UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 20-F
(Mark One)
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO -------------- --------------
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 transaction period from ____________ to __________
COMMISSION FILE NUMBER 1- 32332
CHINA NETCOM GROUP CORPORATION (HONK KONG) LIMITED
(Exact name of Registrant as specified in its charter)
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Hong Kong, The People's Republic of China
(Jurisdiction of incorporation or organization)
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Building C, No. 156 Fuxingmennei Avenue
Xicheng District, Beijing, 100031
The People's Republic of China
(Address of principal executive offices)
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Securities registered or to be registered pursuant to Section 12 (b) of the Act.
Name of Each Exchange
Title of Each Class On Which Registered
------------------- -------------------
American depositary shares, each representing
20 ordinary shares of par value
US$0.04 per share.............................New York Stock Exchange, Inc.
Ordinary shares of par value
US$0.04 per share.............................New York Stock Exchange, Inc.*
__________________
* Not for trading, but only in connection with the registration of American
depositary shares.
Securities registered or to be registered pursuant to Section 12 (g) of the Act:
None
(Title of Class)
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.
As of December 31, 2005, 6,593,529,000 ordinary shares were issued and
outstanding.
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes X 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 X
The Registrant is required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934. Note - Checking the box above will not
relieve any registrant required to file reports pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 from their obligations under those
Sections.
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 X No __
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer.
See definition of "accelerated filer and large accelerated filer" in Rule 12b-2
of the Exchange Act. (Check one):
Large accelerated filer X Accelerated filer __ Non-accelerated filer __
Indicate by check mark which financial statement item the Registrant
has elected to follow.
Item 17 ___ Item 18 X
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).
Yes __ No X
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Table of Contents
Page
PART I........................................................................1
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS..............1
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE............................1
ITEM 3. KEY INFORMATION....................................................2
ITEM 4. INFORMATION ON THE COMPANY........................................16
ITEM 4A. UNRESOLVED STAFF COMMENTS.........................................41
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS......................41
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES........................63
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.................76
ITEM 8. FINANCIAL INFORMATION.............................................85
ITEM 9. THE OFFER AND LISTING.............................................86
ITEM 10. ADDITIONAL INFORMATION............................................87
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK........90
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES............91
PART II......................................................................91
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES...................91
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
USE OF PROCEEDS...................................................92
ITEM 15. CONTROLS AND PROCEDURES...........................................93
ITEM 16A AUDIT COMMITTEE FINANCIAL EXPERT..................................93
ITEM 16B CODE OF ETHICS....................................................93
ITEM 16C PRINCIPAL ACCOUNTANT FEES AND SERVICES............................93
ITEM 16D EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES........94
ITEM 16E PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS........................................................94
ITEM 17. FINANCIAL STATEMENTS..............................................94
ITEM 18. FINANCIAL STATEMENTS..............................................94
ITEM 19. EXHIBITS..........................................................94
FORWARD-LOOKING STATEMENTS
This annual report filed on Form 20-F contains certain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 with respect to financial condition, results of operations, cash flows,
dividends, financing plans, business strategies, capital and other expenditures,
competitive positions, availability of capital, growth opportunities for new and
existing products, availability and deployment of new technologies, plans and
objectives of management, mergers and acquisitions, and other matters.
Statements in this Form 20-F that are not historical facts are hereby
identified as "forward looking statements" for the purpose of the safe harbor
provided by Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. The words "estimate,"
"project," "intend," "expect," "believe," "plan" and similar expressions are
intended to identify forward-looking statements. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date of this document. In addition, other written or oral statements which
constitute forward looking statements have been made and may in the future be
made by us or on our behalf, including with respect to the matters referred to
above. These forward looking statements are necessarily estimates reflecting the
best judgment of senior management that rely on a number of assumptions
concerning future events, many of which are outside of our control, and involve
a number of risks and uncertainties that could cause actual results to differ
materially from those suggested by the forward-looking statements. These
forward-looking statements should, therefore, be considered in light of various
important factors, including those set forth in this annual report. Important
factors that could cause actual results to differ materially from estimates or
projections contained in the forward-looking statements include, without
limitation:
o the level of demand for telecommunications services,
particularly with regard to access lines, traffic and new
value-added services;
o competitive forces in more liberalized markets, including
pricing pressures and our ability to retain market share in
the face of competition from existing telecommunications
companies and potential new market entrants;
o the effects of tariff reduction initiatives, particularly in
our core fixed-line telephone business;
o changes in the regulatory policies of the Ministry of
Information Industry of China and other relevant government
authorities, which could affect, among other things, the
granting of requisite government approvals, licenses and
permits, interconnection and transmission line arrangements,
tariff policies, capital investment priorities, and spectrum
allocation;
o the success of new business initiatives, some of which involve
start-up costs, and new systems and applications, particularly
with regard to the integration of our service offerings;
o our ability to secure or renew the licenses we need to offer
telecommunications services and the cost of these licenses and
related network infrastructure build-outs;
o the success of our Asia-Pacific investments;
o the availability, terms and deployment of capital, and the
impact of regulatory and competitive developments on capital
outlays;
o changes in the assumptions upon which we have prepared our
projected financial information and capital expenditure plans;
o changes in the general political, economic, legal and social
conditions in China, including the PRC government's specific
policies with respect to new entrants in the
telecommunications industry, the entry of foreign operators
into China's telecommunications market, economic growth,
foreign exchange and the availability of credit; and
o risks and uncertainties associated with doing business in many
countries in the Asia-Pacific region.
CONVENTIONS
Definitions
References in this annual report to "we", "us", the "Company" or "CNC
Hong Kong" mean China Netcom Group Corporation (Hong Kong) Limited and, as the
context may require, its subsidiaries. References to "China Netcom Group" mean
China Network Communications Group Corporation and, as the context may require,
its subsidiaries, other than us and our subsidiaries.
As used in this annual report:
o references to "China" or "PRC" mean the People's Republic of
China, excluding, for purposes of this annual report, Hong
Kong, Macau and Taiwan, and references to the "central
government" mean the central government of the PRC;
o references to "State Council" mean the State Council of the
PRC, references to "Ministry of Information Industry" and
"MII" mean the Ministry of Information Industry of the PRC,
and references to the "National Development and Reform
Commission" and the "NDRC" mean the National Development and
Reform Commission of the PRC;
o references to "our northern service region" mean the ten
municipalities and provinces where we operate in northern
China, consisting of Beijing and Tianjin Municipalities, and
Hebei, Henan, Shandong, Liaoning, Heilongjiang, Jilin, and
Shanxi Provinces, and the Inner Mongolia Autonomous Region and
references to "our southern service region" mean Shanghai
Municipality and Guangdong Province;
o references to "HKSE", "SEHK" or "Hong Kong Stock Exchange"
mean The Stock Exchange of Hong Kong Limited, and references
to "NYSE" or "New York Stock Exchange" mean New York Stock
Exchange, Inc;
o references to "Renminbi" or "RMB" are to the currency of the
PRC, references to "U.S. dollars" or "US$" are to the currency
of the United States of America, and references to "HK
dollars" or "HK$" are to the currency of the Hong Kong Special
Administrative Region of the PRC; and
o references to "U.S. GAAP" mean the generally accepted
accounting principles in the United States, references to
"HKFRS" mean Hong Kong Financial Reporting Standards issued by
Hong Kong Institute of Certified Public Accountants, and
references to "PRC GAAP" mean the PRC Accounting Standards for
Business Enterprises and the implementing rules thereof.
Market Share Data Convention
Certain statements made in this annual report that refer to our market
share or competitive position are based on statistical and other information
from a number of government and private sources, including the information
published by the MII. Unless otherwise indicated, the information has not been
verified by us independently and may not be consistent with the information from
other sources within or outside China.
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
SELECTED FINANCIAL DATA
The following tables present our selected consolidated financial data
as of and for the years ended December 31, 2002, 2003, 2004 and 2005.
You should read the selected consolidated financial data below together
with our consolidated financial statements, including the notes thereto,
included elsewhere in this annual report, and "Item 5. Operating and Financial
Review and Prospects".
We publish our financial statements in Renminbi. We have derived the
selected consolidated financial data as of and for the years ended December 31,
2002, 2003, 2004 and 2005 from our consolidated financial statements. Our
consolidated financial statements have been prepared in accordance with Hong
Kong Financial Reporting Standards, or HKFRS, which differ in significant
respects from U.S. GAAP.
Our consolidated financial statements report our results as if (1)
certain assets and liabilities transferred to us from China Netcom Group in
connection with our restructuring in connection with the 2004 global offering
had been transferred to us as of January 1, 2001, (2) certain fixed-line
telecommunications assets and liabilities transferred to us from China Netcom
Group in connection with our acquisition on October 31, 2005, or our 2005
Acquisition, of China Netcom Group's fixed-line telecommunications assets and
liabilities in Heilongjiang Province, Jilin Province, the Inner Mongolia
Autonomous Region and Shanxi Province, or the 2005 Acquired Assets and
Liabilities, had been transferred to us as of January 1, 2002, and (3) in each
case we had owned those assets and liabilities and conducted those operations
throughout the relevant periods. For more details, see "Item 4. Information on
the Company--History and Development".
Since we and the 2005 Acquired Assets and Liabilities were under the
common control of China Netcom Group, our 2005 Acquisition has been treated as a
"combination of entities under common control", which was accounted for in a
manner similar to pooling-of-interests. Accordingly, the 2005 Acquired Assets
and Liabilities have been recognized at historical carrying amounts and our
consolidated financial statements as of and for the years ended December 31,
2002, 2003 and 2004 have been restated to include the financial position and
results of operations of the 2005 Acquired Assets and Liabilities on a combined
basis. All data and information relating to our businesses and operations for
the years ended December 31, 2002, 2003 and 2004 are presented based on those
restated amounts. We have omitted consolidated financial data as of and for the
year ended December 31, 2001 because providing such information would require us
to incur significant expense and devote extraordinary time to derive.
Furthermore, certain amounts in our consolidated financial statements
for the year ended December 31, 2004 have been restated to reflect the changes
in our accounting policies resulting from our adoption of the new and revised
HKFRS in 2005. For more details, please refer to Note 3 to our consolidated
financial statement included elsewhere in this annual report.
Selected Consolidated Financial Information
For the Years Ended December 31,
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2002 2003 2004 2005 2005
---- ---- ---- ---- ----
RMB RMB RMB RMB US$
(in millions, except per share and per ADS information)
Consolidated Income Statement Data:
HKFRS
Revenues:
Domestic telecommunications services:
Fixed-line telephone services(1) 61,766 66,376 69,670 69,647 8,630
Broadband and other Internet-related service 2,682 4,332 6,206 8,352 1,035
Business and data communications services(2) 4,306 4,373 3,615 3,633 450
Other services 1,349 1,138 1,360 2,345 291
International telecommunications services 572 1,379 2,643 3,255 403
Total 70,675 77,598 83,494 87,232 10,809
Operating expenses:
Depreciation and amortization (24,796) (26,800) (25,180) (25,049) (3,104)
Network, operations and support (14,665) (15,108) (13,973) (14,417) (1,787)
Staff costs (9,035) (10,945) (11,950) (12,333) (1,528)
Selling, general and administrative (7,927) (10,322) (12,877) (13,438) (1,665)
Other operating expenses (1,901) (2,197) (1,993) (1,490) (185)
Operating profit before interest income, dividend
income and deficit on revaluation of fixed assets 12,351 12,226 17,521 20,505 2,541
Interest and dividend income 188 140 104 186 23
Deficit on revaluation of fixed assets(3) - (25,778) (11,318) - -
Profit/(Loss) from operations 12,539 (13,412) 6,307 20,691 2,564
Financial costs (4,131) (4,296) (3,930) (3,374) (418)
Share of profit/(loss) of associated companies (1) (416) (1) - -
and jointly controlled entity
Profit/(loss) before taxation 8,407 (18,124) 2,376 17,317 2,146
Taxation (1,789) 7,217 323 (3,429) (425)
Profit/(loss) after taxation 6,618 (10,907) 2,699 13,888 1,721
Minority interests - 1 - - -
Profit/(loss) for the year/period 6,618 (10,906) 2,699 13,888 1,721
Basic earnings/(losses) per share(4) 1.21 (1.99) 0.48 2.11 0.26
Diluted earnings/(losses) per share(4) 1.21 (1.99) 0.48 2.10 0.25
Basic earnings/(losses) per ADS(5) 24.2 (39.8) 9.6 42.2 5.2
Diluted earnings/(losses) per share(5) 24.2 (39.8) 9.6 42.0 5.0
U.S. GAAP
Profit for the year/period 6,572 6,365 7,932 10,465 1,280
Basic earnings /(losses) per share(4) 1.20 1.16 1.41 1.59 0.19
Diluted earnings per share(4) 1.19 1.16 1.41 1.58 0.19
Basic earnings per ADS(5) 24.00 23.20 28.20 31.80 3.80
Diluted earnings per ADS(5) 23.80 23.20 28.20 31.60 3.80
Dividend declared per share - - HKD 0.037 HKD 0.466 USD 0.06
Dividend declared per ADS - - HKD 0.74 HKD 9.32 USD 1.20
------------------
(1) Revenues from fixed-line telephone services included local usage fees,
monthly fees, upfront installation fees, domestic and international long
distance service charges, value-added service charges, interconnection fees
from domestic carriers and upfront connection fees.
(2) Revenues from business and data communications services include fees
charged for managed data and leased line services.
(3) See "Item. 5. Operating and Financial Review and Prospects - Critical
Accounting Policies - Revaluation of fixed assets" for a discussion of this
revaluation.
(4) Basic/diluted earnings/(losses) per share for the years ended December 31,
2002, 2003, 2004 and 2005 set forth above have been computed by
dividing profit/(loss) for each of the year by the weighted average number
of ordinary shares during the year.
(5) Basic/diluted earnings/(losses) per ADS for the years ended December 31,
2002, 2003, 2004 and 2005 set forth above have computed by
multiplying basic earnings/(losses) per share for the year by 20, which is
the number of ordinary shares represented by each ADS.
As at December 31,
-------------------------------------------------
2002 2003 2004 2005 2005
---- ---- ---- ---- ----
RMB RMB RMB RMB US$
(in millions)
Consolidated Balance Sheet Date:
HKFRS
Cash and bank deposits 7,899 7,430 10,633 4,895 607
Accounts receivable 5,896 7,518 7,174 7,401 917
Total current assets 20,780 20,666 24,455 14,499 1,797
Fixed assets and construction in progress 212,053 199,687 177,494 175,485 21,745
Total assets 245,281 236,081 216,417 202,840 25,134
Accounts payable 18,934 20,195 21,125 16,719 2,072
Short-term bank loans and current portion
of long-term bank and other loans 56,406 67,383 56,609 54,187 6,714
Total current liabilities 97,017 118,350 106,044 98,399 12,193
Long-term bank and other loans 40,404 30,172 26,052 18,143 2,248
Deferred revenues 19,744 17,585 13,988 10,925 1,354
Total liabilities 175,510 182,419 151,822 139,830 17,327
Owner's equity 69,767 53,659 64,595 63,010 7,808
U.S. GAAP
Fixed assets and construction in progress 212,053 222,483 204,216 197,097 24,423
Total assets 245,281 258,877 243,139 224,452 27,812
Owner's equity 67,116 66,283 82,664 77,490 9,602
For the Years Ended December 31,
-------------------------------------------------------
2002 2003 2004 2005 2005
---- ---- ---- ---- ----
RMB RMB RMB RMB US$
(in millions)
Consolidated Cash Flow Statement Date:
HKFRS
Net cash inflow from operating activities 30,012 30,917 33,653 33,557 4,158
Net cash outflow from investing activities (34,219) (34,875) (28,702) (24,608) (3,049)
Purchase of fixed assets and construction
in progress including "repayment for
leased land" (34,186) (36,450) (28,256) (27,562) (3,415)
Net cash inflow/(outflow) from financing
activities 3,212 3,595 (1,743) (14,656) (1,816)
EXCHANGE RATE INFORMATION
We prepare our financial statements in Renminbi. Solely for the
convenience of the reader, this annual report contains translations of Renminbi
and Hong Kong dollar amounts into U.S. dollars, and vice versa, at RMB 8.0702 =
US$1.00 and HK$7.7533 = US$1.00, the noon buying rates on December 30, 2005 in
the City of New York for cable transfers as certified for customs purposes by
the Federal Reserve Bank of New York. You should not assume that Renminbi and
Hong Kong dollar amounts could actually be converted into U.S. dollars at these
rates or at all.
On May 31, 2006, the latest practicable date, the noon buying rates
in the City of New York for cable transfers as certified for customs purposes by
the Federal Reserve Bank of New York are RMB 8.0215 = US$1.00 and HK$7.7567 =
US$1.00.
The following table sets forth the high and low noon buying rates
between Renminbi and U.S. dollars and between Hong Kong dollars and U.S. dollars
for each of the periods shown.
Noon Buying Rate
---------------------------------------
RMB per US$ HK$ per US$
------------------ ----------------
High Low High Low
------ ------ ------ ------
December 2005 8.0808 8.0702 7.7548 7.7516
January 2006 8.0702 8.0596 7.7570 7.7506
February 2006 8.0616 8.0415 7.7618 7.7564
March 2006 8.0505 8.0167 7.7620 7.7570
April 2006 8.0248 8.0004 7.7598 7.7529
May 2006 8.0300 8.0005 7.7575 7.7510
The following table sets forth the period-end noon buying rates and the
average noon buying rates between Renminbi and U.S. dollars and between Hong
Kong dollars and U.S. dollars for each of 2001, 2002, 2003, 2004, 2005 and 2006
(through May 31). The average noon buying rates for the periods shown are
calculated by averaging the noon buying rates on the last day of each month in
the period.
Period-End Noon Buying Rate Average(1) Noon Buying Rate
--------------------------- ---------------------------
RMB per US$ HK$ per US$ RMB per US$ HK$ per US$
----------- ----------- ----------- -----------
2001 8.2766 7.7980 8.2772 7.7996
2002 8.2800 7.7988 8.2772 7.7996
2003 8.2767 7.7640 8.2771 7.7864
2004 8.2765 7.7723 8.2768 7.7899
2005 8.0702 7.7533 8.1826 7.7755
2006 (May 31) 8.0215 7.7567 8.0314 7.7760
(1) Determined by averaging the rates on the last business day of each
month during the relevant year, except for the average rate of the
relevant periods in 2006, which is determined by averaging the daily
rates during the respective periods.
CAPITALIZATION AND INDEBTEDNESS
Not applicable.
REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
RISK FACTORS
Risks Relating to Our Business
Increasing competition in each of our service regions and markets may have an
adverse effect on our business growth and financial condition.
The telecommunications industry in China is rapidly evolving. In recent
years, the central government has implemented a number of measures to
restructure, and encourage fair and orderly competition in the
telecommunications industry. As a result, we face increasing competition from
other licensed telecommunications operators in China, including China Telecom
Group, or China Telecom; China Mobile Communications Corporation, or China
Mobile; China United Telecommunications Corporation, or China Unicom; China
Railway Communications Corporation Limited, or China Railcom; and China
Satellite Communications Corporation, or China Satcom. We expect our competitors
to further expand their network coverage and increase their sales and marketing
efforts in our northern and southern service regions. We will also face
competition from foreign-invested telecommunications operators as a result of
China's accession into the World Trade Organization, or the WTO, and the entry
of foreign telecommunications companies into the Chinese market. In addition, we
face competition from other telecommunications operators in our Asia-Pacific
markets. As we operate in an increasingly competitive market, we have
experienced and may continue to experience pressure on operating revenues and
operating margins for some of our telecommunications services.
In our northern service region, competition in fixed-line services and in
broadband and data services may result in lower tariffs, a smaller customer base
and lower usage for our services, thereby adversely affecting our business
growth and financial condition.
We compete with other fixed-line service providers, including China
Telecom, China Unicom and China Railcom, each of which has been licensed to
provide fixed-line telephone services in our northern service region. We have
experienced limited competition from other fixed-line service providers to date
in the market for local telephone services, primarily because our competitors
have not built significant local access infrastructure. However, competition for
the provision of these services may increase in the future as our competitors
develop their own networks, including through the use of alternative
technologies. In the markets for domestic and international long distance
telephone services, we face strong competition from voice over Internet
protocol, or VoIP services, provided by China Telecom, China Mobile, China
Unicom and China Railcom. Tariffs for VoIP services are market-based and
therefore not subject to minimum pricing restriction. In addition, we may face
increasing competition from Internet phone service providers such as Skype and
Vonage if current restrictions on the provision of these services are loosened.
Increased competition from these operators may force us to lower our tariffs or
may reduce the size of our customer base and the usage of our networks. Any of
these developments may materially adversely affect our business growth and
financial condition.
Mobile service substitution for our fixed-line telephone services has
also created considerable competition in the markets for local and long distance
telephone services. Consistent with trends in global markets in recent years, an
increasing proportion of total voice traffic is being carried by mobile
networks. Currently, China Mobile and China Unicom are the only licensed
providers of mobile communications services in China and, in recent years, some
of the traffic from our fixed-line networks has been diverted to the networks of
these two companies. In addition, we face pricing pressure from mobile
operators, which have recently increasingly lowered tariffs through various
discount programs. The usage volume of non-PHS local calls decreased to 172.9
billion pulses in 2005 from 189.0 billion pulses in 2004, at least in part due
to migration of our non-PHS local traffic to mobile services.
For managed data services and broadband Internet access services, or
broadband services, we primarily compete with China Unicom, China Telecom, China
Railcom and other broadband Internet access services providers, such as Beijing
Gehua CATV Network Co., Ltd. on the basis of pricing, the coverage and quality
of networks, ability to provide end-to-end connectivity, quality of network
management and customer service. While other major telecommunications operators
in China have been leasing transport facilities from us to serve their
customers, some of them, such as China Mobile and China Unicom, have in recent
years begun to build their own long distance networks for voice services and
fiber-optic networks for data services. Increased competition from these
domestic telecommunications providers may result in lower revenues for us due to
competitive pricing policies and increased sales and marketing costs to attract
or retain subscribers. In our southern service region, if we do not compete
effectively against China Telecom and other operators, we may achieve lower
returns on our investments than expected and our business growth may be
adversely affected.
In our southern service region, we compete primarily against China
Telecom in the provision of VoIP services, broadband services and data services.
China Telecom has a competitive advantage over us in our southern service region
in terms of its larger customer base, broader network coverage and greater brand
recognition. China Telecom controls most of the local access network, including
the "last mile" access network, in our southern service region. Despite our
efforts to build a local access network over the past five years, China Telecom
is still the dominant service provider in our southern service region. As a
result, we may not be able to compete effectively against China Telecom and
realize acceptable returns on our investments and our business growth prospects
may be adversely affected. In addition to China Telecom, we are faced with
increased competition from other operators in our southern service region.
In the Asia-Pacific markets, continuing pricing pressure or our inability to
meet the requirements of our business customers may reduce our revenues and net
income derived from these markets.
The telecommunications services market for business and carrier
customers in the Asia-Pacific region is highly competitive, and our success in
the region will depend on our ability to compete against a variety of other
telecommunications operators, including regional as well as global
telecommunications operators. Some of our competitors may have competitive
advantages over us, including greater name recognition in a particular market,
greater resources, larger customer bases and better relationships with our
current and potential customers.
Due to substantial excess transport capacity in the Asia-Pacific
carrier market, we face intense competition from other providers of
telecommunications services in the Asia-Pacific region, including C2C Pte. Ltd.
and the FLAG Telecom Group Limited. As a result of strong competition, prices of
data and bandwidth products and services in our target markets have experienced
continual declines in recent years. Competition also exists in the business
customer segment, in which we face strong competition from international
providers such as AT&T Corp. and local incumbent providers such as Singapore
Telecommunications Limited, Japan's Nippon Telegraph & Telephone Corporation, or
NTT, and KT Corp. The incumbent providers in particular tend to have better
control of local networks. Any continued decrease in price or our inability to
meet the requirements of business customers may have a material adverse impact
on our revenues and net income derived from our international telecommunications
services.
Competition from foreign-invested operators and other new entrants may further
increase the competition for employees, exacerbate price competition and
increase our operating expenses, thereby adversely affecting our financial
condition and growth prospects.
As a result of China's accession to the WTO in December 2001, and the
adoption of the Regulations on the Administration of Foreign-Invested
Telecommunications Enterprises in January 2002, which implement China's
commitments to the WTO, the PRC government has agreed to gradually liberalize
the various segments and regions of the telecommunications market in China to
foreign investors. Both the percentage of ownership of Sino-foreign joint
ventures offering telecommunications services in China and the regions where
those joint ventures are permitted to offer telecommunications services will be
increased over several years. For example, foreign operators are permitted,
subject to various ownership and licensing restrictions, to establish joint
venture enterprises in the municipalities of Beijing and Shanghai and the city
of Guangzhou to provide domestic and international voice, packet-switched and
circuit-switched data transmission and other services. Foreign-invested
operators entering China's telecommunications market as a result of this
liberalization may have greater financial, managerial and technical resources
and more expertise in network management and sales and marketing than we do.
Increased competition from these and other new entrants into the
Chinese telecommunications market may further increase the competition for
skilled and experienced employees, exacerbate price competition and increase our
customer acquisition costs and other operating expenses, and thereby adversely
affect our financial condition and growth prospects.
Competition from alternative technologies to our PHS business and an
introduction of TD-SCDMA technology may cause our PHS services to be less
competitive, and adversely affect our growth prospects and revenues.
We currently provide personal handyphone system, or PHS, services in
most cities in our northern service region to reduce the impact of mobile
substitution on our fixed-line operations. PHS is a telecommunications
technology that allows us to offer to our customers wireless local access
services with mobility within an area with the same area code. Our ability to
realize acceptable returns from our investment in PHS technology will depend on
continued customer adoption of this technology. However, this market may not
continue to develop, since potential customers are and will be able to choose
from a variety of alternative fixed-line and wireless communication
technologies, including both existing technologies and new technologies to be
offered in the future, such as third generation, or 3G mobile telephone
services. For instance, if China Mobile or China Unicom reduces the tariffs for
mobile telecommunications services, our existing and potential PHS customers may
choose to use these services instead of our PHS services to take advantage of
the less geographically restricted service scope and other features of mobile
technology. In addition, more mobile licenses may be issued in the near future,
which will increase the level of competition in the provision of mobile
telephone services, which will in turn increase pricing pressure and adversely
affect the growth prospects of our PHS services. Furthermore, if we introduce 3G
mobile telephone services, traffic on our PHS services may migrate to our 3G
services, thereby materially and adversely affect the growth prospects of our
PHS services.
Furthermore, part of the radio spectrum currently used by our PHS
services may be reallocated by the PRC government to time division
synchronization code division multiple access technology, or TD-SCDMA
technology, which is one of the three technologies adopted by the International
Telecommunications Union and is under review by the PRC government for use in
providing 3G mobile telephone services. The PRC government is currently
conducting tests on TD-SCDMA related products. The PRC government has not
officially announced its decisions on issues such as the timing of the grant of
the 3G licenses, the number of 3G licenses to be granted, any technical
requirements, or any selection of preferred technologies. If TD-SCDMA technology
is introduced, our ability to use the existing PHS spectrum may be restricted,
thereby limiting the volume of usage we can handle and adversely affecting our
revenues.
Any of the risks described above may cause our PHS services to become
less competitive and thereby materially and adversely affect our growth
prospects and revenues.
Because we rely on certain arrangements with other telecommunications operators,
changes to the terms or availability of these arrangements may result in
disruptions to our services and operations.
Our ability to provide telecommunications services depends upon certain
arrangements with other telecommunications operators. In particular,
interconnection is necessary to complete all calls between our subscribers and
subscribers of other telecommunications operators. We, either through ourselves
or through China Netcom Group, have entered into interconnection and
transmission line leasing agreements with other fixed-line operators, including
our parent company, China Netcom Group, mobile telephone operators and other
telecommunications providers, as required to conduct our current business. Any
disruption to our interconnection with the networks of those operators or other
international telecommunications carriers with which we interconnect due to
technical or competitive reasons may affect our operations, service quality and
customer satisfaction, thus adversely affecting our business. Furthermore, we
are generally not entitled to collect indirect or consequential damages
resulting from disruptions in the networks to which we are interconnected. Our
failure to renew our existing interconnection and leased line agreements on
commercially acceptable terms may result in disruptions to our services. In
addition, in our southern service region, we may need to lease local access
network facilities from other operators in order to provide services to our
customers. If we are unable to enter into arrangements with such operators in a
timely manner or on acceptable terms, it may result in a delay in providing
services to our customers and disrupt our operations, as we may need to seek
alternative arrangements with other operators, which may adversely affect our
financial condition and our results of operations.
Disruptions to our network or operating systems, or to those with which we
interconnect, may result in customer dissatisfaction and reduced revenues from
operations.
Our network infrastructure and the networks with which we interconnect
are vulnerable to potential damage or interruption from floods, wind, storms,
fires, power loss, severed cables, acts of terrorism and similar events. In
particular, commercial fishing and other maritime activities may damage our
Asia-Pacific submarine cables. Our networks and systems and the networks with
which we interconnect also require regular maintenance and upgrades that may
cause service disruptions. The occurrence of a natural disaster or other
unanticipated problems at our facilities or any other failure of our networks or
systems, or the networks to which we are interconnected, may result in
consequential interruptions in services across our telecommunications
infrastructure. Network or system failures, as well as high traffic volumes, may
also affect the quality of our services and cause temporary service
interruptions. Although we have not experienced material disruptions or damage
to our network and operating systems in the past, any such future occurrence may
result in customer dissatisfaction and reduced revenues from operations.
Failure to successfully respond to technological and industry developments may
hinder our revenue growth and adversely affect our competitive position.
The telecommunications sector has recently experienced rapid increases
in the diversity and sophistication of the technologies and services offered. As
a result, we expect that we will need to constantly upgrade our
telecommunications technologies and services in order to respond to competitive
industry conditions and customer requirements. For example, the next generation
network has the capability of providing new value-added services and content
that combine voice, data and images with increased efficiency and flexibility.
Next generation networks may replace the traditional public switched telephone
networks in the future. We have not experienced significant difficulties in
upgrading new technologies and equipment in the past, but if we fail to smoothly
upgrade or achieve a balanced transition of our existing network to the next
generation network, we may lose our customers and market share, which may
adversely affect our operations and financial condition. Furthermore, if the new
technologies adopted by us do not perform as expected, or if we are unable to
effectively deliver new services based on these technologies in a commercially
viable manner, our revenue growth may decline and our competitive position may
be adversely affected.
If we fail to successfully implement our business strategies, we may not achieve
acceptable investment returns or manage growth in certain services and markets,
and our financial condition may be adversely affected.
We may not be able to successfully implement all of our business
strategies. For example, we have made substantial investments in developing our
broadband network infrastructure and technology. However, the broadband market
in China may not continue to expand at recent rates of growth, and we may not be
able to attract enough customers and generate sufficient usage to achieve an
acceptable return on our significant broadband investment. In addition, we may
not be able to successfully expand our business and achieve profitable growth in
our southern service region and the Asia-Pacific region or be able to
successfully manage the growth in our business. Failure to successfully
implement our business strategies may adversely affect our financial condition.
Our internal controls and management systems are not currently consistent with
international practices in certain respects and we are in the process of
improving these controls and systems to enable us to certify the effectiveness
of our internal controls under the Sarbanes-Oxley Act of 2002. Our failure to
timely and successfully upgrade these controls and systems could subject us to
regulatory actions and harm the price of our stock.
Our primary operating subsidiary was established in the PRC, and as
such our internal control and management systems were designed to meet the
standards generally adopted by companies in China. These standards are different
from the standards and best practices adopted by companies listed in the United
States. We have identified areas in which our current internal control and
management systems do not meet international standards and practices. In
addition, during their recent audit, our external auditors brought to our
attention a number of areas in which there are more than a remote likelihood
that our current internal controls and management systems do not reduce to a
relatively low level of the risk of undetected errors or fraud that are more
than inconsequential and could adversely affect our ability to accurately and
timely record, process, summarize and report financial data. Pursuant to the
Sarbanes-Oxley Act of 2002 and the various rules and regulations adopted
pursuant thereto or in conjunction therewith, we will be required, for fiscal
year 2006, to perform an evaluation of our internal controls over financial
reporting and file an assessment of its effectiveness with the U.S. Securities
and Exchange Commission, or the SEC. Unless we successfully upgrade our controls
and systems, we will not be able to satisfactorily comply with our obligations
under the Sarbanes-Oxley Act of 2002. If we fail to successfully complete the
improvements we have scheduled on a timely basis or if the activities fail to
raise our internal controls and management systems to the levels required by
international standards or legal requirements or if we fail to implement
required new or improved controls, then we may fail to meet our reporting
obligations and our auditors may be unable to certify the management's assertion
of the effectiveness of our internal controls as required under the
Sarbanes-Oxley Act of 2002. This could subject us to regulatory scrutiny and
result in a loss of public confidence in our management, which could, among
other things, adversely affect our stock price.
We rely substantially on short-term borrowings and our inability to obtain
sufficient funding may adversely affect our liquidity and financial condition.
Similar to many enterprises in China, a significant percentage of our
funding requirements is satisfied through short-term borrowings. This has
resulted in a significant increase in our net current liabilities. As of
December 31, 2004 and 2005, our short-term bank loans and the current portion of
our long-term bank and other loans were RMB 56,609 million and RMB 56,147
million, respectively, representing 68.5% and 68.4% of the sum of total
long-term and short-term bank loans and other borrowings as of the respective
dates. Although, in our experience, a substantial portion of our short-term
borrowings is rolled over upon maturity and these borrowings have been, in the
past, a stable source of funding, no assurances can be given that this will
continue to be the case. If our lenders do not roll over our short-term
borrowings, or if we are unable to secure sufficient borrowings, our liquidity
position would be adversely affected, and we may be required to seek more
expensive sources of short-term or long-term funding to finance our operations.
In addition, implementing our strategies may require substantial capital
expenditures. To the extent these expenditures exceed our cash resources, we
will be required to seek additional debt or equity financing. If we are unable
to obtain sufficient funding for our operations or development plans on
commercially acceptable terms, or at all, our liquidity and financial condition
may be adversely affected.
Our ultimate controlling shareholder, China Netcom Group, may cause us to enter
into transactions or take (or fail to take) other actions or make decisions that
conflict with the best interests of our other shareholders.
As of May 31, 2006, China Netcom Group beneficially owned
approximately 70.39% of our outstanding shares. As a result, China Netcom Group,
subject to our articles of association and applicable laws and regulations, will
effectively be able to control our management, policies and business by
controlling the composition of our board of directors, determining the timing
and amount of our dividend payments, approving significant corporate
transactions, including mergers and acquisitions, and approving our annual
budgets. Therefore, China Netcom Group may cause us to enter into transactions
or take (or fail to take) other actions or make decisions that conflict with the
best interests of our other shareholders.
We rely on China Netcom Group to provide certain services and facilities for
which we currently have limited alternative sources of supply. Changes in the
availability, pricing or quality of these services or facilities may have a
material adverse effect on our business and profitability.
Pursuant to various agreements and arrangements, China Netcom Group
provides us with services and facilities necessary for our business activities,
including but not limited to, the use of fiber-optic networks in our northern
and southern service regions, submarine cables in the Asia-Pacific region,
international gateways, leases for properties located in our northern and
southern service regions and the Asia-Pacific region.
The interests of China Netcom Group as provider of these services and
facilities may conflict with our interests. We currently have limited
alternative sources of supply for these services and facilities and, as a
result, may have limited ability to negotiate with China Netcom Group regarding
the terms for providing these services and facilities. Changes in the
availability, pricing or quality of these services or facilities may have a
material adverse effect on our business and profitability.
Failure by China Netcom Group to fulfill its obligations under certain existing
arrangements may have a material adverse effect on our business operations,
growth prospects and profitability.
China Netcom Group has committed to certain arrangements to support our
existing operations and future development, including through a letter of
undertakings, a non-competition agreement and a restructuring agreement. In the
letter of undertakings, China Netcom Group agreed to, among other things, extend
its full support to our current operations and future developments. China Netcom
Group has also entered into a non-competition agreement whereby China Netcom
Group has agreed not to compete with us in our service regions and our
international markets without our consent. In addition, under a restructuring
agreement, China Netcom Group agreed to indemnify CNC China and us for losses
arising from certain matters. Failure by China Netcom Group to fulfill its
obligations under any of these arrangements may have a material adverse effect
on our business operations, growth prospects and profitability.
The PRC National Audit Office and other governmental or third parties may audit
or investigate our ultimate controlling shareholder and us from time to time.
The outcome of these governmental or third party investigations may adversely
affect our corporate image, the reputation and credibility of our management,
our business and financial condition and the prices of our shares and ADSs.
PRC's National Audit Office, or the NAO, from time to time performs
audits on state-owned companies, such as China Netcom Group, our ultimate
controlling shareholder. If, as a result of an NAO audit, material
irregularities are found within China Netcom Group or China Netcom Group becomes
the target of any negative publicity, there would be a material adverse effect
on our corporate image, the reputation and credibility of our management, our
business and financial condition and the prices of our shares and ADSs. In
addition, we may be the subject of other governmental or third party
investigations or similar events that, depending on their outcome, could have a
material adverse effect on our business and financial condition and the prices
of our shares and ADSs.
Risks Relating to the PRC Telecommunications Industry
Extensive government regulation of the telecommunications industry in China may
restrict our ability to respond to market conditions or competition, and may
have a material adverse effect on our operations, business and financial
condition.
As a telecommunications operator in China, we are subject to extensive
regulation by and under the supervision of the MII, which is the primary
telecommunications industry regulator in China. The MII is responsible for
formulating policies and regulations for the telecommunications industry,
granting telecommunications licenses, allocating frequency spectrum and numbers,
formulating interconnection and settlement arrangements between
telecommunications operators, and enforcing industry regulations. Other PRC
governmental authorities also regulate tariff policies, capital investment and
foreign investment in the telecommunications industry. See "Item 4. Information
on the Company -- Regulation". The regulatory framework within which we operate
may constrain our ability to implement our business strategies and limit our
ability to respond to market conditions or to changes in our cost structure.
Moreover, we operate our businesses pursuant to approvals granted by the State
Council and under licenses granted by the MII. If these approvals or licenses
were revoked or suspended, our business and operations would be materially and
adversely affected. In addition, we are subject to various regulatory
requirements as to service quality, pricing and other actions, and failure to
comply with such requirements may subject us to mandatory penalties or other
punitive measures, any of which could have a material adverse effect on our
operations and financial condition.
In addition, some of our competitors, such as China Unicom and China
Railcom, enjoy preferential treatment from the PRC government with respect to
tariff setting. These companies are currently permitted to set their respective
tariffs for certain services, such as long distance calls over the public
switched telephone network, or the traditional network, at price levels above or
below the government fixed tariffs on a long-term basis, subject to filings
with, and approvals from, the relevant regulatory authorities. This preferential
treatment is not available to us. Our competitors who enjoy this preferential
treatment may be able to provide certain services at prices that are more
competitive than our prices, and our business and financial condition may be
adversely affected as a result.
Future changes to the regulations and policies governing the telecommunications
industry in China, including possible future industry restructurings, may have a
material adverse effect on our businesses.
Possible future changes to regulations and policies governing the
telecommunications industry in China may have a material adverse effect on our
businesses and operations. As part of the comprehensive plan to restructure the
telecommunications industry in China, as approved by the State Council in 2001,
the central government stated its intention to further adjust and improve its
regulatory oversight of the telecommunications industry, including gradual
further deregulation of telecommunications tariffs.
The Ministry of Information Industry, or the MII, under the direction
of the State Council, is currently preparing a telecommunications law to provide
a uniform regulatory framework for the telecommunications industry. If and when
the telecommunications law is adopted by the National People's Congress, it will
provide a new framework for telecommunications regulations in China. The
proposed nature and scope of the telecommunications law have not yet been
announced by the PRC government. The telecommunications law and other new
telecommunications regulations or rules, or future changes thereto, such as
enforcement of existing regulations and policies, may materially and adversely
affect our business and financial condition.
Issues may also arise regarding the interpretation and enforcement of
China's WTO commitments regarding telecommunications services, which may affect
telecommunications regulations and the telecommunications industry in China. Any
future regulatory changes, such as those relating to the issuance of additional
telecommunications licenses, tariff setting, interconnection and settlement
arrangements, changes in technical and service standards, universal service
obligations and spectrum and number allocations, may have a material adverse
effect on our business and operations.
The PRC government may issue additional mobile telecommunications
licenses in the future. The timing of issuance and terms of these licenses, if
any, have not yet been announced. We cannot assure you that we will be able to
obtain a mobile license. In addition, if we do obtain a mobile license, we may
not be able to effectively establish mobile operations or that our mobile
operations will generate satisfactory returns for our shareholders. The issuance
of additional licenses would also increase the competition we face.
The PRC telecommunications industry has been extensively restructured
in recent years and may be subject to further restructuring. Such further
industry restructuring may materially affect the operations of all
telecommunications operators in China, including us. Accordingly, we cannot
predict the scope and effect of any further restructuring on our operations.
New regulations, regulatory changes or changes in enforcement policies relating
to telecommunications tariffs may adversely affect our competitiveness, business
and profitability.
Tariffs are the prices we charge our customers for our
telecommunications services. We are subject to extensive government regulations
on tariffs, especially those relating to our basic telecommunications services,
such as local and long distance fixed-line telephone services, managed data
services, leased line services and interconnection agreements. The relevant
provincial telecommunications administrations and provincial price bureaus
currently determine the monthly fees and usage fees for our fixed-line local
telephone services based on a fixed tariff set by the MII in consultation with
the National Development and Reform Commission, or NDRC. The MII and the NDRC
jointly set tariffs for all long distance services using the traditional
network, leased lines and data services. We derive a substantial portion of our
revenues from services that are subject to tariffs determined by the PRC
government. In the past, our revenues have been adversely affected by reductions
in tariffs mandated by the PRC government.
In 2002, the MII indicated in writing that it did not intend to
initiate any adjustment to tariffs for local fixed-line telephone services
during the three to five years commencing in September 2002. However, we cannot
predict with accuracy the timing, likelihood or magnitude of tariff adjustments
or the extent or potential impact on our business of future tariff adjustments.
If the government substantially lowers the tariffs for local fixed-line
telephone services, our business and profitability may be adversely affected.
In addition, the tariffs for some of our services in certain locations
have been set at levels above or below the levels mandated by the government.
The MII may order us to adjust these tariffs and may impose fines on us for
repeated failures to comply with the mandated tariff levels for these services,
or even suspend our business where the situation becomes serious, as determined
at the discretion of the MII. According to a regulatory circular issued by the
MII, the MII reaffirmed its intention to strictly enforce these minimum tariff
levels. In addition, such enforcement may be undertaken in a selective manner.
The enforcement of such tariff levels and the imposition of fines or other
penalties, whether done on a selective or industry-wide basis, may materially
and adversely affect our competitiveness and, consequently, our business and
profitability.
The PRC government may require major operators, including us, to provide
universal services with specified obligations, and we may not be compensated
adequately for providing such services.
Under the Telecommunications Regulations, as promulgated by the State
Council on September 25, 2000, telecommunications operators in China are
required to fulfill universal service obligations in accordance with relevant
regulations to be promulgated by the PRC government, and the MII has the
authority to delineate the scope of universal service obligations. The MII,
together with governmental finance and pricing authorities, is also responsible
for formulating administrative rules relating to the establishment of a
universal service fund and compensation schemes for universal services. These
rules have not yet been promulgated, and there are currently no specific
regulatory requirements relating to the provision of universal services in
China.
While the scope of specific universal services obligations is not yet
clear, we believe that such services may include mandatory provision of basic
telecommunications services in less economically developed areas in China. We
may not be adequately compensated by the government or be able to realize an
adequate return on investments for expanding networks to, and providing
telecommunications services in, those less economically developed areas due to
potentially higher capital expenditure requirements, lower usage by customers
and lack of flexibility in setting our tariffs.
The MII requires China Telecom, China Netcom Group, China Mobile, China
Unicom, China Railcom and China Satcom to participate in a project to provide
telephone services in a number of remote villages in China as transitional
measures prior to the formalization of a universal service obligation framework.
In order to fulfill such obligations under these transitional measures, China
Netcom Group has agreed with us that it will assume the responsibility for
investing in and constructing the necessary network facilities. If we operate
and maintain such network facilities in our northern and southern service
regions, China Netcom Group has agreed to compensate us for the related expenses
based on their fair market value. However, China Netcom Group may fail to
fulfill its obligations under this project, and we may not be adequately
compensated by China Netcom Group for the cost and expenses resulting from our
operation and maintenance of any such network. Either of these events may
adversely affect our financial condition.
We face regulatory uncertainties associated with our Asia-Pacific operations
that may disrupt our operations.
Our Asia-Pacific telecommunications operations are subject to extensive
government regulation, which may limit our flexibility to respond to market
conditions, competition, new technologies or changes in our cost structure. In
most countries and regions, we are required to obtain one or more
telecommunications authorizations for our telecommunications networks and
services and are subject to a variety of regulatory obligations. In most of the
countries in which we have or plan to have operations, the telecommunications
regulations are still evolving. In some countries and regions, the range of
services that we are legally permitted to provide is limited. In other countries
and regions, telecommunications legislation may be applied in an unequal or
discriminatory fashion. Any changes in law, regulations or government and
regulatory policies could have a material adverse effect on our business and
results of operations. In particular, decisions or actions by regulators
concerning economic or business interests or goals that are inconsistent with
our interests may have a material adverse effect on our financial condition and
results of operations. Failure to meet these regulatory requirements may result
in fines or other sanctions, including revocation of our licenses. We may also
be required to obtain new licenses to expand into new areas of business. We may
fail to obtain these licenses and our existing licenses may not be renewed. Any
of these events may disrupt our operations in the Asia-Pacific region.
Risks Relating to China and Asia
Our operations may be adversely affected by China's economic, political and
social conditions.
Most of our assets are located in China and most of our revenues are
derived from our operations in China. Accordingly, our results of operations and
prospects are subject, to a significant extent, to economic, political and
social developments in China. In particular, our operating results may be
adversely affected by:
o changes in China's political, economic and social conditions;
o changes in policies of the government or changes in laws and
regulations, or the interpretation of laws and regulations;
o changes in foreign exchange regulations;
o measures that may be introduced to control inflation, such as
interest rate increases; and
o changes in the rate or method of taxation.
The Chinese economy has historically been a planned economy. The
majority of productive assets in China is still owned by various levels of the
PRC government. In recent years the government has implemented economic reform
measures emphasizing decentralization, utilization of market forces in the
development of the economy and a high level of management autonomy. Such
economic reform measures may be inconsistent or ineffectual, and we may not
benefit from all such reforms. Furthermore, these measures may be adjusted or
modified, possibly resulting in such economic liberalization measures being
applied inconsistently from industry to industry, or across different regions of
the country.
In the past twenty years, China has been one of the world's fastest
growing economies in gross domestic product, or GDP. We cannot assure you that
such growth will be sustained in the future. Moreover, a slowdown in the
economies of the United States, the European Union and certain Asian countries
may adversely affect economic growth in China. Our financial condition and
results of operations, as well as our future prospects, would be materially and
adversely affected by an economic downturn in China.
Economic growth in China has also historically been accompanied by
periods of high inflation. The government has implemented various policies from
time to time to control the rate of economic growth, limit inflation and
otherwise regulate economic expansion. Some of these measures benefit the
overall economy of China, but may also have a negative effect on us. For
example, our operating results and financial condition may be adversely affected
by government control over capital investments or by changes in the tax
regulations applicable to us.
Political and economic conditions in the Asia-Pacific region are unpredictable
and our operations may be disrupted if these conditions become unfavorable to
our business.
A key element of our international business strategy involves the
expansion of our operations in the Asia-Pacific region. Substantially all of our
business activities outside China are concentrated in the Asia-Pacific region.
Changes in political or economic conditions in the region are difficult to
predict and may adversely affect our operations or cause this region to become
less attractive to businesses, which may reduce our revenues. For example, the
recession that many Asia-Pacific countries and regions experienced in 1998 and
early 1999 was characterized by currency fluctuations, liquidity shortages and
an overall economic decline. Declining economic growth rates in the future may
reduce our revenues and cause us to lower our expenditures on our network
infrastructure and operations, which may negatively impact our business and our
profitability over time.
Our Asia-Pacific operations also expose us to additional risks inherent
in international operations, including:
o difficulties in enforcing agreements and collecting receivables
through some Asian legal systems;
o fluctuations in foreign currency exchange rates, which may
adversely affect our results of operations and the value of
our Asian assets and investments;
o implementation of foreign exchange controls or other
restrictions; and
o difficulties in obtaining licenses or interconnection
arrangements on acceptable terms, or at all.
Any of the above risks may adversely affect our financial condition and
results of operations.
Further, some of the countries in the Asia-Pacific region in which we
operate and have investments have experienced or continue to experience
political instability. The continuation or re-emergence of such political
instability may have a material adverse effect on economic or social conditions
in those countries and may result in outbreaks of civil unrest in the affected
areas, any of which may have a material adverse effect on our financial
condition and results of operations or on the ownership, control and condition
of our assets in those areas.
The PRC legal system has inherent uncertainties that may limit the legal
protections available to you as an investor or to us in the event of any claims
or disputes with third parties.
The Chinese legal system is based on written statutes. Prior court
decisions may be cited for reference but have limited precedential value. Since
1979, the central government has promulgated laws and regulations dealing with
economic matters such as foreign investment, corporate organization and
governance, commerce, taxation and trade. In particular, legislation over the
past twenty-six years has significantly enhanced the protections afforded to
various forms of foreign investment in China. CNC China, our primary operating
subsidiary, was incorporated in China as a "wholly foreign-owned enterprise".
Although we are the sole shareholder of, and therefore have full control over,
CNC China, the exercise of our shareholder rights in CNC China are subject to
its articles of association and PRC laws applicable to foreign investment
enterprises in China, which may be different from the laws of the United States.
For example, unlike in the United States, under PRC laws, shareholders do not
have the right to sue the directors or officers for misconduct on our behalf if
we fail to commence such a lawsuit ourselves. As Chinese foreign investment laws
and regulations are relatively new and the Chinese legal system is still
evolving, the interpretations of many laws, regulations and rules are not always
uniform and enforcement of these laws, regulations and rules involve
uncertainties, which may limit the remedies available to you as an investor and
to us in the event of any claims or disputes with third parties. In addition,
any litigation in China may be protracted and result in substantial costs and
diversion of resources and management attention.
Since we are a Hong Kong company, you will not have certain investor rights as
our shareholder, such as the right to bring legal action against other
shareholders on behalf of the company.
We were incorporated in Hong Kong. Under the Company Ordinance of Hong
Kong, any of our shareholders, including our controlling shareholder China
Netcom Group Corporation (BVI) Limited, or CNC BVI, do not have the right to
bring legal action against any other shareholder on our behalf to enforce any
claim against such party or parties if we fail to enforce such claim ourselves.
You may experience difficulties in effecting service of legal process and
enforcing judgments against us and our management.
Most of our current operations are conducted in China and most of our
assets are located in China. In addition, most of our directors and executive
officers reside within China, and substantially all of the assets of these
persons are located within China. As a result, it may not be possible to effect
service of process within the United States or elsewhere outside China upon
these directors or executive officers, including with respect to matters arising
under U.S. federal securities laws or applicable state securities laws.
Moreover, our PRC counsel, Haiwen & Partners, has advised us that China does not
have treaties with the United States or many other countries providing for the
reciprocal recognition and enforcement of court judgments. Our Hong Kong
counsel, Linklaters, has also advised us that Hong Kong has no arrangement for
the reciprocal enforcement of judgments with the United States. As a result,
recognition and enforcement in China of judgments of a court of the United
States or any other jurisdiction, including judgments against us or our
directors, executive officers, underwriters or experts, may be difficult or
impossible.
Government control of currency conversion may adversely affect our operations
and financial results.
We receive substantially all of our revenues in Renminbi, which is not
a freely convertible currency. A portion of such revenues will need to be
converted into other currencies to meet our foreign currency obligations. Our
foreign currency requirements primarily include:
o debt service on foreign currency-denominated debt;
o purchases of imported equipment; and
o payment of any dividends declared in respect of our shares.
Our primary operating subsidiary will be permitted to undertake current
account foreign exchange transactions by producing commercial documents
evidencing such transactions, provided that they are processed through certain
banks in China. However, foreign exchange transactions under the capital
account, including principal payments with respect to foreign
currency-denominated obligations, will be subject to limitations of the State
Administration of Foreign Exchange. These limitations may affect our ability to
obtain foreign exchange through debt or equity financing, or to obtain foreign
exchange for capital expenditures.
In the future, we expect to derive an increasing proportion of our
revenues from our Asia-Pacific operations. The governments of some of the Asian
countries in which we operate have in the past imposed various forms of foreign
exchange controls. We cannot assure you that foreign exchange controls will not
be imposed again in the future. If imposed, these restrictions may adversely
affect our ability to meet our foreign currency obligations.
Fluctuations in exchange rates may adversely affect our financial condition and
results of operations and the prices of our shares and ADSs or any dividends
payable on our shares and ADSs in foreign currency terms.
We conduct our business primarily in Renminbi, which is also our
functional and reporting currency. The Renminbi is not a fully convertible
currency. From 1994 to July 20, 2005, the official exchange rate for the
conversion of Renminbi to U.S. dollars was generally stable. On July 21, 2005,
the PRC government introduced a managed floating exchange rate system to allow
the value of the Renminbi to fluctuate within a regulated band based on market
supply and demand and by reference to a basket of currencies. On the same day,
the value of the Renminbi appreciated by 2% against the U.S. dollar. The PRC
government has since made and in the future may make further adjustments to the
exchange rate system. Substantially all of our revenues are denominated in
Renminbi, while a portion of our capital expenditures are denominated in foreign
currencies, such as U.S. dollars and Hong Kong dollars. Future movements in the
exchange rate of Renminbi and other currencies may have an adverse effect on our
financial condition and results of operations, particularly our international
long distance services and Asia-Pacific telecommunications services. In
addition, any revaluation of the Renminbi may adversely affect the prices of our
shares and ADSs or any dividends payable on our shares and ADSs in foreign
currency terms.
Our corporate structure may restrict our ability to receive dividends from, and
transfer funds to, our Chinese operating subsidiary, which may restrict our
ability to act in response to changing market conditions.
Substantially all of our operations are conducted through our Chinese
operating subsidiary, China Netcom (Group) Company Limited, or CNC China. The
ability of our Chinese subsidiary to make dividend and other payments to us may
be restricted by factors that include changes in applicable foreign exchange and
other laws and regulations. As a wholly foreign-owned enterprise in China, CNC
China is required to provide for a reserve fund and a staff and workers' bonus
and welfare fund, each of which is appropriated from net profit after taxation
but before dividend distribution according to the prevailing accounting rules
and regulations in the PRC. CNC China is required to allocate at least 10% of
its net profit to the reserve fund until the balance of this fund has reached
50% of its registered capital. In addition, the profit available for
distribution from our Chinese subsidiary is determined in accordance with
generally accepted accounting principles in China. This calculation may differ
from one performed in accordance with either HKFRS or U.S. GAAP. As a result, we
may not receive sufficient distributions from our Chinese subsidiary to enable
us to make dividend distributions to our shareholders in the future, even if our
HKFRS or U.S. GAAP financial statements indicate that our operations have been
profitable.
Distributions by our Chinese subsidiary to us other than as dividends
may be subject to governmental approval and taxation. Any transfer of funds from
our company to our Chinese subsidiary, either as a shareholder loan or as an
increase in registered capital, is subject to registration or approval with or
by Chinese governmental authorities, including the relevant administration of
foreign exchange and/or other relevant examining and approval authorities. These
limitations on the free flow of funds between us and our Chinese subsidiary may
restrict our ability to act in response to changing market conditions.
Risk relating to our ADSs
Holders of our ADSs will not have the same voting rights as the holders of our
shares and may not receive voting materials in time to be able to exercise their
right to vote.
Except as described in this document and in the deposit agreement,
holders of our ADSs will not be able to exercise voting rights attaching to the
shares evidenced by our ADSs on an individual basis. Holders of our ADSs will
receive proxy materials with respect to matters to be voted on at a meeting of
shareholders through the depositary and may only exercise voting rights by
appointing the depositary or its nominee as their representative to exercise the
voting rights attaching to the shares represented by the ADSs. Consequently, if
the materials are slow to be forwarded to holders of ADSs by the depositary or
are otherwise delayed or if the depositary sets deadlines by which holders of
ADSs must give their instructions regarding how to vote that fall too soon after
mailing of the proxy materials, you may not receive voting materials in time to
instruct the depositary to vote. Thus, it is possible that you, or persons who
hold their ADSs through brokers, dealers or other third parties, may not have
the opportunity to exercise a right to vote.
ITEM 4. INFORMATION ON THE COMPANY
HISTORY AND DEVELOPMENT
Our legal and commercial name is China Netcom Group Corporation (Hong
Kong) Limited. Our principal executive offices are located at Building C, No.
156 Fuxingmennei Avenue, Xicheng District, Beijing, PRC 100031. Our telephone
number is (86-10) 6642-6655. Our registered offices are located at 6701, 67/F,
The Center, 99 Queen's Road Central, Hong Kong. We have appointed CT Corporation
System, 111 Eighth Avenue, 13th Floor, New York, New York 10011, United States
of America, with telephone number 1-212-894-8940, as our agent for service of
processes for actions brought under the U.S. securities laws.
Our current principal operating subsidiary, CNC China, was incorporated
as a PRC limited liability company in August 1999 by its four founders and
shareholders, the Academy of Sciences, INC-SARFT, CRTC and Shanghai Alliance, as
a facilities-based telecommunications operator in China. We were established on
October 22, 1999 to facilitate investments by foreign investors, including CNC
Fund, L.P., in CNC China. Shortly thereafter, the four founders, using their
respective equity interests in CNC China as capital contributions, established
China Netcom (Holdings) Company Limited, or China Netcom Holdings, which in turn
contributed its entire interests in CNC China through CNC BVI to us. CNC Fund,
L.P. purchased from us 30,967,127 Series A preferred shares of par value US$0.01
each in February 2001 for a cash consideration of US$325,000,000.
We, through China Netcom Corporation International Limited, established
Asia Netcom in 2002. Asia Netcom remained inactive until it acquired
substantially all the assets, including cash, and most of the subsidiaries, of
the former Asia Global Crossing Ltd., or AGC, in March 2003. The transaction was
consummated under Section 363 of the U.S. Bankruptcy Code. The transaction
consisted of the assumption of certain contracts and liabilities, including
selected customer contracts and vendor liabilities, and the payment of cash to
AGC. The assets included submarine cable and network assets connecting Japan,
Korea, Taiwan, Hong Kong, the Philippines, Singapore and Australia, as well as
sales operations in these countries and regions. We held a 51% equity interest
in Asia Netcom after the acquisition of AGC. In December 2003, we acquired the
remaining 49% interest in Asia Netcom for cash consideration of US$61 million.
Formation of the China Netcom Group
Pursuant to a PRC government-issued directive in 2001 to restructure
the PRC fixed-line telecommunications industry, which has been in operation for
decades, China Telecom Group, the then incumbent fixed-line carrier, in May
2002, divided its operations between:
o China Telecom Group, which retained:
o the principal fixed-line networks that were located in 21
southern and western provinces and municipalities of China; and
o assets constituting 70% of the bandwidth of the nationwide
inter-provincial fiber-optic network that were owned by the
former China Telecom Group; and
o China Netcom Group, which was established with:
o the principal fixed-line networks that were located in the
Beijing and Tianjin Municipalities and the provinces of Hebei,
Henan, Shandong, Liaoning, Shanxi, Jilin and Heilongjiang and the
Inner Mongolia Autonomous Region; and
o assets constituting 30% of the bandwidth of the nationwide
inter-provincial fiber-optic network that were owned by the
former China Telecom Group.
Pursuant to the same directive, China Netcom Group purchased the entire
equity interest in Jitong Communications Company Limited on May 28, 2003. In
April 2004, the shareholders of China Netcom Holdings agreed to transfer their
respective interests in China Netcom Holdings to China Netcom Group, as
described below.
Restructuring in Anticipation of the November 2004 Global Offering
The asset and liability transfers
In anticipation of our Global Offering in November 2004, we entered
into certain transactions, including a series of transfers of assets and
liabilities between us and China Netcom Group. Following our restructuring, we
provide:
o telecommunications businesses in our northern and southern service
regions; and
o international telecommunications services in the Asia-Pacific
region.
China Netcom Group continues to:
o provide telecommunications services in provinces, autonomous regions
and municipalities outside our northern and southern service
regions; and
o own non-core businesses.
Our subsidiaries
We own the entire equity interest of CNC China, a company registered in
China and, through China Netcom Corporation International Limited, the entire
issued share capital of Asia Netcom, a company registered in Bermuda. In
addition, in connection with our 2005 Acquisition, we acquired the entire equity
interests of China Netcom Group New Horizon Communications Limited, or CNC New
Horizon, from CNC BVI, which we currently hold through China Netcom Group New
Horizon Communications Corporation (BVI) Limited. See "-- Our 2005 Acquisition".
CNC China and CNC New Horizon are our operating subsidiaries in China. All
businesses in our northern and southern service regions are operated through
their local branch offices. Asia Netcom operates either directly or through its
subsidiaries in Hong Kong and other key business centers in the Asia-Pacific
region.
Change of our financial year end
In order to conform our financial year end, which was March 31
previously, to the financial year end of the businesses that were transferred to
us in connection with the restructuring, we changed our financial year end from
March 31 to December 31 beginning on April 1, 2003.
Name changes
We were incorporated in Hong Kong under the Companies Ordinance as a
private limited liability company on October 22, 1999 under the name of Target
Strong Limited.
o We changed our name from Target Strong Limited to China Netcom
(Hong Kong) Corporation Limited on December 9, 1999.
o We changed our name from China Netcom (Hong Kong) Corporation
Limited to China Netcom Corporation (Hong Kong) Limited on
August 4, 2000.
In connection with our restructuring in anticipation of the November
2004 global offering:
o We changed our company name from China Netcom Corporation
(Hong Kong) Limited to China Netcom Group Corporation (Hong
Kong) Limited on July 23, 2004;
o CNC China's company name was changed from China Netcom
Corporation Limited to China Netcom (Group) Company Limited on
September 10, 2004; and
o CNC BVI's company name was changed from China Netcom Holdings
(BVI) Limited to China Netcom Group Corporation (BVI) Limited
on August 31, 2004.
Our Initial Public Offering in November 2004
In November 2004, we successfully completed our initial public offering
of shares, or IPO, raising approximately RMB 8,944 million in aggregate net
proceeds for us, after deduction of fees and expenses. Our shares are listed and
traded on the Hong Kong Stock Exchange and ADSs representing our shares are
listed and traded on the New York Stock Exchange.
Our 2005 Acquisition
On September 12, 2005, we, CNC BVI and China Netcom Group entered into
a conditional sale and purchase agreement whereby we agreed to acquire the
entire equity interests of China Netcom Group New Horizon Communications
Corporation (BVI) Limited from CNC BVI for a consideration of RMB 12,800
million, RMB 3,000 million of which was paid out to China Netcom Group on
October 31, 2005 at the consummation of our 2005 Acquisition.
Our 2005 Acquisition resulted in the transfer from China Netcom Group
to us its fixed-line telecommunications assets and related liabilities in
Heilongjiang Province, Jilin Province, the Inner Mongolia Autonomous Region and
Shanxi Province, or the 2005 Acquired Assets and Liabilities.
Recent Development-Sale of Asia Netcom
On June 2, 2006, we agreed to sell our equity interest to a group of
investors for US$168.84 million. Asia Netcom is a wholly owned subsidiary
through which we provide international telecommunications services in the
Asia-Pacific region. The sale of Asia Netcom is in line with our strategy to
focus on development of telecommunications services in China. We expect this
transaction to be completed by early August 2006. Upon completion of the
transaction, we expect to continue our buisness relationship with Asia Netcom in
connection with our remaining international operations, including the purchase
of capacity from Asia Netcom.
BUSINESS OVERVIEW
Unless otherwise indicated, all data and information relating to our
businesses and operations for years ended December 31, 2003 and 2004 include the
data and information relating to the 2005 Acquired Assets and Liabilities.
Our Services
We are the dominant provider of fixed-line telephone services,
broadband and other Internet-related services and business and data
communications services in our northern service region in China. We also provide
voice, broadband and data services using new technologies in our southern
service region and international voice and data services throughout the
Asia-Pacific region.
Tariffs for our services are regulated by the government, including the
MII, the NDRC, and provincial telecommunications administrations and price
bureaus in China. We describe, in this "Item 4. Information on the Company --
Business Overview" section, tariffs for services for which we have sole
discretion in setting the market-based tariff levels, including VoIP and
broadband Internet services. For a discussion of government-fixed tariffs and
guidance tariffs, such as those for fixed-line telephone services, see "--
Regulation -- Tariff Setting". Prices for some of our services may be subject to
promotional discounts.
Fixed-line telephone services (including PHS)
We are the dominant provider of fixed-line telephone services in our
northern service region, with a market share of 92.3% as of December 31, 2005,
based on the number of fixed-line subscribers.
Our fixed-line telephone services consist of local telephone, domestic
long distance, international long distance, value-added and interconnection
services. The number of our fixed-line subscribers in our northern service
region has increased from 93.8 million as of December 31, 2003 to 114.7 million
as of December 31, 2005. Of the total number of fixed-line subscribers in our
northern service region, as of December 31, 2005, approximately 61.3% were
residential customers, 9.4% were business customers, 5.5% were public telephones
and 23.8% were PHS subscribers. Fixed-line telephone services represent our
principal business activity.
We have selectively built wireless local access networks based on PHS
technology to offer PHS services as a cost-effective alternative to mobile
services. Our PHS services have been introduced in most cities in our northern
service region, where we have rolled out our PHS networks as an extension to our
existing fixed-line network.
PHS services are wireless telephone services that have features similar
to traditional mobile telephone services. For example, both types of services
offer voice services over handsets as well as short messaging functions.
However, as PHS services have smaller cellular coverage than traditional mobile
networks, PHS networks require more cellular sites for the same area coverage.
In addition, due to regulatory constraints in China, users of PHS services are
only permitted to roam within an area with the same area code while traditional
mobile telephone services offer nationwide or international roaming
capabilities. Tariffs for PHS services are similar to those for traditional
fixed-line services, which are generally lower than those for traditional mobile
services. Furthermore, incoming calls are free when using PHS services but are
charged on a per minute basis when using traditional mobile services.
Our PHS services are designed to provide our subscribers that require
mobility within an area with the same area code with a more cost-effective
tariff plan than traditional mobile services and access to value-added data
services. We believe that our PHS services have contributed to the growth in our
customer base, overall call volumes and revenues, and have also mitigated the
substitution effect of mobile services. Our PHS services are provided in regions
covering more than 100 area codes in our northern service region and the number
of our PHS subscribers has grown rapidly since we began offering this service.
We had 5.2 million new subscribers to our PHS services in 2005. As of December
31, 2005, we had 27.3 million PHS subscribers in our northern service region,
compared to approximately 11.8 million at the end of 2003.
We also operate a network of approximately 6.3 million public
telephones located in our northern service region in China. We provide local,
domestic long distance and international long distance call services and
Internet services through our public telephones. An important contributing
factor to the demand for public telephones services is China's large and growing
migrant population.
We are seeking to stimulate continued growth in fixed-line traffic
through the introduction of value-added services, such as caller identification,
telephone information services, teleconferencing and PHS short messaging
service.
In addition to our northern service region, we also selectively provide
fixed-line telephone services, mainly IP-based domestic and international long
distance services, in our southern service region.
The following table summarizes key information regarding our local
telephone services in our service regions in China as of the dates indicated:
As of December 31,
----------------------------
2003 2004 2005
---- ---- ----
(in thousands, except percentages)
Total number of fixed-line
subscribers(1) 94,073 108,079 115,328
Northern service region
Number of fixed-line subscribers
Residential 68,957 70,638 70,273
Business 8,671 9,251 10,725
PHS 11,796 22,124 27,329
Public telephones 4,416 5,558 6,331
----- ----- -----
Total 93,840 107,571 114,658
====== ======= =======
Market share(2) 95.6% 93.5% 92.3%
Southern service region
Number of fixed-line subscribers 233 508 670
__________
(1) Fixed-line subscribers consist of all access lines in service as well as
PHS subscribers. We calculate PHS subscribers based on number of active
telephone numbers for our PHS services. In cases where a PHS subscriber
uses the same telephone number as an access line in service, the
designation as a PHS subscriber or access line in service depends on which
service is first activated. We increase our total number of fixed-line
subscribers as soon as practicable after activation of the service. We
remove a fixed-line subscriber from the total number of fixed-line
subscribers as soon as practicable after the fixed-line subscriber
deactivates the service voluntarily or three months after the date on which
the fixed-line subscriber's bill becomes overdue. Prepaid and postpaid
telephone card customers are not counted toward our fixed-line subscribers.
(2) Calculated by dividing the number of our fixed-line subscribers by the
total number of fixed-line subscribers in our northern service region
published by the provincial telecommunications administrations or the MII,
as the case may be, as of each of December 31, 2003, 2004 and 2005.
Local telephone services
Our local telephone services have grown steadily in recent years and
continue to represent the largest portion of our fixed-line telephone services
in terms of revenues.
Service usage
The following table sets forth information regarding usage of our local
telephone services provided in our northern service region for the periods
indicated:
For the Years Ended December 31,
-------------------------------
2003 2004 2005
---- ---- ----
Total usage (pulses in millions)(1) 240,998 234,661 228,436
Internet dial-up usage (pulses in millions) (1) 38,943 17,226 8,552
_________________
(1) Pulses are the billing units for calculating local telephone usage fees.
See "-- Regulation -- Tariff Setting -- Local telephone services" for a
discussion of pulses.
The decrease in total usage in our local telephone services from 2004
to 2005 was primarily due to a decrease in Internet dial-up usage, reflecting
the continuing migration to broadband services.
Domestic long distance services
We offer long distance services through our traditional networks and
VoIP long distance services in our northern service region, and primarily
through VoIP in our southern service region.
The usage of our VoIP domestic long distance services in our northern
and southern service regions as a percentage of the total usage of our domestic
long distance services increased from 42.2% for the year ended December 31, 2003
to 48.4% for the year ended December 31, 2005, primarily because the usage of
our lower-priced VoIP long distance services increased at a higher rate than the
usage of our long distance services using our traditional networks over this
period. At the end of 2001, we launched our "IP Direct" service to allow
customers direct access to our VoIP network by dialing a 5-digit access code
from any fixed-line telephone terminal, without having to purchase prepaid phone
cards. We believe our "IP Direct" service has contributed to the increase of our
market share in the VoIP segment and partially offset the decline in our
effective tariffs, since our "IP Direct" services are subject to less discounts
than our VoIP cards.
Service usage
The following table shows the total minutes of domestic long distance
calls carried through our long distance network and the market share of our
domestic long distance services for the periods indicated:
For the Years Ended December 31,
--------------------------------
2003 2004 2005
------ ------ ------
Total minutes of domestic long distance calls (in millions)(1)(2)
Traditional 15,220 15,546 15,979
VoIP 11,110 13,820 14,996
------ ------ ------
Total 26,330 29,366 30,975
Northern service region
Total minutes of usage (in millions)(2) 15,190 15,087 15,653
Traditional
VoIP 9,104 11,960 12,122
------ ------ ------
Sub-total 24,294 27,047 27,775
Southern service region
Total minutes of usage (in millions) 2,036 2,319 3,200
_______________
(1) Includes usage provided over traditional networks in our southern service
region.
(2) Includes calls originated by prepaid phone cards users and VoIP subscribers
that are carried over our long distance networks.
The increase in minutes of usage in our domestic long distance services
in recent years is mainly due to economic development, declining effective
tariffs, increased cross-regional business activities, growth in our customer
base and new service offerings. The increase in competition has, however,
negatively affected our market shares and may affect the future growth rate of
our domestic long distance services.
Tariffs
In 2001, the PRC government abolished regulatory controls on tariffs
for VoIP long distance calls and allowed operators to set their own rates. We
currently charge RMB 0.30 per minute in addition to a local usage fee for our
VoIP domestic long distance services.
International long distance services
We are the leading provider of international long distance services in
our northern service region, with a 48.7% market share for the overall
international long distance service in that region for the year ended December
31, 2005, as compared to 54.3% for the year ended December 31, 2004. This
decrease was primarily due to increasing competitions.
In 1999, we began to offer VoIP international long distance services in
our northern and southern service regions. The usage of our VoIP international
long distance services as a percentage of the total usage of our international
long distance services increased from 59.2% as of December 31, 2003 to 70.7% as
of December 31, 2005, as price-sensitive customers increasingly elected to use
lower-priced VoIP international long distance services.
Service usage
The following table sets forth certain information related to the usage
and market share of our international long distance services for the periods
indicated:
For the Years Ended December 31,
--------------------------------
2003 2004 2005
---- ---- ----
International long distance outbound call
minutes (in millions)(1)(2)
Traditional 187 158 173
VoIP 271 313 418
--- --- ---
Total 458 471 591
Northern service region
Total minutes of usage (in millions)(2)
Traditional 186 148 156
VoIP 179 191 196
--- --- ---
Sub-total 365 339 352
--- --- ---
Southern service region
Total minutes of usage (in millions) 92 132 239
_____________
(1) Includes usage provided over traditional networks in our southern service
region.
(2) Includes calls originated by prepaid phone cards users and VoIP subscribers
that are carried over our international long distance networks.
Our principal outgoing international long distance calls are to Hong
Kong, Taiwan, the United States, Japan and South Korea. The increase in minutes
of usage in our international long distance services in recent years is mainly
due to China's economic development, declining effective tariffs, increasing
interaction between China and other countries and regions, the growth in our
customer base and new service offerings.
Tariffs
The following table sets forth our current VoIP international long
distance tariffs:
Tariff
----------------
(RMB per minute)
VoIP services to:
Hong Kong, Macau and Taiwan 1.50
United States and Canada 2.40
Asia-Pacific and certain European countries(1) 3.60
All other international destinations 4.60
_______________
(1) Includes the United Kingdom, France, Italy, Germany, Australia, New
Zealand, Japan, South Korea, Singapore, Malaysia, Thailand, the Philippines
and Indonesia.
We offer international long distance services through international
gateways that we lease from China Netcom Group, and pay for the use of networks
of operators in foreign jurisdictions for outgoing international calls.
Currently, China Netcom Group negotiates bilateral settlement arrangements and
rates based on international settlement standards in the telecommunications
industry. We have agreed with China Netcom Group that the costs and benefits of
its international interconnection agreements will be for our account. These
agreements are also currently in the process of being assigned or transferred to
us.
Value-added services
In addition to basic telephone services, we offer a range of
value-added services, including caller identification, PHS short messaging and
"personalized ring" services. Personalized ring service enables our PHS
telephone to emit a distinctive ring for incoming calls designated numbers. Our
value-added services increase total usage on our network and average revenues
per fixed-line subscriber, thus contributing to our revenues. As of December 31,
2003, 2004 and 2005, 52.2%, 60.4% and 65.9%, respectively, of our subscribers
subscribed to our caller identification service in our service regions. In 2003,
6.8 billion PHS short messages were sent from our network, representing an
increase of 240.9% from 2.0 billion in 2004. The number of subscribers to our
"personalized ring" services reached 6.8 million as of December 31, 2005, as
compared to 630,000 as of December 31, 2004. In addition, we provide telephone
information, teleconferencing, video conferencing, voice mail services.
Value-added services are still in a relatively early stage of development in
China, and we believe that there is significant growth potential in this area.
Tariffs
We charge RMB 3.00 to RMB 6.00 per month, depending on the region, for
our caller identification service. We charge RMB 0.08 to RMB 0.10 per message
for PHS messages sent within our own network or to the network of China Telecom,
and RMB 0.10 to RMB 0.15 per message for messages sent outside our own network
or the network of China Telecom. We charge RMB 2.00 to RMB 10.00 per month for
using our "personalized ring" and charge separately for downloading "rings
tones"
Interconnection
We earn interconnection fees for terminating or transiting calls that
originate from other domestic operators' networks and pay interconnection fees
to other operators in respect of calls originating from our networks that are
terminated on their networks. We earn and pay such fees in respect of local and
domestic and international long distance calls and Internet service.
All interconnection and settlement arrangements among domestic
operators in China are governed by the Telecommunications Regulations and the
rules on interconnection arrangements and settlement promulgated by the MII.
Most of the agreements pursuant to which we interconnect with other domestic
operators were entered into by China Netcom Group prior to our restructuring. We
have entered into an agreement with China Netcom Group pursuant to which we have
agreed with China Netcom Group that the costs and benefits arising under these
agreements, as they relate to our operations, will be for our account. We have
also entered into an interconnection settlement agreement with China Netcom
Group to interconnect with networks owned by China Netcom Group outside of our
northern and southern service regions.
For information about our domestic and international telecommunications
arrangements, see "--Regulation -- Tariff Setting -- Interconnection" and "Item
7. Major Shareholders and Related Party Transactions -- Related Party
Transactions -- Continuing connected transactions relating to CNC China --
Interconnection Settlement Agreement".
Broadband and other Internet-related services
We are the leading provider of broadband and other Internet-related
services in our northern service region, and one of the major providers in our
southern service region. Broadband services represent one of our fastest growing
businesses. This growth has been driven by the increasing affordability and
rising use of personal computers and other Internet access devices, reduced
tariffs and the proliferation of content and applications, such as online games
and video-on-demand.
The following table sets forth selected information regarding our
broadband, dial-up and dedicated Internet access services.
As of and For the Years Ended
December 31,
----------------------------------
2003 2004 2005
------- ------- --------
Broadband services:(1)
DSL subscribers (in thousands) 2,708.9 5,956.2 8,568.4
LAN subscribers (in thousands) 636.6 2,533.2 2,904.2
Others (in thousands) 0.7 3.0 2.6
------- ------- --------
Subtotal 3,346.2 8,492.4 11,475.2
Northern service region
DSL subscribers (in thousands) 2,708.9 5,939.2 8,529.2
LAN subscribers (in thousands) 603.8 2,207.2 2,507.0
Others (in thousands) 0.7 0 0
------- ------- --------
Subtotal 3,313.4 8,146.4 11,036.2
Market share(2) 91.0% 93.5% 87.6%
Southern service region
DSL subscribers (in thousands) 0 17.1 39.2
LAN subscribers (in thousands) (3) 33 326.3 397.2
------- ------- --------
Subtotal 33 346 439
Dial-up and dedicated Internet access
services:
Dial-up online usage (minutes in
millions) 32,292.7 15,134.2 6,657.5
Dedicated Internet access lines in service
(in thousands) 6.6 2.7 2.0
Northern service region
Dial-up online usage (minutes in
millions) 32,273.3 15,129.8 6,645.6
Dedicated Internet access lines in service
(in thousands) 6.1 2.7 2.0
Southern service region
Dial-up online usage (minutes in
millions) 19.4 4.4 12.0
_______________
(1) We calculate DSL subscribers based on the number of active accounts. LAN
subscribers consist of end-users and dedicated line users. We calculate LAN
end-users based on the number of ports subscribed for. The number of LAN
dedicated line users equals total monthly fees paid by such users divided
by set average revenue per unit. The current set revenue per unit is RMB
90. We consider an account active or a service subscribed for as soon as
practicable after activations of the applicable service. We remove a
subscriber from the total number of subscribers as soon as practicable
after that subscriber deactivates the service voluntarily or three months
after the date on which that subscriber's bill becomes overdue.
(2) Calculated by dividing the number of our own broadband subscribers by the
total number of broadband subscribers in our northern service region, as
published by the provincial telecommunications administrations or the MII,
as the case may be, as of each of December 31, 2003, 2004 and 2005.
(3) Amounts as of December 31, 2004 and 2005 include dedicated Internet access
lines.
Broadband services
We are leveraging our extensive fixed-line network, large customer
base, experienced sales force and established brand to achieve a leading
position in the fast growing market for broadband services in China. We offer
broadband services both in our northern and southern service regions. As of
December 31, 2005, we had 11.47 million broadband subscribers, having averaged
net additional subscribers of approximately 250,000 per month in 2005. In our
southern service region, we target communications- intensive cities such as
Shanghai, Guangzhou and Shenzhen, where we provide LAN-based broadband services.
We increase the speed at which content may be accessed by relocating
and storing broadband content closer to the end users. In addition, we offer a
range of services to our corporate customers designed to help them capture the
full benefits of broadband services. We offer broadband services through a range
of devices, including computers and television set-top boxes. In 2005, we
successfully launched China's first IPTV services in the city of Harbin,
Heilongjiang Province.
DSL services
We promote DSL services as the primary broadband service means for
residential customers and small and medium-sized enterprise customers in our
northern service region. We provide DSL services by upgrading our existing
copper-based local switching network. DSL technology allows us to roll out our
broadband network at lower incremental costs than other types of broadband
networks. In our northern service region, where we are the dominant fixed-line
operator, the number of subscribers to our DSL services has grown steadily in
recent years, with approximately 8.5 million DSL subscribers as of December 31,
2005, compared with approximately 2.7 million subscribers as of the end of 2003.
As of December 31, 2005, our DSL subscribers accounted for 74.7% of our total
number of broadband subscribers in our northern and southern service regions.
LAN services
In addition to DSL technology, we also use Ethernet technology-based
local-area networks, or LANs, to provide our customers with broadband services.
We have selectively rolled out LANs in high density residential and office
buildings in both our northern and southern service regions, where customers
demand a large bandwidth and high-speed Internet access. LAN uses fiber-optic
technology and Ethernet protocol to connect our users to a telecommunications
network and greatly expands capacity of the access network. As of December 31,
2005, we had 2.9 million subscribers of our LAN services, representing 25.3% of
our total broadband subscribers.
Internet application-related services
We have entered into cooperation arrangements with content and
applications providers in the businesses of live webcasting, virtual theater,
video conferencing, IPTV, online education, and broadband games. In addition to
basic services such as games, video and portals, we have also launched a series
of dedicated services catering to the specific needs of local markets and
industry subscribers, namely, an integrated tax payment services platform,
digital libraries and digital photo-finishing. In 2005, we successfully launched
China's first IPTV services in the city of Harbin, Heilongjiang Province.
We also operate Internet data centers, which provide co-location and
website hosting services to business customers that lease servers, routers and
other network components for Internet-related solutions. Internet data centers
are facilities used to house, protect and maintain network service computers
that store and deliver Internet and other network content, such as web pages,
applications and data. These services are used primarily by business customers
seeking to outsource the infrastructure needed to utilize the Internet
effectively.
Tariffs
We charge an upfront installation fee to both DSL and LAN subscribers.
DSL subscribers may choose a monthly package for unlimited usage, or a monthly
package with limited usage, with additional fees charged for overtime usage. For
customers connected through LANs, we offer a monthly package with unlimited
usage.
Dial-up and dedicated Internet access
We are also one of the largest providers of dial-up Internet access
services in our northern service regions in terms of number of subscribers.
Total usage by our dial-up Internet subscribers decreased significantly in 2005.
We believe that the decrease was primarily attributable to the migration of some
high-usage customers from dial-up Internet services to broadband services.
We offer high speed Internet access through dedicated lines to our
business customers, particularly communications-intensive corporate customers.
As of December 31, 2005, we had a total of approximately 2,000 dedicated
Internet access subscribers in our northern service region. We bundle this
service with voice and data services to provide integrated communications
solutions to our business customers. We also offer dedicated Internet access
lines in our southern service region.
Tariffs
Dial-up Internet access
We offer dial-up Internet access on both a postpaid and prepaid basis.
We charge a network usage fee ranging from RMB 1.00 to RMB 3.00 per hour. In
addition, a communication fee of RMB 0.02 per minute is charged and recorded as
fixed-line telephone services revenues. Postpaid customers are billed for this
service together with their monthly telephone service bills. Prepaid customers
must purchase stored value cards that enable them to access the Internet. The
network usage fee is charged against the stored value card, while the
communication fee is billed to the telephone number from which the Internet
connection is made.
Dedicated Internet access
We charge a subscription fee of RMB 100 and a monthly network usage fee
ranging from RMB 2,400 to RMB 5,400, depending on bandwidth, for our dedicated
Internet access. Where the dedicated Internet access is provided through DDN,
frame relay, ATM or digital circuits access, their respective tariffs apply in
addition to the subscription fee and network usage fee. For a more detailed
description of the tariffs for DDN, frame relay, ATM or digital circuits, please
see "-- Regulation -- Tariff Setting".
Business and data communications services
We are the leading provider of business and data communications
services in our northern service region and a leading provider of these services
in our southern service region. Managed data services represent a growing area
in China's telecommunications industry. We bundle the data communications
services together with fixed-line telephone services and broadband services to
attract communications-intensive corporate customers. We are responding to
increasing market demand in this area by leveraging our network platforms for
data transmission and by offering a broad portfolio of services and customized
solutions.
We offer managed data products, such as DDN, frame relay, ATM and
IP-VPN, and leased line products, including domestic and international leased
circuits. Our customers for these services include government entities, large
financial institutions and other domestic and multinational businesses, ISPs and
other telecommunications operators. We focus on diversifying our business and
data communications services and products and providing quality customer service
to our large corporate and carrier customers.
Managed data services
We provide a variety of managed data services to our business
customers, including DDN, frame relay, ATM and IP-VPN services. We anticipate
that demand for data communications services will be fueled by growth in the
emerging services segment, which includes e-commerce, broadband content, network
applications and IP-VPN services. The following table sets forth selected
information regarding our managed data services.
As of December 31,
----------------------------------
2003 2004 2005
------- ------- -------
Number of ports
DDN
Frame relay 36,683 43,078 43,519
ATM 1,239 4,816 4,212
Leased bandwidth
DDN (x64kbps) 319,812 319,323 205,064
Frame relay (x128kbps) 47,123 82,395 177,016
ATM (x2Mbps) 10,010 23,262 12,316
DDN services
DDN systems, composed of fiber-optic cables, digital transmission paths
and digital nodes, are capable of providing high-quality private circuits and
other services at various speeds to satisfy the multimedia communications needs
of customers. Our DDN services provide high quality and reliable transmission at
speeds ranging from 9.6kbps to 2Mbps to meet the increasing demand for low- to
medium-speed transmission capacity from business customers and government
agencies.
Frame relay and ATM services
We offer advanced high-speed data communications services based on
frame relay and ATM technologies to major business customers, including
multinational corporations, government agencies and financial institutions.
These services enable flexible and cost-effective use of bandwidth resources.
Our frame relay service provides high-speed, cost-effective data transmission
services linking different business sites for high volume data traffic. ATM is a
data transmission service using high bandwidth and multiplexing technology
intended to handle high bandwidth, integrated voice, text, data, video and
Internet traffic. Many of our customers are increasingly using frame relay and
ATM services to form VPNs to link their local area networks in different
locations. VPNs enable large companies to link multiple sites and offices
through a single network that uses existing switched lines to reduce cost but
has capabilities comparable to a dedicated private circuit.
IP-VPN
Our IP-VPN service targets business customers that require direct IP
connections between multiple sites. These customers are provided with private
networks connected to our Internet backbone network and intended for secure data
transmission.
Leased line services
We are a major provider of dedicated leased line services to
businesses, government agencies and other telecommunications operators in our
northern service region. These leased lines allow point-to-point connection for
voice and data traffic. Leased lines are used by business customers to assemble
their own private networks and by telecommunications operators to establish
their service networks. We lease network elements, including digital circuits,
digital trunk lines and optical fibers, to business and government customers as
well as other telecommunications operators.
As of December 31, 2005, we leased circuits totaled 129,989 (x2Mbps) in
bandwidth, including 100,387 (x2Mbps) in bandwidth to business customers. An
increasing percentage of our leased circuits are of higher speed as well as
capacity. Revenues generated from our leased line services have grown steadily
in recent years. The following table sets forth the respective amounts of
bandwidth of our leased line services provided to our business customers and
carrier customers as of the dates indicated.
As of December 31,
---------------------------
2003 2004 2005
------- ------- ------
Bandwidth of leased circuits (x2Mbps)
Business customers................................ 39,942 56,363 100,387
Carrier customers................................. 44,196 34,740 29,602
------- ------ --------
Total.......................................... 84,138 91,103 129,989
International telecommunications services
We are a leading provider of international telecommunications services
to small and medium-sized enterprises, multinational business customers,
Internet service providers and telecommunications carriers in the Asia-Pacific
region. We provide international voice services, including termination, refile
and bilateral services for international inbound calls destined for or transit
through China and other Asia-Pacific countries. We also provide international
gateway services for China outbound international long distance voice and
inbound voice termination for international carriers, as well as managed data,
leased line, Internet-related and other value-added data services.
Managed data, leased line and Internet-related services
Through our international branches in China and Asia Netcom, our wholly
owned subsidiary, we have become a leading provider of an array of data
telecommunications services, including ATM, frame relay, IP- VPN, leased line
services such as international private line circuits, indefeasible rights of
use, or IRUs, and Internet services, such as dedicated Internet access and
IP-transit, in key markets in the Asia-Pacific region.
International voice services
By forming partnerships with international carriers principally in the
Asia-Pacific region, we are able to deliver voice services that terminate or
originate in China. We purchase termination services from foreign carriers for
our outbound international voice traffic. In addition, we provide
interconnection services to domestic carriers for their outgoing international
calls, and provide international carriers transit services for calls originating
outside China that are rerouted through our network for termination in a third
country. We also provide international carriers and enterprise customers
teleconferencing, voice-VPN, international toll free services and other
value-added services.
For the international voice service, we pay for the use of networks of
international carriers for outgoing international calls and receive payments
from international carriers for the use of our network for incoming
international calls. Traditionally, these payments have been made pursuant to
settlement arrangements under the recommended regulatory terms of the
International Telecommunications Union.
Infrastructure for our international operations
We provide our regional services through a regional fiber-optic
submarine cable system owned by our parent, China Netcom Group, connecting
Japan, South Korea, Taiwan, Hong Kong, Singapore and the Philippines. This cable
system also connects to the west coast of the United States, and to Australia,
New Zealand, India, Malaysia, Thailand, Indonesia and Europe through additional
circuits that we have purchased or leased. In addition, we operate an
international network with an aggregate capacity of 250 Gbps in 24 international
submarine cables, ten international terrestrial cables and other leased
international circuits that connect to major cities around the world.
Recent Development-Sale of Asia Netcom
On June 2, 2006, we agreed to sell our equity interest in Asia Netcom
to a group of investors for US$168.84 million. The sale of Asia Netcom is in
line with our strategy to focus on development of telecommunications services in
China. Upon completion of the transaction, we expect to continue our business
relationship with Asia Netcom in connection with our remaining interenational
operations, including the purchase of capacity from Asia Netcom. See "--History
and Development-Recent Development-Sale of Asia Netcom".
Marketing, Sales, Distribution and Customer Services
In 2005, we revamped our marketing and sales channels in our northern
service region by establishing a new community manager system. We established a
cross-marketing system based on major account managers, community managers,
sales outlets, 10060 telephone marketing, online marketing, and third party
partners.
Over 40,000 community managers conducted direct marketing through
on-site cold-calling, which significantly enhanced our product sales and service
quality. To ensure the effectiveness of the community manager marketing
strategy, we set key performance indicators for community managers on certain
criteria such as sales revenue, sales growth, service and maintenance.
We improved our system of chief representatives for key accounts and
provide one-stop global services to major customers. We began to offer options
for either centralized or separate settlement based on the clients' needs. In
response to a growing demand from our business customers for communications,
networking and IT services, we heavily marketed a wide range of customized
value-added applications and integrated solution packages, through road shows
targeting specific groups of customers and other promotional activities.
In 2005, for the fourth consecutive year, we ranked number one in a
customer satisfaction survey conducted by the Ministry of Information Industry.
Trademarks
We market our services under the "CNC" brand name and logo, which are
registered trademarks in China owned by our parent company, China Netcom Group.
China Netcom Group has also registered the "CNC Connected" brand name as a
trademark for our broadband services targeted at business customers. On October
8, 2004, we entered into a new trademark licensing agreement with China Netcom
Group for our use of, among other things, the "CNC" brand name and logo, and
"CNC Connected" brand name. Under this agreement, China Netcom Group has agreed
to grant to us and our subsidiaries the right to use these trademarks on a
royalty-free basis for ten years, which is automatically renewable at our
option. Substantially all of our trademarks registered in China by China Netcom
Group expire after 2010.
Billing services and credit control
We bill our residential customers on a monthly basis and payments are
usually due, depending on the location of the customer, within a month and a
half of the last date of the billing period. We provide a range of payment
choices for the convenience of our customers, including direct-debit service,
which automatically deducts the monthly payment from the subscriber's designated
bank account. We also provide specially tailored billing and collection services
to our large business customers to help them more effectively plan and monitor
their telecommunications needs.
We charge a late payment fee on subscriber accounts that are not paid
by the monthly due date. We generally deactivate services for subscribers whose
accounts are more than 30 days overdue. These subscribers whose services have
been deactivated must pay all overdue amounts, including applicable late payment
fees, to reactivate their services. We will terminate a subscriber's service and
will remove him or her from the subscriber list if his or her account is overdue
for more than three months. We have implemented subscriber registration
procedures, including credit and background checking for PHS customers to
strengthen credit control. We also actively promote our prepaid telephone
services, available in our northern and southern service regions, as a means of
controlling bad debts.
Network Infrastructure
We operate a network which provides extensive coverage in China and
connectivity to over ten countries and regions in the Asia-Pacific region. This
network is technologically advanced and conducive to the introduction of the
next generation network and 3G technology. This network supports a wide range of
end-to-end fixed-line telecommunications services and enables customized
products to be delivered to meet a variety of telecommunications needs in
"real-time".
The network which we operate consists of transport networks, service
networks and support and information systems. The transport networks are
primarily fiber-optic based networks covering our northern and southern service
regions and the Asia-Pacific countries and regions in which we operate,
supplemented by satellite transmission and digital microwave links. The service
networks, which support our basic and value-added telecommunications services,
consist of our local access networks, including PHS networks, fixed-line
telephone switch networks, Internet and data service networks and intelligent
networks. The support and information systems include an operation support
system and a business support system to support the reliable and effective
operation of our networks. In addition, we are building an information
technology network and management support system which is designed to ensure the
speed and accuracy of our internal information flow.
Transport networks
We operate an advanced, high-speed, large capacity, secure and reliable
fiber-optic transport network throughout our northern and southern service
regions and in the Asia-Pacific countries and regions in which we operate. The
inter-provincial fiber-optic cables in our northern and southern service regions
and the Asia-Pacific fiber-optic cables, both of which are owned by our parent,
China Netcom Group, and operated by us, are integrated with our own
intra-provincial transport network. This fiber-optic network is supplemented by
satellite transmissions and microwave links. The integrated transport network
links the major economic centers in China, Japan, South Korea, Taiwan, Hong
Kong, Singapore and the Philippines and connects to networks worldwide. The
fiber-optic transport network that we operate allows us to more easily manage
networks with enhanced reliability. In addition, we offer a series of advanced
protection technologies to customers with varying service level requirements.
Service networks
Local access networks
We have extensive local access network coverage in our northern service
region. Our local access network covers most cities, counties and villages in
our northern service region. With our comprehensive local access networks, we
are able to provide customized solutions to our customers. In addition, as of
December 31, 2005, our PHS network had a capacity for 41.4 million lines.
We continue to upgrade our existing copper line local access networks
using DSL technology. We have selectively connected additional large office
buildings and business centers with broadband services using LAN. As of December
31, 2005, the total capacity of our DSL access ports reached 12.3 million lines.
Fixed-line telephone switch networks
A substantial portion of our fixed-line telephone networks has been
built in the last decade. All of our switches are digital. The network consists
of 131 local switch networks and a long distance switch network. As of December
31, 2005, the total capacity of local switches reached 113.9 million lines, and
the capacity of long distance switches reached 1.94 million lines. In addition,
China Netcom Group owns international gateways in Beijing, Shanghai and
Guangzhou with a total capacity of approximately 161,910 lines as of December
31, 2005, and we utilize these international gateways for our international long
distance telephone services. We intend to adopt advanced technology to ensure
network reliability and to improve the utilization rate of our network. We have
substantially completed the implementation of centralized control for our local
switch networks, and have implemented centralized control for approximately 37%
of the long distance switch networks we operate.
Internet and data service networks
We have developed large capacity, high quality and reliable Internet
and data networks in our northern and southern service regions. Our Internet
networks primarily rely on switch routers with high bandwidths. They are
structured with two layers, the backbone network layer and the application
layer. Our backbone networks are meshed to achieve maximum reliability and
stability. A majority of the main routes in this layer has transmission capacity
at 10 Gbps, or at 2.5 Gbps. As of December 31, 2005, we also had a backbone IP
network with a total bandwidth of 603,532 Mbps and international outbound
bandwidth of 39,830 Mbps. In addition, this network also allows us to provide
services such as IP-VPN, Internet data center, e-commerce and video-on-demand
services. Our data network system includes a digital data network and a frame
relay and ATM network. These networks cover all cities and counties in our
northern service region and substantially all cities and counties in our
southern service region. In particular, our ATM network allows us to provide
various access services, flexible broadband management capability and quality
end-to-end services.
Support and information systems
In 2005, we formulated a "Tri-Integration" development strategy for
our corporate information system. We believe this strategy will enable gradual
integration and standardization of our three major systems - application
systems, the data center and the transport network carrying the application
systems. The strategy, as a key part of our preparation for strategic
transformation, aims to enhance management transparency and our ability to
support integrated businesses and respond to the market.
In 2005, we also launched a "2+1" project as part of the implementation
of the "Tri-Integration" strategy. The project involved the full-scale
deployment of enterprise resource planning, or ERP, system and the
centralization of billing systems at the provincial level, and, based on the
needs of these two systems, optimization and integration of the DCN network for
data carrying and transmission. This project is expected to be completed in
2006. Upon completion, we expect our back office information system to improve
substantially in terms of management efficiency and minimized maintenance costs.
The "2+1" project is expected to enhance market responsiveness and business
support capability, by facilitating quick decision-making for our management and
operations, control of operating risks and improvement of internal controls.
Suppliers
We make most of our purchases through competitive bidding primarily
based on product and service quality, system compatibility and price.
Research and Development
Our research and development requirements are primarily fulfilled by
China Netcom Group in return for a service fee that is negotiated on a
case-by-case basis. These research and development activities are focused
primarily on operational planning and development of value-added services. China
Netcom Group has established a centralized research and development center.
Strategic Alliance with Telefonica
In November 2005, we entered into a strategic alliance agreement with
Telefonica Internacional S.A., or Telefonica, pursuant to which we and
Telefonica identified a number of areas in the telecommunications business for
potential cooperation. We believe that our strategic cooperation with Telefonica
will bring new expertise to our operations and management.
Competition
We compete with other telecommunications providers in virtually all
aspects of our business, including our fixed-line telephone services, broadband
and other Internet-related services, business and data communications services
and international telecommunications services. All of our principal competitors
in China are telecommunications carriers wholly or majority-owned by the PRC
government, including three fixed-line service providers and two licensed mobile
service providers. We also face intense competition from foreign
telecommunications service providers in our Asia-Pacific service region, where
we serve both business and carrier customers.
Fixed-line telephone services
In our northern service region, we are the dominant provider of
fixed-line telephone services, including local telephone services, domestic and
international long distance services and value-added services. We currently
compete with China Telecom, China Unicom and China Railcom, each of which has
been licensed to provide fixed-line telephone services in our northern service
region. In the markets for domestic and international long distance telephone
services, we face stronger competition from lower-priced VoIP services provided
by China Telecom, China Unicom, China Railcom and China Mobile. Mobile service
substitution for our fixed-line telephone services has also created considerable
competition for our local and long-distance telephone services. Currently, China
Mobile and China Unicom are the only licensed providers of mobile communications
services in China and, in recent years, some of the traffic from our fixed-line
networks has been diverted to these two companies. Our PHS services provide an
alternative for many of our existing and potential customers who would otherwise
choose mobile services instead of fixed-line services. In our southern service
region, we compete primarily against China Telecom, which holds a dominant
market position as the incumbent operator, in the fixed-line telephone services
markets in southern China. We also compete with China Mobile, China Unicom and
China Railcom in the provision of telephone services in our southern service
region.
Internet-related access services; business and data communications services
For Internet-related access services and business and data
communications services, we compete with China Telecom, China Unicom, China
Railcom and other Internet service providers on the basis of pricing, coverage
and quality of networks, ability to provide end-to-end connectivity, quality of
network management and customer service.
Our international telecommunications services
The telecommunications services market for business and data services
in Asia is highly competitive, and our success in the Asia-Pacific region will
depend on our ability to compete against a variety of other telecommunications
providers, including local incumbent operators as well as global
telecommunications operators. In the business segment, we face strong
competition from international operators, such as AT&T Corp., and local
incumbent operators, including NTT, Singapore Telecom and Korea Telecom. In the
carrier market, we also face intense competition from other providers of
telecommunications services in the Asia-Pacific region, including FLAG Telecom
Group Limited and C2C Pte. Ltd.
Potential competition from foreign operators
As a result of China's accession to the World Trade Organization, the
PRC government has agreed to open up over several years various segments and
regions of the telecommunications market in China to foreign investors. Foreign
operators entering into China's telecommunications market may have greater
financial, managerial and technical resources, and more expertise in network
management, sales and marketing than we do. See "Item 3. Key Information--Risk
Factors -- Risks Relating to Our Business -- Increasing competition in each of
our service regions and markets may have an adverse effect on our business
growth and financial condition -- Competition from foreign-invested operators
and other new entrants may further increase the competition for employees,
exacerbate price competition and increase our operating expenses, thereby
adversely affecting our financial condition and growth prospects". In order to
address the competition we face from foreign operators, we have formed strategic
alliances with some of our potential competitors, including Equant and Singtel.
REGULATION
Overview of Regulation of the Telecommunications Industry in China
The telecommunications industry in China is subject to extensive
government regulation. Under the State Council, a number of central government
authorities have regulatory responsibilities for various aspects of the
telecommunications industry. These authorities primarily include:
o The Ministry of Information Industry, or the MII, which is
responsible for, among other things:
formulating and enforcing telecommunications industry policies
and regulations as well as technical standards;
granting telecommunications service licenses;
supervising the operations and quality of service of
telecommunications operators;
allocating and administering telecommunications resources, such
as spectrum and numbers;
together with other relevant government regulatory authorities,
formulating tariff standards;
formulating interconnection and settlement policies between
telecommunications networks; and
maintaining fair and orderly market competition among operators;
o Provincial telecommunications administrations under the MII,
which oversee the implementation of the MII's regulations and
exercise regulatory authority delegated by the MII within their
respective provinces, autonomous regions and municipalities; and
o The National Development and Reform Commission, or the NDRC,
which, together with the MII, sets government fixed tariffs and
government guidance tariffs for certain telecommunications
services. See "-- Tariff Setting" below. It also approves
investment projects within the restricted sectors specified in
the annually adjusted catalogue released by the State Council.
The PRC government is in the process of drafting a telecommunications
law. We expect that, if and when the telecommunications law is adopted by the
National People's Congress or its standing committee, it will become the basic
telecommunications statute and provide a regulatory framework for the
telecommunications industry in China.
Telecommunications Regulations
The Telecommunications Regulations, effective as of September 25, 2000,
were promulgated by the State Council, and provide the primary regulatory
framework for China's telecommunications industry in the interim period prior to
the finalization and adoption of the telecommunications law. The stated goals of
the Telecommunications Regulations are to develop a transparent and fair
regulatory environment to encourage fair and orderly competition and the
development in the telecommunications industry. The key aspects which the
Telecommunications Regulations address include entry into the telecommunications
industry, network interconnection, telecommunications resource allocation,
tariffs and service standards.
Licensing
The Telecommunications Regulations distinguish between basic and
value-added telecommunications services, which are subject to different
licensing requirements. According to the Catalog of Telecommunications Services,
as promulgated by the MII and effective as of April 1, 2003:
o basic telecommunications services include, among other things,
fixed-line local and domestic long distance telephone services,
international telecommunications services, IP telephone services,
mobile communications services (such as 900/1800MHz GSM, 800MHz
CDMA and 3G mobile communications services), satellite
communications services, paging services, data communications
services (such as Internet data transmission services,
international data communications services), network access
services and the domestic and international telecommunications
facility services; and
o value-added telecommunications services include, among other
things, IP-VPN services, call center, voice mail and video
conferencing call services, Internet data center and Internet
access services, electronic data interchange services and
information services.
Under the Telecommunications Regulations, all telecommunications
operators in China must obtain a telecommunications service operating license
from the MII or from the provincial telecommunications administrations.
Providers of value-added services within a single province are required to
obtain licenses from provincial telecommunications administrations. Providers of
basic telecommunications services and providers of value-added services in two
or more provinces, autonomous regions and municipalities are required to obtain
licenses from the MII. TD-SCDMA technology is one of the three technologies
adopted by the International Telecommunications Union and under review by the
PRC government for use in providing 3G mobile telephone services. The MII is
currently conducting tests on TD-SCDMA related products. The PRC government has
not publicly announced its decisions on issues such as the timing of the grant
of the 3G licenses, the number of 3G licenses to be granted, any technical
requirements, or any selection of preferred technologies. In accordance with the
approval of the MII, CNC China, our principal operating subsidiary in China, as
an indirect subsidiary of China Netcom Group, has the right to operate our
telecommunications business in eight provinces and municipalities under the
authorization of China Netcom Group, which holds the license required for
operating our telecommunications businesses in China.
Tariff Setting
Overview
Our current tariffs are subject to regulation by various government
authorities, including the MII, the NDRC and, at the local level, the relevant
provincial telecommunications administrations and price bureaus. Under the
Telecommunications Regulations, telecommunications tariffs are categorized into
government-fixed tariffs, government guidance tariffs and market-based tariffs.
The monthly fee and usage fee for local telephone service and tariffs
for all domestic and international, Hong Kong, Macau and Taiwan long distance
services using traditional networks are regulated as fixed tariffs, which are
fixed jointly by the MII and the NDRC. Leased line and data services (other than
ATM service) are charged at government-guidance tariffs, which are determined
jointly by the MII and the NDRC. We derive a substantial portion (in excess of
80%) of our revenues from services that are subject to government guidance
tariffs and government-fixed tariffs.
The Notice on Implementation of Market-Based Tariffs for Certain
Telecommunications Services, promulgated jointly by the MII and the NDRC in
2002, specifies the telecommunications businesses to which market-based tariffs
are applicable, including VoIP, Internet access services, and certain
value-added services provided over fixed-line telephone networks, such as
telephone information, caller identification and voice mail. Market-based
tariffs shall be applicable to those telecommunications services for which
effective competition exists in the market. The tariffs of such
telecommunications services are determined at the sole discretion of the
operators, and will be implemented after filing with the MII or provincial
telecommunications administrations, as applicable. There is uncertainty
regarding how the MII determines the existence of effective competition, as the
MII has not publicly disclosed the criteria it uses for determining whether a
certain type of service should be subject to market-based tariffs. Under the
Telecommunications Regulations, cost is the primary basis for tariff setting,
but the tariff levels also take into account social and economic development,
the development of the telecommunications industry and the purchasing power of
the customers. The MII has not provided a timetable for tariff deregulation or
indicated that operators will eventually be permitted to freely set all tariffs.
We expect that increased flexibility in setting certain tariffs will allow us to
better respond to changes in market demand and competitive conditions.
In December 2000, the PRC government issued a notice of tariff
adjustments. The tariff adjustments changed the tariff levels for various
telecommunications services, including local and long distance telephone, data
and leased line services. In general, these adjustments have stimulated the
overall usage of our telecommunications services. In July 2001, the government
eliminated the upfront connection fee for fixed-line telephone services. For a
discussion of the impact of these adjustments on our financial condition and
results of operations, see "Item 5. Operating and Financial Review and
Prospects".
The PRC government retains the ultimate authority to adopt changes to
tariffs. However, the Telecommunications Regulations require the government to
hold public hearings before setting or changing a fixed or guidance tariff,
which should be attended by, among others, telecommunications operators and
consumers. In 2002, the MII indicated in writing that it did not intend to
initiate any adjustment to tariffs for fixed-line local telephone services
during the three to five years commencing in September 2002. Our average
realized tariffs may vary from levels set forth below. See "Item 3. Key
Information--Risk Factors -- Risks Relating to the PRC Telecommunications
Industry -- New regulations, regulatory changes or changes in enforcement
policies relating to telecommunications tariffs may adversely affect our
competitiveness, business and profitability".
Tariffs
The following tables set forth the tariff rates of certain services
provided by us, where government fixed tariffs or government guidance tariffs
are applicable.
Local telephone services
For our local telephone services, we charge a registration fee for
initial installation that varies depending on whether the subscriber is a
residential or a business customer, a fixed monthly fee, local call usage fees
based on call duration and fees for certain value-added services. The following
table sets forth our current tariffs for local telephone services provided on
our traditional and PHS network:
Tariff (in RMB)
---------------
Monthly fee:
Residential subscribers in:
Provincial capitals..................... 20.00 to 25.00
Other cities and counties............... 12.00 to 18.00
Rural areas............................. 10.00 to 15.00
Business subscribers....................... 25.00 to 35.00
Usage fee:
Intra-district............................. 0.18 to 0.22 for the first two
pulses (first three minutes or
less) and 0.09 to 0.11 for each
additional pulse (one minute
intervals)
Inter-district............................. 0.30 to 0.50 per pulse
(one minute intervals)
Communication fee:
Internet dial-up........................... 0.02 per pulse (one minute
intervals)
Domestic long distance services
Our revenues from domestic long distance services consist of charges
based on the duration, time of day and day of the week a call is placed. The
following table sets forth the current tariffs for our domestic long distance
telephone services using our traditional network:
Tariff (RMB)
------------
Domestic long distance services on our
traditional Network................................... 0.07 per six seconds(1)
__________
(1) Subject to filing with the provincial telecommunications administrations,
our provincial level headquarters may apply a 10% to 50% discount rate to
calls made during off-peak hours.
International long distance services
International long distance service is a government-fixed tariff. The
following table sets forth our current international long distance tariffs:
Tariff (RMB)
------------
International long distance services on
our traditional network(1):
To Hong Kong, Macau and Taiwan.......................... 0.20 per six seconds
To all international destinations 0.80 per six seconds
__________
(1) Subject to filing with the provincial telecommunications administrations,
our provincial level headquarters may apply a 10% to 50% discount rate to
calls made during off-peak hours.
Managed data services
The PRC government publishes guidance tariffs for certain managed data
services, including DDN and frame relay services, provided by operators in
China. Interim tariffs for our ATM services are determined at our discretion,
subject to approval by the MII. An initial fee is generally charged for
installation and testing for our data services, as well as a fixed monthly fee
for each of the services.
DDN services
The following table sets forth the monthly fees for DDN services at the
bandwidths of 64kbps, 128kbps, 512kbps and 1Mbps:
Monthly Fee
----------------------------------------------------
64kbps 128kbps 512kbps 1Mbps
------ ------- ------- -----
(RMB)
Intra-district.......... 1,500 2,000 3,800 5,000
Inter-district.......... 2,000 2,500 5,200 7,500
Domestic long distance.. 3,500 5,000 7,000 9,000
Frame relay services
The following tables set forth the monthly fees for frame relay
services, which include monthly fees for port access and permanent virtual
circuits, or PVCs(1):
Monthly Fee
----------------------------------------------------
64kbps 128kbps 512kbps 1Mbps
------ ------- ------- -----
Port Access (RMB)
Monthly fees............. 260 400 500 1,000
PVC
Intra-district........... 550 800 1,000 1,500
Inter-district........... 800 1,150 1,450 2,200
Domestic long distance... 1,700 2,200 2,500 4,000
__________
(1) One-way tariff for PVCs frame relay services.
Leased line services
We charge monthly fees for subscribers to our leased line services
based on guidance tariffs set by the PRC government, which vary based on
bandwidth and whether the leased line is local or long distance. Leased line
tariffs have generally decreased in recent years.
The following table sets forth the tariffs for 2Mbps, 8Mbps, 34Mbps and
155Mbps digital circuits:
Monthly Fee
----------------------------------------------
2Mbps 8Mbps 34Mbps 155Mbps
(RMB)
Intra-district................... 2,000 6,000 16,000 44,000
Inter-district................... 4,000 11,000 31,000 88,000
Domestic long distance(1)........ 6,000 17,000 47,000 132,000
__________
(1) Does not include the tariffs for local digital circuits and access lines.
Interconnection
According to the Telecommunications Regulations and the Administrative
Rules on Interconnection between the Public Telecommunications Networks, as
promulgated by the MII in May 2001, major telecommunications operators in China
may not refuse a request from another operator to interconnect with its network.
Upon such a request, the relevant operator shall enter into an interconnection
agreement with the other operator, and file such agreement with the MII. In
addition, interconnection agreements may not be terminated unilaterally without
an approval from the MII.
The Telecommunications Regulations further provides that the MII shall
establish rules relating to technical standards and settlement procedures of
interconnection. Accordingly, the MII promulgated the Measures on Settlement of
Usage Fees between Telecommunications Networks in March 2001, which specify the
methods for revenue sharing and settlement between telecommunications operators.
China Netcom Group has entered into agreements on interconnection with other
telecommunications operators, including China Telecom, China Mobile, China
Unicom, China Railcom and China Satcom.
In December 2003, the MII revised the rules on interconnection
technical standards and settlement procedures for public telecommunications
networks by promulgating the Measures on Settlement of Interconnection between
Public Telecommunications Networks and Sharing of Relaying Fees.
The following table sets forth selected current major interconnection
revenue sharing and settlement arrangements for local calls, as established in
the 2003 rules:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
------------------------------ ----------------------------- ------------------------------
Mobile operator Local fixed-line operator (1) Mobile operator collects
the cellular usage fees from
its subscribers.
(2) Mobile operator pays RMB
0.06 per minute to local
fixed-line operator.
------------------------------ ----------------------------- ------------------------------
Local fixed-line operator Mobile operator No revenue sharing or
settlement.
------------------------------ ----------------------------- ------------------------------
Local fixed-line operator A Local fixed-line operator B (1) Operator A collects the
usage fees from its
subscribers.
(2) In the case of (i)
intra-district calls,
operator A pays operator
B 50% of the intra-
district usage fees; or
(ii) inter-district
calls (x) where operator
A does not use the
inter-district
transmission facilities
of operator B, operator
A pays operator B 50% of
the intra-district usage
fees; or (y) where
operator A uses operator
B's inter-district
transmission facilities,
operator A pays operator
B 90% of the
inter-district usage
fees.
The following table sets forth selected current major main
interconnection revenue sharing and settlement arrangements for domestic long
distance calls:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
------------------------------ ----------------------------- ------------------------------
Local fixed-line or mobile Local fixed-line or mobile RMB 0.06 per minute to
operator A operator B, through the operator A, RMB 0.06 per
long distance network of minute to operator B, the
operator C balance for operator C.
The following table sets forth selected current major main
interconnection revenue sharing and settlement arrangements for international
long distance calls, including calls originated from and terminated in Hong
Kong, Macau and Taiwan:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
------------------------------ ----------------------------- ------------------------------
Domestic fixed-line or International long distance RMB 0.06 per minute to
mobile operator A operator B, through the operator A, no greater than
domestic long distance RMB 0.54 per minute to
network of operator C to operator C, the balance to
international gateway operator B.
The following table sets forth selected current main interconnection
revenue sharing and settlement arrangements for VoIP long distance calls:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
------------------------------ ----------------------------- ------------------------------
Fixed-line or mobile Fixed-line or mobile (1) Operator C collects the
operator A operator B through the VoIP VoIP long distance
network of operator C usage fees from its
subscribers.
(2) Operator C pays RMB
0.06 per minute to operator
B on the terminating
end.
(3) No settlement between
operator C and operator
A on the originating
end.
(4) Operator A collects
local usage fees.
Effective November 1, 2002, the Ministry of Information Industry has
unified the minimum level of the termination rate for international calls,
including for this purpose calls from Hong Kong, Macau and Taiwan, terminating
in China. Such termination rate is required to be no less than US$0.17 per
minute, but can be higher based upon negotiations between the carriers.
Technical Standards
The MII sets industry technical standards for telecommunications
terminal and interconnection-related equipment used in the public
telecommunications networks. A network access license from the MII and other
relevant regulatory authorities is required for all such equipment. Most of the
standards set by the MII conform to standards recommended by the International
Telecommunications Union and other international telecommunications standards
organizations.
Capital Investment
Prior to July 16, 2004, the State Council authorized the NDRC to
approve any plan to construct a nationwide telecommunications network or any
network construction plan involving a capital investment that totals from RMB 50
million to RMB 200 million. The State Council also authorized the MII to approve
certain aspects of such investment projects. Any investment project with total
capital investment in excess of RMB 200 million was required to obtain approval
from the State Council.
On July 16, 2004, the State Council promulgated, effective immediately,
the Decision on Reform of Investment System, or the Investment Reform Decision,
which significantly modified the government approval process for major
investment projects in China. The Investment Reform Decision eliminated the
government approval requirements for investment projects that do not involve
direct government funding unless the investment projects are in the restricted
sectors specified in the annually adjusted catalogue released by the State
Council. The 2004 catalogue, which was attached as an annex to the Investment
Reform Decision, sets forth approval requirements for individual investment
projects in restricted sectors. Within the telecommunications sector, the
investment projects that require the NDRC's approval include:
o domestic backbone transmission networks (including broadcasting
and television networks);
o international telecommunications transmission circuits;
o international gateways;
o international telecommunications facilities for dedicated
telecommunications networks; and
o other telecommunications infrastructure projects involving
information security.
Accessing International Capital Markets
Prior to accessing the international capital markets, we may be
required to obtain approval from various government authorities depending on the
type of international financing we intend to seek. For example, documents
relating to our future public offerings of new shares must be filed with the
China Securities Regulatory Commission, or the CSRC. If such offerings involve
certain new acquisitions of assets or exchanges of equity interest within China,
the CSRC's prior approval will be required. In addition, China Netcom Group and
our other state-owned shareholders are required to obtain approval from relevant
PRC government authorities prior to their participation in any future share
offering by our company confirming their respective sales of shares and related
contributions to the PRC national social security fund, as required by PRC law.
Furthermore, any use of the proceeds that we receive from international capital
markets by CNC China, either as a shareholder loan or as a capital contribution,
will be subject to registration or approval requirements under PRC law.
Telecommunications Resources
The MII is responsible for the administration and allocation of
telecommunications resources in China, including spectrum frequencies and
telecommunications network numbers. The use of these resources by
telecommunications operators is subject to the approval of the MII or the
relevant provincial telecommunications administrations or provincial radio
administrations and the payment of a telecommunications resources usage fee. The
provincial radio administrations have allocated the 1900-1915 MHz frequency
spectrum to us for PHS services, and we have the exclusive rights to use that
frequency spectrum in our northern service region. On January 1, 2005, the MII
issued a regulation imposing fees for the use of telephone numbers. Under the
regulation, starting from April 1, 2005, all telecommunications operators,
including us, are required to pay RMB 0.01 per telephone number per month.
Quality of Service
Under the Telecommunications Regulations, the MII and the relevant
provincial telecommunications administrations are responsible for supervising
and monitoring the quality of services provided by telecommunications operators
in China. Under the Telecommunications Regulations, customers of
telecommunications operators have the right to submit their complaints to the
MII and the relevant provincial telecommunications administrations or other
relevant government authorities.
Universal Services Obligations
Under the Telecommunications Regulations, telecommunications operators
in China are required to fulfill universal service obligations in accordance
with relevant regulations to be promulgated by the PRC government, and the MII
has the authority to delineate the scope of universal service obligations. The
MII, together with governmental finance and pricing authorities, is also
responsible for formulating administrative rules relating to the establishment
of a universal service fund and compensation schemes for universal services.
These rules have not yet been promulgated, and there are currently no specific
regulatory requirements relating to the provision of universal services in
China.
While the scope of specific universal services obligations is not yet
clear, we believe that such services may include mandatory provision of basic
telecommunications services in economically less developed areas in China. The
MII requires China Telecom, China Netcom Group, China Mobile, China Unicom,
China Railcom and China Satcom to participate in a project to provide telephone
services in a number of remote villages in China as transitional measures prior
to the formalization of a universal service obligation framework. In order to
fulfill such obligations under those transitional measures, China Netcom Group
has agreed with us that it will assume the responsibility for investing in and
constructing the necessary network facilities. If we operate and maintain such
network facilities in our northern and southern service regions, China Netcom
Group has agreed to compensate us for the related expenses based on fair market
value.
Regulation of the Telecommunications Industry in Our Asia-Pacific Region
We are required to obtain and maintain a variety of telecommunications
and other licenses and authorizations in the Asia-Pacific jurisdictions in which
we operate. We must also comply with a variety of regulatory obligations,
including obtaining permits to land our cables in the territories to which they
are connected. In some jurisdictions in our Asia-Pacific service region, we are
subject to ownership limitations with respect to the joint ventures that we form
with our local partners. For example, South Korea currently limits the ownership
of domestic enterprises by offshore telecommunications operators, such as us, to
49%. We hold all necessary telecommunications and other licenses that permit us
to own and independently operate the non-PRC assets in key countries and
regions, including Japan, Hong Kong and Singapore. We also operate in South
Korea, Malaysia, Indonesia and the Philippines through joint ventures or through
contractual relationships with operators that permit us to rely on the relevant
telecommunications licenses. Licenses are not required in other countries in
which we operate, such as Australia.
ORGANIZATIONAL STRUCTURE
Our Shareholding Structure
As of May 31, 2006, China Netcom Group Corporation (Hong Kong)
Limited ("CNC Hong Kong", "we" or "us") is owned by China Netcom Group
Corporation (BVI) Limited ("CNC BVI"), five PRC shareholders, Telefonica
Internacional S.A. which was incorporated in Spain, and public shareholders,
which hold 70.39%, 4.51%, 4.99% and 20.11% of our shares, respectively. Our five
PRC shareholders, all of which are established in the PRC, are the Chinese
Academy of Sciences (or the Academy of Sciences), Information and Network Center
of the State Administration of Radio, Film and Television (or INC-SARFT), China
Railways Telecommunications Center (or CRTC), Shanghai Alliance Investment
Limited (or Shanghai Alliance), and Shandong Provincial State-owned Assets
Supervision and Administration Commission (or Shandong SASAC). All of the
ordinary shares owned by our five PRC shareholders are registered in the name of
China Netcom Group Corporation (BVI) Limited, or CNC BVI, which holds such
ordinary shares in trust for each of the five PRC shareholders. Consequently,
the ownership percentages of our five PRC shareholders reflect the aggregate
beneficial interests of these shareholders as held through CNC BVI. The
ownership of CNC BVI as indicated above reflects CNC BVI's own beneficial
ownership.
CNC BVI is owned 100% by China Network Communications Group Corporation
("China Netcom Group"), which is a wholly state-owned enterprise established in
PRC. China Netcom Group is the parent of wholly owned subsidiaries that,
following the restructuring, include China Netcom (Holdings) Company Limited, or
China Netcom Holdings, an investment holding company, and telecommunications
companies outside our northern and southern service regions. None of these
subsidiary companies have any ownership interest in us, nor do we have any
ownership interest in them.
CNC Hong Kong has three wholly-owned subsidiaries, which include China
Netcom Group New Horizon Communications Corporation (BVI) Limited ("CNC New
Horizon BVI"), China Netcom (Group) Company Limited ("CNC China") which was
incorporated in PRC, and China Netcom Corporation International Limited ("CNC
International") which was incorporated in Bermuda. CNC New Horizon BVI owns 100%
of China Netcom Group New Horizon Communications Corporation Limited ("CNC New
Horizon PRC") which was incorporated in PRC. CNC International has three
wholly-owned subsidiaries, which are Asia Netcom Corporation Limited ("Asia
Netcom") incorporated in Bermuda, China Netcom (USA) Operations Limited ("China
Netcom (USA)"), and China Netcom (Hong Kong) Operations Limited ("China Netcom
(Hong Kong)"). Each of China Netcom (USA) and China Netcom (Hong Kong) was
previously wholly-owned subsidiaries of Asia Netcom and the ownership of each of
these two entities was transferred to China Netcom Corporation International
Limited as of March 15, 2006.
Recent Development-Sale of Asia Netcom
On June 2, 2006, we agreed to sell our equity interest in Asia Netcom
to a group of investors for US$168.84 million. We expect this transaction to be
completed by early August 2006. See "--History and Development--Recent
Development-Sale of Asia Netcom."
PROPERTY, PLANT AND EQUIPMENT
Our principal executive offices are located in Beijing. We also
maintain an executive office in Hong Kong. We own, lease or have usage rights in
various properties, which consist of offices, administrative centers, staff
quarters, retail outlets and technical facilities. We have certain properties
transferred to us by China Netcom Group which do not have vested proper legal
titles, and we have certain properties the titles for which have not been
transferred to us. We believe it is unlikely that we would be denied our right
to use a large number of these properties with title defects at any given time.
China Netcom Group agreed to indemnify us against any loss or damage suffered or
incurred by us, caused by or arising from any challenge to or interference with
our title to and/or right to use properties transferred to us in respect of
which we have not obtained long-term title certificates or those properties
rented by us from China Netcom Group where there are title defects.
ITEM 4A. UNRESOLVED STAFF COMMENTS
None.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following discussion and analysis should be read in conjunction
with our consolidated financial statements, selected consolidated financial data
and unaudited pro forma consolidated financial information, in each case
together with the accompanying notes, all included elsewhere in this document.
Overview of Our Services
We are the dominant provider of fixed-line telephone services,
broadband and other Internet-related services, and business and data
communications services in our northern service region in China. We also provide
voice, broadband and data services using new technologies in our southern
service region and international voice and data services throughout the
Asia-Pacific region.
Factors Affecting Our Results of Operations
Our 2005 Acquisition
On October 31, 2005, we acquired from China Netcom Group the fixed-line
telecommunications assets and related liabilities in Heilongjiang Province,
Jilin Province, the Inner Mongolia Autonomous Region and Shanxi Province. Since
we and the 2005 Acquired Assets and Liabilities were under the common control of
China Netcom Group, our 2005 Acquisition has been treated as a "combination of
entities under common control", which was accounted for in a manner similar to
pooling-of-interests. Accordingly, the 2005 Acquired Assets and Liabilities have
been recognized at carrying amounts and our financial statements as of and for
the years ended December 31, 2003 and 2004 have been restated to include the
financial position and results of operations of the 2005 Acquired Assets and
Liabilities on a combined basis. All data and information relating to our
businesses and operations for the years ended December 31, 2003 and 2004 are
presented based on those restated amounts.
The following table presents a summary of the results of operations of
each of our company, as previously reported by us, and the 2005 Acquired Assets
and Liabilities for the years ended December 31, 2003 and 2004 and the
shareholders' equity as of December 31, 2003 and December 31, 2004, and the
combined amounts presented in our consolidated financial statements included
elsewhere in this annual report. For the periods presented, all significant
balances and transactions between our company and China Netcom Group in relation
to the 2005 Acquired Assets and Liabilities prior to our 2005 Acquisition have
been eliminated.
Our Company 2005 Acquired
(as previously Assets and
reported) Liabilities Combined
RMB RMB RMB
Million Million Million
2003
Operating revenue 59,898 17,700 77,598
Operating income/(loss) (14,489) 1,077 (13,412)
Net income/(loss) (11,112) 205 (10,907)
Basic earnings/(loss) per share (RMB) (2.02) 0.03 (1.99)
2004
Operating revenue 64,878 18,616 83,494
Operating income/(loss) 15,511 (9,204) 6,307
Net income/(loss) 9,230 (6,531) 2,699
Basic earnings/(loss) per share (RMB) 1.64 (1.16) 0.48
Financial condition:
Current assets as of December 31, 2004 17,492 3,174 20,666
Total assets as of December 31, 2004 179,534 56,547 236,081
Current liabilities as of December 31, 2004 86,871 31,479 118,350
Total liabilities as of December 31, 2004 136,155 46,264 182,419
Shareholders' equity as of December 31, 2004 43,376 10,283 53,659
Shareholders' equity as of December 31, 2003 62,213 7,554 69,767
Revaluation of our fixed assets
As part of the reorganization of China Netcom Group and us, and as
required by the relevant PRC regulations, China Enterprise Appraisal, an
independent appraiser registered in China, conducted an appraisal of our fixed
assets as of December 31, 2003 on a depreciated replacement cost basis. This
revaluation resulted in a net reduction in the book value of the fixed assets
other than land and buildings in the amount of RMB 22,796 million.
As required by the relevant PRC regulation, China Enterprise Appraisal,
conducted an appraisal of 2005 Acquired Assets and Liabilities as of December
31, 2004 on a depreciated replacement cost basis. This revaluation resulted in a
net reduction in the book value of the fixed assets other than land and building
in the amount of RMB 7,455 million.
For the purpose of preparing our financial statements, the effect of
the revaluations was reflected in our consolidated financial statements as a
charge of RMB 25,778 million on our consolidated income statements in the form
of a deficit on revaluation of fixed assets in 2003 and surplus of RMB 2,982
million that was credited to the revaluation reserve on December 31, 2003, and a
charge of RMB 11,318 million on our consolidated income statements in the form
of a deficit on revaluation of fixed assets in 2004 and surplus of RMB 3,863
million that was credited to the revaluation reserve on December 31, 2004. This
had the effect of significantly and adversely affecting our profits from
operations in each of 2003 and 2004.
The revaluation also has the effect of decreasing future annual
depreciation and amortization charges.
Results of Operations
The table below sets forth a breakdown of the revenues of our domestic
and international telecommunications services and total operating expenses in
terms of amount and as a percentage of our total revenues, as well as net cash
flow, for the periods indicated. Although in 2003 we did not manage our
international services separately from our domestic services, we have begun to
do so in 2004 and will continue to do so in the future. Therefore, we expect in
the future to continue to report our revenues in the same format as presented
below.
For the Years Ended December 31,
--------------------------------
2003 2004 2005
---- ---- ----
Percentage Percentage Percentage
of of of
Amount Revenues Amount Revenues Amount Revenues
-------- ----------- -------- ----------- -------- -------------
(RMB in millions, except percentage data)
Revenues:
Domestic Telecommunications Services:
Fixed-line telephone services(1):
Local:
Local usage fees 24,685 31.8% 24,858 29.8% 24,582 28.2%
Monthly fees 16,476 21.2% 17,964 21.5% 18,261 20.9%
Upfront installation fees 1,267 1.6% 1,568 1.9% 1,442 1.7%
-------- ----------- -------- ----------- -------- -------------
Subtotal 42,428 54.7% 44,390 53.2% 44,285 50.8%
-------- ----------- -------- ----------- -------- -------------
Domestic long distance(2) 11,425 14.7% 11,266 13.5% 10,260 11.8%
International long distance(2)(3) 1,543 2.0% 1,234 1.5% 1,180 1.4%
Value-added services 2,095 2.7% 2,993 3.6% 4,000 4.6%
Interconnection fees from domestic
Carriers 3,763 4.8% 5,441 6.5% 6,517 7.5%
Upfront connection fees(4) 5,122 6.6% 4,346 5.2% 3,405 3.9%
-------- ----------- -------- ----------- -------- -------------
Subtotal 66,376 85.5% 69,670 83.4% 69,647 79.8%
-------- ----------- -------- ----------- -------- -------------
Broadband Services 2,914 3.8% 5,202 6.2% 7,812 9.0%
other Internet-related
Services 1,418 1.8% 1,004 1.2% 540 0.6%
-------- ----------- -------- ----------- -------- -------------
Subtotal 4,332 5.6% 6,206 7.4% 8,352 9.6%
-------- ----------- -------- ----------- -------- -------------
Business and data communications
services:
Managed data 1,553 2.0% 1,520 1.8% 1,395 1.6%
Leased line 2,820 3.6% 2,095 2.6% 2,238 2.6%
Subtotal 4,373 5.6% 3,615 4.4% 3,633 4.2%
Other services 1,138 1.5% 1,360 1.6% 2,345 2.7%
-------- ----------- -------- ----------- -------- -------------
Subtotal 76,219 98.2% 80,851 96.8% 83,977 96.3%
-------- ----------- -------- ----------- -------- -------------
International Telecommunications
Services:
International long distance - - 181 0.2% 284 0.3%
Interconnection fees from international
Carriers 1,217 1.6% 1,012 1.2% 1,266 1.5%
Broadband and other Internet-related
Services 14 - 360 0.4% 376 0.1%
Managed data 64 0.1% 309 0.4% 407 0.3%
Leased line 63 0.1% 456 0.6% 683 0.5%
Other services 21 - 285 0.3% 239 0.8%
-------- ----------- -------- ----------- -------- -------------
Subtotal 1,379 1.8% 2,643 3.2% 3,255 3.7%
-------- ----------- -------- ----------- -------- -------------
Total 77,598 100.0% 83,494 100.0% 87,232 100.0%
-------- ----------- -------- ----------- -------- -------------
Operating Expenses:
Depreciation and amortization 26,800 34.5% 25,180 30.2% 25,049 28.7%
Network, operations and support 15,108 19.5% 13,973 16.7% 14,417 16.5%
Staff costs 10,945 14.1% 11,950 14.3% 12,333 14.1%
Selling, general and administrative 10,322 13.3% 12,877 15.4% 13,438 15.4%
Other operating expenses 2,197 2.8% 1,993 2.4% 1,490 1.7%
-------- ----------- -------- ----------- -------- -------------
Total 65,372 84.2% 65,973 79.0% 66,727 76.5%
Operating profit before interest income,
dividend income and deficit on
revaluation of
fixed assets 12,226 15.8% 17,521 21.0% 20,505 23.5%
Interest and dividend income 140 0.2% 104 0.1% 186 0.2%
Deficit on revaluation of fixed
Assets (25,778) -33.2% (11,318) -13.6% - 0.0%
-------- ----------- -------- ----------- -------- -------------
Profit/(loss) from operations (13,412) -17.3% 6,307 7.6% 20,691 23.7%
Finance costs (4,296) -5.5% (3,930) -4.7% (3,374) -3.9%
Share of profit/(loss) of associated
companies and jointly controlled entity (416) -0.5% (1) 0.0% - 0.0%
-------- ----------- -------- ----------- -------- -------------
Profit/(loss) before taxation (18,124) -23.4% 2,376 2.8% 17,317 19.9%
Taxation 7,217 9.3% 323 0.4% (3,429) -3.9%
-------- ----------- -------- ----------- -------- -------------
Profit/(loss) after taxation (10,907) -14.1% 2,699 3.2% 13,888 15.9%
Minority interests 1 0.0% - 0.0% - 0.0%
-------- ----------- -------- ----------- -------- -------------
Profit/(loss) for the year (10,906) -14.1% 2,699 3.2% 13,888 15.9%
======== =========== ======== =========== ======== =============
Net cash inflows from operating
Activities 30,917 39.8% 33,653 40.3% 33,557 38.5%
Net cash outflows from investing
Activities (34,875) -44.9% (28,702) -34.4% (24,608) -28.2%
Net cash inflows/(outflows) from
financing Activities 3,595 4.6% (1,743) -2.1% (14,656) -16.8%
__________
(1) Includes revenues from our PHS services.
(2) Includes revenues from our long distance VoIP services.
(3) Includes revenues from calls to Hong Kong, Macau and Taiwan.
(4) Upfront connection fees for basic telephone access services were eliminated
by the MII in July 2001.
Operating results for the year ended December 31, 2005 and the year ended
December 31, 2004
Revenues
Our revenues consist of revenues from the provision of
telecommunications services, net of business tax and government levies. Sources
of our revenues consist of revenues from our domestic businesses, including fees
charged for the provision of fixed-line telephone services, broadband and other
Internet-related services, business and data communications services, and other
services, and revenues from our international telecommunications services.
In 2005, our revenues were RMB 87,232 million, representing an increase
of RMB 3,738 million, or 4.5%, from RMB 83,494 million in 2004. This increase
primarily reflects increases in revenues from our domestic services, including
broadband services, value-added services, interconnection fees and certain other
services.
Domestic telecommunications services
------------------------------------
Fixed-line telephone services
Local telephone services
------------------------
Revenues from our local telephone services (including PHS services)
comprise local usage fees, monthly fees and installation fees. They vary
depending on the number of our fixed-line subscribers, average realized tariffs
and the usage volume of local calls (including those made to connect to our
dial-up Internet service). In 2005, revenues from our local telephone services
were RMB 44,285 million, representing a decrease of RMB 105 million, or 0.2%,
from RMB 44,390 million in 2004, and accounting for 50.8% of our total revenues
in 2005.
This slight decrease in revenues from local telephone services reflects
a combination of decreases in revenues from local usage fees and upfront
installation fees and an increase in revenues from monthly fees. The decreases
in revenues from local usage fees and upfront installation fees were primarily
due to increasing competition in the telecommunications market and increasing
mobile substitution. The increase in revenues from monthly fees was primarily
due to the growth of our PHS services.
Local usage fees. Usage fees for local services include local usage
fees charged for local telephone calls and VoIP long distance calls, and
communications fees for dial-up Internet access.
In 2005, revenues from our local usage fees were RMB 24,582 million,
representing a decrease of RMB 276 million, or 1.1%, from RMB 24,858 million in
2004. The decrease was primarily due to a decrease of 6.2 billion pulses, or
2.7%, in the usage volume of local calls to 228.4 billion pulses in 2005 from
234.6 billion in 2004. The decrease in usage volume of local calls was in turn
caused by a decrease in usage volume of non-PHS calls to 172.9 billion pulses in
2005 from 189.0 billion pulses in 2004, principally reflecting the migration of
our non-PHS local traffic to PHS and mobile services. Usage volume of PHS calls
increased to 55.6 billion pulses in 2005 from 45.7 billion pulses in 2004.
Revenues from communications fees charged for our dial-up Internet
service decreased to RMB 149 million in 2005 from RMB 256 million in 2004, which
was primarily caused by a decrease of 8.674 billion pulses, or 50.4%, in usage
volume of this service to 8.552 billion pulses in 2005 from 17.226 billion
pulses in 2004, reflecting the migration of Internet dial-up traffic to
broadband services.
Monthly fees. Monthly fees represent the fixed amount of service
charges to our customers for using our fixed-line telephone services.
In 2005, our revenue from monthly fees were RMB 18,261 million,
representing an increase of RMB 297 million, or 1.7%, from RMB 17,964 million in
2004, primarily due to an increase in the number of our fixed-line subscribers
in our service regions.
Upfront installation fees. Installation fees represent the amortized
amount of the upfront fees received for installation of non-PHS fixed-line
telephone services. These upfront installation fees are deferred and recognized
over the expected customer relationship period, which is currently estimated to
be ten years.
Revenues from the upfront installation fees were RMB 1,442 million in
2005, representing a decrease of RMB 126 million, or 8.0%, from RMB 1,568
million in 2004. The decrease was principally attributable to upfront
installation discount offered to new subscribers, coupled with a decrease in the
number of new subscribers in 2005 to 2.036 million from 3.678 million in 2004.
Domestic long distance services
-------------------------------
Revenues from our domestic long distance services consist of usage fees
for domestic long distance calls originated by our fixed-line subscribers, users
of our prepaid phone cards and certain other customers. In 2005, our domestic
long distance revenues were RMB 10,260 million, representing a decrease of RMB
1,006 million, or 8.9%, from RMB 11,266 million in 2004. This decrease was
caused by a decrease of RMB 547 million, or 7.2%, in revenues from the domestic
long distance calls carried on our traditional network and a decrease of RMB 458
million, or 12.6%, in revenues from our VoIP long distance service during the
2004-2005 comparison period, which in turn was primarily attributable to
declines in the average realized tariffs for both long distance calls carried on
the traditional network and VoIP calls.
International long distance services
------------------------------------
Revenues from our international long distance services consist of usage
fees charged to our customers for their international long distance calls
originated in our service regions, including those made to Hong Kong, Macau and
Taiwan.
In 2005, this revenue was RMB 1,180 million, representing a decrease of
RMB 54 million, or 4.4%, from RMB 1,234 million in 2004. The revenue decrease
reflects a combination of an increase of 34.0% in the volume of international
long distance calls carried on our VoIP network and a decrease of 22.0% in the
average realized tariff for international long distance calls.
Value-added services
--------------------
Revenues from our value-added services consist of fees that we charge
our customers for the provision of caller identification, PHS short-messaging,
personalized ring, telephone information services, video- and tele-conferencing
and other value-added services. Revenues from our value-added services in 2005
were RMB 4,000 million, representing an increase of RMB 1,007 million, or 33.6%,
from RMB 2,993 million in 2004. The increase was primarily attributable to an
increase in revenues from PHS short message service to RMB 624 million in 2005
from RMB 79 million in 2004, reflecting an increase in the number of PHS short
messages sent from our network to 6.8 billion in 2005 from 2.0 billion in 2004.
The revenue growth was further driven by an increase in revenues from our caller
identification service to RMB 2,241 million in 2005 from 2,231 million in 2004,
reflecting an increase in the number of subscribers of our caller identification
service, which reached a penetration rate of 65.9% of our access lines in
service as of December 31, 2005 from 60.4% as of December 31, 2004.
Interconnection services
------------------------
Revenues from our interconnection services represent interconnection
fees charged to other domestic telecommunications carriers, principally China
Mobile, China Unicom and China Telecom, for both local and long distance calls,
and revenues from our interconnections with China Netcom Group.
Revenues from our interconnection services were RMB 6,517 million in
2005, representing an increase of RMB 1,076 million, or 19.8%, from RMB 5,441
million in 2004. The increase was primarily due to increases in aggregate
revenues from our interconnections with China Unicom and China Mobile to RMB
4,632 million in 2005 from RMB 2,930 million in 2004. The interconnection
revenue growth was further driven by an increase of RMB 270 million in revenues
from interconnections with China Netcom Group, pursuant to the interconnection
service agreement.
Upfront connection fees
-----------------------
Upfront connection fees represent the amortized amount of the upfront
fees received for the initial activation of fixed-line telephone services. As a
result of the elimination of this fee on July 1, 2001, revenues from the
amortized portion of upfront connection fees were RMB 3,405 million in 2005,
representing a decrease of RMB 941 million, or 21.7%, from RMB 4,346 million in
2004, and will continue to decline in the coming years until the expiration of
the amortization period.
Broadband access and other Internet-related services
Revenues from our broadband access and other Internet-related services
consist of revenues for the provision of DSL, LAN, and other Internet-related
services, as well as Internet dial-up (other than communications fees) and
dedicated Internet access services.
Total revenues from our broadband services in 2005 were RMB 7,812
million, representing an increase of RMB 2,610 million, or 50.2%, from RMB 5,202
million in 2004. This increase reflects the rapid expansion of our broadband
subscriber base. The total number of our DSL subscribers increased by
approximately 2.6 million, or 43.3%, or to 8.6 million as of December 31, 2005
from approximately 6.0 million as of December 31, 2004. The effect of the
increase in the number of subscribers on revenue growth was partially offset by
declines in the average realized monthly tariffs for our broadband services,
reflecting the discount and promotional packages that we offer, and the fact
that increasing numbers of our new subscribers are residential users, who
generally have lower usage than business users.
Revenues from other Internet-related services were RMB 540 million in
2005, representing a decrease of RMB 464 million, or 46.2%, from RMB 1,004
million in 2004. The decrease was primarily due to the continuing migration of
subscribers to broadband services from Internet dial-up services.
Business and data communications services
Managed data services
---------------------
Revenues from our corporate data services represent fees that we charge
for our DDN, frame relay, ATM, MPLS VPN and X.25 services. Revenues from our
managed data services were RMB 1,395 million in 2005, representing a decrease of
RMB 125 million, or 8.2%, from RMB 1,520 million in 2004. The decrease was
primarily due to decrease in average realized tariff as a result of increased
market competition.
Leased line services
--------------------
Revenues from our leased line services represent fees that we receive
from our business and carrier customers for leasing circuit capacity to them,
including the lease of digital circuits, digital trunk lines and optic fibers.
Revenues from our leased line services were RMB 2,238 million in 2005,
representing an increase of RMB 143 million, or 6.8%, from RMB 2,095 million in
2004. This increase was primarily due to an increase in circuit bandwidth leased
to 129,989 (x2Mbps) as of December 31, 2005 from 91,103 (x2Mbps) as of December
31, 2004, which was primarily attributable to an increase in circuit bandwidth
leased to business customers to 100,387 (x2Mbps) as of December 31, 2005 from
56,363 (x2Mbps) as of December 31, 2004. The effect of the increased circuit
bandwidth leased to business customers on revenue growth was partially offset by
a decrease in circuit bandwidth leased to carrier customers, and a decrease in
average realized tariffs for our leased line services.
Other services
--------------
Revenues from other services, including revenues from service and
maintenance fees, lease payments for our non-telecommunications equipment,
paging service fees, and revenues from sales of products like handsets and DSL
modems, were RMB 2,345 million in 2005, representing an increase of RMB 985
million, or 72.4%, from RMB 1,360 million in 2004. The increase was primarily
due to an increase in sales of PHS handsets and external modems for our DSL
service.
International telecommunications services
-----------------------------------------
Revenues from our international operations consist of fees charged for
provision to carrier customers of wholesale voice services, including
termination, refile and bilateral services for international inbound calls
destined for the PRC or transit through the PRC or other Asia-Pacific countries
and regions, home country direct and international toll-free services; and
leased line, Internet, managed data and other telecommunications services
provided to business and carrier customers located outside the PRC.
Revenues from our international telecommunications services were RMB
3,255 million in 2005, representing an increase of RMB 612 million, or 23.2%,
from RMB 2,643 million in 2004. The increase was primarily due to a rapid
increase in revenues from leased line services, interconnection fees and managed
data services provided to our international customers.
Operating expenses
The key components of our operating expenses are depreciation and
amortization expenses, network operations and support expenses, selling, general
and administrative expenses, staff costs and other expenses. Our total operating
expenses in 2005 were RMB 66,727 million, representing an increase of RMB 754
million, or 1.1%, from RMB 65,973 million in 2004, as compared to the 4.5%
increase in our revenues during this period. The increase in our total operating
expenses principally reflect the expansion of our customer base and increased
selling, general and administrative expenses, which was in turn primarily caused
by increasing market competition.
The following table sets forth the components of our operating expenses
as percentages of our revenues for the periods indicated.
Years Ended 31 December
--------------------------------------------------
2004 2005
---------------------- ----------------------
Percentage Percentage
Amount of revenue Amount of revenue
------ ---------- ------ ----------
(RMB in millions, except percentage data)
Depreciation and amortization expenses............ 25,180 30.2% 25,049 28.7%
Network, operations and support expenses.......... 13,973 16.7% 14,417 16.5%
Selling, general and administrative expenses...... 12,877 15.4% 13,438 15.4%
Staff costs....................................... 11,950 14.3% 12,333 14.1%
Other operating expenses.......................... 1,993 2.4% 1,490 1.7%
------- ------- -------- -------
Total operating expenses..................... 65,973 79.0% 66,727 76.5%
Depreciation and amortization
We depreciate our property, plant and equipment on a straight-line
basis over the estimated useful lives of the assets, after taking into account
their estimated residual value. For example, our telecommunication network and
equipment are depreciated over periods typically ranging from five to ten years.
In 2005, our depreciation and amortization expenses were RMB 25,049 million,
representing a decrease of RMB 131 million, or 0.5%, from RMB 25,180 million in
2004. The decrease was primarily attributable to the revaluation deficit of our
fixed assets upon our 2005 Acquisition, which resulted in a decrease in our
total assets value. For more details, see "--Factors Affecting Our Results of
Operations--Our 2005 Acquisition". The decrease in our depreciation and
amortization expenses also reflects a decrease in our capital expenditure to RMB
27,562 million in 2005 from RMB 28,256 million in 2004.
Network, operations and support
Network, operations and support expenses primarily consist of repair
and maintenance expenses incurred in connection with the operation of our
telecommunications networks, interconnection expenses, utility expenses,
expenses relating to the disposal of fixed assets and the installation costs for
additional access lines that are put in service each year, which are amortized
on a straight-line basis over ten years to the extent that such costs match the
incremental revenues from new customers. In 2005, these expenses amounted to RMB
14,417 million, representing an increase of RMB 444 million, or 3.2%, from RMB
13,973 million in 2004. The increase was primarily attributable to an increase
of RMB 885 million in interconnection expenses with China Netcom Group and other
carriers, which was in part due to increased volume of outbound calls. The
increase was partially offset by a decrease in repair and maintenance expenses
by RMB 751 million, or 14.4%, to RMB 4,452 million in 2005 from RMB 5,203
million in 2004, as a result of our continued efforts to centralize the
management of our network operations.
Selling, general and administrative
Selling, general and administrative expenses primarily consist of sales
and marketing expenses, general and administrative expense and provision for
doubtful accounts.
In 2005, our selling, general and administrative expenses were RMB
13,438 million, representing an increase of RMB 561 million, or 4.4%, from RMB
12,877 million in 2004. The increase in these expenses was primarily
attributable to an increase in sales and marketing expenses to RMB 8,985 million
in 2005 from RMB 8,152 million, which was partially offset by a decrease in the
general and administrative expenses, particularly office and travel expenses,
resulting from our continued efforts to cut costs.
Staff costs
Staff costs principally consist of expenses for salary and benefits,
contributions to pension plans and a housing fund, and the payment of early
retirement benefits.
In 2005, our staff costs were RMB 12,333 million, representing an
increase of RMB 383 million, or 3.2%, from RMB 11,950 million in 2004, which was
primarily attributable to an increase in staff salary and benefits to RMB 11,046
million in 2005 from RMB 10,076 million in 2004. In 2005, we started to
implement a performance-linked compensation allocation system with an increased
percentage of salaries paid to the front office employees. In addition, we
implemented several employee benefit programs to better retain and motivate
existing employees and to attract qualified potential employees.
Other operating expenses
Other operating expenses include printing costs for bills, invoices and
other materials, charitable donations, and other miscellaneous administrative
and operational expenses. In 2005, other operating expenses were RMB 1,490
million, representing a decrease of RMB 503 million, or 25.2%, from RMB 1,993
million in 2004, reflecting our efforts to reduce such expenses.
Operating profit before interest income, dividend income and deficit on
revaluation of fixed assets
In 2005, our operating profit before interest income, dividend income
and deficit on revaluation of fixed assets was RMB 20,505 million, representing
an increase of RMB 2,984 million, or 17.0%, from RMB 17,521 million in 2004.
Profit/(loss) from operations
In 2005, our profit from operations was RMB 20,691 million,
representing an increase of RMB 14,384 million, or 228.1%, from RMB 6,307
million in 2004.
Finance costs
In 2005, our finance costs were RMB 3,374 million, representing a
decrease of RMB 556 million, or 14.1%, from RMB 3,930 million in 2004, which was
primarily attributable to a reduction in our total borrowings and a gain in
foreign exchange resulting from the appreciation of the value of Renminbi
against U.S. dollars in 2005. For more details, see "Risk Factors--Risks
relating to China and Asia--Fluctuations in exchange rates may adversely affect
our financial condition and results of operations and the prices of our shares
and ADSs or any dividends payable on our shares and ADSs in foreign currency
terms".
Taxation
The statutory tax rate on most of our operations in the PRC is 33%,
although some of our subsidiaries and affiliates in the PRC are subject to lower
statutory tax rates or enjoy preferential tax rates.
In 2005, our taxation expense was RMB 3,429 million, representing an
increase of RMB 3,752 million from a tax credit of RMB 323 million in 2004 and
reflecting a higher profit from operations.
Our effective tax rate of 19.8% in 2005 was lower than the statutory
tax rate, mainly because the revenues from upfront connection fees that we
recognized during the period were not taxable under the PRC law. In addition, we
benefited from a non-recurring tax reduction of RMB 837 million after making up
the accumulated pre-restructuring losses with current profit.
Profit for the period
As a result of the foregoing, our profit for 2005 was RMB 13,888
million, representing an increase of RMB 11,189 million, or 414.6%, from RMB
2,699 million in 2004.
Profit/(Loss) for the Year Reconciled to U.S. GAAP
Our consolidated profit for 2005 determined under U.S. GAAP was RMB
10,465 million. Our profit for 2005 determined under U.S. GAAP was lower than
that under HKFRS. The difference principally reflects the revaluation deficits
of RMB 25,778 million in 2003 and RMB 11,318 million in 2004 taken to the
carrying value of our assets under HKFRS. We expect this factor to continue to
contribute to the difference in our consolidated profit under U.S. GAAP compared
to our consolidated profit under HKFRS.
Operating results for the year ended December 31, 2004 and the year ended
December 31, 2003
Revenues
In 2004, our revenues were RMB 83,494 million, representing an increase
of RMB 5,896 million, or 7.6%, from RMB 77,598 million in 2003. This increase
primarily reflects increases in revenues from our domestic services, including
fixed-line services, broadband and other Internet-related services,
interconnections with other domestic carriers, and value-added services and
revenues from our international telecommunications services.
Domestic telecommunications services
------------------------------------
Fixed-line telephone services
Local telephone services
------------------------
In 2004, revenues from our local telephone services were RMB 44,390
million, representing an increase of RMB 1,962 million, or 4.6%, from RMB 42,428
million in 2003, and accounting for 53.2% of our total operating revenue in
2004.
The revenue growth in 2004 reflects increases in revenues from each of
monthly fees, upfront installation fees and local usage fees, with monthly fee
revenues accounting for the largest portion of the increase. This revenue growth
was primarily attributable to continued growth in the number of our fixed-line
subscribers and the usage volume of our PHS services. This revenue growth was
partially offset by a decline in average usage per subscriber.
Local usage fees. In 2004, revenues from our local usage fees were RMB
24,858 million, representing an increase of RMB 173 million, or 0.7%, from RMB
24,685 million in 2003. As the average realized tariffs for local usage remained
constant, this increase was attributable to an increase of 27.2 billion pulses,
or 147.0%, in PHS usage volume to 45.7 billion pulses in 2004 from 18.5 billion
pulses in 2003. The increase in usage volume was in turn caused by an increase
of 10.3 million, or 87.3%, in the number of our PHS subscribers, to 22.1 million
as of December 31, 2004 from 11.8 million as of December 31, 2003.
The effect of increased PHS usage volume on revenue growth was
partially offset by a revenue decline from non-PHS calls, reflecting a decrease
of 33.5 billion pulses, or 15.1%, in usage volume to 189.0 billion pulses in
2004 from 222.5 billion pulses in 2003 and principally reflecting the migration
of our non-PHS local traffic to PHS and mobile services. While our number of
non-PHS fixed-line subscribers increased by 3.7 million, or 4.5%, to 86.0
million as of December 31, 2004 from 82.3 million as of December 31, 2003, our
monthly usage volume per subscriber declined due to the migration of non-PHS
traffic to PHS and mobile networks.
Revenues from communications fees charged for our dial-up Internet
service also declined in 2004 compared to 2003, which was primarily caused by a
decline of 21.7 billion pulses, or 55.8%, in usage volume of this service to
17.2 billion pulses in 2004 from 38.9 billion pulses in 2003 and reflecting the
migration of Internet dial-up traffic to broadband services.
Monthly fees. In 2004, our revenues from monthly fees were RMB 17,964
million, representing an increase of RMB 1,488 million, or 9.0%, from RMB 16,476
million in 2003. The revenue growth was largely attributable to the 14.0
million, or 14.9%, increase in the number of our fixed-line subscribers during
this period, which was partially offset by a decline in the average realized
tariffs on a per subscriber basis, principally reflecting the increased number
and scope of special promotional packages and discount schemes offered to
certain subscribers of our fixed-line services.
Upfront installation fees. Revenues from the amortized amount of
installation fees were RMB 1,568 million in 2004, representing an increase of
RMB 301 million, or 23.8% from RMB 1,267 million in 2003. This increase
principally reflects an increased number of access lines in service in our
northern service region.
Domestic long distance services
-------------------------------
In 2004, our domestic long distance revenues were RMB 11,266 million,
representing a slight decrease of RMB 159 million, or 1.4%, from RMB 11,425
million in 2003. This decrease reflects a combination of:
o a decrease of RMB 864 million, or 10.2%, in revenues from the
domestic long distance calls carried on our traditional network
in 2004 as compared to 2003, which was in turn primarily caused
by a decrease in the average realized tariffs for this service;
and
o an increase of RMB 706 million, or 24.2%, in revenues from our
VoIP long distance service. With the average realized tariffs for
domestic VoIP long-distance calls remaining relatively constant,
this increase was primarily attributable to an increase of 2.7
billion minutes, or 24.4%, in the usage volume of domestic long
distance calls carried on our VoIP network.
International long distance services
------------------------------------
In 2004, revenues from international long distance services were RMB
1,234 million, representing a decrease of RMB 309 million, or 20.0%, from RMB
1,543 million in 2003. The revenue decline principally reflects a decrease of
RMB 166 million, or 22.8%, in revenues from international long distance calls
carried on our traditional network, which was in turn caused by:
o decreased usage volume due to the continued migration of our
international long distance traffic to VoIP networks of our own
and other service providers, and
o lower average realized tariffs due to the increased usage and
scope of special promotional discounts offered to our customers.
Value-Added Services
--------------------
Revenues from our value-added services in 2004 were RMB 2,993 million,
representing an increase of RMB 898 million, or 42.9%, from RMB 2,095 million in
2003. The increase was primarily due to the growth in the number of subscribers
of our caller identification service, which reached a penetration rate of 60.4%
of our access lines in service as of December 31, 2004, and increasing usage of
PHS messaging and other value-added services in our northern service region.
Interconnection Services
Revenues from our interconnection services were RMB 5,441 million in
2004, representing an increase of RMB 1,678 million, or 44.6%, from RMB 3,763
million in 2003. The increase was primarily due to increases in the revenues
from our interconnections with China Mobile, China Unicom, China Telecom, and
China Netcom Group.
Upfront connection fees
-----------------------
As a result of the elimination of the upfront connection fees on July
1, 2001, revenue from the amortized portion of upfront connection fees decreased
by RMB 776 million, or 15.2%, to RMB 4,346 million in 2004, from RMB 5,122
million in 2003, and will continue to decline in the coming years.
Broadband access and other Internet-related services
----------------------------------------------------
Total revenues from our broadband access in 2004 were RMB 5,202
million, representing an increase of RMB 2,288 million, or 78.5%, from RMB 2,914
million in 2003. This increase reflects the rapid expansion of our broadband
subscriber base. The total number of our DSL subscribers increased by
approximately 3.3 million, or 122.2%, or to 6.0 million as of December 31, 2004
from approximately 2.7 million as of December 31, 2003. The effect of this
subscriber increase on revenue growth was partially offset by declines in the
average realized monthly tariffs for our broadband services, reflecting the
discount and promotional packages that we offer, and the fact that increasing
numbers of our new subscribers are residential users, who generally have lower
usage than business users.
Revenues from other Internet-related services were RMB 1,004 million in
2004, representing a decrease of RMB 364 million, or 26.6%, from RMB 1,368
million in 2003. The decrease was primarily due to the continuing migration of
subscribers to broadband services from Internet dial-up services.
Business and data communications services
Managed data services
---------------------
Revenues from our managed data services in 2004 were RMB 1,520 million,
representing a decrease of RMB 3.3 million, or 2.1%, from RMB 1,553 million in
2003. This decrease principally reflects reduced tariffs for our management data
services as a result of intensified competition.
Leased line services
--------------------
Revenues from our leased line services were RMB 2,095 million in 2004,
representing a decrease of RMB 725 million, or 25.7%, from RMB 2,820 million in
2003. This decrease was primarily caused by a decline in revenues from the
leased line services provided to our carrier customers, as both the leased
bandwidth to these customers and the average realized tariffs declined. Revenues
from our business customers also declined, reflecting a combination of increased
leasing of bandwidth to these customers and lower average realized tariffs.
Other services
--------------
Revenues from other services, including revenues from service and
maintenance fees, lease payments for our non-telecommunications equipment,
paging service fees, and revenues from sales of products such as handsets and
DSL modems, were RMB 1,360 million in 2004, representing an increase of RMB 222
million, or 19.5%, from RMB 1,138 million in 2003 and reflecting revenue growth
from sales of DSL modems and other services.
International telecommunications services
-----------------------------------------
In 2004, total revenues from our international operations were RMB
2,643 million, representing an increase of RMB 1,264 million, or 91.7%, from RMB
1,379 million in 2003. During this period, we recorded RMB 1,040 million in
revenue from the operations of Asia Netcom, which accounted for 82.3% of the
increase in our international revenue. Revenues generated by Asia Netcom are not
reflected in the operating revenue data for 2003, as we used equity accounting
for Asia Netcom during 2003. In addition to revenues from operations of Asia
Netcom, increases in revenues from broadband and other Internet-related
services, managed data services and leased line services provided to non-PRC
customers further contributed to the overall revenue growth from our
international telecommunications services.
Operating expenses
Our total operating expenses in 2004 were RMB 65,973 million,
representing an increase of RMB 601 million, or 0.9%, from RMB 65,372 million in
2003, as compared to the 7.6% increase in our revenues during this period. The
increase in our total operating expenses principally reflect the expansion of
our customer base and increased selling, general and administrative expenses,
which was in turn primarily caused by increasing market competition.
Depreciation and amortization
In 2004, our depreciation and amortization expenses were RMB 25,180
million, representing a decrease of RMB 1,620 million, or 6.0% from RMB 26,800
million in 2003. This decrease principally reflects:
o the revaluation of our fixed assets in 2003 and 2004, which
resulted in decreased depreciation expenses; and
o a decrease in the amounts spent in purchasing and constructing
telecommunications network and equipment during this period.
Network, operations and support
In 2004, these expenses amounted to RMB 13,973 million, representing a
decrease of RMB 1,135 million, or 7.5%, from RMB 15,108 million in 2003.
The decrease was primarily reflects a combination of:
o a decrease of RMB 1,544 million, or 91.4%, in the loss from
disposal of fixed assets, reflecting improved asset quality upon
the consummation of our restructuring in 2003;
o a decrease of RMB 712 million, or 15.7%, in maintenance and
repair costs due to increasingly centralized management of our
network operations;
o an increase of RMB 930 million, or 143.1%, in costs of leasing
digital circuits and other network elements from other carriers;
and
o an increase of RMB 537 million, or 28.6%, in interconnection
expenses with China Netcom Group and other carriers, which was in
part due to increased volume of outbound calls.
Selling, general and administrative
In 2004, our selling, general and administrative expenses were RMB
12,877 million, representing an increase of RMB 2,555 million, or 24.8%, from
RMB 10,322 million in 2003. These expenses increased more rapidly than revenues,
principally as a result of:
o an increase of RMB 2,708 million, or 193.3%, in customer
acquisition costs principally relating to subsidized handsets
provided to some of our PHS subscribers, which are amortized
based on the types of service packages for which they subscribe
and their usage patterns.
o an increase of RMB 213 million, or 34.4%, in provisions for
doubtful accounts, primarily due to increased delinquency rates
among our subscribers, reflecting the increasing percentage of
lower income customers, which in turn was a result of our lower
installation costs and the elimination of upfront connection fees
in July 2001.
Staff costs
In 2004, our staff costs were RMB 11,950 million, representing an
increase of RMB 1,005 million, or 9.2%, from RMB 10,945 million in 2003. This
increase principally reflects a combination of:
o an increase of RMB 357 million, or 106.25%, in early retirement
expenses incurred;
o an increase of RMB 204 million, or 53.4%, in insurance expenses,
reflecting increased scope of participation in national health
insurance plans by our branches;
o an increase of RMB 114 million, or 23.5%, in welfare expenses;
and
o a decrease of 78 million, or 1.53%, in salaries and wages
expense, due to a reduction in the number of our temporary
employees in connection with our restructuring.
Other operating expenses
In 2004, other operating expenses were RMB 1,993 million, representing
a decrease of RMB 204 million, or 9.3%, from RMB 2,197 million in 2003.
Operating profit before interest income, dividend income and deficit on
revaluation of fixed assets
In 2004, our operating profit before interest income, dividend income
and deficit on revaluation of fixed assets was RMB 17,521 million, representing
an increase of RMB 5,295 million, or 43.3%, from RMB 12,226 million in 2003.
Profit/(loss) from operations
In 2004, our profit from operations was RMB 6,307 million, representing
an increase of RMB 19,719 million, from a loss of RMB 13,412 million in 2003.
Finance costs
In 2004, our finance costs were RMB 3,930 million, representing a
decrease of RMB 366 million from RMB 4,296 million in 2003, which was primarily
attributable to the reduction in our total borrowings.
Share of profit/(losses) of a jointly controlled entity
No deficit from our share of losses of our jointly controlled entity
was recorded in 2004, as revenues and expenses associated with Asia Netcom's
operations were consolidated into our results beginning on January 1, 2004.
Taxation
In 2004, we received a tax credit of RMB 323 million, representing a
decrease of RMB 6,894 million from a tax credit of RMB 7,217 million in 2003 and
reflecting a higher profit from operations.
The effective tax rates deviated from the weighted average statutory
tax rate mainly because the upfront connection fee revenues that we recognized
were not taxable under the PRC law.
Profit for the period
As a result of the foregoing, our net income for 2004 was RMB 2,699
million, representing an increase of RMB 13,605 million from a net loss of RMB
10,906 million for 2003.
Profit/(Loss) for the Year Reconciled to U.S. GAAP
Our consolidated profit as determined pursuant to U.S. GAAP for 2004
was RMB 7,932 million, as compared to RMB 2,699 million as determined pursuant
to HKFRS. The principal difference reflects the effect of the revaluation of our
fixed assets in 2003 and 2004. The lower depreciation charges we record under
HKFRS are a result of the lower carrying value of our asset base under HKFRS.
Liquidity and Capital Resources
Overview
Our primary source of funding for both our working capital and our
longer-term funding needs have been cash provided by operating activities and
short-term bank loans and our primary uses of funds have been capital
expenditures, repayment of bank loans and, for the year ended December 31, 2005,
our 2005 Acquisition.
The following table summarizes our cash flows for the periods
indicated:
For the Years Ended December 31,
----------------------------------------
2003 2004 2005
---------- --------- ---------
(RMB in millions)
Net cash inflow from operating activities.. 30,917 33,653 33,557
Net cash outflow for investing activities.. (34,875) (28,702) (24,608)
Net cash inflow/(outflow) from financing
activities................................. 3,595 (1,743) (14,656)
---------- --------- ---------
Increase/(decrease) in cash and cash
equivalents................................ (363) 3,208 (5,707)
Our net cash outflow in 2005 was RMB 5,707 million, representing a
decrease in cash inflow of RMB 8,915 million from the net cash inflow of RMB
3,208 million in 2004, which in turn increased from a net cash outflow of RMB
363 million in 2003. The decrease from 2004 to 2005 and the increase from 2003
to 2004 in net cash inflows were primarily attributable to our global offering
in the fourth quarter in 2004, which resulted in a significant increase in our
cash and cash equivalents as of December 31, 2004.
Taking into account cash generated from operating activities,
short-term and long-term bank loans, we believe that we have access to
sufficient working capital for the next 12 months.
Net cash inflow from operating activities
Our net cash inflow from operating activities in 2005 was RMB 33,557
million, representing a decrease of RMB 96 million, or 0.3%, from RMB 33,653
million in 2004. The decrease principally reflects a combination of:
o a cash outflow for profit tax paid in the amount of RMB 4,065
million for 2005 compared to RMB 7 million in 2004, as a result
of the utilization in 2005 of our provision for profit tax for
2004 pursuant to relevant PRC regulations; and
o an increase of RMB 3,298 million, or 8.8%, in our net cash inflow
generated from operations to RMB 40,732 million in 2005 from RMB
37,434 million in 2004.
Our net cash inflow from operating activities was RMB 33,653 million in
2004, representing a slight increase of RMB 2,736 million, or 8.8%, from RMB
30,917 million in 2003, primarily reflecting:
o an increase of RMB 1,907 million in our net cash flow generated
from operations; and
o a decrease of RMB 924 million in the profit tax paid.
For more details, see Note 34(a) to our consolidated financial
statements included elsewhere in this annual report.
Set out below is a breakdown of our net cash inflow from operating
activities for the periods indicated:
Years Ended December 31,
------------------------------------------
2003 2004 2005
--------- ---------- ----------
(RMB in millions)
Net cash inflows generated from operations................. 35,527 37,434 40,732
Interest received.......................................... 95 86 157
Dividends received......................................... 45 17 29
Interest paid.............................................. (3,819) (3,877) (3,296)
profits tax paid........................................... (931) (7) (4,065)
--------- ---------- ----------
Net cash inflow from operating activities.................. 30,917 33,653 33,557
========= ========== ==========
All of our operations in the PRC are conducted through our wholly
foreign-owned subsidiaries, CNC China and CNC New Horizon. Our
telecommunications businesses outside of the PRC are primarily owned and
conducted by China Netcom (USA) Operations Limited and China Netcom (Hong Kong)
Operations Limited, our wholly owned subsidiaries incorporated in the U.S. and
Hong Kong, respectively. Accordingly, our future cash flow will consist
principally of dividends from our subsidiaries. Our ability to pay dividends
depends substantially on the payment of dividends to us by CNC China and CNC New
Horizon. CNC China and CNC New Horizon must follow the laws and regulations of
the PRC and their respective articles of association in declaring and paying
dividends to us. As wholly foreign-owned enterprises in China, each of CNC China
and CNC New Horizon is required to provide for a reserve fund and staff and
workers' bonus and welfare fund, each of which is allocated from net profit
after taxation but before dividend distribution according to the prevailing
accounting rules and regulations in the PRC. Each of CNC China and CNC New
Horizon is required to allocate at least 10% of its net profit to the reserve
fund until the balance of this fund has reached 50% of its registered capital.
Appropriations to the staff and workers' bonus and welfare fund, which are
determined at the discretion of the respective directors of CNC China and CNC
New Horizon, are charged as expenses on a when-incurred basis in the
consolidated financial statements. During 2003, neither CNC China nor CNC New
Horizon made any contributions into these statutory funds as both of them, on a
stand-alone basis, incurred a net loss in this year. In 2004 and 2005, CNC China
and CNC New Horizon contributed approximately RMB 723 million and RMB 1,040
million, respectively, to these statutory funds. None of the contributions by
CNC China or CNC New Horizon to these statutory funds may be used for dividend
purposes. For more details, see "Item 8. Financial Information -- Dividend
Policy".
Net cash outflow for investing activities
Our net cash outflow from investing activities in 2005 was RMB 24,608
million, representing a decrease of RMB 4,094 million, or 14.3%, from RMB 28,702
million in 2004. This decrease was primarily attributable to (i) a decrease in
our capital expenditures to RMB 27,562 million in 2005 from RMB 28,256 million
in 2004; and (ii) RMB 2,874 million that we realized in 2005 in investments from
the sale of short-term securities acquired in 2004. For more details, see "--
Capital expenditures" below.
Our net cash used in investing activities was RMB 28,702 million in
2004 and RMB 34,875 million in 2003. Our cash outlays for capital expenditures
amounted to RMB 28,256 million in 2004 and RMB 36,450 million in 2003. In 2004,
we realized RMB 1,528 million in investments of from the sale of a portion of
investments we had made primarily in 2001 and 2002 in short-term securities. In
2003 we realized RMB 1,195 million from the sale of a portion of investments we
had made primarily in 2001 and 2002 in short-term securities, as well as RMB
756million from the disposal of fixed assets.
We must obtain approvals from the NDRC and the MII, and in some cases,
the State Council for any government-funded project involving significant
capital investment in our operations. In addition, approvals from the NDRC and
the MII are required for investment projects concerning national security, such
as the construction of domestic backbone transmission networks, international
gateways, and other telecommunications infrastructure projects. For a more
detailed description, see "Item 4. Information on the Company -- Regulation --
Capital Investment".
Net cash inflow/(outflow) from financing activities
Our net cash outflow from financing activities in 2005 was RMB 14,656
million, representing an increase of RMB 12,913 million, or 740.8%, from RMB
1,743 million in 2004. This increase was primarily attributable to:
o cash inflow from our global offering in 2004 in the amount of RMB
8,944 million;
o a net amount of RMB 3,995 million in loans from China Netcom
Group in 2004;
o a payment of distribution to China Netcom Group of RMB 1,566
million in 2005, compared to RMB 7,310 million in 2004; and
o a payment to China Netcom Group in the amount of RMB 3,000
million in 2005 in connection with our 2005 Acquisition.
Our net cash outflow from financing activities was RMB 1,743 million in
2004, compared to an inflow of RMB 3,595 million in 2003. The decrease in cash
inflow primarily reflects:
o net proceeds of RMB 8,944 million from the global offering, less
related expenses of RMB 689 million;
o a payment of distribution to China Netcom Group of RMB 7,310
million;
o new bank loans amounting to RMB 64,664 million;
o repayment of bank loans amounting to RMB 70,051 million; and
o equity distribution to CNC BVI of RMB 1,021 million, upon
assignment of loan prior to the global offering.
Working capital
As of December 31, 2005, our working capital(calculated as current
liabilities less current assets), or net current liabilities, was RMB 83,900
million, representing an increase of RMB 2,311 million, or 2.8%, from RMB 81,589
million as of December 31, 2004. The increase in net current liabilities was
primarily attributable to reduced levels of cash and cash equivalents and bank
loans as of December 31, 2005 compared to the amounts as of December 31, 2004 as
a result of our efforts to reduce working capital.
Indebtedness
In May 2006, we submitted an application to the PBOC for approval to
issue RMB 20.0 billion in short-term debentures with terms less than one year.
We expect to complete the issuance within one year from receiving each approval.
Our indebtedness as of the dates indicated was as follows:
Years Ended December 31,
-------------------------------
2003 2004 2005
---- ---- ----
(RMB in millions)
Short-term loans......................................................... 47,991 44,882 47,341
Long-term bank loans and other loans, current portion.................... 19,392 11,727 6,846
Long-term bank loans and other loans, excluding current portion.......... 30,172 26,052 18,143
Deferred consideration, current portion.................................. - - 1,960
Deferred consideration, excluding current portion........................ - - 7,840
------ ------ ------
Total............................................................... 97,555 82,661 82,130
====== ====== ======
As of December 31, 2005, our total indebtedness were RMB 82,130
million, which included deferred consideration of RMB 9,800 million in relation
to the 2005 Acquired Assets and Liabilities. Our outstanding loans as of
December 31, 2005 amounted to RMB 72,330 million, representing a decrease of RMB
10,331 million, or 12.5%, from RMB 82,661 million as of December 31, 2004,
reflecting a reduced level of our borrowings as we continued to repay some of
our loans with the cash inflow from operating activities.
As of December 31, 2005, our short-term loan represented 68.4% of our
total indebtedness, compared to 68.5% as of December 31, 2004. As of December
31, 2005, our debt-to-capital ratio was 50.1%, calculated as the ratio of total
indebtedness to the sum of total indebtedness, owner's equity and the balance of
deferred revenues.
Our total indebtedness as of December 31, 2004 amounted to RMB 82,661
million, representing a decrease of RMB 14,894 million, or 15.3%, from RMB
97,555 million as of December 31, 2003. As a result, our interest expenses were
reduced during this period.
Our secured long-term loans were RMB 320 million as of December 31,
2005. These loans were secured by:
o RMB 245 million in corporate guarantee granted by third parties;
and
o RMB 75 million in corporate guarantees granted by China Netcom
Group.
As of December 31, 2005, our available and unused credit facilities
amounted to RMB 104,731 million.
Contractual obligations and commitments, including off-balance sheet
arrangements
The following table sets forth information regarding our aggregate
payment obligations in future years of the contractual obligations and
commercial commitments that we had as of December 31, 2005.
Payments Due in the Period
----------------------------------------------------------------------
Total 2006 2007 2008 2009 2010 Thereafter
----- ---- ---- ---- ---- ---- ----------
(RMB in millions)
Short-term debt(1).............. 48,200 48,200 - - - - -
Short-term capacity purchase -
payable......................... - - - - - -
Long-term debt(1)............... 28,652 7,874 9,461 6,124 249 246 4,698
Operating lease commitments..... 4,066 994 434 333 308 298 1,699
Capital commitments............. 1,854 1,678 170 6 - - -
Deferred payment(2)............. 11,133 2,433 2,330 2,227 2,123 2,020 -
------ ------ ------ ------ ----- ----- -----
Total contractual cash
obligations..................... 93,905 61,179 12,395 8,690 2,680 2,564 6,397
Guarantees...................... - - - - - - -
------ ------ ------ ------ ----- ----- -----
Total commercial commitments.. 93,905 61,179 12,395 8,690 2,680 2,564 6,397
------ ------ ------ ------ ----- ----- -----
__________
(1) The amounts shown include interest charged for each year.
(2) The amounts shown include interest payable on the deferred consideration.
We have entered into certain foreign currency exchange forward
contracts with banks, which are non-speculative and used as hedges of certain of
our borrowings that are denominated in foreign currencies. The foreign currency
exchange forward contracts and respective payable balances are included in other
non-current liabilities and disclosed in the section entitled "-- Market Risk
and Risk Management -- Foreign exchange rate risk".
Capital expenditures
The following table sets forth our actual and planned total capital
expenditure requirements for the periods indicated:
Capital Expenditures
--------------------
(RMB in millions)
2003............................................ 36,450
2004............................................ 28,256
2005............................................ 27,562
2006 (Planned).................................. 27,300
Historically, most of our capital expenditures were budgeted for the
improvement of our networks and related equipment. In particular, capital
expenditures related to our local access, switching, data and transport networks
each accounted for a significant percentage of our total capital expenditures.
Expenditures for other projects were mainly related to investments in facilities
to house our telecommunications equipment and other facilities. Our total
capital expenditure in 2003, 2004 and 2005 were substantially lower than those
in 2003 as we focused on controlling our capital expenditure levels by improving
our network efficiency and developing new products and services to better
utilize our existing networks.
In 2005, our capital expenditures were RMB 27,562 million, representing
a decrease of RMB 694million, or 2.5%, from RMB 28,256 million in 2004, which
was primarily attributable to our efforts to improve the utilization rate of our
existing network equipment, the implementation of an efficiency-based capital
expenditure policy. In 2005, we continued to increase investments to RMB 2,909
million in 2005 from RMB 2,166 million in 2004 in operation and supporting
systems in an effort to enhance network, billing and sales services for our
customers. In addition, we increased investments to RMB 7,272 million in 2005
from RMB 6,642 million in 2004 in broadband and content services in an effort to
improve the quality of our broadband services and expanding our broadband
network coverage. We reduced investments to RMB 5,582 million in 2005 from RMB
8,102 million in 2004 in the PHS segment as we increased our focus on enhancing
the utilization of our existing PHS network.
Our capital expenditure estimates are subject to uncertainty, and
actual capital expenditures in future periods may differ significantly from
these estimates. The timing, amount and nature of capital expenditures are
subject to various factors, including the general economic environment, customer
demand, technological advances and other relevant factors.
Capital resources
We expect to fund our capital expenditure needs with a combination of
cash generated from operating activities, short-term and long-term bank loans
and net proceeds from the global offering. We believe that we will have
sufficient capital resources to satisfy our capital expenditure requirements in
the foreseeable future periods.
Reconciliation of HKFRS and U.S. GAAP
Our consolidated financial statements have been prepared in accordance
with HKFRS, which differs significantly in certain respects from U.S. GAAP.
Differences between HKFRS and U.S. GAAP may have significant impact on our
consolidated net profit/(loss) and shareholders' equity. For example, U.S. GAAP
requires fixed assets to be recorded at cost less impairment while HKFRS allows
as providing an appropriate basis for restating the depreciable asset base
revaluation of the fixed assets other than impairment situation. Consequently,
under U.S. GAAP there was no charge to income in 2003 or 2004 resulting from the
revaluation of our fixed assets in the amount of RMB 25,778 million in 2003 or
RMB 11,318 million in 2004, as the case may be. Thus, in future periods we
expect our depreciation and amortization expense as reported in accordance with
U.S. GAAP to be significantly higher than as reported in our financial
statements prepared in accordance with HKFRS.
We have summarized these differences and their effect on our
shareholders' equity as of December 31, 2003, 2004 and 2005 and the results of
our operations for each of the years ended December 31, 2003, 2004 and 2005 in
Note 41 to our consolidated financial statements included elsewhere in this
document. These differences relate primarily to the treatment of the revaluation
of fixed assets, and deferred tax.
The effect on net profit/(loss) of differences between HKFRS and U.S.
GAAP for the years ended December 31, 2003, 2004 and 2005 is as set forth in the
following table.
For the Years Ended December 31,
-----------------------------------------------
2003 2004 2005
---------------- -------------- ---------------
(RMB in millions)
Net profit/(loss) under HKFRS.................. (10,906) 2,699 13,888
U.S. GAAP adjustments.......................... 17,271 5,233 (3,423)
---------------- -------------- ---------------
Net profit under U.S. GAAP..................... 6,365 7,932 10,465
The effect on shareholders' equity of differences between HKFRS and
U.S. GAAP as of December 31, 2002, 2003 and 2004 is as set forth in the
following table.
As of December 31,
-----------------------------------------------
2003 2004 2005
---------------- -------------- ---------------
(RMB in millions)
Owners' equity under HKFRS................... 53,659 64,595 63,010
U.S. GAAP adjustments........................ 12,624 18,069 14,480
---------------- -------------- ---------------
Owners' equity under U.S. GAAP............... 66,283 82,664 77,490
Critical Accounting Policies
We have prepared the consolidated financial statements in accordance
with HKFRS issued by the Hong Kong Institute of Certified Public Accountants.
HKFRS require us to adopt accounting policies and make estimates and assumptions
in the preparation of these financial statements. When we make these estimates
and assumptions, we base our estimates on historical experience and are required
to make judgments about matters that are inherently uncertain. Accordingly, the
reported financial position and results of operations are sensitive to these
estimates and assumptions, and actual results may differ from those estimates as
facts, circumstances and conditions change. Our principal accounting policies
are set out in detail in Note4 to our consolidated financial statements included
elsewhere in this document. The following sections discuss the accounting
policies which involve the most significant estimates and judgments made in the
preparation of our consolidated financial statements.
Depreciation of fixed assets
We depreciate our property, plant and equipment at rates sufficient to
write off their costs or revalued amounts less accumulated impairment losses and
estimated residual values over their estimated useful lives on a straight-line
basis. We review the useful lives periodically to ensure that the method and
rates of depreciation are consistent with the expected pattern of economic
benefits from property, plant and equipment. We estimate the useful lives of the
property, plant and equipment based on our historical experience with similar
assets, taking into account anticipated technological changes. The depreciation
expense in the future periods will change if there are significant changes from
previous estimates.
Revaluation of fixed assets
In connection with our restructuring in anticipation of our global
offering in 2004, our property, plant and equipment were revalued as of December
31, 2003 on a depreciated replacement cost basis. The property, plant and
equipment acquired as part of our 2005 Acquisition were revaluated as of
December 31, 2004 on a depreciated cost basis. In preparation for our 2005
Acquisition, apart from lease prepayment for land and buildings, which are
carried at cost, other property, plant and equipment are carried at the revalued
amounts, being the fair value at the date of revaluation, less subsequent
accumulated depreciation and impairment losses. Revaluations are performed with
sufficient regular intervals by independent valuers and, in each of the
intervening years, valuations are undertaken by our executives. If the revalued
amounts differ significantly from the carrying amounts of the property, plant
and equipment in the future, the carrying amounts will be adjusted to the
revalued amounts. This will have an impact on our future results, since any
subsequent decreases in valuation are first set off against increases on earlier
valuations in respect of the same item and thereafter are charged as expense to
the income statement and any subsequent increases are credited as income to the
income statement up to the amount previously charged. In addition, the
depreciation expense in future periods will change as the carrying amounts of
the fixed assets change as a result of the revaluation.
Impairment of non-current assets
At each balance sheet date, we consider both internal and external
sources of information to assess where there is any indication that non-current
assets, including property, plant and equipment are impaired. If any such
indication exists, the recoverable amount of the asset is estimated and an
impairment loss is recognized to reduce the carrying amount of the asset to its
recoverable amount. The recoverable amount is the higher of value in use or net
selling price. Estimated recoverable amounts are determined based on estimated
discounted future cash flows of the cash-generating unit at the lowest level to
which the asset belongs. Key assumptions made to determine the estimated
discounted cash flows include the estimated growth rate and our estimated
weighted cost of capital. Such impairment losses are recognized in the income
statement, except where the asset is carried at valuation and the impairment
loss does not exceed the revaluation surplus for that same asset, in which case
the impairment loss is treated as a revaluation decrease and charged to the
revaluation reserve. Accordingly, there will be an impact to our future results
if there is a significant change of the recoverable amounts of our non-current
assets.
Revenue recognition for upfront connection and installation fees
We defer the recognition of upfront customer connection and
installation fees and amortize them over the expected customer relationship
period of ten years. The related direct incremental installation costs are
deferred and amortized over the same expected customer relationship period of
ten years, except when the direct incremental costs exceed the corresponding
installation fees. The excess of the direct incremental costs over the
corresponding installation fees, if any, are immediately amortized as expenses
to the income statement. We estimate the expected customer relationship period
based on our historical customer retention experience and other factoring in the
expected level of future competition, the risk of technological or functional
obsolescence to our services, technological innovation, and the expected changes
in the regulatory and social environment. If our estimate of the expected
customer relationship period changes as a result of increased competition,
changes in telecommunications technology or other factors, the amount and timing
of recognition of our deferred revenues may change for future periods.
Recognition of revenues and costs under PHS bundled service contracts
We provide PHS services, which is an extension of the local wireline
telecommunications service, to our customers. Promotional packages comprising
the bundled provision of PHS services and the provision of handsets to
customers, under which customers either prepay a certain amount of service fee
or commit to spend a minimum monthly service fee for a designated period of time
in order to receive a free handset. The total revenues received or receivable
are recognized as deferred income. The cost of handsets provided to customers is
treated as deferred customer acquisition costs to the extent that they are
recoverable through profits made from future service fee. Such deferred revenue
and deferred costs are amortized to the income statement on a systematic basis
to match the shorter of the pattern of usage of the related service and the
minimum non-cancelable contract period. If the pattern of the usage of the PHS
services by our customers changes in the future, the amortization period of the
revenues and costs will change accordingly. This will have an impact to our
future results.
Provision for doubtful debts
We maintain an allowance for doubtful debts for estimated losses
resulting from the inability of our customers to make the required payments. We
make our estimates based on the aging of our accounts receivable balance,
customer creditworthiness, and historical write-off experience. If the financial
condition of our customers were to deteriorate, actual write-offs might be
higher than expected, we would be required to revise the basis of making the
allowance and our future results would be affected.
Fair value
We estimates the fair value of our financial assets and financial
liabilities including the accounts receivable, prepayments, other receivables
and other current assets, accounts payable, and bank and other loans for
disclosure purposes by discounting its future contractual cash flows at the
estimated current market interest rate that is available to us for similar
financial instruments. The future disclosed values will change if there are
changes in the estimated market interest rate.
Accounting for business combinations under common control
We completed our 2005 Acquisition on October 31, 2005. Our 2005
Acquisition is treated as a business combination under common control. Under
HKFRS, we can choose to adopt either acquisition accounting or merger accounting
to record our 2005 Acquisition. We adopted merger accounting to account for the
business combinations under common control as we believe that the financial
statements prepared under merger accounting are more relevant to those
transactions.
Inflation
According to China's National Bureau of Statistics, China's overall
national inflation rate, as represented by the general consumer price index, was
approximately 1.2% in 2003, 3.9% in 2004, and 1.8% in 2005. Inflation or
deflation has not had a significant impact on our results of operations in
recent years.
Market Risk and Risk Management
Market risk is the risk of loss related to adverse changes in market
prices, including interest rates and foreign exchange rates, of financial
instruments we hold or have issued, all of which were for purposes other than
trading purposes. In the normal course of business, we are routinely subject to
a variety of risks, including market risk associated with interest rate
movements and currency rate movements on non-Renminbi denominated assets and
liabilities.
Foreign exchange rate risk
We conduct our business primarily in Renminbi, which is also our
functional and reporting currency. The Renminbi is not a fully convertible
currency. From 1994 to July 20, 2005, the official exchange rate for the
conversion of Renminbi to U.S. dollars was generally stable. On July 21, 2005,
the RPC government introduced a managed floating exchange rate system to allow
the value of the Renminbi to fluctuate within a regulated band based on market
supply and demand and by reference to a basket of currencies. On the same day,
the value of the Renminbi appreciated by 2% against the U.S. dollar. The PRC
government has since made and in the future may make further adjustments to the
exchange rate system. Fluctuations in exchange rates may adversely affect the
value, translated or converted into United States dollars or Hong Kong dollars
(which are pegged to the U.S. dollar), of our net assets, earnings and any
declared dividends. For a detailed description of the unitary managed floating
rate system used by the PRC government to set foreign exchange rates, see "Item
3. Key Information -- Selected Financial Data -- Exchange Rate Information".
We are exposed to foreign currency risk primarily as a result of our
foreign currency borrowings for past purchases of telecommunications equipment
from overseas suppliers. In addition, we receive some of our revenues from our
international operations and pay related expenses in foreign currencies. As a
result, our foreign currency exposure relates to our foreign
currency-denominated debt and, to a limited extent, cash and cash equivalents
denominated in foreign currencies.
We have, in the past, entered into currency swap agreements and foreign
exchange forward contracts designed to mitigate our exposure to foreign currency
risks and may continue to do so in the future.
The following table provides information regarding our foreign
currency-sensitive financial instruments, which consist of cash and cash
equivalents, short-term and long-term debt obligations and capital commitments
as of December 31, 2005 and the expected maturity profile of these debt
obligations and capital commitments.
Expected Maturity
-------------------------------------------------------------------------------
Fair
2006 2007 2008 2009 2010 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
(RMB equivalent in millions, except interest rates)
Assets:
Cash and cash equivalents
U.S. dollars.............. 512 - - - - - 512 512
HK dollars................ 506 - - - - - 506 506
Taiwan dollars............
Liabilities:
U.S. dollar-denominated loans
Fixed rate................. 137 43 30 30 28 556 824 571
Average rate............... 3.91% 2.59% 1.29% 1.26% 0.92% 0.50% 1.24% -
Variable rate.............. 114 303 - - - - 417 492
Average rate(1)............ 3.67% 5.10% - - - - 4.71% -
Euro-denominated loans
Fixed rate................. 31 30 29 27 27 286 430 338
Average rate............... 2.86% 2.69% 2.52% 2.32% 2.32% 2.25% 2.35% -
Variable rate.............. - - - - - - - -
Average rate(1)............ - - - - - - - -
Japanese yen-denominated loans
Fixed rate................. - - - - - - - -
Average rate............... - - - - - - - -
Variable rate.............. 39 39 39 39 39 132 327 319
Average rate(1)..... 2.12% 2.12% 2.12% 2.12% 2.12% 2.12% 2.12% -
__________
(1) The average interest rates for variable rate loans are calculated based on
the rates reported as of December 31, 2005.
Interest Rate Risk
The People's Bank of China has the sole authority in China to establish
the official interest rates for Renminbi-denominated loans. Financial
institutions in China set their effective interest rates within the range
established by the People's Bank of China. Interest rates and payment methods on
loans denominated in foreign currencies are set by financial institutions based
on interest rate changes in the international financial market, cost of funds,
risk levels and other factors.
We are subject to market risks due to fluctuations in interest rates on
our debt. The majority of our debt is in the form of bank loans from banks in
China. Increases in interest rates will increase the cost of new borrowing and
the interest expense with respect to outstanding variable rate debt.
Accordingly, fluctuations in interest rates can lead to significant fluctuations
in the fair value of these debt instruments.
The following table provides information regarding our interest
rate-sensitive financial instruments, which consist of short-term and long-term
debt obligations as well as the expected maturity profile of such obligations.
Expected Maturity
-------------------------------------------------------------------------------
Fair
2006 2007 2008 2009 2010 Thereafter Total Value
---- ---- ---- ---- ---- ---------- ----- -----
(RMB equivalent in millions, except interest rates)
Liabilities:
RMB-denominated loans
Fixed rate........... 36,148 2,320 2,350 - - - 40,818 40,442
Average rate......... 4.86% 5.20% 5.24% - - - 4.9% -
Variable rate........ 1,115 5,040 3,250 - - 2,518 27,159 26,329
Average rate......... 5.00% 5.18% 5.18% - - 5.47% 4.98%
U.S. dollar-denominated loans
Fixed rate........... 137 43 30 30 28 556 824 571
Average rate......... 3.91% 2.59% 1.29% 1.26% 0.92% 0.50% 1.24%
Variable rate........ 114 303 - - - - 417 492
Average rate......... 3.67% 5.10% - - - - 4.71%
Euro-denominated loans
Fixed rate........... 31 30 29 27 27 286 430 338
Average rate......... 2.86% 2.69% 2.52% 2.32% 2.32% 2.25% 2.35%
Variable rate........ - - - - - - - -
Average rate......... - - - - - - - -
Japanese yen-denominated
loans
Fixed rate........... - - - - - - - -
Average rate......... - - - - - - -
Variable rate........ 39 39 39 39 39 132 327 319
Average rate......... 2.12% 2.12% 2.12% 2.12% 2.12% 2.12% 2.12%
__________
(1) The average interest rates for variable rate loans are calculated based on
the rates reported as of December 31, 2005.
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
DIRECTORS AND SENIOR MANAGEMENT
In accordance with Hong Kong law and our articles of association,
members of our board of directors are elected by our shareholders. Our board of
directors consists of 13 members, including five independent non-executive
directors.
The following table sets forth certain information about our directors,
each of whom were duly elected and will retire from office at an annual general
meeting by rotation every three years (but will be eligible for re-election at
such annual general meeting), executive officers and joint company secretaries.
Name Age Positions
-------------------------------------- ---------- -----------------------------------------------
Zhang Chunjiang........................ 47 Chairman and Executive Director
Edward Tian Suning(1).................. 42 Vice Chairman, Non-Executive Director
Zuo Xunsheng(2) ....................... 55 Executive Director and Chief Executive Officer
Zhang Xiaotie.......................... 53 Executive Director
Miao Jianhua........................... 54 Executive Director and Joint Company Secretary
Jiang Weiping(3) ...................... 54 Executive Director
Li Liming.............................. 55 Non-Executive Director
Keith Rupert Murdoch(4) ............... 75 Non-Executive Director
Yan Yixun.............................. 67 Non-Executive Director
Jose Maria Alvarez-Pallete(5) ......... 42 Non-Executive Director
John Lawson Thornton................... 52 Independent Non-Executive Director
Victor Cha Mou Zing.................... 56 Independent Non-Executive Director
Qian Yingyi............................ 49 Independent Non-Executive Director
Hou Ziqiang............................ 68 Independent Non-Executive Director
Timpson Chung Shui Ming................ 54 Independent Non-Executive Director
Mauricio Sartorius(6) ................. 46 Alternate Director
Pei Aihua.............................. 55 Senior Vice President
Zhang Changsheng....................... 58 Senior Vice President
Zhao Jidong............................ 55 Senior Vice President
Li Fushen.............................. 43 Chief Financial Officer
Mok Kam Wan............................ 43 Joint Company Secretary
_______________
(1) Resigned as Chief Executive officer and Executive Director effective May
17, 2006.
(2) Appointed effective May 17, 2006.
(3) Re-designated as an Executive Director on December 7, 2005. Resigned as a
Director effective May 17, 2006.
(4) Resigned as a Director effective September 12, 2005.
(5) Appointed effective September 12, 2005.
(6) Alternate Director to Jose Maria Alvarez-Pallete; appointed effective
September 12, 2005.
Directors, Executive Officers and Joint Company Secretaries
Directors
Zhang Chunjiang, 47, Chairman and Executive Director, has served as a
Director since June 2004. He has been the Chairman of China Netcom (Group)
Company Limited since September 2004 and President of China Netcom Group since
May 2003. He joined PCCW Limited as a Non-executive Director since April 2005.
Prior to joining China Netcom Group, Mr. Zhang served as Deputy Minister of the
Ministry of Information Industry (MII) and was one of the most senior regulatory
officials in the PRC telecommunications industry from December 1999 to May 2003.
From August 1993 to December 1999, Mr. Zhang held a series of senior positions
at the former Liaoning Provincial Posts and Telecommunications Bureau, the
former Ministry of Posts and Telecommunications (MPT) and the MII, including
serving as the Deputy Director of the former Liaoning Provincial Posts and
Telecommunications Administration, Director of Mobile Telecommunications
Administration of the MPT and Director of Telecommunications Administration of
the MII. Mr. Zhang is a senior engineer of professor level and has extensive
experience in telecommunications management, operations and technology. Mr.
Zhang graduated from the Beijing University of Posts and Telecommunications in
1982 with a bachelor's degree in telecommunications.
Dr. Edward Tian Suning, 42, Vice Chairman and Non-Executive Director,
has served as a Director since 2000. He has also served as Vice President of
China Netcom Group from April 2002 to May 2006. From 1999 to May 2006, he has
served as Chief Executive Officer of China Netcom (Holdings) Company Limited and
the Company. He has been a Director of China Netcom (Group) Company Limited from
2001 and May 2006. He has also served as Vice Chairman and a Non-executive
Director of PCCW Limited since April 2005. Dr. Tian is also an Independent
Director of AsiaInfo Holdings Inc., a Nasdaq-listed company. Dr. Tian is a
member of the Advisory Committee to Harvard Business School of the US and the
International Business Council of the World Economic Forum. Prior to joining
China Netcom (Holdings) Company Limited, Dr. Tian was the co-founder and Chief
Executive Officer of AsiaInfo Holdings Inc., a Nasdaq-listed company providing
software and networking solutions in China. Dr. Tian has extensive experience
and knowledge in the management and financing fields of the telecommunications
and information industry. Dr. Tian received a Ph.D. in natural resources
management from Texas Tech University in 1992, a master's degree in ecology from
the Graduate School of the Chinese Academy of Sciences in 1988, and a bachelor's
degree in environmental biology from Liaoning University in 1985.
Zuo Xunsheng, 55, has served as Executive Director and Chief Executive
Officer since May 2006 , overseeing general operations of the Company. Mr. Zuo
has served as Chief Operating Officer and from December 2005 to May 2006.He has
served as Senior Vice President from July 2004 to May 2006. He has also served
as Vice President of China Netcom Group since April 2002. Before joining China
Netcom Group, Mr. Zuo was President of the former Shandong Telecommunications
Company from May 2000 to April 2002. From October 1997 to May 2000, Mr. Zuo
served as Director of the former Posts and Telecommunications Bureau of Shandong
Province. From 1988 to 1997, Mr. Zuo served as Director of the former Bureau of
Telecommunications of Jinan City. Mr. Zuo graduated from Guanghua School of
Management of Peking University with an EMBA degree in 2004. Mr. Zuo was
appointed as an Executive Director and Chief Executive Director effective May
17, 2006.
Zhang Xiaotie, 53, Executive Director, has served as a Director since
October 2004. He has served as Vice President of China Netcom Group since July
2003. From June 2002 to July 2003, Mr. Zhang also served as Assistant to
President and General Manager of Planning and Finance Department of China Netcom
Group. Before joining China Netcom Group, Mr. Zhang served as Vice Director and
Director of the Economic Regulation and Communications Settlement Bureau of the
MII and held a series of senior positions at the former MPT and the former
Beijing Administration of Telecommunications. Mr. Zhang graduated from the
School of Economics and Management of Tsinghua University with a master's
degree.
Miao Jianhua, 54, Executive Director and Joint Company Secretary, has
served as a Director since October 2004. He has also served as Assistant to
President of China Netcom Group since September 2003 to November 2005. From June
2002 to November 2005, Mr. Miao served as the General Manager of the Human
Resources Department of China Netcom Group and the Company. Before joining China
Netcom Group, Mr. Miao served as Director of the Inspection Bureau of the former
MPT and the MII from 1997 to early 2002, and held senior positions at the former
Jilin Provincial Administration of Posts and Telecommunications prior to June
1997. He graduated from the Australian National University with a master's
degree in management.
Jiang Weiping, 54, Executive Director, has served as a Director from
October 2004 to May 2006. He has also served as Assistant to the President of
China Netcom Group since July 2004. Mr. Jiang became the General Manager of
Human Resources Department of the Company since November 2005. From May 2000 to
July 2004, he served as General Manager in the former Liaoning
Telecommunications Company and Liaoning Communications Company. From August 1984
to May 2000, he held a series of senior positions in the former Liaoning
Provincial Administration of Posts and Telecommunications, including Deputy
Director and Director from August 1993 to May 2000. Mr. Jiang graduated from the
Harbin Institute of Technology with a bachelor's degree in radio communications.
Li Liming, 55, Non-Executive Director, has served as a Director since
October 2004. She also served as General Manager of Human Resource Department of
the China Netcom Group since March 2005. From July 2003 to August 2004, she
served as Deputy General Manager of Human Resources Department of China Netcom
Group. Before joining China Netcom Group, Ms. Li held a series of senior
positions at Jitong Network Communications Company Limited from November 1994 to
July 2003. Ms. Li graduated from the Radio Department of Tsinghua University
with a bachelor's degree in semiconductor devices.
Keith Rupert Murdoch, 75, Non-Executive Director, previously served as
a Director from 2001 to June 30, 2004 and from October 2004 to September 2005.
He is Chairman and Chief Officer of News Corporation, a diversified
international media and entertainment company. Mr. Murdoch received on M.A. in
economics from Oxford University in 1953.
Yan Yixun, 67, Non-Executive Director, has served as a Director since
2001. He is a member of the Standing Committee of the Tenth National People's
Congress and Vice Chairman of the Financial and Economic Committee of the
National People's Congress. He was a member of the Standing Committee of the
Eighth and Ninth National People's Congress and a member of the Education,
Science, Culture and Health Committee of the Ninth National People's Congress.
From December 1992 to November 2000, he served as Vice Chairman of the Chinese
Academy of Sciences, prior to that he served as Director of Shanghai Technical
Physics Research Institute. He was a first-term Board Director of Legend
Holdings Limited and now serves as Chairman of the Board of NewMargin Venture
Capital Co., Ltd and Director of Chinese Academy of Sciences Holdings Co., Ltd.
Mr. Yan received a master's degree from the Institute of Electronics of the
Chinese Academy of Sciences in 1966 and graduated from the Department of Radio
Electronics at Tsinghua University in 1962.
Jose Maria Alvarez-Pallete, 42, Non-Executive Director, has served as a
Director since September 2005. He joined Telefonica Internacional in February
1999 as General Manager for Finance. In September of the same year, he became
Chief Financial Officer of Telefonica, S.A. In July 2002, he was appointed as
Chairman and Chief Executive Officer of Telefonica Internacional, S.A. and a
member of the senior management committee of the company. Telefonica
Internacional, S.A. has 5% interest in the issued share capital of the Company.
Mr. Alvarez-Pallete is a Director on the boards of Telecomunicacoes de Sao
Paulo, S.A. (listed on the Stock Exchanges of Sao Paulo and New York), Compania
de Telecomunicaciones de Chile, S.A. (listed on the Stock Exchanges of Santiago
de Chile and New York), Telefonica de Espana, Telefonica Moviles S.A. (listed on
the Stock Exchanges of Madrid and New York), Telefonica Moviles Espana,
Telefonica Data, Telefonica Internacional, Telefonica de Argentina (listed on
the Stock Exchanges of Buenos Aires and New York), Telefonica CTC Chile,
Telefonica de Peru S.A.A. (listed on the Stock Exchange of Lima), Compania de
Telefonos de Chile Transmisiones Regionales, Telefonica Larga Distancia de
Puerto Rico, Telesp and Cointel. In addition, he is a member of the Supervisory
Board of Cesky Telecom (a company listed on the Stock Exchange of Prague). Mr.
Alvarez-Pallete received a bachelor's degree in economics from the Universidad
Complutense of Madrid. Mr. Alvarez-Pallete was appointed as a Director effective
September 12, 2005.
John Lawson Thornton, 52, Independent Non-Executive Director, has
served as a Director since October 2004. Mr. Thornton is Professor and Director
of Global Leadership Project at Tsinghua University in Beijing. He was President
and a Director of The Goldman Sachs Group, Inc. until July 2003. Mr. Thornton is
also a Director of Ford Motor Company (listed on the New York Stock Exchange),
Industrial and Commercial Bank of China, Intel Corporation (listed on NASDAQ
Stock Exchange) and News Corporation, Inc. (listed on the New York Stock
Exchange and the Australian Stock Exchange). He is also Chairman of the
Brookings Institution Board of Trustees, a member of the Council on Foreign
Relations, a trustee or advisory board member of the Asia Society, China
Institute, China Securities Regulatory Commission, the Eisenhower Fellowships,
Financial Services Volunteer Corps, The Hotchkiss School, International Advisory
Committee of the China Reform Forum, Morehouse College, National Committee on
US-China Relations, Nelson Mandela Legacy Foundation (US), Tsinghua University
School of Economics and Management (Beijing) and the Yale School of Management.
Mr. Thornton received an A.B. in history from Harvard College in 1976, a B.A.
and M.A. in jurisprudence from Oxford University in 1978 and a M.P.P.M. from the
Yale School of Management in 1980.
Victor Cha Mou Zing, 56, Independent Non-Executive Director, has served
as a Director since October 2004. Mr. Cha is the Managing Director of HKR
International Limited and Alternate Independent Non-executive Director of New
World Development Company Limited (both companies being listed on the Hong Kong
Stock Exchange). He is also a member of the Chinese People's Political
Consultative Committee of Zhejiang Province and a council member of the Hong
Kong Polytechnic University and the Hong Kong Institute of Education. Mr. Cha
graduated from Stanford University with a MBA degree and University of Wisconsin
with a B.S degree.
Dr. Qian Yingyi, 49, Independent Non-Executive Director, has served as
a Director since October 2004. He is Professor of Economics at the University of
California, Berkeley. Since 2005, Dr. Qian has also been the First Associate
Dean of the School of Economics and Management at Tsinghua University, and
served as Independent Director of the Industrial and Commercial Bank of China.
Before joining the Berkeley faculty in 2001, Dr. Qian taught in the Department
of Economics at Stanford University and the University of Maryland. In 1990, Dr.
Qian received his Ph.D. in Economics from Harvard University, after receiving an
M. Phil. in Management Science/Operations Research from Yale University and an
M.A. in Statistics from Columbia University. In 1981, Dr. Qian graduated from
Tsinghua University with a B.S. degree in Mathematics.
Hou Ziqiang, 68, Independent Non-Executive Director, has served as a
Director since October 2004. He was also Chairman of China Kejian Company
Limited. Mr. Hou founded China Kejian Company Limited in 1984. From 1993 to
1997, Mr. Hou was Director of the Institute of Acoustics of the Chinese Academy
of Sciences. From 1988 to 1993, Mr. Hou was Secretary General of the Chinese
Academy of Sciences. Mr. Hou graduated from Peking University in 1958 with a
bachelor's degree in physics.
Timpson Chung Shui Ming, G.B.S., J.P., 54, Independent Non-Executive
Director, has served as a Director since October 2004. He is a fellow member of
the Hong Kong Institute of Certified Public Accountants and the Association of
Chartered Certified Accountants. He is an Independent Non-executive Director of
Hantec Investment Holdings Limited, Tai Shing International (Holdings) Limited,
Glorious Sun Enterprises Limited, The Miramar Hotel & Investment Co. Limited and
Nine Dragons Paper (Holdings) Limited. In addition, Mr. Chung is a member of the
National Committee of the 10th Chinese People's Political Consultative
Conference, the Vice Chairman of the Council of the City University of Hong
Kong, a member of the Hong Kong Housing Authority and a Court Member of the
University of Hong Kong. Formerly, he was an Executive Director of Shimao China
Holdings Limited, a Director of Stockmartnet Holdings Ltd, Extrawell
Pharmaceutical Holdings Limited and China Rich Holdings Limited. He was also the
Chairman of the Hong Kong Housing Society, a member of the Executive Council of
the Hong Kong Special Administrative Region, the Vice Chairman of the Hong Kong
Special Administrative Region Government Land Fund Advisory Committee, a member
of the Managing Board of the Kowloon-Canton Railway Corporation and a member of
the Disaster Relief Fund Advisory Committee. Mr. Chung holds a Bachelor of
Science Degree from the University of Hong Kong and a master's degree of
Business Administration from the Chinese University of Hong Kong.
Mauricio Sartorius, 46, Alternate Director to Mr. Jose Maria
Alvarez-Pallete. He began his career with Banco del Progreso. In 1983, Mr.
Sartorius joined E. F. Hutton & Co. Inc. as a Registered Commodity
Representative. In 1985, he joined Credit Suisse First Boston as Vice President
of Corporate Finance for the Latin America region based in New York. Mr.
Sartorius joined Telefonica in 1 January 1997 in the Corporate Finance
Department as a Deputy Managing Director. In 1998, he was appointed Director of
Human Resources for Telefonica Internacional. He became the Chief Representative
Officer of Asia of Telefonica Internacional, S.A. on 1 January 2005 and since
then resided in Beijing. Mr. Sartorius holds a degree in economics from the
Universidad Complutense of Madrid and a MBA degree from New York University. Mr.
Sartorius is the Alternate Director to Mr. Alvarez-Pallete and was appointed
effective September 12, 2005.
Executive Officers
Zuo Xunsheng, 55, Executive Director and Chief Executive Officer.
Pei Aihua, 55, has served as Senior Vice President since July 2004
overseeing new technology and network planning and construction, and network
operation and maintenance. He has also served as Vice President of China Netcom
Group since April 2002. Before joining China Netcom Group, he was Deputy General
Manager of the former Beijing Telecommunications Company from July 2001 to April
2002, General Manager of Sichuan Provincial Telecommunications Company from July
2000 to July 2001, and Deputy Director of the former China General Bureau of
Posts and Telecommunications from June 1997 to May 2000. He graduated with a
master's degree in information and communication management jointly sponsored by
the Management School of Fudan University and the Norway Management School. He
graduated from Changchun Optical Precision Machinery College with a master's
degree in electrical engineering in 1993 and Beijing School of Post and
Telecommunications in microwave technology in 1976.
Zhang Changsheng, 58, has served as Senior Vice President since July
2004 overseeing regulatory and legal matters, value-added services and broadband
contents. He has also served as Vice President of China Netcom Group since
February 2003. Before joining China Netcom Group, Mr. Zhang served as Assistant
to Governor and Secretary General of Jiangsu Provincial Government from October
1995 to February 2003. From July 1988 to October 1995, he held several senior
positions in the Ministry of Personnel. He graduated from the Military School of
the People's Liberation Army in 1981.
Zhao Jidong, 55, has served as Senior Vice President since July 2004,
and is responsible for international affairs, Asian Netcom Corporation Limited,
Beijing Municipal Branch Company and the Olympics-related telecommunications
projects. Since November 2005, he has served as the Executive Chairman of Asian
Netcom Corporation Limited. He has also served as Vice President of China Netcom
Group since July 2003. Before joining China Netcom Group, Mr. Zhao served as
General Manager of Beijing Communications Company from July 2002 to July 2003
and General Manager of former Beijing Telecommunications Company from May 2000
to July 2002. From November 1994 to May 2000, Mr. Zhao served as Vice Director
and Director in the former Beijing Telecommunications Bureau. Mr. Zhao holds a
master's degree in information and communication management jointly sponsored by
the Management School of Fudan University and the Norway Management School. He
graduated from Fudan University with a B.A. degree in English in 1975.
Li Fushen, 43, has served as Chief Financial Officer since September
2005. He became Financial Controller in July 2004. Since October 2003, he has
served as General Manager of the Finance Department of China Netcom Group. From
November 2001 to October 2003, he served as Deputy General Manager of the former
Jilin Provincial Telecommunications Company and Jilin Communications Company. He
graduated from the Australian National University with a master's degree in
management and from the Jilin Engineering Institute with a degree in engineering
management in June 1988.
Joint Company Secretaries
Miao Jianhua, 54, Executive Director and Joint Company Secretary.
Mok Kam Wan, 43, Joint Company Secretary. Ms. Mok joined the Company in
October 2005. She holds a bachelor's degree of laws from The University of
London and a master's degree in business administration from The Hong Kong
Polytechnic University. Ms. Mok is an associate member of The Institute of
Chartered Secretaries and Administrators in the United Kingdom and The Hong Kong
Institute of Chartered Secretaries.
COMPENSATION
Our executive directors and executive officers receive compensation in
the form of salaries, housing allowances, other allowances and benefits in kind,
including our contribution to the pension plans for our directors and executive
officers. We have entered into service agreements with our executive directors.
Each of our directors is entitled to an annual director's fee of
HK$250,000 as proposed by the board of directors and approved by our
shareholders. Director's fees are payable on a time pro-rata basis for any non
full year's service. Mr. Zhang Chunjiang will receive annual base salary and
performance-based bonus and any discretionary award of share options as may be
determined by the board of directors. In addition, Dr. Edward Tian Suning is
entitled to an additional annual fee of HK$50,000 as a member of the Corporate
Governance Committee, Mr. John Lawson Thornton is entitled to an additional
annual fee of HK$120,000 as the chairman of the Corporate Governance Committee
and a member of the compensation and Nomination committee. Mr. Victor Cha Mou
Zing is entitled to an additional annual fee of HK$100,000 as a member of the
Audit Committee and the Compensation and Nomination Committee, and Mr. Jose
Maria Alvarez-Pallete is entitled to an additional annual fee of HK$50,000 as a
member of the Strategic Planning Committee. Dr. Edward Tian Suning, Mr. John
Lawson Thornton, Mr. Victor Cha Mou Zing and Mr. Jose Maria Alvarez-Pallette is
entitled to an additional fee of HK$50,000 for each committee meeting they
attend.
The following table sets out the emoluments paid to our directors
in 2005.
Basic
salaries,
housing
allowances,
other share
allowances option Contributions
and benefits benefit to retirement
Fees in kind Bonus amortized schemes Total
-------------------------------------------------------------------------------------
RMB
Zhang Chunjiang.................. 260,715 324,168 753,234 563,883 16,363 1,918,363
Edward Tian Suning............... 260,715 675,983 567,609 563,883 - 2,068,190
Zhang Xiaotie.................... 260,715 395,738 - 490,333 16,363 1,163,149
Miao Jianhua..................... 260,715 310,470 311,079 429,041 16,363 1,327,668
Jiang Weiping(1)................. 309,370 303,387 307,138 429,041 16,363 1,365,299
Li Liming........................ 312,858 282,651 282,235 429,041 16,363 1,323,148
Keith Rupert Murdoch((2))........ 218,858 - - 361,621 - 580,479
Yan Yixun........................ 260,715 - - 361,621 - 622,336
John Lawson Thornton............. 365,002 - - - - 365,002
Victor Mou Zing Cha.............. 360,656 - - - - 360,656
Qian Yingyi...................... 417,145 - - - - 417,145
Hou Ziqiang...................... 412,799 - - - - 412,799
Timpson Chung Shui Ming.......... 332,668 - - - - 332,668
Jose Maria alvarez-Pallete (3)... 94,500 - - - - 94,500
-------------------------------------------------------------------------------------
Total........................... 4,127,431 2,292,397 2,221,295 3,628,464 81,815 12,351,402
=====================================================================================
_____________
(1) Resigned on May 17, 2006.
(2) Resigned on September 12, 2005.
(3) Appointed on September 12, 2005.
The five individuals whose emoluments were the highest for the years
ended December 31, 2005 include two directors whose emoluments are reflected
in the analysis presented above. The emoluments payable to the remaining
individuals are as follows:
Year ended December 31, 2005
----------------------------------
RMB
Basic salaries, housing allowances, bonus, share option benefit
amortized, other allowances and benefits in kind...................... 5,928,713
Contributions to retirement schemes.................................... 32,726
----------------------------------
Total.................................................................. 5,961,439
==================================
The aggregate compensation to which our executive directors and senior
management members were entitled (including amounts paid and accrued) in 2005
was RMB 19.4 million, including directors' fees, basic salaries, bonus, share
option benefit amortized, housing allowances, other allowances and benefits in
kind, as well as contributions to retirement schemes.
BOARD PRACTICE
Our company has entered into service contracts with each of our
executive directors. The directors are subject to rotation under our articles of
association. The service contracts of executive directors are subject to
termination at least sixty days' written notice. Pursuant to our articles of
association, the remuneration of our directors is determined by our shareholders
in a general shareholders' meeting. None of these service contracts will provide
benefits to our directors upon termination.
Except as disclosed in this annual report, none of our directors has or
is proposed to have a service contract with us (excluding contracts expiring or
determinable by the employer within one year without payment of compensation
(other than statutory compensation)).
Board Committees
Audit Committee
We have established an audit committee in compliance with the Code on
Corporate Governance Practices as set out in Appendix 14 to the Listing Rules of
the Hong Kong Stock Exchange. All members of the audit committee are appointed
by the board. The audit committee currently consists of four independent
non-executive directors, Mr. Timpson Chung Shui Ming who serves as its chairman,
Dr. Qian Yingyi, Mr. Victor Cha Mou Zing and Mr. Hou Ziqiang. The primary
responsibilities of the audit committee include supervising and managing our
financial reporting system, reviewing the auditors' appointment, and supervising
the work of the internal audit department.
Compensation and Nomination Committee
Our compensation committee has been renamed as the compensation and
nomination Committee effective September 12, 2005. The duties of this committee
include nominating new board members, reviewing the compensation of our
directors and our management and making recommendations to the board. The
members of the Committee are Mr. Qian, Yingyi, who serves as its chairman, Mr.
Zhang Chunjiang, Mr. Zuo Xunsheng, Mr. John Lawson Thornton, Mr. Victor Cha Mou
Zing and Mr. Hou Ziqiang.
Strategic Planning Committee
We have also established a strategic planning committee. The strategic
planning committee is responsible for reviewing our development strategies,
supervising their implementation and analyzing major investment projects. The
members of this committee are Mr. Zhang Chunjiang, who serves as its chairman,
Mr. Zuo Xunsheng, Mr. Zhang Xiaotie, Ms. Li Liming, Mr. Jose Maria
Alvarez-Pallete, Dr. Qian Yingyi and Mr. Hou Ziqiang.
Corporate Governance Committee
We have also established a corporate governance committee. The duties
of the corporate governance committee are to supervise implementation of our
corporate governance polices, supervise the efficiency and legal compliance of
our board of directors and make recommendations to the board in order to enhance
our corporate governance structure. The chairman of this committee is Mr. John
Lawson Thornton and its members include Dr. Tian Suning, Mr. Miao Jianhua, Dr.
Qian Yingyi and Mr. Timpson Chung Shui Ming.
Summary Corporate Governance Differences
There are significant differences between our corporate governance
practices and those of U.S. issuers listed on the New York Stock Exchange.
Pursuant to Section 303A.11 of the NYSE Listing Manual, we have disclosed
certain of these differences on our website at www.china-netcom.com.
EMPLOYEES
As of December 31, 2005, we had 138,440 full time employees.
Substantially all of our employees are located in China. The following table
sets forth the number of our employees serving in the capacities and for the
periods indicated:
As of December 31,
---------------------------------------------------------------------------------------
2002 2003 2004 2005
------------------- -------------------- ---------------------- --------------------
Number Percentage Number Percentage Percentage Percentage
of of Total of of Total Number of of Total Number of of Total
Employees Employees Employees Employees Employees Employees Employees Employees
--------- --------- --------- --------- --------- --------- --------- ---------
Management, finance and 30,662 21.7 33,341 23.3 22,814 15.8 23,784 17.2
Administrative................
Sales and marketing.............31,707 22.5 29,401 20.6 66,564 46.3 67,603 48.8
Operations and maintenance......71,530 50.6 72,418 50.6 47,322 32.9 42,134 30.4
Others(1)....................... 7,395 5.2 7,803 5.5 7,262 5.0 4,919 3.6
Total........................141,294 100.0 142,963 100.0 143,962 100.0 138,440 100.0
__________
(1) Includes research and development employees.
As of December 31, 2005 we also employed approximately 60,521 temporary
employees.
We participate in defined contribution retirement plans for our
employees. We are required to contribute a portion of our employees' total wages
to the PRC government's pension plan in accordance with relevant local
government regulation. Our contributions were approximately RMB 1,051 million in
2003, RMB 1,181 million in 2004 and RMB 1,285 million in 2005. We also implement
an early retirement scheme whereby employees approaching retirement age may opt
for early retirement in exchange for certain early retirement benefits. The
amount expensed as early retirement benefits was approximately RMB 336 million
in 2003, RMB 693 million in 2004 and RMB 2 million in 2005.
We have implemented a short-term and long-term combined incentive
remuneration scheme. The primary components of an employee's remuneration are a
basic salary, a performance-based bonus and a stock option scheme for certain
employees. In addition, we emphasize the importance of employee training and
seek to improve the skills of our employees.
In 2005, we did not experience any strikes or other labor disturbances
that interfered with our operations, and we believe that the relationship
between our management and our labor union was good.
SHARE OWNERSHIP
Ownership of our shares by our directors and executive officers
Certain of our directors and executive officers have a beneficial
interest in our shares through their ownership of options as further discussed
in "-- Share Option Scheme".
Share option scheme
The shareholders of our company passed a resolution on September 30,
2004 to approve and adopt the share option scheme (the "Share Option Scheme").
Having considered the changes following the completion of our 2005 Acquisition
and for the purpose of clarifying the relevant scope of the Share Option Scheme,
the Board convened meetings on December 6, 2005 and April 28, 2006, and made
minor amendments to the Share Option Scheme.
The main contents of the amended Share Option Scheme are as follows:
Purpose of the Share Option Scheme
The purpose of the Share Option Scheme is to provide our company with a
means to incentivize its senior management, to attract and retain talent and to
encourage other eligible participants to enhance the value of the Company.
Participants of the Share Option Scheme
The directors may invite any person belonging to any of the following
classes of participants to take up options to subscribe for the ordinary shares
of the Company:
(i) the directors (including executive and non-executive directors, but
excluding independent Non-executive directors);
(ii) members of the middle-to-senior management; and
(iii) such class of "specialized professionals" as may be designated by
the Compensation and Nomination Committee.
For the purpose of sub-paragraph (iii) above, "specialized
professionals" means such professionals that are important to the development of
the Group's business and the management, technical and business development
personnel that occupy key positions in the Group. The Compensation and
Nomination Committee has the authority to interpret the meaning of "specialized
professionals".
Maximum number of shares and effective options
(i) The maximum number of shares which may be allotted and issued upon
the exercise of all outstanding options granted and yet to be exercised under
the Share Option Scheme and any other share option scheme must not in aggregate
exceed 30 per cent. of the relevant class of securities of our company in issue
from time to time.
(ii) The total number of shares which may be allotted and issued upon
the exercise of all options to be granted under the Share Option Scheme must not
in aggregate exceed 10 per cent. of the shares in issue immediately after the
completion of the global offering of shares (and American depositary shares) of
our company in November 2004 (the "General Scheme Limit").
(iii) Subject to (i) above, our company may seek approval of the
shareholders in general meeting to refresh the General Scheme Limit and may seek
separate approval of the shareholders in general meeting to grant options beyond
the General Scheme Limit.
(iv) "Effective options" means the share options granted under the
Share Option Scheme, irrespective of whether such options are exercisable in
accordance with the relevant vesting schedule; and "vesting schedule" means the
arrangement whereby options can be exercised by batch in accordance with the
timetable pre-determined by the Share Option Scheme.
As of the date of this annual report, the total number of securities
available for issue under the Share Option Scheme is 236,023,000, representing
3.6% of the issued share capital of our company as of the date of this annual
report.
Maximum entitlement of each participant
Unless otherwise approved by the shareholders in general meeting, the
total number of shares issued and which may fall to be issued upon the exercise
of the options granted under the Share Option Scheme (including both exercised
or outstanding options) to any participant in any 12-month period shall not
exceed 0.2 per cent. of the issued share capital of our company on the date of
grant.
Minimum period for which an option must be held before it can be exercised
With respect to the share options granted prior to the listing of the
Company's shares on the Stock Exchange, there is a minimum period of 18 months
from the later of the date of grant or the date of the listing of the shares on
the Stock Exchange before an option can be exercised; with respect to the share
options granted after the listing of the Company's shares on the Stock Exchange,
there is a minimum period of 24 months from the later of the date of grant or
the date of the listing of the shares on the Stock Exchange before an option can
be exercised.
Period within which the shares must be taken up under an option
Any option shall lapse if not exercised within 6 years from the later
of the date of grant or the date of the listing and commencement of trading of
the shares on the Stock Exchange.
The basis of determining the exercise price for shares
The exercise price is a price determined by the directors but shall not
be less than the highest of: (i) the closing price of the shares on the Stock
Exchange on the date of grant; (ii) the average closing price of shares on the
Stock Exchange for the five trading days immediately preceding the date of
grant; and (iii) the nominal value of the shares.
Consideration
No consideration is payable on acceptance of the grant of an option.
The remaining life of the Share Option Scheme
Unless otherwise terminated by the Board of Directors in exercise of
its power in accordance with the rules governing the Share Option Scheme, the
Share Option Scheme will remain in force for a period of 10 years commencing on
the date on which the Share Option Scheme is adopted.
Amendment to and termination of the Share Option Scheme
(i) The Board of our company may amend any of the provisions of the
Share Options Scheme and the terms of the options at any time, but not so as to
prejudice the rights of the grantees of options.
(ii) Any alterations to the matters set out in the Listing Rules and
alterations which are to the advantage of existing or future grantees of options
shall only be made with the approval of shareholders at general meeting.
(iii) Any alterations to the terms and conditions of the Share Option
Scheme which are of a material nature shall be approved by the shareholders of
our company at general meeting, except where the alterations take effect
automatically under the existing terms of the Share Option Scheme.
(iv) Any change to the authority of the Board in relation to alteration
of the terms of the Share Option Scheme shall be approved by shareholders of our
company at general meeting. The amended Share Option Scheme or the terms thereof
shall comply with the relevant requirements of the Listing Rules.
(v) During the effective term of the Share Option Scheme, the Board may
at any time terminate the Share Option Scheme or decide not to grant any options
under the Share Option Scheme, and in such event the options granted under this
Scheme (to the extent not already exercised) may still be exercisable pursuant
to the rules of the Share Option Scheme or may be cancelled by the Board
pursuant to rules thereof.
(vi) The Share Option Scheme will be terminated upon the expiry of its
effective term and any new share option scheme to be adopted by the Board shall
be approved by the shareholders of our company at general meeting.
Exercise of Options and Proceeds
(1) The Exercise Price for the initial grant of Options shall be the
initial public offering price. The Exercise Price of Options granted
subsequently shall be the higher of the par value of the shares, the closing
price of the shares on the Options Grant Date and the average closing price of
the shares in the five trading days prior to the Options Grant Date.
(2) Share Options shall be effective for a period of six years. Any
Options not exercised after the expiry of six years from the Options Effective
Date shall lapse automatically.
(i) The initial exercise of the Share Options which are
granted prior to the listing of the Company on the Hong
Kong Stock Exchange is subject to an Options Restricted
Period of 1.5 years and such Share Options shall only
be exercised in batches in accordance with the Vesting
Schedule below. The maximum number of Options that can
be exercised at each tier shall not exceed the limits
set out below:
- 40% of the Options granted may be exercised 18
months after the Options Effective Date (the "First
Tier");
- another 20% of the Options granted may be exercised
30 months after the Options Effective Date (the
"Second Tier");
- another 20% of the Options granted may be exercised
42 months after the Options Effective Date (the
"Third Tier"); and
- the remaining 20% of the Options granted may be
exercised 54 months after the Options Effective
Date (the "Fourth Tier").
(ii) The initial exercise of the Share Options which are
granted after the listing of the Company on the Hong
Kong Stock Exchange is subject to an Options Restricted
Period of 2 years and such Share Options shall only be
exercised in batches in accordance with the Vesting
Schedule below. The maximum number of Options that can
be exercised at each tier shall not exceed the limits
set out below:
- 40% of the Options granted may be exercised 24
months after the Options Effective Date (the "First
Tier");
- another 20% of the Options granted may be exercised
36 months after the Options Effective Date (the
"Second Tier");
- another 20% of the Options granted may be exercised
48 months after the Options Effective Date (the
"Third Tier"); and
- the remaining 20% of the Options granted may be
exercised 60 months after the Options Effective
Date (the "Fourth Tier").
(3) The exercise of a portion of the Options of the employees of the
Company (excluding senior management and directors of the Company) exercisable
at each tier pursuant to the above Vesting Schedule (the "Adjustable Options")
shall be subject to the results of the performance review of the grantee in
respect of the year immediately preceding the commencement of the relevant tier
as measured against the Company's performance review plan. Part or all of the
Adjustable Options shall be subject to cancellation depending upon the results
of the performance review. The Adjustable Options shall be determined by the
Company with reference to the number of Options exercisable at each tier, the
expected yield of each Option and the difference between the average price of
the Shares in the year immediately preceding the commencement of the relevant
tier and the exercise price of the Options.
(4) Except for the transmission of the Options on the death of a
grantee of Options to his personal representatives or authorised persons,
neither the Options nor any relevant rights may be transferred, assigned or
otherwise disposed of by any grantee to any other person. If a grantee
transfers, assigns or disposes of such Options or rights, the Company will be
entitled to cancel the Options granted to the grantee.
(5) The increase in exercisable Options of the grantees at each tier
(the Options exercisable at the First Tier shall be deemed as the increase in
exercisable Options at the First Tier) shall be subject to cancellation upon the
happening of any of the following events:
(i) the annual performance review of the Company for the
year preceding the commencement of the relevant tier
shows that the Company is unable to meet the
performance review targets;
(ii) the issuance of a negative opinion by the Company's
accountants or the Company's accountants being unable
to issue an opinion on the financial reports in respect
of the year preceding the commencement of the relevant
tier;
(iii) where the Supervisory Panel or the audit authorities
for State-owned enterprises of the State Council have
raised material objections to the results or the annual
report of the Company in respect of the year preceding
the commencement of the relevant tier.
(6) In the event that the grantee is to be demoted, his unvested
Options pursuant to the Vesting Schedule will be reduced to reflect his new
position and the reduced Options will automatically lapse.
(7) In the event of a capitalisation issue, rights issue, sub-division
or consolidation of shares or reduction of capital, the Board has the right to
make corresponding alterations to the number of shares involved in the Options
granted under the Share Option Scheme (outstanding Options) and the Exercise
Price, provided that the proportion of the total number of ordinary shares
involved in the Share Option Scheme to the total number of issued shares shall
remain unchanged. Such adjustments shall give participants to the Share Option
Scheme the same proportion of the issued share capital to which he would have
been entitled prior to such alteration, and no adjustment shall be made the
effect of which would be to enable shares to be issued at less than its nominal
value.
(8) The proceeds from the exercise of Options shall be the multiple of
the number of Share Options being exercised and the difference between the
market price of the shares of the Company upon the exercise of the Options by
the grantee and the Exercise Price, less the relevant tax expenses. After
exercising the Options, the proceeds shall belong to the person who exercised
the Options. If the grantee does not exercise the Options within the period
during which he is entitled to exercise the Options, the proceeds shall be zero.
(9) Prior to exercising part or all of his Options, the grantee shall
inform the Company in writing of his intention to exercise the Options together
with the number of shares, the Exercise Price etc.
(10) The grantee is required to exercise his Options through the
intermediaries selected by the Company.
Rights on cessation of employment
(1) If the grantee of an Option ceases to be an employee because of
misconduct or criminal conviction, and as a result ceases to be an Eligible
Participant under the Share Option Scheme, all the Effective Options not yet
exercised shall lapse on the date of cessation of his employment and such
Options shall in no circumstances be exercisable.
(2) If the grantee of an Option is transferred internally to China
Network Communications Group Corporation and its controlled entities, the
grantee shall be entitled to exercise the Options in accordance with the Vesting
Schedule.
(3) If the grantee of an Option is transferred out of the Company with
the Company's consent (for reason other than Clause 6(2)), the grantee may, at
any time within 90 days of the date of the cessation of his employment, exercise
the Effective Options which are exercisable as at the date of the cessation of
his employment as well as the Options which are exercisable at the tier
immediately following the date of cessation of his employment. Any such Options
which are not exercised within the 90-day period shall lapse automatically. All
the Options exercisable at later tiers shall lapse automatically.
(4) If the grantee of an Option retires, the grantee may, at any time
within 90 days of the date of his retirement, exercise the Effective Options
which are not yet exercised. Any such Options which are not exercised within the
90-day period shall lapse automatically.
(5) If the grantee of an Option ceases to be an employee for any reason
other than death, loss of capacity or the reasons as referred to under Clauses
6(1), 6(2), 6(3) or 6(4) and for reason of his resignation, and thus as a result
ceases to be an Eligible Participant under the Share Option Scheme, all of his
Effective Options not yet exercised shall lapse on the date of cessation of his
employment.
Where the employment of a grantee ceases or has ceased or the grantee
retires or has retired prior to the 2006 Amendments being approved by
shareholders of the Company at general meeting, the date of cessation of
employment or retirement will be deemed to be the day on which the 2006
Amendments are approved by shareholders of the Company at general meeting.
Rights on death
If the grantee of an Option dies and that none of the grounds for
cessation of employment as referred to in Clause 6(1) has occurred, Effective
Options granted (but not yet exercised) shall be vested in the grantee's estate,
the grantee's personal representatives or authorised persons shall exercise such
Effective Options within 90 days. Any such Options which are not exercised
within the 90-day period shall lapse automatically.
Where the grantee dies or has died prior to the 2006 Amendments being
approved by shareholders of the Company at general meeting, his death will be
deemed to have occurred on the day on which the 2006 Amendments are approved by
shareholders of the Company at general meeting.
Rights on loss of capacity
The guardian of the grantee of an Option or authorised persons may, at
any time during the period within 90 days of the date of the loss of capacity of
such grantee, exercise the Effective Options granted to such grantee but not yet
exercised as at the date of the loss of capacity of such grantee. Any such
Options which are not exercised within the 90-day period shall lapse
automatically.
Where the loss of capacity takes place or has taken place prior to the
2006 Amendments being approved by shareholders of the Company at general
meeting, the loss of capacity will be deemed to have taken place on the day on
which the 2006 Amendments are approved by shareholders of the Company at general
meeting.
Cancellation of the Options
The Board may resolve to cancel any Options granted but not yet
exercised.
Lapsed Options shall be automatically cancelled on the date of lapse.
As at December 31, 2005, the directors, chief executive and employees
of our company had the following personal interests in options to subscribe for
shares of our company granted under the Share Option Scheme.
No. of shares
No. of shares involved involved in the Price per share
in the options options outstanding Date of the of payable for the
outstanding at the at the end of the grant the exercise of the
beginning of the year year options options
------------------------ ------------------- --------------- ----------------
(in HK$)
DIRECTORS
Zhang Chunjiang................ 920,000 920,000 22 October 2004 8.40
Tian Suning.................... 920,000 920,000 22 October 2004 8.40
Zuo Xunsheng 800,000 800,000 22 October 2004 8.40
(also the chief executive officer)
Zhang Xiaotie.................. 800,000 800,000 22 October 2004 8.40
Miao Jianhua................... 700,000 700,000 22 October 2004 8.40
Jiang Weiping.................. 700,000 700,000 22 October 2004 8.40
Li Liming...................... 700,000 700,000 22 October 2004 8.40
Yan Yixun...................... 590,000 590,000 22 October 2004 8.40
Employees and other persons
granted with options in 2004(1) 151,590,000 150,573,000 22 October 2004 8.40
Employees and other persons
granted with options after the
completion of our 2005
Acquisition(2)(3)........... -- 79,320,000 6 December 2005 12.45
Total(4)(5)............... 236,023,000
__________________
Notes:
(1) The total number of shares involved in the options outstanding at the end of
the year represents 3.6 per cent. of the issued share capital of our company as
at the date of this annual report.
(2) Grantees of the share options granted on October 22, 2004 are entitled to
exercise the options in the following periods:
o in respect of 40 per cent. of the options granted, from May 17, 2006 to
November 16, 2010;
o in respect of a further 20 per cent. of the options granted, from May 17,
2007 to November 16, 2010;
o in respect of an additional 20 per cent of the options granted, from May
17, 2008 to November 16, 2010; and
o In respect of the remaining 20 per cent of the options granted, from May
17, 2009 to November 16, 2010.
(3) Options were granted by our company on December 6, 2005. The closing price
per share on the trading day immediately before December 6, 2005 was HK$12.25.
(4) Grantees of the share options granted on December 6, 2005 are entitled to
exercise the options in the following periods:
o in respect of 40 per cent. of the options granted, from December 6, 2007 to
December 5, 2011;
o in respect of a further 20 per cent. of the options granted, from December
6, 2008 to December 5, 2011;
o in respect of an additional 20 per cent. of the options granted, from
December 6, 2009 to December 5, 2011; and
o in respect of the remaining 20 per cent. Of the options granted, from
December 6, 2010 to December 5, 2011.
(5) During the year ended December 31, 2005, no share option has been exercised
and share options representing 1,017,000 shares lapsed as a result of the
resignation of the employees to whom the share options were granted.
According to the requirements under HKFRS 2, the fair value of the
options granted by our company to its employees (including directors) to
subscribe for shares in our company shall be recognized as expenses in the
Company's consolidated income statement. Our company has made retrospective
adjustments to the recognized employee benefit costs or liabilities in relation
to the grant of options to subscribe for shares in our company to employees
(including directors) in prior years.
Apart from the foregoing, at no time during the year ended December 31,
2005 was the Company, any of its holding companies or subsidiaries or fellow
subsidiaries, a party for any arrangement to enable the directors or senior
management of our company or any of their spouses or children under eighteen
years of age to acquire benefits by means of the acquisition of shares in or
debentures of our company or any other body corporate.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
MAJOR SHAREHOLDERS
As of May 31, 2006, we had 6,602,431,000 shares outstanding. The
table below sets forth information as of the date of this annual report
regarding the beneficial ownership of our ordinary shares by each person known
by us to beneficially own 5% or more of our outstanding ordinary shares. Except
as otherwise indicated, we believe each shareholder named in this table has sole
voting and investment power with respect to the shares shown as beneficially
owned. None of our shareholders listed below has voting rights that are
different from any of our other shareholders.
Shares Beneficially
Owned
-------------------------
Name of Beneficial Owner Number Percentage
--------------------------------------------------- ------------ ----------
(in millions)
China Network Communications Group Corporation(1) 4,647,449,014 70.39%
Telefonica Internacional S.A........................ 329,676,450 4.99%
__________
(1) China Network Communications Group Corporation's beneficial interest is
attributable to its ownership interest in CNC BVI, our direct parent
company. The registered address of CNC BVI is P.O. Box 3140, Wickhams Cay 1,
Road Town, Tortola, British Virgin Islands. The registered address of China
Network Communications Group Corporation is Building C, No. 156 Fuxingmennei
Avenue, Xicheng District, Beijing, PRC.
RELATED PARTY TRANSACTIONS
Connected Transactions
Our 2005 Acquisition
See "Item 4. Business Overview--History and Development--Our 2005
Acquisition".
Cooperation Agreement in relation to the 2008 Beijing Olympic Games
On 15 September 2005, the Company's wholly-owned subsidiary, China
Netcom (Group) Company Limited ("CNC China") entered into a cooperation
agreement (the "Cooperation Agreement") with China Netcom Group whereby CNC
China agreed to provide telecommunications goods and services to the Beijing
Organization Committee for the Games of the XXIX Olympiad ("BOCOG"). As
consideration, CNC China is entitled to the right and opportunity to conduct
products-related marketing activities by using the 2008 Olympics composite logo
and sponsorship logo as provided for under the sponsorship agreement between
China Netcom Group and BOCOG. The consideration of the Cooperation Agreement is
RMB480 million.
Continuing Connected Transactions
As of the date of this annual report, China Netcom Group, as the
ultimate controlling shareholder of the Company, beneficially owned 70.39% of
the Company's issued share capital. China Netcom Group is therefore a connected
person of the Company. In October 2004, China Netcom (Group) Company Limited
("CNC China"), a wholly owned subsidiary of the Company, entered into certain
agreements with China Netcom Group, and certain ongoing transactions between CNC
China on the one hand and China Netcom Group and its subsidiaries or associates
(other than the Group) on the other hand ("Continuing connected transactions
relating to CNC China") were conducted in accordance with the provisions under
the aforesaid agreements up to October 31, 2005. In order to facilitate the
management of our continuing connected transactions in China after the
completion of our 2005 Acquisition, CNC China, CNC New Horizon and China Netcom
Group entered into certain connected transaction agreements on September 12,
2005 to regulate the continuing connected transactions between China Netcom
Group and its subsidiaries or associates (other than the Group) on one hand and
the Group on the other hand in respect of the Group's operations in 12
provinces, autonomous region and municipalities in China, and these agreements
would replace the existing connected transaction agreements between CNC China
and China Netcom Group after the completion of our 2005 Acquisition. Certain
ongoing transactions between CNC China and CNC New Horizon on the one hand and
China Netcom Group and its subsidiaries or associates (other than the Group) on
the other hand as from October 31, 2005, ("Continuing connected transactions
relating to CNC China and CNC New Horizon") were conducted in accordance with
the provisions under the new agreements.
On June 30, 2004, Asia Netcom Corporation Limited ("Asia Netcom"), a
wholly owned subsidiary of the Company, entered into certain transactions and a
series of connected transaction agreements with East Asia Netcom Ltd. ("EANL"),
a connected person of the Company by virtue of being an indirect wholly owned
subsidiary of China Netcom Group.
These transactions between CNC China, CNC New Horizon and China Netcom
Group and between Asia Netcom and EANL (the "Continuing Connected Transactions")
constitute continuing connected transactions of the Company under the Rules
Governing the Listing of Securities on The Stock Exchange of Hong Kong Ltd (the
"Listing Rules"). Details of the Continuing Connected Transactions are set out
below and in note 37 to the financial statements regarding relative transactions
with ultimate holding company, fellow subsidiaries and other related companies.
For the financial year ended December 31, 2005, the Continuing Connected
Transactions have not exceeded their respective upper limits set by the Hong
Kong Stock Exchange. In respect of all the connected transactions of the Company
as stated in this annual report, the Company has complied with the disclosure
requirements under the Listing Rules in force from time to time.
Continuing connected transactions relating to CNC China
The following continuing connected transaction agreements took effect
until the completion of our 2005 Acquisition.
Interconnection Settlement Agreement
CNC China and China Netcom Group agreed to interconnect their
respective networks and settle the charges received in respect of domestic and
international long distance voice services within their respective service
regions on a monthly basis.
For domestic long distance voice services between China Netcom Group
and CNC China (except services between subsidiaries of China Netcom Group in
four provinces and autonomous region and the branch companies of CNC China in
six provinces and municipalities), the telephone operator in the location of the
calling party makes a settlement payment to the telephone operator in the
location of the called party at the rate of RMB0.06 per minute or RMB0.09 per
minute (depending on whether the call terminates within or outside the network
of either party).
For outbound international calls, China Netcom Group reimburses CNC
China for any amount it has paid to overseas telecommunications operators. The
revenues received by China Netcom Group less the amount paid to overseas
telecommunications operators are shared between China Netcom Group and CNC China
in proportion to the estimated costs incurred by each party.
For inbound international calls, the revenues received by CNC China
from overseas telecommunications operators less the amount paid to China Netcom
Group at the rate of RMB0.06 per minute or RMB0.09 per minute (depending on
whether the call terminates within the network of China Netcom Group or other
operators) are shared between China Netcom Group and CNC China in proportion to
the estimated costs incurred by each party.
The rates of RMB0.06 per minute and RMB0.09 per minute mentioned above
may be adjusted with reference to the relevant standards, tariffs or policies
promulgated by the relevant regulatory authorities in China from time to time.
Property Leasing Agreement
Pursuant to the Property Leasing Agreement:
(i) CNC China leases to China Netcom Group certain properties located
throughout our northern service region and our southern service region, for use
as offices and other ancillary purposes; and
(ii) China Netcom Group leases to CNC China certain properties located
throughout our northern service region and our southern service region, for use
as offices, telecommunications equipment sites and other ancillary purposes.
The charges payable by CNC China and by China Netcom Group under the
Property Leasing Agreement are based on market rates or the depreciation and
maintenance charges in respect of each property, provided such depreciation and
maintenance charges shall not be higher than the market rates. The charges are
payable quarterly in arrears and are subject to review every year to take into
account the then prevailing market rates.
Property Sub-leasing Agreement
China Netcom Group agreed to sub-let to CNC China certain properties
owned by and leased from independent third parties, for use as offices,
telecommunications equipment sites and other ancillary purposes.
The amounts payable by CNC China under the Property Sub-leasing
Agreement are the same as the rental charges and other fees (including
management fees) payable by China Netcom Group to the relevant third parties.
Master Services Sharing Agreement
Pursuant to the Master Services Sharing Agreement:
(i) CNC China agreed to provide customer relationship management
services, network management services and supporting services such as billing
and settlement to China Netcom Group, and to share with China Netcom Group the
services provided by the administrative and managerial staff at the headquarters
of CNC China in respect of the central management of both CNC China and China
Netcom Group; and
(ii) China Netcom Group agreed to provide to CNC China supporting
services, including telephone card production, development and related services
and IC card inter-provincial and inter-network clearing services, and certain
other shared services, and to provide certain office space in Beijing to CNC
China for use as its principal executive office.
The above services are shared between CNC China and China Netcom Group
on an on-going basis from time to time and the aggregate costs incurred by CNC
China or China Netcom Group for the provision of such services are apportioned
between CNC China and China Netcom Group according to the annual revenues
generated by each party.
Engineering and Information Technology Services Agreement
The Engineering and Information Technology Services Agreement governs
the arrangements with respect to the provision of certain engineering and
information technology-related services to CNC China by China Netcom Group,
including planning, surveying and design services, construction services and
supervision services in relation to telecommunications engineering projects, and
information technology services.
The charges payable for such services are determined with reference to
market rates. In addition, where the value of any single item of services
exceeds RMB 0.5 million (for design or supervision-related services), or where
the value of any single item of services exceeds RMB 2 million (for
construction-related services), the award of such services will be subject to
tender. The charges are settled between CNC China and China Netcom Group as and
when the relevant services are provided.
Materials Procurement Agreement
Under the Materials Procurement Agreement, CNC China may request China
Netcom Group to act as its agent for the procurement of imported and domestic
telecommunications equipment and other domestic non-telecommunications
equipment, and may purchase from China Netcom Group certain products. China
Netcom Group also agreed to provide to CNC China related storage and
transportation.
Commission and/or charges are not to exceed the maximum rate of 3 per
cent. of the contract value for the domestic materials procurement services and
1 per cent. of the contract value for imported materials procurement services.
The price for the purchase of China Netcom Group's products is determined with
reference to the following pricing principles and limits ("Pre-Acquisition
Pricing Principles"):
(a) The government-fixed price;
(b) Where item (a) does not apply, the government guidance price;
(c) Where items (a) and (b) do not apply, the market price; or
(d) Where none of the above is applicable, the price to be agreed
between the relevant parties and determined on a cost-plus basis.
Commission and/or charges for the storage and transportation services
are determined with reference to market rates.
Payments under the Materials Procurement Agreement will be made as and
when the relevant equipment or products have been procured and delivered.
Ancillary Telecommunications Services Agreement
The Ancillary Telecommunications Services Agreement governs the
arrangements with respect to the provision of certain ancillary
telecommunications services to CNC China by China Netcom Group, including
certain telecommunications pre-sale, on-sale and after-sale services.
The charges payable for the services described above are determined
with reference to the Pricing Principles. The service charges are settled
between CNC China and China Netcom Group as and when the relevant services are
provided.
Support Services Agreement
Under the Support Services Agreement, China Netcom Group provide CNC
China with various support services, including equipment leasing and maintenance
services, motor vehicles services, security services, basic construction agency
services, research and development services, employee training services and
advertising services.
The charges payable for the services described above are determined
with reference to the Pricing Principles. The service charges are settled
between CNC China and China Netcom Group as and when relevant services are
provided.
Telecommunications Facilities Leasing Agreement
Under the Telecommunications Facilities Leasing Agreement, China Netcom
Group leases inter-provincial fibre-optic cables within our northern and
southern service regions and certain international telecommunications resources
(including international telecommunication channel gateways, international
telecommunications service gateways, international submarine cable capacity,
international land cables and international satellites facilities) to CNC China.
The rental charges for the leasing of inter-provincial fibre-optic
cables and international telecommunications resources are based on the annual
depreciation charges of such fibre-optic cables and resources, and are settled
between CNC China and China Netcom Group on a quarterly basis.
Continuing connected transactions relating to CNC China and CNC New Horizon
The following continuing connected transaction agreements have come
into effect only after the completion of our 2005 Acquisition.
Domestic Interconnection Settlement Agreement
Pursuant to the Domestic Interconnection Settlement Agreement:
CNC New Horizon, CNC China (CNC New Horizon and CNC China are
collectively referred to as the "Combined Operating Group") and China Netcom
Group agreed to interconnect the network of China Netcom Group on the one hand
and that of the Combined Operating Group on the other and settle the charges
received in respect of domestic long distance voice services within their
respective service regions on a quarterly basis.
For domestic long distance voice services between China Netcom Group
and the Combined Operating Group, the telephone operator in the location of the
calling party makes a settlement payment to the telephone operator in the
location of the called party at the rate of RMB0.06 per minute (in case where
the call terminates within the network of either China Netcom Group or the
Combined Operating Group) or RMB0.09 per minute (in case where the call
terminates outside the network of either China Netcom Group or the Combined
Operating Group).
The rates of RMB0.06 per minute and RMB0.09 per minute mentioned above
shall be adjusted with reference to the relevant standards, tariffs or policies
formulated by the relevant regulatory authorities in China from time to time.
International Long Distance Voice Services Settlement Agreement
Pursuant to the International Long Distance Voice Services Settlement
Agreement:
CNC China and China Netcom Group agreed to interconnect the networks of
China Netcom Group and CNC China and settle the charge received in respect of
international long distance voice services on a quarterly basis.
For outbound international calls, China Netcom Group reimburses CNC
China for any amount it has paid to overseas telecommunications operators. The
revenues received by China Netcom Group less the amount paid to overseas
telecommunications operators are shared between China Netcom Group and CNC China
in proportion to the estimated costs incurred by China Netcom Group and the
Combined Operating Group in connection with the provision of outbound
international long distance voice services.
For inbound international calls, the revenues received by CNC China
from overseas telecommunications operators (other than the Company and its
controlled entities) less the amount paid to China Netcom Group at the rate of
RMB0.06 per minute (in case where the call terminates within the network of
China Netcom Group) or RMB0.09 per minute (in case where the call terminates
within the network of other operators) are shared between China Netcom Group and
CNC China in proportion to the estimated costs incurred by China Netcom Group
and the Combined Operating Group in connection with the provision of inbound
international long distance voice services.
The rates of RMB0.06 per minute and RMB0.09 per minute mentioned above
shall be adjusted with reference to the relevant standards, tariffs or policies
formulated by the relevant regulatory authorities in China from time to time.
Property Leasing Agreement
Pursuant to the Property Leasing Agreement:
(i) The Combined Operating Group leases to China Netcom Group some
certain properties located throughout the Combined Operating Group's service
regions, for use as offices and other ancillary purposes; and
(ii) China Netcom Group leases to the Combined Operating Group some
certain properties located throughout the Combined Operating Group's service
regions, for use as offices, telecommunications equipment sites and other
ancillary purposes.
The charges payable by the Combined Operating Group and by China Netcom
Group are based on market rates or the depreciation and maintenance charges in
respect of each property, provided such depreciation and maintenance charges
shall not be higher than the market rates. The charges are payable quarterly in
arrears and are subject to review every year to take into account the then
prevailing market rates of the properties leased in that year.
Property Sub-leasing Agreement
Pursuant to the Property Sub-leasing Agreement:
China Netcom Group agreed to sub-let to the Combined Operating Group
certain properties owned by and leased from independent third parties, for use
as offices, telecommunications equipment sites and other ancillary purposes.
The amounts payable by the Combined Operating Group under the Property
Sub-leasing Agreement are the same as the rental charges and other fees
(including management fees) payable by China Netcom Group to the relevant third
parties.
Master Sharing Agreement
Pursuant to the Master Sharing Agreement:
(a) The Combined Operating Group will provide customer relationship
management services for large enterprise customers of China Netcom Group;
(b) The Combined Operating Group will provide network management
services to China Netcom Group;
(c) The Combined Operating Group will share with China Netcom Group the
services provided by administrative and managerial staff in respect of central
management of the business operations, financial control, operation and
maintenance of network, human resources and other related matters of both the
Combined Operating Group and China Netcom Group;
(d) The Combined Operating Group will provide to China Netcom Group
supporting services such as billing and settlement provided by the business
support centre;
(e) China Netcom Group will provide to the Combined Operating Group
supporting services, including telephone card production, development and
related services and IC card inter-provincial and inter-network clearing
services;
(f) China Netcom Group will provide to the Combined Operating Group
certain other shared services, including advertising, publicity, research and
development, business hospitality, maintenance and property management; and
(g) China Netcom Group will provide certain office space in its
headquarters to the Combined Operating Group for use as its principal executive
office.
(h) The Combined Operating Group and China Netcom Group will share the
revenues received by China Netcom Group from other operators whose networks
interconnect with the Internet backbone network of China Netcom Group and will
share the monthly connection fee that China Netcom Group pays to the State
Internet Switching Centre.
The Combined Operating Group and China Netcom Group own certain
equipment and facilities forming the Internet backbone network of China Netcom
Group. This Internet backbone network interconnect with the networks of other
operators. Such interconnection generates revenue which is settled with China
Netcom Group and shared between China Netcom Group and the Combined Operating
Group under the Master Sharing Agreement.
The services set out in paragraphs (a) to (g) above and the revenue and
fee set out in paragraph (h) above are shared between the Combined Operating
Group and China Netcom Group on an on-going basis from time to time and the
aggregate costs incurred by the Combined Operating Group or China Netcom Group
for the provision of the services set out in paragraphs (a) to (g) above and the
revenue and fee receivable and payable by China Netcom Group as referred to in
paragraph (h) above are apportioned between the Combined Operating Group and
China Netcom Group according to their respective total assets value as shown in
their respective financial statements on an annual basis.
Engineering and Information Technology Services Agreement
The Engineering and Information Technology Services Agreement governs
the arrangements with respect to the provision of certain engineering and
information technology-related services to the Combined Operating Group by China
Netcom Group, which include planning, surveying and design services in relation
to telecommunications engineering projects, construction services in relation to
telecommunications engineering projects, supervision services in relation to
telecommunications engineering projects and information technology services.
The charges payable for engineering and information technology-related
services described above are determined with reference to market rates. In
addition, where the value of any single item of engineering design of
supervision-related service exceeds RMB0.5 million or where the value of any
single item of engineering construction-related service exceeds RMB2 million,
the award of such services will be subject to tender. The charges are settled
between the Combined Operating Group and China Netcom Group as and when the
relevant services are provided.
Materials Procurement Agreement
Pursuant to the Materials Procurement Agreement, the Combined Operating
Group may request China Netcom Group to act as its agent for the procurement of
imported and domestic telecommunications equipment and other domestic
non-telecommunications equipment, and may purchase from China Netcom Group
certain products, including cables, modems and yellow pages telephone
directories. China Netcom Group further agreed to provide to the Combined
Operating Group storage and transportation services related to the procurement
and purchase of materials or equipment.
Commission and/or charges for the domestic materials procurement
services shall not exceed the maximum rate of 3% of the contract value.
Commission and/or charges for the above imported materials procurement services
shall not exceed the maximum rate of 1% of the contract value. The price for the
purchase of China Netcom Group's products is determined with reference to the
following principles and limits (the "Post-Acquisition Pricing Principles"):
(a) the government fixed price;
(b) where there is no government fixed price but a government guidance
price exists, the government guidance price;
(c) where there is neither a government fixed price nor a government
guidance price, the market price; or
(d) where none of the above is applicable, the price to be agreed
between the relevant parties and determined on a cost-plus basis.
Commission charges for the storage and transportation services are
determined with reference to market rates.
Payments under the Materials Procurement Agreement will be made as and
when the relevant equipment or products have been procured and delivered.
Ancillary Telecommunications Services Agreement
The Ancillary Telecommunications Services Agreement governs the
arrangements with respect to the provision of ancillary telecommunications
services to the Combined Operating Group by China Netcom Group, which include
certain telecommunications pre-sale, on-sale and after-sale services, sales
agency services, printing and invoice delivery services, maintenance of
telephone booths, customers acquisition and servicing and other customers'
services.
The charges payable for the services described above are determined
with reference to the Post-Acquisition Pricing Principles, and the service
charges are settled between the Combined Operating Group and China Netcom Group
as and when the relevant services are provided.
Support Services Agreement
Pursuant to the Support Services Agreement, China Netcom Group provides
the Combined Operating Group with various support services, including equipment
leasing (other than equipment covered under the Telecommunications Facilities
Leasing Agreement) and maintenance services, motor vehicles services, security
services, basic construction agency services, research and development services,
employing training services and advertising services and other support services.
The charges payable for the services described above are determined
with reference to the Post-Acquisition Pricing Principles, and are settled
between the Combined Operating Group and China Netcom Group as and when relevant
services are provided.
Telecommunications Facilities Leasing Agreement
Pursuant to the Telecommunications Facilities Leasing Agreement, China
Netcom Group leases inter-provincial fiber-optic cables within the Combined
Operating Group's service regions to the Combined Operating Group, and leases
certain international telecommunications resources (including international
telecommunications channel gateways, international telecommunications service
gateways, international submarine cable capacity, international land cables and
international satellite facilities) to the Combined Operating Group, and China
Netcom Group leases certain other telecommunications facilities required by the
Combined Operating Group for its operations.
The rental charges and service charges for the leasing of
inter-provincial fiber-optic cables, international telecommunications resources
and other telecommunications facilities are based on the annual depreciation
charges of such fiber-optic cables, resources and telecommunications facilities
provided that such charges shall not be higher than market rates. The Combined
Operating Group shall be responsible for the on-going maintenance of such
inter-provincial fiber-optic cables and international telecommunications
resources. The Combined Operating Group and China Netcom Group shall determine
and agree on which party is to provide maintenance services to the other
telecommunications facilities leased by China Netcom Group to the Combined
Operating Group based on the latter's operational requirements. Unless otherwise
agreed by the Combined Operating Group and China Netcom Group, such maintenance
service charges shall be borne by the Combined Operating Group. If China Netcom
Group shall be responsible for maintaining the other telecommunications
facilities that it leases to the Combined Operating Group based on the latter's
operational requirements, the Combined Operating Group shall pay to China Netcom
Group the relevant maintenance service charges which shall be determined with
reference to market rates. Where there are no market rates, the maintenance
charges shall be agreed between the parties and determined on a cost-plus basis.
The net rental charges and service charges due to China Netcom Group under the
Telecommunications Facilities Leasing Agreement will be settled between the
Combined Operating Group and China Netcom Group on a quarterly basis.
Continuing connected transactions relating to Asia Netcom
Recent Development-Sale of Asia Netcom
On June 2, 2006, we agreed to sell our equity interest in Asia Netcom
to a group of investors for US$168.84 million. We expect this transaction to be
completed by early August 2006. Upon completion of the transaction, we expect to
continue our business relationship with Asia Netcom in connection with our
remaining international operations, including the purchase of capacity from Asia
Netcom.
Capacity Purchase Agreement
Asia Netcom and its subsidiaries receive from EANL and its subsidiaries
a certain amount of long-term telecommunications capacity on the submarine
network. The purchased capacity consists of (i) an initial fixed amount of
capacity ; (ii) an additional amount of capacity up to a maximum figure to be
activated upon written notice to EANL ; and (iii) further additional amount of
capacity that may be ordered within three years following the date of the
Capacity Purchase Agreement.
The charges payable by Asia Netcom to EANL for the initial capacity and
charges payable for the additional capacity activated are based on market rates
determined by reference to a similar transaction between Asia Netcom and a third
party in January 2004 ("Benchmark Transaction") duly adjusted to take into
account of advance receipt of payment prior to the delivery of the capacity. The
pricing of the further additional capacity is to be determined between Asia
Netcom and EANL prior to the placement of the actual order for such capacity.
In addition to the above charges, Asia Netcom pays EANL an annual
operation and maintenance fee equal to 4% of the total charges payable by Asia
Netcom to EANL for the capacity activated and ordered under the Capacity
Purchase Agreement (in so far as such capacity has not been terminated) which is
based on current market rate.
Capacity Lease Agreement
Pursuant to the Capacity Lease Agreement with EANL, Asia Netcom and its
subsidiaries lease from EANL and its subsidiaries a fixed amount of capacity on
EANL's telecommunications network, and may order additional lease capacity from
EANL and its subsidiaries.
EANL and its subsidiaries agreed to permit Asia Netcom or any of its
subsidiaries to interconnect its communications system with the leased capacity,
and to connect such amount of capacity to the facilities of its backhaul
suppliers and/or local exchange carrier. Furthermore, upon request by Asia
Netcom, EANL and its subsidiaries are to use their best efforts to provide to
Asia Netcom or its subsidiaries with local connectivity with end-users in
jurisdictions where Asia Netcom or its subsidiaries are not otherwise authorized
to provide services.
The charges payable by Asia Netcom to EANL for the initial lease
capacity are determined based on market rates by reference to the Benchmark
Transaction, as adjusted to take into account the particular circumstances under
the Capacity Lease Agreement. The pricing for any additional lease capacity is
to be agreed by Asia Netcom and EANL prior to the order for such capacity. These
charges are payable quarterly in arrears.
The connections charges payable by Asia Netcom to EANL is the pro rata
share of reasonable and actual expenses incurred by EANL in making such
connections. The local connectivity charges payable by Asia Netcom to EANL is
EANL's lowest wholesale price without discount, or, if the local connectivity is
provided by an unrelated carrier, the amount charged to EANL by such unrelated
carrier, without surcharge. Such charges for local connectivity are payable
quarterly in arrears.
Management Services Agreement
Pursuant to the Management Services Agreement, Asia Netcom and its
subsidiaries provide EANL and its subsidiaries with certain services, including
government and corporate affairs services, treasury services, financial
services, information technology services, legal and corporate secretarial
services, tax services, payment services, and comprehensive engineering and
operation services in relation to the submarine network.
The charges payable for the above services (except for the payment
services) are determined on the basis of costs plus reasonable profits, but
cannot exceed the market price for the provision of such services.
The charges payable for the payment services are the amounts required
to reimburse all payments made by Asia Netcom and its subsidiaries on behalf of
EANL and its subsidiaries in performing such services.
In the opinion of the independent non-executive directors, the
Continuing Connected Transactions were entered into by the Company:
(i) in the ordinary and usual course of its business;
(ii) either on normal commercial terms or, where there are no
sufficient comparables, on terms no less favorable than the terms the Company
could have obtained from an independent third party; and
(iii) in accordance with the relevant agreements governing such
transactions and on terms that are fair and reasonable and in the interests of
the shareholders of the Company as a whole.
The board of directors has received a letter from the auditors of the
Company stating that the Continuing Connected Transactions:
(A) have received the approval of the Company's board of directors;
(B) were carried out in accordance with the pricing policy as stated in
note 40 to the financial statements for the year ended 31 December 2005;
(C) have been entered into in accordance with the relevant agreements
governing the Continuing Connected Transactions; and
(D) have not exceeded their respective upper limits set by the Hong
Kong Stock Exchange for the financial year ended 31 December 2005.
ITEM 8. FINANCIAL INFORMATION
Our audited consolidated financial statements are set forth beginning
on page F-1. Other than as disclosed elsewhere in this annual report, no
significant change has occurred since the date of the annual financial
statements.
Legal Proceedings
We are involved in legal proceedings in the ordinary course of our
business. We are not involved in any litigation, arbitration or administrative
proceedings that could have a material adverse effect on our financial condition
or results of operations, taken as a whole. So far as we are aware, no such
material litigation, arbitration or administrative proceedings are threatened.
Dividend Policy
The payment and the amount of any dividends will depend on our results
of operations, cash flows, financial condition, statutory and regulatory
restrictions on the payment of dividends by us, future prospects and other
factors, that our directors may consider relevant. In addition, our controlling
shareholder, China Netcom Group, is able to influence our dividend policy.
Dividends may be paid only out of our distributable profits as
permitted under Hong Kong law, which does not restrict the payment of dividends
to non-resident holders of our securities. To the extent profits are distributed
as dividends, such portion of profits will not be available to be reinvested in
our operations.
Holders of our ADSs will be entitled to receive dividends, subject to
the terms of the deposit agreement, to the same extent as holders of our shares,
less the fees and expenses payable under the deposit agreement and any
withholding taxes.
Our ability to pay dividends depends substantially on the payment of
dividends to us by CNC China. CNC China must follow the laws and regulations of
the PRC and its articles of association in declaring and paying dividends to us.
As a wholly foreign-owned enterprise in China, CNC China is required to provide
for a reserve fund and a staff and workers' bonus and welfare fund, each of
which is appropriated from net profit after taxation but before dividend
distribution according to the prevailing accounting rules and regulations in the
PRC. CNC China is required to allocate at least 10% of its net profit to the
reserve fund until the balance of this fund has reached 50% of its registered
capital. Appropriations to the staff and workers' bonus and welfare fund, which
are determined at the discretion of CNC China's directors, are charged to
expense as incurred in the consolidated financial statements. None of CNC
China's contributions to these statutory funds may be used for dividend
purposes.
ITEM 9. THE OFFER AND LISTING
In connection with our initial public offering, our American depositary
shares, or ADSs, each representing 20 ordinary shares, were listed and commenced
trading on the New York Stock Exchange on November 16, 2004 under the symbol
"CN". Our ordinary shares were listed and commenced trading on the Hong Kong
Stock Exchange on November 17, 2004. Prior to these listings, there was no
public market for our equity securities. The New York Stock Exchange and the
Hong Kong Stock Exchange are the principal trading markets for our ADSs and
ordinary shares, which are not listed on any other exchanges in or outside the
United States.
As of December 31, 2005 and May 31, 2006, there were respectively
6,593,529,000 and 6,602,431,000 ordinary shares issued and outstanding. As of
December 31, 2005 and May 31, 2006, there were, respectively 1 and 1 registered
holders of American depositary receipts evidencing 8,991,910 and 6,064,368 ADSs.
Since certain of the ADSs are held by nominees, the above number may not be
representative of the actual number of U.S. beneficial holders of ADSs or the
number of ADSs beneficially held by U.S. persons. The depositary for the ADSs is
Citibank, N.A.
The high and low closing sale prices of the shares on the Hong Kong
Stock Exchange and of the ADSs on the NYSE for the periods indicated are as
follows.
Price per Share (HK$) Price per ADS (US$)
------------------------- -------------------------
High Low High Low
------- --------- ------- -------
Annual
2004 (from listing date)....... 10.60 9.10 26.90 23.10
2005........................... 13.95 9.95 35.99 25.45
Quarterly
Fourth Quarter, 2004........... 10.60 9.10 26.90 23.10
First Quarter, 2005............ 12.55 9.75 31.58 25.30
Second Quarter, 2005........... 11.45 9.95 29.11 25.45
Third Quarter, 2005............ 13.70 11.30 35.99 28.66
Fourth Quarter, 2005........... 13.95 11.45 35.62 29.67
First Quarter, 2006............ 14.35 12.45 36.81 32.66
Monthly
November 2005.................. 13.10 12.40 34.20 32.37
December 2005.................. 12.80 11.70 33.09 31.11
January 2006................... 13.45 12.60 35.03 33.01
February 2006.................. 13.85 12.45 35.70 32.66
March 2006..................... 14.35 13.10 36.81 34.36
April 2006..................... 15.45 13.75 38.94 35.50
May 2006....................... 15.45 12.10 40.28 31.12
ITEM 10. ADDITIONAL INFORMATION
SHARE CAPITAL
Not applicable.
MEMORANDUM AND ARTICLES OF ASSOCIATION
The section entitled "Description of Share Capital" contained in our
registration statement on Form F-1 (File No. 333-119786) filed with the Security
and Exchange Commission is hereby incorporated by reference.
MATERIAL CONTRACTS
See "Item 7. Major Shareholders and Related Party Transactions -
Related Party Transactions" for certain arrangements we have entered into with
China Netcom Group.
EXCHANGE CONTROLS
We receive substantially all of our revenues in Renminbi, which is not
a freely convertible currency. Although central government's policies were
introduced in 1996 to reduce restrictions on the convertibility of Renminbi into
foreign currency for current account items, conversion of Renminbi into foreign
exchange for capital items, such as foreign direct investment, loans or
security, requires the approval of the State Administration of Foreign Exchange
and other relevant authorities.
The People's Bank of China, or PBOC, sets and publishes daily a base
exchange rate with reference primarily to the supply and demand of Renminbi
against a basket of currencies in the market during the prior day. The PBOC also
takes into account other factors, such as the general conditions existing in the
international foreign exchange markets. Since 1994, the conversion of Renminbi
into foreign currencies, including Hong Kong dollars and U.S. dollars, has been
based on rates set by the PBOC, which are set daily based on the previous day's
interbank foreign exchange market rates and current exchange rates in the world
financial markets. From 1994 to July 20, 2005, the official exchange rate for
the conversion of Renminbi to U.S. dollars was generally stable. Although
Chinese governmental policies were introduced in 1996 to reduce restrictions on
the convertibility of Renminbi into foreign currency for current account items,
conversion of Renminbi into foreign exchange for capital items, such as foreign
direct investment, loans or securities, requires the approval of the State
Administration for Foreign Exchange and other relevant authorities. On July 21,
2005, the PRC government introduced a managed floating exchange rate system to
allow the value of the Renminbi to fluctuate within a regulated band based on
market supply and demand and by reference to a basket of currencies. On the same
day, the value of the Renminbi appreciated by 2% against the U.S. dollar. The
PRC government has since made and in the future may make further adjustments to
the exchange rate system. The PBOC announces the closing price of a foreign
currency traded against the Renminbi in the inter-bank foreign exchange market
after the closing of the market on each working day, and makes it the central
parity for the trading against the Renminbi on the following working day.
TAXATION
The taxation of income and capital gains of holders of ordinary shares
or ADSs is subject to the laws and practices of Hong Kong and of jurisdictions
in which holders of ordinary shares or ADSs are resident or otherwise subject to
tax. The following summary of certain relevant taxation provisions is based on
current law and practice, is subject to change and does not constitute legal or
tax advice. The discussion does not deal with all possible tax consequences
relating to an investment in the ordinary shares or ADSs. In particular, the
discussion does not address the tax consequences under state, local and other
laws, such as non-Hong Kong and non-U.S. federal laws. The discussion is based
upon laws and relevant interpretations in effect as of the date of this annual
report. There is no reciprocal tax treaty in effect between Hong Kong and the
United States.
Hong Kong
Tax on dividends
No tax is payable in Hong Kong in respect of dividends paid by us.
Profits
No tax is imposed in Hong Kong in respect of capital gains from the
sale of property such as the shares. Trading gains from the sale of property by
persons carrying on a trade, profession or business in Hong Kong where such
gains are derived from or arise in Hong Kong from such trade, profession or
business will be chargeable to Hong Kong profits tax, which is currently imposed
at the rate of 17.5% on corporations and at a maximum rate of 16.0% on
individuals. Gains from the sale of shares effected on the Hong Kong Stock
Exchange will be considered to be derived from or arise in Hong Kong. Liability
for Hong Kong profits tax would thus arise in respect of trading gains from the
sale of shares realized by persons carrying on a business of trading or dealing
in securities in Hong Kong.
Stamp duty
Hong Kong stamp duty will be payable by the purchaser on every purchase
and by the seller on every sale of the shares. The duty is charged at the
current rate of 0.2% of the consideration or, if higher, the fair value of the
shares being sold or transferred (the buyer and seller each paying half of such
stamp duty). In addition, a fixed duty of HK$5 is currently payable on any
instrument of transfer of shares.
If one of the parties to the sale is a non-resident of Hong Kong and
does not pay the required stamp duty, the duty not paid will be charged on the
instrument of transfer (if any) (in addition to the stamp duty otherwise
chargeable thereon), and the transferee will be liable for payment of such duty.
Estate duty
The shares are Hong Kong property for the purpose of the Estate Duty
Ordinance (Chapter 111 of the Laws of Hong Kong). Accordingly, the shares may be
subject to Hong Kong estate duty on the death of the beneficial owner of the
shares, regardless of the place of the owner's residence, citizenship or
domicile. Hong Kong estate duty is imposed on a progressive scale from 5% to
15%. No estate duty is payable when the aggregate value of the dutiable estate
does not exceed HK$7.5 million, and the maximum rate of duty of 15% applies when
the aggregate value of the dutiable estate exceeds HK$10.5 million.
On March 16, 2005, the Financial Secretary of the Hong Kong Special
Administrative Region announced in his 2005/06 budget speech that the Hong Kong
Government would propose for the abolition of estate duty and that the relevant
bill would be introduced into the Hong Kong Legislative Council (the
"Legislative Council") shortly. Such bill went through its first reading at the
Legislative Council on May 11, 2005. However, as of the date of this annual
report, such bill has yet to go through its second and third readings and other
legal formalities to become law.
United States of America
The following is a summary of certain United States federal income tax
consequences relating to the purchase, ownership and disposition of shares or
ADSs by investors who are "U.S. Persons" (as defined below) that hold the shares
or ADSs as a capital asset. This discussion is based on United States federal
income tax law, as in effect on the date hereof and which is subject to
differing interpretations on change, possibly with retroactive effect. This
discussion is for general information only and does not address all of the tax
considerations that may be relevant to specific holders in light of their
particular circumstances or to holders subject to special treatment under United
States federal income tax law (such as banks, insurance companies, partnerships
and their partners, tax-exempt entities, financial institutions, broker-dealers,
persons who have acquired our shares or ADSs as part of a straddle, hedge,
conversion, or other integrated investment, persons who own, directly or by
attribution, 10% or more of the combined voting power of all classes of stock of
the Company, or persons that have a "functional currency" other than the United
States dollar), and non-U.S. Holders. This summary does not address any United
States state, local or foreign tax considerations or any United States federal
estate, gift or alternative minimum tax considerations of a holder of shares or
ADSs.
As used in this summary, the term "U.S. Person" means (i) an individual
who is a citizen or resident of the United States, (ii) a corporation, or other
entity treated as a corporation, created or organized under the laws of the
United States or any political subdivision thereof, (iii) an estate the income
of which is subject to United States federal income tax regardless of the source
thereof, or (iv) a trust (A) if a court within the United States is able to
exercise primary supervision over the administration of the trust and one or
more United States persons have the authority to control all substantial
decisions of the trust or (B) that otherwise elected to be treated as a United
States person under the Code.
If a partnership (including any entity treated as a partnership for
United States federal income tax purposes) holds shares or ADSs, the tax
treatment of a partner in such partnership will depend upon the status of the
partner and the activities of the partnership. Partners in such a partnership
are urged to consult their tax advisers as to the particular United States
federal income tax consequences applicable to them.
Prospective investors are urged to consult their tax advisers regarding
the United States federal, state, local and foreign income and other tax
considerations of the purchase, ownership and disposition of shares or ADSs.
General
Holders of ADSs evidencing shares will be treated as the owners of the
shares represented by those ADSs. Accordingly, no gain or loss will be
recognized upon the exchange of ADSs for the holder's proportionate interest in
the shares, a holder's tax basis in the withdrawn shares will be the same as its
tax basis in the ADSs surrendered in exchange therefor, and the holding period
in the withdrawn shares will include the period during which the holder held the
surrendered ADSs.
Taxation of dividends
Subject to the discussion below under "--Passive Foreign Investment
Company", the gross amount of cash distributions with respect to the shares or
ADSs will, upon receipt, be includible in the gross income of a holder as
dividend income to the extent of our current and accumulated earnings and
profits, as determined under United States federal income tax principles. A
non-corporate recipient of dividend income will generally be subject to tax on
dividend income from a "qualified foreign corporation" at a maximum United
States federal tax rate of 15% rather than the marginal tax rates generally
applicable to ordinary income so long as certain holding period requirements are
met. A non-United States corporation (other than a passive foreign investment
company) generally will be considered to be a qualified foreign corporation (i)
if it is eligible for the benefits of a comprehensive tax treaty with the United
States which the Secretary of Treasury of the United States determines is
satisfactory for purposes of this provision and which includes an exchange of
information program or (ii) with respect to any dividend it pays on stock (or
ADSs backed by such stock) which is readily tradable on an established
securities market in the United States. There is currently no tax treaty in
effect between the United States and Hong Kong. Because the ADSs are listed on
the New York Stock Exchange (see ITEM 9) they are considered readily tradable on
an established securities market in the United States. Distributions, if any, in
excess of current and accumulated earnings and profits will constitute a return
of capital and will be applied against and reduce the holder's tax basis in such
ADSs or shares. To the extent that distributions are in excess of such basis,
the distributions will constitute capital gain as discussed below. United States
corporate holders will generally not be eligible for the dividends received
deduction for distributions to domestic corporations in respect of distributions
on our ADSs or shares.
The United States dollar value of any distribution made by us in Hong
Kong dollars will be determined by reference to the exchange rate in effect on
the date the distribution is actually or constructively received by the
depositary or the holder of such shares, respectively, regardless of whether the
payment is in fact converted into United States dollars on that date. Any
subsequent gain or loss in respect of such Hong Kong dollars arising from
exchange rate fluctuations will be ordinary income or loss. This gain or loss
will generally be treated as United States source gain or loss for United States
foreign tax credit limitation purposes. If the depositary converts the Hong Kong
dollars to United States dollars on the date it receives such Hong Kong dollars,
holders should not recognize any such gain or loss.
Dividends generally will be treated as income from foreign sources for
United States foreign tax credit limitation purposes. Subject to the limitations
and conditions set forth in the Code, holders may elect to claim a credit
against their United States federal income tax liability in the event that any
Hong Kong tax is withheld from dividends received in respect of the ADSs or
shares. The rules relating to the determination of the foreign tax credit are
complex and prospective purchasers are urged consult their personal tax advisors
to determine whether and to what extent they would be entitled to such credit.
Holders that do not elect or are not permitted to claim foreign tax credits may
instead claim a deduction for any Hong Kong tax withheld.
Sale or other disposition of shares or ADSs
Subject to the discussion below under "-- Passive Foreign Investment
Company", a holder generally will recognize gain or loss for United States
federal income tax purposes upon a sale or other disposition of our shares or
ADSs in an amount equal to the difference between the amount realized from the
sale or disposition and the holder's adjusted tax basis in the shares or ADSs.
Such gain or loss generally will be long-term gain or loss if, on the date of
sale or disposition, the shares or ADSs were held by the holder for more than
one year and will generally be treated as United States source gain or loss for
United States foreign tax credit limitation purposes. The deductibility of a
capital loss may be subject to limitations.
Passive foreign investment company
A foreign corporation will be treated as a "passive foreign investment
company" (a "PFIC"), for United States federal income tax purposes, if 75% or
more of its gross income consists of certain types of passive income or 50% or
more of its assets are passive. If a corporation owns at least 25% by value of
the equity shares of another corporation, it is treated for purposes of these
tests as owning a proportionate share of the assets of the other corporation and
as receiving directly a proportionate share of the other corporation's income.
We presently do not believe that we are a PFIC and do not anticipate becoming a
PFIC. This is, however, a factual determination made on an annual basis and is
subject to change. If we were to be classified as a PFIC in any taxable year,
holders (i) would generally be required to treat any gain on sales of our shares
held by them as ordinary income and pay an interest charge on the value of the
deferral of their United States federal income tax attributable to such gain and
(ii) could also be subject to an interest charge on distributions paid by us. In
addition, we would not provide information to our holders that would enable them
to make a "qualified electing fund" election under which, generally, in lieu of
the foregoing treatment, our earnings would be currently included in their gross
income.
The above results may be eliminated if a "mark-to-market" election is
available and a holder validly makes such an election. If the election is made,
such holder generally will be required to take into account the difference, if
any, between the fair market value and its adjusted tax basis in shares or ADSs
at the end of each taxable year as ordinary income or ordinary loss (to the
extent of any net mark-to-market gain previously included in income). In
addition, any gain from a sale or other disposition of shares or ADSs will be
treated as ordinary income, and any loss will be treated as ordinary loss (to
the extent of any net mark-to-market gain previously included in income).
DIVIDENDS AND PAYING AGENTS
Not applicable.
STATEMENT BY EXPERTS
Not applicable.
DOCUMENTS ON DISPLAY
You can read and copy documents referred to in this annual report that
have been filed with the SEC at the SEC's public reference room located at 450
Fifth Street, NW, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330
for further information on the public reference rooms and their copy charges.
The SEC also maintains a website at http://www.sec.gov that contains reports and
other information that we have filed electronically with the SEC.
SUBSIDIARY INFORMATION
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Item 5. Operating and Financial Review and Prospects--Market Risk
and Risk Management".
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITIES HOLDERS.
None.
USE OF PROCEEDS
The following use of proceeds information relates to our registration
statement on Form F-1 (File No. 333-119786), filed by us in connection with our
initial public offering of ordinary shares in the United States. In connection
with the registration of the ordinary shares, a registration statement on Form
F-6 (File No.333-119970) was also filed for ADSs representing such ordinary
shares. Each of these two registration statements was declared effective by the
SEC on November 10, 2004. Our ordinary shares commenced trading on the Hong Kong
Stock Exchange on November 17, 2004 and the ADSs on the New York Stock Exchange
on November 16, 2004.
The global offering, which consisted of our initial public offering in
the United States, an international offering outside the United States and an
initial public offering in the Hong Kong, was completed and all of the
securities offered in connection therewith were sold. A portion of the
securities registered under our registration statement on Form F-1 were sold in
Hong Kong public offering and the international offering. China International
Capital Corporation Limited, Citigroup Global Markets Inc., and Goldman Sachs
(Asia) L.L.C. acted as U.S. representatives for the U.S. underwriters; and China
International Capital Corporation Limited, Citigroup Global Markets Limited, and
Goldman Sachs (Asia) L.L.C. acted as international representatives for the
international underwriters.
The following table sets forth for CNC Hong Kong as the issuer and each
selling shareholder information regarding our ordinary shares registered and
sold in our November 2004 global offering, including the exercise of the
over-allotment option:
Aggregate Price of the
Amount Registered
Amount Registered and Sold to Date
and Sold(1) (US$)(2)
-------------------- -----------------------
CNC Hong Kong.............................. 1,093,529,000 1,193,040,139
China Netcom Group......................... 102,768,985 112,120,963
Chinese Academy of Sciences................ 818,266 892,728
Information and Network Center of State
Administration of Radio, Film and
Television............................... 818,266 892,728
China Railways Telecommunications Center... 818,266 892,728
Shanghai Alliance Investment Limited....... 818,266 892,728
Shandong Provincial State-owned Assets
Supervision and Administration Commission 3,309,951 3,611,157
Total...................................... 1,202,881,000 1,312,266,801
_________________
(1) The amount of shares registered includes any shares initially offered
or sold outside the U.S. that were thereafter sold or resold in the
U.S. Offers and sales of shares outside the U.S. were made pursuant to
Regulation S under the Securities Act of 1933 and were not covered by
the Registration Statement.
(2) The initial public offering price per ADS in the U.S. and international
offerings was US$21.82. The initial public offering price per ordinary
share in the Hong Kong public offering was HK$8.40, and when increased
by a 1.0% brokerage fee, a 0.005% Hong Kong Securities and Futures
Commission transaction levy, a 0.002% investor compensation levy and a
0.005% Hong Kong Stock Exchange trading fee payable by purchasers, was
effectively equivalent to the initial public offering price per ADS in
the U.S. and international offerings, based on an exchange rate of
HK$7.8000 to US$1.00, the noon buying rate on June 30, 2004, and
adjusted for the ratio of 20 ordinary shares per ADS.
The amount of expenses incurred by us in connection with the issuance
and distribution of the registered securities totaled RMB 689 million, including
RMB 353 million for underwriting discounts and commissions, and approximately
RMB 336 million for other expenses. None of the payments were direct or indirect
payments to our directors, officers, general partners of our associates, persons
owning 10% or more of any class of our shares, or any of our affiliates.
The aggregate net proceeds from the initial public of our shares, after
deduction of fees and expenses, amounted to RMB 8,944 million and were held in
either H.K. dollars or U.S. dollars. The cash proceeds from our initial public
offering were used as follows: (i) the expansion and upgrading of our
telecommunications network infrastructure; (ii) the repayment of a term loan
facility; (iii) the development of new applications and services; and (iv)
general corporate purposes.
ITEM 15. CONTROLS AND PROCEDURES
Our principal executive officers and principal financial officer, after
evaluating the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15(d)-15(e) of the Securities Exchange Act of
1934, as amended) as of the end of the period covered by this annual report,
have concluded that, as of such date, our disclosure controls and procedures
were effective to ensure that material information relating to us and our
consolidated subsidiaries was made known to them by others within our company
and our consolidated subsidiaries on a timely basis.
Our internal control and management systems were designed to meet the
standards generally adopted by companies in China. These standards are different
from the standards and best practices adopted by companies listed in the United
States. See "Item 3. Key Information -- Risk Factors -- Our internal controls
and management systems are not currently consistent with international practices
in certain respects and we are in the process of improving these controls and
systems to enable us to certify the effectiveness of our internal controls under
the Sarbanes-Oxley Act of 2002. Our failure to timely and successfully upgrade
these controls and systems could subject us to regulatory actions and harm the
price of our stock."In 2005, we began a series of initiatives to enhance our (i)
corporate governance structure, (ii) internal controls, (iii) information system
and (iv) administrative policies and compliance.
o Corporate governance structure. At the end of 2005, we retained a
leading international consulting firm to assist us in launching a
special corporate governance project under the direct leadership
of our board's corporate governance committee. The project is
designed to further define the rights and responsibilities of the
board in relation to the management with a set of detailed
policies and procedures. As of the date of this annual report, we
have identified a number of areas which the project will focus
on. We intend to implement the new policies and procedures
produced under the project in the second half of 2006.
o Internal controls. We made significant progress on our internal
controls project, which we launched at the end of 2004 in an
effort to meet the requirements of the Sarbanes-Oxley Act of
2002. We first designed a standard set of internal control
policies and procedures, which is based on the COSO internal
control framework, and takes into account the current needs of
our company. We then conducted a pilot test of our standard
policies and procedures at our branches. Based on the results of
the pilot test, we made adjustments to our standard policies and
procedures and began implementation throughout our company at the
end of 2005. We expect to complete the implementation of our
internal control policies and procedures in the second half of
2006.
o Information system. In 2005, we began implementation of an
Enterprise Resources Planning, or ERP, system. We also launched a
program to integrate and streamline information systems, as well
as to incorporate standardized internal control procedures into
the system. The purpose is to ensure the efficiency of our
internal controls and the accuracy and timeliness of our internal
reporting system. As a result of these efforts, we expect to
further strengthen security and monitoring of operations.
o Administrative procedures and compliance. In conjunction with
efforts to enhance our internal controls, we developed
"Stipulations on Information Quality Guarantee and Accountability
Management" and "CNC Discipline" and other management rules to
ensure the accuracy, completeness and integrity of statistical
data. These guidelines clarify requirements for statistical data
as well as setting out severe penalties for non-compliance. We
also developed "Methods for Handling of Complaints and Reports
Concerning Accounting Information, Internal Controls and Auditing
Methods of the Audit Committee", which prohibits any intentional
reporting of false or erroneous information from all levels of
our company.
ITEM 16A AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Mr. Timpson Chung Shui Ming
qualifies as an audit committee financial expert in accordance with the terms of
Item 16.A of Form 20-F. For Mr. Chung's biographical information, see "Item 6.
Directors, Senior Management and Employees--Directors and Senior Management".
ITEM 16B CODE OF ETHICS
We have adopted a code of ethics that applies to our Chief Executive
Officer, Chief Financial Officer, and other designated members of senior
management of the Company. We have filed this code of ethics as an exhibit to
this annual report.
ITEM 16C PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate audit fees, audit-related
fees, tax fees of our principal accountants and all other fees billed for
products and services provided by our principal accountants other than the audit
fees, audit-related fees and tax fees for such of the two years ended December
31, 2005:
Audit Fees Audit-Related Fees Tax Fees Other Fees
---------- ------------------ -------- ----------
(in millions of RMB)
2004.............. 84.4(1) 0 0.5 6.9(2)
2005.............. 33.8 38.0 4.9 0.8
________
(1) Includes the audit fees for our global offering in November 2004
and the annual financial statements in connection with statutory and
regulatory filings or engagement for the fiscal year of 2004.
(2) Includes the audit fees paid by China Netcom Group in connection
with PRC statutory and regulatory filings or engagements for the fiscal
year of 2004.
Before our principal accountants were engaged by our company or our
subsidiaries to rend audit or non-audit services, the engagement was approved by
our audit committee as required by applicable rules and regulations of the U.S.
Securities and Exchange Commission.
ITEM 16D EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
None.
ITEM 17. FINANCIAL STATEMENTS
We have elected to provide the financial statements and related
information specified in Item 18 in lieu of Item 17.
ITEM 18. FINANCIAL STATEMENTS
See Index to Financial Statements for a list of all financial
statements filed as part of this annual report.
ITEM 19. EXHIBITS
Exhibit
No. Description of Exhibit
--------- -----------------------------------------------------------------------------------------------------------
1.1 Memorandum and Articles of Association of the Registrant(1)
2.1 Form of share certificate(1)
2.2 Form of deposit agreement, including form of American Depositary Receipt(2)
3.1 Declaration of Trust, dated October 5, 2004, from CNC BVI to the Academy of Sciences(1)
3.2 Declaration of Trust, dated October 5, 2004, from CNC BVI to INC-SARFT(1)
3.3 Declaration of Trust, dated October 5, 2004, from CNC BVI to CRTC(1)
3.4 Declaration of Trust, dated October 5, 2004, from CNC BVI to Shanghai Alliance(1)
3.5 Declaration of Trust, dated October 5, 2004, from CNC BVI to Shandong SASAC(1)
3.6 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom Group and the Academy
of Sciences (English Translation)(1)
3.7 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom Group and INC-SARFT
(English Translation)(1)
3.8 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom Group and CRTC
(English Translation)(1)
3.9 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom Group and Shanghai
Alliance (English Translation)(1)
3.10 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom Group and Shandong
SASAC (English Translation)(1)
4.1 Asset Injection Agreement, dated June 29, 2004, among China Netcom Group, CNC BVI, CNC China and us
(English Translation)(1)
4.2 Letter of Undertakings by China Netcom Group (English Translation)(1)
4.3 Trademark Licensing Agreement, dated October 8, 2004 among CNC China, China Netcom Group and us (English
Translation)(1)
4.4 Restructuring Agreement, dated September 6, 2004 among CNC China, China Netcom Group and us (English
Translation)(1)
4.5 Non-Competition Agreement, dated September 6, 2004 among CNC China, China Netcom Group and us (English
Translation)(1)
4.6 Assets and Liabilities Transfer Agreement, dated June 23, 2004 entered into between CNC China and China
Netcom Group (English translation)(1)
4.7 Interconnection Settlement Agreement, dated October 8, 2004 between CNC China and China Netcom Group
(English Translation)(1)
4.8 Property Leasing Agreement, dated October 8, 2004 between CNC China and China Netcom Group (English
Translation)(1)
4.9 Property Sub-leasing Agreement, dated October 8, 2004 between CNC China and China Netcom Group (English
Translation)(1)
4.10 Master Services Sharing Agreement, dated October 8, 2004 between CNC China and China Netcom Group (English
Translation)(1)
4.11 Engineering and Information Technology Services Agreement, dated October 8, 2004 between CNC China and
China Netcom Group (English Translation)(1)
4.12 Materials Procurement Agreement, dated October 8, 2004 between CNC China and China Netcom Group (English
Translation)(1)
4.13 Ancillary Telecommunications Services Agreement, dated October 8, 2004 between CNC China and China Netcom
Group (English Translation)(1)
4.14 Support Services Agreement, dated October 8, 2004 between CNC China and China Netcom Group (English
Translation)(1)
4.15 Telecommunication Facilities Leasing Agreement, dated October 8, 2004 between CNC China and China Netcom
Group (English Translation)(1)
4.16 Capacity Purchase Agreement, dated June 30, 2004 between Asia Netcom and East Asia Netcom Limited(1)
4.17 Capacity Lease Agreement, dated June 30, 2004 between Asia Netcom and East Asia Netcom Limited and
Amendment No. 1 dated October 6, 2004(1)
4.18 Management Services Agreement, dated June 30, 2004 between Asia Netcom and East Asia Netcom Limited and
Amendment No. 1 dated October 6, 2004(1)
4.19 Share Option Plan (English Translation)(1)
4.20 Share Purchase and Exchange Agreement, dated June 11, 2004 and amendment dated July 20, 2004 among China
Netcom Holdings (BVI) Limited, CNC Fund L.P. and us(1)
4.21 Form of Senior Management Employment Agreement (English Translation)(1)
4.22 Form of Director's Employment Agreement (English Translation)(1)
4.23 Share Purchase and Sale Agreement dated June 30, 2004 entered into between Asia Netcom and CNC Network
Corporation Limited(1)
4.24 Assignment and Novation Agreement dated June 30, 2004 entered into among Asia Netcom, CNC Network
Corporation Limited and us(1)
4.25 Share Purchase Agreement dated December 2, 2003 entered into among SBAIF Asia Netcom (Cayman) Holdings,
China Netcom Corporation International Limited, Asia Netcom and us(1)
4.26 Shareholders Agreement dated March 12, 2003 entered into among China Netcom Corporation International
Limited, SB Asia Infrastructure Fund L.P., Newbridge Asia Netcom (Cayman) Holdings, Asia Netcom and us(1)
4.27 Share and Asset Purchase Agreement dated November 17, 2002 entered into between Asia Netcom and AGC(1)
4.28 Share Purchase Agreement, dated December 2, 2003 entered into among Newbridge Asia Netcom (Cayman)
Holdings, China Netcom Corporation International Limited, Asia Netcom and us(1)
4.29 Share Transfer Agreement, dated June 10, 2004, entered into between China Netcom Group and China Netcom
Holdings (English Translation)(1)
4.30 Share Transfer Agreement, dated April 20, 2004, entered into between China Netcom Group and the Academy of
Sciences, INC-SARFT, CRTC and Shanghai Alliance (English Translation)(1)
4.31 Asset Transfer Agreement, dated April 26, 2004, entered into between China Netcom Group and Shandong SASAC
(English Translation)(1)
4.32 Telecommunications Assets Transfer Agreement, dated June 10, 2004, entered into between China Netcom Group
and Jitong Communications Company Limited (English Translation)(1)
4.33 Telecommunications Assets Transfer Agreement, dated June 10, 2004, entered into between China Netcom Group
and Guangdong Telecommunications Company Limited (English Translation)(1)
4.34 Debenture, dated July 29, 2004 entered into among Asia Netcom Asia Pacific Limited, Asia Netcom Asia
Pacific Commercial Limited, Asia Netcom Hong Kong Limited and Industrial and Commercial Bank of China
(Asia) Limited(1)
4.35 Deed of Mortgage of Shares, dated July 29, 2004 entered into between Asia Netcom and Industrial and
Commercial Bank of China (Asia) Limited(1)
4.36 Debenture, dated July 29, 2004 entered into among Asia Netcom Services (S) Pte. Ltd., Asia Netcom
Corporation (Singapore) Pte. Limited, Asia Netcom Singapore Pte. Ltd., Southeast Asia Netcom (Singapore)
Pte. Ltd. and Industrial and Commercial Bank of China (Asia) Limited(1)
4.37 Group Share Mortgage, dated July 29, 2004 entered into among Asia Netcom Corporation (Singapore) Pte.
Limited, Asia Netcom Services (S) Pte. Ltd., Southeast Asia Netcom (Singapore) Pte. Ltd., Asia Netcom
Singapore Pte. Ltd. and Industrial and Commercial Bank of China (Asia) Limited(1)
4.38 Assignment of Building Agreement, dated July 29, 2004 entered into between Asia Netcom Singapore Pte. Ltd.
and Industrial and Commercial Bank of China (Asia) Limited(1)
4.39 Share Pledge Agreement, dated July 28, 2004 entered into among Asia Netcom Corporation (Singapore) Pte.
Ltd., the seven financial institutions listed in the Share Pledge Agreement and Industrial and Commercial
Bank of China (Asia) Limited(1)
4.40 Amended and Restated Facility Agreement, dated July 27, 2004 entered into among Asia Netcom, the seven
banks named in the Amended and Restated Facility Agreement, Industrial and Commercial Bank of China (Asia)
Limited(1)
4.41 Group Subordination Deed, dated July 27, 2004 entered into between Asia Netcom and Industrial and
Commercial Bank of China (Asia) Limited(1)
4.42 Group Subordination Deed, dated July 27, 2004 entered into among our Company and China Netcom Corporation
International Limited, Asia Netcom and Industrial and Commercial Bank of China (Asia) Limited(1)
4.43 Debenture, dated July 27, 2004 entered into between Asia Netcom and Industrial and Commercial Bank of
China (Asia) Limited(1)
4.44 Group Assignment of Insurances, dated July 27, 2004 entered into among Asia Netcom, EANL and Industrial
and Commercial Bank of China (Asia) Limited(1)
4.45 Security Assignment, dated July 27, 2004 entered into between Asia Netcom and Industrial and Commercial
Bank of China (Asia) Limited(1)
4.46 Charge Over Deposit Account, dated July 27, 2004 entered into between Asia Netcom and Industrial and
Commercial Bank of China (Asia) Limited(1)
4.47 Charge Over Accounts, dated July 27, 2004 entered into between Asia Netcom and Industrial and Commercial
Bank of China (Asia) Limited(1)
4.48 Deed of Mortgage of Shares in Asia Netcom, dated July 27, 2004 entered into between China Netcom
Corporation International Limited and Industrial and Commercial Bank of China (Asia) Limited(1)
4.49 Guarantee and Indemnity, dated July 27, 2004 entered into between our Company and Industrial and
Commercial Bank of China (Asia) Limited
8.1 List of subsidiaries of the Registrant
11.1 Code of Ethics (3)
12.1 Chairman Certification
12.2 CEO Certification
12.5 CFO Certification
13.1 Certification by Chairman and CFO
_____________________
(1) Incorporated by reference to our Registration Statement on Form F-1
(File No. 333-119786) filed with the SEC in connection with our global
offering in November 2004.
(2) Incorporated by reference to our Registration Statement on Form F-6
(File No. 333-119970) filed with the SEC with respect to American
Depositary Shares representing our ordinary shares.
(3) Incorporated by reference to our Form 20-F filed with the SEC on June
23, 2005.
SIGNATURE
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.
China Netcom Group Corporation
(Hong Kong) Limited
/s/ Zhang Chunjiang
-----------------------
Name: Zhang Chunjiang
Title: Chairman of the Board of Directors
Date: June 9, 2006
Appendix A
Page No.
--------
Report of Independent Registered Public Accounting Firm F-1
Consolidated income statement for each of the three years ended
December 31, 2003, 2004 and 2005 F-2
Consolidated balance sheets as of December 31, 2004 and 2005 F-3 - F-4
Consolidated statements of changes in equity for each of the
three years ended December 31, 2003, 2004 and 2005 F-5 - F-7
Consolidated statements of cash flows for each of the three
years ended December 31, 2003, 2004 and 2005 F-8
Notes to consolidated financial statements F-9 - F-99
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To The Board of Directors and Shareholders of China Netcom Group Corporation
(Hong Kong) Limited:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, shareholders' equity and cash flows present
fairly, in all material respects, the financial position of China Netcom Group
Corporation (Hong Kong) Limited and its subsidiary companies (collectively
referred to as the "Group") at 31 December 2004 and 2005, and the results of
their operations and their cash flows for the three years ended 31 December
2005, in conformity with accounting principles generally accepted in Hong Kong.
These financial statements are the responsibility of the Group's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States),
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 3 to the consolidated financial statements, the Group
adopted certain new or revised Hong Kong Financial Reporting Standards ("HKFRS")
in 2005 which resulted in changes in the accounting for share-based payments,
goodwill and negative goodwill, lease prepayments and financial instruments.
Accounting principles generally accepted in Hong Kong vary in certain
significant respects from accounting principles generally accepted in the United
States of America ("US GAAP"). Information relating to the nature and effect of
such differences is presented in Note 41 relating to the US GAAP reconciliation
to the consolidated financial statements.
PricewaterhouseCoopers
Certified Public Accoutants
Hong Kong, 9 June 2006
F - 1
CHINA NETCOM GROUP CORPORATION (HONGKONG) LIMITED
CONSOLIDATED INCOME STATEMENT
Year ended December 31,
---------------------------------------------------------------
Note 2003 2004 2005 2005
------- -------------- ------------- ------------- -----------
RMB RMB RMB USD
million million million million
Restated Restated
Notes 2&3 Notes 2&3
Revenues 7 77,598 83,494 87,232 10,809
-------------- ------------- ------------- -----------
Operating expenses
Depreciation and amortization (26,800) (25,180) (25,049) (3,104)
Networks, operations and support (15,108) (13,973) (14,417) (1,786)
Staff costs 14 (10,945) (11,950) (12,333) (1,528)
Selling, general and administrative (10,322) (12,877) (13,438) (1,665)
Other operating expenses (2,197) (1,993) (1,490) (185)
-------------- ------------- ------------- -----------
Total of operating expenses 8 (65,372) (65,973) (66,727) (8,268)
-------------- ------------- ------------- -----------
Operating profit before interest income,
dividend income and deficit on revaluation
of fixed assets 12,226 17,521 20,505 2,541
Interest income 95 87 157 19
Dividend income 45 17 29 4
Deficit on revaluation of fixed assets 20(c) (25,778) (11,318) - -
-------------- ------------- ------------- -----------
Profit from operations (13,412) 6,307 20,691 2,564
Finance costs 9 (4,296) (3,930) (3,374) (418)
Share of loss of
-Associate companies (1) (1) - -
-Jointly controlled entity (415) - - -
-------------- ------------- ------------- -----------
(Loss)/profit before taxation (18,124) 2,376 17,317 2,146
Taxation (charge)/credit 10 7,217 323 (3,429) (425)
-------------- ------------- ------------- -----------
(Loss)/profit for the year (10,907) 2,699 13,888 1,721
============== ============= ============= ===========
Attributable to :
Equity holder of the Company (10,906) 2,699 13,888 1,721
Minority interests (1) - - -
-------------- ------------- ------------- -----------
(Loss)/profit for the year (10,907) 2,699 13,888 1,721
============== ============= ============= ===========
Dividends proposed after the balance sheet
date 12 - 259 3,196 396
============== ============= ============= ===========
Basic (loss)/earnings per share 13 RMB(1.99) RMB0.48 RMB2.11 USD0.26
============== ============= ============= ===========
Diluted (loss)/earnings per share 13 RMB(1.99) RMB0.48 RMB2.10 USD0.26
============== ============= ============= ===========
The notes on pages F-9 to F-99 are an integral part of these consolidated financial statements
F-2
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED BALANCE SHEET
As at December 31,
-------------------------------------------------
Note 2004 2005 2005
-------- --------------- -------------- ----------
RMB RMB USD
million million million
Restated
Notes 2&3
Assets
Current assets
Cash and bank deposits 15 10,633 4,895 607
Short-term investments 16 2,876 2 -
Accounts receivable 17 7,174 7,401 917
Inventories and consumables 18 1,243 472 58
Prepayments, other receivables and other current assets 19 1,442 1,482 184
Due from ultimate holding company and fellow subsidiaries 28 1,087 247 31
--------------- -------------- ----------
Total current assets 24,455 14,499 1,797
--------------- -------------- ----------
Non-current assets
Fixed assets 20 166,897 168,663 20,899
Construction in progress 21 10,597 6,822 845
Lease prepayments for land 22 1,746 1,949 242
Intangible assets 23 382 1,393 173
Deferred tax assets 31 3,804 3,480 431
Other non-current assets 24 8,536 6,034 747
--------------- -------------- ----------
Total non-current assets 191,962 188,341 23,337
--------------- -------------- ----------
Total assets 216,417 202,840 25,134
=============== ============== ==========
The notes on pages F-9 to F-99 are an integral part of these consolidated financial statements
F-3
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED BALANCE SHEET (CONTINUED)
As at December 31,
--------------------------------------------------
Note 2004 2005 2005
---------- ---------------- --------------- ----------
RMB RMB USD
million million million
Restated
Notes 2&3
Liabilities and equity
Current liabilities
Accounts payable 25 21,125 16,719 2,072
Accruals and other payables 26 4,866 3,905 485
Short term bank loans 27(a) 44,882 47,341 5,866
Current portion of long term bank and other loans 27(b) 11,727 6,846 848
Due to ultimate holding company and fellow subsidiaries 28 10,080 8,990 1,114
Current portion of deferred revenues 29 8,876 7,975 988
Current portion of provisions 30 4,127 4,029 499
Taxation payable 361 2,594 321
---------------- --------------- ----------
Total current liabilities 106,044 98,399 12,193
---------------- --------------- ----------
Net current liabilities (81,589) (83,900) (10,396)
---------------- --------------- ----------
Total assets less current liabilities 110,373 104,441 12,942
---------------- --------------- ----------
Non-current liabilities
Long term bank and other loans 27(b) 26,052 18,143 2,248
Due to ultimate holding company and fellow subsidiaries 28 - 7,840 971
Deferred revenues 29 13,988 10,925 1,354
Provisions 30 3,574 3,174 393
Deferred tax liabilities 31 1,576 1,324 164
Other non-current liabilities 588 25 4
---------------- --------------- ----------
Total non-current liabilities 45,778 41,431 5,134
---------------- --------------- ----------
Total liabilities 151,822 139,830 17,327
---------------- --------------- ----------
Financed by:
Share capital 32 2,181 2,181 270
Reserves 62,414 60,829 7,537
---------------- --------------- ----------
Shareholders' equity 64,595 63,010 7,807
---------------- --------------- ----------
Total liabilities & equity 216,417 202,840 25,134
================ =============== ==========
The notes on pages F-9 to F-99 are an integral part of these consolidated financial statements
F-4
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
Attributable to equity holders of the company
-----------------------------------------------------------------------------
Share Share Revaluation Other Retained Minority Total
capital Premium reserve reserve earnings interest equity
RMB RMB RMB RMB RMB RMB RMB
million million million million million million million
(Note 32)
Balance as at January 1, 2003,
as previously reported 1,819 34,168 - - 26,226 4 62,217
Adjusted for the Acquisition (Note 2) - - - 7,554 - - 7,554
-----------------------------------------------------------------------------
Balance as at January 1, 2003, as restated 1,819 34,618 7,554 26,226 4 69,771
Revaluation surplus - - 2,982 - - - 2,982
Transfer from retained earnings to
other reserve due to the Acquisition 2,729 (2,729) -
Revaluation tax credit - - (984) - - - (984)
Movement of deferred tax recognized in equity - - - - (253) - (253)
-----------------------------------------------------------------------------
Net income/(expense) recognized directly in equity - - 1,998 2,729 (2,982) - 1,745
Loss for the year - - - - (10,906) (1) (10,907)
-----------------------------------------------------------------------------
Total expense recognised in 2003 - - 1,998 2,279 (13,888) (1) (9,162)
Net contribution from owners - - - - 2,777 - 2,777
Distributions to owners - - - - (9,724) - (9,724)
Balance at December 31, 2003 1,819 34,168 1,998 10,283 5,391 3 53,662
=============================================================================
The notes on pages F-9 to F-99 are an integral part of these consolidated financial statements
F-5
Attributable to equity holders of the company
----------------------------------------------------------------------------------
Share Share Capital Statutory Revaluation Other Retained Minority Total
capital premium reserve reserve reserve reserve earnings interest equity
RMB RMB RMB RMB RMB RMB RMB RMB RMB
million million million million million million million million million
(Note 32)
Balance as at
January 1, 2004 1,819 34,168 - - 1,998 10,283 5,391 3 53,662
Appropriation to
statutory
reserve (Note 11) - - - 723 - - (723) - -
Revaluation surplus
(Note 20(c)) - - - - 3,863 - - - 3,863
Movement of deferred tax
recognized in equity
(Note 31) - - - - 846 2,355 (137) - 3,064
Transfer to
retained earnings - - - - (697) (241) 938 - -
Transfer to capital
reserve
upon Listing
Reorganization - - 265 - - - (265) - -
Transfer from retained
earnings to
other reserve due
to the Acquisition - - - - - (6,531) 6,531 - -
Revaluation tax credit
(Note31) - - - - (1,275) - - - (1,275)
--------------------------------------------------------------------------------------------------------
Net income/(expense)
recognized
directly in equity - - 265 723 2,737 (4,417) 6,344 - 5,652
Profit for the year - - - - - - 2,699 - 2,699
--------------------------------------------------------------------------------------------------------
Total income recognized
for 2004 - - 265 723 2,737 (4,417) 9,043 - 8,351
Issue of shares through
global offering
("Global Offering")
net of issue expense 362 8,582 - - - - - - 8,944
Contributions from owner - - - - - - 3,995 - 3,995
Distributions to owner - - - - - - (2,600) - (2,600)
Tax loss as utilized by
owner (Note 31) - - - - - - (704) - (704)
Net assets distributed
to owner in
accordance with
Listing Reorganization - - - - - - (6,047) (3) (6,050)
Distribution to an
owner upon
assignment of loan - - - - - - (1,021) - (1,021)
Share-based payments
(Note 3(a)) - - 18 - - - - - 18
--------------------------------------------------------------------------------------------------------
Balance at
December 31, 2004 2,181 42,750 283 723 4,735 5,866 8,057 - 64,595
========================================================================================================
The notes on pages F-9 to F-99 are an integral part of these consolidated financial statements
F-6
Attributable to equity holders of the company
---------------------------------------------------------------------------------
Share Share Capital Statutory Revaluation Other Retained Minority Total
capital premium reserve reserve reserve reserve earnings interest equity
RMB RMB RMB RMB RMB RMB RMB RMB RMB
million million million million million million million million million
(Note 32)
Balance as at
December 31, 2004 2,181 42,750 283 723 4,735 5,866 8,057 - 64,595
Effect of adoption
of HKFRSs:
Derecognition of
negative goodwill
(Note 3(b)) - - - - - - 166 - 166
Financial Instruments
(Note 3(d)) - - - - - - 1 - 1
------------------------------------------------------------------------------------------------------
Balance as at
January 1, 2005,
as restated 2,181 42,750 283 723 4,735 5,866 8,224 - 64,762
Transfer to statutory
reserve (Note 11) - - - 6,783 - - (6,783) - -
Appropriation to
statutory reserve
(Note 11) - - - 1,044 - - (1,044) - -
Transfer to
retained earnings - - - - (1,731) (96) 1,827 - -
Currency translation
differences - - - - - (56) - - (56)
Movement of deferred
tax recognized
in equity (Note 31) - - - - 1,097 843 (2,174) - (234)
Transfer from retained
earnings to other reserve
due to the Acquisition - - - - - 1,040 (1,040) - -
------------------------------------------------------------------------------------------------------
Net income/(expense)
recognized directly
in equity - - - 7,827 (634) 1,731 (9,214) - (290)
Profit for the year - - - - - - 13,888 - 13,888
------------------------------------------------------------------------------------------------------
Total income
recognized for 2005 - - - 7,827 (634) 1,731 4,674 - 13,598
Contributions from owner - - - - - - 68 - 68
Distributions to owner - - - - - - (930) - (930)
Dividend distributed
during the year
(Note 12) - - - - - - (259) - (259)
Net assets distributed
to owner in accordance
with reorganization
for the Acquisition - - - - - - (1,533) - (1,533)
Consideration for the
Acquisition (Note 1) - - - - - (12,800) - - (12,800)
Share-based payments
(Note 3(a)) - - 104 - - - - - 104
------------------------------------------------------------------------------------------------------
Balance as at
December 31, 2005 2,181 42,750 387 8,550 4,101 (5,203) 10,244 - 63,010
======================================================================================================
The notes on pages F-9 to F-99 are an integral part of these consolidated financial statements
F-7
Year ended December 31,
------------------------------------------------------------
Note 2003 2004 2005 2005
-------- ------------ ------------- ----------- -----------
RMB RMB RMB USD
million million million million
Restated Restated
Notes 2 Notes 2&3
Cash flows from operating activities
Net cash inflows generated from operations 34(a) 35,527 37,434 40,732 5,047
Interest received 95 86 157 19
Dividends received 45 17 29 4
Interest paid (3,819) (3,877) (3,296) (408)
Profits tax paid (931) (7) (4,065) (504)
------------ ------------- ----------- -----------
Net cash inflow from operating activities 30,917 33,653 33,557 4,158
------------ ------------- ----------- -----------
Cash flows from investing activities
Purchase of fixed assets and construction in
progress (36,416) (28,054) (27,282) (3,381)
Prepayments for leased land (34) (202) (280) (35)
Sales of fixed assets 756 923 49 6
Sales of other investments 1,195 1,528 2,874 357
Net decrease in time deposits with maturity over
three months 105 5 31 4
Investment in Asia Netcom 34(c) (507) - - -
Purchase of additional interest in Asia Netcom 34(c) 55 - - -
Purchase of other investments (29) (2,902) - -
------------ ------------- ----------- -----------
Net cash outflow from investing activities (34,875) (28,702) (24,608) (3,049)
------------ ------------- ----------- -----------
Cash flows from financing activities
New bank loans and other loans 80,006 64,664 77,578 9,613
Repayment of bank loans (81,992) (70,051) (86,500) (10,718)
Capital element of finance lease payments (140) (964) (909) (113)
Payment of distribution to owner (1,806) (7,310) (1,566) (194)
Advance from owners 4,750 - - -
Payment to owner for the Acquisition (Note 1) - - (3,000) (372)
Dividends payment - - (259) (32)
Loans to fellow subsidiaries and related
parties 38(e(i)) - (1,021) - -
Global Offering net of issue expense 32(d) - 8,944 - -
Net loan from owner 2,777 3,995 - -
------------ ------------- ----------- -----------
Net cash inflow / (outflow) from financing
activities 3,595 (1,743) (14,656) (1,816)
------------ ------------- ----------- -----------
(Decrease)/increase in cash and cash equivalents (363) 3,208 (5,707) (707)
------------ ------------- ----------- -----------
Cash and cash equivalents at beginning of year 7,736 7,373 10,581 1,311
------------ ------------- ----------- -----------
Cash and cash equivalents at end of year 16 7,373 10,581 4,874 604
============ ============= =========== ===========
The notes on pages F-9 to F-99 are an integral part of these consolidated financial statements
F-8
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
1 The group and its principal activities
Background of the group
China Netcom Group Corporation (Hong Kong) Limited (the "Company") was
incorporated in the Hong Kong Special Administrative Region ("Hong
Kong") of the People's Republic of China ("PRC") on October 22, 1999 as
a limited liability company under the Hong Kong Companies Ordinance.
The shares of the Company were listed on The Stock Exchange of Hong
Kong Limited on November 17, 2004 and the ADSs of the Company were
listed on The New York Stock Exchange Inc. on November 16, 2004. Prior
to a reorganization conducted for the listing of the shares of the
Company (the "Listing Reorganization"), the Company's ultimate holding
company was China Netcom Holdings Company Limited ("China Netcom
Holdings").
The Company, China Netcom Holdings and China Network Communications
Group Corporation (the "China Netcom Group") underwent the Listing
Reorganization on June 30, 2004. China Netcom Group, established by the
State Council of the PRC ("State Council") in May 2002, was formed
under a restructuring plan approved by the State Council relating to
the fixed line telecommunication section. Its fixed line
telecommunications businesses were split from the Northern operations
originally operated by China Telecommunication Corporation. Immediately
after the Listing Reorganization, China Netcom Group became the
ultimate holding company of the Group and the Company and its
subsidiaries (the "Group") owned the assets and liabilities of fixed
line telecommunications businesses originally owned by China Netcom
Group in the six northern provinces and municipalities (namely Beijing
Municipality, Tianjin Municipality, Hebei Province, Liaoning Province,
Shandong Province and Henan Province) and two southern province and
municipality (namely Shanghai Municipality and Guangdong Province) in
the PRC and the assets and liabilities of fixed line telecommunications
business in Asia Pacific Region originally owned by the Group. Also,
the Group leased from China Netcom Group, the inter-provincial optic
fibre of the twelve service regions in the PRC and the submarine cable
assets in the Asia Pacific Region which had been retained by China
Netcom Group.
Pursuant to a resolution passed in the extraordinary general meeting of
the shareholders on October 25, 2005, the Company acquired the
principal telecommunications operations and assets in the four northern
provinces/autonomous region, namely Shanxi Province, Neimenggu
Autonomous Region, Jilin Province and Heilongjiang Province from China
Netcom Group (the "Acquisition"). In anticipation for the Acquisition,
China Netcom Group established China Netcom Group New Horizon
Communications Corporation (BVI) Limited ("New Horizon (BVI)") and
China Netcom Group New Horizon Communications Corporation Limited ("New
Horizon"). China Netcom Group's fixed line telecommunications
businesses in the four northern provinces/autonomous region were
transferred to New Horizon (BVI) through a group restructuring. Upon
the completion of the acquisition of the entire interest of New Horizon
(BVI) and New Horizon from China Netcom Group, the Company controlled
the fixed line telecommunications businesses in the four northern
provinces/autonomous region.
After taking into consideration the financial position and prospects of
the acquired businesses and the conditions of the capital market, the
consideration for Acquisition was determined at RMB12,800 million. The
consideration consists of an initial cash payment of RMB3,000 million
and deferred payments of RMB9,800 million. The deferred payments will
be settled in half-yearly instalments over five years. The interest
charged on the deferred payments is to be calculated at 5.265% per
annum.
F-9
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
1 The group and its principal activities (continued)
Background of the group (continued)
The Group's PRC operations are subject to the supervision of and
regulation by the PRC Government. The Ministry of Information Industry
("MII"), pursuant to the authority delegated by the State Council, is
responsible for formulating the telecommunications industry policies
and regulations (the "Telecommunications Regulations").
Under the Telecommunications Regulations, all telecommunications
operators in the PRC must obtain a telecommunications service operating
license from the MII or from the provincial telecommunications
administrations. Providers of value-added services within a single
province are required to obtain licenses from provincial
telecommunications administrations. Providers of basic
telecommunications services and providers of value-added services in
two or more provinces, autonomous regions and municipalities are
required to obtain licenses from the MII. China Netcom (Group) Company
Limited ("CNC China") and New Horizon, the Group's principal operating
subsidiaries in China, as indirect subsidiaries of China Netcom Group,
have the right to operate the Group's telecommunications business in
twelve service regions under the authorization of China Netcom Group,
which holds the license required for operating the Group's
telecommunications businesses in the PRC.
Following the Listing Reorganization and the Acquisition, China Netcom
Group continues to be the holder of the licenses for operating a
telecommunications network in China, but has, with the consent of the
MII, granted the Group the right to operate under its licenses, the
assets described above and the related business. The Company is the
holder of licenses that are necessary to own and operate the assets
that are outside the PRC described above in such key countries and
regions such as Hong Kong, Japan, Singapore and Korea.
Following the Acquisition, the Group is the dominant provider of fixed
line telephone services, broadband, other internet-related services,
and business and data communications services in ten northern
provinces, municipalities and autonomous region, namely Beijing
Municipality, Tianjin Municipality, Hebei Province, Liaoning Province,
Shandong Province, Henan Province, Shanxi Province, Neimenggu
Autonomous Region, Jilin Province, and Heilongjiang Province. The Group
also provides telecommunications services to selected business and
residential customers in two southern municipality and province, namely
Shanghai Municipality and Guangdong Province in the PRC. In addition,
the Group operates a network and offers international data services
throughout the Asia Pacific countries and regions.
F-10
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
1 The group and its principal activities (continued)
Background of the group (continued)
Following the Listing Reorganization and the Acquisition, the Group's
principal services consist of:
o Fixed line telephone services (including the personal handy phone
system (PHS) services), comprising:
(a) Local, domestic long distance and international long
distance services;
(b) Value-added services, including caller identity, telephone
information services; and
(c) Interconnection services provided to other domestic
telecommunications service providers including the fellow
subsidiary owned by China Netcom Group operating outside
the twelve service regions;
o Broadband services and other Internet-related services;
o Business and data communications services, including integrated
regional data and voice communications services; and
o International services consisting of international voice services
including international inbound calls destined for the PRC or
transit through the PRC or other Asia-Pacific countries and regions,
and leased line, Internet access, managed data and other
telecommunications services provided to business and carrier
customers located outside the PRC.
2 Basis of presentation
The financial statements have been prepared in accordance with Hong
Kong Financial Reporting Standards ("HKFRS"), Hong Kong Accounting
Standards ("HKAS") and interpretations issued by the Hong Kong
Institute of Certified Public Accountants ("HKICPA"). They have also
been prepared in accordance with the disclosure requirements of the
Hong Kong Companies Ordinance and Rules Governing the Listing
Securities on The Stock Exchange of Hong Kong Limited. They have been
prepared under the historical cost convention modified by the
revaluation of certain fixed assets and the marking to fair values of
certain investments as explained in the accounting policies in Note 4
below, and on a going concern basis.
Prior to the Acquisition, China Netcom Group held the entire
telecommunications operations and assets of four northern
provinces/autonomous region. Since China Netcom Group is the Group's
ultimate holding company, the Acquisition constitutes a business
combination under common control. Accordingly, the Company has used
merger accounting to record the Acquisition in accordance with the
Accounting Guideline 5 "Merger Accounting For Common Control
Acquisition" ("AG5") issued by HKICPA, and the acquired assets are
stated at carrying amounts as if the fixed line telecommunications
operations and assets of the four provinces/autonomous region have been
held by the Company from the beginning of the earliest period
presented. The 2003 and 2004 comparatives of the financial statements
have been restated accordingly.
F-11
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
2 Basis of presentation (continued)
The preparation of financial statements in conformity with HKFRS
requires the use of certain critical accounting estimates. It also
requires management to exercise its judgement in the process of
applying the Company's accounting policies. The areas involving a
higher degree of judgement or complexity, or areas where assumptions
and estimates are significant to the consolidated financial statements,
are disclosed in Note 5.
The financial statements include the financial information of the
Company and its subsidiaries (collectively referred to as the "Group").
A significant percentage of the Group's funding requirements is
achieved through short term borrowings. Consequently, the balance sheet
indicates a significant working capital deficit. In the past, a
substantial portion of the Group's short term borrowings have been
rolled over upon maturity. Based on the Group's history of obtaining
finance, its relationships with its bankers and its operating
performance, the directors consider that the Group will continue to be
able to roll over such short term financing, or will be able to obtain
sufficient alternative sources of financing to enable it to operate and
meet its liabilities as and when they fall due.
3 Changes in accounting policies
In 2005, the Group adopted certain new or revised HKFRSs which are
relevant to its operations as listed below. The comparative figures in
respect of the year ended December 31, 2003 and 2004 have been restated
where necessary, in accordance with the relevant requirements.
o HKAS 1 Presentation of Financial Statements
o HKAS 2 Inventories
o HKAS 7 Cash Flow Statements
o HKAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors
o HKAS 10 Events after the Balance Sheet Date
o HKAS 12 Income Taxes
o HKAS 14 Segment Reporting
o HKAS 16 Property, Plant and Equipment
o HKAS 17 Leases
o HKAS 18 Revenue
o HKAS 19 Employee Benefits
o HKAS 21 The Effects of Changes in Foreign Exchange Rates
o HKAS 23 Borrowing Costs
o HKAS 24 Related Party Disclosures
o HKAS 27 Consolidated and Separate Financial Statements
o HKAS 28 Investments in Associates
o HKAS 32 Financial Instruments: Disclosure and Presentation
o HKAS 33 Earnings per Share
o HKAS 36 Impairment of Assets
o HKAS 37 Provisions, Contingent Liabilities and Contingent Assets
o HKAS 38 Intangible Assets
o HKAS 39 Financial Instruments: Recognition and Measurement
o HKFRS 2 Share-based Payment
o HKFRS 3 Business Combinations
F-12
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
3 Changes in accounting policies (continued)
The adoption of these new or revised HKFRSs did not have any
significant impact on the results of operations and financial position
of the Group, except for the adoption of HKFRS 2, HKFRS 3, HKAS 36,
HKAS 17, HKAS 32 and HKAS 39 as detailed below.
The impact of the adoption of HKFRS 2, HKFRS 3, HKAS 36, HKAS 17, HKAS
32 and HKAS 39 to the financial position and results of the Group was
as follows:
(a) HKFRS 2
In prior years, no employee benefits cost or obligation was recognized
when employees (including directors) were granted share options by the
Group over shares in the Company. When the share options were
exercised, equity was increased by the amount of the proceeds received.
With effect from January 1, 2005, in order to comply with HKFRS 2, the
Group recognized the fair value of such share options as an expense in
the consolidated income statement, or as an asset if the cost qualifies
for recognition as an asset under the group's accounting policies. A
corresponding increase is recognized in a capital reserve within
equity.
This change in accounting policy has been accounted for retrospectively
as follows:
After Effect of
adjustment for adoption of
the Acquisition new HKFRS As restated
------------------- ------------------ ------------------
RMB RMB RMB
million million million
As at December 31, 2004
Reserves:
Retained earnings 8,075 (18) 8,057
Capital reserve 265 18 283
------------------- ------------------ ------------------
The adoption of HKFRS 2 resulted in:
Year ended December 31,
-------------------------------------------
2004 2005
------------------- -------------------
RMB million RMB million
Restated
Increase in staff costs 18 104
------------------- -------------------
Details of the share option scheme are presented in Note 33 of the
financial statements.
F-13
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
3 Changes in accounting policies (continued)
(b) HKFRS 3 and HKAS 36
In prior years:
- Positive goodwill arising from acquisition on or after January 1,
2001 was amortized to the consolidated income statement on a
straight-line basis over 20 years. Positive goodwill was stated in
the consolidated balance sheet at cost less accumulated
amortization and any impairment losses; and
- Negative goodwill which arose from acquisition on or after January
1, 2001 was amortized over the weighted average useful life of the
depreciable/amortizable non-monetary assets acquired, except to
the extent in relation to identified expected future losses as at
the date of acquisition. In such cases it was recognized in the
consolidated income statement as those expected losses were
incurred.
With effect from January 1, 2005, the Group adopted a new accounting
policy in order to comply with HKFRS 3 and HKAS 36. The Group no longer
amortized positive goodwill. Such goodwill is tested annually for
impairment, including in the year of its initial recognition, as well
as when there are indications of impairment. Impairment losses are
recognized when the carrying amount of the cash generating unit to
which the goodwill has been allocated exceeds its recoverable amount.
With effect from January 1, 2005 and in accordance with HKFRS 3, if the
fair value of the net assets acquired in a business combination exceeds
the consideration paid (i.e. an amount arises which would have been
known as negative goodwill under the previous accounting policy), the
excess is recognized immediately in the consolidated income statement
as it arises.
The change in the net book value of negative goodwill, as disclosed in
Note 23, arising from the above change in accounting policy has been
prospectively accounted for from January 1, 2005 as follows:
Effect of
Before adoption adoption of
of new HKFRS new HKFRS As restated
------------------- ------------------ ------------------
RMB RMB RMB
million million million
As at January 1, 2005
Negative goodwill (included in intangible
assets) (166) 166 -
Retained earnings 8,057 166 8,223
------------------- ------------------ ------------------
F-14
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
3 Changes in accounting policies (continued)
(b) HKFRS 3 and HKAS 36 (continued)
The adoption of HKFRS 3 and HKAS 36 resulted in:
Year ended
December 31,
2005
-----------------
RMB
million
Increase in amortization expense 15
-----------------
(c) HKAS 17
In prior years, land use rights and buildings held for own use were
stated at cost less accumulated depreciation and impairment losses.
Depreciation was calculated to write-off the cost of such assets on a
straight-line basis over their estimated useful lives, to residual
value.
With effect from January 1, 2005, in order to comply with HKAS 17, land
use rights held for own use are accounted for as operating leases where
the fair value of the interest in any buildings situated on the
leasehold land can be separately identified from the fair value of the
land use rights at either the time the lease was first entered into by
the Group or taken over from the previous lessee, or at the date of
construction of those buildings, if later.
Any pre-paid land premiums for acquiring the land use rights, or other
lease payments, are stated at cost and are written off on a
straight-line basis over the respective periods of the rights.
Any buildings held for own use which are situated on such land leases
continue to be presented as part of property, plant and equipment.
The new accounting policy has been adopted retrospectively and land use
rights have been reclassified from "Property, plant and equipment" or
"Construction in progress" to "Lease prepayments for land" on the face
of the consolidated balance sheet. The reclassification has no impact
on the Group's net assets as at year end nor on the Group's profit
attributable to equity shareholders for the years presented.
F-15
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
3 Changes in accounting policies (continued)
(c) HKAS 17 (continued)
After
adjustment Effect of
for the adoption of
Acquisition HKFRS As restated
----------------- ------------------ ----------------
RMB RMB RMB
million million million
As at December 31, 2004
Land and buildings 21,860 (1,275) 20,585
Construction in progress 11,068 (471) 10,597
Lease prepayments for land (Note 22) - 1,746 1,746
----------------- ------------------ ----------------
(d) HKAS 32 and HKAS 39
HKAS 32 and HKAS 39 establish principles for disclosure, presentation,
recognition and measurement of financial instruments, including
non-derivative financial assets, non-derivative financial liabilities
and derivative instruments for hedging activities.
Under HKAS 39, financial instruments will be carried at either
amortized cost or fair value, depending on their classification.
Movements in fair value will be either charged to income statement or
taken to equity in accordance with the standards. In addition, all
derivatives, including those embedded in non-derivative host contracts
are recognized in the balance sheet at fair value.
This change in accounting policy has been prospectively accounted for
from January 1, 2005 as follows:
Effect of
Before adoption adoption of
of new HKFRS new HKFRS As restated
------------------- ------------------ ------------------
RMB RMB RMB
million million million
As at January 1, 2005
Contracts receivable (Included in other
non-current assets) 408 (408) -
Contracts payable (Included in other
non-current liabilities) (533) 533 -
Discount on foreign currency exchange
forward contracts (Included in other
non-current assets) 59 (59) -
Derivative assets (Included in other
non-current assets) - 9 9
Derivative liabilities (Included in other
non-current liabilities) - (74) (74)
Retained earnings 8,057 1 8,058
------------------- ------------------ ------------------
There is no significant impact on the basic and diluted (losses)/earnings per
share upon the adoption of new accounting policies.
3 Changes in accounting policies
(continued)
F-16
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
(d) HKAS 32 and HKAS 39 (continued)
The adoption of HKAS 39 resulted in:
Year ended
December 31,
2005
---------------
RMB
million
Decrease in profit before taxation 15
---------------
(e) Summary of impact of changes in accounting policies
The impact of the changes to accounting policies as set out in Notes
(a) to (d) above on the Group's profit and equity was as follows:
2005
----------------
RMB
million
For the year ended December 31
(a)HKFRS 2 104
(b)HKFRS 3 and HKAS 36 15
(d)HKAS 32 and HKAS 39 15
-----------------
Decrease in profit before taxation 134
-----------------
As at January 1,
(b)HKFRS 3 and HKAS 36 166
(d)HKAS 32 and HKAS 39 1
-----------------
Increase in total equity 167
-----------------
F-17
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies
(a) Basis of consolidation
Acquisitions of businesses under common control are accounted for using
merger accounting in accordance with AG5 issued by HKICPA. The results
of operations and financial position of such businesses are included in
the consolidated financial statements as if the businesses had been
acquired from the beginning of the earliest period presented or the
date that such businesses were acquired by the party common control.
Acquisitions of subsidiaries from third parties are accounted for using
acquisition accounting. The results and financial positions of such
subsidiaries acquired or disposed of during the year are included in
the consolidated income statements from the effective date of
acquisition or up to the effective date of disposal, as appropriate.
All significant intercompany transactions and balances within the Group
are eliminated on consolidation.
Minority interests represent the interests of outside shareholders in
the operating results and net assets of subsidiaries.
(b) Subsidiaries
Subsidiaries are those entities in which the Company, directly or
indirectly, controls the composition of the board of directors,
controls more than half the voting power or holds more than half of the
issued share capital.
In the Company's balance sheet, the investments in subsidiaries are
stated at cost less provision for impairment losses. The results of
subsidiaries are accounted for by the Company on the basis of dividends
received and receivables.
F-18
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(c) Revenue recognition
(i) The Group's revenues are recognized as follows:
o Revenues derived from local, domestic long distance ("DLD")
and international long distance ("ILD") telephone usage,
which vary depending on the day, the time of day, the
distance and duration of the call and the tariffs, are
recognized when the services are provided to customers.
o Monthly telephone service fees are recognized in the period
during which the telephone services are provided to
customers.
o Upfront connection and installation fees received are
deferred and recognized over the expected customer
relationship period of 10 years. With effect from July 1,
2001, no further upfront fees for connection were charged to
customers.
o Revenues from the sale of prepaid calling cards are deferred
and recognized as the cards are consumed by customers.
o Revenues from PHS bundled service contracts are recognized
as local, DLD, or ILD service fees according to the type of
usage and on a systematic basis to match the pattern of
usage of the PHS services by customers. PHS bundled service
contracts comprise the provision of PHS services and
handsets to customers, under which customers either prepay a
certain amount of service fee or commit to spend a minimum
monthly service fee for a designated period in order to
receive a free handset (see Note 4(s)(ii) for the policy on
cost of the handset ).
o Revenues from value-added communication services such as
call waiting, call diverting and caller number display are
recognized when the services are provided to customers.
o Revenues from the provision of broadband and other
Internet-related services and managed data services are
recognized when the services are provided to customers.
o Interconnection fees from domestic and foreign
telecommunications operators are recognized when the
services are rendered as measured by the minutes of traffic
processed.
o Lease income from the leasing of lines and customer-end
equipment is recognized over the term of the lease. Lease
income from other domestic telecommunications operators and
business customers for the usage of the Group's fixed line
telecommunications networks is measured by the number of
lines leased and the agreed upon rate per line leased. The
lease arrangements are primarily determined on a year to
year basis.
(ii) Interest income
Interest income is recognized on a time proportion basis,
taking into account the principal amounts outstanding and the
interest rates applicable.
F-19
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(c) Revenue recognition (continued)
(iii) Dividend income
Dividend income is recognized when the right to receive
payment is established.
(d) Interest expenses
Interest expenses that are attributable to the acquisition,
construction or production of an asset that necessarily takes a
substantial period of time to get ready for its intended use or sale
are capitalized as part of the cost of that asset.
All other interest expenses are charged to the consolidated income
statement in the year in which they are incurred.
(e) Interconnection charges
Interconnection charges represent amounts incurred for the use of other
telecommunications operators' networks for facilitating the completion
of calls that originate from the Group's fixed line telecommunications
networks. Interconnection charges are recognized on an accrual basis.
Interconnection charges with domestic operators and the fellow
subsidiaries of the Group are accrued based on actual amounts, while
those with overseas operators are accrued based on the actual amounts,
if known, or the Group's estimates.
(f) Translation of foreign currencies
(i) Functional and presentation currency
Items included in the financial statements of each of the Group's
entities are measured using the currency of the primary economic
environment in which the entity operates ("the functional
currency") which is Renminbi.
(ii) Transactions and balances
Transactions in foreign currencies are translated at exchange
rates ruling at the transaction dates. Monetary assets and
liabilities expressed in foreign currencies at the balance sheet
dates are translated at rates of exchange ruling at the balance
sheet dates. Exchange differences arising in these cases are
dealt with in the consolidated income statements.
F-20
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(f) Translation of foreign currencies (continued)
(iii) The Group
The results and financial position of all the group entities
that have a functional currency different from the
presentation currency are translated into the presentation
currency as follows:
o Assets and liabilities for each balance sheet presented are
translated at the closing rate at the date of that balance
sheet;
o Income and expenses for each income statement are translated
at average exchange rates (unless this average is not a
reasonable approximation of the cumulative effect of the
rates prevailing on the transaction dates, in which case
income and expenses are translated at the dates of the
transactions); and
o All resulting exchange differences are recognized as a
separate component of equity.
On consolidation, exchange differences arising from the
translation of the net investment in foreign entities, and of
borrowings and other currency instruments designated as hedges
of such investments, are taken to shareholders' equity. When a
foreign operation is sold, such exchange differences are
recognized in the income statement as part of the gain or loss
on sale.
(g) Cash and cash equivalents
Cash and cash equivalents, comprising cash on hand, deposits held at
call with banks and cash investments with original maturities of three
months or less are carried at cost.
(h) Accounts receivable and other receivables
Accounts and other receivables are recognized initially at fair value
and subsequently measured at amortised cost using the effective
interest method, less provision for impairment. A provision for
impairment of accounts and other receivables is established when there
is objective evidence that the Group will not be able to collect all
amounts due according to the original terms of receivables. The amount
of the provision is the difference between the asset's carrying amount
and the present value of estimated future cash flows, discounted at the
effective interest rate. The amount of the provision is recognized in
the income statement.
(i) Inventories and consumables
Inventories comprise mainly telephone handsets and are stated at the
lower of cost and net realizable value on a first-in, first-out basis,
after provisions for obsolescence. Net realizable value is the
estimated selling price in the ordinary course of business, less
applicable variable selling expenses.
Consumables consist of materials and supplies used in maintaining the
Group's telecommunication networks and are charged to the income
statement when brought into use. Consumables are valued at cost less
any provision for obsolescence.
F-21
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(j) Lease prepayments for land
Lease prepayments for land represent payments for land use rights.
Lease prepayments for land are stated at cost initially and expensed on
a straight line basis over the respective periods of the rights.
(k) Fixed assets
(i) Construction-in-progress
Construction-in-progress represents buildings,
telecommunications networks plant, transmission and switching
equipment under construction and pending installation, and is
stated at cost less impairment losses. Cost comprises direct
costs of construction including borrowing costs attributable
to the construction during the period of construction. When
the asset being constructed becomes available for use, the
construction-in-progress is transferred to the appropriate
category of fixed assets.
(ii) Other fixed assets
Fixed assets are initially stated at cost less accumulated
depreciation and accumulated impairment losses. Historical
cost includes expenditure that is directly attributable to the
acquisition of the items. The subsequent costs of an item of
property, plant and equipment that qualifies for recognition
as an asset shall be measured at its revenues and costs. Any
other costs incurred in restoring fixed assets are charged to
the income statement as incurred.
Buildings subsequent to initial recognition are stated at cost
less accumulated impairment losses and depreciated over their
expected useful lives.
(iii) Revaluations
Fixed assets other than buildings are carried at their
revalued amounts. Revalued assets are stated at fair value as
of the revaluation date less depreciation. When an item of
fixed asset is revalued, any accumulated depreciation at the
date of the revaluation is restated proportionately together
with the change in the gross carrying amount of the asset so
that the carrying amount of the asset after revaluation equals
its revalued amount.
Increases in valuation are credited to the revaluation
reserve. Decreases in valuation are first set off against
revaluation surplus on earlier valuations in respect of the
same item and thereafter are debited to operating profit. Any
subsequent increases are credited to operating profit up to
the amount previously debited. Each year the difference
between depreciation based on the revalued carrying amount of
the asset expensed in the income statement and depreciation
based on the asset's original cost is transferred from
revaluation reserve to retained earnings.
F-22
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(k) Fixed assets (continued)
Revaluations on fixed assets will be performed with sufficient
regularity by independent valuers, in each of the intervening
years valuations will be undertaken by executives of the
Group.
(iv) Depreciation
Fixed assets are depreciated at rates sufficient to write off
their costs or revalued amounts less accumulated impairment
losses and estimated residual values over their estimated
useful lives on a straight-line basis. The principal useful
lives are as follows:
Buildings 8-30 years
Telecommunications
networks and equipment 5-10 years
Furniture, fixture, motor
vehicles and other equipment 5-10 years
The useful lives and estimated residual values are reviewed
and modified periodically at every balance sheet date.
(v) Gain or loss on sale of fixed assets
The gain or loss on disposal of a fixed asset is the
difference between the net sales proceeds and the carrying
amount of the relevant asset, and is recognized in the income
statement, except where the fixed asset is carried at
valuation, the relevant portion of the revaluation reserve
realized in respect of previous valuations is transferred to
retained earnings and is shown as a movement in reserves.
(l) Impairment of assets
Assets that have an indefinite useful life are not subject to
amortization, but instead are tested at least annually for impairment
and are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable.
Assets that are subject to amortization are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying
amount may not be recoverable. An impairment loss is recognized for the
amount by which the asset's carrying amount exceeds its recoverable
amount. The recoverable amount is the higher of an asset's fair value
less costs to sell and value in use. For the purposed of assessing
impairment, assets are grouped at the lowest levels for which there are
separately identifiable cash flows (cash-generating units).
(m) Assets under leases
(i) Finance leases
Leases of assets where the Group has substantially all the
risks and rewards of ownership are classified as finance
leases. Finance leases are capitalized upon commencement of
the lease at the lower of the fair value of the leased assets
and the present value of the minimum lease payments. Each
lease payment is allocated between the liability and finance
charges so as to achieve a constant rate on the finance
balance outstanding.
F-23
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(m) Assets under leases (continued)
The corresponding rental obligations, net of finance charges,
are included in current and non-current borrowings. The
interest element of the finance cost is recognized in the
income statement over the lease period so as to produce a
constant periodic rate of interest on the remaining balance of
the liability for each period.
(ii) Operating leases
Leases in which a significant portion of the risks and rewards
of ownership are retained by the leasing company are
classified as operating leases. Payments made under operating
leases (net of any incentives received from the lessor) are
expensed in the income statement on straight-line basis over
the period of the lease.
(n) Intangible assets
(i) Purchased software
Expenditure on purchased software is capitalized and amortized
using the straight-line method over the expected useful lives
of the software, which vary from three to five years.
(ii) Sponsorship fee
The sponsorship fee for 2008 Beijing Olympic Games has been
capitalized and being amortized on a straight-line basis over
4 years, being the beneficial period under the sponsorship
program. The cost of the intangible asset is calculated based
on the expected cash payment and the fair value of the
services to be provided.
(o) Short-term investments
Short-term investments comprise listed securities held for
trading purposes and are carried at fair value. At each
balance sheet date, the net unrealized gains or losses arising
from the changes in fair value of short-term investments are
recognized in the income statement. Profits or losses on
disposal of short-term investments, representing the
difference between the net sales proceeds and the carrying
amounts, are recognized in the income statement as they arise.
F-24
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(p) Provisions
Provisions are recognized when the Group has a present legal or
constructive obligation as a result of past events, it is probable that
an outflow of resources will be required to settle the obligation, and
a reliable estimate of the amount can be made. Provisions are not
recognized for operating loss arising from future periods.
Where there are a number of similar obligations, the likelihood that an
outflow will be required in settlement is determined by considering the
class of obligations as a whole. A provision is recognized even if the
likelihood of an outflow with respect to any one item included in the
same class of obligations may be small.
(q) Employee benefits
(i) Pension obligations
(a) Employees in the PRC are entitled to retirement benefits
equal to a fixed proportion of their salary at their normal
retirement age which are paid by the PRC government. As
stipulated by the regulations of the PRC, the subsidiaries in
the PRC makes contribution in the basic defined contribution
pension plans organized by their respective municipal
governments under which they are governed. The Group is
required to make such contributions to these plans at a rate
of 20% of the salaries, bonuses and certain allowances of the
employees. The Group has no other material obligation for
post-retirement benefits beyond these payments as they fall
due. Payments made under these plans are expensed as incurred.
(b) The Group also operates a mandatory provident fund scheme
("the MPF scheme") under the Hong Kong Mandatory Provident
Fund Schemes Ordinance for employees employed under the
jurisdiction of the Hong Kong Employment Ordinance. The MPF
scheme is a defined contribution retirement scheme
administered by independent trustees. Under the MPF scheme,
the employer and its employees are each required to make
contributions to the scheme at 5 per cent. of the employees'
relevant income, subject to a cap of monthly relevant income
of HK$20,000.
(ii) Early retirement benefits
Early retirement benefits are recognized as expenses when the
Group reaches agreement with the relevant employees for early
retirement.
(iii) Employee housing benefits
One-off cash housing subsidies paid to PRC employees are
charged to the consolidated income statements in the year in
which it is determined that the payment of such subsidies is
probable and the amounts can be reasonably estimated (see Note
30).
PRC full-time employees of the Group participate in various
government-sponsored housing funds. The Group contributes on a
monthly basis to these funds based on certain percentages of
the salaries of the employees.
F-25
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(q) Employee benefits (continued)
The Group's liability in respect of these funds is limited to
the contributions payable in each period. Contributions to
these housing funds are expensed as incurred.
(iv) Share option scheme
The Group operates an equity-settled, share-based compensation
plan. The fair value of the employee services received in
exchange for the grant of the options is recognized as an
expense. The total amount to be expensed over the vesting
period is determined by reference to the fair value of the
options granted, excluding the impact of any non-market
vesting conditions (for example, profitability and sales
growth targets). Non-market vesting conditions are included in
assumptions about the number of options that are expected to
become exercisable. At each balance sheet date, the entity
revises its estimates of the number of options that are
expected to become exercisable. It recognizes the impact of
the revision of original estimates, if any, in the income
statement, and a corresponding adjustment to equity over the
remaining vesting period.
(r) Deferred taxation
Deferred taxation is provided in full, using the liability
method, on temporary differences arising between the tax bases
of assets and liabilities and their carrying amounts in the
financial statements. Taxation rates enacted or substantially
enacted at the balance sheet date are used to determine
deferred taxation. Deferred tax assets are recognized to the
extent that it is probable that future taxable profit will be
available against which the temporary differences can be
utilized.
(s) Other non-current assets
(i) Deferred installation costs
The direct incremental costs associated with the installation
of fixed line services are deferred and expensed to the income
statement over the expected customer relationship period of 10
years except when the direct incremental costs exceed the
corresponding upfront installation fees. In such cases, the
excess of the direct incremental costs over the installation
fees are recorded immediately as expenses in the income
statement.
(ii) Customer acquisition costs
The cost of handsets given to customers under bundled service
contracts and related commissions paid to distributors are
deferred as customer acquisition costs and expensed to the
income statement on a systematic basis to match with the
pattern of the customer service income over the contract
period.
(iii) Prepaid network capacities
Prepayments for the network capacities purchased on an
indefeasible rights to use ("IRU") basis are capitalized and
expensed over the corresponding lease period.
F-26
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(t) Derivative financial instruments
Derivative financial instruments are stated at fair value on the
balance sheet. Realised and unrealised gains and loses arising from
change in the fair value are included in the income statement in the
period in which they arise.
(u) Contingent liabilities
A contingent liability is a possible obligation that arises from past
events and whose existence will only be confirmed by the occurrence or
non-occurrence of one or more uncertain future events not wholly within
the control of the Group. It can also be a present obligation arising
from past events that is not recognized because it is not probable that
outflow of economic resources will be required or the amount of
obligation cannot be measured reliably.
A contingent liability is not recognized but is disclosed in the notes
to the financial statements when an outflow of economic benefits is
less than probable but not remote. When a change in the probability of
an outflow occurs so that the outflow is probable, the contingent
liability will then be recognized as a provision.
A contingent asset is a possible asset that arises from past events and
whose existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain events not wholly within the
control of the Group. A contingent asset is disclosed when an inflow of
economic benefits is probable but only recognized in income statement
when realized.
(v) Segmental reporting
Business segments provide services that are subject to risks and
returns that are different from other business segments. Geographical
segments provide services within a particular economic environment that
is subject to risks and returns that differ from those of components
operating in other economic environments. Currently the Group has one
business segment, the provision of fixed line telecommunications
services. Less than 10% of the Group's assets and operations are
located outside the PRC. Accordingly, no business and geographical
segment information is presented.
(w) Earnings per share ("EPS") and per American Depository Shares ("ADS")
Basic EPS is computed by dividing net profit attributable to ordinary
shareholders by the weighted average number of ordinary shares
outstanding during the year.
Diluted EPS is computed by dividing net profit attributable to
shareholders by the weighted average number of ordinary and dilutive
ordinary equivalent shares outstanding during the year. Ordinary
equivalent shares consist of ordinary shares issuable upon the exercise
of outstanding stock options using the treasury stock method.
Earnings per ADS is computed by multiplying the EPS by 20, which is the
number of shares represented by each ADS.
F-27
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(x) New accounting standard pronouncements
The HKICPA has issued a number of new and revised HKFRSs and HKFRS
Interpretations ("HKFRS - Ints"), and HKAS and HKAS Interpretations
("HKAS - Ints") as set out below which are effective for accounting
periods beginning on or after January 1, 2006. The Group has not early
adopted these new and revised standards and interpretations in the
financial statements for the year ended December 31, 2005. The Group
has commenced an assessment of the impact of these new and revised
standards and interpretations, but is not yet in a position to state
whether these new and revised standards and interpretations would have
a significant impact on its results of operations and financial
position.
o HKFRS 7 -- Financial Instruments: Disclosures
o HKAS 1 (amended) -- Capital Disclosure
o HKAS 21 (amended) -- The Effects of Changes in Foreign Exchange
Rates - Net Investment in a Foreign Operation
o HKAS 39 (amended) -- Cash Flow Hedge Accounting of Forecast
Intragroup Transactions
o HKAS 39 (amended) -- The Fair Value Option
o HKAS 39 (amended) and HKFRS 4 (amended) -- Financial Guarantee
Contracts
F-28
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
5 Critical accounting estimates and judgments
Estimates and judgements are continually evaluated and are based on
historical experience and other factors, including expectations of
future events that are believed to be reasonable under circumstances.
(a) Critical accounting estimates and assumptions
The Group makes estimates and assumptions concerning the future. The
resulting accounting estimates will, by definition, seldom equal the
related actual results. The estimates and assumptions that have a
significant risk of causing a material adjustment to the carrying
amounts of assets and liabilities within the next financial year are
discussed below:
(i) Depreciation of property, plant and equipment
The property, plant and equipment of the Group are depreciated at rates
sufficient to write off their costs or revalued amounts less
accumulated impairment losses and estimated residual values over their
estimated useful lives on a straight-line basis. The Group reviewed the
useful lives periodically to ensure that the method and rates of
depreciation are consistent with the expected pattern of economic
benefits from property, plant and equipment. The Group estimates the
useful lives of the property, plant and equipment as set out in Note
4(k)(iv) based on the historical experience with similar assets, taking
into account anticipated technological changes. The depreciation
expenses in the future periods will change if there are significant
changes from previous estimates.
(ii) Revaluation of property, plant and equipment
For the Listing Reorganization, property, plant and equipment of the
Group were revalued as of December 31, 2003 on a depreciated
replacement cost basis. The property, plant and equipment acquired as
part of the Acquisition were revalued as of December 31, 2004 on a
depreciated replacement cost basis in preparation for the Acquisition.
Apart from lease prepayments for land and buildings, which are carried
at cost, other property, plant and equipment are carried at revalued
amounts, being the fair value at the date of revaluation, less
subsequent accumulated depreciation and impairment losses. Revaluations
on property, plant and equipment will be performed with sufficient
regular intervals by independent valuers, in each of the intervening
years valuations will be undertaken by executives of the Group. If the
subsequent revalued amounts differ significantly from the carrying
amounts of the property, plant and equipment in the future, the
carrying amounts will be adjusted to the revalued amounts. The key
assumptions made to determine the revalued amounts include the newly
estimated replacement costs and the estimated useful lives of the
property, plant and equipment. This will have an impact on the Group's
future results, since any subsequent decreases in valuation are set off
first against increases on earlier valuations in respect of the same
item and thereafter are charged as an expense to the income statement
and any subsequent increases are credited as income to the income
statement up to the amount previously charged. In addition, the
depreciation expense in future periods will change as the carrying
amounts of such property, plant and equipment change as a result of the
revaluation.
F-29
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
5 Critical accounting estimates and judgments (continued)
(iii) Impairment of non-current assets
At each balance sheet date, the Group considers both internal and
external sources of information to assess whether there is any
indication that non-current assets, including property, plant and
equipment, are impaired. If any such indication exists, the recoverable
amount of the assets is estimated and an impairment loss is recognized
to reduce the carrying amount of the assets to its recoverable amount.
The recoverable amount is the higher of value in use or net selling
price. Estimated value in used are determined based on estimated
discounted future cash flows of the cash generating unit at the lowest
level to which the asset belongs. Key assumptions made to determine the
estimated discounted future cash flows include the estimated future
cash flow, estimated growth rate and the estimated weighed cost of
capital of the Group. Such impairments losses are recognized in the
income statement, except where the asset is carried at valuation and
the impairment loss does not exceed the revaluation surplus for that
same asset or group of assets, in which case the impairment loss is
treated as a revaluation decrease and charged to the revaluation
reserve. Accordingly, there will be an impact to the future results if
there is a significant change in the recoverable amounts of the
non-current assets.
(iv) Revenue recognized for upfront connection and installation fees
The Group defers the recognition of upfront customer connection and
installation and amortizes them over the expected customer relationship
period of 10 years. The related direct incremental installation costs
are deferred and amortized over the same expected customer relationship
periods of 10 years, except that when the direct incremental costs
exceed the corresponding installation fees, if any, the excess amounts
are immediately written off as expense to the income statement. The
Group estimates the expected customer relationship period based on the
historical customer retention experience and after factoring in the
expected level of future competition, the risk of technological or
functional obsolescence to the Group's services, technological
innovation, and the expected changes in the regulatory and social
environment. If the Group's estimate of the expected customer
relationship period changes as a result of increased competition,
changes in telecommunications technology or other factors, the amount
and timing of recognition of the deferred revenues may change for
future periods.
(v) Provision for doubtful debts
The Group maintains an allowance for doubtful debts for estimated
losses resulting from the inability of its customers to make the
required payments. The Group makes its estimates based on the aging of
its accounts receivable balances, customers creditworthiness, and
historical write-off experience. If the financial condition of its
customers were to deteriorate, actual write-offs might be higher than
expected, and the Group would be required to revise the basis of making
the allowance and its future results would be affected.
(vi) Fair value
The Group estimates the fair value of its financial assets and
financial liabilities including the accounts receivable, prepayments,
other receivables and other current assets, accounts payable, and bank
and other loans for disclosure purposes by discounting its future
contractual cash flows at the estimated current market interest rate
that is available to the Group for similar financial instruments. The
future disclosed values will change if there are changes in the
estimated market interest rate.
F-30
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
5 Critical accounting estimates and judgments (continued)
(b) Critical judgments in applying the entity's accounting policy
(i) Accounting for business combinations under common control
The Group completed the Acquisition on October 31, 2005. The
Acquisition is a business combination under common control. The Group
adopted merger accounting to account for the business combinations
under common control as the Group believes that the financial
statements prepared under merger accounting is more relevant to those
transactions.
(ii) Recognition of revenues and costs under PHS bundled service contracts
The Group provides PHS services, which is an extension of the local
wireline telecommunications services, to customers. Promotional
packages comprise the bundled provision of PHS services and handsets to
customers, under which customers either prepay a certain amount of
service fee or commit to spend a minimum monthly service fee for a
designated period of time in order to receive a free handset. The total
revenues received or receivable are recognized as deferred revenue. The
cost of handsets provided to customers is treated as deferred customer
acquisition costs, to the extent that they are recoverable through
profits made from future service fees. Such deferred revenue and
deferred costs are amortized to the income statement on a systematic
basis to match the shorter of the pattern of usage of the related
service and the minimum non-cancelable contract period. If the pattern
of the usage of the PHS services by the customers changes in the
future, the amortization period of the revenue and costs will change
accordingly, which will have an impact on future results.
6 Financial risk management
(a) Financial risk factors
The Group's activities expose it to a variety of financial risks:
market risks including currency risk, credit risk, liquidity risk, cash
flow interest risk and fair value interest-rate risk.
(i) Foreign exchange risk
As at December 31, 2005 and 2004, the Group had foreign
currency denominated bank balances amounting to RMB1,098
million and RMB8,186 million respectively. As at December 31,
2005 and 2004, the Group had foreign currency denominated bank
loans amounting to RMB1,998 million and RMB5,365 million
respectively.
(ii) Credit risk
The carrying amount of accounts receivable included in the
balance sheet represents the Group's exposure to credit risk
in relation to its financial assets. The Group's receivables
are unsecured to the extent they are not covered by security
deposits. The Group believes that adequate provision for
uncollectible account receivable has been made.
F-31
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
6 Financial risk management (Continued)
(a) Financial risk factors (Continued)
(iii) Liquidity risk
A significant percentage of the Group's funding requirements
is achieved through short term borrowings, and the balance
sheet indicates a significant working capital deficit. Please
refer to Note 2 for the details.
(iv) Cash flow and fair value interest rate risk
The Group is exposed to changes in interest due to its
long-term debt obligations. The Group enters into debt
obligations to support general corporate purpose including
capital expenditures, acquisitions, and working capital needs.
Borrowings at variable rates expose the Group to cash flow
interest rate risk. Borrowings issued at fixed rates expose
the Group to fair value interest rate risk. The bank loans
issued at variable rates and fixed rates are disclosed in Note
27 of these financial statements.
(b) Fair value estimation
The fair value of financial instruments traded in active markets is
based on quoted market prices at the balance sheet date. The quoted
market price used for financial assets held by the Group is the current
bid price; the appropriate quoted market price for financial
liabilities is the current ask price.
The nominal value less estimated credit adjustments of trade
receivables and payables are assumed to approximate their fair values.
The fair value of financial liabilities for disclosure purposes is
estimated by discounting the future contractual cash flows at the
current market interest rate that is available to the Group for similar
financial instruments.
F-32
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
7 Revenues
Revenues represent the turnover of the Group and are derived from the
provision of fixed line telecommunications and related services, net of
the PRC business taxes and government levies. The Group's revenues by
business nature can be summarized as follows:
Year ended December 31,
---------------------------------------------------------------
2003 2004 2005
------------------ ------------------ -----------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2
Revenues
Local usage fees 24,685 24,858 24,582
Monthly telephone services 16,476 17,964 18,261
Upfront installation fees 1,267 1,568 1,442
DLD usage fees 11,425 11,266 10,260
ILD usage fees 1,543 1,415 1,464
Value-added services 2,095 2,993 4,000
Interconnection fees 4,980 6,453 7,783
Upfront connection fees 5,122 4,346 3,405
Broadband services 2,928 5,307 7,916
Other Internet-related services 1,418 1,259 812
Managed data services 1,617 1,829 1,802
Leased line income 2,883 2,591 2,921
Other services 1,159 1,645 2,584
------------------ ------------------ -----------------
Total 77,598 83,494 87,232
================== ================== =================
F-33
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
7 Revenues (continued)
The Group's revenues by geographical location of the customers can be
summarized as follows:
Year ended December 31,
----------------------------------------------
2003 2004 2005
------------ ------------- ------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2
DOMESTIC TELECOMMUNICATIONS SERVICES
(Being revenues generated from customers located
in the PRC)
Local usage fees 24,685 24,858 24,582
Monthly telephone services 16,476 17,964 18,261
Upfront installation fees 1,267 1,568 1,442
DLD usage fees 11,425 11,266 10,260
ILD usage fees 1,543 1,234 1,180
Value-added services 2,095 2,993 4,000
Interconnection fees 3,763 5,441 6,517
Upfront connection fees 5,122 4,346 3,405
Broadband services 2,914 5,202 7,812
Other Internet-related services 1,418 1,004 540
Managed data services 1,553 1,520 1,395
Leased line income 2,820 2,095 2,238
Other services 1,138 1,360 2,345
------------ ------------- ------------
Subtotal 76,219 80,851 83,977
------------ ------------- ------------
INTERNATIONAL TELECOMMUNICATIONS SERVICES
(Being revenues generated from customers located
outside the PRC, including Hong Kong and
Macau Special Administrative Regions and
Taiwan)
ILD usage fees - 181 284
Interconnection fees 1,217 1,012 1,266
Broadband services 14 105 104
Other Internet-related services - 255 272
Managed data services 64 309 407
Leased line income 63 496 683
Other services 21 285 239
------------ ------------- ------------
Subtotal 1,379 2,643 3,255
------------ ------------- ------------
Total 77,598 83,494 87,232
============ ============= ============
F-34
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
8 Operating expenses
Operating expenses include:
Year ended December 31,
---------------------------------------------
2003 2004 2005
------------- ------------ ------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2
Depreciation (included in depreciation and amortization):
- Owned property, plant and equipment (Note 20) 26,479 24,581 24,287
- Leased property, plant and equipment (Note 20) 183 389 367
Loss on disposal of property, plant and equipment (included
in networks, operations and support expenses) 2,224 212 363
Amortization of intangible assets (included in depreciation
and amortization) (Note 23) 119 159 358
Contributions to pension plans (included in staff costs)
(Note 14) 1,051 1,181 1,285
Early retirement benefits (included in staff costs) (Note 14) 336 693 2
Operating leases:
- Land and buildings (included in networks, operations and
support) 12 394 796
- Land and buildings (included in selling, general and
administrative) 123 204 159
- Network and machinery (included in networks, operations
and support) 698 1,606 1,708
- Network and machinery (included in selling, general and
administrative) 21 19 92
Interconnection charges (included in networks, operations
and support) 2,013 2,602 3,487
Bad and doubtful debt expenses (included in selling, general
and administrative) 1,026 1,185 1,148
Auditor's remuneration (included in selling, general and
administrative) - 18 34
PHS subscriber acquisition costs (included in selling,
general and administrative) 741 3,114 2,323
Cost of PHS handsets (included in other operating expenses) 381 425 861
F-35
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
9 Finance costs
Year ended December 31,
-----------------------------------------------------------------
2003 2004 2005
------------------ ------------------- -------------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2
Interest expenses on:
- Bank and other loans wholly
repayable within five years 4,613 4,185 3,676
- Bank and other loans wholly
repayable after more than five
years 174 114 207
------------------ ------------------- -------------------
4,787 4,299 3,883
Less: Interest expenses capitalized in
construction in progress (779) (548) (297)
------------------ ------------------- -------------------
Amortization of discount on foreign
currency exchange forward contracts 20 18 -
Exchange loss/ (gain), net 238 105 (232)
Bank charges 30 56 20
------------------ ------------------- -------------------
4,296 3,930 3,374
================== =================== ===================
Interest expenses were capitalized in
construction in progress using the
following annual interest rates 3.68%-6.77% 3.69%-5.45% 4.17%-4.97%
================== =================== ===================
10 Taxation
Year ended December 31,
-----------------------------------------------------------------
2003 2004 2005
------------------- --------------------- ------------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2
PRC enterprise income tax ("EIT") 946 2,932 3,581
Overseas profit tax - - 10
Deferred taxation (Note 31) (8,179) (3,255) (162)
Share of taxation attributable to
jointly controlled entity 16 - -
-----------------------------------------------------------------
Taxation (credit) /charges (7,217) (323) 3,429
=================================================================
The provision for PRC EIT is calculated based on the statutory income
tax rate of 33% on the assessable profit of each of the entities now
comprising the Group in the PRC as determined in accordance with the
relevant income tax rules and regulations in the PRC.
F-36
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
10 Taxation (continued)
Taxation on profits derived from certain subsidiaries outside the PRC,
including Hong Kong, has been calculated on the estimated assessable
profit at the rates of taxation ranging from 17.50% to 30.00%,
prevailing in the countries in which those entities operate.
The reconciliation between the Group's actual tax charge/(credit) and
the amount which is calculated based on the weighted average statutory
tax rate is as follows:
Year ended December 31,
---------------------------------------------------------------
2003 2004 2005
------------------ -------------------- -----------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2
(Loss)/profit before taxation (18,124) 2,376 17,317
================== ==================== =================
Weighted average statutory tax rate 33% 33% 33%
Tax calculated at the weighted average
statutory tax rate (5,981) 784 5,715
Non-taxable income (Note (a) below) (1,690) (1,583) (1,499)
Utilization of tax losses not recognized
in previous years (Note (b) below) - - (837)
Expenses not deductible for tax purposes 266 275 69
Tax losses not recognized 129
246 354
Others (58) (153) (148)
------------------ -------------------- -----------------
Tax (credit)/charge (7,217) (323) 3,429
================== ==================== =================
Note (a) Non-taxable income comprises primarily upfront connection
fees charged to customers and amortized over the customer
relationship period.
Note (b) In previous years, deferred tax arising from certain tax
losses was not recognized as it was uncertain at that time
following the change of a subsidiary's tax registration district
that the taxable loss could be utilized at the previous period
end date.
11 Profit attributable to shareholders
(a) Two of the Company's subsidiaries, CNC China and New Horizon were
registered as foreign investment enterprises in the PRC. In accordance
with the Articles and Association of both CNC China and New Horizon,
they are required to provide for certain statutory reserves, namely,
general reserve and staff bonus and welfare fund, which are
appropriated from profits after tax but before dividend distributions.
CNC China and New Horizon are required to allocate at least 10% of
their profits after tax determined under PRC GAAP to the general
reserve fund until the cumulative amounts reach 50% of the registered
capital. The statutory reserve can only be used, upon obtaining
approval from the relevant authority, to offset accumulated losses or
increase capital.
F-37
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
11 Profit attributable to shareholders (continued)
(a) (Continued)
Accordingly, CNC China and New Horizon appropriated approximately
RMB894 million and RMB150 million respectively to the general reserve
fund for the year ended December 31, 2005 (2004: RMB723 million and Nil
respectively).
(b) According to a notification on income tax issued by Ministry of Finance
and State Administration of Taxation to the Group's primary operating
subsidiaries, the Group's upfront connection fees are not subject to
EIT and an amount equal to the upfront connection fees recognized in
the income statement should be transferred from retained earnings to a
statutory reserve. For the year ended December 31, 2005, the aggregated
upfront connection fees recognized in the income statement amounted to
RMB6,783 million (2004: Nil), which was transferred to the statutory
reserve in accordance with the aforementioned approval document.
12 Profit distributions
Year ended December 31,
------------------------------------------------------------------------------------
2003 2004 2005
------------------------------------------------------------------------------------
HK$ RMB HK$ RMB HK$ RMB
million million million million million million
Final dividend proposed - -
after balance sheet date
of HK$0.466 per share
(2004 : HK$0.037 per
share) 245 259 3,073 3,196
Dividend distributed - -
during the year - - 245 259
------------ ------------- ---------- --------- ---------- ---------
Notes:
In a meeting of board of directors held on March 21, 2006, the
directors proposed a final dividend of HK$0.466 per ordinary share for
the year ended December 31, 2005. Dividend proposed after the balance
sheet date have not been reflected as dividend payable and will be
reflected as an appropriation in the 2006 financial statements.
F-38
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
13 Earnings per share
Basic earnings per share is computed using the weighted average number
of ordinary shares outstanding during the year. Diluted earnings per
share is computed using the weighted average number of ordinary shares
and potential ordinary shares outstanding during the year.
The following table sets forth the computation of basic and diluted
earnings per share:
Year ended December 31,
-------------------------------------------------------------------
2003 2004 2005
------------------- -------------------- --------------------
(in RMB millions, except share and per share data)
Restated Restated
Notes 2 Notes 2&3
Numerator:
(Loss)/profit for the year (10,906) 2,699 13,888
=================== ==================== ====================
Denominator
Weighted average number of ordinary shares
outstanding and shares used in
computing basic earnings per share: 5,492,258,218 5,622,685,175 6,593,529,000
Weighted average number of potential
ordinary shares:
Diluted equivalent shares arising from -
convertible preference shares prior to
their conversion into ordinary shares
during 2004 5,140,036 -
Diluted equivalent shares arising from -
share options 2,209,241 34,112,723
------------------- -------------------- --------------------
Shares used in computing diluted
(loss)/earnings per share 5,492,258,218 5,630,034,452 6,627,641,723
------------------- -------------------- --------------------
Basic (loss)/earnings per share (RMB) (1.99) 0.48 2.11
=================== ==================== ====================
Diluted (loss)/earnings per share (RMB) (1.99) 0.48 2.10
=================== ==================== ====================
The diluted loss per share for the year ended December 31, 2003 is the
same as the basic loss per share as all potential ordinary shares are
anti-dilutive.
All the numbers of shares stated above have taken into consideration
the effect of the share consolidation conducted on September 7, 2004 as
set out in note 32(a).
14 Staff cost including directors' remunerations
Year ended December 31,
------------------------------------------------------------------
2003 2004 2005
------------------- -------------------- -------------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2&3
Wages, salaries and welfare 9,558 10,076 11,046
Contributions to pensions 1,051 1,181 1,285
Early retirement benefits 336 693 2
------------------- -------------------- -------------------
Total 10,945 11,950 12,333
=================== ==================== ===================
F-39
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
15. Cash and bank deposits
Group
------------------------------------------------------------
As at December 31
------------------------------------------------------------
2004 2005
----------------------------- --------------------------
RMB million RMB million
Restated
Note 2
Cash and cash equivalents 10,581 4,874
Time deposits with original maturities over three
months 52 21
----------------------------- --------------------------
Total cash and bank deposits 10,633 4,895
============================= ==========================
Effective interest rate of time deposits with
original maturities over three months (%) 0.72 0.72
============================= ==========================
Included in cash and bank deposits as at December 31, 2005 and 2004 are
Renminbi denominated balance amounts held in the PRC amounting to
RMB3,797 million and RMB2,448 million respectively. The conversion of
Renminbi denominated balances into foreign currencies and the
remittance of bank balances and cash out of the PRC are subject to the
rules and regulation of foreign exchange control promulgated by the PRC
government.
16. Short-term investments
The Group and the Company's short-term investments comprise primarily
investments in listed debt securities and investment funds. Most of the
short-term investments were disposed of during the year.
17. Accounts receivable
Amounts due from the provision of fixed line telecommunications
services to residential and business customers are due within 30 days
from the date of billing. Residential customers who have accounts
overdue by more than 90 days will in normal circumstances have their
services disconnected. Accounts receivable from other
telecommunications operators and customers are due between 30 to 90
days from the billing date.
F-40
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
17 Accounts receivable (continued)
The ageing analysis of accounts receivable based on the billing date is
as follows:
As at December 31,
-----------------------------------------
2004 2005
------------------ -------------------
RMB million RMB million
Restated
Note 2
0-30 days 5,503 5,446
31-90 days 1,122 1,556
Over 90 days 1,961 2,053
------------------ -------------------
Total 8,586 9,055
------------------ -------------------
Less: Allowance for doubtful debts (1,412) (1,654)
------------------ -------------------
Net carrying amounts 7,174 7,401
================== ===================
The movement of allowance for doubtful debts is as follows:
As at December 31,
------------------------------------------
2004 2005
------------------- -------------------
RMB million RMB million
Restated
Note 2
Balance at beginning of year 1,175 1,412
Additional provisions 1,244 1,169
Less: Amounts utilized (958) (927)
Distributed to owner in accordance with Listing
Reorganization (49) -
------------------- -------------------
Balance at end of year 1,412 1,654
=================== ===================
The carrying value of accounts receivable approximates their fair
values based on cash flows discounted using a rate based on the average
short-term borrowing rate of 5.58% (2004: 5.22%).
Included in the accounts receivable are amounts due from other
state-owned telecommunication operators amounting to RMB 1,003 million
(2004: RMB 1,278 million).
F-41
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
18 Inventories and consumables
As at December 31,
-----------------------------------------------
2004 2005
----------------------- --------------------
RMB million RMB million
Restated
Note 2
Telephone handsets and other customer end-products held
for resale, at cost 427 144
Consumables, at cost 816 328
----------------------- --------------------
Total 1,243 472
======================= ====================
19 Prepayments, other receivables and other current assets
Group
-----------------------------------------------
As at December 31,
-----------------------------------------------
2004 2005
RMB RMB
million million
Restated
Note 2
Prepaid expenses, deposits and other current assets 637 997
Other receivables 805 485
----------------------- --------------------
Total 1,442 1,482
======================= ====================
Included in the other current assets is deferred customer acquisition
cost of RMB 324 million (2004: Nil).
The carrying value of prepayments and other receivables approximates
their fair values based on cash flows discounted using a rate based on
the average short-term borrowing rate of 5.58% (2004: 5.22%).
F-42
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
20 Fixed assets
Furniture,
fixture,
Telecommu- motor
nications vehicles and
networks and other
Buildings equipment equipment Total
------------ ----------------- ----------------- ------------
RMB RMB RMB RMB
million million million million
Cost / valuation:
Balance at January 1, 2004, as
restated due to the Acquisition
(Note 2) 38,369 247,128 11,438 296,935
Effects of adoption of HKAS 17:
Reclassification of land use rights
to lease prepayments for land
(Note 3(c)) (2,107) - - (2,107)
------------ ----------------- ----------------- ------------
Balance at January 1, 2004, as 36,262 247,128 11,438 294,828
restated
Additions 114 713 526 1,353
Transferred from construction in
progress 1,686 30,817 1,888 34,391
Disposals/write off (67) (949) (177) (1,193)
Increase as a result of revaluation - 17,140 1,503 18,643
Decrease as a result of revaluation - (21,201) (1,065) (22,266)
Distributed to owner on Listing
Reorganization (12,028) (9,265) (325) (21,618)
------------ ----------------- ----------------- ------------
Balance at December 31, 2004, as
restated 25,967 264,383 13,788 304,138
------------ ----------------- ----------------- ------------
Accumulated depreciation:
Balance at January 1, 2004, as
restated due to the Acquisition
(Note 2) (7,361) (102,487) (4,999) (114,847)
Effects of adoption of HKAS 17:
Reclassification of land use rights
to lease prepayments for land
(Note 3(c)) 375 - - 375
------------ ----------------- ----------------- ------------
Balance at January 1, 2004, as (6,986) (102,487) (4,999) (114,472)
restated
Depreciation charge for the year (1,042) (22,377) (1,551) (24,970)
Disposals/write off 7 683 125 815
Increase as a result of revaluation - (13,458) (1,322) (14,780)
Decrease as a result of revaluation - 10,461 487 10,948
Distributed to owner on Listing
Reorganization 2,639 2,505 74 5,218
------------ ----------------- ----------------- ------------
Balance at December 31, 2004, as
restated (5,382) (124,673) (7,186) (137,241)
------------ ----------------- ----------------- ------------
Net book value at December 31, 2004,
as restated 20,585 139,710 6,602 166,897
============ ================= ================= ============
Net book value at January 1, 2004,
as restated 29,276 144,641 6,439 180,356
============ ================= ================= ============
F-43
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
20 Fixed assets (continued)
Furniture,
fixture,
Telecommu- motor
nications vehicles and
networks and other
Buildings equipment equipment Total
------------ ----------------- ----------------- ------------
RMB RMB RMB RMB
million million million million
Cost / valuation:
Balance at January 1, 2005,
as restated due to the
Acquisition (Note 2) 27,649 264,383 13,788 305,820
Effects of adoption of HKAS
17:
Reclassification of land use
rights to lease
prepayments for land (Note
3 (c)) (1,682) - - (1,682)
----------------- ---------------- ----------------- ----------------
Balance at January 1, 2005, 25,967 264,383 13,788 304,138
as restated
Reclassifications 818 (4,981) 4,163 -
Additions 413 975 490 1,878
Transferred from construction
in progress 1,659 23,106 2,053 26,818
Disposals/write off (48) (1,940) (541) (2,529)
Distributed to owner upon
reorganization for the
Acquisition (1,759) (1,242) (183) (3,184)
----------------- ---------------- ----------------- ----------------
Balance at December 31, 2005 27,050 280,301 19,770 327,121
----------------- ---------------- ----------------- ----------------
Accumulated depreciation:
Balance at January 1, 2005,
as restated due to the
Acquisition (Note 2) (5,789) (124,673) (7,186) (137,648)
Effects of adoption of HKAS
17:
Reclassification of land use
rights to lease
prepayments for land (Note
3(c)) 407 - - 407
----------------- ---------------- ----------------- ----------------
Balance at January 1, 2005, (5,382) (124,673) (7,186) (137,241)
as restated
Reclassifications (354) 1,170 (816) -
Charge for the year (956) (21,541) (2,157) (24,654)
Disposals/write off 4 1,662 451 2,117
Distributed to owner upon
reorganization for the
Acquisition 487 743 90 1,320
----------------- ---------------- ----------------- ----------------
Balance at December 31, 2005 (6,201) (142,639) (9,618) (158,458)
----------------- ---------------- ----------------- ----------------
Net book value at December
31, 2005 20,849 137,662 10,152 168,663
================= ================ ================= ================
Net book value at January 1,
2005, as restated 20,585 139,710 6,602 166,897
================= ================ ================= ================
F-44
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
20 Fixed assets (continued)
(a) The net book value of assets held under finance lease is as follows:
Furniture,
fixture,
Telecommu- motor
nications vehicles and
networks and other
Buildings equipment equipment Total
------------ ----------------- ----------------- ------------
RMB RMB RMB RMB
million million million million
As at December 31, 2004 8 3,574 97 3,679
================ ================= ================= ================
As at December 31, 2005 1 2,551 109 2,661
================ ================= ================= ================
(b) The analysis of the cost or revaluation of the fixed assets of the
Group is as follows:
Furniture,
fixture,
Telecommu- motor
nications vehicles and
networks and other
Buildings equipment equipment Total
---------------- ----------------- ----------------- ----------------
RMB RMB RMB RMB
million million million million
December 31, 2004
Cost 25,967 - - 25,967
Valuation - 264,383 13,788 278,171
---------------- ----------------- ----------------- ----------------
25,967 264,383 13,788 304,138
================ ================= ================= ================
December 31, 2005
Cost 27,050 - - 27,050
Valuation ii- 280,301 19,770 300,071
---------------- ----------------- ----------------- ----------------
27,050 280,301 19,770 327,121
================ ================= ================= ================
The Group's buildings are primarily located in the PRC on land held on
leases of primarily between 10 to 50 years.
F-45
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
20 Fixed assets (continued)
(c) As required by the PRC rules and regulations relevant to the Listing
Reorganization, each class of fixed assets as at December 31, 2003 was
valued by Beijing China Enterprise Appraisal Co. Ltd. (the "PRC valuer
"), independent valuers registered in the PRC, on a depreciated
replacement cost basis. The value of such assets in the PRC injected
into the Group was determined at RMB122,456 million. Such revalued
amount serves as the tax base of the assets with immediate effect.
Certain fixed assets, other than lease prepayments for land and
buildings, of which the surplus on revaluation of RMB2,982 million was
credited to the revaluation reserve while the deficit arising from the
revaluation of such fixed assets of RMB25,778 million was recognized as
an expense for the year ended December 31, 2003.
For the Listing Reorganization, valuations of the lease prepayments for
land and buildings were also performed. The surplus value of such
assets was determined at RMB6,967 million. Such amount serves as the
tax base for such assets with immediate effect. Details have been set
out in Note 31(ii).
As required by the PRC rules and regulations relevant to the
Acquisition, each class of fixed assets in the PRC, acquired as at
December 31, 2004, was valued by Beijing China Enterprise Appraisal Co.
Ltd. (the "PRC valuer"), independent valuers registered in the PRC, on
a depreciated replacement cost basis. The value of such assets in the
PRC acquired was determined at RMB42,879 million. Such amount serves as
the tax base for such assets with immediate effect. Certain fixed
assets, other than lease prepayments for land and buildings, of which
the surplus on revaluation of RMB3,863 million was credited to the
revaluation reserve while the deficit arising from the revaluation of
such fixed assets of RMB11,318 million was recognized as an expense for
the year ended December 31, 2004.
For the Acquisition, valuations of the lease prepayments for land and
buildings were also performed. The surplus value of such assets was
determined at RMB2,553 million. Such amount serves as the tax base for
such assets with immediate effect. Details have been set out in Note
31(ii).
The respective carrying amount of the telecommunications networks and
equipment and furniture, fixture, motor vehicles and other equipment
would have been RMB158,193 million and RMB11,233 million as at December
31, 2005 and RMB141,314 million and RMB6,645 million as at December 31,
2004 had they been stated at cost less accumulated depreciation.
F-46
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
20 Fixed assets (continued)
(c) (continued)
Regarding the valuation of fixed assets carried out at December 31,
2004 in relation to the Acquisition, the carrying amounts of these
fixed assets and, where applicable, the corresponding revalued amounts
of these assets are as follows:
Historical
carrying Revaluation Revaluation Revalued
amount surplus deficit amount
--------------- ---------------- ---------------- -------------
RMB RMB RMB RMB
million million million million
At December 31, 2004
Buildings 7,142 - - 7,142
Telecommunications networks and
equipment 39,881 3,682 (10,740) 32,823
Furniture, fixture, motor
vehicles and other equipment 2,542 181 (578) 2,145
--------------- ---------------- ---------------- -------------
49,565 3,863 (11,318) 42,110
=============== ================ ================ =============
The directors have carried out a review of the Group's fixed assets and
concluded that there was no impairment of fixed assets as at December
31, 2005, nor was there any significant change in value of fixed assets
at that date.
At December 31, 2005, no fixed assets were pledged as security for the
Group's long term bank and other loans (2004: RMB 22 million)
21 Construction in progress
As at December 31,
------------------------------------------------------
2004 2005
----------------------- ---------------------
RMB million RMB million
Restated
Notes 2&3
Balance at beginning of year 18,049 11,068
Effects of adoption of HKAS 17:
Reclassification from land use rights to lease
prepayments for land (Note 3 (c)) (643) (471)
----------------------- ---------------------
Balance as at January 1, as restated 17,406 10,597
Additions 28,983 23,258
Transferred to fixed assets (34,391) (26,818)
Distributed to owner in accordance with the
Reorganizations (1,401) (215)
----------------------- ---------------------
Balance at end of year 10,597 6,822
======================= =====================
F-47
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
22 Lease prepayment for land
This represents land use rights in PRC and their net book value is
analyzed as follows:
As at December 31,
------------------------------------------------------
2004 2005
------------------------- ------------------------
RMB million RMB million
Restated
Notes 2&3
Held for
Lease of between 10 to 50 years 1,733 1,933
Lease of less than 10 years 13 16
------------------------- ------------------------
1,746 1,949
========================= ========================
The movement of the lease prepayments for land is as follows:
As at December 31,
------------------------------------------------------
2004 2005
------------------------- ------------------------
RMB million RMB million
Restated
Notes 2&3
Balance at beginning of year from reclassification
from land use right 2,375 1,746
Additions 202 280
Charge for the year (51) (37)
Distributed to owner in accordance with the
reorganizations (780) (40)
------------------------- ------------------------
Balance at end of year 1,746 1,949
========================= ========================
F-48
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
23 Intangible assets
Negative Purchased Sponsorship Total
goodwill software fees
------------- --------------- ----------------- -----------
RMB RMB RMB RMB
million million million million
(Note 37(xv))
Cost:
Balance at January 1, 2004 (178) 984 - 806
Additions - 266 - 266
------------- --------------- ----------------- -----------
Balance at December 31, 2004 (178) 1,250 - 1,072
------------- --------------- ----------------- -----------
Accumulated amortization:
Balance at January 1, 2004 (2) (529) - (531)
Amortization for the year 14 (173) - (159)
------------- --------------- ----------------- -----------
Balance at December 31, 2004 12 (702) - (690)
------------- --------------- ----------------- -----------
Net book value at January 1, 2004 (180) 455 - 275
------------- --------------- ----------------- -----------
Net book value at December 31, 2004 (166) 548 - 382
============= =============== ================= ===========
Cost:
Balance at January 1, 2005 (178) 1,250 - 1,072
Impacts of adoption of HKFRS 3:
Transferred from negative goodwill to retained
earnings (Note 3(b)) 181 - - 181
------------- --------------- ----------------- -----------
Balance at January 1, 2005, as restated 3 1,250 - 1,253
Additions - 663 540 1,203
------------- --------------- ----------------- -----------
Balance at December 31, 2005 3 1,913 540 2,456
------------- --------------- ----------------- -----------
Accumulated amortization
Balance at January 1, 2005 12 (702) - (690)
Impacts of adoption of HKFRS 3:
Transferred from negative goodwill to retained
earnings (Note 3(b)) (15) - - (15)
------------- --------------- ----------------- -----------
Balance at January 1, 2005, as restated (3) (702) - (705)
Amortization for the year - (223) (135) (358)
------------- --------------- ----------------- -----------
Balance at December 31, 2005 (3) (925) (135) (1,063)
------------- --------------- ----------------- -----------
Net book value at December 31, 2005 - 988 405 1,393
============= =============== ================= ===========
The intangible assets will be fully amortized in the five succeeding fiscal years.
F-49
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
24 Other non-current assets
As at December 31,
-------------------------------------------------
2004 2005
---------------------- ---------------------
RMB million RMB million
Restated
Notes 2&3
Installation cost 4,866 4,197
Customer acquisition costs 1,304 -
Prepaid network capacities 1,322 1,454
Discount on foreign exchange forward contracts
(note 3(d)) 59 -
Others 985 383
---------------------- ---------------------
8,536 6,034
======================= =====================
During 2005, due to a change in the nature of promotions
offered by the Group, the amortisation period of customer
acquisition costs fell below one year. In response to this,
the Group has recorded customer acquisition costs arising from
2005 as prepayments and other receivables. The total amount of
customer acquisition costs in prepaid expenses as at December
31, 2005 was RMB 324 million (2004: Nil).
F-50
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
25 Accounts payable
As at December 31,
----------------------------------------------
2004 2005
--------------------- ---------------------
RMB million RMB million
Restated
Note 2
0-30 days 8,371 6,281
31-60 days 2,351 1,796
61-90 days 1,223 1,297
91-180 days 2,922 1,940
Over 180 days 6,258 5,405
--------------------- ---------------------
Total 21,125 16,719
===================== =====================
Included in accounts payable are amounts due to other state-owned
telecommunications operators amounting to RMB 48 million (2004: RMB
69 million).
F-51
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
26 Accruals and other payables
Group
----------------------------------------------
As at December 31,
----------------------------------------------
2004 2005
---------------------- ------------------
RMB RMB
million million
---------------------- ------------------
Restated
Note 2
Accrued expenses 1,580 872
Other payables 3,286 3,033
---------------------- ------------------
Total 4,866 3,905
====================== ==================
27 Bank and other loans
(a) The short term bank loans were unsecured and comprise:
As at December 31,
-----------------------------------------
Currency Interest rate and final maturity 2004 2005
-------------------- -------------------------------------- -------------------- -----------------
RMB million RMB million
Restated
Note 2
Renminbi Interest rates ranging from 4.70% to
denominated 5.02% per annum with maturity
through December 18, 2006 44,692 47,341
US Dollar Interest rates ranging from 2.59% to
denominated 3.98% per annum 190 -
-------------------- -----------------
44,882 47,341
==================== =================
The carrying values of short term bank loans approximate their fair
values which are based on cash flows discounted using a rate based on
the borrowing rate of 4.70%-5.02% (2004: 2.59%-5.94%).
Included in short-term bank loans were loans from state-owned banks
amounting to RMB 46,541 million as at December 31, 2005 (2004: RMB
43,472 million).
F-52
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
27 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise:
As at December 31,
--------------------------------------------------
Note 2004 2005
---------- ------------------------ --------------------
RMB million RMB million
Restated
Note 2
Bank loans (i) 34,678 22,734
Finance lease obligations (ii) 3,101 2,255
------------------------ --------------------
37,779 24,989
======================== ====================
Less: Current portion (11,727) (6,846)
------------------------ --------------------
26,052 18,143
======================== ====================
The carrying values of the current portion of long term bank loans
approximate their fair values which are based on cash flows
discounted using a rate based on the borrowing rate of 5.58% (2004:
5.22%).
Included in the long term bank loans were loans from state-owned
banks amounting to RMB 22,685 million as at December 31, 2005 (2004:
RMB 33,218 million).
(i) Long term bank loans
As at December 31,
-----------------------------------------------
2004 2005
------------------------- ------------------
RMB million RMB million
Restated
Note 2
Loans
Unsecured 32,075 22,414
Secured 2,603 320
------------------------- ------------------
Total 34,678 22,734
------------------------- ------------------
Less: Current portion (10,796) (5,579)
------------------------- ------------------
Long term loans 23,882 17,155
========================= ==================
F-53
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
27 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise (continued):
(i) Long term bank loans (continued)
The Group's long term bank loans were repayable as follows:
As at December 31,
--------------------------------------------------------
2004 2005
------------------------- ---------------------------
RMB million RMB million
Restated
Note 2
Within one year 10,796 5,579
In the second year 8,276 7,774
In the third to fifth year, inclusive 12,140 5,886
After the fifth year 3,466 3,495
------------------------- ---------------------------
34,678 22,734
========================= ===========================
As at December 31,
----------------------------------------------------
Currency Interest rate and final 2004 2005
maturity
------------------- ---------------------------- --------------------- ---------------------
RMB million RMB million
Restated
Bank loan Note 2
Renminbi Interest rates ranging
denominated from 2.40% to 10.08%
per annum with maturity
through December 20, 2019 29,503 20,736
US Dollar Interest rates ranging
denominated from 1.25% to 8.00% per
annum with maturity
through October 31, 2039 3,223 1,241
Japanese Yen Interest rate is 2.12% per
denominated annum with maturity
through January 7, 2014 1,342 327
Euro denominated Interest rates ranging
from 0.50% to 7.35% per
annum with maturity
through March 15, 2034 610 430
--------------------- ---------------------
34,678 22,734
===================== =====================
As at December 31, 2005, secured bank loans of RMB 320 million (2004:
RMB 2,603 million) which were secured by the following:
o Corporate guarantees granted by China Netcom Group to the extent of RMB
75 million (2004: RMB 2,148 million); and
o Corporate guarantee granted by third parties to the extent of RMB 245
million (2004: RMB 452 million).
F-54
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
27 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise (continued):
(ii) Finance lease obligations
As at December 31,
-------------------------------------
2004 2005
---------------- -----------------
RMB million RMB million
Restated
Note 2
Obligation under finance leases 3,101 2,255
Less: current portion (931) (1,267)
---------------- -----------------
2,170 988
================ =================
In 2005, the Group has entered into a finance lease arrangement with a
related party, getting funding of RMB 322 million. The net book value
of the assets under finance lease was RMB 317 million as at December
31, 2005 (2004: RMB 2,592 million). The accumulated finance lease
obligation as at December 31, 2005 amounted to RMB 2,255 million.
(2004: RMB 2,408 million).
The interest rates charged on finance lease are ranging from 2.50% to
5.70% with maturity through December 8, 2008 (2004: 2.50% to 5.18% with
maturity through December 31, 2007).
The Group's liabilities under finance leases are analyzed as follows:
As at December 31,
-------------------------------------------
2004 2005
--------------------- ------------------
RMB million RMB million
Restated
Note 2
Within one year 1,005 1,319
In the second year 1,396 903
In the third to fifth year, inclusive 831 106
--------------------- ------------------
3,232 2,328
Less: future finance charges on finance leases (131) (73)
--------------------- ------------------
Present value of finance lease liabilities 3,101 2,255
===================== ==================
The present value of finance lease liabilities is as follows:
Within one year 931 1,267
In the second year 1,350 885
In the third to fifth year, inclusive 820 103
--------------------- ------------------
3,101 2,255
===================== ==================
F-55
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
27 Bank and other loans (continued)
(c) The fair value of the Group's non-current portion of long term bank and
other loans at December 31, 2005 and 2004 were as follows:
As at December 31,
-----------------------------------------
2004 2005
-------------------- -----------------
RMB million RMB million
Restated
Notes 2&3
Long term bank loans 21,899 15,571
Finance lease obligations 1,908 958
-------------------- -----------------
23,807 16,529
==================== =================
The fair value are based on cash flows discounted using rates based on
the borrowing rates of ranging from 2.54% to 6.12% (2004: 0.19% to
9.20%).
28 Amount due from/(to) holding companies and fellow subsidiaries
As at 31 December,
----------------------------------------
Note 2004 2005
------- ------------------ ------------------
RMB million RMB million
Restated
Note 2
Current:
Due from ultimate holding company (a) 785 89
Due from other holding companies (a) 1 1
Due from fellow subsidiaries (a) 301 157
------------------ -----------------
Total 1,087 247
================== ==================
Due to ultimate holding company
-Deferred consideration (b) - 1,960
-Others (a) 3,704 3,877
Due to fellow subsidiaries (a) 6,376 3,153
------------------ ------------------
Total 10,080 8,990
================== ==================
Non-current:
Due to ultimate holding company
-Deferred consideration (b) - 7,840
------------------ ------------------
Total - 7,840
================== ==================
F-56
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
28 Amount due from/(to) holding companies and fellow subsidiaries
(continued)
Note:
(a) These are interest free, unsecured and have no fixed terms of
repayment.
(b) Balance represents the deferred payments arising from the
Acquisition outstanding at year end. The balance is charged at
interest rate of 5.265% per annum with final maturity through
June 30, 2010. The deferred payment is analyzed as follows:
As at 31 December
------------------------------------------------
2004 2005
---------------------- ----------------------
RMB million RMB million
Within one year - 1,960
In the second year - 1,960
In the third to fifth year, inclusive - 5,880
---------------------- ----------------------
Total - 9,800
====================== ======================
29 Deferred revenues
As at December 31,
-----------------------------------------------
2004 2005
----------------------- --------------------
RMB million RMB million
Restated
Note 2
Balance at beginning of year:
-upfront connection fees 13,256 8,910
-upfront installation fees 8,001 7,638
-advances from network capacity sales 2,050 2,173
-prepaid telephony services 3,677 4,143
----------------------- --------------------
26,984 22,864
----------------------- --------------------
Additions for the year:
-upfront connection fees - -
-upfront installation fees 1,205 573
-advances from network capacity sales 242 461
-prepaid telephony services 18,636 24,435
----------------------- --------------------
20,083 25,469
----------------------- --------------------
Reductions for the year:
-upfront connection fees (4,346) (3,405)
-upfront installation fees (1,568) (1,442)
-advances from network capacity sales (114) (280)
-prepaid telephony services (18,126) (24,306)
----------------------- --------------------
(24,154) (29,433)
----------------------- --------------------
F-57
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
29 Deferred revenues (continued)
As at December 31,
--------------------------------------------------
2004 2005
------------------------ ---------------------
RMB million RMB million
Restated
Note 2
Distributed to owner in accordance with Listing Reorganization
- advances from network capacity sales (5) -
- prepaid telephony services (44) -
------------------------ ---------------------
(49) -
------------------------ ---------------------
Balance at end of year:
- upfront connection fees 8,910 5,505
- upfront installation fees 7,638 6,769
- advances from network capacity sales 2,173 2,354
- prepaid telephony services 4,143 4,272
------------------------ ---------------------
22,864 18,900
------------------------ ---------------------
Representing:
- Current portion 8,876 7,975
- Non-current portion 13,988 10,925
------------------------ ---------------------
22,864 18,900
------------------------ ---------------------
30 Provisions
Early retirement One-off cash Total
benefits housing subsidies
--------------------- -------------------- ----------------
RMB RMB RMB
million million million
Note(b), 4p(ii) Note(a),(b)
At January 1, 2004, as restated (Note 2) 4,139 3,988 8,127
Additional provisions 693 - 693
Payments during the year (640) (479) (1,119)
--------------------- -------------------- ----------------
At December 31, 2004 4,192 3,509 7,701
===================== ==================== ================
Analysis of total provisions:
-Current portion 618 3,509 4,127
-Non-current portion 3,574 - 3,574
--------------------- -------------------- ----------------
4,192 3,509 7,701
===================== ==================== ================
At January 1, 2005 4,192 3,509 7,701
Additional provisions 2 - 2
Payments during the year (431) (69) (500)
--------------------- -------------------- ----------------
At December 31, 2005 3,763 3,440 7,203
--------------------- -------------------- ----------------
F-58
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
30 Provisions (continued)
Early retirement One-off cash Total
benefits housing subsidies
--------------------- --------------------- ------------
RMB RMB RMB
Million million million
Note(b), 4p(ii) Note(a), (b)(C)
Analysis of total provisions:
-Current portion 589 3,440 4,029
-Non-current portion 3,174 - 3,174
--------------------- --------------------- ------------
3,763 3,440 7,203
===================== ===================== ============
(a) Certain staff quarters, prior to 1998, have been sold to its employees,
subject to a number of eligibility requirements, at preferential
prices. In 1998, the State Council issued a circular which stipulated
that the sale of quarters to employees at preferential prices should be
terminated. In 2000, the State Council issued a further circular
stating that cash subsidies should be made to certain eligible
employees following the withdrawal of allocation of staff quarters.
However, the specific timetable and procedures of implementation of
these policies were to be determined by individual provincial or
municipal government based on the particular situation of the provinces
or municipality.
Based on the relevant detailed local government regulations
promulgated, certain entities within the Group have adopted cash
housing subsidy plans. In accordance with these plans, for those
eligible employees who had not been allocated with quarters or who had
not been allocated with quarters up to the prescribed standards before
the discounted sales of quarters were terminated, the Group is required
to pay them one-off cash housing subsidies based on their years of
service, positions and other criteria. Based on the available
information, the Group estimated the required provision for these cash
housing subsidies amounting to RMB4,142 million, which was charged to
the consolidated income statement in the year ended December 31, 2000
when the State Council circular in respect of cash subsidies was
issued.
(b) Pursuant to the Listing Reorganization and the Acquisition, if the
actual payments required for these subsidies and early retirement
benefits differ from the amount provided as at June 30, 2004 and June
30, 2005, China Netcom Group will bear any additional payments required
or will be paid the difference if the actual payments are lower than
the amount provided. There was no material settlement during the year
ended December 31, 2005. (2004: Nil)
F-59
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
31 Deferred taxation
Movements of the deferred tax assets and liabilities are as follows:
Recognized
Balance at in income Recognized Recognized Balance at
December 31, 2004 statement in equity in equity December 31,2005
------------------ ------------- ------------ ------------ ------------------
RMB million RMB million RMB million RMB million RMB million
------------------ ------------- ------------ ------------ ------------------
Restated Note (i) Note
Note 2&3
Deferred tax assets:
Deferred revenue, primarily advances
from customers 208 (29) (9) - 170
Temporary differences from allowance for
doubtful debts 398 245 (293) - 350
Unrecognized revaluation surplus and deficit
(Note (ii)) 2,114 (96) - 843 2,861
Provision for early retirement benefits 597 (99) (498) - -
Depreciation of fixed assets 325 95 (420) - -
Others 162 (10) (53) - 99
------------------ ------------- -------------------------- ------------------
Balance at end of year 3,804 106 (1,273) 843 3,480
------------------ ------------- -------------------------- ------------------
Deferred tax liabilities
Interest capitalized (1,489) 32 196 - (1,261)
Others (87) 24 - - (63)
------------------ ------------- -------------------------- ------------------
Balance at end of year (1,576) 56 196 - (1,324)
------------------ ------------- -------------------------- ------------------
The amounts in the consolidated balance
sheet are as follows:
Deferred tax assets to be recovered after
more than 12 months 2,997 2,906
------------------ ------------------
Deferred tax liabilities to be settled
after more than 12 months (1,318) (1,190)
------------------ ------------------
F-60
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
31 Deferred taxation (continued)
Balance at Recognized Balance at
December 31, in income Recognized Recognized Recognized Recognized December 31,
2003 statement in equity in equity in equity in equity 2004
--------------------------------------------------------------------------------------------
RMB million RMB million RMB million RMB million RMB million RMB million RMB million
--------------------------------------------------------------------------------------------
Restated Note (iii) Note (i) Note (i) Note (ii)
Note 2&3
Deferred tax assets:
Deferred revenue, primarily
advances from customers 944 (223) - - (513) - 208
Temporary differences from
allowance for doubtful debts 458 166 - - (226) - 398
Unrecognized revaluation surplus
and deficit (Note (ii)) - (241) - - 2,355 2,114
Provision for early retirement
benefits 1,431 111 - - (945) - 597
Disposal of fixed assets 1,577 (944) - - (633) - -
Losses of taxation purpose - 704 (704) - - - -
Depreciation of fixed assets - 325 - - - - 325
Others 450 (25) - - (263) - 162
--------------------------------------------------------------------------------------------
Balance at end of year 4,860 (127) (704) - (2,580) 2,355 3,804
--------------------------------------------------------------------------------------------
Deferred tax liabilities:
Revenue recognition (712) 133 - - 579 - -
Depreciation of fixed assets (4,843) 3,321 - (1,275) 2,797 - -
Deferred costs (245) 114 - - 131 - -
Interest capitalized (1,059) (160) - - (270) - (1,489)
Others (113) (26) - - 52 - (87)
--------------------------------------------------------------------------------------------
Balance at end of year (6,972) 3,382 - (1,275) 3,289 - (1,576)
--------------------------------------------------------------------------------------------
The amounts in the consolidated
balance sheet as follows:
Deferred tax assets to be recovered
after more than 12 months 2,408 2,997
------------- -----------
Deferred tax liabilities to be
settled after more than 12 months (5,997) (1,318)
------------- -----------
Balance at
Recognized in Recognized in December 31,
equity equity 2004
----------------- ------------------ ---------------
RMB million RMB million RMB million
----------------- ------------------ ---------------
Note (i) Note (ii)
Deferred tax assets:
Deferred revenue, primarily advances from customers (513) - 208
Temporary differences from allowance for doubtful
debts (226) - 398
Unrecognized revaluation surplus and deficit (Note
(ii)) - 2,355 2,114
Provision for early retirement benefits (945) - 597
Disposal of fixed assets (633) - -
Losses of taxation purpose - - -
Depreciation of fixed assets - - 325
Others (263) - 162
----------------- -----------------------------------
Balance at end of year (2,580) 2,355 3,804
----------------- -----------------------------------
Deferred tax liabilities:
Revenue recognition 579 - -
Depreciation of fixed assets 2,797 - -
Deferred costs 131 - -
Interest capitalized (270) - (1,489)
Others 52 - (87)
----------------- -----------------------------------
ii
Balance at end of year 3,289 - (1,576)
----------------- -----------------------------------
The amounts in the consolidated balance sheet as follows:
Deferred tax assets to be recovered after more than
12 months 2,997
-----------------
Deferred tax liabilities to be settled after more
than 12 months (1,318)
-----------------
F-61
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
31 Deferred taxation (continued)
Notes:
(i) As described in Note 20, in connection with the Listing
Reorganization and the Acquisition, certain of the Group's
telecommunications networks and equipment and furniture, fixture,
motor vehicles and other equipment were revalued as at December
31, 2003 and 2004. Such revalued amounts determine the tax bases
for these assets for future years. In addition, except for the
item described in Note (ii) below, the tax bases of certain assets
and liabilities have been adjusted to the revalued amounts
incorporated as the carrying values in the balance sheet.
In connection with the Listing Reorganization, the Group's net
deferred tax liabilities were reduced by RMB 709 million
(comprising the recognition of deferred tax assets of RMB 2,580
million and deferred tax liabilities of RMB 3,289 million), and
this decrease was recorded as a credit to owner's equity upon the
date of the Reorganization on June 30, 2004. The RMB 709 million
net reduction of deferred tax liabilities, comprised RMB 846
million, being the deferred tax liabilities from the revaluation
surplus of fixed assets credited to revaluation reserves and RMB
137 million of deferred tax assets debited to retained earnings.
In connection with the Acquisition, the Group's net deferred tax
assets were subsequently reduced by RMB 1,076 million (comprising
deferred tax assets of RMB 1,272 million and deferred tax
liabilities of RMB 196 million), and this decrease was recorded as
a debit to owner's equity upon the date of the Reorganization on
June 30, 2005. The RMB 1,076 million net decrease of comprised RMB
1,097 million, being deferred tax liabilities originating from the
revaluation surplus of fixed assets recorded, was credited to
revaluation reserves and RMB 2,174 million deferred tax assets
were debited to retained earnings.
(ii) In addition, in order to determine the future tax bases used for
future years after the Listing Reorganization and the
Acquisition, the Group's up-front prepayments made for the
leasehold land and buildings were revalued for PRC tax purposes
as at December 31, 2003 and 2004. However, the resulting
revaluations of the up-front prepayments made for the leasehold
land and buildings were not incorporated into the consolidated
financial statements. As a result, deferred tax assets were
subsequently recorded with corresponding increases in owner's
equity upon the Listing Reorganization on June 30, 2004 and the
Acquisition on June 30, 2005. In the opinion of the directors,
it is more likely than not that the Group will realize the
benefits of the deferred tax asset after making reference to the
historical taxable income of the Group. The amount is
transferred to retained earnings upon the corresponding
realization of the underlying deferred tax assets.
During the Listing Reorganization, the leasehold land and
buildings had a net surplus on revaluation of RMB 6,967 million as
at December 31, 2003. As explained in the preceding paragraph, a
deferred tax asset of RMB 2,355 million was subsequently recorded
with a corresponding increase in owner's equity upon the Listing
Reorganization on June 30, 2004. The amount of transfer to
retained earnings for the year ended December 31, 2005 was RMB 57
million (2004: 241 million).
F-62
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
31 Deferred taxation (continued)
Notes:
(ii) (continued)
During the Acquisition, the leasehold land and buildings has a net
surplus on revaluation of RMB 2,553 million as at December 31,
2004. As explained above, a deferred tax asset of RMB 843 million
was subsequently recorded with a corresponding increase in owner's
equity upon the Acquisition on June 30, 2005. The amount of
transfer to retained earnings for the year ended December 31, 2005
was RMB 39 million.
(iii) This represents the net tax loss carried forward of the four newly
acquired provinces/autonomous from year 2004. As the tax loss was
utilised by China Netcom Group in the same year, the utilization
of the deferred tax assets was reflected as a distribution to the
owner in the combined statement of changes in owner's equity.
F-63
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
32 Share capital
Authorized
-----------------------------------------------------------------------------------------------------------
Convertible preference shares of
Ordinary shares of US$0.04 each US$0.04 each (Note (c)) Total
------------------------------------------- ------------------------------------- ---------------------
No of shares US$ RMB Million No of shares US$ RMB Million US$ RMB Million
--------------- -------------- ----------- ------------ -------- ------------ -------- -----------
At January 1, 2004,
December 31, 2004
and 2005 25,000,000,000 1,000,000,000 8,277 7,741,782 309,671 3 1,000,309,671 8,280
=============== ============== =========== ============ ========= ====== ============= =========
Issued
-----------------------------------------------------------------------------------------------------------
Convertible preference shares of
Ordinary shares of US$0.04 each US$0.04 each (Note (c)) Total
------------------------------------------------------- ------------------------------------------------
No of shares US$ RMB million No of shares US$ RMB Million US$ RMB Million
--------------- ------------- ----------- ------------ ------- ----------- --------- -----------
At January 1, 2004
(Note (b)) 5,492,258,218 219,690,329 1,816 7,741,782 309,671 3 220,000,000 1,819
--------------- ------------- ----------- ----------- ------- ------ ------------ ---------
Conversion of
convertible
preference shares
(Note (c)) 7,741,782 309,671 3 (7,741,782) (309,671) (3) - -
Issue of shares
through Global
Offering (Note
(d)) 1,093,529,000 43,741,160 362 - - - 43,741,160 362
--------------- ------------- ----------- ------------ -------- ------ ------------ ---------
At December 31,
2004 and 2005 6,593,529,000 263,741,160 2,181 - - - 263,741,160 2,181
--------------- ------------- ----------- ------------ -------- ------ ------------ ---------
F-64
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
32 Share capital (continued)
Notes:
(a) Pursuant to an ordinary resolution dated September 1, 2004,
the authorized share capital of the Company was increased to
US$1,000,000,000 by creating additional 99,600,000,000
shares of US$0.01 each. Pursuant to an ordinary resolution
passed on September 7, 2004, every four issued and unissued
shares of US$0.01 each were consolidated into one new share
of US$0.04 each. Following the creation of 99,600,000,000
additional shares and the share consolidation, the
authorized share capital of the Company is RMB 8,277 million
divided into 25,000,000,000 shares of US$0.04 each, of which
5,492,258,218 shares were in issue and fully paid. The
shares after the share consolidation rank pair in all
respects with each other. All references to the share
capital of the Company in this annual report have been
adjusted retrospectively to take into account the increase
in authorized share capital and share consolidation. The
increase in authorized capital is applied respectively in
presentation of share capital of the consolidated balance
sheets as detailed in notes below.
(b) The share capital presented in the consolidated balance sheet
at January 1, 2004 represents (i) the share capital of the
Company, including the shares as at January 1, 2004 totaling
50,000,000 ordinary shares, (ii) shares issued for the asset
injection arising from the Listing Reorganization totaling
5,442,258,218 ordinary shares.
The shares described in (ii) are deemed to have been issued
since January 1, 2004 as the shares were issued for business
combination under common control. The difference between the
nominal value of the shares described in (ii) and the value of
the net assets injected into the Company under the asset
injection, totaling approximately RMB 3,100 million, is
reflected as share premium.
(c) All preference shares were converted into ordinary shares of
the Company on August 30, 2004.
(d) On December 8, 2004, the Company completed its Global
Offering. The listing proceeds of the aforementioned Global
Offering of shares, net of share issue expenses of HK$650
million (equivalent to RMB689 million) amounted to
approximately HK$8,438 million (equivalent to RMB8,944
million). The resulting share premium amounted to
approximately HK$8,096 million (equivalent to RMB 8,582
million).
F-65
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
33 Share option scheme
A share option scheme was approved pursuant to a directors' resolution
on September 30, 2004 ("Share Option Scheme"). Share options are
granted to directors of the Company and to certain employees of the
Group at the directors' discretion. Share options can be exercised at
least 18 months from the later of the date of grant or the date of the
listing of the shares of the Company on the Hong Kong Stock Exchange
and subject to certain vesting schedules.
On October 22, 2004, 158,640,000 share options with an exercise price
of HK$ 8.40 each were granted to the directors of the Company and
certain employees of the Group (the "First Grant").
The total number of ordinary shares that are available for issuance
upon the exercise of options granted pursuant to this scheme may not
exceed 10% of the total number of issued ordinary shares. The Company
may, however, seek separate approvals from its shareholders for
granting options beyond the 10% limit.
Pursuant to the Company's share option plan, the Company granted
158,640,000 options to certain of its directors and employees,
immediately prior to the closing of its global offering, to subscribe
for its ordinary shares at the initial public offering price under the
Hong Kong public offering, excluding brokerage and trading fees, and
transaction and investor compensation levies. The First Grant has an
exercise period of six years from the date of grant.
On December 6, 2005, the board of directors approved the granting of
79,320,000 shares of share options to certain management personnel of
the newly acquired four northern provinces/autonomous region and other
professional personnel designated by the Compensation and Nomination
Committee.
A director resigned in 2004 and the options granted to him amounting to
920,000 were cancelled on the date of his resignation in accordance
with the terms of the share option scheme.
Three staff resigned in 2005 and the options granted to them amounting
to 1,017,000 cancelled on the date of his resignation in accordance
with the terms of the share option scheme.
The movement of the share options granted in the First Share scheme
during the year is summarized as follows:
No. of share options
Subscription
Outstanding Outstanding price per
as at Granted Exercised r Lapsed Cancelled as at share
January 1, during during the during during the December 31, of the
2005 the year year the year year 2005 Company
------------- ----------- ------------ ------------ ------------ --------------- --------------
HK$
No. of share
options 157,720,000 79,320,000 - - (1,017,000) 236,023,000 8.4/12.45
No. of
directors and
employees 455 260 - - (3) 712
The grant date fair value of the share options granted in the First
Grant is determined by the Black-scholes model based on the following
assumptions: expected dividend pay-off ratio of 35%, expected vesting
period of 5 years, expected fluctuation rate of 23.6% and risk-free
interest rate of 4.3%. The weighted average fair value of the share
option on grant date was determined as HK$ 1.22 per share (RMB1.28 per
share). Since there is subjectivity exercised in the valuation model
adopted and the assumption based on which the fair value of the share
options are determined, and any change in these subjective assumption
may have significant impact to the fair value of the share options, the
Black-Scholes Model adopted may not be able to reliably determine the
fair value of the share options.
F-66
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
34 Consolidated cash flow statements
(a) Reconciliation of profit before taxation to net cash flows generated from
operations
Year ended December 31,
------------------------------------------------------
2003 2004 2005
------------- ------------------ --------------
RMB RMB RMB
million million million
Restated Restated
Note 2 Note 2&3
Profit before taxation (18,124) 2,376 17,317
Depreciation of fixed assets and amortization of
intangible assets 26,781 25,129 25,012
Lease prepayments for land 19 51 37
Amortization of deferred revenues (20,365) (24,154) (29,433)
Deferred costs charged to the income statements 2,050 3,646 2,553
Deficit on revaluation of fixed assets 25,778 11,318 -
Bad and doubtful debts 1,026 1,185 1,148
Loss on disposal of fixed assets 2,224 212 363
Share based compensation - 18 104
Dividend income (45) (17) (29)
Share of loss of associated companies 416 1 -
Interest income (95) (87) (157)
Interest expense 4,008 3,751 3,586
Discount on foreign currency exchange forward contracts 20 18 -
Realized (gain) on disposal of short-term investments (1) - -
Unrealized loss on short-term investments (7) 4 -
Foreign exchange (gain)/loss 142 105 (232)
Impairment of property, plant and equipment and lease
prepayments for land 149 - -
Operating cashflow before working capital changes 23,976 23,556 20,269
Increase in accounts receivable (2,164) (1,010) (1,399)
(Increase)/decrease in inventories and consumables (148) 108 768
Decrease/(increase) in prepayments, other receivables
and other current assets 436 (505) 788
Increase in other non-current assets (3,665) (3,302) (519)
Increase/(decrease) in accounts payable 1,511 1,512 (3,281)
Decrease in accruals and other payables (592) (3,008) (1,363)
Increase in deferred revenues 16,173 20,083 25,469
------------- ------------------ --------------
Net cash inflow generated from operations 35,527 37,434 40,732
============= ================== ==============
(b) Major non-cash transactions
During 2005, the Group paid RMB 3,000 million out of the total
consideration for the Acquisition (Note 1). The remaining balance of
RMB 9,800 is recognized as deferred payments and included in amount due
to the ultimate holding company.
During 2005, the Group entered into finance lease arrangements in
respect of newly acquired fixed assets with a total capital value at
the inception of the lease of RMB 338 million (2004: RMB1,950 million;
2003: RMB 1,175 million).
F-67
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
34 Consolidated cash flow statements (continued)
(b) Major non-cash transactions (continued)
During 2004, the immediate holding company assigned a loan to the
Company which resulted in a direct debit to the Company's equity.
(c) Acquisition of Asia Global Crossing through Asia Netcom
The Group acquired 100% of certain entities previously controlled by
Asia Global Crossing through Asia Netcom by way of two acquisitions. On
March 10, 2003, the Group injected RMB 507 million into Asia Netcom, a
51% owned jointly controlled entity which acquired the entire interest
in certain entities, which own and operate an Asia-Pacific region cable
network providing city-to-city connectivity, data communications and
IP-based services, previously controlled by Asia Global Crossing. On
December 31, 2003, the Group acquired the remaining 49% of the equity
of Asia Netcom for a total cost of RMB 525 million.
From March 10, 2003 to December 31, 2003, Asia Netcom was accounted for
as a jointly controlled entity. On December 31, 2003, Asia Netcom
became a wholly owned subsidiary of the Company and was consolidated
into the Group's financial statements.
The net assets acquired and the net cash inflow in respect of the
purchase of the remaining 49% interest in Asia Netcom, which has a
group of subsidiaries, is analyzed as follows:
As at
December 31,
2003
RMB
million
Net assets acquired at their respective estimated fair values
Fixed assets 3,037
Deferred costs 870
Other non-current assets 157
Cash and bank deposits 580
Accounts receivables and other current assets 442
Accounts payable and other current liabilities (1,207)
Advances from network capacity sales (2,032)
Bank and other loans (1,011)
---------
Net assets 836
---------
49% of net assets 410
Goodwill (note 3b) 115
---------
Satisfied by Cash 525
=========
(525)
Cash and bank deposits acquired 580
---------
Net cash inflow in respect of the purchase of subsidiaries 55
=========
F-68
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
35 Banking facilities
As at December 31, 2005 and 2004, the Group's banking facilities are as
follows:
Group
----------------------------------------
As at December 31
----------------------------------------
2004 2005
-------------- -----------------
RMB million RMB million
Restated
Note 2
Amount utilized 79,560 70,075
Amount unutilized 24,349 104,731
-------------- -----------------
Aggregate banking facilities 103,909 174,806
============== =================
F-69
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
36 Commitments
(a) Capital commitments
Group
-----------------------------------------------------------
As at As at
December 31, December 31,
------------------------------ -------------------------
2004 2005
------------------------------ -------------------------
RMB million RMB million
Restated
Note 2
Contracted but not provided for
-Leasehold land and buildings 137 227
-Telecommunications networks and equipment 1,072 1,376
-Others 6 112
------------------------------ -------------------------
1,215 1,715
============================== =========================
Authorized but not contracted for
-Leasehold land and buildings 2 27
-Telecommunications networks and equipment 1,778 112
-Others - -
------------------------------ -------------------------
1,780 139
============================== =========================
(b) Operating lease commitments
The Group has future minimum lease payments under non-cancelable
operating leases in respect of premises and equipment as follows:
Group
-----------------------------------------------------------
As at As at
December 31, December 31,
----------------------------- --------------------------
2004 2005
----------------------------- --------------------------
RMB million RMB million
Restated
Note 2
Not later than one year 804 994
Later than one year and not later than five
years 1,148 1,373
Later than five years 1,518 1,699
----------------------------- --------------------------
3,470 4,066
============================= ==========================
F - 70
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
37 Related party transactions
All state-controlled enterprises, their subsidiaries, their key
management and their close family, and their employees represent
related parties of the Group as defined by HKAS 24. China Netcom Group,
the Group's parent company, is a state-controlled enterprise directly
controlled by the PRC government, which controls different state-owned
enterprises and drives the economy of the PRC. The Group is the
dominant fixed line telecommunications service provider in northen
China by virtue of its historical monopoly over these services. As a
result, the Group has extensive transactions including sales to,
purchases of services, goods and fixed assets from, leasing of assets
from and banking transactions with other state-owned parties in its
ordinary course of business. These transactions are carried out at
terms similar to those obtained by other state-owned parties and have
been reflected in the financial statements.
The Group's operations are subject to the supervision of and regulation
by the PRC Government. The Ministry of Information Industry (MII),
pursuant to the authority delegated by the PRC's State Council, is
responsible for formulating the policies and regulations for the
telecommunications industry in China, including granting license,
allocating frequency spectrum, formulating interconnection and
settlement arrangement between telecommunications operator, enforcing
industry regulation and reviewing tariffs for domestic services. Other
PRC governmental authorities also regulate tariff polices, capital
investment and foreign investment in the telecommunications industry.
As a state-owned telecommunication operator, the Group has extensive
transactions with other state-owned telecommunication operators in its
ordinary course of business. These transactions are carried out in
accordance with the rules and regulations stipulated by the MII of the
PRC Government and disclosed below.
The Group has extensive transactions with other members of the China
Netcom Group. It is possible that the terms of the transactions between
the Group and other members of the China Netcom Group are not the same
as those that would result from transactions with other related parties
or wholly unrelated parties.
Management believes that meaningful information relative to related
party disclosures has been adequately disclosed.
F - 71
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
37 Related party transactions (continued)
For the year ended,
------------------------------------------------
2003 2004 2005
------------ --------------- -------------
RMB RMB RMB
Notes million million million
--------------- ------------ --------------- -------------
Restated Restated
Note 2 Note 2&3
Emolument of key management (i)
- salaries and welfare - 14 22
- contributions to retirement scheme - 1 1
------------ ---------------- -------------
Subtotal - 15 23
============ =============== =============
Interconnection fees
- from fellow subsidiaries (iv)(b) - 148 251
- from other state-owned
telecommunications operators (iv)(b) 3,763 5,481 6,442
------------ --------------- -------------
Subtotal 3,763 5,629 6,693
============ =============== =============
Interconnection charges
- to fellow subsidiaries (iv)(b) - 198 611
- to other state-owned
telecommunications operators (iv)(b) 756 1,200 1,475
------------ --------------- -------------
Subtotal 756 1,398 2,086
============ =============== =============
Rental income from properties leased
to fellow subsidiaries (iv)(a),(iv)(c) 4 3 -
============ =============== =============
Purchase of materials
- from fellow subsidiaries (iv)(a),(iv)(c) 3,091 2,122 1,298
- from other related companies (iv)(a),(iv)(c) 1,801 822 231
------------ --------------- -------------
Subtotal 4,892 2,944 1,529
============ =============== =============
Receipt of engineering, project
planning, design, construction and
information technology services
- from fellow subsidiaries (iv)(a),(iv)(b) 2,624 3,185 2,236
- from other related companies (iv)(a),(iv)(b) 1,573 392 413
------------ --------------- -------------
Subtotal 4,197 3,577 2,649
============ =============== =============
Ancillary telecommunications
support services
- from fellow subsidiaries (v) 1,113 554 435
- from other related companies (v) 767 235 51
F - 72
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
------------ --------------- -------------
Subtotal 1,880 789 486
============ =============== =============
F - 73
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
37 Related party transactions (continued)
For the year ended,
-----------------------------------------------
2003 2004 2005
------------- ------------- --------------
Notes RMB RMB RMB
-----------------
million million million
Restated Restated
Note 2 Note 2&3
Payment of operating lease rentals
of premises
- to fellow subsidiaries (iv)(a),(iv)(c) 17 311 655
- to other related companies (iv)(a),(iv)(c) 35 5 -
------------- ------------- --------------
Subtotal 52 316 655
============= ============= ==============
Property sub-lease rentals to
fellow subsidiaries (iv)(a),(iv)(c) - 33 15
============= ============= ==============
Common corporate services income
from ultimate holding company (vi) - 19 89
============= ============= ==============
Common corporate services
expenditure paid to ultimate
holding company (vi) - 213 279
============= ============= ==============
Support services received
- from ultimate holding company (vii) - - 2
- from fellow subsidiaries (vii) 1,494 937 888
- from other related companies (vii) 1,479 1,487 264
------------- ------------- --------------
Subtotal 2,973 2,424 1,154
============= ============= ==============
Telecommunications rental income
from other state-owned
telecommunications operators (iv)(b) 1,656 1,182 1,271
============= ============= ==============
Payment for lease of
Telecommunications facility
- to ultimate holding company (viii) - - 85
- to fellow subsidiaries (viii) - 138 215
------------- ------------- --------------
Subtotal - 138 300
============= ============= ==============
Payment for purchase of long-term
telecommunications capacity to
fellow subsidiaries (ix) - 173 117
============= ============= ==============
Payment for lease of long-term
telecommunications capacity to
fellow subsidiaries (x) - 28 84
============= ============= ==============
Management fee received from fellow
subsidiaries (xi) - 28 39
============= ============= ==============
F - 74
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
37 Related party transactions (continued)
Notes:
(i) Represents the emoluments paid to all of the directors and the
top management of the Group, who are considered as the related
parties of the Group.
(ii) The Group entered into finance lease arrangements with a
related party, details have been set out in Note 27 (b(ii)).
(iii) Related party represents the non-listed investees of the
fellow subsidiaries.
(iv) priced based on one of the following three criteria:
(a) market price;
(b) prices based on government guidance; or
(c) cost plus basis.
(v) Represents provision of ancillary telecommunications support
services to the Group by the fellow subsidiaries and the
related companies. These services include certain
telecommunications pre-sale, on-sale and after-sale services,
certain sales agency services, the printing and delivery of
invoice services, the maintenance of certain air-conditioning,
fire alarm equipment and telephone booths and other customer
services.
(vi) The Group entered into a Master Service Sharing agreement with
China Netcom Group pursuant to which expenses associated with
common corporate services is allocated between the Group and
China Netcom Group based on total asset as appropriate.
(vii) Represents the support services provided to the Group by the
fellow subsidiaries and the related companies. These support
services include equipment leasing services, motor vehicles
services, safety and security services, conference services,
basic construction agency services, equipment maintenance
services, employee training services, advertising services,
printing services and other support services.
(viii) The Group entered into a Telecommunications Facilities Leasing
Agreement with China Netcom Group pursuant to which the Group
leases the international telecommunications facilities and
inter-provincial transmission optic fibers from China Netcom
Group. The lease payment is based on the depreciation charge
of the assets.
(ix) The Group entered into a Capacity Purchase Agreement with East
Asia Netcom Limited ("EANL"), a wholly owned subsidiary of
China Netcom Group, pursuant to which the Group receives
certain amounts of long-term telecommunications capacity from
China Netcom Group at market prices as set out in the Capacity
Purchase Agreement.
(x) The Group entered into a Capacity Lease Agreement with EANL,
pursuant to which the Group leases certain amount of capacity
of China Netcom Group's telecommunications network at market
rates as set out in the Capacity Lease Agreement.
F - 75
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
37 Related party transactions (continued)
(xi) The Group entered into a Management Services Agreement with
EANL, pursuant to which the Group provides certain management
services to China Netcom Group either on a cost reimbursement
basis or on the basis of cost plus reasonable profits not
exceeding the market price as set out in the Management
Service Agreement.
(xii) In addition, pursuant to the Listing Reorganization and the
Acquisition, China Netcom Group have agreed to hold and
maintain, for the Group's benefit, all licenses received from
the MII in connection with the Restructured Businesses
transferred to the Group. The licenses maintained by China
Netcom Group were granted by the MII at nil or nominal costs.
To the extent that China Netcom Group incurs a cost to
maintain or obtain licenses in the future, the Company has
agreed reimburse China Netcom Group for any such expense.
(xiii) China Netcom Group has also agreed to indemnify the Group in
connection with any tax and deferred tax liabilities not
recognized in the financial statements of the Group arising
from transactions prior to the date of Listing Reorganization
and the Acquisition in relation to the business of the Group
prior to the Acquisition and the business of the newly
required four provinces/autonomous region respectively.
(xiv) As at December 31, 2005, China Netcom Group granted corporate
guarantee to the Group as set out in Note 27 (b(i)).
(xv) China Netcom Group, the Group's ultimate holding company,
entered into an agreement (the "Sponsorship Agreement") with
Beijing Organization Committee ("BOCOG") which designated
China Netcom Group as the exclusive fixed-line
telecommunications services partner in the People's Republic
of China ("PRC") to sponsor the 2008 Beijing Olympic Games.
China Netcom Group allocated the sponsorship fee to its
members based on the estimated future benefits derived from
the Sponsorship Agreement to respective members and the Group
has contributed a portion of the required support under the
Sponsorship Agreement through providing cash to BOCOG
amounting to RMB 540 million. Accordingly, an intangible asset
and a payable to the ultimate holding company of the said
amount have been recognized on the Group' balance sheet.
(xvi) At December 31, 2005, the Group has balances with other
state-owned telecommunication service providers and loans
granted from state-owned banks as set out in Notes 17, 25 and
27 respectively.
(xvii) The Acquisition was completed at October 31, 2005. Details
have been set out in Note 1.
F - 76
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
38 Condensed financial statements of the Company
INCOME STATEMENT-THE COMPANY
Year ended December 31
2003 2004 2005
--------------- ---------------- --------------
RMB RMB RMB
Million Million Million
Restated
Notes 3
Net revenue 38 - -
Cost of revenues - - -
-----------------------------------------------------
Gross profit 38 - -
Operating expenses:
Staff cost - (18) (112)
Selling, general and administrative (19) (59) (89)
------------------------------------------------------
Total operating expenses (19) (77) (201)
-----------------------------------------------------
Operating loss before interest
income, dividend income and deficit
on revaluation of fixed assets 19 (77) (201)
Interest income - 11 66
Profit from operations
Finance costs - - (15)
Investment income - 7 276
Profit/(loss) before tax 19 (59) 126
Income tax benefit/(expense) - - -
-----------------------------------------------------
Net profit/(loss) 19 (59) 126
=====================================================
F - 77
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
BALANCE SHEET-THE COMPANY As at December 31
------------------------------
Note 2004 2005
------- ------------- -------------
RMB RMB
million million
Restated
Note 3
Assets
Current assets
Cash and bank deposits (b) 7,789 540
Short-term investments 1,651 1
Due from subsidiaries (d) - 573
Prepayments, other receivables and other current assets (c) 16 26
------------- -------------
Total current assets 9,456 1,140
------------- -------------
Non-current assets
Investments in subsidiaries (d) 37,509 58,577
------------- -------------
Total assets 46,965 59,717
============= =============
Liabilities and equity
Current liabilities
Accrued expense 140 93
Due to subsidiaries (d) - 12,820
Due to ultimate holding company (g) 142 150
------------- -------------
Net current (liabilities)/assets 9,174 (11,923)
------------- -------------
Total assets less current liabilities 46,683 46,654
------------- -------------
Financed by:
Share capital 2,181 2,181
Reserves (e) 44,502 44,473
------------- -------------
Shareholders' equity 46,683 46,654
------------- -------------
Total liabilities & equity 46,965 59,717
============= =============
F - 78
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
CONDENSED STATEMENT OF CASH FLOWS-THE COMPANY
For the year ended,
2003 2004 2005
------------- ------------ -----------
RMB RMB RMB
Million Million Million
Net cash used in operating activities (17) 91 (144)
--------------------------------------------
Net cash used in investing activities (62) (1,334) (6,648)
--------------------------------------------
Net cash provided by financing activities - 8,944 (457)
--------------------------------------------
Net (decrease) / increase in cash (79) 7,701 (7,249)
============================================
Cash and bank deposits, at beginning of the
year 167 88 7,789
--------------------------------------------
Cash and bank deposits, at end of the year 88 7,789 540
--------------------------------------------
F - 79
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
(a) The condensed financial statements of the Company have been prepared in
accordance with HKFRS issued by HKICPA.
The subsidiaries declared RMB 260 million dividend to the Company in
2005 (2004: Nil).
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted.
The footnote disclosures contain supplemental information relating to
the operations of the Company and, as such, these statements should be
read in conjunction with the notes to the consolidated financial
statements of the Company.
The Company did not have any significant commitment as at December 31,
2004 and 2005.
(b) Cash and bank deposits
The Company
----------------------------------
As at December 31
----------------------------------
2004 2005
---------------- --------------
RMB RMB
million million
Cash and cash equivalents 7,789 540
==================================
(c) Prepayments, other receivables and other current assets
The Company
----------------------------------
As at December 31,
----------------------------------
2004 2005
RMB RMB
million million
Prepaid expenses, deposits and other current assets 8 14
Other receivables 8 12
---------------- --------------
Total 16 26
================ ==============
F - 80
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
(d) Investments in subsidiaries
The Company
------------------------------
As at December 31,
------------------------------
2004 2005
-------------- -------------
RMB RMB
million million
Investments cost in subsidiaries 37,509 58,577
Due from subsidiaries (Note (b)) - 573
Due to subsidiaries (Note (c)) - (12,820)
-------------- -------------
37,509 46,330
============== =============
F - 81
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
(d) Investments in subsidiaries (continued)
Notes:
(a) As at the December 31, 2005, the Group has direct and indirect
interests in the following principal subsidiaries, all of which are
private companies:
Issued and Percentage Principal
Place and date fully of equity activities
of paid up/ interest and place
incorporation/ registered attributable of
Company name establishment capital to the Group operation
-------------------------- ----------------- --------------------- -------------- -----------------
Directly held:
Provision of
network
China Netcom (Group) Registered capital communication
Company Limited PRC, of RMB services in the
(Note (i)) August 6, 1999 51,481,675,600 100% PRC
Indirectly held:
Provision of
China Netcom Group New network
Horizon Registered share communication
Telecommunications Co. PRC, capital of RMB services in the
Limited (Note (ii)) August 9, 2005 9,466,366,618 100% PRC
120,000,000 Investment
Asia Netcom Corporation Bermuda ordinary shares of holding in
Limited (Note (iii)) October 15, 2002 US$ 0.01 each 100% Bermuda
(i) The company is a wholly owned foreign enterprise established
in the PRC. The accounts of the company for the years ended
December 31, 2004 and 2005 were audited by
PricewaterhouseCoopers Zhong Tian CPAs Limited Company.
(ii) The company is a wholly owned foreign enterprise established
in the PRC. The accounts of this company for the year ended
December 31, 2005 were audited by PricewaterhouseCoopers Zhong
Tian CPAs Limited Company.
(iii) The financial statements for the years ended December 31, 2004
and 2005 had been audited by PricewaterhouseCoopers.
(b) The balances are unsecured, non-interest bearing and have no fixed
repayment terms.
(c) Deferred payments arising from the Acquisition (see note 1) has been
transferred to CNC China at the carrying amount. The balance is
non-secured, non interest bearing and has no fixed repayment terms
F - 82
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
(e) Reserves
Share Capital Retained
premium reserve earnings Total
------------- ------------ -------------- ------------
RMB RMB RMB RMB
million million million million
------------- ------------ -------------- ------------
At January 1, 2004 2,771 - 191 2,962
Issue of shares under listing
Reorganisation 31,397 2,982 - 34,379
Distribution to owner in accordance with
Listing Reorganization - - (359) (359)
Loss for the year - - (59) (59)
Distribution to an owner upon assignment
of loan prior to the Global Offering - - (1,021) (1,021)
Issue of shares through Global Offering
(net of issue expenses) 8,582 - - 8,582
Share based payments (Note 3(a)) - 18 - 18
------------- ------------ -------------- ------------
At December 31,2004 as restated 42,750 3,000 (1,248) 44,502
------------- ------------ -------------- ------------
Profit for the year - - 126 126
Dividends distributed during the year
(Note 12) - - (259) (259)
Share based payments - 104 - 104
------------- ------------ -------------- ------------
At December 31,2005 42,750 3,104 (1,381) 44,473
============= ============ ============== ============
(i) Pursuant to the promissory note (the "Note") signed by Group Wealth
Finance Limited ("Group Wealth"), a fellow subsidiary owned by CNC BVI,
the Company's immediate holding company, dated July 27, 2004, Group
Wealth has borrowed an amount of US$123,301,980 (RMB 1,020,644,470)
from Asia Netcom, and used these funds to acquire the right to receive
the outstanding debt payments owed by East Asia Netcom Limited, a
fellow subsidiary, from the vendors to the aggregate amount of
approximately US$123 million on July 29, 2004.
Subsequently, on September 30, 2004, CNC BVI instructed Group Wealth to
assign the loan to the Company. Accordingly, upon such assignment, the
amount receivable from Group Wealth of the said amount is effectively
waived and the Company recorded such assignment as an equity
distribution to CNC BVI.
(f) For the year ended December 31, 2005, profit attributable to
shareholders included current year profit of RMB 126 million (2004: a
loss of 59 million), which has been dealt with in the financial
statements of the Company.
(g) The balances are unsecured, non-interest bearing and have no fixed
repayment terms paid on behalf of the Group.
39 Significant subsequent events
(a) After the balance sheet date the directors proposed a final dividend.
Further details are disclosed in Note 12.
(b) On 2 June 2006, the Group entered into an agreement to dispose of the
entire interests in Asia Netcom Corporation Limited and its
subsidiaries (collectively referred to as "ANC Group") to two
independent third parties at an aggregate cash consideration of
US$168.84 million (equivalent to RMB 1, 362.57 million). The disposal
is subject to a number of conditions including the receipt of all
regulatory approvals. The Group will receive the aggregate
consideration upon the completion of the disposal which is expected to
be in the second half year of 2006. After the disposal, the Group will
maintain its business relationship with ANC Group in connection with
its own international operations and such business relationship will
include the purchase of certain network capacity from ANC Group. The
directors are currently evaluating the transaction, which will be
recorded when the disposal completes, expected to be in the second half
of 2006.
(c) On 16 May 2006, the Board of Directors of CNC China passed a resolution
to obtain short-term financing through Commercial Paper offering to a
number of PRC banks. The amount of the offering shall not exceed RMB 20
billion. The offering requires an approval from the People's Bank of
China and the Company is currently in the process of applying for such
an approval.
40 Ultimate holding party
The ultimate holding company is China Netcom Group which is owned and
controlled by PRC Government.
F - 83
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP")
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level
The consolidated financial statements of the Group have been prepared
in accordance with HKFRS, which differs in certain material respects
from U.S.GAAP. Differences between HKFRS and U.S.GAAP, which may have
significant impacts on the consolidated net income/(loss) and the
consolidated shareholders' equity are described below.
The effect on net profit/(loss) of significant differences between
HKFRS and U.S.GAAP for the years ended December 31, 2003, 2004 and 2005
is as follows:
2003 2004 2005 2005
------------ ------------ ----------- ------------
Restated Restated
Note Note 2&3 Note 2&3
---- ------------ ------------ ----------- ------------
US$
million
except per
RMB million except per share data share data
------------------------------------------- ------------
Consolidated net income/(loss) for the year under (10,906) 2,699 13,888 1,699
HKFRS
U.S.GAAP adjustments(pound)(0)
Revaluation of fixed assets (a) 25,778 11,318 - -
Depreciation of revalued fixed assets (a) - (3,529) (5,110) (625)
Share-based compensation (b) (2) - - -
Others 3 14 - -
Tax effect on the above adjustments (e) (8,508) (2,570) 1,687 206
------------ ------------ ----------- ------------
Consolidated profit for the year under U.S.GAAP 6,365 7,932 10,465 1,280
============ ============ =========== ============
Shares used in computing basic earnings per share 5,492 5,623 6,594 6,594
------------ ------------ ----------- ------------
Shares used in computing diluted earnings per
share 5,500 5,630 6,628 6,628
------------ ------------ ----------- ------------
Basic earnings per share under U.S.GAAP RMB1.16 RMB1.41 RMB1.59 USD0.19
------------ ------------ ----------- ------------
Diluted earnings per share under U.S.GAAP RMB1.16 RMB1.41 RMB1.58 USD0.19
------------ ------------ ----------- ------------
F - 84
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
The effect on shareholders' equity of significant differences between
HKFRS and U.S.GAAP as at December 31, 2003, 2004 and 2005 is as
follows:
Year ended December 31,
---------------------------------------------------------
2003 2004 2005 2005
----------- ------------ ----------- -----------
Restated Restated
Note Note 2&3 Note 2&3
------ ----------- ------------ ----------- -----------
RMB million US$ in
million
-----------
Consolidated shareholders' equity under 53,659 64,595 63,010 7,808
HKFRS
U.S.GAAP adjustments(pound)(0)
Revaluation of fixed assets (a) 22,796 30,251 30,251 3,749
Depreciation of revalued fixed assets (a) - (3,529) (8,639) (1,071)
Convertible preference shares and
corresponding share premium (d) (2,637) - - -
Difference in distribution to owner upon
Listing Reorganization (f) - 166 - -
Others (13) - - -
Tax effect on the above adjustments (e) (7,522) (8,819) (7,132) (884)
----------- ------------ ----------- -----------
Consolidated shareholders' equity under
U.S.GAAP 66,283 82,664 77,490 9,602
----------- ------------ ----------- -----------
F - 85
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
In 2005, the Group acquired the fixed line telecommunication service of
the northern four provinces/autonomous region (Shanxi Province, Inner
Mongolia Autonomous Region, Jilin Province and Heilongjiang Province)
from the ultimate holding company, China Netcom Group. Since the Group
has adopted merger accounting to account for the Acquisition, 2003 and
2004 comparative figures have been restated as if the Acquisition has
been completed before January 1, 2003 (note 2). Also, in 2005, the
Group has adopted certain new or revised HKFRSs as set out in Note 3 of
the financial statement. Certain 2004 comparative has been restated as
required by the relevant new or revised HKFRSs.
(a) Revaluation of fixed assets
In the Listing Reorganization, certain classes of fixed assets of the
Group were revalued as at December 31, 2003. The revaluation was
performed based on the depreciated replacement costs of the fixed
assets and was not based upon the expected future cash flows of the
fixed assets. The revaluation resulted in a charge of RMB 25,778
million to the Group's consolidated income statement for the year ended
December 31, 2003 with respect to the reduction in carrying amounts of
certain fixed assets below their historical cost bases. In addition, a
surplus arising from the revaluation of certain other fixed assets
totaling RMB 2,982 million has been credited to the revaluation
reserve.
In 2005, the Group acquired telecommunications business and assets of
the four northern provinces/autonomous region from China Netcom Group
as set out in Note 1 to the Group's financial statements. The acquired
fixed assets were revalued as at December 31, 2004. The revaluation was
performed based on the depreciated replacement costs of the fixed
assets and was not based upon the expected future cash flows of the
fixed assets. The revaluation resulted in a charge of RMB 11,318
million to the Group's consolidated income statement for the year ended
December 31, 2004 with respect to the reduction in carrying amounts of
certain fixed assets below their historical cost bases. In addition, a
surplus arising from the revaluation of certain other fixed assets
totaling RMB 3,863 million has been credited to the revaluation
reserve. The effect of the reduction in depreciation of the revalued
assets amounted to RMB 5,110 million in the year ended December 31,
2005 (2004: RMB 3,529 million).
Under U.S.GAAP, the carrying values of fixed assets are stated at their
historical costs less accumulated depreciation and provision for
impairment without making reference to their respective depreciated
replacement costs. An impairment loss on fixed assets is recorded under
U.S.GAAP if the carrying value of such assets exceeds its future
undiscounted cash flow resulting from the use of the assets and their
eventual disposition. The future undiscounted cash flows of the Group's
fixed assets, whose carrying amounts were reduced in connection with
the Reorganization, exceed the historical costs of such fixed assets
and, therefore, no impairment of such assets is recognized under
U.S.GAAP. Accordingly, the deficit on revaluation of fixed assets
charged to the Group' consolidated income statements and the surplus
credited to revaluation reserve recorded under HKFRS during 2003 and
2004 and the corresponding effect on the depreciation of the revalued
assets during the year 2004 and 2005 are reversed for U.S.GAAP
purposes.
F - 86
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
(b) Share-based compensation in the years ended December 31, 2003
The Group had share-based compensation arrangements in the years ended
December 31, 2003. Under HKFRS, the Group accounts for shares issued to
employees as ordinary share issuance and the difference between the
amounts paid by the employees and the par values of the share were
recognized as share premium.
Under U.S.GAAP, the Group accounts for share-based compensation
arrangements in accordance with the provisions of Accounting Principles
Board Opinion No.25 ("APB No.25"), "Accounting for Share Issued to
Employees" and related interpretations thereof. Accordingly, the
difference between the estimated fair values of the ordinary shares
issued and the issuance prices at the issuance dates in recorded as
deferred stock compensation, which is an item in the equity of the
Group, and amortized over two years on a straight-line basis over the
service period of each individual employee.
The estimated fair value of the ordinary shares issued to the employees
was US$ 2.45 per share, which was based on a valuation report from an
independent appraiser dated July 31, 2001 and derived on a
non-marketable aggregate minority basis as of February 7, 2001. The
directors of the Company believe that the assumption that was used in
the valuation report as of February 7, 2001 did not change
significantly in the subsequent periods. As at December 31, 2004 the
difference between the estimated fair value of the ordinary shares
issued and the issuance price at the date has been fully amortized.
(c) Grants of share options in the year ended December 31, 2004 and 2005
The Group granted share options to directors and employees in the years
ended December 31, 2004 and 2005 pursuant to the Company's Stock Option
Scheme as set out in Note 31.
Prior to January 1, 2005, under HKFRS, no charge is recorded to the
income statement and the proceeds received are recognized as an
increase to capital upon the exercise of share options.
Prior to January 1, 2005, under U.S.GAAP, in accordance with the
provisions of SFAS No.148, "Accounting for Stock-Based
Compensation-Transition and Disclosure", the Group has selected to
apply the disclosure only provisions related employee stock and share
purchases and follows the provision of Accounting Principles Board
Opinion No.25(APB 25) in accounting for stock options issued to
employees. Under APB 25, compensation expense, if any, is recognized as
the difference between the exercise price and the estimated fair value
of the ordinary shares on the measurement date, which is typically the
date of grant, and is expensed ratably over the service period, which
is typically the vesting period. Since the options exercise price was
set to be the share issuance price at the time of initial public
offering, there is no expense charged to the income statement.
In 2005, the Group adopted HKFRS 2 - Share-based payment issued by
HKICPA. The Group recognizes the fair value of the share options as an
expense over the vesting period in the consolidated income statement,
or as an asset if the cost qualifies for recognition as an asset under
the Group's accounting policy. A corresponding increase is recognized
in a capital reserve within equity. This change in accounting policy
has been accounted for retrospectively.
In 2005, the Group applied the retroactive restatement method under
FAS148 and retrospectively restated the prior year financial statements
to recognize the share-based compensation to give effect to the
fair-value-based method of accounting for all awards granted on a basis
consistent with the pro forma disclosures required for those periods by
FAS123. Upon the change of accounting policy, the treatment under
U.S.GAAP is consistent with that under HKFRS upon the changes in
accounting policies.
F - 87
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
(d) Convertible preference shares
Under HKFRS, the convertible preference shares and the corresponding
share premium are classified as equity while under U.S.GAAP they are
presented as balances between liabilities and owners' equity because of
the mandatorily redeemable feature of the convertible preference
shares. This difference resulted in a reduction of the owners' equity
by RMB 2,637 million as at December 31, 2003 under U.S.GAAP. The
convertible preference shares were converted to ordinary shares in 2004
and therefore the GAAP difference ceased to exist from that date.
(e) Deferred income tax
The amounts included in the reconciliation show the income tax effects
of the differences between HKFRS and U.S.GAAP as described above.
However, HK GAAP requires recognition of deferred tax asset only to the
extent that recovery of the deferred tax assets is probable, whereas
U.S. GAAP requires full recognition of deferred tax assets and
appropriate valuation allowance is required if the recovery is less
than 50% likely. Recognition of deferred tax previously not recognized
under HK GAAP is presented as a reversal of valuation allowance under
U.S. GAAP.
(f) Goodwill and negative goodwill
Before January 1, 2005, goodwill on acquisition was included in
intangible assets and amortized using the straight-line method over its
estimated useful life of no more than twelve years. Negative goodwill
is presented in the same balance sheet classification as goodwill and
recognized in the income statement over the remaining weighted average
useful life of the related fixed assets.
On January 1, 2005, the Group adopted HKFRS 3 - Business Combination
issued by the HKICPA. Goodwill could no longer be amortized and is
tested annually for impairment, as well as when there are indications
of impairment. If the fair value of the net assets acquired in a
business combination exceeds the consideration paid (i.e. an amount
arises which would have been known as negative goodwill under the
previous accounting policy), the excess is recognized immediately in
the consolidated income statement as it arises. According to the
transitional provision of HKFRS3, the Group should not retrospectively
adjust the financial statements issued in previous years.
Under U.S.GAAP, goodwill is not amortized but tested for impairment
annually and whenever events or circumstances occur indicating that
goodwill might be impaired. When negative goodwill results from an
acquisition, the acquirer must reassess whether all acquired assets and
assumed liabilities have been identified and properly valued and then
allocate negative goodwill to certain acquired non-monetary assets on a
pro rata basis as applicable. Any remaining unallocated negative
goodwill must be recognized immediately as an extraordinary gain.
Goodwill was recognized from the acquisition of the 49% equity interest
in Asia Netcom on December 31, 2003. Accordingly, the amortization of
goodwill of RMB 10 million during the year ended December 31, 2004
under HKFRS is reversed for U.S.GAAP purpose and credited to the
owners' equity.
After the Listing Reorganization, the value of the fixed assets
transferred to China Netcom Group under HKFRS was higher than that
under U.S.GAAP by RMB 166 million for reason of the different treatment
as of the negative goodwill from the acquisition of Asia Global
Crossing. The negative goodwill of RMB 166 million was included in the
balance sheet under HKFRS while offset against certain fixed assets
under U.S.GAAP and the fixed assets had been distributed to owner in
accordance with the Reorganization plan. Accordingly, the amount
distributed to owner under U.S.GAAP was lower than that under HKFRS by
RMB 166 million.
On January 1, 2005, the balance of negative goodwill under HKFRS was
credited directly to the shareholders' equity upon the adoption of
HKFRS 3 and the GAAP difference ceased to exist from then.
F - 88
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
(g) Presentation of revenue
Under HKFRS, revenues are presented net of the PRC business taxes and
government levies which amounted to RMB 2,392 million, RMB 2,493
million and RMB 2,421 million for the years ended December 31, 2003,
2004 and 2005 respectively.
Under U.S.GAAP, revenues should be presented gross with these type of
taxes classified as a cost of revenue.
(h) Presentation of depreciation expenses
Under HKFRS, depreciation expense can be excluded from "Network,
operations and support" and separately disclosed on the face of income
statement.
Under U.S.GAAP, "Network, operations and support" expenses should
include charges for depreciation of property, plant and equipment and
amortization of intangible assets. Industry practice adopted by the
Chinese telecommunications sector is to present these costs of
operations net of depreciations charges. In such circumstance, U.S.GAAP
requires such fact to be highlighted on the face of the income
statement.
(i) Presentation of amortization of subscriber acquisition costs
Under HKFRS, amortization of capitalized subscriber acquisition costs,
being RMB 741 million, RMB 2,602 million and RMB 1,887 million for the
years ended December 31, 2003, 2004 and 2005 respectively is classified
as selling expenses due to the marketing and promotional nature of the
expenditure.
Under U.S.GAAP, amortization of subscriber acquisition costs needs to
be included in the item "Network, operations and support" expense for
the Company.
(j) Other U.S.GAAP disclosures
(i) Acquisition of business under common control
During the year, the Company acquired the businesses of the northern
four provinces, details of which were set out in note 1. Under HKFRS,
the Company applied merger accounting to record the Acquisition and the
acquired assets and liabilities were stated at carrying amounts as if
the fixed line telecommunications operations and assets of the four
provinces/autonomous region had been held by the Company from the
beginning of the earliest period presented. The 2003 and 2004
comparatives of the financial statements were restated accordingly.
Under U.S. GAAP, the Acquisition was treated as a "business combination
of entities under common control" and accounted for in a manner similar
to pooling-of-interests. It also required to reconcile the financial
data from the previously reported figures to the restated amounts.
Accordingly, the Company set out the reconciliation of financial data
from the previously reported figures to the restated amounts for the
income statements for the years ended December 31, 2003 and 2004 and
the balance sheets as of December 31, 2003 and December 31, 2004 as
follows:
F - 89
Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
(j) Other U.S.GAAP disclosures (Continued)
(i) Acquisition of business under common control (Continued)
The year ended at December 31, 2004
-------------------------------------------------------
Effect of
adoption of
merger
accounting
on
Effect of acquisition
adoption of
As of new Acquired
previously HKFRSs Businesses
stated (Note 3) Adjusted (Note 2) Restated
-------------------------------------------------------
RMB'000 RMB'000 RMB'000 RMB'000 RMB'000
Revenue 64,922 - 64,922 18,616 83,538
-------------------------------------------------------
Operating expenses
Depreciation and
amortization (18,754) - (18,754) (6,426) (25,180)
Networks, operations and
support (11,591) - (11,591) (2,426) (14,017)
Staff costs (8,041) (18) (8,059) (3,891) (11,950)
Selling, general and
administrative (9,566) - (9,566) (3,311) (12,877)
Other operating expenses (1,534) - (1,534) (459) (1,993)
-------------------------------------------------------
Total of operating expenses (49,486) (18) (49,504) (16,513) (66,017)
Operating profit before
interest income, dividend
income 15,436 (18) 15,418 2,103 17,521
and deficit on revaluation of
fixed assets
Interest income 76 - 76 11 87
Dividend income 17 - 17 - 17
Deficit on revaluation of
fixed assets - - - (11,318) (11,318)
-------------------------------------------------------
Profit/(loss) from operations 15,529 (18) 15,511 (9,204) 6,307
Finance costs (2,932) - (2,932) (998) (3,930)
Share of loss of associated
companies (1) - (1) - (1)
-------------------------------------------------------
Profit/(loss) before taxation 12,596 (18) 12,578 (10,202) 2,376
Taxation credit (3,348) - (3,348) 3,671 323
-------------------------------------------------------
Profit/(loss) for the year 9,248 (18) 9,230 (6,531) 2,699
=======================================================
F - 90
Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
(j) Other U.S.GAAP disclosures (Continued)
(i) Acquisition of business under common control (Continued)
The year ended at December 31, 2004
-------------------------------------------------------
Effect of
adoption of
merger
accounting
on
Effect of acquisition
adoption of
As of new Acquired
previously HKFRSs Businesses
stated (Note 3) Adjusted (Note 2) Restated
-------------------------------------------------------
RMB'000 RMB'000 RMB'000 RMB'000 RMB'000
Revenue 59,898 - 59,898 17,700 77,598
-------------------------------------------------------
Operating expenses
Depreciation and
amortization (20,483) - (20,483) (6,317) (26,800)
Networks, operations and
support (11,990) - (11,990) (3,118) (15,108)
Staff costs (7,547) - (7,547) (3,398) (10,945)
Selling, general and
administrative (7,053) - (7,053) (3,269) (10,322)
Other operating expenses (1,660) - (1,660) (537) (2,197)
-------------------------------------------------------
Total of operating expenses (48,733) - (48,733) (16,639) (65,372)
Operating profit before
interest income, dividend
income 11,165 - 11,165 1,061 12,226
and deficit on revaluation of
fixed assets
Interest income 79 - 79 16 95
Dividend income 45 - 45 45
Deficit on revaluation of
fixed assets (25,778) - - (25,778) (25,778)
-------------------------------------------------------
Profit/(loss) from operations (14,489) - (14,489) 1,077 (13,412)
Finance costs (3,026) - (3,026) (1,270) (4,296)
Share of loss of :
-Associated companies (1) - (1) - (1)
-Jointly controlled entity (415) - (415) - (415)
-------------------------------------------------------
Profit/(loss) before taxation (17,931) - (17,931) (193) (18,124)
Taxation credit 6,819 - 6,819 398 7,217
Minority interests 1 - 1 - 1
-------------------------------------------------------
Profit/(loss) for the year (11,111) - (11,111) 205 (10,906)
=======================================================
F - 91
Reconciliation of HKFRS and Accounting Principles Generally Accepted in
the United States ("U.S. GAAP") (continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (continued)
(j) Other U.S.GAAP disclosures (Continued)
(i) Acquisition of business under common control (Continued)
The year ended at December 31, 2004
Effect of
adoption of
merger
accounting
on
Effect of acquisition
adoption of
As of new Acquired
previously HKFRSs Businesses
stated (Note 3) Adjusted RMB'000 Restated
RMB'000 RMB'000 RMB'000 (Note 2) RMB'000
Assets
Current assets
Cash and bank deposits 10,053 - 10,053 580 10,633
Short-term investments 2,876 - 2,876 - 2,876
Accounts receivable 5,688 - 5,688 1,486 7,174
Inventories and consumables 941 - 941 302 1,243
Prepayments and other receivables 1,006 - 1,006 436 1,442
Due from holding companies and fellwo
subsidiaries 373 - 373 714 1,087
---------------------------------------------------------------------
Total current assets 20,937 - 20,937 3,518 24,455
---------------------------------------------------------------------
Non-current assets
Lease prepayments for land - 1,266 1,266 480 1,746
Fixed assets 125,582 (795) 124,787 42,110 166,897
Construction in progress 8,073 (471) 7,602 2,995 10,597
Intangible assets 316 316 66 382
Deferred tax assets 2,394 - 2,394 1,410 3,804
Other non-current assets 7,873 7,873 663 8,536
---------------------------------------------------------------------
Total non-current assets 144,238 - 144,238 47,724 191,962
---------------------------------------------------------------------
Total assets 165,175 - 165,175 51,242 216,417
=====================================================================
Liabilities
Current liabilities
Accounts payable 14,653 - 14,653 6,472 21,125
Accruals and other payables 3,353 - 3,353 1,513 4,866
Short-term bank loans 29,339 - 29,339 15,543 44,882
Current portion of long-term bank
and other loans 7,270 - 7,270 4,457 11,727
Due to ulitmate holding company 8,244 - 8,244 1,836 10,080
Current portion of deferred revenues 6,653 - 6,653 2,223 8,876
Current portion of provisions 2,596 - 2,596 1,531 4,127
Taxation payable 196 - 196 165 361
---------------------------------------------------------------------
Total current liabilities 72,304 - 72,304 33,740 106,044
---------------------------------------------------------------------
Net current liabilities (51,367) - (51,367) (30,222) (81,589)
---------------------------------------------------------------------
Total assets less current liabilities 92,871 - 92,871 17,502 110,373
---------------------------------------------------------------------
Non-current liabilities
Long-term bank and other loans 21,861 - 21,861 4,191 26,052
Deferred revenues 11,817 - 11,817 2,171 13,988
F - 92
Provisions 2,143 - 2,143 1,431 3,574
Deferred tax liabilities 1,321 - 1,321 255 1,576
Other non-current liabilities 564 564 24 588
---------------------------------------------------------------------
Total non-current liabilities 37,706 - 37,706 8,072 45,778
---------------------------------------------------------------------
Total liabilities 110,010 - 110,010 41,812 151,822
---------------------------------------------------------------------
Financed by :
Share capital 2,181 - 2,181 - 2,181
Reserves 52,984 52,984 9,430 62,414
---------------------------------------------------------------------
Shareholders' equity 55,165 - 55,165 9,430 64,595
---------------------------------------------------------------------
Total liabilities and equity 165,175 - 165,175 51,242 216,417
=====================================================================
As at December 31, 2003
Effect of
adoption of
merger
accounting
Effect of on
adoption acquisition
As of new of Acquired
previously HKFRSs Businesses
stated (Note 3) Adjusted (Note 2) Restated
RMB'000 RMB'000 RMB'000 RMB'000 RMB'000
Cash and bank deposits 6,316 - 6,316 1,114 7,430
Short-term investments 1,506 - 1,506 - 1,506
Accounts receivable 6,343 - 6,343 1,175 7,518
Inventories and consumables 1,238 - 1,238 209 1,447
Prepayments and other receivables 1,640 - 1,640 582 2,222
Due from holding companies and fellwo
subsidiaries 449 - 449 94 543
------------ ------------ ----------------------------------------
Total current assets 17,492 - 17,492 3,174 20,666
------------ ------------ ----------------------------------------
Non-current assets
Lease prepayments for land - - 450 450
Fixed assets 133,919 133,919 47,719 181,638
Construction in progress 15,695 15,695 2,354 18,049
Intangible assets 184 184 91 275
Deferred tax assets 2,784 - 2,784 2,076 4,860
Lont-term investment 880 - 880 - 880
Interest in associated companies 90 - 90 - 90
Other non-current assets 8,490 8,490 683 9,173
------------ ------------ ----------------------------------------
Total non-current assets 162,042 - 162,042 53,373 215,415
------------ ------------ ----------------------------------------
------------ ------------ ----------------------------------------
Total assets 179,534 - 179,534 56,547 236,081
============ ============ ========================================
Liabilities
Current liabilities
Accounts payable 14,786 - 14,786 5,409 20,195
Accruals and other payables 4,410 - 4,410 1,267 5,677
Short-term bank loans 32,217 - 32,217 15,774 47,991
Current portion of long-term bank and
other loans 15,716 - 15,716 3,676 19,392
F - 93
Due to ulitmate holding company 9,002 - 9,002 1,448 10,450
Current portion of deferred revenues 7,229 - 7,229 2,170 9,399
Current portion of provisions 3,083 - 3,083 1,550 4,633
Taxation payable 428 - 428 185 613
------------ ------------ ----------------------------------------
Total current liabilities 86,871 - 86,871 31,479 118,350
------------ ------------ ----------------------------------------
------------ ------------ ----------------------------------------
Net current liabilities (69,379) - (69,379) (28,305) (97,684)
------------ ------------ ----------------------------------------
------------ ------------ ----------------------------------------
Total assets less current liabilities 92,663 - 92,663 25,068 117,731
------------ ------------ ----------------------------------------
Non-current liabilities
Long-term bank and other loans 22,309 - 22,309 7,863 30,172
Due to holding companies 4,750 - 4,750 - 4,750
Deferred revenues 14,604 - 14,604 2,981 17,585
Provisions 2,341 - 2,341 1,153 3,494
Deferred tax liabilities 4,213 - 4,213 2,759 6,972
Other non-current liabilities 1,067 1,067 29 1,096
------------ ------------ ----------------------------------------
Total non-current liabilities 49,284 - 49,284 14,785 64,069
------------ ------------ ----------------------------------------
------------ ------------ ----------------------------------------
Total liabilities 136,155 - 136,155 46,264 182,419
------------ ------------ ----------------------------------------
Minority interest 3 - 3 - 3
Financed by :
Share capital 1,819 - 1,819 1,819
Reserves 41,557 41,557 10,283 51,840
------------ ------------ ----------------------------------------
Shareholders' equity 43,376 - 43,376 10,283 53,659
------------ ------------ ----------------------------------------
Total liabilities and equity 179,534 - 179,534 56,547 236,081
============ ============ ========================================
(ii) Comprehensive income
U.S.GAAP requires that all items that are required to be recognized as
components of comprehensive income (including cumulative translation
adjustment) be reported in a separate financial statement. There are no
material differences between total recognized gains and losses for the
periods shown in the Consolidated Statements of Changes in Equity
presented under HKFRS and U.S.GAAP comprehensive income, except for the
differences between HKFRS and U.S.GAAP profit attributable to
shareholders shown above.
F - 94
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted
in the United States ("U.S. GAAP") (continued)
(B) Reconciliation of HKFRS and U.S. GAAP at the Company level
The condensed financial statements of the Company as set out in Note
38 have been prepared in accordance withy HKFRS, which differs in
certain material respects from U.S. GAAP. Differences between HKFRS
and U.S. GAAP, which may have significant impacts on the Company's
net profit/ (loss) and the Company's shareholders' equity are
described below.
The effect on the net profit/(loss) of significant differences between
HKFRS and U.S. GAAP at the Company's level for the years ended December
31, 2003, 2004 and 2005 is as follows:
Years ended December 31,
--------------------------------------------------------------
Note 2003 2004 2005 2005
------------ ------------ ------------- ------------
RMB RMB RMB USD
million million million million
Restated Restated
Notes 2 Notes 2&3
Net profit/(loss) for the year under
HKFRS 19 (59) 126 15
U.S. GAAP adjustments:
Equity accounting for share of results of
its subsidiaries, net of tax effect (a) 6,346 7,991 10,339 1,265
Net profit for the year under U.S. GAAP 6,365 7,932 10,465 1,280
============ ============ ============= =============
The effect on the shareholders' equity of significant differences
between HKFRS and U.S. GAAP at the Company's level as at December 31,
2003, 2004 and 2005 is as follows:
2003 2004 2005 2005
RMB RMB RMB USD
million million million million
Restated Restated
Note Notes 2 Notes 2&3
Shareholders' equity under HKFRS 2,981 46,683 46,654 5,781
U.S. GAAP adjustments:
Equity accounting for the subsidiaries
of China Netcom Group, net of tax
effect (Restated (note B(a))) (a) 65,939 21,671 26,677 3,306
Revaluation of fixed assets and
difference in the value of investments
in subsidiaries injected from China
Netcom Group up on Reorganization (b) -- 14,144 4,159 515
Convertible preference share and
corresponding share premium (c) (2,637) -- -- --
Difference in distribution to owners
upon Reorganization (d) -- 166 -- --
Shareholders' equity under U.S. GAAP 66,283 82,664 77,490 9,602
(a) Equity accounting for share of results and net assets of its subsidiaries
Under HKFRS, the Company records its investment in its subsidiaries
under cost method of accounting. In the Company's balance sheet, the
investment in subsidiaries are stated at cost less provision for
impairment losses. The results of the subsidiaries are accounted for by
the Company on the basis of dividend received and receivable.
F - 95
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted
in the United States ("U.S. GAAP") (continued)
(B) Reconciliation of HKFRS and U.S. GAAP at the Company level
Under U.S. GAAP, the Company restates its financial statements as if
the Reorganization happened at the earliest period presented. It
records its investment in its subsidiaries under the equity method of
accounting as prescribed in APB Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock". Since the company holds
100% equity interest in the subsidiaries, the net asset value of the
subsidiaries has been fully reflected as Investment in subsidiaries
on the balance sheet and the results of the subsidiaries have been
accounted for under share of results of subsidiaries, net of tax on
the income statement.
(b) Revaluation of fixed assets and difference in the value of
investments in subsidiaries injected from China Netcom Group up on
Reorganization and on Acquisition.
As a result of the Group's Reorganization consummated on June 30,
2004, the Company issued 5,442,258,218 ordinary shares in exchange of
the telecommunications operations and the related assets and
liabilities in the Eight Service Regions previously owned by China
Netcom Group and injected these operations into its major operating
subsidiary, CNC China. The fixed assets injected by China Netcom
Group have been revalued on December 31, 2003, based on depreciated
replacement cost method pursuant to the PRC rules and regulations
relevant to the Reorganization, resulting in a net reduction of their
total carrying value by RMB 22,796 million (see Note 20). These fixed
assets were then contributed by the Company into CNC China as an
increase in its investment in CNC China.
During the Acquisition, the fixed assets injected by China Netcom
Group have been revalued on December 31, 2004, based on depreciated
replacement cost method pursuant to the PRC rules and regulations
relevant to the Acquisition, resulting in a net reduction of their
total carrying value by RMB 11,318 million (see Note 20).
Under U.S. GAAP, the carrying values of fixed assets are stated at
their historical costs less accumulated depreciation and provision
for impairment without making reference to their respective
depreciated replacement costs. Since the future undiscounted cash
flows of the Group's fixed assets exceed the historical costs of such
fixed assets, no impairment of such assets is recognized under U.S.
GAAP. Accordingly, the carrying value of the fixed assets injected by
China Netcom Group reported under U.S.GAAP was higher than the
carrying value of those assets reported under HKFRS and the carrying
value of the investment in subsidiaries under US GAAP was also higher
than the carrying value of the investment under HKFRS.
(c) Please refer to Note (d) of Section A above.
(d) Please refer to Note (f) of Section A above.
F - 96
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted
in the United States ("U.S. GAAP") (continued)
(C) Recent HK Accounting Pronouncements
The HKICPA has issued a number of new and revised HKFRSs and HKFRS
Interpretations ("HKFRS - Ints"), and HKAS and HKAS Interpretations
("HKAS - Ints") as set out in Note 4(x) to the Group's financial
statements which are effective for accounting periods beginning on or
after January 1, 2006. The Group has not early adopted these new and
revised standards and interpretations in the financial statements for
the year ended December 31, 2005. The Group has commenced an
assessment of the impact of these new and revised standards and
interpretations, but is not yet in a position to state whether these
new and revised standards and interpretations would have a
significant impact on its results of operations and financial
position.
(D) Recent U.S. Accounting Pronouncements
SFAS No. 123R
Revised SFAS No. 123 ("SFAS No. 123R") is a revision of FASB
Statement No. 123, Accounting for Stock-Based Compensation ("SFAS No.
123") and superseded APB 25, Accounting for Stock Issued to
Employees, and its related implementation guidance. SFAS No. 123
establishes standards for the accounting for transactions in which an
entity exchanges its equity instruments for goods or services that
are based on the fair value of the entity's equity instruments or
that may be settled by the issuance of those equity instruments. SFAS
No. 123R requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial
statements based on their grant date fair values. SFAS No. 123R is
effective as at the beginning of the first interim or annual
reporting period that begins after June 15, 2005 for public entities
that do not file as small business issuers. The Company is required
to adopt SFAS No. 123R in the fiscal year beginning January 1, 2006.
In March 2005, the SEC issued Staff Accounting Bulletin No. 107 ("SAB
No. 107") regarding the SEC's interpretation of SFAS No. 123R and the
valuation of share-based payments for public companies. SAB No. 107
provides the staff's view regarding the valuation of share-based
payment arrangements for public companies. In particular, SAB No. 107
provides guidance related to share-based payment transactions with
non-employees, the transition from non public to public entity
status, valuation methods (including assumptions such as expected
volatility and expected term), the accounting for certain redeemable
financial instruments issued under share-based payment arrangements,
the classification of compensation expense, non-GAAP financial
measures, first time adoption of SFAS No. 123R, the modification of
employee share options prior to the adoption of SFAS No. 123R and
disclosure in Management's Discussion and Analysis subsequent to
adoption of SFAS No. 123R.
Upon the adoption of retrospective restatement transitional method
under SFAS No. 148 in the fiscal year 2005, the Company has
retrospectively restated the prior year financial statements to
recognize the share-based compensation to give effect to the
fair-value-based method of accounting for all awards granted on a
basis consistent with the pro forma disclosures required for those
periods by SFAS No. 123.
F - 97
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted
in the United States ("U.S. GAAP") (Continued)
(D) Recent U.S. Accounting Pronouncements (continued)
SFAS No. 151
SFAS No. 151 amends and clarifies the accounting for abnormal amounts
of idle facility expense, freight, handling costs and wasted material
(spoilage). It requires that allocation of fixed production overheads
to the costs of conversion be based on the normal capacity of the
production facilities. SFAS No. 151 is effective for inventory costs
incurred during the fiscal years beginning after June 15, 2005. The
Company is required to adopt SFAS No. 151 in the fiscal year
beginning January 1, 2006. The Company considered the effects of
adoption SFAS No. 151 does not have material impact on its financial
statements.
SFAS No. 153
SFAS No. 153 amends APB Opinion No. 29 on Accounting for Non-monetary
Transactions, to eliminate the exception for nonmonetary exchanges of
similar productive assets and replaces it with a general exception of
exchanges of nonmonetary assets that do not have commercial
substance. It defines `a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. SFAS No. 153 is
effective for nonmonetary asset exchanges occurring in fiscal periods
beginning after June 15, 2005. The Company is required to adopt SFAS
No. 153 in the fiscal year beginning January 1, 2006. The Company
considered the effects of adoption SFAS No. 153 does not have
material impact on its financial statements.
F - 98
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE FINANCIAL STATEMENTS
41 Reconciliation of HKFRS and Accounting Principles Generally Accepted
in the United States ("U.S. GAAP") (continued)
(D) Recent U.S. Accounting Pronouncements (continued)
EITF 05-06
In June 2005, the Emerging Issues Task Force (EITF) issued EITF
05-06, `Amortization periods for leasehold improvements purchased
after lease inception or acquired in a business combination'. EITF
05-06 provides guidance on determining amortization periods for
leasehold improvements purchased after lease inception or acquired in
a business combination. Effective for leasehold improvements (within
the scope of this Issue) purchased or acquired in reporting periods
beginning after June 29 2005. The Company is required to adopt EITF
05-06 in the fiscal year beginning January 1, 2006. The Company is in
the process of assessing the impact of EITF 05-06.
SFAS No. 154
SFAS No. 154 replaces APB Opinion No. 20, Accounting Changes, and
FASB Statement No. 3, Reporting Accounting Changes in Interim
Financial Statements, and changes the requirements for the accounting
for and reporting of a change in accounting principle. The statement
establishes, unless impracticable, retrospective application as the
required method for reporting a change in accounting principle in the
absence of explicit transition requirements specific to the newly
adopted accounting principle. Effective for accounting changes and
corrections of errors made in fiscal years beginning after December
15, 2005. The Company is required to adopt SFAS No. 154 in the fiscal
year beginning January 1, 2006. The Company considered the effects of
adoption SFAS No. 154 does not have material impact on its financial
statements.
FSP No. FAS 13-1
In October 2005, FASB Staff Positions (FSP) issued FSP No. FAS 13-1,
`Accounting for Rental Costs Incurred during a Construction Period'
which addresses the accounting for rental costs associated with
operating leases that are incurred during a construction period.
Given that there is no distinction between the right to use a leased
asset during the construction period and the right to use that asset
after the construction period, rental costs associated with ground or
building operating leases that are incurred during a construction
period shall be recognized as rental expense. The rental costs shall
be included in income from continuing operations. The guidance in
this FSP shall be applied to the first reporting period beginning
after December 15, 2005. The Company is required to adopt FSP No. FAS
13-1 in the fiscal year beginning January 1, 2006. The Company is in
the process of assessing the impact of this guidance.
F - 99