees,
refund arrangement and default liabilities.
On October 16, 2020, the General Office of the MOE and the General Office of the SAMR jointly promulgated the Notice on the Centralized
Rectification of After-school Tutoring Institutions’ Illegal Acts of Infringing Consumers’ Rights by Using Unfair Standard Terms. The Notice stipulates
that local education and market regulation authorities shall increase the efforts for the investigation of after-school tutoring institutions’ illegal acts which
infringes consumers’ rights by using unfair standard terms/ to exempt them from their own responsibility, increase consumers’ liability and exclude
consumers’ legal rights.
The Law of the PRC on the Protection of Minors (“Minors Protection Law”) issued by the National People’s Congress Standing Committee on
September 4, 1991 was recently amended on October 17 2020, which will take effect on June 1, 2021. According to the amended Minors Protection Law,
kindergartens and after-school training agencies may not carry out primary school curriculum education for the preschool-aged minors, and online
education products and services which are targeted at minors shall not include any links to online games or push any advertisements and other
information irrelevant to teaching.
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The MOE, jointly with certain other PRC government authorities, promulgated the Implementation Opinions on Regulating Online After-School
Training (the “Online After-School Training Opinions”), effective on July 12, 2019. The Online After-School Training Opinions are intended to regulate
academic after-school training involving internet technology provided to students in primary and secondary schools. Among other things, the Online
After-School Training Opinions requires that online afterschool training institutions file with the competent provincial education regulatory authorities
and that the education regulatory authorities shall, jointly with other provincial government authorities, review the filings and the qualifications of the
online after-school training institutions submitting these filings.
With respect to the filing requirements, the Online After-School Training Opinions provides, among other things: (i) an online after-school
training institution shall file with the competent provincial education regulatory authorities at the place of its domicile after it has obtained the ICP
license and the certificate and the grade evaluation report for the graded protection of cyber security; (ii) the online after-school training institutions shall
file, among other things, (x) materials related to the institution itself, including information on their respective ICP licenses and other relevant licenses
and the materials related to certain management systems regarding the protection of personal information and cyber security, (y) materials related to the
training content, and (z) materials related to the training personnel; and (iii) the competent provincial education regulatory authorities shall promulgate
local implementing rules on the filing requirements, focusing on training institutions, training content and training personnel. The Online After-School
Training Opinions further provides that the competent provincial education regulatory authorities shall, jointly with other provincial government
authorities, review the filings and the qualification of the online after-school training institutions submitting the filings before the end of December 2019.
Regulations on E-commerce
The E-Commerce Law of the PRC, which was promulgated on August 31, 2018 and became effective on January 1, 2019, set out detailed
obligations for operators of e-commerce businesses and e-commerce platforms and guidelines in terms of contract performance and dispute resolutions in
relation to e-commerce. Pursuant to this law, e-commerce operators shall, for example: (i) present unbiased search results and general product
recommendations that are not based on a potential customer’s particular purchase history and personal profile in addition to tailored product
recommendations and services; and (ii) not cite any provision of a form contract or any other means to invalidate an agreement with a customer after it
has received payment from that customer. In addition, e-commerce platform operators shall: (i) report information such as identity and tax information of
third-party vendors to relevant authorities; (ii) make platform service agreement or web-links thereto prominently displayed and accessible on its
homepage; (iii) be jointly liable in the event that the platform operator fails to take necessary measures when it has or should have the knowledge that
any vendor using its platform has infringed consumers’ rights; and (iv) be jointly liable for any damage or threat to a customer’s personal health and
wellbeing caused by the products sold on its platform if a platform operator fails to examine the qualifications of its vendor using its platform or fails to
protect its customers’ safety in respect of goods or services that may affect a customer’s health. We are subject to this new law as both an e-commerce
business operator and e-commerce platform operator. Failure to comply with this law could subject us to civil liabilities or administrative penalties.
The PRC Consumer Protection Law, as amended on October 25, 2013, sets out the obligations of business operators and the rights and interests
of consumers. Pursuant to this law, business operators must guarantee that the commodities they sell satisfy the requirements for personal or property
safety, provide consumers with authentic information about the commodities, and guarantee the quality, function, usage and term of the validity of
commodities. The amendment in 2013 further strengthens the protection of consumers and imposes more stringent requirements and obligations on
business operators, especially on the businesses operating through the internet. For example, consumers are entitled to return the goods (except for
certain specified goods) within seven days upon receipt without any reasons when they purchase the goods from business operators via the internet.
When a consumer purchases products (including cosmetics and food) or accepts services via an online trading platform and his/her interests are
prejudiced, if the online trading platform provider fails to provide the name, address and valid contact information of the seller, the manufacturer or the
service provider, the consumer is entitled to demand compensation from the online trading platform provider. Failure to comply with this law may subject
business operators to civil liabilities such as refunding purchase prices, replacement of commodities, repairing or ceasing damages, compensation, and
restoring the reputation, and could subject business operators or the responsible individuals to criminal penalties when personal damages are involved or
if the circumstances are severe.
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On January 26, 2014, SAIC issued the Administrative Measures for Online Trading (the “Online Trading Measures”), which replaced its
previous Interim Measures for the Administration of Online Commodities Transaction and Relevant Services. The Online Trading Measures aim to
regulate online commodity trading and relevant services, setting standards for online commodity trading operators and relevant services providers,
including third-party trading platform operators, concerning qualifications, after-sale services, terms of use, user privacy protection, data preservation,
compliance with applicable laws in respect of intellectual property rights protection and unfair competition. In order to further regulate online transaction
activities, on March 15, 2021, SAMR issued the Online Trading Supervision and Management Measures (“Online Trading Supervision Measures”),
which will become effective on May 1, 2021 and replace the Online Trading Measures. The Online Trading Supervision Measures shall apply to the
business activities of selling commodities or providing services in social networking, internet live streaming or other information network activities and it
further regulates the operations of online trading.
On January 5, 2015, SAIC issued the Measures for the Punishment of Conduct Infringing the Rights and Interests of Consumers (the “Consumer
Conduct Measures”), which was amended on October 23, 2020 and became effective on the same date. According to these measures, business operators
are prohibited from a wide range of activities that would infringe upon the rights and interests of consumers, including but not limited to collecting and
using information related to consumers without their consent, illegally providing third parties with this information in any form, or sending promotional
message to consumers despite their express refusal. On January 6, 2017, SAIC issued the Interim Measures for Return of Online Purchases within seven
Days without Reason (the “Online Return Measures”), which was amended on October 23, 2020 and became effective on the same date. According to
these measures, any consumer goods purchased online could be returned without any reason, if in good condition and are returned within seven days of
receipt with signature from the consumers, except for customized products, fresh or live products, perishable goods, digital products, newspapers,
periodicals and the goods confirmed to be exempted from the Online Return Measures by consumers at the time of purchase. On November 21, 2019, the
SAMR issued the Interim Provisions on Administration of Consumer Product Recalls, which became effective on January 1, 2020. The provisions clarify
the recall obligations and responsibilities of both the producers of consumer goods and the operators selling, leasing, or repairing consumer goods.
Defects are defined in the provisions as unreasonable danger found commonly in the same batch, model number or type of consumer goods due to
design, manufacturing, or labeling etc., which compromises personal safety and property safety. According to the provisions, manufacturers are
accountable for the safety of consumer goods manufactured by them, and, where there are defects, the manufacturer must recall the goods.
The Food Safety Law of the PRC, promulgated on February 28, 2009 and effective on June 1, 2009, was amended on December 29, 2018 with
effect from the same date. This amendment sets out a new and stricter regulation framework for the production and circulation of food. On October 11,
2019, the State Council revised and adopted the Implementing Regulation for the Food Safety Law of the PRC, which became effective on December 1,
2019. The regulation underscores tougher supervision, requiring governments above county levels to establish a uniform and authoritative supervision
mechanism to enhance supervisory capabilities. The regulation clarifies the primary responsibilities of producers and business operators in food safety,
specifies the duties of major corporate leaders, regulates the storage and transportation of food products, bans false promotion of food products, and
improves the management of special foods. Under the regulation, legal persons, persons in charge, managers who are directly in charge and individuals
who are directly responsible will be fined if the entity they worked for was found to be intentionally committing an illegal act. However, it currently
remains unclear if food distributed through the recently established cross-border e-commerce industry is required to comply with all the requirements set
forth in the new Food Safety Law of the PRC and its implementing regulation.
Regulations on Online Advertising
According to the Regulations for the Administration of Advertising promulgated by the State Council, which took effect on December 1, 1987,
websites engaged in advertising must apply for a business license to conduct such business.
On February 9, 2012, SAIC and several other government authorities jointly issued the Rules on Review of Advertisement Release by Public
Media, which, among other things, states that public media (including internet information service providers) shall have advertisement reviewers, who
must participate in and pass trainings in relation to advertisement laws, regulations and business, after which, the reviewers should perform tasks
including reviewing advertisements to be released and managing advertisement review archives.
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On April 24, 2015, the Standing Committee of the National People’s Congress enacted the Advertising Law of the PRC (the “New Advertising
Law”), and amended on October 26, 2018. The New Advertising Law, which was a major overhaul of an advertising law enacted in 1994, increases the
potential legal liability of advertising services providers, and includes provisions intended to strengthen identification of false advertising and the power
of regulatory authorities. The New Advertising Law forbids the usage of certain words or phrases in advertisements, such as “national,” “supreme,” or
“best” and provides a more detailed definition of “false advertisement.” The New Advertising Law also forbids sending advertisements to residences,
vehicles, fixed or mobile telephones or personal email addresses if the advertisement is not invited or the receiver of the advertisement has rejected the
advertising.
On July 4, 2016, SAIC promulgated the Provisional Measures of Internet Advertising Management, which took effect on September 1, 2016.
According to these measures: (i) an internet advertisement should be identifiable and clearly labeled as “advertisement”; (ii) paid search advertisements
should be clearly distinguished from natural search results; (iii) advertisements published in the form of pop-up or other forms should be clearly marked
with a “Close” sign to ensure “Single Click to Close”; and (iv) no entity or individual may induce users to click on the contents of an advertisement
through deception, or attach advertisements in any form to an e-mail without user’s permission.
Regulations on Internet Live Streaming Services
On November 4, 2016, the CAC issued Administrative Provisions on Internet Live-Streaming Services, which became effective on December 1,
2016. Under the regulation, “internet live streaming” refers to the activities of continuously releasing real-time information to the public based on the
internet in forms such as video, audio, images and texts, and “internet live-streaming service providers” refers to the operators that provide internet live-
streaming platform services. In addition, the internet live-streaming service providers shall take various measures when operating its services, such as
examining and verifying the authenticity of the identification information and file this information for record.
On September 14, 2020, the Ministry of Culture and Tourism of the PRC issued the Notice on Deepening Reform of “Streamline
Administration, Delegating Power and Improving Services” to Promote Prosperity and Development of the Performance Market, which took effect on
the same date. Under this Notice, those who provide real time live artistic performance to the public through the internet for the purpose of making
profits, shall go through the formalities of application for approval in accordance with the Regulations for the Administration of Commercial
Performances and other relevant provisions, and the online communication services shall be provided by internet cultural units with network culture
operation license. Since the Notice was recently promulgated, there exists uncertainties with respect to the formalities of application for approval.
On July 12, 2017, the CAC issued a Notice on Development of the Filing Work for Enterprises Providing Internet Live Streaming, which
provides that all the companies providing internet live streaming services shall file with the local authority from July 15, 2017, otherwise the CAC or its
local counterparts may impose administrative sanctions on such companies.
Pursuant to the Circular on Tightening the Administration of Internet Live Streaming Services jointly issued by the MIIT, the MOCT, and
several other government agencies on August 1, 2018, live streaming services providers are required to file with the local public security authority within
30 days after it commences the service online.
The Law of the PRC on the Protection of Minors, or the Minors Protection Law, issued by the National People’s Congress Standing Committee
on September 4, 1991, was recently amended on October 17, 2020 and will take effect on June 1, 2021. Under the amended Minors Protection Law,
online product and service providers shall avoid providing content for minors that might induce obsession by minors. Online product and service
providers such as providers of online games, online broadcasts, online audio/video or online social networks shall set up appropriate functions such as the
management of time, authority and spending of minors using their services.
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In November 2020, NRTA issued the Notice on Strengthening the Administration of Online Show Live and E-commerce Live Streaming, which
set forth registration requirements for platforms providing online show live streaming or e-commerce live streaming to have their information and
business operations registered by November 30, 2020. The Notice made it clear that live streaming platforms should implement real-name management
systems. Live streaming platforms should manage the contents of live studios and the corresponding hosts with labels by categories such as “music”,
“dance”, “singing”, “fitness”, “games”, “travel”, “food” and “life services”. Live streaming platforms should set up business-level rating systems for live
studios and hosts, refine program quality ratings and the rating systems if there are violations, and the recommendations or promotions for live studios
and hosts shall be associated with such ratings.
Regulations on Online Music
On November 20, 2006, the Ministry of Culture issued the Several Opinions of the Ministry of Culture on the Development and Administration
of Online Music, or the Online Music Opinions, which became effective on the same date. The Online Music Opinions provide that, among other things,
an internet music service provider must obtain an Online Culture Operating Permit.
In 2010 and 2011, the MOC greatly intensified its regulations on online music products by issuing a series of circulars regarding online music
industry, such as the Circular on Regulating the Market Order of Online Music Products and Renovating Illegal Conducts of Online Music Websites and
the Circular on Investigating Illegal Online Music Websites in 2010. In addition, the Ministry of Culture issued the Circular on Clearing Illegal Online
Music Products in 2011, which clarified that entities engaging in any of the following conducts will be subject to relevant penalties or sanctions imposed
by the Ministry of Culture: (i) providing online music products or relevant services without obtaining corresponding qualifications; (ii) importing online
music products that have not been reviewed by the Ministry of Culture; or (iii) providing domestically developed online music products that have not
been filed with the Ministry of Culture.
On July 8, 2015, the National Copyright Administration issued the Circular regarding Ceasing Transmitting Unauthorized Music Products by
Online Music Service Providers, which requires that: (i) all unauthorized music products on the platforms of online music services providers be removed
prior to July 31, 2015, and (ii) the National Copyright Protection Center investigate and punish online music services providers who continue to transmit
unauthorized music products following July 31, 2015. On October 23, 2015, the Ministry of Culture promulgated the Circular on Further Strengthening
and Improving the Content Administration of Online Music, effective as of January 1, 2016, which provides that internet culture operating entities shall
report through a nationwide administrative platform: (i) its content administration system, department, staffing, job responsibilities, monitoring process
and specifications etc., to its local provincial cultural administrative department; and (ii) the details of its self-monitoring activities to the Ministry of
Culture on a quarterly basis.
Regulations on Anti-Unfair Competition and Anti-Monopoly Matters
According to the PRC Anti-Unfair Competition Law, which took effect on December 1, 1993 and last amended on April 23, 2019, unfair
competition refers to that the operator disrupts the market competition order and damages the legitimate rights and interests of other operators or
consumers in violation of the provisions of the Anti-unfair Competition Law in the production and operating activities. Pursuant to the PRC Anti-unfair
Competition Law, operators shall abide by the principle of voluntariness, equality, impartiality, integrity and adhere to laws and business ethics during
market transactions, and operators in violation shall bear corresponding civil, administrative or criminal liabilities depending on the specific
circumstances.
The PRC Anti-monopoly Law, which took effect on August 1, 2008, prohibits monopolistic conduct such as entering into monopoly
agreements, abusing market dominance and concentration of undertakings that may have the effect of eliminating or restricting competition. On February
7, 2021, the Anti-monopoly Commission of the State Council promulgated the Guidelines to Anti-Monopoly in the Field of Internet Platforms, or the
Anti-Monopoly Guidelines, which took effect on the same date and will operate as a compliance guidance for platform economy operators under the
existing PRC anti-monopoly laws and regulations. The Anti-Monopoly Guidelines mainly covers five aspects, including general provisions, monopoly
agreements, abusing market dominance, concentration of undertakings, and abusing of administrative powers eliminating or restricting competition.
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Regulations on Payment and Finance Services
On June 14, 2010, the PBOC issued the Measures for the Administration of Non-financial Institutions Engaging in Payment and Settlement
Services (the “PBOC Measures”), which was amended on April 29, 2020 and became effective on the same date. The PBOC Measures requires that non-
financial institutions engaging in the payment business before September 1, 2010 obtain a permit, the Payment Service Permit, from the PBOC by
August 31, 2011 to continue operating their business. On December 1, 2010, the PBOC issued the Implementation Rules for the Measures for the
Administration of Non-financial Institutions Engaging in Payment and Settlement Services (Revised on June 2, 2020 and November 12, 2020), which
further elaborates on the application qualification, material and procedure for the Payment Service Permit and further measures aiming at protecting the
rights and interests of clients, including prominent disclosure of service rates, prior notice to clients before any modification can be made to the service
rates or payment service agreement between a payment service provider and its clients. On December 28, 2015, the PBOC issued the Administrative
Measures for Internet Payment Services of Non-banking Payment Institutions, which became effective on July 1, 2016, and requires that non-banking
payment institutions implement the real-name verification system for payment accounts and take effective measures to verify the personal information of
clients. The measures also require that if non-banking payment institutions engage in transferring money between payment accounts and bank accounts,
all of these accounts shall be owned by the same client. On January 13, 2017, the PBOC issued the Notice of the PBOC on Matters concerning
Implementing the Centralized Deposit of the Funds of Pending Payments of Clients of Payment Institutions, which requires that, from April 17, 2017, a
payment institution shall deposit a certain percentage of the funds from its clients, pending payment from such clients, in a special deposit account with a
designated financial institution where no interest on the percentage of funds shall accrue.
On January 19, 2021, the PBOC issued the Measures for Deposit and Management of Customer Reserve Funds by Non-bank Payment
Institutions, or the Measures for Customer Reserve Funds, which became effective on March 1, 2021. The Measures for Customer Reserve Funds define
“Clients’ Reserves” as funds actually received by non-bank payment institutions when processing payments for clients and payable upon clients’ order,
which shall be fully deposited by the non-bank payment institutions into a dedicated deposit account held in the custody of banking institutions. The
Measures for Customer Reserve Funds standardize the centralized deposit and management business of customer’s reserves after centralized deposit of
reserves, further refine the provisions on deposit, use and transfer of reserves, clarify the corresponding reserve management responsibilities of the PBOC
and its branches, clearing institutions and reserve banks, set punishment standards for violations of customer’s reserves and promote the healthy
development of the industry health development. A six-month transitional period shall be set up following the implementation of the Measures for
Customer Reserve Funds.
On July 18, 2015, PBOC, MIIT, Ministry of Public Security, MOF, SAIC, Legislative Affairs Office of the State Council, CBRC, the CSRC,
China Insurance Regulatory Commission and the CAC jointly issued the Guiding Opinions on Promoting the Healthy Development of Internet Finance,
which was imperative in encouraging innovation, and support the steady development of internet finance. According to the above-mentioned Guiding
Opinions, internet enterprises would be supported to set up internet payment institutions, online lending platforms, equity crowd-funding platforms and
online financial product sales platforms in compliance with the law, and a multi-level financial services system that serves the real economy would be
established to better meet the investment and financing needs of medium, small and micro-sized enterprises and individuals, and further expand the
breadth, and increase the depth, of inclusive finance. According to the above-mentioned Guiding Opinions, e-commerce enterprises would be encouraged
to build and improve their own online financial services systems under the premise of compliance with financial laws and regulations, and effectively
expand the supply chain operations of e-commerce enterprises.
On September 15, 2020, PBOC issued the Implementing Measures for Protection of Financial Consumers’ Rights and Interests, which took
effect on November 1, 2020. Under the implementing measures, when explaining important contents and disclosing risks to financial consumers, banks
and payment institutions shall, in accordance with laws, regulations and regulatory provisions, keep the relevant materials for at least three years from the
date of termination of the business relationship.
Regulations on Intellectual Property Rights
The PRC has adopted comprehensive legislation governing intellectual property rights, including patents, trademarks, copyrights and domain
names.
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Patent
According to the Patent Law of the PRC (Revised in 2008) promulgated by the Standing Committee of the National People’s Congress, and its
Implementation Rules (Revised in 2010) promulgated by the State Council, the National Intellectual Property Administration of China is responsible for
administering patent affairs in the PRC. The patent administration departments of provincial or autonomous regions or municipal governments are
responsible for administering patent affairs within their respective jurisdictions. The Patent Law of the PRC and its implementation rules provide for
three types of patents, “invention”, “utility model” and “design.” The Chinese patent system adopts a first-to-file rule, which means that where more than
one person files a patent application for the same invention, the patent will be granted to the person who files the application first. To be patentable,
invention or utility models must meet three criteria: novelty, inventiveness and practicability.
The Patent Law of the PRC was further amended by the Standing Committee of the National People’s Congress in October, 2020 and will come
into effect on June 1, 2021, pursuant to which invention patents are valid for twenty years, while design patents are valid for fifteen years and utility
model patents are valid for ten years, commencing from the date of application. Where a patent right for invention is granted after three years from the
date of request for substantial examination of a patent for invention and after four years from the filing date, the patent administrative department under
the State Council shall grant compensation for the duration of the patent right due to any unreasonable delay in grant of patent rights at the request of the
applicant, except for any unreasonable delay caused by the applicant. In addition, the Law of the Patent PRC (Revised in 2020) provides criterial for
compensation amount for intentional patent infringement, i.e. one to five times of actual loss suffered by the rights holder due to the infringement or the
gains obtained by the infringer from the infringement, and the extension of the limitation of action for patent infringement to three years.
Trademark
According to the Trademark Law of the PRC promulgated by the Standing Committee of the National People’s Congress in August 1982 and
recently amended in April 2019, and its Implementation Regulation promulgated in August 2002 and amended in April 2014 by the State Council, the
period of validity for a registered trademark is ten years, commencing from the date of registration. The registrant must go through the formalities for
renewal within twelve months prior to the expiry date of the trademark if continued use is intended. Where the registrant fails to do so, a grace period of
six months may be granted. The validity period for each renewal of registration is ten years, commencing from the day immediately after the expiry of
the preceding period of validity for the trademark. In the absence of a renewal upon expiry, the registered trademark will be cancelled. The Trademark
Law and its Implementation Regulation also stipulate rules regarding trademark infringement and compensation. Industrial and commercial
administrative authorities have the authority to investigate any alleged infringement of the exclusive right under a registered trademark. If there is a
suspected criminal offense, the case shall be timely referred to and decided by a judicial authority.
Copyright
The Standing Committee of National People’s Congress adopted the Copyright Law of the PRC in 1990 and amended it in 2001, 2010 and 2020,
respectively. The latest amended Copyright Law will take effect on June 1, 2021. The amended Copyright Law extends copyright protection to internet
activities, products disseminated over the internet and software products.
In order to further implement the Copyright Law of the PRC, the Regulations of the PRC for the Implementation of Copyright Law was
promulgated by the State Council on September 15, 2002 and last amended on January 30, 2013.
Pursuant to the Copyright Law and its implementation rules, creators of protected works enjoy personal and property rights, including, among
others, the right of disseminating the works through information networks. In addition, the Regulations for the Protection of Information Network
Transmission Right promulgated by the State Council on May 18, 2006, and amended on January 30, 2013, specify the rules on a safe harbor for use of
copyrights and copyright management technology.
In order to further implement the Regulations for the Protection of Computer Software promulgated by the State Council on December 20, 2001
and last amended on January 30, 2013, the State Copyright Bureau issued the Registration of Computer Software Copyright Procedures on February 20,
2002, which applies to software copyright registration, license contract registration and transfer contract registration.
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Domain name
Domain names are protected under the Administrative Measures on the Internet Domain Names promulgated by the MIIT on August 24, 2017.
The MIIT is the major regulatory body responsible for the administration of the PRC internet domain names. The registration of domain names adopts a
first-to-file rule. On November 27, 2017, the MIIT promulgated the Notice of the MIIT on Regulating the Use of Domain Names in Providing Internet-
based Information Services, which became effective on January 1, 2018. Pursuant to the notice, the domain name used by an internet-based information
service provider in providing internet-based information services must be registered and owned by such provider in accordance with the law. If the
internet-based information service provider is an entity, the domain name registrant must be the entity (or any of the entity’s shareholders), or the entity’s
principal or senior manager.
C. Organizational Structure
Our organizational structure is set forth above under Item 4.B. “Business Overview—Our Organizational Structure.”
D. Property, Plants and Equipment
Our principal executive offices are currently located at NetEase Building, No. 599 Wangshang Road, Binjiang District, Hangzhou, People’s
Republic of China 310052. In addition, as of December 31, 2020, we have leased office, warehouse and store facilities with an aggregate of
approximately 452,474 square meters of space at properties mainly in Shanghai, Guangzhou and Hangzhou.
We own and occupy several research and development centers in Hangzhou and Guangzhou, China with a total floor area of approximately
304,000 and 75,000 square meters, respectively, where our online game and innovative businesses and other services developers, as well as their related
sales, marketing, technology, management and administrative functions are located. We also own and occupy an office building in Beijing with an
aggregate total estimated floor area of 95,000 square meters, where our advertising services and Youdao are located.
We are in the process of constructing several new office buildings and warehouses, primarily located in Guangzhou, Hangzhou and Shanghai.
As of December 31, 2020, we had incurred construction in progress costs of RMB784.4 million (US$120.2 million) for these new office buildings and
warehouses, which primarily comprise costs for building construction.
We continue to assess our needs with respect to office space and may, in the future, vacate or add additional facilities. We believe that our
current facilities and those under construction will be adequate for our needs in the immediate and foreseeable future.
As of December 31, 2020, we owned approximately 112,000 network servers co-located mainly in the facilities of China Telecom’s affiliates,
China Unicom’s affiliates and China Mobile’s affiliates for which we paid server and bandwidth service fees, and we leased dedicated lines mainly from
various affiliates of China Telecom, China Unicom and China Mobile pursuant to short term contracts. Our server and bandwidth service fees were
approximately RMB1,424.2 million (US$218.3 million) for the year ended December 31, 2020.
Item 4A. Unresolved Staff Comments
Not applicable.
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Item 5. Operating and Financial Review and Prospects
The following discussion of our financial condition and results of operations is based upon and should be read in conjunction with our
consolidated financial statements and their related notes included in this annual report. This report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Exchange Act, including, without
limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,”
“believe,” or similar language. All forward-looking statements included in this annual report are based on information available to us on the date
hereof, and we assume no obligation to update any such forward-looking statements. In evaluating our business, you should carefully consider the
information provided under Item 3.D. “Risk Factors.” Actual results could differ materially from those projected in the forward-looking statements. We
caution you that our businesses and financial performance are subject to substantial risks and uncertainties.
A. OPERATING RESULTS
Overview
We have a successful online game business, developing and operating a rich portfolio of highly popular titles. Leveraging on our user insights
and execution expertise, we have also incubated and developed in-house a pipeline of successful businesses, including our intelligent learning platform,
Youdao, and other innovative businesses, ranging from music streaming and private label e-commerce to internet media and e-mail services, among
others.
We generated net revenues of RMB51,178.6 million, RMB59,241.1 million and RMB73,667.1 million (US$11,290.0 million) in 2018, 2019 and
2020, respectively. Our net income from continuing operations was RMB8,616.1 million, RMB13,468.6 million and RMB12,330.2 million (US$1,889.7
million) in 2018, 2019 and 2020, respectively.
Our Corporate Structure
Our company was incorporated in the Cayman Islands. NetEase, Inc. conducts its business in China through its subsidiaries and VIEs. Under
current Chinese regulations, there are restrictions and prohibitions on foreign investment in Chinese companies providing, among other things, value-
added telecommunications services, internet cultural services and internet publication services, which include the provision of online game, online
education and other internet content and services. In addition, the operation by foreign or foreign-invested companies of advertising businesses in China
is subject to government approval. In order to comply with these restrictions and other Chinese rules and regulations, NetEase, Inc. and certain of its
subsidiaries have entered into a series of contractual arrangements for the provision of such services with certain affiliated companies, including
Guangzhou NetEase, Hangzhou Leihuo, Youdao Computer, Shanghai EaseNet and certain other affiliated companies. These affiliated companies are
considered “variable interest entities” for accounting purposes, and are referred to collectively in this annual report as “VIEs.” These contractual
arrangements allow us to exercise effective control over the VIEs and their subsidiaries. The VIEs hold ICP licenses and other regulated licenses in
which foreign investment is restricted or prohibited and operate our Internet businesses and other businesses. The revenue earned by the VIEs largely
flows through to NetEase, Inc. and its subsidiaries pursuant to such contractual arrangements. Based on these agreements, NetEase Hangzhou, Boguan
and certain other affiliated companies provide technical consulting and related services to the VIEs. In addition, Guangzhou NetEase has a wholly-
owned subsidiary, Wangyibao (the operator of our NetEase Pay online payment platform). Please also see Item 4.B. “Business Overview—Our
Organizational Structure.”
As of December 31, 2020, the total assets of all the consolidated VIEs of our company were RMB18.2 billion (US$2.8 billion), mainly
comprising cash and cash equivalents, time deposits, accounts receivable, prepayments and other current assets, net and fixed assets. As of December 31,
2020, the total liabilities of the consolidated VIEs were RMB15.5 billion (US$2.4 billion), mainly comprising accounts payable, deferred revenue,
accrued liabilities and other payables.
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We believe that our present operations are structured to comply with the relevant Chinese laws. However, many Chinese regulations are subject
to extensive interpretive powers of governmental agencies and commissions. We cannot be certain that the Chinese government will not take action to
prohibit or restrict our business activities. Future changes in Chinese government policies affecting the provision of information services, including the
provision of online games, online education, internet access, online advertising and online payment services, may impose additional regulatory
requirements on us or our service providers or otherwise harm our business. Please see Item 3.D. “Risk Factors—Risks Related to Our Corporate
Structure.”
Factors Affecting Our Results of Operations
Our ability to continue to deliver original and compelling content and service offerings and effectively operate our existing products
We take pride in being an original content provider. Our continued success in producing and delivering original and compelling content and
services to our users largely depends on our ability to stay abreast of users’ evolving needs and preferences and dynamics in the digital content and
service industries. We seek to identify trend-setting content and services while striving to maintain the longevity and vitality of our existing products by
effectively leveraging our rich operational know-how. In particular, as we generate a substantial amount of revenues from our online game services, our
ability to successfully update and expand our existing game franchises and maintain a pipeline of new games across diversified genres and geographic
regions will affect our future revenue and financial results.
Our ability to grow our user base and drive user engagement and loyalty
We have built a massive and highly engaged user base across our business segments. We generate a substantial part of our revenues through
sales of in-game virtual items and play time, merchandise sales, music streaming, advertising services and tuition fees for online courses. Our ability to
generate these revenues is affected by the size of our user base and the level of their engagement. Our ability to continue to grow our user base and
engagement is driven by various factors, including our ability to offer diverse, attractive and relevant content and services, deliver differentiated and
superior user experiences, improve the community features on our platforms and enhance our brand reputation.
Our ability to continue to develop proprietary technologies and apply them meaningfully
We have demonstrated capabilities in developing proprietary technologies and applying technology to enhance our products and services and
improve our user experience, which is a critical competitive advantage of ours and a key factor that affects our operations and financial results. We have
successfully developed industry-leading proprietary game, AI, big data and other technologies and integrate these technologies into our products and
services, and we will continue to significantly invest in developing and upgrading our technology with a focus on optimizing our products and services
and delivering a superior and differentiated user experience.
Our ability to manage our costs and expenses effectively across all business segments
Our results of operations are affected by our ability to effectively control our costs and expenses across all of our business segments. We incur
revenue sharing costs, including fees shared with distribution channel providers, game developers and other third parties related to mobile games, course
instructors related to Youdao’s services and others in connection with our other innovative businesses, which may increase in absolute amounts in the
near term as we continue to scale up our operations across our business segments. We may also incur higher content costs in the near term as we continue
to expand our product and service offerings to cater to the evolving user needs. Our ability to continue to manage and control our cost of revenues,
including revenue sharing costs and content costs, while maintaining the high-quality and attractiveness of our products and services will have a
significant impact on our business, financial condition and results of operations.
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We have incurred substantial R&D expenses as we developed more products and improved our content offerings and technologies to deliver
high quality services and value to our users. We strongly believe that R&D must be guided by the principles of commercial viability and applicability,
and we plan to continue making purpose-driven investment in technologies. We have also been able to maintain our sales and marketing expenses as a
relatively low percentage of our net revenues due to our strong brand reputation. Our ability to sell and market our products and services cost-effectively
depends on our ability to continue to leverage our existing brand value, grow and monetize our user bases, and improve our sales and marketing
efficiency.
Our ability to make successful strategic investments and acquisitions
We have made, and intend to make, strategic investments and acquisitions. Our investment and acquisition strategy is focused on strengthening
our content development and R&D capabilities, creating strategic synergies across our businesses, and enhancing our overall value. Our strategic
investments and acquisitions may affect our future financial results, including our margins and net income. In addition, some of our acquisitions and
investments may not be successful. We have recorded net investment losses in equity method investees and impairment provisions related to certain
equity investments in the past and may incur net investment losses or impairment provisions in the future.
Revenues
The following table sets forth our revenue by segment for the periods indicated:
Net revenues:
Online game services
Youdao
Innovative businesses and others
Total net revenues
2018
RMB
For the year ended December 31,
2019
RMB
2020
RMB
(in thousands)
2020
US$
40,190,057
731,598
10,256,920
51,178,575
46,422,640
1,304,883
11,513,622
59,241,145
54,608,717
3,167,515
15,890,901
73,667,133
8,369,152
485,443
2,435,387
11,289,982
We generate our revenues from the provision of online game services, Youdao and other innovative businesses and others. No customer
individually accounted for greater than 10% of our total revenues for the years ended December 31, 2018, 2019 and 2020.
Online Game Services
We generate our mobile game revenues primarily from the sale of in-game virtual items, including avatars, skills, privileges or other in-game
consumables, features or functionality, within the games. We distribute our mobile games through partnerships with major Android- and iOS-based app
stores as well as proprietary distribution channels, such as our mobile apps and websites. Users have a variety of payment options for in-game virtual
items, including using prepaid points or by making online payments through app stores and other online payment channels. Our mobile game portfolio
now consists of over 100 diverse games, and we expect to continue introducing new mobile games each year for the foreseeable future, which we believe
will contribute to future growth in net revenues from online game services.
We generate revenue from our PC games mainly through sales of prepaid points. Customers can purchase prepaid points on our NetEase online
platforms through debit or credit cards or online payment platforms through which players can directly credit points to their accounts. Customers also
can purchase virtual or physical point cards through our third-party retailers. Customers can use the points to play our PC games, either to pay for
playing time or to purchase virtual items within the games, and use our other fee-based services.
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Youdao
Youdao’s revenue consists of three parts: learning services, learning products and online marketing services. We currently generate the majority
of the revenues for Youdao’s learning services from its online courses in the form of the tuition fees received from students. We generate revenues from
Youdao’s learning products from sales of smart devices. We generate revenues from Youdao’s online marketing services through the provision of
different formats of advertisements.
Innovative Businesses and Others
We derive our innovative businesses and others revenues primarily from e-commerce, music streaming, video streaming, advertising services,
premium e-mail and other value-added services.
Seasonality of Revenues
Historically, usage of our online games has generally increased around the Chinese holidays, particularly the winter and summer school
holidays. Revenues from certain of our innovative businesses and others, including advertising services, have followed the same general seasonal trend
throughout each year, with the first quarter of the year being the weakest quarter due to the Chinese New Year holiday and the traditional close of
customers’ annual budgets, and the fourth quarter as the strongest. Our Youdao platform tends to generate higher revenues from online courses in the
second and fourth quarters as a result of increased student enrollments, when it offers more courses including, for example, test preparation courses for
school exams in the spring and fall semesters and China’s national college entrance exams, national postgraduate entrance exams and college English
tests, compared to the rest of the year. Our e-commerce business revenues are relatively lower during the Chinese New Year holiday season in the first
quarter of each year, while sales in the fourth quarter are higher than each of the preceding three quarters due to a variety of promotional activities
conducted by retail and e-commerce businesses in China.
Cost of Revenues
The following table sets forth our cost of revenues by segment for the periods indicated:
Cost of revenues:
Online game services
Youdao
Innovative businesses and others
Total cost of revenues
Online Game Services
For the year ended December 31,
2018
RMB
2019
RMB
2020
RMB
2020
US$
(in thousands)
(14,617,656)
(515,133)
(8,699,637)
(23,832,426)
(16,974,234)
(934,261)
(9,777,350)
(27,685,845)
(19,847,846)
(1,713,229)
(13,122,656)
(34,683,731)
(3,041,815)
(262,564)
(2,011,135)
(5,315,514)
Cost of revenues for our online game services consists primarily of revenue sharing costs paid to distribution channel providers and game
developers, staff costs, royalties and consultancy fees related to our licensed games, server and bandwidth service fees, service fees related to online
payments, depreciation and amortization of computers and software and other direct costs of providing these services.
Youdao
Our cost of revenues of Youdao consists primarily of revenue sharing costs paid to Youdao’s course instructors, teaching assistants and course
development personnel, staff costs, costs of course materials, costs relating to the sales of smart devices, server and bandwidth costs and traffic
acquisition costs.
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Innovative Businesses and Others
Cost of revenues related to our innovative businesses and others segment consists primarily of content costs, cost of merchandise sold in our e-
commerce business and revenue sharing costs with broadcasters. We pay content fees to third-party partners, record labels, and newspaper and magazine
publishers for the right to use proprietary content developed and licensed by them, such as copyrights of music, headline news and articles.
Operating Expenses
The following table sets forth the principal components of our operating expenses for the periods indicated:
Operating expenses:
Selling and marketing expenses
General and administrative expenses
Research and development expenses
Total operating expenses
For the year ended December 31,
2018
RMB
2019
RMB
2020
RMB
2020
US$
(in thousands)
(6,911,710)
(3,078,635)
(7,378,460)
(17,368,805)
(6,221,127)
(3,130,298)
(8,413,224)
(17,764,649)
(10,703,788)
(3,371,827)
(10,369,382)
(24,444,997)
(1,640,427)
(516,755)
(1,589,177)
(3,746,359)
Operating expenses include selling and marketing expenses, general and administrative expenses and research and development expenses.
Selling and Marketing Expenses
Selling and marketing expenses consist primarily of salary and welfare expenses, shipping and handling costs, compensation costs for our sales
and marketing staff, and marketing and advertising expenses payable to third-party vendors, internet companies and agents.
General and Administrative Expenses
General and administrative expenses consist primarily of salary and welfare expenses, compensation costs for our general administrative and
management staff, office rental, legal, professional and consultancy fees, bad debt expenses/expected credit loss, recruiting expenses, travel expenses and
depreciation charges.
Research and Development Expenses
Research and development expenses consist principally of salary and welfare expenses and compensation costs for our research and
development professionals.
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Share-Based Compensation Cost
The following table sets forth the allocation of our share-based compensation costs for the periods indicated:
Share-based compensation cost included in:
Cost of revenues
Selling and marketing expenses
General and administrative expenses
Research and development expenses
Total
NetEase 2009 and 2019 Restricted Share Unit Plans
For the year ended December 31,
2018
RMB
2019
RMB
2020
RMB
2020
US$
(in thousands)
757,341
102,638
787,200
824,552
2,471,731
758,810
84,920
797,120
763,239
2,404,089
794,855
102,300
929,013
837,321
2,663,489
121,817
15,678
142,377
128,326
408,198
In October 2019, we adopted our 2019 Restricted Share Unit Plan, or the 2019 RSU Plan, for our employees, directors and consultants. We have
reserved 322,458,300 ordinary shares for issuance under this plan. The 2019 RSU Plan was adopted by a resolution of the board of directors and became
effective on October 15, 2019 for a term of ten years unless sooner terminated.
In November 2009, we adopted our 2009 Restricted Share Unit Plan, or the 2009 RSU Plan, for our employees, directors and consultants. We
reserved 323,694,050 ordinary shares for issuance under this plan. The 2009 RSU Plan expired on November 16, 2019 in accordance with its terms.
For the years ended December 31, 2018, 2019 and 2020, we recorded share-based compensation cost of approximately RMB2,471.7 million,
RMB2,404.1 million and RMB2,663.5 million (US$408.2 million), respectively, for awards granted under the 2009 RSU Plan and 2019 RSU Plan, as
well as the other share incentive plans discussed as below. This cost has been allocated to (i) cost of revenues, (ii) selling and marketing expenses, (iii)
general and administrative expenses, and (iv) research and development expenses, depending on the responsibilities of the relevant employees.
As of December 31, 2020, total unrecognized compensation cost related to unvested awards granted under the 2009 RSU Plan and 2019 RSU
Plan, adjusted for estimated forfeitures, was RMB2,289.6 million (US$350.9 million), which is expected to be recognized through the remaining vesting
period of each grant. As of December 31, 2020, the weighted average remaining vesting period was 2.25 years.
Other Share Incentive Plans
Beginning in 2014, certain of our subsidiaries granted options exercisable for ordinary shares to certain of our employees. The options expire
five to ten years from the date of grant and either vest or have a vesting commencement date upon certain conditions being met. The awards can become
100% vested on the vesting commencement date, or vest in two, three, four or five substantially equal annual installments with the first installment
vesting on the vesting commencement date. For the years ended December 31, 2018, 2019 and 2020, we recorded RMB32.0 million, RMB56.2 million
and RMB117.7 million (US$18.0 million), respectively in compensation expenses for the share options granted under these plans.
While certain share options which have been granted will become vested or would commence vesting upon their applicable vesting
commencement date, the occurrence of the applicable vesting conditions is not within our control and is not deemed probable to occur for accounting
purposes until the vesting commencement date. For such share options, zero compensation expenses were recorded. As of December 31, 2020, there
were RMB170.0 million (US$26.1 million) in unrecognized share-based compensation expenses related to such share options which are expected to be
recognized when the relevant vesting conditions are met.
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Income Taxes
Cayman Islands
Under the current laws of the Cayman Islands, we and our intermediate holding companies which are incorporated in the Cayman Islands, are
not subject to tax on income or capital gain. Additionally, upon payments of dividends by us to our shareholders or by our intermediate holding
companies in the Cayman Islands to us, no Cayman Islands withholding tax will be imposed.
British Virgin Islands (“BVI”)
Our subsidiaries in the BVI are exempted from income tax on its foreign-derived income in the BVI. There are no withholding taxes in the BVI.
Hong Kong
Our subsidiaries in Hong Kong were subject to income tax on their taxable income generated from operations in Hong Kong at a rate of 16.5%.
For the years 2018, 2019 and 2020, the first HK$2 million of profits earned by one of our subsidiaries incorporated in Hong Kong is taxed at a rate of
8.25%, while the remaining profits will continue to be taxed at the 16.5% tax rate. The payments of dividends by these companies to us are not subject to
any Hong Kong withholding tax.
China
The PRC Enterprise Income Tax Law subjects Foreign Invested Enterprises (“FIEs”) and domestic companies to EIT at a uniform rate of 25%,
and preferential tax treatments may be granted to FIEs or domestic companies which conduct businesses in certain encouraged sectors and to entities
otherwise classified as HNTEs, “Software Enterprises” or “Key Software Enterprises.”
Boguan, NetEase Hangzhou and certain of our other PRC subsidiaries and affiliated entities were qualified as HNTEs and enjoyed a preferential
tax rate of 15% for 2018, 2019 and 2020. In 2018, 2019 and 2020, Boguan, NetEase Hangzhou and certain of our other PRC subsidiaries and affiliated
entities were each also qualified as a Key Software Enterprise and enjoyed a further reduced preferential tax rate of 10% for 2017, 2018 and 2019. The
related tax benefit was recorded in 2018, 2019 and 2020, respectively.
The foregoing preferential income tax rates, however, are subject to periodic review and renewal by PRC authorities.
Sales Tax
Pursuant to the Provisional Regulation of the PRC on Value Added Tax, or VAT, and its implementation rules, or Provisional VAT Regulation,
our PRC subsidiaries and VIEs are generally subject to VAT at a rate of 6% for revenues earned from rendering services. Our sales of general goods to
our customers in the PRC are also subject to VAT, which was 17% until May 1, 2018, 16% from May 1, 2018 to April 1, 2019 and 13% thereafter.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements requires our management to make estimates and assumptions that affect the amounts
reported in the consolidated financial statements. Our management periodically re-evaluates these estimates and assumptions based on historical
experience and other factors, including expectations of future events that they believe to be reasonable under the circumstances. Actual results may differ
significantly from those estimates and assumptions. We have identified the following accounting policies and estimates as the most critical to an
understanding of our financial position and results of operations, because the application of these policies requires significant and complex management
estimates, assumptions and judgment, and the reporting of materially different amounts could result if different estimates or assumptions were used or
different judgments were made.
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Basis of Consolidation
Our consolidated financial statements include the financial statements of our subsidiaries and VIEs for which we are the primary beneficiary
with the ownership interests of minority shareholders reported as noncontrolling interests. All significant transactions and balances among the Company,
our subsidiaries and VIEs have been eliminated upon consolidation. We consolidate a VIE if we have the power to direct matters that most significantly
impact the activities of the VIE, and have the obligation to absorb losses or the right to receive benefits of the VIE that could potentially be significant to
the VIE.
Revenue Recognition
On January 1, 2018, we adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of
January 1, 2018. The impact of adopting the new revenue standard was not material to the consolidated financial statements.
Revenues from contracts with customers are recognized when control of the promised goods or services is transferred to our customers, in an
amount that reflects the consideration we expect to be entitled to in exchange for those goods or services, reduced by estimates for return allowances,
promotional discounts, rebates and VAT. The recognition of revenues involves certain management judgments, including estimated lives of virtual items
purchased by game players, estimated breakage of game points, return allowance for goods sold, the estimation of the fair value of an advertising-for-
advertising barter transaction, and the volume of sales rebates. The amount and timing of our revenues can be different if management made different
judgments or utilized different estimates.
We operate mobile games and PC games. We are the principal of all games we operate, including both in-house developed games and licensed
games. As all these games are hosted on our servers, we have the pricing discretion, and are responsible for the sale and marketing of the games as well
as any related customer services. Fees paid to game developers, distribution channels (for example, app stores) and payment channels are recorded as
cost of revenues.
Mobile Games
We generate mobile game revenues from the sale of in-game virtual items, including avatars, skills, privileges or other in-game consumables,
features or functionality, within the games. The performance obligation is to provide on-going game services to the game players who have purchased
such virtual items and is satisfied over the average playing period of the paying players. Accordingly, we recognize the revenues ratably over the
estimated average playing period of these paying players.
We consider the average period that players typically play the games and other game player behavior patterns, as well as various other factors to
arrive at the best estimates for the estimated playing period of the paying players for each game based on players’ historical churn rate. If a new game is
launched and only a limited period of paying player data is available, then we consider other qualitative factors, such as the playing patterns for paying
users for other games with similar characteristics and playing patterns of paying players, such as targeted players and purchasing frequency. While we
believe our estimates to be reasonable based on available game player information, we may revise such estimates based on new information indicating a
change in the game player behavior patterns and any adjustments are applied prospectively.
PC Games
We sell prepaid points to players of our PC games. Customers can purchase “virtual” prepaid points online or from the vendors who register the
points in our system via debit and credit cards or bank transfers via the online payment services platforms, and receive the prepaid point information over
the internet. Our game players can use the points to play our PC games, pay for in-game items and use other fee-based services. Proceeds received from
the sales of prepaid points to players are recorded as deferred revenues.
We earn revenue through providing PC game services to players under two types of revenue models: the time-based revenue model and item-
based revenue model. For PC games using the time-based model, players are charged based on the time they spend playing games. Revenues are
recognized ratably over the game playing period as the performance obligations are satisfied.
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Under the item-based model, the basic game play functions are free of charge, and players are charged for purchases of in-game items. In-game
items have different life patterns: one-time use, limited life and permanent life. Revenues from the sales of one-time use in-game items are recognized
upon consumption. Limited life items are either limited by the number of uses (for example, 10 times) or limited by time (for example, three months).
Revenues from the sales of limited life in-game items are recognized ratably based on the extent of time passed or expired or when the items are fully
used. Players are allowed to use permanent life in-game items without any use or time limits. Revenues from the sales of permanent life in-game items
are recognized ratably over the estimated average playing period of the paying players.
We consider the average period that players typically play the games and other game player behavior patterns, as well as various other factors,
including the acceptance and popularity of expansion packs, promotional events launched and market conditions to arrive at the best estimates of the
estimated average playing period of the paying players for the permanent in-game items of each PC game based on players’ historical churn rate. This
estimate is re-assessed on a quarterly basis. Adjustments arising from changes in the estimated playing period of paying players are applied
prospectively as such changes result from new information indicating a change in the game player behavior patterns.
Youdao’s Online Courses Services
Youdao’s services consist of online courses delivered via live streaming, other activities during the online live streaming period and content
playback services. The aforementioned services are highly interdependent and interrelated in the context of the contract and are only considered
accessory services to the online live streaming courses, and therefore are not distinct and are not sold standalone. As a result, a live streaming course is
accounted for as a single performance obligation which is satisfied over its learning period. The revenues generated from our live streaming courses are
recognized ratably over an average of the learning periods of our live streaming courses. We consider the average length of period during which students
typically spend time on viewing the courses, as well as other learning behavior patterns, to arrive at the best estimates for the length of the period during
the students view playback of the course recordings.
Advertising services
We derive our advertising revenues principally from short-term online advertising contracts. Advertising service contracts may consist of
multiple performance obligations with a typical term of less than three months. In arrangements where we have multiple performance obligations, the
transaction price is allocated to each performance obligation using the relative stand-alone selling price. We generally determine standalone selling prices
based on the prices charged to customers. If the performance obligation has not been sold separately, we estimate the standalone selling price by taking
into consideration of the pricing for advertising areas of our platform with a similar advertisement with similar formats and quoted prices from
competitors as well as other market conditions. The price allocated to each performance obligation is recognized as revenue over the advertisement
display period, which is usually within three months.
We also enter into performance-based advertising arrangements with customers. For cost per mile or cost per thousand impressions advertising
arrangements with customers, we recognize revenues based on the number of times that the advertisement has been displayed; and for cost per action
advertising arrangements with customers, including Youdao online marketing services, we recognize revenues based on the number of actions completed
through the advertisements, e.g., when users click on links.
Certain customers may receive volume rebates, which are accounted for as variable consideration. We estimate annual expected rebate volume
with reference to their historical results and then reduce revenues recognized.
We recognize revenue from providing advertising service in exchange for non-cash consideration, usually advertising services, promotional
benefits, content, consulting services and software provided by counterparties, at the fair value of the non-cash consideration measured as of contract
inception date. If we are not able to reliably determine the fair value of noncash consideration, the value of the noncash consideration received is
measured indirectly by reference to the standalone selling price of advertising services provided by us.
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E-commerce
Our e-commerce revenue is primarily from our private label e-commerce platform Yanxuan. We are the principal for the online direct sales, as
we control the inventory before the goods are transferred to customers. We have the primary responsibility for fulfilling the contracts, bear the inventory
risk, and have sole discretion in establishing the prices. E-commerce revenues from online direct sales are recognized when control of the goods is
transferred to the customer, which generally occurs upon delivery to the customer. We also provide discount coupons to our customers for use in
purchases on the Yanxuan platform, which are treated as a reduction of revenue when the related transaction is recognized.
Return allowances, which reduce revenue and cost of sales, are estimated using historical experience. Liabilities for return allowances and rights
to recover products from customers associated with our liabilities are recorded as “Accrue liabilities and other payables” and “Inventories, net”,
respectively, on our consolidated balance sheets.
Fee-Based Premium Services
Fee-based premium services revenues, mostly operated on either consumption-basis or a monthly subscription basis, are derived principally
from providing premium live streaming services, online music services, online reading, e-mail and other innovative services. Prepaid subscription fees
collected from customers are deferred and are recognized as revenue on a straight-line basis by us over the subscription period, during which customers
can access the premium online services provided by us. Fees collected from customer to be consumed to purchase online services are recognized as
revenue when related services are rendered.
We generate revenue from the operation of its live streaming platforms whereby users can enjoy live performances provided by the hosts and
interact with the hosts. Most of the hosts host the performance on their own. We create and sell virtual items to users so that the users present them
simultaneously to hosts to show their support. The virtual items sold by us comprise of either (i) consumable items or (ii) time-based item, such as
privilege titles etc. Under the arrangements with the hosts, we share with them a portion of the revenues derived from the sales of virtual items. Revenues
derived from the sale of virtual items are recorded on a gross basis as we act as the principal to fulfill all obligations related to the sale of virtual items.
Accordingly, revenue is recognized when the virtual item is delivered and consumed if the virtual item is a consumable item or, in the case of time-based
virtual item, recognized ratably over the period each virtual item is made available to the user.
Practical Expedients
We have used the following practical expedients as allowed under ASC 606:
(i)
The effects of a significant financing component are not taken into account for contracts if we expect, at contract inception, that the
period between when we transfer a promised good or service to the customer and when the customer pays for that good or service will be one year or
less.
(ii) We apply the portfolio approach in determining the commencement date of consumption of permanent virtual items and the estimated
average playing period of paying players for our PC games and mobile games for the recognition of online game revenue given that the effect of applying
a portfolio approach to a group game players’ behaviors does not differ materially from considering each one of them individually.
(iii) We elect to expense certain costs to obtain a contract as incurred when the expected amortization period is one year or less.
Contract Balances
Timing of revenue recognition may differ from the timing of invoicing to customers. Accounts receivables represent amounts invoiced and
revenue recognized prior to invoicing, when we have satisfied our performance obligations and have the unconditional right to payment.
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Investments
Short-Term Investments
Short-term investments include investments in financial instruments with a variable interest rate indexed to performance of underlying assets
and investments that we intend, and have the ability, to hold to maturity.
In accordance with ASC 825, for investments in financial instruments with a variable interest rate indexed to performance of underlying assets,
we elected the fair value method at the date of initial recognition and carried these investments at fair value. Changes in the fair value are reflected in the
consolidated statements of operations and comprehensive income as other income/(expense). Fair value is estimated based on quoted prices of similar
products provided by banks at the end of each period. We classify the valuation techniques that use these inputs as Level 2 of fair value measurements.
Long-Term Investments
Long-term investments are comprised of equity investments in publicly traded companies, privately-held companies and limited partnerships.
Equity investments in publicly traded companies are reported at fair value as equity investment with readily determinable fair value. Unrealized
gains and losses for the years ended December 31, 2018, 2019 and 2020 are recognized in other income/(expense).
For investments in common stock or in-substance commons stocks issued by privately-held companies over which we did not have significant
influence, and investments in privately-held companies’ shares that are not common stock or in- substance common stocks, as these securities do not
have readily determinable fair value, we measure these investments at cost, less impairment, if any, plus or minus changes resulting from observable
price changes in orderly transactions for the same or a similar investment in the same issuer (referred to as the measurement alternative). All gains and
losses on these equity securities without readily determinable fair value, realized and unrealized, are recognized in other income/(expense).
Investments in common stock or in-substance common stock of investees and limited partnership investments in which we are in a position to
exercise significant influence by participating in, but not controlling or jointly controlling, the financial and operating policies are accounted for using the
equity method.
Management regularly evaluates the impairment of the investments in privately-held companies without readily determinable fair value and
equity method investments at each balance sheet date, or more frequently if events or circumstances indicate that the carrying amount may not be
recoverable. For investments without readily determinable fair values, management performs a qualitative assessment of the fair value of the equity
interest in comparison to its carrying amount to determine if there is an indication of potential impairment. If such indication exists, management
estimates the fair value of the investment and records an impairment in the consolidated statements of operations comprehensive income to the extent the
carrying amount exceeds the fair value. Significant judgments management applies in the impairment assessment for these equity investments include: (i)
the determination as to whether any impairment indicators exist during the year; (ii) the selection of valuation methods; (iii) the determination of
significant assumptions used to value the equity investments, including selection of comparable companies and multiples, timing and probabilities of
different scenarios, estimated volatility rate, risk-free rate and discount for lack of marketability; and (iv) judgments as to whether a decline in value of
equity method investments was other than temporary. For equity method investments, management considers an investment impaired when events or
circumstances suggest the carrying amount may not be recoverable and recognizes any impairment charge in the consolidated statements of operations
and comprehensive income for a decline in value that is determined to be other than temporary.
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Results of Operations
The following table sets forth a summary of our audited consolidated statements of operations for the periods indicated both in Renminbi and as
a percentage of total revenues. In September 2019, we sold our Kaola e-commerce business to Alibaba. As a result, Kaola has been deconsolidated and
Kaola’s historical financial results are reflected in our audited consolidated financial statements as discontinued operations accordingly. Unless otherwise
stated, financial results discussed herein refer to our continuing operations.
Statement of Operations and Comprehensive Income Data:
Net revenues
Cost of revenues
Gross profit
Operating expenses:
Selling and marketing expenses
General and administrative expenses
Research and development expenses
Total operating expenses
Operating profit
Other income/(expenses)
Investment (losses)/income, net
Interest income, net
Exchange (losses)/gains, net
Other, net
Income before tax
Income tax
Net income from continuing operations
Net(loss)/income from discontinued operations
Net income
Accretion and deemed dividends in connection with repurchase of redeemable
noncontrolling interests
Net (income)/loss attributable to noncontrolling interests and redeemable
noncontrolling interests
Net income attributable to NetEase, Inc.’s shareholders
Share-based compensation cost included in:
Cost of revenues
Selling and marketing expenses
General and administrative expenses
Research and development expenses
For the year ended December 31,
2018
2019
RMB
%
RMB
%
(in thousands)
RMB
2020
US$
51,178,575
(23,832,426)
27,346,149
100.0
(46.6)
53.4
59,241,145
(27,685,845)
31,555,300
100.0
(46.7)
53.3
73,667,133
(34,683,731)
38,983,402
11,289,982
(5,315,514)
5,974,468
(6,911,710)
(3,078,635)
(7,378,460)
(17,368,805)
9,977,344
(22,383)
586,671
(51,799)
586,916
11,076,749
(2,460,650)
8,616,099
(2,138,682)
6,477,417
(13.5)
(6.0)
(14.4)
(33.9)
19.5
—
1.1
(0.1)
1.1
21.6
(4.8)
16.8
(4.2)
12.6
(6,221,127)
(3,130,298)
(8,413,224)
(17,764,649)
13,790,651
1,306,320
821,774
25,166
439,422
16,383,333
(2,914,726)
13,468,607
7,962,519
21,431,126
(10.5)
(5.3)
(14.2)
(30.0)
23.3
2.2
1.4
—
0.7
27.6
(4.9)
22.7
13.4
36.1
(10,703,788)
(3,371,827)
(10,369,382)
(24,444,997)
14,538,405
1,610,045
1,598,618
(3,112,152)
737,168
15,372,084
(3,041,849)
12,330,235
—
12,330,235
(1,640,427)
(516,755)
(1,589,177)
(3,746,359)
2,228,109
246,750
244,999
(476,958)
112,976
2,355,876
(466,184)
1,889,692
—
1,889,692
(248,098)
(0.5)
(271,543)
(0.5)
(787,029)
(120,617)
(76,912)
6,152,407
(0.2)
11.9
77,933
21,237,516
0.1
35.7
519,548
12,062,754
79,624
1,848,699
757,341
102,638
787,200
824,552
1.5
0.2
1.5
1.6
758,810
84,920
797,120
763,239
1.3
0.1
1.3
1.3
794,855
102,300
929,013
837,321
121,817
15,678
142,377
128,326
%
100.0
(47.1)
52.9
(14.5)
(4.6)
(14.1)
(33.2)
19.7
2.2
2.2
(4.2)
1.0
20.9
(4.1)
16.8
—
16.8
(1.1)
0.7
16.4
1.1
0.1
1.3
1.1
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Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
We have organized our operations into the following segments: online game services, Youdao and innovative businesses and others. These
segments reflect the way we evaluate, view and run our business operations. The following table sets forth the net revenues and cost of revenues by
segment for the period presented as derived from our audited financial statements.
Net revenues:
Online game services
Youdao
Innovative businesses and others
Total net revenues
Cost of revenues:
Online game services
Youdao
Innovative businesses and others
Total cost of revenues
Net revenues
2019
RMB
For the year ended December 31,
2020
RMB
(in thousands)
2020
US$
46,422,640
1,304,883
11,513,622
59,241,145
(16,974,234)
(934,261)
(9,777,350)
(27,685,845)
54,608,717
3,167,515
15,890,901
73,667,133
(19,847,846)
(1,713,229)
(13,122,656)
(34,683,731)
8,369,152
485,443
2,435,387
11,289,982
(3,041,815)
(262,564)
(2,011,135)
(5,315,514)
Total net revenues increased by 24.4% to RMB73,667.1 million (US$11,290.0 million) in 2020 from RMB59,241.1 million in 2019. Net
revenues from online game services, Youdao and innovative businesses and others constituted 74.1%, 4.3% and 21.6%, respectively, of our total net
revenues in 2020, compared with 78.4%, 2.2% and 19.4%, respectively, in 2019.
Online Game Services
Net revenues from online game services increased by 17.6% to RMB54,608.7 million (US$8,369.2 million) in 2020 from RMB46,422.6 million
in 2019. The increase was principally attributable to the strong performance of mobile games such as Fantasy Westward Journey 3D, Fantasy Westward
Journey H5, Fantasy Westward Journey mobile games, Invincible, Sky, Life-after and Knives out, as well as PC games such as Fantasy Westward Journey
Online and New Westward Journey Online II, as well as World of Warcraft licensed from Blizzard Entertainment, Inc. (together with its affiliated
companies, “Blizzard”). Our mobile game portfolio now consists of over 100 diverse games. Net revenues from mobile games and PC games represented
71.9% and 28.1% of total net revenues from online game services in 2020, respectively, compared to 71.4% and 28.6% in 2019, respectively.
Net revenues from our in-house developed games increased by 14.1% to RMB47,885.6 million (US$7,338.8 million) in 2020 from
RMB41,965.6 million in 2019 as a result of the expansion in our offering of in-house developed games, in particular our mobile games, which gained
popularity in 2020. Net revenues from licensed games increased by 50.8% to RMB6,723.1 million (US$1,030.4 million) in 2020 from RMB4,457.0
million in 2019, which was mainly attributable to World of Warcraft licensed from Blizzard and certain other licensed games. Net revenues generated
from licensed games represented 9.1% and 7.5% of our total net revenues in 2020 and 2019, respectively.
Youdao
Net revenues from our Youdao segment increased by 142.7% to RMB3,167.5 million (US$485.4 million) in 2020 from RMB1,304.9 million in
2019. The increase was mainly attributable to the increased revenue from its learning services and learning products.
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Innovative Businesses and Others
Net revenues from the innovative businesses and others segment increased by 38.0% to RMB15,890.9 million (US$2,435.4 million) in 2020
from RMB11,513.6 million in 2019. This increase mainly resulted from increases in revenue contribution by our NetEase Cloud Music, NetEase CC live
streaming and Yanxuan e-commerce businesses.
Cost of Revenues
Our cost of revenues increase by 25.3% to RMB34,683.7 million (US$5,315.5 million) in 2020 from RMB27,685.8 million in 2019. The year-
over-year increase was mainly due to an increase in revenue sharing costs with distribution channel providers, game developers and other third parties
and content costs. In 2020, costs relating to online game services, Youdao and innovative businesses and others represented 57.2%, 4.9% and 37.9% of
total cost of revenues, respectively, as compared with 61.3%, 3.4% and 35.3% of the total cost of revenues, respectively, in 2019.
Online Game Services
Cost of revenues from our online game services increased by 16.9% to RMB19,847.8 million (US$3,041.8 million) in 2020 from RMB16,974.2
million in 2019. The increase in cost of revenues in 2020 was primarily due to an increase in revenue sharing costs with distribution channel providers,
game developers and other third parties related to mobile games, which was primarily due to the launch of various in-house developed and licensed
mobile games in 2020.
Youdao
Cost of revenues from Youdao increased by 83.4% to RMB1,713.2 million (US$262.6 million) in 2020 from RMB934.3 million in 2019, which
was primarily attributable to increased revenue sharing costs with key instructors and payroll related expenses to support the promotion and expansion of
Youdao’s online course offerings.
Innovative Businesses and Others
Cost of revenues from our innovative businesses and others increased by 34.2% to RMB13,122.7 million (US$2,011.1 million) in 2020 from
RMB9,777.4 million in 2019. The increase in cost of revenues in 2020 was primarily due to increased revenue sharing costs and content costs related to
our NetEase CC live streaming and NetEase Cloud Music platforms, as well as the increased cost of merchandise sold in our E-commerce business,
which is in line with the increase in revenue.
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Gross Profit
Our gross profit increased by 23.5% to RMB38,983.4 million (US$5,974.5 million) in 2020 from RMB31,555.3 million in 2019.
The following table sets forth the consolidated gross profits and gross profit margins of our business activities for the periods indicated as
derived from our audited financial statements. The gross profit margins in 2019 and 2020 were calculated by dividing our gross profits over our net
revenues for the corresponding type of services.
Gross profit:
Online game services
Youdao
Innovative businesses and others
Total gross profit
Gross profit margin:
Online game services
Youdao
Innovative businesses and others
Total gross profit margin
2019
RMB
For the year ended December 31,
2020
RMB
(in thousands)
2020
US$
29,448,406
370,622
1,736,272
31,555,300
34,760,871
1,454,286
2,768,245
38,983,402
5,327,337
222,879
424,252
5,974,468
63.4 %
28.4 %
15.1 %
53.3 %
63.7 %
45.9 %
17.4 %
52.9 %
63.7 %
45.9 %
17.4 %
52.9 %
Our gross profit margin for online game services in 2020 remained stable compared to 2019. The increase in gross profit margin in 2020 for
Youdao was mainly due to increased revenues, improved economies of scale and faculty compensation structure optimization related to its learning
services and learning products. The increase in gross profit margin in 2020 for innovative businesses and others was mainly due to improved
performance from NetEase Cloud Music.
Operating Expenses
Total operating expenses increased by 37.6% to RMB24,445.0 million (US$3,746.4 million) in 2020 from RMB17,764.6 million in 2019 as a
result of increased marketing expenditures related to online game services and Youdao, as well as higher staff-related costs and research and development
investments. The following table sets forth our operating expenses for the periods indicated as derived from our audited financial statements.
Selling and marketing expenses
General and administrative expenses
Research and development expenses
Total operating expenses
2019
RMB
For the year ended December 31,
2020
RMB
(in thousands)
(10,703,788)
(3,371,827)
(10,369,382)
(24,444,997)
(6,221,127)
(3,130,298)
(8,413,224)
(17,764,649)
2020
US$
(1,640,427)
(516,755)
(1,589,177)
(3,746,359)
Selling and marketing expenses increased by 72.1% to RMB10,703.8 million (US$1,640.4 million) in 2020 from RMB6,221.1 million in 2019,
primarily due to the increased marketing spending on our online games and Youdao learning services.
General and administrative expenses increased by 7.7% to RMB3,371.8 million (US$516.8 million) in 2020 from RMB3,130.3 million in 2019,
primarily due to an increase in professional expesnes and staff-related costs driven by higher compensation levels.
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Research and development expenses increased by 23.3% to RMB10,369.4 million (US$1,589.2 million) in 2020 from RMB8,413.2 million in
2019, primarily due to an increase in staff-related costs, mainly as a result of increased headcount for our online game services and Youdao as well as
higher salaries, bonuses and other benefits paid to our research and development teams.
Other Income/(Expenses)
The following table sets forth our other income/(expenses) for the periods indicated as derived from our audited financial statements.
Investment income, net
Interest income, net
Exchange gains/(losses), net
Other, net
2019
RMB
For the year ended December 31,
2020
RMB
(in thousands)
2020
US$
1,306,320
821,774
25,166
439,422
1,610,045
1,598,618
(3,112,152)
737,168
246,750
244,999
(476,958)
112,976
Other income/(expenses) in 2020 mainly consisted of investment income related to short-term investments, interest income, government
incentives, net foreign exchange losses, impairment provisions related to certain equity investments, net investment gain in equity method investees and
fair value change related to our equity investments with readily determinable fair value.
Investment income was RMB1,610.0 million (US$246.8 million) in 2020 compared to investment income of RMB1,306.3 million in 2019,
consisting primarily of (i) an gain from fair value change related to the equity investments with readily determinable fair value of RMB720.6 million
(US$110.4 million) compared to RMB751.7 million in 2019, (ii) investment income related to short-term investments of RMB580.7 million (US$89.0
million) in 2020 compared to RMB657.6 million in 2019, (iii) a net investment gain in equity method investeees of RMB172.5 million (US$26.4 million)
in 2020 compared to RMB4.3 million in 2019 and (iv) a revaluation gain from a previously held equity investee of RMB130.1 million (US$19.9 million)
in 2020 compared to nil in 2019, which was offset in part by impairment provisions related to certain investments of RMB55.6 million (US$8.5 million),
compared to RMB176.4 million in 2019.
Interest income increased to RMB1,598.6 million (US$245.0 million) in 2020 from RMB821.8 million in 2019, primarily due to an increase of
RMB25.0 billion (US$3.8 billion) in our net cash balance, which includes total cash and cash equivalents, time deposits and restricted cash balance
minus short-term loans. We incurred interest expenses of RMB247.8 million (US$38.0 million) in 2020 related to our short-term loans.
We also incurred net foreign exchange losses of RMB3,112.2 million (US$477.0 million) in 2020, compared to net foreign exchange gains of
RMB25.2 million in 2019, primarily due to the translation gains and losses arising from our U.S. dollar denominated bank deposit and short-term loan
balances as the exchange rate of the U.S. dollar against the RMB fluctuated over these periods.
Other, net increased to RMB737.2 million (US$113.0 million) in 2020 from RMB439.4 million in 2019. We received and recognized
unconditional government incentives of approximately RMB759.8 million (US$116.4 million) in 2020, compared to RMB368.2 million in 2019. In 2020,
we also made donations of RMB78.6 million (US$12.0 million) to charities which provided support to fight against the COVID-19 pandemic.
Income Tax
Income tax increased to RMB3,041.8 million (US$466.2 million) in 2020 from RMB2,914.7 million in 2019. Our effective tax rate in 2020 was
19.8% compared with 17.8% in 2019. The change in the effective tax rate was mainly due to increased losses from certain of our subsidiareis.
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Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
For a discussion of our results of operations for the year ended December 31, 2019 compared with the year ended December 31, 2018, see “Item
5. Operating and Financial Review and Prospects — A. Operating Results — Year Ended December 31, 2019 Compared to Year Ended December 31,
2018” of our annual report on Form 20-F for the fiscal year ended December 31, 2019, filed with the SEC on April 29, 2020.
B. LIQUIDITY AND CAPITAL RESOURCES
To date, we have financed our operations primarily through operating cash flows and existing capital resources. As of December 31, 2020, we
had RMB9,117.2 million (US$1,397.3 million) in cash and cash equivalents, RMB77,709.3 million (US$11,909.5 million) in time deposits and
RMB13,273.0 million (US$2,034.2 million) in short-term investments. Net cash provided by continuing operating activities was RMB24,888.2 million
(US$3,814.3 million) in 2020. We had short-term borrowings of RMB19,504.7 million (US$2,989.2 million) as of December 31, 2020. On August 9,
2018, we entered into a three-year US$500.0 million revolving loan facility agreement with a group of four arrangers. The facility was priced at 95 basis
points over LIBOR and has a commitment fee of 0.20% on the undrawn portion. As of December 31, 2020, we had drawn down the entire credit facility.
We also entered into several uncommitted loan credit facility agreements provided by certain financial institution. As at December 31, 2020, US$1,410.6
million of such credit facilities had not been utilized.
We believe that our current levels of cash and cash equivalents, cash flows from operations and short-term investments will be sufficient to meet
our anticipated cash needs for at least the next 12 months. However, we may need additional cash resources if we experience changed business
conditions or other developments. We may also need additional cash resources if we find and wish to pursue opportunities for investment, acquisition,
strategic cooperation or other similar action. If we determine that our cash requirements exceed our amounts of cash and cash equivalents on hand, we
may seek to issue debt or equity securities or obtain a credit facility. Any issuance of equity securities could cause dilution for our shareholders. Any
incurrence of indebtedness could increase our debt service obligations and cause us to be subject to restrictive operating and finance covenants. It is
possible that, when we need additional cash resources, financing will only be available to us in amounts or on terms that would not be acceptable to us or
financing will not be available at all.
Cash Flows
The following table sets forth summary consolidated cash flow data for the periods indicated as derived from our audited financial statements.
We sold our Kaola e-commerce business in September 2019, and Kaola’s historical financial results are reflected in our audited consolidated financial
statements as discontinued operations accordingly. Unless otherwise stated, cash flows discussed herein refer to our continuing activities only.
Net cash provided by continuing operating activities
Net cash used in continuing investing activities
Net cash provided by financing activities
Continuing Operating Activities
2018
RMB
For the year ended December 31,
2019
RMB
2020
RMB
2020
US$
(in thousands)
14,659,843
(14,999,696)
1,587,419
16,910,971
(21,304,489)
1,082,525
24,888,171
(29,192,407)
9,913,087
3,814,281
(4,473,933)
1,519,246
Net cash provided by continuing operating activities was RMB24,888.2 million (US$3,814.3 million), RMB16,911.0 million and RMB14,659.8
million for the years ended December 31, 2020, 2019 and 2018, respectively.
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For the year ended December 31, 2020, cash provided by continuing operating activities consisted primarily of (i) our net income from
continuing operations of RMB12,330.2 million (US$1,889.7 million), (ii) depreciation and amortization charges of RMB3,457.8 million (US$529.9
million), (iii) unrealized exchange loss of RMB3,102.5 million (US$475.5 million), (iv) share-based compensation cost of RMB2,663.5 million
(US$408.2 million), (v) an increase in deferred revenue of RMB2,342.9 million (US$359.1 million), (vi) an increase in payables of RMB1,816.2 million
(US$278.3million), including content costs, bonus and professional and technical charges, and (vi) an increase in tax payables of RMB1,126.6 million
(US$172.7 million), partially offset by (A) fair value change of equity security investments of RMB720.6 million (US$110.4 million), (B) fair value
changes of short-term investments of RMB580.7 million (US$89.0 million), (C) an increase in accounts receivable, prepayments and other current assets
of RMB544.0 million (US$83.4 million), and (D) share of results on equity method investees and revaluating gain from previously held equity interest of
RMB302.6 million (US$46.4 million).
For the year ended December 31, 2019, cash provided by continuing operating activities consisted primarily of (i) our net income from
continuing operations of RMB13,468.6 million, (ii) depreciation and amortization charges of RMB2,613.8 million, (iii) share-based compensation cost of
RMB2,404.1 million, (iv) an increase in deferred revenue of RMB883.7 million, (v) a decrease in inventories of RMB415.1 million, and (vi) impairment
loss for investment of RMB177.6 million, partially offset by (A) an increase in accounts receivable, prepayments and other current assets of RMB1,499.9
million, (B) fair value change of equity security investments and other financial instruments of RMB751.7 million, and (C) fair value changes of short-
term investments of RMB657.6 million.
For the year ended December 31, 2018, cash provided by continuing operating activities consisted primarily of (i) our net income from
continuing operations of RMB8,616.1 million, (ii) share-based compensation cost of RMB2,471.7 million, (iii) depreciation and amortization charges of
RMB2,060.1 million, (iv) an increase in deferred revenue of RMB1,757.9 million, (v) an increase in accounts payable and other liabilities of RMB641.8
million, including content fees, bandwidth cost, bonuses, marketing expenses and sales of game cards, (vi) an increase in taxes payable of RMB685.0
million, (vii) fair value change of equity security investments and other financial instruments of RMB248.2 million, and (viii) impairment loss for
investment of RMB159.7 million, partially offset by (A) an increase in accounts receivable, prepayments and other current assets of RMB1,331.7
million, (B) fair value changes of short-term investments of RMB463.5 million, and (C) gains on disposal of long-term investments, business and
subsidiaries of RMB213.3 million.
Continuing Investing Activities
Net cash used in continuing investing activities was RMB29,192.4 million (US$4,473.9 million), RMB21,304.5 million and RMB14,999.7
million for the years ended December 31, 2020, 2019 and 2018, respectively.
For the year ended December 31, 2020, cash used in continuing investing activities mainly consisted of (i) placement/rollover of matured time
deposits of RMB91,518.8 million (US$14,025.9 million), (ii) purchase of short-term investments of RMB19,905.0 million (US$3,050.6 million), (iii)
purchase of intangible assets, content and licensed copyrights of RMB2,234.9 million (US$342.5 million), (iv) investment in other equity investments
and acquisition of subsidiaries of RMB2,062.0 million (US$316.0 million), (v) net change in short-term investments with terms of three months or less of
RMB1,655.9 million (US$253.8 million), (vi) purchase of property, equipment and software of RMB1,055.6 million (US$161.8 million), and (vii)
investment in equity investees of RMB345.7 million (US$53.0 million), partially offset by (A) proceeds from maturity of time deposits of RMB64,880.3
million (US$9,943.3 million), (B) proceeds from maturity of short-term investments of RMB24,126.2 million (US$3,697.5 million) and (C) proceeds
from disposals of investment in equity investees, business and subsidiaries of RMB722.1 million (US$110.7 million).
For the year ended December 31, 2019, cash used in continuing investing activities mainly consisted of (i) placement/rollover of matured time
deposits of RMB77,083.4 million, (ii) purchase of short-term investments of RMB22,370.0 million, (iii) purchase of intangible assets, content and
licensed copyrights of RMB2,119.3 million, (iv) purchase of property, equipment and software of RMB1,209.5 million, (v) acquisitions of other long-
term investments of RMB1,111.5 million, (vi) net change in short-term investments with terms of three months or less of RMB1,023.2 million, and (vii)
investment in equity investees of RMB450.7 million, partially offset by (A) proceeds from maturity of time deposits of RMB54,381.6 million, (B)
proceeds from maturity of short-term investments of RMB20,225.3 million, (C) proceeds received from discontinued operations of RMB9,031.1 million
and (D) proceeds from disposals of investment in equity investees, business and subsidiaries of RMB406.7 million.
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For the year ended December 31, 2018, cash used in continuing investing activities mainly consisted of (i) placement/rollover of matured time
deposits of RMB41,553.4 million, (ii) purchase of short-term investments of RMB13,393.0 million, (iii) purchase of property, equipment, software and
land use rights of RMB5,096.2 million, (iv) acquisitions of other long-term investments of RMB2,751.0 million, (v) amounts paid to discontinued
operations of RMB1,889.6 million, (vi) purchase of intangible assets, content and licensed copyrights of RMB1,741.2 million, (vii) net change in short-
term investments with terms of three months or less of RMB1,172.3 million, and (viii) investment in equity investees of RMB272.5 million, partially
offset by (A) proceeds from maturity of time deposits of RMB39,924.5 million, and (B) proceeds from maturity of short-term investments of
RMB13,071.4 million.
Financing Activities
For the years ended December 31, 2018, 2019 and 2020, cash provided by or used in financing activities was all from continuing operations.
There were no financing activities from discontinued operations for these years.
Net cash provided by continuing financing activities was RMB9,913.1 million (US$1,519.2 million), RMB1,082.5 million and RMB1,587.4
million for the years ended December 31, 2020, 2019 and 2018, respectively.
For the year ended December 31, 2020, cash provided by continuing financing activities mainly resulted from (i) net proceeds received from
issuance of shares in Hong Kong of RMB21,911.8 million (US$3,358.1 million) and (ii) net proceeds in short-term loan of RMB4,041.1 million
(US$619.3 million), partially offset by repurchase of NetEase’s ADSs and purchase of Youdao’s ADSs totaling of RMB11,491.0 million (US$1,761.1
million) and dividends paid in the amount of RMB4,280.5 million (US$656.0 million).
For the year ended December 31, 2019, cash provided by continuing financing activities mainly resulted from (i) proceeds from issuance of
redeemable noncontrolling shareholder interests and noncontrolling interests, net of issuance costs of RMB6,941.0 million and (ii) net proceeds in short-
term loan of RMB2,971.5 million, partially offset by dividends paid in the amount of RMB8,840.6 million.
For the year ended December 31, 2018, cash provided by continuing financing activities mainly resulted from (i) net proceeds in short- term
loan of RMB6,209.6 million and (ii) proceeds from issuance of redeemable noncontrolling shareholder interests, net of issuance cost of RMB5,294.2
million, partially offset by repurchase of our ADSs of RMB7,516.7 million, dividends paid in the amount of RMB1,440.2 million, and repurchase of
noncontrolling interest and redeemable noncontrolling interests of RMB975.0 million.
Management of Capital Resources
In managing our capital, we seek to maintain a reasonable amount of liquidity to support new business growth and maximize returns on our
capital resources, while at the same time focusing on the preservation of capital and complying with applicable legal requirements. Our capital resources
include primarily cash on hand, demand deposits and time deposits mainly placed with banks in Hong Kong and China and short-term investments.
Although we consolidate the results of our subsidiaries and VIEs in our consolidated financial statements, we do not have direct access to the cash and
cash equivalents or future earnings of our subsidiaries and VIEs. As of December 31, 2020, these subsidiaries and VIEs had RMB86.8 billion (US$13.3
billion) in cash and cash equivalents, demand deposits and short-term and long-term time deposits. Our cash and cash equivalents, demand deposits,
time deposits and short-term investments held outside of China are mainly denominated in U.S. dollars, Renminbi and HK dollars.
To fund any cash requirements we may have, we may need to rely on dividends and other distributions on equity paid by our subsidiaries. Since
substantially all of our operations are conducted through our PRC subsidiaries and VIEs, our subsidiaries may need to rely on dividends, loans or
advances made by another PRC subsidiary or VIE. Certain of these payments are subject to PRC taxes, including sales taxes, which effectively reduce
the received amount. In addition, the PRC government could impose restrictions on such payments or change the tax rates applicable to such payments.
In 2018, 2019 and 2020, we accrued RMB679.4 million, RMB846.6 million and RMB1,056.9million (US$162.0 million) withholding tax liabilities,
respectively, associated with our quarterly dividends and cash expected to be distributed from our PRC subsidiaries to companies in our corporate group
outside of China for general corporate purposes. We repatriated a portion of these earnings and paid related withholding income tax in 2018, 2019 and
2020. For the foreseeable future, we intend to reinvest all remaining undistributed earnings as at December 31, 2020 in our PRC subsidiaries, and
accordingly no other withholding tax is expected to be incurred.
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In addition, the payment of dividends by entities established in the PRC is subject to limitations. Regulations in the PRC currently permit
payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in the PRC. Each of our
PRC subsidiaries that is a domestic company is also required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each
year to its general reserves or statutory capital reserve fund until the accumulative amount of such reserves reach 50.0% of its respective registered
capital. These restricted reserves are not distributable as cash dividends. As a result of these and other restrictions under PRC laws and regulations, our
PRC subsidiaries and VIEs are restricted in their ability to transfer a portion of their net assets to us either in the form of dividends, loans or advances,
which restricted portion amounted to approximately RMB15.9 billion, or 19% of our total consolidated net assets, as of December 31, 2020. In addition,
if any of our PRC subsidiaries incurs debt on its own behalf in the future, the instruments governing the debt may restrict its ability to pay dividends or
make other distributions to us.
Furthermore, any transfer of funds from us to any of our PRC subsidiaries or VIEs, either as a shareholder loan or as an increase in registered
capital, is subject to certain statutory limit requirements and registration or approval of the relevant PRC governmental authorities, including the relevant
administration of foreign exchange and/or the relevant examining and approval authority. Therefore, it is difficult to change our capital expenditure plans
once the relevant funds have been remitted from our company to our PRC subsidiaries or VIEs. These limitations on the free flow of funds between us
and our PRC subsidiaries and VIEs could restrict our ability to act in response to changing market conditions and reallocate funds internally in a timely
manner.
For additional information, see Item 3.D. “Risk Factors—Risks Related to Our Company—Our corporate structure may restrict our ability to
receive dividends from, and transfer funds to, our PRC subsidiaries and VIEs, which could restrict our ability to act in response to changing market
conditions and reallocate funds internally in a timely manner.” and “Risk Factors—Risks Related to Doing Business in China—Restrictions on currency
exchange may limit our ability to utilize our revenues effectively.” and Item 10D. “Exchange Controls.”
Capital Expenditures
Our capital requirements relate primarily to financing:
● our working capital requirements, such as servers and bandwidth service fees, inventory purchase costs, content and copyrights purchase
costs, staff costs, selling and marketing expenses and research and development costs; and
● costs incurred for the construction of our new office buildings and warehouses in Guangzhou, Hangzhou, Shanghai and Jiangxi in China,
acquisition of new servers in connection with the operation of our in-house developed and licensed games, investment in the expansion
packages of the aforementioned games, and upgrades of our online service infrastructure.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
We believe that an integral part of our future success will depend on our ability to develop and enhance our services. Our product development
efforts and strategies consist of incorporating new technologies from third parties as well as continuing to develop our own proprietary technology.
We have utilized and will continue to utilize the products and services of third parties to enhance our platform of technologies and services to
provide competitive and diverse online game, education and other innovative services to our users. In addition, we plan to continue to expand our
technologies, products and services and registered user base through diverse online community products and services developed internally, particularly
with respect to our online game services. We will seek to continually improve and enhance our existing services to respond to rapidly evolving
competitive and technological conditions. For the years 2018, 2019 and 2020, we spent RMB7,378.5 million, RMB8,413.2 million and RMB10,369.4
million (US$1,589.2 million), respectively, on research and development activities.
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D. TREND INFORMATION
Other than as described elsewhere in this annual report, we are not aware of any trends, uncertainties, demands, commitments or events that are
reasonably likely to have a material adverse effect on our revenue, income from continuing operations, profitability, liquidity or capital resources, or that
would cause our reported financial information not necessarily to be indicative of future operation results or financial condition.
E. OFF-BALANCE SHEET ARRANGEMENTS
We do not have any outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions or foreign
currency forward contracts. We do not engage in trading activities involving non-exchange traded contracts.
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
We have operating lease commitments, which are the lease commitments under the lease agreements for our corporate offices, warehouses and
retail stores. We also have contractual obligations in respect of the construction of new office buildings and warehouse facilities in Guangzhou, Shanghai
and Hangzhou, capital expenditures related to computer equipment and server and bandwidth service fee. In addition, we have contractual obligations in
connection with the games licensed from Blizzard. The following sets forth our contractual obligations for server and bandwidth service fees, long-term
payables, capital expenditures and office machine and other obligations related to content and services purchases, including the royalties and minimum
marketing expenditure commitment for the games licensed to us by Blizzard, as of December 31, 2020:
2021
2022
2023
2024
Beyond 2024
Operating
Lease
Server and
Bandwidth
Serve Fee
Capital
Royalties and
Expenditure for
Licensed Content
Office Machines
and Other
Commitments Commitments Commitments Commitments
Commitments
RMB
RMB
RMB
RMB
RMB
Total
RMB
(in thousands)
338,476
204,759
129,932
101,764
93,454
868,385
442,910
306,676
220,198
158,375
142,793
1,270,952
548,713
296,423
234,233
7,722
26,103
1,113,194
2,875,860
2,075,531
1,326,344
5,997
849,780
7,133,512
604,388
25,483
17,113
—
—
646,984
4,810,347
2,908,872
1,927,820
273,858
1,112,130
11,033,027
Other than the obligations set forth above, we do not have any long-term commitments.
Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily to the interest income generated by excess cash invested in
financial products issued by commercial banks in China, as well as interest expenses payable on our short-term bank borrowings. All of our short-term
bank borrowings as of December 31, 2020 were at fixed rates.
Interest instruments carry a degree of interest rate risk. We have not been exposed nor do we anticipate being exposed to material risks due to
changes in interest rates. However, our future net interest income may fall short of expectations due to changes in interest rates. Based on our interest
instruments as of December 31, 2020, a 10% change in the interest rate would result in an increase or decrease of RMB159.9 million (US$24.5 million)
of our total amount of net interest income or of RMB58.1 million (US$8.9 million) of our total amount of investment income from short-term
investments in 2020.
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Foreign Currency Risk
A significant majority of our revenues and expenses are denominated in Renminbi, but as noted above, a certain portion of our cash is kept in
U.S. dollars, HK dollars and Euro. Although we believe that, in general, our exposure to foreign exchange risks should be limited, the value of our ADSs
will be affected by the foreign exchange rate between U.S. dollars, HK dollars, Euro and Renminbi. For example, to the extent that we need to convert
U.S. dollars, HK dollars or Euro into Renminbi for our operational needs and the Renminbi appreciates against the U.S. dollars, HK dollars or Euro at
that time, our financial position and the price of our ADSs may be adversely affected. Conversely, if we decide to convert our Renminbi into U.S. dollars
for the purpose of declaring dividends on our ADSs or otherwise and the U.S. dollar, HK dollars or Euro appreciates against the Renminbi, the U.S.
dollar equivalent of our earnings from our subsidiaries and controlled entities in China would be reduced.
The conversion of Renminbi into foreign currencies, including U.S. dollars, is based on rates set by the PBOC. The PRC government allowed
the Renminbi to appreciate by more than 20% against the U.S. dollar between July 2005 and July 2008. Between July 2008 and June 2010, this
appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, Renminbi has
fluctuated against the U.S. dollar, at certain times significantly and unpredictably. With the development of the foreign exchange market progressing
towards interest rate liberalization and Renminbi internationalization and economic uncertainties in both China and the world, the PRC government may
in the future announce further changes to the exchange rate system and we cannot assure you that the Renminbi will not appreciate or depreciate
significantly in value against the U.S. dollar in the future. It is difficult to predict how market forces or PRC or U.S. government policy may impact the
exchange rate between the Renminbi and the U.S. dollar in the future.
We translate our monetary assets and liabilities which are denominated in currencies other than Renminbi into Renminbi as of each accounting
period end, in accordance with applicable accounting standards. As a result of this foreign currency translation, we reported net foreign exchange losses
of RMB3,112.2 million (US$477.0 million) in 2020, compared to net foreign exchange gains of RMB25.2 million in 2019. To date, we have not entered
into any hedging transactions in an effort to reduce our exposure to foreign currency exchange risk. While we may decide to enter into hedging
transactions in the future, the effectiveness of these hedges may be limited and we may not be able to successfully hedge our exposure. Accordingly, we
may incur economic losses in the future due to foreign exchange rate fluctuations, which could have a negative impact on our financial condition and
results of operations.
As of December 31, 2020, we had U.S. dollar-denominated debt outstanding of US$2,778.0 million. If the U.S. dollar had
appreciated/depreciated by 10% against the Renminbi, our U.S. dollar-denominated debt as of December 31, 2020 would have increased/decreased by
RMB1,812.6 million in Renminbi terms.
As of December 31, 2020, we had U.S. dollar-denominated cash and cash equivalents and time deposits of US$9,231.1 million. If the U.S.
dollar had appreciated/depreciated by 10% against the Renminbi, our U.S. dollar-denominated cash and cash equivalents and time deposits as of
December 31, 2020 would have increased/decreased by RMB6,023.3 million in Renminbi terms.
Recently Issued Accounting Pronouncements
Please refer to Item 18 of Part III, “Financial Statements—Note 2(bb)—Recently adopted accounting pronouncements” and “—Note 2(cc)—
Recently issued accounting pronouncements not yet adopted.”
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Item 6. Directors, Senior Management and Employees
A. Directors and Senior Management
The names of our directors and executive officers, their ages as of April 1, 2021 and the principal positions with NetEase held by them are as
follows:
Name
William Lei Ding
Charles Zhaoxuan Yang
Alice Yu-Fen Cheng (1)
Denny Ting Bun Lee
Joseph Tze Kay Tong (1)
Lun Feng
Michael Man Kit Leung (1)
Age
49
37
59
53
58
61
67
Position
Director and Chief Executive Officer
Chief Financial Officer
Independent Director
Independent Director
Independent Director
Independent Director
Independent Director
(1) Alice Cheng, Joseph Tong and Michael Leung are members of the audit, compensation and nominating committees.
Biographical Information
Lei Ding, also known as William Lei Ding, our founder, has served as our director since July 1999 and as our chief executive officer since
November 2005. From March 2001 until November 2005, Mr. Ding served as our chief architect, and from June 2001 until September 2001, he served as
our acting chief executive officer and acting chief operating officer. From July 1999 until March 2001, Mr. Ding served as co-chief technology officer,
and from July 1999 until April 2000, he also served as our interim chief executive officer. Mr. Ding established Guangzhou NetEase and Shanghai
EaseNet, our affiliates, in June 1997 and January 2008. Mr. Ding holds a Bachelor of Science degree in Communication Technology from the University
of Electronic Science and Technology of China.
Charles Zhaoxuan Yang has served as our chief financial officer since June 2017. Prior to joining us, Mr. Yang was an executive director of the
China technology, media and telecommunications, and corporate finance team at J.P. Morgan Securities (Asia Pacific) Limited and based in Hong Kong
for almost a decade. Mr. Yang currently serves as an independent director on the board of So-Young International Inc. (stock code: SY), a company listed
on the Nasdaq. Mr. Yang holds a master’s degree in Business Administration from the University of Hong Kong, and a bachelor’s degree from Wesleyan
University with majors in Economics and Mathematics. Mr. Yang is a Certified Public Accountant licensed in the State of Michigan.
Alice Yu-Fen Cheng, also known as Alice Cheng, has served as our director since June 2007. Ms. Cheng has been the chief financial officer of
BBK Electronics Corp., Ltd., a PRC-based manufacturer of audio-visual equipment, since May 2005. From 2010 to 2013, Ms. Cheng served as a
supervisor of Wistron Information Technology Corporation in Taiwan, an information technology company with operations in Taiwan, China and Japan.
From 2002 to 2005, Ms. Cheng served as financial controller of Wistron Corporation, a Taiwanese original design manufacturer of notebook computers
and other electronics. Prior to that, Ms. Cheng held various positions with Acer Inc., a Taiwanese computer manufacturer, culminating in the position of
financial controller. Ms. Cheng received a Bachelor of Accounting from the Chinese Culture University in Taiwan in 1983 and a Masters of Business
Administration from the Thunderbird School of Global Management in Arizona in 2003; Ms. Cheng is also licensed as a certified public accountant in
Taiwan and the PRC.
Denny Ting Bun Lee, also known as Denny Lee, has served as our director since April 2002. Mr. Lee previously served as our chief financial
officer from April 2002 until June 2007 and our financial controller from November 2001 until April 2002. Prior to joining our company, Mr. Lee
worked in the Hong Kong office of KPMG for more than ten years. Mr. Lee graduated with a Professional Diploma in Accounting from the Hong Kong
Polytechnic University in November 1990, and is a member of the Hong Kong Institute of Certified Public Accountants, and the Association of
Chartered Certified Accountants. Mr. Lee currently serves as the chairman of the audit committees and an independent non-executive director on the
boards of New Oriental Education & Technology Group Inc., (stock code: EDU), Concord Medical Services Holdings Limited (stock code: CCM), NIO
Inc. (stock code: NIO), and Jianpu Technology Inc. (stock code: JT), which are listed on the New York Stock Exchange, as well as China Metal
Resources Utilization Limited, which is listed on the Hong Kong Stock Exchange (stock code: 1636).
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Joseph Tze Kay Tong, also known as Joseph Tong, has served as our director since March 2003. Mr. Tong has been a director of Parworld
Investment Management Limited, which provides financial and investment advisory services, since January 2003. From December 2002 until April
2004, Mr. Tong was engaged in establishing offices and operations in Hong Kong and China, setting up accounting and internal control policies and
overseeing the overall operations for TLM Apparel Co., Ltd., a garment trading company operating in Hong Kong and China which he co-founded. Prior
to that, from September 2000 to September 2002, Mr. Tong was the e-commerce director of the Asia Region for Universal Music Limited where he was
responsible for forming e-business development strategies and overseeing new promotional opportunities. Mr. Tong received a Bachelor of Social
Science degree with honors in Accounting and Statistics from the University of Southampton, England. He is a member of the American Institute of
Certified Public Accountants, an associate member of the Hong Kong Institute of Certified Public Accountants.
Lun Feng has served as our director since July 2005. Mr. Feng served as the chairman and/or director of Vantone Holdings Co., Ltd., a private
real estate investment company in China, from 1993 to 2017. Mr. Feng currently is the executive director of Beijing Sifang Yufeng Investment Co., Ltd,
an investment firm in China. Mr. Feng serves as an independent director on the boards of Youzu Interactive Co., Ltd. (stock code: 002174), which is
listed on the Shenzhen Stock Exchange, as well as Bank of Xi’An Co., Ltd. (stock code: 600928) and Shanghai Xinnanyang Only Education &
Technology Co., Ltd. (stock code: 600661), both of which are listed on the Shanghai Stock Exchange. Mr. Feng also serves as a director of Shanghai
Cura Investment & Management Co., Ltd. Mr. Feng was an independent non-executive director on the board of China Everbright Bank Company
Limited (stock code: 6818), a company dual listed on the Hong Kong Stock Exchange and the Shanghai Stock Exchange, until July 2019; Mr. Feng
continues to perform his duties on the board of this listed company until the qualifications of the succeeding independent non-executive director are
approved by the China Banking and Insurance Regulatory Commission. Mr. Feng was also an independent non-executive director of Haitong Securities
Co., Ltd. (stock code: 6837) from December 2014 to June 2019. Mr. Feng has a Juris Doctor from the Chinese Academy of Social Sciences, a Masters of
Law degree from the Party School of the Chinese Communist Party, and a Bachelor of Arts in Economics from Northwest University.
Michael Man Kit Leung, also known as Michael Leung, has served as our director since July 2002. Mr. Leung is currently a responsible officer
of Grand Moore Capital Limited since September 2019. Mr. Leung was appointed executive director of Unitas Holdings Limited (stock code: 8020) from
September 2011 to November 2018, and served as a responsible officer from May 2011 to November 2018 of Chanceton Capital Partners Limited, a
subsidiary of Unitas Holdings Limited. Previously, Mr. Leung was a director of Emerging Markets Partnership (Hong Kong) Limited, the principal
adviser to the AIG Infrastructure Fund L.P, in 1999. Mr. Leung also held senior positions in the Hong Kong Branch of the Swiss Bank Corporation, SG
Securities (HK) Limited (formerly known as Crosby Securities (Hong Kong) Limited) and Peregrine Capital Limited. Mr. Leung currently is an
independent non-executive director and chairman of the audit committee for Orange Sky Golden Harvest Entertainment (Holdings) Limited (stock code:
1132) and Luye Pharma Group Ltd. (stock code: 2186), all of which are companies listed on the Hong Kong Stock Exchange. Mr. Leung also serves as
an independent non-executive director on the board of China Ting Group Holdings Limited (stock code: 3398), a company listed on the Hong Kong
Stock Exchange. Mr. Leung was previously an independent non-executive director and chairman of the audit committee of China Electronics Optics
Valley Union Holding Company Limited (stock code: 0798) from March 2014 to May 2020 and China Huiyuan Juice Group Limited (stock code: 1886)
from 2012 to 2019, both of which are companies listed on the Hong Kong Stock Exchange. Mr. Leung received a Bachelor’s Degree in Social Sciences
from the University of Hong Kong in October 1977 with a major in Accounting, Management and Statistics.
Relationships Among Directors or Executive Officers; Right to Nominate Directors
There are no family relationships among any of the directors or executive officers of our company. None of our directors were nominated
pursuant to a contractual or other right.
B. Compensation
Executive Officer and Director Compensation
In 2020, we paid our executive officers and directors aggregate cash compensation of RMB24.5 million (US$3.8 million). In 2020, we also
granted restricted share unit awards under our 2019 RSU Plan (described below) to each of our independent directors which vested on March 1, 2021.
ADRs, representing less than 1% of our total outstanding ordinary shares, were given to the directors in settlement of such awards upon vesting.
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In 2020, we also granted restricted share unit awards under our 2019 RSU Plan to our Chief Financial Officer, which will represent less than 1%
of our total outstanding ordinary shares upon vesting. In addition, prior to 2020, certain of our subsidiaries, including Youdao, granted certain options
pursuant to their respective share incentive plans to our Chief Financial Officer which are exercisable for ordinary shares of those subsidiaries
representing less than 1% of their total outstanding shares.
Director Indemnification Agreements
All of our current directors have entered into indemnification agreements in which we agree to indemnify, to the fullest extent allowed by
Cayman Islands law, our charter documents or other applicable law, those directors from any liability or expenses, unless the liability or expense arises
from the director’s own willful negligence or willful default. The indemnification agreements also specify the procedures to be followed with respect to
indemnification.
We do not have service contracts with any of our directors which provide for benefits upon termination.
Employment Agreements
We have entered into employment and related agreements with each of our executive officers. These agreements include: (i) a covenant that
prohibits the executive officer from engaging in any activities that compete with our business during and for one to two years after their employment
with us, (ii) a requirement that executive officers assign all rights in company-related inventions to us and to keep our proprietary information
confidential, and (iii) provisions for severance payments in the event the executive officer is terminated without cause or resigns for good reason.
Restricted Share Unit Plans
General
We have two restricted share unit plans. We refer to these collectively as our RSU Plans. Our board approved our 2009 Restricted Share Unit
Plan, or 2009 RSU Plan, in November 2009. The 2009 RSU Plan expired in November 2019 in accordance with its terms, such that no new awards may
be granted under this plan although outstanding awards granted previously will remain governed by it. Our board approved our 2019 Restricted Share
Unit Plan, or the 2019 RSU Plan, in October 2019, as a replacement for the 2009 RSU Plan.
The purpose of our RSU Plans is to attract and retain the best available personnel, to provide additional incentive to employees, directors and
consultants and to promote the success of our business. The RSU Plans provide for the granting of incentive awards of restricted share units, which may
or may not be granted with dividend equivalent rights. Participants under the RSU Plans will not receive any account status reports.
The RSU Plans are not subject to the Employee Retirement Income Security Act of 1974, as amended, and neither of the RSU Plans a “qualified
plan” within the meaning of Section 401(a) of the Internal Revenue Code of 1986, as amended.
Plan Administration
Our board has designated our compensation committee to administer the RSU Plans, and it may designate one or more of our officers to exercise
its authority thereunder from time to time.
Securities Subject to the RSU Plans
The maximum aggregate number of our ordinary shares which are issuable pursuant to all awards under the 2009 RSU Plan is 323,694,050
ordinary shares.
The maximum aggregate number of our ordinary shares which may be issued pursuant to all awards under the 2019 RSU Plan is 322,458,300
ordinary shares. Such ordinary shares may, in whole or in part, be authorized but unissued shares or shares that will have been or may be reacquired by
us. It is anticipated that all future awards to our employees, directors and consultants will be granted pursuant to the 2019 RSU Plan or any other future
plan adopted by our board and, if appropriate, our shareholders.
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The 2009 RSU Plan provides that in the event of certain corporate transactions, including specified types of mergers and acquisition
transactions, each outstanding award granted under the 2009 RSU Plan shall automatically become fully vested and be released from any restrictions on
transfer and repurchase or forfeiture rights, immediately prior to the specified effective date of such corporate transaction, unless the award is assumed by
the successor company or its parent company in connection with the corporate transaction. Upon consummation of such corporate transactions, each
outstanding award shall be terminated unless the award is assumed by the successor company or its parent company in connection with the applicable
corporate transaction. Our board will determine whether an award was assumed in the manner contemplated by the 2009 RSU Plan.
The 2019 RSU Plan provides that in the event of certain corporate transactions, including specified types of mergers and acquisition
transactions, the administrator may (a) accelerate the vesting, in whole or in part, of any award; (b) purchase any award for an amount of cash or ordinary
shares of our company equal to the value that could have been attained upon the exercise of the award or the realization of the plan participant’s rights
had the award been currently exercisable or payable or fully vested; or (c) provide for the assumption, conversion or replacement of any award by the
successor corporation, or a parent or subsidiary of the successor corporation, with other rights or property selected by the plan administrator in its sole
discretion, or the assumption or substitution of the award by the successor or surviving corporation, or a parent or subsidiary of the surviving or successor
corporation, with appropriate adjustments as to the number and kind of shares and prices as the plan administrator deems, in its sole discretion,
reasonable, equitable and appropriate.
Eligibility
Awards can be issued to participants in the RSU Plans, which include employees, directors or consultants of us, our subsidiaries, our VIEs and
certain other related entities.
Awards under the RSU Plans
Awards under the RSU Plans are evidenced by an award agreement which contains, among other things, such provisions concerning how the
restricted share unit may be settled upon vesting and forfeiture upon termination of employment or the consulting arrangement (by reason of death,
disability, retirement or otherwise) as have been determined by our board.
Restricted share units do not represent any actual ownership interest in us. The units granted correspond in number and value to a specified
number of our ordinary shares. No actual shares are issued. Instead, the units are tracked in a bookkeeping account. The units may be subject to
forfeiture provisions to replicate the treatment of restricted shares. The units can ultimately be paid in cash or ordinary shares, as our board determines
and as set forth in the applicable award agreement. Dividend equivalents may be paid on the restricted share units. A dividend equivalent right entitles
the participant to receive cash compensation measured by the dividends paid with respect to our ordinary shares. The dividend equivalents may be paid
out at the time of the dividend or may be credited to the participant’s account and converted to additional units.
Conditions of Awards
Our board, either acting directly or through our compensation committee or one or more of our officers, is authorized to determine the
provisions, terms and conditions of each award, including, without limitation, the award vesting schedule, repurchase provisions, rights of first refusal,
forfeiture provisions, settlement of the award, payment contingencies and satisfaction of any performance criteria established by our board. Partial
achievement of the specified criteria may result in a payment or vesting corresponding to the degree of achievement as specified in the award agreement.
Amendment; Termination
Under the RSU Plans, our board may at any time terminate, suspend, or amend the RSU Plans in any respect, except that no termination,
suspension or amendment will be effective without shareholder approval if such approval is required to comply with any law, regulation or stock
exchange rule and no such change may adversely affect any award previously granted without the written consent of the recipient. The 2009 RSU Plan
expired in November 2019 in accordance with its terms. The 2019 RSU Plan will expire in October 2029.
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Non-Transferability of Awards
Under the RSU Plans, awards may not be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of, except by will or by the
laws of descent and distribution and during the lifetime of the participants, to the extent and in the manner provided in the award agreement. The RSU
Plans permit the designation of beneficiaries by holders of awards in the event of the participant’s death. After any such transfer, the original recipient
shall continue to remain subject to the withholding tax requirements described below.
Payment of Taxes
No ordinary shares shall be delivered under the RSU Plans to any participant or other person until such participant or other person has made
arrangements acceptable to us regarding payment of Chinese, Cayman Islands, U.S. and any other federal, state, provincial, local or other taxes required
by law. Alternatively, we will withhold or collect from the participant an amount sufficient to satisfy such tax obligations.
Other Equity Incentive Plans
Youdao, our subsidiary, adopted its 2015 Share Incentive Plan, or the Youdao Plan, in February 2015 (and amended it in April 2018), under
which 10,222,222 ordinary shares of Youdao are reserved for issuance. As of March 31, 2021, options to purchase a total of 5,853,763 ordinary shares
are outstanding under the 2015 Plan, and 2,512,069 of such options had vested and become exercisable.
In addition, certain of our other subsidiaries have adopted their own equity incentive plans, which allow the relevant subsidiaries to grant
options or other awards to certain of our employees. The options under such plans and the Youdao Plan expire in five to ten years from the date of grant
and either vest or have a vesting commencement date upon certain conditions being met. The awards can become 100% vested on the vesting
commencement date, or vest in two, three, four or five substantially equal annual installments with the first installment vesting on the vesting
commencement date.
C. Board Practices
At each annual general meeting of our shareholders, our shareholders are asked to elect the directors nominated to serve for the ensuing year or
until their successors are elected and duly qualified or until such director’s earlier death, bankruptcy, insanity, resignation or removal. For information
regarding the period during which our officers and directors have served in their respective positions, please refer to Item 6.A. “Directors and Senior
Management.” We have no specific policy with respect to director attendance at our annual general meetings of shareholders, and no director attended the
annual general meeting of shareholders held on Septermber 25, 2020.
Each of our non-executive directors has been determined by our board to be “independent” under applicable U.S. regulations, as that term is
defined in NASDAQ Marketplace Rule 5606(a)(2) and acts as an “independent non-executive director” of the company for the purpose of the Hong
Kong Listing Rules. The company has received an annual confirmation on his/her “independence” from each of the non-executive directors, addressing
the factors set out in Rule 3.13 of the Hong Kong Listing Rules, and our board continues to consider all of them to be “independent”.
Our board has three committees, the audit committee, the compensation committee and the nominating committee. Alice Cheng, Joseph Tong,
and Michael Leung are currently the members of each of these committees. Michael Leung is the chairperson of the audit committee. The board of
directors has determined that Mr. Joseph Tong is an “audit committee financial expert” as defined by Item 16A of Form 20-F. The board of directors has
adopted a written audit committee charter pursuant to which the audit committee is responsible for overseeing the accounting and financial reporting
processes of our company, including the appointment, compensation and oversight of the work of our independent auditors, monitoring compliance with
our accounting and financial policies and evaluating management’s procedures and policies relative to the adequacy of our internal accounting controls.
For more information regarding the audit committee, please refer to “Audit committee experience and qualification and board oversight” under Item 4.
“Business Overview.”
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The board of directors has adopted a written compensation committee charter pursuant to which the compensation committee is responsible for,
among other things, annually reviewing and approving our company’s corporate goals and objectives relevant to the compensation of our chief executive
officer, evaluating such officer’s performance in light of those goals and objectives, and, either as a committee or together with the other independent
directors (as directed by our board), determining and approving the chief executive officer’s compensation level based on this evaluation. The committee
also annually reviews and makes recommendations to the board with respect to non-chief executive officer compensation, incentive compensation plans
and equity based plans, administers our incentive compensation plans and equity-based plans as in effect and as adopted from time to time by our board
(the board retains, however, the authority to interpret such plans), and approves any new equity compensation plan or any material change to an existing
plan where shareholders’ approval has not been obtained.
The board of directors has adopted a written nominating committee charter pursuant to which the nominating committee is responsible for
monitoring the size and composition of our board and considering and making recommendations to our board with respect to the nominations or elections
of directors of our company.
The audit, compensation and nominating committees are composed solely of non-employee directors, as such term is defined in Rule 16b-3
under the Exchange Act and the board of directors has determined that all such members are “independent” as that term is defined in NASDAQ
Marketplace Rule 5605(a)(2).
Compensation Committee Interlocks
No interlocking relationships have existed between our board of directors or compensation committee and the board of directors or
compensation committee of any other company.
D. Employees
As of December 31, 2018, 2019 and 2020, we had 22,726, 20,797 and 28,239 full-time employees, respectively. A substantial majority of our
employees are based in China. We believe that we have a good working relationship with our employees, and we have not experienced any significant
labor disputes.
The following table sets forth information regarding our staff as of December 31, 2020. Our R&D staff consisted of 13,565 employees as of
December 31, 2020.
Online game
Youdao
Innovative businesses and others
Total
15,010
4,949
8,280
28,239
All employees of our company and of our affiliated companies are employed under employment contracts which specify, among other things,
the employee’s responsibilities, remuneration and grounds for termination of employment. Each employee signs a confidentiality agreement in respect of
our intellectual property rights.
E. Share Ownership
The table in this section sets forth certain information known to us with respect to the beneficial ownership as of March 31, 2021 (unless
otherwise indicated) by:
● all persons who are beneficial owners of 5% or more of our ordinary shares,
● each of our directors,
● our Chief Executive Officer and Chief Financial Officer, and
● all current directors and executive officers as a group.
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As of March 31, 2021, 3,354,903,391 of our ordinary shares were outstanding. The amounts and percentages of ordinary shares beneficially
owned are reported on the basis of regulations of the SEC governing the determination of beneficial ownership of securities. Under the rules of the SEC,
a person is deemed to be a “beneficial owner” of a security if that person has or shares “voting power,” which includes the power to vote or to direct the
voting of such security, or “investment power,” which includes the power to dispose of or to direct the disposition of such security. A person is also
deemed to be a beneficial owner of any securities of which that person has a right to acquire beneficial ownership within 60 days. Under these rules,
more than one person may be deemed a beneficial owner of securities as to which such person has no economic interest. The shareholders listed below
do not have different voting rights.
5% Shareholder
Shining Globe International Limited/William Lei Ding(1) c/o NetEase, Inc., NetEase Building, No. 599
Wangshang Road, Binjiang District, Hangzhou, People’s Republic of China 310052.
1,450,300,000
43.2 %
Number of Shares
Beneficially Owned
Number
Percentage
Executive Officers and Directors (2)
Charles Zhaoxuan Yang
Alice Cheng
Denny Lee
Joseph Tong
Lun Feng
Michael Leung
All current directors and executive officers as a group (7 persons)(3)
* Less than 1%.
Number of Shares
Beneficially Owned
Number
Percentage
*
*
*
*
*
*
1,451,209,500
*
*
*
*
*
*
43.3 %
(1) Shining Globe International Limited is the record owner of 1,450,300,000 ordinary shares, consisting of 1,406,000,000 ordinary shares and
8,860,000 ADSs. Shining Globe International Limited is wholly owned by Shining Globe Holding Limited, which is in turn wholly owned by
Shining Globe Trust, or the Trust, for which TMF (Cayman) Ltd. acts as the trustee. William Lei Ding, our founder, Chief Executive Officer and a
director, is the sole director of Shining Globe International Limited and the settlor of the Trust, retaining the investment and dispositive powers with
respect to the assets of the Trust. The beneficiaries of the Trust are William Lei Ding and his family.
(2) The address of our current executive officers and directors are c/o NetEase Building, No. 599 Wangshang Road, Binjiang District, Hangzhou,
People’s Republic of China 310052.
(3) Shares owned by all of our current directors and executive officers as a group includes shares beneficially owned by William Lei Ding. This amount
includes ordinary shares and ordinary shares issuable upon the vesting of RSUs held by our directors and executive officers as a group.
As of March 31, 2021, based on public filings with the SEC, there are no major shareholders holding 5% or more of our ordinary shares or
ADSs representing ordinary shares, except as described above.
As of March 31, 2021, there were four ordinary shareholders of record with an address in the United States. The Bank of New York Mellon,
depositary of our ADS program, held 1,506,547,855 ordinary shares as of that date, which accounted for 44.9% of our outstanding ordinary shares.
To our knowledge, except as disclosed above, we are not owned or controlled, directly or indirectly, by another corporation, by any foreign
government or by any other natural or legal person or persons, severally or jointly.
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To our knowledge, there are no arrangements the operation of which may at a subsequent date result in us undergoing a change in control.
Our major shareholders do not have different voting rights than any of our other shareholders.
Item 7. Major Shareholders and Related Party Transactions
A. Major Shareholders
Please see Item 6.E. “Directors, Senior Management and Employees—Share Ownership.”
B. Related Party Transactions
VIE Agreements
NetEase, Inc. and certain of its wholly owned subsidiaries have entered into a series of agreements with Guangzhou NetEase, Hangzhou Leihuo,
Youdao Computer and certain other affiliated entities and the shareholders of these entities, under which we provide our computer software, mobile
applications, technologies and relevant services to Guangzhou NetEase, Hangzhou Leihuo, Youdao Computer and certain other affiliated entities, and
they in turn provide certain of our online games and operate the NetEase websites, our e-commerce platforms, our online advertising business, and e-mail
and certain of our other fee-based premium services. We believe that the terms of each agreement are no less favorable than the terms that we could
obtain from disinterested third parties and that the shareholders of Guangzhou NetEase, Hangzhou Leihuo, Youdao Computer and certain other affiliated
entities will not receive material benefits from these agreements except as shareholders of NetEase. The agreements with Guangzhou NetEase,
Hangzhou Leihuo and Youdao Computer are described below.
Agreements relating to Guangzhou NetEase
William Lei Ding, our Chief Executive Officer, and Xiaojun Hui, our vice president of game development, own 99.0% and 1.0% of the equity
interest in Guangzhou NetEase, respectively.
● Copyright License Agreement between NetEase Beijing and Guangzhou NetEase. NetEase Information Technology (Beijing) Co.Ltd., or
NetEase Beijing, granted Guangzhou NetEase the right to use NetEase Beijing’s web page layout in China for a royalty of RMB10,000
per year. NetEase Beijing may waive this fee at any time.
● Trademark License Agreement between NetEase Beijing and Guangzhou NetEase. NetEase Beijing granted Guangzhou NetEase a license
to use NetEase Beijing’s registered trademarks on the NetEase websites in China for license fees of RMB10,000 per year. NetEase Beijing
may waive this fee at any time.
● Cooperative Agreements. Guangzhou NetEase has entered into cooperative agreements with each of NetEase Beijing, Boguan and NetEase
Hangzhou pursuant to which such subsidiaries have agreed to provide the following services:
● research and development of computer software (including, but not limited to, online games software) and technical support and
maintenance for the operation of computer software;
● technical service for internet media, including, but not limited to, server maintenance and development, update and upgrade of
relevant application software; and
● research and development of electronic publishing technology and relevant technical assistance and support.
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Guangzhou NetEase has agreed to pay a monthly service fee to each such subsidiary in accordance with a formula based on their respective
expenses incurred. The cooperative agreements with each of NetEase Beijing, Boguan and NetEase Hangzhou were effective from September 1,
November 1, and December 1, 2012, respectively, and each will continue to be effective unless any one of the two respective parties terminates such
agreement by written notice.
● Online Advertising Agreement between Guangzhou NetEase and NetEase Advertising. Guangzhou NetEase sells all of the banner space on
the NetEase websites to Beijing NetEase Media Co., Ltd. (previously named Beijing Guangyitong Advertising Co., Ltd.), or NetEase
Advertising, and publishes the advertisements provided by NetEase Advertising on the banner space purchased by NetEase Advertising.
NetEase Advertising pays Guangzhou NetEase RMB10,000 per year. Guangzhou NetEase may waive this fee at any time.
The term of the foregoing agreement is automatically renewable for successive one year term.
● Trademark Transfer Agreement between Guangzhou NetEase and NetEase Beijing. Under this agreement, Guangzhou NetEase transferred
its registered trademarks to NetEase Beijing.
● Supplemental Agreement between NetEase Beijing and Guangzhou NetEase. NetEase Beijing may not grant the license to use its domain
name, copyright and trademark to any third party without Guangzhou NetEase’s consent and may not provide technical service to any third
party.
● Shareholder Voting Rights Trust Agreement among NetEase Beijing and the Individual Shareholders of Guangzhou NetEase. William Lei
Ding and Xiaojun Hui agreed to irrevocably appoint NetEase Beijing to represent him to exercise all voting rights to which he is entitled as
a shareholder of Guangzhou NetEase. The term of this agreement is 20 years from May 12, 2010. This agreement was amended and
novated on May 1, 2014 in connection with Mr. Hui’s acquisition of his equity interest in Guangzhou NetEase from a prior shareholder and
further amended and restated on November 30, 2015 in connection with the equity transfer of NetEase Advertising to William Lei Ding
and Li Li.
● Agreement between NetEase Beijing and Guangzhou NetEase. NetEase Beijing agrees to pay the operating costs of Guangzhou NetEase.
● Letter of Agreement. Each of William Lei Ding and Xiaojun Hui have agreed that any amendments to be made to the Shareholder Voting
Rights Trust Agreement, the Equity Pledge Agreement (described below) and the Loan Agreement (described below), as well as all other
agreements to which our company, NetEase Beijing and/or their respective affiliates is a party, on the one hand, and any of their VIEs
and/or the shareholders of such entities, on the other hand, shall be subject to the approval by the vote of a majority of our board, excluding
the vote of William Lei Ding. Messrs. Ding and Hui have also agreed that, if any amendments to the above-mentioned agreements require a
vote of the shareholders of our company or Guangzhou NetEase, as applicable, both of them will vote in their capacity as direct or indirect
shareholders of these companies to act based upon the instructions of our board. The term of this agreement is 20 years from May 12, 2010,
and this agreement was amended and novated on May 1, 2014 in connection with Mr. Hui’s acquisition of his equity interest in Guangzhou
NetEase from a prior shareholder and further amended and restated on November 30, 2015 in connection with the equity transfer of
NetEase Advertising to William Lei Ding and Li Li.
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● Loan Agreement and Equity Pledge Agreement. Concurrent with Mr. Hui’s acquisition of his equity interest in Guangzhou NetEase from a
prior shareholder, Mr. Hui entered into a Loan Agreement and Equity Pledge Agreement with NetEase Beijing, each dated May 1, 2014.
Under the Loan Agreement, NetEase Beijing provided Mr. Hui with an interest-free loan in the principal amount of RMB0.2 million to
Mr. Hui, which funds were used by Mr. Hui to pay the consideration to acquire such 1.0% equity interest. The loan can be repaid by
transferring such 1.0% equity interest to NetEase Beijing or its designee or through such other method as NetEase Beijing shall determine.
The term of the loan is 10 years from the date of the agreement and can be extended upon the mutual consent of both parties. Under the
Equity Pledge Agreement, Mr. Hui pledges his 1.0% equity interest in Guangzhou NetEase to NetEase Beijing to secure his respective
obligations under the Loan Agreement and Shareholder Voting Rights Trust Agreement. Mr. Hui agrees he shall not transfer, pledge or
encumber his 1.0% equity interest without the prior written consent of NetEase Beijing. During the term of this agreement, NetEase Beijing
is entitled to all dividends and other distributions made by Guangzhou NetEase. The Equity Pledge Agreement will remain binding until
Mr. Hui discharges all his obligations under the above-mentioned agreements.
Agreements relating to Hangzhou Leihuo
Prior to April 18, 2019, Zhipeng Hu and Tianlei Hu, two of our employees, each owned 50.0% of the equity interest in Hangzhou Leihuo. On
April 18, 2019, pursuant to a supplementary agreement of assignment, the equity interest in Hangzhou Leihuo owned by Tianlei Hu and the contractual
obligations described below were assigned to Long Cheng, another employee of ours. As of the date of this annual report, each of Zhipeng Hu and Long
Cheng owns 50.0% of the equity interest in Hangzhou Leihuo.
● Loan Agreements and Equity Pledge Agreements between NetEase Hangzhou and each of the ultimate shareholders of Hangzhou Leihuo.
Each of the ultimate shareholders of Hangzhou Leihuo has entered into a Loan Agreement and an Equity Pledge Agreement with NetEase
Hangzhou, each dated December 1, 2015. Under the Loan Agreements, NetEase Hangzhou provided each of the ultimate shareholders of
Hangzhou Leihuo with an interest-free loan in the principal amount of RMB5.0 million, which funds were used by each of the ultimate
shareholders of Hangzhou Leihuo to pay the consideration to acquire their 50.0% equity interests in Hangzhou Leihuo. Each loan can be
repaid by transferring the ultimate shareholder’s equity interest in Hangzhou Leihuo to NetEase Hangzhou or its designee or through such
other method as NetEase Hangzhou shall determine. The term of each Loan Agreement is 10 years from the date of the agreement and will
be automatically extended for further 10-year terms unless otherwise decided by NetEase Hangzhou. Under the Equity Pledge Agreements,
each of the ultimate shareholders of Hangzhou Leihuo pledges his 50.0% equity interest in Hangzhou Leihuo to NetEase Hangzhou to
secure his respective obligations under the Loan Agreement as well as the Exclusive Purchase Option Agreement, the Shareholder Voting
Rights Trust Agreement and the Operating Agreement. Each of the ultimate shareholders of Hangzhou Leihuo agrees he shall not transfer,
assign or pledge his equity interest in Hangzhou Leihuo without the prior written consent of NetEase Hangzhou. The Equity Pledge
Agreements will remain binding until the pledgor discharges all his obligations under the above-mentioned agreements.
● Exclusive Purchase Option Agreements among NetEase Hangzhou, Hangzhou Leihuo and each of the ultimate shareholders of Hangzhou
Leihuo. Under the Exclusive Purchase Option Agreements, each dated December 1, 2015, each of the ultimate shareholders of Hangzhou
Leihuo has granted NetEase Hangzhou an option to purchase all or a portion of his equity interest in Hangzhou Leihuo at a price equal to
the original and any additional paid-in capital paid by the ultimate shareholder. In addition, Hangzhou Leihuo has granted NetEase
Hangzhou an option under the Exclusive Purchase Option Agreements to purchase all or a portion of the assets held by Hangzhou Leihuo
or its subsidiaries at a price equal to the net book value of such assets. Each of Hangzhou Leihuo and the ultimate shareholders of
Hangzhou Leihuo agrees not to transfer, mortgage or permit any security interest to be created on any equity interest in or assets of
Hangzhou Leihuo without the prior written consent of NetEase Hangzhou. Each Exclusive Purchase Option Agreement shall remain in
effect until all of the equity interests in or assets of Hangzhou Leihuo have been acquired by NetEase Hangzhou or its designee or until
NetEase Hangzhou unilaterally terminates the agreement by written notice.
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● Shareholder Voting Rights Trust Agreement between NetEase Hangzhou and each of the ultimate shareholders of Hangzhou Leihuo. Under
these agreements, each dated December 1, 2015, each of the ultimate shareholders of Hangzhou Leihuo has agreed to irrevocably entrust a
person designated by NetEase Hangzhou to represent him to exercise all the voting rights and other shareholders’ rights to which he is
entitled as a shareholder of Hangzhou Leihuo. Each agreement shall remain effective for as long as such shareholder remains a shareholder
of Hangzhou Leihuo unless NetEase Hangzhou unilaterally terminates the agreement by written notice.
● Operating Agreement among NetEase Hangzhou, Hangzhou Leihuo and the ultimate shareholders of Hangzhou Leihuo. To ensure the
successful performance of the various agreements between the parties, Hangzhou Leihuo and its ultimate shareholders have agreed that,
except for transactions in the ordinary course of business, Hangzhou Leihuo will not enter into any transaction that would materially affect
the assets, liabilities, rights or operations of Hangzhou Leihuo without the prior written consent of NetEase Hangzhou. NetEase Hangzhou
has also agreed that it will provide performance guarantees and, at NetEase Hangzhou’s discretion, guarantee loans for working capital
purposes to the extent required by Hangzhou Leihuo for its operations. Furthermore, the ultimate shareholders of Hangzhou Leihuo have
agreed that, upon instruction from NetEase Hangzhou, they will appoint Hangzhou Leihuo’s board members, president, chief financial
officer and other senior executive officers. The term of this agreement is 20 years from December 1, 2015 and can be extended with the
written consent of NetEase Hangzhou.
● Cooperation Agreement between NetEase Hangzhou and Hangzhou Leihuo. Under this Cooperation Agreement, NetEase Hangzhou has
agreed to provide the following services:
● the development of computer software (including, but not limited to, online games) and technical support and maintenance for
computer software operation;
● the provision of broadband internet access and other operational support; and
● jointly with Hangzhou Leihuo, the provision of value-added telecommunication and other services to users of the Leihuo website
and relevant products.
Hangzhou Leihuo has agreed to pay a monthly service fee to NetEase Hangzhou in accordance with a formula based on its expenses incurred.
This agreement was effective from January 1, 2010 and will continue to be effective unless it is terminated by written notice of NetEase Hangzhou or, in
case of a material breach of the agreement, it is terminated by written notice of the non-breaching party.
Agreements relating to Youdao Computer
Prior to November 20, 2017, William Lei Ding and certain employees or former employees of Youdao Computer owned 71.1% and 28.9% of
the equity interest in Youdao Computer, respectively. As a result of an internal reorganization completed on November 20, 2017, Feng Zhou, the chief
executive officer of Youdao, became the holder of the 28.9% equity interest in Youdao Computer, with William Lei Ding continuing to hold 71.1% of the
equity interest in Youdao Computer.
● Loan Agreements between Youdao Information and each of William Lei Ding and Feng Zhou. Each of William Lei Ding and Feng Zhou
entered into a Loan Agreement with Youdao Information, dated September 26, 2016 and November 20, 2017, respectively. Under these
Loan Agreements, Youdao Information provided each of William Lei Ding and Feng Zhou with an interest-free loan in the principal
amount of approximately RMB3.6 million and RMB1.4 million, respectively. These funds were used by each of William Lei Ding and
Feng Zhou to pay the consideration to acquire his respective equity interest in Youdao Computer. Such loans can be repaid by transferring
each of William Lei Ding and Feng Zhou’s respective equity interest in Youdao Computer to Youdao Information or its designee or through
such other method as Youdao Information shall determine. The term of each of the Loan Agreements is 10 years from the date of such
agreement and will be automatically extended for a further 10-year term unless otherwise decided by Youdao Information.
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● Equity Pledge Agreements between Youdao Information and each of William Lei Ding and Feng Zhou. Each of William Lei Ding and Feng
Zhou entered into an Equity Pledge Agreement with Youdao Information, dated September 26, 2016 and November 20, 2017, respectively.
Under such Equity Pledge Agreements, each of William Lei Ding and Feng Zhou pledged his respective equity interest in Youdao
Computer to Youdao Information to secure his obligations under the applicable Loan Agreement, Exclusive Purchase Option Agreement,
Shareholder Voting Rights Trust Agreement, and Operating Agreement. Each of William Lei Ding and Feng Zhou further agreed to not
transfer or pledge his respective equity interest in Youdao Computer without the prior written consent of Youdao Information. Each of the
Equity Pledge Agreement will remain binding until the respective pledger, William Lei Ding or Feng Zhou, as the case may be, discharges
all his obligations under the above-mentioned agreements.
● Exclusive Purchase Option Agreements. Under the Exclusive Purchase Option Agreements entered into by Youdao Information, Youdao
Computer and each of William Lei Ding and Feng Zhou, dated September 26, 2016 and November 20, 2017, respectively, each of William
Lei Ding and Feng Zhou granted Youdao Information an option to purchase all or a portion of his respective equity interest in Youdao
Computer at a price equal to the original and any additional paid-in capital paid by him. In addition, under each Exclusive Purchase Option
Agreement, Youdao Computer has granted Youdao Information an option to purchase all or a portion of the assets held by Youdao
Computer or its subsidiaries at a price equal to the net book value of such assets. Each of Youdao Computer, William Lei Ding and Feng
Zhou agreed not to transfer, mortgage or permit any security interest to be created on any equity interest in or assets of Youdao Computer
without the prior written consent of Youdao Information. Each Exclusive Purchase Option Agreement shall remain in effect until all of the
equity interests in or assets of Youdao Computer have been acquired by Youdao Information or its designee or until Youdao Information
unilaterally terminates the agreement by written notice.
● Shareholder Voting Rights Trust Agreements between Youdao Information and each of William Lei Ding and Feng Zhou. Under the
Shareholder Voting Rights Trust Agreements between Youdao Information and each of William Lei Ding and Feng Zhou, dated September
26, 2016 and November 20, 2017, respectively, each of William Lei Ding and Feng Zhou, agreed to irrevocably entrust a person designated
by Youdao Information to represent him to exercise all the voting rights and other shareholders’ rights to which he is entitled as a
shareholder of Youdao Computer. Each Shareholder Voting Rights Trust Agreement shall remain effective for as long as William Lei Ding
or Feng Zhou, as applicable, remains a shareholder of Youdao Computer unless Youdao Information unilaterally terminates the agreement
by written notice.
● Operating Agreements among Youdao Computer, Youdao Information and each of William Lei Ding and Feng Zhou. To ensure the
successful performance of the various agreements between the parties, each of Youdao Computer, William Lei Ding and Feng Zhou agreed
that, except for transactions in the ordinary course of business, Youdao Computer will not enter into any transaction that would materially
affect the assets, liabilities, rights or operations of Youdao Computer without the prior written consent of Youdao Information. Youdao
Information also agreed that it would provide performance guarantees and, at Youdao Information’s discretion, guarantee loans for working
capital purposes to the extent required by Youdao Computer for its operations. Furthermore, each of William Lei Ding and Feng Zhou
agreed that, upon instruction from Youdao Information, he would appoint Youdao Computer’s board members, president, chief financial
officer and other senior executive officers. The term of each Operating Agreement is 20 years from the date of execution and can be
extended with the written consent of Youdao Information.
● Cooperation Agreement between Youdao Information and Youdao Computer. Under this Cooperation Agreement, Youdao Information has
agreed to provide the following services:
● the development of computer software (including, but not limited to, generating online advertisement and distribution and
maintenance of related software) and technical support and maintenance for computer software operation;
● the development of computer software related to generating online advertisement, establishment of platforms for online
advertisement and related updates and operational support; and
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● the provision of technology support, including, but not limited to, server maintenance, development of server software and related
maintenance and updates.
Youdao Computer has agreed to share its monthly income (after tax and expenses) with Youdao Information in accordance with certain formulas
as specified in the Cooperation Agreement. This agreement was effective from July 1, 2015 and will continue to be effective unless it is terminated by
written notice of Youdao Information or, in case of a material breach of the agreement, it is terminated by written notice of the non-breaching party.
In addition, in connection with the licensing of certain online games by Blizzard to Shanghai EaseNet for operation in the PRC starting in
August 2008, there are certain contractual arrangements among Shanghai EaseNet, the joint venture established between Blizzard and us, and us. As a
result of these arrangements, Shanghai EaseNet is a controlled VIE, and William Lei Ding, our Chief Executive Officer, director and major shareholder,
does not receive any benefits in his capacity as the shareholder of Shanghai EaseNet or exercise any personal control over it. We have consolidated
Shanghai EaseNet into our financial statements as of and for the years ended December 31, 2018, 2019 and 2020.
Mr. Ding’s role as the shareholder of Shanghai EaseNet is designed to address Chinese regulations which place restrictions on the percentage
interest foreign or foreign-invested companies may have in Chinese companies providing value-added telecommunications services in China, which
include the provision of online games. See Item 5.A — “Operating Results—Our Corporate Structure.”
Subsidiary Guarantees
We have entered into several guarantee agreements in the aggregate amount of US$1,523.0 million in respect of certain credit facilities taken by
our subsidiaries. As of December 31, 2020, US$446.1 million of such credit facilities had not been utilized.
Agreements with Youdao
Youdao, which became listed on the New York Stock Exchange in October 2019, is currently our majority-controlled subsidiary. We have
entered into agreements with Youdao with respect to various ongoing relationships between us, which became effective upon the completion of Youdao’s
initial public offering in October 2019. These include a master transaction agreement, a transitional services agreement, a non-competition agreement, a
cooperation framework agreement and an intellectual property license agreement, each of which are summarized below.
Master Transaction Agreement
We have entered into a master transaction agreement with Youdao to govern certain key aspects of our relationship with Youdao, including the
allocation of liabilities. Pursuant to the master transaction agreement, Youdao is responsible for, among other things, the liabilities associated with the
“Online Learning Business,” which is defined to include the online learning products and online learning services offered by Youdao as of the date of the
master transaction agreement, excluding the NetEase open online courses and the K-12 curriculum course offered by us as of the date of the master
transaction agreement and certain other specified businesses, and we are responsible for, among other things, the liabilities arising on or after June 30,
2019 associated with the “NetEase Business,” which is defined to include the business conducted by the NetEase as of the date of the master transaction
agreement and any business that is derived from such businesses.
The master transaction agreement will automatically terminate five years following the earlier of (i) the first date when we no longer own at
least 20% of the voting power of Youdao’s then outstanding voting securities and (ii) the first date when we cease to be the largest beneficial owner of
Youdao’s then outstanding voting securities. We refer to such earlier date as the “Control Ending Date.” It can also be terminated early or extended by
mutual written consent of Youdao and us. The termination of the master transaction agreement will not affect the validity and effectiveness of the other
business cooperation agreements described below.
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Transitional Services Agreement
Under the transitional services agreement, we have agreed that, during the service period as described below, we will provide Youdao with
various corporate support and services such as legal support, human resources support, financial reporting, internal control and internal audit support,
technology and operational support, and administrative support. The price to be paid for the services provided under the transitional services agreement is
calculated by multiplying the sum of the actual “direct costs” and “indirect costs” of providing such services by 100% plus a reasonable mark-up rate as
determined by us. Direct costs include labor-related compensation and travel expenses, materials and supplies consumed in and agency fees arising from
performing the services. Indirect costs include office occupancy, information technology support and other overhead costs of the departments incurring
the direct costs of providing the services.
The service period under the transitional services agreement commenced upon the completion of Youdao’s initial public offering and will end on
the earliest of (i) the fifth anniversary of the completion of Youdao’s initial public offering, (ii) one year after the Control Ending Date, (iii) the date the
transitional services agreement is terminated by Youdao or us, whichever is earlier.
Non-competition Agreement
Under the non-competition agreement, Youdao and we have each agreed to be subject to certain non-compete restrictions during a “Non-
competition Period,” beginning from the completion of Youdao’s initial public offering and ending on the earlier of (i) five years after the Control Ending
Date; (ii) the date on which Youdao’s ADSs cease to be listed on the New York Stock Exchange; and (iii) the tenth anniversary of the completion of
Youdao’s initial public offering. Specifically:
● We have agreed not to compete with Youdao in the provision of the Online Learning Business, provided that such non-compete restrictions
shall not prevent the us from (i) engaging in the Online Learning Business through or on behalf of Youdao, (ii) continuing to engage in the
NetEase Business, (iii) owning a non-controlling interest in any company engaging in any business that is of the same nature as the Online
Learning Business, or (iv) engaging in any other business that we and Youdao may agree from time to time.
● Youdao has agreed not to compete with us in the NetEase Business or business of a similar nature, provided that such non-compete
restrictions shall not prevent Youdao from (i) engaging in the NetEase Business or business of a similar nature through us or on our behalf,
(ii) continuing to engage in any business that we operate as of the date of the non-competition agreement, (iii) owning a non-controlling
interest in any company engaging in any business that is of the same nature as the NetEase Business, and (iv) engaging in any other
business that we and Youdao may agree from time to time.
The non-competition agreement provides that if there is any ambiguity in the scope of business subject to the foregoing non-compete
restrictions, our interpretation shall prevail.
In addition, we and Youdao have each undertaken to each other that during the Non-competition Period, should a party have a business or
investment opportunity relating to the other party’s businesses covered by the foregoing non-compete restrictions, it shall notify the other party of such
opportunity in writing. If the party receiving the notice elects not to or otherwise fails to take up the opportunity within 30 days, the notifying party may
proceed to take up such business or investment opportunity.
The non-competition agreement also provides for a mutual non-solicitation obligation that neither Youdao nor we may, during the Non-
competition Period, hire, or solicit for hire, any active employees of or individuals providing consulting services to the other party, or any former
employees of or individuals providing consulting services to the other party within six months of the termination of their employment or consulting
services, without the other party’s consent, except for solicitation activities through generalized non-targeted advertisement not directed to such
employees or individuals that do not result in a hiring within the Non-competition Period. In addition, during the Non-competition Period, we and
Youdao have each agreed not to solicit business falling within the other party’s business scope from the other party’s customer, supplier, distributor or
similar third parties.
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Cooperation Framework Agreement
Under the cooperation framework agreement, we and Youdao have agreed to cooperate with each other in the marketing and promotion of each
other’s services and products on our respective platforms. Also, we have agreed to purchase Youdao’s translation services and to allow our users to log
on Youdao’s platforms with their NetEase Passports. The cooperation framework agreement became effective on the date of completion of Youdao’s
initial public offering and will expire on the earlier of (i) the fifteenth anniversary of the effective date of such agreement or (ii) five year after the
Control Ending Date.
Intellectual Property License Agreement
Under the intellectual property license agreement, we and Youdao grant to each other a worldwide, fully paid-up, non-sublicensable (subject to
certain specified exceptions), non-transferable, limited and non-exclusive license of certain intellectual properties for a royalty as agreed by both parties
solely to use, reproduce, modify, prepare derivative works of, perform, display, or otherwise exploit the licensed intellectual property within the term of
such agreement. This agreement became effective on the completion of Youdao’s initial public offering and expires on the earlier of (i) the fifteen
anniversary of the effective date of such agreement, and (ii) one year after the Control Ending Date with respect to the sharing of information and data
and user registration information, or five years after the Control Ending Date with respect to other licenses under such agreement.
C. Interests of Experts and Counsel
Not applicable.
Item 8. Financial Information
A. Consolidated Statements and Other Financial Information
Please see Item 18. “Financial Statements” for our audited consolidated financial statements filed as part of this annual report.
A.7 Legal Proceedings
From time to time, we become subject to legal proceedings and claims in the ordinary course of our business, including claims of alleged
infringement of trademarks, copyrights and other intellectual property rights, and a variety of claims arising in connection with our e-mail, message
boards and other communications and community features, such as claims alleging defamation or invasion of privacy. However, such legal proceedings
or claims, even if not meritorious, could result in the expenditure of significant financial and management resources.
In April 2018, PUBG Corporation and PUBG Santa Monica, Inc. (collectively “PUBG”), filed a lawsuit against defendants NetEase, Inc.,
NetEase Information Technology Corp. and NetEase (Hong Kong) Limited in the U.S. District Court for the Northern District of California. PUBG
subsequently dropped all claims against NetEase (Hong Kong) Limited, and added Hong Kong NetEase Interactive Entertainment Limited to the lawsuit.
PUBG’s complaint generally alleged that two of NetEase’s mobile games, Rules of Survival and Knives Out, infringed PUBG’s copyrights and trade
dress in their competing game, Player Unknown’s Battlegrounds. On March 11, 2019, NetEase entered into a settlement agreement with PUBG, and the
lawsuit was dismissed. On October 15, 2019, PUBG filed a second lawsuit against the same NetEase defendants, also in the U.S. District Court for the
Northern District of California, claiming NetEase had allegedly breached the settlement agreement. On March 3, 2020, the court dismissed PUBG’s new
lawsuit, without prejudice, for lack of subject matter jurisdiction. On March 4, 2020, NetEase initiated a declaratory judgment action against PUBG in
the Superior Court of California for the County of San Mateo, requesting a declaration that NetEase had not breached the settlement agreement. On
March 13, 2020, PUBG filed a cross claim in the same Court, realleging that we breached the settlement agreement. As of the date of the filing of this
annual report, the litigation remains ongoing and the court has not yet set a trial date.
We are not currently a party to, nor are we aware of, any other legal proceeding, investigation or claim which, in the opinion of our
management, is likely to have a material adverse effect on our business, financial condition or results of operations.
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A.8 Dividend Policy
In May 2014, our board of directors approved a quarterly dividend policy commencing in 2014. Under this policy, quarterly dividends were set
at an amount equivalent to approximately 25% of our anticipated net income after tax in each fiscal quarter. In the second quarter of 2019, our board of
directors determined that quarterly dividends will be set at an amount equivalent to approximately 20%-30% of our anticipated net income after tax in
each fiscal quarter. The determination to make dividend distributions and the amount of such distributions in any particular quarter will be made at the
discretion of our board of directors and will be based upon our operations and earnings, cash flow, financial condition and other relevant factors. Our
board of directors declared dividends of US$0.2320 per ADS (US$0.0464 per ordinary share), US$0.2970 per ADS (US$0.0594 per ordinary share),
US$0.1950 per ADS (US$0.0390 per ordinary share) and US$0.0600 per ADS (US$0.0120 per ordinary share) for the first, second, third and fourth
quarters of 2020, respectively.
We are a holding company incorporated in the Cayman Islands, and our ability to pay dividends to our shareholders depends upon dividends,
loans or advances that we receive from our subsidiaries and VIEs. Please refer to Item 3.D. “Risk Factors—Risks Related to Our Company—Our
corporate structure may restrict our ability to receive dividends from, and transfer funds to, our PRC subsidiaries and VIEs, which could restrict our
ability to act in response to changing market conditions and reallocate funds internally in a timely manner.”
Holders of our ADSs will be entitled to receive dividends, if any, subject to the terms of the deposit agreement (including the fees and expenses
payable thereunder), to the same extent as the holders of our ordinary shares. Cash dividends will be paid to the depositary in U.S. dollars, which will
distribute them to the holders of ADSs according to the terms of the deposit agreement. Other distributions, if any, will be paid by the depositary to the
holders of ADSs in any means it deems legal, fair and practical.
B. Significant Changes
We have not experienced any significant changes since the date of our audited consolidated financial statements included in this annual report.
Item 9. The Offer and Listing
Not applicable except for Item 9.A.4. and Item 9.C. Our ADSs have been listed on the NASDAQ Global Select Market since June 30, 2000 and
trade under the symbol “NTES.” Our shares have been listed on the Hong Kong Stock Exchange since June 11, 2020 and trade under the symbol “9999”.
Item 10. Additional Information
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association
The following presents a description of the terms and provisions of our restated memorandum and articles of association.
General
We were incorporated in the Cayman Islands on July 6, 1999 and operate under the Cayman Islands Companies Act, as revised and amended
from time to time, or the Companies Act. Our corporate objectives and purpose are unrestricted.
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Directors
A director may vote in respect of any contract or transaction in which he is interested, provided however, that the nature of the interest of any
director in any such contract or transaction shall be disclosed by him at or prior to its consideration and any vote on that matter. A general notice or
disclosure to the directors or otherwise contained in the minutes of a meeting or a written resolution of the directors or any committee thereof that a
director is a shareholder of any specified firm or company and is to be regarded as interested in any transaction with such firm or company shall be
sufficient disclosure and after such general notice it shall not be necessary to give special notice relating to any particular transaction.
The directors may determine remuneration to be paid to the directors. The directors may exercise all the powers of our company to borrow
money and to mortgage or charge its undertaking, property and uncalled capital or any part thereof, to issue debentures, debenture stock and other
securities whenever money is borrowed or as security for any of our debts, liabilities, or obligations or those of any third party.
A shareholding qualification for directors may be fixed by the Company in a general meeting, but unless and until so fixed, there are no
shareholding qualifications. Further, there are no age limitations or retirement requirements and no share ownership qualifications for directors unless so
fixed by shareholders in a general meeting.
Rights, Preferences and Restrictions of Ordinary Shares
General. All of our issued and outstanding shares are fully paid and non-assessable. Shares are issued in registered form. Our shareholders who
are non-residents of the Cayman Islands may freely hold and vote their shares.
Dividends. The holders of shares are entitled to such dividends as may be declared by our board of directors. Under Cayman Islands law,
dividends may be declared and paid only out of funds legally available therefor, namely out of either profit or our share premium account, and provided
further that a dividend may not be paid if this would result in our company being, immediately following such payment, unable to pay its debts as they
fall due in the ordinary course of business.
Voting Rights. Each share is entitled to one vote on all matters upon which the shares are entitled to vote, including the election of directors.
Voting at any meeting of shareholders is by show of hands unless a poll is demanded. A poll may be demanded by the Chairman or any other shareholder
present in person or by proxy. A quorum required for a meeting of shareholders consists of at least two shareholders present in person or by proxy.
Any ordinary resolution to be made by the shareholders requires the affirmative vote of a simple majority of the votes attaching to the shares
cast in a general meeting, while a special resolution requires the affirmative vote of no less than two-thirds of the votes cast attaching to the shares. A
special resolution is required for matters such as a change of our name. Holders of the shares may by ordinary resolution, among other things, elect
directors, appoint auditors, and increase our share capital. Both ordinary resolutions and special resolutions may also be passed by a unanimous written
resolution signed by all the shareholders of our company.
Liquidation. Upon the winding up of our company, assets available for distribution among the holders of shares shall be distributed among the
holders of the shares pro rata. If the assets available for distribution are insufficient to repay all of the paid-up capital, the assets will be distributed so that
the losses are borne by our shareholders proportionately.
Calls on Shares and Forfeiture of Shares. Our board of directors may from time to time make calls upon shareholders for any amounts unpaid
on their shares in a notice served to such shareholders at least 14 days prior to the specified time or times of payment. The shares that have been called
upon and remain unpaid are subject to forfeiture.
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Redemption, Repurchase and Surrender of Shares. Subject to the provisions of the Companies Act and our memorandum and articles of
association, we may issue shares on the terms that they are, or at our option or at the option of the holders are, subject to redemption on such terms and in
such manner as we may, before the issue of the shares, determine by special resolution. Subject to the provisions of the Companies Act and our
memorandum and articles of association, we may also repurchase any of our shares provided that the manner of such purchase has first been approved by
ordinary resolution of our shareholders. Under the Companies Act, the redemption or repurchase of any share may be paid out of our profits or out of the
proceeds of a fresh issue of shares made for the purpose of such redemption or repurchase, or out of capital (including share premium account and capital
redemption reserve) if we can, immediately following such payment, pay our debts as they fall due in the ordinary course of business. In addition, under
the Companies Act no such share may be redeemed or repurchased (a) unless it is fully paid up, (b) if such redemption or repurchase would result in
there being no shares outstanding, or (c) if we have commenced liquidation. In addition, we may accept the surrender of any fully paid share for no
consideration.
Variations of Rights of Shares
The rights attached to any class of shares (unless otherwise provided by the terms of issue of the shares of that class) may, subject to the
provisions of the Companies Act, be varied either with the consent in writing of the holders of three-fourths of the issued shares of that class or with the
sanction of a special resolution passed at a general meeting of the holders of the shares of that class.
General Meetings of Shareholders
The directors may whenever they think fit, and they shall on the requisition of our shareholders holding not less than one-tenth of our paid-up
capital as at the date of the deposit of the requisition carries the right of voting at general meetings of our company, proceed to convene a general meeting
of our company. If the directors do not within 21 days from the date of the deposit of the requisition duly proceed to convene a general meeting, the
requisitionists, or any of them representing more than one-half of the total voting rights of all of them, may themselves convene a general meeting, but
any meeting so convened shall not be held after the expiration of three months after the expiration of such 21 days. Advanced notice of at least five days
is required for the convening of the annual general meeting and other shareholders meetings.
Limitations on the Right to Own Shares
There are no limitations on the right to own our shares.
Limitations on Transfer of Shares
There are no provisions in our restated memorandum or articles of association that would have an effect of delaying, deferring or preventing a
change in control and that would operate only with respect to a merger, acquisition or corporate restructuring.
Disclosure of Shareholder Ownership
There are no provisions in our restated memorandum or articles of association that require our company to disclose shareholder ownership
above any particular ownership threshold.
Changes in Capital
We may from time to time by ordinary resolution increase the share capital by such sum, to be divided into shares of such amount, as the
resolution shall prescribe. The new shares shall be subject to the same provisions with reference to the payment of calls, lien, transfer, transmission,
forfeiture and otherwise as the shares in the original share capital. We may by ordinary resolution:
(a) consolidate and divide all or any of our share capital into shares of larger amount than our existing shares;
(b) sub-divide our existing shares, or any of them into shares of smaller amount than is fixed by our restated memorandum of association or
into shares without nominal or par value; and
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(c) cancel any shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any person.
We may by special resolution reduce our share capital and any capital redemption reserve fund in any manner authorized by the Companies Act.
Differences in Corporate Law
The Companies Act of the Cayman Islands is modeled after that of the English companies legislation but does not follow recent English law
statutory enactments and accordingly there are significant differences between the Companies Act of the Cayman Islands and the current Companies Act
of England. In addition, the Companies Act of the Cayman Islands differs from laws applicable to U.S. corporations and their shareholders. Set forth
below is a summary of the significant differences between the provisions of the Companies Act of the Cayman Islands applicable to us and the laws
applicable to companies incorporated in the United States and their shareholders.
Mergers and Similar Arrangements. The Companies Act permits mergers and consolidations between Cayman Islands companies and between
Cayman Islands companies and non-Cayman Islands companies. For these purposes, (a) ”merger” means the merging of two or more constituent
companies and the vesting of their undertaking, property and liabilities in one of such companies as the surviving company and (b) a “consolidation”
means the combination of two or more constituent companies into a consolidated company and the vesting of the undertaking, property and liabilities of
such companies to the consolidated company. In order to effect such a merger or consolidation, the directors of each constituent company must approve a
written plan of merger or consolidation (a “Plan”), which must then be authorized by each constituent company by way of (a) a special resolution of the
shareholders of each such constituent company; and (b) such other authorization, if any, as may be specified in such constituent company’s articles of
association. The consent of each holder of a fixed or floating security interest of a Cayman Islands constituent company must be obtained, unless the
Grand Court of the Cayman Islands waives such requirement. The Plan must be filed with the Registrar of Companies together with, among other
documents, a director’s declaration as to the solvency of the constituent company and of the consolidated or surviving company, a director’s declaration
of the assets and liabilities of each constituent company and an undertaking that a copy of the certificate of merger or consolidation will be given to the
members and creditors of each constituent company and that notification of the merger or consolidation will be published in the Cayman Islands Gazette.
Dissenting shareholders have the right to be paid the fair value of their shares (which, if not agreed between the parties, will be determined by the Grand
Court of the Cayman Islands) if they follow the required procedures set out in the Companies Act, subject to certain exceptions. Court approval is not
required for a merger or consolidation which is effected in compliance with these statutory procedures.
Separate from the statutory provisions relating to mergers and consolidations, the Companies Act also contains statutory provisions that
facilitate the reconstruction and amalgamation of companies by way of schemes of arrangement, provided that the arrangement in question is approved
by a majority in number of each class of shareholders or creditors with whom the arrangement is to be made, and who must in addition represent three-
fourths in value of each such class of shareholders or creditors, as the case may be, that are present and voting either in person or by proxy at a meeting,
or meetings convened for that purpose. The convening of the meetings and subsequently the arrangement must be sanctioned by the Grand Court of the
Cayman Islands. While a dissenting shareholder would have the right to express to the court the view that the transaction ought not to be approved, the
court can be expected to approve the arrangement if it satisfies itself that:
● the statutory provisions as to majority vote have been complied with;
● the shareholders have been fairly represented at the meeting in question and the statutory majority are acting bona fide without coercion of
the minority to promote interests adverse to those of the class;
● the arrangement is such that may be reasonably approved by an intelligent and honest man of that class acting in respect of his interest; and
● the arrangement is not one that would more properly be sanctioned under some other provision of the Companies Act.
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The Companies Act contains a statutory power of compulsory acquisition which may facilitate the “squeeze out” of dissentient minority
shareholders upon a tender offer. When a tender offer is made and accepted by holders of 90% of the affected shares within four months, the offeror may,
within a two-month period after expiry of such four-month period, require the holders of the remaining shares to transfer such shares to the offeror on the
terms of the offer. An objection can be made to the Grand Court of the Cayman Islands but this is unlikely to succeed unless there is evidence of fraud,
bad faith or collusion.
If an arrangement and reconstruction by way of a scheme of arrangement is thus approved and sanctioned, or if a tender offer is made and
accepted, in accordance with the foregoing statutory provisions, a dissenting shareholder would have no rights comparable to appraisal rights, which
would otherwise ordinarily be available to dissenting shareholders of United States corporations, providing rights to receive payment in cash for the
judicially determined value of the shares.
Shareholders’ Suits. In principle, we will normally be the proper plaintiff and as a general rule a derivative action may not be brought by a
minority shareholder. However, based on English authorities, which would in all likelihood be of persuasive authority in the Cayman Islands, there are
exceptions to the foregoing principle, including when: (a) a company acts or proposes to act illegally or ultra vires; (b) the act complained of, although
not ultra vires, could only be effected duly if authorized by more than a simple majority vote that has not been obtained; and (c) those who control the
company are perpetrating a “fraud on the minority.”
Indemnification. Cayman Islands law does not (other than as set forth hereafter) limit the extent to which a company’s memorandum and articles
of association may provide for indemnification of officers and directors, except to the extent any such provision may be held by the Cayman Islands
courts to be contrary to public policy, such as to provide indemnification against civil fraud or the consequences of committing a crime. Our articles of
association provide for indemnification of officers and directors for losses, damages, costs and expenses incurred in their capacities as such, except
through their own willful neglect or default.
Insofar as indemnification or liability arising under the Securities Act of 1933 may be permitted to directors, officers or persons controlling the
registrant pursuant to the foregoing provisions, we have been informed that in the opinion of the SEC such indemnification is against public policy as
expressed in the Securities Act of 1933 and is therefore unenforceable.
C. Material Contracts
We have not entered into any material contracts other than in the ordinary course of business and other than those described in this Item 10.C.
"Additional Information-Material Contracts," Item 4. “Information on the Company” or elsewhere in this annual report.
D. Exchange Controls
Foreign currency exchange in the PRC is primarily governed by the Foreign Exchange Administration Rules issued by the State Council on
January 29, 1996 and effective as of April 1, 1996 (and amended on January 14, 1997 and August 1, 2008) and the Regulations of Settlement, Sale and
Payment of Foreign Exchange which came into effect on July 1, 1996.
Under the Foreign Exchange Administration Rules, Renminbi is freely convertible for current account items, including the distribution of
dividends payments, interest payments, trade and service-related foreign exchange transactions. Conversion of Renminbi for capital account items, such
as direct investment, loans, securities investment and repatriation of investment, however, is still generally subject to the approval or verification of
SAFE or its competent local branches.
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In March 2015, SAFE released the Circular on Reforming the Management Approach regarding the Foreign Exchange Capital Settlement of
Foreign-Invested Enterprises, or FIEs, or the Foreign Exchange Capital Settlement Circular, which became effective from June 1, 2015. This circular
replaced SAFE’s previous related circulars, including the Circular on Issues Relating to the Improvement of Business Operation with Respect to the
Administration of Foreign Exchange Capital Payment and Settlement of Foreign Invested Enterprises. The Foreign Exchange Capital Settlement Circular
clarifies that FIEs may settle a specified proportion of their foreign exchange capital in banks at their discretion, and may choose the timing for such
settlement. The proportion of foreign exchange capital to be settled at FIEs’ discretion for the time being is 100% and the SAFE may adjust the
proportion in due time based on the situation of international balance of payments. The FIEs’ capital and Renminbi capital gained from the settlement of
foreign exchange capital may not be directly or indirectly used for expenditure beyond the business scope of the FIEs or as prohibited by laws and
regulations of the PRC. Such capital may not be directly or indirectly used for investments in securities, except as otherwise provided by laws and
regulations. Except foreign-funded real estate enterprises, such capital may not be used for paying the costs relevant to the purchase of the real estate not
for self-use. Such capital also may not be directly or indirectly used for issuing Renminbi entrusted loans except as permitted by the business scope of the
FIE, for repaying inter-enterprise borrowings including any third-party advance, or for repaying the bank loans denominated in RMB that have been sub-
lent to a third party. On June 9, 2016, SAFE issued the Circular on Reform and Regulating of the Administrative Policy of the Settlement under Capital
Accounts, or SAFE Circular 16, which became effective on the same date. Pursuant to SAFE Circular 16, FIEs may either continue to follow the current
payment-based foreign currency settlement system or choose to follow the “conversion-at-will” system for foreign currency settlement. Where a FIE
elects the conversion-at-will system for foreign currency settlement, it may convert, in part or in whole, the amount of the foreign currency in its capital
account into Renminbi. The converted Renminbi will be kept in a designated account labeled as settled but pending payment, and if such FIE needs to
make payment from such designated account, it is required to provide authenticity proof materials to declare the usage of such funds. Although SAFE
Circular 16 effectively simplifies the administrative process for converting foreign currencies into Renminbi for settlement of capital account items, the
Notice on Further Promoting the Reform of Foreign Exchange Administration and Improving Authenticity and Compliance Review (Hui Fa [2017] No.
3), or Notice No. 3, released by SAFE on January 26, 2017, requires a domestic company to provide explanations to the banks through which it seeks to
exchange currency of the sources of funds for investment and the intended use of such funds. Under Notice No. 3, submission of relevant corporate
documents, including board resolutions and relevant contracts is also required to support a domestic company’s claim of intended use. On October 23,
2019, the SAFE promulgated Notice of the State Administration of Foreign Exchange on Further Promoting the Facilitation of Cross-border Trade and
Investment (Hui Fa [2019] No.28), or Notice No. 28, which took effect on the same date (except for Article 8.2, which became effective on January 1,
2020). Under Notice 28, FIEs without an investment business scope are also allowed to utilize and convert capital received from foreign investors for
making equity investment in China. Previously this had been limited to FIEs who explicitly had an investment business scope. However, it is not clear
how Notice 28 will be implemented in practice and the implementing rules for Notice 28 have yet to be promulgated by the SAFE. On April 10, 2020,
SAFE promulgated the Notice of the SAFE on Optimizing Foreign Exchange Administration to Support the Development of Foreign-related Business
(Hui Fa [2020] No.8), or Notice No. 8, which took effect on the same date. According to Notice 8, under the prerequisite of ensuring true and compliant
use of funds and compliance with the prevailing administrative provisions on use of income under the capital account, enterprises which satisfy the
criteria are allowed to use income under the capital account, such as capital funds, foreign debt and overseas listing, for domestic payment, without prior
provision of proof materials for veracity to the bank for each transaction. We closely monitor any changes and new regulatory releases, especially given
the recently increased frequency of SAFE enforcement actions, to ensure that our operations remain in compliance.
In addition, the payment of dividends by entities established in the PRC is subject to limitations. Regulations in the PRC currently permit
payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in the PRC. Each of our
PRC subsidiaries that is a domestic company is also required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards
each year to its general reserves or statutory capital reserve fund until the accumulative amount of such reserves reach 50.0% of its respective registered
capital. These restricted reserves are not distributable as cash dividends. In addition, if any of our PRC subsidiaries incurs debt on its own behalf in the
future, the instruments governing the debt may restrict its ability to pay dividends or make other distributions to us.
Furthermore, pursuant to regulations promulgated by SAFE, PRC subsidiaries of offshore parent companies may be prohibited from making
distributions of profits to such offshore parent companies and from paying the offshore parent companies proceeds from any reduction in capital, share
transfer or liquidation in respect of such PRC subsidiaries, if PRC shareholders with a direct or indirect stake in the offshore parent company fail to make
the requisite SAFE registrations.
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These regulations require PRC residents to file with the competent SAFE offices information about offshore companies in which they have
directly or indirectly invested (including with respect to investments already made as of the inception of the new regulation) and to make follow-up
filings in connection with certain material transaction involving such offshore companies, such as mergers or acquisitions, capital increases or decreases,
and external equity investments or equity transfers.
Moreover, to discourage the outflow of capital from China, the overall current regulatory environment relating to foreign exchange controls in
China suggests that, as a matter of practice, SAFE has been making it increasingly difficult to exchange Renminbi into foreign currencies for offshore
dividend payments or capital account settlement. For additional information on the SAFE regulations and the related risks to our company, see Item 3.D.
“Risk Factors—Risks Related to Doing Business in China—The Chinese government has strengthened the regulation of investments made by Chinese
residents in offshore companies and reinvestments in China made by these offshore companies. Our business may be adversely affected by these
restrictions.”
For more information about foreign exchange control, see Item 3.D. “Risk Factors—Risks Related to Our Company—Our corporate structure
may restrict our ability to receive dividends, loans or advances from, and transfer funds to, our PRC subsidiaries and VIEs, which could restrict our
ability to act in response to changing market conditions and reallocate funds internally in a timely manner.” and “Risk Factors—Risks Related to Doing
Business in China—Restrictions on currency exchange may limit our ability to utilize our revenues effectively.”
E. Taxation
The following summary of the material Cayman Islands and United States federal income tax consequences relevant to the purchase, ownership
or sale of our ordinary shares or ADSs is based upon laws and relevant interpretations thereof in effect as of the date of this annual report, all of which
are subject to change. To the extent that the discussion relates to matters of Cayman Islands tax law, it represents the opinion of Maples and Calder (Hong
Kong) LLP, our Cayman Islands counsel.
Cayman Islands Taxation
The Cayman Islands currently levies no taxes on individuals or corporations based upon profits, income, gains or appreciation and there is no
taxation in the nature of inheritance tax or estate duty. There are no other taxes likely to be material to us levied by the government of the Cayman Islands
except for stamp duties which may be applicable on instruments executed in, or after execution brought within, the jurisdiction of the Cayman Islands.
The Cayman Islands is not party to any double tax treaties that are applicable to any payments made by or to our company. There are no exchange control
regulations or currency restrictions in the Cayman Islands.
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People’s Republic of China Taxation
Under the PRC Enterprise Income Tax Law and its implementation rules, an enterprise established outside of the PRC with “de facto
management body” within the PRC is considered a resident enterprise and will be subject to the enterprise income tax on its global income at the rate of
25%. The implementation rules define the term “de facto management body” as the body that exercises full and substantial control and overall
management over the business, productions, personnel, accounts and properties of an enterprise. In 2009, the STA issued a circular, known as Circular
82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated
offshore is located in China. Although this circular only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those
controlled by PRC individuals or foreigners, the criteria set forth in the circular may reflect the STA’s general position on how the “de facto management
body” text should be applied in determining the tax resident status of all offshore enterprises. According to Circular 82, an offshore incorporated
enterprise controlled by a PRC enterprise or a PRC enterprise group will be regarded as a PRC tax resident by virtue of having its “de facto management
body” in China if all of the following conditions are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions
relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the
enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions, are located or maintained in the PRC;
and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC. We are not aware of any offshore holding companies
with a similar corporate structure to ours that have been deemed as a PRC resident enterprise by the PRC tax authorities. Accordingly, we believe that
none of NetEase, Inc. and its subsidiaries outside of China is a PRC resident enterprise for PRC tax purposes. However, the tax resident status of an
enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto
management body.”
If the PRC tax authorities determine that NetEase, Inc. is a PRC resident enterprise for enterprise income tax purposes, we may be required to
withhold a 10% withholding tax from dividends we pay to our shareholders that are non-resident enterprises, including the holders of our ADSs. In
addition, non-resident enterprise shareholders (including our ADS holders) may be subject to a 10% PRC withholding tax on gains realized on the sale or
other disposition of ADSs or ordinary shares, if such income is treated as sourced from within the PRC. In addition, gains derived by our non-PRC
individual shareholders from the sale of our shares and ADSs may be subject to a 20% PRC withholding tax.
Pursuant to the Arrangement between the Mainland of China and the Hong Kong Special Administrative Region for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income, the withholding tax rate in respect to the payment of dividends by a PRC
enterprise to a Hong Kong enterprise may be reduced to 5% from a standard rate of 10% if the Hong Kong enterprise directly holds at least 25% of the
PRC enterprise. Pursuant to the Notice of the STA on the Issues concerning the Application of the Dividend Clauses of Tax Agreements, a Hong Kong
resident enterprise must meet the following conditions, among others, in order to apply the reduced withholding tax rate: (i) it must be a company; (ii) it
must directly own the required percentage of equity interests and voting rights in the PRC resident enterprise; and (iii) it must have directly owned such
required percentage in the PRC resident enterprise throughout the 12 months prior to receiving the dividends.
It is unclear whether our non-PRC individual shareholders (including our ADS holders) would be subject to any PRC tax on dividends obtained
by such non-PRC individual shareholders in the event we are determined to be a PRC resident enterprise. If any PRC tax were to apply to dividends
realized by non-PRC individuals, it would generally apply at a rate of 20% unless a reduced rate is available under an applicable tax treaty. However, it is
also unclear whether non-PRC shareholders of NetEase, Inc. would be able to claim the benefits of any tax treaties between their country of tax residence
and the PRC in the event that NetEase, Inc. is treated as a PRC resident enterprise.
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Provided that our Cayman Islands holding company, NetEase, Inc., is not deemed to be a PRC resident enterprise, holders of our ADSs and
ordinary shares who are not PRC residents will not be subject to PRC income tax on dividends distributed by us or gains realized from the sale or other
disposition of our shares or ADSs. STA Circular 7 further clarifies that, if a non-resident enterprise derives income by acquiring and selling shares in an
offshore listed enterprise in the public market, such income will not be subject to PRC tax. In addition, STA Public Notice 37 provided certain key
changes to the previous withholding regime, such as (i) the withholding obligation for a non-resident enterprise deriving dividend arises on the date on
which the payment is actually made rather than on the date of the resolution that declared the dividends, (ii) non-resident enterprises shall report tax to
relevant authorities if their withholding agents fail to perform the withholding obligation. However, there is uncertainty as to the application of STA
Public Notice 37 and STA Circular 7, we and our non-PRC resident investors may be at risk of being required to file a return and being taxed under STA
Public Notice 37 and STA Circular 7 and we may be required to expend valuable resources to comply with STA Public Notice 37 and STA Circular 7 or
to establish that we should not be taxed under STA Public Notice 37 and STA Circular 7. See “Item 3.D. Key Information—Risk Factors—Risks Related
to Doing Business in China—We face uncertainties with respect to indirect transfers of equity interests in PRC resident enterprises by a non-PRC
company.”
Hong Kong Taxation
Our subsidiaries in Hong Kong were subject to income tax on their taxable income generated from operations in Hong Kong at a rate of 16.5%.
For the years 2018, 2019 and 2020, the first HK$2 million of profits earned by one of our subsidiaries incorporated in Hong Kong is taxed at a rate of
8.25%, while the remaining profits will continue to be taxed at the 16.5% tax rate. The payments of dividends by these companies to us are not subject to
any Hong Kong withholding tax.
Our principal register of members is maintained by our principal share registrar, Maples Fund Services (Cayman) Limited, in the Cayman
Islands, and our Hong Kong register of members is maintained by the Hong Kong share registrar, Computershare Hong Kong Investor Services Limited,
in Hong Kong.
Dealings in our ordinary shares registered on our Hong Kong share register are subject to Hong Kong stamp duty. The stamp duty is charged to
each of the seller and purchaser at the rate of 0.1% of the consideration for, or (if greater) the value of, our ordinary shares transferred. In other words, a
total of 0.2% is currently payable on a typical sale and purchase transaction of our ordinary shares. In addition, a fixed duty of HK$5.00 is charged on
each instrument of transfer (if required).
To facilitate ADS-ordinary share conversion and trading between the Nasdaq and the Hong Kong Stock Exchange, we have moved a portion of
our issued ordinary shares, including all of the ordinary shares deposited in our ADS program, from our Cayman share register to our Hong Kong share
register. It is unclear whether, as a matter of Hong Kong law, the trading or conversion of ADSs constitutes a sale or purchase of the underlying Hong
Kong-registered ordinary shares that is subject to Hong Kong stamp duty. We advise investors to consult their own tax advisors on this matter. See “Item
3. Key Information — D. Risk Factors — Risks Related to Our ADSs and Shares — There is uncertainty as to whether Hong Kong stamp duty will apply
to the trading or conversion of our ADSs.”
Material United States Federal Income Taxation Considerations
The following discussion is a summary of certain United States federal income tax considerations applicable to the purchase, ownership and
disposition of shares or ADSs by a U.S. Holder (as defined below) who holds such shares or ADSs as capital assets within the meaning of Section 1221
of the Internal Revenue Code of 1986, as amended , referred to in this section as the Code. This summary does not purport to be a complete analysis of
all potential United States federal income tax effects. This summary is based on the Code, United States Treasury regulations promulgated
thereunder, Internal Revenue Service,or IRS, rulings and judicial decisions and the income tax treaty between the United States and the PRC, or the
U.S.-PRC Tax Treaty, all as in effect on the date hereof. All of these are subject to change, possibly with retroactive effect, or to different interpretations.
Such change could materially and adversely affect the tax consequences described below. No assurance can be given that the IRS would not assert, or
that a court would not sustain, a position contrary to any of the tax consequences described below. Additionally, the discussion below is written on the
basis that the representations contained in the deposit agreement are true and that the obligations in the deposit agreement and any related agreement will
be performed in accordance with the terms.
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This summary does not address all aspects of United States federal income taxation that may be relevant to particular U.S. Holders in light of
their specific circumstances (for example, U.S. Holders subject to the alternative minimum tax provisions of the Code) or to holders that may be subject
to special rules under United States federal income tax law, including:
● broker dealers in stocks, securities, commodities or currencies;
● persons (including securities traders) that use a mark-to-market accounting method;
● banks and financial institutions;
● insurance companies;
● regulated investment companies;
● real estate investment trusts;
● tax-exempt entities;
● grantor trusts;
● persons holding shares or ADSs as part of a hedging or conversion transaction or a straddle;
● persons deemed to sell shares or ADSs under the constructive sale provisions of the Code;
● certain former citizens or residents of the United States;
● persons whose functional currency is not the U.S. dollar; and
● direct, indirect or constructive owners of 10% or more of the total combined vote or value of all classes of our equity.
This summary also does not discuss any aspect of state, local or non-U.S. tax law, or United States federal estate or gift tax law as applicable to
U.S. Holders. Prospective purchasers are urged to consult their tax advisors about the United States federal, state and local and non-U.S. tax
consequences to them of the purchase, ownership and disposition of shares or ADSs.
For purposes of this summary, “U.S. Holder” means a beneficial holder of shares or ADSs who or that for United States federal income tax
purposes is:
● an individual citizen or resident of the United States;
● a corporation (or other entity classified as a corporation for United States federal income tax purposes) created or organized in or under the
laws of the United States, any state thereof or the District of Columbia;
● an estate, the income of which is subject to United States federal income taxation regardless of its source; or
● a trust, if a court within the United States is able to exercise primary supervision over the administration of such trust and one or more
“U.S. persons” (within the meaning of the Code) have the authority to control all substantial decisions of the trust, or if a valid election is in
effect to be treated as a domestic trust.
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If a partnership or other entity or arrangement classified as a partnership for United States federal income tax purposes holds shares or ADSs,
the United States federal income tax treatment of a partner generally will depend on the status of the partner and the activities of the partnership. This
summary does not address the tax consequences of any such partner. If you are a partner of a partnership holding shares or ADSs, you should consult
your own tax advisor regarding the U.S. federal income tax consequences of acquiring, owning or disposing of our shares or ADSs.
ADSs
A U.S. Holder of ADSs generally will be treated as the owner of the underlying shares represented by those ADSs for United States federal
income tax purposes. Accordingly, no gain or loss will be recognized if a U.S. Holder exchanges ADSs for the underlying shares represented by those
ADSs.
The U.S. Treasury has expressed concern that parties to whom ADSs are released before shares are delivered to the depositary or intermediaries
in the chain of ownership between holders and the issuer of the security underlying the ADSs, may be taking actions that are inconsistent with the
claiming of foreign tax credits by U.S. Holders of ADSs. These actions would also be inconsistent with the claiming of the reduced rate of tax, described
below, applicable to dividends received by certain non-corporate U.S. Holders. Accordingly, the creditability of non-U.S. withholding taxes (if any), and
the availability of the reduced tax rate for dividends received by certain non-corporate U.S. Holders, each described below, could be affected by actions
taken by such parties or intermediaries. For purposes of the discussion below, we assume that intermediaries in the chain of ownership between the
holder of an ADS and us are acting consistently with the claim of U.S. foreign tax credits by U.S. Holders.
Taxation of Dividends and Other Distributions on the Shares or ADSs
Subject to the passive foreign investment company, or PFIC, rules discussed below, the gross amount of any distributions (including withheld
taxes, if any) paid by our company out of current or accumulated earnings and profits (as determined for United States federal income tax purposes)
generally will be taxable to a U.S. Holder as foreign source dividend income on the date such distribution is actually or constructively received, and will
not be eligible for the dividends received deduction generally allowed to corporations. Distributions in excess of current and accumulated earnings and
profits will be treated as a non-taxable return of capital to the extent of the U.S. Holder’s adjusted tax basis in the shares or ADSs and thereafter as capital
gain. However, we do not maintain calculations of our earnings and profits in accordance with United States federal income tax accounting principles.
U.S. Holders should therefore assume that any distribution by our company with respect to the shares or ADSs will constitute dividend income. U.S.
Holders should consult their own tax advisors with respect to the appropriate United States federal income tax treatment of any distribution received from
our company. This discussion assumes that distributions, if any, will be made in U.S. dollars.
Certain dividends received by non-corporate U.S. Holders, including individuals, may be eligible for the special reduced rates normally
applicable to long-term capital gains, provided that certain conditions are satisfied. A U.S. Holder is not able to claim the reduced rate for any year in
which we are treated as a PFIC. See “Passive Foreign Investment Company Considerations,” below. Dividends may be taxed at the lower applicable
capital gains rate provided that (1) our shares or ADSs, as applicable, are readily tradable on an established securities market in the United States, (2) our
company is not a PFIC (as discussed below) for either our taxable year in which the dividends were paid or the preceding taxable year, and (3) certain
holding period and other requirements are met. Because our ADSs are listed on the NASDAQ Global Select Market, they are considered for purposes of
clause (1) above to be readily tradable on an established securities market in the United States. However, because our ordinary shares are not listed on an
established securities market, we do not believe that dividends paid on our ordinary shares that are not represented by ADSs currently meet the
conditions required for these reduced tax rates. There can be no assurance that our ADSs will be considered readily tradable on an established securities
market in subsequent years.
Alternatively, non-corporate U.S. holders may be eligible for the special reduced rates normally applicable to long-term capital gains if we are
eligible for benefits under a comprehensive U.S. income tax treaty that includes an exchange of information program and which the U.S. Treasury
Department has determined is satisfactory for these purposes. The United States does not have a comprehensive income tax treaty with the Cayman
Islands. However, in the event that we were deemed to be a PRC resident enterprise under the enterprise income tax law, although no assurance can be
given, we might be considered eligible for the benefits of the U.S.-PRC Tax Treaty for purposes of these rules. U.S. Holders should consult their own tax
advisors regarding the availability of the reduced tax rates on dividends paid with respect to our ordinary shares or ADSs in light of their particular
circumstances.
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In the event that dividends from our company are subject to withholding by the PRC, a U.S. Holder may be eligible, subject to a number of
complex limitations, to claim a foreign tax credit in respect of foreign withholding taxes imposed on dividends received on the shares or ADSs. For
purposes of calculating the U.S. foreign tax credit, dividends paid on our shares or ADSs will be treated as income from sources outside the United
States, and will generally constitute passive category income. A U.S. Holder who does not elect to claim a foreign tax credit for foreign income tax
withheld, may instead claim a deduction, for United States federal income tax purposes, in respect of such withholdings, but only for a year in which
such holder elects to do so for all creditable foreign income taxes. The U.S. foreign tax credit rules are complex. U.S. Holders should consult their own
tax advisors regarding the foreign tax credit rules in light of their particular circumstances.
Taxation of Disposition of Shares or ADSs
Subject to the PFIC rules discussed below, you will generally recognize taxable gain or loss on any sale or exchange or other taxable disposition
of a share or ADS in an amount equal to the difference between the amount realized (determined in the case of a sale or exchange in a currency other
than U.S. dollars by reference to the spot exchange rate in effect on the date of the sale or exchange or, if sold or exchanged on an established securities
market and the U.S. Holder is a cash basis taxpayer or an electing accrual basis taxpayer, the spot exchange rate in effect on the settlement date) for the
share or ADS and your adjusted tax basis (in U.S. dollars) in the share or ADS. A U.S. Holder’s initial tax basis will be the U.S. Holder’s U.S. dollar
purchase price for such share or ADS. The gain or loss will generally be capital gain or loss and will be long-term capital gain or loss if you have held the
share or ADS for more than one year. Long-term capital gains of non-corporate U.S. Holders are eligible for reduced rates of taxation. The deductibility
of a capital loss may be subject to limitations. Any gain or loss that you recognize generally will be treated as United States source gain or loss for United
States foreign tax credit purposes. In the event PRC tax were to be imposed on any gain from the disposition of shares or ADSs, such gain may be treated
as PRC source gain under the U.S.-PRC Tax Treaty, in which case a U.S. Holder eligible for treaty benefits may be able to claim a foreign tax credit,
subject to applicable limitations. See discussion above under the heading "Taxation of Dividends and Other Distributions on the Shares or ADSs"
regarding the potential availability of U.S.-PRC Tax Treaty Benefits. Because the determination of treaty benefit eligibility is fact intensive and depends
upon a holder’s particular circumstances, U.S. Holders should consult their tax advisors regarding U.S.-PRC Tax Treaty benefit eligibility. U.S. Holders
are also encouraged to consult their own tax advisors regarding the tax consequences in the event PRC tax were to be imposed on a disposition of shares
or ADSs, including the availability of the U.S. foreign tax credit and the ability and whether to treat any gain as PRC source gain for the purposes of the
U.S. foreign tax credit in consideration of their particular circumstances.
Tax on Net Investment Income
A 3.8% tax is imposed on the “net investment income” (as defined in section 1411 of the Code) of individuals whose income exceeds certain
threshold amounts, and of certain trusts and estates under similar rules. U.S. Holders should consult their tax advisors regarding the applicability of this
net investment income tax in respect of an investment in our company in light of their particular circumstances.
Passive Foreign Investment Companies
A non-U.S. corporation will be classified as a PFIC for any taxable year in which, after taking into account the income and assets of the
corporation and certain subsidiaries pursuant to applicable “look-through rules,” either (i) at least 75% of its gross income is “passive income” or (ii) at
least 50% of the average value (determined on a quarterly basis) of its assets is attributable to assets which produce passive income or are held for the
production of passive income. Passive income generally includes dividends, interest, rents and royalties (other than certain rents and royalties derived in
the active conduct of a trade or business), annuities and gains from assets that produce passive income.
We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of any other corporation in
which we own, directly or indirectly, more than 25% (by value) of the stock.
Additionally, if we are classified as a PFIC in any taxable year with respect to which a U.S. Holder owns shares or ADSs, we generally will
continue to be treated as a PFIC with respect to such U.S. Holder in all succeeding taxable years, regardless of whether we continue to meet the tests
described above, unless the U.S. Holder makes the “deemed sale election” described below. Furthermore, if we are treated as a PFIC then one or more of
our subsidiaries may also be treated as PFICs.
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Based on certain estimates of our gross income and gross assets (which estimates are inherently imprecise), we do not believe that we were a
PFIC for taxable year 2020 for United States federal income tax purposes. The determination of whether we will be classified as a PFIC is made annually
and depends on particular facts and circumstances. In particular, the fair market value of some of our company’s assets may be determined in large part
by the market price of the ADSs, which is likely to fluctuate. In addition, the composition of our company’s income and assets will be affected by how,
and how quickly, our company spends any cash that is raised. Thus, no assurance can be provided that our company would not be classified as a PFIC for
any future taxable year. Furthermore, while we believe our valuation approach is reasonable, it is possible that the IRS could challenge our determination
concerning our PFIC status. For these reasons, there can be no assurance that we were not a PFIC in 2020 or that we will not be a PFIC for any future
taxable year.
U.S. Federal Income Tax Treatment of a Shareholder of a PFIC
If our company is classified as a PFIC for any taxable year during which a U.S. Holder owns shares or ADSs, the U.S. Holder, absent certain
elections (including a mark-to-market election and a QEF election as described below), will generally be subject to adverse rules (regardless of whether
our company continues to be classified as a PFIC) with respect to (i) any “excess distributions” (generally, any distributions received by the U.S. Holder
on the shares or ADSs in a taxable year that are greater than 125% of the average annual distributions received by the U.S. Holder in the three preceding
taxable years or, if shorter, the U.S. Holder’s holding period for the shares or ADSs) and (ii) any gain realized on the sale or other disposition of shares or
ADSs.
Under these rules (a) the excess distribution or gain will be allocated ratably over the U.S. Holder’s holding period, (b) the amount allocated to
the current taxable year and any taxable year prior to the first taxable year in which our company is classified as a PFIC will be taxed as ordinary income,
and (c) the amount allocated to each of the other taxable years during which our company was classified as a PFIC will be subject to tax at the highest
rate of tax in effect for the applicable category of taxpayer for that year and an interest charge will be imposed with respect to the resulting tax
attributable to each such other taxable year.
If we are a PFIC in any year with respect to a U.S. Holder, and any of our subsidiaries are also PFICs, such U.S. Holder will be treated as
owning a proportionate share (by value) of the shares of the lower-tier PFICs for purposes of these rules. Non-corporate U.S. Holders will not be eligible
for the reduced tax rate on any dividends received from us if we are a PFIC in the taxable year in which such dividends are paid or in the preceding
taxable year.
If we are classified as a PFIC and then cease to be so classified, a U.S. Holder may make an election (a “deemed sale election”) to be treated for
U.S. federal income tax purposes as having sold such U.S. Holder’s ordinary shares or ADSs on the last day of our taxable year during which we were a
PFIC. A U.S. Holder that makes a deemed sale election would then cease to be treated as owning stock in a PFIC. However, gain recognized as a result
of making the deemed sale election would be subject to the adverse rules described above and loss would not be recognized.
Mark-to-Market Election
In certain circumstances, a U.S. Holder may be eligible to make a mark-to-market election with respect to its shares or ADSs if such shares or
ADSs qualify as “marketable stock” under applicable U.S. federal income tax rules. For purposes of these rules, “marketable stock” is stock which is
“regularly traded” (traded in greater than de minimis quantities on at least 15 days during each calendar quarter) on a “qualified exchange” or other
market within the meaning of applicable U.S. Treasury regulations. A “qualified exchange” includes a national securities exchange that is registered with
the SEC.
A U.S. Holder that makes an effective mark-to-market election must include in gross income, as ordinary income, rather than capital gain, for
each taxable year an amount equal to the excess, if any, of the fair market value of the shares or ADSs, as applicable, at the close of the taxable year over
the U.S. Holder’s adjusted basis in the shares or ADSs.
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An electing U.S. Holder may also claim an ordinary loss deduction for the excess, if any, of the U.S. Holder’s adjusted tax basis in such shares
or ADSs over their fair market value at the close of the taxable year, but this deduction is allowable only to the extent of any net mark-to-market gains
previously included in income pursuant to the mark-to-market election. The adjusted tax basis of a U.S. Holder’s shares or ADSs with respect to which
the mark-to-market election applies would be adjusted to reflect amounts included in gross income or allowed as a deduction because of such election. If
a U.S. Holder makes an effective mark-to-market election with respect to our shares or ADSs, gains from an actual sale or other disposition of such
shares or ADSs in a year in which we are a PFIC would be treated as ordinary income, and any losses incurred on such sale or other disposition would be
treated as ordinary losses to the extent of any net mark-to-market gains previously included in income.
If we are classified as a PFIC for any taxable year in which a U.S. Holder owns shares or ADSs but before a mark-to-market election is made,
the adverse PFIC rules described above will apply to any mark-to-market gain recognized in the year the election is made. Otherwise, a mark-to-market
election will be effective for the taxable year for which the election is made and all subsequent taxable years unless the shares or ADSs are no longer
regularly traded on a qualified exchange or the IRS consents to the revocation of the election. Our ADSs are listed on the NASDAQ Global Select
Market, which is a qualified exchange or other market for purposes of the mark-to-market election. Consequently, if the ADSs continue to be so listed,
and are “regularly traded” for purposes of these rules (for which no assurance can be given) we expect that the mark-to-market election would be
available to a U.S. Holder with respect to our ADSs.
A mark-to-market election is not permitted for the shares of any of our subsidiaries that are also classified as PFICs. Prospective investors
should consult their own tax advisors regarding the availability of, and the procedure for, and the effect of making, a mark-to-market election, and
whether making the election would be advisable, including in light of their particular circumstances.
“QEF” Election
The PFIC rules permit a holder of PFIC stock in certain circumstances to avoid some of the disadvantageous tax treatment described above by
making a “qualified electing fund,” or QEF, election to be taxed currently on its share of the PFIC’s undistributed income. We do not, however, intend to
provide the information regarding our income that the U.S. Investor would need to make a QEF election if we are classified as a PFIC.
If we are a PFIC in any year with respect to a U.S. Holder, and any of our subsidiaries are also PFICs, such U.S. Holder will be treated as
owning a proportionate share (by value) of the shares of the lower-tier PFICs for purposes of these rules. Non-corporate U.S. Holders will not be eligible
for the reduced tax rate on any dividends received from us if we are a PFIC in the taxable year in which such dividends are paid or in the preceding
taxable year.
If we are a PFIC in any year with respect to a U.S. Holder, such U.S. Holder will be required to file an annual information return on IRS
Form 8621 regarding distributions received on our shares or ADSs and any gain realized on the disposition of our shares or ADSs, and certain U.S.
Holders will be required to file an annual information return (also on IRS Form 8621) relating to their ownership of our shares or ADSs.
U.S. Holders should consult their tax advisors regarding the potential application of the PFIC regime, including eligibility for and the manner
and advisability of making a mark-to-market election and related reporting requirements.
NO ASSURANCE CAN BE GIVEN THAT WE ARE NOT CURRENTLY A PFIC OR THAT WE WILL NOT BECOME A PFIC IN THE
FUTURE. U.S. HOLDERS SHOULD CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE OPERATION OF THE PFIC RULES
AND RELATED REPORTING REQUIREMENTS IN LIGHT OF THEIR PARTICULAR CIRCUMSTANCES, INCLUDING THE ADVISABILITY
AND EFFECTS OF MAKING ANY ELECTION THAT MAY BE AVAILABLE.
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Information Reporting and Backup Withholding; Specified Foreign Financial Assets
The proceeds of a sale or other disposition, as well as dividends paid with respect to shares or ADSs by a United States payor (including any
payments received from a U.S. financial intermediary), generally will be reported to the IRS and to the U.S. Holder as required under applicable
regulations. Backup withholding tax (currently at a rate of 24%) may apply to these payments if the U.S. Holder is not otherwise exempt and:
● the holder fails to furnish the holder’s taxpayer identification number, which for an individual is ordinary his or her social security number;
● the holder furnishes an incorrect taxpayer identification number;
● the applicable withholding agent is notified by the IRS that the holder previously failed to properly report payments of interest or
dividends; or
● the holder fails to certify under penalties of perjury that the holder has furnished a correct taxpayer identification number and that the IRS
has not notified the holder that the holder is subject to backup withholding.
Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against a U.S. Holder’s U.S. federal
income tax liability (if any) or refunded provided the required information is furnished to the IRS in a timely manner. U.S. Holders should consult their
tax advisors as to their qualification for exemption from backup withholding tax and the procedure for establishing an exemption.
Certain U.S. Holders of specified foreign financial assets with an aggregate value in excess of the applicable dollar threshold are required to
report information relating to their holding of stock or securities issued by a non-U.S. person (such as our company), subject to certain exceptions
(including an exception for shares held in accounts maintained by certain financial institutions) with their tax return for each year in which they hold such
stock or securities. U.S. Holders should consult their own tax advisors regarding the information reporting obligations that may arise from their
acquisition, ownership or disposition of our shares or ADSs.
THE ABOVE DISCUSSION DOES NOT COVER ALL TAX MATTERS THAT MAY BE OF IMPORTANCE TO A PARTICULAR
INVESTOR. PROSPECTIVE INVESTORS ARE STRONGLY URGED TO CONSULT THEIR OWN TAX ADVISORS ABOUT THE TAX
CONSEQUENCES OF AN INVESTMENT IN OUR ORDINARY SHARES OR ADSs.
Enforcement of Civil Liabilities
We are an exempted company incorporated in the Cayman Islands because of the following benefits found there:
● political and economic stability;
● an effective judicial system;
● a favorable tax system;
● the absence of exchange control or currency restrictions; and
● the availability of professional and support services.
However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include, but are not limited to, the
following:
● the Cayman Islands has a less developed body of securities laws as compared to the United States and provides significantly less protection
to investors; and
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● Cayman Islands companies may not have standing to sue before the federal courts of the United States.
Our constituent documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United
States, between us, our officers, directors and shareholders be arbitrated.
A substantial portion of our current operations is conducted in China through our wholly-owned subsidiaries which are incorporated in China,
Hong Kong, the British Virgin Islands or the Cayman Islands. All or most of our assets are located in China. A majority of our directors and officers are
nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a
result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them
judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States
or any state in the United States.
Maples and Calder (Hong Kong) LLP, our counsel as to Cayman Islands law, and Zhong Lun Lawyers, our counsel as to Chinese law, have
advised us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands or China would:
(1) recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability
provisions of the securities laws of the United States or any state in the United States; or
(2) entertain original actions brought in the Cayman Islands or China against us or our directors or officers predicated upon the securities laws
of the United States or any state in the United States.
Maples and Calder (Hong Kong) LLP has further advised us that there is uncertainty under Cayman Islands law with regard to whether a
judgment obtained from the United States courts under the civil liability provisions of the securities laws will be determined by the courts of the Cayman
Islands as penal or punitive in nature. If such a determination is made, the courts of the Cayman Islands will not recognize or enforce the judgment
against a Cayman company. Because the courts of the Cayman Islands have yet to rule on whether such judgments are penal or punitive in nature, it is
uncertain whether they would be enforceable in the Cayman Islands. Maples and Calder (Hong Kong) LLP has advised us that although there is no
statutory enforcement in the Cayman Islands of judgments obtained in the federal or state courts of the United States, a judgment obtained in a foreign
court of competent jurisdiction will be recognized and enforced in the courts of the Cayman Islands at common law, without any re-examination of the
merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided that such
judgment: (a) is given by a foreign court of competent jurisdiction; (b) imposes on the judgment debtor a liability to pay a liquidated sum for which the
judgment has been given; (c) is final; (d) is not in respect of taxes, a fine or a penalty; and (e) was not obtained in a manner and is not of a kind the
enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.
Zhong Lun Lawyers has advised us further that the recognition and enforcement of foreign judgments are provided for under Chinese Civil
Procedures Law. Chinese courts may recognize and enforce foreign judgments in accordance with the requirements of Chinese Civil Procedures Law
based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions.
F. Dividends and Paying Agents
Not applicable.
G. Statement by Experts
Not applicable.
H. Documents on Display
We have previously filed with the SEC our registration statement on Form F-1 and prospectus under the Securities Act of 1933, as amended,
with respect to our ADSs.
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We are subject to the periodic reporting and other informational requirements of the Exchange Act. Under the Exchange Act, we are required to
file reports and other information with the SEC. The SEC maintains a website that contains reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC, including us, at http://www.sec.gov. Our company website can be accessed at
http://ir.netease.com.
As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and
proxy statements, and officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in
Section 16 of the Exchange Act.
Our financial statements have been prepared in accordance with U.S. GAAP.
In accordance with NASDAQ Marketplace Rule 5250(d)(1), we will post this annual report on Form 20-F on our website at http://ir.netease.com
under the heading “Annual Reports.” In addition, we will provide hardcopies of our annual report free of charge to shareholders and ADS holders upon
request.
I. Subsidiary Information
Not applicable.
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Please refer to Item 5.F. “Operating and Financial Review and Prospects—Quantitative and Qualitative Disclosures About Market Risk.”
Item 12. Description of Securities Other than Equity Securities
A. Debt Securities
Not applicable.
B. Warrants and Rights
Not applicable.
C. Other Securities
Not applicable.
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D. American Depositary Shares
Fees and charges our ADS holders may have to pay
The Bank of New York Mellon collects its fees for delivery and surrender of ADSs directly from investors depositing ordinary shares or
surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to
investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees. The depositary may refuse
to provide fee-attracting services until its fees for those services are paid.
Persons depositing or withdrawing shares or ADS holders must pay:
For:
US$5.00 or less per 100 ADSs (or portion thereof)
● Issuance of ADSs, including issuances resulting from a distribution of
ordinary shares or rights or other property
● Cancellation of ADSs for the purpose of withdrawal, including if the
deposit agreement terminates
US$0.02 or less per ADS (or portion thereof)
● Distributions of cash dividends or other cash distributions
A fee equivalent to the fee that would be payable if securities distributed to
you had been shares and the shares had been deposited for issuance of
ADSs
● Distribution of securities distributed to holders of deposited securities
(including rights) that are distributed by the depositary to ADS holders
US$1.50 per or less per certificate presented for transfer
● Transfer of American depositary receipts, or ADRs
Registration or transfer fees
● Transfer and registration of shares on our share register to or from the
name of the depositary or its agent when you deposit or withdraw
shares
Expenses of the depositary
● Cable, telex and facsimile transmissions (when expressly provided in
the deposit agreement)
● Converting foreign currency to U.S. dollars
Taxes and other governmental charges the depositary or the custodian have
to pay on any ADS or ordinary shares underlying an ADS, for example,
stock transfer taxes, stamp duty or withholding taxes
● As necessary
Fees and other payments made by the depositary to us
Our depositary has agreed to share with us certain fees payable to the depositary by holders of ADSs. For the year ended December 31, 2020,
the depositary paid us approximately US$0.3 million pursuant to this arrangement.
Conversions between ADSs and Ordinary Shares
Our ordinary shares trade on the Hong Kong Stock Exchange in board lots of 100 ordinary shares. Dealings in our ordinary shares on the Hong
Kong Stock Exchange will be conducted in Hong Kong dollars.
The transaction costs of dealings in our ordinary shares on the Hong Kong Stock Exchange include:
(a) Hong Kong Stock Exchange trading fee of 0.005% of the consideration of the transaction, charged to each of the buyer and seller;
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(b) Securities and Futures Commission of Hong Kong transaction levy of 0.0027% of the consideration of the transaction, charged to each of
the buyer and seller;
(c)
trading tariff of HK$0.50 on each and every purchase or sale transaction. The decision on whether or not to pass the trading tariff onto
investors is at the discretion of brokers;
(d) transfer deed stamp duty of HK$5.00 per transfer deed (if applicable), payable by the seller;
(e) ad valorem stamp duty at a total rate of 0.2% of the value of the transaction, with 0.1% payable by each of the buyer and the seller;
(f)
stock settlement fee, which is currently 0.002% of the gross transaction value, subject to a minimum fee of HK$2.00 and a maximum fee of
HK$100.00 per side per trade;
(g) brokerage commission, which is freely negotiable with the broker (other than brokerage commissions for IPO transactions which are
currently set at 1% of the subscription or purchase price and will be payable by the person subscribing for or purchasing the securities); and
(h) the Hong Kong share registrar will charge between HK$2.50 to HK$20, depending on the speed of service (or such higher fee as may from
time to time be permitted under the Hong Kong Listing Rules), for each transfer of ordinary shares from one registered owner to another,
each share certificate canceled or issued by it and any applicable fee as stated in the share transfer forms used in Hong Kong.
Investors must settle their trades executed on the Hong Kong Stock Exchange through their brokers directly or through custodians. For an
investor who has deposited his/her ordinary shares in his/her stock account or in his/her designated CCASS participant’s stock account maintained with
CCASS, settlement will be effected in CCASS in accordance with the General Rules of CCASS and CCASS Operational Procedures in effect from time
to time. For an investor who holds the physical certificates, settlement certificates and the duly executed transfer forms must be delivered to his/her
broker or custodian before the settlement date.
Conversion between Shares Trading in Hong Kong and ADSs
In connection with the initial public offering of our ordinary shares in Hong Kong, (the “Hong Kong Public Offering”), we established a branch
register of members in Hong Kong, or the Hong Kong share register, which will be maintained by our Hong Kong Share Registrar, Computershare Hong
Kong Investor Services Limited. Our principal register of members, or the Cayman share register, will continue to be maintained by our Principal Share
Registrar, Maples Fund Services (Cayman) Limited.
All ordinary shares offered in the Hong Kong Public Offering were registered on the Hong Kong share register in order to be listed and traded
on the Hong Kong Stock Exchange. As described in further detail below, holders of ordinary shares registered on the Hong Kong share register will be
able to exchange those ordinary shares for ADSs and vice versa.
Our ADSs
Our ADSs representing our ordinary shares are currently traded on Nasdaq. Dealings in our ADSs on Nasdaq are conducted in U.S. dollars.
ADSs may be held either:
(a) directly: (i) by having an American Depositary Receipt, also referred to as an ADR, which is a certificate evidencing a specific number of
ADSs registered in the holder’s name; or (ii) by having uncertificated ADSs registered in the holder’s name; or
(b) indirectly, by holding a security entitlement in ADSs through a broker or other financial institution that is a direct or indirect participant in
The Depository Trust Company, also called DTC.
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The depositary for our ADSs is The Bank of New York Mellon, whose office is located at 240 Greenwich Street, New York, New York 10286,
United States.
Converting Ordinary Shares Trading in Hong Kong into ADSs
An investor who holds the ordinary shares registered in Hong Kong and wishes to receive delivery of ADSs that trade on the Nasdaq must
deposit or have his/her broker deposit the ordinary shares with the depositary’s Hong Kong custodian, The Hong Kong and Shanghai Banking
Corporation Limited, or the custodian, in exchange for ADSs.
A deposit of ordinary shares trading in Hong Kong in exchange for ADSs involves the following procedures:
(a)
If the ordinary shares have been deposited with CCASS, the investor must transfer the ordinary shares to the depositary’s account with the
custodian within CCASS by following the CCASS procedures for transfer and submit and deliver a duly completed and signed ADS
delivery form to the custodian via his/her broker.
(b) If the ordinary shares are held outside CCASS, the investor must arrange for the registration of a transfer of his/her ordinary shares into the
depositary’s name and delivery of evidence of that registration to the custodian, and must sign and deliver an ADS delivery form to the
depositary.
(c) Upon payment of its fees and expenses and of any taxes or charges, such as stamp taxes or stock transfer taxes or fees, if applicable, the
depositary will register the corresponding number of ADSs in the name(s) requested by an investor and will deliver the ADSs as instructed
in the ADS delivery form.
For ordinary shares deposited in CCASS, under normal circumstances, the above steps generally require two business days, provided that the
investor has provided timely and complete instructions. For ordinary shares held outside CCASS in physical form, the above steps may take 14 business
days, or more, to complete. Temporary delays may arise. For example, the transfer books of the depositary may from time to time be closed to ADS
issuances. The investor will be unable to trade the ADSs until the procedures are completed.
Converting ADSs to Ordinary Shares Trading in Hong Kong
An investor who holds ADSs and wishes to receive ordinary shares that trade on the Hong Kong Stock Exchange must cancel the ADSs the
investor holds and withdraw the ordinary shares from our ADS program and cause his/her broker or other financial institution to trade such ordinary
shares on the Hong Kong Stock Exchange.
An investor that holds ADSs indirectly through a broker or other financial institution should follow the procedures of the broker or financial
institution and instruct the broker to arrange for cancellation of the ADSs, and transfer of the underlying ordinary shares from the depositary’s account
with the custodian within the CCASS system to the investor’s Hong Kong stock account.
For investors holding ADSs directly, the following steps must be taken:
(a) To withdraw the ordinary shares from our ADS program, an investor who holds ADSs may turn in such ADSs at the office of the depositary
(and the applicable ADR(s) if the ADSs are held in certificated form), and send an instruction to cancel such ADSs to the depositary. Those
instructions must have a Medallion signature guarantee.
(b) Upon payment or net of its fees and expenses and of any taxes or charges, such as stamp taxes or stock transfer taxes or fees, if applicable,
the depositary will instruct the custodian to deliver the ordinary shares underlying the canceled ADSs to the CCASS account designated by
the investor.
(c)
If an investor prefers to receive the ordinary shares outside CCASS, he/she must so indicate in the instruction delivered to the depositary.
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For the ordinary shares to be received in CCASS, under normal circumstances, the above steps generally require two business days, provided
that the investor has provided timely and complete instructions. For the ordinary shares to be received outside CCASS in physical form, the above steps
may take 14 business days, or more, to complete. The investor will be unable to trade the ordinary shares on the Hong Kong Stock Exchange until the
procedures are completed.
Temporary delays may arise. For example, the transfer books of the depositary may from time to time be closed to ADS cancelations. In
addition, completion of the above steps and procedures for delivery of ordinary shares in a CCASS account is subject to there being a sufficient number
of ordinary shares on the Hong Kong share register to facilitate a withdrawal from the ADS program directly into the CCASS system. We are not under
any obligation to maintain or increase the number of ordinary shares on the Hong Kong share register to facilitate such withdrawals.
Depositary requirements
Before the depositary delivers ADSs or permits withdrawal of the ordinary shares, the depositary may require:
(a) production of satisfactory proof of the identity and genuineness of any signature or other information it deems necessary; and
(b) compliance with procedures it may establish, from time to time, consistent with the deposit agreement, including completion and
presentation of transfer documents.
The depositary may refuse to deliver, transfer, or register issuances, transfers and cancelations of ADSs generally when the transfer books of the
depositary or of the Hong Kong ordinary share Registrar are closed or at any time if the depositary or we determine it advisable to do so.
All costs attributable to the transfer of the ordinary shares to effect a withdrawal from or deposit of the ordinary shares into our ADS program
will be borne by the investor requesting the transfer or deposit. In particular, holders of ordinary shares and ADSs should note that the Hong Kong Share
Registrar will charge between HK$2.50 to HK$20, depending on the speed of service (or such higher fee as may from time to time be permitted under the
Hong Kong Listing Rules), for each transfer of the ordinary shares from one registered owner to another, each share certificate canceled or issued by it
and any applicable fee as stated in the share transfer forms used in Hong Kong. In addition, holders of the ordinary shares and ADSs must pay up to
US$5.00 per 100 ADSs (or portion thereof) for each issuance of ADSs and each cancelation of ADSs, as the case may be, in connection with the deposit
of the ordinary shares into, or withdrawal of the ordinary shares from, the ADS facility.
PART II.
Item 13. Defaults, Dividend Arrearages and Delinquencies
None.
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
Not applicable.
Item 15. Controls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of William Lei Ding, our Chief Executive Officer, and Charles Zhaoxuan Yang, our Chief Financial
Officer, have conducted an evaluation pursuant to Rule 13a-15 promulgated under the Exchange Act, as amended, of the effectiveness of our disclosure
controls and procedures as of December 31, 2020. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that such
disclosure controls and procedures were effective as of December 31, 2020.
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Management’s Annual Report on Internal Control over Financial Reporting
Our management’s annual report on internal control over financial reporting is included in this annual report on pages F-1.
PricewaterhouseCoopers Zhong Tian LLP, our independent registered public accounting firm, audited the effectiveness of our company’s
internal control over the financial reporting period of December 31, 2020 as stated in this annual report beginning on page F-2.
Changes in Internal Control over Financial Reporting
There were no changes in our internal controls over financial reporting identified in connection with the evaluation required by Rules 13a-15 or
15d-15 that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
Item 16A. Audit Committee Financial Expert
Our board of directors has determined that Mr. Joseph Tong qualifies as an “audit committee financial expert” as defined by the applicable
rules of the SEC and that Mr. Tong is “independent” as that term is defined in NASDAQ Marketplace Rule 5605(a)(2).
Item 16B. Code of Ethics
We have adopted a Code of Business Conduct which applies to our employees, officers and non-employee directors, including our principal
executive officer, principal financial officer, principal accounting officer or controller, and persons performing similar functions. This code is intended to
qualify as a “code of ethics” within the meaning of the applicable rules of the SEC.
We have filed our Code of Business Conduct as an exhibit to our annual report on Form 20-F for the year ended December 31, 2006, filed on
June 26, 2007. It is also available on our website under the Investor Relations section at https://ir.netease.com.
Item 16C. Principal Accountant Fees and Services
Disclosure of Fees Charged by Independent Accountants
The following table summarizes the fees charged by PricewaterhouseCoopers Zhong Tian LLP and its affiliates for certain services rendered to
our company during 2019 and 2020.
Audit fees (2)
Tax fees (3)
All other fees (4)
Total
For the year ended December 31,
2020(1)
2019(1)
RMB (in thousands)
30,220
898
832
31,950
35,890
1,489
2,020
39,399
(1) The fees disclosed are exclusive of out-of-pocket expenses on the amounts paid, which totaled approximately RMB1,360,000 and RMB1,394,000 in
2019 and 2020, respectively.
(2) “Audit fees” means the aggregate fees billed in each of the fiscal years for professional services rendered by our principal auditors for the audit of
our annual financial statements and our internal controls over financial reporting issuance of comfort letters in connection with our global offering
and secondary listing of our ordinary shares on the HKSE, as well as assistance with and review of documents filed with the SEC and other statutory
and regulatory filings.
(3) “Tax fees” means the aggregate fees billed in each of the fiscal years for professional services rendered by our principal auditors for tax compliance
and tax advice.
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(4) “All other fees” includes the aggregate fees billed in each of the fiscal years for non-audit services rendered which were not listed above.
Audit Committee Pre-approval Policies and Procedures
Our audit committee has adopted procedures which set forth the manner in which the committee will review and approve all audit and non-audit
services to be provided by PricewaterhouseCoopers Zhong Tian LLP and its affiliates before that firm is retained for such services. The pre-approval
procedures are as follows:
● Any audit or non-audit service to be provided to us by the independent accountant must be submitted to the audit committee for review and
approval, with a description of the services to be performed and the fees to be charged.
● The audit committee in its sole discretion then approves or disapproves the proposed services and documents such approval, if given,
through written resolutions or in the minutes of meetings, as the case may be.
All of the services related to our company provided by PricewaterhouseCoopers Zhong Tian LLP and its affiliates listed above have been
approved by our audit committee.
Item 16D. Exemptions from the Listing Standards for Audit Committees
We have not sought an exemption from the applicable listing standards for the audit committee of our board of directors.
Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers
On November 20, 2019, we announced a share purchase program authorized by our board of directors pursuant to which we were authorized to
purchase up to US$20.0 million worth of Youdao’s outstanding ADSs on the New York Stock Exchange. The share purchase program expired on
November 25, 2020. As of December 31, 2020, approximately 198,000 ADSs had been purchased under this program.
On February 26, 2020, we announced a share repurchase program authorized by our board of directors pursuant to which we were authorized to
purchase up to US$1.0 billion of our outstanding ADSs and ordinary shares in open market transactions for a period not to exceed 12 months. The table
below shows the ADSs that we have repurchased under this program:
Period
March 2020
April 2020
May 2020
June 2020
July 2020
August 2020
September 2020
October 2020
November 2020
December 2020
Total
Total
Number of
ADSs
Purchased(1)
5,555,405
3,507,515
1,852,905
594,315
1,612,630
1,105,695
1,099,270
2,088,695
1,905,380
1,789,771
21,111,581
Average
Price
Paid
Per ADS
US$
61.55
66.19
71.11
83.98
90.26
95.21
95.11
88.60
88.60
89.43
Total Number of
ADSs
Purchased
as Part of
Publicly
Announced
Plans
or
Programs
US$
341,938,288
232,158,835
131,754,966
49,909,605
145,563,341
105,273,933
104,551,958
185,065,621
168,819,432
160,060,443
1,625,096,422
Approximate
Maximum
Dollar Value
of ADSs
that May Yet
Be
Purchased
Under
the Plans or
Programs
658,061,712
425,902,877
1,294,147,911
1,244,238,306
1,098,674,965
993,401,032
888,849,074
703,783,453
534,964,021
374,903,578
(1) Our ADS to ordinary share ratio is one ADS for every 5 ordinary shares.
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On February 25, 2021, we announced a share repurchase program authorized by our board of directors pursuant to which we were authorized to
purchase up to US$2.0 billion of the Company’s outstanding ADSs and ordinary shares in open market transactions for a period not to exceed 24 months.
Item 16F. Change in Registrant’s Certifying Accountants
Not applicable.
Item 16G. Corporate Governance
As permitted by NASDAQ, in lieu of the NASDAQ corporate governance rules, but subject to certain exceptions, we may follow the practices
of our home country which for the purpose of such rules is the Cayman Islands. Specifically, our board of directors adopted our RSU Plans without
seeking shareholder approval which is generally required under Rule 5635(c) of the NASDAQ Marketplace Rules. There is no specific requirement
under Cayman Islands law for shareholder approval to be obtained with respect to the establishment or amendment of equity compensation arrangements.
Item 16H. Mine Safety Disclosure
Not applicable.
PART III.
Item 17. Financial Statements
We have elected to provide financial statements pursuant to Item 18.
Item 18. Financial Statements
The consolidated financial statements for NetEase, Inc. and its subsidiaries are included at the end of this annual report.
Item 19. Exhibits
Exhibit
Number
Document
1.1
1.2
1.3
2.1
2.2
2.3
Amended and Restated Memorandum of Association of NetEase.com, Inc. (incorporated by reference to Exhibit 3.1 to Amendment
No. 1 to the company’s Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on May 15, 2000)
Amended and Restated Articles of Association of NetEase.com, Inc. (incorporated by reference to Exhibit 3.2 to Amendment No. 1 to
the company’s Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on May 15, 2000)
Amendment to Amended and Restated Articles of Association of NetEase.com, Inc. dated as of June 6, 2003 (incorporated by reference
to Exhibit 1.3 to the company’s Annual Report on Form 20-F for the year ended December 31, 2002 filed with the SEC on June 27,
2003)
Specimen American Depositary Receipt of NetEase.com, Inc. (incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the
company’s Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on May 15, 2000)
Specimen Stock Certificate of NetEase.com, Inc. (incorporated by reference to Exhibit 4.2 to Amendment No. 1 to the company’s
Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on May 15, 2000)
Deposit Agreement dated July 6, 2000 by and among NetEase.com, Inc., The Bank of New York and the owners and beneficial owners
of American depositary receipts (incorporated by reference to Exhibit 1 to the Registrant’s Registration Statement on Form F-6EF (File
No. 333-115868) filed with the SEC on May 26, 2004)
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Exhibit
Number
Document
2.4
2.5
3.1
3.2
3.3
3.4
3.5
3.6
4.1
4.2
4.3
4.4
4.5
Description of Ordinary Shares (incorporated by reference to Exhibit 2.4 to the company’s Annual Report on Form 20-F for the year
ended December 31, 2019 filed with the SEC on April 29, 2020)
Description of American Depositary Shares (incorporated by reference to Exhibit 2.5 to the company’s Annual Report on Form 20-F for
the year ended December 31, 2019 filed with the SEC on April 29, 2020)
Proxy Agreement dated April 15, 2009 between NetEase (Hangzhou) Network Co., Ltd. and Zhipeng Hu (incorporated by reference to
Exhibit 3.3 to the company’s Annual Report on Form 20-F for the year ended December 31, 2014 filed with the SEC on April 24, 2015)
Shareholder Voting Rights Trust Agreement dated December 1, 2015 between NetEase (Hangzhou) Network Co., Ltd. and Tianlei Hu
(incorporated by reference to Exhibit 3.8 to the company’s Annual Report on Form 20-F for the year ended December 31, 2015 filed
with the SEC on April 22, 2016)
Shareholder Voting Rights Trust Agreement dated December 1, 2015 between NetEase (Hangzhou) Network Co., Ltd. and Zhipeng Hu
(incorporated by reference to Exhibit 3.9 to the company’s Annual Report on Form 20-F for the year ended December 31, 2015 filed
with the SEC on April 22, 2016)
Amended and Restated Shareholder Voting Right Trust Agreement dated November 30, 2015 among NetEase Information Technology
(Beijing) Co., Ltd., Beijing Guangyitong Advertising Co., Ltd. (now known as Beijing NetEase Media Co., Ltd.) William Lei Ding and
Xiaojun Hui (incorporated by reference to Exhibit 3.7 to the company’s Annual Report on Form 20-F for the year ended December 31,
2015 filed with the SEC on April 22, 2016)
Shareholder Voting Rights Trust Agreement dated September 26, 2016 between NetEase Youdao Information Technology (Beijing)
Co., Ltd. and William Lei Ding (incorporated by reference to Exhibit 3.6 to the company’s Annual Report on Form 20-F for the year
ended December 31, 2016 filed with the SEC on April 21, 2017)
Shareholder Voting Right Trust Agreement dated November 20, 2017 between NetEase Youdao Information Technology (Beijing)
Co., Ltd. and Feng Zhou (incorporated by reference to Exhibit 3.8 to the company’s Annual Report on Form 20-F for the year ended
December 31, 2017 filed with the SEC on April 20, 2018)
2009 Restricted Share Unit Plan (incorporated by reference to Exhibit 10.1 to the company’s Registration Statement on Form S-8 (file
no. 333-164249) filed with the SEC on January 8, 2010)
Form of Employment Agreement between NetEase.com, Inc. and its executive officers (incorporated by reference to Exhibit 4.3 to the
company’s Annual Report on Form 20-F for the year ended December 31, 2009 filed with the SEC on June 29, 2010)
Copyright License Agreement dated February 3, 2000 between NetEase Information Technology (Beijing) Co., Ltd. and Guangzhou
NetEase Computer System Co., Ltd. (incorporated by reference to Exhibit 10.8 to the company’s Registration Statement on Form F-1
(file no. 333-11724) filed with the SEC on March 27, 2000)
Trademark License Agreement dated February 3, 2000 between NetEase Information Technology (Beijing) Co., Ltd. and Guangzhou
NetEase Computer System Co., Ltd. (incorporated by reference to Exhibit 10.9 to the company’s Registration Statement on Form F-1
(file no. 333-11724) filed with the SEC on March 27, 2000)
Supplemental Agreement (to Copyright License Agreement) dated April 27, 2000 between NetEase Information Technology (Beijing)
Co., Ltd. and Guangzhou NetEase Computer System Co., Ltd. (incorporated by reference to Exhibit 10.10 to Amendment No.1 to the
company’s Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on May 15, 2000)
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Exhibit
Number
4.6
Document
Notice of Renewal dated April 2, 2001 relating to the Copyright License Agreement and the Trademark License Agreement each dated
February 3, 2000 and made between NetEase Information Technology (Beijing) Co., Ltd. and Guangzhou NetEase Computer System
Co., Ltd. (incorporated by reference to Exhibit 4.14 to the company’s Annual Report on Form 20-F for the year ended December 31,
2000 filed with the SEC on August 31, 2001)
4.7
4.8
4.9
4.10
4.11
4.12
4.13
4.14
4.15
Online Advertising Agreement dated February 15, 2000 between Guangzhou NetEase Computer System Co., Ltd. and Beijing
Guangyitong Advertising Co., Ltd. (incorporated by reference to Exhibit 10.15 to the company’s Registration Statement on Form F-1
(file no. 333-11724) filed with the SEC on March 27, 2000)
Notice of Renewal dated April 2, 2001 relating to the Online Advertising Agreement dated February 15, 2000 and made between
Guangzhou NetEase Computer System Co., Ltd. and Beijing Guangyitong Advertising Co., Ltd. (incorporated by reference to
Exhibit 4.21 to the company’s Annual Report on Form 20-F for the year ended December 31, 2000 filed with the SEC on August 31,
2001)
Agreement dated May 12, 2000 between NetEase Information Technology (Beijing) Co., Ltd. and Guangzhou NetEase Computer
System Co., Ltd. (incorporated by reference to Exhibit 10.41 to Amendment No. 1 to the company’s Registration Statement on Form F-
1 (file no. 333-11724) filed with the SEC on May 15, 2000)
Supplemental Agreement dated May 12, 2000 (supplementing the Online Advertising Agreement dated February 15, 2000) between
Guangzhou NetEase Computer System Co., Ltd. and Beijing Guangyitong Advertising Co., Ltd. (incorporated by reference to
Exhibit 10.47 to Amendment No. 1 to the company’s Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on
May 15, 2000)
Letter of Agreement dated June 6, 2000 among William Lei Ding, Bo Ding and NetEase.com, Inc. (incorporated by reference to
Exhibit 10.49 to Amendment No. 2 to the company’s Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on
June 15, 2000)
Supplemental Agreement dated June 15, 2000 (supplementing the Online Advertising Agreement dated February 15, 2000), between
Beijing Guangyitong Advertising Co., Ltd. and Guangzhou NetEase Computer System Co., Ltd. (incorporated by reference to
Exhibit 10.50 to Amendment No. 2 to the company’s Registration Statement on Form F-1 (file no. 333-11724) filed with the SEC on
June 15, 2000)
Supplemental Letter of Agreement dated May 17, 2004 (supplementing the Letter Agreement dated June 6, 2000 by and among William
Lei Ding, Bo Ding and NetEase.com, Inc.) by and among William Lei Ding, Bo Ding, Jun Liang and NetEase.com, Inc. (incorporated
by reference to Exhibit 4.39 to the company’s Annual Report on Form 20-F for the year ended December 31, 2004 filed with the SEC
on June 27, 2005)
Second Supplemental Letter of Agreement dated July 15, 2004 (supplementing the Letter Agreement dated June 6, 2000 by and among
William Lei Ding, Bo Ding and NetEase.com, Inc., as supplemented by the Supplemental Letter of Agreement dated May 17, 2004 by
and among William Lei Ding, Bo Ding, Jun Liang and NetEase.com, Inc.) by and among William Lei Ding, Bo Ding, Jun Liang and
NetEase.com, Inc. (incorporated by reference to Exhibit 4.40 to the company’s Annual Report on Form 20-F for the year ended
December 31, 2004 filed with the SEC on June 27, 2005)
No. 3 Supplemental Letter of Agreement dated July 20, 2004 (supplementing the Letter Agreement dated June 6, 2000 by and among
William Lei Ding, Bo Ding and NetEase.com, Inc., as supplemented by the Supplemental Letter of Agreement dated May 17, 2004 and
the Second Supplemental Letter of Agreement dated July 15, 2004, each by and among William Lei Ding, Bo Ding, Jun Liang and
NetEase.com, Inc.) by and among William Lei Ding, Bo Ding, Jun Liang and NetEase.com, Inc. (incorporated by reference to
Exhibit 4.41 to the company’s Annual Report on Form 20-F for the year ended December 31, 2004 filed with the SEC on June 27, 2005)
4.16
Form of Cooperative Agreement (incorporated by reference to Exhibit 4.25 to the company’s Annual Report on Form 20-F for the year
ended December 31, 2012 filed with the SEC on April 22, 2013)
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Exhibit
Number
Document
4.17
4.18
4.19
4.20
4.21
4.22
4.23
4.24
4.25
4.26
4.27
4.28
Amendment and Novation of Operating Agreement dated May 1, 2014 among NetEase Information Technology (Beijing) Co., Ltd.,
Beijing Guangyitong Advertising Co., Ltd., Bo Ding and William Lei Ding (incorporated by reference to Exhibit 4.33 to the company’s
Annual Report on Form 20-F for the year ended December 31, 2014 filed with the SEC on April 24, 2015)
Loan Agreement dated May 1, 2014 between NetEase Information Technology (Beijing) Co., Ltd. and Xiaojun Hui (incorporated by
reference to Exhibit 4.35 to the company’s Annual Report on Form 20-F for the year ended December 31, 2014 filed with the SEC on
April 24, 2015)
Equity Pledge Agreement dated May 1, 2014 between NetEase Information Technology (Beijing) Co., Ltd. and Xiaojun Hui
(incorporated by reference to Exhibit 4.36 to the company’s Annual Report on Form 20-F for the year ended December 31, 2014 filed
with the SEC on April 24, 2015)
Amended and Restated Letter of Agreement dated November 30, 2015 among NetEase, Inc., William Lei Ding and Xiaojun Hui
(incorporated by reference to Exhibit 4.44 to the company’s Annual Report on Form 20-F for the year ended December 31, 2015 filed
with the SEC on April 22, 2016)
Loan Agreement dated December 1, 2015 between NetEase (Hangzhou) Network Co., Ltd. and Tianlei Hu (incorporated by reference to
Exhibit 4.45 to the company’s Annual Report on Form 20-F for the year ended December 31, 2015 filed with the SEC on April 22,
2016)
Loan Agreement dated December 1, 2015 between NetEase (Hangzhou) Network Co., Ltd. and Zhipeng Hu. (incorporated by reference
to Exhibit 4.46 to the company’s Annual Report on Form 20-F for the year ended December 31, 2015 filed with the SEC on April 22,
2016)
Amended and Restated Equity Pledge Agreement dated December 1, 2015 between NetEase (Hangzhou) Network Co., Ltd. and Tianlei
Hu (incorporated by reference to Exhibit 4.47 to the company’s Annual Report on Form 20-F for the year ended December 31, 2015
filed with the SEC on April 22, 2016)
Amended and Restated Equity Pledge Agreement dated December 1, 2015 between NetEase (Hangzhou) Network Co., Ltd. and
Zhipeng Hu. (incorporated by reference to Exhibit 4.48 to the company’s Annual Report on Form 20-F for the year ended December 31,
2015 filed with the SEC on April 22, 2016)
Exclusive Purchase Option Agreement dated December 1, 2015 among NetEase (Hangzhou) Network Co., Ltd., Hangzhou NetEase
Leihuo Technology Co., Ltd. and Tianlei Hu (incorporated by reference to Exhibit 4.49 to the company’s Annual Report on Form 20-F
for the year ended December 31, 2015 filed with the SEC on April 22, 2016)
Exclusive Purchase Option Agreement dated December 1, 2015 among NetEase (Hangzhou) Network Co., Ltd., Hangzhou NetEase
Leihuo Technology Co., Ltd. and Zhipeng Hu (incorporated by reference to Exhibit 4.50 to the company’s Annual Report on Form 20-F
for the year ended December 31, 2015 filed with the SEC on April 22, 2016)
Operating Agreement dated December 1, 2015 among NetEase (Hangzhou) Network Co., Ltd., Hangzhou NetEase Leihuo Technology
Co., Ltd., Tianlei Hu and Zhipeng Hu (incorporated by reference to Exhibit 4.51 to the company’s Annual Report on Form 20-F for the
year ended December 31, 2015 filed with the SEC on April 22, 2016)
Loan Agreement dated September 26, 2016 between William Lei Ding and NetEase Youdao Information Technology (Beijing) Co., Ltd.
(incorporated by reference to Exhibit 4.51 to the company’s Annual Report on Form 20-F for the year ended December 31, 2016 filed
with the SEC on April 21, 2017)
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Exhibit
Number
4.29
Document
Equity Pledge Agreement dated September 26, 2016 between William Lei Ding and NetEase Youdao Information Technology (Beijing)
Co., Ltd. (incorporated by reference to Exhibit 4.52 to the company’s Annual Report on Form 20-F for the year ended December 31,
2016 filed with the SEC on April 21, 2017)
4.30
4.31
4.32
4.33
4.34
4.35
4.36
4.37
4.38
4.39
4.40
Exclusive Purchase Option Agreement dated September 26, 2016 among William Lei Ding, NetEase Youdao Information Technology
(Beijing) Co., Ltd. and Youdao Computer System Co., Ltd. (incorporated by reference to Exhibit 4.53 to the company’s Annual Report
on Form 20-F for the year ended December 31, 2016 filed with the SEC on April 21, 2017)
Operating Agreement dated September 26, 2016 among Youdao Computer System Co., Ltd., NetEase Youdao Information Technology
(Beijing) Co., Ltd. and William Lei Ding. (incorporated by reference to Exhibit 4.54 to the company’s Annual Report on Form 20-F for
the year ended December 31, 2016 filed with the SEC on April 21, 2017)
Cooperation Agreement dated July 1, 2015 between NetEase Youdao Information Technology (Beijing) Co., Ltd. and Youdao Computer
System Co., Ltd. (incorporated by reference to Exhibit 4.55 to the company’s Annual Report on Form 20-F for the year ended
December 31, 2016 filed with the SEC on April 21, 2017)
Loan Agreement dated November 20, 2017 between Feng Zhou and NetEase Youdao Information Technology (Beijing) Co., Ltd.
(incorporated by reference to Exhibit 4.52 to the company’s Annual Report on Form 20-F for the year ended December 31, 2017 filed
with the SEC on April 20, 2018)
Equity Pledge Agreement dated November 20, 2017 between Feng Zhou and NetEase Youdao Information Technology (Beijing)
Co., Ltd. (incorporated by reference to Exhibit 4.53 to the company’s Annual Report on Form 20-F for the year ended December 31,
2017 filed with the SEC on April 20, 2018)
Exclusive Purchase Option Agreement dated November 20, 2017 among NetEase Youdao Information Technology (Beijing) Co., Ltd.,
Feng Zhou and Youdao Computer System Co., Ltd. (incorporated by reference to Exhibit 4.54 to the company’s Annual Report on Form
20-F for the year ended December 31, 2017 filed with the SEC on April 20, 2018)
Operating Agreement dated November 20, 2017 among NetEase Youdao Information Technology (Beijing) Co., Ltd., Youdao Computer
System Co., Ltd. and Feng Zhou (incorporated by reference to Exhibit 4.55 to the company’s Annual Report on Form 20-F for the year
ended December 31, 2017 filed with the SEC on April 20, 2018)
US$500,000,000 Syndicated Facility Agreement between the Registrant and the parties thereto dated August 9, 2018 (incorporated by
reference to Exhibit 4.56 to the company’s Annual Report on Form 20-F for the year ended December 31, 2018 filed with the SEC on
April 26, 2019)
Letter of Amendment between the Registrant and the Agent (as defined therein) dated September 21, 2018 relating to the
US$500,000,000 Syndicated Facility Agreement dated August 9, 2018 (incorporated by reference to Exhibit 4.57 to the company’s
Annual Report on Form 20-F for the year ended December 31, 2018 filed with the SEC on April 26, 2019)
Supplementary Agreement of Assignment among NetEase (Hangzhou) Network Co., Ltd., Hangzhou NetEase Leihuo Technology Co.,
Ltd., Zhipeng Hu, Tianlei Hu and Long Cheng dated April 18, 2019 (incorporated by reference to Exhibit 4.58 to the company’s Annual
Report on Form 20-F for the year ended December 31, 2018 filed with the SEC on April 26, 2019)
Master Transaction Agreement dated September 27, 2019 between NetEase, Inc. and Youdao, Inc. (incorporated by reference to Exhibit
4.52 to the company’s Annual Report on Form 20-F for the year ended December 31, 2019 filed with the SEC on April 29, 2020)
156
Table of Contents
Exhibit
Number
4.41
4.42
4.43
4.44
4.45
4.46
8.1*
11.1
Transitional Services Agreement dated September 27, 2019 between NetEase, Inc. and Youdao, Inc. (incorporated by reference to
Exhibit 4.53 to the company’s Annual Report on Form 20-F for the year ended December 31, 2019 filed with the SEC on April 29,
2020)
Document
Non-Competition Agreement dated September 27, 2019 between NetEase, Inc. and Youdao, Inc. (incorporated by reference to Exhibit
4.54 to the company’s Annual Report on Form 20-F for the year ended December 31, 2019 filed with the SEC on April 29, 2020)
Cooperation Framework Agreement dated September 27, 2019 between NetEase, Inc. and Youdao, Inc. (incorporated by reference to
Exhibit 4.55 to the company’s Annual Report on Form 20-F for the year ended December 31, 2019 filed with the SEC on April 29,
2020)
Intellectual Property License Agreement dated September 27, 2019 between NetEase, Inc. and Youdao, Inc. (incorporated by reference
to Exhibit 4.56 to the company’s Annual Report on Form 20-F for the year ended December 31, 2019 filed with the SEC on April 29,
2020)
Share Purchase Agreement dated September 6, 2019 among Taobao Holding Limited, HQG, Inc., NetEase E-Commerce, Inc. and
NetEase, Inc. (incorporated by reference to Exhibit 4.57 to the company’s Annual Report on Form 20-F for the year ended December
31, 2019 filed with the SEC on April 29, 2020)
2019 Restricted Share Unit Plan (incorporated by reference to Exhibit 4.7 to the company’s Registration Statement on Form S-8 (file no.
333-234189) filed with the SEC on October 15, 2019)
List of Significant Subsidiaries and Variable Interest Entities of NetEase, Inc.
Code of Business Conduct (incorporated by reference to Exhibit 11.1 to the company’s Annual Report on Form 20-F for the year ended
December 31, 2006 filed with the SEC on June 26, 2007)
12.1*
Certification of Chief Executive Officer Required by Rule 13a-14(a)
12.2*
Certification of Chief Financial Officer Required by Rule 13a-14(a)
13.1**
13.2**
15.1
Certification of Chief Executive Officer Required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States
Code
Certification of Chief Financial Officer Required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States
Code
Charter of Audit Committee of the Board of Directors of the Registrant (incorporated by reference to Exhibit 15.1 to the company’s
Annual Report on Form 20-F for the year ended December 31, 2014 filed with the SEC on April 24, 2015)
15.2*
Consent of PricewaterhouseCoopers Zhong Tian LLP, Independent Registered Public Accounting Firm
15.3*
Consent of Maples and Calder (Hong Kong) LLP
15.4*
Consent of Zhong Lun Law Firm
101.INS*
XBRL Instance Document
101.SCH*
XBRL Taxonomy Extension Schema Document
157
Table of Contents
Exhibit
Number
Document
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*
XBRL Taxonomy Extension Label Linkbase Document
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document
104*
Cover Page Interactive Data File (embedded within the Inline XBRL document)
*Filed with this annual report on Form 20-F.
**Furnished with this annual report on Form 20-F.
158
Table of Contents
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to
sign this annual report on its behalf.
SIGNATURES
NETEASE, INC.
By:
/s/ William Lei Ding
William Lei Ding
Chief Executive Officer
Date: April 28, 2021
159
Table of Contents
NETEASE, INC.
Management’s report on internal control over financial reporting
Report of independent registered public accounting firm
Consolidated balance sheets at December 31, 2019 and 2020
Consolidated statements of operations and comprehensive income for the years ended December 31, 2018, 2019 and 2020
Consolidated statements of shareholders’ equity for the years ended December 31, 2018, 2019 and 2020
Consolidated statements of cash flows for the years ended December 31, 2018, 2019 and 2020
Notes to the consolidated financial statements
F-1
F-2
F-5
F-6
F-7
F-8
F-9
Table of Contents
Management’s Report on Internal Control over Financial Reporting
The management of NetEase, Inc., or the Company, is responsible for establishing and maintaining adequate internal control over financial reporting as
defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
The Company’s management, with the participation of the Company’s principal executive and principal financial officer, assessed the effectiveness of the
Company’s internal control over financial reporting as of the end of the most recent fiscal year, December 31, 2020. In making this assessment, the
Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal
Control-Integrated Framework (2013). Based on its assessment, management concluded that, as of the end of the Company’s most recent fiscal year,
December 31, 2020, the Company’s internal control over financial reporting is effective based on those criteria.
PricewaterhouseCoopers Zhong Tian LLP, the Company’s independent registered public accounting firm, has audited the effectiveness of the Company’s
internal control over financial reporting as of December 31, 2020, as stated in their report, which is included herein.
F-1
Table of Contents
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of NetEase, Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of NetEase, Inc. and its subsidiaries (the “Company”) as of December 31, 2020 and
2019, and the related consolidated statements of operations and comprehensive income, of shareholders’ equity and of cash flows for each of the
three years in the period ended December 31, 2020, including the related notes (collectively referred to as the “consolidated financial statements”). We
also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control -
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of
December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020 in
conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control - Integrated
Framework (2013) issued by the COSO.
Basis for Opinions
The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over
Financial Reporting appearing on Page F-1 of this Annual Report on Form 20-F. Our responsibility is to express opinions on the Company’s consolidated
financial statements and on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with
the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in
accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether
effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated
financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test
basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting
principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.
Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk
that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable
basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
F-2
Table of Contents
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were
communicated or required to be communicated to the audit committee and that (i) relate to accounts or disclosures that are material to the consolidated
financial statements and (ii) involved our especially challenging, subjective, or complex judgements. The communication of critical audit matters does
not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters
below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Estimate of average playing period of paying players for recognition of in-game virtual items revenue
As described in Notes 2(c) and 26 to the consolidated financial statements, the Company recognized RMB54.6 billion of revenues from online game
services for the year ended December 31, 2020. Revenues of certain online games in-game virtual items are recognized ratably over the respective
estimated average playing period of paying players in these games. Management considered the average period that players typically play the games and
other game player behavior patterns, as well as various other factors, to arrive at estimates for the estimated average playing period of the paying players
for each game. If a new game was launched and only a limited period of paying player data was available, then management considered other qualitative
factors, such as the playing patterns for paying users for other games with similar characteristics and playing patterns of paying players. Significant
management assumptions applied to estimate the average playing period of paying players for recognition of in-game virtual items revenue include: (i)
estimating future players’ churn rates based on historical players’ churn rates; and (ii) similarities between new games and existing games with sufficient
historical data in terms of characteristics and playing patterns of paying players.
The principal consideration for our determination that performing procedures relating to the estimates of average playing period of paying players for
recognition of in-game virtual items revenue is a critical audit matter is that there are significant assumptions made by management in developing these
estimates, which in turn led to a high degree of auditor judgement, and effort in performing procedures to evaluate the reasonableness of the significant
assumptions used by management, including estimates of future players’ churn rates and estimates of similarities between new games and existing
games.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated
financial statements. These procedures included testing the effectiveness of controls relating to the key judgements, inputs and assumptions of the
estimates of average playing period of paying players for recognition of in-game virtual items revenue. These procedures also included, among others,
testing the completeness, accuracy and relevance of underlying data used in management’s development of the estimates; checking the mathematical
formula used in calculating the historical players’ churn rate and estimated average playing period of paying players for recognition of in-game virtual
items revenue and evaluating significant assumptions used by management. Evaluating management’s assumptions involved assessing the reasonableness
of the significant assumptions used by management including estimating future players’ churn rates based on historical players’ churn rates and
similarities between new games and existing games with sufficient historical data in terms of characteristics and playing patterns of paying players.
F-3
Table of Contents
Impairment assessment of equity method investments and long-term equity investments without readily determinable fair values
As described in Notes 2(j) and 10 to the consolidated financial statements, the Company consolidated balance of investments in equity method investees
and long-term equity investments without readily determinable fair values as at December 31, 2020 was RMB1,621.3 million and RMB6,333.7 million,
respectively. Long-term equity investments without readily determinable fair value include ownership of stock or in-substance common stock issued by
privately-held companies on which the Company does not have significant influence, and investments in privately-held companies’ shares that are not
ordinary shares or in-substance ordinary shares. Management conducts impairment tests for investments in equity method investees and long-term equity
investments without readily determinable fair values at each balance sheet date, or more frequently if events or circumstances indicate that the carrying
amount may not be recoverable. For equity method investments, the Company considers if the investment is impaired when events or circumstances
suggest the carrying amount may not be recoverable, and recognizes any impairment charge in the consolidated statements of operations and
comprehensive income for a decline in value that is determined to be other than temporary. For long-term equity investments without readily
determinable fair values, the Company performs a qualitative assessment of the fair value of the equity interest in comparison to its carrying amount to
determine if there is an indication of potential impairment. If such indication exists, management estimates the fair value of the investment, and records
an impairment in the consolidated statements of operations and comprehensive income to the extent the carrying amount exceeds the fair value.
Significant judgements management applies in the impairment assessment for these equity investments include: (i) the determination as to whether any
impairment indicators exist during the year; (ii) the selection of valuation methods; (iii) the determination of significant assumptions used to value the
equity investments, including selection of comparable companies and multiples, timing and probabilities of different scenarios, estimated volatility rate,
risk-free rate and discount for lack of marketability; and (iv) judgements as to whether a decline in value of equity method investments was other than
temporary.
The principal considerations for our determination that the impairment assessment of equity method investments and long-term equity investments
without readily determinable fair values is a critical audit matter are (i) there was a high degree of auditor judgement and subjectivity involved in
performing procedures relating to evaluating the reasonableness of significant judgements management applied in the impairment assessment; (ii)
significant audit effort was necessary to perform procedures and evaluate evidence relating to significant assumptions management used to value the
equity investments, such as selection of comparable companies and multiples, timing and probabilities of different scenarios, estimated volatility rate,
risk-free rate and discount for lack of marketability; and (iii) the audit effort involved the use of professionals with specialized skill and knowledge to
assist in performing these procedures and evaluating the audit evidence obtained from these procedures.
Addressing the matter involved performing procedures and evaluating audit evidence in connection with forming our overall opinion on the consolidated
financial statements. These procedures included testing the effectiveness of controls relating to management’s impairment assessment of equity method
investments and long-term equity investments without readily determinable fair values. These procedures also included, among others, (i) testing
management’s qualitative evaluation as to whether indicators of impairment existed by assessing the evidence considered by management, as well as
other relevant market information; (ii) assessing the appropriateness of the valuation methodology by exercising professional judgements based on our
knowledge of the industry and the investee; (iii) testing assumptions used in management’s valuation, including selection of comparable companies and
multiples, timing and probabilities of different scenarios, estimated volatility rate, risk-free rate and discount for lack of marketability, by comparing
certain assumptions to applicable industry/business data external to the Company, and leveraging our industry knowledge and information from our
independent research; and (iv) testing the accuracy of the mathematical calculation applied in the valuation models and the calculation of impairment
charges. We involved professionals with specialized skill and knowledge to assist in assessing the valuation model, assumptions used in management’s
valuation, including selection of comparable companies and multiples, estimated volatility rate and discount for lack of marketability, and testing of
mathematical calculation in the valuation models.
/s/ PricewaterhouseCoopers Zhong Tian LLP
PricewaterhouseCoopers Zhong Tian LLP
Beijing, the People’s Republic of China
April 28, 2021
We have served as the Company’s auditor since 2002.
F-4
Table of Contents
NetEase, Inc.
Consolidated Balance Sheets
(in thousands except per share data)
Assets
Current assets:
Cash and cash equivalents
Time deposits
Restricted cash
Accounts receivable, net
Inventories, net
Prepayments and other current assets, net
Short-term investments
Assets held for sale
Total current assets
Non-current assets:
Property, equipment and software, net
Land use rights, net
Operating lease right-of-use assets, net
Deferred tax assets
Time deposits
Long-term investments
Other long-term assets, net
Assets held for sale
Total non-current assets
Total assets
Liabilities, Redeemable noncontrolling interests and Shareholders’ equity
Current liabilities:
Accounts payable (including accounts payable of the consolidated VIEs without recourse to the primary beneficiaries of RMB846,893 and
RMB676,590 as of December 31, 2019 and 2020, respectively)
Salary and welfare payables (including salary and welfare payables of the consolidated VIEs without recourse to the primary beneficiaries of
RMB97,636 and RMB130,122 as of December 31, 2019 and 2020, respectively)
Taxes payable (including taxes payable of the consolidated VIEs without recourse to the primary beneficiaries of RMB122,179 and RMB87,177 as of
December 31, 2019 and 2020, respectively)
Short-term loans (including short-term loans of the consolidated VIEs without recourse to the primary beneficiaries of RMB197,420 and RMB461,309
as of December 31, 2019 and 2020, respectively)
Deferred revenue (including deferred revenue of the consolidated VIEs without recourse to the primary beneficiaries of RMB7,634,637 and
RMB9,850,308 as of December 31, 2019 and 2020, respectively)
Accrued liabilities and other payables (including accrued liabilities and other payables of the consolidated VIEs without recourse to the primary
beneficiaries of RMB1,919,549 and RMB2,309,598 as of December 31, 2019 and 2020, respectively)
Short-term operating lease liabilities (including short-term operating lease liabilities of the consolidated VIEs without recourse to the primary
beneficiaries of RMB14,683 and RMB18,003 as of December 31, 2019 and 2020, respectively)
Liabilities held for sale
Total current liabilities
Non-current liabilities:
Deferred tax liabilities
Long-term operating lease liabilities (including long-term operating lease liabilities of the consolidated VIEs without recourse to the primary
beneficiaries of RMB12,133 and RMB19,619 as of December 31, 2019 and 2020, respectively)
Other long-term payable
Liabilities held for sale
Total non-current liabilities
Total liabilities
Commitments and contingencies
Redeemable noncontrolling interests
Shareholders’ equity:
Ordinary shares, US$0.0001 par value:
1,000,300,000 shares authorized, 3,228,531 shares issued and outstanding as of December 31, 2019 and 3,349,335 shares issued and outstanding as of
December 31, 2020
Additional paid-in capital
Treasury stock
Statutory reserves
Accumulated other comprehensive loss
Retained earnings
NetEase, Inc.’s shareholders’ equity
Noncontrolling interests
Total shareholders’ equity
December 31, December 31, December 31,
Notes
2019
RMB
2020
RMB
2020
US$
Note 2(q)
2(f)
2(f)
2(f)
2(i)
5
6
7
8
9
12(c)
2(f)
10
11
13
14
15
16
9
12(c)
9
22
17
2(u)
17
3,246,373
53,487,075
3,150,354
4,169,358
650,557
4,817,422
15,312,595
271,278
85,105,012
4,621,712
3,707,179
463,688
903,904
2,360,000
9,293,868
5,666,610
2,398
27,019,359
9,117,219
71,079,327
3,051,386
4,576,445
621,207
6,112,433
13,273,026
—
107,831,043
4,555,406
4,178,257
773,176
1,086,759
6,630,000
11,711,259
5,108,682
—
34,043,539
1,397,275
10,893,383
467,645
701,371
95,204
936,771
2,034,180
—
16,525,829
698,147
640,346
118,494
166,553
1,016,092
1,794,829
782,940
—
5,217,401
112,124,371
141,874,582
21,743,230
1,212,303
2,957,360
3,156,513
1,134,413
3,538,732
4,282,835
16,828,226
19,504,696
8,602,227
10,945,143
5,292,774
7,006,819
191,454
2,156
38,243,013
382,030
279,949
176,963
961
839,903
330,853
—
46,743,491
713,439
474,882
148,846
—
1,337,167
173,856
542,334
656,373
2,989,225
1,677,417
1,073,843
50,705
—
7,163,753
109,339
72,778
22,812
—
204,929
39,082,916
48,080,658
7,368,682
10,448,600
10,796,120
1,654,578
2,640
3,913,656
—
1,215,208
(71,445)
56,393,640
61,453,699
1,139,156
62,592,855
2,794
27,829,431
(10,446,107)
1,228,448
(650,457)
64,162,689
82,126,798
871,006
82,997,804
428
4,265,047
(1,600,936)
188,268
(99,687)
9,833,362
12,586,482
133,488
12,719,970
Total liabilities, redeemable noncontrolling interests and shareholders’ equity
112,124,371
141,874,582
21,743,230
The accompanying notes are an integral part of these consolidated financial statements.
F-5
Table of Contents
NetEase, Inc.
Consolidated Statements of Operations and Comprehensive Income
(in thousands except per share data or per ADS data)
Net revenues:
Online game services
Youdao
Innovative businesses and others
Total net revenues
Cost of revenues
Gross profit
Operating expenses:
Selling and marketing expenses
General and administrative expenses
Research and development expenses
Total operating expenses
Operating profit
Other income/(expenses):
Investment (losses)/income, net
Interest income, net
Exchange (losses)/gains, net
Other, net
Income before tax
Income tax
Net income from continuing operations
Net (loss)/income from discontinued operations
Net income
Accretion and deemed dividends in connection with repurchase of redeemable noncontrolling interests
Net (income)/loss attributable to noncontrolling interests and redeemable noncontrolling interests
Net income attributable to NetEase, Inc.’s shareholders
Including:
Net income from continuing operations attributable to NetEase, Inc.’s shareholders
Net (loss)/income from discontinued operations attributable to NetEase, Inc.’s shareholders
Net income
Other comprehensive income
Foreign currency translation adjustment
Total comprehensive income
Comprehensive (income)/ loss attributable to noncontrolling interests and redeemable noncontrolling interests
Comprehensive income attributable to NetEase, Inc.’s shareholders
Net income/(loss) per share, basic
-Continuing operations
-Discontinued operations
Net income/(loss) per ADS, basic
-Continuing operations
-Discontinued operations
Net income/(loss) per share, diluted
-Continuing operations
-Discontinued operations
Net income/(loss) per ADS, diluted
-Continuing operations
-Discontinued operations
Weighted average number of ordinary shares outstanding, basic
Weighted average number of ADS outstanding, basic
Weighted average number of ordinary shares outstanding, diluted
Weighted average number of ADS outstanding, diluted
The accompanying notes are an integral part of these consolidated financial statements
F-6
Notes
26
26
26
26
12(a)
3
21
21
21
For the year ended December 31,
2018
RMB
2019
RMB
2020
RMB
40,190,057
731,598
10,256,920
51,178,575
(23,832,426)
27,346,149
(6,911,710)
(3,078,635)
(7,378,460)
(17,368,805)
9,977,344
(22,383)
586,671
(51,799)
586,916
11,076,749
(2,460,650)
8,616,099
(2,138,682)
6,477,417
(248,098)
(76,912)
6,152,407
8,291,089
(2,138,682)
6,477,417
18,624
6,496,041
(76,912)
6,419,129
1.90
2.56
(0.66)
9.51
12.81
(3.30)
1.89
2.55
(0.66)
9.45
12.74
(3.29)
46,422,640
1,304,883
11,513,622
59,241,145
(27,685,845)
31,555,300
(6,221,127)
(3,130,298)
(8,413,224)
(17,764,649)
13,790,651
1,306,320
821,774
25,166
439,422
16,383,333
(2,914,726)
13,468,607
7,962,519
21,431,126
(271,543)
77,933
21,237,516
13,274,997
7,962,519
21,431,126
(93,774)
21,337,352
83,685
21,421,037
6.59
4.12
2.47
32.97
20.61
12.36
6.53
4.08
2.45
32.67
20.42
12.25
54,608,717
3,167,515
15,890,901
73,667,133
(34,683,731)
38,983,402
(10,703,788)
(3,371,827)
(10,369,382)
(24,444,997)
14,538,405
1,610,045
1,598,618
(3,112,152)
737,168
15,372,084
(3,041,849)
12,330,235
—
12,330,235
(787,029)
519,548
12,062,754
12,062,754
—
12,330,235
(598,108)
11,732,127
538,644
12,270,771
3.65
3.65
—
18.25
18.25
—
3.60
3.60
—
18.01
18.01
—
2020
US$
Note 2(q)
8,369,152
485,443
2,435,387
11,289,982
(5,315,514)
5,974,468
(1,640,427)
(516,755)
(1,589,177)
(3,746,359)
2,228,109
246,750
244,999
(476,958)
112,976
2,355,876
(466,184)
1,889,692
—
1,889,692
(120,617)
79,624
1,848,699
1,848,699
—
1,889,692
(91,664)
1,798,028
82,551
1,880,579
0.56
0.56
—
2.80
2.80
—
0.55
0.55
—
2.76
2.76
—
3,235,324
647,065
3,254,689
650,938
3,220,473
644,095
3,249,972
649,994
3,305,448
661,090
3,349,759
669,952
3,305,448
661,090
3,349,759
669,952
Table of Contents
NetEase, Inc.
Consolidated Statements of Shareholders’ Equity
(in thousands)
Balance as of December 31, 2017
Cumulative effect of changes in accounting principles related to revenue recognition and financial
instruments
Ordinary shares
Share
3,283,217
Amount
RMB
2,678
Additional paid-in
capital
RMB
Treasury stock
Share Amount
RMB
Statutory
reserves
RMB
1,753,439
—
— 1,206,224
Accumulated
other comprehensive
income/(loss)
RMB
36,585
Retained
earnings
RMB
42,733,081
Vesting of restricted share units
Share-based compensation
Appropriation to statutory reserves
Net income attributable to NetEase, Inc. and noncontrolling interest shareholders
Repurchase of shares
Cancellation of treasury stock
Repurchase of noncontrolling interest and redeemable noncontrolling interests
Change of capital from noncontrolling interest shareholders
Dividends to shareholders
Foreign currency translation adjustment
Disposal of a subsidiary
Accretion of redeemable noncontrolling interests
Balance as of December 31, 2018
Vesting of restricted share units
Share-based compensation
Appropriation to statutory reserves
Net income attributable to NetEase, Inc. and noncontrolling interest shareholders
Repurchase of shares
Repurchase of noncontrolling interest and redeemable noncontrolling interests
Change of capital from noncontrolling interest shareholders
Conversion of Youdao’s preferred shares recognized as redeemable noncontrolling interests to ordinary shares
Dividends to shareholders
Foreign currency translation adjustment
Disposal of subsidiaries
Accretion of redeemable noncontrolling interests
Balance as of December 31, 2019
Vesting of restricted share units
Issuance of shares in Hong Kong, net of issuance costs
Share-based compensation
Appropriation to statutory reserves
Net income attributable to NetEase, Inc. and noncontrolling interest shareholders
Repurchase of shares
Repurchase of noncontrolling interest and redeemable noncontrolling interests
Change of capital from noncontrolling interest shareholders
Dividends to shareholders
Foreign currency translation adjustment
Accretion of redeemable noncontrolling interests
Balance as of December 31, 2020
—
30,709
—
—
—
—
(114,908)
—
—
—
—
—
—
3,199,018
29,513
—
—
—
—
—
—
—
—
—
—
—
3,228,531
20,578
197,202
—
—
—
—
—
—
—
—
—
3,446,311
—
19
—
—
—
—
(77)
—
—
—
—
—
—
2,620
20
—
—
—
—
—
—
—
—
—
—
—
2,640
15
139
—
—
—
—
—
—
—
—
—
2,794
(4,151,218)
—
—
—
—
—
—
—
(1,487)
2,341,078
—
—
—
(4,279)
1,153,528
—
—
—
(19)
—
2,397,798
—
—
—
—
— (114,908)
114,908
—
—
—
—
—
—
—
25
—
—
—
(25)
—
—
—
468,788
—
—
—
—
—
(43,972)
—
—
—
3,913,656
8,582
(827,722)
—
21,883,804
—
2,543,435
—
—
—
—
— (105,558)
—
—
—
—
—
(96,976)
(18,852)
335,110
—
—
—
27,829,431
1,467
—
—
—
—
—
—
8,354
—
—
—
—
(7,592,598)
—
7,592,598
—
—
—
—
—
—
—
—
—
—
—
—
— 1,214,578
—
—
—
11,129
—
—
—
—
(1,467)
—
—
—
—
—
—
—
—
—
—
(10,499)
—
—
—
— 1,215,208
—
—
—
13,240
—
—
—
—
—
—
—
(10,446,107) 1,228,448
827,707
—
—
—
—
(11,273,814)
—
—
—
—
—
65,608
—
—
(8,354)
6,400,505
(38,159)
—
—
—
—
—
—
— (3,441,303)
(223,243)
—
—
—
(1,440,194)
—
18,624
—
—
—
(88,712)
—
43,997,388
17,050
—
—
—
—
—
(11,129)
— 21,509,059
—
—
—
—
—
(88,022)
(473)
—
—
—
—
—
(8,840,634)
—
10,499
(271,543)
(71,445) 56,393,640
—
—
—
—
—
—
—
(13,240)
— 12,849,783
—
—
(204,705)
—
—
—
— (4,280,465)
—
(582,324)
(650,457) 64,162,689
(579,012)
—
Noncontrolling Total shareholders
interests
RMB
703,133
12,367
—
131,852
—
76,912
—
—
(131,143)
15,510
—
—
(5,654)
(8,768)
794,209
—
46,100
—
(77,933)
—
(53)
378,654
27,757
—
(5,752)
(11,807)
(12,019)
1,139,156
—
—
71,943
—
(519,548)
—
(2,496)
214,203
—
(19,096)
(13,156)
871,006
equity
RMB
46,435,140
39,816
—
2,529,650
—
6,477,417
(7,592,598
—
(354,386
15,510
(1,440,194
18,624
(5,654
(97,480
46,025,845
—
2,387,178
—
21,431,126
(1,467
(4,332
1,532,182
496,545
(8,840,634
(93,774
(56,252
(283,562
62,592,855
—
21,883,943
2,615,378
—
12,330,235
(11,273,814
(226,053
549,313
(4,280,465
(598,108
(595,480
82,997,804
The accompanying notes are an integral part of these consolidated financial statements.
F-7
Table of Contents
NetEase, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Cash flows from operating activities:
Net income
Net loss/(income) from discontinued operations
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Fair value change of equity security investments and other financial instruments
Impairment losses on investments and other intangible assets
Share-based compensation cost
Allowance for/(Reversal of) doubtful accounts/expected credit losses
(Gains)/Losses on disposal of property, equipment and software
Unrealized exchange losses /(gains)
Gains on disposal of long-term investments, business and subsidiaries
Deferred income taxes
Share of results on equity method investees and revaluation gains from previously held equity interest
Fair value changes of short-term investments
Changes in operating assets and liabilities:
Accounts receivable
Inventories
Prepayments and other assets
Accounts payable
Salary and welfare payables
Taxes payable
Deferred revenue
Accrued liabilities and other payables
Net cash provided by continuing operating activities
Net cash (used in)/provided by discontinued operating activities
Net cash provided by operating activities
Cash flows from investing activities:
Purchase of property, equipment and software
Proceeds from sale of property, equipment and software
Purchase of intangible assets, content and licensed copyrights
Purchase of land use right
Net change of short-term investments with terms of three months or less
Purchase of short-term investments
Proceeds from maturities of short-term investments
Investment in equity method investees
Investment in other equity investments and acquisition of subsidiaries
Proceeds from disposal of investment in equity investees, businesses and subsidiaries
Placement/rollover of time deposits
Proceeds from maturity of time deposits
Change in other long-term assets
Amounts (paid to)/received from disposed businesses
Net cash used in continuing investing activities
Net cash provided by/(used in) discontinued investing activities
Net cash used in investing activities
Cash flows from financing activities:
Net proceeds from short-term loan with terms of three months or less
Proceeds of short-term loan
Repayment of short-term loan
Dividends paid to shareholders
Net proceeds received from issuance of shares in Hong Kong
Repurchase of redeemable noncontrolling interests
Proceeds from issuance of redeemable noncontrolling interest shareholders, net of issuance cost
Repurchase of noncontrolling interest
Capital injection from noncontrolling interest shareholders
Cash (paid for)/ refund received from repurchase of NetEase’s/purchase of Youdao’s ADSs
Net cash provided by financing activities*
For the year ended December 31,
2018
RMB
2019
RMB
2020
RMB
2020
US$
Note 2(q)
21,431,126
(7,962,519)
12,330,235
—
1,889,692
—
6,477,417
2,138,682
2,060,135
248,169
159,703
2,471,731
50,954
(1,385)
31,998
(213,339)
(70,621)
98,301
(463,483)
(612,656)
(81,440)
(719,035)
112,435
725,515
685,024
1,757,874
(196,136)
14,659,843
(1,243,966)
13,415,877
(2,169,404)
6,688
(1,741,225)
(2,926,795)
(1,172,326)
(13,393,000)
13,071,359
(272,451)
(2,751,040)
—
(41,553,428)
39,924,525
(133,039)
(1,889,560)
(14,999,696)
1,430,181
(13,569,515)
6,194,113
34,256
(18,761)
(1,440,194)
—
(780,000)
5,294,174
(195,000)
15,510
(7,516,679)
1,587,419
2,613,782
(751,693)
177,567
2,404,089
(28,583)
5,122
(9,981)
(98,489)
150,629
(4,322)
(657,606)
(11,314)
415,057
(1,488,564)
13,229
146,146
(133,801)
883,742
(182,646)
16,910,971
305,487
17,216,458
(1,209,477)
60,601
(2,119,307)
—
(1,023,165)
(22,370,000)
20,225,342
(450,695)
(1,111,493)
406,702
(77,083,350)
54,381,647
(42,345)
9,031,051
(21,304,489)
(832,252)
(22,136,741)
2,538,267
730,087
(296,823)
(8,840,634)
—
—
5,242,180
—
1,698,810
10,638
1,082,525
3,457,782
(720,565)
58,395
2,663,489
40,600
6,482
3,102,492
(27,063)
88,179
(302,602)
(580,732)
(530,413)
29,699
(13,554)
(86,352)
528,927
1,126,648
2,342,916
1,373,608
24,888,171
—
24,888,171
(1,055,572)
17,540
(2,234,915)
—
(1,655,930)
(19,905,000)
24,126,210
(345,662)
(2,062,030)
722,076
(91,518,767)
64,880,317
(160,674)
—
(29,192,407)
—
(29,192,407)
3,723,109
1,136,495
(818,539)
(4,280,462)
21,911,815
(462,650)
—
—
194,307
(11,490,988)
9,913,087
529,928
(110,431)
8,949
408,198
6,222
993
475,478
(4,148)
13,514
(46,376)
(89,001)
(81,289)
4,552
(2,077)
(13,234)
81,062
172,666
359,068
210,515
3,814,281
—
3,814,281
(161,773)
2,688
(342,516)
—
(253,782)
(3,050,575)
3,697,503
(52,975)
(316,020)
110,662
(14,025,865)
9,943,344
(24,624)
—
(4,473,933)
—
(4,473,933)
570,591
174,175
(125,447)
(656,010)
3,358,133
(70,904)
—
—
29,779
(1,761,071)
1,519,246
24,811
884,405
980,515
1,864,920
—
1,864,920
313,581
37,709
51,699
Effect of exchange rate changes on cash, cash equivalents and restricted cash held in foreign currencies
81,511
29,080
161,894
Net increase/(decrease) in cash, cash equivalents and restricted cash
Cash, cash equivalents and restricted cash, beginning of the year
Cash, cash equivalents and restricted cash, end of the year
Less: Cash, cash equivalents and restricted cash of held for sales at end of the year
Cash, cash equivalents and restricted cash of continuing operations, end of the year
Supplemental disclosures of cash flow information of continuing operation:
Cash paid for income taxes, net of tax refund
Cash paid for interest expenses
Supplemental schedule of non-cash investing and financing activities of continuing operation:
Fixed asset purchases financed by accounts payable and accrued liabilities
*There is no financing activity from discontinued operations.
The accompanying notes are an integral part of these consolidated financial statements.
1,515,292
8,691,246
10,206,538
537,056
9,669,482
2,003,158
301,761
(3,808,678)
10,206,538
6,397,860
1,133
6,396,727
3,193,802
431,395
5,770,745
6,397,860
12,168,605
—
12,168,605
2,046,119
246,051
351,610
304,944
337,333
F-8
Table of Contents
Notes to the Consolidated Financial Statements
(Amounts expressed in Renminbi (“RMB”), unless otherwise stated)
1. Organization and Nature of Operations
(a) The Group
NetEase.com, Inc. was incorporated in the Cayman Islands on July 6, 1999 and changed its name to “NetEase, Inc.” (“the Company”) with effect from
March 29, 2012. The Company completed its initial public offering in July 2000 in connection with its listing on the Nasdaq National Market (now the
Nasdaq Global Select Market) in the United States of America. In June 2020, the Company successfully listed its ordinary shares on the main board of
the Hong Kong Stock Exchange with a global offering of 197,202,000 ordinary shares at a price of HK$123.00 per share. Gross proceeds from the global
offering, before any underwriting fees and other offering expenses, were approximately HK$24,255.8 million.
As of December 31, 2020, the Company has wholly-owned and majority-owned subsidiaries incorporated in countries and jurisdictions mainly in the
People’s Republic of China (“PRC” or “China”, references to “China” and “PRC” are to the People’s Republic of China, excluding, for the purposes of
the financial statements only, Hong Kong, Macau and Taiwan), Hong Kong, Cayman Islands and British Virgin Islands (“BVI”). The Company also
effectively controls a number of variable interest entities (“VIEs”) for which the Company is the primary beneficiary. The Company, its subsidiaries and
VIEs are hereinafter collectively referred to as the “Group”.
In September 2019, the Company sold its Kaola e-commerce business. As a result, Kaola has been deconsolidated from the Company and its historical
financial results are reflected in the Company’s consolidated financial statements as discontinued operations accordingly. See additional discussion on the
discontinued operation in Note 3 to the consolidated financial statements.
On October 26, 2019, Youdao, Inc. (“Youdao”), one of the Company’s majority-controlled subsidiaries completed its initial public offering (“IPO”) on
the New York Stock Exchange. After Youdao’s offering, the Company continues to control Youdao and consolidates Youdao as its controlling
shareholder.
The major subsidiaries and VIEs through which the Company conducts its business operations as of December 31, 2020 are described below:
Major Subsidiaries
Guangzhou Boguan Telecommunication Technology Co., Ltd. (“Boguan”)
NetEase (Hangzhou) Network Co., Ltd. (“NetEase Hangzhou”)
Hong Kong NetEase Interactive Entertainment Limited
Major VIEs and VIEs’ subsidiaries
Guangzhou NetEase Computer System Co., Ltd. (“Guangzhou NetEase”)
Shanghai EaseNet Network Technology Co., Ltd. (“Shanghai EaseNet”)
StormNet Information Technology (Hong Kong) Limited (“StormNet IT HK”)
StormNet Information Technology (Shanghai) Co., Ltd. (“StormNet IT SH”)
Hangzhou NetEase Leihuo Technology Co., Ltd. (“HZ Leihuo”, formerly known as Hangzhou NetEase Leihuo Network
Co., Ltd.)
Place and year of
Incorporation
Guangzhou, China 2003
Hangzhou, China 2006
Hong Kong, China 2007
Place and year of
Incorporation
Guangzhou, China 1997
Shanghai, China 2008
Hong Kong, China 2008
Shanghai, China 2008
Hangzhou, China 2009
Guangzhou NetEase, a major VIE of the Company, was incorporated in June 1997 in China and owned by William Lei Ding, or Mr. Ding, the
Company’s Chief Executive Officer, director and major shareholder, and another Chinese employee of the Group. It is responsible for providing online
game, e-mail and other value-added telecommunication services.
HZ Leihuo was incorporated in April 2009 in China by two Chinese employees of the Group and currently operates the Company’s mobile game
business.
F-9
Table of Contents
In addition, Shanghai EaseNet is a PRC company owned by Mr. Ding, and has contractual arrangements with StormNet IT HK (a joint venture
established between, and owned equally by, Blizzard Entertainment, Inc. (“Blizzard”) and the Company), and with the Company. StormNet IT HK,
together with its wholly owned subsidiary, StormNet IT SH was established concurrently with the licensing of certain online games in August 2008 and
provides technical services to Shanghai EaseNet.
The following combined financial information of the Group’s VIEs was included in the accompanying consolidated financial statements of the Group as
follows (in thousands):
Total assets
Total liabilities
Net revenues
Net income
Net cash provided by/(used in) operating activities
Net cash used in investing activities
Net cash provided by financing activities
December 31,
2019
RMB
14,400,564
12,272,634
December 31,
2020
RMB
18,186,417
15,466,331
2018
RMB
For the year ended December 31,
2019
RMB
2020
RMB
43,231,277
224,253
49,455,146
344,134
62,191,162
712,015
2018
RMB
356,907
(720,675)
229,862
For the year ended December 31,
2019
RMB
(249,387)
(495,160)
26,520
2020
RMB
1,671,457
(263,766)
273,889
In accordance with various contractual agreements, the Company has the power to direct the activities of the VIEs and can have assets transferred out of
the VIEs. Therefore, the Company considers that there are no assets in the respective VIEs that can be used only to settle obligations of the respective
VIEs, except for the registered capital of the VIEs amounting to approximately RMB501.2 million and RMB512.4 million, respectively, as of December
31, 2019 and 2020, as well as certain non-distributable statutory reserves amounting to approximately RMB42.1 million and RMB54.7 million,
respectively, as of December 31, 2019 and 2020. As the respective VIEs are incorporated as limited liability companies under the PRC Company Law,
creditors do not have recourse to the general credit of the Company for the liabilities of the respective VIEs.
Currently, there are certain contractual arrangements between the Company and several of its VIEs which require the Company to provide additional
financial support or guarantees to its VIEs, where necessary. Please see Note 1(b) for additional information.
There is no entity in the Company’s group for which the Company has a variable interest but is not the primary beneficiary as of December 31, 2020.
(b) Nature of operations
The Group generates revenues mainly from providing online game services, online courses services, advertising services, e-commerce, and other fee-
based premium services.
The industry in which the Group operates is subject to a number of industry-specific risk factors, including, but not limited to, rapidly changing
technologies; government regulations of the Internet, online game, online education and e-commerce industry in China; numbers of new entrants;
dependence on key individuals; competition of similar services from larger companies; customer preferences; and the need for the continued successful
development, marketing and selling of its services.
F-10
Table of Contents
VIE arrangements with major VIEs
The Group conducts its business mainly in China. The Chinese government regulates Internet access, telecommunications services, the distribution of
news and other information and the provision of commerce through strict business licensing requirements and other governmental regulations, which
include, among others, those restricting foreign ownership in Chinese companies providing Internet advertising and other Internet or telecommunications
value-added services. To comply with the existing Chinese laws and regulations, the Company and certain of its subsidiaries have entered into a series of
contractual arrangements with its major VIEs with respect to the operation of the NetEase websites, operation of self-developed and licensed PC and
mobile games, Internet content and wireless value-added services, as well as the provision of advertising services.
Based on the agreements with these VIEs, certain of the Company’s subsidiaries provided technical consulting and related services to these VIEs. The
principal agreements that transfer economic benefits of Guangzhou NetEase and HZ Leihuo to the Company and its subsidiaries are:
● Cooperative agreements with Guangzhou NetEase - under these agreements, certain of the Company’s subsidiaries, including Boguan and
NetEase Hangzhou provide various technical consulting and related services to Guangzhou NetEase in exchange for substantially all of
Guangzhou NetEase’s net profits.
● Cooperative agreement with HZ Leihuo - under this agreement, NetEase Hangzhou provides various technical consulting and related
services to HZ Leihuo in exchange for substantially all of HZ Leihuo’s net profits.
Each cooperative agreement will remain in effect indefinitely unless any one of the contract parties terminates such agreement by written notice or
otherwise required by law.
Each VIE, the relevant subsidiary of the Company and the relevant VIE shareholders have entered into a series of agreements that give the Company
effective control over the VIE. The principal agreements that provide the Company and its subsidiaries effective control over Guangzhou NetEase are:
● Shareholder Voting Rights Trust Agreement among the VIE shareholders and the Company’s subsidiary, NetEase Information Technology
(Beijing) Co., Ltd. (“NetEase Beijing”). Each of the VIE shareholders irrevocably appoints NetEase Beijing to represent him to exercise all
the voting rights to which he is entitled as a shareholder of Guangzhou NetEase. The term of this agreement was 10 years from May 12,
2000, which was extended on June 10, 2011 with a term of 20 years from May 12, 2010.
● Letter of Agreement. Each of the VIE shareholders have agreed that any amendments to be made to the agreements to which the Company,
NetEase Beijing and/or their respective affiliates is a party, on the one hand, and any of their variable interest entities and/or the
shareholders of such entities, on the other hand, shall be subject to the approval by the vote of a majority of the Board of the Company,
excluding the vote of Mr. Ding. The VIE shareholders have also agreed that, if any amendments to the above-mentioned agreements
require a vote of the shareholders of the Company or Guangzhou NetEase, as applicable, both of them will vote in their capacity as direct
or indirect shareholders of these companies to act based upon the instructions of the Company’s Board. The term of this agreement is 20
years from May 12, 2010.
● Other Governance Arrangements. The parties have agreed that upon the Company’s determination and at any time when NetEase Beijing
or its affiliates are able to obtain approval to invest in and operate all or any part of any business operated by Guangzhou NetEase, NetEase
Beijing or its affiliates may acquire all or any part of the assets or equity interests of Guangzhou NetEase, to the extent permitted by
Chinese law.
F-11
Table of Contents
The principal agreements that provide the Company and its subsidiaries effective control over HZ Leihuo are:
● Operating Agreement among NetEase Hangzhou, HZ Leihuo and the VIE shareholders of Hangzhou Leihuo. To ensure the successful
performance of the various agreements between the parties, HZ Leihuo and its VIE shareholders have agreed that, except for transactions
in the ordinary course of business, HZ Leihuo will not enter into any transaction that would materially affect the assets, liabilities, rights or
operations of HZ Leihuo without the prior written consent of NetEase Hangzhou. NetEase Hangzhou has also agreed that it will provide
performance guarantees and, at NetEase Hangzhou’s discretion, guarantee loans for working capital purposes to the extent required by HZ
Leihuo for its operations. Furthermore, the VIE shareholders of HZ Leihuo have agreed that, upon instruction from NetEase Hangzhou,
they will appoint HZ Leihuo’s board members, president, chief financial officer and other senior executive officers. The term of this
agreement is 20 years from December 1, 2015 and can be extended with the written consent of NetEase Hangzhou.
● Shareholder Voting Rights Trust Agreement among NetEase Hangzhou and the VIE shareholders of HZ Leihuo. Under these agreements,
each dated December 1, 2015, each of the VIE shareholders of HZ Leihuo agreed to irrevocably entrust a person designated by NetEase
Hangzhou to represent him to exercise all the voting rights and other shareholders’ rights to which he is entitled as a shareholder of HZ
Leihuo. Each agreement shall remain effective for as long as the VIE shareholder remains a shareholder of HZ Leihuo unless NetEase
Hangzhou unilaterally terminates the agreement by written notice.
● Exclusive Purchase Option Agreements among NetEase Hangzhou, HZ Leihuo and the VIE shareholders of HZ Leihuo. Under the
Exclusive Purchase Option Agreements, each dated December 1, 2015, each of the VIE shareholders has granted NetEase Hangzhou an
option to purchase all or a portion of his equity interest in HZ Leihuo at a price equal to the original and any additional paid-in capital paid
by the VIE shareholder. In addition, HZ Leihuo has granted NetEase Hangzhou an option to purchase all or a portion of the assets held by
HZ Leihuo or its subsidiaries at a price equal to the net book value of such assets. Each of HZ Leihuo and the VIE shareholders of HZ
Leihuo agrees not to transfer, mortgage or permit any security interest to be created on any equity interest in or assets of HZ Leihuo without
the prior written consent of NetEase Hangzhou. Each Exclusive Purchase Option Agreement shall remain in effect until all of the equity
interests in or assets of HZ Leihuo have been acquired by NetEase Hangzhou or its designee or until NetEase Hangzhou unilaterally
terminates the agreement by written notice.
The principal agreements amongst the other VIEs, the relevant subsidiaries and VIE shareholders that provide the Company effective control over these
VIEs contains substantially the same terms as those aforementioned agreements related to HZ Leihuo, except that contract expiry date varies.
The Joint Venture
In addition to the foregoing, in connection with the licensing of certain online games by Blizzard to Shanghai EaseNet for operation in the PRC, there are
certain contractual arrangements among the Company and Shanghai EaseNet, the joint venture established between Blizzard and the Company.
StormNet IT HK, StormNet IT SH and Shanghai EaseNet (collectively referred to as the “JV Group”) are variable interest entities as equity investment at
risk is not sufficient to permit the JV Group to finance its activities without additional subordinated financial support provided by any parties. As
Blizzard receives its interest as an indirect contribution from NetEase, Blizzard and the Company are considered related parties for purposes of
identifying which party is the primary beneficiary under ASC 810. Since the aggregate variable interests held by Blizzard and NetEase would, if held by
a single party, identify that party as the primary beneficiary, either Blizzard or the Company will be the primary beneficiary. Based on the assessment of
all relevant facts and circumstances, the Company determined that the Company is most closely associated with the JV Group and therefore is the
primary beneficiary. As a result, the JV Group’s results of operations, assets and liabilities have been included in the Company’s consolidated financial
statements.
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The Company conducts substantially all of its business through the various VIEs discussed above and their subsidiaries, and therefore these companies
directly affect the Company’s financial performance and cash flows. As discussed below, if the Chinese government determines the VIE agreements do
not comply with applicable laws and regulations and requires the Company to restructure its operations entirely or discontinue all or any portion of its
business, or if the uncertainties in the PRC legal system limit the Group’s ability to enforce these contractual agreements, the Group’s business operations
will be significantly disrupted and the Group might be unable to consolidate these companies in the future. In the opinion of management, the likelihood
of loss in respect of the Group’s current ownership structure or the contractual arrangements with its VIEs is remote.
Risks related to the VIE arrangements
The Company believes that its contractual arrangements with the VIEs are in compliance with PRC law and are legally enforceable. Mr. Ding, who is
the major shareholder of Guangzhou NetEase, Shanghai EaseNet and certain of the Company’s other VIEs, is the largest shareholder of the Company.
He therefore has no current interest in seeking to act contrary to the contractual arrangements. However, uncertainties in the PRC legal system could limit
the Company’s ability to enforce these contractual arrangements and if Mr. Ding were to reduce his interest in the Company, his interests may diverge
from that of the Company and that may potentially increase the risk that he would seek to act contrary to the contractual terms, for example by
influencing the VIEs not to pay the service fees when required to do so. If the VIEs or their respective shareholder fail to perform their respective
obligations under the current contractual arrangements, the Company may have to incur substantial costs and expend significant resources to enforce
those arrangements and rely on legal remedies under Chinese laws. The Chinese laws, rules and regulations are relatively new, and because of the limited
volume of published decisions and their non-binding nature, the interpretation and enforcement of these laws, rules and regulations involve substantial
uncertainties. These uncertainties may impede the ability of the Company to enforce these contractual arrangements, or suffer significant delay or other
obstacles in the process of enforcing these contractual arrangements and materially and adversely affect the results of operations and the financial
position of the Company.
In addition, many Chinese regulations are subject to extensive interpretive powers of governmental agencies and commissions, and there are substantial
uncertainties regarding the interpretation and application of current and future Chinese laws and regulations. Accordingly, the Company cannot be
assured that Chinese regulatory authorities will not ultimately take a contrary view to its belief and will not take action to prohibit or restrict its business
activities. The relevant regulatory authorities would have broad discretion in dealing with any deemed violations which may adversely impact the
financial statements, operations and cash flows of the Company (including the restriction on the Company to carry out the business). If the legal structure
and contractual arrangements were found to be in violation of any existing PRC laws and regulations, the PRC government could potentially:
● revoke the Group’s business and operating licenses;
● require the Group to discontinue or restrict operations;
● restrict the Group’s right to collect revenues;
● block the Group’s websites;
● require the Group to restructure the operations in such a way as to compel the Group to establish a new enterprise, re-apply for the
necessary licenses or relocate the Group’s businesses, staff and assets;
● impose additional conditions or requirements with which the Group may not be able to comply; or
● take other regulatory or enforcement actions against the Group that could be harmful to the Group’s business.
The imposition of any of these penalties may result in a material and adverse effect on the Group’s ability to conduct the Group’s business. In addition, if
the imposition of any of these penalties causes the Group to lose the rights to direct the activities of the VIEs or the right to receive their economic
benefits, the Group would no longer be able to consolidate the VIEs. The Group does not believe that any penalties imposed or actions taken by the PRC
government would result in the liquidation of the Company, its subsidiaries or the VIEs.
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2. Principal Accounting Policies
(a) Basis of consolidation
The consolidated financial statements include the financial statements of the Company, its subsidiaries and VIEs for which the Company is the primary
beneficiary with the ownership interests of minority shareholders reported as noncontrolling interests. All significant transactions and balances among the
Company, its subsidiaries and VIEs have been eliminated upon consolidation. The Company consolidates a VIE if the Company has the power to direct
matters that most significantly impact the activities of the VIE, and has the obligation to absorb losses or the right to receive benefits of the VIE that
could potentially be significant to the VIE.
(b) Basis of presentation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United
States of America (“US GAAP”). The consolidated financial statements are prepared based on the historical cost convention.
Effective from October 1, 2020, the Company changed its ADS to ordinary share ratio from the one ADS for every twenty-five ordinary shares to one
ADS for every five ordinary shares. Therefore, the number of ADS and the computations of per ADS data as disclosed elsewhere in these consolidated
financial statements have been retrospectively restated.
The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and
expenses during the reporting periods. Actual results might differ from those estimates. Critical accounting estimates and assumptions include, but are
not limited to, assessing the following: average playing period of paying players of online games and impairment of long-term investments.
(c) Revenue recognition
On January 1, 2018, the Group adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of
January 1, 2018. The impact of adopting the new revenue standard was not material to the consolidated financial statements. For the year ended
December 31, 2018, 2019 and 2020, net revenue recognized from sources other than contracts with customers under ASC 606 was immaterial.
Revenues from contracts with customers are recognized when control of the promised goods or services is transferred to the Group’s customers, in an
amount that reflects the consideration the Group expects to be entitled to in exchange for those goods or services, reduced by estimates for return
allowances, promotional discounts, rebates and Value Added Tax (“VAT”).
The recognition of revenues involves certain management judgments, including estimated lives of virtual items purchased by game players, estimated
breakage of game points, return allowance for goods sold, the estimation of the fair value of an advertising-for-advertising barter transaction, volume
sales rebates. The amount and timing of the Group’s revenues could be different if management made different judgments or utilized different estimates.
The Group’s revenues are mainly generated from online game services, online courses services from Youdao, advertising services, e-commerce and other
fee-based premium services. Refer to “Note 26 - Segment Information” for disaggregation of revenue.
(i) Online game services
The Group operates mobile games and PC games. The Group is the principal of all games it operates, including both self-developed games and licensed
games. As all these games are hosted on the Group’s servers, the Group has the pricing discretion, and is responsible for the sale and marketing of the
games as well as customer services. Fees paid to game developers, distribution channels (app stores) and payment channels are recorded as cost of
revenues.
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Mobile games
The Group generates mobile game revenues from the sale of in-game virtual items, including items, avatars, skills, privileges or other in-game
consumables, features or functionality, within the games. The Group’s performance obligation is to provide on-going game services to players who
purchased virtual items to gain an enhanced game-playing experience. This performance obligation is satisfied over the playing period of the paying
players. Accordingly, the Group recognizes the revenues ratably over the estimated average playing period of these paying players.
The Group considers the average period that players typically play the games and other game player behavior patterns, as well as various other factors to
arrive at the best estimates for the estimated playing period of the paying players for each game based on historical players’ churn rates. If a new game is
launched and only a limited period of paying player data is available, then the Group considers other qualitative factors, such as the playing patterns for
paying users for other games with similar characteristics and playing patterns of paying players, such as targeted players and purchasing frequency.
While the Group believes its estimates to be reasonable based on available game player information, the Group may revise such estimates based on new
information indicating a change in the game player behavior patterns and any adjustments are applied prospectively.
PC games
The Group sells prepaid points to the end users. Customers can purchase “virtual” prepaid points online or from the vendors who register the points in the
Group’s system via debit and credit cards or bank transfers via the online payment services platforms, and receive the prepaid point information over the
Internet. Customers can use the points to play the Group’s PC games, pay for in-game items and use other fee-based services. Proceeds received from the
sales of prepaid online points to players are recorded as deferred revenues.
The Group earns revenue through providing PC game services to players under two types of revenue models: time-based revenue model and item-based
revenue model. For PC games using the time-based model, players are charged based on the time they spend playing games. Revenues are recognized
ratably over the game playing period as the performance obligations are satisfied.
Under the item-based model, the basic game play functions are free of charge, and players are charged for purchases of in-game items. In-game items
have different life patterns: one-time use, limited life and permanent life. Revenues from the sales of one-time use in-game items are recognized upon
consumption. Limited life items are either limited by the number of uses (for example, 10 times) or limited by time (for example, three months).
Revenues from the sales of limited life in-game items are recognized ratably based on the extent of time passed or expired or when the items are fully
used. Players are allowed to use permanent life in-game items without any use or time limits. Revenues from the sales of permanent life in-game items
are recognized ratably over the estimated average playing period of the paying players.
The Group considers the average period that players typically play the games and other game player behavior patterns, as well as various other factors,
including the acceptance and popularity of expansion packs, promotional events launched and market conditions to arrive at the best estimates for the
estimated average playing period of the paying players for the permanent in-game items of each PC game based on historical players’ churn rate. This
estimate is re-assessed on a quarterly basis. Adjustments arising from the changes of estimated playing period of the paying players are applied
prospectively as such changes are resulted from new information indicating a change in the game player behavior patterns.
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(ii) Online courses services
The Group offers various types of integrated learning services through Youdao, which primarily cover a wide spectrum of topics and target people from
broad age groups through its diverse offerings of K-12 tutoring courses, foreign languages, professional and interest education services as well as IT
computer skills, etc. Youdao’s online courses services consist of online live streaming, other activities during the online live streaming period, as well as
the content playback service. The aforementioned services are highly interdependent and interrelated in the context of the contract and are only
considered accessory services to the online live streaming courses and therefore are not distinct and are not sold standalone. Therefore, the Group’s
online courses services are accounted for as a single performance obligation, which is satisfied over the learning period of the students. Accordingly, the
Group recognizes the revenues ratably over the estimated average learning period for different courses. The Group considers the average period that
students typically spend time on the courses and other learning behavior patterns to arrive at the best estimates for the estimated learning period for each
course based on the estimated learning time customers spend on the courses and the expected number of times customers will take the courses.
(iii) Advertising services
The Group derives its advertising revenues principally from short-term online advertising contracts. Advertising service contracts may consist of multiple
performance obligations with a typical term of less than three months. In arrangements where the Group has multiple performance obligations, the
transaction price is allocated to each performance obligation using the relative stand-alone selling price. The Group generally determines standalone
selling prices based on the prices charged to customers. If the performance obligation has not been sold separately, the Group estimates the standalone
selling price by taking into consideration of the pricing for advertising areas of the Group’s platform with a similar popularities and advertisements with
similar formats and quoted prices from competitors as well as other market conditions. Considerations allocated to each performance obligation is
recognized as revenue over the advertisement display period, which is usually within three months.
The Group also enters into performance-based advertising arrangements with customers.
For cost per mille (“CPM”), or cost per thousand impressions, advertising arrangements with customers, the Group recognizes revenues based on the
number of times that the advertisement has been displayed.
For cost per action (“CPA”) advertising arrangements with customers, including Youdao online marketing services, the Group recognizes revenues based
on the number of actions completed resulted from the advertisements, including but not limited to when users click on links.
Certain customers may receive volume rebates, which are accounted for as variable consideration. The Group estimates annual expected rebate volume
with reference to their historical results and reduce revenues recognized.
The Group recognizes revenue from providing advertising service in exchange for non-cash consideration, usually advertising services, promotional
benefits, content, consulting services and software provided by counterparties, at the fair value of the non-cash consideration measured as of contract
inception date. If the Group is not able to reliably determine the fair value of non-cash consideration in some situations, the value of the non-cash
consideration received is measured indirectly by reference to the standalone selling price of advertising services provided by the Group.
For the year ended December 31, 2018, 2019 and 2020, revenue from rendering adverting services in exchange for non-cash consideration is
insignificant.
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(iv) E-commerce
The Group’s e-commerce revenue is primarily from its E-commerce platform Yanxuan, which was established in April 2016. Yanxuan sells its private
label products, including apparel, homeware, kitchenware and other general merchandise which are sourced primarily directly from original design
manufacturers in China through online direct sales. The Group is the principal for the online direct sales, as it controls the inventory before they are
transferred to customers. The Group has the primary responsibility for fulfilling the contracts, bears the inventory risk, and has sole discretion in
establishing the prices. E-commerce revenues from online direct sales are recognized when control of the goods is transferred to the customer, which
generally occurs upon delivery to the customer. The Group also provides discount coupons to its customers for use in purchases on the Yanxuan platform,
which are treated as a reduction of revenue when the related transaction is recognized.
Return allowances, which reduce revenue and cost of sales, are estimated using historical experience. Liabilities for return allowances and rights to
recover products from customers associated with the Group’s liabilities are recorded as “Accrued liabilities and other payables” and “Inventories, net”,
respectively, on the Group’s consolidated balance sheets. Both of the balances are not material as of December 31, 2018, 2019 and 2020.
(v) Fee-based premium services
Fee-based premium services revenues, mostly operated on either consumption-basis or a monthly subscription basis, are derived principally from
providing premium live-streaming services, online music services, online reading, e-mail and other innovative businesses. Prepaid subscription fees
collected from customers are deferred and are recognized as revenue on a straight-line basis by the Group over the subscription period, during which
customers can access the premium online services provided by the Group. Fees collected from customer to be consumed to purchase online services are
recognized as revenue when related services are rendered.
The Group generates revenue from the operation of its live streaming platforms whereby users can enjoy live performances provided by the hosts and
interact with the hosts. Most of the hosts host the performance on their own. The Group creates and sells virtual items to users so that the users present
them simultaneously to hosts to show their support. The virtual items sold by the Group comprise of either (i) consumable items or (ii) time-based item,
such as privilege titles etc. Under the arrangements with the hosts, the Group shares with them a portion of the revenues derived from the sales of virtual
items. Revenues derived from the sale of virtual items are recorded on a gross basis as the Group acts as the principal to fulfill all obligations related to
the sale of virtual items. Accordingly, revenue is recognized when the virtual item is delivered and consumed if the virtual item is a consumable item or,
in the case of time-based virtual item, recognized ratably over the period each virtual item is made available to the user.
Practical expedients
The Group has used the following practical expedients as allowed under ASC 606:
(i) The effects of a significant financing component have not been adjusted for contracts which the Group expects, at contract inception, that the period
between when the Group transfers a promised good or service to the customer and when the customer pays for that good or service will be one year
or less.
(ii) The Group applied the portfolio approach in determining the commencement date of consumption of permanent virtual items and the estimated
average playing period of paying players for PC games and mobile games for the recognition of online game revenue given that the effect of
applying a portfolio approach to a group game players’ behaviors would not differ materially from considering each one of them individually.
(iii) The Group elects to expense certain costs to obtain a contract as incurred when the expected amortization period is one year or less.
Contract balances
Timing of revenue recognition may differ from the timing of invoicing to customers. Accounts receivable represent amounts invoiced and revenue
recognized prior to invoicing, when the Group has satisfied its performance obligations and has the unconditional right to payment.
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The Group’s right to consideration in exchange for goods or services that the Group has transferred to a customer is recognized as a contract asset.
Contract assets as of December 31, 2019 and 2020 were not material.
A contract liability is the Group’s obligation to transfer goods or services to a customer for which the Group has received consideration (or an amount of
consideration is due) from the customer. Contract liabilities are presented as “Deferred Revenue” on the consolidated balance sheets of the Group. Refer
to Note 15 - Deferred revenue for further information, including changes in deferred revenue during the year.
(d) Cost of revenues
Costs of revenues consist primarily of revenue sharing cost, staff costs, royalties fees related to licensed games, traffic acquisition cost, content
acquisition cost, service fees related to online payments, server and bandwidth service fee, depreciation and amortization of severs, computers and
software, and other direct costs of providing these services, as well as cost of merchandise sold. These costs are charged to the consolidated statements of
operations and comprehensive income as incurred.
(e) Research and development costs
Research and development costs mainly consist of personnel-related expenses and technology service costs incurred for the development of online
games, as well as development and enhancement of the Group’s new products, websites and application platforms.
For internal use software, the Group expenses all costs incurred for the preliminary project stage and post implementation-operation stage of
development, and costs associated with repair or maintenance of the existing platforms. Costs incurred in the application development stage are
capitalized and amortized over the estimated useful life. Since the amount of the Group’s research and development expenses qualifying for capitalization
has been immaterial for the years ended December 31, 2018, 2019 and 2020, as a result, all development costs incurred for development of internal used
software have been expensed as incurred.
For external use software, costs incurred for development of external use software have not been capitalized for the years ended December 31, 2018,
2019 and 2020, because the period after the date technical feasibility is reached and the time when the software is marketed is short historically, and the
amount of costs qualifying for capitalization has been immaterial.
(f) Cash, cash equivalents and time deposits
Cash and cash equivalents mainly represent cash on hand, demand deposits placed with large reputable banks in Hong Kong and/or China, and highly
liquid investments that are readily convertible to known amounts of cash and with original maturities from the date of purchase with terms of less than
three months. As of December 31, 2019, there were cash at bank and demand deposits with terms of less than three months denominated in U.S. dollars,
HK dollars and Euro amounting to approximately US$226.6 million, HK$21.3 million and Euro0.4 million, respectively (equivalent to approximately
RMB1,580.7 million, RMB19.0 million and RMB2.7 million, respectively). As of December 31, 2020, there were cash at bank and demand deposits with
terms of less than three months denominated in U.S. dollars, HK dollars and Euro amounting to approximately US$673.1 million, HK$16.4 million and
Euro1.3 million, respectively (equivalent to approximately RMB4,392.0 million, RMB13.8 million and RMB10.7 million, respectively).
Time deposits represent time deposits placed with banks with original maturities of three months or more. As of December 31, 2019, there were time
deposits denominated in U.S. dollars amounting to approximately US$4,382.9 million (equivalent to approximately RMB30,576.3 million). As of
December 31, 2020, there were time deposits denominated in U.S. dollars amounting to approximately US$8,558.0 million (equivalent to approximately
RMB55,840.0 million).
As of December 31, 2019 and 2020, the Group had approximately RMB14.8 billion and RMB23.6 billion cash and cash equivalents and time deposits
held by its PRC subsidiaries and VIEs, representing 25.0% and 27.2% of total cash and cash equivalents and time deposits of the Group, respectively.
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As of December 31, 2019 and 2020, the Group had a restricted cash balance approximately RMB3,150.4 million and RMB3,051.4 million, respectively,
comprising as follows (in millions):
Customer deposit of NetEase Pay accounts
Pledge deposits for short-term bank borrowings
Others
Total
The Group had no other lien arrangements during 2019 and 2020.
(g) Receivables, net
December 31,
December 31,
2019
RMB
1,523.3
1,595.0
32.1
3,150.4
2020
RMB
1,722.0
1,295.0
34.4
3,051.4
The Group closely monitors the collection of its receivables and records a reserve for doubtful accounts against aged accounts and for specifically
identified non-recoverable amounts for periods prior to January 1, 2020. If the economic situation and the financial condition of the customer deteriorate
resulting in an impairment of the customer’s ability to make payments, additional allowances might be required. Receivable balances are written off
when they are determined to be uncollectible.
From January 1, 2020, the Group’s receivables are subject to the measurement of credit losses within the scope of ASC Topic 326. The impact of new
standard was immaterial to the Company.
The Group’s accounts receivable, other receivables recorded in prepayments and other current assets and other long-term receivables recorded in other
long-term assets are within the scope of ASC Topic 326. Accounts receivable consist primarily of receivables from advertising customers, and
receivables from distribution channels. Other receivables consist primarily of receivable due from Alibaba and guarantee payment made to Blizzard.
To estimate expected credit losses, the Group has identified the relevant risk characteristics of its customers and the related receivables and other
receivables which include size, type of the services or the products the Group provides, or a combination of these characteristics. Receivables with
similar risk characteristics have been grouped into pools. For each pool, the Group considers the past collection experience, current economic conditions,
future economic conditions (external data and macroeconomic factors) and changes in the Group’s customer collection trends. This is assessed at each
quarter based on the Group’s specific facts and circumstances.
The following table sets out the movements of the allowance for doubtful accounts/expected credit losses for the years ended December 31, 2018, 2019
and 2020 (in thousands):
Balance at the beginning of year
Provisions
Write-offs
Balance at the end of year
2018
RMB
For the year ended December 31,
2019
RMB
2020
RMB
84,909
50,954
(5,215)
130,648
130,648
(30,946)
(22,555)
77,147
77,147
40,600
(4,494)
113,253
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(h) Fair value of financial instruments
Accounting guidance defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be
recorded at fair value, the Group considers the principal or most advantageous market in which it would transact and it considers assumptions that market
participants would use when pricing the asset or liability.
Accounting guidance establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of
input that is significant to the fair value measurement. Accounting guidance establishes three levels of inputs that may be used to measure fair value:
Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets
Level 2 - Include other inputs that are directly or indirectly observable in the marketplace
Level 3 - Unobservable inputs which are supported by little or no market activity
The Group’s financial instruments include cash and cash equivalents and time deposits, accounts receivable, prepayments and other current assets, short-
term investments, accounts payable, short-term loans, deferred revenue and accrued liabilities and other payables, which the carrying values approximate
their fair value. Please see Note 27 for additional information.
(i)
Inventories, net
Inventories, net mainly represent products for the Group’s e-commerce business, are stated at the lower of cost or net realizable value in the consolidated
balance sheets. Cost of inventory is determined using the weighted average cost method. Adjustments are recorded to write down the cost of inventory to
the estimated net realizable value due to slow-moving merchandise and damaged goods, which is dependent upon factors such as historical and
forecasted consumer demand, and promotional environment. The Group takes ownership, risks and rewards of the products purchased. Write downs are
recorded in cost of revenues in the consolidated statements of operations and comprehensive income. Certain costs attributable to buying and receiving
products, such as purchase freights, are also included in inventories.
(j)
Investments
Short-term investments
Short-term investments include investments in financial instruments with a variable interest rate indexed to performance of underlying assets, all of
which are with an original maturity of less than 12 months.
In accordance with ASC 825, for investments in financial instruments with a variable interest rate indexed to performance of underlying assets, the
Group elected the fair value method at the date of initial recognition and carried these investments at fair value. Changes in the fair value are reflected in
the consolidated statements of operations and comprehensive income as other income/(expense). Fair value is estimated based on quoted prices of similar
products provided by banks at the end of each period. The Group classifies the valuation techniques that use these inputs as Level 2 of fair value
measurements. Please see Note 6 and Note 27 for additional information.
Long-term investments
Long-term investments are mainly comprised of equity investments in publicly traded companies, privately-held companies and limited-partnership.
Equity investments in publicly traded companies are reported at fair value as equity investment with readily determinable fair value. Unrealized gains
and losses for the years ended December 31, 2018, 2019 and 2020 are recognized in other income/(expense).
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For investments in common stock or in-substance common stock issued by privately-held companies on which the Group does not have significant
influence, and investments in privately-held companies’ shares that are not common stocks or in-substance common stocks, as these equity securities do
not have readily determinable fair value, the Group measure these equity securities investments at cost, less impairment, if any, plus or minus changes
resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer (referred to as the measurement
alternative). All gains and losses on these equity securities without readily determinable fair value, realized and unrealized, are recognized in other
income /(expense).
Investments in common stock or in-substance common stock of investees and limited-partnership investments in which the Group is in a position to
exercise significant influence by participating in, but not controlling or jointly controlling, the financial and operating policies are accounted for using the
equity method.
Management regularly evaluates the impairment of the investments in privately-held companies without readily determinable fair value and equity
method investments at each balance sheet date, or more frequently if events or circumstances indicate that the carrying amount may not be recoverable.
For investments without readily determinable fair values, management performs a qualitative assessment of the fair value of the equity interest in
comparison to its carrying amount to determine if there is an indication of potential impairment. If such indication exists, management estimates the fair
value of the investment, and records an impairment in the consolidated statements of operations and comprehensive income to the extent the carrying
amount exceeds the fair value. Significant judgments management applies in the impairment assessment for these equity investments include: (i) the
determination as to whether any impairment indicators exist during the year; (ii) the selection of valuation methods; (iii) the determination of significant
assumptions used to value the equity investments, including selection of comparable companies and multiples, timing and probabilities of different
scenarios, estimated volatility rate, risk-free rate and discount for lack of marketability; and (iv) judgments as to whether a decline in value of equity
method investments was other than temporary. For equity method investments, management considers if the investment is impaired when events or
circumstances suggest the carrying amount may not be recoverable, and recognizes any impairment charge in the consolidated statements of operations
and comprehensive income for a decline in value that is determined to be other than temporary.
(k) Lease
On January 1, 2019, the Group adopted ASU 2016-02, “Leases (Topic 842)”, including certain transitional guidance and subsequent amendments within
ASU 2018-01, ASU 2018-10, ASU 2018-11, ASU 2018-20 and ASU 2019-01 (collectively, including ASU 2016-02, “ASC 842”).
Leases that transfer substantially all of the benefits and risks incidental to the ownership of assets are accounted for as finance leases as if there was an
acquisition of an asset and incurrence of an obligation at the inception of the lease. All other leases are accounted for as operating leases. As of December
31, 2019 and 2020, the Group has no finance leases.
Under ASC 842, the Group determines if an arrangement is a lease at inception. The Group is the lessee in a lease contract when the Group obtains the
right to control the asset. Operating leases are included in operating lease right-of-use (“ROU”) assets, and short-term and long-term operating lease
liabilities in the Group’s consolidated balance sheets. ROU assets represent the Group’s right to use an underlying asset for the lease term and lease
liabilities represent the Group’s obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at
commencement date based on the present value of lease payments over the lease term. As most of the Group’s leases do not provide an implicit rate, the
Group generally uses its incremental borrowing rate based on the estimated rate of interest for collateralized borrowing over a similar term of the lease
payments at commencement date. The operating lease ROU asset also includes any lease payments made and excludes lease incentives. Lease expense is
recognized on a straight-line basis over the lease term.
For leases with a term of twelve months or less (“short-term leases”), the Group has elected not to recognize lease liabilities and associated ROU assets.
Lease payments on short-term leases are recognized as lease expense within cost of revenues or operating expenses on the consolidated statements of
operations and comprehensive income, depending on the nature of the lease, on a straight-line basis over the lease term.
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(l) Property, equipment and software
Property, equipment and software are stated at cost less accumulated depreciation. Depreciation is calculated on the straight-line basis over the following
estimated useful lives, taking into account any estimated residual value:
Building
Decoration
Leasehold improvements
Furniture, fixtures, office and other equipments
Vehicles
Servers and computers
Software
20 years
5 years
lesser of the term of the lease and the estimated useful lives of the assets
3-10 years
5 years
3 years
3 years
Repairs and maintenance expenditures, which are not considered improvements and do not extend the useful life of the property and equipment, are
expensed as incurred.
(m) Land use rights
Land use rights represent lease prepayments to the local government authorities. Upon the adoption of ASC 842 on January 1, 2019, land use rights, net
were identified as operating lease right-of-use assets, which is separately disclosed as “Land use rights” in the Group’s consolidated balance sheets.
Accordingly, the Group disclosed the cash used for obtaining the land use rights in operating cash flow activities for the year ended December 31, 2019
and 2020, with no adjustments made to the comparative periods.
(n) Intangible assets
Finite-lived intangible assets are tested for impairment if impairment indicators arise. The Group amortizes its finite-lived intangible assets using the
straight-line method:
License right
Technology
Trademark
over the license period
7-10 years
10 years
The Group obtains music content for customers through licensing agreements. When the license fee for music title is determinable or reasonably
estimable, the content is available for streaming and the Group has a binding obligation for the payment, the Group recognizes an asset representing the
fee and a corresponding liability for the amounts owed. The Group relieves the liability as payments are made and the Group amortizes the asset to “Cost
of revenues” on a straight-line basis over the term of the respective licensing agreements.
(o) Goodwill
Goodwill represents the excess of the purchase consideration over the fair value of the identifiable assets and liabilities acquired as a result of the Group’s
acquisitions of interests in its subsidiaries and consolidated VIEs. The Group allocates goodwill to reporting units based on the reporting unit expected to
benefit from the business combination. Goodwill is tested for impairment at the reporting unit level on an annual basis, or more frequently if events occur
or circumstances change that indicate that it is more likely than not the fair value of a reporting unit would be below its carrying value. A goodwill
impairment loss, if any, shall be measured as the amount by which the carrying amount of the reporting unit including goodwill exceeds its fair value,
limited to the total carrying amount of goodwill allocated to that reporting unit.
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Application of the goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to
reporting units, assignment of goodwill to reporting units, and determination of the fair value of each reporting unit. The fair value of each reporting unit
is estimated primarily through the use of a discounted cash flow methodology. This analysis requires significant judgments, including estimation of
future cash flows, which is dependent on internal forecasts, estimation of the growth rate for business, estimation of the useful life over which cash flows
will occur, and determination of weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination
of fair value and goodwill impairment for each reporting unit. No impairment charge of goodwill was recognized for the year ended December 31, 2020.
(p) Advertising expenses
The Group expenses advertising costs as incurred and reports these costs under selling and marketing expense. Advertising expenses totaled
approximately RMB2,222.2 million, RMB1,679.3 million and RMB3,782.1 million (US$579.6 million) for the years ended December 31, 2018, 2019,
and 2020, respectively.
(q) Foreign currency translation
The Group’s reporting currency is RMB. The Company and its subsidiaries and VIEs, with an exception of several overseas subsidiaries, use RMB as
their functional currency. Several of the Company’s overseas subsidiaries used US$ or their respective local currencies as their functional currency. The
determination of the respective functional currency is based on the criteria of ASC 830, Foreign Currency Matters.
Transactions in currencies other than the functional currency are measured and recorded in the functional currency using the exchange rate in effect at the
date of the transaction. At the balance sheet date, monetary assets and liabilities that are denominated in currencies other than the functional currency are
translated into the functional currency using the exchange rate at the balance sheet date. The resulting exchange differences are included in the
consolidated statements of operations and comprehensive income.
Assets and liabilities of the Group companies are translated from their respective functional currencies to the reporting currency at the exchange rates at
the balance sheet dates, equity accounts are translated at historical exchange rates and revenues and expenses are translated at the average exchange rates
in effect during the reporting period. The exchange differences for the translation of group companies with non-RMB functional currency into the RMB
functional currency are included in foreign currency translation adjustments, which is a separate component of shareholders’ equity on the consolidated
financial statements.
Translations of amounts from RMB into United States dollars for the convenience of the reader were calculated at the noon buying rate of US$1.00 =
RMB6.5250 on the last trading day of 2020 (December 31, 2020) as set forth in the H.10 statistical release of the U.S. Federal Reserve Board. No
representation is made that the RMB amounts could have been, or could be, converted into United States dollars at such rate.
(r) Share-based compensation
Under its 2009 Restricted Share Unit Plan and 2019 Restricted Share Unit Plan (see Note 20(a)), the Company issues restricted share units (RSUs) to its
employees, directors and consultants with performance conditions and service vesting periods ranging from one year to five years. Some of the RSUs
issued are to be settled, at the Company’s discretion, in stock or cash upon vesting based on the stock price at grant date. At each reporting period, the
Company evaluates the likelihood of performance conditions being met. Share-based compensation costs are then recorded for the number of RSUs
expected to vest on a graded-vesting basis, net of estimated forfeitures, over the requisite service period. The compensation cost of the RSUs to be settled
in stock only is measured based on the fair value of stock when all conditions to establish the grant date have been met. The compensation cost of RSUs
to be settled either in stock or cash at the Company’s discretion is remeasured until the date when settlement in stock or cash is determined by the
Company.
The Company records share-based compensation to the consolidated statements of operations and comprehensive income with the corresponding credit
to the additional paid-in-capital for share options and RSUs to the extent that such awards are to be settled only in stock.
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Certain subsidiaries of the Company granted options exercisable for ordinary shares to certain of the Group’s employees. The options expire five to ten
years from the date of grant and either vest or have a vesting commencement date upon certain conditions being met (“Vesting Commencement Date”).
The Group adopts the binomial option pricing model to determine the fair value of stock options and accounts for share-based compensation cost using
an estimated forfeiture rate.
Forfeitures were estimated based on the Group’s weighted average historical forfeiture rate of the past five years. Differences between actual and
estimated forfeitures are expensed in the period that the differences occur. See Note 20 for further information regarding share-based compensation
assumptions and expense.
(s) Taxation
Income tax expense is recognized in accordance with the laws of the relevant taxing authorities, with deferred taxes being provided for temporary
differences between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. Tax rate changes are
reflected in income during the period the changes are enacted.
A deferred income tax asset or liability is computed for the expected future impact of differences between the financial reporting and tax bases of assets
and liabilities as well as the expected future tax benefit to be derived from tax loss and tax credit carry forwards.
Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount “more likely than not” to be realized in future tax
returns.
For a particular tax-paying component of an enterprise and within a particular tax jurisdiction, all deferred tax assets and liabilities are offset and
presented as a single amount. The Group does not offset deferred tax assets and liabilities attributable to different tax-paying components of the
enterprise or to different tax jurisdictions.
The Group reports tax-related interest expense and penalty in Other, net in the consolidated statements of operations and comprehensive income, if there
is any. The Group did not incur any material penalty or interest payments in connection with tax positions during the years ended December 31, 2018,
2019 and 2020.
The Group did not have any significant unrecognized uncertain tax positions as of December 31, 2019 and 2020.
In order to assess uncertain tax positions, the Group applies a more likely than not threshold and a two-step approach for the tax position measurement
and financial statement recognition. Under the two-step approach, the first step is to evaluate the tax position for recognition by determining if the weight
of available evidence indicates that it is more likely than not that the position will be sustained, including resolution of related appeals or litigation
processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement.
(t) Net earnings per share (“EPS”) and per American Depositary Share (“ADS”)
Basic earnings per share is computed on the basis of the weighted-average number of ordinary shares outstanding during the period under measurement.
Diluted earnings per share are based on the weighted-average number of ordinary shares outstanding and potential ordinary shares. Potential ordinary
shares result from the assumed exercise of outstanding stock options, RSUs or other potentially dilutive equity instruments, when they are dilutive under
the treasury stock method or the if-converted method.
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(u) Statutory reserves
The Company’s subsidiaries and VIEs incorporated in China are required to make appropriations to certain non-distributable statutory reserves. In
accordance with the laws applicable to foreign invested enterprises in China, its subsidiaries have to make appropriations from its after-tax profit as
reported in their PRC statutory accounts to non-distributable statutory reserves including (i) general reserve fund, (ii) enterprise expansion fund and (iii)
staff bonus and welfare fund. The appropriation to the general reserve fund is at least 10% of the after-tax profits as reported in the PRC statutory
accounts. Appropriation is not required if the reserve fund has reached 50% of the registered capital of the respective company. The appropriation to the
other reserve funds is at the discretion of the board of directors of the respective company. At the same time, the Company’s VIEs, in accordance with the
China Company Laws, must make appropriations from their after-tax profit as reported in their PRC statutory accounts to non-distributable statutory
reserves including (i) statutory surplus fund and (ii) discretionary surplus fund. The appropriation to the statutory surplus fund is at least 10% of the after-
tax profits as reported in their PRC statutory accounts. Appropriation is not required if the statutory surplus fund has reached 50% of the registered
capital of the respective company. Appropriation to the discretionary surplus fund is made at the discretion of the board of directors of the respective
companies.
The general reserve fund and statutory surplus fund are restricted to set off against losses, expansion of production and operation or increase in the
registered capital of the respective companies. The staff bonus and welfare fund is available to fund payments of special bonuses to staff and for
collective welfare benefits. Upon approval by the board of directors, the discretionary surplus and enterprise expansion fund can be used to offset
accumulated losses or to increase capital.
(v) Business combination
The Group accounts for its business combinations using the acquisition method of accounting in accordance with ASC 805, Business Combinations. The
cost of an acquisition is measured as the aggregate of the acquisition date fair values of the assets transferred and liabilities assumed by the Group to the
sellers and equity instruments issued. Transaction costs directly attributable to the acquisition are expensed as incurred. Identifiable assets and liabilities
acquired or assumed are measured separately at their fair values as of the acquisition date, irrespective of the extent of any noncontrolling interests. The
excess of (i) the total costs of acquisition, fair value of the noncontrolling interests and acquisition date fair value of any previously held equity interest in
the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is recorded as goodwill. If the cost of acquisition is less than the fair value
of the net assets of the subsidiary acquired, the difference is recognized directly in the consolidated statements of operations and comprehensive income.
During the measurement period, which can be up to one year from the acquisition date, the Group may record adjustments to the assets acquired and
liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of
assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded on the consolidated statements of operations and
comprehensive income.
In a business combination achieved in stages, the Group re-measures the previously held equity interests in the acquiree when obtaining control at its
acquisition date fair value and the re-measurement gain or loss, if any, is recognized on the consolidated statements of operations and comprehensive
income.
When there is a change in ownership interests or a change in contractual arrangements that results in a loss of control of a subsidiary, the Company
deconsolidates the subsidiary from the date control is lost. Any retained noncontrolling investment in the former subsidiary is measured at fair value and
is included in the calculation of the gain or loss upon deconsolidation of the subsidiary.
(w) Noncontrolling interests and redeemable noncontrolling interests
Noncontrolling interests are recognized to reflect the portion of the equity of majority-owned subsidiaries and VIEs which is not attributable, directly or
indirectly, to the controlling shareholder.
The noncontrolling interest will continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance.
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Redeemable noncontrolling interests represent redeemable equity interests issued by the Group’s subsidiaries to certain investors (see Note 17), and have
been classified as mezzanine classified noncontrolling interests in the consolidated financial statements as these redeemable interests are contingently
redeemable upon the occurrence of certain conditional events, which is not solely within the control of the Group. The Group accreted the redeemable
equity interests to their redemption value, which is purchase price plus interest per year over the period since issuance to the earliest redemption date.
The accretions were recorded against retained earnings, or in the absence of retained earnings, by charges against additional paid-in capital. Once
additional paid-in capital had been exhausted, additional charges were recorded by increasing the accumulated deficit.
(x) Related parties
Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or exercise significant influence over the
other party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or significant
influence, such as a family member or relative, stockholder, or a related corporation.
(y) Comprehensive income
Comprehensive income is defined as the change in equity of the Group during a period arising from transactions and other events and circumstances
excluding transactions resulting from investments by shareholders and distributions to shareholders.
(z) Segment reporting
The Group’s internal organizational structure as well as information about geographical areas, business segments and major customers in financial
statements is set out in detail under Note 26.
(aa) Dividends
Dividends of the Company are recognized when declared.
(bb) Recently adopted accounting pronouncements
In June 2016, the FASB issued ASU 2016-13 “Financial Instruments-Credit Losses (Topic 326)”, which requires entities to measure all expected credit
losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This
replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. The Group
adopted this new standard effective January 1, 2020 on a modified retrospective basis. The cumulative effect upon adoption was not material to the
Group’s consolidated financial statements.
In 2017, the FASB issued ASU 2017-04, “Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”, which simplifies
the subsequent measurement of goodwill by removing the requirement to perform a hypothetical purchase price allocation to compute the implied fair
value of goodwill to measure impairment. Instead, any goodwill impairment will equal the amount by which a reporting unit’s carrying value exceeds its
fair value, not to exceed the carrying amount of goodwill. Further, the guidance eliminates the requirements for any reporting unit with a zero or negative
carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. The Group
adopted this new standard effective January 1, 2020 with no material impact on its consolidated financial statements.
(cc) Recently issued accounting pronouncements not yet adopted
In December 2019, the FASB issued ASU 2019-12, “Income Taxes-Simplifying the Accounting for Income Taxes (Topic 740)”, which simplify various
aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in ASC 740 and also clarifies and
amends existing guidance to improve consistent application. The new guidance is effective for the Group on January 1, 2021. The Group does not expect
the adoption of this guidance to have a material impact on its consolidated financial statements.
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In January 2020, the FASB issued ASU 2020-01, “Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic
323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815”, which clarifies the interaction
of the accounting for equity investments under Topic 321 and investments accounted for under the equity method of accounting in Topic 323 and the
accounting for certain forward contracts and purchased options accounted for under Topic 815. The guidance is effective for all entities for fiscal years
beginning after December 15, 2020 and for interim periods within those fiscal years. The Group is currently evaluating the impact and does not expect
the adoption of this guidance to have a material impact on its consolidated financial statements.
3. Discontinued operations
In September 2019, the Group signed a series of agreements with a subsidiary of Alibaba Group Holding Limited (“Alibaba”) to sell its e-commerce
platform Kaola for a consideration of approximately US$1.9 billion. The consideration is comprised of approximately US$1.6 billion in cash payable to
the Group and Kaola equity award holders, as well as approximately 14.3 million Alibaba ordinary shares issued to the Group. Upon completion of the
transaction , Kaola was deconsolidated from the Group and its historical financial results are reflected in the Group’s consolidated financial statements as
discontinued operations accordingly. The financial results of Kaola in the prior period are reflected on the same basis to provide the comparable financial
information.
The following tables set forth the statement of operations and cash flows of discontinued operations which were included in the Group’s consolidated
financial statements (in thousands):
Net revenues
Cost of revenues
Gross profit
Operating expenses:
Selling and marketing expenses
General and administrative expenses
Research and development expenses
Total operating expenses
Operating loss
Other expenses
Loss from discontinued operations
Income tax
Loss from discontinued operations, net of tax
Gains on disposal, net of tax
Net (loss)/income from discontinued operations
Net cash (used in)/provided by discontinued operating activities
Net cash provided by/ (used in) discontinued investing activities
*** Included financial results of discontinued operations from January 1, 2019 to September 6, 2019.
F-27
For the year ended December 31,
2018
RMB
15,977,878
(14,920,531)
1,057,347
(2,614,760)
(112,902)
(414,090)
(3,141,752)
(2,084,405)
(48,246)
(2,132,651)
(6,031)
(2,138,682)
—
(2,138,682)
2019***
RMB
10,571,406
(9,620,388)
951,018
(1,258,413)
(79,985)
(326,127)
(1,664,525)
(713,507)
(69,282)
(782,789)
(5,857)
(788,646)
8,751,165
7,962,519
For the years ended December 31,
2018
RMB
(1,243,966)
1,430,181
2019***
RMB
305,487
(832,252)
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4. Concentrations and Risks
(a) Server and bandwidth service provider
The Group relied on telecommunications service providers and their affiliates for server and bandwidth service to support its operations during fiscal
years 2018, 2019 and 2020 as follows:
Total number of telecommunications service providers
Number of service providers provided by 10% or more of the Group’s server and bandwidth service
expenditure
Total% of the Group’s server and bandwidth service expenditure provided by 10% or greater service
providers
(b) Credit risk
For the year ended December 31,
2019
2020
2018
49
3
79
2
87
3
57.8 %
56.3 %
62.3 %
Financial instruments that potentially subject the Group to significant concentrations of credit risk consist primarily of cash and cash equivalents, time
deposits, restricted cash, accounts receivable and short-term investments. As of December 31, 2019 and 2020, substantially all of the Group’s cash
equivalents, time deposits and restricted cash were held in major financial institutions located in the PRC or Hong Kong, which management considers
being of high credit quality. Accounts receivable are typically unsecured and are generally derived from revenue earned from mobile games services
(mainly related to remittances from distribution channels) and advertising services.
One distribution channel had a receivable balance exceeding 10% of the total accounts receivable balance for the year ended December 31, 2019 and
2020, respectively as follows:
Distribution channel A
December 31,
December 31,
2019
2020
24.7 %
24.5 %
Short-term investments consist of financial products issued by commercial banks in China with a variable interest rate indexed to performance of
underlying assets, which have a maturity date within one year as of the purchase date. The effective yields of the short-term investments range from
2.00% to 4.25% per annum. Any negative events or deterioration in financial well-being with respect to the counterparties of the above investments and
the underlying collateral may cause a material loss to the Group and have a material effect on the Group’s financial condition and results of operations.
(c) Major customers
No single customer represented 10% or more of the Group’s total net revenues for the years ended December 31, 2018, 2019 and 2020.
(d) Online games
The Group derived 39.6%, 36.8% and 33.1% of its total net revenues from its top 5 online games for the years ended December 31, 2018, 2019 and 2020,
respectively.
Additionally, 71.0%, 71.4% and 71.9% of the Group’s total net game revenues were generated from mobile games for the years ended December 31,
2018, 2019 and 2020, respectively.
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Table of Contents
5. Prepayments and Other Current Assets
The following is a summary of prepayments and other current assets (in thousands):
Guarantee payment made to Blizzard - royalty fees
Prepayment for royalties, revenue sharing cost
Receivable due from Alibaba
Interest and other operating income receivable
Prepayments of content and marketing cost and other operational expenses
Prepayment for sales tax and deductible value added tax
Bridge loans in connection with ongoing investments
Deposits
Employee advances
Advance to suppliers
Others
December 31,
December 31,
2019
RMB
356,033
2,627,048
—
524,069
569,122
483,547
21,259
11,882
79,823
26,664
117,975
4,817,422
2020
RMB
334,760
2,389,880
1,360,279
682,328
547,758
477,103
6,469
63,844
74,325
66,930
108,757
6,112,433
In accordance with the license agreements of World of Warcraft®, the StarCraft® II series, Hearthstone®, Heroes of the Storm®, Diablo® III and
Overwatch®, the Group made certain guarantee payments to Blizzard on behalf of Shanghai EaseNet for the minimum guaranteed royalties as of
December 31, 2019 and 2020. The guarantee amounts will be released to the Group when actual royalties are paid by Shanghai EaseNet to Blizzard.
As of December 31, 2019 and 2020, prepayments for royalties and revenue sharing cost mainly represented prepaid royalties or revenue sharing cost
related to operations of licensed PC and mobile games.
Balance of receivable from Alibaba represents receivable for disposal of Kaola which was expected to receive in one year.
The amount of employee advances listed above included staff housing loan balances of RMB43.0 million and RMB37.2 million repayable within 12
months from December 31, 2019 and 2020, respectively (see Note 11). No advances were made directly or indirectly to the Group’s executive officers
for their personal benefit for the years ended December 31, 2019 and 2020.
6. Short-term Investments
As of December 31, 2019 and 2020, the Group’s short-term investments mainly consisted of financial products issued by commercial banks in China
with a variable interest rate indexed to the performance of underlying assets and a maturity date within one year when purchased. As of December 31,
2020, the effective yields of short-term investments ranged from 2.52% to 4.10% per annum (2019: 2.00% to 4.25% per annum).
The following is a summary of short-term investments (in thousands):
Short-term investments
Short-term investments
Cost
RMB
15,116,330
Cost
RMB
13,095,780
December 31, 2019
Unrealized
Gains/(Losses)
RMB
196,265
December 31, 2020
Unrealized
Gains/(Losses)
RMB
177,246
Estimated
Fair Value
RMB
15,312,595
Estimated
Fair Value
RMB
13,273,026
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Table of Contents
During the years ended December 31, 2018, 2019 and 2020, the Group recorded investment income related to short-term investments of RMB463.5
million, RMB657.6 million and RMB580.7 million in the consolidated statements of operations and comprehensive income, respectively.
7. Property, Equipment and Software
The following is a summary of property, equipment and software (in thousands):
Building and decoration
Leasehold improvements
Furniture, fixtures, office and other equipments
Vehicles
Servers and computers
Software
Construction in progress
Less: accumulated depreciation
Net book value
December 31,
December 31,
2019
RMB
2,987,003
153,145
198,909
74,487
4,066,925
181,223
465,993
8,127,685
2020
RMB
2,941,233
196,222
231,238
83,909
4,548,272
207,041
784,375
8,992,290
(3,505,973)
(4,436,884)
4,621,712
4,555,406
Depreciation expense was RMB939.8 million, RMB1,119.1 million and RMB1,113.0 million for the years ended December 31, 2018, 2019 and 2020,
respectively.
As of December 31, 2019 and 2020, the construction in progress balance were mainly comprised of construction of office buildings and warehouses in
Hangzhou, Guangzhou, Jiangxi and Shanghai that have not yet been placed in service for the Group’s intended use. All the related cost is capitalized in
construction in progress to the extent it is incurred for the purposes of bringing the construction development to a usable state.
8. Land Use Rights
Land use rights represent acquired right to use the land on which the Group’s offices and warehouses are built. In 2019 and 2020, the Group obtained the
land use rights in Guangzhou and Shanghai from the local authorities. Amortization of the land use right is made over the remaining term of the land use
right period from the date when the land was made available for use by the Group. The land use rights are summarized as follows (in thousands):
Cost
Incentive payment from local government
Accumulated amortization
Land use right, net
December 31,
December 31,
2019
RMB
3,846,660
(15,000)
(124,481)
3,707,179
2020
RMB
4,402,470
(15,000)
(209,213)
4,178,257
The total amortization expense for each of the years ended December 31, 2018, 2019 and 2020 amounted to approximately RMB31.3 million, RMB72.2
million and RMB84.7 million, respectively.
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9. Leases
The Group has operating leases for corporate offices, warehouses and retail stores. In addition, upon the adoption of ASC 842, land use rights, net with
total carrying amount of RMB3,707.2 million and RMB4,178.3 million (Note 8) were identified as operating lease right-of-use assets as of December 31,
2019 and 2020, respectively.
The Group’s leases have remaining lease terms of 1 months to 69 years, some of which include options to terminate the leases within certain periods. The
Group considers these options in determining the classification and measurement of the leases when it is reasonably certain that the Group will exercise
that option.
The following table provides information related to the Group’s operating leases (in thousands):
Operating lease cost (i)
Cash paid for amounts included in the measurement of operating lease liabilities
Right-of-use assets obtained in exchange for operating lease obligations
For the year ended December 31,
2020
2019
RMB
RMB
360,383
284,969
179,350
433,412
323,836
658,168
(i)
Included short-term lease cost of RMB65.6 million and RMB27.6 million and amortization expenses of land use rights of RMB72.2 million and
RMB84.7 million for the year ended December 31, 2019 and 2020, respectively.
The following table provides a summary of the Group’s operating lease terms and discount rates as of December 31, 2019 and 2020:
Weighted average remaining lease term
Weighted average discount rate
December 31,
2019
1.93 years
December 31,
2020
2.27 years
4.35 %
4.16 %
Prior to adoption of ASC 842, the Group incurred rental expenses in the amounts of approximately RMB280.7 million for the years ended December 31,
2018.
Maturities of operating lease liabilities as of December 31, 2020 were as follows (in thousands):
2021
2022
2023
2024
2025
Thereafter
Total operating lease payments
Less: imputed interest
Total
F-31
RMB
338,476
204,759
129,932
101,764
58,858
34,596
868,385
(62,650)
805,735
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10. Long-term Investments
The following is a summary of long-term investments (in thousands):
Investments in equity method investees
Equity investments with readily determinable fair values
Equity investments without readily determinable fair values
Other debt investments
(a) Investments in equity method investees
December 31,
December 31,
2019
RMB
1,137,774
3,551,545
4,604,549
—
9,293,868
2020
RMB
1,621,327
3,743,590
6,333,746
12,596
11,711,259
The Group recorded equity share of losses of RMB98.3 million, equity share of earnings of RMB4.3 million and RMB172.5 million for the years ended
December 31, 2018, 2019, and 2020, respectively, which was included in “investment income, net” in the consolidated statements of operations and
comprehensive income. Significant equity method investments are summarized as follows.
(1) In August 2013, the Group established a joint venture with China Telecom Corp. Ltd. (“China Telecom”), Zhejiang Yixin Technology Co.,
Ltd. (formerly known as Hangzhou Yixin Technology Co., Ltd.) (“Yixin”) to launch “YiChat”, a proprietary social instant messaging
application for smart phones. The Group contributed RMB200.0 million cash in exchange for a 27.0% equity interest in Yixin. In July
2015, the Group increased its equity shares in Yixin to 35.0% with a cash consideration of approximately RMB127.5 million.
(2) As of December 31, 2019, the Group invested an aggregated cash consideration of RMB680.5 million in three limited partnerships as a
limited partner, and in 2020, the Group further contributed RMB68.1 million, RMB39.1 million and RMB109.5 million cash in these three
limited partnerships. The objective of these limited partnerships are to engage in investment in online game business. The Group accounted
such investments under the equity method.
(b) Equity investments with readily determinable fair values
As of December 31, 2020, equity investments with readily determinable fair values included RMB2,720.1 million invested in shares of Alibaba,
RMB481.5 million invested in shares of Huatai Securities Company Limited (“Huatai”) and RMB542.0 million invested in shares of Shenzhen Transsion
Holding Limited. The Group recorded fair value loss of RMB215.8 million, fair value gain of RMB763.2 million and RMB720.6 million related to the
equity investments with readily determinable fair value for the year ended December 31, 2018, 2019 and 2020, respectively.
The Group also received cash dividends of RMB12.7 million, RMB12.7 million and RMB12.7 million from Huatai for the years ended December 31,
2018, 2019 and 2020, respectively.
(c) Equity investments without readily determinable fair value
Equity investments without readily determinable fair value represent investments in privately held companies with no readily determinable fair value.
The Group does not have significant influence on these investees, or the investments are not common stock or in substance common stock. These
investments are classified as equity investments without readily determinable fair value, and are carried at cost less impairment, plus or minus changes
resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. For the year ended December
31, 2019 and 2020, there’s no upward adjustments to the carrying value of equity securities without readily determinable fair value resulted from such
transactions.
The Group recognized nil, a gain of RMB86.1 million and RMB36.1 million related to the disposal of the Group’s investments in equity securities
without readily determinable fair value as “investment income/(losses), net” in the consolidated statements of operations and comprehensive income for
the years ended December 31, 2018, 2019 and 2020, respectively.
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The Group recognized impairment provision of RMB133.6 million, RMB168.4 million and RMB55.6 million related to certain of the equity investments
as “investment income/(losses), net” in the consolidated statements of operations and comprehensive income for the years ended December 31, 2018,
2019 and 2020, respectively.
11. Other Long-term Assets
The following is a summary of other long-term assets (in thousands):
Copyrights, licenses, domain names, trademark and technology
Long-term receivable
Long-term interest receivables
Goodwill
Staff housing loans
Non-current deposits
Others
December 31,
December 31,
2019
RMB
3,639,211
1,599,524
—
—
71,997
140,869
215,009
5,666,610
2020
RMB
4,125,433
84,849
113,006
318,943
63,531
166,210
236,710
5,108,682
Balances of copyrights and licenses represents prepaid minimum royalties for exploitation of related intellectual properties, which was amortized over
the term of the respective licensing agreements or estimated amortization periods.
Balance of long-term receivable mainly represents receivables from Alibaba for disposal of Kaola which was expected to receive over 1 year.
Goodwill
In the fourth quarter of 2020, the Group acquired an additional 33.1% equity interest of a previously held equity investment with total cash consideration
of RMB168.3 million (the “Acquisition”). Upon the Acquisition, the Group increased its equity interest in this investment from 30.0% to 63.1%, and
accounted for it as a consolidated subsidiary of the Group. A gain of RMB130.1 million in relation to the revaluation of the previously held equity
interests was recorded in “investment income/(losses), net” in the consolidated statements of operations and comprehensive income for the year ended
December 31, 2020.
Consideration for this transaction was allocated on the acquisition date based on the fair value of the assets acquired and the liabilities assumed as
follows (in thousands):
Net assets acquired (i)
Amortizable intangible assets (ii)
Trademark
Developed technology
Deferred tax liabilities
Goodwill
Noncontrolling interests
Total
Amounts
RMB
16,440
59,300
182,200
(60,375)
311,109
(187,762)
320,912
(i) Net assets acquired mainly included cash and cash equivalents as of the date of acquisition.
(ii) Trademark and Developed technology acquired in the Acquisition are included in “Copyrights, licenses, domain names, trademark and technology”.
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The Group made housing loans to its employees (excluding executive officers) for house purchases via a third-party commercial bank in China. Each
individual staff housing loan is collateralized either by the property for which the loan is extended or by approved personal guarantees for the loan
amount granted. The repayment term is five years from the date of drawdown. The interest rate is fixed varying from 1.5% to 4.75% per annum for the
years ended December 31, 2019 and 2020, respectively. The outstanding portion of the staff housing loans repayable within 12 months as of December
31, 2019 and 2020 amounted to approximately RMB43.0 million and RMB37.2 million, respectively, and are reported under prepayments and other
current assets in the consolidated balance sheets (see Note 5).
12. Taxation
(a) Income taxes
Cayman Islands
Under the current laws of the Cayman Islands, the Company, and its intermediate holding companies in the Cayman Islands are not subject to tax on
income or capital gain. Additionally, upon payments of dividends by the Company or its subsidiaries in the Cayman Islands to their shareholders, no
Cayman Islands withholding tax will be imposed.
British Virgin Islands (“BVI”)
Subsidiaries in the BVI are exempted from income tax on its foreign-derived income in the BVI. There are no withholding taxes in the BVI.
Hong Kong
Subsidiaries in Hong Kong are subject to 16.5% income tax on their taxable income generated from operations in Hong Kong. Commencing from the
year of assessment of 2018, 2019 and 2020, the first HK$2 million of profits earned by one of the Company’s subsidiaries incorporated in Hong Kong is
taxed at half the current tax rate (i.e. 8.25%) while the remaining profits will continue to be taxed at the existing 16.5% tax rate. The payments of
dividends by these companies to their shareholders are not subject to any Hong Kong withholding tax.
China
On March 16, 2007, the National People’s Congress of PRC enacted the Enterprise Income Tax (“EIT”) Law, under which Foreign Invested Enterprises
(“FIEs”) and domestic companies would be subject to EIT at a uniform rate of 25%. Preferential tax treatments will continue to be granted to FIEs or
domestic companies which conduct businesses in certain encouraged sectors and to entities otherwise classified as “Software Enterprises”, “Key
Software Enterprises” and/or “High and New Technology Enterprises” (“HNTEs”). The EIT Law became effective on January 1, 2008.
Boguan, NetEase Hangzhou and certain other PRC subsidiaries were qualified as HNTEs and enjoyed a preferential tax rate of 15% for 2018, 2019 and
2020. In 2018, 2019 and 2020, Boguan, NetEase Hangzhou and certain other PRC subsidiaries were also qualified as a Key Software Enterprise and
enjoyed a further reduced preferential tax rate of 10% for 2017, 2018 and 2019. The related tax benefit was recorded in 2018, 2019 and 2020,
respectively.
The aforementioned preferential tax rates are subject to annual review by the relevant tax authorities in China.
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The following table presents the combined effects of EIT exemptions and tax rate reductions enjoyed by the Group for the years ended December 31,
2018, 2019 and 2020 (in thousands except per share data):
Aggregate amount of EIT exemptions and tax rate reductions
Earnings per share effect, basic
Earnings per share effect, diluted
1,621,063
0.50
0.50
1,665,199
0.52
0.51
The following table sets forth the component of income tax expenses of the Group for the years ended December 31, 2018, 2019 and 2020 (in
thousands):
For the year ended December 31,
2019
RMB
2018
RMB
For the year ended December 31,
2019
RMB
2018
RMB
2020
RMB
1,969,414
0.60
0.59
2020
RMB
2,953,670
88,179
3,041,849
Current tax expense
Deferred tax (benefit)/expense
Income tax expenses
2,531,271
(70,621)
2,460,650
2,764,097
150,629
2,914,726
The following table presents a reconciliation of the differences between the statutory income tax rate and the Group’s effective income tax rate for the
years ended December 31, 2018, 2019 and 2020:
For the year ended December 31,
2019
%
2020
%
2018
%
Statutory income tax rate
Permanent differences
Effect due to different tax rates applicable to overseas entities
Effect of lower tax rate applicable to Software Enterprises, Key Software Enterprise and HNTEs
Change in valuation allowance
Effect of withholding income tax
Effective income tax rate
25.0
(0.1)
2.8
(19.4)
7.8
6.1
22.2
25.0
(2.8)
(0.9)
(13.6)
4.9
5.2
17.8
25.0
(1.9)
(0.5)
(16.5)
6.8
6.9
19.8
As of December 31, 2020, certain entities of the Group had net operating tax loss carry forwards as follows (in thousands):
Loss expiring in 2021
Loss expiring in 2022
Loss expiring in 2023
Loss expiring in 2024
Loss expiring after 2025
RMB
163,916
833,766
3,602,358
3,220,185
4,807,464
12,627,689
Full valuation allowance was provided on the related deferred tax assets as the Group’s management does not believe that sufficient positive evidence
exists to conclude that recoverability of such deferred tax assets is more likely than not to be realized.
(b) Sales tax
Pursuant to the provision regulation of the PRC on VAT and its implementation rules, the Company’s subsidiaries and VIEs are generally subject to VAT
at a rate of 6% from revenues earned from services provided or 17% from sales of general goods. Effective from 1 May, 2018, the 17% VAT rates was
reduced to 16% and effective from 1 April, 2019, the 16% VAT rates was further reduced to 13%.
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(c) Deferred tax assets and liabilities
The following table presents the tax impact of significant temporary differences that give rise to the deferred tax assets and liabilities as of December 31,
2019 and 2020 (in thousands):
Deferred tax assets:
Deferred revenue, primarily for advanced payments from online games customers
Accruals
Depreciation of fixed assets
Amortization of intangible assets
Net operating tax loss carry forward
Less: valuation allowance
Total
Deferred tax liabilities:
Withholding income tax(d)
Others
Total
December 31,
2019
RMB
December 31,
2020
RMB
484,637
478,484
4,827
9,360
2,075,475
3,052,783
(2,148,879)
903,904
624,565
547,591
6,911
6,623
3,156,923
4,342,613
(3,255,854)
1,086,759
December 31,
2019
RMB
December 31,
2020
RMB
382,030
—
382,030
621,204
92,235
713,439
The Group does not believe that sufficient positive evidence exists to conclude that the recoverability of deferred tax assets of certain entities of the
Group is more likely than not to be realized. Consequently, the Group has provided full valuation allowances for certain entities of the Group on the
related deferred tax assets. The following table sets forth the movement of the aggregate valuation allowances for deferred tax assets for the periods
presented (in thousands):
2018
2019
2020
(d) Withholding income tax
Balance at
January 1
RMB
472,389
1,269,615
2,148,879
Provision/(Write-off)
for the year
RMB
797,226
879,264
1,106,975
Balance at
December 31
RMB
1,269,615
2,148,879
3,255,854
The EIT Law also imposes a withholding income tax of 10% on dividends distributed by an enterprise in China to its non-resident enterprise investors. A
lower withholding income tax rate of 5% is applied if the non-resident enterprise investor is registered in Hong Kong with at least 25% equity interest in
the PRC enterprise and meets the relevant conditions or requirements pursuant to the tax arrangement between mainland China and Hong Kong. On
February 22, 2008, the Ministry of Finance and State Taxation Administration jointly issued a circular which stated that for FIEs, all profits accumulated
up to December 31, 2007 are exempted from withholding tax when they are distributed to foreign investors.
The Group accrued RMB679.4 million, RMB846.6 million and RMB1,056.9 million (US$162.0 million) withholding tax liabilities associated with its
quarterly dividend and cash expected to be distributed from its PRC subsidiaries to overseas for general corporate purposes in 2018, 2019 and 2020,
respectively. The Group have repatriated a portion of these earnings and paid related withholding income tax in 2018, 2019 and 2020.
As of December 31, 2019 and 2020, there were approximately RMB993.3 million and RMB1,110.9 million (US$170.2 million) unrecognized deferred
tax liabilities related to undistributed earnings of the Group’s PRC subsidiaries, respectively. And the Group still intends to indefinitely reinvest these
remaining undistributed earnings in its PRC subsidiaries.
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13. Taxes Payable
The following is a summary of taxes payable as of December 31, 2019 and 2020 (in thousands):
Sales Tax payable
Withholding individual income taxes for employees
EIT payable
Others
14. Short-term Loans
December 31,
December 31,
2019
RMB
541,175
190,340
2,377,655
47,343
3,156,513
2020
RMB
683,763
237,681
3,286,392
74,999
4,282,835
As of December 31, 2019 and 2020, the short-term loans balances represent short-term loan arrangements with banks which were repayable within a
maturity term ranging from one week to one year and charged at a fixed interest rates ranging 0.65% and 4.57% per annum. As of December 31, 2019
and 2020, the weighted average interest rate for the outstanding short-term loans was approximately 2.38% and 0.86%, respectively. The short-term loans
are denominated in US$, EUR, GBP, CAD, HK$, JPY or CNY.
As of December 31, 2019 and 2020, certain short-term loans were secured by RMB deposits of the Group in onshore branches of the banks in the
amount of RMB1,595.0 million and RMB1,295.0 million (US$198.5 million), which was recognized as restricted cash (see Note 2(f)).
On August 9, 2018, the Group entered into a three-year US$500 million syndicated facility agreement with a group of four mandated lead arrangers and
bookrunners. The facility is priced at 95 basis points over London interbank offered rate (“LIBOR”) and has a commitment fee of 0.20% on the undrawn
portion. There were US$500.0 million of borrowings outstanding under the syndicated facility as of December 31, 2020. The Group was subject to
certain covenants under the syndicated facility agreement and was in compliance with these covenants as of December 31, 2020.
In 2020, the Group also entered into several uncommitted loan credit facility agreements provided by certain financial institutions. As at December 31,
2020, US$1,410.6 million of such credit facilities has not been utilized.
In 2020, the Group also entered into several guarantee agreements in the aggregate amount of US$1,523.0 million in respect of certain credit facilities
taken by its subsidiaries. As at December 31, 2020, US$446.1 million of such credit facilities had not been utilized.
15. Deferred Revenue
Deferred revenue represents sales proceeds from prepaid points sold, unamortized mobile game in-game spending, prepaid products fees before delivery
and prepaid subscription fees for internet value-added services for which services are yet to be provided as of the balance sheet dates.
For the year ended December 31, 2020, the additions to the deferred revenue balance were primarily due to cash payments received or due in advance of
satisfying the Group’s performance obligations, while the reductions to the deferred revenue balance were primarily due to the recognition of revenues
upon fulfillment of the Group’s performance obligations, both of which were in the ordinary course of business. During the year ended December 31,
2019 and 2020, RMB7,319.4 million and RMB8,149.2 million of revenues recognized were included in the deferred revenue balance at the beginning of
the year, respectively.
As of December 31, 2020, the aggregate amount of transaction price allocated to the unsatisfied performance obligations is RMB10,945.1 million, which
includes the deferred revenues balances and amounts to be invoiced and recognized as revenue in future periods. The Group expects to recognize a
significant majority of this balance as revenue over the next 12 months, and the remainder thereafter. This balance does not include an estimate for
variable consideration arising from sales rebates to advertising service customers and estimated breakage for online points.
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16. Accrued Liabilities and Other Payables
The following is a summary of accrued liabilities and other payables as of December 31, 2019 and 2020 (in thousands):
Customer deposits on NetEase Pay accounts
Marketing expenses and promotion materials
Accrued fixed assets related payables
Server and bandwidth service fees
Accrued revenue sharing
Content cost
Professional fees and technical charges
Accrued freight and warehousing charge
Administrative expenses and other staff related cost
Others
December 31,
2019
RMB
1,539,417
1,672,096
304,379
110,786
578,940
403,402
209,123
47,524
69,849
357,258
5,292,774
December 31,
2020
RMB
1,911,841
1,440,661
340,725
150,614
729,688
1,293,598
491,895
61,611
293,693
292,493
7,006,819
17. Noncontrolling Interests and Redeemable Noncontrolling Interests
NetEase Cloud Music
In the first quarter of 2017, pursuant to the agreements entered into by certain of the Group’s subsidiaries and VIE (together referred as “NetEase Cloud
Music”) and some investors, one of NetEase Cloud Music’s PRC subsidiary (“Hangzhou Cloud Music”) issued equity interests with preferential rights to
certain investors for a total cash consideration of RMB600.0 million. In addition, Hangzhou Cloud Music issued equity interest to one investor for a total
cash consideration of RMB150.0 million. After the issuance of the equity interests, the investors together held approximately 12.59% equity interests in
NetEase Cloud Music.
The Group determined that the equity interests with preferential rights of RMB600.0 million should be classified as redeemable noncontrolling interests
since they are contingently redeemable upon the occurrence of a conditional event, which is not solely within the control of the Company. The
redemption price equals initial investment plus annual interests. Equity interests issued of RMB150.0 million was classified as noncontrolling interests.
In the first quarter of 2018, due to the changes of NetEase Cloud Music financing plan, the Group repurchased all of the redeemable noncontrolling
interests and noncontrolling interest issued in China by Hangzhou Cloud Music at a cash consideration of RMB780.0 million and RMB195.0 million,
respectively (the “Onshore Repurchase”). The Group accounted for the Onshore Repurchase as an equity transaction, no gains or losses were recognized
from the repurchase. The excess of the consideration transferred over the carrying amount of the noncontrolling interests surrendered, amounting to
RMB63.9 million was recorded as a reduction to retained earnings. The excess of the consideration transferred over the carrying amount of the
redeemable noncontrolling interests surrendered, amounting to RMB159.4 million was recognized as a deemed dividend to preferred shareholders, which
also reduces the numerator for EPS calculation. The repurchased redeemable noncontrolling interest and noncontrolling interest of NetEase Cloud Music
were then retired.
In 2018 and 2019, Cloud Village Inc. (“Cloud Village”), the Cayman holding company of NetEase Cloud Music issued preferred shares (“NetEase Cloud
Music Preferred Shares”) to certain investors for an aggregated cash consideration of US$716.3 million and US$711.6 million (the “Offshore Issuance”),
respectively.
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In 2020, pursuant to the agreements entered between one of the redeemable noncontrolling interest and Cloud Village, Cloud Village repurchased this
redeemable noncontrolling interest at a cash consideration of US$66.3 million. The Group accounted for the repurchase as an equity transaction, no gains
or losses were recognized from the repurchase. The excess of the consideration transferred over the carrying amount of the redeemable noncontrolling
interests surrendered, amounting to RMB207.0 million was recognized as a deemed dividend to preferred shareholders, among which RMB204.7 million
attributable to the Company’s shareholders also reduces the numerator for EPS calculation.
As of December 31, 2020, the NetEase Cloud Music Preferred Shares investors together held approximately 36.3% issued and outstanding interests in
NetEase Cloud Music. The Company still maintains in control of NetEase Cloud Music.
The NetEase Cloud Music Preferred Shares were entitled to certain preferences and privileges with respect to redemption. The Group determined that the
preferred shares should be classified as redeemable noncontrolling interests since they are contingently redeemable upon the occurrence of a conditional
event or a deemed redemption event, which is not solely within the control of the Group. The redemption price equals to the net initial investment
amount plus annual interests, if any.
Youdao
In April 2018, Youdao issued equity interests with preferential rights (“Youdao Preferred Shares”) to two investors for a total cash consideration of
US$70.0 million. The Group determined that the equity interests with preferential rights should be classified as redeemable noncontrolling interest since
they are contingently redeemable upon the occurrence of a conditional event, which is not solely within the control of the Company. The redemption
price equals to the net initial investment amount plus annual interests. Upon completion of the IPO of Youdao in October 2019, all Youdao Preferred
Shares held by external preferred shareholders were automatically re-designated and converted on a one-for-one basis into Class A ordinary shares of
Youdao.
Each issuance of the preferred shares is recognized at the respective issue price at the date of issuance net of issuance costs. The Group records accretions
on the redeemable noncontrolling interest to the redemption value from the issuance dates to the earliest redemption dates if redemption is probable. The
accretions using the effective interest method, are recorded as deemed dividends to preferred shareholders, which reduces retained earnings and equity
classified noncontrolling interests, and earnings available to common shareholders in calculating basic and diluted earnings per share.
18. Capital Structure
The holders of ordinary shares in the Company are entitled to one vote per share and to receive ratably such dividends, if any, as may be declared by the
board of directors of the Company. In the event of liquidation, the holders of ordinary shares are entitled to share ratably in all assets remaining after
payment of liabilities. The ordinary shares have no preemptive, conversion, or other subscription rights.
19. Employee Benefits
The Company’s subsidiaries and VIEs incorporated in China participate in a government-mandated multi-employer defined contribution plan under
which certain retirement, medical, housing and other welfare benefits are provided to employees. Chinese labor regulations require the Company’s
Chinese subsidiaries and VIEs to pay to the local labor bureau a monthly contribution at a stated contribution rate based on the monthly basic
compensation of qualified employees. The relevant local labor bureau is responsible for meeting all retirement benefit obligations; hence, the Group has
no further commitments beyond its monthly contribution. The following table presents the Group’s employee welfare benefits expense for the years
ended December 31, 2018, 2019 and 2020 (in millions):
Contributions to medical and pension schemes
Other employee benefits
For the year ended December 31,
2019
RMB
2020
RMB
2018
RMB
788.7
548.6
1,337.3
903.4
631.8
1,535.2
769.4
766.8
1,536.2
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Table of Contents
20. Share-based Compensation
(a) Restricted share units plan
2009 Restricted Share Unit Plan
In November 2009, the Company adopted a restricted share unit plan for the Company’s employees, directors and consultants (the “2009 Plan”). The
Company has reserved 323,694,050 ordinary shares for issuance under the plan. The 2009 Plan was adopted by a resolution of the board of directors on
November 17, 2009 and became effective for a term of ten years unless sooner terminated. The 2009 Plan was expired on November 16, 2019.
2019 Restricted Share Unit Plan
In October 2019, the Company adopted a 2019 restricted share unit plan (the “2019 Plan”) for the Company’s employees, directors and others. The 2019
Plan has a ten-year term and a maximum number of 322,458,300 ordinary shares available for issuance pursuant to all awards under the plan.
(b) Share-based compensation expense
The Group recognizes share-based compensation cost in the consolidated statements of operations and comprehensive income based on awards
ultimately expected to vest, after considering estimated forfeitures. Forfeitures are estimated based on the Group’s historical experience over the last five
years and revised in subsequent periods if actual forfeitures differ from those estimates.
The table below presents a summary of the Group’s share-based compensation cost for the years ended December 31, 2018, 2019 and 2020 (in
thousands):
Cost of revenues
Selling and marketing expenses
General and administrative expenses
Research and development expenses
2018
RMB
757,341
102,638
787,200
824,552
2,471,731
For the year ended December 31,
2019
RMB
758,810
84,920
797,120
763,239
2,404,089
2020
RMB
794,855
102,300
929,013
837,321
2,663,489
As of December 31, 2020, total unrecognized compensation cost related to unvested awards under the 2009 Plan and the 2019 Plan, adjusted for
estimated forfeitures, was US$350.9 million (RMB2,289.6 million) and is expected to be recognized through the remaining vesting period of each grant.
As of December 31, 2020, the weighted average remaining vesting periods was 2.25 years.
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(c) Restricted share units award activities
The following table presents a summary of the Company’s RSUs award activities for the years ended December 31, 2018, 2019 and 2020:
Outstanding at January 1, 2018
Granted
Vested
Forfeited
Outstanding at December 31, 2018
Outstanding at January 1, 2019
Granted
Vested
Forfeited
Outstanding at December 31, 2019
Outstanding at January 1, 2020
Granted
Vested
Forfeited
Outstanding at December 31, 2020
Number of RSUs
(in thousands)
Weighted average
grant date fair
value
US$
8,360
10,365
(6,140)
(460)
12,125
12,125
8,815
(5,910)
(955)
14,075
14,075
6,269
(5,832)
(416)
14,096
47.64
54.24
50.11
47.67
52.02
52.02
46.30
51.22
48.82
49.00
49.00
68.35
48.02
54.47
57.85
The aggregate intrinsic value of RSUs outstanding as of December 31, 2020 was US$1,349.9 million. The intrinsic value was calculated based on the
Company’s closing stock price of US$95.77 per ADS as of December 31, 2020.
The Company’s practice is to issue new shares or utilize treasury stock upon vesting of RSUs. The number of shares available for future grant under the
Company’s 2019 RSU Plan was 299,346,760 as of December 31, 2020.
(d) Other Share Incentive Plan
Certain of the Company’s subsidiaries have adopted stock option plans, which allow the related subsidiaries to grant options to certain employees of the
Group. The options expire in five to ten years from the date of grant and either vest or have a vesting commencement date upon certain conditions being
met (“Vesting Commencement Date”). The award can become 100% vested on the Vesting Commencement Date, or vests in two, three, four or five
substantially equal annual installments with the first installment vesting on the Vesting Commencement Date.
The Group has used the binomial model to estimate the fair value of the options granted. For the years ended December 31, 2018, 2019, and 2020,
RMB32.0 million, RMB56.2 million and RMB117.7 million compensation expenses were recorded for the share options granted.
While certain share options granted will become vested or commence vesting beginning on the Vesting Commencement Date, the effectiveness of the
conditions is not within the control of the Group and is not deemed probable to occur for accounting purposes until the Vesting Commencement Date. For
such share options, no compensation expenses were recorded. As of December 31, 2020, there were approximately RMB170.0 million unrecognized
share-based compensation expenses are related to such share options for which the service condition had been met and are expected to be recognized
when the conditions are achieved.
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21. Net Income Per Share
The following table sets forth the computation of basic and diluted net income per share for the years ended December 31, 2018, 2019 and 2020:
Numerator (RMB in thousands):
Net income from continuing operations attributable to NetEase, Inc’s shareholders
Net (loss)/income from discontinued operations attributable to NetEase, Inc’s shareholders
Net income attributable to NetEase, Inc.’s shareholders for basic/dilutive net income per
share calculation
Denominator (No. of shares in thousands):
Weighted average number of ordinary shares outstanding, basic
Dilutive effect of restricted share units
Weighted average number of ordinary shares outstanding, diluted
Net income per share from continuing operations attributable to NetEase, Inc’s
shareholders, basic (RMB)
Net (loss)/income per share from discontinued operations attributable to NetEase, Inc’s
shareholders, basic (RMB)
Net income per share, basic (RMB)
Net income per share from continuing operations attributable to NetEase, Inc’s
shareholders, diluted (RMB)
Net (loss)/income per share from discontinued operations attributable to NetEase, Inc’s
shareholders, diluted (RMB)
Net income per share, diluted (RMB)
2018
For the year ended December 31,
2019
2020
8,291,089
(2,138,682)
13,274,997
7,962,519
12,062,754
—
6,152,407
21,237,516
12,062,754
3,235,324
19,365
3,254,689
3,220,473
29,499
3,249,972
3,305,448
44,311
3,349,759
2.56
(0.66)
1.90
2.55
(0.66)
1.89
4.12
2.47
6.59
4.08
2.45
6.53
3.65
—
3.65
3.60
—
3.60
Basic net income per share is computed using the weighted average number of the ordinary shares outstanding during the year. Diluted net income per
share is computed using the weighted average number of ordinary shares and potential ordinary shares outstanding during the year. For the years ended
December 31, 2018, 2019 and 2020, RSUs that were anti-dilutive and excluded from the calculation of diluted net income per share totaled
approximately 19.6 million shares, 11.4 million shares and 6.0 million shares, respectively.
F-42
Table of Contents
22. Commitments and Contingencies
(a) Commitments
As of December 31, 2020, future minimum payment for server and bandwidth service fee commitments, capital commitments, royalties and other
expenditures commitments related to licensed contents, including the royalties and minimum marketing expenditure commitment for the games licensed
by Blizzard, as well as other commitments related to office machines and services purchases, were as follows (in thousands):
Server and
Bandwidth
Service Fee
Royalties and
Expenditure for
Licensed Content
Capital
Commitments Commitments Commitments
RMB
548,713
296,423
234,233
7,722
26,103
1,113,194
RMB
442,910
306,676
220,198
158,375
142,793
1,270,952
RMB
2,875,860
2,075,531
1,326,344
5,997
849,780
7,133,512
Office Machines
and Other
Commitments
RMB
604,388
25,483
17,113
—
—
646,984
Total
RMB
4,471,871
2,704,113
1,797,888
172,094
1,018,676
10,164,642
2021
2022
2023
2024
Beyond 2024
(b) Litigation
Overview
From time to time, the Group is involved in claims and legal proceedings that arise in the ordinary course of business. Based on currently available
information, management does not believe that the ultimate outcome of these unresolved matters, individually and in the aggregate, is reasonably
possible to have a material adverse effect on the Group’s financial position, results of operations or cash flows. However, litigation is subject to inherent
uncertainties and the Group’s view of these matters may change in the future. Were an unfavorable outcome to occur, there exists the possibility of a
material adverse impact on the Group’s financial position, results of operations or cash flows for the period in which the unfavorable outcome occurs, and
potentially in future periods. The Group records a liability when it is both probable that a liability has been incurred and the amount of the loss can be
reasonably estimated. The Group reviews the need for any such liability on a regular basis. The Group has not recorded any material liabilities in this
regard as of December 31, 2019 and 2020.
Litigation
In April 2018, PUBG Corporation and PUBG Santa Monica, Inc. (collectively “PUBG”), filed a lawsuit against defendants NetEase, Inc., NetEase
Information Technology Corp. and NetEase (Hong Kong) Limited in the U.S. District Court for the Northern District of California. PUBG subsequently
dropped all claims against NetEase (Hong Kong) Limited, and added Hong Kong NetEase Interactive Entertainment Limited to the lawsuit. PUBG’s
complaint generally alleged that two of the Group’s mobile games, Rules of Survival and Knives Out, infringed PUBG’s copyrights and trade dress in
their competing game, Player Unknown’s Battlegrounds. On March 11, 2019, the Group entered into a settlement agreement with PUBG, and the lawsuit
was dismissed. On October 15, 2019, PUBG filed a second lawsuit against the same NetEase defendants, also in the U.S. District Court for the Northern
District of California, claiming the Group had allegedly breached the settlement agreement. On March 3, 2020, the court dismissed PUBG’s new lawsuit,
without prejudice, for lack of subject matter jurisdiction. On March 4, 2020, the Group initiated a declaratory judgment action against PUBG in the
Superior Court of California for the County of San Mateo, requesting a declaration that the Group had not breached the settlement agreement. On March
13, 2020, PUBG filed a cross claim, realleging that the Group breached the settlement agreement. As of the date of this report, the litigation remains
ongoing and the court has not yet set a trial date.
F-43
Table of Contents
23. Dividends
Quarterly Dividend Policy
In May 2014, the Company’s board of directors approved a new quarterly dividend policy. Under this policy, the Company intends to make quarterly
cash dividend distributions at an amount equivalent to approximately 25% of the Group’s anticipated net income after tax in each fiscal quarter. In the
second quarter of 2019, the Company’s board of directors determined that quarterly dividends will be set at an amount equivalent to approximately
20%-30% of the Company’s anticipated net income after tax in each fiscal quarter. The Company’s board of directors also approved an additional special
dividend of US$0.69 per ADS in the third quarter of 2019.
Dividends are recognized when declared. There is no significant dividend payable as of December 31, 2019 and 2020, respectively. The cash dividend
declared related to the net profits of fiscal year 2019 and fiscal year 2020 was RMB9,353.6 million and RMB3,614.8 million (US$554.0 million) in total,
respectively.
The determination to make dividend distributions and the amount of such distributions in any particular quarter will be made at the discretion of the
Company’s board of directors and will be based upon its operations and earnings, cash flow, financial condition, capital and other reserve requirements
and surplus, any applicable contractual restrictions, the ability of the Company’s PRC subsidiaries to make distributions to their offshore parent
companies, and any other conditions or factors which the board deems relevant and having regard to the directors’ fiduciary duties.
24. Share Repurchase Programs
The Company accounts for repurchased ordinary shares under the cost method and includes such treasury stock as a component of the common
shareholders’ equity. Cancellation of treasury stock is recorded as a reduction of ordinary shares, additional paid-in-capital and retained earnings, as
applicable. An excess of purchase price over par value is allocated to additional paid-in-capital first with any remaining excess charged entirely to
retained earnings. The Company may from time to time utilize treasury stock upon vesting of RSUs. The cost of treasury stock reissued is determined
using the weighted average method and recorded as a reduction of additional paid-in-capital.
In November 2017, the Company announced that its board of directors approved a new share repurchase program of up to US$1.0 billion of the
Company’s outstanding ADSs for a period not to exceed 12 months. On June 11, 2018, the Company announced that its board of directors approved an
amendment to its share repurchase program, authorizing the repurchase of up to an additional US$1.0 billion of the Company’s outstanding ADSs. This
expands the US$1.0 billion repurchase program that was approved on November 15, 2017 for a period not to exceed 12 months, bringing the total
authorized repurchase amount to US$2.0 billion. Under the terms of this program, the Company may repurchase its issued and outstanding ADSs in
open-market transactions on the NASDAQ Global Select Market. As of expiration date of the program, the Company has repurchased approximately
23.0 million ADSs (equivalent to 114.9 million ordinary shares) for approximately US$1,178.5 million under this program.
In November 2018, the Company announced that its board of directors approved a new share repurchase program of up to US$1.0 billion of the
Company’s outstanding ADSs for a period not to exceed 12 months. Under the terms of this program, the Company may repurchase its issued and
outstanding ADSs in open-market transactions on the NASDAQ Global Select Market. As of expiration date of the program, the Company has
repurchased approximately 5,075 ADSs (equivalent to 25,375 ordinary shares) for approximately US$0.2 million under this program.
In November 2019, the Company announced that its board of directors has approved a share purchase program of up to US$20.0 million of Youdao’s
outstanding ADSs for a period not to exceed 12 months. Under the terms of this program, the Company may repurchase Youdao’s ADSs in open-market
transactions on the New York Stock Exchange. As of December 31, 2020, approximately 198,000 Youdao’s ADSs had been purchased for approximately
US$3.4 million under this program.
F-44
Table of Contents
In February 2020, the Company announced that its board of directors had approved a share repurchase program of up to US$1.0 billion of the Company’s
outstanding ADSs for a period not to exceed 12 months. On May 19, 2020, the Company announced that its board of directors approved an amendment
to its share repurchase program, authorizing the repurchase of up to an additional US$1.0 billion of the Company’s outstanding ADSs. Under the terms of
this program, the Company may repurchase its issued and outstanding ADSs in open-market transactions on the NASDAQ Global Select Market. As of
December 31, 2020, the Company has repurchased approximately 21.1 million ADSs (equivalent to 105.5 million ordinary shares) for approximately
US$1,625.1 million under this program.
In February 2021, the Company announced that its board of directors had approved a share repurchase program of up to US$2.0 billion of the Company’s
outstanding ADSs and ordinary shares in open market transactions for a period not to exceed 24 months beginning on March 2, 2021.
25. Related Party Transactions
The Group had no material transactions with related parties for the year ended December 31, 2018, 2019 and 2020, and no material related parties’
balances as of December 31, 2020.
26. Segment Information
(a) Description of segments
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the
chief operating decision maker (“CODM”), or decision making group, in deciding how to allocate resources and in assessing performance. The Group’s
CODM is the Chief Executive Officer.
The Group’s organizational structure is based on a number of factors that the CODM uses to evaluate, view and run its business operations which
include, but are not limited to, customer base, homogeneity of products and technology. The Group’s operating segments are based on this organizational
structure and information reviewed by the Group’s CODM to evaluate the operating segment results.
Effective in the third quarter of 2019, the Group changed its segment disclosure to add the financial results of its certain advertising services and Yanxuan
into innovative businesses and others. In addition, the Group has commenced separately reporting the results of Youdao, which completed its initial
public offering and listing on the New York Stock Exchange in October 2019. As a result, the Group now reports segments as online game services,
Youdao and innovative businesses and others. This change in segment reporting aligns with the manner in which the Group’s CODM currently receives
and uses financial information to allocate resources and evaluate the performance of reporting segments. This change in segment presentation does not
affect consolidated balance sheets, consolidated statements of operations and comprehensive income or consolidated statements of cash flows. The Group
retrospectively revised prior year segment information, to conform to current year presentation.
F-45
Table of Contents
(b) Segment data
The table below provides a summary of the Group’s operating segment results for the years ended December 31, 2018, 2019 and 2020. The Group does
not allocate any operating costs or assets to its business segments as the Group’s CODM does not use this information to measure the performance of the
operating segments. There was no significant transaction between reportable segments for the years ended December 31, 2018, 2019 and 2020 (in
thousands).
Net revenues:
Online game services
Youdao
Innovative businesses and others
Total net revenues
Cost of revenues:
Online game services
Youdao
Innovative businesses and others
Total cost of revenues
Gross profit:
Online game services
Youdao
Innovative businesses and others
Total gross profit
2018
RMB
For the year ended December 31,
2019
RMB
2020
RMB
40,190,057
731,598
10,256,920
51,178,575
46,422,640
1,304,883
11,513,622
59,241,145
54,608,717
3,167,515
15,890,901
73,667,133
(14,617,656)
(515,133)
(8,699,637)
(23,832,426)
(16,974,234)
(934,261)
(9,777,350)
(27,685,845)
(19,847,846)
(1,713,229)
(13,122,656)
(34,683,731)
25,572,401
216,465
1,557,283
27,346,149
29,448,406
370,622
1,736,272
31,555,300
34,760,871
1,454,286
2,768,245
38,983,402
The following table set forth the breakdown of net revenues by type of good or service for the years ended December 31, 2018, 2019 and 2020:
Online games services
Youdao learning services
Advertising services
Others
Total Net revenue
40,190,057
398,186
2,769,337
7,820,995
51,178,575
46,422,640
699,826
2,581,623
9,537,056
59,241,145
For the year ended December 31,
2019
RMB
2018
RMB
2020
RMB
54,608,717
2,154,669
2,653,861
14,249,886
73,667,133
The following table presents the total depreciation expenses of property and equipment by segment for the years ended December 31, 2018, 2019 and
2020:
Online game services
Youdao
Innovative businesses and others
Total depreciation expenses of property and equipment
For the year ended December 31,
2019
RMB
256,181
6,076
218,850
481,107
2018
RMB
235,896
3,863
201,707
441,466
2020
RMB
258,357
7,239
208,514
474,110
As substantially all of the Group’s long-lived assets are located in the PRC and substantially all of the Group’s revenue of reportable segments are
derived from China based on the geographical locations where services and products are provided to customers, no geographical information is
presented.
F-46
Table of Contents
27. Financial Instruments
The following table sets forth the financial instruments, measured at fair value, by level within the fair value hierarchy as of December 31, 2019 (in
thousands):
Time deposits-short term
Time deposits-long term
Equity investments with readily determinable fair values
Short-term investments
Total
Fair Value Measurements
(RMB)
Quoted Prices in
Active Market
for Identical
Assets
(Level 1)
53,487,075
2,360,000
3,551,545
—
59,398,620
Total
53,487,075
2,360,000
3,551,545
15,312,595
74,711,215
Significant Other
Observable
Inputs
(Level 2)
—
—
—
15,312,595
15,312,595
The following table sets forth the financial instruments, measured at fair value, by level within the fair value hierarchy as of December 31, 2020 (in
thousands):
Time deposits-short term
Time deposits-long term
Equity investments with readily determinable fair values
Short-term investments
Total
Fair Value Measurements
(RMB)
Quoted Prices in
Active Market
for Identical
Assets
(Level 1)
71,079,327
6,630,000
3,743,590
—
81,452,917
Total
71,079,327
6,630,000
3,743,590
13,273,026
94,725,943
Significant Other
Observable
Inputs
(Level 2)
—
—
—
13,273,026
13,273,026
The rates of interest under the loan agreements with the lending banks were determined based on the prevailing interest rates in the market. The Group
classifies the valuation techniques that use these inputs as Level 2 of fair value measurements of short-term bank loans. For other financial assets and
liabilities with carrying values that approximate fair value, if measured at fair value in the financial statements, these financial instruments would be
classified as Level 3 in the fair value hierarchy. As of December 31, 2019 and 2020, certain equity investments without determinable fair value (Note 10)
were measured using significant unobservable inputs (Level 3) and written down from their respective carrying value to fair value, with impairment
charges of RMB168.4 million and RMB55.6 million incurred and recorded in earnings for the years then ended.
28. Restricted Net Assets
Relevant PRC laws and regulations permit PRC companies to pay dividends only out of their retained earnings, if any, as determined in accordance with
PRC accounting standards and regulations. Additionally, the Company’s PRC subsidiaries and VIEs can only distribute dividends upon approval of the
shareholders after they have met the PRC requirements for appropriation to the general reserve fund and the statutory surplus fund respectively. The
general reserve fund and the statutory surplus fund require that annual appropriations of 10% of net after-tax income should be set aside prior to payment
of any dividends. As a result of these and other restrictions under PRC laws and regulations, the PRC subsidiaries and VIEs are restricted in their ability
to transfer a portion of their net assets to the Company either in the form of dividends, loans or advances, which restricted portion amounted to
approximately RMB15.9 billion, or 19% of the Company’s total consolidated net assets, as of December 31, 2020. Even though the Company currently
does not require any such dividends, loans or advances from the PRC subsidiaries and VIEs for working capital and other funding purposes, the
Company may in the future require additional cash resources from its PRC subsidiaries and VIEs due to changes in business conditions, to fund future
acquisitions and developments, or merely declare and pay dividends to or distributions to the Company’s shareholders.
F-47
LIST OF SIGNIFICANT SUBSIDIARIES AND VARIABLE INTEREST ENTITIES OF NETEASE, INC.
Exhibit 8.1
Subsidiaries:
Jurisdiction of Incorporation
Hong Kong NetEase Interactive Entertainment Limited
Hong Kong
Guangzhou Boguan Telecommunication Technology Co., Ltd.
People’s Republic of China
NetEase (Hangzhou) Network Co., Ltd.
Variable Interest Entities:
Guangzhou NetEase Computer System Co., Ltd.
Hangzhou NetEase Leihuo Technology Co., Ltd. (previously named
Hangzhou NetEase Leihuo Network Co., Ltd.)
People’s Republic of China
Jurisdiction of Incorporation
People’s Republic of China
People’s Republic of China
Exhibit 12.1
I, William Lei Ding, certify that:
1. I have reviewed this annual report on Form 20-F of NetEase, Inc.;
CERTIFICATION
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the
period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;
4. The company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) for the company and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
(d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period
covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal
control over financial reporting; and
5. The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
company’s internal control over financial reporting.
Date: April 28, 2021
By:
/s/ William Lei Ding
William Lei Ding
Chief Executive Officer
Exhibit 12.2
I, Charles Zhaoxuan Yang, certify that:
1. I have reviewed this annual report on Form 20-F of NetEase, Inc.;
CERTIFICATION
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the
period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of the company as of, and for, the periods presented in this report;
4. The company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act
Rules 13a-15(f) and 15d-15(f)) for the company and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the company, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the company’s disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
(d) Disclosed in this report any change in the company’s internal control over financial reporting that occurred during the period
covered by the annual report that has materially affected, or is reasonably likely to materially affect, the company’s internal
control over financial reporting; and
5. The company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial
reporting, to the company’s auditors and the audit committee of the company’s board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the company’s ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the
company’s internal control over financial reporting.
Date: April 28, 2021
By:
/s/ Charles Zhaoxuan Yang
Charles Zhaoxuan Yang
Chief Financial Officer
Exhibit 13.1
906 Certification
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
Ladies and Gentlemen:
In connection with the periodic report of NetEase, Inc. (the “Company”) on Form 20-F for the year ended December 31, 2020 as filed with the
Securities and Exchange Commission (the “Report”), I, William Lei Ding, the Chief Executive Officer of the Company, hereby certify as of the
date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:
1. The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company at the dates and for the periods indicated.
This Certificate has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.
Date: April 28, 2021
/s/ William Lei Ding
By:
Name: William Lei Ding
Title: Chief Executive Officer
Exhibit 13.2
906 Certification
Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
Ladies and Gentlemen:
In connection with the periodic report of NetEase, Inc. (the “Company”) on Form 20-F for the year ended December 31, 2020 as filed with the
Securities and Exchange Commission (the “Report”), I, Charles Zhaoxuan Yang, the Chief Financial Officer of the Company, hereby certify as
of the date hereof, solely for purposes of Title 18, Chapter 63, Section 1350 of the United States Code, that to the best of my knowledge:
1. The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934; and
2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company at the dates and for the periods indicated.
This Certificate has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.
Date: April 28, 2021
/s/ Charles Zhaoxuan Yang
By:
Name: Charles Zhaoxuan Yang
Title: Chief Financial Officer
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Exhibit 15.2
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-100069, No. 333-164249 and No. 333-234189)
of NetEase, Inc. of our report dated April 28, 2021 relating to the financial statements and the effectiveness of internal control over financial reporting,
which appears in this Form 20-F.
/s/ PricewaterhouseCoopers Zhong Tian LLP
PricewaterhouseCoopers Zhong Tian LLP
Beijing, the People’s Republic of China
April 28, 2021
Exhibit 15.3
Our ref
Direct tel
E-mail
RDS/302157-000001/19557921v1
+852 2971 3046
richard.spooner@maples.com
BY COURIER
NetEase, Inc.
NetEase Building, No. 599 Wangshang Road
Binjiang District, Hangzhou, 310052
People’s Republic of China
April 28, 2021
Dear Sir
Re: NetEase, Inc.
We have acted as legal advisors as to the laws of the Cayman Islands to NetEase, Inc., an exempted limited liability company incorporated
in the Cayman Islands (the “Company”), in connection with the filing by the Company with the United States Securities and Exchange
Commission of an annual report on Form 20-F for the year ended December 31, 2020.
We hereby consent to the reference of our name under the headings “Taxation” and “Enforcement of Civil Liabilities” in the Form 20-F.
Yours faithfully
/s/ Maples and Calder (Hong Kong) LLP
Maples and Calder (Hong Kong) LLP
Exhibit 15.4
April 28, 2021
To
NETEASE, INC.
NetEase Building, No. 599 Wangshang Road
Binjiang District, Hangzhou
Zhejiang Province, PRC
Dear Sir/Madam:
We consent to the reference to our firm under the headings of “Enforcement of Civil Liabilities” in NETEASE, INC.’s Annual Report on Form 20-F for
year ended December 31, 2020, which will be filed with the Securities and Exchange Commission.
In giving such consent, we do not hereby admit that we come within the category of persons whose consent is required under Section 7 of the Securities
Act of 1933, or under the Securities Exchange Act of 1934, in each case, as amended, or the regulations promulgated thereunder.
Yours faithfully,
/s/ Zhong Lun Law Firm
Zhong Lun Law Firm