##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, DC 20549
 FORM 20-F/A
Amendment No. 1 o
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OR
12(G) OF THE SECURITIES EXCHANGE ACT OF 1934or
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended August 31,
2004or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934For the transition period from
__________ or __________
 Commission file number:
333-11012 City Telecom (H.K.) Limited (Exact name of
registrant as Specified in its Charter)
 Hong Kong Special Administrative Region,
The Peoples Republic of China (Jurisdiction of
Incorporation or Organization)
 13-16 Floors
Trans Asia Centre
18 Kin Hong Street
Kwai Chung
Hong Kong(Address of Principal Executive Offices) Securities registered or to be registered pursuant to Section 12(b) of the Act:
N/A Securities registered or to be registered pursuant to Section 12(g) of the Act:
American Depositary Shares, representing 20 Ordinary Shares, par value HK$0.10 per share Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
N/A Indicate the number of outstanding shares of each of the issuers classes of capital
or common stock as of August 31, 2004: 610,573,361   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  þ                    No  o Indicate by check mark which financial statement item the registrant has selected to follow. Item 17  o                    Item 18  þ




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CONTENTS CURRENCY TRANSLATION
    
    
    3FORWARD-LOOKING STATEMENTS
    
    
    3PART I
    
    
    4ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
    
    
    4ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
    
    
    4ITEM 3. KEY INFORMATION
    
    
    4ITEM 4. INFORMATION ON THE COMPANY
    
    
    25ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
    
    
    59ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
    
    
    80ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
    
    
    90ITEM 8. FINANCIAL INFORMATION
    
    
    92ITEM 9. THE OFFER AND LISTING
    
    
    97ITEM 10. ADDITIONAL INFORMATION
    
    
    100ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    107ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
    
    
    108PART II
    
    
    109ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
    
    
    109ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE
OF PROCEEDS
    
    
    109ITEM 15. CONTROLS AND PROCEDURES
    
    
    109ITEM 16. [RESERVED]
    
    
    109ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
    
    
    109ITEM 16B. CODE OF ETHICS
    
    
    109ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
    
    
    110ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
    
    
    110ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
PURCHASERS
    
    
    111PART III
    
    
    112ITEM 17. FINANCIAL STATEMENTS
    
    
    112ITEM 18. FINANCIAL STATEMENTS
    
    
    112ITEM 19. EXHIBITS
    
    
    112EX-11 CODE OF BUSINESS CONDUCT AND ETHICS
  2




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CURRENCY TRANSLATION We publish our financial statements in Hong Kong dollars. In this annual report, references
to Hong Kong dollars or HK$ are to the currency of Hong Kong, and references to U.S. dollars
or US$ are to the currency of the United States. This annual report contains translations of
Hong Kong dollar amounts into U.S. dollar amounts, solely for your convenience. Unless otherwise
indicated, the translations have been made at US$1.00=HK$7.8000, which was the noon buying rate in
The City of New York for cable transfers in Hong Kong dollars as certified for customs purposes by
the Federal Reserve Bank of New York on August 31, 2004. On February 4, 2005 the noon buying rate
was US$1.00=HK$7.7984. You should not construe these translations as representations that the Hong
Kong dollar amounts actually represent such U.S. dollar amounts or could have been or could be
converted into U.S. dollars at the rates indicated or at any other rates. 
 FORWARD-LOOKING STATEMENTS This annual report contains forward-looking statements that are, by their nature, subject to
significant risks and uncertainties. These include statements with respect to City Telecom (H.K.)
Limited (City Telecom or the Company) and our plans, strategies and beliefs and other
statements that are not historical facts. These statements can be identified by the use of
forward-looking terminology such as may, will, expect, anticipate, intend, estimate,
continue, plan, predict, project or other similar words. The statements are based on
managements assumptions and beliefs in light of the information currently available to us. These assumptions involve risks and uncertainties which may cause the actual results,
performance or achievements to be materially different from any future results, performance or
achievements expressed or implied by such forward looking statements. Potential risks and
uncertainties include, without limitation:  
    technology changes;
    changes in the regulatory environment in which we operate, or changes in the rules and
policies that government regulators apply to our businesses;
    increased competition in the local or international telecommunications, Internet access
or pay-television (pay-TV) markets;
    the benefits we expect to receive from our continuing capital expenditure on our Metro
Ethernet network;
    our ability to maintain growth and successfully introduce new products and services; and
    the continued development and stability of the technological infrastructure we use to
provide our telecommunications, Internet access and pay-TV using Internet Protocol, which
we refer to as IP-TV, services. When considering such forward-looking statements, you should keep in mind the factors
described in Item 3 Key InformationRisk Factors and other cautionary statements appearing in
Item 5 Operating and Financial Review and Prospects of this annual report. Such risk factors and
statements describe circumstances that could cause actual results to differ materially from those
contained in any forward-looking statement. *********** City Telecom makes periodic filings with the U.S. Securities and Exchange Commission pursuant
to and in accordance with the U.S. Securities Exchange Act of 1934, as amended. This annual report
incorporates by reference all filings made by City Telecom on Form 6-K from February 26, 2004
through and including February 8, 2005. 3




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##### Table of Contents



PART I 
 ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS Not applicable. 
 ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE Not applicable. 
 ITEM 3. KEY INFORMATION Selected Financial Data City Telecoms Historical Financial Information The following table presents the selected consolidated financial information and operating
information of City Telecom as of and for the years ended August 31, 2000, 2001, 2002, 2003 and
2004. The selected financial information should be read in conjunction with, and is qualified in
its entirety by reference to, the financial statements included elsewhere in this annual report,
the accompanying notes thereto and Item 5 Operating and Financial Review and Prospects. As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)(Amounts in thousands except per share data)Consolidated Statement of
Income Data:Hong Kong GAAPRevenues:Fixed telecommunications
network services
    
    
    109,019
    
    
    
    154,262
    
    
    
    241,219
    
    
    
    423,107
    
    
    
    541,902
    
    
    
    69,475International
telecommunications
    
    
    1,119,148
    
    
    
    861,338
    
    
    
    908,981
    
    
    
    875,802
    
    
    
    627,978
    
    
    
    80,510Content and e-commerce
    
    
    5,960
    
    
    
    1,034
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total Operating
Revenue
    
    
    1,234,127
    
    
    
    1,016,634
    
    
    
    1,150,200
    
    
    
    1,298,909
    
    
    
    1,169,880
    
    
    
    149,985Cost of Services:Fixed telecommunications
network services
    
    
    (112,742
    )
    
    
    (69,085
    )
    
    
    (50,808
    )
    
    
    (76,845
    )
    
    
    (122,476
    )
    
    
    (15,702
    )International
telecommunications
    
    
    (770,786
    )
    
    
    (514,182
    )
    
    
    (407,155
    )
    
    
    (245,908
    )
    
    
    (208,932
    )
    
    
    (26,786
    )Content and e-commence
    
    
    (5,080
    )
    
    
    (1,085
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total Cost of Sales
    
    
    (888,608
    )
    
    
    (584,352
    )
    
    
    (457,963
    )
    
    
    (322,753
    )
    
    
    (331,408
    )
    
    
    (42,488
    )Gross Profit:Fixed telecommunications
network services
    
    
    (3,723
    )
    
    
    85,177
    
    
    
    190,411
    
    
    
    346,262
    
    
    
    419,426
    
    
    
    53,773International
telecommunications
    
    
    348,362
    
    
    
    347,156
    
    
    
    501,826
    
    
    
    629,894
    
    
    
    419,046
    
    
    
    53,724Content and e-commence
    
    
    880
    
    
    
    (51
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total Gross Profit
    
    
    345,519
    
    
    
    432,282
    
    
    
    692,237
    
    
    
    976,156
    
    
    
    838,472
    
    
    
    107,497Operating Expenses
    
    
    (506,992
    )
    
    
    (415,135
    )
    
    
    (602,644
    )
    
    
    (704,796
    )
    
    
    (793,125
    )
    
    
    (101,683
    )Operating Income/(loss)
    
    
    (161,473
    )
    
    
    17,147
    
    
    
    89,593
    
    
    
    271,360
    
    
    
    45,347
    
    
    
    5,814Interest income, net
    
    
    25,629
    
    
    
    30,896
    
    
    
    7,366
    
    
    
    2,562
    
    
    
    3,578
    
    
    
    459Other income, net
    
    
    191,989
    
    
    
    10,935
    
    
    
    502
    
    
    
    1,678
    
    
    
    2,668
    
    
    
    342Income taxes
    
    
    (2,328
    )
    
    
    (17,533
    )
    
    
    (15,190
    )
    
    
    (17,857
    )
    
    
    (2,043
    )
    
    
    (262
    )Income after taxation
    
    
    53,817
    
    
    
    41,445
    
    
    
    82,271
    
    
    
    257,743
    
    
    
    49,550
    
    
    
    6,353Minority interest
    
    
    15,058
    
    
    
    13,724
    
    
    
    8,234
    
    
    
    
    
    
    
    
    
    
    
    
 4




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As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)(Amounts in thousands except per share data)Net income
    
    
    68,875
    
    
    
    55,169
    
    
    
    90,505
    
    
    
    257,743
    
    
    
    49,550
    
    
    
    6,353Net income per share
(cents)
    
    
    14.7
    
    
    
    11.2
    
    
    
    18.3
    
    
    
    46.6
    
    
    
    8.1
    
    
    
    1.0Diluted net income per share
(cents)(2)
    
    
    14.4
    
    
    
    11.2
    
    
    
    16.0
    
    
    
    41.9
    
    
    
    8.1
    
    
    
    1.0Dividends declared per share
(cents)
    
    
    2.0
    
    
    
    1.0
    
    
    
    
    
    
    
    5.0
    
    
    
    9.0
    
    
    
    1.2Diluted weighted average
number of shares(3)
    
    
    478,051
    
    
    
    494,449
    
    
    
    565,889
    
    
    
    615,102
    
    
    
    614,365
    
    
    
    614,365Weighted average number of
shares
    
    
    468,946
    
    
    
    490,679
    
    
    
    495,181
    
    
    
    552,600
    
    
    
    610,095
    
    
    
    610,095
 As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Amounts in thousands except per share data)U.S. GAAPTotal operating revenue
    
    
    1,217,169
    
    
    
    1,006,328
    
    
    
    1,141,814
    
    
    
    1,291,119
    
    
    
    1,169,880
    
    
    
    149,985Total operating costs
    
    
    (1,343,408
    )
    
    
    (978,843
    )
    
    
    (1,073,283
    )
    
    
    (1,015,900
    )
    
    
    (1,123,198
    )
    
    
    (144,000
    )Net income from continuing
operations
    
    
    103,089
    
    
    
    65,389
    
    
    
    69,317
    
    
    
    264,151
    
    
    
    51,565
    
    
    
    6,611Net income from continuing
operations per share
(cents)
    
    
    22.0
    
    
    
    13.3
    
    
    
    14.0
    
    
    
    47.8
    
    
    
    8.5
    
    
    
    1.1Net income/(loss) from
discontinued operations
    
    
    (36,939
    )
    
    
    (11,423
    )
    
    
    (352
    )
    
    
    83
    
    
    
    
    
    
    
    Loss arising from disposal of
discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,695
    )
    
    
    
    
    
    
    Net loss from discontinued
operations per share
(cents)
    
    
    (7.8
    )
    
    
    (2.3
    )
    
    
    (0.1
    )
    
    
    (0.5
    )
    
    
    
    
    
    
    Diluted net income from
continuing operations per
share (cents)(4)
    
    
    21.6
    
    
    
    13.2
    
    
    
    12.3
    
    
    
    42.9
    
    
    
    8.4
    
    
    
    1.1Diluted net loss from
discontinued operations per
share (cents)(5)
    
    
    (7.7
    )
    
    
    (2.3
    )
    
    
    (0.1
    )
    
    
    (0.4
    )
    
    
    
    
    
    
    Dividends declared per share
(cents)
    
    
    2.0
    
    
    
    1.0
    
    
    
    
    
    
    
    5.0
    
    
    
    9.0
    
    
    
    1.2Weighted average number of
shares
    
    
    468,946
    
    
    
    490,679
    
    
    
    495,181
    
    
    
    552,600
    
    
    
    610,095
    
    
    
    610,095Diluted weighted average
number of shares(3)
    
    
    478,051
    
    
    
    494,449
    
    
    
    565,889
    
    
    
    615,102
    
    
    
    614,365
    
    
    
    614,365
 As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)(Amounts in thousands)Consolidated Balance Sheet
Data:Hong Kong GAAPTotal assets
    
    
    1,221,050
    
    
    
    1,144,618
    
    
    
    1,327,285
    
    
    
    1,548,534
    
    
    
    1,683,408
    
    
    
    215,822Total liabilities
    
    
    (449,308
    )
    
    
    (333,476
    )
    
    
    (422,297
    )
    
    
    (369,359
    )
    
    
    (507,710
    )
    
    
    (65,091
    )Net assets
    
    
    771,742
    
    
    
    811,142
    
    
    
    904,988
    
    
    
    1,179,175
    
    
    
    1,175,698
    
    
    
    150,731Minority interest
    
    
    (24,131
    )
    
    
    (10,407
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net assets employed
    
    
    747,611
    
    
    
    800,735
    
    
    
    904,988
    
    
    
    1,179,175
    
    
    
    1,175,698
    
    
    
    150,731Share capital
    
    
    48,960
    
    
    
    49,107
    
    
    
    50,086
    
    
    
    60,496
    
    
    
    61,057
    
    
    
    7,828Share premium
    
    
    568,945
    
    
    
    569,180
    
    
    
    572,656
    
    
    
    615,886
    
    
    
    617,986
    
    
    
    79,229Reserves
    
    
    129,706
    
    
    
    182,448
    
    
    
    282,246
    
    
    
    502,793
    
    
    
    496,655
    
    
    
    63,674Total shareholders equity
    
    
    747,611
    
    
    
    800,735
    
    
    
    904,988
    
    
    
    1,179,175
    
    
    
    1,175,698
    
    
    
    150,731
 5




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As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Amounts in thousands except per share data)U.S. GAAPTotal assets
    
    
    1,224,445
    
    
    
    1,146,994
    
    
    
    1,329,707
    
    
    
    1,552,021
    
    
    
    1,688,640
    
    
    
    216,492Total liabilities
    
    
    (449,308
    )
    
    
    (333,476
    )
    
    
    (422,297
    )
    
    
    (369,359
    )
    
    
    (507,710
    )
    
    
    (65,091
    )Net assets
    
    
    775,137
    
    
    
    813,518
    
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    1,180,930
    
    
    
    151,401Minority interest
    
    
    (24,131
    )
    
    
    (10,407
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total assets less
liabilities
    
    
    751,006
    
    
    
    803,111
    
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    1,180,930
    
    
    
    151,401Share capital
    
    
    48,960
    
    
    
    49,107
    
    
    
    50,086
    
    
    
    60,496
    
    
    
    61,057
    
    
    
    7,828Share premium
    
    
    578,380
    
    
    
    578,799
    
    
    
    603,861
    
    
    
    644,360
    
    
    
    646,190
    
    
    
    82,845Reserves
    
    
    123,666
    
    
    
    175,205
    
    
    
    253,463
    
    
    
    477,806
    
    
    
    473,683
    
    
    
    60,728Total shareholders equity
    
    
    751,006
    
    
    
    803,111
    
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    1,180,930
    
    
    
    151,401
 As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2004(HK$)
    
    
    (HK$)
    
    
    (HK$)
    
    
    (HK$)
    
    
    (HK$)
    
    
    (US$)(Amounts in thousands)Other Financial Data:EBITDA(6)
    
    
    98,187
    
    
    
    124,653
    
    
    
    227,684
    
    
    
    449,058
    
    
    
    245,032
    
    
    
    31,414Net cash provided by (used
in) operating activities
    
    
    (30,253
    )
    
    
    38,751
    
    
    
    288,444
    
    
    
    414,500
    
    
    
    203,763
    
    
    
    26,123Net cash used in investing
activities
    
    
    (409,663
    )
    
    
    (48,769
    )
    
    
    (475,212
    )
    
    
    (309,634
    )
    
    
    (406,244
    )
    
    
    (52,083
    )Net cash provided by (used
in) financing activities
    
    
    627,430
    
    
    
    13,880
    
    
    
    9,109
    
    
    
    (10,274
    )
    
    
    47,221
    
    
    
    6,054Capital expenditures
    
    
    260,380
    
    
    
    166,037
    
    
    
    579,066
    
    
    
    250,209
    
    
    
    410,046
    
    
    
    52,570
 As a measure of our operating performance or liquidity, we believe that the most directly
comparable measure to EBITDA is net cash provided by (used in) operating activities. The following
table reconciles our net cash provided by (used in) operating activities under Hong Kong GAAP to
our definition of EBITDA on a consolidated basis for each of fiscal 2000, 2001, 2002, 2003 and
2004. As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)
    
    
    (Restated)(1)(Amounts in thousands)EBITDA
    
    
    98,187
    
    
    
    124,653
    
    
    
    227,684
    
    
    
    449,058
    
    
    
    245,032
    
    
    
    31,414Depreciation and amortization
    
    
    (52,613
    )
    
    
    (82,847
    )
    
    
    (129,355
    )
    
    
    (176,020
    )
    
    
    (197,017
    )
    
    
    (25,258
    )Interest income, net
    
    
    25,629
    
    
    
    30,896
    
    
    
    7,366
    
    
    
    2,562
    
    
    
    3,578
    
    
    
    459Income taxes
    
    
    (2,328
    )
    
    
    (17,533
    )
    
    
    (15,190
    )
    
    
    (17,857
    )
    
    
    (2,043
    )
    
    
    (262
    )Net income
    
    
    68,875
    
    
    
    55,169
    
    
    
    90,505
    
    
    
    257,743
    
    
    
    49,550
    
    
    
    6,353Depreciation and amortization
    
    
    52,613
    
    
    
    82,847
    
    
    
    129,355
    
    
    
    176,020
    
    
    
    197,017
    
    
    
    25,258Amortization of deferred
expenditure
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,828
    
    
    
    234Income taxes
    
    
    2,328
    
    
    
    17,533
    
    
    
    15,190
    
    
    
    17,857
    
    
    
    2,043
    
    
    
    262Interest income
    
    
    (31,857
    )
    
    
    (35,438
    )
    
    
    (10,870
    )
    
    
    (3,163
    )
    
    
    (3,753
    )
    
    
    (481
    )Minority interest
    
    
    (15,058
    )
    
    
    (13,724
    )
    
    
    (8,234
    )
    
    
    
    
    
    
    
    
    
    
    Loss/(gain) on disposal of
fixed assets
    
    
    2,699
    
    
    
    3,512
    
    
    
    2,414
    
    
    
    427
    
    
    
    (34
    )
    
    
    (4
    )Unrealised losses on other
investments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,696
    
    
    
    217Gain on dilution of interest
in subsidiary
    
    
    (185,811
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Loss on disposal of a
subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,695
    
    
    
    
    
    
    
    Taxation refund/(paid)
    
    
    2,542
    
    
    
    
    
    
    
    (4,452
    )
    
    
    (19,861
    )
    
    
    (24,819
    )
    
    
    (3,182
    )Change in long term
receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,206
    )
    
    
    (796
    )Change in
working capital, net
    
    
    73,416
    
    
    
    (71,148
    )
    
    
    74,536
    
    
    
    (17,218
    )
    
    
    (13,559
    )
    
    
    (1,738
    )Net cash flow (used in)
provided by operating
activities
    
    
    (30,253
    )
    
    
    38,751
    
    
    
    288,444
    
    
    
    414,500
    
    
    
    203,763
    
    
    
    26,123
 6




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##### Table of Contents



As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Operating Data:Fixed Telecommunications Network ServicesSubscriptions:Broadband Internet Access
    
    
    1,600
    
    
    
    17,700
    
    
    
    130,000
    
    
    
    172,000
    
    
    
    197,000Local
VOIP(7)
    
    
    
    
    
    
    
    
    
    
    21,000
    
    
    
    140,000
    
    
    
    237,000IP-TV
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,000Total
    
    
    1,600
    
    
    
    17,700
    
    
    
    151,000
    
    
    
    312,000
    
    
    
    465,000Registered InternationalTelecommunications Accounts(8):Residential
    
    
    842,000
    
    
    
    906,388
    
    
    
    1,056,759
    
    
    
    1,495,229
    
    
    
    1,819,481Corporate
    
    
    63,984
    
    
    
    76,067
    
    
    
    90,930
    
    
    
    93,959
    
    
    
    96,754Total
    
    
    905,984
    
    
    
    982,455
    
    
    
    1,147,689
    
    
    
    1,589,188
    
    
    
    1,916,235IDD Outgoing Minutes (in thousands)
    
    
    505,000
    
    
    
    580,000
    
    
    
    916,000
    
    
    
    888,000
    
    
    
    1,007,000
   (1)
    
    In fiscal 2004, we adopted revised Statements of Standard Accounting Practice (SSAP 12),
Income taxes, issued by the Hong Kong Institute of Certified Public Accountants, regarding
the recognition of deferred tax. The adoption of SSAP 12 represents a change in accounting
policy, which we have applied retrospectively. As a result, financial information provided for
all years prior to fiscal 2004 have been restated to conform to the changed policy.(2)
    
    Diluted net income per share is computed by dividing the net income by the diluted weighted
average number of ordinary shares during the year.(3)
    
    Diluted weighted average number of shares is the weighted average number of ordinary shares
outstanding during the year, plus the weighted average number of additional ordinary shares
which would have been outstanding assuming all the outstanding share options and share
warrants have been exercised at the beginning of the year or on the date of issue, whichever
is earlier.(4)
    
    Diluted net income from continuing operations per share is computed by dividing the net
income from continuing operations by the diluted weighted average number of ordinary shares
during the year.(5)
    
    Diluted net loss from discontinued operations per share is computed by dividing the net loss
from discontinued operations by the diluted weighted average number of ordinary shares during
the year.(6)
    
    EBITDA for any period means, without duplication, net income for such period, plus the
following to the extent deducted in calculating such net income: interest expense, income
taxes, depreciation and amortization expense (excluding any such non cash charge to the extent
it represents an accrual of or reserve for cash charges in any future period or amortization
of a prepaid cash expense that was paid in a prior period not included in the calculation).
EBITDA is not a measure of performance under Hong Kong GAAP or U.S. GAAP. We believe that
EBITDA is an additional measure utilized by investors in determining a borrowers ability to
meet debt service requirements. However, EBITDA does not represent, and should not be used as
a substitute for, net earnings or cash flows from operations as determined in accordance with
Hong Kong GAAP or U.S. GAAP, and EBITDA is not necessarily an indication of whether cash flow
will be sufficient to fund our cash requirements. In addition, our definition of EBITDA may
differ from that of other companies.(7)
    
    Includes only on-network subscriptions.(8)
    
    Registered accounts refer to international telecommunications customers that have a valid
account. Account holders may or may not be active users of our services. Exchange Rate Information The Hong Kong dollar is freely convertible into other currencies (including the U.S. dollar).
Since 1983, the Hong Kong dollar has been officially linked to the U.S. dollar and the current rate
is US$1.00 to HK$7.80. However, even with this official exchange rate, and despite the efforts of
the Hong Kong Monetary Authoritys (HKMA) currency board to keep such rate stable, the market
exchange rate of the Hong Kong dollar against the U.S. dollar continues to be influenced by the
forces of supply and demand in the foreign exchange markets. Furthermore, the official exchange
rate is itself subject to fluctuations and can be reset in circumstances where the secondary
foreign exchange markets move beyond the HKMAs ability to back the official rate with foreign
reserves. 7




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##### Table of Contents



Exchange rates between the Hong Kong dollar and other currencies are influenced by the rate
between the U.S. dollar and the Hong Kong dollar. The following table sets forth the average, high, low and period-end noon buying rate between
the Hong Kong dollar and the U.S. dollar (in Hong Kong dollars per U.S. dollar) for the periods
indicated: Average(1)
    
    
    High
    
    
    Low
    
    
    Period-EndHK$
    
    
    HK$
    
    
    HK$
    
    
    HK$1999
    
    
    7.7599
    
    
    
    7.7814
    
    
    
    7.7457
    
    
    
    7.77402000
    
    
    7.7936
    
    
    
    7.8008
    
    
    
    7.7765
    
    
    
    7.79992001
    
    
    7.7996
    
    
    
    7.8004
    
    
    
    7.7970
    
    
    
    7.79802002
    
    
    7.7996
    
    
    
    7.8095
    
    
    
    7.7970
    
    
    
    7.79882003
    
    
    7.7864
    
    
    
    7.8001
    
    
    
    7.7085
    
    
    
    7.7640August 2004
    
    
    7.7997
    
    
    
    7.8005
    
    
    
    7.7970
    
    
    
    7.8000September 2004
    
    
    7.7995
    
    
    
    7.8002
    
    
    
    7.7970
    
    
    
    7.7984October 2004
    
    
    7.7889
    
    
    
    7.7990
    
    
    
    7.7752
    
    
    
    7.7834November 2004
    
    
    7.7755
    
    
    
    7.7815
    
    
    
    7.7718
    
    
    
    7.7760December 2004
    
    
    7.7760
    
    
    
    7.7821
    
    
    
    7.7698
    
    
    
    7.7723January 2005
    
    
    7.7948
    
    
    
    7.7994
    
    
    
    7.7775
    
    
    
    7.7993February 2005 (through February 4, 2005)
    
    
    7.7993
    
    
    
    7.7999
    
    
    
    7.7984
    
    
    
    7.7984
   (1)
    
    The average of the noon buying rates on the last day of each month during the relevant
period. Source: Federal Reserve Bank of New York. 8




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##### Table of Contents



Risk Factors You should carefully consider the risks described below and other information contained in
this annual report before making an investment decision. The risks and uncertainties described
below are not the only ones we face. Additional risks and uncertainties not presently known to us,
or that we currently deem immaterial, may also impair our business operations. We cannot assure you
that any of the events discussed in the risk factors below will not occur. If they do, our
business, financial condition or results of operations could be
materially adversely affected. Risks Relating to Our Business and Operations We have substantially less financial and human resources to apply to the development of our
business than some of our main competitors. The telecommunications and pay-TV markets in Hong Kong are highly competitive. Our main
competitors for Internet access, local telephony, pay-TV and international telecommunications
services are PCCW-HKT Telephone Limited, or PCCW-HKT, Hutchison Global Communications Limited, or
HGC, New World Telecom Company Limited, or New World, Wharf T&T Limited, or Wharf T&T, and i-Cable
Communications Limited, or i-Cable. PCCW-HKT (then Hong Kong Telephone Company Limited) held a
monopoly on local telephony services until 1995 when the Hong Kong government began to introduce
competition to this market. In addition, i-Cable (through its subsidiary Hong Kong Cable Television
Limited) was the first company to offer pay-TV services in Hong Kong beginning in 1993 and held an
effective monopoly until 2003 when we and PCCW-HKT (through its subsidiary PCCW-IMS Limited) began
to offer pay-TV services. As a result of their longer operating histories, and because some of our competitors are
subsidiaries of large business conglomerates, they may have advantages over us in the provision of
telecommunications services, including:  
    greater financial, technical, marketing and other resources;
    greater existing infrastructure;
    greater name recognition; and
    larger customer bases. In addition, certain areas of the fixed telecommunications network services business are very
capital intensive. Our competitors may be able to devote more human and financial resources to
research and development, network improvement and marketing than we can. Since our inception, the
growth of our market share has depended primarily on our ability to react more quickly to changes
in new technology and consumer trends, offer more competitively priced services, and provide better
customer support than our competitors. We cannot assure you that we will continue to be successful
at executing this strategy. If these competitors devote substantial human and financial resources
to their businesses, it could hurt our ability to remain competitive in the quality and range of
services we could provide and we could lose customers to these competitors. This may limit the
growth of our customer base, reduce our revenues and adversely affect our profits. Our growth and profitability could be affected by an increasing number of local and foreign
entrants in the international and local telecommunications and Internet access markets. The Hong Kong government has adopted policies and regulations over the past decade to
liberalize the telecommunications industry in Hong Kong, including issuing new wireless and
wire-line fixed telecommunications network services licenses, which we refer to as FTNS Licenses.
We expect the Hong Kong government to continue to take actions of these types over the next several
years. Further, in contrast to its previous requirements when issuing network licenses, new
licensees are no longer required 9




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##### Table of Contents



to give any commitment relating to network rollout or investment. There are currently eight other
fixed telecommunications network operators in Hong Kong in addition to ourselves who are licensed
to provide local wireline-based fixed line services. These operators are PCCW-HKT, HGC, New World,
Wharf T&T, Towngas Telecommunications Fixed Network Limited, CM Tel (HK) Limited, TraxComm Limited
and HKC Network Limited. In addition, as of November 3, 2004, 230 public non-exclusive
telecommunications service licenses, which we refer to as PNETS Licenses, for the provision of
external telecommunications service had been issued to various operators in Hong Kong. Some of
these licensees are subsidiaries of major foreign telecommunications providers. Increasing liberalization of the telecommunications market in Hong Kong may further attract
new local and foreign entrants to the market and broaden the variety of telecommunications services
supplied by existing service providers, thereby heightening the level of competition in the
industry. Increased competition could result in price reductions, reduced gross margins or loss of
market share, any of which could adversely affect our future growth and profitability. The markets in which we compete may become more competitive should there be significant mergers
and acquisitions in the Hong Kong telecommunications market. Some of our competitors with greater financial resources may attempt to grow their customer
base and product offerings through acquisitions. If these competitors make significant
acquisitions, they may have increased capacity and may be better positioned to increase their
market share by decreasing prices. Additionally, as a result of such acquisitions, these
competitors may be able to provide a broader array of services. If we are unable to grow our
business through our continued expansion or by pursuing our own acquisitions, we may have
difficulties competing successfully against these competitors. On January 20, 2005, PCCW Limited (PCCW) announced it had formed a strategic business
alliance with China Network Communications Group Corporation, or China Netcom, one of Chinas major
telecommunications companies. Under this alliance, China Netcom will pay approximately US$1.0
billion in cash for newly issued PCCW shares, resulting in its holding 20% of PCCWs share capital.
This transaction may have many affects on the telecommunications market in Hong Kong, which are
difficult to predict. In particular, it could result in increased competition for us and other Hong
Kong telecommunications companies if PCCW is able to combine its size and market position with the
increased capital provided by China Netcom to decrease prices. Furthermore, such a transaction
might allow PCCW to invest more capital and human resources in its other fixed telecommunications
network services that directly compete with our services. We experienced a decline in total revenues and profits in fiscal 2004 due to a decline in
revenues and profits from our international telecommunications services business. We cannot
assure you that we will be able to prevent total revenues and profits from continuing to
decline. In fiscal 2004, our total revenue dropped by 9.9% from HK$1,298.9 million in fiscal 2003 to
HK$1,169.9 million, due to a significant drop in revenue from our international telecommunications
services. In addition, our operating profits for this business declined by 52.3% from HK$338.9
million in fiscal 2003 to HK$161.5 million in fiscal 2004. Though our international call traffic
increased in terms of total number of minutes carried, this was offset by the drop in average
tariff rates resulting in a decrease in revenue and operating profits. With the drop in average
tariff rates, we expect that the profit margins in the international telecommunications services
will continue to be under pressure. To maintain our market share, we must continue to offer our
subscribers international telecommunications services that are competitive with the prices offered
by other market players. We therefore must continue to lower our costs of providing these services
if we are to maintain our profitability in this business. We cannot be sure that we will be able to
reduce our operating costs and if we fail to do so, our profits may be adversely affected. We
cannot assure you that we will be able to prevent our total revenues and profits from continuing to
decline. 10




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We rely on third parties to deliver a significant portion of our international
telecommunications traffic and fixed telecommunications network services. Our transmission costs
could increase as a result of changes in our relationships with them. Where we do not currently have our own infrastructure in place, we depend on our contractual
relationships with, and the network infrastructure of, other local network operators and overseas
telecommunications carriers in providing international telecommunications and fixed
telecommunications network services to our customers. Some of these third parties are our
competitors in our international telecommunications or fixed telecommunications network services,
or both. In fiscal 2004, payments to our top five overseas carriers and local network operators
accounted for approximately 21% of our total gross operating costs. The terms and conditions of
these local and international arrangements could be subject to changes or modification upon renewal
of the relevant agreements. If the terms and conditions upon renewal are less favorable or the
arrangements are not renewed, the costs associated with providing our services in locations where
our own infrastructure is not in place could increase significantly. The development of our Metro Ethernet network requires significant capital expenditures. These
capital expenditures may vary materially from those currently planned and may impose a burden on
our financing and operating activities. Our business is capital intensive, and our capital expenditures may not have the positive
effect on our business and revenues that we expect. We have made, and will continue to make,
capital investments in the expansion and upgrade of our Metro Ethernet network and the development
of our telecommunications services. We incurred capital expenditures of approximately HK$392.9
million in fiscal 2004 on our Metro Ethernet infrastructure. We expect to incur total capital
expenditures of approximately HK$990.0 million in fiscal 2005 and fiscal 2006, the large majority
of which will be spent on the continued expansion and upgrade of our Metro Ethernet network. While we intend to fund such expenditures by using our currently available cash as well as
cashflow from operations and the net proceeds from our January 2005 offering of 8.75% senior notes
due 2015, which we refer to in this annual report as the 8.75% notes, we may not have adequate capital to
fund these expenditures. In addition, if we spend our existing capital faster than anticipated or
our capital requirements vary materially from those currently planned, we may require additional
financing sooner than we anticipate, in which case we may need to seek to raise additional capital
through debt or equity financing or other means. Any such additional debt or equity financing may
not be available, and debt financing, if available, may involve restrictions on our financing and
operating activities. If we are unable to obtain additional financing as needed, we may be required
to reduce the scope of our operations or anticipated expansion and business development. We may not realize the benefits we expect from our investments, which may adversely impact our
business. We have made significant investments in our network infrastructure to provide the services we
offer. The launch of new and commercially viable products and services is important to the success
of our business. Commercial acceptance by consumers of the new services we offer may not occur at
the rate or level expected, and we may not be able to successfully adapt the new services
effectively and economically to meet consumers demand, which would limit the return from our
investments. We cannot assure you that services enabled by upgrading and expanding our Metro
Ethernet network will be accepted by the public to the extent required to generate an acceptable
rate of return. In addition, we face the risk of unforeseen complications in the deployment of
these new services, and we cannot assure you that our estimate of the necessary capital expenditure
to offer such services will not be exceeded. For example, the useful life of the equipment that we
employ in buildings and for our fiber-based backbone may be shorter than expected requiring further
capital expenditures. We may be unable to develop and/or deploy new services according to expected
schedules, and these services may not achieve commercial acceptance or be cost effective. The
failure of any of our services to achieve commercial acceptance could result in additional capital
expenditures or a reduction in profitability to the extent that we are required 11




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under the applicable accounting standards to recognize a charge for the impairment of assets. Any such
charge could materially and adversely affect our financial condition and the results of our
operations. Because most of the services we provide through our Metro Ethernet network are still at an early
stage of implementation, evaluation of our business and our prospects is difficult. Because of the short operating history of most of our fixed telecommunications network
services, our historical financial data may not provide a meaningful basis for you to evaluate us
and our prospects. These services are still at an early stage of implementation, and the revenue,
potential income and cash flows from these new businesses are unproven. Accordingly, evaluation of
our businesses and our prospects is difficult, and we cannot give you any assurance that we will
succeed in these businesses. We are involved in several legal proceedings that, if decided unfavorably to us, could adversely
affect our profitability. We are currently involved in several legal proceedings in Hong Kong. If these proceedings are
resolved in a manner adverse to us, our business and profitability may be harmed. The most
significant proceedings are:  
    A case brought in July 1998 in which PCCW-HKT (then Cable & Wireless HKT) alleges that
certain of our business practices breached our agreements with PCCW-HKT and unlawfully
interfered with their telecommunications business.
    A case brought in April 1999 in which the plaintiff alleges that one of our wholly owned
subsidiaries wrongfully terminated a telecommunications service agreement between them
leaving unpaid obligations to the plaintiff of approximately US$3.6 million.
    A judicial review proceeding brought in October 2004 in which PCCW-HKT and PCCW-IMS
requested judicial review of the Telecommunications Authoritys decision concerning the
right of network operators to provide off-network local voice-over-Internet-Protocol, or
VOIP services, which is described in more detail below. In each of the proceedings mentioned above, we are vigorously defending against the claims.
However, we cannot predict the way that an arbitrator or a court of law will view the facts in
dispute nor can we predict how any such arbitrator or court would interpret substantive points of
law; therefore, we cannot predict the outcome of these proceedings. PCCW-HKT and PCCW-IMS have brought legal proceedings against the Telecommunications Authority
that, if decided unfavorably against the Telecommunications Authority, could adversely affect
our ability to provide local VOIP services accessible over the broadband connections provided by
other operators. On October 11, 2004 PCCW-HKT and PCCW-IMS applied to Hong Kongs High Court to commence
judicial review proceedings against the Telecommunications Authority in which our wholly owned
subsidiary Hong Kong Broadband Network Limited, or HKBN, was initially joined as an interested
party. PCCW-HKT and PCCW-IMS seek judicial review of the Telecommunications Authoritys decision
dated September 22, 2004 in which the Telecommunications Authority found no evidence to suggest
that HKBN is acting outside the scope of its FTNS License in providing local VOIP services
accessible over the broadband connections provided by other operators, or off-network local VOIP.
We began offering off-network local VOIP services in August 2004. PCCW-HKT and PCCW-IMS seek to
have the Telecommunications Authoritys decision overturned and had requested the court to grant
interim orders against both the Telecommunications Authority and HKBN to prohibit HKBN from
providing off-network local VOIP services. In November 2004, PCCW-HKT and PCCW-IMS withdrew their
request for interim orders, but amended its original application to include HKBN as a second
respondent. The proceedings of the judicial review will continue and the hearing is set for
November 28, 2005. 12




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##### Table of Contents



We are a party to the judicial review proceedings and are vigorously participating in the
defense against these allegations. However, we cannot predict the outcome of the judicial review
and if PCCW-HKT and PCCW-IMS are successful, we may be forced to discontinue providing off-network
local VOIP services. Such an outcome will not affect our ability to offer local VOIP services
within our own Metro Ethernet network, but would negatively affect our off-network local VOIP
business and would likely limit our ability to add new off-network local VOIP subscribers. We are in the process of instituting changes to our internal controls and management systems in
order to satisfy the requirements of Section 404 of the Sarbanes Oxley Act of 2002. Our failure
to timely and successfully institute these changes and to maintain the adequacy of our internal
controls could subject us to regulatory actions and may adversely affect our stock price and our
ability to raise additional capital. We are in the process of instituting changes to our internal controls and management systems
to satisfy the requirements of Section 404 of the Sarbanes Oxley Act of 2002, which will require us
to perform an evaluation of our internal controls over financial reporting and beginning with our
Form 20-F for the fiscal year ending August 31, 2005, file annual management assessments of their
effectiveness with the SEC that include a certification of our internal controls by our chairman
and director of finance and a counter-certification by our independent accountants. In order for us to meet these requirements, we will need to design procedures to document
various controls and relevant testing procedures under requirements stipulated by the Public
Company Accounting Oversight Board in the United States. We have assigned an internal audit manager to oversee this compliance process, who reports to
both our audit committee and senior management on a periodic basis. In addition, we have hired
external consultants to perform a high-level internal control gap analysis, but we have not
retained the continuous services of these consultants in the later phases of this compliance
process. For fiscal 2005, our independent accountants will be required to attest to our evaluation of
internal controls over financial reporting. Unless we successfully design and implement changes to
our internal controls and management systems, or if we fail to maintain the adequacy of these
controls as such standards are modified or amended from time to time, we may not be able to comply
with Section 404 of the Sarbanes Oxley Act of 2002. As a result, our independent accountants will
be unable to certify our managements assertion of the effectiveness of our internal controls. This
could subject us to regulatory scrutiny and result in a loss of public confidence in our
management, which could, among other things, adversely affect our stock price and our ability to
raise additional capital. We have recognized revenues for mobile interconnection charges that have not yet been paid to
us. We may be forced to reverse or modify our recognition of these revenues if the
Telecommunications Authority determines that the level of mobile interconnection charges that
mobile operators are required to pay us are not at the level that we have calculated. We are currently in dispute with various mobile telecommunications operators as to the level
and effective date of interconnection charges payable to us for direct interconnection between
their mobile networks and our Metro Ethernet network. The Telecommunications Authority has
confirmed that mobile operators are required to pay interconnection charges to fixed network
operators, including us, but most of the mobile operators have not paid any mobile interconnection
charges to us since we began offering fixed telecommunications network services to them. In fiscal 2003 and fiscal 2004, we recognized revenue in the amount of HK$6.1 million and
HK$38.7 million, respectively, for interconnection charges receivable from mobile operators for the
use of our Metro Ethernet network. We determined the amount of these charges based on the fully
distributed cost model determined by the Telecommunications Authority to be applicable in
determining the interconnection charges between fixed and mobile operators, which relies on the
historical levels of 13




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##### Table of Contents



mobile interconnection charges paid by mobile operators to PCCW-HKT. In August
2004, the Telecommunications Authority agreed to determine the level of interconnection charges payable
to us by one of the mobile operators, but we cannot predict the outcome of the Telecommunications
Authoritys determination. If the level of interconnection charges determined by the
Telecommunications Authority to be payable to us is lower than the revenues that we have
recognized, we will be required to write-back the difference from our revenue during fiscal 2005.
This could negatively affect our operating results for fiscal 2005. Our fixed telecommunications network business has incurred losses since inception and we expect
it to incur future losses. For fiscal 2002, 2003 and 2004, we incurred operating losses of approximately HK$121.7
million, HK$62.7 million and HK$109.7 million, respectively, from our fixed telecommunications
network service operations. We expect our fixed telecommunications network service business will
continue to incur net losses as we expend substantial resources on developing and marketing
broadband Internet access, local VOIP, IP-TV and corporate data services. We cannot assure you that
we will achieve and sustain profitability in our fixed telecommunications network operations. Our IP-TV services may not become profitable and may adversely affect our operating results. We began to produce, market and offer IP-TV services via our Metro Ethernet network in August
2003. Our IP-TV service currently consists of a 24-hour news channel and other education and
recreation channels (including childrens programming) that we produce, and channels whose content
we purchase from other content-providers. As we are still at an early stage of development, the
business model, marketing plans, strategy, and the content we will provide are still evolving. As a
result, we cannot provide any assurance that we will be able to successfully build market share in
the pay-TV business or that such business will become profitable. Further, the money that we invest
in providing such service could have an adverse effect on our operating results and profitability. Our programming costs may increase in the future, which could reduce our margins if we are
unable to pass that increase on to our IP-TV subscribers. Revenue growth for our IP-TV services depend on our ability to produce or obtain programming
that is both affordable and appealing to our subscribers. We produce or supplement a small amount
of the programming on our channels and obtain programming from third parties for the remainder. The
cost of some of our purchased programming may increase in the future as competition in the pay-TV
and television services market intensifies. Such increases could potentially affect our subscriber
growth more than the dominant provider as our sales efforts are focused on our offering a
lower-priced pay-TV service than our existing competitors. Our inability to pass on programming
cost increases to our subscribers could reduce our revenues, cash flow and operating margins.
Additionally, if we are unable to purchase programming that appeals to our targeted customer base,
we may not be able to add new subscribers or increase our market share. Our growth and expansion may strain our ability to manage our operations, increase our costs of
operation and adversely affect the quality of our services. We have pursued and continue to pursue a strategy of aggressive growth in our fixed
telecommunications network services business. As part of this strategy, we continue to expand and
invest in the Metro Ethernet network infrastructure we use to deliver broadband Internet access,
local VOIP, IP-TV and corporate data services. The deployment of these projects has resulted and
will result in significant demands on our systems and controls and may place a strain on our
administrative, operational and financial resources. Our ability to manage future growth will
depend upon our ability to continue to:  
    manage the simultaneous implementation of our infrastructure development and marketing
plans; 14




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
    cope with both predictable and unforeseen problems associated with being a relatively
new entrant in rapidly evolving industries;
    effectively monitor our operations so as to control costs and maintain effective quality
controls; and
    offer competitive prices to customers. Our failure to achieve any of the above in an efficient manner and at a pace consistent with
the growth of our fixed telecommunications network services business could have an adverse effect
on the quality of our services and increase our costs of operation. The Office of the Telecommunications Authority has made changes to the manner in which it
regulates PCCW-HKTs tariffs for residential and business direct exchange line telephone
services, which may result in more competition in our markets. In 2003, PCCW-HKT applied twice to the Telecommunications Authority for a declaration of
non-dominance with respect to the markets for residential and business direct exchange line
telephone services. In response to these applications, the Office of the Telecommunications
Authority, or OFTA, issued a new fixed carrier license to PCCW-HKT on January 14, 2005. Under this
new license, PCCW-HKT is not required to obtain prior approval from the Telecommunications
Authority before adjusting its tariffs on residential and business direct exchange line telephone
services, including moves to offer discounts and other benefits in response to price competition.
We anticipate this development will increase pricing competition further in an already competitive
market. Such increased competition may adversely affect our revenues and profitability. We depend on certain key personnel, and our business and growth prospects may be disrupted by
the loss of their services. Our future success is dependent upon the continued service of our key executives and
employees. We also rely extensively on the services of our executive officers, including Wong Wai
Kay, Ricky, our chairman, and Cheung Chi Kin, Paul, our managing director. While we have employment
agreements with members of our senior management staff, we cannot assure you that we will be able
to retain these executives and employees. If one or more of our key personnel were unable or
unwilling to continue in their present positions, or if they joined a competitor or formed a
competing company, we may not be able to replace them easily, our business may be significantly
disrupted and our financial condition and results of operations may be materially and adversely
affected. Furthermore, since our industry is characterized by high demand and increased competition
for talent, we may need to offer higher compensation and other benefits in order to attract and
retain key personnel in the future. We cannot assure you that we will be able to attract and retain
the key personnel that we will need to achieve our business objectives. Universal Services Contributions are reviewed and adjusted periodically by the
Telecommunications Authority, which may result in our either receiving a refund from, or being
required to make whole any shortfall in payments to, PCCW-HKT. These adjustments may affect our
financial results. PCCW-HKT has a universal service obligation to provide basic telephone service to any
individual or entity that requests it. To compensate PCCW-HKT for the expenses of this obligation,
all incoming and outgoing international calls in Hong Kong are charged a per minute fee payable to
PCCW-HKT. The Telecommunications Authority periodically adjusts the amount of this fee, which is
commonly referred to as the USC. In the past we have received large USC refunds, but the amounts of
these refunds have declined in the past few years. We cannot predict whether we will continue to
receive refunds or whether the Telecommunications Authority may determine in the future that we
have underpaid the USC and require us to make whole the shortfall, if any, in payments to PCCW-HKT.
Such adjustments to the USC may affect our financial results. 15




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Expansion of our Metro Ethernet network into certain buildings and residences may be limited by
physical limitations or our ability to obtain access permits. Expanding our Metro Ethernet network coverage requires us to install fiber-to-the-building, as
well as install Cat-5e copper wiring within residential and commercial buildings to reach the
subscribers premises, which we refer to as in-building-wiring. PCCW-HKT has already installed
in-building-wiring in virtually all buildings, and we along with other fixed telecommunications
network service providers may encounter a bottleneck when installing our own in-building-wiring
because many buildings have limited physical space for additional in-building wiring. In addition,
owners of certain single-owner commercial buildings may grant rights of access to our competitors
while barring us from installing our own in-building-wiring. Furthermore, certain developers may
have affiliations with our competitors and may attempt to delay our wiring installations. These
constraints may hinder the expansion of our Metro Ethernet network and reduce our ability to add
new subscribers. Internet security concerns could limit our ability to develop revenues from Internet access
services. We intend to continue developing our broadband Internet access, local VOIP, IP-TV and
corporate data services. Computer viruses, break-ins and other inappropriate or unauthorized uses
of our Metro Ethernet network could affect the provision of our full suite of Internet Protocol, or
IP, services. Computer viruses, break-ins or other problems could have the following effects on our
fixed telecommunications network services business:  
    it could result in interruption, delays or cessation in services to our customers;
    it could jeopardize the security of confidential information stored in the computer
system of our customers; and
    it could result in costly litigation. We may incur significant costs to protect us against the threat of security breaches or to
alleviate problems caused by such breaches. In addition, alleviating these problems may cause
interruptions, delays or cessation in service to our users, which could cause them to stop using
our service or assert claims against us. Other fixed telecommunications network operators may be able to limit the transmission of our
off-network local VOIP traffic carried over their broadband network, which may limit our ability
to offer this service. Our off-network local VOIP service is dependent on the broadband Internet connections provided
by other fixed telecommunications network operators. These operators may be able to limit the
transmission of our off-network local VOIP traffic carried over their broadband network, which may
limit our ability to offer this service. We may be liable for information disseminated over our Internet services network which could
increase our costs or cause us to discontinue certain services. We may be required to spend substantial resources or discontinue certain services, which could
have a material adverse effect on our business, operating results and financial condition, as a
result of liability under Hong Kong law for dissemination of information. Hong Kong law relating to
liability of Internet service providers for information carried on or disseminated through their
networks is new and untested. The imposition of potential liability upon Internet service
providers, such as liability for defamatory speech or copyright infringement, for materials carried
on or disseminated over a network may cause us to adopt measures that may reduce our exposure to
such liability. 16




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Illegal viewing activities may affect our IP-TV subscriber growth and subscription revenue. Our IP-TV business is dependent upon subscription revenue. We are aware that some viewers in
Hong Kong use unauthorized pay-TV decoders to receive pay-TV service illegally. Manufacturers or
vendors of unauthorized pay-TV decoders may overcome our digital encryption methods and if we fail
to deploy appropriate and timely countermeasures in response to such activities, illegal viewing
activities may occur. Such illegal viewing activities will adversely affect the growth of our IP-TV
subscriber base and our subscription revenue. We face risks associated with potential acquisitions, investments, strategic partnerships or
other ventures, including whether we can identify opportunities, complete the transactions and
integrate the other parties into our business. From time to time we have had discussions with companies regarding our acquiring, investing in
or partnering with their businesses, products, services or technologies, and we regularly engage in
such discussions in the ordinary course of our business. We may not be able to identify suitable
acquisition, investment or strategic partnership candidates, which may place us at a disadvantage
if our competitors are able to grow their market share through acquisitions. If we do identify
suitable candidates, we may not be able to complete those transactions on commercially acceptable
terms or at all. If we acquire another company, we could have difficulty in integrating that
companys personnel, products, operations and technology. In addition, the key personnel of the
acquired company may decide not to work for us. These difficulties could disrupt our ongoing
business, distract our management and employees and increase our expenses. Risks Relating to Our Technological Infrastructure Slow system performance over our wireless and leased wireline connections could cause us to lose
Internet customers to our competitors. Our systems performance may slow down at certain peak times, especially with respect to the
transmission of multimedia content over our wireless and leased wireline connections. Our ability
to increase our handling capacity, and increase the networks performance, will depend upon:  
    the successful build out of our own fiber-based backbone, and
    our ability to secure leased lines from other network operators where we do not have our
own infrastructure in place. We cannot be sure that we will be able to replace our wireless and leased wireline connections
with our fiber-based backbone and increase the performance of our Internet access system. If we do
not, our customers may subscribe to other Internet access services provided by our competitors. We will be limited in our ability to continue to expand our international telecommunications
business unless we obtain additional network capacity. Our international telecommunications network has limited capacity. Our ability to continue to
increase traffic volume depends on our ability to expand the network on a timely basis and add new
subscriptions, which in turn is subject to:  
    the expansion and development of our own international telecommunications facilities;
    the availability of leased lines from third party carriers at favorable rates; and
    the possible termination or cancellation of our existing contracts. 17




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If we fail to increase the capacity of our international telecommunications network, our
ability to increase our telecommunications minutes, market share and revenues will be limited. If we are unable to stay ahead of technology trends and evolving industry standards, our
services may become obsolete. Telecommunications businesses are characterized by rapidly changing technology and industry
standards, evolving subscriber needs and the introduction of new services. The continuously
changing nature of these services, and their increasingly shorter life cycles require us to
continually improve our performance, services and network in order to compete successfully with the
services offered by our competitors. Further, new technology or trends in the telecommunications
industry could have an adverse effect on the services we currently offer. For example, the
replacement of traditional fixed line home telephones with mobile telephones and/or VOIP services
may lead to a decline in our International telecommunications services revenues. Changing our
services in response to market demand may require the adoption of new technologies that could
render many of the technologies that we are currently implementing less competitive or obsolete. In
addition, our new products and services may contain design flaws or other defects that could have a
material adverse effect on our business, operating results or financial condition. To respond
successfully to technological advances and emerging industry standards, we may require substantial
capital expenditure and access to related or enabling technologies in order to integrate the new
technology with our existing technology. We may not be successful in modifying our network
infrastructure in a timely and cost-effective manner in response to these changes, which will
affect our ability to continue to offer the products and services demanded by our customers. We are vulnerable to natural disasters, and other disruptive regional events, which could cause
damage to our network and result in lost revenue and perhaps lost customers. Our network is vulnerable to damage or cessation of operations from fire, earthquakes, severe
storms, power loss, telecommunications failures, network software flaws, vandalism, transmission
cable cuts and other catastrophic events. We may experience failures or shutdowns relating to
individual points of presence or even catastrophic failure of our entire network. Any failure of
our network, our servers, or any link in the delivery chain, whether from operational disruption,
natural disaster or otherwise, resulting in an interruption in our operations, could have a
material adverse effect on our business, financial condition and results of operations. The loss of key suppliers or their failure to deliver equipment on a timely basis could
negatively impact our business prospects. We rely on Cisco Systems, Inc. and other suppliers to provide equipment, underground cables
and other key components in building our Metro Ethernet network infrastructure, and on Nortel
Networks Limited for VOIP equipment. In order for new subscribers to be able to access our IP-TV
services, we must install an IP set-top-box in their homes. We must have an adequate supply of such
equipment on hand to respond to new customer subscriptions in a timely manner. We purchase all of
our IP set-top boxes and other equipment from our suppliers on a purchase order basis and have no
long-term contracts. If our suppliers are unable to supply us with these products in a timely
manner or the costs of these products increase due to unforeseen causes, this could negatively
impact our operating results, especially if we are unable to add new subscribers or pass these
costs on to our customers. In addition, if Cisco Systems, Inc. is unable or is delayed in providing
us with the hardware required for building our fiber-based backbone infrastructure, this could
negatively impact our operating results. Our reliance on third parties to provide maintenance and repairs for our Metro Ethernet network
could adversely affect our operating results if their services are not timely or do not meet our
standards. We depend on Cisco Systems, Inc. and other third parties for ongoing support and assistance
with respect to maintenance and repairs. We are also dependent on certain Hong Kong rail transport
providers to maintain and provide us with access to their infrastructure to support the proper
functioning of our 18




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equipment and fiber-based backbone. If these third parties fail to provide us the equipment we
require, or fail to respond or are untimely in their response to our maintenance and repair needs,
our customers may experience interruptions or variations in the quality of our fixed
telecommunications network services, which may adversely affect our operating results and our
ability to retain or add new customers. Environmental factors in Hong Kong could impact our delivery of fixed telecommunications network
services using wireless technology and increase our operating
costs. Wireless transmission of information is subject to environmental influences, which could
impact our delivery of fixed telecommunications network services using this technology. In
particular:  
    Wireless technology requires an unobstructed line of sight between two linked antennas.
Hong Kong is characterized by large variations in elevation and numerous tall buildings.
    Weather conditions, such as heavy rainfall, can adversely impact the transmission
quality of wireless signals and necessitate shorter distances between antennas to maintain
desired transmission quality. Hong Kongs weather patterns often result in heavy rainfall
during certain periods of the year. Each of these factors may cause us to either accelerate our plans to install self-owned
fiber-based backbone or lease capacity on the wireline-based backbone of other fixed network
operators, which may increase our operating costs. Risks Relating to the Regulatory, Political and Economic Environment Regulatory reforms and currently contemplated regulatory initiatives in the telecommunications
industry may adversely affect us. The Hong Kong telecommunications industry is undergoing continuous regulatory reform. In July
2003, the Hong Kong government enacted the Telecommunications (Amendment) Ordinance 2003, or the
2003 Ordinance, which specifically regulates merger and acquisition activities in the Hong Kong
telecommunications industry. The 2003 Ordinance gives the Telecommunications Authority the power to
review mergers and acquisitions concerning carrier licensees and to take appropriate actions when
it determines that the transaction would substantially lessen market competition without any
outweighing public benefits. The Telecommunications Authority also has the right to impose
conditions upon or oppose mergers and acquisitions, which may have an adverse effect on our ability
to grow our business through mergers and acquisitions. On October 4, 2004, the Telecommunications Authority issued a consultation paper requesting
commentary from market participants regarding regulation of Internet Protocol telephony services.
The Telecommunications Authority seeks to determine whether the existing regulatory framework,
which was primarily designed to govern traditional fixed line telephony services, is applicable to
VOIP telephony services. Some of the regulatory issues being addressed include creating a licensing
framework, conformance to the existing system of assigning telephone numbers, imposition of
interconnection charges and establishing guidelines with respect to the quality of services. As we
currently offer local VOIP services, the Telecommunications Authoritys final determination may
subject us to further regulations that affect our operations. Our revenues may be adversely affected by regulatory and commercial increases in tariffs
mandated by the Chinese government and other international carriers. Chinas Ministry of Information Industry, or the MII, and the State Development Planning
Commission jointly set tariffs for all domestic and international long distance services in China
using public switched telephone networks, leased lines and data services. Certain tariffs payable
by us to our carrier partners are based, among other things, on the tariffs determined by these
agencies with respect to the calls our subscribers make to persons in China. In November 2002, our
carrier partners in China 19




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increased the termination rates payable by us to them for international long distance
telephone calls into China due to the imposition by the MII of these rate increases. To cover the
increased cost for terminating traffic in China, we increased the rates we charged our customers
for calls into China, which represented 65% of our international traffic for fiscal 2003. This rate
increase led to an immediate drop of traffic into China. Further, our market share was adversely
affected, as one of our competitors did not increase the rates it charged its customers for calls
into China as a result of the increased tariff. While our carrier partners subsequently reversed this increase in termination rates in 2003,
the MII may impose changes to termination rates and related tariffs in the future, which we would
expect to affect the rates we charge our customers for calls into China. In addition, following the
termination rate increase imposed by Chinas MII, Philippines-based carriers raised their inbound
termination rates and some European mobile carriers have also made such increases in recent years.
Other international carriers may follow these examples. We cannot predict the timing, likelihood or
magnitude of any future tariff adjustment; nor can we predict the extent or potential impact upon
our business of any such future tariff increases. Such increases may lead to a decrease in traffic,
reduce our revenues and adversely affect our business and results of operations. In addition, if we
are unable to pass the increased cost of services onto our customers, it would have an adverse
effect on our profit margins for international telecommunications services. The Communications and Technology Branch has issued a letter stating that we are exempt from
obtaining a broadcasting license to provide our IP-TV services. However, should we be required
to obtain a broadcasting license for our IP-TV services and we are unable to do so, we may be
forced to terminate our IP-TV service. Unlike our competitors, who hold domestic pay-television program service licenses, we provide
our IP-TV services over our Metro Ethernet network under HKBNs FTNS License. The Hong Kong
government has indicated that because our IP-TV services are carried over the Internet, we are
exempt under the Broadcasting Ordinance from the requirement to obtain a domestic pay-television
program service license. However, the governments Communications and Technology Branch has
informed us that the government is considering a review of the broadcasting regulatory regime and
may introduce changes to the existing regulatory framework, including the existing exemption in the
Broadcasting Ordinance. Therefore, we cannot predict whether the government may require us to
obtain a pay-television program service license in the future. If such license requires us to pay
significant fees or imposes restrictions on our current operations, the revenues from our IP-TV
business may be adversely affected or, if we are unable to obtain a pay-television program service
license, we may be forced to terminate our IP-TV services. We require licenses from the Telecommunications Authority to provide our services. If one of
these licenses is revoked or not renewed, we would be unable to deliver the services authorized
by that license. We require licenses from the Telecommunications Authority to provide our international
telecommunications and fixed telecommunications network services. Our PNETS License is subject to
the Telecommunications Authoritys annual renewal and HKBNs FTNS License is initially granted for
a term of 15 years, which may be renewed for such further period not exceeding 15 years at the
discretion of the Telecommunications Authority. The Telecommunications Authoritys failure to renew
or its revocation of any of these licenses for any reason would prohibit us from continuing to
offer the services authorized by that license, which would have a significant adverse impact on our
revenues and profitability. In addition, future changes in Hong Kongs telecommunications
regulations or policies could have an adverse impact on our operations. There may be political risks associated with doing business in Hong Kong. A significant part of our facilities and operations are currently located in Hong Kong. Hong
Kong is a Special Administrative Region of the Peoples Republic of China, with its own executive,
judicial and legislative branches. Hong Kong enjoys a high degree of autonomy from China under the
principle of 20




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one country, two systems; however, we can give no assurance that Hong Kong will continue to
enjoy the same level of autonomy from China. Any intervention by the government of China in the
affairs of Hong Kong, in breach of the one country, two systems principle, may adversely affect
our revenues and our share prices. We have more than 50% of our staff located in Guangzhou, China and changes in Chinese labor or
business laws may significantly affect our operations and our ability to service our Hong Kong
based customers. Our call center in Guangzhou employs over 1,900 persons and is an important resource for us.
We are therefore subject, to a significant degree, to the laws and regulations that govern foreign
companies with operations in China. The Chinese legal system is based on written statutes. Prior
court decisions may be noted for reference but have limited precedential value. Since 1979, the
Chinese government has promulgated laws and regulations dealing with economic matters such as
foreign investment, corporate organization and governance, labor, commerce, taxation and trade.
However, because these laws and regulations are relatively new and because of the limited volume of
published cases and their non-binding nature, interpretation and enforcement of these laws and
regulations involve significant uncertainty. In addition, as the Chinese legal system develops,
changes in such laws and regulations, their interpretation or their enforcement may lead to
additional restrictions on our business. You may have difficulty enforcing judgments against us or our management. City Telecom is incorporated in Hong Kong. All of our directors and executive officers and
some of the experts named in this annual report live outside the United States, principally in Hong
Kong. Also, all or most of City Telecoms assets are located outside the United States. As a
result, you may not be able to:  
    effect service of process upon these persons within the United States, or
    enforce, against us or these persons within the United States, court judgments obtained
in United States courts, including judgments relating to the federal securities laws of the
United States. There is also doubt as to whether courts in Hong Kong will enforce judgments of United States
courts based only upon the civil liability provisions of the federal securities laws of the United
States, or the securities laws of any state of the United States. The state of Hong Kongs economy may affect our profitability. As we are principally engaged in the provision of broadband Internet access, local VOIP,
IP-TV, corporate data and international telecommunications services in Hong Kong, our financial
position and the results of our operations will be affected by the conditions of the
telecommunications, Internet access and pay-TV markets in Hong Kong, which may in turn be
influenced by the general state of the Hong Kong economy, changes in the Hong Kong regulatory
environment, and changes in demand and usage habits of Hong Kong consumers. We have limited control
over any of these factors. The Hong Kong economy has experienced considerable volatility during the
late 1990s and from 2000 to 2003, and there can be no assurance that it will not continue to do so
in the future. This could adversely affect our business operations. Fluctuations of the Hong Kong dollar may increase our operating costs. A major portion of our operating costs is interconnection charges paid to overseas carriers
for the delivery of our international calls. Substantially all of these interconnection charges are
denominated in U.S. dollars or other currencies other than Hong Kong dollars. In addition, the
equipment and hardware we purchase for the expansion of our Metro Ethernet network constitutes a
large portion of our capital expenditure and is also denominated in U.S. dollars. Finally, payment
of interest, principal and any other amounts due under the 8.75% notes issued in January 2005 will
be made in U.S. dollars. However, our revenues are denominated exclusively in Hong Kong dollars.
Any depreciation of the Hong Kong dollar, 21




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against the U.S. dollar or other currencies, would increase our operating costs, including our
debt servicing costs, make our capital expenditure plans more expensive, and adversely affect our
profitability. In addition, the expenses that we incur in relation to our call center located in Guangzhou,
China are denominated exclusively in Renminbi, the official currency of the Peoples Republic of
China. These include the salaries that we pay to our personnel as well as various operating
expenses that we incur to maintain our operations. As a result, we are exposed to a certain amount
of foreign exchange risk based on fluctuations between the Hong Kong dollar and the Renminbi. If
the Renminbi appreciates against the Hong Kong dollar, the amount of Hong Kong dollars we would be
required to spend to maintain our call center would increase. Fluctuations of the Hong Kong Dollar could adversely affect the value of the American depositary
shares. Our outstanding shares are listed on The Stock Exchange of Hong Kong (the SEHK), on which
shares are quoted and traded in Hong Kong dollars. Cash dividends, if any, in respect of the
shares represented by the American depositary shares will be paid to the depositary in Hong Kong
dollars and then converted by the depositary into U.S. dollars, subject to certain conditions. Any
depreciation of the Hong Kong dollar against the U.S. dollar would, among other things, adversely
affect (i) the amounts a registered holder or beneficial owner of American depositary shares will
receive from the depositary in respect of dividends, (ii) the U.S. dollar value of the proceeds
which a holder would receive upon sale of the shares in Hong Kong and (iii) the secondary market
price of the American depositary shares. Risks Relating to our Securities Our Share Price has been and may continue to be volatile. The trading price of our shares has been, and is likely to continue to be, extremely volatile.
Since our offering of our American depositary shares on November 4, 1999, the closing price of our
ordinary shares on the SEHK has ranged from HK$0.420 to HK$8.950. Our share price and the price of
our American depositary shares could be subject to wide fluctuations in response to a variety of
factors, including, among others:  
    actual or anticipated variations in our operating results;
    announcements of new services or pricing options by us or our competitors;
    changes in financial estimates by securities analysts;
    conditions or trends in the Internet and telecommunications industries;
    changes in the market valuations of companies that provide Internet and
telecommunications services; and
    rumors of and announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments. As of February 4, 2005, we had 614,073,404 shares issued and outstanding. All of the
outstanding shares are freely tradable in our primary trading market, the SEHK, and can be traded
in the United States in the form of American depositary shares in compliance with the holding
period, volume, and manner of sale restrictions under Rule 144 under the Securities Act of 1933, as
amended (if applicable). It is possible that we may issue additional shares in connection with our
financing activities, acquisition activities or otherwise. Any shares that we issue will be freely
tradable on the SEHK, and, depending on the circumstances of their issuance, may also be freely
tradable in the U.S. public market. 22




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Risks Related to our Indebtedness In January 2005, we issued 8.75% notes that contain covenants limiting our financial and
operating flexibility. Covenants under the 8.75% notes that we issued in January 2005 restrict our ability to,
among other things:  
    pay dividends, make distributions, redeem capital stock and make certain other
restricted payments or investments;
    incur additional indebtedness or issue certain equity interests;
    merge, consolidate or sell all or substantially all of our assets;
    issue or sell capital stock of some of our subsidiaries;
    sell or exchange assets or enter into new businesses;
    create any restrictions on the payment of dividends, the making of distributions, the
making of loans and the transfer of assets;
    create liens on assets;
    enter into sale and lease back transactions; and
    enter into certain transactions with affiliates or related persons. All of these limitations are subject to exceptions and qualifications specified in the
indenture governing the 8.75% notes. These restrictive covenants could limit our ability to pursue our growth plan, restrict our
flexibility in planning for, or reacting to, changes in our business and industry and increase our
vulnerability to general adverse economic and industry conditions. We may enter into additional
Financing arrangements in the future, which could further restrict our flexibility. We will require a significant amount of cash to service our debt. Our ability to fund operating and capital expenditures and to service debt will depend
significant on our ability to generate cash from operations. We will need to continue generating
cash flows at or above current levels to meet our future debt service requirements. However, we
cannot assure you that we will be able to do so. Our ability to generate cash is subject to general economic, financial, competitive, industry,
legal and other factors and conditions, many of which are outside our control. In particular, our
operations are subject to price and demand volatility in the telecommunications industry. If we
cannot service our debt, we may be required to (among other things) reduce capital expenditures,
sell assets, or raise equity. We may not be successful in taking these actions, which could cause
us to default on our obligations. Further, our ability to take many of these steps may be subject
to approval by future creditors in addition to holders of the 8.75% notes. Our indebtedness could adversely affect our financial condition and prevent us from fulfilling
our obligations under the 8.75% notes. Upon
the issuance of the 8.75% notes, we incurred US$125.0 million amount of indebtedness. In
addition, the indenture governing the 8.75% notes does not prohibit us or our subsidiaries from incurring
substantially more debt, including secured credit facility debt and other debt as long as we meet
certain debt incurrence 23




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ratios (other than CTI Guangzhou Customer Services Co. Limited (CTI Guangzhou) and,
subsequently, any other future subsidiary prohibited by applicable law, regulation or order from
issuing a guarantee of the 8.75% notes, which are restricted from incurring certain indebtedness as
specified in the indenture governing the 8.75% notes). The 8.75% notes and guarantees are effectively
subordinated to all of our existing and future secured debt to the extent of the value of the
assets securing such indebtedness and are effectively subordinated to all existing and future debt
and other liabilities of non-guarantor subsidiaries, including trade payables. If new debt is added
to our consolidated debt level, the related risks that we now face could intensify. Covenants in the agreements governing debt we may incur in the future may materially restrict
our operations, including our ability to incur debt, pay dividends, make certain investments and
payments, and encumber or dispose of assets. In addition, financial covenants contained in
agreements relating to our future debt, including those under a credit agreement, could lead to a
default in the event our results of operations do not meet our plans. A default under one debt
instrument may also trigger cross-defaults under our other debt instruments. An event of default
under any debt instrument, if not cured or waived, could have a material adverse effect on us. Any
new debt that we incur in the future could have important consequences to holders of the 8.75% notes. For
example, it could:  
    make it more difficult for us to satisfy our obligations with respect to the 8.75% notes;
    increase our vulnerability to general adverse economic and industry conditions;
    limit our ability to fund future working capital, capital expenditures, research and
development and other general corporate requirements;
    require us to dedicate a substantial portion of our cash flows from operations to
service payments on our debt;
    limit our flexibility to react to changes in our business and the industry in which we operate;
    place us at a competitive disadvantage to any of our competitors that have less debt;
    require us to meet additional financial covenants; and
    limit, along with other restrictive covenants, among other things, our ability to borrow
additional funds. We cannot assure you that our business will generate cash in an amount sufficient to enable us
to service our debt, including the 8.75% notes, or to fund our other liquidity needs. In addition, we may
need to refinance all or a portion of our debt, including the 8.75% notes, on or before maturity. We
cannot assure you that we will be able to refinance any of our debt on commercially reasonable
terms or at all. We may not have the ability to raise the funds necessary to finance the change of control offer
required by the indenture governing the 8.75% notes. If we undergo a change of control, we must offer to buy back the 8.75% notes for a price equal to
101% of the principal amount of the 8.75% notes, plus accrued and unpaid interest, additional amounts, if
any, and registration default damages, if any. Any new financing arrangement that we may enter into
in the future may require repayment upon a change of control and further prohibit us from
repurchasing the 8.75% notes until we first repay the new debt in full. If a change of control occurs, we
cannot assure you that we will have sufficient funds to satisfy these other debt obligations and
repurchase the 8.75% notes. 24




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ITEM 4. INFORMATION ON
THE COMPANY History and Development of the Company City Telecom (H.K.) Ltd. was incorporated in Hong Kong on May 19, 1992 under the Companies
Ordinance (Chapter 32 of the laws of Hong Kong) (the Companies Ordinance). Our registered office
is located at
13th - 16th Floors, Trans Asia Centre, 18 Kin Hong Street, Kwai
Chung, Hong Kong, telephone (852) 3145-6888. Our agent for U.S. federal securities laws purposes
is CT Corporation System, 111 Eighth Avenue, New York, NY 10011. City Telecom provides international telecommunications and, through HKBN, international
telecommunications, Internet access, local telephony, pay-TV and other fixed telecommunications
network services in Hong Kong. We believe that one of the cornerstones of our success has been our
ability to quickly expand our service offerings when changes in regulation or technology have
provided us with an opportunity to do so. Some of the key events in our history and development
have been:  
    In November 2004, HKBN launched our BB100 Internet access service with symmetric 100
Mbps access for the residential mass market using self-owned fiber-to-the-building and
standard Cat-5e in building copper wiring.
    In August 2004, HKBN launched our off-network BB Phone services, which allows
subscribers to use our local VOIP services using the broadband network of other operators.
    In July 2004, HKBN launched our corporate data services.
    In August 2003, HKBN launched our IP-TV service, which delivers video content to a
television set via an IP set-top-box.
    In July 2003, we sold the entire issued share capital of City Telecom (Japan) Co., Ltd.
to Takua Corporation; City Telecom (Japan) Co., Ltd. (now known as City Call Co., Ltd.)
ceased to be related to our group of companies.
    In July 2002, we established a customer service call center in Guangzhou, China to
provide customer acquisition and back office customer support services.
    In June 2002, we launched a new access number 0030 for our international
telecommunications services, which offers international direct dialing at competitive
calling rates.
    In May 2002, we started operation of our APCN 2 and Japan-U.S. undersea cables for
international calls and broadband Internet access.
    In April 2002, HKBN was notified of our license upgrade from a wireless to a
wireline-based FTNS License and we began upgrading our backbone to a self-owned fiber-based
backbone. In that same month HKBN launched our fixed line on-network local VOIP services in
Hong Kong.
    In March 2002, the Telecommunications Authority granted us a cable-based external FTNS
License.
    In May 2001, the Telecommunications Authority granted us a satellite-based fixed
carrier license.
    In March 2000, HKBN launched our broadband Internet access services and wireless
network in Hong Kong.
    In February 2000, HKBN obtained a wireless FTNS License from the Telecommunications
Authority. 25




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
    In November 1999, we successfully completed a global offering of shares and listed our
American depositary shares on the Nasdaq Stock Market.
    In January 1999, we became the first Hong Kong company to obtain a PNETS License
covering the provision of international telecommunications services using international
simple resale and launched a new direct calling service for our international
telecommunications operations with the access number 1666, supported by the international
simple resale arrangement.
    In November 1998, OFTA announced that PCCW-HKT would lose its monopoly over voice
transmission using international simple resale effective in January 1999.
    In February 1998, PCCW-HKT lost its monopoly over facsimile transmission using
international simple resale. We launched our fax services using international simple resale
in the same month. We launched our first Internet related service, CTIm@il, which provides
email services, in March 1998. We launched our Internet business, named CTInets, in June
1998.
    In August 1997, we completed the initial public offering of our shares, which were
listed on the Stock Exchange of Hong Kong.
    In January 1997, we launched our fourth international telecommunications service, the
IDD 300 Calling Service. In March of that year, to target our prospective and existing
corporate subscribers, we established INC as a special business unit dedicated to providing
high-quality, competitively priced international telecommunications services to
corporations in Hong Kong. In June 1997, we obtained a PNETS License from the
Telecommunications Authority for the provision of virtual private network services,
catering to the needs of multinational corporations.
    In January 1994, we introduced a second international telecommunications service,
marketed under the name 003 International Guaranteed Fax Service, using the
store-and-forward transmission technology. In September 1994, we launched a third
international telecommunications service, called GlobaLink International Calling Card
Service.
    In May 1993, we obtained a PNETS License.
    In September 1992, we began to provide international telecommunications service using
the toll-free transit communication technology, later marketed under the name 888
International Calling Card Service. Business Overview We are a fast growing and innovative provider of residential and corporate fixed
telecommunications network and international telecommunications services in Hong Kong. Using our
self-owned Metro Ethernet network, we deliver fixed telecommunications network services to the
residential mass and small- to-medium enterprise market segments, at attractive prices while
simultaneously offering a bandwidth advantage over comparable offerings by our competitors. Our
integrated suite of services includes the following:  
    high-speed broadband Internet access services that provide our customers with symmetric
access speeds of up to 100 Mbps upstream and downstream;
    fixed line local telephony through our voice-over-Internet-Protocol technology;
    pay television, where we deliver more than 35 channels including self-produced news,
childrens programming and local interest programming using our IP platform; and
    corporate data services, which includes provision of dedicated bandwidth to corporate
customers. 26




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As of August 31, 2004 we had a total of approximately 465,000 fixed telecommunications network
services subscriptions, consisting of approximately 197,000 broadband Internet access, 237,000
local VOIP and 31,000 IP-TV services subscriptions, and as of December 15, 2004, we had a total of
approximately 490,000 subscriptions, consisting of approximately 201,000 broadband Internet access,
253,000 local VOIP and 36,000 IP-TV services subscriptions. In addition to providing fixed telecommunications network services, we believe that we are one
of the largest providers of international telecommunications services in Hong Kong. We offer a
variety of international telecommunications services and products including direct dial services,
international calling cards and mobile call forwarding services. Our total international
telecommunications services customer database comprises approximately 1.9 million registered
accounts with an average of 500,000 customers that are billed on a monthly basis. Our international
telecommunications business contributed approximately 50% to our gross profit in fiscal 2004,
providing us with a stable source of cash flow with minimal additional capital investment, which
complements our fast-growing fixed telecommunications network services business. Our self-owned network is one of the worlds largest Metro Ethernet networks and is cited as a
global reference case by our two primary vendors, Cisco Systems, Inc. and Nortel Networks Limited.
Our Metro Ethernet network conforms to industry standards for 10/100/1,000 Mbps Internet access
speeds, and covers 1.2 million home passes, which represents coverage of approximately 60% of Hong
Kongs population. The coverage of our network is concentrated in Hong Kongs most densely
populated areas and reaches approximately 3,000 residential buildings with an average of
approximately 400 residences per building, and approximately 610 commercial buildings, making us
one of the largest residential fixed telecommunications network operators in Hong Kong. In most other markets, Metro Ethernet technology is primarily used in commercial buildings in
metropolitan areas, as the technology is most cost effective in dense user populations where a
provider can service a large number of users in a single building or cluster of buildings. We have
deployed Metro Ethernet technology in densely populated residential areas in Hong Kong, where most
of our customers live in high-rise apartment buildings with multiple apartments on each floor. As a
result, we have contained the cost of deploying of our core network to approximately US$130 per
home pass. Our strategy is to sell multiple fixed telecommunications network services using our
Metro Ethernet network. All of our fixed telecommunications network services are offered through
our single IP platform, unlike our competitors who use multiple platforms to provide comparable
services. In addition, unlike most of our competitors, we operate an end-to-end network that
extends from our IP network hub sites and our switching centers in Hong Kong to our subscribers
premises. Hong Kong has one of the most developed telecommunications markets in the world with one of
the worlds highest penetration rates for local telephony and broadband Internet access services.
As of December 31, 2003, the penetration rates of residential fixed line local telephony and
residential broadband Internet access were 98% and 52% of Hong Kong households, respectively.
However, since 1995, when the Hong Kong government began to liberalize Hong Kongs
telecommunications industry, PCCW-HKT (the incumbent carrier and largest fixed telecommunications
network telecommunications operator in Hong Kong) began to lose its 100% market share and as of
September 30, 2004 retained a 69% market share with respect to fixed line local telephony services.
We believe this provides an opportunity for us to continue growing market share for our local VOIP
services. In contrast, Hong Kongs pay-TV penetration rate is low compared to other developed countries
in the region and globally. While i-Cable is the established incumbent and has been offering pay-TV
services since October 1993, it had penetrated only 31% of Hong Kongs households as of June 30,
2004. We believe that this and the fact that Hong Kong is primarily served by free-to-air
television stations will enable us to increase penetration of our IP-TV services. In addition,
Chinese-language programs broadcast by free-to-air television stations in Hong Kong attract over
85% of primetime viewership. We produce and obtain programming that targets Hong Kongs under
served largely Chinese-speaking mass market, which we believe differentiates us from our
competitors. We launched our IP-TV services in August 2003 27




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and the other competitors in the pay-TV market are also relative newcomers, with PCCW-HKT
launching its services in September 2003 and Galaxy Satellite Broadcasting Limited, the newest
entrant, launching its services in February 2004. Recent Development On January 20, 2005 we successfully completed a US$125 million offering of 8.75% notes in an
underwritten private placement transaction. Our net proceeds from the transaction were
approximately US$121.0 million after deduction of expenses and commissions. We used the net
proceeds, in part, to repay in full an existing loan facility in the outstanding amount of HK$196.7
million, and intend to use the remaining net proceeds for capital expenditures, including costs
incurred in expanding and upgrading its Metro Ethernet network in Hong Kong, and for additional
working capital and general corporate purposes. We intend to file a registration statement with the
U.S. Securities and Exchange Commission under which we will offer to exchange the 8.75% notes for
notes with identical terms that are freely tradeable. Competitive Strengths: We believe that our demonstrated success is primarily due to our ability to capitalize on the
following key strengths:  
    Focus on the Residential Mass and Small-To-Medium Enterprise Market Segments.We focus
on offering high-bandwidth services to the residential mass and small-to-medium enterprise
market segments, which we believe have significant growth potential. We price our services
attractively and at the same time offer bandwidth advantages over comparable service
offerings by our competitors. Our IP-TV services focus on the residential mass market by
providing Chinese-language content that targets the Chinese-speaking population of Hong
Kong, which we believe to be largely under served. Our focus on the residential mass and
small-to-medium enterprise market segments has enabled us to quickly grow our subscription
base and we believe this will help us to up-sell our services.
    Leading-Edge Metro Ethernet Network.Our network deploys Ethernet technology provided
by Cisco Systems, Inc. We believe our Metro Ethernet network gives us an inherent cost and
performance advantage over our competitors. Our IP platform is highly scalable, enabling us
to offer broadband Internet access, local VOIP, IP-TV and corporate data services over a
single network while still leaving us with capacity to offer more services in the future.
It is also capable of providing symmetric 1,000 Mbps broadband Internet access services.
Our recent BB100 100 Mbps broadband service launch highlights the bandwidth advantage of
our Metro Ethernet network over xDSL or cable modem services. Ethernet technology is
off-the-shelf and has long been deployed for large enterprises, but we believe we are one
of the first to deploy this technology for the residential mass market.
    First Mover Advantage and High Barriers to Entry.Our first mover advantage and the
inherent characteristics of the Hong Kong telecommunications infrastructure, which present
a natural barrier to entry, make it difficult for our competitors to replicate our business
model. Metro Ethernet technology is not appropriate for our competitors who intend to offer
a full coverage network that includes remote and difficult to reach areas of Hong Kong.
Attempting to deploy Metro Ethernet technology in such locations would significantly
increase costs and completion time of such a network. While other telecommunications
operators may lay their own fiber-to-the-building, we believe they would encounter
significant in-building bottlenecks when attempting to complete an end-to-end network. This
is because the majority of Hong Kongs residential properties have limited space for
in-building wiring leading to subscribers residences, making it difficult for new entrants
to replicate our end-to-end network build.
    Innovative and Highly Committed Management Team.Since our inception in 1992, our
management team has built a strong track record as an industry innovator and has
successfully led 28




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us in competing against larger and better resourced operators. Our
management team has consistently demonstrated its ability to quickly capitalize on developments in the Hong Kong
regulatory environment that allow us to expand our service offerings and grow our market
share. Our senior management team owns approximately 56% of the company and does not have
any material outside business interests. Our managements ownership interest represents a
long-term commitment and significant performance incentive.
    Strong Brand and Targeted Marketing Strategy.We have an established brand name that
is identified with high quality and competitively priced telecommunications services in
Hong Kong. In order to further promote our brand recognition and to reach a wider
subscription base, we have established a network of promoters, sales agents and
telemarketers that personally contact potential and existing customers. In addition, we
proactively market our services through a mix of promotions and advertising. We have also
established a call center in Guangzhou, China with over 1,900 customer service personnel,
which provides us with a highly cost efficient resource for processing, servicing and
acquiring customers. Business Strategy Our overall strategy is to grow market share, increase our network coverage and introduce new
services through our IP platform. Key components of this strategy include:  
    Increase Penetration within Existing Network Coverage.We intend to continuously
increase the penetration within our existing network coverage and grow our market share
through targeted sales and marketing efforts. In May 2004 we launched our free appliances
promotion and introduced long-term 24 to 36 month subscription contracts for our local VOIP
services. We revised our customer acquisition strategy from a price centric approach
towards a focus on the bandwidth advantages that we offer and signing customers to
long-term value contracts. We expect that this strategy will decrease churn rates and
customer retention costs as well as set the foundation to up-sell other services to our
subscription base over time.
    Expand and Upgrade our Network Coverage.Our self-owned Metro Ethernet network
currently covers 1.2 million home passes, representing approximately 60% of Hong Kongs
population. With this network foundation in place we will focus our efforts in the next
several years on expanding our network coverage to 1.8 million home passes, representing
over 80% of Hong Kongs population. After establishing a strong base in the mass market, we
plan to broaden our customer base into the remaining market segments. We also intend to
continue upgrading the existing wireless and leased wireline-based backbone in our network
infrastructure with our own fiber-based backbone. In fiscal 2004 we reduced the percentage
of our home passes serviced by wireless backbone from 60% to 28% and we plan to have at
least 90% of our home passes serviced by self-owned fiber-based backbone by the end of
fiscal 2005.
    Offer High-Value Services at Competitive Prices.We focus on providing high bandwidth
services at attractive prices for the residential mass and small-to-medium enterprise
market segments. In November 2004 we launched our leading-edge BB100 broadband Internet
access service with symmetric 100 Mbps upstream and downstream bandwidth at prices
affordable for residential customers. Our BB100 service is 16 times faster for downstream
transmission and 155 times faster for upstream transmission than the bandwidth offered by
the most popular asymmetric digital subscriber line broadband Internet access service in
Hong Kong. Similarly, our IP-TV service includes over 35 channels with a large selection of
Chinese-language channels targeted at Hong Kongs largely Chinese-speaking population at
competitive prices.
    Up-sell Multiple Services.We employ customized and targeted sales and marketing
efforts to up-sell multiple services to each subscriber. The scalability of our network
allows us to sell additional services to our existing customers, for example adding local
VOIP or IP-TV services to our current broadband Internet subscribers, with minimal
additional network and operating costs. As a result, each new service we sell to our
existing subscription base contributes significantly to 29




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our profitability. If we successfully up-sell additional services to our existing subscriber base, this
will result in higher revenues per subscriber, lower our average customer acquisition costs
and help to decrease subscriber churn.
    Introduce New Services on our Single IP Platform.The single IP platform of our Metro
Ethernet network provides us with a structural advantage over our competitors and enables
us to offer multiple services at low incremental costs. We are committed to continuing to
introduce innovative and high bandwidth services in the future, including BB1000, our
planned symmetric 1,000 Mbps (1 Gbps) upstream and downstream broadband Internet access,
which we target for release in the second quarter of 2005. We also plan to offer pay-TV
services to our subscribers over our Metro Ethernet network that our customers will be able
to watch using a personal computer without the need for a set-top-box. As part of our
corporate data services, we recently began to offer backbone transmission services for
mobile operators in Hong Kong. Revenue A significant majority of City Telecoms revenue is derived from business conducted in Hong
Kong. A breakdown of revenue by category of activity is as follows: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$
    
    
    HK$
    
    
    HK$Revenue
    
    (Amounts in thousands)Fixed telecommunications network
services(1)
    
    
    241,219
    
    
    
    423,107
    
    
    
    541,902International telecommunications services
    
    
    908,981
    
    
    
    875,802
    
    
    
    627,978Total operating revenue
    
    
    1,150,200
    
    
    
    1,298,909
    
    
    
    1,169,880
   (1)
    
    Includes Internet access, local telephony services since April 2002 and pay-TV services
since August 2003. Fixed Telecommunications Network Services Metro Ethernet Network Infrastructure Our Metro Ethernet network is formed by using our own fiber-based backbone, wireless
technology or leased wireline-based backbone to connect our in-building Ethernet infrastructures to
our IP hub sites and switching centers in Hong Kong. Our Ethernet infrastructure is a system of
Cat-5e copper wiring that connects our subscribers premises to our local area network, or LAN,
switches within a residential or commercial building. We aim to reduce our reliance on leasing
wireline-based backbone from other network operators, increase our capacity and improve the quality
of our service by continuing to replace wireless backbone with our own fiber-based backbone. In
fiscal 2004 we reduced the percentage of our home-passes serviced by wireless backbone from 60% to
28% and we plan to have at least 90% of our home-passes serviced by self-owned fiber-based backbone
by the end of fiscal 2005. We began replacing the existing wireless and leased wireline-based backbone and installing our
own fiber-based backbone in April 2002 when we received confirmation of our wireless FTNS License
upgrade to a wireline-based FTNS License. When we began these replacements, we initially selected
locations with the highest population density because our fiber-based backbone increased our
capacity to handle the high traffic volume in such locations. We intend to continue making
investments in our own fiber-based backbone in locations where we deem the economic returns
sufficiently high to make replacement of the wireless and leased wireline-based backbone
cost-effective. Until we complete construction of our own fiber-based backbone, we will continue to
rely on our wireless technology and leased capacity on wireline-based networks from other fixed
network operators. 30




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The high capacity of our fiber-based backbone has enabled us to offer a suite of services on a
single IP network platform. These services include our broadband Internet access, local VOIP, IP-TV
and corporate data services. We made capital expenditures for our fixed telecommunications network
infrastructure of approximately HK$229.0 million in fiscal 2003 and HK$392.9 million in fiscal
2004. We plan to further make total capital expenditures of approximately HK$990.0 million in
fiscal 2005 and fiscal 2006 in large part to continue replacing the wireless and leased
wireline-based backbone with our own fiber-based backbone and extending the reach of our Metro
Ethernet network. The service area of our Metro Ethernet network currently includes approximately
1.2 million home passes, representing approximately 60% of Hong Kongs population. We plan to
extend our Metro Ethernet network coverage to 1.8 million home passes, covering approximately 80%
of Hong Kongs population. As we expand the reach and coverage of our Metro Ethernet network, we
plan to continue introducing new services. The first step in expanding the reach of our fixed telecommunications network infrastructure
is to select buildings that we believe will provide sufficient economic returns to justify our
investment based on several factors, including population density, proximity of the building to our
existing fiber loop and our projected ability to sell services. We then perform a site visit to
analyze the feasibility of installing our Ethernet technology. Once we are satisfied with the
prospects of a particular building, we must obtain access rights from the buildings management,
which may take several weeks or months. After receiving access rights, we employ a combination of
our full-time staff and contractors to begin installation of our in-building Ethernet. The length
of time required for the installation process depends on the size and structural features of the
building and can be completed in as little as three weeks or take several months. As we install our
in-building Ethernet we simultaneously connect the building to our fiber-based backbone. All the
buildings that we reach through our expansion efforts will be served by our self-owned
infrastructure. The fixed cost of installing the complete Ethernet within a residential building, which
includes reaching the subscribers premises with our Cat-5e copper wiring are relatively high.
However, our network is highly scalable because once the in-building wiring is completed the
incremental cost of adding subscriptions is small. This is because the next step is simply to make
a connection between the subscriber and our in-building LAN ports and, in the case of our IP-TV
services, providing the customer with an IP set-top-box. The following table shows the growth of our fixed telecommunications network subscriptions
over the past five years: As of August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Fixed Telecommunications Network Services
Subscriptions:Broadband Internet Access
    
    
    1,600
    
    
    
    17,700
    
    
    
    130,000
    
    
    
    172,000
    
    
    
    197,000Local
VOIP(1)
    
    
    
    
    
    
    
    
    
    
    21,000
    
    
    
    140,000
    
    
    
    237,000IP-TV
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,000Total
    
    
    1,600
    
    
    
    17,700
    
    
    
    151,000
    
    
    
    312,000
    
    
    
    465,000
   (1)
    
    Includes only on-network subscriptions. Internet Access HKBN began offering our broadband Internet services in March 2000 after it received a wireless
FTNS License from the Telecommunications Authority to provide fixed telecommunications network
services in Hong Kong using wireless technologies such as local multi-point distribution systems.
Our goal is to build on our position as a leading provider of broadband Internet services in Hong
Kong and increase the revenue we generate from Hong Kongs Internet access market. Our subscription
base for broadband Internet access has increased each year since we introduced this service and has
expanded to approximately 197,000 broadband Internet access subscriptions as of August 31, 2004 and
approximately 201,000 broadband Internet access subscriptions as of December 15, 2004. We use this
subscription base 31




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to up-sell our other fixed telecommunications network services. In addition to
broadband Internet access services, we also currently provide 56k dial-up Internet access and
corporate Internet access via resales of PCCWs Megalink/Mega-access. However, we are focusing exclusively on growing our subscription
base for our high bandwidth broadband Internet access services and are making no further
investments in dial-up or Megalink/Mega-access services. We currently provide broadband Internet access to our residential and corporate customers at
access speeds of up to 100 Mbps, but the majority of our customers currently have access speeds of
up to 10 Mbps. We currently offer BB10, our basic symmetric 10 Mbps broadband Internet access
service plan to residential customers with unlimited Internet access for a monthly fee ranging from
HK$96 to HK$258. Further, we now offer BB100 services that provides symmetric 100 Mbps broadband
Internet access for monthly fees starting at HK$268. All of our broadband Internet access packages
offer a free e-mail service that provides up to 10 megabytes of on-network storage. Additionally,
all packages include a variety of value added services. We frequently change our promotions in
response to market conditions or as a way of attracting additional subscribers. In addition to the residential packages described above, we have also developed broadband
promotions that target corporate customers. We offer prepackaged plans that provide access at
speeds up to 10 Mbps and will soon offer plans that provide speeds up to 100 Mbps, which include
on-site training, on-site maintenance support, high capacity data transfer and e-mail services.
Corporate customers that subscribe to prepackaged plans pay fixed monthly subscription fees that
range from HK$168 to HK$5,200. Competition There have been many new entrants to the Internet access business, but our main competitors
are PCCW-HKT (through its subsidiary PCCW-IMS Limited), i-Cable and HGC. PCCW-HKT has been offering
broadband Internet access services since May 1998 and uses asymmetric digital subscriber line
technology over its telephone network to provide asymmetric Internet access at speeds up to 6 Mbps
downstream and 640 Kbps upstream. i-Cable began providing broadband Internet access services in
March 2000 using its hybrid fiber coaxial network that provides symmetric access speeds up to 8
Mbps shared by a cluster of buildings. HGC predominantly uses VDSL technology and currently
provides symmetric access speeds up to 10 Mbps. Our basic broadband Internet access service provides symmetric access speeds up to 10 Mbps and
our recently launched BB100 service provides symmetric access speeds up to 100 Mbps. We believe
that there is no other fixed telecommunications network service provider in Hong Kong with an
existing infrastructure that could offer broadband Internet access at speeds comparable to our
BB100 offering to the residential mass market at cost-effective prices. However, our largest
competitors have been in operation longer and may have greater market presence, brand recognition
and more financial, technical and personnel resources. In addition, they may have greater network
coverage in terms of homes passed. We had approximately 197,000 broadband Internet access subscriptions as of August 31, 2004,
which represents a market share of approximately 15% with respect to the total number of broadband
Internet access subscribers in Hong Kong. We continue to grow our subscription base and as of
December 15, 2004 we had approximately 201,000 broadband Internet access subscriptions. Local VOIP In April 2002, we began offering our on-network local VOIP services in Hong Kong. To provide
local telephony service, we install IP-based voice switching equipment in locations already covered
by our Metro Ethernet network. Voice signals are transmitted by the VOIP switches into the Ethernet
network installed in the subscribers building. The capital cost of installing VOIP switches is
small because the scalability of our Metro Ethernet network allows us to provide new services over
existing infrastructure with only minimal additional equipment. In addition, we now install such
voice switching equipment together with our new installations of broadband equipment in some
buildings. 32




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The quality of our local VOIP service is indistinguishable from traditional fixed line local
telephony services and customers are able to use their existing telephone equipment. In addition,
fixed line telephony subscribers switching to our local VOIP services are able to retain their existing local
telephone number via fixed line number portability. As of August 31, 2004, we had over 237,000 local VOIP subscriptions, including approximately
16,000 corporate local VOIP subscriptions, and as of December 15, 2004, we had over 253,000
subscriptions, including approximately 19,000 corporate subscriptions. We currently charge from
HK$48 to HK$128 per month for our local VOIP services depending on the service plan, and we offer a
full range of value added services, including call waiting, caller display and conference call
services. We also began offering two off-network local VOIP services in August 2004, our BB Phone and
BB Talk services. BB Phone allows subscribers to use our local VOIP services via the broadband
network of other operators. While our terms and conditions do not permit our subscribers to use
this service outside of Hong Kong, the use of the broadband network of other operators technically
allows subscribers to retain a local Hong Kong phone number in locations outside of Hong Kong so
long as the BB Phone equipment is connected to a broadband network. Calls originating from Hong
Kong to a BB Phone located outside of Hong Kong are treated as a local call. Our BB Talk services
are similar to our BB Phone services in that it can be used on the broadband network of other
service providers, but BB Talk enables voice communication through a personal computer with no
additional equipment. BB Talk services allow a subscriber to use a local Hong Kong phone number at
locations outside of Hong Kong so long as the subscribers computer is connected to a broadband
network. We may be prohibited from providing our off-network local VOIP services in the future
depending on the outcome of a judicial review proceeding brought by PCCW-HKT against the
Telecommunications Authority. For more information see Item 3 Key Information  Risk Factors 
PCCW-HKT and PCCW-IMS have brought legal proceedings against the Telecommunications Authority that,
if decided unfavorably against the Telecommunications Authority, could adversely affect our ability
to provide local VOIP services accessible over the broadband connections provided by other
operators and Item 8 Financial Information  Legal and Regulatory Proceedings of this annual
report. Competition PCCW-HKT, the incumbent and largest fixed telecommunications network operator in Hong Kong,
announced that it had a market share of approximately 69% with respect to local telephony services
as of September 30, 2004. Because of PCCW-HKTs dominant position, PCCW-HKT is required to allow
interconnection to its fixed telecommunications network to other licensed fixed telecommunications
network operators as discussed above. The remainder of the market is shared among ourselves and
three other alternative carriers HGC, New World and Wharf T&T. The principal basis of competition
for local telephony is price and brand name recognition. PCCW-HKT has the highest brand name
recognition, but we and the other competitors are growing our subscription bases by offering
competitively priced local telephony services that provide comparable quality to PCCW-HKT. As of
August 31, 2004, we had approximately 237,000 local VOIP subscriptions, including approximately
16,000 corporate subscriptions. Our market share with respect to local residential telephony
services amounts to approximately 10% as of August 31, 2004. We continue to grow our subscription
base and as of December 15, 2004 we had approximately 253,000 local VOIP subscriptions. There have been a number of developments that could result in changes to the competitive
environment with respect to fixed line local telephony services in Hong Kong. On January 20, 2005,
PCCW announced it had formed a strategic business alliance with or China Netcom, one of Chinas
major telecommunications companies. Under this alliance, China Netcom will pay approximately
US$1.0 billion in cash for newly issued PCCW shares, resulting in its holding 20% of PCCWs share
capital. This transaction may result in increased competition for us and other Hong Kong
telecommunications companies if PCCW is able to combine its size and market position with the
increased capital provided by China Netcom to decrease prices. Additionally, in 2003, PCCW-HKT
applied for two declarations of non- 33




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dominance with respect to the markets for residential and
business fixed line telephone services. In response to these applications, OFTA issued a new fixed
carrier license to PCCW-HKT on January 14, 2005. Under this new license, PCCW-HKT is not required
to obtain prior approval from the Telecommunications Authority before adjusting its tariffs on residential and business direct
exchange line telephone services, including moves to offer discounts and other benefits in response
to price competition. We anticipate this development will increase pricing competition further in
an already competitive market. The competitive environment under which we currently operate may
also be affected by the ongoing changes in the regulatory framework in Hong Kong including the
phasing out of Type II interconnections at Point A by June 2008 and the possible introduction of a
new regulatory framework for local VOIP services. IP-TV In August 2003 we introduced our IP-TV service that provides DVD quality video delivered via
our Metro Ethernet network to an IP set-top-box connected to the subscribers television set. This
monthly subscription-based pay television service offers more than 35 channels consisting of a
24-hour news channel and other education and recreation channels (including childrens programming)
that we produce, and channels whose content is obtained from other content-providers. Our news
production team consists of a staff of 80 employees and produces an average of 40-50 news stories
per day for our 24-hour news cycle. We have three in-house production studios, two of which were
constructed during fiscal 2004 in order to improve the quality of our production. Our service is distinguished from PCCW-HKTs pay-TV services, which also uses a broadband
network to provide its pay-TV services, because we do not bundle our IP-TV services with our other
fixed telecommunications network services. Our customers may subscribe to our IP-TV services as a
stand-alone service without incurring any additional charges, while PCCW-HKT primarily offers its
pay-TV services to its existing broadband Internet access subscribers. Because of the scalability
of our Metro Ethernet network infrastructure, the current cost of adding IP-TV services to an
existing broadband Internet access or local VOIP subscriber is small. We launched our IP-TV
services at an introductory price at HK$88 per month and then increased our monthly charge to
HK$108. We have subsequently increased the fee to HK$128 for package of more than 35 channels. In
our first year of pay television operations, we had acquired approximately 31,000 IP-TV
subscriptions as of August 31, 2004. We had approximately 36,000 IP-TV subscribers as of December
15, 2004. Our strategy is to achieve pay-TV subscription penetration by producing local content
consisting primarily of news, childrens programming and local interest programming and obtaining
Chinese language content from other television content producers in order to target the largely
Chinese speaking population of Hong Kong. Over 70% of the channels we provide are either in
Mandarin or Cantonese, which we believe distinguishes us from our two largest competitors. We continually evaluate other sources of Chinese language and other programming and intend to
selectively add additional channels to our IP-TV service when we identify cost-effective
opportunities to do so. Competition Our three main competitors in the pay-TV business are i-Cable, PCCW-HKT and Galaxy Satellite
Broadcasting Limited. The pay-TV services of i-Cable and PCCW-HKT include a significant amount of
English language content such as English Premier League Football, HBO, Cinemax, ESPN and others. We
target a different market than these competitors by offering predominantly Chinese language
content, and pricing our IP-TV service attractively to the residential mass market. Free-to-air television stations offering Chinese language content attract more than 85% of the
prime-time television viewership in Hong Kong, which is illustrated in the table below: 34




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Period between September
13, 2004and December 5, 2004Station
    
    Language
    
    
    ShareTVB Jade
    
    Chinese
    
    
    72
    %ATV Home
    
    Chinese
    
    
    16
    %TVB Pearl
    
    English
    
    
    4
    %ATV World
    
    English
    
    
    2
    %i-Cable
    
    Mixed
    
    
    6
    %100
    %
    Television Broadcasts Limited and Asia Television Limited, commonly known as TVB and ATV,
respectively, are indirect competitors to our pay-TV services in the Hong Kong television market.
TVB and ATV account for a substantial proportion of Hong Kongs television viewership and we market
our services as supplemental to theirs. TVBs Cantonese channel is the dominant channel in Hong
Kong with approximately 72% of prime-time viewership during the period between September 13, 2004,
and December 5, 2004. TVB and ATV are supported by advertising revenues and, therefore, must design
their programming to attract the widest possible audience. In contrast, we and the other pay-TV
operators rely on monthly subscription fees for most of our revenues. Other competitors include
satellite TV operators, such as Star TV, as well as potential competition from direct-to-home
broadcasters and broadcasters using digital terrestrial delivery methods. Corporate Data Services In July 2004, we commenced commercial trials of our corporate data services over our Metro
Ethernet network. Our corporate data services includes E-1 and T-1 backbone connections and leased
bandwidth capacity over our Metro Ethernet network for mobile and other telecommunications
carriers, as well as connectivity for companies with multiple office locations within Hong Kong. We
believe that the combination of our low cost base provided by our Metro Ethernet network and our
extensive geographic coverage positions us well to be competitive in this market. International Telecommunications Service We were among the first companies to be granted a PNETS License by the Telecommunications
Authority to provide international calling card services in Hong Kong. Since we first began
providing international telecommunications services in 1992, we have greatly expanded the range of
services that we offer. We now offer a variety of international direct dial services to our
customers at competitive rates and are one of the largest providers of international direct dial
services in Hong Kong. We believe that our ability to deliver a range of calling plans with varying
features that cater to different customer needs has been one of the key factors of our success. The primary international telecommunications services that we currently offer our customers
are the following: Service
    
    DescriptionIDD 1666
    
    Provides subscribers with international
direct dial using the access number 1666 in
Hong Kong.IDD 0030
    
    Provides subscribers with international
direct dial using the access number 0030 in
Hong Kong.Mobile Call Forwarding Services
    
    Allows call forwarding of Hong Kong mobile
numbers so that subscribers can receive calls
while overseas.
 35




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We offer our international telecommunications service under the IDD 1666 and IDD 0030
brand names. These two brands provide us with flexibility in our marketing strategies. We charge
our IDD 1666 and IDD 0030 users a per minute tariff rate that varies according to the destination
of the call, while IDD 0030 users are also provided discounts depending on the time of day or day
of the week when the call is placed. We actively promote our international telecommunications services to build our brand name
awareness as one of Hong Kongs leading telecommunications companies. In fiscal 2004, in order to
maintain our market share, we made the decision to price our international telecommunications
services at competitive levels with other market players to compete with their aggressive pricing
strategies. While we experienced an increase in total traffic volume of 13.4% from 888.0 million
minutes to 1,007.0 million minutes, our average prices per minute decreased 36.8% in fiscal 2004
compared to fiscal 2003. A principal reason for the decline in tariff rates was that in fiscal
2003, we increased our rates for outbound calls to China in response to an increase in the
termination rates payable by us to our carrier partners for incoming telecommunications traffic
into China due to the imposition by Chinas MII of these rate increases. As approximately 65% of
our outgoing calls in fiscal 2003 were to China, this increase had a significant effect on our
average prices per minute. When our carrier partners subsequently reduced their termination
charges, we were able to reduce our per minute charges as compared to fiscal 2003. As a result of
the decline in tariff rates, our international telecommunications services revenue declined 28.3%
from HK$875.8 million in fiscal 2003 to HK$628.0 million in fiscal 2004. We expect that pricing
competition will continue, but anticipate that the decline in average prices will be less than in
fiscal 2004. At present, we believe our long distance call rates are competitive with those quoted
by the other four major local fixed network operators and other telecommunications providers for
transmissions originating in Hong Kong to many destinations, including China, the United States,
Canada and the United Kingdom. Our international telecommunications customer base consists of a mix of residential and
corporate subscriptions. While we continued to focus on the residential sector in fiscal 2004, and
achieved success with our IDD 0030 international calling service, we have also emphasized the
development of our corporate customer services and offer customized special discounts to corporate
subscribers. As of August 31, 2004, our registered residential customer base had increased by 21.7%
to 1,819,481 compared to 1,495,229 at August 31, 2003, with an average of 500,000 customers that
are billed on a monthly basis. To foster loyalty among our existing subscribers and increase our
subscription base, we occasionally award free international calling minutes or other gifts for
subscribers who maintain certain usage levels or refer our services to new customers. The following table shows the growth in our international telecommunications subscriptions and
outgoing IDD minutes over the past five years: As of and for the year ended August 31,2000
    
    
    2001
    
    
    2002
    
    
    2003
    
    
    2004Type of
Account(1):Residential
    
    
    842,000
    
    
    
    906,388
    
    
    
    1,056,759
    
    
    
    1,495,229
    
    
    
    1,819,481Corporate
    
    
    63,984
    
    
    
    76,067
    
    
    
    90,930
    
    
    
    93,959
    
    
    
    96,754Total
    
    
    905,984
    
    
    
    982,455
    
    
    
    1,147,689
    
    
    
    1,589,188
    
    
    
    1,916,235IDD Outgoing Minute
(in thousands)
    
    
    505,000
    
    
    
    580,000
    
    
    
    916,000
    
    
    
    888,000
    
    
    
    1,007,000
   (1)
    
    Accounts refer to international telecommunications customers that have a valid account.
Account holders may or may not be active users of our services. International Telecommunications Network Our international telecommunications network infrastructure is a system of switches,
self-owned and leased backbone capacity, interconnection arrangements and undersea cables that
connect the subscribers telephone call to its destination. 36




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In March 2002, we received our license to provide undersea cable-based fixed
telecommunications network services. This license allows us to purchase and operate our own
undersea cables. In 2000, we entered into contracts with two large consortia of international
telecommunications companies to acquire undersea cable capacity. Through the first contract, we
invested in the Japan-U.S. undersea cable, which was completed in August 2001. Pursuant to the
second contract, we agreed to jointly construct and maintain the Asia-Pacific Cable Network 2
undersea cable as an international transmission facility. Construction of the APCN 2 cable was
completed, and commercial operation began, in May 2002. We spent a total of HK$120 million on these
two projects. We believe the utilization of these undersea cables provides capacity for significant
future growth of our international and fixed-network telecommunication services. Having our own undersea cables and our fiber-based backbone has enabled us to better control
international transmission quality, reduced the costs associated with international transmission
and reduced our reliance on third party infrastructure. Our international telecommunications
network currently has a monthly handling capacity of approximately 150 million minutes. We believe
that the continuing improvement of our international telecommunications network is important in
supporting the growth in our subscription base and the expansion of our range of services. International Simple Resale Our international simple resale license, which became effective in January 1999, has
significantly changed the way that we provide our international telecommunications services. To
connect an international call, we must transmit the signal between our switching systems and
switching systems in the country to which the call is directed. Switching systems are the
electronic systems that direct the telecommunications transmission to the selected international
transmission circuit, take the signal from the international transmission circuit in the
destination country and direct it to the local network for delivery to its destination. Since receiving our PNETS License for the provision of external telecommunications service, we
have acquired exclusive use of several leased international transmission circuits for direct
transmission of international calls between our switching systems and switching systems in the
destination countries under an international simple resale arrangement. Exclusive use of leased
transmission circuits to transmit calls between switching systems has enhanced the quality of our
international calls, reduced our reliance on third party infrastructure and lowered transmission
costs of our services. Interconnection Arrangements We have entered into interconnection arrangements with other local fixed network operators in
Hong Kong and overseas carriers to transmit calls between Hong Kong and overseas destinations for
our off-network customers. In choosing the local fixed network operators and overseas carriers with
whom we cooperate, we take into account a number of factors including the level of termination
charges and transmission efficiency and quality. We evaluate the performance of parties with whom
we have interconnection arrangements periodically. We believe that we will not have difficulty in
finding alternative overseas carriers if performance standards are not being met or a change is
otherwise necessary. We have not experienced any disruption in the provision of our services as a
result of a change of arrangements with overseas carriers or local fixed network operators. We pay a fixed monthly fee to local fixed network operators for connection between our
switches and their networks and a variable access fee payable on a per-minute basis when accessing
their network. For customers using our own network, no interconnection fee is charged. We negotiate
the termination charges we pay with the overseas carriers, and the termination charges vary from
one overseas carrier to another. All of the interconnection and termination charges we pay to local
fixed network operators and overseas carriers, respectively, are made on an open account basis with
credit terms ranging from 15 to 30 days. The interconnection charges we pay to local fixed network
operators are denominated in Hong Kong 37




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dollars and substantially all the interconnection charges we pay to overseas carriers are
denominated in U.S. dollars. International Telecommunications Switching Systems We own three international telecommunications switching systems in Hong Kong and two in
Canada, comprising one in each of Vancouver and Toronto. Our three international telecommunications switching systems in Hong Kong handle telephone
calls originating and terminating in Hong Kong. Our telecommunications network mainly consists of
Nortel Networks Limited switching equipment and compression units supplied by Cisco Systems, Inc.
and ECI Telecom Ltd. These systems are programmed to automatically choose the optimal routing for
each transmission. Optimal routing is a function of a variety of factors, such as country or
territory of origination and destination, communication quality, efficiency and costs, and the
capacity of the various communication methods available. Furthermore, since our three international telecommunications switching systems in Hong Kong
operate independently of each other, if one systems breaks down, all transmissions are immediately
diverted to another switching system. We have never experienced a period where all systems
experienced a failure at the same time since we commenced operations in 1992. Competition PCCW-HKT, HGC, New World, and Wharf T&T are our main competitors in the international
telecommunications business. As in previous years, we experienced fierce price competition in Hong
Kong during fiscal 2004. This competition drove down the average tariff rates per minutes and we
expect this price competition to continue in fiscal 2005, but anticipate that the decline in
average prices will be less than in fiscal 2004. In order to maintain our market share and high
traffic volume, we have significantly reduced some of our international telecommunications rates
and introduce new marketing and promotional offers from time to time. We also employ two brand
names, IDD 1666 and IDD 0030, to provide us with flexibility in our marketing strategies. However,
to offset these price reductions, we have taken steps to reduce our cost base, such as using our
relatively large traffic volume to negotiate lower prices from our international partners,
establishing a call center in Guangzhou to provide customer acquisition and back office support
services, and developing our own international telecommunications infrastructure. CTI Mall To take advantage of the regular contact that we have with our existing customers through our
various sales and customer service channels, including our Guangzhou service center, we have begun
offering our customers the opportunity to purchase a selection of consumer goods from us including
audio-visual products, household appliances, computer and accessories, skincare, watches, cooking
utensils and other housewares. We use our large customer base and the potential for high sales
volumes to negotiate discounted prices on electrical goods with distributors, and offer these
electrical goods to our customers at attractive prices. We proactively market CTI Mall via direct
mail accompanying our bills, our web site, as well as direct calling. We earn revenue based on the
difference between the price that the distributors charge us for the appliances, and the amount
that we collect from our customers. Maintenance and Monitoring To ensure reliability of our fixed telecommunications network, our monitoring system involves:  
    a year round, 24-hour, 7 days a week network operation center for real-time service
monitoring and maintenance that is supported by over 130 operational and field staff; 38




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
    individual self-reporting mechanisms and centralized performance monitoring systems for
our switches and equipment;
    an emergency self-reporting system that automatically contacts designated personnel via
mobile phones; and
    back-up systems for our switches, critical software and hardware components. Once a network fault is detected by our control room, we will either remotely rectify the
situation or dispatch field staff to that location should physical interaction be required. After
the situation has been resolved, we will continue to monitor network performance as well as track
customer service feedback until we are assured of the fault being fully rectified. Research and Development Activities We commit considerable resources to our research and development department in order to
continuously improve our services and improve our market position. As of August 31, 2004, our
research and development department in Hong Kong consisted of 28 staff members experienced in
systems design, engineering, telecommunications and computer programming. Our research and
development department is primarily responsible for assessing and adapting the technology that we
employ in upgrading and expanding our Metro Ethernet network. To identify and develop new market
opportunities, the research and development department assesses new services offered by
telecommunications and Internet companies in the United States and elsewhere and works closely with
our marketing department. Our research and development expenditures were approximately HK$2.2
million, HK$2.6 million and HK$6.0 million for fiscal 2002, 2003 and 2004, respectively. Sales and Marketing Our primary marketing goal is to further our brand name as one of Hong Kongs leading
telecommunications companies, and to build HKBNs brand name as a leading broadband Internet
access, local VOIP, IP-TV and corporate data services company. Because there is limited variation
in the prices charged by our competitors, we believe that brand identity is one of the primary
drivers of our continued growth in subscriptions and revenues. We believe that we have been
successful in building a strong corporate image in Hong Kong as a direct result of the efforts we
have made, and intend to continue our efforts to advertise and promote City Telecom and HKBN. We
advertise our products and services through our on-the-street marketing force, door-to-door
marketing team, telemarketing and direct mailing, as well as through television, radio, Chinese
language print media and on the Internet. We have developed an extensive sales network in Hong Kong. Our senior marketing personnel
closely oversee our sales network to ensure that a consistent image is presented by all of the
sales representatives we use to promote City Telecom and HKBN. We provide commission based
incentives to our residential sales force that sell our international and fixed telecommunications
network services, which consists of agents responsible for on-the-street and door-to-door sales, as
well as to our full-time telemarketing staff. Our customer service center in Guangzhou provides
telemarketing services and is an integral part of our overall sales and marketing efforts. We have developed a wide range of promotions which award various technology products and free
trial periods to newly registered customers who sign on to a service contract of up to 36 months.
An example of these promotions is our free appliance program, where we provide new local VOIP
customers a free household appliance of their choice upon their acceptance of a 24 to 36 month
service contract. We have greatly benefited from utilizing on-the-street and door-to-door sales
agents who meet Hong Kong residents in recreational and residential areas to promote our services. We have established a sales division responsible for coordinating our corporate marketing and
sales efforts. We believe our dedicated corporate and small-to-medium enterprise sales force is one
of the largest sales forces targeted at corporate users of telecommunications and Internet services
in Hong Kong. 39




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##### Table of Contents



In addition, our dedicated corporate staff designs marketing and sales promotions specifically
tailored to address the concerns of business users. This division also organizes seminars for
current and prospective customers to promote new products and services and to raise awareness of
our various corporate offerings. Customer Service We believe that providing excellent customer service and support is essential to building and
retaining a large and loyal subscriber base. We therefore have committed considerable personnel and
financial resources to establishing a reliable and accessible customer service system. Our customer service department provides integrated support to our international and fixed
telecommunications network services subscribers. We provide a hotline to handle complaints,
subscription applications and queries relating to account balances, pricing, billing, service and
technical information. Complaints and in-depth queries from subscribers that cannot be immediately
remedied or answered are forwarded to a customer care team, which is responsible for answering such
complaints and queries. We also have a dedicated customer service team to provide service to our
corporate subscribers, which includes access to a highly skilled technical team that may go to the
customer site for trouble shooting and repairs. In July 2002, we established a customer service call center in Guangzhou, and centralized most
of our customer service functions at that location. In addition to providing back office support
services, this facility also provides customer acquisition services and enables us to lower our
operating costs while continuing to increase our customer service capabilities. We have been
expanding our Guangzhou customer service facility since its establishment, which now has over 1,900
employees as of August 31, 2004. Between August 1, 2004 and October 1, 2004, our Guangzhou customer
service call center handled on average more than 27,000 inbound and outbound calls per day. Billing and Collection Our account collection department is responsible for securing prompt payment from subscribers.
Invoices are issued on a monthly or quarterly basis and payments are usually due within 15 days of
the issue date of the invoice for residential subscribers and 21 days for corporate subscribers.
All payments from our subscribers are denominated in Hong Kong dollars and are made by way of cash,
check, credit card, payment by telephone service, automatic transfer from subscribers bank
accounts or through Internet banking. As a result of our tight credit control policy, our bad debts
represented approximately 0.9%, 1.4% and 1.0% of our revenue for each of fiscal 2002, 2003 and
2004, respectively. When an account becomes past due, we send a reminder notice together with the next months
invoice to the customers, usually within 15 days after the due date. The notice states the overdue
amount and informs the customer that we charge a late payment fee of 1.5% per month on the
outstanding overdue amount. For residential subscribers, we have the right to charge the
outstanding overdue amount to the subscribers pre-registered credit card account or, if
applicable, deduct the outstanding overdue amount from the subscribers application deposit. Open
accounts are maintained for most of the corporate subscribers without pre-registered credit card
accounts or deposits. For residential and corporate subscribers, if an overdue IDD account is not settled within 90
days and 60 days after the due date, respectively, we terminate the subscribers account. For local
VOIP, broadband Internet access and IP-TV services, we generally allow a 90 day period before
terminating the account, due to the minimal incremental cost to us of providing such services. If
payment is still not settled after we terminate the account, we determine what recovery actions to
take, which may include court proceedings and/or the use of collection agencies. Environmental Matters Since our date of incorporation, we have not violated any environmental laws, ordinances or
regulations, and believe that all of our operations comply fully with applicable environmental
laws. 40




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##### Table of Contents



Intellectual Property Rights We have registered our trademarks with the Trademarks Registry of the Intellectual Property
Department in Hong Kong. We have no other material intellectual property. Hong Kong Regulatory Overview The following is a brief summary of the Hong Kong laws and regulations that currently
materially affect the telecommunications, including the Internet, and the broadcasting industries
in Hong Kong. This section does not purport to be a comprehensive summary of all present and
proposed regulations and legislation relating to these industries. In particular, the regulatory
principles relating to the pricing of telecommunications services provided in Hong Kong are
relatively complex and are the subject of regular review by the regulator. Accordingly, the
following is not a summary of all the regulations (including pricing regulations) pursuant to which
telecommunications and broadcasting services are provided in Hong Kong, either on a wholesale or
retail basis. Telecommunications Industry History Local Fixed Telecommunications Network Services Prior to July 1995, PCCW-HKT Telephone Limited (then known as Hong Kong Telephone Company
Limited) was the exclusive provider of local fixed wireline telecommunications network services in
Hong Kong under an exclusive franchise granted to it under the now repealed Telephone Ordinance
(Cap 269). In 1995, the Hong Kong government introduced limited competition in the local fixed
telecommunications network services market and three new FTNS Licenses (see below for a more
detailed description of such license) were issued by the Telecommunications Authority to each of
HGC, Wharf T&T, and New World on June 30, 1995, June 27, 1995 and June 20, 1995, respectively,
which allowed them to provide and operate local fixed wireline networks. PCCW-HKT was also granted
a FTNS License in order for it to continue to operate its local fixed wireline network. The Hong
Kong government also agreed to a three-year moratorium on the granting of any further FTNS
Licenses. Following a review conducted by the Hong Kong government regarding its policy in the fixed
telecommunications industry in 1998, on May 5, 1999, it announced its decisions:  
    to extend the moratorium on granting additional wireline-based local FTNS Licenses
until December 31, 2002, subject to the satisfactory binding commitments by each of HGC,
Wharf T&T and New World to roll-out additional local network infrastructure and services;
    to invite applications for FTNS Licenses in respect of non-wireline based local
networks periodically, the first of such invitation to be made in 1999; and
    to fully liberalize the market for local fixed telecommunications network services
(wireline or wireless based) from January 1, 2003. To implement the above decisions, five local wireless-based FTNS Licenses were issued by the
Telecommunications Authority in 2000, including one which was issued to HKBN, for the provision of
local fixed telecommunications services using non-wireline based networks (commonly referred to as
wireless local loop). At the same time, Hong Kong Cable Television Limited, or HKCTV, was also granted a FTNS
License to offer telecommunications services over its hybrid fiber coaxial cable network, subject
to it making binding commitments on the continued roll-out of its cable network and the surrender,
on an agreed schedule, of microwave multipoint distribution system frequencies allocated to it. 41




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In anticipation of the full liberalization of the local fixed telecommunications network
market as from January 1, 2003, the Telecommunications Authority published a statement on January
11, 2002 outlining certain key implementation details, including:  
    there would be no rollout or capital expenditure commitments required from licensees
that are licensed to operate from January 1, 2003 of local fixed networks and/or external
facilities;
    in order to maintain equal treatment between new and existing operators in respect of
performance commitments, all performance commitments of existing local and external fixed
telecommunications network services operators that are due on or after January 1, 2003 as
initially committed to in the licenses granted would be waived;
    the Telecommunications Authority would not grant any fixed carrier licenses (for
details of this license, see description below) to operate local fixed networks to
applicants who intend to rely primarily on interconnection with, and access to, the
infrastructure of other fixed telecommunications network services or fixed carrier
licensees to roll out their networks or provide their services;
    newly licensed local wireline-based fixed network operators may apply, on a
case-by-case basis and subject to certain conditions, for rights of access to buildings and
road opening under section 14(1) of the Ordinance for purposes of installing
telecommunications lines; and
    existing local wireless network operators, including HKBN, would be entitled to apply
for the extension of the scope of services under their existing licenses to operate local
fixed networks and other forms of fixed telecommunications network services. Following the publication of the statement, HKBN applied to the Telecommunications Authority
for modification of the scope of its local wireless FTNS License. HKBNs FTNS License was modified
on April 16, 2002 to include the operation of local fixed wireline network services as from January
1, 2003. In addition, HKBNs performance commitments due on or after January 1, 2003 set forth in
its FTNS License were waived. International Telecommunications Facilities and Services Prior to March 1998, Hong Kong Telecom International Limited, or HKTI, was the exclusive
provider of all external telecommunications circuits and certain external telecommunications
services in Hong Kong. The license granted to HKTI in 1981 was due to expire on September 30, 2006. In May 1993, the Telecommunications Authority began liberalizing certain external
telecommunications services which were not within the scope of HKTIs exclusive license, and issued
PNETS Licenses (see below for a more detailed description of such license) which allowed licensees
to provide customers with access to HKTIs external telecommunications services using a
transmission method commonly known as call-back. Following the issuance of a statement by the Telecommunications Authority in April 1996
further clarifying the extent of the exclusivities of HKTIs license, the Telecommunications
Authority began issuing PNETS Licenses for the provision of international virtual private network
services. In January 1998, the Hong Kong government issued a policy statement stating that the provision
of the services remaining within the HKTI License, on an exclusive basis, was not in Hong Kongs
best interest. On March 31, 1998, HKTI surrendered its exclusive license under the terms of a
framework agreement entered into with the Hong Kong government on January 20, 1998. In the January
1998 policy statement, the government stated that the liberalization of the external
telecommunications services and facilities would take place on a two step basis, the first step
being liberalization of services and the second being the liberalization of facilities.
Accordingly, the external telecommunications services were 42




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liberalized as from
January 1, 1999 and the provision of external facilities was liberalized on January 1, 2000.
Subsequently, in a 2002 statement of the Telecommunications Authority relating to the
implementation of the full liberalization of local fixed telecommunications network services
market, the Telecommunications Authority stated that it would issue licenses for operation from
January 1, 2003 of external facilities based on submarine or land cables to those who may directly
invest in cable capacity or acquire the capacity through the purchase of Indefeasible Rights of
Use, or IRU, of cables, thus further liberalizing the external telecommunications market. In early 1998, PCCW-HKTs FTNS License was transferred to a group comprised of subsidiary
companies providing international and local telecommunications services and the scope of PCCW-HKTs
services to be provided under the FTNS License was in this way expanded to cover the provision of
external telecommunications services and facilities. The FTNS Licenses of the three other local
fixed network operators, i.e. HGC, New World and Wharf T&T, were also amended allowing them to
provide external telecommunications services from January 1, 1999 and all forms of external
facilities (cable and satellite based) from January 1, 2000. The Telecommunications Authority began issuing PNETS Licenses in late 1998 for the provision
of external telecommunications services using international leased circuits provided by licensed
operators as from January 1, 1999. External FTNS Licenses began to be granted to licensees to
operate, as from January 1, 2000, non-cable based external telecommunications facilities (i.e.
satellite or other wireless facilities) and/or external telecommunications facilities based on new
undersea or land cables. Furthermore, the Telecommunications Authority stated that it would issue
licenses for the operation of external telecommunications facilities to IRU owners as from January
1, 2003. The Telecommunications Authority granted us a satellite-based fixed carrier license in May
2001. This license was modified by the Telecommunications Authority in March 2002 to grant us
additional rights to operate a cable-based external fixed telecommunications network. HKBNs local
wireline-based FTNS License was modified on May 22, 2003 to allow for the operation of external
fixed telecommunications network services in exchange for the surrender of our cable-based external
fixed carrier license. Regulatory Environment The main legislation in Hong Kong which regulates the telecommunications industry is the
Telecommunications Ordinance (Cap 106), and related subsidiary legislation, notably the
Telecommunications Regulations (Cap 106A), and the Telecommunications (Carrier Licences) Regulation
(Cap 106V). The Telecommunications Ordinance underwent significant changes in 2000 following a
policy review of the telecommunications industry conducted by the Hong Kong government in 1998. The Telecommunications Authority, an individual appointed by the Chief Executive pursuant to
the Telecommunications Ordinance, is the main regulator of the telecommunications industry in Hong
Kong. The Telecommunications Authoritys general responsibilities include: the issuing of
non-exclusive licenses; the determination of terms of interconnection; promotion of fair
competition in the telecommunications sector; management of the frequency spectrum; development of
technical standards and customer equipment testing; protection of consumer interests; and the
control and administration of the Hong Kong numbering plans (including allocation of numbers or
codes). It should be noted that the Hong Kong government announced in its policy paper Digital 21
Strategy  Sustainability and Opportunities published in March 2004 that it intends to review the
current regulatory structure of having two separate regulatory entities for the telecommunications
industry and the broadcasting industry respectively in light of the convergence and deregulation of
the two industries. It further stated that it will issue its proposal and consult the public on the
creation of a unified regulator in early 2005. 43




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Licensing General Licensing Requirements Section 8(1) of the Telecommunications Ordinance provides, amongst other things, that a
telecommunications license is required if a person in Hong Kong establishes or maintains any means
of telecommunication. Contravention of Section 8 constitutes an offence. Currently, companies
offering telecommunications services without establishing or maintaining any means of
telecommunications (pure resellers) are not yet subject to the licensing regime. The
Telecommunications Authority is currently conducting a public consultation proposing to bring into
force provisions (which were introduced in the Telecommunications Ordinance in 2000) to regulate
certain resale activities. For a more detailed discussion refer to the section entitled  Recent
Regulatory Developments in the Telecommunications Industry below in this annual report. The Telecommunications Regulations and the Carrier Licenses Regulation set forth the licenses
which the Telecommunications Authority may issue pursuant to the Telecommunications Ordinance. Generally, a licensee is required to be a company registered under the Companies Ordinance
(Cap. 32) and this requirement is satisfied either by the incorporation of a Hong Kong company
(which can be wholly owned by a foreign company) or by the registration of a foreign company under
the Companies Ordinance. Currently, there is no foreign ownership restriction on the holder of a
telecommunications license under the current regulatory regime. Non-compliance with the Telecommunications Ordinance, any subsidiary legislation made pursuant
to it, any of the license conditions or any direction issued by the Telecommunications Authority by
a telecommunications licensee, could result in the revocation or suspension of the relevant
license. The Telecommunications Ordinance contains a set of provisions setting forth the procedural
steps which the Telecommunications Authority must adhere to prior to revoking or suspending any
telecommunications licenses. In addition, the Chief Executive in Council has the authority to
revoke a telecommunications license at any time if it is in the public interest to do so. Fixed Telecommunications Network Services License As noted above, the Telecommunications Ordinance was substantially amended in 2000. Prior to
the enactment of the amendments in 2000, FTNS Licenses were issued for the operation of fixed
telecommunications networks in Hong Kong. After the enactment of the amendments in 2000, which was
primarily designed to streamline the licensing regime, FTNS Licenses became a part of the general
category of fixed carrier licenses. An FTNS License authorizes the licensee, among other things:  
    to provide a public fixed telecommunication network service, covering internal services
or external services, or both; and
    to establish and maintain a fixed telecommunications network, which may be
wireline-based or wireless-based, or a combination of both. HKBN currently holds an FTNS License issued to it by the Telecommunications Authority in
February 2000 initially for the operation of a local fixed wireless network. This FTNS License has
since been amended twice and presently, HKBN is authorized to operate both local fixed
telecommunications networks (wireline and wireless based) and external telecommunications
facilities. An FTNS License contains a set of General Conditions, which are prescribed in the
Telecommunications Regulations and a set of Special Conditions usually tailored-made by the
Telecommunications Authority to address issues specific to the license holder, including its
universal service contribution obligation. 44




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The Telecommunications Regulations provide that an FTNS License is valid for a period of 15
years, and is renewable for a further period not exceeding 15 year at the Telecommunications
Authoritys discretion. The amount of license fee payable by a holder of a FTNS License is set out in the
Telecommunications Regulations and comprises (i) a fixed annual amount of HK$1.0 million; (ii) a
variable amount calculated on the basis of the number of customer connections (which is currently
set at HK$700 for each 100 customer connections); and (iii) a variable fee calculated by reference
to the radio spectrum assigned and used by the license holder. Fixed Carrier License The Telecommunications Ordinance was amended by the Telecommunications (Amendment) Ordinance
2000, or the Amendment Ordinance. With the exception of a few provisions, the amendments set out in
the Amendment Ordinance became fully operational as from April 1, 2001. The Amendment Ordinance
creates two new categories of licenses: carrier licenses and class licenses. A carrier license is defined widely in the Amendment Ordinance and covers a number of
existing network-related licenses, including FTNS Licenses. The Telecommunications Authority no longer grants FTNS Licenses to operators which wish to
operate fixed networks, but instead grants fixed carrier licenses. The Telecommunications
Authority is pursuing a gradual program of replacing expired or surrendered FTNS Licenses under the
old regime with fixed carrier licenses, but existing FTNS Licenses remain valid. The conditions of a fixed carrier license, as set forth in the Carrier Licences Regulation,
are essentially the same as the corresponding FTNS License conditions, except that certain of the
General Conditions in a FTNS License have become Special Conditions (in order to make the General
Conditions consistent for both fixed and mobile carriers). Under the Carrier Licences Regulation, the period of validity of a fixed carrier license is 15
years from the date of issuance, which may be renewed for a further period of up to 15 years. The
current fixed annual license fee payable is HK$1.0 million. The variable amounts payable are
calculated on the same basis as those payable under the FTNS Licenses. Public Non-Exclusive Telecommunications Services License A PNETS License is used by the Telecommunications Authority to cover the provision of a number
of different telecommunication services where the service provider provides the service to the
public using the network of a licensed carrier or by establishing or maintaining transmission
facilities within the boundary of a building or property. In practice, the PNETS License is also
used as a sweep-up license category, where a license is required by virtue of the
Telecommunication Ordinance but none of the existing categories are applicable to the means of
telecommunications or telecommunications service for which the license is required. The Telecommunications Authority has issued various PNETS Licenses over the years, including:  
    those for the provision of external telecommunications services, or PNETS ETS License,
over external leased circuits provided by a holder of a FTNS License or other external
switched telecommunications services lawfully operated in Hong Kong; and
    those for the provision of international value-added network services, or PNETS IVANS
License, and/or telecommunications services (including Internet access services) accessed
by customers via public switched telecommunications networks provided by licensed network
operators or leased circuits operated or authorized under the Telecommunications Ordinance. 45




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A PNETS License has a validity period of 12 months, renewable at the discretion of the
Telecommunications Authority on an annual basis upon the payment of a prescribed annual fee, which
is currently set at HK$750. Where radio communications apparatus is used, there is an additional
variable component calculated by reference to the number of base stations and mobile stations
involved. During the mid 1990s, we were initially issued with three PNETS Licenses including a license
to provide calling card services, or a CCS License, a license to provide international simple
resale services for facsimile and data services, or an ISR License, and a license to provide
virtual private network services, or a VPN License. We also hold a PNETS IVANS License which allows
us to act as an Internet Service Provider. In November 1998, we were issued a PNETS ETS License,
replacing the CCS, ISR and VPN Licenses. The PNETS ETS License allows us to continue providing CCS,
ISR and VPN services along with a number of other international telecommunications services. We
were also allowed, under the terms of the PNETS ETS License, to commence the provision of external
telecommunications services from January 1, 1999 over the external facilities of the then HKTI and,
from January 1, 2000, over the external telecommunications facilities of other licensed external
facilities providers. Under the terms of the PNETS ETS and PNETS IVANS Licenses, we and IDD 1600 Company Limited, or
IDD 1600, our wholly owned subsidiary, are required to comply with certain license conditions
relating to technical and reporting matters. Class License In terms of class licenses, the Telecommunications Authority has created two class licenses
thus far, one relating to the operation of in-building telecommunications systems and the other one
relating to the provision of public wireless local area network services. A consultation is
currently being carried out by the Telecommunications Authority with regard to the creation of a
third class license to regulate the resale of certain telecommunications services. See section
entitled Recent Regulatory Developments in the Telecommunications Industry below for more
details. Interconnection Interconnection between telecommunications networks and services are regulated under the
Telecommunications Ordinance and the relevant license conditions. Hong Kongs current policy on
interconnection, including the applicable charging principles and methodology, is set forth in a
series of statements issued by the Telecommunications Authority which were substantially revised in
2002 and further revised in July 2004 following the Chief Executives decision to withdraw
mandatory Type II interconnection at the local telephone exchange level by June 2008. For a more
detailed discussion, refer to the section entitled  Recent Regulatory Developments in the
Telecommunications Industry below in this annual report. The Telecommunications Authority divides interconnection into two main types: The first type
is Type I Interconnection, which is interconnection between network gateways, such as tandem
exchanges, local exchanges or dedicated interconnection gateways, which allows end users on
different networks to communicate with each other. The second type is Type II Interconnection,
which is a connection to a fixed carriers network at points of the customer access network level
(more often referred to as local access or local loop unbundling) allowing the end customer
requesting the interconnection to use the customer access network of the fixed carrier to obtain
fixed telecommunications services. The Telecommunications Authority is empowered to determine the
terms and conditions of both types of interconnections (including the applicable charges) and a set
of guidelines was issued in 1995 (and amended in 2001) setting forth the procedures that the
Telecommunications Authority will follow in making such a determination. 46




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Competition Provisions Regulation of Anti-Competitive Conducts Although Hong Kong has never had a general competition code, historically, holders of FTNS
Licenses were prohibited from engaging in anti-competitive conduct by certain competition-related
license conditions contained in the FTNS Licenses issued by the Telecommunications Authority. The
Telecommunications Authority issued in June 1995 a set of guidelines on how the Telecommunications
Authority would interpret the competition-related provisions in FTNS Licenses, which we refer to in
this annual report as the 1995 Competition Guidelines. When the Telecommunications Ordinance was amended in 2000, a set of competition-related
provisions, which are modeled on the competition-related license conditions contained in the FTNS
License, were introduced into the Telecommunications Ordinance. These statutory provisions provide
that a licensee is prohibited from engaging in any anti-competitive conduct, abusing its dominant
position in a telecommunications market, or engaging in any discriminatory conduct. The Telecommunications Authority continues to apply the 1995 Competition Guidelines in the
application and enforcement of competition provisions contained in the Telecommunications Ordinance
and the FTNS Licenses. However, given that the competition provisions contained in the
Telecommunications Ordinance are applicable to all licensees, not just holders of FTNS Licenses,
the Telecommunications Authority commenced a consultation in February 2004 on the issuance of a new
set of competition guidelines to replace the 1995 Competition Guidelines. The Telecommunications Ordinance provides an appeal mechanism by the establishment of a
Telecommunications (Competition Provisions) Appeal Board. A person or a licensee aggrieved by a
decision made by the Telecommunications Authority relating to the competition provisions may appeal
to the Board. Additionally, a third party suffering loss or damage from breach of such competition
provisions may bring an action for damages or seek other appropriate remedies against the offending
licensee. Control on Mergers and Acquisitions In addition to the competition provisions mentioned above, the Telecommunications Ordinance
also contains a set of new provisions which aim to control certain merger and acquisition
activities within the telecommunications industry that have an anti-competitive effect. The
provisions were introduced by the Telecommunications (Amendment) Ordinance 2003, which we refer to
in this annual report as the 2003 Amendment. The 2003 Amendment came into force on July 9, 2004
after Telecommunications Authority finalized the Guidelines on Mergers and Acquisitions, which we
refer to in this annual report as the M&A Guidelines. This new regulatory regime on mergers and acquisitions only applies to carrier licensees,
which includes HKBN as a holder of a FTNS License, which, as discussed above, is regarded as a
carrier license for the purpose of the Telecommunications Ordinance. Under the 2003 Amendment, if the Telecommunications Authority determines that the relevant
merger and acquisition activity (defined as a change in the ownership or control over a carrier
licensee under the 2003 Amendment) has, or is likely to have, the effect of substantially lessening
competition in a telecommunications market, the Telecommunications Authority is empowered to direct
a carrier licensee to take such actions, such as the complete or partial divestiture of the
relevant parties interests in the merged entity, as the Telecommunications Authority considers
necessary, to eliminate or avoid any anti-competitive effect. However, the Telecommunications
Authority may not issue such a direction if he takes the view that the public benefit of the merger
and acquisition outweighs any detriment caused by a reduction in competition. 47




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The 2003 Amendment provides that a change in relation to a carrier licensee occurs when:  
    a person, either alone or with any associated person, becomes the beneficial owner or
voting controller of more than 15% of the voting shares in the carrier licensee (This
provision does not apply if the person, either alone or with any associated person, is
not or does not concurrently become the beneficial owner or voting controller of more than
5% of the voting shares in another carrier licensee and does not have or acquire the power
to ensure that the affairs of such other carrier licensee are conducted in accordance with
the wishes of such person); or
    a person, either alone or with any associated person, becomes the beneficial owner or
voting controller of more than 30% of the voting shares in a carrier licensee; or
    a person, either alone or with any associated person, becomes the beneficial owner or
voting controller of more than 50% of the voting shares in a carrier licensee, or acquires
the power (including by the acquisition of voting shares), by virtue of any powers
conferred by the memorandum or articles of association or other instrument regulating the
licensee or any other corporation or otherwise, to ensure that the affairs of the licensee
are conducted in accordance with the wishes of that person. An associated person is widely defined in the Telecommunications Ordinance and includes,
where the licensee is a corporation, a corporation over which the licensee has control, a
corporation which has control over the licensee or a corporation which is under the same control as
is the licensee. It also includes a person who controls the licensee and a relative and/or partner
of that person (in the case of a natural person) or a director or principal officer of the
corporation. Although the 2003 Amendment essentially creates an ex post regime whereby regulatory control
will be exercised by the Telecommunications Authority after a merger and acquisition has been
completed, the 2003 Amendment also provides that a carrier licensee (or any interested party, such
as the acquirer) may seek the prior consent of the Telecommunications Authority on a voluntary
basis to any proposed merger or acquisition falling within the definition of change. In this way,
a carrier licensee will have the opportunity to consider whether to seek prior consent, taking into
account the consequences of being potentially required by the Telecommunications Authority to
unwind the transaction, after its completion, if the transaction is found to have an
anti-competitive effect. In addition, the Telecommunications Authority states in the M&A Guidelines that carrier
licensees or interested parties are welcome to have informal preliminary discussions with the
Telecommunications Authority concerning any proposed merger or acquisition. The view expressed by
the Telecommunications Authority in any such informal discussion is, however, non-binding. The 2003 Amendment and the M&A Guidelines further outline the competition analytical framework
which the Telecommunications Authority will adopt and the matters which he will take into
consideration in assessing if the merger or acquisition in question will or is likely to raise any
competition concern in the relevant telecommunications market. Any decision made or direction issued by the Telecommunications Authority under the mergers
and acquisition provision is subject to appeal to the Telecommunications (Competition Provisions)
Appeal Board. Consumer Protection The Telecommunications Ordinance also contains a statutory provision that is primarily aimed
at protecting consumers. This provision prohibits a licensee from engaging in any misleading or
deceptive conduct. The Telecommunications Authority issued the Guidelines in relation to Misleading or Deceptive
Conduct in the Hong Kong Telecommunications Markets in May 2003, which provide practical 48




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guidance on the application and enforcement of the relevant provision in the Telecommunications Ordinance. The Telecommunications Authority has taken an active role in enforcing this prohibition and
has developed voluntary codes to assist in this respect. For instance, in November 2004, the
Telecommunications Authority issued a Code of Practice for the Service Contracts for the Provision
of Public Telecommunications Services which sets out guidelines on the preparation of service
contracts. The code states that important terms of a service contract (e.g. a compensation clause
for early termination by the customer) should be presented in a prominent place and should be
highlighted in the contract. The code is applicable to all service providers (except mobile network
operators which are subject to a separate code of practice) including holders of FTNS Licenses,
such as HKBN, and holders of PNETS ETS Licenses and IVANS Licenses, such as ourselves and IDD 1600.
Although the guidelines are voluntary in nature, the Telecommunications Authority has indicated
that the extent of a licensees compliance with the guidelines will be taken into account in
assessing if a licensee has complied with the statutory provision mentioned above. In addition, on June 17, 2002, the Telecommunications Authority in conjunction with the Hong
Kong Consumer Council, the Independent Commission Against Corruption, and the Office of the Privacy
Commissioner of Personal Data issued a voluntary Code of Practice on the Protection of Customer
Information for Fixed and Mobile Service Operators. The code applies to fixed and mobile operators
and its objective is to set out best practices for such operators for the protection of customer
information (e.g. telephone numbers, residential addresses and details of call history) in light of
the existing sanctions under Hong Kong legislation preventing unauthorized disclosure of protected
information to third parties. Apart from the Telecommunications Ordinance, like any companies carrying on business in Hong
Kong, telecommunications operators are required to comply with applicable Hong Kong consumer
protection laws, for example, the Sale of Goods Ordinance (Cap 26), Control of Exemption Ordinance
(Cap 71), Supply of Services (Implied Terms) Ordinance (Cap 457), and the Unconscionable Contracts
Ordinance (Cap 458). Regulation of Pricing Currently, the pricing of both fixed telecommunications network services and public
non-exclusive external telecommunications services in Hong Kong is regulated by license conditions.
However, the regulatory frameworks of each type of services are different. All PNETS Licenses contain license conditions requiring the licensees to publish their tariffs
and to charge no more than the published tariffs. In other words, the Telecommunications Authority
imposes a maximum ceiling on the prices that holders of PNETS Licenses may charge for their
services. Similarly, holders of FTNS Licenses are prohibited by license conditions from charging more
than their published tariffs for their services. Additionally, the FTNS License conditions prohibit
licensees from offering discounts to their published tariffs and require the licensees to seek
approval from the Telecommunications Authority in connection with (i) any revision of published
tariffs, (ii) tariffs for any new services or products or (iii) tariffs for any trial services.
However, the Telecommunications Authority may grant a waiver of the application of any or all of
these restrictions in relation to a relevant telecommunications market if, in the opinion of the
Telecommunications Authority, the licensee is not dominant in such market. This is known as an ex
ante regime. HKBN has been granted a waiver from all the tariff revision prohibitions contained in its FTNS
License and is able to provide discounts and revise its tariffs in all the fixed telecommunications
network services markets. While it is beyond the scope of this annual report to provide a full account of waivers
granted, it is important to note that prior to January 14, 2005 PCCW-HKT was the only holder of a
FTNS License that was not granted a waiver and was bound by ex ante regulation of its prices in the fixed
telephony markets. 49




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On January 14, 2005 OFTA issued a new fixed carrier license to PCCW-HKT which
only required PCCW-HKT to notify the Telecommunications Authority of its actual prices at least one
day before they become effective. For a more detailed discussion, see the section entitled 
Recent Regulatory Developments in the Telecommunications Industry below in this annual report. Universal Service Contribution and Local Access Charge Under the current regulatory regime, as stated in two statements published by the
Telecommunications Authority in January 1998 and July 2000, PCCW-HKT has a universal service
obligation to provide basic telephone service to any individual or entity that requests it. To
compensate PCCW-HKT for the expenses of this obligation, certain licensees are required to
contribute to such costs, which is referred to as the universal service contribution, or USC.
Holders of FTNS Licenses and PNETS ETS Licenses including ourselves, HKBN, and IDD 1600 are
required to pay USC. The level of USC is determined by the Telecommunications Authority and is adjusted
periodically. The average rate has declined over the past several years. The Telecommunications
Authority recently published a statement on November 19, 2004 confirming that the level of
provisional USC on or after June 1, 2004 is approximately HK$0.3 cents per minute and the confirmed
USC for the period January 1, 2002 to December 31, 2002 for routes that are competitive, which are
referred to as Category A Routes, is HK$0.3 cents per minute and for routes that are to be provided
through Reach Networks Hong Kong Limiteds international gateways/facilities, which are referred to
as Category B Routes, is HK$1.9 cents per minute. It should be noted that after August 2003, all
routes have been classified as Category A Routes and as such, it is no longer necessary for the
Telecommunications Authority to set a provisional USC for Category B Routes. Additionally, providers of external telecommunications services, such as holders of PNETS ETS
Licenses, including ourselves and IDD 1600, are required to pay to the local network operators
whose network facilities holders of PNETS ETS Licenses use to transmit calls to and from their
customers sites a local access charge, or LAC. Although theoretically the operators holding PNETS
ETS Licenses may negotiate the level of LAC with operators whose LAC is not regulated, in practice,
the bench-mark used by operators is the LAC set by the Telecommunications Authority for PCCW-HKT,
whose LAC is regulated. The level of the LAC is calculated on a per-minute basis. At present, the Telecommunications Authority determines the level of LAC imposed by PCCW-HKT
and has indicated that it would determine the LAC imposed by other local fixed line network
operators if it were in the public interest to do so. A review of the principles and costing
methodology of the LAC was conducted by the Telecommunications Authority recently and a formal
statement was issued on February 27, 2004. Shortly before the statement was published, the Telecommunications Authority was requested by
providers of external telecommunications services to make a determination under the
Telecommunications Ordinance with regard to the level of the LAC of PCCW-HKT. Applying the revised
principles and costing methodology set forth in the statement, the Telecommunications Authority
issued its determination on May 4, 2004 and the level of LACs has been reduced and is summarized
below:  
    for LAC for outgoing traffic  from HK$0.121 to HK$0.086;
    for LAC for incoming traffic  from HK$0.126 to HK$0.088;
    for LAC (transit) for outgoing traffic  from HK$0.106 to HK$0.076;
    for LAC (transit) for outgoing traffic  from HK$0.106 to HK$0.076 The new level of LACs was intended to become effective on June 1, 2004. However, PCCW-HKT has
obtained leave for judicial review of the LAC determination and the court has granted an interim
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of the determination pending the outcome of that review. The judicial review commenced on
September 13, 2004, but the judgment of the court has not yet been handed down. Recent Regulatory Developments in the Telecommunications Industry In recent years, the Telecommunications Authority has introduced various measures to implement
the Hong Kong governments policy to liberalize the Hong Kong telecommunications market. The most
important changes have included the full liberalization of the local and external fixed
telecommunications network services market and the introduction of a formal competition regulatory
framework, as discussed above. As part of this ongoing process, the Telecommunications Authority and the Hong Kong government
are looking to introduce new measures to address issues relating to the new telecommunications
marketplace in Hong Kong. Currently, the most important regulatory developments include: Review Of Regulation Of Internet Protocol Telephony Although the Telecommunications Authority takes the view that IP telephony may be provided
under existing licenses, given the specific nature and the technology associated with such service,
the Telecommunications Authority issued a consultation paper on October 4, 2004 to canvass the
views of the public with regard to the appropriate regulatory framework for the provision of such
service. The Telecommunications Authority has invited the industry and interested parties to
comment on the following aspects of the service:  
    the appropriate policy and licensing framework for such service;
    issues relating to numbering, such as number portability;
    the appropriate interconnection arrangements, including the charging principles such as
the USC and LAC arrangements, relating to such service; and
    related consumer issues, such as access to emergency services (given that the service
may not be available if there is a power cut), quality of service and backup power supply. The consultation period ended on December 4, 2004. Review Of The Type II Interconnection Policy Following two rounds of consultation on the review of the Hong Kong governments policy on
Type II interconnection, the Communications and Technology Branch, or CTB, announced in July 2004
that the mandatory Type II interconnection policy applicable to telephone exchanges for individual
buildings (often referred to as Point A in statements issued by the Telecommunications Authority)
will be fully withdrawn by June 30, 2008. The mandatory Type II interconnection policy was drawn up
in 1995 and is applicable to PCCW-HKT, HGC, Wharf T&T and New World. Under this policy, each of
these four FTNS License holders has the right to request (and the obligation to provide)
interconnection with the other relevant FTNS Licensees at any point in the copper-wire local loops
of the licensee providing interconnection. In practice, it is PCCW-HKT which is required to meet
the mandatory obligation given the extensive coverage of its copper-wire local loops. In the interim, the mandatory Type II interconnection policy will be withdrawn on a
building-by-building basis. Buildings that are served by at least two self-built customer access
networks will no longer be subject to the mandatory Type II Interconnection policy following a
two-year transitional period. There will be, in addition, a grandfather period of one year
following the expiry of the transitional period to protect regulated interconnection terms
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transitional period. After the grandfather period, fixed network access to Point A of the
local loops should be subject to commercial negotiations between the carriers. The Telecommunications Authority further clarified in a statement entitled Review of Type II
Interconnection Policy dated July 6, 2004 that mandatory Type II interconnection policy continues
to apply to the following:  (i)
    buildings meeting the essential facilities criterion that justifies mandatory
interconnection in the consumer interest; and(ii)
    interconnection at the street level (often referred to as Point B) and at the
in-building level (often referred to as Point C). It should be noted that the Type II interconnection policy only applies to copper-based local
loops. It does not apply to fiber-based local loops as the Hong Kong government wishes to encourage
network operators to upgrade their networks from copper-based to fiber-based. The maintenance of the mandatory Type II interconnection at the in-building level means that
network operators which roll-out their own copper-based in-building systems, such as HKCTV and
HKBN, will continue to be required to permit other operators to access their respective local loop
facilities. The Telecommunications Authority also issued a statement in July 2004 detailing the
implementation steps for the new policy. Introduction Of A New Class License To Regulate Certain Resale Activities Currently, telecommunications service providers which provide telecommunications services
without establishing or maintaining a means of telecommunications (or pure resellers of
telecommunications services) are not subject to the licensing regime outlined above. However, the
Hong Kong government introduced provisions in the Amendment Ordinance in 2000, which provide that a
person who, in the course of business, offers a telecommunications service is required to obtain a
license. These provisions are not yet in operation. The Telecommunications Authority issued a consultation paper on October 15, 2004 proposing
partially to bring into force the provisions referred to above in order to regulate the following
two types of resale by the creation of a new class license:  (i)
    the resale of telecommunications services on a prepaid basis (e.g. the resale of
calling cards); and(ii)
    the resale of telecommunications services by an associated corporation of a carrier or
a telecommunications licensee in a dominant position. The consultation period ended on December 14, 2004. Introduction of an Ex post Price Control Regime The Telecommunications Authority issued a consultation paper on October 8, 2004 regarding its
proposal to move from ex ante to ex post regulation of the tariffs of PCCW-HKT in response to two
applications by PCCW-HKT to be declared non-dominant in the markets for residential and business
direct exchange line telephone services. On January 14, 2005, OFTA issued a new fixed carrier license to PCCW-HKT (to replace its then
existing FTNS License) that effectively allows PCCW-HKT to provide discounts to customers in these
markets and lifts the requirement that PCCW-HKT obtain prior approval from the Telecommunications
Authority before adjusting its tariffs. 52




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The two applications made by PCCW-HKT for declaration of non-dominance in business and
residential direct exchange line services have become redundant upon the surrender of its then FTNS
license for the new fixed carrier license on January 14, 2005. Under its new fixed carrier
license, PCCW-HKT is now only bound by the competition related regulations prohibiting the abuse of
a dominant position in a relevant market or markets (including, for example, a prohibition against
predatory pricing) if, and only if, PCCW-HKT is found to be dominant in the relevant market(s).
For a more detailed discussion please refer to the section entitled  Competition Provisions
above in this annual report. Television Broadcasting Industry History Until the end of 1990, Hong Kong had only two television broadcasters, Television Broadcasts
Limited, or TVB, and Asia Television Limited, or ATV, that operated under licenses granted by the
then Governor in Council under the Television Ordinance. In December 1990, a satellite television uplink and downlink license was granted to
Hutchvision Hong Kong Limited (now Starvision Hong Kong Limited, or Star TV), by the
Telecommunications Authority for the provision of satellite television services. The market was
further opened up by the grant to HKCTV (then known as Wharf Cable Limited) of a broadcasting
license for the provision of subscription television services in 1993. To protect the heavy
investment involved in the provision of subscription television services, the Hong Kong government
agreed to grant exclusivity to HKCTV for three years. In March 1993, PCCW-HKT was permitted to conduct a commercial trial of video-on-demand
services, which we refer to in this annual report as VOD. The VOD trial service provided by
PCCW-HKT led to HKCTV taking legal action against both the Hong Kong government and PCCW-HKT
alleging breach of its exclusive license. However, it was held that VOD should not be classified as
a broadcasting service for the purpose of the then Television Ordinance (now repealed, see below)
but as a point-to-point telecommunications service which PCCW-HKT would be entitled to provide
under its telecommunications concession granted under the Telephone Ordinance. Following a comprehensive review of the pay-TV industry in 1996, the Television Ordinance was
amended in 1997 and a new category of license  programme service license  was created to bring
the VOD services into the television regulatory regime. In 1998, a program service license was
granted to PCCW VOD Limited, or PCCW-VOD. In September 1998, the CTB (then the Information Technology and Broadcasting Bureau) published
a consultation paper entitled 1998 Review of Television Policy. A number of important decisions
were made following the review including that the moratorium on pay-TV would be lifted and the
market for pay-TV would be opened for free competition from 1998. Simultaneously, the CTB proposed new legislation implementing the policy decisions reached by
the Hong Kong government in 1998 and intended to replace the Television Ordinance. The proposed
legislation would establish a new regulatory regime under which the broadcasting service and the
operation of the underlying telecommunications systems (for the transmission of the broadcasting
service) would be regulated separately, with the broadcasting service itself being subject to the
new legislation and the operation of the underlying telecommunications systems subject to the
telecommunications regulatory regime. At present, Hong Kong has two licensed domestic terrestrial broadcasters, TVB and ATV,
providing free-to-air broadcasting services. In addition, there are also three licensed domestic
pay-TV broadcasters, namely HKCTV, PCCW-VOD and Galaxy Satellite Broadcasting Limited. HKBN
provides TV services over the Internet under its FTNS License, while Star TV continues to provide
its services through satellite means under its satellite television uplink and downlink license. 53




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Regulatory Environment The main legislation in Hong Kong which regulates the television broadcasting industry is the
Broadcasting Ordinance (Cap. 562) and the Broadcasting (License Fees) Regulations (Cap. 562A). The
Broadcasting Ordinance was enacted in 2000 and repealed the Television Ordinance in its entirety. The Broadcasting Authority, a statutory board established under the Broadcasting Authority
Ordinance (Cap. 391), is the main regulator of the television broadcasting industry in Hong Kong. Licensing The Broadcasting Ordinance provides that it is an offence to provide a broadcasting service
without a license. Broadcasting service is further divided into four categories:  
    domestic free television program service;
    domestic pay television program service;
    non-domestic television program service; and
    other licensable television program service. Television programme service is broadly defined to mean the provision of television programs
for transmission by telecommunications that are readily accessible to the general public in or
outside Hong Kong or to persons in 2 or more specified premises simultaneously or on demand,
whether on a point-to- point or a point-to-multipoint basis. The Broadcasting Ordinance importantly exempts certain categories of television program
services from the current licensing regime, including television program services provided on the
service commonly known as the Internet. The Broadcasting Ordinance itself does not contain a
definition of Internet. The Secretary for Commerce, Industry and Technology has indicated that on
the condition that HKBN continues to provide its service on the platform currently deployed by
HKBN, the Government does not dispute that HKBNs service is provided on the Internet and is thus
exempt. On this basis, HKBN has not obtained a pay-television broadcasting license and provides
IP-TV services under its FTNS License. The exemption reflects the policy decision reached by the Hong Kong government in its 1998
television policy review. The policy statement issued by the CTB in December 1998 states that any
new multimedia service, including Internet originated in Hong Kong, which offers television-type
program services on a commercial basis and competes with television program services operating in
Hong Kong should require a television program service license but that Web TV should continue to
be regulated as an Internet service until it is caught by the foregoing description. The commercial television broadcasting licenses granted to TVB and ATV under the Television
Ordinance are deemed to be domestic free television program service licenses. The
Telecommunications Authority also issued to each of TVB and ATV a fixed carrier license in December
2003 in relation to the operation of the underlying fixed telecommunications network. The subscription television broadcasting license issued to HKCTV and the program service
license granted to PCCW-VOD under the Television Ordinance are deemed to be domestic pay television
program service licenses. PCCW-VOD applied to the Hong Kong government for the surrender of its
original program service license and requested the Chief Executive in Council to issue to it a
domestic pay television program service license. Such a license was granted to PCCW-VOD in 2003. The validity period of a broadcasting license varies and will be determined by the Chief
Executive in Council but it is unlikely that a license with a validity period exceeding 12 years
would be approved. 54




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The license fee payable by a broadcasting licensee is set forth in the Broadcasting (License
Fee) Regulation. The license fee comprises a number of components, which include a fixed annual
amount (e.g. for a domestic pay television program service license, the amount is currently set at
around HK$1.4 million) and a variable component (e.g. for a domestic pay television program service
license, HK$4 for each subscriber). Cross Media Ownership Restrictions As with other television regulatory regimes, there are detailed cross-media ownership
restrictions in the Broadcasting Ordinance. The restrictions are only applicable to domestic free
and domestic pay television program service licenses. The Broadcasting Ordinance essentially provides that a company which is either a disqualified
person or has a disqualified person exercising control over it will not be eligible to be
granted a broadcasting license unless it discloses the disqualification in its license application. Disqualified person as defined under Sections 4, 5, 6 and 7 of Schedule 1 of the
Broadcasting Ordinance includes, for example,  
    a company which is an existing domestic free or domestic pay television program licensee;
    an advertising agent;
    a sound broadcasting licensee; or
    a proprietor of newspaper printed or produced in Hong Kong. A disqualified person who has complied with the disclosure requirement (and is otherwise in
compliance with Section 8 of the Broadcasting Ordinance) may apply for a broadcasting license
pursuant to Section 10 of the Broadcasting Ordinance. The Broadcasting Ordinance provides that the
Chief Executive in Council may grant a broadcasting license to a company, including a disqualified
person or to a company which has a disqualified person exercising control, over it or to a
disqualified person in which another disqualified person exercises control subject to such
conditions as the Chief Executive in Council sees fit. Foreign Ownership Restrictions In addition to the cross-media ownership restrictions outlined above, the Broadcasting
Ordinance also imposes restrictions on foreign ownership of a holder of a domestic free television
program service license. The restrictions do not prohibit the ownership of any voting shares in a
domestic free television program service licensee but rather take the form of prohibiting the
exercise of any voting rights attached to such voting shares. Competition Provisions The Broadcasting Ordinance also contain competition provisions which are aimed at:  
    prohibiting a licensee from engaging in anti-competitive conduct which is conduct
that has the purpose or effect of preventing, distorting or substantially restricting
competition in a television program service market;
    prohibiting a licensee who is in a dominant position from abusing its position. 55




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Certain trade practices however are exempted from the prohibition on anti-competitive
conduct provision and these include restrictions imposed on the inclusion in a television program
service of a television program produced wholly or substantially by the licensee of the service. The Broadcasting Ordinance provides that a breach of any of the competition statutory
provision may lead to the relevant contractual provisions in an agreement being regarded as void. The Broadcasting Authority to this end issued two guidelines in 2001: the Competition
Investigation Procedures and Guidelines to the Application of the Competition Provisions of the
Broadcasting Ordinance and Guidelines to the Application of the Competition Provisions of the
Broadcasting Ordinance. These guidelines outline the enforcement procedures and the competition
analytical framework which the Broadcasting Authority intends to adopt in order to implement the
competition provisions. The Broadcasting Authority recently concluded the investigation of a number of competition
complaints relating to certain sports broadcasting rights involving HKCTV, ATV and TVB. Unlike the regulatory regime for the telecommunications industry, there is no equivalent of a
specialised competition appeal board for the television broadcasting industry. A licensee aggrieved
by a decision made by the Broadcasting Authority however may lodge an appeal to the Chief Executive
in Council. Program Standards and Advertising Standards A broadcasting licensee is required to comply with the program standards and the advertising
standards published by the Broadcasting Authority. The program standards and the advertising
standards were revised recently in June 2003 and August 2004, respectively. 56




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Organizational Structure The following chart sets forth our principal subsidiaries as of January 31, 2005: (ORGANIZATIONAL CHART)   (1)
    
    The other immediate subsidiary of City Telecom (H.K.) Limited is Golden Trinity
Holdings Limited, which has Warwick Gold Enterprises Limited and Attitude Holdings Limited as
its immediate subsidiaries.(2)
    
    The company has only registered its Chinese name. The English name is an
unregistered translation.(3)
    
    The other immediate subsidiaries of Automedia Holdings Limited are iStore.com
Limited, TeachOnNet.com Limited, CTI International Limited, BBTV Company Limited, City Telecom
(U.S.A.) Inc., City Telecom (Vancouver) Inc. and City Telecom (Toronto) Inc.(4)
    
    The other subsidiary of City Telecom (Canada) Inc. is 963673 Ontario Ltd.(5)
    
    The immediate subsidiaries of Hong Kong Broadband Network Limited are Excel Billion
Profits Limited, Hong Kong Television Network Limited, Hong Kong Broadband Television Company
Limited and Hong Kong Broadband Phone Limited. 57




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The jurisdiction of incorporation and our ownership percentage of each these subsidiaries
as of January 31, 2005 were as follows: Percentage ofinterest held by CityTelecom (%)Name
    
    Jurisdiction of Incorporation
    
    
    Direct
    
    
    Indirect963673 Ontario Limited
    
    Canada
    
    
    
    
    
    
    100Attitude Holdings Limited
    
    British Virgin Islands
    
    
    
    
    
    
    100Automedia Holdings Limited
    
    British Virgin Islands
    
    
    100BBTV Company Limited
    
    Hong Kong
    
    
    
    
    
    
    100City Telecom (B.C.) Inc.
    
    Canada
    
    
    
    
    
    
    100City Telecom (Canada) Inc.
    
    Canada
    
    
    
    
    
    
    100City Telecom (Toronto) Inc.
    
    Canada
    
    
    
    
    
    
    100City Telecom (U.S.A.) Inc.
    
    United States
    
    
    
    
    
    
    100City Telecom (Vancouver) Inc.
    
    Canada
    
    
    
    
    
    
    100City Telecom Inc.
    
    Canada
    
    
    
    
    
    
    100City Telecom International Limited
    
    British Virgin Islands
    
    
    100Credibility Holdings Limited
    
    British Virgin Islands
    
    
    100CTI Guangzhou Customer Services Co. Limited(1)
    
    China
    
    
    100CTI International Limited
    
    Hong Kong
    
    
    
    
    
    
    100CTI Marketing Company Limited
    
    Hong Kong
    
    
    
    
    
    
    100Excel Billion Profits Limited
    
    Hong Kong
    
    
    
    
    
    
    100Golden Trinity Holdings Limited
    
    British Virgin Islands
    
    
    100Hong Kong Broadband Network Limited
    
    Hong Kong
    
    
    
    
    
    
    100Hong Kong Broadband Phone Limited
    
    Hong Kong
    
    
    
    
    
    
    100Hong Kong Broadband Television Company Limited
    
    Hong Kong
    
    
    
    
    
    
    100Hong Kong Television Network Limited
    
    Hong Kong
    
    
    
    
    
    
    100IDD1600 Company Limited
    
    Hong Kong
    
    
    
    
    
    
    100iStore.com Limited
    
    Hong Kong
    
    
    
    
    
    
    100TeachOnNet.com Limited
    
    Hong Kong
    
    
    
    
    
    
    100Warwick Gold Enterprises Limited
    
    Hong Kong
    
    
    
    
    
    
    100
   (1)
    
    The company has only registered its Chinese name. The English name is an unregistered
translation. Property, Plants and Equipment For the provision of fixed telecommunications network services, we own, or control through
long-term leases, equipment consisting of in-building wiring, switching, transmission and receiving
equipment and connecting lines comprised of fiber-based backbone, wireless and leased wire-line
backbone and other support structures, conduits and similar items that comprise our Metro Ethernet
network. The majority of the fiber-based backbone connecting our services to other
telecommunications operators and power sources are under public road, highways and streets. HKBN,
our wholly owned subsidiary, owns two offices with an aggregate of 147,000 square feet and two
switching centers comprised of five switching systems in Hong Kong. For the provision of international telecommunications services, we own three switching systems
in Hong Kong and two in Canada (one each in Vancouver and Toronto). We have invested and have
rights to dedicated capacity in two undersea cables, the Japan-U.S. cable and the APCN 2 cable, for
use as international transmission facilities, both of which were completed and have been
operational since May 2002. In addition, we lease a retail shop and own a customer service center in Hong Kong. 58




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ITEM 5. OPERATING AND
FINANCIAL REVIEW AND PROSPECTS You should read the following discussion together with the rest of this annual report,
including the financial statements and related notes included elsewhere in this annual report. The
results discussed below are not necessarily indicative of the results to be expected in any future
periods. Overview We are a fast growing and innovative provider of residential and corporate fixed
telecommunications network and international telecommunications services in Hong Kong. We offer our
customers an integrated suite of broadband Internet access, local VOIP, IP-TV and corporate data
services through our self-owned Metro Ethernet network. As of August 31, 2004 we had a total of
approximately 465,000 fixed telecommunications network services subscriptions, consisting of
approximately 197,000 broadband Internet access, 237,000 local VOIP and 31,000 IP-TV services
subscriptions, and as of December 15, 2004, we had a total of approximately 490,000 subscriptions,
consisting of approximately 201,000 broadband Internet access, 253,000 local VOIP and 36,000 IP-TV
services subscriptions. In addition to providing fixed telecommunications network services, we
believe that we are one of the largest providers of international telecommunications services in
Hong Kong. We offer a variety of international telecommunications services and products including
direct dial services, international calling cards and mobile call forwarding services. Our total
international telecommunications services customer database comprises approximately 1.9 million
registered accounts with an average of 500,000 customers that are billed on a monthly basis. Our self-owned network is one of the worlds largest Metro Ethernet networks and is cited as a
global reference case by our primary vendors, Cisco Systems, Inc. and Nortel Networks Limited. Our
Metro Ethernet network has a current coverage of 1.2 million home passes, which represents
approximately 60% of Hong Kongs population. The coverage of our network is concentrated in Hong
Kongs most densely populated areas and reaches on average 3,000 residential buildings with
approximately 400 residences per building and approximately 610 commercial buildings making us one
of the largest residential fixed telecommunications network operators in Hong Kong. In most other
markets, Metro Ethernet is primarily used in commercial buildings in metropolitan areas, as the
technology is most cost effective in dense user populations where a provider can service a large
number of users in a single building or cluster of buildings. We have applied this technology to
densely populated residential areas in Hong Kong where most of our customers live in high-rise
apartment buildings with multiple apartments per floor. This has enabled us to contain our core
network costs to approximately US$130 per home pass. Our Metro Ethernet network conforms to
industry standards for 10/100/1,000 Mbps Internet access speeds. All of our fixed
telecommunications network services are based on the single Internet Protocol, or IP, platform of
our Metro Ethernet network, unlike our competitors who use multiple platforms to provide their
services. In addition, unlike most of our competitors, we operate an end-to-end network that
transmits data between our subscribers premises, our IP network hub sites and our switching
centers in Hong Kong. We were incorporated in May 1992 and we began offering international telecommunications
services in September 1992. From that date, we focused on increasing our subscription base and
amount of international traffic, and on building the CTI brand name as a low cost provider of
international telecommunications services. In January 1999, we became the first Hong Kong company
to obtain a public non-exclusive telecommunications services license, which we refer to in this
annual report as a PNETS License, covering the provision of international telecommunications
services using international simple resale, which had a significant positive impact on our
international telecommunications revenues. We incorporated HKBN in Hong Kong in August 1999 and
launched our broadband Internet access services in March 2000. In addition, we began providing
local VOIP services in April 2002, IP-TV services in August 2003, and corporate data services in
July 2004 using our Metro Ethernet network. Because of the various changes to our business over the past three years, our ability to
forecast our revenues with any degree of accuracy is somewhat limited. In addition, we cannot be
sure that our planned capital expenditures and our marketing and sales expenditures will
necessarily lead to increased 59




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revenues. In fiscal 2004, our total revenue dropped by 9.9% from HK$1,298.9 million in fiscal 2003 to
HK$1,169.9 million, due to a significant drop in revenue from our international telecommunications
services. In addition, our operating profits for this business declined by 52.3% from HK$338.9
million in fiscal 2003 to HK$161.5 million in fiscal 2004. Though our international call traffic
increased in terms of total number of minutes carried, this was offset by the drop in average
tariff rates resulting in a decrease in revenue and operating profits. With the drop in average
tariff rates, we expect that our profit margins in the international telecommunications services
will continue to be under pressure. To maintain our market share, we must continue to offer our
subscribers international telecommunications services that are competitive with the prices offered
by other market players. We therefore must continue to lower our costs of providing these services
if we are to maintain our profitability in this business. Operating Environment Our fixed telecommunications network operations The wireless-based FTNS License that HKBN obtained from the Telecommunications Authority in
February 2000 provided HKBN with the authority to begin installation of the wireless network that
we use to provide broadband Internet access services. To enable HKBN to provide fixed
telecommunications network services using wire-line technology in addition to wireless technology,
our FTNS License was amended in April 2002 to include provision of local fixed wireline network
services. This amendment allowed us to develop our own fiber-based backbone to replace our existing
wireless and leased wireline-based backbone. During fiscal 2004, we reduced the percentage of our
home-passes serviced by wireless backbone from 60% to 28%, and we are on target to have more than
90% of our Metro Ethernet home passes serviced by our self-owned fiber-based backbone by the end of
fiscal 2005. To maximize our return on investment, we have focused on building our Metro Ethernet
network in Hong Kongs most densely populated areas to achieve cost savings and provide additional
bandwidth capacity for further growth. After our initial capital expenditure, we expect our
operating costs to decline and our service quality to improve because we will rely less on backbone
transmission facilities owned by third parties and thereby decrease the leasing fees that we pay. Having our own fiber-based backbone allows us to offer broadband Internet access, local VOIP,
IP-TV and corporate data services over a single IP platform without being subject to network
limitations of other fixed telecommunications network operators. During fiscal 2004, we devoted
considerable resources to marketing our local VOIP and IP-TV services. As a result, our revenues
from fixed telecommunications network services grew by 28% compared to fiscal 2003. Our international telecommunications operations From September 1992 until December 1998, we relied on the circuits of local fixed line network
operators and other overseas carriers to transmit our international calls. This type of
international telecommunications service is commonly referred to as callback. A change in Hong
Kong telecommunications regulations that took effect in January 1999 allowed us to obtain a license
to use international simple resale to transmit international calls. In 2001 we obtained a satellite
based External FTNS License, and then upgraded to a full External FTNS License in 2002. We have
since acquired the exclusive use of several leased international transmission circuits for direct
transmission of international calls between our switches in Hong Kong and switches in other
countries. The license upgrades have had a positive effect on our international telecommunications
revenues and profits. Additionally, in part due to use of our self-owned capacity on undersea
cables, the quality of the service we provide has improved and our transmission costs have
decreased. Our total international telecommunications services customer database comprises approximately
1.9 million registered accounts with an average of 500,000 customers that are billed on a monthly
basis. Our international traffic volume has increased each year since we began providing
international telecommunications services with the exception of fiscal 2003. In fiscal 2003, we
faced significant competitive pressures from both new market entrants and existing players who
adopted aggressive pricing strategies. This created downward pressure on the tariff rates in the
marketplace, which we chose in part 60




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not to match due to the simultaneous increase in termination fees imposed by Chinas MII. See
Item 3 Key Information  Risk Factors  Risk Relating to the Regulatory, Political and Economic
Environment  Our revenues may be adversely affected by increases in tariffs mandated by the
Chinese government and other international carriers of this annual report. In fiscal 2004, we
continued to face heavy competition and large decreases in average tariff rates, but we have kept
our prices at levels comparable to our competitors prices and our traffic volume has rebounded to
1,007.0 million minutes in fiscal 2004 as compared to 888.0 million and 915.9 million minutes in
fiscal 2003 and fiscal 2002, respectively. In terms of traffic routes, China is still the single largest contributor to our international
telecommunications revenues and accounted for approximately 70% of our total traffic in fiscal
2004. The second and third most popular routes remained the United States and Canada, which
together accounted for approximately 12% of our total traffic in fiscal 2004. We have continued to maintain our focus on corporate customers among our international
telecommunications subscribers. We have particularly focused on small-to-medium enterprises, as we
believe our combination of high-quality services and attractive pricing gives us an advantage over
other service providers. Our corporate customer base had grown to 96,754 registered accounts as of
August 31, 2004 with an average of 60,000 customers that are billed on a monthly basis. Because our
corporate customers generally use greater volumes of our services than residential customers, our
corporate customers generate higher revenues per subscriber than residential customers. We intend
to continue marketing our international telecommunications services to small-to-medium enterprises
and other corporate customers in fiscal 2005. Our revenues Fixed Telecommunications Network Services.We charge our customers a monthly service charge
for each of the fixed telecommunications network services that we provide, and the scalability of
our network allows us to sell additional services to our existing customers, for example adding
local VOIP or IP-TV services to our current broadband Internet subscribers, with minimal additional
network and operating costs. As a result, each new service we add to our existing subscription base
contributes significantly to our profitability. We have not generally sold our fixed
telecommunications network services bundled together at discounted rates. Instead, we have focused
on increasing our subscription base by offering a single service to new subscribers at an
attractive entry price. After the customer has begun to use our service, we then try to up-sell
additional services to the customer. In addition to the monthly service charges generated by our fixed telecommunications network
business, we also receive interconnection charges from other telecommunications operators in Hong
Kong that use our network to deliver their customers telecommunications traffic. These charges
include:  
    Local access charges, which we earn when other carriers international
telecommunications traffic is carried over our network;
    Local interconnection charges, which are per-call and per-minute charges for other
fixed line carriers calls that are terminated on our network; and
    Mobile interconnection charges, which we charge to mobile telecommunications operators
that deliver incoming and outgoing traffic over our network. As with other Hong Kong fixed network operators, we invoice other carriers for each of these
charges based on the rates for such charges set by PCCW-HKT. These charges comprised approximately
15% of our fixed telecommunications network revenues in fiscal 2004. International telecommunications.Substantially all of our international telecommunication
revenues are generated by the per minute fees that we charge our IDD customers. For each of our
1666 and 0030 calling plans, these charges vary according to the destination of the call. For our 0030
calling plan, we 61




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also provide certain discounts that depend on the time of day or day of the week
at which the call is placed. In addition to our per minute charges, we also record a small amount of international
telecommunications revenue from our resale of household appliances to existing customers through
our Guangzhou calling center, direct mail and on our website. We earn revenues based on the
difference between the price the product distributors charge us for the appliances, and the amount
that we collect from our customers. Revenue from this activity accounted for less than 1.0% of our
international telecommunications revenues in fiscal 2004. Our Expenses Fixed Telecommunications Network Services.Since 2001, we have invested significant resources
in the development and expansion of our Metro Ethernet network. The scalability of this network
allows us to provide multiple services and increase our revenues per subscription with only small
incremental increases to our cost of services. Cost of Services.Our fixed telecommunications network cost of services primarily consists of
three components:  
    Backbone expenses.To provide broadband Internet access, local VOIP and IP-TV services
in areas where we have not yet installed our own fiber-based backbone, we incur leased
wireline backbone charges, which we currently pay to other local fixed telecommunications
network operators, with respect to the fixed lines that carry the data between the
subscribers premises, our IP network hub sites and our two switching centers in Hong Kong.
However, as we continue to upgrade and expand our fiber-based backbone, we reduce our
reliance on leased transmission capacity.
    Local interconnection charges.We pay fees to local fixed network operators to
transmit information that originates on our network and is terminated outside our network
over their fixed lines.
    International leased lines.We pay fees to international bandwidth providers in
connection with the leased lines that carry the data from our switching centers to overseas
destinations. Operating Costs.We have incurred significant operating costs related to our efforts to
promote our broadband Internet access, local VOIP, IP-TV and corporate data services. As a result,
our subscription acquisition costs have been relatively high. During fiscal 2004, we spent
approximately 29% of our fixed telecommunications network services revenues on sales and marketing
activities. We expect that we will be required to continue to invest significant financial and
human resources in our sales and marketing efforts as we strive to build our subscription base,
particularly as we begin to more extensively market our BB100 broadband Internet access service
and introduce pay television services that our customers will be able to watch using a personal
computer without the need for a set-top-box. Other operating costs related to our fixed telecommunications network services include
salaries and related costs, office, general and administrative costs and depreciation and
amortization. Our salaries and related costs include those employees working on our various service
offerings and on the upgrade and expansion of our Metro Ethernet network. International telecommunications.The expenses we incur for our international
telecommunications business consists of costs related to transmission, or cost of services, and
operating expenses. Cost of services.Our cost of services currently comprises four components:  
    Termination charges.When our subscribers calls arrive at the destination countries,
they are transferred to a local network services operator who delivers the calls to their
final destination. 62




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We pay these local network operators per-minute fees for each call delivered through their
networks to the end destination. For calls placed by our subscribers to countries in which
we do not have a bilateral or servicing agreement or our own switching system, we also pay
these carriers to transmit our calls from our switching facilities in Hong Kong to those
countries. Of the four components that comprise our international telecommunications
expenses, termination charges represent the largest component.
    Local Access Charges.We pay to the network carriers whose local loop facilities we
use to transmit calls to and from our customers sites a local access charge, or LAC. Our
LACs are calculated on a per-minute basis. LACs have been a significant component of our
cost of service for our IDD business, although we do not incur LAC charges for IDD calls
made by our customers that are also subscribers to our local VOIP service as we do not
require the use of other carriers facilities for such calls.
    Charges for our international leased lines.We lease international transmission
circuits from other international carriers between Hong Kong and a number of countries. We
use these circuits to carry our international traffic to and from such countries. We make
fixed monthly lease payments to these international carriers in connection with these
circuits. In fiscal 2004, we continued to benefit from our plan to reduce our reliance on
transmission facilities owned by third parties and lower our cost of services.
Specifically, we capitalized on the two contracts that we had entered into with large
consortia of international telecommunications companies to acquire undersea cable capacity.
Through the first contract, we invested in the Japan-U.S. undersea cable, which was
completed in August 2001. Pursuant to the second contract, we agreed to jointly construct
and maintain the APCN 2 undersea cable as an international transmission facility, which
commenced operation in May 2002. We spent a total of HK$120 million on these projects. We
believe the utilization of these undersea cables provides sufficient international capacity
for significant growth of our international call and broadband Internet services.
    Universal Services Contribution.PCCW-HKT has a universal service obligation to
provide basic telephone service to any individual or entity that requests it. To compensate
PCCW-HKT for the expenses of this obligation, all incoming and outgoing international calls
in Hong Kong are charged a per-minute fee payable to PCCW-HKT. The Telecommunications
Authority periodically adjusts the amount of this fee, which is commonly referred to as the
USC, and our average rate has declined over the past several years. The provisional USC was
approximately HK$0.3 cents per minute as of August 31, 2004 and, HK$1.3 cents per minute as
of August 31, 2003. We have historically paid PCCW-HKT USC fees according to the
provisional USC rate stipulated by the Telecommunications Authority, which were greater
than the actual USC fees that the Telecommunications Authority has subsequently determined
that we owe. As a result, we have deducted from our cost of services a USC fee refund from
PCCW-HKT in each of fiscal 2002, 2003 and 2004. Operating Expenses.In addition to cost of services, we generally incur significant sales and
marketing expenses in connection with our international telecommunications business. Sales and
marketing expenses consist of advertising costs, promotional and public relations expenses and the
salaries and other expenses relating to our commission-based sales personnel. Other operating costs
include maintenance costs associated with our network equipment, salaries and other related
expenses, office expenses and depreciation and amortization charges. Inflation We do not believe that inflation has had a material effect on our business, financial
condition or results of operations. If our costs were to become subject to significant inflationary
pressures, we may not be able to fully offset such higher costs through price increases. Our
inability or failure to do so could adversely affect our business, financial conditions and results
of operations. 63




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Seasonality Our operations are not generally subject to significant seasonal fluctuations. Our
international telecommunications revenues typically experience a slight decrease during the second
fiscal quarter of each year (December through February) in connection with the Chinese New Year
holiday. We do not believe that seasonality has had a material effect on our business, financial
condition or results of operations. Recent Development On
January 20, 2005 we successfully completed a US$125 million offering of
8.75% senior notes due 2015. This offering was an underwritten
transaction and our net proceeds were approximately US$121.0 million after deduction of expenses and
commissions. We used the net proceeds, in part, to repay in full an existing loan
facility in the outstanding amount of HK$196.7 million, and will use the remaining net proceeds for
capital expenditures, including costs incurred in expanding and
upgrading our Metro Ethernet
network in Hong Kong, and for additional working capital and general corporate purposes. Operating Results In addition to our operations in Hong Kong, we also provide international telecommunications
and Internet access services in Canada. We own all of the share capital of two telecommunications
companies in Canada, City Telecom Inc. and City Telecom (B.C.) Inc., through a wholly owned
subsidiary. We acquired our interests in these companies in December 1998 as part of our efforts to
increase our market share of the telecommunications traffic between Canada and Hong Kong. Our consolidated financial statements reflect the consolidated results of operations and
financial position of these subsidiary companies from the date of their acquisition by us. However,
as of August 31, 2004, none of these subsidiary companies located outside of Hong Kong has made a
material contribution to our revenues or results of operations, and in fiscal 2004, they
contributed approximately 2.0% to our revenues. The following table sets forth, for the years indicated, a summary of our results of
operations. Year Ended August 31,2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Restated)(1)
    
    
    (Restated)(1)(In thousands)Hong Kong GAAPRevenuesFixed telecommunications network services
    
    
    241,219
    
    
    
    423,107
    
    
    
    541,902
    
    
    
    69,475International telecommunications
    
    
    908,981
    
    
    
    875,802
    
    
    
    627,978
    
    
    
    80,5101,150,200
    
    
    
    1,298,909
    
    
    
    1,169,880
    
    
    
    149,985Cost of servicesFixed telecommunications network services
    
    
    (50,808
    )
    
    
    (76,845
    )
    
    
    (122,476
    )
    
    
    (15,702
    )International telecommunications
    
    
    (407,155
    )
    
    
    (245,908
    )
    
    
    (208,932
    )
    
    
    (26,786
    )(457,963
    )
    
    
    (322,753
    )
    
    
    (331,408
    )
    
    
    (42,488
    )Gross profitFixed telecommunications network services
    
    
    190,411
    
    
    
    346,262
    
    
    
    419,426
    
    
    
    53,773International telecommunications
    
    
    501,826
    
    
    
    629,894
    
    
    
    419,046
    
    
    
    53,724692,237
    
    
    
    976,156
    
    
    
    838,472
    
    
    
    107,497Operating expenses:Salaries and related costs
    
    
    (196,158
    )
    
    
    (220,350
    )
    
    
    (226,650
    )
    
    
    (29,058
    )Sales and marketing expenses
    
    
    (168,441
    )
    
    
    (182,471
    )
    
    
    (228,169
    )
    
    
    (29,253
    )Office, general and administrative expenses
    
    
    (98,413
    )
    
    
    (108,270
    )
    
    
    (129,787
    )
    
    
    (16,639
    )Depreciation and amortization
    
    
    (129,355
    )
    
    
    (176,020
    )
    
    
    (197,017
    )
    
    
    (25,258
    )Provision for doubtful accounts receivable
    
    
    (10,277
    )
    
    
    (17,685
    )
    
    
    (11,502
    )
    
    
    (1,475
    )Total operating expenses
    
    
    (602,644
    )
    
    
    (704,796
    )
    
    
    (793,125
    )
    
    
    (101,683
    )
 64




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Year Ended August 31,2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Restated)(1)
    
    
    (Restated)(1)(In thousands)Income from operations
    
    
    89,593
    
    
    
    271,360
    
    
    
    45,347
    
    
    
    5,814Interest income
    
    
    10,870
    
    
    
    3,163
    
    
    
    3,753
    
    
    
    481Interest expense
    
    
    (3,504
    )
    
    
    (601
    )
    
    
    (175
    )
    
    
    (22
    )Other income, net
    
    
    502
    
    
    
    1,678
    
    
    
    2,668
    
    
    
    342Income before taxation
    
    
    97,461
    
    
    
    275,600
    
    
    
    51,593
    
    
    
    6,615Income taxes
    
    
    (15,190
    )
    
    
    (17,857
    )
    
    
    (2,043
    )
    
    
    (262
    )Income after taxation
    
    
    82,271
    
    
    
    257,743
    
    
    
    49,550
    
    
    
    6,353Minority interest
    
    
    8,234
    
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    90,505
    
    
    
    257,743
    
    
    
    49,550
    
    
    
    6,353
   (1)
    
    In fiscal 2004, we adopted SSAP 12, issued by the Hong Kong Institute of Certified Public
Accountants, regarding the recognition of deferred tax. The adoption of SSAP 12 represents a
change in accounting policy, which we have applied retrospectively. As a result, financial
information provided for all years prior to fiscal 2004 have been restated to conform to the
changed policy. Year Ended August 31, 2004 Compared to Year Ended August 31, 2003 Revenue.In fiscal 2004, our total revenue dropped by 9.9% from HK$1,298.9 million to
HK$1,169.9 million, due to a significant decrease in revenue from our international
telecommunications services, which was partially offset by the continued revenue growth of our
fixed telecommunications network services. Our fixed telecommunications network services continued to record significant revenue growth
and increased their contribution to our total revenues, accounting for 46.3% of total revenue in
fiscal 2004, compared to 32.6% and 21.0% in fiscal 2003 and fiscal 2002, respectively. Revenue
increased from HK$423.1 million in fiscal 2003 to HK$541.9 million in fiscal 2004, representing
28.1% growth. While our number of broadband subscriptions increased from 172,000 as of August 31,
2003 to 197,000 as of August 31, 2004, our revenue from our Internet access service declined by
9.5% from HK$330.5 million in fiscal 2003 to HK$299.2 million in fiscal 2004. The decline was
mainly due to phasing-out of our resale of Megalink/Mega-access services, and loss of customers to
whom we previously provided dial-up Internet services to alternative broadband Internet access
providers, which more than offset our increase in broadband Internet access revenues. Our local VOIP services recorded significant growth as a result of our strong marketing
efforts and strong brand recognition, which resulted in an increase in local VOIP subscriptions
from 140,000 as of August 31, 2003 to 237,000 as of August 31, 2004. In fiscal 2004, our local VOIP
services revenues increased 156.8% from HK$92.6 million in fiscal 2003 to HK$237.7 million. Our IP-TV services, launched in August 2003, generated HK$5.0 million in revenue in fiscal
2004, and we had acquired 31,000 IP-TV subscriptions as of August 31, 2004. Our corporate data services were launched in July 2004 and therefore did not contribute
significantly to our revenues in fiscal 2004. Our international telecommunications business experienced a decrease of 36.8% in our average
prices per minute in fiscal 2004 compared to fiscal 2003. A principal reason for this decline was
that in fiscal 2003, we increased our rates for outbound calls to China in response to an increase
in the termination rates payable by us to our carrier partners for incoming telecommunications
traffic into China due to the imposition by Chinas MII of these rate increases. As approximately
65% of our outgoing calls in fiscal 2003 were to China, this increase had a significant effect on
our average prices per minute. When our carrier partners subsequently reduced their termination
charges, we were able to reduce our per minute charges as compared to fiscal 2003. In addition, in order to maintain our international telecommunications market share in fiscal
2004, we made the decision to price our international telecommunications services competitively
with other market players despite their aggressive pricing strategies. While we experienced an
increase in total traffic volume of 13.4% from 888.0 million minutes to 1,007.0 million minutes,
our international 65




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telecommunications services revenue decreased 28.3% from HK$875.8 million in fiscal 2003 to HK$628.0 million in
fiscal 2004. We expect the price competition to continue in fiscal 2005, but anticipate that the
decline in average prices will be less than in fiscal 2004. Cost of Services.Cost of services increased by 2.7% from HK$322.8 million during fiscal 2003
to HK$331.4 million during fiscal 2004. While cost of services with respect to our international
telecommunications services decreased, cost of services for our fixed telecommunications network
services increased significantly due to the addition of new subscriptions to our broadband Internet
access and local VOIP services, and start-up expenses associated with our IP-TV services. Accompanying the continued expansion of our Metro Ethernet network and service offerings, the
cost of services for our fixed telecommunications network services increased by 59.5% from HK$76.8
million in fiscal 2003 to HK$122.5 million in fiscal 2004 while representing 37.0% of the total
cost of services. The cost of services for our fixed telecommunications network services
represented 23.8% of our total cost of services in fiscal 2003. Our percentage increase in costs
was greater than our increase in revenues partly as a result of start-up costs of HK$19.2 million
we incurred in connection with our IP-TV services, which generated HK$5.0 million in revenues
during fiscal 2004. We account for the salaries of the production personnel that we employ for our
IP-TV operations in our cost of services, and we added several production personnel during fiscal
2004. Cost of services associated with our local VOIP services increased as our subscriptions
increased, and accounted for HK$64.6 million of our total cost of services. This increase also
contributed to our cost of services increasing at a greater rate than our revenues, as our gross
margins for local VOIP services are less than gross margins in broadband Internet access business. Cost of services for our international telecommunications operations decreased by 15.0% from
HK$245.9 million in fiscal 2003 to HK$208.9 million in fiscal 2004. Excluding the USC refund, our
international telecommunications costs decreased 27.1% to HK$240.6 million, compared to HK$330.0
million in fiscal 2003, despite our increase in traffic volume. This was principally due to our
efforts to leverage our significant volume of traffic to negotiate more attractive pricing with
service providers whom we rely on for international transmission. These savings were partially
offset by a decline in the amount of USC refund received from PCCW-HKT, from HK$84.1 million in
fiscal 2003 to a refund of HK$31.7 million in fiscal 2004. We have historically paid higher aggregate USC fees to PCCW-HKT based on provisional rates
stipulated by the Telecommunications Authority than the rates subsequently determined by the
Telecommunications Authority to be due, and therefore have received a USC refund in each year since
fiscal 2002. However, the uncertainty surrounding the Telecommunications Authoritys calculation of
the USC charge means that we cannot be sure whether we will receive such refunds in future periods,
or what the size of any such refunds may be. Gross Profit.Our gross profit decreased by 9.6% from HK$892.1 million during fiscal 2003 to
HK$806.8 million during fiscal 2004 without accounting for USC rebates. This decrease resulted from
the significant drop in revenues from our international telecommunications network services, which
we expect over time to become a smaller component of our revenues and profits as our fixed
telecommunications network services business matures. Gross profits contributed by our fixed
telecommunications network services increased by 21.1% from HK$346.3 million in fiscal 2003 to
HK$419.4 million in fiscal 2004 due to the cost effectiveness achieved from offering multiple
services over our Metro Ethernet network and thereby receiving multiple revenue streams with
minimal marginal cost. We achieved a profit margin of 77.4% (or 80.8% excluding IP-TV services)
from our fixed telecommunications network services compared to a 66.7% profit margin from our
international telecommunications services. Operating Expenses.Our operating expenses increased by 12.5% from HK$704.8 million during
fiscal 2003 to HK$793.1 million during fiscal 2004 due to increased sales and marketing expenses,
office, general and administrative expenses and depreciation and amortization expenses. 66




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Salaries and related costs.Salaries and related costs increased slightly by 2.9% from
HK$220.4 million during fiscal 2003 to HK$226.7 million during fiscal 2004. A large component of
this increase was attributable to the expansion of our fixed telecommunications network operations.
Most of the additional staff hired during fiscal 2004 were customer service and home equipment
installation employees necessitated by the growth of our customer base for local VOIP and IP-TV
services. Our total number of employees increased from 2,753 as of August 31, 2003 to 3,583 as of
August 31, 2004, of which 1,956 were located in Guangzhou, China, 1,598 were located in Hong Kong
and 29 were located in Canada. We also provided our employees with over 70 types of training
programs in fiscal 2004 in order to develop and enhance their productivity. Furthermore we remain
committed to research and development efforts. During fiscal 2004, we spent HK$6.0 million for
research and development, compared to HK$2.6 million during fiscal 2003. Sales and marketing expenses.Our sales and marketing expenses increased by 25.0% from
HK$182.5 million during fiscal 2003 to HK$228.2 million during fiscal 2004. This investment in
sales and marketing was important to the continued expansion of our customer base for fixed
telecommunications network services, which we believe will increase our revenues in the future. We
focused our marketing activities on direct customer sales, including door-to-door sales,
on-the-street promoters and telemarketing. Most of the increased marketing expenses were
attributable to sales commissions that directly related to our increased fixed telecommunications
network services revenues. Additionally, we incurred sales and marketing expenses in connection
with our free appliances promotion in fiscal 2004. Under this program, new subscribers receive a
household appliance upon signing a contract with HKBN for a term of 24 to 36 months, during which
period we more than recover the cost of the appliance. Finally, we account for salaries of our
sales and marketing personnel in this item, and our sales and marketing expense increased as we
added personnel to our sales and marketing team during fiscal 2004. We expect our sales and
marketing expenses to continue to increase as we continue to market our services to expand our
customer base. Office, general and administrative expenses.Office, general and administrative expenses,
excluding depreciation and amortization, increased by 19.9% from HK$108.3 million in fiscal 2003 to
HK$129.8 million fiscal 2004. This increase was due to the ongoing expansion of our operations. Depreciation and amortization.Depreciation and amortization expenses increased by 11.9% from
HK$176.0 million in fiscal 2003 to HK$197.0 million in fiscal 2004. This increase was driven by the
continued expansion of our Metro Ethernet network, which caused a 20.0% increase in depreciation
and amortization expenses in that segment of our business from HK$140.0 million during fiscal 2003
to HK$168.0 million during fiscal 2004. This increase was partially offset by a 19.5% decrease in
depreciation and amortization expense relating to our international telecommunications business,
which resulted from the full depreciation of certain of the assets used in this business. Provision for doubtful accounts receivable.We record provision for doubtful accounts
receivable based on the aggregate amount of our overdue accounts. We increased our number of
collection personnel, and strengthened our overdue account collection procedures during fiscal
2004, and were successful at reducing the amount of our overdue accounts. As a result, our
provision for doubtful accounts receivable decreased by 35.0% from HK$17.7 million in fiscal 2003
to HK$11.5 million in fiscal 2004. Income from Operations.Operating profit was HK$45.3 million in fiscal 2004, compared to
HK$271.4 million in fiscal 2003, representing a decrease of 83.3%. Operating profit from
international telecommunications operations decreased by 53.4%, from HK$336.7 million in fiscal
2003 to HK$156.8 million in fiscal 2004. The decrease was largely attributable to the large
decrease in average tariff rates per call, which more than offset our increase in international
call traffic. Operating losses from our fixed telecommunications network services increased
significantly, from a loss of HK$65.3 million in fiscal 2003 to a loss of HK$111.5 million in
fiscal 2004, as we incurred significant sales and marketing expenses related to these services, and
incurred start-up costs associated with our IP-TV and corporate data businesses. 67




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Interest Income and Expense.Our interest income was HK$3.8 million in fiscal 2004 compared
to HK$3.2 million in fiscal 2003. We derive interest income from our deposit of surplus capital in
interest-bearing accounts at commercial banks. The increase in interest income was due to an
increase in interest rates. Our interest expense was HK$0.2 million in fiscal 2004 compared to
HK$0.6 million in fiscal 2003. We also capitalized our borrowing costs of HK$3.1 million of the
funding for our network rollout. Other Income and Expense.Our other income and expense consists of the roaming charges we
receive from overseas carriers that deliver traffic over our network, exchange gains and losses,
small penalties we have received from time to time from contractors that we employ, and management
and other fees we receive from other fixed line operators in the ordinary course of our business.
Other income and expense was HK$2.7 million in fiscal 2004 compared to HK$4.4 million in fiscal
2003. Income Taxes.Income tax expense was HK$2.0 million for fiscal 2004 compared to HK$17.8
million during fiscal 2003. Income tax is based on our estimated assessable profit during each
period, and our income tax expense decreased in fiscal 2004 as a result of the decrease in our
assessable profit compared to fiscal 2003. Our effective tax rate decreased from 6.5% fiscal 2003
to 4.0% in fiscal 2004 as a result of the recognition of deferred tax assets on prior years
unrecognized tax losses brought forward from our fixed telecommunications network services business
that offset the taxes associated with profit generated from our international telecommunications
services in this year. Net Income.For the foregoing reasons, our net income decreased by 80.8% from HK$257.7
million in fiscal 2003 to HK$49.6 million in fiscal 2004. Year Ended August 31, 2003 Compared to Year Ended August 31, 2002 Revenue.In fiscal 2003, our total revenue grew by 12.9% from HK$1,150.2 million to
HK$1,298.9 million, spurred by a significant growth of our fixed telecommunications network
services and despite a slight revenue drop in our international telecommunications services. Fixed telecommunications network services continued to increase their strategic importance to
our operations. Revenue increased from HK$241.2 million in fiscal 2002 to HK$423.1 million in
fiscal 2003, representing 75.4% growth. Despite intense market competition with many operators
competing on price, our broadband customer base increased throughout fiscal 2003. Revenue generated
by broadband Internet access services was HK$330.5 million in fiscal 2003 compared to HK$239.2
million in fiscal 2002, representing 38.2% growth. Our local VOIP services also recorded significant growth as a result of our strong marketing
efforts and brand recognition. In fiscal 2003, our local VOIP services generated revenues of
HK$92.6 million, compared to HK$2.0 million for six months operations in fiscal 2002. We launched IP-TV services in August 2003, but these services did not generate revenues in
fiscal 2003. In the international telecommunications business, we were faced with several new market
entrants and existing players who adopted aggressive pricing strategies to seek higher market
share. In addition, the MII substantially increased the termination rate for incoming
telecommunications traffic in China. In an effort to maintain our profit margins in the
international telecommunications business, we significantly raised the fees we charge our
subscribers for outbound calls to China. As China represented 65% of our total outgoing
international telecommunications traffic in fiscal 2003, this had the effect of significantly
increasing our average prices per minute. However, this rate increase led to a drop in our outbound
traffic to China. Further, our market share was adversely affected, as some of our competitors did
not pass the full increase in termination charges on to their customers. The MII reduced the termination charge later in fiscal 2003. Rather than immediately reduce
our rates to correspond to the change in MII policy, we instead reduced our rates gradually over
the balance of the year. While the MII rate increase and our corresponding increases to our rates
had a minor adverse effect 68




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on our IDD revenues, which decreased 3.7% from HK$909.0 million in fiscal 2002 to HK$875.8
million in fiscal 2003, our international telecommunications profit margins and gross profitability
benefited significantly. Cost of Services.Cost of services decreased by 29.5% from HK$458.0 million during fiscal
2002 to HK$322.8 million during fiscal 2003. Cost of services for our fixed telecommunications network services increased by 51.2% from
HK$50.8 million in fiscal 2002 to HK$76.8 million in fiscal 2003, and represented 23.8% of the
total cost of services. By utilizing our own fixed network we were able to add subscriptions and
grow revenues cost effectively, and our increase in cost was much lower than the increase in
revenue. Cost of services for our international telecommunications operations decreased by 39.6% from
HK$407.2 million in fiscal 2002 to HK$245.9 million in fiscal 2003. This was principally due to our
receipt from PCCW-HKT of a refund of HK$84.1 million in USC fees in relation to previous years USC
payments, as well as our continuing efforts to reduce our international telecommunications costs.
Our average IDD costs per minute dropped (excluding the USC refund) by 15.9% compared to fiscal
2002. Cost of services for our international telecommunications operations were 76.2% of the total
cost of services in fiscal 2003, compared with 88.9% in fiscal 2002. Gross Profit.Our gross profit increased by 41.0% from HK$692.2 million during fiscal 2002 to
HK$976.2 million during fiscal 2003. This increase resulted from a number of factors, including
significantly higher revenue from the more profitable fixed telecommunications network services and
our cost effective strategy of using our IP network to deliver multiple fixed telecommunications
network services with corresponding revenue generation. In addition, gross profit benefited from
continuing favorable traffic cost obtained by leveraging our high IDD traffic volume and our
receipt of the HK$84.1 million USC refund. Operating Expenses.Our operating expenses increased by 17.0% from HK$602.6 million during
fiscal 2002 to HK$704.8 million during fiscal 2003. The change was due in large part to increased
depreciation and amortization expenses, as well as increased salaries and sales and marketing
expenses. Salaries and related costs.Salaries and related costs increased by 12.3% to HK$220.4 million
during fiscal 2003 from HK$196.2 million during fiscal 2002. A large component of this increase was
attributable to the expansion of our fixed telecommunications network operations. Most of the
additional staff we added during fiscal 2003 were customer service and installation employees,
which corresponded with our expanding local VOIP customer base. Our total number of employees
increased from 1,814 as of August 31, 2002 to 2,753 as of August 31, 2003, of which 1,418 were
located in Guangzhou and 1,305 were located in Hong Kong and 29 were located in Canada. During
fiscal 2003, we spent HK$2.6 million for research and development, compared to HK$2.2 million
during fiscal 2002. Sales and marketing expenses.Sales and marketing expenses increased by 8.4%, from HK$168.4
million during fiscal 2002 to HK$182.5 million during fiscal 2003. This increase was due to
additional sales and marketing expenses to achieve the continuing expansion of our fixed
telecommunications network services customer base. We believe this investment in customer
acquisition will increase our revenues in the following fiscal years. We focused our marketing
activities on direct customer sales, including door-to-door sales, on-the-street promoters and
telemarketing. Most of these expenses were due to sales commissions paid that are directly related
to our revenue growth. Office, general and administrative expenses.Office, general and administrative expenses,
excluding depreciation and amortization, increased by 10.1% from HK$98.4 million in fiscal 2002 to
HK$108.3 million in fiscal 2003. This increase was due to the ongoing expansion of our operations. Depreciation and amortization.Depreciation and amortization expenses increased by 36.0%,
from HK$129.4 million in fiscal 2002 to HK$176.0 million in fiscal 2003. Although depreciation and
amortization expense relating to our international telecommunications business remained relatively
stable 69




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at HK$36.0 million in fiscal 2003, compared to HK$33.0 million in fiscal 2002, the roll-out of
our Metro Ethernet network caused a 45.2% increase in depreciation and amortization expenses in
that segment of our business, from HK$96.4 million during fiscal 2002 to HK$140.0 million during
fiscal 2003. Provision for doubtful accounts receivable.Provision for doubtful accounts receivable
increased by 71.8% from HK$10.3 million in fiscal 2002 to HK$17.7 million in fiscal 2003. This was
primarily due to increased subscriptions for our fixed telecommunications network businesses. Income from Operations.Operating profit was HK$271.4 million in fiscal 2003, compared to
HK$89.6 million in fiscal 2002, representing an increase of 202.9%. Operating profit from
international telecommunications operations increased by 54.5%, from HK$217.9 million in fiscal
2002 to HK$336.7 million in fiscal 2003. Our fixed telecommunications network services recorded a
reduction of operating loss, from HK$128.3 million in fiscal 2002 to HK$65.3 million in fiscal
2003. This loss was due to continued costs associated with acquiring new local VOIP subscriptions
and a large amount of depreciation and amortization expenses related to capital expenditures on our
local Metro Ethernet network. Interest Income and Expense.Our interest income was HK$3.2 million in fiscal 2003 compared
to HK$10.9 million in fiscal 2002. Interest income was less in fiscal 2003 than in fiscal 2002 due
to lower interest rates. We derive interest income from our deposit of surplus capital in
interest-bearing accounts at commercial banks. Interest expense was HK$0.6 million for fiscal 2003. Loss on Disposal of a Subsidiary.Loss on disposal of a subsidiary was HK$2.7 million in
fiscal 2003, which resulted from the disposal of our Japanese subsidiary, City Telecom (Japan) Co.,
Ltd. Other Income and Expense.Our other income and expense was HK$4.4 million in fiscal 2003
compared to HK$0.5 million in fiscal 2002. Income Taxes.Income tax expense was HK$17.9 million for fiscal 2003 compared to HK$15.2
million during fiscal 2002. Income tax expense is based on our estimated assessable profit during
each period. Our effective rate decreased from 15.6% in fiscal 2002 to 6.5% in fiscal 2003 as a
result of the recognition of deferred tax assets on prior years unrecognized tax losses brought
forward from our fixed telecommunications network services to offset the taxes associated with
profit generated from our international telecommunications services in this year. Minority Interest.In fiscal 2003, we had no minority interest as compared with HK$8.2
million in fiscal 2002, which was due to the acquisition of the remaining interest in HKBN from
KDDI in fiscal 2002. Net Income.For the foregoing reasons, our net income increased by 184.8% from HK$90.5
million in fiscal 2002 to HK$257.7 million in fiscal 2003. Liquidity and Capital Resources A principal source of our liquidity historically has been cash flow from operations. In
addition, we have undertaken several transactions that have provided us with working capital,
including:  
    In August 1997, we completed our initial public offering of 100,000,000 new shares and
listing on The Stock Exchange of Hong Kong. We received net proceeds of HK$159.8 million
from this offering.
    In November 1999, we completed a global offering of 80,000,000 new shares and our
American depositary shares were listed on The Nasdaq Stock Market. We received net proceeds
of approximately HK$411.6 million from this offering. 70




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
    In March 2000, KDDI Corporation, a telecommunications company in Japan, purchased 15.0%
of the share capital of HKBN, now a wholly owned subsidiary of the Company, for HK$225.0
million.
    In December 2003, we drew down HK$100.0 million of a HK$200.0 million loan facility made
available by The Hongkong and Shanghai Banking Corporation Limited, or HSBC, as of October
9, 2002. We drew down a further HK$40.0 million in September 2004, and the remaining
HK$60.0 million in December 2004 for a total amount of HK$200.0 million. All outstanding
amounts under this facility were fully repaid as of January 24, 2005 with the proceeds of
the 8.75% notes offering that was completed on January 20, 2005.
    Subsequent to August 31, 2004, in January 2005, we issued US$125.0 million of our 8.75%
senior notes due 2015. We received net proceeds of approximately US$121.0 million from this
offering. The following table summarizes our cash flows for each of fiscal 2002, 2003 and 2004: Year Ended August 31,2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(In thousands)Net cash flow from operating activities
    
    
    288,444
    
    
    
    414,500
    
    
    
    203,763
    
    
    
    26,123Net cash used in investing activities
    
    
    (475,212
    )
    
    
    (309,634
    )
    
    
    (406,244
    )
    
    
    (52,083
    )Net cash (used in) provided by financing
activities
    
    
    9,109
    
    
    
    (10,274
    )
    
    
    47,221
    
    
    
    6,054(Decrease)/increase in cash and cash equivalents
    
    
    (177,659
    )
    
    
    94,592
    
    
    
    (155,260
    )
    
    
    (19,906
    )Effect of foreign exchange rate changes
    
    
    312
    
    
    
    (1,135
    )
    
    
    (253
    )
    
    
    (32
    )Cash and cash equivalents (closing balance)
    
    
    290,403
    
    
    
    383,860
    
    
    
    228,347
    
    
    
    29,275
 Operating Activities Our principal source of cash from operating activities in each of fiscal 2004, 2003 and 2002
was the cash we generate from our fixed telecommunications network services and international
telecommunications businesses. Net cash provided by operating activities amounted to HK$203.8
million during fiscal 2004, which represented a substantial decrease compared with fiscal 2003,
principally as a result of the significant cash we continued to invest in our Metro Ethernet
network, which resulted in a large increase in our other payables in fiscal 2003. Cash from
operating activities also decreased due to increased costs we incurred in promoting our new
services, as well as decreased profitability of our international telecommunications business. In
addition, we recorded an increase in trade and other payables of HK$31.0 million that comprised
amounts owed to our supplier of household appliances that we offer to new subscribers under our
free appliance program, as well as increased payables associated with our capital expenditures
during the year. We also recorded an increase in deferred service income of HK$29.3 million in
fiscal 2004 associated with our free appliance program, as we billed new subscribers credit cards
a fee equivalent to 18 months of service charges upon their signing a 24 to 36 month contract with
us. Net cash provided by operating activities in fiscal 2004 was offset by an increase in trade
and other receivables of HK$50.4 million. The principal component of this receivable consisted of
an increase in income of HK$38.7 million in connection with mobile interconnection charges that we
believe are due to us by Hong Kong mobile telecommunications operators based on their use of our
Metro Ethernet network to transmit mobile telecommunications traffic. While we have not yet
received payment for use of our Metro Ethernet network from most of these mobile operators, we
believe that we are entitled to payment at the same rates that other fixed network operators
receive, and have notified the mobile operators of our position. The Telecommunications Authority
has agreed to make a determination regarding the level and effective date of interconnection
charges payable to us by one of the mobile operators. Until this matter is resolved, we intend to
continue to record income based on the rates owed to other fixed network operators for comparable
usage of their networks. We also recorded an increase in prepayments of HK$8.3 million 71




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in fiscal 2004 in connection with our use of the fiber ring owned and operated by the KCRC.
Finally, our cash flows from operations were reduced by Hong Kong profits taxes paid of HK$24.0
million. Net cash provided by operating activities amounted to HK$414.5 million in fiscal 2003, a
significant increase versus fiscal 2002 that resulted from increased profitability of each of our
business lines. Income before taxation of HK$275.6 million was offset by a decrease in trade and
other payables of HK$28.7 million that resulted from our lower levels of capital expenditures in
fiscal 2003 as compared to fiscal 2002. In addition, we paid Hong Kong profits tax of HK$18.1
million in fiscal 2003. Net cash provided by operating activities amounted to HK$288.4 million in fiscal 2002. In
addition to HK$97.5 million of income before taxation, net cash increased due to an increase in
trade and other payables of HK$89.7 million in fiscal 2002. Other payables increased as a direct
result of our substantial increase in capital expenditures in fiscal 2002, as we fully ramped up
development of our Metro Ethernet network. Net cash provided by operating activities was reduced by
an increase in trade receivables of HK$15.2 million that was generally related to our increase in
monthly revenues. Investing Activities Net cash used in investing activities was HK$406.2 million, HK$309.6 million and HK$475.2
million during fiscal 2004, 2003 and 2002, respectively. Throughout each of the three fiscal years,
investing activities consisted primarily of purchases of fixed assets for the development of our
Metro Ethernet network. In addition, we used smaller amounts of cash for investing in the upgrade
of our fixed assets, and also made investments in upgrading our international telecommunications
facilities. Financing Activities Net cash provided by financing activities was HK$47.2 million in fiscal 2004, which consisted
of our draw down of HK$100.0 million on our loan facility with HSBC, offset by our payment of
HK$54.9 million in dividends during fiscal 2004. In fiscal 2003, net cash used in financing
activities was HK$10.3 million. This principally consisted of our repayment of a shareholder loan
to KDDI of HK$22.5 million when we purchased KDDIs remaining interest in HKBN, and dividends we
paid in fiscal 2003 of HK$30.2 million. Net cash used in financing activities in fiscal 2003 was
offset by our issues of HK$45.4 million of shares during the year in connection with the exercise
of share options that we had granted to our employees and exercise of outstanding warrants in prior
years. Net cash provided by financing activities in fiscal 2002 was HK$9.1 million and primarily
consisted of issues of warrants for net proceeds of HK$9.8 million, exercises of share options by
employees and exercise of outstanding warrants of HK$3.8 million, offset in part by our repayment
of finance lease payables in the amount of HK$4.4 million. Indebtedness In December 2003, we drew down HK$100.0 million of a HK$200.0 million loan facility made
available by HSBC as of October 9, 2002. We drew down a further HK$40.0 million in September 2004,
and the remaining HK$60.0 million in December 2004. The loan facility accrues interest at the Hong
Kong Interbank Offer Rate plus 1.5%, and repayment is required to be made in 60 equal installments
beginning in January 2005. We have entered into an interest rate swap arrangement to hedge against
interest rate risk for up to HK$100.0 million of the total amount drawn under the facility. All
outstanding amounts under this facility were fully repaid as of January 24, 2005 with the proceeds
of the 8.75% notes offering described below. We also have a banking facility provided by Citibank for the equivalent of HK$19.2 million in
Japanese Yen, which is secured by a pledge over bank deposits. Interest under the facility accrues
at the cost of funds in Japan plus 0.8%. On January 20, 2005, we issued US$125.0 million of our 8.75% notes. We received net proceeds
of approximately US$121.0 million from this offering. 72




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Capital expenditures and working capital In order to continue the development of our Metro Ethernet network, we plan to make total
capital expenditures of approximately HK$990.0 million in fiscal 2005 to 2006. In particular, we
plan to spend approximately HK$520.0 million in connection with our goal to increase the coverage
of our Metro Ethernet network to 1.8 million home passes. We also plan to spend approximately
HK$240.0 million in connection with our continued build out of our fiber-based backbone that we use
to provide fixed telecommunications network services. Our required capital expenditures, other than
with respect to our network expansion, will be influenced to a significant degree by the rate of
growth in the subscription base for our services, the expansion of our network coverage and any
changes to our business plan. As of August 31, 2004, we had cash and cash equivalents, net of short term loans, of HK$228.3
million compared to HK$383.9 million at the end of fiscal 2003. As of August 31, 2004, we had
capital commitments contracted but not provided for relating to the purchase of telecommunications,
computer and office equipment of HK$213.3 million. In addition, we had commitments under
non-cancelable operating leases relating to land, buildings, telecommunications facilities and
computer equipment of HK$70.8 million, of which HK$46.9 million is due in fiscal year 2005. We also
had commitments on program fees of HK$34.4 million, of which HK$15.5 million is due in fiscal 2005.
As of August 31, 2004 we had total amounts available under banking facilities of HK$119.2 million
under which HK$32.5 million is due in fiscal 2005. 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 August 31,
2004. Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    
    More thanContractual Obligations
    
    Total
    
    
    1 year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 years(Thousands of HK$)Capital expenditure
    
    
    213,310
    
    
    
    213,310
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    
    70,783
    
    
    
    46,898
    
    
    
    13,577
    
    
    
    2,508
    
    
    
    7,800Short-term and long-term debt
    
    
    119,170
    
    
    
    32,503
    
    
    
    20,000
    
    
    
    60,000
    
    
    
    6,667Programming fees (IP-TV)
    
    
    34,411
    
    
    
    15,542
    
    
    
    18,869
    
    
    
    
    
    
    
    Total
    
    
    437,674
    
    
    
    308,253
    
    
    
    52,446
    
    
    
    62,508
    
    
    
    14,467
 Our working capital as of August 31, 2004 was HK$55.2 million, which we believe is
sufficient for our current requirements. Further, we believe that our current cash and cash
equivalents, cash flow from operations and the proceeds from the
issuance of our US$125.0 million 8.75% notes
will be sufficient to meet our anticipated cash needs, including for working capital, capital
expenditure, repayment of our indebtedness and various contractual obligations, for at least the
next 12 months. However, if our customer demand changes significantly due to rapid technological
changes, if we are not able to successfully compete with local and foreign entrants into the
market, or if we fail to maintain or obtain the necessary license renewals from the
Telecommunications Authority, this could have a significant adverse impact on our cash flows from
operations, which could effect our ability to make planned capital expenditures as well as meet
scheduled payments on the 8.75% notes, our various operating and capital leases and amounts due under
banking facilities. Research and development, patents and licenses, etc. We commit considerable resources to our research and development department in order to
continuously improve our services and improve our market position. As of August 31, 2004, our
research and development department in Hong Kong consisted of 28 staff members experienced in
systems design, engineering, telecommunications and computer programming. Our research and
development department is primarily responsible for assessing and adapting the technology that we
employ in upgrading and expanding our Metro Ethernet network. To identify and develop new market
opportunities, the research and development department assesses new services offered by
telecommunications and Internet companies in the United States and elsewhere and works closely with
our marketing department. Our 73




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research and development expenditures were approximately HK$2.2 million, HK$2.6 million and HK$6.0 million
for fiscal 2002, 2003 and 2004, respectively. Trend information Our international telecommunications business experienced a decrease of 36.8% in our average
prices per minute in fiscal 2004 compared to fiscal 2003. A principal reason for this decline was
that in fiscal 2003, we increased our rates for outbound calls to China in response to an increase
in the termination rates payable by us to our carrier partners for incoming telecommunications
traffic into China due to the imposition by Chinas MII of these rate increases. As approximately
65% of our outgoing calls in fiscal 2003 were to China, this increase had a significant effect on
our average prices per minute. When our carrier partners subsequently reduced their termination
charges, we were able to reduce our per minute charges as compared to fiscal 2003. In addition, in order to maintain our international telecommunications market share in fiscal
2004, we made the decision to price our international telecommunications services competitively
with other market players despite their aggressive pricing strategies. While we experienced an
increase in total traffic volume of 13.4% from 888.0 million minutes to 1,007.0 million minutes,
our international telecommunications services revenue decreased 28.3% from HK$875.8 million in
fiscal 2003 to HK$628.0 million in fiscal 2004. We expect the price competition to continue in
fiscal 2005, but anticipate that the decline in average prices will be less than in fiscal 2004. Off-Balance Sheet Arrangements Other than as described below in  Critical Accounting Policies, we have not entered into
any off-balance-sheet arrangements with any entities or individuals. Tabular disclosure of contractual obligations. See Liquidity and Capital Resources above in this Item 5. Critical Accounting Policies Introduction Our consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in Hong Kong. Our significant accounting policies are more fully
described in note 2 to our financial statements. The preparation of our financial statements
requires management to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and the disclosure of contingent assets and liabilities. We
continually evaluate our estimates and judgments including those related to fixed assets, bad
debts, deferred taxes, USC charges and certain revenue items. We base our estimates and judgments
on historical experience and on various other assumptions we believe to be reasonable under the
circumstances. This forms the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may differ from these
estimates as facts, circumstances and conditions change. Our accounting policies have been developed over many years as the telecommunications industry
and Generally Accepted Accounting Principles or GAAP have evolved. As our financial statements are
prepared under Hong Kong GAAP, our accounting policies are necessarily compliant with all aspects
of Hong Kong GAAP. Hong Kong GAAP is based on a substance over form conceptual framework that
requires us to look through the legal interpretation of an arrangement or transaction to its
underlying purpose and to reflect it in our financial statements on that basis. In developing accounting policies, in addition to Hong Kong GAAP requirements, we also
consider telecommunications industry practice in other countries. Where there is no conflict with
Hong Kong 74




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GAAP we also align our accounting policies with U.S. GAAP. In all material respects our
accounting policies are applied consistently across City Telecom. The critical accounting policies
discussed below generally apply to all segments of City Telecom. The following are the most significant accounting estimates and judgments we apply in
producing our consolidated financial statements. Useful lives of fixed assets We estimate the useful lives of fixed assets in order to determine the amount of depreciation
expense to be recorded. The useful lives are estimated at the time the asset is acquired based on
historical experience, the expected usage, wear and tear of the assets, as well as technical
obsolescence arising from changes in the market demands or service output of the assets. Impairment of fixed assets Under Hong Kong GAAP and U.S. GAAP, if a triggering event occurs indicating that the carrying
amount of an asset may not be recoverable, a new assessment of the carrying amount of that asset is
required. Triggering events include significant adverse changes in the market value of an asset,
changes in the business or regulatory environment, or certain legal events. The interpretation of
such events requires judgment from the management with respect to whether such an event has
occurred and whether the management feels that reassessment of the carrying value of the asset is
required. If an event occurs that could affect the carrying value of the asset and the management
does not identify it as a triggering event and identify the asset as impaired, future operations
could be adversely affected if this asset is subsequently written off or sold for less than its
carrying value due to sudden downturns in the business environment. Upon the occurrence of triggering events, the carrying amounts of fixed assets are reviewed to
assess whether their recoverable amounts have declined below their carrying amounts. The
recoverable amount is the present value of estimated net future cash flows which we expect to
recover from the future use of the asset, plus the assets residual value on disposal. Where the
recoverable amount of fixed and other long-lived assets is less than their carrying value, an
impairment loss is recognized to write the assets down to their recoverable amount, which is based
on the undiscounted estimated cash flows. Under U.S. GAAP the impairment testing is done on the basis of undiscounted cash flows as
opposed to discounted cash flows under Hong Kong GAAP. Estimation of cash flows arising from future use of the asset requires careful analysis
regarding what we expect to recover from its future use. This includes consideration of our target
market share and customer base, market competition, future changes to our cost structure and
technological change. In addition, the residual value of the asset on disposal requires judgment,
as the estimated fair value of the asset at the time of disposal could change in response to market
conditions and changes in expected use of the asset prior to disposal. Changes in the estimate of
cash flows arising from expected future use of the asset or its residual value on disposal  based
on changes in market conditions, changes in the use of assets, managements plan, foreseeable
technological changes or otherwise  could significantly change the calculation of the fair value
or recoverable amount of the asset and the resulting impairment loss. This in turn could
significantly affect the results of our operations. Accounts Receivable Under Hong Kong GAAP and U.S. GAAP, provision is made against accounts receivable to the
extent they are considered to be doubtful. This provision requires judgment regarding the
collectibility of certain receivables both as they are incurred and as they age. We determine bad
debt provisions based on past experience of recovery of old receivables, the aging of the accounts
receivable balance and historical write-off experience. Certain receivables may be initially
identified as collectible, yet subsequently become uncollectible and result in a subsequent
write-off of the related receivable to the statement of 75




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operations. Changes in the collectibility of accounts receivable for which provisions are not
made could affect our future results of operations. Deferred Taxation Under Hong Kong GAAP, deferred taxation is provided in full, using the liability method, on
temporary differences arising between the tax bases of assets and liability and their carrying
amounts in the accounts. 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.
Deferred taxation is provided on temporary differences arising on investments in subsidiaries
except where the timing of the reversal of the temporary difference can be controlled and it is
probable that the temporary difference will not reverse in the foreseeable future. In determining
whether a liability or asset is expected to be payable or recoverable in the foreseeable future, we
assess the effect of our capital expenditures and other plans, such as the existing network
capacity, technological changes, future market trends and projected fixed network coverage. Under U.S. GAAP, deferred tax assets and liabilities are determined based on the temporary
differences between the financial reporting basis and tax basis of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected to reverse. Future
tax benefits in respect of tax loss carry forwards are also required to be recognized in full. We
must establish a valuation allowance for such assets if we determine it is more likely than not
that we will not be able to utilize such benefits in the future. The recording of certain deferred tax assets requires judgment regarding the results of future
operations, including the assumption that there will be sufficient future operations to allow us to
utilize the related deferred tax asset. Any changes in the estimate of future operations could
change the recognition of such assets, which could significantly affect the results of our
operations. Carrying value of fixed assets, investments and goodwill We assess the carrying value of our investments in subsidiaries, including acquired goodwill,
for impairment on an annual basis based on their recoverable amount. Our assessments generally
include methodology of discounted cash flow analysis, and review of comparable entities. This
methodology sometimes relies on factors such as forecasts of future performance and long-term
growth rates of the investee, and selection of discount rate. If these forecasts and assumptions
prove to be incorrect or circumstances change, we may be required to write down our investments. Based on our most recent assessment of recoverable amount we believe that as at August 31,
2004 our goodwill is recoverable at the amounts at which they are stated in our financial
statements. USC charges Our management makes their best estimates for charges of the USC payable to PCCW-HKT in order
to fund the costs of network development incurred by PCCW-HKT in remote areas in Hong Kong (the
Development). Such estimated costs are included as part of our costs of rendering services. The
estimate is made based on the provisional rates announced by the Telecommunications Authority and
is effective up to the date of the release of our financial statements. The Telecommunications
Authority periodically reviews the actual costs incurred by PCCW-HKT in the Development and adjusts
the amounts owed to PCCW-HKT, or to be refunded by it, to the respective USC contributing parties,
including our company (the Rate Revisions). Accordingly, the estimate made by our management is
subject to changes based on the Rate Revisions identified during a financial year and up to the
date prior to the release of our financial statements. We adjust such differences as an addition
to, or reduction of, the corresponding costs of services in that particular reporting period. 76




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Any sum received in advance from PCCW-HKT as an estimated refund of USC on a provisional
basis, which is subject to the final confirmation and determination of the Telecommunications
Authority, is recorded in other payables and accrued charges in our balance sheet. Revenue Recognition Revenue for the provision of telecommunications services is recognized when the services are
rendered. Revenue received in advance is deferred and amortized based on estimated actual usage by
customers or the stated period of time in the subscriber agreement. Network interconnection charges
are recorded as revenue based on usage of the fixed telecommunications network of the Company by
mobile and other fixed telecommunications network operators. The determination of the rates at
which revenue is recognized involved significant estimates by management. Significant changes in
management estimates may result in material revenue adjustments. Legal contingencies We are currently involved in certain legal proceedings. The assessment of the ultimate outcome
of those proceedings is derived from consultation with outside counsel, as well as an assessment of
litigation and settlement strategies. A future event or change in the facts and circumstances may
require us to make accruals with would be charged to our income statement in the future. U.S. GAAP Reconciliation Our financial statements are prepared in accordance with Hong Kong GAAP, which differs in
certain material respects from U.S. GAAP. The following tables provide a comparison of our net
income and shareholders equity in accordance with Hong Kong GAAP and U.S. GAAP Year Ended August 31,2002
    
    
    2003
    
    
    2004
    
    
    2004HK$
    
    
    HK$
    
    
    HK$
    
    
    US$(Restated)
    
    
    (Restated)(in thousands)Net incomeHong Kong GAAP
    
    
    90,505
    
    
    
    257,743
    
    
    
    49,550
    
    
    
    6,353U.S. GAAP adjustments:Compensation benefit cost associated with share
options
    
    
    (21,586
    )
    
    
    2,731
    
    
    
    270
    
    
    
    35Amortization of goodwill (acquired prior to June
30, 2001)
    
    
    (1,019
    )
    
    
    
    
    
    
    
    
    
    
    Reversal of amortization of goodwill (acquired
after June 30, 2001)
    
    
    1,065
    
    
    
    1,065
    
    
    
    1,065
    
    
    
    136Fair value of interest rate swap
    
    
    
    
    
    
    
    
    
    
    680
    
    
    
    87Net income under U.S. GAAP
    
    
    68,965
    
    
    
    261,539
    
    
    
    51,565
    
    
    
    6,611Shareholders EquityHong Kong GAAP
    
    
    904,988
    
    
    
    1,179,175
    
    
    
    1,175,698
    
    
    
    150,731U.S. GAAP adjustments:Goodwill
    
    
    5,092
    
    
    
    5,092
    
    
    
    5,092
    
    
    
    653Accumulated amortization of goodwill
    
    
    (3,735
    )
    
    
    (3,735
    )
    
    
    (3,735
    )
    
    
    (479
    )Reversal of amortization of goodwill
    
    
    1,065
    
    
    
    2,130
    
    
    
    3,195
    
    
    
    409Fair value of interest rate swap
    
    
    
    
    
    
    
    
    
    
    680
    
    
    
    87Total shareholders equity under U.S. GAAP
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    1,180,930
    
    
    
    151,401
 Under Hong Kong GAAP, no compensation cost is required to be recognized in respect of the
grant of stock options to employees and executive directors. Under U.S. GAAP, compensation expense
is required to be measured either in accordance with the intrinsic value method prescribed by APB
Opinion No. 25 Accounting for Stock Issued to Employees or the fair value method prescribed by
Statement of Financial Accounting Standards (SFAS) No. 123 Accounting for Stock-based
Compensation. We apply the intrinsic value method prescribed by APB Opinion No. 25 and disclose in
our consolidated financial statements the pro forma effect that use of the fair value method would
have on our net income 77




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and earnings per share. The compensation cost for stock options under U.S. GAAP represents the
cost of amortizing the compensation expense given to employees over the vesting period of the
options. Because the exercise price of certain options granted can decrease during the vesting
period, such options are considered variable options under U.S. GAAP and compensation expense is
based on our share price at the balance sheet date. The charge for compensation expense for fiscal
2004 primarily relates to such variable options. Goodwill and accumulated amortization comprises goodwill arising on the acquisition in 1999 of
963673 Ontario Limited group of companies and the goodwill arising on the deemed acquisition of
additional interest in one of our wholly owned subsidiaries, HKBN, through subscription of Rights
Issue and from acquiring remaining interest from the minority shareholder in 2002. Under Hong Kong GAAP, the Company charged the goodwill arising from the acquisition of 963673
Ontario Limited group of companies against available reserves. However, in accordance with the
change in accounting standards in Hong Kong, goodwill on acquisitions occurring on or after
September 1, 2001 is shown separately on the consolidated balance sheet and is amortized using the
straight-line method over its estimated useful life. As a result of that, the goodwill arising for
HKBN is recorded as an asset on the balance sheet and amortized over its estimated useful life,
which in this case is five years. For the goodwill arising for the 963673 Ontario Limited group of
companies, the Company has taken advantage of the transitional provisions of the new accounting
standard and goodwill previously written off against reserves has not been restated. Where an
indication of impairment exists, the carrying amount of goodwill, including goodwill previously
written off against reserves, is assessed and written down immediately to its recoverable amount
with the charges being recorded in the Companys profit and loss accounts. Under U.S. GAAP, goodwill recorded on the acquisition of a business prior to June 30, 2001 was
capitalized and amortized to the profit and loss accounts over its expected useful life of five
years. In June 2001, FASB issued the SFAS No. 142 Goodwill and other Intangible Assets effective
for fiscal years beginning after December 15, 2001. In connection with the adoption of this
standard in fiscal 2003 under U.S. GAAP, we ceased amortizing goodwill recognized on business
combinations initiated prior to June 30, 2001 and performed a transitional goodwill impairment
assessment. Goodwill recognized on business combinations initiated after June 30, 2001, is not
amortized under SFAS No. 142 and is required to be tested annually for impairment in accordance
with the provisions of SFAS No. 142. We have performed the impairment tests on the goodwill
recorded prior to and after June 30, 2001 at the fiscal year end and no impairment loss was
identified from the process for fiscal 2004. Under Hong Kong GAAP, there are no specific accounting standards governing the accounting for
derivative instruments. As a result, the Company does not recognize the interest rate swap at fair
value and does not account for the gains or losses relating to the fair value changes in this
derivative. Under U.S. GAAP, the Company recognized the interest rate swap on the balance sheet at
fair value in accordance with SFAS No. 133 Accounting for Certain Derivative Instruments and
Certain Hedging Activities. Since the interest rate swap is not designated as a hedge, the gain or
loss on change in fair value of this derivative instrument is recognized currently in earnings. Recent Accounting Pronouncements Hong Kong GAAP In March 2004, the Hong Kong Institute of Certified Public Accountants (HKICPA) issued the
Hong Kong Accounting Standards (HKAS) and HKAS Interpretation (HKAS Interpretation) that were
converged with equivalent International Accounting Standards and Standing Interpretations Committee
Interpretations issued by the International Accounting Standards Board (IASB), most of which were
revised recently as a result of the IASBs improvements project. The HKAS and HKAS Interpretation will become effective for accounting periods beginning on or
after January 1, 2005 and are required to be adopted by us for the year ending August 31, 2006. As
a consequence, all existing Statement of Standard Accounting Practices (SSAP) and the related 78




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interpretations issued by the HKICPA, for which there are equivalent International Accounting
Standards and Standing Interpretations Committee Interpretations will be renamed as HKAS and HKAS
Interpretations, or otherwise, will be superseded at that time. U.S. GAAP In December 2003, the FASB issued FIN 46-R Consolidation of Variable Interest Entities  an
Interpretation of ARB No. 51. FIN 46-R requires that certain variable interest entities, or VIEs,
be consolidated by their primary beneficiary if the primary beneficiary is subject to a majority of
the risk of losses from the VIE activities, or entitled to receive a majority of the VIEs residual
returns, or both. An entity is subject to FIN 46-R and is considered to be a VIE if it has (1)
equity that is insufficient to permit the entity to finance its activities without additional
subordinated financial support from other parties, or (2) equity investors that cannot make
significant decisions about the entitys operations, or that do not absorb the expected losses or
receive the expected returns of the entity. FIN 46-R is effective immediately for all new VIEs
created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1,
2003, the provisions of FIN 46-R must be applied by the end of the first reporting period ending
after March 15, 2004. The adoption of FIN 46 for VIEs would not have any significant impact on our
financial statements. In December 2003, the Securities and Exchange Commission issued SAB No. 104, Revenue
Recognition. SAB No. 104 supersedes SAB No. 101, Revenue Recognition in Financial Statements.
SAB No. 104s primary purpose is to rescind accounting guidance contained in SAB No. 101 related to
multiple element revenue arrangements, superseded as a result of the issuance of Emerging Issues
Task Force Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables (EITF
00-21). Additionally, SAB No. 104 rescinds the Securities and Exchange Commissions Revenue
Recognition in Financial Statements Frequently Asked Questions and Answers (the FAQ) issued with
SAB No. 101 that had been codified in Securities and Exchange Commission Topic 13, Revenue
Recognition. Selected portions of the FAQ have been incorporated into SAB No. 104. While the
wording of SAB No. 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition
principles of SAB No. 101 remain largely unchanged by the issuance of SAB No. 104. As a result, the
adoption of this pronouncement did not have any significant impact on our consolidated financial
statements. 79




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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES Directors and Senior Management Our board of directors consists of ten directors, three of whom are independent non-executive
directors and one of whom is a non-executive director. Six are executive directors, namely, Mr.
Wong Wai Kay, Ricky, Mr. Cheung Chi Kin, Paul, Mr. Chong Kin Chun, John, Ms. Fung So Mui, Fion, Ms.
Sio Veng Kuan, Corinna and Ms. To Wai Bing. The non-executive director is Mr. Cheng Mo Chi, Moses.
The three independent non-executive directors are Mr. Lee Hon Ying, John, Dr. Chan Kin Man and Mr.
Peh Tun Lu, Jefferson. The following table sets forth certain information concerning our directors and senior
management as of January 31, 2005. DateJoined CityName
    
    Age
    
    
    Position
    
    
    TelecomBoard of Directors:WONG Wai Kay, Ricky
    
    
    43
    
    
    Chairman
    
    
    1992CHEUNG Chi Kin, Paul
    
    
    47
    
    
    Managing Director
    
    
    1992CHONG Kin Chun, John
    
    
    42
    
    
    Director, Corporate Division
    
    
    1996FUNG So Mui, Fion
    
    
    42
    
    
    Director, Business Development
    
    
    1993SIO Veng Kuan, Corinna
    
    
    37
    
    
    Director, Finance
    
    
    1993TO Wai Bing
    
    
    43
    
    
    Director, International Business
    
    
    1998CHENG Mo Chi, Moses
    
    
    54
    
    
    Non-Executive Director
    
    
    1997LEE Hon Ying, John
    
    
    58
    
    
    Non-Executive Director
    
    
    1997CHAN Kin Man
    
    
    45
    
    
    Non-Executive Director
    
    
    1997PEH Tun Lu, Jefferson
    
    
    45
    
    
    Non-Executive Director
    
    
    2004Senior Management:CHOY Mei Yuk, Mimi
    
    
    40
    
    
    Director, Administration &
Human Resources
    
    
    1998LEUNG Kim Ming, Sam
    
    
    37
    
    
    Director, Technical
    
    
    1992LO Sui Lun
    
    
    40
    
    
    Director, Network Operation
    
    
    1998SIN Siu Fun, Annie
    
    
    45
    
    
    Director, Customer Service
    
    
    1995MOK King Man, Thomas
    
    
    43
    
    
    Director, Customer Service
    
    
    2002YIM Chi Hang, Sunny
    
    
    41
    
    
    Director, Information Technology
    
    
    2004LAI Ni Quiaque
    
    
    35
    
    
    Director, Corporate Development
    
    
    2004LEUNG Yau Man, Haily
    
    
    36
    
    
    Director, IP-TV
    
    
    2003LEUNG, Eva
    
    
    35
    
    
    Secretary and In-House Legal Counsel
    
    
    2000
 Executive Directors Mr. WONG Wai Kay, Ricky, aged 43, is the co-founder and chairman of City Telecom. He is
responsible for our overall strategic planning and management. Mr. Wong holds a bachelors degree
in science from The Chinese University of Hong Kong and has over 19 years experience in the
telecommunications and computer industries. Mr. Wong has worked at a major U.S.-listed computer
company as a marketing representative and was responsible for the marketing and the distribution of
computer products in Hong Kong from 1985 to 1989. He was also a co-founder and director of a
company principally engaged in the import and distribution of computer systems in Canada prior to
co-founding City Telecom. Mr. Wong is a first cousin of Mr. Cheung Chi Kin, Paul, our managing
director. Mr. CHEUNG Chi Kin, Paul, aged 47, is the co-founder and managing director of City Telecom. He
is responsible for our day-to-day operations and technological research, development and support
activities. Mr. Cheung graduated with a diploma of advanced programming and system concepts design 80




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from Herzing Institute, Canada. He has more than 24 years experience in the telecommunications and
computer industries. Mr. Cheung has worked in companies engaged in application software development
and computer consultancy prior to co-founding City Telecom. Mr. Cheung is a first cousin of Mr.
Wong Wai Kay, Ricky, our chairman. Mr. CHONG Kin Chun, John, aged 42, is our director of our corporate division. He is
responsible for sales, marketing and servicing of our international telecommunications services,
Internet products, and fixed telecommunications network services for our business and corporate
customers. Mr. Chong joined City Telecom in February 1996 and was appointed an executive director
in June 1997. He holds a bachelors degree in arts from The University of Hong Kong. Mr. Chong
worked as a general manager overseeing product management and the sales force of a listed
telecommunications products company in Hong Kong from 1987 to 1996. Ms. FUNG So Mui, Fion, aged 42, is the director of business development. She holds a
bachelors degree in business administration from the University of Wisconsin, Madison in the
United States. Ms. Fung is currently in charge of our business planning and development. Prior to
that she was responsible for the development of our fixed telecommunications network businesses,
the expansion of network coverage in Hong Kong, regulatory affairs and other business development
operations of City Telecom. Ms. Fung worked as a research manager in a foreign-based executive
recruitment firm in Hong Kong from 1986 to 1989. She joined City Telecom in October 1993 and was
appointed an executive director in June 1997. Ms. SIO Veng Kuan, Corinna, aged 37, is our finance director. She is in charge of City
Telecoms financial operations. Ms. Sio joined City Telecom in January 1993 and was appointed an
executive director in June 1997. She is a Certified Public Accountant of the Hong Kong Institute of
Certified Public Accountants and a fellow member of Association of Chartered Certified Accountants.
Ms. Sio worked in the accounting department of various international banking corporations in Hong
Kong from 1985 to 1992 prior to joining City Telecom. Ms. TO Wai Bing, aged 43, is our director in charge of international business, carrier
business and building access liaison. She joined City Telecom in September 1998 and was appointed
an executive director in October 2000. Under the scope of our carrier business, she is in charge of
interconnection and business development with local fixed network operators, local mobile operators
and other local carriers. Under the scope of building access liaison, she is responsible for
liaising with building owners, housing authority and other building management authorities for
approval of fiber access to the buildings and in-building wiring. Ms. To worked in Hong Kong
Telecom for 16 years after receiving her diploma and higher certificate in electronics engineering
from The Hong Kong Polytechnic University. She is experienced in international business development
and international network engineering including international network planning, quality and
security. Non-executive Director Mr. CHENG Mo Chi, Moses, aged 54, was re-designated as a non-executive director of City
Telecom with effect from September 30, 2004. He was appointed as an independent non-executive
director of the Company since June 17, 1997 and a member of the Audit Committee since its
establishment on March 22, 1999. He is the senior partner of P.C. Woo & Co., a firm of solicitors
and notaries in Hong Kong, the Founder Chairman of the Hong Kong Institute of Directors of which he
is now the Honorary President and Chairman Emeritus, the Chairman of the Council and Court of the
Hong Kong Baptist University and the Football Betting and Lotteries Commission. Mr. Cheng was
appointed a member of the Legislative Council of Hong Kong from 1991 to 1995. Independent Non-executive Directors Mr. LEE Hon Ying, John, aged 58, is managing director of Cyber Networks Consultants Company in
Hong Kong. He was the regional director, Asia Pacific, of Northrop Grumman  Canada Ltd. He was
previously the director of network services of Digital Equipment (HK) Limited and prior to that,
worked 81




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for Cable & Wireless HKT and Hong Kong Telecom. He is a chartered engineer and is a member of
the Institution of Electronic and Radio Engineers, the United Kingdom and the Hong Kong Institution
of Engineers and the Hong Kong Computer Society. He received a masters degree in information
systems from The Hong Kong Polytechnic University in 1992. In addition, he is the territory
vice-president of the Society of St. Vincent de Paul of Asia and Oceania, which is an international
charity body. He is the Chairperson of the Catholic Diocese of Hong Kong Diocesan for Hospital
Pastoral Care. Mr. Lee has been a director of City Telecom since June 1997. Dr. CHAN Kin Man, aged 45, is an associate professor of the Department of Sociology of the
Chinese University of Hong Kong, specializing in the state-society relations in China and Hong
Kong. He received a bachelor of social science degree from The Chinese University of Hong Kong in
1983 and a doctor of philosophy degree from Yale University in the U.S. in 1995. Dr. Chan has been
a director of City Telecom since June 1997. Mr. PEH Tun Lu, Jefferson, aged 45, is a director of Shriro Equipment Limited, a member of the
Shriro Group. He is also a Certified Public Accountant of the Hong Kong Institute of Certified
Public Accountants and a Certified Practicing Accountant of CPA Australia. Mr. Peh holds a masters
degree in business from the University of Technology, Sydney. He has over 22 years of experience in
finance, accounting and management with listed and private companies in Hong Kong and Australia.
Mr. Peh has been a director of City Telecom since September 2004. Senior Management Ms. CHOY Mei Yuk, Mimi, aged 40, is our director of administration & human resources. Ms. Choy
holds a masters degree in Human Resources Management from Macquarie University, Australia. She
joined City Telecom in 1998. Ms. Choy has worked in the human resources department of various
companies prior to joining City Telecom. She has over 10 years of experience in administration and
personnel management activities. Mr. LEUNG Kim Ming, Sam, aged 37, is our technical director. Mr. Leung joined City Telecom in
September 1992 and was promoted to the title of director in 1997. He is responsible for the new
development of telecommunications network, Internet and IP-TV services. Mr. Leung has worked as a
computer programmer in various computer software development companies prior to joining City
Telecom. Mr. LO Sui Lun, aged 40, is our network operation director. He is responsible for the
engineering and development of our Metro Ethernet network. He joined City Telecom in September 1998
and was promoted to the title of director in 1999. Prior to joining City Telecom, Mr. Lo worked for
PCCW-HKT for nine years, gaining experience in network planning and undersea cable investment. Mr.
Lo holds a bachelors degree in sciences in electronics from The Chinese University of Hong Kong
and a masters degree in Business Administration from the University of Strathclyde, UK. Ms. SIN Siu Fun, Annie, aged 45, is our director of customer service. Ms. Sin joined City
Telecom in February 1995 and was promoted to the title of director in 1997 and holds a masters
degree in business administration from The University of Hull, the U.K. Ms. Sin has over 11 years
experience in the customer service field gained through employment at two major international hotel
chains prior to joining City Telecom. Mr. MOK King Man, Thomas, aged 43, is our director of customer service in Hong Kong Broadband
Network Limited. Mr. Mok joined City Telecom in April 2002 with the title of director. He is
responsible for all aspects of the daily operation of the Customer Service Department. He holds a
masters degree in Human Resources Management from the Macquarie University and a bachelors degree
in Management and Economics from James Cook University and HK Baptist University, respectively. He
also holds a diploma in Training Management from the Chinese University of Hong Kong. Prior to
joining City Telecom, Mr. Mok was the Senior Training Officer for MTR Corporation and having spent
5 years with the firm. Before that, Mr. Mok held positions with AIA and HK Jockey Club. 82




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Mr. YIM Chi Hang, Sunny, aged 41, is our director of information technology. Mr. Yim joined
City Telecom in August 2004 with the title of director and is responsible for the planning and
development of information services. He holds a bachelor of science degree in Computer Science from
Laurentian University, Canada and a masters degree in Computer Science from Concordia University,
Canada. Prior to joining City Telecom, Mr. Yim had over 13 years experience in the information
technology and telecommunication fields gained from multinational companies including DHL and
Singapore Technologies Group. Mr. LAI Ni Quiaque, aged 35, is our director of corporate development. Mr. Lai joined City
Telecom in May 2004 with the title of director and is responsible for overseeing our investor
relations and corporate finance functions. Mr. Lai has 12 years experience in telecommunications
industry research and finance, being highly rated in this field. Prior to joining City Telecom, Mr.
Lai was Director and Head of Asia Telecom Research for Credit Suisse First Boston, having spent 8
years with the firm. Before that, Mr. Lai held positions with Hongkong Telecom and Kleinwort Benson
Securities (Asia). Mr. Lai holds a bachelor of commerce degree from the University of Western
Australia and is a qualified member of the Australian Society of CPAs. Ms. LEUNG Yau Man, Haily, aged 36, is our director of our IP-TV services. Ms. Leung joined
City Telecom in April 2003 with the title of director and is responsible for the overall planning
and development of City Telecoms IP-TV business. She graduated from the University of Hong Kong
and holds a bachelors of arts degree. Prior to joining City Telecom, Ms. Leung has worked in
various large corporations including a television broadcaster, a mobile company and a
telecommunications company. Ms. LEUNG Eva, aged 35, is our secretary and in-house legal counsel. Ms. Leung graduated from
The University of Hong Kong with a bachelors degree in laws and obtained her masters degree in
business administration from the University of South Australia. Ms. Leung is admitted to practice
as a solicitor in Hong Kong. Compensation Directors and Senior Managements Compensation Our directors and senior management receive compensation in the form of salaries, housing
allowances, discretionary bonuses, other allowances and benefits in kind, including our
contribution to the pension schemes for such individuals. The aggregate amount of salaries or other compensation, housing allowances, discretionary
bonuses, other allowances and benefits in kind paid by us to our directors (not including our
independent non-executive directors) during the year ended August 31, 2004 was approximately
HK$19.4 million. We paid approximately HK$1.6 million as our contribution to the pension schemes of
the directors in the year ended August 31, 2004. In addition we paid our independent non-executive
directors fees of approximately HK$370,000 during the year ended August 31, 2004. Each executive director is entitled to receive an annual discretionary bonus of such amount as
shall be determined by the board of directors upon recommendation by the Remuneration Committee (as
defined below). Additionally, our senior management and employees are entitled to receive an annual
discretionary bonus based on their individual performance and our financial performance during the
year in question. The total number of ordinary shares representing outstanding options granted under the 2002
Scheme (as defined under  Share Option Schemes below) as of January 31, 2005 was 36,670,000. On
October 21, 2004, we granted to our directors and senior managers under our 2002 Scheme options to
subscribe for 14,670,000 ordinary shares. On October 21, 2004, the board of directors also proposed
to grant options to subscribe for 8,000,000 ordinary shares to each of Mr. Wong Wai Kay, Ricky and
Mr. Cheung Chi Kin, Paul. The proposed grants of option were approved by shareholders at our annual
general 83




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meeting held on December 29, 2004. The total number of ordinary shares representing
outstanding options under the 1997 Scheme (as defined under  Share Option Schemes below) as of January 31, 2005 was 600,000,
of which 250,000 were held by Ms. Mimi Choy. Except as discussed herein, no other payments have been paid or are payable, in respect of the
year ended August 31, 2004, by us or any of our subsidiaries to our directors. The aggregate amount of salaries or other compensation, housing allowances, other allowances
and benefits in kind paid by us to our senior management during the year ended August 31, 2004 was
approximately HK$9.8 million. For the year ended August 31, 2004, the aggregate amount accrued by us to provide pension
retirement or similar benefits for our directors, senior management and other employees was
approximately HK$26.3 million. Board Practices Service Contracts We have entered into service contracts with six of our executive directors, Wong Wai Kay,
Ricky, Cheung Chi Kin, Paul, Chong Kin Chun, John, Fung So Mui, Fion, Sio Veng Kuan, Corinna, and
To Wai Bing. All of these service agreements, except for Ms. Tos, commenced on July 1, 1997, and
had an initial term that ended June 30, 2000. Ms. Tos service contract commenced on September 15,
1998, and she was appointed director on October 4, 2000. All service agreements are automatically
renewed annually after the initial term until termination with prior notice. After the initial
term, the agreements with Mr. Wong and Mr. Cheung can be terminated by either party with six
months notice. The service agreements entered with Mr. Chong, Ms. Fung, Ms. Sio and Ms. To are
terminable at anytime with three months advance notice. These service contracts include
non-competition clauses under which our executive directors agree not to compete with us in
accordance with the terms and conditions therein. None of the agreements provide for any benefits
or compensation upon termination of employment. Audit Committee Our board of directors established an Audit Committee to ensure the impartial supervision of
our accounting and business operations. The Audit Committee is comprised of three independent,
non-executive directors, namely, Mr. Lee Hon Ying, John, Dr. Chan Kin Man and Mr. Peh Tun Lu,
Jefferson and a non-executive director, Mr. Cheng Mo Chi, Moses. Mr. Peh was appointed to the Audit
Committee on September 1, 2004 and is a financial expert within the meaning of, and as required
by the U.S. Sarbanes-Oxley Act of 2002. The Audit Committee is governed by our audit committee
charter, which was adopted by our board of directors at a meeting held in August 2004. It is
responsible for making recommendations to our board of directors regarding the selection of
independent auditors, reviewing the results and scope of audits and other services provided by our
independent auditors. Additionally, the Audit Committee is in charge of reviewing and evaluating
our internal audit and control functions. The committee meets at least two times per year, normally
prior to the finalization of both interim and annual financial results. Remuneration Committee Our board of directors established a remuneration committee to ensure the supervision of the
remuneration packages we pay to our executive directors. The remuneration committee is comprised of
Mr. Lee Hon Ying, John, Mr. Cheng Mo Chi, Moses, Dr. Chan Kin Man, our director of finance and our
director of administration and human resources. The remuneration committee is responsible for
reviewing and evaluating the remuneration packages of our executive directors and making
recommendations to our board of directors from time to time. 84




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Employees The following chart sets forth the number of our employees by functional area as of August 31,
2004. EmployeesInformation technology and engineering
    
    
    614Sales and marketing
    
    
    1,632Customer service
    
    
    1,018General administration and others
    
    
    319Total
    
    
    3,583
 The following chart sets forth the number of our employees by geographical region as of August
31, 2004. EmployeesHong Kong
    
    
    1,598Guangzhou
    
    
    1,956Canada
    
    
    29Total
    
    
    3,583
 As of August 31, 2002, 2003 and 2004, we had 1,814, 2,753 and 3,583 employees, respectively.
In connection with the transfer of our calling center operations to Guangzhou, China, we have hired
over 1,900 customer service representatives, customer acquisition and back office employees to
staff that facility. We also substantially increased the number of our sales and marketing, back
office and customer service staff during fiscal 2004. As a result, our total number of employees
increased. We have not experienced any work slowdowns or stoppages and we consider our relations
with our employees to be good. Share Ownership The following chart sets forth the share ownership of our directors and senior management as
of January 31, 2005. Number of Shares
    
    
    Percentage ofIdentity of
    
    
    Beneficially
    
    
    Shares BeneficiallyTitle of Class
    
    Person or Group
    
    

Owned(19)
    
    
    Owned (%)(3)
    
    
    Share OptionsOrdinary Shares
    
    Wong Wai Kay, Ricky
    
    
    333,540,999
    (1)
    
    54.32
    
    
    8,000,000
    (4)Ordinary Shares
    
    Cheung Chi Kin, Paul
    329,024,999
    (2)
    
    53.58
    
    
    8,000,000
    (5)Ordinary Shares
    
    Chong Kin Chun, John
    
    
    1,574,000
    
    
    Less than 1.0
    
    
    2,000,000
    (6)Ordinary Shares
    
    Fung So Mui, Fion
    
    
    1,964,000
    
    
    Less than 1.0
    
    
    500,000
    (7)Ordinary Shares
    
    Sio Veng Kuan, Corinna
    
    
    1,550,000
    
    
    Less than 1.0
    
    
    1,000,000
    (8)Ordinary Shares
    
    To Wai Bing
    
    
    398,000
    
    
    Less than 1.0
    
    
    2,000,000
    (9)Ordinary Shares
    
    Choy Mei Yuk, Mimi
    
    
    
    
    
    
    
    
    
    
    350,000
    (10)Ordinary Shares
    
    Leung Kim Ming, Sam
    
    
    277,602
    
    
    Less than 1.0
    
    
    500,000
    (11)Ordinary Shares
    
    Lo Sui Lun
    
    
    700,000
    
    
    Less than 1.0
    
    
    500,000
    (12)Ordinary Shares
    
    Sin Siu Fun, Annie
    
    
    
    
    
    
    
    
    
    
    100,000
    (13)Ordinary Shares
    
    Mok King Man, Thomas
    
    
    
    
    
    
    
    
    
    
    500,000
    (14)Ordinary Shares
    
    Yim Chi Hang, Sunny
    
    
    
    
    
    
    
    
    
    
    100,000
    (15)Ordinary Shares
    
    Lai Ni Quiaque
    
    
    7,220,000
    
    
    
    1.2
    
    
    
    6,000,000
    (16)Ordinary Shares
    
    Leung Yau Man, Haily
    
    
    
    
    
    
    
    
    
    
    300,000
    (17)Ordinary Shares
    
    Leung, Eva
    
    
    
    
    
    
    
    
    
    
    150,000
    (18)
   (1)
    
    Of the 333,540,999 shares, 318,516,999 shares are beneficially owned through Mr. Wongs 34.7%
interest in Top Group International Limited, or Top Group, 1,346,000 shares are held by
Bullion Holdings Limited, which is wholly owned by Mr. Wong, 2,428,000 shares are owned
jointly by Mr. Wong and his spouse, and 11,250,000 shares are owned personally by him.(2)
    
    Of the 329,024,999 shares, 318,516,999 shares are beneficially owned through Mr. Cheungs
34.5% interest in Top Group and 10,508,000 shares are owned personally by Mr. Cheung. 85




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(3)
    
    Percentage ownership is based on 614,073,404 shares issued and outstanding as of February 4,
2005.(4)
    
    Options to subscribe for 8,000,000 shares were granted to Mr. Wong for a purchase price of
HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20,
2014 in the following manner: (i) 4,000,000 on or after January 5, 2005, (ii) 2,000,000 on or
after January 1, 2006 and (iii) 2,000,000 on or after January 1, 2007. The grant of option was
proposed on October 21, 2004 and approved by shareholders at our annual general meeting held
on December 29, 2004.(5)
    
    Options to subscribe for 8,000,000 shares were granted to Mr. Cheung for a purchase price of
HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or before October 20,
2014 in the following manner: (i) 4,000,000 on or after January 5, 2005, (ii) 2,000,000 on or
after January 1, 2006 and (iii) 2,000,000 on or after January 1, 2007. The grant of option was
proposed on October 21, 2004 and approved by shareholders at our annual general meeting held
on December 29, 2004.(6)
    
    Options to subscribe for 2,000,000 shares were granted to Mr. Chong on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 1,000,000 on or after January 1, 2005,
(ii) 500,000 on or after January 1, 2006, and (iii) 500,000 on or after January 1, 2007.(7)
    
    Options to subscribe for 500,000 shares were granted to Ms. Fung on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 200,000 on or after January 1, 2005, (ii)
200,000 on or after January 1, 2006, and (iii) 100,000 on or after January 1, 2007.(8)
    
    Options to subscribe for 1,000,000 shares were granted to Ms. Sio on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 500,000 on or after January 1, 2005, (ii)
250,000 on or after January 1, 2006, and (iii) 250,000 on or after January 1, 2007.(9)
    
    Options to subscribe for 2,000,000 shares were granted to Ms. To on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 1,000,000 on or after January 1, 2005,
(ii) 500,000 on or after January 1, 2006, and (iii) 500,000 on or after January 1, 2007.(10)
    
    Options to subscribe for 100,000 shares were granted to Ms. Choy on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 on or after January 1, 2005; options to subscribe for 250,000 shares
were granted to Ms. Choy on October 20, 2000 for a purchase price of HK$1.0 at an exercise
price of HK$0.58 per share and exercisable on or after June 2, 2001 until and including
October 19, 2010.(11)
    
    Options to subscribe for 500,000 shares were granted to Mr. Leung on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 200,000 on or after January 1, 2005, (ii)
200,000 on or after January 1, 2006, and (iii) 100,000 on or after January 1, 2007.(12)
    
    Options to subscribe for 500,000 shares were granted to Mr. Lo on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 200,000 on or after January 1, 2005, (ii)
200,000 on or after January 1, 2006, and (iii) 100,000 on or after January 1, 2007.(13)
    
    Options to subscribe for 100,000 shares were granted to Ms. Sin on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
after January 1, 2005 until and including October 20, 2014.(14)
    
    Options to subscribe for 500,000 shares were granted to Mr. Mok on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 200,000 on or after January 1, 2005, (ii)
200,000 on or after January 1, 2006, and (iii) 100,000 on or after January 1, 2007. 86




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(15)
    
    Options to subscribe for 100,000 shares were granted to Mr. Yim on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
after January 1, 2006 until and including October 20, 2014.(16)
    
    Options to subscribe for 6,000,000 shares were granted to Mr. Lai on June 3, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.47 per share and exercisable on or
before June 2, 2014 in the following manner: (i) 5,000,000 on or after May 1, 2005, and (ii)
1,000,000 on or after May 1, 2006.(17)
    
    Options to subscribe for 300,000 shares were granted to Ms. Leung on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
before October 20, 2014 in the following manner: (i) 120,000 on or after January 1, 2005, (ii)
100,000 on or after January 1, 2006, and (iii) 80,000 on or after January 1, 2007.(18)
    
    Options to subscribe for 150,000 shares were granted to Ms. Leung on October 21, 2004 for a
purchase price of HK$1.0, at an exercise price of HK$1.54 per share and exercisable on or
after January 1, 2005 until and including October 20, 2014.(19)
    
    Beneficial ownership is determined in accordance with the rules of the SEC. All shareholders own ordinary shares and enjoy the same voting rights with respect to
each share. Share Option Schemes We adopted a second share option scheme, which we refer to as the 2002 Scheme, on December 23,
2002 and terminated the share option scheme adopted and in effect since July 12, 1997, which we
refer to as the 1997 Scheme. The provisions of the 1997 Scheme remain in force to the extent
necessary to give effect to the exercise of any option granted pursuant to the 1997 Scheme. Such
options continue to be valid and exercisable in accordance with the 1997 Scheme. Under the terms of
the 2002 Scheme, our board of directors or the Board, may, in its discretion from time to time, and
subject to such conditions as the Board may determine, within ten years beginning on December 23,
2002, grant employees, including executive, non-executive and independent non-executive directors,
of City Telecom or any of its subsidiaries and any suppliers and professional advisers of City
Telecom or any of its subsidiaries options to subscribe for our ordinary shares. The maximum number of ordinary shares which may be issued upon exercise of all options to be
granted under our 2002 Scheme and any of our other share option scheme(s) must not exceed 10% of
the ordinary shares in issue as of the date of approval or adoption of the scheme by the
shareholders which was December 23, 2002 for the 2002 Scheme. Ordinary shares which would have been
issuable pursuant to options which have lapsed in accordance with the terms of such share option
schemes will not be counted for the purpose of the 10% limit. Such limit may be refreshed upon
approval by shareholders and compliance with all requirements under the Rules Governing the Listing
of Securities on The Stock Exchange of Hong Kong Limited, which we refer to as the Listing Rules.
Pursuant thereto, such limit was refreshed with the approval of our
shareholders in our annual general meeting held on December 29, 2004 up to a maximum limit equal to
10% of our total number of issued shares as at December 29, 2004. Notwithstanding
the foregoing, the number of ordinary shares which may be issued upon exercise of all outstanding
options granted and yet to be exercised under our 2002 Scheme and any of our other share option
scheme(s) at any time shall not exceed 30% of the total number of ordinary shares in issue from
time to time. The total number of ordinary shares issued and which may be issued upon exercise in full of
the options granted under our 2002 Scheme and any of our other share option scheme(s) (including
exercised, cancelled and outstanding options) to each eligible participant in any 12 month period
up to and including the date of grant shall not exceed 1% of the outstanding ordinary shares as at
the date of grant. Any further grant of options in excess of this 1% limit must be approved by
shareholders. The subscription price for an ordinary share payable by a participant upon the exercise of any
option granted under the 2002 Scheme will be determined by the Board in its absolute discretion,
except that 87




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such price will not be less than the highest of (a) the closing price of the ordinary shares
as stated in The Stock Exchange of Hong Kong Limiteds daily quotations sheet on the date of grant,
which must be a business day; (b) the average of the closing prices of the ordinary shares as
stated in The Stock Exchange of Hong Kong Limiteds daily quotations sheets for the five business
days immediately preceding the date of grant; and (c) the nominal value of an ordinary share. Any grant of options to any of our directors, chief executives or substantial shareholders or
any of their respective associates (as defined in the Listing Rules) is required to be approved by
our non-grantee independent non-executive directors. If we propose to grant options to a
substantial shareholder or any of its independent non-executive directors, or their respective
associates, which will result in the number of ordinary shares issued and to be issued upon
exercise of options granted and to be granted under our 2002 Scheme and any of our other share
option scheme(s) (including options exercised, cancelled and outstanding) to such person in the 12
month period up to and including the date of such grant (a) representing in aggregate over 0.1% of
the outstanding ordinary shares; and (b) having an aggregate value in excess of HK$5 million, based
on the closing price of the ordinary shares at the date of each grant, such further grant of
options will be subject to approval by shareholders and all requirements under the Listing Rules. A grant of options may not be made after a price sensitive event has occurred or a price
sensitive matter has been the subject of a decision until such price sensitive information,
including annual and interim results, has been made public. The period during which an option may be exercised will be determined by the Board in its
absolute discretion, except that no option may be exercised later than ten years from the date of
grant. No option may be granted more than ten years after December 23, 2002. Subject to our earlier
termination, the 2002 Scheme shall be valid and effective for a period of ten years after the date
of adoption, that is, until December 23, 2012. In addition and to the extent not already exercised,
an option will automatically lapse and not be exercisable upon the occurrence of any of the
following events:  (i)
    the expiry date relevant to that option;(ii)
    one month following the date a grantee ceases to be an eligible participant for any
reason other than death or termination of his relationship with us (or the relevant
subsidiary, as the case may be) on any of the grounds specified in (vii) below;(iii)
    12 months, or such longer period as the Board may determine, following the death of a
grantee whose relationship with us (or the relevant subsidiary, as the case may be) would
not have been terminated on any of the grounds specified in (vii) below;(iv)
    21 days following the date an effective resolution is passed for our voluntary
winding-up;(v)
    subject to (iv) above, the date of commencement of such winding-up;(vi)
    the date on which any compromise or arrangement between us and our members or creditors
in connection with a scheme for our reconstruction or our amalgamation with any other
company or companies becomes effective;(vii)
    the date on which the grantee ceases to be an eligible participant by reason of the
termination of his or her relationship with us or the relevant subsidiary on any one or
more of the grounds of serious misconduct or breach, bankruptcy, insolvency, composition
with his or her creditors or conviction of any criminal offense involving his or her
integrity or honesty or, in the case of a grantee-employee and if so determined by the
Board, on any other common law, statutory or contractual ground on which an employer would
be entitled to terminate such grantees employment; 88




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(viii)
    14 days following the date a general offer (which has been made to shareholders by way of
take-over offer, share repurchase offer or scheme of arrangement or otherwise in like
manner) becomes, or is declared unconstitutional; and(ix)
    the date on which we cancel the options by reason that the grantee in any way sells,
transfers, charges, mortgages, encumbers or creates any interest in favor of any third
party over or in relation to any of his or her options or attempt to do so. Through January 31, 2005, the Board had adopted nine resolutions pursuant to the 1997 Scheme
and two resolutions pursuant to the 2002 Scheme. The total number of options granted in the
resolutions pursuant to the 1997 Scheme as of January 31, 2005 is 80,490,000, of which 35,894,000
have been exercised, 600,000 are outstanding and 43,996,000 have lapsed, been forfeited or
cancelled. The number of options granted in the resolutions pursuant to the 2002 Scheme is
36,670,000 of which none have been exercised. 89




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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS Major Shareholders The following table sets forth certain information regarding ownership of our ordinary shares
as of January 31, 2005 by all persons who are known to us to own beneficially 5% or more of our
ordinary shares. Percentages of SharesBeneficially
    
    
    Beneficially OwnedTitle of Class
    
    Identity of Person or Group
    
    
    Owned(6)
    
    
    (%)(1)Ordinary Shares
    
    Wong Wai Kay, Ricky
    
    
    333,540,999
    (2)
    
    
    54.32Ordinary Shares
    
    Cheung Chi Kin, Paul
    
    
    329,024,999
    (3)
    
    
    53.58Ordinary Shares
    
    Top Group International Limited
    
    
    318,516,999
    
    
    
    51.87Ordinary Shares
    
    Leung Ka Pak
    
    
    318,516,999
    (4)
    
    
    51.87Ordinary Shares
    
    Yau Ming Yan, Andrew
    
    
    318,516,999
    (4)
    
    
    51.87Ordinary Shares
    
    EK Investment Management Limited
    
    
    67,050,000
    (5)
    
    
    10.92
   (1)
    
    Percentage ownership is based on 614,073,404 shares issued as of February 4, 2005.(2)
    
    Of the 333,540,999 shares, 318,516,999 shares are beneficially owned through Mr. Wongs 34.7%
interest in Top Group, 1,346,000 shares are held by Bullion Holdings Limited, which is wholly
owned by Mr. Wong, 2,428,000 shares are owned jointly by Mr. Wong and his spouse, and
11,250,000 shares are owned personally by Mr. Wong.(3)
    
    Of the 329,024,999 shares, 318,516,999 shares are beneficially owned through Mr. Cheungs
34.5% interest in Top Group and 10,508,000 shares are owned personally by Mr. Cheung.(4)
    
    The 318,516,999 shares are beneficially owned through Mr. Leungs 21.0% and Mr. Yaus 9.8%
interest in Top Group.(5)
    
    The 67,050,000 shares owned by EK Investment Management Limited is the number of shares as
notified to us by EK Investment Management Limited as of May 6, 2004.(6)
    
    Beneficial ownership is determined in accordance with the rules of the SEC. Top Group is a holding company incorporated in British Virgin Islands with no active
operations. Top Group has two directors, Mr. Wong Wai Kay, Ricky and Mr. Cheung Chi Kin, Paul, who
are our chairman and managing director. Mr. Leung Ka Pak and Mr. Yau Ming Yan, Andrew are the two
other shareholders of Top Group. Top Groups corporate secretary is Ms. Sio Veng Kuan, Corinna, our
director of finance. Mr. Leung Ka Pak is an executive director and the president of our subsidiaries in Canada
other than City Telecom (Canada) Inc. Mr. Yau Ming Yan, Andrew, is an executive director and the
secretary of our subsidiaries in Canada other than City Telecom (Canada) Inc. EK Investment Management Limited is not affiliated with us or our officers or directors. All shareholders own ordinary shares and enjoy the same voting rights with respect to each
share. As of January 31, 2005, there were sixteen registered holders of 2,347,048 of our American
depositary shares in the United States, consisting of approximately 7.64% of our outstanding
shares. Except as disclosed above, we are not directly or indirectly owned or controlled by any other
person, corporation or foreign government. 90




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We are not aware of any arrangement the operation of which may at a subsequent date result in
a change of control of City Telecom. Related Party Transactions During
the period from September 1, 2002 to February 4, 2005, we were party to the following
related party transactions. Sale of City Telecom (Japan) Co., Ltd. On July 15, 2003, Automedia Holdings Limited, a wholly-owned subsidiary of the Company,
entered into a conditional agreement with Takua Corporation, or Takua, for the sale of the entire
issued share capital of City Telecom (Japan) Co., Ltd., or City Telecom Japan, for an aggregate
price of JPY30.0 million (approximately HK$2.0 million), which is to be paid by Takua in thirty
monthly installments. Prior to the entering into the Agreement, City Telecom Japan was our
wholly-owned subsidiary. Takua is wholly-owned by Mr. Masaaki Asai, who is a brother of Mr.
Tatsushi Asai, a director of City Telecom Japan. Mr. Tatsushi Asai also acts as a guarantor for the
due and punctual performance of Takuas obligations under this agreement for no additional
consideration. As of August 31, 2004, we had received approximately HK$0.8 million from Takua. Contracts with Our Directors and Senior Management All of our directors and senior management have service agreements with us and the service
contracts of our six executive directors include non-competition clauses under which our executive
directors agree not to compete with us in accordance with the terms and conditions therein. Certain
of our directors and senior management receive housing allowances, pensions and bonuses. In
addition, some of our directors are also senior management of City Telecom and these persons may
also have the ability to make significant business decisions effecting our operations and determine
the compensation they will be paid in connection with their roles as directors or management. See
Item 6 Directors and Senior Management of this annual report for details concerning these
arrangements. 91




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ITEM 8. FINANCIAL INFORMATION Consolidated Statements and Other Financial Information See
pages F-1  F-52 following Item 19. Legal and Regulatory Proceedings The claim filed against us in mid June 1999 in the High Court of Hong Kong by New World
Telephone Limited (New World), a Hong Kong Company, was concluded by mutual agreement. The
parties agreed to discontinue the proceedings and a consent summons was filed in November 2004 with
the High Court of Hong Kong. We are currently involved in four material legal or regulatory proceedings. They are
described below: Peoples Telecom.In March 2004, we asked the Telecommunications Authority to make a
determination on the level of charges to be paid by China Resources Peoples Telephone Company
Limited, or Peoples Telecom, for direct interconnection between its mobile network and our Metro
Ethernet network and the effective date of such charges under the Telecommunications Ordinance. In
May 2004, the Telecommunications Authority confirmed to Peoples Telecom and HKBN that mobile
operators should pay interconnection charges to fixed network operators, including ourselves, in
accordance with the existing charging principles provided by the Telecommunications Authority. In
August 2004, the Telecommunications Authority agreed to make a determination regarding the level
and effective date of interconnection charges payable to us by Peoples Telecom. These proceedings
are still in progress and the Telecommunications Authority has not yet reached any conclusion. Our revenues for fixed telecommunications network services for fiscal 2003 and fiscal 2004
include interconnection charges of HK$6.1 million and HK$38.7 million, respectively, receivable
from Peoples Telecom and other mobile operators for the usage of our Metro Ethernet network. We
determined the amount of these charges based on the fully distributed cost model determined by the
Telecommunications Authority to be applicable in determining the interconnection charges between
fixed and mobile operators, which relies on the historical levels of mobile interconnection charges
paid by mobile operators to PCCW-HKT. Having considered this matter, we are of the view that the
result of this determination will have a material impact on the amount of interconnection charges
receivable from mobile operators for the usage of our Metro Ethernet network. We cannot predict the
ultimate outcome of the Telecommunications Authoritys determination. If the level of
interconnection charges determined by the Telecommunications Authority to be payable to us is lower
than the revenues that we have recognized, we will be required to write-back the difference from
our revenue during fiscal 2005. PCCW-HKT and PCCW-IMS.PCCW-HKT and PCCW-IMS brought an action for judicial review against
the Telecommunications Authority, in which HKBN was initially joined as an interested party, on
October 11, 2004 in the High Court of Hong Kong. PCCW-HKT and PCCW-IMS seek judicial review of the
Telecommunications Authoritys decision dated September 22, 2004 in which the Telecommunications
Authority found no evidence to suggest that HKBN is acting outside the scope of its FTNS License in
providing local VOIP services accessible over the broadband connections provided by other
operators. PCCW-HKT and PCCW-IMS seek to have the Telecommunications Authoritys decision
overturned and had requested interim orders against both the Telecommunications Authority and HKBN
to prohibit HKBN from providing off-network local VOIP services, which we launched in August 2004.
In November 2004, PCCW-HKT and PCCW-IMS withdrew their interim applications, but amended their
original application to include, among other things, naming HKBN as a second respondent to which
HKBN consented. The proceedings of the judicial review will continue and the hearing is set for
November 28, 2005. HKBN and the Telecommunications Authority are required to file further evidence
for the judicial review proceedings. We cannot accurately predict the outcome of the judicial
review, but we believe that such decision will not affect our ability to provide local VOIP
services within our own Metro Ethernet network. 92




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PCCW-HKT.PCCW-HKT (then Cable & Wireless HKT), a Hong Kong company, brought an action
against us on July 10, 1998 in the High Court of Hong Kong, alleging breach of agreements relating
to the supply and operation of telecommunications services and unlawful interference with trade.
This claim was subsequently amended on September 1, 1998. The PCCW-HKT claim relates specifically
to its alleged monetary loss between the months of February and October in 1997 resulting from the
manner in which we used its telecommunications transmission lines. The sole issue raised by Cable &
Wireless HKT in this case is whether we are liable for monetary damages to PCCW-HKT. As a result,
we do not believe that the resolution of this case will impair our ability to lease transmission
circuits from PCCW-HKT or significantly alter the commercial terms on which these transmission
circuits are leased. PCCW-HKT has yet to stipulate the exact amount of their monetary loss during
that period as a result of our alleged misuse. We filed a defense and a counterclaim on October 7, 1998 alleging anti-competitive practices
on the part of PCCW-HKT. We subsequently amended our counterclaim on November 18, 1998. The case is
currently in its discovery phase. The first trial proceedings in the case have not yet taken place.
We cannot accurately predict the expected date of resolution of this case and we have not made any
reserve for this case. Jade Com.Jade Com Development Limited, or Jade Com, a Hong Kong company, alleged in a claim
filed in April 13, 1999 in the High Court of Hong Kong that we, as a principal of one of our wholly
owned subsidiaries, wrongfully terminated a telecommunications service agreement entered into on
November 26, 1997. Jade Com claimed damages for breach of contract and misrepresentation, but did
not state the specific amount of its claim. If the agreement had not been terminated, we would have
had a remaining commitment of approximately US$3.6 million under the agreement. We filed a defense
in May 24, 1999 asserting that we were not the principal of the wholly owned subsidiary which
entered the agreement and alternatively, Jade Com had breached a condition of the agreement that
they possess all the legal approvals and licenses necessary for the provision of their services.
Specifically, our defense asserts that Jade Com did not have certain regulatory approvals required
for the provision of the international telecommunications services that formed the basis of the
agreement. As such, we asserted in our defense that our wholly owned subsidiary was entitled to
terminate the agreement. In February 2001, the parties consented to adjourn the case indefinitely
with liberty to restore. We have not made any reserve for this litigation. Dividends Unless the relevant provisions of the Companies Ordinance require otherwise, we may by
ordinary resolution (being a resolution passed by a majority of our shareholders who attend and
vote at a meeting of shareholders) from time to time declare dividends, but no dividend shall
exceed the amount recommended by our board of directors. Our Articles contain provisions on
apportioning dividends where shares are not or were not fully paid for during the period covered by
the dividend. Unless the relevant provisions of the Companies Ordinance require otherwise, our board of
directors may pay such interim dividends as appears to them to be justified by our financial
position and pay any dividend payable at a fixed rate at intervals decided upon by our board of
directors, whatever our financial position, if the board of directors feels that this payment is
justified. In respect of any dividend proposed to be paid or declared by our board of directors or by us
in a general meeting, our board of directors may further propose and announce prior to or at the
same time as the payment or declaration of such dividend either that:  (a)
    such dividend be made in whole or in part in the form of an allotment of shares to
the shareholders, credited as being fully paid. However, all the shareholders entitled to
receive these new shares will also be entitled to choose to receive the dividend (or a
part of it) in cash and not shares; or 93




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(b)
    the shareholders entitled to such dividend are entitled to elect to receive an
allotment of shares, credited as fully paid instead of the whole or that part of the cash
dividend as the board of directors may decide upon. Any general meeting declaring a dividend may, upon the recommendation of our board of
directors, by ordinary resolution, direct that the dividend shall be met, wholly or partly, by the
distribution of our assets. Any dividend not claimed by a shareholder after a period of six years from the date when it
was first due to be paid shall be forfeited and shall revert to us. The payment by our board of
directors of any unclaimed dividend, interest or other sum payable on or in respect of a share into
a separate account shall not make us responsible as a trustee for such sums. The board of directors has declared an interim dividend of HK$0.05 per ordinary share for the
six months ended February 28, 2003 to shareholders whose names appeared on our Register of Members
on May 27, 2003; such interim dividend was paid on or about June 10, 2003. The board of directors
has further recommended a final dividend of HK$0.075 per ordinary share to shareholders whose names
appeared on our Register of Members on December 23, 2003. This final dividend was approved by the
shareholders in the annual general meeting of the Company held on December 23, 2003 and was paid on
or about January 9, 2004. Significant Changes On
January 20, 2005, we successfully completed a US$125 million offering of
8.75% senior notes due 2015. This offering was an underwritten
transaction and our net proceeds were approximately US$121.0 million after deduction of expenses and
commissions. We used the net proceeds, in part, to repay in full an existing loan
facility in the outstanding amount of HK$196.7 million, and will use the remaining net proceeds for
capital expenditures, including costs incurred in expanding and
upgrading our Metro Ethernet
network in Hong Kong, and for additional working capital and general corporate purposes. The following paragraphs provide a brief summary of the material terms of the 8.75% notes: Issuer
    
    City Telecom (H.K.) LimitedGuarantees
    
    The 8.75% notes will be irrevocably and unconditionally
guaranteed, subject to release as specified in the
indenture governing the 8.75% notes as to the payment of all
principal, and interest, additional amounts, if any, and
registration default damages, if any, jointly and
severally, on a senior unsecured basis by all of our
existing and future subsidiaries (other than, as of the
issue date of the 8.75% notes, CTI Guangzhou and,
subsequently, any other subsidiary prohibited by
applicable law, regulation or order from issuing a
guarantee of the 8.75% notes). If we cannot make payments on
the 8.75% notes when they are due, the guarantors must make
them instead. The guarantees may be released without the
consent of the holders of the 8.75% notes in accordance with
the terms of the Indenture.Notes Offered
    
    US$125,000,000 of 8.75% senior notes due 2015.Maturity Date
    
    February 1, 2015.Issue Price
    
    100%.Interest Rate and Payment Dates
    
    Interest on the 8.75% notes will be payable at the rate of
8.75% per annum, payable every six months in arrears on
February 1 and August 1 of each year, beginning August
1, 2005.
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Ranking of the 8.75% Notes
    
    The 8.75% notes and the guarantees will be our unsecured
senior debt obligations and those of the guarantors. The 8.75% notes and the guarantees will:   be effectively subordinated to all of our existing and
future secured debt, including any new credit agreement,
to the extent of the value of the assets securing such
debt;   be effectively subordinated to all existing and future
debt and other liabilities of any non-guarantor
subsidiary, including trade payables;   rank
pari passu with all our current and future
unsubordinated unsecured debt and those of the
guarantors; and   be senior in right of payment to all the guarantors
and our subordinated debt.As of the issue date of the 8.75% notes, CTI Guangzhou will be
the only non-guarantor subsidiary and it has no
outstanding third-party indebtedness. The Limitation of
Indebtedness covenant in the indenture governing the
8.75% notes will restrict any non-guarantor subsidiary from
incurring any indebtedness.The indenture governing the 8.75% notes will permit us,
subject to specified limitations, to incur additional
debt, some or all of which may be senior debt and some
of which may be secured debt.Optional Redemption
    
    We may redeem the 8.75% notes, in whole or in part, on or
after February 1, 2010, at the redemption prices set
forth in the indenture governing the 8.75% notes. In addition,
prior to February 1, 2008, we may redeem up to a maximum
of 35% of the original aggregate principal amount of the
8.75% notes with the proceeds from one or more specified
public or private offerings of our common stock at a
redemption price equal to 108.75% of the principal
amount of the 8.75% notes. In all cases of optional
redemption, we will pay principal at the redemption
price specified plus accrued and unpaid interest,
additional amounts, if any, and registration default
damages, if any, thereon to, but not including, the date
of redemption.Optional Tax Redemption
    
    We may redeem all, but not part, of
the 8.75% notes if there
are specified changes in tax laws, at a redemption price
equal to 100% of the principal amount of the 8.75% notes, plus
accrued and unpaid interest to the date of redemption.Change of Control
    
    Upon the occurrence of change of control events, unless
we have exercised our right to redeem all of the 8.75% notes
by way of optional redemption or optional tax
redemption, noteholders may require us to repurchase all
or a portion of their 8.75% notes at 101% of the principal
amount, plus accrued and unpaid interest, additional
amounts, if any, and registration default damages, if
any, to, but not including the repurchase date.Covenants
    
    The indenture governing the 8.75% notes will contain covenants
that will limit, among other things, our ability and the
ability of certain of our existing and future
subsidiaries to:   pay dividends, make distributions, redeem capital
stock and make certain other restricted payments or
investments;   incur additional indebtedness or issue certain equity
interests;
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   merge, consolidate or sell all or substantially all of
our assets;   issue or sell capital stock of some of our
subsidiaries;   sell or exchange assets or enter into new businesses;   create any restrictions on the payment of dividends,
the making of distributions, the making of loans and the
transfer of assets;   create liens on assets;   enter into certain transactions with affiliates or
related persons; and   enter into sale and lease back transactions.All of these limitations are subject to certain
exceptions and qualifications set forth in the indenture
governing the 8.75% notes.Registration Rights
    
    Under a registration rights agreement that we executed
in connection with the offering of our 8.75% notes, we
have agreed to:   file a registration statement within 60 days after the
issue date of the 8.75% notes with respect to an offer to
exchange the 8.75% notes for a new issue of notes registered
under the Securities Act, which will have terms
substantially identical in all material respects to the
8.75% notes;   use our reasonable efforts to cause the registration
statement to be declared effective under the Securities
Act within 180 days after the issue date of the 8.75% notes
and to keep the exchange offer open for not less than 30
days (or longer, if required by applicable law); and   file a shelf registration statement for the resale of
the 8.75% notes, if we cannot effect an exchange offer within
the required time period and in several other specified
circumstances.If we fail to satisfy our registration obligations under
the registration rights agreement, we will be required
to pay registration default damages to the holders of
the 8.75% notes.Transfer Restrictions
    
    The 8.75% notes have not been registered under the Securities
Act and are subject to certain restrictions on transfer.
The 8.75% notes are eligible to trade in the Portal Market and
are listed and quoted on the SGX-ST.Further Notes
    
    We may from time to time, without notice to or the
consent of the holders of the 8.75% notes, issue further
notes, which will form a single series with the 8.75% notes.Trustee, Registrar, Principal
Paying Agent and Transfer Agent
    
    Deutsche Bank Trust Company
Americas.Governing Law
    
    The 8.75% notes and the indenture will be governed by, and
shall be construed in accordance with, the laws of the
State of New York.
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ITEM 9. THE OFFER AND LISTING Offer and Listing Details Our ordinary shares of common stock were listed under the number 1137 on the Stock Exchange
of Hong Kong Limited (the SEHK) on August 4, 1997. Our American depositary shares, each
representing 20 ordinary shares, were listed under the symbol CTEL on the Nasdaq on November 3,
1999. We listed our warrants, each representing the right to purchase one ordinary share of our
common stock, under the number 0940 on the SEHK on November 2, 2000 and the warrants expired
on November 1, 2004. Trading in the warrants ceased at 4:00 p.m. on October 27, 2004 and listing
of the warrants was withdrawn at the close of business on November 1, 2004. The price of our ordinary shares on the SEHK as of its close of trading on February 4, 2005
was HK$1.41 per share. The table below shows the high and low closing prices of the shares on the
SEHK since listing. PriceHigh
    
    
    Low(In HK$)2000
    
    
    8.000
    
    
    
    0.5402001
    
    
    0.890
    
    
    
    0.4202002
    
    
    1.690
    
    
    
    0.7402003
    
    
    3.375
    
    
    
    1.3202004
    
    
    2.975
    
    
    
    1.3102003January to March
    
    
    1.490
    
    
    
    1.320April to June
    
    
    2.150
    
    
    
    1.420July to September
    
    
    2.975
    
    
    
    2.050October to December
    
    
    3.375
    
    
    
    2.6752004January to March
    
    
    2.975
    
    
    
    2.400April to June
    
    
    2.525
    
    
    
    1.310July to September
    
    
    1.930
    
    
    
    1.390October to December
    
    
    1.690
    
    
    
    1.4602004July
    
    
    1.540
    
    
    
    1.390August
    
    
    1.930
    
    
    
    1.420September
    
    
    1.830
    
    
    
    1.620October
    
    
    1.690
    
    
    
    1.460November
    
    
    1.640
    
    
    
    1.470December
    
    
    1.590
    
    
    
    1.5002005January
    
    
    1.530
    
    
    
    1.380
 The price of our American depositary shares on Nasdaq as of its close of trading on February
4, 2005 was US$3.52 per American depositary share. The table below shows the high and low closing
prices of the American depositary shares on Nasdaq since listing. PriceHigh
    
    
    Low(In US$)2000
    
    
    20.500
    
    
    
    1.1252001
    
    
    2.400
    
    
    
    1.030
 97




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PriceHigh
    
    
    Low(In US$)2002
    
    
    4.350
    
    
    
    2.6002003
    
    
    9.550
    
    
    
    3.0802004
    
    
    7.720
    
    
    
    3.3202003January to March
    
    
    3.700
    
    
    
    3.080April to June
    
    
    6.000
    
    
    
    3.510July to September
    
    
    7.940
    
    
    
    5.400October to December
    
    
    9.550
    
    
    
    6.8202004January to March
    
    
    7.720
    
    
    
    5.900April to June
    
    
    6.570
    
    
    
    3.320July to September
    
    
    4.960
    
    
    
    3.410October to December
    
    
    4.600
    
    
    
    3.7102004July
    
    
    3.890
    
    
    
    3.410August
    
    
    4.960
    
    
    
    3.640September
    
    
    4.750
    
    
    
    4.260October
    
    
    4.440
    
    
    
    3.710November
    
    
    4.600
    
    
    
    3.780December
    
    
    4.160
    
    
    
    3.8112005January
    
    
    3.980
    
    
    
    3.500
 The price of our warrants on the SEHK as of its close of trading on October 27, 2004 was
HK$1.00 per warrant. The table below shows the high and low closing prices of the warrants on SEHK
since listing until the cessation of trading. PriceHigh
    
    
    Low(In HK$)2001November 2 to December 31
    
    
    0.410
    
    
    
    0.1802002
    
    
    1.220
    
    
    
    0.3652003
    
    
    2.825
    
    
    
    0.9502004
    
    
    2.650
    
    
    
    1.0002003January to March
    
    
    1.040
    
    
    
    0.950April to June
    
    
    1.650
    
    
    
    0.960July to September
    
    
    2.350
    
    
    
    1.650October to December
    
    
    2.825
    
    
    
    2.2752004January to March
    
    
    2.650
    
    
    
    2.400April to June
    
    
    2.400
    
    
    
    2.400July to September
    
    
    2.400
    
    
    
    2.000October 1 to October 27
    
    
    2.000
    
    
    
    1.000
 98




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PriceHigh
    
    
    Low(In HK$)2004July
    
    
    2.400
    
    
    
    2.400August
    
    
    2.400
    
    
    
    2.400September
    
    
    2.400
    
    
    
    2.000October 1 to October 27
    
    
    2.000
    
    
    
    1.000
 Markets Our ordinary shares of common stock were listed under the number 1137 on the SEHK on August
4, 1997. Our American depositary shares, each representing 20 ordinary shares, were listed under
the symbol CTEL on the Nasdaq on November 3, 1999. We listed our warrants, each representing the
right to purchase one ordinary share of our common stock, under the number 0940 on the SEHK on
November 2, 2000 and the warrants expired on November 1, 2004. Trading in the warrants ceased
at 4:00 p.m. on October 27, 2004 and listing of the warrants was withdrawn at the close of business
on November 1, 2004. 99




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ITEM 10. ADDITIONAL INFORMATION Memorandum and Articles of Association Described below is a summary of certain provisions of our Memorandum and Articles of
Association (the Articles), as amended on December 29, 2004 and currently in effect, and, where
relevant, the Companies Ordinance (Chapter 32 of the laws of Hong Kong) (the Companies
Ordinance). As this is a summary, it does not contain all the information that may be important
to you. You should therefore read our complete Articles if you would like additional information,
which are filed with the U.S. Securities and Exchange Commission as exhibit 1 to this annual
report. General We were incorporated in Hong Kong on May 19, 1992 under the Companies Ordinance. Article 3
states that City Telecoms objects are to carry on the business of telecommunications services in
addition to various other related and unrelated business activities. Directors Interests A director shall not vote on, or be counted in the quorum in relation to, any resolution of
the board of directors in respect of any contract in which the director or any of his associate(s)
(within the meaning of the Listing Rules) has a material interest. This prohibition shall not
apply to the following:  (a)
    the giving of any security or indemnity to him or his associates(s) in respect of
money lent or obligations incurred or undertaken by him or any of them at the request of
or for the benefit of the Company or any of its subsidiaries;(b)
    the giving of any security or indemnity to a third party in respect of a debt or
obligation of the Company or any of its subsidiaries for which he or his associate(s) has
himself/themselves assumed responsibility in whole or in part and whether alone or
jointly under a guarantee or indemnity or by the giving of security;(c)
    any proposal concerning an offer of shares, debentures or other securities of or by
the Company or any other company which the Company may promote or be interested in for
subscription or purchase in which offer he or his associate(s) is/are or is/are to be
interested as a participant in the underwriting or sub-underwriting thereof;(d)
    any proposal concerning any other company in which he or his associate(s) is/are
interested only, whether directly or indirectly, as an officer, executive or shareholder
or in which he or his associate(s) is/are beneficially interested in shares of that
company, provided that he and any of his associate(s) are not in aggregate beneficially
interested in five per cent. or more of the issued shares of any class of such company
(or of any third company through which his interest or that of his associate(s) is
derived) or of the voting rights;(e)
    any proposal or arrangement concerning the benefit of employees of the Company or
its subsidiaries, including the adoption, modification or operation of any employees
share scheme or any share incentive or share option scheme under which the director or
his associate(s) may benefit;(f)
    any proposal or arrangement concerning the benefit of employees of the Company or
its subsidiaries, including the adoption, modification or operation of a pension fund or
retirement, death or disability benefits scheme which relates both to directors (or his
associate(s)) and employees of the Company or any of its subsidiaries and does not
provide in respect of any director or his associate(s), as such any privilege or
advantage not generally accorded to the class of persons to which such scheme or fund
relates; and 100




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(g)
    any contract or arrangement in which he or his associate(s) is/are interested in
the same manner as other holders of shares or debentures or other securities of the
Company by virtue only of his/their interest in shares or debentures or other securities
of the Company. Additionally, there is no shareholding qualification required to be a director. Dividends Unless the relevant provisions of the Companies Ordinance require otherwise, we may by
ordinary resolution (being a resolution passed by a majority of our shareholders who attend and
vote at a meeting of shareholders) from time to time declare dividends, but no dividend shall
exceed the amount recommended by our board of directors. Our Articles contain provisions on
apportioning dividends where shares are not or were not fully paid for during the period covered by
the dividend. Unless the relevant provisions of the Companies Ordinance require otherwise, our board of
directors may pay such interim dividends as appears to them to be justified by our financial
position and pay any dividend payable at a fixed rate at intervals decided upon by our board of
directors, whatever our financial position, if the board of directors feels that this payment is
justified. In respect of any dividend proposed to be paid or declared by our board of directors or by us
in a general meeting, our board of directors may further propose and announce prior to or at the
same time as the payment or declaration of such dividend either that:  (a)
    such dividend be made in whole or in part in the form of an allotment of shares to
the shareholders, credited as being fully paid. However, all the shareholders entitled to
receive these new shares will also be entitled to choose to receive the dividend (or a
part of it) in cash and not shares; or(b)
    the shareholders entitled to such dividend are entitled to elect to receive an
allotment of shares, credited as fully paid instead of the whole or that part of the cash
dividend as the board of directors may decide upon. Any general meeting declaring a dividend may, upon the recommendation of our board of
directors, by ordinary resolution, direct that the dividend shall be met, wholly or partly, by the
distribution of our assets. Any dividend not claimed by a shareholder after a period of six years from the date when it
was first due to be paid shall be forfeited and shall revert to us. The payment by our board of
directors of any unclaimed dividend, interest or other sum payable on or in respect of a share into
a separate account shall not make us responsible as a trustee for such sums. Liquidation If City Telecom commences liquidation, the liquidator may, with the sanction of a special
resolution of City Telecom and any other sanction required by the Companies Ordinance:  (a)
    divide among the shareholders the whole or any part of the assets of City Telecom and
set such value as the liquidator deems fair upon any property to be divided and determine
how the division shall be carried out between the shareholders; or(b)
    vest the whole or any part of such assets in trustees upon such trusts for the
benefit of the contributories as the liquidator shall think fit, but no shareholder shall be compelled to accept any shares or other assets upon which there is
any liability. 101




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Annual and Extraordinary General Meeting of Shareholders The Companies Ordinance requires our board of directors to hold an annual general meeting of
our shareholders once every calendar year and not more than 15 months after our previous annual
general meeting. The annual general meeting and any other general meeting of our shareholders held
for the passing of a special resolution (being a resolution passed by a majority of not less than
75% of those shareholders who attend and vote at a meeting of shareholders) should be convened by
not less than 21 clear days notice in writing. The notice shall specify the place, date and time
of meeting and the general nature of the business to be transacted. An annual general meeting may
be called by less than 21 days notice if it is agreed to by all shareholders entitled to attend
and vote at the meeting. The business of the annual general meeting will include:  (a)
    the declaration and sanctioning of dividends;(b)
    the consideration and adoption of the accounts and balance sheet and the report of
the directors and other documents required to be attached to the accounts;(c)
    the appointment of directors in place of those retiring (by rotation or otherwise);(d)
    the appointment of auditors; and(e)
    the fixing of, or the determining of the method of fixing, the remuneration of the
directors and of the auditors. Our board of directors may convene an extraordinary general meeting (which is any general
meeting of the shareholders other than the yearly annual general meeting) whenever it thinks fit
and must do so upon the request in writing of shareholders holding not less than one-twentieth of
our paid-up capital carrying the right to vote at the general meeting. All extraordinary general
meetings (other than those convened for the passing of a special resolution referred to above)
should be convened by not less than 14 clear days notice in writing. Extraordinary general
meetings may be called by less than 14 days notice by a majority in number of the shareholders
having the right to attend and vote at the meeting, being a majority together holding not less than
95% in nominal value of the shares giving that right. Except as otherwise provided by our Articles, two shareholders present in person or by proxy
and entitled to vote shall be a quorum for all purposes. No business shall be transacted at any
general meeting unless a quorum is present when the meeting proceeds to business, but the absence
of a quorum shall not preclude the choice or appointment of a chairman which shall not be treated
as part of the business of the meeting. Nasdaqs marketplace rules, which apply to all companies listed on the Nasdaq Stock Market,
state in Rule 4350(f) that the minimum quorum for any meeting of holders of a companys common
stock is 33 1/3% of the outstanding shares. Consistent with practice of companies incorporated in
Hong Kong, our articles of association only require a quorum of two Members (as such term is
defined our articles of association) for any general meeting of our shareholders. As a result, we
requested, and Nasdaq granted to us, an exemption from compliance with the Rule 4350(f)
requirement. Restrictions on Ownership of Shares There are no restrictions, either pursuant to our Articles, or pursuant to the laws of Hong
Kong, on the rights of non-residents of Hong Kong or foreign persons to hold or exercise voting
rights with respect to our ordinary shares. 102




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Voting Rights Under the Companies Ordinance, any action to be taken by the shareholders in a general meeting
requires the passing of either an ordinary or a special resolution at such meeting. Generally,
resolutions of the shareholders are passed by ordinary resolution. However, the Companies
Ordinance and our Articles provide that certain matters may only be passed as special resolutions. Unless any shares have special terms as to voting, on a show of hands every member who is
present in person at a general meeting, shall have one vote and on a poll every member who is
present in person or by proxy shall have one vote for every share of which he is the holder. Our
Articles set out the circumstances in which a poll can be demanded. Any shareholder that is a recognized clearing house within the meaning of the Securities and
Futures Ordinance of Hong Kong may authorize such person or persons as it thinks fit to act as its
representative (or representatives) at any general meeting or at any separate meeting of any class
of shareholders (if relevant). However, if more than one person is authorized, the authorization
must specify the number and class of shares in respect of which each person is in fact authorized.
The authorized person will be entitled to exercise the same power on behalf of the recognized
clearing house as that clearing house (or its nominees) could exercise if it were an individual
shareholder. Issue of Shares Under the Companies Ordinance, our board of directors may, without the prior approval of the
shareholders, offer to issue new shares to existing shareholders in proportion to their current
shareholdings. Our board of directors may not issue new shares in any other way without the prior
approval of the shareholders in a general meeting. Any such approval given in a general meeting
shall continue in force until the earlier of: (1) the conclusion of next years annual general
meeting; or (2) the expiration of the period within which the next annual general meeting is
required by law to be held; or (3) when revoked or varied by an ordinary resolution of the
shareholders in a general meeting. If such approval is given, our unissued shares shall be at the
disposal of our board of directors, which may offer, allot, grant options over or otherwise dispose
of them to such persons, at such times and for such consideration and upon such terms and
conditions as the directors may decide. Unless specifically restricted by our Articles, any shareholder may transfer all or any of his
shares by an instrument of transfer in the usual or common form or in such other form as our board
of directors may accept and may approve. Such transfer may be signed by hand or, if the buyer or
seller is a clearing house or its nominee(s), signed by hand or by a machine imprinted signature or
by such other manner as our board of directors may approve from time to time. The instrument of transfer of a share shall be signed by or on behalf of both the buyer and
the seller of that share provided that our board of directors may dispense with the signing of the
instrument of transfer by the buyer in any case which it thinks fit in its discretion to do so.
Except as provided in the paragraph above, our board of directors may also decide, either generally
or in any particular case, upon request by either the buyer or seller of shares to accept
mechanically signed transfers. The seller shall be deemed to remain the holder of the share until
the name of the buyer is entered into our register in respect of that share. All instruments of
transfer, when registered, may be retained by us. Nothing in our Articles shall prevent our board
of directors from recognizing a renunciation of the allotment or provisional allotment of any share
by the person to whom the shares were to be allotted in favor of some other person. Our board of directors may in its absolute discretion and without giving any reason, decline
to register any transfer of any share which is not a fully paid share. Our board of directors may also decline to register any transfer unless: 103




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(a)
    the instrument of transfer, duly stamped, is lodged with us accompanied by the
certificate for the shares to which it relates and such other evidence as our board of
directors may reasonably require to show the right of the seller to make the transfer;(b)
    such fee, not more than the maximum amount allowed by the Stock Exchange of Hong Kong
from time to time, as our board of directors may from time to time require is paid to us
in respect of it;(c)
    the instrument of transfer is in respect of only one class of share;(d)
    in the case of a transfer of a share to be registered in more than one name (i.e.
there are joint holders), the number of joint holders to whom the share is to be
transferred does not exceed four; and(e)
    the shares concerned are free of any lien in favor of us. If our board of directors declines to register a transfer of any share, it shall, within two
months after the date on which the instrument of transfer was lodged, send to the purchaser notice
of the refusal. Shareholders In accordance with the Companies Ordinance and our Articles, only persons who are registered
in our register of members are recognized by us as shareholders and absolute owners of the shares.
The register of members may be closed by our board of directors at such times and for such periods
as it may from time to time decide, but the register shall not be closed in any year for more than
30 days (excluding Sundays and public holidays). Material Contracts Other than such contracts as are described in our disclosure in Item 7 Major Shareholders and
Related Party Transactions  Related Party Transactions, we have not entered into any material
contracts, outside the ordinary course of our business within the two years preceding the date of
this annual report. Exchange Controls The Basic Law of Hong Kong provides that the Hong Kong dollar will remain the legal tender in
Hong Kong after July 1, 1997. The Basic Law also provides that no foreign exchange control
policies will be applied in Hong Kong and that the Hong Kong dollar will be freely convertible.
During the Asia regional economic crisis in 1998, however, the Hong Kong Government intervened on
several occasions in the foreign exchange market by purchasing the Hong Kong dollar and selling the
U.S. dollar to support the value of the Hong Kong dollar. There are no restrictions, either pursuant to our Articles, or pursuant to the laws of Hong
Kong, on the rights of non-residents of Hong Kong or foreign persons to hold or exercise voting
rights with respect to our ordinary shares, or export or import capital. Hong Kong Taxation The following provides a general outline of the material tax considerations that may be
relevant to a decision to own or dispose of the American depositary shares or shares but does not
purport to deal with the tax consequences applicable to all categories of investors. Prospective
investors should consult their own professional advisers on the Hong Kong and overall tax
implications of investing, holding or disposing the American depositary shares or shares under the
laws of the countries in which they are liable to taxation. The discussion below is applicable to
both U.S. and non-U.S. citizens as an investor. 104




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Tax on dividends No tax is payable in Hong Kong by withholding or otherwise in respect of dividends paid by
City Telecom. Profits tax No tax is imposed in Hong Kong in respect of gains from the sale of property, including shares
and American depositary shares, unless all the following three factors are present:  (i)
    such gain is derived from or arising in Hong Kong;(ii)
    such gain is attributable to a trade, profession or business carried on in Hong Kong;
and(iii)
    the property in question such as shares and American depositary shares was not a
capital asset of that trade, profession or business. Taxable gains will be subject to Hong Kong profits tax which is currently imposed on
corporations at a rate of 17.5%. A persons income from employment, less allowable deductions,
charitable donations and personal allowances, is chargeable to salaries tax at progressive rates
ranging from 2% to 20%. The maximum tax payable is, however, limited to tax at the standard rate
of 16% on the persons income from employment less allowable deductions and charitable donations,
but without a deduction for personal allowances. Gains from sales of shares effected on the Hong Kong Stock Exchange will be considered to be
derived from or arising in Hong Kong. Liability to Hong Kong profits tax in respect of such gains
would arise if the Shares were not held as capital assets and the gains are attributable to a
business, trade or profession carried out in Hong Kong. Gains from sales of American depositary shares will be considered to be derived from or
arising in Hong Kong if the relevant purchase or sales contracts are negotiated and concluded in
Hong Kong, and such gains will be subject to Hong Kong profits tax in the case of those persons
dealing or trading in the American depositary shares as part of their business being carried out in
Hong Kong. In any case of an exchange of any American depositary receipts evidencing American
depositary shares for certificates representing shares, any gain on subsequent disposition of such
shares will be the difference between the initial price of American depositary shares and the
market value of such shares at the date of disposition. Stamp duty A sale or purchase of shares is subject to Hong Kong stamp duty if the transfer of such shares
is required to be registered in Hong Kong. The shares will be registered in City Telecoms Hong
Kong branch register of members and, therefore, will constitute Hong Kong stock for the purposes
of Hong Kong stamp duty. For such purposes any person who effects a sale or purchase of Hong Kong
stock such as the shares registered on City Telecoms Hong Kong register of members, whether as
principal or agent, is required to execute a contract note evidencing such sale or purchase and to
have that note stamped. Contract notes attract stamp duty, payable by the seller and the purchaser
in equal shares, at the rate of HK$1.00 per HK$1,000 or part thereof by reference to the value of
the consideration paid or the market value of the shares on the Hong Kong Stock Exchange or
otherwise on the date the contract note is executed, whichever is greater. If, in the case of a
sale or purchase of the shares by a person who is not resident in Hong Kong, the stamp duty on
either or both of the contract notes is not paid, the transferee will be liable to pay stamp duty
on the instrument of transfer in an amount equal to the unpaid duty. If the stamp duty is not paid
on or before the due date, a penalty of up to ten times the duty payable may be imposed. In
addition, a fixed duty of HK$5.00 is currently payable on any instrument of transfer of shares. 105




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Upon the exchange of any American depositary receipts evidencing American depositary shares
for certificates representing shares, or exchange of shares for American depositary receipts
evidencing American depositary shares, stamp duty aggregating HK$1.00 per HK$1,000 or part thereof is payable
in addition to the depositarys charges, if any. Investors are not liable for stamp duty on the
issuance of the American depositary shares upon the initial deposit of shares issued directly to
the depositary or for the account of the depositary. No Hong Kong stamp duty is payable upon the
transfer of American depositary receipts evidencing American depositary shares if such American
depositary receipts are not maintained on a register in Hong Kong. Estate duty The shares, being registered on City Telecoms register of members in Hong Kong, are property
in relation to which Hong Kong estate duty will be chargeable on the death of the owner of such
shares regardless of the place of the owners residence, citizenship or domicile, unless there is an
applicable exemption under the Estate Duty Ordinance (Chapter 111 of the Laws of Hong Kong). Tax treaty There is currently no reciprocal tax treaty between Hong Kong and the U.S. regarding
withholding. Documents on Display We filed with Securities and Exchange Commission in Washington, D.C. a registration statement
on Form F-1 (Registration No. 333-11012) under the Securities Act in connection with our global
offering of American depositary shares in November 1999. The registration statement contains
exhibits and schedules. For further information with respect to City Telecom and the American
depositary shares, please refer to the registration statement and to the exhibits and schedules
filed with the registration statement. In addition, whenever a reference is made in this annual
report to a contract or other document of City Telecom, you should be aware that such reference is
not necessarily complete and that you should refer to the exhibits and schedules that are a part of
the registration statement for a copy of the contract or other document. 106




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ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our functional currency is the Hong Kong dollar, the currency in which the majority of our
revenue and related accounts receivable and expenses are denominated. Certain of the expenses of
our telecommunications business are payable in other currencies, primarily the U.S. dollar. Since
the exchange rate between the Hong Kong and the U.S. dollar was fixed before we commenced business,
our operations have not been significantly affected by exchange rate fluctuations. Therefore, we
do not use derivative financial instruments to manage our exchange rate exposures. In the normal course of business, we also face risks that are either non-financial or
non-quantifiable. Such risks principally include country risk, credit risk and legal risk and we
do not use derivative financial instruments to hedge such risks. We are exposed to market risk from changes in currency exchange rates and interest rates. Foreign Currency Risk The functional currency of our operations, and our financial statement reporting currency, is
the Hong Kong dollar. Our monetary assets and liabilities are primarily denominated in Hong Kong
dollars, substantially all our net sales are denominated and received in Hong Kong dollars, and our
labor and administrative costs are incurred primarily in Hong Kong dollars. However, we have
certain current and long-term bank deposits, other investments and short-term bank loans which are
primarily denominated in U.S. dollars. As of August 31, 2004, we had the following significant foreign currencies denominated account
balances: As of August 31, 2004(Thousands of HK$)Cash and bank balances:Denominated in U.S. dollars
    
    
    193,823Denominated in Chinese renminbi
    
    
    6,183Denominated in Canadian dollars
    
    
    2,341Denominated in Japanese yen
    
    
    23Long-term bank deposits:Denominated in U.S. dollars
    
    
    15,600Other investments:Denominated in U.S. dollars
    
    
    25,604Short-term loans:Denominated in Japanese yen
    
    
    19,170
 Further,
our most recent principal long-term debt obligations are the US$125.0 million 8.75% senior
notes issued in January 2005, which are denominated in U.S. dollars. As the exchange rate of the Hong Kong dollar to the U.S. dollar has remained close to the
current pegged rate of HK$7.80=$1.00 since 1983, we have not experienced significant foreign
exchange gains or losses associated with that currency. The Hong Kong government could, however,
change the pegged rate or abandon the peg altogether. Depreciation of the Hong Kong dollar against
the U.S. dollar would generally increase our U.S. dollar expenses, and increase the amount of Hong
Kong dollar revenue that we would be required to earn to meet our payment obligations under the
8.75% notes or exchange notes. We also incur expenses denominated in Renminbi, the official currency of the Peoples Republic
of China, in connection with our Guangzhou call centre. These include the salaries that we pay to
our personnel as various operating expenses that we incur to maintain our operations. As a result,
we are exposed to a certain amount of foreign exchange risk based on fluctuations between the Hong
Kong dollar and the Renminbi. If the Renminbi appreciates against the Hong Kong dollar, the amount
of Hong Kong dollars we would be required to spend to maintain our call center would increase. 107




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Interest Rate Risk Prior to our repayment in full of our loan facility with HSBC, for which HK$100 million as of
August 31, 2004 was outstanding, we were exposed to interest rate risks. In connection with this
facility, we entered into an interest rate swap agreement to hedge the impact of fluctuations in
interest rates, under which we make a monthly interest payment at a fixed rate of 2.675% per annum
on a notional amount of HK$100.0 million, and will receive monthly interest payments calculated at
HIBOR during the period from March 2004 to December 2009 or until the facility is repaid and we
terminate the swap agreement. No recognition of such instrument is required under Hong Kong GAAP.
Under U.S. GAAP reporting, such interest rate swap instrument must be recorded at fair value, which
we determined to be approximately HK$680,000 as of August 31, 2004. The interest rate swap
agreement is still valid following the full repayment of our loan facility with HSBC and we plan to
terminate it based on open market prices. 
 ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES Not applicable. 108




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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 Security Holders None. Use of Proceeds We have used all of the net proceeds of approximately HK$411.6 million from a global offering
of 80,000,000 new shares in November 1999 on the upgrade and expansion of our fixed
telecommunications network. 
 ITEM 15. CONTROLS AND PROCEDURES We maintain a set of disclosure controls and procedures designed to ensure that information
required to be disclosed by City Telecom in reports that we file or submit under the U.S.
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commissions rules and forms. Within the
90-day period prior to the filing of this report, an evaluation was carried out under the
supervision and with the participation of our management, including our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and
procedures. Based on that evaluation, the CEO and CFO have concluded that our disclosure controls
and procedures are effective. Subsequent to the date of their evaluation, there have been no significant changes in our
internal controls or in other factors that could significantly affect these controls. 
 ITEM 16. [RESERVED] 
 ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT Our board of directors established an Audit Committee to ensure the impartial supervision of
our accounting and business operations. The Audit Committee is comprised of three independent,
non-executive directors, namely, Mr. Lee Hon Ying, John, Dr. Chan Kin Man and Mr. Peh Tun Lu
Jefferson and a non-executive director, Mr. Cheng Mo Chi, Moses. Mr. Peh was appointed to the Audit
Committee on September 1, 2004 and is a financial expert within the meaning of, and as required
by the U.S. Sarbanes-Oxley Act of 2002. 
 ITEM 16B. CODE OF ETHICS All of our employees, officers and directors are bound by our code of business conduct and
ethics, which is filed with the U.S. Securities and Exchange
Commission as exhibit 11 to this annual report. We adopted our code of ethics in 1995 and modified it
following the passage of, and to comply with, the U.S.
Sarbanes Oxley Act of 2002. We have never granted a waiver for non-compliance with the policies and
procedures set 109




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##### Table of Contents



forth in the code of ethics for any employee of our company or any of our subsidiaries. Copies of our
code of ethics are also available free of charge upon request made to our corporate secretary. 
 ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES PricewaterhouseCoopers, or PwC, is our principal accountant. The fees for the professional
services rendered by PwC, in fiscal 2003 and fiscal 2004, are depicted in the table below. Nature of the service
    
    2003
    
    
    2004(HK$ million)
    
    
    (HK$ million)Audit fees
    
    
    0.9
    
    
    
    0.8Audit-related fees
    
    
    0.3
    
    
    
    0.3Tax fees
    
    
    0.3
    
    
    
    0.2All other fees
    
    
    
    
    
    
    Total
    
    
    1.5
    
    
    
    1.3
 Audit Fees Audit fees are the aggregate fees billed by our independent auditors for the annual financial
statement audit, subsidiary audits and other procedures required to be performed for the auditors
to form an opinion on our consolidated financial statements. Other procedures include information
systems and procedural reviews and testing performed in order to understand and rely on the
internal control systems and consultations relating to the audit and interim review. Audit services
will also include the attestation engagement for the independent auditors report on managements
report on internal controls for financial reporting in fiscal 2005 and thereafter. Audit-Related Fees Audit-related fees are the aggregate fees billed by our independent auditors for accounting
and advisory services fees and generally include support for the interpretation and implementation
of new accounting and reporting standards and acquisition accounting. It also includes the review
of the Statement on Details of Contribution of the Occupational Retirement Scheme, and the audit
and review of reports for compliance with telecommunications regulations and debt obligations. Tax Fees Tax Fees are the aggregate fees billed by our independent auditors for tax compliance, tax
planning and tax consultation services on domestic and international taxation matters. All Other Fees All other fees are the aggregate fees billed by our independent auditors for financial due
diligence services relating to potential business acquisitions and dispositions. Pre-approval Polices The engagement of PwC and the services provided pursuant to such engagement were approved by
our audit committee in accordance with paragraph (c)(7)(i) of Rule 2-01 of Regulation S-X. The fees
for all such services have been pre-approved by our audit committee. Our audit committee has
satisfied itself that the provision of the above-stated non-audit services has not impaired the
independence of PwC. 
 ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES Not Applicable. 110




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ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS The following table sets forth information relating to the repurchase of our shares by way of
a general mandate granted to our directors, which we refer to as the Mandate. The maximum
aggregate nominal amount of shares that may be purchased pursuant to a Mandate corresponds to 10%
of the aggregate nominal amount of our issued share capital at the date the Mandate was granted.
In fiscal 2004, no shares were purchased under any of the Mandates then in force. Total Number of
    
    
    Maximum Number ofShares Purchased as
    
    
    Shares that May BeTotal Number of
    
    
    Average Price Paid
    
    
    Part of Publicly
    
    
    Purchased Under thePeriod
    
    
    Shares Purchased
    
    
    per Share
    
    
    Announced Mandates
    
    
    MandatesSeptember 1 to 30, 2003
    
    
    0
    
    
    N/A
    
    
    0
    
    
    50,302,066 (1)October 1 to 31, 2003
    
    
    0
    
    
    N/A
    
    
    0
    
    
    50,302,066 (1)November 1 to 30, 2003
    
    
    0
    
    
    N/A
    
    
    0
    
    
    50,302,066 (1)December 1 to 22, 2003
    
    
    0
    
    
    N/A
    
    
    0
    
    
    50,302,066 (1)December 23 to 31, 2003
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)January 1 to 31, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)February 1 to 29, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)March 1 to 31, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)April 1 to 30, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)May 1 to 31, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)June 1 to 30, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)July 1 to 31, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)August 1 to 31, 2004
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)Total
    
    
    0
    
    
    N/A
    
    
    0
    
    
    61,051,969 (2)
   (1)
    
    The relevant Mandate was granted at our annual general meeting on December 23, 2002.(2)
    
    The relevant Mandate was granted at our annual general meeting on December 23, 2003 and
replaced the Mandate granted on December 23, 2002. 111




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##### Table of Contents



PART III 
 ITEM 17. FINANCIAL STATEMENTS City Telecom has selected to provide the financial statements and related information
specified in Item 18 in lieu of 17. 
 ITEM 18. FINANCIAL STATEMENTS See pages F-1 to F-52 following Item 19. 
 ITEM 19. EXHIBITS  (a)
    See pages F-1 to F-52 following this item.(b)
    Exhibit 1  the Articles.(c)
    Exhibit 11  Code of Business Conduct and Ethics.(d)
    Exhibit 31  Section 302 Certifications of each of the Chairman and Finance Director.(e)
    Exhibit 32  Section 906 Certification of Chairman and Finance Director. 112




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##### Table of Contents



Report of Independent Accountants INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Audited Consolidated Financial StatementsReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Statements of Income
    
    
    F-3Consolidated Balance Sheets
    
    
    F-4Consolidated Statements of Changes in Shareholders Equity
    
    
    F-5Consolidated Statements of Cash Flows
    
    
    F-6Notes to the Consolidated Financial Statements
    
    
    F-9
 F-1




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of
City Telecom (H.K.) Limited We have audited the accompanying consolidated balance sheets of City Telecom (H.K.) Limited
and its subsidiaries (hereafter collectively referred to as the Company) as of August 31, 2003
and 2004 and the related consolidated statements of income, of cash flows and of changes in
shareholders equity for each of the three years ended August 31, 2002, 2003 and 2004, all
expressed in Hong Kong Dollars. These financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these financial statements based on our
audits. We conducted our audits 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 from material
misstatement. An audit includes examining, on a test basis, evidence supporting amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements audited by us present fairly, in all
material respects, the financial position of the company at August 31, 2003 and 2004, and the
results of its operations and cash flows for each of the three years ended August 31, 2002, 2003
and 2004, in conformity with accounting principles generally accepted in Hong Kong. Accounting principles generally accepted in Hong Kong vary in certain significant respects
from accounting principles generally accepted in the United States of America. Information relating
to the nature and effect of such differences is presented in Note 30 to the consolidated financial
statements. PRICEWATERHOUSECOOPERS
Certified Public Accountants
 Hong Kong,
November 23, 2004 except for Note 31(b) and Note 32, which are as of January 20, 2005 F-2




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF INCOME
 Year ended August 31,Note
    
    
    2002
    
    
    2003
    
    
    2004HK$
    
    
    HK$
    
    
    HK$As restated(1)
    
    
    As restated(1)(Amounts in thousands except per share data)Revenue from provision of telecommunication and
other services, net
    
    
    
    
    
    
    1,150,200
    
    
    
    1,298,909
    
    
    
    1,169,880Cost of services provided
    
    
    3
    
    
    
    (457,963
    )
    
    
    (322,753
    )
    
    
    (331,408
    )Gross profit
    
    
    
    
    
    
    692,237
    
    
    
    976,156
    
    
    
    838,472Operating expensesSalaries and related costs
    
    
    
    
    
    
    (196,158
    )
    
    
    (220,350
    )
    
    
    (226,650
    )Sales and marketing expenses
    
    
    
    
    
    
    (168,441
    )
    
    
    (182,471
    )
    
    
    (228,169
    )General and administrative expenses
    
    
    
    
    
    
    (227,768
    )
    
    
    (284,290
    )
    
    
    (326,804
    )Provision for doubtful accounts receivable
    
    
    
    
    
    
    (10,277
    )
    
    
    (17,685
    )
    
    
    (11,502
    )Income from operations
    
    
    
    
    
    
    89,593
    
    
    
    271,360
    
    
    
    45,347Bank interest income
    
    
    
    
    
    
    10,870
    
    
    
    3,163
    
    
    
    3,753Interest expense
    
    
    
    
    
    
    (3,504
    )
    
    
    (601
    )
    
    
    (175
    )Loss on disposal of a subsidiary
    
    
    4
    
    
    
    
    
    
    
    (2,695
    )
    
    
    Other income, net
    
    
    
    
    
    
    502
    
    
    
    4,373
    
    
    
    2,668Income before taxation
    
    
    5
    
    
    
    97,461
    
    
    
    275,600
    
    
    
    51,593Income tax charges
    
    
    6
    
    
    
    (15,190
    )
    
    
    (17,857
    )
    
    
    (2,043
    )Income after taxation
    
    
    
    
    
    
    82,271
    
    
    
    257,743
    
    
    
    49,550Minority interests
    
    
    
    
    
    
    8,234
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    90,505
    
    
    
    257,743
    
    
    
    49,550Earnings per shareBasic
    
    
    7
    
    
    18.3 cents
    
    46.6 cents
    
    8.1 centsDiluted
    
    
    7
    
    
    16.0 cents
    
    41.9 cents
    
    8.1 cents
  (1)
    
    In the year ended August 31, 2004, we adopted revised SSAP 12, Income Taxes (SSAP 12
(revised)), issued by the Hong Kong Institute of Certified Public Accountants (HKICPA)
regarding the recognition of deferred tax. The adoption of SSAP 12 (revised) represents a
change in accounting policy, which we have applied retrospectively. As a result, financial
information provided for all years prior to the year ended August 31, 2004 have been restated
to conform to the changed policy.  The accompanying notes are an integral part of these consolidated financial statements. F-3




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 August 31,Note(s)
    
    
    2003
    
    
    2004HK$
    
    
    HK$As restated(1)(Amounts in thousandsexcept number of sharesand per share amounts)ASSETSCurrent assetsCash and bank balances
    
    
    20
    
    
    
    402,034
    
    
    
    247,517Pledged bank deposits
    
    
    16
    
    
    
    29,608
    
    
    
    26,805Trade receivables, net
    
    
    8
    (a)
    
    
    94,080
    
    
    
    134,849Other receivables, deposits and prepayments
    
    
    8
    (b)
    
    
    34,714
    
    
    
    44,029Total current assets
    
    
    
    
    
    
    560,436
    
    
    
    453,200Goodwill
    
    
    9
    
    
    
    3,196
    
    
    
    2,131Fixed assets, net
    
    
    10
    
    
    
    945,952
    
    
    
    1,158,875Other investments
    
    
    17
    
    
    
    23,370
    
    
    
    25,604Long term bank deposit
    
    
    18
    
    
    
    15,580
    
    
    
    15,600Long term receivables
    
    
    4,28
    (a)
    
    
    
    
    
    
    6,206Deferred tax assets
    
    
    12
    
    
    
    
    
    
    
    229Deferred expenditure
    
    
    13
    
    
    
    
    
    
    
    21,563Total assets
    
    
    
    
    
    
    1,548,534
    
    
    
    1,683,408LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesTrade payables
    
    
    
    
    
    
    113,384
    
    
    
    122,459Deposits received
    
    
    
    
    
    
    19,908
    
    
    
    17,983Current portion of deferred service income
    
    
    
    
    
    
    10,172
    
    
    
    35,288Other payables and accrued charges
    
    
    11
    
    
    
    164,552
    
    
    
    188,605Income taxes payable
    
    
    
    
    
    
    22,895
    
    
    
    1,173Short-term bank loan  secured
    
    
    20,22
    
    
    
    18,174
    
    
    
    19,170Current portion of long-term bank loan  secured
    
    
    14,22
    
    
    
    
    
    
    
    13,333Total current liabilities
    
    
    
    
    
    
    349,085
    
    
    
    398,011Long-term liabilitiesDeferred taxation
    
    
    12
    
    
    
    20,274
    
    
    
    18,891Long-term portion of deferred service income
    
    
    
    
    
    
    
    
    
    
    4,141Long-term bank loan  secured
    
    
    14,22
    
    
    
    
    
    
    
    86,667Total liabilities
    
    
    
    
    
    
    369,359
    
    
    
    507,710Commitments and contingencies
    
    
    15Shareholders equityOrdinary shares, par value $0.1 per share 2,000,000,000 shares authorized at August 31, 2003
and August 31, 2004 604,959,787 shares issued and outstanding at August
31, 2003, 610,573,361 shares issued and outstanding
at August 31, 2004
    
    
    19
    
    
    
    60,496
    
    
    
    61,057Share premium
    
    
    
    
    
    
    615,886
    
    
    
    617,986Retained profits
    
    
    
    
    
    
    500,704
    
    
    
    495,307Exchange reserve
    
    
    
    
    
    
    1,231
    
    
    
    983Warrant reserve
    
    
    
    
    
    
    858
    
    
    
    365Total shareholders equity
    
    
    
    
    
    
    1,179,175
    
    
    
    1,175,698Total liabilities and shareholders equity
    
    
    
    
    
    
    1,548,534
    
    
    
    1,683,408
  (1)
    
    In the year ended August 31, 2004, we adopted SSAP 12 (revised), issued by the HKICPA
regarding the recognition of deferred tax. The adoption of SSAP 12 (revised) represents a
change in accounting policy, which we have applied retrospectively. As a result, financial
information provided for all years prior to the year ended August 31, 2004 have been restated
to conform to the changed policy. The accompanying notes are an integral part of these consolidated financial statements. F-4




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY
 Ordinary sharesNumber of
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Totalshares
    
    
    Amount
    
    
    Share
    
    
    Warrant
    
    
    Exchange
    
    
    Retained
    
    
    shareholdersNote
    
    
    outstanding
    
    
    Outstanding
    
    
    premium
    
    
    reserve
    
    
    reserve
    
    
    profits
    
    
    equityHK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$As restated
    
    
    As restated(Amounts in thousands, except number of shares)Balance at August 31, 2002
    
    
    
    
    
    
    500,863,202
    
    
    
    50,086
    
    
    
    572,656
    
    
    
    9,089
    
    
    
    (38
    )
    
    
    278,390
    
    
    
    910,183Changes in accounting policy provision for net deferred tax liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,195
    )
    
    
    (5,195
    )Balance at August 31, 2002, as restated(1)
    
    
    
    
    
    
    500,863,202
    
    
    
    50,086
    
    
    
    572,656
    
    
    
    9,089
    
    
    
    (38
    )
    
    
    273,195
    
    
    
    904,9882003 interim dividends paid
    
    
    21
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (30,234
    )
    
    
    (30,234
    )Shares issued upon exercise of warrants
    
    
    
    
    
    
    82,976,585
    
    
    
    8,298
    
    
    
    33,124
    
    
    
    (8,231
    )
    
    
    
    
    
    
    
    
    
    
    33,191Shares issued upon exercise of share options
    
    
    
    
    
    
    21,120,000
    
    
    
    2,112
    
    
    
    10,106
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,218Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    257,743
    
    
    
    257,743Exchange reserve realized upon disposal of a subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,469
    
    
    
    
    
    
    
    1,469Exchange adjustment on translation of the accounts of
overseas subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (200
    )
    
    
    
    
    
    
    (200
    )Balance at August 31, 2003
    
    
    
    
    
    
    604,959,787
    
    
    
    60,496
    
    
    
    615,886
    
    
    
    858
    
    
    
    1,231
    
    
    
    500,704
    
    
    
    1,179,175Balance at August 31, 2003
    
    
    
    
    
    
    604,959,787
    
    
    
    60,496
    
    
    
    615,886
    
    
    
    858
    
    
    
    1,231
    
    
    
    505,978
    
    
    
    1,184,449Changes in accounting policy provision for net deferred tax liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,274
    )
    
    
    (5,274
    )Balance at August 31, 2003, as restated(1)
    
    
    
    
    
    
    604,959,787
    
    
    
    60,496
    
    
    
    615,886
    
    
    
    858
    
    
    
    1,231
    
    
    
    500,704
    
    
    
    1,179,1752003 final dividends paid
    
    
    21
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (45,789
    )
    
    
    (45,789
    )2004 interim dividends paid
    
    
    21
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,158
    )
    
    
    (9,158
    )Shares issued upon exercise of warrants
    
    
    
    
    
    
    4,973,574
    
    
    
    497
    
    
    
    1,985
    
    
    
    (493
    )
    
    
    
    
    
    
    
    
    
    
    1,989Shares issued upon exercise of share options
    
    
    
    
    
    
    640,000
    
    
    
    64
    
    
    
    115
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    49,550
    
    
    
    49,550Exchange adjustment on translation of the accounts of
overseas subsidiaries
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (248
    )
    
    
    
    
    
    
    (248
    )Balance at August 31, 2004
    
    
    
    
    
    
    610,573,361
    
    
    
    61,057
    
    
    
    617,986
    
    
    
    365
    
    
    
    983
    
    
    
    495,307
    
    
    
    1,175,698
  (1)
    
    In the year ended August 31, 2004, we adopted SSAP 12 (revised), issued by the HKICPA
regarding the recognition of deferred tax. The adoption of SSAP 12 (revised) represents a
change in accounting policy, which we have applied retrospectively. As a result, financial
information provided for all years prior to the year ended August 31, 2004 have been restated
to conform to the changed policy.  The accompanying notes are an integral part of these consolidated financial statements. F-5




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Year ended August 31,2002
    
    
    2003
    
    
    2004HK$
    
    
    HK$
    
    
    HK$(Amounts in thousands)Cash flows from operating activitiesIncome before taxation
    
    
    97,461
    
    
    
    275,600
    
    
    
    51,593Adjustments to reconcileIncome before taxation to net cash (used in)/provided
from operating activities:Amortization of goodwill
    
    
    1,065
    
    
    
    1,065
    
    
    
    1,065Depreciation of purchased fixed assets
    
    
    124,563
    
    
    
    173,619
    
    
    
    195,952Depreciation of fixed assets held under finance leases
    
    
    3,727
    
    
    
    1,336
    
    
    
    Amortization of deferred expenditure
    
    
    
    
    
    
    
    
    
    
    1,828Interest income
    
    
    (10,870
    )
    
    
    (3,163
    )
    
    
    (3,753
    )Interest expense
    
    
    3,279
    
    
    
    559
    
    
    
    175Interest element of finance leases
    
    
    225
    
    
    
    42
    
    
    
    (Gain)/loss on disposal of fixed assets
    
    
    2,414
    
    
    
    427
    
    
    
    (34
    )Unrealised losses on other investments
    
    
    
    
    
    
    
    
    
    
    1,696Loss on disposal of a subsidiary
    
    
    
    
    
    
    2,695
    
    
    
    Increase in long term receivable
    
    
    
    
    
    
    
    
    
    
    (6,206
    )Changes in operating assets and liabilities:(Increase)/decrease in trade receivables, other
receivables, deposits and prepayments
    
    
    (15,211
    )
    
    
    6,455
    
    
    
    (50,382
    )Increase in deferred expenditure
    
    
    
    
    
    
    
    
    
    
    (23,391
    )Increase/(decrease) in trade payables, other payables,
accrued charges, deposits received
    
    
    87,627
    
    
    
    (28,678
    )
    
    
    30,957Increase in deferred service income
    
    
    2,120
    
    
    
    5,005
    
    
    
    29,257Net cash inflow generated from operations
    
    
    296,400
    
    
    
    434,962
    
    
    
    228,757Interest paid
    
    
    (3,279
    )
    
    
    (559
    )
    
    
    (175
    )Interest element of finance leases
    
    
    (225
    )
    
    
    (42
    )
    
    
    Hong Kong profits tax paid
    
    
    (4,107
    )
    
    
    (18,107
    )
    
    
    (24,011
    )Overseas tax paid
    
    
    (345
    )
    
    
    (1,754
    )
    
    
    (808
    )Net cash inflow from operating activities
    
    
    288,444
    
    
    
    414,500
    
    
    
    203,763Investing activitiesAcquisition of additional interest in a subsidiary (Note
(1) below)
    
    
    (7,500
    )
    
    
    
    
    
    
    Decrease in prepayments for fixed assets
    
    
    54,929
    
    
    
    
    
    
    
    Decrease in bank deposits
    
    
    20,000
    
    
    
    
    
    
    
    Decrease/(increase) in pledged bank deposits
    
    
    23,000
    
    
    
    (24,608
    )
    
    
    2,803Increase in long term bank deposits
    
    
    
    
    
    
    (15,580
    )
    
    
    Purchases of fixed assets
    
    
    (579,066
    )
    
    
    (250,209
    )
    
    
    (410,046
    )Interest received
    
    
    10,870
    
    
    
    3,163
    
    
    
    3,753Purchase of other investments
    
    
    
    
    
    
    (23,370
    )
    
    
    (3,900
    )Proceeds from disposal of fixed assets
    
    
    2,555
    
    
    
    1,552
    
    
    
    1,146Disposal of a subsidiary, net of cash disposed (Note (2)
below)
    
    
    
    
    
    
    (582
    )
    
    
    Net cash outflow from investing activities
    
    
    (475,212
    )
    
    
    (309,634
    )
    
    
    (406,244
    )Net cash (outflow)/inflow before financing activities
    
    
    (186,768
    )
    
    
    104,866
    
    
    
    (202,481
    )
 (Continued)  The accompanying notes are an integral part of these consolidated financial statements. F-6




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##### Table of Contents



Year ended August 31,2002
    
    
    2003
    
    
    2004HK$
    
    
    HK$
    
    
    HK$(Amounts in thousands)Financing activitiesIssue of new shares
    
    
    3,787
    
    
    
    45,409
    
    
    
    2,168Issue of warrants
    
    
    10,815
    
    
    
    
    
    
    
    Expenses in connection with the issue of warrants
    
    
    (1,058
    )
    
    
    
    
    
    
    Bank loan drawn down
    
    
    
    
    
    
    
    
    
    
    100,000Repayment of loan to a former minority shareholder
    
    
    
    
    
    
    (22,500
    )
    
    
    Repayment of capital element of finance leases
    
    
    (4,435
    )
    
    
    (2,949
    )
    
    
    Dividend paid
    
    
    
    
    
    
    (30,234
    )
    
    
    (54,947
    )Net cash inflow/(outflow) from financing activities
    
    
    9,109
    
    
    
    (10,274
    )
    
    
    47,221(Decrease)/increase in cash and cash equivalents
    
    
    (177,659
    )
    
    
    94,592
    
    
    
    (155,260
    )Cash and cash equivalents at the beginning of year
    
    
    467,750
    
    
    
    290,403
    
    
    
    383,860Effect of foreign exchange rate changes on cash and cash
equivalents
    
    
    312
    
    
    
    (1,135
    )
    
    
    (253
    )Cash and cash equivalents at the end of year (Note 20)
    
    
    290,403
    
    
    
    383,860
    
    
    
    228,347
 Note(1): Acquisition of additional interest in a subsidiary Year ended August 31,2002
    
    
    2003
    
    
    2004HK$
    
    
    HK$
    
    
    HK$(Amounts in thousands)Minority interests acquired
    
    
    6,483
    
    
    
    
    
    
    
    Goodwill in acquisition
    
    
    1,017
    
    
    
    
    
    
    
    7,500
    
    
    
    
    
    
    
    Satisfied by:Cash
    
    
    7,500
    
    
    
    
    
    
    
    
 F-7




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##### Table of Contents



Note(2): Disposal of a subsidiary Year ended August 31,2002
    
    
    2003
    
    
    2004HK$
    
    
    HK$
    
    
    HK$(Amounts in thousands)Fixed assets
    
    
    
    
    
    
    1,354
    
    
    
    Trade receivable, other receivables, deposits and
prepayments
    
    
    
    
    
    
    1,914
    
    
    
    Cash and bank balances
    
    
    
    
    
    
    714
    
    
    
    Trade payable, other payables, accrued charges and deposits
received
    
    
    
    
    
    
    (805
    )
    
    
    Income taxes payable
    
    
    
    
    
    
    (1
    )
    
    
    Net assets disposed of
    
    
    
    
    
    
    3,176
    
    
    
    Exchange reserve transferred to statements of income
    
    
    
    
    
    
    1,469
    
    
    
    Net loss on disposal
    
    
    
    
    
    
    (2,695
    )
    
    
    Sale proceeds
    
    
    
    
    
    
    1,950
    
    
    
    Less: Cash and cash equivalents of the subsidiary
disposed
    
    
    
    
    
    
    (714
    )
    
    
    Sale proceeds receivable
    
    
    
    
    
    
    (1,818
    )
    
    
    Net cash outflow in respect of the disposal of a
subsidiary
    
    
    
    
    
    
    (582
    )
    
    
    
    The accompanying notes are an integral part of these consolidated financial statements. F-8




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##### Table of Contents



1
    Description of business and basis of presentation City Telecom (H.K.) Limited was incorporated in Hong Kong on May 19, 1992 under the Hong Kong
Companies Ordinance. The company and its subsidiaries (collectively referred to as the Company)
are engaged in the provision of international telecommunications services and fixed
telecommunications network services to customers in Hong Kong and Canada. As of August 31, 2004, the Company had the following principal direct and indirect
subsidiaries: Place and date of
    
    
    
    Percentage holdingName
    
    establishment/operation
    
    Issued capital
    
    Direct
    
    Indirect
    
    Nature of business963673 Ontario
Limited
    
    Canada
November 12, 1991
    
    Common CAD502,000
    
    
    
    
    
    
    100
    
    
    Investment holding
in CanadaAttitude Holdings
Limited
    
    British Virgin Islands
November 3, 1997
    
    Ordinary US$1
    
    
    
    
    
    
    100
    
    
    InactiveAutomedia Holdings
Limited
    
    British Virgin Islands
January 23, 2001
    
    Ordinary US$1
    
    
    100
    
    
    
    
    
    
    Investment holding
in Hong KongCity Telecom (B.C.)
Inc.
    
    Canada
February 25, 1992
    
    Common CAD501,000
    
    
    
    
    
    
    100
    
    
    Provision of
international
telecommunications
and dial-up
internet access
services in CanadaCity Telecom
(Canada) Inc.
    
    Canada
October 6, 1997
    
    Common CAD100
    
    
    
    
    
    
    100
    
    
    Maintenance of
switching equipment
and provision of
operational
services in CanadaCity Telecom Inc.
    
    Canada
September 19, 1991
    
    Common CAD1,000
    
    
    
    
    
    
    100
    
    
    Provision of
international
telecommunications
and dial-up
internet access
services in CanadaCity Telecom
International Limited
    
    British Virgin Islands
May 8, 1997
    
    Ordinary US$5,294
    
    
    100
    
    
    
    
    
    
    Investment holding
in Hong KongCity Telecom (USA)
Inc.
    
    USAMay 5, 1997
    
    Common US$1
    
    
    
    
    
    
    100
    
    
    InactiveCredibility Holdings
Limited
    
    British Virgin Islands
December 18, 1998
    
    Ordinary US$1
    
    
    100
    
    
    
    
    
    
    Investment holding
in Hong KongCTI Guangzhou
Customer Service Co.
Ltd. (translated
from the registered
name in Chinese)
    
    The Peoples Republic
of
China (the PRC) April 29, 2002
    
    Paid in capital of
HK$8,000,000
    
    
    100
    
    
    
    
    
    
    Provision of
administrative
support services in
the PRCCTI International
Limited
    
    Hong Kong
August 23, 1999
    
    Ordinary
HK$10,000,000
    
    
    
    
    
    
    100
    
    
    InactiveCTI Marketing
Company Limited
    
    Hong Kong
August 23, 1999
    
    Ordinary HK$10,000
    
    
    
    
    
    
    100
    
    
    Provision of media
marketing services
in Hong KongGolden Trinity
Holdings Limited
    
    British Virgin Islands
June 11, 1997
    
    Ordinary US$1
    
    
    100
    
    
    
    
    
    
    Investment holding
in Hong Kong
 F-9




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##### Table of Contents



Place and date of
    
    
    
    Percentage holdingName
    
    establishment/operation
    
    Issued capital
    
    Direct
    
    Indirect
    
    Nature of businessHong Kong Broadband
Network Limited
    
    Hong Kong
August 23, 1999
    
    Ordinary HK$383,049
    
    
    
    
    
    
    100
    
    
    Provision of
international
telecommunications
and fixed
Telecommunications
network services in
Hong KongIDD1600 Company
Limited
    
    Hong Kong
November 4, 1998
    
    Ordinary HK$2
    
    
    
    
    
    
    100
    
    
    Provision of
international
telecommunications
services in Hong
KongiStore.com Limited
    
    Hong Kong September 17, 1999
    
    Ordinary HK$10,000
    
    
    
    
    
    
    100
    
    
    Inactive
 The consolidated financial statements have been prepared in accordance with generally
accepted accounting principles in Hong Kong and comply with accounting standards issued by the
HKICPA. They have been prepared under the historical cost convention except that, as disclosed in
the accounting policies below, other investments are stated at fair value. These principles differ
in certain significant respects from generally accepted accounting principles in the United States
of America (U.S. GAAP), details of which are set out in Note 30. The consolidated financial statements do not represent the Hong Kong statutory financial
statements of the Company as certain reclassifications and changes in presentation have been made
to the financial statements in order to conform more closely to presentations customary in filings
with the Securities and Exchange Commission of the United States of America (the SEC). All amounts are expressed in Hong Kong Dollars, the Companys functional currency. Unless
indicated otherwise, amounts in Hong Kong Dollars have been rounded to the nearest thousand.  2
    Principal accounting policies The principal accounting policies adopted in the preparation of these financial statements are
set out below:  (a)
    Consolidation The consolidated financial statements include the financial position of the Company and all
its subsidiaries as of August 31, 2003 and 2004, and the results of operations, cash flows and
changes in shareholders equity for the years ended August 31, 2002, 2003 and 2004. All significant
inter-company transactions and balances are eliminated on consolidation. 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. The results of subsidiaries acquired or disposed of during the year are included in the
consolidated statements of income from the effective dates of acquisition or up to the effective
dates of disposal, as appropriate. The gain or loss on the disposal of a subsidiary represents the
difference between the proceeds of the sale and the Companys share of its net assets together with
any unamortized goodwill or goodwill/negative goodwill taken to reserves and which was not
previously charged or recognized in the consolidated statements of income. F-10




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##### Table of Contents



Minority interests represent the interests of outside shareholders in the operating results
and net assets of subsidiaries.  (b)
    Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the
Companys share of the identifiable net assets of the acquired subsidiary at the date of
acquisition. Goodwill on acquisitions that occurred prior to September 1, 2001 was written off against
reserves. Goodwill on acquisitions occurring on or after September 1, 2001 is separately shown on the
consolidated balance sheets and is amortized using the straight-line method over its estimated
useful life. Goodwill arising on major strategic acquisitions of the Company to expand its product
or geographical market coverage is amortized over a period of not more than 20 years. Where an indication of impairment exists, the carrying amount of goodwill, including goodwill
previously written off against reserves, is assessed and written down immediately to its
recoverable amount and any write down is accounted for in the consolidated statements of income.  (c)
    Fixed assets Fixed assets are stated at cost less accumulated depreciation and accumulated impairment
losses. Leasehold land is depreciated over the period of the lease while other tangible fixed assets
are depreciated at rates sufficient to write off their costs less accumulated impairment losses
over their estimated useful lives on a straight-line basis. The principal annual rates are as
follows: %Leasehold land
    
    2Leasehold buildings
    
    2Furniture, fixtures and fittings
    
    25Telecommunications, computer and office equipment
    
    7 - 25Auto-dialers
    
    25Motor vehicles
    
    25
 Depreciation of leasehold improvements is calculated to write off their cost less accumulated
impairment losses over the unexpired periods of the leases or their expected useful lives to the
Company whichever is shorter. Major costs incurred in restoring fixed assets to their normal working condition are charged
to the consolidated statements of income. Improvements are capitalized and depreciated over their
expected useful lives to the Company. At each balance sheet date, both internal and external sources of information are considered
to assess whether there is any indication that fixed and other long lived assets are impaired. If
any such indication exists, the recoverable amount of the asset is estimated and where relevant, an
impairment loss is recognized to reduce the assets to its recoverable amount. Such impairment
losses are recognized in the consolidated statements of income. No such impairment losses were
required in the three years ended August 31, 2004. The gain or loss on disposal of a fixed asset is the difference between the net sale proceeds
and the carrying amount of the relevant asset, and is recognized in the consolidated statements of
income. F-11




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##### Table of Contents



(d)
    Assets held under leases  (i)
    Finance leases Leases that substantially transfer
to the Company all the risks and rewards of ownership of
assets are accounted for as finance leases. Finance leases are capitalized at the inception of the
leases at the lower of fair value of the leased assets or the present value of the minimum lease
payments. Each lease payment is allocated between capital and finance charges so as to achieve a
constant rate on the capital balances outstanding. The corresponding rental obligations, net of
finance charges, are included in long-term liabilities. The finance charges are charged to the
consolidated statements of income over the lease periods. Assets held under
finance leases are depreciated over the shorter of lease periods or their
estimated useful lives.  (ii)
    Operating leases Leases where
substantially all the risk and rewards of ownership of assets remain with the
leasing company are accounted for as operating leases. Payments made under operating leases net of
any incentives received from the leasing company are charged to the consolidated statements of
income on a straight-line basis over the lease periods.  (e)
    Other investments Other investments are carried at fair value.
At each balance sheet date, the net unrealized
gains or losses arising from the changes in fair value of other investments are recognized in the
consolidated statements of income. Profits or losses on disposal of other investments, representing
the difference between the net sales proceeds and the carrying amounts, are recognized in the
consolidated statements of income as they arise.  (f)
    Deferred expenditure Customer acquisition costs incurred to
obtain long term service agreements with customers are
deferred and amortised on a straight line basis over the period of the underlying service
subscription agreements executed with the customers. All other related advertising and marketing
costs are charged to the consolidated statements of income as incurred.  (g)
    Accounts receivable Provision is made against accounts
receivable to the extent they are considered to be
doubtful. Accounts receivable in the consolidated balance sheets are stated net of such provision.  (h)
    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 accounts.
Taxation rates enacted or substantively enacted by 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 utilised. Deferred taxation is provided on temporary differences arising on investments in subsidiaries
except where the timing of the reversal of the temporary difference can be controlled and it is
probable that the temporary difference will not reverse in the foreseeable future. In prior years, deferred taxation was accounted for at the current taxation rate in respect of
timing differences between profit as computed for taxation purposes and profit as stated in the
accounts to the F-12




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##### Table of Contents



extent that a liability or an asset was expected to be payable or recoverable in the
foreseeable future. The adoption of the SSAP 12 (revised), represents a change in accounting
policy, which has been applied retrospectively so that the comparatives presented have been
restated to conform to the changed policy. As detailed in the Consolidated Statement of Changes in Shareholders Equity, opening retained
profits at September 1, 2002 and 2003 have been reduced by HK$5,195,000 and HK$5,274,000,
respectively, which represents the unprovided net deferred tax liabilities as at the two dates, as
a result of the change in accounting policy. In addition, the profit for the year ended August 31,
2003 and 2002 have been reduced by HK$79,000 and HK$624,000, respectively.  (i)
    Translation of foreign currencies 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 date
are translated at the rates of exchange ruling at the balance sheet date. Exchange differences
arising in these cases are dealt with in the consolidated statements of income. The balance sheets of subsidiaries expressed in foreign currencies are translated at the rates
of exchange ruling at the balance sheet date whilst the statements of income are translated at an
average rate for the year. Exchange differences are dealt with as a movement in reserves.  (j)
    Cash and cash equivalents Cash equivalents are stated at cost, which approximates fair value because of the short-term
maturity of these instruments. For the purposes of the consolidated statements of cash flows, cash
and cash equivalents are short-term highly liquid investments, which are readily convertible into
cash and have original maturity of three months or less at the date of acquisition, and short-term
loans and overdrafts repayable within three months.  (k)
    Provisions Provisions are recognized when the Company 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. Where the Company expects a
provision to be reimbursed, the reimbursement is recognized as a separate asset but only when the
reimbursement is virtually certain.  (l)
    Contingent liabilities and contingent assets 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 Company. 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 consolidated
financial statements. When a change in the probability of an outflow occurs so that outflow is
probable, they 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 Company. Contingent assets are not recognized but are disclosed in the notes to the consolidated
financial statements when an inflow of economic benefits is probable. When inflow is virtually
certain, an asset is recognized. F-13




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##### Table of Contents



(m)
    Revenue recognition Revenue for the provision of international telecommunications and fixed telecommunications
network services is recognized, net of discounts, when the services are rendered. Revenue received in advance for the provision of international telecommunications services
using calling cards is deferred and included under deferred services income, which is amortized
based on the estimated actual usage by customers. Revenue received in advance for provision of fixed telecommunications network services is
deferred and included under deferred services income, which is amortized on a straight line basis
over the agreed period of time in accordance with the terms of the subscriber agreement. Interest income is recognized on a time proportion basis, taking into account the principal
amounts outstanding and the interest rates applicable.  (n)
    Employee benefits  (i)
    Employee leave entitlements Employee entitlements to annual leave and long service leave are recognized when they accrue
to employees. A provision is made for the estimated liability for annual leave and long-service
leave as a result of services rendered by employees up to the balance sheet date. Employee entitlements to sick leave and maternity or paternity leave are not recognized until
the time of leave.  (ii)
    Profit sharing and bonus plans Provisions for profit sharing and bonus plans due wholly within twelve months after balance
sheet date are recognized when the Company has a present legal or constructive obligation as a
result of services rendered by employees and a reliable estimate of the obligation can be made.  (iii)
    Retirement benefit costs The Company contributes to defined contribution retirement schemes which are available to all
employees. Contributions to the schemes by the Company and employees are calculated as a percentage
of employees basic salaries. The retirement benefit scheme cost charged to the consolidated
statements of income represents contributions payable by the Company to the fund. The Companys
contributions are reduced by contributions forfeited by those employees who leave the scheme prior
to vesting fully in the contributions. The assets of the scheme are held separately from those of the Company in an independently
administered fund.  (o)
    Research and development costs Research and development costs of new services and enhancements to existing services are
charged to the consolidated statements of income as incurred. Total research and development expenses incurred for the years ended August 31, 2002, 2003 and
2004 amounted to HK$2,166,000, HK$2,622,000 and HK$5,962,000, respectively. F-14




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##### Table of Contents



(p)
    Borrowing costs Borrowing costs that are directly 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 borrowing costs are charged to
the consolidated statements of income in the year in which they are incurred. Total borrowing costs capitalized for the year ended August 31, 2004 was HK$3,053,000 (2003:
Nil and 2002: Nil).  (q)
    Segment reporting In accordance with the Companys internal financial reporting, the Company has determined that
business segments be presented as the primary reporting format and geographical as the secondary
reporting format. Segment assets consist primarily of goodwill, fixed assets, receivables and operating cash.
Segment liabilities comprise operating liabilities and exclude items such as taxation and certain
corporate borrowings. Capital expenditure comprises additions to fixed assets. In respect of geographical segment reporting, sales are reported based on the country in which
the customer is located. Total assets and capital expenditure are reported based on where the
assets are located.  (r)
    Barter transactions When goods or services are exchanged or swapped for goods or services which are of a similar
nature and value, the exchange is not regarded as a transaction which generates revenue. When goods
are sold or services are rendered in exchange for dissimilar goods or services, the exchange is
regarded as a transaction which generates revenue. The revenue is measured at the fair value of the
goods or services received, adjusted by the amount of any cash or cash equivalents transferred.
When the fair value of the goods or services received cannot be measured reliably, the revenue is
measured at the fair value of the goods or services given up, adjusted by the amount of any cash or
cash equivalents transferred.  (s)
    Use of estimates The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the year. Actual
results could differ from these estimates. Please also refer to critical accounting estimate in
Note 3 below.  3
    Cost of services provided The Company estimates the Universal Services Contributions (USC) payable to PCCW-HKT
Telephone Limited (PCCW-HKT) to fund the costs of network development in remote areas in Hong
Kong (the Development) and includes such estimated costs as part of the cost of its services. The
Telecommunications Authority periodically reviews the actual costs of such developments and revises
the amounts owed to, or to be refunded by, PCCW-HKT to the USC contributing parties. Management of the Company makes their best estimates for charges of the USC payable to
PCCW-HKT. Such estimated costs are included as part of the Companys costs of rendering its
services. The estimate is made based on the provisional rates announced by the Telecommunications
Authority and effective up to the date of the release of the financial statements of the Company.
The Telecommunications Authority periodically reviews the actual costs incurred by PCCW-HKT in the
Development and revises the amounts owed to, or to be refunded by, PCCW-HKT to the respective USC
contributing parties, including the Company (the Rate Revisions). Accordingly, the estimate made
by F-15




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##### Table of Contents



the Companys management is subject to changes based on the Rate Revisions identified during a
financial year and up to the date prior to the release of the financial statements of the Company.
The Company adjusts such differences as an addition or reduction of the corresponding costs of
services in that particular reporting period. Any sum received in advance from PCCW-HKT as an estimated refund of the USC on a provisional
basis, which is subject to the final confirmation and determination of OFTA, is recorded in other
payables and accrued charges in the Companys balance sheet. On November 30, 2002, the Telecommunications Authority issued a statement (the November 2002
Statement) that confirmed the actual USC payable by USC contributing parties for the calendar year
2000. As a result of the release of the November 2002 Statement, in February 2003, the Company
received a refund of USC paid for the period from January 1, 2000 to December 31, 2000 of
HK$40,585,606 and the amount was set off against the cost of services of the Company for the year
ended August 31, 2003. On March 8, 2003, the Company received in advance a sum of HK$56,488,570 from PCCW-HKT as a
provisional refund of the USC paid for the period from January 1, 2001 to June 30, 2002 (the
Provisional Refund). On October 20, 2003, OFTA issued another statement on the USC and confirmed
the contribution level for calendar year 2001. Accordingly, HK$40,276,440 out of the Provisional
Refund and an additional refund of approximately HK$3,000,000 payable by PCCW-HKT to the Company
for the calendar year 2001 were set off against the costs of services of the Company. In aggregate,
the Company had set off against the costs of services of HK$84,119,117 in respect of USC refund for
the year ended August 31, 2003. The remaining HK$16,212,130 of the Provisional Refund received by
the Company, being the provisional refund of the USC for the period from January 1, 2002 to June
30, 2002 which was subject to confirmation of the Telecommunications Authority (2002 Provisional
Refund) was included in other payables and accrued charges in the Companys balance sheets as at
August 31, 2003. On November 19, 2004, the Telecommunications Authority issued a statement on the USC that
confirmed the actual contribution level for calendar year 2002. The 2002 Provisional Refund was
confirmed. Additional refund payable by PCCW-HKT to the Company and related adjustments required to
be made to the USC for calendar year 2002 were also determined. In aggregate, an amount of
HK$31,688,696 was recorded as an off-set against the costs of services of the Company for the year
ended August 31, 2004.  4
    Loss on disposal of a subsidiary During the year ended August 31, 2003, the Companys operation in Japan was discontinued
following the disposal of its subsidiary operating in Japan to a company wholly-owned by a relative
of a director of the subsidiary (the Purchaser). The subsidiary was sold for a consideration of
JPY30,000,000 (equivalent to HK$1,950,000) which is to be satisfied by the Purchaser in thirty
monthly installments commencing July 15, 2003. The disposal resulted in a loss of HK$2,695,000
which was recognized in the consolidated statements of income. As at August 31, 2004, a receivable balance of HK$1,136,000 was due from the Purchaser, of
which HK$780,000 included in other receivables, deposits and prepayments is expected to be received
within one year. The remaining HK$356,000 is included in long term receivables and is expected to
be received after one year. F-16




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##### Table of Contents



5
    Income before taxation Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Income before taxation is stated after charging:Amortization of goodwill
    
    
    1,065
    
    
    
    1,065
    
    
    
    1,065Amortization of deferred expenditure
    
    
    
    
    
    
    
    
    
    
    1,828Depreciation of purchased fixed assets
    
    
    124,563
    
    
    
    173,619
    
    
    
    195,952Depreciation of fixed assets held under finance
leases
    
    
    3,727
    
    
    
    1,336
    
    
    
    Operating lease charges in respect of: Land and buildings
    
    
    11,486
    
    
    
    6,481
    
    
    
    8,084 Computer equipment
    
    
    5,141
    
    
    
    100
    
    
    
    31Research and development costs
    
    
    2,166
    
    
    
    2,622
    
    
    
    5,962Retirement benefit costs  defined contribution plans
(Note 24)
    
    
    11,335
    
    
    
    15,843
    
    
    
    26,287Interest expense comprises:Interest element of finance leases
    
    
    225
    
    
    
    42
    
    
    
    Interest on bank overdrafts
    
    
    235
    
    
    
    210
    
    
    
    3,228Interest paid to third parties
    
    
    2,198
    
    
    
    349
    
    
    
    Interest paid to a minority shareholder
    
    
    846
    
    
    
    
    
    
    
    Less: amount capitalised as fixed assetsInterest capitalised
    
    
    
    
    
    
    
    
    
    
    (2,553
    )Other incidental borrowing cost
    
    
    
    
    
    
    
    
    
    
    (500
    )Total borrowing cost capitalised
    
    
    
    
    
    
    
    
    
    
    (3,053
    )Total interest expenses
    
    
    3,504
    
    
    
    601
    
    
    
    175Other income comprises: Exchange gains (loss), net
    
    
    (508
    )
    
    
    1,291
    
    
    
    131Others
    
    
    1,010
    
    
    
    3,082
    
    
    
    2,537502
    
    
    
    4,373
    
    
    
    2,668
  6
    Income tax charges Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Hong Kong
    
    
    95,396
    
    
    
    272,016
    
    
    
    53,200Overseas
    
    
    2,065
    
    
    
    3,584
    
    
    
    (1,607
    )Income before taxation
    
    
    97,461
    
    
    
    275,600
    
    
    
    51,593
 Income tax charges consist of the following: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000As restated
    
    
    As restatedHong Kong income taxcurrent (note (a))
    
    
    (18,000
    )
    
    
    (15,300
    )
    
    
    (1,537
    )(under)/overprovision in prior years
    
    
    10,665
    
    
    
    
    
    
    
    (1,221
    )deferred (Note 12)
    
    
    (10,139
    )
    
    
    (79
    )
    
    
    1,311Overseas taxationcurrent (note (b))
    
    
    (116
    )
    
    
    (2,478
    )
    
    
    (596
    )over provisions in prior years
    
    
    2,400
    
    
    
    
    
    
    
    (15,190
    )
    
    
    (17,857
    )
    
    
    (2,043
    )
   (a)
    
    The Company is subject to tax on an entity basis on income arising in or derived from Hong
Kong. The rate of taxation of the Company operating in Hong Kong for the year ended August 31,
2002 was 16% and for the years ended August 31, 2003 and 2004 was 17.5%. In 2003, the Hong
Kong government enacted a change in the profits tax rate from 16% to 17.5% for the year ended
August 31, 2003 and 2004, respectively. F-17




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##### Table of Contents



(b)
    
    Taxation on overseas profits has been calculated on the estimated assessable profit for the
year at the rates of taxation prevailing in the countries in which the Company operates. The income taxes attributable to income for the years ended August 31, 2002, 2003 and 2004
differs from the amount of income taxes determined by applying the applicable income tax rate
prevailing in the countries in which the Company operates to pre-tax income as a result of the
following differences: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000As restated
    
    
    As restatedIncome tax charge calculated at the prevailing
taxation rate of respective countries
    
    
    15,847
    
    
    
    48,520
    
    
    
    9,696Effect of expenses not deductible for income taxes
    
    
    12,988
    
    
    
    5,584
    
    
    
    730Effect of income not subject to income taxes
    
    
    (4,445
    )
    
    
    (5,151
    )
    
    
    (825
    )Under/(over)provision for Hong Kong income tax in
prior years
    
    
    (10,665
    )
    
    
    
    
    
    
    1,221Overprovision for overseas income tax in prior
years
    
    
    (2,400
    )
    
    
    
    
    
    
    Recognition of deferred tax assets on prior years tax
losses, net of other temporary difference
    
    
    (3,588
    )
    
    
    (36,505
    )
    
    
    (9,066
    )Effect of tax loss not recognized
    
    
    8,150
    
    
    
    208
    
    
    
    27Increase in opening net deferred tax liabilities
resulting from an increase in tax rate
    
    
    
    
    
    
    1,893
    
    
    
    Others
    
    
    (697
    )
    
    
    3,308
    
    
    
    260Income tax charges
    
    
    15,190
    
    
    
    17,857
    
    
    
    2,043
  7
    Earnings per share Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000As restated
    
    
    As restatedNet income
    
    
    90,505
    
    
    
    257,743
    
    
    
    49,550No. of
    
    No. of
    
    No. ofshares
    
    shares
    
    sharesin thousand
    
    in thousand
    
    in thousandWeighted average number of shares in
issue
    
    
    495,181
    
    
    
    552,600
    
    
    
    610,095Incremental shares from assumed
exercise of share options
    
    
    11,219
    
    
    
    7,112
    
    
    
    604Incremental shares from assumed
exercise of warrants
    
    
    59,489
    
    
    
    55,390
    
    
    
    3,666Diluted weighted average number of
shares
    
    
    565,889
    
    
    
    615,102
    
    
    
    614,365Basic earnings per share
    
    HK$18.3 cents
    
    
    HK$46.6 cents
    
    
    HK$8.1 centsDiluted earnings per share
    
    HK$16.0 cents
    
    
    HK$41.9 cents
    
    
    HK$8.1 cents
 Earnings per share are calculated based on the weighted average number of issued ordinary
shares and, as appropriate, diluted ordinary shares equivalent outstanding for each of the relevant
years and the related income amount. The number of incremental shares from assumed exercise of
share options and warrants has been determined using the treasury stock method. F-18




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##### Table of Contents



8
    Receivables  (a)
    Trade receivables, net August 31,2003
    
    
    2004HK$000
    
    
    HK$000Trade receivables
    
    
    116,996
    
    
    
    157,808Less: provision for doubtful debts
    
    
    (22,916
    )
    
    
    (22,959
    )94,080
    
    
    
    134,849
 Changes in the provision for doubtful debts consist of: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Balance at beginning of the year
    
    
    14,362
    
    
    
    17,139
    
    
    
    22,916Additions charged to expense
    
    
    10,277
    
    
    
    17,685
    
    
    
    11,502Write-off
    
    
    (7,500
    )
    
    
    (11,908
    )
    
    
    (11,459
    )Balance at the end of the year
    
    
    17,139
    
    
    
    22,916
    
    
    
    22,959
  (b)
    Other receivables, deposits and prepayments August 31,2003
    
    
    2004HK$000
    
    
    HK$000Deposits for purchase of fixed assets
    
    
    8,051
    
    
    
    7,090Deposits for lease of land and building
    
    
    4,121
    
    
    
    2,995Network connection charges receivables
    
    
    11,982
    
    
    
    Prepayments
    
    
    6,475
    
    
    
    17,943Receivables from disposal of a subsidiary (Note 4)
    
    
    1,818
    
    
    
    780USC refund receivable
    
    
    
    
    
    
    9,848Others
    
    
    2,267
    
    
    
    5,37334,714
    
    
    
    44,029
  9
    Goodwill August 31,2003
    
    
    2004HK$000
    
    
    HK$000CostAt the beginning of the year
    
    
    5,326
    
    
    
    5,326Accumulated amortizationAt the beginning of the year
    
    
    1,065
    
    
    
    2,130Charge for the year
    
    
    1,065
    
    
    
    1,065At the end of the year
    
    
    2,130
    
    
    
    3,195Net book valueAt the end of the year
    
    
    3,196
    
    
    
    2,131
 Goodwill was recognized for the amount of the excess of the purchase price paid over the
net book value (which approximates fair value) of the assets acquired, and is amortized on a
straight-line basis over five year. F-19




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##### Table of Contents



10
    Fixed assets, net Leasehold
    
    
    
    
    
    
    Furniture,
    
    
    Telecommunicationsland and
    
    
    Leasehold
    
    
    fixtures
    
    
    computers and
    
    
    Auto-
    
    
    Motorbuildings
    
    
    improvements
    
    
    and fittings
    
    
    office equipment
    
    
    diallers
    
    
    vehicles
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000CostAt September 1, 2002
    
    
    58,182
    
    
    
    53,874
    
    
    
    9,858
    
    
    
    1,045,147
    
    
    
    17,268
    
    
    
    7,860
    
    
    
    1,192,189Exchange adjustments
    
    
    
    
    
    
    181
    
    
    
    89
    
    
    
    2,115
    
    
    
    
    
    
    
    
    
    
    
    2,385Additions
    
    
    3,417
    
    
    
    4,174
    
    
    
    1,957
    
    
    
    239,629
    
    
    
    
    
    
    
    1,032
    
    
    
    250,209Disposals
    
    
    
    
    
    
    (2,038
    )
    
    
    
    
    
    
    (5,324
    )
    
    
    
    
    
    
    
    
    
    
    (7,362
    )Disposal of a
subsidiary
    
    
    
    
    
    
    
    
    
    
    (984
    )
    
    
    (2,904
    )
    
    
    (301
    )
    
    
    
    
    
    
    (4,189
    )At August 31, 2003
    
    
    61,599
    
    
    
    56,191
    
    
    
    10,920
    
    
    
    1,278,663
    
    
    
    16,967
    
    
    
    8,892
    
    
    
    1,433,232At September 1, 2003
    
    
    61,599
    
    
    
    56,191
    
    
    
    10,920
    
    
    
    1,278,663
    
    
    
    16,967
    
    
    
    8,892
    
    
    
    1,433,232Exchange adjustments
    
    
    
    
    
    
    (76
    )
    
    
    (21
    )
    
    
    915
    
    
    
    
    
    
    
    
    
    
    
    818Additions
    
    
    22,109
    
    
    
    15,344
    
    
    
    2,339
    
    
    
    369,583
    
    
    
    
    
    
    
    671
    
    
    
    410,046Disposals
    
    
    
    
    
    
    (6,760
    )
    
    
    
    
    
    
    (5,329
    )
    
    
    
    
    
    
    (1,790
    )
    
    
    (13,879
    )At August 31, 2004
    
    
    83,708
    
    
    
    64,699
    
    
    
    13,238
    
    
    
    1,643,832
    
    
    
    16,967
    
    
    
    7,773
    
    
    
    1,830,217Accumulated depreciationAt September 1, 2002
    
    
    2,308
    
    
    
    16,687
    
    
    
    6,308
    
    
    
    273,646
    
    
    
    15,436
    
    
    
    4,708
    
    
    
    319,093Exchange adjustments
    
    
    
    
    
    
    82
    
    
    
    36
    
    
    
    1,332
    
    
    
    
    
    
    
    
    
    
    
    1,450Charge for the year
    
    
    1,186
    
    
    
    6,332
    
    
    
    1,572
    
    
    
    163,443
    
    
    
    1,140
    
    
    
    1,282
    
    
    
    174,955Disposals
    
    
    
    
    
    
    (1,830
    )
    
    
    
    
    
    
    (3,553
    )
    
    
    
    
    
    
    
    
    
    
    (5,383
    )Disposal of a
subsidiary
    
    
    
    
    
    
    
    
    
    
    (409
    )
    
    
    (2,279
    )
    
    
    (147
    )
    
    
    
    
    
    
    (2,835
    )At August 31, 2003
    
    
    3,494
    
    
    
    21,271
    
    
    
    7,507
    
    
    
    432,589
    
    
    
    16,429
    
    
    
    5,990
    
    
    
    487,280At September 1, 2003
    
    
    3,494
    
    
    
    21,271
    
    
    
    7,507
    
    
    
    432,589
    
    
    
    16,429
    
    
    
    5,990
    
    
    
    487,280Exchange adjustments
    
    
    
    
    
    
    22
    
    
    
    15
    
    
    
    840
    
    
    
    
    
    
    
    
    
    
    
    877Charge for the year
    
    
    1,530
    
    
    
    7,067
    
    
    
    1,530
    
    
    
    184,018
    
    
    
    371
    
    
    
    1,436
    
    
    
    195,952Disposals
    
    
    
    
    
    
    (6,757
    )
    
    
    
    
    
    
    (4,220
    )
    
    
    
    
    
    
    (1,790
    )
    
    
    (12,767
    )At August 31, 2004
    
    
    5,024
    
    
    
    21,603
    
    
    
    9,052
    
    
    
    613,227
    
    
    
    16,800
    
    
    
    5,636
    
    
    
    671,342Net book valueAt August 31, 2003
    
    
    58,105
    
    
    
    34,920
    
    
    
    3,413
    
    
    
    846,074
    
    
    
    538
    
    
    
    2,902
    
    
    
    945,952At August 31, 2004
    
    
    78,684
    
    
    
    43,096
    
    
    
    4,186
    
    
    
    1,030,605
    
    
    
    167
    
    
    
    2,137
    
    
    
    1,158,875
  (a)
    The interests in leasehold land and buildings situated in Hong Kong at their net book
values are analyzed as follows: August 31,2003
    
    
    2004HK$000
    
    
    HK$000Leases of between 10 to 50 years
    
    
    58,105
    
    
    
    78,684
  (b)
    Certain telecommunications, computer equipment and office equipment are held under
finance leases. The total cost of these assets and the related accumulated depreciation as
of the end of each of the relevant years are as follows: August 31,2003
    
    
    2004HK$000
    
    
    HK$000Cost
    
    
    23,581
    
    
    
    Accumulated depreciation
    
    
    (23,581
    )
    
    
    
    
    
    
    
  11
    Other payables and accrued charges August 31,2003
    
    
    2004HK$000
    
    
    HK$000Accrual for staff salaries and bonus
    
    
    42,795
    
    
    
    26,557Accrual for premium costs
    
    
    
    
    
    
    23,309Accrual for vetting charges
    
    
    2,775
    
    
    
    1,204Accrual for porting charges
    
    
    2,001
    
    
    
    5,378Accrual for international call forwarding service charges
    
    
    1,452
    
    
    
    2,501Payable for additions of fixed assets
    
    
    76,341
    
    
    
    92,383Payable for advertising and promotional expenses
    
    
    5,645
    
    
    
    14,676Payable for USC
    
    
    2,817
    
    
    
    905Provisional refund of USC (Note 3)
    
    
    16,212
    
    
    
    Others
    
    
    14,514
    
    
    
    21,692164,552
    
    
    
    188,605
 F-20




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##### Table of Contents



12
    Deferred taxation Deferred taxation is calculated in full on temporary differences under the liability method
using the taxation rates prevailing in respective countries in which the Company operates. The movement on the deferred tax liabilities account is as follows: August 31,2003
    
    
    2004HK$000
    
    
    HK$000As restatedAt September 1
    
    
    20,195
    
    
    
    20,274Exchange differences
    
    
    
    
    
    
    (301
    )Deferred taxation (credited)/charged to statements of income relating to the origination and reversal of temporary differences
    
    
    (1,814
    )
    
    
    (1,311
    ) resulting from an increase in tax rate
    
    
    1,893
    
    
    
    At August 31
    
    
    20,274
    
    
    
    18,662
 Prior to 2003, the Company recognized deferred taxation arising from timing differences
attributable to accelerated depreciation at profits tax rate in force in the year in which the
temporary differences arose. SSAP 12 (revised) requires the provision of deferred taxation on
temporary differences between the tax bases of assets and liabilities and their carrying amounts in
the accounts using the profits tax rate enacted, or substantially enacted, at the balance sheet
date. On adoption of SSAP 12 (revised) retrospectively, opening retained profits at September 1,
2002 and 2003 have been reduced by HK$5,195,000 and HK$5,274,000, respectively, which represents
the unprovided net deferred tax liabilities as at the two dates, as a result of the change in
accounting policy. In addition, the profit for the year ended August 31, 2003 and 2002 have been
reduced by HK$79,000 and HK$624,000, respectively. As of August 31, 2004, the Company had accumulated tax losses amounting to HK$735,059,000
(2003: HK$598,583,000) may be carried forward and applied to reduce future taxable income which is
carried in or derived from Hong Kong, Canada and the United States. The tax effect on the
accumulated tax losses amounted to HK$129,222,000 (2003: HK$105,822,000). Deferred income tax assets are recognized for tax loss carry forwards to the extent that the
related tax benefit through the utilization of tax losses against the future taxable profits is
probable. The Company has unrecognized tax losses of HK$40,573,000 at August 31, 2004 (2003:
HK$80,577,000) to carry forward against future taxable income, these tax losses will expire in the
following periods: August 31,2003
    
    
    2004HK$000
    
    
    HK$000As restatedAfter 5 years
    
    
    
    
    
    
    133From 2 to 5 years
    
    
    4,600
    
    
    
    2,597No expiry date
    
    
    75,977
    
    
    
    37,84380,577
    
    
    
    40,573
 F-21




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##### Table of Contents



The movement in deferred tax assets and liabilities (prior to offsetting of balances
within the same taxation jurisdiction) during the year is as follows: Accelerateddepreciationallowances
    
    
    Others
    
    
    TotalDeferred tax liabilities
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000As restated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    As restatedAt September 1,
    
    
    84,978
    
    
    
    110,925
    
    
    
    
    
    
    
    
    
    
    
    84,978
    
    
    
    110,925Charged to statements of
income
    
    
    25,947
    
    
    
    29,590
    
    
    
    
    
    
    
    49
    
    
    
    25,947
    
    
    
    29,639Exchange differences
    
    
    
    
    
    
    (313
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (313
    )At August 31,
    
    
    110,925
    
    
    
    140,202
    
    
    
    
    
    
    
    49
    
    
    
    110,925
    
    
    
    140,251
 Tax LossesDeferred tax assets
    
    2003
    
    
    2004HK$000
    
    
    HK$000As restatedAt September 1,
    
    
    (64,783
    )
    
    
    (90,651
    )Credited to statements of income
    
    
    (25,868
    )
    
    
    (30,950
    )Exchange differences
    
    
    
    
    
    
    12Balance at August 31,
    
    
    (90,651
    )
    
    
    (121,589
    )
 Deferred income tax assets and liabilities are offset when there is a legally enforceable
right to set off current tax assets against current tax liabilities and when the deferred income
taxes relate to the same fiscal authority. The following amounts, determined after appropriate
offsetting, are shown in the consolidated balance sheet: August 31,2003
    
    
    2004HK$000
    
    
    HK$000As restatedDeferred tax assets
    
    
    
    
    
    
    (229
    )Deferred tax liabilities
    
    
    20,274
    
    
    
    18,89120,274
    
    
    
    18,662
  13
    Deferred expenditure August 31,2003
    
    
    2004HK$000
    
    
    HK$000Additions during the year
    
    
    
    
    
    
    23,391Less: Amortisation charge for the year (Note 5)
    
    
    
    
    
    
    (1,828
    )Balance at August 31,
    
    
    
    
    
    
    21,563
 Deferred expenditure represents costs incurred in acquiring subscribers of the fixed line
phone services, which is treated as customer acquisition costs and are amortised over the expected
subscription period of the services.  14
    Long-term bank loan  secured At August 31, 2004, the Companys bank loan was repayable as follows: August 31,2003
    
    
    2004HK$000
    
    
    HK$000Within one year
    
    
    
    
    
    
    13,333In the second year
    
    
    
    
    
    
    20,000In the third to fifth year
    
    
    
    
    
    
    60,000After the fifth year
    
    
    
    
    
    
    6,667
    
    
    
    100,000Less: current portion of long-term bank loan
    
    
    
    
    
    
    (13,333
    )
    
    
    
    86,667
 F-22




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##### Table of Contents



Please refer to Note 16(b) for details of the loan facility associated with this
outstanding bank loan balance and securities given by the Company for it. In connection with the
draw-down of this bank loan, the Company entered into an interest rate swap agreement with the
bank, under which, the Company makes a monthly interest payment at a fixed rate of 2.675% per annum
on a notional amount of HK$100 million, and receives monthly interest payments calculated at Hong
Kong Interbank borrowing rate (HIBOR) during a period from March 2004 to December 2009.  15
    Commitments and contingencies  (a)
    Capital commitments August 31,2003
    
    
    2004HK$000
    
    
    HK$000Purchases of telecommunications, computer and office
equipment contracted but not provided for
    
    
    122,540
    
    
    
    213,310
  (b)
    Commitments under operating leases As of August 31, 2003 and 2004, the Company had future aggregate minimum lease payments under
non-cancelable operating leases as follows: August 31,2003
    
    
    2004HK$000
    
    
    HK$000Leases in respect of land and buildings which are payable:within one year
    
    
    10,229
    
    
    
    10,419in the second year
    
    
    3,240
    
    
    
    4,369in the third year
    
    
    28
    
    
    
    2,688in the forth year
    
    
    
    
    
    
    446in the fifth year
    
    
    
    
    
    
    46213,497
    
    
    
    18,384Leases in respect of telecommunications facilities and
computer equipment which are payable:within one year
    
    
    22,996
    
    
    
    36,479in the second year
    
    
    8,324
    
    
    
    5,697in the third year
    
    
    22
    
    
    
    823in the fourth year
    
    
    22
    
    
    
    800in the fifth year
    
    
    
    
    
    
    800within sixth year to twelve years
    
    
    
    
    
    
    7,80031,364
    
    
    
    52,39944,861
    
    
    
    70,783
 F-23




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##### Table of Contents



(c)
    Program fee commitments The Company entered into agreements with program content providers for granting the program
rights to deliver certain program contents in the Companys IP-TV services. Minimum amounts of
program fees are committed to be paid by the Company which are analysed as follows: August 31,2003
    
    
    2004HK$000
    
    
    HK$000Program fee in respect of program rights which are payable:within one year
    
    
    
    
    
    
    15,542in the second year
    
    
    
    
    
    
    12,873in the third year
    
    
    
    
    
    
    5,996
    
    
    
    34,411
  (d)
    Contingent liabilities August 31,2003
    
    
    2004HK$000
    
    
    HK$000Bank guarantees provided to suppliers (Note 16(a)(i))
    
    
    7,812
    
    
    
    6,295Bank guarantee in lieu of payment of utility deposits (Note 16(a)(ii))
    
    
    3,622
    
    
    
    3,62211,434
    
    
    
    9,917
  (e)
    Pending litigation (i) In July 1998, Cable & Wireless HKT, a Hong Kong company, commenced proceedings against the
Company and served a statement of claim which alleged that the Company has breached the terms of a
contract it had with Cable & Wireless HKT and committed an economic tort. The Company denied these
allegations in a comprehensive defence which included a counterclaim lodged against the plaintiffs
seeking damages for anti-competitive practices conducted by Cable & Wireless HKT in Hong Kong.
Neither the claim by Cable & Wireless HKT nor the counterclaim by the Company has been quantified.
The directors believe that the allegations against the Company are without merit and intend to
defend the litigation vigorously. The case is currently in its discovery phase and no provision
against the claims has been made in the consolidated financial statements as the directors do not
consider provision is necessary. (ii) In January 1999, Jade Com Development Limited (Jade Com) commenced proceedings against
the Company and two directors of the Company, alleging them of repudiation of an international
carrier service agreement executed between Jade Com and Attitude Holdings Limited, a wholly-owned
subsidiary of the Company. Jade Com claimed damages for breach of contract and misrepresentation
and alleged that the Company has a remaining commitment of approximately US$3.6 million under the
agreement. The Company filed a defense in May 1999 on the basis that Jade Com had breached a
condition of the agreement that they obtain the necessary legal approvals and licenses necessary
for the provision of their services. In February 2001, the parties consented to adjourn the case
indefinitely with liberty to restore. No provision has been made in the consolidated financial
statements with respect to the litigation.  16
    Pledge of assets  (a)
    As at August 31, 2004, the Company had:  (i)
    bank deposits of US$800,000 (equivalent to HK$6,240,000) (2003: HK$Nil) and
HK$1,395,000 (2003: HK$11,434,000); and(ii)
    a charge over an investment with market value as at August 31, 2004 of US$468,000
(equivalent to HK$3,650,000) (Note 17) (2003: HK$Nil). F-24




---



##### Table of Contents



as security for:(i)
    bank guarantees of HK$6,295,000 (2003: HK$7,812,000) issued by the banks to third party
suppliers of the Company for payment of certain products and services procured by the Company
from these third party suppliers; and(ii)
    bank guarantees of HK$3,622,000 (2003: HK$3,622,000) issued by a bank to certain
utility vendors in lieu of payment of utility deposits.As at August 31, 2004, the Company had pledged bank deposits of HK$7,635,000 (2003:
HK$11,434,000). (b) On October 9, 2002, the Company entered into a HK$200,000,000 long-term loan facility with
The Hong Kong and Shanghai Banking Corporation Limited (HSBC) to provide funding for further
development of the fixed telecommunications network of Hong Kong Broadband Network Limited
(HKBN), a wholly-owned subsidiary of the Company. According to the agreement, all amounts under
the facility should be drawn by December 31, 2004. The principal balance drawn down is to be repaid
in 60 equal monthly installments beginning in January 2005. As at August 31, 2004, the amount drawn
down and outstanding was HK$100,000,000 (see note 14). On July 27, 2004, the Company entered into an additional HK$200,000,000 long term loan
facility with HSBC to provide funding for the same purpose. All amounts under the facility should
be drawn by December 31, 2006. The principal balance drawn down is to be repaid in 60 equal monthly
installments beginning in January 2007. As at August 31, 2004, the Company has not drawn any amount
under this facility. The Company is required to comply with certain covenants under the grant of both facilities.
Both facilities are secured by a fixed and floating charge over all assets of HKBN. (c) As at August 31, 2004, the short-term bank loan was secured by a bank deposit of
HK$19,170,000 (2003: HK$18,174,000).  17
    Other investments August 312003
    
    
    2004HK$000
    
    
    HK$000Debt
securities, at fair value
Unlisted outside Hong Kong
secured (Note 16(a)(ii)
    
    
    
    
    
    
    3,650unsecured
    
    
    23,370
    
    
    
    21,95423,370
    
    
    
    25,604
  18
    Long term bank deposit The balance is a ten-year US$2,000,000 (2003: US$2,000,000) (equivalent to HK$15,600,000)
deposit placed with a bank in which the Company receives a floating rate deposit interest while the
principal amount is fully protected. An interest rate of 10% per annum has been guaranteed for the
first year of placement in 2003. The deposit will be terminated once the cumulative interest
reaches the predetermined accrued interest cap at 13% of principal amount or an aggregate sum of
US$260,000 (equivalent to HK$2,028,000), or otherwise, will reach maturity on August 22, 2013 when
interest will be paid out at the guaranteed accrued interest rate of 13% or the aggregate interest
amount of US$260,000 (equivalent to HK$2,028,000). F-25




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##### Table of Contents



19 Share capital Authorised Ordinary shares ofHK$0.10 eachNo. of shares
    
    
    HK$000At August 31, 2003 and August 31, 2004
    
    
    2,000,000,000
    
    
    
    200,000
 Issued and fully paid (Ordinary shares of HK$0.10 each)August 31, 2003
    
    
    August 31, 2004No. of shares
    
    
    HK$000
    
    
    No. of shares
    
    
    HK$000At the beginning of the year
    
    
    500,863,202
    
    
    
    50,086
    
    
    
    604,959,787
    
    
    
    60,496Exercise of share options (note (a) and (b))
    
    
    21,120,000
    
    
    
    2,112
    
    
    
    640,000
    
    
    
    64Exercise of warrants (Note (d))
    
    
    82,976,585
    
    
    
    8,298
    
    
    
    4,973,574
    
    
    
    497At the end of the year
    
    
    604,959,787
    
    
    
    60,496
    
    
    
    610,573,361
    
    
    
    61,057
  (a)
    During the year ended August 31, 2003, 100,000 shares were issued at a price of HK$0.26
per share and 21,020,000 shares were issued at a price of HK$0.58 per share to the share
option holders who exercised their subscription rights. These shares rank pari passuwith
the then existing shares in issue.(b)
    During the year ended August 31, 2004, 600,000 shares were issued at a price of HK$0.26
per share and 40,000 shares were issued at a price of HK$0.58 per share, respectively to
share option holders who had exercised their subscription rights. These shares so issued
rank pari passuwith the then existing shares in issue.(c)
    Details of the share option scheme of the Company, the share options granted by the
Company during the relevant years and the options outstanding at August 31, 2003 and 2004
are set out in Note 25.(d)
    The Company effected a warrant issue at a price of HK$0.11 per warrant to certain
qualifying shareholders (shareholders domiciled in Hong Kong) for cash during the year
ended August 31, 2002. The issue price per warrant of HK$0.11 and the initial subscription
price of HK$0.40 per share were determined after negotiation between the Company and Top
Group as underwriter. Top Group is a significant shareholder whose directors are the
chairman and managing director of the Company. The Company believes that the terms of the
warrant issue were no less favourable than terms available from third parties. One warrant
was offered for every five existing shares held on the date of record. The warrants entitle
the holders to subscribe for ordinary shares of the Company (on one to one basis) at a
price of HK$0.40 per share (subject to adjustment) totalling, HK$39,325,920 in cash, at any
time on or before November 1, 2004. If the warrants are fully exercised, the Company will
be required to issue 98,314,800 additional shares. During the year ended August 31, 2004,
4,973,574 (2003: 82,976,585) warrants were exercised for an equivalent number of shares and
3,635,439 (2003: 8,609,013) warrants were outstanding at year end. The shares issued rank
pari passuwith the then existing shares in issue.  20
    Cash and cash equivalents August 31,2003
    
    
    2004HK$000
    
    
    HK$000Cash and bank balances
    
    
    88,119
    
    
    
    107,517Bank deposits
    
    
    313,915
    
    
    
    140,000Short-term bank loan  secured
    
    
    (18,174
    )
    
    
    (19,170
    )383,860
    
    
    
    228,347
 F-26




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##### Table of Contents



21
    Dividends Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Interim, declared and paid, of HK$0.015 (2003:HK$0.05, 2002: Nil) per ordinary share
    
    
    
    
    
    
    30,234
    
    
    
    9,158Final, dividend paid, of HK$Nil (2003: HK$0.075, 2002:Nil) per ordinary share
    
    
    
    
    
    
    
    
    
    
    45,789
    
    
    
    30,234
    
    
    
    54,947
  22
    Banking facilities The Companys banking facilities as of each balance sheet date, denominated in Hong Kong
dollars and Japanese Yen, can be analysed as follows: Amount available
    
    
    Amount utilizedAugust 31,
    
    
    August 31,
    
    
    Terms as of August 31, 20042003
    
    
    2004
    
    
    2003
    
    
    2004
    
    
    Interest rate
    
    Repayment termsHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Bank overdrafts/bank loans
    
    
    232,000
    
    
    
    432,000
    
    
    
    18,174
    
    
    
    119,170
    
    
    Cost of Funds + 0.8% or
    
    Repayable on demandHIBOR + 1.5% ~ 1.25% or
commercial best lending rate
    
    or by 60 monthly installment from
January 1, 2005 or 2007
 The cost of funds and HIBOR rate were 0.05% and 0.44% respectively, as of August 31,
2004. The cost of funds is determined by the individual banks and is subject to revision from time
to time. The utilized banking facilities as of August 31, 2003 and 2004 were denominated in Hong Kong
Dollar and Japanese Yen. The currency denomination of the utilized banking facilities for the
borrowings was as follows: 2003
    
    
    2004HK$000
    
    
    HK$000Hong Kong Dollars  secured
    
    
    
    
    
    
    100,000Japanese Yen  secured
    
    
    18,174
    
    
    
    19,170Total
    
    
    18,174
    
    
    
    119,170
 The weighted average interest rates of short-term borrowings of the Company were 0.85% as of
August 31, 2003 and 2004, respectively. The Company has entered into an interest rate swap arrangement for the HK$100,000,000
long-term loan with a bank. Under the arrangement, the Company will pay a fixed rate interest of
2.675% per annum on the notional amount of HK$100,000,000 on a monthly basis commencing from March
2004 to December 2009, and receiving a floating interest at HIBOR rate. The purpose of this
arrangement is to hedge the interest payments on the loan drawn down as describe in Note 14 to a
fixed rate of 4.175%. F-27




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##### Table of Contents



23
    Related party transactions Significant related party transactions, which were carried out in the normal course of the
Companys business are as follows: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Calling charges payable to KDDI Corporation (Note (a))
    
    
    13,161
    
    
    
    
    
    
    
    Interest expenses payable to KDDI Corporation (Note (b))
    
    
    846
    
    
    
    
    
    
    
    Disposal of a subsidiary (Note 4)
    
    
    
    
    
    
    1,950
    
    
    
    
   (a)
    
    The calling charges were payable to KDDI Corporation, a former minority shareholder of a
subsidiary of the Company, pursuant to the service agreements entered into between the Company
and KDDI Corporation in 1999. The transactions were conducted in accordance with the terms of
the service agreements and the Company believes that the terms are no less favourable than
terms available from third parties. For the year ended August 31, 2002, the above amount
represents the calling charges payable to KDDI Corporation for the period from September 1,
2001 to March 13, 2002. KDDI Corporation ceased to have any interest in the subsidiary on
March 13, 2002.(b)
    
    These represent interest payable on the interest-bearing loan from KDDI Corporation. For the
year ended August 31, 2002, the above amount represents the interest payable for the period
from September 1, 2001 to March 13, 2002.  24
    Provident fund arrangements The Company contributes to a defined contribution retirement scheme, an Occupational
Retirement Scheme (the ORSO Scheme), which is available to some of its employees. Under the ORSO
Scheme, the employees are required to contribute 5% of their monthly salaries, while the Companys
contributions are calculated at 10% and 5% of the monthly salaries of senior management staff and
all other staff, respectively. The employees are entitled to 100% of the employers contributions
after 10 years of completed service, or at a reduced scale after completion of 3 to 9 years of
service. Contributions to the ORSO Scheme are reduced by contributions forfeited by those employees
who leave the ORSO Scheme prior to vesting fully in the Companys contributions. A mandatory provident fund scheme (the MPF Scheme) has been established under the Hong Kong
Mandatory Provident Fund Scheme Ordinance in December 2000, the then existing employees of the
Company in Hong Kong could elect to join the MPF Scheme, while all new employees joining the
Company in Hong Kong from then onwards are required to join the MPF Scheme. Both the Company and
the employees are required to contribute 5% of each individuals relevant income with a maximum
amount of HK$1,000 per month as a mandatory contribution. Employers mandatory contributions are
100% vested in the employees as soon as they are paid to the MPF Scheme. Employees may also elect
to contribute more than the minimum as a voluntary contribution. The retirement schemes for staff of the Company in other countries follow the local statutory
requirements of the respective countries. F-28




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##### Table of Contents



The aggregate employers contributions, net of forfeited contributions, which have been dealt
with in the consolidated statements of income during the year are as follows: Year Ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Gross contributions
    
    
    11,965
    
    
    
    16,340
    
    
    
    26,922Less: forfeited contributions utilized to offset the Companys
contributions during the year
    
    
    (630
    )
    
    
    (497
    )
    
    
    (635
    )Net contributions charged to the consolidated statements of income
    
    
    11,335
    
    
    
    15,843
    
    
    
    26,287
 At August 31, 2004, forfeited contribution available to offset future contributions by
the Company to the schemes was HK$12,000 (2003: HK$Nil; 2002: HK$21,000).  25
    Share option scheme On July 12, 1997, a share option scheme (the 1997 Share Option Scheme) was approved by the
shareholders of the Company under which its directors may, at their discretion, invite employees of
the Company including any executive directors of the Company to take up options (the Share
Options) to subscribe for shares in the Company subject to the terms and conditions stipulated
therein. Share options granted under the 1997 Share Option Scheme will lapse no later than July 11,
2007. At an extraordinary general meeting held on December 23, 2002, a new share option scheme (the
2002 Share Option Scheme) was approved by the shareholders of the Company and the 1997 Share
Option Scheme was terminated on the same date. No further share option could be granted under the
1997 Share Option Scheme after the date of its termination, but all share options outstanding in
respect of the 1997 Share Option Scheme as of August 31, 2004 shall continue to be exercisable in
accordance with the terms of the 1997 Share Option Scheme. Under the 2002 Share Option Scheme, directors may grant options to employees (including
executive, non-executive and independent non-executive directors), suppliers and professional
advisers (the New Share Options) to subscribe for Shares in the Company. The maximum number of
options authorized under the 2002 Share Option Scheme may not, when aggregated with any shares
subject to any other executive and employee share option scheme, exceed 10% of the Companys issued
share capital on the date of adoption. The exercise price of a New Share Option will be determined
by the Companys board of directors at a price not less than the highest of (a) the par value of a
share; (b) the average closing price of the Companys shares for five trading days preceding the
grant date; and (c) the closing price of the Companys shares on the date of grant. The 2002 Share
Option Scheme is valid and effective for a ten year period up to December 22, 2012 subject to
earlier termination by the Company in general meeting or the board of directors. The period during
which a New Share Option may be exercised will be determined by the board of directors at its
discretion, save that no option may be exercised after more than ten years from the date of grant.
During the year ended August 31 2004, options were granted under the 2002 Share Option Scheme to an
eligible participant for the subscription of 6,000,000 shares of the Company at an exercise price
of HK$1.47 each. Under Hong Kong GAAP, no compensation cost to staff is required to be recognized in respect of
the grant of share options. Proceeds from issue of shares upon the exercise of share options are
credited to share capital and share premium account respectively and there is no effect on the
results of the Company in connection with any share option schemes. Details of compensation cost
for share options which is required to be recognized under U.S. GAAP are disclosed in Note
30(a)(i). F-29




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##### Table of Contents



Details of Share Options granted pursuant to the 1997 Share Option Scheme and 2002 Share
Option Scheme, and outstanding at August 31, 2002, 2003 and 2004, which will lapse not later than
July 11, 2007 and December 22, 2012, respectively, are as follows: September 3, 1998
    
    
    September 10, 1999
    
    
    October 20, 2000
    
    
    June 3, 2004Date of grant
    
    (Note a)
    
    
    (Note b)
    
    
    (Note c)
    
    
    (Note d)Exercise price per Share (HK$)
    
    
    0.26
    
    
    
    2.10
    
    
    
    0.58
    
    
    
    1.47Market price per Share (HK$) at date of
grant
    
    
    0.26
    
    
    
    2.10
    
    
    
    0.58
    
    
    
    1.43Outstanding at August 31, 2001
    
    
    3,010,000
    
    
    
    60,000
    
    
    
    22,386,000
    
    
    
    Exercised
    
    
    (2,120,000
    )
    
    
    
    
    
    
    (940,000
    )
    
    
    Cancelled
    
    
    
    
    
    
    
    
    
    
    (16,000
    )
    
    
    Lapsed upon resignation of employees
    
    
    
    
    
    
    
    
    
    
    (20,000
    )
    
    
    Outstanding at August 31, 2002
    
    
    890,000
    
    
    
    60,000
    
    
    
    21,410,000
    
    
    
    Exercised
    
    
    (100,000
    )
    
    
    
    
    
    
    (21,020,000
    )
    
    
    Outstanding at August 31, 2003
    
    
    790,000
    
    
    
    60,000
    
    
    
    390,000
    
    
    
    Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,000,000Exercised
    
    
    (600,000
    )
    
    
    
    
    
    
    (40,000
    )
    
    
    Outstanding at August 31, 2004
    
    
    190,000
    
    
    
    60,000
    
    
    
    350,000
    
    
    
    6,000,000
  (a)
    On September 3, 1998, employees including executive directors were granted options to
subscribe for 12,270,000 shares at a price of HK$0.26 per share. These share options are
immediately exercisable.(b)
    On September 10, 1999, employees were granted options to subscribe for 674,000 shares at a
price of HK$2.10 per share. These share options are immediately exercisable.(c)
    On October 20, 2000, employees including executive directors were granted options to
subscribe for 22,408,000 shares at a price of HK$0.58 per share. These share options are
immediately exercisable.(d)
    On June 3, 2004, an employee was granted options to subscribe for 6,000,000 shares at a price
of HK$1.47 per share. The vesting period for those shares is May 1, 2005 to May 1, 2006.(e)
    The Share Options outstanding in respect of the 1997 Share Option Scheme and 2002 Share
Options Scheme as of August 31, 2002, 2003 and 2004 is summarized as follows: Number of
    
    
    
    
    
    
    Weighted averageShare Options
    
    
    Average exercise
    
    
    market price at theOutstanding
    
    
    price per Share
    
    
    date of grant(Thousands)
    
    
    HK$000
    
    
    HK$000Balance at August 31, 2001
    
    
    25,456
    
    
    
    0.55
    
    
    
    0.55Exercised during the year
    
    
    (3,060
    )
    
    
    0.36
    
    
    
    0.36Cancelled during the year
    
    
    (16
    )
    
    
    0.58
    
    
    
    0.58Lapsed upon resignation of employees during the
year
    
    
    (20
    )
    
    
    0.58
    
    
    
    0.58Balance at August 31, 2002
    
    
    22,360
    
    
    
    0.57
    
    
    
    0.57Exercised during the year
    
    
    (21,120
    )
    
    
    0.58
    
    
    
    0.58Balance at August 31, 2003
    
    
    1,240
    
    
    
    0.45
    
    
    
    0.45Granted during the year
    
    
    6,000
    
    
    
    1.47
    
    
    
    1.43Exercised during the year
    
    
    (640
    )
    
    
    0.28
    
    
    
    0.28Balance at August 31, 2004
    
    
    6,600
    
    
    
    1.39
    
    
    
    1.36
 F-30




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##### Table of Contents



(f)
    The following table summarizes the information about share options outstanding at August
31, 2004: Exercise
    
    
    Number
    
    
    
    
    
    
    Exercisableprice at
    
    
    outstanding at
    
    
    
    
    
    
    shares atDate of grant
    
    August 31, 2004
    
    
    August 31, 2004
    
    
    Remaining life
    
    
    August 31, 2004(Thousands)
    
    
    (Years)
    
    
    (Thousands)September 3, 1998
    
    
    0.26
    
    
    
    190
    
    
    
    3.0
    
    
    
    190September 10, 1999
    
    
    2.10
    
    
    
    60
    
    
    
    3.0
    
    
    
    60October 20, 2000
    
    
    0.58
    
    
    
    350
    
    
    
    3.0
    
    
    
    350June 3, 2004
    
    
    1.47
    
    
    
    6,000
    
    
    
    10.0
    
    
    
    6,600
    
    
    
    
    
    
    
    600
 Except for the share options granted on June 3, 2004, all of the above share options were
granted under the 1997 Share Option Scheme and are immediately exercisable. The outstanding share
options are exercisable until the date of employment contracts between the Company and its
employees are terminated or July 11, 2007, whichever is the earlier. The Share Options granted on
June 3, 2004 were granted under the 2002 Share Option Scheme as described in Note 25 (d).  26
    Turnover, revenues and segmental information Revenue recognized during the year is as follows: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000As restated
    
    
    As restatedTurnoverInternational telecommunications services
    
    
    908,981
    
    
    
    875,802
    
    
    
    627,978Fixed telecommunications network services
    
    
    241,219
    
    
    
    423,107
    
    
    
    541,9021,150,200
    
    
    
    1,298,909
    
    
    
    1,169,880Other revenuesInterest income
    
    
    10,870
    
    
    
    3,163
    
    
    
    3,753Other income
    
    
    1,010
    
    
    
    4,373
    
    
    
    2,66811,880
    
    
    
    7,536
    
    
    
    6,421Total revenues
    
    
    1,162,080
    
    
    
    1,306,445
    
    
    
    1,176,301
 (a)  Primary reporting format  business segments The Company is organized on a worldwide basis into two business segments:  
    International telecommunications  provision of international long distance calls
services.
    Fixed telecommunications network  provision of Internet access services, local
voice-over-IP services and IP-TV services. The Companys inter-segment transactions mainly consist of provision of leased lines services.
The Company believes that the terms were similar to those available from third parties. F-31




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##### Table of Contents



Year ended August 31, 2002International
    
    
    Fixedtelecommunications
    
    
    telecommunicationsservices
    
    
    network services
    
    
    Elimination
    
    
    CompanyHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000As restatedTurnoverExternal sales
    
    
    908,981
    
    
    
    241,219
    
    
    
    
    
    
    
    1,150,200Inter-segment sales
    
    
    8,100
    
    
    
    25,786
    
    
    
    (33,886
    )
    
    
    917,081
    
    
    
    267,005
    
    
    
    (33,886
    )
    
    
    1,150,200Segment results
    
    
    222,651
    
    
    
    (121,686
    )
    
    
    
    
    
    
    100,965Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,504
    )Income before taxation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    97,461Segment assets
    
    
    581,253
    
    
    
    746,032
    
    
    
    
    
    
    
    1,327,285Segment liabilities
    
    
    205,542
    
    
    
    152,401
    
    
    
    
    
    
    
    357,943Unallocated liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    64,354Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    422,297Capital expenditure
    
    
    138,521
    
    
    
    440,545
    
    
    
    
    
    
    
    579,066Depreciation
    
    
    32,951
    
    
    
    95,339
    
    
    
    
    
    
    
    128,290Goodwill amortization charge
    
    
    
    
    
    
    1,065
    
    
    
    
    
    
    
    1,065
 Year ended August 31, 2003International
    
    
    Fixedtelecommunications
    
    
    telecommunicationsservices
    
    
    network services
    
    
    Elimination
    
    
    CompanyHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000As restatedTurnoverExternal sales
    
    
    875,802
    
    
    
    423,107
    
    
    
    
    
    
    
    1,298,909Inter-segment sales
    
    
    15,302
    
    
    
    26,449
    
    
    
    (41,751
    )
    
    
    891,104
    
    
    
    449,556
    
    
    
    (41,751
    )
    
    
    1,298,909Segment results
    
    
    341,588
    
    
    
    (62,692
    )
    
    
    
    
    
    
    278,896Loss on disposal of a subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,695
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (601
    )Income before taxation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    275,600Segment assets
    
    
    674,066
    
    
    
    874,468
    
    
    
    
    
    
    
    1,548,534Segment liabilities
    
    
    157,524
    
    
    
    150,492
    
    
    
    
    
    
    
    308,016Unallocated liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    61,343Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    369,359Capital expenditure
    
    
    20,749
    
    
    
    229,460
    
    
    
    
    
    
    
    250,209Depreciation
    
    
    36,043
    
    
    
    138,912
    
    
    
    
    
    
    
    174,955Goodwill amortization charge
    
    
    
    
    
    
    1,065
    
    
    
    
    
    
    
    1,065
 Year ended August 31, 2004International
    
    
    Fixedtelecommunications
    
    
    telecommunicationsservices
    
    
    network services
    
    
    Elimination
    
    
    CompanyHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000TurnoverExternal sales
    
    
    627,978
    
    
    
    541,902
    
    
    
    
    
    
    
    1,169,880Inter-segment sales
    
    
    5,682
    
    
    
    30,183
    
    
    
    (35,865
    )
    
    
    633,660
    
    
    
    572,085
    
    
    
    (35,865
    )
    
    
    1,169,880Segment results
    
    
    161,463
    
    
    
    (109,695
    )
    
    
    
    
    
    
    51,768Interest expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (175
    )Income before taxation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51,593Segment assets
    
    
    532,161
    
    
    
    1,151,018
    
    
    
    
    
    
    
    1,683,179Unallocated assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    229Total assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,683,408Segment liabilities
    
    
    128,304
    
    
    
    340,172
    
    
    
    
    
    
    
    468,476Unallocated liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    39,234Total liabilities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    507,710Capital expenditure
    
    
    17,164
    
    
    
    392,882
    
    
    
    
    
    
    
    410,046Depreciation
    
    
    29,023
    
    
    
    166,929
    
    
    
    
    
    
    
    195,952Goodwill amortization charge
    
    
    
    
    
    
    1,065
    
    
    
    
    
    
    
    1,065
 F-32




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##### Table of Contents



(b) Geographical segments Although the Companys two business segments are managed on a worldwide basis, they operate in
two main geographical areas:  
    Hong Kong  international telecommunications and fixed telecommunications network
services.
    Canada  international telecommunications and fixed telecommunications network
services. In presenting information on the basis of geographical segments, turnover and segment results
are based on the geographical location of customers. Total assets and capital expenditure are based
on the geographical location of the assets. There were no sales between the geographical segments. Segment
    
    
    Total
    
    
    CapitalTurnover
    
    
    results
    
    
    assets
    
    
    expenditure2002
    
    
    2002
    
    
    2002
    
    
    2002HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Hong Kong
    
    
    1,107,987
    
    
    
    98,687
    
    
    
    1,304,789
    
    
    
    578,979Canada
    
    
    33,827
    
    
    
    2,413
    
    
    
    18,099
    
    
    
    42Japan
    
    
    8,386
    
    
    
    (135
    )
    
    
    4,397
    
    
    
    451,150,200
    
    
    
    100,965
    
    
    
    1,327,285
    
    
    
    579,066
 Segment
    
    
    Total
    
    
    CapitalTurnover
    
    
    results
    
    
    assets
    
    
    expenditure2003
    
    
    2003
    
    
    2003
    
    
    2003HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Hong Kong
    
    
    1,263,160
    
    
    
    275,126
    
    
    
    1,539,212
    
    
    
    250,093Canada
    
    
    27,959
    
    
    
    3,501
    
    
    
    9,322
    
    
    
    116Japan
    
    
    7,790
    
    
    
    269
    
    
    
    
    
    
    
    1,298,909
    
    
    
    278,896
    
    
    
    1,548,534
    
    
    
    250,209Loss on disposal of a subsidiary
    
    
    
    
    
    
    (2,695
    )Operating profit
    
    
    
    
    
    
    276,201
 Segment
    
    
    Total
    
    
    CapitalTurnover
    
    
    results
    
    
    assets
    
    
    expenditure2004
    
    
    2004
    
    
    2004
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Hong Kong
    
    
    1,145,102
    
    
    
    53,375
    
    
    
    1,675,546
    
    
    
    409,866Canada
    
    
    24,778
    
    
    
    (1,607
    )
    
    
    7,633
    
    
    
    1801,169,880
    
    
    
    51,768
    
    
    
    1,683,179
    
    
    
    410,046Unallocated assets
    
    
    
    
    
    
    
    
    
    
    2291,683,408
 (c) During the year ended August 31, 2003, the Companys operation in Japan was
discontinued following the disposal of its subsidiary operating in Japan (Note 4). The contribution
to turnover and the operating results in respect of the discontinued Japanese segment are disclosed
in (b) above and are included in the international telecommunications services reporting segment. (d) Revenue of fixed telecommunications network services for the year includes interconnection
charges of HK$38,676,000 (2003: HK$6,090,000) receivable from several mobile operators for the
usage of the fixed telecommunications network of the Company. The charges were determined using the
available rates under the existing calculation model (fully distributed cost model) for
interconnection charges between fixed and mobile operators, which are based on historical cost data
of PCCW-HKT. In May 2004, the Telecommunications Authority confirmed to HKBN that mobile operators
should pay interconnection charges to fixed network operators in accordance with the existing
charging principles under the relevant Telecommunications Authority statements. In August 2004, the
Telecommunications Authority agreed to make a determination under 36A of the Telecommunications
Ordinance as to the F-33




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##### Table of Contents



effective date and the level of mobile and fixed interconnection charges payable by one of the
mobile operators to HKBN. The Company believes, based on the application of the existing
calculation model to our cost structure, we will obtain the same rates applied to PCCW-HKT and this
rate will be applicable to all other mobile operators.  27
    Financial instruments  (a)
    Fair value The Companys financial instruments primarily comprise cash and cash equivalents, short-term
loans, bank overdrafts, loan from a minority shareholder/former minority shareholder and other
investments and long term debt. The fair values of the cash and cash equivalents, short-term loans and bank overdrafts as of
August 31, 2003 and 2004 approximate their carrying values because of the short maturity of
instruments. The fair value of other investments as of August 31, 2004 based on the market prices
approximates the carrying value. The fair value of the long term debt and long term bank deposit as of August 31, 2004
approximate their carrying values. All other financial instruments included among current assets and liabilities are stated at
cost which approximates their fair values.  (b)
    Concentration of credit risk Financial instruments which potentially subject the Company to concentration of credit risk
consist principally of cash and cash equivalents, trade receivables and deposits, prepayments and
other receivables. Cash and cash equivalents  substantially all the Companys cash and bank balances are placed
with a number of international banks in Hong Kong to which the Company believes its exposure to
risk is limited. Trade receivables  these mainly represent service fee receivables from the Companys
customers in Hong Kong and Canada. Deposits, prepayments and other receivables  these are spread among numerous third parties.  28
    Off balance sheet items  (a)
    Barter transactions During the year ended August 31, 2004, HKBN entered into two agreements on the same date with
an unrelated third party (the Contract Party). Pursuant to one agreement, the Contract Party
agreed to sell to HKBN a set of un-activated telecommunications facility (the Facility) at a cash
consideration of approximately $42 million (the Facility Consideration), which HKBN has paid in
full as of August 31, 2004. In the other agreement entered into between the Contract Party and HKBN, HKBN undertakes to
provide certain telecommunication services to the Contract Party with fees computed based on unit
service charges specified in the agreement. However, the Contract Party is required to pay to HKBN
a guarantee minimum service fee of approximately HK$42 million over a period of three years,
commencing September 1, 2004. As at August 31, 2004, a prepayment of the service charges of $36.5
million (the Prepaid Charges) was paid by the Contract Party to HKBN. F-34




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##### Table of Contents



The directors of the Company made an assessment of the fair value of the items under exchange
and have drawn a conclusion that no fair value could be assigned to them. Accordingly, the
Facility was not recognized as an asset and no revenue or deferred revenue was recognized in the
financial statements of the Company as at and for the year ended August 31, 2004. The difference
between the amounts paid for the Facility Consideration and the Prepaid Charges received, amounting
to approximately HK$5.5 million, was recorded as a long-term receivable balance in the balance
sheet.  (b)
    Interest rate swap On January 19, 2004, the Company entered into an interest rate swap arrangement for a notional
amount of HK$100,000,000 with a bank. Under the arrangement, the Company will pay a fixed rate
interest of 2.675% per annum on the notional amount of HK$100,000,000 on a monthly basis commencing
from March 2004 to December 2009, and receiving a floating interest at HIBOR rate. The purpose of
this arrangement is to hedge the interest payments on the loan drawn down as described in Note 14
to a fixed rate of 4.175%. Under Hong Kong GAAP, there are no specific accounting standards governing the accounting for
derivative instruments, however, under U.S. GAAP, it requires all financial instruments and
derivatives be recognized on the balance sheet at fair value and the accounting for changes in fair
value depends on whether the derivative instrument is designated and qualifies as a hedging
relationship. For purposes of the reconciliation of the Companys financial statements to U.S.
GAAP, the interest rate swap has been accounted for at fair value on the balance sheet, the details
of which are set out in Note 30 (a)(v).  29
    New effective standards/recent accounting pronouncements  (i)
    Hong Kong GAAP In March 2004, the Hong Kong Institute of Certified Public Accountants (HKICPA) issued the
following Hong Kong Accounting Standards (HKASs) and HKAS Interpretation (HKAS-Ints) that were
converged with equivalent International Accounting Standards and Standing Interpretations Committee
Interpretations issued by the International Accounting Standards Board (IASB), most of which were
revised recently as a result of the IASBs improvements project: HKAS 1
    
    Presentation of Financial StatementsHKAS 2
    
    InventoriesHKAS 7
    
    Cash Flow StatementsHKAS 8
    
    Accounting Policies, Changes in Accounting Estimates and ErrorsHKAS 10
    
    Events after the Balance Sheet DateHKAS 11
    
    Constructions ContractsHKAS 12
    
    Income TaxesHKAS 14
    
    Segment ReportingHKAS 16
    
    Property, Plant and EquipmentHKAS 17
    
    LeasesHKAS 18
    
    RevenueHKAS 19
    
    Employee BenefitsHKAS 20
    
    Accounting for Government Grants and Disclosure of Government AssistanceHKAS 21
    
    The Effects of Changes in Foreign Exchange RatesHKAS 23
    
    Borrowing CostsHKAS 24
    
    Related Party DisclosuresHKAS 26
    
    Accounting and Reporting by Retirement Benefit PlansHKAS 27
    
    Consolidated and Separate Financial StatementsHKAS 28
    
    Investments in AssociatesHKAS 29
    
    Financial Reporting in Hyperinflationary EconomiesHKAS 30
    
    Disclosures in the Financial Statements of Banks and Similar Financial InstitutionsHKAS 31
    
    Investment in Joint venturesHKAS 32
    
    Financial Instruments: Disclosure and PresentationHKAS 33
    
    Earnings Per ShareHKAS 34
    
    Interim Financial ReportingHKAS 36
    
    Impairment of AssetsHKAS 37
    
    Provisions, Contingent Liabilities and Contingent AssetsHKAS 38
    
    Intangible AssetsHKAS 39
    
    Financial Instruments: Recognition and MeasurementHKAS 40
    
    Investment PropertyHKAS 41
    
    AgricultureHKAS-Int-12
    
    Consolidation  Special Purposes EntitiesHKAS-Int 13
    
    Jointly Controlled Entities  Non-Monetary Contributions by VenturersHKAS-Int 15
    
    Operating Leases  IncentivesHKAS-Int 21
    
    Income Taxes  Recovery of Revalued Non-Depreciable Assets
 F-35




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##### Table of Contents



The above HKASs and HKAS-Ints will become effective for accounting periods beginning on
or after January 1, 2005 and are required to be adopted by us for the year ending August 31, 2006.
As a consequence, the following Statement of Standard Accounting Practices (SSAPs) and the
related interpretations issued by the HKICPA will be superseded at that time: SSAP 1
    
    Presentation of Financial Statements (revised 2001)SSAP 2
    
    Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies (revised 2001)SSAP 5
    
    Earnings Per Share (revised 1998)SSAP 9
    
    Events after the Balance Sheet Date (revised 2001)SSAP 10
    
    Accounting for Investments in Associates (revised 2001)SSAP 11
    
    Foreign Currency Translation (revised 2001)SSAP 12
    
    Income TaxesSSAP 13
    
    Accounting for Investment Properties (revised 2000)SSAP 14
    
    Leases (revised 2000)SSAP 17
    
    Property, Plant and Equipment (revised 2001)SSAP 18
    
    Revenue (revised 2001)SSAP 19
    
    Borrowing CostsSSAP 20
    
    Related Party DisclosuresSSAP 21
    
    Accounting for Interests in Joint Ventures (revised 2001)SSAP 22
    
    Inventories (revised 2001)SSAP 23
    
    Construction Contracts (revised 2001)SSAP 24
    
    Accounting for Investments in SecuritiesSSAP 25
    
    Interim Financial Reporting (revised 2001)SSAP 26
    
    Segment Reporting (revised 2001)SSAP 28
    
    Provisions, Contingent Liabilities and Contingent AssetsSSAP 29
    
    Intangible AssetsSSAP 31
    
    Impairment of AssetsSSAP 32
    
    Consolidated Financial Statements and Accounting for Investments in SubsidiariesSSAP 34
    
    Employee Benefits (revised 2003)SSAP 35
    
    Accounting for Government Grants and Disclosure of Government AssistanceSSAP 36
    
    AgricultureInterpretation 1
    
    Costs of Modifying Existing SoftwareInterpretation 5
    
    Property, Plant and Equipment  Compensation for the Impairment or Loss of ItemsInterpretation 8
    
    Presentation of Financial Statements  Current Assets:
Classification of Restricted and Appropriated Cash BalanceInterpretation 10
    
    Earnings per Share  Financial Instruments and Other Contracts that may be Settled in SharesInterpretation 18
    
    Consolidated and Equity Method  Potential Voting Rights and Allocation of Ownership Interests
 Given the HKICPAs policy to converge Hong Kong accounting standards with the IASBs
financial reporting standards, the HKASs were issued to adopt the changes made as a result of the
IASB improvements project as well as to eliminate, to the greatest extent possible, all differences
that previously existed between Hong Kong accounting standards and the equivalent International
Accounting Standards (IASs) issued by the IASB. F-36




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During 2004, the HKICPA issued the following Hong Kong Financial Reporting Standards
(HKFRS): HKFRS 2
    
    Share-based PaymentHKFRS 3
    
    Business CombinationsHKFRS 4
    
    Insurance ContractsHKFRS 5
    
    Non-current Asset Held for Sale and Discontinued Operations
 In April 2004, the HKICPA issued HKFRS 2 Share-based Payment (HKFRS 2). HKFRS 2
prescribes the recognition principles and fair value measurement basis for all-share based payment
transactions, including (i) equity-settled share-based payment transactions; (ii) cash-settled
share-based payment transactions; and (iii) transactions with a choice of whether they are settled
in cash or by issuing equity instruments. It requires companies to reflect in their profit or loss
and financial position the effects of share-based payment transactions, including expenses
associated with transactions in which share options are granted to employees. HKFRS 2 applies to
grant of shares, share options or other equity instruments that were granted after November 7, 2002
and had not yet vested as at January 1, 2005 and it applies retrospectively to liabilities arising
from share-based payment transactions existing as at January 1, 2005. In August 2004, the HKICPA issued HKFRS 3 Business Combinations requires that all business
combinations within the scope of HKFRS 3 must be accounted for using the purchase method. Costs
expected to be incurred to restructure an acquired entitys (or the acquirers) activities must be
treated as post-combination expenses, unless the acquired entity has a pre-existing liability for
restructuring its activities. Intangible items acquired in a business combination must be
recognized as assets separately from goodwill if they meet the definition of an asset, are either
separable or arise from contractual or other legal rights, and their fair value can be measured
reliably. Identifiable assets acquired, and liabilities and contingent liabilities incurred or
assumed, must be measured initially at fair value. Amortisation of goodwill and intangible assets
with indefinite useful lives is prohibited. Instead they must be tested for impairment annually, or
more frequently if events or changes in circumstances indicate a possible impairment. Negative
goodwill should be credited to the income statements immediately. The Company is currently assessing the potential impact on the adoption of HKFRS 2 and HKFRS 3
may have on our financial statements presented in accordance with Hong Kong GAAP. The Company considers that there is no significant impact on the adoption of HKFRS 4 and HKFRS
5 on our financial statements presented in accordance with Hong Kong GAAP.  (ii)
    U.S. GAAP The United States Financial Accounting Standards Board (FASB) has issued certain
pronouncements which are effective or will be effective with respect to the fiscal years presented
in the consolidated financial statements:   (a)  In December 2003, the FASB issued FIN 46-R Consolidation of Variable Interest Entities
 an Interpretation of ARB No. 51. FIN 46-R requires that certain variable interest entities, or
VIEs, be consolidated by their primary beneficiary if the primary beneficiary is subject to a
majority of the risk of loss from the VIE activities, or entitled to receive a majority of the
VIEs residual returns, or both. An entity is subject to FIN 46-R and is considered to be a VIE
if it has (1) equity that is insufficient to permit the entity to finance its activities without
additional subordinated financial support from other parties, or (2) equity investors that
cannot make significant decisions about the entitys operations, or that do not absorb the
expected losses or receive the expected returns of the entity. FIN 46-R is effective immediately
for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired
prior to February 1, 2003, the provisions of FIN 46-R must be applied by the end of the first
reporting period ending after March 15, 2004. The adoption of FIN 46 for VIEs would not have any
significant impact on our financial statements. F-37




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(b)  In December 2003, the Securities and Exchange Commission issued SAB No. 104, Revenue
Recognition. SAB No. 104 supersedes SAB No. 101, Revenue Recognition in Financial Statements.
SAB No. 104s primary purpose is to rescind accounting guidance contained in SAB No. 101 related
to multiple element revenue arrangements, superseded as a result of the issuance of Emerging
Issues Task Force Issue No. 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables (EITF 00-21). Additionally, SAB No. 104 rescinds the Securities and Exchange
Commissions Revenue Recognition in Financial Statements Frequently Asked Questions and Answers
(the FAQ) issued with SAB No. 101 that had been codified in Securities and Exchange Commission
Topic 13, Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB No.
104. While the wording of SAB No. 104 has changed to reflect the issuance of EITF 00-21, the
revenue recognition principles of SAB No. 101 remain largely unchanged by the issuance of SAB
No. 104. As a result, the adoption of this pronouncement did not have any impact on the
Companys consolidated financial statements.  30
    Summary of differences between Hong Kong GAAP and U.S. GAAP The Companys consolidated financial statements are prepared in accordance with Hong Kong
GAAP, which differ in certain significant respects from U.S. GAAP. Differences between Hong Kong
GAAP and U.S. GAAP which have significant effects on the consolidated net income, total
shareholders equity and statements of cash flows of the Company are summarized as follows:  (a)
    Net income and total shareholders equity Year ended August 31,Note
    
    
    2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000As restated
    
    
    As restatedNet incomeAs stated under Hong Kong GAAP
    
    
    
    
    
    
    90,505
    
    
    
    257,743
    
    
    
    49,550U.S. GAAP adjustments: Compensation benefit cost associated with share options
    
    (i)
    
    
    (21,586
    )
    
    
    2,731
    
    
    
    270Amortization of goodwill (acquired prior to June 30, 2001)
    
    (ii)
    
    
    (1,019
    )
    
    
    
    
    
    
    Reversal of amortization of goodwill (acquired after June
30, 2001)
    
    (ii)
    
    
    1,065
    
    
    
    1,065
    
    
    
    1,065Fair value of interest rate swap
    
    (v)
    
    
    
    
    
    
    
    
    
    
    680Net income under U.S. GAAP
    
    
    
    
    
    
    68,965
    
    
    
    261,539
    
    
    
    51,565Profit from continuing operations (less taxation
2004: HK$2,043,000, 2003: HK$17,857,000, 2002: HK$15,186,000)
    
    
    
    
    
    
    69,317
    
    
    
    264,151
    
    
    
    51,565Profit/(loss) from discontinued operations (less
taxation 2004: Nil, 2003: Nil, 2002: HK$4,000)
    
    (iv)
    
    
    (352
    )
    
    
    83
    
    
    
    Loss arising from disposal of discontinued operations
    
    (iv)
    
    
    
    
    
    
    (2,695
    )
    
    
    Net income under U.S. GAAP
    
    
    
    
    
    
    68,965
    
    
    
    261,539
    
    
    
    51,565
 F-38




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##### Table of Contents



Year ended August 31,Note
    
    
    2002
    
    
    2003
    
    
    2004HK$
    
    
    HK$
    
    
    HK$Earnings/(loss) per share under U.S. GAAPBasic:Continuing operations
    
    
    
    
    
    14.0 cents
    
    47.8 cents
    
    8.5 centsDiscontinued operations
    
    
    
    
    
    (0.1) cents
    
    (0.5) cents
    
    
    Total
    
    (iii)
    
    13.9 cents
    
    47.3 cents
    
    8.5 centsDiluted:Continuing operations
    
    
    
    
    
    12.3 cents
    
    42.9 cents
    
    8.4 centsDiscontinued operations
    
    (iv)
    
    (0.1) cents
    
    (0.4) cents
    
    
    Total
    
    (iii)
    
    12.2 cents
    
    42.5 cents
    
    8.4 cents
 August 31,Note
    
    
    2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000As restated
    
    
    As restatedTotal shareholders equityAs stated under Hong Kong GAAP
    
    
    
    
    
    
    904,988
    
    
    
    1,179,175
    
    
    
    1,175,698U.S. GAAP adjustments:Goodwill
    
    (ii)
    
    
    5,092
    
    
    
    5,092
    
    
    
    5,092Accumulated amortization of goodwill
    
    (ii)
    
    
    (3,735
    )
    
    
    (3,735
    )
    
    
    (3,735
    )Reversal of amortization of goodwill
    
    (ii)
    
    
    1,065
    
    
    
    2,130
    
    
    
    3,195Fair value of interest rate swap
    
    (v)
    
    
    
    
    
    
    
    
    
    
    680Total shareholders equity under U.S. GAAP
    
    
    
    
    
    
    907,410
    
    
    
    1,182,662
    
    
    
    1,180,930
  (i)
    Compensation cost for share options APB No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations
have been applied in the computation of the compensation cost for outstanding share options granted
to the Companys employees. Under Hong Kong GAAP, no compensation cost to staff is required to be recognized in respect of
the grant of share options. Proceeds from issue of shares upon the exercise of share options are
credited to share capital and share premium accounts respectively and there is no effect on the
results of the Company in connection with any share option schemes. The Company issued 1,500,000 options to certain executive directors of the Company at an
exercise price fixed at HK$1.20 on September 19, 1997. The difference of HK$0.30 per Share between
the exercise price of HK$1.20 and the market value of the Shares on September 19, 1997 of HK$1.50
was being amortized to the statements of income over the vesting period of the options of three
years up to September 18, 2000. Pursuant to a board resolution passed on October 20, 2000, the
options were cancelled and on the same date, 1,500,000 options were issued to the same executive
directors at an exercise price fixed at HK$0.58 per Share. Due to this repricing arrangement, under
U.S. GAAP the 1,500,000 options have been accounted for as variable options since that date in
accordance with FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation, and various interpretations of APB25. Compensation expense is recognized based on
the difference between the exercise price of HK$0.58 and the Companys share price at the date on
which they are exercised or at each balance sheet date if they are still outstanding. Pursuant to a board resolution passed on October 20, 2000, 20,908,000 out of 21,030,000
options granted to certain employees including three executive directors on June 2, 2000 at an
exercise price of HK$1.50 were cancelled. On the same date, 20,908,000 new options were issued to
the same employees including three executive directors at an exercise price fixed at HK$0.58.
Because of this repricing arrangement, these options shall also be accounted for as variable
options and compensation expense is recognized based on the difference between the exercise price
of HK$0.58 and the Companys share price at the date on which they are exercised or at each balance
sheet date if they are still outstanding and F-39




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amortized to the profit and loss account over the vesting period of the options. All options
were fully vested as of August 31, 2004. A benefit was recorded in the years ended August 31, 2003
and 2004 in calculating the final cost amount associated with options that were exercised during
the year. During the year ended August 31, 2004, the Company issued 6,000,000 options to an employee at
an exercise price fixed at HK$1.47 on June 3, 2004. The difference of HK$0.04 per Share between the
exercise price of HK$1.47 and the market value of the Shares on June 3, 2004 of HK$1.43 was being
amortised to the statement of income over the vesting period from May 1, 2005 to May 1, 2006. Although the Company accounts for share options using the intrinsic value method in APB 25,
pro forma information regarding net income and earnings per share is required by SFAS No. 123
Accounting for Stock-Based Compensation, and has been determined as if the Company had accounted
for its employee share options under the fair value method outlined in SFAS 123. The weighted
average fair value of options granted during the years ended August 31, 2000 and 2001 were HK$3.84
and HK$0.51, respectively. No options were granted in fiscal 2002 and 2003 and therefore no
assumptions were required as new calculations were not performed in fiscal 2002 and 2003. During
the year ended August 31, 2004, 6,000,000 share options were granted and its fair value is HK$0.7.
The fair value for these options was estimated at the date of grant using the Black-Scholes Option
Valuation model with the following weighted-average assumptions for the relevant years: Year ended August 31,Weighted average
    
    2001
    
    
    2004Risk-free interest rates
    
    
    6.6%
    
    
    
    3.78%Dividend yield
    
    
    0%
    
    
    
    1.02%Volatility factor of the expected market price of the Companys shares
    
    
    102.0%
    
    
    
    59.04%Expected life of the options
    
    5.4 years
    
    5 years
 For the purpose of pro forma disclosure, the estimated fair value of the options is
amortized to expense over the options vesting period. Options will be vested during May 1, 2005 to
May 1, 2006. The Companys pro forma information for the years ended August 31, 2002, 2003 and 2004
is set out as follows: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Net incomeAs reported
    
    
    68,965
    
    
    
    261,539
    
    
    
    51,565Add: total stock-based employee compensation
expense determined under intrinsic value
method for all awards
    
    
    21,586
    
    
    
    (2,731)
    
    
    
    (270)Less: total stock-based employee compensation
expense determined under fair value method
for all awards, net of tax
    
    
    (18,219)
    
    
    
    
    
    
    
    (1,904)Pro forma
    
    
    72,332
    
    
    
    258,808
    
    
    
    49,391Basic earnings per shareAs reported
    
    HK$13.9 cents
    
    HK$47.3 cents
    
    HK$8.5 centsPro forma
    
    HK$14.6 cents
    
    HK$46.8 cents
    
    HK$8.1 centsDiluted earnings per shareAs reported
    
    HK$12.2 cents
    
    HK$42.5 cents
    
    HK$8.4 centsPro forma
    
    HK$12.8 cents
    
    HK$42.1 cents
    
    HK$8.0 cents
  (ii)
    Goodwill Prior to September 1, 2001, under Hong Kong GAAP the Company charged goodwill on acquisition
of a business, which represents the excess of the cost of investment over the fair value ascribed
to the net underlying assets acquired, against available reserves. In accordance with the change in
accounting standards of Hong Kong GAAP, goodwill on acquisitions occurring on or after September 1,
2001 is shown separately on the consolidated balance sheet and is amortized using the straight-line
method over its estimated useful life (see Note 2(b) of the notes to the consolidated financial
statements). Goodwill F-40




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##### Table of Contents



arising on major strategic acquisitions of the Company to expand its product or geographical
market coverage is amortized over a period of not more than five years. The Company has taken
advantage of the transitional provisions of Statement of Standard Accounting Practice No. 30
Business Combinations issued by the Hong Kong Society of Accountants and goodwill previously
written off against reserves has not been restated. Where an indication of impairment exists, the
carrying amount of goodwill, including goodwill previously written off against reserves, is
assessed and written down immediately to its recoverable amount with the charge being recorded in
the Companys consolidated statements of income. Under U.S. GAAP, goodwill recorded on the acquisition of a business prior to June 30, 2001 was
capitalized and amortized to the consolidated statements of income over its expected useful life of
five years. In June 2001, the FASB issued SFAS 142 Goodwill and Other Intangible Assets effective
for fiscal years beginning after December 15, 2001. In connection with the adoption of this
standard, in fiscal 2003 under U.S. GAAP, the Company ceased amortizing goodwill recognized on
business combinations initiated prior to June 30, 2001 and performed a transitional goodwill
impairment assessment. Goodwill recognized on business combinations initiated after June 30, 2001,
is not amortised under SFAS No. 142 in fiscal 2002 and is required to be tested annually for
impairment in accordance with the provisions of SFAS No. 142. The Company has performed the
transitional goodwill impairment tests on the goodwill recorded prior to and after June 30, 2001
and no impairment loss was identified. The Company has also performed the impairment tests on the
goodwill recorded prior to and after June 30, 2001 at the fiscal year end and no impairment loss
was identified from the process for year ended August 31, 2004.  (iii)
    Earnings per share Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Net income under U.S. GAAP
    
    
    68,965
    
    
    
    261,539
    
    
    
    51,565Basic weighted average common shares
issued and outstanding (in 000s)
    
    
    495,181
    
    
    
    552,600
    
    
    
    610,095Incremental shares from assumed
exercise of share options (in
000s)
    
    
    11,219
    
    
    
    7,112
    
    
    
    604Incremental shares from assumed
exercise of warrants (in 000s)
    
    
    59,489
    
    
    
    55,390
    
    
    
    3,666Diluted weighted average common and
potential shares issued and
outstanding (in 000s)
    
    
    565,889
    
    
    
    615,102
    
    
    
    614,365Earnings per share under U.S. GAAPBasic
    
    HK$13.9 cents
    
    
    HK$47.3 cents
    
    
    HK$8.5 centsDiluted
    
    HK$12.2 cents
    
    
    HK$42.5 cents
    
    
    HK$8.4 cents
 Basic earnings per share is calculated based on the weighted average number of ordinary
shares issued and outstanding. Diluted earnings per share includes the effect of diluted ordinary
common share equivalents as if outstanding for each of the relevant years and the related income
amounts. The number of incremental shares from assumed exercise of stock options and warrants have
been determined using the treasury stock method. At August 31, 2002, 2003 and 2004, 60,000 options to purchase shares of the Company, were
outstanding but have not been included in the calculation of diluted earnings per share as the
effect of exercise would have been anti-dilutive.  (iv)
    Discontinued operations The discontinued operations of the Company for years ended August 31, 2002 and 2003 included
the operating loss of approximately HK$352,000 and operating profit of approximately HK$83,000
respectively of the subsidiary operating in Japan. Under Hong Kong GAAP, presentation of continuing
and discontinued operations is not required to be disclosed on the face of the consolidated
statements of income, while under U.S. GAAP, profit or loss from discontinued operations would be
shown on a separate line in the consolidated statements of income below income from continuing
operations. F-41




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(v)
    Interest rate swap In connection with the drawdown of the long term bank loan of HK$100 million in the year ended
August 31, 2004, the Company engages in an interest rate swap agreement to hedge the impact of
fluctuations in interest rates. Under Hong Kong GAAP, there are no specific accounting standards
governing the accounting for derivative instruments. As a result, the Company does not recognise
the interest rate swap at fair value and does not account for the gains or losses relating to the
fair value changes in this derivative. Interest income or expense arising from the interest rate
swap contracts are netted off against the related interest income or expenses applicable to the
bank loan. Under U.S. GAAP, the Company adopted SFAS No. 133 Accounting for Derivative Instruments and
Hedge Activities, as amended by SFAS No. 138 Accounting for Certain Derivative Instruments and
Certain Hedging Activities which requires all financial instruments and derivatives be recognized
on the balance sheet at fair value. The accounting for changes in fair value depends on whether the
derivative instrument is designated and qualifies as a hedging relationship. For derivatives not
designed as hedging instrument, the gain or loss is recognized in earnings in the period of change.
Since the interest rate swap is not designated as a hedge, the gain or loss on this derivative
instrument is recognized currently in earnings.  (b)
    Statements of income under U.S. GAAP Under Hong Kong GAAP, depreciation charges of network assets are included in general and
administrative expenses under operating expenses. Under U.S. GAAP, however, depreciation charges of networks assets which are directly related
to the generation of revenue are included in cost of services provided. As a result, under U.S.
GAAP, the consolidated statements of income, including the U.S. GAAP adjustments as set out in note
30(a), would be reported as follows: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Revenue from provision of telecommunication and
other services, net
    
    
    1,141,814
    
    
    
    1,291,119
    
    
    
    1,169,880Cost of services provided
    
    
    (555,692
    )
    
    
    (469,238
    )
    
    
    (499,519
    )Gross profit
    
    
    586,122
    
    
    
    821,881
    
    
    
    670,361Operating expenses:Salaries and related costs
    
    
    (215,523
    )
    
    
    (215,541
    )
    
    
    (226,380
    )Sales and marketing expenses
    
    
    (168,440
    )
    
    
    (182,471
    )
    
    
    (228,169
    )General and administrative expenses
    
    
    (123,376
    )
    
    
    (130,965
    )
    
    
    (157,628
    )Provision for doubtful accounts receivable
    
    
    (10,252
    )
    
    
    (17,685
    )
    
    
    (11,502
    )Income from operations
    
    
    68,531
    
    
    
    275,219
    
    
    
    46,682Bank interest income
    
    
    10,870
    
    
    
    3,163
    
    
    
    3,753Interest expense
    
    
    (3,291
    )
    
    
    (415
    )
    
    
    (175
    )Other income, net
    
    
    159
    
    
    
    4,041
    
    
    
    3,348Income before taxation
    
    
    76,269
    
    
    
    282,008
    
    
    
    53,608Income tax charges
    
    
    (15,186
    )
    
    
    (17,857
    )
    
    
    (2,043
    )Income after taxation
    
    
    61,083
    
    
    
    264,151
    
    
    
    51,565Minority interests
    
    
    8,234
    
    
    
    
    
    
    
    Income from continuing operations
    
    
    69,317
    
    
    
    264,151
    
    
    
    51,565Net income/(loss) from discontinued operation
    
    
    (352
    )
    
    
    83
    
    
    
    Loss arising from disposal of a subsidiary
    
    
    
    
    
    
    (2,695
    )
    
    
    Net income
    
    
    68,965
    
    
    
    261,539
    
    
    
    51,565
 F-42




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##### Table of Contents



(c)
    Comprehensive income The comprehensive income of the Company, disclosed in accordance with SFAS No. 130 Reporting
Comprehensive Income, is set out as follows: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Net income under U.S. GAAP
    
    
    68,965
    
    
    
    261,539
    
    
    
    51,565Foreign currency translation adjustments
    
    
    204
    
    
    
    (200
    )
    
    
    (248
    )Comprehensive income
    
    
    69,169
    
    
    
    261,339
    
    
    
    51,317
 F-43




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##### Table of Contents



CITY TELECOM (H.K.) LIMITED AND ITS SUBSIDIARIES
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  (Continued)  (d)
    Statement of changes in shareholders equity under U.S. GAAP Ordinary sharesNumber of
    
    
    
    
    
    
    
    
    
    
    Additional
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Totalshares
    
    
    Amount
    
    
    Share
    
    
    paid in
    
    
    Warrant
    
    
    Exchange
    
    
    Retained
    
    
    shareholdersoutstanding
    
    
    outstanding
    
    
    premium
    
    
    capital
    
    
    reserve
    
    
    reserve
    
    
    profits
    
    
    equityHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Balance at August 31, 2001
    
    
    491,074,000
    
    
    
    49,107
    
    
    
    569,180
    
    
    
    9,619
    
    
    
    
    
    
    
    (242
    )
    
    
    175,447
    
    
    
    803,111Shares issued upon exercise of share options
    
    
    3,060,000
    
    
    
    306
    
    
    
    790
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,096Compensation cost for outstanding share options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,586
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    21,586Issue of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,815
    
    
    
    
    
    
    
    
    
    
    
    10,815Expenses in connection with issue of warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,058
    )
    
    
    
    
    
    
    
    
    
    
    (1,058
    )Shares issued upon exercise of warrants
    
    
    6,729,202
    
    
    
    673
    
    
    
    2,686
    
    
    
    
    
    
    
    (668
    )
    
    
    
    
    
    
    
    
    
    
    2,691Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    68,965
    
    


    68,965Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    204
    
    
    
    
    
    
    
    204Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    69,169Balance at August 31, 2002
    
    
    500,863,202
    
    
    
    50,086
    
    
    
    572,656
    
    
    
    31,205
    
    
    
    9,089
    
    
    
    (38
    )
    
    
    244,412
    
    
    
    907,410Shares issued upon exercise of share options
    
    
    21,120,000
    
    
    
    2,112
    
    
    
    10,106
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,218Compensation cost for outstanding share options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,731
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,731
    )Shares issued upon exercise of warrants
    
    
    82,976,585
    
    
    
    8,298
    
    
    
    33,124
    
    
    
    
    
    
    
    (8,231
    )
    
    
    
    
    
    
    
    
    
    
    33,191Exchange reserve realized upon disposal of a subsidiary
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,469
    
    
    
    
    
    
    
    1,4692003 Interim dividend paid (Note 21)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (30,234
    )
    
    
    (30,234
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    261,539
    
    
    
    261,539Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (200
    )
    
    
    
    
    
    
    (200
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    261,339Balance at August 31, 2003
    
    
    604,959,787
    
    
    
    60,496
    
    
    
    615,886
    
    
    
    28,474
    
    
    
    858
    
    
    
    1,231
    
    
    
    475,717
    
    
    
    1,182,662Shares issued upon exercise of share options
    
    
    640,000
    
    
    
    64
    
    
    
    115
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    179Compensation cost for outstanding share options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (270
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (270
    )Shares issued upon exercise of warrants
    
    
    4,973,574
    
    
    
    497
    
    
    
    1,985
    
    
    
    
    
    
    
    (493
    )
    
    
    
    
    
    
    
    
    
    
    1,9892003 final dividend paid (Note 21)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (45,789
    )
    
    
    (45,789
    )2004 interim dividend paid (Note 21)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,158
    )
    
    
    (9,158
    )Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51,565
    
    
    
    51,565Foreign currency translation adjustments
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (248
    )
    
    
    
    
    
    
    (248
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    51,317Balance at August 31, 2004
    
    
    610,573,361
    
    
    
    61,057
    
    
    
    617,986
    
    
    
    28,204
    
    
    
    365
    
    
    
    983
    
    
    
    472,335
    
    
    
    1,180,930
 F-44




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##### Table of Contents



(e)
    Statement of cash flows Under Hong Kong GAAP, in adopting SSAP 15 (revised), only three categories of activities are
reported: operating activities; investing activities and financing activities, which is similar to
U.S. GAAP. However, the difference is that cash flows from interest income would be included in
investing activities under Hong Kong GAAP but it would be included in operating activities under
U.S. GAAP. Further, under Hong Kong GAAP, cash and cash equivalents include bank loans and
overdrafts repayable within three months from the date of the advance, such items would not be
considered as cash and cash equivalents under U.S. GAAP and would be included in financing
activities under U.S. GAAP. Under U.S. GAAP, the following amounts would be reported: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Net cash provided from operating activities
    
    
    321,814
    
    
    
    417,663
    
    
    
    207,516Net cash used in investing activities
    
    
    (486,082
    )
    
    
    (312,797
    )
    
    
    (409,997
    )Net cash provided from/(used in) financing activities
    
    
    (20,620
    )
    
    
    (11,280
    )
    
    
    48,217(Decrease)/increase in cash and cash equivalents
    
    
    (184,888
    )
    
    
    93,586
    
    
    
    (154,264
    )Cash and cash equivalents at the beginning of year
    
    
    494,159
    
    
    
    309,583
    
    
    
    402,034Effect of foreign exchange rate changes
    
    
    312
    
    
    
    (1,135
    )
    
    
    (253
    )Cash and cash equivalents at the end of year
    
    
    309,583
    
    
    
    402,034
    
    
    
    247,517
  (f)
    Deferred taxes Until August 31, 2003, under Hong Kong GAAP, deferred taxation is accounted for at the current
taxation rate with respect to timing differences between profit as computed for taxation purposes
and profit as stated in the account to the extent that a liability or an asset is expected to be
payable or receivable in the foreseeable future. In determining whether a liability is expected to
be payable in the foreseeable future the Company assesses the effect of its capital expenditures
and other plans. If these plans indicate that sufficient accelerated depreciation allowances will
be available to offset the effect of the reversal of timing differences, a deferred tax liability
is not established for such timing differences, in accordance with the requirements of Hong Kong
GAAP. With effect from September 1, 2004, in order to comply with SSAP 12 (revised) issued by the
HKICPA, the company adopted a new accounting policy for deferred tax as follow: 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 accounts. 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 utilised. The new accounting policy has been adopted retrospectively. Under U.S. GAAP, the Company is required to recognize deferred tax assets and liabilities for
the expected future tax consequences of all events that have been included in the account or tax
returns. Under this method, deferred tax assets and liabilities are determined based on the
temporary differences between the financial reporting basis and tax basis of assets and liabilities
using enacted tax rates in effect for the year in which the differences are expected to reverse.
Future tax benefits in respect of tax losses carry forward are also required to be recognized in
full. A valuation allowance is required to be established for such assets if it is more likely than
not that the Company will not be able to utilize such benefits in the future. As a result of the adoption of SSAP 12 (revised), there are no longer any differences arising
from the recognition of deferred tax under Hong Kong GAAP and U.S. GAAP. F-45




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##### Table of Contents



As of August 31, 2004, the Company had accumulated tax losses amounting to HK$735,059,000
(2003: HK$598,583,000) may be carried forward and applied to reduce future taxable income which is
carried in or derived from Hong Kong, Canada and the United States. The tax effect on the
accumulated tax losses amounted to HK$129,222,000 (2003: HK$105,822,000). The tax losses of the Hong Kong subsidiaries can be carried forward indefinitely while the tax
losses of subsidiaries in the Mainland China and overseas expire within periods ranging from 2 to
20 years. Realisation of deferred tax assets associated with tax loss carry forwards is dependent
upon generating sufficient taxable income. At August 31, 2004, a valuation allowance of
HK$7,633,000 (2003: HK$15,171,000) had been provided for against the remaining deferred tax assets
related to the tax losses carried forward since management believes it is more likely than not that
insufficient taxable income will be generated in the foreseeable future to utilise the tax loss
carry forwards. Changes in the valuation allowance consist of: Year ended August 31,2002
    
    
    2003
    
    
    2004HK$000
    
    
    HK$000
    
    
    HK$000Balance at beginning of the year
    
    
    49,049
    
    
    
    62,739
    
    
    
    15,171(Reduction)/additions to income tax expenses
    
    
    13,690
    
    
    
    (47,568
    )
    
    
    (7,538
    )Balance at end of the year
    
    
    62,739
    
    
    
    15,171
    
    
    
    7,633
  (g)
    Other investments Under Hong Kong GAAP, other investments of the Company are carried at fair value. At each
balance sheet date, the net unrealised gains or losses arising from the changes in fair value of
other investments are recognized in the consolidated statements of income. Under U.S. GAAP, the Company adopted SFAS No. 133 Accounting for Derivative Instruments and
Hedging Activities, as amended by SFAS No. 138 Accounting for Certain Derivative Instruments and
Certain Hedging Activities for other investments during the year. SFAS No. 133, as amended,
establishes accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities. It requires that
all derivatives be recorded on the balance sheet at fair value. Additionally, it requires that an
embedded derivative instrument to be separated from the host contract and accounted for as a
derivative instrument if all the following criteria are met: the economic characteristics of the
embedded derivative are not clearly and closely related to the economic characteristics of the host
contract; the hybrid instrument is not re-measured at fair value with changes in fair value
reported in earnings and a separate derivative with the same terms as the embedded derivative would
meet the definition of a derivative instrument under SFAS No. 133. If an embedded derivative
instrument is separated from its host contract, the host contract shall be accounted for based on
U.S. GAAP applicable of that type that do not contain embedded derivative instruments. However, if
an embedded derivative instrument cannot be reliably identified and measured separately from the
host contract, the entire contract shall be measured at fair value with gain or loss recognized in
the statements of income, but it may not be designated as hedging instrument. As the embedded derivative of the other investments held by the Company as of August 31, 2004
cannot be reliably identified and measured separately from the host contract, the entire contract
has been measured at fair value under U.S. GAAP. There is no reconciling difference between Hong
Kong GAAP and U.S. GAAP in this respect. Unrealised loss has been recognized in the statements of
income for the year ended August 31, 2004.  31
    Post balance sheet event (a) In August 2004, HKBN launched its off-network local voice-over-IP phone services
(Broadband Phone Services) for customers in Hong Kong. In early October 2004, PCCW-HKT Telephone
Limited F-46




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##### Table of Contents



and PCCW-IMS Limited (collectively, Applicants) applied for leave to apply for judicial
review against the decision of the Telecommunications Authority by a letter dated September 22,
2004 stating that there is no evidence to suggest that HKBNs Broadband Phone Services is outside
the scope of its Fixed Telecommunications Network Services Licence. HKBN was added by the
Applicants as an interested party in these judicial review proceedings. No revenue or cost had been recorded in the consolidated profit and loss accounts for the year
ended August 31, 2004 in relation to the Broadband Phone Services. The cumulative capital
expenditure incurred by the Company for the Broadband Phone Services as at August 31, 2004 was
approximately HK$4.3 million. The board of directors of the Company presently have not formed any
views as to any material adverse effect to the Company that may arise from this event. (b) Subsequent to August 31, 2004, the Company drew down additional bank loan in an amount of
HK$100 million. On January 3, 2005, approximately HK$3.3 million was repaid. On January 20, 2005,
the Company completed a US$125 million notes offering of 8.75% Senior Notes due 2015 (the Notes).
This offering was an underwritten transaction and the net proceeds were approximately
US$121.0 million after deduction of expenses and commissions. The Company used the net proceeds, in
part, to repay in full the then outstanding loan facility in the amount of HK$196.7 million. The
Notes contain covenants restricting the ability of the Company to, among other things:  
    pay dividends, make distributions, redeem capital stock and make certain other
restricted payments or investments;
    incur additional indebtedness or issue certain equity interests;
    merge, consolidate or sell all or substantially all of our assets;
    issue or sell capital stock of some of our subsidiaries;
    sell or exchange assets or enter into new businesses;
    create any restrictions on the payment of dividends, the making of distributions, the
making of loans and the transfer of assets;
    create liens on assets;
    enter into sale and lease back transactions; and
    enter into certain transactions with affiliates or related persons. All of these limitations are subject to exceptions and qualifications specified in the
indenture governing the Notes.  32
    Supplemental Guarantors Consolidated Financial Information The Notes mentioned above in Note 31(b) are irrevocably and unconditionally guaranteed,
jointly and severally, on a senior unsecured basis by all of the subsidiaries of City Telecom (HK)
Limited (collectively defined as Guarantor Subsidiaries), except CTI Guangzhou Customer Services
Co. Ltd. in the PRC (Non-guarantor Subsidiary). The condensed consolidated financial information is presented below and should be read in
connection with the consolidated financial statements of City Telecom (HK) Limited prepared under
HK GAAP. Separate financial statements of the Guarantor Subsidiaries are not presented because the
Guarantor Subsidiaries are wholly-owned and will fully and unconditionally guarantee to the Notes
on a joint and several basis. Reconciliations to U.S. GAAP are not presented because the majority
of the reconciling items relate to City Telecom (HK) Limited and Guarantor Subsidiaries and such
reconciling items are already disclosed and explained in Note 30. The following condensed consolidated financial information presents the condensed consolidated F-47




---



##### Table of Contents



balance sheets as of August 31, 2004 and 2003 and the related condensed consolidated
statements of income and statements of cash flows for the years ended August 31, 2004, 2003 and
2002 of (a) City Telecom (HK) Limited, the parent; (b) the Guarantor Subsidiaries on a combined
basis; (c) the Non-guarantor Subsidiary; (d) eliminating entries; and (e) the total consolidated
amounts. Condensed Consolidated Balance Sheet as of August 31, 2004 City Telecom
    
    
    Guarantor
    
    
    Non-Guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiary
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Current assetsCash and bank balances
    
    
    199,643
    
    
    
    41,691
    
    
    
    6,183
    
    
    
    
    
    
    
    247,517Pledged bank deposits
    
    
    20,565
    
    
    
    6,240
    
    
    
    
    
    
    
    
    
    
    
    26,805Trade receivables, net
    
    
    24,275
    
    
    
    110,574
    
    
    
    
    
    
    
    
    
    
    
    134,849Other receivables, deposits and
prepayments
    
    
    13,060
    
    
    
    59,865
    
    
    
    1,967
    
    
    
    (30,863
    )
    
    
    44,029Total current assets
    
    
    257,543
    
    
    
    218,370
    
    
    
    8,150
    
    
    
    
    
    
    
    453,200Fixed assets, net
    
    
    157,407
    
    
    
    983,872
    
    
    
    17,596
    
    
    
    
    
    
    
    1,158,875Investments
in subsidiaries(1)
    
    
    909,126
    
    
    
    269,029
    
    
    
    
    
    
    
    (1,178,155
    )
    
    
    Long-term bank deposits
    
    
    15,600
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,600Other long-term assets
    
    
    22,310
    
    
    
    31,292
    
    
    
    
    
    
    
    2,131
    
    
    
    55,733Total assets
    
    
    1,361,986
    
    
    
    1,502,563
    
    
    
    25,746
    
    
    
    
    
    
    
    1,683,408Current liabilitiesAmounts due to subsidiaries/fellow
subsidiaries
    
    
    10,000
    
    
    
    683,771
    
    
    
    9,591
    
    
    
    (703,362
    )
    
    
    Trade payables
    
    
    72,577
    
    
    
    49,882
    
    
    
    
    
    
    
    
    
    
    
    122,459Deposits received
    
    
    11,093
    
    
    
    6,890
    
    
    
    
    
    
    
    
    
    
    
    17,983Current portion of deferred service
income
    
    
    29,222
    
    
    
    35,076
    
    
    
    
    
    
    
    (29,010
    )
    
    
    35,288Other payables and accrued
charges
    
    
    24,113
    
    
    
    157,173
    
    
    
    8,890
    
    
    
    (1,571
    )
    
    
    188,605Income tax payable/(recoverable)
    
    
    1,271
    
    
    
    (98
    )
    
    
    
    
    
    
    
    
    
    
    1,173Short-term bank loan  secured
    
    
    19,170
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19,170Current portion of long-term bank
loan  secured
    
    
    
    
    
    
    13,333
    
    
    
    
    
    
    
    
    
    
    
    13,333Total current liabilities
    
    
    167,446
    
    
    
    946,027
    
    
    
    18,481
    
    
    
    
    
    
    
    398,011Long-term liabilitiesLong-term bank loan  secured
    
    
    
    
    
    
    86,667
    
    
    
    
    
    
    
    
    
    
    
    86,667Other long-term liabilities
    
    
    18,842
    
    
    
    4,141
    
    
    
    49
    
    
    
    
    
    
    
    23,032Total liabilities
    
    
    186,288
    
    
    
    1,036,835
    
    
    
    18,530
    
    
    
    
    
    
    
    507,710Commitments and contingenciesShareholders equityOrdinary shares, par value $0.1 per
share 2,000,000,000 shares
authorized at August 31, 2004 610,573,361 shares issued and
outstanding at August 31,
2004
    
    
    61,057
    
    
    
    15,486
    
    
    
    8,131
    
    
    
    (23,617
    )
    
    
    61,057Share premium
    
    
    617,986
    
    
    
    470,836
    
    
    
    
    
    
    
    (470,836
    )
    
    
    617,986Retained profits/(accumulated
losses)
    
    
    495,307
    
    
    
    (20,637
    )
    
    
    (852
    )
    
    
    21,489
    
    
    
    495,307Other reserves
    
    
    1,348
    
    
    
    43
    
    
    
    (63
    )
    
    
    20
    
    
    
    1,348Total shareholders equity
    
    
    1,175,698
    
    
    
    465,728
    
    
    
    7,216
    
    
    
    
    
    
    
    1,175,698Total liabilities and shareholders
equity
    
    
    1,361,986
    
    
    
    1,502,563
    
    
    
    25,746
    
    
    
    
    
    
    
    1,683,408
  (1)
    
    The investment in subsidiaries amounts at City Telecom (HK) Limited level have included the
share of net assets of its subsidiaries using the equity method of accounting. F-48




---



##### Table of Contents



Condensed Consolidated Balance Sheet as of August 31, 2003 City Telecom
    
    
    Guarantor
    
    
    Non-Guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiary
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Current assetsCash and bank balances
    
    
    370,686
    
    
    
    29,317
    
    
    
    2,031
    
    
    
    
    
    
    
    402,034Pledged bank deposits
    
    
    1,812
    
    
    
    27,796
    
    
    
    
    
    
    
    
    
    
    
    29,608Trade receivables, net
    
    
    32,011
    
    
    
    62,069
    
    
    
    
    
    
    
    
    
    
    
    94,080Other receivables, deposits and
prepayments
    
    
    17,720
    
    
    
    42,639
    
    
    
    2,833
    
    
    
    (28,478
    )
    
    
    34,714Total current assets
    
    
    422,229
    
    
    
    161,821
    
    
    
    4,864
    
    
    
    
    
    
    
    560,436Fixed assets, net
    
    
    176,441
    
    
    
    756,051
    
    
    
    13,460
    
    
    
    
    
    
    
    945,952Investments
in subsidiaries(1)
    
    
    771,627
    
    
    
    430,153
    
    
    
    
    
    
    
    (1,201,780
    )
    
    
    Long-term bank deposits
    
    
    15,580
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15,580Other long-term assets
    
    
    23,370
    
    
    
    
    
    
    
    
    
    
    
    3,196
    
    
    
    26,566Total assets
    
    
    1,409,247
    
    
    
    1,348,025
    
    
    
    18,324
    
    
    
    
    
    
    
    1,548,534Current liabilitiesAmounts due to subsidiaries/fellow
subsidiaries
    
    
    11,794
    
    
    
    767,591
    
    
    
    (3,775
    )
    
    
    (775,610
    )
    
    
    Trade payables
    
    
    77,484
    
    
    
    35,900
    
    
    
    
    
    
    
    
    
    
    
    113,384Deposits received
    
    
    12,502
    
    
    
    7,406
    
    
    
    
    
    
    
    
    
    
    
    19,908Current portion of deferred service
income
    
    
    16,111
    
    
    
    9,809
    
    
    
    
    
    
    
    (15,748
    )
    
    
    10,172Other payables and accrued charges
    
    
    51,294
    
    
    
    107,951
    
    
    
    18,037
    
    
    
    (12,730
    )
    
    
    164,552Income tax payable
    
    
    22,523
    
    
    
    125
    
    
    
    247
    
    
    
    
    
    
    
    22,895Short-term bank loan  secured
    
    
    18,174
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,174Total current liabilities
    
    
    209,882
    
    
    
    928,782
    
    
    
    14,509
    
    
    
    
    
    
    
    349,085Long-term liabilities
    
    
    20,190
    
    
    
    (383
    )
    
    
    467
    
    
    
    
    
    
    
    20,274Total liabilities
    
    
    230,072
    
    
    
    928,399
    
    
    
    14,976
    
    
    
    
    
    
    
    369,359Commitments and contingenciesShareholders equityOrdinary shares, par value $0.1 per
share 2,000,000,000 shares
authorized at August 31,
2003 604,959,787 shares issued and
outstanding at August 31,
2003
    
    
    60,496
    
    
    
    15,485
    
    
    
    8,131
    
    
    
    (23,616
    )
    
    
    60,496Share premium
    
    
    615,886
    
    
    
    470,836
    
    
    
    
    
    
    
    (470,836
    )
    
    
    615,886Retained profits/(accumulated
losses)
    
    
    500,704
    
    
    
    (66,693
    )
    
    
    (4,805
    )
    
    
    71,498
    
    
    
    500,704Other reserves
    
    
    2,089
    
    
    
    (2
    )
    
    
    22
    
    
    
    (20
    )
    
    
    2,089Total shareholders equity
    
    
    1,179,175
    
    
    
    419,626
    
    
    
    3,348
    
    
    
    
    
    
    
    1,179,175Total liabilities and shareholders
equity
    
    
    1,409,247
    
    
    
    1,348,025
    
    
    
    18,324
    
    
    
    
    
    
    
    1,548,534
  (1)
    
    The investment in subsidiaries amounts at City Telecom (HK) Limited level have included the
share of net assets of its subsidiaries using the equity method of accounting. F-49




---



##### Table of Contents



Condensed Consolidated Statements of Income for the year ended August 31, 2004 City Telecom
    
    
    Guarantor
    
    
    Non-Guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiary
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Revenue from provision of
telecommunication and other
services, net
    
    
    260,675
    
    
    
    1,081,591
    
    
    
    113,953
    
    
    
    (286,339
    )
    
    
    1,169,880Cost of services provided
    
    
    (90,520
    )
    
    
    (282,282
    )
    
    
    
    
    
    
    41,394
    
    
    
    (331,408
    )Gross profit
    
    
    170,155
    
    
    
    799,309
    
    
    
    113,953
    
    
    
    
    
    
    
    838,472Operating expensesSalaries and related costs
    
    
    (49,367
    )
    
    
    (191,751
    )
    
    
    (86,544
    )
    
    
    101,012
    
    
    
    (226,650
    )Sales and marketing expenses
    
    
    (53,251
    )
    
    
    (351,518
    )
    
    
    
    
    
    
    176,600
    
    
    
    (228,169
    )General and administrative
expenses
    
    
    (71,124
    )
    
    
    (240,874
    )
    
    
    (23,342
    )
    
    
    8,536
    
    
    
    (326,804
    )Provision for doubtful accounts
receivable
    
    
    (1,683
    )
    
    
    (9,819
    )
    
    
    
    
    
    
    
    
    
    
    (11,502
    )(Loss)/income from operations
    
    
    (5,270
    )
    
    
    5,347
    
    
    
    4,067
    
    
    
    
    
    
    
    45,347Bank interest income
    
    
    3,580
    
    
    
    135
    
    
    
    38
    
    
    
    
    
    
    
    3,753Interest expenses
    
    
    (175
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (175
    )Other income, net
    
    
    3,516
    
    
    
    41,038
    
    
    
    17
    
    
    
    (41,903
    )
    
    
    2,668Share of income from
subsidiaries(2)
    
    
    49,309
    
    
    
    
    
    
    
    
    
    
    
    (49,309
    )
    
    
    Income before taxation
    
    
    50,960
    
    
    
    46,520
    
    
    
    4,122
    
    
    
    
    
    
    
    51,593Income tax charges
    
    
    (1,410
    )
    
    
    (464
    )
    
    
    (169
    )
    
    
    
    
    
    
    (2,043
    )Net income
    
    
    49,550
    
    
    
    46,056
    
    
    
    3,953
    
    
    
    
    
    
    
    49,550
  (2)
    
    The net income amounts at City Telecom (HK) Limited level have included the share of net
income/(losses) of its subsidiaries using the equity method of accounting. Condensed Consolidated Statements of Income for the year ended August 31, 2003 City Telecom
    
    
    Guarantor
    
    
    Non-Guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiary
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Revenue from provision of
telecommunication and other
services, net
    
    
    351,866
    
    
    
    1,090,195
    
    
    
    37,921
    
    
    
    (181,073
    )
    
    
    1,298,909Cost of services provided
    
    
    (69,307
    )
    
    
    (295,553
    )
    
    
    
    
    
    
    42,107
    
    
    
    (322,753
    )Gross profit
    
    
    282,559
    
    
    
    794,642
    
    
    
    37,921
    
    
    
    
    
    
    
    976,156Operating expensesSalaries and related costs
    
    
    (78,009
    )
    
    
    (148,726
    )
    
    
    (29,104
    )
    
    
    35,489
    
    
    
    (220,350
    )Sales and marketing expenses
    
    
    (46,939
    )
    
    
    (263,878
    )
    
    
    
    
    
    
    128,346
    
    
    
    (182,471
    )General and administrative
expenses
    
    
    (102,259
    )
    
    
    (202,566
    )
    
    
    (11,159
    )
    
    
    31,694
    
    
    
    (284,290
    )Provision for doubtful accounts
receivable
    
    
    (5,139
    )
    
    
    (12,546
    )
    
    
    
    
    
    
    
    
    
    
    (17,685
    )Income/(loss) from operations
    
    
    50,213
    
    
    
    166,926
    
    
    
    (2,342
    )
    
    
    
    
    
    
    271,360Bank interest income
    
    
    2,480
    
    
    
    670
    
    
    
    13
    
    
    
    
    
    
    
    3,163Interest expenses
    
    
    (414
    )
    
    
    (324
    )
    
    
    
    
    
    
    137
    
    
    
    (601
    )Loss on disposal of a subsidiary
    
    
    
    
    
    
    (2,695
    )
    
    
    
    
    
    
    
    
    
    
    (2,695
    )Other income, net
    
    
    2,657
    
    
    
    58,976
    
    
    
    (92
    )
    
    
    (57,168
    )
    
    
    4,373Share of income from
subsidiaries(2)
    
    
    218,602
    
    
    
    
    
    
    
    
    
    
    
    (218,602
    )
    
    
    Income before taxation
    
    
    273,538
    
    
    
    223,553
    
    
    
    (2,421
    )
    
    
    
    
    
    
    275,600Income tax charges
    
    
    (15,795
    )
    
    
    397
    
    
    
    (2,459
    )
    
    
    
    
    
    
    (17,857
    )Net income/(loss)
    
    
    257,743
    
    
    
    223,950
    
    
    
    (4,880
    )
    
    
    
    
    
    
    257,743
  (2)
    
    The net income amounts at City Telecom (HK) Limited level have included the share of net
income/(losses) of its subsidiaries using the equity method of accounting. F-50




---



##### Table of Contents



Condensed Consolidated Statements of Income for the year ended August 31, 2002 City Telecom
    
    
    Guarantor
    
    
    Non-Guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiary
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Revenue from provision of
telecommunication and other
services, net
    
    
    744,914
    
    
    
    488,223
    
    
    
    2,010
    
    
    
    (84,947
    )
    
    
    1,150,200Cost of services provided
    
    
    (349,253
    )
    
    
    (142,236
    )
    
    
    
    
    
    
    33,526
    
    
    
    (457,963
    )Gross profit
    
    
    395,661
    
    
    
    345,987
    
    
    
    2,010
    
    
    
    
    
    
    
    692,237Operating expensesSalaries and related costs
    
    
    (100,919
    )
    
    
    (96,477
    )
    
    
    (772
    )
    
    
    2,010
    
    
    
    (196,158
    )Sales and marketing expenses
    
    
    (79,478
    )
    
    
    (160,705
    )
    
    
    
    
    
    
    71,742
    
    
    
    (168,441
    )General and administrative
expenses
    
    
    (83,148
    )
    
    
    (154,083
    )
    
    
    (1,162
    )
    
    
    10,625
    
    
    
    (227,768
    )Provision for doubtful accounts
receivable
    
    
    (7,577
    )
    
    
    (2,700
    )
    
    
    
    
    
    
    
    
    
    
    (10,277
    )Income/(loss) from operations
    
    
    124,539
    
    
    
    (67,978
    )
    
    
    76
    
    
    
    
    
    
    
    89,593Bank interest income
    
    
    6,884
    
    
    
    3,986
    
    
    
    
    
    
    
    
    
    
    
    10,870Interest expenses
    
    
    (4,652
    )
    
    
    (1,205
    )
    
    
    
    
    
    
    2,353
    
    
    
    (3,504
    )Other income, net
    
    
    41,878
    
    
    
    37,953
    
    
    
    
    
    
    
    (79,329
    )
    
    
    502Share of losses from
subsidiaries(2)
    
    
    (63,214
    )
    
    
    
    
    
    
    
    
    
    
    63,214
    
    
    
    Income before taxation
    
    
    105,435
    
    
    
    (27,244
    )
    
    
    76
    
    
    
    
    
    
    
    97,461Income tax charges
    
    
    (14,930
    )
    
    
    (260
    )
    
    
    
    
    
    
    
    
    
    
    (15,190
    )Income after taxation
    
    
    90,505
    
    
    
    (27,504
    )
    
    
    76
    
    
    
    
    
    
    
    82,271Minority interests
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,234
    
    
    
    8,234Net income/(loss)
    
    
    90,505
    
    
    
    (27,504
    )
    
    
    76
    
    
    
    
    
    
    
    90,505
  (2)
    
    The net income amounts at City Telecom (HK) Limited level have included the share of net
income/(losses) of its subsidiaries using the equity method of accounting. Condensed Consolidated Statement of Cash Flow for the Year Ended August 31, 2004 City Telecom
    
    
    Guarantor
    
    
    Non-Guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiary
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Net cash (used in)/provided by
operating activities
    
    
    (47,586
    )
    
    
    237,247
    
    
    
    13,476
    
    
    
    626
    
    
    
    203,763Net cash used in investing
activities
    
    
    (71,625
    )
    
    
    (374,577
    )
    
    
    (9,622
    )
    
    
    49,580
    
    
    
    (406,244
    )Net cash (used in)/provided by
financing activities
    
    
    (52,779
    )
    
    
    150,000
    
    
    
    
    
    
    
    (50,000
    )
    
    
    47,221Net (decrease)/increase in cash
and cash equivalents
    
    
    (171,990
    )
    
    
    12,670
    
    
    
    3,854
    
    
    
    
    
    
    
    (155,260
    )Cash and cash equivalents at
beginning of year
    
    
    352,512
    
    
    
    29,317
    
    
    
    2,031
    
    
    
    
    
    
    
    383,860Effects of foreign exchange rates
changes
    
    
    (49
    )
    
    
    (296
    )
    
    
    298
    
    
    
    (206
    )
    
    
    (253
    )Cash and cash equivalents at end
of year
    
    
    180,473
    
    
    
    41,691
    
    
    
    6,183
    
    
    
    
    
    
    
    228,347
 Condensed Consolidated Statement of Cash Flow for the Year Ended August 31, 2003 City Telecom
    
    
    Guarantor
    
    
    Non-guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiary
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Net cash provided by operating
activities
    
    
    119,634
    
    
    
    290,376
    
    
    
    4,940
    
    
    
    (450
    )
    
    
    414,500Net cash used in investing
activities
    
    
    (5,877
    )
    
    
    (250,118
    )
    
    
    (10,718
    )
    
    
    (42,921
    )
    
    
    (309,634
    )Net cash (used in)/provided by
financing activities
    
    
    (10,274
    )
    
    
    (50,564
    )
    
    
    7,082
    
    
    
    43,482
    
    
    
    (10,274
    )Net (decrease)/increase in cash and
cash equivalents
    
    
    103,483
    
    
    
    (10,306
    )
    
    
    1,304
    
    
    
    
    
    
    
    94,592Cash and cash equivalents at
beginning of year
    
    
    249,029
    
    
    
    40,363
    
    
    
    1,011
    
    
    
    
    
    
    
    290,403Effects of foreign exchange rates
changes
    
    
    
    
    
    
    (740
    )
    
    
    (284
    )
    
    
    (111
    )
    
    
    (1,135
    )Cash and cash equivalents at end of
year
    
    
    352,512
    
    
    
    29,317
    
    
    
    2,031
    
    
    
    
    
    
    
    383,860
 F-51




---



##### Table of Contents



Condensed Consolidated Statement of Cash Flow for the Year Ended August 31, 2002 City Telecom
    
    
    Guarantor
    
    
    Non-guarantor
    
    
    Eliminating
    
    
    Consolidated(HK) Limited
    
    
    Subsidiaries
    
    
    Subsidiaries
    
    
    Entries
    
    
    TotalHK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000
    
    
    HK$000Net cash (used in)/provided by
operating activities
    
    
    (6,299
    )
    
    
    289,802
    
    
    
    5,030
    
    
    
    (89
    )
    
    
    288,444Net cash used in investing
activities
    
    
    (119,999
    )
    
    
    (558,562
    )
    
    
    (5,071
    )
    
    
    208,420
    
    
    
    (475,212
    )Net cash provided by financing
activities
    
    
    9,109
    
    
    
    207,371
    
    
    
    1,049
    
    
    
    (208,420
    )
    
    
    9,109Net (decrease)/increase in cash
and cash equivalents
    
    
    (117,189
    )
    
    
    (61,389
    )
    
    
    1,008
    
    
    
    
    
    
    
    (177,659
    )Cash and cash equivalents at
beginning of year
    
    
    366,218
    
    
    
    101,532
    
    
    
    
    
    
    
    
    
    
    
    467,750Effects of foreign exchange rates
changes
    
    
    
    
    
    
    220
    
    
    
    3
    
    
    
    89
    
    
    
    312Cash and cash equivalents at end
of year
    
    
    249,029
    
    
    
    40,363
    
    
    
    1,011
    
    
    
    
    
    
    
    290,403
 F-52