UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 20-F
(Mark One)
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________
OR
[ ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Date of event requiring this shell company report .....................
For the transaction period from __________ to __________
COMMISSION FILE NUMBER 1- 32332
___________________________________
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
(Exact name of Registrant as specified in its charter)
____________________________
Hong Kong, The People's Republic of China
(Jurisdiction of incorporation or organization)
____________________________
No. 21, Financial Street
Xicheng District, Beijing, 100032
The People's Republic of China
(Address of principal executive offices)
____________________________
Securities registered or to be registered pursuant to Section 12 (b) of the Act.
Name of Each Exchange
Title of Each Class On Which Registered
--------------------- ----------------------
American depositary shares, each
representing 20 ordinary shares of
par value US$0.04 per share..................... New York Stock Exchange, Inc.
Ordinary shares of par value US$0.04 per share.. New York Stock Exchange, Inc.
__________________
* Not for trading, but only in connection with the registration of American
depositary shares.
Securities registered or to be registered pursuant to Section 12 (g) of the Act:
None
(Title of Class)
Securities for which there is a reporting obligation
pursuant to Section 15 (d) of the Act:
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's classes of
capital or common stock as of the close of the period covered by the annual
report.
As of December 31, 2006, 6,650,643,500 ordinary shares were issued and
outstanding.
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes X No__
If this report is an annual or transition report, indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.
Yes__ No X
The Registrant is required to file reports pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934.
Note - Checking the box above will not relieve any registrant required to file
reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
from their obligations under those Sections.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No__
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer X Accelerated filer __ Non-accelerated filer __
Indicate by check mark which financial statement item the Registrant
has elected to follow.
Item 17 ___ Item 18 X
If this is an annual report, indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes __ No X
TABLE OF CONTENTS
PART I 3 Page
----
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS..................................3
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE................................................3
ITEM 3. KEY INFORMATION........................................................................3
ITEM 4. INFORMATION ON THE COMPANY............................................................18
ITEM 4A. UNRESOLVED STAFF COMMENTS.............................................................44
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS..........................................45
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES............................................69
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.....................................85
ITEM 8. FINANCIAL INFORMATION.................................................................94
ITEM 9. THE OFFER AND LISTING.................................................................94
ITEM 10. ADDITIONAL INFORMATION................................................................95
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................99
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES...............................100
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES......................................100
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS.........100
ITEM 15. CONTROLS AND PROCEDURES..............................................................101
ITEM 16A AUDIT COMMITTEE FINANCIAL EXPERT.....................................................102
ITEM 16B CODE OF ETHICS.......................................................................102
ITEM 16C PRINCIPAL ACCOUNTANT FEES AND SERVICES...............................................102
ITEM 16D EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES...........................102
ITEM 16E PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS...............102
ITEM 17. FINANCIAL STATEMENTS.................................................................103
ITEM 18. FINANCIAL STATEMENTS.................................................................103
ITEM 19. EXHIBITS.............................................................................103
FORWARD-LOOKING STATEMENTS
This annual report filed on Form 20-F contains certain forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 with respect to financial condition, results of operations, cash flows,
dividends, financing plans, business strategies, capital and other expenditures,
competitive positions, availability of capital, growth opportunities for new and
existing products, availability and deployment of new technologies, plans and
objectives of management, mergers and acquisitions, and other matters.
Statements in this Form 20-F that are not historical facts are hereby
identified as "forward looking statements" for the purpose of the safe harbor
provided by Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. The words "estimate,"
"project," "intend," "expect," "believe," "plan" and similar expressions are
intended to identify forward-looking statements. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date of this annual report. In addition, other written or oral statements
which constitute forward looking statements have been made and may in the future
be made by us or on our behalf, including with respect to the matters referred
to above. These forward looking statements are necessarily estimates reflecting
the best judgment of senior management that rely on a number of assumptions
concerning future events, many of which are outside of our control, and involve
a number of risks and uncertainties that could cause actual results to differ
materially from those suggested by the forward-looking statements. These
forward-looking statements should, therefore, be considered in light of various
important factors, including those set forth in this annual report. Important
factors that could cause actual results to differ materially from estimates or
projections contained in the forward-looking statements include, without
limitation:
o the level of demand for telecommunications services, particularly
with regard to access lines, traffic and new value-added services;
o competitive forces in more liberalized markets, including pricing
pressures and our ability to retain market share in the face of
competition from existing telecommunications companies and
potential new market entrants;
o the effects of tariff reduction initiatives, particularly in our
core fixed-line telephone business;
o changes in the regulatory policies of the Ministry of Information
Industry of China and other relevant government authorities, which
could affect, among other things, the granting of requisite
government approvals, licenses and permits, interconnection and
transmission line arrangements, tariff policies, capital
investment priorities, and spectrum allocation;
o the success of new business initiatives, some of which involve
start-up costs, and new systems and applications, particularly
with regard to the integration of our service offerings;
o our ability to secure or renew the licenses we need to offer
telecommunications services and the cost of these licenses and
related network infrastructure build-outs;
o the availability, terms and deployment of capital, and the impact
of regulatory and competitive developments on capital outlays;
o changes in the assumptions upon which we have prepared our
projected financial information and capital expenditure plans; and
o changes in the general political, economic, legal and social
conditions in China, including the PRC government's specific
policies with respect to new entrants in the telecommunications
industry, the entry of foreign operators into China's
telecommunications market, economic growth, foreign exchange and
the availability of credit.
1
CONVENTIONS
Definitions
References in this annual report to "we", "us", the "Company" or "CNC
Hong Kong" mean China Netcom Group Corporation (Hong Kong) Limited and, as the
context may require, its subsidiaries. References to "China Netcom Group" mean
China Network Communications Group Corporation and, as the context may require,
its subsidiaries, other than us and our subsidiaries.
As used in this annual report:
o references to "China" or "PRC" mean the People's Republic of
China, excluding, for purposes of this annual report, Hong Kong,
Macau and Taiwan, and references to the "central government" mean
the central government of the PRC;
o references to "State Council" mean the State Council of the PRC,
references to "Ministry of Information Industry" and "MII" mean
the Ministry of Information Industry of the PRC, and references to
the "National Development and Reform Commission" and the "NDRC"
mean the National Development and Reform Commission of the PRC;
o references to "our northern service region" mean the ten
municipalities and provinces where we operate in northern China,
consisting of Beijing and Tianjin Municipalities, and Hebei,
Henan, Shandong, Liaoning, Heilongjiang, Jilin, and Shanxi
Provinces, and the Neimenggu Autonomous Region and references to
"our southern service region" mean Shanghai Municipality and
Guangdong Province. We sold our telecommunications assets,
liabilities and business operations in our southern service region
to China Netcom Group on February 28, 2007. See "Item 4.
Information on the Company--History and Development--Recent
Development--Sale of Southern Service Region Business;"
o references to "HKSE", "SEHK" or "Hong Kong Stock Exchange" mean
The Stock Exchange of Hong Kong Limited, and references to "NYSE"
or "New York Stock Exchange" mean New York Stock Exchange, Inc;
o references to "Renminbi" or "RMB" are to the currency of the PRC,
references to "U.S. dollars" or "US$" are to the currency of the
United States of America, and references to "HK dollars" or "HK$"
are to the currency of the Hong Kong Special Administrative Region
of the PRC; and
o references to "U.S. GAAP" mean the generally accepted accounting
principles in the United States, references to "HKFRS" mean Hong
Kong Financial Reporting Standards issued by Hong Kong Institute
of Certified Public Accountants, and references to "PRC GAAP" mean
the PRC Accounting Standards for Business Enterprises and the
implementing rules thereof.
Market Share Data Convention
Certain statements made in this annual report that refer to our market
share or competitive position are based on statistical and other information
from a number of government and private sources, including the information
published by the MII. Unless otherwise indicated, the information has not been
verified by us independently and may not be consistent with the information from
other sources within or outside China.
2
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
SELECTED FINANCIAL DATA
The following tables present our selected consolidated financial data
as of and for the years ended December 31, 2002, 2003, 2004, 2005 and 2006.
You should read the selected consolidated financial data below together
with our consolidated financial statements, including the notes thereto,
included elsewhere in this annual report, and "Item 5. Operating and Financial
Review and Prospects."
We publish our financial statements in Renminbi. We have derived the
selected consolidated financial data as of and for the years ended December 31,
2002, 2003, 2004, 2005 and 2006 from our consolidated financial statements. Our
consolidated financial statements have been prepared in accordance with Hong
Kong Financial Reporting Standards, or HKFRS, which differ in significant
respects from U.S. GAAP.
Our consolidated financial statements report our results as if (1)
certain assets and liabilities transferred to us from China Netcom Group in
connection with our restructuring in connection with the 2004 global offering
had been transferred to us as of January 1, 2002, (2) certain fixed-line
telecommunications assets and liabilities transferred to us from China Netcom
Group in connection with our acquisition on October 31, 2005, or our 2005
Acquisition, of China Netcom Group's fixed-line telecommunications assets and
liabilities in Heilongjiang Province, Jilin Province, the Neimenggu Autonomous
Region and Shanxi Province, or the 2005 Acquired Assets and Liabilities, had
been transferred to us as of January 1, 2002, and (3) in each case we had owned
those assets and liabilities and conducted those operations throughout the
relevant periods. For more details, see "Item 4. Information on the
Company--History and Development."
Since we and the 2005 Acquired Assets and Liabilities were under the
common control of China Netcom Group, our 2005 Acquisitin has been treated as a
"combination of entities under common control," which was accounted for in a
manner similar to pooling-of-interests. Accordingly, the 2005 Acquired Assets
and Liabilities have been recognized at historical carrying amounts and our
consolidated financial statements as of and for the years ended December 31,
2002, 2003 and 2004 have been restated to include the financial position and
results of operations of the 2005 Acquired Assets and Liabilities on a combined
basis. All data and information relating to our businesses and operations for
the years ended December 31, 2002, 2003 and 2004 are presented based on those
restated amounts.
On August 22, 2006, we sold our 100% equity interest in Asia Netcom to
Connect Holdings Limited for US$168.84 million. The results of operations of
Asia Netcom have been classified as discontinued operations, and our
consolidated income statements and cash flow statement for the years ended
December 31, 2004 and 2005 have been restated. The revenue of Asia Netcom, the
major source of revenue of our international telecommunication services, has
accordingly been separately disclosed as discontinued operations for the years
ended December 31,
3
2004 and 2005. Since the remaining revenue derived from our international
telecommunication services historically has not been material, we do not
separately set forth the revenue from our remaining international
telecommunication services.
Selected Consolidated Financial Information
For the Years Ended December 31,
-----------------------------------------------------------------------
2002 2003 2004 2005 2006 2006
-----------------------------------------------------------------------
(Restated) (Restated)
(RMB) (RMB) (RMB) (RMB) (RMB) (USD)
(in millions, except per share and per ADS information)
Consolidated Income Statement Data:
HKFRS
Continuing operations:
Revenues:
Fixed-line telephone services (1) .. 62,338 67,593 70,733 70,913 67,904 8,696
Broadband and other Internet-related service 2,682 4,346 6,382 8,415 11,248 1,440
Business and data communications services (2) 4,306 4,500 4,175 4,252 4,479 574
Other services ..................... 1,349 1,159 991 2,281 3,290 421
Total .............................. 70,675 77,598 82,281 85,861 86,921 11,131
Operating expenses:
Depreciation and amortization ...... (24,796) (26,800) (24,873) (24,919) (25,608) (3,279)
Network, operations and support .... (14,665) (15,108) (13,092) (13,465) (14,383) (1,842)
Staff costs ........................ (9,035) (10,945) (11,630) (12,034) (12,151) (1,556)
Selling, general and administrative (7,927) (10,322) (12,617) (13,322) (13,366) (1,712)
Other operating expenses ........... (1,901) (2,197) (1,982) (1,390) (2,054) (263)
Other income........................ 621 80
Interest and dividend income ....... 188 140 85 160 132 17
Deficit on revaluation of fixed assets (3) - (25,778) (11,318) - (1,524) (195)
Profit/(loss) from operations ...... 12,539 (13,412) 6,854 20,891 18,588 2,380
Financial costs .................... (4,131) (4,296) (3,769) (3,347) (3,888) (498)
Share of loss of associated companies and
jointly controlled entity........... (1) (416) (1) - - -
Profit/(loss) before taxation ...... 8,407 (18,124) 3,084 17,544 14,700 1,883
Taxation ........................... (1,789) 7,217 326 (3,430) (3,559) (456)
Profit/(loss) after taxation ....... 6,618 (10,907) 3,410 14,114 11,141 1,427
Minority interests ................. - 1 - - - -
Profit/(loss) for the year from continuing 7
operations.......................... 6,618 (10,906) 3,410 14,114 11,141 1,42
Discontinued operations(4):
Loss /(profit ) for the year from discontinued 3
operations.......................... - - (711) (226) 1,819 23
4
Profit/(loss) for the year.......... 6,618 (10,906) 2,699 13,888 12,960 1,660
Dividends proposed after the balance sheet date - - 259 3,196 3,695 473
Earnings/(loss) per share for profit/(loss)
from continuing operations attributable to
shareholders of the Company for the year
Basic earnings/(losses) per share.. 1.21 (1.99) 0.61 2.14 1.68 0.22
Diluted earnings/(losses) per share 1.21 (1.99) 0.61 2.13 1.67 0.21
(Losses)/earnings per share for (loss)/
profit from discontinued operations
attributable to shareholders of the Company
for the year........................
Basic losses/(earnings) per share... - - (0.13) (0.03) 0.27 0.03
Diluted losses/(earnings) per share. - - (0.13) (0.03) 0.27 0.03
Earnings/(losses) per share from operations
attributable to shareholders of the Company
for the year .......................
Basic earnings/(losses) per share... 1.21 (1.99) 0.48 2.11 1.95 0.25
Diluted earnings/(losses) per share. 1.21 (1.99) 0.48 2.10 1.94 0.25
Basic earnings/(losses) per ADS .... 24.2 (39.8) 9.6 42.2 39 5.00
Diluted earnings/(losses) per ADS .. 24.2 (39.8) 9.6 42 38.8 4.97
U.S. GAAP
Profit/(loss) for the year/period .. 6,572 6,365 7,932 10,465 10,886 1,394
-Continuing operations............ 6,572 6,365 8,643 10,691 9,067 1,161
-Discontinued operations.......... - - (711) (226) 1,819 233
Basic earnings/(losses) per share(5) 1.2 1.16 1.41 1.59 1.64 0.21
-Continuing operations............ 1.2 1.16 1.54 1.62 1.37 0.18
-Discontinued operations.......... 0 0 (0.13) (0.03) 0.27 0.04
Diluted earnings/(losses) per share(5) 1.19 1.16 1.41 1.58 1.63 0.21
-Continuing operations............ 1.19 1.16 1.54 1.61 1.36 0.17
-Discontinued operations.......... 0 0 (0.13) (0.03) 0.27 0.03
Basic earnings/(losses) per ADS..... 24 23.2 28.2 31.8 32.8 4.23
-Continuing operations............ 24 23.2 30.8 32.4 27.4 3.51
-Discontinued operations.......... 0 0 (2.6) (0.6) 5.4 0.72
Diluted earnings per ADS(6)......... 23.8 23.2 28.2 31.6 32.6 4.17
-Continuing operations............ 23.8 23.2 30.8 32.2 27.2 3.48
-Discontinued operations.......... 0 0 (2.6) (0.6) 5.4 0.69
Dividend declared per share ........ - - HKD0.04 HKD0.47 HKD0.55 USD0.07
------------------------------------------------------------------------
Dividend declared per ADS........... - - HKD0.74 HKD9.32 HKD11.06 USD1.42
------------------------------------------------------------------------
________________________
(1) Revenues from fixed-line telephone services included local usage fees,
monthly fees, upfront installation fees, domestic and international long
distance service charges, value-added service charges, interconnection fees
from domestic carriers and upfront connection fees.
(2) Revenues from business and data communications services include fees
charged for managed data and leased line services.
(3) See "Item. 5. Operating and Financial Review and Prospects - Critical
Accounting Policies - Revaluation of fixed assets" for a discussion of this
revaluation.
5
(4) Revenue of Asia Netcom, the major source of revenue of our international
telecommunication services, has been separately disclosed as discontinued
operations for the years ended December 31, 2004 and 2005.
(5) Basic/diluted earnings/(losses) per share for the years ended December 31,
2002, 2003, 2004, 2005 and 2006 set forth above have been computed by
dividing profit/(loss) for each of the year by the weighted average number
of ordinary shares during the year.
(6) Basic/diluted earnings/(losses) per ADS for the years ended December 31,
2002, 2003, 2004, 2005 and 2006 set forth above have computed by
multiplying basic earnings/(losses) per share for the year by 20, which is
the number of ordinary shares represented by each ADS.
As of December 31,
-----------------------------------------------------------------------
2002 2003 2004 2005 2006 2006
-----------------------------------------------------------------------
(RMB) (RMB) (RMB) (RMB) (RMB) (USD)
(in millions)
Consolidated Balance Sheet Data:
HKFRS
Cash and bank deposits ............. 7,899 7,430 10,633 4,895 7,571 970
Accounts receivable ............... 5,896 7,518 7,174 7,401 8,283 1,061
Total current assets .............. 20,780 20,666 24,455 14,499 18,059 2,313
Fixed assets and construction in progress 212,053 199,687 177,494 175,485 174,399 22,334
Total assets ...................... 245,281 236,081 216,417 202,840 203,835 26,104
Accounts payable .................. 18,934 20,195 21,125 16,719 17,654 2,261
Short-term bank loans and current portion of
long-term bank and other loans .... 57,126 67,383 56,609 54,187 38,284 4,902
Total current liabilities ......... 97,017 118,350 106,044 98,399 90,802 11,629
Long-term bank and other loans .... 40,404 30,172 26,052 18,143 23,219 2,973
Deferred revenues ................. 19,744 17,585 13,988 10,925 6,198 794
Total liabilities ................. 175,510 182,419 151,822 139,830 129,857 16,630
Owner's equity .................... 69,767 53,659 64,595 63,010 73,978 9,474
U.S. GAAP
Fixed assets and construction in progress 212,053 222,483 204,216 197,097 191,845 24,568
Total assets ...................... 245,281 258,877 243,139 224,452 221,281 28,338
Owner's equity...................... 67,116 66,283 82,664 77,490 85,912 11,002
For the Years Ended December 31,
-----------------------------------------------------------------------
2002 2003 2004 2005 2006 2006
-----------------------------------------------------------------------
(Restated) (Restated)
(RMB) (RMB) (RMB) (RMB) (RMB) (USD)
(in millions)
Consolidated Cash Flow Statement Data:
HKFRS
Continuing operations:
Net cash inflow from operating
activities. 30,012 30,917 34,127 33,483 33,950 4,348
Net cash outflow from investing activities. (34,219) (34,875) (28,474) (24,296) (25,973) (3,326)
Purchase of fixed assets and construction
in progress, repayments for leased land (34,186) (36,450) (28,027) (27,247) (26,474) (3,390)
Net cash inflow/(outflow) from financing
activities 3,212 3,595 (2,246) (14,764) (6,447) (826)
6
Discontinued operations:
Net outflow/(inflow) from operating
activities - - (474) 74 183 23
Net cash outflow/(inflow) from investing
activities - - (228) (312) 982 126
Net cash inflow from financing
activities. - - 503 108 - -
Decrease/(increase) in cash and cash
equivalents (995) (363) 3,208 (5,707) 2,695 345
EXCHANGE RATE INFORMATION
We prepare our financial statements in Renminbi. Translations of
amounts from Renminbi and Hong Kong dollar into U.S. dollars, and vice versa,
are solely for the convenience of the reader. Unless otherwise indicated, any
translations from Renminbi to US dollars or from US dollars to Renminbi were
translated at the average rate announced by the People's Bank of China (the
"PBOC Rate") on December 29, 2006 at RMB 7.8087 = US$1.00 and translations from
Hong Kong dollars to US dollars or from US dollars to Hong Kong dollars were
translated at HK$7.7771 = US$1.00, the noon buying rate on December 29, 2006 in
the City of New York for cable transfers as certified for customs purposes by
the Federal Reserve Bank of New York. You should not assume that Renminbi and
Hong Kong dollar amounts could actually be converted into U.S. dollars at these
rates or at all.
On April 30, 2007, the latest practicable date, the PBOC Rate was RMB
7.7055 = US$1.00 and the noon buying rate in the City of New York for cable
transfers as certified for customs purposes by the Federal Reserve Bank of New
York was HK$7.8212 = US$1.00.
The following table sets forth the high and low noon buying rates in
the City of New York for cable transfers as certified for customs purposes by
the Federal Reserve Bank of New York between Renminbi and U.S. dollars and
between Hong Kong dollars and U.S. dollars for each of the periods shown.
Noon Buying Rate
-----------------------------------------
RMB per US$ HK$ per US$
-----------------------------------------
High Low High Low
-----------------------------------------
November 2006................... 7.8750 7.8303 7.7875 7.7751
December 2006................... 7.8350 7.8041 7.7787 7.7665
January 2007.................... 7.8127 7.7705 7.8112 7.7885
February 2007................... 7.7632 7.7410 7.8141 7.8041
March 2007...................... 7.7454 7.7232 7.8177 7.8093
April 2007...................... 7.7345 7.7090 7.8155 7.8095
The following table sets forth the period-end noon buying rates and the
average noon buying rates in the City of New York for cable transfers as
certified for customs purposes by the Federal Reserve Bank of New York between
Renminbi and U.S. dollars and between Hong Kong dollars and U.S. dollars for
each of 2002, 2003, 2004, 2005, 2006 and 2007 (through April 30). The average
noon buying rates for the periods shown are calculated by averaging the noon
buying rates on the last day of each month in the period.
Period-End Noon Buying Rate Average(1) Noon Buying Rate
--------------------------- ---------------------------
RMB per US$ HK$ per US$ RMB per US$ HK$ per US$
--------------------------- ---------------------------
2002................... 8.2800 7.7988 8.2772 7.7996
2003................... 8.2767 7.7640 8.2771 7.7864
2004................... 8.2765 7.7723 8.2768 7.7899
2005................... 8.0702 7.7533 8.1826 7.7755
2006................... 7.8041 7.7771 7.9723 7.7685
2007 (up to
April 30, 2007)...... 7.7090 7.8212 7.7497 7.8100
---------------------
(1) Determined by averaging the rates on the last business day of each month
during the relevant year, except for the average rate of the relevant
periods in 2007, which is determined by averaging the daily rates during the
respective periods.
7
CAPITALIZATION AND INDEBTEDNESS
Not applicable.
REASONS FOR THE OFFER AND USE OF PROCEEDS
Not applicable.
RISK FACTORS
Risks Relating to Our Business
INCREASING COMPETITION MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS GROWTH AND
FINANCIAL CONDITION.
The telecommunications industry in China is rapidly evolving. In recent
years, the central government has implemented a number of measures to
restructure, and encourage fair and orderly competition in the
telecommunications industry. As a result, we face increasing competition from
other licensed telecommunications operators in China, including China Telecom
Group, or China Telecom; China Mobile Communications Corporation, or China
Mobile; China United Telecommunications Corporation, or China Unicom; China
Railway Communications Corporation Limited, or China Railcom; and China
Satellite Communications Corporation, or China Satcom. We expect our competitors
to further expand their network coverage and increase their sales and marketing
efforts in our northern service regions. We will also face competition from
foreign-invested telecommunications operators as a result of China's accession
into the World Trade Organization, or the WTO, and the entry of foreign
telecommunications companies into the Chinese market. As we operate in an
increasingly competitive market, we have experienced and may continue to
experience pressure on operating revenues and operating margins for some of our
telecommunications services.
COMPETITION IN OUR SERVICES MAY RESULT IN LOWER TARIFFS, A SMALLER CUSTOMER BASE
AND LOWER USAGE FOR OUR SERVICES, THEREBY ADVERSELY AFFECTING OUR BUSINESS
GROWTH AND FINANCIAL CONDITION.
We compete with other fixed-line service providers, including China
Telecom, China Unicom and China Railcom, each of which has been licensed to
provide fixed-line telephone services. We have experienced limited competition
from other fixed-line service providers to date in the market for local
telephone services, primarily because our competitors have not built significant
local fixed-line access infrastructure. However, competition for the provision
of these services may increase in the future as our competitors develop their
own networks, including through the use of alternative technologies. In the
markets for domestic and international long distance telephone services, we face
strong competition from voice over Internet protocol, or VoIP services, provided
by China Telecom, China Mobile, China Unicom and China Railcom. Tariffs for VoIP
services are market-based and therefore not subject to minimum pricing
restriction. In addition, we face increasing competition from Internet phone
service providers such as Skype and Vonage. This competition may become more
severe if current restrictions on the provision of these services are
liberalized. Increased competition from these operators may force us to lower
our tariffs or may reduce the size of our customer base and the usage of our
networks. Any of these developments may materially adversely affect our business
growth and financial condition.
Mobile service substitution for our fixed-line telephone services has
also created considerable competition in the markets for local and long distance
telephone services. Consistent with trends in global markets in recent years, an
increasing proportion of total voice traffic is being carried by mobile
networks. Currently, China Mobile and China Unicom are the only licensed
providers of mobile communications services in China and, in recent years,
significant traffic from our fixed-line networks has been diverted to the
networks of these two companies. In 2006, mobile substitution accelerated as a
result of stronger pricing pressure from mobile operators, which increasingly
lowered tariffs through various discount programs. The usage volume of local
calls in our service regions decreased to 217.27 billion pulses in 2006 from
228.44 billion pulses in 2005, mainly due to migration of our local voice
traffic to mobile services. Mobile operators may further reduce tariffs for
mobile services, which may result in further migration from fixed-line services
to mobile services.
8
For managed data services and broadband Internet access services, or
broadband services, we primarily compete with China Unicom, China Telecom, China
Railcom and other broadband Internet access service providers such as Beijing
Gehua CATV Network Co., Ltd. on the basis of pricing, the coverage and quality
of networks, ability to provide end-to-end connectivity, quality of network
management and customer service. While other major telecommunications operators
in China have been leasing transport facilities from us to serve their
customers, some of them, such as China Mobile and China Unicom, have in recent
years begun to build their own long distance networks for voice services and
fiber-optic networks for data services. Increased competition from these
domestic telecommunications providers may result in lower revenues for us due to
competitive pricing policies and increased sales and marketing costs to attract
or retain subscribers. We are a major broadband Internet access service provider
in our northern service region and have a leading market position. Our broadband
Internet access services will face more competition and we may lose market share
if cable television companies and other broadband service providers enhance
their network and promotion of their broadband Internet access services.
We began offering information and communication technology services in
2006. Our major competitors for such services are other telecommunication
operators such as China Telecom, and system integration service providers such
as Digital China Holdings Limited and Taiji Computer Corporation Limited. We may
lack experience in providing information and communication technology services
and may not have qualified personnel with relevant experiences and skills
because we began offering information and communication technology services in
2006. As a result, we may not be able to effectively compete against our
competitors.
COMPETITION FROM FOREIGN-INVESTED OPERATORS AND OTHER NEW ENTRANTS MAY FURTHER
INCREASE THE COMPETITION FOR EMPLOYEES, EXACERBATE PRICE COMPETITION AND
INCREASE OUR OPERATING EXPENSES, THEREBY ADVERSELY AFFECTING OUR FINANCIAL
CONDITION AND GROWTH PROSPECTS.
As a result of China's accession to the WTO in December 2001, and the
adoption of the Regulations on the Administration of Foreign-Invested
Telecommunications Enterprises in January 2002, which implement China's
commitments to the WTO, the PRC government has agreed to gradually liberalize
the various segments and regions of the telecommunications market in China to
foreign investors. Beginning on December 2, 2007, foreign investors are
permitted to increase their ownership of fixed-line telecommunication operators
that provide domestic and international voice, packet-switched and
circuit-switched data transmission and other services to not more than 49%. More
foreign-invested operators may enter China's telecommunications market as a
result of this liberalization. They may have greater financial, managerial and
technical resources and more expertise in network management and sales and
marketing than we do.
Increased competition from these and other new entrants into the
Chinese telecommunications market may further increase the competition for
skilled and experienced employees, exacerbate price competition and increase our
customer acquisition costs and other operating expenses, and thereby adversely
affect our financial condition and growth prospects.
COMPETITION FROM ALTERNATIVE TECHNOLOGIES TO OUR PHS BUSINESS AND AN
INTRODUCTION OF TD-SCDMA TECHNOLOGY MAY CAUSE OUR PHS SERVICES TO BE LESS
COMPETITIVE, AND ADVERSELY AFFECT OUR GROWTH PROSPECTS AND REVENUES.
We currently provide personal handyphone system, or PHS, services to
reduce the impact of mobile substitution on our fixed-line operations. PHS is a
telecommunications technology that allows us to offer to our customers wireless
local access services with mobility within an area with the same area code. Our
ability to realize acceptable returns from our investment in PHS technology will
depend on continued customer adoption of this technology. However, this market
may not continue to develop, since potential customers are and will be able to
choose from a variety of alternative fixed-line and wireless communication
technologies, including both existing technologies and new technologies to be
offered in the future, such as third generation, or 3G mobile telephone
services. For instance, if China Mobile or China Unicom reduces the tariffs for
mobile telecommunications services, our existing and potential PHS customers may
choose to use these services instead of our PHS services to take advantage of
the less geographically restricted service scope and other features of mobile
technology. In addition, more mobile licenses may be issued in the near future,
which will increase the level of competition in the provision
9
of mobile telephone services, which will in turn increase pricing pressure and
adversely affect the growth prospects of our PHS services. Furthermore, if we
introduce 3G mobile telephone services, traffic on our PHS services may migrate
to our 3G services, thereby materially and adversely affect the growth prospects
of our PHS services.
Furthermore, part of the radio spectrum currently used by our PHS
services may be reallocated by the PRC government to time division
synchronization code division multiple access technology, or TD-SCDMA
technology, which is one of the three technologies adopted by the International
Telecommunications Union and is under review by the PRC government for use in
providing 3G mobile telephone services. The PRC government is currently
conducting tests on TD-SCDMA related products. The PRC government has not
officially announced its decisions on issues such as the timing of the grant of
the 3G licenses, the number of 3G licenses to be granted, any technical
requirements, or any selection of preferred technologies. If TD-SCDMA technology
is introduced, our ability to use the existing PHS spectrum may be restricted,
thereby limiting the volume of usage we can handle and adversely affecting our
revenues.
Any of the risks described above may cause our PHS services to become
less competitive and thereby materially and adversely affect our growth
prospects and revenues.
BECAUSE WE RELY ON CERTAIN ARRANGEMENTS WITH OTHER TELECOMMUNICATIONS OPERATORS,
CHANGES TO THE TERMS OR AVAILABILITY OF THESE ARRANGEMENTS MAY RESULT IN
DISRUPTIONS TO OUR SERVICES AND OPERATIONS.
Our ability to provide telecommunications services depends upon certain
arrangements with other telecommunications operators. In particular,
interconnection is necessary to complete all calls between our subscribers and
subscribers of other telecommunications operators. We, either through ourselves
or through China Netcom Group, have entered into interconnection and
transmission line leasing agreements with other fixed-line operators, including
our parent company, China Netcom Group, mobile telephone operators and other
telecommunications providers, as required to conduct our current business. Any
disruption to our interconnection with the networks of those operators or other
international telecommunications carriers with which we interconnect due to
technical or competitive reasons may affect our operations, service quality and
customer satisfaction, thus adversely affecting our business. Furthermore, we
are generally not entitled to collect indirect or consequential damages
resulting from disruptions in the networks to which we are interconnected. Our
failure to renew our existing interconnection and leased line agreements on
commercially acceptable terms may result in disruptions to our services. If we
are unable to enter into arrangements with such operators in a timely manner or
on acceptable terms, it may result in a delay in providing services to our
customers and disrupt our operations, as we may need to seek alternative
arrangements with other operators, which may adversely affect our financial
condition and our results of operations.
DISRUPTIONS TO OUR NETWORK OR OPERATING SYSTEMS, OR TO THOSE WITH WHICH WE
INTERCONNECT, MAY RESULT IN CUSTOMER DISSATISFACTION AND REDUCED REVENUES FROM
OPERATIONS.
Our network infrastructure and the networks with which we interconnect
are vulnerable to potential damage or interruption from floods, wind, storms,
fires, power loss, severed cables, acts of terrorism and similar events. Our
networks and systems and the networks with which we interconnect also require
regular maintenance and upgrades that may cause service disruptions. The
occurrence of a natural disaster or other unanticipated problems at our
facilities or any other failure of our networks or systems, or the networks to
which we are interconnected, may result in consequential interruptions in
services across our telecommunications infrastructure. Network or system
failures, as well as high traffic volumes, may also affect the quality of our
services and cause temporary service interruptions. Although we have not
experienced material disruptions or damage to our network and operating systems
in the past, any such future occurrence may result in customer dissatisfaction
and reduced revenues from operations.
10
FAILURE TO SUCCESSFULLY RESPOND TO TECHNOLOGICAL AND INDUSTRY DEVELOPMENTS MAY
HINDER OUR REVENUE GROWTH AND ADVERSELY AFFECT OUR COMPETITIVE POSITION.
The telecommunications sector has recently experienced rapid increases
in the diversity and sophistication of the technologies and services offered. As
a result, we expect that we will need to constantly upgrade our
telecommunications technologies and services in order to respond to competitive
industry conditions and customer requirements. For example, the next generation
network has the capability of providing new value-added services and content
that combine voice, data and images with increased efficiency and flexibility.
Next generation networks may replace the traditional public switched telephone
networks in the future. We have not experienced significant difficulties in
upgrading new technologies and equipment in the past, but if we fail to smoothly
upgrade or achieve a balanced transition of our existing network to the next
generation network, we may lose our customers and market share, which may
adversely affect our operations and financial condition. Furthermore, if the new
technologies adopted by us do not perform as expected, or if we are unable to
effectively deliver new services based on these technologies in a commercially
viable manner, our revenue growth may decline and our competitive position may
be adversely affected.
IF WE FAIL TO SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGIES, WE MAY NOT ACHIEVE
ACCEPTABLE INVESTMENT RETURNS OR MANAGE GROWTH IN CERTAIN SERVICES AND MARKETS,
AND OUR FINANCIAL CONDITION MAY BE ADVERSELY AFFECTED.
We may not be able to successfully implement all of our business
strategies. For example, we have made substantial investments in developing our
broadband network infrastructure and technology. However, the broadband market
in China may not continue to expand at recent rates of growth, and we may not be
able to attract enough customers and generate sufficient usage to achieve an
acceptable return on our significant broadband investment. Failure to
successfully implement our business strategies may adversely affect our
financial condition.
WE RELY SUBSTANTIALLY ON SHORT-TERM BORROWINGS AND OUR INABILITY TO OBTAIN
SUFFICIENT FUNDING MAY ADVERSELY AFFECT OUR LIQUIDITY AND FINANCIAL CONDITION.
Similar to many enterprises in China, a significant percentage of our
funding requirements is satisfied through short-term borrowings. As of December
31, 2005 and 2006, our short-term bank loans, short-term commercial paper and
the current portion of our long-term bank and other borrowings were RMB 56,147
million and RMB 50,055 million, respectively, representing 68.4% and 63.2% of
the sum of total long-term and short-term bank loans and other borrowings as of
the respective dates. Although, in our experience, a substantial portion of our
short-term borrowings is rolled over upon maturity and these borrowings have
been, in the past, a stable source of funding, no assurances can be given that
this will continue to be the case. If our lenders do not roll over our
short-term borrowings, or if we are unable to secure sufficient borrowings, our
liquidity position would be adversely affected, and we may be required to seek
more expensive sources of short-term or long-term funding to finance our
operations. In addition, implementing our strategies may require substantial
capital expenditures. To the extent these expenditures exceed our cash
resources, we will be required to seek additional debt or equity financing. If
we are unable to obtain sufficient funding for our operations or development
plans on commercially acceptable terms, or at all, our liquidity and financial
condition may be adversely affected.
OUR ULTIMATE CONTROLLING SHAREHOLDER, CHINA NETCOM GROUP, MAY CAUSE US TO ENTER
INTO TRANSACTIONS OR TAKE (OR FAIL TO TAKE) OTHER ACTIONS OR MAKE DECISIONS THAT
CONFLICT WITH THE BEST INTERESTS OF OUR OTHER SHAREHOLDERS.
As of April 30, 2007, China Netcom Group beneficially owned
approximately 69.88% of our outstanding shares. As a result, China Netcom Group,
subject to our articles of association and applicable laws and regulations, will
effectively be able to control our management, policies and business by
controlling the composition of our board of directors, determining the timing
and amount of our dividend payments, approving significant corporate
transactions, including mergers and acquisitions, and approving our annual
budgets. Therefore, China Netcom Group may cause us to enter into transactions
or take (or fail to take) other actions or make decisions that conflict with the
best interests of our other shareholders.
11
WE RELY ON CHINA NETCOM GROUP TO PROVIDE CERTAIN SERVICES AND FACILITIES FOR
WHICH WE CURRENTLY HAVE LIMITED ALTERNATIVE SOURCES OF SUPPLY. CHANGES IN THE
AVAILABILITY, PRICING OR QUALITY OF THESE SERVICES OR FACILITIES MAY HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND PROFITABILITY.
Pursuant to various agreements and arrangements, China Netcom Group
provides us with services and facilities necessary for our business activities,
including but not limited to, the use of fiber-optic networks in our northern
service regions, international gateways, leases for properties located in our
northern service regions.
The interests of China Netcom Group as provider of these services and
facilities may conflict with our interests. We currently have limited
alternative sources of supply for these services and facilities and, as a
result, may have limited ability to negotiate with China Netcom Group regarding
the terms for providing these services and facilities. Changes in the
availability, pricing or quality of these services or facilities may have a
material adverse effect on our business and profitability.
FAILURE BY CHINA NETCOM GROUP TO FULFILL ITS OBLIGATIONS UNDER CERTAIN EXISTING
ARRANGEMENTS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS OPERATIONS,
GROWTH PROSPECTS AND PROFITABILITY.
China Netcom Group has committed to certain arrangements to support our
existing operations and future development, including through a letter of
undertakings, a non-competition agreement and a restructuring agreement. In the
letter of undertakings, China Netcom Group agreed to, among other things, extend
its full support to our current operations and future developments. China Netcom
Group has also entered into a non-competition agreement whereby China Netcom
Group has agreed not to compete with us in our service regions and our
international markets without our consent. In addition, under a restructuring
agreement, China Netcom Group agreed to indemnify CNC China and us for losses
arising from certain matters. Failure by China Netcom Group to fulfill its
obligations under any of these arrangements may have a material adverse effect
on our business operations, growth prospects and profitability.
THE PRC NATIONAL AUDIT OFFICE AND OTHER GOVERNMENTAL OR THIRD PARTIES MAY AUDIT
OR INVESTIGATE OUR ULTIMATE CONTROLLING SHAREHOLDER AND US FROM TIME TO TIME.
THE OUTCOME OF THESE GOVERNMENTAL OR THIRD PARTY INVESTIGATIONS MAY ADVERSELY
AFFECT OUR CORPORATE IMAGE, THE REPUTATION AND CREDIBILITY OF OUR MANAGEMENT,
OUR BUSINESS AND FINANCIAL CONDITION AND THE PRICES OF OUR SHARES AND ADSS.
PRC's National Audit Office, or the NAO, from time to time performs
audits on state-owned companies, such as China Netcom Group, our ultimate
controlling shareholder. If, as a result of an NAO audit, material
irregularities are found within China Netcom Group or China Netcom Group becomes
the target of any negative publicity, there would be a material adverse effect
on our corporate image, the reputation and credibility of our management, our
business and financial condition and the prices of our shares and ADSs. In
addition, we may be the subject of other governmental or third party
investigations or similar events that, depending on their outcome, could have a
material adverse effect on our business and financial condition and the prices
of our shares and ADSs.
Risks Relating to the PRC Telecommunications Industry
EXTENSIVE GOVERNMENT REGULATION OF THE TELECOMMUNICATIONS INDUSTRY IN CHINA MAY
RESTRICT OUR ABILITY TO RESPOND TO MARKET CONDITIONS OR COMPETITION, AND MAY
HAVE A MATERIAL ADVERSE EFFECT ON OUR OPERATIONS, BUSINESS AND FINANCIAL
CONDITION.
As a telecommunications operator in China, we are subject to extensive
regulation by and under the supervision of the MII, which is the primary
telecommunications industry regulator in China. The MII is responsible for
formulating policies and regulations for the telecommunications industry,
granting telecommunications licenses, allocating frequency spectrum and numbers,
formulating interconnection and settlement arrangements between
telecommunications operators, and enforcing industry regulations. Other PRC
governmental authorities also regulate tariff policies, capital investment and
foreign investment in the telecommunications industry. See "Item 4. Information
on the Company -- Regulation." The regulatory framework within which we operate
may constrain our ability to implement our business strategies and limit our
ability to respond to market conditions or to changes in our
12
cost structure. Moreover, we operate our businesses pursuant to approvals
granted by the State Council and under licenses granted by the MII. If these
approvals or licenses were revoked or suspended, our business and operations
would be materially and adversely affected. In addition, we are subject to
various regulatory requirements as to service quality, pricing and other
actions, and failure to comply with such requirements may subject us to
mandatory penalties or other punitive measures, any of which could have a
material adverse effect on our operations and financial condition.
In addition, some of our competitors, such as China Unicom and China
Railcom, enjoy preferential treatment from the PRC government with respect to
tariff setting. These companies are currently permitted to set their respective
tariffs for certain services, such as long distance calls over the public
switched telephone network, or the traditional network, at price levels above or
below the government fixed tariffs on a long-term basis, subject to filings
with, and approvals from, the relevant regulatory authorities. This preferential
treatment is not available to us. Our competitors who enjoy this preferential
treatment may be able to provide certain services at prices that are more
competitive than our prices, and our business and financial condition may be
adversely affected as a result.
FUTURE CHANGES TO THE REGULATIONS AND POLICIES GOVERNING THE TELECOMMUNICATIONS
INDUSTRY IN CHINA, INCLUDING POSSIBLE FUTURE INDUSTRY RESTRUCTURINGS, MAY HAVE A
MATERIAL ADVERSE EFFECT ON OUR BUSINESSES.
Possible future changes to regulations and policies governing the
telecommunications industry in China may have a material adverse effect on our
businesses and operations. As part of the comprehensive plan to restructure the
telecommunications industry in China, as approved by the State Council in 2001,
the central government stated its intention to further adjust and improve its
regulatory oversight of the telecommunications industry, including gradual
further deregulation of telecommunications tariffs.
The Ministry of Information Industry, or the MII, under the direction
of the State Council, is currently preparing a telecommunications law to provide
a uniform regulatory framework for the telecommunications industry. If and when
the telecommunications law is adopted by the National People's Congress, it will
provide a new framework for telecommunications regulations in China. The
proposed nature and scope of the telecommunications law have not yet been
announced by the PRC government. The telecommunications law and other new
telecommunications regulations or rules, or future changes thereto, such as
enforcement of existing regulations and policies, may materially and adversely
affect our business and financial condition.
Issues may also arise regarding the interpretation and enforcement of
China's WTO commitments regarding telecommunications services, which may affect
telecommunications regulations and the telecommunications industry in China. Any
future regulatory changes, such as those relating to the issuance of additional
telecommunications licenses, tariff setting, interconnection and settlement
arrangements, changes in technical and service standards, universal service
obligations and spectrum and number allocations, may have a material adverse
effect on our business and operations.
The PRC government may issue additional mobile telecommunications
licenses in the future. The timing of issuance and terms of these licenses, if
any, have not yet been announced. We cannot assure you that we will be able to
obtain a mobile license. In addition, if we do obtain a mobile license, we
cannot assure you that we will have sufficient resources to establish mobile
operations or that our mobile operations will generate satisfactory returns for
our shareholders. The issuance of additional licenses would also increase the
competition we face.
The PRC telecommunications industry has been extensively restructured
in recent years and may be subject to further restructuring. Such further
industry restructuring may materially affect the operations of all
telecommunications operators in China, including us. Accordingly, we cannot
predict the scope and effect of any further restructuring on our operations.
13
NEW REGULATIONS, REGULATORY CHANGES OR CHANGES IN ENFORCEMENT POLICIES RELATING
TO TELECOMMUNICATIONS TARIFFS MAY ADVERSELY AFFECT OUR COMPETITIVENESS, BUSINESS
AND PROFITABILITY.
Tariffs are the prices we charge our customers for our
telecommunications services. We are subject to extensive government regulations
on tariffs, especially those relating to our basic telecommunications services,
such as local and long distance fixed-line telephone services, managed data
services, leased line services and interconnection agreements. The relevant
provincial telecommunications administrations and provincial price bureaus
currently determine the monthly fees and usage fees for our fixed-line local
telephone services based on a fixed tariff set by the MII in consultation with
the National Development and Reform Commission, or NDRC. The MII and the NDRC
jointly set tariffs for all long distance services using the traditional
network, leased lines and data services. We derive a substantial portion of our
revenues from services that are subject to tariffs determined by the PRC
government. In the past, our revenues have been adversely affected by reductions
in tariffs mandated by the PRC government.
In 2002, the MII indicated in writing that it did not intend to
initiate any adjustment to tariffs for local fixed-line telephone services
during the three to five years commencing in September 2002. However, we cannot
predict with accuracy the timing, likelihood or magnitude of tariff adjustments
or the extent or potential impact on our business of future tariff adjustments.
If the government substantially lowers the tariffs for local fixed-line
telephone services, our business and profitability may be adversely affected. In
particular, monthly fees on fixed-line services have recently drawn attention
from customers and the government. Revenues from some of our customers have
decreased as a result of discounts on monthly fees that we offered through
bundled service packages. Our revenues will be adversely affected if the
government abolishes such monthly fees.
In addition, the tariffs for some of our services in certain locations
have been set at levels above or below the levels mandated by the government.
The MII may order us to adjust these tariffs and may impose fines on us for
repeated failures to comply with the mandated tariff levels for these services,
or even suspend our business where the situation becomes serious, as determined
at the discretion of the MII. According to a regulatory circular issued by the
MII, the MII reaffirmed its intention to strictly enforce these minimum tariff
levels. In addition, such enforcement may be undertaken in a selective manner.
The enforcement of such tariff levels and the imposition of fines or other
penalties, whether done on a selective or industry-wide basis, may materially
and adversely affect our competitiveness and, consequently, our business and
profitability.
The PRC government may promulgate new regulations to abolish fees on
mobile service incoming calls, which will accelerate mobile substitution of our
fixed-line services. In addition, as a result of the growth in customer base of
mobile services and the reduction in tariffs, voice traffic originated from
fixed-line networks to mobile networks has exceeded that originated from mobile
networks to fixed-line networks. Furthermore, new regulations may require us to
pay interconnections fees to mobile operators for calls originating from our
networks that are terminated on their networks. Interconnection fees that we
earn from mobile operators may decrease and may be exceeded by those that they
earn from us.
THE PRC GOVERNMENT MAY REQUIRE MAJOR OPERATORS, INCLUDING US, TO PROVIDE
UNIVERSAL SERVICES WITH SPECIFIED OBLIGATIONS, AND WE MAY NOT BE COMPENSATED
ADEQUATELY FOR PROVIDING SUCH SERVICES.
Under the Telecommunications Regulations, as promulgated by the State
Council on September 25, 2000, telecommunications operators in China are
required to fulfill universal service obligations in accordance with relevant
regulations to be promulgated by the PRC government, and the MII has the
authority to delineate the scope of universal service obligations. The MII,
together with governmental finance and pricing authorities, is also responsible
for formulating administrative rules relating to the establishment of a
universal service fund and compensation schemes for universal services. These
rules have not yet been promulgated, and there are currently no specific
regulatory requirements relating to the provision of universal services in
China.
14
While the scope of specific universal services obligations is not yet
clear, we believe that such services may include mandatory provision of basic
telecommunications services in less economically developed areas in China. We
may not be adequately compensated by the government or be able to realize an
adequate return on investments for expanding networks to, and providing
telecommunications services in, those less economically developed areas due to
potentially higher capital expenditure requirements, lower usage by customers
and lack of flexibility in setting our tariffs.
The MII requires China Telecom, China Netcom Group, China Mobile, China
Unicom, China Railcom and China Satcom to participate in a project to provide
telephone services in a number of remote villages in China as transitional
measures prior to the formalization of a universal service obligation framework.
In order to fulfill such obligations under these transitional measures, China
Netcom Group has agreed with us that it will assume the responsibility for
investing in and constructing the necessary network facilities. If we operate
and maintain such network facilities in our northern service regions, China
Netcom Group has agreed to compensate us for the related expenses based on their
fair market value. However, China Netcom Group may fail to fulfill its
obligations under this project, and we may not be adequately compensated by
China Netcom Group for the cost and expenses resulting from our operation and
maintenance of any such network. Either of these events may adversely affect our
financial condition.
Risks Relating to China
OUR OPERATIONS MAY BE ADVERSELY AFFECTED BY CHINA'S ECONOMIC, POLITICAL AND
SOCIAL CONDITIONS.
Most of our assets are located in China and most of our revenues are
derived from our operations in China. Accordingly, our results of operations and
prospects are subject, to a significant extent, to economic, political and
social developments in China. In particular, our operating results may be
adversely affected by:
o changes in China's political, economic and social conditions;
o changes in policies of the government or changes in laws and
regulations, or the interpretation of laws and regulations;
o changes in foreign exchange regulations;
o measures that may be introduced to control inflation, such as
interest rate increases; and
o changes in the rate or method of taxation.
The Chinese economy has historically been a planned economy. The
majority of productive assets in China is still owned by various levels of the
PRC government. In recent years the government has implemented economic reform
measures emphasizing decentralization, utilization of market forces in the
development of the economy and a high level of management autonomy. Such
economic reform measures may be inconsistent or ineffectual, and we may not
benefit from all such reforms. Furthermore, these measures may be adjusted or
modified, possibly resulting in such economic liberalization measures being
applied inconsistently from industry to industry, or across different regions of
the country.
In the past twenty years, China has been one of the world's fastest
growing economies in gross domestic product, or GDP. We cannot assure you that
such growth will be sustained in the future. Moreover, a slowdown in the
economies of the United States, the European Union and certain Asian countries
may adversely affect economic growth in China. Our financial condition and
results of operations, as well as our future prospects, would be materially and
adversely affected by an economic downturn in China.
Economic growth in China has also historically been accompanied by
periods of high inflation. The government has implemented various policies from
time to time to control the rate of economic growth, limit
15
inflation and otherwise regulate economic expansion. Some of these measures
benefit the overall economy of China, but may also have a negative effect on us.
For example, our operating results and financial condition may be adversely
affected by government control over capital investments or by changes in the tax
regulations applicable to us.
THE PRC LEGAL SYSTEM HAS INHERENT UNCERTAINTIES THAT MAY LIMIT THE LEGAL
PROTECTIONS AVAILABLE TO YOU AS AN INVESTOR OR TO US IN THE EVENT OF ANY CLAIMS
OR DISPUTES WITH THIRD PARTIES.
The Chinese legal system is based on written statutes. Prior court
decisions may be cited for reference but have limited precedential value. Since
1979, the central government has promulgated laws and regulations dealing with
economic matters such as foreign investment, corporate organization and
governance, commerce, taxation and trade. In particular, legislation since 1979
has significantly enhanced the protections afforded to various forms of foreign
investment in China. CNC China, our primary operating subsidiary, was
incorporated in China as a "wholly foreign-owned enterprise." Although we are
the sole shareholder of, and therefore have full control over, CNC China, the
exercise of our shareholder rights in CNC China are subject to its articles of
association and PRC laws applicable to foreign investment enterprises in China,
which may be different from the laws of the United States. As Chinese foreign
investment laws and regulations are relatively new and the Chinese legal system
is still evolving, the interpretations of many laws, regulations and rules are
not always uniform and enforcement of these laws, regulations and rules involve
uncertainties, which may limit the remedies available to you as an investor and
to us in the event of any claims or disputes with third parties. In addition,
any litigation in China may be protracted and result in substantial costs and
diversion of resources and management attention.
SINCE WE ARE A HONG KONG COMPANY, YOU WILL NOT HAVE CERTAIN INVESTOR RIGHTS AS
OUR SHAREHOLDER, SUCH AS THE RIGHT TO BRING LEGAL ACTION AGAINST OTHER
SHAREHOLDERS ON BEHALF OF THE COMPANY.
We were incorporated in Hong Kong. Under the Company Ordinance of Hong
Kong, any of our shareholders, including our controlling shareholder China
Netcom Group Corporation (BVI) Limited, or CNC BVI, do not have the right to
bring legal action against any other shareholder on our behalf to enforce any
claim against such party or parties if we fail to enforce such claim ourselves.
YOU MAY EXPERIENCE DIFFICULTIES IN EFFECTING SERVICE OF LEGAL PROCESS AND
ENFORCING JUDGMENTS AGAINST US AND OUR MANAGEMENT.
Most of our current operations are conducted in China and most of our
assets are located in China. In addition, most of our directors and executive
officers reside within China, and substantially all of the assets of these
persons are located within China. As a result, it may not be possible to effect
service of process within the United States or elsewhere outside China upon
these directors or executive officers, including with respect to matters arising
under U.S. federal securities laws or applicable state securities laws.
Moreover, our PRC counsel, Haiwen & Partners, has advised us that China does not
have treaties with the United States or many other countries providing for the
reciprocal recognition and enforcement of court judgments. Our Hong Kong
counsel, Linklaters, has also advised us that Hong Kong has no arrangement for
the reciprocal enforcement of judgments with the United States. As a result,
recognition and enforcement in China of judgments of a court of the United
States or any other jurisdiction, including judgments against us or our
directors, executive officers, underwriters or experts, may be difficult or
impossible.
GOVERNMENT CONTROL OF CURRENCY CONVERSION MAY ADVERSELY AFFECT OUR OPERATIONS
AND FINANCIAL RESULTS.
We receive substantially all of our revenues in Renminbi, which is not
a freely convertible currency. A portion of such revenues will need to be
converted into other currencies to meet our foreign currency obligations. Our
foreign currency requirements primarily include:
o debt service on foreign currency-denominated debt;
16
o purchases of imported equipment; and
o payment of any dividends declared in respect of our shares.
Our primary operating subsidiary will be permitted to undertake current
account foreign exchange transactions by producing commercial documents
evidencing such transactions, provided that they are processed through certain
banks in China. However, foreign exchange transactions under the capital
account, including principal payments with respect to foreign
currency-denominated obligations, will be subject to limitations of the State
Administration of Foreign Exchange. These limitations may affect our ability to
obtain foreign exchange through debt or equity financing, or to obtain foreign
exchange for capital expenditures.
FLUCTUATIONS IN EXCHANGE RATES MAY ADVERSELY AFFECT OUR FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AND THE PRICES OF OUR SHARES AND ADSS OR ANY DIVIDENDS
PAYABLE ON OUR SHARES AND ADSS IN FOREIGN CURRENCY TERMS.
We conduct our business primarily in Renminbi, which is also our
functional and reporting currency. The Renminbi is not a fully convertible
currency. From 1994 to July 20, 2005, the official exchange rate for the
conversion of Renminbi to U.S. dollars was generally stable. On July 21, 2005,
the PRC government introduced a managed floating exchange rate system to allow
the value of the Renminbi to fluctuate within a regulated band based on market
supply and demand and by reference to a basket of currencies. Since that date,
the value of the Renminbi has appreciated by approximately 7.4% against the U.S.
dollar. The PRC government has since made and in the future may make further
adjustments to the exchange rate system. Substantially all of our revenues are
denominated in Renminbi, while a portion of our capital expenditures are
denominated in foreign currencies, such as U.S. dollars and Hong Kong dollars.
Future movements in the exchange rate of Renminbi and other currencies may have
an adverse effect on our financial condition and results of operations,
particularly our international long distance services. In addition, any
revaluation of the Renminbi may adversely affect the prices of our shares and
ADSs or any dividends payable on our shares and ADSs in foreign currency terms.
OUR CORPORATE STRUCTURE MAY RESTRICT OUR ABILITY TO RECEIVE DIVIDENDS FROM, AND
TRANSFER FUNDS TO, OUR CHINESE OPERATING SUBSIDIARY, WHICH MAY RESTRICT OUR
ABILITY TO ACT IN RESPONSE TO CHANGING MARKET CONDITIONS.
Substantially all of our operations are conducted through our Chinese
operating subsidiary, China Netcom (Group) Company Limited, or CNC China. The
ability of our Chinese subsidiary to make dividend and other payments to us may
be restricted by factors that include changes in applicable foreign exchange and
other laws and regulations. As a wholly foreign-owned enterprise in China, CNC
China is required to provide for a reserve fund and a staff and workers' bonus
and welfare fund, each of which is appropriated from net profit after taxation
but before dividend distribution according to the prevailing accounting rules
and regulations in the PRC. CNC China is required to allocate at least 10% of
its net profit to the reserve fund until the balance of this fund has reached
50% of its registered capital. In addition, the profit available for
distribution from our Chinese subsidiary is determined in accordance with
generally accepted accounting principles in China. This calculation may differ
from one performed in accordance with either HKFRS or U.S. GAAP. As a result, we
may not receive sufficient distributions from our Chinese subsidiary to enable
us to make dividend distributions to our shareholders in the future, even if our
HKFRS or U.S. GAAP financial statements indicate that our operations have been
profitable.
Distributions by our Chinese subsidiary to us other than as dividends
may be subject to governmental approval and taxation. Any transfer of funds from
our company to our Chinese subsidiary, either as a shareholder loan or as an
increase in registered capital, is subject to registration or approval with or
by Chinese governmental authorities, including the relevant administration of
foreign exchange and/or other relevant examining and approval authorities. These
limitations on the free flow of funds between us and our Chinese subsidiary may
restrict our ability to act in response to changing market conditions.
17
Risk relating to our ADSs
HOLDERS OF OUR ADSS WILL NOT HAVE THE SAME VOTING RIGHTS AS THE HOLDERS OF OUR
SHARES AND MAY NOT RECEIVE VOTING MATERIALS IN TIME TO BE ABLE TO EXERCISE THEIR
RIGHT TO VOTE.
Except as described in this annual report and in the deposit agreement,
holders of our ADSs will not be able to exercise voting rights attaching to the
shares evidenced by our ADSs on an individual basis. Holders of our ADSs will
receive proxy materials with respect to matters to be voted on at a meeting of
shareholders through the depositary and may only exercise voting rights by
appointing the depositary or its nominee as their representative to exercise the
voting rights attaching to the shares represented by the ADSs. Consequently, if
the materials are slow to be forwarded to holders of ADSs by the depositary or
are otherwise delayed or if the depositary sets deadlines by which holders of
ADSs must give their instructions regarding how to vote that fall too soon after
mailing of the proxy materials, you may not receive voting materials in time to
instruct the depositary to vote. Thus, it is possible that you, or persons who
hold their ADSs through brokers, dealers or other third parties, may not have
the opportunity to exercise a right to vote.
ITEM 4. INFORMATION ON THE COMPANY
HISTORY AND DEVELOPMENT
Our legal and commercial name is China Netcom Group Corporation (Hong
Kong) Limited. Our principal executive offices are located at No. 21, Financial
Street, Xicheng District, Beijing, PRC 100032. Our telephone number is (86-10)
6625-8899. Our registered offices are located at 6701, 67/F, The Center, 99
Queen's Road Central, Hong Kong. We have appointed CT Corporation System, 111
Eighth Avenue, 13th Floor, New York, New York 10011, United States of America,
with telephone number 1-212-894-8940, as our agent for service of processes for
actions brought under the U.S. securities laws.
Our current principal operating subsidiary, CNC China, was incorporated
as a PRC limited liability company in August 1999 by its four founders and
shareholders, the Academy of Sciences, INC-SARFT, CRTC and Shanghai Alliance, as
a facilities-based telecommunications operator in China. We were established on
October 22, 1999 to facilitate investments by foreign investors, including CNC
Fund, L.P., in CNC China. Shortly thereafter, the four founders, using their
respective equity interests in CNC China as capital contributions, established
China Netcom (Holdings) Company Limited, or China Netcom Holdings, which in turn
contributed its entire interests in CNC China through CNC BVI to us. CNC Fund,
L.P. purchased from us 30,967,127 Series A preferred shares of par value US$0.01
each in February 2001 for a cash consideration of US$325,000,000.
We, through China Netcom Corporation International Limited, established
Asia Netcom in 2002. Asia Netcom remained inactive until it acquired
substantially all the assets, including cash, and most of the subsidiaries, of
the former Asia Global Crossing Ltd., or AGC, by the end of 2003. On August 22,
2006, we sold our 100% equity interest in Asia Netcom to Connected Holding
Limited for US$ 168.84 million.
Formation of the China Netcom Group
Pursuant to a PRC government-issued directive in 2001 to restructure
the PRC fixed-line telecommunications industry, which has been in operation for
decades, China Telecom Group, the then incumbent fixed-line carrier, in May
2002, divided its operations between:
o China Telecom Group, which retained:
o the principal fixed-line networks that were located in 21
southern and western provinces and municipalities of China;
and
18
o assets constituting 70% of the bandwidth of the nationwide
inter-provincial fiber-optic network that were owned by the
former China Telecom Group; and
o China Netcom Group, which was established with:
o the principal fixed-line networks that were located in the
Beijing and Tianjin Municipalities and the provinces of
Hebei, Henan, Shandong, Liaoning, Shanxi, Jilin and
Heilongjiang and the Neimenggu Autonomous Region; and
o assets constituting 30% of the bandwidth of the nationwide
inter-provincial fiber-optic network that were owned by the
former China Telecom Group.
Pursuant to the same directive, China Netcom Group purchased the entire
equity interest in Jitong Communications Company Limited on May 28, 2003. In
April 2004, the shareholders of China Netcom Holdings agreed to transfer their
respective interests in China Netcom Holdings to China Netcom Group.
Restructuring in Anticipation of the November 2004 Global Offering
The asset and liability transfers
In anticipation of our global offering in November 2004, we entered
into certain transactions, including a series of transfers of assets and
liabilities between us and China Netcom Group. Following our restructuring, we
provided:
o telecommunications businesses in our northern and southern service
regions; and
o international telecommunications services in the Asia-Pacific
region.
China Netcom Group continued to:
o provide telecommunications services in provinces, autonomous
regions and municipalities outside our northern and southern
service regions; and
o own non-core businesses.
Our subsidiaries
We own the entire equity interest of CNC China, a company registered in
China. CNC China is our operating subsidiary in China. All businesses in our
northern service regions are operated through the local branch offices of CNC
China.
Change of our financial year end
In order to conform our financial year end, which was March 31
previously, to the financial year end of the businesses that were transferred to
us in connection with the restructuring, we changed our financial year end from
March 31 to December 31 beginning April 1, 2003.
Name changes
We were incorporated in Hong Kong under the Companies Ordinance as a
private limited liability company on October 22, 1999 under the name of Target
Strong Limited.
19
o We changed our name from Target Strong Limited to China Netcom
(Hong Kong) Corporation Limited on December 9, 1999.
o We changed our name from China Netcom (Hong Kong) Corporation
Limited to China Netcom Corporation (Hong Kong) Limited on August
4, 2000.
In connection with our restructuring in anticipation of the November
2004 global offering:
o We changed our company name from China Netcom Corporation (Hong
Kong) Limited to China Netcom Group Corporation (Hong Kong)
Limited on July 23, 2004;
o CNC China's company name was changed from China Netcom Corporation
Limited to China Netcom (Group) Company Limited on September 10,
2004; and
o CNC BVI's company name was changed from China Netcom Holdings
(BVI) Limited to China Netcom Group Corporation (BVI) Limited on
August 31, 2004.
Our Initial Public Offering in November 2004
In November 2004, we successfully completed our initial public offering
of shares, or IPO, raising approximately RMB 8,944 million in aggregate net
proceeds for us, after deduction of fees and expenses. Our shares are listed and
traded on the Hong Kong Stock Exchange and ADSs representing our shares are
listed and traded on the New York Stock Exchange.
Our 2005 Acquisition
On September 12, 2005, we, CNC BVI and China Netcom Group entered into
a conditional sale and purchase agreement whereby we agreed to acquire the
entire equity interests of China Netcom Group New Horizon Communications
Corporation (BVI) Limited, or CNC New Horizon BVI, from CNC BVI for a
consideration of RMB 12,800 million, RMB 3,000 million of which was paid out to
China Netcom Group on October 31, 2005 at the consummation of our 2005
Acquisition.
Our 2005 Acquisition resulted in the transfer from China Netcom Group
to us its fixed-line telecommunications assets and related liabilities in
Heilongjiang Province, Jilin Province, the Neimenggu Autonomous Region and
Shanxi Province, or the 2005 Acquired Assets and Liabilities.
On November 3, 2006, CNC China completed its merger with CNC New
Horizon BVI, with CNC China being the surviving entity.
Sale of Asia Netcom
On August 22, 2006, we sold our 100% equity interest in Asia Netcom to
Connect Holdings Limited for US$168.84 million. Asia Netcom was a wholly owned
subsidiary through which we provided international telecommunications services
in the Asia-Pacific region. The sale of Asia Netcom is in line with our strategy
to focus on development of telecommunications services in China. After the
completion of the sale, we continued to have business relationships with Asia
Netcom in connection with our remaining international operations, including the
purchase of network capacity from Asia Netcom, which is not expected to be
significant.
Recent Development - Sale of Southern Service Region Business
On February 28, 2007, we sold our telecommunications assets,
liabilities and business operations in Guangdong Province and Shanghai
Municipality, or our southern service region, to China Netcom Group for a cash
20
consideration of RMB 3,500 million. China Netcom Group assumed an aggregate
principal amount of RMB 3,000 million of debt which is due and owing from the
Guangdong and Shanghai branches to independent third parties upon completion of
the disposal. We believe that the sale of our southern service region business
has increased our ability to allocate more resources to solidifying and
strengthening our leading position in our northern service region.
21
BUSINESS OVERVIEW
Unless otherwise indicated, all data and information relating to our
businesses and operations for the year ended December 31, 2004 include the data
and information relating to the 2005 Acquired Assets and Liabilities, and all
data and information relating to our business and operations for the years ended
December 31, 2004 and 2005 are presented as if the sale of Asia Netcom occurred
on January 1, 2004. The operations results of Asia Netcom, which will be
eliminated from the ongoing operations and cash flows of the Company following
the sale, are presented as discontinued operations for the period from January
1, 2004 to December 31, 2006.
Our Services
We are a leading broadband communications and fixed-line
telecommunications operator in China and a dominant provider of fixed-line
telephone services, broadband and other Internet-related services, business and
data communications services, as well as information and communications
technology services in our northern service region. The services that we offer
include:
o fixed-line telephone services (including Personal Handyphone
System, or PHS services), including local, domestic long distance
and international long distance services;
o broadband and other Internet-related services, including XDSL,
LAN, wireless and other Internet access services, broadband
content and applications services;
o business and data communications services, including managed data
and leased line services; and
o information and communications technology services, including
services such as system integration, software development,
maintenance and consultancy.
Tariffs for most of our services are regulated by the government,
including the MII, the NDRC, and provincial telecommunications administrations
and price bureaus in China. We describe, in this "Item 4. Information on the
Company -- Business Overview" section, tariffs for services for which we have
sole discretion in setting the market-based tariff levels, including VoIP and
broadband Internet services. For a discussion of government-fixed tariffs and
guidance tariffs, such as those for fixed-line telephone services, see "--
Regulation -- Tariff Setting." Prices for some of our services may be subject to
promotional discounts.
Fixed-line telephone services (including PHS)
We are the dominant provider of fixed-line telephone services in our
northern service region, with a market share of 91.5% as of December 31, 2006,
based on the number of fixed-line subscribers.
Our fixed-line telephone services consist of local telephone, domestic
long distance, international long distance, value-added and interconnection
services. The number of our fixed-line subscribers in our northern service
region increased from 107.6 million as of December 31, 2004 to 114.7 million as
of December 31, 2005. In 2006, as domestic mobile operators launched service
packages at competitive prices, the migration from fixed-line to mobile
communications intensified, and the number of our fixed-line subscribers in our
northern service region decreased to 114.0 million as of December 31, 2006. Of
the total number of fixed-line subscribers in our northern service region, as of
December 31, 2006, approximately 60.4% were residential customers, 9.6% were
business customers, 6.0% were public telephones and 24.0% were PHS subscribers.
Fixed-line telephone services represent our principal business activity.
In an effort to maintain our leading position in local telephone
services, we have recently launched a number of bundled services targeting
selected consumer segments by capitalizing on our service offerings and network
resources. For example:
22
o For urban subscribers, we provide bundled services under the brand
name of "Family 1+" and "Unified Number" with both fixed-line and
mobile functionalities;
o For campus subscribers, we offer "New Sunshine" service to provide
more SMS and family calls;
o For rural subscribers, we offer the "Economical Phone," a bundled
voice and value-added service, which does not charge monthly fees
to encourage higher voice traffic and value-added-service usage.
We believe that these new services have reduced the mobile substitution
effect by increasing voice traffic. However, because we are still in the process
of upgrading our network to include intelligent functionalities and other
supporting infrastructure, these bundled services were not yet offered on a
large scale in our northern service region by the end of 2006. We expect that,
upon completion of the upgrading of our network, these bundled services will be
offered throughout our northern service region and will help mitigate the
declines in our local voice communications services.
We have selectively built wireless local access networks based on PHS
technology to offer PHS services as an alternative to mobile services. Our PHS
services have been introduced in most cities in our northern service region,
where we have rolled out our PHS networks as an extension to our existing
fixed-line network. We believe that our PHS services have mitigated the
substitution effect of mobile services.
PHS services are wireless telephone services that have features similar
to traditional mobile telephone services. For example, both types of services
offer voice services over handsets as well as short messaging functions.
However, as PHS services have smaller cellular coverage than traditional mobile
networks, PHS networks require more cellular sites for the same area coverage.
In addition, due to regulatory constraints in China, users of PHS services are
only permitted to roam within an area with the same area code while traditional
mobile telephone services offer nationwide or international roaming
capabilities. Tariffs for PHS services are similar those for traditional
fixed-line voice services. Incoming calls are free when using PHS services but
are generally charged on a per minute basis when using traditional mobile
services.
As of December 31, 2006, our PHS services were provided in regions
covering more than 100 area codes in our service regions. The number of our PHS
subscribers grew rapidly from when we began offering this service to the end of
2005. As of December 31, 2005, we had approximately 27.3 million PHS subscribers
in our service regions, compared to approximately 22.1 million at the end of
2004. However, in 2006, as mobile operators launched aggressive tariff packages,
the tariff advantage of PHS services diminished, and our PHS subscribers as of
December 31, 2006 decreased for the first time by approximately 3,000 from
approximately 27.3 million as of December 31, 2005. In 2006, we reduced our
capital expenditures on PHS services and decreased our subsidies of PHS
terminals. Our PHS services focused more on selected consumer segments such as
hospitals, school campus, hotels and other commercial buildings, and were
offered as a key component of our bundled services.
We also operate a network of approximately 6.9 million public
telephones located in our northern service region in China. We provide local,
domestic long distance and international long distance call services and
Internet services through our public telephones. An important contributing
factor to the demand for public telephones services is China's large and growing
migrant population.
The following table summarizes key information regarding our local
telephone services in our service regions in China as of the dates indicated:
As of December 31,
----------------------------------
2004 2005 2006
----------------------------------
(in thousands, except percentages)
Total number of fixed-line
subscribers(1)......................... 108,079 115,328 114,934
Northern service region
23
Number of fixed-line subscribers
Residential......................... 70,638 70,273 68,803
Business............................ 9,251 10,725 10,946
PHS................................. 22,124 27,329 27,316
Public telephones................... 5,558 6,331 6,907
Sub-total......................... 107,571 114,658 113,972
Market share(2)....................... 93.5% 92.3% 91.5%
Southern service region (3)
Number of fixed-line subscribers...... 508 670 962
______________________
(1) Fixed-line subscribers consist of all access lines in service as well as PHS
subscribers. We calculate PHS subscribers based on the number of active
telephone numbers for our PHS services. In cases where a PHS subscriber uses
the same telephone number as an access line in service, the designation as a
PHS subscriber or access line in service depends on which service is first
activated. We increase our total number of fixed-line subscribers as soon as
practicable after activation of the service. We remove a fixed-line
subscriber from the total number of fixed-line subscribers as soon as
practicable after the fixed-line subscriber deactivates the service
voluntarily or three months after the date on which the fixed-line
subscriber's bill becomes overdue. Prepaid and postpaid telephone card
customers are not counted toward our fixed-line subscribers.
(2) Calculated by dividing the number of our fixed-line subscribers by the total
number of fixed-line subscribers in our northern service region published by
the provincial telecommunications administrations or the MII, as the case
may be, as of each of December 31, 2004, 2005 and 2006.
(3) We sold our telecommunications assets, liabilities and business operations
in our southern service region to China Netcom Group on February 28, 2007.
See "Item 4. Information on the Company--History and Development--Recent
Development--Sale of Southern Service Region Business."
Local telephone services
Our local telephone services, which represent the largest portion of
our fixed-line telephone services in terms of revenues, grew continuously in
recent years until 2005 but experienced a decline in 2006.
Service usage
The following table sets forth information regarding usage of our local
telephone services provided in our service regions for the periods indicated:
For the Years Ended December 31,
---------------------------------
2004 2005 2006
---------------------------------
Total usage (pulses in millions)(1)........ 234,661 228,436 217,270
Internet dial-up usage (pulses
in millions)(1)........................... 17,226 8,552 5,271
Total usage excluding Internet
dial-up usage (pulses in millions)........ 217,435 219,884 211,999
_____________________
(1) Pulses are the billing units for calculating local telephone usage fees. See
"-- Regulation -- Tariff Setting -- Local telephone services" for a
discussion of pulses.
In 2006, total usage in local telephone services was 217,270 million,
which included 5,271 million Internet dial-up usage. Total usage of local
telephone services excluding Internet dial-up usage was 211,999 million,
representing a 3.59% decrease from last year's 219,884 million, reflecting
increasing migration of local fixed-line voice traffic to mobile services.
Domestic long distance services
We offer traditional long distance services and VoIP long distance
services in our northern service region, and until we sold our southern service
region business on February 28, 2007, primarily through VoIP in our southern
service region.
In 2006, the usage of our domestic long distance services increased by
8.7% over that of 2005, primary due to promotional tariff offerings and our
enhanced sales and marketing efforts to increase traditional long distance voice
traffic.
24
Service usage
The following table shows the total minutes of domestic long distance
calls carried through our long distance network for the periods indicated:
For the Years Ended December 31,
-------------------------------
2004 2005 2006
-------------------------------
Total minutes of domestic long distance
calls (in millions)(1)(2)
Traditional................................ 15,546 15,979 18,612
VoIP....................................... 13,820 14,996 15,058
-------------------------------
Total..................................... 29,366 30,975 33,670
Northern service region
Total minutes of usage (in millions)(2)
Traditional................................ 15,087 15,653 17,327
VoIP....................................... 11,960 12,122 11,482
-------------------------------
Sub-total................................. 27,047 27,775 28,809
Southern service region(3)
Total minutes of usage (in millions)....... 2,319 3,200 4,861
-----------------------------
(1) Includes usage provided over traditional networks in our southern service
region.
(2) Includes calls originated by prepaid phone cards users and VoIP subscribers
that are carried over our long distance networks.
(3) We sold our telecommunications assets, liabilities and business operations
in our southern service region to China Netcom Group on February 28, 2007.
See "Item 4. Information on the Company--History and Development--Recent
Development--Sale of Southern Service Region Business."
The increase in minutes of usage in our domestic long distance services
in recent years was mainly due to economic development, declining effective
tariffs, increased cross-regional business activities, growth in our customer
base and new service offerings. The increase in competition has, however,
negatively affected our market share, which decreased from 41.7 % in 2004 to
33.9 % in 2006 in our northern service region, and may affect the future growth
rate of our domestic long distance services.
Tariffs
In 2001, the PRC government abolished regulatory controls on tariffs
for VoIP long distance calls and allowed operators to set their own rates. We
currently charge RMB 0.30 per minute in addition to a local usage fee for our
VoIP domestic long distance services.
International long distance services
We are the leading provider of international long distance services in
our northern service region, with a 41% market share for the overall
international long distance service in that region for the year ended December
31, 2006, as compared to 46.8% for the year ended December 31, 2005. This
decrease was primarily due to increasing competitions from other international
long distance service providers.
In 1999, we began to offer VoIP international long distance services in
our service regions. The usage of our VoIP international long distance services
as a percentage of the total usage of our international long distance services
increased from 66.5% as of December 31, 2004 to 67.0% as of December 31, 2006,
as price-sensitive customers increasingly elected to use lower-priced VoIP
international long distance services.
Service usage
The following table sets forth certain information related to the usage
of our international long distance services for the periods indicated:
25
For the Years Ended December 31,
--------------------------------
2004 2005 2006
--------------------------------
International long distance outbound
call minutes (in millions)(1)(2)
Traditional............................... 158 173 187
VoIP...................................... 313 418 379
--------------------------------
Total................................... 471 591 566
Northern service region
Total minutes of usage (in millions)(2)
Traditional............................... 148 156 144
VoIP...................................... 191 196 180
--------------------------------
Sub-total............................... 339 352 324
Southern service region (3)
Total minutes of usage (in millions)...... 132 239 242
-----------------------------
(1) Includes usage provided over traditional networks in our southern service
region.
(2) Includes calls originated by prepaid phone cards users and VoIP subscribers
that are carried over our international long distance networks.
(3) We sold our telecommunications assets, liabilities and business operations
in our southern service region to China Netcom Group on February 28, 2007.
See "Item 4. Information on the Company--History and Development--Recent
Development--Sale of Southern Service Region Business."
Our principal outgoing international long distance calls are to Hong
Kong, Taiwan, the United States, Japan and South Korea.
Tariffs
The following table sets forth our current VoIP international long
distance tariffs:
Tariff
-----------------
(RMB per minute)
VoIP services:
Hong Kong, Macau and Taiwan........................ 1.50
United States and Canada........................... 2.40
Asia-Pacific and certain European countries(1)..... 3.60
All other international destinations............... 4.60
----------------
(1) Includes the United Kingdom, France, Italy, Germany, Australia, New Zealand,
Japan, South Korea, Singapore, Malaysia, Thailand, the Philippines and
Indonesia.
We offer international long distance services through international
gateways that we lease from China Netcom Group, and pay for the use of networks
of operators in foreign jurisdictions for outgoing international calls. We
negotiate bilateral settlement arrangements and rates with operators in foreign
jurisdictions based on international settlement standards in the
telecommunications industry.
Value-added services
In addition to basic telephone services, we offer a range of
value-added services, including caller identification, PHS short messaging and
"personalized ring" services. Personalized ring service enables our traditional
fixed-line telephone and PHS telephone to emit a distinctive ring for incoming
calls designated numbers. Our value-added services generate additional usage on
our network and increase our average revenues per fixed-line subscriber, thus
mitigating the impact of mobile substitution and contributing to our revenues.
In 2006, we introduced additional value-added services, including
"Phone Navigation," "Phonemate" and "Concealed Number." These services increased
the usage of voice traffic through our fixed line network and increased our
average revenue per unit. Upon completion of upgrading our network to allow
intelligent functionalities, new value-added services can be offered on a large
scale in our service region.
26
As of December 31, 2004, 2005 and 2006, 60.4%, 65.9% and 68.5%,
respectively, of our subscribers subscribed to our caller identification service
in our service regions. In 2006, 7.8 billion PHS short messages were sent from
our network, representing an increase of 15.3% from 6.8 billion in 2005. The
number of subscribers to our "personalized ring" services reached 15.8 million
as of December 31, 2006, as compared to 6.8 million as of December 31, 2005. In
addition, we provide telephone information, teleconferencing, video
conferencing, voice mail services. Value-added services are still in a
relatively early stage of development in China, and we believe that there is
significant growth potential in this area.
Tariffs
We charge RMB 3.00 to RMB 6.00 per month, depending on the region, for
our caller identification service. We charge RMB 0.08 to RMB 0.10 per message
for PHS messages sent within our own network or to the network of China Telecom,
and RMB 0.10 to RMB 0.15 per message for messages sent outside our own network
or the network of China Telecom. We charge RMB 2.00 to RMB 10.00 per month for
using our "personalized ring" and charge separately for downloading "ring tones"
Interconnection
We earn interconnection fees for terminating or transiting calls that
originate from other domestic operators' networks and pay interconnection fees
to other operators in respect of calls originating from our networks that are
terminated on their networks. We earn and pay such fees in respect of local and
domestic and international long distance calls and Internet services.
All interconnection and settlement arrangements among domestic
operators in China are governed by the Telecommunications Regulations and the
rules on interconnection arrangements and settlement promulgated by the MII.
Most of the agreements pursuant to which we interconnect with other domestic
operators were entered into by China Netcom Group prior to our restructuring. We
have entered into an agreement with China Netcom Group pursuant to which we have
agreed with China Netcom Group that the costs and benefits arising under these
agreements, as they relate to our operations, will be for our account. We have
also entered into an interconnection settlement agreement with China Netcom
Group to interconnect with networks owned by China Netcom Group outside of our
northern service regions.
For information about our domestic and international telecommunications
arrangements, see "--Regulation -- Tariff Setting -- Interconnection" and "Item
7. Major Shareholders and Related Party Transactions -- Related Party
Transactions -- Continuing connected transactions relating to CNC China and CNC
New Horizon -- Interconnection Settlement Agreement."
Broadband and other Internet-related services
We are the leading provider of broadband and other Internet-related
services in our northern service region. Broadband services represent one of our
fastest growing businesses. This growth has been driven by the increasing
affordability and rising use of personal computers and other Internet access
devices, gradual recognition by businesses of the importance of information,
reduced tariffs and the proliferation of content and applications, such as
online games and video-on-demand.
The following table sets forth selected information regarding our
broadband, dial-up and dedicated Internet access services.
27
As of and For the Years Ended December 31,
---------------------------------------------
2004 2005 2006
---------------------------------------------
Broadband services:(1)
DSL subscribers (in thousands).................................. 5,956.2 8,568.4 11,378.9
LAN subscribers (in thousands).................................. 2,533.2 2,904.2 3,698.2
Others (in thousands)........................................... 3.0 2.6 3.7
---------------------------------------------
Subtotal...................................................... 8,492.4 11,475.2 15,080.8
Northern service region
DSL subscribers (in thousands).................................. 5,939.2 8,529.2 11,287.9
LAN subscribers (in thousands).................................. 2,207.2 2,507.0 3,140.7
Others (in thousands)........................................... 0 0 0
---------------------------------------------
Subtotal...................................................... 8,146.4 11,036.2 14,428.6
Market share(2)................................................... 93.5% 87.6% 87.5%
Southern service region (3)
DSL subscribers (in thousands).................................. 17.1 39.2 91.0
LAN subscribers (in thousands) (4).............................. 326.3 397.2 557.5
---------------------------------------------
Subtotal.......................................................... 346 439 652.2
Dial-up and dedicated Internet access services:
Dial-up online usage (minutes in millions)...................... 15,134.2 6,657.5 5,392.8
Dedicated Internet access lines in service (in thousands)....... 2.7 2.0 1.9
Northern service region
Dial-up online usage (minutes in millions)...................... 15,129.8 6,645.6 5,384.3
Dedicated Internet access lines in service (in thousands)....... 2.7 2.0 1.8
Southern service region (3)
Dial-up online usage (minutes in millions)...................... 4.4 12.0 8.5
____________________
(1) We calculate DSL subscribers based on the number of active accounts. LAN
subscribers consist of end-users and dedicated line users. We calculate LAN
end-users based on the number of ports subscribed for. The number of LAN
dedicated line users equals total monthly fees paid by such users divided by
set average revenue per unit. The current set revenue per unit is RMB 90. We
consider an account active or a service subscribed for as soon as
practicable after activations of the applicable service. We remove a
subscriber from the total number of subscribers as soon as practicable after
that subscriber deactivates the service voluntarily or three months after
the date on which that subscriber's bill becomes overdue.
(2) Calculated by dividing the number of our own broadband subscribers by the
total number of broadband subscribers in our northern service region, as
published by the provincial telecommunications administrations or the MII,
as the case may be, as of each of December 31, 2004, 2005 and 2006.
(3) We sold our telecommunications assets, liabilities and business operations
in our southern service region to China Netcom Group on February 28, 2007.
See "Item 4. Information on the Company--History and Development--Recent
Development--Sale of Southern Service Region Business."
(4) Amounts as of December 31, 2004, 2005 and 2006 include dedicated Internet
access lines.
Broadband services
We seek to achieve a leading position in the fast growing market for
broadband services in China by capitalizing on our extensive fixed-line network,
large customer base, experienced sales force and established brand. We offer
broadband services in our service regions. In 2006, we continued to develop our
broadband business model focusing on providing access through computers and
television set-top boxes and charging fees on access and content and adopted
measures such as selectively upgrading our network speed, introducing more
diversified product and price offerings to satisfy the needs of different market
segments.
In 2006, we established "China Netcom Group Broadband Online Limited
Corporation," a wholly-owned subsidiary of CNC China specially designated for
broadband content and launched the first comprehensive audio-visual
entertainment portal in the PRC "CNC MAX." We also leveraged on our status as an
official partner of the 2008 Olympic Games to develop the "2008 Broadband
Hotels" services. As of December 31, 2006, 1,267 hotels offered to their guests
broadband services provided by us. In addition, in 2006, we devoted more efforts
in promoting our comprehensive information services for corporate customers,
especially small and medium size enterprises. We provided them comprehensive
communication and information services including information technology
applications and basic communication products.
28
Our broadband subscribers increased to 15.08 million as of December 31,
2006, representing an increase of 3.61 million, or 31.4%, from 11.48 million as
of December 31, 2005.
DSL services
We promote DSL services as the primary broadband service means for
residential customers and small and medium-sized enterprise customers in our
northern service region. We provide DSL services by upgrading our existing
copper-based local switching network. DSL technology allows us to roll out our
broadband network at lower incremental costs than other types of broadband
networks. In our northern service region, where we are the dominant fixed-line
operator, the number of subscribers to our DSL services has grown steadily in
recent years, with approximately 11.4 million DSL subscribers as of December 31,
2006, compared with approximately 6.0 million subscribers as of the end of 2004.
As of December 31, 2006, our DSL subscribers accounted for 75.5% of our total
number of broadband subscribers in our service regions.
LAN services
In addition to DSL technology, we also use Ethernet technology-based
local-area networks, or LANs, to provide our customers with broadband services.
We have selectively rolled out LANs in high density residential and office
buildings in our northern service regions, where customers demand a large
bandwidth and high-speed Internet access. LAN uses fiber-optic technology and
Ethernet protocol to connect our users to a telecommunications network and
greatly expands capacity of the access network. As of December 31, 2006, we had
3.7 million subscribers of our LAN services, representing 24.5% of our total
broadband subscribers.
Internet application-related services
We have entered into cooperation arrangements with content and
applications providers in the businesses of live webcasting, virtual theater,
video conferencing, IPTV, online education, and broadband games. In addition to
basic services such as games, video and portals, we have also launched a series
of dedicated services catering to the specific needs of local markets and
industry subscribers, namely, an integrated tax payment services platform,
digital libraries and digital photo-finishing. In 2005, we successfully launched
China's first IPTV services in the city of Harbin, Heilongjiang Province. In
2006, we were granted a right to provide IPTV services in five cities, including
Heihe and Mudanjiang of Heilongjiang Province, Shenyang, Dalian and Panjin of
Liaoning Province and we began providing information technology services for the
rural areas based on IPTV technology in Henan Province. The number of IPTV
subscribers reached 144.5 thousand as of December 31, 2006, representing an
increase of 201% from December 31, 2005.
We also operate Internet data centers, which provide co-location and
website hosting services to business customers that lease servers, routers and
other network components for Internet-related solutions. Internet data centers
are facilities used to house, protect and maintain network service computers
that store and deliver Internet and other network content, such as web pages,
applications and data. These services are used primarily by business customers
seeking to outsource the infrastructure needed to utilize the Internet
effectively.
Tariffs
We charge an upfront installation fee to both DSL and LAN subscribers.
DSL subscribers may choose a monthly package for unlimited usage, or a monthly
package with limited usage, with additional fees charged for overtime usage. For
customers connected through LANs, we offer a monthly package with unlimited
usage.
Dial-up and dedicated Internet access
We are also one of the largest providers of dial-up Internet access
services in our northern service region in terms of number of subscribers. Total
usage by our dial-up Internet subscribers decreased significantly in 2006.
29
We believe that the decrease was primarily attributable to the migration of some
high-usage customers from dial-up Internet services to broadband services.
We offer high speed Internet access through dedicated lines to our
business customers, particularly communications-intensive corporate customers.
As of December 31, 2006, we had a total of approximately 1,800 dedicated
Internet access subscribers in our northern service region. We bundle this
service with voice and data services to provide integrated communications
solutions to our business customers.
Tariffs
Dial-up Internet access
-----------------------
We offer dial-up Internet access on both a postpaid and prepaid basis.
We charge a network usage fee ranging from RMB 1.00 to RMB 3.00 per hour. In
addition, a communication fee of RMB 0.02 per minute is charged and recorded as
fixed-line telephone services revenues. Postpaid customers are billed for this
service together with their monthly telephone service bills. Prepaid customers
must purchase stored value cards that enable them to access the Internet. The
network usage fee is charged against the stored value card, while the
communication fee is billed to the telephone number from which the Internet
connection is made.
Dedicated Internet access
-------------------------
We charge a subscription fee of RMB 100 and a monthly network usage fee
ranging from RMB 2,400 to RMB 5,400, depending on bandwidth, for our dedicated
Internet access. Where the dedicated Internet access is provided through DDN,
frame relay, ATM or digital circuits access, their respective tariffs apply in
addition to the subscription fee and network usage fee. For a more detailed
description of the tariffs for DDN, frame relay, ATM or digital circuits, please
see "-- Regulation -- Tariff Setting."
Business and data communications services
We are the leading provider of business and data communications
services in our northern service region. Managed data services represent a
growing area in China's telecommunications industry. Our business and data
communications services enjoyed significant development from high demand for
information services from government administration related needs, centralized
data processing for financial institutions, needs for IT-related services from
logistics- and manufacturing-related industries. We bundle the data
communications services together with fixed-line telephone services and
broadband services to attract communications-intensive corporate customers. We
are responding to increasing market demand in this area by leveraging our
network platforms for data transmission and by offering a broad portfolio of
services and customized solutions.
We offer managed data products, such as DDN, frame relay, ATM and
IP-VPN, and leased line products, including domestic and international leased
circuits. Our customers for these services include government entities, large
financial institutions and other domestic and multinational businesses, ISPs and
other telecommunications operators. We focus on diversifying our business and
data communications services and products and providing quality customer service
to our large corporate and carrier customers.
Managed data services
We provide a variety of managed data services to our business
customers, including DDN, frame relay, ATM and IP-VPN services. We anticipate
that demand for data communications services will be fueled by growth in the
emerging services segment, which includes e-commerce, broadband content, network
applications and IP-VPN services. The following table sets forth selected
information regarding our managed data services.
30
As of December 31,
--------------------------------------------
2004 2005 2006
--------------------------------------------
Number of ports
DDN
Frame relay.................... 43,078 43,519 41,448
ATM ........................... 4,816 4,212 6,441
Leased bandwidth
DDN (x64kbps).................. 319,323 205,064 200,138
Frame relay (x128kbps)......... 82,395 177,016 196,597
ATM (x2Mbps)................... 23,262 12,311 16,890
DDN services
DDN systems, composed of fiber-optic cables, digital transmission paths
and digital nodes, are capable of providing high-quality private circuits and
other services at various speeds to satisfy the multimedia communications needs
of customers. Our DDN services provide high quality and reliable transmission at
speeds ranging from 9.6kbps to 2Mbps to meet the increasing demand for low- to
medium-speed transmission capacity from business customers and government
agencies.
Frame relay and ATM services
We offer advanced high-speed data communications services based on
frame relay and ATM technologies to major business customers, including
multinational corporations, government agencies and financial institutions.
These services enable flexible and cost-effective use of bandwidth resources.
Our frame relay service provides high-speed, cost-effective data transmission
services linking different business sites for high volume data traffic. ATM is a
data transmission service using high bandwidth and multiplexing technology
intended to handle high bandwidth, integrated voice, text, data, video and
Internet traffic. Many of our customers are increasingly using frame relay and
ATM services to form VPNs to link their local area networks in different
locations. VPNs enable large companies to link multiple sites and offices
through a single network that uses existing switched lines to reduce cost but
has capabilities comparable to a dedicated private circuit.
IP-VPN
Our IP-VPN service targets business customers that require direct IP
connections between multiple sites. These customers are provided with private
networks connected to our Internet backbone network and intended for secure data
transmission.
Leased line services
We are a major provider of dedicated leased line services to
businesses, government agencies and other telecommunications operators in our
northern service region. These leased lines allow point-to-point connection for
voice and data traffic. Leased lines are used by business customers to assemble
their own private networks and by telecommunications operators to establish
their service networks. We lease network elements, including digital circuits,
digital trunk lines and optical fibers, to business and government customers as
well as other telecommunications operators.
As of December 31, 2006, we leased circuits totaled 171,249 (x2Mbps) in
bandwidth, including 147,459 (x2Mbps) in bandwidth to business customers. An
increasing percentage of our leased circuits are of higher speed as well as
capacity. Revenues generated from our leased line services have grown steadily
in recent years. The following table sets forth the respective amounts of
bandwidth of our leased line services provided to our business customers and
carrier customers as of the dates indicated.
As of December 31,
-----------------------------------
2004 2005 2006
-----------------------------------
Bandwidth of leased circuits (x2Mbps)
Business customers.................... 56,363 100,387 147,459
Carrier customers..................... 34,740 29,602 23,790
-----------------------------------
Total.............................. 91,103 129,989 171,249
31
Information and communication technology services
We began offering information and communication technology services in
2006. We provide integrated services of system integration, software
development, management applications and fixed-line communication.
o We provide custodian services to small and medium size enterprises
through our proprietary "IT Platform for Small and Medium
Enterprises;"
o We provide comprehensive system consulting and industry
application system services to large enterprises;
o We provide LAN services and outsourcing services to governmental
customers.
In 2006, revenue from our information and communication technology
services was RMB 788 million.
Marketing, Sales, Distribution and Customer Services
In 2006, we made significant improvements to our sales and marketing
systems, which comprise major account managers, community managers, sales
outlets, 10060 telephone marketing and customer service hotline and online
marketing and other channels.
We set up six types of professional sales and marketing teams
comprising public customer managers, business managers and network development
managers. We promoted a sale and marketing model that combines frontline sales,
back office support, brand image building and experience presentation. In
addition, we improved our 10060 hotline's customer service and sales and
marketing functions. The 10060 hotline handles approximately 25% of our total
volume of our customer service transactions.
Trademarks
We market our services under the "CNC" brand name and logo, which are
registered trademarks in China owned by our parent company, China Netcom Group.
China Netcom Group has also registered the "CNC Connected" brand name as a
trademark for our broadband services targeted at business customers. On October
8, 2004, we entered into a new trademark licensing agreement with China Netcom
Group for our use of, among other things, the "CNC" brand name and logo, and
"CNC Connected" brand name. Under this agreement, China Netcom Group has agreed
to grant to us and our subsidiaries the right to use these trademarks on a
royalty-free basis for ten years, which is automatically renewable at our
option.
Billing services and credit control
We bill our residential customers on a monthly basis and payments are
usually due, depending on the location of the customer, within a month and a
half of the last date of the billing period. We provide a range of payment
choices for the convenience of our customers, including a direct-debit service,
which automatically deducts the monthly payment from the subscriber's designated
bank account. We also provide specially tailored billing and collection services
to our large business customers to help them more effectively plan and monitor
their telecommunications needs.
We charge a late payment fee on subscriber accounts that are not paid
by the monthly due date. We generally deactivate services for subscribers wose
accounts are more than 30 days overdue. These subscribers whose services have
been deactivated must pay all overdue amounts, including applicable late payment
fees, to reactivate their services. We will terminate a subscriber's service and
will remove him or her from the subscriber list if his or her account is overdue
for more than three months. We have implemented subscriber registration
32
procedures, including credit and background checking for PHS customers to
strengthen credit control. We also actively promote our prepaid telephone
services as a means of controlling bad debts. Upon the completion of the
upgrading of our local network to include intelligent functionalities, we will
gradually provide customers with detailed breakdown of fee charges.
Network Infrastructure
We operate a network which provides extensive coverage in China. This
network is technologically advanced and conducive to the introduction of the
next generation network and 3G technology. This network supports a wide range of
end-to-end fixed-line telecommunications services and enables customized
products to be delivered to meet a variety of telecommunications needs in
"real-time."
The network which we operate consists of transport networks, service
networks and support and information systems. The transport networks are
primarily fiber-optic based networks covering our northern service regions in
which we operate, supplemented by satellite transmission and digital microwave
links. The service networks, which support our basic and value-added
telecommunications services, consist of our local access networks, including PHS
networks, fixed-line telephone switch networks, Internet and data service
networks and intelligent networks. The support and information systems include
an operation support system and a business support system to support the
reliable and effective operation of our networks.
In 2006, we completed the construction of the double-plan long distance
exchange network, the large-customer network, the telecommunication IP carrier
network and the initial trials of our IPv6 project. In addition, we are in the
process of upgrading our network to include intelligent functionalities and
other supporting infrastructure. In 2006, our capital expenditure in broadband
and internet services increased by 38.7% from that of 2005 and our capital
expenditure in the PHS network decreased to RMB 2,748 from RMB 4,784 million in
2005.
Suppliers
We make most of our purchases through a competitive bidding process
primarily based on product and service quality, system compatibility and price.
Research and Development
Our research and development requirements are primarily fulfilled by
China Netcom Group in return for a service fee that is negotiated on a
case-by-case basis. These research and development activities are focused
primarily on operational planning and development of value-added services. China
Netcom Group has established a centralized research and development center. On
January 6 2006, China Netcom Group and its partners jointly established the
National Lab of Next Generation Network in Broadband Application. This lab is
the only national level research and development center in China in the
information and communications industry. Its research and development efforts
will focus on next generation internet IPv6, Triple-Play and 3G operating and
supporting systems.
Strategic Alliance with Telefonica
In November 2005, we entered into a strategic alliance agreement with
Telefonica Internacional S.A., or Telefonica, pursuant to which we and
Telefonica identified a number of areas in the telecommunications business for
potential cooperation. In 2006, we strengthened our cooperative relationship
with Telefonica in the areas of strategy, innovation, budgeting and operations.
We believe our cooperation with Telefonica has helped improve our management.
33
Competition
We compete with other telecommunications providers in virtually all
aspects of our business, including our fixed-line telephone services, broadband
and other Internet-related services, business and data communications services
and information communication technology services. All of our principal
competitors in China are telecommunications carriers wholly or majority-owned by
the PRC government, including three fixed-line service providers and two
licensed mobile service providers. In February 2007, our controlling
shareholder, China Netcom Group, entered into a one-year agreement with China
Telecommunications Corporation, the controlling shareholder of China Telecom,
whereby China Netcom Group agreed not to acquire new customers outside our
northern service region and China Telecommunications Corporation agreed not to
acquire new customers in our northern service region.
Fixed-line telephone services
In our northern service region, we are the dominant provider of
fixed-line telephone services, including local telephone services, domestic and
international long distance services and value-added services. We currently
compete with China Telecom, China Unicom and China Railcom, each of which has
been licensed to provide fixed-line telephone services in our northern service
region. In the markets for domestic and international long distance telephone
services, we face stronger competition from lower-priced VoIP services provided
by China Telecom, China Unicom, China Railcom and China Mobile. Mobile service
substitution for our fixed-line telephone services has also created considerable
competition for our local and long-distance telephone services. Currently, China
Mobile and China Unicom are the only licensed providers of mobile communications
services in China and, in recent years, some of the traffic from our fixed-line
networks has been diverted to these two companies. Our PHS services provide an
alternative for many of our existing and potential customers who would otherwise
choose mobile services instead of fixed-line services.
Internet-related access services; business and data communications
services; information and communications technology services
For Internet-related access services and business and data
communications services, we compete with China Telecom, China Unicom, China
Railcom and other Internet service providers on the basis of pricing, coverage
and quality of networks, ability to provide end-to-end connectivity, quality of
network management and customer service. Our major competitors for information
and communications technology services are other telecommunication operators
such as China Telecom, and system integration service providers such as Digital
China Holdings Limited and Taiji Computer Corporation Limited.
Potential competition from foreign operators
As a result of China's accession to the World Trade Organization, the
PRC government has agreed to open up over several years various segments and
regions of the telecommunications market in China to foreign investors. Foreign
operators entering into China's telecommunications market may have greater
financial, managerial and technical resources, and more expertise in network
management, sales and marketing than we do. See "Item 3. Key Information--Risk
Factors -- Risks Relating to Our Business -- Increasing competition in each of
our service regions and markets may have an adverse effect on our business
growth and financial condition -- Competition from foreign-invested operators
and other new entrants may further increase the competition for employees,
exacerbate price competition and increase our operating expenses, thereby
adversely affecting our financial condition and growth prospects." In order to
address the competition we face from foreign operators, we have formed strategic
alliances with some of our potential competitors, including Equant and Singtel.
34
REGULATION
Overview of Regulation of the Telecommunications Industry in China
The telecommunications industry in China is subject to extensive
government regulation. Under the State Council, a number of central government
authorities have regulatory responsibilities for various aspects of the
telecommunications industry. These authorities primarily include:
o The Ministry of Information Industry, or the MII, which is
responsible for, among other things:
o formulating and enforcing telecommunications industry
policies and regulations as well as technical standards;
o granting telecommunications service licenses;
o supervising the operations and quality of service of
telecommunications operators;
o allocating and administering telecommunications resources,
such as spectrum and numbers;
o together with other relevant government regulatory
authorities, formulating tariff standards;
o formulating interconnection and settlement policies between
telecommunications networks; and
o maintaining fair and orderly market competition among
operators;
o Provincial telecommunications administrations under the MII, which
oversee the implementation of the MII's regulations and exercise
regulatory authority delegated by the MII within their respective
provinces, autonomous regions and municipalities; and
o The National Development and Reform Commission, or the NDRC,
which, together with the MII, sets government fixed tariffs and
government guidance tariffs for certain telecommunications
services. See "-- Tariff Setting" below. It also approves
investment projects within the restricted sectors specified in the
annually adjusted catalogue released by the State Council.
The PRC government is in the process of drafting a telecommunications
law. We expect that, if and when the telecommunications law is adopted by the
National People's Congress or its standing committee, it will become the basic
telecommunications statute and provide a regulatory framework for the
telecommunications industry in China.
Telecommunications Regulations
The Telecommunications Regulations, effective as of September 25, 2000,
were promulgated by the State Council, and provide the primary regulatory
framework for China's telecommunications industry in the interim period prior to
the finalization and adoption of the telecommunications law. The stated goals of
the Telecommunications Regulations are to develop a transparent and fair
regulatory environment to encourage fair and orderly competition and the
development in the telecommunications industry. The key aspects which the
Telecommunications Regulations address include entry into the telecommunications
industry, network interconnection, telecommunications resource allocation,
tariffs and service standards.
35
Licensing
The Telecommunications Regulations distinguish between basic and
value-added telecommunications services, which are subject to different
licensing requirements. According to the Catalog of Telecommunications Services,
as promulgated by the MII and effective as of April 1, 2003:
o basic telecommunications services include, among other things,
fixed-line local and domestic long distance telephone services,
international telecommunications services, IP telephone services,
mobile communications services (such as 900/1800MHz GSM, 800MHz
CDMA and 3G mobile communications services), satellite
communications services, paging services, data communications
services (such as Internet data transmission services,
international data communications services), network access
services and the domestic and international telecommunications
facility services; and
o value-added telecommunications services include, among other
things, IP-VPN services, call center, voice mail and video
conferencing call services, Internet data center and Internet
access services, electronic data interchange services and
information services.
Under the Telecommunications Regulations, all telecommunications
operators in China must obtain a telecommunications service operating license
from the MII or from the provincial telecommunications administrations.
Providers of value-added services within a single province are required to
obtain licenses from provincial telecommunications administrations. Providers of
basic telecommunications services and providers of value-added services in two
or more provinces, autonomous regions and municipalities are required to obtain
licenses from the MII. TD-SCDMA technology is one of the three technologies
adopted by the International Telecommunications Union and under review by the
PRC government for use in providing 3G mobile telephone services. The MII is
currently conducting tests on TD-SCDMA related products. The PRC government has
not publicly announced its decisions on issues such as the timing of the grant
of the 3G licenses, the number of 3G licenses to be granted, any technical
requirements, or any selection of preferred technologies. In accordance with the
approval of the MII, CNC China, our principal operating subsidiary in China, as
an indirect subsidiary of China Netcom Group, has the right to operate our
telecommunications business in ten provinces and municipalities under the
authorization of China Netcom Group, which holds the license required for
operating our telecommunications businesses in China.
Tariff Setting
Overview
Our current tariffs are subject to regulation by various government
authorities, including the MII, the NDRC and, at the local level, the relevant
provincial telecommunications administrations and price bureaus. Under the
Telecommunications Regulations, telecommunications tariffs are categorized into
government-fixed tariffs, government guidance tariffs and market-based tariffs.
The monthly fee and usage fee for local telephone service are regulated
as fixed tariffs, which are fixed jointly by the MII and the NDRC. The MII
regulates the maximum tariffs for traditional domestic long distance services,
traditional international long distance services to Hong Kong, Macau and Taiwan.
Leased line and data services (other than ATM service) are charged at
government-guidance tariffs, which are determined jointly by the MII and the
NDRC. We derive a substantial portion of our revenues from services that are
subject to government guidance tariffs and government-fixed tariffs.
The Notice on Implementation of Market-Based Tariffs for Certain
Telecommunications Services, promulgated jointly by the MII and the NDRC in
2002, specifies the telecommunications businesses to which market-based tariffs
are applicable, including VoIP, Internet access services, and certain
value-added services provided over fixed-line telephone networks, such as
telephone information, caller identification and voice mail. Market-based
tariffs shall be applicable to those telecommunications services for which
effective competition exists
36
in the market. The tariffs of such telecommunications services are determined at
the sole discretion of the operators, and will be implemented after filing with
the MII or provincial telecommunications administrations, as applicable. There
is uncertainty regarding how the MII determines the existence of effective
competition, as the MII has not publicly disclosed the criteria it uses for
determining whether a certain type of service should be subject to market-based
tariffs. Under the Telecommunications Regulations, cost is the primary basis for
tariff setting, but the tariff levels also take into account social and economic
development, the development of the telecommunications industry and the
purchasing power of the customers. The MII has not provided a timetable for
tariff deregulation or indicated that operators will eventually be permitted to
freely set all tariffs. We expect that increased flexibility in setting certain
tariffs will allow us to better respond to changes in market demand and
competitive conditions.
In December 2000, the PRC government issued a notice of tariff
adjustments. The tariff adjustments changed the tariff levels for various
telecommunications services, including local and long distance telephone, data
and leased line services. In general, these adjustments have stimulated the
overall usage of our telecommunications services. In July 2001, the government
eliminated the upfront connection fee for fixed-line telephone services. For a
discussion of the impact of these adjustments on our financial condition and
results of operations, see "Item 5. Operating and Financial Review and
Prospects."
The PRC government retains the ultimate authority to adopt changes to
tariffs. However, the Telecommunications Regulations require the government to
hold public hearings before setting or changing a fixed or guidance tariff,
which should be attended by, among others, telecommunications operators and
consumers. In 2002, the MII indicated in writing that it did not intend to
initiate any adjustment to tariffs for fixed-line local telephone services
during the three to five years commencing in September 2002. Our average
realized tariffs may vary from levels set forth below. See "Item 3. Key
Information--Risk Factors -- Risks Relating to the PRC Telecommunications
Industry -- New regulations, regulatory changes or changes in enforcement
policies relating to telecommunications tariffs may adversely affect our
competitiveness, business and profitability."
Tariffs
The following tables set forth the tariff rates of certain services
provided by us, where government fixed tariffs or government guidance tariffs
are applicable.
Local telephone services
For our local telephone services, we charge a registration fee for
initial installation that varies depending on whether the subscriber is a
residential or a business customer, a fixed monthly fee, local call usage fees
based on call duration and fees for certain value-added services. The following
table sets forth our current tariffs for local telephone services provided on
our traditional and PHS network:
Tariff (in RMB)
---------------------------------------------
Monthly fee:
Residential subscribers in:
Provincial capitals........... 20.00 to 25.00
Other cities and counties..... 12.00 to 18.00
Rural areas................... 10.00 to 15.00
Business subscribers.......... 25.00 to 35.00
Usage fee:
Intra-district................. 0.18.to 0.22 for the first two pulses (first
three minutes or less) and 0.09 to 0.11 for
each additional pulse (one minute intervals)
Inter-district................. up.to 0.40 per pulse (one minute intervals)
Communication fee:
Internet dial-up............... 0.02.per pulse (one minute intervals)
37
Domestic long distance services
Our revenues from domestic long distance services consist of charges
based on the duration, time of day and day of the week a call is placed. The
following table sets forth the current tariffs for our domestic long distance
telephone services using our traditional network:
Tariff (in RMB)
------------------------
Domestic long distance services
on our traditional Network....................... 0.07 per six seconds(1)
___________________
(1) Subject to filing with the provincial telecommunications administrations,
our provincial level headquarters may apply a 10% to 50% discount rate to
calls made during off-peak hours.
International long distance services
The MII regulates the maximum tariffs that we may charge for
international long distance services. The following table sets forth our current
international long distance tariffs:
Tariff (in RMB)
----------------------
International long distance services on
our traditional network(1):
To Hong Kong, Macau and Taiwan.......................... 0.20 per six seconds
To all international destinations....................... 0.80 per six seconds
_____________________
(1) Subject to filing with the provincial telecommunications administrations,
our provincial level headquarters may apply a 10% to 50% discount rate to
calls made during off-peak hours.
Managed data services
The PRC government publishes guidance tariffs for certain managed data
services, including DDN and frame relay services, provided by operators in
China. Interim tariffs for our ATM services are determined at our discretion,
subject to approval by the MII. An initial fee is generally charged for
installation and testing for our data services, as well as a fixed monthly fee
for each of the services.
DDN services
The following table sets forth the monthly fees for DDN services at the
bandwidths of 64kbps, 128kbps, 512kbps and 1Mbps:
Monthly Fee
--------------------------------------
64kbps 128kbps 512kbps 1Mbps
--------------------------------------
(RMB)
Intra-district..................... 1,500 2,000 3,800 5,000
Inter-district..................... 2,000 2,500 5,200 7,500
Domestic long distance............. 3,500 5,000 7,000 9,000
Frame relay services
The following tables set forth the monthly fees for frame relay
services, which include monthly fees for port access and permanent virtual
circuits, or PVCs(1):
Monthly Fee
--------------------------------------
64kbps 128kbps 512kbps 1Mbps
--------------------------------------
(RMB)
Port Access
Monthly fees........................ 260 400 500 1,000
PVC
Intra-district........................ 550 800 1,000 1,500
Inter-district........................ 800 1,150 1,450 2,200
Domestic long distance................1,700 2,200 2,500 4,000
_________________
(1) One-way tariff for PVCs frame relay services. Leased line services
38
We charge monthly fees for subscribers to our leased line services
based on guidance tariffs set by the PRC government, which vary based on
bandwidth and whether the leased line is local or long distance. Leased line
tariffs have generally decreased in recent years.
The following table sets forth the tariffs for 2Mbps, 8Mbps, 34Mbps and
155Mbps digital circuits:
Monthly Fee
--------------------------------------
64kbps 128kbps 512kbps 1Mbps
--------------------------------------
(RMB)
Intra-district...................... 2,000 6,000 16,000 44,000
Inter-district...................... 4,000 11,000 31,000 88,000
Domestic long distance(1)........... 6,000 17,000 47,000 132,000
____________________
(1) Does not include the tariffs for local digital circuits and access lines.
Interconnection
According to the Telecommunications Regulations and the Administrative
Rules on Interconnection between the Public Telecommunications Networks, as
promulgated by the MII in May 2001, major telecommunications operators in China
may not refuse a request from another operator to interconnect with its network.
Upon such a request, the relevant operator shall enter into an interconnection
agreement with the other operator, and file such agreement with the MII. In
addition, interconnection agreements may not be terminated unilaterally without
an approval from the MII.
The Telecommunications Regulations further provides that the MII shall
establish rules relating to technical standards and settlement procedures of
interconnection. Accordingly, the MII promulgated the Measures on Settlement of
Usage Fees between Telecommunications Networks in March 2001, which specify the
methods for revenue sharing and settlement between telecommunications operators.
China Netcom Group has entered into agreements on interconnection with other
telecommunications operators, including China Telecom, China Mobile, China
Unicom, China Railcom and China Satcom.
In December 2003, the MII revised the rules on interconnection
technical standards and settlement procedures for public telecommunications
networks by promulgating the Measures on Settlement of Interconnection between
Public Telecommunications Networks and Sharing of Relaying Fees.
The following table sets forth selected current major interconnection
revenue sharing and settlement arrangements for local calls, as established in
the 2003 rules:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
--------------------------- --------------------------- --------------------------------------------------
Mobile operator Local fixed-line operator (1) Mobile operator collects the cellular usage
fees from its subscribers. (2) Mobile operator
pays RMB 0.06 per minute to local fixed-line
operator.
--------------------------- --------------------------- --------------------------------------------------
Local fixed-line operator Mobile operator No revenue sharing or settlement.
--------------------------- --------------------------- --------------------------------------------------
Local fixed-line operator A Local fixed-line operator B (1) Operator A collects the usage fees from its
subscribers. (2) In the case of (i) intra-district
calls, operator A pays operator B 50% of the
intra- district usage fees; or (ii) inter-district
calls (x) where operator A does notuse the
inter-district transmission facilities of operator
B, operator A pays operator B 50% of the
intra-district usage fees; or (y) where operator A
uses operator B's inter-district transmission
facilities, operator A pays operator B 90% of the
inter-district usage fees.
39
The following table sets forth selected current major main
interconnection revenue sharing and settlement arrangements for domestic long
distance calls:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
--------------------------- --------------------------------------- -------------------------------------
Local fixed-line or mobile Local fixed-line or mobile operator B, RMB 0.06 per minute to operator A, RMB
operator A through the long distance network of 0.06 per minute to operator B, the
operator C balance for operator C.
The following table sets forth selected current major main
interconnection revenue sharing and settlement arrangements for international
long distance calls, including calls originated from and terminated in Hong
Kong, Macau and Taiwan:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
--------------------------- ------------------------------------------- --------------------------------------
Domestic fixed-line or mobile International long distance operator B, RMB 0.06 per minute to operator A, no
operator A through the domestic long distance network greater than RMB 0.54 per minute to
of operator C to international gateway operator C, the balance to operator B.
The following table sets forth selected current main interconnection
revenue sharing and settlement arrangements for VoIP long distance calls:
Operator from whose Network Operator at whose Network
Calls are Originated Calls are Terminated Settlement Arrangement
--------------------------- ------------------------------------------- --------------------------------------
Fixed-line or mobile operator A Fixed-line or mobile operator B (1) Operator C collects the VoIP long
through the VoIP network of operator C distance usage fees from its subscribers.
(2) Operator C pays RMB 0.06 per minute to
operator B on the terminating end.
(3) No settlement between operator C and
operatorA on the originating end.
(4) Operator A collects local usage fees.
Effective November 1, 2002, the Ministry of Information Industry has
unified the minimum level of the termination rate for international calls,
including for this purpose calls from Hong Kong, Macau and Taiwan, terminating
in China. Such termination rate is required to be no less than US$0.17 per
minute, but can be higher based upon negotiations between the carriers.
Technical Standards
The MII sets industry technical standards for telecommunications
terminal and interconnection-related equipment used in the public
telecommunications networks. A network access license from the MII and other
relevant regulatory authorities is required for all such equipment. Most of the
standards set by the MII conform to standards recommended by the International
Telecommunications Union and other international telecommunications standards
organizations.
40
Capital Investment
Prior to July 16, 2004, the State Council authorized the NDRC to
approve any plan to construct a nationwide telecommunications network or any
network construction plan involving a capital investment that totals from RMB 50
million to RMB 200 million. The State Council also authorized the MII to approve
certain aspects of such investment projects. Any investment project with total
capital investment in excess of RMB 200 million was required to obtain approval
from the State Council.
On July 16, 2004, the State Council promulgated, effective immediately,
the Decision on Reform of Investment System, or the Investment Reform Decision,
which significantly modified the government approval process for major
investment projects in China. The Investment Reform Decision eliminated the
government approval requirements for investment projects that do not involve
direct government funding unless the investment projects are in the restricted
sectors specified in the annually adjusted catalogue released by the State
Council. The 2004 catalogue, which was attached as an annex to the Investment
Reform Decision, sets forth approval requirements for individual investment
projects in restricted sectors. Within the telecommunications sector, the
investment projects that require the NDRC's approval include:
o domestic backbone transmission networks (including broadcasting
and television networks);
o international telecommunications transmission circuits;
o international gateways;
o international telecommunications facilities for dedicated
telecommunications networks; and
o other telecommunications infrastructure projects involving
information security.
Accessing International Capital Markets
Prior to accessing the international capital markets, we may be
required to obtain approval from various government authorities depending on the
type of international financing we intend to seek. For example, documents
relating to our future public offerings of new shares must be filed with the
China Securities Regulatory Commission, or the CSRC. If such offerings involve
certain new acquisitions of assets or exchanges of equity interest within China,
the CSRC's prior approval will be required. In addition, China Netcom Group and
our other state-owned shareholders are required to obtain approval from relevant
PRC government authorities prior to their participation in any future share
offering by our company confirming their respective sales of shares and related
contributions to the PRC national social security fund, as required by PRC law.
Furthermore, any use of the proceeds that we receive from international capital
markets by CNC China, either as a shareholder loan or as a capital contribution,
will be subject to registration or approval requirements under PRC law.
Telecommunications Resources
The MII is responsible for the administration and allocation of
telecommunications resources in China, including spectrum frequencies and
telecommunications network numbers. The use of these resources by
telecommunications operators is subject to the approval of the MII or the
relevant provincial telecommunications administrations or provincial radio
administrations and the payment of a telecommunications resources usage fee. The
provincial radio administrations have allocated the 1900-1915 MHz frequency
spectrum to us for PHS services, and we have the exclusive rights to use that
frequency spectrum in our northern service region. On January 1, 2005, the MII
issued a regulation imposing fees for the use of telephone numbers. Under the
regulation, starting from April 1, 2005, all telecommunications operators,
including us, are required to pay RMB 0.01 per telephone number per month.
41
Quality of Service
Under the Telecommunications Regulations, the MII and the relevant
provincial telecommunications administrations are responsible for supervising
and monitoring the quality of services provided by telecommunications operators
in China. Under the Telecommunications Regulations, customers of
telecommunications operators have the right to submit their complaints to the
MII and the relevant provincial telecommunications administrations or other
relevant government authorities.
Universal Services Obligations
Under the Telecommunications Regulations, telecommunications operators
in China are required to fulfill universal service obligations in accordance
with relevant regulations to be promulgated by the PRC government, and the MII
has the authority to delineate the scope of universal service obligations. The
MII, together with governmental finance and pricing authorities, is also
responsible for formulating administrative rules relating to the establishment
of a universal service fund and compensation schemes for universal services.
These rules have not yet been promulgated, and there are currently no specific
regulatory requirements relating to the provision of universal services in
China.
While the scope of specific universal services obligations is not yet
clear, we believe that such services may include mandatory provision of basic
telecommunications services in economically less developed areas in China. The
MII requires China Telecom, China Netcom Group, China Mobile, China Unicom,
China Railcom and China Satcom to participate in a project to provide telephone
services in a number of remote villages in China as transitional measures prior
to the formalization of a universal service obligation framework. In order to
fulfill such obligations under those transitional measures, China Netcom Group
has agreed with us that it will assume the responsibility for investing in and
constructing the necessary network facilities. If we operate and maintain such
network facilities in our northern service regions, China Netcom Group has
agreed to compensate us for the related expenses based on fair market value.
42
ORGANIZATIONAL STRUCTURE
Our Shareholding Structure
The following chart sets forth our main operational and shareholding
structure as of April 30, 2007.
_______________________________
| China Network Communications |
| Group Corporation(1)(2) |
| ("China Netcom Group") |
| (PRC)(6) |
|_______________________________|
|
|
______________|________________ _____________________ _____________________ _____________________
| China Network | | | | | | |
| Group Corporation (BVI) | | | | | | |
| Limited(4) | | Five PRC | | Telefonica | | Public |
| ("CNC BVI") | | Shareholders (3) | | Internacional S.A. | | Shareholders |
| (British Virgin Islands | | | | | | |
|_______________________________| |_____________________| |_____________________| |_____________________|
| | | |
| 69.88%(5) | 4.47%(5) | 4.99% | 20.66%
|_____________________________|__________________________|___________________________|
|
|
________________|___________________
| China Netcom Group |
| Corporation (Hong Kong) Limited(4) |
| ("CNC Hong Kong", "Company", |
| "we" or "us") |
| (Hong Kong)(6) |
|____________________________________|
|
|
___________________________________|_______________________________
| | |
| 100% | 100% | 100%
______________|_____________ _____________|_____________ _______________|______________
| China Netcom (Group) | | China Netcom Group New | | China Netcom Corporation |
| Compnpay Limited(2) | | Horizon Communications | | International Limited(4) |
| ("CNC China") | | Corporation (BVI) Limited | | (Bermuda)(6) |
| (PRC)(6) | |(British Vigin Islands)(6) | | |
|____________________________| |___________________________| |______________________________|
| | |
| | |100%
| | _________________________________________|__________________________________
| | | | | |
| | | | | |
| | _________|___________ _________|____________ ___________|___________ __________|__________
| | |China Netcom (Japan) | | China Netcom | | China Netcom (USA) | | China Netcom (Hong|
| | | Operations | | (Europe) | | Operations Limited(2) | | Kong) |
|100% 100%| | Corporation(2) | |Operations Limited(2) | | (US.)(6)(7) | |Operations Limited(2)|
| | | (Japan)(9) | | (UK)(8) | | | | (Hong Kong)(6)(7) |
| | |_____________________| |______________________| |_______________________| |_____________________|
| |
| |
____|_______________ _|_________________
| China Netcom Group | |China Netcom Group |
| Broadband Online | |System Integration |
| Limited Corporation| |Limited Corporation|
| (PRC)(6)(10) | |(PRC)(6)(11) |
|____________________| |___________________|
43
___________________
(1) China Netcom Group is a wholly state-owned enterprise. China Netcom Group
is the parent of wholly owned subsidiaries that, following the
restructuring, include China Netcom (Holdings) Company Limited, or China
Netcom Holdings, an investment holding company, and telecommunications
companies outside our northern service region. None of these subsidiary
companies have any ownership interest in us, nor do we have any ownership
interest in them.
(2) The principal business is provision of telecommunications services.
(3) Our five PRC shareholders, all of which are established in the PRC, are:
o Chinese Academy of Science Holdings Co., or the Academy of Sciences;
o Information and Network Center of the State Administration of Radio,
Film and Television, or INC-SARFT;
o China Railways Telecommunications Center, or CRTC;
o Shanghai Alliance Investment Limited, or Shanghai Alliance; and
o Shandong Provincial State-owned Assets Supervision and Administration
Commission, or Shandong SASAC.
(4) The principal business is investment holding.
(5) All of the ordinary shares owned by our five PRC shareholders are
registered in the name of China Netcom Group Corporation (BVI) Limited, or
CNC BVI, which holds such ordinary shares in trust for each of the five PRC
shareholders. Consequently, the ownership percentages of our five PRC
shareholders in the chart above reflect the aggregate beneficial interests
of these shareholders as held through CNC BVI. The ownership of CNC BVI as
indicated in the table above reflects CNC BVI's own beneficial ownership.
(6) Indicates jurisdiction of incorporation.
(7) Previously wholly-owned subsidiaries of Asia Netcom. The ownership of each
of these entities was transferred to China Netcom Corporation International
Limited as of March 15, 2006.
(8) Incorporated in the United Kingdom on November 8, 2006.
(9) Incorporated in Japan on January 25, 2007.
(10) Incorporated in the PRC in March , 2006.
(11) Incorporated in the PRC in April, 2006.
Sale of Asia Netcom
On August 22, 2006, we sold our 100% equity interest in Asia Netcom to
Connect Holdings Limited for US$168.84 million. See "--History and
Development--Sale of Asia Netcom."
Recent Development - Sale of Southern Service Region Business
On February 28, 2007, we sold our telecommunications assets,
liabilities and business operations in our southern service region to China
Netcom Group for a cash consideration of RMB 3,500 million. China Netcom Group
assumed an aggregate principal amount of RMB 3,000 million of debt which is due
and owing from the Guangdong and Shanghai branches to independent third parties
upon completion of the sale.
PROPERTY, PLANT AND EQUIPMENT
Our principal executive offices are located in Beijing. We also
maintain an executive office in Hong Kong. We own, lease or have usage rights in
various properties, which consist of offices, administrative centers, staff
quarters, retail outlets and technical facilities. We have certain properties
transferred to us by China Netcom Group which do not have vested proper legal
titles, and we have certain properties the titles for which have not been
transferred to us. We believe it is unlikely that we would be denied our right
to use a large number of these properties with title defects at any given time.
China Netcom Group agreed to indemnify us against any loss or damage suffered or
incurred by us, caused by or arising from any challenge to or interference with
our title to and/or right to use properties transferred to us in respect of
which we have not obtained long-term title certificates or those properties
rented by us from China Netcom Group where there are title defects.
ITEM 4A. UNRESOLVED STAFF COMMENTS
None.
44
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following discussion and analysis should be read in conjunction
with our consolidated financial statements and selected consolidated financial
data, in each case together with the accompanying notes, all included elsewhere
in this annual report.
On August 22, 2006, we sold our 100% equity interest in Asia Netcom.
The results of operations of Asia Netcom have been classified as discontinued
operations. Unless otherwise specified, the following analysis is made on the
basis of continuing operations.
OVERVIEW
We are a leading broadband communications and fixed-line
telecommunications operator in China and a dominant provider of fixed-line
telephone services, broadband and other Internet-related services, as well as
business and data communications services in our northern service region.
In 2006, we faced increasing mobile substitution and as a result
experienced increasing migration of fixed-line voice traffic, particularly local
fixed-line voice traffic, to mobile services. In an effort to mitigate the
effect of mobile substitution on our fixed-line telephone services, we
strengthened our broadband and other Internet-related services, introduced a
variety of value added services and began offering information and
communications technology services in 2006.
Our profit before tax decreased by RMB 2,844 million, or 16.2%, to RMB
14,700 million in 2006 compared to RMB 17,544 in 2005. The decrease in our
profit before tax from 2005 to 2006 was primarily due to:
o our revenues from local fixed-line telephone services decreased by
RMB 3,953 million from RMB 44,285 million in 2005 to RMB 40,332
million in 2006, primarily as a result of mobile substitution;
o our operating expenses increased by RMB 2,432 million from RMB
65,130 million in 2005 to RMB 67,562 million in 2006;
o deficit on revaluation of assets increased by RMB 1,524 million
from nil in 2005 to RMB 1,524 in 2006;
and partially offset by:
o an increase of RMB 2,833 million in revenues from our broadband
and other Internet-related services from 2005 to 2006; and
o an increase of RMB 788 million in revenues from our information
and communications technology services.
FACTORS AFFECTING OUR RECENT RESULTS OF OPERATIONS
Sale of Asia Netcom
On August 22, 2006, we sold our 100% equity interest in Asia Netcom to
Connect Holdings Limited for US$168.84 million. The results of operations of
Asia Netcom have been classified as discontinued operations, and
45
our consolidated income statements and cash flow statement for the years ended
December 31, 2004 and 2005 have been restated to reflect the results of our
remaining operations, or the continuing operations. The revenue of Asia Netcom,
the major source of revenue of our international telecommunication services, has
accordingly been separately disclosed as discontinued operations for the years
ended December 31, 2004 and 2005. Since the remaining revenue derived from our
international telecommunication services historically has not been material, we
do not separately set forth the revenue from our remaining international
telecommunication services. The following table presents the income statement
and cash flow statement related to Asia Netcom.
For the year ended 31 December, For the period ended
--------------------------------------------------------
2004 2005 22 August, 2006
--------------------------------------------------------
(in millions of RMB)
Revenues......................................................... 1,213 1,371 980
Loss for the period/year of discontinued operations.............. (711) (226) (59)
Net gain from disposal of discontinued operations................ - - 1,878
Gain/(loss) for the period/year from discontinued operations..... (711) (226) 1,819
Net cash inflow from operating activities........................ (474) 74 183
Cash outflow from investing activities........................... (228) (312) (182)
Cash inflow from disposal of ANC Group........................... - - 1,164
Net cash outflow for investing activities........................ (228) (312) 982
Net cash inflow from financing activities........................ 503 108 -
Cash flow from discontinued operations........................... (199) (130) 1,165
The following table presents the composition of net liabilities of Asia
Netcom as at August 22, 2006
As at August 22, 2006
---------------------
(in millions of RMB)
Accounts receivable and other current assets............. 504
Fixed assets and other non-current assets................ 1,997
Current portion of deferred income....................... (308)
Accounts payable and other current liabilities........... (592)
Non-current portion of deferred income................... (2,286)
Exchange differences realized............................ (29)
Net liabilities(excluding the cash and cash equivalents) (714)
Our 2005 Acquisition
On October 31, 2005, we acquired from China Netcom Group the fixed-line
telecommunications assets and related liabilities in Heilongjiang Province,
Jilin Province, the Neimenggu Autonomous Region and Shanxi Province. Since we
and the 2005 Acquired Assets and Liabilities were under the common control of
China Netcom Group, our 2005 Acquisition has been treated as a "combination of
entities under common control" which was accounted for in a manner similar to
pooling-of-interests. Accordingly, the 2005 Acquired Assets and Liabilities have
been recognized at carrying amounts and our financial statements as of and for
the year ended December 31, 2004 have been restated to include the financial
position and results of operations of the 2005 Acquired Assets and Liabilities
on a combined basis. All data and information relating to our businesses and
operations for the year ended December 31, 2004 are presented based on those
restated amounts.
The following table presents a summary of the results of operations of
each of our company, previously reported by us, and the 2005 Acquired Assets and
Liabilities for the year ended December 31, 2004 and the shareholders' equity as
of December 31, 2004, and the combined amounts presented in our consolidated
financial statements included elsewhere in this annual report. For the periods
presented, all significant balances and transactions between our company and
China Netcom Group in relation to the 2005 Acquired Assets and Liabilities prior
to our 2005 Acquisition have been eliminated.
46
Our Company (as
previously 2005 Acquired
reported) Assets Combined
---------------- ---------------- ---------
(in millions of RMB)
2004
Continuing operations:
Operating revenue............................... 63,665 18,616 82,281
Operating income/(loss) ........................ 16,058 (9,204) 6,854
Net income/(loss)............................... 9,941 (6,531) 3,410
Basic earnings/(loss) per share (RMB)........... 1.77 (1.16) 0.61
Financial condition:
Current assets as of December 31, 2004.......... 20,937 3,518 24,455
Total assets as of December 31, 2004............ 165,175 51,242 216,417
Current liabilities as of December 31, 2004..... 72,304 33,740 106,044
Total liabilities as of December 31, 2004....... 110,010 41,812 151,822
Shareholders' equity as of December 31, 2004.... 55,165 9,430 64,595
Revaluation of our fixed assets
As required by the relevant PRC regulation, China Enterprise Appraisal,
conducted an appraisal of 2005 Acquired Assets and Liabilities as of December
31, 2004 on a depreciated replacement cost basis. This revaluation resulted in a
net reduction in the book value of the fixed assets acquired as part of the 2005
acquisition other than land and buildings in the amount of RMB 7,455 million.
According to our accounting policy under HKFRS, China Enterprise
Appraisal, conducted an appraisal of all our fixed assets (excluding land and
buildings) located in China as of December 31, 2006 on a depreciated replacement
cost basis. This revaluation resulted in a net reduction in the book value of
our fixed assets as of December 31, 2006 in the amount of RMB 453 million
For the purpose of preparing our financial statements, the effect of
the revaluations performed in 2004 was reflected in our consolidated financial
statements as a charge of RMB 11,318 million on our consolidated income
statements in the form of a deficit on revaluation of fixed assets in 2004 and
surplus of RMB 3,863 million that was credited to the revaluation reserve on
December 31, 2004.
For the purpose of preparing our financial statements, the effect of
the revaluations performed in 2006 was reflected in our consolidated financial
statements as a charge of RMB 1,524 million on our consolidated income
statements in the form of a deficit on revaluation of fixed assets in 2006 and a
surplus of RMB 1,071 million that was credited to the revaluation reserve on
December 31, 2006.
The revaluations had the effect of significantly and adversely
affecting our profits in each of 2004 and 2006 and will also have the effect of
decreasing future annual depreciation and amortization charges.
RESULTS OF OPERATIONS
The table below sets forth a breakdown of the revenues of our services
and total operating expenses in terms of amount and as a percentage of our total
revenues, as well as net cash flow, for the periods indicated. On August 22,
2006, we sold our 100% equity interest in Asia Netcom to Connect Holdings
Limited for US$168.84 million. The results of operations of Asia Netcom have
been classified as discontinued operations, and our consolidated income
statements and cash flow statement for the years ended December 31, 2004 and
2005 have been restated. The revenue of Asia Netcom, the major source of revenue
of our international telecommunication services, has accordingly been separately
disclosed as discontinued operations for the years ended December 31, 2004 and
2005. Since the remaining revenue derived from our international
telecommunication services historically has not been material, we do not
separately set forth the revenue from our remaining international
telecommunication services. Unless otherwise specified, the following analysis
is made on the basis of continuing operations.
47
For the Years Ended December 31,
--------------------------------
2004 2005 2006
----------------------- --------------------- ---------------------
Percentage Percentage Percentage
of of of
Amount Revenues Amount Revenues Amount Revenues
------ ------------ -------- ------------ ------- -----------
(Restated) (Restated)
(millions of RMB, except percentage data)
CONTINUING OPERATIONS
Revenues:
Fixed-line telephone services(1):
Local:
Local usage fees 24,858 30.2% 24,582 28.6% 22,274 25.6%
Monthly fees 17,964 21.8% 18,261 21.3% 16,689 19.2%
Upfront installation fees 1,568 1.9% 1,442 1.7% 1,369 1.6%
Subtotal 44,390 53.9% 44,285 51.6% 40,332 46.4%
Domestic long distance(2) 11,266 13.7% 10,260 11.9% 10,185 11.7%
International long distance(2)(3) 1,285 1.6% 1,180 1.4% 1,160 1.3%
Value-added services 2,993 3.6% 4,000 4.7% 5,421 6.2%
Interconnection fees 6,453 7.8% 7,783 9.0% 8,400 9.7%
Upfront connection fees(4) 4,346 5.3% 3,405 4.0% 2,406 2.8%
Subtotal 26,343 32.0% 26,628 31.0% 27,572 31.7%
Broadband and other Internet-related
services:
Broadband services 5,307 6.5% 7,824 9.1% 10,556 12.1%
Other Internet-related services 1,075 1.3% 591 0.7% 692 0.8%
Subtotal 6,382 7.8% 8,415 9.8% 11,248 12.9%
Business and data communications
services:
Managed data services 1,584 1.9% 1,656 1.9% 1,505 1.8%
Leased line income 2,591 3.2% 2,596 3.0% 2,974 3.4%
Subtotal 4,175 5.1% 4,252 4.9% 4,479 5.2%
Information and communication technology
services - - - - 788 0.9%
Other services 991 1.2% 2,281 2.7% 2,502 2.9%
Total 82,281 100.0% 85,861 100.0% 86,921 100.0%
Operating Expenses:
Depreciation and amortization (24,873) -30.2% (24,919) -29.0% (25,608) -29.5%
Network, operations and support (13,092) -15.9% (13,465) -15.7% (14,383) -16.5%
Staff costs (11,630) -14.1% (12,034) -14.0% (12,151) -14.0%
Selling, general and administrative (12,617) -15.3% (13,322) -15.5% (13,366) -15.4%
Other operating expenses (1,982) -2.5% (1,390) -1.7% (2,054) -2.3%
Total (64,194) -78.0% (65,130) -75.9% (67,562) -77.7%
Other income - - - - 621 0.7%
Interest and dividend income 85 0.1% 160 0.2% 132 0.2%
Deficit on revaluation of fixed assets (11,318) -13.8% - - (1,524) -1.8%
Profit from operations 6,854 8.3% 20,891 24.3% 18,588 21.4%
Finance costs (3,769) -4.6% (3,347) -3.9% (3,888) -4.5%
Share of loss of associated companies and
jointly controlled entity (1) 0.0% - - - -
Profit before taxation 3,084 3.7% 17,544 20.4% 14,700 16.9%
Taxation 326 0.4% (3,430) -4.0% (3,559) -4.1%
Profit after taxation 3,410 4.1% 14,114 16.4% 11,141 12.8%
Minority interests - - - - - -
Profit for the year from continuing operations 3,410 4.1% 14,114 16.4% 11,141 12.8%
DISCONTINUED OPERATIONS
Loss/(profit) for the year from discontinued
operations (711) - (226) - 1,819 -
Profit for the year 2,699 - 13,888 - 12,960 -
48
CONTINUING OPERATIONS
Net cash inflows from operating activities 34,127 41.5% 33,483 39.0% 33,950 39.1%
Net cash outflows from investing activities (28,474) -34.6% (24,296) -28.3% (25,973) -29.9%
Net cash outflows from financing activities (2,246) -2.7% (14,764) -17.2% (6,447) -7.4%
Increase/(decrease) in cash from continuing
operations 3,407 4.2% (5,577) -6.5% 1,530 1.8%
DISCONTINUED OPERATIONS
Net cash (outflow)/inflow from operating
activities of discontinued operation (474) - 74 - 183 -
Net cash (outflow)/inflow from investing
activities of discontinued operations (228) - (312) - 982 -
Net cash inflow from financing activities
of discontinued operations 503 - 108 - - -
Increase/(decrease) in cash from
discontinued operations (199) - (130) - 1,165 -
Increase/(decrease) in cash and cash
equivalents 3,208 - (5,707) - 2,695 -
______________________
(1) Includes revenues from our PHS services.
(2) Includes revenues from our long distance VoIP services.
(3) Includes revenues from calls to Hong Kong, Macau and Taiwan.
(4) Upfront connection fees for basic telephone access services were eliminated
by the MII in July 2001.
Operating results for the year ended December 31, 2006 and the year ended
December 31, 2005
Revenues
Our revenues consist of revenues from the provision of
telecommunications services, net of business tax and government levies. Sources
of our revenues include fees charged for the provision of fixed-line telephone
services, broadband and other Internet-related services, business and data
communications services, and other services, and revenues from our information
and communication technology services.
Our revenue for 2006 amounted to RMB 86,921 million, of which upfront
connection fees amounted to RMB 2,406 million. Excluding upfront connection
fees, our revenue for 2006 would amount to RMB 84,515 million, representing a
growth of RMB 2,059 million, or 2.5%, from our revenue (excluding upfront
connection fees) of RMB 82,456 million in 2005. The growth primarily reflected
increases in revenues from broadband services, value-added services, information
and communication technology services and interconnection and leased line
services.
Fixed-line telephone services
-----------------------------
Local telephone services
------------------------
Revenues from our local telephone services (including PHS services)
comprise local usage fees, monthly fees and installation fees. They vary
depending on the number of our fixed-line subscribers, average realized tariffs
and the usage volume of local calls (including those made to connect to our
dial-up Internet service). In 2006, revenues from our local telephone services
were RMB 40,332 million, representing a decrease of RMB 3,953 million, or 8.9%,
from RMB 44,285 million in 2005, and accounting for 46.4% of our total revenues
in 2006.
This decrease in revenues from local telephone services reflects a
combination of decreases in revenues from local usage fees, monthly fees and
upfront installation fees. The decreases in revenues from local usage fees,
monthly fees and upfront installation fees were primarily due to increasing
competition in the telecommunications market and increasing mobile substitution.
Local usage fees. Usage fees for local services include local usage
fees charged for local telephone calls and VoIP long distance calls, and
communications fees for dial-up Internet access.
49
In 2006, revenues from our local usage fees were RMB 22,274 million,
representing a decrease of RMB 2,308 million, or 9.4%, from RMB 24,582 million
in 2005. The decrease was primarily due to a decrease of 11.17 billion pulses,
or 4.9%, in the usage volume of local calls to 217.27 billion pulses in 2006
from 228.44 billion in 2005, and a decrease in our realized tariff caused by
changes in tariff policies and increased competition.
Monthly fees. Monthly fees represent the fixed amount of service
charges to our customers for using our fixed-line telephone services.
In 2006, our revenues from monthly fees were RMB 16,689 million,
representing a decease of RMB 1,572 million, or 8.6%, from RMB 18,261 million in
2005, primarily due to a decrease in the number of our fixed-line subscribers in
our service regions and a decrease in our realized tariff.
Upfront installation fees. Installation fees represent the amortized
amount of the upfront fees received for installation of non-PHS fixed-line
telephone services. These upfront installation fees are deferred and recognized
over the expected customer relationship period, which is currently estimated to
be ten years.
Revenues from the upfront installation fees were RMB 1,369 million in
2006, representing a decrease of RMB 73 million, or 5.1%, from RMB 1,442 million
in 2005. The decrease was principally attributable to upfront installation
discount offered to new subscribers, coupled with a decrease in the number of
new subscribers in 2006 to 9.06 million from 9.41 million in 2005.
Domestic long distance services
-------------------------------
Revenues from our domestic long distance services consist of usage fees
for domestic long distance calls originated by our fixed-line subscribers, users
of our prepaid phone cards and certain other customers. In 2006, our domestic
long distance revenues were RMB 10,185 million, representing a decrease of RMB
75 million, or 0.7%, from RMB 10,260 million in 2005. The decrease was primarily
attributable to the decrease of revenues from our VoIP long distance service,
partially offset by the increase of revenues from our traditional domestic long
distance service. Revenues from our traditional domestic long distance service
totaled RMB 7,248 million, representing an increased of RMB 155 million, or
2.2%, from RMB 7,093 million in 2005, primarily due to an increase in usage of
such long distance calls from 15,978 million minutes in 2005 to 18,612 million
minutes in 2006 and partially offset by declines in average realized tariffs.
Revenues from our VoIP long distance service totaled RMB 2,937 million,
representing a decrease of RMB 231 million or 7.3% from RMB 3,168 million in
2005, primarily due to a decline in the average realized tariffs for VoIP calls.
International long distance services
------------------------------------
Revenues from our international long distance services consist of usage
fees charged to our customers for their international long distance calls
originated in our service regions, including those made to Hong Kong, Macau and
Taiwan.
In 2006, this revenue was RMB 1,160 million, representing a decrease of
RMB 20 million, or 1.7%, from RMB 1,180 million in 2005. The revenue decrease
was primarily attributable to a decrease in the volume of international long
distance calls. In 2006, the usage of international long distance calls
decreased from 591 million minutes in 2005 by 25 million minutes, or 4.2%, to
566 million minutes.
Value-added services
--------------------
Revenues from our value-added services consist of fees that we charge
our customers for the provision of caller identification, PHS short-messaging,
personalized ring, telephone information services, video- and tele-
50
conferencing and other value-added services. Revenues from our value-added
services in 2006 were RMB 5,421 million, representing an increase of RMB 1,421
million, or 35.5%, from RMB 4,000 million in 2005. The increase was primarily
attributable to increases in the number of subscribers and average business
volume per customer. In 2006, the number of subscribers of our caller
identification service totaled 78.78 million, which reached a penetration rate
of 68.5% of our access lines in service as of December 31, 2006. The number of
PHS short messages sent from our network in 2006 increased to 7.8 billion from
6.8 billion in 2005 and the number of our personalized ring subscribers totaled
15.77 million, representing an increase of 131.4% from that in 2005.
Interconnection services
------------------------
Revenues from our interconnection services represent interconnection
fees charged to other domestic telecommunications carriers, principally China
Mobile, China Unicom and China Telecom, for both local and long distance calls,
and revenues from our interconnections with China Netcom Group.
Revenue from our interconnection services amounted to RMB8,400 million
in 2006, representing an increase of RMB617 million, or 7.9%, from RMB7,783
million in 2005. The growth in revenue was mainly due to an increase in
interconnection fees from other domestic and international telecommunication
carriers and an increase in revenue from settlement of interconnection fees with
our associates.
Upfront connection fees
-----------------------
Upfront connection fees represent the amortized amount of the upfront
fees received for the initial activation of fixed-line telephone services. As a
result of the elimination of this fee on July 1, 2001, revenues from the
amortized portion of upfront connection fees were RMB 2,406 million in 2006,
representing a decrease of RMB 999 million, or 29.3%, from RMB 3,405 million in
2005, and will continue to decline in the coming years until the expiration of
the amortization period.
Broadband access and other Internet-related services
----------------------------------------------------
Revenues from our broadband access and other Internet-related services
consist of revenues for the provision of DSL, LAN, and other Internet-related
services, as well as Internet dial-up (other than communications fees) and
dedicated Internet access services.
Total revenues from our broadband services in 2006 were RMB 10,556
million, representing an increase of RMB 2,732 million, or 34.9%, from RMB 7,824
million in 2005. This increase reflects the rapid expansion of our broadband
subscriber base. The total number of subscribers of our broadband services
increased by approximately 3.6 million, or 31.4%, or to 15.1 million as of
December 31, 2006 from approximately 11.5 million as of December 31, 2005.
Revenues from other Internet-related services were RMB 692 million in
2006, representing an increase of RMB 101 million, or 17.1%, from RMB 591
million in 2005. The increase was primarily due to an increase in revenues from
dedicated Internet access service of RMB 192 million from RMB 374 million in
2005, partially offset by a decrease in revenues from Internet dial-up service.
Business and data communications services
-----------------------------------------
Managed data services
---------------------
Revenues from our corporate data services represent fees that we charge
for our DDN, frame relay, ATM, MPLS VPN and X.25 services. Revenues from our
managed data services were RMB 1,505 million in 2006,
51
representing a decrease of RMB 151 million, or 9.1%, from RMB 1,656 million in
2005. The decrease was primarily due to decrease in average realized tariff as a
result of increased market competition.
Leased line services
--------------------
Revenues from our leased line services represent fees that we receive
from our business and carrier customers for leasing circuit capacity to them,
including the lease of digital circuits, digital trunk lines and optic fibers.
Revenues from our leased line services were RMB 2,974 million in 2006,
representing an increase of RMB 378 million, or 14.6%, from RMB 2,596 million in
2005. This increase was primarily due to an increase in domestic circuit
bandwidth leased to 169,040 (x2Mbps) as of December 31, 2006 from 129,539
(x2Mbps) as of December 31, 2005.
Information and communication technology services
-------------------------------------------------
Through our information and communication technology services, which we
started in 2006, we provide integrated services of system integration, software
development, management applications and fixed-line communication. In 2006,
which was the first year in which we offered such services, revenue from our
information and communication technology services was RMB 788 million.
Other services
--------------
Revenues from other services, including revenues from service and
maintenance fees, lease payments for our non-telecommunications equipment, and
revenues from sales of products like handsets and DSL modems, were RMB 2,502
million in 2006, representing an increase of RMB 221 million, or 9.7%, from RMB
2,281 million in 2005. The increase was primarily due to an increase in
businesses such as the maintenance of equipment for customers and project
construction.
Operating expenses
The key components of our operating expenses are depreciation and
amortization expenses, network operations and support expenses, selling, general
and administrative expenses, staff costs and other expenses. Our total operating
expenses in 2006 were RMB 67,562 million, representing an increase of RMB 2,432
million, or 3.7%, from RMB 65,130 million in 2005, as compared to the 2.5%
increase in our revenues (excluding upfront connection fees) during this period.
The increase in our total operating expenses is principally attributable to
increased depreciation and amortization expenses and other expenses, partially
offset by decreases in network, operations and support expenses, selling,
general and administrative expenses and staff costs.
The following table sets forth the components of our operating expenses
as percentages of our revenues for the periods indicated.
Years Ended 31 December
-----------------------
2005 2006
------------------------- ---------------------------
Percentage of Percentage of
Amount revenues Amount revenues
------ -------------- -------- -------------
(in millions of RMB, except percentage data)
Depreciation and amortization expenses............ 24,919 29.0% 25,608 29.5%
Network, operations and support expenses.......... 13,465 15.7% 14,383 16.5%
Selling, general and administrative expenses...... 13,322 15.5% 13,366 15.4%
Staff costs....................................... 12,034 14.0% 12,151 14.0%
Other operating expenses.......................... 1,390 1.7% 2,054 2.3%
------ ----- ------ ------
Total operating expenses.................... 65,130 75.9% 67,562 77.7%
52
Depreciation and amortization
We depreciate our property, plant and equipment on a straight-line
basis over the estimated useful lives of the assets, after taking into account
their estimated residual value. For example, our telecommunication network and
equipment are depreciated over periods typically ranging from five to ten years.
In 2006, our depreciation and amortization expenses were RMB 25,608 million,
representing an increase of RMB 689 million, or 2.8%, from RMB 24,919 million in
2005. The increase was primarily attributable to an increase in the total amount
of fixed assets subject to depreciation and amortization. As of December 31,
2006, the value of our fixed assets subject to depreciation or amortization
totaled RMB 335.7 billion, representing an increase of 8.6 billion, or 2.6%,
from RMB 327.1 billion as of December 31, 2005.
Network, operations and support
Network, operations and support expenses primarily consist of repair
and maintenance expenses incurred in connection with the operation of our
telecommunications networks, interconnection expenses, utility expenses and
expenses relating the installation costs for additional access lines that are
put in service each year, which are amortized on a straight-line basis over ten
years to the extent that such costs match the incremental revenues from new
customers. In 2006, these expenses amounted to RMB 14,383 million, representing
an increase of RMB 918 million, or 6.8%, from RMB 13,465 million in 2005. The
increase was primarily attributable to an increase of RMB 846 million in
interconnection expenses with China Netcom Group and other carriers, which was
in part due to increased volume of outbound calls, and an increase of RMB 167
million in costs of electricity and fuel consumption.
Selling, general and administrative
Selling, general and administrative expenses primarily consist of sales
and marketing expenses, general and administrative expense and provision for
doubtful accounts.
Our selling, general and administrative expenses amounted to RMB13,366
million in 2006, representing an increase of RMB44 million, or 0.3%, from
RMB13,322 million in 2005. The increase was mainly attributable to an increase
in subscribers retention cost, sales channel cost and other marketing expenses
resulting from elevated competition and an increase of maintenance and utility
expenses. The increase was partially offset by a decrease in subscribers
acquisition cost resulting from a decrease in the growth in the number of new
PHS customers and a decrease of RMB 135 million in provision for bad debts.
Staff costs
Staff costs principally consist of expenses for salary and benefits,
contributions to pension plans and a housing fund, and the payment of early
retirement benefits.
In 2006, our staff costs were RMB 12,151 million, representing an
increase of RMB 117 million, or 1.0%, from RMB 12,034 million in 2005, which was
primarily attributable to an increase in contribution to pension plans to RMB
1,359 million in 2006 from RMB 1,285 million in 2005. In 2006, we continued to
implement a performance-linked compensation allocation system with an increased
percentage of salaries paid to the front office employees.
Other operating expenses
Other operating expenses include printing costs for bills, invoices and
other materials, charitable donations, and other miscellaneous administrative
and operational expenses. In 2006, other operating expenses were RMB 2,054
million, representing an increase of RMB 664 million, or 47.8%, from RMB 1,390
million in 2005, primarily
53
due to an increase in expenses relating to developing information and
communication technology services. Such expenses totaled RMB 627 million in
2006.
Deficit on revaluation of fixed assets
In 2006, we recorded an expense of RMB 1,524 million relating to the
deficit arising from the revaluation of fixed assets following the completion of
a valuation by an independent valuer of our fixed assets other than land and
buildings on a depreciated replacement basis according to our accounting
policies under HKFRS. We did not record any such expenses in 2005 as our
management performed a valuation of our fixed assets other than land and
buildings and concluded that the value of fixed assets were close to the
carrying value of these fixed assets as at December 31, 2005.
Finance costs
In 2006, our finance costs were RMB 3,888 million, representing an
increase of RMB 541 million, or 16.2%, from RMB 3,347 million in 2005, which was
primarily attributable to an increase of RMB 320 million in interest expenses
and a decrease of RMB 221 million in foreign exchange gains primarily resulting
from the depreciation of the value of Renminbi against the Euro in 2006. For
more details, see "Risk Factors--Risks relating to China --Fluctuations in
exchange rates may adversely affect our financial condition and results of
operations and the prices of our shares and ADSs or any dividends payable on our
shares and ADSs in foreign currency terms." The increase in interest expenses
was primarily attributable to an increase of RMB 392 million in 2006 resulting
from deferred payments in respect of the 2005 Acquired Assets and Liabilities.
Taxation
The statutory tax rate on most of our operations in the PRC is 33%,
although some of our subsidiaries and affiliates in the PRC are subject to lower
statutory tax rates or enjoy preferential tax rates.
In 2006, our taxation expense was RMB 3,559 million, representing an
increase of RMB 129 million from RMB 3,430 million in 2005.
Our effective tax rate in 2006 was 24.2%, as compared to 19.6% in 2005.
The effective tax rate in 2005 was lower primarily because we benefited from a
non-recurring tax reduction of RMB 837 million after offsetting the accumulated
pre-restructuring losses with a taxable profit in 2005. The tax rate in 2006 was
lower than the statutory tax rate mainly because the revenues from upfront
connection fees and certain revenues from investment were not taxable under the
PRC law.
Profits from continuing operations
Our profit for the year from continuing operations amounted to
RMB11,141 million in 2006, representing a decrease of RMB2,973 million, or
21.1%, from RMB14,114 million in 2005. Excluding income from upfront connection
fees, our profit for 2006 amounted to RMB8,735 million, representing a decrease
of RMB1,974 million, or 18.4%, from RMB10,709 million in 2005. The decrease was
primarily attributable to the RMB1,524 million of expenses relating to deficit
on revaluation of fixed asset.
Profits from discontinued operations
In 2006, our profit from discontinued operations was RMB 1,819 million,
representing a net gain of RMB 1,878 million from the sale of Asia Netcom and a
net loss of RMB 59 million incurred by Asia Netcom in 2006 prior to the closing
of the sale of Asia Netcom.
54
Profit for the year
In 2006, our profit from operations (including continuing and
discontinued operations) was RMB 12,960 million, representing a decrease of RMB
928 million, or 6.7%, from RMB 13,888 million in 2005.
Profit/(Loss) for the Year Reconciled to U.S. GAAP
Our consolidated profit for 2006 (including continuing and discontinued
operations) determined under U.S. GAAP was RMB 10,886 million. Our profit for
2006 determined under U.S. GAAP was lower than that under HKFRS. The difference
principally reflects the revaluation deficits of RMB 25,778 million in 2003 and
RMB 11,318 million in 2004 taken to the carrying value of our assets under
HKFRS, making our depreciation and amortization expenses in 2006 RMB 4,619
million lower under HKFRS than under U.S. GAAP. In addition, the carrying value
of our assets decreased by RMB 1,524 million under HKFRS as a result of the
revaluation of assets in 2006. Such decrease will not be recorded as an expenses
relating to deficit on revaluation of assets under U.S. GAAP. We expect this
factor to continue to contribute to the difference in our consolidated profit
under U.S. GAAP compared to our consolidated profit under HKFRS in the future.
Operating results for the year ended December 31, 2005 and the year ended
December 31, 2004
Revenues
Our revenue for 2005 amounted to RMB 85,861 million, of which upfront
connection fees amounted to RMB 3,405 million. Excluding upfront connection
fees, our revenue for 2005 would amount to RMB 82,456 million, representing a
growth of RMB 4,521 million, or 5.8%, from RMB 77,935 million in 2004. This
increase primarily reflects increases in revenues from broadband services,
value-added services, interconnection fees and certain other services.
Fixed-line telephone services
-----------------------------
Local telephone services
------------------------
In 2005, revenues from our local telephone services were RMB 44,285
million, representing a decrease of RMB 105 million, or 0.2%, from RMB 44,390
million in 2004, and accounting for 51.6% of our total revenues in 2005.
The decrease in revenues from local telephone services reflects a
combination of decreases in revenues from local usage fees and upfront
installation fees and an increase in revenues from monthly fees. The decreases
in revenues from local usage fees and upfront installation fees were primarily
due to increasing competition in the telecommunications market and increasing
mobile substitution. The increase in revenues from monthly fees was primarily
due to the growth of our PHS services.
Local usage fees. In 2005, revenues from our local usage fees were RMB
24,582 million, representing a decrease of RMB 276 million, or 1.1%, from RMB
24,858 million in 2004. The decrease was primarily due to a decrease of 6.2
billion pulses, or 2.7%, in the usage volume of local calls to 228.4 billion
pulses in 2005 from 234.6 billion in 2004. The decrease in usage volume of local
calls was in turn caused by a decrease in usage volume of non-PHS calls to 172.9
billion pulses in 2005 from 189.0 billion pulses in 2004, principally reflecting
the migration of our non-PHS local voice traffic to PHS and mobile services.
Usage volume of PHS calls increased to 55.6 billion pulses in 2005 from 45.7
billion pulses in 2004.
Revenues from communications fees charged for our dial-up Internet
service decreased to RMB 149 million in 2005 from RMB 301 million in 2004, which
was primarily caused by a decrease of 8.6 billion pulses, or
55
50.4%, in usage volume of this service to 8.6 billion pulses in 2005 from 17.2
billion pulses in 2004, reflecting the migration of Internet dial-up traffic to
broadband services.
Monthly fees. In 2005, our revenue from monthly fees were RMB 18,261
million, representing an increase of RMB 297 million, or 1.7%, from RMB 17,964
million in 2004, primarily due to an increase in the number of our fixed-line
subscribers in our service regions.
Upfront installation fees. Revenues from the upfront installation fees
were RMB 1,442 million in 2005, representing a decrease of RMB 126 million, or
8.0%, from RMB 1,568 million in 2004. The decrease was principally attributable
to upfront installation discount offered to new subscribers, coupled with a
decrease in the number of new subscribers in 2005 to 9.41 million from 10.64
million in 2004.
Domestic long distance services
-------------------------------
In 2005, our domestic long distance revenues were RMB 10,260 million,
representing a decrease of RMB 1,006 million, or 8.9%, from RMB 11,266 million
in 2004. This decrease was caused by a decrease of RMB 547 million, or 7.2%, in
revenues from traditional domestic long distance calls and a decrease of RMB 458
million, or 12.6%, in revenues from our VoIP long distance service during the
2004-2005 comparison period, which in turn was primarily attributable to
declines in the average realized tariffs for both traditional long distance
calls and VoIP calls.
International long distance services
------------------------------------
In 2005, this revenue was RMB 1,180 million, representing a decrease of
RMB 105 million, or 8.2%, from RMB 1,285 million in 2004. The revenue decrease
reflects a combination of an increase of 34.0% in the volume of VoIP
international long distance calls and a decrease of 22.0% in the average
realized tariff for international long distance calls.
Value-Added Services
--------------------
Revenues from our value-added services in 2005 were RMB 4,000 million,
representing an increase of RMB 1,007 million, or 33.6%, from RMB 2,993 million
in 2004. The increase was primarily attributable to an increase in revenues from
PHS short message service to RMB 624 million in 2005 from RMB 79 million in
2004, reflecting an increase in the number of PHS short messages sent from our
network to 6.8 billion in 2005 from 2.0 billion in 2004. The revenue growth was
further driven by an increase in revenues from our caller identification service
to RMB 2,241 million in 2005 from 2,231 million in 2004, reflecting an increase
in the number of subscribers of our caller identification service, which reached
a penetration rate of 65.9% of our access lines in service as of December 31,
2005 from 60.4% as of December 31, 2004.
Interconnection Services
------------------------
Revenues from our interconnection services were RMB 7,783 million in
2005, representing an increase of RMB 1,330 million, or 20.6%, from RMB 6,453
million in 2004. The increase was primarily due to increases in aggregate
revenues from our interconnections with China Unicom and China Mobile. The
interconnection revenue growth was further driven by an increase in revenues
from interconnections with China Netcom Group, pursuant to the interconnection
service agreement.
Upfront connection fees
-----------------------
Revenues from the amortized portion of upfront connection fees were RMB
3,405 million in 2005, representing a decrease of RMB 941 million, or 21.7%,
from RMB 4,346 million in 2004, and will continue to decline in the coming years
until the expiration of the amortization period.
56
Broadband access and other Internet-related services
----------------------------------------------------
Total revenues from our broadband services in 2005 were RMB 7,824
million, representing an increase of RMB 2,517 million, or 47.4%, from RMB 5,307
million in 2004. This increase reflects the rapid expansion of our broadband
subscriber base. The total number of our DSL subscribers increased by
approximately 2.99 million, or 35.2%, or to 11.48 million, as of December 31,
2005 from approximately 8.49 million as of December 31, 2004. The effect of the
increase in the number of subscribers on revenue growth was partially offset by
declines in the average realized monthly tariffs for our broadband services,
reflecting the discount and promotional packages that we offered, and the fact
that increasing numbers of our new subscribers were residential users, who
generally had lower usage than business users.
Revenues from other Internet-related services were RMB 591 million in
2005, representing a decrease of RMB 484 million, or 45%, from RMB 1,075 million
in 2004. The decrease was primarily due to the continuing migration of
subscribers to broadband services from Internet dial-up services.
Business and data communications services
-----------------------------------------
Managed data services
---------------------
Revenues from our managed data services were RMB 1,656 million in 2005,
representing an increase of RMB 72 million, or 4.5%, from RMB 1,584 million in
2004. The increase was primarily due to increase in average realized tariff,
which was partially offset by a migration of our managed data service traffic to
leased line service.
Leased line services
--------------------
Revenues from our leased line services were RMB 2,596 million in 2005,
as compared to RMB 2,591 million in 2004. Our domestic circuit bandwidth leased
to business customers increased to 129,539 (x2Mbps) as of December 31, 2005 from
91,117 (x2Mbps) as of December 31, 2004. The effect of the increased circuit
bandwidth leased to business customers on revenue growth was partially offset by
a decrease in average realized tariffs for our leased line services.
Information and communication technology services
-------------------------------------------------
We did not have any revenues from information and communication
technology services in 2004 or 2005 because we did not provide such services in
these two years.
Other services
-------------
Revenues from other services, including revenues from service and
maintenance fees, lease payments for our non-telecommunications equipment,
paging service fees, and revenues from sales of products like handsets and DSL
modems, were RMB 2,281 million in 2005, representing an increase of RMB 1,290
million, or 130.2%, from RMB 991 million in 2004. The increase was primarily due
to an increase in sales of PHS handsets and external modems for our DSL service.
Operating expenses
Our total operating expenses in 2005 were RMB 65,130 million,
representing an increase of RMB 936 million, or 1.5%, from RMB 64,194 million in
2004. The increase in our total operating expenses principally reflect the
expansion of our customer base and increased selling, general and administrative
expenses, which was in turn primarily caused by increasing market competition.
57
Depreciation and amortization
In 2005, our depreciation and amortization expenses were RMB 24,919
million, representing an increase of RMB 46 million from RMB 24,873 million in
2004. The increase was primary due to an increase in assets subject to
depreciation or amortization resulting from the combination of capital
expenditures in 2006 and a revaluation deficit on our fixed assets.
Network, operations and support
In 2005, our network, operations and support expenses amounted to RMB
13,465 million, representing an increase of RMB 373 million, or 2.8%, from RMB
13,092 million in 2004. The increase was primarily attributable to an increase
of RMB 884 million in interconnection expenses with China Netcom Group and other
carriers, which was in part due to increased volume of outbound calls. The
increase was partially offset by a decrease in repair and maintenance expenses
by RMB 450 million to RMB 4,689 million in 2005 from RMB 5,139 million in 2004,
as a result of our continued efforts to centralize the management of our network
operations.
Selling, general and administrative
In 2005, our selling, general and administrative expenses were RMB
13,322 million, representing an increase of RMB 705 million, or 5.6%, from RMB
12,617 million in 2004. The increase in these expenses was primarily
attributable to an increase in power and water expenses and vehicle maintenance
expenses.
Staff costs
In 2005, our staff costs were RMB 12,034 million, representing an
increase of RMB 404 million, or 3.5%, from RMB 11,630 million in 2004, which was
primarily attributable to an increase in staff salary and benefits to RMB 10,747
million in 2005 from RMB 9,756 million in 2004. In 2005, we started to implement
a performance-linked compensation allocation system with an increased percentage
of salaries paid to the front office employees. In addition, we implemented
several employee benefit programs to better retain and motivate existing
employees and to attract qualified potential employees.
Other operating expenses
In 2005, other operating expenses were RMB 1,390 million, representing
a decrease of RMB 592 million, or 29.9%, from RMB 1,982 million in 2004. The
decrease was primarily attributable to a decrease in business material
expenditure, reflecting our efforts to reduce such expenses.
Deficit on revaluation of fixed assets
We did not record any expense relating to deficit on revaluation of
fixed assets in 2005. We recorded such expense in the amount of RMB 11,318
million in 2004.
Finance costs
In 2005, our finance costs were RMB 3,347 million, representing a
decrease of RMB 422 million, or 11.2%, from RMB 3,769 million in 2004, which was
primarily attributable to a reduction in our total borrowings and a gain in
foreign exchange resulting from the appreciation of the value of Renminbi
against U.S. dollars in 2005. For more details, see "Risk Factors--Risks
relating to China and Asia--Fluctuations in exchange rates may adversely affect
our financial condition and results of operations and the prices of our shares
and ADSs or any dividends payable on our shares and ADSs in foreign currency
terms."
58
Taxation
In 2005, our taxation expense was RMB 3,430 million, representing an
increase of RMB 3,756 million from a tax credit of RMB 326 million in 2004 and
reflecting a higher profit from operations.
Our effective tax rate of 19.6% in 2005 was lower than the statutory
tax rate, mainly because the revenues from upfront connection fees that we
recognized during the period were not taxable under the PRC law. In addition, we
benefited from a non-recurring tax reduction of RMB 837 million after making up
the accumulated pre-restructuring losses with current profit.
Profits from continuing operations
In 2005, our profit from continuing operations was RMB 14,114 million,
representing an increase of RMB 10,704 million, or 313.9%, from RMB 3,410
million in 2004.
Profits from discontinued operations
In 2005, our loss from discontinued operations was RMB 226 million,
representing the net loss incurred by Asia Netcom in 2005.
Profit for the period
As a result of the foregoing, our profit (including continuing and
discontinued operations) for 2005 was RMB 13,888 million, representing an
increase of RMB 11,889 million, or 414.6%, from RMB 2,699 million in 2004.
Profit/(Loss) for the Year Reconciled to U.S. GAAP
Our consolidated profit for 2005 (including continuing and discontinued
operations) determined under U.S. GAAP was RMB 10,465 million. Our profit for
2005 determined under U.S. GAAP was lower than that under HKFRS. The difference
principally reflects the revaluation deficits of RMB 25,778 million in 2003 and
RMB 11,318 million in 2004 taken to the carrying value of our assets under
HKFRS. We expect this factor to continue to contribute to the difference in our
consolidated profit under U.S. GAAP compared to our consolidated profit under
HKFRS.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our primary source of funding for both our working capital and our
longer-term funding needs have been cash provided by operating activities and
short-term bank loans and our primary uses of funds have been capital
expenditures and repayment of bank loans, for the year ended December 31, 2006.
The following table summarizes our cash flows for the periods
indicated:
For the Years Ended December 31,
--------------------------------------
2004 2005 2006
--------- ---------- ---------
(in millions of RMB)
Net cash inflow from operating
activities from continuing operations... 34,127 33,483 33,950
Net cash outflow for investing
activities from continuing operations... (28,474) (24,296) (25,973)
Net cash outflow from financing
activities from continuing operations... (2,246) (14,764) (6,447)
--------- ---------- ---------
Increase/(decrease) in cash from
continuingoperations.................... 3,407 (5,577) 1,530
--------- ---------- ---------
Increase/(decrease) in cash from
discontinued operations................. (199) (130) 1,165
--------- ---------- ---------
Increase/(decrease) in cash and
cash equivalents........................ 3,208 (5,707) 2,695
========= ========== =========
59
Our net cash inflow in 2006 was RMB 1,530 million, representing an
increase in cash inflow of RMB 7,107 million from the net cash outflow of RMB
5,577 million in 2005, which decreased from a net cash inflow of RMB 3,407
million in 2004. The increase in net cash inflows from 2005 to 2006 was due to a
decrease of RMB8,317 million in cash outflows for financing activities and an
increase of RMB467 million in cash inflows from operating activities and
partially offset by an increase in cash outflows for investing activities.
Taking into account cash generated from operating activities and
short-term and long-term bank loans, we believe that we have access to
sufficient working capital for the next 12 months.
Net cash inflow from operating activities
Our net cash inflow from operating activities in 2006 was RMB 33,950
million, representing an increase of RMB 467 million, or 1.4%, from RMB 33,483
million in 2005. The increase principally reflects a combination of:
o an increase of RMB 418 million in net cash inflows generated from
operations from 2005 to 2006;
o a decrease of RMB 397 million in cash outflow for profit tax paid
from 2005 to 2006; and
o an increase of RMB 320 million in interest paid from 2005 to 2006
resulting primarily from interest on a deferred payment for the
2005 Acquired Assets and Liabilities.
Our net cash inflow from operating activities in 2005 was RMB 33,483
million, representing a decrease of RMB 644 million, or 1.9%, from RMB 34,127
million in 2004. The decrease principally reflects a combination of:
o a cash outflow for profit tax paid in the amount of RMB 4,065
million for 2005 compared to RMB 7 million in 2004, as a result of
the utilization in 2005 of our provision for profit tax for 2004
pursuant to relevant PRC regulations; and
o an increase of RMB 2,856 million, or 7.6%, in our net cash inflow
generated from operations to RMB 40,632 million in 2005 from RMB
37,776 million in 2004.
For more details, see Note 34(a) to our consolidated financial
statements included elsewhere in this annual report.
Set out below is a breakdown of our net cash inflow from operating
activities for the periods indicated:
Years Ended December 31,
-----------------------------------
2004 2005 2006
------- -------- --------
(RMB in millions)
Net cash inflows generated from
operations............................. 37,776 40,632 41,050
Interest received........................ 68 131 132
Dividends received....................... 17 29 -
Interest paid............................ (3,727) (3,244) (3,564)
Profits tax paid......................... (7) (4,065) (3,668)
Cash inflow from operating
activities of continuing operations..... 34,127 33,483 33,950
Cash inflow from operating
activities of discontinued operations... (474) 74 183
------- -------- --------
Net cash inflow from operating
activities................................ 33,653 33,557 34,133
======= ======== =========
All of our operations in the PRC are conducted through our wholly
foreign-owned subsidiary, CNC China. Our telecommunications businesses outside
of the PRC are primarily owned and conducted by China Netcom (USA) Operations
Limited and China Netcom (Hong Kong) Operations Limited, our wholly owned
subsidiaries incorporated in the U.S. and Hong Kong, respectively. Accordingly,
our future cash flow will consist principally of
60
dividends from our subsidiaries. Our ability to pay dividends depends
substantially on the payment of dividends to us by CNC China. CNC China must
follow the laws and regulations of the PRC and their respective articles of
association in declaring and paying dividends to us. As a wholly foreign-owned
enterprise in China, CNC China is required to provide for a reserve fund and
staff and workers' bonus and welfare fund, each of which is allocated from net
profit after taxation but before dividend distribution according to the
prevailing accounting rules and regulations in the PRC. CNC China is required to
allocate at least 10% of its net profit to the reserve fund until the balance of
this fund has reached 50% of its registered capital. Appropriations to the staff
and workers' bonus and welfare fund, which are determined at the discretion of
the directors of CNC China, are charged as expenses as incurred in the
consolidated financial statements. In 2004, 2005 and 2006, CNC China contributed
approximately RMB 723 million, RMB 1,044 million and RMB 885 million,
respectively, to these statutory funds. None of the contributions by CNC China
to these statutory funds may be used for dividend purposes. For more details,
see "Item 8. Financial Information -- Dividend Policy."
Net cash outflow for investing activities
Our net cash outflow from investing activities in 2006 was RMB 25,973
million, representing an increase of RMB 1,677 million, or 6.9%, from RMB 24,296
million in 2005. The increase was primarily attributable to the fact that we had
more cash inflow in 2005 as we sold certain short-term investments in that year.
Our net cash outflow from investing activities in 2005 was RMB 24,296
million, representing a decrease of RMB 4,178 million, or 14.7%, from RMB 28,474
million in 2004. This decrease was primarily attributable to (i) a decrease in
our capital expenditures to RMB 27,247 million in 2005 from RMB 28,027 million
in 2004 and (ii) RMB 2,874 million that we realized in 2005 in investments from
the sale of short-term securities acquired in 2004.
We must obtain approvals from the NDRC and the MII, and in some cases,
the State Council for any government-funded project involving significant
capital investment in our operations. In addition, approvals from the NDRC and
the MII are required for investment projects concerning national security, such
as the construction of domestic backbone transmission networks, international
gateways, and other telecommunications infrastructure projects. For a more
detailed description, see "Item 4. Information on the Company -- Regulation --
Capital Investment."
Net cash inflow/(outflow) from financing activities
Our net cash outflow from financing activities in 2006 was RMB 6,447
million, representing a decrease of RMB 8,317 million, or 56.3%, from RMB 14,764
million in 2005. This decrease primarily reflects:
o an outflow resulting from an increase of RMB 13,223 million in
repayment of bank loans from 2005 to 2006;
o an inflow resulting from an increase of RMB 11,424 million in new
bank loans and other loans from 2005 to 2006;
o an inflow resulting from the issuance of short-term commercial
paper in the amount of RMB 9,676 million in 2006; and
o an outflow resulting from an increase of RMB 2,937 in the amount
of dividend payment from 2005 to 2006.
Our net cash outflow from financing activities in 2005 was RMB 14,764
million, representing an increase of RMB 12,518 million, or 557.4%, from RMB
2,246 million in 2004. This increase was primarily attributable to:
o cash inflow from our global offering in 2004 in the amount of RMB
8,944 million;
61
o a net amount of RMB 3,995 million in loans from China Netcom Group
in 2004;
o a payment of distribution to China Netcom Group of RMB 1,566
million in 2005, compared to RMB 7,310 million in 2004; and
o a payment to China Netcom Group in the amount of RMB 3,000 million
in 2005 in connection with our 2005 Acquisition.
Net cash inflow/(outflow) from discontinued operations
In 2006, our net cash inflow from discontinued operations was RMB 1,165
million, compared to a net cash outflow of RMB 130 million from discontinued
operations in 2005. The increase resulted from the consideration we received
from the sale of Asia Netcom.
In 2005, our net cash outflow from discontinued operations was RMB 130
million, representing a decrease of RMB 69 million, or 34.6%, from RMB 199
million in 2004. The decrease was primarily attributable to positive cash inflow
generated by Asia Netcom in 2005.
Working capital
As of December 31, 2006, the shortfall of our working capital
(calculated as current liabilities less current assets), or net current
liabilities, was RMB 72,743 million, representing a decrease of RMB 11,157
million, or 13.3%, from RMB 83,900 million as of December 31, 2005. The decrease
in net current liabilities was primarily attributable to reduced levels of
short-term bank loans as of December 31, 2006 compared to the amounts as of
December 31, 2005.
Indebtedness
In July 2006, we completed the issuance of RMB 10.0 billion in one-year
commercial paper with an annual interest of 3.35%. Our net proceeds from this
issuance was RMB 9,676 million.
Our indebtedness as of the dates indicated was as follows:
As of December 31,
----------------------------
2004 2005 2006
------ ------- -------
(in millions of RMB)
Short-term loans................................. 44,882 47,341 30,980
Short-term commercial paper...................... - - 9,811
Long-term bank loans and other loans,
current portion............................... 11,727 6,846 7,304
Long-term bank loans and other loans,
excluding current portion .................... 26,052 18,143 23,219
Deferred consideration, current portion.......... - 1,960 1,960
Deferred consideration, excluding
current portion............................... - 7,840 5,880
------ ------- -------
Total................................... 82,661 82,130 79,154
====== ======= =======
As of December 31, 2006, our total indebtedness was RMB 79,154 million,
which included deferred consideration of RMB 7,840 million in relation to the
2005 Acquired Assets and Liabilities. Our outstanding loans as of December 31,
2006 amounted to RMB 61,503 million, representing a decrease of RMB 10,827
million, or 15.0%, from RMB 72,330 million as of December 31, 2005, primarily
due to a decrease of RMB 16,361 million in short-term loans from 2005 to 2006.
As of December 31, 2006, our short-term indebtedness represented 63.2%
of our total indebtedness, compared to 68.4% as of December 31, 2005. As of
December 31, 2006, our debt-to-capital ratio was 47.4%, calculated as the ratio
of total indebtedness to the sum of total indebtedness, owner's equity and the
balance of deferred revenues.
62
Our total indebtedness as of December 31, 2005 amounted to RMB 82,130
million, representing a decrease of RMB 531 million from RMB 82,661 million as
of December 31, 2004. As a result, our interest expenses were reduced during
this period.
Our secured long-term loans were RMB 340 million as of December 31,
2006. These loans were secured by:
o RMB 275 million in corporate guarantee granted by third parties;
and
o RMB 65 million in corporate guarantees granted by China Netcom
Group.
As of December 31, 2006, our available and unused credit facilities
amounted to RMB 115,588 million.
Contractual obligations and commitments, including off-balance sheet
arrangements
The following table sets forth information regarding our aggregate
payment obligations in future years of the contractual obligations and
commercial commitments that we had as of December 31, 2006.
Payments Due in the Period
------------------------------------------------------------------------
Total 2007 2008 2009 2010 2011 Thereafter
------- ------- ------- ------- ------ ------ ---------
(RMB in millions)
Short-term debt(1)................... 31,563 31,563 - - - - -
Short-term commercial paper(1)....... 10,000 10,000 - - - - -
Long-term debt(1).................... 36,224 8,860 7,814 10,416 431 430 8,273
Operating lease commitments.......... 2,353 734 313 283 261 245 517
Capital commitments.................. 2,833 2,746 86 1 0 0 0
Deferred payment(2).................. 8,781 2,352 2,248 2,143 2,038 - -
Total contractual cash obligations... 91,754 56,255 10,461 12,843 2,730 675 8,790
Total commercial commitments......... 91,754 56,255 10,461 12,843 2,730 675 8,790
======= ======= ======= ======= ======= ====== =========
____________________
(1) The amounts shown include interest charged for each year.
(2) The amounts shown include interest payable on the deferred consideration.
Capital expenditures
Capital expenditure includes cash paid towards the purchase of fixed
assets, construction in progress, prepayment for leased network capacity and
prepayment for leased land. The following table sets forth our actual and
planned total capital expenditure requirements for the periods indicated:
Capital Expenditures
---------------------
(in millions of RMB)
2004......................................... 28,027
2005......................................... 27,247
2006......................................... 26,474
2007(Planned)................................ 21,000
Historically, most of our capital expenditures were budgeted for the
improvement of our networks and related equipment. In particular, capital
expenditures related to our local access, switching, broadband services, data
and transport networks each accounted for a significant percentage of our total
capital expenditures. Expenditures for other projects were mainly related to
investments in facilities to house our telecommunications equipment and other
facilities. Our total capital expenditures in each of 2004, 2005 and 2006 were
lower than that of each previous year as we focused on controlling our capital
expenditure levels by improving our network efficiency and developing new
products and services to better utilize our existing networks.
In 2006, our capital expenditures were RMB 26,474 million, representing
a decrease of RMB 773 million, or 2.8%, from RMB 27,247 million in 2005, which
was primarily attributable to our efforts to improve the utilization rate of our
existing network equipment, the implementation of an efficiency-based capital
expenditure
63
policy. In 2006, we continued to increase investments in broadband and
Internet-related services and reduced investments in PHS and fixed-line
services. Our investments in broadband and Internet-related services increased
from RMB 3,559 million in 2005 to RMB 4,937 million in 2006 and our investments
in PHS and fixed-line services decreased from RMB 9,314 million to RMB 6,627
million.
We expect to further reduce our capital expenditures to RMB 21,000 in
2007. Our capital expenditure estimates are subject to uncertainty, and actual
capital expenditures in future periods may differ significantly from these
estimates. The timing, amount and nature of capital expenditures are subject to
various factors, including the general economic environment, regulatory
environment, customer demand, technological advances and other relevant factors.
Capital resources
We expect to fund our capital expenditure needs with a combination of
cash generated from operating activities, short-term and long-term bank loans,
short-term commercial paper and other borrowings or equity financings. We
believe that we will have sufficient capital resources to satisfy our capital
expenditure requirements in the foreseeable future periods.
RECONCILIATION OF HKFRS AND U.S. GAAP
Our consolidated financial statements have been prepared in accordance
with HKFRS, which differs significantly in certain respects from U.S. GAAP.
Differences between HKFRS and U.S. GAAP may have a significant impact on our
consolidated net profit/(loss) and shareholders' equity. For example, U.S. GAAP
requires fixed assets to be recorded at cost less impairment while HKFRS allows
revaluation of the fixed assets other than in an impairment situation.
Consequently, under U.S. GAAP there was no charge to income in 2004 and 2006
resulting from the revaluation of our fixed assets in the amount of RMB 11,318
million in 2004 or RMB 1,524 million in 2006, as the case may be, while such
charges were recorded under HKFRS. Thus, in future periods we expect our
depreciation and amortization expense as reported in accordance with U.S. GAAP
to be significantly higher than as reported in our financial statements prepared
in accordance with HKFRS.
We have summarized these differences and their effect on our
shareholders' equity as of December 31, 2004, 2005 and 2006 and the results of
our operations for each of the years ended December 31, 2004, 2005 and 2006 in
Note 40 to our consolidated financial statements included elsewhere in this
annual report. These differences relate primarily to the treatment of the
revaluation of fixed assets, and deferred tax.
The effect on net profit/(loss) of differences between HKFRS and U.S.
GAAP for the years ended December 31, 2004, 2005 and 2006 is as set forth in the
following table.
For the Years Ended December 31,
----------------------------------------
2004 2005 2006
------ -------- --------
(in millions of RMB)
Net profit/(loss) under HKFRS.... 2,699 13,888 12,960
U.S. GAAP adjustments............ 5,233 (3,423) (2,074)
------ -------- --------
Net profit under U.S. GAAP....... 7,932 10,465 10,886
The effect on shareholders' equity of differences between HKFRS and
U.S. GAAP as of December 31, 2004, 2005 and 2006 is as set forth in the
following table.
For the Years Ended December 31,
----------------------------------------
2004 2005 2006
------ -------- --------
(in millions of RMB)
Owners' equity under HKFRS......... 64,595 63,010 73,978
U.S. GAAP adjustments.............. 18,069 14,480 11,689
------ -------- --------
Owners' equity under U.S. GAAP..... 82,664 77,490 85,667
64
CRITICAL ACCOUNTING POLICIES
We have prepared the consolidated financial statements in accordance
with HKFRS issued by the Hong Kong Institute of Certified Public Accountants.
HKFRS require us to adopt accounting policies and make estimates and assumptions
in the preparation of these financial statements. When we make these estimates
and assumptions, we base our estimates on historical experience and are required
to make judgments about matters that are inherently uncertain. Accordingly, the
reported financial position and results of operations are sensitive to these
estimates and assumptions, and actual results may differ from those estimates as
facts, circumstances and conditions change. Our principal accounting policies
are set out in detail in Note 4 to our consolidated financial statements
included elsewhere in this annual report. The following sections discuss the
accounting policies which involve the most significant estimates and judgments
made in the preparation of our consolidated financial statements.
Depreciation of fixed assets
We depreciate our property, plant and equipment at rates sufficient to
write off their costs or revalued amounts less accumulated impairment losses and
estimated residual values over their estimated useful lives on a straight-line
basis. We review the useful lives periodically to ensure that the method and
rates of depreciation are consistent with the expected pattern of economic
benefits from property, plant and equipment. We estimate the useful lives of the
property, plant and equipment based on our historical experience with similar
assets, taking into account anticipated technological changes. The depreciation
expense in the future periods will change if there are significant changes from
previous estimates.
Revaluation of fixed assets
In connection with our restructuring in anticipation of our global
offering in 2004, our property, plant and equipment were revalued as of December
31, 2003 on a depreciated replacement cost basis. The property, plant and
equipment acquired as part of our 2005 Acquisition were revaluated as of
December 31, 2004 on a depreciated cost basis. In preparation for our 2005
Acquisition, apart from lease prepayment for land and buildings, which are
carried at cost, other property, plant and equipment are carried at the revalued
amounts, being the fair value at the date of revaluation, less subsequent
accumulated depreciation and impairment losses. Revaluations are performed with
sufficient regular intervals by independent valuers and, in each of the
intervening years, valuations are undertaken by our executives. As of December
31, 2006, apart from land and buildings, all our fixed assets were evaluated by
an independent valuer. If the revalued amounts differ significantly from the
carrying amounts of the property, plant and equipment in the future, the
carrying amounts will be adjusted to the revalued amounts. This will have an
impact on our future results, since any subsequent decreases in valuation are
first set off against increases on earlier valuations in respect of the same
item and thereafter are charged as expense to the income statement and any
subsequent increases are credited as income to the income statement up to the
amount previously charged. In addition, the depreciation expense in future
periods will change as the carrying amounts of the fixed assets change as a
result of the revaluation.
Impairment of non-current assets
At each balance sheet date, we consider both internal and external
sources of information to assess where there is any indication that non-current
assets, including property, plant and equipment are impaired. If any such
indication exists, the recoverable amount of the asset is estimated and an
impairment loss is recognized to reduce the carrying amount of the asset to its
recoverable amount. The recoverable amount is the higher of value in use or net
selling price. Estimated recoverable amounts are determined based on estimated
discounted future cash flows of the cash-generating unit at the lowest level to
which the asset belongs. Key assumptions made to determine the estimated
discounted cash flows include the estimated growth rate and our estimated
weighted cost of capital. Such impairment losses are recognized in the income
statement, except where the asset is carried at valuation and the impairment
loss does not exceed the revaluation surplus for that same asset, in which case
the impairment loss is treated as a revaluation decrease and charged to the
revaluation reserve. Accordingly, there will be an impact to our future results
if there is a significant change of the recoverable amounts of our non-current
assets.
65
Revenue recognition for upfront connection and installation fees
We defer the recognition of upfront customer connection and
installation fees and amortize them over the expected customer relationship
period of ten years. The related direct incremental installation costs are
deferred and amortized over the same expected customer relationship period of
ten years, except when the direct incremental costs exceed the corresponding
installation fees. The excess of the direct incremental costs over the
corresponding installation fees, if any, are immediately amortized as expenses
to the income statement. We estimate the expected customer relationship period
based on our historical customer retention experience and other factoring in the
expected level of future competition, the risk of technological or functional
obsolescence to our services, technological innovation, and the expected changes
in the regulatory and social environment. If our estimate of the expected
customer relationship period changes as a result of increased competition,
changes in telecommunications technology or other factors, the amount and timing
of recognition of our deferred revenues may change for future periods.
Recognition of revenues and costs under PHS bundled service contracts
We provide PHS services, which is an extension of the local wireline
telecommunications service, to our customers. Promotional packages comprising
the bundled provision of PHS services and the provision of handsets to
customers, under which customers either prepay a certain amount of service fee
or commit to spend a minimum monthly service fee for a designated period of time
in order to receive a free handset. The total revenues received or receivable
are recognized as deferred income. The cost of handsets provided to customers is
treated as deferred customer acquisition costs to the extent that they are
recoverable through profits made from future service fee. Such deferred revenue
and deferred costs are amortized to the income statement on a systematic basis
to match the shorter of the pattern of usage of the related service and the
minimum non-cancelable contract period. If the pattern of the usage of the PHS
services by our customers changes in the future, the amortization period of the
revenues and costs will change accordingly. This will have an impact to our
future results.
Provision for doubtful debts
We maintain an allowance for doubtful debts for estimated losses
resulting from the inability of our customers to make the required payments. We
make our estimates based on the aging of our accounts receivable balance,
customer creditworthiness, and historical write-off experience. If the financial
condition of our customers were to deteriorate, actual write-offs might be
higher than expected, we would be required to revise the basis of making the
allowance and our future results would be affected.
Discontinued operations
A discontinued operation is a component of our Company that may be a
major line of business or geographical area of operations that has been disposed
or is held for sale. The result of that component is separately reported as
"discontinued operations" in the income statement. The comparative income
statement is restated as if the operation had been discontinued from the start
of the comparative period. The assets, liabilities and minority interests of
such component classified as "discontinued operations" or "held for sale" is
presented separately in the assets, liabilities and minority sections,
respectively, of the consolidated Balance Sheet.
Fair value
We estimate the fair value of our financial assets and financial
liabilities including the accounts receivable, prepayments, other receivables
and other current assets, accounts payable, and bank and other loans for
disclosure purposes by discounting its future contractual cash flows at the
estimated current market interest rate that is available to us for similar
financial instruments. The future disclosed values will change if there are
changes in the estimated market interest rate.
66
Accounting for business combinations under common control
We completed our 2005 Acquisition on October 31, 2005. Our 2005
Acquisition is treated as a business combination under common control. Under
HKFRS, we can choose to adopt either acquisition accounting or merger accounting
to record our 2005 Acquisition. We adopted merger accounting to account for the
business combinations under common control as we believe that the financial
statements prepared under merger accounting are more relevant to those
transactions.
New accounting pronouncements
For a detailed discussion of new accounting pronouncements, see Notes 3
and 40 (D) to the Financial Statements.
INFLATION
According to China's National Bureau of Statistics, China's overall
national inflation rate, as represented by the general consumer price index, was
approximately 3.9% in 2004, 1.8% in 2005 and 1.5% in 2006. Inflation or
deflation has not had a significant impact on our results of operations in
recent years.
MARKET RISK AND RISK MANAGEMENT
Market risk is the risk of loss related to adverse changes in market
prices, including interest rates and foreign exchange rates, of financial
instruments we hold or have issued, all of which were for purposes other than
trading purposes. In the normal course of business, we are routinely subject to
a variety of risks, including market risk associated with interest rate
movements and currency rate movements on non-Renminbi denominated assets and
liabilities.
Foreign exchange rate risk
We conduct our business primarily in Renminbi, which is also our
functional and reporting currency. The Renminbi is not a fully convertible
currency. From 1994 to July 20, 2005, the official exchange rate for the
conversion of Renminbi to U.S. dollars was generally stable. On July 21, 2005,
the RPC government introduced a managed floating exchange rate system to allow
the value of the Renminbi to fluctuate within a regulated band based on market
supply and demand and by reference to a basket of currencies. On the same day,
the value of the Renminbi appreciated by 2% against the U.S. dollar. The PRC
government has since made and in the future may make further adjustments to the
exchange rate system. Fluctuations in exchange rates may adversely affect the
value, translated or converted into United States dollars or Hong Kong dollars
(which are pegged to the U.S. dollar), of our net assets, earnings and any
declared dividends. For a detailed description of the unitary managed floating
rate system used by the PRC government to set foreign exchange rates, see "Item
3. Key Information -- Selected Financial Data -- Exchange Rate Information."
We are exposed to foreign currency risk primarily as a result of our
foreign currency borrowings for past purchases of telecommunications equipment
from overseas suppliers. In addition, we receive some of our revenues from our
international operations and pay related expenses in foreign currencies. As a
result, our foreign currency exposure relates to our foreign
currency-denominated debt and, to a limited extent, cash and cash equivalents
denominated in foreign currencies.
We have, in the past, entered into currency swap agreements and foreign
exchange forward contracts designed to mitigate our exposure to foreign currency
risks and may continue to do so in the future.
67
The following table provides information regarding our foreign
currency-sensitive financial instruments, which consist of cash and cash
equivalents, short-term and long-term debt obligations and capital commitments
as of December 31, 2006 and the expected maturity profile of these debt
obligations and capital commitments.
Expected Maturity
---------------------------------------------------------------------------------
2007 2008 2009 2010 2011 Thereafter Total Fair Value
------ ------ ------- ------ ------- --------- -------- ----------
Assets:
Cash and cash equivalents
U.S. dollars.................... 1,314 - - - - - 1,314 1,314
HK dollars...................... 632 - - - - - 632 632
Liabilities:
U.S. dollar-denominated loans
Fixed rate..................... 110 24 23 22 22 520 721 379
Average rate................... 3.1% 0.9% 0.9% 0.4% 0.4% 0.2% 0.7% -
Euro-denominated loans
Fixed rate..................... 39 31 29 30 30 276 435 311
Average rate................... 2.6% 2.5% 2.3% 2.3% 2.3% 2.1% 2.2% -
Japanese yen-denominated loans....
Fixed rate..................... 37 37 37 36 36 93 276 254
Average rate................... 2.1% 2.1% 2.1% 2.2% 2.2% 2.1% 2.1% -
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 in
the PRC 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
instruments.
The following table provides information regarding our interest
rate-sensitive financial instruments, which consist of short-term and long-term
debt obligations as well as the expected maturity profile of such obligations.
Expected Maturity
---------------------------------------------------------------------------------
2007 2008 2009 2010 2011 Thereafter Total Fair Value
------ ------ ------- ------ ------- --------- -------- ----------
(RMB equivalent in millions, except interest rates)
Liabilities:
RMB-denominated loans
Fixed rate............. 32,020 2,751 3,926 1 1 6,011 44,710 43,771
Average rate........... 5.1% 5.5% 5.6% - - - 5.2% -
Variable rate.......... 5,220 3,648 5,530 - - - 14,398 13,920
Average rate(1)........ 5.4% 5.3% 5.5% - - - 5.4% -
U.S. dollar-denominated loans
Fixed rate............. 110 24 23 22 22 520 721 379
Average rate........... 3.1% 0.9% 0.9% 0.4% 0.4% 0.2% 0.7% -
Euro-denominated loans
Fixed rate............. 39 31 29 30 30 276 435 311
Japanese yen-denominated loans
Fixed rate............. 37 37 37 36 36 93 276 254
Average rate........... 2.1% 2.1% 2.1% 2.2% 2.2% 2.1% 2.1% -
__________________
(1) The average interest rates for variable rate loans are calculated based on
the rates reported as of December 31, 2006.
68
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
DIRECTORS AND SENIOR MANAGEMENT
In accordance with Hong Kong law and our articles of association,
members of our board of directors are elected by our shareholders. Our board of
directors consists of 14 members, including five independent non-executive
directors.
The following table sets forth certain information about our directors,
each of whom were duly elected and will retire from office at an annual general
meeting by rotation every three years (but will be eligible for re-election at
such annual general meeting), senior management officers, joint company
secretaries and qualified accountant.
Name Age Positions
------------------------------- ---- ----------------------------------------
Zhang Chunjiang................ 48 Chairman and Executive Director
Zuo Xunsheng((1)).............. 56 Executive Director and Chief Executive
Officer
Zhang Xiaotie(2)............... 54 Executive Director and Senior Vice
President
Li Fushen(3)................... 44 Executive Director, Chief Financial
Officer and Joint Company Secretary
Miao Jianhua................... 55 Executive Director
Tian Suning(4)................. 43 Vice Chairman, Non-Executive Director
Yan Yixun...................... 68 Non-Executive Director
Jose Maria Alvarez-Pallete..... 43 Non-Executive Director
Mauricio Sartorius(5).......... 47 Non-executive Director
John Lawson Thornton........... 53 Independent Non-Executive Director
Victor Cha Mou Zing............ 57 Independent Non-Executive Director
Qian Yingyi.................... 50 Independent Non-Executive Director
Hou Ziqiang.................... 69 Independent Non-Executive Director
Timpson Chung Shui Ming........ 55 Independent Non-Executive Director
Hong Chen Jin(6)............... 44 Alternate Director
Pei Aihua...................... 56 Senior Vice President
Zhao Jidong.................... 56 Senior Vice President
Teng Yong (7).................. 52 Chief Technology Officer
Zhu Lijun(8)................... 53 Vice President
Huo Haifeng(9)................. 52 Vice President
Mok Kam Wan.................... 44 Joint Company Secretary
Leung June Man................. 37 Qualified Accountant
69
_______________________
(1) Appointed as Executive Director and Chief Executive Officer effective
May 17, 2006.
(2) Appointed as Senior Vice President on January 15, 2007.
(3) Appointed as Joint Company Secretary effective December 20, 2006 and
appointed as Executive Director effective January 15, 2007.
(4) Re-designated as a Non-Executive Director effective May 17, 2006. Resigned
as Chief Executive Officer effective May 17, 2006.
(5) Appointed as a Non-Executive Director effective December 19, 2006.
(6) Alternate Director to Mr. Jose Maria Alvarez-Pallete and Mr. Mauricio
Sartorius, effective December 19, 2006.
(7) Appointed as Chief Technology Officer effective August 23, 2006.
(8) Appointed as Vice President effective December 19, 2006.
(9) Appointed as Vice President effective December 19, 2006.
Directors, Senior Management Officers, Joint Company Secretaries and Qualified
Accountant
Directors
Zhang Chunjiang, 48, 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 has joined PCCW Limited as a non-executive director since April
2005. Prior to joining China Netcom Group, Mr. Zhang served as Deputy Minister
of the Ministry of Information Industry (MII) and was one of the most senior
regulatory officials in the PRC telecommunications industry from December 1999
to May 2003. From August 1993 to December 1999, Mr. Zhang held a series of
senior-level positions at the former Liaoning Provincial Posts and
Telecommunications Bureau, the former Ministry of Posts and Telecommunications
(MPT), and the MII, including serving as the Deputy Director of the former
Liaoning Provincial Posts and Telecommunications Administration, Director of
Mobile Telecommunications Administration of the MPT and Director of
Telecommunications Administration of the MII. Mr. Zhang is a senior engineer of
professor level and has extensive experience in telecommunications management,
operations and technology. Mr. Zhang graduated from the Beijing University of
Posts and Telecommunications in 1982 with a bachelor's degree in
telecommunications.
Zuo Xunsheng, 56, Executive Director and Chief Executive Officer, has
served as Executive Director and Chief Executive Officer since May 2006, and
served as Chief Operating Officer of the Company from December 2005 to May 2006
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 has served as Director of the former Posts
and Telecommunications Bureau of Shandong Province. From 1993 to 1997, Mr Zuo
has served as Director of the former Bureau of Telecommunications of Jinan City.
Mr Zuo graduated from Guanghua School of Management of Peking University with an
EMBA degree.
Zhang Xiaotie, 54, Executive Director and Senior Vice President, has
served as a Director since October 2004 and Senior Vice President since January
2007 overseeing procurement and logistics management. 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 Deputy Director and Director of Economic Planning and
Communication Settlement Department of MII. He also held a series of
senior-level positions at the former MPT and Beijing Administration of
Telecommunications. Mr. Zhang graduated from the School of Economics and
Management of Tsinghua University with an M.S. degree.
Li Fushen, 44, Executive Director, Chief Financial Officer and Joint
Company Secretary, has served as executive director since January 2007, has
served as Joint Company Secretary since December 2006, and has served as Chief
financial Officer since September 2005. He served as Financial Controller from
July 2004 to August 2005. Since October 2005, he served as the Chief Accountant
of China Netcom Group. From October 2003 to August 2005, he served as General
Manager of the Finance Department of China Netcom Group. From November 2001 to
70
October 2003, he served as Deputy General Manager of Jilin Communications
Company and Deputy General Manager of the former Jilin Provincial
Telecommunications 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.
Miao Jianhua, 55, Executive Director, has served as a Director since
October 2004. He served as the Joint Company Secretary from December 2005 to
December 2006. 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-level 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.
Tian Suning, 43, Vice Chairman, Non-Executive Director, has served as a
Director since 2000 and re-designated as a Non-Executive Director since May
2006. He has also served as Vice President of China Netcom Group from April 2002
to May 2006. From 1999 to May 2006, he has served as Chief Executive Officer of
China Netcom (Holdings) Company Limited and the Company. He has been a Director
of China Netcom (Group) Company Limited from 2001 to May 2006. He has also
served as Vice Chairman and a Non-executive director of PCCW Limited since April
2005. Starting from April 2006, Dr. Tian has served as Independent Director of
MasterCard International. After Dr. Tian resigned his CEO position at the
Company on May 17, 2006, he founded and became Chairman of China Broadband
Capital Partners L.P. . Invited by KKR, Dr. Tian has been appointed as Senior
Advisor since November, 2006. 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, an M.S. degree in ecology from the Graduate
School of the Chinese Academy of Sciences in 1988,and a B.S. degree in
environmental biology from Liaoning University in 1985.
Yan Yixun, 68, 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 Tenth
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 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, 43, 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
Chairman and Chief Executive Officer of Telefonica Internacional, S.A. and
General Manager of Telefonica Latinoamerica as well as a member of the Board of
Telefonica, S.A. in July 2006. As at December 31, 2006, Telefonica
Internacional, S.A. had 4.99% 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
71
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.
Mauricio Sartorius, 47, Non-executive Director, was the alternate
director to Mr. Jose Maria Alvarez-Pallete from September 2005 to December 2006
and served as Non-executive Director from December 2006. Mr. Sartorius began his
career with Banco del Progreso. In 1983, Mr. Sartorius started working at 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
American Region based in New York. Mr. Sartorius joined Telefonica on January 1,
1997 as a Deputy Managing Director of the Corporate Finance Department. In 1998,
Mr. Sartorius was appointed to be responsible for human resources for Telefonica
Internacional, S.A. On January 1, 2005, he became the Chief Representative
Officer of Asia of Telefonica Internacional and since then resides in Beijing.
Mr. Sartorius holds a degree in economics from the Universidad Complutense of
Madrid and a MBA degree from New York University.
John Lawson Thornton, 53, 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 Ltd. (listed on the Shanghai and Hong
Kong Stock Exchanges), 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 US Foreign Relations, a trustee of 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, 57, Independent Non-executive Director, has served
as a Director since October 2004. Since September 2001, 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. Mr. Cha graduated from Stanford University
with a MBA degree and University of Wisconsin with a B.S. degree.
Qian Yingyi, 50, Independent Non-executive Director, has served as a
Director since October 2004. He is also a Professor of Economics at the
University of California, Berkeley. Since 2005, Dr. Qian has served as
Independent Director of the Industrial and Commercial Bank of China Ltd. (listed
on the Shanghai and Hong Kong Stock Exchanges). Since 2006, Dr. Qian has been
the Dean of the School of Economics and Management at Tsinghua University, and
also has served as Independent Director of Vimicro International Corporation
(listed on New York NASDAQ). Before joining the Berkeley faculty in 2001, Dr.
Qian taught in the Department of Economics at Stanford University and the
University of Maryland. In 1990, Dr. Qian received his Ph.D. in Economics from
Harvard University, after receiving an M.Phil. in management science/operations
research from Yale University and an M.A. in statistics from Columbia
University. In 1981, Dr. Qian graduated from Tsinghua University with a B.S.
degree in mathematics.
Hou Ziqiang, 69, Independent Non-executive Director, has served as a
Director since October 2004. He had also been Chairman of China Kejian Company
Limited. Mr. Hou has served as Independent Director of the Varitronix
International Ltd. (listed on Hong Kong Stock Exchange) Since 2005, Hou founded
China Kejian
72
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, 55, G.B.S., J.P., 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 Executive Director of Hantec
Investment Holdings Limited and Independent Non-executive Director of 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 Chairman of the Council of the
City University of Hong Kong and a member of the Hong Kong Housing Authority.
Formerly, he was an Executive Director of Shimao China Holdings Limited, a
Director of Stockmartnet Holdings Ltd and Extrawell Pharmaceutical Holdings
Limited. He was also 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.
Hong Chen Jin, 44, Alternate Director to Mr. Jose Maria Alvarez-Pallete
and Mr. Mauricio Sartorius, she served as an Alternate Director since December
2006. She joined Telefonica in Spain eleven years ago; since then, she has had a
variety of professional experience working in the Telefonica fixed business (IT
Strategy), mobile business (marketing department and mobile Value-Added and
content services department) , and Telefonica Data (Broadband and Online
Services), and also in Telefonica Soluciones (Key account client solution and
sales). She was assigned to Beijing and appointed as the Asia Director in the
beginning of 2005. Since then, her responsibility covers the government and
institutional relationship, external communication, business development and
strategies in Asia and office operation. Ms. Chen holds a bachelor's degree in
Computer Science of Shanghai Jiaotong University and MBA. She began her career
in China as faculty member of the Management School of Shanghai Jiaotong
University. During seven years in the USA, she obtained a master's degree in
industrial engineering (majoring in investment analysis and corporate management
skills). During that period, she worked as a Vice President of R&D in ACS - a US
software company and headed the IT and network department of another US
multinational corporation. In Spain, prior to joining Telefonica, she was a
partner of a telecom consulting company.
Senior Management Officers
Zuo Xunsheng, Executive Director and Chief Executive Officer.
Pei Aihua, 56, has served as Senior Vice President since July 2004
overseeing corporate development, mobile communications and administration. 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. Mr. Pei is a senior engineer of
professor level. He graduated with a master's degree in information
communication management jointly sponsored by Fudan University and the Norway
Management School in 2001. He graduated from Changchun Optical Precision
Machinery College with a master's degree in electrical engineering in 1993 and
Beijing School of Telecommunications in microwave technology in 1976.
Zhao Jidong, 56, has served as Senior Vice President since July 2004,
and is responsible for Olympics communications, international affairs and
Beijing Municipal Branch Company. 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 the former Beijing
73
Telecommunications Company from May 2000 to July 2002. From November 1994 to May
2000, Mr. Zhao served as the Deputy Director and Director of the former Beijing
Telecommunications Bureau. Mr. Zhao 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, and from Fudan
University with a B.A. degree in English in 1975.
Zhang Xiaotie, Executive Director and Senior Vice President.
Li Fushen, Executive Director , Chief Financial Officer and Joint
Company Secretary.
Teng Yong, 52, has served as Chief Technology Officer since August
2006, responsible for technical issues and ICT applications. He served as the
General Manager of Hebei Communications Company from July 2004 to April 2006 and
the General Manager of Tianjin Communications Company from May 2002 to July
2004. Mr. Teng held the position of General Manager of Tianjin
Telecommunications Company from July 2000 to July 2002 and the Deputy Director
and later Director of the Posts and Telecommunications Administration of Tianjin
from May 1995 to May 2000. Mr. Teng graduated from Nanjing University of Posts
and Telecommunications with a major in automatic telephone switching in February
1980, and later obtained a doctor degree of management and engineering from
Tianjin University.
Zhu Lijun, 53, has served as Vice President since December 2006,
responsible for network operation and consumer rights protection. Since March
2005 , he has served as Assistant to the General Manager of China Netcom Group,
and served as General Manager of Department of Planning and Construction
starting from July 2004. He was the General Manager of Shanxi Communications
Company from August 2002 to July 2004. He was the General Manager of Shanxi
Telecommunications Company from December 2001 to August 2002. He worked as the
General Manager of Telecommunications Company of Guangxi Zhuang Autonomous
Region from July 2000 to December 2001, and served as the Deputy Director of the
Posts and Telecommunications Administration of Neimenggu Autonomous Region from
August 1996 to July 2000. Mr. Zhu graduated from the Department of Chinese
Language and Literature of Inner Mongolia Normal University in 1986, and later
obtained a master degree of international business management from Australian
National University.
Huo Haifeng, 42, has served as the Vice President from December 2006,
in charge of marketing and key account management. He was the General Manager of
Tianjin Communications Company since August 2004 to November 2006 and served as
the General Manager of Dalian Branch of Liaoning Communications Company from
December 2002 to August 2004. Before joining China Netcom Group, Mr. Huo was the
General Manager of Dalian Branch of Liaoning Telecommunications Company of
former China Telecom Group from April 2001 to December 2002. He worked as the
General Manager of Anshan Branch of Liaoning Telecommunications Company from
August 2000 to April 2001. Mr. Huo served as Director of Bureau of
Telecommunications Administration in Anshan city of Liaoning Province from
October 1998 to August 2000. After his graduation from the Changchun University
of Posts and Telecommunications with a bachelor degree of computer application
in September 1987, he obtained a master degree of telecommunications engineering
management degree from Beijing University of Posts and Telecommunications and a
master degree of business management from Australian National University.
Joint Company Secretaries and Qualified Accountant
Li Fushen, Executive Director, Chief Financial Officer and Joint
Company Secretary.
Mok Kam Wan, 44, 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.
74
Leung June Man, 37, Assistant to the Chief Financial Officer and
Qualified Accountant. Mr. Leung has joined the Company since June 2005. He
graduated from Washington State University in 1992 with a bachelor's degree in
business administration, major in accounting. Mr. Leung is a member of both of
Hong Kong Institute of Certified Public Accountants and American Institute of
Certified Public Accountants.
COMPENSATION
Our executive directors and senior management officers receive
compensation in the form of salaries and allowances and benefits in kind,
including our contribution to the pension plans for our executive directors and
senior management officers. We have entered into service agreements with our
executive directors.
Each of our directors is entitled to an annual director's fee of
HK$200,000 (other than Executive Directors and all Non-Executive Directors
nominated by China Netcom Group) as proposed by the board of directors and
approved by our shareholders at the extraordinary general meeting held on 14
February 2007. Director's fees are payable on a time pro-rata basis for any
non-full year's service. Such directors shall also be entitled to an additional
fee of HK$10,000 for each Board meeting which such directors attend. Our
executive directors and senior management officers are entitled to receive
annual base salary and performance-based bonus and any discretionary award of
share options as may be determined by the board of directors. In addition, each
director who is the chairperson of any of the Audit Committee, Nominating and
Corporate Governance Committee, Compensation Committee, Strategy Committee and
Supervision Committee is entitled to receive an annual fee of HK$70,000 and each
director (other than Executive Directors and all Non-executive Directors
nominated by China Netcom Group) who is a member of these committees is entitled
to receive an annual fee of HK$50,000. Such directors shall also be entitled to
an additional fee of HK$5,000 for each committee meeting which such directors
attend.
The following table sets out the emoluments paid to our directors in
2006.
Basic salaries, Share option
allowances and benefit Contributions to
Fees (a) benefits in kind Subtotal amortized retirement schemes Total
--------- ----------------- ------------- -------------- ------------------ -------
(in thousands of RMB)
Zhang Chunjiang.............. - 763 763 312 19 1,094
Zuo Xunsheng(1).............. - 746 746 272 19 1,037
Zhang Xiaotie................ - 671 671 272 19 962
Li Fushen(2)................. - 671 671 272 19 962
Miao Jianhua................. - 671 671 238 19 928
Jiang Weiping(3)............. - 453 453 238 19 710
Li Liming(4)................. - 420 420 238 19 677
Tian Suning(5)............... - - - 312 - 312
Yan Yixun.................... 251 - 251 200 - 451
Jose Maria alvarez-Pallete... 317 - 317 - - 317
Mauricio Sartorius(6)........ 9 - 9 - - 9
John Lawson Thornton......... 409 - 409 - - 409
Victor Mou Zing Cha.......... 453 - 453 - - 453
Qian Yingyi.................. 545 - 545 - - 545
Hou Ziqiang.................. 483 - 483 - - 483
Timpson Chung Shui Ming...... 460 - 460 - - 460
--------- ----------------- ------------- -------------- ------------------- --------
Total........................ 2,927 4,395 7,322 2,354 133 9,809
========= ================= ============= ============== =================== ========
______________________
(a) On December 6, 2006, Zhang Chunjiang, Zuo Xunsheng, Zhang Xiaotie, Miao
Jianghua, Jiang Weiping, Li Liming and Tian Suning voluntarily waived their
emoluments for the years ended December 31 2006 and 2005 totalling RMB 1,526
thousand and 1,666 thousand, respectively. These amounts waived consist of:
Zhang Chunjiang RMB 251 thousand for 2006 and RMB 261 thousand for 2005, Zuo
Xunsheng RMB 158 thousand for 2006 and nil for 2006, Zhang Xiaotie RMB 251
thousand for 2006 and RMB 261 thousand for 2005, Miao Jianghua RMB 251
thousand for 2006 and RMB 261 thousand for 2005, Jiang Weiping RMB 94
thousand for 2006 and RMB 309 thousand for 2005, Li Liming RMB 270 thousand
for 2006 and RMB 313 thousand for 2005 and Tian Suning RMB 251 thousand for
2006 and RMB 261 thousand for 2005.
(1) Appointed in May 2006.
(2) Appointed in January 2007.
75
(3) Resigned in May 2006.
(4) Resigned in January 2007.
(5) Re-designated as non-executive Directors in May 2006.
(6) Appointed in December 2006.
The five individuals whose emoluments were the highest for the years
ended December 31, 2006 include two directors whose emoluments are reflected in
the analysis presented above. The emoluments payable to the remaining
individuals are as follows:
Year ended December 31, 2006
-----------------------------
in thousands of RMB
Basic salaries, bonus, allowances and
benefits in kind.............................. 2,013
Share based compensation...................... 816
Contributions to retirement schemes........... 57
-----------------------------
Total......................................... 2,886
=============================
The aggregate compensation to which our executive directors and senior
management members were entitled (including amounts paid and accrued) in 2006
was RMB 9 million, including directors' fees, basic salaries, bonus, share
option benefit amortized, allowances and benefits in kind, as well as
contributions to retirement schemes.
BOARD PRACTICE
Our company has entered into service contracts with each of our
executive directors. The directors are subject to rotation under our articles of
association. The service contracts of executive directors are subject to
termination at least sixty days' written notice. Pursuant to our articles of
association, the remuneration of our directors is determined by our shareholders
in a general shareholders' meeting. None of these service contracts will provide
benefits to our directors upon termination.
Except as disclosed in this annual report, none of our directors has or
is proposed to have a service contract with us (excluding contracts expiring or
determinable by the employer within one year without payment of compensation
(other than statutory compensation)).
Board Committees
Audit Committee
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. Other members of the
committee include Mr. Victor Cha Mou Zing, Dr. Qian Yingyi 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 well as guiding and
supervising our internal control system.
Compensation Committee
On June 28, 2006, the Compensation and Nomination Committee was
reorganized and renamed as the compensation Committee. The duties of this
committee include making recommendation to the Board in respect of the overall
compensation policies and structure of the directors and senior management of
the company and the establishment of formal and transparent procedures for the
formulation of these policies, determining the specific compensation package of
the senior management on behalf of the Board and making recommendations to the
Board in respect of the compensation of the non-executive directors; reviewing
and supervising the share option scheme
76
and option allocation plan of the company; and assessing the performance of the
directors as well as the senior management. The members of the Committee are Dr.
Qian Yingyi, who serves as its chairman, Mr. Zhang Xiaotie, Mr. Li Fushen, Mr.
John Lawson Thornton and Mr. Timpson Chung Shui Ming.
Nominating and Corporate Governance Committee
On June 28, 2006, the relevant powers and functions of the Corporate
Governance Committee merged with those of the original Compensation and
Nomination Committee with regard to the nomination of directors and senior
management, and the committee was re-named as the Nominating and Corporate
Governance Committee.
The Nominating and Corporate Governance Committee is dedicated to the
realization of a sound composition with industry experience and professional
capability within the Board. The primary duties of the committee include the
nomination of directors and senior management, supervising the implementation of
corporate governance system and the operation efficiency of the Board and making
recommendations to the Board with regard to the optimization of the corporate
governance structure. In accordance with our Guidelines for Directors, the
Nominating and Corporate Governance Committee is responsible for formulating the
criteria for selecting directors, working out Directors' succession plan,
suggesting candidates of Directors, and submitting the related proposals to the
Board and/or shareholders' meeting for review and approval. For the nomination
of candidates for new appointments of directors, the committee primarily
considers whether the candidates have the necessary professional expertise and
experience to help the Board to perform its duties in a better way and to
promote the development of the Company. The independence of independent
non-executive directors is examined by the committee.
The committee is chaired by Mr. John Lawson Thornton, an independent
non-executive Director. Other members include: Mr. Zhang Chunjiang, Mr. Zuo
Xunsheng, Dr. Qian Yingyi and Mr. Victor Cha Mou Zing.
Strategy Committee
On June 28, 2006, the original powers and functions of the Strategic
Planning Committee were suitably adjusted and the committee was re-named as the
Strategy Committee.
The Strategy Committee is primarily responsible for reviewing the
medium to long-term strategies, annual operation plans and budgets and
significant investment plans of the Company. It also reviews and monitors the
procedures and system for the risk management of the Company and supervises the
implementation of our development strategies.
The committee is chaired by Mr. Zhang Chunjiang. Other members include:
Dr. Tian Suning, Mr. Zuo Xunsheng, Mr. Li Fushen, Mr. Jose Maria
Alvarez-Pallete, Dr. Qian Yingyi and Mr. Hou Ziqiang. Ms Li Liming resigned as a
director and member of the Strategy Committee on January 15, 2007.
Supervision Committee
The Supervision Committee is primarily responsible for identifying any
disciplinary breach, violation of regulations and corrupt acts of the
middle-to-senior management by establishing and improving the supervisory system
and workflow and opening up channels for reporting such behaviors in accordance
with the Listing Rules and regulatory requirements. It urges the directors and
the middle-to senior management as well as other staff to abide by the rules and
be conscious of self-discipline and faithfully discharge their duties.
The committee is chaired by Mr. Miao Jianhua. Other members include Mr.
Zhang Xiaotie, Mr. Timpson Chung Shui Ming, Mr. Victor Cha Mou Zing and Mr. Hou
Ziqiang.
77
Summary Corporate Governance Differences
There are significant differences between our corporate governance
practices and those of U.S. issuers listed on the New York Stock Exchange.
Pursuant to Section 303A.11 of the NYSE Listing Manual, we have disclosed
certain of these differences on our website at www.china-netcom.com.
EMPLOYEES
As of December 31, 2006, we had 140,747 full time employees.
Substantially all of our employees are located in China. The following table
sets forth the number of our employees serving in the capacities and for the
periods indicated:
As of December 31,
---------------------------------------------------------------------------------------
2004 2005 2006
--------------------------- ----------------------------- -----------------------------
Percentage of Percentage of Percentage of
Number of Total Number of Total Number of Total
Employees Employees Employees Employees Employees Employees
----------- --------------- ------------- --------------- --------------- -------------
Management, finance and
Administrative............ 22,814 15.8 23,784 17.2 25,112 17.8
Sales and marketing......... 66,564 46.3 67,603 48.8 69,926 49.7
Operations and maintenance.. 47,322 32.9 42,134 30.4 40,837 29.0
Others(1)................... 7,262 5.0 4,919 3.6 4,872 3.5
----------- --------------- ------------- --------------- --------------- -------------
Total..................... 143,962 100.0 138,440 100.0 140,747 100.0
=========== =============== ============= =============== =============== =============
_____________________-
(1) Includes research and development employees.
As of December 31, 2006 we also employed approximately 55,416 temporary
employees.
We participate in defined contribution retirement plans for our
employees. We are required to contribute a portion of our employees' total wages
to the PRC government's pension plan in accordance with relevant local
government regulation. Our contributions were approximately RMB 1,181 million in
2004, RMB 1,285 million in 2005 and RMB 1,359 million in 2006. We also implement
an early retirement scheme whereby employees approaching retirement age may opt
for early retirement in exchange for certain early retirement benefits. The
amount expensed as early retirement benefits was approximately RMB 693 million
in 2004, RMB 2 million in 2005 and nil in 2006.
We have implemented a short-term and long-term combined incentive
remuneration scheme. The primary components of an employee's remuneration are a
basic salary, a performance-based bonus and a stock option scheme for certain
employees. In addition, we emphasize the importance of employee training and
seek to improve the skills of our employees.
In 2006, we did not experience any strikes or other labor disturbances
that interfered with our operations, and we believe that the relationship
between our management and our labor union was good.
SHARE OWNERSHIP
Ownership of our shares by our directors and executive officers
Certain of our directors and executive officers have a beneficial
interest in our shares through their ownership of options as further discussed
in "-- Share Option Scheme."
78
Share option scheme
The shareholders of our company passed a resolution on September 30,
2004 to approve and adopt the share option scheme (the "Share Option Scheme").
Having considered the changes following the completion of our 2005 Acquisition
and for the purpose of clarifying the relevant scope of the Share Option Scheme,
the Board convened meetings on December 6, 2005, and made minor amendments to
the Share Option Scheme. The shareholders of the Company passed a resolution at
an extraordinary general meeting held on May 16, 2006 to approve certain changes
to the rules of Share Option Scheme.
The main contents of the amended Share Option Scheme are as follows:
Purpose of the Share Option Scheme
The purpose of the Share Option Scheme is to provide our company with a
means to incentivize its senior management, to attract and retain talent and to
encourage other eligible participants to enhance the value of the Company.
Participants of the Share Option Scheme
The directors may invite any person belonging to any of the following
classes of participants to take up options to subscribe for the ordinary shares
of the Company:
(i) the directors (including executive and non-executive directors, but
excluding independent non-executive directors);
(ii) members of the middle-to-senior management; and
(iii) such class of "specialized professionals" as may be designated by
the Compensation Committee.
For the purpose of sub-paragraph (iii) above, "specialized
professionals" means such professionals or management staff or technical or
marketing staff holding important positions that are important to the
development of the Company business. The Compensation Committee has the right to
interpret "specialized professionals" and identify them.
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 percent of the shares of the Company then in issue.
(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 percent 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 (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.
79
(iv) "Effective Options" means the share options granted under the
Share Option Scheme, irrespective of whether such options are exercisable in
accordance with the relevant vesting schedule; and "Vesting Schedule" means the
arrangement whereby options can be exercised by batch in accordance with the
timetable pre-determined by the Share Option Scheme.
As at the latest practicable date prior to the printing of this report,
the total number of securities available for issue under the Share Option Scheme
is 176,193,900, representing 2.65 percent of the issued share capital of the
Company as at that date.
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 percent of the issued share capital of the Company on the date of
grant.
Minimum period for which an option must be held before it can be exercised
With respect to the share options granted prior to the listing of the
Company's shares on the Stock Exchange, there is a minimum period of 18 months
from the later of the date of grant or the date of the listing of the shares on
the Stock Exchange before an option can be exercised; with respect to the share
options granted after the listing of the Company's shares on the Hong Kong 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 Hong Kong Stock Exchange
before an option can be exercised.
Period within which the shares must be taken up under an option
Any option shall lapse if not exercised within 6 years from the later
of the date of grant or the date of the listing and commencement of trading of
the shares on the Hong Kong Stock Exchange.
The basis of determining the exercise price for shares
The exercise price is a price determined by the Board or the
Compensation Committee but shall not be less than the highest of: (i) the
closing price of the shares on the Hong Kong Stock Exchange on the date of
grant; (ii) the average closing price of shares on the Hong Kong Stock Exchange
for the five trading days immediately preceding the date of grant; and (iii) the
nominal value of the shares.
Consideration
No consideration is payable on acceptance of the grant of an option.
The remaining life of the Share Option Scheme
Unless otherwise terminated by the Board of Directors in exercise of
its powers in accordance with the rules governing the Share Option Scheme, the
Share Option Scheme will remain in force for a period of 10 years commencing on
the date on which the Share Option Scheme is adopted.
Amendment to and termination of the Share Option Scheme
(i) The Board of the Company may amend any of the provisions of the
Share Options Scheme and the terms of the options at any time.
80
(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.
Exercise of Options and Proceeds
(1) The Exercise Price for the initial grant of Options shall be the
initial public offering price. The Exercise Price of Options granted
subsequently shall be the higher of the par value of the shares, the closing
price of the shares on the Options Grant Date and the average closing price of
the shares in the five trading days prior to the Options Grant Date.
(2) Share Options shall be effective for a period of six years. Any
Options not exercised after the expiry of six years from the Options Effective
Date shall lapse automatically.
(i) The initial exercise of the Share Options which are granted
prior to the listing of the Company on the Hong Kong Stock
Exchange is subject to an Options Restricted Period of 1.5
years and such Share Options shall only be exercised in
batches in accordance with the Vesting Schedule below. The
maximum number of Options that can be exercised at each tier
shall not exceed the limits set out below:
- 40% of the Options granted may be exercised 18 months
after the Options Effective Date (the "First Tier");
- another 20% of the Options granted may be exercised 30
months after the Options Effective Date (the "Second
Tier");
- another 20% of the Options granted may be exercised 42
months after the Options Effective Date (the "Third
Tier"); and
- the remaining 20% of the Options granted may be exercised
54 months after the Options Effective Date (the "Fourth
Tier").
81
(ii) The initial exercise of the Share Options which are granted
after the listing of the Company on the Hong Kong Stock
Exchange is subject to an Options Restricted Period of 2 years
and such Share Options shall only be exercised in batches in
accordance with the Vesting Schedule below. The maximum number
of Options that can be exercised at each tier shall not exceed
the limits set out below:
- 40% of the Options granted may be exercised 24 months
after the Options Effective Date (the "First Tier");
- another 20% of the Options granted may be exercised 36
months after the Options Effective Date (the "Second
Tier");
- another 20% of the Options granted may be exercised 48
months after the Options Effective Date (the "Third
Tier"); and
- the remaining 20% of the Options granted may be exercised
60 months after the Options Effective Date (the "Fourth
Tier").
(3) The exercise of a portion of the Options of the employees of the
Company (excluding senior management and directors of the Company) exercisable
at each tier pursuant to the above Vesting Schedule (the "Adjustable Options")
shall be subject to the results of the performance review of the grantee in
respect of the year immediately preceding the commencement of the relevant tier
as measured against the Company's performance review plan. Part or all of the
Adjustable Options shall be subject to cancellation depending upon the results
of the performance review. The Adjustable Options shall be determined by the
Company with reference to the number of Options exercisable at each tier, the
expected yield of each Option and the difference between the average price of
the Shares in the year immediately preceding the commencement of the relevant
tier and the exercise price of the Options.
(4) Except for the transmission of the Options on the death of a
grantee of Options to his personal representatives or authorized persons,
neither the Options nor any relevant rights may be transferred, assigned or
otherwise disposed of by any grantee to any other person. If a grantee
transfers, assigns or disposes of such Options or rights, the Company will be
entitled to cancel the Options granted to the grantee.
(5) The increase in exercisable Options of the grantees at each tier
(the Options exercisable at the First Tier shall be deemed as the increase in
exercisable Options at the First Tier) shall be subject to cancellation upon the
happening of any of the
following events:
(i) the annual performance review of the Company for the year
preceding the commencement of the relevant tier shows that
the Company is unable to meet the performance review targets;
(ii) the issuance of a negative opinion by the Company's
accountants or the Company's accountants being unable to
issue an opinion on the financial reports in respect of the
year preceding the commencement of the relevant tier;
(iii) where the Supervisory Panel or the audit authorities for
State-owned enterprises of the State Council have raised
material objections to the results or the annual report of
the Company in respect of the year preceding the commencement
of the relevant tier.
82
(6) In the event that the grantee is to be demoted, his unvested
Options pursuant to the Vesting Schedule will be reduced to reflect his new
position and the reduced Options will automatically lapse.
(7) In the event of a capitalization issue, rights issue, sub-division
or consolidation of shares or reduction of capital, the Board has the right to
make corresponding alterations to the number of shares involved in the Options
granted under the Share Option Scheme (outstanding Options) and the Exercise
Price, provided that the proportion of the total number of ordinary shares
involved in the Share Option Scheme to the total number of issued shares shall
remain unchanged. Such adjustments shall give participants to the Share Option
Scheme the same proportion of the issued share capital to which he would have
been entitled prior to such alteration, and no adjustment shall be made the
effect of which would be to enable shares to be issued at less than its nominal
value.
(8) The proceeds from the exercise of Options shall be the multiple of
the number of Share Options being exercised and the difference between the
market price of the shares of the Company upon the exercise of the Options by
the grantee and the Exercise Price, less the relevant tax expenses. After
exercising the Options, the proceeds shall belong to the person who exercised
the Options. If the grantee does not exercise the Options within the period
during which he is entitled to exercise the Options, the proceeds shall be zero.
(9) Prior to exercising part or all of his Options, the grantee shall
inform the Company in writing of his intention to exercise the Options together
with the number of shares, the Exercise Price etc.
(10) The grantee is required to exercise his Options through the
intermediaries selected by the Company.
Rights on cessation of employment
(1) If the grantee of an Option ceases to be an employee because of
misconduct or criminal conviction, and as a result ceases to be an Eligible
Participant under the Share Option Scheme, all the Effective Options not yet
exercised shall lapse on the date of cessation of his employment and such
Options shall in no circumstances be exercisable.
(2) If the grantee of an Option is transferred internally to China
Network Communications Group Corporation and its controlled entities, the
grantee shall be entitled to exercise the Options in accordance with the Vesting
Schedule.
(3) If the grantee of an Option is transferred out of the Company with
the Company's consent (for reason other than Clause 6(2)), the grantee may, at
any time within 90 days of the date of the cessation of his employment, exercise
the Effective Options which are exercisable as at the date of the cessation of
his employment as well as the Options which are exercisable at the tier
immediately following the date of cessation of his employment. Any such Options
which are not exercised within the 90-day period shall lapse automatically. All
the Options exercisable at later tiers shall lapse automatically.
(4) If the grantee of an Option retires, the grantee may, at any time
within 90 days of the date of his retirement, exercise the Effective Options
which are not yet exercised. Any such Options which are not exercised within the
90-day period shall lapse automatically.
(5) If the grantee of an Option ceases to be an employee for any reason
other than death, loss of capacity or the reasons as referred to under Clauses
6(1), 6(2), 6(3) or 6(4) and for reason of his resignation, and thus as a result
ceases to be an Eligible Participant under the Share Option Scheme, all of his
Effective Options not yet exercised shall lapse on the date of cessation of his
employment.
83
Where the employment of a grantee ceases or has ceased or the grantee
retires or has retired prior to the 2006 Amendments being approved by
shareholders of the Company at general meeting, the date of cessation of
employment or retirement will be deemed to be the day on which the 2006
Amendments are approved by shareholders of the Company at general meeting.
Rights on death
If the grantee of an Option dies and that none of the grounds for
cessation of employment as referred to in Clause 6(1) has occurred, Effective
Options granted (but not yet exercised) shall be vested in the grantee's estate,
the grantee's personal representatives or authorized persons shall exercise such
Effective Options within 90 days. Any such Options which are not exercised
within the 90-day period shall lapse automatically.
Where the grantee dies or has died prior to the 2006 Amendments being
approved by shareholders of the Company at general meeting, his death will be
deemed to have occurred on the day on which the 2006 Amendments are approved by
shareholders of the Company at general meeting.
Rights on loss of capacity
The guardian of the grantee of an Option or authorized persons may, at
any time during the period within 90 days of the date of the loss of capacity of
such grantee, exercise the Effective Options granted to such grantee but not yet
exercised as at the date of the loss of capacity of such grantee. Any such
Options which are not exercised within the 90-day period shall lapse
automatically.
Where the loss of capacity takes place or has taken place prior to the
2006 Amendments being approved by shareholders of the Company at general
meeting, the loss of capacity will be deemed to have taken place on the day on
which the 2006 Amendments are approved by shareholders of the Company at general
meeting.
Cancellation of the Options
The Board may resolve to cancel any Options granted but not yet
exercised.
Lapsed Options shall be automatically cancelled on the date of lapse.
As at December 31, 2006, the directors, chief executive and employees
of our company had the following personal interests in options to subscribe for
shares of our company granted under the Share Option Scheme.
No. of shares
involved in No. of Price per share
the options shares involved payable for
outstanding at in the options the exercise
the beginning outstanding at the Date of the of grant of the options
of the year end of the year the options (in HK$)
--------------- ------------------ -------------------- ----------------
DIRECTORS
Zhang Chunjiang................. 920,000 920,000 October 22, 2004 8.40
Zuo Xunsheng.................... 800,000 480,000 October 22, 2004 8.40
Zhang Xiaotie................... 800,000 480,000 October 22, 2004 8.40
Miao Jianhua.................... 700,000 420,000 October 22, 2004 8.40
Tian Suning..................... 920,000 920,000 October 22, 2004 8.40
Li Liming....................... 700,000 420,000 October 22, 2004 8.40
Yan Yixun....................... 590,000* 354,000 October 22, 2004 8.40
Employees and other persons
granted with options after the
date of listing of the Company's
shares on the Stock Exchange.... 79,320,000 79,034,200 December 6, 2005 12.45
Employees and other persons
granted with options before the
date of listing of the Company's
shares on the Hong Kong Stock
Exchange........................ 151,273,000** 93,618,700 October 22, 2004 8.40
Total........................... 236,023,000 176,646,900
84
_______________________
Notes:
* Mr. Yan Yixun has undertaken that all after-tax proceeds from the sale of
shares acquired on the exercise of his options will be donated charity.
** The number of shares involved in the options outstanding at the beginning
of the year included the share options granted to Mr. Jiang Weiping
involving a total of 700,000 shares. Mr. Jiang Weiping resigned as
executive director of the Company on May 17, 2006, and he continues to
serve as the general manager of the human resources department of the
Company.
(a) The total number of shares involved in the options outstanding represents
2.65 percent of the issued share capital of the Company as at the latest
practicable date prior to the printing of this report.
(b) Grantees of the share options granted on October 22, 2004 are entitled to
exercise the options in the following periods:
(i) in respect of 40 percent of the options granted, from May 17, 2006
to November 16, 2010;
(ii) in respect of a further 20 percent of the options granted, from May
17, 2007 to November 16, 2010;
(iii) in respect of a further 20 percent of the options granted, from May
17, 2008 to November 16, 2010; and
(iv) in respect of the remaining 20 percent of the options granted, from
May 17, 2009 to November 16, 2010.
(c) Grantees of the share options granted on December 6, 2005 are entitled to
exercise the options in the following periods:
(i) in respect of 40 percent of the options granted, from December 6,
2007 to December 5, 2011;
(ii) in respect of a further 20 percent of the options granted, from
December 6, 2008 to December 5, 2011;
(iii) in respect of a further 20 percent of the options granted, from
December 6, 2009 to December 5, 2011; and
(iv) In respect of the remaining 20 percent of the options granted, from
December 6, 2010 to December 5, 2011.
(d) During the year ended December 31, 2006, no share option was granted by the
Company under the Share Option Scheme.
According to the requirements under HKFRS 2, the fair value of the
options granted by our company to its employees (including directors) to
subscribe for shares in our company shall be recognized as expenses in the
Company's consolidated income statement. Our company has made retrospective
adjustments to the recognized employee benefit costs or liabilities in relation
to the grant of options to subscribe for shares in our company to employees
(including directors) in prior years.
Apart from the foregoing, at no time during the year ended December 31,
2006 was the Company, any of its holding companies or subsidiaries or fellow
subsidiaries, a party for any arrangement to enable the directors or senior
management of our company or any of their spouses or children under eighteen
years of age to acquire benefits by means of the acquisition of shares in or
debentures of our company or any other body corporate.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
MAJOR SHAREHOLDERS
As of April 30, 2007, we had 6,651,394,400 shares outstanding. The
table below sets forth information as of the date of this annual report
regarding the beneficial ownership of our ordinary shares by each person known
by us to beneficially own 5% or more of our outstanding ordinary shares. Except
as otherwise indicated, we believe each shareholder named in this table has sole
voting and investment power with respect to the shares shown as beneficially
owned. None of our shareholders listed below has voting rights that are
different from any of our other shareholders.
Shares Beneficially Owned
--------------------------
Name of Beneficial Owner Number Percentage
------------------------ ------ ----------
(in millions)
China Network Communications Group Corporation(1) 4,647,449,014 69.88%
AllianceBernstein L.P............................. 398,841,192 6.0%
________________
(1) China Network Communications Group Corporation's beneficial interest is
attributable to its ownership interest in CNC BVI, our direct parent
company. The registered address of CNC BVI is P.O. Box 3140, Wickhams Cay
1, Road Town, Tortola, British Virgin Islands. The registered address of
China Network Communications Group Corporation is No. 21, Financial Street,
Xicheng District, Beijing, PRC.
85
RELATED PARTY TRANSACTIONS
Connected Transactions
Our 2005 Acquisition
See "Item 4. Business Overview--History and Development--Our 2005
Acquisition."
Sale of Southern Service Region Business
See "Item 4. Information on the Company--History and
Development--Recent Development--Sale of Southern Service Region Business."
Cooperation Agreement in relation to the 2008 Beijing Olympic Games
On September 15, 2005, the Company's wholly-owned subsidiary, China
Netcom (Group) Company Limited ("CNC China") entered into a cooperation
agreement (the "Cooperation Agreement") with China Netcom Group whereby CNC
China agreed to provide telecommunications goods and services to the Beijing
Organization Committee for the Games of the XXIX Olympiad ("BOCOG"). As
consideration, CNC China is entitled to the right and opportunity to conduct
products-related marketing activities by using the 2008 Olympics composite logo
and sponsorship logo as provided for under the sponsorship agreement between
China Netcom Group and BOCOG. The consideration of the Cooperation Agreement is
RMB 480 million.
Continuing Connected Transactions
As of the date of this annual report, China Netcom Group, as the
ultimate controlling shareholder of the Company, beneficially owned 69.88% of
the Company's issued share capital. China Netcom Group is therefore a connected
person of the Company. In October 2004, CNC China entered into certain
agreements with China Netcom Group, and certain ongoing transactions between CNC
China on the one hand and China Netcom Group and its subsidiaries or associates
(other than the Group) on the other hand, were conducted in accordance with the
provisions under the aforesaid agreements up to October 31, 2005. In order to
facilitate the management of our continuing connected transactions in China
after the completion of our 2005 Acquisition, CNC China, China Netcom Group New
Horizon Communications Corporation Limited ("CNC New Horizon") and China Netcom
Group entered into certain connected transaction agreements on September 12,
2005 to regulate the continuing connected transactions between China Netcom
Group and its subsidiaries or associates (other than the Group) on one hand and
the Group on the other hand in respect of the Group's operations in 12
provinces, autonomous region and municipalities in China, and these agreements
would replace the existing connected transaction agreements between CNC China
and China Netcom Group after the completion of our 2005 Acquisition. Certain
ongoing transactions between CNC China and CNC New Horizon on the one hand and
China Netcom Group and its subsidiaries or associates (other than the Group) on
the other hand as from October 31, 2005, ("Continuing connected transactions
relating to CNC China and CNC New Horizon") were conducted in accordance with
the provisions under the new agreements. CNC China completed its merger with CNC
New Horizon on November 3, 2006 ("Merger"). Pursuant to the aforesaid connected
transaction agreements, all rights and obligations of CNC New Horizon under the
agreements were taken over by CNC China after the Merger and the agreements
remained effective between China Netcom Group and CNC China. Therefore, certain
ongoing transactions between CNC China and CNC New Horizon (CNC China alone as
one party after the Merger) 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 and CNC New Horizon") were
conducted in accordance with the provisions of the connected transaction
agreements entered into on September 12, 2005.
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The Company established China Netcom Group System Integration Limited
Corporation ("China Netcom System Integration") as an indirect wholly-owned
subsidiary in April 2006. China Netcom System Integration entered into certain
transactions with China Netcom Group (and its subsidiaries), and on November 7,
2006, China Netcom System Integration entered into a connected transaction
agreement ("Information and Communications Technology Agreement") with China
Netcom Group.
These transactions between CNC China and China Netcom Group and between
China Netcom System Integration (the "Continuing Connected Transactions")
constitute continuing connected transactions of the Company under the Listing
Rules. Details of the Continuing Connected Transactions are set out below and in
note 37 to the financial statements regarding relative transactions with
ultimate holding company, fellow subsidiaries and other related companies. For
the financial year ended December 31, 2006, the Continuing Connected
Transactions have not exceeded their respective upper limits set by the Hong
Kong Stock Exchange. In respect of all the connected transactions of the Company
as stated in this annual report, the Company has complied with the disclosure
requirements under the Listing Rules in force from time to time.
On June 30, 2004, Asia Netcom, a former wholly-owned subsidiary of our
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. On June 2, 2006, the Company, China Netcom Corporation International
Limited ("CNCI," a wholly-owned subsidiary of the Company) and two third parties
entered into a share purchase agreement, pursuant to which CNCI sold 100% of its
equity interests in Asia Netcom. The share sale was completed on August 22,
2006. After completion of the share sale, transactions between Asia Netcom and
EANL will no longer constitute continuing connected transactions of the Company
under the Rules Governing the Listing of Securities on The Stock Exchange of
Hong Kong Limited (the "Listing Rules").
Continuing connected transactions relating to CNC China and CNC New Horizon
The following continuing connected transaction agreements have come
into effect only after the completion of our 2005 Acquisition.
Domestic Interconnection Settlement Agreement
Pursuant to the Domestic Interconnection Settlement Agreement:
CNC New Horizon, CNC China (CNC New Horizon and CNC China are
collectively referred to as the "Combined Operating Group") and China Netcom
Group agreed to interconnect the network of China Netcom Group on the one hand
and that of the Combined Operating Group on the other and settle the charges
received in respect of domestic long distance voice services within their
respective service regions on a quarterly basis.
For domestic long distance voice services between China Netcom Group
and the Combined Operating Group, the telephone operator in the location of the
calling party makes a settlement payment to the telephone operator in the
location of the called party at the rate of RMB0.06 per minute (in case where
the call terminates within the network of either China Netcom Group or the
Combined Operating Group) or RMB0.09 per minute (in case where the call
terminates outside the network of either China Netcom Group or the Combined
Operating Group).
The rates of RMB0.06 per minute and RMB0.09 per minute mentioned above
shall be adjusted with reference to the relevant standards, tariffs or policies
formulated by the relevant regulatory authorities in China from time to time.
87
International Long Distance Voice Services Settlement Agreement
Pursuant to the International Long Distance Voice Services Settlement
Agreement:
CNC China and China Netcom Group agreed to interconnect the networks of
China Netcom Group and CNC China and settle the charge received in respect of
international long distance voice services on a quarterly basis.
For outbound international calls, China Netcom Group reimburses CNC
China for any amount it has paid to overseas telecommunications operators. The
revenues received by China Netcom Group less the amount paid to overseas
telecommunications operators are shared between China Netcom Group and CNC China
in proportion to the estimated costs incurred by China Netcom Group and the
Combined Operating Group in connection with the provision of outbound
international long distance voice services.
For inbound international calls, the revenues received by CNC China
from overseas telecommunications operators (other than the Company and its
controlled entities) less the amount paid to China Netcom Group at the rate of
RMB0.06 per minute (in case where the call terminates within the network of
China Netcom Group) or RMB0.09 per minute (in case where the call terminates
within the network of other operators) are shared between China Netcom Group and
CNC China in proportion to the estimated costs incurred by China Netcom Group
and the Combined Operating Group in connection with the provision of inbound
international long distance voice services.
The rates of RMB0.06 per minute and RMB0.09 per minute mentioned above
shall be adjusted with reference to the relevant standards, tariffs or policies
formulated by the relevant regulatory authorities in China from time to time.
Property Leasing Agreement
Pursuant to the Property Leasing Agreement:
(i) The Combined Operating Group leases to China Netcom Group some
certain properties located throughout the Combined Operating Group's service
regions, for use as offices and other ancillary purposes; and
(ii) China Netcom Group leases to the Combined Operating Group some
certain properties located throughout the Combined Operating Group's service
regions, for use as offices, telecommunications equipment sites and other
ancillary purposes.
The charges payable by the Combined Operating Group and by China Netcom
Group are based on market rates or the depreciation and maintenance charges in
respect of each property, provided such depreciation and maintenance charges
shall not be higher than the market rates. The charges are payable quarterly in
arrears and are subject to review every year to take into account the then
prevailing market rates of the properties leased in that year.
Property Sub-leasing Agreement
Pursuant to the Property Sub-leasing Agreement:
China Netcom Group agreed to sub-let to the Combined Operating Group
certain properties owned by and leased from independent third parties, for use
as offices, telecommunications equipment sites and other ancillary purposes.
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The amounts payable by the Combined Operating Group under the Property
Sub-leasing Agreement are the same as the rental charges and other fees
(including management fees) payable by China Netcom Group to the relevant third
parties.
Master Sharing Agreement
Pursuant to the Master Sharing Agreement:
(a) The Combined Operating Group will provide customer relationship
management services for large enterprise customers of China Netcom Group;
(b) The Combined Operating Group will provide network management
services to China Netcom Group;
(c) The Combined Operating Group will share with China Netcom Group the
services provided by administrative and managerial staff in respect of central
management of the business operations, financial control, operation and
maintenance of network, human resources and other related matters of both the
Combined Operating Group and China Netcom Group;
(d) The Combined Operating Group will provide to China Netcom Group
supporting services such as billing and settlement provided by the business
support centre;
(e) China Netcom Group will provide to the Combined Operating Group
supporting services, including telephone card production, development and
related services and IC card inter-provincial and inter-network clearing
services;
(f) China Netcom Group will provide to the Combined Operating Group
certain other shared services, including advertising, publicity, research and
development, business hospitality, maintenance and property management; and
(g) China Netcom Group will provide certain office space in its
headquarters to the Combined Operating Group for use as its principal executive
office.
(h) The Combined Operating Group and China Netcom Group will share the
revenues received by China Netcom Group from other operators whose networks
interconnect with the Internet backbone network of China Netcom Group and will
share the monthly connection fee that China Netcom Group pays to the State
Internet Switching Centre.
The Combined Operating Group and China Netcom Group own certain
equipment and facilities forming the Internet backbone network of China Netcom
Group. This Internet backbone network interconnect with the networks of other
operators. Such interconnection generates revenue which is settled with China
Netcom Group and shared between China Netcom Group and the Combined Operating
Group under the Master Sharing Agreement.
The services set out in paragraphs (a) to (g) above and the revenue and
fee set out in paragraph (h) above are shared between the Combined Operating
Group and China Netcom Group on an on-going basis from time to time and the
aggregate costs incurred by the Combined Operating Group or China Netcom Group
for the provision of the services set out in paragraphs (a) to (g) above and the
revenue and fee receivable and payable by China Netcom Group as referred to in
paragraph (h) above are apportioned between the Combined Operating Group and
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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 RMB 2 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.
90
Payments under the Materials Procurement Agreement will be made as and
when the relevant equipment or products have been procured and delivered.
Ancillary Telecommunications Services Agreement
The Ancillary Telecommunications Services Agreement governs the
arrangements with respect to the provision of ancillary telecommunications
services to the Combined Operating Group by China Netcom Group, which include
certain telecommunications pre-sale, on-sale and after-sale services, sales
agency services, printing and invoice delivery services, maintenance of
telephone booths, customers acquisition and servicing and other customers'
services.
The charges payable for the services described above are determined
with reference to the Post-Acquisition Pricing Principles, and the service
charges are settled between the Combined Operating Group and China Netcom Group
as and when the relevant services are provided.
Support Services Agreement
Pursuant to the Support Services Agreement, China Netcom Group provides
the Combined Operating Group with various support services, including equipment
leasing (other than equipment covered under the Telecommunications Facilities
Leasing Agreement) and maintenance services, motor vehicles services, security
services, basic construction agency services, research and development services,
employing training services and advertising services and other support services.
The charges payable for the services described above are determined
with reference to the Post-Acquisition Pricing Principles, and are settled
between the Combined Operating Group and China Netcom Group as and when relevant
services are provided.
Telecommunications Facilities Leasing Agreement
Pursuant to the Telecommunications Facilities Leasing Agreement, China
Netcom Group leases inter-provincial fiber-optic cables within the Combined
Operating Group's service regions to the Combined Operating Group, and leases
certain international telecommunications resources (including international
telecommunications channel gateways, international telecommunications service
gateways, international submarine cable capacity, international land cables and
international satellite facilities) to the Combined Operating Group, and China
Netcom Group leases certain other telecommunications facilities required by the
Combined Operating Group for its operations.
The rental charges and service charges for the leasing of
inter-provincial fiber-optic cables, international telecommunications resources
and other telecommunications facilities are based on the annual depreciation
charges of such fiber-optic cables, resources and telecommunications facilities
provided that such charges shall not be higher than market rates. The Combined
Operating Group shall be responsible for the on-going maintenance of such
inter-provincial fiber-optic cables and international telecommunications
resources. The Combined Operating Group and China Netcom Group shall determine
and agree on which party is to provide maintenance services to the other
telecommunications facilities leased by China Netcom Group to the Combined
Operating Group based on the latter's operational requirements. Unless otherwise
agreed by the Combined Operating Group and China Netcom Group, such maintenance
service charges shall be borne by the Combined Operating Group. If China Netcom
Group shall be responsible for maintaining the other telecommunications
facilities that it leases to the Combined Operating Group based on the latter's
operational requirements, the Combined Operating Group shall pay to China Netcom
Group the relevant maintenance service charges which shall be determined with
reference to market rates. Where there are no market rates, the maintenance
charges shall be agreed between the parties and determined on a cost-plus basis.
The net rental charges and service charges due to China Netcom Group under the
Telecommunications
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Facilities Leasing Agreement will be settled between the Combined Operating
Group and China Netcom Group on a quarterly basis.
Continuing Connected Transaction Relating to China Netcom System Integration
Information and Communications Technology Agreement
Pursuant to the Master Sharing Agreement:
(a) China Netcom System Integration (and its subsidiaries) provides
information and communications technology services to China Netcom Group (and
its subsidiaries (other than the Group)), which include the system integration
services, software development services, operational maintenance services,
consultancy services, equipment leasing-related services and product sales and
distribution related services.
(b) China Netcom System Integration will also subcontract services
ancillary to the provision of information communication technology services,
namely the system installation and configuration services, to the subsidiaries
and branches of China Netcom Group in China Netcom Group's southern service
region in the PRC.
The charges payable for the services provided under the Information and
Communications Technology Agreement, are determined with reference to the
following pricing principles and limits:
(a) The government fixed price;
(b) Where there is no government fixed price but a government guidance
price exists, the government guidance price; or
(c) Where there is neither a government price nor a government guidance
price, the market price.
In relation to the charges payable for the services provided under the
Information and Communications Technology Agreement that are to be determined
with reference to the market price:
(a) If the value of any single item of system installation and
configuration services provided by China Netcom Group (and its subsidiaries) to
China Netcom System Integration (and its subsidiaries) exceeds RMB 0.3 million,
the award of such services will be subject to tender; or
(b) If the value of any single item of system integration, software
development, operational maintenance, consultancy and equipment leasing-related
services exceeds RMB 0.5 million, or where the value of any single item of
product sales and distribution related services exceeds RMB 2 million, the award
of such services will be subject to tender.
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
92
to EANL; and (iii) further additional amount of capacity that may be ordered
within three years following the date of the Capacity Purchase Agreement.
The charges payable by Asia Netcom to EANL for the initial capacity and
charges payable for the additional capacity activated are based on market rates
determined by reference to a similar transaction between Asia Netcom and a third
party in January 2004 ("Benchmark Transaction") duly adjusted to take into
account of advance receipt of payment prior to the delivery of the capacity. The
pricing of the further additional capacity is to be determined between Asia
Netcom and EANL prior to the placement of the actual order for such capacity.
In addition to the above charges, Asia Netcom pays EANL an annual
operation and maintenance fee equal to 4% of the total charges payable by Asia
Netcom to EANL for the capacity activated and ordered under the Capacity
Purchase Agreement (in so far as such capacity has not been terminated) which is
based on current market rate.
Capacity Lease Agreement
Pursuant to the Capacity Lease Agreement with EANL, Asia Netcom and its
subsidiaries lease from EANL and its subsidiaries a fixed amount of capacity on
EANL's telecommunications network, and may order additional lease capacity from
EANL and its subsidiaries.
EANL and its subsidiaries agreed to permit Asia Netcom or any of its
subsidiaries to interconnect its communications system with the leased capacity,
and to connect such amount of capacity to the facilities of its backhaul
suppliers and/or local exchange carrier. Furthermore, upon request by Asia
Netcom, EANL and its subsidiaries are to use their best efforts to provide to
Asia Netcom or its subsidiaries with local connectivity with end-users in
jurisdictions where Asia Netcom or its subsidiaries are not otherwise authorized
to provide services.
The charges payable by Asia Netcom to EANL for the initial lease
capacity are determined based on market rates by reference to the Benchmark
Transaction, as adjusted to take into account the particular circumstances under
the Capacity Lease Agreement. The pricing for any additional lease capacity is
to be agreed by Asia Netcom and EANL prior to the order for such capacity. These
charges are payable quarterly in arrears.
The connections charges payable by Asia Netcom to EANL is the pro rata
share of reasonable and actual expenses incurred by EANL in making such
connections. The local connectivity charges payable by Asia Netcom to EANL is
EANL's lowest wholesale price without discount, or, if the local connectivity is
provided by an unrelated carrier, the amount charged to EANL by such unrelated
carrier, without surcharge. Such charges for local connectivity are payable
quarterly in arrears.
Management Services Agreement
Pursuant to the Management Services Agreement, Asia Netcom and its
subsidiaries provide EANL and its subsidiaries with certain services, including
government and corporate affairs services, treasury services, financial
services, information technology services, legal and corporate secretarial
services, tax services, payment services, and comprehensive engineering and
operation services in relation to the submarine network.
The charges payable for the above services (except for the payment
services) are determined on the basis of costs plus reasonable profits, but
cannot exceed the market price for the provision of such services.
The charges payable for the payment services are the amounts required
to reimburse all payments made by Asia Netcom and its subsidiaries on behalf of
EANL and its subsidiaries in performing such services.
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ITEM 8. FINANCIAL INFORMATION
Our audited consolidated financial statements are set forth beginning
on page F-1. Other than as disclosed elsewhere in this annual report, no
significant change has occurred since the date of the annual financial
statements.
Legal Proceedings
We are involved in legal proceedings in the ordinary course of our
business. We are not involved in any litigation, arbitration or administrative
proceedings that could have a material adverse effect on our financial condition
or results of operations, taken as a whole. So far as we are aware, no such
material litigation, arbitration or administrative proceedings are threatened.
Dividend Policy
The payment and the amount of any dividends will depend on our results
of operations, cash flows, financial condition, statutory and regulatory
restrictions on the payment of dividends by us, future prospects and other
factors, that our directors may consider relevant. In addition, our controlling
shareholder, China Netcom Group, is able to influence our dividend policy.
Dividends may be paid only out of our distributable profits as
permitted under Hong Kong law, which does not restrict the payment of dividends
to non-resident holders of our securities. To the extent profits are distributed
as dividends, such portion of profits will not be available to be reinvested in
our operations.
Holders of our ADSs will be entitled to receive dividends, subject to
the terms of the deposit agreement, to the same extent as holders of our shares,
less the fees and expenses payable under the deposit agreement and any
withholding taxes.
Our ability to pay dividends depends substantially on the payment of
dividends to us by CNC China. CNC China must follow the laws and regulations of
the PRC and its articles of association in declaring and paying dividends to us.
As a wholly foreign-owned enterprise in China, CNC China is required to provide
for a reserve fund and a staff and workers' bonus and welfare fund, each of
which is appropriated from net profit after taxation but before dividend
distribution according to the prevailing accounting rules and regulations in the
PRC. CNC China is required to allocate at least 10% of its net profit to the
reserve fund until the balance of this fund has reached 50% of its registered
capital. Appropriations to the staff and workers' bonus and welfare fund, which
are determined at the discretion of CNC China's directors, are charged to
expense as incurred in the consolidated financial statements. None of CNC
China's contributions to these statutory funds may be used for dividend
purposes.
ITEM 9. THE OFFER AND LISTING
In connection with our initial public offering, our American depositary
shares, or ADSs, each representing 20 ordinary shares, were listed and commenced
trading on the New York Stock Exchange on November 16, 2004 under the symbol
"CN." Our ordinary shares were listed and commenced trading on the Hong Kong
Stock Exchange on November 17, 2004. Prior to these listings, there was no
public market for our equity securities. The New York Stock Exchange and the
Hong Kong Stock Exchange are the principal trading markets for our ADSs and
ordinary shares, which are not listed on any other exchanges in or outside the
United States.
As of December 31, 2006 and April 30, 2007, there were respectively
6,650,643,500 and 6,651,394,400 ordinary shares issued and outstanding. As of
December 31, 2006 and April 30, 2007, there were, respectively 2 and 2
registered holders of American depositary receipts evidencing 6,027,009 and
6,925,800 ADSs. Since certain of the ADSs are held by nominees, the above number
may not be representative of the actual number of U.S. beneficial
94
holders of ADSs or the number of ADSs beneficially held by U.S. persons. The
depositary for the ADSs is Citibank, N.A.
The high and low closing sale prices of the shares on the Hong Kong
Stock Exchange and of the ADSs on the NYSE for the periods indicated are as
follows.
Price per Share (HK$) Price per ADS (US$)
---------------------- --------------------
High Low High Low
------- -------- ------- --------
Annual
2004 (from listing date).... 10.60 9.10 26.90 23.10
2005........................ 13.95 9.95 35.99 25.45
2006........................ 25.45 11.98 61.15 30.82
Quarterly
First Quarter, 2005......... 12.55 9.75 31.58 25.30
Second Quarter, 2005........ 11.45 9.95 29.11 25.45
Third Quarter, 2005......... 13.70 11.30 35.99 28.66
Fourth Quarter, 2005........ 13.95 11.45 35.62 29.67
First Quarter, 2006......... 13.96 11.98 35.66 31.64
Second Quarter, 2006........ 15.45 12.10 40.28 30.82
Third Quarter, 2006......... 14.55 12.92 38.00 33.50
Fourth Quarter, 2006........ 25.45 13.52 61.15 34.99
Monthly
November 2006............... 16.00 13.56 40.85 34.99
December 2006............... 25.45 14.90 61.15 38.69
January 2007................ 21.30 18.32 56.82 47.62
February 2007............... 20.75 18.46 52.91 45.55
March 2007.................. 20.55 16.64 52.26 42.53
April 2007.................. 21.00 19.36 54.24 49.06
ITEM 10. ADDITIONAL INFORMATION
SHARE CAPITAL
Not applicable.
MEMORANDUM AND ARTICLES OF ASSOCIATION
The section entitled "Description of Share Capital" contained in our
registration statement on Form F-1 (File No. 333-119786) filed with the Security
and Exchange Commission is hereby incorporated by reference.
MATERIAL CONTRACTS
See "Item 7. Major Shareholders and Related Party Transactions -
Related Party Transactions" for certain arrangements we have entered into with
China Netcom Group.
EXCHANGE CONTROLS
We receive substantially all of our revenues in Renminbi, which is not
a freely convertible currency. Although central government's policies were
introduced in 1996 to reduce restrictions on the convertibility of Renminbi into
foreign currency for current account items, conversion of Renminbi into foreign
exchange for capital items, such as foreign direct investment, loans or
security, requires the approval of the State Administration of Foreign Exchange
and other relevant authorities.
The People's Bank of China, or PBOC, sets and publishes daily a base
exchange rate with reference primarily to the supply and demand of Renminbi
against a basket of currencies in the market during the prior day. The PBOC also
takes into account other factors, such as the general conditions existing in the
international foreign
95
exchange markets. Since 1994, the conversion of Renminbi into foreign
currencies, including Hong Kong dollars and U.S. dollars, has been based on
rates set by the PBOC, which are set daily based on the previous day's interbank
foreign exchange market rates and current exchange rates in the world financial
markets. From 1994 to July 20, 2005, the official exchange rate for the
conversion of Renminbi to U.S. dollars was generally stable. Although Chinese
governmental policies were introduced in 1996 to reduce restrictions on the
convertibility of Renminbi into foreign currency for current account items,
conversion of Renminbi into foreign exchange for capital items, such as foreign
direct investment, loans or securities, requires the approval of the State
Administration for Foreign Exchange and other relevant authorities. On July 21,
2005, the PRC government introduced a managed floating exchange rate system to
allow the value of the Renminbi to fluctuate within a regulated band based on
market supply and demand and by reference to a basket of currencies. On the same
day, the value of the Renminbi appreciated by 2% against the U.S. dollar. The
PRC government has since made and in the future may make further adjustments to
the exchange rate system. The PBOC announces the closing price of a foreign
currency traded against the Renminbi in the inter-bank foreign exchange market
after the closing of the market on each working day, and makes it the central
parity for the trading against the Renminbi on the following working day.
TAXATION
The taxation of income and capital gains of holders of ordinary shares
or ADSs is subject to the laws and practices of Hong Kong and of jurisdictions
in which holders of ordinary shares or ADSs are resident or otherwise subject to
tax. The following summary of certain relevant taxation provisions is based on
current law and practice, is subject to change and does not constitute legal or
tax advice. The discussion does not deal with all possible tax consequences
relating to an investment in the ordinary shares or ADSs. In particular, the
discussion does not address the tax consequences under state, local and other
laws, such as non-Hong Kong and non-U.S. federal laws. The discussion is based
upon laws and relevant interpretations in effect as of the date of this annual
report. There is no reciprocal tax treaty in effect between Hong Kong and the
United States.
Hong Kong
Tax on dividends
No tax is payable in Hong Kong in respect of dividends paid by us.
Profits
No tax is imposed in Hong Kong in respect of capital gains from the
sale of property such as the shares. Trading gains from the sale of property by
persons carrying on a trade, profession or business in Hong Kong where such
gains are derived from or arise in Hong Kong from such trade, profession or
business will be chargeable to Hong Kong profits tax, which is currently imposed
at the rate of 17.5% on corporations and at a standard rate of 16.0% on
individuals. Gains from the sale of shares effected on the Hong Kong Stock
Exchange will be considered to be derived from or arise in Hong Kong. Liability
for Hong Kong profits tax would thus arise in respect of trading gains from the
sale of shares realized by persons carrying on a business of trading or dealing
in securities in Hong Kong.
Stamp duty
Hong Kong stamp duty will be payable by the purchaser on every purchase
and by the seller on every sale of the shares. The duty is charged at the
current rate of 0.2% of the consideration or, if higher, the fair value of the
shares being sold or transferred (the buyer and seller each paying half of such
stamp duty). In addition, a fixed duty of HK$5 is currently payable on any
instrument of transfer of shares.
If one of the parties to the sale is a non-resident of Hong Kong and
does not pay the required stamp duty, the duty not paid will be charged on the
instrument of transfer (if any) (in addition to the stamp duty otherwise
chargeable thereon), and the transferee will be liable for payment of such duty.
96
Estate duty
The Revenue (Abolition of Estate Duty) Ordinance 2005 came into effect
on 11 February 2006 in Hong Kong. No Hong Kong estate duty is payable and no
estate duty clearance papers are needed for an application for a grant of
representation in respect of holders of shares whose death occurs on or after
February 11, 2006.
Prior to its abolition, estate duty was charged, according to a
progressive scale of rates which vary with the date of the deceased's death, on
the principal value of the property situate in Hong Kong which passes on the
death of the deceased, or at the amount of HK$100 (for transitional estates).
The shares are Hong Kong property for the purpose of the Estate Duty Ordinance
(Chapter 111 of the Laws of Hong Kong). Accordingly, the shares may be subject
to Hong Kong estate duty on the death of the beneficial owner of the shares,
regardless of the place of the owner's residence, citizenship or domicile.
In respect of estates of a deceased whose death occurred on or after
April 1, 1998 and before July 15, 2005, estate duty was chargeable on the
principal value of the deceased's estate at a progressive rates from 5% to 15%
and no estate duty was payable where the principal value of the dutiable estate
did not exceed HK$7.5 million. The maximum rate of 15% was applied where the
principal value exceeded HK$10.5 million. The estate duty chargeable in respect
of estates of a deceased whose death occurred on or after July 15, 2005 and
before February 11, 2006 with the principal value exceeding HK$7.5 million (the
"transitional estates") was reduced to a nominal amount of HK$100. No Hong Kong
estate duty is payable for death occurring on or after February 11, 2006.
United States of America
The following is a summary of certain United States federal income tax
consequences relating to the purchase, ownership and disposition of shares or
ADSs by investors who are "U.S. Persons" (as defined below) that hold the shares
or ADSs as a capital asset. This discussion is based on United States federal
income tax law, as in effect on the date hereof and which is subject to
differing interpretations or change, possibly with retroactive effect. This
discussion is for general information only and does not address all of the tax
considerations that may be relevant to specific holders in light of their
particular circumstances or to holders subject to special treatment under United
States federal income tax law (such as banks, insurance companies, partnerships
and their partners, tax-exempt entities, financial institutions, broker-dealers,
persons who have acquired our shares or ADSs as part of a straddle, hedge,
conversion, or other integrated investment, persons who own, directly or by
attribution, 10% or more of the combined voting power of all classes of stock of
the Company, or persons that have a "functional currency" other than the United
States dollar), and non-U.S. Holders. This summary does not address any United
States state, local or foreign tax considerations or any United States federal
estate, gift or alternative minimum tax considerations of a holder of shares or
ADSs.
As used in this summary, the term "U.S. Person" means (i) an individual
who is a citizen or resident of the United States, (ii) a corporation, or other
entity treated as a corporation, created or organized under the laws of the
United States or any political subdivision thereof, (iii) an estate the income
of which is subject to United States federal income tax regardless of the source
thereof, or (iv) a trust (A) if a court within the United States is able to
exercise primary supervision over the administration of the trust and one or
more United States persons have the authority to control all substantial
decisions of the trust or (B) that otherwise elected to be treated as a United
States person under the Code.
If a partnership (including any entity treated as a partnership for
United States federal income tax purposes) holds shares or ADSs, the tax
treatment of a partner in such partnership will depend upon the status of the
partner and the activities of the partnership. Partners in such a partnership
are urged to consult their tax advisers as to the particular United States
federal income tax consequences applicable to them.
Prospective investors are urged to consult their tax advisers regarding
the United States federal, state, local and foreign income and other tax
considerations of the purchase, ownership and disposition of shares or ADSs.
97
General
Holders of ADSs evidencing shares will be treated as the owners of the
shares represented by those ADSs. Accordingly, no gain or loss will be
recognized upon the exchange of ADSs for the holder's proportionate interest in
the shares, a holder's tax basis in the withdrawn shares will be the same as its
tax basis in the ADSs surrendered in exchange therefor, and the holding period
in the withdrawn shares will include the period during which the holder held the
surrendered ADSs.
Taxation of dividends
Subject to the discussion below under "--Passive Foreign Investment
Company", the gross amount of cash distributions with respect to the shares or
ADSs will, upon receipt, be includible in the gross income of a holder as
dividend income to the extent of our current and accumulated earnings and
profits, as determined under United States federal income tax principles. A
non-corporate recipient of dividend income will generally be subject to tax on
dividend income from a "qualified foreign corporation" at a maximum United
States federal tax rate of 15% rather than the marginal tax rates generally
applicable to ordinary income so long as certain holding period requirements are
met. A non-United States corporation (other than a passive foreign investment
company) generally will be considered to be a qualified foreign corporation (i)
if it is eligible for the benefits of a comprehensive tax treaty with the United
States which the Secretary of Treasury of the United States determines is
satisfactory for purposes of this provision and which includes an exchange of
information program or (ii) with respect to any dividend it pays on stock (or
ADSs backed by such stock) which is readily tradable on an established
securities market in the United States. There is currently no tax treaty in
effect between the United States and Hong Kong. Because the ADSs are listed on
the New York Stock Exchange (see ITEM 9) they are considered readily tradable on
an established securities market in the United States. Distributions, if any, in
excess of current and accumulated earnings and profits will constitute a return
of capital and will be applied against and reduce the holder's tax basis in such
ADSs or shares. To the extent that distributions are in excess of such basis,
the distributions will constitute capital gain as discussed below. United States
corporate holders will generally not be eligible for the dividends received
deduction for distributions to domestic corporations in respect of distributions
on our ADSs or shares.
The United States dollar value of any distribution made by us in Hong
Kong dollars will be determined by reference to the exchange rate in effect on
the date the distribution is actually or constructively received by the
depositary or the holder of such shares, respectively, regardless of whether the
payment is in fact converted into United States dollars on that date. Any
subsequent gain or loss in respect of such Hong Kong dollars arising from
exchange rate fluctuations will be ordinary income or loss. This gain or loss
will generally be treated as United States source gain or loss for United States
foreign tax credit limitation purposes. If the depositary converts the Hong Kong
dollars to United States dollars on the date it receives such Hong Kong dollars,
holders should not recognize any such gain or loss.
Dividends generally will be treated as income from foreign sources for
United States foreign tax credit limitation purposes. Subject to the limitations
and conditions set forth in the Code, holders may elect to claim a credit
against their United States federal income tax liability in the event that any
Hong Kong tax is withheld from dividends received in respect of the ADSs or
shares. The rules relating to the determination of the foreign tax credit are
complex and prospective purchasers are urged to consult their tax advisors to
determine whether and to what extent they would be entitled to such credit.
Holders that do not elect or are not permitted to claim foreign tax credits may
instead claim a deduction for any Hong Kong tax withheld.
Sale or other disposition of shares or ADSs
Subject to the discussion below under "-- Passive Foreign Investment
Company", a holder generally will recognize gain or loss for United States
federal income tax purposes upon a sale or other disposition of our shares or
ADSs in an amount equal to the difference between the amount realized from the
sale or disposition and the holder's adjusted tax basis in the shares or ADSs.
Such gain or loss generally will be long-term gain or loss if, on the date of
sale or disposition, the shares or ADSs were held by the holder for more than
one year and will generally be treated
98
as United States source gain or loss for United States foreign tax credit
limitation purposes. The deductibility of a capital loss may be subject to
limitations.
Passive foreign investment company
A foreign corporation will be treated as a "passive foreign investment
company" (a "PFIC"), for United States federal income tax purposes, if 75% or
more of its gross income consists of certain types of passive income or 50% or
more of its assets are passive. If a corporation owns at least 25% by value of
the equity shares of another corporation, it is treated for purposes of these
tests as owning a proportionate share of the assets of the other corporation and
as receiving directly a proportionate share of the other corporation's income.
We presently do not believe that we are a PFIC and do not anticipate becoming a
PFIC. This is, however, a factual determination made on an annual basis and is
subject to change. If we were to be classified as a PFIC in any taxable year,
holders (i) would generally be required to treat any gain on sales of our shares
held by them as ordinary income and pay an interest charge on the value of the
deferral of their United States federal income tax attributable to such gain and
(ii) could also be subject to an interest charge on distributions paid by us. In
addition, we would not provide information to our holders that would enable them
to make a "qualified electing fund" election under which, generally, in lieu of
the foregoing treatment, our earnings would be currently included in their gross
income.
The above results may be eliminated if a "mark-to-market" election is
available and a holder validly makes such an election. If the election is made,
such holder generally will be required to take into account the difference, if
any, between the fair market value and its adjusted tax basis in shares or ADSs
at the end of each taxable year as ordinary income or ordinary loss (to the
extent of any net mark-to-market gain previously included in income). In
addition, any gain from a sale or other disposition of shares or ADSs will be
treated as ordinary income, and any loss will be treated as ordinary loss (to
the extent of any net mark-to-market gain previously included in income).
DIVIDENDS AND PAYING AGENTS
Not applicable.
STATEMENT BY EXPERTS
Not applicable.
DOCUMENTS ON DISPLAY
You can read and copy documents referred to in this annual report that
have been filed with the SEC at the SEC's public reference room located at 450
Fifth Street, NW, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330
for further information on the public reference rooms and their copy charges.
The SEC also maintains a website at http://www.sec.gov that contains reports and
other information that we have filed electronically with the SEC.
SUBSIDIARY INFORMATION
Not applicable.
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Item 5. Operating and Financial Review and Prospects--Market Risk
and Risk Management."
99
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE
OF PROCEEDS
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITIES HOLDERS.
None.
USE OF PROCEEDS
The following use of proceeds information relates to our registration
statement on Form F-1 (File No. 333-119786), filed by us in connection with our
initial public offering of ordinary shares in the United States. In connection
with the registration of the ordinary shares, a registration statement on Form
F-6 (File No.333-119970) was also filed for ADSs representing such ordinary
shares. Each of these two registration statements was declared effective by the
SEC on November 10, 2004. Our ordinary shares commenced trading on the Hong Kong
Stock Exchange on November 17, 2004 and the ADSs on the New York Stock Exchange
on November 16, 2004.
The global offering, which consisted of our initial public offering in
the United States, an international offering outside the United States and an
initial public offering in the Hong Kong, was completed and all of the
securities offered in connection therewith were sold. A portion of the
securities registered under our registration statement on Form F-1 were sold in
Hong Kong public offering and the international offering. China International
Capital Corporation Limited, Citigroup Global Markets Inc., and Goldman Sachs
(Asia) L.L.C. acted as U.S. representatives for the U.S. underwriters; and China
International Capital Corporation Limited, Citigroup Global Markets Limited, and
Goldman Sachs (Asia) L.L.C. acted as international representatives for the
international underwriters.
The following table sets forth for CNC Hong Kong as the issuer and each
selling shareholder information regarding our ordinary shares registered and
sold in our November 2004 global offering, including the exercise of the
over-allotment option:
Amount Registered and Aggregate Price of the Amount Registered
Sold(1) and Sold to Date (US$)(2)
--------------------- ----------------------------------------
CNC Hong Kong.............................. 1,093,529,000 1,193,040,139
China Netcom Group......................... 102,768,985 112,120,963
Chinese Academy of Sciences................ 818,266 892,728
Information and Network Center of
State Administration of Radio,
Film and Television...................... 818,266 892,728
China Railways Telecommunications Center... 818,266 892,728
Shanghai Alliance Investment Limited....... 818,266 892,728
Shandong Provincial State-owned
Assets Supervision and
Administration Commission................ 3,309,951 3,611,157
Total...................................... 1,202,881,000 1,312,266,801
_______________________
(1) The amount of shares registered includes any shares initially offered or
sold outside the U.S. that were thereafter sold or resold in the U.S.
Offers and sales of shares outside the U.S. were made pursuant to
Regulation S under the Securities Act of 1933 and were not covered by the
Registration Statement.
100
(2) The initial public offering price per ADS in the U.S. and international
offerings was US$21.82. The initial public offering price per ordinary
share in the Hong Kong public offering was HK$8.40, and when increased by
a 1.0% brokerage fee, a 0.005% Hong Kong Securities and Futures Commission
transaction levy, a 0.002% investor compensation levy and a 0.005% Hong
Kong Stock Exchange trading fee payable by purchasers, was effectively
equivalent to the initial public offering price per ADS in the U.S. and
international offerings, based on an exchange rate of HK$7.8000 to
US$1.00, the noon buying rate on June 30, 2004, and adjusted for the ratio
of 20 ordinary shares per ADS.
The amount of expenses incurred by us in connection with the issuance
and distribution of the registered securities totaled RMB 689 million, including
RMB 353 million for underwriting discounts and commissions, and approximately
RMB 336 million for other expenses. None of the payments were direct or indirect
payments to our directors, officers, general partners of our associates, persons
owning 10% or more of any class of our shares, or any of our affiliates.
The aggregate net proceeds from the initial public of our shares, after
deduction of fees and expenses, amounted to RMB 8,944 million and were held in
either H.K. dollars or U.S. dollars. The cash proceeds from our initial public
offering were used as follows: (i) the expansion and upgrading of our
telecommunications network infrastructure; (ii) the repayment of a term loan
facility; (iii) the development of new applications and services; and (iv)
general corporate purposes.
ITEM 15. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer
and Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures, as that term is defined in Rules 13a-15(e) and
15d-15(e) of the U.S. Securities Exchange Act of 1934, as of the end of the
fiscal year covered by this annual report. Based on this evaluation, our Chief
Executive Officer and Chief Financial Officer have concluded that our disclosure
controls and procedures were effective as of the end of the fiscal year covered
by this annual report.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting, as defined in Rules 13a-15(f) and
15d-15(f) of the U.S. Securities Exchange Act of 1934.
The Company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with applicable generally accepted accounting principles. The
Company's internal control over financial reporting includes those policies and
procedures that: (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the Company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in
accordance with applicable generally accepted accounting principles, and that
receipts and expenditures of the Company are being made only in accordance with
authorizations of management and directors of the Company; and (iii) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the Company's assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Our management conducted an evaluation of the effectiveness of our
internal control over financial reporting as of the end of the fiscal year
covered by this annual report based upon the framework in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission
101
("COSO"). Based on this evaluation, our management has concluded that our
internal control over financial reporting was effective as of December 31,
2006.
Our management's evaluation of the effectiveness of our internal
control over financial reporting as of December 31, 2006 has been audited by
PricewaterhouseCoopers, an independent registered public accounting firm, as
stated in their report on page F-1 and page F-2.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the year ended December 31, 2006, we enhanced our internal
control policies and procedures based on the COSO internal control framework. We
also enhanced our administrative policies and compliance, and continued to
integrate and streamline our financial information systems, as well as to
incorporate respective internal control procedures into these systems. In the
year 2006, we implemented certain new policies and procedures in respect of our
corporate governance structure. During the year, most of these changes were
related to the improvement of the documentation of our internal control
procedures and the enhancement of the monitoring of their operating
effectiveness. We have continued to improve and upgrade our internal control
over financial reporting based on our needs and changes in the business
environment.
ITEM 16A AUDIT COMMITTEE FINANCIAL EXPERT
Our board of directors has determined that Mr. Timpson Chung Shui Ming
qualifies as an audit committee financial expert in accordance with the terms of
Item 16.A of Form 20-F. For Mr. Chung's biographical information, see "Item 6.
Directors, Senior Management and Employees--Directors and Senior Management."
ITEM 16B CODE OF ETHICS
We have adopted a code of ethics that applies to our Chief Executive
Officer, Chief Financial Officer, and other designated members of senior
management of the Company. We have filed this code of ethics as an exhibit to
this annual report.
ITEM 16C PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate audit fees, audit-related
fees, tax fees of our principal accountants and all other fees billed for
products and services provided by our principal accountants other than the audit
fees, audit-related fees and tax fees for such of the two years ended December
31, 2006:
Tax Fees
Audit Audit-Related and Transfer Other
Fees Fees Pricing Reports Fees
---------- ------------- --------------- --------
(in millions of RMB)
2005....... 33.8 38.0 5.5 0.2
2006....... 61 31 1.2 0.6
ITEM 16D EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
ITEM 16E PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS.
None.
102
ITEM 17. FINANCIAL STATEMENTS
We have elected to provide the financial statements and related
information specified in Item 18 in lieu of Item 17.
ITEM 18. FINANCIAL STATEMENTS
See Index to Financial Statements for a list of all financial
statements filed as part of this annual report.
ITEM 19. EXHIBITS
Exhibit
No. Description of Exhibit
---------- ----------------------------------------------------------------------------------------
1.1 Memorandum and Articles of Association of the Registrant(1)
2.1 Form of share certificate(1)
2.2 Form of deposit agreement, including form of American Depositary Receipt(2)
3.1 Declaration of Trust, dated October 5, 2004, from CNC BVI to the Academy of Sciences(1)
3.2 Declaration of Trust, dated October 5, 2004, from CNC BVI to INC-SARFT(1)
3.3 Declaration of Trust, dated October 5, 2004, from CNC BVI to CRTC(1)
3.4 Declaration of Trust, dated October 5, 2004, from CNC BVI to Shanghai Alliance(1)
3.5 Declaration of Trust, dated October 5, 2004, from CNC BVI to Shandong SASAC(1)
3.6 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom
Group and the Academy of Sciences (English Translation)(1)
3.7 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom
Group and INC-SARFT (English Translation)(1)
3.8 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom
Group and CRTC (English Translation)(1)
3.9 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom
Group and Shanghai Alliance (English Translation)(1)
3.10 Trust Arrangement, dated October 5, 2004, entered into between CNC BVI, China Netcom
Group and Shandong SASAC (English Translation)(1)
4.1 Asset Injection Agreement, dated June 29, 2004, among China Netcom Group, CNC BVI, CNC
China and us (English Translation)(1)
4.2 Letter of Undertakings by China Netcom Group (English Translation)(1)
4.3 Trademark Licensing Agreement, dated October 8, 2004 among CNC China, China Netcom Group
and us (English Translation)(1)
4.4 Restructuring Agreement, dated September 6, 2004 among CNC China, China Netcom Group and
us (English Translation)(1)
4.5 Non-Competition Agreement, dated September 6, 2004 among CNC China, China Netcom Group
and us (English Translation)(1)
4.6 Assets and Liabilities Transfer Agreement, dated June 23, 2004 entered into between CNC
China and China Netcom Group (English translation)(1)
4.7 Interconnection Settlement Agreement, dated October 8, 2004 between CNC China and China
Netcom Group (English Translation)(1)
4.8 Property Leasing Agreement, dated October 8, 2004 between CNC China and China Netcom
Group (English Translation)(1)
4.9 Property Sub-leasing Agreement, dated October 8, 2004 between CNC China and China Netcom
Group (English Translation)(1)
4.10 Master Services Sharing Agreement, dated October 8, 2004 between CNC China and China
Netcom Group (English Translation)(1)
4.11 Engineering and Information Technology Services Agreement, dated October 8, 2004 between
CNC China and China Netcom Group (English Translation)(1)
4.12 Materials Procurement Agreement, dated October 8, 2004 between CNC China and China Netcom
Group (English Translation)(1)
4.13 Ancillary Telecommunications Services Agreement, dated October 8, 2004 between CNC China
and China Netcom Group (English Translation)(1)
103
4.14 Support Services Agreement, dated October 8, 2004 between CNC China and China Netcom
Group (English Translation)(1)
4.15 Telecommunication Facilities Leasing Agreement, dated October 8, 2004 between CNC China
and China Netcom Group (English Translation)(1)
4.16 Capacity Purchase Agreement, dated June 30, 2004 between Asia Netcom and East Asia Netcom
Limited(1)
4.17 Capacity Lease Agreement, dated June 30, 2004 between Asia Netcom and East Asia Netcom
Limited and Amendment No. 1 dated October 6, 2004(1)
4.18 Management Services Agreement, dated June 30, 2004 between Asia Netcom and East Asia
Netcom Limited and Amendment No. 1 dated October 6, 2004(1)
4.19 Share Option Plan (English Translation)(1)
4.20 Share Purchase and Exchange Agreement, dated June 11, 2004 and amendment dated July 20,
2004 among China Netcom Holdings (BVI) Limited, CNC Fund L.P. and us(1)
4.21 Form of Senior Management Employment Agreement (English Translation)(1)
4.22 Form of Director's Employment Agreement (English Translation)(1)
4.23 Share Purchase and Sale Agreement dated June 30, 2004 entered into between Asia Netcom
and CNC Network Corporation Limited(1)
4.24 Assignment and Novation Agreement dated June 30, 2004 entered into among Asia Netcom, CNC
Network Corporation Limited and us(1)
4.25 Share Purchase Agreement dated December 2, 2003 entered into among SBAIF Asia Netcom
(Cayman) Holdings, China Netcom Corporation International Limited, Asia Netcom and us(1)
4.26 Shareholders Agreement dated March 12, 2003 entered into among China Netcom Corporation
International Limited, SB Asia Infrastructure Fund L.P., Newbridge Asia Netcom (Cayman)
Holdings, Asia Netcom and us(1)
4.27 Share and Asset Purchase Agreement dated November 17, 2002 entered into between Asia
Netcom and AGC(1)
4.28 Share Purchase Agreement, dated December 2, 2003 entered into among Newbridge Asia Netcom
(Cayman) Holdings, China Netcom Corporation International Limited, Asia Netcom and us(1)
4.29 Share Transfer Agreement, dated June 10, 2004, entered into between China Netcom Group
and China Netcom Holdings (English Translation)(1)
4.30 Share Transfer Agreement, dated April 20, 2004, entered into between China Netcom Group
and the Academy of Sciences, INC-SARFT, CRTC and Shanghai Alliance (English
Translation)(1)
4.31 Asset Transfer Agreement, dated April 26, 2004, entered into between China Netcom Group
and Shandong SASAC (English Translation)(1)
4.32 Telecommunications Assets Transfer Agreement, dated June 10, 2004, entered into between
China Netcom Group and Jitong Communications Company Limited (English Translation)(1)
4.33 Telecommunications Assets Transfer Agreement, dated June 10, 2004, entered into between
China Netcom Group and Guangdong Telecommunications Company Limited (English
Translation)(1)
4.34 Debenture, dated July 29, 2004 entered into among Asia Netcom Asia Pacific Limited, Asia
Netcom Asia Pacific Commercial Limited, Asia Netcom Hong Kong Limited and Industrial and
Commercial Bank of China (Asia) Limited(1)
4.35 Deed of Mortgage of Shares, dated July 29, 2004 entered into between Asia Netcom and
Industrial and Commercial Bank of China (Asia) Limited(1)
4.36 Debenture, dated July 29, 2004 entered into among Asia Netcom Services (S) Pte. Ltd.,
Asia Netcom Corporation (Singapore) Pte. Limited, Asia Netcom Singapore Pte. Ltd.,
Southeast Asia Netcom (Singapore) Pte. Ltd. and Industrial and Commercial Bank of China
(Asia) Limited(1)
4.37 Group Share Mortgage, dated July 29, 2004 entered into among Asia Netcom Corporation
(Singapore) Pte. Limited, Asia Netcom Services (S) Pte. Ltd., Southeast Asia Netcom
(Singapore) Pte. Ltd., Asia Netcom Singapore Pte. Ltd. and Industrial and Commercial Bank
of China (Asia) Limited(1)
4.38 Assignment of Building Agreement, dated July 29, 2004 entered into between Asia Netcom
Singapore Pte. Ltd. and Industrial and Commercial Bank of China (Asia) Limited(1)
4.39 Share Pledge Agreement, dated July 28, 2004 entered into among Asia Netcom Corporation
(Singapore) Pte. Ltd., the seven financial institutions listed in the Share Pledge
Agreement and Industrial and Commercial Bank of China (Asia) Limited(1)
4.40 Amended and Restated Facility Agreement, dated July 27, 2004 entered into among Asia
Netcom, the seven banks named in the Amended and Restated Facility Agreement, Industrial
and Commercial Bank of China (Asia) Limited(1)
4.41 Group Subordination Deed, dated July 27, 2004 entered into between Asia Netcom and
Industrial and Commercial Bank of China (Asia) Limited(1)
4.42 Group Subordination Deed, dated July 27, 2004 entered into among our Company and China
Netcom Corporation International Limited, Asia Netcom and Industrial and Commercial Bank
of China (Asia) Limited(1)
4.43 Debenture, dated July 27, 2004 entered into between Asia Netcom and Industrial and
Commercial Bank of China (Asia) Limited(1)
4.44 Group Assignment of Insurances, dated July 27, 2004 entered into among Asia Netcom, EANL
and Industrial and Commercial Bank of China (Asia) Limited(1)
4.45 Security Assignment, dated July 27, 2004 entered into between Asia Netcom and Industrial
and Commercial Bank of China (Asia) Limited(1)
4.46 Charge Over Deposit Account, dated July 27, 2004 entered into between Asia Netcom and
Industrial and Commercial Bank of China (Asia) Limited(1)
4.47 Charge Over Accounts, dated July 27, 2004 entered into between Asia Netcom and Industrial
and Commercial Bank of China (Asia) Limited(1)
4.48 Deed of Mortgage of Shares in Asia Netcom, dated July 27, 2004 entered into between China
Netcom Corporation International Limited and Industrial and Commercial Bank of China
(Asia) Limited(1)
4.49 Asset Transfer Agreement dated January 15, 2007 entered into between China Netcom (Group)
Company Limited and China Netcom Group (4)
104
8.1 List of subsidiaries of the Registrant
11.1 Code of Ethics (3)
12.1 CEO Certification
12.2 CFO Certification
13.1 Certification by CEO and CFO
________________
(1) Incorporated by reference to our Registration Statement on Form F-1 (File
No. 333-119786) filed with the SEC in connection with our global offering
in November 2004.
(2) Incorporated by reference to our Registration Statement on Form F-6 (File
No. 333-119970) filed with the SEC with respect to American Depositary
Shares representing our ordinary shares.
(3) Incorporated by reference to our Form 20-F filed with the SEC on June 23,
2005.
(4) Filed herewith.
105
SIGNATURE
The registrant hereby certifies that it meets all of the requirements
for filing on Form 20-F and that it has duly caused and authorized the
undersigned to sign this annual report on its behalf.
China Netcom Group Corporation (Hong Kong) Limited
/s/ Zuo Xunsheng
______________________
Name: Zuo Xunsheng
Title: Chief Executive Officer
Date: May 31, 2007
106
Appendix A
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page No.
----------------
Report of Independent Registered Public Accounting Firm F-1 - F-2
Consolidated income statement for each of the three years
ended December 31, 2004, 2005 and 2006 F-3 - F-4
Consolidated balance sheets as of December 31, 2005 and 2006 F-5 - F-7
Consolidated statements of changes in equity for each of the
three years ended December 31, 2004, 2005 and 2006 F-8 - F-10
Consolidated statements of cash flows for each of the
three years ended December 31, 2004, 2005 and 2006 F-11 - F-12
Notes to consolidated financial statements F-13 - F-98
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders of China Netcom Group (Hong Kong)
Corporation Limited:
We have completed an integrated audit of China Netcom Group (Hong Kong)
Corporation Limited and its subsidiaries' ("the Group") 2006 consolidated
financial statements and of its internal control over financial reporting as of
December 31, 2006 and audits of its 2005 and 2004 consolidated financial
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Our opinions, based on our audits, are
presented below.
Consolidated financial statements
---------------------------------
In our opinion, the consolidated financial statements listed in the accompanying
page F-3 to page F-98 present fairly, in all material respects, the financial
position of the Group at December 31, 2006 and December 31, 2005, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2006 in conformity with accounting principles
generally accepted in Hong Kong. These financial statements are the
responsibility of the Group's management. Our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit of financial
statements includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Note 3(b) to the consolidated financial statements, the Group
adopted the Revised Hong Kong Financial Reporting Standards ("HKFRS") issued by
the Hong Kong Institute of Certified Public Accountants during the year ended
December 31, 2005. The effect of adoption of certain HKFRS, which resulted in
changes to some accounting policies of the Company, is set out in Note 3(b) to
the consolidated financial statements.
Accounting principles generally accepted in Hong Kong vary in certain
significant respects from accounting principles generally accepted in the United
States of America ("US GAAP"). Information relating to the nature and effect of
such differences is presented in Note 40 to the consolidated financial
statements.
Internal control over financial reporting
-----------------------------------------
Also, in our opinion, management's assessment, included in Management's Report
On Internal Control over Financial Reporting in Item 15 appearing on page 101 of
the 2006 Annual Report that the Group maintained effective internal control over
financial reporting as of December 31, 2006 based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO"), is fairly stated, in all
material respects, based on those criteria. Furthermore, in our opinion, the
Group maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2006, based on criteria established in
Internal Control - Integrated Framework issued by the COSO. The Group's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express opinions on
management's assessment and on the effectiveness of the Group's internal control
over financial reporting based on our audit. We conducted our audit of internal
control over financial reporting in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. An audit of internal control over financial reporting
includes obtaining an understanding of internal control over financial
reporting, evaluating management's assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing such
F-1
other procedures as we consider necessary in the circumstances. We believe that
our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers
Certified Public Accountants
Hong Kong
May 31, 2007
F-2
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2006
Year ended December 31
----------------------------------------------------------------
Note 2004 2005 2006 2006
---------- ------------ ------------ ----------- ------------
RMB RMB RMB USD
million million million million
Restated Restated
Note 2 Note 2
Continuing operations:
Revenues 7 82,281 85,861 86,921 11,131
------------ ------------ ----------- ------------
Operating expenses
Depreciation and amortization (24,873) (24,919) (25,608) (3,279)
Networks, operations and support (13,092) (13,465) (14,383) (1,842)
Staff costs 14 (11,630) (12,034) (12,151) (1,556)
Selling, general and administrative (12,617) (13,322) (13,366) (1,712)
Other operating expenses (1,982) (1,390) (2,054) (263)
------------ ------------ ----------- ------------
Total of operating expenses 8 (64,194) (65,130) (67,562) (8,652)
------------ ------------ ----------- ------------
Other income - - 621 80
Interest income 68 131 132 17
Dividend income 17 29 - -
Deficit on revaluation of fixed assets 19(c) (11,318) - (1,524) (195)
------------ ------------ ----------- ------------
Profit from operations 6,854 20,891 18,588 2,381
Finance costs 9 (3,769) (3,347) (3,888) (498)
------------ ------------ ----------- ------------
Share of loss of associate companies (1) - -
Profit before taxation 3,084 17,544 14,700 1,883
Taxation 10 326 (3,430) (3,559) (456)
------------ ------------ ----------- ------------
Profit for the year from continuing
operations 3,410 14,114 11,141 1,427
============ ============ =========== ============
Discontinued operations :
(Loss)/profit for the year from
discontinued operations 24 (711) (226) 1,819 233
============ ============ =========== ============
Profit for the year 2,699 13,888 12,960 1,660
============ ============ =========== ============
Dividends proposed after the balance sheet
date 12 259 3,196 3,695 473
============ ============ =========== ============
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statements.
F-3
Earnings per share for profit from
continuing operations attributable to
shareholders of the Company for the year
Basic earnings per share 13 0.61 2.14 1.68 0.22
============ ============ =========== ============
Diluted earnings per share 13 0.61 2.13 1.67 0.21
============ ============ =========== ============
(Losses)/earnings per share for
(loss)/profit from discontinued operations
attributable to shareholders of the Company
for the year
Basic (losses)/earnings per share 13 (0.13) (0.03) 0.27 0.03
============ ============ =========== ============
Diluted (losses)/earnings per share 13 (0.13) (0.03) 0.27 0.03
============ ============ =========== ============
Earnings per share from operations
attributable to shareholders of the Company
for the year
Basic earnings per share 13 0.48 2.11 1.95 0.25
============ ============ =========== ============
Diluted earnings per share 13 0.48 2.10 1.94 0.25
============ ============ =========== ============
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statements.
F-4
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED BALANCE SHEET
AS AT DECEMBER 31, 2006
As at December 31
-------------------------------------------
Note 2005 2006 2006
-------- ------------ ------------ -----------
RMB RMB USD
million million million
Assets
Current assets
Cash and bank deposits 15 4,895 7,571 970
Accounts receivable 16 7,401 8,283 1,061
Inventories and consumables 17 472 416 53
Prepayments, other receivables and other current assets 18 1,484 1,437 184
Due from holding companies and fellow subsidiaries 28 247 352 45
------------ ------------ -----------
Total current assets 14,499 18,059 2,313
------------ ------------ -----------
Non-current assets
Fixed assets 19 168,663 168,044 21,520
Construction in progress 20 6,822 6,355 814
Lease prepayments 21 1,949 2,364 303
Intangible assets 22 1,393 1,588 203
Deferred tax assets 31 3,480 3,459 443
Other non-current assets 23 6,034 3,966 508
------------ ------------ -----------
Total non-current assets 188,341 185,776 23,791
------------ ------------ -----------
Total assets 202,840 203,835 26,104
============ ============ ===========
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statements.
F-5
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED BALANCE SHEET (CONTINUED)
AS AT DECEMBER 31, 2006
As at December 31
-------------------------------------------
Note 2005 2006 2006
-------- ------------ ------------ -----------
RMB RMB USD
million million million
Liabilities and equity
Current liabilities
Accounts payable 25 16,719 17,654 2,261
Accruals and other payables 26 3,905 3,056 391
Short term commercial papers 27(a)(i) - 9,811 1,256
Short term bank loans 27(a)(ii) 47,341 30,980 3,967
Current portion of long term bank and other loans 27(b) 6,846 7,304 935
Due to ultimate holding company and fellow subsidiaries
28 8,990 7,519 963
Current portion of deferred revenues 29 7,975 7,733 990
Current portion of provisions 30 4,029 3,736 478
Taxation payable 2,594 3,009 387
------------ ------------ -----------
Total current liabilities 98,399 90,802 11,629
------------ ------------ -----------
Net current liabilities (83,900) (72,743) (9,316)
------------ ------------ -----------
Total assets less current liabilities 104,441 113,033 14,475
------------ ------------ -----------
Non-current liabilities
Long term bank and other loans 27(b) 18,143 23,219 2,973
Due to ultimate holding company and fellow subsidiaries
28 7,840 5,880 753
Deferred revenues 29 10,925 6,198 794
Provisions 30 3,174 2,586 331
Deferred tax liabilities 31 1,324 1,156 148
Other non-current liabilities 25 16 2
------------ ------------ -----------
Total non-current liabilities 41,431 39,055 5,001
------------ ------------ -----------
The notes on pages F-13 to F-98 are an integral part of these consolidated statements.
F-6
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED BALANCE SHEET (CONTINUED)
AS AT DECEMBER 31, 2006
Total liabilities 139,830 129,857 16,630
------------ ------------ -----------
Financed by:
Share capital 32 2,181 2,199 282
Reserves 60,829 71,779 9,192
------------ ------------ -----------
Shareholders' equity 63,010 73,978 9,474
------------ ------------ -----------
Total liabilities & equity 202,840 203,835 26,104
============ ============ ===========
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statements
F-7
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED DECEMBER 31, 2006
Attributable to equity holders of the company
------------------------------------------------------------------------------
Share Share Capital Statutory Revaluation Other Retained
capital premium reserve reserve reserve reserve earnings
RMB RMB RMB RMB RMB RMB RMB
million million million million million million million
(Note 32)
Balance as at January 1, 2004 1,819 34,168 - - 1,998 10,283 5,391
Appropriation to statutory reserve (Note 11) - - - 723 - - (723)
Revaluation surplus (Note 19(c)) - - - - 3,863 - -
Movement of deferred tax recognized in equity - - - - 846 2,355 (137)
(Note 31)
Transfer to retained earnings - - - - (697) (241) 938
Transfer to capital reserve upon Listing - - 265 - - - (265)
Reorganization
Transfer from retained earnings to other reserve due - - - - - (6,531) 6,531
to the Acquisition
Revaluation tax credit (Note 31) - - - - (1,275) - -
---------- ---------- ---------- ---------- ------------ ---------- ----------
Net income/(expense) recognized directly in equity - - 265 723 2,737 (4,417) 6,344
Profit for the year - - - - - - 2,699
---------- ---------- ---------- ---------- ------------ ---------- ----------
Total income recognized for 2004 - - 265 723 2,737 (4,417) 9,043
Issue of shares through global offering ("Global 362 8,582 - - - - -
Offering") net of issue expense
Contributions from owner - - - - - - 3,995
Distributions to owner - - - - - - (2,600)
Tax loss as utilized by owner (Note 31) - - - - - - (704)
Net assets distributed to owner in accordance with - - - - - - (6,047)
Listing Reorganization
Distribution to an owner upon assignment of loan - - - - - - (1,021)
Share-based payments - - 18 - - - -
---------- ---------- ---------- ---------- ------------ ---------- ----------
Balance at December 31, 2004 2,181 42,750 283 723 4,735 5,866 8,057
========== ========== ========== ========== ============ ========== ==========
[TABLE CONTINUED]
Minority Total equity
interest
RMB RMB
million million
Balance as at January 1, 2004 3 53,662
Appropriation to statutory reserve (Note 11) - -
Revaluation surplus (Note 19(c)) - 3,863
Movement of deferred tax recognized in equity - 3,064
(Note 31)
Transfer to retained earnings - -
Transfer to capital reserve upon Listing - -
Reorganization
Transfer from retained earnings to other reserve du - -
to the Acquisition
Revaluation tax credit (Note 31) - (1,275)
----------- --------------
Net income/(expense) recognized directly in equity - 5,652
Profit for the year - 2,699
----------- --------------
Total income recognized for 2004 - 8,351
Issue of shares through global offering ("Global - 8,944
Offering") net of issue expense
Contributions from owner - 3,995
Distributions to owner - (2,600)
Tax loss as utilized by owner (Note 31) - (704)
Net assets distributed to owner in accordance with (3) (6,050)
Listing Reorganization
Distribution to an owner upon assignment of loan - (1,021)
Share-based payments - 18
----------- --------------
Balance at December 31, 2004 - 64,595
=========== ==============
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statements
F-8
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2006
Attributable to equity holders of the company
-----------------------------------------------------------------------------
Share Share Capital Statutory Revaluation Other Retained
capital premium reserve reserve reserve reserve earnings
RMB RMB RMB RMB RMB RMB RMB
million million million million million million million
(Note 32)
Balance as at December 31, 2004 2,181 42,750 283 723 4,735 5,866 8,057
Effect of adoption of HKFRSs :
Derecognition of negative goodwill (Note (3)(b)(ii)) - - - - - - 166
Financial instruments (Note 3(b)(iv)) - - - - - - 1
---------- ---------- ---------- ---------- ------------ --------- ----------
Balance as at January 1, 2005 2,181 42,750 283 723 4,735 5,866 8,224
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) -
Movement of deferred tax recognized in equity
(Note 31) - - - - 1,097 843 (2,174)
Transfer from retained earnings to other reserve
due to the Acquisition of New Horizon - - - - - 1,040 (1,040)
---------- ---------- ---------- ---------- ------------ --------- ----------
Net income/(expense) recognized directly in equity - - - 7,827 (634) 1,731 (9,214)
Profit for the year - - - - - - 13,888
---------- ---------- ---------- ---------- ------------ --------- ----------
Total income recognized for 2005 - - - 7,827 (634) 1,731 4,674
Contributions from owner - - - - - - 68
Distributions to owner - - - - - - (930)
Dividend for 2004 distributed during 2005 (Note 12) - - - - - - (259)
Net assets distributed to owner in accordance with
reorganization for the Acquisition of New Horizon
- - - - - - (1,533)
Consideration for the Acquisition of New Horizon - - - - - (12,800) -
(Note 1)
Share-based payments - - 104 - - - -
---------- ---------- ---------- ---------- ------------ --------- ----------
Balance as at December 31, 2005 2,181 42,750 387 8,550 4,101 (5,203) 10,244
========== ========== ========== ========== ============ ========= ==========
[TABLE CONTINUED]
Total equity
RMB
million
Balance as at December 31, 2004 64,595
Effect of adoption of HKFRSs :
Derecognition of negative goodwill (Note (3)(b)(ii)) 166
Financial instruments (Note 3(b)(iv)) 1
----------
Balance as at January 1, 2005 64,762
Transfer to statutory reserve (Note 11) -
Appropriation to statutory reserve (Note 11) -
Transfer to retained earnings -
Currency translation differences (56)
Movement of deferred tax recognized in equity
(Note 31) (234)
Transfer from retained earnings to other reserve
due to the Acquisition of New Horizon -
----------
Net income/(expense) recognized directly in equity (290)
Profit for the year 13,888
----------
Total income recognized for 2005 13,598
Contributions from owner 68
Distributions to owner (930)
Dividend for 2004 distributed during 2005 (Note 12) (259)
Net assets distributed to owner in accordance with
reorganization for the Acquisition of New Horizon
(1,533)
Consideration for the Acquisition of New Horizon (12,800)
(Note 1)
Share-based payments 104
----------
Balance as at December 31, 2005 63,010
==========
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statements
F-9
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2006
Attributable to equity holders of the company
-----------------------------------------------------------------------------
Share Share Capital Statutory Revaluation Other Retained
capital premium reserve reserve reserve reserve earnings
RMB RMB RMB RMB RMB RMB RMB
million million million million million million million
(Note 32)
Balance as at January 1, 2006 2,181 42,750 387 8,550 4,101 (5,203) 10,244
Transfer to statutory reserve (Note 11) - - - 2,406 - - (2,406)
Appropriation to statutory reserve (Note 11) - - - 855 - - (855)
Transfer to retained earnings - - - - (1,933) (51) 1,984
Revaluation surplus (Note 19) - - - - 1,071 - -
Currency translation differences (i) - - - - - (79) -
Movement of deferred tax recognized in equity - - - - (353) - -
(Note 31)
--------- --------- ----------- ---------- ------------ ---------- ----------
Net income/(expense) recognized directly in equity - - - 3,261 (1,215) (130) (1,277)
Profit for the year - - - - - - 12,960
--------- --------- ----------- ---------- ------------ ---------- ----------
Total income recognized for 2006 - - - 3,261 (1,215) (130) 11,683
Dividend for 2005 distributed during 2006 (Note 12) - - - - - - (3,196)
Exercise of share options (Note 32) 18 545 (73) - - - -
Share-based payments - - 75 - - - -
--------- --------- ----------- ---------- ------------ ---------- ----------
Balance at December 31, 2006 2,199 43,295 389 11,811 2,886 (5,333) 18,731
========= ========= =========== ========== ============ ========== ==========
Balance at December 31, 2006 (in USD million) 282 5,544 50 1,513 370 (683) 2,399
========= ========= =========== ========== ============ ========== ==========
[TABLE CONTINUED]
Total equity
RMB
million
Balance as at January 1, 2006 63,010
Transfer to statutory reserve (Note 11) -
Appropriation to statutory reserve (Note 11) -
Transfer to retained earnings -
Revaluation surplus (Note 19) 1,071
Currency translation differences (i) (79)
Movement of deferred tax recognized in equity (353)
(Note 31)
-------------
Net income/(expense) recognized directly in equity 639
Profit for the year 12,960
-------------
Total income recognized for 2006 13,599
Dividend for 2005 distributed during 2006 (Note 12) (3,196)
Exercise of share options (Note 32) 490
Share-based payments 75
-------------
Balance at December 31, 2006 73,978
=============
Balance at December 31, 2006 (in USD million) 9,474
=============
(i) Including accumulated currency translation differences realized upon disposal of ANC Group
amounting to RMB29 million See Note 34(c)
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statement
F-10
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED STATEMENT OF CASH FLOW
FOR THE YEAR ENDED DECEMBER 31, 2006
Year ended December 31
---------------------------------------------------------
Note 2004 2005 2006 2006
--------------------------- ------------- -------------
RMB million RMB million RMB million USD million
Restated Restated
Note 2 Note 2
Cash flows from operating activities
Net cash inflows from operations 35(a) 37,776 40,632 41,050 5,257
Interest received 68 131 132 17
Dividends received 17 29 - -
Interest paid (3,727) (3,244) (3,564) (456)
Profits tax paid (7) (4,065) (3,668) (470)
--------------------------- ------------- -------------
Cash inflow from operating activities of continuing operation 34,127 33,483 33,950 4,348
Cash (outflow)/inflow from operating activities of discontinued
operation 24 (474) 74 183 23
--------------------------- ------------- -------------
Net cash inflow from operating activities 33,653 33,557 34,133 4,371
--------------------------- ------------- -------------
Cash flows from investing activities
Purchase of fixed assets and construction in progress (27,825) (26,967) (25,978) (3,327)
Prepayments for leased network capacity - - (318) (40)
Prepayments for leased land (202) (280) (178) (23)
Sale of fixed assets 922 49 126 16
Sale of other investments 1,528 2,874 - -
Net decrease in time deposits with maturity over three months 5 28 - -
Other income - - 375 48
Purchase of other investments (2,902) - - -
--------------------------- ------------- -------------
Cash outflow from investing activities of continuing operations
(28,474) (24,296) (25,973) (3,326)
Cash (outflow)/inflow from investing activities of
discontinued operations 24 (228) (312) 982 126
--------------------------- ------------- -------------
Net cash outflow from investing activities (28,702) (24,608) (24,991) (3,200)
--------------------------- ------------- -------------
Cash flows from financing activities
New bank loans and other loans 63,053 77,578 89,002 11,398
Issuance of short-term commercial papers - - 9,676 1,239
Repayment of bank loans (69,964) (85,289) (98,512) (12,617)
Capital element of finance lease payments (964) (909) (1,347) (172)
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statement.
F-11
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
CONSOLIDATED STATEMENT OF CASH FLOW (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2006
Payment of prior year distributions to owner (7,310) (1,566) (600) (77)
Payment to ultimate holding company for the Acquisition of New
Horizon - (3,000) (1,960) (251)
Dividends payment - (259) (3,196) (409)
Loans to fellow subsidiaries and related parties - (1,319) - -
Issuance of shares upon exercise of share options - - 490 63
Global Offering net of issue expense 8,944 - - -
Net loan from owner 3,995 - - -
--------------------------- ------------- -------------
Cash outflow from financing activities of continuing operations (2,246) (14,764) (6,447) (826)
Cash inflow from financing activities of discontinued operations 24 503 108 - -
--------------------------- ------------- -------------
Net cash outflow from financing activities (1,743) (14,656) (6,447) (826)
-------------------------- ------------- -------------
Cash flows from continuing operations 3,407 (5,577) 1,530 196
Cash flows from discontinued operations (199) (130) 1,165 149
-------------------------- ------------- -------------
Increase/(decrease) in cash and cash equivalents 3,208 (5,707) 2,695 345
-------------------------- ------------- -------------
Cash and cash equivalents at beginning of year 7,373 10,581 4,874 624
-------------------------- ------------- -------------
Cash and cash equivalents at end of year 15 10,581 4,874 7,569 969
========================== ============= =============
The notes on pages F-13 to F-98 are an integral part of these consolidated financial statements.
F-12
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED 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 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 based on the fixed line telecommunication
section from the Northern operations originally operated by China
Telecommunication Corporation ("China Telecom Group"). 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.
Pursuant to a resolution passed at the extraordinary general meeting of the
shareholders on October 25, 2005, the Company acquired the principal
telecommunications operations, assets and liabilities in the four Northern
provinces/autonomous region, namely Shanxi Province, Neimenggu Autonomous
Region, Jilin Province and Heilongjiang Province from China Netcom Group.
In anticipation of the acquisition, China Netcom Group established China
Netcom Group New Horizon Communications Corporation (BVI) Limited ("New
Horizon (BVI)") and China Netcom Group New Horizon Communications
Corporation Limited ("New Horizon Communications"). 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 Communications from China
Netcom Group (hereinafter the "Acquisition of New Horizon'), the Company
controlled the fixed line telecommunications businesses in the four
Northern provinces/autonomous region. On November 3, 2006, New Horizon
Communications was deregistered and its operations were merged into the
Company's wholly owned subsidiary, China Netcom (Group) Company Limited
("CNC China"). The Group leased from China Netcom Group the
inter-provincial fiber-optic cables of the service regions the Group
operates in the PRC and which had been retained from China Netcom Group.
F-13
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1 The Group and its principal activities (continued)
Background of the Group (continued)
After taking into consideration the financial position and prospects of the
acquired businesses and the conditions of the capital market, the
consideration for Acquisition of New Horizon 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.
Following the Listing Reorganization and the Acquisition of New Horizon,
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.
The Group is also the holder of licenses that are necessary to own and
operate the assets held outside the PRC in such key countries and regions
such as United States, Hong Kong and Japan.
The Group's PRC operations are subject to the supervision of and regulation
by the PRC Government. The Ministry of Information Industry ("MII"),
pursuant to the authority delegated by the State Council, is responsible
for formulating the telecommunications industry policies and regulations
(the "Telecommunications Regulations").
Under the Telecommunications Regulations, all telecommunications operators
in the PRC must obtain a telecommunications service operating license from
the MII or from the provincial telecommunications administrations.
Providers of value-added services within a single province are required to
obtain licenses from provincial telecommunications administrations.
Providers of basic telecommunications services and providers of value-added
services in two or more provinces, autonomous regions and municipalities
are required to obtain licenses from the MII. CNC China, the Group's
principal operating subsidiary in China, as an indirect subsidiary of China
Netcom Group, has 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.
On June, 2, 2006, the Group entered into an agreement with third party
buyers to dispose of its entire interest in the Asia Netcom Corporation
Limited ("ANC Group") for an aggregate cash consideration of US$168.84
million, at fair value determined by both parties. The transaction was
completed on August 22, 2006.
F-14
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1 The Group and its principal activities (continued)
Background of the Group (continued)
Currently, 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 Information Communications Technology Services, including system
integration, software development, maintenance services, consultancy
services, product sales and agency services, and equipment leasing
services;
o Business and data communications services, including integrated
regional data and voice communications services.
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 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 as explained in the
accounting policies in Note 4 below, and on a going concern basis.
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. In
addition, on July 20, 2006, the Group issued commercial papers to raise
additional funding of RMB10 billion. Based on the Group's history of
obtaining finance, its relationships with its bankers and its operating
performance, the board of 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.
Since the Group disposed of the ANC Group during the year, in accordance
with HKFRS 5 "Non-current assets held for sale and discontinued
operations" issued by the HKICPA, the results and cash flows of the
operations of the ANC Group have been presented as discontinued operations.
The 2005 and 2004 comparative figures in the income statements and
statements of cash flow are restated accordingly.
F-15
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3 Changes in accounting policies
(a) Changes in accounting policies in 2006
In 2006, the Group adopted certain revised HKFRSs which are relevant to its
operations as listed below.
o HKAS 21 (Amendment) - Net investment in a Foreign Operation
o HKAS39 (Amendment) - Cash Flow Hedge Accounting for Forecast Intragroup
Transactions
o HKAS 39 (Amendment) - Fair Value Options
o HKFRS 39 (Amendment) and HKAS 4 (Amendment) - Financial guarantee
contracts
The adoption of these new or revised HKFRSs by the Company did not have any
significant impact on its results of operations and financial position.
The HKICPA has also issued a number of new and revised HKFRSs which are
relevant to the Group's operation as set out below which are effective for
accounting periods beginning on or after January 1, 2007. The Group has not
early adopted these new or revised HKFRSs in the financial statements for
the year ended December 31, 2006. The Group has commenced an assessment of
the impact of these new and revised HKFRSs, but is not yet in a position to
state whether these new and revised HKFRSs would have a significant impact
on its results of operations and financial position.
o HKFRS 7 - Financial Instruments : Disclosures
o HKAS 1 (Amendment) - Presentation of Financial Statements: Capital
Disclosure
o HK(IFRIC) - Int 8 - Scope of HKFRS 2
o HK(IFRIC) - Int 10 - Interim Reporting and Impairment
(b) Changes in accounting policies in 2005
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
F-16
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3 Changes in accounting policies (Continued)
(b) Changes in accounting policies in 2005 (Continued)
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.
The changes in accounting policies from the adoption of HKFRS 3, HKAS
32, HKAS 36 and HKAS 39 were not accounted for retrospectively. The
impact of the adoption of these standards to the financial position
and results of the Group was as follows:
(i) HKFRS 3 and HKAS 36
In prior years:
o 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
o 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.
F-17
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3 Changes in accounting policies (Continued)
(b) Changes in accounting policies in 2005 (Continued)
(i) HKFRS 3 and HKAS 36(continued)
The change in the net book value of negative goodwill, as disclosed in Note
23, arising from the above change in accounting policy has been
prospectively accounted for from January 1, 2005 as follows:
Effect of
Before adoption adoption of
of new HKFRS new HKFRS As restated
--------------------- ----------------- --------------
RMB RMB RMB
million million million
As at January 1, 2005
Negative goodwill (included in
intangible assets) (166) 166 -
Retained earnings 8,057 166 8,223
--------------------- ----------------- --------------
The adoption of HKFRS 3 and HKAS 36 resulted in:
Year ended
December 31,
2005
---------------------
RMB
million
Increase in amortization expense 15
---------------------
F-18
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3 Changes in accounting policies (Continued)
(b) Changes in accounting policies in 2005 (Continued)
(iv) HKAS 32 and HKAS 39
HKAS 32 and HKAS 39 establish principles for disclosure, presentation,
recognition and measurement of financial instruments, including
non-derivative financial assets, non-derivative financial liabilities and
derivative instruments for hedging activities.
Under HKAS 39, financial instruments will be carried at either amortized
cost or fair value, depending on their classification. Movements in fair
value will be either charged to income statement or taken to equity in
accordance with the standards. In addition, all derivatives, including
those embedded in non-derivative host contracts are recognized in the
balance sheet at fair value.
This change in accounting policy has been prospectively accounted for from
January 1, 2005 as follows:
Effect of
Before adoption adoption of
of new HKFRS new HKFRS As restated
------------------- ---------------- --------------
RMB RMB RMB
million million million
------------------- ---------------- --------------
As at January 1, 2005 Contracts receivable
(Included in other non-current assets) 408 (408) -
Contracts payable (Included in other
non-current liabilities) (533) 533 -
Discount on foreign currency exchange forward
contracts (Included in other non-current assets) 59 (59) -
Derivative assets (Included in other non-current
assets) - 9 9
Derivative liabilities (Included in other
non-current liabilities) - (74) (74)
Retained earnings 8,057 1 8,058
------------------- --------------- ---------------
The adoption of HKAS 39 resulted in:
Year ended
December 31,
2005
---------------------
RMB
million
Decrease in profit before taxation 15
---------------------
F-19
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies
(a) Basis of consolidation
Acquisitions of businesses under common control are accounted for
using merger accounting in accordance with Accounting Guideline 5
issued by HKICPA. 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.
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.
When a subsidiary is disposed, the difference between the proceeds
from the disposal of the subsidiary and its carrying amount as of the
date of disposal, including the cumulative amount of any exchange
differences that relates to the subsidiary recognized in equity is
recognized in the consolidated income statement as the gain or loss
on the disposal of the subsidiary.
All significant intercompany transactions and balances within the
Group are eliminated on consolidation.
(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.
F-20
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies
(c) Revenue recognition (Continued)
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(r)(ii) for the policy on accounting for the 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 Revenue from information communication technologies services are
recognized when goods are delivered to the customer (which
generally coincides with the time when the customer has accepted
the goods and the related risks and rewards of ownership have
been transferred to the customer) or when services are rendered
to customer.
o Interconnection fees from domestic and foreign
telecommunications operators are recognized when the services
are rendered as measured by the minutes of traffic processed.
o Lease income from the leasing of lines and customer-end
equipment is recognized over the term of the lease. Lease income
from other domestic telecommunications operators and business
customers for the usage of the Group's fixed line
telecommunications networks is measured by the number of lines
leased and the agreed upon rate per line leased. The lease
arrangements are primarily determined on a year to year basis.
(ii) Interest income
Interest income is recognized on a time proportion basis,
taking into account the principal amounts outstanding and
the interest rates applicable.
(iii) Dividend income
Dividend income is recognized when the right to receive
payment is established.
(d) Interest expenses
Interest expenses 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.
F-21
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(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").
(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
(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 disposal.
(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.
F-22
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(h) Accounts receivable and other receivables
Accounts and other receivables are recognized initially at fair value
and subsequently measured at amortized 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.
(j) Lease prepayments
(i) 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.
(ii) Lease prepayments for network capacity
Lease prepayments for network capacity represent payments for
network capacity on an indefeasible right of use basis for the
own use of the Company. Lease prepayments for network capacity
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 are included in
the assets' carrying amount or recognized as a separate asset,
as
F-23
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(k) Fixed assets (continued)
appropriate, only when it is probable that future economic
benefits associated with the item will flow to the Group and
the cost of the item can be measured reliably. 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 accumulated 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 any
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 the
revaluation reserve to retained earnings.
Revaluations on fixed assets will be performed with sufficient
regularity by independent valuers and in each of the
intervening years valuations will be undertaken by executives
of the Group.
(iv) Depreciation
Fixed assets are depreciated at rates sufficient to write off
their costs or revalued amounts less accumulated impairment
losses and estimated residual values over their estimated
useful lives on a straight-line basis. The principal useful
lives are as follows:
Buildings 8-30 years
Telecommunications networks and equipment 5-10 years
Furniture, fixture, motor vehicles and other
equipment 5-10 years
The useful lives and estimated residual values are reviewed
and modified periodically at every balance sheet date.
(v) Gain or loss on sale of fixed assets
The gain or loss on disposal of a fixed asset is the
difference between the net sales proceeds and the carrying
amount of the relevant asset, and is recognized in the income
statement, except where the fixed asset is carried at
valuation. The relevant portion of the revaluation reserve
realized in respect of previous valuations is transferred to
retained earnings and is shown as a movement in reserves.
F-24
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(l) Impairment of assets
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
purpose of assessing impairment, assets are grouped at the lowest
levels for which there are separately identifiable cash flows
(cash-generating units).
(m) Assets held 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 lesser are classified as
operating leases. Payments made under operating leases (net of
any incentives received from the lesser) 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 two to five years.
(ii) Sponsorship fee
The sponsorship fee for the 2008 Beijing Olympic Games has
been capitalized and amortized on a straight-line basis over 4
years, being the estimated 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) 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.
F-25
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(o) Provisions (Continued)
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.
(p) 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 is paid by the PRC
government. As stipulated by the regulations of the
PRC, the subsidiaries in the PRC make contributions to
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 percent of the employees' relevant income, subject
to a cap of monthly relevant income of HK$20,000,
Employer's contribution are expensed as incurred..
(ii) Early retirement benefits
Early retirement benefits are recognized as expenses when
the Group reaches agreement with the relevant employees for
early retirement.
(iii) Employee housing benefits
One-off cash housing subsidies paid to PRC employees are
charged to the consolidated income statements in the year in
which it is determined that the payment of such subsidies is
probable and the amounts can be reasonably estimated (see
Note 30).
PRC full-time employees of the Group participate in various
government-sponsored housing funds. The Group contributes on
a monthly basis to these funds based on certain percentages
of the salaries of the employees. 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.
F-26
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(p) 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.
(q) 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.
(r) 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) Subscriber acquisition costs
The cost of handsets given to customers under bundled
service contracts are deferred as subscriber 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 for resale are
capitalized and expensed over the corresponding lease
period.
(s) Derivative financial instruments
Derivative financial instruments are stated at fair value on the
balance sheet. Realized and unrealized gains and loses arising
from change in the fair value are included in the income statement
in the period in which they arise.
F-27
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4 Principal accounting policies (continued)
(t) Discontinued operation
A discontinued operation is a component of the Group that may be a
major line of business or geographical area of operations that has
been disposed or is held for sale. The result of that component is
separately reported as "discontinued operations" in the income
statement. The comparative income statement is restated as if the
operation had been discontinued from the start of the comparative
period. The assets, liabilities and minority interests of such
component classified as "discontinued operations" or "held for sale"
is presented separately in the assets, liabilities and minority
interests sections, respectively, of the consolidated Balance Sheet.
(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 such that the outflow is probable,
the contingent liability will then be recognized as a provision.
A contingent asset is a possible asset that arises from past events
and whose existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain events not wholly within the
control of the Group. A contingent asset is disclosed when an inflow
of economic benefits is probable but only recognized in income
statement when realized.
(v) Segmental reporting
Business segments provide services that are subject to risks and
returns that are different from other business segments. Geographical
segments provide services within a particular economic environment
that is subject to risks and returns that differ from those of
components operating in other economic environments. Currently the
Group has one business segment, the provision of fixed line
telecommunications services. Less than 10% of the Group's assets and
operations are located outside the PRC. Accordingly, no business and
geographical segment information is presented.
(w) Earnings per share ("EPS") and per American Depository Shares ("ADS")
Basic EPS is computed by dividing net profit attributable to ordinary
shareholders by the weighted average number of ordinary shares
outstanding during the year.
Diluted EPS is computed by dividing net profit attributable to
shareholders by the weighted average number of ordinary and dilutive
ordinary equivalent shares outstanding during the year. Ordinary
equivalent shares consist of ordinary shares issuable upon the
exercise of outstanding stock options using the treasury stock
method.
Earnings per ADS is computed by multiplying the EPS by 20, which is
the number of shares represented by each ADS.
F-28
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5 Critical accounting estimates and judgments
Estimates and judgments 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 reviews 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
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. Property, plant and equipment apart from the
buildings of the Group was revalued as of December 31, 2006 on
a depreciated replacement cost basis by an independent valuer.
If the revalued amounts differ significantly from the carrying
amounts of the property, plant and equipment in the future,
the carrying amounts will be adjusted to the revalued amounts.
The key assumptions made to determine the revalued amounts
include the 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
then to equity. 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.
(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 values in use are determined based on estimated
F-29
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5 Critical accounting estimates and judgments (continued)
(a) Critical accounting estimates and assumptions (continued)
(iii) Impairment of non-current assets (continued)
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 weighted average cost of capital of
the Group. Such impairment losses are recognized in the
income statement, except where the asset is carried at
valuation and the impairment loss does not exceed the
revaluation surplus for that same asset, in which case the
impairment loss is treated as a revaluation decrease and
charged to the revaluation reserve, Accordingly, there will
be an impact to 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 fees 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
period of 10 years, except when the direct incremental costs
exceed the corresponding installation fees, the excess
amounts are immediately written off as an 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, customer's 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 accounts receivable,
prepayments, other receivables and other current assets,
accounts payable, and bank and other loans for disclosure
purposes by discounting its future contractual cash flows at
the estimated current market interest rate that is available
to the Group for similar financial instruments. The future
disclosed values will change if there are changes in the
estimated market interest rate.
F-30
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5 Critical accounting estimates and judgments (continued)
(b) Critical judgments in applying the entity's accounting policies
(i) Accounting for business combinations under common control
The Group completed the Acquisition of New Horizon on October
31, 2005. The Acquisition of New Horizon is a business
combination under common control. The Group adopted merger
accounting to account for the business combination under
common control as the Group believes that the financial
statements prepared under merger accounting are 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 customer changes in the future, the
amortization period of the revenue and costs will change
accordingly, which will have an impact on future results.
6 Financial risk management
(a) Financial risk factors
The Group's activities expose it to a variety of financial risks:
market risk (including currency risk, cash flow interest rate risk,
and fair value interest-rate risk), credit risk and liquidity risk.
(i) Foreign exchange risk
As at December 31, 2006 and 2005, the Group had foreign
currency denominated bank balances amounting to RMB1,946
million and RMB1,098 million respectively. As at December 31,
2006 and 2005, the Group had foreign currency denominated bank
loans amounting to RMB1,432 million and RMB1,998 million
respectively.
(ii) Cash flow and fair value interest rate risk
The Group is exposed to changes in interest due to its
long-term debt obligation. The Group enters into debt
obligations to support general corporate operations including
capital expenditures, acquisitions, and working capital needs.
Borrowings at variable interest rates expose the Group to cash
flow interest rate risk. Borrowings issued at fixed interest
rates expose the Group to fair value interest rate risk. The
bank loans issued at variable and fixed interest rates are
disclosed in Note 27 of these financial statements.
F-31
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
6 Financial risk management (Continued)
(a) Financial risk factors (Continued)
(iii) 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.
(iv) 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.
(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 carrying value less estimated credit adjustments of trade
receivables and payables are assumed to approximate their fair
values. The fair value of financial liabilities for disclosure
purposes is estimated by discounting the future contractual cash
flows at the current market interest rate that is available to the
Group for similar financial instruments.
F-32
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
7 Revenues
Revenues represent the turnover of the Group and are derived from the
provision of fixed line telecommunications and related services, net of the
PRC business taxes and government levies. The Group's revenues by business
nature can be summarized as follows:
Year ended December 31
----------------------------------------------------------------
2004 2005 2006
------------------ --------------------- -------------------
RMB million RMB million RMB million
Restated Restated
Note 2 Note 2
Revenues
Local usage fees 24,858 24,582 22,274
Monthly telephone services 17,964 18,261 16,689
Upfront installation fees 1,568 1,442 1,369
DLD usage fees 11,266 10,260 10,185
ILD usage fees 1,285 1,180 1,160
Value-added services 2,993 4,000 5,421
Interconnection fees 6,453 7,783 8,400
Upfront connection fees 4,346 3,405 2,406
Broadband services 5,307 7,824 10,556
Other Internet-related services 1,075 591 692
Managed data services 1,584 1,656 1,505
Leased line income 2,591 2,596 2,974
Information communication technologies service - - 788
Other services 991 2,281 2,502
------------------ --------------------- -------------------
Total 82,281 85,861 86,921
------------------ --------------------- -------------------
F-33
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
8 Operating expenses by nature
Operating expenses mainly represent:
Year ended December 31
------------------ --------------------- ------------------
2004 2005 2006
------------------ --------------------- ------------------
RMB million RMB million RMB million
Restated Restated
Note 2 Note 2
Staff cost 11,630 12,034 12,151
Depreciation and amortization 24,873 24,919 25,608
Maintenance cost 5,139 4,689 4,688
Miscellaneous taxes and fees 304 252 282
Customer installation cost 1,252 1,157 1,161
Interconnection charges 2,602 3,487 4,332
Advertising and promotion expenses 1,093 926 933
Sales channel cost 2,169 2,304 2,643
Subscriber acquisition and retention cost 4,228 4,308 3,686
Auditor's remuneration 18 34 61
Bad and doubtful debt expenses 1,158 1,144 1,009
Operating leases 1,756 2,109 2,208
================== ===================== ==================
F-34
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
9 Finance costs
Year ended December 31
--------------------------------------------
2004 2005 2006
--------------- -------------
RMB million RMB million RMB million
Restated Restated
Note 2 Note 2
Interest expenses on:
-Bank and other loans wholly repayable within five years 4,035 3,589 3,305
-Bank and other loans wholly repayable after more than five
years 114 177 325
-Deferred consideration related to Acquisition of New Horizon - 87 479
--------------- -------------- -------------
4,149 3,853 4,109
Less: Interest expenses capitalized in construction in progress (548) (297) (233)
--------------- -------------- -------------
3,601 3,556 3,876
Amortization of discount on foreign currency exchange forward
contracts 18 - -
Exchange gain, net 98 (229) (8)
Bank charges 52 20 20
--------------- -------------- -------------
3,769 3,347 3,888
=============== ============== =============
Interest expenses were capitalized in construction in progress
using the following annual interest rates 3.69%-5.45% 4.17%-4.97% 4.71%-5.28%
=============== ============== =============
10 Taxation
Year ended December 31
--------------------------------------------
2004 2005 2006
--------------- -------------
RMB million RMB million RMB million
Restated Restated
Note 2 Note 2
PRC enterprise income tax ("EIT") 2,929 3,581 4,039
Overseas profit tax - 11 20
Deferred taxation (Note 31) (3,255) (162) (500)
--------------- -------------- -------------
Taxation charges/(credit) (326) 3,430 3,559
=============== ============== =============
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.
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
F-35
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
ranging from 17.50% to 34.00%, prevailing in the countries in which those
entities operate.
F-36
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
10 Taxation (continued)
The reconciliation between the Group's actual tax (credit)/charge and the
amount which is calculated based on the weighted average statutory tax
rate is as follows:
Year ended December 31
-------------------------------------------------------
2004 2005 2006
----------------- ------------------- -----------------
RMB RMB million RMB
million million
Restated Restated
Note 2 Note 2
Profit before taxation 3,084 17,544 14,700
================= =================== =================
Weighted average statutory tax rate
33% 33% 33%
Tax calculated at the weighted average statutory tax rate 1,018 5,790 4,851
Non-taxable income (Note (a) below) (1,583) (1,499) (1,216)
Utilization of tax losses not recognized in previous years
(Note (b) below) - (837) -
Expenses not deductible for tax purposes 275 69 64
Tax losses not recognized 354 55 26
Others (390) (148) (166)
----------------- ------------------- -----------------
Tax (credit)/charge (326) 3,430 3,559
================= =================== =================
Note (a) Non-taxable income comprises primarily upfront
connection fees charged to customers which are amortized
over the customer relationship.
Note (b) Prior to 2005, a deferred tax asset arising from certain
tax losses was not recognized as it was uncertain at that
time, following the change of a subsidiary's tax
registration district, that the taxable loss could be
utilized at the previous period end date.
11 Profit attributable to shareholders
(a) For the year ended December 31, 2006, profit attributable to
shareholders includes current year profit of RMB17,475 million
(2005: RMB126 million, 2004: loss of RMB59 million), which has
been recognized in the financial statements of the Company.
(b) The Company's subsidiary, CNC China is registered as a foreign
investment enterprise in the PRC. In accordance with the Articles
and Association of CNC China, it is 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 any dividend distribution.
CNC China is required to allocate at least 10% of their profit
after tax determined under PRC GAAP to the general reserve fund
until the cumulative amounts reach 50% of the registered capital.
The statutory reserve can only be used, upon obtaining approval
from the relevant authority, to offset accumulated losses or
increase capital.
F-37
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
11 Profit attributable to shareholders (continued)
Accordingly, CNC China appropriated approximately RMB855 million
to the general reserve fund for the year ended December 31, 2006
(2005: RMB1, 044 million, 2004: RMB723 million)
(c) According to a PRC tax approval document issued by the Ministry of
Finance and State Administration of Taxation to the Group, the
Group's upfront connection fees are not subject to EIT and an
amount equal to the upfront connection fees recognized in the
retained earnings should be transferred from retained earnings to
a statutory reserve. At December 31, 2006, the Company has made an
accumulated appropriation of RMB9,189 million to the statutory
reserve (2005 : RMB6,783 million, 2004: nil).
12 Profit distributions
Year ended December 31
-------------------------------------------------------------------------------
2004 2005 2006
---------------------- ------------------------- --------------------------
HK$ RMB HK$ RMB HK$ RMB
million million million million million million
Final dividend proposed after balance sheet
date of HK$0.553 per share (2005 : HK$0.466 per
share, 2004 : HK$0.037 per share) 245 259 3,073 3,196 3,678 3,695
---------- ---------- ------------ ----------- ------------ ------------
Dividend distributed during the year - - 245 259 3,073 3,196
========== ========== ============ =========== ============ ============
In the meeting of the board of directors held on April 2, 2007, the
directors proposed a final dividend of HK$0.553 per ordinary share for
the year ended December 31, 2006. Dividends proposed after the balance
sheet date have not been reflected as a dividend payable and will be
reflected as an appropriation in the 2007 financial statements.
F-38
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
13 Earnings per share
Basic earnings per share is computed using the weighted average number of
ordinary shares outstanding during the year. Diluted earnings per share
is computed using the weighted average number of ordinary shares and
potential ordinary shares outstanding during the year.
The following table sets forth the computation of basic and diluted
earnings per share:
Year ended December 31
------------------------------------------------------------
2004 2005 2006
---------------- ---------------- ----------------
(in RMB millions, except share and per share data)
Restated Restated
Note 2 Note 2
Numerator:
Profit/ (loss) for the year
- Continuing operations 3,410 14,114 11,141
- Discontinued operations (711) (226) 1,819
Denominator
Weighted average number of ordinary shares outstanding 5,622,685,175 6,593,529,000 6,615,520,381
and shares used in computing basic earnings per share
Diluted equivalent shares arising from share options 7,349,277 34,112,723 51,955,496
---------------- ---------------- ----------------
Shares used in computing diluted earnings per share 5,630,034,452 6,627,641,723 6,667,475,877
---------------- ---------------- ----------------
Basic earnings/(loss) per share (RMB)
- Continuing operations 0.61 2.14 1.68
---------------- ---------------- ----------------
- Discontinued operations (0.13) (0.03) 0.27
---------------- ---------------- ----------------
- Profit for the year 0.48 2.11 1.95
================ ================ ================
Diluted earnings/(loss) per share (RMB)
- Continuing operations 0.61 2.13 1.67
---------------- ---------------- ----------------
- Discontinued operations (0.13) (0.03) 0.27
---------------- ---------------- ----------------
- Profit for the year 0.48 2.10 1.94
================ ================ ================
F-39
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
14 Staff cost including directors' remuneration
Year ended December 31
---------------------------------------------------------------
2004 2005 2006
-------------------- --------------------- --------------------
RMB million RMB million RMB million
Restated Restated
Note 2 Note 2
Wages, salaries and welfare 9,756 10,747 10,792
Contributions to pensions 1,181 1,285 1,359
Early retirement benefits 693 2 -
-------------------- --------------------- --------------------
Total 11,630 12,034 12,151
==================== ===================== ====================
F-40
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
15 Cash and bank deposits
Group
-----------------------------------
As at December 31
-----------------------------------
2005 2006
----------------- --------------
RMB million RMB million
Cash and cash equivalents 4,874 7,569
Time deposits with original maturities over three months 21 2
----------------- --------------
Total cash and bank deposits 4,895 7,571
================= ==============
Effective interest rate of time deposits with original
maturities over three months (% per annum) 0.72 0.72
================= ==============
Included in cash and bank deposits as of December 31, 2006 and 2005 are RMB
denominated balances kept in the PRC amounting to RMB5,625 million and
RMB3,797 million respectively. The conversion of RMB 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.
Included in the bank deposits were deposits in state-owned banks amounting
to RMB7,422 million at December 31, 2006 (2005: RMB4,791 million). For the
year ended December 31, 2006, interest income earned from these state-owned
banks deposits amounted to RMB121 million (2005 : RMB124 million ; 2004 :
RMB59 million).
F-41
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
16 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 operations 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 2006
---------------- ----------------
RMB million RMB million
0-30 days 5,446 5,744
31-90 days 1,556 1,557
Over 90 days 2,053 2,326
---------------- ----------------
Total 9,055 9,627
---------------- ----------------
Less: Allowance for doubtful debts (1,654) (1,344)
---------------- ----------------
Net carrying amounts 7,401 8,283
================ ================
The movement of allowance for doubtful debts is as follows:
As at December 31
-----------------------------------
2005 2006
--------------- ----------------
RMB million RMB million
Balance at beginning of year 1,412 1,654
Additional provisions 1,169 1,002
Less: Write-offs (927) (1,246)
Disposal of ANC Group - (66)
--------------- ----------------
Balance at end of year 1,654 1,344
=============== ================
The carrying value of accounts receivable approximates their fair values
based on cash flows discounted using a rate based on the average
short-term borrowing rate of 6.12% (December 31, 2005: 5.58%).
Included in the accounts receivable are amounts due from other
state-owned telecommunication operators amounting to RMB1,079 million on
December 31, 2006. (December 31, 2005: RMB1,003 million).
F-42
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
17 Inventories and consumables
As at December 31
---------------------------------
2005 2006
-------------- --------------
RMB million RMB million
Telephone handsets and other customer end-products held for resale, at cost 144 155
Consumables, at cost 328 261
-------------- --------------
Total 472 416
============== ==============
18 Prepayments, other receivables and other current assets
Group
---------------------------------
As at December 31
---------------------------------
2005 2006
RMB RMB
million million
Prepaid expenses, deposits and other current assets 999 808
Other receivables 485 629
------------- --------------
Total 1,484 1,437
============= ==============
Included in the other current assets is deferred subscriber acquisition
costs of RMB274 million (2005: RMB324 million).
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 6.12% (2005: 5.58%).
F-43
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
19 Fixed assets
Telecommunications Furniture, fixture, motor
networks vehicles and other
Buildings and equipment equipment Total
----------- ------------------- --------------------------- ------------
RMB RMB RMB RMB
million million million million
Cost / valuation:
Balance at January 1, 2005 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 of New Horizon (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 (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 of New Horizon 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 20,585 139,710 6,602 166,897
=========== =================== =========================== ============
F-44
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
19 Fixed assets (continued)
Telecommunications Furniture, fixture, motor
networks vehicles and other
Buildings and equipment equipment Total
----------- ------------------- --------------------------- ------------
RMB RMB RMB RMB
million million million million
Cost / valuation:
Balance at January 1, 2006 27,050 280,301 19,770 327,121
Additions 52 755 635 1,442
Transferred from construction in progress 688 21,449 2,621 24,758
Disposals/write off (5) (1,947) (543) (2,495)
Disposal of ANC Group (172) (636) (45) (853)
Fixed assets revaluation deficit, net - (10,659) (3,588) (14,247)
----------- ------------------- --------------------------- ------------
Balance at December 31, 2006 27,613 289,263 18,850 335,726
----------- ------------------- --------------------------- ------------
Accumulated depreciation:
Balance at January 1, 2006 (6,201) (142,639) (9,618) (158,458)
Depreciation charge for the year (995) (21,842) (2,282) (25,119)
Disposals/write off 3 1,315 443 1,761
Disposal of ANC Group 51 261 28 340
Fixed assets revaluation deficit, net - 11,778 2,016 13,794
----------- ------------------- --------------------------- ------------
Balance at December 31, 2006, (7,142) (151,127) (9,413) (167,682)
----------- ------------------- --------------------------- ------------
Net book value at December 31, 2006 20,471 138,136 9,437 168,044
=========== =================== =========================== ============
Net book value at January 1, 2006 20,849 137,662 10,152 168,663
=========== =================== =========================== ============
F-45
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
19 Fixed assets (continued)
(a) The net book value of assets held under finance lease is as follows:
Telecommunications Furniture, fixture, motor
networks vehicles and other
Buildings and equipment equipment Total
----------- ------------------- --------------------------- ------------
RMB RMB RMB RMB
million million million million
As at December 31, 2006 - 2,000 62 2,062
=========== =================== =========================== ============
As at December 31, 2005 1 2,551 109 2,661
=========== =================== =========================== ============
The depreciation charge on assets held under finance lease amounted
to RMB351 million in the year ended December 31, 2006 (2005: RMB367
million ; 2004 : RMB389 million).
(b)The analysis of the cost or revaluation of the fixed assets of the
Group is as follows:
Telecommunications Furniture, fixture, motor
networks vehicles and other
Buildings and equipment equipment Total
----------- ------------------- --------------------------- ------------
RMB RMB RMB RMB
million million million million
December 31, 2006
Cost 27,613 - - 27,613
Valuation - 289,263 18,850 308,113
----------- ------------------- --------------------------- ------------
27,613 289,263 18,850 335,726
=========== =================== =========================== ============
December 31, 2005
Cost 27,050 - - 27,050
Valuation - 280,301 19,770 300,071
----------- ------------------- --------------------------- ------------
27,050 280,301 19,770 327,121
=========== =================== =========================== ============
F-46
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
19 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"), an independent
valuer 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 amounts served 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 of the Group were also performed. The surplus value
of such assets was determined at RMB6,967 million. Such amounts served
as the tax base for such assets with immediate effect. Details have
been set out in Note 31(iii).
As required by the PRC rules and regulations relevant to the
Acquisition of New Horizon, 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 the PRC valuer, on a depreciated
replacement cost basis. The value of such acquired assets in the PRC
was determined at RMB42,879 million. Such amounts served 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 of New Horizon, 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 amounts served as the
tax base for such assets with immediate effect. Details have been set
out in Note 31(iii).
According to the group's accounting policies, each class of fixed
assets of the Group other than buildings as at December 31, 2006 has
been revalued by the PRC valuer on a depreciated replacement cost
basis. The value of such fixed assets was determined at RMB147,573
million. The net deficit arising on the revaluation was RMB453 million,
the net deficit was split between a credit to the revaluation reserve
amounting to RMB1,071 million and an expense to the profit and loss
account of RMB1,524 million for the year.
The respective carrying amounts of the telecommunication networks and
equipment and furniture, fixtures, motor vehicles and other equipment
would have been RMB153,368 million and RMB11,651 million as at December
31, 2006 and RMB158,193 million and RMB11,233 million as at December
31, 2005 had they been stated at cost less accumulated depreciation.
F-47
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
19 Fixed assets (continued)
Regarding the revaluation of fixed assets carried out at December 31,
2006, the carrying amounts of these fixed assets and, where applicable,
the corresponding revalued amounts of these assets are as follows:
Historical Revaluation Revaluation Revalued
carrying amount surplus deficit amount
----------------- ------------- ------------- ----------
RMB RMB RMB RMB
million million million million
At December 31, 2006
Telecommunication networks and equipment 137,017 9,048 (7,929) 138,136
Furniture, fixtures, motor vehicles and other
equipment 11,009 436 (2,008) 9,437
----------------- ------------- ------------- ----------
148,026 9,484 (9,937) 147,573
================= ============= ============= ==========
20 Construction in progress
As at December 31
-----------------------------------
2005 2006
--------------- ---------------
RMB million RMB million
Balance at beginning of year 10,597 6,822
Additions 23,258 24,863
Transferred to fixed assets (26,818) (24,758)
Transferred to intangible assets - (572)
Distributed to owner in accordance with the Acquisition of New Horizon (215) -
--------------- ---------------
Balance at end of year 6,822 6,355
=============== ===============
F-48
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
21 Lease prepayment
As at December 31
-----------------------
2005 2006
----------- -----------
RMB million RMB million
Lease prepayments for land (i) 1,949 2,046
Lease prepayments for network capacity (ii) -- 318
----------- -----------
1,949 2,364
=========== ===========
(i) Lease prepayments for land
This represents land use rights held in the PRC and their net book value
is analyzed as follows:
As at December 31
-------------------------
2005 2006
----------- -----------
RMB million RMB million
Held for
Lease of between 10 to 50 years 1,933 2,024
Lease of less than 10 years 16 22
----------- -----------
1,949 2,046
=========== ===========
The movement of the lease prepayments for land is as follows:
As at December 31
--------------------------
2005 2006
----------- -----------
RMB million RMB million
Balance at beginning of year 1,746 1,949
Additions 280 165
Amortization for the year (37) (68)
Distributed to owner in accordance with
the Acquisition of New Horizon (40) --
----------- -----------
Balance at end of year 1,949 2,046
=========== ===========
F-49
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
21 Lease prepayment (continued)
(ii) Lease prepayments for network capacity
The net book value is analyzed as follows:
As at December 31
-------------------------
2005 2006
----------- -----------
RMB million RMB million
Held for Lease of between 10 to 50 years -- 318
----------- -----------
Balance at end of year -- 318
=========== ===========
The movement of the lease prepayments for network capacity is as follows:
As at December 31
-------------------------
2005 2006
----------- -----------
RMB million RMB million
Balance at beginning of year -- --
Additions -- 318
Amortization for the year -- --
----------- -----------
Balance at end of year -- 318
=========== ===========
F-50
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
22 Intangible assets
Negative Purchased Sponsorship
goodwill software fees Total
RMB RMB RMB RMB
million million million million
Cost:
Balance at January 1, 2005 (179) 1,250 -- 1,072
Impact of adoption of HKFRS 3 :
Transfer of negative goodwill to
retained earnings (Note 3(b)) 181 -- -- 181
----------- ----------- ----------- -----------
Balance at January 1, 2005 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 (3) (702) -- (705)
Amortization for the year -- (223) (135) (358)
Balance at December 31, 2005 (3) (925) (135) (1,063)
Net book value at January 1, 2005 -- 548 -- 548
Net book value at December 31, 2005 -- 988 405 1,393
Cost:
Balance at January 1, 2006 3 1,913 540 2,456
Additions -- 94 -- 94
Transferred from construction in progress -- 572 -- 572
Write off (3) (692) -- (695)
Balance at December 31, 2006 -- 1,887 540 2,427
Accumulated amortization:
Balance at January 1, 2006 (3) (925) (135) (1,063)
Amortization for the year -- (336) (135) (471)
Write off 3 692 -- 695
Balance at December 31, 2006 -- (569) (270) (839)
Net book value at January,1, 2006 -- 988 405 1,393
Net book value at December 31, 2006 -- 1,318 270 1,588
-----------------------------------------------------------------------------------------------------
The intangible assets will be fully amortized in the five succeeding fiscal
years.
F-51
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
23 Other non-current assets
As at December 31
-------------------------
2005 2006
----------- -----------
RMB million RMB million
Installation costs 4,197 3,525
Prepaid network capacity 1,454 --
Others 383 441
----------- -----------
6,034 3,966
=========== ===========
24 Discontinued operations
On June, 2, 2006, the Group entered into an agreement with third party
buyers to dispose of its entire interest in the ANC Group for an
aggregate cash consideration of US$168.84 million, at fair value
determined by both parties. The disposal was completed on August 22,
2006. The gain on disposal amounted to RMB1, 878 million. The results and
cash flows of the ANC Group for the year ended December 31, 2006 are
presented as discontinued operations.
The income statement and cash flow statement related to the ANC
Group are as follows:
For the period
For the year For the year From 1
ended ended January,
31 December, 31 December, 2006 to
2004 2005 22 August,
Note 2006
--------------------------------------------
RMB RMB RMB
million million million
Discontinued operations:
Revenues 1,213 1,371 980
Expenses (1,921) (1,598) (1,038)
--------------------------------------------
Loss before taxation (708) (227) (58)
--------------------------------------------
Taxation (3) 1 (1)
--------------------------------------------
Loss for the period/year of
discontinued operations (711) (226) (59)
Gain on disposal of discontinued
operations -- -- 1,878
--------------------------------------------
(Loss)/profit for the year/period from
discontinued operations (711) (226) 1,819
============================================
F-52
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
24 Discontinued operations (continued)
For the period
For the year For the year From 1
ended ended January,
31 December, 31 December, 2006 to
2004 2005 22 August,
Note 2006
--------------------------------------------
RMB RMB RMB
million million million
Discontinued operations:
Net cash outflow/(inflow)
from operating activities (474) 74 183
--------------------------------------------
Cash outflow from investing activities (228) (312) (182)
Cash inflow from disposal of ANC Group 37(c) -- -- 1,164
--------------------------------------------
Net cash outflow/(inflow) for
investing activities (228) (312) 982
Net cash inflow from financing activities 503 108 --
--------------------------------------------
Cash flows from discontinued operations (199) (130) 1,165
============================================
F-53
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
25 Accounts payable
As at December 31
---------------------------
2005 2006
----------- -----------
RMB million RMB million
0-30 days 6,281 5,762
31-60 days 1,796 2,236
61-90 days 1,297 1,449
91-180 days 1,940 2,989
Over 180 days 5,405 5,218
----------- -----------
Total 16,719 17,654
=========== ===========
Included in accounts payable are amounts due to other state-owned
telecommunications operators amounting to RMB97 million on December 31,
2006.(2005: RMB48 million).
26 Accruals and other payables
Group
-------------------------
As at December 31
-------------------------
2005 2006
---------- ----------
RMB RMB
million million
Accrued expenses 872 549
Other payables 3,033 2,507
---------- ----------
Total 3,905 3,056
========== ==========
F-54
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
27 Bank and other loans
(a)(i) On July 20, 2006, the Group issued RMB10 billion one-year
unsecured commercial papers in the PRC capital market and raised net
cash proceeds of RMB9,676 million from this exercise. The commercial
papers are interest bearing at 3.35%.
(ii) The short term bank loans on December 31, 2006 were unsecured and
comprise:
As at December 31
--------------------------
Currency Interest rate and final maturity 2005 2006
------------ -------------------------------- ----------- -----------
RMB million RMB million
RMB Interest rates ranging
denominated from 4.86% to5.51% per
annum with maturity
through December 26, 2007 47,341 30,980
=========== ===========
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 4.86%-5.51% (December 31, 2005:
4.70%-5.02%).
Included in the short-term bank loans were loans from state-owned
banks amounting to RMB29,700 million as at December 31, 2006
(December 31, 2005: RMB46,541 million).
F-55
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
27 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise:
As at December 31
--------------------------
Note 2005 2006
----------- -----------
RMB million RMB million
Long term bank loans (i) 22,734 29,560
Finance lease obligations (ii) 2,255 963
----------- -----------
24,989 30,523
=========== ===========
Less: Current portion (6,846) (7,304)
----------- -----------
18,143 23,219
=========== ===========
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 6.12%
(December 31, 2005: 5.58%).
Included in the long term bank loans were loans from state-owned
banks amounting to RMB29,560 million as at December 31, 2006 (2005:
RMB22,685 million).
(i) Long term bank loans
As at December 31
-----------------------------
2005 2006
----------- -----------
RMB million RMB million
Loans
Unsecured 22,414 29,220
Secured 320 340
----------- -----------
Total 22,734 29,560
----------- -----------
Less: Current portion (5,579) (6,446)
----------- -----------
Long term loans 17,155 23,114
=========== ===========
F-56
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
27 Bank and other loans (continued)
(b) The Group's long term bank and other loans comprise (continued):
(i) Long term bank loans (continued)
The Group's long term bank loans were repayable as follows:
As at December 31
-------------------------
2005 2006
----------- -----------
RMB million RMB million
Within one year 5,579 6,446
In the second year 7,774 6,491
In the third to fifth year,
inclusive 5,886 9,723
After the fifth year 3,495 6,900
----------- -----------
22,734 29,560
=========== ===========
As at December 31
-------------------------------------
Currency Interest rate and
final maturity 2005 2006
-------------- ----------------- ----------------- -----------------
RMB million RMB million
Bank loan
Renminbi Interest rates
denominated ranging from
2.40% to
10.08% per
annum with
maturity through
December 20,
2019 20,736 28,128
US Dollar Interest rates
denominated ranging from
1.25% to 6.44%
per annum with
maturity through
October 31, 2039 1,241 721
Japanese Interest rate is
Yen 2.12% per annum
denominated with maturity
through January
7, 2014 327 276
Euro Interest rates
denominated ranging from
0.50% to 7.35%
per annum with
maturity through
March 15, 2034 430 435
----------------- -----------------
22,734 29,560
================= =================
F-57
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
27 Bank and other loans (continued)
As at December 31, 2006, bank loans of RMB340 million (December 31,
2005: RMB320 million) were secured by the following:
o Corporate guarantees granted by China Netcom Group to the
extent of RMB65 million (December 31, 2005: RMB75 million); and
o Corporate guarantees granted by third parties to the extent of
RMB275 million (December 31, 2005: RMB245 million).
(b) The Group's long term bank and other loans comprise (continued):
(ii) Finance lease obligations
As at December 31
--------------------------
2005 2006
----------- -----------
RMB million RMB million
Obligation under finance leases 2,255 963
Less: current portion (1,267) (858)
----------- -----------
988 105
=========== ===========
The accumulated finance lease obligation as at December 31, 2006
amounted to RMB963 million. (2005: RMB2,255 million).
The interest rates charged on finance lease are ranging from2.68% to
6.83% with maturity through December 8, 2008 (2005: 2.50% to 5.70%
with maturity through December 31, 2008).
The Group's liabilities under finance leases are analyzed as
follows:
As at December 31
--------------------------
2005 2006
----------- -----------
RMB million RMB million
Within one year 1,319 888
In the second year 903 106
In the third to fifth year, inclusive 106 --
----------- -----------
2,328 994
Less: future finance charges on finance leases (73) (31)
----------- -----------
Present value of finance lease liabilities 2,255 963
=========== ===========
The present value of finance lease
liabilities is as follows:
Within one year 1,267 858
In the second year 885 105
In the third to fifth year, inclusive 103 --
----------- -----------
2,255 963
=========== ===========
F-58
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
27 Bank and other loans (continued)
(c) The fair value of the Group's non-current portion of long term bank and
other loans at December 31, 2006 and 2005 were as follows:
As at December 31
-------------------------
2005 2006
----------- -----------
RMB million RMB million
Long term bank loans 15,571 21,209
Finance lease obligations 958 85
----------- -----------
16,529 21,294
=========== ===========
The fair value is based on cash flows discounted using rates based
on the borrowing rates of ranging from 3.75% to 8.33% (December 31,
2005: 2.54% to 6.12%).
28 Amount due from/(to) holding companies and fellow subsidiaries
As at 31 December
-------------------------
Note 2005 2006
----------- -----------
RMB million RMB million
Current:
Due from ultimate holding company (a) 89 173
Due from other holding companies (a) 1 3
Due from fellow subsidiaries (a) 157 176
----------- -----------
Total 247 352
=========== ===========
Due to ultimate holding company
-Deferred consideration (b) 1,960 1,960
-Others (a) 3,877 3,282
Due to fellow subsidiaries (a) 3,153 2,277
----------- -----------
Total 8,990 7,519
=========== ===========
F-59
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Non-current:
Due to ultimate holding company
-Deferred consideration (b) 7,840 5,880
----------- -----------
Total 7,840 5,880
=========== ===========
F-60
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
28 Amount due from/ (to) holding companies and fellow subsidiaries
(continued)
Note:
(a) These are interest free, unsecured and have no fixed terms of
repayment.
(b) Balance represents the deferred payments arising from the
Acquisition of New Horizon outstanding at year end. The balance is
charged at interest rate of 5.265 % per annum with final maturity
through June 30, 2010. The deferred payment is analyzed as follows:
As at 31 December
-------------------------
2005 2006
----------- -----------
RMB million RMB million
Within one year 1,960 1,960
In the second year 1,960 1,960
In the third to fifth year, inclusive 5,880 3,920
----------- -----------
Total 9,800 7,840
=========== ===========
F-61
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
29 Deferred revenues
As at December 31
--------------------------
2005 2006
----------- -----------
RMB million RMB million
Balance at beginning of year:
-upfront connection fees 8,910 5,505
-upfront installation fees 7,638 6,769
-advances from network capacity sales 2,173 2,354
-prepaid telephony services 4,143 4,272
----------- -----------
22,864 18,900
----------- -----------
Additions for the yeariG
-upfront connection fees -- --
-upfront installation fees 573 357
-advances from network capacity sales 461 236
-prepaid telephony services 24,435 30,360
----------- -----------
25,469 30,953
----------- -----------
Reductions for the yeariG
-upfront connection fees (3,405) (2,406)
-upfront installation fees (1,442) (1,359)
-advances from network capacity sales (280) (2,590)
-prepaid telephony services (24,306) (29,567)
----------- -----------
(29,433) (35,922)
----------- -----------
Included: Disposal of the ANC Group
- advances from network capacity
sales -- (2,450)
- prepaid telephony services -- (144)
----------- -----------
-- (2,594)
----------- -----------
Balance at end of yeariG
- upfront connection fees 5,505 3,099
- upfront installation fees 6,769 5,767
- advances from network capacity sales 2,354 --
- prepaid telephony services 4,272 5,065
----------- -----------
18,900 13,931
----------- -----------
Representing:
- Current portion 7,975 7,733
- Non-current portion 10,925 6,198
----------- -----------
18,900 13,931
=========== ===========
F-62
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
30 Provisions
Early retirement One-off cash housing
benefits subsidies Total
-------------------- -------------------- --------------------
RMB RMB RMB
million million million
Note a Note a & b
As at 1 January, 2006 3,763 3,440 7,203
Additional provisions -- -- --
Payments during the year (626) (255) (881)
-------------------- -------------------- --------------------
As at 31 December, 2006 3,137 3,185 6,322
==================== ==================== ====================
Analysis of total provisions:
-Current portion 551 3,185 3,736
-Non-current portion 2,586 -- 2,586
-------------------- -------------------- --------------------
3,137 3,185 6,322
==================== ==================== ====================
As at 1 January, 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 the Group's
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 the
allocation of staff quarters. However, the specific timetable and
procedures for the implementation of these policies were to be
determined by individual provincial or municipal government based on
the particular situation of the provinces or municipality.
Based on the relevant detailed local government regulations
promulgated, certain entities within the Group have adopted cash
housing subsidy plans. In accordance with these plans, for those
eligible employees who had not been allocated with quarters or who
had not been allocated with quarters up to the prescribed standards
before the discounted sales of quarters were terminated, the Group
is required to pay them one-off cash housing subsidies based on
their years of service, positions and other criteria. Based on the
available information, the Group estimated the required provision
for these cash housing subsidies amounting to RMB4,142 million,
which was charged to the consolidated income statement in the year
ended December 31, 2000 when the State Council circular in respect
of cash subsidies was issued.
(b) Pursuant to the Listing Reorganization and the Acquisition of New
Horizon, 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 respectively, 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.
F-63
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
31 Deferred taxation
Movements of the deferred tax assets and liabilities are as follows:
Balance on Recognized Balance on Balance on
December 31st, 2005 in income statement Recognized in equity December 31st,2006
-------------------- -------------------- -------------------- --------------------
RMB million RMB million RMB million RMB million
-------------------- -------------------- -------------------- --------------------
Note Note
Deferred tax assets:
Deferred revenue, primarily
advances from customers 170 (43) -- 127
Temporary differences from
allowance for doubtful debts 350 (36) -- 314
Unrecognized revaluation
surplus and deficit (Note iii) 2,861 (51) -- 2,810
Others 99 109 -- 208
-------------------- -------------------- -------------------- --------------------
Balance at end of year 3,480 (21) -- 3,459
==================== ==================== ==================== ====================
Deferred tax liabilitiesiG
Interest capitalized (1261) 472 -- (789)
Depreciation
of fixed assets (Note i) -- 52 (353) (301)
Others (63) (3) -- (66)
-------------------- -------------------- -------------------- --------------------
Balance at end of year (1,324) 521 (353) (1,156)
==================== ==================== ==================== ====================
The amounts in the consolidated
balance sheet are as follows:
Deferred tax assets to be recovered
after more than 12 months 2,906 -- -- 2,860
-------------------- -------------------- -------------------- --------------------
Deferred tax liabilities to be
settled after more than 12 months (1,190) -- -- (1,014)
-------------------- -------------------- -------------------- --------------------
F-64
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
31 Deferred taxation (continued)
Balance at Recognized Balance at
December 31, in income Recognized Recognized December 31,
2004 statement in equity in equity 2005
---------------- ---------------- ---------------- ---------------- ----------------
RMB million RMB million RMB million RMB million RMB million
---------------- ---------------- ---------------- ---------------- ----------------
Note(ii) Note (iii)
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 (iii) 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 liabilitiesiG
Interest capitalized (1,489) 32 196 -- (1,261)
Others (87) 24 -- -- (63)
---------------- ---------------- ---------------- ---------------- ----------------
Balance at end of year (1,576) 56 196 -- (1,324)
================ ================ ================ ================ ================
The amounts in the consolidated
balance sheet are as follows:
Deferred tax assets to be
recovered after more than
12 months 2,997 -- -- -- 2,906
---------------- ---------------- ---------------- ---------------- ----------------
Deferred tax liabilities to be
settled after more than 12 months (1,318) -- -- -- (1,190)
---------------- ---------------- ---------------- ---------------- ----------------
F-65
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
31 Deferred taxation (continued)
Notes:
(i) According to the Group's accounting policy as set out in note 4(k),
the fixed assets other than the lease prepayments for land and
buildings of the Group were revalued by the PRC valuer on a
depreciated replacement cost basis as disclosed in note 19. The
revalued amounts are not used to determine the tax bases of these
assets in the future years. Accordingly, the Group's deferred tax
liabilities on the balance sheet decreased by RMB150million. The net
reduction comprised RMB353 million, being the deferred tax
liabilities originated from the revaluation surplus of fixed assets
which was debited to revaluation reserves, offset by RMB503 million,
being the deferred tax assets originated from the revaluation
deficit of fixed assets which was credited to profit and loss for
the year.
(ii) In connection with the Listing Reorganization and the Acquisition of
New Horizon, certain of the Group's telecommunication networks and
equipment and furniture, fixtures, 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 (iii)
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 Acquisition of New Horizon, the Group's net
deferred tax assets were subsequently reduced by RMB1,077 million
(comprising deferred tax assets of RMB1,273 million and deferred tax
liabilities of RMB196 million), and this decrease was recorded as a
debit to owners' equity upon the date of the Reorganization on June
30, 2005. The RMB1,077 million deduction comprises RMB1,097 million,
being deferred tax liabilities originating from the revaluation
surplus of fixed assets recorded and credited to revaluation
reserves offset by RMB2,174 million deferred tax assets debited to
retained earnings.
(iii) In addition, in order to determine the tax bases used for future
years after the Listing Reorganization and the Acquisition of New
Horizon, the Group's up-front prepayments for the leasehold land and
buildings were revalued for PRC tax purposes as at 31 December, 2003
and 2004. However, the resulting revaluations of the up-front
prepayments made for the leasehold land and buildings were not
incorporated into the consolidated financial statements. As a
result, deferred tax assets were subsequently recorded with
corresponding increases in owners' equity upon the Listing
Reorganization on 30 June, 2004 and the Acquisition of New Horizon
on 30 June, 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.
F-66
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
31 Deferred taxation (continued)
The amount is to be 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 31
December, 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.
During the Acquisition of New Horizon, the leasehold land and
buildings had a net surplus on revaluation of RMB2,553 million as at
31 December, 2005. 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 30 June 2005.
The amount of transfer to retained earnings from unrecognized
revaluation surplus and deficit for the year ended December 31st,
2006 was RMB51 million. (2005: RMB96 million ; 2004 : RMB241
million).
F-67
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
32 Share capital
Authorized
---------------------------------------------------------------------------------------------------
Convertible preference shares of
Ordinary shares of US$0.04 each US$0.04 each
------------------------------------------------ ------------------------------------------------
No of shares US$ RMB Million No of shares US$ RMB Million
-------------- -------------- -------------- -------------- -------------- --------------
AS at 1 January, 2005,
31 December, 2005
and 2006 25,000,000,000 1,000,000,000 8,277 7,741,782 309,671 3
============== ============== ============== ============== ============== ==============
Issued
---------------------------------------------------------------------------------------------------
Convertible preference shares of
Ordinary shares of US$0.04 each US$0.04 each
------------------------------------------------ ------------------------------------------------
No of shares US$ RMB Million No of shares US$ RMB Million
-------------- -------------- -------------- -------------- -------------- --------------
AS at 1 January ,
2005 and 2006 6,593,529,000 263,741,160 2,181 -- -- --
-------------- -------------- -------------- -------------- -------------- --------------
Exercise of share
option (Note) 57,114,500 2,284,580 18 -- -- --
-------------- -------------- -------------- -------------- -------------- --------------
AS at 31 December,
2006 6,650,643,500 266,025,740 2,199 -- -- --
-------------- -------------- -------------- -------------- -------------- --------------
[table continued]
-------------------------------
Total
-------------------------------
US$ RMB Million
-------------- --------------
AS at 1 January, 2005,
31 December, 2005
and 2006 1,000,309,671 8,280
============== ==============
-------------------------------
Total
-------------------------------
US$ RMB Million
-------------- --------------
AS at 1 January ,
2005 and 2006 263,741,160 2,181
-------------- --------------
Exercise of share
option (Note) 2,284,580 18
-------------- --------------
AS at 31 December,
2006 266,025,740 2,199
-------------- --------------
F-68
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
32 Share capital (continued)
Note: For issuance under the plan, the Company issues new shares upon share
option exercise based on the number of options exercised during
the year. As at December 31, 2006, 40% of the 156,703,000 First Grant
options (note 32) outstanding at January 1, 2006 were exercisable, of
which 57,114,500 options (2005: Nil) were exercised during the year
with an exercise price of HK$8.40. The total consideration
received amounting to RMB490 million (2005:nil) and the portion
exceeds the nominal value of the shares issued was recorded as
share premium of the Company.
33 Share option scheme
A share option scheme was approved pursuant to a directors' resolution on
September 30th, 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 restrictions on timing.
On October 22nd, 2004, 158,640,000 share options with an exercise price
of HK$8.40 each were granted to the directors of the Company and certain
employees of the Group (the "First Grant").
Pursuant to the Company's share option plan, the Company granted
158,640,000 options to certain of its directors and employees,
immediately prior to the closing of its global offering, to subscribe for
its ordinary shares at the initial public offering price under the Hong
Kong public offering, excluding brokerage and trading fees, and
transaction and investor compensation levies. The First Grant has an
exercise period of six years from the date of grant.
On December 6th, 2005, the board of directors approved the granting of
79,320,000 shares of share options to certain management personnel and
other professional personnel designated by the Compensation Committee of
the newly acquired four northern provinces/autonomous region. ("Second
Grant").
The grant date fair value of the share options granted in the First Grant
is determined by the Black-Scholes model based on the following
assumptions: expected dividend pay-out ratio of 35%, expected vesting
period of 5 years, expected volatility rate of 23.6% and risk-free
interest rate of 4.3%. The weighted average fair value of the share
options on grant date was determined as HK$ 1.22 per share (RMB1.28 per
share). The grant date fair value of the share options granted in the
Second Grant is determined by the Black-Scholes model based on the
following assumptions: expected dividend pay-out ratio of 35%, expected
vesting period of 4 years, expected volatility rate of 21.46% and
risk-free interest rate of 4.3%. The weighted average fair value of the
share option on grant date was determined as HK$1.28 per share (RMB1.34
per share). The model that decided the weighted average fair value of the
share options and the assumptions mentioned above are subjective, and the
changes of these
F-69
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
33 Share option scheme (continued)
subjective assumptions could affect the weighted average fair value of
the share option. Therefore, Black-Scholes model may not reliably
calculate the weighted average fair value of the share options.
Modifications to certain clauses of the share options schemes already
granted were approved on 16 May 2006, pursuant to a resolution of the
Extraordinary General Meeting. The modifications were mainly related to
eligibility of the participants, number of options and exercise vesting
schedules, rights upon cessation of employment, death and loss of
capacity, performance targets, and cancellation of options. The
modifications did not have significant impact to the financial
statements.
The movement of the share options granted during the year is summarized
as follows :
No. of share options
-------------------------------------------------------
Weighted average closing
price per share at
respective days
As at As at Exercise immediately before the
January 1, December 31, price exercises of options
2005 Granted Exercised Lapsed Cancelled 2005 HK$ HK$
-----------------------------------------------------------------------------------------------------------------
First Grant 157,720,000 - - - 1,017,000 156,703,000 8.4 -
Second Grant - 79,320,000 - - - 79,320,000 12.45 -
-----------------------------------------------------------------------------------------------------------------
Total 157,720,000 79,320,000 - - 1,017,000 236,023,000 9.76 -
-----------------------------------------------------------------------------------------------------------------
No. of share options
-------------------------------------------------------
Weighted average
closing price
per share
respective days at
immediately before
As at As at Exercise the exercises Exercisable as
January 1, December 31, price of options of December 31,
2006 Granted Exercised Lapsed Cancelled 2006 HK$ HK$ 2006
-------------------------------------------------------------------------------------------------------------------
First Grant 156,703,000 - 57,114,500 300 1,975,500 97,612,700 8.4 14.46 4,776,380
Second Grant 79,320,000 - - - 285,800 79,034,200 12.45 - -
-------------------------------------------------------------------------------------------------------------------
Total 236,023,000 - 57,114,500 300 2,261,300 176,646,900 10.21 - 4,776,380
-------------------------------------------------------------------------------------------------------------------
Company uses historical data to estimate pre-vesting option forfeitures and
record stock-based compensation expense only for those awards that are expected
to vest.
The compensation cost recognized in staff cost during fiscal 2006, 2005 and 2004
was RMB18 million, RMB104 million, and RMB75 million. As of December 31, 2006,
there was 106 million of unrecognized compensation cost, adjusted for estimated
forfeitures, related to non-vested stock-based awards granted to the Company's
employees. This cost is expected to be recognized over a weighted-average period
of 1.24 years. Total unrecognized compensation cost may be adjusted for future
changes in estimated forfeitures.
There were no capitalized share-based compensation costs during the years ended
December 31, 2006 and 2005.
The intrinsic value for the exercised options amounting to HK$ 346 million is
calculated as the difference between the market value on the date of exercise
and the exercise price of the shares, and the aggregate intrinsic value of
options outstanding, vested and expected to vest options, and options
exercisable as of December 31, 2006 amounting to HK$ 1,879 million, HK$ 771
million, and HK$ 59 million respectively is calculated as the difference between
the closing stock price as of December 29, 2006 and the exercise price of the
shares.
The weighted average remaining contractual life for outstanding options, vested
and expected to vest options, and options exercisable as of December 31, 2006
was 4.35 years, 4.35 years and 3.88 years, respectively.
F-70
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
34 Consolidated cash flow statements
(a) Reconciliation of profit before taxation to net cash flows generated
from the operating activities of continuing operation.
Year ended December 31st
--------------------------------------------
2004 2005 2006
--------------------------------------------
RMB million RMB million RMB million
Note 2 Note 2
Profit before taxation 3,084 17,544 14,700
Depreciation of fixed assets and
amortization of intangible assets 24,822 24,882 25,540
Lease prepayments for land 51 37 68
Amortization of deferred
revenues (24,040) (29,482) (33,137)
Deferred costs charged to the
income statements 3,555 2,473 1,002
Deficit on revaluation of fixed
assets 11,318 -- 1,524
Bad and doubtful debts 1,158 1,148 1,009
Loss on disposal of fixed assets 198 360 606
Share-based compensation -- 104 75
Other income 18 -- (621)
Dividend income (17) (29) --
Share of loss of associated
companies 1
Interest income (69) (131) (132)
Interest expense 3,601 3,556 3,876
Discount on foreign currency
exchange forward contracts 18 -- --
Unrealized loss on short-term
investments 4 -- --
Foreign exchange gain 98 (229) (8)
--------------------------------------------
Operating cash flow before
working capital changes 23,800 20,233 14,502
Increase in accounts receivable (1,000) (1,398) (2,135)
Decrease in inventories and
consumables 108 768 54
Decrease in prepayments, other
receivables and other current
assets (490) 775 252
Increase in other non-current
assets (3,052) (529) (343)
Increase/(decrease) in accounts
payable 1,554 (3,277) 1,221
Decrease in accruals and other
payables (2,985) (1,374) (3,115)
Increase in deferred revenues 19,841 25,434 30,614
--------------------------------------------
Net cash inflow generated from
operating activities of
continuing operation 37,776 40,632 41,050
============================================
F-71
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
34 Consolidated cash flow statements (continued)
(b) Major non-cash transactions
During 2005, the Group paid RMB3,000 million out of the total
consideration for the Acquisition of the New Horizon. The remaining
balance of RMB9,800 million was recognized as a deferred payment and
is included in amounts due to the ultimate holding company. During
the year ended December 31, 2006, payments made in respect of the
purchase were RMB1,960 million, the unpaid balance at December 31,
2006 was RMB7,840 million.
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.
During 2004, the immediate holding company assigned a loan to the
Company which resulted in a direct debit to the Company's equity.
(c) Net investment gain from disposal of ANC Group
On June 2, 2006, the Group entered into an agreement to dispose of
its entire interest in the ANC Group for a consideration of
US$168.84 million. The disposal was completed on August 22, 2006. At
the completion date, the net liabilities of the disposed ANC Group
comprised:
As at August 22, 2006
-------------------------
RMB
million
Net liabilities disposed of (excluding the cash
and cash equivalents) :
Accounts receivable and other current assets 504
Fixed assets and other non-current assets 1,997
Current portion of deferred income (308)
Accounts payable and other current liabilities (592)
Non-current portion of deferred income (2,286)
Exchange differences realised (29)
-------------------------
Net liabilities (714)
-------------------------
Gain on disposal 1,878
-------------------------
Net cash inflow from disposal of ANC Group 1,164
=========================
Satisfied by :
Cash consideration 1,344
Less : Cash and cash equivalents of ANC (180)
-------------------------
Net cash inflow 1,164
-------------------------
F-72
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
35 Banking facilities
As at 31 December, 2006 and 2005, the utilized and unutilized banking
facilities are as follows:
Group
----------------- ------------------
As at 31 December
----------------- ------------------
2005 2006
----------------- ------------------
RMB million RMB million
Amount utilized 70,075 60,541
Amount unutilized 104,731 115,588
----------------- ------------------
Aggregate banking facilities 174,806 176,129
================= ==================
36 Commitments
(a)Capital commitments
As at 31 As at 31
December,2005 December,2006
------------- -------------
RMB RMB
------------- -------------
million million
Contracted but not provided for
-Leasehold land and buildings 215 26
-Telecommunication networks and equipment 1,357 2,502
-Others 112 5
------------- -------------
Total 1,684 2,533
============= =============
Authorized but not contracted for
-Leasehold land and buildings 1 --
-Telecommunication networks and equipment 112 300
-Others -- --
------------- -------------
113 300
============= =============
F-73
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
36 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:
As at 31 As at 31
December,2005 December,2006
RMB RMB
million million
Not later than one year 583 734
Later than one year and not
later than five years 527 1,102
Later than five years 186 517
--------------- ---------------
Total 1,296 2,353
--------------- ---------------
37 Related party transactions
All state-controlled enterprises, their subsidiaries, their key
management and their close family, and their employees represent related
parties of the Group as defined by HKAS 24. China Netcom Group, the
Group's parent company, is a state-controlled enterprise directly
controlled by the PRC government which controls different state-owned
enterprises driving the economy of the PRC. The Group is the dominant
fixed line telecommunications service provider in northern 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 licenses,
allocating frequency spectrum, formulating interconnection and settlement
arrangements between telecommunications operators, enforcing industry
regulations and reviewing tariffs for domestic services. Other PRC
governmental authorities also regulate tariff policies, capital
investment and foreign investment in the telecommunications industry.
As a state-owned telecommunication operator, the Group has extensive
transactions with other state-owned telecommunication operators in its
ordinary course of business. These transactions are carried out in
accordance with the rules and regulations stipulated by the MII of the
PRC Government and disclosed below.
The Group has extensive transactions with other members of the China
Netcom Group. It is possible that the terms of the transactions between
the Group and other members of the China Netcom Group are not the same as
those that would result from transactions with other related parties or
wholly unrelated parties.
F-74
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Management believes that meaningful information relative to related party
disclosures has been adequately disclosed.
F-75
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
37 Related party transactions (continued)
For the year ended December 31,
-------------------------------------------------
2004 2005 2006
-------------------------------------------------
Notes RMB million RMB million RMB million
-------------------------------------------------
Emolument of key management
- salaries and welfare and contributions to
retirement scheme (i) 15 23 13
-------------------------------------------------
Interconnection fees
- from fellow subsidiaries (iv)(b) 148 251 381
- from other state-owned telecommunications
operators (iv)(b) 5,481 6,442 6,726
-------------------------------------------------
Subtotal 5,629 6,693 7,107
=================================================
Interconnection charges
- to fellow subsidiaries (iv)(b) 198 611 820
- to other state-owned telecommunications
operators (iv)(b) 1,200 1,475 1,758
-------------------------------------------------
Subtotal 1,398 2,086 2,578
=================================================
Rental income from properties leased to
fellow subsidiaries (iv)(a),(iv)(c) 3 - 2
=================================================
Purchase of materials
- from fellow subsidiaries (iv)(a),(iv)(c) 2,122 1,298 1,170
- from other related companies (iv)(a),(iv)(c) 822 231 122
-------------------------------------------------
Subtotal 2,944 1,529 1,292
=================================================
Receipt of engineering, project planning,
design, construction and information
technology services
- from fellow subsidiaries (iv)(a),(iv)(b) 3,185 2,236 2,178
- from other related companies (iv)(a),(iv)(b) 392 413 368
-------------------------------------------------
Subtotal 3,577 2,649 2,546
=================================================
Ancillary telecommunications support
services
- from fellow subsidiaries (v),(iv) 554 435 350
- from other related companies (v),(iv) 235 51 58
-------------------------------------------------
Subtotal 789 486 408
=================================================
F-76
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
37 Related party transactions (continued)
For the year ended December 31,
-------------------------------------------------
2004 2005 2006
-------------------------------------------------
Notes RMB million RMB million RMB million
-------------- -------------------------------------------------
Payment of operating lease rentals of
premises
- to fellow subsidiaries (iv)(a),(iv)(c) 311 655 680
- to other related companies (iv)(a),(iv)(c) 5 - -
------------------------------------------------
Subtotal 316 655 680
================================================
Property sub-lease rentals to fellow
subsidiaries (iv)(a),(iv)(c) 33 15 15
================================================
Common corporate services income from
ultimate holding company (vi) 19 89 121
================================================
Common corporate services expenditure paid to 213
ultimate holding company (vi) 279 448
================================================
Support services received
- from ultimate holding company (vii), (iv) - 2 2
- from fellow subsidiaries (vii), (iv) 937 888 712
- from other related companies (vii), (iv) 1,487 264 23
------------------------------------------------
Subtotal 2,424 1,154 737
================================================
Telecommunications rental income from other
state-owned telecommunications operators (iv)(b) 1,182 1,271 1,327
================================================
Payment for lease of Telecommunications
facility
- to ultimate holding company (viii),(iv) - 85 75
- to fellow subsidiaries (viii),(iv) 138 215 307
------------------------------------------------
Subtotal 138 300 382
================================================
Payment for purchase of long-term
telecommunications capacity to fellow
subsidiaries (ix),(xii) 173 117 36
================================================
Payment for lease of long-term
telecommunications capacity to fellow
subsidiaries (x),(xii) 28 84 65
================================================
Management fee received from fellow
subsidiaries (xi),(xii) 28 39 23
================================================
F-77
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
37 Related party transactions (continued)
Information communication technologies
service received
- from ultimate holding company (xix) - - 2
- from fellow subsidiaries (xix) - - 34
------------------------------------------------
Subtotal - - 36
================================================
F-78
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
37 Related party transactions (continued)
Notes:
(i) Represents the emoluments paid to all of the directors and the top
management of the Group, who are considered as the related parties
of the Group.
(ii) The Group entered into finance lease arrangements with a related
party, details have been set out in Note 27 (b)
(iii) Related party represents the non-listed investors of the fellow
subsidiaries.
(iv) Priced based on one of the following three criteria:
(a) market price;
(b) prices based on government guidance; or
(c) cost plus basis.
(v) Represents provision of ancillary telecommunications support
services to the Group by the fellow subsidiaries and the related
companies. These services include certain telecommunications
pre-sale, on-sale and after-sale services, certain sales agency
services, the printing and delivery of invoice services, the
maintenance of certain air-conditioning, fire alarm equipment and
telephone booths and other customer services.
(vi) The Group entered into a Master Service Sharing agreement with
China Netcom Group pursuant to which expenses associated with
common corporate services is allocated between the Group and China
Netcom Group based on total assets as appropriate.
(vii) Represents the support services provided to the Group by the fellow
subsidiaries and the related companies. These support services
include equipment leasing services, motor vehicles services, safety
and security services, conference services, basic construction
agency services, equipment maintenance services, employee training
services, advertising services, printing services and other support
services.
(viii) The Group entered into a Telecommunications Facilities Leasing
Agreement with China Netcom Group pursuant to which the Group
leases the international telecommunications facilities and
inter-provincial transmission optic fibers from China Netcom Group.
The lease payment is based on the depreciation charge of the
assets.
(ix) The Group entered into a Capacity Purchase Agreement with East Asia
Netcom Limited ("EANL"), a wholly owned subsidiary of China Netcom
Croup, 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 Groiup'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
F-79
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
37 Related party transactions (continued)
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) Due to the disposal of ANC Group on August 22, 2006, the Capacity
Purchase Agreement, the Capacity Lease Agreement and the Management
Services Agreement between the Group and East Asia Netcom Ltd (a
formerly wholly owned subsidiary of China Netcom Group) were no
longer related party transactions to the Group after August 22nd,
2006.
(xiii) In addition, pursuant to the Listing Reorganization and the
Acquisition of New Horizon, 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.
(xiv) 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 by
Telecom and the business of the newly required four
provinces/autonomous region respectively.
(xv) As at 31 December, 2006, China Netcom Group granted corporate
guarantees to the Group as set out in Note 27(b).
(xvi) 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 RMB0.54 billion. 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.
(xvii) As at 31 December, 2006, the Group has balances with other
state-owned telecommunication service providers, cash deposited in
and loans granted from state-owned banks as set out in Notes 16,
26, 15 and 27 respectively.
(xviii)For the year ended 31 December, 2006, the deferred consideration
in respect of the Acquisition of New Horizon paid to China Netcom
Group amounted to RMB1,960 million, and the balance of the deferred
consideration amounted to RMB7,840 million (2005: RMB9,800
million). The related interest charged for the year ended 31
December 2006 amounted to RMB567 million (2005: RMB87 million).
(xix) China Netcom System Integration, an indirect wholly owned
subsidiary of the Company, entered into an Information and
Communications Technology Agreement on 7 November 2006 with China
Netcom Group. Pursuant to the Information and
F-80
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
37 Related party transactions (continued)
Communications Technology Agreement, China Netcom System
Integration (and its subsidiaries) will provide Information
Communications Technology Services to China Netcom Group. China
Netcom System Integration will also subcontract services ancillary
to the provision of Information Communications Technology Services,
namely the System Installation and Configuration Services to the
subsidiaries and branches of China Netcom Group in China Netcom
Group's southern service region in PRC.
(xx) On December 31, 2006, the Group acquired certain assets from China
Netcom Group at an agreed price of RMB81 million.
F-81
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
38 Condensed financial statements of the Company
INCOME STATEMENT-THE COMPANY
Year ended December 31
2004 2005 2006
RMB RMB RMB
Million Million Million
Net revenue - - -
Cost of revenues - - -
--------------------------------------------
Gross profit - - -
Operating expenses:
Staff cost (18) (112) (83)
Selling,general and administrative expenses (59) (89) (114)
Other operating expenses - - 22
--------------------------------------------
Total operating expenses (77) (201) (175)
--------------------------------------------
Operating (loss)/income (77) (201) (175)
Other income - - 621
Interest income 11 51 21
Investment income 7 276 17,008
Non operating income/(Loss) - 3 -
(Loss)/profit before tax (59) 126 17,475
Income tax benefit/(expense) - - -
---------------------------------------------
Net (loss)/profit (59) 126 17,475
=============================================
F-82
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
BALANCE SHEET-THE COMPANY
As at December 31
---------------------------
Note 2005 2006
---------------------------
RMB RMB
million million
Assets
Current assets
Cash and bank deposits b) 540 1,772
Due from subsidiaries d) 573 9,411
Prepayments, other receivables and other current assets c) 27 268
----------------------------
Total current assets 1,140 11,451
----------------------------
Non-current assets
Investments in subsidiaries d) 58,577 62,937
----------------------------
Total assets 59,717 74,388
============================
Liabilities and equity
Current liabilities
Accrued expenses 93 136
Due to subsidiaries d) 12,820 12,754
Due to ultimate holding company g) 150 -
----------------------------
Total current Liabilities 13,063 12,890
----------------------------
Net current liabilities (11,923) (1,439)
----------------------------
Total assets less current liabilities 46,654 61,498
----------------------------
Financed by:
Share capital 2,181 2,199
Reserves e) 44,473 59,299
----------------------------
Shareholders' equity 46,654 61,498
----------------------------
Total liabilities & equity 59,717 74,388
============================
F-83
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
CONDENSED STATEMENT OF CASH FLOWS-THE COMPANY
2004 2005 2006
RMB RMB RMB
Million Million Million
Net cash used in operating activities 91 (144) (242)
----------------------------------------------
Net cash used in investing activities (1,334) (6,648) 4,180
----------------------------------------------
Net cash provided by financing activities 8,944 (457) (2,706)
----------------------------------------------
Net (decrease) / increase in cash 7,701 (7,249) 1,232
==============================================
Cash and cash equivalent, at beginning of the year 88 7,789 540
----------------------------------------------
Cash and cash equivalent, at end of the year 7,789 540 1,772
----------------------------------------------
(a) The condensed financial statements of the "Company have been prepared in
accordance with HKFRS issued by HKICPA.
The subsidiaries declared RMB 17,008 million dividend to the Company in
2006 (2005: 260 million, 2004: Nil)
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted.
The footnote disclosures contain supplemental information relating to the
operations of the Company and, as such, these statements should be read in
conjunction with the notes to the consolidated financial statements of the
Company.
The Company did not have any significant commitment as at December 31,
2004, 2005 and 2006.
F-84
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
(b) Cash and bank deposits
Company
---------------------------------------
As at December 31
---------------------------------------
2005 2006
--------------- ---------------
RMB million RMB million
Cash and cash equivalents with original maturities
less than three months 540 1,772
Effective interest rate of time deposits with original
maturities over three months (%) - -
(c) Prepayments, other receivables and other current assets
Company
-----------------------------------
As at December 31,
-----------------------------------
2005 2006
RMB RMB
million million
Prepaid expenses, deposits and other current assets 14 15
Other receivables 12 253
-------------- -------------------
Total 26 268
============== ===================
(d) Investments in subsidiaries
Company
--------------------------------------
As at December 31,
--------------------------------------
2005 2006
------------- --------------------
RMB RMB
million million
Investments cost in subsidiaries 58,577 62,937
Due from subsidiaries (Note (b)) 573 9,411
Due to subsidiaries (Note (c)) (12,820) (12,754)
------------- --------------------
46,330 59,594
============= ====================
F-85
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
Notes:
(a) As at December 31, 2006, the Company has direct interests in the
following subsidiary, which is a private company:
Percentage
of equity Principal
interest activities
Place and date attributable and place
Of incorporation/ Registered to the of
Company name establishment capital Company operation
--------------------- ------------------ ------------------ ------------- --------------
Directly held:
China Netcom (Group) PRC, RMB65,308 million 100% Provision of
Company Limited August 6, 1999 network
(Note (i)) communication
services in
the PRC
(i) The company is a wholly owned foreign enterprise established in
the PRC. The accounts of the company for the years ended
December 31, 2005 and 2006 were audited by
PricewaterhouseCoopers Zhong Tian CPAs Limited Company.
(b) The balances are unsecured, non-interest bearing and have no fixed
repayment terms.
(c) Deferred payments arising from the Acquisition of New Horizon have
been transferred to CNC China at the carrying amount.
(d) The balance is non-secured, non interest bearing and has no
fixed repayment terms.
F-86
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
38 Condensed financial statements of the Company (Continued)
(e) Reserves - Company
Share premium Capital reserve Retained earnings Total
--------------- --------------- ----------------- -----------
RMB RMB RMB RMB
million million million million
At January 1,2005 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
=============== ================ ================== ==============
Profit for the year - - 17,475 17,475
Dividends distributed during the year (Note 12) - - (3,196) (3,196)
Share based payments - 75 - 75
Exercise of share options 545 (73) - 472
--------------- ----------------- ------------------- --------------
As at 31 December 2006 43,295 3,106 12,898 59,299
=============== ================= =================== ==============
F-87
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
39 Significant subsequent events
(i) On January 15, 2007, CNC China entered into an assets transfer
agreement with it s ultimate holding Company, China Netcom Group.
Pursuant to the agreement, CNC China agreed to dispose of its
assets and liabilities in relation to its telecommunications
operations in Guangdong Province and Shanghai Municipality branches
in the PRC for consideration of RMB3.5 billion. China Netcom Group
assumed an aggregate principal amount of RMB3 billion of debt which
was due and owing from the Guangdong and Shanghai branches of the
Group to independent third parties upon completion of the disposal.
On February 14, 2007, the independent shareholders passed an
ordinary resolution to approve the disposal. The disposal was
completed on February 28, 2006 upon the approval granted from MII.
The Group expect to recognize a pre-tax gain ranging approximately
RMB 0.95billion and the gain will be reported as part of the
discontinued operation for the year ending 31 December, 2007.
(ii) After the balance sheet date the directors proposed a final
dividend. Further details are disclosed in Note 12.
(iii) On 16 March 2007, the National People's Congress approved the new
PRC Enterprise Income Tax Law ("New Income Tax Law"). This
legislation reduces the enterprise income tax rate for domestic
enterprises from 33% to 25% with effect from 2008. The tax rate
reduction will also affect the carrying value of the net deferred
tax assets of the Group's domestic operations as HKAS 12 requires
deferred tax items to be written down to reflect future realization
at the newly enacted tax rate of 25% upon approval by the National
People's Congress. The financial impact will be reflected in the
financial statements for the year ended December 31, 2007. The
Group cannot reasonably estimate the financial impact of the New
Income Tax Law to the Group at this stage as the implementation
measures to the New Income Tax Law was not yet finalized.
(iv) On 30 April 2007, CNC China completed the issue of the commercial
paper with a maturity period of 365 days for an aggregated amount
of RMB10 billion at an interest rate of 3.34% per annum and with
interest accruing from 10 May 2007.
F-88
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in the
United States ("U.S. GAAP")
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level
The consolidated financial statements of the Group have been prepared in
accordance with HKFRS, which differs in certain material respects from those
prepared under generally accepted accounting principles in the United States
("U.S.GAAP"). Differences between HKFRS and U.S.GAAP, which may have significant
impacts on the consolidated net income/(loss) and the consolidated shareholders'
equity are described below.
The effect on net profit/ (loss) of significant differences between HKFRS and
U.S.GAAP for the years ended December 31, 2004, 2005 and 2006 is as follow:
Year ended at December 31
-----------------------------------------------------------
2004 2005 2006 2006
----------- ----------- ----------- ------------
Restated Restated
Note Note 2 Note 2
----------- ----------- ----------- ------------
RMB million except per share data US$ million
except per
share data
Consolidated net income/(loss) for the
year under HKFRS
Profit after taxation for the year
from continuing operations 3,410 14,114 11,141 1,427
Profit /loss after taxation for
the year from discontinued operations (711) (226) 1,819 233
----------- ------------- ------------ -------------
2,699 13,888 12,960 1,660
U.S.GAAP adjustments
Revaluation of fixed assets (a) 11,318 - 1,524 195
Depreciation of revalued fixed assets (a) (3,529) (5,110) (4,619) (592)
Others 14 - - -
Tax effect on the above adjustments (b) (2,570) 1,687 1,021 131
----------- ------------- ------------ -------------
Consolidated profit for the year under U.S.GAAP
Profit after taxation for the year from continuing
operations 8,643 10,691 9,067 1,161
Profit /loss after taxation for the year from
discontinued operations (711) (226) 1,819 233
----------- ------------- ------------ -------------
7,932 10,465 10,886 1,394
=========== ============= ============ =============
Shares used in computing basic earnings
per share (million) 5,623 6,594 6,616 6,616
----------- ------------- ------------ -------------
Shares used in computing diluted
earnings per share (million) 5,630 6,628 6,667 6,667
----------- ------------- ------------ -------------
Earnings per share for profit from
continuing operations attributable to
shareholders of the Company for the
year under U.S GAAP
Basic earnings per share under U.S.GAAP RMB1.54 RMB1.62 RMB1.37 USD0.18
=========== ============ ============ ============
Diluted earnings per share under U.S.GAAP RMB1.54 RMB1.61 RMB1.36 USD0.17
=========== ============ ============ ============
Earnings/(loss) per share for profit/(loss)
from discontinued operations attributable
to shareholders of the Company for the
year under U.S GAAP
Basic earnings/(loss) per share under U.S.GAAP RMB(0.13) RMB(0.03) RMB0.27 US$0.03
============ ============= ============ =============
Diluted earnings/(loss) per share under U.S.GAAP RMB(0.13) RMB(0.03) RMB0.27 US$0.03
============ ============= ============ =============
Earnings per share from operations attributable to
shareholders of the Company for the year under
U.S GAAP
Basic earnings per share under U.S.GAAP RMB1.41 RMB1.59 RMB1.64 US$0.21
=========== ============ ============ ===========
Diluted earnings per share under U.S.GAAP RMB1.41 RMB1.58 RMB1.63 US$0.20
=========== ============ ============ ===========
F-89
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted
in the United States ("U.S. GAAP") (Continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (Continued)
The effect on shareholders' equity of significant differences between HKFRS and
U.S.GAAP as at 31, December 2004, 2005 and 2006 is as follows:
As at December 31
----------------------------------------------------
2004 2005 2006 2006
---------- ----------- ---------- ---------
Restated Restated
Note Note 2 Note 2
---------- ----------- ---------- ---------
RMB million US$
million
--------------------------------------- ---------
Consolidated shareholders' equity under HKFRS 64,595 63,010 73,978 9,474
U.S.GAAP adjustments
Revaluation of fixed assets (a) 30,251 30,251 30,704 3,932
Depreciation of revalued fixed assets (a) (3,529) (8,639) (13,258) (1,698)
Difference in distribution to owner upon Listing
Reorganization (c) 166 - - -
Tax effect on the above adjustments (b) (8,819) (7,132) (5,757) (737)
----------- ---------- ---------- ---------
Consolidated shareholders' equity under U.S.GAAP 82,664 77,490 85,667 10,971
=========== ========== ========== =========
F-90
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (Continued)
On June, 2, 2006, the Group entered into an agreement with third party
buyers to dispose of its 100% interest in the ANC Group and the transaction
was completed on August 22, 2006. In accordance with HKFRS 5 "Non-current
assets held for sales and discontinued operations" issued by the HKICPA,
the results and cash flows of the operations of the ANC Group for the year
ended December 31, 2006 are presented as discontinued operations.
Accordingly, certain comparative figures of 2004 and 2005 have been
restated.
(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 December 31, 2003 with respect to the
reduction in carrying amounts of certain fixed assets below their
historical cost bases. In addition, a surplus arising from the revaluation
of certain other fixed assets totaling 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 December 31, 2004 with
respect to the reduction in carrying amounts of certain fixed assets below
their historical cost bases. In addition, a surplus arising from the
revaluation of certain other fixed assets totaling RMB3,863 million has
been credited to the revaluation reserve.
According to the Group's accounting policy under HKFRS as set out in
Note4(k)(iii), certain classes of fixed assets of the Group were revalued
at December 31, 2006.The revaluation was performed based on the depreciated
replacement costs for fixed assets and was not based upon the expected
future cash flows of the fixed assets. The revaluation resulted in a charge
of RMB1,524 million to the Group's consolidated income statement for the
year ended December 31, 2006 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 RMB1,071million has been credited to the revaluation
reserve. The effect of the reduction in depreciation of the revalued assets
amounted to RMB4,619 million in the year ended December 31, 2006 (2005:
RMB5,110 million, 2004: RMB3,529 million).
Under U.S.GAAP, the carrying values of fixed assets are stated at their
historical cost less accumulated depreciation and impairment loss without
making reference to their respective depreciated replacement cost. An
impairment loss on fixed assets is recorded under U.S.GAAP if the carrying
value of such assets exceeds its future undiscounted cash flows 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's consolidated income
F-91
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (Continued)
statements and the surplus credited to the 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) 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.
HKFRS requires recognition of a deferred tax asset only to the extent that
recovery of the deferred tax asset is probable, whereas U.S. GAAP requires
full recognition of deferred tax assets, reduced by an appropriate
valuation allowance if the recovery is less than 50% likely. Recognition of
deferred tax asset previously not recognized under HKFRS is presented as a
reversal of the valuation allowance under U.S. GAAP.
(c) Goodwill and negative goodwill
Under HKFRS, before January 1, 2005, goodwill on acquisition was included
in intangible assets and amortized using the straight-line method over its
estimated useful life of no more than twelve years. Negative goodwill is
presented in the same balance sheet classification as goodwill and
recognized in the income statement over the remaining weighted average
useful life of the related fixed assets.
On January 1, 2005, the Group adopted HKFRS 3 - "Business Combinations"
issued by the HKICPA. Goodwill can 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.
After the Listing Reorganization, the value of the fixed assets transferred
to China Netcom Group under HKFRS was higher than that under U.S.GAAP by
RMB166 million due to the different treatment of the negative goodwill
arising from the acquisition of Asia Global Crossing. The negative goodwill
of RMB166 million was included in the balance sheet under HKFRS while
offset against certain fixed assets under U.S.GAAP and the fixed assets had
been distributed to the owner in accordance with the Reorganization plan.
Accordingly, the amount distributed to the owner under U.S.GAAP was lower
than that under HKFRS by RMB166 million.
On 1 January 2005, the balance of negative goodwill under HKFRS was
credited directly to the shareholders' equity upon the adoption of HKFRS 3
and the GAAP difference ceased to exist from then.
F-92
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (Continued)
(d) Presentation of revenue
Under HKFRS, revenues are presented net of the PRC business taxes and
government levies which amounted to RMB2,493 million, RMB2,421 million and
RMB2,450 million for the years ended December 31, 2004, 2005 and 2006
respectively.
Under U.S.GAAP, EITF 06-3 "How Taxes Collected from Customers and Remitted
to Governmental Authorities Should Be Presented in the Income Statement
(That is, Gross versus Net Presentation)" a company can make an accounting
policy decision to present revenues gross of taxes (included in revenues
and costs) or on a net basis (excluded from revenues).
(e) Presentation of depreciation expenses
Under HKFRS, depreciation expense can be excluded from "Network, operations
and support" and separately disclosed on the face of income statement.
Under U.S.GAAP, "Network, operations and support" expenses should include
charges for depreciation of property, plant and equipment and amortization
of intangible assets. Industry practice adopted by the Chinese
telecommunications sector is to present these costs of operations net of
depreciations charges. In such circumstances, U.S.GAAP requires such facts
to be highlighted on the face of the income statement.
(f) Presentation of amortization of subscriber acquisition costs
Under Hong Kong GAAP, amortization of capitalized subscriber acquisition
costs, being RMB2,602 million, RMB1,887 million and RMB739 million for the
years ended December 31, 2004, 2005 and 2006 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.
F-93
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (Continued)
(g) Other U.S.GAAP disclosures
(i) Acquisition of business under common control
The year ended at December 31, 2004
Effect of
adoption of
Effect of merger
adoption accounting on
As of new acquisition of
previously HKFRSs Acquired Business
stated (Note 3) Adjusted (Note 2) Restated
RMB'000 RMB'000 RMB'000 RMB'000 RMB'000
Revenue 64,922 - 64,922 18,616 83,538
Operating expenses Depreciation and
amortization (18,754) - (18,754) (6,426) (25,180)
Networks, operations and support (11,591) - (11,591) (2,426) (14,017)
Staff costs (8,041) (18) (8,059) (3,891) (11,950)
Selling, general and administrative (9,566) - (9,566) (3,311) (12,877)
Other operating expenses (1,534) - (1,534) (459) (1,993)
-----------------------------------------------------------------------------------------------------------------------
Total of operating expenses (49,486) (18) (49,504) (16,513) (66,017)
Operating profit before interest income,
dividend income and deficit on
revaluation of fixed assets 15,436 (18) 15,418 2,103 17,521
---------------------------------------------------------------------------
Interest income 76 - 76 11 87
Dividend income 17 - 17 - 17
Deficit on revaluation of fixed assets - - - (11,318) (11,318)
Profit/(loss) from operations 15,529 (18) 15,511 (9,204) 6,307
Finance costs (2,932) - (2,932) (998) (3,930)
Share of loss of associated companies (1) - (1) - (1)
----------------------------------------------------------------------------
Profit/(loss) before taxation 12,596 (18) 12,578 (10,202) 2,376
Taxation credit (3,348) - (3,348) 3,671 323
----------------------------------------------------------------------------
Profit/(loss) for the year 9,248 (18) 9,230 (6,531) 2,699
============================================================================
F-94
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (Continued)
(g) Other U.S.GAAP disclosures (Continued)
(i) Acquisition of business under common control (Continued)
As at December 31, 2004
Effect of
adoption of
Effect of merger
adoption accounting on
As of new acquisition of
previously HKFRSs Acquired Business
stated (Note 3) Adjusted (Note 2) Restated
RMB'000 RMB'000 RMB'000 RMB'000 RMB'000
Assets
Current assets
Cash and bank deposits 10,053 - 10,053 580 10,633
Short-term investments 2,876 - 2,876 - 2,876
Accounts receivable 5,688 - 5,688 1,486 7,174
Inventories and consumables 941 - 941 302 1,243
Prepayments and other receivables 1,006 - 1,006 436 1,442
Due from holding companies and fellow
subsidiaries 373 - 373 714 1,087
--------- ------------ -------------- ------------------- ----------------
Total current assets 20,937 - 20,937 3,518 24,455
--------- ------------ -------------- ------------------- ----------------
Non-current assets
Lease prepayments for land - 1,266 1,266 480 1,746
Fixed assets 125,582 (795) 124,787 42,110 166,897
Construction in progress 8,073 (471) 7,602 2,995 10,597
Intangible assets 316 316 66 382
Deferred tax assets 2,394 - 2,394 1,410 3,804
Other non-current assets 7,873 7,873 663 8,536
--------- ------------ -------------- ------------------- ----------------
Total non-current assets 144,238 - 144,238 47,724 191,962
--------- ------------ -------------- ------------------- ----------------
Total assets 165,175 - 165,175 51,242 216,417
========= ============ ============== =================== ================
Liabilities
Current liabilities
Accounts payable 14,653 - 14,653 6,472 21,125
Accruals and other payables 3,353 - 3,353 1,513 4,866
Short-term bank loans 29,339 - 29,339 15,543 44,882
Current portion of long-term bank
and other loans 7,270 - 7,270 4,457 11,727
Due to ulitmate holding company 8,244 - 8,244 1,836 10,080
Current portion of deferred revenues 6,653 - 6,653 2,223 8,876
Current portion of provisions 2,596 - 2,596 1,531 4,127
Taxation payable 196 - 196 165 361
--------- ------------ -------------- ------------------- ----------------
Total current liabilities 72,304 - 72,304 33,740 106,044
--------- ------------ -------------- ------------------- ----------------
Net current liabilities (51,367) - (51,367) (30,222) (81,589)
--------- ------------ -------------- ------------------- ----------------
Total assets less current liabilities 92,871 - 92,871 17,502 110,373
--------- ------------ -------------- ------------------- ----------------
Non-current liabilities
Long-term bank and other loans 21,861 - 21,861 4,191 26,052
Deferred revenues 11,817 - 11,817 2,171 13,988
Provisions 2,143 - 2,143 1,431 3,574
Deferred tax liabilities 1,321 - 1,321 255 1,576
Other non-current liabilities 564 564 24 588
--------- ------------ -------------- ------------------- ----------------
Total non-current liabilities 37,706 - 37,706 8,072 45,778
--------- ------------ -------------- ------------------- ----------------
Total liabilities 110,010 - 110,010 41,812 151,822
========= ============ ============== =================== ================
Financed by :
Share capital 2,181 - 2,181 - 2,181
Reserves 52,984 52,984 9,430 62,414
--------- ------------ -------------- ------------------- ----------------
Shareholders' equity 55,165 - 55,165 9,430 64,595
--------- ------------ -------------- ------------------- ----------------
Total liabilities and equity 165,175 - 165,175 51,242 216,417
========= ============ ============== =================== ================
F-95
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(A) Reconciliation of HKFRS and U.S. GAAP at the Group level (Continued)
(g) Other U.S.GAAP disclosures (Continued)
(ii) Comprehensive income
U.S.GAAP requires that all items that are required to be recognized as
components of comprehensive income (including cumulative translation
adjustment) be reported in a separate financial statement. There are no
material differences between total recognized gains and losses for the
periods shown in the Consolidated Statements of Changes in Equity presented
under HKFRS and U.S.GAAP comprehensive income, except for the differences
between HKFRS and U.S.GAAP profit attributable to shareholders shown above.
(B) Reconciliation of HKFRS and U.S. GAAP at the Company level
The condensed financial statements of the Company as set out in Note 38
have been prepared in accordance withy HKFRS, which differs in certain
material respects from U.S. GAAP. Differences between HKFRS and U.S. GAAP,
which may have significant impacts on the Company's net profit/ (loss) and
the Company's shareholders' equity are described below.
The effect on the net profit/(loss) of significant differences between
HKFRS and U.S. GAAP at the Company's level for the years ended December 31,
2004, 2005 and 2006 is as follows:
Year ended December 31,
Note 2004 2005 2006 2006
RMB RMB RMB USD
million million million million
Restated
Notes 2
Net profit/(loss) for the year under HKFRS (59) 126 17,475 2,238
U.S. GAAP adjustments:
Equity accounting for share of results of
its subsidiaries net of tax effect (a) 7,991 10,339 (6,589) (844)
-------------------------------------------------------
Net profit for the year under US GAAP 7,932 10,465 10,886 1,394
=======================================================
F-96
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(B) Reconciliation of HKFRS and U.S. GAAP at the Company level (Continued)
The effect on the shareholders' equity of significant differences between HKFRS
and U.S. GAAP at the Company's level as at December 31, 2004, 2005 and 2006 is
as follows:
As at December 31,
2004 2005 2006 2006
RMB RMB RMB USD
million million million million
Restated
Note Notes 2
Shareholders' equity under HKFRS
U.S. GAAP adjustments: 46,683 46,654 61,498 7,876
Equity accounting for the subsidiaries of
China Netcom Group, net of tax effect (a) 35,815 30,863 24,169 3,095
Difference in distribution to owners upon Reorganization (b) 166 - - -
-------------------------------------------------------------------------------------------------------------------------
Shareholders' equity under U.S. GAAP 82,664 77,490 85,667 10,971
=========================================================================================================================
(a) Equity accounting for share of results and net assets of its subsidiaries
Under HKFRS, the Company records its investment in its subsidiaries under
cost method of accounting. In the Company's balance sheet, the investment
in subsidiaries are stated at cost less provision for impairment losses.
The results of the subsidiaries are accounted for by the Company on the
basis of dividend received and receivable.
Under U.S. GAAP, the Company restates its financial statements as if the
Reorganization happened at the earliest period presented. It records its
investment in its subsidiaries under the equity method of accounting as
prescribed in APB Opinion No. 18, "The Equity Method of Accounting for
Investments in Common Stock". Since the company holds 100% equity interest
in the subsidiaries, the net asset value of the subsidiaries has been fully
reflected as Investment in subsidiaries on the balance sheet and the
results of the subsidiaries have been accounted for under share of results
of subsidiaries, net of tax on the income statement.
As set out in Note 40(A)(a) above, the accounting treatments on revaluation
of fixed assets are different under HKFRS and US GAAP. Therefore,
difference in the net assets value and results of the subsidiaries are
dealt with in this reconciliation item.
(b) Please refer to Note (c) of Section A 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 3 to the Group's financial statements which are
effective for accounting periods beginning on or after January 1, 2007. The
Group has not early adopted these new and revised standards and
interpretations in the financial statements for the year ended December 31,
2006. 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.
F-97
CHINA NETCOM GROUP CORPORATION (HONG KONG) LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40 Reconciliation of HKFRS and Accounting Principal Generally Accepted in
the United States ("U.S. GAAP") (Continued)
(D) Recent U.S. Accounting Pronouncements
EITF 06-3
In March 2006, the Emerging Issues Task Force ("EITF") issued EITF Issue
06-3, "How Sales Taxes Collected From Customers and Remitted to
Governmental Authorities Should Be Presented in the Income Statement."
("Issue 06-3"). This Issue discussed how entities are to adopt a policy of
presenting any tax assessed by a governmental authority that is both
imposed on and concurrent with a specific revenue-producing transaction
between a seller and a customer in the income statement on either a gross
or net basis. If taxes are significant, an entity should disclose its
policy of presenting taxes and the amounts of taxes. The guidance is
effective for periods beginning after December 15, 2006. The Group has
early adopted EITF 06-3 on a retrospective basis and made the accounting
policy decision to present such taxes on a net basis which is consistent
with HKFRS.
FIN 48
In June 2006, the FASB issued FASB Interpretation Number 48, Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109
(FIN 48). The interpretation clarifies the accounting for uncertainty in
income taxes and utilizes a two-step approach. The first step is to
determine whether it is more likely than not that a tax position accounted
for under SFAS 109 will be sustained upon examination, with the presumption
that the position will be examined. The second step is to measure the
amount of benefit to recognize in the financial statements. The tax
position is measured at the largest amount of benefit that is greater than
50% likely of being realized upon ultimate settlement. The Group is
evaluating the impact this interpretation will have on its financial
statements.
(D) Recent U.S. Accounting Pronouncements (Continued)
SFAS 157
In September 2006, the FASB issued SFAS 157, Fair Value Measurement. SFAS
157 defines fair value, establishes a framework for measuring fair value,
and enhances disclosures about fair value measurements. The adoption of
SFAS 157 will be effective for financial statements issued for fiscal years
beginning after November 15, 2007, and interim periods within those fiscal
years. The Group is evaluating the impact adopting SFAS 157 will have on
its financial statements.
SAB 108
In September 2006, the SEC released Staff Accounting Bulletin No. 108,
Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements (SAB 108). SAB 108
provides guidance on the SEC's views regarding quantifying the materiality
of financial statement misstatements, including misstatements that were not
material to prior years' financial statements. SAB 108 is effective for
fiscal years ending after November 15, 2006. The Group does not consider
that the application of this guidance have a material effect on our
financial position, results of operations, or cash flows.
SFAS 159
In February, 2007, the FASB issued SFAS 159 i(degree)The Fair Value Option
for Financial Assets and Financial Liabilities--Including an amendment of
FASB Statement No. 115i+/-. This statement permits all entities to choose
to measure many financial instruments and certain other items at fair value
at specified election dates. SFAS 159 will be effective as of the beginning
of an entityi-s first fiscal year that begins after November 15, 2007. The
Group is currently evaluating the effect that the adoption of this
statement will have on its consolidated results of operations and financial
condition but does not expect it to have a material impact.
F-98