FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934
For the month of March, 2006
(Indicate by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F.)
Form 20-F __X__ Form 40-F _____
(Indicate by check mark whether the registrant by furnishing the
information contained in this form is also thereby furnishing
the information to the Commission pursuant to Rule 12g3-2(b)
under the Securities Exchange Act of 1934. )
Yes ____ No __X__
(If "Yes" is marked, indicate below the file number assigned to registrant in
connection with Rule 12g3-2(b): 82-__________. )
N/A
China Netcom Group Corporation (Hong Kong) Limited
Building C, No. 156, Fuxingmennei Avenue
Xicheng District
Beijing, 100031 PRC
This Form 6-K consists of:
The Hong Kong annual report for the year 2005 of China Netcom Group Corporation
(Hong Kong) Limited (the "Registrant"), made by the Registrant in English on
March 22, 2006.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
under-signed, thereunto duly authorized.
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
By /s/ Miao Jianhua
------------------
By /s/ Mok Kam Wan
------------------
Name: Miao Jianhua and Mok Kam Wan
Title: Joint Company Secretaries
Date: March 22, 2006
[o] Company Profile and Corporate Information
[o] 2005 Major Milestones
[o] Financial Highlights
[o] Chairman's Statement
[o] Chief Executive Officer's Statement
[o] Profile of Directors and Senior Management
[o] Corporate Governance
[o] Human Resources Development
[o] Business Review
[o] Management's Discussion and Analysis of Financial Condition and
Results of Operations
[o] Report of the Directors
[o] Notice of Annual General Meeting
[o] Auditors' Report
[o] Financial Information of the Company
[o] Supplementary Information for American Depositary Shares Holders
[o] Financial Summary
Company Profile and Corporate Information
China Netcom Group Corporation (Hong Kong) Limited (the "Company", "our
Company", "we" or "us", and together with its subsidiaries, the "Group")) is a
company incorporated in accordance with the Companies Ordinance (Chapter 32 of
the Laws of Hong Kong) in Hong Kong on 22 October 1999 with limited liability.
We were listed on the New York Stock Exchange and the Main Board of The Stock
Exchange of Hong Kong Limited on 16 November 2004 and 17 November 2004,
respectively.
We are a leading fixed-line telecommunications operator in China and a leading
international data communications operator in the Asia-Pacific region. Our
northern service region in China consists of Beijing Municipality, Tianjin
Municipality, Hebei Province, Henan Province, Shandong Province, Liaoning
Province, Heilongjiang Province, Jilin Province, Neimenggu Autonomous Region
and Shanxi Province. In these regions, the Company is a dominant provider of
fixed-line telephone services, broadband and other Internet-related services,
as well as business and data communications services. Our southern service
region in China consists of Shanghai Municipality and Guangdong Province in
which we focus on providing telecommunications services to enterprises and high
usage residential customers in selected densely populated areas. In addition,
we are also the only telecommunications operator in China that operates an
extensive network and offers international data services in the Asia-Pacific
region.
We offer an extensive range of telecommunications and data services, including:
o fixed-line telephone services (including PHS), including local, domestic
long distance and international long distance services;
o broadband and other Internet-related services, including DSL and LAN
services;
o business and data communications services, including managed data and
leased line services; and
o international telecommunications services, including international voice,
international data and leased line services.
As at 31 December 2005, China Network Communications Group Corporation (our
ultimate controlling shareholder, "China Netcom Group"), held about 70.49%of
our shares in the Company through China Netcom Group Corporation (BVI) Limited
("CNC BVI"), Shandong Provincial State-owned Assets Supervision and
Administration Commission ("Shangdong SASAC") beneficially owned 2.27%of shares
in the Company, each of Chinese Academy of Sciences, Information and Network
Center of the State Administration of Radio, Film and Television, China
Railways Telecommunications Center and Shanghai Alliance Investment Limited
beneficially owned 0.56% of shares in the Company, and other overseas public
investors owned 25% of shares in the Company.
2
Registered office Room 6701, 67/F, The Center
99 Queen's Road Central
Hong Kong
Board of Directors Mr. Zhang Chunjiang
Chairman and Executive Director
Dr. Tian Suning
Vice Chairman, Executive Director and
Chief Executive Officer
Mr. Zhang Xiaotie
Executive Director
Mr. Miao Jianhua
Executive Director and Joint Company
Secretary
Mr. Jiang Weiping
Executive Director
Ms. Li Liming
Non-executive Director
Mr. Yan Yixun
Non-executive Director
Mr. Jose Maria Alvarez-Pallete
Non-executive Director
Mr. John Lawson Thornton
Independent Non-executive Director
Mr. Victor Cha Mou Zing
Independent Non-executive Director
Dr. Qian Yingyi
Independent Non-executive Director
Mr. Hou Ziqian
Independent Non-executive Director
Mr. Timpson Chung Shui Ming
Independent Non-executive Director
Mr. Mauricio Sartorius
(Alternative Director to
Mr. Jose Maria Alvarez-Pallete)
3
Joint company secretaries Mr. Miao Jianhua
Ms. Mok Kam Wan
Qualified accountant Mr. Oliver E Lixin (ACCA)
Auditors PricewaterhouseCoopers
Legal advisers As to Hong Kong Laws:
Linklaters
As to U.S. Laws:
Skadden, Arps, Slate,
Meagher & Flom LLP
Investor Relations Beijing Office
Building C,
156 Fuxingmennei Street
Xicheng District
Beijing 100031
Telephone: 8610-66429550
Facsimile: 8610-66429544
E-mail:
IR@CHINA-NETCOM.COM
Website:
WWW.CHINA-NETCOM.COM
Stock code: HKSE: 906
NYSE: CN
Share registrar and transfer office Computershare Hong Kong Investor
Services Limited
Rooms 1712-1716,
17th Floor, Hopewell Centre
183 Queen's Road East
Wan Chai
Hong Kong
American depositary receipts Citibank, N.A.
depositary Depositary Receipt Services
388 Greenwich Street,14th Floor
New York, NY 10013
USA
4
Committees of the Board
Audit committee Mr. Timpson Chung Shui Ming Chairman
Dr. Qian Yingyi
Mr. Victor Cha Mou Zing
Mr. Hou Ziqiang
Remuneration and Mr. Zhang Chunjiang Chairman
nomination committee Mr. John Lawson Thornton
Mr. Victor Cha Mou Zing
Mr. Hou Ziqiang
Mr. Jiang Weiping
Strategic planning committee Mr. Zhang Chunjiang Chairman
Dr. Qian Yingyi
Mr. Hou Ziqiang
Mr. Zhang Xiaotie
Mr. Jiang Weiping
Ms. Li Liming
Mr. Jose Maria Alvarez-Pallete
Corporate governance committee Mr. John Lawson Thornton Chairman
Dr. Tian Suning
Dr. Qian Yingyi
Mr. Miao Jianhua
Mr. Timpson Chung Shui Ming
5
2005 Major Milestones
January 21, China Netcom Group, our parent company, and China Mobile
Communications Corporation realized SMS interconnection between mobile and PHS
networks, which promoted rapid growth of our value-added services.
March 10, China Netcom Group continued to top the chart in the 2004
telecommunications industry customer satisfaction survey conducted by the
Ministry of Information Industry.
March 31, China Netcom Group officially launched "CNC MAX" - a new brand for
broadband services.
May 16, China Netcom Group and China Telecommunications Corporation ("China
Telecom") held a joint press conference in Beijing on the launch of PHS handsets
with detachable SIM card, which was expected to promote the development of
value-added services, marketing channels and service qualities of the PHS
business.
May 17, the Company and its partner jointly launched IPTV services in
Heilongjiang Province.
June 15, the Company kicked off "CNC Connected -- 2005 Nationwide Roadshow on
Solutions for Business Customers", a 2-month campaign intended to provide
"premium business solutions" for SMEs.
June 22, the Company's Beijing branch company signed a "Comprehensive
Cooperation Agreement on Olympics Communications Construction" with the National
Olympic Sports Center to formally launch the telecommunications project for
Beijing 2008 Olympics in Beijing.
July 21, the Company and Telefonica, S.A. entered into a Memorandum of
Understanding on Cooperation with the aim of seeking cooperation opportunities
in multiple fields.
July 26, China Netcom Group and China Telecom signed in Beijing an agreement on
nationwide IC card roaming, which was expected to stimulate the usage of the
Company's IC cards.
September 12, the Company signed an acquisition agreement with China Netcom
Group to acquire its telecommunication assets and businesses in the provinces
and regions of Heilongjiang , Jilin, Neimenggu and Shanxi. The acquisition
agreement was approved at the Extraordinary General Meeting held on October 25.
Through this acquisition, we will further consolidate our dominance in our
northern service region market.
November 10, China Netcom Group signed a strategic cooperation agreement with
the Bank of China, aiming to cooperate in terms of resources and information
sharing new product development etc..
November 14, the Company and Telefonica International, S.A. signed a strategic
alliance agreement, pursuant to which Telefonica International, S.A. seeks to
increase its shareholding in the Company and embark on further discussions on
strategic cooperation in a broad range of fields with the Company.
6
December 4, a live charity programme titled "My Dream - In Commemoration of
International Day of Disabled Persons" was successfully broadcasted online to
more than 60 countries and regions of the world via the "CNC MAX" platform,
being the largest broadband live broadcast in China's Internet history and
marking a great stride by the Company towards broadband value-added services and
live webcast.
December 22, China Netcom Group received an award for "Best Internet Access
Service" in "China Top 50 Internet Brands" ratings.
December 7, China Netcom Group was granted a nationwide Internet Cultural
Operating Permit by the Ministry of Culture and intended to expand its chain of
cyber cafe.
7
Financial Highlights
Hong Kong GAAP 2004 2005
(in RMB millions, except earnings per share)
Revenues: 83,494 87,232
Including: upfront connection fees 4,346 3,405
EBITDA (1) 42,701 45,554
Operating profit (2) 17,521 20,505
Profit for the year/period 2,699 13,888
CAPEX 28,256 27,562
Basic earnings/ per Share RMB0.48 RMB2.11
Basic earning/ per ADS RMB9.6 RMB42.2
(1) EBITDA refers to profit before finance costs, interests income, dividend
income, deficit on revaluation of fixed assets, income tax, depreciation
and amortization, share of profit of associated companies. To supplement
our consolidated financial statements presented in accordance with the
Hong Kong GAAP, we use the non-Hong Kong GAAP measure of EBITDA, which is
adjusted from our results based on Hong Kong GAAP. We believes that EBITDA
provides useful information to both management and investors to further
analyze our operating results since we, as a company operating in the
capital intensive telecommunication industry, incurred significant capital
expenditure and finance costs which have significant impact to our results
based on Hong Kong GAAP. EBITDA should only be considered in addition to
our Hong Kong GAAP results. It should not be considered a substitute for
or superior to our Hong Kong GAAP results as it cannot be used to measure
operation results and liquidity and does not represent operation cash
flows. In addition, our EBITDA may not be comparable to similar indicators
of other companies.
(2) Operating profit refers to profit before interests income, dividend income
and deficit on revaluation of fixed assets.
2004-2005 Revenue (in RMB million) 2004-2005 EBITDA (in RMB million)
2004-2005 Profit (in RMB million) 2004-2005 EPS (in RMB)
8
Chairman's Statement
Dear Shareholders,
I am pleased to report to you our operating results for the year 2005. In 2005,
the Company successfully achieved its goal of "growth and efficiency", with
sustained rapid growth in key businesses and substantial improvements in
management efficiency. For the year 2005, we recorded net profits of RMB13,888
million and profits per share of RMB2.11.
During the year, the Company moved ahead on important strategic initiatives,
including the enhancement of the Company's corporate governance and internal
controls and reforms in our marketing and sales channels. These have helped to
establish a strong foundation for sustainable growth.
Strategic Goals and Execution Capabilities
Shortly after our listing, we identified that becoming a "broadband
communications and multi-media services provider" was our ultimate strategic
goal. Since then, we have been committed to a transformation from a voice-based
narrowband operator to a provider of broadband communications and multi-media
services. To this end, the Company made significant progress in 2005 in its
three core strategies, "Broadband, Olympic and International". In 2005, our
broadband business sustained robust growth, including important advances in
broadband content and applications services. During the year, we also commenced
IPTV business in Harbin jointly with our partner. Harbin was the first city in
the PRC with permission to deploy IPTV service. We believe that our IPTV
services will bring about a major breakthrough in the growth our broadband
businesses.
In 2005, the Company entered into a Comprehensive Cooperation Agreement on
Olympics Communications Project Construction with the National Olympic Sports
Centre, aimed at providing broadband support to the Olympic Games. Besides
generating enormous revenues for the host country, previous Olympic Games have
served as an important driver for the adoption of technological breakthroughs,
such as television, mobile phones and even the Internet. Against this backdrop,
it is our dream that the coming Olympic Games will be the first "Broadband
Olympics". We will strive to develop our broadband businesses through
technological, business and service innovations, thereby expediting the
strategic transformation of the Company.
In 2005, we also made major headway in terms of international cooperation. Our
Strategic Alliance Agreement with Telefonica Internacional S.A. enabled
cooperation at shareholding and Board levels. We discussed opportunities for
cooperation in a variety of telecommunications service businesses. We believe
strategic cooperation will bring new expertise to our operations and management.
This will further enhance our ability to implement new business strategies and
innovation, and promote organic and rapid growth of the Company.
9
Expansion through Acquisitions in Four Northern Provinces
In the Extraordinary General Meeting held on 25 October 2005, shareholders
considered and approved the Company's acquisition from China Network
Communications Group Corporation, our controlling shareholder, of its the major
telecommunications assets and business operations in the provinces and regions
of Heilongjiang, Jilin, Neimenggu and Shanxi. After completion of the
transaction, our position as the leading operator in the northern service
regions was further strengthened, leading to a substantial increase in
shareholders' value.
Management Reforms and Governance Enhancement
We believe that a robust corporate governance structure and internal control
system are the key factors for the Company's core competence. A sound corporate
governance structure with effective checks-and-balances, strict and prudent
internal control system and a reliable information system is essential for the
sustained development of the Company and for maximizing shareholders' value.
Therefore, we have initiated management reforms in our corporate governance
structure, internal control system, information system and administrative
system. We are determined to create a world-class corporate governance structure
and to serve as a model for large-scale state-owned enterprises in China.
Since going public, the Company has made significant progress in developing a
sound Board structure, which serves as a solid "hardware" platform for good
corporate governance. To further enhance corporate governance, a special
corporate governance project was launched at the end of 2005 under the direct
leadership of our Board's Corporate Governance Committee. This project has the
ultimate goal of building up effective and robust corporate governance
"software" incorporating world-class best practices.
On another front, our internal control system project launched at the end of
2004 made significant progress in 2005. The objective of this project was to
comply with provisions of the Sarbanes-Oxley Act. During the year, the Company
designed systematic internal control standard models with reference to the
internationally recognized COSO internal control framework. The models have been
officially introduced throughout the Company. In 2005, we embarked on
implementation of an Enterprise Resources Planning (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 assure the efficiency of our internal controls and the accuracy
and timeliness of the Company's internal reporting system. As a result, we will
further strengthen security and monitoring of operations, creating a strong
foundation for healthy growth.
Adding Value to Shareholders
Taking into consideration our financial position, cash flow and potential new
businesses opportunities, the Board proposed a final dividend of HK$0.466 per
share for the financial year ended 31 December 2005.
In February 2006, the Company was officially declared and admitted as a
constituent stock of the Hang Seng Index, reflecting the recognition of our
efforts in maximizing shareholders' value. We will continue to strive for the
highest returns for our shareholders.
10
Future Prospects
Looking ahead, rapid development of the PRC economy and technological advances
in the information industry are expected to bring to the Company both
opportunities and challenges. The telecommunications sector is undergoing a
global transformation. Given the dominant trend, it is essential for the Company
to leverage opportunities presented by technological development and improve its
capacity for innovation. With "Transformation and Innovation" as our focus for
2006, we will strive to enhance operational efficiency through management
optimization. We will also seek to achieve sustainable profitable growth through
innovation. We will further strategic cooperation with international
telecommunications operators in order to introduce into the Company their
advanced management expertise and know-how, thereby enhancing management
efficiency and minimizing the risks of implementing new business strategies.
Given the growing trend of mobile substitution, mobile business has inevitably
become a key strategic focus of the Company. In 2006, we will prepare for the
launch of mobile services, especially by promoting integration between mobile
and fixed-line networks. On this basis, we are committed to providing customers
with broadband-based, multi-media information services integrating voice, data
and video, thereby gradually completing our transformation into a "broadband
communications and multi-media services provider".
Lastly, I would like to extend my sincere appreciation to our shareholders for
their trust and support. I am also grateful for the management and staff's
contribution to the Company in 2005. We are confident in our future. With the
continued commitment of management and staff, we will be able to deliver better
services to customers and create more value for shareholders.
Zhang Chunjiang
Chairman
Hong Kong, 21 March 2006
11
Chief Executive Officer's Statement
Dear Shareholders,
I have great pleasure in presenting our operating results for 2005, which
represent an outstanding performance. Efforts we made in streamlining our
management have produced remarkable results. In 2005, the Company has
experienced a second straight year of substantial improvements in operational
efficiency, coupled with solid growth in both net profits and free cash flow.
While the traditional fixed-line business remained healthy, our growth
businesses including broadband and value-added services grew rapidly, and
contributed a fast increasing share of total revenues. "CNC Connected", a
service targeted to business customers, has helped to build market share and
strengthen our competitive edge in the segment for business customers and key
accounts. We have been able to demonstrate our knowledge of the needs of this
segment, by integrating domestic and international resources and by offering
customized solutions.
In 2005, our efforts at external growth also paid off with acquisitions of major
telecom assets and businesses in the provinces and regions of Heilongjiang,
Jilin, Neimenggu and Shanxi. These enhanced competitiveness as well as value to
our shareholders.
1. Robust Financial Performance
In 2005, the Company experienced sustained growth in revenues and
operational efficiency, due to vigorous business expansion as well as the
imposition of strict cost controls. According to our financial statements
prepared by the merger accounting under generally accepted accounting
principles in Hong Kong and on the basis that all assets and businesses
acquired in 2004 were under the Company's control, revenues in 2005 were
RMB87,232 million, including amortization of upfront connection fees of
RMB3,405 million. If we exclude upfront connection fees, revenue was
RMB83,827 million, a year-on-year increase of 5.9%; EBITDA was RMB42,149
million, up 9.9% year-on-year; EBITDA margin improved from 48.5% last year
to 50.3%; Net profits were RMB10,483 million, while profit margin was
12.5%. Operational efficiency was significantly improved.
In 2005, the Company continued to implement strict control over capital
expenditures in order to achieve profitable growth. CAPEX was reduced by
2.5% in 2005, to RMB27,562 million. CAPEX as a percentage of total revenue
(excluding upfront connection fees) was also lower than the previous year,
falling by 2.8 percentage points to 32.9% in 2005. In 2005, we maintained
growth in free cash flow, which amounted to RMB5,995 million, up 11.1% from
last year.
As of the end of 2005, total interest-bearing debts declined modestly by
0.6% to RMB82,130 million. However, the interest coverage ratio rose from
8.9 times of the last year to 10.9 times, reflecting an improved ability to
repay debts and interests.
12
2. Traditional Fixed-line Business: Stable Growth
In 2005, we effectively mitigated the impact of mobile substitution on the
traditional fixed-line business through service improvements, reform of
marketing and sales channels, and the introduction of new services and
service bundling. Each of these contributed to maintaining healthy growth
in this business segment. By the end of 2005, the number of fixed-line
telephone subscribers reached 115.33 million, representing growth of 6.7%.
This included 27.34 million PHS subscribers, an increase of 23.6% over the
end of 2004. Sustained high growth in the PHS business remained the key
driver for the expansion of the fixed-line telephone subscriber base. In
2005, local voice services maintained stable revenue in contrast to revenue
from long distance voice services, which continued to decline. Owing to
substantial revenue growth in interconnection services during the year,
overall revenues from the traditional fixed-line voice business were
stable. Besides, average subscriber acquisition cost for PHS business
significantly declined in 2005, down to RMB100 from RMB255 in 2004.
Meanwhile, improvement in services and development of new products helped
to control the downward trend in Average Revenue per Unit (ARPU) of local
telephone services in the second half of 2005, establishing a solid
foundation for healthy development in 2006.
3. High Growth Businesses: Sharp Expansion
Broadband services and value-added services are playing a pivotal role in
our transformation into a "broadband communications and multi-media
services provider." Both experienced rapid growth in 2005. They have become
the engine for sustainable and profitable growth of the Company. In 2005,
the number of broadband subscribers increased by 35.1% to11.48 million.
Revenues from broadband and Internet businesses grew by 34.6% to RMB8,350
million contributing 10.0% of total revenue (excluding upfront connection
fees).
In the second half of 2005, we invested heavily in broadband content and
application services and undertook an integration of related resources in
this sector and internal broadband resources in order to prepare for the
development of "video-oriented" broadband content and application services
in the future. During the year, the Company also launched trial IPTV
services with our partners in Harbin, Heilongjiang Province. The growth of
application-based businesses and intensified marketing efforts devoted to
business customers in 2005 stabilized and even tilt upward ARPU in the
broadband business from the second half of 2005. Subject to regulatory
approval, we believe that growth in IPTV and other broadband
application-based services will further promote expansion of our broadband
businesses in the future.
In 2005, our value-added services recorded strong growth. Revenues from
value-added services were RMB4,000 million, representing year-on-year
growth of 33.6%. The increase was due in large part to the launch of
value-added services for PHS subscribers. The volume of PHS short messages
reached 6,780 million while the number of Personalized Ring subscribers
reached 6.814 million, up 241% and 981% respectively from the previous
year.
Thanks to strong revenue growth from broadband and value-added services,
the Company was able to achieve a more balanced revenue structure. The
category of "High Growth Business Revenues," which includes revenue from
broadband services, value-added services, and business and data
communications services, increased 24.5% over the previous year, while its
contribution to total revenue (excluding upfront connection fees) rose by
3.5 percentage points to 23.0%.
In relation to the business customers' market, the Company re-launched the
"CNC Connected" brand in 2005, providing integrated solutions to business
customers. Due to the competitive edge we have due to our geographical
location in the capital city, as well as our rich international network
resources, we were able to further consolidate our lead in the business
market.
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4. Management Innovations Leading to Prominent Effect
We relentlessly pursued our objective of enhancing operational efficiency
by closely monitoring the best practices in the sector and establishing
first class operation management systems. In 2005, the Company built on the
management advantages of our "Headquarters-Branches" structure. We
continued to centralize management in terms of financial management,
capital controls, human resources, procurement, information systems, and
network operations, as well as maintenance and development. The
centralization of operational procedures and resources management
significantly enhanced operational efficiency. In 2005, operating expenses
accounted for 79.6% of total revenue(excluding upfront connection fees), a
decrease of 3.8 percentage points from 2004. The proportion of various
costs to total revenues generally recorded decreases.
Management innovations helped to improve operational efficiency. At the
same time, the Company's ERP and internal control projects are in progress
as planned.
In 2005, the Company was ranked No. 1 in the "Integrated Satisfaction Index
Survey on Telecommunication Customer Services," sponsored by The Ministry
of Information Industry. The Company has maintained this ranking for four
consecutive years.
5. Future Outlook
Looking ahead, we expect market competition to intensify across the
telecommunications sector. However, we also see abundant opportunities
arising from changes in the market environment and regulatory policies,
which will help us achieve our strategic goal of transformation into a
"broadband communications and multi-media services provider." In 2006, the
Company will focus on the following key operating strategies:
-- Traditional fixed-line business: Our strategy is to strengthen our
leading position in the market by bundling PHS and other services;
-- High-growth businesses: We will devote substantial efforts to the
development of broadband and value-added services in order to further
boost the segment's revenue contribution. While expanding the
broadband subscriber base, we will promote development of
"video-oriented" broadband contents and application services. We will
maintain growth momentum in value-added services by introducing
innovations in value-added services for fixed-line telephones;
-- "CNC Connected": We will provide one-stop customized services for
business customers integrating communications, networking and IT in
order to satisfy their diversified and personalized needs. The
objective is to foster a stable and loyal business customer base and
to maintain market share in the market for business customers;
-- Mobile business: We will actively prepare for entry into the mobile
sector, so as to establish a solid foundation for the Company's
transformation into a provider of broadband communications and
multi-media services to all end users across all networks;
14
-- Cooperation with leading international operators: We will extend
strategic cooperation with international telecom operators in order to
adopt advanced management practices and benefit from their expertise,
thereby enhancing our capability for business innovation and
mitigating the entry risks of new businesses; and
-- Operations management: We will maintain cost control efforts through
prudent management of capital expenditures, and pursue higher free
cash flow and improved gearing structure of the Company.
2006 is a year of challenges and opportunities. With the joint efforts of
the Board, management and staff, I am confident that we will continue to
achieve substantial gains for our shareholders. Last but not least, I would
like to take this opportunity to express my deepest gratitude to all our
customers, shareholders, Board, management and employees for their
invaluable trust and support.
Tian Suning
Vice Chairman and Chief Executive Officer
Hong Kong, 21 March 2006
15
Profile of Directors and Senior Management
Directors, Senior Management Officers and Joint Company Secretaries:
Details of our current Directors and Joint Company Secretaries are set out as
follows:
Name Age Position
Executive Directors
Mr. Zhang Chunjiang 47 Chairman and Executive Director
Dr. Tian Suning 42 Vice Chairman, Executive Director
and Chief Executive Officer
Mr. Zhang Xiaotie 53 Executive Director
Mr. Miao Jianhua 54 Executive Director and
Joint Company Secretary
Mr. Jiang Weiping 54 Executive Director
Non-executive Directors
Ms. Li Liming 55 Non-executive Director
Mr. Yan Yixun 67 Non-executive Director
Mr. Jose Maria Alvarez-Pallete 42 Non-executive Director
Independent Non-executive Directors
Mr. John Lawson Thornton 52 Independent Non-executive Director
Mr. Victor Cha Mou Zing 56 Independent Non-executive Director
Dr. Qian Yingyi 49 Independent Non-executive Director
Mr. Hou Ziqiang 68 Independent Non-executive Director
Mr. Timpson Chung Shui Ming 54 Independent Non-executive Director
Alternate Director
Mr. Mauricio Sartorius 46 Alternate Director to
Mr. Jose Maria Alvarez-Pallete
Joint Company Secretaries
Mr. Miao Jianhua 54 Executive Director and
Joint Company Secretary
Ms. Mok Kam Wan 43 Joint Company Secretary
16
Directors and Senior Management Officers
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 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 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. Tian Suning, 42, Vice Chairman, Executive Director and Chief Executive
Officer, has served as a Director since 2000. He has also served as Vice
President of China Netcom Group since April 2002. Since 1999, he has served as
Chief Executive Officer of China Netcom (Holdings) Company Limited and the
Company. He became a Director of China Netcom (Group) Company Limited and China
Netcom Corporation International Limited since 2001 and October 2002,
respectively. 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.
17
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 since October
2004. 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.
18
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.
19
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.
20
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.
21
Senior Management Officers
Dr. Tian Suning, 42, Vice Chairman, Executive Director and Chief Executive
Officer.
Zuo Xunsheng, 55, has served as Chief Operating Officer since December 2005
overseeing general operations of the Company. Mr. Zuo has served as Senior Vice
President since July 2004. 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 Deputy Director and 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 2005.
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.
22
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.
23
Corporate Governance
Since its establishment, the Company has been dedicated to world-class corporate
governance. The Company is convinced that a sophisticated corporate governance
structure is the basis of competitiveness, and supports improvement in corporate
performance as well as maximizing value to shareholders.
In order to achieve a first-class corporate governance structure, at the early
stage of its listing, the Company set up corporate governance "hardware" by
having a high proportion of independent directors and separating of the
positions of Chairman and Chief Executive Officer. Under the Board of Directors,
board committees including a Corporate Governance Committee, Strategic Planning
Committee, Audit Committee, Compensation and Nomination Committee were
established.
In order to take full advantage of this corporate governance "hardware," in
2005, the Company engaged a well-known international consulting firm to assist
the Company in designing a "software" well functioning platform. At the end of
the first phase, the project team finished diagnosis and discussion of problems,
and identified the key areas of improvement needed to achieve a world-class
corporate governance structure and system. In the second phase and the third
phase of this project, we will introduce new corporate governance operational
procedures that will help us become a model for the corporate governance of
large-scale Chinese companies.
In 2005, the Company has fully complied with the code provisions in the Code set
out in Appendix 14 to the Listing Rules.
Board of Directors
The Board comprises thirteen Directors, including five independent non-executive
Directors, three non-executive Directors and five executive Directors. Members
of the board of directors are professionals from the telecommunications,
finance, property development and consultancy industries and economists. They
have extensive professional background and a wealth of experience, and take an
active role in overseeing our development and corporate governance. A majority
of the Board seats is taken by non-executive Directors, which ensures that
decisions are made independently and in the best interests of shareholders.
The responsibility for overall management of the business of the Company is
vested in the Board of Directors. The Board is responsible for formulating the
Company's overall strategies, authorizing the annual strategic development plan,
budget targets, capital expenditures and investment plans; monitoring the
effectiveness of internal controls and regulatory compliance; setting
development targets; and supervising and managing management's performance. The
Board has delegated day-to-day management of the Company's business and
administration to the management.
24
The Board meets four times each year and on other occasions when a Board
decision is required. All members of the Board have full and timely access to
relevant information for meetings. Proposed Board meeting dates for the
financial year are normally agreed in the preceding year's Board meeting. During
this reporting period, the Board held seven meetings. The attendance record of
each member of the Board is set out below:
Directors Attendance of Board meetings in 2005
Executive Directors
Zhang Chunjiang (Chairman) 7/7
Tian Suning (Vice Chairman and Chief
Executive Officer) 7/7
Zhang Xiaotie 4/7
Miao Jianhua 7/7
Jiang Weiping 7/7
Non-executive Directors
Li Liming 7/7
Keith Rupert Murdoch* 4/6
Yan Yixun 5/7
Jose Maria Alvarez-Pallete # 2/2
Independent non-executive Directors
John Lawson Thornton 3/7
Victor Cha Mou Zing 4/7
Qian Yingyi 6/7
Hou Ziqiang 6/7
Timpson Chung Shui Ming 6/7
* Resigned with effect from 12 September 2005
# Appointed with effect from 12 September 2005
25
During this reporting period, the Board at all times complied with the
requirement of the Listing Rules relating to the appointment of at least three
independent non-executive Directors, and complied with the requirement that at
least one of the independent non-executive Directors must have appropriate
professional qualifications or accounting or related financial management
expertise.
Details of the Chairman, Vice Chairman, Executive Directors, Non-executive
Directors and Independent Non-executive Directors are set out on pages [o] to
[o] of this annual report.
Chairman and Chief Executive Officer
The positions of Chairman and Chief Executive Officer are held by Mr. Zhang
Chunjiang and Dr Tian Suning, respectively. The separation of functions ensures
greater independence between the Board and management. The Chairman is
responsible for chairing and managing the Board, as well as focusing on major
strategic issues and corporate governance. The Chief Executive Officer is
responsible to the Board for managing the business of the Company.
Independent non-executive Directors
The Independent non-executive Directors actively take part in the Company's
business through attendance in Board meetings, Board committee meetings and
independent Board committee meetings. They provide constructive comments and
suggestions to the Company including corporate governance practices, strategic
planning, and internal control system optimization. In 2005, management of the
Company proposed the acquisition of the major telecommunications assets and
businesses in four provinces and autonomous regions in the northern part of
China held by the Company's controlling shareholder. According to the
requirements of the Listing Rules, an Independent Board Committee which
comprised all the Independent Non-executive Directors was set up to consider and
comment on whether the acquisition was fair and reasonable. The Independent
Board Committee acted in the interests of minority shareholders, reviewed the
qualifications and capabilities of the independent financial adviser, held four
special meetings within one month to consider this project, and discussed in
detail the fairness and reasonableness of the terms of the acquisition, in order
to protect the legitimate rights and interests of the minority shareholders.
To fully demonstrate the function of Independent Non-executive Directors on the
Board and protect the interests of minority shareholders, the Board of
Directors, in accordance with legal requirements and international best
practice, arranges for the Independent non-executive Directors to play a key
role in reviewing connected transactions.
26
The Company has obtained the confirmation of all the Independent Non-executive
Directors relating to their independence under the Listing Rules. The Company
considers all the Independent Non-executive Directors to be independent. There
are no relations among the directors (including the Chairman and the Chief
Executive Officer).
Non-executive Directors
All Non-executive Directors are appointed for a term of three years, and are
subject to retirement by rotation and re-election by shareholders. Pursuant to
the Articles of Association of the Company, one-third of the Directors,
including both Executive and Non-executive Directors, are required to retire
from office at the annual general meeting each year. A retiring Director is
eligible for re-election. Any Director who is appointed by the Directors will
hold office until the next following annual general meeting and will be eligible
for re-election.
Board Committees
The Board has established four committees, namely the Audit Committee, the
Compensation and Nomination Committee, the Corporate Governance Committee and
the Strategic Planning Committee, to oversee particular aspects of the Company's
affairs. The Committees are governed by their respective Terms of Reference
which are set out in full on the website of the Company and make their
recommendations or decisions independently.
Audit Committee
To guarantee the objectiveness, fairness and independence of the Audit
Committee, the Audit Committee comprises four Independent Non-executive
Directors, chaired by Mr Timpson Chung Shui Ming. The other members of the
Committee are 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.
As an experienced member of the HKSA and of the ACCA, Mr Chung has extensive
professional experience. His active participation has helped to continuously
improve the internal control system and the financial reporting system of the
Company. Led by Mr. Chung, the Audit Committee not only has performed its
responsibilities for supervising corporate auditing, but also played an
important role in optimizing the internal control system. The Audit Committee
leads implementation of the Company's internal control project, reviews regular
reports submitted by the internal control project team, and supervises
implementation of solutions to internal control issues.
27
In 2005, the Audit Committee held four meetings and discharged its
responsibilities in its review of the half-yearly and annual results and the
system of internal control, as well as its other duties as set out in the Terms
of Reference. The attendance record of each Audit Committee member is set out
below.
Directors Attendance of Committee meetings in 2005
Timpson Chung Shui Ming 4/4
Dr Qian Yingyi 4/4
Victor Cha Mou Zing 3/4
Hou Ziqiang 4/4
The work performed by the Audit Committee in 2005 included reviews of:
- the Accounts and report of Directors for the year ended 31 December 2004
and the annual results announcement, with a recommendation to the Board
for approval;
- the Interim Accounts for the six months ended 30 June 2005 and the interim
results announcement, with a recommendation to the Board for approval;
- the 2005 Interim Review Engagement Letter with External Auditors;
- Engagement Letter with External Auditors in relation to the acquisition of
the entire issued share capital of China Netcom Group New Horizon
Communications Corporation (BVI) Limited;
- audit related and permissible non-audit services including tax advisory
and filing services and their related fees;
- the Audit Service Agreement for 2005 Annual Report with External Auditors
and related costs with a recommendation to the Board for approval;
- the audit work plan for the 2005 Annual Report;
- the internal audit function and the resources of the internal audit team
when undertaking its duties and responsibilities, and Summarized Report on
the work performed for the year 2005 and a Report on the work plan for the
year 2006 of the internal audit team;
- the provisions of the Olympic Sponsorship Agreement between China Netcom
Group and the Company;
- the management's preparation for compliance with the internal control
requirements under section 404 of the Sarbanes-Oxley Act; and
- Methods for Handling of Complaints and Reports Concerning Accounting
Information, Internal Control and Auditing Method of the Audit Committee
for China Netcom Group Corporation (Hong Kong) Limited submitted by Audit
Committee Office.
28
On 9 June 2005, the Audit Committee met with the general manager of the
Company's Internal Audit Department, and the Company's External Auditors, in the
absence of the Company's management.
The Board of Directors acknowledges the responsibility for preparing the
accounts. A statement of the auditors about their reporting responsibilities is
set out in the auditors' report on the financial statements on page [o] of the
annual report.
During the year ended 31 December 2005, the fees paid/payable to the auditors in
respect of audit and non-audit services provided by the auditors to the Company
were as follows:
Nature of Services Amount (RMB)
Audit Services 33,800,000
Audit Related Services 38,000,000
Non-audit services
(i) Tax services 4,928,812
(ii) Transfer pricing research 637,318
(iii) Other services 206,912
Compensation and Nomination Committee
The Compensation Committee has been renamed as Compensation and Nomination
Committee with effect from 12 September 2005. The duties of the Committee
include nominating new board members, reviewing the compensation of our
Directors and the Company's management and making recommendations to the Board
of Directors. The members of the Committee are Mr Zhang Chunjiang (Chairman),
Mr John Lawson Thornton, Mr Victor Cha Mou Zing, Mr Hou Ziqiang and Mr Jiang
Weiping.
In 2005, the Compensation and Nomination Committee held two meetings. The
Compensation and Nomination Committee in 2005 reviewed the nomination of a new
director to fill a casual vacancy, the draft severance agreement with the Chief
Financial Officer, the nomination of the Chief Financial Officer and the change
in company secretaries, and the amendment to the share option scheme, which
were recommended to the Board for approval.
29
The attendance record of each Compensation and Nomination Committee member in
2005 is set out below.
Directors Attendance of Committee meetings in 2005
Zhang Chunjiang (Chairman)^ 1/1
Keith Rupert Murdoch * 0/1
John Lawson Thornton 1/2
Victor Cha Mou Zing 2/2
Hou Ziqiang 2/2
Miao Jianhua ** 2/2
Jiang Weiping # 0/0 (Only in attendance)
^ Appointed as Member with effect from 12 September 2005
* Resigned as Director and a Member with effect from 12 September 2005
** Resigned as Member with effect from 7 December 2005
# Appointed as Member with effect from 7 December 2005
The Compensation and Nomination Committee is committed to achieving a sound
balance on the Board in terms of experience and expertise. The nomination of
Directors is assessed on the basis of the ability of potential candidates to
contribute to the Board so that the Board can discharge its responsibilities to
the Company as a whole. The Committee reviews the independence of the
Independent Non-executive Directors.
At a meeting of the Compensation Committee on 27 December 2004, the members
approved the compensation proposal for Executive Directors and reviewed service
agreements with the Executive Directors. In 2005, there was no change to the
compensation policy of the Executive Directors or service agreements with the
Executive Directors.
The compensation for the Executive Directors comprises basic salaries, cash
bonuses, share options, other allowances and benefits in kind. In addition to
basic salaries, Executive Directors are eligible to receive a performance bonus,
taking into consideration factors such as corporate and individual performance.
The performance of the executive Directors is reviewed annually according to set
goals. Salaries are reviewed annually, and increases are made when it is
appropriate to reflect performance contributions, increased responsibilities and
market conditions. The Compensation and Nomination Committee provides to the
Board its recommendations on compensation to the Executive Directors when
appropriate. The Compensation and Nomination Committee reviews the terms of
service contracts with Executive Directors, and makes recommendations to the
Board for approval.
In addition, the Company has adopted a share option scheme to attract and retain
senior management personnel and key employees of the Company. Details of the
amount of Directors' emoluments during 2005 and details of the share option
scheme are set out in notes 15 and 35 respectively to the accounts.
30
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 of
Directors in order to optimize our corporate governance structure. The chairman
of the Committee is Mr John Lawson Thornton (Chairman) and its members include
Dr Tian Suning, Dr Qian Yingyi, Mr Miao Jianhua and Mr Timpson Chung Shui Ming.
The Corporate Governance Committee has played a very active part in promoting
and improving corporate governance. Based on in-depth knowledge and assessment
of the current situation of corporate governance, the Committee recommended that
the Board engage a professional consulting company to improve the efficiency and
effectiveness of corporate governance practices and build the Company into a
model for Chinese companies listed overseas. The Board approved the
recommendation in 2005. At the end of 2005, the Company launched a corporate
governance consulting project under the direct leadership of the Corporate
Governance Committee. The Committee reviewed suggestions and proposals submitted
by the project team on a regular basis. In 2005, the Corporate Governance
Committee held one meeting and Mr John Lawson Thornton (Chairman), Dr Qian
Yingyi, Mr Miao Jianhua and Mr Timpson Chung Shui Ming attended the meeting. At
the meeting, the Committee members reviewed the proposed corporate governance
consulting project, with a recommendation to the Board for approval.
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 the Committee are Mr Zhang Chunjiang (Chairman), Dr
Qian Yingyi, Mr Jose Maria Alvarez-Pallete, Mr Hou Ziqiang, Mr Zhang Xiaotie, Mr
Jiang Weiping and Ms Li Liming.
In 2005, the Strategic Planning Committee held one meeting and the committee
members discussed and approved the strategic and business plan for the year
2005. Mr Zhang Chunjiang (Chairman), Dr Qian Yingyi, Mr Hou Ziqiang, Mr Zhang
Xiaotie, Mr Jiang Weiping and Ms Li Liming attended the meeting. Mr Jose Maria
Alvarez-Pallete was appointed as a member after this Committee meeting.
Directors' Securities Transactions
The Board has adopted the Model Code for Securities Transactions by Directors of
Listed Issuers (the "Model Code") as set out in Appendix 10 to the Listing Rules
as the code of conduct regarding directors' dealing in securities of the
Company. The Company has received confirmation from all Directors that they have
complied with the required standard throughout this reporting period.
Comparison between corporate governance requirements of the New York Stock
Exchange and the Hong Kong Listing Rules
31
According to the Corporate Governance Listing Standards set out in Section 303A
of New York Stock Exchange (NYSE) Listing Company Manual, foreign issuers listed
in NYSE (including China Netcom Group Corporation (Hong Kong) Limited) are
required to disclose major differences in requirements of corporate governance
between its place of incorporation and that of NYSE applicable to local US
issuer. A summary of such difference is available on the website of the Company
at http://www.china-netcom.com/English/inv/Corporate_Governance_Differences.htm
Internal Controls
The Company attaches great importance to its internal control system. It aims to
establish a world-class internal control system compliant with the latest
regulatory requirements. In 2005, the Board conducted a review of the
effectiveness of the Group's system of internal controls.
At the end of 2004, the Company launched a project to optimize its internal
control system. The Company's internal control project team regularly reported
to the management and Audit Committee on the progress of the project and issues
identified. The Audit Committee, in turn, reported to the Board on major
findings of the project team.
The internal control system project made a number of major progresses in 2005.
Through comprehensive studies, pilot design and other phase work, the Company
has conducted in-depth investigation, diagnosis and analysis of management and
service procedures. Based on the internationally recognized COSO internal
control framework, the Company has designed an internal control system standard
template that integrates international advanced management philosophy as well as
conforming to the Company's actual needs. The Company has conducted a pilot test
of the standard template in the Company's Hebei branch company. Based on the
pilot test results, the Company has improved the standard template and started
to introduce it across the Company, beginning at the end of last year. It is
expected that the introduction of the standard template will be fully completed
in the latter half of 2006.
While improving the internal control flow system, the Company developed
Stipulations on Information Quality Guarantee and Accountability Management of
China Netcom Group 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. The Company has also developed Methods for
Handling of Complaints and Reports Concerning Accounting Information, Internal
Controls and Auditing Methods of the Audit Committee for China Netcom Group
Corporation (Hong Kong) Limited, which prohibits any intentional reporting of
false or erroneous information from all levels of the Company.
32
Investor Relations
The Company aims to introduce industry best practices, improve the scope and
quality of information disclosure and make the Company more transparent so that
all investors have access to information of the Company on a timely basis.
Besides the regular annual results announcements meeting, interim results
announcements meeting and non-deal road show, the Company has kept close contact
with investors through one-on-one meetings, telephone conferences, and corporate
days. Investors have easy access to financial information, the annual report,
presentations and other materials released to the public on the Company's
website. Beginning in 2006, the Company will release its key operational
information on a quarterly basis and increase the disclosure scope and frequency
of information disclosure.
As a company listed on both U.S. and Hong Kong stock markets, the Company
follows the strictest requirements and strives to ensure fair disclosure to all
investors. The Company requires all major information to be uploaded to its
website immediately after its release to the public through notices and press
conferences to ensure that all shareholders and investors can have access to
relevant information as quickly as possible. There are differences between the
rules of the Hong Kong and New York Stock Exchanges. Among the risk factors
listed in the Company's prospectus is that holders of American Depository Shares
(ADS) may not receive the proxy materials on issues to be discussed at
shareholders' meetings in time. Nonetheless, the Company will do its utmost to
consider the interests of both Hong Kong shareholders and ADS holders. When
arranging the timetable of the annual shareholders' meeting and extraordinary
general meeting, the Company will ensure timely delivery of all relevant meeting
materials to the shareholders, so that all shareholders can have access to
necessary information prior to the meetings, have the chance to participate in
the decision-making process, and give their opinions.
33
General Meetings
The most recent general meeting was an extraordinary general meeting ("EGM")
held on 25 October 2005 at Nathan Room, the Conrad Hotel, Hong Kong. The major
items discussed at the meeting and the percentage of votes cast in favour of the
resolutions relating to those items are set out below:
- Approval of the Conditional Sale and Purchase Agreement dated 12 September
2005 regarding the purchase of the entire issued share capital of China
Netcom Group New Horizon Communications Corporation (BVI) Limited
(99.99998%);
- Approval of the Continuing Connected Transactions contemplated under the
Engineering and Information Technology Services Agreement and the Materials
Procurement Agreement both dated 12 September 2005 together with the
relevant annual caps (99.99996%); and
- Approval of the Continuing Connected Transactions contemplated under the
Domestic Interconnection Settlement Agreement and the International Long
Distance Voice Services Settlement Agreement both dated 12 September 2005
and for which transactions no caps have been proposed (100%).
The resolutions put to the shareholders were passed at the EGM. The results of
the voting by poll have been published on the Company's website, the website of
the Hong Kong Stock Exchange and also by notice in local newspapers.
The next shareholders meeting will be the 2006 annual general meeting of the
Company to be held on 16 May 2006.
Information relating to the details of shareholders, their shareholding and the
Company's public float status are set out on page [o] in the Report of the
Directors in the annual report.
There has been no change in the articles of associations of the Company during
2005.
34
Human Resources Development
The objective of our human resources development strategy is to enhance the
Company's human capital value and operational capability. We have designed these
strategies to support our strategic transformation into a broadband
communications and multi-media services provider.
As of 31st December 2005, there were 138,440 full-time employees and 60,521
temporary employees in the Company.
Remuneration and Incentives
At the time that it listed its shares, the Company began to revise its
remuneration and incentive system, and established a new remuneration and
incentive scheme based on a system employing digital KPI (key performance
indicators) performance assessments. The introduction of this new incentive
scheme has improved staff motivation and efficiency. Through digital KPI
performance management, strategic goals of the Company have been quantified and
segmented for every employee, so that every individual employee can align
himself or herself with corporate goals.
Staff Development and Organizational Reform
The Company believes that training is one of the most effective ways to promote
individual competitiveness, satisfaction and loyalty. Management reform and
streamlining has been a constant feature of our strategic transformation, and
our corporate structure undergoes continual fine-tuning. Training is also a
means to ensure smooth implementation of organizational reform and employees'
adaptation to organizational reform and strategic transformation.
In 2005, the Company conducted a radical reform on the marketing & sales system
in the northern service region with the introduction of a community manager
system across the Company. In view of this, the Company developed special
training programmes and trained 989 internal community manager coaches, who in
turn trained the 36,000 community managers in the Company, thereby enabling the
successful implementation of the marketing and sales channels reform. In
addition, the Company also provided assistance to its staff in grasping the
development trend of modern communication technologies by engaging renowned
experts in the sector to conduct training on advanced communication network
technologies. These training programmes enabled our staff to understand the
importance of our strategic transformation and facilitated their adaptation of
such transformation and reform.
In 2005, the Company increased its investment in staff training, especially for
middle and senior management staff and core employees. In order to cope with
requirements for listed companies, the Company entered into collaboration with a
world-renowned investment bank to organize a management-training course. We now
have 54 graduates of this program who are familiar with the concepts of
corporate value management and capital markets. The Company has cooperated with
leading universities in the PRC to develop two advanced English training courses
to cope with the internationalization of the Company. A total of 60 employees
have benefited from these courses. In order to accelerate the adoption of
international best management practices, the Company has entered into a series
of talent exchange programs with leading global telecommunication operators.
35
Systematic and Detail-Oriented Management
With the aim of elevating the efficiency of our human resources management and
information system, the Company embarked on the development of an e-HR system,
which commenced operations in December 2005. As an integral part of our ERP
system, the e-HR system provides a modern approach for the optimization of our
human resources management.
Aiming for the Best in Human Resources Systems
The Company will continue to select, train and nurture senior management
personnel and core employees in 2006 in order to support the Company's ongoing
organizational reforms. Group training will be provided to division heads to
impart an understanding of the rationale, objectives and initiatives of our
transformation strategy. In addition, the Company will launch a series of mobile
business and technology related training programs to prepare our staff for
future developments in the mobile business.
36
Business Review
Key Developments in 2005:
o The acquisition of assets and businesses in the four northern provinces
significantly strengthened the Company's leading position in the relevant
market.
o Broadband services have become the chief driver of revenue growth for the
Company, contributing 55.8% to the increase in revenue (excluding upfront
connection fee). The number of broadband subscribers increased by 35.1%
over last year.
o Fixed-line telephone services maintained a healthy rate of growth with the
number of subscribers increasing by 6.7%. The number of PHS subscribers
increased by 23.6%. The Company achieved 92.3% market share in its northern
service region.
o Value-added services continued to see rapid growth. Value-added revenues
increased by 33.6% over last year, and became one of the main drivers of
overall revenue growth.
o The Company's competitive advantages in the business segment were further
consolidated. Bandwidth subscribed by corporate customers grew by 78.1%
from last year.
o Capital expenditures continued to decline and as a percentage of total
revenues dropped by 2.8 percentage points compared with last year.
o For the fourth year in a row, the Company ranked first in a
telecommunications industry customer satisfaction survey conducted by the
Ministry of Information Industry.
37
"Growth and efficiency" were the goals of corporate and strategic development
in 2005. We executed a two-pronged strategy. In the fixed-line business, we
were able to attract and retain customers and strengthen our dominance in the
northern service region by offering first class services, and ensuring the
stable growth of fixed-line business. In our high-growth broadband and
value-added services, we were able to leverage our enormous subscriber base to
achieve sustainable growth and transform towards the strategic goal of becoming
a "broadband communications and multi-media services provider".
In 2005, the Company recorded strong growth across business sectors. The
Company achieved revenues in 2005 of RMB83.83 billion (excluding upfront
connection fees), representing an increase of 5.9% from the previous year.
Broadband and value-added services remained the major drivers for revenue
growth. The number of fixed-line telephone subscribers grew by 6.7% over 2004
to 115.328 million. The Company achieved a 92.3% market share in the northern
service region and consolidated its dominance in such market. The number of
broadband subscribers grew by 35.1% to 11.475 million, and achieved 87.6%
market share in the northern service region. Value-added services continued to
expand rapidly, with a contribution to total revenue of 4.8%. This represented
an increase of 33.6% over last year. In the business customers market, a number
of factors strengthened the Company's competitiveness, including the launch of
"CNC Connected", the Company's geographical advantage in the capital city, and
its ability to provide one-stop global communications networking services. As a
result, bandwidth subscribed by corporate customers grew by 78.1% over the
previous year.
Summary of Key Products
Fixed-line Telephone Broadband and Other Business and Data International
Services Internet-related Communications ` Telecommunications
Services Services Services
115.328 million 11.475 million Premium customer 1,854 international
subscribers broadband base corporate customers
(including PHS) subscribers
92.3% market 87.6%(1)(2) broadband Leading provider in the Leading operator in the
share(1)(2) market share northern service region Asia-Pacific region
81.8%of revenue(3)(4) 10.0% of revenue(4) 4.3% of revenue(4) 3.9% of revenue(4)
2.9% growth(4) 34.6% growth 0.5% growth(4) 23.2% growth(4)
(1) As of December 31, 2005
(2) In our northern service region
(3) Including other services revenues
(4) Excluding upfront connection fees
38
The following table illustrates the key operating data in 2005 and 2004:
% / increase
2004 2005 /decrease
Fixed-line subscribers (`000) 108,079 115,328 6.7%
Including: PHS subscribers (`000) 22,124 27,337 23.6%
Broadband subscribers (`000) 8492 11475 35.1%
Total usage (pulses in millions) 234,661 228,436 -2.7%
Excluding Internet dial-up usage (pulses in millions) 217,435 219,884 1.1%
Internet dial-up usage (pulses in millions) 17,226 8,552 -50.4%
Domestic long distance calls (minutes in millions) 29,366 30,975 5.5%
International long distance calls (minutes in millions)(1) 471 591 25.5%
Number of ports for DDN (ports) 150,630 131,812 -12.5%
Number of ports for Frame Relay (ports) 43,078 43,519 1%
Number of ports for ATM (ports) 4,816 4,212 -12.5%
Digital circuits leased (x2Mbps) 91,103 129,989 42.7%
Volume of PHS short messages (in millions) 1,988 6,777 240.9%
"Personalised Ring" service subscribers (`000) 630 6,814 981%
Penetration rate for caller identification (%) 60.4% 65.9% 5.5ppt
Telephone information services (million minutes) 2,969 3,084 3.9%
(1) International long distance call volume includes calls to Hong Kong, Macau
and Taiwan.
Broadband and other Internet-related Services
The broadband and internet service markets of the PRC recorded rapid growth as a
result of sustained rapid economic growth and the swift penetration of the
Internet in the PRC, as well as the aggressive push to digital technologies by
the PRC government for the purposes of enhancing national and industrial
competitiveness. In 2005, the broadband segment continued to grow in scale. The
number of broadband subscribers increased by approximately 2.983 million a
growth rate of 35.1%, making the segment the Company's most important growth
driver. As a result of vigorous market competition, the Company's market share
in the northern service region dropped to 87.6% in 2005, although the Company
still maintained its leading position in the market.
39
In order to enhance the market penetration rate of its broadband services, the
Company is offering a diverse range of products with different price packages to
satisfy the individual needs of customers. Catering to business customers'
diversified needs, the Company launched DSL private lines and optical fibre
access products at a range of different speeds, with integrated broadband access
products bundled with applications such as corporate web hosting, email, office
automation and a sales management platform. In view of the increased demand for
Internet services from students during the summer vacation, the Company launched
new broadband access products such as "Holiday Broadband" and "Green Internet".
These have been bundled with broadband content and application services and
jointly promoted with computer manufacturers, which has effectively stimulated
the demand for broadband services among household subscribers. Targeting the
huge cyber cafe market, the Company cooperated with cyber cafes under the brand
name of "CNC Garden" through franchise licensing. In December 2005, China Netcom
Group was officially granted an "Internet Cultural Operating Permit" by the
Ministry of Culture which is applicable nationwide. As such, the Company will
expand its chain of cyber cafes, building on its advantage of a strong brand
image and solid Internet resources.
Development of the Company's broadband subscriber base:
2003 2004 2005
Number of broadband subscribers ('000) 3,346.2 8,492.4 11,475.2
Including: DSL 2,708.9 5,956.2 8,568.4
LAN 636.6 2,533.2 2,904.2
Northern service region ('000) 3,313.4 8,146.4 11,036.2
Including: DSL 2,708.9 5,939.2 8,529.2
LAN 603.8 2,207.2 2,507.0
Southern service region ('000) 32.8 346 439
Although access speed and price are still the decisive factors in the broadband
market at present, the Company believes that development in broadband content
and applications is the key to sustainable growth. The Company has achieved
innovations and breakthroughs in content and applications through both
proprietary development and collaboration with third parties. The Company has
entered into cooperation with approximately 500 content and applications
providers in the businesses of live webcasting, virtual theater, video
conferencing, IPTV, online education, and broadband games. Besides basic
services such as games, video and portals, the Company has also launched a
series of dedicated services catering to the specific needs of local markets and
industry subscribers, namely integrated tax payment services platform, digital
libraries and digital photo-finishing. In 2005, the Company's exploration and
promotion of commercial applications of IPTV also paid off well. The Company
successfully launched China's first IPTV services in Harbin, Heilongjiang
Province.
As a result of economies of scale arising from its huge subscriber base and due
to rapid growth, in 2005 the Company's investment per line and procurement costs
of equipment for the DSL platform continued to decline. The Company's broadband
business maintained a satisfactory return on investment.
40
Fixed-line Telephone Services
The Company's core business in fixed-line telephones was able to secure its
existing customer base and continue to dominate the market for new customers in
2005. The number of fixed-line telephone subscribers increased by 6.7% from the
same period last year to 115.3 million, with 7.249 million new subscribers. The
Company achieved 92.3% market share in the northern service region.
Unit: '000 subscribers 2003 2004 2005
Total number of fixed-line subscribers 94,073 108,079 115,328
Northern service region 93,840 107,571 114,658
Including: 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
Southern service region 233 508 670
41
Local Telephone Services
In 2005, in local telephone services, the Company focused on the issues of loss
of existing customers and consolidating its lead in new customers. The Company
continued to optimize its PHS network in 2005, which improved the voice quality
and further reinforced advantages of PHS services in terms of lower service fees
and less radiation than that generated by mobile networks . The number of new
subscribers to PHS services amounted to 5.21million, accounting for 71.9% of the
total number of new local telephone service subscribers. This reflected a
successful mitigation of risks associated with mobile substitution and market
competition. Meanwhile, The Company established a customer loss alert and
retention programme. Together with the Company's community manager system, it
has helped to reinforce customer retention, enabling us to effectively prevent
the loss of customers and business to other fixed-line competitors. The Company
leveraged its competitive edge as a multiple telecommunications services
provider and bundled products for fixed-line, broadband and PHS telephone
services in order to increase service value to subscribers. This value-added
measure for subscribers has strengthened loyalty to the Company. Consequently,
the Company managed to control customer losses and recruit new customers. The
Company has aggressively explored the markets of urban commercial buildings and
new residential districts, as well as wealthy rural areas. As a result, the
Company successfully expanded its subscriber base for local telephone services,
and more importantly, has reinforced its strategic development platform for the
development of broadband business.
42
In addition to retaining existing subscribers and attracting new ones, the
Company stabilized subscriber MOU by encouraging the use of fixed-line
telephones. The strategy produced a slowdown in the decline of fixed-line
telephone usage in the second half of 2005. Tapping into the key customer groups
and market segments, the Company adopted various measures including the launch
of differentiated monthly packages to promote the return of old users and
stimulate nil volume users, which effectively promoted growth in phone traffic.
Reflecting customer preferences, the Company has developed new fixed-line
terminals and successfully launched a new phone terminal named "One Touch ",
which bundled 114, weather forecast and call forwarding services, etc. The
package quickly acquired a subscriber base of over 1.6 million subscribers. In
December 2005, the Company launched "Home Box", which integrates PHS and
fixed-line telephone services. A pilot project as the Company moves towards
Fixed-Mobile Convergence (FMC), "Home Box" will help to reinvigorate use of
fixed-line services and will have a very positive impact on the Company's future
mobile business.
In 2005, the Company's local telephone usage excluding Internet dial-up usage
reached 219.88 billion pulses, an increase of 1.1% over the same period last
year. Because of the gradual migration of narrow-band subscribers to broadband
services, local telephone Internet dial-up usage continued to decline to 8.55
billion pulses, representing a decline of 50.4% from last year.
Value-added Services
In order to fully leverage the Company's large subscriber base and stablize the
ARPU of its fixed-line phone services, the Company is committed to avoiding
price competition by aggressively developing value-added services. In 2005,
fixed-line telephone value-added services grew rapidly and achieved scale growth
in all services including PHS short messages, "Personalised Ring" services,
caller identification, and telephone information services. This business segment
has become a major driver of revenue growth for the company's fixed-line
telephone services and a key segment for enhancing the Company's operational
competitiveness.
As of the end of 2005, the volume of PHS short messages was 6.78 billion, an
increase of 240.9% over the previous year. The number of "Personalised Ring"
service subscribers reached 6.81 million, representing a year-on-year increase
of 981% . Caller identification penetration rate grew by 5.5 percentage points
from the previous year to 65.9%.
The growth in value-added services to some extent compensated for the decline in
ARPU of the traditional local fixed-line telephone business. Value-added
services enjoyed a relatively higher return on investment due to lower
investment costs.
43
2003-2005 Growth in the number of 2003-2005 Growth in volume of SMS
our Personalized King Subscribers ('000) (in millions)
Long Distance Services
Unit: million minutes 2003 2004 2005
Domestic long distance calls 26,330 29,366 30,976
Including: Traditional network 15,220 15,546 15,979
VOIP 11,110 13,820 14,997
Northern service region 24,294 27,047 27,775
Including: Traditional network 15,190 15,087 15,653
VOIP 9,104 11,960 12,122
Southern service region 2,036 2,319 3,200
Reflecting the increasing popularity of VOIP phone and fierce price competition,
the Company's market share in the long distance service sector declined in 2005
despite marked growth in usage over last year. In 2005, domestic long distance
usage increased by 5.5% over the same period last year, while the Company's
market share in the northern service region fell by 3.4 percentage points from
2004 to 38.3%. International long distance call usage, including long distance
calls made to Hong Kong, Macau and Taiwan, increased by 25.5% over the same
period last year, while market share in the northern service region dropped by
5.6 percentage points from the same period last year to 48.7%.
44
Unit: million minutes 2003 2004 2005
International long distance calls 458 471 591
Including: Traditional network 187 158 173
VOIP 271 313 418
Northern service region 365 339 353
Including: Traditional network 186 148 156
VOIP 179 191 197
Southern service region 92 132 239
Interconnection Service
With overall growth in the domestic telecommunications market and expansion of
the Company's customer base, as a result inbound call volume and revenues from
interconnection service between the Company and other operators increased. The
volume of inbound calls through the Company's networks increased by 27.1% in
2005 compared to the same period in the previous year.
Business and Data Communications Services
Unit: ports 2003 2004 2005
Number of ports
DDN (ports) 153,838 150,630 131,812
Frame Relay (ports) 36,683 43,078 43,519
ATM (ports) 1,239 4,816 4,212
Leased line bandwidth
DDN ('000 x 64kbps) 319,812 319,323 205,064
Frame Relay ('000 x 128kbps) 47,123 82,395 177,016
ATM (x 2Mbps) 10,010 23,262 12,316
MPLS VPN (x 2Mbps) 10 125 311
Leased circuit bandwidth (x 2Mbps) 84,138 91,103 129,989
Business customers (x 2Mbps) 39,942 56,363 100,387
Carrier customers (x 2Mbps) 44,196 34,740 29,602
45
The business service market has long been a focus of the Company's growth
strategy. The Company is able to leverage its the competitive advantage of its
geographical location in the nation's capital, Beijing, its network resources,
business innovation capability and ability to provide one-stop solutions to
dominate the business service market. In 2005, the Company launched the "CNC
Connected" brand targeting the business service market, providing one-stop
communications solutions catering to needs of business customers in different
sectors. The Company improved its marketing and service systems for major
customers. Dedicated managers were appointed to serve these customers. Members
of the Company's management team served as chief representatives in charge of
key customers. During the year, the Company strengthened its dominance of the
business service market. Due to robust growth in demand in the business segment,
its total leased circuit bandwidth was 100387 x 2M, representing an increase of
78.1% over the previous year.
International Telecommunications Services
The Company has always attached great importance to the development of
international telecommunications services and aims to become the leading
alliance partner for foreign telecommunication operators in the PRC, providing
one-stop, end-to-end telecommunication and networking services to an increasing
number of multinational companies in the PRC. The Company's strategy is to use
its international business as a driving force for growth of its domestic
service. Capitalizing on its extensive cooperation with foreign
telecommunication operators and its proprietary international network resources,
the Company offers end-to-end global telecommunication network services for an
ever-increasing number of Chinese corporate customers that are seeking to "go
global". These services helped to further fortify the Company's position in this
segment.
As of the end of 2005, the international business of the Company spanned 263
countries and regions around the globe. International telecommunications
services were provided to 1,854 international corporate customers, with an
annual growth rate in subscriber base of 30.1%. In 2005, international incoming
calls amounted to 2.09 billion minutes, representing an increase of 21.2% over
the same period last year. Access bandwidth the Company provided for
international managed data services amounted to 21,458 units, representing and
increase of 94.3% over the previous year.
Branding
To better support the Company's broadband strategy, in 2004 the Company launched
a new core brand of "A Broadened World". In 2005, the Company launched "CNC
MAX", a new brand for its broadband services targeted at residential and
individual users. In order to support its strategy for business customers, the
Company has restructured "CNC Connected," its brand for business customers.
These two brands are providing a solid foundation for marketing and development
of broadband businesses.
46
Marketing and Customer Service
In 2005, the Company throughly revised marketing and sales channels in the
northern service region, based on a new community manager system. It established
a cross-marketing system on the basis of the Company's major account managers,
community managers, sales outlets, 10060 telephone marketing, online marketing,
and third partners.
Over 40,000 community managers carried out direct marketing through on-site
cold-calling, which significantly enhanced the Company's product sales and
service quality. To ensure the effectiveness of the community manager marketing
strategy, the Company set key performance indicators for community managers on
certain criteria such as sales revenue, sales growth, service and maintenance.
In 2005, the Company improved its system of chief representatives for key
accounts and provided one-stop global services to major customers. Centralised
or separate settlement options were offered based on the clients' needs. In
response to growing demand of business customers for communications, networking
and IT services, in 2005 the Company promoted a wide range of customized
value-added applications and integrated solution packages through promotion
activities such as road show targeting specific groups of customers.
In 2005, the Company was able to improve customer satisfaction and, for the
fourth consecutive year, ranked the first in a customer satisfaction survey
conducted by the Ministry of Information Industry.
Network Construction
In 2005, the Company increased investment in growth business networks and pilot
networks of new technologies. In order to ensure the growth of its rapidly
expanding broadband business, the Company made substantial investments in
broadband and supporting networks. In 2005, investments in broadband and data
services accounted for 26.4% of the Company's total investments, at RMB7.3
billion, representing an increase of 9.8% over the same period last year. In
2005, the Company completed network-intelligentizing projects for 38 local
networks, which helped the Company to adopt flexible marketing initiatives such
as cross-service bundling, as well as to provide better customer services and
respond quickly to changes in the market.
The Company's investment in the PHS network declined from RMB8.1 billion in last
year to RMB5.6 billion in 2005. Investment in the PHS network was mainly for
network optimization and provision of value-added services. In the traditional
fixed-line network, investment was applied for market expansion on the one hand,
and for network optimization on the other, which enhanced network utilization,
improved service quality, and earned at the loyalty of our customers. In 2005,
the Company's investment in its fixed-line telephone business, including
value-added services, was RMB6.8 billion.
As part of its efforts to apply new technology and to complete its strategic
transformation, the Company embarked on construction of a pilot soft-switch
network and a pilot broadband IP carrier network. It also initiated pilot
commercial projects for new technologies such as IPv6 and ASON, preparing for an
anticipated large-scale evolution of its network in the future.
In 2005, the Company further its existing policies of standardizing
administrative procedures for fixed assets investment and centralizing
procurement policy, for the purpose of enhancing network utilization and
investment returns while reducing investment risks.
47
Support System Construction
In 2005, the Company formulated a "Tri-Integration" development strategy for its
corporate information system. This will enable gradual integration and
standardization of its three major systems - application systems, the data
center and the transport network carrying the application systems. The strategy
aims at enhancing management transparency and the Company's ability to support
integrated businesses and respond to the market, and is a key part of
preparations for strategic transformation of the Company.
In 2005, a "2+1" project was launched as part of the implementation of the
"Tri-Integration" strategy. The project involved the full-scale deployment of
ERP 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, the Company's back office information system
will see substantial improvements in terms of maintenance costs and management
efficiency. The "2+1" project is expected to enhance market responsiveness and
business support capability, by facilitating quick decision-making for the
Company's management and operations, control of operating risks and improvement
of internal controls.
48
Management's Discussion and Analysis of Financial Condition
and Results of Operations
On 31 October 2005, the Company acquired from China Netcom Group the telecom
businesses and assets in Heilongjiang Province, Jilin Province, Neimenggu
Autonomous Region and Shanxi Province (collectively the "Acquired Business").
Since the Company and the Acquired Business were under the common control of
China Netcom Group, the acquisition was deemed as a restructuring of entities
under common control. As such, it accounted for by merger accounting pursuant to
Accounting Guidelines 5 "Merger Accounting for Common Control Combinations".
Accordingly, all business operations and assets of the Acquired business were
accounted for based on their carrying amounts, as if they have been held by the
Company throughout the historical periods covered by the report.
In 2005, our operating revenues increased steadily while operating expenses were
kept under effective control. Our profitability recorded a substantial growth
with strong operating cash flow.
Our operating revenues recorded a satisfactory increase of 4.5% to RMB87,232
million in 2005 from 2004. Under continued and effective cost control, our
operating expenses increased to RMB66,727 million in 2005 from 2004 by merely
1.1%, which was less than the growth in revenue. EBITDA was RMB45,554 million,
with an EBITDA margin of 52.2%. Operating profit increased substantially by 17.0
% from 2004 to RMB20,505 million and reached net profit to RMB13,888 million.
Capital expenditure was kept under effective control at RMB27,562million. Our
free cash flow(1) amounted to RMB5,995 million and interest coverage ratio(2)
was 10.9 times. The basic earnings per share was RMB2.11.
(1) Cash flow from operating activities minus our capital expenditures
(2) EBITDA to interest expense
The following table sets out the operating revenues, operating expenses,
operating profit and net profit of the Company (based on amount and percentage
of total revenues).
Years Ended 31 December
2004 2005
Percentage Percentage
Amount of Revenues Amount of Revenues
(RMB in millions, except percentage data)
Operating revenues 83,494 100% 87,232 100%
Operating expenses 65,973 79.0 66,727 76.5
Operating profit 17,521 21.0 20,505 23.5
Net profit 2,699 3.2 13,888 15.9
49
Revenue
Sources of our revenue consist of revenues from fixed-line telephone services,
broadband and other Internet-related services, business and data communications
services and international telecommunications services.
Our revenue was RMB87,232 million in 2005, representing a growth of RMB3,738
million or 4.5% over RMB83,494 million in 2004. This growth primarily reflected
increases in broadband services, value-added services, domestic interconnection
fees and international telecommunications services.
The following table illustrates a breakdown of our revenue and their percentage
of our total revenue in 2004 and 2005.
Years Ended 31 December
2004 2005
Percentage Percentage
Amount of Revenue Amount of Revenue
(RMB in millions, except percentage data)
Domestic Telecommunications Services:
Fixed-line telephone services:
Local:
Local usage fees 24,858 29.8% 24,582 28.2%
Monthly fees 17,964 21.5 18,261 20.9
Upfront installation fees 1,568 1.9 1,442 1.7
Subtotal 44,390 53.2 44,285 50.8
Domestic long distance 11,266 13.5 10,260 11.8
International long distance 1,234 1.5 1,180 1.4
Value-added services 2,993 3.6 4,000 4.6
Interconnection fees 5,441 6.5 6,517 7.5
Upfront connection fees 4,346 5.2 3,405 3.9
Subtotal 69,670 83.4 69,647 79.8
Broadband services 5,202 6.2 7,812 9.0
Other Internet-related services 1,004 1.2 540 0.6
Subtotal 6,206 7.4 8,352 9.6
50
Years Ended 31 December
2004 2005
Percentage Percentage
Amount of Revenue Amount of Revenue
(RMB in millions, except percentage data)
Business and data communications services
Managed data 1,520 1.8 1,395 1.6
Leased line 2,095 2.6 2,238 2.6
Subtotal 3,615 4.4 3,633 4.2
Other services 1,360 1.6 2,345 2.7
Subtotal 80,851 96.8 83,977 96.3
International Telecommunications Services:
International long distance 181 0.2 284 0.3
International interconnection fees 1,012 1.2 1,266 1.5
Broadband services 105 0.1 104 0.1
Other Internet-related services 255 0.3 272 0.3
Managed data 309 0.4 407 0.5
Leased Lines 496 0.6 683 0.8
Other services 285 0.3 239 0.3
Subtotal 2,643 3.2 3,255 3.7
Total 83,494 100.0 87,232 100.0
Domestic telecommunications services
Fixed-line telephone services
Local telephone services. Revenue from our local telephone services (including
PHS services) comprises local usage fees, monthly fees and upfront installation
fees.
Revenue from our local telephone services was RMB44,285 million in 2005,
representing a decrease of RMB105 million, or 0.2%, from RMB44,390 million in
2004, accounting for 50.8% of our total revenue in 2005. Competition in the
telecommunications services market intensified in 2005 with an increasing trend
of mobile substitution. However, the decline in this sector was partially offset
by the growth in 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 usage fees for
dial-up Internet access.
Local usage fees amounted to RMB24,582 million in 2005, representing a decrease
of RMB276 million, or 1.1%, from RMB24,858 million in 2004. The decline was
mainly attributable to reduced usage volume of local calls, which dropped by 6.2
billion pulses or 2.7% from last year to 228.4 billion pulses in 2005. The usage
volume of our dial-up Internet access fell by 50.4%, reflecting the migration of
Internet dial-up traffic to broadband services.
51
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 RMB18,261 million, representing an
increase of RMB297 million, or 1.7%, from RMB17,964 million in 2004. The revenue
growth was largely attributable to the steady increase in the number of our
fixed-line subscribers in our service regions.
Upfront installation fees represent the amortised amount of the upfront fees
received for installation of fixed-line telephone services. These upfront
installation fees are amortised over the expected customer relationship period,
which is currently estimated to be ten years.
Revenue from the upfront installation fees was RMB1,442 million in 2005,
representing a decrease of RMB126 million, or 8.0%, from RMB1,568 million in
2004. This was principally attributable to upfront installation discount offered
to new subscribers and a slow-down in the growth of our subscriber base.
Long distance services. Revenue from our long distance services consists of
usage fees for domestic and international long distance calls.
Our revenue from our long distance calls was RMB11,440 million in 2005,
representing a drop of RMB1,060million, or 8.5%, from RMB12,500 million in 2004.
The usage volume of long distance calls was 31.6 billion minutes in 2005,
representing an increase of 1.8 billion minutes, or 6.0%, from 29.8 billion
minutes in 2004. The decrease in revenue was mainly resulted from a decrease in
our realized tariff due to the continuous increase in the proportion of long
distance calls carried on our VOIP network.
Value-added services. Revenue from our value-added services consists of fees
that we charge our customers for the provision of caller identification, PHS
short messages, ring tone, telephone information services, tele-conferencing and
other value-added services.
Revenue from our value-added services was RMB4,000 million in 2005, representing
an increase of RMB1,007 million, or 33.6%, from RMB2,993 million in 2004. With
the continuous expansion of subscriber base in our service regions, value-added
services revenue generated from fixed-line telephone and PHS services has become
one of our main sources of revenue growth. In 2005, penetration of our caller
identification service reached 65.9%, while the number of PHS short messages
amounted to 6.8 billion, representing an increase of 241% as compared with the
previous year.
Interconnection services. Revenue from our interconnection services represents
interconnection fees charged to other domestic telecommunications carriers and
associates for interconnection of both local and long distance calls.
Revenue from our interconnection services with domestic carriers was RMB6,517
million in 2005, representing an increase of RMB1,076 million or 19.8%, from
RMB5,441 million in 2004. The increase was primarily due to increases in the
interconnection fees from other domestic carriers, and that the Company began to
settle interconnection fees with associates.
Upfront connection fees. Upfront connection fees represent the amortised amount
of the upfront fees received for the initial activation of fixed-line telephone
services.
Revenue from our upfront connection fees was RMB3,405 million in 2005, decreased
by RMB941 million, or 21.7%, from RMB4,346 million in 2004, and will continue to
decline in the coming years until they are amortised completely.
52
Broadband Services
Our broadband services refer to those with revenue generated from DSL, LAN, and
broadband-related value-added services.
With phenomenal growth in revenue, broadband services have become the major
revenue driver of the Company. Revenue of broadband services was RMB7,812
million in 2005, representing a increase of RMB2,610 million, or 50.2%, from
RMB5,202 million in 2004. The growth in revenue from brandband services is
mainly attributable to the sustained expansion of subscriber base and enriched
broadband content services. As of the end of 2005, the number of broadband
services subscribers in our service regions was 11.48 million, representing an
increase of 2.99million, or 35.1%, from 8.49 million in 2004.
Other Internet-related Services
Other Internet-related services of the Company refer to those with revenue
generated from the provision of Internet dial-up (other than communication fees)
and dedicated Internet access services.
Revenue from other Internet-related services of the Company was RMB540 million
in 2005, representing a drop of RMB464million, or 46.2%, from RMB1,004 million
in 2004. The fall was mainly due to the increasing number of subscribers
following the development of broadband services.
Business and data communications services
Managed data services. Revenue from our managed data services represents fees
that we charge for DDN, frame relay, ATM, MPLS VPN and X.25 services.
Revenue from our managed data services was RMB1,395 million in 2005,
representing a drop of RMB125 million, or 8.2%, from RMB1,520 million in 2004.
The drop was primarily due to decrease in realized tariff as a result of
intensified market competition.
Leased line services. Revenue from our leased line services represents 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.
Operating revenue from our leased line service was RMB2,238 million in 2005,
representing an increase of RMB143 million, or 6.8%, from RMB2,095 million in
2004. This was primarily attributable to our effective competition strategy in
actively exploring business customer group and attracting more companies to
lease our networks. As such, we successfully made up for the decline in leased
line revenue resulting from a shift of other carriers to their own networks.
Other services. Revenue from other services includes revenue from service and
maintenance fees, lease payments for non-telecommunications equipment and
revenue from sales of products such as PHS and DSL modems.
Revenue from other services was RMB2,345 million in 2005, representing an
increase of RMB985 million, or 72.4%, from RMB1,360 million in 2004. The
increase was mainly due to a faster growth in revenue from terminal sales in
connection with our communications services.
53
International telecommunications services
Revenue from our international telecommunications services consists of fees
charged for provision to carrier customers of wholesale voice services, and
leased line, Internet, managed data and other telecommunications services
provided to business and carrier customers located outside the PRC.
Revenue from our international telecommunications services was RMB3,255 million
in 2005, representing an increase of RMB612 million, or 23.2%, from RMB2,643
million in 2004. The increases were primarily due to a rapid increase in revenue
from leased line services, interconnection fees and managed data services of our
international telecommunications services.
Operating expenses
The key components of our operating expenses are depreciation and amortisation
expenses, network, operations and support expenses, selling, general and
administrative expenses, staff costs and other operating expenses. Under our
strategy in stringently controlling cost and boosting efficiency in 2005,
operating expenses continued to record a relatively low growth of RMB754 million
or 1.1% from RMB65,973 million in 2004 to RMB66,727 million in 2005. Such growth
rate was substantially lower than the rise in revenue.
Years Ended 31 December
2004 2005
Percentage Percentage
Amount of revenue Amount of revenue
(RMB in millions, except percentage data)
Depreciation and amortisation 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 amortisation expenses
We depreciated 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. In 2005, our depreciation and amortisation expenses
were RMB25,049 million, representing a reduction of RMB131 million, or 0.5%,
from RMB25,180 million in 2004. The decrease was primarily attributable to the
revaluation deficit of our fixed assets upon acquisition of telecom businesses
and assets of the acquired business in the four northern provinces including
Shanxi etc., resulting in a slight decline in our total assets. In the meantime,
the steady fall in our capital expenditure is also a major factor pulling down
the expenses.
54
Network, operations and support expenses
Network, operations and support expenses primarily consist of repair and
maintenance expenses incurred in connection with the operation of our
telecommunications networks, interconnection fees, utility expenses and
installation fees for additional access lines put in service each year. In 2005,
these expenses amounted to RMB14,417 million, representing an increase of RMB444
million, or 3.2%, from RMB13,973 million in 2004. The increase was primarily
attributable to increase in the number of customers and in interconnection
volume between the Company and the other carriers and associates. As a result,
interconnection fees gradually increased. However, as the Company continued the
implementation of centralized management of resources, thereby reducing the
repair and maintenance expenses by RMB751 million, or 14.4%, as compared to
2004.
Selling, general and administrative expenses
Selling, general and administrative expenses primarily consist of sales and
marketing expenses, general and administrative expenses.
In 2005, our selling, general and administrative expenses were RMB13,438
million, representing an increase of RMB561 million, or 4.4%, from RMB12,877
million in 2004. The growth in these expenses was primarily attributable to
further intensified market competitions in the service regions as well as rise
in marketing expenses for securing new customers and retaining old ones. As a
result of our commitment in reducing administrative and management expenses, our
office expenses, convention expenses and traveling expenses continued to
decrease, reflecting further optimized allocation of our resources.
Staff costs
Staff costs principally consist of expenses for salary and benefits,
contributions to pension plans and others.
In 2005, our staff costs were RMB12,333 million, representing an increase of
RMB383 million, or 3.2%, from RMB11,950 million in 2004, which was primarily
attributable to a modest raise in staff salary and benefits. In 2005, the
Company established a preliminary performance-linked system of staff cost
allocation and distribution and increased the compensation to front-line staff.
Under this system, our labour structure was further optimized. Furthermore, we
implemented various employee benefit programmes which had profound effect in
attracting talents and motivating our staff.
Other operating expenses
In 2005, other operating expenses of the Company were RMB1,490 million,
representing a decrease of RMB503million, or 25.2%, from RMB1,993 million in
2004, which was mainly due to our rigid and effective control over other
operating expenses.
55
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 RMB20,505 million, representing an
increase of RMB2,984 million, or 17.0%, from RMB17,521 million in 2004, which
was primarily attributable to the higher increase in revenue over the increase
in operating expenses.
Profit from operations
In 2005, our profit from operations was RMB20,691 million, representing an
increase of RMB14,384 million, or 228.1%, from RMB6,307 million in 2004. This
was primarily attributable to the revaluation deficit of fixed assets of
RMB11,318 million upon acquisition of telecommunications business and assets of
the acquired business in the four northern provinces including Shanxi etc..
Another important factor for the significant increase in operating profit was
the higher growth rate of revenue compared to operating expenses.
Finance costs
In 2005, our finance costs were RMB3,374 million, representing a decrease of
RMB556 million, or 14.1%, from RMB3,930 million in 2004, which was primarily
attributable to the slight increase in exchange gain resulted from the
appreciation of Renminbi and a decrease in total bank loans.
Taxation
In 2005, our taxation expense was RMB3,429 million, with an effective tax rate
of 19.8%.
Our effective tax rate was lower than the State statutory tax rate, mainly
because the revenue from upfront connection fees that we recognized during the
period were exempted from taxation under the PRC laws. Another reason was that
the Company enjoyed a tax reduction of RMB837million after making up the
accumulated pre-restructuring losses with current profit. Yet, such factor is
non-recurring in nature and will no longer affect effective tax rate in the
future.
Profit for the year
As a result of the foregoing, our profit for 2005 was RMB13,888 million,
representing an increase of RMB11,189 million, or 414.6%, from RMB2,699 million
in 2004.
Profit for the year reconciled to US GAAP
Our consolidated profit for 2005 determined under US GAAP was RMB10,465 million.
Our profit for 2005 determined under US GAAP was lower than that under Hong Kong
GAAP. This was principally due to a revaluation deficit of RMB25,778 million in
2003 taken to the carrying value of our assets under Hong Kong GAAP and the
revaluation deficit of RMB11,318 million in 2004 of business and assets acquired
by the Company in the four northern provinces. in 2005, which resulted in lower
depreciation charges recorded under Hong Kong GAAP than those under U.S. GAAP.
The Company expects that this factor will continue to contribute to a major
difference in the accounts prepared under the two sets of GAAPs in the coming
years.
56
Capital expenditures
The following table sets forth our actual or planned total capital expenditures
for the periods indicated:
(RMB in millions)
2003 36,450
2004 28,256
2005 27,562
2006 (Planned) 27,300
In 2005, our capital expenditures were RMB27,562million, representing a decline
of RMB694million, or 2.5%, over RMB28,256 million in 2004, which was primarily
attributable to our focus in improving the utilization rate of our existing
network equipment, implementation of efficiency-based capital expenditure
policy, and the reasonable reduction in capital expenditures. During the year,
we continued to increase investments in operation and supporting systems, with
an endeavour of providing customers with better network, billing and sales
services. In addition, we were committed to improving the quality of our
broadband services and expanding our broadband network coverage with increased
investment in broadband and content services segments. On the other hand, in
2005 the investment in the PHS segment was moderately reduced as we shifted our
focus from expansion to optimization of the existing PHS network.
It is expected that our capital expenditures are subject to uncertainty, and
actual capital expenditures in the future may differ significantly from our
budget. The timing, amount and nature of capital expenditures are subject to
various factors, including the general economic environment, customer's demand,
technology development and other relevant factors.
We anticipate that we will utilize cash derived from operating activities,
short- and long-term loans, debentures and other borrowings and equity financing
to satisfy our capital expenditure needs. We consider that we have sufficient
capital resources to satisfy our capital expenditure requirements in the future.
57
Liquidity and capital resources
Liquidity
Our net cash outflow in 2005 was RMB5,707 million , representing a decrease of
RMB8,915 million from the net cash inflow of RMB3,208 million in 2004. The
reason for the decrease in net cash inflow compared with 2004 was that we
derived substantial amount of cash from the global offering in the fourth
quarter in 2004, resulting in a significant increase in cash and cash
equivalents at the end of 2004.
The following table summarizes our net cash flows for the periods indicated:
Years Ended 31 December
2004 2005
(RMB in millions)
Net cash inflow from operating activities 33,653 33,557
Net cash outflow from investing activities (28,702) (24,608)
Net cash outflow from financing activities (1,743) (14,656)
Net cash inflow/(outflow) 3,208 (5,707)
Net cash inflow from operating activities
Our net cash inflow from operating activities in 2005 was RMB33,557 million,
representing a decrease of RMB96 million, or 0.3%, from RMB33,653 million in
2004. The main reason for the decrease in net cash inflow from operating
activities compared with 2004 was that, according to the relevant PRC
regulations on domestic profits tax, provision for profits tax of the Company
for 2004 was mainly utilized in 2005, resulting in a cash outflow for profits
tax of RMB4,065 million for the year. Taking no account of the cash outflow from
income tax and other factors the net cash inflow from generated from operations
of the Company would have been RMB40,732 million, which represented an increase
of RMB3,298 million, or 8.8%, from RMB37,434 million in 2004.
Set out below is a breakdown of our net cash inflow from operating activities
for the periods indicated:
Years Ended 31 December
2004 2005
(RMB in millions)
Net cash inflows generated from operations 37,434 40,732
Interest received 86 157
Dividends received 17 29
Interest paid (3,877) (3,296)
profits tax paid (7) (4,065)
Net cash inflow from operating activities 33,653 33,557
58
Net cash outflow from investing activities
Our net cash outflow from investing activities in 2005 was RMB24,608 million,
representing a decrease of RMB4,094 million, or14.3%, from RMB28,702 million in
2004. The relatively substantial decrease in net cash outflow from investing
activities in 2005 was primarily attributable to our further efforts to trim
capital expenditures and the cash inflow from our disposal of short-term
securities investment acquired in 2004.
Net cash outflow from financing activities
Our net cash outflow from financing activities in 2005 was RMB14,656 million,
representing an increase of RMB12,913 million, or 740.8%, from RMB1,743 million
in 2004. The relatively significant rise in net cash outflow from financing
activities in 2005 compared with 2004 was primarily attributable to the
reduction in loan amount and the cash inflow from global offering in 2004.
Working capital
As at 31 December 2005, our working capital was a shortage of RMB83,900 million,
representing an increase of RMB2,311 million, or 2.8%, from the shortage of
RMB81,589 million as at 31 December 2004. The increase in working capital
shortage was primarily attributable to the reductions in cash on hand and in
bank under our strict control over capital risks.
Indebtedness
The following table sets forth our liabilities as at the dates indicated:
As at 31 December
2004 2005
(RMB in millions)
Short-term loans 44,882 47,341
Long-term bank loans and other loans, current portion 11,727 6,846
Long-term bank loans and other loans excluding current portion 26,052 18,143
Deferred consideration, current portion -- 1,960
Deferred consideration, excluding current portion -- 7,840
Total liabilities 82,661 82,130
As at 31 December 2005, our total liabilities were RMB82,130 million, which
included a deferred consideration of RMB9,800 million with respect to our
acquisition of telecom businesses and assets in the four northern provinces
including Shanxi etc. in 2005. Taking no account of the deferred consideration
of RMB9,800 million, total liabilities of the Company as at 31 December 2005
would have been RMB72,330 million, representing a decrease of RMB10,331 million,
or 12.5%, from RMB82,661 million in 2004. The Company repaid its liabilities
with cash inflow from operating activities and cash and cash equivalents in
hand.
59
As at 31 December 2005, the Company's short-term loan represent 68.4% of total
liabilities, which was about the same compared with 68.5% as at 31 December
2004.
As at 31 December 2005, the debt-to-capital ratio of the Company was 50.1%. (3)
(3) Debt to capital ratio as at 31 December 2005 represented ratio of total
liabilities to sum of total liabilities, owner's equity and balance of
deferred revenue.
As at 31 December 2005, our aggregate unutilized credit facilities were
RMB104,731 million.
Contractual obligations and commitments
The following table sets forth our aggregate payments as at 31 December 2005 in
respect of contractual obligations and commercial commitments in future years:
Payments Due (by stages as indicated)
(RMB in millions)
Total 2006 2007 2008 2009 2010 Thereafter
Short-term loans 47,341 47,341 -- -- -- -- --
Long-term loans 24,989 6,846 8,659 5,800 95 94 3,495
Operating leases committees 4,066 994 434 333 308 298 1,699
Capital commitments 1,854 1,678 170 6 -- -- --
Total liabilities 78,250 56,859 9,263 6,139 403 392 5,194
Market risks and risk management
Market risks are the risks of loss of financial instruments held or issued by us
for non-trading purposes arising from adverse changes in market prices,
including interest rates and foreign exchange rates. The Company is subject to
various risks in the normal course of its business, including market risk
associated with interest rate movements and exchange rate movements on Renminbi
denominated assets and Liabilities.
60
Foreign exchange risk
We conduct our business primarily in Renminbi, which is also our functional and
reporting currency. Fluctuations in Renminbi exchange rates may adversely affect
the value, translated or converted into United States dollars or Hong Kong
dollars (which are pegged to the US dollar), of our net assets, earnings and any
declared dividends.
We are exposed to foreign currency risk primarily as a result of our foreign
currency borrowings for purchases of telecommunications equipment from overseas
suppliers in the past. In addition, we receive some of our revenue from our
international telecommunications services and pay related expenses in foreign
currencies. As a result, our foreign currency exposure relates to our foreign
currency-denominated operations and, to a limited extent, cash and cash
equivalents denominated in foreign currencies.
As the reform of the PRC foreign exchange market gathered momentum, exchange
rate of Renminbi began to rise since July 2005. As our borrowings denominated in
foreign currencies significantly exceeded our cash and cash equivalents
denominated in foreign currencies since July 2005, we recorded an exchange gain
of RMB232 million As the exchange rate of Renminbi is subject to various
factors, its effect on our exchange gain and loss in future years remain
uncertain.
We have 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.
Interest rate risk
The People's Bank of China has the sole authority in the PRC to establish the
official interest rates for Renminbi-denominated loans. Financial institutions
in the PRC 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 the financial institutions based on
interest rate changes in the international financial market, cost of funds, risk
levels and other factors.
We are subject to risks arising from fluctuations in interest rates on our
debts. The majority of our liabilities are loans from banks in the PRC. Rise in
interest rates will increase the cost of new borrowings and interest expenses
of outstanding floating rate liabilities. Accordingly, fluctuations in interest
rates can lead to significant fluctuations in the fair value of these debt
instruments.
61
Report of the Directors
The directors are pleased to present their annual report together with the
audited financial statements for the year ended 31 December 2005.
Principal activities
The Group is a dominant provider of fixed-line telephone services, broadband,
other internet-related services, and business and data communications services
in ten northern municipalities and provinces in China, namely Beijing
Municipality, Tianjin Municipality, Hebei Province, Henan Province, Shandong
Province, Liaoning Province, Heilongjiang Province, Jilin Province, Neimenggu
Autonomous Region and Shanxi 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 China. The Group operates an extensive network and offers
international data services in the Asia Pacific region. The principal activity
of the Company is investment holding.
The turnover of the Group during the financial year consisted primarily of
income generated from the provision of fixed-line telecommunications and related
services.
Major customers and suppliers
The Group's aggregate sales attributable to its five largest customers did not
exceed 30 per cent. of the Group's total sales in 2005.
The Group's aggregate purchases from its five largest suppliers did not exceed
30 per cent. of the Group's total purchases in 2005.
Subsidiaries
Particulars of the Company's subsidiaries as at 31 December 2005 are set out in
note 26 to the financial statements.
Financial statements
The results of the Group for the year ended 31 December 2005 and the Company's
and the Group's financial positions as at that date are set out in the financial
statements on pages [o] to [o].
Dividends
The Company has always held in the highest regard the interests of and returns
achieved for its shareholders. Having taken into account such factors as our
results of operations, cash flows, financial condition, future prospects, and
statutory and regulatory restrictions on the payment of dividend by the Company,
the Board recommends payment of a final dividend of HK$[o] per share and a total
dividend of HK$[o] million for the financial year ended 31 December 2005. In
2005, the Company has made an acquisition which was completed on 31 October
2005. The Company's net profits for the year ended 31 December 2005 available
for distribution were in the total sum of HK$[o] million, consisting of the net
profit of the Company (without taking into account the assets acquired) for the
full year of 2005 and the net profit attributable to China Netcom Group New
Horizon Communications Corporation Limited (being the assets acquired) from 31
October 2005 (being the completion date of the acquisition) to 31 December 2005
(excluding upfront connection fees). The dividend payout ratio for 2005, based
on the said net profit of HK$[o] million is [o]%. If the relevant resolution
relating to declaration of dividend is passed, the dividend will be distributed
on or about 6 June 2006 to shareholders whose names are registered on the
Company's shareholders' register on 16 May 2006.
62
Charitable donations
Donations made by the Group during the year amounted to RMB0.8 million (2004:
RMB24 million).
Fixed assets
Changes of the fixed assets of the Group and the Company during the year are set
out in note 21 to the financial statements.
Bank and other loans
Particulars of bank and other loans of the Group as at 31 December 2005 are set
out in note 29 to the financial statements.
Share capital and share option scheme
Details of the Company's share capital and share option scheme are set out in
note 34 and note 35, respectively, to the financial statements. Information on
the share option scheme can also be found in the paragraphs "Share option
scheme" and "Supplementary Information for American Depositary Shares Holders"
below.
Purchase, sale or redemption of the Company's listed securities
During the year, neither the Company nor any of its subsidiaries purchased, sold
or redeemed any of the Company's listed securities.
Reserves
Changes to the reserves of the Company and the Group during the year are set out
in note 36 to the financial statements, and consolidated statement of changes in
equity, respectively.
Financial summary
A summary of the audited results and of the audited assets and liabilities of
the Group for the last four financial years is set out on pages [o] to [o].
63
Connected Transactions
(1) The Acquisition
The Company, China Netcom Group Corporation (BVI) Limited ("CNC BVI"),
the direct controlling shareholder of the Company and China Network
Communications Group Corporation ("China Netcom Group"), the ultimate
controlling shareholder of the Company, entered into a conditional sale
and purchase agreement (the "Acquisition Agreement") on 12 September 2005,
pursuant to which the Company agreed to acquire the entire equity
interests of China Netcom Group New Horizon Communications Corporation
(BVI) Limited (the "Target Company") from CNC BVI (the "Acquisition"). The
Target Company holds the business operations and assets in
telecommunications of China Netcom Group in Heilongjiang Province, Jilin
Province, Neimenggu Autonomous Region and Shanxi Province through China
Netcom Group New Horizon Communications Corporation Limited ("New Horizon
Communications"). The purchase price of the Acquisition was RMB12,800
million, the initial consideration of RMB3,000 million was satisfied on
completion of the Acquisition, and the payment of the balance in the
amount of RMB9,800 million is deferred. From the date of completion of the
Acquisition, the deferred consideration and interest on the actual amount
of the deferred consideration remaining outstanding will be repaid at
half-yearly intervals, and the interest rate is 5.265% per annum. The
repayment of deferred consideration at each half-yearly interval will be
in equal amount of RMB980 million. The Acquisition was announced by the
Company on 12 September 2005, and the details was contained in a circular
which was despatched to the shareholders of the Company on 23 September
2005. The Acquisition was completed on 31 October 2005.
(2) Continuing connected transactions
As of the date of this report, China Netcom Group, as the ultimate
controlling shareholder of the Company, beneficially owned 70.49% 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 ("Continuing connected transactions relating to CNC China") were
conducted in accordance with the provisions under the aforesaid agreements
up to 31 October 2005. In order to facilitate the management of all
continuing connected transactions of the Company in China after the
completion of the Acquisition, New Horizon Communications, CNC China and
China Netcom Group entered into certain connected transaction agreement
on 12 September 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 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 the Acquisition. Certain ongoing transactions between CNC
China and New Horizon Communications on the one hand and China Netcom
Group and its subsidiaries or associates (other than the Group) on the
other as from 31 October 2005 ("Continuing connected transactions relating
to CNC China and New Horizon Communications") were conducted in accordance
with the provisions under the new agreements.
On 30 June 2004, Asia Netcom Corporation Limited ("Asia Netcom"), a wholly
owned subsidiary of the Company, entered in 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.
64
These transactions between CNC China, New Horizon Communications 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 40 to the financial
statements regarding relative transactions with ultimate holding company,
fellow subsidiaries and other related companies. For the financial year
ended 31 December 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 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 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.
65
Property Leasing Agreement
Pursuant to the Property Leasing Agreement:
(i) CNC China leases to China Netcom Group certain properties located
throughout the Company's northern service region and southern service
region, for use as offices and other ancillary purposes; and
(ii) China Netcom Group leases to CNC China certain properties located
throughout the Company's northern service region and 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.
66
Engineering and Information Technology Services Agreement
The Engineering and Information Technology Services Agreement govern 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
RMB0.5 million (for design or supervision-related services), or where the value
of any single item of services exceeds RMB2 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 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 govern 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 Pre-Acquisition Pricing Principles. The service charges are
settled between CNC China and China Netcom Group as and when the relevant
services are provided.
67
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 Pre-Acquisition 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 the Company's northern and
southern service regions and certain international telecommunications resources
(including international telecommunications 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 New Horizon
Communications
The following continuing connected transaction agreements have come into effect
only after the completion of Acquisition.
Domestic Interconnection Settlement Agreement
Pursuant to the Domestic Interconnection Settlement Agreement:
New Horizon Communications, CNC China (New Horizon Communications 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.
68
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.
69
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.
70
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.
71
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.
72
Continuing connected transactions relating to 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 authorised
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.
73
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 Group:
(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 favourable 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.
74
Directors
The directors for this financial year are:
Executive Directors
Zhang Chunjiang
Tian Suning
Zhang Xiaotie
Miao Jianhua
Jiang Weiping (re-designated as an
2005) Executive Director on 7 December
Non-executive Directors
Li Liming
Jose Maria Alvarez-Pallete (appointed on 12 September 2005)
Keith Rupert Murdoch (resigned on 12 September 2005)
Yan Yixun
Independent Non-executive Directors
John Lawson Thornton
Victor Cha Mou Zing
Qian Yingyi
Hou Ziqiang
Timpson Chung Shui Ming
Alternate Director
Mauricio Sartorius (appointed on 12 September 2005)
(alternate to Mr. Jose Maria
Alvarez-Pallete)
In accordance with Article 99 of the Company's Articles of Association, Mr.
Zhang Xiaotie, Mr. Miao Jianhua, Mr. John Lawson Thornton, and Mr. Victor Cha
Mou Zing will retire by rotation at the forthcoming annual general meeting of
the Company and, being eligible, offer themselves for re-election. In accordance
with Article 103 of the Company's Articles of Association, Mr. Jose Maria
Alvarez-Pallete will also retire at the forthcoming annual general meeting and,
being eligible, offer himself for re-election.
The biographical details of the directors proposed for re-election at the
forthcoming annual general meeting ("Directors for Re-election") are set out on
pages [o] to [o]. Except as disclosed in such biographical details, the
Directors for Re-election have not held any other directorships in any listed
public companies in the last three years. Further, except as noted in the
biographical details, none of the Directors for Re-election is connected with
any directors, senior management or substantial or controlling shareholders of
the Company and, except for the share options granted to the Directors for
Re-election (other than Mr. John Lawson Thornton, Mr. Victor Cha Mou Zing and
Mr. Jose Maria Alvarez-Pallete) as set out in the paragraph "Share option
scheme" below, none of them has any interests in the shares of the Company
within the meaning of Part XV of the Securities and Futures Ordinance ("SFO").
75
The service contracts for Mr. Zhang Xiaotie and for Mr. Miao Jianhua do not
provide for a specified length of services. Mr. John Lawson Thornton, Mr. Victor
Cha Mou Zing and Mr. Jose Maria Alvarez-Pallete have not entered into any
service contract with the Company. Each of the Directors for Re-election will be
subject to retirement by rotation and re-election at annual general meetings of
the Company every three years. Each of such directors is entitled to an annual
director's fee of HK$250,000 as proposed by the board of directors and approved
by the shareholders of the Company at the annual general meeting held on 20 May
2005. Director's fees are payable on a time pro-rata basis for any non full
year's service. In addition, Mr. John Lawson Thornton is entitled to an
additional annual fee of HK$100,000 as a member of the Compensation and
Nomination Committee and the Corporate Governance 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.
None of the Directors for Re-election has an unexpired service contract which is
not determinable by the Company or any of its subsidiaries within one year
without payment of compensation, other than under normal statutory obligations.
Save as disclosed herein, there are no other matters relating to the re-election
of the Directors for Re-election that need to be brought to the attention of the
shareholders of the Company nor there is any information to be disclosed
pursuant to any of the requirements of Rule 13.51(2) of the Listing Rules.
Directors' interests in contracts
No contract of significance to which the Company, its holding company, or any of
its fellow subsidiaries or subsidiaries was a party and in which a director of
the Company had a material interest, whether directly or indirectly, subsisted
at the end of the year or at any time during the year.
Directors' interest in competing businesses
China Netcom Group is engaged in fixed-line telecommunications business and
other related businesses in the PRC and Asia-Pacific which are similar to that
of the Company. The executive directors of the Company also hold executive
positions with China Netcom Group. On 6 September 2004, China Netcom Group, the
Company and CNC China entered into a non-competition agreement, under which
China Netcom Group undertakes not to compete with the Company in the businesses
as prescribed in the agreement without the Company's prior written consent.
Mr. Zhang Chunjiang and Dr. Tian Suning, the Company's executive directors, have
served as directors in PCCW Limited since 1 April 2005. Mr. Jose Maria
Alvarez-Pallete is a Director of Telefonica de Espana, Telefonica Moviles,
Telefonica Moviles Espana, Telefonica Data, Telefonica Internacional, Telefonica
de Argentina, Telefonica CTC Chile, Telefonica de Peru, 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. Apart from the above, none of the directors of the Company is or
was interested in any business, apart from the Company's business, that competes
or competed or is or was likely to compete, either directly or indirectly, with
the Company's business at any time during the 2005 financial year up to and
including the date of this report.
76
Directors' and chief executive's interest and short positions in shares,
underlying shares and debentures
Certain directors of the Company personally hold options to subscribe for
ordinary shares of the Company. Details of such options are disclosed under the
paragraph "Share option scheme" below. These share options were granted pursuant
to the terms of the share option scheme adopted by the Company.
Apart from those disclosed herein, as at 31 December 2005, none of the directors
nor the chief executive of the Company had any interests or short positions in
any of the shares, underlying shares or debentures of the Company or any of its
associated corporations (within the meaning of the SFO) that is required to be
recorded and kept in the register in accordance with section 352 of the SFO, any
interests required to be notified to the Company and the Stock Exchange pursuant
to the Model Code for Securities Transactions by Directors of Listed Issuers
("Model Code").
Emolument policy
The emolument policy of the Company is based on the key principles of
maintaining competitiveness in the market for talent, retaining talent and
rewarding high performance. In line with these key principles, employees are
remunerated with a combination of a basic salary, a performance-based bonus and
a long-term incentive scheme in the form of a share option scheme for eligible
employees, details of which can be found in the paragraph "Share option scheme"
below.
The Company has established a Compensation and Nomination Committee, which is
responsible for making recommendations to the Board on the Company's emolument
policy and structure in relation to all directors, the chief executive officer
and other executive officers. The Compensation and Nomination Committee
determines the remuneration packages of executive directors and senior
management, and make recommendations to the Board on the remuneration of
non-executive directors. In making such determination, the Compensation and
Nomination Committee considers factors such as salaries payable by comparable
companies, the time commitment and responsibilities involved in the relevant
position, employment conditions elsewhere in the group of companies to which the
Company belongs and the desirability of performance-based remuneration with
reference to corporate goals and objectives resolved by the Board from time to
time. No director is involved in deciding his or her own remuneration.
Employee retirement benefits
Particulars of the employee retirement benefits of the Group are set out in note
4(q)(i) and note 14 to the financial statements.
77
Share option scheme
The shareholders of the Company passed a resolution on 30 September 2004 to
approve and adopt the share option scheme (the "Share Option Scheme"). Having
considered the changes following the completion of the Acquisition and for the
purpose of clarifying the relevant scope of the Share Option Scheme, the Board
convened a meeting on 6 December 2005 and made minor amendments to the Share
Option Scheme.
The main contents of the amended Share Option Scheme are as follows:
(a) Purpose of the Share Option Scheme
The purpose of the Share Option Scheme is to provide the Company with a
means to incentivise its senior management, to attract and retain talent
and to encourage other eligible participants to enhance the value of the
Company.
(b) 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);
(ii) members of the middle-to-senior management; and
(iii) such class of "specialised professionals" as may be designated by
the Compensation and Nomination Committee.
For the purpose of sub-paragraph (b)(iii) above, "specialised
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 "specialised professionals".
78
(c) 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 the 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 the Company in November 2004
(the "General Scheme Limit").
(iii) Subject to (c)(i) above, the 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.
(d) As at the date of this report, the total number of securities available
for issue under the Share Option Scheme is 237,040,000, representing 3.6
per cent. of the issued share capital of the Company as at the date of
this report.
(e) 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 the
Company on the date of grant.
(f) 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.
(g) 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.
(h) 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.
79
(i) Consideration
No consideration is payable on acceptance of the grant of an option.
(j) 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.
(k) Amendment to and termination of the Share Option Scheme
(i) The Board of the 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 the 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 the 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 the Company at
general meeting.
80
As at 31 December 2005, the directors, chief executive and employees of the
Company had the following personal interests in options to subscribe for shares
of the Company granted under the Share Option Scheme.
No. of shares No. of shares
involved in the involved in
options the options Price per share
outstanding at outstanding at Date of the payable for the
the beginning the end of grant of exercise of
of the year the year the options the 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
(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
(1) Employees and other
persons granted with
options after the
completion of
the Acquisition -- 79,320,000 6 December 2005 12.45
(2) Employees and other
persons granted with
options in 2004 152,390,000 151,373,000 22 October 2004 8.40
Total 236,023,000(a)
Notes:
(a) 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 the
Company as at the date of this report.
(b) Grantees of the share options granted on 22 October 2004 are entitled to
exercise the options in the following periods:
(i) in respect of 40 per cent. of the options granted, from 17 May 2006
to 16 November 2010;
(ii) in respect of a further 30 per cent. of the options granted, from
17 May 2007 to 16 November 2010; and
(iii) in respect of the remaining 30 per cent. of the options granted,
from 17 May 2008 to 16 November 2010.
81
(c) Options were granted by the Company on 6 December 2005. The closing price
per share on the trading day immediately before 6 December 2005 was
HK$12.25.
(d) Grantees of the share options granted on 6 December 2005 are entitled to
exercise the options in the following periods:
(i) in respect of 40 per cent. of the options granted, from 6 December
2007 to 5 December 2011;
(ii) in respect of a further 30 per cent. of the options granted, from 6
December 2008 to 5 December 2011; and
(iii) in respect of the remaining 30 per cent. of the options granted,
from 6 December 2009 to 5 December 2011.
(e) During the year ended 31 December 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 the Company to its employees (including directors) to subscribe for
shares in the Company shall be recognised as expenses in the Company's
consolidated income statement. The 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 the Company to employees (including
directors) in prior years.
Apart from the foregoing, at no time during the year ended 31 December 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 the 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 the Company or any other body corporate.
Substantial shareholders' and other persons' interests and short positions in
shares and underlying shares
The Company has been notified of the following interests in the Company's issued
shares as at 31 December 2005 amounting to 5 per cent. or more of the ordinary
shares in issue:
Number of ordinary Percentage
shares interested of total issued
directly indirectly share capital
(%)
China Network Communications Group Corporation -- 4,945,148,000(1)(2) 75%
China Netcom Group Corporation (BVI) Limited 4,647,449,014(1) 297,698,986(1)(2) 75%
Telefonica Internacional, S.A. 329,676,450 -- 5%
Notes:
(1) China Network Communications Group Corporation ("China Netcom Group")
beneficially owns 4,647,449,014 shares held by its wholly owned
subsidiary, China Netcom Group Corporation (BVI) Limited ("CNC BVI") and 1
share held by CNC Cayman, Limited, a wholly owned subsidiary of CNC BVI.
The percentage of total issued share capital beneficially held by China
Netcom Group is 70.49%.
(2) China Netcom Group is deemed under the SFO to be interested in 297,698,985
shares held by CNC BVI as trustee on behalf of certain shareholders.
82
Apart from the foregoing, as at 31 December 2005, no person or corporation had
any interest in 5 per cent. or more of or any short position in the issued share
capital of the Company as recorded in the registers required to be kept under
section 336 of the SFO.
Public Float
As at the date of this report, the Company has maintained the prescribed public
float of not less than 23 per cent. of the issued share capital of the Company
pursuant to the Listing Rules and as agreed with the Stock Exchange, based on
the information that is publicly available to the Company and within the
knowledge of the directors of the Company.
Auditors
A resolution for the reappointment of PricewaterhouseCoopers as auditors of the
Company shall be proposed at the forthcoming annual general meeting.
By order of the board
Zhang Chunjiang
Executive Chairman
Hong Kong
83
Notice of Annual General Meeting
Notice is hereby given that the Annual General Meeting of China Netcom Group
Corporation (Hong Kong) Limited will be held on 16 May 2006 at 11:00 a.m. in The
Ballroom, Island Shangri-la, Hong Kong for the following purposes:
As Ordinary Business:
1. To receive and consider the financial statements for the year ended 31
December 2005 and the Reports of the Directors and the Auditors.
2. To declare a final dividend for the year ended 31 December 2005.
3. To elect Directors.
4. To re-appoint Auditors and authorise the Directors to fix their
remuneration.
And as Special Business, to consider and, if thought fit, to pass the following
as ordinary resolutions:
ORDINARY RESOLUTIONS
5. "THAT:
(a) subject to paragraph (b) below, the exercise by the Directors during
the Relevant Period of all the powers of the Company to purchase
shares of US$0.04 each in the capital of the Company including any
form of depositary receipt representing the right to receive such
shares ("Shares") be and is hereby generally and unconditionally
approved;
(b) the aggregate nominal amount of Shares which may be purchased on The
Stock Exchange of Hong Kong Limited or any other stock exchange on
which securities of the Company may be listed and which is
recognised for this purpose by the Securities and Futures Commission
of Hong Kong and The Stock Exchange of Hong Kong Limited pursuant to
the approval in paragraph (a) above shall not exceed or represent
more than 10 per cent. of the aggregate nominal amount of the share
capital of the Company in issue at the date of passing this
Resolution, and the said approval shall be limited accordingly;
(c) for the purpose of this Resolution "Relevant Period" means the
period from the passing of this Resolution until whichever is the
earlier of:
(i) the conclusion of the next annual general meeting of the
Company;
(ii) the expiration of the period within which the next annual
general meeting of the Company is required by law to be held;
and
(iii) the revocation or variation of the authority given under this
Resolution by ordinary resolution of the shareholders of the
Company in general meeting."
84
6. "THAT a general mandate be and is hereby unconditionally given to the
Directors to exercise full powers of the Company to allot, issue and deal
with additional shares in the Company (including the making and granting
of offers, agreements and options which might require shares to be
allotted, whether during the continuance of such mandate or thereafter)
provided that, otherwise than pursuant to (i) a rights issue where shares
are offered to shareholders on a fixed record date in proportion to their
then holdings of shares; (ii) the exercise of options granted under any
share option scheme adopted by the Company; or (iii) any scrip dividend or
similar arrangement providing for the allotment of shares in lieu of the
whole or part of a dividend in accordance with the Articles of Association
of the Company, the aggregate nominal amount of the shares allotted shall
not exceed the aggregate of:
(a) 20 per cent. of the aggregate nominal amount of the share capital of
the Company in issue at the date of passing this Resolution, plus
(b) (if the Directors are so authorised by a separate ordinary
resolution of the shareholders of the Company) the nominal amount of
the share capital of the Company repurchased by the Company
subsequent to the passing of this Resolution (up to a maximum
equivalent to 10 per cent. of the aggregate nominal amount of the
share capital of the Company in issue at the date of passing this
Resolution).
Such mandate shall expire at the earlier of:
(i) the conclusion of the next annual general meeting of the
Company;
(ii) the expiration of the period within which the next annual
general meeting of the Company is required by law to be held;
and
(iii) the date of any revocation or variation of the mandate given
under this Resolution by ordinary resolution of the
shareholders of the Company at a general meeting."
7. "THAT the Directors be and they are hereby authorised to exercise the
powers of the Company referred to in the resolution set out in item 6 in
the notice of this meeting in respect of the share capital of the Company
referred to in paragraph (b) of such resolution."
By order of the Board
Miao Jianhua
Mok Kam Wan
Joint Company Secretaries
Hong Kong, 28 March 2006
85
Notes:
1. Any member entitled to attend and vote at the above Meeting is entitled to
appoint one or more proxies to attend and, on a poll, vote in his stead. A
proxy need not be a member of the Company.
2. In order to be valid, a form of proxy together with the power of attorney
or other authority (if any) under which it is signed, or a notarially
certified copy thereof, must be deposited at the Company's registered
office at Room 6701, The Center, 99 Queen's Road Central, Hong Kong at
least 48 hours before the time for holding the above Meeting. Completion
and return of a form of proxy will not preclude a member from attending
and voting in person if he is subsequently able to be present.
3. The Board of Directors has recommended a final dividend for the year ended
31 December 2005 of HK$[o] per share and, if such dividend is declared by
the members passing Resolution 2, it is expected to be paid on or about 6
June 2006 to those shareholders whose names appear on the Company's
register of members on 16 May 2006.
4. The register of members of the Company will be closed from 11 May 2006 to
16 May 2006 (both days inclusive), during which period no transfer of
shares in the Company will be effected. In order to qualify for the
proposed final dividend, all transfers, accompanied by the relevant share
certificates, must be lodged with the Company's registrar, Computershare
Hong Kong Investor Services Limited, Room 1712-16, 17th Floor, Hopewell
Centre, 183 Queen's Road East, Wan Chai, Hong Kong, not later than 4 p.m.
on 10 May 2006.
5. Concerning Resolution 5 above, the Directors wish to state that they will
exercise the powers conferred thereby to repurchase shares of the Company
in circumstances which they deem appropriate for the benefit of the
shareholders. The Explanatory Statement containing the information
necessary to enable the shareholders to make an informed decision on
whether to vote for or against the resolution to approve the repurchase by
the Company of its own shares, as required by the Rules Governing the
Listing of Securities on The Stock Exchange of Hong Kong Limited will be
set out in a separate letter from the Company to be enclosed with the 2005
Annual Report.
86
Auditors' Report
TO THE SHAREHOLDERS OF CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
(Incorporated in Hong Kong with limited liability)
We have audited the financial statements on pages [o] to [o] which have been
prepared in accordance with accounting principles generally accepted in Hong
Kong.
Respective responsibilities of directors and auditors
The Hong Kong Companies Ordinance requires the directors to prepare financial
statements which give a true and fair view. In preparing the financial
statements which give a true and fair view it is fundamental that appropriate
accounting policies are selected and applied consistently.
It is our responsibility to form an independent opinion, based on our audit, on
those financial statements and to report our opinion solely to you, as a body,
in accordance with section 141 of Hong Kong Companies Ordinance, and for no
other purpose. We do not assume responsibility towards or accept liability to
any person for the contents of this report.
Basis of opinion
We conducted our audit in accordance with Statements of Auditing Standards
issued by the Hong Kong Institute of Certified Public Accountants. An audit
includes examination, on a test basis, of evidence relevant to the amounts and
disclosures in the financial statements. It also includes an assessment of the
significant estimates and judgements made by the directors in the preparation of
the financial statements, and of whether the accounting policies are appropriate
to the circumstances of the Company and the Group, consistently applied and
adequately disclosed.
We planned and performed our audit so as to obtain all the information and
explanations which we considered necessary in order to provide us with
sufficient evidence to give reasonable assurance as to whether the financial
statements are free from material misstatement. In forming our opinion we also
evaluated the overall adequacy of the presentation of information in the
financial statements. We believe that our audit provides a reasonable basis for
our opinion.
Opinion
In our opinion the financial statements give a true and fair view of the state
of affairs of the Company and of the Group as at 31 December 2005 and of the
Group's profit and cash flows for the year then ended and have been prepared in
accordance with the Hong Kong Companies Ordinance.
PricewaterhouseCoopers
Certified Public Accountants
Hong Kong, March 21, 2006
87
Consolidated Income Statement
For the year ended December 31, 2005
Year ended December 31,
Note 2005 2004
RMB RMB
million million
Restated
Notes 2&3
Revenues 7 87,232 83,494
Operating expenses
Depreciation and amortization (25,049) (25,180)
Networks, operations and support (14,417) (13,973)
Staff costs 14 (12,333) (11,950)
Selling, general and administrative (13,438) (12,877)
Other operating expenses (1,490) (1,993)
Total of operating expenses 8 (66,727) (65,973)
Operating profit before interest income, dividend income and
deficit on revaluation of fixed assets 20,505 17,521
Interest income 157 87
Dividend income 29 17
Deficit on revaluation of fixed assets 21(c) -- (11,318)
Profit from operations 20,691 6,307
Finance costs 9 (3,374) (3,930)
Share of loss of associated companies -- (1)
Profit before taxation 17,317 2,376
Taxation (charge)/credit 10 (3,429) 323
Profit for the year 13,888 2,699
Dividends proposed after the balance sheet date 12 3,196 259
Basic earnings per share 13 RMB2.11 RMB0.48
Diluted earnings per share 13 RMB2.10 RMB0.48
The notes on pages [o] to [o] are an integral part of these consolidated
financial statements.
88
Consolidated Balance Sheet
As at December 31, 2005
As at December 31,
Note 2005 2004
RMB RMB
million million
Restated
Notes 2&3
Assets
Current assets
Cash and bank deposits 16 4,895 10,633
Short-term investments 17 2 2,876
Accounts receivable 18 7,401 7,174
Inventories and consumables 19 472 1,243
Prepayments, other receivables and other current assets 20 1,482 1,442
Due from ultimate holding company and fellow subsidiaries 30 247 1,087
Total current assets 14,499 24,455
Non-current assets
Fixed assets 21 168,663 166,897
Construction in progress 22 6,822 10,597
Lease prepayments for land 23 1,949 1,746
Intangible assets 24 1,393 382
Deferred tax assets 33 3,480 3,804
Other non-current assets 25 6,034 8,536
Total non-current assets 188,341 191,962
Total assets 202,840 216,417
The notes on pages [o] to [o] are an integral part of these consolidated
financial statements.
89
As at December 31,
Note 2005 2004
RMB RMB
million million
Restated
Notes 2&3
Liabilities and equity
Current liabilities
Accounts payable 27 16,719 21,125
Accruals and other payables 28 3,905 4,866
Short term bank loans 29(a) 47,341 44,882
Current portion of long term bank and other loans 29(b) 6,846 11,727
Due to ultimate holding company and fellow subsidiaries 30 8,990 10,080
Current portion of deferred revenues 31 7,975 8,876
Current portion of provisions 32 4,029 4,127
Taxation payable 2,594 361
Total current liabilities 98,399 106,044
Net current liabilities (83,900) (81,589)
Total assets less current liabilities 104,441 110,373
Non-current liabilities
Long term bank and other loans 29(b) 18,143 26,052
Due to ultimate holding company and fellow subsidiaries 30 7,840 --
Deferred revenues 31 10,925 13,988
Provisions 32 3,174 3,574
Deferred tax liabilities 33 1,324 1,576
Other non-current liabilities 25 588
Total non-current liabilities 41,431 45,778
Total liabilities 139,830 151,822
Financed by:
Share capital 34 2,181 2,181
Reserves 60,829 62,414
Shareholders' equity 63,010 64,595
Total liabilities & equity 202,840 216,417
The notes on pages [o] to [o] are an integral part of these consolidated
financial statements.
Zhang Chunjiang Miao Jianhua
Director Director
90
Balance Sheet - Company
As at December 31, 2005
As at December 31,
Note 2005 2004
RMB RMB
million million
Assets
Current assets
Cash and bank deposits 16 540 7,789
Short-term investments 17 1 1,651
Due from subsidiaries 26 573 --
Prepayments, other receivables and other current assets 20 26 16
Total current assets 1,140 9,456
Non-current assets
Investments in subsidiaries 26 58,577 37,509
Total assets 59,717 46,965
Liabilities and equity
Current liabilities
Accruals and other payables 28 93 140
Due to subsidiaries 26 12,820 --
Due to ultimate holding company 150 142
Net current (liabilities)/assets (11,923) 9,174
Total assets less current liabilities 46,654 46,683
Financed by:
Share capital 34 2,181 2,181
Reserves 36 44,473 44,502
Shareholders' equity 46,654 46,683
Total liabilities & equity 59,717 46,965
The notes on pages [o] to [o] are an integral part of these consolidated
financial statements.
Zhang Chunjiang Miao Jianhua
Director Director
91
Consolidated Statement of Changes in Equity
For the year ended December 31, 2005
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 34)
Balance as at January 1, 2004,
as previously reported 1,819 34,168 -- -- 1,998 -- 5,391 3 43,379
Adjusted for the Acquisition (Note 2) -- -- -- -- -- 10,283 -- -- 10,283
Balance as at January 1, 2004,
as restated 1,819 34,168 -- -- 1,998 10,283 5,391 3 53,662
Appropriation to statutory reserve
(Note 11) -- -- -- 723 -- -- (723) -- --
Revaluation surplus (Note 21(c)) -- -- -- -- 3,863 -- -- -- 3,863
Movement of deferred tax recognized
in equity (Note 33) -- -- -- -- 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 (Note33) -- -- -- -- (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 33) -- -- -- -- -- -- (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 [o] to [o] are an integral part of these consolidated financial statements.
92
Attributable to equity holders of the company
Share Share Capital Statutory Revaluation Other Retained Total
capital premium reserve reserve reserve reserve earnings equity
RMB RMB RMB RMB RMB RMB RMB RMB
million million million million million million million million
(Note 34)
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 33) -- -- -- -- 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 [o] to [o] are an integral part of these consolidated financial statements.
93
Consolidated Statement of Cash Flow
For the year ended December 31, 2005
Year ended December 31,
Note 2005 2004
RMB RMB
million million
Restated
Notes 2&3
Cash flows from operating activities
Net cash inflows generated from operations 37(a) 40,732 37,434
Interest received 157 86
Dividends received 29 17
Interest paid (3,296) (3,877)
Profits tax paid (4,065) (7)
Net cash inflow from operating activities 33,557 33,653
Cash flows from investing activities
Purchase of fixed assets and construction in progress (27,282) (28,054)
Prepayments for leased land (280) (202)
Sales of fixed assets 49 923
Sales of other investments 2,874 1,528
Net decrease in time deposits with maturity over three months 31 5
Purchase of other investments -- (2,902)
Net cash outflow from investing activities (24,608) (28,702)
Cash flows from financing activities
New bank loans and other loans 77,578 64,664
Repayment of bank loans (86,500) (70,051)
Capital element of finance lease payments (909) (964)
Payment of distribution to owner (1,566) (7,310)
Payment to owner for the Acquisition (Note 1) (3,000) --
Dividends payment (259) --
Loans to fellow subsidiaries and related parties -- (1,021)
Global Offering net of issue expense -- 8,944
Net loan from owner -- 3,995
Net cash outflow from financing activities (14,656) (1,743)
(Decrease)/increase in cash and cash equivalents (5,707) 3,208
Cash and cash equivalents at beginning of year 10,581 7,373
Cash and cash equivalents at end of year 16 4,874 10,581
The notes on pages [o] to [o] are an integral part of these consolidated financial statements.
94
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 which had been, retained by China Netcom Group from
China Netcom Group leased the retained inter-provincial optic fiber of the
twelve service regions in the PRC and the submarine cable assets in the
Asia Pacific Region.
Pursuant to a resolution passed in the special 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 (BVI) Limited ("New
Horizon (BVI)") and China Netcom Group New Horizon Telecommunication
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 installments over five years. The interest charged
on the deferred payments is to be calculated at 5.265% per annum.
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").
95
1 The group and its principal activities (continued)
Background of the group (continued)
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.
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.
96
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 2004 comparatives of the
financial statements have been restated accordingly.
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.
97
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, 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
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.
98
3 Changes in accounting policies (continued)
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
adjustment Effect of
for the adoption of
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,
2005 2004
RMB million RMB million
Restated
Increase in staff costs 104 18
Details of the share option scheme are presented in Note 35 of the financial statements.
99
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 24, arising from the above change in accounting policy has been
prospectively accounted for from January 1, 2005 as follows:
Before Effect of
adoption of adoption 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
The adoption of HKFRS 3 and HKAS 36 resulted in:
Year en ded
Decem ber
31, 2 005
RMB
mill ion
Increase in amortization expense 15
100
3 Changes in accounting policies (continued)
(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.
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 23) -- 1,746 1,746
101
3 Changes in accounting policies (continued)
(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:
Before Effect of
adoption adoption
of new of new
HKFRS 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
The adoption of HKAS 39 resulted in:
Year ended
December
31, 2005
RMB
million
Decrease in profit before taxation 15
102
3 Changes in accounting policies (continued)
(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
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.
103
4 Principal accounting policies (continued)
(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.
(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.
104
4 Principal accounting policies (continued)
(c) Revenue recognition (continued)
(ii) Interest income
Interest income is recognized on a time proportion basis,
taking into account the principal amounts outstanding and the
interest rates applicable.
(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.
105
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.
106
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 lease period.
(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.
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.
107
4 Principal accounting policies (continued)
(k) Fixed assets (continued) (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).
108
4 Principal accounting policies (continued)
(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. 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 lessor 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.
109
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 32).
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. 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.
110
4 Principal accounting policies (continued)
(q) Employee benefits (continued)
(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.
(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.
111
4 Principal accounting policies (continued)
(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.
112
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
113
5 Critical accounting estimates and judgements
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.
114
5 Critical accounting estimates and judgements (continued)
(a) Critical accounting estimates and assumptions (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.
115
5 Critical accounting estimates and judgements (continued)
(b) Critical judgements 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.
116
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.
(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 29 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.
117
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,
2005 2004
RMB million RMB million
Restated
Note 2
Revenues
Local usage fees 24,582 24,858
Monthly telephone services 18,261 17,964
Upfront installation fees 1,442 1,568
DLD usage fees 10,260 11,266
ILD usage fees 1,464 1,415
Value-added services 4,000 2,993
Interconnection fees 7,783 6,453
Upfront connection fees 3,405 4,346
Broadband services 7,916 5,307
Other Internet-related services 812 1,259
Managed data services 1,802 1,829
Leased line income 2,921 2,591
Other services 2,584 1,645
Total 87,232 83,494
118
7 Revenues (continued)
The Group's revenues by geographical location of the customers can be
summarized as follows:
Year ended December 31,
2005 2004
RMB million RMB million
Restated
Note 2
Domestic telecommunications services
(Being revenues generated from customers located in the PRC)
Local usage fees 24,582 24,858
Monthly telephone services 18,261 17,964
Upfront installation fees 1,442 1,568
DLD usage fees 10,260 11,266
ILD usage fees 1,180 1,234
Value-added services 4,000 2,993
Interconnection fees 6,517 5,441
Upfront connection fees 3,405 4,346
Broadband services 7,812 5,202
Other Internet-related services 540 1,004
Managed data services 1,395 1,520
Leased line income 2,238 2,095
Other services 2,345 1,360
Subtotal 83,977 80,851
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 284 181
Interconnection fees 1,266 1,012
Broadband services 104 105
Other Internet-related services 272 255
Managed data services 407 309
Leased line income 683 496
Other services 239 285
Subtotal 3,255 2,643
Total 87,232 83,494
119
8 Operating expenses
Operating expenses include:
Year ended December 31,
2005 2004
RMB million RMB million
Restated
Notes 2&3
Depreciation (included in depreciation and amortization):
-- Owned property, plant and equipment (Note 21) 24,287 24,581
-- Leased property, plant and equipment (Note 21) 367 389
Loss on disposal of property, plant and equipment
(included in networks, operations and support expenses) 363 212
Amortization of intangible assets (included in
depreciation and amortization) (Note 24) 358 159
Contributions to pension plans (included in staff costs) (Note 14) 1,285 1,181
Early retirement benefits (included in staff costs) (Note 14) 2 693
Operating leases:
-- Land and buildings (included in networks, operations and support) 796 394
-- Land and buildings (included in selling, general and administrative) 159 204
-- Network and machinery (included in networks, operations and support) 1,708 1,606
-- Network and machinery (included in selling, general and administrative) 92 19
Interconnection charges (included in networks, operations and support) 3,487 2,602
Bad and doubtful debt expenses (included in selling, general and administrative) 1,148 1,185
Auditor's remuneration (included in selling, general and administrative) 34 18
PHS subscriber acquisition costs (included in selling, general and administrative) 2,323 3,114
Cost of PHS handsets (included in other operating expenses) 861 425
120
9 Finance costs
Year ended December 31,
2005 2004
RMB million RMB million
Restated
Note 2
Interest expenses on:
-- Bank and other loans wholly repayable within five years 3,676 4,185
-- Bank and other loans wholly repayable after more than five years 207 114
3,883 4,299
Less: Interest expenses capitalized in construction in progress (297) (548)
Amortization of discount on foreign currency
exchange forward contracts -- 18
Exchange (gain)/loss, net (232) 105
Bank charges 20 56
3,374 3,930
Interest expenses were capitalized in construction
in progress using the following annual interest rates 4.17%-4.97% 3.69%-5.45%
10 Taxation
Year ended December 31,
2005 2004
RMB million RMB million
Restated
Note 2
PRC enterprise income tax ("EIT") 3,581 2,932
Overseas profit tax 10 --
Deferred taxation (Note 33) (162) (3,255)
Taxation charges/(credit) 3,429 (323)
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.
121
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,
2005 2004
RMB million RMB million
Restated
Note 2
Profit before taxation 17,317 2,376
Weighted average statutory tax rate 33% 33%
Tax calculated at the weighted average statutory tax rate 5,715 784
Non-taxable income (Note (a) below) (1,499) (1,583)
Utilization of tax losses not recognized
in previous years (Note (b) below) (837) --
Expenses not deductible for tax purposes 69 275
Tax losses not recognized 129 354
Others (148) (153)
Tax charge/(credit) 3,429 (323)
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.
122
11 Profit attributable to shareholders
(a) For the year ended December 31, 2005, profit attributable to
shareholders included current year profit of RMB125 million (2004: a
loss of RMB41 million), which has been dealt with in the financial
statements of the Company.
(b) 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.
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).
(c) 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,
2005 2004
HK$ RMB HK$ RMB
million million million million
Final dividend proposed after
balance sheet date
of HK$0.466 per share
(2004 : HK$0.037 per share) 3,073 3,196 245 259
Dividend distributed during the year 245 259 -- --
Notes:
(i) 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.
123
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,
2005 2004
(in RMB millions, except share
and per share data)
Restated
Notes 2&3
Numerator:
Profit for the year 13,888 2,699
Denominator:
Weighted average number of ordinary shares
outstanding and shares used in computing
basic earnings per share: 6,593,529,000 5,622,685,175
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 34,112,723 2,209,241
Shares used in computing diluted earnings per share 6,627,641,723 5,630,034,452
Basic earnings per share (RMB) 2.11 0.48
Diluted earnings per share (RMB) 2.10 0.48
124
14 Staff cost including directors' remunerations
Year ended December 31,
2005 2004
RMB million RMB million
Restated
Notes 2&3
Wages, salaries and welfare 11,046 10,076
Contributions to pensions 1,285 1,181
Early retirement benefits 2 693
Total 12,333 11,950
15 Directors' and senior management's emoluments
(a) Directors' emoluments
The following table sets out the emoluments paid to the Company's
directors during the year:
Year ended December 31, 2005
RMB
Basic salaries,
housing
allowances,
other
allowances Contributions
and benefits to retirement
Fees in kind (i) schemes Total
Zhang Chunjiang 260,715 3,331,565 16,363 3,608,643
Edward Tian Suning 260,715 6,272,346 -- 6,533,061
Zhang Xiaotie 260,715 886,071 16,363 1,163,149
Miao Jianhua 260,715 1,050,590 16,363 1,327,668
Jiang Weiping 309,370 1,039,565 16,363 1,365,298
Li Liming 312,858 993,926 16,363 1,323,147
Keith Rupert Murdoch (ii) 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 Lopez (iii) 94,500 -- -- 94,500
Total 4,127,431 14,297,305 81,815 18,506,551
125
15 Directors' and senior management's emoluments (continued)
(a) Directors' emoluments (continued)
For the year ended December 31, 2005, the fees disclosed above include
HK$ 1,815,121(2004: HK$ 378,449 (Restated)) paid to independent
non-executive directors.
The following table sets out the emoluments paid to the Company's
directors during the year ended 31 December 2004:
Year ended December 31, 2004
RMB
Basic salaries,
housing
allowances,
other
allowances Contributions
and benefits to retirement
Fees in kind (i) schemes Total
Restated
Notes 2 & 3
Zhang Chunjiang 141,786 646,065 13,927 801,778
Leng Rongquan -- 439,365 13,927 453,292
Edward Tian Suning 260,715 4,174,884 -- 4,435,599
Zhang Xiaotie 63,453 571,343 13,927 648,723
Miao Jianhua 63,453 623,247 13,927 700,627
Jiang Weiping 73,572 504,672 9,324 587,568
Li Liming 73,572 482,897 13,927 570,396
Keith Rupert Murdoch (ii) 73,572 70,315 -- 143,887
Yan Yixun 63,453 70,315 -- 133,768
John Lawson Thornton 83,691 -- -- 83,691
Victor Mou Zing Cha 73,572 -- -- 73,572
Qian Yingyi 93,810 -- -- 93,810
Hou Ziqiang 83,691 -- -- 83,691
Timpson Chung Shui Ming 60,715 -- -- 60,715
Total 1,209,055 7,583,103 78,959 8,871,117
Note:
(i) Benefits in kind include share option benefit.
(ii) Resigned on 12th September 2005.
(iii) Appointed on 12th September 2005.
126
`
15 Directors' and senior management's emoluments (continued)
(b) Five highest paid individuals
The five individuals whose emoluments were the highest for the years
ended December 31, 2005 include two directors (2004: three) whose
emoluments are reflected in the analysis presented above. The
emoluments payable to the remaining individuals are as follows:
Year ended December 31,
2005 2004
RMB RMB
Restated
Notes 2&3
Basic salaries, housing allowances,
other allowances and benefits in kind 8,670,729 3,399,848
Contributions to retirement schemes 32,726 13,927
Total 8,703,455 3,413,775
The number of the remaining individuals whose emoluments fell within
the following bands are set out as follows:
Year ended December 31,
2005 2004
Nil - RMB1,040,300
(equivalent of Nil - HK$ 1,000,000) -- 1
RMB1,040,300 - RMB3,120,900
(equivalent of HK$ 1,000,000 - HK$ 3,000,000) 3 1
127
16 Cash and bank deposits
Group Company
As at December 31 As at December 31
2005 2004 2005 2004
RMB million RMB million RMB million RMB million
Restated
Note 2
Cash and cash equivalents 4,874 10,581 540 7,789
Time deposits with original maturities
over three months 21 52 -- --
Total cash and bank deposits 4,895 10,633 540 7,789
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 RMB4,058
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.
17 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.
128
18 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.
The ageing analysis of accounts receivable based on the billing date is as
follows:
As at December 31,
2005 2004
RMB million RMB million
Restated
Note 2
0-30 days 5,446 5,503
31-90 days 1,556 1,122
Over 90 days 2,053 1,961
Total 9,055 8,586
Less: Allowance for doubtful debts (1,654) (1,412)
Net carrying amounts 7,401 7,174
The movement of allowance for doubtful debts is as follows:
As at December 31,
2005 2004
RMB million RMB million
Restated
Note 2
Balance at beginning of year 1,412 1,175
Additional provisions 1,169 1,244
Less: Amounts utilized (927) (958)
Distributed to owner in accordance
with Listing Reorganization -- (49)
Balance at end of year 1,654 1,412
The carrying value of accounts receivable approximate 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 accounts receivable are amounts due from other state-owned
telecommunication operators amounting to RMB1,003 million (2004: RMB1,278
million).
129
19 Inventories and consumables
As at December 31,
2005 2004
RMB million RMB million
Restated
Note 2
Telephone handsets and other customer
end-products held for resale, at cost 144 427
Consumables, at cost 328 816
Total 472 1,243
20 Prepayments, other receivables and other current assets
Group Company
As at December 31, As at December 31,
2005 2004 2005 2004
RMB RMB RMB RMB
million million million million
Restated
Note 2
Prepaid expenses, deposits and
other current assets 997 637 14 8
Other receivables 485 805 12 8
Total 1,482 1,442 26 16
Included in other current assets are deferred customer acquisition cost of RMB324 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%).
130
21 Fixed assets
Furniture,
Telecommu- fixture, 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 restated 36,262 247,128 11,438 294,828
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 restated (6,986) (102,487) (4,999) (114,472)
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
131
21 Fixed assets (continued)
Furniture,
Telecommu- fixture, 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, as restated 25,967 264,383 13,788 304,138
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, as restated (5,382) (124,673) (7,186) (137,241)
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
132
>
21 Fixed assets (continued)
(a) The net book value of assets held under finance lease is as follows:
Furniture,
Telecommu- fixture, motor
nications vehicles and
networks and other
Buildings equipment equipment Total
RMB RMB RMB RMB
million million million million
As at December 31, 2005 1 2,551 109 2,661
As at December 31, 2004 8 3,574 97 3,679
(b) The analysis of the cost or revaluation of the fixed assets of the Group is as follows:
Furniture,
Telecommu- fixture, motor
nications vehicles and
networks and other
Buildings equipment equipment Total
RMB RMB RMB RMB
million million million million
December 31, 2005
Cost 27,050 -- -- 27,050
Valuation -- 280,301 19,770 300,071
27,050 280,301 19,770 327,121
December 31, 2004
Cost 25,967 -- -- 25,967
Valuation -- 264,383 13,788 278,171
25,967 264,383 13,788 304,138
The Group's buildings are primarily located in the PRC and held on leases of primarily between 10 to 50 years.
133
21 Fixed assets (continued)
(c) As required by the PRC rules and regulations relevant to the Listing
Reorganization, each class of fixed assets other than lease
prepayments for land and buildings 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. The
surplus on revaluation of certain fixed assets of RMB2,982 million was
credited to the revaluation reserve while the deficit arising from the
revaluation of certain 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 33(ii).
As required by the PRC rules and regulations relevant to the
Acquisition, each class of fixed assets, other than lease prepayments
for land and buildings 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. The surplus on revaluation
of certain fixed assets of RMB3,863 million was credited to the
revaluation reserve while the deficit arising from the revaluation of
certain 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
33(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.
134
21 Fixed assets (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: RMB22 million).
135
22 Construction in progress
As at December 31,
2005 2004
RMB RMB
million million
Restated
Notes 2&3
Balance at beginning of year 11,068 18,049
Effects of adoption of HKAS 17:
Reclassification from land use rights to lease prepayments for land (Note 3 (c)) (471) (643)
Balance as at January 1, 2005, as restated 10,597 17,406
Additions 23,258 28,983
Transferred to fixed assets (26,818) (34,391)
Distributed to owner in accordance with the Reorganizations (215) (1,401)
Balance at end of year 6,822 10,597
23 Lease prepayments for land
This represents land use rights in PRC and their net book value is analyzed
as follows:
As at December 31,
2005 2004
RMB RMB
million million
Restated
Notes 2&3
Held for:
Lease of between 10 to 50 years 1,933 1,733
Lease of less than 10 years 16 13
Balance at end of year 1,949 1,746
136
23 Lease prepayments for land (continued)
The movement of the lease prepayments for land is as follows:
As at December 31,
2005 2004
RMB RMB
million million
Restated
Notes 2&3
Balance at beginning of year from reclassification from land use right 1,746 2,375
Additions 280 202
Charge for the year (37) (51)
Distributed to owner in accordance with the reorganizations (40) (780)
Balance at end of year 1,949 1,746
137
24 Intangible assets
Negative Purchased Sponsorship
goodwill software fees Total
RMB RMB RMB RMB
million million million million
(Note 40(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
138
25 Other non-current assets
As at December 31,
2005 2004
RMB RMB
million million
Restated
Notes 2&3
Installation cost 4,197 4,866
Customer acquisition costs -- 1,304
Prepaid network capacities 1,454 1,322
Discount on foreign exchange forward contracts (note 3(d)) -- 59
Others 383 985
6,034 8,536
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 RMB324 million (2004: Nil).
26 Investments in subsidiaries
Company
As at December 31,
2005 2004
RMB RMB
million million
Investments cost in subsidiaries 58,577 37,509
Due from subsidiaries (Note (b)) 573 --
Due to subsidiaries (Note (c)) (12,820) --
46,330 37,509
139
26 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
fully of equity Principal
Place and date paid up/ interest activities
of incorporation/ registered attributable and place
Company name establishment capital to the Group of operation
Directly held:
China Netcom (Group) PRC, Registered 100% Provision of
Company Limited August 6, capital of network
(Note (i)) 1999 RMB150 communication
million services in the PRC
Indirectly held:
China Netcom Group PRC, Registered 100% Provision of
New Horizon August 9, share capital of network
Telecommunications 2005 RMB9,466,366,600 communication
Co.Limited (Note (ii)) services in the PRC
Asia Netcom Corporation Bermuda 120,000,000 100% Investment holding
Limited (Note (iii)) October 15, ordinary shares of in Bermuda
2002 US$ 0.01 each
(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
140
27 Accounts payable
As at December 31,
2005 2004
RMB RMB
million million
Restated
Note 2
0-30 days 6,281 8,371
31-60 days 1,796 2,351
61-90 days 1,297 1,223
91-180 days 1,940 2,922
Over 180 days 5,405 6,258
Total 16,719 21,125
Included in accounts payable are amounts due to other state-owned
telecommunications operators amounting to RMB48 million (2004: RMB69
million).
28 Accruals and other payables
Group Company
As at December 31, As at December 31,
2005 2004 2005 2004
RMB RMB RMB RMB
million million million million
Restated
Note 2
Accrued expenses 872 1,580 93 140
Other payables 3,033 3,286 -- --
Total 3,905 4,866 93 140
141
29 Bank and other loans
(a) The short term bank loans were unsecured and comprise:
As at December 31,
Currency Interest rate and final maturity 2005 2004
RMB RMB
million million
Restated
Note 2
Renminbi Interest rates ranging from 4.70%
denominated to 5.02% per annum with
maturity through December 18, 2006 47,341 44,692
US Dollar Interest rates ranging from 2.59%
denominated to 3.98% per annum -- 190
47,341 44,882
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 RMB46,541 million as at December 31, 2005 (2004:
RMB43,472 million).
142
29 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise:
Note As at December 31,
2005 2004
RMB RMB
million million
Restated
Note 2
Long term bank loans (i) 22,734 34,678
Finance lease obligations (ii) 2,255 3,101
24,989 37,779
Less: Current portion (6,846) (11,727)
18,143 26,052
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 long term bank loans were loans from state-owned banks
amounting to RMB22,685 million as at December 31, 2005 (2004:
RMB33,218 million).
(i) Long term bank loans
As at December 31,
2005 2004
RMB RMB
million million
Restated
Note 2
Loans
Unsecured 22,414 32,075
Secured 320 2,603
Total 22,734 34,678
Less: Current portion (5,579) (10,796)
Long term loans 17,155 23,882
143
29 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,
2005 2004
RMB RMB
million million
Restated
Note 2
Within one year 5,579 10,796
In the second year 7,774 8,276
In the third to fifth year, inclusive 5,886 12,140
After the fifth year 3,495 3,466
22,734 34,678
As at December 31,
Currency Interest rate and final maturity 2005 2004
RMB RMB
million million
Restated
Bank loan Note 2
Renminbi Interest rates ranging from 2.40%
denominated to 10.08% per annum with
maturity through December 20, 2019 20,736 29,503
US Dollar Interest rates ranging from 1.25%
denominated to 8.00% per annum with
maturity through October 31, 2039 1,241 3,223
Japanese Yen Interest rate is 2.12% per annum
denominated with maturity through January 7, 2014 327 1,342
Euro denominated Interest rates ranging from 0.50%
to 7.35% per annum with
maturity through March 15, 2034 430 610
22,734 34,678
144
29 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise: (continued)
(i) Long term bank loans (continued)
As at December 31, 2005, secured bank loans of RMB320 million
(2004: RMB2,603 million) which were secured by the following:
o Corporate guarantees granted by China Netcom Group to the
extent of RMB75 million (2004: RMB2,148 million); and
o Corporate guarantee granted by third parties to the extent
of RMB245 million (2004: RMB452 million).
(ii) Finance lease obligations
As at December 31,
2005 2004
RMB RMB
million million
Restated
Note 2
Obligation under finance leases 2,255 3,101
Less: current portion (1,267) (931)
988 2,170
In 2005, the Group has entered into a finance lease arrangement
with a related party, receiving funding of RMB322 million. The
net book value of the assets under finance lease was RMB317
million as at December 31, 2005 (2004: RMB2,592 million). The
accumulated finance lease obligation as at December 31, 2005
amounted to RMB2,255 million. (2004: RMB2,408 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).
145
29 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise: (continued)
(ii) Finance lease obligations (continued)
The Group's liabilities under finance leases are analyzed as follows:
As at December 31,
2005 2004
RMB RMB
million million
Restated
Note 2
Within one year 1,319 1,005
In the second year 903 1,396
In the third to fifth year, inclusive 106 831
2,328 3,232
Less: future finance charges on finance leases (73) (131)
Present value of finance lease liabilities 2,255 3,101
The present value of finance lease liabilities is as follows:
Within one year 1,267 931
In the second year 885 1,350
In the third to fifth year, inclusive 103 820
2,255 3,101
(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,
2005 2004
RMB RMB
million million
Restated
Notes 2&3
Long term bank loans 15,571 21,899
Finance lease obligations 958 1,908
16,529 23,807
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%).
146
30 Amount due from/(to) holding companies and fellow subsidiaries
Note As at December 31,
2005 2004
RMB RMB
Million million
Restated
Note 2
Current:
Due from ultimate holding company (a) 89 785
Due from other holding companies (a) 1 1
Due from fellow subsidiaries (a) 157 301
Total 247 1,087
Due to ultimate holding company
-- Deferred consideration (b) 1,960 --
-- Others (a) 3,877 3,704
Due to fellow subsidiaries (a) 3,153 6,376
Total 8,990 10,080
Non-current:
Due to ultimate holding company
-- Deferred consideration (b) 7,840 --
Total 7,840 --
147
30 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 December 31,
2005 2004
RMB RMB
million million
Within one year 1,960 --
In the second year 1,960 --
In the third to fifth year, inclusive 5,880 --
Total 9,800 --
31 Deferred revenues
As at December 31,
2005 2004
RMB RMB
million million
Restated
Note 2
Balance at beginning of year:
-- upfront connection fees 8,910 13,256
-- upfront installation fees 7,638 8,001
-- advances from network capacity sales 2,173 2,050
-- prepaid telephony services 4,143 3,677
22,864 26,984
Additions for the year:
-- upfront connection fees -- --
-- upfront installation fees 573 1,205
-- advances from network capacity sales 461 242
-- prepaid telephony services 24,435 18,636
25,469 20,083
148
31 Deferred revenues
As at December 31,
2005 2004
RMB RMB
million million
Restated
Note 2
Reductions for the year:
-- upfront connection fees (3,405) (4,346)
-- upfront installation fees (1,442) (1,568)
-- advances from network capacity sales (280) (114)
-- prepaid telephony services (24,306) (18,126)
(29,433) (24,154)
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 5,505 8,910
-- upfront installation fees 6,769 7,638
-- advances from network capacity sales 2,354 2,173
-- prepaid telephony services 4,272 4,143
18,900 22,864
Representing:
-- Current portion 7,975 8,876
-- Non-current portion 10,925 13,988
18,900 22,864
149
32 Provisions
Early One-off
retirement cash housing
benefits subsidies Total
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
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.
150
32 Provisions (continued)
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)
151
33 Deferred taxation
Movements of the deferred tax assets and liabilities are as follows:
Balance at Recognised Balance at
December in income Recognized Recognized December
31, 2004 statement in equity in equity 31, 2005
RMB RMB RMB RMB RMB
million million million million million
Restated Note (i) Note (ii)
Notes 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)
152
33 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 RMB RMB RMB RMB RMB RMB
million million million million million million million
Restated Note (iii) Note (i) Note (i) Note (ii)
Notes 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)
153
33 Deferred taxation (continued)
Notes:
(i) As described in Note 21, 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 RMB709 million (comprising
the recognition of deferred tax assets of RMB2,580 million and
deferred tax liabilities of RMB3,289 million), and this decrease was
recorded as a credit to owner's equity upon the date of the
Reorganization on June 30, 2004. The RMB709 million net reduction of
deferred tax liabilities, comprised RMB846 million, being the deferred
tax liabilities from the revaluation surplus of fixed assets credited
to revaluation reserves and RMB137 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 RMB1,076 million (comprising
deferred tax assets of RMB1,272 million and deferred tax liabilities
of RMB196 million), and this decrease was recorded as a debit to
owner's equity upon the date of the Reorganization on June 30, 2005.
The RMB1,076 million deduction comprises RMB1,097 million, being
deferred tax liabilities originating from the revaluation surplus of
fixed assets recorded, was credited to revaluation reserves offset by
RMB2,174 million deferred tax assets 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 a corresponding increase 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 RMB6,967 million as at December
31, 2003. As explained in the preceding paragraph, a deferred tax
asset of RMB2,355 million was subsequently recorded with a
corresponding increase in owner's equity upon the Listing
Reorganization on June 30, 2004. The amount transferred to retained
earnings for the year ended December 31, 2005 was RMB57 million (2004:
241 million).
During the Acquisition, the leasehold land and buildings has a net
surplus on revaluation of RMB2,553 million as at December 31, 2004. As
explained above, a deferred tax asset of RMB843 million was
subsequently recorded with a corresponding increase in owner's equity
upon the Acquisition on June 30, 2005. The amount transferred to
retained earnings for the year ended December 31, 2005 was RMB39
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.
154
34 Share capital
Authorised
Convertible preference shares of
Ordinary shares of US$0.04 each US$0.04 each (note (c)) Total
No. of RMB No. of RMB RMB
shares US$ million shares US$ million US$ 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$0.04 each (note (c)) Total
No. of RMB No. of RMB RMB
shares US$ million shares US$ million US$ 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
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 an 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 RMB8,277
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 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 RMB3,100
million, is reflected as share premium
(c) All preference shares were converted into ordinary shares of the
Company on August 30, 2004.
155
34 Share capital (continued)
(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$8,096 million (equivalent to RMB8,582 million).
35 Share option scheme
A share option scheme was approved pursuant to a directors' resolution on
September 30, 2004 ("Share Option Scheme"). Share options are granted to
directors of the Company and to certain employees of the Group at the
directors' discretion. Share options can be exercised at least 18 months
from the later of the date of grant or the date of the listing of the
shares of the Company on the Hong Kong Stock Exchange and subject to
certain vesting schedules.
On October 22, 2004, 158,640,000 share options with an exercise price of
HK$ 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 and
other professional personnel designated by the Compensation Committee of
the newly acquired four northern provinces/autonomous region.
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 during the year is summarized
as follows,
Granted Exercised Lapsed Cancelled Outstanding Subscription price
Outstanding during during during during as at per share of
as at 01/Jan/05 the year the year the year the year 31/Dec/05 the Company
HK$
No. of share options 157,720,000 79,320,000 -- -- (1,017,000) 236,023,000 8.4/12.5
No. of directors and
employees 455 260 -- -- (3) 712
156
35 Share option scheme(continued)
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.
36 Reserves - Company
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
157
37 Consolidated cash flow statements
(a) Reconciliation of profit before taxation to net cash flows generated
from operations
Year ended December 31,
2005 2004
RMB RMB
million million
Restated
Note 2&3
Profit before taxation 17,317 2,376
Depreciation of fixed assets and amortization of intangible assets 25,012 25,129
Lease prepayments for land 37 51
Amortization of deferred revenues (29,433) (24,154)
Deferred costs charged to the income statements 2,553 3,646
Deficit on revaluation of fixed assets -- 11,318
Bad and doubtful debts 1,148 1,185
Loss on disposal of fixed assets 363 212
Share based compensation 104 18
Dividend income (29) (17)
Share of loss of associated companies -- 1
Interest income (157) (87)
Interest expense 3,586 3,751
Discount on foreign currency exchange forward contracts -- 18
Unrealized loss on short-term investments -- 4
Foreign exchange (gain)/loss (232) 105
Operating cashflow before working capital changes 20,269 23,556
Increase in accounts receivable (1,399) (1,010)
Decrease in inventories and consumables 768 108
Decrease/(increase) in prepayments, other receivables and
other current assets 788 (505)
Increase in other non-current assets (519) (3,302)
(Decrease)/increase in accounts payable (3,281) 1,512
Decrease in accruals and other payables (1,363) (3,008)
Increase in deferred revenues 25,469 20,083
Net cash inflow generated from operations 40,732 37,434
158
37 Consolidated cash flow statements (continued)
(b) Major non-cash transactions
During 2005, the Group paid RMB3,000 million as part of the total
consideration for the Acquisition (Note 1). The remaining balance of
RMB9,800 million 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 RMB338 million (2004: RMB1,950 million).
During 2004, the immediate holding company assigned a loan to the
Company which resulted in a direct debit to the Company's equity.
38 Banking facilities
As at December 31, 2005 and 2004, the Group's banking facilities (most of
them can be utilised for more than one year) are as follows:
Group Company
As at December 31, As at December 31,
2005 2004 2005 2004
RMB RMB RMB RMB
million million million million
Restated
Note 2
Amount utilized 70,075 79,560 -- --
Amount unutilized 104,731 24,349 -- --
Aggregate banking facilities 174,806 103,909 -- --
159
39 Commitments
(a) Capital commitments
Group Company
As at As at As at As at
December 31, December 31, December 31, December 31,
2005 2004 2005 2004
RMB RMB RMB RMB
million million million million
Restated
Note 2
Contracted but not provided for
-- Leasehold land and buildings 227 137 -- --
-- Telecommunications networks
and equipment 1,376 1,072 -- --
-- Others 112 6 -- --
1,715 1,215 -- --
Authorized but not contracted for
-- Leasehold land and buildings 27 2 -- --
-- Telecommunications networks
and equipment 112 1,778 -- --
-- Others -- -- -- --
139 1,780 -- --
160
39 Commitments (continued)
(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 Company
As at As at As at As at
December 31, December 31, December 31, December 31,
2005 2004 2005 2004
RMB RMB RMB RMB
million million million million
Restated
Note 2
Not later than one year 994 804 -- --
Later than one year and
not later than five years 1,373 1,148 -- --
Later than five years 1,699 1,518 -- --
4,066 3,470 -- --
40 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.
161
40 Related party transactions (continued)
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.
As at December 31,
2005 2004
RMB RMB
Notes million million
Restated
Note 2
Emolument of key management (i)
- salaries and welfare 35 14
- contributions to retirement scheme 1 1
Subtotal 36 15
Interconnection fees
-- from fellow subsidiaries (iv)(b) 251 148
-- from other state-owned
telecommunications operators (iv)(b) 6,442 5,481
Subtotal 6,693 5,629
Interconnection charges
-- to fellow subsidiaries (iv)(b) 611 198
-- to other state-owned
telecommunications operators (iv)(b) 1,475 1,200
Subtotal 2,086 1,398
Rental income from properties
leased to fellow subsidiaries (iv)(a),(iv)(c) -- 3
Purchase of materials
-- from fellow subsidiaries (iv)(a),(iv)(c) 1,298 2,122
-- from other related companies (iv)(a),(iv)(c) 231 822
Subtotal 1,529 2,944
162
40 Related party transactions (continued)
As at December 31,
2005 2004
RMB RMB
Notes million million
Restated
Note 2
Receipt of engineering, project planning,
design, construction and information
technology services
-- from fellow subsidiaries (iv)(a),(iv)(b) 2,236 3,185
-- from other related companies (iv)(a),(iv)(b) 413 392
Subtotal 2,649 3,577
Ancillary telecommunications support services
-- from fellow subsidiaries (v) 435 554
-- from other related companies (v) 51 235
Subtotal 486 789
Payment of operating lease rentals of premises
-- to fellow subsidiaries (iv)(a),(iv)(c) 655 311
-- to other related companies (iv)(a),(iv)(c) -- 5
Subtotal 655 316
Property sub-lease rentals to fellow subsidiaries (iv)(a),(iv)(c) 15 33
Common corporate services income
from ultimate holding company (vi) 89 19
Common corporate services expenditure
paid to ultimate holding company (vi) 279 213
Support services received
-- from ultimate holding company (vii) 2 --
-- from fellow subsidiaries (vii) 888 937
-- from other related companies (vii) 264 1,487
Subtotal 1,154 2,424
163
40 Related party transactions (continued)
As at December 31,
2005 2004
RMB RMB
Notes million million
Restated
Note 2
Telecommunications rental income from
other state-owned telecommunications
operators (iv)(b) 1,271 1,182
Payment for lease of Telecommunications facility
-- to ultimate holding company (viii) 85 --
-- to fellow subsidiaries (viii) 215 138
Subtotal 300 138
Payment for purchase of long-term
telecommunications capacity to
fellow subsidiaries (ix) 117 173
Payment for lease of long-term
telecommunications capacity
to fellow subsidiaries (x) 84 28
Management fee received from
fellow subsidiaries (xi) 39 28
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 29 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.
164
40 Related party transactions (continued)
Notes: (continued)
(v) Represents the 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 are allocated between the Group and China
Netcom Group based on total asset as appropriate.
(vii) Represents the support services provided to the Group by 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.
(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 acquired four provinces/autonomous region
respectively.
(xiv) As at December 31, 2005, China Netcom Group granted corporate
guarantees to the Group as set out in Note 29 (b).
(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 RMB540 million. Accordingly, an intangible asset
and a payable to the ultimate holding company of the said amount
have been recognized on the Group's balance sheet.
165
40 Related party transactions (continued)
Notes: (continued)
(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 18, 27 and 29 respectively.
(xvii) The Acquisition was completed at October 31, 2005. Details have
been set out in Note 1.
41 Significant subsequent events
After the balance sheet date the directors proposed a final dividend.
Further details are disclosed in Note 12.
42 Ultimate holding party
The ultimate holding company is China Netcom Group which is owned and
controlled by PRC Government.
43 Approval of financial statements
The financial statements were approved by the Board of Directors on March
21, 2006.
166
Supplementary Information for American Depositary Shares Holders
The consolidated financial statements of the Group have been prepared in
accordance with Hong Kong GAAP, which differs in certain material respects from
U.S.GAAP. Differences between Hong Kong GAAP 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 Hong Kong
GAAP and U.S.GAAP for the years ended December 31, 2003, 2004 and 2005 is as
follows:
Year ended at December 31,
2003 2004 2005 2005
Restated Restated
Note Notes 2&3 Notes 2&3
RMB million except per share data US$ million
except per
share data
Consolidated net income/(loss)
for the year under Hong Kong GAAP (10,906) 2,699 13,888 1,699
U.S.GAAP adjustments:
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 unde
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
167
The effect on shareholders' equity of significant differences between Hong Kong
GAAP 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 Hong Kong GAAP 53,659 64,595 63,010 7,808
U.S.GAAP adjustments:
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
In 2005, the Group acquired the fixed line telecommunication service of four
northern provinces/autonomous region (Shanxi Province, Neimenggu 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 had 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 comparatives have been
restated as required by the relevant new or revised HKFRSs.
168
(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 RMB25,778 million to the Group's consolidated
income statement for the year ended 31 December, 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 RMB2,982 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 RMB11,318 million to the Group's
consolidated income statement for the year ended 31 December, 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 RMB3,863 million has
been credited to the revaluation reserve. The effect of the reduction in
depreciation of the revalued assets amounted to RMB5,110 million in the
year ended December 31, 2005 (2004: RMB3,529 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
Hong Kong GAAP and the corresponding effect on the depreciation of the
revalued assets in the subsequent periods are reversed for U.S.GAAP
purposes.
(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 Hong Kong GAAP, 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.
169
(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 35.
Prior to 1 January 2005, under Hong Kong GAAP, 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 1 January 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 Hong Kong GAAP upon the changes in accounting
policies.
(d) Convertible preference shares
Under Hong Kong GAAP, 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
RMB2,637 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 Hong Kong GAAP 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 US
GAAP requires full recognition of deferred tax assets and reduced by
appropriate valuation allowance 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 US GAAP.
170
(f) Goodwill and negative goodwill
Before 1 January 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 1 January 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 RMB10 million during the year ended December 31, 2004 under Hong Kong
GAAP 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 Hong Kong GAAP was higher than that under
U.S.GAAP by RMB166 million for reason of the different treatment as of the
negative goodwill from the acquisition of Asia Global Crossing. The
negative goodwill of RMB166 million was included in the balance sheet under
Hong Kong GAAP 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 Hong Kong GAAP by RMB166 million.
On 1 January 2005, the balance of negative goodwill under Hong Kong GAAP
was credited directly to the shareholders' equity upon the adoption of
HKFRS 3 and the GAAP difference ceased to exist from then.
(g) Presentation of revenue
Under Hong Kong GAAP, revenues are presented net of the PRC business taxes
and government levies which amounted to RMB2,392 million, RMB2,493 million
and RMB2,421 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.
171
(h) Presentation of depreciation expenses
Under Hong Kong GAAP, 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 Hong Kong GAAP, amortization of capitalized subscriber acquisition
costs, being RMB741 million, RMB2,602 million and RMB1,887 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.
Other U.S.GAAP disclosures
(a) Related party transaction
In previous years, under Hong Kong GAAP, transactions with state-controlled
enterprises other than China Netcom Group and its affiliates are not
required to be disclosed as related party transactions. In addition,
government departments and agencies are deemed not to be related parties to
the extent that such transactions are in the normal course of business. No
exemptions were provided as that under U.S.GAAP.
In 2005, the Group adopted HKAS 24 - Related Party Disclosures issued by
HKICPA in which the related exemption was removed. The GAAP difference
ceased to exist by then.
(b) 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 Hong Kong GAAP and U.S.GAAP comprehensive income, except for the
differences between Hong Kong GAAP and U.S.GAAP profit attributable to
shareholders shown above.
(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.
172
(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 15 June 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 1 January 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. The Company does not expect the adoption of SFAS No. 123R
and the guidance of SAB No. 107 to have a material impact on the financial
condition or operating results of the Company.
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. Accordingly, the Company does
not expect to have significant impact upon the adoption of SFAS No. 123R
and SAB No. 107 on the financial statements.
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 15 June 2005. The Company is required to
adopt SFAS No. 151 in the fiscal year beginning 1 January 2006. The Company
considered the effects of adoption SFAS No. 151 does not have material
impact on its financial statements.
173
(d) Recent U.S. Accounting Pronouncements (continued)
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 15 June 2005. The Company is
required to adopt SFAS No. 153 in the fiscal year beginning 1 January 2006.
The Company considered the effects of adoption SFAS No. 153 does not have
material impact on its financial statements.
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 29 June 2005.
The Company is required to adopt EITF 05-06 in the fiscal year beginning 1
January 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 15 December 2005. The Company is required to adopt
SFAS No. 154 in the fiscal year beginning 1 January 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 15 December 2005. The Company is required
to adopt FSP No. FAS 13-1 in the fiscal year beginning 1 January 2006. The
Company is in the process of assessing the impact of this guidance.
174
Financial Summary
Selected Consolidated Balance Sheet Data
As at December 31,
2005 2004 2003 2002
RMB million RMB million RMB million RMB million
Fixed assets 168,663 166,897 181,638 190,752
Construction in progress 6,822 10,597 18,049 21,301
Other non-current assets 12,856 14,468 15,728 12,448
Cash and bank deposits 4,895 10,633 7,430 7,899
Other current assets 9,604 13,822 13,236 12,881
Total assets 202,840 216,417 236,081 245,281
Short-term bank loans 47,341 44,882 47,991 36,590
Accounts payable 16,719 21,125 20,195 18,934
Other current liabilities 34,339 40,037 50,164 41,493
Long-term bank and other loans 18,143 26,052 30,172 40,404
Deferred revenues 10,925 13,988 17,585 19,744
Other non-current liabilities 12,363 5,738 16,312 18,345
Total liabilities 139,830 151,822 182,419 175,510
Minority interests -- -- 3 4
Shareholders' equity 63,010 64,595 53,659 69,767
Total liabilities and shareholders' equity 202,840 216,417 236,081 245,281
Selected Consolidated Cash Flow
Statement Data
For the year ended December 31,
2005 2004 2003 2002
RMB million RMB million RMB million RMB million
Net cash inflow from operating activities 33,557 33,653 30,917 30,012
Net cash outflow from investing activities (24,608) (28,702) (34,875) (34,219)
Purchase of fixed assets and construction
in progress, Pepayments for land (27,562) (28,256) (36,450) (34,186)
Net cash inflow/(outflow) from
financing activities (14,656) (1,743) 3,595 3,212
175
Selected Consolidated income Statement Data
Year ended December 31,
2005 2004 2003 2002
RMB million RMB million RMB million RMB million
Revenues 87,232 83,494 77,598 70,675
Domestic telecommunications services 83,977 80,851 76,219 70,103
Local usage fees 24,582 24,858 24,685 23,229
Monthly fees 18,261 17,964 16,476 14,987
Upfront installation fees 1,442 1,568 1,267 1,147
DLD usage fees 10,260 11,266 11,425 10,947
ILD usage fees 1,180 1,234 1,543 1,478
Value-added services 4,000 2,993 2,095 1,140
Interconnection fees 6,517 5,441 3,763 3,242
Upfront connection fees 3,405 4,346 5,122 5,596
Broadband service 7,812 5,202 2,914 2,468
Other Internet-related service 540 1,004 1,418 214
Managed data service 1,395 1,520 1,553 1,501
Leased line income 2,238 2,095 2,820 2,805
Other services 2,345 1,360 1,138 1,349
International telecommunications
services 3,255 2,643 1,379 572
Operating expense (66,727) (65,973) (65,372) (58,324)
Depreciation and amortisation (25,049) (25,180) (26,800) (24,796)
Network, operations and support (14,417) (13,973) (15,108) (14,665)
Staff cost (12,333) (11,950) (10,945) (9,035)
Selling, general and administrative (13,438) (12,877) (10,322) (7,927)
Other operating expense (1,490) (1,993) (2,197) (1,901)
Operating profit before interest income,
dividend income and deficit
on revaluation of fixed assets 20,505 17,521 12,226 12,351
Interest income 157 87 95 110
Dividend income 29 17 45 78
Deficit on revaluation of fixed assets -- (11,318) (25,778) --
Profit/(Loss) from operations 20,691 6,307 (13,412) 12,539
Financial cost (3,374) (3,930) (4,296) (4,131)
Share of loss of Associated companies -- (1) (416) (1)
Profit/(Loss) before taxation 17,317 2,376 (18,124) 8,407
Taxation (3,429) 323 7,217 (1,789)
Profit/(Loss) after taxation 13,888 2,699 (10,907) 6,618
Minority interests -- -- 1 --
Profit/(Loss) for the year 13,888 2,699 (10,906) 6,618
176