Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 6-K

 


 

REPORT OF FOREIGN PRIVATE ISSUER
PURSUANT TO RULE 13a-16 OR 15d-16 OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For the month of May 2020

 

Commission File Number: 000-30666

 


 

NETEASE, INC.

 


 

NetEase Building, No. 599 Wangshang Road

Binjiang District, Hangzhou, 310052

People’s Republic of China

(Address of principal executive offices)

 


 

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.

 

Form 20-F x     Form 40-F o

 

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1): o

 

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7): o

 

 

 


Table of Contents

 

NETEASE, INC.

 

Form 6-K

 

TABLE OF CONTENTS

 

Signature

 

Page 3

 

 

 

Unaudited Condensed Consolidated Financial Statements as of March 31, 2020 and for the three months ended March 31, 2019 and 2020

 

Exhibit 99.1

 

2


Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

NETEASE, INC.

 

 

 

 

By:

/s/ Charles Zhaoxuan Yang

 

Name: Charles Zhaoxuan Yang

 

Title: Chief Financial Officer

 

 

Date:

May 29, 2020

 

 

 

3


Exhibit 99.1

 

Table of Contents

 

NETEASE, INC.

 

Unaudited Condensed Consolidated Balance Sheets as of December 31, 2019 and March 31, 2020

F-2

 

 

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended March 31, 2019 and 2020

F-3

 

 

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2019 and 2020

F-4

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2020

F-5

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

F-6

 

F-1


 

Unaudited Condensed Consolidated Balance Sheets

(in thousands except per share data)

 

 

 

Notes

 

December 31,
2019

 

March 31,
2020

 

March 31,
2020

 

 

 

 

 

RMB

 

RMB

 

US$

 

 

 

 

 

 

 

 

 

Note 2(a)

 

Assets

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

2(d)

 

3,246,373

 

5,592,847

 

789,861

 

Time deposits

 

2(d)

 

53,487,075

 

50,515,092

 

7,134,094

 

Restricted cash

 

2(d)

 

3,150,354

 

3,507,105

 

495,298

 

Accounts receivable, net

 

 

 

4,169,358

 

4,559,441

 

643,916

 

Inventories, net

 

 

 

650,557

 

562,117

 

79,386

 

Prepayments and other current assets

 

5

 

4,817,422

 

6,060,421

 

855,895

 

Short-term investments

 

 

 

15,312,595

 

19,373,366

 

2,736,042

 

Assets held for sale

 

 

 

271,278

 

50,751

 

7,167

 

Total current assets

 

 

 

85,105,012

 

90,221,140

 

12,741,659

 

 

 

 

 

 

 

 

 

 

 

Non-current assets:

 

 

 

 

 

 

 

 

 

Property, equipment and software, net

 

6

 

4,621,712

 

4,569,982

 

645,405

 

Land use rights, net

 

7

 

3,707,179

 

3,687,971

 

520,841

 

Operating lease right-of-use assets, net

 

7

 

463,688

 

502,941

 

71,029

 

Deferred tax assets

 

 

 

903,904

 

934,604

 

131,991

 

Time deposits

 

2(d)

 

2,360,000

 

3,850,000

 

543,724

 

Long-term investments

 

8

 

9,293,868

 

9,217,017

 

1,301,691

 

Other long-term assets

 

9

 

5,666,610

 

5,670,163

 

800,780

 

Assets held for sale

 

 

 

2,398

 

 

 

Total non-current assets

 

 

 

27,019,359

 

28,432,678

 

4,015,461

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

 

 

112,124,371

 

118,653,818

 

16,757,120

 

 

 

 

 

 

 

 

 

 

 

Liabilities, Redeemable noncontrolling interests and Shareholders’ equity

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable

 

 

 

1,212,303

 

1,197,007

 

169,050

 

Salary and welfare payables

 

 

 

2,957,360

 

2,429,147

 

343,061

 

Taxes payable

 

10(b)

 

3,156,513

 

4,390,606

 

620,072

 

Short-term loans

 

11

 

16,828,226

 

19,624,535

 

2,771,514

 

Deferred revenue

 

13

 

8,602,227

 

9,981,353

 

1,409,636

 

Accrued liabilities and other payables

 

12

 

5,292,774

 

5,546,607

 

783,331

 

Short-term operating lease liabilities

 

 

 

191,454

 

238,071

 

33,622

 

Liabilites held for sale

 

 

 

2,156

 

87

 

12

 

Total current liabilities

 

 

 

38,243,013

 

43,407,413

 

6,130,298

 

 

 

 

 

 

 

 

 

 

 

Non-current liabilities:

 

 

 

 

 

 

 

 

 

Deferred tax liabilities

 

 

 

382,030

 

625,578

 

88,348

 

Long-term operating lease liabilities

 

 

 

279,949

 

282,892

 

39,952

 

Other long-term payable

 

 

 

176,963

 

144,384

 

20,391

 

Liabilities held for sale

 

 

 

961

 

 

 

Total non-current liabilities

 

 

 

839,903

 

1,052,854

 

148,691

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

 

39,082,916

 

44,460,267

 

6,278,989

 

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies

 

17

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

14

 

10,448,600

 

10,385,411

 

1,466,700

 

 

 

 

 

 

 

 

 

 

 

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 3,221,331 shares issued and outstanding as of March 31, 2020

 

 

 

2,640

 

2,654

 

375

 

Additional paid-in capital

 

 

 

3,913,656

 

4,687,742

 

662,036

 

Treasury Stock

 

 

 

 

(2,395,815

)

(338,354

)

Statutory reserves

 

 

 

1,215,208

 

1,215,208

 

171,620

 

Accumulated other comprehensive (loss)/income

 

 

 

(71,445

)

69,456

 

9,809

 

Retained earnings

 

 

 

56,393,640

 

59,018,101

 

8,334,948

 

NetEase, Inc.’s shareholders’ equity

 

 

 

61,453,699

 

62,597,346

 

8,840,434

 

Noncontrolling interests

 

14

 

1,139,156

 

1,210,794

 

170,997

 

Total shareholders’ equity

 

 

 

62,592,855

 

63,808,140

 

9,011,431

 

 

 

 

 

 

 

 

 

 

 

Total liabilities, redeemable noncontrolling interests and shareholders’ equity

 

 

 

112,124,371

 

118,653,818

 

16,757,120

 

 

The accompanying notes form an integral part of these unaudited condensed consolidated financial statements.

 

F-2


 

Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income

(in thousands except per share data or per ADS data)

 

 

 

 

 

For the three months ended March 31,

 

 

 

Notes

 

2019

 

2020

 

2020

 

 

 

 

 

RMB

 

RMB

 

US$

 

 

 

 

 

 

 

 

 

Note 2(a)

 

Net revenues:

 

 

 

 

 

 

 

 

 

Online game

 

20

 

11,850,184

 

13,518,244

 

1,909,141

 

Youdao

 

20

 

225,731

 

541,388

 

76,459

 

Innovative businesses and others

 

20

 

2,346,294

 

3,002,735

 

424,067

 

Total net revenues

 

 

 

14,422,209

 

17,062,367

 

2,409,667

 

Cost of revenues

 

20

 

(6,684,535

)

(7,684,745

)

(1,085,293

)

Gross profit

 

 

 

7,737,674

 

9,377,622

 

1,324,374

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Selling and marketing expenses

 

 

 

(1,158,090

)

(1,863,071

)

(263,116

)

General and administrative expenses

 

 

 

(786,850

)

(885,434

)

(125,047

)

Research and development expenses

 

 

 

(2,037,694

)

(2,142,649

)

(302,600

)

Total operating expenses

 

 

 

(3,982,634

)

(4,891,154

)

(690,763

)

Operating profit

 

 

 

3,755,040

 

4,486,468

 

633,611

 

Other income/(expenses):

 

 

 

 

 

 

 

 

 

Investment income/(losses), net

 

 

 

155,824

 

(109,731

)

(15,497

)

Interest income, net

 

 

 

172,206

 

345,184

 

48,749

 

Exchange (losses)/gains

 

 

 

(39,520

)

244,057

 

34,467

 

Other, net

 

 

 

37,164

 

66,708

 

9,421

 

Income before tax

 

 

 

4,080,714

 

5,032,686

 

710,751

 

Income tax

 

10(a)

 

(1,266,685

)

(1,082,033

)

(152,812

)

Net income from continuing operations

 

 

 

2,814,029

 

3,950,653

 

557,939

 

Net loss from discontinued operations

 

 

 

(350,755

)

 

 

Net income

 

 

 

2,463,274

 

3,950,653

 

557,939

 

Accretion and deemed dividends in connection with repurchase of redeemable noncontrolling interests

 

 

 

(68,783

)

(386,019

)

(54,516

)

Net income attributable to noncontrolling interests and redeemable noncontrolling interests

 

 

 

(12,373

)

(13,628

)

(1,925

)

Net income attributable to NetEase, Inc.’s shareholders

 

 

 

2,382,118

 

3,551,006

 

501,498

 

Including:

 

 

 

 

 

 

 

 

 

Net income from continuing operations attributable to NetEase, Inc.’s shareholders

 

 

 

2,732,873

 

3,551,006

 

501,498

 

Net loss from discontinued operations attributable to NetEase, Inc.’s shareholders

 

 

 

(350,755

)

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

2,463,274

 

3,950,653

 

557,939

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

 

(58,761

)

150,103

 

21,199

 

Total other comprehensive (loss)/income

 

 

 

(58,761

)

150,103

 

21,199

 

Total comprehensive income

 

 

 

2,404,513

 

4,100,756

 

579,138

 

Comprehensive income attributable to noncontrolling interests and redeemable noncontrolling interests

 

 

 

(12,373

)

(22,830

)

(3,224

)

Comprehensive income attributable to NetEase, Inc.’s shareholders

 

 

 

2,392,140

 

4,077,926

 

575,914

 

 

 

 

 

 

 

 

 

 

 

Net income/(loss) per share, basic

 

 

 

0.74

 

1.10

 

0.16

 

-Continuing operations

 

 

 

0.85

 

1.10

 

0.16

 

-Discontinued operations

 

 

 

(0.11

)

 

 

 

 

 

 

 

 

 

 

 

 

Net income/(loss) per ADS, basic

 

 

 

18.57

 

27.47

 

3.88

 

-Continuing operations

 

 

 

21.31

 

27.47

 

3.88

 

-Discontinued operations

 

 

 

(2.74

)

 

 

 

 

 

 

 

 

 

 

 

 

Net income/(loss) per share, diluted

 

16

 

0.74

 

1.08

 

0.15

 

-Continuing operations

 

 

 

0.85

 

1.08

 

0.15

 

-Discontinued operations

 

 

 

(0.11

)

 

 

 

 

 

 

 

 

 

 

 

 

Net income/(loss) per ADS, diluted

 

 

 

18.43

 

27.12

 

3.83

 

-Continuing operations

 

 

 

21.14

 

27.12

 

3.83

 

-Discontinued operations

 

 

 

(2.71

)

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of ordinary shares outstanding, basic

 

16

 

3,206,194

 

3,231,395

 

3,231,395

 

Weighted average number of ADS outstanding, basic

 

 

 

128,248

 

129,256

 

129,256

 

Weighted average number of ordinary shares outstanding, diluted

 

16

 

3,231,321

 

3,273,999

 

3,273,999

 

Weighted average number of ADS outstanding, diluted

 

 

 

129,253

 

130,960

 

130,960

 

 

The accompanying notes form an integral part of these unaudited condensed consolidated financial statements.

 

F-3


 

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity (in thousands)

 

 

 

Ordinary shares

 

Additional
paid-in

 

Treasury stock

 

Statutory

 

Accumulated
other
comprehensive

 

Retained

 

Noncontrolling

 

Total shareholders’

 

 

 

Share

 

Amount

 

capital

 

Share

 

Amount

 

reserves

 

income

 

earnings

 

interests

 

equity

 

 

 

 

 

RMB

 

RMB

 

 

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

RMB

 

Balance as of January 1, 2019

 

3,199,018

 

2,620

 

 

 

 

1,214,578

 

17,050

 

43,997,388

 

794,209

 

46,025,845

 

Ordinary shares issued upon settlement of restricted share units

 

20,832

 

14

 

(14

)

 

 

 

 

 

 

 

Share-based compensation

 

 

 

626,814

 

 

 

 

 

 

8,384

 

635,198

 

Net income attributable to NetEase, Inc. and noncontrolling interest shareholders

 

 

 

 

 

 

 

 

2,450,901

 

12,373

 

2,463,274

 

Dividends to shareholders

 

 

 

 

 

 

 

 

(413,589

)

 

(413,589

)

Foreign currency translation adjustment

 

 

 

 

 

 

 

(58,761

)

 

 

(58,761

)

Accretion of redeemable noncontrolling interests

 

 

 

 

 

 

 

 

(68,783

)

(2,923

)

(71,706

)

Balance as of March 31, 2019

 

3,219,850

 

2,634

 

626,800

 

 

 

1,214,578

 

(41,711

)

45,965,917

 

812,043

 

48,580,261

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of January 1, 2020

 

3,228,531

 

2,640

 

3,913,656

 

 

 

1,215,208

 

(71,445

)

56,393,640

 

1,139,156

 

62,592,855

 

Ordinary shares issued upon settlement of restricted share units

 

20,577

 

14

 

(14

)

 

 

 

 

 

 

 

Share-based compensation

 

 

 

639,895

 

 

 

 

 

 

17,285

 

657,180

 

Net income attributable to NetEase, Inc. and noncontrolling interest shareholders

 

 

 

 

 

 

 

 

3,937,025

 

13,628

 

3,950,653

 

Repurchase of shares

 

 

 

 

(27,777

)

(2,395,815

)

 

 

 

 

(2,395,815

)

Repurchase of noncontrolling interest and redeemable noncontrolling interests

 

 

 

(10,045

)

 

 

 

 

(237,723

)

(3,068

)

(250,836

)

Capital injection in subsidiaries by noncontrolling interest shareholders

 

 

 

144,250

 

 

 

 

 

 

37,380

 

181,630

 

Dividends to shareholders

 

 

 

 

 

 

 

 

(926,545

)

 

(926,545

)

Foreign currency translation adjustment

 

 

 

 

 

 

 

140,901

 

 

9,202

 

150,103

 

Accretion of redeemable noncontrolling interests

 

 

 

 

 

 

 

 

(148,296

)

(2,789

)

(151,085

)

Balance as of March 31, 2020

 

3,249,108

 

2,654

 

4,687,742

 

(27,777

)

(2,395,815

)

1,215,208

 

69,456

 

59,018,101

 

1,210,794

 

63,808,140

 

 

The accompanying notes form an integral part of these unaudited condensed consolidated financial statements

 

F-4


 

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

 

 

 

For the three months ended March 31,

 

 

 

2019

 

2020

 

2020

 

 

 

RMB

 

RMB

 

US$

 

 

 

 

 

 

 

Note 2(a)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

2,463,274

 

3,950,653

 

557,939

 

Net loss from discontinued operations

 

350,755

 

 

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

581,177

 

690,057

 

97,455

 

Fair value change of equity security investments

 

(129,912

)

327,040

 

46,187

 

Investment impairment

 

96,099

 

6,600

 

932

 

Share-based compensation cost

 

620,799

 

665,814

 

94,031

 

(Reversal of)/ allowance for doubtful debts

 

(18,319

)

49,939

 

7,053

 

Loss on disposal of property, equipment and software

 

2,738

 

37

 

5

 

Unrealized exchange losses/(gains)

 

41,806

 

(242,508

)

(34,249

)

Gain on disposal of long-term investments, business and subsidiaries

 

(11,978

)

(15,433

)

(2,180

)

Deferred income taxes

 

303,052

 

212,848

 

30,060

 

Net equity share of losses/(gains) from equity method investees

 

17,454

 

(46,211

)

(6,526

)

Fair value changes of short-term investments

 

(124,648

)

(153,106

)

(21,623

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

(609,092

)

(430,535

)

(60,803

)

Inventories

 

163,004

 

88,440

 

12,490

 

Prepayments and other assets

 

(979,373

)

(1,103,798

)

(155,886

)

Accounts payable

 

94,147

 

(98,679

)

(13,936

)

Salary and welfare payables

 

(484,045

)

(537,907

)

(75,967

)

Taxes payable

 

939,359

 

1,234,078

 

174,285

 

Deferred revenue

 

151,641

 

1,379,126

 

194,770

 

Accrued liabilities and other payables

 

(842,077

)

524,194

 

74,030

 

Net cash provided by continuing operating activities

 

2,625,861

 

6,500,649

 

918,067

 

Net cash provided by discontinued operating activities

 

760,713

 

 

 

Net cash provided by operating activities

 

3,386,574

 

6,500,649

 

918,067

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchase of property, equipment and software

 

(369,590

)

(164,320

)

(23,206

)

Proceeds from sale of property, equipment and software

 

3,820

 

772

 

109

 

Purchase of intangible assets, content and licensed copyrights

 

(851,560

)

(306,835

)

(43,333

)

Net change of short-term investments with terms of three months or less

 

(40,255

)

(780,535

)

(110,233

)

Purchase of short-term investments

 

(4,890,000

)

(10,070,000

)

(1,422,156

)

Proceeds from maturities of short-term investments

 

2,311,322

 

6,887,976

 

972,768

 

Investment in equity method investees

 

(11,200

)

(9,643

)

(1,362

)

Acquisitions of other equity investments

 

(380,816

)

(195,362

)

(27,590

)

Proceeds from disposal of subsidiaries, investment in equity method investees and other equity investments

 

208,682

 

196,952

 

27,815

 

Placement/rollover of time deposits

 

(16,596,540

)

(11,667,487

)

(1,647,764

)

Proceeds from maturity of time deposits

 

15,959,459

 

13,640,617

 

1,926,423

 

Change in other long-term assets

 

(31,759

)

(10,522

)

(1,486

)

Amounts received from disposed businesses

 

651,176

 

 

 

Net cash used in continuing investing activities

 

(4,037,261

)

(2,478,387

)

(350,015

)

Net cash used in discontinued investing activities

 

(704,004

)

 

 

Net cash used in investing activities

 

(4,741,265

)

(2,478,387

)

(350,015

)

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Net proceeds from short-term loan with terms of three months or less

 

741,113

 

2,539,570

 

358,656

 

Proceeds of short-term loan

 

15,000

 

100,000

 

14,123

 

Repayment of short-term loan

 

 

(98,395

)

(13,896

)

Dividends paid to shareholders

 

(413,589

)

(926,545

)

(130,853

)

Repurchase of redeemable noncontrolling interests

 

 

(462,632

)

(65,336

)

Proceeds from issuance of redeemable noncontrolling interest shareholders, net of issuance cost

 

68,611

 

 

 

Capital injection from noncontrolling interest shareholders

 

 

15,000

 

2,118

 

Cash paid for repurchase of Netease’s ADSs/ purchase of Youdao’s ADSs

 

 

(2,560,897

)

(361,668

)

Net cash provided by/(used in) financing activities*

 

411,135

 

(1,393,899

)

(196,856

)

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash, cash equivalents and restricted cash held in foreign currencies

 

(17,894

)

74,100

 

10,465

 

 

 

 

 

 

 

 

 

Net (decrease)/increase in cash, cash equivalents and restricted cash

 

(961,450

)

2,702,463

 

381,661

 

Cash, cash equivalents and restricted cash, beginning of the period

 

10,206,538

 

6,397,860

 

903,550

 

Cash, cash equivalents and restricted cash, end of the period

 

9,245,088

 

9,100,323

 

1,285,211

 

Less: Cash, cash equivalents and restricted cash of held for sales at end of the period

 

580,979

 

371

 

52

 

Cash, cash equivalents and restricted cash of continuing operations, end of the period

 

8,664,109

 

9,099,952

 

1,285,159

 

 

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information of continuing operation:

 

 

 

 

 

 

 

Cash paid for income taxes, net of tax refund

 

535,723

 

202,044

 

28,534

 

Cash paid for interest expenses

 

108,664

 

96,711

 

13,658

 

Supplemental schedule of non-cash investing and financing activities of continuning operation:

 

 

 

 

 

 

 

Fixed asset purchases financed by accounts payable and accrued liabilities

 

253,232

 

377,564

 

53,322

 

 


*There is no financing activity from discontinued operations.

 

The accompanying notes form an integral part of these unaudited condensed consolidated financial statements

 

F-5


 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2020

(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. As of March 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 condensed 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 March 31, 2020 are described below:

 

Major Subsidiaries

 

Place and year of
Incorporation

Guangzhou Boguan Telecommunication Technology Co., Ltd. (“Boguan”)

 

Guangzhou, China 2003

NetEase (Hangzhou) Network Co., Ltd. (“NetEase Hangzhou”)

 

Hangzhou, China 2006

Hong Kong NetEase Interactive Entertainment Limited

 

Hong Kong, China 2007

 

Major VIEs and VIEs’ subsidiaries

 

Place and year of
Incorporation

Guangzhou NetEase Computer System Co., Ltd. (“Guangzhou NetEase”)

 

Guangzhou, China 1997

Shanghai EaseNet Network Technology Co., Ltd. (“Shanghai EaseNet”)

 

Shanghai, China 2008

StormNet Information Technology (Hong Kong) Limited (“StormNet IT HK”)

 

Hong Kong, China 2008

StormNet Information Technology (Shanghai) Co., Ltd. (“StormNet IT SH”)

 

Shanghai, China 2008

Hangzhou NetEase Leihuo Technology Co., Ltd. (“HZ Leihuo”, formerly known as Hangzhou NetEase Leihuo Network Co., Ltd.)

 

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 Group’s mobile game business.

 

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.

 

(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-6


 

2.                  Summary of Significant Accounting Policies

 

(a)             Basis of presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by US GAAP for a complete set of financial statements. Certain information and note disclosures normally included in our annual financial statements prepared in accordance with US GAAP have been condensed or omitted consistent with Article 10 of Regulation S-X.

 

The unaudited condensed consolidated financial statements have been prepared on the same basis as the audited financial statements and include all adjustments as necessary for the fair statement of the Group’s financial position as of March 31, 2020, and the results of operations and cash flows for the three months ended March 31, 2019 and 2020. The consolidated balance sheet at December 31, 2019 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by US GAAP. The unaudited condensed consolidated financial statements and related disclosures have been prepared with the presumption that users of the unaudited condensed consolidated financial statements have read or have access to the audited consolidated financial statements for the preceding fiscal years. Accordingly, these financial statements should be read in conjunction with the audited consolidated financial statements and related footnotes for the years ended December 31, 2019. Results for the three months ended March 31, 2020 are not necessarily indicative of the results expected for the full fiscal year or for any future period.

 

Translations of balances in the condensed consolidated balance sheets, condensed consolidated statements of operations and comprehensive income and condensed consolidated statement of cash flows from Renminbi (“RMB”) into the United States Dollar (“US$”) as of and for the three months ended March 31, 2020 are solely for the convenience of the readers and are calculated at the rate of US$1.00 = RMB7.0808, representing the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on March 31, 2020. No representation is made that the RMB amounts could have been, or could be, converted, realized or settled into US$ at this rate, or at any other rate.

 

(b)             Basis of consolidation

 

The condensed 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. The nature of the businesses and activities of the consolidated VIEs have not changed materially from the preceding fiscal year.

 

(c)              Use of estimates

 

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.

 

(d)             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 US 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 March 31, 2020, there were cash at bank and demand deposits with terms of less than three months denominated in US dollars, HK dollars and Euro amounting to approximately US$327.4 million, HK$5.0 million and Euro0.4 million, respectively (equivalent to approximately RMB2,319.5 million, RMB4.5 million and RMB2.8 million, respectively).

 

F-7


 

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 US dollars amounting to approximately US$4,382.9 million (equivalent to approximately RMB30,576.3 million). As of March 31, 2020, there were time deposits denominated in US dollars amounting to approximately US$4,497.4 million (equivalent to approximately RMB31,864.5 million).

 

As of December 31,2019 and March 31, 2020, the Group had approximately RMB14.8 billion and RMB17.6 billion cash and cash equivalents and time deposits held by its PRC subsidiaries and VIEs, representing 25.0% and 29.3% of total cash and cash equivalents and time deposits of the Group, respectively.

 

As of December 31,2019 and March 31, 2020, the Group had a restricted cash balance approximately RMB3,150.4 million and RMB3,507.1 million, respectively, comprising as follows (in millions):

 

 

 

December 31,
2019

 

March 31,
2020

 

 

 

RMB

 

RMB

 

Customer deposit of NetEase Pay accounts

 

1,523.3

 

1,879.1

 

Pledge deposits for short-term bank borrowings

 

1,595.0

 

1,595.0

 

Others

 

32.1

 

33.0

 

Total

 

3,150.4

 

3,507.1

 

 

The Group had no other lien arrangements during the three months ended March 31, 2019 and 2020.

 

(e)              Credit Losses

 

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 Company adopted the new standard effective January 1, 2020 on a modified retrospective basis. The cumulative impact of adopting Topic 326 on the beginning retained earnings as of January 1, 2020 and on the Company’s operating results for the three months ended March 31, 2020 is immaterial.

 

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 in September 2019, Kaola was deconsolidated from the Group and its historical financial results are reflected in the Group’s consolidated financial statements as discontinued operations. The financial results of Kaola in the prior period are reflected on the same basis to provide the comparable financial information.

 

4.                  Concentrations and Risks

 

(a)             Credit risk

 

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 March 31, 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 consider 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. Only one distribution channel had a receivable balance exceeding 10% of the total accounts receivable balance as of December 31, 2019 and March 31, 2020.

 

(b)             Major Customers

 

No single customer represented 10% or more of the Group’s total net revenues for the three months ended March 31, 2019 and March 31, 2020.

 

F-8


 

5.                  Prepayments and Other Current Assets

 

The following is a summary of prepayments and other current assets (in thousands):

 

 

 

December 31,
2019

 

March 31,
2020

 

 

 

RMB

 

RMB

 

Guarantee payment made to Blizzard - royalty fees

 

356,033

 

1,129,699

 

Prepayment for royalties, revenue sharing cost

 

2,627,048

 

2,809,860

 

Interest and other operating income receivable

 

524,069

 

708,548

 

Prepayments of content and marketing cost and other operational expenses

 

569,122

 

598,214

 

Prepayment for sales tax and deductible value added tax

 

483,547

 

461,822

 

Bridge loans in connection with ongoing investments

 

21,259

 

21,578

 

Deposits

 

11,882

 

38,017

 

Employee advances

 

79,823

 

76,816

 

Advance to suppliers

 

26,664

 

55,179

 

Others

 

117,975

 

160,688

 

 

 

4,817,422

 

6,060,421

 

 

6.                  Property, Equipment and Software

 

The following is a summary of property, equipment and software (in thousands):

 

 

 

December 31,
2019

 

March 31,
2020

 

 

 

RMB

 

RMB

 

Building and decoration

 

2,987,003

 

2,989,873

 

Leasehold improvements

 

153,145

 

157,514

 

Furniture, fixtures and office equipment

 

198,909

 

198,813

 

Vehicles

 

74,487

 

75,048

 

Servers and computers

 

4,066,925

 

4,248,148

 

Software

 

181,223

 

184,393

 

Construction in progress

 

465,993

 

505,061

 

 

 

8,127,685

 

8,358,850

 

 

 

 

 

 

 

Less: accumulated depreciation

 

(3,505,973

)

(3,788,868

)

 

 

 

 

 

 

Net book value

 

4,621,712

 

4,569,982

 

 

Depreciation expense was RMB266.4 million and RMB285.1 million for the three months ended March 31, 2019 and 2020, respectively.

 

7.                  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 RMB3,688.0 million were identified as operating lease right-of-use assets as of December 31, 2019 and March 31, 2020, respectively.

 

The Group’s leases have remaining lease terms of 1 months to 49 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.

 

F-9


 

8.                  Long-term Investments

 

The following is a summary of long-term investments (in thousands):

 

 

 

December 31,
2019

 

March 31,
2020

 

 

 

RMB

 

RMB

 

Investments in equity method investees

 

1,137,774

 

1,178,773

 

Equity investments with readily determinable fair values

 

3,551,545

 

3,264,128

 

Equity investments without readily determinable fair values

 

4,604,549

 

4,774,116

 

 

 

9,293,868

 

9,217,017

 

 

(a)         Investments in equity method investees

 

The Group recorded equity share of losses of RMB17.5 million and equity share of earnings of RMB46.2 million for the three months ended March 31, 2019, and 2020, respectively, which was included in “investment income, net” in the condensed consolidated statements of operations and comprehensive income.

 

(b)         Equity investments with readily determinable fair values

 

As of March 31, 2020, equity investments with readily determinable fair values included RMB2,468.2 million invested in shares of Alibaba Group Holding Limited (“Alibaba”),  RMB493.6 million invested in shares of Huatai Securities Company Limited (“Huatai”) and RMB302.3 million invested in shares of Shenzhen Transsion Holding Limited (“Transsion”). The Group recorded fair value gain of RMB141.9 million and fair value loss of RMB327.0 million related to the equity investments with readily determinable fair value for the three months ended March 31, 2019 and 2020, respectively.

 

(c)          Equity investments without readily determinable fair value

 

The Group recognized impairment provision of RMB87.7 million and RMB6.6 million related to certain of the equity investments as “investment income/(losses), net” in the condensed consolidated statements of operations and comprehensive income for the three months ended March 31, 2019 and 2020, respectively.

 

9.                  Other Long-term Assets

 

The following is a summary of other long-term assets (in thousands):

 

 

 

December 31,

 

March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

Copyrights, licenses and domain names

 

3,639,211

 

3,459,151

 

Long-term receivable

 

1,599,524

 

1,621,304

 

Staff housing loans

 

71,997

 

62,487

 

Non-current deposits

 

140,869

 

139,546

 

Others

 

215,009

 

387,675

 

 

 

5,666,610

 

5,670,163

 

 

10.           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.

 

F-10


 

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. For the three months ended March 31, 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 Law, under which Foreign Invested Enterprise s (“FIEs”) and domestic companies would be subject to enterprise income tax (“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 Enterprise Income Tax Law became effective on January 1, 2008.

 

Boguan, NetEase Hangzhou and certain PRC subsidiaries were qualified as HNTEs and enjoyed a preferential tax rate of 15% for the three months ended March 31, 2019 and 2020. Certain PRC subsidiaries were also qualified as a Key Software Enterprise and enjoyed a further reduced preferential tax rate of 10% and the related tax benefit was recorded in the period in which the Key Software Enterprise status is recognized and notified.

 

The following table sets forth the component of income tax expenses of the Group for the three months ended March 31, 2019 and 2020 (in thousands):

 

 

 

For the three months ended March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

Current tax expense

 

963,633

 

869,185

 

Deferred tax expense

 

303,052

 

212,848

 

Income tax expenses

 

1,266,685

 

1,082,033

 

 

(b)             Taxes Payable

 

The following is a summary of taxes payable as of December 31, 2019 and March 31, 2020 (in thousands):

 

 

 

December 31,

 

March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

Sales Tax payable

 

541,175

 

359,579

 

Withholding individual income taxes for employees

 

190,340

 

948,952

 

Enterprise income taxes

 

2,377,655

 

3,044,903

 

Others

 

47,343

 

37,172

 

 

 

3,156,513

 

4,390,606

 

 

11.           Short-term Loans

 

As of December 31, 2019 and March 31, 2020, the short-term loans balances represent short-term loan arrangements with banks which were repayable within a maturity term within one year and charged at a fixed interest rates ranging from 0.68% to 4.57% and 0.68% to 2.41% per annum, respectively. As of December 31, 2019 and March 31, 2020, the weighted average interest rate for the outstanding short-term loans was approximately 2.38% and 1.54%, respectively. The short-term loans are denominated in US$, EUR, GBP, CAD, HK$, JPY or CNY.

 

As of December 31, 2019 and March 31, 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 RMB1,595.0 million (US$225.3 million), which was recognized as restricted cash (see Note 2(d)).

 

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$200.0 million of borrowings outstanding under the syndicated facility as of March 31, 2020. The Group was subject to certain covenants under the syndicated facility agreement and was in compliance with these covenants as of March 31, 2020.

 

F-11


 

12.           Accrued Liabilities and Other Payables

 

The following is a summary of accrued liabilities and other payables as of December 31, 2019 and March 31, 2020 (in thousands):

 

 

 

December 31,

 

March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

Customer deposits on NetEase Pay accounts

 

1,539,417

 

1,933,706

 

Marketing expenses and promotion materials

 

1,672,096

 

1,343,975

 

Accrued fixed assets related payables

 

304,379

 

291,400

 

Server and bandwidth service fees and technical charges

 

231,868

 

206,128

 

Accrued revenue sharing

 

578,940

 

623,924

 

Content cost

 

403,402

 

561,872

 

Professional fees

 

88,041

 

130,740

 

Accrued freight and warehousing charge

 

47,524

 

49,846

 

Other staff related cost

 

69,849

 

150,127

 

Others

 

357,258

 

254,889

 

 

 

5,292,774

 

5,546,607

 

 

13.           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 three months ended March 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.

 

As of March 31, 2020, a significant majority of the balances of deferred revenue are generally recognized 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.

 

14.           Noncontrolling Interests and Redeemable Noncontrolling Interests

 

NetEase Cloud Music

 

During 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, respectively.

 

In the first quarter of 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 RMB240.6 million was recognized as a deemed dividend to preferred shareholders, which also reduces the numerator for EPS calculation.

 

F-12


 

As of March 31, 2020, the NetEase Cloud Music Preferred Shares investors together held approximately 36.5% 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.

 

15.           Share-based Compensation

 

(a)             Restricted share units plan

 

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 condensed 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 three months ended March 31, 2019 and 2020 (in thousands):

 

 

 

For the three months
ended March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

Cost of revenues

 

199,209

 

207,915

 

Selling and marketing expenses

 

25,247

 

24,811

 

General and administrative expenses

 

197,858

 

230,371

 

Research and development expenses

 

198,485

 

202,717

 

 

 

620,799

 

665,814

 

 

As of March 31, 2020, total unrecognized compensation cost related to unvested awards under the restricted share unit plans, adjusted for estimated forfeitures, was US$546.9 million (RMB3,872.6 million) and is expected to be recognized through the remaining vesting period of each grant. As of March 31, 2020, the weighted average remaining vesting periods was 2.35 years.

 

F-13


 

(c)              Restricted share units award activities

 

The following table presents a summary of the Company’s RSUs award activities for the three months ended March 31, 2020:

 

 

 

Number of RSUs

 

Weighted average
grant date fair
value

 

 

 

(in thousands)

 

US$

 

 

 

 

 

 

 

Outstanding at January 1, 2020

 

2,815

 

244.99

 

Granted

 

1,005

 

312.75

 

Vested

 

(823

)

231.99

 

Forfeited

 

(16

)

251.46

 

Outstanding at March 31, 2020

 

2,981

 

271.39

 

 

The aggregate intrinsic value of RSUs outstanding as of March 31, 2020 was US$956.6 million. The intrinsic value was calculated based on the Company’s closing stock price of US$320.96 per ADS as of March 31, 2020.

 

The number of shares available for future grant under the Company’s 2019 RSU Plan was 304,776,175 as of March 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 three months ended March 31, 2019 and 2020, RMB7.2 million and RMB23.4 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 March 31, 2020, there were RMB314.8 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.

 

F-14


 

16.           Net Income Per Share

 

The following table sets forth the computation of basic and diluted net income per share for the three months ended March 31, 2019 and 2020:

 

 

 

For the three months ended March 31,

 

 

 

2019

 

2020

 

Numerator (RMB in thousands):

 

 

 

 

 

Net income from continuing operations attributable to NetEase, Inc’s shareholders

 

2,732,873

 

3,551,006

 

Net loss from discontinued operations attributable to NetEase, Inc’s shareholders

 

(350,755

)

 

Net income attributable to NetEase, Inc.’s shareholders for basic/dilutive net income per share calculation

 

2,382,118

 

3,551,006

 

Denominator (No. of shares in thousands):

 

 

 

 

 

Weighted average number of ordinary shares outstanding, basic

 

3,206,194

 

3,231,395

 

Dilutive effect of employee stock options and restricted share units

 

25,127

 

42,604

 

Weighted average number of ordinary shares outstanding, diluted

 

3,231,321

 

3,273,999

 

 

 

 

 

 

 

Net income per share from continuing operations attributable to NetEase, Inc’s shareholders, basic (RMB)

 

0.85

 

1.10

 

Net loss per share from discontinued operations attributable to NetEase, Inc’s shareholders, basic (RMB)

 

(0.11

)

 

Net income per share, basic (RMB)

 

0.74

 

1.10

 

Net income per share from continuing operations attributable to NetEase, Inc’s shareholders, diluted (RMB)

 

0.85

 

1.08

 

Net loss per share from discontinued operations attributable to NetEase, Inc’s shareholders, diluted (RMB)

 

(0.11

)

 

Net income per share, diluted (RMB)

 

0.74

 

1.08

 

 

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 three months ended March 31, 2019 and 2020, options to purchase ordinary shares and RSUs that were anti-dilutive and excluded from the calculation of diluted net income per share totaled approximately 34.2 million shares and 17.4 million shares, respectively.

 

17.           Contingencies

 

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 March 31, 2020.

 

F-15


 

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, 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.  As at the date of this report, this lawsuit against PUBG is on-going.

 

18.           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.

 

Dividends are recognized when declared. There is no dividend payable as of December 31, 2019 and March 31, 2020, 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.

 

19.           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.

 

In November 2019, the Company announced that its board of directors had 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. As of March 31, 2020, approximately 134,000 Youdao’s ADSs had been purchased under this program for a total cost of US$2.1 million.

 

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.

 

As of March 31, 2020, approximately 1.1 million ADSs had been purchased under this program for a total cost of US$341.9 million.

 

20.           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.

 

F-16


 

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 condensed consolidated balance sheets, condensed consolidated statements of operations and comprehensive income or condensed consolidated statements of cash flows. The Group retrospectively revised prior year segment information, to conform to current year presentation.

 

(b)             Segment data

 

The table below provides a summary of the Group’s operating segment results for the three months ended March 31, 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 three months ended March 31, 2019 and 2020 (in thousands).

 

 

 

For the three
months ended March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

Net revenues:

 

 

 

 

 

Online game services

 

11,850,184

 

13,518,244

 

Youdao

 

225,731

 

541,388

 

Innovative businesses and others

 

2,346,294

 

3,002,735

 

Total net revenues

 

14,422,209

 

17,062,367

 

 

 

 

 

 

 

Cost of revenues:

 

 

 

 

 

Online game services

 

(4,299,345

)

(4,851,831

)

Youdao

 

(172,836

)

(305,663

)

Innovative businesses and others

 

(2,212,354

)

(2,527,251

)

Total cost of revenues

 

(6,684,535

)

(7,684,745

)

 

 

 

 

 

 

Gross profit:

 

 

 

 

 

Online game services

 

7,550,839

 

8,666,413

 

Youdao

 

52,895

 

235,725

 

Innovative businesses and others

 

133,940

 

475,484

 

Total gross profit

 

7,737,674

 

9,377,622

 

 

The following table set forth the breakdown of net revenues by type of good or service for the three months ended March 31, 2019 and 2020 (in thousands):

 

 

 

For the three
months ended March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

 

 

 

 

 

 

Online games services

 

11,850,184

 

13,518,244

 

Youdao learning services and products

 

135,455

 

442,138

 

Advertising services

 

483,153

 

473,912

 

Others

 

1,953,417

 

2,628,073

 

Total net revenue

 

14,422,209

 

17,062,367

 

 

F-17


 

The following table presents the total depreciation and amortization expenses of property and equipment and land use rights by segment for the three months ended March 31, 2019 and 2020 (in thousands):

 

 

 

For the three
months ended March 31,

 

 

 

2019

 

2020

 

 

 

RMB

 

RMB

 

 

 

 

 

 

 

Online game services

 

52,485

 

66,703

 

Youdao

 

1,085

 

1,604

 

Innovative businesses and others

 

60,325

 

49,916

 

Total depreciation and amortization expenses of property and equipment and land use rights

 

113,895

 

118,223

 

 

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.

 

21.           Subsequent Events

 

After March 31, 2020, the extent and duration of the COVID-19 pandemic remains uncertain. The Group will pay close attention to the development of the COVID-19 outbreak and evaluate its impact on the financial position and operating results of the Group. As at the date on which this set of financial statements were authorised for issue, the Group was not aware of any material adverse effects on the financial statements as a result of the COVID-19 outbreak.

 

In May 2020, the Company’s board of directors approved a dividend of US$1.16 per ADS for the first quarter of 2020, which is expected to be paid on June 23, 2020 to shareholders of record as of the close of business on June 12, 2020.

 

In May 2020, the Company announced that its board of directors had approved an amendment to the share repurchase program to expand the authorized repurchase amount to US$2.0 billion.

 

F-18